Neel Kamal & Preeti Sharma

United States Tax Court
T.C. Memo. 2023-80NEEL KAMAL AND PREETI SHARMA,
Petitioners
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent
—————
Docket No. 8122-21. Filed June 22, 2023.
—————
Neel Kamal, pro se.
David M. Carl and Trent D. Usitalo, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
PUGH, Judge: In 2016 Neel Kamal received a substantial
payment after exercising his stock options and later selling the stock. To
offset his income from the stock sale, Mr. Kamal claimed business
expense deductions for a consulting business. Respondent issued
petitioners a notice of deficiency on February 11, 2021, determining the
following deficiencies, additions to tax, and penalties: 1
Penalties / Additions to Tax
Year Deficiency
§ 6662(a) § 6651(a)(1)
2016 $160,447 $32,089 —
2017 3,594 302 —
2018 8,229 557 $697
1 Unless otherwise indicated, all statutory references are to the Internal
Revenue Code, Title 26 U.S.C. (Code), in effect at all relevant times, all regulation
references are to the Code of Federal Regulations, Title 26 (Treas. Reg.), in effect at all
relevant times, and all Rule references are to the Tax Court Rules of Practice and
Procedure. We round all monetary amounts to the nearest dollar.
Served 06/22/23
2
[*2] The deficiency resulted largely from inclusion of unreported stock
sale proceeds and denied deductions for unsubstantiated business
expenses. Respondent made various other income adjustments and
reduced or disallowed some itemized deductions. At the close of the trial,
respondent asserted a civil fraud penalty against Mr. Kamal. 2
After concessions, 3 the issues remaining for decision are whether
for 2016 petitioners (1) underreported net long-term capital gain income
by $165,337; (2) underreported $2,681 of taxable interest income;
(3) overreported $211 of ordinary dividend income; (4) underreported
$1,000 of qualified dividend income; (5) underreported state tax refunds
by $1,288; (6) received gross receipts of $335,000 in connection with
Aarya Consulting, Inc. (Aarya Consulting); (7) are entitled to deduct
$409,823 of trade or business expenses of Aarya Consulting; (8) are
entitled to deduct a partnership loss of $64,799 from Rasoi Restaurant
(Rasoi); (9) overreported their real estate tax deduction by $7,589;
(10) overreported their home mortgage interest deduction by $127,627;
(11) overreported their charitable contributions deduction by $39,748;
and (12) overreported their miscellaneous deductions by $27,070.
We also must decide whether respondent established by clear and
convincing evidence that for 2016 petitioners underreported their
income and underpaid their tax and that those underpayments were
attributable to Mr. Kamal’s fraud, making him liable for the civil fraud
penalty under section 6663.
FINDINGS OF FACT
The facts below are derived from the pleadings, the trial
testimony, and the documents admitted into evidence and include the
2 Preeti Sharma did not appear for trial and was held in default with the
understanding that she would receive the same result as Mr. Kamal. Respondent did
not assert a fraud penalty against Ms. Sharma.
3 Respondent conceded deficiencies and accuracy-related penalties for 2017 and
2018 and the accuracy-related penalty for 2016. Respondent also conceded that
petitioners are not liable for the addition to tax for failure to timely file under section
6651(a)(1) for 2018. At trial, respondent orally moved to amend his Answer to assert
that petitioner Mr. Kamal was liable for civil fraud penalties for 2016 and 2017. Later,
respondent conceded that Mr. Kamal was not liable for a fraud penalty for 2017.
Lastly, respondent conceded that for 2016 petitioners had net long-term capital gain
of $165,337 (the notice of deficiency determined that for 2016 petitioners had long-term
capital gain of $403,497).
3
[*3] stipulated facts and documents. Petitioners were married residents
of California when they timely filed their Petition.
I. Unreported Income
A. Background
Mr. Kamal obtained a master’s degree in business administration
from the University of Florida in the 1990s. Sometime later, Mr. Kamal
started working at Jasper Wireless, Inc., which later changed its name
to Jasper Technologies, Inc. We will refer to Mr. Kamal’s employer as
“Jasper” because the name change does not affect our analysis. Mr.
Kamal worked for Jasper until November 2015. In 2016 Mrs. Sharma
worked at Tek Systems, Inc. (Tek Systems). Mr. Kamal regularly
underlines his signature.
B. Mr. Kamal’s Stock Options
Mr. Kamal was granted incentive stock options (stock options) in
Jasper stock while employed by Jasper. He exercised some of his stock
options before his departure; but when he left in November 2015, he still
had unexercised and vested options to purchase 30,805 shares of Jasper
stock.
In 2016 Cisco Systems, Inc. (Cisco), entered into an agreement to
acquire 4 Jasper in a merger. 5 Jasper notified its stock option holders
4 Jasper entered into an agreement with Cisco, Jaipur Acquisition Corp. (a
wholly owned subsidiary of Cisco), and other parties whereby Jaipur Acquisition would
merge with and into Jasper, with Jasper continuing as the surviving corporation and
a wholly owned subsidiary of Cisco.
5 During trial respondent sought to introduce several documents (Exhibits
19–R to 27–R) received from Cisco in compliance with the subpoena and relating to the
Cisco-Jasper merger. Mr. Kamal confirmed receiving the documents from respondent
before trial. These documents are hearsay, as they constitute out-of-court statements
offered for their truth. See Fed. R. Evid. 801(c). But they are business records
accompanied by a certification from the custodian of records for the business providing
them and therefore satisfy an exception to the rule against hearsay. See Fed. R. Evid.
803(6)(D), 902(11). Mr. Kamal did not object to the admission of those documents that
bore his signature (Exhibits 20–R, 21–R, 23–R, and parts of 27–R) but did object to the
documents that he did not sign. Mr. Kamal did not point to any circumstances to
suggest they lacked trustworthiness or were not authentic, and he testified
consistently with the documents about the underlying facts related to his stock options
and the Cisco-Jasper merger. We therefore admit respondent’s proposed trial exhibits
marked 19–R, 22–R, 24–R, 25–R, 26–R, and 27–R pursuant to the business record
exception to hearsay. See Fed. R. Evid. 803(6).
4
[*4] about the upcoming merger and advised that if they would not be
continuing their employment with Cisco or with Jasper after the merger,
then their vested, unexpired, unexercised, and outstanding stock
options would be converted into a right to receive an amount of cash at
the time of the merger (cash-out amount). It further advised that the
cash-out amount would constitute wages and would be subject to federal
and state income, employment, and other tax withholdings. Stock option
holders also were offered the opportunity to exercise their Jasper stock
options before the closing of the merger.
Because Mr. Kamal was no longer employed by Jasper and would
not be employed by Cisco, he had two choices: he could exercise his
remaining stock options before the closing of the merger or he could wait
and receive a cash-out amount after the closing. Mr. Kamal did both: he
exercised most of his stock options in February 2016, before the merger,
and after the merger he received a cash-out amount for the unexercised
stock options he still held.
C. Amounts Mr. Kamal Received in Connection with the
Merger
On April 4, 2016, Jasper paid Mr. Kamal $101,726 which it
characterized as “Bonus.” After deductions for tax and other
withholdings, Jasper direct deposited $57,190 into one of Mr. Kamal’s
personal bank accounts. Jasper reported $101,726 as wages, tips, or
other compensation on Form W–2, Wage and Tax Statement, for tax
year 2016. Petitioners reported this amount as compensation income on
their 2016 tax return. And respondent made no adjustments to this
amount. 6
After the merger, Mr. Kamal sold the shares in Cisco he received
in exchange for his Jasper stock in the Cisco-Jasper merger. 7 In April
2016 Cisco’s paying agent Computershare, Inc. (Computershare), paid
Mr. Kamal $396,264, which was deposited into Mr. Kamal’s personal
bank account. Computershare reported the $396,264 on Form 1099–B,
Proceeds From Broker and Barter Exchange Transactions. Cisco also
issued to Mr. Kamal Form W–2 for 2016, reporting $199,801 as “ISO Stk
Option Gain.” Of the $396,264 received from Cisco, petitioners reported
6Respondent claims that this was the cash-out amount paid to Mr. Kamal for
the unexercised stock options.
7 The record does not specify how Mr. Kamal came to hold Cisco stock but does
support this inference.
5
[*5] only $199,800 as income from wages on their 2016 tax return.
Respondent made no adjustments to the reported amount.
D. Long-Term Capital Gains
In 2016 petitioners traded stocks through the online
stock-trading platform Scottrade, Inc. (Scottrade). They reported a net
long-term capital loss of $6,909 on Form 8949, Sales and Other
Dispositions of Capital Assets, filed with their 2016 tax return, as the
result of their trading activity on Scottrade.
Scottrade reported on Forms 1099–B that petitioners had $5,039
of long-term capital gain and a capital gain distribution of $1,063, i.e.,
total net capital gain of $6,102 ($5,039 + $1,063). The difference in
petitioners’ and Scottrade’s reporting resulted from petitioners’ failure
to report the sale of Apple, Inc. stock as reported by Scottrade on Forms
1099–B for 2016.
In 2016 petitioners also traded stocks through the online
stock-trading platform E Trade Securities, LLC (E Trade), but did not
report a January 4, 2016, sale of Yahoo, Inc., stock for $5,022 as shown
on Form 1099–B filed by E Trade.
After concessions, respondent contends that for 2016, petitioners
failed to report $165,337 of net long-term capital gain:
Gain from Cisco stock sale $154,213
Gain from trading activity on Scottrade 6,102
Gain from trading activity on E Trade 5,022
Total $165,337
E. Taxable Interest
Petitioners reported $191 in taxable interest on their 2016 tax
return. Forms 1099–INT, Interest Income, from Ally Bank and
Technology Credit Union, reported that in 2016 they paid Mr. Kamal
interest of $382 and $2,490, respectively.
Respondent determined that for 2016 petitioners failed to report
$2,681 ($2,490 + $382 − $191) of taxable interest income.
6
[*6] F. Ordinary and Qualified Dividends
Petitioners reported $341 in ordinary dividend income and $211
in qualified dividend income for 2016. Scottrade’s Form 1099–B reported
that in 2016 Mr. Kamal received $1,341 in dividends of which $1,211
were qualified.
Respondent determined that for 2016 petitioners overreported
their ordinary dividends by $211 and underreported qualified dividends
by $1,000.
G. State Tax Refunds
Petitioners reported no income from taxable refunds, credits, or
offsets of state and local income taxes on their 2016 tax return. A Form
1099–G, Certain Government Payments, filed by the California
Franchise Tax Board, reported that during 2016 petitioners received a
refund of state taxes of $1,288.
Respondent therefore determined that petitioners underreported
their 2016 income from taxable refunds of state income taxes by $1,288.
II. Aarya Consulting
A. Background
In June 2016 Mr. Kamal incorporated Aarya Consulting. On
Schedule C, Profit or Loss From Business, petitioners listed a business
address for Aarya Consulting at their home address.
B. Bank Account Activity
On June 24, 2016, Mr. Kamal opened a bank account with
Citibank for Aarya Consulting (CITI 6232). The only deposits into CITI
6232 in 2016 were checks written by either Mr. Kamal or Ms. Sharma.
The only checks written from CITI 6232 in 2016 were to Charles Schwab
& Co., Inc., Mr. Kamal, a daycare center, Corporate Compliance Center,
Ms. Sharma, the California Employment Development Department
(EDD), and the California Council of Corporations. The only
withdrawals other than checks from CITI 6232 in 2016 were for
payments to American Express, Ally Bank, AT&T, Capital One,
Comcast, Deluxe Check, EDD, the Internal Revenue Service (IRS), and
payroll taxes.
7
[*7] On May 22, 2017, Mr. Kamal opened a checking account with
Bank of America in the name of Aarya Consulting (BofA 6721).
C. Aarya Consulting Business Expenses
On their 2016 tax return petitioners reported that from operating
Aarya Consulting they had gross income of $335,000, expenses of
$409,823, and a net loss of $74,823. The reported business expense
deductions consisted of the following:
Advertising $30,487
Depreciation and Section 179 183,600
Insurance (other than health) 2,800
Legal and Professional 30,180
Meals and Entertainment 3,555
Office Expense 3,400
Other Expense 4,660
Rent / Lease – Other Business Property 54,250
Repairs and Maintenance 7,200
Supplies 7,575
Taxes and Licenses 4,753
Travel 6,953
Utilities 5,390
Wages 65,020
Total $409,823
In the notice of deficiency respondent determined that Aarya
Consulting did not carry on any trade or business and that petitioners
did not properly substantiate deductions claimed on Schedule C.
Respondent removed Aarya Consulting’s reported gross receipts and
disallowed all expense deductions.
III. Rasoi Partnership Loss
Petitioners also filed a 2016 Schedule C for Rasoi, an Indian food
catering business. They reported gross income of $224,518, expenses of
8
[*8] $349,336, and a loss of $124,818. Aside from Mr. Kamal’s vague
testimony, the record does not include any evidence about Rasoi and
petitioners’ connection to this business. Respondent disallowed
petitioners’ claimed partnership loss deduction from Rasoi because they
failed to show they sustained any loss.
IV. Itemized Deductions (Schedule A)
A. Real Estate Taxes
Petitioners claimed an itemized deduction of $18,400 for real
estate taxes on their 2016 tax return. During the examination
respondent determined that petitioners had paid only $10,811 in real
estate taxes in 2016 and disallowed the excess deduction of $7,589 as
unsubstantiated.
B. Interest Deduction
On their 2016 tax return petitioners claimed an interest
deduction of $149,087, consisting of home mortgage interest of $148,200
and other interest expenses of $887. Citimortgage, Inc., reported on
Form 1098, Mortgage Interest Statement, that Mr. Kamal paid $20,573
of mortgage interest on petitioners’ residence during 2016. This was the
only real property petitioners owned in 2016.
In the notice of deficiency respondent determined that petitioners
were eligible to deduct mortgage interest of $20,573 as reported on Form
1098 and disallowed the excess amount as unsubstantiated.
C. Charitable Contribution Deduction
Petitioners claimed an itemized deduction for noncash charitable
contributions of $45,948 on their 2016 tax return. They filed Form 8283,
Noncash Charitable Contributions, claiming that in 2016 they
contributed over 100 items to charities, including appreciated stock.
Petitioners also deducted $7,950 for a contribution of a Toyota Camry to
Vehicles for Veterans.
In the notice of deficiency respondent allowed a charitable
contribution deduction of $6,200, consisting of a $500 deduction for the
contribution of a Toyota Camry and $5,700 for a contribution to Second
Harvest Food Bank. The remaining $39,748 respondent disallowed as
unsubstantiated.
9
[*9] D. Tax Preparation Fees and Other Miscellaneous Deductions
On their 2016 tax return petitioners claimed a $7,500 deduction
for tax return preparation fees and $19,570 for miscellaneous expenses.
On a statement filed with their 2016 tax return, petitioners reported
that their miscellaneous expenses consisted of the following:
Investment Advisory Fees $4,500
Attorney and Accounting Fees 14,500
IRA Custodial Fees 570
Total $19,570
In the notice of deficiency respondent disallowed in full
petitioners’ deductions for tax return preparation fees and other
miscellaneous expenses as unsubstantiated.
V. IRS Examination
During the examination of petitioners’ 2016 tax return, Mr.
Kamal submitted to the IRS revenue agent various documents to
support petitioners’ reporting position:
• A document titled “This General Service Agreement” dated
January 10, 2016 (before Aarya Consulting was incorporated),
between Rob Savalgno, the head of corporate development for
Cisco Investments, and Mr. Kamal as managing director of Aarya
Consulting (service agreement). Notable terms include the
following: (1) Aarya Consulting will provide services on demand
to Cisco; (2) the term begins on execution and lasts indefinitely;
(3) the amount of compensation is “per project agreed” and
payable upon completion of services; (4) Aarya Consulting is
responsible for paying any Superannuation Guarantee
Contributions that may be required; and (5) the agreement shall
be construed under the law of the State of New South Wales and
any suits and proceedings shall be brought in the State of New
South Wales. The document contains signatures of Rob Savalgno,
Scott Barkley, and Mr. Kamal. All three signatures are dated
January 10, 2016, and all three are underlined.
• A copy of an invoice book (consisting of invoice forms to be
completed and issued along with space to record the invoices
10
[*10] issued) that reflects the purported issuance of ten invoices written
to Cisco Systems, Inc., Cisco Inc., and Jasper:
Invoice To Date Amount
No. 529419 Cisco Systems, Inc. 1/25/2016 $55,000
No. 529406 Cisco Systems, Inc. 1/27/2016 55,000
No. 529426 Cisco Systems, Inc. 2/3/2016 59,000
No. 529415 Jasper 2/15/2016 77,000
No. 529428 Cisco Inc. 2/27/2017 45,000
No. 529427 Cisco Inc. 2/27/2017 55,000
No. 529424 Cisco Inc. 2/20/2017 62,000
No. 529425 Cisco Inc. 2/20/2017 63,000
No. 529411 Cisco Inc. 1/15/2018 58,000
No. 529410 Cisco Inc. 1/15/2018 57,000
• A copy of a receipt book with a handwritten note stating that
$6,500 was paid to “Tax Genie-Income Tax Preparation” on March
30, 2016, for a “tax consultation.”
• Relating to travel expenses: (1) a page from a receipt book with a
handwritten note stating that $2,075 was paid to “Booking.com”
on March 3, 2016; (2) a page from a receipt book with a
handwritten note stating that $1,982 was paid to “American
Airlines” and “Expedia.com” on September 16, 2016; (3) a page
from a receipt book with a handwritten note stating that $2,425
was paid to “American Airlines” and “Hotels.com” on October 5,
2016.
• Relating to meal expenses: three pages from a receipt book with
handwritten notes stating that, on various dates in 2016, $9,047
was paid to cover “Lunch Bills” and “Food Bills.”
• Relating to charitable contributions: (1) a Vehicle Pickup/
Donation Acknowledgement from “Vehicles for Veterans”
thanking Mr. Kamal for the donation of a Toyota Camry on
December 24, 2016, and stating that Mr. Kamal “may use this
receipt to take an itemized tax deduction of $500 or fair market
value, whichever is lesser of the two” and (2) an email from
11
[*11] Second Harvest Food Bank, containing a customer receipt and
purchase confirmation for a $5,700 donation to the Second
Harvest Food Bank in 2016.
VI. Trial Preparation
Mr. Kamal submitted additional documents to respondent’s
counsel during trial preparation:
• In support of trade or business expenses: (1) four pages from a
receipt book with handwritten notes stating that on various dates
in 2016, $10,220 was paid to “U.S. Foods” to cover “Food Bills”;
(2) a page from a receipt book with a handwritten note stating
that on October 30, 2016, $4,597 was paid to “Anderson
Commercial Flooring”; (3) a page from a receipt book with a
handwritten note stating that on October 4, 2016, $1,195 was
paid to “Roto-Rooter Hero”; (4) a page from a receipt book with a
handwritten note stating that on November 29, 2016, $1,875 was
paid to “RK Electric”; (5) two pages from a receipt book with
handwritten notes stating that on March 15 and October 30, 2016,
$2,206 was paid to “Office Depot” to cover “Office Depot Bills”;
(6) three pages from a receipt book with handwritten notes
stating that on various dates in September, October, and
November 2016, $49,792 was paid to “Ashley Furniture” for
various items of furniture; (7) two pages from a receipt book with
handwritten notes stating that in August and November 2016,
$45,090 was paid to “Managed Facilities Solutions” for “office
furnishing bill” and “Data Center cost for 12 months”; (8) five
purported invoices issued by NetApp, Inc., to Aarya Consulting
on various dates in March, September, October, and November
2016, for a total of $190,041 for sale of equipment; (9) six
purported invoices issued by VMWare, Inc., to both Mr. Kamal
and Aarya Consulting on various dates in March, April, June,
September, November, and December 2016, for a total of $431,825
for sale of equipment.
• Purported invoices from Aarya Consulting to Cisco and Jasper:
12
[*12] Invoice To Date Amount
No. 450345 Cisco 1/27/2016 $55,000
No. 450356 Cisco 1/28/2016 55,000
No. 450435 Cisco 2/3/2016 31,000
No. 450375 Cisco 2/3/2016 59,000
No. 550160 Cisco 1/16/2017 65,000
No. 450345 Cisco 1/16/2017 70,000
No. 450780 Cisco 1/17/2017 65,000
No. 450970 Cisco 1/17/2017 25,000
No. 570441 Jasper 2/15/2016 45,000
No. 570341 Jasper 2/15/2016 55,000
• A copy of a check dated September 1, 2016, from the BofA 6721
account written to Irvine Company Office Properties, Inc. (Irvine
Co.), for $54,487. The check was copied with a portion of the check
book used for balancing the check book still attached to the check,
suggesting that the check was still in the checkbook when Mr.
Kamal made the copy to submit to respondent.
• A document titled “Commercial Lease Agreement” (lease
agreement), dated August 4, 2016, for the lease of commercial
property at 15050 Los Gatos Blvd., Los Gatos, CA 95032, from
Irvine Co. to Mr. Kamal. The lease agreement bears signatures of
Mr. Kamal and Todd Hedrick, the vice president of Irvine Co.
Both signatures are underlined. At the bottom of each page is a
legend “Commercial Lease Agreement (Rev. 133EE24),” and on
the last page, titled “General Instructions,” are instructions about
what to include in a commercial lease agreement.
• A letter on “Jasper Inc.” letterhead, dated June 18, 2020, bearing
an underlined signature of Suparna Kumar, chief financial
officer, stating:
My Name is Suparna Kumar and I am presently
responsible for Payroll at Jasper Inc. I am writing this
letter on behalf of Payroll at Jasper that for year 2016,
Jasper paid Aarya Consulting for providing cloud business
services. This service payment was incorrectly recorded in
13
[*13] form of personal W2 for Neel Kamal for 2016. Please
consider this letter in lieu of actual paperwork for Jasper
payments for Aarya Consulting. Please reach out to payroll
at Jasper for any questions.
• A letter on “Cisco Inc.” letterhead, dated July 6, 2020, bearing an
underlined signature of Kelly Kramer, head of payroll, stating:
My name is Kelly Kramer and I am presently responsible
for Payroll department at Cisco Inc. I am writing this letter
on behalf of Payroll to confirm that for the year 2016, Cisco
paid Aarya Consulting for providing cloud services. This
services payment was incorrectly reported in form personal
W2 for Neel Kamal for 2016. Please consider this letter in
lieu of actual paperwork for Cisco services payments for
Aarya Consulting. Please reach out to Cisco’s payroll
department for any questions.
VII. Civil Fraud Penalty
This case was initially set for trial on May 2, 2022. On February
14, 2022, respondent filed a Motion for Continuance, offering two
primary bases. First, the case was referred to the Independent Office of
Appeals for a potential settlement, which required more time. Second,
respondent was waiting for petitioners to respond to document requests
and anticipated filing a motion for a document subpoena hearing with
respect to document requests issued to Cisco and Jasper. Respondent
also advised that after receiving and reviewing documents from
petitioners, Cisco, and Jasper, he might move for leave to amend his
answer to assert the civil fraud penalty. Petitioners objected to the
Motion for Continuance.
On March 9, 2022, after receiving documents from Mr. Kamal,
respondent filed a Motion for Document Subpoena Hearing. Respondent
expressed doubts about the authenticity of documents received from Mr.
Kamal and wanted documents directly from Cisco. Petitioners objected
to this Motion as well. Respondent received documents from Cisco in
compliance with the subpoena and advised us that the subpoena hearing
was no longer necessary. Cisco informed respondent that it “was unable
to locate any contracts with records of payment to Aarya Consulting.”
We held a remote hearing on respondent’s Motion for
Continuance on April 13, 2022, after trying unsuccessfully to schedule a
conference call with the parties, to discuss petitioners’ objections to
14
[*14] respondent’s Motion, because petitioners’ written objections
appeared instead to suggest they would benefit from a continuance. Mr.
Kamal and respondent’s counsel appeared and were heard. Mr. Kamal
insisted that even though he did not yet have counsel, he would be ready
for trial in three weeks. Respondent’s counsel stated that he had been
unable to reach petitioners and stipulate the facts of the case. In a
subsequent conference call Mr. Kamal continued to object to
respondent’s Motion for Continuance. We delayed acting on
respondent’s Motion to afford petitioners time to find a representative.
When the case was called from the calendar on May 2, 2022, the parties
provided an agreed stipulation of facts and respondent’s counsel
withdrew the Motion. We proceeded to trial on May 3, 2022. Mr. Kamal
did not object to respondent’s withdrawal and did not himself seek a
continuance (although he did seek a break in his testimony as we note
below).
At the close of trial, respondent’s counsel made an oral Motion to
Amend the Pleadings to Conform to the Evidence and asserted a civil
fraud penalty under section 6663 against Mr. Kamal. The record
includes a Memorandum from Trent D. Usitalo, Associate Area Counsel,
and the immediate supervisor of respondent’s counsel, David Carl, dated
May 3, 2022, approving the initial determination of the civil fraud
penalty under section 6663(a) with respect to 2016 and 2017.
OPINION
I. Burden of Proof
Generally, the taxpayer bears the burden of proving that the
Commissioner’s determinations are erroneous. Rule 142(a); Welch v.
Helvering, 290 U.S. 111, 115 (1933). Under section 7491(a)(1), “[i]f, in
any court proceeding, a taxpayer introduces credible evidence with
respect to any factual issue relevant to ascertaining the liability of the
taxpayer for any tax imposed by subtitle A or B, the Secretary shall have
the burden of proof with respect to such issue.” See Higbee v.
Commissioner, 116 T.C. 438, 442 (2001). Petitioners have neither
claimed, nor introduced credible evidence sufficient to show, that the
burden of proof should shift to respondent under section 7491(a) as to
any relevant factual issue. Therefore, petitioners generally bear the
burden of proof.
In cases of unreported income, the Commissioner must establish
an evidentiary foundation connecting the taxpayer to the income-
15
[*15] producing activity, Weimerskirch v. Commissioner, 596 F.2d 358,
361 (9th Cir. 1979), rev’g 67 T.C. 672 (1977), or demonstrate that the
taxpayer actually received income, Edwards v. Commissioner, 680 F.2d
1268, 1270–71 (9th Cir. 1982). Once the Commissioner has met this
threshold burden, the burden shifts to the taxpayer to show that the IRS
determination of income was arbitrary or erroneous. Hardy v.
Commissioner, 181 F.3d 1002, 1005 (9th Cir. 1999), aff’g T.C. Memo.
1997-97. The Commissioner may not rely solely on third-party
information reporting if the taxpayer raises a reasonable dispute
concerning the accuracy of the third-party report. See § 6201(d).
Petitioners have not raised a reasonable dispute about the accuracy of
the information reporting here.
II. Unreported Income
Respondent contends that petitioners failed to report (1) gain
recognized upon the sale of Cisco stock; (2) gain from trading activity on
Scottrade; and (3) gain from trading activity on E Trade.
Mr. Kamal appeared to concede these issues at trial, stating that
he received and cashed a check from Cisco for $396,264. He further
stated that he received the check because he “sold everything over
there,” “whatever shares [he] ha[d] and a majority of them were Cisco
shares.” Mr. Kamal also admitted that some stock sales “were missed”
when his tax return was printed and filed. Mr. Kamal did not specify
which stock sales he meant, but in context we understood from his
testimony that he inadvertently failed to report some of his gains from
his stock trading activities on Scottrade and E Trade.
Contrary to his admissions, Mr. Kamal also stated that the Forms
W–2 issued by Cisco and Jasper were in error and that all the payments
received from Cisco (also Jasper and Tek Systems) were of payments for
business services provided by Aarya Consulting. As we explain below,
Mr. Kamal failed to introduce credible evidence in support of these
contentions.
A. Unreported Amounts Received from Cisco
A taxpayer must recognize gain on the sale of property in an
amount equal to the difference between the amount realized and the
taxpayer’s basis in the property. §§ 1001, 1012; see also O’Boyle v.
Commissioner, T.C. Memo. 2010-149, 2010 WL 2766818, at *3, aff’d per
curiam, 464 F. App’x 4 (D.C. Cir. 2012). Taxpayers bear the burden of
establishing their basis in the property. See Rule 142(a); O’Boyle v.
16
[*16] Commissioner, 2010 WL 2766818, at *3. Gain from the sale of a
capital asset, such as stock, may constitute long-term capital gain if
certain conditions are met. See §§ 1(h), 1221(a)(1), 1222(3).
Mr. Kamal admitted that after the merger he sold his shares for
$396,264 to Cisco, which then issued Form W–2 reporting that Mr.
Kamal had $199,801 of compensation income. Petitioners correctly
reported that amount on their 2016 tax return as ordinary income, and
respondent made no adjustment to that amount. But petitioners failed
to report the remainder of the $396,264 received from Cisco.
Respondent contends that because the sale proceeds exceeded Mr.
Kamal’s basis in Cisco stock, petitioners realized income that they did
not report. Petitioners have neither submitted any evidence of nor
argued that they had any basis in their Cisco stock. In his posttrial brief
respondent conceded that in computing unreported capital gain on the
Cisco stock sold, petitioners were entitled to include (1) the amount Mr.
Kamal paid to exercise his Jasper stock options ($42,280) and (2) the
amount of ordinary income Mr. Kamal recognized from disqualifying
dispositions of stock ($199,801). Respondent also conceded that the gain
recognized with respect to the sale of Cisco stock was long-term capital
gain.
Because Mr. Kamal admitted receiving the $396,264 and
petitioners failed to introduce any evidence to dispute respondent’s
determination, we sustain respondent’s determination (after
concessions) that for 2016 petitioners had capital gain income equal to
$154,213 with respect to Cisco stock sale, which they failed to report.
B. Scottrade and E Trade
The Forms 1099–B filed by Scottrade and E Trade support
respondent’s determination that for 2016 petitioners had net unreported
long-term capital gain of $6,102 from their transactions through
Scottrade and gain from a sale of Yahoo, Inc., stock for $5,022 through
E Trade. Petitioners did not argue that respondent’s determinations
were arbitrary or erroneous and did not introduce any evidence but
rather Mr. Kamal vaguely conceded that some amounts may have been
omitted.
We therefore sustain respondent’s determinations with respect to
unreported capital gain income reported by Scottrade and E Trade.
17
[*17] C. Taxable Interest
Petitioners did not offer any argument or evidence to dispute
respondent’s determination that they failed to report $2,681 of interest
income for 2016. Accordingly, we sustain respondent’s interest income
determination.
D. Ordinary and Qualified Dividends
Petitioners did not offer any argument or evidence to dispute
respondent’s determination that they overreported 2016 ordinary
income by $211 and underreported qualified dividend income by $1,000.
Accordingly, we sustain respondent’s ordinary and qualified dividend
income determinations.
E. State Tax Refunds
Petitioners did not offer any argument or evidence to dispute
respondent’s determination that they failed to report $1,288 of state tax
refund income for 2016. Therefore, we sustain respondent’s
determination with respect to their unreported state tax refund income.
III. Aarya Consulting and Schedule C Business Expenses
A few months after Mr. Kamal sold his Cisco stock, he
incorporated Aarya Consulting. Although admitting he received
$396,264 from Cisco because he “sold everything over there,” Mr. Kamal
contends that the amounts paid by Cisco and Jasper to Mr. Kamal, and
by Tek Systems to Mrs. Sharma, were payments to Aarya Consulting
for business services performed for these companies in 2016. Mr. Kamal
further contends that the Forms W–2 issued by the three companies to
petitioners were issued by mistake and that petitioners reported these
amounts as compensation income on their 2016 tax return by mistake.
Petitioners also claimed substantial business expense deductions on
their 2016 tax return, which offset all of Aarya Consulting’s alleged
business income and generated a loss.
Respondent counters that Mr. Kamal incorporated Aarya
Consulting and reported fictitious business income and business
expenses to offset the income he received from Cisco and Jasper.
Respondent contends that Aarya Consulting did not conduct a trade or
business and therefore petitioners are not entitled to business
deductions. And, respondent argues, even assuming Aarya Consulting
18
[*18] did conduct a trade or business in 2016, petitioners failed to
substantiate its business expense deductions.
We first must decide whether Aarya Consulting carried on any
trade or business in 2016, and, if so, whether it is entitled to any of the
business expense deductions petitioners claimed on their 2016 tax
return.
A. Carrying on a Trade or Business Requirement
Neither the Code nor the regulations provide a generally
applicable definition of the term “trade or business.” Commissioner v.
Groetzinger, 480 U.S. 23, 27 (1987). But “to be engaged in a trade or
business, the taxpayer must be involved in the activity with continuity
and regularity and . . . the taxpayer’s primary purpose for engaging in
the activity must be for income or profit.” Id. at 35. The taxpayer must
establish that he “engaged in the activity with ‘the predominant,
primary or principal objective’ of realizing an economic profit
independent of tax savings.” Giles v. Commissioner, T.C. Memo.
2006-15, 2006 WL 237503, at * 7 (quoting Wolf v. Commissioner, 4 F.3d
709, 713 (9th Cir. 1993), aff’g T.C. Memo. 1991-212). Sporadic activities
do not rise to the level of a “trade or business.” See Commissioner v.
Groetzinger, 480 U.S. at 35.
Determining the existence of a trade or business “requires an
examination of the facts in each case.” Id. at 36 (quoting Higgins v.
Commissioner, 312 U.S. 212, 217 (1941)). Here, the facts establish that
petitioners were not actively engaged in a trade or business.
According to Mr. Kamal, all payments that Jasper, Tek Systems,
and Cisco reported on Forms W–2, were in fact payments to Aarya
Consulting for “business services.” But at trial Mr. Kamal had trouble
explaining what exactly Aarya Consulting did. For example, when
counsel for respondent asked Mr. Kamal to explain what type of services
Aarya Consulting performed for Cisco, Mr. Kamal responded that he
“met a bunch of people” and that those people were “celebrities from
Cisco investing in . . . [his] business.” He explained that “Cisco
celebrities” gave him money to invest in his business and then Cisco
reported that on Form W–2 as compensation in error. He claimed that
the money received from Cisco was for “raising capital” but was also “a
payment for business services.” When asked to explain in more detail
what services Aarya Consulting provided to Cisco in 2016, Mr. Kamal
responded that it “provided . . . equipment as well as customizing
19
[*19] whatever they need.” Mr. Kamal could not remember the name of
the person he worked with at Cisco but stated that it was a vice
president of Cisco’s capital department. He also could not remember
whether Cisco made payments into his personal or Aarya Consulting’s
business bank account.
Mr. Kamal testified that Aarya Consulting was “providing certain
electronic equipment” and “computing services” to Jasper. And he
explained that it provided the same services to Jasper and Tek Systems
as to Cisco. Mr. Kamal could not remember whether Jasper made
payments into his personal or Aarya Consulting’s business bank
account. And he did not remember who he worked with at Tek Systems.
We did not find Mr. Kamal to be a credible witness. His testimony
was inconsistent, confusing, and difficult to follow. He was defensive and
evasive from the start, and he appeared increasingly uncomfortable and
agitated as cross-examination exposed more holes in his story. His
testimony about Aarya Consulting did not match the documents
provided by third parties. It did not stand up to logic and was not
credible. After a series of questions and repeated admonishments, Mr.
Kamal answered questions by stating that he did not remember or
refused to answer altogether.
In addition to his testimony, Mr. Kamal submitted a copy of a
service agreement, invoices, and letters, which he claimed were from
Cisco and Jasper employees. These documents are poor attempts at
fabrication.
The service agreement between Aarya Consulting and Cisco,
dated January 10, 2016, predates the incorporation of Aarya Consulting.
It does not specify the type of services or terms of compensation. It
adopts the law of the Australian State of New South Wales even though,
according to Mr. Kamal, Aarya Consulting never operated or had clients
in Australia. The service agreement is allegedly signed by the head of
corporate development of Cisco, Rob Savalgno, but both Mr. Kamal’s and
Mr. Savalgno’s signatures are underlined and appear similar. Mr.
Kamal admitted that he always underlines his signature. Both names
appear to have been signed by the same person.
The invoice book Mr. Kamal submitted during the audit listed
various amounts allegedly charged by Aarya Consulting to Cisco and
Jasper. Later, during preparation for trial, he also submitted to counsel
for respondent invoices that he claimed were submitted to Jasper and
20
[*20] Cisco. Invoice numbers, dates, and amounts recorded in the
invoice book do not match the invoices themselves. And the total amount
of the invoices ($525,000) does not match the total amount recorded in
the invoice book ($586,000). Notably, neither the notes in the invoice
book nor the invoices mention Tek Systems. Aarya Consulting and
petitioners’ bank account records do not reflect any payment of any of
the amounts indicated on the invoices. Furthermore, Cisco responded to
a document request from respondent that it was unable to find any
contracts or records of payments between Cisco and Aarya Consulting.
In support of his claim that Jasper’s and Cisco’s Forms W–2 were
issued in error, Mr. Kamal submitted two identical letters, allegedly
issued and signed by Jasper and Cisco representatives in June and July
2020, respectively. Each letter essentially states that Aarya Consulting
provided services to the company for which it was paid, but the
“payment was incorrectly recorded in form of personal W2 for Neel
Kamal for 2016.” Each letter asks the reader to “please consider this
letter in lieu of actual paperwork” to support the payments made to
Aarya Consulting. As on the service agreement, both names on these
letters are underlined as if signed by the same person.
Mr. Kamal also submitted a number of invoices allegedly issued
to Aarya Consulting by other companies in 2016. Notably, some of the
invoices predate the incorporation of Aarya Consulting. Also, the total
amount of those invoices is over $600,000, but neither petitioners’ nor
Aarya Consulting’s bank account records show a single payment to any
of those companies.
Nothing in the record indicates that Aarya Consulting provided
any services to Jasper, Cisco, Tek Systems, or anyone else. The evidence
that is in the record, coupled with Mr. Kamal’s evasive and confusing
testimony, easily supports respondent’s argument that in 2016 Aarya
Consulting was not carrying on any trade or business and that Mr.
Kamal fabricated documents to support the deduction of fictitious
business expenses to offset income from the stock sale.
B. Substantiation Requirement
Section 162(a) allows a deduction for “all the ordinary and
necessary expenses paid or incurred during the taxable year in carrying
on any trade or business.” Because we conclude that Aarya Consulting
was not carrying on any trade or business, it is not allowed to deduct
any business expenses. However, even if we concluded that Aarya
21
[*21] Consulting was operating a business in 2016, we still would hold
that petitioners failed to properly substantiate the alleged business
expenses.
Taxpayers bear the burden of proving that they are entitled to
deductions claimed. Rule 142(a); INDOPCO, Inc. v. Commissioner, 503
U.S. 79, 84 (1992); New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440
(1934). Therefore, they are required to substantiate expenses underlying
each claimed deduction by maintaining records sufficient to establish
the amount of the deduction and to enable the Commissioner to
determine the correct tax liability. § 6001; Higbee, 116 T.C. at 440.
Under the Cohan rule, the Court may estimate the amount of the
expense if the taxpayer is able to demonstrate that he has paid or
incurred a deductible expense but cannot substantiate the precise
amount, as long as he produces credible evidence providing a basis for
the Court to do so. Cohan v. Commissioner, 39 F.2d 540, 543–44 (2d Cir.
1930). For the Court to estimate the amount of an expense, there must
be some basis upon which an estimate can be made. Norgaard v.
Commissioner, 939 F.2d 874, 879 (9th Cir. 1991), aff’g in part, rev’g in
part T.C. Memo. 1989-390. Otherwise, an allowance would amount to
“unguided largesse.” Id. (quoting Williams v. United States, 245 F.2d
559, 560 (5th Cir. 1957)).
Certain business expenses (including travel, lodging, and meal
expenses) are subject to the heightened substantiation requirements of
section 274(d). Section 274(d) supersedes the Cohan rule. Temp. Treas.
Reg. § 1.274-5T(a). Section 274(d) contemplates that no deduction or
credit shall be allowed on the basis of a taxpayer’s mere approximations
or unsupported testimony. Sanford v. Commissioner, 50 T.C. 823, 827
(1968), aff’d per curiam, 412 F.2d 201 (2d Cir. 1969).
To meet the requirements of section 274(d), a taxpayer must
substantiate the following by adequate records or by sufficient evidence
corroborating the taxpayer’s own statement: (1) the amount of the
expense, (2) the time and place of the travel or use, and (3) the business
purpose of the expense. To substantiate by adequate records, the
taxpayer must provide: (1) an account book, log, or similar record and
(2) documentary evidence, which together are sufficient to establish
each element with respect to an expenditure. Temp. Treas. Reg.
§ 1.274-5T(c)(2)(i). Although a contemporaneous log is not required,
corroborative evidence to support a taxpayer’s reconstruction “must
have a high degree of probative value to elevate such statement” to the
level of credibility of a contemporaneous record. Id. subpara. (1). If a
22
[*22] taxpayer cannot substantiate each element of an expense with
adequate records, he may do so “by other sufficient evidence,” namely
“[b]y his own statement, whether written or oral, containing specific
information in detail as to such element” and “[b]y other corroborative
evidence sufficient to establish such element.” Id. subpara. (3).
Fictitious expenses reported with respect to nonexistent trades or
businesses are not deductible. See, e.g., Weber v. Commissioner, T.C.
Memo. 1994-307 (finding taxpayer liable for civil fraud where he
concealed illegal kickback income by reporting income and deducting
personal expenses on Schedule C filed with respect to nonexistent
business).
Here, petitioners failed to substantiate Aarya Consulting’s
business expense deductions. First, petitioners did not even attempt to
substantiate the following deductions: advertising ($30,487),
depreciation ($183,600), insurance ($2,800), legal and professional
expenses ($30,180), other expenses ($4,660), taxes and licenses ($4,753),
utilities ($5,390), supplies ($7,575), and wages ($65,020). 8 Thus, we
sustain respondent’s determination to disallow these deductions as
unsubstantiated.
Second, petitioners’ attempt to substantiate the other business
expenses deducted on their 2016 tax return fails to satisfy even the most
lenient substantiation rules and falls well short of the heightened
requirements in section 274(d), which apply to their meal and
entertainment and travel expenses. To substantiate expenses for office
($3,400), repairs and maintenance ($7,200), meals and entertainment
($3,555), and travel ($6,953), petitioners submitted pages from a receipt
book with various handwritten notes stating for example “Food Bills,”
“U.S. Foods,” “Office Depot Bills,” “Booking.com,” “Hotels.com,” “Ashley
Furniture,” etc. The handwritten amounts do not match the amounts
they reported on Schedule C. Petitioners failed to submit actual bills or
invoices issued to Aarya Consulting or documents confirming that any
of the indicated amounts were actually paid. They also failed to provide
corroborating and credible testimony explaining the amounts, the times
and dates, or the business purposes for any of these expenses.
8 For example, Mr. Kamal testified that in 2016 he and Ms. Sharma were the
only two employees at Aarya Consulting. Petitioners reported on their 2016 tax return
that Aarya Consulting paid them wages of approximately $6,000. But on the attached
Schedule C they claimed a business expense deduction of over $65,000 for wages paid
by Aarya Consulting to its employees.
23
[*23] To substantiate the expense for rent ($54,250), Mr. Kamal
submitted a lease agreement for the lease of commercial property in Los
Gatos, California. The document bears signatures of Mr. Kamal and the
vice president of the leasing company; both signatures are underlined.
At the bottom of each page there is a form number “Commercial Lease
Agreement (Rev. 133EE24),” and the last page, titled “General
Instructions,” provides instructions about what should be included in a
commercial lease agreement.
Mr. Kamal also submitted a check for $54,487 dated September
1, 2016, allegedly issued from the BofA 6721 account written to the
leasing company. But on September 1, 2016, the BofA 6721 account did
not exist; it was opened almost a year later, in May 2017. The copy of
the check submitted as evidence of payment was made while the check
was still in the check book. Lastly, Aarya Consulting and petitioners’
bank account records do not reflect this, or any other payment made to
the leasing company.
At trial Mr. Kamal was defensive and evasive when respondent
asked pointed questions related to the lease agreement and rent
payments. Mr. Kamal could not describe details about the alleged office
space, did not remember details about signing the agreement, and could
not explain why he never listed the Los Gatos address on any of
petitioners’ tax returns. He became increasingly agitated when counsel
for respondent asked whether he drafted and signed the agreement for
both parties. Plainly uncomfortable answering these simple, direct
questions, Mr. Kamal asked that the Court adjourn trial to next day; the
Court gave the parties a lunch break instead.
C. Conclusion
Aarya Consulting did not carry on any trade or business in 2016;
therefore, petitioners were not entitled to deduct any of its reported
business expenses. They also failed to properly substantiate those
business expense deductions. We therefore sustain respondent’s
disallowance of deductions for Aarya Consulting’s business expenses.
IV. Rasoi Partnership Loss
Petitioners filed an additional Schedule C in 2016 for Rasoi
reporting a loss of $124,818. However, they did not deduct this amount
but instead claimed a $64,799 nonpassive partnership loss deduction
from Rasoi on Schedule E, Supplemental Income and Loss, of their 2016
tax return. Petitioners failed to submit credible evidence to support their
24
[*24] entitlement to this loss deduction. Mr. Kamal’s testimony on this
issue was confusing and vague. The record contains no other evidence to
connect petitioners to this restaurant or otherwise support their
claiming any associated loss deduction on their 2016 tax return. Thus,
we sustain respondent’s disallowance for lack of substantiation.
V. Itemized Deductions (Schedule A)
In the notice of deficiency, respondent disallowed as
unsubstantiated $7,589 of petitioners’ claimed $18,400 deduction for
real estate taxes. Petitioners offered no evidence substantiating the
amount respondent disallowed. Accordingly, we sustain respondent’s
determination.
Using third-party reporting information, respondent disallowed
$127,627 of petitioners’ claimed $148,200 home mortgage interest
deduction. Petitioners failed to challenge the determination and did not
submit any evidence to substantiate the entire amount of mortgage
interest deduction claimed. Therefore, we sustain respondent’s
determination.
Next, petitioners claimed a $45,948 deduction for noncash
charitable contributions. During the audit petitioners submitted to
respondent (1) a letter from “Vehicles for Veterans,” stating that Mr.
Kamal could use the letter to claim an itemized deduction of $500 and
(2) an email from Second Harvest Food Bank, confirming a $5,700
donation by petitioners in 2016. Accordingly, respondent allowed a
deduction of $6,200 ($500 + $5,700) and disallowed the remaining
$39,748. Petitioners failed to submit credible evidence substantiating
the disallowed amount. Thus, we sustain respondent’s disallowance of
the unsubstantiated charitable contribution deductions.
Finally, petitioners also claimed an itemized deduction of $7,500
for tax preparation fees and $19,570 for miscellaneous expenses. In
support petitioners offered copies of the purported receipt book with
handwritten notes “Tax Genie-Income Tax Preparation.” But again, Mr.
Kamal offered nothing but his evasive and vague testimony to
corroborate these expenses. Thus, we sustain respondent’s disallowance
of itemized deductions for tax preparation fees and miscellaneous
expenses.
25
[*25] VI. Civil Fraud Penalty
A. Respondent’s Motion to Amend the Pleadings
At the end of the trial respondent orally moved under Rule 41(b)
to conform the pleadings to the evidence presented and alleged that Mr.
Kamal is liable for the civil fraud penalty under section 6663(a) for 2016.
We first must decide whether to grant respondent’s Motion.
Whether to allow an amendment to conform pleadings to the
evidence is a matter within the discretion of the Court. See, e.g., Estate
of Quick v. Commissioner, 110 T.C. 172, 178 (1998), supplemented by 110
T.C. 440 (1998); Arberg v. Commissioner, T.C. Memo. 2007-244;
Bhattacharyya v. Commissioner, T.C. Memo. 2007-19. We must examine
whether the opposing party would suffer unfair surprise or prejudice if
a motion to amend was granted. See, e.g., Estate of Quick, 110 T.C.
at 178.
Respondent informed Mr. Kamal on several occasions before the
start of the trial that he might assert a civil fraud penalty depending on
the evidence gathered in discovery and offered at trial. Respondent’s
Motion for Continuance stated that the parties might need additional
time to prepare for trial, explaining that one of the reasons for requiring
more time was the possible assertion of the section 6663 civil fraud
penalty. We encouraged Mr. Kamal to reconsider his objection to
respondent’s Motion for Continuance, but he insisted that he would be
prepared.
Furthermore, respondent bases his Motion to Amend the
Pleadings on Mr. Kamal’s own testimony and documents Mr. Kamal
produced to the IRS and respondent’s counsel during the audit and while
the parties were preparing for trial. Mr. Kamal cannot reasonably claim
to be surprised by his own testimony and documents. See Daoud v.
Commissioner, T.C. Memo. 2010-282, aff’d, 548 F. App’x 441 (9th Cir.
2013).
Finally, we gave Mr. Kamal an opportunity to respond to
respondent’s Motion to Amend the Pleadings in posttrial briefs (even
reminding the parties of the briefing deadlines in an Order issued
posttrial), but Mr. Kamal did not file any briefs. We therefore grant
respondent’s Motion and allow him to assert the civil fraud penalty
against Mr. Kamal for 2016. We next must determine whether Mr.
Kamal is liable for the section 6663 civil fraud penalty.
26
[*26] B. Penalty Approval Under Section 6751(b)(1)
The Commissioner bears the burden of production with respect to
an individual taxpayer’s liability for any penalty, requiring the
Commissioner to come forward with sufficient evidence indicating that
the imposition of the penalty is appropriate. See § 7491(c); Higbee, 116
T.C. at 446–47. As part of that burden, the Commissioner must produce
evidence of compliance with the procedural requirements of section
6751(b)(1). See Graev v. Commissioner, 149 T.C. 485, 492–93 (2017),
supplementing and overruling in part 147 T.C. 460 (2016). Section
6751(b)(1) requires the initial determination of certain penalties to be
“personally approved (in writing) by the immediate supervisor of the
individual making such determination.” See Graev, 149 T.C. at 492–93.
The U.S. Court of Appeals for the Ninth Circuit, to which any
appeal in this case would ordinarily lie, see § 7482(b)(1)(A), has held that
section 6751(b)(1) permits written supervisory approval at any time
before assessment of the penalty, provided that at the time of the
approval, a supervisor still has discretion whether to approve the
penalty determination, Laidlaw’s Harley Davidson Sales, Inc. v.
Commissioner, 29 F.4th 1066, 1071 (9th Cir. 2022), rev’g and remanding
154 T.C. 68 (2020).
Respondent’s counsel made the initial determination to assert the
civil fraud penalty for 2016 against Mr. Kamal. Respondent’s counsel’s
immediate supervisor approved that initial determination on May 3,
2022, before it was asserted in respondent’s oral Motion to Amend the
Pleadings. The approval was timely, and respondent has satisfied
section 6751(b) under the standard established by the Ninth Circuit.
C. Fraudulent Intent
Section 6663 imposes a penalty of 75% of an underpayment of tax
if any part of the underpayment is due to fraud. Once the Commissioner
establishes that part of an underpayment is due to fraud, the entire
underpayment is treated as “attributable to fraud,” except to the extent
the taxpayer establishes that some part is not. § 6663(b). This section
does not apply with respect to a spouse filing a joint return unless some
part of the underpayment is due to the fraud of the spouse. § 6663(c).
Here, respondent alleged that only Mr. Kamal is liable for fraud.
The Commissioner must prove fraud by “clear and convincing
evidence.” Rule 142(b); see § 7454(a); Castillo v. Commissioner, 84 T.C.
405, 408 (1985). To carry that burden, the Commissioner must show that
27
[*27] (1) an underpayment of tax exists for the year in issue and (2) some
part of the underpayment is attributable to fraud. See §§ 6663(a),
7454(a); DiLeo v. Commissioner, 96 T.C. 858, 873 (1991), aff’d, 959 F.2d
16 (2d Cir. 1992).
Respondent contends that the underpayment resulting from Mr.
Kamal’s failure to report long-term capital gains and claiming business
expense deductions for Aarya Consulting is attributable to Mr. Kamal’s
fraud. Respondent has clearly and convincingly demonstrated that Mr.
Kamal has an underpayment of tax. The first element of the civil fraud
penalty therefore has been established.
We next must determine whether Mr. Kamal had the requisite
fraudulent intent. Fraud is intentional wrongdoing on the part of the
taxpayer with the specific purpose of evading a tax believed to be owing.
Petzoldt v. Commissioner, 92 T.C. 661, 698 (1989). Fraud is never
presumed and must be established by independent evidence of
fraudulent intent. See Baumgardner v. Commissioner, 251 F.2d 311, 322
(9th Cir. 1957), aff’g T.C. Memo. 1956-112. Fraud may be shown by
circumstantial evidence because direct evidence of a taxpayer’s
fraudulent intent is seldom available. See Petzoldt, 92 T.C. at 699. The
taxpayer’s entire course of conduct may establish the requisite
fraudulent intent. See Niedringhaus v. Commissioner, 99 T.C. 202, 210
(1992). Fraudulent intent may be inferred when a taxpayer files a
document intending to conceal, mislead, or prevent the collection of tax.
Durland v. Commissioner, T.C. Memo. 2016-133, at *79.
Courts often rely on various “badges of fraud” to find
circumstantial evidence of fraud. See Bradford v. Commissioner, 796
F.2d 303, 307 (9th Cir. 1986), aff’g T.C. Memo. 1984-601. These badges
focus on whether the taxpayer engaged in certain conduct that is
indicative of fraudulent intent, such as (1) understating income;
(2) failing to maintain adequate records; (3) offering implausible or
inconsistent explanations; (4) concealing income or assets; (5) failing to
cooperate with tax authorities; (6) engaging in illegal activities;
(7) providing incomplete or misleading information to the taxpayer’s tax
return preparer; (8) offering false or incredible testimony; (9) filing false
documents, including filing false income tax returns; (10) failing to file
tax returns; and (11) engaging in extensive dealings in cash. See id.at 307–08; Parks v. Commissioner, 94 T.C. 654, 664–65 (1990); Recklitis
v. Commissioner, 91 T.C. 874, 910 (1988). The existence of any one badge
is not dispositive, but the existence of several badges is persuasive
circumstantial evidence of fraud. Niedringhaus, 99 T.C. at 211.
28
[*28] Several badges of fraud are evident in this case: Mr. Kamal
understated income, failed to maintain adequate records, offered
implausible and inconsistent explanations, failed to cooperate with the
IRS or respondent’s counsel, and offered vague, conflicting, defensive,
and unbelievable testimony. Mr. Kamal failed to report a substantial
amount of long-term capital gain income and deducted fictitious
business expenses for a phantom business. To support his implausible
story, Mr. Kamal submitted numerous documents that bear hallmarks
of fabrication, he could not explain who drafted those documents, and he
became increasingly uncomfortable and defensive every time he was
asked direct questions related to their drafting or signing. His theories
were inconsistent and illogical, designed to offset the income he received
from Cisco.
Respondent has demonstrated by clear and convincing evidence
that Mr. Kamal had fraudulent intent. Mr. Kamal has neither argued
nor shown that any amount should not be subject to the civil fraud
penalty. Accordingly, the Court holds that Mr. Kamal is liable for the
section 6663 civil fraud penalty on the entire underpayment of tax.
To reflect the foregoing,
An appropriate order and decision will be entered.