                         T.C. Memo. 1998-78



                     UNITED STATES TAX COURT



               WILLIAM HENRY SUNDEL, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



        Docket No. 4620-94.           Filed February 25, 1998.



        William Henry Sundel, pro se.

        Michael P. Breton and Bradford A. Johnson, for

respondent.


             MEMORANDUM FINDINGS OF FACT AND OPINION


        WHALEN, Judge:   Respondent determined the following

deficiency in and additions to petitioner's income tax for

1983:
                                - 2 -



                                 Additions to Tax
Deficiency        Sec. 6653(b)(1) Sec. 6653(b)(2)   Sec. 6661(a)
                                          1
$1,581,128          $790,564                          $395,282
       1
      Plus 50 percent of the interest payable under sec.
6601 with respect to the portion of the underpayment which
is attributable to fraud.


Unless stated otherwise, all section references are to the

Internal Revenue Code as in effect for 1983.

       After concessions, the issues remaining for decision

are:       (1) Whether, and to what extent, petitioner realized

unreported income in 1983 from the sale of marijuana; (2)

whether petitioner is liable for self-employment tax on

the income earned from the sale of marijuana; (3) whether

petitioner is entitled to deduct expenses allegedly

incurred during 1983 for legal services; (4) whether

petitioner is liable for the additions to tax for fraud

prescribed by section 6653(b)(1) and (2); (5) whether

petitioner is liable for the addition to tax for

substantial understatement of liability prescribed by

section 6661(a); and (6) whether the period of limitations

on assessment and collection of tax prescribed by section

6501 expired before respondent issued the subject notice

of deficiency.
                            - 3 -


                      FINDINGS OF FACT

     Some of the facts have been stipulated and are so

found.   The stipulation of facts and attached exhibits are

incorporated herein by this reference.   Petitioner resided

in Portsmouth, Rhode Island, at the time he filed his

petition in this case.   He is a high school graduate but

has no other formal education.

     Sometime prior to August 1983, petitioner entered into

a conspiracy with Messrs. Victor Lubiejewski, Frank Nelson,

Robert Bonalewicz, Gilbert Cabeceiras, Joel Pinkard, and a

person called "Ricardo" to purchase a large quantity of

marijuana from wholesalers in Colombia, South America, for

distribution in the United States.   The purpose of the

conspiracy was to earn a profit from the sale of the

marijuana.   Petitioner had become acquainted with his co-

conspirators several years earlier through his involvement

in another drug smuggling operation known as the "Hot Tubs

case".

     Petitioner and his coconspirators arranged for a

shipment of approximately 51,000 pounds of Colombian

marijuana to be delivered by boat to a location in or near

Atlantic City, New Jersey, in early to mid August 1983.
                             - 4 -


At that time, the average wholesale price of Colombian

marijuana was approximately $16 per pound.

     Petitioner and several of his coconspirators traveled

to Atlantic City on or about August 9, 1983, to wait for

the marijuana to arrive.   While he was waiting, petitioner

received a downpayment of $1 million from Mr. Dennis

Erickson.   Mr. Erickson made this payment to secure his

promise to purchase a large portion of the marijuana for

approximately $280 per pound.

     The boat containing the marijuana arrived at a dock

in or near Atlantic City on or about August 14, 1983.

Petitioner and his coconspirators paid $500,000 to the

captain of the boat, Mr. Gilbert Cabeceiras, for his

services.

     Shortly after the boat arrived in New Jersey,

petitioner sold approximately 3,000 or 3,500 pounds of the

marijuana to unrelated individuals for approximately

$300,000.   Petitioner and his coconspirators also gave some

portion of the marijuana to individuals related to the

conspiracy.   The remaining marijuana, approximately 43,000

pounds, was loaded onto a tractor-trailer for transport to

Kalamazoo, Michigan, where it was to be weighed and

delivered to Mr. Erickson.
                             - 5 -


     The tractor-trailer containing the marijuana arrived

in the Kalamazoo area on or about August 15, 1983.    On the

same day, petitioner and several coconspirators, including

Messrs. Lubiejewski and Nelson, traveled to Kalamazoo on a

private jet to supervise and assist in unloading and

weighing the marijuana and to receive payment of a portion

of the purchase price from Mr. Erickson.    Another of

petitioner's coconspirators, Mr. Bonalewicz, unloaded the

tractor-trailer and placed the marijuana on scales so that

it could be weighed.    Mr. Nelson personally observed all of

the marijuana as it was unloaded.    He recorded the weight

of each bale and the total number of bales unloaded in a

notebook which he maintained on petitioner's behalf.

Mr. Erickson purchased at least 37,000 pounds of the

marijuana that was shipped to the Kalamazoo area.    That

amount was the gross weight of the marijuana as shipped

and included approximately 5,000 pounds of wrapping and

packaging material.    Mr. Erickson later returned

approximately 7,000 pounds of the marijuana because it

was wet and unmarketable.

     Petitioner and Messrs. Lubiejewski, Nelson, and

Bonalewicz and several other individuals involved in

the conspiracy remained in Michigan for a short period
                            - 6 -


after the marijuana arrived there.   During this time,

the coconspirators received a large amount of cash from

Mr. Erickson in exchange for marijuana.   Mr. Bonalewicz

left the Kalamazoo area 3 or 4 days after the marijuana

arrived there.   Petitioner and Mr. Lubiejewski left on

August 20, 1983, to travel to New York.   Mr. Nelson

remained in Kalamazoo for 9 to 11 days thereafter to

supervise the transfer of the marijuana to Mr. Erickson

and to accept and record the related cash payments.

Mr. Nelson recorded these additional cash payments in a

notebook and stored the cash on behalf of petitioner and

Mr. Lubiejewski.

     Petitioner returned to the Kalamazoo area on

August 22, 1983, to take some of the cash Mr. Nelson had

received up to that time.   Petitioner again returned on

August 28, 1983, after the transaction with Mr. Erickson

was completed.   At the time of petitioner's second trip to

the Kalamazoo area, he and Mr. Nelson packed the remaining

cash receipts into bags and traveled on a private jet to

New York City.   Upon arriving in New York, petitioner and

Mr. Nelson went to petitioner's mother-in-law's house and

counted the cash they had transported from Michigan.     This

cash totaled in excess of $4.5 million.   Mr. Nelson helped
                            - 7 -


petitioner deposit a portion of the cash into several safe

deposit boxes and bank accounts in petitioner's name in New

York City.

     In total, Mr. Erickson paid in excess of $7 million

for the marijuana he purchased from petitioner and his

coconspirators.   Petitioner divided the proceeds of the

transaction equally with Mr. Lubiejewski.

     While in New York City, after the transaction with

Mr. Erickson was completed, petitioner spent approximately

$8,000 to $10,000 in cash for lodging at the Helmsley

Palace Hotel.   Petitioner also spent $45,000 to lease an

apartment and approximately $100,000 to purchase an

Aston-Martin sports car.   At petitioner's request,

Mr. Nelson made several deposits of approximately $9,500

each into brokerage accounts in petitioner's name.

Petitioner instructed Mr. Nelson to limit the amount of

each deposit to avoid the filing of Currency Transaction

Report forms with the Internal Revenue Service.   At

petitioner's request, Mr. Nelson also delivered cash

payments of $40,000 to $50,000 each to various individuals

in payment of gambling debts.   In addition, petitioner paid

a man named Ricardo approximately $250,000 to satisfy a

debt that petitioner had incurred in the Hot Tubs case.
                             - 8 -


     Petitioner invested some of the proceeds from the

Michigan transaction in legitimate business ventures.

Sometime after the transaction, petitioner purchased a

going concern known as Village Imports which was in the

business of importing and converting "grey market"

automobiles for sale in the United States.    Petitioner

also invested approximately $250,000 in a facility known

as Ben Boat Basin.    At petitioner's request, Mr. Nelson

used approximately $100,000 of the cash that petitioner

had received from the Michigan transaction to purchase

equipment to be used in petitioner's various business

ventures.    Petitioner also used a portion of the proceeds

to purchase gold Krugerrands.

     Petitioner had originally agreed to pay Mr. Nelson

$100,000 for his participation in the marijuana smuggling

operation.    However, because petitioner earned more than

twice what he had expected to earn from the transaction,

he paid Mr. Nelson approximately $200,000.

     On August 11, 1988, petitioner was indicted in the

United States District Court for the Western District of

Michigan and charged with the following offenses in

connection with his involvement in the transaction

described above:    (1) Conspiracy to possess with intent to
                            - 9 -


distribute and distributing in excess of 1,000 pounds of

marijuana; (2) possession with intent to distribute and

distributing in excess of 1,000 pounds of marijuana; and

(3) conspiracy to import marijuana.   On April 27, 1989,

petitioner entered a plea of guilty to the first count

of the indictment, conspiracy to possess with intent to

distribute and distributing in excess of 1,000 pounds of

marijuana.   The remaining counts were dismissed pursuant

to a plea agreement with the U.S. Attorney.

     During a plea hearing in his criminal case, petitioner

testified that he had engaged in a conspiracy with several

individuals to distribute and sell marijuana, and that the

purpose of this conspiracy was to earn a profit from the

sale of marijuana.   Petitioner also testified that he flew

from New Jersey to Michigan on a private jet on August 15,

1983, before traveling to New York City on August 20, 1983.

Petitioner further testified that he returned to Kalamazoo,

Michigan, on August 22, 1983, and again on August 28, 1983.

Petitioner admitted that during the time he was in

Michigan, he received cash payments which he estimated

totaled "hundreds of thousands" of dollars.   He also

admitted that during his third and final trip to Michigan
                           - 10 -


on August 28, 1983, Mr. Erickson paid him "a lot of money",

which he estimated may have been more than $1 million.

     Petitioner filed a timely Federal income tax return

for 1983.   On his return, petitioner reported adjusted

gross income of $53,504.99, consisting primarily of wages

from his employment with the Key Container Corp. in

Pawtucket, Rhode Island.   Petitioner did not report any

income from the sale of marijuana on his 1983 return,

and he did not inform his return preparer of the Michigan

transaction or the existence or extent of the income

realized from the transaction.


                           OPINION

Unreported Income

     As a general rule, gross income includes "all income

from whatever source derived".   Sec. 61(a).   This includes

income obtained from illegal sources.   See James v. United

States, 366 U.S. 213 (1961); Browning v. Commissioner, T.C.

Memo. 1991-93; sec. 1.61-14(a), Income Tax Regs.

Respondent determined that petitioner realized $3,158,000

of unreported income in 1983 from the sale of marijuana.

Petitioner, on the other hand, maintains that he did not

realize any such income.
                           - 11 -


     Throughout his posttrial briefs, petitioner repeatedly

asserts that respondent failed to prove that he realized

unreported income.   In effect, petitioner argues that

respondent bears the burden of proving that he realized

unreported income from the marijuana transaction in 1983.

As a general rule, the Commissioner's determination of a

tax deficiency is presumptively correct, and the taxpayer

bears the burden of proving that it is erroneous.   See Rule

142(a); Welch v. Helvering, 290 U.S. 111 (1933).    All Rule

references are to the Tax Court Rules of Practice and

Procedure.

     Courts recognize a limited exception to this general

rule in cases such as this where the Commissioner's notice

of deficiency determines that the taxpayer failed to report

income derived from illegal activities.   See Petzoldt v.

Commissioner, 92 T.C. 661, 688 (1989); see also Rapp v.

Commissioner, 774 F.2d 932, 935 (9th Cir. 1985); Llorente

v. Commissioner, 649 F.2d 152, 156 (2d Cir. 1981), affg. in

part and revg. in part 74 T.C. 260 (1980); Weimerskirch v.

Commissioner, 596 F.2d 358 (9th Cir. 1979), revg. 67 T.C.

672 (1977); Dellacroce v. Commissioner, 83 T.C. 269, 287

(1984).   In such cases, the notice of deficiency will be

considered lacking a rational basis and not entitled to
                          - 12 -


the presumption of correctness, unless there is some

reasonable foundation for the determination.    E.g.,

Erickson v. Commissioner, 937 F.2d 1548, 1551 (10th Cir.

1991), affg. T.C. Memo. 1989-552; Rapp v. Commissioner,

supra at 935; Llorente v. Commissioner, supra at 156;

Weimerskirch v. Commissioner, supra at 360-361.    The

reasonable foundation may consist of evidence linking the

taxpayer with an income-producing activity such that it can

be inferred that the taxpayer received income from the

activity, see, e.g., Weimerskirch v. Commissioner, supra

at 360, or it may consist of evidence showing an ownership

interest in assets possessed by the taxpayer, see, e.g.,

Erickson v. Commissioner, supra at 1551-1552.    Once the

Commissioner has demonstrated sufficient minimal facts to

link the taxpayer with an income-producing activity or

to show an ownership interest in assets possessed by the

taxpayer, the presumption of correctness arises, and the

taxpayer has the burden to rebut the presumption by

establishing by a preponderance of the evidence that any

deficiency determination is arbitrary or erroneous.      See

Erickson v. Commissioner, supra at 1551-1552; Rapp v.

Commissioner, supra; Petzoldt v. Commissioner, supra at

689.
                           - 13 -


     In this case, respondent has produced more than

adequate substantive evidence linking petitioner to income

from the sale of marijuana in 1983.    This includes

petitioner's criminal conviction arising from the Michigan

transaction, petitioner's own testimony during the plea

hearing in the criminal case, testimony of law enforcement

officers, and detailed testimony of coconspirators.

Indeed, petitioner stipulates that he was engaged in the

sale of marijuana during 1983.   Under the circumstances,

we find that respondent has more than satisfied

respondent's initial burden of producing some substantive

evidence connecting petitioner with an income-producing

activity, and we find that the burden of disproving

respondent's determination of unreported income remains

with petitioner.

     We also sustain respondent's calculation of the amount

of petitioner's unreported income.    Section 6001 requires

all taxpayers to maintain sufficient records to determine

their correct tax liability.   See Petzoldt v. Commissioner,

supra at 686.   If a taxpayer fails to maintain or does not

produce adequate books and records, the Commissioner is

authorized by section 446 to reconstruct the taxpayer's

income.   See sec. 446(b); Petzoldt v. Commissioner, supra
                            - 14 -


at 686-687; Bratulich v. Commissioner, T.C. Memo. 1990-600.

The Commissioner's reconstruction need only be reasonable

in light of all the surrounding facts and circumstances.

See Petzoldt v. Commissioner, supra at 687; Giddio v.

Commissioner, 54 T.C. 1530, 1533 (1970); Schroeder v.

Commissioner, 40 T.C. 30, 33 (1963).

     Respondent calculated petitioner's unreported

income on the basis of the amount of marijuana sold to

Mr. Erickson, approximately 37,000 pounds.    Respondent

deducted 5,000 pounds for wrapping and packaging material

and 7,000 pounds to allow for the marijuana that

Mr. Erickson returned as wet and unusable.    Respondent,

thus, determined that Mr. Erickson purchased a total of

25,000 pounds of usable marijuana.

     Respondent found that petitioner and Mr. Lubiejewski

sold the marijuana to Mr. Erickson for approximately $280

per pound.    Based on a net weight of 25,000 pounds of

marijuana sold, respondent calculated the gross receipts

from the sale as $7 million.    Because these receipts were

split equally between petitioner and Mr. Lubiejewski,

respondent determined that petitioner's gross receipts were

$3,500,000.
                           - 15 -


     Finally, respondent reduced petitioner's gross

receipts by the cost of petitioner's share of the

marijuana.   Respondent computed the cost of goods sold by

first determining that petitioner and his coconspirators

had paid $16 per pound to purchase the marijuana from the

Colombian wholesalers.   Respondent derived this amount from

information provided by the Drug Enforcement Administration

regarding the average wholesale price of Colombian

marijuana during the period in question.   Respondent next

increased the wholesale price of the marijuana by $11.36

per pound.   This is the amount that petitioner and his co-

conspirators had paid to Mr. Cabeceiras, the boat captain,

for transporting approximately 44,000 pounds of marijuana

from South America to New Jersey ($500,000 ÷ 44,000 pounds

= $11.36 per pound).   The record does not explain why

respondent allocated the boat captain's fee to 44,000

pounds of marijuana.   In any event, respondent determined

that the sum of these amounts, $27.36, is the total cost

of goods sold, computed on a per-pound basis.   Respondent

determined that the cost of the marijuana sold by

petitioner is $342,000 (i.e., 12,500 pounds x $27.36).

Reducing petitioner's portion of the gross receipts by the

cost of goods attributable to his portion of the marijuana,
                           - 16 -


respondent determined that petitioner realized $3,158,000

from the transaction.

     Petitioner does not dispute certain factual

assumptions made by respondent in calculating the gross

receipts from the Michigan transaction.   In fact,

petitioner agrees that a total of 25,000 pounds of

marijuana was sold to Mr. Erickson for an average price

of $280 per pound.   Petitioner argues that respondent made

three errors in computing petitioner's income.   First,

petitioner argues that he and his coconspirators paid $80

per pound to the Colombian wholesalers for the marijuana.

Second, petitioner maintains that his gross receipts from

the Michigan transaction should be reduced for expenditures

not reflected in respondent's calculation.   Finally,

petitioner maintains that the proceeds of the transaction

were divided three ways, rather than two as determined by

respondent.

     The following schedule compares petitioner's

computation of his net profit from the transaction with

respondent's:
                                                      - 17 -

                                                       Petitioner's Computation                Respondent's Computation


Gross pounds of marijuana sold to Mr. Erickson                                     37,000                             37,000

Net pounds of marijuana                                                            32,000                             32,000
Pounds of marijuana returned                                                       (7,000)                            (7,000)
                                                                                   25,000                             25,000
Split                                                                                 33%                                50%
Petitioner's share                                                                  8,333                             12,500
Sale price per pound                                                                 $280                               $280

Gross receipts                                                                 $2,333,240                         $3,500,000
Math error                                                                          ($840)                             --
                                                                               $2,332,240                         $3,500,000
Advance from Coco Joe                                                             $95,000                             --

Petitioner's gross receipts                                                    $2,427,400                         $3,500,000
    Petitioner's share of marijuana                   $8,330                                 $12,500.00
Cost per pound                                         ($80)                                    ($27.36)
                                                                                ($666,400)                         ($342,000)



Petitioner's gross profit                                                      $1,761,000                         $3,158,000

   Amount   paid   to Nelson                         ($250,000)                                  --
   Amount   paid   to Bonalewicz                     ($250,000)                                  --
   Amount   paid   to boat captain                   ($500,000)                                  --
   Amount   paid   to unloaders                      ($250,000)                                  --
   Amount   paid   for dock                          ($250,000)                                  --
                                                   ($1,500,000)                                  --
                                                           50%                                        50%
   Petitioner's share                                             ($750,000)                                          --

   Amount paid for prior transaction ("Hot Tubs)                  ($550,000)                                          --

   Amount unpaid by purchaser ("Erickson Owes")     ($758,000)                                   --
                                                          50%                                         50%             --
                                                                  ($379,000)

    Driver, Detroit to NY                            ($50,000)                                  --
 Scales                                              ($10,000)                                  --
    Planes                                           ($12,500)                                  --
    Conveyor belts                                    ($6,700)                                  --
                                                                   ($79,200)                                --
                                                                            ($1,758,200)                              --

   Petitioner's net profit                                                         $2,800                         $3,158,000




         We agree with respondent's calculation of petitioner's

unreported income.                       First, petitioner has not satisfied his

burden of proving that he and his coconspirators paid $80

per pound for the marijuana, rather than $16 as determined

by respondent.                       The only evidence that petitioner presented

to support his position is Mr. Nelson's testimony that the

cost of the marijuana may have been as much as $80 per

pound.             We found Mr. Nelson's testimony in this regard to
                          - 18 -


be vague and uncertain and not sufficient to rebut

respondent's determination.

     Second, we reject petitioner's argument that his gross

receipts should be reduced by additional expenditures not

reflected in respondent's calculation.    These expenditures

consist of various fees allegedly paid to individuals

involved in the drug smuggling operation, including

individuals responsible for unloading the boat after it

arrived in New Jersey and the owner of the dock where the

boat was unloaded, and amounts allegedly paid to satisfy

debts from previous drug transactions.    In passing, we

note that in his calculation of net profit set out above,

petitioner deducts $550,000 as an amount paid to satisfy a

debt arising from the Hot Tubs case.    However, petitioner

testified during his plea hearing in the criminal case that

he paid only $250,000.

     Section 280E provides that no deduction or credit

shall be allowed for any expenditure paid or incurred in

carrying on a trade or business which consists of

trafficking in controlled substances.    See sec. 280E;

S. Rept. 97-494, at 309 (1982).    Marijuana is a controlled

substance as defined in section 280E.    See Browning v.
                           - 19 -


Commissioner, T.C. Memo. 1991-93; Bratulich v. Commis-

sioner, T.C. Memo. 1990-600.

     In this case, petitioner does not address respondent's

position that the additional expenditures are subject to

section 280E and are not deductible, nor does petitioner

argue or present any reason to conclude that the additional

expenditures should be treated as an exclusion from gross

income on account of cost of goods sold.   See Franklin v.

Commissioner, T.C. Memo. 1993-184.   We therefore reject

petitioner's contention that the receipts from the Michigan

transaction should be reduced by such expenditures.

     Finally, we reject petitioner's assertion that the

proceeds of the marijuana transaction were split three ways

rather than two, as determined by respondent.    Petitioner

bases this assertion on his own testimony and that of

Mr. Bonalewicz.   However, petitioner admitted during his

plea hearing in the criminal case that he split the

proceeds equally with Mr. Lubiejewski.   Moreover,

Mr. Bonalewicz testified that he had a limited role in the

transaction, and that he was present in Michigan for only

3 to 4 days after the marijuana arrived there.    Given the

nature of his involvement in the transaction, we find that
                            - 20 -


Mr. Bonalewicz's testimony regarding the division of

proceeds is not credible.

     Moreover, we note that petitioner has made numerous

inconsistent statements regarding the amount of money he

earned from the subject transaction.   On July 25, 1990,

petitioner testified in the case of United States v.

Paul Nathaniel Hankish, CR 8900235, in the U.S. District

Court for the District of West Virginia, that he "ended up

with $1.5 million".   During a November 6, 1991, meeting

with Revenue Agent Jeff Silva and his supervisor,

petitioner admitted that he earned a profit of $227,000 and

an additional $550,000 which he used to satisfy previously

incurred debt.   On a third occasion, petitioner admitted to

Drug Enforcement Administration Agent John Peterson that he

and Mr. Lubiejewski made a net profit on several drug

smuggling operations, including the August 1983 transaction

in Michigan.   At trial in the instant matter, however,

petitioner claimed that he did not earn any money from the

transaction.

     We are not obligated to accept a taxpayer's self-

serving, improbable, uncorroborated testimony.   See Quock

Ting v. United States, 140 U.S. 417 (1891); Geiger v.

Commissioner, 440 F.2d 688, 689 (9th Cir. 1971), affg. per
                           - 21 -


curiam T.C. Memo. 1969-159.    We find petitioner's testimony

in this case to be wholly incredible.   Based upon all of

the foregoing, we sustain respondent's determination that

petitioner realized at least $3,158,000 of unreported

income in 1983 from the sale of marijuana.


Self-Employment Tax

     Respondent determined that petitioner is liable for

the self-employment tax prescribed by section 1401.

Section 1401(a) imposes a tax "on the self-employment

income of every individual".    Self-employment income is

defined generally as "net earnings from self-employment",

which in turn is defined as "the gross income derived by

an individual from any trade or business carried on by such

individual, less the deductions allowed by this subtitle

which are attributable to such trade or business".    Sec.

1402(a) and (b).

     Section 1402(c) provides that the term "trade or

business" as used in this regard "shall have the same

meaning as when used in section 162 (relating to trade or

business expenses)".   This includes an illegal trade or

business such as selling illegal drugs.    See Petzoldt

v. Commissioner, 92 T.C. at 698; Johnson v. Commissioner,

T.C. Memo. 1994-350; see also Reed v. Commissioner, T.C.
                             - 22 -


Memo. 1997-388; Markham v. Commissioner, T.C. Memo. 1991-

430; Eschweiler v. Commissioner, T.C. Memo. 1989-601.

        Petitioner bears the burden of proving that

respondent's determination of liability for the self-

employment tax is erroneous.     See Rule 142(a).   Petitioner

did not present any evidence relating to this issue at

trial and does not address the issue in his posttrial

briefs.     Accordingly, we sustain respondent's determination

that petitioner is liable for the self-employment tax with

respect to the income he realized in 1983 from selling

marijuana.

Deduction for Legal Expenses

     On Schedule A attached to his 1983 tax return,

petitioner claimed a deduction of $7,500 for legal

expenses.    This deduction is listed on petitioner's

return as "LEGAL FEES PROTECTION OF INCOME".     Respondent

disallowed this deduction on the ground that petitioner

failed to establish either that the expenses were actually

incurred or that they are deductible under section 212.

In his posttrial briefs, petitioner states that he did not

keep records relating to the claimed deduction, and that

the attorney who rendered the legal services has since

died.    Petitioner argues that "Respondent never presented
                             - 23 -


any evidence at trial concerning a $7,500 dollar [sic]

legal deduction in 1983."

     Respondent's determinations are presumed correct,

and petitioner bears the burden of proving that such

determinations are erroneous.    See Rule 142(a).   Moreover,

every taxpayer is required to maintain adequate records to

substantiate both the existence and amount of any deduction

or credit claimed.   Sec. 6001; Smith v. Commissioner, T.C.

Memo. 1997-544; sec. 1.6001-1(a), Income Tax Regs.     In

this case, petitioner bears the burden of proving that he

is entitled to the claimed deduction.    See Rule 142(a).

Because petitioner failed to present any evidence to

substantiate the claimed deduction, we find that petitioner

has failed to meet his burden of proof, and we sustain

respondent's disallowance of this deduction.


Additions to Tax for Fraud

     Respondent determined that petitioner is liable for

the additions to tax for fraud prescribed by section

6653(b)(1) and (2) with respect to his 1983 return.

Section 6653(b)(1), as in effect for 1983, imposed an

addition to tax equal to 50 percent of any underpayment

of tax, any part of which is attributable to fraud.

Section 6653(b)(2) imposed an addition to tax equal to
                            - 24 -


50 percent of the interest payable under section 6601

with respect to the portion of the underpayment which is

attributable to fraud.   "Fraud" for these purposes is

defined as an intentional wrongdoing designed to evade

tax believed to be owing.   See Powell v. Granquist, 252

F.2d 56 (9th Cir. 1958); Mitchell v. Commissioner, 118

F.2d 308 (5th Cir. 1941), revg. 40 B.T.A. 424 (1939);

Petzoldt v. Commissioner, supra at 698; Estate of Pittard

v. Commissioner, 69 T.C. 391 (1977).

     Respondent bears the burden of proving fraud by clear

and convincing evidence.    See sec. 7454(a); Rule 142(b);

Castillo v. Commissioner, 84 T.C. 405, 408 (1985); Stone

v. Commissioner, 56 T.C. 213, 220 (1971).    To meet this

burden, respondent must show that an underpayment of tax

exists, and that petitioner intended to evade taxes known

to be owing by conduct intended to conceal, mislead, or

otherwise prevent the collection of such taxes.    Stoltzfus

v. United States, 398 F.2d 1002, 1004 (3d Cir. 1968); see

Parks v. Commissioner, 94 T.C. 654, 660 (1990); Recklitis

v. Commissioner, 91 T.C. 874, 909 (1988); Castillo v.

Commissioner, supra at 408-409; Rowlee v. Commissioner,

80 T.C. 1111, 1123 (1983); Acker v. Commissioner, 26 T.C.

107, 112 (1956).   Respondent need not establish that
                             - 25 -


petitioner's primary motivation was tax evasion but must

show that a "tax-evasion motive played any part" in his

conduct, including conduct designed to conceal another

crime.   See Recklitis v. Commissioner, supra at 909

(quoting Worcester v. Commissioner, 370 F.2d 713, 717

(1st Cir. 1966), vacating T.C. Memo. 1965-199).

     The existence of fraud is a question of fact to

be resolved upon consideration of the entire record.

See Castillo v. Commissioner, supra at 409; Rowlee v.

Commissioner, supra at 1123; Gajewski v. Commissioner, 67

T.C. 181, 199 (1976), affd. without published opinion 578

F.2d 1383 (8th Cir. 1978).    Fraud will never be imputed or

presumed, but must be established by independent evidence.

See Recklitis v. Commissioner, supra at 910; Castillo v.

Commissioner, supra; Beaver v. Commissioner, 55 T.C. 85,

92 (1970).   However, because direct proof of a taxpayer's

intent is rarely available, fraud may be proved by

circumstantial evidence, including the implausibility of

the taxpayer's explanations.    See Boyett v. Commissioner,

204 F.2d 205, 208 (5th Cir. 1953), affg. a Memorandum

Opinion of this Court dated Mar. 14, 1951; Castillo v.

Commissioner, supra; Stephenson v. Commissioner, 79 T.C.

995, 1005-1006 (1982), affd. 748 F.2d 331 (6th Cir. 1984);
                             - 26 -


Gajewski v. Commissioner, supra at 200.    The taxpayer's

entire course of conduct may establish the requisite

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

492 (1943); Castillo v. Commissioner, supra; Gajewski v.

Commissioner, supra; Stone v. Commissioner, supra at 223-

224.

       Over the years, courts have developed a nonexclusive

list of factors that demonstrate fraudulent intent.    These

"badges of fraud" include:    (1) Understating income; (2)

maintaining inadequate records; (3) failing to file tax

returns; (4) implausible or inconsistent explanations of

behavior; (5) concealment of income or assets; (6) failing

to cooperate with tax authorities; (7) engaging in illegal

activities; (8) an intent to mislead which may be inferred

from a pattern of conduct; (9) lack of credibility of the

taxpayer's testimony; (10) filing false documents; and (11)

dealing in cash.    See Spies v. United States, supra at 499;

Douge v. Commissioner, 899 F.2d 164, 168 (2d Cir. 1990);

Bradford v. Commissioner, 796 F.2d 303, 307-308 (9th

Cir. 1986), affg. T.C. Memo. 1984-601; Recklitis v.

Commissioner, supra at 910.    Although no single factor is

necessarily sufficient to establish fraud, the combination

of a number of factors may be persuasive evidence of fraud.
                           - 27 -


See Solomon v. Commissioner, 732 F.2d 1459, 1461 (6th Cir.

1984), affg. per curiam T.C. Memo. 1982-603.   A taxpayer's

intelligence, education, and tax expertise are also

relevant for purposes of determining fraudulent intent.

See Stephenson v. Commissioner, 79 T.C. 995, 1006 (1982),

affd. 748 F.2d 331 (6th Cir. 1984); Iley v. Commissioner,

19 T.C. 631, 635 (1952).

     Respondent contends that the following facts, taken

as a whole, establish that the entire underpayment of tax

for 1983 was attributable to fraud:   (1) The unreported

income was derived from an illegal activity; (2) petitioner

failed to maintain or produce adequate records of his drug

smuggling income; (3) he dealt exclusively in cash; (4) he

never informed his return preparer of his income from the

illegal activity; (5) he made inconsistent statements

regarding the amount of money he earned from the activity;

(6) there is a large discrepancy between petitioner's

actual income and the income reported on his return;

and (7) petitioner structured his bank deposits in such

a manner as to avoid the filing of Currency Transaction

Report forms with the Internal Revenue Service.

     We agree with respondent.   Petitioner failed to report

a very large portion of his income for 1983 in an attempt
                           - 28 -


to conceal the illegal activity which produced that income.

See Patton v. Commissioner, 799 F.2d 166, 171 (5th Cir.

1986), affg. T.C. Memo. 1985-148.    Moreover, petitioner has

not shown that he maintained adequate books and records

regarding his involvement in the illegal activity.      His

failure to maintain adequate books and records is

indicative of fraud.   See Truesdell v. Commissioner, 89

T.C. 1280, 1302 (1987); Gajewski v. Commissioner, supra

at 200.   The fact that petitioner dealt in large amounts

of cash and his failure to inform his return preparer

of his illegal income also evidence fraud.    See Estate

of Mazzoni v. Commissioner, 451 F.2d 197, 202 (3d Cir.

1971), affg. T.C. Memo. 1970-37.    We also find that

petitioner's lack of credibility, his inconsistent

testimony regarding the marijuana smuggling activity,

and his general evasiveness evidence fraudulent intent.

See Bradford v. Commissioner, supra at 307; Toussaint v.

Commissioner, 743 F.2d 309, 312 (5th Cir. 1984), affg. T.C.

Memo. 1984-25; Welker v. Commissioner, T.C. Memo. 1997-472.

In addition, petitioner instructed Mr. Nelson to deposit

the proceeds of the illegal activity in bank accounts in

amounts of less than $10,000 each for the purpose of

concealing such deposits from respondent.    See Parks
                           - 29 -


v. Commissioner, supra at 665; Estate of Temple v.

Commissioner, 67 T.C. 143, 162-163 (1976); Burke v.

Commissioner, T.C. Memo. 1995-608.

     We find that the circumstances of this case, taken

as a whole, clearly and convincingly establish that

petitioner acted with the requisite fraudulent intent,

and that the entire underpayment of tax for 1983 is

due to fraud, as determined by respondent.    Accordingly,

we sustain respondent's determination that petitioner is

liable for the additions to tax for fraud prescribed by

section 6653(b)(1) and (2).


Addition to Tax for Substantial Understatement of Liability

     Respondent also determined that petitioner is liable

for the addition to tax for substantial understatement of

liability prescribed by section 6661.    Section 6661, as in

effect for 1983, imposed an addition to tax equal to 25

percent of any underpayment which is attributable to a

"substantial understatement of income tax".    See Pallottini

v. Commissioner, 90 T.C. 498 (1988).     A "substantial

understatement of income tax" is defined as any

understatement which exceeds the greater of 10 percent of

the tax required to be shown on the return for the taxable

year or $5,000.   See sec. 6661(b)(1).   Petitioner bears
                           - 30 -


the burden of proving that respondent's determination is

incorrect.   See Rule 142(a).

     Petitioner failed to address this issue in his post-

trial briefs and has not shown any reason why he is not

liable for the addition.   Accordingly, we sustain

respondent's imposition of the addition to tax for

substantial understatement of liability under section 6661.


Period of Limitations

     Petitioner maintains that the period of limitations

on assessment and collection with respect to his income

tax for 1983 expired before respondent issued the subject

notice of deficiency.   Section 6501(a) generally imposes a

3-year period of limitations on assessment and collection

of tax.   Section 6501(a) provides as follows in this

regard:


          SEC. 6501(a). General Rule.--Except as
     otherwise provided in this section, the amount
     of any tax imposed by this title shall be
     assessed within 3 years after the return was
     filed (whether or not such return was filed on
     or after the date prescribed) * * * and no
     proceeding in court without assessment for the
     collection of such tax shall be begun after the
     expiration of such period.


     There is an exception to this 3-year period in the

case of a "false or fraudulent return with the intent to
                           - 31 -


evade tax".   See sec. 6501(c)(1); Lowy v. Commissioner,

288 F.2d 517, 520 (2d Cir. 1961), affg. T.C. Memo.

1960-32; Colestock v. Commissioner, 102 T.C. 380, 385

(1994).   Section 6501(c) provides as follows in this

regard:


          (1) False Return.--In the case of a false or
     fraudulent return with the intent to evade tax,
     the tax may be assessed, or a proceeding in court
     for collection of such tax may be begun without
     assessment, at any time.


     Because we have sustained respondent's determination

that petitioner's underpayment of tax for 1983 was

attributable to fraud, the 3-year period of limitations

is inapplicable to that return.     See Lowy v. Commissioner,

supra at 520; Colestock v. Commissioner, supra at 285;

Beauchamp v. Commissioner, T.C. Memo. 1997-393.    Pursuant

to section 6501(c)(1), a tax deficiency with respect to

petitioner's 1983 return may be assessed at any time.

Accordingly, we reject petitioner's argument that the

period of limitations expired prior to the time respondent

issued the subject notice of deficiency.
                     - 32 -


In light of the foregoing,


                              An appropriate order will

                         be issued and a decision

                         will be entered for

                         respondent.
