                        T.C. Memo. 2011-73



                     UNITED STATES TAX COURT



               MONA LISA HERRINGTON, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 12204-04.              Filed March 30, 2011.



     R. Cody Mayo, Jr., for petitioner.

     Marshall R. Jones, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     THORNTON, Judge:   Respondent determined the following

deficiencies, penalties, and additions to tax with respect to

petitioner’s 1997 and 1998 Federal income taxes:1


     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
                                                   (continued...)
                                      - 2 -

                                  Penalties and Additions to Tax
                            Sec.          Sec.       Sec.          Sec.
 Year       Deficiency   6651(a)(1)     6651(f)    6662(a)         6663
 1997        $46,587      $11,647           ---      ---       $34,940
                                        1
 1998         62,094        ---          $46,571   $12,419         ---

       1
      The notice of deficiency states that if it is
determined that the sec. 6651(f) addition to tax is inapplicable,
the sec. 6651(a) addition to tax is applicable.

       After concessions by both parties, the issues to be decided

are:       (1) Whether petitioner is entitled to deduct as

compensation or theft losses certain amounts that her abusive

boyfriend took from her business while working there during 1997

and 1998; (2) whether for 1997 petitioner is liable for the civil

fraud penalty under section 6663; and (3) whether for 1998

petitioner is liable for an addition to tax under section 6651(f)

for fraudulent failure to file.2




       1
      (...continued)
Procedure. All amounts are rounded to the nearest dollar.
       2
      Petitioner concedes that if she is not liable for the sec.
6651(f) addition to tax and sec. 6663 fraud penalty, she is
liable for the sec. 6651(a)(1) addition to tax for 1997 and the
sec. 6662(a) penalty for 1998 to the extent that they apply
computationally. Although, as indicated above, respondent
determined in the notice of deficiency that for 1998 the sec.
6651(a) addition to tax should apply if the sec. 6651(f) addition
to tax is inapplicable, on brief respondent has not advanced this
alternative position, and we deem him to have abandoned or waived
it.
                                - 3 -

                         FINDINGS OF FACT

     The parties have stipulated some facts, which we incorporate

by this reference.   When she petitioned the Court, petitioner

resided in Louisiana.

     In 1991 petitioner was working two jobs to support herself

and her two young children.    One job was as the owner of an H&R

Block franchise; the other was in a prison detention center.     She

had recently divorced, her father had recently died, and her

mother had moved into her house to help take care of the

children.   About this time petitioner became involved with a man

working at her H&R Block office, and he moved in with her.     She

later learned that he had an extensive criminal record and a

violent temper.

     Petitioner’s relationship with the boyfriend was marked by

intimidation and physical abuse.   When she failed to do his

bidding or attempted to leave him, he reacted violently.   He once

threw her from a moving car.   Another time when she threatened to

leave him, he placed a gun against her forehead and cocked the

hammer.   On another occasion, in midwinter, he hit her in the

head with a beer bottle and threw her from a boat into a lake.

On another occasion, she testified credibly, he “gave me a

picture of my daughter with her face shot out, and told me that’s

what would happen to her if I tried to leave.”
                                - 4 -

     At some point after becoming involved with petitioner, the

boyfriend obtained a video poker license and opened an

establishment in Monroe, Louisiana.     After only a few months, he

lost his license for misdeeds that included selling liquor to a

minor.   The boyfriend convinced petitioner to open her own video

poker business.

     In 1996 petitioner acquired two video poker licenses in her

own name.   Because, according to petitioner’s testimony, the

licenses were required “to be run separately”, she opened two

sandwich shops next door to each other in Farmerville, Louisiana,

each with a video poker machine.    Petitioner worked in the shops

making sandwiches and dealing with the public.    The boyfriend

took charge of the finances and the books and had check-signing

authority on the business bank accounts.    Virtually all the

shops’ income resulted from video poker revenue.

     Petitioner and the boyfriend had no agreement regarding his

compensation.    Rather, as petitioner testified, he “set his own

compensation”.    He did this by writing checks to himself or to

cash, signing either his name or petitioner’s name.    In this

manner he withdrew from petitioner’s business accounts $114,000

during 1997 and $96,000 during 1998.    He used these funds to pay

his personal expenses, including his child support obligations.

     Petitioner knew that the boyfriend was writing checks and

taking money out of her business accounts.    But she did not know
                                - 5 -

beforehand when he might write checks or for how much.

Consequently, she was left in constant uncertainty about the

balances in her business checking accounts.    To avoid overdraft

fees, she worked out an arrangement with a friend who worked at

her local bank and who knew of petitioner’s troubles with the

boyfriend.   Each morning petitioner would call her friend at the

bank to determine how many of her checks were set to clear the

accounts that day.    As long as petitioner made a cash deposit to

cover the checks by noon of any given business day, the bank

would honor the checks and not charge overdraft fees.

     The shops operated until 1999, when the parish outlawed

video poker.   By that time, petitioner had moved with her family

to Shreveport.   The boyfriend initially followed her there but

eventually moved on.

     As a condition for maintaining her video poker licenses,

petitioner had been required annually to submit copies of her

Federal income tax returns to the Louisiana State Police.    The

boyfriend had prepared petitioner’s 1997 Federal income tax

return, and petitioner had signed it.    According to petitioner’s

testimony, the boyfriend told her that he would file the return,

but he never did.    Shortly before her shops ceased operations,

petitioner attached a copy of the return to her State video poker

application and signed a release allowing the police to verify

that the return had been filed with the Internal Revenue Service
                                 - 6 -

(IRS).   It then came to light that petitioner’s 1997 and 1998

returns had never been filed.3

     Resulting inquiries led, in the summer of 1999, to an IRS

criminal investigation.   In 2004 petitioner pleaded guilty to

willful failure to file tax returns under section 7203 for tax

years 1997 and 1998.

     During the course of the criminal investigation the

boyfriend, who was also under criminal investigation, contacted

petitioner and told her that he needed to file his own tax

returns and needed a statement from her regarding the amount of

money he had received from her business.   After reviewing the

books, they agreed that the boyfriend had received from her

business $114,000 in 1997 and $96,000 in 1998.   At the

boyfriend’s urging, they signed affidavits stating that during

each of the years 1997 and 1998 the boyfriend “took cash and paid

personal expenses from the two businesses” in the amounts

previously agreed upon and that these takings represented “his

total compensation as a consultant to the businesses”.

     On April 14, 2000, petitioner filed her 1997 Federal income

tax return, reporting income from her two shops, as sole

proprietorships, on two Schedules C, Profit or Loss From




     3
      The record does not reveal the circumstances of
petitioner’s failure to file her 1998 return.
                                - 7 -

Business.    She reported total Schedule C expenses of $263,590.4

On April 9, 2001, petitioner filed her 1998 Federal income tax

return, claiming total Schedule C expenses for the two shops of

$197,157.5

     In the notice of deficiency respondent disallowed $133,284

of petitioner’s Schedule C expenses for 1997 and $174,701 for

1998, for the stated reason that it had not been established that

these amounts constituted ordinary and necessary business

expenses or were expended for the purpose designated.6

                               OPINION

I.   Deductibility of the Withdrawals

     There is no dispute about any item of petitioner’s income or

deductions other than the deductions that petitioner claims with

respect to the amounts the boyfriend received, stipulated to have


     4
      Petitioner’s 1997 Federal income tax return showed net
Schedule C income of $51,848 and total tax liability of $13,270.
On the same day she filed her 1997 return, she also submitted an
amended 1997 Federal income tax return, showing a greater amount
of net Schedule C income than that reported on her original
return but a smaller total tax liability. Respondent did not
process the amended 1997 return, and the notice of deficiency is
based on the original 1997 return.
     5
      Petitioner’s 1998 return showed Schedule C net income of
$35,634 and total tax liability of $7,356.
     6
      The notice of deficiency does not itemize exactly which
Schedule C expenses are disallowed other than by a line-item
reference to “Sched C - Other expenses”. The Court is unable to
correlate the amount of the “Other expenses” disallowed in the
notice of deficiency with specific expenses that petitioner
claimed on her Schedules C.
                                - 8 -

been $114,000 for 1997 and $96,000 for 1998.7   Petitioner

contends that these amounts are deductible as compensation for

personal services rendered.    Petitioner further contends that any

amounts not deductible as compensation are deductible as thefts

or conversions by the boyfriend.8   For the reasons discussed

below, we conclude that none of the amounts at issue are properly

deductible as reasonable compensation under section 162 but that

all these amounts are deductible as theft losses under section

165.

       Section 162(a) allows as a deduction ordinary and necessary

expenses paid or incurred during the taxable year in carrying on

any trade or business, including “a reasonable allowance for

salaries or other compensation for personal services actually

rendered”.    The test of deductibility for compensation payments

is “whether they are reasonable and are in fact payments purely

for services.”    Sec. 1.162-7(a), Income Tax Regs.   In Paula


       7
      The parties have stipulated that if the payments to the
boyfriend are held to be fully deductible, petitioner “is due
negative adjustments to income (as computed by reference to the
Notice) for 1997 and 1998 of $26,030.35 and $12,058.00,
respectively.” The record is inadequate for the Court to
replicate these calculations.
       8
      Pursuant to Rule 142(a) and sec. 7491(a), petitioner has
the burden of proof on these issues unless she introduces
credible evidence so as to shift the burden to respondent.
Because our conclusions are based on a preponderance of the
evidence, the allocation of the burden of proof is immaterial
with respect to these issues. See Martin Ice Cream Co. v.
Commissioner, 110 T.C. 189, 210 n.16 (1998).
                               - 9 -

Constr. Co. v. Commissioner, 58 T.C. 1055, 1058-1059 (1972),

affd. without published opinion 474 F.2d 1345 (5th Cir. 1973),

this Court stated:   “It is now settled law that only if payment

is made with the intent to compensate is it deductible as

compensation.   Whether such intent has been demonstrated is a

factual question to be decided on the basis of the particular

facts and circumstances of the case.”   (Citations omitted.)

     A preponderance of the evidence convinces us that the

amounts that the boyfriend took from petitioner’s business

accounts were not paid with the requisite intent by petitioner to

compensate him.   To the contrary, the facts indicate that

petitioner was not even aware beforehand when the boyfriend might

decide to write himself a check or for how much.   To avoid

overdraft fees, she had to communicate with her bank each day to

see whether she needed to cover whatever amounts the boyfriend,

without her knowledge, might have withdrawn from the business

accounts.   Given the nature of the relationship between

petitioner and the boyfriend, which even respondent characterizes

as “incredibly abusive”, we are not convinced that this

arrangement signified anything more than the boyfriend’s

domination and control over her.   We believe the situation is

summed up by petitioner’s testimony that the boyfriend “set his

own compensation”.   For similar reasons, we attach little

significance to the fact that during the criminal investigation
                               - 10 -

petitioner signed affidavits, at the boyfriend’s urging,

indicating that the amounts he had taken represented

compensation.   And although the boyfriend apparently performed

some services for petitioner’s businesses, the record does not

suggest any correlation between the services he rendered and the

amounts he took.   We conclude that the amounts the boyfriend took

are not properly deductible as reasonable compensation.

     An individual may deduct losses, including theft losses,

incurred in a trade or business.    Sec. 165(a), (c); see Marian v.

Commissioner, T.C. Memo. 1985-554; Clemons v. Commissioner, T.C.

Memo. 1979-273.    A theft loss is “sustained during the taxable

year in which the taxpayer discovers such loss.”    Sec. 165(e).

If in the year of discovery, however, there exists a claim for

reimbursement, no loss shall be considered sustained until the

taxable year in which it can be ascertained with reasonable

certainty that no reimbursement will be received.    Sec.

1.165-1(d)(3), Income Tax Regs.

     “[T]heft” is “a word of general and broad connotation,

intended to cover and covering any criminal appropriation of

another’s property to the use of the taker, particularly

including theft by swindling, false pretenses, and any other form

of guile.”   Edwards v. Bromberg, 232 F.2d 107, 110 (5th Cir.

1956); see also sec. 1.165-8(d), Income Tax Regs.    Generally,

whether a theft loss has been sustained depends upon the law of
                              - 11 -

the State where the loss was sustained.    Bellis v. Commissioner,

540 F.2d 448, 449 (9th Cir. 1976), affg. 61 T.C. 354 (1973);

Luman v. Commissioner, 79 T.C. 846, 860 (1982); Paine v.

Commissioner, 63 T.C. 736, 740 (1975), affd. without published

opinion 523 F.2d 1053 (5th Cir. 1975).    Although a criminal

conviction in a State court may conclusively establish the

existence of a theft, the deduction does not depend upon whether

the perpetrator is convicted or prosecuted or even whether the

taxpayer chooses to move against the perpetrator.    Weingarten v.

Commissioner, 38 T.C. 75, 78 (1962); Vietzke v. Commissioner, 37

T.C. 504, 510 (1961).   The taxpayer need prove only by a

preponderance of the evidence that a theft occurred under the

relevant State statute.   Allen v. Commissioner, 16 T.C. 163, 166

(1951).

     Petitioner’s loss occurred in the State of Louisiana.

Louisiana law provides:

     Theft is the misappropriation or taking of anything of
     value which belongs to another, either without the
     consent of the other to the misappropriation or taking,
     or by means of fraudulent conduct, practices, or
     representations. An intent to deprive the other
     permanently of whatever may be the subject of the
     misappropriation or taking is essential. [La. Rev.
     Stat. Ann. sec. 14:67 (2007).]

     A preponderance of the evidence convinces us that the

boyfriend’s taking of funds from petitioner’s business accounts

for his personal purposes constituted theft within the meaning of

Louisiana law.   The evidence does not suggest, and respondent
                               - 12 -

does not contend, that petitioner consented before the fact to

the boyfriend’s writing checks from petitioner’s business

accounts to pay his personal expenses.    To the contrary, as

previously discussed, the evidence shows that petitioner would

often find out about these checks only after the fact by making

inquiries at the bank.    We infer that petitioner proceeded in

this manner to avoid physical confrontation with the boyfriend.

     On brief, respondent contends that the boyfriend’s takings

should not be viewed as thefts or conversions because petitioner

“never objected to the transfers and there is no evidence that

she reported any theft to the appropriate authorities”.    Under

Louisiana law, however:   “In order to consent to the theft of his

property, an owner must do more than passively assent to the

taking.”    State v. Johnson, 408 So. 2d 1280, 1283 (La. 1982).    We

do not believe that petitioner ever gave more than passive assent

to the boyfriend’s taking her business funds.    But even if

petitioner might be thought in some general way to have consented

to the boyfriend’s compensating himself with her business funds,

we do not believe that it was effective consent, but rather that

it was induced by force and threats by the boyfriend, who had on

more than one occasion threatened to kill petitioner and her

children.    For similar reasons, we assign little significance to

the fact that she did not report the thefts to the authorities.
                                - 13 -

      Respondent contends that because petitioner and the

boyfriend lived together at times, she personally benefited from

the withdrawals, such that they should be considered her

nondeductible living expenses pursuant to section 262.      We are

not convinced by respondent’s argument, which is inconsistent

with our finding, based upon petitioner’s unopposed proposed

finding of fact, that the boyfriend used the funds taken from

petitioner’s business to pay his personal expenses.

      On a preponderance of the evidence we find (and respondent

does not contend otherwise) that petitioner had no prospect of

being reimbursed for any amounts the boyfriend took and that she

sustained the losses in the years for which she has claimed the

deductions.   There is no dispute as to the amounts.   On the basis

of all the evidence, we hold and conclude that petitioner is

entitled to deduct as theft losses incurred in a trade or

business the $114,000 that the boyfriend took in 1997 and the

$96,000 that he took in 1998.

II.   Section 6663(a) Fraud Penalty

      Section 6663(a) imposes a penalty on the taxpayer if any

part of a tax underpayment is due to fraud.    The burden of proof

is upon the Commissioner to show by clear and convincing evidence

that the fraud penalty applies.    Sec. 7454(a); Rule 142(b).    To

satisfy his burden of proof, the Commissioner must establish both

that an underpayment exists for each year and that some part of
                                - 14 -

the underpayment is due to fraud.    See DiLeo v. Commissioner, 96

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

     Respondent’s determination of the section 6663(a) penalty

for 1997 is predicated upon his determination that part of

petitioner’s underpayment is attributable to her claiming

improper deductions for the funds taken by the boyfriend and that

this part of the underpayment is due to fraud.    Because we have

held that petitioner is entitled to deduct these amounts as a

theft loss, respondent has failed to show that any part of the

underpayment is due to fraud.    Consequently, we do not sustain

the section 6663(a) fraud penalty.

III. Section 6651(f) Addition to Tax

     Respondent determined that petitioner is liable for the

section 6651(f) addition to tax for fraudulently failing to

timely file her 1998 tax return.    Respondent must establish by

clear and convincing evidence that petitioner’s failure to timely

file was an intentional attempt to evade tax believed to be

owing.   See sec. 7454(a); Rule 142(b); Clayton v. Commissioner,

102 T.C. 632, 653 (1994); Gajewski v. Commissioner, 67 T.C. 181,

199 (1976), affd. without published opinion 578 F.2d 1383 (8th

Cir. 1978).

     Although petitioner’s guilty plea under section 7203

conclusively establishes petitioner’s willfulness in failing to

file her 1998 return, it does not conclusively establish
                               - 15 -

fraudulent intent under section 6651(f).     See Grosshandler v.

Commissioner, 75 T.C. 1, 19 (1980); Wilkinson v. Commissioner,

T.C. Memo. 1997-410.    Petitioner’s ownership of an H&R Block

franchise also suggests that she knew or should have known of the

filing requirement.    Although these are significant badges of

fraud, we are not convinced that even taken together they

conclusively establish her fraudulent intent, particularly taking

into account her physical abuse and the abusive boyfriend’s

intrusion into her business and tax matters.     Respondent

presented no witnesses and introduced no clear and convincing

evidence to establish that petitioner’s failure to timely file

her 1998 tax return was fraudulent.     We do not sustain the

section 6651(f) addition to tax.

     To reflect the foregoing and the parties’ stipulations,


                                             Decision will be entered

                                        under Rule 155.
