Black v. Comm'r

T.C. Memo. 2007-364
UNITED STATES TAX COURT
FRANK H. AND MARLA C. BLACK, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 15629-04. Filed December 10, 2007.
Frank H. and Marla C. Black, pro se.
J. Craig Young, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
WELLS, Judge: Respondent determined the following
deficiencies in income tax and penalties for petitioners’ 1991
and 1992 taxable years:
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Frank H. Black
Year Deficiency Penalty sec. 6662(a) Penalty sec. 6663
1991 $22,904 n/a $17,178.00
1992 60,262 n/a 45,196.50
Marla C. Black
Year Deficiency Penalty sec. 6662(a) Penalty sec. 6663
1991 $22,904 $4,580.80 n/a
1992 60,262 12,052.40 n/a
After concessions, the issues we must decide are: (1)
Whether petitioner Frank Black is liable for the fraud penalty
pursuant to section 66631 for taxable years 1991 and 1992; (2)
whether assessment of the deficiencies in income tax and
penalties for the taxable years 1991 and 1992 is barred by the
statute of limitations; (3) whether petitioners failed to report
income of $107,082 and $160,706, respectively, on their 1991 and
1992 joint income tax returns; (4) whether petitioners have
substantiated the existence or amounts of any net operating
losses for the taxable years 1991 and 1992; (5) whether
petitioners have substantiated that they are entitled to capital
loss carryover deductions for the taxable years 1991 and 1992 of
$3,000 for each year; (6) whether petitioners failed to report
interest and dividend income on their 1992 joint return of $3,748
and $35, respectively; and (7) whether petitioner Marla Black is
liable for a penalty pursuant to section 6662(a).
1
Unless otherwise indicated, all Rule references are to the
Tax Court Rules of Practice and Procedure, and all section
references are to the Internal Revenue Code, as amended.
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FINDINGS OF FACT
Some of the facts and certain exhibits have been stipulated.
The parties’ stipulations of fact are incorporated herein by
reference and are found as facts. Petitioners resided in Rock
Hill, South Carolina, at the time the petition was filed.
Petitioners are Frank H. Black (Mr. Black) and Marla C.
Black (Mrs. Black). Petitioners were married throughout all
relevant periods.
Mr. Black graduated from Michigan State University in 1969
with a Bachelor of Science degree, majoring in sociology and
minoring in religion. He was self-employed during 1991 and 1992
as a licensed stockbroker, investment consultant, and insurance
agent.
On July 1, 1990, Mr. Black started his own business, Frank
Black d/b/a Robert Thomas Securities, which continued to operate
throughout 1991 and 1992. On May 18, 1992, Mr. Black formed a
North Carolina “C-Corporation”, Frank Black, Inc. Respondent has
not conducted an examination of Frank Black, Inc., for the
taxable year 1992.
Mr. Black maintained his own books and records for 1991 and
1992, but failed to maintain complete and accurate books and
records of income and expenses for either taxable year.
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Petitioners filed timely joint Federal income tax returns
for taxable years 1991 and 1992. Mr. Black prepared a draft of
the 1991 joint return and took it to a certified public
accountant (C.P.A.) for review. The C.P.A. made some minor
corrections, then used the data shown on the draft to create a
computer-generated 1991 joint return. The 1992 joint return was
prepared by an accountant based upon computer printouts of income
and expenses and oral information provided by Mr. Black.
Internal Revenue Service (IRS) Revenue Agent Margaret
McCarter (Agent McCarter) was assigned to the examination of
petitioners’ joint returns for the taxable years 1991 and 1992.
Agent McCarter’s initial contact with Mr. Black occurred on
May 11, 1993, when she mailed him a letter advising him that
his 1991 income tax return was being examined and scheduling an
appointment for May 24, 1993.
Mr. Black refused to meet with Agent McCarter. As a result,
most of Agent McCarter’s later contacts were with the
representatives to whom Mr. Black delegated powers of attorney.
On May 26, 1994, Agent McCarter referred Mr. Black’s case to
the IRS Criminal Investigation Division.
On October 18, 1994, IRS Special Agent Dennis O’Dell (Agent
O’Dell) and Agent McCarter went to meet with Mr. Black at his
place of business in Charlotte, North Carolina. After arriving,
they introduced themselves to Mr. Black, and Agent O’Dell
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informed Mr. Black why they were there. As Agent O’Dell began
reading him his rights, Mr. Black interrupted him, said the
interview was over, and asked them to leave.
Agent McCarter, and later also Agent O’Dell, were forced,
because of Mr. Black’s refusal to provide requested bank and
other relevant records, to serve numerous IRS summonses on Mr.
Black, banks, and other third parties in order to obtain the
information necessary to determine petitioners’ income tax
liabilities for the taxable years 1991 and 1992.
During November 1994, Agent O’Dell provided Mr. Black’s
representatives with a printout of canceled checks and asked them
to have Mr. Black classify the purpose of the checks as either
business or personal. Over 3 months later, Mr. Black still had
not classified the checks. On March 4, 1995, Agent O’Dell wrote
Mr. Black’s representatives, again requesting that Mr. Black
classify the checks, and also asked that Mr. Black complete and
return the Cash On Hand Statement enclosed with that letter. On
March 15, 1995, Mr. Black’s principal attorney, Robert
Mendenhall, advised Agent O’Dell that Mr. Black “is being very
obstinate” and that he hoped that one of Mr. Black’s other
attorneys, who was meeting with Mr. Black “can convince him that
this is a serious matter”. On the basis of Mr. Black’s lack of
cooperation, the lack of adequate books and records of income and
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expenses, and evidence showing that petitioners had acquired
assets and made substantial expenditures, Agent McCarter decided
to use an indirect method of proof to reconstruct Mr. Black’s
income for 1991 and 1992. Agent McCarter ultimately determined
that the net worth method would be the most appropriate method to
use. Agent McCarter prepared a revenue agent’s report setting
forth the results of her examination of petitioners’ returns for
the taxable years 1991 and 1992.
On June 9, 2004, respondent issued a statutory notice of
deficiency to petitioners for taxable years 1991 and 1992. In
the notice of deficiency, respondent determined petitioners’
taxable income for 1991 and 1992 using the net worth method of
proof. Respondent determined that petitioners made nondeductible
expenditures during taxable years 1991 and 1992 of $108,768.01
and $188,219.01, respectively.
Mr. Black applied for a $250,000 life insurance policy.
Mr. Black’s business wrote check No. 1908 dated 12/10/92 to First
Colony Life Insurance Co. of $318.24 for a $50,000 life insurance
policy on Mr. Black.
Respondent’s net worth computations treat certain payments
made by Mr. Black’s businesses during 1991 and 1992 for medical
expenses as nondeductible personal expenditures made by
petitioners.
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Mr. Black wrote a letter as manager of Robert Thomas
Securities to Lincoln National Insurance canceling a group
medical insurance policy and stating that his business was
renewing a group medical insurance policy with Continental
Insurance.
Special Agent O’Dell stated in his report that Mr. Black
paid a total of $4,371 in health insurance premiums during the
period January through July 1991, before terminating the policy.
During 1992, Mr. Black paid the C.P.A. firm of Martinson,
Newton & Co., C.P.A.s, a fee of $225 for preparing petitioners’
1991 joint return, and for preparing amended joint Federal and
State income tax returns for 1990.
During 1992, Mr. Black paid Bob West a fee of $250 to form
Mr. Black’s North Carolina C-Corporation, Frank Black, Inc.
The notice of deficiency treated both the $225 income tax
return preparation fee and the $250 incorporation fee as
nondeductible expenditures for purposes of respondent’s net worth
computation.
During 1991 and 1992, petitioners made credit card payments
totaling $22,796.48 and $20,320.19, respectively, all of which
payments were treated as nondeductible in the notice of
deficiency.
Petitioners claimed Schedule C, Profit or Loss From
Business, deductions on their 1991 joint return for payments of
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$3,000 to each of their children Dominique (born on October 27,
1983) and Jonathan (born on May 31, 1985). Petitioners claimed
Schedule C deductions on their 1992 joint return for payments of
$5,240 made to each of their children Dominique and Jonathan.
The notice of deficiency treated the full amounts of the payments
by Mr. Black to Dominique and Jonathan during 1991 and 1992 as
nondeductible for purposes of respondent’s net worth computation.
Mr. Black issued Forms 1099-MISC reporting the payments made
to Dominique and Jonathan in 1991 and 1992. Federal and State
income tax returns were filed for Dominique and Jonathan for the
taxable years 1991 and 1992 reporting the amounts shown on Forms
1099-MISC.
On December 3, 1991, Mr. Black met with C.P.A. Walter
Martinson to discuss various aspects of Mr. Black’s business.
One of the items discussed was the possibility of Mr. Black’s
paying his children. C.P.A. Martinson advised putting money in
an account for them in their names.
During the taxable year 1991, Mr. Black was a general agent
for Clark Capital Management Group (Clark Capital) and received
commissions from Clark Capital of $21,843.36. Petitioners did
not report any of the Clark Capital commission income on their
1991 joint return.
On July 26, 1985, petitioners submitted a consumer loan
application to Home Federal (Home Federal application). On the
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Home Federal application, they listed under “ASSETS” a “BRADFORD
MONEY MARKET” account valued at $9,000. On the “PERSONAL
STATEMENT” attached to the Home Federal application, petitioners
stated that they possessed “Cash on hand and in banks” totaling
$9,000.
IRS Revenue Agent Robin Helton (Agent Helton) was assigned
to examine petitioners’ joint returns for the taxable years 1987,
1988, and 1989. Petitioners’ 1987, 1988, and 1989 income tax
returns reported taxable income of $76,332, $44,581, and $26,791,
respectively. Petitioners later agreed to deficiencies for
taxable years 1987, 1988, and 1989.
On May 8, 1990, Agent Helton conducted an initial interview
with Mr. Black in connection with her examination of petitioners
for the years 1987, 1988, and 1989. During that interview, she
questioned Mr. Black about what was the “most cash you had on
hand during the tax year,” to which Mr. Black responded that
petitioners kept no great amounts of cash on hand. At no time
during Agent Helton’s investigation did petitioners ever claim to
have had large amounts of cash on hand.
On February 18, 1987, petitioners received a check of
$69,133.31 from the sale of a residence owned by Mrs. Black,
which they deposited into one of their bank accounts during 1987.
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On December 31, 1992, petitioners had cash on hand of
approximately $60,000 and did not possess cash on hand in any
significantly greater amount.2
Petitioners were not mistrustful of banks, and they
maintained several bank accounts and engaged in large numbers of
banking transactions during both 1991 and 1992. Petitioners’ use
of bank accounts included the unusual practice of depositing and
writing numerous checks for small amounts. During 1991 and 1992,
petitioners deposited 22 checks ranging from $0.63 to $23.47, and
also wrote 38 checks ranging from $2 to $9.93.
Mr. Black knew that bank deposits are insured by the Federal
Deposit Insurance Corporation and that he could have earned
considerable sums of interest income, with no risk, if he had
deposited the alleged cash hoard into a bank account.
Petitioners borrowed money and paid interest on loans during
not only 1991 and 1992, but also during prior years when they
allegedly were accumulating their cash hoard. Petitioners
claimed and respondent allowed, Schedule A, Itemized Deductions,
mortgage interest deductions for each of the taxable years 1987
through 1992.
Mr. Black borrowed $9,000 from his office manager, Jeanette
Roberts, and repaid her during the same year that the loan was
made.
2
The parties stipulated these facts.
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Petitioners were unable to estimate, in dollars, the amounts
of the alleged cash hoard they contend were expended during
either 1991 or 1992. Petitioners failed to provide any specific
details (i.e., dates, amounts, or items purchased) concerning the
use of the alleged cash hoard during either 1991 or 1992 for
either personal or business purposes.
All of the nondeductible expenditures Agent McCarter took
into account in her net worth computation were paid either by
check, or by credit card charges later paid by check.
The cash deposits into petitioners’ bank accounts totaled
$4,500 in 1991, and no cash deposits were made into petitioners’
bank accounts during 1992.
Petitioners claimed net operating loss deductions of $19,008
and $29,917 on their 1991 and 1992 joint returns respectively.
Petitioners claimed $3,000 deductions for short-term capital
losses on their 1991 and 1992 joint returns.
In the notice of deficiency, respondent determined that
petitioners omitted from their 1992 joint return interest income
of $3,748 and dividend income of $35 that they received from
American Funds Service Company.
Agent McCarter based her adjustments to petitioners’ 1992
interest income upon Forms 1099 issued in Mr. Black’s name and
Social Security number. None of the Forms 1099 were issued in
the name or employer identification number of Frank Black, Inc.
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Frank Black, Inc., did not have any bank or other accounts
during 1992. Frank Black, Inc., did not conduct any business
during 1992. All of petitioners’ existing accounts remained in
their individual names. All interest paid on petitioners’
accounts was earned by petitioners individually.
During the examination conducted for the taxable years 1979
through 1981, Mr. Black refused to discuss the large deductions
claimed for alleged contributions to the Universal Life Church
(ULC). In addition, he refused to provide any substantiation in
order to verify the secretarial expense and the casualty loss
claimed on the returns and stated that the agent had no authority
to ask any personal questions.
When questioned by Agent Helton during the initial interview
for the examination of petitioners’ 1987 through 1989 tax years,
Mr. Black generally was unresponsive and evasive.
During Agent Helton’s initial interview, Mr. Black told her
that petitioners had not acquired any assets during the years
1987 through 1989, even though they had acquired assets,
including several automobiles.
On their joint returns for the taxable years 1987, 1988, and
1989, petitioners deducted $22,350, $13,125, and $13,250,
respectively, for their alleged contributions to “New Faith
Baptist Church” (NFBC). Respondent disallowed all of the
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NFBC deductions, and petitioners subsequently conceded, pursuant
to settlement, that no NFBC deductions were allowable.
During the examination, Mr. Black gave Agent Helton a
statement which he stated should be sufficient to verify the
deductions claimed for contributions to NFBC. The statement
provided by Mr. Black included both the name of the alleged
church, listed as “New Faith Baptist, Inc.” and the amounts of
the alleged charitable contributions. Petitioners never provided
any evidence to Agent Helton to show that any church named NFBC
actually existed. Agent Helton tried, without success, to verify
the existence of NFBC through other means. Agent Helton checked
the telephone listing for Rock Hill, South Carolina, and also
checked the IRS’s official listing of approved section 501(c)(3)
organizations, but found no listings for the alleged church.
Because the statement provided by Mr. Black included “Inc.”
in the alleged church’s name, Agent Helton checked with the South
Carolina Secretary of State (SCSOS). Agent Helton learned from
the SCSOS that a corporation named New Faith Baptist, Inc., was
on file with the SCSOS, and that its articles of incorporation
listed petitioners’ Rock Hill, South Carolina, address as its
corporate address, and listed Mr. Black as a corporate officer.
During a January 28, 1991, telephone conversation, Mr. Black told
Agent Helton that NFBC had moved to Hickory, North Carolina.
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Petitioners never provided Agent Helton with any canceled
checks or any other credible evidence to show that they had made
any contributions to NFBC (or any church) during 1987, 1988, or
1989.
During May 1991, Mrs. Black purchased a new Magic-Chef
electric range at Appliance and Furniture World in Charlotte,
North Carolina. The range was installed in petitioners’ kitchen,
was used to cook meals for petitioners’ family and their guests,
and it was not used for any business purposes. Mr. Black
deducted the $839.95 paid for the electric range as “Supplies” on
the Schedule C attached to the 1991 joint return.
During February, 1991, petitioners paid $929.10 to Steve
Starnes, d.b.a. Steve’s Upholstery, for replacing the foam and
re-upholstering a sectional sofa. The sofa was kept in the den
in petitioners’ home, which was used on a regular basis as a
family room by petitioners and their children and was not devoted
exclusively to business purposes. Mr. Black deducted the $929.10
paid for the sofa re-upholstery as “Supplies” on the Schedule C
attached to the 1991 joint return.
During May 1991, Mrs. Black purchased a 75-gallon salt water
aquarium from Kent Drum (Mr. Drum), the owner of K&M Pet Center.
The aquarium and related equipment were delivered to petitioners’
house on the evening of May 29, 1991, and left unassembled in
their den. The next day Mr. Drum assembled the aquarium in
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petitioners’ den. The aquarium was set up the day before the
sixth birthday of petitioners’ son, Jonathan. The aquarium
remained in petitioners’ den until at least March 6, 1995.
Mr. Black deducted the $1,150 paid for the aquarium as “Supplies”
on the Schedule C attached to the 1991 joint return.
During 1992, Daniel Howachyn performed alterations on an
iron gate and also fabricated an arched door made of treated
wood. Both the gate and door were located in petitioners’
residential courtyard. Mrs. Black paid for the work on the gate
with two checks of $425 and $200. Mr. Black deducted both checks
to Mr. Howachyn as “Supplies” on the Schedule C attached to the
1992 joint return.
During both 1991 and 1992, Mr. Black wrote checks to
petitioners’ daughter, Anita Black, who was attending college at
the time. A summary of these checks is as follows:
Year Amount Stated Purpose
1991 $900 Supplies
1991 $438 Supplies
1992 $102 Small overhead projector - supplies
1992 $375 Brother processor - supplies
1992 $400 Typewriter - supplies
1992 $500 Pay
1992 $500 Pay
1992 $300 Pay
Mr. Black deducted the foregoing eight checks based on their
“Stated Purpose” on the Schedule C attached to the 1991 and 1992
joint returns. Anita Black never purchased equipment for or sold
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any equipment to Mr. Black. Although Anita Black occasionally
did some work for her father’s business, she never received a
paycheck. Anita Black did have a Brother processor and
typewriter and used them for schoolwork. Mr. Black did not issue
a Form 1099 or Form W-2, Wage and Tax Statement, for the $1,300
allegedly paid to Anita Black as wages during 1992.
For 1991 and 1992, petitioners claimed Schedule C deductions
for travel expenses of $43,084 and $18,272, respectively, and
claimed Schedule C deductions for meals and entertainment of
$29,561 and $14,734, respectively.
For many years, Mr. Black has placed title to his property
solely in his wife’s name because of his concerns that his
property could be reached by potential creditors.
Mrs. Black holds a bachelor of visual arts degree in
sculpture. Mrs. Black did not personally sign the 1991 and 1992
joint returns. Mr. Black signed Mrs. Black’s name to the 1991
and 1992 joint returns. Mrs. Black did not review, and never
saw, the 1991 or 1992 joint returns before they were filed. She
also never asked Mr. Black whether he had timely filed those
returns and did not know until well after the fact that those
returns had been filed.
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OPINION
1. Period of Limitations and Fraud
We address the issues of fraud and the period of limitations
prior to the other issues in the instant case because, absent
fraud, the period of limitations prevents respondent’s assessment
of the taxable years in issue. Sec. 6501(c)(1); see, e.g.
Langworthy v. Commissioner, T.C. Memo. 1998-218. The notice of
deficiency was issued on June 9, 2004, after the expiration of
the general 3-year period of limitations on assessments for both
petitioners’ 1991 and 1992 taxable years. Sec. 6501(a).
However, in the case of the filing of a false or fraudulent
return with intent to evade tax, the tax may be assessed at any
time. Sec. 6501(c)(1). If the return is fraudulent in any
respect, it deprives the taxpayer of the bar of the statute of
limitations for that year. Lowy v. Commissioner, 288 F.2d 517,
520 (2d Cir. 1961), affg. T.C. Memo. 1960-32. “Thus, where fraud
is alleged and proven, respondent is free to determine a
deficiency with respect to all items for the particular taxable
year without regard to the period of limitations.” Colestock v.
Commissioner, 102 T.C. 380, 385 (1994). Moreover, if a joint
return was filed, proof of the fraudulent intent as to one spouse
lifts the bar of the statute of limitations as to both spouses.
Vannaman v. Commissioner, 54 T.C. 1011, 1018 (1970).
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The Commissioner has the burden of proving fraud by clear
and convincing evidence. Sec. 7454(a); Rule 142(b).
Respondent’s burden of proof under section 6501(c)(1) is the same
as that imposed by section 6663. See Schaffer v. Commissioner,
779 F.2d 849, 857 (2d Cir. 1985), affg. in part and remanding in
part Mandina v. Commissioner, T.C. Memo. 1982-34.
A. Proof of an Underpayment
To satisfy the Commissioner’s burden, the Commissioner must
show: (1) An underpayment exists; and (2) the taxpayer intended
to evade taxes known to be owing by conduct intended to conceal,
mislead, or otherwise prevent the collection of taxes. Parks v.
Commissioner, 94 T.C. 654, 660-661 (1990). The Commissioner must
meet that burden through affirmative evidence because fraud is
never imputed or presumed. Petzoldt v. Commissioner, 92 T.C.
661, 699 (1989). If the Commissioner establishes that any
portion of an underpayment in a particular year is attributable
to fraud, the entire underpayment is treated as attributable to
fraud, except with respect to any portion of the underpayment
which the taxpayer establishes (by a preponderance of the
evidence) is not attributable to fraud. Sec. 6663(b).
Respondent used the net worth method to establish
petitioners’ income and the fact of an underpayment. Under the
net worth method, taxable income is computed by reference to the
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change in the taxpayer’s net worth3 during a year, increased for
nondeductible expenses such as living expenses, and decreased for
items attributable to nontaxable sources such as gifts and loans.
The resulting figure may be considered to represent taxable
income, provided: (1) The Commissioner establishes the
taxpayer’s opening net worth with reasonable certainty, and
(2) the Commissioner either shows a likely source of unreported
income or negates possible nontaxable sources. United States v.
Massei, 355 U.S. 595, 595-596 (1958); Holland v. United States,
348 U.S. 121, 132-138 (1954); Brooks v. Commissioner, 82 T.C.
413, 431-432 (1984), affd. without published opinion 772 F.2d 910
(9th Cir. 1985). Deductions are a matter of legislative grace,
and petitioners must prove they are entitled to the deductions.
Rule 142(a); New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440
(1934).
Respondent has established petitioners’ opening net worth
with reasonable accuracy. Petitioners, however, argue that Mr.
Black maintained a cash hoard and that respondent’s determination
of petitioners’ opening net worth does not take into
consideration petitioners’ cash hoard. According to Mr. Black,
as of December 31, 1990, petitioners had accumulated a cash hoard
of between $500,000 and $505,000, consisting of bundles of $100
3
Assets are generally listed at their cost rather than at
their current market value. Camien v. Commissioner, 420 F.2d
283, 285 (8th Cir. 1970), affg. T.C. Memo. 1968-12.
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bills, and kept this cash hoard inside a suitcase in an unlocked
closet in their residence.
We decide whether a witness is credible on the basis of
objective facts, the reasonableness of the testimony, and the
demeanor of the witness. Quock Ting v. United States, 140 U.S.
417, 420-421 (1891); Wood v. Commissioner, 338 F.2d 602, 605 (9th
Cir. 1964), affg. 41 T.C. 593 (1964); Dozier v. Commissioner,
T.C. Memo. 2000-255. Having had the opportunity to observe
petitioners and Mr. Black’s employee, Mr. Plexico, at trial, we
find their testimony regarding the existence of a cash hoard to
lack credibility.
Petitioners had several bank and investment accounts and
made regular use of them. We find it implausible that, as a
stockbroker and investment adviser, Mr. Black had accumulated
$500,000 in cash, and that he kept that cash in a closet at his
house.
Respondent repeatedly requested that petitioners provide
information about petitioners’ cash on hand, but they refused to
provide such information. Petitioners and their representatives
were aware that respondent was using the net worth method of
proof to compute petitioners’ taxable income for the taxable
years 1991 and 1992. However, at no time during Agent McCarter’s
civil examination, or Agent O’Dell’s criminal investigation, did
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petitioners or any of their representatives claim that the net
worth adjustments could be explained by the use of a large cash
hoard.
Petitioners did not raise any cash hoard defense in either
their petition or their reply. Petitioners first raised their
cash hoard defense only after this case initially was set for
trial in Winston-Salem, North Carolina, on May 23, 2005.
Petitioners have failed to identify any source of funds for
the cash hoard other than supposed savings over a number of
years. On the July 26, 1985, consumer loan application to Home
Federal, petitioners stated that they possessed “Cash on hand and
in banks” totaling $9,000. During Agent Helton’s examination of
petitioners 1987 through 1989 taxable years, petitioners failed
to identify any large quantities of cash on hand. At trial, Mr.
Black testified that he had lied to Agent Helton.
Furthermore, all of the expenditures in respondent’s net
worth calculations are by check or credit cards eventually paid
by check. Also, there is no evidence of large cash deposits into
petitioners’ bank accounts. Thus, even if petitioners had a cash
hoard, it would not affect the net worth calculations as there is
no evidence that any of the expenditures were paid by cash either
directly or through deposit and payment by check.
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Respondent has negated all nontaxable sources of income
alleged by petitioners. Respondent has shown that petitioners
did not receive any gifts or inheritances. Most importantly,
respondent has negated petitioners’ cash hoard argument.
During 1991 and 1992, Mr. Black paid medical insurance
premiums of $6,307 and $4,744, respectively. Respondent’s net
worth calculation treats such amounts as nondeductible
expenditures. However, respondent allowed deductions for 25-
percent of the premiums paid as self-employment health insurance.
See sec. 162(l)(1).
Under section 213(a), personal medical and dental expenses
are deductible only to the extent they exceed 7.5 percent of
adjusted gross income (AGI). Accordingly, petitioners are not
entitled to deduct the remaining 75 percent of the medical
insurance premiums paid as personal medical expenses as they do
not exceed 7.5 percent of petitioners’ adjusted gross income.
Secs. 213(a), 162(l)(3)(A). Petitioners have not proven that any
deduction above the 25 percent allowed is appropriate.
Petitioners appear to argue that some portion of the medical
insurance premiums should be deductible under section 162(a) as
ordinary and necessary business expenses. The parties have
stipulated that Mr. Black had a health insurance policy covering
himself and his family as well as several employees. However,
the record is silent as to what portion of the premiums paid was
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for petitioners’ family and what portion for the employees.
Thus, we are unable to estimate an amount deductible under
section 162(a). See Cohan v. Commissioner, 39 F.2d 540, 543-544
(2d Cir. 1930); Vanicek v. Commissioner, 85 T.C. 731, 742-743
(1985).
Petitioners challenge several other aspects of respondent’s
net worth computation. Many of petitioners’ arguments confuse
benefits provided by an employer to an employee with those
provided by a self-employed individual to himself. Additionally,
petitioners attempt to attribute some payments to Frank Black,
Inc. However, Frank Black, Inc., did not have any bank or other
accounts in 1992, nor did it transact any business or have any
employees.
B. Proof That the Underpayment Was Due to Fraud
Section 6663 imposes a penalty equal to 75 percent of the
portion of any underpayment which is attributable to fraud. Sec.
6663(a). The penalty in the case of fraud is a civil sanction
provided primarily as a safeguard for the protection of the
revenue and to reimburse the Government for the heavy expense of
investigation and the loss resulting from a taxpayer’s fraud.
Helvering v. Mitchell, 303 U.S. 391, 401 (1938). Fraud is
intentional wrongdoing on the part of the taxpayer with the
specific purpose to evade a tax believed to be owing. McGee v.
Commissioner, 61 T.C. 249, 256 (1973), affd. 519 F.2d 1121 (5th
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Cir. 1975). The existence of fraud is a question of fact to be
resolved from the entire record. Gajewski v. Commissioner, 67
T.C. 181, 199 (1976), affd. without published opinion 578 F.2d
1383 (8th Cir. 1978).
However, fraud need not be established by direct evidence,
which is rarely available, but may be proved by surveying the
taxpayer’s entire course of conduct and drawing reasonable
inferences therefrom. Spies v. United States, 317 U.S. 492, 499
(1943). Courts have relied on a number of indicia or badges of
fraud in deciding whether to sustain the Commissioner’s
determinations with respect to the additions to tax for fraud.
Although no single factor may be necessarily sufficient to
establish fraud, the existence of several indicia may be
persuasive circumstantial evidence of fraud. Solomon v.
Commissioner, 732 F.2d 1459, 1461 (6th Cir. 1984), affg. per
curiam T.C. Memo. 1982-603; Beaver v. Commissioner, 55 T.C. 85,
93 (1970).
Circumstantial evidence that may give rise to a finding of
fraudulent intent includes: Understatement of income, inadequate
records, failure to file tax returns, concealment of assets,
failure to cooperate with tax authorities, filing false
documents, failure to make estimated tax payments, engaging in
illegal activity, attempting to conceal illegal activity, dealing
in cash, implausible or inconsistent explanations of behavior, an
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intent to mislead which may be inferred from a pattern of
conduct, and lack of credibility of the taxpayer’s testimony.
Spies v. United States, supra at 499. The taxpayer's background
and the context of the events in question may be considered as
circumstantial evidence of fraud. Spies v. United States, supra
at 497; Bradford v. Commissioner, 796 F.2d 303, 307 (9th Cir.
1986), affg. T.C. Memo. 1984-601; Niedringhaus v. Commissioner,
99 T.C. 202, 211 (1992).
The instant case involves numerous badges of fraud. Mr.
Black grossly understated his income. The 1991 and 1992 joint
returns reported negative taxable income of $49,538 and $11,981,
respectively. Even after respondent’s minor concessions at
trial, petitioners failed to report substantial amounts of
income, including commissions from Clark Capital of $21,843.36.
Petitioners argue that their omission was an oversight on their
part because Mr. Black did not receive a Form 1099 from Clark
Capital. However, Mr. Black testified at trial that he
maintained records of his business gross receipts, that he knew
he had received the Clark Capital commissions, and that he had
recorded the commission checks in his records. Mr. Black failed
to provide such records to his return preparer.
Petitioners’ standard of living was inconsistent with the
negative income reported on the 1991 and 1992 joint returns.
Petitioners hired a housekeeper and paid for their daughter’s
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college expenses. During the years in issue, petitioners reduced
their home mortgage balance from $36,857 to zero and reduced
their home equity loan balance from $47,823 to $20,062. In 1992,
they also spent a total of $32,299 for improvements to their
residence and landscaping.
Mr. Black has a history of refusing to cooperate with
respondent’s agents. During the examination of his taxable years
1979 through 1981, Mr. Black refused to discuss the large
deductions claimed for contributions to the Universal Life
Church. During Agent Helton’s investigation of taxable years
1987 through 1989, Mr. Black generally was unresponsive and
evasive. At trial, while cross-examining Agent Helton, Mr. Black
described his own behavior during that audit as “a little
evasive”.
Finally, during the examination of his taxable years 1991
and 1992, Mr. Black refused to meet first with Agent McCarter and
then with both Agents McCarter and O’Dell. Consequently, all of
Agent McCarter’s and Agent O’Dell’s contacts with Mr. Black were
made through his representatives. Although the Agents attempted
to get Mr. Black to cooperate, he provided only limited records.
Mr. Black failed to provide records for the bank accounts that
were in his name. Mr. Black refused respondent’s repeated
requests to classify his checks as either business or personal
and to provide information concerning petitioners’ cash on hand.
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Because Mr. Black refused to provide relevant records, Agents
McCarter and O’Dell were forced to serve IRS summonses upon Mr.
Black, banks, and other third parties.
Mr. Black’s failure to cooperate caused frustration to his
own representatives. During November, 1994, Agent O’Dell
provided Mr. Black’s representatives with a printout of canceled
checks and asked them to have Mr. Black classify the purpose of
the checks as either business or personal. More than 3 months
later, Mr. Black still had not classified the checks. On
March 4, 1995, Agent O’Dell wrote Mr. Black’s representatives,
again requesting that Mr. Black classify the checks, and also
asked that Mr. Black complete and return the Cash On Hand
Statement enclosed with that letter. On March 15, 1995, Mr.
Black’s principal attorney, Robert Mendenhall, advised Agent
O’Dell that Mr. Black “is being very obstinate” and that he hoped
that one of Mr. Black’s other attorneys, who was meeting with Mr.
Black that “afternoon, can convince him that this is a serious
matter”.
Petitioners also have a history of claiming inappropriate
charitable deductions first to ULC and to NFBC. On their joint
returns for taxable years 1979, 1980, and 1981, petitioners
claimed deductions for charitable contributions to the Universal
Life Church of $59,182, $57,181, and $33,629, respectively.
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After examination, respondent disallowed these deductions in
full. Petitioners ultimately agreed to the disallowance of all
claimed ULC deductions.
Likewise, petitioners claimed charitable deductions on their
1987, 1988, and 1989 joint tax returns of $22,350, $13,125, and
$13,250, respectively for contributions to NFBC. After
examination, respondent disallowed the NFBC deductions in full.
Petitioners ultimately agreed to the disallowance of all claimed
NFBC deductions.
During the examination, Mr. Black gave Agent Helton a
statement which he stated should be sufficient to verify the
deductions claimed for contributions to NFBC. The statement
provided by Mr. Black included both the name of the alleged
church, listed as “New Faith Baptist, Inc.”, and the amounts of
the alleged charitable contributions.
Petitioners never provided any evidence to Agent Helton to
show that NFBC was a church. Agent Helton tried, without
success, to verify the existence of NFBC through other means.
Agent Helton checked the telephone listing for Rock Hill, S.C.,
and also checked the IRS’s official listing of approved section
501(c)(3) organizations, but found no listings for the alleged
church.
Because the statement provided by Mr. Black included “Inc.”
in the alleged church’s name, Agent Helton checked with the
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SCSOS. Agent Helton learned from the SCSOS that a corporation
named New Faith Baptist, Inc., was on file, and that its articles
of incorporation listed petitioners’ Rock Hill, South Carolina,
address as its corporate address and listed Mr. Black as a
corporate officer.
At trial, Mrs. Black testified that she first became aware
of NFBC “when someone called me on the phone and asked to speak
to somebody from the church”. Mrs. Black also testified that
after the call she asked Mr. Black about NFBC and “he said [it]
used to be in the house; it used to be a church that he and his
friends had formed, and it was not valid”. After Mr. Black’s
objection, Mrs. Black altered her testimony saying: “what I was
saying is it was not there in the home anymore.” Petitioners
never provided Agent Helton with any canceled checks or any other
credible evidence to show that they had made any contributions to
NFBC (or any church) during 1987, 1988, or 1989.
Petitioners claimed a number of inappropriate deductions for
personal expenditures for the years in issue, including, but not
limited to, a new range, re-covering a sofa, an aquarium, and the
work performed by Daniel Howachyn. Petitioners argue that such
deductions were for their home office or Mrs. Black’s home-based
business. However, at trial, they testified repeatedly that the
office was, in fact, their den and was not used exclusively for
business purposes.
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Section 280A(a) provides as a general rule that no deduction
otherwise allowable to an individual “shall be allowed with
respect to the use of a dwelling unit which is used by the
taxpayer during the taxable year as a residence.” As relevant
herein, section 280A(c)(1) provides that the general rule of
section 280A(a) is not applicable to any item to the extent it is
allocable to a portion of the dwelling unit which is exclusively
used on a regular basis as the principal place of business for
any trade or business of the taxpayer, or as a place of business
which is used by patients, clients, or customers in meeting or
dealing with the taxpayer in the normal course of his trade or
business. Expenses deducted as a business use of home must be
deductible under section 162 or some other Code section. See
sec. 280A(a).
Petitioners claimed Schedule C deductions for eight checks
written to their daughter Anita. We conclude, largely on the
basis of Agent O’Dell’s interview with Anita on September 6,
1995, that such checks to Anita were gifts of money and supplies
for her college work. The checks to Anita were not properly
deductible as business expenses.
Petitioners also claimed Schedule C deductions on their
joint 1991 and 1992 returns for payments to their two young
children, Dominique and Jonathan. Petitioners contend that
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Dominique and Jonathan were Mr. Black’s employees and the
payments to them were properly deducted as salary.
The record establishes that Dominique and Jonathan did spend
some time in Mr. Black’s office in Charlotte. Likewise, Ms.
Roberts, an employee of Mr. Black, told Agent O’Dell that the
children sometimes helped her “stuff and stamp” envelopes and
perform other chores like emptying the trash. However, we are
not persuaded that amounts paid to petitioners’ children were
compensation for services rendered.
Petitioners failed to present any records to substantiate
that he employed Dominique and Jonathan throughout 1991 and 1992,
and admitted that they kept no written records of the hours they
worked. When asked at trial to estimate the total hours each
child worked, Mr. Black answered: “let’s call it 1,000 hours per
year.” According to his estimate, Mr. Black’s children, who were
6 and 8 years old in 1991, worked the same hours as one full-time
adult.
Mr. Black did not pay the children for services rendered.
His actual employee, Ms. Roberts, received a set annual salary,
plus a bonus, and was paid by check twice per month. Mr. Black
properly withheld Social Security and income taxes from her pay,
and issued a Form W-2 reporting her wages. No Forms W-4,
Employees Withholding Allowance Certificate, were ever executed
for Dominique and Jonathan, no Social Security or income taxes
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were withheld, their pay was reported on a Form 1099, and the
1991 salary was paid in a lump sum to each. We conclude that
respondent properly treated the payments to Dominique and
Jonathan as nondeductible personal expenditures and indicia of
fraud.
Petitioner overstated deductions for travel, meals and
entertainment expenses and failed to provide credible evidence to
support such deductions at trial. During the examination of
petitioners’ taxable years 1991 and 1992, petitioners’
representative provided Agent McCarter with a travel log prepared
by Mr. Black which purported to show Mr. Black’s business travel
for taxable years 1991 and 1992. Agent McCarter returned the log
to petitioners’ representative because she could not read Mr.
Black’s handwriting and requested a legible copy of the log or
other documentation to support Mr. Black’s deductions. Neither
Mr. Black nor his representatives ever provided a new travel log
or any other evidence to support his deductions for business
travel, meals, or entertainment.
Agent McCarter concluded that, on the basis of the amounts
of claimed travel deductions and Mr. Black’s use of the standard
mileage rate, Mr. Black had to have driven 156,669 miles in 1991
and 181,692 miles in 1992, which averages 429 miles per day in
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1991 and 498 miles per day in 1992.4 At an average rate of 60
miles per hour, Mr. Black would have had to drive between 7 and 8
hours per day, 7 days per week,5 not including time spent stopped
for gas or meals, or meeting with clients.
At trial, both petitioners testified that Mr. Black “loved
to drive”. Petitioners argue that Mr. Black’s business was just
starting up and client contact was very important. However,
petitioners failed to identify even one instance of any business-
related travel for either year in issue by destination or name of
client. Additionally, the original travel log is now missing and
is not part of the record.
Mr. Black may have traveled for business purposes. However,
we are convinced that the deductions for travel claimed on the
1991 and 1992 joint returns are grossly overstated. We find that
such overstatements are indicative of Mr. Black’s fraudulent
intent to avoid taxes.
Petitioner is an intelligent and well-educated businessman.
We find that he had a basic comprehension of Federal tax matters
and he understood that individuals must report their gross income
and can only claim deductions for amounts actually paid in the
ordinary and necessary course of business, and not for personal
expenditures.
4
156,669/365 = 429.23; 181,692/365 = 497.79
5
429/60 = 7.15; 498/60 = 8.3
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Mr. Black attempted to conceal assets by placing title to
the assets in his wife’s name. At trial, Mr. Black testified
that he placed title to property solely in his wife’s name so
that his creditors would not be able to reach it.
Finally, petitioners provided implausible or inconsistent
explanations to explain the discrepancy in the net worth
calculations; namely, that they had a cash hoard of $500,000.
As discussed above, we do not find any of the testimony presented
regarding the cash hoard to be credible.
C. Conclusion
We conclude that the record shows by clear and convincing
evidence that petitioners understated their income and overstated
deductions and that there are sufficient badges of fraud to show
that understated income and overstated deductions are due to Mr.
Black’s fraudulent intent. Petitioners have failed to prove any
portion of the underpayment is not attributable to fraud.
Accordingly, we hold that section 6501(a) does not bar the
assessment and collection of taxes for 1991 and 1992 and that Mr.
Black is liable for the fraud penalty pursuant to section 6663.
2. Amount of the Deficiency
Although petitioners conceded some unreported gross income,
petitioners did not concede the deficiencies determined by
respondent. Petitioners contend they are entitled to a number of
adjustments to gross income not allowed by respondent.
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Generally, the Commissioner’s determinations are presumed
correct, and the taxpayer bears the burden of proving otherwise.
Rule 142(a)(1); Welch v. Helvering, 290 U.S. 111, 115 (1933).
Some of petitioners’ contentions are addressed above in the
discussion of fraud and do not bear repeating here, except that
we conclude that petitioners have failed to prove respondent’s
adjustments are not correct. Accordingly, we uphold respondent’s
determination with respect to those adjustments; i.e., the
Schedule C adjustments, the payments to petitioners’ children,
and the travel adjustments. The remaining contested items are
addressed below.
In the notice of deficiency, respondent disallowed a net
operating loss deduction for petitioners’ taxable years 1991 and
1992. Section 172(a) allows a “net operating loss deduction” for
the aggregate of net operating loss carrybacks and carryovers to
the taxable year. The term “net operating loss” (NOL) is defined
in section 172(c) to mean the excess of deductions allowed by
chapter one over gross income. Section 172(b)(1)(A) generally
provides that the period for an NOL carryback is 3 years and that
the period for an NOL carryover is 15 years.
However, a taxpayer may elect to relinquish the carryback
period with respect to an NOL for any taxable year, thereby using
the loss to offset income only in future years. Sec. 172(b)(3).
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Respondent does not dispute that petitioners elected to
relinquish the carryback periods for 1990 and 1991 and apply the
NOLs against income for 1991 and 1992. Respondent, however,
argues that petitioners have failed to show that they incurred
any NOL in either 1990 or 1991. Deductions are a matter of
legislative grace, and petitioners must prove they are entitled
to the deductions. Rule 142(a); New Colonial Ice Co. v.
Helvering, 292 U.S. 435, 440 (1934).
Petitioners were audited for the taxable years 1987, 1988,
and 1989, and later resolved their Tax Court cases6 for those
years by agreeing to deficiencies in income tax and related
additions to tax for all 3 years. Additionally, the settlement
establishes that petitioners did not incur any NOLs in any of
those years, and that no NOL carryover deduction from any pre-
1987 taxable year existed to be carried forward. Thus,
petitioners’ entitlement to any NOL carryover deduction for
taxable years 1991 and 1992 depends solely on whether they have
substantiated both the existence and amount of any NOL for 1990
or 1991.
Petitioners argue that their 1990 return shows an NOL of
$19,008, and that, by not examining petitioners’ 1990 taxable
year, respondent has conceded the NOL and cannot disallow it now.
Petitioners’ argument is without merit. Respondent’s failure to
6
Docket Nos. 10472-91 and 1615-92.
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audit or disallow a loss claimed on a return for one year does
not estop respondent from disallowing an NOL carryover of that
loss to a future year. Rollert Residuary Trust v. Commissioner,
80 T.C. 619, 636 (1983), affd. on another issue 752 F.2d 1128
(6th Cir. 1985). Petitioners have failed to substantiate the
existence or amount of any NOL carryover deduction for the
taxable years 1991 and 1992.
Under section 1211(b), noncorporate taxpayers are allowed
capital losses only to the extent of capital gains plus $3,000.
Section 1212(b) allows noncorporate taxpayers to carry forward
capital losses to subsequent taxable years, but it does not allow
such taxpayers to carry back capital losses to prior taxable
years.
In the notice of deficiency, respondent disallowed capital
loss deductions for petitioners’ taxable years 1991 and 1992 of
$3,000 and $2,721, respectively. Petitioners advance essentially
the same estoppel argument as with the NOL carryover.
Petitioners, however, claim the capital losses carried over to
1991 and 1992 arose in taxable years 1981 through 1983 and that
deductions of those losses were subsequently allowed in the
audited years 1987 through 1989. Petitioners argue that by
allowing the loss in the audited years, respondent has conceded
the full capital loss carryover amount shown on the returns for
1991 and 1992.
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Each taxable year stands alone, and the Commissioner may
challenge in a succeeding year what was condoned or agreed to in
a former year. Auto. Club of Mich. v. Commissioner, 353 U.S. 180
(1957). A settlement agreement is binding only with respect to
the years specified by the agreement. Goldman v. Commissioner,
39 F.3d 402, 405-406 (2d Cir. 1994), affg. T.C. Memo. 1993-480.
Petitioners have failed to substantiate that they are entitled to
claim any capital loss deduction for the taxable year 1991 or a
capital loss in excess of $271 for taxable year 1992.7
In the notice of deficiency, respondent determined that
petitioners failed to report interest and dividend income on
their 1992 joint return of $3,748 and $35, respectively.
Gross income includes all interest and dividends received by a
taxpayer during the taxable year. Sec. 61(a)(4).
Petitioners argue that they reported $754 of interest on the
1992 income tax return filed by Frank Black, Inc. However, all
interest at issue appears on Forms 1099 issued to Mr. Black in
his individual name and Social Security number. At trial, Mr.
Black indicated that he had assigned that income to the
corporation.8 The assignment of income doctrine prevents
7
Respondent allowed a capital loss deduction of $271 for
taxable year 1992.
8
We note that Frank Black, Inc., had no checking or other
accounts in 1992 and does not appear to have carried on any
operations.
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petitioners from avoiding taxation on their interest income by
assigning that income to another. Lucas v. Earl, 281 U.S. 111
(1930).
Petitioners failed to present any evidence regarding the $35
of dividend income. Accordingly, we conclude that petitioners
failed to report interest and dividend income on their 1992 joint
return of $3,748 and $35, respectively.
3. Section 6662(a) Penalty
Pursuant to section 6662(a), a taxpayer may be liable for a
penalty of 20 percent of the portion of an underpayment of tax
attributable to a substantial understatement of income tax or
due to negligence or disregard of rules or regulations.
Sec. 6662(b). The term “understatement” means the excess of the
amount of tax required to be shown on a return over the amount of
tax imposed which is shown on the return, reduced by any rebate
(within the meaning of section 6211(b)(2)). Sec. 6662(d)(2)(A).
Generally, an understatement is a “substantial understatement”
when the understatement exceeds the greater of $5,000 or 10
percent of the amount of tax required to be shown on the return.
Sec. 6662(d)(1)(A). The term “negligence” in section 6662(b)(1)
includes any failure to make a reasonable attempt to comply with
the Code. Sec. 6662(c).
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Mrs. Black is not liable for the accuracy-related penalty
imposed by section 6662(a) because the underpayments of tax for
taxable years 1991 and 1992 are due to fraud by Mr. Black. Sec.
6662(b); Zaban v. Commissioner, T.C. Memo. 1997-479; Aflalo v.
Commissioner, T.C. Memo. 1994-596; Minter v. Commissioner, T.C.
Memo. 1991-448.
We have considered all of petitioners’ contentions, and, to
the extent they are not addressed herein, they are irrelevant,
moot, or without merit.
To reflect the foregoing,
Decision will be entered
under Rule 155.