Appendix — House v. Commissioner

oe -upreme Court, U.S.

FILED

011734 mar 14 2002

No. | OPAIGE GF THE CLERK

THE SUPREME COURT OF THE UNITED STATES

JOSEPH J. HOUSE

Petitioner-Appellant

v.

COMMISSIONER OF INTERNAL REVENUE

Respondent-Appellee

ON PETITION FOR A WRIT OF CERTIORARI

TO THE SUPREME COURT OF THE UNITED STATES

APPENDIX TO

PETITION FOR A WRIT OF CERTIORARI

Joseph J. House

210 Muehl

Lockport, Illinois 60441

Telephone: 815-838-6182

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POETIC

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TABLE OF CONTENTS

Joseph J. House v. Commissioner of Internal Revenue Tax

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Joseph J. House v. Commissioner of Internal Revenue

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Amendment 8, Appendix 5............ccccssesssssssssssssecscsesecee. 47

T. C. Memo. 2000-22

UNITED STATES TAX COURT

JOSEPH J HOUSE, Petitioner v.

COMMISIONER OF INTERNAL REVENUE, Respondent

JOSEPH J. HOUSE INC., Petitioner v.

COMMISIONER OF INTERNAL REVENUE, Respondent

Docket Nos. 8664-98, 8665-98.

Filed January 19, 2000.

P is a former revenue agent with the Internal Revenue

Service and has been a return preparer for over 28 years. P

set up J-Co., a wholly owned corporation, purportedly to

conduct his accounting business. P also set up C-Co. to hide

his assets from the Internal Revenue Service and X-Co. for

his wife’s arts and crafts business. P conducted his

accounting business at his personal residence. P’s clients

hired him individually to prepare their returns. P was not an

employee of J-Co. and was not acting on J-Co.’s behalf when

servicing clients. J-Co. did not engage in a substantive

business activity. Neither P nor his family members

maintained personal checking accounts. P deposited all his

Appendix 1 -

l

gross receipts into J-Co’s account and paid all his business

and personal expenses from this account without maintaining

adequate records to differentiate between business and

personal items. P also transferred funds from this account to

the accounts of C-Co and X-Co to allow other family

members to use the funds for personal purposes. P reported

all receipts from his accounting services on J-Co’s return,

then deducted all business ad personal items therefrom,

disguising most of the items as “cost of goods solid”. J-Co

paid no tax. P did not report any income from J-Co on his

return for 1994, nor did he report income from the payment

of personal expenses.

Held: J-Co is a sham, and we disregard it for tax purposes.

Petitioner’s gross receipts, less allowable business expenses,

are includable in his income. Held, further: P is liable for-

the fraud penalty under sec. 6663, I.R.C.

Joseph J. House, pro se.

John J. Comeau, for respondent.

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2

MEMORANDUM FINDINGS OF FACT AND OPINION

LARO, Judge: These cases are before the Court

consolidated for purposes of trials, briefing, and opinion.

Joseph J. House (petitioner) and Joseph J. House, Inc. (JJH)

separately petitioned the Court to redetermine respondeni’s

determinations of the following deficiencies in Federal

income tax, addition to tax, and accuracy related to penalties.

Joseph J. House. Docket No. 8664-98

Accuracy-related penalty

Year Deficiency Sec. 6662(a)

1994 $32,921 $6,584

Joseph J. House Inc. Docket No. 8665-98

Year ended June 30 Deficiency

1994 $39,723

Sec. 6651(a)(1) Sec. 6662(a)

$9,931 $7,945

By amendment to answer in docket No. 8664-98,

respondent affirmatively asserted that petitioner was liable

for an increased deficiency in tax and that petitioner was

Appendix 1 -

3

tit apna IMO a tl Ere ae te PD NaN wo cert, BW ee RE

sett ibd ae amit hy Moncratey ABRs Sone tae

liable for the fraud penalty. (Respondent asserted in his

amendment to answer that petitioner failed to report

$156,197 in gross receipts instead of $77,550, as determined

in the notice of deficiency, and he asserted the entire

deficiency resulting therefrom was attributable to fraud.

Respondent did not set forth a specific dollar amount for the

increased deficiency or the fraud penalty, stating that the

amounts were computational). On brief, respondent

conceded the deficiency in tax, addition to tax, and accuracy

related penalty in docket No. 8665-98. Following

concessions of the parties, we decide the following issues:

Whether petitioner has unreported income in 1994

related to his accounting business. We hold he did to the

extent set forth herein.

Whether petitioner is liable for the fraud penalty. We

hold he is.

Unless otherwise indicated, section references are to

applicable provisions of the Internal Revenue Code, Ruie

references are to the Tax Court Rules of Practice and

Procedure, and dollar amounts are rounded.

Appendix 1 -

4

so

FINDINGS OF FACT

Some of the facts have been stipulated and are so

found. The stipulated facts and exhibits submitted therewith

are incorporated herein by this reference. Petitioner resided

in Lockport, Illinois, when he petitioned the Court.

Petitioner has been an accountant and tax preparer for

over 28 years, and he has a bachelor’s degree in accounting

from Lewis College in Lockport, Illinois. Petitioner worked

as a revenue agent for the Internal Revenue Service (the

Service) for 5 years in the 1970’s. While he was at the

Service, his duties included auditing Federal income tax

returned of individuals and corporations. Petitioner has

prepared thousands of Federal income tax returns in his

career, and he is knowledgeable about the Federal income tax

laws. Petitioner has also set up hundreds of corporations for

various individuals, and he serves as registered agent for at

least 163 of these corporations.

Petitioner is married to Charlene House (Charlene),

and they have two sons, Craig House (Craig) and Tim House

(Tim). Craig was a construction worker in 1994, and he built

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5

at least two homes during 1992 through 1994. Tim was a

college student at the University of Central Florida in 1994.

During all relevant times, petitioner, Charlene and Craig

lived at 210 Muehl, Lockport, Illinois (Muehl residence).

The Muehl residence was owned by Lewis Simmons

(Simmons), who rented the residence to petitioner.

Petitioner incorporated JJH in 1985 purportedly to

conduct his tax return preparation business. At all relevant

times, JJH’s address and business location were at the Muehl

residence. The Muehl residence has three levels: A

basement, a main floor and an upstairs floor where the

bedrooms are located. Petitioner conducted his return

preparation business in the basement, and he saw clients at

his office in the basement.

‘Tim has been collecting Walt Disney toys and

characters since he was very young, and his collection today

includes numerous figurines and other collectible items of a

variety of sizes and types (Disney collection). Petitioner is

similarly intrigued with Mickey Mouse, Donald Duck, and

the Walt Disney fantasy, and he enjoys sharing his affinity

Appendix 1 -

6

for these characters with others. (For example, petitioner

submitted his brief to the Court on a diskette bearing Mickey

Mouse’s image). When Tim left home for college, he left

behind his Disney collection, and petitioner displays the

Disney collection throughout the basement where he meets

tax and accounting clients.

During all relevant periods, petitioner was the

beneficial owner of all JJH’s stock. Petitioner did not have

an employment contract with JJH, and he was not an

employee of JJH. JJH had no employees and no officers or

directors. When clients obtained petitioner’s services, they

did not execute an engagement contract with JJH, and the

clients did not recognize JJH as the service provider. JJH did

not have a rental agreement for its office space from

Simmons; Simmons had a verbal agreement with petitioner

to rent the entire house to petitioner. JJH did not engage in a

business activity.

Charlene made fabric and wood country crafts that

she sold to craft malls. Petitioner and Charlene incorporated

Char’s Country Accents, Inc. (CCA) I 1986 to operate this

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7

eee oF +

business. Charlene and Craig were the owners and officers.

CCA’s address and location were at the Muehl residence.

In 1987, petitioner incorporated an entity he called

Coastal Leasing (Coastal) to conceal his assets form the

Service. Coastal’s address was the Muehl residence. Coastal

did not conduct an business activity, and petitioner used

Coastal to circulate funds among and between his other

entities and his family members. By 1994, petitioner allowed

Craig to operate his construction activities under the Coastal

name to give the appearance that Craig was a mature

individual with his own construction company.

The Bank Accounts

Neither petitioner, Charlene, no Craig maintained any

personal checking accounts of any kind. Petitioner

transferred funds freely among JJH, CCA and Coastal, as he

saw fit.

JJH Account — Petitioner opened an account in the name of

JJH in 1985 (JJH account) over which he had signature

authority, and this account remained open throughout 1994.

Petitioner used the JJH account as his personal and business

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8

account, and he paid all business and personal expenses

through this account. Charlene also had access to the account

and used it to pay some of her personal expenses. Petitioner

deposiced all income generated from her return preparation

business into the JJH account. Petitioner did not designate

what amounts in the account, if any, were salary or other

income to him, and he did not document whether expenses

paid from the account were business or personal. Petitioner

commingled his personal income and expenses with his

business income and expenses without limitation.

As relevant herein, petitioner wrote a total of $150,208 in

checks from the JJH account. Of the total, $47,105 related to

expenses of operating petitioner’s return preparation

business, and the $103,103 balance related to personal living

expenses of petitioner and his family.

For 1994, total deposits to the JJH account were $176,547,

comprising $144,812 in gross receipts and $31,735 in

transfers from CCA’s and Coastal’s accounts. Petitioner

withdrew virtually all of those deposits by either check or

withdrawal, leaving 1994 ending balance of $853. The

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9

~~

following is a summary of the checks drawn on the JJH

account during 1994:

Payee/Category Amount

Petitioner $4,680

Charlene 7,725

Coastal 18,525

CCA 8,375

Craig 1,950

Tim 14,454

Walt Disney 4,869

Utilities 6,768

Lewis Simmons _ 8,780

I.R..5 4,570

Other 63,514

TOTAL 144,210

Personal

$4,680

7,725

18,525

8,375

1,950

14,454

4,869

4,125

5,853

4,570

21,979

97,105

Business

$2,643

aei

{).

41,535

47,105

(Utilities — The total electric, gas, and water bills of the

Muehl residence were $3,948. We allocate one-third to

business use and two-thirds to personal use as there are

no separate meters for the basement of the residence, and

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10

petitioner has provided no credible evidence that this

allocation, which was proffered by respondent, 1s

improper. The balance of the utilities expense

compromises telephone expenses allocated $1,362 to

personal use and $1,458 to business use).

(Lewis Simmons — This represents rent for the Muehl

residence allocated one-third to business and two-thirds

to personal).

(Other — We allocate the following payment categories

100 percent to personal: River Park Apartments, $1,360;

Insurance, $8,631; Medical, $2,130; Misc. expenses

petitioner admits are personal, $3,621. We allocate the

following payment categories 100 percent to business:

Charles Losa, $5,276; Tax Court, $300; Dir of Labor,

$39; misc. payments $10,581; Office Max, $598; S.W.

Financial, $1,818; various individuals, $3,677; Cindy

Manzzi, $4,485, Postmaster, $2,526. On the basis of a

reasonable estimation and lack of exact substantiation in

the record, we allocate the following payments categories

50 percent to business and 50 percent to personal (amount

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11

stated is the total expense): Credit cards, $6,468; Hintze

Auctions, $4,360; cable, $953, automotive related,

$12,690).

None of the above personal expenses were ordinary and

A ae tat Se ARE Re

atiodt «

necessary business expenses of JJH or petitioner. The

checks to petitioner, Charlene, Coastal, CCA, and Craig

were for the personal use of petitioner and his family.

Sok nT AAS as A Stan, PRS Mt a OL Naat

The checks to Tim and the University of Central Florida

were for Tim’s tuition, room and board, and other college

expenses. The automotive expenses included petitioner’s

monthly car payments, payments for gas, and car

maintenance expenses. The payments to the IRS were

Sie Cane NRL it nah 9 Hs

payments for petitioner’s and Craig’s Federal income tax

obligations.

| CCA’s Account — CCA had a checking account over which

petitioner and Charlene had signatory authofity. Charlene

used this account as her personal checking account. The

deposits to this account during 1994 included $16,100 in

checks from JJH written to Charlene and CCA and

$9,000 in checks from Coastal. Charlene also deposited

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12

receipts from her craft business into this account, but she

did not know what portion of the deposits these receipts

were. During 1994, Charlene write approximately

$30,569 in checks from this account, including $9,400 in

checks to JJH, $7,700 in checks to Charlene or Coastal,

and other miscellaneous checks to cover personal living

expenses.

Costal’s Account — Coastal had a checking account over

which Charlene and Craig had signatory authority, but

petitioner was in control of the account, and Charlene and

Craig obtained petitioner’s approval before using the

funds. The Coastal account served primarily as a

“clearing account” through which petitioner circulated

fund for the purpose of paying Craig’s personal and

construction expenses, and other personal expenses of

petitioner’s family. During 1994, the deposits into

Coastal’s checking account consisted of primarily checks

written from JJH and also included checks from CCS and

a small amount of unidentified deposits. The transfers

from JJH’s account were not loans, and the transfers were

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not related to the petitioner’s accounting business.

(Petitioner admitted these transfers were made “on the

basis of an affinity, of a relationship” between him and

his family). Craig used the funds in the Coastal account

to pay some of his personal living and construction

expenses and to funnel money to other family members.

During 1994, Craig wrote a total of $39,863 in checks

from this account, including $22,335 in checks to JJH and

$11,920 in checks to petitioner, Charlene, CCA and

Craig.

Tax Reporting

: Petitioner — Petitioner filed a 1994 income tax return

j claiming married filing separate status. Charlene did not file

a return from 1994. On his 1994 return, petitioner reported

no salary, wages, dividends, or other compensation from JJH.

He reported total income of $31,500, comprising $1,000

Schedule C income, $10,000 rent income, $3,000 capital gain

income, and $17,500 as income from a covenant not to

compete. On the Schedule C attached to his return, petitioner

_ States that he was an “accountant” and that his business name

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v

was “House Accountant”. Petitioner failed to provide a

complete business address but states his office was in

Lockport, Illinois.

-JJH — Petitioner prepared and files returned for JJH

for the fiscal years ending June 30, 1994 and 1995, reporting

that the business activity of JJH was “sales” and the product

or service was “process;”. For these years, petitioner reported

gross receipts of $156,197 and $152,340, respectively. These

gross receipts equaled the total deposits into the JJH account

for both years. (For the calendar year, the reported gross

receipts equal the $176,547 in deposits identified). In

reporting the total bank deposits as gross receipts, petitioner

was aware he was including transfers from CCA’s and

Coastal’s accounts. Im each year, petitioner claimed the gross

receipts, and JJH paid no tax in either year. The claimed

deductions and cost of goods sold included the checks drawn

for business and personal items of $150,208 as set forth

above for calendar year 1994.

CCA’s Returns — Petitioner prepared and filed a

return on behalf of CCA for 1994, reporting gross receipts of

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15

Se + Es

$66,994, expenses and cost of goods sold of $68,358, and no

taxable income. Charlene has no idea what these figures

comprised or whether the reported gross receipts, expenses,

and cost of good sold were accurate. Most of the $68,358

claimed on CCA’s return was listed as cost of goods sold,

and a large portion of the cost of goods sold figure

represented personal living expenses of petitioner Charlene.

(Charlene admitted that she used the funds in the CCA

account for personal purposes, and there is insufficient

evidence in this record to determine what items, if any, were

business related).

Costal’s Return — Petitioner prepared and filed

Coastal’s returns for fiscal years ended June 30, 1994 and

1995, reporting as gross receipts $23,056 and $94, 952,

respectively. In both years, the reported expenses exceeded

the reported gross receipts, and Coastal reported no taxable

income and paid no tax. Craig signed the returns but had no

idea where the reported receipts came from or whether it was

accurate. The reported gross receipts comprise primarily of

checks and transfers from JJH’s account to Coastal.

Appendix 1 - -

16

The Audit

Revenue Agent Ruby Townsend (Townsend)

conducted the audits of petitioner’s and JJH’s returns at issue.

~ Petitioner was uncooperative with Townsend. Townsend

repeatedly requested to meet with petitioner and requested

that petitioner provide documents to substantiate the items on

his return and JJH’s return. After refusing several times to

meet with Townsend, petitioner reluctantly appeared for a

meeting wherein he provided no documents.

Respondent’s Determination

Respondent determined petitioner had unreported

income in 1994 of $81,879, computed as follows:

Deposits to JJH’s account $176,547

Less: Transfers from CCA

(9,400)

Less: Transfers from Coastal

(22,335)

Total gross receipts $144,812

Less: Business expenses ~ fai,

433)

Appendix 1 -

17

Taxable Income $113,379

Less: Reported Income erie

500)

Unreported Income 81,87

The unreported income figure is respondent’s revised

determination set forth on brief and is less than the amount he

set forth by amendment to answer.

Respondent determined that JJH is a sham and should be

disregarded for tax purposes, or, alternatively, that petitioner

improperly assigned his income to JJH.

OPINION

Economic Reality of JJH

Petitioner was a knowledgeable former Internal

Revenue Service agent who advised a deceitful plan to divert

and disguise his income and used his insight and skill in an

attempt to avoid detection.

We first decide whether JJH should be disregarded for

tax purposes. According to respondent, it should because it

lacked economic substance and is asham. We agree. The

burden of proof as to the $77,550 in unreported income

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respondent determined in the notice of deficiency. See Rule

142(a). Respondent has the burden of proof as to the $4,328

increase in unreported income and as to fraud. See Rule 142

(a) and (b). (On brief, respondent maintains that petitioner’s

unreported income was $81,879, leaving respondent with the

burden of proof on $4,328, the excess over the $77,550

determined in the notice of deficiency).

There is no dispute that JJH was properly organized

under Illinois law. However, even though a corporation is

organized under the laws of a State, we may disregard it for

Federal tax purposes if it is no more than a vehicle for tax

avoidance and void of a legitimate business purpose. See

Gregory v. Helvering, 293 U.S. 465 (1935); American Sav.

Bank v. Commissioner, 56 T.C. 828, 838 (1971); Aldon

Homes, Inc. v. Commissioner, 33 T.C. 582 (1959). While a

taxpayer is free to adopt the corporate form of doing

business, a corporation must engage in some meaningful

business activity to be recognized as a separate entity for tax

purposes. See Moline Properties, Inc. v Commissioner, 319

U.S. 436 (1943); Achiro vy. Commissioner, 77 T.C. 881

Appendix 1 -

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BRC Red wethen WMS nad Ni Ser aa Plt Cet Pah o

(1981). Avoiding taxation is not a business activity. See

National Carbide Corp. v. Commissioner, 336 U.S. 422, 437

n.20 (1949); Higgins v. Smith, 308 U.S. 473 (1940);

Gregory v. Helvering, supra. On this record, we find that JJH

lacked economic substance and was merely a paper entity

that engaged in no meaningful business activity.

The purported purpose of JJH was to render

accounting services, yet it had no employees to carry out this

purpose. (Petitioner reported a negligible amount of wages

paid on JJH’s returned but does not argue these wages were

paid to him, and the record does not disclose who purportedly

earned them. Petitioner has not suggested that JJH’s payment

of personal expenses constitute compensation). Petitioner

admits he was not an employee of JJH, testifying at trial “As

Joseph J House, the individual, I was not an employee. I did

not consider myself an employee of Joseph J. House inc. |

considered myself an independent contractor”. To the extent

petitioner suggests he was acting on behalf of JJH as an

independent contractor, we are not persuaded. Petitioner was

acting on behalf of himself individually when he rendered

Appendix | -

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services to clients. There was no employment or agency

contract between petitioner and JJH. There is no credible

evidence that there was a relationship between JJH and

petitioner’s clients or that the clients recognized JJH as the

service provider. The relationship was directly between

petitioner and his clients. Petitioner’s clients paid petitioner

directly. JJH did not pay petitioner compensation for his

services and did not issue him a Form 1099 or W-2. To

embrace petitioner’s argument, we would have to find that he

worked for JJH without compensation. We decline to do so.

Petitioner did not respect the separateness of JJH, and

he commingled his income and expenses with JJH’s.

Petitioner maintained no personal checking accounts, and he

treated JJH’s account as his own. Petitioner had dominion

and control over the account, and he readily admits that he

used it as his own, boasting at trial: “my home, my style of

living, is paid from by Joseph J. House, Inc.”, and that

“personal checkbooks are not a good thing”. See Denali

Dental Services v. Commissioner, T.C. Memo. 1989-482

(corporation a sham where its checking account was used as a

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- oe

“pocketbook” for payment of shareholder’s expenses). JJH

did not keep separate books and records of the deposits,

checks, transfers, or withdrawals from JJH’s account to

differentiate between business and personal income and

expenses. Instead, petitioner treated his affairs as one and the

sein with JJH’s.

JJH had no management other than petitioner, and

petitioner acknowledged that he was in complete control of

JJH. Petitioner’s contention the Charlene and Craig were

officers of JJH does not stand up in the face of the evidence,

which shows that they had nothing to do with its activities.

In discussing the use of the family corporations, petitioner

admitted that “This whole operation, this whole function, is

my responsibility * * *. These people (Charlene and Craig)

don’t understand what’s going on. They’re part of it; they

benefit from it, and they don’t understand”. Charlene’s

testimony corroborates petitioner’s admission, as she was

obviously unfamiliar with JJH. Charlene did not know what

JJH’s assets were, and she had no idea whether it operated at

a profit or loss. What Charlene did know about JJH was that

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it had a checking account from which she could withdraw

funds. Her knowledge about JJH’s affairs stopped there.

Craig knew even less about JJH, admitting that he does not

recall how or why he became an officer and that petitioner

just said “this is what we'll do”. Petitioner’s attempt to lend

legitimacy to the arrangement by naming his family as

officers of JJH is unavailing.

JJH did not contract with Simmons for rental of the

Muehl residence; petitioner did, and Simmons believed that

rent checks were personal payment from petitioner.

Petitioner prepared Simmons’ tax returns, and Simmons

considered petitioner individually his “tax person”. JJH did

not have services or utilities (e.g. telephone and electric)

billed in its name, and there is no other credible evidence that

it contracted with third partied or held itself out to the public

as a business. The only activity in which JJH engaged was

receiving, spending and circulating the funds earned by

petitioner. JJH was essentially a conduit through which

petitioner moved funds. Petitioner admitted JJH “repetitively

and continuously, in the normal course of business, transfers

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A iveiccceaaialll

RAN Shite ho Bale sj sD at

money to the account of Coastal Leasing; it transfers money

to the account of Char’s Country Accents; transfers money to

and from Joseph Craig House, the individual”. We find no

business purpose for this circular flow of funds.

In substance, there really was not JJH; there was only

petitioner. Petitioner recognized JJH once a year, at tax time,

and the fact that petitioner so recognized it and filed returns

on its behalf fails to legitimize its existence. As outlines

above, JJH was little more than a clearing account through

which petitioner moved funds, and the returns were the

vehicle through which petitioner improperly reported the

flow of funds and payment of personal expenses to avoid

taxes. Petitioner did not respect the separateness of JJH, nor

do we. We disregard JJH for tax purposes, and we hold that

petitioner had unreported income I the amount of $66,207

determined as follows:

Deposits to JJH’s account $176,547

Less: Transfers from CCA (9,400)

Less: Transfers from Coastal

—

(22,335)

Appendix 1 -

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Total gross receipts $144,812

Less: Business expenses (47,105)

Taxable Income $ 97,707

Less: Reported Income (31, 500)

Unreported Income ~ $66,207

(The unreported income figure is less than the unreported

income figure of $81,879 advanced by respondent on brief

because of out finding petitioner is entitled to additional

business expenses). We sustain respondent’s determination

of unreported income to the extent of $66,207.

Petitioner maintains that buried somewhere in JJH’s

large cost of goods sold figure are several other business

expenses which are deductible, in addition to the expenses of

$47,105 allowed above. We have carefully reviewed all

arguments made by petitioner as to his expenses, and we are

unpersuaded that he had business expenses greater than the

amounts decided herein. For example, petitioner argues that

in 1990, JJH obtained a covenant not to compete from

petitioner for $105,000 to be paid over a 6-year period, and

that $17,500 of the cost of goods sold represents a payment

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25

under the covenant. Purportedly, petitioner sold his stock in

JJH to a friend, Charles Losa (Losa) in exchange for $1,000

and a covenant not to complete. (The purported covenant

provides that petitioner will not compete with JJH for 6 years

within a 50-mile radius of the Muehl residence. Petitioner is

precluded from engaging in the following activities:

“Accounting Work, Bookkeeping, Financial Consulting, Tax

Preparation & Advice, Consulting, Service”). We are

unpersuaded and find petitioner’s testimony and documentary

evidence on this point not credible. We have already found

that petitioner remained the beneficial owner of the JJH stock

at all times, and petitioner’s contention that he transferred

anything other than nominal title to the stock is not credible.

Losa admitted that he was a shareholder in “name only” and

that the transfer was effected to get assets out of the

petitioner’s name because of his tax problems. Further, the

purported covenant is an unsigned document with no

effective date, and it does not identify to whom the covenant

is granted. Most telling, petitioner’s conduct belies the

existence of the covenant. He engaged in an accounting and

Appendix | -

26

tax business within the prohibited territory during the entire

prohibited period. Petitioner’s contentions as to covenant are

meritless.

Petitioner attempts to legitimize the payments made

by JJH to Tim and the University of Central Florida by

arguing the payments were attributable to a lease between

JJH and Tim for the use of Tim’s Disney collection.

Petitioner asserts that JJH made payments for the lease of

Mickey Mouse, Donald Duck, Goofy and other colorful

Disney characters in his basement office as bona fide

business expense. Petitioner’s story is as fantastic as the

Disney characters themselves. Petitioner did not know the

value of the collection or how many items were in the

collection, and there is no evidence the Disney collection

furthered any advertising goal. Charlene’s testimony that she

engaged in bona fide negotiations with Tim with respect to a

lease price on New Year’s Day in 1993 is not credible. The

lease document is concocted and backdated, and the stated

rent of $1,000 per month bears no relation to the actual

payments made to Tim or to the University of Central

Appendix 1 -

a7

Florida.

Petitioner argues that the payments by JJH to CCA,

Coastal, and Crai g were deductible because JJH transferred

funds to these entities “in the normal course of business”.

We disagree. Petitioner has put forth no credible evidence

that these payments by JJH to these entities or to Crai g are

deductible. To the contrary, petitioner’s own statements

Support our finding that the funds were circulated without a

business purpose to fund petitioner’s personal expenses. We

reject petitioner’s argument that the amounts paid to

Simmons are deductible interest payments. Simmons

admitted he rented the Muehl residence to petitioner, and the

fact that Simmons reported the payments from petitioner as

“interest” on his return is unpersuasive since is was petitioner

who prepared this return. Finally, petitioner argues generally

that all amounts paid by JJH are deductible because “personal

living expenses, when provided by an employer, are not

income to the person who receives it”. Petitioner’s argument

is without merit, and, on the basis of his knowledge ad

experience, petitioner knows it. We find all other testimony

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28

and evidence not discussed herein in favor of additional

deduction to be unpersuasive or incredible.

Fraud Penalty Under Section 6663

We turn now to the fraud penalty. Respondent bears

the burden of proving by clear and convincing evidence that

petitioners are liable for the penalty of fraud. See sec.

7454(a); Rule 142(b); Toussaint v. Commissioner, 743 F.2d

309, 312 (5" Cir. 1984), affg. T.C. Memo. 1984-25; Wright

v. Commissioner, 84 T.C. 636, 639 (1985). Respondent must

meet this burden through affirmative evidence because fraud

is never imputed or presumed. See Toussaint v.

Commissioner, supra at 312; Beaver v. Commissioner, 55

T.C. 85, 92 (1970). The existence of fraud is a question of

fact to be resolved from the entire record. See Gajewski v.

Commissioner, 67 T.C. 181, 199 (1976) affd. Without

published opinion 578 F.2d 1383 (8" Cir. 1978). Petitioners’

entire course of conduct can be indicative of fraud. See

tone v. Commissioner, 56 T.C. 213, 224 (1971); Otsuki v.

Commissioner, 53 T.C. 96, 105-106 (1969).

To satisfy his burden of proof, respondent must show

Appendix 1 -

29 -

two things. First, respondent must prove that an

underpayment exists. Respondent may not rely on

petitioner’s failure to disprove a deficiency determination to

satisfy this element. See Drieborg v. Commissioner 225 F.2d

216, 218 (6" Cir. 1955), affg. In part a Memorandum

Opinion of this Court; Parks v Commissioner, 94 T.C. 654,

660-661 (1990); Petzoldt v Commissioner, 92 T.C. 661, 700

(1989). Second, respondent must show petitioners intended

to evade taxes known to be owing by conduct intended to

conceal, mislead, or otherwise prevent the collection of taxes.

See Stoltzfus vy Commissioner, 398 F.2d 1002, 1004 (3d Cir.

1968); DiLeo v. Commissioner, 96 T.C. 858, 874 (1991),

affd. 959 F.2d 16 (2d Cir. 1992); Rowlee v. Commissioner,

80 T.C. 1111, 1123 (1983).

To satisfy the first prong, there must be clear and

convincing evidence to support respondent’s determination of

an underpayment; i.e. clear and convincing evidence that JJH

was a sham and that the income generated from petitioner’s

accounting serviced belonged to him. This prong must be

satisfied with affirmative proof, and a taxpayer’s failure to

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30

meet his or her burden of proof alone with not suffice. We

find such clear and convincing evidence here. Much of this

evidence came directly from petitioner’s own testimony,

including petitioner’s admissions that: He was not an

employee of JJH; he paid his personal expenses from JJH’s

account; the purported officers of JJH, Charlene and Craig,

knew nothing about JJH; he moves funds in a circular

manner among the accounts of JJH, CCA, and Coastal; and

he fabricated the numbers and categories on his 1994 return

(see discussion of fraud below). These admissions together

with the other evidence detailed under our discussion of the

deficiency are clear and convincing affirmative evidence that

petitioner underpaid his 1994 taxes.

With respect to the second prong of the fraud test; 1.e.,

that petitioner had the requisite fraudulent intent, fraud may

be proven by circumstantial evidence because fraud can

rarely be established by direct proof of the taxpayer’s

intention. See Rowlee v. Comesinsieaes. supra at 1123.

Courts have developed various factors of “badges” which

tend to establish fraud. Some of the “badges of fraud” are:

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31

(1) Understating income, (2) maintaining inadequate records,

(3) failing to file tax returns, (4) giving implausible or

inconsistent explanations of behavior, (5) concealing assets,

(6) failing to cooperate with tax authorities, (7) engaging in

illegal activities, (8) attempting to conceal activities, (9)

dealing in cash, and (10) failing to make estimated tax

payments. See Bradford v. Commissioner, 796 F.2d 303,

307-308 (9" Cir. 1986), affg. T.C. Memo. 1984-601; Clayton

v Commissioner, 102 T.C. 632, 647 (1994). We consider this

list nonexclusive, and we take into account all the unique

facts and circumstances of every case in determining whether

fraudulent intent exists.

After examination of some of the applicable factors

above as well as other factors in this case, we conclude

respondent has satisfied his burden of proving fraud.

Petitioner is a former Internal Revenue Service agent, which

gives him insight into audit techniques and the Services’

means of detecting inaccurate returns. He has practiced as a

return preparer and accountant for over 20 years, and is

knowledgeable about tax law. Petitioner put his knowledge

Appendix 1 -

32

and insight to use and tried to disguise his income to

underpay his taxes, and he tried to circumvent detection of

his deceit by the Service. In filing his return for 1994,

petitioner knew he was not reporting his income from his

accounting business of the income attributable to JJH’s

payment of his personal expenses, and he knew this was

contrary to the tax law. See Taxpayers Assistance Corp. v.

Commissioner, T.C. Memo. 1988-343 (taxpayer’s

background and experience taken into account as evidence of

fraud).

Petitioner used JJH, CCA, and Coastal to conceal his

income and personal expenses. The corporations were a

critical part of his scheme. Petitioner frequently circulated

funds among JJH, Coastal and CCA for no business purpose

and then used the funds in these accounts to pay personal

expenses. JJH’s and Coastal’s bank accounts were

petitioner’s and Charlene’s personal pocketbook. CCA’s

bank account was also Charlene’s personal pocketbook, and

petitioner funneled money from JJH and Coastal to this

account to fund Charlene’s expenditures. The use of a

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33

corporation to disguise the personal nature of income and

expenses is evidence of fraud. See Truesdell v.

Commissioner, 89 T.C. 1280, 1302-1303 (1987); Benes v.

Commissioner, 42 T.C. 358, 383 (1964), affd. 355 F.2d 929

(6" Cir. 1966).

Petitioner claimed the living expenses detailed in our

findings of fact as business expenses of JJH’s return,

concealing them as cost of goods sold. Petitioner deliberately

mischaracterized JJH’s business activity on its return to

create the appearance JJH was a merchandise business rather

than a service business, stating that JJH’s business activity

was “sales” and that the product or service was “process”. In

so mischaracterizing, petitioner intended that a large portion

of the personal expenses be buried in cost of goods sold,

minimizing the possibility that the personal nature of the

expenses would be detected. (Petitioner was aware that the

largest expense of a merchandising business is generally cost

of goods sold, and he knew a large cost of goods sold was

less likely to “red flag” his return than a larger expenses

elsewhere on the return). These claims were false and

Appendix 1 -

34

petitioner knew it. (As just one example, petitioner admitted

that the ineurance paid by JJH to Prudential was a personal

expense, and that he deducted it anyway, Stating: “It’s not

probably technically, in the truest accounting sense a good

thing to do”). Petitioner’s testimony that “any personal

expenses that are paid by the corporation are not deducted by

the corporation” is not credible. Finally, petitioner’s failure

to include in his income JJH’s payment of his personal

expenses resulted in a large understatement of his income.

Petitioner failed to maintain adequate records of his

income and expenses. Petitioner maintained three corporate

checking accounts from which he paid all business and

personal expenses, and he maintained no records to determine

which expenses were business and personal. The records

petitioner did keep were inadequate. Petitioner purportedly

maintained a ledger for his “draw account” for JJH. This

ledger recorded negligible amounts as “drawn” by petitioner,

did include JJH’s payment of the personal expenses, and did

_ hot correlate with the numbers on the petitioner’s return.

Petitioner admits he engaged in a pattern of

Appendix | -

35

concealing assets from the Service, and he was not reluctant

to acknowledge his disdain for paying taxes, bragging at trial

that he formed Coastal to hide his assets from the Service.

Petitioner failed to cooperate during the audit, and his

claim that the floor of the Muehl residence prevented him

from so doing is not credible. The flood did not destroy

relevant documents requested by respondent, such as bank

statements, canceled checks, or deposit slips, as evidences by

the fact petitioner was able to produce these documents close

to trial.

Petitioner precisely included in the income of JJH all

amounts deposited into its bank account, no.withstanding the

fact that he knew he was including transfers between

accounts and double counting income. (Petitioner testified:

‘Now, the problem with that income is that it includes

transfers and/or loans and/or exchanged of money between

those corporations of Joseph House, Coastal Leasing and

Char’s”). Petitioner points to this as evidence there was no

intent to deceive. To the contrary, this was part of the

deception plan. Petitioner admitted that he knew a tax

Appendix | -

36

auditor would always compare bank statements with reported

receipts. Petitioner’s ensuring that the numbers matched was

his attempt to deceive the Service into believing his return

and JJH’s return were accurate. This double counting of

income was of no consequence to petitioner since managed to

manipulate the numbers on all returns to the point where

there was little to no taxable income.

Petitioner intentionally mischaracterized items of

income on his 1994 return. He reported total income of

$31,5000, comprising $1,000 Schedule C income, $10,000

rent income, $3,000 capital gain income and $17,500 as

income from a covenant not to compete. At trial, he admitted

these categories were all concocted, stating: “I don’t mind

giving you [IRS] the elbow, but I’m not going to lie to him

[the Court]”. Petitioner mischaracterized his income to avoid

self-employment tax and to deter the Service from

discovering unreported income related to JJH. Petitioner’s

lack of candor was prevalent throughout the discovery

process and trial. (By interrogatory, respondent asked why

JJH paid the University of Central Florida, and petitioner

Appendix 1 -

37

stated the payments were for “equipment rental”. When

questioned on cross-examination about why JJH paid

petitioner’s personal living expenses, petitioner stated: “I’ve

got to live somewhere”).

Petitioner filed a separate return to avoid payment of

taxes on the unreported income in the event he got caught.

(Charlene did not file and testified that she bought her

husband out of JJH and took his name off everything

including the CCA signature card because of the IRS

collection activity. In avoiding the joint and several liability

of a joint return, petitioner hoped to remain free to transfer

assets and income to Charlene to frustrate the Service’s

collection activities). Petitioner’s attempt to legitimize JJH’s

payment of personal expense with his fabricated Disney

collection lease story and the covenant not to compete story

is further evidence of petitioner’s fraudulent intent. These

concocted stories show petitioner does not hesitate to

manufacture facts and events to further his interests.

(Petitioner similarty disliked having to pay out-of-state

tuition for Tim at the University of Central Florida, so he

Appendix 1 -

38

perpetrated the Disney collection lease scheme to create the

appearance the Tim was self-sufficient and had fixed income.

This allowed Tim to obtain residency status for tuition

purposes).

Petitioner’s fraudulent scheme was not just a family

affair, and he recommended it to others. He set up 163

corporations for other taxpayers. In at least one such case

where the Service challenged the personal expenses paid by

the corporation and deducted as cost of goods sold, petitioner

advised his clients to settle, stating: “Hey, we got away with

it for ten years, it’s time”. At trial, petitioner proudly stood

by his prior statement, bragging: “it was good advice then

and I stand by it now”. |

We conclude on this record that “it’s time” for

petitioner also. Respondent has proven by clear and

convincing evidence that petitioner underreported his income

in 1994 with the fraudulent intent of evading taxes. We

sustain respondent’s determination as to fraud.

We have considered all other arguments advances by

petitioner for a contrary result and, to the extent not discussed

Appendix 1 -

39

herein, find them to be irrelevant or without merit.

Decision will _

Rule 155 loc] N. 8664-98:

decision will for

petitioner in docket No. 8665-98.

Appendix | -

40

United States Court of Appeals

For the Seventh Circuit

Chicago, Illinois 60604

Submitted December 13, 2001

Decided December 14, 2001

Before

Hon. WILLIAM J. BAUER, Circuit Judge

Hon. FRANK H. EASTERBROOK, Circuit Judge

Hon. TERENCE T. EVANS, Circuit Judge _

No. 00-4037

JOSEPH J. HOUSE, Appeal from the United States Tax

Petitioner-Appellant, Court

No. 8664-98

COMMISSIONER OF David Laro,

INTERNAL REVENUE Judge.

Respondent-Appellee.

ORDER

Joseph House is an accountant and a former IRS agent.

In 1985 he incorporated Joseph J. House, Inc. (JJH), ostensibly

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41

for the purpose of conducting his accounting and return

preparation business. In 1998 the Commissioner issued separate

notices of deficiency against House and JJH for tax year 1994.

House and JJH separately petitioned for the redetermination, and

the two petitions were subsequently consolidated for trial. At

trial House proceeded pro se and also elected to appear o JJH’s

behalf, as the tax court rules permit him to do, see Tax Court

Rule 24(b). The tax court ultimately concluded that JJH would

be disregarded for federal income tax purposes because it “lacked

economic substance and was merely a paper entity that engages

in no meaningful business activity”. Based on this finding, the

tax court held that JJH owed no income taxes and that House

owed $28,544 in income taxes. House was also assessed a

$21,408 civil fraud penalty under I.R.C. 6663. House appealed

the tax court’s judgement as to him individually and as to JJH.

The appeal of JJH is not at issue here — that appeal was dismissed

because in this court House cannot represent JJH. Scandia Down

Corp v. Euroquilt, Inc. 772 F.2d 1423, 1427 (7" Cir. 1985) (“A

‘corporation’ is an abstraction, and abstractions cannot appear

pro se.”).

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42

On appeal House first contends (although in a rather

perfunctory fashion) that the tax court erred in imposing the civil

fraud penalty. He seems to suggest in particular that the

Commissioner failed to prove by clear and convincing evidence

that he fraudulently intended to evade taxes. The tax court

found, and we agree, that several indicia of fraud were present:

House used his knowledge of the tax laws to disguise his income

he used JJH, as well as two other corporations he formed, to

conceal his income and personal expenses by circulating funds

among the three corporations for no business purpose and then

using those funds to pay personal expenses; he deliberately

mischaracterized JJH’s business activity on its return as “sales”

so that he could bury his personal expenses in cost of goods sold;

he failed to maintain adequate records of his income and

expenses; he engages in a pattern of concealing assets from the

Commissioner; he failed to cooperate during the audit; and he

recommended his fraudulent scheme to others. See Pittman v.

Commissioner, 100 F.3d 1308, 1319 (7 Cir. 1996). In short, the

Commissioner presented overwhelming evidence of fraudulent

intent, and we see no basis on this record from concluding that

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43

the tax court committed clear error in imposing the civil fraud

penalty. See id.

House next asserts that the tax court’s finding of fraud

was erroneous because the court was “biased and prejudiced

against him”. This argument is meritless. The tax court decision

to impose the civil fraud penalty was based on the evidence

before it, and as we concluded above, its finding of fraud was not

clearly erroneous.

House lastly argues that the tax court erred by “allowing”

him to proceed on JJH’s behalf at trail. According to House, he

“had a conflict of interest in representing himself” and JJH.

JJH’s appeal was dismissed by this court, so this argument is not

properly before us. To the extent House is asserting that his

representation of JJH impeded his ability to represent himself, we

reject the argument. First, House did not have the right to the

assistance of counsel. If he had doubts about his dual

representation, then he should have hired a lawyer. Second,

House overlooks that he alone chose to proceed on JJH’s behalf,

see Tax Court Rule 24(b), and thus any prejudice allegedly

resulting from the dual representation was self-inflicted.

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44

Amendment 5

GUARANTY OF TRIAL BY JURY; PRIVATE PROPERTY

TO BE RESPECTED.

No person shall be held to answer for a capital, or otherwise

infamous crime, unless on a presentment or indictment of a grand

jury, except in cases arising in the land or naval forces, or in the

militia, when in actual service in time of war or public danger;

nor shall any person be subject for the same offense to be twice

put in jeopardy of life or limb; nor shall be compelled in any

criminal case to be a witness against himself, no be deprived of

life, liberty, or property, without due process of law; nor shall

private property be taken for public use, without just

compensation.

Appendix 3 -

45

Amendment 6

RIGHTS OF ACCUSED PERSONS

In all criminal prosecutions, the accused shall enjoy the right to a

speedy and public trial, by an impartial jury of the State and

district wherein the crime shall have been committed, which

districts shall have been previously ascertained by law, and to be

informed of the nature and cause of the accusation; to be

confronted with the witnesses against him; to have compulsory

process for obtaining witnesses in his favor, and to have the

assistance of counsel for his defense.

Appendix 4 -

46

Amendment 8

EXCESSIVE BAIL, FINES, AND PUNISHMENT

PROHIBITED

Excessive bail shall not be required, nor excessive fines imposed,

nor cruel and unusual punishments inflicted.

Appendix 5 -

47