                          T.C. Memo. 2006-84



                      UNITED STATES TAX COURT



         CHARLES McHAN AND MARTHA McHAN, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 550-92.                  Filed April 24, 2006.



     Charles McHan, pro se.

     R. Walton Davis III, for petitioner Martha McHan.

     Eric B. Jorgensen and Gwendolyn C. Walker, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION

     SWIFT, Judge:   Pursuant to section 7443A and Rules 180 and

183,1 this case was assigned to and heard by Special Trial Judge



     1
       Unless otherwise indicated, all section references are to
the Internal Revenue Code as amended and in effect for the years
in issue, and all Rule references are to the Tax Court Rules of
Practice and Procedure.
                               - 2 -

Lewis R. Carluzzo.   His recommended findings of fact and

conclusions of law were filed and served upon the parties on

July 7, 2005.   Subsequently, the petitioners filed objections

thereto, and petitioner Charles McHan moved for a new trial.

Respondent filed no objection to the Special Trial Judge’s

recommended findings of fact and conclusions of law, but

respondent did file a reply to petitioners’ objections.

Hereinafter, references to petitioner in the singular are to

petitioner Charles McHan.

     We are mindful that with regard to our review of Special

Trial Judge Carluzzo’s recommended findings of facts new Rule

183(d) provides:


     Due regard shall be given to the circumstance that the
     Special Trial Judge had the opportunity to evaluate the
     credibility of witnesses, and the findings of fact
     recommended by the Special Trial Judge shall be presumed to
     be correct.


     We have given appropriate deference to the Special Trial

Judge’s recommended factual findings, and, after consideration of

the evidence and the record in this case, we have made minor

changes to his recommended findings and analysis.   We also have

made a number of editorial changes to the Special Trial Judge’s

recommended findings of fact and conclusions of law in an effort

to clarify certain matters.
                                        - 3 -

         After consideration of the record herein, the briefs of the

parties, petitioners’ objections to the Special Trial Judge’s

recommended findings of fact and conclusions of law, and

respondent’s reply thereto, we conclude that the recommended

findings of fact and conclusions of law of Special Trial Judge

Carluzzo, which are hereinafter set forth as modified in a number

of minor respects, should be adopted as the report of the Court.

          In a notice of deficiency dated November 15, 1991,

respondent determined deficiencies in and additions to the

Federal income taxes of petitioner, as follows:


                                               Additions to Tax

                          Sec.          Sec.            Sec.           Sec.        Sec.
Years Deficiencies     6653(b)(1)   6653(b)(1)(A)   6653(b)(1)(B)   6653(b)(2)    6661

1985    $329,911       $164,956        ----            ----         50% of Int.
$82,478
                                                                      due on
                                                                     $305,762

1986       90,590        ----        $52,226        50% of Int.        ----
17,409
                                                      due on
                                                      $69,635


         In a separate notice of deficiency, also dated November 15,

1991, respondent determined deficiencies of $329,911 and $90,590

in Martha McHan’s respective 1985 and 1986 Federal income taxes,

which deficiencies are based solely on Martha’s alleged joint

liability under section 6013 for the tax deficiencies determined

against petitioner.

         After settlement of some issues, the primary issues for

decision are:        (1) Whether petitioners on their 1985, 1986, and

1987 joint Federal income tax returns underreported petitioner’s
                               - 4 -

income from the sale of marijuana; and (2) whether petitioner is

liable for the additions to tax for fraud under section 6653(b).

     Petitioners’ 1987 income is also considered in this

proceeding in order to determine the correct amount of a net

operating loss carryback from 1987 to 1985 and 1986.    See sec.

6214(b).

     Also raised as an issue herein is whether petitioner Martha

McHan is eligibile for relief from joint liability under section

6015.   That issue has been severed from the issues tried and

addressed in this opinion.


                         FINDINGS OF FACT

     Petitioners were married in 1966 and remained so as of the

date of trial.   At the time the petition was filed in this case,

petitioners were residents of Murphy, North Carolina.


Petitioner’s Drug Trafficking Activities

     In 1984 through 1988, petitioner participated in various

transactions involving the illegal purchase and sale of

marijuana.   Generally, petitioner purchased the marijuana with

cash from sources in Mexico and Belize and sold the marijuana in

North Carolina for resale by others in Florida and other States.

A number of individuals participated with petitioner in various

aspects of the illegal drug transactions.   We focus, as did
                               - 5 -

respondent, on specific transactions involving petitioner, Paul

Thomas Posey (Posey), and Paul Leroy Cunningham (Cunningham).

     In 1985, on a number of occasions, petitioner, accompanied

by Posey, traveled to Lajitas, Texas (the Texas source), and

purchased marijuana.   On average, each purchase by petitioner

from the Texas source consisted of 480 to 520 pounds of marijuana

for which petitioner paid approximately $275 a pound.   With

respect to each purchase, petitioner also paid $10,000 to an

individual identified as “the Colonel”, who provided “security”

and who helped transport the marijuana from Mexico to Lajitas,

Texas.

     After its purchase from the Texas source, generally the

marijuana was transported to North Carolina by Posey and an

associate.   The marijuana would be divided between petitioner and

Posey, and petitioner would sell his portion of the marijuana to

Cunningham who, in turn, generally would resell the marijuana in

Florida.

     During 1986 and 1987, petitioner and Cunningham were

involved in the purchase of marijuana in Florida and Texas and

the resale of the marijuana in Florida (the Florida

transactions).   In connection with the 1986 and 1987 Florida

transactions, petitioner lost $73,000 and $42,000, respectively.

     In November 1987, as a result of his arrest for conspiracy

to possess and to distribute marijuana, Posey agreed to cooperate
                                 - 6 -

with law enforcement officials, to provide information about

petitioner’s drug trafficking activities, and to assist

Government agents in gathering evidence against petitioner.

     On March 31 and April 1, 1988, Posey secretly made tapes of

conversations between himself and petitioner.   The tapes of these

conversations were turned over to Government agents investigating

petitioner’s drug trafficking activities.

     In May 1988, petitioner, Cunningham, and several other

individuals traveled to El Paso, Texas, to purchase marijuana.

On May 3, 1988, after purchasing for $100,000 200 pounds of

marijuana from an undercover Government agent, petitioner and

Cunningham were arrested and charged under 21 U.S.C. section 846

(2000) with conspiring to possess with the intent to distribute

200 pounds of marijuana with regard to the May 1988 drug

transaction.

     Petitioner pleaded guilty to the above Federal criminal

charge, and petitioner was sentenced to a prison term of 52

months and was fined $100,000.    See United States v. McHan, 920

F.2d 244, 245 (4th Cir. 1990).

     In connection with the above prosecution, under 21 U.S.C.

section 853 the Government obtained an in rem criminal forfeiture

of petitioner’s interests in a 35-acre parcel of real estate and

in two automobiles.
                              - 7 -

     Cunningham also pleaded guilty to the above criminal charge.

As part of his plea agreement, Cunningham testified against

petitioner before a Federal grand jury regarding various illegal

drug transactions in which he and petitioner participated in

1985, 1986, and 1987.

     On September 13, 1990, in an additional indictment filed in

the Federal District Court for the Western District of North

Carolina, petitioner was charged with 17 counts of illegal drug

trafficking, filing false tax returns, and engaging in a

continuing criminal enterprise in connection with the illegal

drug transactions that Cunningham had testified about and that

occurred beginning in the fall of 1984, in 1985, 1986, and 1987,

and in early 1988.

     In July of 1992, petitioner pleaded guilty to some of the

charges, and petitioner was convicted on all charges submitted to

the jury.

     Petitioner was sentenced to a prison term of 150 months.

     Also, the Government obtained another criminal forfeiture

against petitioner of $395,670 (the amount of the net proceeds

that the District Court determined petitioner received from the

related drug transactions, after deducting $857,030 for

petitioner’s estimated costs of purchasing and transporting the

marijuana and after deducting $236,650 for one-half of the net
                                 - 8 -

marijuana sales proceeds that petitioner purportedly shared with

Posey).

     On appeal, the United States Court of Appeals for the Fourth

Circuit affirmed petitioner’s above second conviction, but the

Court of Appeals reversed the District Court as to the proper

amount subject to criminal forfeiture and held that, under 21

U.S.C. section 853, the Government’s criminal forfeiture against

petitioner extended to the entire $1,489,350 gross proceeds that

the District Court determined petitioner received from the

illegal drug transactions and was not to be reduced by

petitioner’s costs nor by amounts shared with co-conspirators.

United States v. McHan, 101 F.3d 1027, 1041-1042 (4th Cir. 1996).

     As a result of petitioner’s criminal convictions, petitioner

has been incarcerated since 1989.

     Petitioner Martha McHan is not implicated in petitioner’s

illegal drug transactions.   With assets petitioners acquired over

the years, petitioners apparently have fully satisfied both

criminal forfeiture judgments.

     For 1985, 1986, and 1987, petitioners’ joint Federal income

tax returns were prepared by a professional income tax return

preparer based on information provided to him by petitioners and

were signed by petitioners and filed with respondent.    Thereon,

the following adjusted gross income and loss figures for

petitioners were reported:
                               - 9 -

           Year           Adjusted Gross Income or Loss

           1985                   $122,352

           1986                   $180,687

           1987                  ($332,696)


     The above adjusted gross income and loss figures reported on

petitioners’ joint Federal income tax returns for 1985, 1986, and

1987 did not reflect any of the proceeds of petitioner’s illegal

drug transactions.

     Petitioners did not provide any books and records or

otherwise disclose to their tax return preparer any information

relating to petitioner’s drug transactions, and petitioners

failed to provide to their tax return preparer and to respondent

any books and records with respect to the illegal drug

transactions in which petitioner participated.

     Respondent’s agent investigated petitioner for failing to

report income from illegal drug transactions in 1985, 1986, and

1987.   Respondent’s agent and an agent of the North Carolina

State Bureau of Investigation interviewed Posey and Cunningham

regarding their participation with petitioner in the illegal drug

transactions during the years in issue.

     On the basis of his investigation and his interviews with

Posey and Cunningham, respondent’s agent determined the amounts

petitioner received on the sales of marijuana in which petitioner

and Posey and/or Cunningham were involved.
                              - 10 -

     Also, based in part on the statements made by petitioner to

Posey on the undercover tapes, respondent’s agent determined how

much petitioner received on the sales of marijuana purchased from

the Texas source.

     Respondent’s agent used information from his investigation

to reconstruct petitioner’s 1985, 1986, and 1987 income from

illegal drug transactions.   Respondent’s agent identified certain

specific marijuana transactions in which petitioner, Posey, and

Cunningham participated during 1985, 1986, and 1987.

     With respect to each such marijuana transaction,

respondent’s agent determined the number of pounds of marijuana

purchased, petitioner’s cost for the marijuana, and the sales

proceeds and gross profit petitioner received.

     For example, respondent’s agent determined that petitioner

paid on average $275 per pound for the marijuana purchased from

the Texas source.   Also, to take into account amounts paid by

petitioner to the Colonel on the purchase of marijuana from the

Texas source, respondent’s agent added $20 per pound, allowing

petitioner a total cost of goods sold in the amount of $295 per

pound.   Where petitioner purchased marijuana from a different

source, respondent’s agent used a cost for the marijuana

according to information provided by Posey and Cunningham.

     In calculating petitioner’s gross profits for 1986 and 1987

from illegal drug transactions in which petitioner participated,
                              - 11 -

respondent’s agent disregarded petitioner’s losses in 1986 and

1987 on the Florida transactions.

     Respondent’s agent prepared a schedule of omitted gross

receipts (the schedule), which specifically identifies the

marijuana sales petitioner participated in with Posey and

Cunningham.   For each of these transactions, respondent’s special

agent calculated:   (1) Gross receipts (amount of marijuana

purchased x sale price), (2) cost of marijuana sold (amount of

marijuana purchased x purchase price), and (3) the gross profit

(gross receipts minus cost of marijuana sold).

     Respondent’s agent’s calculation of petitioner’s gross

receipts, cost of marijuana sold, and gross profit for each year

(from the specific marijuana sales transactions in which

petitioner participated) is summarized below:


                  Petitioner’s Marijuana Sales
                           1985          1986         1987
Gross Receipts         $1,311,670      $252,800     $266,400
Cost of Goods Sold        689,410       159,525       65,490
Gross Profit              622,260        93,275      200,910


     On November 15, 1991, respondent mailed to petitioner and to

Martha McHan a notice of deficiency for 1985 and 1986 based on

the above-determined $622,260 and $93,275 in income (i.e., gross
                             - 12 -

profit) of petitioner from marijuana sales not reported on

petitioners’ 1985 and 1986 Federal income tax returns.2

     In addition, based on his above calculation and

determination that petitioner had $200,910 in additional

unreported income in 1987 from marijuana sales, respondent

disallowed the portions of petitioners’s claimed 1987 $332,696

net operating loss carryback that were claimed on petitioners’

1985 and 1986 Federal income tax returns.

     For 1985 and 1986, respondent also determined that

petitioner was liable for additions to tax for fraud and for

substantially understating his Federal income tax liability.

     Certain other adjustments made by respondent against

petitioners in each notice of deficiency are no longer in

dispute.

     At trial, respondent sought to significantly increase the

illegal drug income to be charged to petitioner for each year.

     As indicated, the tax deficiencies reflected in respondent’s

notice of deficiency to Martha Mchan were based solely on

Martha’s alleged joint liability under section 6013 for the tax

deficiencies determined against petitioner, and no fraud or other

additions to tax were determined against Martha.




     2
       Respondent’s calculations of petitioner’s income from the
sale of marijuana were also used by the District Court in the
second criminal forfeiture action against petitioner.
                              - 13 -

                             OPINION

     According to petitioners, the determinations made in

respondent’s notices of deficiency are arbitrary and erroneous

and therefore are not entitled to the normal presumption of

correctness provided in our Rules and by the caselaw.   See Rule

142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933).     Where a

taxpayer establishes that a deficiency determination is

arbitrary, capricious, or without reasonable foundation, the

normal presumption of correctness attached thereto may not be

applicable.   Helvering v. Taylor, 293 U.S. 507 (1935); Dellacroce

v. Commissioner, 83 T.C. 269, 287 (1984); Riland v. Commissioner,

79 T.C. 185, 201 (1982); Jackson v. Commissioner, 73 T.C. 394,

401 (1979).

     Petitioners maintain that petitioner did not realize any

income during the years in issue from the marijuana transactions

identified by respondent’s agent.   Throughout the proceedings and

in their briefs, petitioners argue that petitioner was acting as

a mere conduit or agent for the other co-conspirators and that

petitioner did not have ownership in the funds or profits

relating to the marijuana transactions.   Further, petitioners

claim that respondent has failed to produce any predicate

evidence to establish that petitioner received income from

illegal drug sales.
                              - 14 -

     We recognize the difficulty of proving a negative, that is,

the nonreceipt of income, and in cases involving allegations of

unreported illegal income, we may reject respondent’s deficiency

determinations if they constitute “naked assessments”; i.e., if

they are not supported by the evidence.    See, e.g., Williams v.

Commissioner, 999 F.2d 760 (4th Cir. 1993), affg. T.C. Memo.

1992-153; Cozzi v. Commissioner, 88 T.C. 435, 444 (1987);

Dellacroce v. Commissioner, supra at 280.

     The present case, however, does not involve a naked

assessment.   In this case, there is substantial evidence linking

petitioner to income from the illegal sale of marijuana during

1985, 1986, and 1987.   That evidence consists not only of

petitioner’s arrest and subsequent criminal convictions for

engaging in the illegal sale of marijuana, criminal forfeitures,

and the testimony of various co-conspirators, but also

petitioner’s own admission that he was involved in a conspiracy

to possess and to sell marijuana.   In Franklin v. Commissioner,

T.C. Memo. 1993-184, we held that indictment, guilty plea, and

conviction are sufficient to support an inference linking a

taxpayer to illegal income-generating activity.

     Respondent’s tax deficiency determinations herein against

petitioners are entitled to the usual presumption of correctness.

     As a general rule, gross income includes “all income from

whatever source derived”.   Sec. 61(a).   This includes income
                               - 15 -

obtained from illegal sources.   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.

     Section 6001 requires taxpayers to maintain records

sufficient to determine their correct Federal income taxes.

Petzoldt v. Commissioner, 92 T.C. 661, 686 (1989).   If taxpayers

fail to maintain or do not produce adequate books and records,

respondent is authorized by section 446 to reconstruct the

taxpayers’ income.   Sec. 446(b); Petzoldt v. Commissioner, supra

at 686-687; Giddio v. Commissioner, 54 T.C. 1530, 1533 (1970);

Schroeder v. Commissioner, 40 T.C. 30, 33 (1963); Bratulich v.

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

     For the years in issue petitioners failed to maintain and to

produce records of petitioner’s illegal marijuana sales.

Respondent reconstructed petitioners’ income for each year by

using the specific item method of proof, a method approved by

this Court on numerous occasions.    See, e.g., Estate of Beck v.

Commissioner, 56 T.C. 297, 353-354 (1971); Pappas v.

Commissioner, T.C. Memo. 2002-127; Levine v. Commissioner, T.C.

Memo. 1998-383, affd. 229 F.3d 1158 (9th Cir. 2000); Baker v.

Commissioner, T.C. Memo. 1991-340, affd. 9 F.3d 1550 (9th Cir.

1993).

     Based on information respondent’s agent obtained from

interviews with Posey and Cunningham and from undercover tapes,
                              - 16 -

respondent’s agent identified a number of specific marijuana

sales transactions in which petitioner participated with Posey

and Cunningham in 1985, 1986, and 1987.   Based on the information

obtained, respondent’s agent determined petitioner’s related

gross receipts, cost of goods sold, and gross profits.

     Petitioners do not dispute that petitioner participated in

marijuana transactions with Posey and Cunningham, and for the

most part petitioners do not dispute certain facts relied on by

respondent in calculating petitioner’s gross receipts, cost of

goods sold, and gross profit therefrom.   To the contrary, at both

his criminal trial and his trial herein petitioner generally

admitted to his involvement in the marijuana transactions

described by Posey and by Cunningham.3

     Nevertheless, petitioner claims that he did not receive any

net income or profit from the marijuana sales.   According to

petitioner, he was merely assisting friends in the purchase and

sale of marijuana.   Our view of petitioner’s claim, however, is

stated in Petzoldt v. Commissioner, supra at 697:


     There is nothing in the record which would indicate
     that petitioner sold marijuana for philanthropic
     reasons, expecting no profit for his efforts. Common
     sense would dictate the conclusion that anyone who is
     in an illegal and dangerous business such as the
     dealing of drugs would demand a very large profit for
     his enormous risks. * * *


     3
       The transcripts of petitioner’s July 1992 criminal trial
were admitted into evidence herein.
                               - 17 -

The danger and risks to which petitioner exposed himself could

not be more apparent.   Petitioner was arrested, tried, convicted,

and sentenced to a lengthy period of incarceration in a Federal

penitentiary.    We reject petitioner’s testimony that he did not

have an ownership interest in the illegal drug transactions

identified and used by respondent in his calculations of

petitioners’ income.

     For purposes of the tax deficiencies herein, and based on

petitioners’ burden of proof and with the two exceptions noted

below, we agree with respondent’s calculations of petitioners’

unreported income from marijuana sales, as set forth in the

notices of deficiency for 1985, 1986, and 1987.

     The first adjustment to be made to respondent’s calculations

relates to a November 1985 transaction involving purported gross

receipts of $64,000 and, after $29,500 in cost of goods sold, a

purported gross profit of $34,500.      Respondent now concedes this

transaction did not occur or should not be charged to petitioner.

     The second adjustment to be made to respondent’s

calculations involves the losses of $73,000 and $42,000 that

petitioner realized in 1986 and 1987, respectively, from the

Florida transactions.   Respondent’s agent apparently overlooked

or disregarded these loss transactions that are to be taken into

account in the calculations of petitioners’ unreported income for

1986 and 1987.
                              - 18 -

     In addition to the transactions included in respondent’s

notices of deficiency, at trial respondent claims that in July of

1985 petitioner participated in an additional purchase and sale

of marijuana not included in respondent’s calculations.

Respondent submits that this transaction involved petitioner’s

purchase of 500 pounds of marijuana for $275 per pound and

petitioner’s sale of the marijuana for $550 per pound.    The

inclusion of this transaction would result in an increased

deficiency for 1985 on which respondent would bear the burden of

proof.   Rule 142(a); Achiro v. Commissioner, 77 T.C. 881, 890

(1981); Williams v. Commissioner, T.C. Memo. 1992-153, affd. 999

F.2d 760 (4th Cir. 1993).   We find the evidence insufficient to

satisfy respondent’s burden on this alleged sale of marijuana.

     On brief, respondent also takes the position that the $20

per pound paid to the Colonel by petitioner for security and for

transporting the marijuana into the Untied States should not have

been added by respondent’s agent to petitioner’s cost of goods

sold for marijuana purchased from the Texas source.   Respondent

contends that under section 280E this amount is not properly

treated as an item of petitioner’s cost of goods sold.

     Generally, we do not consider issues that are raised for the

first time on brief, and we decline to consider this untimely

raised issue.   See, e.g., Foil v. Commissioner, 92 T.C. 376, 418

(1989), affd. 920 F.2d 1196 (5th Cir. 1990); Markwardt v.
                               - 19 -

Commissioner, 64 T.C. 989, 997 (1975); see also Grossman v.

Commissioner, 182 F.3d 275, 281 (4th Cir. 1999), affg. T.C. Memo.

1996-452.

     Rejecting respondent’s assertion of increased income for

1985 and adjusting respondent’s calculations to account for the

1986 and 1987 losses on the Florida transactions mentioned

above,4 we conclude that petitioner’s sale of marijuana generated

the following gross receipts, cost of goods sold, and gross

profit:


                          1985            1986         1987
Gross Receipts         $1,247,670       $279,800     $306,400
Cost of Goods Sold        659,910        259,525      147,490
Gross Profit              587,760         20,275      158,910


     As indicated, under section 6653(b)(1) and (2) for 1985 and

under section 6653(b)(1)(A) and (B) for 1986, respondent

determined that petitioner is liable for additions to tax for

fraud.    Respondent also determined that for 1985 and 1986

petitioner is liable for additions to tax under section 6661 for

substantial understatements of tax.

     No additions to tax were determined by respondent against

Martha McHan.




     4
       Taking into account the 1986 and 1987 Florida loss
transactions also involved making certain other adjustments to
petitioner’s gross receipts and cost of goods sold for 1986 and
1987.
                             - 20 -

     For 1985, section 6653(b)(1) imposes an addition to tax

equal to 50 percent of a tax underpayment if any portion of the

underpayment is due to fraud, and section 6653(b)(2) imposes

another addition to tax equal to 50 percent of the interest with

respect to the portion of an underpayment attributable to fraud.

     For 1986, section 6653(b)(1)(A) imposes an addition to tax

equal to 75 percent of the tax underpayment attributable to

fraud, and section 6653(b)(1)(B) imposes a separate addition to

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

6601, on the portion of an underpayment attributable to fraud.

     Further, for 1986, if fraud is established with respect to

any portion, under section 6653(b)(2) the entire underpayment is

to be treated as attributable to fraud, except to the extent the

taxpayer establishes that some portion of the underpayment is not

attributable to fraud.

     For purposes of section 6653(b), fraud is defined as an

intentional wrongdoing designed to evade tax believed to be owed.

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, 92 T.C. at 698; Estate of

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

     Respondent bears the burden of proving each of the elements

of fraud by clear and convincing evidence – an intent to evade

tax and an underpayment of tax.   Sec. 7454(a); Rule 142(b);
                              - 21 -

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

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

respondent must establish 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.   Grossman v. Commissioner, supra

at 277; Stoltzfus v. United States, 398 F.2d 1002, 1004 (3d Cir.

1968); 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 tax evasion was

petitioner’s primary motivation but must show that a “‘tax-

evasion motive’” played a part in petitioner’s conduct, including

conduct designed to conceal another crime.     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.     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

is never imputed or presumed; it must be established by
                               - 22 -

independent evidence.    Recklitis v. Commissioner, supra at 910;

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

85, 92 (1970).    Because, however, direct proof of a taxpayer’s

intent is often not available, fraud may be proved by

circumstantial evidence.    Grossman v. Commissioner, supra at 277;

Boyett v. Commissioner, 204 F.2d 205, 208 (5th Cir. 1953), affg.

a Memorandum Opinion of this Court; Castillo v. Commissioner,

supra; Stephenson v. Commissioner, 79 T.C. 995, 1005-1006 (1982),

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

supra at 200.    The taxpayer’s entire course of conduct may

establish the requisite fraudulent intent.    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.    Spies v.
                               - 23 -

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.

     Often, a combination of factors may provide persuasive

evidence of fraud.   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 also may be

relevant for purposes of determining fraudulent intent.

Stephenson v. Commissioner, supra at 1006; Iley v. Commissioner,

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

     We acknowledge that the facts and evidence in the trial

record in this case as to the precise amount of total costs

incurred, sales proceeds, and profit petitioner realized in each

year from his illegal drug sales are not established with a great

deal of clarity.   Respondent relies heavily on the testimony of

convicted felons and on grand jury testimony admitted at

petitioner’s criminal trial.

     However, to find civil tax fraud, the exact amount of income

underreported by a taxpayer need not be established.   It is

sufficient that respondent establish, by clear and convincing

evidence, that petitioners failed to report substantial income

for each year and did so intentionally, at which point the burden

of proof shifts to the taxpayer to prove the amount of any
                                - 24 -

related expenses.     Siravo v. United States, 377 F.2d 469, 473

(1st Cir. 1967); Franklin v. Commissioner, T.C. Memo. 1993-184.

     Petitioner has not produced credible evidence of additional

expenses incurred relating to his purchase and sale of marijuana

in excess of those allowed by respondent.    Accordingly,

respondent has established by clear and convincing evidence that

in 1985 and 1986 petitioner herein had significant additional

income and income taxes relating to petitioner’s illegal sale of

marijuana that petitioner did not report on his 1985 and 1986

Federal income tax returns.

     Petitioner was indicted and convicted on numerous charges

relating to his purchase and sale of marijuana during 1985, 1986,

and 1987.   No income relating to petitioner’s sale of marijuana

was reported on petitioners’ joint Federal income tax return for

the years in issue.     Gatling v. Commissioner, 286 F.2d 139, 145

(4th Cir. 1961) (“[P]roof of consistent and substantial

understatements of income over a period of years may constitute

persuasive and convincing evidence of fraud.”), affg. T.C. Memo.

1959-224; see also Patton v. Commissioner, 799 F.2d 166, 171 (5th

Cir. 1986), affg. T.C. Memo. 1985-148; Merritt v. Commissioner,

301 F.2d 484, 487 (5th Cir. 1962), affg. T.C. Memo. 1959-172.

     Petitioner dealt in large amounts of cash when buying and

selling marijuana, but petitioner failed to maintain or to

produce books and records relating to the transactions, see
                                - 25 -

Truesdell v. Commissioner, 89 T.C. 1280, 1302 (1987); Gajewski v.

Commissioner, 62 T.C. at 200, and petitioner failed to inform his

tax return preparer of his marijuana sales, see Estate of Mazzoni

v. Commissioner, 451 F.2d 197, 202 (3d Cir. 1971), affg. T.C.

Memo. 1970-37.

     Taken as a whole, the evidence establishes that petitioner

acted with the requisite fraudulent intent and that petitioner

underreported substantial income for 1985 and 1986 relating to

marijuana sales with fraudulent intent.   We also note that

Special Trial Judge Carluzzo observed petitioner’s testimony and

rejected, in his recommended findings of fact and conclusions of

law, petitioner’s testimony as to his limited participation in

the marijuana sales transactions and concluded that petitioner

had the requisite fraudulent intent in filing his 1985 and 1986

Federal income tax returns without reporting thereon his

marijuana sales transactions.

     We sustain respondent’s determinations that petitioner is

liable for the additions to tax for fraud prescribed under

section 6653(b) for 1985 and 1986.

     Respondent also determined additions to tax under section

6661 for 1985 and 1986.   For tax returns due after December 31,

1982 (but before January 1, 1990), section 6661 provides for an

addition to tax equal to 25 percent of the amount of any tax

underpayment attributable to a substantial understatement.    An
                                - 26 -

understatement is “substantial” if it exceeds the greater of

(1) 10 percent of the tax required to be shown on the return or

(2) $5,000.   Sec. 6661(b)(1)(A).   The understatement is reduced

to the extent that the taxpayer (1) has adequately disclosed his

or her position, or (2) has substantial authority for the tax

treatment of an item.   Sec. 6661(b)(2)(B); sec. 1.6661-6(a),

Income Tax Regs.   For 1985 and 1986, petitioner bears the burden

of proof as to the issue of his liability for the addition to tax

under section 6661.   Rule 142(a); Cochrane v. Commissioner, 107

T.C. 18, 29 (1996).

     Due to petitioners’ substantial unreported income for 1985

and 1986, petitioner’s income tax deficiencies for the taxable

years in issue trigger the substantial understatement addition to

tax under section 6661(b)(1).    Petitioner has presented no

evidence to show that respondent erroneously determined the

additions to tax under section 6661.     Petitioner is liable for

the additions to tax under section 6661 for 1985 and for 1986.

     Section 6501(c)(1) expressly provides that in the case of a

false or fraudulent tax return with the intent to evade tax, the

tax may be assessed at any time.    Petitioners’ argument that the

period of limitations on assessment with respect to their income

taxes for 1985 and 1986 expired before respondent issued the

notices of deficiency to petitioners is rejected.
                             - 27 -

     Because petitioners filed joint Federal income tax returns

for 1985 and 1986, the assessment period of limitations under

section 6501 remains open as to Martha McHan as well.   Stone v.

Commissioner, 56 T.C. at 227-228.

     Other arguments raised by petitioners and not discussed

herein have been considered, are without merit, and are rejected.

     To reflect the foregoing,

                                       An appropriate order will

                                 be issued.
