Lakeisha Degourville ( 2022 )

United States Tax Court
T.C. Memo. 2022-93LAKEISHA DEGOURVILLE,
Petitioner
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent
—————
Docket No. 4369-16. Filed September 12, 2022.
—————
Lakeisha Degourville, pro se.
John T. Arthur and Ashley Y. Smith, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
WELLS, Judge: By notice of deficiency dated January 19, 2016,
respondent determined a deficiency of $139,249 in petitioner’s federal
income tax for the 2012 taxable year (year in issue) and a civil fraud
penalty under section 6663 1 of $100,022.
The issues to be decided are (1) whether certain proceeds remitted
to petitioner’s bank accounts are taxable income; (2) petitioner’s filing
status; (3) petitioner’s claim to the Earned Income Tax Credit (EITC);
(4) petitioner’s deductions of business expenses on two Schedules C,
Profit or Loss From Business; (5) imposition of the civil fraud penalty
1 Unless otherwise indicated, all statutory references are to the Internal
Revenue Code (I.R.C. or Code), Title 26 U.S.C., 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. Monetary amounts are rounded to the nearest dollar.
Served 09/12/22
2
[*2] under section 6663(a); and (6) imposition of the EITC 10-year ban
on account of fraud under section 32(k)(1)(B)(i).
FINDINGS OF FACT
Some of the facts have been deemed admitted upon the lack of a
timely response under Rule 90(c) or deemed stipulated under Rule 91(f)
and are so found. 2 The deemed admissions, stipulated facts, and
attached exhibits are incorporated into our findings by this reference.
Petitioner resided in Georgia when she timely filed her Petition for
redetermination with the Court.
Petitioner married Kenneth Degourville on October 15, 1999;
they remain married and resided within the same household along with
their three children until mid-2016. The couple never legally separated
during that time.
I. Background
A. Petitioner’s Businesses and Prior Tax Experience
Petitioner is a licensed cosmetologist and an experienced tax
return preparer. During the year in issue she solely owned and operated
a tax preparation company (TaxTime Services or TaxTime) and a hair
salon (Xplosions Hair Design) and co-owned a restaurant with her
husband. Petitioner and her husband maintained bank accounts at
SunTrust Bank to manage cashflow from each of these businesses.
TaxTime was recognized as one of the largest tax return preparation
companies in Columbus, GA, had continuous operations from 2009 until
2014, and employed approximately 18 persons on average.
Before running her own businesses, petitioner worked as a tax
return preparer for Expert Tax Services from 2007 to 2009. She also
dedicated time to furthering her tax expertise by attending several
courses and seminars in individual tax return preparation. Eventually
2 On May 25, 2017, respondent filed a First Request for Admissions under Rule
90 which was later deemed admitted and incorporated into the record at trial on
September 25, 2017. On July 6, 2017, respondent likewise filed a Rule 91(f) Motion
with regard to proposed stipulated facts. On July 18, 2017, the Court issued an Order
granting respondent’s Rule 91(f) Motion and directing petitioner to file a response to
the Motion by August 22, 2017. Petitioner failed to respond to respondent’s Rule 91(f)
Motion, and on August 31, 2017, the Court made absolute its July 18, 2017, Order.
The facts set forth in the Proposed Stipulation of Facts were deemed stipulated, and
the Exhibits were admitted for purposes of trial and opinion herein.
3
[*3] she accumulated enough knowledge to host her own tax return
preparation courses, which she administered from 2011 to 2016.
B. Assessment of the Due Diligence Penalty Under Section
6695(g)
On July 28, 2014, respondent properly assessed against petitioner
a Return Preparer EITC Due Diligence Penalty under section 6695(g) of
$45,000 for the 2012 taxable year.
C. Cash Purchases
Petitioner used cash to purchase four properties in Georgia
between 2012 and 2013. The general location and purchase price of each
transaction are as follows: Amber Drive in Midland for $23,000;
Beallwood Avenue in Columbus for $20,000; Maddox Drive in Hamilton
for an unspecified amount; and Glenwood Road in Columbus for
$52,000. In May 2013 petitioner’s husband made a cash purchase of
property on Irwin Way in Columbus for $42,000. Petitioner, together
with her husband, made a cash purchase of a plot of land on
Preservation Trail in Midland in November 2013 for $90,000, and
subsequently paid $366,436 via personal and cashier’s checks for the
construction of a 3,727-square-foot home on the property. Additionally,
between 2010 and 2013 petitioner made cash purchases of a 2006
Hummer, a 2009 Chevy C15, a 2012 Lexus, a 2013 Honda, a 2013 Audi,
and a motorcycle.
D. Conviction for State-Level Tax Evasion and Theft By
Taking
On June 10, 2016, the State of Georgia convicted petitioner of one
count of state tax evasion (for failing to report income on her state
individual income tax return) and one count of theft by taking (for
improperly filing her TaxTime clients’ state income tax returns). As part
of her sentence, which included 15 years of probation and a $31,300 fine,
the State of Georgia permanently barred petitioner from owning or
operating any tax preparation company and preparing income tax
returns at the state, local, or federal level for other persons.
Petitioner testified at her state criminal trial that TaxTime
earned $552,865 in fees for the 2012 tax year and that $168,466 of these
gross receipts was reported as profit on an amended 2012 state income
tax return. She further testified that she brought in revenues of around
4
[*4] $150,000 from Xplosions Hair Design and incurred a substantial
loss attributable to her restaurant business.
II. Petitioner’s 2012 Tax Reporting
Petitioner and her husband each filed their own Forms 1040, U.S.
Individual Income Tax Return, for the 2012 taxable year electing the
head of household filing status. Petitioner listed her address as the
home she purchased on Beallwood Avenue. She later conceded that her
mother lived there and that she in fact resided with her husband in the
newly constructed home on Preservation Trail during 2012. Her
husband listed his address as a home on Quail Creek Drive in Columbus,
GA. Petitioner prepared her 2012 state income tax return using the
information from her 2012 federal income tax return. After examining
petitioner’s federal return, respondent adjusted her filing status from
head of household to married filing separately.
A. EITC
Petitioner and her husband both separately claimed the EITC
from 2007 to 2012 on their respective tax returns. Respondent
disallowed petitioner’s claim to the EITC for the year in issue.
B. Schedule C
Petitioner attached two Schedules C to her 2012 federal income
tax return. She reported gross receipts of $20,316 for Xplosions Hair
Design and $15,811 for TaxTime, both offset by several business
deductions. Among those deductions, respondent disallowed those for
rent/lease expenses of $18,300 in regard to Xplosions Hair Design and
commission expenses of $5,000 in regard to TaxTime. No records were
produced to substantiate these expenses. Petitioner reported net profits
of $980 for Xplosions Hair Design and $9,088 for TaxTime.
III. Respondent’s Audit and Bank Deposits Analyses
Respondent initiated an examination of petitioner’s federal
individual income tax return for the 2012 taxable year and requested
that she produce complete and adequate records and accounts of her
income-producing activities in that year. Petitioner failed to proffer any
business records at that time. At trial petitioner claimed that she
remained unable to produce any records of her income-producing
activities because they were being held by Georgia state authorities as
part of the state’s criminal investigation.
5
[*5] In lieu of business records respondent conducted bank deposit
analyses on seven separate SunTrust Bank accounts associated with
petitioner and her husband to determine petitioner’s 2012 adjusted
gross income. Respondent’s bank deposits analyses demonstrated that
$1,054,255 was deposited into the couple’s SunTrust Bank accounts in
2012. Respondent’s initial analysis calculated unexplained deposits of
$911,033. After accounting for gross revenues already reported,
properly allowed business expenses, and computational adjustments, 3
respondent determined that petitioner had unreported gross receipts of
$439,705.
Petitioner has assigned no error to respondent’s bank deposit
analyses. In addition, there is no evidence that petitioner received any
gifts, inheritances, legacies, devices, nontaxable or excludable income,
receipts, cash, or other assets during the year in issue.
OPINION
As a general rule, the Commissioner’s determination of a
taxpayer’s liability in a notice of deficiency is presumed correct and the
taxpayer bears the burden of proving that the determination is
incorrect. Rule 142(a)(1); Welch v. Helvering, 290 U.S. 111, 115 (1933).
In certain circumstances, if the taxpayer introduces credible evidence
with respect to any factual issue relevant to ascertaining the proper tax
liability, section 7491(a)(1) shifts the burden of proof to the
Commissioner. Rule 142(a)(2). The Commissioner also has the burden
of proof in respect of any new matter pleaded in the answer. See Rule
142(a)(1).
Petitioner has not introduced credible evidence sufficient to shift
the burden of proof to respondent as to any relevant issue in dispute
here. Respondent raised the section 32(k) issue in an Amendment to
Answer, however. Since the section 32(k) issue was not included in the
notice of deficiency and requires the presentation of different evidence,
viz, evidence of a final determination of prior fraud, respondent has
introduced a new matter and bears the burden of proof. See Achiro v.
Commissioner, 77 T.C. 881, 890 (1981); Sanderling, Inc. v.
Commissioner, 66 T.C. 743, 757–58 (1976), aff’d in part, 571 F.2d 174(3d Cir. 1978). Accordingly, petitioner bears the burden of proof as to
3 Respondent indicates that the notice of deficiency asserts one-half of the
unexplained taxable income against petitioner; the remaining half was asserted
against petitioner’s husband in his separately issued notice of deficiency.
6
[*6] all factual issues with the exception of the dispute relating to
section 32(k).
I. Unreported Income
A. Presumption of Correctness
Efficient and harmonious judicial administration requires us to
follow the law of the Court of Appeals to which appeal of our decision
directly lies. Golsen v. Commissioner, 54 T.C. 742, 757 (1970), aff’d, 445
F.2d 985 (10th Cir. 1971). For cases appealable to the U.S. Court of
Appeals for the Eleventh Circuit, as this case appears to be absent a
stipulation to the contrary, see I.R.C. § 7482(b)(1)(A), (2), the
Commissioner’s determination of unreported income is entitled to a
presumption of correctness only if the determination is supported by a
minimal evidentiary foundation linking the taxpayer to an income-
producing activity, see Blohm v. Commissioner, 994 F.2d 1542, 1549
(11th Cir. 1993), aff’g, T.C. Memo. 1991-636. Once the Commissioner
produces evidence linking the taxpayer to an income-producing activity,
the presumption of correctness applies and the burden of production
shifts to the taxpayer to rebut that presumption by establishing that the
Commissioner's determination is arbitrary or erroneous. Id.Respondent has shown that petitioner directly operated both
TaxTime Services and Xplosions Hair Design, and at minimum received
distributions from the restaurant she co-owned with her husband. As
discussed below, these businesses were capable of producing the
significant amounts deposited into petitioner and her husband’s
SunTrust Bank accounts during the year in issue. Petitioner failed to
produce evidence establishing that respondent’s determinations
concerning her bank deposits are arbitrary or erroneous. Accordingly,
we find that respondent laid the requisite minimal evidentiary
foundation for the contested unreported income adjustments and that
his determinations are entitled to a presumption of correctness.
B. Gross Income and Bank Deposits Analyses
Gross income includes “all income from whatever source derived,
including (but not limited to) . . . [g]ross income derived from business.”
I.R.C. § 61(a). This definition is construed broadly and extends to all
accessions to wealth, clearly realized, over which the taxpayer has
complete control. See Commissioner v. Glenshaw Glass Co., 348 U.S.
426, 431 (1955). A taxpayer must maintain books and records
establishing the amount of his or her gross income. I.R.C. § 6001. If a
7
[*7] taxpayer fails to maintain and produce the required books and
records, the Commissioner may determine the taxpayer’s income by any
method that clearly reflects income. See I.R.C. § 446(b); Petzoldt v.
Commissioner, 92 T.C. 661, 693 (1989); Treas. Reg. § 1.446-1(b)(1). The
Commissioner’s reconstruction of income “need only be reasonable in
light of all surrounding facts and circumstances.” Petzoldt, 92 T.C.
at 687.
The bank deposits method is a permissible method of
reconstructing income. See Clayton v. Commissioner, 102 T.C. 632, 645
(1994); see also Langille v. Commissioner, T.C. Memo. 2010-49, aff’d, 447
F. App’x 130 (11th Cir. 2011). Bank deposits are considered prima facie
evidence of a taxpayer’s receipt of income. Tokarski v. Commissioner,
87 T.C. 74, 77 (1986). The Commissioner need not show the likely source
of a deposit treated as income, but the Commissioner “must take into
account any nontaxable source or deductible expense of which [he] has
knowledge” in reconstructing income using the bank deposits method.
See Clayton, 102 T.C. at 645–46. After the Commissioner reconstructs
a taxpayer’s income and determines a deficiency, the taxpayer bears the
burden of proving that the Commissioner’s use of the bank deposits
method is unfair or inaccurate. See id. at 645. The taxpayer may prove
that the reconstruction is in error, in whole or in part, by proving that a
deposit is not taxable. Id.Respondent introduced credible evidence that petitioner failed to
maintain, or to submit for examination, complete and adequate records
of her income-producing activities for the 2012 taxable year. Petitioner
was fully aware of her obligation to maintain such records as she held
herself out to the public and qualified as an expert in tax return
preparation. We therefore find that it was reasonable for respondent to
reconstruct petitioner’s income using the bank deposits method.
Accordingly, petitioner bears the burden of proving that respondent’s
reconstruction is unfair, inaccurate, or in error by proving that a deposit
is not taxable.
Respondent’s bank deposits analyses determined that petitioner
and her husband received taxable income in excess of $1 million, of
which at least $800,000 went unreported on their collective tax returns
for the year in issue. Respondent allocated the unreported income pro
rata with respect to the couple’s ownership interests in their mutually
owned businesses after accounting for verifiable expenses. Ultimately,
following respondent’s accounting of gross revenues already reported,
properly allowed business expenses, and computational adjustments,
8
[*8] respondent concluded that petitioner failed to report gross receipts
of $439,705.
Respondent has shown that petitioner’s business interests are a
likely source of the deposits made into the couple’s bank accounts.
Petitioner herself illustrated the earnings potential of her business
interests at her state criminal trial wherein she testified that TaxTime
earned $552,865 in fees for the 2012 tax year, $168,466 of which was
reported as profit in an amended 2012 state income tax return.
Petitioner further testified at this trial that Xplosions Hair Design
earned around $150,000 in revenues. The exception is the substantial
loss attributed to her restaurant business, which her husband estimated
during the same trial to be about $119,000. The testimony produced at
her criminal trial supports the conclusion that petitioner’s business
interests likely produced the amounts deposited into her and her
husband’s bank accounts. Although petitioner has not conceded these
amounts, she has assigned no error to respondent’s bank deposits
analyses.
Petitioner disputes respondent’s determinations on the basis that
(1) the $439,705 in unreported gross receipts was earned not only by her
but also by other contractors who worked at TaxTime and (2) that
respondent failed to take into account her restaurant loss of around
$250,000. Petitioner contends the significant loss was funded by the
revenue generated by her other businesses. Notwithstanding this claim,
petitioner has presented no evidence proving either a deduction of fees
paid to TaxTime contractors or the restaurant loss. Petitioner contends
she is unable to present evidence because her business records were
seized and remain held by Georgia state authorities in connection with
her state criminal case; but petitioner also admits to failing to request
the return of these records as of the date of trial in this case. In
consideration of the foregoing, petitioner has failed to show the non-
taxable nature of any bank deposits, or that respondent’s reconstruction
is unfair, inaccurate, or in error. Respondent’s determination that
petitioner had unreported taxable income of $439,705 during tax year
2012 is sustained in full.
II. Head of Household Filing Status
Section 1(b) provides a special tax rate for an individual who
qualifies as a head of household. A taxpayer qualifies for head of
household filing status if he or she (1) is not married at the close of the
taxable year and (2) maintains as his or her home “a household which
9
[*9] constitutes for more than one-half of such taxable year the principal
place of abode” of a son or daughter. I.R.C. § 2(b)(1)(A). A taxpayer who
is married may nevertheless qualify as not married for head of
household filing purposes if (1) the taxpayer files a separate tax return,
(2) the household is, for more than one-half of the taxable year, the
principal place of abode of the taxpayer’s child for whom the taxpayer
would be entitled to claim a dependency exemption, (3) the taxpayer
“furnishes over one-half of the cost of maintaining such household
during the taxable year,” and (4) the taxpayer’s spouse is not a member
of the household during the last six months of the taxable year. I.R.C.
§ 7703(b).
Petitioner and her husband filed separate income tax returns for
2012, each electing head of household status and indicating that they
lived in separate residences. Petitioner listed Beallwood Avenue as her
home address while her husband listed his as Quail Creek Drive.
However, petitioner conceded that both she and her husband physically
resided within the same household on Preservation Trail for the entirety
of the 2012 tax year and were not legally separated during that time.
On the basis of that admission, petitioner failed to meet the fourth
requirement of section 7703(b) and is therefore not entitled to elect head
of household filing status for the 2012 tax year. Respondent’s
adjustment of petitioner’s filing status from head of household to
married filing separately is sustained.
III. EITC
Section 32(a)(1) provides an earned income tax credit for certain
“eligible individuals” against the individual’s income tax liability. The
credit is calculated as a percentage of the individual’s earned income.
I.R.C. § 32(a)(1). Section 32(d) provides, however, that a married
individual within the meaning of section 7703 is eligible for the EITC
only if a joint return is filed for the taxable year. Treas. Reg. § 1.32-
2(b)(2). Section 7703(b) provides, in pertinent part, that a married
person whose spouse did not live with him or her for the last six months
of the taxable year is not considered to be married for federal income tax
purposes. I.R.C. § 7703(b)(3).
As discussed above, petitioner is a married individual within the
meaning of section 7703 and filed an income tax return separately from
her husband for the 2012 tax year. In order to qualify for the EITC
petitioner listed as her home address a residence that she concededly
did not physically reside in. Because petitioner and her husband were
10
[*10] married, not legally separated, and shared the same household
during the year in issue, section 32(d) required them to file a joint return
to properly qualify for the EITC. Moreover, it is highly unlikely
petitioner would have qualified for the EITC even if she had filed jointly
with her husband considering the couple’s substantial unreported gross
receipts and the income phaseout limitations described in section
32(a)(2). We therefore hold that petitioner is not entitled to the EITC
for the year in issue.
IV. Schedule C Business Expenses
Deductions are a matter of legislative grace, and the taxpayer
generally bears the burden of proving entitlement to any deduction
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).
Under section 162(a), a deduction is allowed for ordinary and necessary
expenses paid or incurred during the taxable year in carrying on any
trade or business. Such expenses must be directly connected with or
pertain to the taxpayer’s trade or business. Treas. Reg. § 1.162-1(a).
A taxpayer must substantiate deductions claimed by keeping and
producing adequate records that enable the Commissioner to determine
the taxpayer’s correct tax liability. I.R.C. § 6001; Hradesky v.
Commissioner, 65 T.C. 87, 89–90 (1975), aff’d per curiam, 540 F.2d 821(5th Cir. 1976); Treas. Reg. § 1.6001-1(a). When a taxpayer establishes
that she paid or incurred a deductible expense but does not establish the
amount of the expense, we may estimate the amount allowable under
limited circumstances. See Cohan v. Commissioner, 39 F.2d 540, 543–
44 (2d Cir. 1930). However, there must be sufficient evidence in the
record to permit us to conclude that the taxpayer paid or incurred the
deductible expense in at least the amount allowed. See Williams v.
United States, 245 F.2d 559, 560 (5th Cir. 1957).
Petitioner claimed deductions for rent/lease expenses of $18,300
and commission expenses of $5,000 for her two reported Schedule C
businesses, Xplosions Hair Design and Taxtime Services, respectively.
Respondent disallowed each of these deductions for lack of
substantiation following petitioner’s failure to produce requested
documentation of her income-producing activities. Petitioner indicated
at trial that she could not produce any evidence of her expenses because
her business records were still held by Georgia state authorities. She
did not consider requesting the documents from the state authorities
because the state criminal case remained active. There is no evidence
11
[*11] she attempted to secure copies from alternative sources. It follows
that there is no documentation in the record to substantiate her claimed
Schedule C business expenses, and we have no basis to make any
estimates under the Cohan rule. Under the circumstances, petitioner
has failed to meet her burden of proving that she incurred these
expenses and that they were incurred for ordinary and necessary
business purposes. Respondent’s disallowance of these deductions is
sustained.
V. Penalty
Respondent determined that petitioner is liable for the section
6663 civil fraud penalty for the year in issue. 4
A. Section 6751(b) Compliance
We initially must determine whether respondent has satisfied the
section 6751(b) procedural requirements for imposing the section 6663
civil fraud penalty. 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 I.R.C.
§ 7491(c); Higbee v. Commissioner, 116 T.C. 438, 446–47 (2001). 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 (Graev III), 149 T.C. 485, 492–93 (2017), supplementing
and overruling in part Graev v. Commissioner (Graev II), 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 III,
149 T.C. at 492–93; see also Clay v. Commissioner, 152 T.C. 223, 248
(2019) (quoting section 6751(b)(1)), aff’d, 990 F.3d 1296 (11th Cir. 2021).
Trial of this case was held and the record was closed before the
issuance of our opinion in Graev III, which overruled in part our decision
in Graev II and held that the Commissioner’s burden of production
under section 7491(c) includes showing supervisory approval as
required by section 6751(b). In the light of the Court’s decision in
4 In the event that we do not uphold the section 6663 civil fraud penalty,
respondent asks the Court to find petitioner liable for the section 6662 (a) and (b)(2)
substantial understatement penalty. Because we find that petitioner is liable for the
section 6663 civil fraud penalty and that the penalty applies to the entirety of her
underpayment of tax, the section 6662 penalty is moot. See I.R.C. § 6662(b).
12
[*12] Graev III, respondent filed a motion to reopen the record to include
a completed Civil Penalty Approval Form dated November 2, 2015, and
signed before the issuance of the notice of deficiency on January 19,
2016, along with a declaration by the examining agent who
recommended the penalty. Respondent’s Civil Penalty Approval Form
evinces supervisory approval from the group manager (with agreement
from the revenue agent) for the section 6663 civil fraud penalty imposed
“due to the egregious under-reporting of income by the taxpayers.” We
ordered petitioner to file a response to respondent’s motion, but she
neglected to do so.
The decision to reopen the record to admit additional evidence is
within our broad discretion. Zenith Radio Corp. v. Hazeltine Rsch., Inc.,
401 U.S. 321, 331–32 (1971); Butler v. Commissioner, 114 T.C. 276, 286–
87 (2000). We “will not grant a motion to reopen the record unless,
among other requirements, the evidence relied on is not merely
cumulative or impeaching, the evidence is material to the issues
involved, and the evidence probably would change the outcome of the
case.” Butler, 114 T.C. at 287. We also balance the moving party’s
diligence against the possible prejudice to the nonmoving party. In
particular we consider whether reopening the record after trial would
prevent the nonmoving party from examining and questioning the
evidence as it would have during the proceeding. Estate of Freedman v.
Commissioner, T.C. Memo. 2007-61, 2007 WL 831802, at *12.
We agree with respondent that the Civil Penalty Approval Form
is not cumulative, is material to the penalty issues in this case, and
probably would change the outcome. See Butler, 114 T.C. at 287.
Reopening the record here serves the interests of justice because the
record was closed in this case before we issued Graev III and because
petitioner never raised compliance with section 6751(b)(1) as an issue
before the record was closed. This is the type of evidence we routinely
admit at trial solely on the basis of declarations such as those proffered.
For these reasons, we will grant respondent’s motion to reopen the
record and admit the Civil Penalty Approval Form into evidence. And,
because the group manager approved the section 6663 civil fraud
penalty for petitioner’s 2012 tax year before respondent sent the notice
of deficiency, which served as the first formal communication of the
determination to assert a penalty for the year in issue, we find that
respondent has satisfied his burden with respect to the procedural
requirements of section 6751(b).
13
[*13] B. Section 6663 Civil Fraud Penalty
Next, we will address whether petitioner is liable for the section
6663 civil fraud penalty for the year in issue. Section 6663(a) imposes a
penalty equal to 75% of the taxpayer’s underpayment of federal income
tax that is due to fraud. Fraud is an intentional wrongdoing on the part
of the taxpayer with the specific purpose of evading a tax believed to be
owing. Petzoldt, 92 T.C. at 698; Minchem Int’l, Inc. v. Commissioner,
T.C. Memo. 2015-56, at *43, aff’d sub nom. Sun v. Commissioner, 880
F.3d 173 (5th Cir. 2018). If any portion of the underpayment is
attributable to fraud, the entire underpayment will be treated as
attributable to fraud unless the taxpayer establishes by a
preponderance of the evidence that part of the underpayment is not due
to fraud. I.R.C. § 6663(b).
Respondent has the burden of proving fraud by clear and
convincing evidence. See I.R.C. § 7454(a); Rule 142(b). To carry that
burden, respondent must show that (1) an underpayment of tax exists
for the year in issue, and (2) some part of the underpayment is
attributable to fraud. See I.R.C. §§ 6663(a), 7454(a); DiLeo v.
Commissioner, 96 T.C. 858, 873 (1991), aff’d, 959 F.2d 16 (2d Cir. 1992).
Respondent has clearly and convincingly demonstrated that petitioner
failed to report income derived from her three business interests during
the year in issue and that her failure ultimately led to an underpayment
of tax. The first element of the civil fraud penalty has therefore been
established.
Turning to the second element, we must determine whether
petitioner had the requisite fraudulent intent. The existence of fraud is
a question of fact to be resolved upon consideration of the entire record.
See DiLeo, 96 T.C. at 874. 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. However, 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; Gajewski v.
Commissioner, 67 T.C. 181, 199–200 (1976), aff’d without published
opinion, 578 F.2d 1383 (8th Cir. 1978). The taxpayer’s entire course of
conduct may establish the requisite fraudulent intent. See
Niedringhaus v. Commissioner, 99 T.C. 202, 210 (1992).
The circumstantial evidence by which the Commissioner may
prove fraud includes various “badges of fraud” on which courts often
14
[*14] rely. See Bradford v. Commissioner, 796 F.2d 303, 307 (9th Cir.
1986), aff’g T.C. Memo. 1984-601; DiLeo, 96 T.C. at 875. 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
Bradford v. Commissioner, 796 F.2d at 307–08; Parks v. Commissioner,
94 T.C. 654, 664–65 (1990); Recklitis v. Commissioner, 91 T.C. 874, 910
(1988); Lipsitz v. Commissioner, 21 T.C. 917 (1954), aff’d, 220 F.2d 871(4th Cir. 1955). 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. We may also consider a taxpayer’s
intelligence, education, and tax expertise in deciding whether the
taxpayer acted with fraudulent intent. Iley v. Commissioner, 19 T.C.
631, 635 (1952).
Respondent has shown that several badges of fraud are evident
in this case. Respondent’s bank deposits analyses demonstrate that
petitioner’s substantially understating gross receipts from her
businesses resulted in a substantial understatement of income on her
2012 federal income tax return. The analyses show that for tax year
2012 petitioner reported gross receipts of $36,127 when the bank
deposits show the correct amount attributed to her was $439,705, more
than ten times larger. As a consequence of her substantial
understatement of income and her improper claim to the EITC,
petitioner did not pay any tax for 2012 and instead received a refund of
$2,886.
Petitioner engaged in more than one illegal activity during the
year in issue. She was assessed the Return Preparer EITC Due
Diligence Penalty under section 6695(g) for failing to comply with the
due diligence requirements of the Code when determining her clients’
eligibility to claim the earned income credit available under section 32.
15
[*15] Section 6695(g) mandated a penalty of $500 for each such failure. 5
The fact that petitioner’s penalty under section 6695(g) totaled $45,000
indicates that she improperly filed 90 tax returns on behalf of her
clients. Moreover, petitioner was convicted by the State of Georgia in
June 2016 of theft by taking, relating to the fraudulent preparation and
filing of her clients’ state income tax returns, and state income tax
evasion, relating to fraudulently preparing and filing her own state
income tax return, with respect to tax year 2012. We have previously
held that although a criminal conviction involving state income tax
violations does not by itself establish fraudulent intent, it does provide
“evidence of a propensity to defraud.” See Hatling v. Commissioner, T.C.
Memo. 2012-293, at *17 (quoting Lee v. Commissioner, T.C. Memo. 1995-
597); see also Petzoldt, 92 T.C. at 701–02.
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. Filing false
documents with the IRS constitutes “an ‘affirmative act’ of
misrepresentation sufficient to justify the fraud penalty.” Zell v.
Commissioner, 763 F.2d 1139, 1146 (10th Cir. 1985), aff’g T.C. Memo.
1984-152. Petitioner filed federal income tax returns for the year in
issue knowingly omitting significant amounts of gross income. This act
plainly exhibited an unquestionable intent to conceal, mislead, or
prevent the collection of tax. We also find that respondent has
demonstrated by clear and convincing evidence that petitioner
intentionally falsified information on her 2012 tax return in order to
fraudulently claim the EITC, for which she was ineligible. Petitioner
deliberately listed as her home address an address at which she did not
reside. Petitioner filed under head of household status when in fact she
was married and resided with her husband. Taxpayers who are married
and share the same household with their spouse must file a joint income
tax return to properly qualify for the EITC. See I.R.C. § 32(d). Petitioner
also significantly underreported her income. Even if petitioner had lived
separately from her husband, her income would have negated eligibility
for the EITC because of its income restrictions. See I.R.C. § 32(a)(2).
These inaccuracies appear to have been made in a deliberate effort to
fraudulently claim the EITC and avoid detection by tax authorities, and
5 The prior version of section 6695(g) effective as of taxable year 2012 penalized
tax preparers $500 for each failure to determine eligibility for the earned income credit.
The statute has since been amended to include within its scope each failure by a tax
preparer to determine (1) eligibility to file as a head of household on the return, or
(2) eligibility for, or the amount of, the credit allowable by section 24, 25A(a)(1), or 32.
16
[*16] we so find. Petitioner’s expertise in individual income tax
preparation demonstrates that she particularly would have had the
requisite knowledge of the threshold income eligibility and filing status
requirements to qualify for the EITC.
Intent to evade tax may be inferred from the “concealment of
assets or covering up sources of income.” Spies v. United States, 317
U.S. 492, 499 (1943). Petitioner covered up sources of income by failing
to produce adequate business records in response to the initial
examination of her tax returns. She concealed assets through a
multitude of cash purchases as outlined below.
Extensive dealing in cash to avoid scrutiny of a taxpayer’s
finances is a badge of fraud. See Bradford v. Commissioner, 796 F.2d
at 307–08. In particular, when a taxpayer’s dealings in cash are
accompanied by attempts to conceal transactions, that course of conduct
is probative evidence of fraud. See Valbrun v. Commissioner, T.C.
Memo. 2004-242. Petitioner’s cash dealings alone may be sufficient to
be dispositive of her fraudulent intent. Petitioner and her husband
purchased six properties in cash or cash equivalents throughout
Muscogee County, GA. On one of those properties, the couple paid
$366,436 in cash to fund the construction of a 3,727-square-foot home.
In addition, petitioner made cash purchases of six vehicles between 2010
and 2013. She provided no explanations or records concerning any of
these cash transactions. Accordingly, we find that petitioner engaged in
cash transactions in an effort to conceal income and that her overall
course of conduct is probative of fraud.
Petitioner appears to argue that her failure to report income was
due to negligence, rather than fraud, by testifying that operating many
businesses at once caused her to “lack attention to certain areas,” and
that neglect was responsible for the “mistake” of underreporting her
income. While it may be true that 2012 was a busy year for her,
petitioner’s tax knowledge, training, and course instruction weigh
heavily against her claim that underreporting significant amounts of
gross income was a mistake. See, e.g., Becker v. Commissioner, T.C.
Memo. 2018-69, at *49. As an experienced, highly trained tax return
preparer who held herself out to the public as such, petitioner was or
should have been fully aware of her obligation to accurately report
income and of the consequences of failing to do so. In general, operating
a few businesses is not a reasonable defense to underreporting the
income derived therefrom, nor is it a reasonable excuse considering one
of those businesses was a tax preparation company. The evidence in this
17
[*17] case supports the conclusion that petitioner knowingly attempted
to evade her tax obligations and that her underpayment of tax was due
to fraud. Petitioner has not raised any other argument nor shown that
any amount should be excluded from the civil fraud penalty.
Accordingly, the Court holds that she is liable for the section 6663 civil
fraud penalty on the entirety of her underpayment of tax.
VI. EITC 10-Year Ban
Respondent sought our “approval” to impose the EITC 10-year
ban due to fraud under section 32(k)(1)(B)(i) in an Amendment to
Answer. Section 32(k)(1)(A) establishes the general rule that “[n]o credit
shall be allowed under this section for any taxable year in the
disallowance period.” Section 32(k)(1)(B)(i) defines the disallowance
period, in relevant part here, as “the period of 10 taxable years after the
most recent taxable year for which there was a final determination that
the taxpayer’s claim of credit under this section was due to fraud.”
It is unclear what respondent means by approval to impose such
a ban. Respondent contends in the Amendment to Answer that
petitioner improperly claimed the EITC in “various preceding tax years”
but neither alleges nor offers proof of a prior determination of fraud.
Respondent does not identify nor allege the “most recent taxable year”
for which there was a final determination that petitioner’s claim to the
EITC was due to fraud. Respondent does not clarify his view of the role
played by the state conviction or any unidentified prior determinations
by this Court. It follows that respondent has provided insufficient
pleadings and supporting facts to permit the Court to determine
compliance with section 32(k)(1) under a plain and ordinary reading of
the statute. See Klein v. Commissioner, 45 T.C. 308, 311 (1965) (“Our
rules require full—rather than incomplete, fragmentary, or vague—
pleadings by the parties.”). Furthermore, the Court has already decided
above for the year in issue that petitioner is not eligible to claim the
EITC pursuant to section 32(a)(1). Accordingly, we find that the issue
is not properly before the Court and we decline to address it. 6
6 In his Simultaneous Opening Brief, respondent asks us for the first time to
“uphold” imposition of the EITC 2-year ban due to negligence pursuant to section
32(k)(1)(B)(ii) in the event the Court does not “uphold” imposition of the EITC 10-year
ban due to fraud. In addition to raising the issue too late, respondent’s request for the
2-year ban fails for the same reasons as for the 10-year ban. The 2-year disallowance
18
[*18] We have considered all of the arguments made by the parties and,
to the extent they are not addressed herein, we find them to be moot,
irrelevant, or without merit.
To reflect the foregoing,
An appropriate order and decision will be entered.
period is defined as “the period of 2 taxable years after the most recent taxable year for
which there was a final determination that the taxpayer's claim of credit under this
section was due to reckless or intentional disregard of rules and regulations (but not
due to fraud).” See id. (emphasis added).