Powerstein v. Comm'r , 102 T.C.M. 497 ( 2011 )

T.C. Memo. 2011-271
UNITED STATES TAX COURT
ALLEN POWERSTEIN AND RITA POWERSTEIN ROSEN, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
ALLEN POWERSTEIN, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 30261-89, 13443-92.1 Filed November 16, 2011.
Mitchell I. Horowitz and Micah G. Fogarty, for petitioners.
Stephen R. Takeuchi and Robert W. Dillard, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
LARO, Judge: At the heart of these cases is petitioner
Allen Powerstein (Mr. Powerstein), a former certified public
1
These cases were consolidated for purposes of trial,
briefing, and opinion pursuant to Rule 141(a).
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accountant (C.P.A.) who in 1993 pleaded guilty to criminal tax
evasion in violation of section 7201.2 At issue are the 1984
through 1988 joint Federal income taxes of petitioners Mr.
Powerstein and Rita Powerstein Rosen (Ms. Rosen) and the 1989
individual Federal income tax of Mr. Powerstein.
In docket No. 30261-89, petitioners petitioned the Court to
redetermine respondent’s determination of the following Federal
income tax deficiencies and additions to tax:
Additions to Tax
Sec. Sec. Sec. Sec. Sec.
Year Deficiency 6653(b)(1) 6653(b)(2) 6653(b)(1)(A) 6653(b)(1)(B) 6661
1984 $28,664 $14,374 $7,918 -0- -0- $7,166
1985 48,948 24,474 9,520 -0- -0- 12,237
1986 38,186 -0- -0- $28,640 $5,095 9,547
1987 39,749 -0- -0- 29,935 2,952 9,937
1988 30,915 23,186 -0- -0- -0- 7,729
In his answer, respondent adjusted the deficiencies and additions
to tax, decreasing the amounts for 1984 and 1985 and increasing
the amounts for each of the years 1986 through 1988 as follows:
Additions to Tax
Sec. Sec. Sec. Sec. Sec.
Year Deficiency 6653(b)(1) 6653(b)(2) 6653(b)(1)(A) 6653(b)(1)(B) 6661
1984 $1,599 $842 $442 -0- -0- -0-
1985 23,492 11,695 4,549 -0- -0- $5,873
1986 47,566 -0- -0- $35,353 (1) 11,892
1987 58,251 -0- -0- 43,536 (1) 14,563
1988 58,187 43,563 -0- -0- -0- 14,547
1
Respondent determined that if the addition to tax under sec. 6653(b)(1)(A)
applies, then the addition to tax under sec. 6653(b)(1)(B) applies in an
amount equal to 50 percent of the interest payable with respect to the portion
of the underpayment that is due to fraud.
2
Unless otherwise indicated, section references are to the
applicable versions of the Internal Revenue Code, and Rule
references are to the Tax Court Rules of Practice and Procedure.
Some dollar amounts have been rounded.
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In docket No. 13443-92, Mr. Powerstein petitioned the Court to
redetermine respondent’s determination of a $49,000 deficiency in
his 1989 Federal income tax and a $36,750 fraud penalty under
section 6663.
After concessions by the parties,3 we decide: (1) Whether
the burden of proof shifts to respondent with respect to his
reconstruction of petitioners’ net worth for 1984 through 1988.
We hold that it does to the extent stated herein; (2) whether
petitioners omitted income of $5,668, $42,212, $107,089,
$153,670, and $153,351, for 1984 through 1988, respectively. We
hold that they omitted income of $3,624, $83,739, $85,702,
3
In docket No. 30261-89, the parties agree that petitioners
(1) failed to report interest income of $2,148, $79, $239, $101,
and $2,409 for 1984 through 1988, respectively; (2) understated
dividend income of $138, $200, and $196 for 1984 through 1986,
respectively; (3) received $563 of dividends for 1987 of which
$282 is excluded from income as a nontaxable distribution; (4)
failed to report net capital gains of $3,167 for 1984, (5) failed
to report net capital gains of $2,282 and instead reported a net
capital loss of $2,926, resulting in a $5,208 adjustment for
1986; and (6) overstated capital losses by $2,747 and $875 for
1987 and 1988, respectively. In docket No. 13443-92, the parties
agree that for 1989 Mr. Powerstein (1) failed to report gross
receipts of $56,063 on Schedule C, Profit or Loss From Business;
(2) is entitled to deduct $67,250 of legal fees as an expense on
Schedule C; (3) is not entitled to a $122 loss on Schedule F,
Profit or Loss From Farming; (4) failed to report capital gains
of $4,058; (5) is not entitled to a fuel tax credit of $63; (6)
is liable for self-employment tax of $6,250; and (7) is not
liable for a fraud penalty under sec. 6663 but is liable for an
accuracy-related penalty under sec. 6662. We deem petitioners to
have conceded that the period of limitations for assessment of
their 1984 through 1988 Federal income taxes is open and that Ms.
Rosen is not entitled to relief under sec. 6013(e), by virtue of
the fact that these issues were not raised at trial or on brief.
See Nicklaus v. Commissioner, 117 T.C. 117, 120 n.4 (2001).
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$145,266, and $142,637, for 1984 through 1988, respectively; (3)
whether petitioners are entitled to deductions related to Mr.
Powerstein’s accounting practice. We hold they are to the extent
stated herein; (4) whether petitioners are entitled to a $22,290
loss as reported on their 1988 Schedule F. We hold they are not;
(5) whether petitioners may use special income-averaging
provisions pursuant to section 1305. We hold they may not; (6)
whether Mr. Powerstein may deduct $65,778 of interest which
respondent jeopardy-assessed and collected by levy in 1989. We
hold he may not; (7) whether petitioners are liable for additions
to tax under section 6653(b) for 1984 through 1988. We hold that
Mr. Powerstein is to the extent stated herein, and that Ms. Rosen
is not; and (8) whether petitioners are liable for additions to
tax under section 6661 for 1985 through 1988. We hold they are.
FINDINGS OF FACT
I. Preliminaries
The parties submitted to the Court numerous stipulations of
fact and accompanying exhibits. The stipulated facts and
exhibits submitted therewith are incorporated herein by this
reference. We find the stipulated facts accordingly. When their
respective petitions were filed, petitioners resided in Florida.
II. Mr. Powerstein
Mr. Powerstein was raised in Brooklyn, New York (Brooklyn),
and he served in the U.S. Army from May 4, 1958, through May 3,
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1964. He holds a bachelor of business administration degree in
accounting from the City College of New York, and he has
completed work towards a master’s degree. He was a C.P.A. from
June 1967 until at least January 1987.
Between May 1964 and 1976 Mr. Powerstein was an accountant
at various accounting firms and businesses. Beginning in 1965
and at all relevant times, he operated a bookkeeping, accounting,
and tax return preparation business; namely, Allen D. Powerstein,
CPA (accounting firm).
III. Ms. Rosen
Ms. Rosen was born and raised in Brooklyn. She graduated
from high school and did not attend college. Over the years, Ms.
Rosen was mostly a homemaker though she occasionally held a job
during some of the years in issue.
IV. Petitioners
Petitioners were married in June 1957 and have two children;
namely, Madelyn Ballard (Ms. Ballard) and Irene Powerstein (Ms.
I. Powerstein). Mr. Powerstein was the household’s primary
income producer, and he regularly provided financial assistance
to Ms. Ballard into her adult years. Throughout the years in
issue, petitioners incurred typical household expenses, including
amounts for groceries, utilities, and other necessities.
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Petitioners were married until July 1989, at which time they
legally divorced.4
V. The Ballards
Ms. Ballard and Michael Ballard (Mr. Ballard) (collectively,
the Ballards) were married in 1983, and they had at least one
child; namely, K.B. Mr. Ballard was raised on a farm in
Arkansas. He drank alcohol during the years in issue, and he has
been convicted of driving under the influence.
VI. Coral Springs Residence
Petitioners lived in Brooklyn until 1972, when they moved
their family and household property to Miami, Florida. They paid
$6,700 for a parcel of land in Coral Springs, Florida, and
subsequently built a home (Coral Springs residence) thereon.
They deposited $500 with respect to that residence and secured a
$60,472 residential loan (first Glendale mortgage) from Glendale
Federal Bank (Glendale Bank) after construction of the residence
was completed.5 Petitioners’ actual cost of constructing that
home exceeded its estimated cost by approximately $11,191. In
addition to principal and interest due under the first Glendale
mortgage, petitioners also impounded (escrowed) $153 per month
4
Despite their divorce, petitioners continued to live
together, Mr. Powerstein continued to support the family, and Ms.
Rosen continued to maintain the household.
5
The first Glendale mortgage was issued by First Federal
Savings & Loan of Broward County (First Federal). We refer to
First Federal and its successors as Glendale Bank.
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for real estate taxes. In 1978 petitioners moved in to the Coral
Springs residence, and they continued to live there through
August 1984.
Petitioners refinanced the first Glendale mortgage in
February 1984 with a $100,000 loan (second Glendale mortgage)
from Glendale Bank. At the closing of the second Glendale
mortgage, petitioners escrowed 5 months of real estate taxes
totaling $453. Payments due under the second Glendale mortgage
impounded $91 per month for real estate taxes. During 1984
petitioners made nine payments against the second Glendale
mortgage totaling $9,324, of which $820 was paid through escrow
for real estate taxes. During 1985 petitioners made two payments
against the second Glendale mortgage totaling $2,072.
In early-to-mid-1984, petitioners contracted to sell the
Coral Springs residence to Dale Underhill (Mr. Underhill) and
Mona Underhill (Ms. Underhill) (collectively, the Underhills) for
$112,000. The Underhills deposited $8,000 to an interest-bearing
account (Underhill account) at Atlantic Federal Savings & Loan
(Atlantic Bank) which was jointly held by Mr. Powerstein and Mr.
Underhill in trust for Ms. Rosen and Ms. Underhill. That deposit
served as a downpayment for the purchase of the Coral Springs
residence, and as of December 31, 1984, the Underhill account had
earned interest of $259.
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The Underhills leased the Coral Springs residence beginning
in August 1984 and continued to do so through April 1985, at
which time they secured financing to close the sale. Although
the Underhills paid rent of $1,000 per month to petitioners, this
income was not reported as taxable on petitioners’ Federal income
tax returns. After the Underhills began leasing the Coral
Springs residence, petitioners moved to Romeo, Florida (Romeo).
On April 12, 1985, the sale of the Coral Springs residence closed
for $112,000, and petitioners realized net proceeds of $107,201.
At the closing, petitioners were charged $288 for unpaid county
taxes from January 1 through April 11, 1985, and $234 for taxes
related to 1980.
VII. Vacation Home
On November 14, 1981, petitioners purchased a residence in
Lake Lure, North Carolina. In or around 1983, the Powersteins
exchanged that property and additional consideration to purchase
a second residence in Lake Lure, North Carolina (vacation home).
The cost of acquiring the vacation home totaled $7,333, and
petitioners paid $53 of real estate taxes on it in 1984.
VIII. Romeo Property
A. Overview
In August 1983 petitioners purchased an 11.06-acre wooded
parcel of land (Romeo property) in Romeo for $20,009. Shortly
thereafter, the Ballards moved to the Romeo property to make the
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land habitable. With the help of local workers, the Ballards
cleared the Romeo property and installed fences, roads, and other
improvements. The Ballards left their jobs to move to the Romeo
property and, having earned no wages in 1984, received support
from petitioners. The Ballards lived on the Romeo property in a
tent for approximately 6 months and eventually constructed a
wooden cabin which they lived in temporarily.
B. Improvements
Petitioners purchased two mobile homes in 1983 and 1984, and
situated those homes on the Romeo property in close proximity.
First, they purchased a mobile home (Pine Street mobile home) for
$26,164 which the Ballards used as their residence. Second,
petitioners purchased a mobile home (Addison mobile home) for
$23,431 which they lived in. By August 1984 the Ballards and
petitioners had also improved the Romeo property with, among
other improvements, a three-stall barn, a pump house, fencing,
and a septic tank.
C. Mortgages
Petitioners mortgaged the Romeo property with a $26,000 loan
(first Sun Bank mortgage) from Sun Bank of Ocala (Sun Bank) in
January 1984. On or about October 5, 1984, petitioners retired
the first Sun Bank mortgage with a second loan (second Sun Bank
mortgage) for $53,918 which was secured by the Romeo property.
The second Sun Bank mortgage remained until October 5, 1987, when
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petitioners refinanced that mortgage with a $51,068 loan (first
Mid State mortgage) from Mid State Federal Savings and Loan (Mid
State). Petitioners satisfied the first Mid State mortgage
through a loan (second Mid State mortgage) in or around 1988.
D. Farming Activities
Although they lacked experience to do so, petitioners became
minimally engaged in farming activities after moving to the Romeo
property. Without conducting due diligence of the agricultural
feasibility of using the Romeo property as a farm, they
purchased, among other things, a tractor for $10,500 and a
chainsaw for $600. They raised approximately 16 head of cattle,
2 horses, pigs, and chickens; and although they sold 2 head of
cattle at a livestock market in 1985, they mostly used these
animals for personal consumption and enjoyment. They also
attempted to grow several types of crops without success. By
July 1989 petitioners had abandoned their farming activity.
IX. Petitioners’ Support of the Ballards
A. Overview
During the years in issue Mr. Powerstein furnished
considerable support to the Ballards. By letter dated April
1986, petitioners stated that they paid support to the Ballards
of $4,870 in 1985 and $1,635 through April 1986. This support
included rent, utility payments, food, and medical bills.
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B. M&M
The Ballards incorporated M&M Tree Service, Inc. (M&M) as
equal shareholders on or about October 13, 1983. Through M&M,
the Ballards provided landscaping and tree services in central
Florida during 1984 and 1985. Mr. Powerstein provided most, if
not all, of the financing for the startup and operation of M&M.
He purchased various assets for M&M, including the tractor and
the chainsaw which petitioners used in their farming activity.
C. Income
The Ballards received minimal income during the years in
issue, and they received support in addition to that described
above. The Ballards’ 1984 joint return reported zero wages,
interest income of $131, a $28,659 distributive loss from M&M,
and total income of negative $28,528. The Ballards’ 1985 joint
return reported wages of $780, interest income of $83, a $19,714
distributive loss from M&M, and total income of negative $18,851.
The Ballards’ 1986 joint return reported wages of $5,963,
interest income of $439, and total income of $6,402. The
Ballards’ 1987 joint return reported wages of $8,749, interest
income of $135, a $2,098 net farm loss, and total income of
$6,786. The Ballards’ 1988 joint return reported wages of
$13,108, interest income of $86, a $3,348 net farm loss, and
total income of $9,846.
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X. Financial Arrangement With Clients
After petitioners moved to the Romeo property in 1984, Mr.
Powerstein continued to operate his accounting firm in South
Florida, and he frequently traveled there by car. He was
diligent in preparing original and amended Federal income tax
returns for his clients, but far from honest. He significantly
understated income and overstated deductions on his clients’
Federal income tax returns as early as 1983. For example, Mr.
Powerstein wrote the following letter to two clients in 1985:
Received your recent letter and IRS letter
regarding the 1983 taxes. Before I explain the real
meaning of their letter, I must point out that I am not
surprised that we got such a letter and that the IRS
computer is accurate in tracking bank interest reported
on 1099s. We must carefully reply to [the] IRS and
explain what we did and if there is any additional tax
to pay, and I am not saying there will be, we will pay
it at the appropriate time.
* * * * * * *
Here is why I like their letter:
1) I reported the Ford pension of $4,634, but showed
the entire amount to be non-taxable and the IRS did not
question this. I know you are both aware of this.
2) I claimed Airlift International as a worthless
security in the amount of $4,251, however it really
cost you $1,251. IRS did not question this.
3) I claimed a $2,000 exclusion for All-Savers
Certificates at American Savings, when in fact you
never had an All-Saver Certificate. IRS did not
question this.
4) I claimed a $200 exclusion against the Merrill Lynch
dividends. These dividends do not qualify for the
exclusion. IRS did not question this.
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5) I claimed 3-additional exemptions * * * which the
IRS did not question. Each exemption is $1,000 or a
total of $3,000 which we are really not entitled to.
6) I claimed a political party contribution credit of
$100. IRS did not question this.
7) I claimed a residential energy credit carryforward
from 1982 which the IRS did not question.
Here is what the IRS picked up:
1) I reported * * * 50% of the Chase Federal interest
that you earned in 1983 on account no. (IRS does not
know the account number as they show the number to be
10-zeroes). * * *
2) I reported a CD penalty forfeiture of $2,479 which
the IRS has no record of receiving from any of our
banks. I know the IRS is correct and we will concede
on this point at the time I answer on the Chase Federal
account. * * *
* * * * * * *
* * * Please understand that the IRS sends these
letters out to anyone who fails to report the amount
shown on the 1099, namely in our case Chase Federal.
The CD penalty is something else. This is a routine
letter but important to answer on time. Just think if
they decided to audit the return on all the points I
raised in the early part of this letter. You would owe
a fortune. Speak to noone at the bank about the IRS
letter but only that we need an amended 1099.
For preparing his clients’ amended Federal income tax
returns, Mr. Powerstein charged a contingent fee of one-third to
one-half of the amount refunded to his clients. He reported the
return address on the amended return as a P.O. Box in his name,
and the refunds were sent to that address. Upon receipt of a
refund check, Mr. Powerstein contacted his client, went to the
bank with that client, deposited the check, and took his “share”.
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XI. Loan Applications
In connection with their various mortgages, petitioners
completed and submitted various bank loan applications that
reported income greater than that reported on their joint Federal
income tax returns. First, they estimated the net income from
the accounting firm for 1977 as $24,185 on a residential loan
application to Glendale Bank dated August 2, 1977 (1977 loan
application). However, petitioners reported business income from
the accounting firm of only $3,289 on their 1977 joint Federal
income tax return (1977 joint return). Second, they estimated
the net income from the accounting firm for 1978 as $31,262 on a
residential loan application to Glendale Bank dated September 19,
1978 (1978 loan application). However, petitioners reported
business income from the accounting firm of only $3,060 on their
1978 joint Federal income tax return (1978 joint return).
Third, they estimated the net income from the accounting
firm for 1983 as $27,500 on a residential loan application to Sun
Bank dated December 23, 1983 (1983 loan application). However,
petitioners reported business income from the accounting firm of
only $195 on their 1983 joint Federal income tax return (1983
joint return). Attached to the 1983 loan application were
purported joint Federal income tax returns for petitioners for
1981 and 1982 (purported 1981 and 1982 returns, respectively)
which reported business income from the accounting firm of
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$24,028 and $23,886, respectively. The amounts reported as
business income from the accounting firm on the purported 1981
and 1982 returns did not match the amounts reported on the 1981
and 1982 joint Federal income tax returns (respectively, 1981 and
1982 joint returns) that petitioners filed with respondent.
Fourth, on a residential loan application to Sun Bank dated June
20, 1984 (1984 loan application), petitioners estimated their
1984 net income from the accounting firm as $26,000. However,
petitioners reported a business loss from the accounting firm of
$996 on their 1984 joint Federal income tax return (1984 joint
return).
XII. Investments
A. Bank Accounts
During the years at issue, petitioners maintained at least
40 bank accounts. Most of the accounts were held jointly in
petitioners’ names. However, Mr. Powerstein held certain
accounts jointly or in trust for Pearl Powerstein (Ms. P.
Powerstein), his step-mother; Ann Pasternak (Ms. Pasternak), his
aunt; or Stacey Korman (Ms. Korman), his cousin.
B. Investments
During the subject years petitioners also purchased more
than $200,000 in stock and debt of various companies. Included
in the stock purchased were 775 shares of Charme Properties, Inc.
(Charme). Charme filed a chapter 11 bankruptcy petition on May
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11, 1984, which the bankruptcy court subsequently converted to a
chapter 7 liquidation in 1985. Charme forfeited its corporate
charter with the Delaware secretary of state on September 24,
1985, though the bankruptcy continued into April 1995 when final
distributions were made.
XIII. Asset Transfers
Between February 23 and May 25, 1989, Mr. Powerstein and/or
Ms. Rosen transferred approximately 30 bank accounts to Ms.
Ballard and Ms. I. Powerstein, either individually or as trustees
for K.B. On March 6, 1989, Mr. Powerstein and Ms. Rosen deeded
the vacation home to Ms. Ballard and Ms. I. Powerstein as joint
tenants for $10. Also on March 6, 1989, Mr. Powerstein and Ms.
Rosen deeded the Romeo property to Ms. Ballard and Ms. I.
Powerstein as joint tenants for $10.
XIV. Federal Tax Reporting
Petitioners filed joint Federal income tax returns for years
before 1989, including returns for 1983 through 1988 (1983
through 1988 joint returns, respectively). The 1983 joint return
reported wages of $7,629, interest income of $14,305, dividend
income of $227 of which $200 was excludable from gross income,
business income of $195, a capital loss of $696, and total income
of $21,475. Attached to the 1983 joint return was Schedule B,
Interest and Dividend Income, which reported interest earned from
All-Savers Certificates of $2,000.
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The 1984 joint return reported wages of $5,244, interest
income of $19,396; dividend income of $138, all of which was
treated as nontaxable; a business loss of $996; net capital gain
of $168; and total income of $23,812. Attached to the 1984 joint
return was a Schedule C which reported income that Mr. Powerstein
received from two clients. The 1985 joint return reported
interest income of $23,705; dividend income of $427, of which
$200 was excluded from gross income; business income of $392; net
capital gain of $2; and total income of $24,326. The 1986 joint
return reported interest income of $27,288; dividend income of
$602, of which $200 was excluded from gross income; a business
loss of $5,505; a net capital loss of $2,926; and total income of
$19,259. The 1987 joint return reported interest income of
$30,224; dividend income of $263; a business loss of $8,924; a
capital loss of $2,976; and total income of $18,587. The 1988
joint return reported interest income of $35,298, dividend income
of $822, a business loss of $24,279, a capital loss of $1,131,
and total income of $10,710. Attached to the 1988 joint return
was a Schedule C which reported a $1,989 loss from the accounting
firm and a Schedule F on which petitioners reported a $22,290
loss from growing vegetables and melons. Also attached to the
1988 joint return was Form 4562, Depreciation and Amortization,
on which petitioners reported 7-year property with a depreciable
basis of $1,442.
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Mr. Powerstein filed an individual Federal income tax return
for 1989 (1989 return). The 1989 return reported interest income
of $7,214, dividend income of $974, a business loss of $118,953,
capital gains of $8,458, a farm loss of $122, and total income of
negative $102,429.
XV. Criminal Proceeding
A. Preliminary Investigation
In early 1989 the Questionable Refund Detection Team (QRDT)
of the Atlanta, Georgia, Service Center forwarded information to
the Criminal Investigation Division (CID) of the Internal Revenue
Service (IRS) in Jacksonville, Florida, indicating that Mr.
Powerstein had prepared false Federal tax returns on behalf of
numerous individuals. CID investigated Mr. Powerstein, contacted
third parties, and issued summonses in furtherance of that
investigation.
B. Search Warrant
On July 19, 1989, special agents with CID executed a search
warrant at the Addison mobile home, three detached outbuildings,
and automobiles located on the Romeo property. Among the
documents seized were financial records related to the accounting
firm, client files, correspondence, check registers, deposit
tickets, envelopes containing cash receipts, and bank documents
and statements. CID did not find books, records, cash
disbursement journals, or bank reconciliation papers. An
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envelope with more than $1,000 was also found in the Addison
mobile home. The special agents who executed the search warrant
inventoried the seized items by description and location found.
C. Jeopardy Assessment
Respondent determined that collection of the deficiencies
allegedly due from petitioners was in jeopardy because, among
other things, Mr. Powerstein was perceived as a flight risk who
placed assets beyond the reach of the Federal Government by
transferring them to nominees. Respondent’s auditor used the net
worth and expenditures method to determine the amounts to be
jeopardy-assessed. The auditor made these determinations over a
4-day period in which information seized from the Romeo property
was examined and analyzed.
For jeopardy assessment purposes, respondent’s auditor
calculated petitioners’ increase in net worth between December
1988 and July 1989. Petitioners’ opening net worth was
determined from the 1983 loan application, and their ending net
worth was determined by reference to bank account balances as of
July 1989. The difference between petitioners’ ending and
opening net worth was allocated equally over each of the years
1984 through 1988; i.e., the increase in net worth was divided by
5. Additional adjustments were made for each of the years 1984
through 1988 for living expenses and available cash. The net
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worth increase for each of the years 1984 through 1988 was
determined to be business income from the accounting firm.
On July 24, 1989, respondent jeopardy-assessed taxes,
additions to tax, and interest against petitioners for each of
the years 1984 through 1988. See sec. 6861. On July 25, 1989,
respondent issued a notice of jeopardy assessment to petitioners
for 1984 through 1988 in the following amounts:
Additions to Tax
Sec. Sec. Sec. Sec. Sec.
Year Deficiency 6653(b)(1) 6653(b)(2) 6653(b)(1)(A) 6653(b)(1)(B) 6661
1984 $28,664 $14,374 $7,918 -0- -0- $ 7,166
1985 48,948 24,474 9,520 -0- -0- 12,237
1986 38,186 -0- -0- $28,640 $5,095 9,547
1987 39,749 -0- -0- 29,935 2,952 9,937
1988 30,915 23,186 -0- -0- -0- 7,729
Respondent also jeopardy-assessed interest of $65,778 against
petitioners and collected that amount in 1989 by levying upon
petitioners’ bank accounts. In total, respondent seized $449,513
from petitioners’ various accounts.6 After jeopardy assessment
of petitioners’ assets was made, respondent continued his
criminal investigation by summoning at least 36 banks and
interviewing at least 36 witnesses. Respondent subsequently
redetermined petitioners’ net worth and reflected those
determinations in his answer.
6
Respondent took the position that as of July 24, 1989, the
total tax, additions to tax, and interest purportedly due from
petitioners for 1984 through 1988 was $429,424 (total liability).
As of the date of the trial in these cases, respondent has not
refunded petitioners the $20,089 difference between the amount
seized ($449,513) and the total liability ($429,424).
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D. Indictment
A Federal grand jury in the U.S. District Court for the
Middle District of Florida indicted Mr. Powerstein for various
Federal tax offenses in a 13-count indictment (indictment). The
indictment charged Mr. Powerstein with (1) one count of corruptly
obstructing and impeding the due administration of the internal
revenue laws by preparing and filing false and fraudulent Federal
income tax returns for himself and clients in violation of
section 7212(a); (2) eight counts of knowingly and willfully
aiding and assisting in the preparation and presentation of
materially false income tax returns of clients in violation of
section 7206(2); (3) three counts of knowingly and willfully
attempting to evade taxes during 1986 through 1988 in violation
of section 7201; and (4) one count of publishing a false power of
attorney in violation of 18 U.S.C. sec. 495.
E. Plea Agreement and Sentencing
On July 2, 1993, Mr. Powerstein signed a plea agreement in
which he pleaded guilty to one count of corrupt interference with
the administration of the internal revenue laws in violation of
section 7212(a) and one count of criminal tax evasion in
violation of section 7201. In connection with the plea
agreement, Mr. Powerstein agreed that he prepared and filed false
and fraudulent Federal income tax returns individually and on
behalf of his client-taxpayers in order to fraudulently obtain
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tax refunds. Mr. Powerstein agreed that he understated his 1987
income by approximately $150,159 and that he owed the U.S.
Treasury approximately $53,715 of Federal income tax for 1987.
Mr. Powerstein admitted to preparing fraudulent Forms W-2,
Wage and Tax Statement, which overstated the Federal income taxes
withheld for 79 client-taxpayers. He also admitted to, on
several occasions, creating false and fraudulent Forms W-2 for
client-taxpayers that identified firms or business that had never
employed, paid wages to, or withheld Federal income taxes from
those client-taxpayers. In total, the District Court found that
the total tax losses attributable to Mr. Powerstein were
“slightly less than” $1.5 million.7 On March 31, 1994, the
District Court sentenced Mr. Powerstein to 63 months of
imprisonment, 3 years of supervised release, a fine of $100,000,
and a special assessment of $100.
7
The tax losses included Federal income tax deficiencies and
interest for 1984 through 1988 of $191,812, tax losses of
$246,615 related to the 79 client-taxpayers for whom Mr.
Powerstein prepared fraudulent returns, and tax losses of almost
$1.1 million attributable to Mr. Powerstein’s clients whose
returns were not examined. We observe that the tax losses are
slightly more than $1.5 million.
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XVI. Pleadings
A. Docket No. 30261-89
1. Notice of Deficiency and Petition
By notice of deficiency dated September 21, 1988, respondent
determined deficiencies in petitioners’ 1984 through 1988 Federal
income taxes and additions to tax as follows:
Additions to Tax
Sec. Sec. Sec. Sec. Sec.
Year Deficiency 6653(b)(1) 6653(b)(2) 6653(b)(1)(A) 6653(b)(1)(B) 6661
1984 $28,664 $14,374 $7,918 -0- -0- $ 7,166
1985 48,948 24,474 9,520 -0- -0- 12,237
1986 38,186 -0- -0- $28,640 $5,095 9,547
1987 39,749 -0- -0- 29,935 2,952 9,937
1988 30,915 23,186 -0- -0- -0- 7,729
The amounts determined in the notice of deficiency were equal to
those determined in the jeopardy assessment; i.e., both
determinations used the same method for calculating net worth.
Thus, the notice of deficiency reports petitioners’ opening net
worth as of December 31, 1983, their closing net worth as of
December 31, 1988, and the increase or decrease during that time
as follows:
12/31/83 12/31/88 Increase/(Decrease)
Stocks $5,000 $43,024 $38,024
Bank accounts 85,000 529,700 444,700
Real estate 107,201 42,461 (64,740)
Total assets 197,201 615,185 417,984
Total liabilities 73,000 -0- -0-
Net worth 124,201 615,185 490,894
Respondent then divided the $490,894 increase to petitioners’ net
worth between 1984 and 1988 by 5 to arrive at petitioners’ annual
- 24 -
net worth increase, or $98,197. Respondent then determined
petitioners’ business income, as follows:
12/31/84 12/31/85 12/31/86 12/31/87 12/31/88
Increase in net worth $98,197 $98,197 $98,197 $98,197 $98,197
Additions:
Personal living
expenses 25,085 26,781 26,540 26,540 26,540
Subtractions:
Cash available 20,095 3,479 29,903 13,162 10,710
1
Business income 103,187 121,499 94,834 111,575 98,680
1
We observe that respondent’s calculation of business income does not equal
increase in net worth plus personal living expenses less cash available.
Petitioners petitioned the Court in response to the notice
of deficiency, and the Court docketed that case at docket No.
30261-89.
2. Answer
In the answer, respondent asserted that because the notice
of deficiency averaged petitioners’ understatements evenly over
1984 through 1988, petitioners’ reconstructed taxable income was
(1) overstated for 1984 and 1985, and (2) understated for 1986,
1987, and 1988. Accordingly, respondent asserted adjustments to
the deficiencies and additions to tax determined to be due from
petitioners as follows:
Additions to Tax
Sec. Sec. Sec. Sec. Sec.
Year Deficiency 6653(b)(1) 6653(b)(2) 6653(b)(1)(A) 6653(b)(1)(B) 6661
1984 $1,599 $842 $442 -0- -0- -0-
1985 23,492 11,695 4,549 -0- -0- $5,873
1986 47,566 -0- -0- $35,353 (1) 11,892
1987 58,251 -0- -0- 43,536 (1) 14,563
1988 58,187 43,563 -0- -0- -0- 14,547
1
50 percent of the interest due on the deficiency.
- 25 -
For purposes of the answer, respondent used the net worth method
to determine increases to petitioners’ 1984 through 1988 taxable
income as follows:
12/31/83 12/31/84 12/31/85 12/31/86 12/31/87 12/31/88
Net worth
computation:
Cash on hand $188,159 $231,552 $231,848 $325,992 $457,059 $565,765
Investments 26,662 21,441 21,441 23,703 32,935 47,469
Personal assets 26,099 36,599 36,599 36,687 36,687 51,015
Real estate 96,376 143,371 81,171 81,171 81,171 81,171
Additional
investments 9,065 7,422 7,787 7,712 10,082 10,321
Total assets 346,361 440,385 378,846 475,265 617,934 755,741
Loans and
mortgages 72,807 153,627 52,674 51,420 51,023 51,497
Charge accounts -0- -0- -0- -0- -0- -0-
Accumulated
depreciation 6,637 10,535 10,535 6,093 7,755 9,373
Total liabilities 79,444 164,162 63,209 57,513 58,778 60,870
Net worth 266,917 276,223 315,637 417,752 559,156 694,871
Less prior year’s
net worth N/A 266,917 276,223 315,637 417,752 559,156
Net worth increase N/A 9,306 39,414 102,115 141,404 135,715
Personal expenses N/A 25,085 26,781 26,540 28,549 28,549
Less nontaxable
income N/A 5,333 329 4,233 429 203
Adjusted gross
income N/A 29,058 65,866 124,422 169,524 164,061
Less itemized
deductions N/A 15,304 16,087 6,148 8,655 5,000
Less exemptions N/A 3,000 3,120 3,240 5,700 5,850
Corrected taxable
income N/A 10,754 46,659 115,034 155,169 153,211
Reported taxable
income N/A 5,086 4,447 7,945 1,499 (140)
Increase to taxable
income N/A 5,668 42,212 107,089 153,670 153,351
a. Cash On Hand
Respondent determined petitioners’ cash on hand as follows:
Cash in Banks 12/31/83 12/31/84 12/31/85 12/31/86 12/31/87 12/31/88
American Savings $37,301 $35,003 -0- -0- -0- -0-
Atlantic Bank 3,169 63,430 $10,047 $64,208 $160,961 $202,448
BankAtlantic 51,352 -0- -0- -0- -0- -0-
Barnett Bank -0- -0- -0- -0- -0- 2,670
Biscayne Federal 10,846 10,884 10,930 10,965 10,185 10,185
Brooklyn Federal 158 218 178 142 150 148
California Federal -0- 10,762 75,490 11,912 25,468 10,133
Carteret Savings 10,237 6,368 6,485 6,592 6,699 6,827
- 26 -
Centrust Savings -0- -0- -0- 10,000 10,000 20,897
Citicorp Savings 6,518 6,419 56,678 126,445 96,775 96,860
City Federal
Savings 20,233 20,233 20,353 20,358 20,364 20,343
Commonwealth 2,590 22,643 22,697 22,750 2,804 2,857
Dime Savings 135 526 559 591 624 659
First Nationwide 2,513 2,858 3,142 -0- -0- -0-
First Union 102 108 114 120 126 132
Fund for
Government Inc. 89 39 39 39 40 40
Glendale Bank -0- 10,512 -0- -0- -0- -0-
Greater New York 3,562 -0- -0- -0- -0- -0-
Hollywood Federal 1,073 1,134 1,198 1,265 1,337 1,412
Mid State Federal -0- -0- -0- 11,446 85,464 154,840
Roosevelt Bank 1,049 1,253 1,438 2,159 1,562 814
Safra Bank 36,832 38,858 22,500 37,000 34,500 34,500
Sun Bank 400 304 -0- -0- -0- -0-
Total 188,159 231,552 231,848 325,992 457,059 565,765
b. Investments
Respondent valued petitioners’ investments in 1983 through
1988 at $35,727, $28,863, $29,228, $31,415, $43,017, and $57,790,
respectively. Included in this determination were 775 shares of
Charme which petitioners contend are worthless.
c. Personal Assets
Respondent valued petitioners’ personal assets as follows:
Description 12/31/83 12/31/84 12/31/85 12/31/86 12/31/87 12/31/88
1986 Caprice
classic -0- -0- -0- $9,373 $9,373 $9,373
International
tractor -0- $10,500 $10,500 10,500 10,500 10,500
1982 Chevy pickup $15,564 15,564 15,564 15,564 15,564 15,564
1982 Caprice 10,535 10,535 10,535 -0- -0- -0-
1984 Plymouth
Reliant -0- -0- -0- -0- -0- 4,284
1985 Mercury -0- -0- -0- -0- -0- 8,500
1973 Ford truck -0- -0- -0- -0- -0- 2,544
1980 Dodge aspen -0- -0- -0- 1,000 1,000 -0-
1973 Ford S/W -0- -0- -0- 250 250 250
Total 26,099 36,599 36,599 36,687 36,687 51,015
Petitioners contend that they owned additional personal property,
including a copier.
- 27 -
d. Real Estate
Respondent valued petitioners’ real estate as follows:
Description 12/31/83 12/31/84 12/31/85 12/31/86 12/31/87 12/31/88
Romeo property $20,009 $20,009 $20,009 $20,009 $20,009 $20,009
Coral Springs
residence 62,200 62,200 -0- -0- -0- -0-
Vacation home 7,333 7,333 7,333 7,333 7,333 7,333
Addison mobile
home -0- 23,431 23,431 23,431 23,431 23,431
Well 1,375 1,375 1,375 1,375 1,375 1,375
Fenceposts 2,358 2,358 2,358 2,358 2,358 2,358
Crossties 501 501 501 501 501 501
Pine Street
mobile home 2,600 26,164 26,164 26,164 26,164 26,164
Total 96,375 143,371 81,171 81,171 81,171 81,171
e. Loans and Mortgages
Respondent valued petitioners’ loans and mortgages as
follows:
Description 12/31/83 12/31/84 12/31/85 12/31/86 12/31/87 12/31/88
Glendale Bank $72,807 -0- -0- -0- -0- -0-
Glendale Bank -0- $99,873 -0- -0- -0- -0-
Sun Bank -0- 53,754 $52,674 $51,420 -0- -0-
Mid State -0- -0- -0- -0- $51,023 -0-
Mid State -0- -0- -0- -0- -0- $51,497
Total 72,807 153,627 52,674 51,420 51,023 51,497
Petitioners contend that there is an additional loan outstanding
for $19,500 from Atlantic Bank.
3. Amended Answer
Respondent amended his answer on April 27, 2007 (amended
answer), to assert that Mr. Powerstein is collaterally estopped
from denying (1) his liability for the additions to tax imposed
by section 6653(b)(1)(A) and (B); and (2) the facts necessary to
convict him under counts 1 and 11 of the indictment.
- 28 -
4. Second Amended Answer
Respondent’s net worth computation determined nondeductible
expenditures allocable to petitioners of $135,504 on the basis of
average annual expenditures for a family of three as determined
by the Bureau of Labor Statistics (BLS). In his second amendment
to answer (second amended answer) filed with the Court on April
21, 2010, respondent revised his determination of petitioners’
nondeductible personal expenditures. The second amended answer
determined nondeductible personal expenditures allocable to
petitioners of $241,789 using a composite of check registers from
petitioners’ various bank accounts, BLS, and petitioners’ 1984
through 1988 joint returns. In particular, respondent
recalculated petitioners’ personal expenditures using a
combination of BLS, check registers, and petitioners’ tax
returns. The second amended answer also asserted an increased
deficiency if respondent’s personal living expenses analysis is
sustained.
B. Docket No. 13443-92
On March 30, 1992, respondent issued to Mr. Powerstein a
notice of deficiency which determined a $49,000 deficiency in Mr.
Powerstein’s 1989 Federal income tax and a $36,750 fraud penalty
under section 6663. Mr. Powerstein petitioned the Court in
response to that notice of deficiency, and the Court docketed the
case at docket No. 13443-92.
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OPINION
I. Burden of Proof
Petitioners moved the Court in limine to modify the burden
of proof with respect to amounts shown on respondent’s net worth
schedule because, petitioners contended, respondent seized but
did not return some of their personal and business records. We
denied petitioners’ motion without prejudice to arguing the point
in their opening brief, and they again asserted on brief that the
burden of proof should shift to respondent. Absent a written
stipulation to the contrary, these cases are appealable to the
U.S. Court of Appeals for the Eleventh Circuit. See sec.
7482(b)(1)(A), (2).
The Commissioner’s determinations in a notice of deficiency
are generally presumed correct, and taxpayers must prove those
determinations erroneous in order to prevail. Rule 142(a); Welch
v. Helvering, 290 U.S. 111, 115 (1933). In cases involving
unreported income, however, the presumption of correctness does
not attach until the Commissioner supports his determinations
with a minimal “‘evidentiary foundation linking the taxpayer to
the alleged income-producing activity.’” Blohm v. Commissioner,
994 F.2d 1542, 1549 (11th Cir. 1993) (quoting Weimerskirch v.
Commissioner, 596 F.2d 358, 362 (9th Cir. 1979), revg. 67 T.C.
672 (1977)), affg. T.C. Memo. 1991–636. Once the Commissioner
has produced evidence linking the taxpayers to an income-
- 30 -
producing activity, the burden of proof shifts to the taxpayers
to rebut that presumption by establishing that the Commissioner’s
determinations are arbitrary or erroneous. Blohm v.
Commissioner, supra at 1549.
The Court of Appeals for the Eleventh Circuit has described
the situation in which the burden of proof shifts to the
Commissioner as “rare” and only occurring “where the Commissioner
has introduced no substantive evidence, and the evidence shows
that the claimed tax deficiency arising from unreported income
was derived by the government from unreliable evidence.” Gatlin
v. Commissioner, 754 F.2d 921, 923 (11th Cir. 1985), affg. T.C.
Memo. 1982-489. To satisfy his initial burden of production,
respondent introduced records which were seized from petitioners
or summoned from third parties. Those records establish that
petitioners received, but did not report, substantial amounts of
income between 1984 and 1988. On the basis of this credible
evidence, we are satisfied that respondent has made the requisite
showing for his determinations as set forth in the notice of
deficiency to be entitled to the general presumption of
correctness. See Schad v. Commissioner, 87 T.C. 609, 620 (1986)
(connecting a taxpayer with funds that form the basis of the
deficiency is sufficient for the presumption of correctness to
attach), affd. without published opinion 827 F.2d 774 (11th Cir.
1987).
- 31 -
As relevant here, the presumption of correctness is modified
in several respects. First, respondent asserted a claim for an
increased deficiency in his answer for each of the years 1986
through 1988, and he bears the burden of proof as to those
increased deficiencies. See Rule 142(a)(1). Second, respondent
amended his answer to assert that Mr. Powerstein is collaterally
estopped from denying liability for the fraud additions to tax
for 1987, and he bears the burden of proof with respect to that
newly pleaded matter. See id. Third, respondent revised his
determination of petitioners’ nondeductible personal expenditures
in the second amended answer, and he bears the burden of proof
with respect to that issue. See id. We have decided the issues
herein with these general principles in mind. To the extent that
we have not specifically addressed whether respondent has met his
burden of proof with respect to any of the foregoing issues, we
decline to do so because the record favors respondent.
II. Unreported Income
A. Overview
Gross income includes all income from whatever source
derived, including income derived from business. Sec. 61(a)(2).
Taxpayers are required to maintain books and records sufficient
to establish the amount of their Federal income tax liability.
See sec. 6001; sec. 1.6001-1(a), Income Tax Regs. In the absence
of such books and records, the Commissioner is authorized to
- 32 -
reconstruct the taxpayers’ income by any method that clearly
reflects income. Sec. 446(b); Parks v. Commissioner, 94 T.C.
654, 658 (1990). One such method that courts have long
recognized as reasonable, and the method used by respondent in
these cases, is the net worth method. See Holland v. United
States, 348 U.S. 121, 131 (1954).
Under the net worth method, the Commissioner reconstructs
the taxpayers’ income by determining the taxpayers’ net worth at
the beginning and end of each of the years in issue. The
difference between those amounts for each successive year is the
taxpayers’ annual net worth increase (or decrease). The net
worth for each year is then adjusted by adding nondeductible
personal expenditures and subtracting nontaxable receipts. Id.
at 125. An increase in net worth in any given year creates an
inference of taxable income in that year, provided that the
Commissioner shows a likely source of the unreported income, or
negates possible nontaxable sources. See United States v.
Massei, 355 U.S. 595 (1958).
In the instant cases, petitioners failed to maintain books
or records from which their Federal tax liabilities could be
computed, and respondent reconstructed petitioners’ income using
the net worth method. As the starting point for determining
petitioners’ net worth, respondent used the net worth statement
included in the 1983 loan application. Respondent then computed
- 33 -
petitioners’ net worth for each of the years from 1984 through
1988 and determined an aggregate increase in net worth of
$427,954. Respondent attributed the source of this increase to
Mr. Powerstein’s accounting firm.
Petitioners challenge the accuracy of respondent’s income
reconstruction on four principal grounds. First, petitioners
contend that respondent overstated their opening net worth by
including, among other things, cash in certain bank accounts
which they did not wholly own. Second, petitioners claim that
respondent failed to make various adjustments to their net worth
in each of the years in issue. Third, petitioners assert that
respondent’s calculation of nondeductible personal expenditures
is erroneous, duplicative, and/or unsupported by the record.
Fourth, petitioners argue that respondent’s calculation of
nontaxable receipts is understated.
B. Disputed Opening Net Worth
Petitioners cite three reasons for challenging respondent’s
computation of their opening net worth. First, they contend that
respondent’s calculation erroneously included cash in bank
accounts held jointly or in trust for Ms. P. Powerstein, Ms.
Pasternak, and Ms. Korman. Second, they claim that respondent
failed to account for household furnishings which they owned at
the start of 1984. Third, they assert that respondent failed to
adjust the basis of the Coral Springs residence for certain
- 34 -
additions and improvements. We agree with petitioners for the
most part, and consider their arguments seriatim.
1. Bank Accounts
Petitioners begin by arguing that respondent incorrectly
included in their opening net worth, cash in bank accounts which
Mr. Powerstein held jointly with or in trust for Ms. P.
Powerstein, Ms. Pasternak, and Ms. Korman. First, petitioners
claim that cash in nine accounts at Safra Bank was improperly
included in their opening net worth because those accounts were
jointly owned with Ms. P. Powerstein and that she funded one-half
of the initial deposits made to those accounts.8 We agree. To
satisfy their burden, petitioners rely upon the testimony of Mr.
Powerstein and bank records for these accounts. Included in the
records are account signature cards which list the owners’
address as being in Brooklyn and a letter requesting changes to
those accounts that is signed by Mr. Powerstein and Ms. P.
Powerstein. We understand the address referenced in the
signature cards to be that of Ms. P. Powerstein, and we credit
Mr. Powerstein’s testimony in the light of the corroborating
documentary evidence. Accordingly, we find that petitioners’
opening net worth should be reduced by $11,250, which is Ms. P.
Powerstein’s share of cash in the accounts held jointly with Mr.
8
The accounts at Safra Bank claimed to be held jointly with
Ms. P. Powerstein are account numbers ending 1178, 1770, 1202,
1203, 1204, 1205, 1206, 2334, and 2335.
- 35 -
Powerstein. Cf. Unger v. Commissioner, T.C. Memo. 2000-267
(including cash in jointly held bank accounts in a taxpayer’s net
worth where inclusion of those accounts was supported by
documentary evidence).
Second, petitioners ascribe error to the inclusion of cash
in accounts at Brooklyn Federal Savings & Loan (Brooklyn Federal)
and Roosevelt Savings Bank (Roosevelt Bank) in their opening net
worth.9 According to petitioners, these accounts are not
attributable to them because they were jointly owned with and
wholly funded by Ms. Pasternak. We agree. Petitioners again
rely upon the testimony of Mr. Powerstein and bank records for
these accounts. The account records for each of the Brooklyn
Federal and Roosevelt Bank accounts establish that those accounts
were held in trust for Susan Mark, Mr. Powerstein’s cousin. A
signature card for the Roosevelt Bank account was signed by Mr.
Powerstein and Ms. Pasternak, and listed separate addresses for
each account holder. We again credit Mr. Powerstein’s testimony
given the supporting documentary evidence. Accordingly, we find
that petitioners’ opening net worth for cash on deposit at
Brooklyn Federal and Roosevelt Bank should be reduced by $158 and
$1,049, respectively. Cf. id.
9
The accounts alleged to be jointly held with Ms. Pasternak
are account number ending 0790 at Brooklyn Federal and account
number ending 9211 at Roosevelt Bank.
- 36 -
Third, petitioners maintain that an account at Citicorp Bank
(Citicorp), which was held in trust for Ms. Korman and funded by
her father, is not an asset belonging to them.10 We agree.
Petitioners carry their burden with the testimony of Mr.
Powerstein and bank records which establish that this account was
held in trust for Ms. Korman. We credit Mr. Powerstein’s
testimony in the light of the supporting documentary evidence.
Accordingly, we find that petitioners’ opening net worth for cash
held at Citicorp should be reduced by $217. See Estate of
Cardulla v. Commissioner, T.C. Memo. 1986-307.
2. Household Furnishings
Petitioners next argue that respondent erroneously excluded
an allowance for personal household furnishings from their
opening net worth. According to petitioners, their opening net
worth should be increased to reflect household items which they
moved from Brooklyn to the Coral Springs residence. We agree.
To support this increase in opening net worth, petitioners rely
upon a bill of lading from the moving company that transported
their furnishings, proof of insurance for $64,800 of personal
property located at the Coral Springs residence, and Mr.
10
The account claimed to be held in trust for Ms. Korman is
account number ending 7299 at Citicorp. We observe that Mr.
Powerstein testified at trial that the $1,533 balance in account
number ending 161-8 at Atlantic Bank was also attributable to Ms.
Korman. We consider petitioners to have conceded this argument
since they do not address it on brief. See Nicklaus v.
Commissioner, 117 T.C. 120.
- 37 -
Powerstein’s testimony that the household items cost
approximately $30,000. We credit Mr. Powerstein’s testimony as
reasonable and hold that petitioners’ opening net worth is
increased by $30,000.
3. Basis in the Coral Springs Residence
Petitioners further argue that their opening net worth
should be increased to reflect $11,191 of costs incurred in
constructing the Coral Springs residence and $14,529 of expenses
incurred to improve that property. As petitioners see it, these
additional costs increase their basis in the Coral Springs
residence and thereby affect their opening net worth. We agree
in part. With respect to the $11,191 of construction costs,
petitioners rely upon Mr. Powerstein’s direct testimony, his
handwritten notes regarding the payment of such expenses in the
late 1970s, and the 1978 loan application, all of which support
petitioners’ claim that they incurred such expenses. Given the
corroborating evidence, we credit Mr. Powerstein’s testimony as
reasonable, and hold that petitioners’ basis in the Coral Springs
residence is increased by $11,191. See sec. 1016(a)(1).
With respect to the $14,529 in additional improvements,
petitioners rely solely upon the testimony and handwritten notes
of Mr. Powerstein to establish such an increase to their basis in
the Coral Springs residence. We decline to credit this evidence
absent further corroborating evidence, such as testimony of the
- 38 -
contractors who performed the work or receipts for the work
performed.11 Mr. Powerstein maintained receipts and records
related to a variety of expenses associated with petitioners’
investments. Although Mr. Powerstein’s handwritten notes
reference canceled checks and invoices as source documents,
petitioners did not provide copies of those items. Accordingly,
we hold that petitioners’ basis increase in the Coral Springs
residence is limited to $11,191.
C. Disputed Increases to Net Worth
Petitioners next contend that respondent’s determination of
their annual net worth increase for each of the years in issue
failed to account for various adjustments to their assets and
liabilities. We consider petitioners’ contentions in turn.
1. Cash in Banks
We previously held that respondent incorrectly included in
petitioners’ opening net worth cash in bank accounts held jointly
or in trust for Ms. Pasternak, Ms. P. Powerstein, and Ms. Korman.
On the basis of the record as a whole, and taking into account
the parties’ stipulations as to bank accounts which petitioners
owned, we hold that petitioners’ net worth for 1984, 1986, 1987,
and 1988 should be reduced by $17,948, $3,807, $1,982, and
11
In the absence of such records, we assume that they did
not exist or were unfavorable to petitioners’ position. See
Wichita Terminal Elevator Co. v. Commissioner, 6 T.C. 1158, 1165
(1946), affd. 162 F.2d 513 (10th Cir. 1947).
- 39 -
$1,247, respectively.12 We also hold that petitioners’ net worth
for 1985 should be increased by $21,895.13
2. Investments
Petitioners maintain that their net worth should be reduced
to exclude the value of 775 shares of Charme stock which were
worthless during the years in issue. We disagree. Taxpayers
generally bear the burden of proving that the stock in question
was “wholly worthless” and when it becomes worthless. See Boehm
v. Commissioner, 326 U.S. 287, 294 (1945); sec. 1.165-5(c),
Income Tax Regs. We ordinarily treat stock as worthless if it
has neither liquidating value nor potential value. Austin Co. v.
Commissioner, 71 T.C. 955, 970 (1979). A corporation’s stock has
liquidating value if the corporation’s assets exceed its
liabilities. Id. A corporation’s stock has potential value if
there is a reasonable expectation that it will become valuable in
the future. Morton v. Commissioner, 38 B.T.A. 1270, 1278 (1938),
affd. 112 F.2d 320 (7th Cir. 1940). Where a corporation declares
12
These adjustments relate to bank accounts at Brooklyn
Federal, Citicorp, Roosevelt Bank, and Safra Bank. The 1984
adjustment reflects the parties’ stipulation that petitioners’
bank account should be reduced by $8,259 for amounts deposited to
the Underhill account. We attribute any difference in amounts to
rounding.
13
Included in the 1985 adjustment are a reduction in net
worth of $13,108 related to various bank accounts, and an
increase in net worth of $35,003 as reflected by petitioners’
receipt of a certificate of deposit from California Federal Bank
(California Federal).
- 40 -
bankruptcy, ceases to conduct business, liquidates, or has a
receiver appointed, its stock may be worthless because these
events can limit or destroy the stock’s potential value. See id.
That rule, however, is not absolute. See, e.g., Dallmeyer v.
Commissioner, 14 T.C. 1282, 1291-1292 (1950); Patten & Davies
Lumber Co. v. Commissioner, 45 F.2d 556, 558 (9th Cir. 1930),
revg. a Memorandum Opinion of this Court dated July 29, 1929; see
also Scagliotta v. Commissioner, T.C. Memo. 1996-498; Storch v.
Commissioner, T.C. Memo. 1985-17.
In applying the foregoing principles, we are unable to agree
with petitioners that the Charme stock became wholly worthless
during any of the years in issue. Although Charme declared
bankruptcy in 1985, its bankruptcy continued into 1995, which
suggests that its stock had at least some residual liquidation
value in 1985. Such value might have included, for example,
liquidating distributions to the stockholders after creditors’
claims had been satisfied. Absent additional facts surrounding
the financial viability of Charme, the assets it held when placed
into chapter 7 liquidating bankruptcy, the expenses of
administration, or a fixed and identifiable event establishing
complete worthlessness, we decline to accept that the stock was
devoid of all present or potential value. See Miami Beach Bay
Shore Co. v. Commissioner, 136 F.2d 408, 409 (5th Cir. 1943)
(stock is not worthless until the “last vestige of value has
- 41 -
disappeared”). Accordingly, we hold that petitioners’ net worth
includes the $1,750 value of the Charme stock.
3. Household Property
We previously held that respondent incorrectly omitted from
petitioners’ opening net worth a $30,000 allowance for personal
household furnishings. Petitioners now contend that they are
entitled to a nondeductible loss to reflect the disposition of
that property when they moved from the Coral Springs residence to
the Addison mobile home. We are not persuaded. Without
elaboration, petitioners contend on brief that they disposed of
“a good amount” of these furnishings because the Addison mobile
home was “substantially smaller” than the Coral Springs
residence. As support for their entitlement to the nondeductible
loss, petitioners state that they did not claim a charitable
contribution deduction for that property, which suggests that
they donated it. Absent a receipt of the donation or other
corroborating evidence, we decline to accept petitioners’ self-
serving statements. We find petitioners’ claims especially
implausible given that the property listed in the bill of lading
included bedroom furniture, electronics, living room furniture,
office furniture, and household items, all of which conceivably
would have been suitable for use in the Addison mobile home. On
the basis of the record at hand, petitioners have not proved
their entitlement to a nondeductible loss for personal property
- 42 -
in 1985. Accordingly, we hold that petitioners’ net worth is
increased by $30,000 for each of the years in issue to reflect
petitioners’ household property.
4. Real Estate
a. Coral Springs Property
We previously held supra p. 37 that petitioners’ basis in
the Coral Springs residence should be increased by $11,191 to
account for construction costs related to that home. We
similarly hold that petitioners’ basis in the Coral Springs
residence for 1984 is increased by $11,191. See sec. 1016(a)(1).
b. Romeo Property
Petitioners contend that respondent understated their basis
in the Romeo property. According to petitioners, their basis in
the Romeo property should be increased by $10,284 to reflect
costs of clearing and improving that property, support paid to
the Ballards, and costs of hiring workers to assist in clearing
that property. Petitioners rely upon a number of methods of
proof to carry their burden. First, they rely upon the direct
testimony of Mr. Powerstein, Mr. Ballard, and Ms. Ballard.
Second, they offered an appraisal which reported improvements to
that property such as a three-stall barn, a pump house, and a
septic tank. Third, they submitted checks, receipts, and letters
establishing that they paid support to the Ballards while the
Romeo property was developed and hired workers to help in the
- 43 -
clearing of that land. Fourth, they offered the handwritten
notes of Mr. Powerstein listing the expenses incurred in
connection with developing the Romeo property. We also note that
petitioners’ estimates of the cost of developing the Romeo
property reasonably excluded (1) expenses related to M&M, and (2)
improvements that respondent had credited them with. Given the
overwhelming evidence introduced to corroborate petitioners’
claim, we hold that their basis in the Romeo property is
increased by $10,284. See id.
c. Addison Mobile Home
Petitioners maintain that their basis in the Addison mobile
home should be reduced by $970 from $23,431 to $22,461. We
disagree. In an attempt to meet their burden, petitioners rely
upon the handwritten notes of Mr. Powerstein showing a purchase
price for the Addison mobile home of $22,461. Respondent, on the
other hand, submitted canceled checks establishing that the cost
of acquiring the Addison mobile home was $23,431. As compared
with Mr. Powerstein’s handwritten schedule, we find the checks
relied upon by respondent to be more persuasive. Accordingly, we
sustain respondent’s determination that petitioners’ basis in the
Addison mobile home was $23,431.
5. Loans and Mortgages
Petitioners assert that their net worth should be adjusted
to reflect a $19,500 loan (Atlantic loan) from Atlantic Bank. We
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agree. Petitioners submitted evidence showing that they became
liable on the Atlantic loan in or around 1984. First, they made
a large deposit to a bank account with Atlantic Bank on February
2, 1984, which we believe reasonably could have included the
proceeds from the Atlantic loan. Second, petitioners submitted a
bank deposit ticket showing that a $19,500 loan with Atlantic
Bank was repaid in 1985. Third, petitioners presented
handwritten notes of Mr. Powerstein showing that a $19,500 note
was taken from Atlantic Bank. Accordingly, we hold that
petitioners’ net worth should be increased by $19,500 in 1984 and
1985, the years during which the Atlantic loan was outstanding.
6. Depreciation
Respondent determined that petitioners were entitled to
adjustments for accumulated depreciation of $10,535, $10,535,
$6,093, $7,755, and $9,373 in 1984 through 1988, respectively.
Petitioners counter that they are entitled to additional
depreciation of $200, $349, $299, $250, and $452 in 1984 through
1988, respectively. These adjustments stem from petitioners’
alleged use of the Addison mobile home and the copier in Mr.
Powerstein’s accounting firm. As discussed more fully below, we
conclude that expenses related to the copier, but not to the
Addison mobile home, were ordinary and necessary business
expenses of Mr. Powerstein’s accounting firm. We thus hold that
petitioners’ adjustments for accumulated depreciation in 1984
- 45 -
through 1988 are $10,535, $10,535, $6,093, $7,755, and $9,538,
respectively.
D. Disputed Nondeductible Personal Expenditures
1. Overview
Given the absence of information concerning petitioners’
specific personal living expenses, respondent used BLS figures to
calculate petitioners’ nondeductible personal living expenses for
1984 through 1988 and reflected his determinations in the answer.
After more than 20 years, respondent amended the answer a second
time to assert increases in petitioners’ nondeductible personal
expenses of $106,285. The revised expenditures were based on a
composite of BLS figures and expenditures reflected in
petitioners’ three main checking accounts. Because the
adjustments in nondeductible personal living expenses increased
petitioners’ annual net worth for each of the years 1984 through
1988, we treat the revised personal nondeductible expenditures as
a new matter on which respondent bears the burden of proof. See
Rule 142(a); Michas v. Commissioner, T.C. Memo. 1992-161.
Petitioners offered substantial proof to rebut respondent’s
imputation of items under the BLS and additional adjustments. In
particular, petitioners submitted evidence that proved that (1)
they did not make certain expenditures attributed to them under
BLS, or (2) respondent erroneously classified expenses as
nondeductible that were in fact deductible. Although we mostly
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agree with petitioners’ challenges to respondent’s revised
adjustments, that agreement is not unlimited. We explain
seriatim only those adjustments proposed by petitioners with
which we disagree or those items that we feel warrant
explanation. To the extent that we have rejected any adjustment
proposed by respondent as to petitioners’ nondeductible personal
expenditures, we have done so because respondent failed to
persuade us that such an adjustment was proper.
2. Alcoholic Beverages
Respondent imputed to petitioners allowances of $275, $286,
$272, $294, and $268 for alcoholic beverages for 1984 through
1988, respectively. Although petitioners testified that they did
not consume alcohol during the years in issue, they also
testified that they provided most (if not all) of the Ballards’
support from 1984 through 1986. Mr. Ballard was described at
trial as a “social drinker”, and he was convicted of driving
under the influence. We thus believe it reasonable to impute
expenses for alcoholic beverages to petitioners for 1984 through
1986 because petitioners supported the Ballards, at least one of
whom consumed alcohol. We do not believe it reasonable to impute
expenses for alcoholic beverages to petitioners during 1987 and
1988 because petitioners apparently did not support the Ballards
during those years and petitioners testified credibly that they
did not consume alcohol. Accordingly, we sustain respondent’s
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determination that nondeductible personal expenses for alcoholic
beverages of $275, $286, and $272 for 1984 through 1986,
respectively, are imputed to petitioners.
3. Second Glendale Mortgage
Respondent determined that petitioners made four payments on
the second Glendale mortgage during 1985, including (1) two
payments totaling $2,072 from an account with Atlantic Bank, and
(2) two payments totaling $2,072 from other sources. Petitioners
contend that they made only three payments during 1985 because it
“appeared to be” petitioners’ “custom and habit * * * to make
payments around the fifteenth of each month.” We disagree.
Petitioners were obliged to make payments under the second
Glendale mortgage until that note was satisfied. The sale of the
Coral Springs residence closed on April 12, 1985, and the second
Glendale mortgage was satisfied with the proceeds of that sale.
Regardless of when petitioners customarily paid their mortgage,
they were obligated for the pro rata share of the mortgage up
until the date of repayment. We are satisfied that the amounts
imputed to petitioners regarding the fourth mortgage payment
covered April 1985 and sustain respondent’s determination that
petitioners made four payments on the second Glendale mortgage
during 1985 totaling $4,144.
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4. First Sun Bank Mortgage
Respondent determined that petitioners made nine payments of
approximately $342 on the first Sun Bank mortgage during 1984,
including (1) four payments totaling $1,367 from an account with
Atlantic Bank, and (2) five payments totaling $1,710 from other
sources.14 According to petitioners, only seven payments were
due under the first Sun Bank mortgage during 1984, and respondent
has not proved that petitioners made any more than three payments
under that mortgage. We conclude that petitioners made seven
payments under the first Sun Bank mortgage. Payment due on that
loan began on March 1, 1984, and continued until October 5, 1984,
when petitioners retired the first Sun Bank mortgage with the
proceeds of the second Sun Bank mortgage. Thus, petitioners were
required to make payments under the first Sun Bank mortgage for
the 7-month period between March 1 and October 1, 1984, and for
the first 5 days of October 1984. Accordingly, we hold that
petitioners incurred $2,392 of nondeductible personal
expenditures in 1984 related to the first Sun Bank mortgage ($342
times 7 months).15
Petitioners contend that each of the seven payments paid
under the first Sun Bank mortgage reduced the principal due on
14
Monthly payments of approximately $342 were calculated as
total payments of $1,367 divided by 4 months.
15
The product of the items may not equal the total because
of rounding.
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that note. We agree. The first Sun Bank mortgage provided for
monthly payments of principal and interest. Because the record
does not contain a copy of the note on which the first Sun Bank
mortgage was based, we are forced to estimate the proper
allocation between principal and interest on that note. The
short-term, semiannual-compounding applicable Federal rate (AFR)
in effect for 1984 was 10 percent.16 See Rev. Rul. 84-163, 1984-
2 C.B. 179. Assuming a principal amount of $26,000, an interest
rate of 10 percent, and a 3-year term, we find that principal due
under the first Sun Bank mortgage was more than $2,392. We limit
the principal reduction to the amount petitioners proposed.
5. Real Estate Taxes
Respondent imputed to petitioners real estate tax payments
for the Coral Springs residence of $1,761 and $522 in 1984 and
1985, respectively. With respect to 1984, petitioners counter
that imputing real estate taxes to them is improper because (1)
the first and second Glendale mortgages impounded real estate
taxes of $91 per month, and (2) petitioners prepaid 5 months of
real estate taxes totaling $453. Petitioners concede that $367
of real estate taxes should be imputed to them in 1984. We agree
with petitioners that they paid real estate taxes through the
16
We use the short-term AFR because the term of the first
Sun Bank mortgage was 3 years. See sec. 1274(d)(1)(A). We use
the semiannual-compounding convention as that most closely
approximating the average daily interest rate for 1984.
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first and second Glendale mortgages, and we hold that they need
impute real estate taxes only in the amount conceded.
With respect to 1985, petitioners contend that respondent’s
imputation of real estate taxes is improper because those real
estate taxes were paid from the closing proceeds on the sale of
the Coral Springs residence. We disagree. The settlement
statement with respect to the sale of the Coral Springs residence
to the Underhills made two adjustments related to real estate
taxes. First, petitioners were assessed $288 for unpaid county
taxes from January 1 through April 11, 1985. Second, petitioners
were charged $234 for taxes related to 1980. Thus, petitioners
paid $522 of real estate taxes with respect to the Coral Springs
residence, which is the amount respondent imputed to them.
Accordingly, we sustain respondent’s imputation of $522 in real
estate taxes to petitioners for 1985.
6. Improvements to Romeo Property
Petitioners contend that their nondeductible personal
expenditures should be reduced by amounts expended to improve the
Romeo property. We agree. We have held that petitioners
incurred $10,284 in connection with improving the Romeo property,
and those costs were already included in the increased basis of
the Romeo property. Accordingly, we hold that petitioners’
nondeductible personal expenditures should be reduced by $10,284.
- 51 -
7. Summary
On our review of the record as a whole and with due regard
to respondent’s burden of proof, we conclude that petitioners’
nondeductible personal expenditures for 1984 through 1988 were
$54,807, $39,452, $39,274, $22,854, and $22,261, respectively.
E. Disputed Nontaxable Receipts
1. Overview
As asserted in the answer, respondent’s net worth
computation adjusted petitioners’ nontaxable receipts only for
Federal income tax refunds for each of the years 1984 through
1988. The parties have stipulated that petitioners received
additional nontaxable receipts as follows: (1) Qualified
reinvested dividends of $549 and $331 in 1984 and 1985,
respectively; and (2) nontaxable distributions of $282 in 1987.
Petitioners also contend that they are entitled to further
adjustments for nontaxable items, including a 60-percent
deduction on the net capital gain from the sale of the Coral
Springs residence, certain interest income, an inheritance
allegedly received from Ms. P. Powerstein, and a deduction for
dual-income taxpayers filing a joint return.
2. Gain on the Sale of the Coral Springs Residence
After accounting for settlement charges and credits due to
the Underhills, petitioners realized $107,201 on the sale of the
Coral Springs residence. Petitioners’ basis in the Coral Springs
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residence was $79,133. Therefore, their net capital gain on the
sale of the Coral Springs residence is $28,068 ($107,201 less
$79,133). See sec. 1001(a). The parties agree, and we conclude,
that petitioners are entitled to a 60-percent deduction on that
gain. See sec. 1202(a) (allowing individual taxpayers a 60-
percent deduction for net capital gains). Accordingly, we hold
that petitioners may exclude $16,841 ($28,068 times 60 percent).
3. Interest Income
Petitioners contend that they are entitled to exclude $2,000
of interest income which they purportedly earned on an All-Savers
Certificate issued by Safra Bank. They cite no legal support for
their entitlement to such an exclusion, instead referring the
Court to their 1983 joint return on which they excluded $2,000 of
interest income. Section 128(a) allows for the exclusion from
gross income of interest earned on a “depository institution tax-
exempt savings certificate”, sometimes referred to as an “All-
Savers Certificate”. In the case of a joint return, the
excludable amount during any taxable year is limited to $2,000
less the aggregate amount the taxpayers received in prior years.
Sec. 128(b). Thus, taxpayers were entitled to a one-time $2,000
exclusion from gross income for interest paid on an All-Savers
Certificate. Because petitioners claimed a $2,000 exclusion on
their 1983 joint return, we hold that they are not entitled to a
similar exclusion for 1984.
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4. Inheritance
Petitioners contend that they are entitled to exclude Ms. P.
Powerstein’s share of nine bank accounts held at Safra Bank as
nontaxable inheritance. We are not persuaded. Petitioners did
not establish that Mr. Powerstein was a beneficiary under Ms. P.
Powerstein’s will (if she died testate) or as an heir at law (if
she died intestate). We thus hold that petitioners may not
exclude as nontaxable income the balances of accounts held
jointly with Ms. P. Powerstein. Cf. Morrow v. Commissioner, T.C.
Memo. 1967-242 (crediting a taxpayer’s claim that amounts
received as inheritance should be excluded from his net worth
where that testimony was corroborated with a copy of the State
estate tax return filed by the decedent’s estate).
5. Married Couple’s Deduction
Petitioners further contend that they are entitled to a
married couple’s deduction for 1984. We agree. For taxpayers
filing a 1984 joint return, section 221 allows dual-income
married couples a deduction equal to 10 percent of the lesser of
$30,000 or the “qualified earned income” of the spouse with the
lower qualified earned income for the taxable year.17 Estate of
Johnson v. Commissioner, T.C. Memo. 2001-182, affd. without
17
The term “qualified earned income” is defined as an amount
equal to the excess of (a) the earned income of the spouse for
the taxable year, over (b) an amount equal to the sum of the
certain deductions allowable under sec. 62 and properly allocable
to or chargeable against earned income. Sec. 221(b).
- 54 -
published opinion 129 Fed. Appx. 597 (11th Cir. 2005). Ms. Rosen
earned $5,244 of income in 1984, which is less than the income
that Mr. Powerstein earned in his accounting firm. Accordingly,
petitioners are entitled to a married couple’s deduction for 1984
of $524.
F. Summary
On the basis of the foregoing, we determine increases in
petitioners’ taxable income as follows:
12/31/83 12/31/84 12/31/85 12/31/86 12/31/87 12/31/88
Net worth
computation:
Cash on hand $175,485 $213,604 $253,743 $322,185 $455,077 $564,518
Investments 26,662 21,441 21,441 23,703 32,935 47,469
Personal assets 56,099 66,599 66,599 66,687 66,687 82,168
Real estate 123,599 170,588 91,455 91,455 91,455 91,455
Additional
investments 10,474 8,831 9,196 7,947 10,317 10,556
Total assets 392,319 481,063 442,434 511,977 656,471 796,166
Loans and
mortgages 72,807 173,127 52,674 51,420 51,023 51,497
Charge accounts -0- -0- -0- -0- -0- -0-
Accumulated
depreciation 6,637 10,535 10,535 6,093 7,755 9,538
Total liabilities 79,444 183,662 63,209 57,513 58,778 61,035
Net worth 312,875 297,401 379,225 454,464 597,693 735,131
Less prior year’s
net worth N/A 312,875 297,401 379,225 454,464 597,693
Net worth increase N/A (15,474) 81,824 75,239 143,229 137,438
Personal expenses N/A 54,807 39,452 39,274 22,854 22,261
Nondeductible loss -0- -0- -0- -0- -0- -0-
Less nontaxable
income N/A 6,406 17,501 4,233 711 203
Adjusted gross
income N/A 32,927 103,775 110,280 165,372 159,496
Less itemized
deductions N/A 21,217 12,469 13,393 12,907 11,149
Less exemptions N/A 3,000 3,120 3,240 5,700 5,850
Corrected taxable
income N/A 8,710 88,186 93,647 146,765 142,497
Reported taxable
income N/A 5,086 4,447 7,945 1,499 (140)
Increase to taxable
income N/A 3,624 83,739 85,702 145,266 142,637
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It follows that petitioners’ income for 1984 through 1988 is
increased by $3,624, $83,739, $85,702, $145,266, and $142,637,
respectively. See sec. 61(a)(2).
III. Deductions
A. Overview
Having determined the increases to petitioners’ taxable
income under the net worth method, we now examine the additional
components of petitioners’ taxable income for the years in issue.
Although the parties agreed to many of the additional components
of adjusted gross income, petitioners contend that they are
entitled to deductions related to Mr. Powerstein’s accounting
firm and their farming activity. Respondent apparently relies
upon the general presumption afforded the notice of deficiency,
not addressing these issues with any real precision. We consider
petitioners’ contentions in turn.
B. Schedule C Expenses
1. Home Office Expense
Petitioners allege that Mr. Powerstein kept an office in the
Addison mobile home that qualified as his principal place of
business and that they are entitled to a deduction for home
office expenses for 1984 through 1988.18 As a general rule, a
18
Although petitioners assert that they are entitled to a
home office deduction with respect to the Coral Springs residence
for 1984, they abandon that argument because according to them,
the benefit of the depreciation deduction in 1984 will be offset
(continued...)
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taxpayer is not allowed a deduction for expenses related to
property that a taxpayer occupies as his or her residence. Sec.
280A(a). An exception to the general rule is found in section
280A(c)(1)(A), which provides that an expense that is allocable
to a portion of the taxpayer’s dwelling that is used exclusively
on a regular basis as the taxpayer’s “principal place of
business” will be allowed as a deduction. In deciding whether a
home office qualifies as a taxpayer’s principal place of
business, we consider (1) the relative importance of the
activities performed at each business location; and (2) the
amount of time spent at each location. Commissioner v. Soliman,
506 U.S. 168, 175 (1993). The location where a taxpayer contacts
clients is an important indicator of the principal place of
business. Id.
Although we are satisfied that Mr. Powerstein worked on
client matters from the Addison mobile home, we are not persuaded
that such activity entitles petitioners to home office expense
deductions. For an accountant such as Mr. Powerstein, soliciting
business and collecting information from client-taxpayers is as
important a function of that trade or business as analyzing the
underlying information to report on the returns to be filed with
the IRS. Mr. Powerstein testified that he spent considerable
18
(...continued)
by recapture of that depreciation upon the sale of the Coral
Springs residence in 1985.
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time servicing clients in south Florida, yet he did not elaborate
on the amount of time he spent at each location or the functions
he performed while there. Nor did petitioners offer any evidence
indicating the amount of time and the relative importance of the
activities that Mr. Powerstein performed in the Addison mobile
home as compared to work conducted in south Florida. We are
particularly skeptical of petitioners’ claim that Mr. Powerstein
used the Addison mobile home as his principal place of business
in the light of the fact that he did not meet with clients there.
Moreover, on Schedules C attached to the 1984 through 1987 joint
returns, petitioners reported that they were not deducting
expenses for an office in their home. Their reporting, we
believe, is indicative of Mr. Powerstein’s state of mind during
the years in issue. We doubt that Mr. Powerstein would not have
claimed a home office expense deduction if he regarded that
residence as his principal place of business, especially because
he so liberally claimed deductions to which he was not entitled
or failed to report income altogether. We thus hold that
petitioners are not entitled to deduct expenses associated with
the Addison mobile home, including utilities expenses.
2. Copier
Petitioners contend that they are entitled to a $206
depreciation deduction in connection with a copier which Mr.
Powerstein purchased in 1988 for his accounting firm. Attached
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to the joint return was Form 4562, which reported 7-year property
with a depreciable basis of $1,442. Mr. Powerstein, however,
recorded that the purchase price of the copier was $1,153. We
credit Mr. Powerstein’s testimony, and in the light of his
handwritten cash disbursements journal, we hold that the copier’s
depreciable basis was $1,153. Depreciating the copier by a
straight-line method over 7 years, we hold that petitioners are
entitled to a depreciation deduction of $165 for 1988 ($1,153
divided by 7 years).19 See secs. 167(a), 168(a) through (d).
3. Additional Legal Expenses
Petitioners deducted $946 as legal fees on Schedule C
attached to the 1988 joint return. Petitioners contend that they
are entitled to additional deductions of $2,066 for legal fees
incurred in connection with Mr. Powerstein’s accounting firm.
They refer the Court to two separate exhibits which purport to be
cashier’s checks issued to various law firms but are actually
checks or deposit slips for accounts that Mr. Powerstein held at
California Federal. Accordingly, we hold that petitioners have
failed to prove their entitlement to additional deductions for
legal fees because they have not proved that these fees were paid
19
Whereas petitioners contend that their 1988 net worth
should be increased by $1,538 to reflect ownership of the copier,
we limit the increased net worth for that copier to the purchase
price of the copier, or $1,153.
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or that they were ordinary and necessary expenses. See sec.
162(a).
D. Schedule F Expenses
Attached to the 1988 joint return was Schedule F, on which
petitioners reported that they were engaged in the trade or
business of farming. Respondent determined that petitioners were
not engaged in the trade or business of farming during 1988 and
that they could not claim depreciation and expenses as deductions
on Schedule F. We agree with respondent.
Section 162(a) allows as a deduction all the ordinary and
necessary expenses paid or incurred in carrying on any activity
that constitutes a trade or business. Section 212 allows as a
deduction all the ordinary and necessary expenses paid or
incurred in carrying on an activity for the (1) production or
collection of income, or (2) management, conservation, or
maintenance of property held for the production of income.
Section 183 generally limits deductions for an activity not
entered into for profit to the amount of the activity’s gross
income. Sec. 183(b). Section 183(c) defines an activity not
engaged in for profit as “any activity other than one with
respect to which deductions are allowable for the taxable year
under section 162 or under paragraph (1) or (2) of section 212.”
To be engaged in a trade or business, the taxpayer must
conduct the activity with continuity, regularity, and for the
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primary purpose of realizing income or profit. Commissioner v.
Groetzinger, 480 U.S. 23, 35 (1987). While a reasonable
expectation of profit is not required, the objective facts and
circumstances must demonstrate an actual and honest objective to
realize a profit. Osteen v. Commissioner, 62 F.3d 356, 358 (11th
Cir. 1995), affg. in part and revg. in part T.C. Memo. 1993-519;
sec. 1.183-2(a), Income Tax Regs. Greater weight is given to
objective facts than a taxpayer’s mere statement of his or her
intent to make a profit. Sec. 1.183-2(a), Income Tax Regs.
Applying the above principles, we conclude that petitioners
were not engaged in the trade or business of farming. They did
not consult with an expert or conduct any research on developing
the Romeo property into a farm. Although they raised a modest
number of cattle, pigs, horses, and chickens, they did not
establish that they intended to profit from raising these
animals. Nor did they establish that they intended to profit
from raising crops which never grew because of “drought
conditions”. Although an appraisal performed for Sun Bank states
that “some farming is planned in the future”, we are not
persuaded on the basis of the record at hand that petitioners’
farming activity rose to the level of being engaged in as a trade
or business.
On balance, we believe petitioners’ farming activity was
more consistent with rural living and not with the trade or
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business of farming. We hold that petitioners were not engaged
in the trade or business of farming. Because we have found that
petitioners’ farming activity did not constitute a trade or
business or was not entered into for profit, it follows that
expenses associated with that activity are limited to the amount
of the activity’s gross income. See sec. 183(b). Given that
petitioners reported zero gross income from their farming
activity on Schedule F attached to the 1988 joint return, it
follows that they are not entitled to any deduction in connection
with their farming activity.
IV. Income Averaging
Petitioners contend that for 1984 and 1986 they are entitled
to special income-averaging provisions afforded taxpayers under
section 1305. That section, which was repealed for tax years
beginning after December 31, 1986, by the Tax Reform Act of 1986,
Pub. L. 99-514, sec. 141(a), 100 Stat. 2117, allows for averaging
of damages arising from causes of action for breach of contract
or breach of fiduciary duty. Petitioners’ unreported income is
attributable to Mr. Powerstein’s accounting firm and not to an
award of damages for breach of contract or breach of fiduciary
duty. Thus, section 1305 is not applicable.
V. Interest Expense
Mr. Powerstein contends that he is entitled to a $65,778
interest expense deduction for interest that respondent jeopardy-
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assessed during 1989. Respondent answers that the interest is
nondeductible personal interest within the purview of section
1.163-9T(b)(2)(i)(A), Temporary Income Tax Regs., 52 Fed. Reg.
48409 (Dec. 22, 1987) (regulation). Mr. Powerstein urges the
Court to invalidate the regulation on the basis of our reasoning
in Redlark v. Commissioner, 106 T.C. 31 (1996), revd. and
remanded 141 F.3d 936 (9th Cir. 1998). We decline to do so.
We had occasion to carefully consider the validity of the
regulation in Robinson v. Commissioner, 119 T.C. 44, 73-75
(2002), a Court-reviewed Opinion. In Robinson, we concluded that
the regulation was valid, that our Opinion in Redlark should no
longer be followed, and that interest paid on individual tax
liabilities relating to income from a sole proprietorship is to
be treated as nondeductible personal interest. Id. at 75. While
we are not aware of any decision in the Court of Appeals for the
Eleventh Circuit deciding the validity of the regulation, we note
that our decision in Robinson is consistent with opinions of the
Courts of Appeals for the Fourth, Fifth, Sixth, Seventh, Eighth,
and Ninth Circuits.20 We see no reason to disturb our decision
20
See Alfaro v. Commissioner, 349 F.3d 225, 231 (5th Cir.
2003), affg. T.C. Memo. 2002-309; Kikalos v. Commissioner, 190
F.3d 791, 798–799 (7th Cir. 1999), revg. T.C. Memo. 1998–92;
McDonnell v. United States, 180 F.3d 721, 723 (6th Cir. 1999);
Allen v. United States, 173 F.3d 533, 538 (4th Cir. 1999);
Redlark v. Commissioner, 141 F.3d 936, 937–938, 942 (9th Cir.
1998), revg. and remanding 106 T.C. 31 (1996); Miller v. United
States, 65 F.3d 687, 691 (8th Cir. 1995).
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in Robinson, and therefore we reject petitioners’ invitation to
invalidate the regulation. It follows that interest respondent
jeopardy-assessed is nondeductible personal interest.
VI. Additions to Tax
A. Fraud
Respondent determined that petitioners are liable for
additions to tax for fraud under section 6653(b)(1) and (2) with
respect to their 1984 through 1988 joint returns. For 1984 and
1985, section 6653(b)(1) imposed a 50-percent addition to tax on
any portion of an underpayment of tax that is due to fraud, and
section 6653(b)(2) imposed a 50-percent addition to tax on any
interest payable under section 6661 with respect to any portion
of an underpayment of tax that is attributable to fraud. For
1986 and 1987, section 6653(b)(1)(A) imposed a 75-percent
addition to tax on any portion of an underpayment of tax due to
fraud, and section 6653(b)(1)(B) imposed a 50-percent addition to
tax on any interest payable under section 6661 with respect to
any portion of an underpayment of tax that is attributable to
fraud. For 1988, section 6653(b)(1) imposed a 75-percent
addition to tax where any portion of an underpayment of tax is
due to fraud. For all years, in the case of a joint return the
additions to tax imposed by section 6653(b)(1) and (2) do not
apply to a spouse unless some part of the underpayment is
attributable to the fraud of that spouse. Sec. 6653(b)(4) (as in
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effect for 1984 and 1985), sec. 6653(b)(3) (as in effect for 1986
through 1988).
The Commissioner bears the burden of establishing fraud by
clear and convincing evidence. Sec. 7454(a); Rule 142(b). Clear
and convincing evidence is that degree of proof that produces “‘a
firm belief or conviction as to the allegations sought to be
established. It is intermediate, being more than a mere
preponderance, but not the extent of such certainty as is
required beyond a reasonable doubt as in criminal cases. It does
not mean clear and unequivocal.’” Ohio v. Akron Ctr. for Reprod.
Health, 497 U.S. 502, 516 (1990) (quoting Cross v. Ledford, 120
N.E.2d 118, 123 (Ohio 1954)). To carry his burden, the
Commissioner must prove as to each taxpayer for each year in
which fraud is alleged that (1) an underpayment of tax existed,
and (2) each taxpayer intended to evade taxes known to be owing
by conduct intended to conceal, mislead, or otherwise prevent the
collection of such taxes. Korecky v. Commissioner, 781 F.2d
1566, 1568 (11th Cir. 1986), affg. T.C. Memo. 1985-63; Parks v.
Commissioner, 94 T.C. 654, 660-661 (1990). We consider whether
respondent has met his burden as to each of Mr. Powerstein and
Ms. Rosen.
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1. Mr. Powerstein
a. Collateral Estoppel
We begin by recognizing that Mr. Powerstein was convicted of
income tax evasion under section 7201 for 1987. As a result, Mr.
Powerstein is collaterally estopped from denying civil fraud with
respect to 1987. See Gray v. Commissioner, 708 F.2d 243, 246
(6th Cir. 1983), affg. T.C. Memo. 1981-1. We next consider
whether Mr. Powerstein is liable for additions to tax for fraud
for 1984, 1985, 1986, and 1988. We hold he is.
b. Underpayment of Tax
The Commissioner can prove an underpayment of tax stemming
from unreported and indirectly reconstructed income by, among
other means, proving a likely source of the unreported income.
DiLeo v. Commissioner, 96 T.C. 858, 873-874 (1991), affd. 959
F.2d 16 (2d Cir. 1992). To satisfy his burden, respondent
submitted into evidence records showing that petitioners
deposited and/or invested substantial sums of money in bank
accounts, investments, and real estate. Respondent also
established that petitioners received these moneys in connection
with Mr. Powerstein’s accounting firm. The record clearly and
convincingly establishes that petitioners understated their
income by more than $450,000. We find that respondent has
clearly and convincingly proven the first element of fraud.
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c. Fraudulent Intent
Whether a portion of the underpayment of tax is attributable
to fraud is a question of fact to be resolved on the basis of the
record as a whole. Parks v. Commissioner, supra at 660. Fraud
has been defined as the intentional commission of an act or acts
for the specific purpose of evading taxes believed to be owing.
Petzoldt v. Commissioner, 92 T.C. 661, 698 (1989). “‘Fraud
implies bad faith, intentional wrong doing and a sinister
motive.’” Webb v. Commissioner, 394 F.2d 366, 377 (5th Cir.
1968) (quoting Carter v. Campbell, 264 F.2d 930, 935 (5th Cir.
1959)), affg. T.C. Memo. 1966-81. Fraud is never imputed or
presumed but must be established by clear and convincing evidence
that establishes fraudulent intent. Petzoldt v. Commissioner,
supra at 699. Fraud need not be established by direct evidence
because such evidence is rarely available but can be shown by
surveying the taxpayer’s entire course of conduct and drawing
reasonable inferences therefrom. Biggs v. Commissioner, 440 F.2d
1, 5 (6th Cir. 1971), affg. T.C. Memo. 1968-240. We may infer
fraud from “any conduct, the likely effect of which would be to
mislead or to conceal.” Spies v. United States, 317 U.S. 492,
499 (1943).
Courts often rely upon certain indicia or badges of fraud in
deciding whether a taxpayer acted with fraudulent intent. These
badges of fraud include: (1) A pattern of understating income,
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(2) giving implausible or inconsistent explanations of behavior,
(3) concealing income and/or assets, (4) failing to cooperate
with taxing authorities, (5) an intent to mislead, which may be
inferred from a pattern of conduct; (6) providing false
documents; and (7) dealing in cash. See id.; Niedringhaus v.
Commissioner, 99 T.C. 202, 211 (1992). No single factor is
dispositive, though the existence of several indicia is competent
evidence of fraud. See Niedringhaus v. Commissioner, supra at
211. In determining the existence of fraud, we may look to
evidence of prior and subsequent similar acts reasonably close to
the years at issue. Tipton v. Commissioner, T.C. Memo. 1994-624
(citing United States v. Johnson, 386 F.2d 630 (3d Cir. 1967)).
i. Understatements of Income
The consistent and substantial understatement of income over
several years is strong evidence of fraudulent intent. Korecky
v. Commissioner, supra at 1568 (citing Merritt v. Commissioner,
301 F.2d 484, 487 (5th Cir. 1962), affg. T.C. Memo. 1959-172).
Between 1984 and 1988 petitioners failed to report or account for
more than $450,000 of income which Mr. Powerstein earned through
his accounting firm. The evidence clearly and convincingly
establishes that petitioners substantially understated their
taxable income from 1984 through 1988. The failure to report
this income is strong evidence of fraud.
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ii. Implausible Explanations of Behavior
Giving implausible or inconsistent explanations of behavior
may implicate fraudulent intent. Bradford v. Commissioner, 796
F.2d 303, 307 (9th Cir. 1986), affg. T.C. Memo. 1984-601. Mr.
Powerstein consistently exhibited implausible behavior suggesting
fraudulent intent. As a college graduate and a C.P.A., Mr.
Powerstein is knowledgeable in tax matters and was capable of
preparing accurate returns for 1984 through 1988. Nevertheless,
he omitted from each of the 1984 through 1988 joint returns
substantial income earned from the accounting firm. In preparing
petitioners’ joint returns for those years, Mr. Powerstein also
understated capital gains, overstated capital losses, and/or
omitted interest and dividend income.21
Mr. Powerstein also exhibited implausible behavior in the
loan applications that he submitted to banks. Each of those loan
applications reported income substantially higher than that
reported to respondent for Federal income tax purposes. First,
Mr. Powerstein reported on the 1977 loan application that he
expected to earn $24,185 of income from his accounting firm, yet
the 1977 joint return reported that he earned only $3,289 from
that business. Second, although he reported on the 1978 loan
21
Although respondent does not contend that the rental
income petitioners received in connection with the Coral Springs
residence was taxable to them, we observe that such income is
ordinarily taxable. See sec. 61(a)(5).
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application that he expected to earn $31,262 from his accounting
firm, the 1978 joint return reported that he earned only $3,060
from that business. Third, the 1984 loan application estimated
income from his accounting firm of $26,000, but the 1984 joint
return claimed a loss of $996 from that business. Fourth,
attached to the 1983 loan application were the purported 1981 and
1982 returns, each of which reported income different from that
reported on the corresponding 1981 and 1982 joint return filed
with respondent. We find it implausible that an uncorrupted
individual would attach false tax returns to a loan application.
We also doubt that Mr. Powerstein’s gross underestimation of his
income was harmless.
Also indicative of fraud is that Mr. Powerstein was unable
to offer any logical explanation for his behavior. He evaded
basic questions about the letter he drafted to his clients. He
was unable to rationalize the differences in income reported on
the loan applications submitted to banks and the joint returns
filed with respondent. He sought to explain his actions by
suggesting that he neglected himself and his personal Federal
income tax returns to place his clients’ needs first. We doubt
that placing his clients’ needs above his own would lead him to
file false returns absent fraudulent intent. Such behavior
supports a consistent pattern of fraud before 1984 and continuing
throughout 1988.
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iii. Concealment of Income or Assets
Fraud may be implicated where a taxpayer conceals assets or
income. Spies v. United States, 317 U.S. at 499. Petitioners’
use of nominees to place assets beyond the reach of the Federal
Government supports a finding of fraudulent intent. Between
February 23 and May 25, 1989, Mr. Powerstein and Ms. Rosen
transferred approximately 30 bank accounts to Ms. Ballard and Ms.
I. Powerstein individually or in trust for K.B. They transferred
the vacation home and the Romeo property to Ms. Ballard and Ms.
I. Powerstein for $20. On the record as a whole, we believe it
reasonable to conclude that petitioners transferred these assets
in an attempt to place them beyond the reach of the Government.
Such acts favor a finding of fraudulent intent.
iv. Accurate Returns
The failure to file accurate tax returns may indicate
fraudulent intent. Mr. Ballard testified credibly that amounts
reported as loans from shareholders on the Federal income tax
returns for M&M were “stretched”. For example, Mr. Ballard
attributed expenses provided by Mr. Powerstein as consisting of
$14,000 for a tractor, $600 for a chainsaw, and then amounts for
ropes, fertilizer, and other equipment. Mr. Powerstein also
purchased other items such as a riding lawnmower for $1,425 on
February 5, 1983. The 1984 and 1985 returns for M&M reported
that Mr. and Ms. Ballard made more than $63,000 in loans to that
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company even though neither individual had the financial
wherewithal to contribute such moneys.
v. Illegal Activities
A criminal conviction for engaging in illegal activities may
be probative of fraudulent intent. Bradford v. Commissioner,
supra at 308. We consider it significant that Mr. Powerstein
pleaded guilty to income tax evasion under section 7201 for 1987.
Although his conviction does not decidedly establish fraudulent
intent with respect to 1984 through 1986 and 1988, we consider
that crime evidence of a propensity to defraud. See McGee v.
Commissioner, 61 T.C. 249, 260 (1973), affd. 519 F.2d 1121 (5th
Cir. 1975).
In connection with the plea agreement, Mr. Powerstein
admitted to preparing Forms W-2 that overreported Federal income
taxes withheld for 79 client-taxpayers. He wrote a letter during
1985 that acknowledged, either explicitly or implicitly, that he
mischaracterized his client-taxpayers’ Federal tax treatment of
dividends, pension distributions, political party contributions,
and basis. Mr. Powerstein also deliberately misrepresented the
investments of those client-taxpayers to the IRS and claimed
exemptions to which he admitted that they were “not entitled”.
Although this letter is direct evidence of his fraud for 1983, we
also rely on that letter as evidence of Mr. Powerstein’s attempts
to conceal and mislead the Government in determining his client-
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taxpayers’ Federal income tax liabilities. Cf. Richardson v.
Commissioner, 509 F.3d 736, 743-744 (6th Cir. 2007) (considering
a taxpayer’s actions after returns have been filed to determine
his earlier state of mind), affg. T.C. Memo. 2006-69. Such
behavior favors a finding of fraudulent intent.
vi. Dealing in Cash
A taxpayer’s use of cash evidences fraudulent intent because
it demonstrates a desire to avoid detection of income-producing
activities. Bradford v. Commissioner, 796 F.2d at 308. Mr.
Powerstein kept numerous bank accounts, and he dealt with many of
his clients in cash both before and after the years at issue.
Such dealings in cash favor a finding of fraudulent intent.
vii. Summary
After applying the foregoing factors, we are satisfied that
respondent has clearly and convincingly proved that Mr.
Powerstein filed the 1984 through 1986 and 1988 joint returns
intending to conceal, mislead, or otherwise prevent the
collection of taxes. Respondent has therefore satisfied the
second prong of the fraud test as to Mr. Powerstein. For each of
the years 1984 and 1985, we hold that Mr. Powerstein is liable
for an addition to tax equal to 50 percent of the underpayment of
tax for that year. See sec. 6653(b)(1); Harvey v. Commissioner,
T.C. Memo. 1999-229. With respect to additions to tax under
section 6653(b)(1) for 1988, section 6653(b)(2) for 1984 and
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1985, and section 6653(b)(1)(A) and (B) for 1986 and 1988, Mr.
Powerstein is liable for those additions to tax only on the
portions of the underpayments attributable to fraud. See Harvey
v. Commissioner, supra. The burden of proving by a preponderance
of the evidence that a portion of the underpayment for each year
is not attributable to fraud lies with Mr. Powerstein; otherwise
the entire underpayment is subject to the fraud addition to tax.
d. Portion of Underpayment Attributable to Fraud
Petitioners contend that the portions of the underpayments
attributable to the gain on the sale of the of the Coral Springs
residence, their farming activity, capital gains on the sale or
disposition of certain stock, and “relatively small amounts of
interest and dividend” were not attributable to fraud. We agree
in part. With respect to that portion of the deficiency from the
gain on the sale of the Coral Springs residence, we conclude that
the underpayment was not attributable to fraud. Attached to the
1985 joint return was Form 2119, Sale or Exchange of Principal
Residence, which reported the selling price of the Coral Springs
residence and petitioners’ perceived basis in that property. As
evidenced by the fact that Form 2119 was filed, albeit
incorrectly, we do not believe that petitioners reported the sale
of the Coral Springs residence intending to conceal, mislead, or
otherwise prevent the collection of tax.
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As to that portion of the deficiency attributable to their
alleged farming activity, we find that the underpayment is not
attributable to fraud. Petitioners attached to the 1988 joint
return Schedule F alerting respondent to their farming activity,
and respondent disallowed those losses in connection with his
criminal investigation of Mr. Powerstein. Although petitioners’
position regarding the status of their farming activity as a
trade or business was wrong, it was not entirely unreasonable and
did not rise to the level of intending to mislead, conceal, or
otherwise prevent the collection of tax. Accordingly, we hold
that the portion of the underpayment attributable to petitioners’
farming activity was not attributable to fraud.
As to that portion of the deficiency attributable to capital
gains, interest income, and dividend income which Mr. Powerstein
“overlooked” in preparing the 1986 and 1988 joint returns, we
conclude that those underpayments were attributable to fraud.
Mr. Powerstein devised a scheme to conceal his income from
respondent. As evidenced by Mr. Powerstein’s letter to two
clients in 1985, he misstated capital transactions, interest
income, and dividend income which he believed the IRS was unable
to “track”. We believe that petitioners employed a similar
strategy on their joint returns. Omitting such gains and income
allowed Mr. Powerstein to further conceal his income fraudulently
in an attempt to conceal, mislead, and otherwise frustrate the
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collection of taxes. We thus hold that portions of the
underpayment attributable to unreported capital gains and to
interest and dividend income are attributable to fraud. It
follows that Mr. Powerstein is liable for additions to tax under
section 6653(b)(1) for 1988, section 6653(b)(2) for 1984 and
1985, and section 6653(b)(1)(A) and (B) for 1986 and 1988, to the
extent stated herein.
2. Ms. Rosen
On our review of the record, we are not convinced that
respondent has carried his burden of proving fraud by clear and
convincing evidence as to Ms. Rosen. Although she signed the
1984 through 1988 joint returns, which substantially understated
petitioners’ income, and aided the fraudulent transfer of assets
to family members, we are left with only a suspicion of fraud on
her part. She did not understand accounting, was unfamiliar with
the bank accounts and recordkeeping of Mr. Powerstein, and was
not involved with the accounting firm whatsoever. While we have
our suspicions as to whether Mr. Powerstein explained the nuances
of his fraudulent scheme to Ms. Rosen, such suspicions do not
warrant imposition of the fraud addition to tax absent more
compelling evidence. See Gow v. Commissioner, T.C. Memo. 2000-
93, affd. 19 Fed. Appx. 90 (4th Cir. 2001). In this regard,
respondent has failed to satisfy his burden of proof with respect
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to Ms. Rosen. We therefore hold that she is not liable for fraud
additions to tax for 1984 through 1988.
B. Section 6661
Respondent determined that petitioners are liable for
additions to tax under section 6661 for 1985 through 1988. For
tax returns due on or before December 31, 1986, section 6661(a)
imposed an addition to tax for substantial understatements of
income tax equal to 10 percent of the underpayment attributable
to the understatement. Pallottini v. Commissioner, 90 T.C. 498,
500-503 (1988). The amount of the section 6661(a) addition to
tax was subsequently increased to 25 percent for returns due on
or after January 1, 1987. An understatement is substantial if it
exceeds the greater of: (1) 10 percent of the tax required to be
reported on the return, or (2) $5,000. Sec. 6661(b)(1)(A). An
understatement is reduced to the extent that the understatement
is attributable to any item which is (1) supported by substantial
authority, or (2) adequately disclosed in the return or in a
statement attached to the return. Sec. 6661(b)(2)(B).
Petitioners did not adequately disclose the amounts leading
to the understatements on their 1985 through 1988 returns. Nor
have they cited any authority to support the understatements. We
therefore sustain respondent’s determination that petitioners are
liable for additions to tax under section 6661.
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VII. Epilogue
We have considered all arguments raised by the parties, and
to the extent not discussed herein we conclude that they are
irrelevant, moot, or without merit.
To reflect the foregoing,
Decisions will be entered
under Rule 155.