Petition — Tooke v. Commissioner

In the Supreme Court

OF THE

United States

Octoser Term, 1978

P f 2 = ‘ _ i. ~ é

No. ’ , ; 4 ;

James C. Tooke and Brute A. Tooxg,

Petitioners,

VS.

CoMMISSIONER OF INTERNAL REVENUE,

Respondent.

PETITION FOR A WRIT OF CERTIORARI

To The United States Court of Appeals

For The Ninth Circuit

J. Ricnarp JOHNSTON

Rosert H. SoLomon

JoHNSTON & KLEIN

1221 Broadway, 20th Floor

Oakland, California 94612

Telephone: (415) 452-2133

Attorneys for Petitioners

BOWNE-PERNAU WALSH * 1045 SANSOME ST. © S.F.,CAS41I1f ¢ (415) 981-7882

SUBJECT INDEX

as)

ry

gS

a

Opinions below

Jurisdiction Ua 2

Questions presented

Se why d vta poe sivas ss ed dese ae 8

Statement of the case

I. Proceedings below

il. Facts

Reasons for granting the petition

So OWN nN NY NO = =

(1) Partnership distributions to the taxpayer

(a) Escaping costs

(b) Other distributions

(2) Partnership receipts received by the taxpayer

(3) Partnership disbursements made by the taxpayer 10

(4) Burden of proof 11

Conclusion 12

li

TABLE OF AUTHORITIES CITED

Cases

Page

Cohen v. Commissioner, 266 F.2d 5 (9th Cir. 1959) ........ ll

Helvering v. Taylor, 293 U.S. 507 (1935) ................ a

United States v. Janis, 428 U.S. 433 (1976) ................ ll

Rules

Rules of practice and procedure of the United States Tax

EE MIEN? os Bey US Sy asta cd ew cad Sa es cores ll

Statutes

Internal Revenue Code:

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28 U.S.C. 1254(1) ........ Nn eR ESA IE! eats ies 1

In the Supreme Court

OF THE

United States

OcTroBer Term, 1978

No.

James C. Tooke and Binur A. Tooks,

Petitioners,

VS.

CoMMISSIONER OF INTERNAL REVENUE,

Respondent.

PETITION FOR A WRIT OF CERTIORARI

_ To The United States Court of Appeals

For The Ninth Circuit

James C. Tooke and Billie A. Tooke petition for a writ

of certiorari to review the judgment of the United States

Court of Appeals for the Ninth Circuit in this case.

OPINIONS BELOW

The memorandum findings of fact and opinion of the

Tax Court (App. A, infra, A-1 to A-47), while not officially

reported, may be found at 36 TCM 396, 77,091 P-H Memo

TC. The opinion of the court of appeals (App. B, infra) is

reported at ........... > (eee ;

JURISDICTION

The judgment of the court of appeals (App. B, imfra)

was entered on March 21, 1979. The jurisdiction of this

Court is invoked under 28 U.S.C. 1254(1).

2

QUESTIONS PRESENTED

1. Whether the Commissioner of Internal Revenue may

determine that distributions to e partner from his partner-

ship are ordinary income to the partner and include such

distributions in his determination of the partner’s taxable

income.

2. Whether the Commissioner of Internal Revenue may

directly inerease a partner’s taxable income on the basis

of (a) partnership receipts received by him, and (b) part-

nership disbursements which the Commissioner disallows

as deductions, without reference to the pertinent partner-

ship return or the computation of partnership net income.

STATUTES INVOLVED

The pertinent provisions of Sections 701, 702, 703, 704,

705, 707, 722, 731, and 733 of the Internal Revenue Code

of 1954 (26 U.S.C.) are set forth in Appendix C, infra,

C-1 to C-7.

STATEMENT OF THE CASE

This is a federal income tax case involving the individ-

ual income tax liability of James C. Tooke and his wife,

Billie A. Tooke, for the years 1959 through 1963. James

C. Tooke, the primary party on appeal, is sometimes re-

ferred to herein as “the taxpayer.”

I. Proceedings Below

On February 18, 1972, the Commissioner of Internal

Revenue mailed to the taxpayer and his wife a notice

determining income tax deficiencies for the years 1959

through 1964 in the total amount of $86,384.61 plus a 50%

frand penalty pursuant to Section 6653(b) of the Internal

3

Revenue Code. (R. 24-54.) The taxpayer and his wife timely

filed a petition with the United States Tax Court for

a redetermination of those deficiencies and additions.

(R. 1-54.) |

Prior to trial, the parties entered into a written stipula-

tion resolving some of the issues raised by the Commis-

sioner. (R. 107-145.) The remaining issues litigated at the

trial included (a) the fraud penalty, (b) whether the tax-

payer and his wife were taxable on payments made to the

taxpayer by his partnership and partnership receipts re-

ceived by him, (c) whether the taxable income of the tax-

payer and his wife should be increased by a portion of

certain partnership disbursements which the Commissioner

had determined to be nondeductible, (d) the income of the

taxpayer and his wife from sources other than the part-

nership, and (e) whether certain deductions claimed on

the returns were deductible.

The Tax Court entered a memorandum findings of fact

and opinion on March 31, 1977, which, while not officially

reported, may be found at 36 TCM 396, 77,091 P-H Memo

TC. The taxpayer and his wife filed their notice of appeal

from that decision on March 27, 1978. (R. 276.)

The court of appeals had jurisdiction under Section 7482

of the Internal Revenue Code of 1954 (26 U.S.C.).

II. Facts

During the years in question, the taxpayer was a partner

in the partnership of Dawson, Desmond, Van Cleve and

Tooke, which specialized in property tax consulting. (R.

112, 197.) He also carried on his business of property tax

consultant as a sole proprietor. (R. 112.) As a property

4

tax consultant, the taxpayer represented businesses having

real and personal property located in various county juris-

dictions. This representation included the analysis and

valuation of property interests, preparation of returns to

be filed with the County Assessor and negotiation of as-

sessed valuation to be determined by the County Assessor.

(R. 112, 197.)

Under his agreement with the partnership, the taxpayer

was to receive the first $13,700 of partnership annual

profits, plus 10 percent (decreasing to 5 percent after three

years) of gross fees of business profits, plus one-third of

the remaining profits. (R. 199.) At the first meeting of

the partnership, it was agreed that in addition to his

share of partnership profits, the taxpayer “would be en-

titled to withdraw amounts of $25.00 per week in order to

cover his expenses incident to the conduct of the business

for which he would not be directly reimbursed because of

the difficulty of accurate accounting.” These payments were

thereafter referred to as “escaping costs.” (R. 113.)

During the years in question, the partnership made a

number of payments to individuals employed by county as-

sessors. Some of these payments were illegal, and the tax-

payer, his partners and the recipients of these payments

were convicted of state criminal violations with respect to

such payments. (R. 201-211.)

The partnership return for the fiscal year ended Novem-

ber 30, 1963 was thereafter audited by the Internal Reve-

nue Service, and certain adjustments were proposed by the

examining agent which increased partnership net income

by $12,136.93. The agent also proposed the 50% fraud pen-

5

alty to the individual partners for the vear 1963. The case

was settled without the fraud penalty. (R. 143 7 145.)*

Following the audit at the partnership level, the Internal

Revenue Service audited the joint individual income tax

returns filed by the taxpayer and his wife for the calendar

years 1959 to 1964, inclusive, and it made a series of ad-

justments directly to their income, without recomputing

partnership net income or the taxpayer’s distributive share

thereof, and without reference to the partnership returns

or the prior audit of the partnership. Those adjustments

included increases in the taxpayer’s income by the amount

of the following kinds of items received by the taxpayer:

(a) The $25.00 per week, paid to the taxpayer by the

partnership, to cover expenses not otherwise reimbursed

and referred to as “escaping costs”. (R. 31, 42.)

(b) Payments by the partnership to the taxpayer repre-

senting his 10% of gross fees of business secured by him.

(R. 40, 41.)

(c) Partnership receipts, paid to the taxpayer by part-

nership clients. (R. 32-33, 40.)

(d) A portion of payments made by the partnership

to members of tax assessors’ staffs or their relatives.

(R. 31, 42.)

The Tax Court sustained the Commissioner’s determina-

tion that all such items were taxable as income directly

‘The facts summarized in this paragraph were included in a

written stipulation of the parties. At the trial, the government ex-

ercised its right, reserved in the stipulation (R. 107), to object to

their introduction in evidence as irrelevant, and the objection was

sustained. (Tr. 252-255.) There is, however, no dispute as to the

existence of the facts themselves.

6

to the taxpayer, without reference to partnership net in-

come or the taxpayer's distributive share thereof, and the

court of appeals affirmed.

REASONS FOR GRANTING THE PETITION

The court of appeals has decided important questions of

federal tax law which have not been, but should be, settled

by this Court. These questions are whether the Internal

Revenue Service, in auditing the individual income tax re-

turns of a partner, may make adjustments directly to his

income based upon (a) amounts distributed to him by his

partnership, (b) partnership receipts received by him, and ,

(ec) partnership disbursements which the commissioner dis-

allows as deductions, without reference to the pertinent

partnership return or the computation of partnership net

income.

In this case, the Commissioner made such adjustments,

his determinations were sustained by the Tax Court, and

the court of appeals affirmed in a one-page memorandum

opinion. In its opinion (App. A, infra A-1 to A-47) the

Tax Court enunciated rules of tax law inconsistent with

the clear provisions of the Internal Revenue Code, and the

eourt of appeals affirmed without discussing the issues in

its opinion (App. B, infra).

We discuss the three kinds of adjustments below.

(1) Partnership Distributions to the Taxpayer.

These distributions were of two kinds: (a) “Escaping

costs” in the amount of $25.00 per week, paid to the taz-

payer to reimburse him for otherwise unreimbursed part-

nership expenses, and (b) other partnership distributions.

(a) Escaping costs.

The Tax Court held that these payments constituted

ordinary income to the taxpayer under section 61(a) of the

Internal Revenue Code, on the ground that there was no

credible evidence that the taxpayer had incurred any ex-

penses for which he required reimbursement, and that

“these regular payments are in the nature of guaranteed

payments made to petitioner without regard to the income

of the partnership. Section 707(c). As such, these payments

are treated as if they were made to an employee. Such

payments to an employee would clearly be compensation

and therefore constitute ordinary income under section

61(a).” (App. A, mfra, A-30.)

These payments were not “guaranteed payments” under

section 707(c), since that section applies only to payments

for services or the use of capital. Payments “in the nature

of guaranteed payments” are unknown to federal tax law.

Since the taxpayer was a partner, and not an employee,

the tax treatment of such payments, if made to an

employee, is not relevant.

Under section 702 of the Internal Revenue Code (App.

C, infra, C-1 to C-3), a partner is taxed on his distributive

share of the partnership’s income, which may be more or

less than the amount distributed to him by the partnership.

Under section 731(a) of the Code (App. C, infra, C-6),

a partner is taxed on his partnership distributions only to

the extent that they exceed the adjusted basis of his in-

terest in the partnership.

If the payments of “escaping costs” were not reimburse-

ment for expenses, and they were not “guaranteed pay-

8

ments”, they can only have been partnership distributions.

Since there was no determination by the Commissioner

nor any finding by the Tax Court that such payments

exceeded the adjusted basis of the taxpayer’s interest in

the partnership, such distributions were not taxable as

income.

(b) Other distributions.

The other payments held to be taxable as income to the

taxpayer were so-called commission payments, a payment

from Tax Management Associates, and “Unreported part-

nership gross receipts”, all of which the Tax Court cor-

rectly held “were payments made to petitioner from the

partnership as part of his share of partnership profits

under the partnership agreement.” (App. A, infra, A-32.)

That agreement provided that, as part of his share of

partnership profits, the taxpayer should receive 10 percent

(decreasing to 5 percent after three years) of the gross

fees of any business secured by him. (App. A, infra,

A-4.)

In its opinion, the Tax Court disposed of these payments

as follows (App. A, infra, A-33):

“Such amounts appear to be advance distributions

to petitioner of current profits of the partnership

taxable to petitioner as ordinary income under section

702(a)(8), and treated as if distributed on the last

day of the partnership year. Section 1.731-1 (a) (1)

(ii) Income Tax Regs.”

Section 702(a)}(8), cited by the Tax Court, deals with

the computation of a partner’s distributive share of part-

nership income, while the cited section of the regulations

9

deals only with the computation of the basis of the part-

ner’s interest in the partnership, and the determination

of whether his distributions have exceeded that basis.

Neither the code section nor the regulation even remotely

suggests that a partner is taxable on a distribution of

partnership income, and the law is clear that, unless such —

a distribution exceeds the basis of his partnership interest,

a partner is taxable only on his distributive share of

partnership income, regardless of the amount distributed

to him.

(2) Partnership Receipts Received by the Taxpayer.

In 1961 the taxpayer received a fee of $9,409.60 from

the Jack Tar Hotel, and the Commissioner determined that

$5,959.42 of this amount was income to him. The Com-

missioner determined that this payment was made to the

taxpayer by the partnership, but he contended on brief

that his determination was in error, and that this payment

was instead made directly to the taxpayer in his capacity

as a sole proprietor. The Tax Court held that the Com-

missioner had failed to sustain his burden of proof on this

issue, but held that it didn’t really matter, since the pay-

ment was taxable to the taxpayer as ordinary income

“whether paid to him directly by the client or distributed

to him as part of his share of the profits of the partner-

ship...” (App. A, infra, A-32.) —

Here we have an item of partnership gross receipts,

received by the taxpayer from the partnership, and held

to constitute ordinary income to the taxpayer, without

reference to the amount of the partnership’s net income

or the taxpayer’s distributive share thereof.

10

As in the case of the “escaping costs” and “commissions’

received by the taxpayer from the partnership, this pay-

ment must be classified as a partnership distribution, and,

as such, it was not income to the taxpayer, for the same

reasons that the other partnership distributions were not

income to him.

(3) Partnership Disbursements Made by the Taxpayer.

The Commissioner determined, and the Tax Court found,

that during the years in question the partnership expended

the following amounts for the entertainment of public offi-

cials (App. A, infra, A-40):

Sears, ~ | |

1960. ...... 1,184.40

1961 , 771.50

1962. Fone 4 364.64

1963... .. 277.73

The Commissioner determined that such expenses were

not deductible, and he increased the taxpayer’s income by

one-third of such amounts. The Tax Court sustained and

the court of appeals affirmed. There was no evidence that

such expenses had been claimed as deductions by the part-

nership, and the adjustment was made without reference to

the computation of partnership income or the taxpayer’s

distributive share thereof.

A partner is no more taxable on nondeductible partner-

ship expenditures than on partnership receipts. He is

taxable only on his distributive share of partnership in-

come, and any adjustment increasing his income directly

on the basis of partnership receipts or expenditures is con-

trary to section 702 of the Internal Revenue Code. (App.

C, infra, C-1 to C-3.)

11

(4) Burden of Proof.

The decision of the Tax Court rests, in part, upon its

finding that the taxpayer failed to sustain the burden of

proof placed on him by virtue of the presumption that the

Commissioner’s determinations are correct.

As a general rule, it is true that a taxpayer contesting

the Commissioner’s determination of tax bears the burden

of proof. United States v. Janis, 428 U.S. 433, 440-441

(1976); Helvering v. Taylor, 293 U.S. 507, 515 (1935);

Rules of Practice and Procedure of the United States Tax

Court, Rule 142(a), Appendix D, infra D-1. However,

where the Commissioner’s determination is arbitrary and

excessive, it is not presumed correct, and the taxpayer is

relieved of the burden of proof. Helvering v. Taylor,

supra; Cohen v. Commissioner, 266 F.2d 5, 11 (9th Cir.

1959); see United States v. Janis, supra.

Here the Commissioner’s determination was based upon

an assumption (a) that a partner is taxable on distribu-

tions from his partnership, and (b) that a partner is di-

rectly taxable on partnership receipts and nondeductible

partnership expenditures, without reference to any com-

putation of partnership income or of the partner's dis-

tributive share of that income.

As shown above, such assumptions are contrary to well-

established principles of partnership taxation, and they

render the Commissioner’s determinations arbitrary and

execssive. As a result, the presumption of correctness dis-

appeared, and the taxpayer was relieved of the burden of

proving that such determinations were incorrect, or even

of going forward with the evidence.

12

While the opinion of the Tax Court is partially grounded

on the taxpayer’s failure to sustain his burden of proof,

it nevertheless reflects a fundamental misapprehension of

federal tax law in holding that a partner is taxable on

partnership distributions. This is bad law, which will serve

as a precedent for future arbitrary determinations by the

Commissioner and future court decisions, if it is allowed

to stand uncorrected.

CONCLUSION

For the foregoing reasons, the petition for a writ of

certiorari should be granted.

Respectfully submitted,

J. RicHarp JOHNSTON

Rosert H. Sotomon

JOHNSTON & KLEIN

1221 Broadway, 20th Floor

Oakland, California 94612

Telephone: (415) 452-2133

Attorneys for Petitioners

May 17, 1979

(Appendices Follow)

i

Appendices

APPENDIX “A”

[CCH Dee. 34,336(M)] James C. Tooke and Billie A.

Tooke v. Commissioner.

Docket No. 3652-72. T. C. Memo. 1977-91. Filed March 31,

1977. [Appealable, barring stipulation to the contrary, to

CA-9.—CCH.]

Memorandum Findings of Fact and Opinion

Haui, Judge: Respondent determined the following defi-

ciencies and additions to tax:

Year Deficiency Section 6653(b)*

Additions

1959 fon ay cece . $2,166.06 $ 1,934.11

RES Re ae dies pm, re 10,291.69 5,182.55

MN a cei. 5 a @ RON x wick cute 11,449.16 6,022.45

MU coke vida eee es lis 5 Okie 0 6,144.20

Se mea tea 8,767.08 4,383.54

SPR, 21,368.76

Concessions having been made by the parties, the issues

presented for decision are:

(1) Whether any underpayments for any of the years

in issue were due to fraud.

(2) Whether petitioner is taxable on additional items of

income paid to him by a partnership of which he was a

partner or earned by him as a sole proprietor during the

years in issue,

(3) Whether there should be disallowed as a deduction

alleged bribes paid public officials or the cost of entertain-

ment of public officials, some such amounts having allegedly

been paid by the partnership and others by petitioner’s

sole proprietorship.

1All section references are to the Internal Revenue Code of 1954,

as in effect during the years in issue.

A-2

(4) Whether petitioner had unreported income during

the years in issue attributable to certain bank accounts

and rentals.

(5) Whether petitioner is entitled to business expense

deductions during the years in issue for certain expenses

claimed by him.

(6) Whether petitioner is entitled to additional business

expense deductions for items not claimed on his return for

the years 1962, 1963 and 1964.

(7) Whether petitioner is entitled to a bad debt deduc-

tion for a note which he alleges became worthless in 1960.

(8) Whether petitioner is entitled to an additional

$249.12 sales tax deduction in 1963 beyond the $180 allowed

by respondent.

Findings of Fact

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

At the time petitioners filed the petition herein, they

resided in Castro Valley, California. Because the majority

of events in this case revolve around James C. Tooke, we

will refer to him as “petitioner.”

Petitioner attended the University of California at

Berkeley, graduating in 1949 with an accounting major.

He did not thereafter practice accounting or prepare in-

come tax returns for clients. During the years in issue,

petitoner was licensed by the State of California as a pub-

lie accountant.

After graduation, petitioner held various managerial or

accounting positions for short periods of time. In 1952

A-3

petitioner obtained employment as a senior auditor-

appraiser with the Office of the Tax Assessor of Alameda

County, California. Petitioner ended his employment with

Alameda County in March 1959.

Thereafter, petitioner became a partner in the newly

created partnership of Dawson, Desmond, Van Cleve and

Tooke (“partnership”), which specialized in property tax

consulting. Petitioner’s association with the partnership

continued until November 1963. Petitioner’s principal task

as a property tax consultant was to represent businesses

having personal property located within the county. Such

representation included analysis and valuation of personal

property, preparation of returns to be filed with the local

assessor, and negotiations with the assessor or his delegate

concerning the assessed valuation of the property.

Prior to March 1959, the partnership of Dawson,

Desmond and Van Cleve had conducted its property tax

consulting business throughout the United States. In a

Memorandum of Agreement, dated March 5, 1959, Dawson,

Desmond and Van Cleve and the partnership agreed to

divide the fifty states into two business spheres with the

partnership receiving the ten western states of Alaska,

Arizona, California, Hawaii, Idaho, Montana, Nevada,

Oregon, Utah and Washington, and Dawson, Desmond and

Van Cleve reserving the remaining forty states. Dawson,

Desmond and Van Cleve and the partnership also agreed

that Dawson, Desmond and Van Cleve would transfer

those of its clients located in the partnership’s territory

to the partnership in return for compensation under a fee

allocation schedule.

A-4

At the partnership’s first meeting, the partners agreed

that petitioner would receive $25 per week as “escaping

costs”, i.e., reimbursement for costs incurred by petitioner

which were too difficult to account for. These payments

were niade without regard to the profits of the partnership.

Under the original version of the partnership agreement,

petitioner was to receive the first $15,000 of profits and,

in addition, one-third of all profits in excess of that amount.

In October 1960 the partnership agreement was redrafted.

The new agreement was substantially similar to the old

one except in relation to petitioner’s compensation. His

initial share of the profits was reduced to $13,700, and a

second category of partnership profits was carved out for

petitioner, namely, a sales commission of 10 percent

(decreasing to 5 percent after three years) of the gross

fee of any business secured by him. Petitioner’s share of

any remaining profits continued to be one-third.

A year later, the partnership agreement was again

changed. By a letter dated September 1, 1961 from Tooke

to his partners, the partnership agreement was modified

to provide that all sales commissions earned by Tooke

were to be paid to his closely held corporation, Goldleaf

Properties, Inc. (“Goldleaf”). No further changes were

made until the partnership dissolved, effective November

30, 1963, pursuant to an agreement executed by all of the

partners dated December 9, 1963. Fees received after No-

vember 9, 1963 for partnership work performed prior to

that date were disbursed on the basis of the partnership

agreement outlined above.

The partnership maintained a systems and procedures

manual which detailed the allocation of fee income and

A-5

expenses between Dawson, Desmond and Van Cleve and

the partnership. This manual, together with the partner-

ship’s financial statements, provided petitioner with suffi-

cient information to ascertain income, expenses, and profit

distributions.

Petitioner’s partners, Dawson, Desmond and Van Cleve,

also owned and operated a corporation called Tax Man-

agement Associates. Petitioner was aware of Tax Manage-

ment Associates’ existence, the identity of its shareholders,

and some of its activities, and had some dealings with

the corporation. Expenses incurred by the partnership,

by Dawson, Desmond and Van Cleve, or by Tax Manage-

ment Associates were allocated among these three entities

in accordance with agreed formulas. On occasion expenses

were allocated to an entity which had not directly incurred

the expense.

During the years in issue petitioner also performed

property tax consulting work as a sole proprietor. Initially

he operated under the name of Bureau of Property Re-

search. Upon dissolution of the partnership in 1963, peti-

tioner continued in the property tax consulting business

under the name of James C. Tooke and Associates.

Goldleaf also played a role in petitioner’s activities. It

was originally organized by his wife and another to con-

duct a small scale real estate business. In 1961 petitioner

bought out the other person. Soon thereafter petitioner

had the partnership pay to Goldleaf any sales commissions

he earned, as noted above. Goldleaf’s returns for 1961

and 1963 listed tax consulting as one of its activities, al-

though all income from tax consulting was in fact earned

by petitioner.

A-6

From 1959 through 1964, the partnership, Dawson, Des-

mond and Van Cleve, Tax Managenient Associates, and

petitioner (operating through Bureau of Property Research

and James C. Tooke and Associates) made illegal pay-

ments to individuals, most of whom were employed in the

offices of county property tax assessors. These payments

were claimed by the payors as deductible business expenses

on their respective tax returns.

From 1959 through 1963, the partnership made pay-

ments to the Assessor of Alameda County and to employees

of that office to secure low property tax assessments for

the partnership’s clients. During these years, the Charter

of Alameda County forbade county officers or employees

from receiving anything of value from third parties. Each

partner, including petitioner, knew that such payments

were improper and illegal.

Arthur M. Spriggs, an auditor-appraised with the Ala-

meda County Assessor’s Office in 1959, was one of the

employees who secured unjustifiably low assessments for

the partnership’s clients. Spriggs also worked for several

clients of the partnership on tax problems relating to prop-

erty located in another county.

Petitioner also had contact during these years with

Michael J. McLaughlin, who was employed as an auditor-

appraiser in the Alameda County Assessor’s Office. Me-

Laughlin first met petitioner in 1958, while petitioner was

working on the Assessor’s staff. In his capacity as auditor-

appraiser, McLaughlin would randomly select and audit

property tax returns. In return for payments from peti-

tioner on behalf of the partnership, McLaughlin would

A-7

either assign a low assessment value to property owned

by the partnership clients or not select for audit the returns

of the partnership clients. Petitioner made payments to

McLaughlin on behalf of Bureau of Property Research

and James C. Tooke and Associates. In 1960 he paid Me-

Laughlin $1,675 for the unjustifiably low assessment of

Co-Op Garment Manufacturers, Inc.

Karle T. Parrish was another member of the staff of

the Assessor’s Office of Alameda County. During the years

in issue, the partnership and Bureau of Property Research

or James C. Tooke and Associates made payments to

Parrish in return for favorable treatment of their clients.

Donald KE. Feragen, the Chief Deputy in the Alameda

County Assessor’s Office, was also a recipient of illegal pay-

ments from the partnership. While serving as Chief Dep-

uty, Feragen had informed petitioner that he would give

petitioner’s clients special treatment. This included, among

other things, adjusting inventory below either cost or mar-

ket value, reducing the useful life of equipment, and not

auditing petitioner’s clients. In 1963 Feragen was elected

the Assessor for Alameda County and held his position

through 1964. After this election, petitioner and Feragen

agreed that petitioner would file his clients’ property tax

returns with either McLaughlin or Parrish. In return for

Feragen’s favors, petitioner made payment to Feragen

on behalf of the partnership equal to approximately 25

percent of the fee the partnership received from its clients. -

Eventually this pattern of illegal payments became the

subject of official investigation. As a consequence of this

investigation, Feragen was indicted and, on April 14, 1966,

A-8

convicted of taking bribes from petitioner on eight separate

occasions from 1960 through 1964 in violation of Cal. Penal

Code, sec. 68. Feragen was also indicted and, on May 11,

1966, convicted of receiving bribes of $2,000 from peti-

tioner on two separate occasions in 1964.

Parrish was indicted in 1964 on two counts of grand

theft in excess of $200. He pleaded guilty on December

15, 1966. 3

McLaughlin was indicted on two counts of accepting

bribes in 1964 and a third count of grand theft in 1964.

He pleaded guilty to the third count, and in December

1966, the first two counts were dismissed.

Petitioner was indicted on one count of offering bribes

in 1964, in violation of Cal. Penal Code, sec. 67, and on

a.second count of grand theft. Petitioner pleaded guilty

to both counts on December 8, 1966.

Petitioner’s activities also extended to Donald James,

who, during the years in issue, was an appraiser in the

Assessor’s Office of the County of San Diego. During the

partnership’s 1960 taxable year, the partnership made a

payment of $550 to James. Sometime in 1963, petitioner met

James and paid him $700. Petitioner soon thereafter sub-

mitted a bill to the partnership, which subsequently reim-

bursed him. The partnership deducted both these payments —

as business expenses.

These transactions eventually led to a criminal proceed-

ing in 1966 in which petitioner was a witness for the prose-

cution. James, on March 2, 1966, was indicted on multiple

charges, including five counts of asking for or receiving

A-9

bribes, in violation of Cal. Penal Code, sec. 68, and one

count of conspiring to commit such a crime. The bribes

involved in that proceeding included the amount of $700

transferred to James in 1963 from Dawson, Desmond and

Van Cleve and petitioner, as individuals and as partners.

In return for James’ agreement to testify before the San

Diego County Grand Jury, the charges against him were

dismissed.

Desmond and Van Cleve were indicted along with James

on multiple counts, including giving or offering bribes to

executive officers in the San Diego County Assessor’s Office

and one count of conspiring between 1959 and 1963 to com-

mit such a crime. Petitioner was included as a co-conspira-

tor. Both Van Cleve and Desmond, on February 6, 1967,

pleaded nolo contendere to one count of giving bribes, and

the other counts were dismissed.

This pattern of illegal payments also extended to San

Francisco. One significant participant was Max J. Newstat,

a supervising auditor-appraiser in the San Francisco As-

sessor’s Office for twenty years, including the years in issue.

Newstat’s duties centered around personal property assess-

ments for property having an assessed valuation of at least

$15,000. Newstat processed the property tax returns for

clients of the partnership and James C. Tooke and Asso-

ciates, subject to approval by the Assessor, Russell L.

Wolden. In return for the payments from the partnership

and petitioner, Newstat extended favorable treatment to

their clients. For example, he assessed the inventory of

their clients at ratios rainging from 25 percent to 40

percent rather than the usual 50 percent ratio. One of the

A-10

clients receiving such favorable treatment from 1961

through 1964 was the Jack Tar Hotel, located in San Fran-

cisco.

During the years in issue, the Charter of the City and

County of San Francisco prohibited officers and employees

from engaging in any activity in conflict with their duties.

The rules of the Civil Service Commission required Com-

mission approval of any outside employment. Newstat

never sought such approval. Nevertheless, while employed

by the Assessor’s Office, Newstat performed property tax

services for Dawson, Desmond and Van Cleve in the mid-

1950’s in various locales outside of San Francisco. He

ceased working for Dawson, Desmond and Van Cleve

around 1959, yet he continued to receive payments from

them. In connection with these payments, Newstat sub-

mitted bills first to Dawson, Desmond and Van Cleve and

later to the partnership for each of the years in issue.

Desmond instructed Newstat how to prepare the bills, in-

cluding the amount to charge and the date to submit them.

Sometimes the partnership itself prepared the bills. The

partnership and petitioner desired these bills to enable the

partnership to deduct these payments.

On some bills, the partnership, or Tax Management As-

sociates for the partnership, indicated that Newstat per-

formed certain services which he, in fact, did not perform.

In 1959 the partnership paid Newstat $2,200 in this man-

ner. In 1961 Tax Management Associates paid Newstat

over $9,000. The partnership absorbed $3,810.84 of this

payment as an expense. One of the Newstat bills for 1961

was for $5,537.80. This bill recited that he had performed

A-11

work for Tax Management Associates in relation to assess-

ment of aircraft and airframe industries. Newstat, how-

ever, had not done this work. In 1962 Tax Management

Associates paid Newstat $4,240.72. Dawson, Desmond and

Van Cleve and the partnership allocated this amount like

an expense, with $3,553.48 being charged to Dawson, Des-

mond and Van Cleve and $687.24 being charged to the part-

nership. One of the Newstat bills for 1962 was for $2,120.36

and falsely stated that he had performed “Professional

Services—Assessment of Government Contract Indus-

tries—Possessory Interest, ete.” In 1963 the partnership

prepared another false bill for Newstat. This 1963 bills was

for $8,406.42 and purportedly related to an analysis of new

appraisal approaches in Arizona. No such analysis was

prepared. The sum of $8,406.42 was paid Newstat by the

partnership in connection with this bill. Petitioner was

aware of these partnership and Tax Management Asso-

ciates payments and, throughout the years, helped arrange

and facilitate Newstat’s billing procedure.

In 1964, after the dissolution of the partnership, peti-

tioner prepared three bills for Newstat, one for $4,457,

another for $4,458, and a final one for $2,185. Although

some of these bills purported to be for services performed

for James C. Tooke and Associates, Newstat had in fact

never performed any such services. As was the case with

the partnership, petitioner desired these bills to substan-

tiate business expense deductions.

Newstat’s sister-in-law, Sylvia Glickman, was also in-

volved in this system of payments. During the years in

issue, she lived with Newstat. Desmond in 1956 arranged

A-12

for Glickman to be carried on the books as doing clerical

and stenographic work for Dawson, Desmond and Van

Cleve in return for compensation. Glickman, however, could

not in fact type of take dictation. With the creation of the

partnership, she began to receive her payments from the

partnership. She continued not to perform any clerical

services. Petitioner was aware of this situation shortly

after becoming a partner in 1959. At least for 1959 any

partnership payments to Glickman reduced the amount

owed to Newstat for his services. Prior to 1960 she received

$150 per month; beginning in 1960 she received $300 per

month. Glickman used approximately half of these amounts

to pay for expenses of the Newstat household, including

groceries and utilities. In 1963, petitioner helped prepare

Glickman’s Form W-2. First the partnership and then in

1964 James C. Tooke and Associates labeled these pay-

ments as salary so as to deduct them on their respective

Federal income tax returns, and did in fact deduct such

amounts.

Petitioner put Glickman on Goldleaf’s payroll in 1964, al-

though she still performed no clerical services. Goldleaf’s

payments to Glickman in 1964 totaled $4,272.54. Goldleaf

prepared the accompanying withholding tax forms and em-

ployer’s Form 941. Petitioner reimbursed Goldleaf for this

amount and deducted the payment on his 1964 return. Peti-

tioner concedes that no payments made to or on behalf of

Glickman are deductible.

Beside Newstat, petitioner also made illegal payments to

Wolden. In accordance with an agreement between Wolden

and petitioner, Ralph Yeo (Wolden’s conduit for bribes)

A-13

submitted bills to petitioner which petitioner then paid. Pe-

titioner wanted Yeo to submit these bills to substantiate

deductions on his Federal income tax returns. Yeo per-

formed no services in return for these payments. These

payments in fact bought Wolden’s cooperation in reducing

assessments for petitioner’s clients. Petitioner paid Yeo

$2,500 in 1962 and in 1963 had Goldleaf pay Yeo $1,550 in

relation to the Jack Tar Hotel assessment. Petitioner in

1964, while operating as James C. Tooke and Associates,

paid Yeo $1,750 for the Jack Tar Hotel assessment and

$3,750 for the American Can Company assessment.

On October 28, 1965, Wolden was indicted on ten counts

of bribery and one count of conspiracy, in violation of Cal.

Penal Code, secs. 68 and 182. Four of the counts involved

the following bribes from petitioner to Wolden: (1) a 1961

payment from petitioner in relation to the Jack Tar assess-

ment; (2) a 1962 bribe from petitioner through Yeo to

Wolden in relation to the Jack Tar assessment for that

year; (3) a 1963 bribe from petitioner through Yeo to Wol-

den in relation to the Jack Tar assessment for that year;

and (4) a 1964 bribe from petitioner through Yeo to Wol-

dne concecrning the American Can Company assessment.

There was also a conspiracy count which involved, inter

alia, conversations by Wolden with petitioner in 1963 and

1964. In May 1966, Wolden was found guilty on all of these

counts.

From 1959 through 1963 the partnership made the fol-

lowing payments to public officials or their relatives, or was

allocated a portion thereof by Tax Management Associates:

A-14

Name 1959 1960 1961 1962 1963

Max J. Newstat .. $2,000 ..... $3,810.84 $ 687.24 $ 8406.42

Sylvia Glickman . 742.50 $3,813.60 3,844.40 3,300 3,845.75

Art Spriggs ...... RS ere oer yee:: « Goakaiad eh ein

600

Michael

McLaugblin ... 93,544.95

Orion Baker, em-

ployee of Califor-

nia’s State Board

of Equalization , 366 a” spe hia dans

Don James ...... Bo Al tig ei cane CAA at: 700

TOTAL $5,605 $8,274.55 $7,655.24 $3,987.24 $12,952.17

Increase in peti-

tioner’s distribu-

tive share of part-

nership taxable

income _.. $1,868.33 $2,758.18 $2,551.74 $1,329.08 $ 4,317.39

On the partnership’s state income tax information return

filed with the State of California for the fiscal year ended

November 30, 1959, the partnership deducted $9,000 of

bribes to public officials under such varied labels as “pro-

fessional fees”, “handling costs”, and “service costs.” No

partnership return was submitted into evidence for fiscal

1960. On the partnership’s Federal income tax information

return for the year ended November 30, 1961, appear the

categories “Handling Costs of Contracts”, $3,166, and “Ser-

vice Cost of Contracts”, $1,188.67. On the partnership’s re-

turn for the year ended November 30, 1962, there appear

the categories: “Handling Cost Contracts” $3,016.22, “Ser-

vice Expenses Clients” $1,250.43, “Professional Fees”

$7,624. On the partnership’s final income tax return, it de-

dueted $1,070.63 for “Handling Costs—Contracts”, $775.50

for “Professional Services”, and $75.14 for “Service Ex-

pense-Clients.” The above categories cover bribes paid to

°The partnership initially paid $6,000 to McLaughlin but, pursu-

ant to expense allocation agreements between it and Dawson, Des-

mond and Van Cleve and Tax Management Associates, it ulti-

mately shouldered only this amount of the expense.

A-15

public officials. The partnership also paid payroll taxes of

$225.18 on the “wages” paid Glickman in 1962.

The partnership spent the following amounts on the

entertainment of public officials, which respondent deter-

mined are not deductible from petitioner’s income:

Petitioner's

Year Amount 144 Share

1959 cs ae

1109.81

$1,291.81 $430.60

RSE ORE Ue ea cae 1,134.40 378.13

Scat eT Ileana es 771.50 257.17

A a) Aen Ae IP mee 364.64 121.55

I ag a at uk Sea Sa ary 277.73 92.58

The partnership deducted these amounts on its partnership

returns.

In accordance with the 1959 agreement among the part-

ners to reimburse petitioner $25 per week, the partnership

paid petitioner the following amounts labeled “escaping

costs”:

Year Amount

ee re

es

SE Agee Ce eee ee 1,350°

ARR RS peiatiaa 1,300

1963 . 1,100

Petitioner kept no receipts or records of his expenses.

In 1961 petitioner in his capacity as a partner, did prop-

erty tax work for the Jack Tar Hotel for a fee of $9,409.60.

Petitioner deposited this payment in Goldleaf’s bank ac-

’The record does not indicate the modification of the basic for

mula which evidently occurred to produce a sum which is $50

greater than the product of 52 weeks times $25 per week.

A-16

count. Out of this fee, he paid Dawson, Desmond and Van

Cleve $3,450.18. The remaining $5,959.42 was income to

the partnership. In 1962 petitioner dealt with the hotel in

his capacity as a sole proprietor, receiving $6,675.34 as a

fee. Petitioner again deposited this fee in Goldleaf’s bank

account. Out of this fee he paid Dawson, Desmond and Van

Cleve $2,447.60. The remaining $4,227.74 was income to

petitioner, rather than the partnership. In relation to this

fee, Goldleaf paid Ralph Yeo for the benefit of Russell

Wolden $2,500, as noted previously. In 19638, acting in the

same capacity as in 1962, he received a fee of $5,000 from

the hotel, paying $1,888 over to Dawson, Desmond and Van

Cleve. The difference of $3,167 was income to petitioner.

In relation to this fee, Goldleaf paid Ralph Yeo $1,550 for

the benefit of Russell Wolden, as previously noted.

On his 1960 individual return (Schedule C), petitioner

claimed a deduction of $7,575 for “Professional Services.”

On his 1961 return, in the category labeled “Professional

Fees” on Schedule C, he deducted $4,559.81. On his 1963

return, he deducted $3,201.72 for “Commissions Paid.” On

his 1964 return, he deducted $16,284.94 for “Handling Cost-

Contracts”, $2,623.74 for “Service Expense-Clients”, and

$12,662.50 for “Professional Services.” These were the

labels under which petitioner deducted the bribes he paid

to various public officials.

On his individual returns for 1959 through 1964 peti-

tioner omitted certain items of income derived from his

interest in Bureau of Property Research and James C.

Tooke and Associates. Omission of these items totaling

A-17

approximately $44,000 has been explicitly conceded by

petitioner.*

Petitioner also failed to report on his income tax returns

certain payments which he received directly from the part-

nership as follows:

Year

1961 Unreported gross receipts at PRE By: $2,693.35

Pacific Play Togs __. . IEE Oy 1,500.00

Commissions :

Jersey Shore Steel ........... $ 34.62

MJB ae . . 25.00

Gerber Foods _. . 400.00

Oliver Tire & Rubber Co. ..... 2.50

Pacific Tire Co. ... 25.00

. 487.12

eRe OD cat arer Xs $4,680.47

1962 Partnership Commission $ 712.31

Partnership Commission 6,124.00

MIE RLS eek ay org $6,836.31

He directed that each of these payments be made to Gold-

leaf, although they represent petitioner's income.

Petitioner indirectly received another $2,600 from the

partnership in the following manner: In 1960 the partner-

ship paid McLaughlin $6,000, MeLanghlin then paid $2,600

of this sum to petitioner. Petitioner did not report the re-

ceipt of this sum on his 1960 income tax return. Petitioner

also reeeived but failed to report income he received from

Tax Management Associates in 1961, totaling $5,929.

Petitioner claimed business expense deductions in rela-

tion to his individual consulting business for items which

*In addition, petitioner did not contest and therefore implicitly

conceded respondent’s determination that petitioner's 1964 income

should be increased by $29,645.18 (which represents the amount of

income deleted by Michael McLaughlin, petitioner’s income tax

return preparer), less $433 of expenses allowed by respondent.

A-18

were either gifts, capital expenditures, personal expenses,

or which were nonexistent. In 1960, his brother, David L.

Tooke, came to California from Ohio to be trained in real

estate and property tax matters. In that year petitioner

paid his brother $4,000, and in 1961, $4,207.81, and deducted

these sums from his individual returns. His brother, how-

ever, provided no services to petitioner, in return for these

payments.

In 1960 petitioner, acting as a sole proprietor, made pay-

ments of $1,675 to Michael McLaughlin and $1,650 to Ralph

Yeo and deducted these sums from his returns. These pay-

ments were made to secure low assessments for petitioner’s

clients.

In 1961, in relation to his rental activities, petitioner de-

ducted the cost of new furniture under the category of re-

pairs.

In 1963 petitioner deducted certain expenses incident to

the dissolution of the partnership for which he subsequently

received reimbursement from the partnership, comprising

a $1,026.13 payment to Norman Phillips and a $123.83 tele-

phone bill. In that year he deducted another $503.19 as a

business expense and $567.17 as a travel expense. In 1964

he deducted $2,126.75 as a business expense.

In 1963 and 1964 petitioner’s spouse drove a Cadillac.

She occasionally used the car to conduct her real estate

business and to aid petitioner’s business, but, for the most

part, used it for her personal transportation. Petitioner de-

ducted operating expenses for the car of $1,528.47 in 1963

and $1,840.52 in 1964.

A-19

Petitioner in 1964 made the following payments to indi-

viduals in relation to his tax consulting business:

Michael McLaughlin ..._.....—s......... $ 300

Max Newstat ... ROP ARSE PE Sh he" ta, 4,457

4,458

2,185

es a than Maa et RNa A 1,750

Earl Parrish ....... Pera ae say to eye 2,000

2,000

Petitioner made these payments to secure favorable prop-

erty tax treatment for petitioner’s clients.

Distinct from his tax consulting activities, petitioner and

his wife had other unreported income, including gain from

the sale of a parcel of land and interest income. Petitioner

also had rental income which he failed to report in 1960

of $236.83 and in 1961 of $1,230.19 (excluding lease deposits

of $275). Petitioner had $503.60 of unreported rental in-

come in 1962, composed of $423.60 of unidentified deposits

and $80 of income included on his books but not reported.

In 1963 petitioner had $1,157.35 of unreported rental in-

come, including $157.52 of income indicated on his books

but not reported on his return and $999.83 of unidentified

bank deposits. In 1964 petitioner had $900.79 in unreported

rental income, including $303.79 of income on his books but

not reported on his return, $529.69 of unidentified bank de-

posits and $67.31 of income from Service Distributors, Inc.

for use by his tenants of their laundry equipment.

In 1959 petitioner made two deposits in his bank account,

totaling $455. This was income to him.

‘Respondent's ninety-day letter characterized this $275 item as

“lease deposits” but treated them as income. No evidence regarding

this item was introduced. Lease deposits are normally not income

(Mantell v. Commissioner [Dec. 18,733], 17 T. C. 1143, 1148

(1952) and in view of respondent's admission we exclude this item.

A-20

In 1960 petitioner loaned Art Spriggs $1,550. Spriggs

disappeared and petitioner was thereafter not able to lo-

cate him. The loan was never repaid.

In 1963 petitioner purchased a Lincoln automobile and

paid $249.12 in sales tax as part of the transaction. In re-

lation to other 1963 purchases, petitioner paid $180 in sales

tax.

Petitioner during the years in issue compiled books and

records for Bureau of Property Research, James C. Tooke

and Associates, Goldleaf and his rental business. The bulk

of petitioner’s records were taken, without his permission,

from his office in mid-1965, These records came to rest in

the Attorney General’s Office for the State of California

and subsequently were distributed to the offices of local

county district attorneys throughout California for use in

criminal proceedings. Respondent received copies of the

records. Petitioner subsequently made some efforts to re-

trieve his records but was unsuccessful. Respondent per-

mitted petitioner to go through the copies which had been

distributed to respondent.

During respondent’s audit of petitioner’s individual re-

turns, petitioner provided the auditing agent with his rental

records. Petitioner also provided the agent with a ledger

containing a check register and income notations. The au-

diting agent found no entries for income from property tax

activities and observed that more income was reported on

Goldleaf’s returns than was on Goldleaf’s books. From the

agent’s analysis of Goldleat’s bank deposits, he was able to

determine that petitioner had deposited property tax con-

sulting income into Goldleaf bank accounts.

A-21

Michael J. McLaughlin aided petitioner in the prepara-

tion of Goldleaf’s books and records. McLaughlin organ-

ized Goldleaf’s books of original entry as well as Goldleaf’s

ledger. In addition, he prepared the corporate income tax

returns for Goldleaf from 1959 through 1963. Petitioner

supplied McLaughlin with Goldleaf’s journals and ledgers

in each year from 1959 to 1963. Such books and reco'ds

pertained only to real estate operations. The corporate re-

turns were usually filed after their respective due dates

because petitioner did not supply McLaughlin with the

necessary records until after the filing date.

McLaughlin also prepared the joint individual income

tax returns for petitioner and his wife for the years 1959

through 1964. For each of these years, petitioner did not

request that McLaughlin prepare these returns until a day

or two before the filing deadline. McLaughlin returned the

completed returns to petitioner on the evening of April

15 of each year. Petitioner normally examined the returns

with some care before signing them.

Generally the information petitioner provided McLaugh-

lin was already arrayed in summary schedules composed

of general categories, such as travel or entertainment ex-

pense. Petitioner did not make available to McLaughlin

any other information or inform McLaughlin that he could

have access to any other information.

For 1964 petitioner provided McLaughlin with a sum-

mary schedule of income and expenses as well as a general

ledger. When McLaughlin examined the ledger, he saw

the specific items which composed the $29,645.18 “Profes-

sional Fees” category on the summary schedule. These

A-22

items mainly invoived payments to members of the staff

of assessor’s offices, including McLaughlin, Parrish and

Newstat. McLaughlin deleted this professional fee cate-

gory as a deduction and also lowered total gross income

by the same amount. He discussed his action at length with

petitioner before petitioner signed the return. McLaughlin

told petitioner that the deleted income had to be reported

either on Goldleaf’s return or his own. Petitioner, however,

never filed a return for Goldleaf in 1964 and signed his

own return without revising it.

Respondent sent a statutory notice of deficiency to peti-

tioner on February 18, 1972, containing the determination

of deficiencies in Federal income tax and additions to tax .

for fraud under section 6653(b) set forth at the outset of

this opinion.

Opinion

From 1959 through 1964 petitioner was active as a prop-

erty tax consultant in California conducting business

through a partnership (Dawson, Desmond, Van Cleve and

Tooke) and a sole proprietorship. One significant aspect

of his activities was to secure favorable property tax treat-

ment through the use of bribes. An array of criminal con-

victions, encompassing assessors, members of their staffs,

petitioner, and his partners flowed from petitioner’s activi-

ties.

Respondent has determined deficiencies in petitioner’s

Federal income tax for the years 1959 through 1964, arising

from omitted income and overstated deductions. Respond-

ent has also asserted the fraud penalty against petitioner

in each of these years. The parties agree that the years

A-23

1959, 1960 and 1961 are barred by the statute of limitations

unless we find fraud in these years. Sections 6501(a) and

6501(c). Stone v. Commissioner (Dec. 30,767], 56 T. C. 213,

220-221 (1971).

1. Fraud

Respondent has determined that petitioner is liable for

additions to tax for fraud (section 6653(b))° for each of

the years in issue.

For fraud to be present, we must find that petitioner

acted with the specific intent to evade a tax believed to be

owing. Estate of Temple v. Commissioner [Dec. 34,083],

67 T. C. 148, (1976); Mitchell v. Commissioner [41-1 ustc

7 9317], 118 F. 2d 308, 310 (5th Cir. 1941), revg. and remg.

[Dec. 10,799] 40 B. T. A. 424 (1939), supp. opinion [Dec.

12,183] 45 B. T. A. 822 (1941); see Powell v. Granquist

[58-1 usre J 9223], 252 F. 2d 56, 60 (9th Cir. 1958) (failure

to file). The burden of proving that part of the petitioner’s

underpayment for the years in issue was due to fraud is

upon respondent (section 7454(a)), who must prove fraud

by clear and convincing evidence. Rule 142(b), Tax Court

Rules of Practice and Procedure; Cefalu v. Commissioner

[60-1 ustc J 9296], 276 F. 2d 122, 128 (5th Cir. 1960), affg.

a Memorandum Opinion of this Court [Dee. 22,883(M)];

Otsuki Ve Commissioner [Dec. 29,807], 53 T. C. 96, 106

(1969). He may meet this burden with circumstantial evi-

dence. Powell v. Granquist, supra at 61. The issue of fraud

*Section 6653(b), in relevant part, provides:

(b) Fraud.—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 50 percent of the under-

payment. ° ° ®

A-24

poses a factual question which is to be decided upon an

examination of all the evidence in the record. Stratton v.

Commissioner [Dec. 29,958], 54 T. C. 255, 284 (1970). And

respondent must establish fraud for each individual year

in issue. Stone, supra at 220. For the reasons set forth

below, we hold that respondent has sustained his burden of

proving fraud for each of the years 1959 through 1964,

thereby also lifting the bar of the statute of limitations for

the first three years.

A. Credibility

We found petitioner to be almost completely lacking in

credibility. His narrative was occasionally vague, often in-

consistent, and frequently changing. Another sign of un-

trustworthiness was petitioner’s assertion at trial that his

1965 testimony before the Grand Jury of Alameda County,

California, while under oath, was false. Such a candid ad-

mission of past perjury does little to support his claims

of present honesty.

We also found petitioner’s spouse not to be an exemplar

of truthfulness.

In contrast to petitioner and his wife were respondent’s

witnesses, Michael J. McLaughlin and Max J. Newstat.

Although both possessed tarnished pasts, nonetheless each

answered his questions at trial forthrightly.

We have drawn no negative inferences from the incom-

plete nature of petitioner’s books and records. We have

found as a fact that his records were taken without his

knowledge from his office and thereafter used in various

criminal proceedings. Compare Anderson v. Commissioner

A-25

(58-1 usre 9 9117), 250 F. 2d 242, 245-246 (5th Cir. 1957),

affg. and remg. a Memorandum Opinion of this Court [Dee.

21,874(M) J, cert. denied 356 U.S. 950 (1958) ; Shaw v. Com-

missioner | Dee. 22,078], 27 T. C. 561, 574 (1956), affd. [58-1

uste J 9322] 252 F. 2d 681 (6th Cir. 1958).

B. Petitioner's business background

One relevant factor in an inquiry into fraud is the degree

of accounting experience and the general business back-

ground possessed by the taxpayer. Cf. Lord v. Commis-

stoner [75-2 ustc 99799], 525 F. 2d 741, 745 (9th Cir.

1975); L. Schepp Co. v. Commissioner [ Dec. 7419], 25 B. T.

A. 419, 438 (1932). Petitioner possessed college training in

accounting, had performed services as an auditor-ap-

praiser, and by 1959 was a partner in a property tax con-

sulting partnership. For each succeeding year in issue, it

seems reasonable to conclude that his commercial expertise

and general business experience increased, Although he did

not prepare Federal income tax returns for clients, we zon-

clude that his general business and accounting background

supports an inference that he was acquainted with proper

accounting procedures and was familiar with accounting

notions of income and expense.

C. Omissions of income

A second, relevant, though not dispositive, factor is

omitted income. Merritt v. Commissioner [62-1 ustTc

7 9408], 301 F. 2d 484, 487 (Sth Cir. 1962), affg. a Memo-

randum Opinion of this Court [Dee. 25,741(M) ]. Respond-

ent has shown by clear and convincing evidence that peti-

tioner has failed to report on his income tax returns income

that he received during the years in issue. Other omissions

A-26

were conceded by petitioners. Repeated omissions of in-

come are indicative of fraud. Merritt v. Commissioner,

supra.

D. Pattern of false or misleading billings

to substantiate deductions

Fraud may arise in the content of deductions as well as

in omitted income. Benes v. Commissioner [Dec. 26,794],

42 T.C. 358, 383 (1964), affd. [66-1 usre J 9205] 355 F. 2d

929 (6th Cir. 1966), cert. denied 384 U.S. 961 (1966). We

have found as a fact that petitioner was aware of and par-

ticipated in the partnership’s creation of false bills from

recipients of bribes in each of the years 1959 through 1963.

Eck v. Commissioner |Dec. 18,146], 16 T. C. 511, 513-514

(1951), affd. per curiam [53-1 uste J 9287], 202 F. 2d 750

(2d Cir. 1953), cert. denied 346 U.S. 822 (1953). Compare

Estate of Roe v. Commissioner (Dee. 25,008], 36 T. C. 939,

948 (1961). The partnership required the recipients of its

largesse to prepare bills (often the partnership itself pre-

pared the bills) to make it appear that the recipient had

performed some type of customary, commercial service for

which he required payment. The partnership wanted these

bills so that it could substantiate its deductions of these

bribes in the event of an audit. This purpose and this pat-

tern of billings suggest that the partners, including peti-

tioner, wished to conceal the actual nature of expenses

which they were deducting knowing that their bribes would

not be allowed as deductions if they were identified as such

in the returns. Additionally, in each of the years 1959-

1963, the partnership prepared bills for Max Newstat

which stated that Newstat rendered certain services which

in fact he never performed.

A-27

Petitioner continued this pattern of false billings in 1964

when operating as James C. Tooke and Associates. In

1964 petitioner also had withholding statements prepared

for Sylvia Glickman, even though he knew she had per-

formed no clerical services. At trial he continued to assert

that these payments were for legitimate services, untrue

assertions which at least suggest that the necessary intent

existed not only at trial but also during the years in rela-

tion to which he was testifying. See Beaver v. Commis-

sioner [Dec. 30,380], 55 T. C. 85, 93 (1970) (failure to

file; false statement by petitioner during respondent’s in-

vestigation).

Kk. False or misleading statements on tax returns

Another significant factor in an inquiry into fraud is the

presence of false or misleading statements on the tax re-

turns for the years in issue. Coast Carton Co. v. Commis-

stoner [45-2 uste J 9325], 149 F. 2d 739, 742 (9th Cir. 1945)

(petitioner deducted salaries for people who were not em-

ployees), affg. sub nom. Norte v. Commissioner [Dee.

13,885], 3 T. C. 676 (1944); Gano v. Commissioner [Dee.

5962], 19 B. T. A. 518, 533 (1930) (inter alia, petitioner

deducted gambling losses as a loss “by fire, storm, etc.”) ;

ef. Dorsey v. Commissioner [Dec. 9109], 33 B. T. A. 295,

299 (1935) (petitioner labeled ordinary income as capital

gain on his return). On the partnership’s 1959 information

return filed with the State of California, the partnership

deducted $9,000 of bribes to public officials under such

varied labels as “professional fees”, “handling costs”, and

“service costs”, and petitioner was aware of this fact. The

purpose of these labels was to conceal from respondent’s

A-28

auditing agents the nature of the payments which peti-

tioner and his partners were making, and petitioner real-

ized that these labels would have this effect. On the infor-

mation returns for its last three fiscal years, 1961 through

1963, the partnership continued to use misleading labels

for its bribes, a usage of which petitioner continued to be

aware.

As we have indicated in our findings, in 1960, 1961, 1968,

and 1964, petitioner also used labels on his returns in de-

scribing his bribes which were calculated to mislead or

deceive. Although no such labels appear on his returns for

1959 and 1962, petitioner was aware in those years of the

partnership’s use of misleading categories.

EF. Preparation of tax returns

In each of the years in issue, petitioner employed one of

the recipients of his bribes, Michael J. MeLaughlin, to pre-

pare his income tax returns. We can hardly view as mere

inadvertence petitioner’s decision to select as his tax pre-

parer a person with so deep an involvement in petitioner’s

illicit activities and with so great a stake in keeping these

activities hidden, Petitioner knew that McLaughlin would

accept without question the information petitioner pre-

sented him in a summary form very near the filing dead-

line. Petitioner’s use of such a tainted artisan suggests to

us an awareness of a tainted product.

The preparation of petitioner’s 1964 individual tax re-

turn revealed another badge of fraud. In that year Me-

Laughlin told petitioner that he had deleted deductions

totaling almost $30,000 (representing bribes) and lowered

A-29

gross income by the same amount. Although McLaughlin

discussed these deletions with petitioner, petitioner did

nothing to rectify these omissions of almost $30,000.

After considering all of these various factors as they

applied to each of the six years in issue, we conclude that

respondent has clearly and convincingly established fraud

fer each year. Given our finding of fraud in 1959, 1960 and

1961, the statute of limitations is not applicable to these

yeas. Section 6501(c).

II. Specific Items of Income and Deductions

We now turn to the issues raised in relation to respond-

ent’s reconstruction of petitioner’s income. Respondent em-

ployed the specific item method of income reconstruction

under which he evaluates individual items of income or

deduction to determine whether they were properly re-

ported. His reconstruction is presutaptively correct, leav-

ing petitioner with, at the minimum, the burden of going

forward with the evidence to establish a prima facie case.

Clark v. Commissioner [59-1 ustc § 9430], 266 F. 2d 698,

706 (9th Cir. 1959).

The parties have raised many issues, some legal and

some factual. We shall first consider partnership pay-

ments to petitioner, and the partnership’s and petitioner’s

payments to third parties. We will then analyze petition-

er’s other sources of income. After that, we will move to

business expense disputes, and we will end with questions

involving itemized deductions.

A-30

A. Partnership payments to petitioner

(1) Escaping costs

From 1959 through 1963, the partnership paid petitioner

$25 per week as escaping costs, i.e. amounts allegedly to

reimburse petitioner for miscellaneous business expenses.

Respondent determined that these payments were income

to petitioner in the following amounts:

1959 . $1,025

er 1,

Ee ee 1,350

|. ee 1,300

PT ee 1,100

Respondent justifies this conclusion by arguing that peti-

tioner has not established that he incurred any expenses

for which he was being reimbursed, and we agree.

We have carefully analyzed the record for each year but

have found no credible evidence which establishes that

petitioner incurred any expenses for which he required

reimbursement. Rather, these regular payments are in the

nature of guaranteed payments made to petitioner without

regard to the income of the partnership. Section 707(c).

As such, these payments are treated as if they were made

to an employee. Such payments to an employee wouid

clearly be compensation and therefore constitute ordinary

income under section 6l(a). See Turner v. Commissioner

[Dee. 30,717], 56 T. C. 27, 33 (1971) (reimbursements by

corporate employer for expenses not accounted for by em-

ployee are includible in gross income) ; ef. Cockrell v. Com-

missioner [Dee. 25,562], 38 T. C. 470, 477-479 (1962), affd.

[63-2 usre J 9674], 321 F. 2d 504 (Sth Cir. 1963); Yeomans

v. Commissioner (Dee. 14,774], 5 T. C. 870, 875 (1945).

A-31

(2) Commission and other payments from

the partnership to petitioner

Respondent in his statutory notice determined that peti-

tioner failed to report the following items of income:

1961 Detail Income

Pacific Play Togs ........... Sony tee SF

Jack Tar Hotel .......... $9,409.60

less share to partnership ... 98,450.18 5,959.42

Commissions:

raety Shore Steel . Peon ts tee ROME: 34.62

MIT aero 5 viet lis acs fe wae 25.90

OT REE ey eee 400.00

Oliver Tire & Rubber Co. ................. 2.50

I yl at 25.00

Tax een paar "FIO SSE ee 5,929.00

Unreported partnership gross receipts ........ 2,693.35

a EE si AAR tm teeny Ate $16,568.89

10% partnership commission .... . ewe wart 712.31

10% partnership commission ................ 6,124.00

I I 0 ed 0 a Spine aces _ $ 6,836.31

Respondent further determined that petitioner reported

the 1961 items on Goldleaf’s returns.

On brief, respondent contended he was in error when he

determined that the 1961 Pacific Play Togs and Jack Tar

payments were made to petitioner by te partnership. He

now contends that these two payments were made directly

to petitioner by the clients in petitioner’s capacity as a

sole proprietor. Since respondent’s present position is in-

consistent with his position in the statutory notice, and

since the evidence petitioner would need to rebut the latter

differs from that needed to rebut the former, the burden

of persuasion shifts to respondent. Estate of Falese v. Com-

missioner [Dec. 31,517], 58 T. C. 895, 898-900 (1972);

A-32

McSpadden v. Commissioner {Dee. 28,998], 50 T. C. 478,

491-493 (1968).

We think respondent has failed to show that the 1961

Jack Tar payment was made to petitioner as an individual

rather than to him on behalf of the partnership. The evi-

dence in the record only indicates that the Jack Tar Hotel

made a payment to petitioner who then deposited the fee

in the Goldleaf account, shared a portion of it with Dawson,

Desmond and Van Cleve, and paid off Wolden through

Yeo from his Goldleaf account. However, whether paid to

him directly by the client or distributed to him as part of

his share of the profits of the partnership, it is taxable to

him as ordinary income.

We conclude that respondent has met his burden con-

cerning the 1961 Pacific Play Togs payment. The parties

have already stipulated that a comparable payment in 1962

was made to petitioner as a sole practitioner. The 1961 bill

prepared by petitioner was not on partnership stationery;

there is no mention of the partnership on any document;

and the resulting payment was deposited in Goldleaf’s

checking account and was listed on petitioner’s records.

Under these circumstances, we think that respondent has

met his burden.

All other payments noted above, including the payment

from Tax Management Associates, were payments made to

petitioner from the partnership as part of his share of

partnership profits under the partnership agreement.

Petitioner contends, as a factual matter, that respondent

did not submit any evidence into the record concerning the

A-33

method the partnership used to compute petitioner’s re-

ported distributive share of partnership taxable income

and so respondent cannot know whether these various pay-

ments are reflected in it. However, this argument assumes

that respondent has the burden of proof whereas the

burden of proof lies with petitioner, and properly so since

he is in a much better position than respondent to prove

the method used to compute his distributive share of part-

nership.income. Since the statutory notice carries a pre-

sumption of correctness and since petitioner introduced no

evidence on this point, we ho!u that the amounts involved

were not reflected in petitioner’s reported distributive share

of profits from the partnership.

Petitioner next argues that, as a legal matter, these

payments are necessarily either partnership distributions

under section 731 or reimbursement for partnership ex-

penses. Petitioner does not explain why he concludes sec-

tion 731 is applicable. Generally speaking, section 731 con-

cerns changes in a partner’s capital account whereas here

we are concerned with distributions of current partnership

profits to petitioner. There is no evidence that petitioner

was being reimbursed for partnership expenses in connec-

tion with any of these payments. Such amounts appear to

be advance distributions to petitioner of current profits

of the partnership taxable to petitioner as ordinary income

under section 702(a)(8), and treated as if distributed on

the last day of the partnership year. Section 1.731-1(a) (1)

(ii), Income Tax Regs.

A-34

B. Partnership and James C. Tooke &

Assocutes payments to public officials

or on their behalf

(1) Payments to Public Officials

Respondent, in his statutory notice, determined that pay-

ments made by the partnership and James C. Tooke &

Associates directly to members of assessor’s staffs or their

relatives were not allowable as deductions because they

were not ordinary and necessary expenses and because they

were bribes. Respondent therefore increased petitioner’s

income by the entire amount of payments made by his sole

proprietorship, i.e., the $1,675 payment to McLaughlin in

1960 and the $1,650 payment to Ralph Yeo in 1960, and by

petitioner’s one-third share of the re disallowed

partnership deductions: :

1959 1960 1961 1962 1963

Max Newstat ...... $2,200 Bert seanapate $687.35 $8,406.42

Art Spriggs ....... —" Testes re FS ei a ees, Chey

Michael McLaughlin. ...... RF RIE SAG PLY.

ooo Caees adele Coe

Cee gs sc ccnc. lh ewes Ds re kees Ae OU ee oe ee

RR ere i Co Gy ee a 700

Ralph Yeo ......... TB PAA ae Be By Oe

TOTAL ... $4,862 50 $7,235.95 $4,360.54 $687.35 $9,106.

Petitioner criticizes, as an initial matter, respondent’s

methodology. He argues that respondent must, as a matter

of law, determine that the partnership actually deducted

these expenses on its returns before respondent may

increase petitioner’s distributive share of partnership

income. By failing to do so, petitioner asserts, respondent

has acted in an arbitrary and capricious manner. We dis-

agree. We consider it quite reasonable, in light of the

partnership’s motives behind its preparing of false bills,

A-35

for respondent, at the stage of issuing his statutory notice,

to assume that the partnership deducted such payments.

In essence, petitioner’s argument constitutes an attempt

so to expand the notion of arbitrariness as to diminish

the scope of his burden of persuasion. Even though many

of the relevant partnership records may have been located

in New Jersey, petitioner was certainly in a better position

to investigate them than was respondent. Such ease of

inquiry is one of the principal factors justifying the pre-

sumption of correctness accorded to respondent’s statu-

tory notice. United States v. Rexach [73-2 uste { 9527],

482 F. 2d 10, 16 (1st Cir. 1973), cert. denied 414 U. S.

1039 (1973). Thus we think petitioner is the proper party

to bear the burden of establishing that the partnership

did not deduct these expenses. Since petitioner has failed

to establish this, we must decide against him on this issue.

Petitioner then contends that, even if the partnership

deducted these expenses, petitioner is only taxable on

his distributive share of partnership income, and that

respondent has failed to determine petitioner’s distributive

share. Respondent has attributed only petitioner’s share

of these amounts to petitioner. We think respondent has

adequately, even if summarily, indicated the effect on

petitioner’s distributive share resulting from the dis-

allowed deductions. If, however, an error was made, the

burden of so showing again rests on petitioner, who has

failed to meet this burden.

Petitioner next argues that respondent is incorrect and

that the partnership’s payments to government officials

and employees from 1959 through 1963 as well as _peti-

A-36

tioner’s payments in 1960 and 1964 are ordinary and neces-

sary business expenses and therefore are deductible under

section 162. He contends that they were appropriate,

helpful, and ordinary in the business of property tax con-

sulting. He argues that such payments to county tax

assessors were widespread, and that if the partnership

and James C. Tooke & Associates had not made them, they

could pot have competed successfully for clients.

However, petitioner has failed to prove that these pay-

ments were in fact widespread and that there were not

others in his profession who were carrying on their

business without resorting to bribing officials. An impor-

tant element in a finding of “ordinary” is that the expendi-

ture is customary within the taxpayer’s line of business.

Lilly v. Commissioner [52-1 ustce 7 9231], 343 U. S. 90

(1952) (commercial kic’ «xs); Deputy v. duPont [40-1

usre [9161], 308 U. © sm. (1940); Welch v. Helvering

[3 usre 7 1164], 290 L. © 111, 114 (1933); ef. Valetti v.

Commissioner [58-2 usre J 9869], 260 F. 2d 185, 186-187

(3d Cir. 1958) (commercial kickbacks); Diamond v. Com-

missioner [Dec. 30,888], 56 T. C. 530, 542-543 (1971)

(commercial kickback) ; United Draperies, Inc. v. Commis-

sioner [Dec. 26,602], 41 T. C. 457, 463 (1964) (commercial

kickback) [65-1 ustc J 9136], affd. 340 F. 2d 936 (7th Cir.

1964), cert. denied 382 U. S. 813 (1965). Petitioner, upon

whom the burden of persuasion lies, has not shown that

the practice of bribery was common among other firms in

his field. The only indication we have that any others

may also have bribed assessors is the numerous criminal

indictments where one or two others are named along with

petitioner and his partners as bribing assessors. This: in

A-37

no way establishes a custom in the industry. We conclude

that petitioner has failed to prove that bribes paid by

him were “ordinary.”

Respondent contends that the payments listed above

are not only not ordinary and necessary business expenses

but also are nondeductible as bribes under section 162

(c)(1), which provides as follows: .

No deduction shall be allowed under subsection (a)

for any payment made, directly or indirectly, to an

official or employee of any government, or of any

agency or instrumentality of any government, if the

payment constitutesan illegal bribe or kickback * * *

The burden of proof in respect of the issue, for the

purposes of this paragraph, as to whether a payment

constitutes an illegal bribe or kickback * * * shall be

upon the Secretary to the same extent as he bears the

burden of proof under section 7454 (concerning the

burden of proof when the issue relates to fraud).

Section 1.162-18(a)(12), Income Tax Regs., defines an

indirect payment to an individual as a payment which

inures to his benefit or promotes his interests regardless

of the medium in which the payment is made and regard-

less of the identity ef the recipient or payor. Examples

are payments made to an agent, relative or independent

contractor. Section 1.162-18(a)(3), Income Tax Regs., de-

fines an official or employee of a government as any indi-

vidual officially connected with the government of the

United States, a state, a territory or possession of the

United States, the District of Columbia or the Common-

wealth of Puerto Rico, or a political sub-division of any

of these political entities serving in any capacity and re-

gardless of compensation. In order to meet the burden of

A-38

proof of clear and convincing evidence, respondent need

not establish a criminal conviction or a plea of guilty or

nolo contendere. See Conf. Rept. No. 91-782, 91st Cong.,

Ist Session (1969), 1969-3 C. B. 644, 676.

It is clear that under the law of California, bribes paid

to or received by public officials or einployees are illegal.

The principal statutes prohibiting this conduct are Cal.

Penal Code, sections 67, 6714 and 68. Section 67 provides

that every person who gives or offers any bribe to any

executive officer in California with intent to influence him

in respect to any matter involving his official duties is

guilty of a felony. Section 6714 provides that any person,

who gives or offers any bribe to any ministerial officer,

employee or appointee of the State of California, county or

city therein or political sub-division thereof is guilty of a

felony or misdemeanor, depending on the size of the bribe.

Under section 68, every executive or ministerial officer,

employee or appointee of the State of California, county

or city therein or political subdivision thereof, who asks,

receives, or agrees to receive, any bribe upon any agree-

ment or understanding that his official duties will be in-

fluenced thereby is guilty of a felony.

Additionally, section 222 of the Charter of the City and

County of San Francisco, Rule 36 of the Civil Service Com-

mission of the City and County of San Francisco and

section 66 of the Charter of Alameda County, all prohibit

as improprieties any undertaking or employment which

would conflict with or influence the performance of any

official duties. Section 66 of the Charter of the County of

Alameda specifically prohibits any officer or employee re-

A-39

ceiving any money or thing of value or any benefit or

advantage directly or indirectly from or by reason of any

dealings with or service for the County, except his lawful

compensation.

The question of whether bribes have been paid within

the meaning of section 162(¢)(1) is predominantly a fac-

tual one pursuant to which all the facts and circumstances

are to be considered.

We conclude that respondent has shown by clear and

convincing evidence that at least the following payments

were bribes under section 162(¢) (1):

1959 1960 1961 1962 1963

Max Newstat ...... $2,200 .. $3,810.54 $687.35 $8,406.42

Michael McLaughlin . i $1,675 he ey Tiegh ry re

Don James ........ 700

We have found as facts that in 1962, 1963 and 1964, pe-

titioner received payments from the Jack Tar Hotel. He

seeks to deduct from this income the following amounts

which he paid over to Ralph Yeo:

ee es a 2,500

De No ee cct 1,550

Rt RR aby ad ier 1,750

We conclude, however, that he is not entitled to deduct

these Yeo payments because respondent has established

that they were bribes. We also conclude that a $3,750 pay-

ment to Yeo in relation to the 1964 American Can Com-

pany assessment was a bribe.

Petitioner also seeks to deduct as business expenses (al-

though not claimed on his returns) payments he made in

1964 to McLaughlin, Parrish and Newstat. We conclude

that one 1964 payment of $300 to McLaughlin was a bribe,

A-40

that two 1964 payments of $2,000 each to Parrish were

also bribes, and that payments of $4,457, $4,458 and $2,185

to Newstat were bribes.

(2) Partnership Entertainment of Public Officials

From 1959 through 1963, the partnership entertained

various public officials. Respondent in his statutory notice

determined that the following entertainment expenses were

includible in petitioner’s income and not deductible by the

partnership:

Partnership's Petitioner's

2 Expense 4% Share

ee Ly $ 182

1,109.81 $1,291.81 $430.60

Se acai. os 1,134.40 378.13

196] _.. ; 771.50 257.17

1962 . AS ao 364.64 121.55

EP a oy ot 277.73 92.58

Respondent, in addition, disallowed a deduction of $182 in

1959 as petitioner’s portion of partnership expense for en-

tertainment of Newstat and Wolden. Respondent contends

that these are not ordinary and necessary expenses. Pe-

titioner’s sole argument in opposition is that there is no

evidence indicating that the partnership actually deducted

these expenses. We have already discussed and rejected

this argument. Petitioner submitted no evidence on the

merits of this issue, leaving us no choice but to find for

respondent.

C. Other tax consulting related income

In 1960 the partnership paid Michael McLaughlin $6,000.

McLaughlin then paid $2,600 of this sum to petitioner.

Petitioner did not report this sum on his return. Respond-

A-41

ent determined that this kickback was income to petitioner.

Petitioner’s testimony that this was repayment of a loan

is unpersuasive. Since petitioner, on whom the burden er

persuasion lies, submitted no credible evidence on this

issue, we must decide in favor of respondent.

Respondent in his statutory notice determined that pe-

titioner, in his capacity as a sole proprietor, received net

fees from the Jack Tar Hotel of $4,227.74 in 1962 and

$3,167 in 1963. Petitioner contends that Jack Tar paid the

partnership, rather than petitioner. Respondent asserts

that the payments were made to petitioner, and we agree.

Petitioner bears the burden of proof concerning the Jack

Tar payments. He has, however, failed to show that the

partnership played any role in relation to these payments.

On the contrary, the documents entered into evidence in

relation to these payments consistently refer to petitioner

individually, not in his role as a partner. Petitioner fur-

ther argued that if these payments are included in his

income, then he is entitled to deduct certain payments that

he made to Ralph Yeo. We reject this argument, since, as

we indicated above, these payments were bribes and there-

fore not deductible.

D. Non-tax-consulting income

(1) Unidentified Bank Deposits

Respondent determined on the basis of the bank deposits

method that petitioner had $455 in income (in 1959) which

he had failed to report. Petitioner raised several legal ar-

guments in relation to respondent’s method. He contended

that for respondent to focus only on one or two bank de-

posits and then not to identify the source of the ones he

A-42

found suspect is arbitrary. He also asserts that respond-

ent cannot employ the bank deposits method in relation to

only a few deposits. We disagree. This Court has in the

past approved just such a method. Hollman v. Commis-

stoner (Dec. 25,495], 38 T. C. 251, 261 (1921), ef. O'Dwyer

v. Commissioner [Dec. 22,484], 28 T. C. 698, 705 (1957),

affd. [59-1 usre 7 9441] 266 F. 2d 575 (4th Cir. 1959),

cert. denied 361 U.S. 862 (1960). Thus the burden of per-

suasion remains with petitioner who, however, has offered

no evidence on this issue and has not employed any other

method of reconstruction to refute respondent. We find

for respondent.

(2) Rental Income

Petitioner owned several rental units during the years in

issue. Petitioner concedes receipt of $236.83 in unreported

rental income in 1960. For subsequent years respondent

determined the following amounts of unreported rental

income:

Year Amount

ARES aoe .. eee, 0,950.10"

Rt Sa RC as Saee TM ao 503.60

| Ste A SR Os 1,157.35

I ti ens ies Pa 900.79

The components of these amounts include rental income im-

properly reported by Goldleaf, improper expensing of capi-

tal expenditures, income on petitioner’s rental records

which exceed his reported rental income, and unidentified

bank deposits for 1964. Petitioner did not provide any

credible evidence on any of these issues and questioned

only one of them on brief. He contends that respondent’s

See footnote 5 on page A-19.

A-43

1964 determination that certain unidentified bank deposits

were income to petitioner is arbitrary. For the reason we

indicated earlier, we disagree. Since petitioner has failed

to carry his burden of persuasion, we decide in respond-

ent’s favor.

KE. Business expenses

In 1960 petitioner paid his brother $4,000 and, in 1961,

$4,207.81, and deducted these sums from his individual tax

returns. Respondent disallowed these payments as deduc-

tions on the ground that they were not ordinary and neces-

sary business expenses. Petitioner’s testimony that these

amounts were compensation for services rendered is not

persuasive. Petitioner, who bears the burden of persuasion

on this issue, has failed to submit any credible evidence

concerning these payments. We therefore decide in favor

of respondent.

Respondent determined that petitioner was not entitled

to $503.19 of deductions in 1963 and $2,126.75 of dedue-

tions in 1964. Petitioner introduced no evidence at trial in-

dicating that these were ordinary and necessary business

expenses. Since he has failed to meet his burden of persua-

sion, we find for respondent on this issue.

Petitioner claimed other business expenses on his 1963

and 1964 returns. Respondent determined (1) that the

partnership had reimbursed petitioner for $1,149.93 of ex-

penses which he deducted in 1963, (2) that petitioner’s de-

duction of $567.17 for 1963 travel expenses was not an

ordinary and necessary expense, and (3) that petitioner’s

spouse’s auto expenses in 1963 and 1964 were not ordinary

and necessary. Petitioner contested on brief only respond-

A-44

ent’s determination concerning his wife’s Cadillac expenses

and the other 1963 expenses. Petitioner, however, failed to

submit credible evidence on any of these issues, including

the auto expense. Therefore we hold against him.

F. Additional business deductions not

claimed on petitioner’s return

For 1962, 1963 and 1964 petitioner in his petition claimed

large, additional amounts of business deductions which he

alleges he failed to deduct in his original returns. His ad-

ditional claim for 1962 is $4,635.60, for 1963 is $9,531.40,

and for 1964 is $30,758.5i. The additional expenses range

from advertising, telephone, clerical, accounting, and enter-

tainment expenses, to referral fees. On brief, petitioner

conceded certain of these items for erch year.

In support of his additional claims for 1962 and 1963,

petitioner submitted into evidence certain handwritten

sheets containing figures representing yearly totals for cer-

tain expense items, such as entertainment and advertising.

Petitioner conceded that a portion of each expense cate-

gory was properly allocable to Goldleaf. To implement this

allocation, he multiplied each expense category in each

year by a fraction whose numerator was petitioner’s tax

consulting income for that year and whose denominator

was the total of petitioner’s tax consulting income for that

year and Goldleaf’s income for that year. Petitioner con-

tends that the resulting figure represents expenses incurred

in his tax consulting business which he did not deduct on

his original returns for 1962 and 1963.

A-45

We reject petitioner’s argument for a variety of reasons.

We first observe that petitioner has failed to substantiate

his expense summaries. He failed to submit into evidence

any of the underlying receipts or documents which allegedly

formed the basis for his summaries. The only evidence in

the record supporting these summaries is his oral testi-

mony, but we found his testimony to be totally lacking in

credibility. For certain of the items, he used certain ledgers

and check registers to refresh his memory. However, he

failed to submit these into evidence. Although we recog-

nize that due to the requirements of various criminal pro-

ceedings petitioner was deprived of many of his records,

we find his decision not to submit into evidence those

records which he still possessed to be inexplicable and open

only to adverse inferences. Wichita Terminal Elevator Co.

v. Commissioner [Dee. 15,171], 6 T. C. 1158, 1165 (1946),

affd. [47-1 usrc 9253] 162 F. 2d 513 (10th Cir. 1947).

Moreover, there is no evidence confirming petitioner’s allo-

eation fraction. On the contrary, petitioner himself indi-

eated that, for certain expense categories, the amount

properly allocable to Goldleaf exceeded its share under

the allocation fraction. Petitioner has simply failed to

establish that his fraction approach adequately reflected

the actual division of expenses between Goldleaf and peti-

tioner’s tax activities. Cf. Larsen v. Commissioner [Dee.

33,881], 66 T. C. 478, 483-484 (1976). Concerning his

claimed 1963’ entertainment expenses, we further conclude

that petitioner has failed to meet the substantiation re-

quirements under section 274(d). Section 1.274-5, Income

Tax Reg. We finally observe that, aside from petitioner’s

A-46

testimony which we have already indicated was incredible,

there is no evidence establishing that these expenses were

not, at least to some degree, already claimed on his orig-

inal income tax returns for 1962 and 1963.

In support of his claims for additional deductions for

1964, petitioner did not submit a summary sheet but in-

stead testified from a ledger and check register. As was

the case for 1962 and 1963, he failed to submit these under-

lying documents into evidence. We are thus left with noth-

ing to supplement his unpersuasive testimony. We also

observe that the record contains no credible evidence from

which we could conclude that petitioner had not already

claimed these expenses on his 1964 return. We further con-

clude that petitioner has failed to substantiate adequately

his entertainment expenses. Section 1.274-5, Income Tax

Regs. We finally note that we have earlier concluded that

some of petitioner’s additional claims are disallowed as

bribes.

G. Itemized deductions

In 1960 petitioner loaned $1,550 to Art Spriggs. In the

same year petitioner concluded that the debt was worth-

less and deducted $1,000 of it as a short-term capital loss.

In 1961 he deducted the remainder, Respondent disallowed

the deduction contending that petitioner had failed to es-

tablish worthlessness. We agree with respondent. There

is no credible evidence in the record from which we could

determine the year of worthlessness. Petitioner has failed

to carry his burden of persuasion with respect to this

issue. Cf. Mathews v. Commissioner [Dee. 32,161], 61 T. C.

A-47

12, 27 (1973), revd. on other grounds [75-2 ustc { 9734],

520 F. 2d 323 (Sth Cir. 1975), cert. denied 424 U.S. 967

(1976).

In 1963 petitioner purchased a new automobile and paid

$249.12 in sales tax. On his return he claimed a deduction

of $500 for sales tax. Respondent allowed only $180 as a

deduction. We have found as a fact that petitioner pur-

chased this auto, paid $249.12 in sales tax on it, and other-

wise paid $180 in sales tax in 1963. We therefore hold for

petitioner on this isue to this extent.

Decision will be entered under Rule 155.

APPENDIX “B”

United States Court of Appeals

for the Ninth Cireuit

James C. Tooke and Billie A. Tooke,

Appellants,

a No. 78-1855

so : Memorandum

Commissioner of Internal Revenue,

pss

{Filed March 21, 1979]

Appeal from the Decision of the United States Tax Court

Before: Ely and Wallace, Circuit Judges, and Pregerson,*

District Judge

The opinion of the Tax Court, while not officially re-

ported, can be found at § 77,091 P-H Memo TC.

The appellants’ attorney, with commendable ingenuity,

here makes numerous contentions in support of the appel-

lants’ basic argument that the opinion of the Tax Court

should be overturned. We have concluded that the conten-

tions must be rejected. The Tax Court’s opinion, authored

by Judge Hall, is written with detailed precision, and we

cannot find that the opinion is significantly fallacious,

either in respect to issues of law or issues of fact.

Accordingly, the challenged determinations of the Tax

Court are

AFFIRMED.

*Honorable Harry Pregerson, United States District Court for the

Central District of California, sitting by designation.

APPENDIX “C”

INTERNAL REVENUE CODE OF 1954 (26 U.S.C.)

Sec. 701. Partners, not partnership, subject to tax.

A partnership as such shall not be subject to the income

tax imposed by this chapter. Persons carrying on business

as partners shall be liable for income tax only in their

separate or individual capacities.

[See. 702]

Sec. 702. Income and credits of partner.

[See. 702(a) ]

(a) General Rule.—In determining his income tax, each

partner shall take into account separately his distributive

share of the partnership’s—

(1) gains and losses from sales or exchanges of capital

assets held for not more than 9 months,

(1) gains and losses from sales or exchanges of capital

assets held for not more than 1 year,

(2) gains and losses from sales or exchanges of capital

assets held for more than 9 months,

(2) gains and losses from sales or exchanges of capital

assets held for more than 1 year,

(3) gains and losses from sales or exchanges of property

described in section 1231 (relating to certain property used

in a trade or business and involuntary conversions),

(4) charitable contributions (as defined in section 170

(¢)), ‘

C-2

(5) dividends with respect to which there is provided an

exclusion under section 116, or a deduction under part VIII

of subchapter B,

(6) taxes, described in section 901, paid or accrued to

foreign countries and to possessions of the United States,

(7) other items of income, gain, loss, deduction, or

credit, to the extent provided by regulations prescribed by

the Secretary, and

(8) taxable income or loss, exclusive of items requiring

separate computation under other paragraphs of this sub-

section.

[Sec. 702(b) }

(b) Character of Items Constituting Distributive Share.

—The character of any item of income, gain, loss, dedue-

.tion, or credit included in a partner’s distributive share

under paragraphs (1) through (7) of subsection (a) shall

be determined as if such item were realized directly from

the source from which realized by the partnership, or in-

curred in the same manner as incurred by the partnership.

[See. 702(¢) |

(¢) Gross Income of a Partner.—In any case where it is

necessary to determine the gross income of a partner for

purposes of this title, such amount shall include his dis-

tributive share of the gross income of the partnership.

[See. 703 |

Sec. 703. Partnership Computations.

[ See. 703 (a) |

(a) Income and Deductions.—The taxable inconie of a

partnership shall be computed in the same manner as in the

case of an individual except that—

C-3

(1) the items described in section 702(a) shall be sep-

arately stated, anu

(2) the following deductions shall not be allowed to

the partnership:

(A) the deductions for personal exemptions pro-

vided in section 151,

(B) the deduction for taxes provided in section 164

(a) with respect to taxes, described in section 901,

paid or accrued to foreign countries and to possessions

of the United States,

(C) the deduction for charitable contributions pro-

vided in section 170,

(D) the net operating loss deduction provided in

section 172,

(I) the additional itemized deductions for individ-

uals provided in part VII of subchapter B (see. 211 and

following), and

(F) the deduction for depletion under section 611

with respect to oil and gas wells.

[See. 703(b) ]

(b) Elections of the Partnership.—Any election affecting

the computation of taxable income derived from a partner-

ship shall be made by the partnership, except that the elee-

tion under section 901, relating to taxes of foreign countries

and possessions of the United States, and any election

under section 617 (relating to deduction and recapture of

certain mining exploration expenditures), under section

57(c) (relating to definition of net lease), or under section

163(d) (relating to limitation on interest on investment in-

debtedness), shall be made by each partner separately.

C-4

[ Sec. 704]

See. 704. Partner’s Distributive Share.

[See. 704(a) |

(a) Effect of Partnership Agreement.—A partner’s dis-

tributive share of income, gain, loss, deduction, or credit

shall, except as otherwise provided in this chapter, be

determined by the partnership agreement.

Source: New.

[See. 704(b) }

(b) Determination of Distributive Share.—A partner’s

distributive share of income, gain, loss, deduction, or credit

(or item thereof) shall be determined in accordance with

the partner’s interest in the partnership (determined by

taking into account all facts and circumstances), if—

(1) the partnership agreement does not provide as

to the partner’s distributive share of income, gain, loss,

deduction, or credit (or item thereor), or

(2) the allocation to a partner under the agreement

of income, gain, loss, deduction, or credit (or item

thereof) does not have substantial economic effect.

[See. 705]

Sec. 705. Determination of Basis of Partner’s Interest.

[See. 705(a) ]

(a) General Rule—The adjusted basis of a partner’s

interest in a partnership shall, except as provided in sub-

section (b), be the basis of such interest determined under

section 722 (relating to contributions to a partnership) or

section 742 (relating to transfers of partnership inter-

ests )—

C-5

(1) increased by the sum of his distributive share for

the taxable year and prior taxable years of—

(A) taxable income of the partnership as determined

under section 703(a),

(B) income of the partnership exempt from tax

under this title, and

(C) the excess of the deductions for depletion over

the basis of the property subject to depletion;

(2) decreased (but not below zero) by distributions by

the partnership as provided in section 733 and by the sum

of his distributive share for the taxable year and prior

taxable years of—

(A) losses of the partnership, and

(B) expenditures of the partnership not deductible

in computing its taxable income and not properly

chargeable to capital account; and

(3) deereased (but not below zero), by the amount of

the partner’s deduction for depletion under section 611

with respect to oil and gas wells.

[Sec. 707]

See. 707. Transactions between Partner and Partnership.

[Sec. 707(e) ]

(c)GuARANTEED PayMeENTs.—T'o the extent determined

without regard to the income of the partnership, payments

to a partner for services or the use of capital shall be con-

sidered as made to one who is not a member of the partner-

ship, but only for the purposes of section 61 (a) (relating

to gross income) and, subject to section 263, for purposes

of section 162 (a) (relating to trade or business expenses).

C-6

[See. 722]

See. 722. Basis of Contributing Partner's Interest.

The basis of an interest in a partnership acquired by a

contribution of property, including money, to the partner-

ship shall be the amount of such money and the adjusted

basis of such property to the contributing partner at the

time of the contribution increased by the amount (if any)

of gain recognized to the contributing partner at such time.

[See. 731]

Sec. 731. Extent of Recognition of Gain or Loss on Dis-

tribution.

[See. 731 (a) ]

(a) Partners.—In the case of a distribution by a part-

nership to a partner—

(1) gain shall not be recognized to such partner,

except to the extent that any money distributed exceeds

the adjusted basis of such partner’s interest in the

partnership immediately before the distribution, and

(2) loss shall not be recognized to such partner, ex-

cept that upon, a distribution in liquidation of a part-

ner’s interest in a partnership where no property other

than that described in subparagraph (A) or (B) is dis-

tributed to such partner, loss shall be recognized to the

extent of the excess of the adjusted basis of such part-

ner’s interest in the partnership over the sum of—

(A) any money distributed, and

(B) the basis to the distributee, as determined

under section 732, of any unrealized receivables (as

defined in section 751(c)) and inventory (as defined

in section 751(d) (2).

C-7

Any gain or loss recognized under this subsection shall be

considered as gain or loss from the sale or exchange of the

partnership interest of the distributee partner.

[See. 731(b) ]

(b) Parrnersuips.—No gain or loss shall be recognized

to a partnership on a distribution to a par/ner of prop-

erty, including money.

[See. 731(¢) ]

(c) Excreprions.—This section shall not apply to the

extent otherwise provided by section 736 (relating to pay-

ments to a retiring partner or a deceased partner’s suc-

cessor in interest) and section 751 (relating to unrealized

receivables and inventory items).

| See. 733]

Sec. 733. Basis of Distributee Partner’s Interest.

In the case of a distribution by a partnership to a part-

ner other than in liquidation of a partner’s interest, the

adjusted basis to such partner of his interest in the part-

nership shall be reduced (but not below zero) by—

(1) the amount of any money distributed to such

partner, and

(2) the amount of the basis to such partner of dis-

tributed property other than money,:as determined

under section 732.

APPENDIX “D”

RULES

OF PRACTICE AND PROCEDURE

OF THE

UNITED STATES TAX COURT

Effective January 1, 1974

Rule 142. Burden of Proof. (a) General. The bur-

den of proof shall be upon the petitioner, except as other-

wise provided by statute or determined by the Court; and

except that, in respect of any new matter, increases in de-

ficiency and affirmative defenses, pleaded in his answer, it

shall be upon the respondent. As to affirmative defenses,

see Rule 39.

(b) Fraud. In any case involvi'g the issue of

fraud with intent to evade tax, the burden of proof in

respect of that issue is on the respondent, and that

burden of proof is to be carried by clear and con-

vincing evidence. Code section 7454(a).

(c) Foundation Managers. In any case involving

the issue of the knowing conduct of a foundation

manager as set forth in the provisions of Code sec-

tions 4941, 4944, or 4945, the burden of proof in respect

of such issue is on the respondent, and such burden

of proof is to be carried by clear and convincing evi-

dence. Code section 7454(b).

(d) Transferee Liability. The burden of proof is

on the respondent to show that a petitioner is liable

as a transferee of property of a taxpayer, but not to

D-2

show that the taxpayer was liable for the tax. Code

section 6902(a).

(e) Accumulated Earnings Tax. Where the notice

of deficiency is based in whole or in part on an alle-

gation of accumulation of corporate earnings and

profits beyond the reasonable needs of the business,

the burden of proof with respect to such allegation is

determined in aecordance with Code section 534. If

the petitioner has submitted to the respondent a state-

ment which is claimed to satisfy the requirements of

Code section 534(¢), the Court will ordinarily on

timely motion filed after the case has been calendared

for trial, rule prior to the trial on whether such state-

ment is sufficient to shift the burden of proof to the

respondent to the limited extent set forth in Code

section 534(a) (2).