UNITED STATES TAX COURT
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T.C. Memo. 2003-347
UNITED STATES TAX COURT
MICHAEL J. DOWNING AND SANDRA M. DOWNING, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 12108-98.
Filed December 29, 2003.
Ps resided in Louisiana, a community property State.
Shortly before their wedding, in 1989, they “filed for
registry” (La. Civ. Code Ann. art. 2332 (West 1985)) in St.
Tammany Parish (where both of them then resided) a marriage
contract which provided that “The intended husband and wife
shall be separate in property * * *.” Before the years in
issue (1994 and 1995), Ps moved to Jefferson Parish. P-H
operated a plumbing business during the years in issue. Ps
filed separate tax returns for the years in issue, on which
they reported only their respective incomes, without regard
to Louisiana’s usual community property laws. R determined
that (1) substantial amounts of income from P-H’s plumbing
business had not been reported on Ps’ separate income tax
returns, (2) the marriage contract did not have the effect
of stopping application of Louisiana’s usual community
property laws for Federal income tax purposes, (3) both Ps
are liable for the fraud addition to tax for both years in
issue, and (4) there were other miscellaneous adjustments.
- 2 1. Held: Ps’ marriage contract did have the effect of
stopping application of Louisiana’s usual community property
laws for Federal income tax purposes. R has conceded that
such a holding would result in P-W’s not being liable for
deficiencies and additions to tax for the years in issue; R
has asserted against P-H increased deficiencies and
additions that are intended to apply if all the omitted
income were properly reportable by P-H.
2. Held, further, R proved by clear and convincing
evidence that P-H had unreported plumbing business income
for 1994 and for 1995, that each year’s unreported plumbing
business income resulted in an underpayment of tax for that
year, and that at least some part of each year’s
underpayment of tax was due to P-H’s fraud. Amounts
determined. Sec. 6663, I.R.C. 1986.
3. Held, further, no portion of the underpayment of
tax for either year was not due to fraud, except to the
extent the underpayment resulted from causes other than
unreported plumbing business income. Amounts determined.
Sec. 6663(b), I.R.C. 1986.
John S. Ponseti, for petitioners.
Susan S. Canavello, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
CHABOT, Judge: By separate notices of deficiency, respondent
determined deficiencies in individual income tax and penalties
under section 66631 (fraud) against petitioners as follows:
1
Unless indicated otherwise, all section and chapter
references are to sections and chapters of the Internal Revenue
Code of 1986 as in effect for the years in issue.
- 3 -
1
Penalties
Sec. 6663
Year
Deficiency
Michael J. Downing
1994
1995
$7,396
29,557
$5,444
22,088
Sandra M. Downing
1994
1995
$2,545
20,432
$2,012
15,404
1
Of these totals for Michael J. Downing (hereinafter sometimes
referred to as Michael), for 1994, $2,773 is income tax under ch.
1 and $4,623 is self-employment tax under ch. 2; for 1995,
$19,065 is income tax under ch. 1 and $10,492 is self-employment
tax under ch. 2. For Sandra M. Downing (hereinafter sometimes
referred to as Sandra), all the amounts are income tax under ch.
1.
Both sides apparently view the facts in the instant case as
leading to Michael’s being solely liable for self-employment tax
on any additional net earnings from self-employment, regardless
of the disposition of the community property issue. That is,
neither side views Sandra’s involvement in the business as
resulting in a partnership. See sec. 1402(a)(5)(A). Petitioners
did not file joint returns for either of the years in issue
(infra note 4), and so Sandra does not have joint and several
liability for Michael’s self-employment tax. See sec. 1.60171(b), Income Tax Regs.; see also Johnson v. Commissioner, 74 T.C.
1057, 1062 (1980), affd. 661 F.2d 53 (5th Cir. 1981).
In each notice of deficiency, respondent determined in the
alternative to the fraud penalty that “the addition prescribed by
Section 6662(a)” applies (in an unspecified amount) for each
year.
In the answer, respondent narrows this determination to
the negligence penalty, section 6662(b)(1), but the amount
remains unspecified.
At trial and on brief respondent conceded that if
petitioners’ marriage contract was effective to take petitioners
out of Louisiana’s usual community property matrimonial regime,
- 4 then decision should be entered for Sandra that she has no
deficiency and no addition to tax for any year in issue.
By
amendment to answer, respondent asserts in the alternative to the
deficiencies and additions to tax determined in the notices of
deficiency that, if the Court determines that petitioners’
marriage contract has this effect and Sandra does not have any
liability, then Michael is liable for deficiencies and penalties
as follows:
Year
Deficiency
Penalties
Sec. 6663
1994
1995
$8,966
30,872
$6,725
23,154
See sec. 6214(a).
Respondent also asserts, in the alternative to
section 6663, additions to tax under section 6662(a).
6214(a).
See sec.
- 5 After concessions by both sides,2 the issues for decision3
2
Respondent concedes that petitioners are entitled to
deduct as 1995 Schedule A, Itemized Deductions, the $58 paid by
Michael for Louisiana income tax and the $10,133 of mortgage
interest paid. Both petitioners had claimed the standard
deduction for married filing separate on their 1994 and 1995 tax
returns. On brief, petitioners argue that they also are entitled
to deduct the $24.90 paid for real property taxes. On brief,
respondent concedes deductibility of this amount.
Respondent concedes that petitioners are entitled to deduct
$972 of the $1,871 disallowed Schedule C, Profit or Loss From
Business, telephone expenses for 1994; petitioners concede the
remaining $899. Respondent concedes that petitioners are
entitled to deduct $744 of the $1,618 disallowed Schedule C
telephone expenses for 1995; petitioners concede the remaining
$874.
Petitioners concede the entire $1,246 inventory adjustment
for 1995.
Respondent concedes that petitioners are entitled to
additional Schedule C car and truck expense deductions for 1994
and 1995 in the amounts of $2,318 and $1,337, respectively.
Respondent also concedes that petitioners are entitled to an
additional $6,348 depreciation expense deduction for 1995 on the
Ford F250 truck.
Respondent concedes that petitioners are entitled to deduct
additional Schedule C expenses for 1994 and 1995 in the amounts
of $461 and $530, respectively.
In the notices of deficiency, respondent disallowed in full
the deductions for Schedule C travel and entertainment expenses.
Petitioners acknowledge on brief that they lack the requisite
documents “to enable these expenses to be deductible.”
Petitioners contend that they “did incur these expenses * * *.
However, Mr. Downing simply did not know that he was required to
keep a detailed log of who he went to lunch with, and what
business they discussed.” We treat this as petitioners’
concession of the adjustment and, in effect, of the applicability
of sec. 6662.
Petitioners concede that Michael underreported 1995 plumbing
business gross receipts by $5,781. That is, the 1995 tax return
(continued...)
- 6 are as follows:
(1)
Whether each petitioner omitted from gross income
his or her respective community property law one-half
interest in the spouse’s earnings.
(2) Whether petitioners had unreported Schedule C gross
receipts for the years in issue, and, if so, then in what
amounts.
(3)(a) Whether petitioners are liable for the civil
fraud additions to tax under section 6663, or (b) in the
alternative, if petitioners’ underpayments (if any) are not
due to fraud, then whether petitioners are liable for the
negligence additions to tax under section 6662(a).
2
(...continued)
shows gross receipts of $82,721--petitioners acknowledge 1995
plumbing business gross receipts of $88,502.
On brief, respondent indicates that respondent’s concessions
have the effect of reducing the original deficiency notice
determination by more than one-third as to Michael and by more
than half as to Sandra. Further concessions were made in the
course of certain postbrief proceedings. Infra note 24.
Computations will be required under Rule 155.
Unless indicated otherwise, all Rule references are to the
Tax Court Rules of Practice and Procedure.
3
The following adjustments are computational: (1) The
deduction for exemptions, (2) the child care credit, and (3) the
computation of both Michael’s self-employment tax liability and
self-employment tax deduction; their resolution depends on our
determination of the issues for decision.
- 7 FINDINGS OF FACT
Some of the facts have been stipulated; the stipulations and
the stipulated exhibits are incorporated herein by this
reference.
When the petition was filed in the instant case, petitioners
resided in Metairie, Louisiana.
Metairie is in Jefferson Parish.
Petitioners filed timely calendar year tax returns for the
years in issue, using the filing status “married filing
separate”.4
A.
Michael’s Background
Michael was born in 1963.
He began working when he was 12.
His jobs included cutting lawns and washing cars; he initially
charged $5 per lawn and about $10 per car.
Michael worked after
school, on weekends, and throughout the summers.
During high
school, Michael continued to cut lawns; he also worked at
Fasullo’s Drug Store.
4
In addition, as part of his schooling,
After the notices of deficiency were mailed to
petitioners, petitioners submitted Forms 1040X, Amended U.S.
Individual Income Tax Return, for 1994 and 1995, in which they
changed their filing status from “married filing separate” to
“married filing joint” and claimed the earned income credit.
Sec. 6013(b)(2)(C) prohibits spouses from making a joint return
after they have previously filed separate returns if a notice of
deficiency has been mailed to either spouse with respect to the
tax for that taxable year, and the spouse has filed a petition
with the Tax Court. See Phillips v. Commissioner, 86 T.C. 433
(1986), affd. in part and revd. in part 851 F.2d 1492 (D.C. Cir.
1988). At trial, petitioners conceded that their filing status
is “married filing separate”. Consequently, they are not
entitled to the earned income credit. See sec. 32(d).
- 8 Michael worked half time at JEDCO for 1 year, where he received
training in plumbing and auto mechanics.
Michael saved the money
that he earned from these jobs; he did not deposit this money
into a bank because he believed that was inconvenient.
Indeed,
he did not open a bank account until March of 1989.
In 1982, Michael was graduated from high school.
His first
job thereafter was as a courier for Suburban Coastal Corporation.
After he left Suburban Coastal Corporation, he worked at Nature
Tubs and Spas, where he installed and plumbed spas and installed
gas lines.
Toward the end of 1982 and beginning of 1983, Michael
went to work at Lenny’s Plumbing, where he worked until the end
of 1987.
At the end of 1987, Michael began working at Milliken &
Michaels, Inc., a company owned by his brother-in-law, Michael
Sanderson (hereinafter sometimes referred to as Sanderson).
Before then, Michael had been living at his parents’ house.
When
he began working for Sanderson, he moved into Sanderson’s guest
house.
At the end of 1989, Michael began operating his own plumbing
business, doing business as Michael Downing Plumbing Co.,
hereinafter sometimes referred to as the plumbing business.
Michael continued to conduct the plumbing business as a sole
proprietor during the years in issue.
- 9 Michael first had Social Security earnings in 1979, in the
amount of $913.
This dropped to $287 in 1980, and zero in 1981.
In 1982 when he was graduated from high school, he had Social
Security earnings of $5,246.
His Social Security earnings
increased each year until 1989, when they reached $21,778.
His
1990 and 1991 Social Security earnings were $1,660 and $5,759,
respectively.
Michael’s Social Security earnings from 1979
through 1991 totaled $114,358.
B.
Sandra’s Background
Sandra was born in 1960; she was graduated from high school
in 1978.
At some point, she completed a semester of college.
In
1979, Sandra married Gary Rucker, hereinafter sometimes referred
to as Rucker.
They had two children: Rachel, born in 1983, and
Sean, born in 1985.
Sandra and Rucker separated in 1987; their
divorce became final in 1989.
Rucker paid to Sandra $4,200 of
child support in cash in each year in issue.5
5
The parties stipulated that these payments were in cash
in 1994 and 1995. On answering brief, petitioners contend that
$2,800 of the 1995 payments was by check. Although petitioners’
contentions are presented in great detail, (1) petitioners do not
direct our attention to any evidence in the record that supports
their contentions (see Rule 143(b)), and (2) petitioners do not
ask to be relieved from the conclusive effect of the parties’
stipulation that the 1995 payments were in cash (see Rule 91(e)).
Our findings are in accord with the parties’ stipulations;
petitioners’ contrary contentions are rejected.
- 10 During the years in issue, Sandra worked as a clerk at LCR
Corporation, a plumbing supply house, where she earned $17,877 in
1994 and $17,700 in 1995.
Sandra had Social Security earnings at least as far back as
1976.
Her Social Security earnings increased from $781 in 1976
and $434 in 1977, to $8,700 in 1982.
Her Social Security
earnings then declined, reaching zero in 1987.
Thereafter,
Sandra’s Social Security earnings varied greatly from one year to
the next.
Sandra’s Social Security earnings for 1976 through
1995 totaled $142,902.
C.
The Marriage Contract
Sandra and Michael met in December 1988.
On July 14, 1989,
they were married in St. Tammany Parish, Louisiana.
Louisiana is
a community property State.
Before their marriage, Sandra and Michael entered into a
marriage contract (see infra note 16), which made them “separate
in property”.
One of the reasons they did so was, on the advice
of Sandra’s divorce attorney, to prevent Rucker from aggregating
Sandra and Michael’s income in an attempt to reduce or eliminate
Rucker’s child support payment obligations.
Petitioners executed
the marriage contract on July 12, 1989; on July 14, 1989, the
marriage contract was “filed for registry” in the conveyance
records of St. Tammany Parish, where petitioners then resided.
The marriage contract provides as follows:
- 11 I.
The intended husband and wife shall be separate in
property, therefore, neither of them shall be liable for the
debts contracted by the other, either before or during their
marriage;
The intended wife shall have the free and exclusive
enjoyment of her separate property, and the full
administration thereof, without the assistance of her
husband.
II.
All property and effects of the said husband and wife,
whether owned by him or her at the time of the celebration
of said intended marriage, or acquired during said marriage,
are hereby declared to be separate property, and that of the
wife, separate and paraphernal property, and they and each
of them do hereby expressly reserve to themselves
individually the entire administration of their respective
particular movable and immovable property, and the
respective free enjoyment of each of their revenues.
On February 2, 2000, the marriage contract was “filed for
registry” in the conveyance records of Jefferson Parish,
Louisiana.
D.
The Plumbing Business
Michael generally worked alone in the plumbing business.
If
he needed help, then he hired independent contractors.
Sandra
handled all the bookkeeping for the plumbing business.
She wrote
out the invoices and mailed them to customers, paid the bills,
organized the records, did the banking, and submitted figures to
petitioners’ C.P.A. for use in preparing petitioners’ tax
returns.
The plumbing business was on the cash basis for 1994
and 1995.
Sandra computed gross income for the years in issue by
- 12 adding the invoices for the work that Michael had completed each
month, and then adding the monthly totals.
The invoices totaled
$68,757 for 1994 and $88,502 for 1995.
On the Schedules C for the plumbing business, Michael
reported 1994 gross receipts of $68,758 and 1995 gross receipts
of $82,721.
On answering brief, petitioners concede that Michael
should have reported 1995 gross receipts of $88,502--$5,781 more
than Michael in fact reported.
Supra note 3.
Table 1 sets forth the amounts of the Forms 1099 issued to
the plumbing business for 1994 and the amounts of the
corresponding invoices that Sandra prepared.
Table 1
Customer
Randy Bolnar
Walter Martinolich
Renard J. Falcon Plumbing
Sizeler Property
Bayona Corp.
Metro Bank
Southern Foods Group
Totals:
Form 1099 Amounts
Invoice Amounts
$1,080
4,062
5,492
1,010
3,960
1,392
9,283
26,279
$300
2,855
864
1,641
2,285
1,180
9,213
18,338
Table 2 sets forth the amounts of the Forms 1099 issued to
the plumbing business for 1995 and the amounts of the
corresponding invoices that Sandra prepared.
- 13 Table 2
Customer
Form 1099 Amounts
Invoice Amounts
$4,929
14,396
8,983
684
1,185
1,790
1,281
1,171
1,941
26,361
62,721
$5,576
14,396
10,403
684
1,185
1,790
1,281
1,218
3,438
26,439
66,410
Lemaire
Southern Foods
R. L. Falcon
Junior League
A-Z Home
Vino Vino
Metro Bank
Sizeler
Bayona
Maurice’s
Totals:
E.
Personal Finances
1.
The Houses
Michael did not own any realty before he married Sandra.
On October 3, 1991, he bought a house for $65,000 on Newman
Avenue (hereinafter sometimes referred to as the Newman property)
in Metairie, Jefferson Parish.
Michael’s uncle gave $7,000 to
him for a downpayment; Michael financed the remainder through
Sanderson at 12 percent interest.
$702.10.
The monthly payment was
The act of sale for the Newman property states, in
pertinent part, as follows:
MICHAEL J. DOWNING, a person of the full age of majority and
resident of the Parish of Jefferson,[6] State of Louisiana,
6
The parties do not deal with the question of when
petitioners moved their legal residence from St. Tammany Parish
to Jefferson Parish, except that they stipulate that “During
* * * 1994 and 1995, petitioners were married and residing
(continued...)
- 14 who declared under oath unto me, Notary, that he has been
married but once and then to Sandra Martinolich Downing with
whom he lives and resides; from whom he is separate in
property by virtue of a marriage contract which is recorded
in the Parish of Jefferson, in the conveyance records; * * *
The marriage contract was attached to the act of sale, which was
filed in the conveyance records of Jefferson Parish on October 8,
1991.7
Petitioners’ renovation work on the Newman property,
included painting, roof, carpeting, and doors.
On November 15,
1993, Michael sold the Newman property for $93,500.
The check
for the net proceeds from this sale, in the amount of $31,307.06,
was made out solely to Michael.
Petitioners spent $1,600 to
$2,000 of this amount before January 1, 1994 and the remainder of
the $31,307.06 by the end of 1994.
On March 24, 1995, Michael bought for $180,000 a house on
Metairie Court Parkway (hereinafter sometimes referred to as the
Metairie Court property) in Jefferson Parish.
The Metairie Court
property has been petitioners’ residence since March 1995.
Michael made a downpayment of $5,000 and financed the remainder
initially through Mark Margavio and then through Sanderson at 10
6
(...continued)
together in Jefferson Parish, Louisiana”.
7
The parties stipulated that this filing was “in the
conveyance records of St. Tammany Parish”. However, on brief the
parties’ statements are to the effect that this Oct. 8, 1991,
filing of the Newman property act of sale, with marriage contract
attached, was in the Jefferson Parish conveyance records. Also,
the Newman property was in Jefferson Parish. Under the
circumstances, we conclude that the parties’ stipulation on this
point was in error and our finding reflects that conclusion
rather than the parties’ stipulation.
- 15 percent interest.
The mortgage payment was $1,880.56 per month.
The 1995 mortgage payments were made by checks signed by Sandra
drawn on Premier Bank account number 5101023648.
5.
See infra table
The interest portion of these 1995 mortgage payments
aggregated $10,133.
See supra note 2, as to respondent’s
concessions.
Both the act of sale and the mortgage on the Metairie Court
property were recorded in the Jefferson Parish conveyance records
on March 28, 1995.
Unlike the act of sale for the Newman
property, the Metairie Court property act of sale did not have
attached to it a copy of the marriage contract.
Rather, the
Metairie Court property act of sale states as follows:
MICHAEL JOSEPH DOWNING, a person of the full age of majority
and a resident of the Parish of JEFFERSON, State of
LOUISIANA, who, declared unto me, Notary, that he has been
married but once and then to Sandra Martinolich, with whom
he is presently living and residing, and with whom he is
separate in property by virtue of a marriage contract dated
July 12, 1989, and annexed to act recorded as Act No. 9144488, in the Parish of Jefferson, Louisiana, [the Newman
property act of sale]
Mailing Address:
70001
2117 METAIRIE COURT PARKWAY, METAIRIE, LA
here present accepting and purchasing for himself, his heirs
and assigns, and acknowledging due delivery and possession
thereof, all and singular the following described property
to-wit:
The Metairie Court property mortgage includes a similar
reference; the mortgage also does not have attached to it a copy
of the marriage contract.
- 16 2.
The Vehicles
On December 6, 1994, Michael bought a new Ford F250 truck
for the plumbing business.
He paid $2,100 in cash and financed
the remaining $22,261.30 at an interest rate of 9.9 percent, with
monthly payments of $471.83.
In 1995, petitioners made payments
on this loan totaling $5,662.
Of this total, petitioners paid
$1,200 by check and $4,462 in cash.
respondent’s concessions.
See supra note 2, as to
Michael continued to use the truck for
business purposes in 1995.
On August 15, 1995, Michael bought a 1993 500SL MercedesBenz for $85,311.
He did not make a downpayment.
He financed
the car at an interest rate of 13.25 percent, with monthly
payments of $1,449.73.
On September 1, 1995, Michael bought a 1994 C2 3.6 Porsche
for $108,630.61.
Again, he did not make a downpayment.
He
financed the car at an interest rate of 13.1 percent, with
monthly payments of $1,775.26.
A Mercedes-Benz that had been bought by one or both of the
petitioners in 1992 or 1993, was stolen in 1994 or 1995.
3. Cash Advances
On May 30, 1994, petitioners withdrew a $2,500 cash advance
from their American Express Optima account.
On August 12, 1994,
petitioners withdrew a $3,000 cash advance from their First USA
Visa account.
On March 21, 1995, petitioners deposited a $5,000
- 17 convenience check issued by AT&T Universal Gold MasterCard into
one of their personal checking accounts.
F.
Tax Returns
Petitioners timely filed “married filing separate” income
tax returns for both of the years in issue.
In each of these tax
returns, the respective petitioner correctly showed that
petitioner’s spouse’s name and Social Security number at the
appropriate places.
Their tax returns for 1989 through 1993 also
were “married filing separate”.
For 1994 and 1995 petitioners reported adjusted gross income
and total tax as shown in table 3.
Table 3
Year
1994
1995
Michael
Adjusted Gross
Total Tax
Income
$8,360
8,926
Sandra
Adjusted Gross
Income
Total Tax
$17,877
17,700
$1,068
946
$1,314
1,456
On the 1994 and 1995 Schedules C, Michael reported gross
receipts, cost of goods sold, expenses, and net profit for the
plumbing business as shown in table 4.
Table 4
Year
Gross Receipts
Cost of Goods Sold
Expenses
Net Profit
1994
$68,758
$44,780
$14,982
$8,996
1995
82,721
54,141
18,975
9,605
The tax returns for both petitioners were prepared by Jeanne
S. Duhé (hereinafter sometimes referred to as Duhé), a C.P.A.
- 18 G.
The Audit
Revenue Agent Adoraliese Klimkiewicz (hereinafter sometimes
referred to as Klimkiewicz) conducted the examination of
petitioners’ tax returns.
She initially examined only Michael’s
1994 tax return, but about the end of 1996 or the beginning of
1997, she expanded the examination to include Michael’s 1995 tax
return.
Klimkiewicz did not begin to audit Sandra’s tax returns
until sometime between March and May of 1997.
Klimkiewicz’ first meeting with petitioners or their
representatives was on or about June 19, 1996, when Klimkiewicz
met with Sandra in Duhé’s office.
At Klimkiewicz’ request,
Sandra brought to the meeting both business and personal records,
the major records being the following:
(1) All the 1994 invoices
from the plumbing business that were reported on Michael’s 1994
tax return; (2) adding-machine tapes categorized by month; (3)
Forms 1099; (4) the plumbing business and personal bank account
statements; (5) some credit card statements; and (6) some
automobile insurance documents.
At that meeting, in response to
Klimkiewicz’ question about petitioners’ cash on hand at the
beginning of 1994, Sandra said that they would have had cash on
hand from the sale of the Newman property, and that they probably
had spent all the Newman property proceeds by the end of 1994.
On July 17, 1997, Klimkiewicz met with both petitioners and
their then representative, Sean Dawson, at Dawson’s office.
Both
- 19 petitioners told Klimkiewicz that there was a box in which the
proceeds from the Newman property and other cash savings were
kept, and that only Michael had access to this box.
Michael told
Klimkiewicz that he alone had a key to the box, and that he alone
knew the amount of cash in the box.
He also provided to
Klimkiewicz a typed statement he had prepared, indicating that,
as of January 1, 1994, he had accumulated a cash hoard of roughly
$180,000 in the box.
When Klimkiewicz asked petitioners at this
meeting how much cash remained in the box at that time, Michael
told her that, while he did not know the exact amount of cash
remaining in the box, she could determine the amount by
subtracting out--presumably from the roughly $180,000 cash hoard
that he said at this meeting had been in the box at the beginning
of 1994--the amount that she was proposing as an understatement;
the resulting amount would be the amount of cash remaining in the
box as of that date.
At trial, Michael testified that there was
roughly $60,000 to $70,000 in the box at the beginning of 1994,
and that he ran out of money in the box a year after he bought
the Metairie Court property.
Also at the July 1997 meeting, Michael provided to
Klimkiewicz a written statement in which he indicated that he did
not use any of his cash savings from the time he was 12 until the
beginning of 1994.
- 20 By November 1997, Klimkiewicz was no longer on the case,
having been succeeded by Mia Sylve.
H.
Bank Deposits
Petitioners maintained four bank accounts in two separate
institutions; both petitioners were signatories on each of these
accounts.
Neither petitioner maintained a separate account
(i.e., an account as to which that petitioner, but not the other
petitioner, was a signatory) during the years in issue.
Table 5 shows petitioners’ aggregate deposits into each
account, by account number, in each year in issue.
Table 5
Account
1225725403
5101046656
16423248061
5101023648
Total Deposits
1
1994
$8,874
48,335
8,207
64,936
130,352
2
1995
$5,787
114,702
N/A
95,409
215,898
This account was closed in April 1994.
2
Of the total 1995 deposits in these listed accounts, $200,
$5,000, and $31,475, respectively, were in cash.
The bank accounts listed in table 5 are hereinafter sometimes
referred to collectively as the listed accounts.
All four of the listed accounts were checking accounts.
first and third of the listed accounts were in the Jefferson
The
Guaranty Bank; the second and fourth were in the Premier Bank.
The first and second of the listed accounts were business
- 21 accounts entitled “Michael Downing Plumbing Co.”; the third and
fourth were personal accounts.
Table 6 sets forth the aggregate of the balances in the
listed accounts at the specified dates.
Table 6
I.
Dates
Aggregate Amounts
Jan. 1, 1994
Dec. 31, 1994
Dec. 31, 1995
$3,584
2,759
1,113
Bank Deposits Method Omitted Income
Tables 7 (for 1994) and 8 (for 1995) set forth our findings
as to the bank deposits method for determining unreported
income.8
The column headed “Respondent” takes into account
respondent’s concessions, by stipulation or otherwise, including
those made in the course of proceedings occurring after the
completion of the briefing process.9
The columns headed “Court--
Fraud” and “Court--Nonfraud” represent, respectively, our
findings based on the clear-and-convincing-evidence burden of
8
Although both sides refer to respondent’s analysis as
“the bank deposits method”, it appears that the better term is
“the bank deposits and cash expenditures method”. See generally
United States v. Abodeely, 801 F.2d 1020, 1023-1024 (8th Cir.
1986). For convenience, we follow the parties’ terminology and
refer to it as the bank deposits method.
9
In the notices of deficiency respondent determined that
unreported Schedule C gross receipts were $28,857 for 1994 and
$144,369 for 1995. As tables 7 and 8 show, respondent’s position
now is that unreported Schedule C gross receipts were $24,425 for
1994 and $84,085 for 1995.
- 22 proof and our findings based on the preponderance of the
evidence.
Table 7--1994
Item
Respondent
Court--Fraud
Court--Nonfraud
Total listed
accounts deposits
$130,352
$130,352
$130,352
Nontaxable
transfers
(12,142)
(12,142)
(12,142)
Gifts
(265)
(265)
(265)
Expense checks
from LCR; rebates
(185)
(185)
(185)
Business
expenditures--cash
25,612
25,612
25,612
Personal living
expenditures--cash
6,154
4,054
4,054
Opening listed
accounts balances
(3,584)
(3,584)
(3,584)
Closing listed
accounts balances
2,759
2,759
2,759
Nontaxable cash
(39,507)
(44,907)
(40,507)
Net wages--Sandra
(16,011)
(16,011)
(16,011)
Correct Sched. C
gross receipts
93,183
85,683
90,083
Reported Sched. C
gross receipts
68,758
68,758
68,758
Unreported Sched.
C gross receipts
24,425
16,925
21,325
- 23 Table 8--1995
Respondent
Court--Fraud
Court--Nonfraud
Total listed
accounts deposits
$215,898
$215,898
$215,898
Nontaxable transfers
(35,275)
(35,275)
(35,275)
Returned checks
(NSF)
(7,132)
(7,132)
(7,132)
Gifts
(502)
(502)
(502)
Expense checks from
LCR; rebates
(228)
(228)
(228)
Business
expenditures--cash
4,136
4,136
4,136
Personal living
expenditures--cash
11,618
6,900
6,900
Opening listed
accounts balances
(2,759)
(2,759)
(2,759)
Closing listed
accounts balances
1,113
1,113
1,113
Nontaxable cash
(4,200)
(4,200)
(4,200)
Net wages--Sandra
(15,913)
(15,913)
(15,913)
Corrected Sched. C
gross receipts
166,756
162,038
162,038
Reported Sched. C
gross receipts
82,721
82,721
82,721
Unreported Sched. C
gross receipts
84,035
79,317
79,317
Item
The parties’ disputes about other Schedule C items, and
about Schedule A items, all have been resolved by stipulations,
concessions, and deemed concessions.
These resolutions are to be
given effect in the computations under Rule 155.
- 24 Respondent has shown by clear and convincing evidence as to
each year in issue that:
(1) Michael understated his plumbing
business Schedule C gross receipts; (2) this understatement
resulted in an underpayment of tax; and (3) some part of this
underpayment of tax was due to Michael’s fraud.
OPINION
I.
Summary; Conclusions
Because of its impact on the rest of the case, we first deal
with the parties’ dispute as to whether each petitioner was
required to report on that petitioner’s separate Federal income
tax return in accordance with the splits ordinarily required by
Louisiana’s community property regime.
that they were not so required.
We agree with petitioners
Respondent conceded that, if we
so held, then Sandra had no deficiencies and no additions to tax;
that concession will be given effect in our decision.10
We then consider the fraud issue.
We agree with respondent
that respondent has shown by clear and convincing evidence that
Michael has an underpayment of tax for each year and that part of
each year’s underpayment is due to Michael’s fraud.
Our
redeterminations as to amounts agree largely, but not entirely,
with respondent’s determinations as modified by the parties’
stipulations and respondent’s concessions.
10
Sandra nevertheless remains a party in the instant case.
DeLucia v. Commissioner, 87 T.C. 804 (1986).
- 25 II.
The Marriage Contract
Respondent contends that, during the years in issue, the
marriage contract was not effective toward third persons because
petitioners failed to properly record it.
Respondent also
contends that, even if the marriage contract was properly
recorded, it was nevertheless not effective because petitioners
did not conduct their financial affairs in accordance with the
contract’s terms.
Petitioners maintain11 that:
(1) The marriage contract was
properly recorded at all relevant times; and (2) they complied
with the terms of their marriage contract.
We agree with petitioners that the marriage contract was
properly recorded at all relevant times, and that it was
effective during the years in issue.12
11
Petitioners also maintain that respondent is not a third
person protected by the filing requirements of La. Civ. Code Ann.
art. 2332 (West 1985). Because we conclude that petitioners’
marriage contract was properly recorded at all relevant times, we
need not address this contention.
12
It was apparent before the trial that petitioners’
contentions on this issue, if successful, would amount to a
victory for Sandra but would expose Michael to the potential of
an increased deficiency. This conflict between the individual
interests of Sandra and Michael was noted before the trial. The
Court discussed this matter with counsel for both sides and both
petitioners, ensemble. On the basis of the discussion in
chambers and the statements on the record, the Court is satisfied
(a) that petitioners’ counsel had previously explained the
conflict to both petitioners and it was again explained in
chambers, (b) that both petitioners previously understood the
matter and that both petitioners understood the matter
(continued...)
- 26 -
Both questions before us appear to be matters of first
impression, and both sides maintain that our determination as to
the role of the marriage contract depends on Louisiana law.
In
the absence of any Louisiana court opinion resolving these
matters, we make our own analysis of what Louisiana law provides.
See Commissioner v. Estate of Bosch, 387 U.S. 456, 465 (1967).
We consider first whether a marriage contract, which was
properly filed for registry in the parish in which petitioners
were domiciled at the time of this filing, must also be filed for
registry in a different parish for the marriage contract to be
effective toward third persons as to movables,13 if petitioners
have in the meanwhile become domiciled14 in that different
parish.
12
(...continued)
immediately before and during the trial, and (c) that both
petitioners intended that their counsel (1) continue to represent
both of them simultaneously in the instant case and (2) continue
to present in the instant case contentions which exposed Michael
to the potential of increased liabilities. See Rule 24(g)(2).
13
Both sides treat the matter before us as being
controlled entirely by the rules as to movables; under the
circumstances, we limit our determinations to the dispute that
the parties present.
14
The Louisiana statutory term is “domiciled”. From time
to time we refer to “residing”, or to “moving”. We intend
thereby to deal only with residence that constitutes domicile,
and with moving that constitutes changes of domicile, within the
meaning of that term in art. 2332.
Unless indicated otherwise, all article references are to
the articles of the Louisiana Civil Code Annotated (West 1985).
- 27 A.
General Rules; Statutes
Louisiana law provides that “A matrimonial regime[15] may be
legal, contractual, or partly legal and partly contractual.”
Art. 2326.
Under Louisiana law, “The legal regime of community
of acquets and gains applies to spouses domiciled in this state”
(art. 2334), and “Each spouse owns a present undivided one-half
interest in the community property”, art. 2336.
As a result, a
Louisiana married person under the legal regime is taxable under
Federal law on one-half the earnings of his or her spouse.
United States v. Mitchell, 403 U.S. 190 (1971); see Case of
Hamner, 411 So.2d 567, 568-569 (La. App. 1st Cir. 1982), revd. on
a different issue 427 So.2d 1188 (La. 1983).
The “legal” regime is commonly referred to as “community
property”.
The “contractual” regime alternative referred to in
article 2326, is authorized in article 2328, as follows:
A matrimonial agreement is a contract establishing
a regime of separation of property or modifying or
terminating the legal regime. Spouses are free to
establish by matrimonial agreement a regime of
separation of property or modify the legal regime as
provided by law. The provisions of the legal regime
that have not been excluded or modified by agreement
retain their force and effect.
Under article 2331--
15
Art. 2325 provides the following definition:
A matrimonial regime is a system of principles and
rules governing the ownership and management of the
property of married persons as between themselves and
toward third persons.
- 28 A matrimonial agreement may be executed by the
spouses before or during marriage. It shall be made by
authentic act or by an act under private signature duly
acknowledged by the spouses.
Under article 2336-the spouses may, without court approval, voluntarily
partition the community property in whole or in part.
In such a case, the things that each spouse acquires
are separate property. The partition is effective
toward third persons when filed for registry in the
manner provided by Article 2332.
Article 2332, entitled “Effect toward third persons”, provides in
entirety as follows:
A matrimonial agreement, or a judgment
establishing a regime of separation of property is
effective toward third persons as to immovable
property, when filed for registry in the conveyance
records of the parish in which the property is situated
and as to movables when filed for registry in the
parish or parishes in which the spouses are domiciled.
B.
Effect of the Marriage Contract
The parties initially dispute whether the marriage
contract,16 which concededly was “filed for registry” in St.
Tammany Parish on July 14, 1989, also had to be “filed for
registry” in Jefferson parish at some point before the years in
16
Both sides use the term “marriage contract”, rather than
the statutory term “matrimonial agreement”. For convenience, we
will follow the parties’ terminology.
- 29 issue,17 in order to be effective toward third persons as to
movables during the years in issue.18
The parties agree that this is a matter of first impression
under Louisiana law and present this matter to us for decision in
the instant case.
Both sides direct our attention to 16 Spaht &
Hargrave, Louisiana Civil Law Treatise, Matrimonial Regimes (West
2d ed. 1997), hereinafter sometimes referred to as 16 Spaht &
Hargrave.19
17
Both sides agree that the marriage contract was “filed
for registry” in Jefferson Parish on Feb. 2, 2000, but this
filing is not effective toward third persons for the years in
issue.
18
The instant case does not present any question or
contention as to whether-(1) the marriage contract resulted in a matrimonial
regime that was partly legal and partly contractual (art.
2326);
(2) the marriage contract involved matters prohibited
by public policy (art. 2329);
(3) the marriage contract violated any of the limits of
contractual freedom set forth in art. 2330 or established
under any other Louisiana law;
(4) the marriage contract violated any of the
requirements as to form set forth in art. 2331 or
established under any other Louisiana law; or
(5) Sandra’s efforts on behalf of the plumbing business
result in a recognition of some amount of income to Sandra
because of the operation of art. 2368.
19
Petitioners’ citations are to the 1989 edition; the
texts and section numbers of the matters petitioners referred to
appear to be unchanged in the 1997 edition, but the page numbers
are different.
- 30 Article 2332 on its face requires that the filing be in the
parish of the property’s situs as to immovables and in the parish
or parishes of the spouses’ domicile as to movables.
The 1989
filing in St. Tammany Parish complied with the requirements as to
movables in 1989.
Although Louisiana law permits a filing of a
marriage contract that applies to some movables but not to
others, the marriage contract involved in the instant case
applied by its terms to all future acquired movables and to the
fruits of all their separate properties.
Thus, respondent has
not suggested that any later filings would have been required
under article 2332 merely because of the passage of time or
because the movables relevant to 1994 and 1995 did not exist at
the time of the 1989 St. Tammany Parish filing.
See, e.g.,
article 2339, relating to fruits of movables.
The statute does not provide, in terms, that a change in
domicile requires a change in filing situs as to movables, where
there already has been a properly sited filing.
Article 2332
does refer to “the parish or parishes in which the spouses are
domiciled.”
(Emphasis added.)
However, comment (b) to article
2332 suggests that the words “or parishes” merely reflects a
recognition that spouses might be domiciled in separate parishes,
as a result of the repeal of Louisiana law which had provided
that “A married woman has no other domicile than that of her
- 31 husband.”
16 Spaht & Hargrave, sec. 8.5, n.9 and associated
text.
We have not been directed to, and our research has not
disclosed, anything in the legislative history of the enactment
of article 2332 that suggests that the words “or parishes” were
intended to require new filings in the circumstances of the
instant case.20
Respondent raises the concern that a ruling in favor of
petitioners-would mean that third parties would have to search the
conveyance records of each of the 64 parishes in the State
of Louisiana in order to assure themselves that the parties
had not filed a matrimonial agreement that would affect the
third parties’ right as to petitioners’ movables. * * *
Respondent submits that this result would be completely
contradictory to the purpose of La. Civ. Code art. 2332
(West 1985), which provides in a clear and straightforward
20
Spaht and Hargrave note as follows (16 Spaht & Hargrave,
sec. 8.5):
Indeed, when the legislation was drafted, central statewide
registry of matrimonial agreements was part of the proposal,
rendering unnecessary a continuing registration as spouses
moved about the state. That proposal was defeated,
however.10 The result is that in a mobile society, third
persons are not well protected with respect to matrimonial
agreements that were contracted when the spouses were
domiciled elsewhere. In a crucial situation, a search of
the records in 64 parishes would be required to ascertain
with certainty that no such agreement was recorded in the
state.
10
K. Spaht and C. Samuel, Equal Management Revisited: 1979
Legislative Modifications of the 1978 Matrimonial Regimes
Law, 40 La. L. Rev. 84, 106; La. H.B. No. 802, 5th Reg.
Sess. (1979).
- 32 fashion that with respect to movables, to be effective as to
third parties, the agreement must be filed in the parish or
parishes where the spouses are domiciled. The most sensible
reading of this article is that third parties are not
required to research the records of all 64 parishes, but
rather are entitled to rely on what is or is not filed for
registry in the records of the parish where the spouses are
domiciled.
However, respondent overlooks the burdens that respondent’s
rule might impose on spouses who move.
Would respondent’s rule
require that a refiling be accomplished before or on the date of
domicile change, or would there be a standard grace period after
the domicile change?
Who is better able to negotiate their
respective burdens, third parties who look to assets to satisfy
existing debts or to assure payments of prospective advances of
funds or credit, or spouses who may not be represented by counsel
and may be surprised to learn that a filing they had thought was
good-until-revoked-or-modified, had in fact been rendered
ineffective.
In this regard, the same increase in mobility that
creates the danger of imposing more burdens on third persons also
creates the danger of removing more protections from
unsophisticated spouses.
We do not mean to make light of the concerns respondent
describes.
We suggest that the weighing of these and contrary
concerns are properly within the province of Louisiana’s
lawmaking structure.
We decline to go further than what the
statute in terms prescribes.
We conclude that, under art. 2332,
- 33 the marriage contract was properly recorded and that it was
effective during the years in issue.
We must note, however, that the foregoing discussion, in
response to the parties’ focus, deals with the rights of third
persons, as against the spouses’ movables.
However, the question
that we must ultimately rule on is not a matter of what assets
respondent may look to in order to satisfy the liabilities of
either or both petitioners, but rather whether each petitioner
has a present undivided interest in the earnings of the other
spouse, for it is that present undivided interest that is the
foundation of the community property Federal income tax rules.
United States v. Mitchell, 403 U.S. 190 (1971).
In that light,
we conclude that Spaht’s and Hargrave’s analysis which closes the
cited section in their treatise (16 Spaht & Hargrave, sec. 8.5)
is particularly illuminating.
Under Civil Code Article 2332, matrimonial agreements
do not have to be recorded to be valid. It may well suit a
couple to deal with third persons as though they were under
the legal community regime, especially as to contracting
debts and alienating assets, but to have a different regime
as between themselves. Some persons may simply want to keep
such matters private. Whatever the reason, there is nothing
to require them to make such agreements public so long as
third persons are not injured in the process.21 Their
heirs, of course, would not qualify as protected third
persons because they would be successors.22 It is required,
however, that the agreement be in writing and that it be
either “made by authentic act or by an act under private
signature duly acknowledged by the spouses.”23
___________________
21
Comment, Marital Property Agreements--Being Creative
with the New Legislation, 43 La. L. Rev. 159 (1982).
- 34 22
La. Civ. Code arts. 880 et seq., 3506(28); La. R.S.
9:2722.
23
La. Civ. Code art. 2331.
The existence of the marriage contract has been conclusively
established.
The text of the marriage contract has been
conclusively established.
On the basis of the record in the
instant case, we conclude that respondent has not been injured.
C.
Failure To Conform With the Contract’s Terms
Respondent contends in the alternative that petitioners’
failure to conform to the terms of their marriage contract
rendered the contract ineffective.
Respondent has not directed our attention to any Louisiana
law, or to any other authority for that matter, that specifically
addresses this issue.
In fact, respondent acknowledges on brief
that respondent was unable to find any case that directly
addresses this issue.
In our own search, we likewise have been
unable to find any authority that supports respondent’s
contention.
Nevertheless, we need not decide whether in the
abstract spouses’ failure to conform to the terms of their
marriage contract can render it ineffective because, even if
respondent is correct, we conclude that petitioners substantially
conformed to the terms of their marriage contract.
In evaluating the evidence in the instant case, we are
mindful that “‘agreements legally entered into have the effect of
laws on those who form them.
R.C.C. Art. 1901 * * * Arkansas
- 35 Fuel Oil Corporation v. Puccio, 141 So. 2d 516, [520 (La App.
1962)]’”.
Morgavi v. Mumme, 270 So. 2d 540, 543 (La. 1972)
(quoting Succession of Caine v. Tanho Land and Cattle Co., 198
So. 2d 439, 444 (La. App. 1967)).
“[C]ourts are bound to give
effect to all contracts according to the true intent of the
parties when the language is clear and leads to no absurd
consequences.”
Stack v. De Soto Properties, Inc., 59 So. 2d 428,
430 (La. 1952).
Respondent asserts on opening brief that a court may
consider
evidence on the extent to which the parties to the
matrimonial agreement are fulfilling the stipulations of the
contract, i.e., whether or not and to what extent the two
actually share income notwithstanding the existence of the
matrimonial agreement. Knoepfler v. Knoepfler, 553 So.2d
1031, 1032 (La. App. 1989).
Respondent argues that the evidence in the instant case clearly
shows that petitioners did not comply with the terms of their
marriage contract because (1) petitioners commingled all their
income into four joint checking accounts, (2) petitioners had
signature authority on all bank accounts, (3) petitioners
transferred funds between the business and personal checking
accounts; and (4) petitioners paid business expenses from
personal accounts, and vice versa.
Petitioners reply that they “merely pooled their resources
to provide for the expenses of the marriage”.
They point to the
fact that they filed separate tax returns for each year in issue
- 36 and that they bought “all their [large] property and other
assets” separately as evidence that they did, indeed, conform to
the terms of their marriage contract.
We agree with petitioners’ conclusions for the following
reasons.
Firstly, because respondent relies on Knoepfler v.
Knoepfler, supra, and that case has some surface similarities to
the instant case, it may be appropriate to examine more deeply
the setting of Knoepfler and the expressed rationale of the
Louisiana courts.
Knoepfler v. Knoepfler, supra, was a dispute
about the level of required child support obligations, the
parents having divorced each other and each having married a new
spouse.
The father had been ordered to pay child support.
The
father moved to decrease the amount of child support; the mother
responded with a petition to increase the amount of child
support.
At the trial court hearing, the father:
introduced into evidence the matrimonial agreement in which
Mr. Knoepfler and his second spouse established a separation
of property regime. The [trial] court disallowed testimony
as to the intent behind the agreement. The court stated
that he was “not considering the [second] wife’s income.”
553 So. 2d at 1032.
The trial court decreased the amount of child support.
The
mother appealed, assigning as error (1) the trial court’s refusal
to consider the income of the father’s second spouse and (2) the
trial court’s conclusion that the evidence showed a change in
circumstances which could justify the reduction.
553 So. 2d at
- 37 1032-1033.
The appellate court reversed the reduction of child
support, agreeing with the mother on the second assignment of
error, relating to changes in circumstances.
553 So. 2d at 1033.
However, the appellate court upheld the trial court’s refusal to
take into account the income of the father’s second spouse, based
on the evidence in the record.
The appellate court stated as
follows (553 So. 2d at 1032):
We note, however, that our decision in Alt [v. Alt, 453
So. 2d 400, 402 (La. App. 4th Cir. 1983),] does not in any
way preclude the taking of evidence on the extent to which
the parties to the matrimonial agreement are fulfilling the
stipulations of the contract, i.e., whether or not and to
what extent the two actually share income notwithstanding
the existence of the matrimonial agreement. To rule
otherwise would enable a parent to circumvent his child
support obligation by executing, but never giving effect to,
a marriage contract establishing a separation of property
regime.
The appellate court explained the suggestion permitting
inquiry into “the extent to which the parties to the matrimonial
agreement are fulfilling the stipulations of the contract” as
being necessary in order to stop a parent from circumventing his
child support obligation.
The appellate court did not take the
position that such inquiries are proper to test all marriage
contracts.
In the instant case there is not any contention that
the marriage contract circumvents any obligation that either
petitioner may have toward respondent or any other person that
respondent seeks to protect.
- 38 The appellate court in Knoepfler did not describe the
inquiry in terms of the validity of the marriage contract (i.e.,
whether the spouse owns a present undivided interest in the
earnings of the other spouse), but only whether the other
spouse’s income ought to be taken into account in applying
Louisiana’s child support laws.
553 So. 2d 1032-1033.
In the
instant case, the only inquiry is as to the validity of the
marriage contract in order to decide whether Sandra and Michael
each had a present undivided interest in the earnings of the
other.
Secondly, all of the opinions cited by respondent discuss
commingling in terms of mixing separate property with community
property, not separate property with separate property.
See,
e.g., Thibodaux v. Thibodaux, 577 So. 2d 758 (La. App. 1st Cir.
1991).
Even so, those cases hold that depositing separate funds
and community funds into the same bank account does not
necessarily “extinguish the separate character of either the
husband’s or the wife’s separate funds; only indiscriminate
commingling, so that one cannot identify or differentiate among
the funds, results in the account being deemed community.”
McMorris v. McMorris, 654 So. 2d 742, 746 (La. App. 1st Cir.
1995).
Thus, even when separate funds are mixed with community
funds, it is only when those funds are “indiscriminately
- 39 commingled” such that they cannot be traced to their separate
source that they are deemed community.
2d 56, 59 (La. 1981).
Curtis v. Curtis, 403 So.
Such treatment is consistent with the
presumption of community property in Louisiana.
See La. Civ.
Code Ann. art. 2340 (West 1985).
Applying those holdings to the instant case, respondent
argues that it is impossible to trace the funds petitioners used
from their joint accounts back to the separate funds of either
spouse because petitioners did not “make any effort to track
payments on allegedly separate assets, * * * in order to
establish what was paid for with separate funds.”
It is unclear
from the record, however, whether petitioners were asked or even
attempted to track the payments.
tracking is required.
Moreover, we do not think such
Unlike in the cases cited above, the legal
presumption that the spouses are living in community does not
apply in the instant case because, as we concluded, supra,
petitioners’ marriage contract was properly recorded during the
years in issue.
See 16 Spaht & Hargrave sec. 4.7.
Further, we
are not deciding the character of the funds petitioners deposited
into their joint accounts, but rather, we are deciding whether
petitioners’ asserted indiscriminate commingling of separate
funds with other separate funds invalidates petitioners’ marriage
contract.
We do not think it does.
Thirdly, the documents relating to the Newman property and
the Metairie Court property list only Michael as the owner of
- 40 those properties.
While it is true, as respondent argues, that
the fact that “property is in the name of only one spouse and
there is a statement of paraphernality in the act of sale does
not change” the presumption that “all property acquired during
marriage is presumed to belong to the community”, Cheramie v. St.
Pierre, 382 So. 2d 1003, 1006 (La. App. 1st Cir. 1980), it is
also true that “If the spouses are living under a separate
property regime, the presumption does not apply.”
Hargrave, sec. 4.7.
16 Spaht &
Because we found, supra, that petitioners
properly recorded their marriage contract, there is no applicable
presumption that petitioners’ property is community property.
Thus, the facts that (1) only Michael’s name was on the documents
relating to petitioners’ residences and (2) the documents of sale
recite that Michael was “separate in property” from his wife
support petitioners’ contention that they were complying with the
terms of their marriage contract.
Fourthly, we note that petitioners filed separate tax
returns for the years in issue, using the filing status “married
filing separate”.
Respondent argues that the mere fact that
petitioners filed separate tax returns does not prove that
petitioners were separate in property under Louisiana law.
agree.
We
This fact, however, is evidence that petitioners viewed
and treated their respective earnings as their separate property.
- 41 In concluding that Louisiana property law determines
ownership for purposes of Federal income taxation in the instant
case, we are aware of our prior decisions holding that in some
circumstances we would ignore State law as to property ownership.
For example, we have held that a trust, valid under State law,
may be treated as a nullity for Federal income tax purposes if it
lacks economic reality.
See Markosian v. Commissioner, 73 T.C.
1235, 1241 (1980); Furman v. Commissioner, 45 T.C. 360, 364
(1966), affd. 381 F.2d 22 (5th Cir. 1967); see also Audano v.
United States, 428 F.2d 251, 257-259 (5th Cir. 1970).
In those
cases, we looked at whether there were any economic changes to
the donors other than changes to their Federal income tax
liability.
In Furman, we indicated that it was the “extreme
case” where we would disregard for Federal income tax purposes
the existence of a trust valid under State law.
Furman v.
Commissioner, 45 T.C. at 366.
In the instant case, petitioners entered into the marriage
contract, among other reasons, to prevent Rucker from aggregating
petitioners’ incomes in an attempt to reduce or eliminate his
child support obligations.
Comparisons of Sandra’s and Michael’s
Federal income tax returns plainly show that they are not under a
community property marriage regime.
This is not one of those
“extreme cases” that calls for us to disregard a contract valid
under State law for Federal income tax purposes.
- 42 We conclude that petitioners’ marriage contract was
effective during the years in issue.
We hold for petitioners on this issue.
III.
Fraud
Respondent contends (1) that Michael underpaid his taxes for
each year in issue, and (2) that all or part of his underpayments
are due to fraud, and, thus, Michael is liable for the fraud
penalties under section 6663.
Petitioners acknowledge that Michael may have underpaid his
taxes for each year in issue, but maintain that any underpayment
was not due to fraud because Michael lacked the requisite
fraudulent intent.
We agree with respondent.
When respondent seeks to impose the penalty under section
6663,21
21
respondent has the burden of proof.
SEC. 6663.
To carry this
IMPOSITION OF FRAUD PENALTY
(a) Imposition of Penalty.-- If any part of any
underpayment of tax required to be shown on a return is due
to fraud, there shall be added to the tax an amount equal to
75 percent of the portion of the underpayment which is
attributable to fraud.
(b) Determination of Portion Attributable to Fraud.-If the Secretary establishes that any portion of an
underpayment is attributable to fraud, the entire
underpayment shall be treated as attributable to fraud,
except with respect to any portion of the underpayment which
the taxpayer establishes (by a preponderance of the
evidence) is not attributable to fraud.
- 43 burden for a year, respondent must prove two elements, as
follows:
(1) That Michael has an underpayment of tax for that
year, and (2) that some part of the underpayment is due to fraud.
See sec. 7454(a);22 Rule 142(b); see, e.g., Carter v. Campbell,
264 F.2d 930, 936 (5th Cir. 1959); Stone v. Commissioner, 56 T.C.
213, 220 (1971); Otsuki v. Commissioner, 53 T.C. 96, 105-106
(1969).23
Each of the elements must be proven by clear and
convincing evidence.
See DiLeo v. Commissioner, 96 T.C. 858, 873
(1991), affd. 959 F.2d 16 (2d Cir. 1992); Parks v. Commissioner,
94 T.C. 654, 663-664 (1990).
For this purpose, respondent need not prove the precise
amount of the underpayment resulting from fraud, but only that
there is some underpayment and that some part of it is
attributable to fraud.
See, e.g., Lee v. United States, 466 F.2d
11, 16-17 (5th Cir. 1972);
Plunkett v. Commissioner, 465 F.2d
299, 303 (7th Cir. 1972), affg. T.C. Memo. 1970-274.
In carrying
this burden, respondent may not rely on petitioners’ failure to
22
SEC. 7454.
BURDEN OF PROOF IN FRAUD, FOUNDATION
MANAGER, AND TRANSFEREE CASES.
(a) Fraud.-- In any proceeding involving the issue
whether the petitioner has been guilty of fraud with intent
to evade tax, the burden of proof in respect of such issue
shall be upon the Secretary.
23
The elements of fraud under sec. 6663 are essentially
the same as those we considered under sec. 6653(b) of prior law.
See also Rhone-Poulenc Surfactants v. Commissioner, 114 T.C. 533,
547-548 (2000); Clayton v. Commissioner, 102 T.C. 632, 652-653
(1994); Houser v. Commissioner, 96 T.C. 184, 185 n.1 (1991).
- 44 meet their burden of proving error in respondent’s determinations
as to the deficiencies.
See, e.g., Petzoldt v. Commissioner, 92
T.C. 661, 700 (1989); Habersham-Bey v. Commissioner, 78 T.C. 304,
312 (1982), and cases cited therein.
Where fraud is determined for each of several years,
respondent’s burden applies separately for each of the years.
See Estate of Stein v. Commissioner, 25 T.C. 940, 959-963 (1956),
affd. sub nom. Levine v. Commissioner, 250 F.2d 798 (2d Cir.
1958); McLaughlin v. Commissioner, 29 B.T.A. 247, 249 (1933).
mere understatement of income does not establish fraud.
A
See
Estate of Mazzoni v. Commissioner, 451 F.2d 197, 202 (3d Cir.
1971), affg. T.C. Memos. 1970-144 & 1970-37; Otsuki v.
Commissioner, 53 T.C. at 108.
In order to establish fraud as to Michael, respondent must
show that Michael intended to evade taxes which Michael knew or
believed were owed, by conduct intended to conceal, mislead, or
otherwise prevent the collection of taxes.
See, e.g., Grossman
v. Commissioner, 182 F.3d 275, 277 (4th Cir. 1999), affg. T.C.
Memo. 1996-452; Powell v. Granquist, 252 F.2d 56, 60 (9th Cir.
1958); Danenberg v. Commissioner, 73 T.C. 370, 393 (1979); McGee
v. Commissioner, 61 T.C. 249, 256-257 (1973), affd. 519 F.2d 1121
(5th Cir. 1975).
This intent may be inferred from circumstantial
evidence, see Powell v. Granquist, 252 F.2d at 61; Gajewski v.
Commissioner, 67 T.C. 181, 200 (1976), affd. without published
- 45 opinion 578 F.2d 1383 (8th Cir. 1978), including the
implausibility of petitioners’ explanations.
See Bradford v.
Commissioner, 796 F.2d 303, 307 (9th Cir. 1986)(and cases cited
therein), affg. T.C. Memo. 1984-601; Boyett v. Commissioner, 204
F.2d 205, 208 (5th Cir. 1953), affg. a Memorandum Opinion of this
Court dated March 14, 1951.
A.
Underpayment
Respondent used the bank deposits method to determine
Michael’s income for the years in issue.
Supra note 8.
It is
well settled that bank deposits are evidence of income where the
deposits were made by the party charged with the income or to an
account controlled by the party charged with the income.
Tokarski v. Commissioner, 87 T.C. 74, 77 (1986).
The premise
underlying the bank deposits method of income reconstruction is
that, absent some explanation, a taxpayer’s bank deposits
represent income subject to income tax.
96 T.C. at 868.
DiLeo v. Commissioner,
The use of the bank deposits method of income
reconstruction has long been sanctioned by the courts.
In using
this method, respondent must take into account any nontaxable
deposits or deductible expenses of which respondent has
knowledge.
Id.
We have held that, where respondent has the burden of proof
in a bank deposits case, e.g., where respondent has determined
that a taxpayer has committed tax fraud, then--
- 46 Respondent can satisfy * * * [the] burden of proving
the first prong of the fraud test, i.e., an underpayment,
when the allegations of fraud are intertwined with
unreported and indirectly reconstructed income in one of two
ways. Parks v. Commissioner, 94 T.C. at 661. Respondent
may prove an underpayment by proving a likely source of the
unreported income. Holland v. United States, 348 U.S. 121
(1954); Parks v. Commissioner, supra at 661; Nicholas v.
Commissioner, 70 T.C. * * * [1057,] 1066 [(1978)].
Alternatively, where the taxpayer alleges a nontaxable
source, respondent may satisfy * * * [the] burden by
disproving the nontaxable source so alleged. United States
v. Massei, 335 U.S. 595 (1958); Parks v. Commissioner, supra
at 661. [DiLeo v. Commissioner, 96 T.C. at 873.]
In the notices of deficiency, respondent determined that, in
essence, every element of each year’s underpayment was due to
fraud.
On brief, respondent’s fraud contentions focus entirely
on the unreported Schedule C receipts.
We consider the elements of the bank deposit analysis (supra
tables 7 and 8), in order to determine whether, as to each year
in issue, respondent has shown by clear and convincing evidence
that there was unreported Schedule C income and that this
produced an underpayment of tax.
(1)
Total Listed Accounts Deposits
The parties stipulated that the total bank deposits were
$130,352 in 1994 and $215,898 in 1995.
(2)
Nontaxable Transfers
The parties stipulated that the nontaxable transfers were
$12,142 in 1994 and not less than $35,275 in 1995.24
24
Of this 1995 total, $29,275 was stipulated before trial,
(continued...)
- 47 Petitioners’ only contentions as to the 1995 nontaxable transfers
were among the items respondent conceded in the postbrief actions
referred to supra note 24.
The parties’ postbriefs concessions
are taken into account in tables 7 and 8, supra.
(3)
Returned Checks (NSF)
The parties stipulated that returned checks (insufficient
funds) were not less than $7,132 in 1995.25
Petitioners’ only
contention as to the 1995 returned checks (insufficient funds)
was among the items respondent conceded in the postbriefs actions
referred to supra note 24.
(4)
Gifts
The parties stipulated petitioners received as gifts from
relatives checks and cash that were deposited totaling “no less
than” $265 in 1994 and “no less than” $502 in 1995.26
On opening brief, petitioners contend that Sandra
“calculated” that petitioners’ bank deposits included cash gifts
from relatives in the amounts of “about” $2,490 in 1994 and
“about” $5,235 in 1995.
On answering brief, petitioners contend
24
(...continued)
and $6,000 was agreed to in proceedings under a motion to reopen
the record after the answering briefs were filed.
25
Of this 1995 total, $7,082 was stipulated before trial
and $50 was agreed to in the postbriefs actions referred to supra
note 24.
26
Of this 1995 total, $402 was stipulated before the trial
and $100 was agreed to in the postbriefs actions referred to
supra note 24.
- 48 that the correct total amounts of cash and checks are $3,208 in
1994 (an increase of $2,943 from the stipulation) and $3,276 in
1995 (an increase of $2,874 from the stipulation).
On answering
brief, petitioners contend that $1,000 cash was deposited into
the Premier Bank personal account.
Although petitioners have not
directed our attention to evidence of record, our examination
shows that this deposit is listed on Exhibit 40-J (p.1).
On
answering brief, petitioners further state that this $1,000 was
“for Mrs. Downing’s birthday”.
Petitioners have not directed our
attention to evidence of record on this latter point, which we
gather to be an implicit assertion that the $1,000 was a gift,
and we have not found any such evidence.
Respondent has the
burden of proving by clear and convincing evidence that there is
an underpayment, but respondent cannot properly be charged with
negativing theoretical possibilities first asserted on answering
brief without foundation in the evidentiary record.
We are satisfied that the stipulated gift deposits are all
that should be allowed (except for the $100 discussed in note 26,
supra), for the following reasons:
(a)
On neither opening nor answering brief have petitioners
directed our attention to any evidence in the record that
supports the numbers for which they contend, or any other amounts
that exceed the stipulated minima.
- 49 (b)
Petitioners do not explain the differences between
their contended-for amounts in their opening and answering
briefs.
(c)
Sandra testified that her mother typically bought
savings bonds for Rachel and Sean, and that her mother kept the
bonds until well after the years in issue.
Clearly, those gifts
(whatever their amounts) would not have been deposited in any of
the listed accounts in 1994 or 1995, or otherwise spent by
petitioners in those years, and so no adjustment should be made
on account of those 1994 gifts or 1995 gifts.
(d)
On answering brief, petitioners explain their lack of
evidence on this issue by stating “that Petitioners were
unsuccessful in persuading any of the relatives to attend the
trial as a witness despite numerous efforts.”
However, although
petitioners’ witness list includes four close relatives, none of
these relatives was to testify about gifts from them (or from any
other relatives they were aware of) in 1994 or 1995.
Under these circumstances we conclude that the reason
petitioners did not have evidence of additional gifts that were
deposited is that there were not any such additional gifts.
hold that respondent has established by clear and convincing
evidence the correctness of the table 7 and 8 adjustments on
account of gifts.
We
- 50 (5)
Expense Checks From LCR; Rebates
Petitioners do not dispute the adjustments on account of
expense reimbursement checks from LCR (Sandra’s employer) and
rebate checks, as shown in tables 7 and 8, supra.
(6)
Business Expenditures--Cash
Respondent contends that, to the extent petitioners made
business expenditures in cash that did not go through bank
accounts, petitioners had sources of income in addition to the
amounts they deposited into the bank accounts.
Petitioners
contend (a) they had nontaxable sources of cash, chiefly family
gifts (discussed supra) and the cash hoard (discussed infra), and
(b) their business cash expenditures amounted to less than the
amounts for which respondent contends.
(a)
1994.--Respondent contends petitioners made $25,612
business expenditures in cash in 1994.
Petitioners contend on
answering brief the correct amount is only $18,308.
Both sides
calculate the cash expenditures by starting with “total
expenditures reported” of $64,070.
Both sides subtract from this
amount, $4,100 telephone expenses and $624 insurance expenses.
Respondent further subtracts $29,969 (business checks) and $3,765
(credit cards), totaling $33,734.
Petitioners contend that
$41,038 business expenditures were made by check and credit
cards.
Thus, the difference between the parties on this matter
is accounted for entirely by the differences in their contentions
- 51 as to business expenditures made by check and business
expenditures made by credit card.
Respondent’s numbers on these two items are the numbers that
the parties stipulated.
stipulations.
Petitioners’ numbers are contrary to the
The stipulations are binding, unless the parties
agree otherwise or the Court relieves a party from the binding
effect “where justice requires.”
Rule 91(e).
Petitioners have
not asked to be relieved from these stipulation, and nothing has
been brought to the Court’s attention that leads us to conclude
that justice so requires.
Elec. Arts, Inc. v. Commissioner, 118
T.C. 226, 253 (2002).
We hold that respondent has established by clear and
convincing evidence the correctness of the 1994 adjustment (supra
table 7) on account of business expenditures made by cash.
(b) 1995.--Respondent contends petitioners made $4,136
business expenditures in cash in 1995.27
Petitioners contend on
answering brief the correct amount is zero.
Both sides calculate
the cash expenditures by starting with “total expenditures
reported” of $80,615.
Both sides subtract from this amount,
$4,600 telephone expenses and $1,250 insurance expenses.
27
Respondent’s contention on brief was $5,534. However,
in the postbriefs proceedings (supra note 24) respondent conceded
that three checks for Ford F250 truck payments (total $1,200) and
one check for truck insurance ($198) should be added to the
stipulated business expenditures made by check. This concession
reduces pro tanto respondent’s contention as to cash business
expenditures.
- 52 Respondent further subtracts $66,412 (business checks--$65,014
plus $1,200 plus $198) and $4,217 (credit cards), totaling
$70,629.
Petitioners contend that $82,576 business expenditures
was made by checks and credit cards.
Thus, the difference
between the parties on this matter is accounted for entirely by
the differences in their contentions as to business expenditures
made by check and business expenditures made by credit card.
Respondent’s numbers on these two items are the numbers that
the parties stipulated, adjusted to include respondent’s
postbriefs concessions.
Supra note 24.
As we noted in
discussing the 1994 cash business expenditures, the parties are
bound by their stipulations, and we hold that respondent has
established by clear and convincing evidence the correctness of
the 1995 adjustment (supra table 8) on account of business
expenditures made by cash.
(7)
Personal Living Expenditures--Cash
Respondent contends that, to the extent petitioners made
personal living expenditures in cash that did not go through the
bank accounts, petitioners had sources of income in addition to
the amounts they deposited into the bank accounts.
Petitioners
contend (1) respondent included certain cash expenditures in this
category that are not personal living expenditures, and (2)
respondent included certain expenditures in this category that
are not cash expenditures.
- 53 (a) 1994.--Respondent contends that petitioners made $6,154
personal living expenditures in cash in 1994.
Petitioners
contend the correct amount is only $1,216.
Respondent treats as a personal cash expenditure the $2,100
cash downpayment petitioners made for the Ford F250 truck.
We
agree with petitioners that the $2,100 is a business cash
expenditure, and that it should not be included in the personal
expenditure category.
The $2,100 is a part of the $25,612
business cash expenditures that we have upheld, supra.
The remaining $4,054 consists of groceries expenditures made
by cash.
Petitioners seem to agree that $4,054 is the correct
starting number, but “propose” that that be reduced by 70 percent
on the ground that that percentage “be deemed to be paid by
credit card based on Mrs. Downing’s testimony (R.75) that she
typically deposited the cash savings into the bank accounts and
then paid the personal bills from there.”
Sandra’s testimony reflected on the cited trial transcript
page explains as follows:
A. [Sandra] The cash that was deposited into the joint
personal checking account that belonged to Michael and I
[sic] came from savings that Michael had accumulated over
the years and gifts from relatives on his side of the family
and mine.
Q [Ponseti] Why was this cash deposited into the joint
personal account?
A The money was deposited into the checking account to
supplement income in order to pay bills.
- 54 Q Why were these cash deposits not added into the
gross income for 1994 and 1995?
A Because it wasn’t gross income that was earned
during those two tax years.
Thus, the cited testimony deals with amounts deposited into the
bank accounts, and does not tell us anything about cash
expenditures that bypassed the bank accounts.
The parties stipulated that during 1994 “petitioners spent
no less than $85 per week on personal grocery expenses, for a
total of $4,420.”
Respondent does not contend petitioners spent
more than $4,420 on personal grocery expenses.
not contend they spent less.
Petitioners do
The parties’ stipulated listing of
1994 “personal living expenses which petitioner paid by check”
shows only three such payments, totaling $366, under the category
“Food”.
Total personal grocery expenses of $4,420, less $366
food expenses paid by check, leaves $4,054 grocery expenses paid
by cash.
In light of the irrelevance of the only evidence
petitioners rely on for their objection, we conclude that the
foregoing constitutes clear and convincing evidence of the
correctness of the 1994 adjustment (supra table 7) on account of
personal living expenditures made by cash.
(b) 1995.--Respondent contends for an adjustment of $11,618;
petitioners for an adjustment of $5,600.
Both sides agree that
petitioners’ $5,000 cash house downpayment should be included in
this adjustment.
For the same reasons we expressed as to 1994,
- 55 we agree with petitioners and reject respondent’s proposal to
include $4,718 truck payments.
For the same reasons we express
as to 1994, we agree with respondent and reject petitioners’
proposal to reduce the $1,900 groceries to $600.
We conclude
that the foregoing constitutes clear and convincing evidence of
the correctness of the 1995 adjustment (supra table 8) on account
of personal living expenditures by cash.
(8)
Bank Balances
The parties have stipulated the opening and closing listed
accounts balance totals shown in tables 7 and 8.
(9)
Nontaxable Cash
As noted supra (items (6) and (7)), cash expenditures (i.e.,
expenditures made by cash that did not go through the bank
accounts) are added to bank deposits in order to determine the
amount of potentially taxable receipts that must be accounted
for.
One way to account for cash expenditures as not having a
taxable source in that taxable year is to determine the amount of
cash petitioners had available to them that came from nontaxable
sources.
In the instant cases, respondent agrees that
petitioners had a substantial amount of cash available to them
- 56 from nontaxable sources.28
We consider seriatim the components
of the category of cash from nontaxable sources.
(a)
The Newman Property.--Michael sold the Newman property
on November 15, 1993.
The net proceeds were $31,307.06.
Respondent, relying on Klimkiewicz’s testimony based on her notes
as to what Sandra said at a meeting during the audit, contends
that petitioners spent $2,000 of these net proceeds in 1993, had
$29,307 left at the beginning of 1994, and spent all this $29,307
in 1994.
Petitioners deny the correctness of Klimkiewicz’s notes
on this matter and “suggest that at most $1,600 * * * was spent
during 1993. * * * For the sake of computing numbers only, the
Petitioners will assume the amount of $1,600.”
As a result,
petitioners contend that the correct amount for this component is
$29,707.
Both sides agree that, by the end of 1994, petitioners
spent all that remained of the Newman property proceeds.
Taking into account the conflicting testimony, and the fact
that this testimonial conflict is solely as to what Sandra said
to Klimkiewicz in 1996 as to Sandra’s 1996 estimate of what
petitioners spent out of this source in 1993, we conclude (and we
28
Respondent refers to this category of items as
“nontaxable undeposited cash”. (Emphasis supplied.) Yet, for
1994 respondent would allow $39,507 to be subtracted, even though
respondent would have included only $31,766 of cash expenditures.
Thus, respondent appears to have implicitly accepted petitioners’
contentions (and Sandra’s testimony) that, at least in 1994,
petitioners took money from some cash storage and, at least to
the extent of $7,741 ($39,507 minus $31,766), deposited that
money into the bank accounts.
- 57 have found--tables 7 and 8) that respondent has shown by clear
and convincing evidence that not more than $29,707 of
petitioners’ 1994 expenditures came from the Newman property net
proceeds, and that none of petitioners’ 1995 expenditures came
from this source.
(b) Credit Card Advances.--Both sides agree that petitioners
received two credit card cash advances, totaling $5,500, in 1994.
Petitioners contend on answering brief that they received two
additional cash advances, of $1,942 and $2,113, in 1994.
However, in the postbriefs actions referred to supra note 24,
petitioners concede that “the credit card amount of $2113.15 is
really just a transfer and not a Cash Advance and * * * the
$1,942 amount was used to pay off a credit card debt.
As such,
it should not be counted as a credit card advance for 1994.”
Respondent does not allow, and petitioners do not contend for,
1995 credit card advances.
Thus, the allowance of $5,500 credit
card advances for 1994 and nothing for 1995 is agreed to by both
sides.
(c)
Child Support.--The parties stipulated that petitioners
received $4,200 in cash child support payments for Rachel and
Sean in each year, 1994 and 1995.
(d)
Supra note 5.
Refund of Deposit on House.--The parties stipulated
that in 1994 petitioners received a refund of a $500 deposit on a
house.
- 58 (e)
Michael’s Accumulated Savings.--Originally, Michael
told respondent’s revenue agent that, at the beginning of 1994,
he had a cash hoard of $180,000, which he had accumulated over
the years.
At trial, Michael testified that he had “Roughly
* * * around 60 to 70,000" in the cash box at the beginning of
1994 and that he “ran out of money a year after I bought the
Metairie Court house”, which he bought on March 24, 1995.
Respondent allowed as a starting 1994 cash hoard only the
remaining net proceeds of the sale of the Newman property,
together with the credit card advances, 1994 child support, and
deposit refund, and treated the entire allowed amount as having
been spent in 1994; respondent has not allowed any starting 1995
cash hoard.
Petitioners do not appear to have taken any position
as to how much of their claimed cash hoard was spent in 1994
(except for Sandra’s testimony that she had told Klimkiewicz that
all the remaining net proceeds of the sale of the Newman property
had been spent by the end of 1994), how much was spent in 1995,
and how much was spent (consistent with Michael’s above-quoted
testimony) in early 1996.
On brief, petitioners appear to have
abandoned Michael’s $180,000 contention and instead adopted as
their position Michael’s above-quoted trial testimony.
(i)
For Cash Hoard
Considerations pointing toward cash hoard include the
following:
(1) Respondent has already accepted the idea that
- 59 petitioners kept a large amount of cash someplace (not
necessarily in a box) for some period of time--viz the $29,000plus remainder of the Newman property proceeds, which was used
from time to time during 1994.
(2) Respondent has already
accepted the idea that petitioners on occasion deposited
nontaxable cash receipts into the bank accounts.
As noted supra,
respondent agrees that for 1994 petitioners should be allowed to
subtract more in nontaxable cash than petitioners’ 1994 cash
expenditures.
(ii)
Against Cash Hoard
Considerations pointing against cash hoard include the
following:
(1) Petitioners’ claim of cash hoard, even if
accepted in entirety, would explain only a small fraction of the
otherwise-unexplained omitted income; in the context of clear and
convincing evidence of substantial omitted income in 1995 on the
record herein, it is difficult to credit Michael’s testimony as
to any specific amount.
(2) Michael’s testimony as to the cash
hoard, especially in light of his acknowledged earlier
statements, seems to be tailored to his time-to-time perceptions
of what suits his purposes, rather than his best recollection of
the actual events.
Michael’s written statement to Klimkiewicz at
the July 1997 meeting was specific in describing why he estimated
- 60 he had a January 1, 1994, cash hoard of $180,000.29
29
At trial, he
On cross-examination, Michael testified as follows:
Q [Canavello] Mr. Downing, is this a typewritten
statement that you provided to the revenue agent at the July
meeting in 1997? Not the handwritten part, just the typing
part.
A
(Perusing documents.)
Oh. Yes, it is.
Q Thank you. I’d like you to read this sentence right
here to me, please, at the beginning of this -- this little
paragraph here.
A
“I did not use any of my savings until 1994.” That?
Q Yes. Thank you. And on the second page, would you
read for me, please -- would you read me the numbers -- this
part of it, please, from here to here?
A “Approximate 1974 through 1981 estimated savings,
40,000. Approximate between 1982 and 1987, estimated annual
savings, 15,600.”
Q
Yes.
A “Times five years equals 78,000. Approximate 1988
through 1989 estimated savings while employed at Millican
[Milliken] & Michaels, 31,000. Sale of house in 1993 profit
approximately 31,000. Total of 180,000.”
Q So now these would be the items that you listed in
your statement that you just identified, this statement here
that you brought to that meeting, as being the amounts that
added up to what was in the cash box?
A
Approximately.
A rough estimate.
Q
Thank you very much.
So then, when you prepared that statement, your
estimate of what was in the cash box as at the beginning of
1994 was $180,000?
A
I was speculating -- or estimate.
- 61 explained the $180,000 as a rough estimate.
At trial, he
testified that the correct January 1, 1994, amount was roughly
$60,000 to $70,000.
He did not explain in his testimony why his
rough estimates at trial differed from his rough estimate to
Klimkiewicz by about $110,000 to $120,000.
Nor did petitioners
clarify this substantial difference on brief.
(3) On numerous
occasions Michael borrowed--sometimes from family and sometimes
from business lenders--amounts for short terms and for long
terms.
In the case of borrowings from business lenders Michael
incurred substantial interest expenses.
Michael incurred these
expenses without seeking to earn income on what he contended were
large amounts in his cash hoard.
Because he neither earned on
his claimed cash hoard nor used his cash hoard to reduce
borrowings when opportunities were presented, it is evident that
Michael’s actions were not significantly affected by any
evaluation of opportunity cost.
(iii)
Analysis
In DeVenney v. Commissioner, 85 T.C. 927, 933 (1985), we
stated that-we cannot fail to note that the existence of a cash
hoard is endlessly claimed by taxpayers to explain the
existence of otherwise unexplained sources of funds.
It is rare indeed that a taxpayer successfully proves
this contention.
In DeVenney, the taxpayers’ evidence prevailed completely; not
only did it overcome the Commissioner’s fraud contentions, but it
- 62 also resulted in our holding that the taxpayers had no
deficiencies.
Id. at 928.
The record in the instant case is far
different from that in DeVenney.
Although we are not willing to conclude that respondent has
shown by clear and convincing evidence that petitioners had no
cash hoard (other than the items respondent specifically
allowed), we are satisfied that (1) any such cash hoard carryover
into 1994 was not sufficient to substantially affect the amount
of 1994 unreported income and (2) there was not any cash hoard
carryover into 1995.
Our findings in tables 7 and 8, supra, incorporate these
conclusions, on the lines labeled “Nontaxable Cash”.
(10) Net Wages--Sandra
The parties have agreed that Sandra’s net wages (i.e., Form
W-2, Wage and Tax Statement, wages less withheld taxes) are as
shown supra in tables 7 and 8.
(11)
Conclusions
We conclude and we have found that respondent has shown by
clear and convincing evidence that Michael understated his
plumbing business Schedule C gross receipts by the amounts set
forth in tables 7 and 8, supra, in the columns headed “Court-Fraud”--about $17,000 for 1994 and about $80,000 for 1995--and
that these understatements of receipts resulted in
- 63 understatements of income, which in turn resulted in
underpayments of tax for each year.
We hold for respondent on this issue.
B.
Fraudulent Intent
Respondent contends that the following indicia of fraud are
present in the instant case:
(1) Petitioners failed to report
substantial amounts of income; (2) petitioners failed to keep
adequate books and records; and (3) petitioners made inconsistent
and implausible explanations regarding the alleged nontaxable
sources of deposits to their bank accounts during 1994 and 1995.
Petitioners maintain that:
(1) Michael had no intention to
underreport income; (2) Michael provided the records he had to
respondent throughout the administrative process; and (3) the
alleged inconsistent statements “make no sense at all”.
Courts have identified numerous factors, sometimes referred
to as indicia of fraud, or badges of fraud, which may be
persuasive circumstantial evidence of fraud.
See, e.g.,
Niedringhaus v. Commissioner, 99 T.C. 202, 211 (1992).
We focus
on those indicia that appear to be most significant in the
context of the record in the instant case.
(1)
Failure To Report Substantial Amounts of Income
“Although mere understatement of income alone is not
sufficient to prove fraud, the consistent and substantial
understatement of income is, by itself, strong evidence of
- 64 fraud.”
Truesdell v. Commissioner, 89 T.C. 1280, 1302 (1987);
Marcus v. Commissioner, 70 T.C. 562, 577 (1978), affd. without
published opinion 621 F.2d 439 (5th Cir. 1980).
For 1994, Michael reported $68,758 of Schedule C gross
receipts from the plumbing business.
Respondent has shown by
clear and convincing evidence that Michael should have reported
at least $85,683.
Supra table 7.
We conclude that the $16,925
difference is a substantial underreporting.
For 1995, Michael reported $82,721 of Schedule C gross
receipts from the plumbing business.
Respondent has shown by
clear and convincing evidence that Michael should have reported
at least $162,038.
Supra table 8.
We conclude that the $79,317
difference is a substantial underreporting.
For the 2 years in issue, Michael failed to report an
aggregate of about 40 percent of his Schedule C gross receipts
from the plumbing business.
(2)
Failure To Keep Adequate Books and Records
Taxpayers are required to maintain books and records
sufficient to show their tax liabilities.
See sec. 6001.
Failure to do so is another indicium of fraudulent intent.
See
Bradford v. Commissioner, 796 F.2d at 307.
Respondent contends that petitioners’ records for the
plumbing business were incomplete and inconsistent.
For 1995,
respondent points to the fact that the total amount of the adding
- 65 machine tape--the amount Michael purportedly reported on the
Schedule C for that year--was $5,781 more than the amount
actually reported on the Schedule C.
Respondent also points to
the fact that Sandra omitted from four of the invoices $8,683
when she was calculating the monthly totals.
For 1994,
respondent points to the fact that seven of the Forms 1099 issued
to the plumbing business exceeded by $7,941 the amounts listed on
their corresponding invoices.
“Petitioners
Thus, respondent concludes:
obviously were not concerned with having an
accurate record of the income from the plumbing business.
Their
method of record keeping, or lack thereof, is another badge of
fraud for 1994 and 1995.
Petitioners reply, on answering brief, as follows:
The volume of records, checks, invoices, bank statement
[sic], bank deposit slips, the purchase agreements, the sale
agreements, the mortgages, the amortization schedule, the
social security statement, the marriage agreement, etc. are
a silent testimony as to the efforts that Petitioners have
made to accurately determine and substantiate the tax return
that was filed.
Petitioners concede that Michael understated gross receipts for
the plumbing business by $5,781 in 1995; they attribute this
understatement to a computational error that occurred when Sandra
added together the invoices.
Petitioners argue, however, that
because Michael was a cash basis taxpayer, and because they did
not receive in 1995 the $8,683 that was listed on the invoices
but not included on the adding machine tape, they did not have to
- 66 report that income for that year.
(This seems to be inconsistent
with petitioners’ $5,781 concession.)
Petitioners further argue
that, for 1994, the discrepancies between the amounts reported on
the Forms 1099 and the amounts listed on the corresponding
invoices were simply due to timing considerations.
We are somewhat puzzled by some of the assertions by both
sides.
Firstly, petitioners were cash basis taxpayers.
The
Schedules C for both years show that the plumbing business was on
the cash basis.
Respondent’s reconstruction of income and
Michael’s self-employment tax are cash-basis determinations.
Accordingly, Michael was required to report gross income from the
plumbing business when it was received, not when the work was
completed.
Sec. 451(a).
Sandra testified, however, that she
computed gross income for the years in issue by adding together
the invoices for the work Michael had done each month, and then
adding together the monthly totals.
In addition, the parties
stipulated, in relevant part, as follows:
Attached as Exhibit 39-J are copies of adding machine tapes
which petitioner Sandra Downing provided with the invoices
she identified to respondent’s revenue agent as gross
receipts reported on the 1995 Schedule C for Michael Downing
Plumbing Company.
Thus, it appears that Sandra calculated gross receipts from the
plumbing business as if Michael were an accrual basis taxpayer.
If this is so, then the adding machine tape totals for the years
in issue were not the proper amounts to report on the Schedules C
- 67 as gross receipts because those totals reflect the amounts due
for work done, not the amounts received for the work.
As such,
Sandra’s computational error in adding together the invoices for
1995 is irrelevant to the determination of the amount that should
have been reported on the Schedule C.
Nevertheless, this error
in bookkeeping suggests that petitioners’ records for the years
in issue are insufficient to show Michael’s tax liabilities.
Secondly, petitioners, for the first time on answering
brief, appear to argue that the adding machine tape totals
represent the amounts received by the plumbing business, not the
total amount of the invoices.
In response to respondent’s
proposed finding of fact that Sandra understated, by a total of
$8,683, the amounts of four invoices shown on the adding machine
tapes, petitioners claim that they did not have to report that
$8,683 because they did not receive it.
If petitioners did not
receive the $8,683 in 1995, then they are correct that Michael
was not required to report that amount on the Schedule C.
However, as stated above, Sandra testified that she calculated
gross receipts by adding together the invoices, not the receipts.
And the parties stipulated that Sandra provided to the revenue
agent copies of the adding machine tapes along with the invoices
used to calculate gross receipts for the plumbing business.
We
do not know whether petitioners did not realize until answering
- 68 brief that they calculated gross receipts incorrectly or whether
they incorrectly described their method of calculation.
Lastly, because petitioners were cash basis taxpayers, it
would not be surprising to find that the amount reported on a
Form 1099 is different from the total amount of the corresponding
invoices.
The Form 1099 amount may be less in situations where
the customer paid only part or some of the invoices.
The Form
1099 amount may be greater than the total amount of the
corresponding invoices in situations where the customer paid for
services rendered in prior years.
Thus, it is possible, as
petitioners contend, that the discrepancies are due to “timing
considerations”.
Petitioners, however, have not provided us with
any records from which we can ascertain the actual relationships
between the Form 1099 amounts and Michael’s plumbing business
receipts for the years in issue.
Accordingly, based on the record as a whole, we conclude
that Michael’s books and records are sufficiently confused so
that they do not reliably show the gross receipts from the
plumbing business, and consequently, Michael’s tax liabilities,
for the years in issue.
(3)
Inconsistent and Implausible Explanations
Petitioners attribute a significant portion of their bank
deposits for the years in issue to Michael’s cash hoard.
Respondent maintains that petitioners’ explanations and behavior
- 69 do not support petitioners’ contention.
Petitioners contend that
the “inconsistent statements” were due to the selective hearing
of Klimkiewicz.
Petitioners sum up their contentions as follows:
The Alleged Inconsistent Statements are discussed
throughout this reply brief and there is no need to repeat
these same arguments. It should also be mentioned that all
of these alleged inconsistent statements are also arguably
the self-serving testimony of the Revenue Agent * * *.
We agree with respondent.
Firstly, Michael’s testimony at trial is inconsistent with
the written statement Michael provided to Klimkiewicz regarding
the amount of cash remaining in the box at the beginning of 1994.
At trial, Michael testified that there was roughly $60,000 to
$70,000 cash in the box at the beginning of 1994.
During the
July 1997 meeting, however, Michael provided to Klimkiewicz a
prepared, detailed statement in which he declared that he had a
total of $180,000 in cash at the beginning of 1994.
At trial,
Michael acknowledged that he prepared this written statement and
that he presented it to Klimkiewicz at their July 1997 meeting.
When questioned at trial about this substantial discrepancy,
Michael replied that when he prepared the written statement in
1997, he “was speculating”.
This conflict is not attributable to
any asserted “selective hearing” by Klimkiewicz.
We also note that Michael testified that he ran out of cash
a year after he bought the Metairie Court property.
Michael
bought the Metairie Court property in March of 1995.
At the July
- 70 1997 meeting, when Klimkiewicz asked Michael how much remained in
the box at the time of the meeting, Michael told her to subtract
out from the alleged $180,000 that existed at the beginning of
1994 the amount she was proposing as a deficiency, and that would
be the amount remaining in the box at that time.
On brief,
petitioners state that they do not dispute that, at that meeting,
Michael did make this statement.
Petitioners do not contend that
Klimkiewicz’s “selective hearing” was incorrect as to this point.
This statement to Klimkiewicz was made more than 2 years after
Michael bought the Metairie Court property, and more than a year
after all of the cash from the box had been spent, according to
Michael’s trial testimony.
As we indicated supra (part A(9)(e)(ii) of this opinion),
Michael’s trial testimony and his oral and written statements to
respondent’s agent during the audit, seem to be tailored to his
shifting perceptions of what suits his purposes, rather than to
his best recollections of actual events.
Secondly, it has long been established that a taxpayer’s
“recurring need to borrow money is inconsistent with the claim to
a secret hoard.
205.”
Boyett v. Commissioner, 5 Cir., 1953, 204 F.2d
Cefalu v. Commissioner, 276 F.2d 122, 127 (5th Cir. 1960),
affg. T.C. Memo. 1958-37.
Respondent points to petitioners’
extensive borrowing–-a total of $391,615, respondent says (our
calculations are slightly less), with interest rates ranging from
- 71 9.9 percent to 13.25 percent–-as being inconsistent with having a
cash hoard.
When asked why he financed the cars, Michael replied:
The reason why I finance everything is because,
listening to Mike Sanderson that’s so successful was –his big thing was use other people’s money and put down
as little as possible or nothing, and that’s what I was
doing.
On answering brief, petitioners assert that “This strategy is not
an uncommon one as many ‘financial gurus’ explain at seminars
that this is one way to make money.”
While we do not doubt that
“this is one way to make money”, we strongly doubt Michael
intended to do so by paying high interest rates while earning no
interest income on the alleged cash hoard.
Moreover, in response
to the Court’s question whether Michael had noticed that, during
the early 1980s, banks were advertising interest rates of 10
percent or higher on savings deposits, Michael stated:
“I’ve
never been one to look at anything like that to –- no concern.”
We cannot reconcile this statement with Michael’s alleged desire
to make money in the manner that Sanderson allegedly did.
We
believe Michael’s testimony on this point was incredible.
Michael’s incredible explanations of his behavior constitute an
additional “badge of fraud”.
Bradford v. Commissioner, 796 F.2d
at 307; Boyett v. Commissioner, 204 F.2d at 208.
In addition, between May 30, 1994, and March 21, 1995,
petitioners took a total of $10,500 in cash advances.
- 72 Petitioners paid an annual percentage rate of 18.13 percent on at
least $5,000 of that amount.
All of the cash advances were taken
before Michael bought the Metairie Court property, when,
according to Michael’s testimony, he had cash remaining in the
box.
Petitioners have not provided, and we cannot discern, any
reasonable explanation for their willingness to pay high interest
rates on cash advances when they allegedly had a substantial cash
hoard.
Based on the foregoing indicia of fraud, we conclude that
respondent has proved by clear and convincing evidence that some
or all of the underpayments of tax that result from Michael’s
failure to report all of his plumbing business Schedule C gross
receipts were due to Michael’s fraud.
We have so found.
We hold for respondent on this issue.
C.
Amounts; Burdens of Proof
In parts II-A and II-B of this opinion, respondent had the
burden of proving, by clear and convincing evidence, that there
were underpayments of tax, some part of which was due to
Michael’s fraud; respondent carried this burden for each year in
issue.
(1)
Under section 6663(b), the entire underpayment of tax
for each year is treated as attributable to fraud, “except with
respect to any portion of the underpayment which the taxpayer
- 73 establishes (by a preponderance of the evidence) is not
attributable to fraud.”
As we noted, supra, in the notices of deficiency, respondent
determined that, in essence, every element of each year’s
underpayment was due to fraud.
On brief, respondent’s fraud
contentions focus entirely on the unreported Schedule C gross
receipts.
We treat this as respondent’s concession that the
fraud penalty applies only to so much of the underpayment as
results from the unreported Schedule C receipts.
On the basis of
the preponderance of the evidence, we conclude that for each year
in issue the fraud penalty applies to all of the underpayment
that results from the unreported Schedule C receipts.
(2) In general, petitioners have the burden of proving, by a
preponderance of the evidence, that the deficiencies30 are less
than the amounts respondent determined in the notices of
deficiency.
See Rule 142(a)(1); Welch v. Helvering, 290 U.S.
111, 115 (1933).31
However, respondent has the burden of proof
30
For purposes of the instant case, “deficiency” is the
same as “underpayment”. Compare sec. 6211(a) with sec. 6664(a).
31
Sec. 7491, which shifts the burden of proof to the
Commissioner if the taxpayer meets certain conditions, does not
apply in the instant case because the examination of petitioners’
tax returns began in 1996 or 1997, before the July 22, 1998,
effective date of sec. 7491. Internal Revenue Service
Restructuring and Reform Act of 1998, Pub. L. 105-206, sec.
3001(a), 112 Stat. 726.
- 74 with respect to “new matter”, including increased deficiencies.
Rule 142(a)(1).
Because all of our redeterminations except fraud have been
made on the basis of the preponderance of the evidence, it is not
necessary to decide which side has the burden of proof as to any
item.
See, e.g., Romann v. Commissioner, 111 T.C. 273, 285
(1998); Martin Ice Cream Co. v. Commissioner, 110 T.C. 189, 210
n.16 (1998), and cases cited therein.
Our preponderance-of-the-evidence findings as to omitted
Schedule C receipts are shown in the right-most columns of tables
7 and 8, supra.
All other adjustments, whether related to
adjustments in the notices of deficiency or other matters, have
been resolved by way of concessions or stipulations.
These redeterminations, stipulations, and concessions are to
be given effect in the Rule 155 computations and will govern
whether any part of the deficiency for either of the years in
issue is not due to fraud.
To the extent that any part of the deficiency for either of
the years in issue is not due to fraud, see part IV of this
opinion.
IV.
Negligence
In the notices of deficiency, respondent determined, in the
alternative to the fraud penalties under section 6663, that
Michael is liable for the negligence penalties under section
- 75 6662(a).
Respondent contends that Michael’s “substantial
omissions of income and other factors set forth above [e.g.,
Michael’s failure to keep adequate books and records]” clearly
show that the negligence penalties apply in the instant case.
Petitioners do not appear to contest this.32
Accordingly, we conclude that section 6662(a) applies for
each year in issue to that portion, if any, of Michael’s
underpayments determined in the Rule 155 computation to be
attributable to items other than the unreported Schedule C gross
receipts.
To take account of the parties’ concessions and the
foregoing,
Decision will be entered
under Rule 155.
32
Petitioners argued that reasonable cause excused their
failure to report one-half of their respective spouse’s income on
their separate tax returns. Because we concluded that
petitioners properly filed for registry their marriage contract
so as to keep their respective incomes the separate property of
the income-earning spouse, we need not address this defense to
the negligence penalty.
This is a copy of a public record, reproduced as it was published. It is not legal advice, and it may not be the version a court would rely on. Check the official source before you cite it.