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T.C. Memo. 1997-49
UNITED STATES TAX COURT
RICHARD AND BRENDA NELON, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 1253-94. Filed January 28, 1997.
E. K. Morley, for petitioners.
Amy J. Sargent, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
GERBER, Judge: In a notice of deficiency dated October 21,
1993, respondent determined the following income tax deficiencies
and additions with respect to petitioner Richard Nelon's Federal
income taxes:
- 2 -
Additions to Tax
Sec. Sec. Sec. Sec.
Year Deficiency 6651(f) 6653(b)(1)(A) 6653(b)(1) 6654
1
1986 $77,772 -0- $58,329 -0- $3,762
1988 75,917 -0- -0- $56,938 4,855
1989 90,355 $67,766 -0- -0- 6,110
1990 79,886 59,915 -0- -0- 5,261
1991 96,053 72,040 -0- -0- 5,526
1
In addition, with respect to the taxable year 1986, respondent has
determined an addition to tax pursuant to sec. 6653(b)(1)(B) in an amount
equal to 50 percent of the interest due on the underpayment attributable to
fraud.
Respondent also determined a deficiency and additions to tax
against petitioners, jointly, for the 1987 taxable year.
Additions to Tax
Sec. Sec.
Year Deficiency 6653(b)(1)(A) 6661
1
1987 $93,523 $70,142 $23,381
1
Respondent also determined, with respect to the taxable
year 1987, an addition to tax pursuant to sec. 6653(b)(1)(B) in an
amount equal to 50 percent of the interest due on the underpayment
attributable to fraud.
Finally, as an alternative position, respondent determined that
if the Court does not find liability for sections 6651(f) and/or
6653(b), then the delinquency addition to tax should apply in
each year and the negligence addition should also be applied for
1986, 1987, and 1988.
After concessions, the remaining issues for our
consideration are: (1) Whether petitioner Richard Nelon is
liable for additions to tax for fraud under section
6653(b)(1)(A)1 and (B) for the taxable years 1986 and 1987 and
1
Section references are to the Internal Revenue Code in
effect for the taxable years at issue. Rule references are to
this Court’s Rules of Practice and Procedure.
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under section 6653(b)(1) for the taxable year 1988; (2) whether
petitioner Richard Nelon is liable for additions to tax for
fraudulent failure to file income tax returns under section
6651(f) for the taxable years 1989 through 1991; (3) whether
petitioner Richard Nelon is liable, in the alternative, for a 25-
percent addition to tax under section 6651(a)(1); and (4) whether
petitioner Richard Nelon is liable, in the alternative, for a 5-
percent addition to tax under section 6653(a)(1)(A) and (B) for
1986 and 1987 and section 6653(a)(1) for 1988.
FINDINGS OF FACT2
Petitioners Richard and Brenda Nelon resided in
Rutherfordton, North Carolina, at the time the petition in this
case was filed.3 Richard Nelon (petitioner) left high school
when he was 16 years old, and he is inexperienced in bookkeeping
and financial matters. Petitioner operated a logging business in
the area around Rutherfordton as a sole proprietorship. This
activity was his primary source of income during the years 1986
through 1991. The activity in question was physically demanding
and dangerous work. In practice, petitioner would have to cut
the standing timber, put it on the truck, and deliver the logs to
the yard.
2
The stipulations of facts and the exhibits are
incorporated by this reference.
3
Brenda Nelon is a party only with respect to the 1987 tax
year.
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Petitioner received compensation in the amounts and years at
issue:
Year Amount Payer
1986 $24,026 Bristol Industries, Inc.
1986 142,338 Gilkey Lumber Co.
1987 249,006 Gilkey Lumber Co.
1988 241,859 Gilkey Lumber Co.
1989 293,790 Gilkey Lumber Co.
1990 254,340 Gilkey Lumber Co.
1991 295,872 Gilkey Lumber Co.
The payers supplied Forms 1099 to respondent and petitioner
reflecting the above-listed payments. During the aforementioned
years, petitioner did not make any estimated payments of income
tax. Petitioner also did not file any income tax returns for the
years at issue. Petitioner maintained some records of his
expenses for his logging business in the form of receipts, which
he could not locate for purposes of trial.
Sometime in 1985, petitioner hired Larry R. Melton (Melton)
to paint his residence. Melton, who was not a qualified tax
adviser, was involved in a tax protester group. The primary
precept of members of the protester group was that they were not
subject to Federal income taxes. Consonant with that belief,
Melton advised that petitioner was not required to pay taxes to
the U.S. Government. Petitioner accepted Melton's advice, and he
joined the protester group, attended meetings, and paid dues
during 1987 and 1988. Beginning with his 1986 taxable year,
petitioner did not file a Federal income tax return in accord
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with his belief that he was not subject to the Federal income
tax.
An accountant prepared petitioner's 1985 Federal income tax
return. In 1989, respondent audited petitioner's 1985 return.
Petitioner represented himself in the audit process and did not
agree with the adjustments respondent's agent proposed or that he
owed additional tax for his 1985 tax year. Petitioner believed
that his income and deductions for 1985 had been correctly
reported. Petitioner took no further action, the additional tax
was assessed, and respondent seized petitioner's bank account for
satisfaction of the assessed deficiency. The results of his 1985
audit during 1989 made petitioner angry and frustrated. Because
of that experience and following the seizure of the proceeds of
his bank account in 1989, petitioner chose to no longer maintain
a bank account.
On June 15, 1992, respondent's agent, David Walden (Walden),
advised petitioner by letter that his 1986 through 1991 tax years
were being subjected to examination. Brenda Nelon's 1987 taxable
year was also under examination by Walden. By a June 25, 1992,
letter, Walden was advised that petitioner was under no
obligation to communicate with respondent's agents and that
petitioner was not subject to the Federal income tax. The letter
also acknowledged that petitioner did not file Federal income tax
returns for the years in question. The letter was written by
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another person but was signed by petitioner. Petitioner did not
meet with Walden or produce requested records or documents.
On October 21, 1993, respondent issued a statutory notice of
deficiency to petitioner, determining deficiencies in income tax
for the 1986, 1988, 1989, 1990, and 1991 tax years and related
additions to tax. On the same date, respondent also issued a
statutory notice of deficiency to both Richard Nelon and Brenda
Nelon for the taxable year 1987, determining a deficiency in
income tax and related additions to tax.
At trial, petitioner acknowledged that he did not file
income tax returns for 1986 through 1991 and that he followed the
advice of Melton and the protester group that he did not have to
pay income taxes. After trial, the parties filed a stipulation
of settled issues. Among the issues settled, respondent conceded
that there was no deficiency in income tax due from, nor
overpayment due to, petitioner Brenda Nelon for the taxable year
1987. The parties also stipulated that petitioner was entitled
to deductions in connection with his logging business, as
follows:
Year Amount
1986 $127,038
1987 189,342
1988 188,927
1989 218,969
1990 194,088
1991 210,687
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OPINION
The parties have agreed that petitioner earned income and
incurred deductions for the 1986 through 1991 taxable years. The
only remaining controversy is whether petitioner is liable for
the addition to tax for fraud or, in the alternative, negligence
and failure to file. For 1986 and 1987, section 6653(b)(1)(A)
and for 1988 section 6653(b)(1) provide for an addition to tax in
an amount equal to 75 percent of the underpayment that is
attributable to fraud. For 1986 and 1987, section 6653(b)(1)(B)
provides for an additional amount equal to 50 percent of the
interest due on any part of the underpayment attributable to
fraud. Section 6653(b)(2) provides that if any portion of an
underpayment is due to fraud, the entire underpayment is treated
as fraudulent, unless the taxpayer proves some portion of the
underpayment is not due to fraud.
For 1989, 1990, and 1991, section 6651(f) provides for a
maximum addition to tax of 75 percent if any failure to file is
fraudulent. If the failure to file is not due to reasonable
cause and it is not fraudulent, section 6651(a) provides for a
maximum addition to tax of 25 percent.
The addition to tax in the case of fraud is a civil sanction
provided primarily as a safeguard for the protection of the
revenue and to reimburse the Government for the heavy expense of
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investigation and the loss resulting from the taxpayer's fraud.
Helvering v. Mitchell, 303 U.S. 391, 401 (1938).
Respondent bears the burden of proving fraud by clear and
convincing evidence. Sec. 7454(a); Rule 142(b). Respondent's
burden is met if it is shown that petitioner intended to evade
taxes known to be due and owing by conduct intended to conceal,
mislead, or otherwise prevent the collection of taxes, and that
there is an underpayment of tax. Stoltzfus v. United States, 398
F.2d 1002, 1004 (3d Cir. 1968); Rowlee v. Commissioner, 80 T.C.
1111, 1123 (1983); Acker v. Commissioner, 26 T.C. 107, 112
(1956).
The existence of fraud is a question of fact to be resolved
upon consideration of the entire record. DiLeo v. Commissioner,
96 T.C. 858, 874 (1991), affd. 959 F.2d 16 (2d Cir. 1992). Fraud
is never presumed but, rather, must be established by affirmative
evidence. Edelson v. Commissioner, 829 F.2d 828 (9th Cir. 1987),
affg. T.C. Memo. 1986-223. Direct evidence of the requisite
fraudulent intent is seldom available, but fraud may be proved by
circumstantial evidence. Spies v. United States, 317 U.S. 492,
499 (1943); Rowlee v. Commissioner, supra at 1123. The
taxpayer's entire course of conduct may establish the requisite
intent. Otsuki v. Commissioner, 53 T.C. 96, 105-106 (1969).
- 9 -
Over the years, courts have developed various factors, or
"badges", which tend to establish fraud. Recklitis v.
Commissioner, 91 T.C. 874, 910 (1988). These include: (1) A
pattern of understatement of income; (2) inadequate books and
records; (3) failure to file tax returns; (4) concealment of
assets; (5) failure to cooperate with tax authorities; (6) income
from illegal activities; (7) implausible or inconsistent
explanations of behavior; (8) an intent to mislead which may be
inferred from a pattern of conduct; (9) lack of credibility of
the taxpayer's testimony; (10) dealings in cash. Laurins v.
Commissioner, 889 F.2d 910, 913 (9th Cir. 1989), affg. Norman v.
Commissioner, T.C. Memo. 1987-265; Edelson v. Commissioner, supra
at 832; Bradford v. Commissioner, 796 F.2d 303, 307 (9th Cir.
1986), affg. T.C. Memo. 1984-601; Petzoldt v. Commissioner, 92
T.C. 661, 699 (1989); Rowlee v. Commissioner, supra at 1125.
These badges of fraud are nonexclusive. Miller v. Commissioner,
94 T.C. 316, 334 (1990).
The list of the badges of fraud, however, is illustrative.
We consider the totality of the facts and circumstances of each
case to determine whether there is fraudulent intent. King's
Court Mobile Home Park, Inc. v. Commissioner, 98 T.C. 511, 516
(1992); Recklitis v. Commissioner, supra.
- 10 -
Respondent contends that the following facts, taken as a
whole, prove that petitioner had the intent to fraudulently evade
paying income tax on at least some part of the underpayment for
the years in issue: (1) His failure to file income tax returns
for the years 1986 through 1991; (2) through that failure to
file, a corresponding consistent failure to report substantial
amounts of income from the logging business; (3) the failure to
maintain books and records of the amounts derived from the
logging business; (4) his failure to pay estimated income taxes
for the years in question; and (5) the cashing, rather than
depositing, of checks derived from the logging business.
In the instant case, petitioner did not file income tax
returns for the taxable years 1986 through 1991. The parties
have stipulated this fact. It is also without dispute that
petitioner did not report relatively large amounts of income and
expenses in connection with his logging business.
An initial analysis reveals that some of the badges of fraud
are present. Petitioner earned substantial amounts of income
that were not reported, did not keep adequate records, and failed
to provide records to or meet with respondent's agent. Due to
the 1989 audit of his 1985 Federal income tax return and the
seizure of his bank account, petitioner decided to close his bank
account and, to some extent, deal in cash. Petitioner, however,
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did not misrepresent, secrete, or attempt to deceive. Although
we do not approve of petitioner's reasons for failing to file
returns and failing to submit to respondent's examination, those
events, on this record, do not satisfy respondent's burden to
clearly and convincingly prove fraud.
On this record, we do not find that petitioner's
underpayment was due to an intent to evade taxes known to be due
and owing by conduct intended to conceal, mislead, or otherwise
prevent the collection of taxes. Stoltzfus v. United States,
supra at 1004; Rowlee v. Commissioner, supra at 1123; Acker v.
Commissioner, supra at 112.
Respondent places great emphasis on the fact that
petitioner had an accountant for the 1985 taxable year,
contending that this reflects a history of filing timely tax
returns, and thus petitioner knew of the filing requirements.
Petitioner, however, did not set out to evade tax he thought to
be due. Instead, he came to believe that he was not obligated to
file a Federal tax return and that he had no obligation to pay
Federal tax. On this record, we find that his belief was not an
intentional attempt to fraudulently evade the payment of tax.
Respondent also argues that petitioner attempted to conceal
assets by dealing in cash. Petitioner's resolve to close his
bank account and, therefore, use cash was not coupled with his
- 12 -
belief that he was not obligated to pay tax. Petitioner, based
on his belief, failed to file his 1986 and later years' returns.
It was only after his bank account was seized in 1989 in
connection with the audit of his 1985 tax return that petitioner
closed his bank account. By 1989, petitioner had failed to file
several Federal income tax returns. Petitioner believed that he
had correctly reported his income and deductions for 1985 by
using a professional return preparer (accountant). Petitioner,
who is not well educated or versed in business and tax matters,
represented himself in the 1985 audit. From his perspective he
had properly filed his 1985 return, and the resulting seizure of
his bank account caused him to react by closing the bank account.
There is no indication that the 1989 audit of petitioner's 1985
return involved the so-called protester arguments or that he
failed to cooperate with respondent's agent.
Petitioner did not cooperate with the revenue agent in the
determination of his tax liability for 1986 through 1991. On
occasion, this has been found to be an indicium of fraud. See
Rowlee v. Commissioner, 80 T.C. at 1125; Grosshandler v.
Commissioner, 75 T.C. 1, 20 (1980); Gajewski v. Commissioner, 67
T.C. 181, 200 (1976), affd. without published opinion 578 F.2d
1383 (8th Cir. 1978). Here, however, petitioner did not attempt
to deceive or mislead the revenue agent. Instead, he
- 13 -
acknowledged that he did not file any Federal income tax returns
and provided his reasons for not meeting with the agent or filing
returns. In this regard, tax protester arguments, even though
meritless and frivolous, without more, do not necessarily amount
to fraud. Kotmair v. Commissioner, 86 T.C. 1253, 1262 (1986).4
Petitioner's failure to cooperate here was to his own detriment.
Respondent had received Forms 1099 from the company(ies) that had
paid petitioner for harvested timber in each year. Petitioner,
by his failure to come forward, however, did not obtain the
benefit of the deductions to which he was entitled in connection
with the harvesting of timber. His failure to cooperate did not
keep respondent from being able to determine his income or
receipts.
At trial, petitioner admitted that he knew Melton was not an
accountant or an attorney experienced in tax matters, but he
believed Melton's advice that he did not owe tax. Petitioner is
not well versed in tax and financial matters and has only limited
formal education. We cannot say that his holding to so-called
protester tenets was with intent to defraud or misrepresent. In
4
We stated in Kotmair v. Commissioner,86 T.C. 1253, 1262
(1986) that the taxpayer's protester arguments "may have been
meritless, frivolous, wrongheaded, and even stupid, but we cannot
hold that they amounted to fraud, without something more. Were
we to do so, every failure-to-file protester case would be
automatically converted into a fraud case."
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general, a taxpayer's negligence, whether slight or gross, is not
enough to prove fraud. Kellett v. Commissioner, 5 T.C. 608, 616
(1945).
Respondent maintains that petitioner's failure to file
timely income tax returns was part of a pattern of fraud.
Although a taxpayer's failure to file is prima facie evidence of
negligence for purposes of section 6653(a), see Emmons v.
Commissioner, 92 T.C. 342, 350 (1989), affd. 898 F.2d 50 (5th
Cir. 1990), it is insufficient in and of itself to prove fraud.
Rowlee v. Commissioner, supra at 1123.
The record here simply does not show any affirmative acts of
concealment or misrepresentation so as to constitute fraud, such
as filing false information or attempting to mislead respondent.
Zell v. Commissioner, 763 F.2d 1139, 1146 (10th Cir. 1985), affg.
T.C. Memo. 1984-152. For respondent to sustain her position as
to the fraud addition to tax, it is not enough that respondent
can show the taxpayer to be devious. See Kreps v. Commissioner,
351 F.2d 1, 7 (2d Cir. 1965), affg. 42 T.C. 660 (1964); Shaw v.
Commissioner, 27 T.C. 561, 569-570 (1956), affd. 252 F.2d 681
(6th Cir. 1958); Gano v. Commissioner, 19 B.T.A. 518, 532-533
(1930). The evidence must be clear and convincing. In the
instant case, we find that the evidence falls short of being
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clear and convincing. Accordingly, we find that petitioner is
not liable for additions to tax or penalties based on fraud.
In the alternative, respondent determined that petitioner is
liable for the additions to tax for failure to timely file for
all the years in issue. Section 6651(a)(1) imposes an addition
to tax for a taxpayer's failure to file timely returns required
to be filed (including income tax returns), unless the taxpayer
can establish that such failure "is due to reasonable cause and
not due to willful neglect". The addition to tax is 5 percent of
the amount required to be shown on the return for each month
beyond the return's due date, not exceeding 25 percent. Sec.
6651(a)(1). Petitioner bears the burden of showing respondent's
determination to be in error and that there was reasonable cause
for his failure to timely file. Rule 142(a).
Respondent, in the alternative, also determined a 5-percent
addition to tax for each of the years 1986 through 1988 for
negligence or intentional disregard of rules or regulations.
Section 6653(a)(1)(A) for 1986 and 1987 and section 6653(a)(1)
for 1988 provide for a 5-percent addition to tax if any part of
the underpayment is due to negligence or intentional disregard of
rules and regulations. If section 6653(a)(1)(A) applies for 1986
and 1987, then section 6653(a)(1)(B) provides for a further
addition to tax equal to 50 percent of the interest attributable
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to that portion of the underpayment resulting from negligence or
intentional disregard of rules and regulations. Negligence is
defined as a lack of due care or failure to do what a reasonable
and prudent person would do under the circumstances. Neely v.
Commissioner, 85 T.C. 934, 947 (1985). Petitioner bears the
burden of showing that he was not negligent. Rule 142(a); Bixby
v. Commissioner, 58 T.C. 757, 791-792 (1972).
Petitioner did not contend, either at trial or on brief,
that his failure to file returns was due to reasonable cause or
that his actions were reasonable. On this record, we find that
petitioner is liable for additions to tax for failure to file and
negligence for the years indicated above. In addition, we find
that petitioner is liable for additions to tax under section 6654
as determined by respondent.
To reflect the foregoing,
Decision will be entered under
Rule 155.