                              T.C. Memo. 2012-32



                         UNITED STATES TAX COURT



               PAUL R. AVENELL AND DAIA AVENELL, Petitioners v.
               COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 26452-07.                     Filed February 2, 2012.



      Lawrence W. Sherlock, Renesha N. Fountain, and Dianne C. Mehany, for

petitioners.

      M. Kathryn Bellis, Ashley Vaughan Targac, and Randall G. Durfee, for

respondent.
                                           -2-

                MEMORANDUM FINDINGS OF FACT AND OPINION


       KROUPA, Judge: Respondent determined deficiencies in petitioner Paul

Avenell’s individual Federal income tax return for 1992 and in petitioners’ joint

Federal income tax return for 1993.1 Respondent determined that petitioner2 was

liable for an addition to tax under section 6651(a)(1) for failure to file a return timely

(late filing) for 1992 and that petitioners were liable for a late-filing addition to tax

for 1993. Respondent also determined that petitioner is liable for the fraud penalty

under section 6663 for 1992 and 1993 (the years at issue).3

       The primary issue is whether respondent has proven by clear and convincing

evidence that petitioner is liable for the fraud penalty for the years at issue. We hold

that he has not. We therefore need not decide other issues relating to the

deficiencies and additions to tax because the limitations period for assessment has

expired.



       1
        The parties stipulated in a Stipulation of Settled Issues that Daia Avenell is
not liable for the fraud penalty and is entitled to relief under sec. 6015(b) from any
income tax liability determined to be due from petitioners for 1993.
       2
           For convenience, we refer to Mr. Avenell as petitioner.
       3
       All section references are to the Internal Revenue Code in effect for the
years at issue, and all Rule references are to the Tax Court Rules of Practice and
Procedure, unless otherwise indicated.
                                         -3-

                                FINDINGS OF FACT

      The parties have stipulated some facts. We incorporate the stipulation of

facts, supplemental stipulation of facts, second supplemental stipulation of facts and

accompanying exhibits by this reference. Petitioners resided in Houston, Texas

when they filed the petition.

      Petitioner started work in the air conditioning business after graduating from

high school in 1961. He then maintained radar systems on fighter planes in the Air

Force for a while before returning to the air conditioning business as a technician.

Petitioner established a commercial heating and air conditioning business called

Tacon Mechanical Contractors, Inc. (Tacon) in 1973. During the years at issue, he

was president of and owned at least 96 percent of Tacon.

      Tacon was sued by one of its subcontractors, Grant Sheet Metal (Grant

Metal), in 1986. Tacon had subcontracted certain fabrication and duct work

installation to Grant Metal and had fired Grant Metal when it failed to adequately

staff the projects. Grant Metal then sued Tacon for breach of contract and other

causes. The case was tried in 1992 and the jury awarded Grant Metal actual

damages, exemplary damages and fees.

      Petitioner was furious about the lawsuit and felt that Grant Metal had been

awarded double the contract amount despite its poor work performance. Petitioner
                                        -4-

appealed the judgment. He also acted upon his attorney’s advice to file for chapter

11 bankruptcy protection and to keep funds out of Tacon’s bank account.

Specifically, petitioner did not deposit payments from general contractors to Tacon

during the years at issue. Instead, he exchanged the checks for cashier’s checks that

he carried in his back pocket to protect his funds from Grant Metal’s judgment

collection.

      Petitioner used the cashier’s checks to pay Tacon’s expenses, subcontractors

and suppliers. He deposited some of the cashier’s checks into a Cayman Islands

bank account 4 and he lent money to a friend’s company. He relied, knowing little

about bookkeeping and having only a high school degree, upon Tacon’s

bookkeepers to track the funds. Petitioner thought that his bookkeepers kept such

records and that almost all funds kept in the Cayman Islands account and lent to his

friend were returned to Tacon.




      4
        Petitioner had learned about high-interest-paying bank accounts in the
Cayman Islands during a weekend trip sponsored by an equipment supplier.
Petitioner had not previously traveled to the Cayman Islands. During his short visit,
he saw an advertisement inviting hotel guests to a seminar about Cayman Islands
bank accounts and, when attending, was told that he could earn at least 20 percent
interest on a deposit.
                                         -5-

      The tax return that petitioner filed for 1992 and the joint tax return that

petitioners filed for 1993 were both prepared by an accountant. In 1996 petitioner

filed an amended tax return for 1993 reporting additional income.

      IRS Special Agent Buddy Adams (Mr. Adams) began investigating petitioner

in the mid-1990s based on small-town rumors of drug dealing and large property

purchases. Mr. Adams continued his investigation, despite finding no basis for the

drug allegations. He discovered during his investigation that petitioner’s son had

purchased a rural property in Sequin, Texas in 1993 (Sequin residence). That same

year, a ranch was purchased in Guadalupe County, Texas (Guadalupe ranch) in the

name of petitioner’s lawyer’s company.

      When questioned, petitioner told Mr. Adams that he helped his son with the

Sequin residence purchase and that he purchased the Guadalupe ranch. Petitioner

voluntarily disclosed the Cayman Islands bank account. Mr. Adams traced

cashier’s checks to petitioner’s personal use and concluded that petitioner used

general contractors’ payments to Tacon to purchase the Guadalupe ranch.

      In 2000 petitioner pled guilty to filing a false tax return for 1993. He did so

based on his attorney’s warning that Mr. Adams said he would indict petitioner’s

family members, bookkeeper and accountant if petitioner did not accept the plea.
                                             -6-

      Respondent issued the deficiency notices approximately 13 years after the

years at issue. Respondent determined that petitioner was liable for a $48,723 fraud

penalty for 1992 and a $224,3225 fraud penalty for 1993. Respondent also

determined additions to tax for failure to timely file a return.

      Petitioners timely filed a petition.

                                       OPINION

      Respondent argues that petitioners underreported income when petitioner

diverted funds from Tacon for his personal use and that the resulting underpayment

of tax is attributable to fraud. Petitioners argue that petitioner did not intend to

evade tax but instead attempted to safeguard company funds from judgment

collection. Petitioners further note that the deficiencies were determined after the

period expired for assessing tax absent fraud. See sec. 6501. We agree with

petitioners. Respondent has failed to show by clear and convincing evidence that

any of the underpayment of tax for either of the years at issue was due to fraud.

      We now address fraud. Fraud is an intentional wrongdoing on the part of the

taxpayer with the specific purpose of evading a tax believed to be owing. Webb v.

Commissioner, 394 F.2d 366, 377 (5th Cir. 1968), aff’g T.C. Memo.



      5
          Dollar amounts are rounded to the nearest dollar.
                                         -7-

1966-81; Di Ricco v. Commissioner, T.C. Memo. 2009-300. Petitioner’s guilty

plea under section 7206(1) does not prove fraud, but rather respondent must show

that petitioner intended to evade tax in filing the returns. See Wright v.

Commissioner, 84 T.C. 636, 643 (1985). Respondent bears this burden of proving

fraud by clear and convincing evidence. See sec. 7454(a); Rule 142(b); Toussaint

v. Commissioner, 743 F.2d 309, 312 (5th Cir. 1984), aff’g T.C. Memo. 1984-25.

This high standard precludes the presumption of correctness that generally attaches

to a deficiency determination from extending to a fraud determination. See Smith v.

Commissioner, 926 F.2d 1470, 1474-1475 (6th Cir. 1991), aff’g 91 T.C. 1049

(1988); Di Ricco v. Commissioner, supra.

      Fraud is never presumed and must be affirmatively established by clear and

convincing evidence. See, e.g., Rowlee v. Commissioner, 80 T.C. 1111, 1123

(1983); Beaver v. Commissioner, 55 T.C. 85, 92 (1970). Fraud may be proven by

circumstantial evidence because direct evidence of the taxpayer’s fraudulent intent

is seldom available. Spies v. United States, 317 U.S. 492 (1943); Rowlee v.

Commissioner, 80 T.C. at 1123; Gajewski v. Commissioner, 67 T.C. 181, 200

(1976), aff’d without published opinion, 578 F.2d 1383 (8th Cir. 1978). Mere

suspicion, however, is not enough. Katz v. Commissioner, 90 T.C. 1130, 1144
                                           -8-

(1988); Shaw v. Commissioner, 27 T.C. 561, 569-570 (1956), aff’d, 252 F.2d 681

(6th Cir. 1958).

       Respondent did not establish by clear and convincing evidence that petitioner

fraudulently intended to evade tax. See sec. 7454(a); Rule 142(b). Respondent had

more than 13 years to build a case against petitioner before issuing the deficiency

notices, and another 3 years to prepare for trial after petitioners filed the petition.

Yet respondent did not provide sufficient evidence to establish that petitioner acted

with the intent to evade tax.

       Respondent infers that petitioner intended to evade taxes by exchanging

general contractor’s checks for cashier’s checks and using those funds for personal

purposes, including making a personal loan and opening a Cayman Islands bank

account. Respondent further infers fraudulent intent from petitioner’s purchases of

real estate in others’ names. Piling inference upon inference, however, does not

qualify as clear and convincing evidence. See Penn-Ohio Steel Corp. v.

Commissioner, T.C. Memo. 1964-124 (quoting Goldberg v. Commissioner, 239

F.2d 316, 320 (5th Cir.1956), rev’g T.C. Memo.1954–242). His inferences fall

short of the required proof of fraud by clear and convincing evidence. We cannot

conclude that petitioner’s delusive behavior was part of a deliberate scheme of

fraudulent tax evasion.
                                         -9-

      We find that petitioner’s diversion of money from Tacon was done with the

intent to evade judgment collection, rather than the intent to evade taxes. Petitioner

treated Tacon’s assets and funds as his own. Tacon’s assets were subject to a

judgment collection that petitioner felt was unjust. Petitioner credibly testified that

he refused to deposit funds into Tacon’s account to avoid the judgment collection.

The timing of petitioner’s delusive behavior involving cashier’s checks, the Cayman

Islands bank account, real property purchases and the personal loan is consistent

with that of Grant Metal’s judgment. We do not condone petitioner’s efforts to

avoid judgment collection. We also do not find, however, that his actions were

done with the intent to evade tax.

      Petitioner’s liberties with Tacon’s funds may have resulted in underreported

income. A taxpayer’s failure to report income does not, by itself, establish

fraudulent intent. See Marsellus v. Commissioner, 544 F.2d 883, 885 (5th

Cir.1977), aff’g T.C. Memo. 1975-368; Niedringhaus v. Commissioner, 99 T.C.

202, 210 (1992); Pappas v. Commissioner, T.C. Memo. 1981-639. Petitioner

credibly testified that he thought he could use Tacon’s funds because he had

previously put money into Tacon. Given his limited education and relevant

expertise, he did not understand that Tacon was a separate entity and that Tacon’s

funds were different and separate from his own. Despite petitioner’s erroneous
                                           - 10 -

understanding of corporate and tax laws, spending company funds for personal use

is not per se fraudulent. See Knutsen-Rowell, Inc. v. Commissioner, T.C. Memo.

2011-65. We find that petitioner’s actions stemmed from an intent to avoid

judgment collection coupled with a lack of sophistication about and attention to

legal obligations and financial details.

      We note that petitioner cooperated with Mr. Adams throughout the

investigation. He voluntarily disclosed the Cayman Islands bank account and

admitted that he lent company money to a friend. He further disclosed that he

helped his son purchase the Sequin residence and that he purchased the Guadalupe

ranch. Petitioner’s cooperation with respondent during the audit suggests that he

was not attempting to evade Federal tax.

      Again, we do not condone his cavalier use of corporate income. We

disagree, however, with respondent’s position that it was part of a conscious and

clever scheme to avoid Federal income taxes.

      Nearly two decades after the years at issue, we hold that respondent has

failed to prove by clear and convincing evidence that petitioner fraudulently

intended to evade tax. Our conclusion is based on the record as a whole, taking into

account our determination as to the credibility of petitioner and the other
                                          - 11 -

witnesses called at trial. Accordingly, the statute of limitations bars the assessment

of tax, additions to tax and penalties for the years at issue.6

      We have considered all arguments made in reaching our decision and, to the

extent not mentioned, we conclude that they are moot, irrelevant, or without merit.

      To reflect the foregoing,


                                                          Decision will be entered for

                                                   petitioners.




      6
        The parties stipulated that petitioners are not entitled to the long-term capital
loss of $100,385 claimed on the return for 1993 pertaining to the Guadalupe ranch.
The statute of limitations bars the assessment of this additional tax.
