Opposition Brief — Caulfield v. Commissioner

QUESTIONS PRESENTED

1. Whether the Commissioner properly reconstructed

petitioner’s taxable income under the bank deposits and

cash expenditures method.

2. Whether the Commissioner properly imposed

additions to tax against petitioner for negligence under

Section 6653(a) of the Internal Revenue Code and for

substantial understatement of tax liability under Section

6661 of the Code.

(I)

TABLE OF CONTENTS

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TABLE OF AUTHORITIES

Cases:

Blackwell v. United States, 244 F.2d 423 (8th Cir. 1957),

cert. denied, 355 U.S. 838 (1967) ...........0...cccccccosccosscesess

Commissioner v. Indianapolis Power & Light Co., 493

RESETS Sale SO Ee aa

Commissioner v. Tufts, 461 U.S. 300 (1988) ..................

Dodge v. Commissioner, 981 F.2d 350 (8th Cir. 1992),

cert. demoed, 114 S. Ct. GB (1GGB) .0.......000ccccccscccccocssesses.

Holland v. United States, 348 U.S. 121 (1954) ......0000....

Kearns v. Commissioner, 979 F.2d 1176 (6th Cir. 1992)..

Petzoldt v. Commissioner, 92 T.C. 661 (1989) ................

Rowell v. Commissioner, 884 F.2d 1085 (8th Cir. 1989) ....

Scallen v. Commisioner, 877 F.2d 1364 (8th Cir. 1989) ....

Schwartzkopf v. Commissioner, 246 F.2d 731 (3d Cir.

aa hndictinnneneunaveesecs

Singleton v. Wulff, 428 U.S. 106 (1976) .0..... eee

United States v. Abodeely, 801 F.2d 1020 (8th Cir. 1986) .

United States v. Johnson, 319 U.S. 503 (1948) .............

Statutes:

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(III)

In the Supreme Court of the Giuted States

OCTOBER TERM, 1994

No. 94-1229

JOSEPH P. CAULFIELD, PETITIONER

v.

COMMISSIONER OF INTERNAL REVENUE

ON PETITION FOR A WRIT OF CERTIORARI

TO THE UNITED STATES COURT OF APPEALS

FOR THE EIGHTH CIRCUIT

BRIEF FOR THE RESPONDENT IN OPPOSITION

OPINIONS BELOW

The opinion of the court of appeals (Pet. App. A32-

A838) is reported at 33 F.3d 991. The opinion of the Tax

Court (Pet. App. Al-A31) is unofficially reported at 66

T.C.M. (CCH) 710 (1993).

JURISDICTION

The judgment of the court of appeals was entered on

August 29, 1994. The petition for rehearing was denied

on October 19, 1994. The petition for a writ of certiorari

was filed on January 17, 1995. This Court’s jurisdiction

is invoked under 28 U.S.C, 1254.

(1)

STATEMENT

1. During 1982 and 1984, petitioner was a self-

employed insurance adjuster. His income tax return for

1982 reported gross business receipts of $380,891 and

business expense deductions of $380,379; his return for

1984 reported gross business receipts of $760,249 and

business expense deductions of $773,200 (Pet. App. A3).

Upon audit, the Commissioner determined that peti-

tioner’s books and records did not accurately reflect his

business receipts. Because of the absence of adequate

records, the Commissioner reconstructed petitioner’s

income using the bank deposits and cash expenditures

method (Pet. App. A4). Based on this reconstruction,

the Commissioner determined that petitioner had under-

reported his income for both years. The Commissioner

therefore issued notices of deficiencies and additions to

tax to petitioner (Pet. App. A13).

2. Petitioner contested the Commissioner’s deter-

minations in Tax Court. After trial, the Tax Court held

that petitioner failed to carry his burden of proving that

he did not realize the additional income determined by

the Commissioner (Pet. App. A13). The court therefore

upheld the deficiency determinations and the additions to

tax for negligence and substantial understatement of tax

under Sections 6653 and 6661 of the internal Reven

Code (Pet. App. A30-A31).

3. The court of appeals affirmed. The court rejected

petitioner’s contention that his records of income and

expense were adequate and that reconstruction of his

income was therefore improper (Pet. App. A33-A35).

The court noted initially that petitioner had not

preserved this issue for appeal because, in the Tax

Court, petitioner “‘[did] not challenge [the Com-

missioner’s] finding of inadequate records or otherwise

3

seriously question [her] authority to reconstruct his

income’” (Pet. App. AS84). The court concluded that

petitioner’s contention was in error in any event, for

“the problem in this case is not what [petitioner’s]

records showed, it was the substantial unrecorded

taxable income” (ibid.).

The court of appeals further determined that the

findings of the Tax Court upholding the Commissioner’s

reconstruction of petitioner’s income were not clearly

erroneous. The court noted that, even if some minor

errors occurred in the reconstruction, “[t]axpayers who

cannot produce adequate records ‘may not complain of

the inevitable inaccuracies in assessment their default

occasions’” (Pet. App. A36, quoting Dodge v. Com-

missioner, 981 F.2d 350, 353 (8th Cir. 1992), cert. denied,

114 S. Ct. 58 (1993)). Because petitioner had sub-

stantially underreported his income, the court sustained

the penalties and additions to tax imposed under Sections

6653 and 6661 of the Code (Pet. App. A36-A38).

ARGUMENT

The decision of the court of appeals is correct and does

not conflict with any decision of this Court or any other

court of appeals. Further review is therefore not war-

ranted.

1. Petitioner contends (Pet. 10) that reconstruction of

his income by indirect methods was improper because he

maintained adequate records for the years in issue.’ But,

1 In the Tax Court, petitioner “ ‘[did] not challenge [the Com-

missioner’s] finding of inadequate records or otherwise seriously

question [the Commissioner’s] authority to reconstruct his

income’” (Pet. App. Al13). The court of appeals thus properly

determined that petitioner failed to preserve this issue for appeal

(Pet. App. A34). See Singleton v. Wulff, 428 U.S. 106, 120 (1976);

Scallen v. Commissioner, 877 F.2d 1364, 1375 (8th Cir. 1989).

4

even when a taxpayer keeps books and records that

appear to support the return as filed, it is well

established that the Commissioner may determine the

taxpayer’s income through indirect methods. Holland v.

United States, 348 U.S. 121, 132 (1954); Blackwell v.

United States, 244 F.2d 423, 427 (8th Cir. 1957), cert.

denied, 355 U.S. 838 (1957); Schwartzkopf v. Com-

missioner, 246 F.2d 731, 733-734 (8d Cir. 1957). More-

over, as the court of appeals stated in this case, “the

problem [here] was not what [petitioner’s] records

showed, it was the substantial wnrecorded taxable

income” that they did not show (Pet. App. A384). The

inaccuracy of petitioner’s books and records was

confirmed by the Commissioner’s reconstruction of

income. Petitioner’s assertion that the Commissioner

should be required to accept petitioner’s erroneous

records at face value simply lacks any support.

2. Petitioner asserts that the Commissioner’s

determination of a deficiency in his tax was not entitled

to a presumption of correctness because the Com-

missioner failed to show a “rational basis” for the

determination. Petitioner correctly observes that “the

Commissioner must have some reasonable foundation for

the assessment to preserve the presumption of correct-

ness” and the Commissioner “must do more than

calculate income based on speculation” (Pet. 11). Peti-

tioner errs, however, in contending that the Com-

missioner’s determinations were based on “speculation.”

The Commissioner’s reconstruction of income was

based on petitioner’s bank deposits and cash expendi-

tures during the years in issue, most of which were

stipulated to by petitioner (Pet. App. A2-A13). In these

Petitioner concedes that he “did not focus on the adequacy issue”

(Pet. 9).

5

circumstances, the contention that the deficiency deter-

mination was based on speculation or had no rational

basis lacks any plausible support.

3. Petitioner also errs in contending (Pet. 11-12) that

slight errors found in the calculations underlying the

notice of deficiency deprive the Commissioner’s deter-

mination of the normal presumption of correctness. In

the absence of adequate records, the Commissioner’s

reconstruction of petitioner’s income was necessarily a

reasonable estimate. It has consistently been held that,

so long as a reasonable method is used for reconstruction

of income, the taxpayer cannot complain of the inevitable

inaccuracies that result from the taxpayer’s failure to

keep adequate records.” Dodge v. Commissioner, 981

F.2d at 353; Rowell v. Commissioner, 884 F.2d 1085,

1087-1088 (8th Cir. 1989). Mathematical exactitude is not

required of the Commissioner. If it were, it “would be

tantamount to holding that skillful concealment is an

invincible barrier to proof.” Petzoldt v. Commissioner,

92 T.C. 661, 693-694 (1989), quoting United States v.

Johnson, 319 U.S. 508, 517-518 (1943).

The calculations underlying the notice of deficiency

were accurate under the circumstances. Although

certain items, such as the opening balances of

petitioner’s bank accounts, were understated in the

computation in the notice of deficiency, the proper

figures were stipulated prior to trial and were reflected

in the Tax Court’s decision. Indeed, as the Tax Court

stated, “the unreported income determined by [the

Commissioner] for each of the years in issue is less than

2 The bank deposits and cash expenditures method is a

reasonable method for reconstructing income. See United States

v. Abodeely, 801 F.2d 1020, 1023 (8th Cir. 1986); Kearns v. Com-

missioner, 979 F.2d 1176, 1177 (6th Cir. 1992).

6

the amounts that would have been determined using the

deposits stipulated by the parties” (Pet. App. A17;

emphasis added). Petitioner cannot establish any harm

from a deficiency calculation that was less than the

amount of tax ultimately determined due.”

4. Petitioner errs in contending that the decision in

this case conflicts with the established proposition that

loan proceeds are not income (Pet. 15, citing Com-

missioner Vv. Indianapolis Power & Light Co., 493 U.S.

203, 207 (1990); Commissioner v. Tufts, 461 U.S. 300, 307

(1983)). As the Tax Court explained (Pet. App. A22-

A23), the Commissioner properly made allowance for the

non-taxability of loan proceeds by subtracting the

stipulated amount of loan proceeds from petitioner’s total

deposits to arrive at a net figure representing taxable

business receipts.

5. The courts below also properly sustained the im-

position of additions to tax against petitioner under

Section 6653(a) of the Code for negligence and under

Section 6661 for substantial understatement of tax

liability. With respect to the additions to tax for

negligence, the court of appeals noted (Pet. App. A36)

that petitioner “presented no evidence on this issue

other than to defend the accuracy of his tax returns.”

Because petitioner’s books and records did not report all

3 Petitioner errs in contending (Pet. 12-13) that the Com-

missioner failed to take into account nontaxable income pur-

portedly received from the settlement of lawsuits. As the Tax

Court noted (Pet. App. A24), petitioner introduced no documents

to substantiate the assertion that he received nontaxable income.

Indeed, the only evidence offered by petitioner on this point was

his testimony that he received an wnspecified amount of funds

from such settlements at some unspecified time in the 1980’s. That

testimony was insufficient to carry petitioner’s burden of proof to

demonstrate that the deficiency was inaccurate (Pet. App. A13).

7

of his business receipts and the Commissioner therefore

was required to reconstruct his income, the courts below

correctly concluded that the deficiencies in petitioner’s

income taxes were attributable, at least in part, to his

negligence (id. at A36-A37). Moreover, since there was

a “substantial understatement” of tax within the

meaning of Section 6661 of the Code for petitioner’s

taxable years 1982 and 1984, he was liable for the addition

to tax imposed by that Section unless he established sub-

stantial authority for his position. See 26 U.S.C.

6661(b)(2)(B)(i) and (ce). As the court of appeals noted

(Pet. App. A387), petitioner did not establish any

substantial authority for his failure to report income.

CONCLUSION

The petition for a writ of certiorari should be denied.

Respectfully submitted.

DREwW S. DAYS, III

Solicitor General

LORETTA C. ARGRETT

Assistant Attorney General

RICHARD FARBER

WILLIAM J. PATTON

Attorneys

FEBRUARY 1995