14thSeptember2012

6663nocivilfraud

RalphE.Holmesv.Commissioner,TCMemo2012251,CodeSec(s)16510011045120212111212
6651666266637491.
RALPHE.HOLMES,Petitionerv.COMMISSIONEROFINTERNALREVENUE,Respondent.
CaseInformation:
CodeSec(s):165100110451202121112126651666266637491
Docket:DocketNo.376910.
DateIssued:08/30/2012
HEADNOTE
XX.
Reference(s): Code Sec. 165 Code Sec. 1001 Code Sec. 1045 Code Sec. 1202 Code Sec. 1211 Code
Sec.1212CodeSec.6651CodeSec.6662CodeSec.6663CodeSec.7491
Syllabus
OfficialTaxCourtSyllabus

II. Application of the Section 6663 Civil Fraud Penalty We next determine whether petitioner is liable for a
section6663(a)penaltyforeachyearinissue.Section6663(a)providesthat,ifanypartofanunderpayment
oftaxrequiredtobeshownonareturnisduetofraud,anamountisaddedtothetaxequalto75%ofthe
portionoftheunderpaymentwhichisattributabletofraud.TheCommissionerbearstheburdenofproof.See
sec.15[*29]7454(a)Rule142(b).Tosatisfyhisburdenofproof,theCommissionermustestablishbyclear
andconvincingevidenceboththat(1)thetaxpayerunderpaidhisincometaxforeachyearinissueand(2)at
leastsomeportionofeachsuchunderpaymentwasduetofraud.DiLeov.Commissioner,96T.C.858,873
(1991), aff'd , 959 F.2d 16 [69 AFTR 2d 92998] (2d Cir. 1992). In establishing the underpayment, the
Commissioner may not rely on the taxpayer's failure to meet his burden of proving error in the
Commissioner'sdeterminationastothedeficiencies.Id.IftheCommissionerestablishesthatanyportionof
anunderpaymentisattributabletofraud,theentireunderpaymentistreatedasattributabletofraudexcept
foranyportionoftheunderpaymentwhichthetaxpayerestablishesbyapreponderanceoftheevidenceis
notattributabletofraud.Sec.6663(b).
A.UnderpaymentofTax
Respondent has shown by clear and convincing evidence that petitioner underpaid his tax for each year in
issue.PetitionerstipulatedthathereceivedproceedsineachyearinissuefromthesaleofMacroPorestock
andthathefailedtoincludetheminhisincome.Hedisputesthetaxabilityoftheresultinggain,arguinghis
entitlementtodeferitsrecognitionpursuanttosection1045.AsdiscussedsuprasectionI.A.2.c.ofthisreport,
wefindthatheisnotsoentitled.Healsoconcedesthatheerroneouslyclaimedan$8,000longtermcapital
loss for [*30] 2004. Finally, he makes no argument that he has unclaimed deductions or credits that would
reducethetaxburdenattributableeachyeartohisunreportedincome.

Wefindthatrespondenthasshownbyclearandconvincingevidencethatpetitionerunderreportedhisgross
incomeand,consequently,underpaidhistax,foreachyearinissue.
B.FraudulentIntent
ThesecondprongofthefraudtestrequirestheCommissionertoprovethat,foreachyearinissue,atleast
some portion of the taxpayer's underpayment of tax is due to fraud. Fraud for that purpose is defined as
intentional wrongdoing, with the specific purpose of avoiding a tax believed to be owed. E.g., DiLeo v.
Commissioner,96T.C.at874.TheCommissionermustthusprovethatthetaxpayerintendedtoevadetax
believedtobeowingbyconductintendedtoconceal,mislead,orotherwisepreventthecollectionoftax.See,
e.g.,Browningv.Commissioner,T.C.Memo.2011261[TCMemo2011261],2011WL5289636,at*13.A
fraudulent state of mind may be proved by circumstantial evidence because direct proof of the taxpayer's
intent is rarely available. E.g., DiLeo v. Commissioner, 96 T.C. at 874. Mere suspicion, however, is not
enough.E.g.,Katzv.Commissioner,90T.C.1130,1144(1988).[*31]Courtshavedevelopedanonexclusive
listoffactorsthatdemonstratefraudulentintent.Thosebadgesoffraudinclude:(1)understatingincome,(2)
maintaininginadequaterecords,(3)implausibleorinconsistentexplanationsofbehavior,(4)concealmentof
assets,(5)failingtocooperatewithtaxauthorities,(6)engaginginillegalactivities,(7)anintenttomislead,
(8)lackofcredibilityofthetaxpayer'stestimony,(9)filingfalsedocuments,(10)failingtofiletaxreturns,and
(11)dealingincash.E.g.,Browningv.Commissioner2011WL5289636[TCMemo2011261],at*13,(and
cases cited thereat). Although no single factor is necessarily sufficient to establish fraud, a combination of
factors is more likely to constitute persuasive evidence. Id. The taxpayer's intelligence, education, and tax
expertisearealsorelevantindeterminingfraudulentintent.E.g.,id.
Wefindthatrespondenthasfailedtoprovebyclearandconvincingevidencethatpetitionerhadthespecific
intent to evade tax when he filed his 200004 Federal tax returns. Respondent contends that five indicia of
fraud exist: (1) understatement of income, (2) implausible and inconsistent explanations of behavior, (3)
failure to cooperate with tax authorities, (4) failure to make estimated payments, and (5) petitioner's
education and sophistication. 16 Although [*32] respondent has proffered some evidence of fraud, that
evidence relates exclusively to petitioner's postfiling actions and does not convince us of his intention to
evadetaxwhenhefiledhistaxreturnforeachyearinissue.Respondentmustprovebyclearandconvincing
evidencethatpetitionerintendedtoevadetaxinfilingthereturns.E.g.,Avenellv.CommissionerT.C.Memo.
201232[TCMemo201232],2012WL,333786,at*2.Wediscusseachassertedindiciuminturn.
1.UnderstatementofIncome
A pattern of consistent underreporting of income, particularly when accompanied by other circumstances
exhibitinganintenttoconceal,justifiestheinferenceoffraud.Furnishv.Commissioner,262F.2d727,728
729 [3 AFTR 2d 541] (9th Cir. 1958), aff'g in part, remanding in partFunk v. Commissioner, 29 T.C. 279
(1957) Parks v. Commissioner, 94 T.C. 654, 664 (1990). Respondent argues that petitioner's fiveyear
patternofunderreportingincomeandhisreportingoffalselossesfortaxyears2002and2004byinflating
hisbasisinhisMacroPorestockdemonstrateaspecificintenttoevadeFederalincometax.[*33]Petitioner
failedtoreportoneachofthesubjecttaxreturnssubstantialamountsofgainfromMacroPorestocksales.As
aresultheunderreportedhisincomeforeachyearinissue.Wedonotfind,however,thathedidsowiththe
requisite fraudulent intent. Petitioner testified that, from a discussion with Mr. Calhoun in late 2000, he
believed that recognition of those gains could be deferred because he sold stock in one startup company
and invest[ed] that in another *** startup company. He further testified that he directed his tax return
preparer,Mr.Afshar,todeferthosegainsonhis200004taxreturnsandassumedthatheknewhowtodo

that, himself remaining ignorant of, and uninterested in, the statutory and regulatory requirements for so
doing. We find that petitioner's actions before he filed the subject returns support a conclusion that, at that
time,hebelievedingoodfaiththatheneednotimmediatelyrecognizethosegains.Respondentdidnotpoint
toanythingintherecordattributingpetitioner'sfailuretorecognizethefullamountofrealizedgainforeach
taxableyearatissuetohisintenttoevadehistaxliabilityratherthantohispossiblenegligenceanddisregard
oftheapplicablestatutoryandregulatoryrequirements.
We are not swayed by petitioner's concession that he deferred recognition of the entire amount of gain
realized for 200104 despite not having reinvested all of the MacroPore sale proceeds for those years in
LeonardoMDstock.Wehave[*34]foundnoevidencethat,insodoing,petitionerknewthathisreportedtax
liabilities for those years failed to reflect his true tax liabilities and thereby intended to conceal income and
evadetax.
We are, however, suspicious of petitioner's failure to report gain on his 2000 tax return, but suspicious
circumstancesalonewillnotsustainafindingoffraud.Katzv.Commissioner,90T.C.at1144(ThisCourt,
however, will not sustain a finding of fraud based upon circumstances which at the most create only
suspicion.).Petitioner'sdefenserestsuponhisbeliefthathecoulddeferrecognitionofgainfromthe2000
04MacroPorestocksalesbecauseheinvestedthosesaleproceedsinLeonardoMDstock.Yetheadmitsto
having invested none of the 2000 sale proceeds in that manner within the taxable year. Indeed, he did not
makehisfirstLeonardoMDstockpurchaseuntilapproximately18monthsafterthesolestocksalein2000.
However, because he filed the 2000 tax return on May 29, 2002, after he had purchased shares of
LeonardoMD stock, it is possible that the 2000 understatement was due to his (incorrect) belief that the
eventualpurchaseofstockinastartupcompanyjustifieddeferringrecognitionofthegainrealizedin2000.
Respondenthasfailedtoconvinceusthatpetitionerhadafraudulentintentinfailingtoreporthis2000gain.
[*35]Wealsodisagreewithrespondentthatpetitionerfraudulentlyclaimedlongtermcapitallossesfor2002
and 2004. Respondent asserts that petitioner fraudulently claimed a $35,450 longterm capital loss from
CharlesSchwabstocktradesin2002becausehereportedontheattachedScheduleDinflatedstockbases
in MacroPore stock. We infer from respondent's contention an assumption that petitioner sold some of his
shares of MacroPore stock, in which he held a basis of 1 cent each, in those transactions. As discussed
supra, the record is devoid of evidence identifying MacroPore stock as the only stock, or even among the
stocks, sold in those trades. Absent such information, we cannot begin to determine the inaccuracy of
reportingthelongtermcapitallossletalonepetitioner'sintentinsoreporting.
Respondentfailedtoofferclearandconvincingevidenceofpetitioner'sintenttoevadetaxinfilingthe2004
Schedule D, which reports an $8,000 longterm capital loss from the sale of MacroPore Biosurgery.
Althoughpetitionerconcedesitisanerroneousloss,17heassertsthattheentrywasmadebyPetitioner's
returnpreparer,Afshar,andPetitionerhadinformedAfsharthathesoughttodeferorrollovergainsfromthe
saleofstockinMacroPoreandalways[*36]assumedthatAfsharknewhowtodothatinthepreparationof
Petitioner'sreturns.Wefindunlikelypetitioner'signoranceoftheerroneousnessofthelongtermcapitalloss
uponfilingthetaxreturnbecause2004istheonlyyearforwhichheomittedthatyear'srealizedMacroPore
gainandreportedalongtermcapitallossfromthestocksales.Althoughassertingthesameaforementioned
argumentfortaxableyears200003,hedidnotclaimsimilarlongtermcapitallossesforthoseyearsanddid
notofferanexplanationastothatdisparatetaxreporting.Nevertheless,wearenotconvincedthatheindeed
intended,infilingthe2004taxreturn,todeceiverespondentandavoidhispropertaxliabilitybyclaimingthe
erroneousloss.Mindfulthatitisrespondent'sburdentoprovefraudbyclearandconvincingevidence,and
absentpersuasivesupportingevidence,wecannotfindthatpetitionerhadtherequisitefraudulentintentfor
2004.

Respondenthasfailedtoprovebyclearandconvincingevidencethatpetitionerunderstatedhisincomefor
anyyearinissuewiththeintenttoevadetax.
2. Implausible and Inconsistent Explanations of Behavior Respondent next contends that petitioner "
(personallyorthroughhisrepresentative)offeredaseriesofinconsistentexplanationsastowhyhefailedto
reporthissubstantialgainsfromhissalesofMacroPorestock,specificallyMr.Afshar'sstatementsthat:(1)
petitioner held no interests in MacroPore, [*37] denying that petitioner founded the corporation, (2) the
deposits into petitioner's Charles Schwab account resulted from transfers from petitioner's other bank
accounts, and (3) petitioner had no gains as a result of the sales. He argues that, to support the latter
statement, petitioner prepared, and Mr. Afshar submitted to Agent Mahamoud, a spreadsheet listing false
bases in his shares of MacroPore for the purpose of misleading respondent's agents into concluding the
audit,therebyallowingpetitionertoevadetax.
Whilethelawisclearthatfraudulentintentmustexistatthetimethetaxpayerfilesthereturn,e.g.,Gleisv.
Commissioner,24T.C.941,952(1955),aff'd,245F.2d237[52AFTR598](6thCir.1957),postfilingevents,
such as inconsistent explanations and failing to cooperate in examination of the taxpayer's return, can be
indiciaoffraudulentintentatthetimethereturnwasfiled,e.g.,Scottv.Commissioner,T.C.Memo.201265
[TC Memo 201265], 2012 WL 798039 [TC Memo 201265], at *12 (taxpayer admitting that his lack of
cooperationinexaminationofhisreturnsindicatedthatheintendedtoevadetax)Grahamv.Commissioner,
T.C.Memo.200568[TCMemo200568],2005WL730078,at*19(inconsistenttestimonyattrialconcerning
distributions from partnership),aff'd, 257 Fed. Appx. 4 [100 AFTR 2d 20076605] (9th Cir. 2007).
Nevertheless, conduct of the taxpayer, even though reprehensible, will not justify the imposition of the
penalty, unless the fraudulent intent is shown to have existed when the return was made. [*38] Barrier v.
Commissioner, T.C. Memo. 1983258 [83,258 PH Memo TC]. It seems very likely that Mr. Afshar was
attempting to hide his own erroneous reporting on petitioner's behalf, done without petitioner's knowledge,
when,withtheintenttomisleadthemastopetitioner'spropertaxliabilityfor200004,hetoldrespondent's
agentsthatnogains[were]involvedintheMacroPorestocksalesforthoseyears.However,itisalsovery
likely that petitioner prepared and allowed the submission to Agent Mahamoud of the supporting false
spreadsheet with the intent to evade tax. Indeed, he concedes as much. There is no clear and convincing
evidence, however, indicating that petitioner had formed that intention when he filed his tax return for each
year in issue rather than afterwards upon presumably realizing the significant tax reporting errors on his
200004taxreturns.
3.FailureToCooperateWithTaxAuthoritiesRespondentnextarguesthatpetitionerfailedtocooperatewith
respondent's agents during the examination of his tax returns, an indicium of fraud. He asserts specifically
that: (1) petitioner failed to attend scheduled meetings, failed to produce requested records, and provided
vague or inaccurate explanations to justify his improper tax reporting, (2) Mr. Afshar, petitioner's
representative,wouldcommunicateonlywithAgentMahamoudbecausehebelievedthathecouldpersuade
Mr. Mahamoud to accept the false bases for MacroPore by [*39] appealing to their cultural and religious
similarities,and(3)Mr.AfsharattemptedtoinfluenceAgentMahamoudintoacceptinglargerfalsebasesby
offeringhimgifts.
Wedisagree.Respondentfurnishednoevidencethat,incancelingtheOctober17,2007,meetingpetitioner
intended to hinder the audit in hopes of evading tax believed to be owing. When canceling the meeting on
behalf of petitioner, Mr. Afshar's employee cited as the reason petitioner's busy surgery schedule.
Respondent,althoughincredulousastothereason,statingonbriefthattheinterviewwasscheduledovera
monthpriortotheinterviewdate,profferednoevidencerefutingitstruth.Wecannotconcludethatasudden
claimed change in petitioner's surgery schedule alone evidences an intent to evade tax. To the contrary,

petitioner or Mr. Afshar attended other meetings with Revenue Agent Lee and agreed with respondent's
request to extend the applicable periods of limitation for assessment for each year in issue so that a more
completeauditcouldbeperformed.
Wedofind,however,thatpetitionerfailedtocooperatewithrespondent'sagentsbyintentionallysubmittinga
falsedocument.See,e.g.,Stephensonv.Commissioner,79T.C.995,1007(1982),aff'd,748F.2d331[55
AFTR 2d 85313] (6th Cir. 1984) Dobrich v. Commissioner, T.C. Memo. 1997477 [1997 RIA TC Memo
97,477],1997WL669649,at*10[*40](SubmittingfalsedocumentstotheIRSisanindicationoffraud.),
supplemented,T.C.Memo.199839[1998RIATCMemo98,039],aff'dwithoutpublishedopinion188F.3d
512,(9thCir.1999).DuringtheexaminationMr.AfsharpresentedtoAgentMahamoudadocumentlisting
false bases that petitioner purportedly held in MacroPore stock, which petitioner had prepared during the
examinationdespitebeingawareofitsfalsecontent.Wearenotconvincedthathepreparedandallowedthe
submissionofthefalsedocumenttoperpetuateaschemeformedatthetimeoffilinghis200004taxreturns
toconcealtaxablegain.Petitionerarguesthathelackedsuchanintentatthattime,attributinghisbehaviorto
a scheme concocted by Afshar to cover Afshar's failure to *** [properly make a section 1045 election] on
Petitioner's tax return by creating a spreadsheet with fictitious figures on basis. Respondent bears the
burdenofproofastothisissueandhasnotpointedtoanythingintherecordtoconvinceusthatpetitioner's
statementisuntrue.
Finally,therecordisdevoidofevidenceindicatingthatMr.Afshar'sactionstowardsAgentMahamoud,while
highlyinappropriate,werepartofpetitioner'sschemeoftaxevasioninitiatedatthetimeoffilingthesubject
taxreturns.Aswehavestatedabove,itseemsmorelikelythatMr.Afshar'sactionswereacontinuationofhis
attemptatmitigatingthetaxpreparationerrors.[*41]Wefindthat,althoughpetitionerfailedtocooperatewith
respondent'sagentsbyintentionallysubmittingafalsedocument,hisfailuredoesnotcompeltheconclusion
thathehadafraudulentintentinfilinghis200004taxreturns.
4.FailureToMakeEstimatedTaxPaymentsRespondentcontendsthatpetitioner'sfailuretomakeadequate
estimated tax payments for each year in issue indicates his intention to not pay his correct tax liabilities for
thoseyears.Petitionerdisagrees,arguingthathisestimatedtaxpaymentsandwithholdingswereinamounts
adequatetothepaymentofthetaxliabilityshowntobedueonthereturn.Hefurtherassertsthathisfailure
to pay estimated tax in excess of the reported tax liabilities is further evidence of his belief that he could
defer the recognition of gain from the sale of stock in MacroPore by investing the proceeds of the sale in
LeonardoMD.
Respondenthasofferednoevidenceandwehavefoundnoindicationintherecordthatpetitionerknewthat
his liability for each year in issue required estimated tax payments in excess of those reported. Cf.
Niedringhaus v. Commissioner, 99 T.C. 202, 213 (1992) (finding as evidence of an intent to evade tax the
factthatthetaxpayerceasedfilingestimatedtaxpaymentsfortheyearsinissueeventhoughheknewthat
his business was expanding). We do not find that [*42] petitioner's failure to make adequate estimated tax
paymentsisindicativeofhisfraudulentintenttofilefalsereturns.
5.Conclusion
We find that respondent has failed to prove by clear and convincing evidence that any part of the
underpayments of tax required to be shown on petitioner's 200004 returns was due to fraud. Accordingly,
petitionerisnotliableforasection6663(a)civilfraudpenaltyforanyyearinissue.
III. Imposition of the Section 6662 AccuracyRelated Penalty We next consider whether, alternatively,

petitionerisliableforasection6662(a)accuracyrelatedpenaltyforeachyearinissue.
A.Introduction
Section 6662(a) imposes an accuracyrelated penalty in the amount of 20% of the portion of an
underpayment of tax attributable to, among other things, negligence or disregard of rules or regulations
(without distinction, negligence), any substantial understatement of income tax, or any substantial valuation
misstatement. Sec. 6662(a) and (b)(1)(3). The accuracyrelated penalty, however, does not apply to any
partofanunderpaymentifitisshownthatthetaxpayeractedwithreasonablecauseandingoodfaith.Sec.
6664(c)(1).[*43]TheCommissionerbearstheburdenofproduction.Seesec.7491(c).Tomeetthatburden,
hemustproduceevidenceregardingtheappropriatenessofimposingthepenalty.Higbeev.Commissioner,
116 T.C. 438, 446 (2001). Once he has met that burden, the taxpayer must come forth with evidence
sufficient to persuade a court that the Commissioner's determination is incorrect, by showing, for instance,
thatthepenaltiesareinappropriatebecauseofreasonablecause.Seeid.at446447.
Petitionerassignserrortorespondent'sdeterminationofanaccuracyrelatedpenaltyforeachyearinissue
on the grounds of "(1) negligence or disregard of rules or regulations, (2) a substantial understatement of
incometax,or(3)asubstantialvaluationmisstatement.Onbrief,respondentreliesonlyonthegroundsof
substantial understatement of income tax and negligence. We construe that as a concession that the other
groundsforimpositionofthepenaltyforeachyearinissueareinapplicable.SeeRule151(e)(4)and(5).
Only one accuracyrelated penalty may be applied with respect to any given portion of an underpayment,
even if that portion is subject to the penalty on more than one of the grounds described in section
6662(b).Sec. 1.66622(c), Income Tax Regs. [*44] B. Substantial Understatement of Income Tax Penalty
Section 6662(a) and (b)(2) imposes a 20% accuracyrelated penalty on any portion of an underpayment of
taxrequiredtobeshownonareturnwhichisattributabletoanysubstantialunderstatementofincometax.An
understatementofincometaxgenerallymeanstheexcessoftheamountoftaxrequiredtobeshownonthe
return for the taxable year, over the amount of the tax shown on the return. Sec. 6662(d)(2)(A). The
understatementisdeemedsubstantialiftheamountoftheunderstatementforthetaxableyearexceedsthe
greaterof10%ofthetaxrequiredtobeshownonthereturnforthetaxableyearor$5,000.Sec.6662(d)(1)
(A).
Respondenthassatisfiedhisburdenofproductionregardingtheexistenceofsubstantialunderstatementsof
incometaxfortheyearsinissue.Wehaveforthoseyearssustainedrespondent'sadjustmentstopetitioner's
taxable income in the amounts of $500,800, $411,562, $1,103,166, $1,015,702, and $69,875, respectively.
Theresultingdeficiencies,whichinthiscaseequaltheunderstatements,are$139,967,$116,466,$217,289,
$184,335,and$37,368,respectively.AnincompleteForm5278,StatementIncomeTaxChanges,attached
tothenoticeofdeficiency,showsthattheamountsoftaxrequiredtobeshownonpetitioner's2000,2001,
and 2002 Forms 1040 are $142,060, $124,746, [*45] and $217,562, respectively. Each understatement of
income tax for 200002 exceeds the greater of 10% of the tax required to be shown on the tax return or
$5,000. While the incomplete Form 5278 is missing the page that would show the amounts required to be
shownonpetitioner's2003and2004returns,wethinkitafairassumptionthatthoseamountshereequalthe
sumofthedeficiencyfortheyearplusthetotaltaxshownontheyear'sreturnviz,$194,305and$200,300
for 2003 and 2004, respectively. See Viralam v. Commissioner 136 T.C. 151, 176 (2011). , The
understatementsoftaxfor2003and2004exceedsthegreaterof10%ofthetaxrequiredtobeshownonthe
returnsor$5,000.
Accordingly, petitioner is liable for the 20% accuracyrelated penalty under section 6662(d) for the years in

issueunlesshemeetsthesection6664(c)exceptionforreasonablecauseandgoodfaith.Becauseofsection
1.66622(c),IncomeTaxRegs.,weneednotaddresstheapplicabilityofthepenaltybasedupontheground
ofnegligenceforthoseyears.
Posted14thSeptember2012bywww.irstaxattorney.com
1 Viewcomments

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