                        T.C. Memo. 2003-148



                      UNITED STATES TAX COURT



           ALBER I. AND GEORGETTE H. SAID, Petitioners v.
            COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 11202-01.               Filed May 22, 2003.



     Alber I. Said and Georgette H. Said, pro sese.

     Nguyen-Hong Hoang, for respondent.



              MEMORANDUM FINDINGS OF FACT AND OPINION


     COHEN, Judge:   Respondent determined deficiencies in, and

penalties on, petitioners’ Federal income tax liabilities as

follows:
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                                          Penalty, I.R.C.
          Year       Deficiency             Sec. 6663(a)

          1993         $41,582                $31,187
          1994          57,974                 43,481
          1995         346,400                259,800

     After concessions, the issues for decision are:        (1) Whether

petitioners are entitled to claim additional cost of goods sold

of $47,884 for 1995; (2) whether petitioner Alber I. Said

(petitioner) is liable for the fraud penalty under section

6663(a) for 1993, 1994, and 1995 or, in the alternative, liable

for an accuracy-related penalty under section 6662(a) for the

years in issue; and (3) whether petitioner Georgette H. Said

(Mrs. Said) is liable for the accuracy-related penalty under

section 6662(a) for the years in issue.

     Unless otherwise indicated, all section references are to

the Internal Revenue Code in effect for the years in issue, and

all Rule references are to the Tax Court Rules of Practice and

Procedure.

                         FINDINGS OF FACT

     Some of the facts have been stipulated, and the stipulated

facts are incorporated in our findings by this reference.

Petitioners resided in Moreno Valley, California, at the time

they filed the petition in this case.

     Petitioner attended the College of Commerce at the

University of Alexandria, Egypt, and obtained a degree in

accounting.   Petitioner owned and operated a gasoline station,
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Mena’s Arco (Mena’s), in San Bernardino, California, as a sole

proprietorship during the years in issue.    Mena’s sold gasoline

and other merchandise such as snacks, lottery tickets,

cigarettes, and automotive parts and supplies.   Mena’s received

commissions on repair work completed by third parties.   There

were two public telephones on Mena’s premises that paid Mena’s a

commission.

Petitioners’ Federal Returns

     Petitioners filed Form 1040, U.S. Individual Income Tax

Return, for 1993 reporting adjusted gross income of $12,282 and

taxable income of $0.   Petitioners claimed an earned income

credit of $1,311.   Petitioners filed a Schedule C, Profit or Loss

From Business, reporting gross receipts of $4,963,722, expenses

of $4,956,469, and a net profit of $7,253 that was reported on

their Form 1040.

     Petitioners filed a Form 1040 for 1994 reporting adjusted

gross income of $14,523 and taxable income of $0.   Petitioners

claimed an earned income credit of $1,904.   Petitioners filed a

Schedule C reporting gross receipts of $4,668,333, cost of goods

sold of $4,219,896, expenses of $346,907, and a net profit of

$15,627 that was reported on their Form 1040.

     Petitioners filed a Form 1040 for 1995 reporting adjusted

gross income of $15,717 and taxable income of $0.   Petitioners

claimed an earned income credit of $2,214.   Petitioners filed a
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Schedule C reporting gross receipts of $3,615,300, cost of goods

sold of $3,392,128, expenses of $208,380, and a net profit of

$16,912 that was reported on their Form 1040.

Respondent’s Examination

     Revenue Agent Emmanuel Pascual (Pascual) audited

petitioners’ returns for all 3 years.   Respondent’s standard

procedure when examining a sole proprietorship engaged in

operating a gasoline station involves a field visit of the

proprietor’s home and business.   Pascual drove by Mena’s and by

petitioners’ home prior to contacting petitioners regarding the

examination of their returns.   Pascual observed that petitioners

resided in a two-story home with a three-car garage and that

petitioner drove a Mercedes-Benz.

     During the examination, petitioners consistently postponed

scheduled interviews and appointments with Pascual.   Pascual

requested from petitioners documentation regarding their income,

expenses, and cost of goods sold for Mena’s.    Petitioners did not

provide complete bank records, and Pascual issued summonses to

obtain copies of petitioners’ personal and business bank

statements, canceled checks, and deposit slips.   At one point,

petitioners’ representative told Pascual that petitioners had no

personal bank accounts.    Pascual found that petitioners did have

both business and personal bank accounts, and he obtained copies

of bank statements, canceled checks, and deposit slips.    Pascual
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conducted a bank deposits analysis of petitioners’ accounts.

After allowing for nontaxable transfers, Pascual determined that

petitioners had unreported gross receipts deposited into their

bank accounts in each of the years in issue.

     Petitioners did not provide complete records of Mena’s

expenses, instead turning over various incomplete and disorderly

receipts and documents.   To calculate Mena’s cost of goods sold,

Pascual relied on two documents provided by petitioners.   Pascual

reviewed an ARCO Products Company, Product Sales for Customer

spreadsheet that indicated how much gasoline was sold to Mena’s

and a Summary of Items Collected from ARCO Productions Company.

Pascual determined the cost of goods sold by calculating the

amount of gasoline and other items sold based on these two

documents and substantiating invoices.

     Pascual also reviewed Mena’s daily cash log of gasoline

sales for all 3 years.    Pascual added the amounts from the log on

his adding machine, keeping a copy of the tape and returning the

original log to petitioners.   Subsequently, petitioners disputed

Pascual’s tape totals for 1995 and again provided the daily log

sheets.   Before resubmitting the daily log sheets to Pascual,

petitioner altered the amounts on the logs and made erasures.

     During the audit, Pascual questioned whether petitioners

received gross receipts from automobile repairs.   Petitioner told

Pascual that Mena’s conducted smog checks and engaged in tuneups
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and brake services.    Petitioner denied conducting any other major

mechanical repair services.    Subsequently, however, petitioner

provided Pascual with receipts and invoices for mechanical repair

work in order to substantiate Mena’s expenses.    When Pascual

questioned petitioner regarding the repair work, petitioner took

the invoices back from Pascual and told him not to include the

invoices in the calculation of expenses.    Petitioner later told

Pascual that he received a 10-percent fee for referring Mena’s

customers for repair work completed by third parties.    Petitioner

also did not disclose to Pascual gross receipts from two public

telephones located on Mena’s property.

     On July 10, 2001, respondent sent to petitioners a notice of

deficiency listing adjustments for unreported gross receipts and

disallowing a portion of the cost of goods sold and of the

business expenses.    Respondent also disallowed petitioners’

earned income credit for all 3 years.

     The petition disputed respondent’s determination of cost of

goods sold but not the determination of unreported gross

receipts.   Petitioner stipulated that he had unreported gross

receipts from Mena’s in the amounts of $302,550, $579,528, and

$561,200 for 1993, 1994, and 1995, respectively.    Respondent

concedes that petitioners are entitled to cost of goods sold of

$99,251 in 1993 and $336,008 in 1994 in addition to the amounts

previously determined, decreasing the deficiency and penalty
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amounts reflected in the notice of deficiency.   Respondent also

concedes that the initial cost of goods sold that was disallowed

in the notice of deficiency for 1995 should be reduced from

$260,282 to $47,884.   Respondent also concedes that petitioners

are entitled to additional Schedule C expense deductions (in

excess of what was initially reported by petitioners) in the

amounts of $109,436, $104,690, and $12,155 for 1993, 1994, and

1995, respectively.

                               OPINION

Stipulation of Facts

     In the stipulation of facts, petitioners conceded unreported

gross receipts for each of the years in issue.   In their brief,

however, petitioners claim that they did not stipulate to these

amounts and that respondent’s counsel told them they had to sign

the stipulation prior to trial.   Petitioners have not moved to be

relieved from the stipulation or presented grounds that they

should not be bound to their admissions.   See Rule 91(e).   We are

not persuaded by petitioners’ argument and hold that the

stipulation remains binding.

Cost of Goods Sold

     Petitioners continue to dispute that respondent incorrectly

disallowed $47,884 of petitioners’ claimed cost of goods sold for

1995.   Respondent argues that petitioners have failed to
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establish their entitlement to any cost of goods sold over the

amount conceded by respondent.

     Generally, the taxpayer bears the burden of disproving the

Commissioner’s determination.    Rule 142(a).   Section 7491 does

not apply in this case to shift the burden to respondent because

the record shows that the examination of petitioners’ returns

commenced prior to July 22, 1998.    See Internal Revenue Service

Restructuring and Reform Act of 1998, Pub. L. 105-206, sec.

3001(c), 112 Stat. 726, 727.    (In any event, petitioner did not

retain required records, did not cooperate with reasonable

requests for information, and did not introduce credible evidence

with respect to his income and deductions.)

     The income of a sole proprietorship must be included in

calculating the income and tax liabilities of the individual

owning the business.    Sec. 61(a)(2).   The net profit or loss of

the business is computed on a Schedule C by subtracting the cost

of goods sold and ordinary and necessary business expenses from

the gross receipts.    Sec. 1.61-3(a), Income Tax Regs.   It is a

taxpayer’s responsibility to maintain adequate books and records

sufficient to substantiate all items on the tax return, including

the cost of goods sold.    See sec. 6001.

     Pascual reviewed all documentation that petitioners provided

to him to substantiate their cost of goods sold for 1995.

Petitioners did not provide evidence to substantiate an amount
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larger than that allowed by respondent.   At trial, petitioner

offered oral testimony unsubstantiated by documentary evidence to

demonstrate additional costs.   See Hradesky v. Commissioner, 65

T.C. 87, 90 (1975), affd. 540 F.2d 821 (5th Cir. 1976).    Even the

oral testimony was not specific in identifying additional

amounts.   On brief, petitioners argue that Pascual miscalculated

amounts for all 3 years and that petitioners owe no tax.     The

calculations provided in petitioners’ brief are not supported by

evidence in the record.   Petitioner’s claim that he had no

taxable income is not credible in the circumstances.   He is

entitled to no costs of goods sold or deductions beyond those

conceded by respondent.

Fraud Penalty

     The penalty 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

investigation and the loss resulting from the taxpayer’s fraud.

Helvering v. Mitchell, 303 U.S. 391, 401 (1938); Sadler v.

Commissioner, 113 T.C. 99, 102 (1999).    Respondent has the burden

of proving, by clear and convincing evidence, an underpayment for

the years in issue and that some part of the underpayment for

those years was due to fraud.   Sec. 7454(a); Rule 142(b).    If

respondent establishes that any portion of the underpayment is

attributable to fraud, the entire underpayment is treated as
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attributable to fraud and subjected to a 75-percent penalty,

unless the taxpayer establishes that some part of the

underpayment is not attributable to fraud.    Sec. 6663(b).

Respondent must show that the taxpayer intended to conceal,

mislead, or otherwise prevent the collection of taxes.     Katz v.

Commissioner, 90 T.C. 1130, 1143 (1988); Rowlee v. Commissioner,

80 T.C. 1111, 1123 (1983).

     The existence of fraud is a question of fact to be resolved

upon consideration of the entire record.     King’s Court Mobile

Home Park, Inc. v. Commissioner, 98 T.C. 511, 516 (1992).      Fraud

will never be presumed.   Id.; Beaver v. Commissioner, 55 T.C. 85,

92 (1970).   Fraud may, however, be proved by circumstantial

evidence and inferences drawn from the facts because direct proof

of a taxpayer’s intent is rarely available.     Niedringhaus v.

Commissioner, 99 T.C. 202, 210 (1992).     The taxpayer’s entire

course of conduct may establish the requisite fraudulent intent.

Stone v. Commissioner, 56 T.C. 213, 223-224 (1971).

     Respondent must prove fraudulent intent.    Fraudulent intent

may be inferred from various kinds of circumstantial evidence, or

“badges of fraud”, including a consistent understatement of

income, inadequate records, implausible or inconsistent

explanations of behavior, failure to cooperate with tax

authorities, and dealing with cash.    Bradford v. Commissioner,

796 F.2d 303, 307 (9th Cir. 1986), affg. T.C. Memo. 1984-601.      A
                               - 11 -

taxpayer’s level of education is a relevant factor.   See

Niedringhaus v. Commissioner, supra at 211; Stephenson v.

Commissioner, 79 T.C. 995, 1006 (1982), affd. 748 F.2d 331 (6th

Cir. 1984).

     Although respondent must prove an underpayment of tax in

support of the fraud penalty, respondent’s burden is met here by

proof of unreported income.   An underpayment will exist where

unreported gross receipts are not exceeded by costs of goods sold

and deductible expenses.    In establishing the underpayment, the

Commissioner may not simply rely on the taxpayer’s failure to

prove error in the deficiency determination.    DiLeo v.

Commissioner, 96 T.C. 858, 873 (1991), affd. 959 F.2d 16 (2d Cir.

1992); Parks v. Commissioner, 94 T.C. 654, 660-661 (1990); Otsuki

v. Commissioner, 53 T.C. 96, 106 (1969).    However, upon clear

proof of unreported receipts, even in a criminal case, the burden

of coming forward with offsetting costs or expenses generally

shifts to the taxpayer.    See Siravo v. United States, 377 F.2d

469, 473-474 (1st Cir. 1967); Elwert v. United States, 231 F.2d

928, 933 (9th Cir. 1956).

     Petitioner stipulated that he had unreported gross receipts

for all 3 tax years.   Petitioner has failed to show that the

receipts were offset by deductible costs or expenses.      As a

result, it is established by clear and convincing evidence that

petitioner had an underpayment of tax for each of the years.
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     Respondent must show that petitioner acted with fraudulent

intent.   The facts in this case include many “badges of fraud”.

Petitioner substantially and consistently understated his income

for each of the years in issue.    Petitioner failed to cooperate

with respondent and offered inconsistent explanations for items

on the returns.    Petitioner did not maintain complete and

accurate records of his income-producing activities and did not

produce complete records during examination.    Even when

petitioner produced documents to substantiate the information on

the returns, the records were in disarray and were incomplete.

In addition, petitioner’s business involved many cash

transactions.     Considering his education as an accountant and the

degree of noncompliance with record keeping requirements, we

infer an intention to conceal and deceive.

     Petitioner, and his representative, also made false and

misleading statements to Pascual during the examination.

Petitioners’ representative told Pascual that petitioners had no

personal bank accounts, which later proved to be false.     There is

also evidence that petitioner attempted to alter records by

changing the numbers on his gasoline log sheets in order to claim

more costs of goods sold and deductions.

     Respondent has proven by clear and convincing evidence an

underpayment of tax due to fraud for each year.    Petitioner has

not proven that any part of the underpayment is not attributable
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to fraud.    See sec. 6663(b).   Petitioner consistently made

assertions throughout trial and in his brief that are not worthy

of belief.   We have no reason to doubt Pascual’s credibility.    On

consideration of the entire record, we conclude that petitioner

is liable for the fraud penalty under section 6663(a).

Accuracy-Related Penalty

      Respondent concedes that Mrs. Said is not liable for the

fraud penalty under section 6663.     Alternatively, respondent

argues that Mrs. Said is liable for the accuracy-related penalty

under section 6662(a) for all 3 years.

      Under section 6662(a), a taxpayer may be liable for a

penalty of 20 percent on the portion of an underpayment of tax

attributable to a substantial understatement of tax or due to

negligence or disregard of rules or regulations.     Sec. 6662(b).

Section 6662 shall not apply, however, to any portion of an

underpayment subject to the fraud penalty under section 6663.

Id.

      The accuracy-related penalty cannot be imposed on one spouse

where the other spouse is liable for fraud.     Under section

6663(c), the fraud penalty is imposed on each spouse separately,

even when a joint return is filed, whereas the accuracy-related

penalty is imposed jointly and severally.     Where a joint return

is filed and one spouse is found liable for the fraud penalty,

imposing the accuracy-related penalty on the other spouse would
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result in “impermissible stacking”.      Zaban v. Commissioner, T.C.

Memo. 1997-479.   Because petitioner is liable for the fraud

penalty on the entire underpayment, Mrs. Said is not liable for

the accuracy-related penalty.

     To reflect the foregoing and the concessions of the parties,


                                            Decision will be entered

                                      under Rule 155.
