                        T.C. Memo. 2005-157



                      UNITED STATES TAX COURT



              SAM KONG FASHIONS, INC., Petitioner v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent

            SAM KONG AND RUN YUAN CHEN, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket Nos. 9600-02, 9601-02.   Filed June 28, 2005.


     Gary Lee, for petitioners.

     Gerald A. Thorpe and James N. Beyer, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     RUWE, Judge:   Respondent determined deficiencies and

penalties with respect to petitioners’ Federal income taxes as

follows:
                                 - 2 -

                     Sam Kong Fashions, Inc.
                       docket No. 9600-02

                                               Penalty
             Year          Deficiency         Sec. 6663

             1994          $135,643         $101,732.25
             1995           103,999           77,999.25


                             Sam Kong
                        docket No. 9601-02

                                               Penalty
             Year          Deficiency         Sec. 6663

             1994          $137,026         $102,769.50
             1995           104,129           78,096.75


                          Run Yuan Chen
                        docket No. 9601-02

                    Year                 Deficiency

                    1994                 $137,026
                    1995                  104,129


The parties have stipulated that Run Yuan Chen is entitled to

relief under section 6015(c)1 and is not liable for any

deficiencies in tax, penalties, or interest.




     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.
                                 - 3 -

        After concessions,2 the issues for decision are:

     (1) Whether Sam Kong Fashions, Inc. (Sam Kong Fashions),

failed to report gross receipts of $391,885.75 and $303,918.75

for the taxable years 1994 and 1995, respectively;

     (2) whether Sam Kong Fashions incurred additional unreported

deductible business expenses during the taxable years 1994 and

1995;

     (3) whether Sam Kong (Mr. Kong) received and failed to

report constructive dividends from Sam Kong Fashions totaling

$391,885.75 in 1994 and $303,918.75 in 1995;

     (4) whether Sam Kong Fashions and Mr. Kong (petitioners) are

liable for fraud penalties pursuant to section 6663 for the

taxable years 1994 and 1995; or, in the alternative, whether

petitioners are liable for accuracy-related penalties pursuant to

section 6662 for the taxable year of 1995; and

     (5) whether the period of limitations bars the assessment

and collection of the deficiencies in taxes and penalties that


        2
       On brief, respondent concedes that the unreported gross
receipts of Sam Kong Fashions, Inc., which were determined in the
notices of deficiency, should be reduced by $7,047 in 1994 and
$5,600 in 1995. Also, respondent concedes that the unreported
constructive dividends of Sam Kong, which were determined in the
notices of deficiency, should be reduced by $7,047 in 1994 and
$5,601 in 1995. Respondent’s concession with respect to Mr.
Kong’s 1995 unreported constructive dividend appears to be a
typographical error because respondent concedes $5,600 of
unreported gross receipts of Sam Kong Fashions in 1995, but
concedes $5,601 of unreported constructive dividends in 1995 for
Mr. Kong.
                              - 4 -

respondent has determined against petitioners for the taxable

years 1994 and 1995.

                        FINDINGS OF FACT

     Some of the facts have been stipulated and are so found.

The stipulation of facts and the supplemental stipulation of

facts are incorporated herein by this reference.

     At the time the petition was filed, Sam Kong Fashions

maintained its principal place of business in Philadelphia,

Pennsylvania, and Mr. Kong (a.k.a Sam Yee Kong or Siu Yee Kong)

resided in Philadelphia, Pennsylvania.

     From the time that Sam Kong Fashions was formed on October

1, 1993, until sometime in March or April 1994, Mr. Kong and Kwok

Wen, Mr. Kong’s brother-in-law, each held 50 shares of 100 total

shares of Sam Kong Fashions’s stock.   In 1994 and 1995, Mr. Kong

served as president of Sam Kong Fashions.   During the taxable

years in issue, Sam Kong Fashions held a business checking

account at the First Fidelity Bank (First Fidelity).

     Mr. Wen never served as an officer of Sam Kong Fashions, and

he never participated in the management of the business.     While

he worked at Sam Kong Fashions,3 Mr. Wen performed various

duties, including ironing, handiwork, and delivery services.

Sometime in March or April of 1994, Sam Kong Fashions redeemed



     3
       Sam Kong Fashions employed Mr. Wen until it redeemed his
50 shares of stock.
                                - 5 -

Mr. Wen’s shares of stock.    Sam Kong Fashions paid Mr. Wen

$50,000 for his 50 shares of stock.     From April 1994 to December

1995, Mr. Kong was the sole shareholder of Sam Kong Fashions.

     During the taxable years in issue, Sam Kong Fashions engaged

in the business of sewing garments as a subcontractor for other

companies in the garment business.4     It performed sewing services

for Style Setter Fashions, Inc. (Style Setter), Half Moon Bay,

Inc. (Half Moon Bay), and East West Manufacturing, Inc. (East

West).   Sam Kong Fashions delivered the completed garments to the

contractors, and the contractors paid Sam Kong Fashions per

completed garment.   Mr. Kong provided hangers and bags to the

contractors as an accommodation; the contractors paid for the

bags and hangers in addition to the per garment fee.     At least

one contractor created different invoices and issued separate

checks for the hangers and bags.

     During 1994, Style Setter issued 48 checks to “Sam Kong”,

which totaled $592,370.50.5   Sam Kong Fashions deposited only 16

of these checks into its business checking account maintained at




     4
       Generally, Sam Kong Fashions assembled garments using cut
pieces supplied by the contractors.
     5
       On the basis of the evidence presented, we calculate that
these 48 checks total $592,550.50. Because respondent requests
that we find that the 1994 Setter Style checks issued to Mr. Kong
total $592,370.50, we shall use respondent’s figure.
                                - 6 -

First Fidelity.6    The checks that were deposited into the First

Fidelity account in 1994 totaled $192,815.05.7    In 1994, Sam Kong

Fashions failed to deposit checks totaling $399,555.45 into its

business checking account.

     During 1995, Style Setter issued 50 checks totaling

$507,987.64 that were payable to either “Sam Kong” or “Sam Kong

Inc.” for services rendered by Sam Kong Fashions.    Sam Kong

Fashions deposited only 24 of these checks into its business

checking account maintained at First Fidelity.8    The checks

deposited into the First Fidelity account in 1995 totaled

$227,727.40.   Sam Kong Fashions failed to deposit $280,260.24

into its corporate bank account.    Sam Kong Fashions deposited

only one of the checks payable to “Sam Kong Inc.” into its First

Fidelity account.



     6
       Respondent requests that we find that Sam Kong Fashions
deposited 15 of the Style Setters checks into its business
checking account. On the basis of the stipulation of facts, we
find that Sam Kong Fashions deposited 16 checks issued by Style
Setters into its checking account.
     7
       Respondent requests that we find that these checks
deposited into Sam Kong Fashions’s business checking account
total $181,256.75. On the basis of the evidence presented, we
find that these 16 checks total $192,815.05.
     8
       On brief, respondent requests that we find that Sam Kong
Fashions deposited only 23 checks, totaling $213,654.40, into its
business checking account. In his list of checks deposited into
Sam Kong Fashions business checking account, respondent failed to
include check No. 11979. As stipulated by the parties, we find
that this check was deposited into Sam Kong Fashions’s First
Fidelity account.
                               - 7 -

     During the 1994 taxable year, Half Moon Bay issued eight

checks payable to “Sam Kong”, “Sam Kong Fashions”, or “Sam Kong

Fashions, Inc.”, for sewing services rendered by Sam Kong

Fashions.   These checks totaled $24,203.75.   Only three of these

checks, totaling $11,664, were deposited into Sam Kong Fashions’s

First Fidelity account.   Seven of the eight checks were payable

to either “Sam Kong Fashions” or “Sam Kong Fashions, Inc.”;

however, five of these checks were not deposited into Sam Kong

Fashions’s First Fidelity account.

     In 1995, Half Moon Bay issued one check in the amount of

$3,000 payable to Sam Kong Fashions, Inc., which Sam Kong

Fashions deposited into its First Fidelity account.

     During the taxable year 1995, East West issued three checks,

totaling $10,226.96, payable to either “Sam Kong” or “Sam Kong

Fashions, Inc.”   Sam Kong Fashions deposited all three checks

into its First Fidelity account.

     In 1994 and 1995, Mr. Kong maintained a personal checking

account at Mellon Bank.   In 1994, 16 checks issued by Style

Setter, totaling $213,264.65, were deposited into Mr. Kong’s

personal account at Mellon Bank.   Also in 1994, two checks issued

by Half Moon Bay, totaling $4,832.50, were deposited into Mr.

Kong’s personal checking account at Mellon Bank.   One of the Half

Moon Bay checks was payable to “Sam Kong Fashions, Inc.”
                               - 8 -

     Similarly, in 1995, 18 checks issued by Style Setter,

totaling $212,388.40, were deposited into Mr. Kong’s personal

checking account at Mellon Bank.   One of these checks issued by

Style Setters was payable to “Sam Kong Inc.”

     In 1994, Mr. Wen endorsed several of the checks that Style

Setter issued payable to either Sam Kong or Sam Kong Fashions.

Mr. Wen deposited seven checks, totaling $100,329.95, into an

account maintained at Corestates Bank.    Mr. Kong and Mr. Wen had

access to this account.

     During the taxable years 1994 and 1995, the accounting firm

of Kim Y. Ling, P.C., provided services to Sam Kong Fashions and

Mr. Kong.   Kim Y. Ling, P.C., prepared Sam Kong Fashions’s 1994

and 1995 tax returns.   Kim Y. Ling, P.C., also prepared Sam Kong

Fashions’s payroll checks, quarterly employer tax returns, and

Forms W-2, Wage and Tax Statement.     Kim Ling advised Mr. Kong to

report all income and to deposit all gross receipts into the

corporation’s bank account.   Mr. Kong did not inform Mr. Ling

that corporate checks had been either cashed or deposited into

noncorporate bank accounts until after respondent began his

investigation of Mr. Kong and Sam Kong Fashions.

     During the taxable years 1994 and 1995, Sam Kong Fashions

reported gross receipts and deductions on its Forms 1120, U.S.

Corporation Income Tax Return, as follows:
                                 - 9 -

              Reported                     1994         1995

     Gross receipts/sales                $224,718     $217,296
     Deductions:
       Compensation to                    14,520         --
         officers
       Salaries and wages                 122,528      119,170
       Rents                               24,475       29,026
       Taxes and licenses                  16,719       14,880
       Depreciation                        20,180       17,680
       Other deductions                    26,268       36,387

     Taxable income                           28              153

          Total tax                               4            23

     In preparing the 1995 corporate income tax return of Sam

Kong Fashions, an employee of Kim Y. Ling, P.C., made a

mathematical mistake in calculating the gross receipts.        The

employee listed the corporation’s gross receipts as $217,296.06

instead of $241,890.9

     Sam Kong Fashions did not claim a deduction for the cost of

thread used in its sewing business on its 1994 corporate income

tax return.     On its 1995 corporate income tax return, the

corporation reported a business expense deduction of $12,013 for

the cost of thread.10

     In 1994 and 1995, Kim Y. Ling, P.C., prepared a depreciation

schedule for the equipment purchased by Sam Kong Fashions.          Kim



     9
       The parties agree that the sum of the 1995 gross receipts
reported to Kim Y. Ling, P.C., totaled $241,890.
     10
       On brief, petitioners assert that either Mr. Kong or Sam
Kong Fashions is entitled to a deduction of at least $40,000 to
$50,000 for thread used in its sewing business in 1994.
                                   - 10 -

Y. Ling, P.C., created this depreciation schedule from a list of

equipment prepared by Mr. Kong.       Mr. Kong’s list showed that Sam

Kong Fashions purchased the following pieces of equipment:11

                             No. of               Purchase price
          Equipment         machines               per machine

     Button machine            1                         $2,300
     Pocket opener          Unknown                       6,500
       machine
     Two needles               1                          2,000
       sewing machine
     Twelve needles            1                          2,900
       sewing machine
     Sewing equipment          2                          1,900


     During the taxable years of 1994 and 1995, Sam Kong Fashions

employed 10 to 20 full- and part-time employees.         Sam Kong

Fashions paid some employees partially by check and partially in

cash.     An employee of the corporation, Bi Ling Wu, received cash



     11
       On brief, petitioners assert that Mr. Kong or Sam Kong
Fashions purchased the following equipment:

                             No. of               Total
           Equipment        machines          purchase price

     Button machines           2                $2,008   ea.
     Sewing machines         22-23               1,800   ea.
     Other machines            3                 2,300   ea.
     Other machines           6-7                1,900   ea.
     New button                2                 2,100
       machines
     Used button               1                 1,500 ea.
       machine

Petitioners argue that they are entitled to additional
depreciation deductions of $14,263 and $22,821 in 1994 and 1995,
respectively.
                               - 11 -

payments of approximately $10,000 in 1994 and $10,000 in 1995.

Wan Zi Chen, another employee of Sam Kong Fashions, was paid

approximately $600 per week, receiving $440 per week in cash and

$160 per week by check.

     Siew Khim Soon, a C.P.A. and employee of Kim Y. Ling, P.C.,

prepared the 1994 and 1995 corporate income tax returns for Sam

Kong Fashions, and the 1994 and 1995 joint income tax returns for

Mr. Kong and Run Yuan Chen.    All the information reported on the

corporate and individual income tax returns was based upon

information provided to Ms. Soon by Mr. Kong.     Ms. Soon asked Mr.

Kong whether he had provided all the information necessary to

prepare the income tax returns; Mr. Kong indicated that he had

faxed all the documents to Kim Y. Ling, P.C.      Mr. Kong never told

Ms. Soon that some corporate receipts were not deposited in the

corporate bank account.    Mr. Kong also never told Ms. Soon that

he or the corporation incurred expenses in addition to those

contained in the information that he provided to her.

     During the taxable years 1994 and 1995, Mr. Kong and Run

Yuan Chen reported gross income and deductions on their Federal

income tax returns as follows:

     Reported                            1994           1995

     Income:
       Wages                            $14,520       $23,650
     Deductions:
       State and Local
         Income Taxes                      --           1,864
       Real Estate Taxes                   --           2,003
                                 - 12 -

        Home Mortgage Interest
          and Points                        --           5,516

      Taxable income                       3,270         6,767


                                 OPINION

I.    Burden of Proof

      Generally, the Commissioner’s determinations in a notice of

deficiency are presumed to be correct, Welch v. Helvering, 290

U.S. 111, 115, (1933); Anastasato v. Commissioner, 794 F.2d 884,

886 (3d Cir. 1986), and the taxpayer bears the burden of

producing evidence to show that the Commissioner’s determinations

are erroneous, Rule 142(a); Welch v. Helvering, supra; Anastasato

v. Commissioner, supra.

      Section 7491(a) modifies the general rule regarding the

burden of proof in court proceedings arising in connection with

examinations commencing after July 22, 1998.       Internal Revenue

Service Restructuring and Reform Act of 1998, Pub. L. 105-206,

sec. 3001(c)(1), 112 Stat. 727.     When a taxpayer has introduced

credible evidence with respect to a factual issue relevant to his

liability for tax, section 7491(a) may shift the burden from the

taxpayer to the Commissioner.     As a prerequisite for shifting the

burden to the Commissioner, section 7491(a) requires a taxpayer

to:   (1) Comply with substantiation requirements; (2) maintain

records and cooperate with the Commissioner’s reasonable requests

for documents, information, interviews, etc.; and (3) in the case
                             - 13 -

of a corporation, partnership, or trust, satisfy the net worth

requirement of 28 U.S.C. sec. 2412(d)(2)(B).   Sec. 7491(a)(2).

     Petitioners argue that section 7491 shifts the burden of

proof to respondent with respect to the underpayment of tax.

Respondent argues that section 7491 does not apply because

petitioners have not shown that they maintained proper records or

that they cooperated with respondent during the examinations.

     We find that petitioners have failed to satisfy the

requirements of section 7491; therefore, the burden of proof does

not shift to respondent with respect to the underpayment of tax.

Petitioners failed to provide adequate records and to

substantiate all the unreported expenses that they now claim.12

While petitioners have the burden of proving that respondent’s

deficiency determinations are erroneous, respondent bears the

burden of proving, by clear and convincing evidence, that

petitioners are liable for the fraud penalties.   If respondent

establishes that the returns in question were fraudulent with the

intent to evade tax, the tax may be assessed at any time.    See

6501(c)(1).




     12
       As noted infra pp. 19-20, we have allowed some deductions
in addition to those claimed by Sam Kong Fashions on its returns.
These additional corporate deductions also decrease the
constructive dividends that respondent determined were received
by Mr. Kong.
                                 - 14 -

II.   Understatement of Income

      A.   Gross Receipts Unreported by Sam Kong Fashions

      Respondent argues that the checks and the parties’

stipulations of fact establish that Sam Kong Fashions

underreported its gross receipts by $391,885.75 in 1994 and

$303,918.64 in 1995.   Petitioners argue that Sam Kong Fashions

does not have additional unreported gross receipts because

respondent failed to prove that the checks payable to Mr. Kong

were issued for services performed by the corporation.

Petitioners further argue that the checks issued by Style Setter

were payments for the hangers and bags that Mr. Kong provided as

an accommodation, not for the sewing services provided by Sam

Kong Fashions.

      Based on the evidence presented, we find that respondent has

established that Sam Kong Fashions received unreported gross

receipts in 1994 and 1995 and performed sewing services for Style

Setters and Half Moon Bay.   To establish unreported income,

respondent has introduced checks issued by Style Setters and Half

Moon Bay that were payable to “Sam Kong”, “Sam Kong Inc.”, or

“Sam Kong Fashions, Inc.”    Representatives of both companies

testified that the contractors issued these checks as

compensation for sewing services performed by Sam Kong Fashions.

While Sam Kong Fashions reported some of these checks as gross

receipts on its 1994 and 1995 corporate income tax returns, the
                               - 15 -

corporation failed to deposit numerous checks into its business

checking account and failed to report these amounts on its

returns.    We disagree with petitioners’ contention that

respondent inappropriately attributed receipts received by Mr.

Kong to Sam Kong Fashions.    Indeed, if Mr. Kong received the

checks that were not deposited in the corporate bank account in

his individual capacity, he clearly failed to report any of those

amounts on his individual income tax returns.    The only income

reported by Mr. Kong and Run Yuan Chen for 1994 and 1995 was

wages received from Sam Kong Fashions in the respective amounts

of $14,520 and $23,650.

     Petitioners’ conduct also indicates that these checks

constitute unreported gross receipts to Sam Kong Fashions for

sewing services rendered.    The corporation deposited numerous

checks issued to “Sam Kong” into its First Fidelity account.

This shows that Sam Kong Fashions treated some of the checks

issued by the contractors to “Sam Kong” as corporate gross

receipts.   Furthermore, Sam Kong Fashions failed to deposit into

its First Fidelity account at least five checks issued by

contractors and payable to either “Sam Kong Inc.” or “Sam Kong

Fashions, Inc.”

     Also, petitioners’ contention that these checks represent

income to Mr. Kong for the hangers and bags supplied to the

contractors is undermined by the fact that this income was
                               - 16 -

neither reported on Mr. Kong’s Federal income tax returns nor

disclosed to his return preparer.    Robin Augustyn, the bookkeeper

and office manager of Style Setters, confirmed that Mr. Kong

provided hangers and bags in addition to performing sewing

services.   Ms. Augustyn testified, however, that the checks in

the record were not issued as payment for bags and hangers.

Further, petitioners offered no records, documents, or other

evidence to substantiate their claim that these checks represent

payments for hangers and bags.

     Finally, it “is well established that the failure of a party

to introduce evidence within his possession and which, if true,

would be favorable to him, gives rise to the presumption that if

produced it would be unfavorable.”      Wichita Terminal Elevator Co.

v. Commissioner, 6 T.C. 1158, 1165 (1946), affd. 162 F.2d 513

(10th Cir. 1947).    Mr. Kong served as president of Sam Kong

Fashions and controlled the business.     He was also the sole

shareholder for at least 8 months in 1994 and for the entire year

in 1995.    Mr. Kong was present during the trial but chose not to

testify.    Because Mr. Kong did not testify at trial, we infer

that his testimony would not have been helpful to Sam Kong

Fashions’s claim that it did not underreport its gross receipts.

See Petzoldt v. Commissioner, 92 T.C. 661, 685-686 (1989); Rivera

v. Commissioner, T.C. Memo. 1979-343.
                               - 17 -

     We find that respondent has proven by clear and convincing

evidence that Sam Kong Fashions received and failed to report

gross receipts in 1994 and 1995.    On the basis of the customers’

payments for sewing services, we find that Sam Kong Fashions

received total gross receipts of $616,574.25 in 1994 and

$521,214.64 in 1995.   On its corporate income tax returns, Sam

Kong Fashions reported gross receipts in the amount of $224,718

and $217,296 in 1994 and 1995, respectively.    Therefore, we find,

by clear and convincing evidence, that the unreported gross

receipts of Sam Kong Fashions totaled $391,856.25 in 1994 and

$303,918.64 in 1995.

     B.     Unreported Business Expenses

     Section 162(a) provides a deduction for all ordinary and

necessary expenses paid or incurred in carrying on a trade or

business.    Taxpayers bear the burden of proving that they are

entitled to any claimed deductions.     Rule 142(a); INDOPOC, Inc.

v. Commissioner, 503 U.S. 79, 84 (1992).

     Section 6001 provides that a taxpayer must substantiate any

deductible expenses claimed.    Taxpayers are required to maintain

records that sufficiently establish the amount of claimed

deductions.    Sec. 6001; sec. 1.6001-1(a), Income Tax Regs.   When

taxpayers present convincing evidence that they incurred

deductible expenses, but lack the records to substantiate the

claimed amounts, courts may estimate the allowable deductions.
                               - 18 -

Cohan v. Commissioner, 39 F.2d 540, 544 (2d Cir. 1930); Vanicek

v. Commissioner, 85 T.C. 731, 742-743 (1985); Pratt v.

Commissioner, T.C. Memo. 2002-279.      Courts will only estimate the

expenses when the record provides some basis for computation.

Cohan v. Commissioner, supra; Vanicek v. Commissioner, supra.       In

estimating the taxpayer’s allowable deductions, the court bears

heavily against the taxpayer because the “inexactitude is of his

own making.”    Cohan v. Commissioner, supra; Maciel v.

Commissioner, T.C. Memo. 2004-28.

     Petitioners argue that Sam Kong Fashions is entitled to

additional deductions for employee compensation, thread expenses,

and depreciation that the corporation did not report on its 1994

and 1995 corporate income tax returns.     Alternatively,

petitioners argue that Sam Kong Fashions’s gross income should be

determined by multiplying its gross receipts by the IRS’s

statistically estimated ratio of net income to business receipts

for the apparel and other textile products.     Respondent argues

that petitioners have failed to provide adequate books and

records to substantiate the claimed unreported business expenses.

     We find that Sam Kong Fashions has failed to provide

evidence necessary to substantiate the claimed additional

deductions.    Petitioners submitted copies of bank statements and

checks drawn from the business checking account of Sam Kong

Fashions for the 1994 and 1995 taxable years.     We did not find
                               - 19 -

any evidence in these records that substantiates petitioners’

claimed additional deductions.      Also, nothing in the record

provides a basis for estimating the claimed deductions.      We shall

address each deduction claimed by petitioners, and petitioners’

alternative argument, which claims deductions based upon

statistical data.

            1.   Additional Wages

     Respondent concedes that Sam Kong Fashions incurred

additional cash wage expenses, but argues that petitioners failed

to provide enough specificity to estimate these additional

expenses.    However, respondent does not dispute that cash

payments of $10,000 in 1994 and 1995 were made to Bi Ling Wu, an

employee of Sam Kong Fashions.13     Respondent also does not

dispute that another employee, Wan Zi Chen, was paid both in cash

and by check.    Wan Zi Chen received cash payments of $440 per

week, or $22,880 per year, in 1994 and 1995.14     We find that Sam

Kong Fashions is entitled to deduct these payments in addition to


     13
       Petitioners’ request for findings of fact states: “Bi
Ling Wu was paid approximately $10,000 in 1994 and $10,000 in
1995 in cash.” In response to this requested finding of fact,
respondent stated that he had “No objection.”
     14
       Petitioners’ request for findings of fact states: “In
1994 and 1995 Sam Kong or Sam Kong Fashions, Inc. paid Wan Zi
Chen, a manager, $2,400 a month, consisting of $160 in check and
$2,240 in cash.” Respondent objected to this requested finding
of fact “because it is not supported by the record. Respondent
proposes an alternative finding of fact that Ms. Zi Chen was paid
a total of $2,400.00 per month consisting of $160.00 per week by
check and $440.00 per week in cash.”
                               - 20 -

the amount of salaries and wages deducted on the corporate

returns.

     With respect to the other alleged cash wage payments, the

evidence is insufficient for us to estimate these amounts.

Although petitioners offered timecards as evidence that Sam Kong

Fashions incurred additional wage expenses, we do not think that

these records provide a sufficient basis for estimating cash wage

expenses of the corporation.   Petitioners offered the timecards

for only a few months in 1995.   The sums listed on the timecards

do not indicate whether an employee was paid in cash or by check.

The timecards state that they are for “Shun Wo Fashions Inc.”,

and these records do not contain any discernable reference to Sam

Kong Fashions.   We find that these records fail to establish the

number of employees, the amount of cash that its employees were

paid, or the number of hours that these employees worked.    Mr.

Kong, who was in charge of the business, chose not to testify.

Because there is no credible evidence to support petitioners’

estimated cash wage expenses, we find that they are not entitled

to additional deductions for these expenses.

           2.    Thread Expense in 1994

     Petitioners also failed to present credible evidence to

support the claimed expense of $40,000 to $50,000 for thread in

1994.   Although Sam Kong Fashions failed to claim this deduction

on its 1994 corporate income tax return, it did report an expense
                               - 21 -

of $12,013 for the cost of threads on its 1995 corporate tax

return.

     Petitioners did not offer any documents, such as receipts or

invoices, to substantiate its claimed expense.    However,

petitioners rely on the testimony of Mr. Wen to support the

claim.    Mr. Wen stated that he was not involved in the management

of the business.   While he was employed by Sam Kong Fashions, Mr.

Wen delivered finished products, ironed garments, and performed

handiwork.   We are not convinced that Mr. Wen had adequate

knowledge of Sam Kong Fashions’s business operations to

accurately testify about the amount of thread that Mr. Kong

purchased in 1994.

     Additionally, representatives of Style Setters and Half Moon

Bay testified that the contractors often provided the thread that

Sam Kong Fashions used to sew the garments.15    Ms. Augustyn and

Mr. Sporidis testified that the contractors provided some thread

to Sam Kong Fashions, particularly at the beginning of their

business relationship.   Although the record establishes that Sam

Kong Fashions did purchase thread, the evidence fails to

establish whether Sam Kong Fashions incurred any expenses beyond


     15
       Ms. Augustyn testified that Style Setters provided thread
to Sam Kong Fashions “Most of the time.” Mr. Sporidis, the
president of Half Moon Bay, testified that Half Moon Bay
initially provided thread to the corporation. Later, Half Moon
Bay stopped providing the corporation with thread because “[Half
Moon Bay] would never get [the thread] back” and “it became a big
cost”.
                                - 22 -

those reported on its 1995 corporate income tax return.     Again,

we note that Mr. Kong did not testify.     We find that petitioners

failed to substantiate the claimed additional thread expenses in

1994.

             3.   Additional Depreciation Deductions

        Petitioners argues that they are entitled to depreciation

deductions for machines that were not listed on the depreciation

schedule prepared by Kim Y. Ling, P.C.     In calculating the

additional depreciation deductions, petitioners rely on the

testimony of Mr. Wen.     We find that Mr. Wen testified

inconsistently with regard to his duties and responsibilities at

Sam Kong Fashions.     Regarding his role in the purchase of

equipment, Mr. Wen testified that he sometimes made withdrawals

from the Corestates checking account “to buy some factory

machines, sewing machines.”     However, when asked whether his

responsibilities at the corporation included paying bills, Mr.

Wen indicated that his job was “to pick up and deliver the

finished product, and do the handiwork.”     With respect to the

payroll, Mr. Wen testified that he made withdrawals from the

Corestates checking account “[Sometimes] to make payrolls”, but

later testified that he was not responsible for the payroll.

Because of these inconsistences, we do not rely on Mr. Wen’s

testimony.
                                - 23 -

      Mr. Kong did not testify about any of the claimed

additional equipment, and petitioners failed to provide any

documents to establish that Sam Kong Fashions purchased any

additional equipment.    We find that petitioners failed to prove

any entitlement to depreciation deductions in excess of those

shown on their returns.

     4.     Deductions Based on Respondent’s Statistics of
            Income

     As an alternative, petitioners contend that respondent’s

1994 and 1995 Statistics of Income, Corporation Income Tax

Returns, provide the ratios of net income to business receipts

that should be used to estimate the additional business expenses

of Sam Kong Fashions.

     In a similar case we refused to use evidence of statistical

data to establish additional unreported business expenses.

Schachter v. Commissioner, T.C. Memo. 1998-260, affd. 225 F.3d

1031 (9th Cir. 2001).     In Schachter, the taxpayer offered general

survey information that did not purport to represent data from

comparable companies and requested that the Court use this data

to calculate allowable business expenses.     Id.   The Court

rejected the taxpayer’s attempt to use the average profit margins

of other businesses, finding that the general survey information

failed to provide credible evidence of additional business

expenses.    Id.   The Court noted that once the Commissioner has
                              - 24 -

established unreported sales, the taxpayer has the burden of

proving offsetting expenses with credible evidence.    Id.


     Although used in appropriate cases--particularly by
     respondent where taxpayers have not filed income tax
     returns and have not maintained adequate books and
     records--general survey data may be rejected where
     taxpayers, as in the instant case, seek to use such
     data to overcome clear evidence of unreported income.
     [Id.; citations omitted.]

     Here, petitioners have not persuaded us that the ratio of

net income to business receipts should apply to the unreported

gross receipts of Sam Kong Fashions.    We have found that

respondent has proven by clear and convincing evidence that Sam

Kong Fashions underreported its gross receipts.    As noted in

Schachter, the use of general data may be appropriate when the

taxpayer did not file returns and failed to maintain books and

records.   Here, Sam Kong Fashions filed corporate income tax

returns in 1994 and 1995 and reported more than $200,000 in

deductions in each year at issue.16    Instead of offering credible

evidence such as invoices, receipts, and other business records,

petitioners rely on testimony and general statistical data to

prove additional business expenses.    Because the “inexactitude is


     16
       In support of this position, petitioners rely on Adair v.
Commissioner, T.C. Memo. 2000-110, and the related case styled
Houser v. Commissioner, T.C. Memo. 2000-111. We find Adair and
Houser distinguishable from this case. Unlike Sam Kong Fashions,
which claimed deductions on its 1994 and 1995 corporate income
tax returns, the Commissioner’s determination in Adair and Houser
did not allow for business expenses even though expenses
“obviously were incurred in the roofing business”.
                              - 25 -

of his own making”, the burden of proving that Sam Kong Fashions

incurred additional expenses bears heavily on petitioners.     Cohan

v. Commissioner, 39 F.2d at 544.   Again, we note that Mr. Kong,

who would be the most knowledgeable person regarding the claimed

additional business expenses, chose not to testify.   We decline

petitioners’ invitation to estimate additional business expenses

using respondent’s statistical data.

     The unreported gross receipts of Sam Kong Fashions total

$391,856.25 in 1994 and $303,918.64 in 1995.   See supra p. 17.

We find that Sam Kong Fashions is entitled to deduct cash wage

payments made to Bi Ling Wu of $10,000 in 1994 and 1995.    See

supra pp. 19-20.   Additionally, we find that Sam Kong Fashions is

entitled to deduct cash wage payments made to Wan Zi Chen of

$22,880 in 1994 and 1995.   See supra pp. 19-20.   After taking

into consideration the cash payments made to Bi Ling Wu and Wan

Zi Chen, we hold that Sam Kong Fashions had unreported taxable

income of $358,976.25 in 1994 and $271,038.64 in 1995.

     C.   Constructive Dividends Received by Mr. Kong

     A dividend is a distribution of property made by a

corporation to its shareholders from its earnings and profits.

Sec. 316(a).   A shareholder may receive a dividend even though

the corporation has not formally declared a distribution.

Truesdell v. Commissioner, 89 T.C. 1280, 1295 (1987).     When the

corporation confers an economic benefit on a shareholder from
                                - 26 -

available earnings and profits without the expectation of

repayment, the benefit is taxable to the shareholder as a

constructive dividend.     Neonatology Associates, P.A. v.

Commissioner, 299 F.3d 221, 232 (3d Cir. 2002), affg. 115 T.C. 43

(2000); Magnon v. Commissioner, 73 T.C. 980, 993-994 (1980).

“The crucial test of the existence of a constructive dividend is

whether ‘the distribution was primarily for the benefit of the

shareholder.’”     Magnon v. Commissioner, supra at 994 (quoting

Loftin v. United States, 577 F.2d 1206, 1214 (5th Cir. 1978)).

When shareholders divert corporate funds for their own personal

use, those diverted funds are constructive dividends to the

shareholders to the extent of the corporation’s earnings and

profits.   Falsetti v. Commissioner, 85 T.C. 332, 356 (1985).

     Mr. Kong argues that he did not receive constructive

dividends from Sam Kong Fashions because the money was used to

pay employees, to purchase machines, and to redeem Mr. Wen’s

shares of stock in Sam Kong Fashion.17    Mr. Kong further argues

that he did not have control over the $100,330 deposited into the

Corestates bank account because Mr. Wen endorsed checks deposited

to that account.    Respondent argues that Mr. Kong had control




     17
       As previously noted, Mr. Kong also seems to argue that
some of the corporate income that he received was actually
received from customers in his individual capacity. However, Mr.
Kong failed to report any of these amounts as income.
                                - 27 -

over these funds and that he failed to prove that these funds

were used for corporate purposes.

     We find that Mr. Kong diverted corporate funds from Sam Kong

Fashions for his personal use.    The parties have stipulated that

checks issued by Style Setters and Half Moon Bay were deposited

into Mr. Kong’s personal checking account maintained at Mellon

Bank in 1994 and 1995.   Style Setter and Half Moon Bay issued

these checks as compensation for sewing services performed by Sam

Kong Fashions.   In 1994, Mr. Kong deposited 18 checks totaling

$218,097.15 into his checking account maintained at Mellon Bank.

In 1995, Mr. Kong also deposited 18 checks totaling $212,388.40

into his Mellon Bank account.    Mr. Kong received checks that were

payments to Sam Kong Fashions for sewing service and deposited

these funds into his personal checking account.    Furthermore,

these amounts were not recorded as gross receipts by Sam Kong

Fashions, nor was the receipt of these checks disclosed to

petitioners’ accountant.   We find that Mr. Kong diverted

corporate funds for his own personal use and that these funds

constitute a corporate distribution to Mr. Kong.

     We are also convinced that Mr. Kong did have control over

the funds deposited into the Corestates Bank account by Mr. Wen.

The record reveals that Mr. Kong had control over this account.

Even though Mr. Wen deposited checks issued to Sam Kong Fashions
                               - 28 -

into the Corestates account, we find that Mr. Kong maintained

control over these funds.

     We also find that Mr. Kong received the benefit from other

checks that may not have been deposited into the First Fidelity

account or the Corestates account.18    These checks were issued by

the customers of Sam Kong Fashions, and Mr. Kong endorsed all

these checks.   Some of these checks include Mr. Kong’s Mellon

Bank account number below his signature or a stamp bearing the

name Mellon Bank, while other checks include an unidentified

account number.   We are unable to identify the bank that

processed two additional checks that Mr. Kong endorsed.     We note

again that Mr. Kong failed to testify and explain the

circumstances surrounding the receipt of these checks.

     Mr. Kong also argues that he did not receive the benefit of

the $50,000 that Sam Kong Fashions paid to redeem Mr. Wen’s 50

shares of its stock.    Mr. Kong alleges that this $50,000 was paid

from the Corestates Bank account.   Petitioners offered no records

from Corestates Bank.   Petitioners failed to show that Sam Kong

Fashions redeemed Mr. Wen’s shares of stock using the unreported

receipts deposited into the Corestates Bank account.    Mr. Wen’s

testimony regarding the redemption was vague.    Mr. Wen testified



     18
       Even though some of these checks include the Mellon Bank
account number on the back of the check, the parties did not
stipulate or argue that these checks were deposited into that
account.
                              - 29 -

that he received the $50,000 payment in cash and by check.

Although he testified that the entire $50,000 payment came from

the Corestates Bank account, Mr. Wen failed to identify how he

knew the source of the cash payments.     No credible evidence in

the record connects the $50,000 paid to Mr. Wen to the above-

mentioned deposits to the Corestates Bank account.

     We hold that Mr. Kong received distributions of $358,976.25

in 1994 and $271,038.64 in 1995 from Sam Kong Fashions.19

Petitioners did not argue that Sam Kong Fashions had insufficient

earnings and profits for these amounts to constitute constructive

dividends.   Based on the corporate returns and our findings of

additional corporate unreported income, we find that there were

sufficient corporate earnings and profits and that Mr. Kong

received constructive dividends in 1994 and 1995.

III. Section 6663--Fraud Penalty

     Section 6663(a) provides that “If any part of any

underpayment of tax required to be shown on a return is due to

fraud, there shall be added to the tax an amount equal to 75

percent of the portion of the underpayment which is attributable

to fraud.”   The Commissioner bears the burden of proving fraud by

clear and convincing evidence.     Secs. 7454(a), 7491(c); Rule

142(b).   To satisfy this burden, the Commissioner must establish


     19
       See supra p. 25, where we held that Sam Kong Fashions had
additional unreported taxable income of $358,976.25 in 1994 and
$271,038.64 in 1995.
                               - 30 -

that (1) an underpayment exists, and (2) some portion of the

underpayment is attributable to fraud.    DiLeo v. Commissioner, 96

T.C. 858, 873 (1991), affd. 959 F.2d 16 (2d Cir. 1992).

     If the Commissioner establishes that any portion of an

underpayment is attributable to fraud, the entire underpayment

shall be treated as attributable to fraud.   Sec. 6663(b).     When

taxpayers establish by a preponderance of the evidence that any

portion of the underpayment is not attributable to fraud, they

shall not be liable for a fraud penalty with respect to that

portion of the underpayment.    Id.

     Petitioners argue that respondent has “failed to prove that

Sam Kong had the intent to conceal, mislead, or otherwise prevent

the assessment and collection of the taxes at issue and attempted

to evade taxes.”   Petitioners further argue that if we find that

they are liable for the fraud penalties, a penalty should not be

imposed on $24,594 of gross receipts, which petitioners’

accountant mistakenly omitted from the 1995 corporate income tax

return of Sam Kong Fashions.

     A.   Underpayment

     To prove an underpayment, the Commissioner is not required

to establish the exact amount of the deficiency.    DiLeo v.

Commissioner, supra at 873.    The Commissioner, however, has not

satisfied his burden of proof by relying on the taxpayer’s

failure to prove that the Commissioner erred in the determination
                                - 31 -

of the deficiency.     Parks v. Commissioner, 94 T.C. 654, 660-661

(1990).     “It is only if and when the Commissioner establishes an

underpayment by clear and convincing evidence that his deficiency

determination will enjoy its usual presumption of correctness.”

DiLeo v. Commissioner, supra at 873.

        When a taxpayer fails to report gross receipts, an

underpayment of tax exists if the costs of goods sold and

deductible expenses are less than the unreported gross receipts.

Franklin v. Commissioner, T.C. Memo. 1993-184.     The burden is on

the taxpayer to prove any deductions in addition to those claimed

on the return.

     [Even] in criminal tax evasion cases, where the
     Government bears the greater burden of proof beyond a
     reasonable doubt, it is well settled--“that evidence of
     unexplained receipts shifts to the taxpayer the burden
     of coming forward with evidence as to the amount of
     offsetting expenses, if any.” * * * [Franklin v.
     Commissioner, supra (quoting Siravo v. United States,
     377 F.2d 469 (1st Cir. 1967)).]

     As stated above, we find that respondent has clearly proven

that Sam Kong Fashions received unreported income from Style

Setter and Half Moon Bay, and that Mr. Kong received unreported

constructive dividends.     Other than the wage payments to Bi Ling

Wu and Wan Zi Chen, we also find that neither Sam Kong Fashions

nor Mr. Kong is entitled to any additional deductions.

Accordingly, we find that both Sam Kong Fashions and Mr. Kong

substantially understated their tax liabilities for 1994 and

1995.
                                   - 32 -

       B.     Fraudulent Intent

       “‘Fraud’ * * * means intentional wrongdoing on the part of a

taxpayer motivated by a specific purpose to evade a tax known or

believed to be owing.”       Stoltzfus v. United States, 398 F.2d

1002, 1004 (3d Cir. 1968).        The Commissioner must establish by

clear and convincing evidence that some portion of the

underpayment in each year in issue was due to fraud; he is not

required to prove the precise amount of the underpayment that

resulted from fraud.       Otsuki v. Commissioner, 53 T.C. 96, 105

(1969).      Because direct evidence of fraud is rarely available,

respondent may prove fraudulent intent using circumstantial

evidence.       Stoltzfus v. United States, supra at 1005; DiLeo v.

Commissioner, 96 T.C. at 874; Otsuki v. Commissioner, supra at

106.    In determining fraudulent intent, we consider the

taxpayer’s entire course of conduct and reasonable inferences

that may be drawn from the facts.        Parks v. Commissioner, supra

at 664; Bacon v. Commissioner, T.C. Memo. 2000-257, affd. without

published opinion 275 F.3d 33 (3d Cir. 2001).        Courts have looked

to the following “badges of fraud” as evidence of fraudulent

intent:       (1) Understatement of income; (2) implausible or

inconsistent explanations of behavior; (3) failure to provide

return preparers with accurate and necessary information; (4)

maintaining inadequate books and records; and (5) dealing in

cash.       Spies v. United States, 317 U.S. 492, 499 (1943); Bradford
                               - 33 -

v. Commissioner, 796 F.2d 303, 307-308 (9th Cir. 1986), affg.

T.C. Memo. 1984-601; DiLeo v. Commissioner, supra at 875; Parks

v. Commissioner, supra at 664-665; Bacon v. Commissioner, supra.

     A corporation acts only through its officers, and it does

not escape responsibility for its officers’ actions while serving

in their corporate capacity.    DiLeo v. Commissioner, supra;

Federbush v. Commissioner, 34 T.C. 740, 749 (1960), affd. 325

F.2d 1 (2d Cir. 1963); Gold Bar, Inc. v. Commissioner, T.C. Memo.

2000-211.    Fraudulent intent by a corporation “necessarily

depends upon the fraudulent intent of the corporate officer.”

Federbush v. Commissioner, supra.     Also, “fraud of a sole or

dominant shareholder can be attributed to the corporation.”        Gold

Bar, Inc. v. Commissioner, supra.     In determining whether Sam

Kong Fashions and Mr. Kong acted with fraudulent intent, we

examine the conduct of Mr. Kong, who was the corporation’s

president and dominant shareholder.

            1.   Understatement of Income

     Petitioners substantially understated their incomes in 1994

and 1995.    “A pattern of consistent underreporting of income,

especially when accompanied by other circumstances showing an

intent to conceal, justifies the inference of fraud.”     Parks v.

Commissioner, supra at 664 (citing Holland v. United States, 348

U.S. 121, 137 (1954); Otsuki v. Commissioner, supra at 105-106).
                                - 34 -

In 1994 and 1995, petitioners understated their incomes by

substantial amounts.

          2.   Implausible or Inconsistent Explanations of
               Behavior

     Petitioners also offered implausible explanations for

failing to deposit customer checks into the checking account of

Sam Kong Fashions.     Petitioners assert that the contractors

issued the checks payable to Mr. Kong because he provided

services to the contractors.     Yet, representatives of Style

Setters and Half Moon Bay testified that the checks in the record

were issued to Sam Kong Fashions, not Mr. Kong.     Furthermore, Mr.

Kong acted inconsistently with this explanation because he listed

wages from Sam Kong Fashions as his only source of income on his

1994 and 1995 income tax returns.

     Petitioners’ explanations are also inconsistent with how Sam

Kong Fashions processed customer checks.     Sam Kong Fashions

deposited numerous checks payable to “Sam Kong” into its business

checking account.    Nothing on the face of these checks explains

why some checks issued to Mr. Kong were deposited into Sam Kong

Fashions’s business account while others were deposited into Mr.

Kong’s personal checking account.     Similarly, several checks

issued to Sam Kong Fashions were deposited into Mr. Kong’s

personal account.    From the inconsistent treatment of customer

checks, we infer that petitioners attempted to hide the receipt
                               - 35 -

of income and avoid the payment of taxes.   We find petitioners’

explanation implausible.

            3.   Failure To Provide Return Preparer With Accurate
                 and Necessary Information

     Petitioners also failed to provide their tax preparer with

all the information and records necessary to prepare their 1994

and 1995 individual and corporate income tax returns.   Mr. Ling

informed Mr. Kong that all income should be reported and all

corporate receipts should be deposited into a corporate account.

When Mr. Kong provided information to Kim Y. Ling, P.C., to

prepare the individual and corporate income tax returns in 1994

and 1995, Mr. Kong failed to inform the tax preparer that a large

portion of the corporate receipts had not been deposited into the

corporate account.   Mr. Kong did not advise Kim Y. Ling, P.C., of

additional unreported income until after respondent began his

investigation.   We believe that Mr. Kong intended to reduce taxes

by concealing corporate receipts and by failing to provide this

information to his accountant.   See Federbush v. Commissioner, 34

T.C. at 750.

            4.   Maintaining Inadequate Books and Records

     Sam Kong Fashions failed to maintain adequate books and

records and failed to maintain correct records of its gross

receipts.    Petitioners have failed to offer any records from Sam

Kong Fashions to show the number of full- and part-time

employees, the hours that these employees worked, or the hourly
                              - 36 -

wage or other compensation received by the employees.

Petitioners offered timecards to substantiate its alleged wages;

however, the timecards only encompassed a few months in 1995 and

purported to be for a company named “Shun Wo Fashions Inc.”, not

Sam Kong Fashions.   We find that the inadequate records

maintained by Sam Kong Fashions indicate that petitioners

intended to conceal income and evade taxes owed in 1994 and 1995.

     Based on the foregoing, we find that petitioners

fraudulently understated their tax liabilities for 1994 and 1995

and hold that they are liable for the fraud penalty under section

6663.20

     Section 6663(b) provides that a taxpayer will not be liable

for the fraud penalty with respect to any portion of the

underpayment that the taxpayer proves by a preponderance of the

evidence is not attributable to fraud.   Mr. Kong submitted to his

accountant a list of Sam Kong Fashions’s gross receipts and

expenses for 1995.   Although the gross receipts on the list

totaled $241,890, an employee of Kim Y. Ling, P.C., mistakenly

calculated this amount as $217,296.06.   Because this omission was

the mistake of the tax preparer, we find that the tax




     20
       Because we find that petitioners are liable for fraud
penalties under sec. 6663, we shall not address respondent’s
alternative argument that petitioners are liable for the
accuracy-related penalties pursuant to sec. 6662.
                              - 37 -

attributable to $24,594 of the unreported income was not

attributable to fraud.

     IV.   Statute of Limitation

     Petitioners argue that the 3-year period of limitations on

assessment had expired when respondent issued the notices of

deficiencies.   Because the 3-year period of limitations of

section 6501(a) ended before respondent issued the notices of

deficiency, respondent relies on the exception to the general

period of limitations provided in section 6501(c)(1).

     Section 6501(c)(1) provides that “In the case of a false or

fraudulent return with the intent to evade tax, the tax may be

assessed, or a proceeding in court for collection of such tax may

be begun without assessment, at any time.”   Because we have held

that petitioners filed fraudulent individual and corporate

income tax returns for the years in issue, we hold that the

period of limitations does not bar the assessment of the

deficiencies and penalties in these cases.   Sec. 6501(c)(1).

     To reflect the foregoing,

                                         Decisions will be entered

                                    under Rule 155.
