                          T.C. Memo. 1996-381



                     UNITED STATES TAX COURT



                   INEZ MEILAK, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 104-95.                 Filed August 19, 1996.



     Kathleen E. Giancana and Carol E. Remy, for petitioner.

     Patricia Riegger and Jody Tancer, for respondent.




                          MEMORANDUM OPINION

     PAJAK, Special Trial Judge:     This case was heard pursuant to

section 7443A(b)(3) of the Code and Rules 180, 181, and 182.     All

section references are to the Internal Revenue Code in effect for

the taxable years in issue, and all Rule references are to the

Tax Court Rules of Practice and Procedure.
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          Respondent determined deficiencies in petitioner's

Federal income taxes, together with penalties, as follows:

                                               Penalty
          Year            Deficiency         Sec. 6662(a)

          1989            $5,390                $944
          1990             4,046                 779

     By Amendment to Answer, respondent asserted penalties under

section 6663(a) for 1989 and 1990 in the amounts of $4,042 and

$3,034, respectively.

     The issues for decision are:   (1) Whether petitioner

understated her income from tips for the years in issue; (2)

whether petitioner is liable for fraud penalties pursuant to

section 6663(a); and (3) if not liable for the fraud penalties,

whether petitioner is liable for accuracy-related penalties

pursuant to section 6662(a).

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

Petitioner resided in Astoria, New York, when her petition was

filed.

     For clarity and convenience, our findings of fact and

opinion have been combined.

     During the years in issue, petitioner worked full-time as a

waitress at Sandomenico New York, Inc. (Sandomenico), an upscale,

expensive restaurant in New York City, New York.   The principal

issue in this case is the amount of tip income earned by

petitioner at this job.
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     On her 1989 Federal income tax return, petitioner reported

tip income of $7,200.   Petitioner failed to include in income

$7,931 of tips allocated to her by Sandomenico pursuant to

section 6053(c)(3) and noted in Box 6 of her Form W-2.    On her

1990 return, petitioner reported tip income of $13,147, which

included the $347 of tips allocated to her by Sandomenico

pursuant to section 6053(c)(3).

     In 1989 and 1990, Sandomenico's directly tipped employees

included captains, waiters and waitresses, and busboys.    After

each shift (either lunch or dinner), the directly tipped

employees would pool all the charged and cash tips received.     The

next day, two of the employees would allocate and distribute the

tips pursuant to a point system (described in greater detail

below).   They allegedly recorded the amount of tips received in

notebooks, along with the resulting allocation and distribution

among the employees who worked that shift.   Petitioner claimed

these notebooks were kept on the premises of Sandomenico.

     During the initial audit of petitioner's returns by

respondent, petitioner did not produce any personal records of

her tip income.   Later in the audit, petitioner produced one of

the above mentioned notebooks, purportedly covering the period of

April 28, 1990 to December 31, 1990.   Other than this notebook,

during the audit petitioner did not mention, nor did she produce,

any personal records of her tip income.
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     Respondent prepared analyses of Sandomenico's Forms 8027,

Employer's Annual Information Return of Tip Income and Allocated

Tips, for purposes of reconstructing the directly tipped

employees' tip income for 1989 and 1990.    The Forms 8027 reflect

Sandomenico's total charged tips, total charged receipts, total

tips reported by its directly tipped employees, gross receipts

from food and beverage operations, the number of directly tipped

employees, and an allocated tip amount of 8 percent of its gross

receipts.   These Forms 8027 show that $558,227 and $390,004.49 of

charged tips had not been declared to Sandomenico by the directly

tipped employees for 1989 and 1990, respectively.

     Respondent's determinations of petitioner's unreported tip

income are based on Sandomenico's allocation of gross receipts

among its directly tipped employees, prepared pursuant to section

6053 and the regulations thereunder.     The allocations were done

by Mr. Hemang Patel (Mr. Patel), Sandomenico's then bookkeeper.

Mr. Patel explained that he allocated gross receipts on a daily

basis among directly tipped employees using a point system of 10

points for captains, 8 points for waiters and waitresses, and 5

points for busboys.   Sandomenico's directly tipped employees used

this same point system to divide and distribute the pooled tips

among themselves on the day after a particular shift.

     Mr. Patel would total the points of all the employees that

worked a shift, and then divide the total gross receipts for that

shift by the number of points.    Mr. Patel would then take the
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resulting number and multiply it by the number of points for each

employee to arrive at that employee's total gross receipts for

the shift.    For example, if 3 captains (30 points), 8 waiters and

waitresses (64 points), and 3 busboys (15 points) worked a shift,

the total would be 109 points.    If the restaurant made $5,000 in

gross receipts that shift, $45.87 ($5,000 divided by 109) would

be allocated for each point.    Thus, a waiter or waitress would be

allocated gross receipts of $366.96 ($45.87 times 8 points) for

that shift by Mr. Patel.

     Based on the tip allocation spreadsheets prepared by Mr.

Patel, the rounded-off percentage of gross receipts attributed to

petitioner by Sandomenico was approximately 5 percent for 1989,

and approximately 7 percent for 1990.

     Respondent determined petitioner had $26,511 and $21,396 of

unreported tip income for 1989 and 1990, respectively, using the

following method.    For each year in issue, respondent multiplied

the total charged tip amount from Sandomenico's Form 8027 by the

percentage of total gross receipts Sandomenico attributed to

petitioner.   From this figure, respondent subtracted the tip

amount petitioner reported on her return.    This was the amount

respondent determined was unreported charged tip income for

petitioner.   Cash tips were figured by subtracting the total

charged receipts from the gross receipts reported on

Sandomenico's Form 8027, which resulted in the total cash

receipts amount.    Respondent then multiplied this figure by 12
                               - 6 -

percent, to come up with a total cash tip amount.   Respondent's

agent testified that the rate of 12 percent was used for cash

tips "to be as conservative and, hopefully, equitable as

possible, since usually the charge [tip] rates range from 15 to

20 percent".   Respondent once again used petitioner's percentage

of total gross receipts as allocated by Sandomenico, and

multiplied the total cash tips figure by petitioner's percentage

of total gross receipts to arrive at petitioner's cash tips.

Respondent then added the unreported charged tips to the cash

tips to determine the amount of tip income petitioner failed to

report.

     Petitioner conceded that she underreported her tip income on

her 1989 and 1990 Federal income tax returns.   However,

petitioner contends that she earned tip income of $22,026 and

$18,988 for 1989 and 1990, respectively, rather than the amounts

determined by respondent.

     It is well established that tips are includable in gross

income under section 61(a).   Killoran v. Commissioner, 709 F.2d

31 (9th Cir. 1983), affg. T.C. Memo. 1981-659; sec. 1.61-2(a)(1),

Income Tax Regs.   Under section 6001 a taxpayer is required to

keep sufficient records to enable respondent to compute the

taxpayer's correct tax liability.   In the absence of such

records, respondent may use any method of computation that will

clearly reflect the income of the taxpayer.   Sec. 446(b);

Menequzzo v. Commissioner, 43 T.C. 824, 831 (1965).
                                - 7 -

     Petitioner did not produce any personal records of her tip

income during respondent's audit of her returns.    However, at

trial, petitioner was able to introduce purported personal

records of her tip income for 1989 and 1990.    She testified that

she received her tips in cash from the restaurant on the day

following the shift when the tips were earned.    Attached to the

cash was a small, white paper with the amount of the tips and

petitioner's name written on it.    Petitioner alleged that she

went home, recorded the amount of tip money she received on a

yellow sheet of paper, and then discarded the original white

paper.    Petitioner testified she recorded her tips on these

yellow sheets every night or at least every other night.

Petitioner kept these yellow sheets in a manilla envelope in

which she kept all her Sandomenico records.

     After inspection of the yellow sheets introduced by

petitioner, we do not believe that these alleged daily records

were contemporaneous and accurate records of the tip income she

received in 1989 and 1990.    The uniformity and consistency of the

handwriting, as well as the appearance of the yellow sheets, lead

us to the conclusion that the entries on the sheets were written

about the same time, rather than on a daily basis over a 2-year

period.    Indeed, when testifying about the amount of allocated

tips on the Forms W-2 issued to her by Sandomenico for the years

in issue, petitioner admitted "I had no idea what I made."      We

can only conclude that had petitioner kept these yellow sheets
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contemporaneously, she would have had an "idea" of what she

"made" in tips for each year.

     Petitioner also attempts to rely on 3 notebooks kept by the

tipped employees of Sandomenico as an accurate daily record of

her tip income.   Respondent introduced 5 of these notebooks at

trial, purportedly covering from sometime in 1988 to the

beginning of 1991.   As mentioned, petitioner claims that these

notebooks were maintained by the waitstaff of Sandomenico.     The

day after each shift, two employees allegedly would record the

amount of tips received in the notebook, along with the amounts

to be distributed to the employees who worked that shift.

     Respondent's audit of the 5 books shows that the total tips

listed under petitioner's name are $22,409 and $19,150 for 1989

and 1990, respectively.   Petitioner disputes certain of the

entries under the surname "Meilak", alleging that other Meilaks

also worked during the years in issue.   Thus, petitioner asserts

that the total tips listed under petitioner's name are $21,825

and $19,015 for 1989 and 1990, respectively.

     An examination of these books reveals that the entries in 2

of the books, purportedly daily records for June 13, 1989 to

December 31, 1989 (Exhibit J), and January 2, 1990 to April 27,

1990 (Exhibit I), could not have been written in either 1989 or

1990.   The cover of Exhibit J has a copyright date of 1993.   A

representative of Mead Corporation, the manufacturer of the 2

notebooks that are Exhibits J and I, testified that Exhibit J was
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not available to the public until after October 1993.   Mead's

representative also testified that based on the design of the

cover, the earliest Exhibit I would have been available for

retail sale was the second half of 1991.   Due to the

noncontemporaneous nature of these 2 notebooks, petitioner did

not "rely" on Exhibits J and I as original records.

     The handwriting of different persons, including

petitioner's, appears in Exhibits J and I.   Petitioner guessed

that these notebooks were copied from the originals, but she

could not recall why they were recopied or when they were

recopied.   She also could not recall when she rewrote her

portion.    When further queried about the 2 notebooks, petitioner

asserted they may have been recopied because the notebooks "could

have been torn."   Additionally, she claimed that "We had a couple

of leaks in the building, because the restaurant is underneath a

building, and if somebody had them in the locker, they could have

gotten wet and that's why we'd have to rewrite them."

     Though only Exhibits J and I were clearly shown to be

noncontemporaneous, we do not accept the notebooks for the years

in issue as accurate and contemporaneous records of petitioner's

tip income.   Petitioner did not explain the discrepancies between

the amounts reported on petitioner's alleged personal records,

the yellow sheets, and the amounts recorded in the notebooks.

Moreover, respondent's audit of the notebooks reveals that the

total of the charged and cash tips reflected in the notebooks for
                                - 10 -

each year in issue is less than the charged tips alone as

reported by Sandomenico on the Form 8027 for each year.     Due to

the inadequacy of the records produced by petitioner, it became

incumbent upon respondent to reconstruct petitioner's income for

the years in issue.

     When reconstruction of a taxpayer's income is necessary,

respondent has great latitude in the method of reconstruction

used.     Catalano v. Commissioner, 81 T.C. 8, 13 (1983), affd.

without published opinion sub nom. Knoll v. Commissioner, 735

F.2d 1370 (9th Cir. 1984).     The method of reconstruction is

sufficient if the reconstruction is reasonable in light of all of

the surrounding facts and circumstances.     Schroeder v.

Commissioner, 40 T.C. 30, 33 (1963).     This Court and other courts

have accepted the use of formulas in the reconstruction of tip

income.     Cracchiola v. Commissioner, 643 F.2d 1383 (9th Cir.

1981), affg. per curiam T.C. Memo. 1979-3 and Lombardo v.

Commissioner, T.C. Memo. 1979-11.     A taxpayer may, however, point

out areas or specific instances in which the method used by

respondent fails to reflect his or her true income.     Miller v.

Commissioner, 237 F.2d 830, 838 (5th Cir. 1956), affg. in part

and revg. in part T.C. Memo. 1955-112.

        Petitioner argues that the amounts allocated to her by

respondent are inherently erroneous because the gross receipts

allocated to her by Sandomenico are too high.     Petitioner asserts

Sandomenico employed numerous directly tipped employees who were
                               - 11 -

"illegal" aliens.   She argues her allocative share of gross

receipts is distorted by the fact that these illegal aliens did

not appear on the payroll, were not included on the Forms 8027,

and were not allocated gross receipts by Mr. Patel.

     We are not persuaded by petitioner's protestations that

illegal aliens adversely affected her allocation of gross

receipts.    Several employees whom she stated were "illegal" were

in fact allocated gross receipts by Mr. Patel for the years in

issue.   Petitioner has not persuaded us that the percentage of

gross receipts allocated to her by Mr. Patel for the years in

issue was wrong.

     Petitioner also contends that respondent's formula fails to

reflect her true tip income because Sandomenico allegedly kept

approximately 2.7 percent of all charged tips to cover the cost

of fees imposed by the credit card companies.    Petitioner failed

to furnish adequate proof with respect to this point.    Assuming,

arguendo, that this contention was true, we believe respondent's

formula has sufficient leeway to encompass it.

     Petitioner further attacks respondent's formula by claiming

that after each lunch shift and dinner shift, the directly tipped

employees would give $20 and $40, respectively, to the "pantry"

employees.   Again, we are satisfied that respondent's

conservative formula would encompass any tip sharing that

occurred between the directly tipped employees and the pantry

employees.
                                - 12 -

     Upon consideration of the record, we conclude the method

used by respondent to determine petitioner's unreported tip

income was reasonable.    Thus, petitioner has failed to satisfy

her burden of proving error in respondent's determination of her

1989 and 1990 tip income.    Rule 142(a); Welch v. Helvering, 290

U.S. 111, 115 (1933).    Accordingly, we sustain those

determinations.

     We next turn to the question of whether petitioner is liable

for fraud penalties under section 6663(a) for both 1989 and 1990.

Respondent must prove by clear and convincing evidence that

petitioner is liable for the fraud penalty.    Sec. 7454(a); Rule

142(b).   Respondent must meet her burden of proving fraud through

affirmative evidence; fraud is never imputed or presumed.       Beaver

v. Commissioner, 55 T.C. 85, 92 (1970).     Whether fraud exists in

a given situation is a factual determination that must be made

after reviewing the particular facts and circumstances of the

case.   DiLeo v. Commissioner, 96 T.C. 858, 874 (1991), affd. 959

F.2d 16 (2d Cir. 1992).     Respondent must show clearly that

petitioner intended to evade a tax known or believed to be owing.

Stoltzfus v. United States, 398 F.2d 1002, 1004 (3d Cir. 1968).

Fraud cannot be found if the circumstances only create a

suspicion of its existence.     Petzoldt v. Commissioner, 92 T.C.

661, 700 (1989).   The mere failure to report income is not

sufficient to establish fraud.     Petzoldt v. Commissioner, supra.
                                 - 13 -

     Based on our review of the record, we are not convinced that

the underpayment of tax for each year at issue is due to fraud on

the part of petitioner.   We conclude that respondent has not

proven by clear and convincing evidence that petitioner is liable

for the section 6663(a) fraud penalty for 1989 and 1990.

     Respondent determined that petitioner is liable for

accuracy-related penalties under section 6662(a) for both 1989

and 1990.   Section 6662(a) and (b)(1) imposes a penalty on any

portion of an underpayment that is attributable to negligence or

disregard of rules or regulations.        The term "negligence"

includes any failure to make a reasonable attempt to comply with

the statute, and the term "disregard" includes any careless,

reckless, or intentional disregard.        Sec. 6662(c).   The penalty

does not apply to any portion of an underpayment for which there

was reasonable cause and with respect to which the taxpayer acted

in good faith.   Sec. 6664(c).    Respondent's determinations are

presumed correct, and petitioner bears the burden to prove she is

not liable for the accuracy-related penalties under section

6662(a).    Rule 142(a); Neely v. Commissioner, 85 T.C. 934, 947

(1985); Bixby v. Commissioner, 58 T.C. 757, 791-792 (1972).

     Petitioner conceded that she substantially underreported her

income from tips on her Federal income tax returns for 1989 and

1990.   The record shows that petitioner maintained inadequate

records of her tip income for those years.        Moreover, petitioner

admitted she did not check her income tax returns for accuracy.
                              - 14 -

     Petitioner has failed to demonstrate that she was not

negligent or that she had a reasonable basis for underreporting

her tip income.   Petitioner has not satisfied her burden of

proof, and accordingly, is liable for the accuracy-related

penalty under section 6662(a) for both 1989 and 1990.    We must

sustain respondent on this issue.

     In conclusion, we have considered all the arguments made by

the parties and, to the extent not discussed above, find them to

be without merit.   To reflect the foregoing,

                                         Decision will be entered

                                    for respondent as to the

                                    deficiencies and the section

                                    6662(a) penalties, and for

                                    petitioner as to the section

                                    6663(a) penalties.
