Paterson v. Comm'r , 93 T.C.M. 1184 ( 2007 )

T.C. Memo. 2007-109
UNITED STATES TAX COURT
PATRICIA B. PATERSON, ET AL.1 Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 8093-04, 8094-04, Filed April 30, 2007.
22397-04.
Thomas Edward Brever, for petitioners.
David W. Sorenson and Lisa R. Woods, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
KROUPA, Judge: Respondent determined deficiencies in
petitioners’ Federal income taxes and fraud penalties under
1
This case is consolidated for briefing, trial and opinion
with the cases of George M. Paterson, Docket No. 8094-04, and
George M. Paterson, Docket No. 22397-04. Mr. and Mrs. Paterson
are referred to collectively as petitioners.
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section 6663 for 1997 and 1998 (the years at issue).2
Respondent determined that petitioner Patricia B. Paterson
(Mrs. Paterson) was liable for a $53,168 deficiency and a $39,876
fraud penalty for 1997. For 1998, respondent determined that
Mrs. Paterson was liable for a $16,402 deficiency and a
$12,301.50 fraud penalty.
Respondent determined that petitioner George M. Paterson
(Mr. Paterson) was liable for a $125,280 deficiency and a $93,960
fraud penalty for 1997. For 1998, respondent determined that Mr.
Paterson was liable for a $88,257 deficiency and a $66,192.75
fraud penalty.
There are three issues for decision. The first issue is
whether petitioners understated their income in the amounts
respondent determined for the years at issue. We hold that they
did. The second issue is whether petitioners are liable for the
fraud penalties for the years at issue. We hold that they are.
The third issue is whether the limitations period bars respondent
from assessing petitioners’ taxes for the years at issue. We
hold that it does not.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
The stipulation of facts and the accompanying exhibits are
2
All section references are to the Internal Revenue Code in
effect for the years at issue, and all Rule references are to the
Tax Court Rules of Practice and Procedure, unless otherwise
indicated.
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incorporated by this reference. Petitioners resided in Eden
Prairie, Minnesota, at the time they filed the petitions.
Petitioners are married and were married during the years at
issue. Petitioners filed the tax returns for the years at issue
as married filing separately.
Mr. Paterson’s Bookmaking Activities
Mr. Paterson stipulated that he has been a professional
bookmaker for about 20 years including the years at issue. Mr.
Paterson has a criminal history. He was convicted of tax evasion
in 1979. He also recently pleaded guilty to another criminal
fraud charge relating to Form 730, Tax on Wagering, that he filed
for years other than the years at issue. Mr. Paterson expected
at the time of trial that he might have to serve time for these
criminal offenses.
Mr. Paterson conducted his illegal activities with two sons
from a previous marriage. The three of them took bets at one
son’s apartment in Eden Prairie, Minnesota. The primary assets
of the bookmaking enterprise were three cellular phones. Mr.
Paterson had no credit history because he dealt solely in cash
and had no credit card, so Mrs. Paterson obtained them in her
name. Mr. Paterson’s customers called these phones to place
bets.
Mr. Paterson had between 50 and 75 regular customers who bet
with him. These customers bet on college and professional
football and usually called Mr. Paterson to bet on Saturdays and
Sundays, the highest volume days. Mr. Paterson charged his
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customers a 10-percent commission, called vigorish, on bets that
his customers lost.3
Mr. Paterson did not accept bets on other sports, except a
few on World Series games. He occupied himself during the
football off-season by gambling on golf and cards. He won as
much as $2,000 at a time on golf and card games but did not
report any of these winnings on his tax returns.
Mr. Paterson tried to avoid being caught at his illegal
activities. He accepted mainly cash from his customers and used
code numbers to identify his customers in case his bookmaking
business was ever raided. In addition, he destroyed his records
of who each customer was and how much each customer bet weekly.
He instead kept a tally of profit in his head.
Mr. Paterson attempted to comply with laws regarding
registration of bookmakers with the Internal Revenue Service
(IRS) because he feared that he and his sons would be jailed for
failure to register. He purchased a “gambling stamp,” Form 11C,
Occupational Tax and Registration Return for Wagering, for 1997
and 1998. Mr. Paterson also filed monthly Forms 730 with the IRS
for all of 1997 and January through October of 1998. The Forms
730 indicate that Mr. Paterson reported a total of gross wagers
of $196,500 for 1997 and $210,400 for 1998.
3
Vigorish has been described as a means to compensate the
bookmaker for the privilege of placing bets. See United States
v. Pinelli, 890 F.2d 1461, 1465 (10th Cir. 1989). If a bookmaker
is balanced, meaning he or she has an even number of bets on both
sides of the contest, the vigorish will be profit to the
bookmaker. See id.
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Despite Mr. Paterson’s efforts to avoid being caught at his
illegal activities, agents of the Minnesota Gambling Enforcement
Division searched Mr. Paterson’s home and his son’s apartment on
December 12, 1999. The agents arrested Mr. Paterson and seized
gambling records covering 4 days of betting and three cellular
phones. The gambling records seized indicate that Mr. Paterson
accepted an average of $96,070.50 of bets each day for those 4
days, a vastly larger amount than the gross wagers Mr. Paterson
reported on the Forms 730. In fact, the total gross wagers
accepted over those 4 days exceeded the total wagers Mr. Paterson
reported he accepted for the entire year 1997 or the entire year
1998. Moreover, the seized records did not include a Saturday,
which is generally a high-volume day, and included one partial
day of wagering because the search commenced before the day’s
wagering was complete.
Mrs. Paterson’s Activities
Mrs. Paterson was aware of her husband’s illegal gambling
activities. She has worked as a flight attendant for Northwest
Airlines (NWA) for approximately 25 years, but she worked only
limited hours during the years at issue. In fact, NWA reported
it paid her only $3,105 in 1997 and $16 in 1998.
Mrs. Paterson helped her husband hide his bookmaking
activities although she did not accept bets herself. She
obtained the cellular phones in her name that were seized in the
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December 1999 search.4 Mrs. Paterson herself never used these
telephones.
Mrs. Paterson also assisted her husband in concealing assets
to help hide his bookmaking activity. Petitioners’ joint bank
accounts had only minimal activity during the years at issue.
Mrs. Paterson kept separate bank accounts and brokerage accounts,
however, solely in her own name. She made numerous deposits of
large sums totaling thousands of dollars into these accounts
during the years at issue. Many of these deposits were of cash
or checks made payable to her husband.
Mrs. Paterson also kept significant assets in her own name
rather than having assets titled in both petitioners’ names or
having assets titled only in Mr. Paterson’s name. For example,
the home in which she and Mr. Paterson have resided for the past
20 years is solely in Mrs. Paterson’s name, and she is the only
person listed on the mortgage. She also paid approximately
$34,000 cash in 1997 to buy a Cadillac for her husband to use,
paying with a check drawn on her checking account. The vehicle
purchase contract was in Mrs. Paterson's name.
4
The Court finds petitioners’ testimony that Mrs. Paterson
obtained the cellular phones for a computer business they were
trying to start inconsistent with other evidence in the record.
Neither petitioner reported any income or expenses relating to
the computer business. Presumably phone costs could be expensed
if they were incurred in a trade or business. Moreover,
petitioners have not introduced any evidence corroborating their
testimony concerning the computer business.
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Preparation of Mr. and Mrs. Paterson’s Tax Returns
Both petitioners retained a tax preparer, Mr. Hughes, to
prepare their returns for the years at issue. Mr. Hughes had
assisted petitioners with their returns for years and knew about
Mr. Paterson’s bookmaking activities.
Mrs. Paterson gave Mr. Hughes her Forms W-2, Wage and Tax
Statement, from NWA but did not tell him about the large deposits
into her separate bank accounts during the years at issue. Mr.
Paterson simply told Mr. Hughes how much income he had because
Mr. Paterson kept no records. Mr. Hughes prepared returns for
Mr. Paterson using the amounts Mr. Paterson gave him even though
Mr. Hughes knew Mr. Paterson was a bookmaker and dealt in cash.
Petitioners each filed tax returns for the years at issue as
married filing separately.5 Mr. Paterson reported total income
of $46,018 in 1997 and $48,481 in 1998. Mrs. Paterson reported
total income of $5,947 in 1997 and $1,511 in 1998.
Respondent’s Examination
Respondent examined the married filing separate returns of
both petitioners. Neither petitioner cooperated with respondent
during the audit, and respondent issued summonses to each of
them. Both petitioners asserted their Fifth Amendment rights in
response to the summonses and refused to answer any questions or
produce any records to respondent.
5
The record does not reflect the dates petitioners filed the
tax returns. We note that respondent did not determine that
either petitioner was liable for the addition to tax under sec.
6651(a)(1) for failure to file timely returns for the years at
issue.
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Respondent’s Determination of Petitioners’ Income
Respondent’s revenue agents determined petitioners’ income.
A different revenue agent was assigned to each petitioner.
Respondent’s revenue agent Ms. Johnson (Revenue Agent Johnson)
was assigned to Mr. Paterson. Revenue Agent Johnson used the
profit factor method to redetermine Mr. Paterson’s income.
Revenue Agent Johnson began by examining the 4 days of betting
sheets seized in the December 1999 search. Revenue Agent Johnson
added 10 percent vigorish, the amount charged on a losing bet, to
the bets listed on the sheet that did not carry vigorish and then
added all bets together to find the gross wagers. Revenue Agent
Johnson then divided the total gross wagers she found, $384,282,
by 4 days of betting to obtain the average daily bet of
$96,070.50.
Revenue Agent Johnson then used the call records for the
cellular phones to determine the number of days people called Mr.
Paterson to place bets. Revenue Agent Johnson multiplied the
$96,070.50 average daily bet by the number of days people placed
bets for each year to arrive at the gross wagers for each year.
Finally, Revenue Agent Johnson multiplied the gross wagers for
each year by 4.54 percent. This percentage represented the
profit a bookmaker would make if his or her books were balanced.
Revenue Agent Johnson determined that Mr. Paterson had gross
income of $357,651.26 in 1997, of which $305,151 Mr. Paterson
failed to report. For 1998, Revenue Agent Johnson determined
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that Mr. Paterson had gross income of $270,419.24, of which
$215,019 Mr. Paterson failed to report.
Respondent’s revenue agent Ms. Zamora (Revenue Agent Zamora)
was responsible for handling the determination of Mrs. Paterson’s
income. Revenue Agent Zamora used the bank deposits method to
reconstruct Mrs. Paterson’s income. Revenue Agent Zamora used
third-party procedures to obtain bank records and other
documents. Revenue Agent Zamora added together all the taxable
deposits into Mrs. Paterson’s various separate bank accounts and
subtracted the sources of income reported on the return. Revenue
Agent Zamora determined that for 1997, Mrs. Paterson had taxable
deposits of $170,579.41, of which $160,637.41 Mrs. Paterson
failed to report. For 1998, Revenue Agent Zamora determined that
Mrs. Paterson had taxable deposits of $63,343.42, of which
$61,832.42 Mrs. Paterson failed to report.
Respondent issued deficiency notices to petitioners for 1997
and 1998. The deficiency notices to Mr. Paterson were dated
April 1, 2004, with respect to 1997 and November 4, 2004, with
respect to 1998. The deficiency notice to Mrs. Paterson covered
both 1997 and 1998 and was dated April 1, 2004. Petitioners each
timely filed petitions. The cases were consolidated for purposes
of trial, briefing, and opinion.
OPINION
We are asked to decide whether petitioners, a longtime
bookmaker with a criminal history and his wife, failed to report
income in the amounts respondent determined. We are also asked
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to decide whether petitioners are liable for fraud penalties with
regard to the unreported income. Finally, we are asked to decide
whether the limitations period bars respondent from assessing
petitioners’ liabilities. We begin by discussing the unreported
income.
I. Unreported Income
Gross income generally includes all income from whatever
source derived. Sec. 61(a). Taxpayers must keep adequate books
and records from which their correct tax liability can be
determined. Sec. 6001. When a taxpayer fails to keep records,
the Commissioner has discretion to reconstruct the taxpayer’s
income by any reasonable means. Sec. 446(b); Webb v.
Commissioner, 394 F.2d 366, 372 (5th Cir. 1968), affg. T.C. Memo.
1966-81; Factor v. Commissioner, 281 F.2d 100, 117 (9th Cir.
1960), affg. T.C. Memo. 1958-94. Where a taxpayer has destroyed
his or her tax records, the Commissioner’s reconstruction need
not be arithmetically precise. DiMauro v. United States, 706
F.2d 882, 885 (8th Cir. 1983), affg. 81-2 USTC par. 16,373 (D.
Neb. 1981).
A. Mr. Paterson’s Unreported Income: Profit Factor Method
We first discuss respondent’s use of the profit factor
method to reconstruct Mr. Paterson’s income. The Commissioner’s
determinations are generally presumed correct, and the taxpayer
bears the burden of proving that these determinations are
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erroneous.6 Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115
(1933). Unreported income from wagering activities involves a
special rule, however. The Commissioner must first present some
evidence connecting the taxpayer with a wagering activity during
the years at issue to obtain the benefit of the presumption of
correctness. DiMauro v. United States, supra at 884; De
Cavalcante v. Commissioner, 620 F.2d 23, 27-28 (3d Cir. 1980),
affg. Barrasso v. Commissioner, T.C. Memo. 1978-432; Pizzarello
v. United States, 408 F.2d 579, 583 (2d Cir. 1969). Once the
Commissioner has met this minimal evidentiary foundation, the
burden then shifts to the taxpayer to prove the Commissioner’s
determination was incorrect. DiMauro v. United States, supra at
884.
Mr. Paterson stipulated that he operated a professional
bookmaking and wagering business during the years at issue.
Sufficient evidence therefore exists to connect Mr. Paterson with
a wagering activity during the years at issue. The burden is
thus on petitioners to prove that respondent’s determination was
incorrect.
We have previously approved the profit factor method as a
reasonable method to determine income from bookmaking activities.
Robinson v. Commissioner, T.C. Memo. 1986-382. Revenue Agent
Johnson applied the profit factor method as described in Robinson
6
This principle is not affected by sec. 7491(a) because
neither petitioner cooperated with respondent’s reasonable
requests during respondent’s examinations. See sec.
7491(a)(2)(B). Accordingly, the burden of proof remains with
petitioners.
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to reconstruct Mr. Paterson’s income using 4 days of wagering
records seized in the search. The wagering records show an
average daily bet of over $96,000, and the profit factor method
suggests net income of approximately $350,000 and $270,000 for
the respective years at issue, while Mr. Paterson reported gross
income of only approximately $45,000 for each year at issue.
This is a vast disparity. Petitioners make several arguments why
the profit factor method is inappropriate and does not accurately
reflect Mr. Paterson’s income for the years at issue.
First, petitioners argue that Mr. Paterson’s sons were
involved in the gambling enterprise with him and should be
allocated some of the income. Petitioners have introduced no
evidence, however, regarding how the resulting income from the
wagering activity was allocated between Mr. Paterson and his
sons. Mr. Paterson’s sons did not testify at the trial, nor was
any evidence introduced to document what amount, if any, was
attributable to the sons or reported on their returns. We
conclude that petitioners have failed to prove that respondent
erroneously allocated all of the gambling income to Mr. Paterson.
Second, petitioners argue that the small sample of 4 days of
wagering cannot be extrapolated to reflect accurately Mr.
Paterson’s overall wagering activity for 2 years. Petitioners
argue that the profit factor method is inappropriate because it
is based on such a small sample of wagering activity, relying on
Clayton v. Commissioner, 102 T.C. 632, 644 (1994). We held in
Clayton that the profit factor method was inappropriate because
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the calculation was based on a day of very active wagering on
conference championship games. Id. We reject petitioners’
argument. The 4 days of seized wagering records are an accurate
reflection of Mr. Paterson’s wagering activity and can be used to
redetermine Mr. Paterson’s income for the years at issue. None
of the 4 days involved high profile conference championship games
like those related to the day of wagering records in Clayton.
Moreover, the 4 days of wagering records did not include a
Saturday, which is generally a high-volume day, but included a
partial day of wagering as the search occurred before that day’s
wagering was complete. These facts would actually tend to
underestimate Mr. Paterson’s income. Simply underestimating the
income does not make the method unreliable.
Third, petitioners argue that the 4 days of wagering records
are inaccurate because some of the wagers were never consummated
because of Mr. Paterson’s arrest. This fact is irrelevant.
Before the search, Mr. Paterson was engaged in his normal
bookmaking activities and would have collected the wagers absent
the search and his arrest. Moreover, the unconsummated wagers
and the raid occurred in 1999, not 1997 or 1998, the years at
issue, where the bookmaking activities occurred without
interruption. We conclude the 4 days of wagering records are an
accurate reflection of Mr. Paterson’s wagering activity even if
some wagers were never consummated.
Finally, petitioners argue that the profit factor method
disregards Mr. Paterson’s actual losses and that the 4.54-percent
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theoretical profit unreasonably exaggerates Mr. Paterson’s
income. We disagree. Mr. Paterson has introduced no evidence of
his actual profit margin or any evidence that would tend to show
respondent’s method was unreasonable or incorrect. Moreover, the
United States District Court for the District of Nebraska has
found it reasonable to assume a bookmaker’s profits will
generally amount to 4.5 percent of total wagers in the excise tax
context. DiMauro v. United States, 81-2 USTC par. 16,373 (D.
Neb. 1981).
In sum, we find Mr. Paterson had unreported income in the
amounts respondent determined in the deficiency notices. We
conclude that the profit factor method respondent used to
reconstruct Mr. Paterson’s bookmaking income was reasonable and
substantially accurate. Petitioners have introduced no
documentary evidence to show otherwise. Any inaccuracies in the
income reconstruction are attributable to Mr. Paterson’s failure
to maintain books and records and to his failure to cooperate
with respondent during the audit.
B. Mrs. Paterson’s Unreported Income: Bank Deposits
Method
We next examine respondent’s use of the bank deposits method
to determine Mrs. Paterson’s unreported income. We have
previously approved the use of the bank deposits method as a
means of income reconstruction. Clayton v. Commissioner, supra
at 645; DiLeo v. Commissioner, 96 T.C. 858, 867 (1991), affd. 959
F.2d 16 (2d Cir. 1992). It is not arbitrary or capricious for
the Commissioner to use the bank deposits method to compute the
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income of a taxpayer who has kept no books and records and who
has large bank deposits. Clayton v. Commissioner, supra at 645;
DiLeo v. Commissioner, supra at 867. Bank deposits are prima
facie evidence of income. Tokarski v. Commissioner, 87 T.C. 74,
77 (1986). The bank deposits method assumes that all money
deposited into a taxpayer’s bank account during a particular
period constitutes taxable income. Clayton v. Commissioner,
supra at 645. The Commissioner must take into account, however,
any known nontaxable source or deductible expense. Id.
We reiterate that the Commissioner’s determinations are
generally presumed correct, and the taxpayer bears the burden of
proving that these determinations are erroneous. Rule 142(a);
Welch v. Helvering, 290 U.S. at 115. Respondent’s agent used
third-party procedures to obtain information about funds
deposited into Mrs. Paterson’s personal bank accounts and
subtracted from these funds the amounts of income Mrs. Paterson
reported on her returns for the years at issue. Mrs. Paterson
reported a mere $5,947 in 1997 and $1,511 in 1998, while
respondent determined she had unreported income from the cash
deposits of $160,637.41 in 1997 and $61,832.42 in 1998.
Petitioners make two primary arguments why respondent’s
determinations regarding Mrs. Paterson’s unreported income are
erroneous.
First, petitioners argue that the bank deposits method
double counts income that Mr. Paterson reported on his returns.
Petitioners have introduced no evidence to support this argument,
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however. Petitioners have failed to prove the portion of
deposits in Mrs. Paterson’s separate bank accounts that were
attributable to Mr. Paterson’s bookmaking activities. Absent any
documentary evidence, we decline to speculate as to the extent of
any double counting of income. Moreover, respondent’s profit
factor method used to determine Mr. Paterson’s income may
underestimate Mr. Paterson’s income. We note that one of the 4
days used in the method was just a partial day, and none of the
days used in the method was a Saturday, a high-volume day. Thus,
any potential double counting of income may be offset by
underestimating some of Mr. Paterson’s income, and we shall not
speculate further.
Second, petitioners argue that some of the deposits Mrs.
Paterson made into her bank accounts during the years at issue
are nontaxable or are loans. Petitioners argue that these
deposits include a $160,000 gain on the sale of stock, insurance
reimbursement for stolen jewelry, a $50,000 loan, and $6,900 of
gain on the sale of other stock.7 Petitioners have introduced no
documentary evidence to support their claims and rely only on
their uncorroborated, self-serving testimony, which we are not
required to accept and which we do not find to be credible. See
7
Petitioners argue on brief that the amounts representing
gain on the sale of stock are nontaxable. We surmise that
petitioners mean that the deposits in Mrs. Paterson’s account are
the proceeds of stock sales and she should be taxed only to the
extent the proceeds exceed her basis. There is no evidence that
after the stock sales, cash was transferred from Mrs. Paterson’s
securities account into her bank account. Instead, proceeds from
securities transactions remained in the securities account to be
reinvested.
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Neidringhaus v. Commissioner, 99 T.C. 202, 219 (1992). In
addition, petitioners argue that a good friend of Mrs. Paterson
“loaned” her $50,000 because the memo notation on the check said
“loan-taxes.” Petitioners did not have the friend testify or
produce any documentation regarding this “loan.” The failure of
a party to introduce evidence which, if true, would be favorable
to that party gives rise to the presumption that the evidence
would be unfavorable if produced. Wichita Terminal Elevator Co.
v. Commissioner, 6 T.C. 1158, 1165 (1946), affd. 162 F.2d 513
(10th Cir. 1947). Petitioners have not proven that any of these
items are nontaxable deposits or are loans. Petitioners have
also introduced no evidence to support that Mrs. Paterson is
entitled to any additional expenses or losses.
In sum, we find that Mrs. Paterson had unreported income in
the amounts respondent determined in the deficiency notice.
II. Fraud Penalty
We next consider whether either petitioner is liable for the
fraud penalty for the years at issue. The Commissioner must
prove by clear and convincing evidence that the taxpayer
underpaid his or her income tax and that some part of the
underpayment was due to fraud. Sec. 6663(a); Clayton v.
Commissioner, 102 T.C. 646. If the Commissioner establishes
that any portion of an underpayment is attributable to fraud, the
entire underpayment is treated as attributable to fraud, except
to the extent the taxpayer establishes by a preponderance of the
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evidence that a portion of the underpayment is not due to fraud.
Sec. 6663(b); Smoll v. Commissioner, T.C. Memo. 2006-157.
Fraud is a factual question to be decided on the entire
record and is never presumed. Rowlee v. Commissioner, 80 T.C.
1111, 1123 (1983); Beaver v. Commissioner, 55 T.C. 85, 92 (1970).
The Commissioner must show that the taxpayer acted with specific
intent to evade taxes that the taxpayer knew or believed he or
she owed by conduct intended to conceal, mislead, or otherwise
prevent the collection of the tax. Sec. 7454; Recklitis v.
Commissioner, 91 T.C. 874, 909 (1988); Stephenson v.
Commissioner, 79 T.C. 995, 1005 (1982), affd. 748 F.2d 331 (6th
Cir. 1984).
Direct evidence of fraud is seldom available, and its
existence may therefore be determined from the taxpayer’s conduct
and the surrounding circumstances. Stone v. Commissioner, 56
T.C. 213, 223-224 (1971). Courts have developed several indicia
or badges of fraud. These badges of fraud include understating
income, maintaining inadequate records, concealing income or
assets, failing to cooperate with tax authorities, engaging in
illegal activities, filing false documents, and dealing in cash.
Spies v. United States, 317 U.S. 492, 499 (1943); Bradford v.
Commissioner, 796 F.2d 303, 307-308 (9th Cir. 1986), affg. T.C.
Memo. 1984-601. Although no single factor is necessarily
sufficient to establish fraud, a combination of several of these
factors may be persuasive evidence of fraud. Solomon v.
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Commissioner, 732 F.2d 1459, 1461 (6th Cir. 1984), affg. per
curiam T.C. Memo. 1982-603.
A. Mr. Paterson’s Liability for the Fraud Penalty
We now consider whether Mr. Paterson is liable for the fraud
penalty. We agree with respondent that several badges of fraud
are present with respect to Mr. Paterson’s underpayments of tax.
Mr. Paterson earned his income through an illegal wagering
enterprise. Mr. Paterson routinely destroyed his wagering
records after each football game to avoid being held accountable
for his illegal activities. He was arrested for his activities,
was convicted of tax evasion, and pleaded guilty to filing false
and fraudulent Forms 730. Mr. Paterson dealt in cash
exclusively. He did not keep records of the cash he received
from his customers and did not maintain a bank account that would
allow tracking of his income. Mr. Paterson also concealed
assets. He shielded his property by not taking title to assets,
such as the home in which he resided with Mrs. Paterson and the
Cadillac he drove. In addition, the primary asset of his
wagering enterprise was the cellular phones, which were
registered in his wife’s name. Mr. Paterson provided incomplete
and false information to his return preparer, simply telling his
return preparer how much income to report instead of providing
him documentation. Mr. Paterson also failed to report his golf
or card game winnings on his returns. Finally, Mr. Paterson
failed to cooperate with respondent during the audit.
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We conclude that respondent has proven by clear and
convincing evidence that Mr. Paterson fraudulently understated
his tax liabilities for the years at issue, and Mr. Paterson has
failed to show that any portion of the underpayments is not due
to fraud. We find that the fraud penalty under section 6663
applies to Mr. Paterson’s underpayments of tax for the years at
issue.
B. Mrs. Paterson’s Liability for the Fraud Penalty
We now consider whether Mrs. Paterson is liable for the
fraud penalty. We agree with respondent that many of the badges
of fraud are present with respect to Mrs. Paterson’s
underpayments. Mrs. Paterson was aware of her husband’s illegal
activities. She facilitated the illegal activities by obtaining
the cellular phones her husband used to accept bets. She also
received the benefit of these illegal activities by accepting and
depositing cash or checks made out to her husband. She concealed
the source of these funds further by depositing them into her
separate bank accounts, not the joint bank accounts that had only
minimal activity. She also kept title solely in her name to the
Patersons’ significant assets, such as their home and bank
accounts and brokerage accounts with considerable funds. Mrs.
Paterson did not maintain adequate records and never told her tax
preparer about the large sums she periodically deposited into her
separate bank accounts. Finally, Mrs. Paterson understated her
income significantly on her tax returns and did not cooperate
with respondent during the audit.
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We conclude that respondent has proven by clear and
convincing evidence that Mrs. Paterson fraudulently understated
her tax liabilities for the years at issue and Mrs. Paterson has
failed to prove that any portion of the underpayments is not due
to fraud. We find that the fraud penalty under section 6663
applies to Mrs. Paterson’s underpayments of tax for the years at
issue.
III. Limitations Period
Petitioners argue that the 3-year limitations period under
section 6501(a) has expired and that respondent is therefore
barred from assessing petitioners’ taxes for the years at issue.
Respondent issued deficiency notices to petitioners on April 1,
2004 (with respect to Mrs. Paterson’s liability for both years
and Mr. Paterson’s liability for 1997) and November 4, 2004 (with
respect to Mr. Paterson’s liability for 1998). The limitations
period commences on the date the return is filed. Sec. 6501(a).
Returns filed before the due date are deemed filed on the due
date.8 Sec. 6501(b).
In the case of false and fraudulent returns with the intent
to evade tax, the tax may be assessed at any time. Sec.
6501(c)(1). Because we have found that petitioners are each
liable for the fraud penalty under section 6663, we hold that the
limitations period for assessing petitioners’ taxes is extended
8
Although the dates petitioners filed the returns are not
evident from the record, the earliest the returns would be
treated as filed is Apr. 15, 1998 and 1999, respectively. Sec.
6501(b).
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indefinitely. See sec. 6501(c)(1); Sam Kong Fashions, Inc. v.
Commissioner, T.C. Memo. 2005-157. Accordingly, respondent is
not barred from assessing petitioners’ deficiencies. See sec.
6501(c)(1).
Respondent would not be barred from assessing petitioners’
taxes for the years at issue even if we had not found that
petitioners had filed false and fraudulent returns. The
limitations period is extended to 6 years if a taxpayer omits
from gross income an amount that is 25 percent of the amount the
taxpayer stated in the return. Sec. 6501(e)(1)(A). Both
petitioners omitted from gross income amounts vastly in excess of
25 percent of the amounts stated on the returns, and the
limitations period would be extended to 6 years. Respondent
issued deficiency notices within 6 years of the due dates of the
returns and is thus not barred from assessing petitioners’ taxes.
We have considered all remaining arguments the parties made
and, to the extent not addressed, we conclude they are
irrelevant, moot, or meritless.
To reflect the foregoing,
Decisions will be entered
for respondent.