                                 T.C. Memo. 2013-3



                          UNITED STATES TAX COURT



               TYRONE MORGAN CHERRY, Petitioner v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 2561-10.                             Filed January 9, 2013.



      Tyrone Morgan Cherry, pro se.

      Nancy L. Karsh and Michael S. Kramarz, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


      HALPERN, Judge: By notice of deficiency (notice), respondent determined

deficiencies in petitioner's Federal income tax, additions to tax, and accuracy-related

penalties as follows:
                                            -2-

             [*2]                      Addition to tax             Penalty
             Year     Deficiency       sec. 6651(a)(1)           sec. 6662(a)
             2003       $6,143              $1,965                  $1,229
             2004       24,275               6,733                   4,855
             2005        6,771               1,693                   1,354

       The issues for decision are whether petitioner (1) underreported his income,

(2) is liable for additions to tax for failure to timely file, and (3) is liable for the

accuracy-related penalties.1

       Unless otherwise indicated, all section references are to the Internal Revenue

Code in effect for the years in issue, and all Rule references are to the Tax Court

Rules of Practice and Procedure. All dollar amounts have been rounded to the

nearest dollar.

                                  FINDINGS OF FACT

Background

       Petitioner resided in Florida at the time he filed the petition. He is a cash

method taxpayer who makes his return on the basis of a calendar year.


       1
        The deficiencies also reflect computational adjustments based on the
phaseout of itemized deductions under sec. 68(a) for 2003 and 2004 and the
phaseout of the personal exemption under sec. 151(d)(3) for 2004, all of which
derive from the principal adjustments and are not in dispute. We expect these
computational adjustments to be revised in the Rule 155 computation in accordance
with this report.
                                         -3-

[*3] Designer Gallery is a furniture store in Wellington, Florida. During the years

in issue, petitioner was employed there as a sales manager. His duties included

selling furniture, receiving payments therefor, and installing furniture purchased in

the store in customers' homes.

      During the years in issue, petitioner was married to Melina Kampanarou

Cherry. Ms. Cherry was unemployed during 2003 and was self-employed as a

personal trainer during 2004 and 2005. Ms. Cherry never worked for Designer

Gallery or any other furniture store.

      On March 24, 2005, petitioner was arrested and charged with grand theft and

the fraudulent use of other person's personal identification (credit card) information.

He pleaded guilty to those charges and was incarcerated from March 24, 2005, to

mid-December 2006. Petitioner's 2005 gain from his credit-card-related criminal

activity was $17,863. As part of the plea agreement, petitioner was ordered to

make restitution payments in that amount. Petitioner did not make any restitution

payments in 2005.

Petitioner's Returns

      Petitioner obtained extensions of time to file his 2003, 2004, and 2005

Federal income tax returns until October 15, 2004, 2005, and 2006, respectively.
                                          -4-

[*4] The Internal Revenue Service (IRS) received those returns on April 17, 2007.

On each return, petitioner elected the filing status "Married filing separately".

IRS Investigation

      Stanley Lottman is a revenue agent employed by respondent. In March 2005,

after he read a newspaper account of petitioner's arrest for theft, he began an

investigation of petitioner's Federal income tax compliance. He looked first at

petitioner's filing history and discovered that petitioner had not filed a Federal

income tax return for 2003. He then contacted the Palm Beach sheriff's office,

which provided him with a copy of petitioner's arrest report and with bank records

that the office had obtained during its investigation of petitioner. The arrest report

showed thefts of items worth approximately $17,000. Working with the bank

records that he had obtained, Mr. Lottman identified three bank accounts that he

believed were associated with petitioner: (1) a personal checking account at

Wachovia Bank, account number ending in 1614 (personal account); (2) a joint

checking account of petitioner and Ms. Cherry's at Washington Mutual Bank,

account number ending in 8236 (joint account); and (3) a business checking account

opened by Ms. Cherry at Wachovia Bank in the name "The Design Gallery",

account number ending in 1579 (Design Gallery account). Mr. Lottman obtained

additional information from the banks with respect to those accounts.
                                         -5-

[*5] Design Gallery Account

      The Design Gallery account was opened in September 2003 by Ms. Cherry,

who signed the account application as president of "The Design Gallery". She

opened the account at the direction of petitioner, who had explained to her that he

was partnering with the owner of Designer Gallery, they were doing some extra

business, and it would be good for her have a business account in her name in order

to build up her credit history. Between September 10, 2003, and March 14, 2005,

petitioner (or, on three occasions, Ms. Cherry, on his behalf) deposited 123 checks

into the Design Gallery account. Petitioner obtained all of those checks from

customers of Designer Gallery, who had given him the checks in payment for

furniture or other items purchased from the store. Wachovia Bank issued a debit

card associated with the Design Gallery account (Design Gallery debit card).

Petitioner had sole possession of the card, and he regularly used it to make

purchases for himself. In April 2005, after petitioner was arrested, Ms. Cherry

closed the Design Gallery account. She did so at petitioner's direction, and, also at

his direction, she used the funds withdrawn from the closed account to pay

petitioner's criminal attorney, their home mortgage, and other expenses.
                                          -6-

[*6] Respondent's Adjustments

      Mr. Lottman continued his investigation of petitioner until and after April

2007 when the IRS received (and filed) petitioner's 2003-05 returns. In part on the

basis of his examination of bank records for the personal, joint, and Design Gallery

accounts, Mr. Lottman concluded that petitioner had on those returns underreported

his income. He believed petitioner to have sufficient dominion and control over the

Design Gallery account that he should be considered its owner. He believed that the

funds deposited to the account represented petitioner's unreported income. To

determine the amounts of income that petitioner had each year deposited into those

accounts and not reported, he employed a bank deposits analysis pursuant to which

he (1) identified the year's total deposits into each account, (2) determined which of

those deposits were taxable and which were not (e.g., transfers between accounts of

amounts already taken into account), (3) subtracted from the year's total taxable

deposits the gross income petitioner reported on that year's return, and (4)

concluded that the difference was unreported gross income. He further determined

that, for 2005, petitioner had failed to report the $17,863 that, for that year,

petitioner had obtained from his credit-card-related criminal activity.
                                         -7-

[*7] Following a review of Mr. Lottman's adjustments to petitioner's 2003-05

income by respondent's Appeals Office, respondent issued the notice, which, among

other things, increased petitioner's income by $32,668, $96,854, and $41,310 for

2003, 2004, and 2005, respectively.2

                                       OPINION

I.    Unreported Income

      Petitioner gained $17,863 in 2005 from his credit-card-related criminal

activity that he did not report on his 2005 return. Petitioner concedes that the

$17,863 constitutes gross income, and we agree. See, e.g., Collins v.

Commissioner, 3 F.3d 625 (2d Cir. 1993) (gross income from theft from employer

of off-track betting tickets), aff'g T.C. Memo. 1992-478; sec. 61(a). Since

petitioner did not report the $17,863 on his 2005 return, respondent was correct in

increasing petitioner's 2005 gross income by that amount. Petitioner claims that

he made restitution in that amount in 2008. Whether he did or did not, he has

failed to show that he is entitled to a deduction for any such payment for 2005.

See Ianniello v. Commissioner, 98 T.C. 165, 174 (1992); Mannette v.



      2
        Respondent has made certain concessions with respect to the amount of
petitioner's 2005 unreported income, which the parties can take into account in the
computation to be made pursuant to Rule 155.
                                         -8-

[*8] Commissioner, 69 T.C. 990, 992 (1978) (embezzlers generally prohibited from

carrying back losses arising from repayment of embezzled funds).

      Petitioner does not disagree with certain aspects of respondent's bank

deposits analysis. He does not disagree with respondent's determinations of the

amounts of the deposits to the personal, joint, and Design Gallery accounts. He

argues, however, that he "did not open, control, or have access [to] or dominion

[over]" the Design Gallery account and that he did not fail to report any income for

any of the years in issue "because he did not receive income from the [Design

Gallery] account." He also objects to respondent's classification of three 2004 cash

deposits ($2,000, $3,800, and $8,000) into the joint account as taxable deposits. He

claims the three deposits were nontaxable loans.

      Petitioner was not a credible witness. Ms. Cherry was. On the basis of her

testimony, we have found that she opened the Design Gallery account at his

direction, that he regularly deposited checks into the account, that he obtained those

checks from Designer Gallery's customers, that he had sole possession of the Design

Gallery credit card, which he regularly used to make purchases for himself, and that,

on liquidation of the account, Ms. Cherry used the proceeds in part to pay his

criminal defense expenses and their joint expenses. We believe that petitioner used

the money in the Design Gallery account for personal purposes and, by doing
                                         -9-

[*9] so, demonstrated his dominion and control over the account. For tax purposes,

therefore, he must be considered owner of the account. As we put it in Tandon v.

Commissioner, T.C. Memo. 1998-66, aff'd without published opinion, 210 F.3d 372

(6th Cir. 2000):

            Unless the nontaxable nature of deposits is established, gross
      income includes deposits to bank accounts where the taxpayer has
      dominion and control of the funds. See Commissioner v. Glenshaw
      Glass Co., 348 U.S. 426, 431 (1955); Davis v. United States, 226 F.2d
      331, 334-335 (6th Cir. 1955); see also Manzoli v. Commissioner, T.C.
      Memo. 1988-299, affd. 904 F.2d 101 (1st Cir. 1990). The use of
      money for personal purposes is an indication of dominion and control.
      Woods v. Commissioner, T.C. Memo. 1989-611, affd. without
      published opinion 929 F.2d 702 (6th Cir. 1991).

      While unexplained bank deposits are ordinarily sufficient evidence of

unreported income, Tokarski v. Commissioner, 87 T.C. 74, 77 (1986) ("A bank

deposit is prima facie evidence of income and respondent need not prove a likely

source of that income."), here we have evidence that the Design Gallery account

served as the depository of funds that, it appears, petitioner embezzled from his

employer, Designer Gallery. Embezzled funds constitute gross income. See

James v. United States, 366 U.S. 213 (1961). Petitioner's only defense to

respondent's bank deposits analysis imputing to him unreported income from the

Design Gallery account is that the Design Gallery account was not his; i.e., he had

nothing to do with it. Petitioner's statement is not credible, and, not believing him,
                                          - 10 -

[*10] we find that respondent's bank deposits analysis establishes petitioner's gross

income from unexplained deposits into the Design Gallery account.

      With respect to respondent's classifying three 2004 cash deposits to the joint

account as taxable deposits, petitioner does not contest his receipt of those amounts,

claiming only that the amounts deposited were nontaxable proceeds of loans.

Petitioner bears the burden of proving that respondent's determinations of income

using the bank deposits method are erroneous. See Clayton v. Commissioner, 102

T.C. 632, 645 (1994); Mistlebauer v. Commissioner, T.C. Memo. 2012-186, 2012

WL 2608410, at *3. Petitioner may satisfy that burden by establishing that the

deposits that remain at issue are derived from a nontaxable source. See Nicholas v.

Commissioner, 70 T.C. 1057, 1064 (1978). We reiterate that, in general, we did not

find petitioner credible. He produced no documents substantiating his claim that the

deposits were the proceeds of loans. Nor did he present testimony from the family

or friends from whom the alleged loans originated. Petitioner claims in his brief that

he provided "sworn affidavits to the IRS auditing agent in 2007 and again during

trial", but the record contains no such affidavits. Petitioner has failed to carry his

burden of proving that the deposits at issue were from nontaxable sources, and we

sustain respondent's classification of those deposits into the joint account as taxable

deposits.
                                         - 11 -

[*11] We thus sustain respondent's adjustments increasing petitioner's gross income

for each of the years in issue.

II.   Section 6651(a)(1) Additions to Tax

      Section 6651(a)(1) provides for an addition to tax in the event a taxpayer fails

to file a timely return (determined with regard to any extension of time for filing)

unless the taxpayer shows that such failure is due to reasonable cause and not due to

willful neglect. The amount of the addition is equal to 5% of the amount required to

be shown as tax on the delinquent return for each month or fraction thereof during

which the return remains delinquent, up to a maximum addition of 25% for returns

more than four months delinquent. Id. The Commissioner bears the burden of

production with respect to the liability of any individual for any penalty or addition

to tax. Sec. 7491(c). His burden is to show that imposition of the penalty or

addition to tax is appropriate. Higbee v. Commissioner, 116 T.C. 438, 446 (2001).

If he carries that burden, the taxpayer must come forward with evidence sufficient to

persuade us that imposition of the penalty or addition to tax is incorrect (e.g.,

because of the existence of reasonable cause and the absence of willful neglect).

See id. at 447.

      After extensions, petitioner's Federal income tax returns for 2003, 2004, and

2005 were due by October 15, 2004, 2005, and 2006, respectively. The parties
                                         - 12 -

[*12] stipulated that respondent received petitioner's returns for all three years on

April 17, 2007. Thus, there is sufficient evidence to find, and we do find, that it was

appropriate for respondent to impose on petitioner a section 6651(a)(1) addition to

tax for untimely filing for each year. To avoid the addition to tax, petitioner must

come forward with evidence of reasonable cause and the absence of willful neglect.

See Higbee v. Commissioner, 116 T.C. at 447-448.

      Petitioner contends that he should not be liable for the additions to tax

because he had an "unavoidable absence" because of his incarceration. The mere

fact that petitioner was incarcerated at the time his return was due does not

constitute reasonable cause for his failure to timely file. See, e.g., Mendes v.

Commissioner, 121 T.C. 308, 321 (2003). Nor is the unavailability of records

generally reasonable cause for failure to file a timely return. E.g., Thrower v.

Commissioner, T.C. Memo. 2003-139, 2003 WL 21107675, at *5.

      Petitioner's incarceration began on March 24, 2005. Petitioner was not

incarcerated until after the extended due date for his 2003 return. For all years,

moreover, petitioner has failed to show that his untimely filing was due to

reasonable cause and the absence of willful neglect. We sustain respondent's

determination of additions to tax under section 6651(a)(1) for all years.
                                         - 13 -

[*13] III.   Section 6662(a) Penalty

       Section 6662(a) and (b)(1) provides for an accuracy-related penalty (penalty)

of 20% of the portion of any underpayment attributable to, among other things,

negligence or intentional disregard of rules or regulations.

       Negligence has been defined as a lack of due care or failure to do what a

reasonably prudent person would do under like circumstances. E.g., Hofstetter v.

Commissioner, 98 T.C. 695, 704 (1992). It also "includes any failure to make a

reasonable attempt to comply with the provisions of the internal revenue laws or to

exercise ordinary and reasonable care in the preparation of a tax return." Sec.

1.6662-3(b)(1), Income Tax Regs.

       Section 6664(c)(1) provides that the penalty shall not be imposed with

respect to any portion of an underpayment if the taxpayer shows that there was

reasonable cause for, and that he acted in good faith with respect to, that portion.

       Section 1.6664-4(b)(1), Income Tax Regs., provides:

       The determination of whether a taxpayer acted with reasonable cause
       and in good faith is made on a case-by-case basis, taking into account
       all pertinent facts and circumstances. * * * Generally, the most
       important factor is the extent of the taxpayer's effort to assess the
       taxpayer's proper tax liability. Circumstances that may indicate
       reasonable cause and good faith include an honest misunderstanding of
       * * * law that is reasonable in light of all of the facts and
       circumstances, including the experience, knowledge, and education of
       the taxpayer. * * *
                                          - 14 -

[*14] Respondent bears the burden of production with respect to the penalty. See

sec. 7491(c). The burden imposed by section 7491(c) is "only to come forward with

evidence regarding the appropriateness of applying a particular addition to tax or

penalty to the taxpayer." Good v. Commissioner, T.C. Memo. 2008-245, 2008 WL

4756483, at *9. Once that burden is met, petitioner bears the burden of proving that

he is entitled to relief under section 6664(c)(1). See Higbee v. Commissioner, 116

T.C. at 446.

      By demonstrating petitioner's failure to report as income the funds in the

Design Gallery account and the stolen merchandise, respondent has met his burden

of production. To avoid the penalty, petitioner must come forward with evidence

that he acted with reasonable cause and in good faith.

      Petitioner asserts that he did not understate his income because the money in

the Design Gallery account and the alleged loans were not income. For the reasons

discussed supra, petitioner's argument fails. Petitioner further argues that he acted

with reasonable cause and in good faith but was simply unaware that stolen

merchandise constitutes income. Petitioner fails to show, however, that he made

any effort to comply with the internal revenue laws or to assess his proper tax

liability with respect to that item. See sec. 1.6664-4(b)(1), Income Tax Regs.

Petitioner has failed to carry his burden of showing that he is entitled to relief
                                           - 15 -

[*15] under section 6664(c)(1). Therefore, we sustain respondent's imposition of

section 6662(a) penalties for all years.

IV.   Conclusion

      Petitioner is liable for the deficiencies, additions to tax, and penalties as

determined herein.


                                                          Decision will be entered under

                                                    Rule 155.
