                        T.C. Memo. 2004-90



                      UNITED STATES TAX COURT



  VIRGINIA FERGUSON, f.k.a. VIRGINIA DEL BOSQUE, AND ESTATE OF
    ARMAND J. DEL BOSQUE, DECEASED, LORI DEL BOSQUE, SPECIAL
             ADMINISTRATOR, ET AL.,1 Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket Nos. 3275-01, 3276-01,           Filed March 29, 2004.
                 3277-01.

     Peter L. Milinkovich, for petitioners.

     David L. Zoss, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     JACOBS, Judge:   Respondent determined deficiencies in

petitioners’ Federal income tax, additions to tax, and a penalty


     1
      Cases of the following petitioners are consolidated
herewith: Estate of Armand J. Del Bosque, Deceased, Lori Del
Bosque, Special Administrator, docket No. 3276-01; Bradley T.
Jacobsen and Donna M. Cleare-Jacobsen, docket No. 3277-01.
                                 - 2 -

for 1987, 1988, and 1989 as follows:2

Docket No. 3275-01
                                            Additions to Tax
                                Sec.               Sec.            Sec.
    Year      Deficiency   6653(b)(1)(A)      6653(b)(1)(B)      6653(b)
    1987       $20,861        $15,646      50% of the interest     --
                                              due on $20,861
    1988         3,213         --                   --           $2,410

Docket No. 3276-01
                                                 Penalty
    Year      Deficiency                        Sec. 6663
    1989       $10,494                           $7,871

Docket No. 3277-01
                                            Additions to Tax
                                Sec.               Sec.            Sec.
    Year      Deficiency   6653(b)(1)(A)      6653(b)(1)(B)      6653(b)
    1987       $12,005         $9,004      50% of the interest     --
                                              due on $12,005
    1988         9,985         --                   --           $7,489

     The issues remaining to be decided are:3

     1.    Whether decedent, Armand J. Del Bosque (Mr. Del Bosque),

had unreported gross receipts for 1987, 1988, and 1989 in the

respective amounts of $67,163, $16,557, and $32,779, computed

under the net worth method.

     2
      All section references are to the Internal Revenue Code in
effect for the years in issue, and all Rule references are to the
Tax Court Rules of Practice and Procedure. Amounts are rounded
to the nearest dollar.
     3
      The parties have stipulated that (1) Bradley T. Jacobsen
(Mr. Jacobsen) and Donna M. Cleare-Jacobsen (Mrs. Jacobsen) are
entitled to deduct in 1987 the $2,000 contribution to an IRA that
respondent disallowed, (2) Virginia Ferguson is entitled to
relief under sec. 6015(c) with respect to the deficiencies and
additions to tax for 1987 and 1988, and (3) Mrs. Jacobsen is
entitled to relief under sec. 6015(b) with respect to the
deficiencies and additions to tax for 1987 and 1988.
                               - 3 -

     2.   Whether Bradley T. Jacobsen (Mr. Jacobsen) had

unreported gross receipts of $28,378 in 1987 and $29,747 in 1988,

computed under the net worth method.

     3.   Whether Mr. Jacobsen had additional unreported income of

$6,285 in 1987 and $6,309 in 1988, on the basis of Bureau of

Labor Statistics figures.

     4.   Whether Mr. Del Bosque is liable for additions to tax

and/or a civil fraud penalty for 1988 and 1989.4

     5.   Whether Mr. Jacobsen is liable for an addition to tax

for fraud for 1988.5

     6.   Whether the period of limitations on assessment and

collection with respect to 1988 and 1989 expired before

respondent issued the subject notices of deficiency to

petitioners.

                         FINDINGS OF FACT

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

The stipulation of facts and the attached exhibits are

incorporated herein by this reference.

     Mr. Del Bosque died on April 5, 2003, after the conclusion

of the trial in these cases.   When the petitions in these cases

were filed, Mr. Del Bosque resided in Roseville, Minnesota,


     4
      Mr. Del Bosque’s estate concedes that he is liable for the
addition to tax for fraud for 1987.
     5
      Mr. Jacobsen concedes that he is liable for the addition to
tax for fraud for 1987.
                                - 4 -

Virginia Ferguson (Ms. Ferguson) resided in Fridley, Minnesota,

and Mr. Jacobsen and Donna M. Cleare-Jacobsen (Mrs. Jacobsen)

resided in Apple Valley, Minnesota.     Hereinafter, references to

petitioners are to Messrs. Del Bosque and Jacobsen.

     On December 31, 1986, petitioners each owned two

snowmobiles--a 1987 Polaris Indy 600 and a 1987 Polaris Indy

Sport.    Petitioners each purchased the 1987 Polaris Indy 600s

from Metro-North Sports on October 15, 1986, for the base price

of $4,688; two items identified as “north country” were purchased

at the same time for $469 each.    The record does not disclose

when the 1987 Polaris Indy Sports were purchased; however, a

receipt from Metro-North Sports shows that, on October 29, 1986,

petitioners purchased accessories and parts for two “Indy 600s”

and two “Sports”.    Mr. Jacobsen disposed of his Sport in 1988.

     In December 1986, Mrs. Jacobsen made a $2,000 loan to her

employer.    This loan was repaid in 1987.

     Mrs. Jacobsen had a Chase Manhattan “money market with

checks” account (the MMWC account).     On December 31, 1986, the

balance in that account was $8,618.

     In 1986, Mrs. Jacobsen received an inheritance of $12,518

plus a one-eighth interest in a contract for deed valued at

$1,966.

     On December 31, 1986, Mr. Del Bosque had $12,000 in an

account with First Bank East.    In January 1987, he used funds
                                 - 5 -

from that account to open a brokerage account.   On January 16,

1987, Mr. Del Bosque purchased 234 shares of Fidelity Growth Fund

for $3,320.   On April 22, 1987, he sold those shares for $3,756

and purchased 1 share for $16.    Mr. Del Bosque reported the $436

gain from the sale of the 234 shares on his 1987 return.   On

January 22, 1988, he sold the remaining share for $13.   On his

1988 return, he erroneously reported a basis of $3,320 in the 1

share and a $3,307 long-term capital loss on the sale of the

share.

      At the end of 1987, Mr. Del Bosque owed $3,921 to Larson

Quinn Motor Co.   He repaid the loan in 1988.

     During the years at issue, petitioners purchased leather

goods (mostly leather jackets) for resale.   In both 1987 and

1988, Mr. Jacobsen purchased $3,770 of leather goods for resale.

Mr. Del Bosque purchased $13,298 of leather goods for resale in

1987, $3,862 for resale in 1988, and $2,375 for resale in 1989.

Petitioners did not keep any records of their sales of leather

goods.

     During the years at issue, petitioners each owned 50 percent

of the stock of Top Play, Inc. (Top Play), an S corporation doing

business as Twin Star Limousine Service.
                                - 6 -

     In 1987, 1988, and 1989, petitioners were employed by, and

received wages from, Top Play.6   Also during those years, Mr.

Jacobsen was employed by, and received wages from, Chinook, Inc.

(Chinook), doing business as Five Corners Saloon.

     In 1987, Top Play purchased a mobile telephone system for

$1,797.   This purchase was charged to Mr. Jacobsen’s credit card.

Top Play paid the credit card company $1,300 in 1987 and $763 in

1988 for the purchase of the mobile telephone system.

     Some of the limousine runs generated cash for which no run

sheets were prepared, and petitioners often paid drivers in cash.

Petitioners did not maintain accurate records of Top Play’s cash

receipts and cash payroll.    They did not inform Top Play’s

accountant of the cash receipts and payroll items.    As a result,

Top Play’s 1987 and 1988 income tax returns and financial

statements did not reflect those items.

     In February of 1990, petitioners sold the assets of the

limousine service to Susan Pavlak for approximately $350,000.

After a few months, Ms. Pavlak compared Top Play’s operating

performance in 1989 to its performance in 1990, as indicated in

the financial records she had reviewed before purchasing the

limousine business.   She concluded that the limousine business

was producing less revenue.


     6
      In 1988, Ms. Ferguson was employed by, and received wages
from, Gantos, Inc. In 1987, Mrs. Jacobsen was employed by, and
received wages from, Gray Display and Chinook, Inc.
                               - 7 -

     Ms. Pavlak believed that petitioners had misrepresented the

profitability of the limousine business on the Top Play income

tax returns that she had reviewed and relied upon in purchasing

Top Play.   On July 8, 1990, she met with petitioners and proposed

that they repurchase Top Play for $340,000.     Petitioners did not

respond to her proposal.   Thereafter, Ms. Pavlak sued petitioners

for fraud and misrepresentation with respect to her purchase of

Top Play.   She received a judgment in the amount of $95,000.

     Because Ms. Pavlak believed that a portion of Top Play’s

cash receipts in 1989 had likely been derived from illegal

activities, she contacted the U.S. Drug Enforcement

Administration (DEA).   The DEA referred Ms. Pavlak to the

Criminal Investigation Division of the Internal Revenue Service

(IRS).

     In July of 1990, Tom Fisher, an IRS special agent assigned

to the Federal narcotics task force, began investigating

petitioners’ business activities.    Agent Fisher determined that

petitioners had unreported income.     He believed that narcotics

and/or gambling activities were the possible sources for this

income.

     Agent Fisher reconstructed petitioners’ incomes using the

net worth method.   Agent Fisher chose the net worth method to

compute petitioners’ incomes because (1) excessive cash had been
                               - 8 -

deposited into Top Play’s accounts, (2) petitioners used cash for

personal expenditures, and (3) there were no specific items of

unreported income.

     To compute petitioners’ incomes, Agent Fisher identified

petitioners’ assets, liabilities, and expenses.    Agent Fisher

used information obtained from third parties, searches of

petitioners’ residences, and Top Play’s records.    For some items,

Agent Fisher used financial statements prepared by petitioners in

1986 and 1987.   Agent Fisher determined petitioners’ net worths

as of December 31, 1986 through 1989.   (Reference to petitioners’

1986, 1987, 1988, and 1989 net worths are to their respective net

worths on December 31 of the referenced year.)    Agent Fisher

reconstructed petitioners’ incomes by comparing changes in their

net worths from one year to the next for the years in issue.

     In February 1993, Mr. Del Bosque was arrested for purchasing

anabolic steroids.7   On March 3, 1993, a four-count indictment

was filed in the U.S. District Court for the District of

Minnesota, charging Mr. Del Bosque with conspiring to import, and

to possess with the intent to distribute, controlled substances

(anabolic steroids), and with aiding and abetting the importing,

and possessing with the intent to distribute, controlled

substances (anabolic steroids).


     7
      Mr. Del Bosque competed in body building competitions and
had held two Mr. Minnesota titles. To that end he used anabolic
steroids.
                                - 9 -

     In April 1993, Mr. Del Bosque became ill and was diagnosed

with cardiomyopathy.    He was hospitalized in a coronary intensive

care unit for 9 days.

     On June 23, 1993, a five-count criminal information was

filed in the U.S. District Court for the District of Minnesota

(the criminal tax proceeding) naming petitioners codefendants.

Counts I, II, and III charged Mr. Del Bosque with tax evasion for

1987, 1988, and 1989 in violation of section 7201.    Counts IV and

V charged Mr. Jacobsen with tax evasion for 1987 and 1988 in

violation of section 7201.

     Petitioners entered into plea agreements by which

they agreed to plead guilty to tax evasion in 1987 as set forth

in counts I and IV, and the Government agreed to move for

dismissal of counts II, III, and V.     Mr. Del Bosque also entered

into a plea agreement in his drug case in which he agreed to

plead guilty to conspiring to import anabolic steroids.

     In the criminal tax proceeding, Mr. Del Bosque acknowledged

that his steroid arrest and his illness were contributing factors

in his decision to plead guilty to the tax evasion charge and

that his medical condition was such that he could not withstand a

trial.

     Mr. Del Bosque’s plea agreement set forth the factual basis

upon which the agreement was reached.    The agreement stated that

(1) from January 1, 1987, through December 31, 1989, Mr. Del
                             - 10 -

Bosque worked with Mr. Jacobsen to hide income and evade taxes,

(2) in furtherance of his scheme with Mr. Jacobsen, Mr. Del

Bosque filed false tax returns for 1987, 1988, and 1989, (3) Mr.

Del Bosque omitted substantial income from those returns with the

intent to evade taxes, (4) the Government contended that Mr. Del

Bosque understated his income for 1987 through 1989 by $116,499,

and (5) Mr. Del Bosque accepted the Government’s calculation of

the omitted income.

     For purposes of the sentencing guidelines, Mr. Del Bosque

stipulated that (1) he understated his taxable income in 1987,

1988, and 1989 by $116,499, (2) the corresponding tax loss

(calculated at 28 percent) was approximately $32,734, and (3) he

“employed the same course of conduct and a common plan with

respect to the evasion of taxes in tax years 1987, 1988, and

1989, with the relevant conduct * * * consisting of the total tax

loss for all three years even though the offense of conviction is

for tax year 1987.”

     Mr. Jacobsen’s plea agreement set forth the factual basis

upon which that agreement was reached.   The agreement stated that

(1) from January 1, 1987, through December 31, 1988, Mr. Jacobsen

worked with Mr. Del Bosque to hide income and evade taxes, (2) in

furtherance of his scheme with Mr. Del Bosque, Mr. Jacobsen filed

false tax returns for 1987 and 1988, (3) Mr. Jacobsen omitted

substantial income from his 1987 and 1988 returns with the intent
                             - 11 -

to evade taxes, (4) the Government contended that Mr. Jacobsen

understated his income for 1987 and 1988 by $58,125, and (5) Mr.

Jacobsen accepted the Government’s calculation of the omitted

income.

     For purposes of the sentencing guidelines, Mr. Jacobsen

stipulated that (1) he understated his taxable income in 1987 and

1988 by $58,125, (2) the corresponding tax loss (calculated at 28

percent) was approximately $16,275, and (3) he “employed the same

course of conduct and a common plan with respect to the evasion

of taxes in tax years 1987 and 1988, with the relevant conduct *

* * consisting of the total tax loss in both years even though

the offense of conviction is for tax year 1987.”

     In their plea agreements, petitioners acknowledged that the

IRS was not a party to the agreements and that when determining

their civil tax liabilities, the IRS was not bound by the stated

amounts of omitted income in the criminal tax proceeding.

     On December 17, 1993, petitioners were convicted of tax

evasion under section 7201 for 1987.   They each were sentenced to

6 months’ imprisonment, 2 years’ supervised release, and a $50

special assessment for the Crime Victims’ Fund.    As a condition

of the supervised release, petitioners were required to cooperate

with the IRS with regard to civil tax penalties.

     Also on December 17, 1993, Mr. Del Bosque was convicted of

conspiring to import a substance containing anabolic steroids.
                                     - 12 -

He was sentenced to 3 months’ imprisonment to be served

concurrently with his sentence for tax evasion, 2 years’

supervised release, and a $50 special assessment for the Crime

Victims’ Fund.

     On December 12, 2000, respondent issued a notice of

deficiency to Mr. Del Bosque and Ms. Ferguson for 1987 and 1988

and another notice of deficiency to Mr. Del Bosque for 1989.                In

those notices of deficiency, respondent determined that Mr. Del

Bosque received, but failed to report, gross receipts of $67,163

in 1987, $16,557 in 1988, and $32,779 in 1989, computed as

follows:

                                       1986       1987       1988        1989
Net worth computation:
 Assets                               $143,230   $208,392   $235,941   $292,189
 Liabilities                            71,995    125,564    139,430    142,708
 Net worth                              71,235     82,828     96,511    149,481
 Less prior year’s net worth                       71,235     82,828     96,511
 Increase in net worth                             11,593     13,683     52,970
Adjustments:
 Additions:
  Nondeductible expenses                          75,826     86,751     77,356
  Itemized deductions expenditures                12,840     22,007     23,254
 Subtractions:
  Nonincome items                                 (2,546)   (67,090)   (63,912)
Adjusted gross income                             97,713     55,351     89,668
Itemized deductions                              (12,118)   (15,627)   (16,545)
Personal exemptions                               (3,800)    (3,900)    (2,000)
Corrected taxable income                          81,795     35,824     71,123
Taxable income reported                          (14,632)   (19,267)   (38,344)
Gross receipts                                    67,163     16,557     32,779
                                     - 13 -

The gross receipts adjustments are the same as, and are directly

based upon, the net worth computations used in Mr. Del Bosque’s

criminal tax proceeding.

     On December 12, 2000, respondent issued a notice of

deficiency to Mr. and Mrs. Jacobsen for 1987 and 1988.              In that

notice of deficiency, respondent determined that Mr. Jacobsen

received, but failed to report, gross receipts of $28,378 in 1987

and $29,747 in 1988, computed as follows:

                                               1986       1987        1988
Net worth computation:
 Assets                                       $330,569   $356,098    $441,985
 Liabilities                                   144,741    152,332     159,418
 Net worth                                     185,828    203,766     282,567
 Less prior year’s net worth                              185,828     203,766
 Increase in net worth                                     17,938      78,801
Adjustments:
 Additions:
  Nondeductible expenses                                  46,965      45,866
  Itemized deductions expenditures                        15,295      18,967
 Subtractions:
  Nonincome items                                         (2,051)     (59,504)
Adjusted gross income                                     78,147       84,130
Itemized deductions                                      (13,130)     (14,857)
Personal exemptions                                       (3,800)      (3,900)
Corrected taxable income                                  61,217       65,373
Taxable income reported                                  (32,839)     (35,626)
Gross receipts                                            28,378       29,747

The gross receipts adjustments are the same as, and are directly

based upon, the net worth computations used in Mr. Jacobsen’s

criminal tax proceeding.

     Respondent also increased the Jacobsens’ income by $6,285 in

1987 and $6,309 in 1988 using Bureau of Labor Statistics figures.
                                - 14 -

These additional amounts were computed on the basis of 1991

Bureau of Labor Statistics figures, discounted by 10 percent for

1987 and by 7.5 percent for 1988.    The figures each year included

$266 for cigarettes and $1,640 for auto repairs.

     Mr. Jacobsen does not smoke cigarettes.   Mr. Jacobsen

purchased a new car each year in issue.   Since his cars were

always under warranty, Mr. Jacobsen incurred nominal expenses for

auto repairs.

                                OPINION

I.   Issues 1, 2, and 3--Unreported Income

     A. The Net Worth Method

     A taxpayer is required to maintain records sufficient to

enable the Commissioner to determine his tax liabilities.     Sec.

1.6001-1(a), Income Tax Regs.    When a taxpayer keeps no books, or

keeps books that are inadequate or demonstrably inaccurate,

section 446(b) authorizes the Commissioner to compute the

taxpayer’s income by any method that clearly reflects his income.

In such cases, the Commissioner may compute a taxpayer’s income

and income tax liability by a variety of indirect methods,

including the net worth method, as used by respondent in this

case.   Holland v. United States, 348 U.S. 121 (1954).

     If the Commissioner’s determination of tax liability is

calculated according to an acceptable procedure, such as the net

worth method, the taxpayer has the burden of producing evidence
                              - 15 -

to the contrary.   Helvering v. Taylor, 293 U.S. 507 (1935); Simon

v. Commissioner, 248 F.2d 869, 874 (8th Cir. 1957), affg. U.S.

Packing Co. v. Commissioner, T.C. Memo. 1955-194.   Generally, the

taxpayer will bear not only the burden of production, but also

the burden of proving by a preponderance of the evidence that the

Commissioner’s assessment is “arbitrary and excessive”.

Helvering v. Taylor, supra at 515; Boles Trucking, Inc. v. United

States, 77 F.3d 236 (8th Cir. 1996); Mattingly v. United States,

924 F.2d 785, 787 (8th Cir. 1991).

     Under the net worth method, taxable income is computed by

reference to the change in the taxpayer’s net worth8 during a

year, increased for nondeductible expenses such as living

expenses, and decreased for items attributable to nontaxable

sources such as gifts and loans.   The resulting figure may be

considered to represent taxable income, provided:   (1) The

Commissioner establishes the taxpayer’s opening net worth with

reasonable certainty, and (2) the Commissioner either shows a

likely source of unreported income or negates possible nontaxable

sources.   United States v. Massei, 355 U.S. 595, 595-596 (1958);

Holland v. United States, supra at 132-138; Brooks v.

Commissioner, 82 T.C. 413, 431-432 (1984), affd. without

published opinion 772 F.2d 910 (9th Cir. 1985).

     8
      Assets are generally listed at their cost rather than at
their current market value. Camien v. Commissioner, 420 F.2d
283, 284-285 (8th Cir. 1970), affg. T.C. Memo. 1968-12.
                               - 16 -

      In establishing a taxpayer’s net worth the Commissioner owes

a duty to the taxpayer of approaching the problem fairly and open

mindedly.    Holland v. United States, supra; Banks v.

Commissioner, 322 F.2d 530 (8th Cir. 1963), affg. in part and

remanding in part T.C. Memo. 1961-237; Gunn v. Commissioner, 247

F.2d 359 (8 Cir. 1957), affg. in part and revg. in part T.C.

Memo. 1956-24.   The use of the net worth method requires “the

exercise of great care and restraint” to prevent a taxpayer from

being “ensnared in a system” that is difficult for the taxpayer

to refute.    Holland v. United States, supra at 129.

      The taxpayer’s opening net worth is of critical importance

and must be established with reasonable certainty.      “The

importance of accuracy in this figure is immediately apparent, as

the correctness of the result depends entirely upon the inclusion

in this sum of all assets on hand at the outset.”       Id. at 132.

Once the Commissioner’s determination is established with

reasonable certainty, the taxpayer bears the burden of disproving

it.   Welch v. Helvering, 290 U.S. 111 (1933); Banks v.

Commissioner, supra; Schroeder v. Commissioner, 291 F.2d 649 (8th

Cir. 1961), affg. T.C. Memo. 1957-162.

      Petitioners assert that respondent’s computations of their

unreported income under respondent’s net worth method are

inaccurate because the computations fail to properly account for

certain specific items.   Respondent concedes some of the items
                               - 17 -

that petitioners were able to substantiate with substantial

evidence.   At the trial of these cases, petitioners and/or their

witnesses testified with regard to these items.    Respondent

offered no witness or evidence to contradict their testimony.

     The Court may not arbitrarily discredit or disregard

uncontradicted evidence that is competent, relevant, and

credible.   The Court, however, is not bound to accept improbable,

unreasonable, or questionable testimony at face value, even if it

is uncontroverted.    Banks v. Commissioner, supra at 537; Weiss v.

Commissioner, 221 F.2d 152, 156 (8th Cir. 1955), affg. T.C. Memo.

1954-51; Rand v. Helvering, 77 F.2d 450, 451 (8th Cir. 1935).

The emphasis is on credibility.

     In his criminal tax proceeding, Mr. Del Bosque expressly

admitted that he omitted substantial income from his 1987, 1988,

and 1989 returns with the intent to evade taxes.    For purposes of

the sentencing guidelines, Mr. Del Bosque stipulated that he

understated his taxable income in 1987, 1988, and 1989 by

$116,499 and that the corresponding tax loss was approximately

$32,734.    The Government’s computation of Mr. Del Bosque’s

understated income in the criminal tax proceeding was derived

from Agent Fisher’s computations using the net worth method.

     In his criminal tax proceeding, Mr. Jacobsen expressly

admitted that he omitted substantial income from his 1987 and

1988 returns with the intent to evade taxes.    For purposes of the
                               - 18 -

sentencing guidelines, Mr. Jacobsen stipulated that he

understated his taxable income in 1987 and 1988 by $58,125 and

that the corresponding tax loss was approximately $16,275.

        Petitioners’ stipulations in their criminal tax proceedings

do not collaterally estop them from challenging the specific

deficiency amount in this civil proceeding, because “the

determination of an exact liability was not essential to the

judgment, a prerequisite to the application of the doctrine of

collateral estoppel.”    Moore v. United States, 360 F.2d 353, 356

(4th Cir. 1965) (internal quotation marks omitted); see Wapnick

v. Commissioner, T.C. Memo. 1997-133; Larson v. Commissioner,

T.C. Memo. 1993-188.    Nonetheless, petitioners’ stipulations of

the amounts of understated income in their criminal tax

proceedings are strong evidence that Agent Fisher’s net worth

computations, and consequently respondent’s net worth

computations in the notices of deficiency derived directly

therefrom, are valid.    See Livingston v. Commissioner, T.C. Memo.

2000-121.    However, we find petitioners’ evidence in these civil

cases persuasive that some adjustments to income respondent

determined, in addition to those respondent conceded, must be

made.    We conclude that the net worth computations and

nondeductible expenditures used in determining the deficiencies

in tax for the years at issue should be adjusted as follows.
                                - 19 -

          1.      Net Worth Adjustments

                  a. Petitioners’ Snowmobiles

     On December 31, 1986, petitioners each owned two

snowmobiles--each owned a 1987 Polaris Indy 600 and a 1987

Polaris Indy Sport.    The 1987 Polaris Indy 600s were purchased

from Metro-North Sports on October 15, 1986, for the base price

of $4,688 each.    Further, two items identified as “north country”

were purchased at the same time for $469 each.    Although the

record does not disclose when the 1987 Polaris Indy Sports were

purchased, a receipt from Metro-North Sports shows that, on

October 29, 1986, petitioners purchased accessories and parts for

two “Indy 600s” and two “Sports”.    Mr. Jacobsen disposed of his

Sport in 1988.

     Mr. Del Bosque’s 1986 net worth statement includes only his

1987 Polaris Indy 600.    The Sport, valued at $2,250, is shown as

an asset on his 1987 and 1988 net worth statements.    In computing

Mr. Del Bosque’s taxable income under the net worth method, the

Sport should be included as an asset in the 1986 net worth

statement.

     Mr. Jacobsen’s 1986, 1987, and 1988 net worth statements

include as an asset a snowmobile valued at $4,688 (the price of

the Indy 600).    Although the snowmobile included in Mr.

Jacobsen’s net worth statement is not specifically identified,

the parties appear to agree that it is the Indy 600.    Mr.
                              - 20 -

Jacobsen asserts that his 1986 and 1987 net worth statements

should include $3,000 representing the value of the Sport.      He

has offered no evidence to substantiate the cost of the Sport.

Mr. Del Bosque’s Sport is valued at a cost of $2,500.    We

conclude that Mr. Jacobsen’s 1986 and 1987 net worth statements

should also include $2,500 for the Sport.   Since Mr. Jacobsen

disposed of the Sport in 1988, it was properly omitted from his

1988 net worth statement.

                b.   Mr. Del Bosque’s First Bank East Account

     Mr. Del Bosque asserts that his 1986 net worth should be

increased to reflect $12,000 in an account he had at First Bank

East.   Mr. Del Bosque’s financial statement dated September 5,

1986, reflects a savings account at First Bank East with a

balance of $12,000 at that time.   Although Agent Fisher used the

financial statement to identify assets included in the 1986 net

worth statement, the First Bank East account was not included as

an asset in Mr. Del Bosque’s 1986 net worth statement.    The

existence (but not the amount) of the account is evidenced by

Form 1099-INT for 1987 issued by First Bank East to “A J Del

Bosque itf Wilma Del Bosque” with Mr. Del Bosque’s Social

Security number shown as the taxpayer identification number.      The

Form 1099-INT reports that only $24.93 of interest was paid on

the account in 1987, supporting Mr. Del Bosque’s testimony that

he withdrew most of the money in that account early in 1987.      We
                                - 21 -

believe, and have found, that Mr. Del Bosque used those funds to

open a brokerage account in January 1987.     We conclude that, in

determining the deficiencies in tax, Mr. Del Bosque’s 1986 net

worth should include $12,000 in the First Bank East account.

                  c.   Mrs. Jacobsen’s Chase Manhattan Money Market
                       With Checks Account

     Mrs. Jacobsen had a Chase Manhattan “money market with

checks” account (the MMWC account).      On December 31, 1986, there

was a balance of $8,618 in that account.     The account balance was

not included as an asset in the Jacobsens’ 1986 net worth

statement.   Respondent concedes that $8,618 should be included on

that net worth statement.

                  d.   The Jacobsens’ Joint Chase Manhattan Bank
                       Money Market Account

     The Jacobsens had a joint money market account at Chase

Manhattan Bank.    This account was included as an asset valued at

$37,200 on the Jacobsens’ 1986 net worth statement.     The $37,200

Agent Fisher used as the account balance was based on the amount

($37,200) reflected on financial statements the Jacobsens

completed in 1986; Agent Fisher did not confirm the account

balance as of December 31, 1986, with Chase Manhattan Bank.     Mr.

Jacobsen contends that the account balance was at least $38,200

on December 31, 1986.    The statement of the account dated

February 11, 1987, reports that the account balance was $38,324

as of January 13, 1987.    The February statement shows that the
                                - 22 -

account was interest bearing.     The record does not show the

amount of interest paid to the account between January 1 and 13,

1986.     We conclude, however, that the balance in the account as

of December 31, 1986, was approximately $38,000.      Therefore, the

Jacobsens’ 1986 net worth should be increased by $800.

                  e.   Mrs. Jacobsen’s Loan to Her Employer

        In December 1986, Mrs. Jacobsen made a $2,000 loan to her

employer.     This loan was repaid in 1987.   The receivable from

Mrs. Jacobsen’s employer was not included as an asset on December

31, 1986.     Respondent concedes that the $2,000 receivable from

Mrs. Jacobsen’s employer should be included as an asset on the

Jacobsens’ 1986 net worth statement.

                  f.   Mrs. Jacobsen’s Inheritance

        In 1986, Mrs. Jacobsen received an inheritance of $12,518

plus a one-eighth interest in a contract for deed valued at

$1,966.     The inheritance was not reflected as an asset on the net

worth calculations as of December 31, 1986.      Mrs. Jacobsen

testified that she held the distribution check into 1987 because

she could not decide how to spend or invest the funds.      She

further testified that after she cashed the check in 1987 she

kept the cash and used it to pay expenses in 1987 and 1988.       Mr.

Jacobsen did not produce the canceled check or call the

administrator who issued the check on behalf of the estate to

confirm when the check was cashed.       Furthermore, the inheritance
                                - 23 -

is not reflected on the financial statements the Jacobsens

completed in 1986.     We conclude that the Jacobsens’ 1986 net

worth should not include Mrs. Jacobsen’s inheritance.

                  g.   Mr. Del Bosque’s Shares of Fidelity Growth
                       Fund

     On January 16, 1987, Mr. Del Bosque purchased 234 shares of

Fidelity Growth Fund for $3,320.     On April 22, 1987, he sold

those shares for $3,756 and purchased 1 share for $16.     On

January 22, 1988, he sold the remaining share for $13.     The

original 234 shares with a value of $3,320 (rather than the 1

share with a value of $16) were shown as an asset in Mr. Del

Bosque’s 1987 net worth calculation.

     Respondent agrees that Mr. Del Bosque’s 1987 net worth

should include only 1 share of Fidelity Growth Fund with a value

of $16.   Therefore, the assets included in the 1987 net worth

statement should be reduced by $3,304 ($3,320 - $16).

                  h.   Mr. Del Bosque’s Debt to Larson Quinn Motor
                       Co.

      At the end of 1987, Mr. Del Bosque owed $3,921 to Larson

Quinn Motor Co.    The loan was repaid in 1988.   The loan was not

included as a liability in the 1987 net worth computation but was

included as a liability in the 1988 net worth computation.

Respondent concedes that the $3,921 debt should be shown as a

liability on the 1987 net worth statement and excluded from the

1988 net worth statement.
                                - 24 -

            2.    Nondeductible Personal Expenses

                  a.   Petitioners’ Leather Goods Purchases

     In 1987 and 1988, Mr. Jacobsen purchased $3,770 of leather

goods for resale each year.    Mr. Del Bosque purchased $13,298 of

leather goods for resale in 1987, $3,862 for resale in 1988, and

$2,375 for resale in 1989.    Respondent treated amounts paid by

petitioners to North Beach Leathers as nondeductible personal

expenses.    These were not personal expenditures but rather

expenditures for leather goods purchased and resold.     Although

petitioners did not maintain any records of their purchases, a

few receipts were obtained from North Beach Leathers.     The

receipts show that within a month petitioners purchased numerous

jackets in various sizes; the number of jackets purchased

supports petitioners’ assertions that the jackets were not for

personal use but rather for resale.      Petitioners’ leather goods

sales activities are further confirmed by the testimony of two

individuals to whom petitioners sold leather goods during the

years at issue.

     On the basis of our observation of petitioners’ witnesses at

trial, including our observation of their demeanor, we found

petitioners’ witnesses to be credible and earnest.     Their

testimony was direct, plausible, and uncontroverted.     It was not

evasive, conclusory, or inconsistent.     We are satisfied that

their testimony was honest.
                              - 25 -

     We concluded that, in computing petitioners’ taxable income

each year, the cost of the leather goods purchased each year

should be deducted from petitioners’ gross receipts as cost of

goods sold.

                b.   Mr. Jacobsen’s Clothing Purchases

     Mr. Jacobsen claims that he often paid for clothing for the

limousine drivers.   Specifically, he claims that he paid $349 in

1987 to Jerry Leonard, a big and tall men’s store, $349 in 1987

and $771 in 1988 to Daytons department store, and $1,950 in 1988

to Merles department store.   Respondent treated these items as

Mr. Jacobsen’s personal expenses in computing his income.

     Mr. Jacobsen did not call any of the limousine drivers to

confirm that he made such purchases.   He offered no sales

receipts or other documentary evidence.   We conclude that the

items were properly treated as nondeductible personal expenses.

                c.   Mr. Jacobsen’s Purchase of a Mobile Telephone
                     System

     In 1987, Top Play purchased a mobile telephone system for

$1,797.   Payment for the system was charged to Mr. Jacobsen’s

credit card.   Top Play paid the credit card company $1,300 in

1987 and $763 in 1988 for the purchase of the mobile telephone

system.   Agent Fisher treated this purchase as a nondeductible

personal expenditure.   Respondent concedes that the item is not a

nondeductible personal expense.
                                - 26 -

     B.     Bureau of Labor Statistics Figures

     Using the Bureau of Labor Statistics figures, respondent

increased Mr. Jacobsen’s income by $6,285 in 1987 and $6,309 in

1988.     The figures each year included $266 for cigarettes.   Mr.

Jacobsen does not smoke, and respondent concedes that the

increase based on the Bureau of Labor Statistics figures should

not include the amounts for cigarettes.

     The figures also included $1,640 each year for auto repairs.

Mr. Jacobsen purchased a new car every year.     Since his cars were

always under warranty, Mr. Jacobsen incurred only nominal auto

repair expenses.     Although, as respondent points out, some

repairs may not be covered by a warranty, we do not believe that

it was appropriate to include $1,640 for auto repairs for a new

car on the basis of the Bureau of Labor Statistics figures.     We

conclude that the increase based on the Bureau of Labor

Statistics figures should not include amounts for auto repair

expenses.

     C.      Computations of Unreported Income

             1.   Mr. Del Bosque’s Unreported Income

     In accordance with the above discussion, Mr. Del Bosque’s

unreported gross receipts for 1987, 1988, and 1989 are as

follows:
                                     - 27 -

                                       1986       1987        1988        1989
Net worth computation:
 Assets
  Agent Fisher’s computations         $143,230   $208,392  $235,941     $292,189
  Snowmobile                             2,250       -–        -–           -–
  First Bank East                       12,000       --        --           --
  Fidelity Growth Fund                    –-       (3,304)     –-           –-
   Total assets                        157,480    205,088   235,941      292,189
 Liabilities                            71,995    125,564   139,430      142,708
  Larson Quinn Motor Co.                  --        3,921    (3,921)         –-
   Total liabilities                   71,995    129,485     135,509    142,708
 Net worth                              85,485    75,603     100,432    149,481
 Less prior year’s net worth                      85,485      75,603    100,432
 Increase in net worth                            (9,882)     24,829     49,049
Adjustments:
 Additions:
  Nondeductible expenses
   Agent Fisher’s computations                    75,826      86,751     77,356
   Cost of leather goods                         (13,298)     (3,862)    (2,375)
  Itemized deductions expenditures                12,840      22,007     23,254
 Subtractions:
  Nonincome items                                 (2,546)    (67,090)   (63,912)
Adjusted gross income                             62,940      62,635     83,372
Itemized deductions                              (12,118)    (15,627)   (16,545)
Personal exemptions                               (3,800)     (3,900)    (2,000)
Corrected taxable income                          47,022      43,108     64,827
Taxable income reported                          (14,632)    (19,267)   (38,344)
Unreported gross receipts                         32,390      23,841     26,483

     On April 22, 1987, Mr. Del Bosque purchased 1 share of

Fidelity Growth Fund for $16.         On January 22, 1988, he sold the

share for $13.    On his 1988 return, he erroneously reported a

basis of $3,320 in the 1 share and a $3,307 long-term capital

loss on the sale of the share in that year.              Mr. Del Bosque’s
                                   - 28 -

1988 long-term capital loss on the sale of that share should be

reduced to $3.

           2.     Mr. Jacobsen’s Unreported Income

     Mr. Jacobsen’s unreported gross receipts for 1987 and 1988

are as follows:

                                             1986       1987       1988
Net worth computation:
 Assets
  Agent Fisher’s computations               $330,569   $356,098   $441,985
  Snowmobile                                   2,500      2,500       --
  MMWC account                                 8,618       --         --
  Joint money market account                     800       --         --
  Loan receivable                              2,000        –          –
    Total assets                             344,487    358,598    441,985
 Liabilities                                 144,741    152,332    159,418
 Net worth                                   199,746    206,266    282,567
 Less prior year’s net worth                            199,746    206,266
 Increase (decrease) in net worth                         6,520     76,301
 Additions:
  Nondeductible expenses
   Agent Fisher’s computations                          46,965     45,866
   Cost of leather goods                                (3,770)    (3,770)
   Mobile phone                                         (1,300)      (763)
  Itemized deductions expenditures                      15,295     18,967
 Subtractions:
  Nonincome items                                       (2,051)   (59,504)
 Adjusted gross income                                  61,659     77,097
 Itemized deductions                                   (13,130)   (14,857)
 Personal exemptions                                    (3,800)    (3,900)
 Corrected taxable income                               44,729     58,340
 Taxable income reported                               (32,839)   (35,626)
 Gross receipts                                         11,890     22,714
Bureau of Labor statistics adjustment:
 Agent Fisher’s computations                             6,285      6,309
 Cigarettes                                               (266)      (266)
 Car repairs                                            (1,640)    (1,640)
  Correct adjustment                                     4,379      4,403
    Total unreported gross receipts                     16,269     27,117
                                - 29 -

     Citing Livingston v. Commissioner, T.C. Memo. 2000-121,

petitioners contend that, as a result of the errors in

respondent’s computations, the computations are so unreliable as

to negate any presumption of correctness.    Petitioners assert

that the facts in Livingston are “strikingly similar” to the

facts in these cases.     We disagree.

        In Livingston, we first found the 1989 opening net worth of

zero suspect given that the taxpayer was self-employed in that

year.     Further, the Commissioner’s 1989 net worth computation did

not account for the wife’s income, which was available to fund

the taxpayers’ joint expenditures; the computation effectively

treated all asset purchases and other joint expenditures as being

financed solely by the husband’s unreported income.    As a result

of those errors, we held that the Commissioner’s 1989 net worth

computation was so unreliable as to negate any presumption of

correctness.

     The types of errors in the Commissioner’s 1989 net worth

computation in Livingston are not present in the case at hand.

Respondent’s net worth computations of unreported income reflect

the combined incomes of petitioners and their wives.    The opening

and closing net worths include joint and separate property, and

respondent’s computations of unreported income take into account

the wives’ separate income.
                                - 30 -

      Respondent’s net worth computations of petitioners’

unreported income were not made on the basis of a “strong

underlying element of guesswork”.    Polizzi v. Commissioner, 265

F.2d 498, 502 (6th Cir. 1959), affg. in part and revg. in part

T.C. Memo. 1957-159.   The errors in respondent’s net worth

computations of unreported income are more akin to the errors in

the Commissioner’s net worth computation of the husband’s 1990

understatement in Livingston.    In Livingston, we reduced the

Commissioner’s computation of the husband’s 1990 understatement

by $65,000 attributable to a business owned by the husband’s

mother and by the $7,523 in settlement proceeds that the

taxpayers received as a result of an automobile accident.     Those

errors, like the errors in this case, did not render the 1990 net

worth computation so unreliable as to negate any presumption of

correctness.

      We have considered all of petitioners’ arguments, and to the

extent not specifically addressed, we find them unpersuasive.

II.   Issues 4 and 5--Fraud Penalties and/or Additions to Tax

      Respondent determined that petitioners are liable for the

additions to tax for fraud under section 6653(b) for 1988 and

that Mr. Del Bosque is liable for the fraud penalty under section

6663 for 1989.9


      9
      Petitioners concede that their convictions of criminal tax
evasion for 1987 under sec. 7201 collaterally estop them from
                                                   (continued...)
                              - 31 -

     A taxpayer is liable for an addition to tax or penalty for

fraud equal to 75 percent of the part of the underpayment that is

due to fraud.   Secs. 6653(b), 6663(a).   If the Commissioner shows

that any part of an underpayment is due to fraud, the entire

underpayment is treated as due to fraud unless the taxpayer

proves that part of the underpayment is not due to fraud.   Secs.

6653(b)(2), 6663(b).

     Respondent bears the burden of proving the applicability of

the civil fraud additions to tax and penalty by clear and

convincing evidence.   Sec. 7454(a); Rule 142(b).   To sustain this

burden, respondent must establish by this level of proof both (1)

that there was an underpayment of tax for the taxable year in

issue and (2) that at least some portion of the underpayment was

due to fraud.   DiLeo v. Commissioner, 96 T.C. 858, 873 (1991),

affd. 959 F.2d 16 (2d Cir. 1992); Parks v. Commissioner, 94 T.C.

654, 660-661 (1990); Petzoldt v. Commissioner, 92 T.C. 661, 699

(1989).




     9
      (...continued)
denying that their underpayments of income tax for 1987 were due
to fraud for purposes of sec. 6653(b). See Johnson v. Sawyer, 47
F.3d 716, 722 (5th Cir. 1995); Gray v. Commissioner, 708 F.2d 243
(6th Cir. 1983), affg. T.C. Memo. 1981-1; Brooks v. Commissioner,
82 T.C. 413, 431 (1984), affd. without published opinion 772 F.2d
910 (9th Cir. 1985); Arctic Ice Cream Co. v. Commissioner, 43
T.C. 68 (1964); Amos v. Commissioner, 43 T.C. 50 (1964), affd.
360 F.2d 358 (4th Cir. 1965).
                                  - 32 -

     A.     Underpayment of Tax

     An underpayment will exist where unreported gross receipts

are not exceeded by costs of goods sold and deductible expenses.

In establishing the requisite underpayment, the Commissioner may

not simply rely on the taxpayer’s failure to prove error in the

deficiency determination.     DiLeo v. Commissioner, supra at 873;

Parks v. Commissioner, supra at 660-661; Otsuki v. Commissioner,

53 T.C. 96, 106 (1969).    However, upon clear proof of unreported

receipts, the burden of coming forward with offsetting costs or

expenses shifts to the taxpayer.      Siravo v. United States, 377

F.2d 469, 473-474 (1st Cir. 1967); Elwert v. United States, 231

F.2d 928, 933 (9th Cir. 1956); United States v. Bender, 218 F.2d

869, 871-872 (7th Cir. 1955); United States v. Stayback, 212 F.2d

313, 317 (3d Cir. 1954).

     Here, respondent used the net worth method of proving

income, which the Supreme Court has approved as a reasonable and

logical means of reconstructing unreported income in a fraud

case.     Holland v. United States, 348 U.S. at 125; United States

v. Johnson, 319 U.S. 503, 517 (1943).

     The Commissioner may prove that the taxpayer underpaid tax

by proving that the taxpayer had a likely source of the

unreported income, Holland v. United States, supra; Parks v.

Commissioner, supra; Nicholas v. Commissioner, 70 T.C. 1057

(1978), or, where the taxpayer alleges a nontaxable source, by
                               - 33 -

disproving the alleged nontaxable source, United States v.

Massei, 355 U.S. 595 (1958); Kramer v. Commissioner, 389 F.2d

236, 239 (7th Cir. 1968), affg. T.C. Memo. 1966-234; Parks v.

Commissioner, supra.   Petitioners do not allege that they had

nontaxable sources of income during the years at issue.   Their

known sources of income were the limousine service and sales of

leather goods.10   Petitioners have not offered any proof of

offsetting costs or expenses except those which we have allowed.

Respondent has shown by clear and convincing evidence that Mr.

Del Bosque underreported his income by $23,841 in 1988 (without

regard to the overstated long-term capital loss from the sale of

the 1 share of Fidelity Growth Fund) and $26,483 in 1989.

Respondent also has shown by clear and convincing evidence that

Mr. Jacobsen underreported his income by $27,649 in 1988.      Thus,

respondent has carried the burden of establishing underpayments

of tax attributable to that omitted income each year by clear and

convincing evidence.

     B.   Fraudulent Intent

     Respondent must prove by clear and convincing evidence that

petitioners had a fraudulent intent.    Parks v. Commissioner,

supra at 664.   This burden is met if it is shown that petitioners



     10
      Petitioners asserted in their criminal tax proceedings and
at the trial in these cases that the omitted income was from
gambling. None of the parties has offered any further
description or explanation of petitioners’ gambling activities.
                              - 34 -

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

conceal, mislead, or otherwise prevent the collection of such

taxes.   Webb v. Commissioner, 394 F.2d 366, 377 (5th Cir. 1968),

affg. T.C. Memo. 1966-81.   Respondent must prove fraud in each of

the years involved.   Drieborg v. Commissioner, 225 F.2d 216, 220

(6th Cir. 1955), affg. in part and revg. in part on other grounds

a Memorandum Opinion of this Court dated Feb. 24, 1954.   Fraud is

never presumed; it must be established by affirmative evidence.

Beaver v. Commissioner, 55 T.C. 85, 92 (1970).   Since direct

evidence of fraud rarely is available, respondent may prove each

petitioner’s fraud by circumstantial evidence.   Scallen v.

Commissioner, 877 F.2d 1364, 1370 (8th Cir. 1989), affg. T.C.

Memo. 1987-412; Klassie v. United States, 289 F.2d 96, 101 (8th

Cir. 1961).

     Courts have identified numerous factors, sometimes referred

to as indicia or badges of fraud, which may be persuasive

circumstantial evidence of fraud.   See, e.g., Niedringhaus v.

Commissioner, 99 T.C. 202, 211 (1992); Petzoldt v. Commissioner,

supra at 700.   We focus on those indicia that appear to be most

significant in the context of the record in the instant cases.

Although no single factor is necessarily sufficient to establish

fraud, a combination of several factors is persuasive

circumstantial evidence of fraud.   Bradford v. Commissioner, 796
                              - 35 -

F.2d 303, 307 (9th Cir. 1986), affg. T.C. Memo. 1984-601;

Petzoldt v. Commissioner, 92 T.C. at 700.

     The following badges of fraud are present in this case: (1)

Substantially understating income over a period of years,(2)

maintaining inadequate records; (3) dealing in cash; (4)

providing incomplete or misleading information to petitioners’

tax preparer, (5) filing false returns, (6) engaging in a pattern

of behavior which indicates an intent to mislead, (7) dishonesty

in a business transaction.   Spies v. United States, 317 U.S. 492,

499 (1943); Conti v. Commissioner, 39 F.3d 658, 662 (6th Cir.

1994), affg. and remanding on other grounds T.C. Memo. 1992-616;

Scallen v. Commissioner, supra; Bradford v. Commissioner, supra

at 307-308; Korecky v. Commissioner, 781 F.2d 1566, 1569 (11th

Cir. 1986), affg. T.C. Memo. 1985-63; Ruark v. Commissioner, 449

F.2d 311, 312-313 (9th Cir. 1971), affg. T.C. Memo. 1969-48;

Recklitis v. Commissioner, 91 T.C. 874, 910 (1988); Wright v.

Commissioner, 84 T.C. 636, 643-644 (1985); Farber v.

Commissioner, 43 T.C. 407, 420 (1965), modified 44 T.C. 408

(1965); Middleton v. Commissioner, T.C. Memo. 2002-164.

           1.   Failure To Report Substantial Amounts of Income

     “Although mere understatement of income alone is not

sufficient to prove fraud, the consistent and substantial

understatement of income is, by itself, strong evidence of

fraud.”   Truesdell v. Commissioner, 89 T.C. 1280, 1302 (1987);
                             - 36 -

see also Marcus v. Commissioner, 70 T.C. 562, 577 (1978), affd.

without published opinion 621 F.2d 439 (5th Cir. 1980).

     Mr. Del Bosque failed to report a large portion of his

income for 1987, 1988, and 1989, and Mr. Jacobsen failed to

report a large portion of his income for 1987 and 1988.

Petitioners assert that the income was gambling winnings.

Petitioners provided no explanation for underreporting that

income regardless of the source.   A consistent pattern of

underreporting large amounts of income over a period of years is

substantial evidence bearing upon an intent to defraud,

particularly where the reason for such understatement is not

satisfactorily explained or shown to be due to innocent mistake.

Holland v. United States, 348 U.S. at 137; Webb v. Commissioner,

supra at 379; Lusk v. Commissioner, 250 F.2d 591, 594 (7th Cir.

1957), affg. T.C. Memo. 1955-119; Schwarzkopf v. Commissioner,

246 F.2d 731, 734 (3d Cir. 1957), affg. and remanding T.C. Memo.

1956-155; Kurnick v. Commissioner, 232 F.2d 678, 681 (6th Cir.

1956), affg. T.C. Memo. 1955-31.

          2.   Failure To Keep Adequate Books and Records

     Taxpayers are required to maintain books and records

sufficient to show their tax liabilities.   See sec. 6001.

Failure to do so is another indicium of fraudulent intent.

Bradford v. Commissioner, supra at 307.
                                - 37 -

     Petitioners did not maintain adequate books and records

regarding the operation of the limousine service, their sales of

leather goods, or their gambling winnings.     Because petitioners’

records for the years in issue are insufficient to show the gross

receipts from the limousine service, sales of leather goods, or

gambling winnings, the records are insufficient to accurately

compute petitioners’ tax liabilities for the years in issue.

Their failure to maintain adequate books and records is

indicative of fraud.    See Truesdell v. Commissioner, supra at

1302.

           3.   Dealing in Cash

        Petitioners often failed to keep records of cash income

from limousine runs and cash payments made to limousine drivers.

Dealings in cash may indicate fraud and heighten the negative

effect of inadequate record keeping.     Friedman v. Commissioner,

421 F.2d 658 (7th Cir. 1970), affg. per curiam a Memorandum

Opinion of this Court; Nicholas v. Commissioner, 70 T.C. at 1066.

           4.   Providing Incomplete or Misleading Information to
                Tax Preparer

     Petitioners did not inform their return preparer of their

cash items, their income from the sale of leather goods, or their

gambling winnings.     These facts also evidence fraud.   See Estate

of Mazzoni v. Commissioner, 451 F.2d 197, 202 (3d Cir. 1971),

affg. T.C. Memo. 1970-37.
                              - 38 -

           5.   Filing False Returns

     Filing a false income tax return may be evidence that the

taxpayer fraudulently intended to evade taxes.     Bradford v.

Commissioner, 796 F.2d at 308; Wright v. Commissioner, supra at

643-644.   In the plea agreements in their criminal tax

proceedings, petitioners admitted that they filed false tax

returns for 1987, 1988, and/or 1989 and omitted substantial

income from those returns with the intent to evade taxes.    They

failed to submit credible evidence to contradict those admissions

or show that they filed the false returns for any reason other

than to evade taxes they knew to be owing.   Petitioners’ filing

of false tax returns each year is a strong indication of

fraudulent intent with respect to those years.   See Klassie v.

United States, 289 F.2d at 102.

           6.   Pattern of Behavior Which Indicates Intent to
                Mislead

     A taxpayer’s course of conduct or a pattern of conduct may

establish, by inference, an intent to conceal or mislead.        Spies

v. United States, supra at 499; Webb v. Commissioner, 394 F.2d at

379; Otsuki v. Commissioner, 53 T.C. at 105-106.

     Mr. Del Bosque admitted in his plea agreement in his

criminal tax proceeding that he schemed with Mr. Jacobsen to hide

income and evade taxes, filed false tax returns for 1987, 1988,

and 1989 in furtherance of that scheme, and omitted substantial
                              - 39 -

income from those returns with the intent to evade taxes.    Mr.

Jacobsen admitted in his plea agreement in his criminal tax

proceeding that he schemed with Mr. Del Bosque to hide income and

evade taxes, filed false tax returns for 1987 and 1988 in

furtherance of that scheme, and omitted substantial income from

those returns with the intent to evade taxes.

     For purposes of the sentencing guidelines, Mr. Del Bosque

stipulated that he “employed the same course of conduct and a

common plan with respect to the evasion of taxes in tax years

1987, 1988, and 1989”, and Mr. Jacobsen stipulated that he

“employed the same course of conduct and a common plan with

respect to the evasion of taxes in tax years 1987 and 1988”.

They reiterated the substance of those admissions in testimony

supporting their guilty pleas.

     Mr. Del Bosques’s admissions are strong evidence that he

intended to evade taxes he knew to be owing in 1988 and 1989.

Mr. Jacobsen’s admissions are strong evidence that he intended to

evade taxes he knew to be owing in 1988.

          7.   Dishonesty in Business Transactions

     A taxpayer’s dishonesty in business transactions or

willingness to defraud others may indicate a willingness to

defraud the Commissioner.   Solomon v. Commissioner, 732 F.2d

1459, 1462 (6th Cir. 1984), affg. per curiam T.C. Memo. 1982-603;

McGee v. Commissioner, 61 T.C. 249, 260 (1973), affd. 519 F.2d
                              - 40 -

1121 (5th Cir. 1975); Johnson v. Commissioner, T.C. Memo.

1999-48; House v. Commissioner, T.C. Memo. 1995-92.    Petitioners

misrepresented the profitability of the limousine service to Ms.

Pavlak.   She sued petitioners for fraud and misrepresentation

relating to her purchase of Top Play and received a judgment in

the amount of $95,000.   Petitioners’ dishonesty in their business

transaction with Ms. Pavlak is evidence of petitioners’

willingness to defraud respondent.

     C.    Conclusion as to Fraud

     We find that the circumstances of this case, taken as a

whole, clearly and convincingly establish that petitioners acted

with the requisite fraudulent intent, and that their

underpayments of tax for 1988 and Mr. Del Bosque’s underpayment

of tax for 1989 are due to fraud.    Accordingly, we sustain

respondent’s determination that petitioners are liable for the

additions to tax for fraud under section 6653(b) for 1988 and

that Mr. Del Bosque is liable for the fraud penalty under section

6663 for 1989.

III. Issue 6–Period of Limitations on Assessment and Collection

     Section 6501(a) generally imposes a 3-year period of

limitations on assessment and collection of tax.    There is an

exception to this 3-year period in the case of a “false or

fraudulent return with the intent to evade tax”.    Sec.

6501(c)(1); Lowy v. Commissioner, 288 F.2d 517, 520 (2d Cir.
                              - 41 -

1961), affg. T.C. Memo. 1960-32; Colestock v. Commissioner, 102

T.C. 380, 385 (1994).   The determination of fraud for purposes of

the period of limitations on assessment under section 6501(c)(1)

is the same as the determination of fraud for purposes of the

addition to tax and penalty under sections 6653 and 6663.    Neely

v. Commissioner, 116 T.C. 79, 85 (2001); Rhone-Poulenc

Surfactants & Specialties v. Commissioner, 114 T.C. 533, 548

(2000).   Thus, because we conclude that petitioners filed

fraudulent returns for each of these years, the period for

assessment remains open.

     To reflect the above,

                                         Decisions will be entered

                                    under Rule 155.
