Alan Brian Fabian ( 2022 )

United States Tax Court
T.C. Memo. 2022-94ALAN BRIAN FABIAN,
Petitioner
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent
—————
Docket No. 25589-14. Filed September 13, 2022.
—————
P was the sole shareholder of C. C purported to
engage in sale-and-leaseback transactions in which it
would purchase computer equipment and software
(together, equipment), sell the equipment to a third party,
lease it back from that party, and make lease payments in
return. The third party did not take possession of the
equipment that it had agreed to purchase from C, and C
did not purchase much of the equipment it purported to sell
to the third party. C made “lulling payments” from the
lease payments received from the third party. P caused C
to pay out a portion of those receipts to entities in which P
had an ownership interest or otherwise controlled as well
as to personal bank and brokerage accounts of P’s. The
issues we must address include (1) P’s objection to the
testimony of one of R’s witnesses on the grounds that her
testimony improperly discloses a grand jury matter;
(2) whether the periods of limitation on assessment and
collection have expired; (3) whether P received constructive
distributions on account of transfers from C to the various
entities and to him, (4) whether those constructive
distributions constituted “dividends” within the meaning of
I.R.C. § 316(a), (5) whether P is liable for I.R.C. § 6663(a)
fraud penalties for the years at issue, and (6) whether P is
liable for I.R.C. § 6651(a)(1) additions to tax for two of the
years at issue.
Served 09/13/22
2
[*2] Held: R’s witness’s testimony does not improperly
disclose a grand jury matter.
Held, further, because R has shown false or
fraudulent returns with intent to evade tax, the period of
limitations has not run for any of the years at issue.
Held, further, because of P’s control over C, C’s
payments for his benefit were constructive distributions to
him.
Held, further, because P has failed to show that C
lacked sufficient earnings and profits, the constructive
distributions constituted dividends within the meaning of
I.R.C. § 316(a).
Held, further, P is liable for I.R.C. § 6663(a) fraud
penalties for the years at issue.
Held, further, P is liable for I.R.C. § 6651(a)(1)
additions to tax for two of the years at issue.
—————
Alan Brian Fabian, pro se.
Elizabeth C. Mourges, Elizabeth M. Shaner, Victoria E. Cvek, and
Michael A. Raiken, for respondent.
3
[*3] MEMORANDUM FINDINGS OF FACT AND OPINION
HALPERN, Judge: Respondent determined deficiencies,
penalties, and additions to tax in Alan Fabian’s (petitioner’s) and
Jacqueline Richards-Fabian’s 1 federal income tax as follows: 2
Penalties and Additions to Tax
Year Deficiency § 6663(a) § 6651(a)(1)
2002 -0- $22,075 -0-
2003 $1,307,849 1,004,909 $327,943
2004 1,192,974 1,250,992 417,403
Petitioner assigned error to respondent’s determinations. The
parties have stipulated certain issues. The issues remaining for decision
are (1) petitioner’s objection to the testimony of one of respondent’s
witnesses on the grounds that her testimony improperly discloses a
grand jury matter; (2) whether the periods of limitations on assessment
and collection have expired; (3) for 2003, whether petitioner failed to
report income of $3,623,964 on account of transfers from Strategic
Partners International, Inc. (SPI, Inc.), to Ocean Quest LLC (Ocean
Quest), to Centre for Management and Technology, Inc. (CMAT), and to
petitioner’s personal accounts or otherwise for his benefit; 3 (4) for 2004,
1 Mrs. Richards-Fabian filed a separate petition at docket No. 25261-14. On
September 18, 2017, the parties in that case filed a stipulation of settled issues in
which Mrs. Richards-Fabian was granted full relief from liability under section 6015(b)
for each of the years at issue. That case remains open pending a final decision in this
case.
2 Unless otherwise indicated, all statutory references are to the Internal
Revenue 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.
All dollar amounts have been rounded to the nearest dollar.
In an explanation attached to his statutory notice of deficiency (notice) for the
3
years at issue, respondent presented the following computation of petitioner’s
unreported income for 2003.
Transfers from SPI, Inc., to Ocean Quest $538,458
Transfers from SPI, Inc., to CMAT, et al. 1,931,664
4
[*4] whether petitioner failed to report income of $5,126,382 on account
of transfers from SPI, Inc., to Ocean Quest, to CMAT, to CMAT
International, Inc. (CMATI), to Competitive Innovations, LLC (CI,
LLC), and to petitioner’s personal accounts or otherwise for his benefit; 4
(5) whether petitioner is liable for fraud penalties under section 6663(a)
for the years at issue, and (6) whether petitioner is liable for additions
to tax under section 6651(a)(1) for 2003 and 2004.
Petitioner bears the burden of proof, see Rule 142(a), except that,
with respect to the issue of fraud with intent to evade tax, the burden is
Transfers from SPI, Inc., to petitioner’s personal accounts 1,613,842
Total $4,083,964
In his Opening Brief, respondent includes a similar table in support of a
proposed finding of fact (PFF No. 409) that, for 2003, petitioner failed to report income
in the amounts shown, and from the sources shown. That table differs from the table
attached to the notice in that the third row of the second column shows $1,593,842
transferred from SPI, Inc., to petitioner’s personal accounts. Respondent directs us to
Exhibit 38-J, at 2, for that amount, but that Exhibit shows only $1,173,842 as
transferred from SPI, Inc., to petitioner’s personal accounts. Subsequently, respondent
proposes that we find that, in 2003, petitioner transferred $1,153,842 from SPI, Inc.,
to his personal accounts. See PFFs Nos. 414 and 420. We will accept that last amount
as respondent’s proposal, so that, in total, respondent is proposing that, for 2003,
petitioner failed to report income of $3,623,964, comprising the following:
Transfers from SPI, Inc., to Ocean Quest $538,458
Transfers from SPI, Inc., to CMAT, et al. 1,931,664
Transfers from SPI, Inc., to petitioner’s personal accounts 1,153,842
Total $3,623,964
4 Consistent with the notice, respondent proposes that, for 2004, we find
petitioner failed to report income of $5,126,382, comprising of the following:
Transfers from SPI, Inc., to Ocean Quest $35,000
Transfers from SPI, Inc., to CMAT, et al. 3,938,698
Transfers from SPI, Inc., to petitioner’s personal accounts 1,152,684
Total $5,126,382
5
[*5] on respondent, which he must carry by clear and convincing
evidence, see § 7454(a); Rule 142(b).
FINDINGS OF FACT
The parties have stipulated certain facts and certain documents.
The facts stipulated are so found, and documents stipulated are accepted
as authentic.
Petitioner
Petitioner resided in Maryland when he filed the petition.
In 1986, petitioner graduated summa cum laude from
Shippensburg University with a degree in accounting. Following
college, petitioner went to work for Arthur Andersen, where he
remained until sometime in 1991 and where, among other assignments,
he prepared tax returns and performed audits and consulting work for
closely held companies. He was licensed as a Certified Public
Accountant in the State of Maryland from 1994–2006.
Fabian Bank and Brokerage Accounts
During the years at issue, the Fabians had a bank account with
Mercantile Safe Deposit & Trust Co. (MSDT) (Fabian bank account).
During the years at issue, the Fabians had a brokerage account
with Charles Schwab (Fabian brokerage account).
SPI LLC
In 1998, petitioner and a business partner formed a Nevada
limited liability company, Strategic Partners International LLC (SPI
LLC), with petitioner as the managing member. SPI LLC specialized in
information technology and activity-based costing and consulting
services. In July 2000, petitioner and his business partner sold SPI LLC
to Maximus, Inc. (Maximus), a publicly traded government consulting
company. Petitioner became an employee of Maximus with the title
“Division Vice President.” SPI LLC remained a subsidiary of Maximus
until September 2001, when Maximus merged SPI LLC into itself and
out of existence.
6
[*6] SPI, Inc.
In March 2002, petitioner organized SPI, Inc. He did not inform
Maximus that he had organized SPI, Inc., and Maximus had no
ownership interest in it. Petitioner was SPI, Inc.’s sole shareholder.
SPI, Inc., had no internal financial controls, and petitioner controlled its
money, accounting, and books and records. SPI, Inc., had two bank
accounts at MSDT, with account numbers ending in 2028 and 9538 (SPI,
Inc. bank accounts Nos. 2028 and 9538). Petitioner was the only
individual with signature authority over the accounts.
For 2002, SPI, Inc., filed a Form 1120–A, U.S. Corporation Short-
Form Income Tax Return. It reported gross receipts of $6,736,624, no
cost of goods sold, and taxable income of $206,186 after deducting
approximately $4.5 million for rent and close to $2 million of other
expenses, mostly for travel and outside services. Its included balance
sheet shows no loans to shareholders. It reported its business activity
as “technical and assistance” and its product or service as “software and
computers.” The Internal Revenue Service (IRS) has no record of SPI,
Inc.’s filing a 2003 Form 1120. SPI, Inc., filed a 2004 Form 1120, U.S.
Corporation Income Tax Return, signed by SPI, Inc.’s bankruptcy
trustee. See infra p. 8. That return reports neither receipts nor
expenses. It reports loans to shareholders of $450,241.
Maximus
Petitioner managed his own independent group within the
Maximus structure. The group maintained its own office in Greenbelt
and, later, Columbia, Maryland. Although Maximus’s main office was
nearby, in Reston, Virginia, petitioner reported to officers of Maximus
in Northbrook, Illinois, who visited his group’s office only two to three
times a year. Maximus executives did not have knowledge of the daily
operations of petitioner’s group.
Sale-and-Leaseback Transactions
Sometime before SPI LLC’s merger into Maximus, SPI LLC began
to engage in transactions involving the sale and leaseback of computer
equipment and software. The transactions were facilitated by a leasing
broker, Solarcom, Inc. (Solarcom). In form, the transactions were to
work as follows. SPI LLC specified the computer equipment and
software that was to be the subject of each sale-and-leaseback
transaction. Solarcom then found third-party funding sources for the
7
[*7] transactions. Using the funds obtained from those sources,
Solarcom purchased the specified computer equipment and software
from SPI LLC and immediately leased it back to it without ever taking
physical possession. SPI LLC was obligated under its leases with
Solarcom to pay it three months’ rent, with subsequent lease payments
going to the funding sources.
Following the demise of SPI LLC, SPI, Inc., carried on the sale-
and-leaseback activity that SPI LLC had begun (SPI LLC and SPI, Inc.,
together, the entities). Between approximately March 2001 and June
2004, Solarcom paid the entities approximately $32 million to purchase
computer equipment and software. The payments were deposited into
the entities’ bank accounts, over which petitioner had sole signature
authority. During that period, the entities made ostensible lease
payments of $16.2 million ($3.3 million to Solarcom and $12.9 million to
the funding sources).
Things, however, were not as they appeared. With respect to most
of the transactions that took place between March 2001 and the fall of
2003, the entities did not purchase the computer hardware that they
purported to sell to Solarcom. Beginning in the fall of 2003, petitioner
caused SPI, Inc., to purchase computer hardware but provided Solarcom
with fraudulent quotes and invoices to make it appear that the
equipment purchased cost more than SPI, Inc., had actually paid.
Petitioner also created fraudulent records of wire transfers that
reflected wire transfers from SPI, Inc.’s accounts to the manufacturers
of the purchased computer equipment.
Beginning in 2001 and continuing until early 2003, the entities,
purported to sell to, and then lease back from, Solarcom computer
software licenses that had been provided free to Maximus for use in
consulting engagements. Petitioner further involved Maximus in SPI,
Inc.’s fraudulent activities by representing that SPI, Inc., was a wholly
owned subsidiary of it and purporting to obligate Maximus for payment
of the leases in the event of the entities’ default. Maximus was unaware
that petitioner was purporting to obligate it, and, in fact, petitioner
lacked authority to do so.
Because, for the most part, the entities had not purchased the
computer equipment and software that they purported to sell to
Solarcom, the lease payments the entities made to Solarcom and to the
funding sources were merely “lulling payments,” i.e., payments made to
hide the fraudulent nature of the entities’ activities.
8
[*8] By July 2004, SPI, Inc.’s financial machinations began to unravel,
and the company defaulted on 11 outstanding leases.
SPI, Inc. Bankruptcy
In August 2004, SPI, Inc., was forced into bankruptcy. At the
request of SPI, Inc.’s creditors, the U.S. Bankruptcy Court for the
District of Maryland (Bankruptcy Court) appointed Zvi Guttman, an
attorney, as trustee for SPI, Inc. Mr. Guttman concluded that SPI, Inc.,
had received $32 million from the funding sources for equipment and
software that, for the most part, it had not purchased and that it had
returned approximately half of that sum to the funding sources as
lulling payments. Mr. Guttman sought to determine the disposition of
the other half of the $32 million. Presented with voluminous records
with respect to SPI, Inc.’s activities, Mr. Guttman hired attorneys and a
forensic accountant, Raymond Peroutka, to analyze SPI, Inc.’s bank and
business records.
Mr. Guttman’s team constructed a chart that traced the
movement of money between SPI, Inc., and related parties (cashflow
chart). The cashflow chart identifies in a row at the top SPI, Inc.’s bank
accounts along with bank accounts of other petitioner-related entities,
as well as accounts in petitioner’s name. Columns on the left identify by
date particular transactions, such as a deposit, a check written, or a wire
transfer. The body of the chart shows the amounts moving in, out, or
through the accounts, and a column on the right shows the beneficiary
or payee. With the aid of the cashflow chart, Mr. Guttman was able to
trace funds that went out of SPI, Inc.’s bank accounts and moved
through and to petitioner’s bank accounts and to bank accounts of other
petitioner-controlled entities such as Ocean Quest and CMAT, or
directly to private jet rental companies such Sentient Jet and Marquis
Jet for private jet travel for petitioner and his family, and to the private
school that petitioner=s children attended.
Mr. Guttman determined that many transfers from SPI, Inc.,
served no business purpose and were fraudulent with respect to its
creditors. In particular, he determined that Ocean Quest had no
business relationship with SPI, Inc. and that SPI, Inc., had no business
purpose for sending money to Ocean Quest, which it never repaid to SPI,
Inc. He determined petitioner had used Ocean Quest to purchase beach
houses in North Carolina. Mr. Guttman also determined that transfers
from SPI, Inc., to CMAT served no purposes related to the former’s
business and, although a small amount of the funds received from SPI,
9
[*9] Inc., was used to pay for computers for underprivileged children,
most of the funds received from it ended up in petitioner’s pocket or were
otherwise used for his benefit.
In an attempt to recover the millions of dollars that petitioner had
transferred out of SPI, Inc., Mr. Guttman brought 11 adversary
proceedings against defendants including Ocean Quest, CMAT, the jet
rental companies, petitioner, and Mrs. Richards-Fabian. Mr. Guttman’s
collection efforts were not particularly successful, producing only
approximately $750,000 for SPI, Inc.’s creditors. His collection efforts
stopped once SPI, Inc., had no remaining assets and petitioner had filed
for personal bankruptcy late in 2008.
During SPI, Inc.’s bankruptcy proceeding, petitioner provided
false testimony under oath. He filed a false Statement of Financial
Affairs (SOFA) for SPI, Inc., with the Bankruptcy Court. He caused two
software vendors to create backdated paperwork to give the appearance
that certain software sales occurred earlier than the actual dates of sale.
Other Relevant Entities
Special Properties
Special Properties is an entity not owned by petitioner but with
the same address as SPI, Inc. Special Properties had a bank account at
MSDT with an account number ending in 2036 (Special Properties bank
account). Petitioner had signature authority on the Special Properties
bank account.
Ocean Quest
From 2000 through 2005, petitioner vacationed with his family in
North Carolina, and, during that period, he and his wife purchased at
least two beach houses there.
In 2003, he organized Ocean Quest, a Maryland limited liability
company. He was both a member of Ocean Quest and managing
director. Ocean Quest had a bank account at MSDT with an account
number ending in 4808 (Ocean Quest bank account). Petitioner was the
only individual with signature authority on the Ocean Quest bank
account. During 2003, petitioner caused SPI, Inc., to transfer $538,458
from its bank account No. 2028 to the Ocean Quest bank account, and,
during 2004, he caused SPI, Inc., to transfer $35,000 from its bank
account No. 2028 to the Ocean Quest bank account. In November 2003,
10
[*10] Ocean Quest purchased two beachfront lots in Holden Beach,
North Carolina. Petitioner signed the HUD-1 Settlement Statement for
Ocean Quest as “Managing Member.” In December 2003, Ocean Quest
purchased another beachfront lot in Holden Beach. Petitioner again
signed the HUD-1 Settlement Statement for Ocean Quest as “Managing
Member.” The SOFA recorded no payments from SPI, Inc., to Ocean
Quest.
CMAT
Petitioner organized CMAT, a Maryland nonstock corporation, in
2003. CMAT was an organization exempt from income tax under section
501(c)(3) of the Internal Revenue Code. Petitioner was a member of its
board of directors and its chief executive officer (CEO). CMAT’s
ostensible purpose was to expose underprivileged children to technology
by providing them with computers, software, and knowhow. CMAT had
a bank account at MSDT, with an account number ending in 6031
(CMAT bank account), and petitioner had signature authority on the
account.
2003
During 2003, petitioner caused $100,000 to be transferred from
the Special Properties bank account to the CMAT bank account. He also
caused $1,900,000 to be transferred from SPI, Inc. bank account No.
2028 to the CMAT bank account. In December 2003, CMAT paid
$68,336 to Dell Computers for computers.
On various dates in 2003, CMAT transferred $446,000 to the
Fabian bank account and $30,000 to Ocean Quest (in total, $476,000).
2004
On various dates beginning in January 2004 and continuing
through October 2004, petitioner caused $3,735,000 to be transferred
from SPI, Inc. bank account No. 2028 to the CMAT bank account. 5
Beginning in May 2004, petitioner caused CMAT to return to SPI, Inc.,
$71,000: $38,000 from the CMAT bank account to SPI, Inc. bank
account No. 2028 and $33,000 from the CMAT bank account to SPI, Inc.
bank account No. 9538. The net 2004 transfer from SPI, Inc., to CMAT
5 Exhibit 37-J, on which respondent relies for his calculation of the transfers,
apparently double counts a transfer of $70,000 on February 4, 2004. We will count the
$70,000 transfer once.
11
[*11] was $3,664,000 ($3,735,000 − 71,000 = $3,664,000). In February
2004, CMAT paid $80,946 to Dell Computers for computers.
On various dates in 2004, CMAT transferred $581,000 to the
Fabian bank account. It also transferred $335,000 to an account for the
construction of a swimming pool at petitioner’s home (in total, transfers
of $916,000).
CMATI
In 2004, CMAT’s board of directors organized CMATI, a
Maryland for-profit corporation that was wholly owned by CMAT.
Petitioner was CEO of CMATI. CMATI had a bank account at MSDT,
with an account number ending in 2746 (CMATI bank account), and
petitioner had signature authority on the account. In March 2004,
petitioner caused $26,000 to be transferred from SPI, Inc. bank account
No. 2028 to the CMATI bank account.
CI, LLC
CI, LLC, is an entity not owned by petitioner. During 2003 and
2004, CI, LLC, had a bank account with Provident Bank with an account
number ending in 0420 (CI, LLC bank account). In his plea agreement,
discussed infra p. 16, petitioner describes his use of CI, LLC, between
April 2005 and March 2007 as an instrumentality to create false sale
invoices purportedly showing purchases by CMAT of computer
equipment from CI, LLC. Petitioner used the false invoices to obtain
loans to finance the ostensible purchases.
During 2004, petitioner caused $105,000 to be transferred from
SPI, Inc. bank account No. 2028 to the CI, LLC bank account.
American Patriot PAC
American Patriot PAC is a political action committee that
petitioner organized. It had a bank account at MSDT with an account
number ending in 2541 (American Patriot PAC bank account).
Ansbacher
Ansbacher is a foreign bank located in the Caribbean. In
February 2004, petitioner caused SPI, Inc., to transfer $25,000 from its
bank account No. 2028 to Ansbacher. In October 2004, Ansbacher
returned $20,000 to SPI, Inc. bank account No. 9538.
12
[*12] Unknown Entity
In May 2004, SPI, Inc., received a $25,000 payment from an
unknown entity (Unknown Entity).
The Cambridge School
From 2002 through 2004, petitioner’s children attended a private
school, the Cambridge School. During 2003 and 2004, SPI, Inc.,
transferred $35,000 and $150,000, respectively, to the school.
Personal Accounts; Payments of Expenses, 2003
Transfers to the Fabian Bank Account
On various dates in 2003, petitioner caused SPI, Inc., to transfer
sums totaling $676,644 from its bank account No. 2028 to the Fabian
bank account.
On January 6 and July 25, 2003, petitioner caused Special
Properties to transfer a total of $30,000 from its bank account to the
Fabian bank account.
Transfers to the Fabian Brokerage Account
On April 25, 2003, petitioner caused SPI, Inc., to transfer $20,000
from its bank account No. 2028 to the Fabian brokerage account.
On July 25, 2003, petitioner caused Special Properties to transfer
$20,000 from its bank account to the Fabian brokerage account.
Private Jet Payments
On February 21, 2003, petitioner caused SPI, Inc., to transfer
$164,527 from its bank account No. 2028 to Marquis Jet. In SPI, Inc.’s
records, petitioner falsely recorded that payment as a lease payment to
a funding source.
On July 25, 2003, petitioner caused Special Properties to transfer
$174,644 from its bank account to Marquis Jet. The SOFA petitioner
filed with the Bankruptcy Court fails to show the $174,644 transfer as
a business expense.
13
[*13] On May 7, 2003, Sentient Jet refunded $68,027 originally
received from SPI, Inc., which petitioner received and deposited into the
Fabian bank account.
In both 2003 and 2004, petitioner used private jets to travel for
personal purposes, including traveling with his family and his dogs to
his beach house in North Carolina and (perhaps without the dogs) to
Disneyland. He did not use private jets to meet with Solarcom or the
funding sources or to do any business related to the sale-and-leaseback
transactions.
Personal Accounts; Personal Expenses, 2004
Transfers to Special Properties Account
On March 16, 2004, petitioner caused SPI, Inc., to transfer
$170,000 from its bank account No. 2028 to the Special Properties bank
account. On that same day, petitioner caused Special Properties to
transfer a total of $169,366 from its bank account to Maximus.
On June 22, 2004, petitioner caused SPI, Inc., to transfer
$123,040 from its bank account No. 2028 to the Special Properties bank
account. On that same day, petitioner caused Special Properties to
transfer a total of $112,053 to Maximus.
On July 9, 2004, petitioner caused Special Properties to transfer
$15,000 back to SPI, Inc. bank account No. 2028.
The net amount petitioner transferred from SPI, Inc. bank
account No. 2028 to the Special Properties bank account during 2004
was $278,040. During 2004, Special Properties transferred $281,419 to
Maximus.
Private Jet Payments
On June 4, 2004, petitioner caused SPI, Inc., to transfer $174,644
from its bank account No. 2028 to Marquis Jet.
American Patriot PAC
On July 12, 2004, petitioner caused SPI, Inc., to transfer $700,000
from its bank account No. 2028 to the American Patriot PAC bank
account. On the next day, July 13, American Patriot PAC transferred
$700,000 from its bank account to the CMAT bank account.
14
[*14] Income Tax Returns
The Fabians timely made a joint return of income for 2002 on
Form 1040, U.S. Individual Income Tax Return. For 2003 and 2004,
they similarly made joint returns of income on Forms 1040. On April
15, 2004, petitioner filed a request for an extension of time to file the
Fabians’ 2003 income tax return until August 15, 2004. The Fabians
filed the 2003 Form 1040 on February 13, 2005. They filed the 2004
Form 1040 on December 27, 2005. Petitioner prepared the three
returns.
2002 Form 1040
The Fabians reported $354,783 of wages on their 2002 Form 1040.
They reported federal income tax withheld from Forms W–2 and 1099 of
$46,425. Their reported wages and withholding do not match the
information reported to the Social Security Administration (SSA) by
third parties for 2002. 6 Maximus reported to the SSA on IRS Form W–2
wages paid to petitioner for 2002 of $289,853 and withheld income tax
of “$11,424+.” No other party reported to the SSA paying wages either
to petitioner or to his spouse during 2002. The Fabians reported no
income from SPI, Inc. No Form W–2 accompanies the copy of the 2002
Form 1040 stipulated by the parties. The income tax withholding of
$46,425 that the Fabians claimed on their 2002 Form 1040 reduced the
amount shown on the form as owing to the government from $98,814
(before credits) to $53,967, which included an estimated tax penalty of
$1,578 ($98,814 + 1,578 − 46,425 = $53,967).
2003 Form 1040
The Fabians reported $550,000 of wages on their 2003 Form 1040.
They reported federal income tax withheld from Forms W–2 and 1099 of
$46,000. Their reported wages and withholdings do not match
information reported by third parties to the SSA. Maximus reported to
the SSA wages paid to petitioner for 2003 of $231,855 and Form W–2
withholding of $13,969. A Form W–2 from Maximus accompanying the
2003 Form 1040 agrees. No other party reported to the SSA paying
wages either to petitioner or to his spouse during 2003. The Fabians
reported no income from SPI, Inc. The income tax withholding of
$46,000 that the Fabians reported on their 2003 Form 1040 reduced the
6 A taxpayer’s employer uses a Form W–3, Transmittal of Wage and Tax
Statements, to transmit a copy of the taxpayer’s Form W–2, Wage and Tax Statement,
to the SSA, which shares relevant information with IRS. See Treas. Reg. § 31.6051-2.
15
[*15] amount shown on the form owing to the government from
$115,940 (before credits) to $69,940, which, along with $71,613 claimed
on account of a previous payment made with their request for an
extension of the time to file, and adding an estimated tax penalty of
$1,673, further reduced the amount shown as owing to the government
to zero ($115,940 + 1,673 – 46,000 – 71,613 = $0).
2004 Form 1040
The Fabians reported $1,995,750 of wages on their 2004 Form
1040. They reported federal income tax withheld from Forms W–2 and
1099 of $504,000. Their reported wages and withholdings do not match
information reported by third parties to the SSA. CMATI reported to
the SSA wages paid to petitioner for 2004 of $171,875 and Form W–2
withholding of $22,000. A Form W–2 from CMATI accompanying the
2004 Form 1040 agrees. Maximus reported to the SSA wages paid to
petitioner for 2004 of $121,928 and Form W–2 withholding of $6,984. A
Form 4852, Substitute for Form W–2, Wage and Tax Statement, or Form
1099–R, Distributions From Pensions, Annuities, Retirement or Profit
Sharing Plans, IRAs, Insurance Contracts, Etc., from Maximus
accompanying the 2004 Form 1040 reports different amounts, i.e.,
compensation paid of $171,875 and federal income tax withheld of
$22,000 (amounts identical to the amounts reported by CMATI on the
Form W–2). No other party reported to the SSA paying wages either to
petitioner or to his spouse during 2004. The Fabians reported no income
from SPI, Inc. The income tax withholding of $504,000 that the Fabians
reported on their 2004 Form 1040 reduced the amount shown on the
form as owing to the government from $531,111 (before credits) to
$27,111, which, along with $10,900 claimed on account of an excess
Social Security tax, further reduced the amount shown as owing to the
government to $16,211 ($531,111 − 504,000 – 10,900 = $16,211).
2004 Amended Return
On January 9, 2006, respondent filed an amended 2004 return
received from the Fabians.
Criminal Investigation and Plea Agreement
During SPI, Inc.’s bankruptcy proceeding, the FBI and the U.S.
Attorney’s Office for the District of Maryland opened an investigation
into SPI, Inc.’s sale-and-leaseback transactions.
16
[*16] After a referral from the U.S. Attorney’s Office asking for IRS
assistance, IRS Special Agent (SA) Genine Furguiele was assigned to
investigate petitioner. SA Furguiele’s task was to investigate possible
criminal violations of the law over which the IRS had jurisdiction. She
prepared a report recommending money laundering charges and a
charge under section 7206(1) based on petitioner’s filing false tax
returns for 2002 and 2003 and for making a false claim for 2004.
That investigation culminated in 2007 with a multicount grand
jury indictment charging petitioner with, among other crimes, mail
fraud in violation of 18 U.S.C. § 1341, and making and subscribing a
false tax return for 2003 in violation of section 7206(1). On May 16,
2008, petitioner pleaded guilty to one count of mail fraud and to the
false-tax-return count for 2003.
Before his guilty plea, on May 13, 2008, petitioner signed a plea
agreement and a supporting statement of facts (together, plea
agreement) summarizing events that occurred between 2001 and 2004
and that supported his guilty plea. A principal element of the crime of
mail fraud, 18 U.S.C. § 1341, is a scheme to defraud. See, e.g., United
States v. Loayza, 107 F.3d 257, 260 (4th Cir. 1997). In his plea
agreement, petitioner described with particularity the fraudulent
nature of SPI, Inc.’s dealings with Solarcom, including the former’s not
having purchased much of the computer equipment and software that it
purported to sell to the latter and petitioner’s having provided Solarcom
with documentation, including equipment itemizations, that contained
“material misrepresentations that . . . [he had] made with knowledge of
their falsity.” As to the proceeds of his fraudulent scheme, he admitted:
Of the $32,000,000 that . . . [the entities] received
from the funding sources through Solarcom, [petitioner]
used a large sum of the money to create CMAT. [He] also
used sale-leaseback proceeds, among other things, to
purchase real estate in North Carolina, to make donations
to his children’s private school, and to pay for private jet
travel.
The elements of the crime of filing a false tax return are (1) the
defendant made and subscribed to a tax return containing a written
declaration; (2) the tax return was made under penalties of perjury;
(3) the defendant did not believe the return to be true and correct as to
every material matter; and (4) the defendant acted willfully. E.g.,
United States v. Aramony, 88 F.3d 1369, 1382 (4th Cir. 1996). In his
17
[*17] plea agreement, petitioner agreed that he “endeavored to conceal
his income and assets from the IRS to evade the assessment of taxes on
current income.” He agreed that, on the Fabians’ 2002, 2003, and 2004
Forms 1040, he overstated the amounts of income tax that had been
withheld from his wages, specifically acknowledging that, with respect
to the 2003 and 2004 overstatements, he acted willfully. He agreed that,
for 2003 and 2004, he received income from SPI, Inc., at least a portion
of which he willfully failed to report on the Fabians’ Forms 1040.
In the plea agreement, petitioner also agreed that he had engaged
in conduct not part of the charged offenses but relevant to them. Among
other things, in 2006, to support an equipment loan from Wachovia
Bank to CMAT, petitioner submitted to the bank false invoices
purporting to show that CMAT had purchased computer equipment
from a company, CI, LLC, notwithstanding that CMAT had not
purchased computer equipment from CI, LLC.
In signing the plea agreement, petitioner agreed that he had read
and reviewed the agreement with his attorney, understood it,
voluntarily agreed to it, and did not wish to change any part of the
statement of facts. He agreed with the United States that, had the case
gone to trial, the United States would have proved beyond a reasonable
doubt the facts set forth in the plea agreement.
The agreement expressly states that the IRS is not a party to it
and that the IRS was “free to pursue any and all lawful remedies it may
have.” The U.S. District Court for the District of Maryland accepted
petitioner’s plea, found him guilty, and convicted him of the offenses.
The court sentenced him to serve 90 months in prison. The court also
ordered petitioner to pay restitution of $40,162,634 to his victims,
including $974,009 to the IRS for the resulting tax loss. As of October
18, 2018, petitioner had paid only $4,595 in restitution to the IRS.
On April 4, 2019, the district court issued its order granting the
United States’ motion to disclose grand jury material to the IRS. The
court made its order pursuant to Rule 6(e)(3)(E)(i) of the Federal Rules
of Criminal Procedure (District Court’s Rule 6(e) order), finding that
there was a particularized need to grant limited disclosure of grand jury
material in connection with another judicial proceeding, viz, this case,
i.e., Fabian v. Commissioner, dkt. No. 25589-14. In pertinent part, the
district court ordered that grand jury material in petitioner’s criminal
case “shall be disclosed” to the Tax Court, limited, however, to the
disclosure of “information and records related to the resolution of the
18
[*18] alleged tax deficiencies and penalties for the tax years 2002, 2003,
and 2004.”
Civil Examination
In 2009, respondent assigned Revenue Agent (RA) Dolores Hicks
to examine SPI, Inc.’s tax returns, which led her to an examination of
the Fabians’ tax returns for 2002 through 2004. RA Hicks obtained from
the Bankruptcy Court boxes of documents from SPI, Inc.’s and
petitioner’s bankruptcy cases. The boxes contained bank statements,
deposit slips, copies of canceled checks, and other financial information.
She also obtained a copy of the cashflow chart. She verified the entries
on the chart “line-by-line” by comparing the entries with the bank
statements she had received. Although the Fabians had not reported
any income from the entities on their 2002 through 2004 Forms 1040,
the Cash Flow Chart showed moneys flowing in and out of bank accounts
associated with SPI, Inc., Ocean Quest, CMAT, petitioner, other entities
associated with petitioner, and otherwise going for what RA Hicks
thought was petitioner’s benefit. RA Hicks organized those cashflows
into three categories: (1) payments to Ocean Quest, (2) payments to
CMAT, et al., and (3) personal draws for petitioner’s benefit.
Category 1: Payments to Ocean Quest
Petitioner caused SPI, Inc., to transfer $538,458 and $35,000 to
Ocean Quest in 2003 and 2004, respectively. RA Hicks did not believe
that SPI, Inc., was doing business in North Carolina real estate nor that
it had any business relationship with Ocean Quest. She did not consider
the transfers as paying any business expense of SPI, Inc. She considered
the transfers taxable distributions from SPI, Inc., to petitioner for 2003
and 2004, respectively.
Category 2: Payments to CMAT, et al.
2003
During 2003, petitioner caused Special Properties to transfer
$100,000 to CMAT and SPI, Inc., to transfer $1,900,000 to CMAT
(together, $2,000,000). CMAT paid $68,336 in 2003 to purchase
computers. RA Hicks considered the difference, $1,931,664 ($2,000,000
– 68,336 = $1,931,664), a taxable distribution from SPI, Inc., to
19
[*19] petitioner in 2003 that he then used to make a capital contribution
to CMAT. 7
2004
During 2004, petitioner caused SPI, Inc., to transfer $3,664,000
to CMAT (net of $71,000 that CMAT returned to it). 8 CMAT paid
$80,946 in 2004 to purchase computers. RA Hicks considered the
difference, $3,583,054 ($3,664,000 – 80,946 = $3,583,054), a taxable
distribution from SPI, Inc., to petitioner in 2004 that he then used to
make a capital contribution to CMAT.
During 2004, petitioner caused SPI, Inc., to transfer $26,000 to
CMATI. RA Hicks considered the $26,000 a taxable distribution from
SPI, Inc., to petitioner.
During 2004, petitioner caused SPI, Inc., to transfer $105,000 to
CI, LLC. RA Hicks considered the $105,000 a taxable distribution from
SPI, Inc., to petitioner.
On June 4, 2004, petitioner caused SPI, Inc., to transfer $174,644
to Marquis Jet, which RA Hicks included in both her second and third
categories of distributions to petitioner (i.e., payments to CMAT, et al.
and personal draws for petitioner’s benefit). We will include it only in
RA Hicks’s third category.
During 2004, petitioner caused SPI, Inc., to make a net payment
to Ansbacher of $5,000. RA Hicks treated the payment a taxable
distribution, but, on brief, respondent concedes that adjustment on the
grounds that he does not have sufficient evidence of petitioner’s control
of Ansbacher. 9
7 Apparently, RA Hicks did not distinguish between transfers coming from SPI,
Inc., and Special Properties. We have little information about Special Properties other
than that its address was the same as SPI, Inc.’s, and petitioner had signature
authority on its bank account. It was reasonable for SA Hicks to assume that it was
an instrumentality of SPI, Inc.
8 RA Hicks characterized the $71,000 CMAT returned to SPI, Inc., as a return
of capital.
9 On brief, respondent asks that, considering his concession, we treat $5,000 of
a $150,000 payment that SPI, Inc., made to petitioner’s children’s private school, the
Cambridge School, as a taxable distribution to him because it served no business
purpose of SPI, Inc. He adds that RA Hicks did not include the Cambridge School
20
[*20] During 2004, Unknown Entity made a $25,000 payment to SPI,
Inc. RA Hicks treated the payment as a return of capital, and she
reduced her computation of SPI, Inc.’s 2004 taxable distributions to
petitioner by that amount.
Summary
In summary, considering respondent’s concession with respect to
the $5,000 transfer to Ansbacher, RA Hicks’s double counting of both
SPI, Inc.’s $70,000 transfer to CMAT, see supra note 5, and eliminating
the $174,644 payment to Marquis Jet, RA Hicks considered the
following category 2 payments from SPI, Inc., to constitute taxable
distributions from it to petitioner.
Table 1
Payments to CMAT, et al.: 2003 2004
Payments to CMAT $1,931,664 $3,583,054
Payments to CMATI -- 26,000
Payments to CI, LLC -- 105,000
Payments from Unknown Entity -- (25,000)
Total $1,931,664 $3,689,054
payments as income to petitioner, respondent decided that payments to the school were
distributions only during trial preparation, and he was not requesting an increased
deficiency, only a substitution for the $5,000 Ansbacher payment he was not pursuing.
Rule 41(b)(1) provides that an issue may be tried by implied consent where the issue
was not specifically pleaded. To determine whether it is appropriate to apply the
principle of implied consent, we consider whether sustaining the issue would result in
unfair surprise or prejudice to the opposing party and limit the evidence that party
might have otherwise introduced if the issue had been timely raised. See, e.g., WB
Acquisition, Inc. & Sub. v. Commissioner, T.C. Memo. 2011-36, 2011 WL 477697,
at *18, aff’d sub nom. DJB Holding Corp. v. Commissioner, 803 F.3d 1014 (9th Cir.
2015). Respondent neither invokes Rule 41(b)(1) nor considers the potential for
surprise and prejudice to petitioner. We will not accept the substitution that
respondent wants.
21
[*21] Category 3: Personal Draws for Petitioner’s Benefit
2003
For 2003, Ms. Hicks considered the following transfers that
petitioner caused SPI, Inc., and Special Properties to make, along with
the refund from Sentient Jet, taxable distributions from SPI, Inc., to
petitioner.
Table 2
Type Amount
Transfers on various dates from SPI, Inc. bank account No. 2028
to the Fabian bank account $676,644
January 6 and July 25 transfers from Special Properties bank
account to the Fabian bank account 30,000
April 25 transfer from SPI, Inc. bank account No. 2028 to the
Fabian brokerage account 20,000
July 25 transfer from Special Properties bank account to the
Fabian brokerage account 20,000
February 21 transfer from SPI, Inc. bank account No. 2028 to
Marquis Jet 164,527
July 25 transfer from Special Properties bank account to Marquis
Jet 174,644
May 7 Sentient Jet refund deposited into the Fabian bank account 68,027
Total $1,153,842
RA Hicks considered the two transfers to the Fabian bank account
taxable distributions from SPI, Inc., directly to petitioner. She
considered the payments for jet travel taxable distributions to him from
SPI, Inc., because he used the jets for personal travel and not for SPI,
Inc.’s business. She considered the refund a taxable distribution to him
because he deposited it into his personal account.
2004
For 2004, Ms. Hicks considered the following transfers that
petitioner caused SPI, Inc., to make, net of the July 9 retransfer, taxable
distributions from it to him.
22
[*22] Table 3
Type Amount
March 16 transfer from SPI, Inc. bank account No. 2028 to the
Special Properties bank account ($169,366 of which was, on the
same day, transferred to Maximus) $170,000
June 22 transfer from SPI, Inc. bank account No. 2028 to the
Special Properties bank account ($112,053 of which was, on the
same day, transferred to Maximus) 123,040
July 9 transfer from Special Properties to SPI, Inc. bank account
No. 2028 (15,000)
June 4 transfer from SPI, Inc. bank account No. 2028 to Marquis
Jet 174,644
Transfer from SPI, Inc. bank account No. 2028 to the American
Patriot PAC bank account (retransferred the next day to CMAT) 700,000
Total $1,152,684
RA Hicks considered the net amount transferred from SPI, Inc.,
to Special Properties, $278,040, a taxable distribution to petitioner
because, concomitant with the transfers to Special Properties, Special
Properties transferred in excess of that amount (viz, $281,419) to
Maximus. RA Hicks believed that petitioner caused that to be done to
“launder,” or disguise, the source of Special Properties payments to
Maximus so that Maximus would not learn of the existence of SPI, Inc.,
and petitioner’s involvement of Maximus in his fraudulent sale-and-
leaseback transactions. As for 2003, she considered the payment to
Marquis Jet a taxable distribution to petitioner from SPI, Inc., because
he used the jet for personal travel and not for SPI, Inc.’s business. She
considered the indirect transfer to CMAT a taxable distribution from
SPI, Inc.
Summary
With adjustments for RA Hicks’s double counting of $70,000 and
$174,644 and respondent’s concession of a $5,000 transfer, the following
table summarizes RA Hicks’s calculation of petitioner’s unreported
income resulting from payments made by SPI, Inc.
23
[*23] Table 4
2003 2004
Payments to Ocean Quest $538,458 $35,000
Payments to CMAT, et al. 1,931,664 3,689,054
Payments to petitioner’s personal accounts 1,153,842 1,152,684
Total $3,623,964 $4,876,738
Penalty Approval
On October 12, 2010, RA Hicks prepared an IRS Penalty Approval
Form, Workpaper # 300-1.1, seeking approval to assert a section 6663
fraud penalty. The form identifies petitioner as the taxpayer to be
penalized and, in the heading, identifies “2006” as the relevant tax year.
The body of the form, however, speaks exclusively of 2002, 2003, and
2004 as the years for which approval is being sought. RA Hicks testified
that the heading was in error and should have identified 2002, 2003,
and 2004 as the relevant years. RA Hicks submitted the form to her
group manager, Steven Hansen, for approval, which he gave on April
14, 2011, by signing the form. Mr. Hansen was, at the time, RA Hicks’s
immediate supervisor. On the following day, respondent mailed to
petitioner a Letter 950, a so-called 30-day letter, enclosing RA Hicks’s
examination report, which included the fraud penalty for all years, and
explaining petitioner’s options, including the right to appeal to the IRS
Appeals Office (now the IRS Independent Office of Appeals).
Notice
In determining whether there were deficiencies in tax for the
years at issue, respondent made both positive and negative adjustments
to the Fabians’ taxable income and adjusted certain credits and other
taxes (e.g., household employment tax). Respondent determined no
deficiency in tax for 2002 but determined an overassessment (decrease
in tax) of $5,568. Because certain prepayment credits (including income
tax withholding) are not considered in the determination of a deficiency
in tax, see § 6211(b)(1), the notice separately makes an adjustment to
the credit for income tax withholding claimed by the Fabians on the 2002
Form 1040. The Fabians had claimed a credit of $46,425 for income tax
withheld by Maximus. Because Maximus had reported to the SSA
withheld income tax of only $11,424, the notice makes a negative
adjustment of $35,001 to the claimed credit ($46,425 – 11,424 =
$35,001). Netting the $5,568 overassessment against the disallowed
24
[*24] withholding credit of $35,001, the notice determines that the
Fabians underpaid their 2002 tax by $29,433 ($35,001 – 5,568 =
$29,433). The notice determines a 75% section 6663 fraud penalty of
$22,075 for that underpayment ($29,433 × 75% = $22,075).
For each of 2003 and 2004, the notice both determines a deficiency
in tax and makes a negative adjustment to the credit for income tax
withholding claimed by the Fabians. The notice explains that the
Fabians income is being adjusted upward for each year to reflect
unreported items—“bank deposits, withdrawals, and transfers”—shown
in a table similar to Table 4, supra. The resulting underpayment in tax
for the year is combined with the additional underpayment for the year
resulting from the negative credit adjustment, and the section 6663
fraud penalty is applied to the sum. The notice also determines an
addition to tax for each year for failure to timely file a return.
OPINION
I. Evidentiary Matters
As an initial matter we address petitioner=s objection to SA
Furguile’s testimony. Rule 6(e)(2)(A) and (B) of the Federal Rules of
Criminal Procedure governs the secrecy of grand jury proceedings and
prohibits certain persons from disclosing a matter occurring before the
grand jury unless the rules provide otherwise. SA Furguile assisted the
U.S. Attorney’s Office in its prosecution of petitioner, and one of the
office’s attorneys may have disclosed to her a matter occurring before
the grand jury that placed her in the class of persons prohibited from
disclosing that matter unless an exception applies. See Fed. R. Crim. P.
6(e)(2)(B)(vii), (3)(A)(ii). And while petitioner is familiar with the
District Court’s Rule 6(e) order, he argues that “[t]he order . . . does not
explicitly or implicitly” authorize SA Furguile’s testimony. For that
reason, petitioner continues, “[r]espondent should not be permitted to
make any findings of fact based on” her testimony.
We disagree. The consequence of the District Court’s Rule 6(e)
order was to authorize a disclosure of a grand jury matter. The order
did not specify a particular actor authorized to make the disclosure but
simply ordered that the referenced grand jury material in petitioner’s
case “shall be disclosed.” Implicit in that order is that someone
otherwise prohibited from disclosing the material may, with impunity,
disclose it to one of the permitted recipients, i.e., to the Tax Court. SA
Furguile may well have been a member of the class of persons otherwise
25
[*25] prohibited from disclosing the material, but the order freed her, as
it did everyone in that class, to disclose the material within the
parameters set by the order. To the extent SA Furguile’s testimony
touched on grand jury material in petitioner’s criminal case, we see no
violation of the grand jury secrecy rule established by Rule 6(e)(2)(A)
and (B) of the Federal Rules of Criminal Procedure. There is no merit
to petitioner’s objection to her testimony, and we overrule his
objection. 10
II. Period of Limitations
A. Introduction
Generally, the period of limitations to assess any unpaid income
tax (including penalties and additions to tax) runs three years from the
later of (1) the date a taxpayer files a return or (2) the last day prescribed
by law or by regulations for filing the return. See § 6501(a) and (b)(1).
If a taxpayer files a false or fraudulent return with the intent to evade
tax, however, the tax may be assessed at any time. § 6501(c)(1). The
period of limitations is an affirmative defense, which must be pleaded.
See Rule 39. If the taxpayer raises the defense and the Commissioner
relies on section 6501(c)(1) to show that the period of limitations has not
expired, the Commissioner bears the burden to prove that the taxpayer
has filed a false or fraudulent return with the intent to evade tax for
each year at issue. See § 7454(a); Rule 142(b). Fraud for this purpose is
defined as intentional wrongdoing by the taxpayer with the specific
purpose of avoiding tax believed to be owed. E.g., Schwartz v.
Commissioner, T.C. Memo. 2016-144, at *19, aff’d in an unpublished
order, No. 16-2502, 2017 WL 5125662 (6th Cir. Sept. 5, 2017). “Put
differently, imposition of the civil fraud penalty is appropriate upon a
showing that the taxpayer intended to evade taxes believed to be owing
by conduct designed to conceal, mislead, or otherwise prevent the
collection of taxes.” Id. (citing DiLeo v. Commissioner, 96 T.C. 858, 874
(1991), aff’d, 959 F.2d 16 (2d Cir. 1992)). The determination of fraud for
the period of limitations on assessment under section 6501(c)(1) is the
same as the determination of fraud for purposes of the penalty under
section 6663. Neely v. Commissioner, 116 T.C. 79, 85 (2001).
10 Petitioner also objects to the Court’s giving weight to the testimony of Mr.
Peroutka, the forensic accountant retained by Mr. Guttman, the bankruptcy trustee.
Because we have not relied on Mr. Peroutka’s testimony, we do not address petitioner’s
objection.
26
[*26] Because direct evidence of an intent to evade tax is rarely
available, intent may be proved by circumstantial evidence and
reasonable inferences from the facts. E.g., Feller v. Commissioner, 135
T.C. 497, 501–02 (2010). If any part of a return is determined to be the
result of fraud, a taxpayer may not assert as a defense that the period
of limitations has expired. E.g., Lowy v. Commissioner, 288 F.2d 517,
520 (2d Cir. 1961), aff’g T.C. Memo. 1960-32; Garavaglia v.
Commissioner, T.C. Memo. 2011-228, 2011 WL 4448913, at *30, aff’d,
521 F. App’x 476 (6th Cir. 2013). Moreover, it is sufficient to satisfy
section 6501(c)(1) that one spouse filing a joint return had the requisite
fraudulent intent. See, e.g., Vannaman v. Commissioner, 54 T.C. 1011,
1018 (1970).
Petitioner asserts as a defense to respondent’s attempt to collect
any of the deficiencies, additions to tax, and penalties at issue that the
periods of limitations for assessment and collection for all the years at
issue have expired. Respondent relies on section 6501(c)(1), the plea
agreement, and certain other established facts to rebut petitioner’s
defense. As discussed infra, petitioner’s defense fails.
B. Discussion
Petitioner pleaded guilty to mail fraud and to making and
submitting a false tax return for 2003 in violation of section 7206(1). He
admitted in his plea agreement that, on the Fabians’ 2002, 2003, and
2004 Forms 1040, he overstated the amount of income tax that had been
withheld from his wages. And while he specifically acknowledged that
he acted willfully with respect to the 2003 and 2004 overstatements, we
cannot escape the conclusion that, notwithstanding the lack of a specific
acknowledgment of willfulness with respect to the 2002 overstatement,
he also acted willfully with respect to that overstatement. He admitted
receiving income from SPI, Inc., for 2003 and 2004 that he failed to
report. Without attaching any temporal limitation to his admission of
filing false income tax returns for 2002, 2003, and 2004, petitioner
admitted that he had “endeavored to conceal his income and assets from
the IRS to evade the assessment of taxes on current income.” (Emphasis
added.)
Petitioner’s admissions are sufficient for us to conclude that he
intended to evade taxes believed to be owing for 2002, 2003, and 2004
by deceiving the IRS as to the amount of tax withheld from his wages
each year and, additionally, for 2003 and 2004, by concealing income he
received from SPI, Inc.
27
[*27] Petitioner takes exception to our considering the plea agreement,
arguing that we should disregard the agreement because a conviction
under section 7206(1) is insufficient to establish fraud, respondent is
treating the plea agreement as testimony, and the agreement is
inadmissible hearsay. Respondent’s response to petitioner’s first claim
is that he is not relying on petitioner’s conviction to establish fraud but
relies on it only as a “badge of fraud.” See Sodipo v. Commissioner, T.C.
Memo. 2015-3, at *23 (stating that “a conviction under section 7206(1)
is a badge of fraud”; i.e., something “from which fraudulent intent may
be inferred”), aff’d, 633 F. App’x 148 (4th Cir. 2016).
Petitioner’s second claim, that respondent is treating his plea
agreement as testimony, apparently results from our refusal in Neder v.
Commissioner, T.C. Memo. 2006-54, 2006 WL 741386, at *8, to consider
the taxpayer’s testimony in his prior criminal case, in which he was
convicted of filing false income tax returns, as a badge of fraud in his
subsequent civil trial, in which the addition to tax for fraud was an issue;
but the taxpayer’s testimony in the prior criminal case was not part of
the record before us. Neder is inapropos because petitioner’s plea
agreement is part of the record before us. We often rely on statements
in a taxpayer’s plea agreement in his or her criminal case as evidence of
fraud in a following civil fraud penalty case. See, e.g., Laciny v.
Commissioner, T.C. Memo. 2013-107, at *19–20; Evans v.
Commissioner, T.C. Memo. 2010-199, 2010 WL 3564727, at *6 (“The
details alleged in the counts of which he was convicted [including filing
a false tax return in violation of section 7206(1)] and admitted in the
plea agreement are specific and convincing evidence of fraud . . . .”), aff’d,
507 F. App’x 645 (9th Cir. 2013).
Petitioner’s third argument, that his plea agreement is excludible
hearsay, has no merit because an opposing party’s statement offered
against the party is not hearsay. See Fed. R. Evid. 801(d)(2)(A).
We find that respondent has shown by clear and convincing
evidence that petitioner made his returns for the years at issue with the
intent to evade tax. See, e.g., Feller, 135 T.C. 497 (involving taxpayer
who overstated income tax withheld in order to obtain refunds).
C. Conclusion
Because we find that the Fabians filed returns for the years at
issue fraudulently with the intent to evade tax, it follows that the
28
[*28] periods of limitations on assessment are open for those years. See
§ 6501(c)(1). 11
III. Deficiencies in Tax
A. Introduction
For decision is whether the Fabians underreported their gross
income for 2003 and 2004 on account of the payments listed supra
Table 4, viz,
Table 4
2003 2004
Payments to Ocean Quest $538,458 $35,000
Payments to CMAT, et al. 1,931,664 3,689,054
Payments to petitioner’s personal accounts 1,153,842 1,152,684
Total $3,623,964 $4,876,738
Petitioner contests neither the amounts of the payments (sometimes,
collectively, Table 4 payments) nor that SPI, Inc., made them. With
respect to SPI, Inc.’s payments to Ocean Quest, petitioner claims
without elaboration only that “[p]ayments in [2003 and 2004] to Ocean
Quest LLC are not taxable to [him].” With respect to SPI, Inc.’s
payments in 2003 to CMAT, he claims that the payments are not taxable
to him because they “have been reported on CMAT’s tax returns,” and,
similarly, with respect to SPI, Inc.’s 2004 payments to CMAT and
CMATI, “they were reported as income by CMAT and CMATI.” With
respect to Ms. Hicks’s third category, personal draws for petitioner’s
benefit, he concedes that most of the payments were distributions made
by SPI, Inc., to him with respect to his stock in the corporation and
would be dividends but, he argues, for the fact that the corporation had
no earnings and profits and his adjusted basis in his shares in the
corporation exceeded the amounts of the payments. He argues that the
payments to Marquis Jet were properly treated under the law at the
time the payments were made. Finally, he argues that payments to his
personal accounts were loans to him from SPI, Inc.
11 In the Petition, petitioner also raises the affirmative defense of laches. But
not having addressed the defense on brief, he is considered to have abandoned it, see,
e.g., Burke v. Commissioner, T.C. Memo. 2009-282, 2009 WL 4639695, at *5, and we
will not further address it.
29
[*29] Respondent has two theories as to why the Table 4 payments are
includible in petitioners’ gross income for the years indicated. First:
Petitioner earned income from conducting illegal
fraudulent sale-leaseback transactions through SPI, Inc.
He had dominion and control over all the funds earned
from the scheme[,] and he treated those funds as his own.
Accordingly, the millions of dollars that petitioner stole
from the Funding Sources is ordinary income to him[,] and
he is required by law to report the income on his tax return.
(Citations of the record omitted.)
Alternatively, respondent argues that the Table 4 payments were
direct or constructive distributions of income illegally earned by SPI,
Inc., that constituted taxable dividends to petitioner because paid out of
the corporation’s earnings and profits.
We rely on respondent’s alternative theory except, only in part,
with respect to the payments to CMAT.
B. Petitioner’s Income from Conducting Illegal Activities
The threshold for respecting the corporate form for tax purposes
is low. See Moline Props., Inc. v. Commissioner, 319 U.S. 436, 438–39
(1943). Respondent proposes to include in petitioner’s income the
amounts shown in Table 4. But those amounts are payments out of SPI,
Inc. If, instead, we are to disregard SPI, Inc.’s jural existence and treat
petitioner as recognizing income as and when received by the
corporation, almost certainly respondent’s adjustments for the years at
issue would have differed from the Table 4 amounts. But respondent
did not determine alternative deficiency amounts. We will, therefore,
proceed to his alternative theory.
C. Distributions with Respect to Corporate Stock
1. In General
Sections 301 and 316 govern the characterization of a corporate
distribution of property (including money) to a shareholder with respect
to its stock. If the distributing corporation has sufficient earnings and
profits, then the distribution is a dividend, which is included in the
shareholder’s gross income. §§ 301(c)(1), 316. If the distribution exceeds
the corporation’s earnings and profits, the excess is, first, a return of
30
[*30] capital, and any remaining amount is taxed as capital gain.
§ 301(c). Among the items entering the computation of corporate
earnings and profits for a particular period are items includible in gross
income under section 61. See Treas. Reg. § 1.312-6(b). Gross income
includes income derived from a business, regardless of whether the
business is lawful or whether the money was obtained unlawfully. See
§ 61(a)(2); James v. United States, 366 U.S. 213, 221 (1961) (holding that
embezzled funds are included in gross income); United States v.
Sullivan, 274 U.S. 259, 263 (1927) (holding that income from an
unlawful business is included in gross income). Generally, the taxpayer
bears the burden of proving that the corporation lacks sufficient
earnings and profits to support dividend treatment. Truesdell v.
Commissioner, 89 T.C. 1280, 1295–96 (1987); see also Luczaj & Assocs.
v. Commissioner, T.C. Memo. 2017-42, at *22–23.
2. Petitioner’s Theory
Petitioner believes that, during the years at issue, SPI, Inc., had
no earnings and profits, so that any of the Table 4 payments determined
to be distributions with respect to SPI, Inc.’s stock would not be
dividends. See §§ 301(c)(1), 316(a); see also Podlucky v. Commissioner,
T.C. Memo. 2022-45, at *9 (holding that constructive distributions of
misappropriated corporate funds did not constitute dividends to
controlling shareholder because of inadequate corporate earnings and
profits). Moreover, he believes that he had sufficient adjusted basis in
his SPI, Inc. shares that the amount of actual or constructive
distributions to him during those years did not exceed that basis and,
accordingly, produced no gain. See § 301(c)(2). We disagree that
petitioner has shown that SPI, Inc.’s earnings and profits were
insufficient for the Table 4 payments to constitute dividends.
3. Distributions with Respect to Stock
a. Constructive Distributions
We first address whether the Table 4 payments were constructive
distributions with respect to SPI, Inc.’s stock.
Characterization of a payment by a corporation as a distribution
with respect to its stock depends neither upon the corporation’s formally
declaring a dividend nor upon a shareholder’s actually receiving it. See,
e.g., Boulware v. United States, 552 U.S. 421, 430 (2008); Combs v.
Commissioner, T.C. Memo. 2019-96, at *12-13, aff’d, 859 F. App’x 807
(9th Cir. 2021). A dividend not formally declared is a constructive
31
[*31] dividend. See Combs, T.C. Memo. 2019-96, at *12. 12 The test for
a constructive dividend has two prongs: First, the corporation must
have conferred an economic benefit on the shareholder without
expectation of repayment, and, second, the benefit conferred by the
corporation must primarily advance the shareholder’s personal interest
as opposed to the business interest of the corporation. See, e.g., Midwest
Stainless, Inc. v. Commissioner, T.C. Memo. 2000-314, 2000 WL
1470664, at *4. Petitioner was SPI, Inc.’s sole shareholder. A
constructive distribution may result when a controlling shareholder has
the effective power to direct the flow of corporate wealth to another
without routing the transaction through his own hands. Green v. United
States, 460 F.2d 412, 419 (5th Cir. 1972).
b. Ocean Quest
From 2000 through 2005, petitioner vacationed with his family in
North Carolina, and, during that period, he testified, he and his wife
purchased at least two beach houses there. In 2003 and 2004, he caused
SPI, Inc., to transfer $538,458 and $35,000, respectively, to Ocean
Quest, which it used to purchase beach houses in Holden Beach, North
Carolina. Petitioner was both managing director and a member of
Ocean Quest, and, while the record is silent as to the identity of the other
members, we think it a fair inference that his wife and, perhaps, other
family members were the remaining members. Mr. Guttman
determined that SPI, Inc.’s, payments to Ocean Quest were not of any
benefit to SPI, Inc. We agree. Whether Ocean Quest bought houses for
the Fabian family to use or for investment, the transfers from SPI, Inc.,
to Ocean Quest benefited petitioner personally, and petitioner has not
shown that either he or Ocean Quest was under any obligation to repay
the moneys received from SPI, Inc. Petitioner’s exercise of his control
over SPI, Inc., to direct funds to Ocean Quest for no apparent benefit to
the former and for his own benefit is sufficient for us to conclude that
the moneys paid to Ocean Quest constituted constructive distributions
by SPI, Inc., to petitioner with respect to his stock in the corporation
(which, in effect, he then paid over to Ocean Quest). The Table 4
amounts shown as “Payments to Ocean Quest” constitute constructive
distributions to petitioner.
12Courts sometimes speak colloquially of a corporate distribution to a
shareholder with respect to his stock as a “dividend” without considering that section
316 accords the term a technical meaning. We will be precise when necessary.
32
[*32] c. CMAT
We turn now to the payments to CMAT. Mr. Guttman
determined that SPI, Inc.’s payments to CMAT were not of any benefit
to the latter and, except for CMAT’s expenditure of a small amount for
computers for underprivileged children, benefited only petitioner.
Moreover, as with the payments to Ocean Quest, petitioner, through his
control of SPI, Inc., orchestrated the payments to CMAT; and we find
that CMAT was under no obligation to repay the moneys received.
Moreover, at least some of the moneys that SPI, Inc., paid to CMAT
directly benefited petitioner personally (e.g., a $335,000 payment in
2004 from CMAT into his swimming pool construction account). Despite
that, SPI, Inc.’s payments to CMAT cannot be analyzed on the same
terms as its payments to Ocean Quest because CMAT was an
organization described in section 501(c)(3) to which gifts were likely
deductible as charitable contributions. See § 170(a).
In Knott v. Commissioner, 67 T.C. 681 (1977), we addressed a
bargain sale by a closely held corporation to an organization exempt
from tax under section 501(c)(3) and to which gifts would be deductible
as charitable contributions under section 170(a). We held that, because
neither the shareholders of the corporation nor their families received
any property or economic benefit from the sale, there was no
constructive distribution to the shareholders as a result of the sale. Id.
at 694. The Commissioner has acquiesced in our holding in Knott. See
Rev. Rul. 79-9, 1979-1 C.B. 125, 126 (“[P]roperty or an economic benefit
must be received by the controlling shareholders or their families as a
result of the corporation’s charitable contribution in order for the
contribution to be treated as a constructive dividend to the
shareholders.”). It may be that respondent overlooked Knott and his
Revenue Ruling, but, in any event, we would look with disfavor on any
effort by respondent to take a position contrary to one of his own revenue
rulings. See, e.g., Rauenhorst v. Commissioner, 119 T.C. 157, 171 (2002)
(rejecting the proposition “that the Commissioner is not bound to follow
his revenue rulings in Tax Court proceedings”).
We have made some findings from which we can determine for
2003 and 2004 economic benefits obtained by petitioner from CMAT.
During 2003, CMAT transferred $446,000 and $30,000 to the Fabian
bank account and to Ocean Quest, respectively (in total, $476,000).
During 2004, CMAT transferred $581,000 and $335,000 to the Fabian
bank account and to an account for the construction of a swimming pool
at petitioner’s home, respectively (in total, $916,000). In accordance
33
[*33] with Knott and Rev. Rul. 79-9, we find that for 2003 and 2004
petitioner received constructive distributions from SPI, Inc., on account
of its payments to CMAT, of $476,000 and $916,000, respectively. 13
d. CMATI
In 2004, petitioner was chief executive officer of CMATI, a
subsidiary, for-profit corporation of CMAT (of which he was a board
member and also CEO). In 2004, he caused SPI, Inc., to transfer $26,000
to CMATI. Petitioner abused his authority as CEO of CMAT to benefit
himself, and we think that is evidence that he could use his authority as
CEO of CMATI for the same end. Petitioner has not convinced us that
CMATI had any obligation to repay the moneys it received from SPI,
Inc. The $26,000 paid by SPI, Inc., to CMATI in 2004 constituted a
constructive dividend to petitioner with respect to his stock in the
former. Therefore, the Table 1 amount shown as “Payments to CMATI”
constitutes a constructive distribution to petitioner.
e. CI, LLC
We likewise conclude that the Table 1 amount shown as
“Payments to CI, LLC” constitutes a constructive distribution to
petitioner. Petitioner did not own CI, LLC, but, during 2004, he caused
SPI, Inc., to transfer $105,000 to the entity, which it used to further
petitioner’s corrupt scheme to obtain money from the funding sources.
13Respondent’s notice determines no deficiency in any of the excise taxes
provided for in section 4958. Section 4958 imposes excise taxes on excess benefit
transactions between disqualified persons and section 501(c)(3) or (4) organizations.
The excise tax, which is paid by the disqualified person, is imposed on the amount
received by the disqualified person that exceeds the value of consideration provided to
the organization. Section 4958 also requires correction of the excess benefit
transaction or a second-tier tax of 200% is imposed. Organization managers may also
be liable for section 4958 excise taxes if they knowingly participate in an excess benefit
transaction. Excess benefit transactions are situations where a section 501(c)(3) or (4)
organization is used for improper personal gain by a person in a position to exercise
substantial influence over its affairs. The section 4958 taxes are popularly known as
“intermediate sanctions,” because they provide a remedy short of revocation of exempt
status for transactions that constitute inurement. A deficiency in such taxes is
collected pursuant to the deficiency procedures provided for in section 6212.
34
[*34] f. Unknown Payment
We make no adjustment with respect to the unknown payment.
g. Revision to Table 1
To take account of our analysis of the CMAT payments, we revise
Table 1 as follows (now Table 1.a.).
Table 1.a
Payments to CMAT, et al. 2003 2004
Payments to CMAT $476,000 $916,000
Payments to CMATI -- 26,000
Payments to CI, LLC -- 105,000
Payments from Unknown Entity -- (25,000)
Total $476,000 $1,022,000
h. Personal Draws for Petitioner’s Benefit
Petitioner does not address on brief the payments from SPI, Inc.,
that Ms. Hicks included in her category “Personal draws for petitioner’s
benefit” other than the payments to Marquis Jet. Petitioner appears to
believe that those payments were an employee fringe benefit paid by
SPI, Inc., and addresses the amount of deduction SPI, Inc., would be
allowed on account of the payments. The discussion is not relevant
because we do not have the corporation’s tax liability before us. And
while petitioner concludes his discussion of the Marquis Jet payments
by adding that respondent has accepted that he reimbursed the
corporation for those payments—which we take as his admission that
the payments were for his benefit—RA Hicks, in her examination report,
states that petitioner’s bank account records did not match his claims of
reimbursement. Indeed, petitioner proposes that we find that SPI, Inc.,
recorded all disbursements to him as advances on its financial books and
records. Respondent points out that, while that statement might
literally be true, it is misleading because petitioner is relying on the
SOFA, which the record shows contained numerous false entries (and
which, supra p. 9, we find to be a false statement that petitioner filed
with the bankruptcy court). The payments Ms. Hicks categorized as for
petitioner’s benefit were made for his benefit, and he has failed to
convince us that any were advances from the corporation that he was
obligated to (or expected to) repay. For those reasons, we conclude that
35
[*35] those payments were distributions by SPI, Inc., to petitioner made
with respect to the corporation’s stock.
i. Revision to Table 4
To take account of new Table 1.a, we revise Table 4 as follows
(now Table 4.a).
Table 4.a
2003 2004
Payments to Ocean Quest $538,458 $35,000
Payments to CMAT, et al. 476,000 1,022,000
Payments to petitioner’s personal accounts 1,153,842 1,152,684
Total $2,168,300 $2,209,684
Table 4.a. reports constructive distributions to petitioner with
respect to his stock in SPI, Inc. We next consider whether those
distributions constituted dividends includible in petitioner’s gross
income.
4. Table 4.a Payments Out of Earnings and Profits
SPI, Inc., was the vehicle that petitioner used to carry out his
fraudulent scheme. It was the counterparty in the sale-and-leaseback
transactions with Solarcom. Petitioner makes no argument that we
should disregard SPI, Inc.’s corporate existence, and, as we said supra
p. 29, the threshold for respecting the corporate form for tax purposes is
low. Ostensibly, SPI, Inc., realized gain on each computer or software
item sold only to the extent that the amount realized on the sale
exceeded the corporation’s cost for the property sold. See Treas. Reg. §
1.1001-1(a). To the extent, however, that SPI, Inc., sold phantom
property, its “gain” likely would equal (or, if there were selling expenses,
come close to equaling) the amount received for the property. And while
the lulling payments might be deductible, it is likely that SPI, Inc.’s
taxable income from the fraudulent sales was considerable, resulting in
an equally considerable increase in earnings and profits. See Treas. Reg.
§ 1.312-6(b).
Petitioner’s answer is: “The proceeds from Solarcom were
borrowed funds and as such were debt capital and not earnings and
profits. As such, any distributions were not taxable to the Petitioner.”
Petitioner would disavow the form of the sale-and-leaseback
36
[*36] transactions SPI, Inc., claimed to have entered into, which, at
least in form (fraud aside), were supposed to involve SPI, Inc.’s sale of
computers and software to Solarcom, followed by Solarcom’s lease of the
computers and software back to SPI, Inc., which, as lessee, would make
some business use of the property while Solarcom, as owner, would enjoy
the tax benefits (e.g., depreciation) that usually accompany ownership
of business property. 14 Compare Frank Lyon Co. v. United States, 435
U.S. 561 (1978) (successful transfer), with, e.g., Guaderrama v.
Commissioner, T.C. Memo. 2000-104 (unsuccessful transfer), aff’d, 21
F. App’x 858 (10th Cir. 2001). Having structured the transactions
apparently to obtain tax benefits at least for Solarcom, petitioner is not
free to disavow that form in favor of what he now claims is the
transaction’s economic substance. See, e.g., Complex Media, Inc. v.
Commissioner, T.C. Memo. 2021-14, at *64.
Considering the transactions as structured, petitioner has failed
to show that SPI, Inc., did not have income on the sale of property to
Solarcom, so that the Table 4.a payments—distributions with respect to
petitioner’s SPI, Inc. stock—were not out of its earnings and profits and,
accordingly, were dividends includible in petitioner’s gross income. See
§§ 301(c)(1), 316(a).
IV. Fraud Penalty
A. Introduction
Respondent has already established with respect to the years at
issue that petitioner intended to evade tax and, thus, engaged in
fraudulent conduct. See supra pt. II.C. For the fraud penalty to attach,
however, he must prove also that the fraud resulted in the
underpayments of tax required to be shown on the returns.
Section 6663(a) provides: “If any part of any underpayment of tax
required to be shown on a return is due to fraud, there shall be added to
the tax an amount equal to 75 percent of the portion of the
underpayment which is attributable to fraud.” Moreover, if the
Commissioner establishes that some part of an underpayment was due
14 It is unclear whether SPI, Inc., borrowed from Solarcom the amounts it was
to spend for the equipment that it was to sell to, and then lease back from, Solarcom.
If it did, we assume that the parties treated SPI, Inc.’s resulting indebtedness as
discharged by way of a credit to the sales price of the property purchased by Solarcom,
which credit would be included in the amount realized by SPI, Inc., on that sale and
treated as part or all of Solarcom’s cost basis in the property.
37
[*37] to fraud, the entire underpayment is treated as attributable to
fraud unless the taxpayer proves otherwise. § 6663(b). The fraud
penalty may be applied against a spouse only where some part of the
underpayment is due to the fraud of the spouse. § 6663(c). And finally,
no fraud penalty will be imposed with respect to any portion of an
underpayment if the taxpayer can show “that there was a reasonable
cause for such portion and that the taxpayer acted in good faith with
respect to [it].” § 6664(c)(1).
The term “underpayment” is defined in section 6664(a) as follows:
Sec. 6664(a). Underpayment.—For purposes of this
part, the term “underpayment” means the amount by
which any tax imposed by this title exceeds the excess of—
(1) the sum of—
(A) the amount shown as the tax by the
taxpayer on his return, plus
(B) amounts not so shown previously
assessed (or collected without assessment),
over
(2) the amount of rebates made.
For purposes of paragraph (2), the term “rebate” means so
much of an abatement, credit, refund, or other repayment,
as was made on the ground that the tax imposed was less
than the excess of the amount specified in paragraph (1)
over the rebates previously made.
Neither paragraph (1)(B) nor (2) applies in this case.
Treasury Regulation § 1.6664-2(c)(1) interprets the definition of
“underpayment” in section 6664 by stating that, for purposes of
determining an underpayment, the amount shown as the tax by the
taxpayer on his return is reduced by the excess of:
(i) The amounts shown by the taxpayer on his return
as credits for tax withheld under section 31 (relating to tax
withheld on wages) . . ., over
(ii) The amounts actually withheld . . . with respect
to a taxable year before the return is filed for such taxable
year.
38
[*38] In other words, the regulation interprets the meaning of
“underpayment” to include a taxpayer's overstated credits for
withholding. See Treas. Reg. § 1.6664-2(g) (example 3). Accordingly, if
a taxpayer overstates a prepayment credit for wages withheld, the
overstatement decreases the amount of tax shown on the return and
increases the underpayment of tax. Feller, 135 T.C. at 503.
The amount of tax shown due on a taxpayer's return also includes
amounts shown as additional tax on a qualified amended return “except
that such amount is not included if it relates to a fraudulent position on
the original return.” See Treas. Reg. § 1.6664-2(c)(2). As relevant here,
a qualified amended return is an amended return filed after the due date
for the return but before the taxpayer is first contacted by the IRS
concerning any examination with respect to the return. See id.subpara. (3)(i)(A).
Finally, for respondent to carry the burden of production that
section 7491(c) imposes on him with respect to penalties, he must make
a prima facie case that imposition of the penalty is appropriate, see, e.g.,
Costello v. Commissioner, T.C. Memo. 2021-9, at *20, which includes
establishing compliance with the supervisory approval requirement of
section 6751(b), see Graev v. Commissioner, 149 T.C. 485, 493 (2017),
supplementing and overruling in part 147 T.C. 460 (2016). Section
6751(b)(1) provides: “No penalty under this title shall be assessed
unless the initial determination of such assessment is personally
approved (in writing) by the immediate supervisor of the individual
making such determination or such higher level official as the Secretary
may designate.”
If the Commissioner carries his burden of production, the
taxpayer has the burden of proving that any affirmative defenses apply,
such as reasonable cause. E.g., Costello, T.C. Memo. 2021-9, at *20.
B. Underpayments of Tax
1. Underpayments Exist
To prove the existence of an underpayment, the Commissioner
may not rely on a taxpayer’s failure to carry his or her burden of proof
with respect to the underlying deficiency. Parks v. Commissioner, 94
T.C. 654, 660–61 (1990). The Commissioner must prove only that an
underpayment exists, however, and not the precise amount of the
underpayment. DiLeo, 96 T.C. at 873.
39
[*39] “A taxpayer’s conviction pursuant to section 7206(1) estops him
or her from contesting that an underpayment exists for the years at
issue in the criminal case.” Laciny, T.C. Memo. 2013-107, at *15; see
also Seiffert v. Commissioner, T.C. Memo. 2014-4, at *13, supplemented
by T.C. Memo. 2014-61. Petitioner’s criminal conviction under section
7206(1) estops him from contesting that an underpayment exists for
2003.
Regarding 2002 and 2004, as reported supra pp. 16–17, petitioner
admitted in the plea agreement that, on the Fabians’ returns for those
years, he overstated the amount of income tax that had been withheld
on his wages. He was represented by counsel when he executed the
agreement, and he agreed that, had the case gone to trial, the United
States would have proved beyond a reasonable doubt the facts set forth
in the agreement. Overstated income tax withholding constitutes an
underpayment of tax. See Feller v. Commissioner, 135 T.C. 497; Treas.
Reg. § 1.6664-2(c)(1). Petitioner’s admissions as to 2002 and 2004 are
sufficient to satisfy respondent’s burden of proving that the Fabians
underpaid their federal income tax for those years. See, e.g., Laciny,
T.C. Memo. 2013-107, at *15 (holding that taxpayer’s acknowledgment
under oath while represented by counsel that returns did not report all
income subject to tax establishes taxpayer’s underpayment); Kaufman
v. Commissioner, T.C. Memo. 2003-262, 2003 WL 22078659, at *4
(holding that admissions resulting from failure to reply to answer are
sufficient to meet Commissioner’s burden of proving fraudulent intent
and underpayment of tax).
Respondent has carried his burden of proving that the Fabians
underpaid their income tax for each year at issue by overstating their
income tax withholding for the year. That gives rise to a rebuttable
presumption that the whole of the underpayment for the year is due to
fraud. See § 6663(a) and (b). A taxpayer may rebut the presumption by
proving by a ponderance of the evidence the portion of the
underpayment not attributable to fraud. See, e.g., § 6663(b); Hobart v.
Commissioner, T.C. Memo. 1995-517, 1995 WL 634442, at *5. Petitioner
has not attempted to do that, but, at trial, he tried to show that, for 2002
and 2004, respondent erred in determining the amounts Maximus
actually withheld. The larger that amount, the smaller the
underpayment.
40
[*40] 2. Amounts of Income Tax Actually Withheld
a. Introduction
The following table compares the amounts the Fabians reported
as income tax withheld with the amounts reported to the SSA as having
been withheld and paid to the IRS for the corresponding year.
Table 5
Amount reported Amount reported
Year on return to SSA as having Difference
been withheld
and paid to IRS
2002 $46,425 $11,424 $35,001
2003 46,000 13,969 32,031
2004 504,000 28,984 475,016
Respondent accepted the amounts reported to the SSA as having
been withheld from petitioner’s wages as actually having been withheld
from his wages. He did not accept that any additional amounts had been
withheld. For each year, respondent made a negative adjustment to the
Fabians’ claimed credit for income tax withheld equal to the difference
between the amount claimed and the amount reported by the SSA and
treated the adjustment as contributing to or, for 2002, establishing an
underpayment in tax. See Feller, 135 T.C. at 503; Treas. Reg. § 1.6664-
2(g) (example 3).
b. 2002
Because petitioner admitted in the plea agreement that, on the
Fabians’ 2002 return, he overstated the amount of income tax that had
been withheld, we give no weight to the $46,425 reported on that return
as the amount of income tax that Maximus (or anybody else) actually
withheld from compensation paid to him.
At trial, petitioner tried to show that the amounts Maximus
actually withheld exceeded the $11,424 reported withheld to the SSA.
To support that claim, petitioner proffered three exhibits: The first was
a 2002 Form W–2 purportedly from Maximus reporting amounts in
agreement with what Maximus reported to the SSA, viz, wages of
$289,853 and withheld income tax of $11,424. We received the exhibit
without objection. Petitioner’s second exhibit also purported to be a
2002 Form W–2 from Maximus. It shows wages of $52,692 and federal
41
[*41] income tax withheld of $3,230. Respondent objected to the second
Form W–2 as excludible hearsay. We allowed it into evidence for the
limited purpose that one might find from it that petitioner had received
it from Maximus but not to prove the truth of matters asserted therein,
viz, the amounts of wages paid and tax withheld. See Fed. R. Evid.
801(c)(2). Petitioner’s third exhibit was a purported pay stub that he
claimed he had received from Maximus for the pay period ending
November 30, 2002. The exhibit shows, for the first 11 months of the
year, gross pay of $281,336 and federal tax withholding of $61,376.
Respondent objected, and, as with petitioner’s second exhibit, we
received it into evidence for the limited purpose that one might find from
it that petitioner had received it from Maximus but not to prove the
truth of matters asserted therein, viz, the amounts of gross pay and
withholding.
We have no need to consider whether petitioner received the two
exhibits from Maximus, and, considering the exhibits for no other
purpose, the record is bare of any admissible evidence of an amount
actually withheld by Maximus in excess of the $11,424 reported as
received by the SSA. Petitioner has failed to prove actual withholding
for 2002 in excess of $11,424, and we find that to be the amount of
income tax actually withheld for 2002.
c. 2003
As with 2002, because of petitioner’s admission of overstating
withholding on the Fabians’ 2003 return, we give no weight to the
$46,000 reported on that return as the amount of income tax that
Maximus (or anybody else) actually withheld from compensation paid to
him. The Form W–2 that accompanied that return agrees with the
amounts reported to the IRS. Petitioner has failed to prove actual
withholding for 2003 in excess of the $13,969 Maximus reported to the
SSA, and we find that to be the amount of income tax actually withheld
for 2003.
d. 2004
Respondent’s records show that petitioner filed an amended 2004
return on January 9, 2006. The parties did not stipulate a copy of that
return. At trial we received without objection an unsigned copy of a
Form 1040X, Amended U.S. Individual Income Tax Return, for 2004
(2004 Form 1040X). In pertinent part, the 2004 Form 1040X reports a
reduction in wages, salaries, tips, etc. of $1,652,000, resulting in a
42
[*42] corrected amount of $343,750, a reduction in total tax (before
credits) of $470,741, resulting in a corrected amount of $60,370, and a
reduction of federal income tax withheld by $460,000 (from $504,000 to
$44,000), which, along with a credit for excess Social Security of $5,450,
and an estimated tax penalty of $155, reduced the amount shown as
owing the government to $11,075 ($60,370 – 44,000 – 5,450 + 155 =
$11,075). Although the return reports that amount as due, it is unclear
whether respondent processed the return because respondent’s records
do not show any additional assessment of tax. The Form W–2 for
CMATI that accompanied the 2004 Form 1040 that the Fabians filed in
December 2005 reports compensation paid of $171,875 and federal
income tax withheld of $22,000. On the 2004 Form 1040X, petitioner
explains that the reason for the amended return is: “W–2 for CMAT
International incorrectly reported loan proceeds as income.”
We are not sure for what purpose petitioner wants us to consider
the 2004 Form 1040X. A tax return is not evidence of the truth of the
statements in it. E.g., Hale v. Commissioner, T.C. Memo. 2010-229,
2010 WL 4120880, at *2. It does not persuade us that we have erred in
redetermining the deficiencies in tax determined by respondent; and,
because it reports less tax due before credits ($$60,370) than on the 2004
Form 1040 ($531,111), were we to credit its report of tax due it would
seemingly increase petitioner’s underpayment of tax and the resulting
underpayment penalty. See Treas. Reg. § 1.6664-2(a). And the corrected
amount of income tax withheld reported on the 2004 Form 1040X,
$44,000, differs both from the amount of 2004 income tax reported to the
SSA as withheld by Maximus, $6,984, and the amount reported on the
2004 Form 4852 as withheld by Maximus, i.e., $22,000. The coincidence
between the amounts reported on that form and on the now disavowed
2004 Form W–2 from CMATI leads us to question the accuracy of the
former, and the huge reduction—$460,000—in petitioner’s claim of
income tax withheld for 2004 leads us to the conclusion that we have no
reliable basis for concluding that the amount of income tax withheld for
2004 was any greater than the amount reported to the SSA for the year,
$28,984, and we so hold.
e. Conclusion
The amounts of income tax actually withheld for the years at
issue are as determined by respondent and set forth in Table 5 as
amounts reported received by the SSA.
43
[*43] C. Burden of Production
For each of the years at issue, respondent has shown both
fraudulent intent to evade tax and an underpayment of tax. He has thus
made the prima facie case required by section 7491(c) that imposition of
the section 6663 fraud penalty is appropriate. Respondent has produced
an IRS Penalty Approval Form prepared by RA Hicks and signed by Mr.
Hansen, her immediate supervisor, that we find would satisfy section
6751(b)(1) but possibly for the fact that the heading of the form refers to
tax year 2006 rather than the years at issue. We must determine
whether the error in the heading precludes our making that finding. We
think not. The body of the form speaks exclusively of 2002, 2003, and
2004 as the years for which approval is being sought. We assume that
Mr. Hansen did not notice the error in the heading, or he would have
brought it to RA Hicks’s attention. The form’s signature block states
that he is approving the penalties identified on the form. We take his
signature as evidence that he read the body of the form and was
approving fraud penalties pursuant to RA Hicks’s request on the first
page of the form that Ҥ 6663 should be asserted to the TP [petitioner]
for the significant misstatements on the 2002, 2003, and 2004 forms
1040.” Petitioner makes no mention on brief of the error on the approval
form. We consider it a scrivener’s error that we can ignore. See Sells v.
Commissioner, T.C. Memo. 2021-12, at *9 (holding misdescription of
penalty on approval form a “scrivener’s error” and accepting
Commissioner’s clarification). Respondent has shown that the written
supervisory approval requirement of section 6751(b) is satisfied. He has
carried the burden imposed on him by section 7491(c) to show that
imposition of the section 6663 fraud penalty for each year at issue is
appropriate.
D. Reasonable Cause
A taxpayer may avoid the section 6663(a) penalty by showing that
he had reasonable cause for a portion of the underpayment and that he
acted in good faith with respect to that portion. § 6664(c)(1). The
decision as to whether the taxpayer acted with reasonable cause and in
good faith depends upon all the pertinent facts and circumstances.
Treas. Reg. § 1.6664-4(b)(1). Avoidance of a penalty by such a showing
is an affirmative defense for which the taxpayer bears the burden of
proof. See, e.g., Hall v. Commissioner, T.C. Memo. 2014-16, at *9.
44
[*44] Petitioner did not address this defense at trial or on brief except
for a single sentence in his opening brief stating that he “took tax
positions that were reasonable and consistent with law and guidelines
in existence at that time [apparently the time he filed the returns for
the years at issue].” Moreover, the record does not otherwise reflect that
petitioner acted with reasonable cause and in good faith. Petitioner has
failed to show for any of the years at issue that he had reasonable cause
for any portion of the underpayment and that he acted in good faith with
respect to that portion.
E. Conclusion
Respondent has by clear and convincing evidence shown that the
Fabians both underpaid their 2002, 2003, and 2004 tax liabilities and
that, with respect to those underpayments, petitioner acted with
fraudulent intent. The fraud penalty applies to the entirety of the
underpayments for those years.
V. Section 6651(a)(1) Additions to Tax
Section 6651(a)(1) imposes an addition to tax for failure to file a
timely tax return. The addition equals 5% of the amount required to be
shown as tax on the delinquent return for each month or fraction thereof
during which the return remains delinquent, up to a maximum addition
of 25% for returns more than four months delinquent. Id. The addition
to tax does not apply if the failure to file timely is due to reasonable
cause and not to willful neglect. Id.On April 15, 2004, petitioner filed a request for an extension of
time to file the Fabians’ 2003 income tax return until August 15, 2004.
The Fabians filed the 2003 Form 1040 on February 13, 2005, which was
almost six months after it was due. The Fabians’ 2004 Form 1040 was
due on April 15, 2005, and they filed it on December 27, 2005. Petitioner
makes no argument that the Fabians’ failure to file the two returns
timely was due to reasonable cause and not willful neglect. Thus, we
will sustain the section 6651(a)(1) additions to tax for 2003 and 2004.
To reflect the foregoing,
Decision will be entered under Rule 155.