                        T.C. Memo. 1998-111



                      UNITED STATES TAX COURT



JOAN WALTERS, F.K.A. JOAN GHERMAN, AND HENRY GHERMAN, Petitioners
         v. COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 23443-91.               Filed March 18, 1998.



     Henry Gherman and Joan Walters, pro se.

     Reginald R. Corlew and W. Robert Abramitis, for respondent.




             MEMORANDUM FINDINGS OF FACT AND OPINION

     PARR, Judge:   Respondent determined deficiencies in, and

additions to, petitioners' Federal income taxes as follows:
                                        - 2 -


Petitioners Joan Walters and Henry Gherman:

                                             Additions to Tax
                          Sec.          Sec.          Sec.        Sec.        Sec.
TYE      Deficiency   6653(a)(1)   6653(a)(1)(a) 6653(a)(1)(B) 6653(a)(2)     6661
                                                                   1
1982        $3,191       $160           -          $28,318                      -
                                                                   1
1984       769,999     38,500           -             -                     $192,500
                                                                   1
1985       679,323     33,966           -             -                      169, 831
                                                      1
1986       792,359        -          $39,618                       -         198,090
1
 50 percent of the interest due on the entire deficiency in income tax.

Petitioner Henry Gherman:

                                             Additions to Tax
                          Sec.        Sec.          Sec.        Sec.           Sec.
TYE      Deficiency   6651(a)(1)   6653(a)(1) 6653(a)(1)(A) 6653(a)(1)(B)     6661
                                                               1
1987      $566,350        -            -         $28,318                    $141,588
1988       461,477    $115,369      $24,828          -         -             115,369
1
    50 percent of the interest due on the entire deficiency in income tax.

         Unless otherwise indicated, 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.            Respondent concedes the deficiency and

additions to tax for taxable year ended 1982.                Accordingly,

references to the years in issue hereinafter refer to years ended

1984 through 1988.

         The issues for decision are:

         (1)   Whether petitioners for taxable years ended 1984

through 1986 and petitioner Henry Gherman for taxable years ended

1987 and 1988 omitted income in the amounts determined by

respondent, or in some other amounts.              We hold that they omitted

income to the extent determined herein.
                                - 3 -


     (2)   Whether petitioners for taxable years ended 1984

through 1986 and petitioner Henry Gherman for taxable years ended

1987 and 1988 are liable for additions to tax under section

6653(a)(1) or (a)(1)(A).    We hold that they are, but subject to

the relief provisions of section 6013(e).

     (3)   Whether petitioners for taxable years ended 1984

through 1986 and petitioner Henry Gherman for taxable years ended

1987 and 1988 are liable for additions to tax under section

6653(a)(1)(B) or (a)(2).    We hold that they are, but subject to

the relief provisions of section 6013(e).

     (4)   Whether petitioners for taxable years ended 1984

through 1986 and petitioner Henry Gherman for taxable years 1987

and 1988 are liable for additions to tax under section 6661.    We

hold that they are, but subject to the relief provisions of

section 6013(e).

     (5)   Whether petitioner Henry Gherman is liable for an

addition to tax under section 6651(a)(1) for taxable year ended

1988.   We hold that he is.

     (6)   Whether petitioner Joan Walters is entitled to innocent

spouse relief under section 6013(e) for taxable years ended 1984

through 1986.   We hold that she is.

                           FINDINGS OF FACT

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

The stipulated facts and accompanying exhibits are incorporated
                                - 4 -


into our findings by this reference.    When they filed their

petition, petitioner Henry Gherman (Mr. Gherman) resided in

Atlanta, Georgia, and petitioner Joan Walters (Ms. Walters)

resided in Miami, Florida.

Background Information

     Petitioners were married in December 1956 and were divorced

in July 1989.   When they married, Ms. Walters was 20 years old.

Petitioners had two children, Shari Gherman Rance (Shari), born

in 1958, and Craig Gherman (Craig), born in 1963.    Petitioners

lived together from the time they married until August 1988, when

Mr. Gherman fled the country.   See infra.   Ms. Walters sought the

divorce because she became ashamed of the "Gherman" name.    Mr.

Gherman and Ms. Walters have two grandsons, Chasyn and Ashtyn

Rance, who are the children of Shari and her former husband

Leslie Rance (Mr. Rance), and one granddaughter, Kara, who is the

child of Craig.

     Before marriage, Ms. Walters graduated from high school and

attended college for 1 year.    She worked for Equity Advertising

and later for the Theater Guild in the subscription department

and as a script reader.   Ms. Walters did not maintain her own

checking account before marriage but instead relied on her father

to cash her paychecks for her and to give her additional spending

money.   After petitioners married, Ms. Walters worked for 4

months as a receptionist for a knitting mill; then she did not
                               - 5 -


work outside of the home for many years, other than as described

infra.   She involved herself in various community and volunteer

activities and at one time served as a secretary for the Miami

chapter of the Congress of Racial Equality.   Mr. Gherman handled

the family's financial matters throughout the time that

petitioners were married.

     Mr. Gherman began selling insurance during the late 1950's

or early 1960's.   He worked hard and built up his business.

Nonetheless, during 1969 petitioners filed for bankruptcy (1969

bankruptcy).   Subsequently, Ms. Walters received a discharge in

the 1969 bankruptcy.   Mr. Gherman, however, did not receive a

discharge, because the bankruptcy court found that he had

obtained credit by issuing certain false financial statements.

Following the 1969 bankruptcy, Mr. Gherman did not keep secret

the fact that he was not granted a discharge in the bankruptcy

proceeding, and at meetings with clients or potential clients he

often mentioned that he had not been granted a discharge in the

1969 bankruptcy.

     After the 1969 bankruptcy, petitioners sold their personal

residence and used some of the proceeds to purchase another home.

Ms. Walters considered the new house to be inferior to their

prior house.

     Following the 1969 bankruptcy, Mr. Gherman never again held

an asset in his own name.   Mr. Gherman used Ms. Walters' name to
                               - 6 -


transact his business and financial matters.   Ms. Walters knew

that Mr. Gherman used her name for those purposes because he had

not been granted a discharge in the 1969 bankruptcy.

Financial & Investment Planning, Inc.

     During March 1970, Mr. Gherman organized Financial &

Investment Planning, Inc. (FIP) to sell insurance and, to provide

financial services, employee benefit consulting, deferred

compensation plans, estate planning, tax planning, and trust

work.   By 1988, FIP provided a range of business and financial

services to its clients, who primarily were successful physicians

located in the Miami area.   Other clients of FIP included

attorneys, accountants, commercial businesses, hospitals, and a

university.    FIP performed many financial functions for its

clients, including collecting bills, paying employees, in some

cases paying the clients' personal and household expenses, filing

tax returns, and handling insurance, investments, and financial

planning.

     Warren Gherman, Mr. Gherman's brother, served as FIP's first

president and as a director.   From its beginning, however, Mr.

Gherman controlled FIP and made all the decisions relating to its

operations.   He became president of FIP during 1976 and served in

that capacity and as a director during the years in issue.

     Ms. Walters was the sole shareholder of FIP and, until May

6, 1988, she served as its secretary and treasurer and as a
                                - 7 -


director.    Ms. Walters knew that the FIP stock was held in her

name, because Mr. Gherman had not been granted a discharge in the

1969 bankruptcy.    Ms. Walters attended FIP's monthly board of

directors meetings, signed FIP's corporate minutes, and, until

1984, was on FIP's payroll.    Ms. Walters, however, was not

involved in the day-to-day operations of FIP, and she seldom

visited FIP's offices during the years in issue.    Although Ms.

Walters owned all of FIP's stock, FIP's clients knew that Mr.

Gherman controlled FIP and that he made all decisions regarding

its operations.    Those clients trusted Mr. Gherman and remained

with him over a number of years.

     Shari, a licensed insurance agent, was on FIP's payroll.

From at least February 1983 until May 1988, Shari also served as

a director of FIP.    In addition, she owned 50 percent of the

shares of First Financial Planning Corp. of South Florida, Inc.

(FFP), an S corporation formed during 1983 and controlled by Mr.

Gherman.    FFP sold insurance to FIP's clients.   The record does

not show the full extent of services that Shari performed for FIP

or FFP or for any other corporation controlled by Mr. Gherman,

but it does indicate that she was credited with selling insurance

to FIP's clients.    Shari did not testify at the trial.

     Craig also was on FIP's payroll.    He worked primarily as a

mechanic for FIP.    In addition, from at least October 1984 until

May 1988, Craig served as a director of FIP.    Craig owned 50
                                - 8 -


percent of the shares of FFP.   The record does not show the full

extent of services that Craig performed for FIP or for any other

corporation controlled by Mr. Gherman.     Craig did not testify at

the trial.

     Mr. Rance, Shari's husband, was on FIP's payroll as well.

He managed FIP's real estate holdings, buildings, and office

buildings.    He additionally managed Custom-Molded, an orthopedic

equipment company, for FIP.

     Other than 1982, FIP operated at a loss.    On its Forms 1120,

U.S. Corporation Income Tax Return, for tax periods ended March

31, 1984 through 1989, FIP reported gross receipts, total income,

and income or loss before net operating loss (NOL) as follows:

                 Gross            Total          Taxable income
  FYE           receipts         income         (loss) before NOL

3/31/84       $1,395,875      $1,482,346           ($77,338)
3/31/85        1,433,183       1,608,507           (251,665)
3/31/86        1,609,935       1,879,881           (233,033)
3/31/87        1,337,567       1,687,830           (812,602)
3/31/88        1,400,911       1,691,473           (473,238)
3/31/89          481,629         712,444           (143,554)

The returns for tax periods ended March 31, 1988 and 1989, were

prepared by or for the trustee in bankruptcy for the 1988

bankruptcy.   See infra.

     During the years 1980 through 1985, FIP filed five petitions

with the Court relating to taxable periods ended 1973 through

1981.   In the notices of deficiency for those periods, respondent

determined deficiencies in tax, in the aggregate, totaling
                                - 9 -


$1,078,177.    Additions to tax for fraud were determined in the

related notices of deficiency and affirmatively pleaded in the

answers to the petitions for taxable periods ended 1973 through

1979.    By agreement of the parties, decisions were entered

wherein deficiencies in tax for taxable periods ended 1975

through 1981, aggregating $164,626, were sustained, but additions

to tax for fraud were not sustained for any taxable period at

issue.

     In the notices of deficiency sent to FIP for years ended

1975 through 1981, respondent disallowed as unreasonable

compensation deductions claimed for moneys FIP paid to Ms.

Walters on the basis that Ms. Walters "performed no more than

nominal services" for FIP.    In those notices of deficiency

respondent also disallowed as unreasonable a portion of the

compensation FIP paid to Mr. Gherman.    During 1984, Ms. Walters

asked Mr. Gherman to remove her from FIP's payroll, because she

wanted to avoid future problems with the IRS.

     Another issue in those Tax Court cases related to activities

in marketing tax shelters (film and art) to FIP's clients.     Ms.

Walters participated to some degree in setting up or putting

together at least one tax shelter, but the record does not show

the extent of that participation.    Respondent also disallowed

some business expenses claimed by FIP in the notices of

deficiency for years ended 1973 through 1981.    Unreported income
                               - 10 -


from an illegal activity, however, was not in issue for years

ended 1973 through 1981.

     Following the audit of FIP's tax returns for years ended

1973 through 1981, petitioners' accountants became more conscious

of items, especially items of expense, recorded in FIP's books

and records.   From time to time, the accountants requested

documentation for items recorded in the books and records to

ascertain whether large or extraordinary items were reasonable

and accurately recorded.    The accountants' primary concern was to

prevent personal expenditures' being claimed as business expenses

on FIP's tax returns and to assure that withdrawals from FIP were

properly recorded on FIP's books and records.

     On April 9, 1985, FIP's board of directors authorized the

corporation to establish a payroll deduction plan, optional at

the employee's request, whereby certain enumerated payroll

deductions would be allowed, e.g., for automobile insurance

premiums, life, accident, and death and dismemberment insurance,

mortgage payments, corporate and pension plan loan payments,

court orders for family support, and automobile loan payments.

During the years in issue, FIP had in effect a medical expense

reimbursement plan whereby FIP reimbursed covered employees for

their medical expenses.    During those years, FIP also had a

matching gift program whereby FIP agreed to match dollar for
                                - 11 -


dollar contributions made by FIP's professional employees to

qualified U.S. charitable organizations.

     FIP paid the personal expenses of Mr. Gherman, Ms. Walters,

and other Gherman family members.    FIP paid for the cars driven

by petitioners and their children during the years in issue.      The

cars included Cadillacs, a BMW, a Town Car (Ms. Walters), and a

Buick (Mr. Gherman).

     FIP's books and records reflect that, dating back to 1975,

FIP made personal loans to FIP's clients, employees, and

shareholders, including Gherman family members or entities in

which they held interests.    The records also reflect payments of

interest and principal on those loans.     Ms. Walters was not aware

that FIP's books recorded loans' being made to her.

     During the years in issue, FIP chartered a 45-foot boat, the

Camelot, from ShariCraig, Inc. (ShariCraig), an S corporation

owned by Ms. Walters until 1986 when she sold her shares to Shari

and Craig.   Neither Shari nor Craig was actively involved in the

day-to-day activities of ShariCraig.     ShariCraig's books and

records were maintained by Mike Landa (Mr. Landa), who also

captained the boat.    The record does not reveal in which year the

Camelot was purchased by ShariCraig or the source of the funds

for that purchase.     The Camelot cost $150,000.   FIP paid

ShariCraig $600 for each day it used the Camelot, with a

guaranteed charter of at least two times a month.     It was docked
                               - 12 -


behind Mr. Landa's house or petitioners' house.    Petitioners used

the Camelot for personal pleasure and to entertain FIP's clients.

The Camelot was rarely used by anyone other than petitioners or

FIP.    On occasion, petitioners took the Camelot on weekend

excursions and to vacation in the Bahamas.    On visits to the

Bahamas, the boat would stay in Freeport for an extended period

of time with Ms. Walters and Mr. and Mrs. Landa on board, while

Mr. Gherman and clients of FIP would fly in from Miami to stay

during the weekends.    When the Camelot was used to entertain

FIP's clients, Ms. Walters helped prepare and serve food.

       FIP had a bank account in its name at Commerce Bank, N.A.

(the FIP account).    From 1983 through the end of 1986, hundreds

of thousands, and sometimes millions, of dollars flowed through

the FIP account each month.    All of the checks drawn on the FIP

account required two signatures.    Mr. Gherman generally signed

all of the checks written on the FIP account.    Additionally,

during all of 1983 and until December 1984, Ms. Walters cosigned

all of the checks.    During December 1984, Craig began also to

cosign checks written on the FIP account.    From that point

forward, Ms. Walters and Craig each cosigned approximately 50

percent of the checks.    Ms. Walters and Craig signed the checks

in blank, usually 300 at a time, at their personal residences.

The blank checks then were taken to FIP's offices, usually by an

FIP employee, for use when needed, at which time the checks would
                              - 13 -


be completed by Mr. Gherman or an FIP employee and then signed by

Mr. Gherman.   Between January 1983 and December 1986, Ms. Walters

signed over 11,000 checks, of which she had written only two.

     During the years in issue, Ms. Walters also had signatory

authority over two bank accounts that were in her name.     Ms.

Walters shared with Mr. Gherman signatory authority on an account

titled "Joan Gherman No. 2 account".   Ms. Walters signed checks

written on the Joan Gherman No. 2 account using the same process

that was used for checks written on the FIP account except that

only one signature was required on the Joan Gherman No. 2

account.   During the years of its existence, hundreds of

thousands of dollars flowed through the Joan Gherman No. 2

account.   Any money earned by Ms. Walters was deposited into the

Joan Gherman No. 2 account.   Checks made payable to Mr. Gherman

drawn on the FIP account were deposited into the Joan Gherman No.

2 account.   Ms. Walters regarded the Joan Gherman No. 2 account

as a business account.   Business expenditures of FIP as well as

some personal expenditures of petitioners were paid from the Joan

Gherman No. 2 account.   The bank statements for the Joan Gherman

No. 2 account were mailed to FIP's business address, and the

statements were reconciled by Mr. Gherman or an FIP employee.

     The other account in Ms. Walters' name served as her

personal checking account (Joan Gherman No. 1 account).     Ms.

Walters used the Joan Gherman No. 1 account for paying basic
                              - 14 -


household expenses, such as groceries, the cleaners, and the

gardeners.   Mr. Gherman made weekly deposits into the Joan

Gherman No. 1 account.   Ms. Walters recorded $500 in the check

registrar as the weekly deposit amount regardless of the amount

that Mr. Gherman actually deposited into the account.    For the

years in issue, Ms. Walters wrote and signed all but one of the

checks issued from the Joan Gherman No. 1 account.    Mr. Gherman

or an FIP employee, however, generally balanced the bank

statements for the Joan Gherman No. 1 account, and the bank

statements were mailed directly to FIP's business address.    Most

of Ms. Walters' personal expenditures were paid for by major

credit cards.   Mr. Gherman paid the credit card bills from a

checking account other than the Joan Gherman No. 1 account.

     All of the money in the Joan Gherman No. 1 account and the

Joan Gherman No. 2 account came directly or indirectly from FIP.

     Ms. Walters had little interest in or awareness of the

financial dealings that Mr. Gherman carried out in her name.    She

had absolute faith in Mr. Gherman's business judgment and

followed his instructions without question.    She would and did

sign any document that he asked her to sign.

The Embezzlement

     During August 1988, Mr. Gherman, suddenly and without any

warning, abandoned his family and fled the United States to

Taiwan.   Until he was arrested, Ms. Walters did not know his
                               - 15 -


whereabouts.   He took with him suitcases filled with $100 bills

that totaled $4.4 million (exit money).   Over a 10-day period

before he fled the country, Mr. Gherman had written checks on the

FIP account that totaled $5,092,500, of which $5,090,000 was made

payable to Mr. Gherman and $2,500 was made payable to Ms.

Walters.   Some of the money in the FIP account came from funds

that Mr. Gherman had embezzled from accounts of FIP's clients

(primarily employee benefit trust accounts) through a so-called

certificate of deposit scheme.   See infra.   Mr. Gherman was

captured in Taiwan in October 1988 and subsequently returned to

the United States for trial.

     Mr. Gherman had deposited all of the funds he embezzled into

the FIP account.   He converted those funds to his own use.     Mr.

Gherman alone controlled the embezzled funds.   Until he fled the

country, Mr. Gherman's family, including Ms. Walters, did not

know that Mr. Gherman was embezzling money from FIP's clients.

     In an Information filed in the criminal case in the U.S.

District Court, Southern District of Florida, Mr. Gherman was

charged with having embezzled and converted for his own use,

from or about December 1982 until or about August 1988, $9.8

million in assets from employee benefit plans entrusted to him.

The Information alleged that, as part of the scheme to defraud,

Mr. Gherman represented that funds were placed in certificates of

deposit (CD's), but the investments were never made and the CD's
                              - 16 -


did not exist (the CD scheme).   The Information alleged further

that, as part of the CD scheme, Mr. Gherman transferred embezzled

funds to an account in a bank in Antigua, West Indies, that he

had opened under the name of "Chaska Trading, Ltd." (Chaska

Trading), and that approximately $2.2 million of those funds then

were transferred to an account in Chaska Trading's name at

Prudential-Bache Securities, Inc. (Prudential-Bache), and were

available to Mr. Gherman.

     Mr. Gherman entered into a plea agreement in which he

admitted embezzling $9.7 million from FIP's clients, including

the removal of $4.4 million in July and August 1988.    At his

sentencing hearing, he claimed that the money did not go into his

own pocket, but instead it went into the corporate funds of FIP,

which he controlled, and that the money was used in the

operations of FIP.   Of the $4.4 million exit money, $1 million

was unaccounted for at the time of sentencing and was still

unaccounted for at the time of the trial of the instant case.

     In accordance with the plea agreement, Mr. Gherman was found

guilty on three counts of mail fraud in violation of 18 U.S.C.

sec. 1341, and four counts of embezzlement from employee pension

funds in violation of 18 U.S.C. sec. 664.   On May 10, 1989, he

was sentenced to consecutive sentences totaling 30 years.    He

also was ordered to make restitution in the amount of
                              - 17 -


$12,903,250, less any recoveries made by the bankruptcy trustee.

See infra.

     The Federal Bureau of Investigation agent who investigated

the embezzlement believed that approximately $3 million of the

funds Mr. Gherman embezzled was used to support FIP's losses over

the years 1982 through 1988, approximately $3 million was used in

so-called loans to Mr. Gherman or family members, and the balance

became the exit money.

The 1988 Bankruptcy

     On August 10, 1988, certain clients of FIP filed a

receivership action captioned Shapiro v. Gherman, against Mr.

Gherman, FIP, and FFP in the Circuit Court of the Eleventh

Judicial Circuit in and for Dade County, Florida, wherein the

clients sought the appointment of a receiver, damages, and other

relief.   James Feltman (Mr. Feltman) was appointed receiver.   A

temporary restraining order was entered on that date which

prohibited the defendants from transferring or otherwise

disposing of their assets.   Two days later, Mr. Feltman was

authorized to seize the Camelot.

     Subsequently, on August 18, 1988, while the receivership

action was pending, some of the same clients commenced an

involuntary chapter 11 bankruptcy proceeding against the same

entities (bankruptcy estates) in the U.S. Bankruptcy Court for
                              - 18 -


the Southern District of Florida (bankruptcy court).   Mr. Feltman

was appointed trustee of the bankruptcy estates.

     Additionally, on August 31, 1988, creditors of Mr. Gherman

filed an action in the High Court of Antigua, seeking the

turnover of $2.97 million they alleged Mr. Gherman had deposited

at that bank.   Subsequently, the three actions were consolidated

in the bankruptcy court.   Hereinafter, we will refer to the

consolidated proceedings as the 1988 bankruptcy.

     On January 26, 1989, Mr. Feltman filed a cross-claim and

third party complaint in the 1988 bankruptcy against Mr. Gherman,

Ms. Walters, Shari, Craig, Mr. Rance, Chasyn Rance, Ashtyn Rance,

and Kara Gherman (Gherman family members), wherein Mr. Feltman

sought recovery of fraudulently transferred funds and assets

purchased with those funds, and a denial of Mr. Gherman's

discharge.   Mr. Feltman's position was that all assets owned by

the Gherman family members were derived from embezzled funds and

should be returned.

     For purposes of the 1988 bankruptcy, accountants hired by

Mr. Feltman prepared a schedule, dated November 22, 1988,

entitled "Schedule of Perceived Certificates of Deposit by

Investor" (CD schedule).   The CD schedule reflects the names of

the individuals, corporations, estates, trusts, or other entities

from whom Mr. Gherman had embezzled money as a part of the CD

scheme.   The CD schedule also reflects, by date and segregated by
                                 - 19 -


name of individual or entity, the amounts that had been either

invested in a "phantom CD" or withdrawn from a "phantom CD" and

redeposited into the party's account, with dates commencing

December 15, 1982, and ending November 3, 1988.      By year, the CD

schedule indicates that Mr. Gherman had embezzled the following

net amounts (withdrawals from accounts of FIP's clients less

redeposits to accounts of FIP's clients) from FIP's clients as

part of the CD scheme:

             Withdrawals           Redeposits
            from accounts         to accounts             Net
Year       of FIP's clients     of FIP's clients         amount

1982        $1,480,000.00              -0-           $1,480,000.00
1983         1,315,000.00          $685,000.00          630,000.00
1984         2,663,500.00         1,088,500.00        1,575,000.00
1985         1,726,162.52           565,000.00        1,161,162.52
1986         2,305,000.00           552,462.52        1,752,537.48
1987         3,794,500.00         2,086,000.00        1,708,500.00
1988         1,571,000.00            45,700.00        1,525,300.00
  Total     14,855,162.52         5,022,662.52        9,832,500.00

Of the $1,525,300 net amount reflected on the CD schedule for

calendar year 1988, a total of $155,300 of the withdrawals and

redeposits were made on dates after Mr. Gherman fled the United

States.

       The CD schedule was introduced in evidence during the 1988

bankruptcy proceeding.      Respondent used the CD schedule to

develop the amounts reflected in the notices of deficiency as

having been embezzled from FIP's clients on a year-by-year basis.

See infra.    The CD schedule was prepared from FIP's books and

records and from subpoenaed bank records.
                              - 20 -


     The accountants retained by Mr. Feltman also prepared a

schedule entitled "Analysis of CD 'Sweep' Withdrawals" (Sweep

schedule).   The Sweep schedule attempted to identify when money

came into FIP for purported CD purchases, and to whom or where

the money subsequently flowed.   A portion of the Sweep schedule

later was incorporated into the CD schedule.      The Sweep schedule,

among other things, shows disbursements to or for the benefit of

Mr. Gherman, Ms. Walters, Shari, and Craig, as well as other

individuals, and to various investment accounts.     Additionally,

the Sweep schedule indicates "interest paid to CD participants"

for the following years and in the following amounts:

                Year                     Amount

                1983                   $83,815.92
                1984                   304,863.72
                1985                   282,452.50
                1986                   406,916.76
                1987                   484,547.94

     The accountants retained by Mr. Feltman also prepared a

schedule entitled "Disbursements From FIP, Inc. For Family

Members" (family disbursements schedule) which attempted to

itemize all moneys paid out of the FIP account to or for the

benefit of Mr. Gherman or members of his family.     The family

disbursements schedule reflects total disbursements to or for Mr.

Gherman or his family members of $8,146,895.40, commencing

December 1, 1982, and ending July 8, 1988.    The family

disbursements schedule attempts to identify all transfers or
                              - 21 -


payments to or for Mr. Gherman or a family member by date, check

number, payee, amount, and description.   The accountant who

prepared the family disbursements schedule made no attempt to

distinguish legitimate disbursements (such as for business

purposes or salaries) from nonlegitimate disbursements.    The

family disbursements schedule was prepared by use of FIP's books

and records and for use in the 1988 bankruptcy proceeding.

     Prior to trial in the 1988 bankruptcy, Mr. Feltman proposed

a settlement with Ms. Walters, Shari, and Craig whereby each of

them would retain a residence, an automobile, furniture, personal

possessions, and some cash.   On the advice of Mr. Gherman,

however, the Gherman family members rejected that offer.

Following trial, the bankruptcy court issued a memorandum

decision in favor of Mr. Feltman, as trustee, pursuant to which

he was awarded approximately $6.2 million in money damages and a

constructive trust over the homes, automobiles, boats, and other

assets of Mr. Gherman and his family members.   In addition, Mr.

Gherman was denied a discharge.   Accordingly, judgments were

entered against Ms. Walters in the amount of $6 million and

against other Gherman family members in various amounts.

Pursuant to a subsequent settlement offer, however, the Gherman

family members were released from the judgments entered against

them and were paid $35,000.   As a result of the 1988 bankruptcy,

however, Ms. Walters, Shari, and Craig lost their personal
                              - 22 -


residences and other personal assets.    The $35,000 was retained

by the Gherman family members' bankruptcy attorney.

     The bankruptcy court further found that Justice for All,

Inc. (see infra), Chaska Trading, Ltd., FFP, and ShariCraig,

Inc., were sham corporations and mere instrumentalities and alter

egos of FIP.

     Mr. Feltman believed that no Gherman family member other

than Mr. Gherman had any knowledge of Mr. Gherman's embezzlement

activities before he fled the country.

Ms. Walters' Entertainment Business Activities

     Sometime after Shari's birth, Ms. Walters started a personal

management company to manage singing acts.   She formed Gherman

Associates, Inc. (Gherman Associates), with Mr. Gherman's

brother, Warren, to operate the personal management business.

Gherman Associates operated as a subsidiary of FIP.   FIP owned 80

percent of the stock of Gherman Associates, Ms. Walters owned 5

percent of the stock, and Peter Michael Lewis, a Miami record

producer and arranger, owned the remaining 15 percent.   Mr.

Gherman, however, handled all of the financial aspects of Gherman

Associates.

     During 1969, Ms. Walters began managing Gherman Associates'

first client, Barry Smith (Mr. Smith), who sang with the Gospel

Jazz Singers.   She also managed the Gospel Jazz Singers.   Later,

Mr. Smith introduced Ms. Walters to other singers whom she began
                               - 23 -


to manage; that is, the Freeman Sisters (who appeared as the

opening act for well-known singers including Pat Boone, Engelbert

Humperdinck, and Tom Jones) and Patti Jo (who appeared in the

Broadway musical "Purlie").    Ms. Walters' activities on behalf of

clients of Gherman Associates included writing biographies,

handling press releases, counseling the clients regarding their

craft, selecting clothing for them, working with choreographers

and the artists as to their performances, selecting engagements,

selecting promotional materials, making travel arrangements for

them, and handling clients' personal matters.   Ms. Walters

received a commission of 25 percent of the moneys earned by the

acts, but she never made a profit from her activities.

     Mr. Gherman used funds from FIP to help finance Gherman

Associates' activities.    During March 1974, Gherman Associates'

board of directors voted to write off as uncollectible moneys

advanced to Mr. Smith, Patti Jo, and the Freeman Sisters.

     Additionally, during the early 1970's, Ms. Walters produced

a national traveling production of the musical "Purlie", with

Patti Jo playing the female lead.    Mr. Gherman used FIP funds to

help finance the production.    Ms. Walters additionally arranged

for clients of FIP to invest in "Purlie".   Although well received

artistically, "Purlie" ultimately lost money when it flopped in

Los Angeles, California.
                               - 24 -


     Also during the 1970's, Ms. Walters produced and cast a

local production of "Bubbling Brown Sugar" at the Coconut Grove

Playhouse in Miami, Florida.   Mr. Gherman provided money from FIP

to fund that production.   Although an artistic success, "Bubbling

Brown Sugar" lost money.   Mr. Gherman decided to close the

production following a lawsuit he filed against the owner of the

Coconut Grove Playhouse in which Mr. Gherman alleged that he was

not getting a fair share of the proceeds from the show.

     Over a year after Mr. Gherman was incarcerated, Ms. Walters

received an offer to manage a nightclub and restaurant located in

California.   She managed the business for 3 months until, through

no fault of her own, the business failed.    Ms. Walters no longer

engages in entertainment business endeavors, because she no

longer has access to the money needed to finance them.    At the

time of the trial of the instant case, Ms. Walters worked part-

time as an embarkation representative for Carnival Cruise Line

and earned $7.15 per hour.

Petitioners' Style of Living

     When petitioners first moved to the Miami, Florida, area

during 1957, they lived in an apartment.    Over the years that

they were married, petitioners purchased and sold a number of

personal residences.   Their first house cost about $16,500.

Except for the house they purchased immediately following the

1969 bankruptcy, each new residence was better than the prior
                               - 25 -


residence.   Following the 1969 bankruptcy, the residences were

titled in Ms. Walters' name alone.

     During 1981 or 1982, petitioners purchased waterfront

property in Eastern Shores, an upscale section of North Miami

Beach, Florida.    The property cost over $500,000 and consisted of

two lots.    The house on the property had two stories, over 5,000

square feet, and five bedrooms.   Petitioners built a tennis court

on the property.   As she had done previously with other homes,

Ms. Walters employed domestic help whose wages were paid by Mr.

Gherman from an account other than the Joan Gherman No. 1

account.

     Petitioners sold their former home to Shari and her husband

for $210,000.   Approximately $90,000 to $100,000 of the purchase

price was paid by a note given to Ms. Walters.   The funds Shari

used to purchase that house came from one or more of the accounts

in her name that Mr. Gherman controlled.   None of the money in

the account came from Mr. Rance, and he did not know from where

it came.

     Ms. Walters recognized that petitioners maintained a "nice"

lifestyle and that it was similar to that of many of the people

with whom they socialized.   She believed that the improvements in

their standard of living were gradual over a number of years,

commensurate with the increase in Mr. Gherman's income, and that

there was no drastic change in their standard of living, inasmuch
                                - 26 -


as they always had a beautiful home and a good car, they always

ate well, and they always went to good restaurants.    She believed

that the only extravagance in their lives was the purchase of the

Camelot.    Ms. Walters believed that the income reported on their

income tax returns was sufficient to support their standard of

living.

     Mr. Gherman was considered extravagant in his use of money.

Petitioners entertained FIP's clients and friends at their home

at least five times each year.    On occasion, petitioners gave

shopping sprees for relatives at grocery stores and at least one

department store (Macy's).    The department store shopping spree

was a Mother's Day gift for Shari and a few other relatives, but

Ms. Walters was not one of the shoppers.

     Dating back to 1965, petitioners had a history of making

gifts.     Petitioners together made gifts to Shari, Craig, Chasyn,

and Ashtyn.    During 1983 through 1987, petitioners made gifts of

$20,000 each to Shari, Craig, and Chasyn.    During 1986 and 1987,

they also made gifts of $20,000 to Ashtyn.    Petitioners signed

joint gift tax returns for various years on which they reported

that gifts had been made to their children and grandsons.    The

Internal Revenue Service (IRS) has no record of any gift tax

returns filed by petitioners for any year.    Nonetheless, the

record shows that the IRS had received gift tax returns from
                                - 27 -


petitioners at least for calendar quarters ended March 31, 1975

and 1977, and for calendar year 1983.

     An investment account in the name of Ms. Walters was

maintained at Prudential-Bache.    The funds in that account came

directly or indirectly from FIP.    Ms. Walters executed a power of

attorney by which she authorized Mr. Gherman to manage her

Prudential-Bache account.    She knew that Mr. Gherman used the

Prudential-Bache account to make investments on her behalf.     Mr.

Gherman made all decisions relating to the investment account.

     Mr. Gherman funded and controlled brokerage accounts and

banks accounts in the names of other members of his family.     The

funds in those accounts came directly or indirectly from FIP.

     At the time of trial in the instant case, Ms. Walters lived

in a townhouse condominium owned by Shari.    Shari paid the

mortgage on the condominium and Ms. Walters paid Shari what rent

she could, but some months she paid nothing.

Prior Income Tax Returns

     During the late 1970's or early 1980's, Mr. Gherman was the

subject of a criminal tax investigation by a Federal grand jury.

Ms. Walters knew about the investigation and presented testimony

before the grand jury.     The grand jury investigation never led to

an indictment.   As early as 1980, Ms. Walters became aware that

the IRS's Criminal Investigation Division had discontinued its

investigation of Mr. Gherman.
                              - 28 -


     During the years 1980 through 1985, petitioners filed five

petitions with the Tax Court relating to taxable years ended 1972

through 1977 and to taxable years ended 1979 through 1981.    In

the notices of deficiency for those years, respondent determined

deficiencies in tax totaling $2,088,901.   Additions to tax for

fraud were determined in the notices of deficiency and

affirmatively pleaded in the answers to the petitions for taxable

years ended 1972 through 1975.   Unreported income from an illegal

activity was not in issue for years ended 1972 through 1977 or

1979 through 1981.   By agreement of the parties, decisions were

entered wherein deficiencies in tax for years ended 1974 through

1981, aggregating $286,126, were sustained, but additions to tax

for fraud were not sustained for any taxable year asserted.     On

September 28, 1986, a Notice of Federal Tax Lien was filed in the

Circuit Court, Dade County, Miami, Florida, which reflected an

unpaid balance of assessment against petitioners for Federal

income taxes for the years ended 1974 through 1979, in the

aggregate amount of $818,184.16.   Ms. Walters was aware of the

Tax Court litigation when she signed the tax returns for the

years in issue.

     On December 29, 1986, Ms. Walters signed an IRS collection

information statement under penalty of perjury which did not list

as an investment an account at Prudential-Bache that was

maintained in the name "Justice For All Inc."   Funds in that
                                - 29 -


account had been transferred during December 1986 from an account

with Prudential-Bache in Ms. Walters' name.       Justice For All Inc.

was a Florida corporation formed by Mr. Gherman to hold funds in

brokerage accounts and to hold cash in bank accounts.

Tax Returns for the Years in Issue

     Petitioners filed joint Federal income tax returns for tax

years ended 1984, 1985, and 1986.    The returns were prepared by

or under the supervision of Ronnie Thaw (Mr. Thaw), a certified

public accountant (C.P.A.), who had prepared tax returns for

petitioners since the 1970's.    The joint return for tax year

ended 1984 was filed on August 19, 1985.       The joint return for

tax year ended 1985 was filed on August 15, 1986.       The joint

return for tax year ended 1986 was filed on September 21, 1987.

Mr. Thaw relied on FIP's books and records to prepare

petitioners' joint income tax returns for the years ended 1984

through 1986.   Petitioners did not engage Mr. Thaw to verify the

books or to perform a certified audit, and he did not perform

those services.   When the joint tax returns were prepared for tax

years ended 1984 through 1986, Mr. Thaw was not aware of the CD

scheme.   Mr. Thaw did not include in income on those joint tax

returns any moneys charged on FIP's books and records as loans to

either Ms. Walters or Mr. Gherman.       After the returns were

prepared by their accountant, Mr. Gherman had the returns

reviewed by petitioners' tax attorneys before petitioners signed
                                             - 30 -


them.     Although Ms. Walters did not review their joint tax

returns in depth, before she signed them she sought, and

received, assurances from Mr. Gherman that everything was

correctly reported on the returns because she did not want to

have any more trouble with the IRS.                        She knew before signing the

returns that they had been prepared by a C.P.A. and reviewed by

attorneys who specialized in tax matters.

       On the joint returns filed for years ended 1984 through

1986, petitioners reported Form W-2 wages, income and FICA tax

withholding, gross income, itemized deductions, and taxable

income as follows:
         Form                      Form
       W-2 wages   Withholding   W-2 wages   Withholding     Gross     Itemized       Taxable
Year   (husband)    (husband)      (wife)       (wife)       income    deductions     income

1984   $355,500     $47,178       $87,724      $19,597      $477,197    $209,343    $262,254
1985    512,040      48,374         -             -          498,634     360,411     134,528
1986    532,201      48,586         -             -          533,901     445,374      85,177



On the returns for those years petitioners reported that they

paid interest to FIP or the FIP Pension Plan as follows:

                    Year                            Interest expense

                    1984                                    $67,325
                    1985                                    143,344
                    1986                                    161,422

Additionally, on the returns for those years, petitioners

reported net losses from ShariCraig and J. Gherman Productions,

an S corporation, as follows:
                                  - 31 -


                             Net losses reported
       Year           ShariCraig   J. Gherman Productions

       1984           $30,105                   -
       1985            37,045                $46,825
       1986             4,703                 65,567

In signing the joint tax returns, Ms. Walters concerned herself

only with how much Mr. Gherman was earning.        Although Ms. Walters

was aware of the grand jury investigation of Mr. Gherman, the Tax

Court cases, and the $800,000 tax lien against Mr. Gherman and

her, she did not review the entire return.        She relied on Mr.

Gherman's assurances that their income tax returns accurately

reflected their income.

       Mr. Gherman filed separate returns for tax years ended 1987

and 1988.     His return for tax year ended 1987 was filed on July

25, 1988.     His return for tax year ended 1988 was filed on

October 30, 1989.     On the separate returns filed for years ended

1987 and 1988, Mr. Gherman reported Form W-2 wages, income and

FICA tax withholding, gross income, itemized deductions, and

taxable income as follows:

          Form                     Gross      Itemized     Taxable
Year    W-2 Wages   Withholding   income     deductions    income

1987    $395,810      $48,714     $416,333    $268,262    $146,171
1988     122,067       37,626      122,067        -        117,617

On the separate return he filed for year ended 1987, Mr. Gherman

reported that he had paid interest to FIP in an amount totaling

$126,075.     Mr. Gherman claimed the standard deduction on the

separate return that he filed for year ended 1988.        Additionally,
                             - 32 -


he attached to the return for that year a disclosure statement

asserting that the return was substantially incomplete, because

at the time of filing he had not received from Mr. Feltman

information needed to prepare the return.

     On audit, respondent determined that petitioners had

unreported income for 1984, 1985, and 1986 of $1,540,000,

$1,365,462, and $1,642,537, respectively.   Additionally,

respondent determined that Mr. Gherman had unreported income for

1987 and 1988 of $1,529,500 and $1,645,000, respectively.    The

notices of deficiency for the years in issue were mailed on July

19, 1991, and state that respondent's determinations were "based

on information available from certificates of deposit records

compiled by the bankruptcy trustee."

                             OPINION

Statutory Period of Limitations

     Petitioners contend that assessment of the deficiency and

additions to tax that respondent determined for each of the years

ended 1984 through 1988 is barred by expiration of the periods of

limitations under section 6501.   Respondent contends, however,

that the period of limitations to assess the deficiencies and

additions to tax has not expired for any year in issue.

     Generally, under section 6501(a) an income tax deficiency

and additions to tax must be assessed within 3 years of the later

of (1) the date the tax return was filed or (2) the due date of
                              - 33 -


the return.   If the taxpayer proves that the notice of deficiency

was mailed more than 3 years after the applicable date, then the

Commissioner has the burden of proving the existence of an

exception to the general period of limitations.   Minahan v.

Commissioner, 88 T.C. 492, 506 (1987); Stratton v. Commissioner,

54 T.C. 255, 289 (1970).

     Under section 6501(e)(1)(A), the period during which the

Commissioner may assess a deficiency is 6 years when a taxpayer

omits from income an amount that exceeds 25 percent of the gross

income required to be shown on the taxpayer's return.   The

Commissioner has the burden of proving by a preponderance of the

evidence that the taxpayer has omitted an amount in excess of 25

percent of the gross income required to be shown on the return.

Armes v. Commissioner, 448 F.2d 972, 974 (5th Cir. 1971), affg.

in part and revg. in part T.C. Memo. 1969-181; Colestock v.

Commissioner, 102 T.C. 380, 383 (1994); Burbage v. Commissioner,

82 T.C. 546, 553 (1984), affd. 774 F.2d 644 (4th Cir. 1985).

Where a joint return has been filed, the omission of income is

considered to be a failure to report income by each spouse.

Benjamin v. Commissioner, 66 T.C. 1084, 1100 (1976), affd. on

another issue 592 F.2d 1259 (5th Cir. 1979).

     Mr. Gherman's return for the year ended 1988 was filed on

October 30, 1989.   The notice of deficiency for that year was

mailed to him on July 19, 1991.   Thus, the notice of deficiency
                               - 34 -


relating to the year ended 1988 was mailed within 3 years of the

time in which the return for that year was filed.    The 3-year

period of limitations for assessing the tax and additions to tax,

consequently, did not expire for the year ended 1988 before

respondent mailed the notice of deficiency relating to that year.

Accordingly, the statute of limitations does not bar respondent

from assessing any deficiencies in tax and additions to tax for

the year ended 1988.

     Respondent does not deny that the notices of deficiency for

the years ended 1984 through 1987 were mailed more than 3 years

after the later of the date on which the returns were filed or

their due dates.   Respondent contends, however, that petitioners

had unreported income in the amounts of $1,540,000, $1,365,462,

$1,642,537, and $1,529,500 for tax years ended 1984, 1985, 1986,

and 1987, respectively.    Respondent further contends that the

unreported income exceeds 25 percent of the gross income of

$477,197, $498,634, $533,901, and $416,333 reported in the

returns for those years.    Accordingly, respondent maintains, the

periods of limitations for assessment of any deficiencies for

1984 through 1987 had not expired when the notices of deficiency

were mailed because the 6-year period of limitations for the

assessment of tax applies for those years.

     Whether respondent is barred from assessing additional tax

and additions to tax for the years ended 1984 through 1987 rests
                              - 35 -


on whether petitioners, for the years ended 1984 through 1986,

and Mr. Gherman, for the year ended 1987, omitted from income an

amount equal to more than 25 percent of the gross income reported

on the returns.   We turn now to that issue.

     Unreported Income

     Petitioners do not deny that Mr. Gherman embezzled money

from FIP's clients between 1982 and 1988, but they nevertheless

contend that Mr. Gherman did not receive any unreported income,

from any source, before calendar year 1988.    Petitioners further

contend that Ms. Walters has never received any unreported

income.   Petitioners maintain that respondent has failed to prove

unreported income for the years in issue because, they contend,

the schedules prepared for the 1988 bankruptcy, such as the Sweep

schedule, the family disbursements schedule, and other schedules

that indicate amounts purportedly owned by Ms. Walters and other

family members, and on which respondent relies to prove

unreported income, are not trustworthy.

     Petitioners contend further that neither Mr. Gherman nor any

Gherman family member benefited from the CD scheme.   Petitioners

maintain that the Sweep schedule reflects that only $100,000 was

payable to a Gherman family member (Ms. Walters).   Petitioners

contend further that the family disbursements schedule shows that

some of the funds reflected on that schedule were used to pay

FIP's operating expenses while other funds were paid out as loans
                                - 36 -


and used to make investments.    Petitioners also assert that

Gherman family members made deposits to FIP for which no credit

was made in the computation of unreported income and that no

consideration was given in the computation of unreported income

for stock losses.   Petitioners assert that they and their

children borrowed money from FIP, that they made payments of

interest and principal on those loans, and that the loans and

payments are reflected in FIP's books and records.    Petitioners

also contend that personal expenses of Mr. Gherman that FIP paid

were charged to his payroll account and reported as Form W-2

income on petitioners' joint Federal income tax returns.

     Respondent contends that Mr. Gherman embezzled $14.2 million

from FIP's clients, consisting of the $9.8 million from the CD

scheme, converted over the years 1982 through 1988, and the $4.4

million exit money with which he fled the country in August 1988.

Respondent contends that there is no evidence that any valid

loans existed and, furthermore, there were no consensual

agreements with the investors that their funds could be used by

petitioners as "loans".   Respondent asserts further that the

source of any funds purportedly "loaned" was money stolen from

FIP's clients.   Respondent additionally disputes petitioners'

contention that the Gherman family members received only $100,000

from the embezzlement.    Respondent contends rather that, albeit

sometimes through a circuitous route, all of the embezzled funds
                                - 37 -


ultimately wound up in the FIP account over which Mr. Gherman

exercised complete dominion and control.    Respondent further

disputes whether moneys deposited into FIP accounts by Gherman

family members came from their own funds.    Respondent maintains

that the record does not establish that all payments of personal

expenses were charged to Mr. Gherman's payroll account.

Respondent contends further that FIP was a sham and that Mr.

Gherman used it merely as a conduit to perpetrate his scam and to

defraud his investors.   Respondent asserts that Mr. Gherman had

complete dominion and control over the transfer, investment, and

disbursement of the embezzled funds and derived readily

realizable economic value from those funds.    Respondent contends

that Mr. Gherman's exercise of total dominion and control over

the phantom CD funds requires that the amounts be treated as

additional unreported income.    Accordingly, respondent contends,

petitioners had unreported income from the CD scheme of at least

$9,832,500; i.e., the amount reflected on the CD schedule.

     We agree with respondent that petitioners had unreported

income for the years in issue as a result of Mr. Gherman's

embezzlement of funds from FIP's clients.    Petitioners' arguments

to the contrary appear based on a misunderstanding of the

applicable law and of the effect of admissions made during the

criminal proceeding and throughout the instant action.
                              - 38 -


     Section 61 includes in income "all income from whatever

source derived", including income from an illegal source.      James

v. United States, 366 U.S. 213, 219-220 (1961); Commissioner v.

Glenshaw Glass Co., 348 U.S. 426, 431 (1955).    It is well settled

that money obtained by means of embezzlement constitutes income

to the perpetrator.   Money received without recognition of an

obligation to repay and without restriction as to its disposition

is taxable when it is received, even though the taxpayer may be

required to restore the money later.    James v. United States,

supra; North Am. Oil Consol. v. Burnet, 286 U.S. 417, 424 (1932);

Solomon v. Commissioner, 732 F.2d 1459, 1460-1461 (6th Cir.

1984), affg. per curiam T.C. Memo. 1982-603.    Moreover, an

embezzler must include embezzled funds in income even though the

funds are lent or given to another.    Bailey v. Commissioner, 420

F.2d 777 (5th Cir. 1969), affg. 52 T.C. 115 (1969) (funds

deposited into brother's account); Estate of Geiger v.

Commissioner, 352 F.2d 221 (8th Cir. 1965), affg. T.C. Memo.

1964-153 (funds used to make loans and gifts to others); see also

United States v. Lippincott, 579 F.2d 551 (10th Cir. 1978).      A

taxpayer restoring embezzlement income may deduct the repayment

in the year repaid.   James v. United States, supra at 220.

     Petitioners' argument that they did not have any unreported

income from embezzlement before 1988 is focused on the

disposition of the embezzled money after that money was deposited
                               - 39 -


into the FIP account.   The proper focus, however, must be on Mr.

Gherman's unauthorized diversions of funds from the accounts of

FIP's clients into the FIP account.     Those unauthorized

diversions constitute the taxable events, and not Mr. Gherman's

subsequent use of the embezzled funds, whatever that use might

have been.   See Bailey v. Commissioner, supra; Estate of Geiger

v. Commissioner, supra.

     Mr. Gherman admitted during the criminal proceeding that he

had embezzled approximately $9.7 million from FIP's clients.    It

is well settled that a judgment of conviction in a criminal

prosecution is admissible in evidence in a subsequent civil

action which is based on the act for which the conviction was

rendered.    Fed. R. Evid. 803(22).   Mr. Gherman's guilty plea in

the criminal proceeding, furthermore, is a confession of truth to

the charges and is admissible in the instant action as his

admission that he in fact embezzled funds from FIP's clients.

Fed. R. Evid. 801(d)(2).

     Additionally, petitioners do not challenge the accuracy of

the amounts listed in the CD schedule, prepared from FIP's books

and records, nor do they deny that Mr. Gherman exercised total

control over the embezzled funds.     Petitioners, furthermore, do

not challenge respondent's allegation that Mr. Gherman embezzled

the $9,832,500 reflected on the CD schedule.     Rather, petitioners

contend that Mr. Gherman did not receive any unreported income
                               - 40 -


until 1988 because the embezzled funds were not disbursed

directly to Gherman family members but were funneled into the FIP

account and used to pay FIP's operating expenses or were used to

make loans to Gherman family members or other individuals or were

used to make investments.    We do not agree.   Mr. Gherman

received, and should have included on his tax returns, income

from embezzlement at the time he converted the funds from the

accounts of FIP's clients.    See James v. United States, supra;

Estate of Geiger v. Commissioner, supra.     Accordingly, we sustain

respondent's position that petitioners received unreported income

from embezzlement for the years in issue.    However, we believe

that some adjustment is required in the amount of unreported

income determined in the notices of deficiency.

     Computation of Unreported Income

     We begin our computation of unreported income for the years

in issue with the amounts reflected on the CD schedule for those

years, which petitioners do not challenge.      We use the net amount

reflected for each year to account for embezzled funds that were

returned to accounts of FIP's clients.    The repayments to

accounts of FIP's clients appear to be an integral part of the CD

scheme.   The repayments helped to perpetuate the fraud over a

number of years.    Consequently, we treat them as expenses of the

illegal activity.   Additionally, for the year ended 1988, we

exclude any withdrawal from, or repayment to, a client account
                              - 41 -


with a transaction date after Mr. Gherman fled the country.     We

are not persuaded that either Mr. Gherman or Ms. Walters

exercised any dominion or control over those funds.    We further

reduce the net amounts reflected on the CD schedule by the

purported interest paid to CD participants.    Those payments also

appear to be an integral part of the CD scheme and helped to

perpetuate the fraud and are accordingly treated as an expense of

the illegal activity.

     Additionally, we reduce the net amounts reflected on the CD

schedule by amounts that we believe petitioners already included

in income in the form of Form W-2 wages from FIP.    FIP paid wages

to Mr. Gherman for all of the years in issue and to Ms. Walters

for year ended 1984, which petitioners reported on their tax

returns.   A portion of the wages paid to petitioners by FIP would

have been paid from gross receipts.    For each of the years in

issue, however, FIP operated at a loss.    Mr. Gherman used a

portion of the embezzled moneys to fund FIP's operations,

including petitioners' salaries.   Consequently, for each year we

reduce the net amount embezzled by the lesser of the Form W-2

wages reported on the return or FIP's reported net operating

loss.   Accordingly, we hold that the unreported income (rounded)

for the years in issue is as follows:
                                    - 42 -


                                             Year
                1984        1985             1986       1987          1988

Net amount
 per CD Sch. $1,575,000    $1,161,163   $1,752,537     $1,708,500   $1,525,300
Less:
 Invoices
   dated after
   8/88           -0-         -0-            -0-          -0-         155,300
 Interest
   paid to CD
   participants 304,864      282,452         406,917     484,548        -0-
 Lesser of
   W-2 wages or
   FIP's NOL     251,665     233,033         532,201     395,810      122,067
Unreported
 income        1,018,471     645,678         813,419     828,142    1,247,933

For each of the years 1984 through 1987, the unreported income

exceeds 25 percent of the income reported on the return.

Accordingly, we conclude that for each of those years the statute

of limitations does not bar the assessment of the deficiency or

additions to tax.

Addition to Tax for Negligence

     Respondent determined that petitioners are subject to an

addition to tax for negligence under section 6653 for the years

in issue.

     Section 6653(a)(1) (for 1984, 1985, and 1988) or section

6653(a)(1)(A) (for 1986 and 1987) imposes an addition to tax

equal to 5 percent of the underpayment if any part of the

deficiency was due to negligence or intentional disregard of

rules or regulations.      Section 6653(a)(2) (for 1984 and 1985) or

section 6653(a)(1)(B) (for 1986 and 1987) provides for an

addition to tax in the amount of 50 percent of the interest
                              - 43 -


payable on the portion of the underpayment of tax attributable to

negligence.

      The term "negligence" includes any failure to make a

reasonable attempt to comply with the provisions of the Code.

Sec. 6653(a)(3).   Negligence also has been defined as a lack of

due care or the failure to do what a reasonable and ordinarily

prudent person would do under the circumstances.     See Crocker v.

Commissioner, 92 T.C. 899, 916 (1989); Neely v. Commissioner, 85

T.C. 934, 947-948 (1985).   Petitioners have the burden of proving

that the deficiency was not due to neglect or the intentional

disregard of rules or regulations.     Rule 142(a); Neely v.

Commissioner, supra.

     Petitioners did not address this issue in their brief nor

did they present any evidence at trial which would prove that the

omission of income was not due to negligence or the intentional

disregard of rules or regulations.     Accordingly, we sustain

respondent's determination as to the additions to tax under

section 6653(a).

Addition to Tax for Substantial Understatement of Tax

     Respondent determined that petitioners are liable for

additions to tax for the substantial understatement of their tax

liability for the years in issue.

     Section 6661 imposes an addition to tax of 25 percent (10

percent for assessments made before October 22, 1986) of any
                                - 44 -


underpayment attributable to a substantial understatement of tax.

Sec. 6661(a); Pallottini v. Commissioner, 90 T.C. 498, 500-503

(1988).   A substantial understatement of income tax is defined as

an understatement of tax that exceeds the greater of 10 percent

of the tax required to be shown on the return for the year or

$5,000, whichever is greater.    Sec. 6661(b)(1)(A).     An

understatement is the amount required to be shown on the return

less the amount actually shown on the return.     Sec.

6661(b)(2)(A).   The Commissioner may waive the addition to tax if

the taxpayer had reasonable cause for the understatement and

acted in good faith.   Sec. 6661(c).     Petitioners bear the burden

of proving that respondent's imposition of additions to tax under

section 6661 is erroneous.   Rule 142(a); Tweeddale v.

Commissioner, 92 T.C. 501, 506 (1989).

     Petitioners did not address this issue in their brief, nor

did they present any evidence at trial which would prove that

they had reasonable cause for the understatement and acted in

good faith in omitting the income from their returns.

Accordingly, we sustain respondent's determination as to the

additions to tax under section 6661.

Addition to Tax for Failure To Timely File

     Respondent determined that Mr. Gherman is liable for the

addition to tax imposed under section 6651(a)(1) for the year

ended 1988, because he failed to timely file his Federal income
                             - 45 -


tax return for that year and he did not prove that the failure to

timely file was due to reasonable cause.

     Section 6651(a)(1) imposes an addition to tax of 5 percent

of the amount of the tax due for each month a return is

delinquent, up to a maximum of 25 percent.    The addition to tax

is not applicable if it is shown that the failure is due to

reasonable cause and not willful neglect.    Sec. 6651(a)(1);

United States v. Boyle, 469 U.S. 241, 245 (1985).     Petitioner has

the burden of proving that his failure to file was due to

reasonable cause and not to willful neglect.     Niedringhaus v.

Commissioner, 99 T.C. 202, 220-221 (1992); Baldwin v.

Commissioner, 84 T.C. 859, 870 (1985).     To prove "reasonable

cause", taxpayers must show that they exercised ordinary business

care and prudence and were nevertheless unable to file the return

within the statutorily prescribed time.     Crocker v. Commissioner,

supra at 913; sec. 301.6651-1(c)(1), Proced. & Admin. Regs.

Taxpayers may, generally, establish reasonable cause by proving

that they reasonably relied on the advice of an accountant or

attorney that it was unnecessary to file a return and later found

that the advice was erroneous or mistaken.     United States v.

Boyle, supra at 250; Estate of Paxton v. Commissioner, 86 T.C.

785, 820 (1986).

     Mr. Gherman did not address this issue on brief, nor did he

present any evidence at trial which would prove that he had

reasonable cause for failing to timely file his return for year
                                - 46 -


ended 1988.   Accordingly, we sustain respondent's determination

as to the addition to tax under section 6651(a)(1).

Innocent Spouse Relief

     Petitioners contend that Ms. Walters qualifies for relief

under the innocent spouse provisions of section 6013(e) from

liability for the deficiencies and additions to tax determined

for years ended 1984, 1985, and 1986 (the applicable years).

Respondent contends, however, that Ms. Walters is not entitled to

relief under section 6013(e).

     Spouses who file a joint income tax return generally are

jointly and severally liable for its accuracy and the tax due,

including any additional taxes, interest, or additions to tax

determined on audit of the return.       Sec. 6013(d)(3).   However,

pursuant to section 6013(e), a spouse can be relieved of tax

liability if that spouse shows that he or she qualifies as an

"innocent spouse".   To qualify as an innocent spouse under

section 6013(e), a taxpayer must prove:       (1) He or she filed a

joint return for the years in issue; (2) there is a substantial

understatement of income tax attributable to grossly erroneous

items of the other spouse on the return; (3) he or she did not

know or have reason to know of the substantial understatement

when the return was signed; and (4) it would be inequitable to

hold the "innocent" spouse liable for the deficiency attributable

to the substantial understatement.       Sec. 6013(e)(1).   Failure to

meet any of the requirements precludes a taxpayer from qualifying
                              - 47 -


as an innocent spouse.   Sec. 6013(e)(1); Purcell v. Commissioner,

826 F.2d 470, 473 (6th Cir. 1987), affg. 86 T.C. 228 (1986); Shea

v. Commissioner, 780 F.2d 561, 565 (6th Cir. 1986), affg. in part

and revg. and remanding T.C. Memo. 1984-310; Bokum v.

Commissioner, 94 T.C. 126, 138-139 (1990), affd. 992 F.2d 1132

(11th Cir. 1993).

     Respondent concedes that joint returns were filed for the

applicable years and that the tax involved is the result of

grossly erroneous items.   Petitioners must prove, however, that

Ms. Walters satisfies the remaining criteria for relief under

section 6013(e).

     Grossly Erroneous Item of the Other Spouse

     Respondent contends that funds derived from the CD scheme

are income also attributable to Ms. Walters.   Respondent

maintains that Ms. Walters had control over the embezzled funds

sufficient to make the income attributable to her as well as to

Mr. Gherman because she cosigned FIP's checks.    Accordingly,

respondent maintains, Ms. Walters does not qualify for relief

under the innocent spouse provisions.

     Respondent's arguments are not persuasive.    The fact that

Ms. Walters cosigned FIP's checks, attended board of directors

meetings, and held all of FIP's stock in her name might have been

determinative had the unreported income resulted from an

understatement of the income earned by FIP or an overstatement of

the deductions claimed by FIP.   The unreported income, however,
                               - 48 -


arose from embezzlement of funds from accounts of FIP's clients.

As we discussed supra, the embezzlement occurred when Mr. Gherman

converted funds from various accounts of FIP's clients, not when

those funds subsequently were deposited into or disbursed from

the FIP account.   Ms. Walters had no control over the accounts of

FIP's clients.   She was not a participant in the embezzlement of

funds from those accounts.

     Moreover, if control over the FIP account was determinative,

we are convinced that Ms. Walters did not exercise that control.

Ms. Walters signed blank checks in large numbers.   Mr. Gherman's

signature, however, also was required on all of the checks before

they became valid.    Ms. Walters made no decisions as to when or

where the funds would be used.   Mr. Gherman alone made the

decisions relating to the disbursement of funds from the FIP

account.   Additionally, Mr. Gherman alone embezzled the funds and

he alone knew that money from accounts of FIP's clients was being

diverted into the FIP account.   Mr. Gherman alone made all

financial decisions relating to the use of those diverted funds.

Accordingly, we hold that the unreported income is attributed

solely to Mr. Gherman.   See Feldman v. Commissioner, 20 F.3d

1128, 1136-1137 (11th Cir. 1994) (the test for whether an item is

attributable to a spouse is whether the spouse has sufficient

connection through ownership rights or otherwise to make it an

item for which both spouses should bear responsibility), affg.

T.C. Memo. 1993-17.
                               - 49 -


     Knowledge of the Understatement

     Petitioners contend that Ms. Walters had no actual or

constructive knowledge of the embezzlement income before or

during the applicable years.   Respondent does not agree.

     To establish lack of knowledge of the understatement, Ms.

Walters must show that she was unaware of the circumstances

giving rise to the omission of income.   See Park v. Commissioner,

25 F.3d 1289, 1294 (5th Cir. 1994) ("Courts have generally agreed

that in innocent spouse cases involving the omission of income,

relevant inquiry is whether the spouse claiming innocent spouse

relief knew or should have known of an income-producing

transaction that the other spouse failed to report in their joint

return."), affg. T.C. Memo. 1993-252; Purcell v. Commissioner, 86

T.C. at 238.   She must show that she lacked both actual knowledge

and constructive knowledge of the omission such that a reasonably

prudent person under the circumstances at the time that the

return was filed could not be expected to know that the tax

liability stated was erroneous or that further inquiry was

necessary.   See Stevens v. Commissioner, 872 F.2d 1499, 1504-1505

(11th Cir. 1989), affg. T.C. Memo. 1988-63; Sanders v. United

States, 509 F.2d 162, 167 (5th Cir. 1975).    Whether the spouse

seeking relief had reason to know of the substantial

understatement is a question of fact to be determined after

reviewing the entire record.   Guth v. Commissioner, 897 F.2d 441

(9th Cir. 1990), affg. T.C. Memo. 1987-522.
                              - 50 -


     Where omissions from income are in issue, courts generally

agree that it is actual or constructive knowledge of the

underlying transactions, not of the tax consequences of those

transactions, that is material.   Park v. Commissioner, supra at

1293-1294.   However, the failure to review a tax return generally

does not absolve a taxpayer of liability.     Hayman v.

Commissioner, 992 F.2d 1256, 1262 (2d Cir. 1993), affg. T.C.

Memo. 1992-228.   A taxpayer may not generally close his or her

eyes to what is disclosed on the tax return and plead ignorance.

Edmondson v. Commissioner, T.C. Memo. 1996-393; Cohen v.

Commissioner, T.C. Memo. 1987-537.     Nonetheless, while a spouse

cannot close his or her eyes to unusual or lavish expenditures,

the spouse is not required to have perfect knowledge of family

financial matters.   Belk v. Commissioner, 93 T.C. 434, 441

(1989); Mysse v. Commissioner, 57 T.C. 680, 699 (1972).

Furthermore, "one person's luxury may be another's necessity, and

the lavishness of an expense must be measured from each family's

relative level of ordinary support."     Kistner v. Commissioner, 18

F.3d 1521, 1525 (11th Cir. 1994), revg. and remanding T.C. Memo.

1991-463; see also Sanders v. United States, supra at 168.

However, "the alleged innocent spouse's role as a homemaker and

complete deference to the spouse's judgment concerning the

couple's finances, standing alone, are insufficient to establish

that a spouse had no 'reason to know.'"     Kistner v. Commissioner,

supra at 1525; see also Stevens v. Commissioner, supra at 1505.
                              - 51 -


     We are persuaded that Ms. Walters did not know that Mr.

Gherman was embezzling money from FIP's clients until 1988, after

he fled the country and after the returns for the applicable

years were filed.   Mr. Gherman did not tell Ms. Walter that he

was embezzling money from the accounts of FIP's clients.     The

embezzled funds, furthermore, did not go into the Joan Gherman

No. 1 account, over which she had control, but into the FIP

account, over which she exercised no supervision.   Although Ms.

Walters attended monthly board meetings of FIP, it is unlikely

that the embezzlement of funds from accounts of FIP's clients was

a topic of discussion at those meetings.   Even Mr. Feltman, the

trustee for the 1988 bankruptcy, became convinced after a lengthy

investigation of the CD scheme that Ms. Walters was unaware of

the embezzlement until after Mr. Gherman fled the country.

Accordingly, we conclude that at the time the tax returns for the

applicable years were filed, Ms. Walters had no actual knowledge

of the transaction giving rise to the unreported income--the

embezzlement of funds from the accounts of FIP's clients.

     Additionally, we are persuaded that Ms. Walters had no

reason to know that Mr. Gherman was embezzling money from the

accounts of FIP's clients.   Ms. Walters was a high school

graduate and was basically ignorant of tax, financial, and

accounting principles.   Mr. Gherman's financial affairs were

complex, and Ms. Walters had very little to do with them.     The CD

scheme continued over a number of years and deceived many
                              - 52 -


individuals more financially astute than Ms. Walters.     We are

convinced that Mr. Gherman also managed to convince Ms. Walters

and other family members that the family "fortune" came from his

financial expertise.

     Respondent contends further that Ms. Walters should have

known about the unreported income, because the income reported on

petitioners' tax returns for the applicable years could not

support their lifestyle.   Beyond general references to

petitioners' "level of expenditures", information about their

personal residence, the use of household help, and their use of

the Camelot, the record is vague as to the nature of Ms. Walters'

standard of living during 1984, 1985, and 1986.    Consequently, it

is not clear whether petitioners' reported gross income of

$477,197, $498,634, and $533,901 for 1984, 1985, and 1986,

respectively, could have supported that lifestyle.   Nonetheless,

having observed Ms. Walters at trial and having heard her

testimony and considering the circumstances, we are persuaded

that Ms. Walters believed the reported income for those years was

sufficient to support their lifestyle.

     Ms. Walters did not sign blank tax returns.   She reviewed

the returns at least to the point of checking to ascertain how

much money Mr. Gherman was earning.    Consequently, she was aware

that petitioners reported gross income of close to half a million

dollars for each of the applicable years.   We are persuaded that,

in light of her limited education and lack of business expertise,
                               - 53 -


the high amount of gross income reported on the returns caused

Ms. Walters to assume that their reported income was sufficient

to support their standard of living.

     Furthermore, petitioners began moving up into better homes

and neighborhoods, had household help, threw elaborate parties,

and otherwise enjoyed a fairly high, and generally improving,

standard of living years before Mr. Gherman began embezzling

money from FIP's clients.   The house in which petitioners lived

during the years in issue was purchased in 1981 or 1982, before

that Mr. Gherman began embezzling money from FIP's clients.     Mr.

Gherman made all decisions relating to financial matters that

affected both FIP and petitioners.      Except for some minor

household expenditures that were paid out of the Joan Gherman No.

1 account, Mr. Gherman or a member of his office staff paid

petitioners' personal bills from the FIP account or the Joan

Gherman No. 2 account.   Ms. Walters signed checks drawn on those

accounts in blank.   Furthermore, she did not balance any of the

checking account statements.   Consequently, we are persuaded that

Ms. Walters had no reason to suspect that their lifestyle

exceeded their reported income, if it did.      See Sanders v. United

States, 509 F.2d at 168.

     Respondent contends further that Ms. Walters' show business

activities demonstrate that she lived extravagantly during 1984

through 1986.   The show business activities addressed at trial,

e.g., her producing "Purlie" and "Bubbling Brown Sugar" and her
                              - 54 -


managing Barry Smith, the Freeman Sisters, and Patti Jo, took

place during the 1970's.   Inasmuch as those show business

activities preceded the embezzlement, they do not support

respondent's position.

     Additionally, not all of the embezzled money flowed directly

to Gherman family members.   Mr. Gherman used a portion of the

embezzled funds to pay FIP's operating expenses and to make loans

and investments.   Mr. Gherman alone controlled FIP's operations.

Large sums of money flowed through the FIP account at any time.

Although Ms. Walters attended board of director meetings, her

role in FIP's operations was to sign checks in blank and to help

entertain clients, not to control how the funds were to be used.

We are persuaded that her minimal participation in the activities

of FIP did not provide her sufficient facts such that a

reasonably prudent taxpayer in her position would be put on

notice of the embezzlement income or of a need to make further

inquiry.

     Respondent contends further that Ms. Walters had reason to

inquire as to whether Mr. Gherman was properly reporting all

income because he had been denied a discharge in the 1969

bankruptcy as a result of false statements that he had made to a

lender, Mr. Gherman had been investigated by a Federal grand jury

relating to tax crimes, and Ms. Walters had been involved in Tax

Court litigation relating to the joint tax returns that she had

filed with Mr. Gherman which resulted in a tax liability in
                               - 55 -


excess of $800,000.    Respondent asserts that Ms. Walters

nevertheless made no attempt to ascertain that the joint tax

returns were true and correct.    We disagree with respondent, for

several reasons.

     First, FIP's clients generally were well-educated,

successful professional business men and women who remained

clients of FIP for many years.    Mr. Gherman did not keep secret

from FIP's clients the fact that he was not discharged in the

1969 bankruptcy.    Nonetheless, FIP's clients relied on Mr.

Gherman's advice and trusted him to handle their financial

affairs honestly and fairly.    Similarly, we are persuaded that

Mr. Gherman's failure to obtain a discharge in the 1969

bankruptcy would not cause Ms. Walters to suspect that Mr.

Gherman was embezzling money from FIP's clients.

     Second, the embezzlement of millions of dollars from

accounts of FIP's clients was not related or even similar to the

activities cited by respondent.    None of those prior activities,

furthermore, resulted in a criminal indictment.    Moreover, the

prior audits of petitioners' tax returns did not involve the

failure to report income from an illegal activity and those

audits were settled with respondent's conceding the imposition of

additions to tax for fraud as well as a substantial portion of

the deficiencies.    Ms. Walters knew that the IRS had dropped its

fraud investigation of Mr. Gherman and that the grand jury did

not bring an indictment against him.    Under those circumstances,
                               - 56 -


we believe that the prior audits and grand jury investigation

would not cause Ms. Walters to suspect that Mr. Gherman was

embezzling money from the accounts of FIP's clients.

     Third, during 1984, Ms. Walters requested that she be

removed from FIP's payroll because she wanted to avoid trouble in

the future with the IRS.    Furthermore, Ms. Walters knew that

following the audits and the grand jury investigation, the

accountants who prepared the tax returns for FIP and petitioners

began to take a closer look at large and extraordinary items,

especially expense items, reported on the tax returns and that

after they were prepared, the returns were reviewed by attorneys

who specialized in tax matters before being presented to

petitioners for their signature.    We are persuaded that, as far

as Ms. Walters knew, she had taken appropriate action to assure

herself that the returns were proper and correct.

     Finally, we do not agree that Ms. Walters blindly accepted

petitioners' tax returns.    While she may not have reviewed the

returns in depth, Ms. Walters knew that the returns had been

prepared by a C.P.A. and then reviewed and approved by attorneys

who specialized in tax matters before the returns were given to

petitioners for signature.    Furthermore, Ms. Walters sought and

received assurances from Mr. Gherman that the returns were

properly prepared before she signed them.    Accordingly, we are

persuaded that Ms. Walters satisfied her duty to inquire as to

the accuracy of the joint tax returns.
                              - 57 -


     Consequently, we conclude that Ms. Walters had not been put

on notice that embezzlement income was being unreported or that

further inquiry was needed.

     As we stated earlier, we are not faced with a situation

where income earned by FIP was understated or deductions claimed

by FIP were overstated on its tax returns.   If we were, we agree

that Mr. Gherman's prior activities and difficulties might have

put Ms. Walters on notice that further inquiry as to unreported

income was necessary.   But FIP's income and deductions are not

the issue.   In our view, under the circumstance of the instant

case, Mr. Gherman's prior activities are not relevant to the

issue of whether Ms. Walters had reason to know that Mr. Gherman

was stealing money from accounts of FIP's clients.

     On the basis of the foregoing, we conclude that Ms. Walters

had neither actual nor constructive knowledge of the

embezzlement.   See Park v. Commissioner, 25 F.3d at 1293-1294.

Accordingly, we hold that Ms. Walters did not know, nor did she

have reason to know, about the unreported income.

     Inequitable To Hold Liable for Tax

     Petitioners contend that it would be inequitable to hold Ms.

Walters liable for the deficiencies in tax and additions to tax.

Respondent disagrees.

     Whether it is inequitable to hold a person liable for

additional tax, interest, and additions to tax is to be

determined on the basis of all the facts and circumstances.    Sec.
                                - 58 -


6013(e)(1)(D); Flynn v. Commissioner, 93 T.C. 355, 367 (1989);

sec. 1.6013-5(b), Income Tax Regs.       A factor to be considered is

whether the purported innocent spouse significantly benefited

beyond normal support, either directly or indirectly, as a result

of the unreported income.     Hayman v. Commissioner, 992 F.2d at

1262; Belk v. Commissioner, 93 T.C. at 440; Purcell v.

Commissioner, 86 T.C. 228, 242 (1986); sec. 1.6013-5(b), Income

Tax Regs.   Normal support is determined by the circumstances of

the taxpayers.    See Sanders v. United States, 509 F.2d at 168;

Estate of Krock v. Commissioner, 93 T.C. 672, 678 (1989); Flynn

v. Commissioner, supra.     Petitioners bear the burden of proving

that Ms. Walters received no significant benefit from the

understatement other than normal support, and that burden must be

satisfied with specific facts regarding lifestyle, expenditures,

asset acquisitions, and the disposition of the benefits of the

understatement.    See Bokum v. Commissioner, 94 T.C. at 157;

Estate of Krock v. Commissioner, supra.

     Petitioners contend that Ms. Walters did not benefit

significantly from the unreported income but rather received

merely ordinary support that was commensurate with the upper

middle class lifestyle that petitioners had maintained before the

embezzlement.     They assert that Ms. Walters herself was not

extravagant in her spending habits.       Petitioners contend further

that the Camelot benefited FIP through the entertainment of its

clients and does not demonstrate an extravagant lifestyle.       They
                              - 59 -


contend further that the income reported on their joint returns

for years ended 1984 through 1986 was sufficient to support their

lifestyle.

     Respondent contends that it is not inequitable to hold Ms.

Walters liable for the deficiency attributable to the substantial

understatement, because she benefited from the income above

normal support and she helped Mr. Gherman obtain the unreported

income through her ownership of FIP.   As examples of significant

benefits from the unreported income, respondent cites the Eastern

Shores house, the purchase and use of the Camelot, her show

business endeavors, lavish gifts to her children and

grandchildren, parties and other entertainment, and personal

investments and bank accounts.   Additionally, respondent contends

that Ms. Walters benefited from the embezzlement because Mr.

Gherman used some of the stolen funds to pay off major debts of

Ms. Walters, such as her automobile and Federal income tax

liabilities.

     We have been provided with few specific facts relating to

petitioners' lifestyle, expenditures, and asset acquisitions and

dispositions for the years 1984 through 1986.   See Bokum v.

Commissioner, supra at 157; Estate of Krock v. Commissioner,

supra.   To a large extent, the specific facts regarding

petitioners' lifestyle, spending habits, and asset acquisitions

and dispositions revealed in the record relate to years before or

after the applicable years.
                                - 60 -


     The record establishes that Mr. Gherman funneled embezzled

funds through the FIP account.    The record also shows that during

the 1970's he used FIP funds to subsidize Ms. Walters' show

business endeavors, but it appears, and we so find, that Ms.

Walters did not undertake any show business activities during

1984 through 1986, and none of FIP's money, including embezzled

funds, went to support those activities.

     It is possible, and for purposes of deciding the issue we

assume, that Ms. Walters benefited from the unreported income to

some extent above normal support.    Nonetheless, under the

circumstances, we find that the fact that she did so benefit is

not determinative because other factors outweigh any benefit she

may have received.

     Whether a spouse substantially benefited from the unreported

income is only one factor to consider in determining whether it

is inequitable to hold the spouse liable for the deficiencies and

additions to tax.    An additional factor to consider is whether

the spouse claiming relief was deserted, divorced, or separated.

Kistner v. Commissioner, T.C. Memo. 1995-66; sec. 1.6013-5(b),

Income Tax Regs.     We also may consider whether the spouse seeking

relief will suffer undue hardship as a result of being held

liable for the deficiencies if relief is denied.    See Sanders v.

United States, supra at 171; Dakil v. United States, 496 F.2d

431, 433 (10th Cir. 1974).
                               - 61 -


     Ms. Walters and Mr. Gherman were divorced during 1989.    Mr.

Gherman is in jail, serving a 30-year sentence.    As far as we

know, he does not have the financial resources to pay the

deficiencies and additions to tax, nor does he have the means to

obtain those resources.    Ms. Walters also lacks the financial

resources to pay the deficiencies and additions to tax.     Because

of the 1988 bankruptcy, Ms. Walters walked away from her marriage

with no personal assets.    She is living in her daughter's

apartment and can scarcely support herself.    Additionally, as a

63-year old woman with only a high school education and a low-

paying job, there is little likelihood that Ms. Walters will ever

be able to amass the funds needed to pay the deficiencies and

additions to tax.   Consequently, she would suffer undue hardship

should relief be denied.

     Ms. Walters did not participate in the embezzlement of funds

from the accounts of FIP's clients, nor did she assist in the

embezzlement, as respondent contends, because she allowed Mr.

Gherman to use her name to conduct business.    To accept

respondent's contention that Ms. Walters aided and abetted the

embezzlement because she allowed Mr. Gherman to organize and

operate FIP under her name, we would have to believe that Mr.

Gherman, with Ms. Walters' knowledge and consent, planned to

defraud FIP's clients at the time that FIP was organized during

1969 and then waited until the end of 1982 to effectuate that

plan.   Respondent's position defies common sense and is not
                               - 62 -


supported by the record.    Although she did allow Mr. Gherman to

use her name in order to conduct business, there is no suggestion

that Ms. Walters did so with the understanding that criminal

activities would occur.    Indeed, as far as we know, during the

first 13 years of FIP's existence, no conversion of client funds

occurred.

     Under the circumstances, we conclude that it would be

inequitable to hold Ms. Walters liable for the deficiencies and

additions to tax.   Accordingly, we hold that Ms. Walters is

entitled to relief under section 6013(e) as an innocent spouse.

     To reflect the foregoing,

                                          Decision will be entered

                                     under Rule 155.
