DocketNumber: Docket No. 24382-06
Citation Numbers: 2012 T.C. Memo. 350, 104 T.C.M. 795, 2012 Tax Ct. Memo LEXIS 353
Judges: LARO
Filed Date: 12/19/2012
Status: Non-Precedential
Modified Date: 11/20/2020
Decision will be entered for respondent.
LARO,
Additions to tax and penalties | |||
1999 | $41,786 | $10,446.50 | $31,339.50 |
2000 | 52,583 | 13,145.75 | 39,437.25 |
2001 | 78,572 | 19,881.50 | 58,929 |
The issues for decision are: (1) whether petitioner failed to report income for 1999, 2000, and 2001 of $174,838.79, $157,841.80, and $230,194.04, respectively. We hold that he did; (2) whether petitioner is entitled to net operating loss (NOL) deductions for the years at issue. We hold that he is not; (3) whether petitioner is liable for additions to tax under
The parties filed with the Court a stipulation of facts and related exhibits. The stipulated facts and the accompanying exhibits are incorporated herein by this reference. We find the facts accordingly. Petitioner resided in San Diego, California, when he filed the petition.
For more than a decade and a half, petitioner has been entangled in legal battles with the United States. Petitioner was indicted in 1996 in U.S. District Court for mail fraud, money laundering, and bankruptcy fraud; he was subsequently found guilty of bankruptcy fraud for hiding certain assets from the bankruptcy court by knowingly and fraudulently making false and material financial statements in separate bankruptcy proceedings, for which he served a short sentence.
After he completed his sentence for bankruptcy fraud, he purportedly went into different business dealings in real estate development and marketing nutritional supplements. The record is devoid of details of the specific nature of these businesses or their day-to-day operations because petitioner has not provided any.
*354 In and around 2000, respondent instituted a project to identify taxpayers who were holders of credit cards issued by banks in off-shore tax havens because these credit cards tended to provide opportunities for their holders to evade Federal income tax. A series of John Doe summonses resulted in a list of taxpayers who had been issued credit cards by Cayman National Bank; petitioner, who at the time had not filed his Federal income tax returns for 1999 through 2001, was on the list. Preliminary investigation indicated that petitioner might be conducting personal transactions and business activities through multiple fictitious businesses and entities, none of which had *357 filed Federal income tax returns for at least 1999 and 2000.
Following the leads, the Internal Revenue Service (IRS) agent in charge of the investigation, Huong T. Phan, attempted to contact petitioner about why neither he nor the businesses he ostensibly owned had filed tax returns for the subject years. On separate occasions Agent Phan attempted to interview petitioner and his accountant, Gary List, to elicit income information for the years at issue, but petitioner was uncooperative and provided little information. Petitioner's continued resistance to cooperating with Agent Phan in the audit left Agent Phan *355 with no choice but to obtain the information from third-party sources. In October 2002 respondent issued administrative summonses directing Wells Fargo Bank and other financial institutions to produce petitioner's financial and banking records in their possession. Petitioner intervened and petitioned the District Court to quash these summonses.
After considering the parties' pleadings and moving papers, the District Court in January 2003 ordered the summonses to Wells Fargo Bank enforced after finding that the IRS had met the standard announced in
Of all the entities and bank accounts identified, Agent Phan focused on four entities and their bank accounts: R Michael Construction, Pacific Sun Construction, Inc. (Pacific Sun), Torrey Beach, Inc. (Torrey Beach), and 4181 Mississippi, Inc (4181 Mississippi). 4 It is undisputed that these entities did not file Federal income tax returns for the years at issue. 5 Except for R Michael *357 Construction and 4181 Mississippi, the entities did not have employer identification numbers. No one besides petitioner had signature *360 authority over the bank accounts belonging, at least in name, to these entities.
In May 2003 while petitioner's audit was underway, petitioner filed his Federal income tax returns with respondent for the three years at issue. Both the 1999 and 2000 returns reported substantial business losses on Schedule C, Profit or Loss from Business, and the 2001 return reported a modicum of business income but claimed substantial net operating loss (NOL) carryovers. Finding inconsistencies between the late-filed returns and petitioner's previous statements to Agent Phan as well as petitioner's bank records obtained through the summonses, Agent Phan concluded petitioner had underreported his income and thus rejected petitioner's returns.
With extensive bank records in hand, *361 Agent Phan reconstructed petitioner's income and made several determinations. First, Agent Phan determined that unexplained deposits of approximately $3.5 million were made to the four bank accounts held by the four businesses that were the focus of the audit. Agent Phan also determined that petitioner owned these four entities, a fact that petitioner has *358 not sought to dispute. Then she disregarded the corporate form of these four fictitious businesses as entities separate from their owner and treated income of these entities as income to petitioner since petitioner had sole control of their bank accounts and none of these entities had filed Federal income tax returns or paid any Federal income taxes.
But to be conservative, Agent Phan considered only amounts of withdrawals that personally benefited petitioner. 6 First, Agent Phan treated checks petitioner wrote to himself as income to him. She also took into account withdrawals that petitioner made to purchase cashier's checks that he used to make payments on his Cayman National Bank credit card account. Finally, Agent Phan included in petitioner's income checks petitioner wrote to John Fikes—who was petitioner's equity partner in *362 R Michael Construction, Pacific Sun, and 4181 Mississippi—and to several other individuals and entities 7 because those payments were made for petitioner's personal benefit and were not business expenses deductible by the entities on whose bank accounts the checks were drawn. For the three years at *359 issue, Agent Phan sourced petitioner's income with substantive evidence, as follows:
1999 | $91,978.58 | $53,455.82 | $29,404.39 | - - - |
2000 | 59,716.80 | 59,716.80 | 28,508.20 | $9,900.00 |
2001 | - - - | 75,207.37 | 20,958.49 | 134,028.18 |
Total | 151,695.38 | 188,379.99 | 78,871.08 | 143,928.18 |
In total, Agent Phan determined that petitioner had $562,874.63 of unreported income.
In addition to the income determinations, Agent Phan identified several indicia of fraud in the course of the audit. First, petitioner persistently refused *363 to cooperate with Agent Phan in his audit. Further, petitioner failed to file his Federal income tax returns for several years. And when he did file his returns after respondent had commenced the audit, petitioner underreported his income for multiple years. Moreover, petitioner did not hold any of the bank accounts under his name but rather held them under various business entities that he used to route and reroute his money to conceal the personal nature of his expenses. Finally, he failed to maintain adequate books and records for these businesses and made multiple cash withdrawals from their bank accounts to pay his Cayman National Bank credit card account. In March 2004 Agent Phan referred the case to the *360 Criminal Investigation Division (CID) of the IRS, but the referral was rejected six weeks later.
At trial in San Diego, California, petitioner challenged some of Agent Phan's findings but did not testify himself; he prosecuted his case solely on the basis of the testimony of three witnesses: Mr. Fike, Mr. List, and Agent Phan. Neither petitioner nor any of his witnesses disputed that petitioner owned the four business entities, that none of these entities paid any Federal income *364 tax, or that he wrote the checks on which Agent Phan relied to reconstruct his income. Petitioner disputed only whether some of these check withdrawals were made for his own benefit.
In addition to questioning Agent Phan's income characterization of these numerous check withdrawals, petitioner argues on brief that respondent's determinations in the deficiency notice were based on information acquired through invalid administrative summonses and the civil audit was a criminal investigation in disguise. Petitioner has also raised at trial a different but related argument that the notice of deficiency was arbitrary and capricious because it was a part of the Government's vendetta against him in connection with its prior criminal prosecution in the District Court for fraud and money laundering.
Petitioner's primary argument on brief is that the summonses leading to the discovery of the Wells Fargo Bank records on which respondent based his determinations in the notice of deficiency were improperly issued. Specifically, petitioner argues the issuing of these summonses violated
Under res judicata, or claim preclusion, a final judgment on the merits in a prior suit bars a second suit involving the same cause of action and the same *362 parties or their privies.
Even though the District Court proceeding and the petition before this Court involve what appear on the surface to be two distinct causes of action (i.e., a petition to quash summonses and a petition for redetermination of deficiencies), petitioner's underlying claims—that the issuing of the Wells Fargo Bank summonses violated
Similarly, collateral estoppel precludes petitioner from relitigating the same issues that he litigated in the District Court. The doctrine of collateral estoppel, or issue preclusion, "preclude[s] relitigation of both issues of law and issues of fact if those issues were conclusively *369 determined in a prior action."
*365 The District Court decided that respondent had met all the
The District Court's finding that respondent had *370 followed all administrative steps also means implicitly that respondent did not impermissibly issue the administrative summonses when "a Justice Department referral [was] in effect" in violation of
Even if petitioner's claims were not barred by claim preclusion or issue preclusion, the facts before us would still compel the conclusion that the issuance of the administrative summonses complied with
First, respondent met the requirement under
Second, respondent did not violate
There is nothing in the record that shows respondent had made such a recommendation to the Department of Justice when he issued the administrative summonses. The only part of the record that even remotely suggests there was a criminal referral is Agent Phan's testimony that she referred the civil audit to the *370 CID in March 2004, almost a year and a half after respondent issued the summonses. Even had Agent Phan made the referral to the CID at the time respondent issued the summonses, that referral was not a "Justice Department referral" within the meaning of the statute. Indeed, Congress intended to draw *376 a clear line to limit the Commissioner's power to issue administrative summonses as the criminal aspect of a tax investigation becomes clear. 14 Respondent did not cross that line in this case.
Petitioner made one final argument on brief asking the Court to disregard the entire civil audit and find against respondent's *377 deficiency notice because it was *371 based on a criminal investigation, which violated the law and respondent's internal guidelines.
The body of law that petitioner refers to in his brief concerns situations where the Commissioner has obtained evidence through a criminal investigation cloaked in a civil audit. Courts have held that evidence acquired through such "deceit, trickery or misrepresentation" would be excluded in the subsequent criminal prosecution against the taxpayer because such conduct would violate the taxpayer's constitutional rights under the Fourth and the
Petitioner does not specifically point out in his brief the internal guidelines that respondent had allegedly failed to follow. In very general language, petitioner *372 states: "IRS guidelines specifically warn the revenue agents who are in the process of determining the appropriateness of a criminal referral must not obtain evidence and/or direction from the Criminal Investigation Division for a specific case that is under examination." The part of the IRM that appears to relate to petitioner's contention states: "If after consultation with the district fraud coordinator (DFC), it is determined a potential fraud case has firm indicators of fraud and meets criminal criteria, the compliance employee will suspend all activities without disclosing to the taxpayer or representative the reason for the suspension." IRM pt. 104.2.3.4 (May 19, 1999).
Even if, for the sake of argument, a criminal referral was pending and respondent did not follow *379 his internal procedures to suspend the civil audit, such procedures were not required by either the Constitution or statute, and noncompliance is not fatal to respondent's determinations in the notice of deficiency.
It is a well-settled principle that the Court will not look behind a statutory notice of deficiency "to examine the evidence used, the propriety of the Commissioner's motive, or the administrative policy or procedure in making his determinations."
Gross income includes all income from whatever source derived, unless otherwise specifically excluded.
The Commissioner's determinations in a notice of deficiency are generally presumed correct, and the taxpayer bears the burden of proving that those determinations are erroneous.
Because petitioner argues on brief only that respondent had improper motives and allegedly violated the law in issuing the administrative summonses and in conducting the civil audit, we will treat petitioner's silence on the remaining issues as a concession of those issues.
When a taxpayer has provided little information in an audit, as is the case here, the Commissioner may reconstruct the taxpayer's income using any available method including examining the taxpayer's bank records.
Indeed, in several instances the record reveals the personal nature of these withdrawals. In one of these instances, petitioner had written several checks to Heidi Humphreys who, according to Mr. *384 Fike's testimony, was petitioner's "part-*377 time girlfriend." 16 Petitioner had also written checks to San Diego Travel and Havasu Springs Resort which respondent determined to be for petitioner's personal benefit. In addition to the checks he wrote to purchase cashier's checks to pay off his Cayman National Bank credit card account, petitioner wrote numerous checks separately to Brad Dingham, Dawn Landrum, Dan Sanders, Heather Winger, and petitioner's son Michael Scharringhausen, which all appear to be personal.
Viewing the record as a whole, the Court concludes that respondent has established the minimum evidentiary foundation to show that the check withdrawals were not business expenses deductible by the four business entities, but they were rather made for petitioner's personal gain and thus are income to petitioner. 17*385
For his part, petitioner called Mr. Fike at trial to challenge respondent's determination of petitioner's unreported income. Petitioner also called Agent Phan and Mr. List to testify regarding respondent's computation of petitioner's *386 income and respondent's motives behind the civil audit. Petitioner himself did not testify.
On brief, petitioner argues only that respondent violated the law and his internal procedures when he issued the administrative summonses and conducted the civil audit, arguments we have already rejected as unfounded. To the extent petitioner also claims that respondent's determinations were otherwise arbitrary and capricious because the audit was part of the Government's vendetta against him in connection with its prior criminal prosecution in the District Court for fraud and money laundering, we also reject that argument because, as it is worth emphasizing again, the Court will not look behind the statutory notice to question "the propriety of * * * [respondent's] motive" unless petitioner is able to show by *379 substantial evidence that respondent's conduct gravely offends the Constitution.
In any event, petitioner's presentation at trial alone did not succeed in rebutting the presumption of the correctness of the notice of deficiency by a preponderance of the evidence. The only relevant testimony was from Mr. Fike, who testified that he received a number of checks from petitioner that were drawn on some of the bank accounts at issue, that he kept the money, and that the amounts deposited were of no benefit to petitioner. Mr. Fike also testified as to the checks that petitioner wrote to the other individuals and entities and attempted to explain how they did not personally benefit petitioner, even though Mr. Fike admitted that he had no personal knowledge of the specific circumstances surrounding the writing of those checks. On cross-examination, Mr. Fike stated that he was not aware of any Forms 1099-MISC, Miscellaneous Income, or Forms *380 W-2, Wage and Tax Statement, issued to these individuals and admitted he did not have much personal knowledge of the financial affairs *388 and accounting of the four business entities involved and that these were all "Mr. Scharringhausen's department." He could not even recall the nature of some of the checks that he received from petitioner. Thus, as the trier of fact, we are unable to rely on Mr. Fike's wavering testimony, which was ambiguous at times and self-contradicting as a whole, especially given his admission that petitioner was the only person in charge of the finances of the four business entities involved.
In sum, petitioner has failed to show by a preponderance of the evidence that respondent's determinations in the statutory notice are incorrect.
Deductions are a matter of legislative grace, and a taxpayer bears the burden of producing sufficient evidence to substantiate any allowable deduction under the Code.
Because petitioner's brief does not discuss whether he is entitled to the NOL deductions for the years at issue, we consider petitioner to have waived the argument.
The Commissioner bears the initial burden of establishing fraud by clear and convincing evidence. "that measure or degree of proof which will produce in the mind of the trier of facts a firm belief or conviction as to the allegations sought to be established. It is intermediate, being more than a mere preponderance, but *392 not to the extent of such certainty as is required beyond a reasonable doubt as in criminal cases. It does not mean clear and unequivocal."
The Commissioner may satisfy his burden of proving an underpayment of tax attributable to unreported income by either (1) proving a likely source of the unreported income, or (2) *393 disproving any alleged nontaxable source of that income.
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.
There are several nonexclusive "badges of fraud" from which the Court may infer a taxpayer's fraudulent intent: (1) understating income, (2) maintaining inadequate records, (3) failing to file tax returns, (4) giving implausible or inconsistent explanations of behavior, (5) concealing assets, (6) failing to cooperate with tax authorities, (7) engaging in illegal activities, (8) attempting to conceal illegal activities, and (9) dealing extensively in cash.
*387 After thoroughly examining the record, we found present in this case all but one indicium of fraud that the Court of Appeals stated in
Before respondent opened an audit relating to petitioner's 1999 through 2001 tax years, petitioner failed to file Federal income tax returns for those years. The same is true with his various business entities. And when he finally did file the returns after respondent commenced the audit, petitioner repeatedly underreported his income and reported substantial losses. Time and time again throughout his audit, petitioner steadfastly refused to cooperate with respondent. He also made groundless arguments in the District Court's petition-to-quash proceedings to obstruct respondent's efforts to obtain information from third parties about his financial and business affairs. Hoping that one hand of the Federal judiciary does not know what the other hand is doing, petitioner is now making the same meritless arguments why the administrative summonses respondent *397 had issued were invalid, arguments which the District Court had already rejected in those proceedings. Given petitioner's rich experience litigating cases in Federal courts and the fact that he is also an intelligent and sophisticated businessman, we will infer with conviction from petitioner's evasive and litigious *388 behavior that he intended to conceal and obscure the true nature of his financial dealings in the years at issue.
The evidence has also convinced us that petitioner's various entities were part of an elaborate scheme to conceal his income and expenses. It is undisputed that petitioner owned these business entities, which had not filed any Federal income tax returns. These entities held multiple bank accounts in their names over which petitioner—who had no bank accounts under his name—had the sole signatory authority. Petitioner offered no explanation as to how he supported himself financially, whereas the record provides us a clear picture of how petitioner regularly withdrew money from the bank accounts to pay his personal expenses. He repeatedly withdrew large sums of cash, some of which he used to purchase cashier's checks to pay off the Cayman National Bank credit card *398 account that he used to conduct personal transactions. Further, petitioner has not come forward with any detail or any accounting to show the daily operations, the business structures, or the financial affairs of his business entities. He did not testify at trial but instead presented his case with misleading arguments and innuendos. These facts together with petitioner's evasive behavior and failure to maintain adequate records for his businesses allow a strong inference that these businesses are a sham to hide income.
*389 In addition, petitioner's involvement in prior illegal, fraudulent activities also weighs against him in our analysis. He was previously charged with five counts of mail fraud, two counts of money laundering, and four counts of bankruptcy fraud. Ultimately, a jury convicted him of three counts of bankruptcy fraud for hiding assets from the bankruptcy court. This is highly probative because respondent determined petitioner committed tax fraud by concealing his income and assets from respondent.
The absence of the fourth
In the light of the foregoing discussion, we are convinced that petitioner's underreporting of income for the years at issue resulted in underpayments of tax. We are also convinced that at least a portion of each underpayment was attributable to fraud. Because petitioner has not provided any evidence that any portion of any underpayment was not attributable to fraud, we find the entire amount *400 of each underpayment of tax was attributable to fraud and sustain respondent's determinations of the fraud penalties.
In reaching our holdings, we have considered all arguments raised by the parties. To the extent not discussed herein, we find them to be irrelevant, moot, or without merit.
To reflect the foregoing,
1. Unless otherwise indicated, section references are to the Internal Revenue Code (Code) in effect for the years at issue, and Rule references are to the Tax Court Rules of Practice and Procedure. Some dollar amounts are rounded.
2. The notice of deficiency relied on bank records produced from the summonses issued to Wells Fargo Bank only.↩
3. Our record shows Agent Phan sent notices in the form of Letter 3164 together with the initial contact letter to petitioner before she contacted any third party, in compliance with
4. The bank records relating to these accounts were produced in response to the Wells Fargo Bank summonses. In her income reconstruction, Agent Phan relied only on bank records produced from the Wells Fargo Bank summonses.↩
5. R Michael Construction was the subject of an IRS audit for 1999 and 2000. As a result of the audit, the Commissioner assessed tax deficiencies of approximately $125,000 and $65,000 for 1999 and 2000, respectively.↩
6. In his answer to the petition, respondent argues an alternative theory under which the amounts charged to petitioner would be constructive dividends.↩
7. These individuals and entities included Brad Dingham, Heidi Humphreys, Dawn Landrum, Dan Sanders, Heather Winger, petitioner's son Michael Scharringhausen, San Diego Travel, and Havasu Springs Resort.↩
8. Respondent has not asserted res judicata or collateral estoppel as affirmative defenses.
9. Clearly, if respondent met the requirement under
10.
11. In holding that res judicata and collateral estoppel foreclose petitioner's claims that respondent violated
12. Lawyers appearing before us generally have the duty to advise the Court of any relevant and controlling authorities even if they are directly adverse to the position being advocated.
13. A "Justice Department referral" is also in effect when the Attorney General (or Deputy Attorney General or Assistant Attorney General) requests under
14. Many tax investigations by the Internal Revenue Service have both civil and criminal aspects. The * * * [Senate Finance Committee] believes that a clear definition of when the power to issue an administrative summons exists and when it does not exist in cases with a criminal aspect will simplify administration of the laws without prejudicing the rights of taxpayers. To permit the drawing of a clear distinction, it was necessary to expand the purposes for which an administrative summons may be issued by the Internal Revenue Service.
15. In certain situations the exclusionary rule would apply in a civil tax deficiency proceeding on due process grounds under the
16. Mr. Fike also testified that Ms. Humphreys was also working for petitioner and Mr. Fike under another entity called Stimulife, Inc.↩
17. Under the constructive dividend theory, which respondent argues as an alternative theory for finding the unreported income, expenses nondeductible to a corporation are income to the corporation's shareholder if they "also represent some economic gain or benefit to the owner-taxpayer."
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