AJF Transportation Consultants, Inc. v. Commissioner ( 1999 )

T.C. Memo. 1999-16
UNITED STATES TAX COURT
AJF TRANSPORTATION CONSULTANTS, INC., ET AL.,1 Petitioners
v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 12590-95, 24190-96, Filed January 28, 1999.
24482-96, 24483-96.
J is a corporation engaged in furniture delivery
services. F is J's sole shareholder and president. J's
client issued checks to J for its delivery services and for
fuel costs. F cashed the checks personally and diverted the
funds for his own personal benefit. None of the diverted
funds were reported as income on F's individual tax returns
or on J's corporate tax returns for the 1988, 1989, and 1990
taxable years. J did not timely file its corporate tax
returns for the years at issue. R determined that the full
amount of the diverted funds was taxable to both J and F.
R's deficiency notices were issued more than 3 years after J
and F's income tax returns were filed.
1. Held: The period of assessment is unlimited
because J and F filed fraudulent tax returns. Sec.
6501(c)(1), I.R.C.
1
Cases of the following petitioners are consolidated
herewith: AJF Transportation Consultants, Inc., docket No. 24190-
96; Anthony J. Ferrentino, docket No. 24482-96; and Anthony J.
Ferrentino and Carol L. Ferrentino, docket No. 24483-96.
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2. Held, further, the diverted funds were
constructive dividends and taxable to F in the manner
provided by secs. 301(c) and 316(a), I.R.C.
3. Held, further, the diverted funds were properly
includable in J's income. Sec. 61(a), I.R.C.; Commissioner
v. Glenshaw Glass Co., 348 U.S. 426, 431 (1955).
4. Held, further, J and F are liable for additions to
tax and penalties under secs. 6653(b) and 6663, I.R.C.
5. Held, further, J is liable for additions to tax
under sec. 6651(a), I.R.C.
Gary D. Borek, for petitioners.
Jerome F. Warner and Raymond M. Boulanger, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
NIMS, Judge: Respondent determined deficiencies, additions
to tax, and penalties for 1988, 1989, and 1990 with respect to
petitioner AJF Transportation Consultants, Inc.'s (AJF) Federal
income taxes as follows:
Additions to Tax Penalty
Year Deficiency Sec. 6653(b) Sec. 6651(a) Sec. 6663
1988 $90,137 $45,751.50 $7,284
1989 66,240 16,560 $36,099.75
1990 46,694 11,674 32,841.75
Respondent also determined deficiencies, an addition to tax,
and penalties for 1988 and 1989 with respect to petitioners
Anthony J. and Carol L. Ferrentino's Federal income taxes, and
for 1990 with respect to petitioner Anthony J. Ferrentino's
Federal income taxes, as follows:
Addition to Tax Penalty
Year Deficiency Sec. 6653(b) Sec. 6663
1988 $53,480 $38,440.50
1989 54,048 $32,292.75
1990 110,581 34,201.50
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The parties have agreed that petitioner Carol L. Ferrentino
is entitled to innocent spouse relief under the provisions of
sections 6013(e) and 6015 for the 1988 and 1989 taxable years.
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the years in issue, and
all Rule references are to the Tax Court Rules of Practice and
Procedure.
After concessions by both parties, the remaining issues for
decision are: (1) Whether an exception under section 6501(c) to
the general 3-year period of limitations on assessment under
section 6501(a) applies to petitioners' 1988, 1989, and 1990
taxable years; (2) if so, whether petitioners must include
diverted corporate funds in gross income; (3) whether petitioners
are liable for the additions to tax for fraud under section
6653(b) for 1988, and the penalties for fraud under section 6663
for 1989 and 1990; and (4) whether petitioner AJF is liable for
additions to tax imposed by section 6651(a) for failing to file
timely 1988, 1989, and 1990 income tax returns.
FINDINGS OF FACT
Background of Petitioners
Anthony J. Ferrentino (Ferrentino) was the president and
sole shareholder of AJF during the years at issue. Ferrentino
resided in Williamsville, New York, at the time the petitions
were filed. Ferrentino married Carol Ferrentino on December 30,
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1954. They separated in the fall of 1985, and on April 6, 1989,
they entered into a Separation Agreement, Support and Property
Settlement (Separation Agreement).
Under the Separation Agreement, Ferrentino was obligated to
pay Carol $376,000 over 8 years. Specifically, Ferrentino was
required to pay Carol Ferrentino $22,000 per year from 1989 to
1992, and was thereafter obligated to pay at least $22,000 per
year until the remainder of the obligation was satisfied.
Ferrentino has not paid all the amounts reflected in the
Separation Agreement. At various times between 1989 and 1991,
Ferrentino asked Carol to modify their Separation Agreement, or
forbear his obligation to pay the required amounts. Ferrentino
told Carol that she would recognize a greater return on her money
if she allowed Ferrentino to keep the funds owed invested in AJF.
Their divorce became final on May 4, 1990.
AJF is a New York corporation with principal offices in
Williamsville, New York, at the time the petitions were filed.
AJF is involved in the business of furniture delivery and is a
cash receipts and disbursement method taxpayer. AJF's employees
were mainly drivers, helpers for loading, helpers for drivers of
home deliveries, and tractor-trailer drivers.
During the years in issue, AJF earned income by performing
services for J.C. Penney Company, Inc. (J.C. Penney), pursuant to
a Delivery Service Agreement (Contract) dated March 6, 1987. The
Contract required AJF to deliver furniture to customers of J.C.
Penney and transport furniture for J.C. Penney from various
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locations, including the Buffalo, New York, and Toledo, Ohio,
distribution centers of J.C. Penney. AJF also performed delivery
work for J.C. Penney in other States and delivered fabricated
goods for the Buffalo Custom Decorating Division of J.C. Penney.
AJF used the trucks of J.C. Penney to perform its contract
services from 1988 to October 1990. Thereafter, AJF supplied
both the drivers and the trucks. J.C. Penney reimbursed AJF for
fuel purchased by AJF in performing its delivery services under
the Agreement. AJF employees used cash and corporate credit
cards for the purchase of fuel used in the delivery of J.C.
Penney products.
AJF's delivery employees, generally a driver and sometimes a
helper, maintained a "trip sheet" which was a diary of their
deliveries. The trip sheet formed the basis of AJF's payroll and
billing to J.C. Penney. The drivers would also maintain a
delivery manifest which listed tasks the drivers were to perform
for the day.
When AJF's employees delivered the furniture, they would
sometimes collect a COD (Cash on Delivery) from J.C. Penney's
customer. Under the Contract, AJF was responsible for the
collection of COD's and maintained a COD account which was an
account of cash collected from J.C. Penney's customers. The
delivery manifest reflected all the COD's collected and the form
in which those COD's were paid, e.g., checks, cash, or money
orders. The trip sheet or manifest contained the name or names
of employees on the particular delivery and listed expenses
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incurred by the driver. As of the time of trial, AJF did not
retain the delivery manifests or the trip sheets for the years in
issue.
The drivers were authorized to and did use COD cash funds to
pay for any expenses such as towing charges or anything out of
the ordinary and would insert the invoice for the services in an
envelope.
When AJF suffered a shortage of drivers for its scheduled
deliveries, it hired leased labor from Manpower Temporary
Services. During 1988, 1989, and 1990, AJF claimed expenses for
leased labor in the amounts of $5,074, $16,946, and $22,332,
respectively. AJF also claimed deductions for "driver expenses"
for 1988, 1989, and 1990 in the amounts of $37,172, $68,157, and
$60,596, respectively. Respondent has allowed these deductions.
Circumstances Surrounding Ferrentino's Cashing of AJF's Delivery
Service and Fuel Reimbursements Checks
During the years in issue, Ferrentino controlled all the
checks issued from J.C. Penney to AJF. Ferrentino determined
whether he would cash checks personally or have them deposited
into AJF's corporate operating account. Ferrentino knew that AJF
corporate income was determined by its accountants by examining
deposits into AJF's bank account. AJF's gross income was
determined from deposits to the bank account which were reflected
in the cash receipts journal. He also knew that if the checks
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for fuel reimbursement and delivery services were not deposited
into AJF's bank account, then corporate income tax returns would
not reflect these amounts.
J.C. Penney Custom Decorating Divisions (Custom Decorating)
issued checks to "AJF and/or A.J. Ferrentino" for services
performed. Ferrentino cashed checks issued by Custom Decorating
in the following amounts:
Year Amount Cashed by Ferrentino
1988 $70,721.02
1989 57,680.35
1990 53,030.51
AJF did not include these amounts in gross income on its Federal
income tax returns.
The J.C. Penney Buffalo distribution center issued checks
for fuel reimbursement solely to Ferrentino. During the years at
issue, Ferrentino cashed all but two fuel reimbursement checks
from the Buffalo distribution center. The cashed check proceeds
totaled:
Year Amount Cashed by Ferrentino
1988 $66,194.16
1989 65,725.26
1990 109,684.97
The J.C. Penney Toledo distribution center issued checks for
fuel reimbursement to "Anthony J. Ferrentino/AJF Trans. Inc."
Ferrentino cashed these checks in the following amounts:
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Year Amount Cashed by Ferrentino
1988 $26,457.17
1989 26,163.56
1990 148.34
AJF maintained a cash disbursements journal which tracked,
among other things, fuel expenses, but the journal did not
account for fuel reimbursements from J.C. Penney. Employees of
AJF would prepare an invoice entitled Fuel Billing which would be
sent to J.C. Penney for fuel reimbursement. These Fuel Billings
also included amounts for tolls and truck repairs. AJF's
accountants would use the cash disbursements journal to prepare
AJF's tax returns and financial statements.
AJF claimed deductions for "gas, oil and tires" expenses in
1988 and 1989 in the amounts of $184,621 and $183,651,
respectively. In 1990, AJF claimed a deduction for fuel expenses
of $195,035. AJF did not include any amounts relating to fuel
reimbursements in gross income.
Ferrentino's Cash Hoard
AJF maintained a business operating account at Manufacturers
Hanover Trust Co. (subsequently purchased by Fleet Bank).
Ferrentino cashed checks on approximately a weekly basis, usually
averaging $7,000 to $9,000 per transaction and paid in $100
denominations. On January 11, 1991, Ferrentino presented for
exchange $122,600 in water-damaged currency to the Federal
Reserve Bank in Buffalo. Of the amount presented, $75,000 was in
denominations of $100 or larger.
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Ferrentino's Guilty Plea to Filing a False Tax Return
On April 13, 1995, Ferrentino pleaded guilty to a one count
information charging him with willfully making and subscribing to
a false and fictitious U.S. income tax return for the year 1988
in violation of section 7206(1). On January 29, 1996, Ferrentino
filed Forms 1040X, Amended U.S. Individual Income Tax Return, for
the taxable years 1988, 1989, and 1990, which reported additional
income in the amounts of $30,975, $28,870, and $32,572,
respectively.
Respondent Issued Notices of Deficiency After the 3-Year Period
of Limitations on Assessment Had Expired
Ferrentino filed timely tax returns for the 1988, 1989, and
1990 taxable years. AJF, on the other hand, filed its tax
returns late. AJF filed its 1988 and 1989 tax returns on May 10,
1991, and its 1990 return on July 17, 1991.
Respondent mailed notices of deficiency on August 13, 1996,
with respect to petitioners' 1988, 1989, and 1990 income tax
returns. The general 3-year period of limitations on assessment
under section 6501(a) expired before the issuance of the notices
of deficiency in these consolidated cases.
Circumstances Surrounding the Late Filing of AJF's Tax Returns
John Witkowski, C.P.A. (Witkowski), prepared AJF's tax
returns during the years in issue. When preparing the returns,
Witkowski relied on AJF's books and records, which included
receipts journals, disbursement journals, payroll records, and
bank reconciliations. Witkowski determined AJF's gross income
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from AJF's cash receipts journal. Expenses were determined using
check registers and cash-paid-out journals. AJF's books and
records did not disclose amounts pertaining to the fuel
reimbursement checks from the J.C. Penney distribution centers,
nor did they disclose the Custom Decorating checks for delivery
services.
In general, after the returns were prepared for clients
including petitioners, Witkowski's office would contact the
client, who would normally pick them up. If the client had not
picked them up after a reasonable length of time, Witkowski's
office would again contact the client.
Witkowski signed AJF's corporate returns for 1988, 1989, and
1990 on June 15, 1989, June 1, 1990, and July 8, 1991,
respectively. For some unexplained reason, the 1988 and 1989
corporate returns reflect that Ferrentino signed them on May 6,
1991. He signed the 1990 corporate return on July 12, 1991.
OPINION
I. Fraudulent Return Exception
Since the 3-year period of limitations on assessment under
section 6501(a) has expired with respect to the taxable years at
issue, respondent is barred from assessing the deficiencies
unless an exception to section 6501(a) applies.
However, section 6501(c) provides exceptions to the general rule.
The pertinent exception in this case is found in section
6501(c)(1) which provides that "In the case of a false or
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fraudulent return with the intent to evade tax, the tax may be
assessed, or a proceeding in court for collection of such tax may
be begun without assessment, at any time."
Where respondent asserts that a taxpayer has filed a
fraudulent return with the intent to evade tax, the burden of
proof is on the respondent. Sec. 7454(a); Rule 142(b).
Respondent must satisfy his burden of proof with "clear and
convincing evidence". Rule 142(b); Fox v. Commissioner, 61 T.C.
704, 717 (1974). To establish fraud, respondent must prove, by
clear and convincing evidence, for each year and with respect to
each petitioner, that: "(1) petitioner underpaid his income tax
and (2) some part of the underpayment was due to fraud."
Recklitis v. Commissioner, 91 T.C. 874, 909 (1988) (citations
omitted); see also Hebrank v. Commissioner, 81 T.C. 640, 642
(1983).
Although respondent need not prove the precise amount of the
underpayment resulting from fraud, respondent may not carry his
burden by merely relying on a taxpayer's failure to carry the
burden of proof on the underlying deficiency. DiLeo v.
Commissioner, 96 T.C. 858, 873 (1991), affd. 959 F.2d 16 (2d Cir.
1992); Otsuki v. Commissioner, 53 T.C. 96, 106 (1969).
A. Underreporting of Tax
Respondent asserts that petitioners had unreported income
arising from the checks issued by J.C. Penney for delivery
services rendered by AJF to Custom Decorating and fuel
reimbursements for fuel expenses incurred by AJF.
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Petitioner AJF concedes that checks which were cashed by
Ferrentino, received from Custom Decorating for delivery
services, should have been included in AJF's gross income.
However, petitioners argue that the fuel reimbursements are not
includable in gross receipts of AJF, and the proceeds from
Ferrentino's check cashing are not includable in his gross income
because he used the proceeds to pay "casual labor" for
performance of services for which the checks were issued,
entitling him to deduct such amounts from gross income resulting
in no underpayment.
1. Fuel Reimbursement Checks
The first question is whether the fuel reimbursement checks
should be included in AJF's gross income. Section 61(a) defines
the term "gross income" as "all income from whatever source
derived", except as otherwise provided by law. Income has been
defined as "undeniable accessions to wealth, clearly realized,
and over which the taxpayers have complete dominion."
Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 431 (1955).
Unless specifically excluded by another provision of the Internal
Revenue Code, all income is subject to tax. Id. at 430.
Therefore, reimbursed expenses must be included in gross income,
but these expenses may be deducted only if allowed under other
provisions of the Internal Revenue Code and if adequately
substantiated. Rietzke v. Commissioner, 40 T.C. 443, 453 (1963);
Vaughn v. Commissioner, T.C. Memo. 1992-317, affd. without
published opinion 15 F.3d 1095 (9th Cir. 1993).
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Petitioners argue that the unreported fuel reimbursement
checks should not be included in gross income because the checks
were repayments of a loan made from AJF to J.C. Penney for
expenses incurred by AJF on behalf of J.C. Penney. It is true
that we have previously held that "'where a taxpayer makes
expenditures under an agreement that he will be reimbursed
therefor, such expenditures are in the nature of loans or
advancements and are not deductible as business expenses.'"
Canelo v. Commissioner, 53 T.C. 217, 224 (1969) (quoting Patchen
v. Commissioner, 27 T.C. 592, 600 (1956)), affd. 447 F.2d 484
(9th Cir. 1971).
Nevertheless, as respondent points out, AJF deducted amounts
for fuel reimbursement expenses on its 1988, 1989, and 1990 tax
returns which persistent course of action is inconsistent with
petitioners' assertion that the reimbursements were repayments of
a loan. We have also held that "Taxpayers are entitled to attack
the form of their transactions only when their tax reporting and
other actions have shown an honest and consistent respect for
what they argue is the substance of the transactions." FNMA v.
Commissioner, 90 T.C. 405, 426 (1988), affd. 896 F.2d 580 (D.C.
Cir. 1990).
Neither AJF's cash disbursements journal nor other
accounting records treated the fuel reimbursements as loan
repayments. Had AJF intended to treat the fuel reimbursement
arrangement as a loan, it would not have claimed deductions for
fuel expenses.
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In sum, AJF's tax reporting and other actions have not shown
an honest and consistent respect for what petitioners argue is
the substance of these reimbursements. Therefore, respondent has
shown by clear and convincing evidence that the fuel
reimbursement checks should be included in AJF's gross income.
2. Inclusion of AJF's Custom Decorating Checks and
Fuel Reimbursement in Ferrentino's Gross Income
The next question is whether Ferrentino, as president and
sole shareholder of AJF, must include the Custom Decorating and
fuel reimbursement checks in gross income because he cashed the
checks personally. Generally, "income that is subject to a man's
unfettered command and that he is free to enjoy at his own option
may be taxed to him as his income, whether he sees fit to enjoy
it or not." Corliss v. Bowers, 281 U.S. 376, 378 (1930).
Respondent argues that Ferrentino should include the
diversions as ordinary income. Ferrentino, on the other hand,
argues that the cashed checks do not represent income to him
because he received the checks on behalf of AJF as its "agent"
and that the cash was held in "constructive trust" to pay a
business expense of AJF.
Generally, "a taxpayer need not treat as income moneys which
he did not receive under a claim of right, which were not his to
keep, and which he was required to transmit to someone else as a
mere conduit." Diamond v. Commissioner, 56 T.C. 530, 541 (1971),
affd. 492 F.2d 286 (7th Cir. 1974). No tax is imposed upon the
receipt of money in a fiduciary or agency capacity. Stone v.
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Commissioner, 865 F.2d 342, 343 (D.C. Cir. 1989); Heminway v.
Commissioner, 44 T.C. 96, 101 (1965). However, where a
shareholder uses corporate property for his personal benefit, not
proximately related to corporate business, the shareholder must
include the value of the benefit in income as constructive
dividends to the extent of the corporation's earnings and
profits. DiZenzo v. Commissioner, 348 F.2d 122, 125 (2d Cir.
1965), revg. in part and remanding for additional findings to
support the Tax Court's holding, T.C. Memo. 1964-121, remanding
T.C. Memo. 1966-16; Truesdell v. Commissioner, 89 T.C. 1280, 1294
(1987); Falsetti v. Commissioner, 85 T.C. 332, 356 (1985).
Ferrentino argues that he used the check proceeds to pay for
"casual labor" needs of AJF during certain peak times or when
additional help was needed. Respondent counters that any
additional labor needs of AJF were satisfied by the use of leased
helpers from Manpower Services.
The burden of proof to establish the existence of cash
payments to casual labor is on petitioners. Once respondent
establishes the existence of unreported income and allows the
deductions claimed on the return, he does not have the further
burden of proving the negative that the taxpayer did not have any
additional deductions. See Perez v. Commissioner, T.C. Memo.
1974-211 (citations omitted). One Court of Appeals has stated
that "This rule is grounded on the realization that it would be
virtually impossible for the Government to show the negative fact
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that a taxpayer had no unreported deductions or exclusions."
United States v. Bender, 218 F.2d 869, 871 (7th Cir. 1955).
Respondent is entitled to rely on the
presumption that the deductions and exclusions listed
by a taxpayer in his return are all that exist. This
presumption is based upon reasonable experience * * *
and has the effect of shifting the burden of going
forward with the evidence to the * * * [taxpayer], when
the Government has shown unreported income. [United
States v. Lennon, 246 F.2d 24, 27 (2d Cir. 1957)
(quoting United States v. Bender, supra at 871-872).]
In this case, Ferrentino has admitted, by filing amended
returns for the years in issue, that he had unreported income.
AJF has conceded that it should have reported the amounts earned
from delivery services for Custom Decorating. Furthermore,
respondent has shown that the fuel reimbursement check amounts
should have been included in AJF's gross income. Therefore,
since respondent has shown that petitioners had unreported
income, the burden of proving the existence of cash payments to
casual labor lies with Ferrentino.
Relying on Perez v. Commissioner, supra; Richardson v.
Commissioner, 264 F.2d 400 (4th Cir. 1959), affg. in part, revg.
in part T.C. Memo. 1958-59, and H.J. Feinberg & Co., Inc. v.
Commissioner, a Memorandum Opinion of this Court dated Sept. 20,
1950, Ferrentino argues that respondent should be required to
present affirmative evidence disputing Ferrentino's claim of
"casual labor" expenditures. In these cases, the courts
recognized that understatements of gross receipts did not
establish that a taxpayer had fraudulently intended to evade tax
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where the taxpayer also showed that he had offsetting deductions
relating to such receipts that he failed to claim on his return.
Zack v. Commissioner, T.C. Memo. 1981-700, affd. 692 F.2d 28 (6th
Cir. 1982).
The taxpayers in Perez, Richardson, and H.J. Feinberg & Co.,
Inc. submitted positive proof that unreported deductible payments
were in fact made and were related to their respective unreported
receipts. Zack v. Commissioner, supra. Based on such proof, the
courts shifted the burden of going forward to the Commissioner to
prove that at least some unreported net income resulted from the
unreported transactions. Id. Therefore, to shift such burden to
respondent, Ferrentino must submit credible evidence of whether
and to what extent he made such payments.
The underlying support for Ferrentino's claimed "casual
labor" cash payments rests on Ferrentino's credibility, on the
testimonial credibility of AJF's employees, and on a report
authored by Elaine Brittain (Brittain), AJF's office manager.
It is well established that we are not required to accept
self-serving testimony in the absence of corroborating evidence.
Niedringhaus v. Commissioner, 99 T.C. 202, 212 (1992); Tokarski
v. Commissioner, 87 T.C. 74, 77 (1986). Ferrentino testified
that he cashed the checks when he needed funds to pay for casual
labor. Brittain testified that she obtained cash from Ferrentino
to cover shortages of COD funds received by the drivers. But
Brittain's testimony indicates that she did not have personal
knowledge of a casual laborer ever working at AJF. Donald
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Travis, an employee of AJF, testified that he could recall hiring
his son, Doug, and a person named Harold. Andrew Davis, another
employee, testified that he had once hired his ex-brother-in-law,
and a "big Indian gentleman" whose name started with a "C" and
was "7 foot tall."
For the reasons stated below, we hold that Ferrentino has
not submitted credible evidence of any cash payments made to
casual labor.
Petitioners have presented no documentation to corroborate
the oral testimony of the above-mentioned witnesses. AJF did not
maintain any records of alleged payees who received cash for
services performed as casual laborers during the 1988, 1989, and
1990 taxable years. AJF did not retain the trip sheets or
delivery manifests which might have verified the existence of
casual labor. AJF did not maintain any lists of names of any
casual laborers, records reflecting casual labor hours worked, or
records of individual earnings in a given year of any casual
laborer. Employment tax returns prepared by Brittain did not
show casual laborers being paid in cash. AJF did not maintain
records of how many alleged casual laborers were paid in cash.
Finally, AJF did not require receipts from alleged casual
laborers when they were paid in cash.
A factor which dilutes the credibility of Ferrentino and
Brittain's testimony is that casual labor was never mentioned
during audit. Revenue Agent Kathleen Oswald, who conducted the
audit of AJF, testified that neither Ferrentino nor Brittain had
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disclosed casual labor expenses during audit. Had Ferrentino
actually paid cash for casual labor, we think that Ferrentino or
Brittain would have disclosed the payments during the audit
process instead of waiting until litigation commenced.
Petitioners did not introduce testimony of any purported
casual laborer. The rule is well established that the failure of
a party to introduce evidence within his possession and which, if
true, would be favorable to him, gives rise to the presumption
that, if produced, it would be unfavorable. Wichita Terminal
Elevator Co. v. Commissioner, 6 T.C. 1158, 1165 (1946), affd. 162
F.2d 513 (10th Cir. 1947). Donald Travis testified that his son
Doug was used as casual labor. Andrew Davis testified that he
hired his ex-brother-in-law as a casual laborer. We think that
petitioners could have called these people to testify, under
subpoena, if necessary, without undue hardship. Therefore, we
presume that these alleged casual laborers would have testified
unfavorably.
Petitioners' most strenuous effort to establish cash
payments for casual labor took the form of a report (Report)
authored by Brittain which attempted to illustrate the use by AJF
of cash payments in very large amounts for casual labor. If the
Report were to be believed, AJF expended cash for casual labor in
the respective amounts of $98,670.65, $138,220.40, and $102,480
in 1988, 1989, and 1990, respectively.
Petitioners claim that Brittain's Report accurately computed
the number of hours attributable to the alleged casual labor by
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comparing AJF's payroll figures to the billing invoices for
services rendered by AJF to J.C. Penney. Brittain used the
billing invoices to determine the total number of manpower hours
AJF employees actually rendered to J.C. Penney. She used AJF's
payroll records to determine the number of manpower hours
attributable to AJF employees as reflected on the payroll
records. The Report attributed the difference between the
payroll and billing invoice figures to "casual labor". For
example, the Report concludes that for the second quarter of 1988
the manpower hours attributable to casual labor totaled 2464.3
hours. The Report derived this figure by subtracting 41,670.3
manpower hours shown on AFJ's payroll records from the manpower
hours of 44,134.6 shown on the invoices.
Brittain's Report is laced with flaws. For purposes of
computing payroll manpower hours, the Report treated all
employees listed in the Report as drivers, even though they had
helpers who were also on the payroll. The record indicates that
a delivery truck required two people: a driver and a helper.
Brittain testified that she had no way of knowing which
individual was a driver or a helper. In fact, she had no way of
knowing, in her Report and the records it was based on, the
capacity in which a particular employee was employed. Thus,
drivers listed in the Report could instead have been helpers.
The Report thus arbitrarily assumes that the helper on any given
delivery truck crew must have been a casual laborer not listed on
the payroll who was paid in cash. It follows that the hours
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attributed to casual labor--if any were in fact hired--were
erroneously increased because payroll manpower hours were
erroneously treated as drivers' hours alone. Moreover, the
Report does not account for the hours attributable to leased
labor which AJF had deducted on its tax returns. This omission
further erroneously inflates the hours attributable to casual
labor. Therefore, we cannot trust the accuracy of the Report.
The credibility of Brittain's Report is further challenged
by other evidence. Brittain admitted on direct examination that
her Report was prepared specifically for this litigation to
support her theory that there must have been substantially more
manpower hours than shown on AJF's payroll records, and which
therefore must have been worked by casual laborers paid solely in
cash. As we have observed, AJF failed to produce records which
could have verified the existence of casual labor and the numbers
used in the Report. Brittain testified that the trip sheets that
drivers used, nonexistent as of the time of trial, would have
shown whether casual labor was used. Since the Report bases
manpower hours attributable to delivery services on the trip
sheets, these key figures in the Report cannot be verified.
Brittain did not keep any records on the number of alleged casual
laborers used.
Brittain testified that she had knowledge of casual labor
being paid in cash, but did not include the amount paid to casual
labor on employment tax returns and did not withhold amounts from
laborers' wages. Brittain also testified that she knows
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everything about the business of AJF, with the exception of how
to drive a truck, but does not know how many casual laborers were
used. Finally, Brittain's testimony indicates that she herself
doubts the accuracy of her Report. When asked whether the
Buffalo office hired casual laborers, Brittain replied,
"probably, yes." The tentativeness of her response suggests a
significant lack of confidence in her Report.
Based on the foregoing, we reject the Report in its entirety
due to its flawed analysis and lack of credibility. Since
Ferrentino cannot show that payments were made for casual labor,
we conclude that Ferrentino used the funds derived from cashing
the delivery service and fuel reimbursement checks solely for his
own benefit.
Since Ferrentino used the check proceeds solely for his
personal benefit, we must then decide whether Ferrentino must
include the value of the check proceeds as dividends in gross
income. Under sections 301(c) and 316(a), dividends are taxable
to the shareholder as ordinary income to the extent of the
corporation's earnings and profits, and any amount received by
the shareholder in excess of earnings and profits is considered a
nontaxable return of capital to the extent of the shareholder's
basis in his stock. Any amount received in excess of both the
earnings and profits of the corporation and the shareholder's
basis in his stock is treated as gain from the sale or exchange
of property. Truesdell v. Commissioner, 89 T.C. 1280, 1294-1295
(1987).
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Dividends may be formally declared or they may be
constructive. A constructive dividend is found where a
corporation confers a benefit upon its shareholder in order to
distribute available earnings and profits without expectation of
repayment. Truesdell v. Commissioner, supra at 1295. Therefore,
if Ferrentino is to be required to include the constructive
distribution in gross income as a dividend, AJF must have had
earnings and profits sufficient to support the distribution of a
dividend.
The U.S. Court of Appeals for the Second Circuit, the Court
to which this case would normally be appealable, has held that in
cases where the Commissioner alleges fraudulent intent to evade
income tax with respect to the diversion of corporate funds which
is not per se unlawful, the burden of proof is on the taxpayer to
establish that the corporation did not have earnings and profits
equal to the amounts diverted. DiZenzo v. Commissioner, 348 F.2d
at 127.
Section 312(a) provides that a corporation's earnings and
profits are reduced by, among other things, the amount of money
distributed with respect to its stock. Earnings and profits for
a particular period include tax-exempt income, as well as items
included in gross income under section 61. Sec. 1.312-6, Income
Tax Regs. We are required to make a finding as to whether AJF
had sufficient earnings and profits to sustain a dividend.
DiZenzo v. Commissioner, supra at 127 (remanding to the Tax Court
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to make a finding with respect to whether amounts of accumulated
earnings and profits were at least equal to a constructive
distribution).
The only evidence with respect to AJF's earnings and profits
is AJF's tax returns for 1988, 1989, and 1990. The tax returns
reveal that AJF reported taxable income of $151,199 and $247,037
in 1988 and 1989, respectively. AJF's 1990 tax return reports a
$2,169 loss. Since we have held that AJF should have included
the amounts of the checks cashed by Ferrentino in gross income,
earnings and profits for 1988, 1989, and 1990 must be increased
by $163,372.35, $135,458.78, and $162,863.82, respectively. If
distributed funds constitute constructive dividends, earnings and
profits should be reduced by such amount under section 312(a).
Enoch v. Commissioner, 57 T.C. 781, 800 (1972). Because AJF is
on the cash receipts and disbursements method of accounting,
accrued tax liabilities and penalties do not reduce earnings and
profits until paid. Sec. 1.312-6(a), Income Tax Regs.
Petitioners have presented no credible evidence requiring the
further reduction of AJF's earnings and profits.
We conclude that petitioners have not shown that AJF had
insufficient earnings and profits to sustain a dividend to
Ferrentino for each of the years in issue. The evidence shows
that AJF had sufficient current earnings and profits to sustain a
dividend in each of the 1988 and 1989 taxable years. Although
AJF shows a deficit of $2,169 in taxable income for the 1990
taxable year, AJF had sufficient accumulated earnings and profits
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to sustain a dividend. Therefore, the constructive distributions
from AJF to Ferrentino must be included in Ferrentino's income as
a dividend.
Accordingly, we hold that respondent has shown by clear and
convincing evidence that Ferrentino had underpayments in tax for
the years in issue due to unreported dividend income in the
amounts he diverted from AJF by cashing the Custom Decorating and
fuel reimbursement checks.
B. Underpayments Due to Fraud
Since we have found that respondent has shown by clear and
convincing evidence that petitioners had underpayments of tax for
the years in issue, the next issue is whether some part of
petitioners' underpayment each year was due to fraud with the
intent to evade tax. Fraud is established by showing that the
taxpayer intended "to evade tax believed to be owing by conduct
intended to conceal, mislead, or otherwise prevent the collection
of such tax." Recklitis v. Commissioner, 91 T.C. 909. Tax
evasion need not be a primary motive, but the respondent may
satisfy his burden by showing that a "'tax-evasion motive
[played] any part' in petitioner's conduct". Id. Respondent
must establish fraud on the part of each petitioner for each
taxable year involved by clear and convincing evidence. Otsuki
v. Commissioner, 53 T.C. 96, 105 (1969).
The fraud of a sole or dominant shareholder can be
attributed to the corporation. Benes v. Commissioner, 42 T.C.
358, 383 (1964), affd. 355 F.2d 929 (6th Cir. 1966); see also
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DiLeo v. Commissioner, 96 T.C. 875 (1991), ("[C]orporate fraud
necessarily depends upon the fraudulent intent of the corporate
officers."), affd. 959 F.2d 16 (2d Cir. 1992). In these cases,
Ferrentino is the sole shareholder and president of AJF. He
exercised total control over all the checks issued from J.C.
Penney to AJF. Ferrentino determined whether he would cash
checks personally or have them deposited into AJF's corporate
operating account. We think Ferrentino exercised sufficient
control over the affairs of AJF to justify imputing to AJF any
fraud committed by Ferrentino.
The existence of fraud is a question of fact to be resolved
upon examination of the entire record. Parks v. Commissioner, 94
T.C. 654, 660 (1990); Recklitis v. Commissioner, supra at 909.
Fraud is never presumed, but it must be established by
independent evidence. Beaver v. Commissioner, 55 T.C. 85, 92
(1970); Otsuki v. Commissioner, supra at 105. Fraud may be
proven by circumstantial evidence because direct evidence of the
taxpayer's intent is rarely available. Recklitis v.
Commissioner, supra at 910; Rowlee v. Commissioner, 80 T.C. 1111,
1123 (1983).
Circumstantial evidence of fraud includes:
(1) Consistent and substantial understatement of
income, (2) failure to maintain adequate records, (3)
failure to cooperate with an IRS investigation, (4)
inconsistent or implausible explanations of behavior
and (5) awareness of the obligation to file returns,
report income and pay taxes. [Douge v. Commissioner,
899 F.2d 164, 168 (2d Cir. 1990) (citing Bradford v.
Commissioner, 796 F.2d 303, 307-308 (9th Cir. 1986),
affg. T.C. Memo. 1984-601).]
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Other badges of fraud include concealing assets, extensive
dealings in cash, Recklitis v. Commissioner, supra at 910,
failure to file timely returns, Kotmair v. Commissioner, 86 T.C.
1253, 1261 (1986), and failure to provide tax return preparers
with complete and accurate information, Korecky v. Commissioner,
781 F.2d 1566, 1569 (11th Cir. 1986), affg. T.C. Memo. 1985-63.
Ferrentino presented a cash hoard of $122,600 to the Federal
Reserve Bank in Buffalo, New York. According to the required
Currency Transaction Report, $75,000 of the amount presented was
in bills of $100 or higher. The record indicates that when
Ferrentino cashed the Custom Decorating and fuel reimbursement
checks, Manufacturer's Hanover would generally cash the checks in
$100 denominations. During audit, Ferrentino told Revenue Agent
Oswald: (1) He did not report the cash hoard as income, (2) he
knew that the source of the cash hoard constituted taxable
income, and (3) he called the cash hoard pocket monies. At
trial, Ferrentino explained that he had accumulated the cash
hoard over a period of 15 to 18 years. He further testified that
the cash hoard resulted from the selling and restoration of
furniture and that he accumulated the cash hoard in anticipation
of his divorce.
Based on the amount of $100 bills presented to the Federal
Reserve Bank and the fact that Ferrentino received $100 bills
when cashing the checks at Manufacturer's Hanover, we may
justifiably infer that part of Ferrentino's cash hoard was
attributable to the cashed checks. We may further infer that
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Ferrentino hoarded the cash to conceal income from his wife,
Carol Ferrentino, in order to avoid meeting the obligations
enumerated in the Separation Agreement. It is therefore fair to
apply to Ferrentino and his devious course of conduct what we
said in a prior case; namely, "that a man who will misappropriate
another's funds to his own use through * * * concealment will not
hesitate to * * * conceal his receipt of those same funds from
the Government with intent to evade tax." McGee v. Commissioner,
61 T.C. 249, 260 (1973), affd. 519 F.2d 1121 (5th Cir. 1975).
Ferrentino's extensive use of cash is a further badge of
fraud because it indicates a desire to avoid detection of income-
producing activities. Bradford v. Commissioner, T.C. Memo. 1984-
601, affd. 796 F.2d 303 (9th Cir. 1986). Petitioners have not
presented credible evidence of cash payments to casual labor.
Furthermore, Ferrentino did not disclose during audit that the
delivery service and fuel reimbursement checks were issued and
cashed. Instead, respondent became aware of Ferrentino's
dealings only through contacts with J.C. Penney and Wittlin,
Ferrentino's accountant at the time. The circumstances here
suggest that Ferrentino was attempting to conceal income.
Ferrentino pleaded guilty to violating section 7206(1) for
the taxable year 1988. Section 7206(1) makes it a crime for a
taxpayer to willfully make and submit any return verified by a
written declaration that it is made under the penalties of
perjury which he does not believe to be true and correct as to
every material matter. Wright v. Commissioner, 84 T.C. 636, 639
- 29 -
(1985). While not dispositive on the issue of fraud, it is a
factor we may consider relevant. See id. at 639-640. The
Supreme Court has defined "willfully", as used in section
7206(1), as "a voluntary, intentional violation of a known legal
duty." United States v. Pomponio, 429 U.S. 10, 12 (1976). We
think Ferrentino's intentional filing of a false tax return for
1988 is strong indicia of fraudulent intent with respect to the
1988 taxable year.
The failure to provide tax return preparers with complete
and accurate information is also an indication of fraud.
Witkowski determined AJF's gross income from AJF's cash receipts
journal. AJF's books and records did not disclose the fuel
reimbursement checks from the J.C. Penney distribution centers,
nor did they disclose the delivery service checks from Custom
Decorating. Ferrentino knew that AJF's corporate income was
determined by deposits to its operating account. He also knew
that by not depositing the Custom Decorating and fuel
reimbursement checks, AJF's corporate tax returns would not
report these amounts. Under these circumstances, Ferrentino's
failure to provide accurate information to Witkowski is strong
indicia of fraud with the intent to evade tax.
Petitioners' failure to maintain adequate books and records
of alleged casual labor is further evidence of fraudulent intent.
See Spies v. United States, 317 U.S. 492, 500 (1943);
Grosshandler v. Commissioner, 75 T.C. 1, 20 (1980); Zack v.
Commissioner, T.C. Memo. 1981-700. Petitioners failed to
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maintain records of trip sheets and manifests which would have
verified the existence of casual labor and cash payments to the
alleged casual labor. Petitioners failed to keep a list of the
names and Social Security numbers of alleged casual laborers. We
think petitioners intentionally chose not to maintain adequate
records of their activities in order to conceal income.
Finally, petitioners AJF and Ferrentino have deliberately
failed to report $442,138 and $475,805.34, respectively, in
cashed checks over the course of the 3 taxable years in issue.
We conclude that respondent has proven by clear and
convincing evidence that at least part of petitioners'
underpayment for each taxable year involved is attributable to
fraud with the intent to evade tax. Therefore, the fraudulent
return exception under section 6501(c)(1) applies.
II. The Additions to Tax and Fraud Penalties Under Secs. 6653(b)
and 6663(a)
Respondent has determined that petitioners owe additions to
tax and penalties under sections 6653(b) and 6663(a). Section
6663(a) provides: "If any part of any underpayment of tax
required to be shown on a return is due to fraud, there shall be
added to the tax an amount equal to 75 percent of the portion of
the underpayment which is attributable to fraud." Once the
Secretary establishes that a part of an underpayment is due to
fraud, "the entire underpayment shall be treated as attributable
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to fraud, except with respect to any portion of the underpayment
which the taxpayer establishes (by a preponderance of the
evidence) is not attributable to fraud." Sec. 6663(b).
The burden that respondent bears in proving fraud under
section 6501(c)(1) is the same burden that he bears in
establishing fraud for purposes of the section 6663(a) penalty.
Ruidoso Racing Association, Inc. v. Commissioner, 476 F.2d 502,
507 (10th Cir. 1973), affg. in part and remanding in part T.C.
Memo. 1971-194; DeBrouse v. Commissioner, T.C. Memo. 1988-119,
affd. 878 F.2d 379 (4th Cir. 1989). Since respondent has met his
burden for purposes of section 6501(c)(1), we hold that
respondent has established that a portion of petitioners'
underpayment is due to fraud for purposes of section 6663(a). We
further hold that petitioners have not presented credible
evidence that any portion of their underpayment was not due to
fraud. Accordingly, we sustain respondent's determination for
additions to tax and penalties imposed by sections 6653(b) and
6663(a).
III. Additions to Tax Under Sec. 6651
Respondent determined that petitioner AJF was liable for the
additions to tax imposed by section 6651(a). Section 6651(a)
imposes an addition to tax for failing to file a timely income
tax return, unless such failure to file is due to reasonable
cause and not due to willful neglect. The addition to tax is 5
percent of the amount required to be reported on the return for
each month or fraction thereof during which such failure to file
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continues, but not to exceed 25 percent in the aggregate. Sec.
6651(a). In this case, AJF's 1988, 1989, and 1990 tax returns
were due on March 15, 1989, 1990, and 1991, respectively. Sec.
6072(b). AJF filed its 1988 and 1989 returns on May 10, 1991,
and its 1990 return on July 17, 1991. Unless AJF can show that
its failure to timely file its returns was due to reasonable
cause and not due to willful neglect, respondent's determination
will be sustained.
The term "reasonable cause" as set forth in section 6651(a)
has been defined as the exercise of ordinary business care and
prudence. Sec. 301.6651-1(c)(1), Proced. & Admin. Regs.
"Willful neglect" means a "conscious, intentional failure or
reckless indifference." United States v. Boyle, 469 U.S. 241,
246 (1985). The question of whether a failure to file timely is
due to reasonable cause and not willful neglect is one of fact,
on which petitioners bear the burden of proof. Rule 142(a); Lee
v. Commissioner, 227 F.2d 181, 184 (5th Cir. 1955), affg. a
Memorandum Opinion of this Court dated July 31, 1953; BJR Corp.
v. Commissioner, 67 T.C. 111, 131 (1976).
Taxpayers have a nondelegable duty to file timely tax
returns. United States v. Boyle, supra at 250. Reasonable cause
for the failure to timely file the return cannot be established
merely by stating that such return was in the hands of the agent.
Lynch v. Commissioner, T.C. Memo. 1983-173 (citing Logan Lumber
Co. v. Commissioner, 365 F.2d 846, 854 (5th Cir. 1966), affg.
T.C. Memo. 1964-126).
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In this case, AJF neglected to retrieve its tax returns from
its return preparer, Witkowski, and timely file them with
respondent. Therefore, we find that AJF's untimely filing of its
returns was not due to reasonable cause. Accordingly, we sustain
respondent's determination with respect to the additions to tax
imposed by section 6651(a) for AJF's 1988, 1989, and 1990 taxable
years.
Contentions not addressed are either irrelevant or without
merit.
To reflect the foregoing,
Decisions will be entered
under Rule 155.