                                              MARK W. MAY AND CYNTHIA R. MAY, PETITIONERS v.
                                                   COMMISSIONER OF INTERNAL REVENUE,
                                                              RESPONDENT

                                                CYNTHIA R. MAY, PETITIONER, AND MARK W. MAY,
                                                  INTERVENOR v. COMMISSIONER OF INTERNAL
                                                            REVENUE, RESPONDENT
                                                Docket Nos. 14385–05, 4782–07.                        Filed October 24, 2011.

                                                   P–H’s corporation reduced P–H’s paycheck by amounts that
                                                were not remitted to the Government. R determined fraud
                                                penalties and disallowed deductions for State and local income
                                                taxes. Ps claim this Court does not have jurisdiction to
                                                redetermine underpayments, that no underpayments exist,
                                                that P–H is not liable for fraud penalties, and that the deduc-
                                                tions for State and local taxes are proper. Held: This Court
                                                has jurisdiction to redetermine the applicability of sec. 6663,
                                                I.R.C., penalties for fraud resulting from overstated with-
                                                holding tax credits. Held, further, an ‘‘underpayment’’ includes
                                                a taxpayer’s overstated credits for withholding under the rule
                                                in Feller v. Commissioner, 135 T.C. 497 (2010). Held, further,
                                                sec. 1.31–1(a), Income Tax Regs., is inapplicable because
                                                funds due to the Government were not actually withheld from
                                                P–H’s wages. This is a matter of first impression for this
                                                Court, and we adopt the test applied in United States v. Blan-
                                                chard, 618 F.3d 562 (6th Cir. 2010). Held, further, P–H is
                                                liable for fraud penalties under sec. 6663, I.R.C. Held, further,
                                                Ps are entitled to a partial deduction for local income taxes
                                                paid.

                                           Mark W. May and Cynthia R. May, pro sese.
                                           Edward Lee Walter, for respondent.
                                         GOEKE, Judge: Respondent determined deficiencies in peti-
                                      tioners’ 1994, 1995, and 1996 joint Federal income taxes of
                                      $7,659, $10,389, and $8,771, respectively, as a result of
                                                                                                                                  147




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                                      unpaid State and local income taxes deducted on petitioners’
                                      returns. Respondent also determined penalties for fraud
                                      under section 6663 1 for 1994, 1995, and 1996 against Mark
                                      May (Mr. May) of $84,957.75, $89,748.75, and $70,160.25,
                                      respectively, resulting from the deficiencies and overstated
                                      credits for taxes withheld from wages. Respondent separately
                                      determined that Cynthia May (Mrs. May) is not entitled to
                                      relief under section 6015 from joint and several liability for
                                      the years at issue. The cases were then consolidated for trial.
                                      After trial respondent conceded that Mrs. May is entitled to
                                      relief under section 6015(b) for the years at issue, resolving
                                      all issues pertaining to her. After this concession, the issues
                                      remaining for decision are:
                                         (1) Whether the Court has jurisdiction to redetermine the
                                      underpayments for purposes of calculating the section 6663
                                      fraud penalties when a portion of the underpayment for each
                                      taxable year resulted from overstated credits for taxes with-
                                      held from wages. We hold that the Court does have jurisdic-
                                      tion to determine the correct amounts of the underpayments
                                      and corresponding penalties;
                                         (2) whether Mr. May is liable for the section 6663 fraud
                                      penalties for the taxable years at issue with respect to the
                                      claimed withholding tax credits. We hold that Mr. May is so
                                      liable; and
                                         (3) whether Mr. May is liable for the deficiencies resulting
                                      from disallowed deductions for State and local income taxes
                                      paid and for section 6663 fraud penalties with respect to
                                      such deficiencies. We hold that Mr. May is liable for the defi-
                                      ciencies in part and for section 6663 fraud penalties with
                                      respect to the remaining deficiencies.
                                                                          FINDINGS OF FACT

                                         Some of the facts have been stipulated and are so found.
                                      At the time the petition was filed, Mr. May was incarcerated
                                      in Kentucky; Mrs. May resided in Ohio.
                                         During 1994, 1995, and 1996 Mr. May was an employee,
                                      officer, and shareholder of Maranatha Financial Group, Inc.
                                      (Maranatha), a corporation with approximately 100
                                      employees. Mr. May was also Maranatha’s president and
                                        1 Unless otherwise indicated, all section references are to the Internal Revenue Code (Code)

                                      in effect for the years in issue, and all Rule references are to the Tax Court Rules of Practice
                                      and Procedure.




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                                      (147)                            MAY v. COMMISSIONER                                        149


                                      CEO.  Mr. May received a biweekly paycheck and pay stub
                                      issued by a payroll service provider, Paychex, for his services
                                      to Maranatha. The pay stubs reflected biweekly gross pay of
                                      $10,000 per pay period. After withholdings for Federal, State,
                                      local, and FICA taxes, Mr. May’s net paycheck was in the
                                      range of $6,500 per pay period.
                                         During the years at issue Mr. May fully controlled the
                                      finances of Maranatha. Mr. May had sole check signature
                                      authority on Maranatha’s corporate bank account and was
                                      the sole signatory on payroll checks issued by Paychex on
                                      Maranatha’s behalf. Mr. May did not sign the paychecks
                                      manually, but an electronic facsimile of his signature
                                      appeared on all paychecks.
                                         During the years at issue Maranatha withheld all proper
                                      taxes from employee paychecks (including Mr. May’s) but
                                      failed to remit these withholdings to Federal, State, or local
                                      tax authorities. Maranatha used at least a portion of the
                                      unremitted funds to continue operation of the business,
                                      which included paying Mr. May an annual salary of
                                      $260,000. Mr. May was admittedly the person responsible for
                                      remittance of these withholdings and was aware of the
                                      failure to remit them. Mr. May was also responsible for filing
                                      Maranatha’s Forms 941, Employer’s Quarterly Federal Tax
                                      Return, but failed to file those forms for the taxable years in
                                      issue until early 1997. Because he was the responsible
                                      officer, all unremitted withholdings were later assessed
                                      against Mr. May under section 6672.
                                         Petitioners timely filed joint Federal income tax returns
                                      with the Internal Revenue Service (IRS) for the taxable years
                                      1994, 1995, and 1996. Attached to each tax return was Mr.
                                      May’s Form W–2, Wage and Tax Statement, issued by
                                      Paychex. Petitioners claimed withholding credits each year
                                      resulting from amounts withheld from Mr. May’s paychecks
                                      for Federal taxes. Petitioners also claimed deductions each
                                      year for State income taxes paid through withholdings. Peti-
                                      tioners also claimed deductions in 1995 and 1996 for local
                                      taxes paid. Petitioners testified that they paid local income
                                      taxes by personal check during 1995 and 1996 and produced
                                      a copy of a single canceled check issued to and endorsed by
                                      the city of Xenia, Ohio, for $2,550 in April 1997.
                                         On April 9, 2002, Mr. May was indicted on two counts of
                                      Federal income tax evasion, as well as four counts of willful




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                                      failure to account for and pay over payroll taxes while
                                      working for Maranatha. The U.S. District Court for the
                                      Southern District of Ohio found Mr. May guilty on all six
                                      counts. On appeal, the U.S. Court of Appeals for the Sixth
                                      Circuit affirmed the conviction but vacated the sentence and
                                      remanded the case for resentencing. After resentencing, Mr.
                                      May appealed the District Court’s resentencing to the Court
                                      of Appeals for the Sixth Circuit, which again vacated the sen-
                                      tence and remanded with a directed order of restitution. This
                                      second appeal did not address or disturb the underlying
                                      conviction.
                                         Evidence at the criminal trial established that Mr. May
                                      had used funds in the corporate account for personal
                                      expenditures. However, no such evidence was presented in
                                      these cases.
                                         On May 4, 2005, respondent issued a notice of deficiency
                                      to petitioners for tax years 1994, 1995, and 1996. Petitioners
                                      timely filed a petition for redetermination of the deficiencies
                                      and penalties.
                                                                                  OPINION

                                      I. Jurisdiction To Redetermine Section 6663 Fraud Penalties
                                         Resulting From Overstated Credits for Taxes Withheld
                                         From Wages
                                         The jurisdiction of this Court is limited by statute and
                                      attaches only upon the issuance of a valid notice of deficiency
                                      and the timely filing of a petition. Pietanza v. Commissioner,
                                      92 T.C. 729, 735 (1989), affd. without published opinion 935
                                      F.2d 1282 (3d Cir. 1991). In these cases, the notice of defi-
                                      ciency determined a deficiency relating to disallowed deduc-
                                      tions for State and local income taxes, as well as section 6663
                                      fraud penalties applied to the deficiencies and underpay-
                                      ments resulting from overstated credits for tax withholding.
                                      Petitioners argue that this Court does not have jurisdiction
                                      over any aspect of these cases involving the overstated with-
                                      holding credits because they do not meet the statutory defini-
                                      tion of a tax deficiency so as to form the basis for a valid
                                      notice of deficiency.
                                         This Court has previously addressed this issue in Rice v.
                                      Commissioner, T.C. Memo. 1999–65. Rice involved overstated
                                      withholding credits which resulted in a section 6663 fraud




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                                      (147)                            MAY v. COMMISSIONER                                        151


                                      penalty but no deficiency. In holding that this Court had
                                      jurisdiction to redetermine fraud penalties, including the
                                      effect of the overstated withholding credits on the amount of
                                      the penalty, the Court stated:
                                         Section 6665 provides that ‘‘additions to the tax, additional amounts,
                                      and penalties * * * shall be paid upon notice and demand and shall be
                                      assessed, collected, and paid in the same manner as taxes’’. A deficiency
                                      in tax is assessed, collected, and paid only after respondent makes a deter-
                                      mination and sends a notice of that determination in accordance with sec-
                                      tion 6213, which provides for the jurisdiction of this Court. Eck v. Commis-
                                      sioner, 16 T.C. 511, 515 (1951), affd. per curiam 202 F.2d 750 (2d Cir.
                                      1953). Thus, respondent, in sending a notice determining petitioner was
                                      liable for a section 6663 penalty, was complying with the law that requires
                                      him to proceed in the same manner as if there were a deficiency. ‘‘The
                                      statute was intended to mean * * * that where such a notice was sent,
                                      the Tax Court has jurisdiction.’’ Accordingly, a statutory notice from
                                      respondent, in which no deficiency is determined, advising the taxpayer
                                      that a penalty for fraud is due, is a valid basis for jurisdiction to this
                                      Court. [Id.; emphasis added.]

                                      Applying this logic, we find that this Court has jurisdiction
                                      to the extent necessary to redetermine whether any section
                                      6663 fraud penalties are applicable.
                                      II. Fraud With Respect to Overstated Withholding Credits
                                        Respondent has the burden of proving fraud by clear and
                                      convincing evidence. See sec. 7454(a); Rule 142(b). To satisfy
                                      the burden of proof, respondent must show by clear and con-
                                      vincing evidence: (1) An underpayment of tax exists for each
                                      year; and (2) Mr. May intended to evade taxes known to be
                                      owing by conduct intended to conceal, mislead, or otherwise
                                      prevent the collection of taxes. See Sadler v. Commissioner,
                                      113 T.C. 99, 102 (1999); Parks v. Commissioner, 94 T.C. 654,
                                      660–661 (1990).
                                           A. Underpayment of Tax
                                        Petitioners argue that there is no underpayment of tax in
                                      these cases and that without an underpayment respondent
                                      cannot properly determine a fraud penalty under section
                                      6663.
                                        Section 6664(a) defines an ‘‘underpayment’’ as:
                                      the amount by which any tax imposed by this title exceeds the excess of—
                                        (1) the sum of—




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                                             (A) the amount shown as the tax by the taxpayer on his return, plus
                                             (B) amounts not so shown previously assessed (or collected without
                                           assessment), over
                                           (2) the amount of rebates made.

                                        Section 1.6664–2(c)(1)(i) and (ii), Income Tax Regs., pro-
                                      vides that in making the above computation ‘‘the ‘amount
                                      shown as the tax by the taxpayer on his return’ ’’ is reduced
                                      by the excess of:
                                        (i) The amounts shown by the taxpayer on his return as credits for tax
                                      withheld under section 31 (relating to tax withheld on wages) * * * over
                                        (ii) The amounts actually withheld, actually paid as estimated tax, or
                                      actually paid with respect to a taxable year before the return is filed for
                                      such taxable year.

                                      This regulation encompasses the situation in which a tax-
                                      payer overstates the credit for withholding. See also sec.
                                      1.6664–2(g), Example (3), Income Tax Regs. Accordingly, if a
                                      taxpayer overstates prepayment credits, such as the credit
                                      for wages withheld, the overstatement decreases taxes due as
                                      shown on the return and increases the underpayment of tax.
                                      Rice v. Commissioner, supra.
                                         Petitioners first argue that no underpayment exists
                                      because the disallowed withholding credits do not meet the
                                      definition of an underpayment under section 6664, taking
                                      into account the provisions of section 6211. However, we
                                      have found that ‘‘restrictions in section 6211(b)(1), excluding
                                      estimated tax and withholding credits from the calculation of
                                      a deficiency, no longer apply to an underpayment’’. Feller v.
                                      Commissioner, 135 T.C. 497, 507–508 (2010). The Court in
                                      Feller also found that section 1.6664–2(c)(1), Income Tax
                                      Regs., validly interprets the definition of ‘‘underpayment’’ in
                                      section 6664 and therefore extends the meaning of ‘‘under-
                                      payment’’ to include a taxpayer’s overstated credits for with-
                                      holding. Id. at 503, 510–511; sec. 1.6664–2(g), Example (3),
                                      Income Tax Regs. As a result, we reject petitioners’ first
                                      argument.
                                         Petitioners next argue that no underpayment exists
                                      because taxes were actually withheld from Mr. May’s pay-
                                      checks and petitioners are entitled to the withholding credits
                                      even though the tax withholdings were not paid to the
                                      Government. In support of their position, petitioners cite sec-
                                      tion 1.31–1(a), Income Tax Regs., which states in part that




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                                      ‘‘If the tax has actually been withheld at the source, credit
                                      or refund shall be made to the recipient of the income even
                                      though such tax has not been paid over to the Government
                                      by the employer.’’
                                          In United States v. Blanchard, 618 F.3d 562, 576 (6th Cir.
                                      2010), the defendant owned and operated his business and
                                      withheld taxes from his own paychecks but failed to remit
                                      those withholdings to the Government. In affirming the
                                      defendant’s conviction under 18 U.S.C. sec. 287 for making
                                      a false claim for a tax refund with regard to his personal
                                      taxes, the court stated:
                                      Rather than creating an overly formalistic division between the personal
                                      and official capacities of an individual operating as both employer and
                                      employee, which would permit the corporate form to serve as a shield to
                                      individual liability, we find it more consonant with the purposes of § 287
                                      to conduct a functional inquiry into whether funds due the government left
                                      the defendant’s control and so may be deemed ‘‘actually withheld’’ from his
                                      wages. * * * [Id.]

                                         We agree with the Court of Appeals for the Sixth Circuit
                                      that the proper test to determine whether actual withholding
                                      at the source occurred should consider whether the funds
                                      functionally left the control of a taxpayer. Such a test should
                                      not be strictly constrained by the multiple identities one per-
                                      son may have when acting in both a personal and a corporate
                                      capacity.
                                         In applying the test, we look to the facts of the case. Mr.
                                      May was not only a shareholder, employee, and officer of
                                      Maranatha; he was also president and CEO. He was the per-
                                      son responsible for Maranatha’s failure to remit tax
                                      withholdings (including his own) to the Government and
                                      knew that those withholdings were not being remitted. Mr.
                                      May had sole check signature authority on Maranatha’s cor-
                                      porate bank account, giving him full control of its finances.
                                      Even though he was technically subject to tax withholding,
                                      we believe Mr. May is more analogous to a person filing a
                                      completely falsified Form W–2, given his knowledge and
                                      participation in failing to remit the withholdings.
                                         The fact that control of the funds shifted from Mr. May’s
                                      personal/employee identity to his corporate/employer identity
                                      is of no consequence. Mr. May was entrusted with the with-
                                      held funds and misappropriated them back to the corporate




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                                      account which he controlled, using them to continue oper-
                                      ation of the corporation in which he had an equity stake and
                                      which paid him an annual salary of $260,000. At all times
                                      during and after this act of misappropriation Mr. May deter-
                                      mined how those funds would be used. Because Mr. May was
                                      responsible for the nonremittance and fully controlled the
                                      corporate finances, we conclude that the funds never left Mr.
                                      May’s functional control and were therefore not ‘‘actually
                                      withheld at the source’’ from his wages for purposes of sec-
                                      tion 1.31–1(a), Income Tax Regs. Section 1.31–1(a), Income
                                      Tax Regs., is therefore inapplicable, and petitioners’ reliance
                                      on it is misplaced.
                                         When a taxpayer has overstated credits for tax
                                      withholdings, ‘‘the overstatement decreases the amount
                                      shown as the tax by the taxpayer on his return and increases
                                      the underpayment of tax.’’ Sadler v. Commissioner, 113 T.C.
                                      at 103; see also sec. 1.6664–2(g), Example (3), Income Tax
                                      Regs. The facts here establish petitioners’ liability for the
                                      underpayments determined by respondent with respect to
                                      such withholdings. As a result, we hold that petitioners have
                                      underpayments of taxes of $105,618, $109,276, and $84,776
                                      for years 1994, 1995, and 1996, respectively.
                                           B. Fraudulent Intent
                                        Respondent must prove by clear and convincing evidence
                                      that a portion of the underpayment for each taxable year in
                                      issue was due to Mr. May’s fraud. See Profl. Servs. v.
                                      Commissioner, 79 T.C. 888, 930 (1982). Once respondent
                                      establishes that any portion of an underpayment is attrib-
                                      utable to fraud, the entire underpayment is subject to the 75-
                                      percent penalty, except with respect to any portion of the
                                      underpayment that petitioners establish is not attributable
                                      to fraud. See sec. 6663(a) and (b). The existence of fraud is
                                      a question of fact to be resolved upon consideration of the
                                      entire record. See King’s Court Mobile Home Park, Inc. v.
                                      Commissioner, 98 T.C. 511, 516 (1992). Mr. May’s entire
                                      course of conduct may establish the requisite fraudulent
                                      intent. See Stone v. Commissioner, 56 T.C. 213, 223–224
                                      (1971).
                                        Mr. May was responsible for Maranatha’s failure to remit
                                      employee tax withholdings, including his own. In spite of his




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                                      admitted knowledge and orchestration of Maranatha’s failure
                                      to remit those withholdings, Mr. May chose to claim credits
                                      for the unremitted withholdings on his personal income tax
                                      returns. Mr. May was later convicted of tax evasion with
                                      respect to his personal income taxes and willful failure to
                                      account for and pay over payroll taxes while working for
                                      Maranatha.
                                        We conclude that respondent has proved by clear and con-
                                      vincing evidence that petitioners fraudulently underpaid tax
                                      for each of the years at issue with respect to the withholding
                                      credits. Accordingly, we hold that the 75-percent fraud pen-
                                      alty is justified with respect to the underpayments resulting
                                      from overstated withholding credits for the years at issue.
                                      III. Deficiencies Resulting From Disallowed Deductions for
                                           State and Local Income Taxes Paid and Fraud With
                                           Respect to any Such Deficiencies
                                         The Commissioner’s determinations in the notice of defi-
                                      ciency are presumed correct, and the taxpayer bears the bur-
                                      den of proving that they are incorrect. See Rule 142(a); Welch
                                      v. Helvering, 290 U.S. 111, 115 (1933). However, the
                                      Commissioner has the burden of proving fraud by clear and
                                      convincing evidence. See sec. 7454(a); Rule 142(b). To satisfy
                                      the burden of proof for fraud, the Commissioner must show
                                      by clear and convincing evidence: (1) An underpayment of tax
                                      exists; and (2) the taxpayer intended to evade taxes known
                                      to be owing by conduct intended to conceal, mislead, or other-
                                      wise prevent the collection of taxes. See Sadler v. Commis-
                                      sioner, supra at 102; Parks v. Commissioner, 94 T.C. at 660–
                                      661.
                                         Petitioners make several claims with regard to the unpaid
                                      State and local income taxes deducted on their Federal tax
                                      returns for the years at issue. Petitioners’ first claim is that
                                      because the State income tax amounts were withheld by
                                      Maranatha from Mr. May’s personal paycheck they are enti-
                                      tled to the deduction, even though Maranatha failed to pay
                                      over the amounts to State tax authorities. Petitioners’ second
                                      claim is that if their first claim fails, the State income tax
                                      amounts withheld should never have been included in peti-
                                      tioners’ gross income, as they never received these withheld
                                      amounts. This would result in petitioners’ being entitled to




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                                      an offsetting deduction equal to the disallowed State income
                                      tax deduction with no corresponding deficiency. Petitioners’
                                      third claim is that they paid all local income taxes owed for
                                      the years at issue. Petitioners’ final claim is that the period
                                      of limitations has expired because respondent has not proven
                                      that the deficiencies are a result of fraud. We shall address
                                      each claim in turn.
                                           A. Whether Petitioners Are Entitled to the Deductions as a
                                              Result of the Withholdings
                                        Petitioners claim that the amounts withheld from Mr.
                                      May’s paycheck for State income taxes entitle them to Fed-
                                      eral income tax deductions for those taxes under section 164.
                                      We disagree. Like the withholdings for Federal taxes, the
                                      withholdings from Mr. May’s paycheck for State income taxes
                                      were not remitted to the proper authorities. Those
                                      withholdings remained in Maranatha’s bank account under
                                      the functional control of Mr. May. Mr. May knew of and
                                      orchestrated Maranatha’s failure to remit the withholdings,
                                      using these funds to continue operation of the business in
                                      which he owned an equity stake and which employed him at
                                      an annual salary of $260,000.
                                        For the same reasons stated above with respect to Federal
                                      tax withholdings, we find that no actual withholding
                                      occurred with respect to State income taxes. See supra pp.
                                      153–154. Consequently, we hold petitioners are not entitled
                                      to deductions for any amounts allegedly withheld for State
                                      income taxes.
                                           B. Whether Reductions in Gross Income Resulted
                                         Petitioners claim that if the amounts withheld from Mr.
                                      May’s paycheck for State income taxes do not entitle them to
                                      deductions, then those amounts should not be included in
                                      calculating their gross income because those amounts were
                                      withheld from Mr. May’s wages and never received by peti-
                                      tioners. We disagree.
                                         We have previously found that Mr. May retained func-
                                      tional control of all withheld funds. See supra pp. 153–154.
                                      The funds were kept in the account for the corporation of
                                      which Mr. May was president, CEO, shareholder, officer, and
                                      employee. Mr. May had full control of the corporate finances.




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                                      Those funds were used to benefit the corporation in which
                                      Mr. May held an equity stake and which paid Mr. May an
                                      annual salary of $260,000.
                                        Given Mr. May’s actions in keeping the withholdings in
                                      Maranatha’s account, the amount of control he exercised over
                                      the funds in Maranatha’s account, and the benefits accruing
                                      to Mr. May as a result of the nonremittance, we view these
                                      funds more as capital contributions to Maranatha out of Mr.
                                      May’s paychecks than as funds never received by petitioners.
                                      Therefore, the funds were properly included in petitioners’
                                      gross income.
                                           C. Whether Local Income Taxes Were Paid
                                         Petitioners claim that no local income taxes were due for
                                      1994 and testified they paid local income taxes of $1,896 and
                                      $2,000 for 1995 and 1996, respectively, by personal check.
                                      Petitioners produced a copy of a canceled check for $2,550 for
                                      the 1996 local taxes endorsed by the city of Xenia, but no
                                      such evidence has been produced for taxable year 1995.
                                         In 1996 petitioners owed $2,000 in local income taxes and
                                      $1,778 in local real estate taxes. Only the $2,000 in local
                                      income taxes was disallowed as a deduction; the $1,778
                                      deduction for local real estate taxes was allowed. Petitioners’
                                      check for $2,550 gave no indication of the portion paid
                                      toward local income or local real estate taxes. Because the
                                      burden of proof is on petitioners, we will assume that the
                                      check first went toward paying local real estate taxes of
                                      $1,778, with the remaining $772 being paid toward local
                                      income taxes.
                                         We find that petitioners have met their burden of proof
                                      with respect to $772 of the 1996 local income taxes but not
                                      with respect to the 1995 local income taxes. Therefore, peti-
                                      tioners are entitled to a deduction of $772 for 1996 local
                                      income taxes. The amount of the deficiency for that year
                                      shall be reduced accordingly.
                                           D. Whether the Period of Limitations May Be Extended as
                                              a Result of Fraud
                                         Petitioners argue that the normal 3-year period of limita-
                                      tions to issue a notice of deficiency under section 6501(a) has
                                      expired and that respondent cannot show fraud to increase




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                                      this period of limitations under section 6501(c)(1) because no
                                      tax deficiency exists. Petitioners argue in the alternative that
                                      even if a deficiency exists, respondent still cannot show fraud
                                      because Mr. May’s actions amounted only to an honest mis-
                                      take, negligence, or inadvertence.
                                        We have already found that nonremittance of the State
                                      and local income taxes created deficiencies. See supra pp.
                                      155–157. The only remaining issue is whether Mr. May’s
                                      actions were fraudulent.
                                        The burden is upon respondent to prove that Mr. May filed
                                      a false return with the intent to evade tax for each year at
                                      issue. See sec. 7454(a); Rule 142(b). Because direct evidence
                                      of an intent to evade tax is rarely available, intent may be
                                      proved by circumstantial evidence and reasonable inferences
                                      from the facts. Petzoldt v. Commissioner, 92 T.C. 661, 699
                                      (1989).
                                        Mr. May was responsible for Maranatha’s failure to remit
                                      employee State tax withholdings, including his own. In spite
                                      of his admitted knowledge and orchestration of Maranatha’s
                                      failure to remit such withholdings, Mr. May chose to claim
                                      deductions for the unremitted withholdings on his personal
                                      tax returns.
                                        We conclude that respondent has proved by clear and con-
                                      vincing evidence that Mr. May filed returns for the years at
                                      issue with the intent to evade tax. Therefore, the 3-year
                                      period of limitations under section 6501(a) does not apply for
                                      any of the years at issue, and respondent was not barred
                                      from issuing the notices of deficiency for those years.
                                           E. Fraud With Respect to State and Local Tax Deficiencies
                                        Respondent has established by clear and convincing evi-
                                      dence that Mr. May engaged in fraudulent activity with
                                      respect to the deficiencies resulting from disallowed State
                                      and local tax deductions. See supra pp. 157–158.
                                        Once the Commissioner establishes that any portion of an
                                      underpayment is attributable to fraud, the entire under-
                                      payment is treated as attributable to fraud and subject to a
                                      75-percent penalty, except with respect to any portion of the
                                      underpayment that the taxpayer establishes is not attrib-
                                      utable to fraud. Sec. 6663(a) and (b); Sadler v. Commissioner,
                                      113 T.C. at 105. Petitioners have not met this burden. There-




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                                      (147)                            MAY v. COMMISSIONER                                        159


                                      fore, the fraud penalty is applicable to all remaining defi-
                                      ciencies resulting from State and local income taxes.
                                      IV. Conclusion
                                        We find Mr. May liable in part for deficiencies resulting
                                      from disallowed deductions for State and local income taxes
                                      paid. We also find Mr. May liable for section 6663 fraud pen-
                                      alties with respect to all claimed withholding tax credits as
                                      well as all remaining deficiencies resulting from disallowed
                                      deductions for State and local income taxes.
                                        In reaching our holdings herein, we have considered all
                                      arguments made, and, to the extent not mentioned above, we
                                      conclude they are moot, irrelevant, or without merit.
                                        To reflect the foregoing,
                                                                     Decision will be entered under Rule 155 in
                                                                   docket No. 14385–05.

                                                                     Decision will be entered for petitioner in
                                                                   docket No. 4782–07.

                                                                               f




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