Worth v. Comm'r
This text of 2014 T.C. Memo. 232 (Worth 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 appropriate order and decision will be entered.
LAUBER,
In each case respondent filed an amended answer that alleged increased deficiencies for certain years. In docket No. 12808-09, respondent determined against Frank Worth deficiencies and fraud penalties, subsequently amended, as follows:
| 1998 | $63,689 | $47,767 | $73,403 | $55,052 |
*234 In docket No. 12573-09, respondent determined against Frank and Helen Worth deficiencies and fraud penalties, subsequently amended, as follows:
| 1999 | $74,829 | $56,122 | $43,187 | $32,390 |
| 2000 | 99,999 | 74,999 | 171,207 | 128,405 |
In docket number 14580-09, respondent determined against Donald and Marie Worth deficiencies and fraud penalties, subsequently amended, as follows:
Free access — add to your briefcase to read the full text and ask questions with AI FRANK KENNETH WORTH, a.k.a. FRANK K. WORTH, a.k.a. FRANK WORTH AND HELEN LAURA WORTH, a.k.a. HELEN L. WORTH, a.k.a. HELEN WORTH, ET AL.,1 Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent Worth v. Comm'r Docket Nos. 12573-09, 12808-09, 14580-09. T.C. Memo 2014-232; 2014 Tax Ct. Memo LEXIS 231; 108 T.C.M. (CCH) 522; November 13, 2014, FiledAn appropriate order and decision will be entered. *231 Donald Kenneth Worth and Marie Ann Worth, pro se in docket No. 14580-09. LAUBER, Judge. LAUBER LAUBER, In each case respondent filed an amended answer that alleged increased deficiencies for certain years. In docket No. 12808-09, respondent determined against Frank Worth deficiencies and fraud penalties, subsequently amended, as follows:
*234 In docket No. 12573-09, respondent determined against Frank and Helen Worth deficiencies and fraud penalties, subsequently amended, as follows:
In docket number 14580-09, respondent determined against Donald and Marie Worth deficiencies and fraud penalties, subsequently amended, as follows:
Respondent has conceded the deficiency and the fraud penalty as to Donald and Marie Worth for 1997. Frank Worth has conceded the fraud penalty for all years in issue, and respondent does not contend that Helen Worth was involved with White Sands or the alleged fraud. Because the deficiencies and the fraud penalties relate to conduct involving the White Sands business, we will generally refer to Donald, Marie, and Frank as petitioners. *235 Apart from computational matters the remaining issues for*233 decision are: (1) whether petitioners failed to report income for 1998-2000 as determined by respondent using the net worth method of reconstructing income and (2) whether petitioners Donald and Marie Worth are liable for the fraud penalty for 1998-2000. We answer both questions in the affirmative. Some of the facts have been stipulated and are so found. The stipulations of facts and the attached exhibits are incorporated by this reference. All petitioners resided in California when they petitioned this Court. Donald and Marie Worth were married in 1961. After receiving their B.A. degrees, both earned master's degrees in education from Washburn University in Topeka, Kansas. Marie was employed as a schoolteacher from 1969 through 1997; she previously held positions as an order department manager, an instructional materials clerk, a secretary, and a bookkeeper. Donald and Marie have one son, Frank Worth, who is married to Helen Worth. During the early 1990s Donald and Frank operated Sports Image, a sporting goods shop in Santa Maria, California. In 1993 they converted Sports Image into a specialty skateboard and surfing store called White Sands. By 1998 Donald*234 and *236 Frank had expanded their business and operated a total of four stores in Santa Maria, Northridge, Valencia, and Ventura. During 1999-2000 they added a fifth store in Palmdale. As of April 2002 they were operating seven White Sands stores at various locations across southern California. Because the stores were a fair distance from each other, Donald and Marie generally managed the stores nearer to them and Frank managed the stores nearer to him. Over time Frank managed about half of the stores. As manager, Frank had the authority to write checks on certain White Sands bank accounts. He wrote checks on these accounts or used cash to pay vendors for merchandise as it came in. He also wrote checks to reimburse himself for White Sands expenses that he had paid. Frank's responsibilities included selecting shopping centers at which to open stores; managing store employees; supervising the buildout of the interior of new stores; making decisions about which brands and products to carry; managing inventory at the warehouse; and making deliveries of inventory and supplies to various stores. Frank was also responsible for collecting the daily receipts (cash, customer checks, and credit card*235 slips) from the stores he managed and delivering them in a sealed envelope to his mother, who did the bookkeeping for White Sands. *237 Petitioners used large amounts of cash in the operation of White Sands. Many customers paid in cash, and petitioners paid many vendors in cash. Marie and Donald had primary responsibility for depositing White Sands receipts. They frequently made large cash deposits spread among a dozen different bank accounts. Petitioners had no formal arrangements concerning the ownership of White Sands during 1997-2000. They had what Donald called a "gentlemen's agreement," and the actual ownership interests were a principal focus of dispute at trial. Respondent contended that Frank should be regarded as a 50% owner of White Sands. Petitioners contended that Frank had no ownership interest in White Sands or, alternatively, that he owned only a minority stake, with the majority interest split between Donald and Marie. Throughout White Sands' existence, Donald and Frank both held themselves out as its owners. Frank represented himself as an owner to banks, vendors, insurance companies, and the Santa Maria Police Department. Donald and Frank both negotiated and signed (jointly*236 or separately) lease agreements for White Sands, including leases of stores and storage space. Donald, Marie, and Frank jointly filed with the State of California a fictitious business name statement for *238 White Sands, and they jointly, and later separately, obtained seller's permits from the State of California. Petitioners have admitted on prior occasions that Frank was a co-owner of White Sands. In a trademark infringement case filed against petitioners and White Sands in 2001 Frank averred in a filing with the California superior court that he was "a part owner in WHITE SANDS SKATE & SURF" and that Marie had no interest in the business. Later in that litigation Frank testified during a deposition that he and Donald were "partners" in White Sands. While stating that he and Donald had no formal agreement for sharing the profits from White Sands, Frank testified that they each received compensation of approximately $2,000 per month, suggesting a 50-50 ownership split. Donald and Marie filed joint Federal income tax returns for all years in issue. On these returns they reported profits from White Sands on Schedules C, Profit or Loss From Business. For 1998 Frank filed a Federal income*237 tax return as married filing separately, and he likewise reported profits from White Sands on a Schedule C. For 1999-2000 Frank and Helen filed joint Federal income tax returns, and they reported profits from White Sands on Schedules C. Frank and his parents obtained different employee identification numbers (EINs) for White Sands, and they used their respective EINs on their respective Schedules C. Frank *239 at no time reported receipt of any salary or wages from White Sands, and White Sands did not furnish him a Form W-2, Wage and Tax Statement, for any year in issue. The evidence established that Marie prepared the original tax returns filed on behalf of all petitioners as described above. The Schedules C included in these returns assigned roughly half of the reported gross receipts and expenses of White Sands to Donald and Marie and roughly half of the reported gross receipts and expenses of White Sands to Frank, as shown in the table below:
Frank testified that White Sands was incorporated in 2002 and that Donald and*238 Marie each were issued 50% of its stock. Apart from this testimony there is no evidence in the record that White Sands was ever incorporated or, if it was incorporated, as to who owned its stock. We did not find Frank's testimony on this point to be credible. In early 2001 petitioners came to the attention of Federal and State authorities because of certain banking irregularities. These included numerous deposits to multiple banks in the range of $8,000 to $9,000, slightly below the $10,000 threshold that would have required the bank to complete a currency transaction report. The case was assigned to IRS Criminal Investigation Division Agents Carol Broderick and Bonnie Decker (agents) to conduct an investigation of Donald, Marie, and Frank. During this investigation the Agents spoke with petitioners as well as with petitioners' relatives, vendors, lessors, and other third parties. During an interview with Agent Broderick, Frank admitted that he was a 50% owner of White Sands. Donald and Marie provided inconsistent and fraudulent statements during this criminal investigation. They made inconsistent statements to the Agents concerning the ownership of the White Sands*239 stores, and they made false statements concerning its business records. They told Agent Broderick that they could not produce White Sands' business records because the records had been stolen during a theft of merchandise. However, when California Board of Equalization (BOE) agents executed a search warrant in December 2003, they seized various items from a White Sands warehouse, including business records. The BOE search *241 revealed that Donald and Marie had custody of the business records they asserted had been stolen. On April 11, 2007, Frank pleaded guilty to willfully making and subscribing to a false return for 2000 in violation of The IRS subsequently conducted a civil examination of petitioners' 1998-2000 returns. Because petitioners lacked complete and reliable records, the IRS had to reconstruct their incomes using an indirect method of proof. Because of petitioners' commingling of funds and extensive*241 use of cash, the IRS was unable to isolate each petitioner's income using the "bank deposits" method. The IRS accordingly determined to reconstruct their incomes for 1998-2000 using the "net worth and personal expenditures" method (net worth method). Revenue Agent Helen Chan had principal responsibility for this exercise. She identified the assets, liabilities, and expenses of the respective petitioners, then reconstructed their incomes for 1998-2000 by comparing changes in their net worths from one year to the next. For Donald and Marie, Agent Chan's net worth analysis was as follows:
*243 for Frank, Agent Chan's net worth analysis was as follows:
*244 Agent Chan testified for nearly two days regarding the details of her net worth calculations. Her analysis required her to marshal large amounts of data-- e.g., from bank and brokerage statements, canceled checks, credit card statements, real estate closing documents, and vehicle leases--and feed these data into the net worth calculus. The Court admitted her various summary charts under Agent Chan testified as to how she had characterized certain elements of these data in some cases. For example, for a real estate closing document, she broke out separately the "cost basis" of the property, any tax-deductible items (such as real*243 property taxes), and nondeductible items (such as prepaid insurance premiums). In those cases the Court accepted her testimony and admitted schedules of this type, not for the purpose of demonstrating the correctness of her methodology, but solely for the purpose of explaining what she had done. Petitioners had the opportunity to challenge all aspects of her methodology through cross-examination at trial and in posttrial briefs. Agent Chan began her analysis by determining petitioners' net worths at the end of 1997. Donald and Marie asserted that Agent Chan's opening net worth figure for them was low because it did not account for a "cash hoard," namely, *245 cash in excess of $200,000 that they had allegedly received from Donald's father, Fred Worth. However, according to Social Security Administration (SSA) records, Fred's total income during the 40-year period ending in 1977 was $185,430. Fred started living in a federally subsidized housing unit for low-income seniors in 1985, and by 1986 his income consisted solely of Social Security and retirement payments totaling approximately $1,000 a month. Agent Chan determined that the "cash hoard" lead that petitioners suggested was not reasonable,*244 and she did not adjust Donald and Marie's opening net worth on this account. Petitioners also asserted that they had on hand large amounts of cash derived from White Sands' operations. Agent Chan did not dispute that assertion, but she was unable to determine exact changes in cash balances because of petitioners' incomplete records and commingling of funds. She therefore used the "floating cash" or "dash method" as approved in In determining petitioners' respective assets Agent Chan identified property that included bank accounts, brokerage statements, mutual funds, real estate, vehicles, *246 and inventory. The principal uncertainty concerned how White Sands' assets should be allocated among petitioners. Agent Chan determined that 50% of its assets should be allocated to Donald and Marie and 50% to Frank. She based this allocation on (among other things) the facts that: (1) Frank and Donald held themselves out to numerous third parties as coowners of White Sands; (2) Frank and Donald*245 admitted in civil litigation that they were coowners of (or "partners" in) White Sands; (3) Frank admitted to Agent Broderick that he was a 50% owner of White Sands; (4) Frank managed about half of the White Sands stores; (5) Frank and his parents each obtained EINs for White Sands; (6) Frank and his parents each reported shares of White Sands' profits on their respective Schedules C; and (7) the White Sands gross receipts and expenses reported on those Schedules C were divided roughly 50-50 between Frank on the one hand and Donald and Marie on the other.4 Frank's construction of a house in Santa Barbara during 1998-2000 evidenced significant increases to his net worth. He purchased the lot for $400,000 and tore down the existing dwelling unit. He then began construction of a 5,000-square-foot home that entailed at least $400,000 in construction costs, as *247 reported to Santa Barbara County authorities. Agent Chan allocated the construction costs to tax year 1998, 1999, or 2000 primarily on the basis of invoices*246 from contractors or similar evidence. She allocated costs for which she did not have invoices to tax year 2000, the year construction was completed. All construction costs served to increase Frank's net worth for the relevant year. Agent Chan next determined petitioners' respective liabilities for each year. These liabilities included mortgages on real estate, credit card debt, and vehicle loans. For each year in issue Agent Chan subtracted liabilities from assets to produce closing net worth, then offset the prior year's closing net worth to produce the annual change in net worth. The next step in Agent Chan's analysis was to "tax effect" the annual changes in net worth to produce AGI figures for each year. She therefore added "nondeductible items" and "itemized deductions" and subtracted "non-income items." For the most part "nondeductible items" consisted of personal living expenses. Such expenses must be paid from some source and, under the net worth theory, Agent Chan assumed that petitioners defrayed these expenses using unreported income. In adding back "nondeductible items" to petitioners' annual changes in net worth, Agent Chan included only those items (such as rent or car*247 lease payments) for which she had clear evidence of the amount and purpose, as *248 evidenced by canceled checks, invoices, or credit card statements. For this reason her implementation of the net worth methodology consistently understated petitioners' actual personal living expenses and hence understated their AGI for each year. For example, Agent Chan had evidence that petitioners paid residential water bills, and she included these expenses as "nondeductible items" in her calculation. However, she did not add back any other residential utility charges--e.g., for telephone, cable, gas, or electric service--because she did not have definitive evidence of such payments. Further, although Agent Chan had bank statements for most of Donald and Marie's accounts, she had canceled checks showing the payee for only a small number of the checks that cleared these accounts. In computing "nondeductible items" she added back only those expenses for which she had a canceled check denoting a personal type of expenditure (e.g., a check payable to a pharmacy). The effect was to treat all other checks as allocable to deductible business expenditures. Similarly, Agent Chan did not add back any expenses*248 for items like groceries, restaurant meals, clothing, or gasoline for which petitioners paid cash. In all these respects she resolved uncertainties in petitioners' favor, consistently understated their "nondeductible items," and correspondingly understated their AGI for each year in issue. *249 After adding back nondeductible expenses and petitioners' reported itemized deductions, Agent Chan subtracted "non-income items," that is, receipts from nontaxable sources. Frank asserted that certain funds he had received from his parents constituted a loan rather than a division of White Sands' profits and hence that these funds should have been treated as a "non-income item." However, Frank failed to present Agent Chan or the Court with any documentation of such a loan, any loan terms, or any proof of repayment. Without any proof that the transferred funds were nontaxable, Agent Chan declined to subtract this amount in determining Frank's AGI for the relevant year. At this step Agent Chan also made assumptions that benefited petitioners. For example, during one year in issue, Frank sold a house and realized a gain of $60,000. Agent Chan treated this as nontaxable gain from the sale of a principal*249 residence under Donald and Marie, who appeared pro se at trial, requested that they be allowed to present their case after respondent had put on his case. The Court *250 granted this request. After respondent rested, Donald and Marie decided to rest without putting on an affirmative case. The Court noted that Donald and Marie had included in the stipulation of facts a number of documents to which respondent had reserved objections and explained that these documents could not come into evidence unless they put on their case. They still wished to rest. The Court, on its own initiative, then examined the documents in question and admitted into evidence those for which there were no hearsay objections. After trial respondent filed a motion to amend to conform the pleadings to the proof. The purpose of this motion was to revise Agent Chan's net worth calculation to correct two minor errors that*250 came to light during her testimony. Specifically, respondent revised her calculation: (1) to move from 1999 to 2000, in determining Frank and Helen's net worth increases for those years, construction expenses of $7,268 on the Santa Barbara home and (2) to subtract, in determining Frank and Helen's AGI for 1999, an additional nontaxable item of $481. The revised deficiencies and fraud penalties for Frank and Helen are as follows:
*251 Because the Court instructed respondent to make these changes on the basis of the evidence heard at trial, we will grant respondent's motion. The IRS' determinations in a notice of deficiency are generally presumed correct, and the taxpayer bears the burden of proving those determinations erroneous. To satisfy his initial burden of production, respondent introduced records that he obtained during the criminal investigation and the civil examination. Those records establish that petitioners received during 1998-2000, but did not *252 report, substantial amounts of additional income from operation of White Sands. On the basis of this credible evidence, we are satisfied that the IRS' determinations as set forth in the notices of deficiency are entitled to the general presumption of correctness. As relevant here, the presumption of correctness is modified in one respect. Respondent in his answers asserted increased deficiencies as to Donald and Marie for 1999 and 2000, as to Frank for 1998, and as to Frank and Helen for 2000. Respondent bears the burden of proof as to these increased deficiencies. The IRS has great latitude in reconstructing a taxpayer's income, and the reconstruction "need only be reasonable in light of all surrounding facts and circumstances." *254 Under the net worth method the IRS reconstructs a taxpayer's income by determining his net worth (excess of assets at cost over liabilities) at the beginning and end of each year in issue. The difference between those amounts is the taxpayers' annual net worth increase (or decrease). The net worth increase for each year is then adjusted by adding nondeductible expenses (such as everyday living costs) and subtracting receipts from nontaxable sources (such as gifts, inheritances, and loans). In the instant cases petitioners failed to maintain accurate books or records from which their Federal tax liabilities could be computed. Frank admitted during *255 trial and in posttrial briefs that he failed to report at least $200,000 of income from White Sands. In their criminal tax case Donald and Marie stipulated that the tax loss attributable to their underreporting of income from White Sands was $210,628. Although this prior stipulation does not collaterally estop them from challenging the specific tax deficiencies asserted here, it does constitute an admission that their tax returns omitted substantial amounts of gross income. Petitioners do not question respondent's use of the net worth method to reconstruct their incomes for 1998-2000. They likewise do not challenge the analytical approach that Agent Chan adopted in implementing this methodology*255 or the manner in which she resolved most subsidiary issues. Petitioners contest respondent's position on five main grounds. First, they contend that Agent Chan testified as an expert and that her testimony and exhibits were inadmissible because respondent did not follow Tax Court Rules regarding the submission of expert testimony. Second, petitioners contend that Agent Chan did not accurately calculate their net worths because she failed to take into account "cash hoards" *256 that they allegedly derived from gifts and/or from operation of White Sands. Third, Frank contends that the increase in his net worth derived in part from a nontaxable source, namely, a loan from his parents. Fourth, Frank contends that Agent Chan erred in determining that he was a 50% owner of White Sands. Finally, Donald and Marie contend that the net worth calculation did not take into account their outstanding liability for California sales tax. We address these contentions below. Petitioners argue that Agent Chan testified as an expert by providing scientific, technical, and specialized knowledge. *257 An IRS revenue agent who reconstructs a taxpayer's income*257 and later testifies as to the methodology she employed generally is not an expert witness. For example, in [T]he witness was not testifying as an expert when she described the methodology used by respondent to ascertain petitioner's unreported income. The witness testified regarding what methodology was used, not the validity of that methodology. Since the witness was not providing scientific, technical, or other specialized knowledge to assist *258 the court to understand the evidence in this case, We agree with the Court's reasoning in *259 In the criminal tax context, "testimony by an IRS agent that allows the witness to apply the basic assumptions and principles of tax accounting to particular facts is appropriate." In *260 Using bank deposit records, Pleshaw computed the defendant's gross receipts * * *. He then set to one side non-taxable*260 receipts (such as loan proceeds) and subtracted business expenses (treating all non-cash withdrawals from the defendant's accounts as deductible) * * *. To the 2002 total, he added the cash found during the search (which the defendant had admitted * * * emanated from his business dealings). In that manner, Pleshaw arrived at an estimate of the defendant's net profits for each year. Thereafter, he adjusted for self-employment taxes, took the standard deduction, and factored in personal exemptions. These computations yielded the defendant's putative taxable income for each of the four years in question. * * * The Court of Appeals held that the characterizations Agent Pleshaw had made en route to his conclusions, e.g., classifying receipts as "income" and withdrawals as "expenses," did not represent impermissible legal opinions, but rather "were part of a mechanical sorting of entries" under the methodology he had employed. We reach the same conclusion here. Agent Chan testified about facts and*261 numerical data that were admitted into evidence, generally by stipulation. She testified as to the methodology she employed in reconstructing petitioners' incomes on the basis of these data. This methodology occasionally required her to characterize certain data, e.g., to break out cost basis, tax-deductible items, and *261 nondeductible items from a real estate closing document. But in so doing she was not offering legal opinions. She was simply explaining the "mechanical sorting of entries" in which she engaged using the methodology she had employed. Petitioners contend that the analysis set forth above "stems from case law that has been superseded by an amendment to the Federal Rules of Evidence." According to petitioners, before 2000 courts routinely allowed lay witnesses to offer opinion testimony in tax cases under Petitioners are mistaken. The same conclusion follows here. Since Agent Chan's testimony was not based on scientific, technical, or other specialized knowledge, it fell outside the scope of Proper implementation of the net worth method requires the IRS to establish the taxpayer's opening net worth with reasonable certainty. Donald and Marie allege that they had an undeposited cash hoard of about $200,000 at the end of 1997, supposedly resulting from a gift from Donald's father, Fred. The evidence established, however, that Fred was not in a financial position to make such a gift. According to SSA records Fred's total income during the 40-year period ending in 1977 was $185,430. Fred retired in 1985 and moved into a federally subsidized housing unit for low-income seniors. By 1986 *264 his income consisted solely of Social Security and retirement payments totaling about $1,000 a month. This evidence was clearly sufficient to support the inference that Fred lacked the wherewithal to make a $200,000 cash gift to Donald and Marie. Frank makes a somewhat different argument concerning his alleged undeposited cash. He contends that he derived large amounts of cash from White Sands' operations and that Agent Chan's net worth analysis failed to take this into account. The principal support for Frank's "cash hoard" argument was his own testimony,*265 which we did not find credible. Having observed his demeanor on the witness stand, we found him evasive and lacking in candor. We have considered his conviction for willfully making and subscribing to false returns as an additional factor bearing on his credibility. Credibility apart, Frank's "cash hoard" argument has no support in the record. Although Frank used cash to pay White Sands' expenses, there is no evidence that he accumulated a cash hoard from White Sands' operations. Quite the contrary: Frank testified that he collected the daily receipts from the stores he *265 managed, put them into a sealed envelope, and gave the envelope to his mother. The best evidence was that the store receipts constituting White Sands' profits were deposited by Marie or Donald into various bank accounts. There was no evidence that Frank "skimmed" profits from the stores he managed before delivering the sealed envelopes to Marie. White Sands was a cash-intensive business, and petitioners kept substantial amounts of cash on hand to pay its vendors and expenses. Changes in these cash balances theoretically could affect annual changes in their net worths. But the records petitioners supplied, which were*266 incomplete and often unreliable, did not enable Agent Chan to determine with any precision annual changes in cash balances. Petitioners can hardly complain of this. As the Court of Appeals for the Ninth Circuit put it: "Arithmetic precision was originally and exclusively in * * * [the taxpayer's] hands, and he had a statutory duty to provide it. * * * [H]aving defaulted in his duty, he cannot frustrate the Commissioner's reasonable attempts by compelling investigation and recomputation under every means of income determination." *266 For these reasons Agent Chan relied on the so-called dash method of accounting for undeposited cash. Instead of trying to calculate annual cash balances, Agent Chan assumed that the amounts of cash petitioners kept on hand for use in their business were relatively constant from year to year. In her net worth calculations, she accordingly placed a dash, or zero, in the column labeled "cash on hand." As a result the annual change in petitioners' net worths was not affected, positively or negatively, by the undeposited cash they held. Because it is impossible to ascertain, in unreported income situations, precisely how much cash a taxpayer has at any*267 particular time, courts have consistently approved the use of the "dash method." Proper implementation of the net worth method requires the IRS to adjust annual net worth increases by subtracting amounts received from nontaxable sources, such as gifts, inheritances, and loans. Frank contends that he "took out a variety of short-term personal loans from White Sands or his parents that were always repaid." A loan is "an agreement, either express or implied, whereby one person advances money to the other and the other agrees to repay it upon such terms as to time and rate of interest, or without interest, as the parties may agree." Agent Chan thoroughly investigated the transfers to Frank from his parents and determined that these transfers were not loans. There was no evidence whatsoever, apart from petitioners' uncorroborated testimony, that the sums transferred were loans as opposed to a division of White Sands' profits. No promissory notes were executed. There was no evidence of a stated interest rate. There was *268 no instrument establishing a repayment schedule. And there was no evidence that Frank ever repaid his parents or that his parents ever sought repayment. We found Frank's testimony on this point to be vague, conclusory, and unworthy of belief. Considering all the facts and circumstances, we find that Agent Chan correctly determined that these transfers were not loans. Frank contends that Agent Chan erred in allocating half of White Sands' assets to him. Before the IRS criminal investigation began, Frank repeatedly represented himself as a coowner of White Sands to vendors, landlords, banks, lessors, insurance companies, municipal officials, and the*269 State of California. During the criminal investigation Frank admitted in an interview with Agent Broderick that he was a 50% owner of White Sands. He reported White Sands' profits on his Schedules C, and its reported gross receipts and expenses were divided roughly 50-50 between his Schedules C and his parents' Schedules C. Considering all this evidence, Agent Chan reasonably concluded that 50% of White Sands' assets should be allocated to Frank. Frank testified inconsistently on this point at trial. He initially asserted that he had no ownership interest in White Sands but was a mere employee. Confronted with the facts that White Sands did not pay him a regular salary and *269 never issued him a Form W-2, he admitted that he might have had some ownership interest in the business. He then suggested that his ownership interest was, at most, one-third, with the remaining two-thirds split between his parents. His testimony to this effect was impeached by his averment, in a 2001 filing with the California superior court, that his mother had no ownership interest in the business. All in all we find that the evidence conclusively supports Agent Chan's determination that 50% of White Sands' assets*270 should be allocated to Frank for purposes of the net worth analysis. Donald and Marie contend that Agent Chan erred, in determining their liabilities, by failing to consider their "unpaid, outstanding debts to the California State Board of Equalization." Donald and Marie presented no affirmative case at trial and introduced no evidence to establish the fact of these liabilities. The only evidence they point to is a one-page exhibit captioned "Sales Tax Schedule." This schedule is not an official BOE document and appears to have been created using a Microsoft Excel program. The evidence does not establish that these amounts were bona fide liabilities that were due but unpaid. Absent such proof, they have failed to show any error in Agent Chan's calculations. Respondent has shown, by a preponderance of the evidence, that Agent Chan's net worth calculations were reasonable and free of arbitrariness and error. If anything, her calculations were generous to petitioners: she resolved numerous doubts in their favor, and she made assumptions that uniformly tended to understate their AGIs. She established petitioners' opening net worths*271 with reasonable certainty; reasonably determined that White Sands was the likely source of their omitted income; and negated all plausible nontaxable sources of income. Petitioners have identified no errors in her implementation of the net worth method, other than the minor errors that respondent conceded in his posttrial motion to amend to conform pleadings to proof. As thus adjusted we sustain respondent's determinations of petitioners' unreported income for 1998, 1999, and 2000 and his assertions of increased deficiencies for certain of these years. Respondent determined fraud penalties against petitioners for 1998, 1999, and 2000. Frank conceded the fraud penalties determined against him, and respondent does not contend that any of the underpayments were due to fraud perpetrated by Helen. "If any part of any underpayment of tax required to be shown on a return is due to fraud," *272 Fraud is intentional wrongdoing designed to evade tax believed to be owing. Circumstances that may indicate fraudulent intent, commonly referred to as "badges of fraud," include but are not limited to: (1) understating income; (2) maintaining inadequate records; (3) giving implausible or inconsistent explanations of behavior; (4) concealing income or assets; (5) failing to cooperate with tax authorities; (6) engaging in illegal activities; (7) providing testimony that lacks credibility; (8) filing false documents, including false income tax returns; (9) failing to file tax returns; and (10) dealing extensively in cash. Donald and Marie pleaded guilty to willfully making and subscribing to a false tax return for 1998. In their plea agreement they admitted that the "mistakes" they made on their 1999 and 2000 returns were the same as those they had made on their 1998 return. While willfully making and subscribing to a false return does not in itself establish liability for the civil fraud penalty, such activity may properly*274 be considered in connection with other facts in determining whether an underpayment of tax was due to fraud. Numerous badges of fraud demonstrate that Donald and Marie intentionally evaded the payment of tax they knew to be owed. They substantially understated their income for all three years in issue. We find that the facts, taken as a whole, clearly and convincingly establish that Donald and Marie acted with fraudulent intent and that each of their underpayments of tax for 1998,*275 1999, and 2000 was due to fraud. We accordingly sustain respondent's imposition of the civil fraud penalty under *275 To reflect the foregoing, Footnotes
RelatedJames A. Lloyd v. Commissioner 2020 T.C. Memo. 92 (U.S. Tax Court, 2020) Illinois Tool Works Inc. & Subsidiaries v. Commissioner 2018 T.C. Memo. 121 (U.S. Tax Court, 2018) O'Neal v. Comm'r 2016 T.C. Memo. 49 (U.S. Tax Court, 2016) Musa v. Comm'r 2015 T.C. Memo. 58 (U.S. Tax Court, 2015) Welch v. Helvering 290 U.S. 111 (Supreme Court, 1933) Helvering v. Taylor 293 U.S. 507 (Supreme Court, 1935) Spies v. United States 317 U.S. 492 (Supreme Court, 1943) Holland v. United States 348 U.S. 121 (Supreme Court, 1955) United States v. Stierhoff 549 F.3d 19 (First Circuit, 2008) George Schwarzkopf v. Commissioner of Internal Revenue 246 F.2d 731 (Third Circuit, 1957) Gene O. Clark and Faye Clark v. Commissioner of Internal Revenue 266 F.2d 698 (Ninth Circuit, 1959) Bernard G. McGarry v. United States 388 F.2d 862 (First Circuit, 1968) Bolen Webb and Cornelia Webb v. Commissioner of Internal Revenue 394 F.2d 366 (Fifth Circuit, 1968) Chris D. Stoltzfus and Irma H. Stoltzfus v. United States 398 F.2d 1002 (Third Circuit, 1968) United States v. Joe Raymond Diez and Peter A. Palori 515 F.2d 892 (Fifth Circuit, 1975) United States v. William A. Goichman 547 F.2d 778 (Third Circuit, 1976) United States v. Anthony J. Giacalone 574 F.2d 328 (Sixth Circuit, 1978) Johnny Weimerskirch v. Commissioner of Internal Revenue 596 F.2d 358 (Ninth Circuit, 1979) United States v. Leroy Lloyd Anderson, Sandra Miller Anderson 642 F.2d 281 (Ninth Circuit, 1981) Kent A. Adamson v. Commissioner of Internal Revenue 745 F.2d 541 (Ninth Circuit, 1984) Aleksandrs v. Laurins Cathie Laurins v. Commissioner Internal Revenue Service 889 F.2d 910 (Ninth Circuit, 1989) United States v. Nagesh Shetty 130 F.3d 1324 (Ninth Circuit, 1997) Cathy Miller Hardy v. Commissioner of Internal Revenue 181 F.3d 1002 (Ninth Circuit, 1999) Robert D. Grossman, Jr. v. Commissioner of Internal Revenue 182 F.3d 275 (Fourth Circuit, 1999) Illinois Tool Works Inc. & Subsidiaries v. Commissioner U.S. Tax Court, 2018 holding that revenue agent’s testi- mony “would be accepted, not for the purpose of demonstrating the correctness of her methodology, but solely for the purpose of explaining what she did”
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