                                 T.C. Memo. 2016-49



                           UNITED STATES TAX COURT



          JAMES T. O’NEAL, JR., AND SALLY L. O’NEAL, Petitioners v.
            COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 3648-10.                            Filed March 14, 2016.



      James T. O’Neal, Jr., and Sally L. O’Neal, pro sese.

      Laura A. Price, Mark J. Tober, and Lauren B. Epstein, for respondent.



               MEMORANDUM FINDINGS OF FACT AND OPINION


      NEGA, Judge: By notice of deficiency dated November 6, 2009,

respondent determined deficiencies and penalties with respect to petitioners’

Federal income tax as follows:1


      1
          All section references are to the Internal Revenue Code (Code) in effect at
                                                                       (continued...)
                                          -2-

          [*2]                                    Penalty          Addition to tax
          Year               Deficiency         sec. 6663(a)       sec. 6651(a)(1)
          1994                $92,260            $69,195                  --
          1995                341,497            256,123                  --
          1996                357,357            268,018                  --
          1997               1,168,411            876,308                 --
          1998                516,579            387,434              $128,942

      The issues for decision are:

      (1) whether the periods of limitations for assessment of petitioner’s income

tax liabilities remain open for tax years 1994-98;

      (2) whether petitioners failed to report taxable income of $286,091,

$924,603, $964,326, $3,019,208, and $1,376,697 on their 1994-98 Federal income

tax returns, respectively;

      (3) whether petitioners are entitled to net operating loss (NOL) carryforward

deductions of $6,101,509, $6,091,822, $6,087,370, $6,086,170, and $6,084,165

for tax years 1994, 1995, 1996, 1997, and 1998, respectively;

      (4) whether petitioners are liable for fraud penalties pursuant to section

6663 for tax years 1994-98; and


      1
        (...continued)
all relevant times. All Rule references are to the Tax Court Rules of Practice and
Procedure. All monetary amounts are rounded to the nearest dollar.
                                         -3-

[*3] (5) whether petitioners are liable for the addition to tax pursuant to section

6651(a)(1) for tax year 1998.

                                FINDINGS OF FACT

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

married and resided in Florida at the time they filed their petition.

      Petitioners James T. O’Neal, Jr. (petitioner), and Sally L. O’Neal were

married in 1967 and have four children together: James T. O’Neal III (J.T.), Kelly

O’Neal, Kathleen O’Neal (Katie), and Patrick O’Neal.

I.    Petitioners’ Income and Losses Before Tax Years at Issue

      A.     Petitioner’s Business Dealings and Theft

      In the mid-1970s petitioners joined the Bay Hill Club and Lodge (Bay Hill

Club), a private golf resort located in Bay Hill, Florida. In 1975 petitioners

became acquainted with Arnold Palmer, a professional golfer. Petitioner and Mr.

Palmer became friends and golfing partners. In 1977 Mr. Palmer introduced

petitioner to Mark McCormack, Mr. Palmer’s business partner and agent. Mr.

McCormack was the founder and chairman of International Management Group

(IMG), an international management company that represents professional athletes

and other celebrities.
                                        -4-

[*4] Petitioner’s friendship with Messrs. Palmer and McCormack developed into

a business relationship over the years. Beginning in 1979, petitioner was involved

with Arnold Palmer’s automobile dealerships. In 1988, 1989, and 1990 petitioner

and Messrs. Palmer and McCormack were each one-third shareholders in five

subchapter S corporations that were in the business of selling automobiles:

Arnold Palmer Motors, Inc., Arnold Palmer Ford Lincoln Mercury, Inc., Fairway

Ford, Inc., PMO Motors of Kentucky, Inc., and Nugget Motors of California, Inc.

(collectively, Arnold Palmer dealerships). Petitioner managed the daily operations

of these dealerships. Messrs. Palmer and McCormack were not involved in day-

to-day operations.

      Petitioner began siphoning money from Arnold Palmer Motors, Inc., as

early as October 1985. When one dealership ran short on cash, petitioner

transferred money from another dealership to cover the shortfall. Rather than

transferring funds directly between dealership accounts, petitioner routed transfers

through his personal bank account. Petitioner routinely kept some of the

transferred funds in his own account instead of transferring them to the

appropriate dealership. Messrs. Palmer and McCormack did not authorize

petitioner to take money from the dealerships. On October 15, 1985, petitioner

signed a demand promissory note (October 1985 promissory note) in favor of
                                        -5-

[*5] Arnold Palmer Motors, Inc., reflecting the amounts he had taken from the

dealership. Petitioner updated the promissory note from time to time. An

attachment to the October 1985 promissory note reflects that as of December 31,

1986, petitioner had taken at least $287,000 from the dealership.

      In the spring of 1989 an Arnold Palmer dealership in South Carolina lost its

financing source, Ford Motor Credit Co. (Ford Motor Credit). Petitioner accepted

responsibility for the financial troubles of the dealership and promised Messrs.

Palmer and McCormack that he would reimburse them for any money that had

been lost. Petitioner also informed Messrs. Palmer and McCormack that he had

borrowed approximately $2 million from the dealerships. Upon learning of

petitioner’s misappropriations, IMG audited the dealerships’ records to determine

the extent of petitioner’s theft. The IMG audit discovered that petitioner had in

fact taken more than $6 million from the dealerships. On April 30, 1989,

petitioner executed an indemnity and security agreement in favor of Messrs.

Palmer and McCormack which granted a security interest in all of his assets to

Messrs. Palmer and McCormack. On May 31, 1989, petitioner executed a demand

promissory note in favor of Fairway Ford, Inc. (Fairway Ford note), in the amount

of $6,056,862 in repayment of the amount he had taken from the dealerships.
                                        -6-

[*6] Glen Blackburn, a former certified public accountant (C.P.A.) for the

Arnold Palmer dealerships, testified at trial. However, there is no evidence as to

the specific years in which any payments were made on the Fairway Ford note or

any specific amounts of such payments, only that they occurred in the “early 90’s”.

Mr. Blackburn’s testimony was not substantiated by any documentation regarding

the dates or amounts of transfers of funds from petitioners to Messrs. Palmer and

McCormack. While petitioners transferred their Isleworth home, discussed in

further detail below, to Messrs. Palmer and McCormack for a purchase price of $4

million, the record is unclear as to whether any money actually changed hands as

part of the transfer of the Isleworth home, and the exchange was not substantiated

by any documentation. Petitioner was removed from any ownership interests in

the Arnold Palmer dealerships in 1990. Mrs. O’Neal subsequently returned to

work to support the family in 1992.

      B.     Loan to Dealerships

      After the South Carolina dealership lost financing, petitioner and Messrs.

Palmer and McCormack executed a promissory note on July 2, 1990,2 in favor of

Ford Motor Credit in the amount of $10.4 million (July 1990 promissory note) in

      2
        It is unclear from the record whether petitioner still had an ownership
interest in the Arnold Palmer dealerships when he signed the July 1990 promissory
note.
                                        -7-

[*7] order to personally guarantee further credit from Ford Motor Credit. The

proceeds of the promissory note were directly invested in Arnold Palmer Ford

Lincoln Mercury, Inc., and treated as a contribution to capital. Petitioner and

Messrs. Palmer and McCormack were each allotted one-third of the total

contribution. Petitioner never made any payments toward the $10.4 million loan

from Ford Motor Credit, and Messrs. Palmer and McCormack ended up making

equal payments toward the loan. Ford Motor Credit looked to Messrs. Palmer and

McCormack for guaranties first and would not have entered into the agreement to

provide credit if Messrs. Palmer and McCormack had not signed the July 1990

promissory note.

      On August 1, 1992, petitioner and Messrs. Palmer and McCormack

executed an amended and restated note in favor of Pittsburgh National Bank in the

amount of $10,230,362 (August 1992 promissory note). The note was an

amendment and restatement of four loans previously made to petitioner and

Messrs. Palmer and McCormack in 1989. These four loans were used to capitalize

Arnold Palmer Motors, Inc., and Fairway Ford, Inc., and treated as a shareholders’

contribution to capital. Each shareholder was allotted one-third of the total

contribution. Petitioner never made any payments toward the loans from

Pittsburgh National Bank, and Messrs. Palmer and McCormack paid off the loans.
                                        -8-

[*8] C.      Petitioners’ Properties

      In 1989 petitioners owned property known as the Bay Hill Farm that was

located across the street from the Bay Hill Club subdivision in Bay Hill, Florida.

Petitioners kept various farm animals at the Bay Hill Farm, including a horse

ridden by one of their daughters, goats, a miniature horse named Smurf, and two

llamas named Leroy and Lollipop. Petitioner’s personal assistant worked in an

office located at the Bay Hill Farm. On August 21, 1989, petitioners sold the Bay

Hill Farm to Mr. Palmer for $1 million. Consideration for the property consisted

of $500,000 to be rendered at closing and forgiveness of $500,000 owed by

petitioner to Mr. Palmer “on a certain Judgment Note”. Petitioners continued to

keep their animals at the Bay Hill Farm after the sale to Mr. Palmer in 1989.

Additionally, two individuals who worked for petitioner resided at the farm for

some time. Mr. Palmer filed suit against petitioners in 1994 to evict the two

individuals and the farm animals from the Bay Hill Farm.

      From 1987 to 1989 petitioners constructed a 28,000-square-foot home at

9766 Green Island Cove in the Isleworth subdivision in Windermere, Florida.

Petitioners paid Thomas Coudriet $1.4 million to build the house, which was

modeled on the clubhouse at the Augusta National Golf Club. Some of the checks

petitioners used to pay Mr. Coudriet were from the checking account belonging to
                                        -9-

[*9] Arnold Palmer Motors, Inc. In the summer of 1989 petitioners owed Mr.

Coudriet between $300,000 and $400,000 to complete construction of the

Isleworth house. Petitioner asked Mr. Palmer for a loan to finish construction on

the house, and Mr. Palmer lent petitioners $1 million in August 1989 to finance

the remaining construction costs. It is unclear to the Court whether Mr. Palmer’s

August 1989 $1 million loan to petitioners was related to his purchase of the Bay

Hill Farm from petitioners for $1 million in August 1989.

      D.     Petitioners’ 1988, 1989, and 1990 Tax Returns

      Petitioners reported NOLs on their 1988, 1989, and 1990 Federal income

tax returns.3 For tax year 1988 petitioners reported an NOL of $813,475 and an

NOL carryforward of $568,352. For tax year 1989 petitioners reported an NOL of

$4,538,294, and an NOL carryover from prior years of $899,206, and an NOL

carryforward of $5,294,098. For tax year 1990 petitioners reported an NOL of

$759,586, an NOL carryover from prior years of $5,440,317, and an NOL

carryforward of $6,161,447. The NOLs claimed by petitioners for 1988-90 totaled

$6,111,355. An addendum to petitioner’s 1989 tax return titled “NOL” recites

amounts of $34,896 for 1985, $25,539 for 1986, $122,028 for 1987, and $716,743


      3
        The record does not contain copies of petitioners’ tax returns for years prior
to tax year 1988.
                                       - 10 -

[*10] for 1988, totaling $899,206, despite the 1988 tax return’s reporting an NOL

carryforward of only $568,352 and no NOL carryovers from prior years.

Petitioners have not offered an explanation for why their 1989 tax return reports a

carryover amount from prior years that is larger than the amount claimed as a

carryforward in 1988, nor have they explained why their 1990 tax return reports a

larger carryover amount from prior years than what was reported on their 1989 tax

return. Petitioners did not report on their 1988 or 1989 income tax return any of

the $6,056,862 petitioner had misappropriated from the Arnold Palmer

dealerships.

      E.       Judgments Against Petitioners

      On April 9, 1991, a final summary judgment in the amount of $5,550,336

was entered against petitioners in the action entitled Sun Bank, N.A. v. APAG

Holdings, Inc., Orange County, Florida, No. CI-90-9676.

      On April 25, 1991, a final judgment in the amount of $300,731 was entered

against petitioner in the action entitled Miller v. O’Neal, Orange County, Florida,

No. CI-1228.

      On December 2, 1991, a default judgment in the amount of $478,224 was

entered against petitioner in the action entitled Bank One, Indianapolis, N.A. v.

O’Neal, Hamilton County Superior Court, Indiana, No. 29D03-9107-CP-318.
                                        - 11 -

[*11] On February 27, 1992, a default judgment in the amount of $11,313,377

plus any related costs was entered against petitioners in the action entitled Bank

One, Indianapolis, N.A. v. O’Neal, Hamilton County Superior Court, Indiana, No.

29D03-9107-CP-318. The judgment was entered in favor of Messrs. Palmer and

McCormack and related to petitioner’s nonpayment toward the July 1990

promissory note.

      In February 1994 petitioner was convicted by a jury in the State of Florida

of two counts of State sales tax evasion. On May 17, 1994, petitioner was ordered

to pay restitution and investigation costs of $389,526 to the State of Florida

pursuant to this conviction.

      The above-described judgments against petitioner individually and

petitioners jointly total in excess of $18 million. Petitioners have never made any

payments toward the $11,313,377 judgment entered against them in favor of

Messrs. Palmer and McCormack. As a result of these judgments, petitioners were

insolvent from 1994 through 1998, the tax years at issue.

II.   Business Dealings During Tax Years at Issue

      A.     Fee Agreement With Patrick Baker

      In 1990 petitioner was the sole shareholder of Arnold Palmer Automotive

Group Holdings, Inc. (APAG Holdings). APAG Holdings wholly owned Arnold
                                       - 12 -

[*12] Palmer Automotive Group of Orlando, Inc. (APAG Orlando). In the early

1990s petitioner, APAG Holdings, and APAG Orlando were plaintiffs in a lawsuit

against General Motors, Inc. (GMC), and General Motors Acceptance Corp.

(GMAC).

      Petitioner met Patrick Baker in either 1992 or 1993. On May 19, 1994, Mr.

Baker agreed to fund petitioner’s lawsuit against GMC and GMAC by paying for

legal fees and petitioner’s living expenses in exchange for receipt of any proceeds

resulting from the litigation (1994 fee agreement). The lawsuit ended in 1994 in

favor of GMC and GMAC. Petitioner did not inform Mr. Baker of the status of

the lawsuit, and he never asked Mr. Baker to pay any of his living expenses.

      B.    Baker O’Neal Holdings, Inc., and American Public Automotive
            Group, Inc.

            1.     Overview of Companies’ Purpose

      Shortly after meeting Mr. Baker, petitioner pitched him the idea of creating

a publicly traded corporation that would operate automobile malls. A witness

compared the concept to Carmax, with locations offering numerous automobile

brands to customers. Petitioner and Mr. Baker formed Baker O’Neal Holdings,

Inc. (BOH), on December 6, 1993. At the time Mr. Baker had some personal

wealth from the recent sale of a family business, and he invested approximately
                                        - 13 -

[*13] $400,000 into BOH. Mr. Baker was the sole shareholder of BOH, and

petitioner served as the president of BOH from its incorporation until September

2, 1998. American Public Automotive Group, Inc. (APAG), was incorporated on

December 27, 1995. BOH was the sole shareholder of APAG, and as with BOH,

petitioner served as the president of APAG from its inception until September 2,

1998. Mr. Baker was aware of petitioner’s prior business involvement with

Messrs. Palmer and McCormack, but petitioner never apprised Mr. Baker of the

judgments entered against him and his wife that exceeded $18 million.

      BOH and APAG were organized for the purpose of developing and

operating automobile dealerships to be located in and around shopping malls (auto

malls). To achieve this purpose, APAG endeavored to purchase several

automobile dealerships from Donald Massey, a Detroit-area automobile dealer,

and raised capital by soliciting private investors. Rather than issuing stock to

investors, APAG memorialized each investment with a promissory note. The

promissory notes bore interest at a rate of 8% less transaction expenses not to

exceed 10% of the outstanding amount of each note. Petitioner and Mr. Baker

gave each investor a personal guaranty in which they agreed to guarantee the

payment of all indebtedness of APAG. APAG promised investors that their

money would be converted to shares of APAG stock upon the earlier of the date
                                        - 14 -

[*14] APAG entered into a definitive agreement with Mr. Massey to acquire his

dealerships or a date certain set forth in each financing letter. Eventually, APAG

planned to execute an initial public offering.

      APAG sought investments only from individuals who were accredited

investors as that term is defined by the Securities and Exchange Commission.

Investors were told their funds were being held in an escrow account. A total of

$16,797,000 in investor money was deposited into APAG’s bank account from

1995 to 1998. At an investor meeting in March 1998, an investor asked about the

status of money that had been raised up to that point. Petitioner told investors that

approximately $1 million had been spent on expenses, $2.5 million had been

deposited with Mr. Massey, and the rest of the funds were in APAG’s bank

account. At the time the meeting was held, APAG had received investor deposits

totaling $16,597,000.4 Subtracting the amounts petitioner represented had been

spent on expenses and deposited with Mr. Massey, APAG should have had

approximately $13,097,000 in its bank account. However, as of April 1, 1998,

BOH and APAG bank accounts held a total of only $1,688,232. In total,

$11,408,768 was missing from the accounts.


      4
      APAG received one additional investment of $200,000 after this meeting
was held.
                                       - 15 -

[*15]         2.    Petitioners’ Theft From BOH and APAG

        Petitioner never drew a salary as president of BOH or APAG. Petitioner’s

family members, including his father, wife, and four children, also did not receive

salaries from BOH or APAG since they never worked for either company.

Beginning in 1994 and continuing through his dismissal as president of BOH and

APAG on September 2, 1998, petitioners used BOH and APAG funds for all of

their personal expenses. Both petitioners were aware that this was done, in part, to

defeat their creditors by not placing assets in their own names.

        As he had previously done during his tenure with Arnold Palmer Motors,

Inc., petitioner executed a demand promissory note in favor of BOH on October 6,

1995 (October 1995 promissory note). The October 1995 promissory note signed

in favor of BOH is nearly identical to the October 1985 promissory note signed in

favor of Arnold Palmer Motors, Inc., with the only differences being the dates, the

holders of the notes, and the witnesses. The October 1995 promissory note

contains an attachment that is similar to the attachment used for the October 1985

promissory note. The attachment reflects that petitioner had taken more than $3

million from BOH from 1994 to 1997. Additionally, petitioner disguised the

taking of BOH and APAG funds by categorizing them as loans in BOH’s general

ledger.
                                       - 16 -

[*16]               a.    Credit Cards and Bank Accounts

        From 1994 to 1998, petitioners and their children freely spent BOH and

APAG money. Petitioners, J.T., Kelly, and Katie each had BOH corporate

American Express credit cards in their names which they used for personal

expenses. Additionally, petitioner directed BOH to pay the personal credit card

bills of Mrs. O’Neal, J.T., Kelly, and Katie. Petitioner created bank accounts in

the names of three of his children, J.T., Kelly, and Katie, into which he deposited

BOH and APAG funds. Petitioners each took steps to hide BOH and APAG

money in their children’s names. For example, in the summer of 1997, Mrs.

O’Neal took Katie to National City Bank and deposited approximately $30,000 of

BOH and APAG funds into an account titled in Katie’s name. Mrs. O’Neal

returned with Katie in May 1998 and withdrew the funds. Petitioner also took

Katie to two banks to deposit BOH and APAG funds in accounts created in her

name and later returned to withdraw the funds.

        Mrs. O’Neal directed the BOH accountant, Paul Mohabir, to pay her

personal expenses using BOH funds. In 1994 and 1995 petitioner wrote checks

payable to Mrs. O’Neal on BOH’s checking account to pay their daily living

expenses. In 1994, 1995, and 1996 Mrs. O’Neal also wrote checks on BOH’s

checking account to pay personal expenses.
                                        - 17 -

[*17]                 b.   Gifts, Automobiles, and Vacations

        Petitioners and their children drove various automobiles that were

purchased or leased with BOH funds. Mrs. O’Neal planned three cruises, all paid

for with BOH money, for various individuals, including her parents, petitioners’

children, and the children’s significant others and friends. For Christmas in 1997

petitioner gave Mrs. O’Neal a check for $50,000 and each of his children and his

father checks for $10,000, all of which were drawn on BOH’s bank account. Mrs.

O’Neal returned the $50,000 check to petitioner as she said she felt it was an

inappropriate gift.

                      c.   Children’s Education

        Petitioner used BOH funds to pay for his children’s educations and living

expenses. On January 12, 1998, petitioner paid off J.T.’s student loans incurred

for undergraduate and juris doctor degrees by transferring $53,005 from BOH’s

bank account to the Department of Education. Petitioner also used BOH funds to

pay for J.T.’s bar exam preparation course. When J.T. was accepted to New York

University School of Law to complete an LL.M. in taxation, petitioner transferred

$142,000 to J.T. ostensibly to cover the cost of tuition and housing in New York

City. Mr. Baker specifically denied petitioner’s request that BOH cover the costs

associated with J.T.’s schooling. Petitioner also wrote checks for Kelly’s tuition
                                        - 18 -

[*18] and rent while she was at college and wrote checks to cover the cost of

tutoring for Patrick.

      Mrs. O’Neal also used BOH funds for the children’s schooling. Mrs.

O’Neal wrote checks on BOH’s checking account for both J.T.’s and Kelly’s

tuition. She also wrote checks for Kelly’s rent and wrote a check to Katie’s high

school for $275 for Katie’s yearbook.

                    d.   Real Estate Purchases

      Petitioners also used BOH and APAG money to purchase various real

properties, none of which had any relationship to the companies’ mission of

creating a publicly traded auto mall corporation. On July 29, 1994, petitioner

caused BOH to purchase 12321 Creekwood Lane in Carmel, Indiana, for $239,886

from friends, Thomas and Barbara Harris. Petitioners had previously owned

12321 Creekwood Lane and had defaulted on their mortgage; the Harrises had

purchased the property at a sheriff’s sale. In conjunction with BOH’s purchase of

12321 Creekwood Lane, petitioner issued checks totaling $75,000 on BOH’s

checking account to Mr. Harris to repay him for personal loans in the same

amount.

      In 1994 petitioners purchased the Smurf Farm in J.T.’s and Kelly’s names,

named after the miniature horse that petitioners had previously housed at the Bay
                                       - 19 -

[*19] Hill Farm. After Mr. Palmer evicted petitioners from the Bay Hill Farm,

they moved their personal buildings and animals to the Smurf Farm. Petitioners

hired Eric Reid to live on the Smurf Farm and look after their animals. Checks to

Mr. Reid were written on BOH’s checking account. Petitioners visited the Smurf

Farm with their children on Sundays; except for one visit by Mr. Baker, BOH

employees never visited the farm. On May 23, 1994, petitioner executed a

quitclaim deed on behalf of J.T. and Kelly transferring the Smurf Farm to Mr.

Baker. On December 22, 1997, petitioner used a check for $146,446 from BOH’s

checking account to make final payment for the Smurf Farm. Petitioners also

hired Richard Henderson to perform maintenance and improvements to the various

farms as well as their personal residence, petitioner’s father’s residence, and 9090

Bay Hill Boulevard (discussed in further detail below). Mr. Henderson was paid

with checks from BOH’s checking account, despite invoices’ being addressed to

petitioner personally.

      Petitioners purchased five other farms with BOH funds. On December 27,

1995, petitioner purchased the Alba Farm for $206,326 using BOH’s checking

account and titled it in BOH’s name. On June 20, 1995, petitioner made a

downpayment on the Deese Farm by executing a check for $25,004 from BOH’s

checking account. On February 8, 1996, petitioner made a second payment on the
                                      - 20 -

[*20] Deese Farm by executing a $25,000 check on BOH’s checking account. On

January 23, 1997, petitioner used a check for $99,941 from BOH’s checking

account to make final payment for the Deese Farm. The owners of the Deese Farm

transferred it to BOH on February 7, 1997. Other farms purchased with BOH

money include: (1) the Brannan Farm in 1997 for $44,636, (2) the Poiret Farm in

1997 for $30,642, and (3) the Walser Farm in 1998 for $29,957.

      After Mr. Palmer evicted petitioners from the Bay Hill Farm in 1994,

petitioner moved his personal office to 8484 Bay Hill Boulevard, Orlando, Florida,

a house owned by petitioner’s good friend Julian Laughinghouse. Petitioner

conducted his personal affairs as well as BOH/APAG business from 8484 Bay Hill

Boulevard from 1994 to 1998. In 1995 Mr. Laughinghouse filed two separate

lawsuits against petitioner to evict him from 8484 Bay Hill Boulevard for failure

to pay rent and for failure to repay a $100,000 loan. Mr. Laughinghouse withdrew

the lawsuits on July 27, 1995. In September, November, and December 1995

petitioner executed checks totaling $75,012 on BOH’s checking account made

payable to Mr. Laughinghouse.

      Mr. Laughinghouse also owned 9090 Bay Hill Boulevard, Orlando, Florida,

which he used as his personal residence. On July 30, 1997, petitioner entered into

an agreement with Mr. Laughinghouse to have BOH purchase the residences at
                                       - 21 -

[*21] 8484 Bay Hill Boulevard and 9090 Bay Hill Boulevard. Mr. Laughinghouse

transferred 9090 Bay Hill Boulevard to BOH, subject to a life interest for himself,

via warranty deed on July 30, 1997. The warranty deed reflects that Mr.

Laughinghouse was paid $900,000 for 9090 Bay Hill Boulevard. On February 25,

1998, petitioner purchased a vacant lot adjacent to 8484 Bay Hill Boulevard using

$144,934 in BOH funds. The lot was zoned for residential use and had no

business purpose.

      On June 15, 1997, petitioners leased a condominium with BOH funds at

13565 Kensington Place in Carmel, Indiana, for personal use. Petitioners had

considered personally leasing 13565 Kensington Place as early as September 26,

1995. In 1997 and 1998 petitioners spent $235,820 and $39,860 of BOH funds,

respectively, on decorations and rent for 13565 Kensington Place. Petitioner

categorized the expenses associated with 13565 Kensington Place as “corporate

condo expenses” in BOH’s general ledger. No BOH employees ever visited

13565 Kensington Place, but Mrs. O’Neal and the O’Neal children stayed there

during summers and Christmas vacations.

            3.      Petitioner’s Dismissal From BOH and APAG

      In late August 1998 Kevin Rankel, a financial adviser employed by BOH

and APAG, discovered petitioners’ extensive personal use of BOH and APAG
                                        - 22 -

[*22] funds. Mr. Rankel resigned upon discovery of petitioners’ use of BOH and

APAG funds but not before showing a portion of the BOH general ledger to

another BOH employee, Michael Quinn. Mr. Quinn immediately called Mr. Baker

to the office. Messrs. Quinn and Baker discovered that petitioners had spent in

excess of $10 million of BOH and APAG funds on nonbusiness expenses. Mr.

Baker terminated petitioner’s employment at BOH and APAG on September 2,

1998.

III.    Aftermath of Petitioners’ Management of BOH and APAG Funds

        A.    BOH and APAG Bankruptcies

        On October 9, 1998, BOH and APAG filed voluntary petitions for relief

pursuant to chapter 11 of title 11 of the United States Code. As part of the

bankruptcy proceedings, BOH and APAG filed an adversary proceeding against

petitioners and their four adult children, alleging that they had fraudulently

transferred assets from BOH and APAG to themselves for personal use. On

August 9, 2000, the bankruptcy court found in favor of BOH and APAG in the

adversary proceeding and issued a final judgment against petitioner and findings

of fact and conclusions of law and final judgment against Mrs. O’Neal, J.T., Kelly,

and Katie. The bankruptcy court found that petitioners and J.T., Kelly, and Katie

were fraudulent transferees of BOH and APAG. Further, the bankruptcy court
                                       - 23 -

[*23] found that Mrs. O’Neal knowingly and actively participated in the scheme to

fraudulently deplete BOH and APAG assets.

      B.    Petitioner’s Conviction

      Special Agent Annette Waldon (SA Waldon) was assigned to investigate

any tax-related crimes petitioner may have committed in relation to his spending

of BOH’s and APAG’s money between 1994 and 1998. SA Waldon determined

that there were two components to petitioner’s unreported income: (1) income

disguised as loans and (2) income classified as business expenses related to

purchases of personal assets and expenses for those assets. SA Waldon excluded

from the second category certain automobiles that petitioner was able to prove

were used for business purposes. Petitioner cooperated with her investigation only

after another target of the investigation began cooperating with the Government.

      As a result of SA Waldon’s investigation, petitioner was indicted by a grand

jury on 49 counts of mail fraud, 30 counts of money laundering, and 3 counts of

filing false income tax returns under section 7206(1) for tax years 1996, 1997, and

1998. The grand jury determined that for tax years 1996 through 1998 petitioner

willfully made and subscribed Forms 1040, U.S. Individual Income Tax Return,

which he knew to be false, in violation of section 7206(1). Further, the grand jury
                                        - 24 -

[*24] determined that for tax year 1998, petitioner acted with intent to engage in

conduct constituting a violation of sections 7201 and 7206.

      On December 23, 2005, petitioner pleaded guilty to two counts of filing

false income tax returns pursuant to section 7206(1) for tax years 1997 and 1998.

In the plea agreement petitioner agreed that money categorized as loans and

money disguised as business expenses were instead income to him. Petitioner

agreed that he had received unreported income for the tax years at issue in the

following amounts:

              Income disguised as      Income disguised as
 Tax year           loans               business expenses              Total
   1994             $211,091                    $75,000              $286,091
   1995              568,232                    356,371               924,603
   1996              746,886                    217,440               964,326
   1997            1,461,908                1,557,300                3,019,208
   1998              507,513                    869,184              1,376,697
                                            1
   Total           3,495,630                    3,075,293            6,570,923

      1
        All figures in this table were taken from petitioner’s plea agreement. It is
unclear why the plea agreement’s calculation of the total amount of income
disguised as business expenses and the total amount of unreported income is $2
less than the sum of these same amounts for 1994-98.
                                       - 25 -

[*25] IV.   Petitioners’ Tax Returns For 1994-98

      Petitioners timely filed their 1994 tax return, in which they reported wages

of $9,687 attributable to income earned by Mrs. O’Neal as a registered nurse and

taxable interest income of $4. Petitioners claimed a $3,000 capital loss and a

$6,101,509 NOL carryover, reducing their income to -$6,094,818.

      Petitioners timely filed their 1995 tax return, in which they reported wages

of $4,452 attributable to income earned by Mrs. O’Neal as a registered nurse and

taxable interest income of $186. Petitioners claimed a $3,000 capital loss and a

$6,091,822 NOL carryover, reducing their income to -$6,090,184.

      Petitioners timely filed their 1996 tax return, in which they reported wages

of $1,200 attributable to income earned by Mrs. O’Neal as a registered nurse,

$9,472 in taxable distributions from retirement plans, and taxable interest income

of $249. Petitioners claimed a $3,000 capital loss and a $6,087,370 NOL

carryover, reducing their income to -$6,079,449.

      Petitioners timely filed their 1997 tax return, in which they reported wages

of $2,868 attributable to income earned by Mrs. O’Neal as a registered nurse and

taxable interest income of $325. Petitioners claimed a $3,000 capital loss and a

$6,086,170 NOL carryover, reducing their income to -$6,085,977.
                                        - 26 -

[*26] Petitioners filed their 1998 tax return late on August 1, 2001, in which they

reported wages of $2,005 attributable to income earned by Mrs. O’Neal as a

registered nurse and taxable interest income of $503. Petitioners claimed a $3,000

capital loss and a $6,084,165 NOL carryover, reducing their income to

-$6,084,657.

      Petitioners failed to make any estimated tax payments for the 1994, 1995,

1996, 1997, and 1998 tax years.

V.    Notice of Deficiency

      Respondent issued a notice of deficiency to petitioners on November 6,

2009, for tax years 1994 to 1998. The adjustments to income in the notice of

deficiency are based on the amounts petitioner admitted to receiving as income in

his plea agreement. Additionally, the notice of deficiency disallowed in full

petitioners’ NOL deductions carried forward from prior years.

                                     OPINION

I.    Statute of Limitations

      A deficiency in tax generally must be assessed within three years from the

date on which the return was filed. See sec. 6501(a). However, if a taxpayer files

a false or fraudulent return with the intent to evade tax, the tax may be assessed at

any time. Sec. 6501(c)(1). Unless petitioners’ returns for 1994-98 were made
                                        - 27 -

[*27] falsely or fraudulently with the intent to evade tax, the periods of limitations

on assessment and collection of petitioners’ income tax for those years have

expired.

      Respondent bears the burden of proving an exception to the general

limitations period. See Gould v. Commissioner, 139 T.C. 418, 431 (2012), aff’d,

552 F. App’x 250 (4th Cir. 2014); Harlan v. Commissioner, 116 T.C. 31, 39

(2001). Petitioner’s guilty plea under section 7206(1) for intentionally filing false

returns for tax years 1997 and 1998 does not in and of itself prove that section

6501(c) applies because the intent to evade tax is not an element of the crime

charged under section 7206(1); however, a guilty plea under section 7206(1) may

be considered in connection with other facts in determining whether an

underpayment of tax was due to fraud. Wright v. Commissioner, 84 T.C. 636,

643-644 (1985). Respondent’s burden of proof under section 6501(c)(1) is the

same as his burden to prove applicability of the section 6663 civil fraud penalty,

which is also at issue here. Gould v. Commissioner, 139 T.C. at 431; Browning v.

Commissioner, T.C. Memo. 2011-261. To satisfy that burden, respondent must

show by clear and convincing evidence that (1) an underpayment of tax exists, and

(2) the taxpayer intended to evade taxes known to be owing by conduct intended

to conceal, mislead, or otherwise prevent the collection of taxes. See Sadler v.
                                        - 28 -

[*28] Commissioner, 113 T.C. 99, 102 (1999); Parks v. Commissioner, 94 T.C.

654, 660-661 (1990).

      Because we find that there are underpayments for tax years 1994-98, and

further, that those underpayments are attributable to petitioners’ fraudulent intent,

the period of limitations for assessment of deficiencies in petitioners’ income tax

for the years at issue remains open.

II.   Deficiencies in Tax for Tax Years 1994-98

      A finding of fraud under section 6663 requires us to first find that there was

an underpayment of tax for each of the tax years in issue. This case also asks us to

examine deficiencies in petitioners’ income tax for the tax years at issue. For

purposes of section 6663 and as relevant here, section 6664(a) defines the term

“underpayment” in essentially the same terms as the term “deficiency” is defined

by section 6211. See Feller v. Commissioner, 135 T.C. 497, 507 (2010) (“In a

case involving a deficiency and fraud in which no excess withholding credits are

claimed, * * * the terms ‘deficiency’ and ‘underpayment’ can be used

interchangeably.”); see also Rand v. Commissioner 141 T.C. 376, 386-387 (2013)

(“Congress expressly indicated that uncoupling these terms was not intended to

remove their definitional nexus.”). As those terms are used here, an underpayment

or deficiency is equal to the amount by which the tax imposed by the Code
                                        - 29 -

[*29] exceeds the amount shown as the tax by petitioners on their return for each

of the tax years at issue. See secs. 6211(a), 6664(a).

      To prove an underpayment, the Commissioner is not required to establish

the precise amount of the deficiency determined by him. DiLeo v. Commissioner,

96 T.C. 858, 873 (1991), aff’d, 959 F.2d 16 (2d Cir. 1992). However, he cannot

meet his burden of proof by merely relying on the taxpayer’s failure to prove error

in the determination of the deficiency. Id. (citing Otsuki v. Commissioner, 53 T.C.

96, 106 (1969), and Pigman v. Commissioner, 31 T.C. 356, 370 (1958)). The

deficiency determination does not enjoy its usual presumption of correctness

unless the Commissioner establishes an underpayment by clear and convincing

evidence. Id.; see also Parks v. Commissioner, 94 T.C. at 660-661 (“We must be

careful in such cases not to bootstrap a finding of fraud upon a taxpayer’s failure

to prove respondent’s deficiency determination erroneous.”).

      The Commissioner may prove an underpayment by proving a likely source

of the unreported income. DiLeo v. Commissioner, 96 T.C. at 873. Alternatively,

where the taxpayer alleges a nontaxable source of income, the Commissioner may

satisfy his burden by disproving the nontaxable source so alleged. Id. at 873-874.

Respondent argues that petitioners failed to report income from their misuse of

BOH and APAG funds from 1994 to 1998, and accordingly, a deficiency exists for
                                       - 30 -

[*30] each of the years at issue. Petitioners argue that the amounts received from

BOH and APAG were loans to petitioner and therefore were properly excluded

from income. Petitioners alternatively argue that if we find that the amounts

received from BOH and APAG were income, they had sufficient NOL carryover

deductions to offset any income and therefore no deficiency exists for any of the

years at issue. We agree with respondent that the funds petitioners took from

BOH and APAG were income during the years at issue and further that petitioners

are not entitled to the claimed NOL carryover deductions.

      A.    Whether Amounts Received Were Income, Loans, or Business
            Expenses

      There are two components to petitioners’ unreported income: (1) income

disguised as loans, and (2) income classified as business expenses related to

purchases of personal assets and expenses for those assets. We address each

component of the amounts taken from BOH and APAG.

            1.     Amounts Disguised as Loans

      Respondent has established by clear and convincing evidence that the

amounts taken by petitioners from BOH and APAG were income rather than loans.

Petitioners never drew salaries from BOH or APAG and were heavily indebted to

creditors during the years at issue. However, they maintained a lavish lifestyle
                                       - 31 -

[*31] through liberal use of BOH and APAG funds. Their explanation that the

amounts taken from BOH and APAG were loans and not income is not credible in

light of the evidence respondent has presented to the contrary.

      First, petitioner’s 1994 fee agreement was executed with Mr. Baker

personally, rather than with BOH or APAG. It is unreasonable to believe that

petitioner, a longtime businessman, would think that his personal agreement with

Mr. Baker could serve as an excuse to drain money from BOH and APAG.

Additionally, the lawsuit that underpinned the 1994 fee agreement ended in 1994

in favor of GMC and GMAC. Thus, the 1994 fee agreement is not a plausible

explanation for petitioners’ siphoning of money from BOH and APAG from 1994

to 1998.

      Second, petitioners cannot transmute the nature of the amounts taken from

income to loans merely by calling them so via notations in BOH’s general ledger

and the signing of a promissory note. Whether a bona fide debtor-creditor

relationship exists is a question of fact to be determined upon a consideration of

all the pertinent facts. See Haber v. Commissioner, 52 T.C. 255, 266 (1969),

aff’d, 422 F.2d 198 (5th Cir.1970). The most important elements of this

determination are a good-faith intent on the part of the debtor to repay the loan and

a good-faith intent of the creditor to enforce repayment. Fisher v. Commissioner,
                                        - 32 -

[*32] 54 T.C. 905, 909-910 (1970). Courts examine various factors to determine

whether the parties had the requisite good-faith intent, including whether the

following elements existed: (1) a written loan agreement, (2) a fixed schedule for

repayment, (3) any request for security or collateral, (4) interest charged on the

loan, (5) a demand for repayment, (6) a memorialization of the loan in the parties’

books, (7) any repayments actually made, and (8) the borrower’s solvency at the

time of the loan. See, e.g., Rickard v. Commissioner, T.C. Memo. 2010-159.

      These factors weigh heavily against petitioners’ argument that there were

bona fide loans between them and BOH and APAG. In contrast, they bolster

respondent’s evidence that the funds taken from BOH and APAG were income to

petitioners. There was no written loan agreement, only a promissory note signed

by petitioner that was never shown to Mr. Baker or any other corporate officers at

BOH. There was no fixed schedule for repayment, nor were there demands for

repayment or any repayments actually made, in large part because petitioner

executed the promissory note in secrecy. Petitioners did not offer any security or

collateral and did not pay any interest on the loan. Further, petitioners were

insolvent because of the judgments against them relating to their earlier theft from

Messrs. Palmer and McCormack. Moreover, neither Mr. Baker nor any other

representative of BOH or APAG authorized petitioners to “lend” themselves vast
                                       - 33 -

[*33] sums of company money. We find that petitioners did not have a good-faith

intent to repay the amounts taken and there was no genuine debtor-creditor

relationship.

      Third, petitioners argue that petitioner discussed with his C.P.A., Charles

Roach, whether to treat the funds received from BOH and APAG as income or

loans. Petitioners contend that they concluded that even if the “loans” were

income, they would not be liable for any income tax because they had NOL

carryover deductions sufficient to offset any such income. Mr. Roach did not

testify, and we are left with only petitioner’s unsubstantiated testimony regarding

discussions he may have had about the tax treatment of the amounts received from

BOH and APAG. Petitioner’s description of his discussions with Mr. Roach

bolsters our conclusion that the amounts received were never bona fide loans. For

the foregoing reasons, we find that the amounts received were not loans because

they were not received under the 1994 fee agreement and petitioners never had a

good-faith intent to repay any amounts received from BOH and APAG.

                2.   Amounts Disguised as Business Expenses

      Respondent has also proven by clear and convincing evidence that the

amounts disguised as business expenses were in fact income to petitioners. Most

of the so-called business expenses had no relationship to BOH’s and APAG’s
                                        - 34 -

[*34] intended purpose of creating a publicly traded auto mall. Instead, they

inured solely to the benefit of petitioners and their children. Petitioners’

arguments that the expenses associated with various automobiles and real estate

were in fact business expenses of BOH and APAG are not credible. For example,

petitioners argue that “certain parcels of real estate” were purchased for

“investment” or “corporate use”. However, all of the farms purchased and titled in

BOH’s and APAG’s names were used exclusively by petitioners and their children

and had no function other than entertainment for the O’Neal family. Furthermore,

the personal residences in Florida and the condominium in Indiana inured

exclusively to the benefit of petitioners; except for some BOH and APAG business

petitioner performed at 8484 Bay Hill Boulevard, BOH and APAG employees

never used these premises for BOH or APAG business. Additionally, SA Waldon

reduced the amounts attributable to automobile purchases because some

automobiles had a legitimate business purpose; the remaining automobiles were

used exclusively for the benefit of petitioners and their children.

      Petitioners attempt to sidestep the characterization of the amounts disguised

as business expenses by pointing out that the real estate and automobiles were

titled in BOH’s and APAG’s names. It is well established that tax consequences

are determined by substance and not mere form. See, e.g., Frank Lyon Co. v.
                                       - 35 -

[*35] United States, 435 U.S. 561, 573 (1978) (“The [Supreme] Court has never

regarded ‘the simple expedient of drawing up papers[]’ * * * as controlling for tax

purposes when the objective economic realities are to the contrary.” (quoting

Commissioner v. Tower, 327 U.S. 280, 291 (1946))). Command over property or

enjoyment of its economic benefits identifies the real owner for Federal income

tax purposes. Anderson v. Commissioner, 164 F.2d 870, 873 (7th Cir. 1947),

aff’g 5 T.C. 443 (1945). Petitioners were the beneficial owners of various

properties titled in BOH’s and APAG’s names. Additionally, they benefitted by

paying expenses related to those properties from BOH’s and APAG’s accounts

and disguising the costs as business expenses. Accordingly, respondent has

proven by clear and convincing evidence that these amounts are income to

petitioners rather than business expenses of BOH and APAG.

            3.     Conclusion as to Amounts Includible in Income

      Although not conclusive as to the precise understatement amount, a

taxpayer’s admission in a plea agreement from a prior criminal proceeding as to

the precise amount by which he understated net income constitutes strong

evidence of the understatement amount. See Ephrem v. Commissioner, T.C.

Memo. 2014-12. Further, petitioner’s conviction pursuant to section 7206(1) for

tax years 1997 and 1998 estops him from contesting that an underpayment exists
                                        - 36 -

[*36] for those tax years. See, e.g., Considine v. United States, 683 F.2d 1285,

1287 (9th Cir. 1982); Wright v. Commissioner, 84 T.C. at 643-644; Reinhard v.

Commissioner, T.C. Memo. 2015-116. Petitioner admitted in his plea agreement

to receiving income in the amounts identified as having been disguised as loans or

business expenses. Petitioners offer no credible basis for reducing these amounts.

Consequently, petitioners received unreported taxable income of $286,091,

$924,603, $964,326, $3,019,208, and $1,376,697 in 1994, 1995, 1996, 1997, and

1998, respectively.

      B.      Entitlement to NOL Carryforward Deductions

      Respondent has proven by clear and convincing evidence that petitioners

received unreported income during each of the years at issue. However,

petitioners argue that in the event we find the amounts received from BOH and

APAG were income, they nevertheless do not owe any additional Federal income

tax because they have sufficient NOL carryover deductions to offset the receipt of

any income.

              1.      Generally Applicable S Corporation Basis Rules

      Generally, the term “net operating loss” is defined in section 172(c) to mean

the excess of allowable deductions over gross income. Taxpayers are entitled to

an NOL deduction for the aggregate of NOL carrybacks and carryovers to the
                                        - 37 -

[*37] taxable year. Sec. 172(a). For taxable years beginning after August 5, 1997,

the period for an NOL carryback is 2 years and the period for an NOL carryover is

20 years. Sec. 172(b)(1)(A). For taxable years beginning on or before August 5,

1997, the period for an NOL carryback is 3 years and the period for an NOL

carryover is 15 years. Taxpayer Relief Act of 1997, Pub. L. No. 105-34, sec.

1082(a), 111 Stat. at 950.

      A shareholder of an S corporation can directly deduct his or her share of

entity-level losses in accordance with the flowthrough rules of subchapter S. See

sec. 1366(a). The losses cannot exceed the sum of the shareholder’s adjusted basis

in his or her stock and the shareholder’s adjusted basis in any indebtedness of the

S corporation to the shareholder. Sec. 1366(d)(1)(A) and (B). The disallowed

losses may be carried forward indefinitely and claimed when and to the extent that

the shareholder increases his or her basis in the S corporation. See sec.

1366(d)(2). Additionally, the basis of a shareholder’s stock in an S corporation is

reduced by nontaxable distributions by the corporation. Sec. 1367(a)(2)(A).

Thus, petitioner could have claimed losses from the Arnold Palmer dealerships

only to the extent he had sufficient stock basis in the corporations or basis in any

indebtedness of the corporations.
                                        - 38 -

[*38] What constitutes “adjusted basis of any indebtedness of the S corporation to

the shareholder” under section 1366(d)(1)(B) is a question that has been

considered numerous times by this and other courts. Generally, mere shareholder

guaranties of S corporation indebtedness fail to satisfy the requirements of section

1366(d)(1)(B). Spencer v. Commissioner, 110 T.C. 62, 83 (1998); Estate of

Leavitt v. Commissioner, 90 T.C. 206, 211 (1988), aff’d, 875 F.2d 420, 422 (4th

Cir. 1989); Raynor v. Commissioner, 50 T.C. 762, 770-771 (1968). In Raynor v.

Commissioner, 50 T.C. at 770-771, we held that indirect borrowing does not give

rise to indebtedness from the corporation to the shareholder until and unless the

shareholder pays part or all of the obligation. Until the shareholder actually pays

the obligation, “‘liability’ may exist, but not debt to the shareholders.” Id. at 771;

see also Brown v. Commissioner, T.C. Memo. 1981-608, 42 T.C.M. (CCH) 1460,

1464 (1981) (“Not until the guarantor pays on the obligation does the guarantor

make an actual investment.”), aff’d, 706 F.2d 755 (6th Cir.1983). Further, for a

loan to create basis, the taxpayer must make an economic outlay, which is

accomplished when the taxpayer incurs a cost on a third-party loan or is left poorer

in a material sense after the transaction. Maloof v. Commissioner, T.C. Memo.

2005-75, aff’d, 456 F.3d 645 (6th Cir. 2006).
                                        - 39 -

[*39] However, the Court of Appeals for the Eleventh Circuit, to which an appeal

in this case would lie, has held that a shareholder who has guaranteed a loan to an

S corporation may increase his basis where, in substance, the shareholder has

borrowed funds and subsequently advanced them to the corporation. Selfe v.

United States, 778 F.2d 769, 773 (11th Cir. 1985). The Court of Appeals partially

agreed with the reasoning of the Court of Appeals for the Sixth Circuit in Brown

v. Commissioner, 706 F.2d 755 (6th Cir. 1983), that an economic outlay is

required before a shareholder may increase his basis in an S corporation; however,

the Court of Appeals in Selfe disagreed that a shareholder must, in all cases, make

payments on a loan before increasing his basis as a result of guaranteeing the loan

to the corporation. Relying on Plantation Patterns, Inc. v. Commissioner, 462 F.2d

712 (5th Cir. 1972),5 the court in Selfe held that a shareholder guaranty of a loan

may be treated, for tax purposes, as an equity investment in the corporation where

the lender looks to the shareholder as the primary obligor. Selfe, 778 F.2d at 774.

The court in Selfe also noted that the analysis in Plantation Patterns focused on


      5
       The U.S. Court of Appeals for the Eleventh Circuit was established on
October 1, 1981, pursuant to the Fifth Circuit Court of Appeals Reorganization
Act of 1980, Pub. L. No. 96-452, 94 Stat. 1994. In Bonner v. City of Prichard,
661 F.2d 1206, 1207 (11th Cir. 1981), that court adopted the decisions of the U.S.
Court of Appeals for the Fifth Circuit handed down before close of business on
September 30, 1981, as governing law in the Eleventh Circuit.
                                       - 40 -

[*40] “highly complex issues of fact” and that consideration of similar inquiries

must be “carefully evaluated on their own facts”. Id.

      2.    Petitioner’s Bases in the Arnold Palmer Dealerships

      Petitioners’ brief does not identify the exact amount of NOLs claimed, but

the Court assumes that, pursuant to petitioners’ 1994-98 tax returns, the claimed

NOLs exceed $6 million.6 The claimed NOL carryover deductions relate to losses

originally reported on petitioners’ 1988, 1989, and 1990 Federal income tax

returns. The claimed NOLs are purportedly attributable to flowthrough losses

from the Arnold Palmer dealerships and totaled $6,111,355 for tax years 1988,

1989, and 1990.

      The record contains no evidence reliably establishing petitioners’ bases, if

any, in the Arnold Palmer dealerships or their entitlement to NOLs arising


      6
       Petitioners contend that equitable estoppel precludes respondent from
challenging their claim to NOLs arising in 1988, 1989, and 1990 since those
losses were not questioned by the Internal Revenue Service before this case.
Petitioners’ argument ignores that “[i]t is well settled that we may determine the
correct amount of taxable income or net operating loss for a year not in issue
(whether or not the assessment of a deficiency for that year is barred) as a
preliminary step in determining the correct amount of a net operating loss
carryover to a taxable year in issue.” Lone Manor Farms, Inc. v. Commissioner,
61 T.C. 436, 440 (1974), aff’d without published opinion, 510 F.2d 970 (3d Cir.
1975). Additionally, each tax year stands on its own, and the Commissioner may
challenge in a succeeding year what was condoned or agreed to for a prior year.
See Rose v. Commissioner, 55 T.C. 28, 31-32 (1972).
                                        - 41 -

[*41] therefrom. Petitioners have not provided any Forms 1120S, U.S. Income

Tax Return for an S Corporation, or Forms 1065, Schedule K-1, Partner’s Share of

Income, Deductions, Credits, etc., for any of the Arnold Palmer dealerships in

which petitioner was a one-third shareholder. They contend that he

contributed “significant funds” to the dealerships but do not identify any specific

dollar amounts contributed. In contrast, the record reflects that petitioners

misappropriated amounts in excess of $6 million from the Arnold Palmer

dealerships during the late 1980s which they did not report on their 1988 or 1989

income tax return. Furthermore, the NOLs reported on the 1988, 1989, and 1990

tax returns are factually inconsistent with each other and do not support a finding

that petitioners are entitled to the claimed amounts. The 1989 and 1990 tax

returns report larger carryover amounts than what was reported on the 1988 and

1989 returns, respectively, and petitioners have not offered any explanation to

address these inconsistencies.

      In addition to the fact that petitioners siphoned money from the dealerships

rather than contributing capital, petitioner’s signing of the July 1990 promissory

note does not constitute indebtedness from the corporations to him within the

meaning of section 1366(d)(1)(B). Petitioners have presented no information that

Ford Motor Credit looked to petitioner as the primary obligor on the note, as
                                        - 42 -

[*42] would be required under Selfe. Instead, testimony from Mr. Blackburn

indicates that Messrs. Palmer and McCormack were the primary obligors on the

note. In sum, petitioner did not make any economic outlay on the July 1990

promissory note, nor was he left poorer in a material sense, as Messrs. Palmer and

McCormack ultimately repaid the loan. Likewise, there is no evidence to indicate

that petitioner made any economic outlay when he signed the August 1992

promissory note.

      Even in criminal cases, where the Government bears the burden of proof

beyond a reasonable doubt, proof of unreported income is sufficient to establish an

underpayment of tax absent proof by the taxpayer of offsetting expenses. Monroy

v. Commissioner, T.C. Memo. 1996-540 (citing United States v. Hiett, 581 F.2d

1199, 1202 (5th Cir. 1978), Elwert v. United States, 231 F.2d 928, 933-936 (9th

Cir. 1956), and United States v. Bender, 218 F.2d 869, 871 (7th Cir. 1955)).

Petitioners have introduced no evidence, other than their uncorroborated

testimony, that would bolster their unsubstantiated claim that they had any bases

in the dealerships, and we find that petitioners (1) lacked bases in the dealerships,

(2) were not entitled to NOLs for 1988-90, and therefore (3) do not have NOL

carryovers that would offset the unreported income from the years in issue. See,

e.g., Gould v. Commissioner, 139 T.C. 418 (finding that the Commissioner’s
                                        - 43 -

[*43] burden as to fraud was met where the taxpayers failed to introduce evidence

establishing the existence or amount of claimed NOLs); Brooks v. Commissioner,

82 T.C. 413, 433-434 (1984) (“Notwithstanding respondent’s burden of proof as

to fraud, there comes a time when petitioner must come forward with evidence in

support of his claimed defenses[.] * * * Petitioner’s failure * * * to explain the

incriminating evidence by coming forward with other evidence in support of his

contentions justifies the inference that such evidence does not exist or would be

unfavorable to him.” (citations omitted)), aff’d without published opinion, 772

F.2d 910 (9th Cir. 1985); Green v. Commissioner, T.C. Memo. 2010-109, 99

T.C.M. (CCH) 1444, 1449 (2010) (“Respondent has also shown that petitioners

claimed deductions for * * * NOL carryforwards * * * to which they were not

entitled and which resulted in underpayments of tax.”).

      Respondent has demonstrated through clear and convincing evidence that

petitioners were not entitled to the NOL deductions they claimed on their 1988-90

tax returns, and petitioners do not therefore have NOL carryovers from those years

to offset the unreported income during the years at issue. Accordingly, respondent

has met his burden of proof to show that there is an underpayment for each of the

tax years at issue.
                                       - 44 -

[*44] Respondent makes two arguments as to why petitioners are not entitled to

the claimed NOL deductions. First, respondent argues that petitioners lacked

bases in the Arnold Palmer dealerships sufficient to allow them to use any losses

flowing therefrom, as discussed above. Second, respondent argues that petitioners

had unreported income for 1988 and 1989 that reduces their claimed NOL

deductions accordingly. We need not and do not decide respondent’s alternative

argument regarding petitioners’ unreported income for tax years 1988 and 1989.

       C.    Conclusion as to Deficiencies for 1994-98

       Because we find that petitioners received income from BOH and APAG

during the years at issue in the form of amounts disguised as loans and business

expenses and they are not entitled to NOL carryover deductions from tax years

1988-90, we further find that there was a deficiency in petitioners’ income tax for

each year at issue. Consequently, respondent has also satisfied the first prong of

section 6663 by proving that an underpayment exists for each year at issue.

III.   Fraudulent Intent

       If any part of any underpayment of tax required to be shown on a return is

attributable to fraud, section 6663(a) imposes a penalty equal to 75% of the

portion of the underpayment which is attributable to fraud. Section 6663(b)

provides that once the Commissioner establishes that any portion of the
                                        - 45 -

[*45] underpayment is due to fraud, the entire underpayment is to be treated as

attributable to fraud except with respect to any portion that the taxpayer

establishes, by a preponderance of the evidence, is not attributable to fraud. The

entire taxable year remains open under section 6501(c)(1) even if only a part of the

underpayment for a year is attributable to fraud. Lowy v. Commissioner, 288 F.2d

517, 520 (2d Cir. 1961), aff’g T.C. Memo. 1960-32. “Thus, where fraud is alleged

and proven, respondent is free to determine a deficiency with respect to all items

for the particular taxable year without regard to the period of limitations.”

Colestock v. Commissioner, 102 T.C. 380, 385 (1994).

      Once an underpayment has been proven, the second prong of the fraud test

requires the Commissioner to prove that, for each year at issue, at least some

portion of the underpayment is due to fraud, defined as an intentional wrongdoing

designed to evade tax believed to be owing. DiLeo v. Commissioner, 96 T.C. at

874. The Court may examine the taxpayer’s whole course of conduct to determine

whether fraud exists. Stone v. Commissioner, 56 T.C. 213, 224 (1971). The

existence of fraud is a question of fact to be resolved from the entire record.

Gajewski v. Commissioner, 67 T.C. 181, 199 (1976), aff’d without published

opinion, 578 F.2d 1383 (8th Cir. 1978). Fraud is never imputed or presumed, and

therefore the Commissioner must meet his burden through affirmative evidence.
                                         - 46 -

[*46] See Niedringhaus v. Commissioner, 99 T.C. 202, 210 (1992); Petzoldt v.

Commissioner, 92 T.C. 661, 699 (1989); Beaver v. Commissioner, 55 T.C. 85, 92

(1970). Fraud may be proved by circumstantial evidence and reasonable

inferences drawn from the facts because direct proof of a taxpayer’s intent is rarely

available. Toushin v. Commissioner, 223 F.3d 642, 647 (7th Cir. 2000), aff’g T.C.

Memo. 1999-171; Petzoldt v. Commissioner, 92 T.C. at 699. Fraud is not imputed

from one spouse to another. Stone v. Commissioner, 56 T.C. at 227-228. In the

case of a joint return, the section 6663 penalty does not apply with respect to a

spouse unless some part of the underpayment is due to the fraud of such spouse.

Sec. 6663(c).

      A.     Determination of Fraudulent Intent for 1994-98

      Over the years, courts have developed a nonexclusive list of factors that

demonstrate fraudulent intent. These badges of fraud include: (1) understatement

of income, (2) inadequate maintenance of records, (3) implausible or inconsistent

explanations of behavior, (4) concealment of assets or income, (5) failure to

cooperate with tax authorities, (6) engaging in illegal activities, (7) an intent to

mislead which may be inferred from a pattern of conduct, (8) lack of credibility of

the taxpayer’s testimony, (9) failure to file tax returns, (10) filing false documents,

(11) failure to make estimated tax payments, and (12) dealing in cash. See Spies
                                        - 47 -

[*47] v. United States, 317 U.S. 492, 499 (1943); Bradford v. Commissioner, 796

F.2d 303, 307-308 (9th Cir. 1986), aff’g T.C. Memo. 1984-601; Niedringhaus v.

Commissioner, 99 T.C. at 211. A taxpayer’s intelligence, education, and tax

expertise are relevant for purposes of determining fraudulent intent. See

Stephenson v. Commissioner, 79 T.C. 995, 1006 (1982), aff’d, 748 F.2d 331 (6th

Cir. 1984); Iley v. Commissioner, 19 T.C. 631, 635 (1952). We consider several

of these factors in turn.

             1.     Understatement of Income

      Petitioners consistently understated their income by large amounts for the

years at issue. During the years at issue, petitioners never reported any income

from either BOH or APAG, despite receiving millions from company coffers.

Petitioners’ omitted income dwarfs the income they did report from Mrs. O’Neal’s

nursing job. For example, for 1997 they reported income from Mrs. O’Neal’s

nursing job of $2,868, which is less than 0.1% of the $3,019,208 they received that

year. Consistent and substantial underreporting of income is strong evidence of

fraud, particularly if there are other circumstances showing an intent to conceal

income. See Parks v. Commissioner, 94 T.C. at 664 (“A pattern of consistent

underreporting of income, especially when accompanied by other circumstances

showing an intent to conceal, justifies the inference of fraud.”); Abdallah v.
                                        - 48 -

[*48] Commissioner, T.C. Memo. 2013-279 (finding fraud where taxpayers

reported between 6% and 19% of their actual income over the course of five years

of reporting); Branson v. Commissioner, T.C. Memo. 2012-124, 103 T.C.M.

(CCH) 1680, 1686 (2012) (“A pattern of substantially underreporting income for

several years is strong evidence of fraud, particularly if the reason for the

understatements is not satisfactorily explained or due to innocent mistake.”).

Accordingly, this factor favors a finding of fraud by both petitioners from 1994

through 1998.

             2.     Inadequate Maintenance of Records

       Petitioner maintained some records pertaining to his misuse of BOH and

APAG money. Specifically, he documented in BOH’s general ledger the “loans”

which were actually disguised income and signed the October 1995 promissory

note to reflect amounts taken from BOH. However, given that these records were

themselves fraudulent in that petitioner created them in order to mask his theft

from BOH and APAG, we are disinclined to credit petitioners for this factor.

Accordingly, this factor is neutral with respect to both petitioners for all tax years

at issue.
                                        - 49 -

[*49]         3.     Implausible or Inconsistent Explanations of Behavior

        Petitioner offered various implausible and inconsistent explanations for the

understated income. First, he claimed that he took money from BOH and APAG

under the 1994 fee agreement with Mr. Baker even though the 1994 fee agreement

did not extend to BOH and APAG and the lawsuit underpinning the 1994 fee

agreement concluded in 1994. Despite these facts, petitioner has attempted to use

the 1994 fee agreement as an excuse for taking money from BOH and APAG from

1994 through 1998. Second, petitioner claimed that the misappropriated funds

were loans from the companies to him, a claim which, as we discussed earlier, is

simply not credible. Separately, petitioner has claimed that he and his accountant

discussed whether to treat the transfers from BOH and APAG as loans or as

income on petitioners’ tax returns. These explanations are inconsistent with one

another and implausible. This factor favors a finding of fraud against petitioner

for all tax years at issue.

        Mrs. O’Neal’s position throughout this case has been that she never

questioned why she and her children were allowed access to BOH and APAG

funds, she never questioned her husband’s finances, and she did not give more

than a cursory glance to their tax returns during the years at issue. She also

testified that it was her habit to provide receipts for various expenses, and she
                                        - 50 -

[*50] “never got involved with * * * [petitioner’s] business”. However, she knew

that the amounts she was receiving from BOH and APAG were for personal

expenses, and she was aware that she and petitioner did not title assets in their

names to avoid creditors who had judgments in excess of $18 million against

them.

        It would defy common sense to believe that Mrs. O’Neal never questioned

the source of funds for the family’s personal expenses during the years at issue,

particularly in light of the fallout from petitioner’s business dealings with Messrs.

Palmer and McCormack. Mrs. O’Neal was aware of the judgments against them

from various creditors; those judgments arose out of the same pattern of corporate

theft that petitioners perpetrated during the years at issue. Further, Mrs. O’Neal

was aware of the significant dollar amounts attached to those judgments and yet

supposedly did not question the lavish lifestyle she and petitioner continued to

enjoy during the years at issue, even though she had to return to work in 1992 to

support the family after petitioner was fired from the Arnold Palmer dealerships.

She also clearly had some misgivings over receiving large amounts of corporate

funds from BOH, such as when she returned a $50,000 check written on BOH’s

bank account to her husband. Even if we were to take Mrs. O’Neal at her word,

“willful blindness” is an indicator of fraud if the taxpayer is aware of a high
                                        - 51 -

[*51] probability of unreported income and deliberately avoids steps to confirm

this awareness. Fiore v. Commissioner, T.C. Memo. 2013-21. On balance, this

factor favors a finding of fraud against Mrs. O’Neal for all tax years at issue.

             4.    Concealment of Assets or Income

      Petitioners consistently concealed assets or income over the course of the

years at issue. Not only did they freely spend BOH and APAG money on personal

expenses; they titled various properties--including six farms, three properties or

parcels on Bay Hill Boulevard in Orlando, Florida, two properties in Carmel,

Indiana, and several automobiles--in others’ names. These properties were used

solely for petitioners’ personal benefit and did not serve any business purpose for

BOH or APAG. Petitioners also opened bank accounts in their children’s names

into which they deposited BOH and APAG funds.

      Petitioner also pleaded guilty to two counts of filing a false tax return in

violation of section 7206(1) for tax years 1997 and 1998. Although his guilty plea

does not collaterally estop petitioner from denying that he fraudulently understated

petitioners’ income, it is a probative fact which may be considered persuasive

evidence of fraudulent intent. See Wright v. Commissioner, 84 T.C. at 643-644.

Upon entering his guilty plea, petitioner acknowledged that he was guilty of

signing materially false tax returns for tax years 1997 and 1998 and that he
                                          - 52 -

[*52] underreported income in each tax year at issue. This factor favors a finding

of fraud against both petitioners for all tax years at issue.

               5.     Failure To Cooperate With Tax Authorities

         Petitioner cooperated with SA Waldon’s investigation only after another

target of the investigation began cooperating. This factor is therefore neutral with

respect to petitioner. There is no information in the record pertaining to Mrs.

O’Neal’s cooperation, or lack thereof, with the Government, and this factor is

therefore absent with respect to Mrs. O’Neal.

               6.     Pattern of Conduct Showing an Intent To Mislead

         Petitioners engaged in a pattern of conduct that indicates an intent to

mislead. They consistently disguised personal expenses as business expenses and

titled assets in the names of their children and BOH and APAG. Petitioner signed

the October 1995 promissory note, reflecting totals taken from BOH from 1994 to

1997 but never showed it to Mr. Baker or any other officers within the company.

This factor favors a finding of fraud against both petitioners for all tax years at

issue.

               7.     Lack of Credibility of Petitioners’ Testimony

         A taxpayer’s lack of credibility, “the inconsistencies in his testimony and

his evasiveness on the stand[,] are heavily weighted factors in considering the
                                           - 53 -

[*53] fraud issue.” Toussaint v. Commissioner, 743 F.2d 309, 312 (5th Cir. 1984),

aff’g T.C. Memo. 1984-25; DeVries v. Commissioner, T.C. Memo. 2011-185. We

find that petitioners’ respective testimonies are not credible. Petitioners have a

history of theft from the companies with which petitioner has been affiliated.

They knew third parties had judgments against them in excess of $18 million as a

result of petitioner’s earlier theft from the Arnold Palmer dealerships. It strains

credibility that Mrs. O’Neal “never questioned” petitioner regarding the source of

the funding for their lifestyle during the years at issue when she was aware of the

judgments against them and knew that they were avoiding titling assets in their

names in order to avoid their creditors.

      Petitioner’s explanations for many of his actions are not credible. First, he

knew the lawsuit against GMC and GMAC ended in 1994 but claims that the 1994

fee agreement rationalized his taking of funds from BOH and APAG from 1994

until his dismissal from the companies in 1998. Second, he claims that the six

farms he purchased with BOH and APAG money were intended to be corporate

retreats despite his never telling anyone affiliated with either company about their

existence. Similarly, he disguised the Carmel, Indiana, condominium as a

“corporate condo” even though he and his family had exclusive use of it and

nobody at BOH or APAG was aware of its existence. Third, petitioner’s
                                          - 54 -

[*54] statements that the amounts he took from the companies were loans is not

credible because (1) no bona fide loan agreements existed between petitioner and

BOH or APAG, (2) he lacked the ability to repay any loans because of the $18

million judgments against him and his wife, and (3) any characterization of the

income as “loans” runs counter to his other claim that the funds were taken under

the 1994 fee agreement. This factor favors a finding of fraud against both

petitioners for all tax years at issue.

              8.     Filing False Documents

       Filing false documents includes filing false income tax returns. Worth v.

Commissioner, T.C. Memo. 2014-232; Potter v. Commissioner, T.C. Memo. 2014-

18; Morse v. Commissioner, T.C. Memo. 2003-332, aff’d, 419 F.3d 829 (8th Cir.

2005). Petitioners filed false documents for each year at issue in which they

significantly underreported their income by not reporting any of the amounts taken

from BOH and APAG. Mrs. O’Neal claims that she never reviewed the tax returns

but simply “showed up” to sign them. Regardless of her level of review, she

signed the returns under penalty of perjury; she cannot abdicate the responsibility

to file a correct tax return by failing to review it in its entirety. Moreover, a

reasonable person reviewing petitioners’ joint returns for the years at issue would

have questioned the lack of reported income in comparison to petitioners’ lavish
                                         - 55 -

[*55] lifestyle. This factor favors a finding of fraud for both petitioners for all tax

years at issue.

              9.     Failure To Make Estimated Tax Payments

       Petitioners failed to make any estimated tax payments during the years at

issue. Section 6654(d)(1)(A) requires quarterly installment payments of 25% of

the required annual payment. The required annual payment is the lesser of 90% of

the tax due for the year or 100% of the tax shown on the preceding year’s return.

Sec. 6654(d)(1)(B). This factor favors a finding of fraud against both petitioners

for all tax years at issue.

       B.     Conclusion as To Petitioners’ Fraud

       Seven badges of fraud are present in this case for both petitioners for all tax

years at issue. After considering the entire record and the factors discussed supra,

we find that for 1994-98 respondent has provided clear and convincing evidence

that petitioners intended to evade taxes known to be owing by conduct intended to

conceal, mislead, or otherwise prevent the collection of taxes. See Sadler v.

Commissioner, 113 T.C. at 102; Parks v. Commissioner, 94 T.C. at 660-661.

Accordingly, respondent has met his burden of proof, and petitioners are liable for

the section 6663 civil fraud penalty for each year at issue. Consequently, the

entire amount of the underpayment for each taxable year at issue is attributable to
                                       - 56 -

[*56] fraud. Petitioners have not shown that any portion of the underpayment for

each year at issue is not due to fraud. See sec. 6663(b).

IV.   Section 6651(a)(1) Addition to Tax

      Normally, the Commissioner bears the burden of production with respect to

any penalty or addition to tax. Sec. 7491(c); Higbee v. Commissioner, 116 T.C.

438, 446 (2001). In this case, it is unclear whether respondent bears any burden of

production under section 7491(c) because it is not clear whether the examination

commenced after July 22, 1998, the effective date of section 7491. However,

respondent has met any burden of production that he may have. To meet that

burden, the Commissioner must come forward with sufficient evidence indicating

that it is appropriate to impose the relevant penalty. Higbee v. Commissioner, 116

T.C. at 446. However, once the Commissioner has met the burden of production,

the taxpayer bears the burden of proving that the penalty is inappropriate. See

Rule 142(a); Higbee v. Commissioner, 116 T.C. at 446-449.

      Section 6651(a)(1) provides for an addition to tax for failure to timely file a

return unless it is shown that such failure is due to reasonable cause and not due to

willful neglect. See United States v. Boyle, 469 U.S. 241, 245 (1985). Petitioners

filed their 1998 tax return late on August 1, 2001, and respondent has therefore

met his burden of production. Petitioners did not address the section 6651(a)(1)
                                        - 57 -

[*57] addition to tax in their brief and have offered no reasonable cause for their

failure to timely file their 1998 tax return. Accordingly, petitioners are liable for

the section 6651(a)(1) addition to tax for tax year 1998.

         In reaching our holdings, we have considered all arguments made. To the

extent not mentioned above, we conclude they are moot, irrelevant, or without

merit.

         To reflect the foregoing,


                                                 Decision will be entered

                                        for respondent.
