                           T.C. Memo. 1999-415



                         UNITED STATES TAX COURT



        J. RANDALL GROVES AND JANE B. GROVES, Petitioners v.
            COMMISSIONER OF INTERNAL REVENUE, Respondent



       Docket No. 1958-98.                  Filed December 23, 1999.



       Richard Lane Brown III, for petitioners.

       Jennifer H. Decker and Andrew M. Winkler, for respondent.



               MEMORANDUM FINDINGS OF FACT AND OPINION


       COLVIN, Judge:    Respondent determined deficiencies in

petitioners' Federal income tax, additions to tax, and a penalty

as follows:

                                  Additions to tax and penalty
Year        Deficiency       Sec. 6653(b)(1)   Sec. 6659   Sec. 6663
1988          $50,538            $37,904        $15,161
1989           19,758                                       $14,819
                                 - 2 -

     After concessions, the issues for decision are:

     1.      Whether petitioner1 is liable for the addition to tax

for fraud under section 6653(b) for 1988 or the fraud penalty

under section 6663 for 1989.     We hold that he is not.

     2.      Whether the statute of limitations bars assessment of

tax for 1988 and 1989.     We hold that it does.

                           FINDINGS OF FACT

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

A.   Petitioners

     Petitioners lived in Matthews, North Carolina, when they

filed their petition.

     1.      Petitioner's Law Practice

     Petitioner is a tax attorney who began practicing law in

1967.     Petitioner was a trial attorney in the office of the Chief

Counsel for the Internal Revenue Service (IRS) from 1967 to 1971.

He began to practice law in Charlotte, North Carolina, in 1971.

Petitioner tried 13 regular cases and numerous small cases in the

Tax Court from 1968 to 1976.

     2.      Petitioner’s Activities in 1988 and 1989

     Petitioner was a partner in the law firm Weinstein &

Sturgess in 1988 and 1989.     In those years, petitioner


     1
       References to petitioner are to J. Randall Groves.
Section references are to the Internal Revenue Code in effect
during the years at issue. Unless otherwise indicated, Rule
references are to the Tax Court Rules of Practice and Procedure.
                                - 3 -

represented clients before the IRS, established trusts and

provided estate planning services for clients, was a member of

the North Carolina Bar Association Section of Taxation (which he

had previously chaired), chaired the Southeastern Region Special

Liaison Tax Committee (not further identified in the record), and

managed his law firm.    Also in those years, petitioner was an

elder of the Calvary Church and a member of its finance and

building committees.    He also negotiated a $17 million

construction loan for the Calvary Church, formed the St.

Catherine partnership with two of his law partners to manage the

construction and leasing of a building for Weinstein and

Sturgess, cared for his mother during a long illness, invested in

a Texas corporation that was the plaintiff in a class action

lawsuit for which petitioner hired the attorney and in which he

participated extensively, and was a member of the board of

directors of One Price Clothing Stores, Inc., discussed at

paragraph B-2, below.

B.   Petitioner's Investment in Women's Clothing Stores

     1.   Formation of J.K. Apparel

     In 1984, Edward and Arlene Karp (the Karps), Henry Jacobs

(Jacobs), Raymond Waters (Waters), John Waters, and petitioner

decided to open a women's clothing store which would sell

everything at one price.    In June 1984, they incorporated J.K.

Apparel, Inc. (J.K. Apparel), in North Carolina.    J.K. Apparel
                                - 4 -

issued 30,000 shares of common stock with a par value of $1 per

share.    On June 29, 1984, petitioner bought 3,000 shares of J.K.

Apparel stock for $3,000.   The owners of J.K. Apparel's shares

were as follows:

                  Number of              Percentage of      Cost
Shareholder    shares purchased         shares purchased    basis
Arlene Karp         12,000                     40%         $12,000
Henry Jacobs        12,000                     40           12,000
Petitioner           3,000                     10            3,000
Raymond Waters       1,500                      5            1,500
John Waters          1,500                      5            1,500
     Total          30,000                    100           30,000

     On August 23, 1984, J.K. Apparel opened its first one price

women's clothing store in South Carolina.

     2.    One Price Clothing Stores, Inc.

     In 1985, petitioner and the other shareholders of J.K.

Apparel decided to change the name of the corporation and to

reincorporate in South Carolina.   On August 28, 1985, One Price

Clothing Stores, Inc. (the original One Price), was incorporated

in South Carolina.

     On August 30, 1985, J.K. Apparel merged into the original

One Price.   The original One Price was the surviving corporation.

As part of the merger, the shareholders of J.K. Apparel received

10 shares of original One Price common stock for each of their

shares of J.K. Apparel.   Thus, petitioner received 30,000 shares

of original One Price common stock in exchange for his 3,000

shares of J.K. Apparel stock.
                                 - 5 -

     The original One Price also issued 10,000 shares of common

stock and 62,000 shares of Class A nonvoting common stock with a

par value of $.10 per share.     On August 30, 1985, petitioner

bought 1,000 shares of the original One Price common stock for

$100.     The owners of the newly issued shares of original One

Price stock were as follows:

                  Number of                                    Cost
Shareholder    shares purchased               Class            basis
Arlene Karp          4,000                    common            $400
Henry Jacobs         4,000                    common             400
Petitioner           1,000                    common             100
Raymond Waters         500                    common              50
John Waters            500                    common              50
     Total          10,000                    common           1,000

Henry Jacobs           54,560            Class A, nonvoting   $5,456
Raymond Waters          7,440            Class A, nonvoting      744

     At the end of 1985, petitioner owned 31,000 shares of the

original One Price stock.

     3.      The Karp Option

     Mrs. Karp owned 124,000 shares of original One Price stock.

On December 17, 1986, she sold petitioner, Waters, John Waters,

and Jacobs (the four founders) an option to buy her stock for

$4,860,000.     Each of the four founders paid $1,250 for the option

($5,000 total) and agreed that they would each receive 31,000

(one-fourth) of Mrs. Karp’s shares.

     On January 30, 1987, the four founders exercised the option

and each bought 31,000 shares from Mrs. Karp for $1,215,000.           To

pay for the shares, each of the four founders immediately resold
                                - 6 -

18,274 of their 31,000 shares (a total of 73,096 shares).     Each

of the four founders received $1,215,000 for the 18,274 shares of

stock they sold.

       4.   Petitioner's Gifts of Stock

       On February 6, 1987, petitioner gave 1,000 shares of

original One Price stock to Mrs. Groves.    In March 1987, he gave

3,000 shares to his children.

       5.   OPCS, Inc.

       In March 1987, the founders of original One Price decided to

make a public offering of its stock and to reincorporate the

original One Price in Delaware.    On April 6, 1987, they filed

articles of incorporation in Delaware for OPCS, Inc.    The

original One Price owned all of the outstanding shares of OPCS,

Inc., stock.

       On April 8, 1987, the original One Price merged into OPCS,

Inc.    OPCS, Inc., was the surviving corporation and changed its

name to One Price Clothing Stores, Inc. (OPCS).    As a result of

the merger, the original One Price shareholders received

10.120811 shares of OPCS stock for each of their shares in the

original One Price.

       Petitioners received a total of 412,179 shares of OPCS

stock; petitioner received 402,059 shares, and Mrs. Groves

received 10,120 OPCS shares.    Petitioner received six stock
                                - 7 -

certificates for his 402,059 shares, and Mrs. Groves received

four certificates for her 10,120 shares.

     In May 1987, OPCS made an initial public offering of 500,000

shares of stock.    Its shareholders, including petitioner, also

offered 500,000 shares of their OPCS stock for sale.    On May 19,

1987, petitioner sold 99,838 shares of OPCS stock for $1,392,740.

     On June 3, 1987, petitioner gave to Calvary Church 22,730

shares of OPCS stock.

     Adrian Delk (Delk) prepared petitioners' tax returns for tax

years 1982 to 1991.    Delk was the managing partner of his

accounting office.    Petitioner met with Delk in June 1987 to

discuss petitioner’s potential tax liability after the public

offering.    Delk knew that petitioner had acquired stock at

different times and that petitioner had different bases in the

stock.

     On September 30, 1987, OPCS stock split 3 for 2.      As an OPCS

director, petitioner approved the April 1987 merger and signed a

corporate resolution authorizing the September 1987 stock split.

     6.     Petitioners’ Sales of Stock and SEC Rule 144

     In 1988 and 1989, petitioners told their broker to sell

blocks of 5,000, 30,000, 10,000, 4,000, 2,000, 20,000, and 20,000

OPCS shares.    Securities and Exchange Commission (SEC) rule

144(d), 17 C.F.R. sec. 230.144 (1984), prohibited petitioner from

selling the OPCS stock that he bought from Mrs. Karp for 2 years.
                                           - 8 -

He was required to report on SEC Form 144 the number of shares he

proposed to sell and his acquisition date.                    For each proposed

sale of OPCS stock in 1988 and 1989 by petitioners, petitioners

submitted to their stock broker and to the SEC a Form 144

executed by petitioner or Mrs. Groves, a seller's representation

letter signed by petitioner or Mrs. Groves, and letters from the

attorney for OPCS stating the opinion that petitioners had

complied with SEC rule 144.               Petitioners reported their proposed

sales of OPCS stock during 1988 and 1989 on Forms 144 as follows:

                         Sales Reported on Forms 144
      Stock          Acquisition    # of shares Proposed Acquired            Nature of
      owner              date        to be sold sale date from/by            acquisition
Jane B. Groves        2/6/87         5,000       2/25/88 J.R. Groves          Gift of
                                                                              June 1984
                                                                              stock
Jane B. Groves        2/6/87         2,000          5/2/88     J.R. Groves    Gift of
                                                                              June 1984
                                                                              stock

J. Randall Groves     6/2/84        30,000          5/3/88     The company    Private
                                                                              placement
                                     1
J. Randall Groves     6/2/84          4,000         5/3/88     The company    Private
                                                                              placement
J. Randall Groves     6/2/84        20,000          3/13/89    Purchase       Founder
                                                                              stock
J. Randall Groves     1/30/87       20,000          5/26/89    Purchase       A. Kemp2
                                                               from           [sic]
                                                               selling
                                                               shareholder
      1
        This was an amended form.        The original Form 144 contained the
following information:

J. Randall Groves     6/2/84        10,000          5/3/88     The company    Private
                                                                              placement
      2
          This should read:    A. Karp.

      Petitioner could not sell the stock he had acquired from

Mrs. Karp in 1988 because it was still subject to a 2-year

holding period under SEC rule 144.                 Thus, he reported to the SEC
                               - 9 -

in 1988 that he intended to sell only shares he had acquired from

OPCS (or its predecessor).

      7.   Petitioner’s Gift of Stock in 1989

      On May 5, 1989, petitioner gave 20,000 shares of One Price

stock to Campus Crusade for Christ.     He told Campus Crusade for

Christ that petitioners’ tax considerations would determine when

he made further contributions to that organization.

C.    Preparation of Petitioners' Income Tax Returns for 1988 and
      1989

      Petitioner prepared tax organizers for 1988 and 1989 and

gave them to Delk.   Petitioner used Forms 1099 and W-2 to

complete the tax organizers for 1988 and 1989.    Petitioner did

not have a schedule or records showing his basis in, or number of

shares of, OPCS stock when he listed the bases of the stock

petitioners sold in 1988 and 1989 on the tax organizers.     There

is no indication that petitioner knew the basis in his OPCS stock

in 1988 or 1989.   Petitioner listed the following information

about the stock he sold in 1988 and 1989 in the tax organizer for

1988 and 1989:

                              1988
      # of           Date      Date       Gross sales     Cost or
     shares        acquired    sold          price      other basis
     35,280        1/30/87     5/3/88      $467,500       $158,760
      3,000         2/1/87    3/15/88        52,500         13,000
      2,000         2/2/87    5/15/88        26,500          9,000
                                    - 10 -

                                 1989
       # of           Date       Date          Sales        Cost or
      shares        acquired     sold          price         basis
      20,000        1/30/87     3/13/89      $240,000       $74,000
      20,000        1/30/87     5/26/89       322,500        74,000

       Petitioner correctly listed the number of shares sold, the

date on which they were sold, and the sales price on the 1988

organizer.     However, he incorrectly listed acquisition dates.   He

also incorrectly listed the basis of the stock he sold in 1988

and 1989.

       Petitioner did not give Delk documents to support the

information he listed on the tax organizers.      Delk used the

information from petitioner’s tax organizers to prepare

petitioners' 1988 and 1989 tax returns.

D.     Petitioners’ Tax Returns for 1988 and 1989

       Petitioners reported on their 1988 and 1989 returns that

they sold OPCS stock as follows:

                                 1988
# of shares         Reported       Sale           Gain       Actual
   sold               Basis        price        reported     basis1
  35,280           $158,760      $467,500       $308,740     $235
   3,000             13,000        52,500         39,500       20
   2,000              9,000        26,500         17,500       13

                                 1989
# of shares          Reported       Sale          Gain       Actual
   sold               Basis         price       reported     basis1
  20,000             $74,000      $240,000      $166,000      $133
  20,000              74,000       322,500       248,500    51,800
1
    This column was not on petitioners’ 1988 return.

       Petitioner received the 1988 return from Delk on April 14,

1989, and signed it without reviewing it in detail.
                               - 11 -

E.   Audit of Petitioners' Returns

     Revenue Agent Kathy Sexton (Sexton) began examining

petitioners' 1987, 1988, and 1989 returns in July 1990.    Sexton

asked petitioner to substantiate the capital gains petitioners

reported on their 1988 and 1989 returns and to provide a schedule

showing the number of shares of original One Price stock

petitioners owned on January 1, 1987; the date of purchase,

number, and purchase price of shares they bought in 1987, 1988,

and 1989; all stock splits in 1987, 1988, and 1989; and

petitioners’ computation of per share costs.   Petitioner sent

Sexton a letter and memorandum and gave her boxes of documents

about OPCS in response to her document request.    The record does

not show specifically what records petitioner gave to Sexton.

     Petitioner told Sexton that he reported the basis of the

OPCS stock based on how much petitioner had paid for it.   He gave

her some, but not all, of the basis information she requested.

She could not compute petitioner’s basis because, for example, he

did not mention the September 30, 1987, stock split.   Sexton and

Delk met several times in 1990 and 1991.   Delk showed Sexton

petitioner’s tax organizers.

F.   Petitioner's Criminal Case

     On August 27, 1992, petitioner pleaded guilty to two counts

of violating section 7203 (willful failure to file a return,

supply information, or pay tax) (a misdemeanor).   Petitioner
                                - 12 -

admitted in the plea agreement that he had willfully failed to

supply information on his tax returns for 1988 and 1989 about

$180,485 and $96,066, respectively, of gains from sales of OPCS

stock.

     On March 28, 1996, the U.S. District Court for the Western

District of North Carolina, Judge Graham C. Mullen (Judge Mullen)

presiding, accepted petitioner's guilty plea.     On April 22, 1996,

judgment was entered against petitioner pursuant to his guilty

plea.

G.   State Bar Grievance Committee Proceedings

        In 1996, the Grievance Committee of the North Carolina State

Bar Association decided there was not probable cause to initiate

disciplinary action against petitioner as a result of

petitioner’s conviction.

H.      Notice of Deficiency

        On November 21, 1997, respondent issued a notice of

deficiency to petitioners for 1988 and 1989.     In it, respondent

determined that petitioners had capital gains of $626,619 in 1988

and $514,850 in 1989, which was $180,492 more than petitioners

had reported for 1988 and $96,067 more than they had reported for

1989.     Respondent also determined that petitioners were liable

for additions to tax and a penalty for overvaluation of their

OPCS stock under section 6659 for 1988 and for fraud for 1988 and

1989.
                                - 13 -

                                OPINION

A.   Addition to Tax for Fraud Under Section 6653(b) and
     Penalty Under Section 6663(a)

     1.   Background

     Respondent contends that petitioner is liable for the

addition to tax for fraud under section 6653(b) for 1988 and the

fraud penalty under section 6663(a) for 1989, and concedes that

Mrs. Groves is not liable for fraud.      Respondent has the burden

of proving fraud by clear and convincing evidence.     See sec.

7454(a); Rule 142(b).    Respondent must establish:   (a) Petitioner

underpaid tax for each year in issue, and (b) some part of the

underpayment is due to fraud.    See sec. 6653(b); Parks v.

Commissioner, 94 T.C. 654, 660-661 (1990); Petzoldt v.

Commissioner, 92 T.C. 661, 699 (1989).

     2.   Underpayment

     Petitioners concede that they underpaid tax related to their

sales of OPCS stock for 1988 and 1989.

     3.   Fraudulent Intent

     For purposes of section 6653(b), fraud is the intentional

commission of an act to evade a tax believed to be owing.     See

Webb v. Commissioner, 394 F.2d 366, 377 (5th Cir. 1968), affg.

T.C. Memo. 1966-81; Mitchell v. Commissioner, 118 F.2d 308, 310

(5th Cir. 1941), revg. 40 B.T.A. 424 (1939).     Fraud is never

presumed; it must be established by affirmative evidence.     See

Beaver v. Commissioner, 55 T.C. 85, 92 (1970).      The Commissioner
                                - 14 -

may prove fraud by circumstantial evidence because direct

evidence of the taxpayer's intent is rarely available.   See

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

748 F.2d 331 (6th Cir. 1984).

     Petitioner recognizes that he is collaterally estopped from

contesting each element of section 7203.   Thus, he does not

dispute that he is collaterally estopped from denying that he

knew he had the duty to maintain records or supply information

and that he willfully failed to do so for 1988 and 1989.    See

Kotmair v. Commissioner, 86 T.C. 1253, 1264 (1986).   Petitioner's

conviction under section 7203 does not estop him from arguing

that he lacked fraudulent intent for 1988 and 1989, but it is

evidence that he committed fraud.    See Wilkinson v. Commissioner,

T.C. Memo. 1997-410.

     4.   Badges of Fraud

     Courts have developed several objective indicators, or

"badges", of fraud.    See Recklitis v. Commissioner, 91 T.C. 874,

910 (1988).   Respondent argues that the following badges of fraud

are present in this case:   (1) Large understatements of income;

(2) inadequate books and records; (3) failure to give accurate

information to tax return preparer; (4) failure to cooperate with

tax authorities; (5) implausible and inconsistent explanations of

behavior; and (6) training, business experience, and knowledge of

the income tax laws.
                               - 15 -

     We disagree that respondent has clearly and convincingly

proven that petitioner committed fraud.    We think a more likely

explanation is that petitioner’s understatements of income were

due to negligence.

     Petitioner had large understatements of income in 1988 and

1989 resulting from his sale of OPCS stock.     While that is a

factor to be considered, a substantial understatement of income

standing alone does not prove fraud.    See Vannaman v.

Commissioner, 54 T.C. 1011, 1018 (1970).

     Petitioner did not keep records showing the number of his

shares of, or his basis in, OPCS stock in 1988 and 1989.

However, we do not believe that he did so with the intent to

underpay tax.   Instead, we think he was careless.    Carelessness

in the preparation and maintenance of books and records is not

fraud.   See Mitchell v. Commissioner, supra.

     Respondent argues that petitioner intentionally misled Delk.

We disagree.    Petitioner admits that he hurriedly and negligently

prepared the 1988 tax organizer.   However, he testified that he

told Delk about the errors on the organizers and that Delk had

the correct information available to him.   Petitioner credibly

testified that he did not expect that the information on the 1988

and 1989 organizers would appear on petitioners’ returns as given

to Delk.   Although petitioner did not give correct information to

Delk about the bases in the OPCS stock, we are not convinced that
                                - 16 -

he did so with the intent to mislead Delk.     Respondent has not

shown that petitioner knew the bases of the shares he sold in

1988 and 1989 or that he intentionally gave Delk incorrect

information.

     Respondent disputes petitioner’s claim that he told Delk

about the errors on petitioner’s 1988 and 1989 organizers.

Despite respondent’s suspicions, respondent offered no credible

evidence to the contrary.     Neither party called Delk to testify

due to his poor health.

     Respondent argues that petitioner did not cooperate with

respondent's agents because he did not give Sexton all of the

documents she requested.     Petitioner provided a substantial

amount of documents to Sexton in response to her requests, and

petitioner or Delk attended meetings with Sexton.     Respondent did

not show what documents petitioner gave Sexton, and so we cannot

evaluate respondent’s contention that petitioner was so

uncooperative as to constitute a badge of fraud.

     Respondent contends:    (a) Petitioner’s testimony that

he thought he had a basis of about $4 per share in the OPCS stock

he sold in 1988 was not credible, (b) petitioner did not explain

why petitioners reported sales of high basis stock on their 1988

return when SEC rule 144 barred him from selling stock he had

acquired within 2 years, and (c) petitioner knew that his 1988

organizer was in error.     Respondent relies on these points in
                                - 17 -

arguing that petitioner knew and intentionally misstated the

bases of the stock he sold in 1988 and 1989.     We are not

convinced that he did.    Respondent has not offered any evidence

that petitioner intended to underpay tax that is as convincing as

the many indications that his conduct is more fairly viewed as

negligent.

     Respondent points out that petitioner was an experienced tax

attorney.    While that is a factor to be considered, it does not

establish that he had fraudulent intent.     We do not find fraud

under "circumstances which at most create only suspicion."       Davis

v. Commissioner, 184 F.2d 86, 87 (10th Cir. 1950); Katz v.

Commissioner, 90 T.C. 1130, 1144 (1988).     There is neither direct

evidence nor enough circumstantial evidence to show clearly and

convincingly that the understatements on the returns were due to

fraud.

     5.      Conclusion

     We hold that petitioner is not liable for the addition to

tax for fraud for 1988 and the fraud penalty for 1989.

B.   Statute of Limitations

     Respondent mailed the notice of deficiency to petitioners

more than 6 years after they filed their returns for 1988 and

1989.     Thus, the statute of limitations bars assessment and

collection of the deficiencies determined for 1988 and 1989,

unless petitioners’ returns for those years were false or
                             - 18 -

fraudulent with the intent to evade tax.    See sec. 6501(c)(1).

As discussed above, respondent failed to prove by clear and

convincing evidence that petitioner committed fraud.    We hold

that respondent is barred by the statute of limitations from

assessing and collecting tax and the addition to tax for

valuation overstatement for the years in issue.

     To reflect the foregoing,


                                           Decision will be entered

                                   for petitioners.
