                  T.C. Memo. 1997-388



                UNITED STATES TAX COURT



             RONALD E. REED, Petitioner v.
     COMMISSIONER OF INTERNAL REVENUE, Respondent



Docket No. 29376-91.                    Filed August 25, 1997.



     R determined deficiencies in and additions to tax
on account of petitioner’s omissions of income from
illegal drug activities.
     1. Held: Petitioner failed to prove that the
source of certain expenditures was other than illegal
drug activities.
     2. Held, further, petitioner substantially
understated his income tax liability for 2 of the years
in question.
     3. Held, further, respondent proved fraud for
each of the years in question.
     4. Held, further, petitioner is liable for self-
employment taxes.



Ronald E. Reed, pro se.

Sandra M. Jefferson, for respondent.
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                                   MEMORANDUM OPINION

        HALPERN, Judge:         By notice of deficiency dated October 17,

1991, respondent determined deficiencies in and additions to

petitioner's Federal income tax as follows:

                                                Additions to Tax
                           Sec.        Sec.        Sec.           Sec.
                           6653        6653        6653           6653        Sec.
 Year        Deficiency   (b)(1)    (b)(1)(A)     (b)(2)       (b)(1)(B)      6661
 1985          $4,770     $2,385        --      50% of the         --          --
                                                interest due
                                                on $4,770
 1986          66,094      --        $49,571         --       50% of the     $16,524
                                                              interest due
                                                              on $66,094
 1987          15,757      --         11,818         --       50% of the       3,939
                                                              interest due
                                                              on $15,757

        The issues for decision are as follows:

        1.     Whether petitioner failed to report gross income from

drug-related activities for the years in question.

        2.     Whether petitioner is liable for additions to tax under

section 6661 for substantial understatement of income tax for

1986 and 1987.

        3.     Whether petitioner is liable for additions to tax under

section 6653(b) for fraud for each of the years in question.

        4.     Whether petitioner is liable for self-employment taxes

under section 1401 for each of the years in question.

        Unless otherwise noted, all section references are to the

Internal Revenue Code in effect for the years in issue, and all
                               - 3 -


Rule references are to the Tax Court Rules of Practice and

Procedure.




                            Background

     Some of the facts have been stipulated and are so found.

The stipulation of facts filed by the parties, with attached

exhibits, is incorporated herein by this reference.

     Petitioner was incarcerated in a Federal prison in Danbury,

Connecticut, at the time the petition herein was filed.

     From 1985 through 1989, petitioner was involved in dealing

cocaine in amounts ranging from 1/4 pound to multiple kilograms.

     In June 1989, petitioner was indicted by a Federal grand

jury for conspiracy to distribute cocaine, distribution of

cocaine, and money laundering (the indictment).

     On September 6, 1989, in response to the indictment,

petitioner executed an agreement (the plea agreement) with the

U.S. Attorney for the District of Maryland to plead guilty to two

counts of the indictment:   conspiracy to distribute cocaine and

money laundering.   In paragraph 3.(f) of the plea agreement,

petitioner admits that he knowingly acquired, with proceeds

traceable to transactions involving narcotics, certain real
                                 - 4 -


estate and motor vehicles listed as follows and agrees that the

property is forfeited to the United States:

            1.   102 Regent Dr., Belair, MD.

            2.   4120 Eierman Ave., Baltimore, MD.

            3.   One 1984 red Porsche 911 automobile.

            4.   One 1983 black Porsche 944 automobile.

     On October 4, 1989, petitioner was rearraigned in the U.S.

District Court for the District of Maryland (District Court) and

pleaded guilty to money laundering and conspiracy to distribute

cocaine.    In connection with the rearraignment, a document, “The

Government’s Statement of Facts” (statement of facts), was filed

with the District Court.     At the rearraignment, petitioner agreed

with both the statement of facts (refusing to make any additions

or corrections) and the plea agreement (stating that it was

correct).    The statement of facts recites that, as a result of

petitioner’s illegal earnings from trafficking in cocaine, he

purchased both real and personal property, including the

following (the listed property), expending the amounts shown:

             Item                 1985         1986     1987

     1985 Chevrolet Corvette     $17,774      --          --
     102 Regent Dr.                --      $75,577        --
     8554 Willow Oak Rd.           --       27,767        --
     M. Shaivitz & Sons            --        9,543        --
     Freestate Sales, Inc.         --        4,400        --
     Brandon Carpet Sales          --        3,027        --
     1986 Chevrolet Corvette       --       17,000        --
     1986 Porsche                  --       10,000        --
     1984 Volvo                    --        9,450        --
                                 - 5 -


      1986 Pantera                 --        22,445      --
                                                      1
      4120 Eierman Ave.            --          --      $10,558
      Rt. 40 West Furniture        --          --        2,196
      1984 Lotus                   --          --       13,185
      1984 Porsche Cabriolet        --         --        5,000
        Totals                    17,774    179,209     30,939

      The amount shown as expended for this property has been
      1

adjusted to reflect the agreement of the parties.

      With respect to certain of those items, the statement of

facts recites that petitioner used his mother, Dolores Bruno, as

a nominee to disguise his purchases.

      The District Court accepted petitioner’s guilty pleas and

entered verdicts of guilty.     Subsequently, the District Court

entered a judgment in accordance with its verdicts and sentenced

petitioner to imprisonment for 97 months.

      Petitioner made returns of income for each of the years in

issue, but reported no income from his illegal drug activities.

      Respondent’s determination of deficiencies in tax for the

years in question is, principally, the result of respondent’s

adjusting petitioner’s gross income for each year to include

amounts equal to petitioner’s expenditures for the listed

property.

                               Discussion

I.   Preliminary Matter

      The general rule is that the burden of proof is upon

petitioner, Rule 142(a), which he must carry by a preponderance

of the evidence, e.g., Schaffer v. Commissioner, 779 F.2d 849,
                              - 6 -


858 (2d Cir. 1985), affg. in part and remanding Mandina v.

Commissioner, T.C. Memo. 1982-34.   Petitioner, however, argues

that “there isn't any evidence at all that Respondent can furnish

to prove that Petitioner made a single dollar from drug

proceeds”, notwithstanding respondent's reliance on the plea

agreement and the statement of facts.1   Since this case involves

illegal unreported income, petitioner's assertion suggests that

Llorente v. Commissioner, 649 F.2d 152 (2d Cir. 1981), affg. in

part, revg. in part and remanding 74 T.C. 260 (1980),2 applies

and requires respondent to satisfy the burden of coming forward

with evidence linking petitioner to an income-producing activity.

In the stipulation of facts, however, petitioner concedes that he

spent the amounts specified for the listed property.

Petitioner's concession necessarily acknowledges receipt of funds

to purchase the listed property and eliminates any threshold

requirement imposed by Llorente.    See Tokarski v. Commissioner,



1
     Petitioner also argues that he was assured that the plea
agreement and the statement of facts would not be used against
him in any other proceeding. This Court determined petitioner's
argument to be without merit and denied his motion to dismiss for
lack of jurisdiction on Apr. 15, 1993. We see no need to
reconsider that decision.
2
     In accordance with the doctrine of Golsen v. Commissioner,
54 T.C. 742 (1970), affd. 445 F.2d 985 (10th Cir. 1971), we would
defer to Llorente v. Commissioner, 649 F.2d 152 (2d Cir. 1981),
affg. in part, revg. in part and remanding 74 T.C. 260 (1980), if
that case were applicable and this case were appealable to the
Court of Appeals for the Second Circuit.
                               - 7 -


87 T.C. 74, 76-77 (1986).   Therefore, petitioner bears the burden

of proving that respondent's determination of deficiencies is

erroneous.   Rule 142(a).

II.   Deficiencies in Tax

      Petitioner assigns error to respondent’s determination of

deficiencies in tax on the grounds that respondent failed to

consider the nontaxable sources of the amounts expended for the

listed property.

      In 1989, petitioner was adjudged guilty of money laundering

and conspiracy to distribute cocaine.   At petitioner’s

rearraignment on the charges that led to that judgment, the

District Court was presented with the plea agreement and

statement of facts, in which (when taken together) it is stated

that petitioner had received illegal earnings from trafficking in

cocaine, which were expended for certain property, including the

listed property.   During his rearraignment hearing, petitioner

agreed that the plea agreement and the statement of facts were

correct.   In this Court, however, petitioner asks us not to

credit the plea agreement and statement of facts, claiming that

he entered into the plea agreement and agreed that the plea

agreement and statement of facts were correct only to please the

Government and to avoid further prosecution.   He further claims

that he earned no cash income from drug sales, being paid for his

drug-connected activities in drugs that he consumed, and that the
                                 - 8 -


expenditures for the listed property were financed

“legitimately”, using funds from his parents, from loans, and

from lawful business ventures.    Petitioner has failed to persuade

us that that is the case.    For instance, petitioner testified

that his parents put up almost $9,000 towards the purchase of the

1985 Chevrolet Corvette.    Petitioner’s father died before 1985,3

and neither his mother nor his stepfather testified at the trial

in this case.   Petitioner’s mother worked as a secretary in the

service department of an automobile dealership, and petitioner

has given us no reason to believe that she had the wherewithal to

help him with that automobile purchase.      Petitioner has not shown

that his mother and stepfather were unavailable, and we infer

from their failure to testify that their testimony would have

been negative to petitioner.     McKay v. Commissioner, 886 F.2d

1237, 1238 (9th Cir. 1989), affg. 89 T.C. 1063 (1987); Wichita

Terminal Elevator Co. v. Commissioner, 6 T.C. 1158, 1165 (1946),

affd. 162 F.2d 513 (10th Cir. 1947).      Likewise, we draw a

negative conclusion from petitioner’s failure to offer any

person’s testimony or other evidence to support certain loans

that petitioner claims account for the cash he expended in 1986

for certain of the listed property.      Petitioner testified that



3
     Although the date of death of petitioner's father is not
clear from the record, petitioner did not object to respondent's
proposed finding of fact to that effect. Rule 151(e)(3).
                                - 9 -


some of the expenditures came from a painting company he owned,

but he could not remember the name of that company.   Also,

petitioner’s testimony that he was involved in drug dealing only

to get drugs for his own use is made suspect by the testimony of

Detective Thomas M. Lau of the Baltimore County Police

Department.   Detective Lau testified that he was introduced to

petitioner as an individual who could arrange drug purchases.     He

also testified to petitioner’s participation in (1) an

approximately $20,000 drug transaction and (2) an aborted

$100,000 drug transaction.   We found Detective Lau credible.   We

do not think that petitioner’s participation, as described by

Detective Lau, is consistent with petitioner’s testimony that he

engaged in drug-related activities only to get drugs for personal

use; rather, we think that petitioner’s participation is

consistent with drug-related activities for pecuniary benefit.

In all substantial respects relating to the listed property, we

find petitioner’s testimony to be unbelievable, and we accord it

no weight.

     Petitioner acknowledges his expenditures for the listed

property.    Such expenditures are prima facie evidence of income

(see Tokarski v. Commissioner, supra at 77), and, except with

respect to one adjustment agreed to by the parties, petitioner

has failed to prove that the amounts shown as expenditures came

from nontaxable sources.   Moreover, based on the plea agreement
                                - 10 -


and the statement of facts, we find that petitioner received

proceeds from his illegal drug activities, which were expended

to purchase the listed property, in total amounts as follows:

1985--$17,774; 1986--$179,209; 1987--$30,939.    Therefore, except

as necessary to reflect that one adjustment, we sustain

respondent’s determination of deficiencies.4

III.    Additions to Tax for Substantial Understatement of
        Liability

       Respondent also determined that petitioner substantially

understated his income tax liability and is liable for the

additions to tax under section 6661 for 1986 and 1987.     The

amount of an addition to tax for a substantial understatement of

income tax for a taxable year, which addition is assessed after

October 21, 1986, equals 25 percent of the amount of any

underpayment attributable to such substantial understatement.

Sec. 6661(a); Pallottini v. Commissioner, 90 T.C. 498, 500-503

(1988).    A substantial understatement of income tax is defined as

an understatement of tax that exceeds the greater of 10 percent

of the tax required to be shown on the return for the year or

$5,000, whichever is greater.    Sec. 6661(b)(1)(A).   Petitioner

has assigned error to respondent’s determination of a section



4
     On brief, respondent states that $179,000 is the amount of
the 1986 expenditures. That amount is slightly different from
the amount set forth in the notice of deficiency. It appears
that the brief is in error.
                              - 11 -


6661 addition to tax but has not averred any facts in support of

that assignment.   We assume that petitioner relies on our finding

no (or reduced) deficiencies to support his assignment of error.

Petitioner bears the burden of proof.   Rule 142(a).   We do not

find any reduced deficiencies (except as necessary to take into

account one adjustment agreed to by the parties); therefore,

petitioner has failed to carry his burden of proof, and we

sustain the determination of additions to tax under section 6661,

modified to take account of the agreement of the parties.

IV.   Additions to Tax for Fraud

      Respondent also determined additions to tax for fraud under

section 6653(b)(1) and (2) for 1985 and under section

6653(b)(1)(A) and (B) for 1986 and 1987.   For 1985, section

6653(b)(1) imposes an addition to tax equal to 50 percent of any

underpayment in tax if any part of the underpayment is due to

fraud; section 6653(b)(2) imposes a separate addition to tax,

equal to 50 percent of the interest payable under section 6601,

determined on the portion of the underpayment attributable to

fraud.   For 1986 and 1987, section 6653(b)(1)(A) imposes an

addition to tax equal to 75 percent of any underpayment in tax if

any part of the underpayment is due to fraud; section

6653(b)(1)(B) imposes a separate addition to tax, equal to

50 percent of the interest payable under section 6601, determined

on the portion of the underpayment attributable to fraud.
                                  - 12 -


Respondent has the burden of proving fraud by clear and

convincing evidence.    Sec. 7454(a); Rule 142(b).   To prove that a

taxpayer fraudulently underpaid a dollar of tax, respondent must

prove both the fact of the underpayment and fraudulent intent

with respect thereto.   See, e.g., Recklitis v. Commissioner,

91 T.C. 874, 909 (1988).    “Fraud is established by proving that

the taxpayer intended to evade tax believed to be owing by

conduct intended to conceal, mislead, or otherwise prevent the

collection of such tax.”    Id.

     We have found that, based on the plea agreement and the

statement of facts, petitioner received proceeds from illegal

drug activities, which proceeds were not reported as income for

the years in question, and sustained respondent's determination

of deficiencies against petitioner (with one adjustment).    We

believe that the evidence in this case clearly and convincingly

supports findings of underpayments in equal amounts.    See sec.

6653(c)(1).   Thus, the sole issue remaining for consideration in

determining the applicability of the additions to tax for fraud

is whether petitioner acted willfully to evade taxes known to be

owing.   We believe that he did, for each year, with respect to

the totality of that year’s underpayment.

     Petitioner filed income tax returns for the years in

question, establishing that he understood his obligation to file

returns and pay tax.    Petitioner’s failure to report substantial
                                - 13 -


amounts of income over a period of years is evidence of

fraudulent intent.    E.g., Truesdell v. Commissioner, 89 T.C.

1280, 1302 (1987).     The income that petitioner failed to report

was generated by an illegal activity, viz, the sale of drugs.       We

reasonably assume that persons who are engaged in illegal

activity and who derive income therefrom generally do not report

that income to conceal or mislead for the purpose of avoiding

criminal prosecution with knowledge that taxes are avoided.

Petitioner’s failure to report income from the sale of drugs,

thus, provides a basis for inferring intent to evade tax.     See,

e.g., Baker v. Commissioner, T.C. Memo. 1991-340, affd. without

published opinion 9 F.3d 1550 (9th Cir. 1993).     Petitioner tried

to conceal the proceeds derived from his criminal activities by

placing assets in the name of his mother.     That is evidence of

fraudulent intent.    See Spies v. United States, 317 U.S. 492, 499

(1943).   We believe that petitioner’s illegal drug activities

were substantially engaged in for pecuniary gain, which gain

would not be decreased if he could evade Federal income tax on

his drug income.     Based on the record as a whole, we find that

petitioner underpaid his tax for each of the years in question

with the intent to evade a tax known to be owing.     In other

words, petitioner acted fraudulently; he did so for each of the
                               - 14 -


years in question with respect to the totality of the

underpayment for that year.




V.   Self-Employment Tax

      The last issue is whether petitioner is liable for self-

employment taxes.   A self-employment tax is imposed on income

earned from self-employment.    Sec. 1401.    Respondent determined

that petitioner was liable for self-employment taxes on account

of income from drug trafficking in the amounts of $2,097, $1,324,

and $5,387, for the years 1985, 1986, and 1987, respectively.

Petitioner has assigned error to respondent’s determination of

self-employment taxes but has not averred any facts in support of

that assignment.    We assume that petitioner relies on our finding

that he received no (or a reduced amount of) income from drug

trafficking to support his assignment of error.      Petitioner bears

the burden of proof.   Rule 142(a).     Petitioner has failed to

carry his burden of proof.    Therefore, we sustain the

determination of self-employment taxes, modified only as

necessary to take into account one adjustment agreed to by the

parties.

      To reflect the foregoing,
- 15 -


          Decision will be entered

     under Rule 155.
