                        T.C. Memo. 2007-173



                      UNITED STATES TAX COURT



            TIMOTHY AND BARBARA KOSINSKI, Petitioners v.
            COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 9911-04.              Filed July 2, 2007.



     Neal Nusholtz and Richard M. Lustig, for petitioners.

     Timothy S. Murphy, for respondent.



              MEMORANDUM FINDINGS OF FACT AND OPINION


     COHEN, Judge:   Respondent determined a deficiency of

$1,205,548 and an addition to tax for fraud pursuant to section

6663 of $904,161 with respect to petitioners’ Federal income tax

for 1997.   Unless otherwise indicated, all section references are

to the Internal Revenue Code in effect for the year in issue, and
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all Rule references are to the Tax Court Rules of Practice and

Procedure.   After concessions, the issues for decision are:

     (1) Whether petitioners have unreported flowthrough income

for 1997 resulting from overstated cost of goods sold on the

Federal income tax return for petitioner Timothy Kosinski’s

solely owned S corporation;

     (2) whether petitioners are liable for the fraud penalty

pursuant to section 6663 for the year in issue, or, in the

alternative, whether petitioners are liable for the accuracy-

related penalty pursuant to section 6662;

     (3) whether petitioner Barbara Kosinski is entitled to

relief pursuant to section 6015 for 1997; and

     (4) whether the statute of limitations bars assessment and

collection of petitioners’ income tax liabilities for 1997.

                         FINDINGS OF FACT

     Some of the facts have been stipulated, and the stipulated

facts are incorporated into our findings by this reference.

Petitioners are married and resided in Novi, Michigan, at the

time that they filed their petition.

     Petitioner Timothy Kosinski (petitioner) has been a licensed

dentist since 1984 and was employed as an associate in a dental

practice until 1991.   In 1992, petitioner incorporated Timothy F.

Kosinksi, P.C., his solely owned corporation, and was practicing

dentistry under this name in 1997.
                               - 3 -

     At the time of trial, petitioner Barbara Kosinski

(Mrs. Kosinski) had been married to petitioner for 22 years.    She

received a bachelor’s degree in psychology from the University of

Michigan in Dearborn and was employed part time as a bank teller

at two different banks consecutively during the 1980s.    At the

time of trial, Mrs. Kosinski was a full-time homemaker.

Petitioner’s Contracting Business

     After the death of his father in 1991, petitioner

incorporated T.J. Construction Co. (T.J. Construction) to

continue certain building projects on which his father had been

working prior to his death.   Petitioner’s father had been a

carpenter and independent contractor and had worked primarily

with Thyssen Steel Inc. (Thyssen Steel), which manufactures steel

wire, steel coil, and other steel products.   From 1991 through

1999, Thyssen Steel was the only customer of T.J. Construction.

     Much of the work performed by T.J. Construction was as a

contractor for foundation cement work for two Thyssen Steel

plants.   Most of the work for the plant in Detroit, Michigan, was

subcontracted out by T.J. Construction to Melvin Phillips

(Phillips), the sole owner of Phillips Contracting Co. (Phillips

Contracting), and Phillips was one of several subcontractors for

the plant in Richburg, South Carolina.   Phillips and petitioner

were close family friends, and Phillips substantially facilitated

petitioner’s entrance into the contracting field.   On the Thyssen
                               - 4 -

Steel projects, Phillips performed the work at the sites, and

petitioner, through T.J. Construction, primarily handled the

paperwork between Phillips and Thyssen Steel.

     The Thyssen Steel projects involved numerous jobs for which

individual proposals were submitted by Phillips to petitioner,

who then forwarded the proposals to Thyssen Steel.   Phillips

included a 20-percent profit margin in his proposal for each job,

and petitioner added a 10-percent administrative fee to the

figure proposed by Phillips before submitting the final proposal

to Al Paas (Paas), the project manager for Thyssen Steel, who

then submitted the proposals for final approval by Thyssen Steel

management.   Petitioner typically requested payment from Paas for

work completed, and payments were received from Thyssen Steel in

checks made out to T.J. Construction.   Petitioner then remitted

to Phillips whatever petitioner determined was owed to Phillips,

after deducting funds previously advanced to Phillips by

petitioner.

     On several occasions, envelopes containing $5,000 in $100

bills were given by petitioner to Paas, petitioner’s contact for

payment from Thyssen Steel.   Paas was instrumental in T.J.

Construction’s receiving a performance bonus nearly double that

which was required by the contract between Thyssen Steel and

T.J. Construction.   Petitioner did not require that Paas use the

cash in a particular manner or keep receipts for the cash he
                               - 5 -

used, and petitioner kept no record of the cash he advanced to

Paas.

     Various methods of payment were used at various times by

petitioner to pay Phillips or to advance money to Phillips.

During the first couple of years that T.J. Construction was in

business, it was petitioner’s practice simply to write checks to

cash from T.J. Construction’s account to pay himself and

Phillips.   During their compilation at a later date, he would

inform his accountants which of the checks that were written to

cash went to Phillips and which ones went to petitioner.

However, petitioner was advised by his accountants in late 1993

that checks written to cash would no longer be deducted and that

petitioner would need documentation, such as checks to a specific

payee, in order to claim a business deduction for those expenses.

     Until mid-June 1996, petitioner paid Phillips and advanced

funds on current projects by writing checks in the amount of

$9,500 to Phillips from T.J. Construction’s account, which checks

Phillips cashed.   Around that time, however, petitioner changed

his practice and began to advance cash to Phillips as well as to

write checks made out to Phillips from T.J. Construction’s

account, which checks were then endorsed by Phillips back to

petitioner and deposited by petitioner into petitioners’ personal

bank account, allegedly as repayments for cash advanced.

Petitioner did not inform his accountants that he was advancing
                              - 6 -

cash to Phillips in addition to writing the checks or that the

checks were endorsed back to petitioner and deposited in

petitioners’ personal bank account.   All of the checks that were

endorsed back to petitioner were deducted as business expenses on

T.J. Construction’s Forms 1120S, U.S. Income Tax Return for an S

Corporation.

     The nature of the cash transactions between petitioner and

Phillips was such that the actual amount of money paid to

Phillips could be verified only by petitioner and Phillips.

Petitioner kept track of the amounts owed to Phillips by T.J.

Construction, but he destroyed those records regularly.    Phillips

did not keep records of the amounts he was owed, but rather

relied on petitioner to handle the paperwork with regard to the

Thyssen Steel projects.

     From 1994 through 1998, Phillips paid his employees with a

combination of checks and cash.   He did not withhold any taxes

and did not issue any Forms 1099 or Forms W-2, Wage and Tax

Statement, with regard to payments to his employees.   With the

cash he received from petitioner, Phillips customarily made cash

payments to temporary workers, to subcontractors, to regular

employees as incentives and bonuses, and to suppliers.

     In addition to substantial cash payments, petitioner made

three large wire transfers to Phillips Contracting totaling

$1,440,500 between 1996 and 1997.   Petitioner treated these
                                 - 7 -

amounts as cost of goods sold for the relevant years.    However,

petitioner also treated these amounts as cash advances or loans

to Phillips, and he made out to Phillips from T.J. Construction’s

account, and had Phillips endorse back to him, checks equal to

the total of the wire transfers, which checks petitioner then

deposited into petitioners’ personal bank account, even though

petitioner had not advanced his own funds with regard to the wire

transfers.    Both the amounts transferred by wire transfer and the

checks made payable to Phillips that were endorsed back to

petitioner were treated as cost of goods sold during the

preparation of petitioners’ and T.J. Construction’s tax returns,

resulting in the full amounts of the wire transfers being so

treated twice.

     In late December 1998, Phillips needed a personal loan of

$101,000.    Petitioner advanced funds to Phillips out of his

personal accounts, but he then had Phillips endorse checks out of

T.J. Construction’s account back to him, which checks were then

deposited in petitioners’ personal bank account.    The checks made

payable to Phillips and endorsed back to petitioner were then

treated as cost of goods sold on T.J. Construction’s return for

1998.

     Petitioners regularly kept hundreds of thousands of dollars

in cash in their home safe and safe-deposit boxes, as well as at

petitioner’s dentistry office.
                                - 8 -

     Between 1995 and 1999, petitioners, Phillips, and Nina

Spratt, an employee of petitioner’s dental office, cashed checks

and withdrew cash totaling $7,676,000 in $9,500 increments both

from petitioners’ personal account and from that of T.J.

Construction.   The $9,500 amount was just below the $10,000

threshold at which banks are required to report large

transactions to the Federal Government, which resulted in these

cash transactions’ avoiding at least immediate scrutiny.    In

1997, the year in issue, petitioner cashed or caused to be cashed

checks totaling $1,976,000.   In 1996 and 1998, petitioner cashed

or caused to be cashed checks totaling $1,957,000 and $2,527,000,

respectively.

     Mrs. Kosinski regularly withdrew cash in $9,500 increments

from petitioners’ checking accounts at her husband’s direction.

Between 1995 and 1999, she cashed nearly 300 checks for her

husband totaling approximately $2.85 million.   In 1997 alone,

Mrs. Kosinski cashed 87 checks, each for $9,500.   On one

occasion, she wrote a check to cash for $10,000 and left the

check in an envelope under a doormat for Phillips to pick up.

     Petitioner wrote 36 checks totaling $2,919,974 in 1997 to

Phillips or Phillips Contracting that were endorsed back to

petitioner and deposited into the personal bank account of

petitioners.    In 1996 and 1998, petitioner wrote checks totaling

$2,079,253 and $3,144,398, respectively, that were endorsed back
                               - 9 -

to petitioner and deposited into the personal bank account of

petitioners.   All of the checks that were made payable to

Phillips or to Phillips Contracting but endorsed back to

petitioner were treated as cost of goods sold on the Forms 1120S

of T.J. Construction for tax years 1996 through 1998.

     From early 1996 through 1998, petitioner’s brother, George

Kosinski, performed substantial home improvements on petitioners’

personal residence and on the home in which petitioner’s mother

lived, which home was owned by petitioners.   The work performed

by George Kosinski was billed by his company, Rougewood

Construction, to “Tim Kosinski” but was paid for by checks out of

T.J. Construction’s account.   Until December 1997, invoices from

Rougewood Construction were addressed to petitioners’ personal

residence.   Beginning in December 1997, the invoices were

addressed to petitioner at his business address.   All of the

checks to Rougewood Construction, totaling nearly $141,000 from

1996 through 1998, were signed by petitioner, and none had any

notation indicating that they were for personal expenses.

Payments to Rougewood Construction for personal home improvement

expenses of petitioners were deducted as business expenses on the

Forms 1120S of T.J. Construction.   Some of the personal home

improvement work for petitioners was performed by Star

Mechanical, a subcontractor of Rougewood Construction, and Star
                                - 10 -

Mechanical billed its expenses to T.J. Construction at the

direction of George Kosinski.

Preparation of Petitioners’ Federal Tax Returns

     Susan Pereira (Pereira), an employee of Plotnik &

Associates, was the certified public accountant (C.P.A.) who did

the accounting for T.J. Construction and for petitioner’s dental

practice from 1991 through 1999.    She also prepared the Forms

1040, U.S. Individual Income Tax Return, for petitioners and the

Forms 1120S for T.J. Construction during that period.    The

returns prepared by Pereira were signed by Steven J. Plotnik,

also a C.P.A.

     For purposes of preparing the Forms 1040, petitioner

generally provided Pereira with Forms W-2, yearend bank

statements indicating any interest or dividend accounts, and

copies of some relevant canceled checks and bills.    For purposes

of preparing the Forms 1120S for T.J. Construction, petitioner

generally provided Pereira with bank statements, check stubs,

check stubs received from Thyssen Steel, and green sheets, which

were petitioner’s handwritten ledgers recording gross receipts

and expenditures from T.J. Construction’s account.    Pereira did

not use the green sheets provided unless she had a question about

something in her review of the bank statements and check

registers during the course of her compilation and preparation of

petitioners’ and T.J. Construction’s tax returns.
                              - 11 -

     Pereira relied on deposits into T.J. Construction’s bank

account in determining the company’s gross receipts and on

T.J. Construction’s check stubs, which were categorized by

Pereira based on the information recorded on the check stubs, in

determining cost of goods sold, operating expenses, and other

deductible expenditures.   All checks written to Phillips or to

Phillips Contracting from T.J. Construction’s bank account were

included in the cost of goods sold listed on the Forms 1120S.

Once the Forms 1120S were completed, the returns and a financial

statement were hand delivered or mailed by Plotnik & Associates

to petitioner, who was directed to sign and mail the returns.

Petitioner never informed Pereira that he was advancing large

amounts of cash to Phillips or that the checks made payable to

Phillips were being endorsed back to petitioner and deposited

into petitioners’ personal account.    She first became aware of

the cash transactions and of the checks that were endorsed back

to petitioner when the IRS initiated a criminal investigation of

petitioners, as discussed below.

     The green sheets that petitioner provided to Pereira

included as business deductions of T.J. Construction estimated

tax payments made on behalf of petitioner personally.    On one

occasion in 1995 or 1996, Pereira compared petitioner’s figures

on his green sheets with the figures she calculated and explained

to him that tax payments made on behalf of petitioner personally,
                              - 12 -

when paid by T.J. Construction, were additional income to

petitioner and not business expenses of the company.

     Pereira had frequent discussions with petitioner regarding

the books and records of T.J. Construction, but petitioner never

disclosed to her that payments to Rougewood Construction and to

Star Mechanical out of T.J. Construction’s account were for his

personal benefit or that they were related to personal home

improvements.   When Pereira sorted the check stubs that she was

provided during her compilation for T.J. Construction, she

categorized these payments under cost of goods sold as payments

to subcontractors, because the names of the payees did not

trigger any suspicion regarding whether the payments were

business items, no notation was made on the check stubs that the

payments were personal, petitioner’s green sheets listed the

payments as miscellaneous expenses of T.J. Construction, and

Pereira was never informed otherwise by petitioner.    In addition,

T.J. Construction issued Forms 1099 to Rougewood Construction and

to Star Mechanical for 1996 through 1998 for payments made to

those entities to cover the personal expenses of petitioners.

Criminal Investigation and Conviction

     During an initial interview with special agents of the

Criminal Investigation Division of the Internal Revenue Service

(IRS) on July 20, 1999, when asked why he and his wife had been

consistently withdrawing large sums of cash from their accounts,
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petitioner represented to the special agents that he was putting

away money “in anticipation of the Y2K problem”.    Petitioner

stated that he had $300,000 in cash in petitioners’ personal safe

at home and another $200,000 in cash in safe-deposit boxes.      Upon

review of the contents of the home safe, the special agents found

37 envelopes, each containing $5,000 in $100 bills, totaling

$185,000.   When asked why he withdrew cash in $9,500 increments,

petitioner stated that he did it because that was the way his

father used to make cash withdrawals and that he understood that

a form must be filled out if cash transactions exceed $10,000.

At the initial interview with the special agents, petitioner did

not mention that he made regular cash payments to Phillips.

     At petitioner’s second interview 2 days later, the special

agents’ review of the contents of petitioners’ safe-deposit boxes

revealed 60 envelopes, each containing $5,000 in cash, totaling

$300,000.   When the special agents asked about the balance of the

cash that petitioners had withdrawn over the last 3 years, which

the special agents estimated at approximately $1.8 million,

petitioner said that “he spent it”.    He did mention to the

special agents at that time that Phillips, his main contractor,

preferred to be paid in cash, and informed them that petitioner

issued Forms 1099 to Phillips each year, but Phillips did not

sign receipts for the cash payments he received from T.J.

Construction.
                              - 14 -

     On June 20, 2002, a grand jury returned a nine-count

indictment against petitioner including:    (a) One count of

conspiracy to defraud the IRS and to structure currency

transactions to evade reporting requirements; (b) five counts of

subscribing a false Federal tax return; and (c) three counts of

structuring a currency transaction to evade reporting

requirements.   The grand jury also returned a three-count

indictment against Mrs. Kosinski, including one count of

conspiracy and two counts of structuring currency transactions.

The Government alleged in the indictment that petitioners

withdrew cash amounting to $7,666,500 for the purpose of

concealing Phillips’s payment of taxable wages in cash to his

employees between 1995 and 1999.

     A jury found petitioner guilty of seven counts (the

conspiracy count, all of the false tax return counts, and one

structuring count) and not guilty on two of the three structuring

counts.   Petitioner was initially sentenced to imprisonment of

two concurrent 30-month sentences and a 2-year and 1-year

concurrent supervised release.   The case was appealed to the

United States Court of Appeals for the Sixth Circuit, which

remanded the case for resentencing.    Upon resentencing,

petitioner was sentenced to 6 months in a halfway house, 6 months

in home confinement, and 3 years of probation, in addition to

being ordered to pay a $60,000 fine.    The United States Court of
                              - 15 -

Appeals for the Sixth Circuit has again remanded the case for

resentencing.   United States v. Kosinski, 480 F.3d 769 (6th Cir.

2007).

     Mrs. Kosinski pleaded guilty to one count of structuring

currency transactions and received probation, in addition to

being ordered to pay a $5,000 fine and perform 100 hours of

community service.   When she pleaded guilty, Mrs. Kosinski

testified under oath that no one had threatened her or her loved

ones to induce her to plead guilty and no one had promised her

favorable treatment if she pleaded guilty.   She also explained

her involvement in petitioner’s currency structuring

transactions:

     My husband and I agreed that I would go to the bank
     hundreds of times, almost always, and took money out in
     the amount of $9500. This is between 1996 and 1999.
     The account usually had a [sic] substantial more money
     in it than what I withdrew. The withdrawals were kept
     in an amount so that the bank would not have to fill
     out the federal reports for cash withdrawals over
     $10,000.

     Phillips was indicted and pleaded guilty to conspiracy to

defraud the United States and to tax evasion for the taxable

year 1998 with respect to paying his employees in cash with no

income tax withholdings, failing to issue Forms 1099 and Forms

W-2, and failing to file his own income tax returns.   He was

sentenced to 21 months’ incarceration and 2 years’ supervised

release, and he was ordered to file income tax returns for the

taxable years 1996 through 1998.
                                - 16 -

                             OPINION

Unreported Flowthrough Income

     As a general rule, a taxpayer challenging the

Commissioner’s determinations in a notice of deficiency bears

the burden of proof.   Rule 142(a).      That burden may shift to the

Commissioner if the taxpayer introduces credible evidence with

respect to any factual issue relevant to ascertaining the

taxpayer’s tax liability.   Sec. 7491(a)(1).     However, section

7491(a)(1) applies with respect to an issue only if the taxpayer

has complied with the requirements under the Code to

substantiate any item, has maintained all records required by

the Code, and has cooperated with reasonable requests by the

Commissioner for witnesses, information, documents, meetings,

and interviews.   Sec. 7491(a)(2)(A) and (B).     Petitioners have

not satisfied the conditions for shifting the burden of proof to

respondent.   In any event, the evidence establishes

overstatement of cost of goods sold resulting in understated

income and understated tax liability.

     In calculating gross income, taxpayers may offset gross

receipts by the cost of goods sold.       Metra Chem Corp. v.

Commissioner, 88 T.C. 654, 661 (1987); sec. 1.61-3(a), Income

Tax Regs.   In order to substantiate claimed cost of goods sold,

taxpayers are expected to maintain adequate records.      Sec. 6001;

sec. 1.6001-1(a), Income Tax Regs.
                             - 17 -

     On the 1997 Form 1120S for petitioner’s solely owned

corporation, T.J. Construction, petitioners claimed cost of goods

sold in the amount of $7,857,791.   All checks made payable to

Phillips or to Phillips Contracting were treated as cost of goods

sold, including $2,919,974 in checks that were issued to

Phillips, endorsed back to petitioner, and then deposited in

petitioners’ personal bank account.    Respondent disallowed the

costs of good sold for these checks.   Respondent concedes that

petitioner made cash advances of $1 million to Phillips in 1997

and may treat $1 million of the checks that were endorsed back to

petitioner as cost of goods sold.   Petitioners assert that their

estimation of cash advanced to Phillips in 1997 is closer to

$2.5 million.

     Petitioners have presented no credible evidence that more

than $1 million was advanced to Phillips.   In 1997, petitioner

cashed or caused to be cashed checks totaling $1,976,000.    This

amount is far less than the $2.5 million in cash that petitioners

claim was advanced to Phillips that year.   Petitioner has

presented no credible substantiating documentation regarding the

amount of cash he claims to have advanced to Phillips.   Rather,

he regularly destroyed the records he created to keep track of

such cash advances and the balances owed Phillips.

     Additionally, the record shows that petitioners’ dealings in

cash extended beyond his transactions with Phillips.   On several
                              - 18 -

occasions, petitioner gave cash to Paas, who was responsible for

approving his bids and recommending him for bonuses from Thyssen

Steel.   Petitioners kept substantial cash hoards in their home

safe and in safe-deposit boxes.   Petitioner made a $101,000

personal loan to Phillips in December 1998, for which he then

wrote checks made payable to Phillips out of T.J. Construction’s

account and had Phillips endorse them back to petitioner, who

then deposited them in his personal accounts.   Those checks were

deducted as a business expense of T.J. Construction on its

Form 1120S for that year.

     One of the checks that was endorsed back to petitioner for

$450,000 is related to a $450,000 wire transfer from T.J.

Construction to Phillips.   Petitioner’s accountants treated as

cost of goods sold both the wire transfer amount and the endorsed

back check made payable to Phillips, which supposedly represented

Phillips’s indebtedness for receipt of the wired funds, and thus

resulted in the $450,000 amount’s being subtracted twice from

gross receipts as cost of goods sold.   Both the wire transfer and

the matching endorsed back check occurred on October 3, 1997.

Petitioners have conceded the $450,000 duplication of cost of

good sold related to the wire transfer in 1997, and they have

also conceded that additional wire transfers totaling $1 million

were treated similarly in 1996, resulting in $1 million of costs
                              - 19 -

of good sold being subtracted from gross receipts twice in 1996.

However, that year is not before the Court in this case.

     Petitioners argue that the cash advances to Phillips and the

endorsed back checks should be viewed as two independent

liabilities stemming from separate and unrelated facts.    Under

such treatment, the cash advances from petitioner to Phillips

would be viewed as personal loans, and the endorsed back checks

would be viewed first as compensatory payments to Phillips and

then as repayments to petitioner of the borrowed funds when the

check was endorsed back to petitioner.   Thus, because the

endorsed back checks would be viewed as compensatory payments

when issued from T.J. Construction, all of the endorsed back

checks would be deductible business expenses of T.J.

Construction, and the taxability to petitioner of the endorsed

back checks would be dependent on how much cash was advanced as

loans to Phillips.   Petitioners argue that the tax treatment

outlined above is required because it is undisputed that T.J.

Construction owed Phillips money, and thus the checks issued to

Phillips were payments of legitimate corporate obligations.

     We are not persuaded by petitioners’ retroactive portrayal

of the transactions between Phillips and petitioners.   It is not

a necessary conclusion that all of the checks made payable to

Phillips were payments of legitimate obligations of T.J.

Construction.   There is no credible evidence in the record
                              - 20 -

regarding the amounts that T.J. Construction owed to Phillips,

and petitioner kept no reliable records to substantiate any

liabilities or payments.

     Because T.J. Construction is a flowthrough entity,

petitioners claimed the benefit of the corporate deductions and

costs of good sold taken for checks written to Phillips for which

Phillips did not actually receive payment.   Due to the volume of

the cash withdrawn by petitioners and the absence of any accurate

records as to how much actually was given to Phillips, it is

impossible to determine how much of the amount paid out in

endorsed back checks represented payments received by Phillips.

However, respondent has conceded $1 million as an approximation

of cash received by Phillips from petitioner, and thus $1 million

of the endorsed back checks is allowable as cost of goods sold in

1997.

     In an amended answer, respondent alleged that the cost of

goods sold of T.J. Construction was overstated by an additional

$21,253 because T.J. Construction paid for personal home

improvement expenses of petitioner in that amount in 1997 for

work performed by petitioner’s brother and his brother’s

subcontractor.   Petitioners concede that these payments are

personal, but they allege that they were not improperly treated

under cost of goods sold for 1997 on the Form 1120S because

petitioner allegedly had contributed funds to T.J. Construction
                              - 21 -

in prior years in order to cover the home improvement expenses.

Although the capital contributions made by petitioner in prior

years were not included in the income of T.J. Construction,

petitioners argue that they should have been included and then

the later deductions should be allowed.   In support of their

argument, petitioners cite Lemler v. Commissioner, T.C. Memo.

1980-507, where this Court held that payments made to a

corporation in reimbursement by the owner of the corporation

should be included in the corporation’s income.   Because we are

not persuaded by the evidence petitioners have presented in

support of their allegation that prior contributions were made to

T.J. Construction as reimbursements in advance, we need not reach

the question of whether such reimbursements should be included in

the corporation’s income.   We hold that the disbursements from

T.J. Construction to pay for improvements on the personal home of

petitioners and on the home occupied by petitioner’s mother are

not cost of goods sold and create additional flowthrough income

to petitioners in 1997.

Fraud Penalty

     The penalty in the case of fraud is a civil sanction

provided primarily as a safeguard for the protection of the

revenue and to reimburse the Government for the heavy expense of

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

Helvering v. Mitchell, 303 U.S. 391, 401 (1938); Sadler v.
                               - 22 -

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

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

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

year is due to fraud.    Sec. 7454(a); Rule 142(b).   If respondent

establishes that any portion of the underpayment is attributable

to fraud, the entire underpayment is treated as attributable to

fraud and subjected to a 75-percent penalty, unless the taxpayer

establishes that some part of the underpayment is not

attributable to fraud.    Sec. 6663(b).   Respondent must show that

the taxpayer intended to conceal, mislead, or otherwise prevent

the collection of taxes.    Katz v. Commissioner, 90 T.C. 1130,

1143 (1988).

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

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

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

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

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

evidence and inferences drawn from the facts because direct proof

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

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

course of conduct may establish the requisite fraudulent intent.

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

intent may be inferred from various kinds of circumstantial

evidence, or “badges of fraud”, including the consistent
                               - 23 -

understatement of income, inadequate records, implausible or

inconsistent explanations of behavior, concealing assets, and

failure to cooperate with tax authorities.      Bradford v.

Commissioner, 796 F.2d 303, 307 (9th Cir. 1986), affg. T.C. Memo.

1984-601.    Dealing in cash is also considered a “badge of fraud”

by the courts because it is indicative of a taxpayer’s attempt to

avoid scrutiny of his finances.   See id. at 308.     Whether a

taxpayer has consistently underreported income over an extended

period of time is also a relevant factor in analyzing whether the

taxpayer had a fraudulent intent in understating his tax

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

Cir. 1984), affg. T.C. Memo. 1982-603.

     Respondent’s burden regarding the underpayment of tax in

support of the fraud penalty has been met.     Petitioners have

conceded more than $450,000 in overstatements of cost of goods

sold, and we have found clear and convincing evidence, for the

reasons set forth above, that approximately $1.5 million more was

overstated by petitioners in 1997.      Those overstatements resulted

in substantial understatements of petitioners’ tax liability for

that year.

     The evidence in this case also establishes the existence of

several “badges of fraud” in petitioners’ financial dealings.

Petitioners understated their income in 1997 by approximately

$2 million, and the record shows that they understated their
                              - 24 -

income by similarly substantial amounts in at least 1996 and

1998, the years immediately before and after the year in issue.

Petitioner kept some detailed records regarding expenses, but

regularly destroyed those that recorded his cash disbursements to

Phillips.   Petitioner did not inform his accountants about the

substantial cash withdrawals and payments to Phillips, and the

records he provided to his accountants did not disclose such cash

transactions on their face.   He adopted this course after being

advised by his accountants that checks to cash would not be

deducted on returns prepared by the accountants.

     There are multiple inconsistencies and implausible

explanations of behavior in the testimony of both petitioners.

For instance, petitioner testified at one point that his profit

margin was from work performed by subcontractors other than

Phillips.   At another time, he admitted that Phillips was his

primary contractor and represented the majority of his cost of

goods sold expenditures.   When asked at his first meeting with

special agents from the IRS about why he kept hundreds of

thousands of dollars in cash on hand, petitioner claimed that he

was accumulating cash “in anticipation of the Y2K problem”, never

mentioning his cash dealings with Phillips.   At his second

interview with them, when asked what happened to the additional

$1.8 million in cash petitioners had withdrawn over the preceding
                              - 25 -

3 years, petitioner told the special agents that he had spent the

cash and mentioned Phillips for the first time.

     Mrs. Kosinski, who had worked previously as a teller at two

different banks, admitted to withdrawing personally nearly

$3 million in $9,500 cash increments on behalf of her husband

from 1995 through 1999, nearly $1 million of which was withdrawn

in 1997 alone.   Although she testified in her criminal proceeding

that she made hundreds of $9,500 withdrawals so that the bank

would not have to fill out Federal reports for cash transactions

over $10,000, Mrs. Kosinski testified in this case that she did

not know and never inquired about her husband’s purpose in

withdrawing the cash, why the money was withdrawn in $9,500

increments, or what her husband did with the money once she gave

it to him.   Mrs. Kosinski also testified that she did not know

that her husband was making substantial cash payments to

Phillips; yet she also testified that on one occasion she left a

$10,000 check payable to cash under a doormat for Phillips at her

husband’s direction.   Not only did petitioners both participate

in structuring substantial cash transactions, they both gave

inconsistent and implausible testimony regarding that issue.

     Evidence of fraud in this case also includes the substantial

number of structured cash transactions outlined above in which

petitioners regularly engaged over several years.   Petitioners

purposefully made withdrawals just below the threshold at which
                                - 26 -

financial institutions are required to report to the Government

and documented (or failed to document) their use of the cash in

such a way that not even petitioner could verify where the money

went.

     Petitioners had on hand nearly half a million dollars in

cash in their personal safe at home and in their safety deposit

boxes when criminal investigators from the IRS first interviewed

them.     Petitioner’s statements to the criminal investigators at

his first meeting with them regarding his purpose in hoarding

cash differed from those statements made at his second meeting

with them.

     Although petitioner’s conviction for subscribing false

Federal tax returns does not collaterally estop him from denying

that he fraudulently understated petitioners’ income tax

liability, his conviction is evidence of fraudulent intent.    See

Wright v. Commissioner, 84 T.C. 636, 643-644 (1985).

        Petitioners assert that any inaccuracies in their reported

tax liabilities for the relevant years are attributable primarily

to miscommunication between them and their return preparers and

accountants, Susan Pereira and Steven J. Plotnik.    Petitioners

claim that their accountants should have caught several of the

checks that were for personal expenses by looking at records,

some of which were made available to the accountants, outside of

the bank statements and check stubs of T.J. Construction.
                              - 27 -

However, petitioners’ accountants were hired by petitioners to

perform only a compilation of their accounts and prepare their

tax returns.   The evidence does not show that the accountants

could have discerned the nature of the extensive cash dealings by

petitioners if the additional documents had been reviewed.

Although petitioner’s accountants had warned him that checks must

be made payable to the actual recipients of the money, petitioner

never informed them of his cash transactions, which were

obviously designed to circumvent their advice to him.   The first

time the accountants were made aware of any cash dealings was

when approached by IRS agents investigating petitioners for

criminal tax violations.

     A taxpayer is not entitled to shift responsibility for

inaccurate returns onto his return preparer where the preparer is

not provided with complete and accurate information regarding the

taxpayer’s income and expenses.   See Korecky v. Commissioner, 781

F.2d 1566, 1569 (11th Cir. 1986), affg. per curiam T.C. Memo.

1985-63; Merritt v. Commissioner, 301 F.2d 484, 487 (5th Cir.

1962), affg. T.C. Memo. 1959-172.   The responsibility of filing

accurate returns remains principally with the taxpayer,

especially where the taxpayer has taken an active and controlling

role regarding the information that is used for the preparation

of the returns.   See Medlin v. Commissioner, T.C. Memo. 2003-224,

affd. 138 Fed. Appx. 298 (11th Cir. 2005).   Petitioners cannot
                              - 28 -

blame their return preparers for the substantial errors in

reporting their tax liability for 1997 when petitioner, who alone

possessed the information that would have indicated potential

discrepancies between petitioners’ actual tax liabilities and the

amounts reported on their returns, provided the accountants with

misleading information and documentation regarding the nature of

disbursements out of T.J. Construction.   See Bacon v.

Commissioner, T.C. Memo. 2000-257, affd. without published

opinion 275 F.3d 33 (3d Cir. 2001).    Furthermore, petitioner’s

failure to inform the accountants, despite regular meetings with

them, of the existence of the cash advances from petitioner to

Phillips or that Phillips was endorsing checks received from

T.J. Construction back to petitioner, who was then depositing

those funds in petitioners’ personal bank account, is indicative

of fraud.   See Medlin v. Commissioner, supra; Ishler v.

Commissioner, T.C. Memo. 2002-79.

     Petitioners cite McGowan v. Commissioner, T.C. Memo. 2004-

146, affd. 187 Fed. Appx. 915 (11th Cir. 2006), in support of

their contention that the errors on petitioner’s tax returns are

due to confusion between petitioner and his accountants, and not

fraudulent intent.   We have found, for the reasons stated above,

that the errors were deliberately designed by petitioner and were

coupled with several other indications of fraudulent intent.
                               - 29 -

     As outlined above, the evidence indicates the fraudulent

intent of both petitioner and Mrs. Kosinski with regard to the

overstatement of cost of goods sold and understatement of their

taxable income for 1997.   Petitioners have not proven that any

part of the underpayments was not attributable to fraud.      See

sec. 6663(b).   On consideration of the entire record, we conclude

that petitioners are liable for the fraud penalty determined

under section 6663(a).

Section 6015 Relief

     Generally, married taxpayers may elect to file a joint

Federal income tax return.   Sec. 6013(a).   After making the

election, each spouse is fully responsible for the accuracy of

the return and jointly and severally liable for the entire tax

due for that year.    Sec. 6013(d)(3); Butler v. Commissioner, 114

T.C. 276, 282 (2000).    A spouse (requesting spouse) may, however,

seek relief from joint and several liability by following

procedures established in section 6015.   Sec. 6015(a).   A

requesting spouse may seek relief from liability under section

6015(b) or, if eligible, may allocate liability according to

provisions under section 6015(c).   Sec. 6015(a).   If relief is

not available under section 6015(b) or (c), an individual may

seek equitable relief under section 6015(f).    Section 6015(f)

permits relief from joint and several liability where “it is
                              - 30 -

inequitable to hold the individual liable for any unpaid tax or

any deficiency (or any portion of either)”.

     Mrs. Kosinski seeks relief under section 6015(b) for 1997.

Section 6015(b) provides, in pertinent part, as follows:

          SEC. 6015(b). Procedures For Relief From
     Liability Applicable to All Joint Filers.--

               (1) In general.--Under procedures prescribed
          by the Secretary, if--

                     (A) a joint return has been made for a
                taxable year;

                     (B) on such return there is an
                understatement of tax attributable to
                erroneous items of 1 individual filing the
                joint return;

                     (C) the other individual filing the
                joint return establishes that in signing the
                return he or she did not know, and had no
                reason to know, that there was such
                understatement;

                     (D) taking into account all the facts
                and circumstances, it is inequitable to hold
                the other individual liable for the
                deficiency in tax for such taxable year
                attributable to such understatement; and

           *       *      *      *      *      *      *

          then the other individual shall be relieved of
          liability for tax (including interest, penalties,
          and other amounts) for such taxable year to the
          extent such liability is attributable to such
          understatement.

     The requirements of section 6015(b)(1) are stated in the

conjunctive.   Accordingly, a failure to meet any one of them

prevents a requesting spouse from qualifying for the relief
                              - 31 -

offered therein.   Alt v. Commissioner, 119 T.C. 306, 313 (2002),

affd. 101 Fed. Appx. 34 (6th Cir. 2004).

     Respondent argues that Mrs. Kosinski has failed to meet the

requirements of subparagraphs (C) and (D) of section 6015(b)(1).

Petitioners argue that Mrs. Kosinski meets the requirements of

section 6015(b)(1)(C) because she had no actual knowledge of

improper deductions taken on petitioners’ tax return and because

she did not benefit from the improper deductions “because of the

volume of income on the tax return.”    Petitioners urge the Court

to consider “how a reasonable person would react to a 1997 tax

return where $1,392,874.00 of taxable income is reported and

$521,305.00 of tax is paid, knowing that her spouse had withdrawn

large amounts of cash from the bank.”   We understand petitioners’

argument to be that Mrs. Kosinski was not capable of

understanding that excessive costs of good sold and deductions

were improperly claimed on their tax return for 1997 because

there was too much money involved overall for her to notice the

discrepancy.   Given Mrs. Kosinski’s education and employment

history, as well as her substantial and active role in the cash

structuring transactions, we are not persuaded by this argument.

     Petitioners also argue that Mrs. Kosinski was unaware of any

necessary increase in petitioners’ income due to the $21,252 of

expenses related to improvements to petitioners’ home that was

paid out of T.J. Construction’s account and deducted as business
                              - 32 -

expenses.   Petitioners make no argument with regard to section

6015(b)(1)(D) that it would be inequitable to hold Mrs. Kosinski

liable for the deficiencies in tax stated on petitioners’ 1997

joint return.

     Mrs. Kosinski is a college graduate and has previous work

experience as a bank teller for two different banks.    From 1995

through 1999, she cashed approximately $2.85 million in checks,

all in $9,500 increments, from petitioners’ personal and business

accounts.   She cashed 87 checks totaling over $800,000 during

1997.   Mrs. Kosinski testified that she did not know her

husband’s purpose for the cash withdrawn or what he did with it

once she gave it to him.   On one occasion, at her husband’s

direction, she wrote a check to cash in the amount of $10,000 and

left the check in an envelope under a doormat for Phillips.    She

testified that she never asked her husband why they were

withdrawing millions of dollars of cash in $9,500 increments from

their bank accounts.

     Mrs. Kosinski testified that she did not know that checks

from T.J. Construction’s bank account rather than from

petitioners’ personal account were written to pay for

approximately $141,000 of improvements on petitioners’ home and

the home of petitioner’s mother between 1996 and 1998.

Mrs. Kosinski was aware of the extensive improvements being made

to her home, and the majority of the invoices from Rougewood
                               - 33 -

Construction in 1997 for the home improvements were addressed to

petitioners’ personal residence.    Petitioners shared a joint

checking account for personal finances, Mrs. Kosinski’s name was

on the account, and she wrote checks on that account.    Even if

her husband was responsible for balancing their joint checking

account, as Mrs. Kosinski testified, it is implausible that

Mrs. Kosinski was not aware that the expenses for improvements to

petitioners’ home were paid out of T.J. Construction’s bank

account and not from petitioners’ personal account.

     We do not believe Mrs. Kosinski’s implausible testimony and

conclude that she was an active participant in a fraudulent

scheme to understate petitioners’ income and tax liability.      She

has not met the requirement of section 6015(b)(1)(C), nor has she

established, pursuant to section 6015(b)(1)(D), that it would be

inequitable to hold her liable for the deficiency in petitioners’

tax for 1997.

Statute of Limitations

     As a general rule, section 6501 provides that any tax must

be assessed within 3 years of the date on which the pertinent tax

return was filed.   Sec. 6501(a).   However, an exception exists in

the case of a “false or fraudulent return”, under which exception

tax may be assessed at any time.    Sec. 6501(c)(1).   Respondent

bears the burden of proving fraud in this context.     Sec. 7454(a);

Rule 142(b).    Because respondent has done so here for the reasons
                             - 34 -

explained above, assessment of petitioners’ 1997 tax liability is

not barred by the statute of limitations.

     We have considered the arguments of the parties that were

not specifically addressed in this opinion.   Those arguments are

either without merit or irrelevant to our decision.

     To reflect the foregoing,


                                        Decision will be entered

                                   under Rule 155.
