Daoud v. Comm'r
This text of 2010 T.C. Memo. 282 (Daoud v. Comm'r) is published on Counsel Stack Legal Research, covering United States Tax Court primary law. Counsel Stack provides free access to over 12 million legal documents including statutes, case law, regulations, and constitutions.
Opinion
An order granting respondent's oral motion to conform the pleadings to the proof will be issued, and decision will be entered under
HOLMES,
Edward and Odette Daoud are both highly educated. Mr. Daoud has a Ph.D. in engineering and an M.B.A., and he worked as the director of engineering for Ameritech (the telecommunications company) in 2000 and part of 2001. By his own account he was business savvy. He claimed to have anticipated the *318 downturn in the telecommunication market, causing him to look for a new job even before he was laid off in April 2001. Mrs. Daoud has a bachelor's degree in physical science and has taken classes toward a master's degree in psychology. She also managed the day-to-day operations of the couple's two Wienerschnitzel franchises in Southern California: one in Cypress and the other in Irvine.
In addition to wage and business income, the couple earned rent on a house they owned in Austin, Texas. Yet despite their many sources of income, the Daouds reported zero taxable income in both 2000 and 2001 after claiming a combination of losses and deductions. The largest of all were business expenses from their Wienerschnitzel operations. These claimed expenses reduced the more than $1 million in combined yearly sales the restaurants produced to $22,000 of income in 2000 and a $7,000 loss in 2001. The Commissioner sent the Daouds a notice of deficiency. We tried the case in Los Angeles, where the Daouds lived when they filed their petition.
Our first task was to determine what expenses are at issue and in what amounts. This was complicated by the way the Commissioner *319 made adjustments to the Daouds' returns, and by how Mr. Daoud prepared the returns in the first place.
According to Mr. Daoud's testimony, his wife kept the Wienerschnitzels' books on handwritten daily logs. He would then take these daily logs and transfer the information onto his Quicken software program. Once all the information was entered, he was able to use the program to generate reports. He claims that it was from his Quicken reports that he prepared the couple's tax returns.
The curious thing about this claim is that many of the amounts on the Quicken reports do not match the amounts listed on the Daouds' returns. The revenue agent nevertheless allowed the Daouds to substantiate their expenses with these Quicken reports. She made a few exceptions, but if an expense was documented on the Quicken reports, she generally allowed it—even if the amount was greater than the Daouds reported on their returns.1*320 A consequence of allowing the Daouds amounts for certain expenses greater than those which they reported on their returns is that if they can substantiate all the expenses still in dispute, their net income would be even less than what they originally reported.
We also had difficulty determining the amounts in dispute because the revenue agent inadvertently increased the Daouds' Schedule C income by sometimes disallowing the same expense twice. She first disallowed the expenses under an adjustment labeled "Other Expenses," which included her changes to the stores' 2000 and 2001 Schedule Cs. She then disallowed some of the same expenses in other parts of the notice of deficiency. We have corrected her mistakes in making our calculations and constructing our tables.
The following tables summarize the adjustments made to the Daouds' Schedule C income:
Free access — add to your briefcase to read the full text and ask questions with AI EDWARD AND ODETTE DAOUD, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent Daoud v. Comm'r Docket No. 12070-04. T.C. Memo 2010-282; 2010 Tax Ct. Memo LEXIS 317; 100 T.C.M. (CCH) 570; December 22, 2010, Filed*317 An order granting respondent's oral motion to conform the pleadings to the proof will be issued, and decision will be entered under HOLMES, Judge. HOLMES HOLMES, Edward and Odette Daoud are both highly educated. Mr. Daoud has a Ph.D. in engineering and an M.B.A., and he worked as the director of engineering for Ameritech (the telecommunications company) in 2000 and part of 2001. By his own account he was business savvy. He claimed to have anticipated the *318 downturn in the telecommunication market, causing him to look for a new job even before he was laid off in April 2001. Mrs. Daoud has a bachelor's degree in physical science and has taken classes toward a master's degree in psychology. She also managed the day-to-day operations of the couple's two Wienerschnitzel franchises in Southern California: one in Cypress and the other in Irvine. In addition to wage and business income, the couple earned rent on a house they owned in Austin, Texas. Yet despite their many sources of income, the Daouds reported zero taxable income in both 2000 and 2001 after claiming a combination of losses and deductions. The largest of all were business expenses from their Wienerschnitzel operations. These claimed expenses reduced the more than $1 million in combined yearly sales the restaurants produced to $22,000 of income in 2000 and a $7,000 loss in 2001. The Commissioner sent the Daouds a notice of deficiency. We tried the case in Los Angeles, where the Daouds lived when they filed their petition. Our first task was to determine what expenses are at issue and in what amounts. This was complicated by the way the Commissioner *319 made adjustments to the Daouds' returns, and by how Mr. Daoud prepared the returns in the first place. According to Mr. Daoud's testimony, his wife kept the Wienerschnitzels' books on handwritten daily logs. He would then take these daily logs and transfer the information onto his Quicken software program. Once all the information was entered, he was able to use the program to generate reports. He claims that it was from his Quicken reports that he prepared the couple's tax returns. The curious thing about this claim is that many of the amounts on the Quicken reports do not match the amounts listed on the Daouds' returns. The revenue agent nevertheless allowed the Daouds to substantiate their expenses with these Quicken reports. She made a few exceptions, but if an expense was documented on the Quicken reports, she generally allowed it—even if the amount was greater than the Daouds reported on their returns.1*320 A consequence of allowing the Daouds amounts for certain expenses greater than those which they reported on their returns is that if they can substantiate all the expenses still in dispute, their net income would be even less than what they originally reported. We also had difficulty determining the amounts in dispute because the revenue agent inadvertently increased the Daouds' Schedule C income by sometimes disallowing the same expense twice. She first disallowed the expenses under an adjustment labeled "Other Expenses," which included her changes to the stores' 2000 and 2001 Schedule Cs. She then disallowed some of the same expenses in other parts of the notice of deficiency. We have corrected her mistakes in making our calculations and constructing our tables. The following tables summarize the adjustments made to the Daouds' Schedule C income:
The *321 parties compromised or conceded some of these adjustments. What's left for us to decide are the following amounts (in each instance the difference between the parties' final positions):
The parties did stipulate that the Daouds are not entitled to *322 any of the deductions claimed for charitable contributions. The Commissioner challenged two of the Daouds' Schedule A deductions from 2000: $3,640 in claimed gift/jewelry expenses and $10,183 for mileage. The Daouds conceded after trial that they aren't entitled to any Schedule A deductions beyond those already allowed by the Commissioner, but they are still relevant for our determination of penalties. The Daouds also concede that they failed to report a $2,565 state-income-tax refund received in 2000. The Daouds were required to include this amount because their 1999 Schedule A claimed a deduction for all of the state income taxes paid, including the amount that they overpaid. In the notice of deficiency, the Commissioner adopted the calculations of the revenue agent and determined that there was unreported gain realized on the sale of the Irvine business in 2001. The Daouds purchased the Irvine Wienerschnitzel in 1994 for approximately $200,000, and sold it for about $350,000. The IRS determined that the adjusted basis in the business was $236,166.55, which included the cost of improvements made by the Daouds *323 in 2001. In addition, it was determined that the Daouds had an available net capital loss of $88,896 that could offset some of the gain realized on the sale. Out of the $54,866 gain subject to tax, he also determined that $38,848 was ordinary income under On their 2000 return, the Daouds reported a $110,015 loss on the sale of kitchen equipment. As a result, the revenue agent requested documentation from the Daouds substantiating this loss; and Mr. Daoud gave the agent a document titled "CONTRACT" that was written on SILVA/MBA II Restaurant Equipment letterhead. The document was a bid from SILVA listing new equipment and equipment upgrades that the Daouds would have to buy before they could sell the Irvine Wienerschnitzel. The total amount of SILVA's bid was $110,015. When the revenue agent received the bid she noticed a couple of odd things about it. The document was signed by Edward Daoud but the line for Michael Freed, one of the contractor's partners, was blank. It also appeared as though the date on the document had been altered to read March 1, 2000. Her suspicions prompted her to issue a summons to SILVA. SILVA quickly sent her a list of bids it had made for the Daouds' Irvine Wienerschnitzel, and three canceled checks totaling $31,241 written by the Daouds. One of the bids *325 on the list was for $110,015 and was made on March 1, 2001. From this the revenue agent determined that the document provided by Mr. Daoud had been altered, causing her to disallow the kitchen-equipment loss and apply a civil-fraud penalty under At the end of trial, however, the Commissioner orally moved under The Daouds were unable to substantiate many of their deductions at trial, and Mr. Daoud's testimony did not help their case. Mr. Daoud conceded that he and his wife were not entitled to the loss on the sale of kitchen equipment, but *326 he tried to explain why he reported a loss for equipment he had neither bought nor sold. He testified that he was unsure how the $110,015 loss got on his return, but he speculated that the bid was mixed up with all the other paperwork on his desk, which caused him to enter it into Turbo Tax by mistake. He also testified that the date he recorded on the Form 4797, Sales of Business Property, as the date that he sold the equipment was simply one that he chose at random after Turbo Tax prompted him to enter a date. He went on to explain that he gave the altered document to the revenue agent "out of panic." During the remainder of Mr. Daoud's direct examination, he proffered numerous bits of evidence and explained how each piece substantiated the Daouds' deductions and expenses. One of these exhibits included two mileage logs and various receipts from airline, hotel, and car rental companies. Mr. Daoud offered this exhibit to substantiate the travel-expense deductions he claimed for his job search and for the Wienerschnitzel restaurants. The two mileage logs—especially the dates on them—are particularly interesting. On the first entry of the first log, Mr. Daoud filled in 1/7/00 for the *327 date, wrote his destination, the business purpose, and the miles driven. The log continues sequentially until 12/18 when just the day and month are noted. On the second log the dates start over with 1/5/00 and the log again continues sequentially with just the day and month written from 1/9 until 11/27. Some of the dates appear twice and others do not. The Commissioner's counsel wondered why Mr. Daoud had two logs for the same year, and during the cross-examination she asked him: Q Are they all for 2000, or could you explain that to us? A It looks like both of them are for 2000. * * * * * * * Q And you don't have one for 2001? A I may. I don't really know. During the next part of her cross-examination, the Commissioner's counsel asked Mr. Daoud about his other travel expenses. She questioned him about the dates of specific trips and the corresponding business purpose. For each trip, Mr. Daoud explained who interviewed him or described a Wienerschnitzel function that he and his wife attended. One of the receipts Mr. Daoud was questioned about came from a hotel in Lake Tahoe. The receipt showed that two adults checked into a hotel on December 22, 2001, and checked out on the 26th. Mr. Daoud *328 explained that this trip was for a Wienerschnitzel conference. The Commissioner's counsel found it odd and asked: Q Would you characterize this as a Christmas conference? A It is not really up to us when they hold it. It is when they hold it and we go to it. Q Do they typically hold Wienerschnitzel conferences over the Christmas holidays? A Occasionally, yes, they do. This is on the request of the franchisees. The Commissioner's counsel continued asking Mr. Daoud questions about specific receipts but soon returned to the mileage logs to ask about specific dates listed. For example: Q And on 2/7, you went to Mission [Viejo]? A Yes. Q And who did you interview with there? A Another employer. I don't really remember the name. Q On 2/16, you went to Santa Monica? A It looks like Santa Monica. Q Okay. And on 2/19 you went to Riverside? Q And who did you interview with in Santa Monica? A I don't really remember. Q Okay. But you had an interview? A Yes, all these are interview related. Q Okay. And who did you interview with in Riverside? A Give me a second, please. I believe it was—I believe they are a subsidiary, and I don't remember exactly their name. Having gotten what she wanted from *329 Mr. Daoud, the Commissioner's counsel asked him to compare the dates on the receipts with those on the mileage logs: Q All right. Mr. Daoud, we have now just gone over some of your travel, and I am just curious. Isn't it true that you just testified that on February 7, 2000, you were on an interview in Mission [Viejo]? Yet, you have also testified that * * * on 2/7 * * * you were in Portland? * * *. A It can be. Something in the morning and something in the afternoon. Q And so you went to both of them? A Possibly. Q Okay. Now what about how you just testified that on 2/14 that you were in Long Beach, and on 2/16, * * * were in Santa Monica, and on 2/19, you were in Riverside for interviews. Yet at the same time, you were in Korea between 2/13 and 2/19? How can that be? That's quite a far distance. A The Korea trip * * * was 2001. Q This is your ticket to Korea, correct? Q And if you look at the date of issue, February 9, 2000 and not 2001, correct? A It looks like it. Through further cross-examination, the Commissioner's counsel showed that the mileage logs placed Mr. Daoud in Oxnard on the same day he was in Toronto, in California when he was in Illinois, at *330 interviews in several California cities when he was apparently in London, and in San Jose and Santa Monica when he was shown to be in Hawaii. Mr. Daoud then conceded that it was possible that the mileage logs reflected two separate years, one for 2000 and one for 2001. But even if we assume that the mileage logs cover both years, it would not explain the inconsistences between the logs and Mr. Daoud's other travel receipts. This extraordinarily effective cross-examination substantially undermined Mr. Daoud's credibility and the value of any of the evidence that he himself created. We must first decide whether to grant the Commissioner's motion to conform the pleadings to the evidence presented at trial, to let him assert a fraud penalty for both 2000 and 2001. See The parties dispute $192,683 of Schedule C expenses for 2000 and $204,276 for 2001. The Daouds deducted expenses in multiple categories, but we divide them into two: (1) expense categories for which the Daouds have offered no evidence, and (2) expense categories that the Daouds actually tried to substantiate. We quickly deal with those items that fall into the first category. Because the Commissioner's determination is presumed correct, without further evidence the Daouds have not met their burden *332 of proof. See We next consider whether the Daouds have substantiated any of the remaining expenses. The Commissioner says that the Daouds aren't entitled to $23,158 of their cost-of-goods-sold adjustment—the difference between the total cost of goods sold reported on the Daouds' 2000 return and the corresponding amount listed on the Quicken reports. The Daouds don't attempt to reconcile this discrepancy. Instead they argue that the amounts they claimed were reasonable, and thus should be allowed in full. But we don't believe that the Commissioner acted unreasonably in denying less than four percent of the Daouds' claimed cost of goods sold in 2000. This is especially true given the fact that the revenue agent relied on the Daouds' own Quicken reports in reaching her conclusion. The Daouds also tried to substantiate the disputed portion of the cost of goods sold with an exhibit containing page after page of photocopied receipts *333 from grocery stores and wholesale clubs. These receipts are of little value. Without an explanation from the Daouds, it is impossible for us to distinguish items used at their Wienerschnitzels from those used by them personally. Many of the items on the receipts are household or personal care products, or food and drink (e.g., liquor) that we find were probably not served or used at their restaurants. We therefore sustain the Commissioner's cost-of-goods-sold adjustment for 2000.5 The parties dispute only the Cypress restaurant's insurance expenses for 2000 and 2001. The Commissioner did allow $2,314 of the $4,633 amount claimed for 2000, and $1,875 of the $4,994 amount claimed for 2001. But the Daouds argue that they are entitled to the full amount and offer invoices from their insurance agent, and a policy summary from their insurance carrier. According to these documents, the insurance premium for the Cypress *334 Wienerschnitzel in 2001 was about $2,000. (The Daouds introduced no evidence on their 2000 insurance expense.) Although the $1,875 the Commissioner allowed is less than the premiums shown on the documents, the Daouds have not proven that they paid those premiums. We therefore find in favor of the Commissioner. The parties dispute $13,286 of the mortgage-interest expense claimed for 2000 and $7,685 for 2001. The Commissioner disallowed these expenses because the Daouds were renters, not owners, of their Wienerschnitzels' real estate. Mr. Daoud conceded that the mortgage label wasn't proper, but said that he had just mistakenly reported as mortgage interest the interest they paid to finance their purchase of restaurant equipment. As proof, he offered canceled checks totaling $15,807 written to a credit union in 2001. These checks and Mr. Daoud's testimony don't prove that the payments were being made on a business, and not a personal, loan; therefore, we find that they failed to substantiate the disputed interest expenses. The Commissioner disputes equipment-lease deductions totaling $18,839 for 2000 and $23,869 for 2001. The Daouds claim *335 that part of the 2000 equipment-lease expense was for an ice machine at their Irvine restaurant that cost $165 per month. To substantiate this expense, they introduced a leasing contract for years other than 2000 and canceled checks showing that they made their payments. These are the types of records we like to see, but the Commissioner is also correct that on this point they were superfluous—he had already allowed the ice-machine expense.6 The only evidence the Daouds provide to substantiate the rest of their equipment-lease expenses is a stack of canceled checks written to three different banks. As with the mortgage-interest expense, they did not provide any additional documentation to show the purpose for those checks. And our examination of the 2000 Quicken reports showed checks written to the same banks for the same amounts also showing up as "Mortgage interest expense," "Other interest expense," and "Misc. materials" and "Supplies." Such double-duty doesn't work: the Daouds aren't entitled to claim any of the disputed equipment-lease expenses. The parties' only dispute in this category is over the expense of leasing the building and land used by the Cypress Wienerschnitzel in 2001. The Commissioner allowed $72,000 of the $88,640 claimed. The Daouds argue that they are entitled to a deduction for the money they paid the franchisor under a common-area maintenance contract, about $395 a month. But the invoices offered are for the Irvine, not the Cypress, store and from 2000, not 2001. The Daouds did not provide us with Cypress's lease or any other evidence showing Cypress's obligation to pay this amount. We nevertheless found, buried deep within one of the Commissioner's exhibits, copies of eight checks drawn on Cypress's bank account and deposited by the building's lessor. Five checks are for $6,129.69 and three are for $6,341.73. We find these checks substantiate eight rent payments made for eight different months in 2001. Although the Daouds cannot fully substantiate their rental expense for the entire year, under The Daouds offered copies of checks to prove the disputed repair expenses of $6,930 for 2000 and $19,541 for 2001. Three of the checks were written from the Irvine Wienerschnitzel's bank account in 2000, and their total is less than the amount already allowed by the Commissioner for this category. The fourth check was written from the Daouds' personal account in 2001, and the only evidence offered to explain its purpose is Mr. Daoud's testimony that it was for repairs. We are not persuaded, and find that the Daouds have not substantiated the disputed repair expenses. Included with the receipts previously discussed are ones from Home Depot and Restaurant Depot, which the Daouds argue substantiate their deductions for supplies. During his testimony, Mr. Daoud claimed that these receipts were for restaurant supplies. We do find Mr. Daoud's *338 claims more likely than not true for the items that he bought at Restaurant Depot, but the things he bought at Home Depot could just as likely have been used by the Daouds at home. The Daouds' inability to prove that these items were bought for a business purpose is not the only problem here—the total amount the Commissioner allowed the Daouds for supplies is greater than the total amount they claimed on their returns.7 And while $3,099 is still in dispute for 2001 ($1,474 for Cypress and $1,625 for Irvine), the Daouds have not provided any specific proof that these receipts correspond to that amount. We again find for the Commissioner. The Commissioner and the Daouds continue to argue over property taxes *339 and licensing fees. For the Cypress store, the Commissioner allowed only $5,088 for 2000 and $25 for 2001; for the Irvine store, he allowed $2,497 for 2000 and nothing for 2001. Even though the Daouds did not own the property their Wienerschnitzels sat on, they claim that both franchise agreements required them to pay property taxes. If true, this would be a proper business deduction, though properly reportable as part of their rental/lease expense. See The Daouds did produce invoices for real-property taxes on the Irvine store for two fiscal years: 1999-2000 and 2000-2001. The tax liabilities shown were for $4,816 and $4,894.82, respectively. They also provided records showing that their landlord billed them for the Irvine property's taxes (plus a copy of a $424 bill from the City of Orange for health-service fees). Invoices by themselves don't prove payment. But the Closing Statement generated by Heritage Escrow Company, documenting the sale of their Irvine business in November 2001, confirms that they were current on their *340 real-property taxes and health-service fees through the closing date. Though the documentation is sparse, we do find it more likely than not that the Daouds paid real property taxes totaling $4,856 in 2000 and $4,283 in 2001.8 We also find it more likely than not that the Daouds paid $424 in health-service fees in 2000 and $347 in 2001. After subtracting what the Commissioner previously allowed, the Daouds are entitled to claim an additional $2,783 for 2000 and $4,630 for 2001. The Daouds argue that they are entitled to deduct $10,534 in expenses for travel to Lake Tahoe in 2000, and $7,782 for travel to Hawaii for a Wienerschnitzel conference in 2001. They showed receipts from these trips and Mr. Daoud testified about the trips' business purpose. While we believe that the Wienerschnitzel organization has conferences, we do not believe Mr. Daoud's testimony that these trips were for those conferences. We need corroboration, especially given Mr. Daoud's claim that he and Mrs. Daoud were in Lake Tahoe on Christmas Day for a conference. Even *341 if we credited his testimony on this point, The Daouds also claim that the numerous restaurant receipts introduced into evidence were for meals with suppliers and other people related to the Wienerschnitzel business. Mr. Daoud cannot remember the specifics of the meals, but he assured us in his testimony that they were for business. This testimony also lacks the specificity that To substantiate the deductions for contracted services, the Daouds offer copies of checks written to various individuals. The Daouds, however, failed to explain what the individuals did for them. The only explanation they gave is that one of the individuals was a labor contractor who helped out at their Irvine store. With only the checks and Mr. Daoud's testimony, we are not convinced that the money was spent for a business purpose. Therefore, we will allow neither the disputed $931 for 2000 nor the disputed $1,932 for 2001. The Commissioner allowed the Daouds almost $1,000 for pest-control expenses in 2001, but the parties still fight over $918 in 2000 and an extra $96 in 2001. To support their claim, the Daouds offer invoices from Lloyd Pest Control for $692 billed and dated 2001. But they don't argue that these invoices substantiate expenses disallowed by the Commissioner, nor do they offer any evidence to substantiate any 2000 expense for this category. We find for the Commissioner on this issue as well. The Commissioner allowed the Daouds most of their claimed expenses for trash collection, including an amount greater than what they claimed on their 2001 returns for their Cypress store. But the Daouds say they should still be able to deduct an extra $381 in 2000 ($149 for the Cypress store and $232 for Irvine store) and $104 in 2001 (for the Irvine store). The Daouds produced a few invoices billed to the Cypress location, but the Commissioner already allowed an amount greater than the total of the invoices. The Daouds' failure to show how the invoices prove any disputed amount forces us to toss this argument. We find that the Daouds failed to substantiate the disputed *343 trash-collection expense. The disputed uniform expenses are $2,401 for 2000 and $2,407 for 2001. To substantiate these expenses, the Daouds offer only invoices sent to their Cypress Wienerschnitzel in 2001. The invoices total $1,310, which is the exact amount the Commissioner allowed their Cypress store for that year. Because no other evidence was provided, we find that the Daouds have not substantiated the disputed portions of the uniform expense. The parties agree that the Daouds realized at least $12,325 of capital gain on the sale of their Irvine Wienerschnitzel in 2001, so we need to decide only if the Daouds are liable for the $38,848 of As we've already briefly noted, in calculating the Daouds' The math works, but the reasoning is wobbly. "[S]ection 1250 property" is usually a building, including its structural components, owned by the taxpayer and used in his trade or business. See Under Because the Code treats In case of a sale, exchange, or involuntary conversion of In this case, the Commissioner incorrectly assumed that the Irvine Wienerschnitzel was composed of only The Commissioner also confused the application of There is no evidence in the record that suggests the Daouds used anything other than a straight-line method when depreciating and amortizing their business's 1250 property. The Daouds paid rent in equal, monthly installments for the use of the land and building, and it appears that they claimed depreciation deductions on their Schedule Cs only for The question of recapture under The Commissioner neither argued nor determined that a part of the Daouds' deficiency stemmed from Neither party litigated the issue of To impose a penalty for fraud we must find that the Commissioner has proven by clear and convincing evidence that (1) an underpayment of taxes occurred, and (2) that some portion of the underpayment was due to fraud. See • understatement of income; • inadequate records; • failure to file tax returns; • implausible or inconsistent explanations of behavior; • concealment of assets; • failure to cooperate with tax authorities; • engaging in illegal activities; • attempting to conceal illegal activities; • dealing in cash; and • failing to make estimated tax payments. If the Commissioner meets his burden as to any portion of the underpayment, then we have to treat the entire underpayment as attributable to fraud except to the extent the taxpayer establishes, by a preponderance of the evidence, that a portion of the underpayment is not due to fraud. The Commissioner has met his burden with respect to the first element of fraud—he has shown that the Daouds underpaid their 2000 taxes. Mr. Daoud even concedes that he wasn't entitled to the loss reported on the sale of kitchen equipment. *353 The second element, requiring the Commissioner to show fraudulent intent at the time the Daouds reported the loss, is a bit trickier. This case is a good example of why we allow the Commissioner to prove fraudulent intent using circumstantial evidence and the taxpayer's entire course of conduct. Mr. Daoud claims that he reported the loss by mistake, and he asks us to believe that he first learned about it when the revenue agent brought it to his attention. We do not believe him—Mr. Daoud's credibility suffered during trial. His testimony was often suspect, and the records he provided have proven not to be what he said they were on many subjects. The first indicium of fraud, understatement of income, can be shown by an overstatement of deductions. E.g., Mr. Daoud was also unable to substantiate expenses and deductions because the Daouds kept inadequate *354 records—another indicium of fraud. He tried to disguise this shortcoming by throwing piles of documents at the revenue agent and counsel for the IRS. These documents are spotty and disorganized. They include what appear to be falsified mileage logs and numerous receipts for personal items. And almost all of Mr. Daoud's records proved inadequate to substantiate the deductions and expenses he disputes. Attempting to conceal fraudulent activity is another indicium of fraud present in this case. When asked to substantiate the $110,015 loss, Mr. Daoud gave the revenue agent the altered bid that he was trying to pass off as a contract for the purchase of equipment. He claims that he gave the document to the revenue agent because he panicked after finding out about his mistake. This story does not help his cause. Whatever his reasoning, he was trying to conceal his true income from the Commissioner and that shows fraud. Further evidence of fraud, and perhaps the most damaging, is Mr. Daoud's implausible explanation of how the $110,015 loss got onto his return. He asks us to believe that while preparing his 2000 return he found a bid among his tax papers and he mistakenly entered it into Turbo *355 Tax in a way that reduced his income by $110,015. Then months later, upon realizing his mistake, he found the bid again, altered it, and gave it to the revenue agent to substantiate the loss because he panicked. This is an implausible story: Mr. Daoud was actively negotiating for other bids from SILVA when the alleged mistake took place, so he was familiar with the document. The Daouds didn't sell any equipment in 2000. And why wouldn't he recognize his mistake when he completed the return and discovered that all they owed in taxes was $2,621 in self-employment tax? The final indicium of fraud present in this case is the Daouds' failure to make estimated tax payments. In 2000, the only tax payments they made were those that Ameritech withheld. With so many of the indicia of fraud present, we find that the Commissioner has met his burden and proved by clear and convincing evidence that a portion of the Daouds' 2000 underpayment was due to fraud. We will therefore treat the Daouds' entire 2000 underpayment as fraudulent. See In his brief, the Commissioner attempts to conflate the penalty issue for 2000 and 2001, arguing the evidence of fraud without referring to the particular tax year he is addressing. But we can't impute or presume fraud—it must be established by independent evidence for each tax year. See, e.g., The Commissioner did establish the first element: There clearly was an underpayment in 2001. The parties have even stipulated the fact that the Daouds should have reported the capital gain realized on the sale of their Irvine franchise. And as previously *357 determined, the Daouds did take Schedule C deductions in 2001 to which they were not entitled. As to the issue of fraudulent intent, we look at the various badges of fraud. The first one, an understatement of income, is shown by Mr. Daoud's unsubstantiated job search and Schedule C expenses, and his failure to report the gain realized when the Daouds sold their Irvine business. Mr. Daoud also failed to make estimated tax payments in 2001, another indicium of fraud. But these transgressions could also reflect mere negligence or a disregard of the Code and regulations. The Commissioner argues that Mr. Daoud's education and experience elevate these omissions to fraud. The Commissioner, however, does not allege, and the record does not suggest, that Mr. Daoud had any expertise or specialized knowledge in tax law. We are not persuaded by the Commissioner's argument that Mr. Daoud's general intelligence and prior experience of being audited are enough to prove an intent to evade taxes. The Commissioner also alleges that Mr. Daoud tried to conceal his income in 2001 by "[burying] the sale of the Irvine franchise as a loss on Schedule D-1, following the list of stock sales." We are unpersuaded. *358 Mr. Daoud, although incorrectly, did disclose the sale of the Irvine business on the returns. Moreover, the way he reported the sale shows an attempt to disclose information, not conceal it. The Commissioner also points to Mr. Daoud's testimony regarding the mileage logs as proof of fraudulent intent. Mr. Daoud, however, did not use the mileage logs to substantiate any of his 2001 deductions. He testified that the mileage logs were exclusively for 2000, and only after the Commissioner's effective cross-examination did Mr. Daoud suggest that it was possible that some of the notations on the mileage logs were for 2001. This does not show an intent to evade his 2001 taxes, and in fact his not relying on it to shrink his 2001 tax bill shows the opposite. And the Commissioner does not allege any other misleading statements were made by Mr. Daoud about his 2001 return. We can't help but find that Mr. Daoud kept inadequate records and was not always cooperative with the IRS for both years. But poor bookkeeping and frostiness toward IRS agents do not necessarily prove fraudulent intent. See The Commissioner does not allege, and the evidence does not suggest, that Mr. Daoud fabricated, destroyed, or concealed documents related to his 2001 return. Given the weight of the evidence, we conclude that the Commissioner has failed to carry his burden of proving, by clear and convincing evidence, that any part of the 2001 underpayment was a result of fraud. On the portion of the Daouds' deficiency not subject to The Commissioner also wants Mrs. Daoud to be liable for an accuracy-related penalty *360 on the portion of the underpayment already subject to Mr. Daoud's civil-fraud penalty. An accuracy-related penalty, however, cannot be imposed on one spouse where the other one is liable for fraud. See, e.g., Once the Commissioner provides some evidence of negligence, disregard of the Code and regulations, or a substantial understatement, the burden of proving that the Commissioner got his penalty determination wrong shifts to the taxpayer. See Negligence, as the regulations define it, is the failure to make a reasonable attempt to prepare one's tax returns, keep adequate books and records, substantiate items properly, or otherwise comply with the Code. We find that Mr. Daoud clearly disregarded the rules when he deducted the cost of jewelry given to his wife in 2000 as a business expense. The Daouds don't argue otherwise. The Daouds also claimed excessive Schedule C expenses on their 2001 return which they were unable to substantiate, disregarding the requirements of The fact that the Quicken reports do not match the amounts claimed on their returns buttresses our finding that these *362 taxpayers were negligent in keeping their records and preparing their 2001 returns. See We also believe that we can sustain the The accuracy-related penalty does not apply if the taxpayer had reasonable cause and acted in good faith, Footnotes
RelatedLeFever v. Commissioner 100 F.3d 778 (Tenth Circuit, 1996) Edward T. And Isabel J. Lysek v. Commissioner of Internal Revenue 583 F.2d 1088 (Ninth Circuit, 1978) Robert W. Bradford v. Commissioner of Internal Revenue 796 F.2d 303 (Ninth Circuit, 1986) Ronald L. Pack, and Marla Pack, for Themselves and as Representatives of a Class v. United States 992 F.2d 955 (Ninth Circuit, 1993) Walgreen Company & Subsidiaries v. Commissioner of Internal Revenue 68 F.3d 1006 (Seventh Circuit, 1995) Cohan v. Commissioner of Internal Revenue 39 F.2d 540 (Second Circuit, 1930) Troutman v. Comm'r 2004 T.C. Memo. 32 (U.S. Tax Court, 2004) Talmage v. Comm'r 2008 T.C. Memo. 34 (U.S. Tax Court, 2008) LeFever v. Commissioner 103 T.C. No. 31 (U.S. Tax Court, 1994) Walgreen Co. & Subsidiaries v. Commissioner 103 T.C. No. 33 (U.S. Tax Court, 1994) Hospital Corp. of Am. v. Commissioner 109 T.C. No. 2 (U.S. Tax Court, 1997) HIGBEE v. COMMISSIONER OF INTERNAL REVENUE 116 T.C. No. 28 (U.S. Tax Court, 2001) Dutton v. Comm'r 122 T.C. No. 7 (U.S. Tax Court, 2004) Hurst v. Comm'r 124 T.C. No. 2 (U.S. Tax Court, 2005) Estate of Finder v. Commissioner 37 T.C. 411 (U.S. Tax Court, 1961) Hicks Co. v. Commissioner 56 T.C. 982 (U.S. Tax Court, 1971) Markwardt v. Commissioner 64 T.C. 989 (U.S. Tax Court, 1975) Kingsbury v. Commissioner 65 T.C. 1068 (U.S. Tax Court, 1976) Buffalo Tool & Die Mfg. Co. v. Commissioner 74 T.C. No. 31 (U.S. Tax Court, 1980) Vanicek v. Commissioner 85 T.C. No. 43 (U.S. Tax Court, 1985)
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