                         T.C. Memo. 2011-161



                       UNITED STATES TAX COURT



            WILLIAM AND SHARON NORRIS, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 2224-09.                 Filed July 7, 2011.



     John A. Beam III and John M. Sharp, for petitioners.

     Caroline R. Krivacka, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     HAINES, Judge:   Respondent determined deficiencies in

petitioners’ Federal income tax and penalties as follows:

                                          Penalties
          Year        Deficiency         Sec. 6663(a)

          1996         $83,907            $62,930
          1998          29,569             22,145
                                 -2-

     On March 16, 2010, the Court granted respondent’s motion for

partial summary judgment, thereby ruling that petitioner William

Norris (Mr. Norris) is collaterally estopped from challenging the

deficiency and fraud penalty for 1998 because of his criminal

conviction for tax evasion pursuant to section 7201.1   As a

result, the Court further held that the limitations period for

Mr. Norris for 1998 remained open at the time the notice of

deficiency was issued.    On March 31, 2011, the Court granted

respondent’s motion for leave to file an amendment to answer out

of time to correct an error in respondent’s calculation of the

deficiency and penalties.2

     The remaining issues for decision are:

     (1)    Whether petitioners are subject to the section 6663

civil fraud penalty for 1996 and whether petitioner Sharon Norris

(Mrs. Norris) is subject to the section 6663 civil fraud penalty

for 1998;

     (2)    whether the period of limitations for assessing taxes

and penalties against petitioners expired for 1996 and whether




     1
      Unless otherwise indicated, all section references are to
the Internal Revenue Code of 1986, as amended, and all Rule
references are to the Tax Court Rules of Practice and Procedure.
Amounts are rounded to the nearest dollar.
     2
      The original notice of deficiency included deficiency and
sec. 6663(a) penalty calculations of $71,699 and $53,774 for
1996, respectively, and $39,641 and $29,699 for 1998,
respectively.
                                 -3-

the period of limitations for assessing taxes and penalties

against Mrs. Norris expired for 1998; and

     (3)   if the Court determines that the periods of limitations

for assessing taxes and penalties were open for 1996 and 1998 at

the time of assessment, whether respondent’s deficiency

determinations and related fraud penalties are correct.

                           FINDINGS OF FACT

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

The stipulation of facts, together with the attached exhibits, is

incorporated herein by this reference.    At the time petitioners

filed their petition, they lived in Tennessee.

I.   Background

     Mr. Norris was born in Nashville, Tennessee.    He completed a

10th grade education and began working in the specialty welding

business in the late 1970s.    Mrs. Norris completed some college

courses at Macon College in Georgia.    While living in Georgia,

she worked as a purchasing agent for the City of Macon Water

Department.   Petitioners were married on December 28, 1990.    In

1996 petitioners bought land in Joelton, Tennessee, and began

construction on a new home.    Petitioners’ home was completed in

1998.   Mr. Norris acted as the general contractor during the

construction of petitioners’ home and performed much of the work

himself to reduce costs.
                                 -4-

      Mr. Norris owned and operated a specialty welding business

until early 1996.   As his business grew, he was required to

travel frequently to jobsites throughout the United States.      He

employed new workers at the different jobsites.     Mr. Norris

testified that one of the challenges of traveling from town to

town was that it was sometimes difficult to cash checks to pay

his workers.    As a result, he developed the habit of going to the

bank before traveling to a jobsite to get the cash he felt was

necessary for each job.   If he did not spend all the cash he had

on a jobsite, he put it in a safe in his home.     Mr. Norris

accumulated cash this way over a 6- to 7-year period.     In 1996 he

had approximately $100,000 in cash in his home.

II.   The Little Barn Market

      A.   Recordkeeping and Reporting

      In 1994 Mr. Norris purchased a convenience store and gas

station in Nashville, Tennessee, called the Little Barn Market

(the market).    Mr. and Mrs. Norris both worked at the market in

1996 and 1998.   Mrs. Norris wrote and signed checks to pay

vendors, prepared monthly sales summaries, and prepared and filed

sales and employment tax returns.      On their 1996 and 1998 Federal

income tax returns, petitioners reported gross receipts from the

market of $717,550 and $840,672, respectively.     The gross

receipts reported on petitioners’ 1996 Federal income tax return
                                -5-

omitted at least $200,000 in sales from the market because of a

mistake in Mrs. Norris’ calculations.

     Petitioners hired Evan Rogers (Mr. Rogers) to represent them

in a sales tax dispute with the State of Tennessee.   Mr. Rogers,

who was not involved in the preparation of petitioners’ 1996

Federal income tax return, reviewed the market’s records for 1996

and uncovered Mrs. Norris’ mistake.

     The market’s cash register printed daily sales records on

what petitioners referred to as the “Z-tapes”.   Mrs. Norris

totaled the daily Z-tapes and created monthly sales records (the

Z-out reports).   The Z-out reports have five columns of

calculations.   The first column is for total taxable sales.   The

next four columns list the sales figures for newspapers,

kerosene, gasoline, and food stamps, items with separate Z-out

functions on the market’s cash register because they were not

subject to sales tax.   Mr. Rogers’ analysis revealed that Mrs.

Norris had subtracted the totals from these four columns from

total taxable sales under the mistaken belief that the Z-out

reports for total taxable sales included those amounts.    As a

result, because Mrs. Norris believed that the totals for

newspapers, kerosene, gasoline, and food stamps were already

included in total taxable sales for Federal tax purposes on the

Z-out reports, she failed to add those items to total taxable
                                 -6-

sales for Federal tax reporting purposes.    Mrs. Norris did not

understand the mistake until preparation for this trial.

     B.     Illegal Poker Machines

     Mr. Norris owned and operated illegal poker machines in the

back room of the market in 1996 and 1998.    On August 8, 1996, the

Metropolitan Police Department of Nashville-Davidson (the metro

police) seized eight illegal poker machines from the market.      Mr.

Norris was arrested and charged and pleaded guilty to a

misdemeanor gambling offense.    After the 1996 seizure Mr. Norris

purchased new illegal poker machines and again operated them in

the back room of the market.    The metro police seized the

replacement illegal poker machines in January 1997.    Mr. Norris

was arrested and charged and pleaded guilty to a misdemeanor

gambling offense with respect to the 1997 seizure.    After the

1997 seizure Mr. Norris once again replaced the illegal poker

machines.    The metro police seized these illegal poker machines

in 1998.    Mr. Norris was once again arrested and charged and

pleaded guilty to a misdemeanor gambling offense.

     The illegal poker machines generated illegal gambling

income.    Mr. Norris failed to keep sufficient records of his

illegal gambling income, but he earned at least $22,380 from his

illegal poker machine business in 1996.    Petitioners’ Federal

income tax returns for 1996 and 1998 were prepared by John Gaddy

(Mr. Gaddy), a former revenue agent with the Internal Revenue
                                 -7-

Service (IRS).   Mr. Gaddy had operated a tax preparation business

since 1974, and he first worked with Mr. Norris to help prepare

tax returns for Mr. Norris’ specialty welding business long

before 1996.

     Mr. Gaddy knew that Mr. Norris operated an illegal poker

machine business in the back room of the market in 1996.   In

fact, he wrote “poker machine income” in reference to Mr. Norris’

$22,380 estimate of income from the illegal poker machines in

1996 that was written in Mr. Norris’ notes.   Mr. Gaddy testified

that Mr. Norris’ income from the illegal poker machines was

reported on petitioners’ tax returns.   On cross-examination,

however, Mr. Gaddy testified that he was not aware of

petitioners’ illegal gambling income in 1996.    He later explained

this conflicting testimony by stating that he did not have his

workpapers in front of him and could not remember exactly what

had happened.

III. Legal Gambling

     During 1996 and 1998 petitioners gambled frequently in Las

Vegas, Nevada.   Petitioners reported legal gambling income of

$96,210 in 1996.   A portion of this amount was documented using

Forms W-2G, Certain Gambling Winnings, given to petitioners by

the casinos where they had gambled.    Petitioners orally informed

Mr. Gaddy of their winnings in excess of those documented by

Forms W-2G.    Where petitioners’ oral accounts of their winnings
                                  -8-

exceeded their documentation, Mr. Gaddy reported the higher of

the two numbers.

      Petitioners did not report an additional $43,120 of legal

gambling income on their 1996 Federal income tax return.       Of this

amount, $35,800 is attributable to a 1957 Corvette that Mr.

Norris won at the Mirage Casino in a slot machine tournament.

The Mirage Casino issued petitioners a Form 1099-MISC,

Miscellaneous Income, for $35,800 but mailed it to the wrong

address.

IV.   Mr. Norris’ Criminal Case

      In March 2005 Mr. Norris was indicted on two counts of

criminal tax evasion under section 7201, one count for 1996

(count 1) and one count for 1998 (count 2).     On January 13, 2006,

he pleaded guilty to count 2 in the U.S. District Court for the

Middle District of Tennessee.     In the plea hearing of the

criminal case he admitted to taking “affirmative acts in 1998 to

evade tax by conducting his affairs in cash, destroying records,

and by concealing petitioners’ true and correct income.”       Mr.

Norris further admitted a total tax deficiency for 1996 and 1998

of approximately $111,298 but did not admit to taking any

affirmative acts in 1996 to evade tax.     As part of Mr. Norris’

plea agreement, the Department of Justice dismissed count 1.         On

April 15, 2006, Mr. Norris was sentenced to 15 months in prison

and ordered to pay restitution of $111,298 to the IRS.
                                -9-

V.   Deficiency Determination

     On October 22, 2008, respondent issued a notice of

deficiency to petitioners for 1996 and 1998.   As part of the

criminal investigation of Mr. Norris, David Martin (Mr. Martin)

of the IRS Criminal Investigation Division used the indirect net

worth method to reconstruct petitioners’ income.   According to

Mr. Martin’s reconstruction, after allowable deductions and

exemptions of $104,862 petitioners’ underreported taxable income

for 1996 was $226,628.   For 1998 Mr. Martin’s reconstruction

determined petitioners’ underreported taxable income to be

$84,002 after allowable deductions and exemptions of $59,361.

     Mr. Martin’s analysis attributes income to petitioners for

expenses relating to the construction of their home.   However,

his analysis confused bids with amounts actually paid.    For

example, Mr. Martin used a bid from Oakley Lumber of $41,000 (the

Oakley Lumber bid) as the amount petitioners paid for lumber but

proved only $13,000 was paid.   Further, the Oakley Lumber bid

included nails and bolts, which were eventually purchased

separately.   Mr. Martin also failed to properly account for

petitioners’ accumulation of cash and its use to pay certain

construction workers, to make Mr. Norris’ spousal support

payments to his ex-wife, and to pay certain market vendors.

Petitioners used an unusual system to make record of payment.
                                -10-

They would write a check to the payee and immediately cash the

check for the payee.    The check served as a record of payment.

                               OPINION

     Ordinarily, the limitations period for assessment is 3 years

from the later of the filing date or the due date of the return.

Sec. 6501(a).    The parties do not dispute that the notice of

deficiency, even with agreed-upon extensions, was not issued

within the statutory deadlines set forth in section 6501(a).

Respondent issued the notice of deficiency on October 22, 2008,

and relied on section 6501(c)(1), which states that “in the case

of false or fraudulent return with the intent to evade tax, the

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

such tax may be begun without assessment, at any time.”

Accordingly, our determination of whether the period of

limitations was open on October 22, 2008, depends on proof of

fraud.

I.   Burden of Proof

     The Commissioner’s determinations in a notice of deficiency

are generally presumed correct, and the taxpayer bears the burden

of proving that those determinations are incorrect.    Rule

142(a)(1).   The Commissioner has the burden of proof by clear and

convincing evidence with respect to a determination of fraud.

Rule 142(b).    If fraud is proven, the Commissioner
                                  -11-

will also have the burden of proof with respect to an increased

deficiency.   Rule 142(a)(1).

II.   Fraud Generally

      The determination of fraud for purposes of section

6501(c)(1) is the same as the determination of fraud for purposes

of the penalty under section 6663.       Neely v. Commissioner, 116

T.C. 79, 85 (2001); Rhone-Poulenc Surfactants & Specialties, L.P.

v. Commissioner, 114 T.C. 533, 548 (2000).      For Federal tax

purposes, fraud entails intentional wrongdoing with the purpose

of evading a tax believed to be owing.      See Neely v.

Commissioner, supra at 86.      In order to show fraud, respondent

must prove:   (1) An underpayment exists; and (2) petitioners

intended to evade taxes known to be owing by conduct intended to

conceal, mislead, or otherwise prevent the collection of taxes.

See Parks v. Commissioner, 94 T.C. 654, 660-661 (1990).

      A.   Underpayment of Tax

      Respondent must first show by clear and convincing evidence

that an underpayment of tax exists for 1996 and for 1998.        The

parties have stipulated that:     (1) Gross receipts reported from

the market for 1996 omitted $200,000; and (2) petitioners did not

report $43,120 of gambling income for 1996.      Mr. Norris is

collaterally estopped from denying the 1998 deficiency.
                                 -12-

Accordingly, respondent has proven that an underpayment of tax

exists for 1996 and for 1998.3

     B.   Fraudulent Intent

     Because direct evidence of fraud is rarely available, fraud

may be proved by circumstantial evidence and reasonable

inferences from the facts.    Petzoldt v. Commissioner, 92 T.C.

661, 699 (1989).   Courts have developed a nonexclusive list of

factors, or “badges of fraud”, that demonstrate fraudulent



     3
      Respondent determined petitioners’ underpayments through
Mr. Martin’s reconstruction of petitioners’ income using the net
worth method. The net worth method computes income by
determining a taxpayer’s net worth at the beginning and end of a
period. The difference between the amounts is the increase in
net worth. An increase in a taxpayer’s net worth, plus his
nondeductible expenditures, less nontaxable receipts, may be
considered taxable income. Holland v. United States, 348 U.S.
121, 125 (1954). While the net worth method is an acceptable
method of reconstructing petitioners’ income, its use requires
the exercise of “great care and restraint” to prevent petitioners
from being “ensnared in a system which, though difficult for the
prosecution to utilize, is equally hard for the defendant to
refute.” Id. at 129.

     For 1996 respondent determined petitioners’ underpayment to
be greater than the underpayment attributable to petitioners’
stipulated omissions. Respondent spent considerable time
attributing additional income to petitioners from expenses
relating to the construction of their home. Petitioners
identified numerous errors in this analysis, including
respondent’s mistaking of bids for amounts paid and failing to
properly account for petitioners’ use and accumulation of cash.
Respondent’s failure to prove the accuracy of his net worth
computations renders the computations incapable of sustaining the
deficiencies circumstantially derived therefrom. Id. Thus, we
limit petitioners’ underreported gross income and related
deficiency for 1996 to amounts resulting from the $200,000 of
omitted gross receipts from the market and $43,120 of omitted
gambling income, as stipulated.
                                 -13-

intent.    Niedringhaus v. Commissioner, 99 T.C. 202, 211 (1992).

These badges of fraud include:    (1) Understating income, (2)

maintaining inadequate records, (3) implausible or inconsistent

explanations of behavior, (4) concealment of income or assets,

(5) failing 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) filing false documents, (10)

failing to file tax returns, and (11) dealing in cash.     Id.; see

also Spies v. United States, 317 U.S. 492, 499 (1943); Morse v.

Commissioner, 419 F.3d 829, 832 (8th Cir. 2005), affg. T.C. Memo.

2003-332; Recklitis v. Commissioner, 91 T.C. 874, 910 (1988).

Although no single factor is necessarily sufficient to establish

fraud, the combination of a number of factors constitutes

persuasive evidence.     Niedringhaus v. Commissioner, supra at 211.

Respondent must prove fraud for each year at issue.     See id. at

210; Ferguson v. Commissioner, T.C. Memo. 2004-90.

III. Fraud Penalties--Mr. Norris

     As discussed above, Mr. Norris is collaterally estopped from

denying the deficiency and fraud penalties for 1998.4    Respondent

argues that Mr. Norris is also subject to the fraud penalty for

1996.    We disagree.   No single factor or combination of factors


     4
      The parties agree that amounts Mr. Norris pays as
restitution in his criminal case should be credited against any
civil deficiency judgment.
                                 -14-

adverse to petitioner is sufficient in this case to establish

fraud for 1996.     Therefore we will undertake to weigh the factors

equally, and on that basis we find respondent has failed to

provide clear and convincing evidence of fraud.    Mr. Norris’

behavior with respect to petitioners’ income shows four of the

above-listed factors in support of a finding of fraud, five

factors against, and two factors neutral, as follows.

     A.   Understating Income

     As stated above, petitioners understated their income in

1996 by $200,000 with respect to sales from the market and by

$43,120 of gambling income.    Accordingly, this factor favors a

finding of fraud.

     B.   Maintaining Inadequate Records

     Mr. Norris failed to maintain adequate records of income

from his illegal poker machine business.    Further, petitioners

did not report as income the value of the 1957 Corvette as

reported by the Mirage Casino on Form 1099-MISC.    Petitioners

argue, however, that the Mirage Casino sent the Form 1099-MISC

for the 1957 Corvette to the wrong address.    Petitioners further

argue that they produced appropriate records for all other

gambling winnings in 1996 and their failure to produce the Form

1099-MISC for the 1957 Corvette was an honest mistake caused by

the mailing error.
                                -15-

     With respect to the market, petitioners produced records of

the market’s sales and expenses, inventory, and tax records.

Taxpayers are required to maintain records sufficient to

establish the amounts of allowable deductions and to enable the

Commissioner to determine the correct tax liability.     Sec. 6001;

Shea v. Commissioner, 112 T.C. 183, 186 (1999).     Respondent

conceded that petitioners are entitled to $104,862 of itemized

deductions for 1996.   Petitioners kept adequate records with

respect to the market but failed to maintain adequate records

with respect to their gambling winnings.     Accordingly, this

factor is neutral.

     C.   Implausible or Inconsistent Explanations of Behavior

     Respondent argues that it is implausible that petitioners

built their home with approximately $13,000 of lumber when the

Oakley lumber bid estimated a need for approximately $41,000 of

lumber.   Respondent fails, however, to provide a factual basis

for this assertion with evidence pertinent to the construction

and design of petitioners’ home.   Mr. Norris performed a

significant amount of the work on petitioners’ home on his own

and was thus able to keep costs low.    Additionally, Mr. Norris

purchased the lumber apart from the nails and bolts, which were

included in the Oakley lumber bid.     Accordingly, respondent has

not demonstrated implausible or inconsistent explanations of
                                -16-

behavior, and this factor goes against a finding of fraudulent

intent.

     D.     Concealment of Income or Assets

     It is unclear whether petitioners reported income from Mr.

Norris’ illegal poker machine business on their 1996 Federal

income tax return.    Mr. Norris’ notes with respect to income and

expense items of the market include a notation for income from

the illegal poker machines of $22,380.    Petitioners’ accountant,

Mr. Gaddy, wrote the term “poker machine income” above Mr.

Norris’ notation of $22,380.    Mr. Gaddy testified that he was

aware that Mr. Harris was operating the illegal poker machines in

1996 and that any income from the illegal poker machines was

reported.    During respondent’s cross-examination, Mr. Gaddy

testified that the $22,380 was not reported on petitioners’

Schedule C, Profit or Loss From Business, and he did not recall

whether it was reported in petitioners’ gross receipts.    Mr.

Gaddy explained this conflicting testimony by saying that he did

not have his workpapers available and was not sure.

     Mr. Norris’ notes were provided to Mr. Gaddy, who inserted

the term “poker machine income”.    Respondent has not provided any

evidence that petitioners attempted to conceal this income, but

respondent argued that it was petitioners’ responsibility to

review their tax return to verify its accuracy.    Accordingly,

although it is unclear whether Mr. Gaddy included the $22,380 as
                                 -17-

part of petitioners’ gross receipts, this factor goes against a

finding of fraudulent intent.

     E.     Failing To Cooperate With Tax Authorities

     Respondent has not presented any evidence that petitioners

failed to cooperate with tax authorities.     Accordingly, this

factor goes against a finding of fraudulent intent.

     F.     Engaging in Illegal Activities

     Petitioners concede that Mr. Norris kept illegal poker

machines at the market in 1996.     Accordingly, this factor favors

a finding of fraud.

     G.     An Intent To Mislead Which May Be Inferred From a
            Pattern of Conduct

     The metro police seized illegal poker machines from the

market in 1996.     Mr. Norris replaced the seized poker machines in

1997.     After the metro police seized the replacement illegal

poker machines in 1997, Mr. Norris again replaced them in 1998.

In the plea hearing of Mr. Norris’ criminal case he admitted to

taking affirmative acts in 1998 to evade tax by conducting his

affairs in cash, destroying records, and concealing petitioners’

true and correct income.     Accordingly, this factor favors a

finding of fraud.

     H.     Lack of Credibility of the Taxpayer’s Testimony

     Respondent argues that Mr. Norris’ testimony was not

credible because he downplayed the profitability of the illegal

poker machines.     This argument is based on Mr. Norris’ testimony
                                 -18-

that the machines generated “some income”, rather than “a lot of

income”.    Whether $22,380 is “some income” or “a lot of income”

is a subjective question to which there is no right or wrong

answer.

     Throughout his testimony the Court found Mr. Norris to be

credible.    While some of his business practices were unusual,

particularly his use of cash, he provided logical explanations

for his behavior that respondent was unable to refute.

Accordingly, this factor goes against a finding of fraudulent

intent.

     I.     Filing False Documents

     Petitioners concede that they understated their income on

their 1996 Federal income tax return.     Respondent has not

presented any evidence that petitioners filed any other false

documents.    Accordingly, this factor is neutral.

     J.     Failing To File Tax Returns

     On November 1, 1998, petitioners filed their 1996 income tax

return.     Mr. Norris’ plea agreement in his criminal case required

him to file amended returns for 1996 and 1998.     Mr. Norris did

not file amended returns as required.     Accordingly, this factor

favors a finding of fraud.

     K.     Dealing in Cash

     Petitioners sometimes used cash to pay Mr. Norris’ ex-wife,

workers on the construction of petitioners’ home, and certain of

the market’s vendors.    Mr. Norris explained that he began using
                                -19-

cash in his welding business in the late 1970s.    He explained

that he traveled as part of the welding business and because it

was difficult to cash checks, he developed the habit of taking

large sums of cash with him to a jobsite to pay the workers.

Often, after a job had been completed and he had paid the

workers, he had cash left over.    As a result, Mr. Norris

accumulated a cash hoard.    The Court recognizes that Mr. Norris’

propensity to accumulate cash may be considered unusual in

today’s business environment.    Nonetheless, because Mr. Norris

used cash regularly throughout his career, the Court does not

find his mere continued use of cash to be evidence of an intent

to evade tax.

     Respondent has not provided evidence that petitioners tried

to hide or conceal cash transactions in 1996.    Petitioners

oftentimes paid workers on the construction of their home in cash

by providing them with a check and immediately cashing the check.

The check would then become petitioners’ record of payment.    This

process was also used for spousal support payments made to Mr.

Norris’ ex-wife.   Mrs. Norris explained that cash payments made

to the market’s vendors were based on receipts that were used to

determine vendor totals.    Petitioners kept a record of all

vendors paid in cash.   Accordingly, there is no evidence that

petitioners used cash to avoid reporting requirements, and this

factor favors against a finding of fraudulent intent.
                                  -20-

      As discussed above, respondent must provide proof by clear

and convincing evidence with respect to the determination of

fraud.    See Rule 142(b).    Respondent has proven only four badges

of fraud with respect to Mr. Norris in 1996.      Mr. Norris’ plea

agreement in his criminal case does not provide any additional

support for respondent’s determinations.      Despite conceding a

deficiency, Mr. Norris’ plea agreement does not include any

concession with respect to fraud in 1996.      Thus, Mr. Norris is

not liable for the fraud penalties for 1996.

IV.   Fraud Penalties--Mrs. Norris

      Generally, a husband and wife are jointly and severally

liable for the total tax due on their joint Federal income tax

return.    Sec. 6013(d)(3).    Fraud, however, is not imputed from

one spouse to the other.      Sec. 6663(c).   Accordingly, respondent

has the burden of proving by clear and convincing evidence that

some part of each underpayment is due to the fraud of Mrs.

Norris.    See Stone v. Commissioner, 56 T.C. 213, 227-228 (1971);

Ortiz v. Commissioner, T.C. Memo. 1998-141.

      Respondent argues that Mrs. Norris knew of the illegal poker

machines in the back of the market; however, respondent has not

presented any evidence that she was involved in Mr. Norris’

illegal poker machine business or had any direct knowledge of

such operations.    While it is likely that she was not completely

unaware of Mr. Norris’ activity, that fact alone cannot sustain a

finding of fraud as to her.     See Ortiz v. Commissioner, supra.
                               -21-

     Respondent further argues that Mrs. Norris was the primary

bookkeeper for the market and, as such, was aware that gross

receipts from the market were understated.   Again, however,

respondent has failed to present any evidence of these

assertions.   Petitioners concede that gross receipts from the

market were underreported; however, they argue that Mrs. Norris’

made an innocent mistake in reporting the sales totals from the

Z-out reports.   Mr. Rogers discovered this mistake while helping

Mrs. Norris work through a State sales tax audit of the market.

According to Mr. Rogers, Mrs. Norris failed to report gross

receipts from gasoline, kerosene, newspapers, and other items

that were reported separately on the Z-tapes.   Mr. Rogers

testified that Mrs. Norris subtracted these items from total

sales without realizing that they had already been omitted.    Mrs.

Norris testified that she did not completely understand this

mistake until preparation for this trial.

     Respondent has not presented any evidence disputing Mr.

Rogers’ or Mrs. Norris’ description of this mistake.   Rather,

respondent relies on a theory that requires the Court to assume

that because Mrs. Norris was responsible for the market’s

bookkeeping, and because Mr. Rogers was not involved in the

preparation of petitioners’ 1996 and 1998 income tax returns and

therefore did not have firsthand knowledge of what was and was

not reported, Mrs. Norris intentionally underreported total sales
                                  -22-

from the Z-out reports for the purpose of evading tax.      We cannot

draw that conclusion.      Accordingly, respondent has failed to

prove by clear and convincing evidence that Mrs. Norris displayed

a fraudulent intent to evade taxes for 1996 and 1998.

V.   Statute of Limitations

     As stated above, the limitations period for assessment is 3

years from the later of the filing date or the due date of the

return.   Sec. 6501(a).     The parties do not dispute that the

notice of deficiency, even with agreed-upon extensions, was not

issued within the statutory deadline for either 1996 or 1998 as

set forth in section 6501(a).

     Respondent relied on the fraud exception of section 6501(c)

to issue the notice of deficiency for both 1996 and 1998.      The

Court previously held that the limitations period for Mr. Norris

for 1998 remained open because Mr. Norris is estopped from

denying fraud.     Generally, in the case of a joint return, proof

of fraudulent intent as to either taxpayer lifts the bar of the

statute of limitations as to both taxpayers.      See Vannaman v.

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

     A refinement to the general rule exists when the fraud of

one spouse is established via collateral estoppel from a section

7201 conviction.     Id.   The innocent spouse is not estopped from

denying that the joint return is fraudulent.      Id.   If such a
                               -23-

challenge is raised, the Commissioner must affirmatively prove by

clear and convincing evidence that at least one of the spouses

filed with the requisite fraudulent intent.   Id.   Such a showing

will then lift the bar of limitations as to both spouses and will

render the nonestopped spouse liable for the subject deficiency.

Id.   Thus, the limitations period for 1998 is not open for Mrs.

Norris unless respondent affirmatively proves, by clear and

convincing evidence, that Mr. Norris committed fraud in 1998.

Id.

      In the plea hearing of Mr. Norris’ criminal case, he

admitted to taking affirmative acts in 1998 to evade tax.     This

admission is clear and convincing evidence of Mr. Norris’

fraudulent conduct in 1998.   Accordingly, at the time the notice

of deficiency was issued, the limitations period for 1998

remained open for Mrs. Norris as well.

      Pursuant to section 6663(c), Mrs. Norris is not liable for

the fraud penalties.   She is, however, jointly and severally

liable for any deficiencies in 1998 resulting from the findings

and conclusions reached herein with respect to Mr. Norris.    See

sec. 6013(d)(3).   With respect to 1996, because the fraud penalty

does not apply to either petitioner, respondent may not rely on

section 6501(c) to extend the limitations period.   Accordingly,

the period of limitations was closed on October 22, 2008, when
                                 -24-

the notice of deficiency was issued, and therefore it is invalid

for 1996.

     In reaching our holdings herein, we have considered all

arguments made, and, to the extent not mentioned above, we

conclude they are moot, irrelevant, or without merit.

     To reflect the foregoing,


                                        An appropriate order will

                                   be issued, and decision will be

                                   entered under Rule 155.
