                           T.C. Memo. 1999-171



                         UNITED STATES TAX COURT



                   STEVEN H. TOUSHIN, Petitioner v.
             COMMISSIONER OF INTERNAL REVENUE, Respondent



       Docket No. 21724-92.                            Filed May 20, 1999.



       Angelo Ruggiero and Michael R. Esposito, for petitioner.

       Luanne S. DiMauro and Donna C. Hansberry, for respondent.


               MEMORANDUM FINDINGS OF FACT AND OPINION

       VASQUEZ, Judge:    Respondent determined the following

deficiencies in and additions to petitioner's Federal income

taxes:

                                       Additions to Tax
Year     Deficiency   Sec. 6653(b)      Sec. 6653(b)(2)        Sec. 6661
1980      $25,265       $16,983                $0                 $0
1981       34,220        25,018                 0                  0
                                                   1
1982       21,196        10,598                                  5,299
1
    50 percent of the statutory interest on $21,196.
                                - 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.

     The issues for decision are:   (1) Whether petitioner had

unreported income in 1980, 1981, and 1982; (2) whether petitioner

is liable for the additions to tax for fraud for 1980, 1981, and

1982; (3) whether petitioner is liable for an addition to tax for

a substantial understatement for 1982; and (4) whether respondent

is barred by the statute of limitations from assessing the

deficiencies and additions to tax for 1980, 1981, and 1982.

                         FINDINGS OF FACT

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

The stipulation of facts, the supplemental stipulation of facts,

and the attached exhibits are incorporated herein by this

reference.   At the time the petition was filed, petitioner

resided in Chicago, Illinois.

Petitioner's Business Interests Prior to May 1978

     During the early 1970's, petitioner was a partner in the

Festival Theater Partnership (Festival Partnership), which owned

a three-story building located at 1349 N. Wells Street in

Chicago, Illinois.   During that time, petitioner was also a

shareholder in the Festival Theater Corp. (Festival Corp.), which

owned and operated the Bijou Theater (the Bijou), a movie theater
                               - 3 -


located in the first story of the building located at 1349 N.

Wells Street.

     As a result of a dispute among the partners, the assets of

the Festival Partnership were placed into receivership in 1976.

The assets of the Festival Corp. were eventually added to the

receivership.   On March 24, 1978, the receiver turned over the

Bijou and the building in which it was operated to petitioner.

Petitioner's Poor Financial Condition During Receivership

     During the receivership years (1976-1978), petitioner had

serious financial problems.   Petitioner borrowed from numerous

relatives, was frequently overdrawn on his personal checking

account, made minimum payments on his credit card balances, and

took a job performing menial tasks at his in-law's business.

Petitioner's Business Interests as of May 1978

     From May 1978 through December 1982, Entertainment &

Amusement, Inc., a corporation incorporated in the State of

Illinois (E&A of IL), operated the Bijou.   Petitioner was the

president of E&A of IL at all times and was the sole shareholder

of E&A of IL until 1981.   In 1982, petitioner was at least a 50-

percent shareholder of E&A of IL.

     On October 1, 1981, Entertainment and Amusement, Inc., was

incorporated in the State of California (E&A of CA).   Petitioner

was the sole shareholder and president of E&A of CA.   E&A of CA
                                - 4 -


operated the Screening Room, a movie theater located in San

Francisco, California, similar to the Bijou.

Cash Receipts at the Bijou and the Screening Room

     The Bijou and the Screening Room were predominantly cash

businesses.    At both the Bijou and the Screening Room, there were

established procedures for dealing with the daily cash receipts.

     At the Bijou, employees collected admission fees from

patrons, issued numbered tickets, and allowed patrons to pass

through a turnstile equipped with a counting device.    The

employees would reconcile the tickets and turnstile numbers on an

hourly basis to ensure the correct amount of money had been

collected.    After collecting $100 in admission fees, the Bijou

employees would put the $100 in an envelope (drop envelope), mark

the envelope sequentially, and drop it in a safe.    Similar drops

were made for cash receipts from video and other sales.

     The Bijou employees recorded their daily receipts from

ticket, video, and other sales on daily sheets (sometimes called

shift or drop sheets).    Daily sheets contained the date, the

shift, the admission tickets and turnstile numbers (for admission

fees receipts), and each $100 drop into the safe.

     Petitioner was the sole person with access to the Bijou's

drop safe.    On a daily basis, petitioner removed the drop

envelopes and the daily sheets from the safe and placed them into

a duffle (shoulder) bag.
                                 - 5 -


     After filling the duffle bag, petitioner left to reconcile

the drop envelopes and the daily sheets.      After reconciling these

amounts, petitioner destroyed these documents.

     From the daily sheets and the drop envelopes, petitioner

created "daily report sheets" and made ledger entries summarizing

the Bijou's monthly cash receipts.       Petitioner's accountant used

the ledger to prepare the Bijou's income tax return.      Petitioner

did not include all of the Bijou's cash receipts in the daily

report sheets or ledger.

     Petitioner generally made the daily deposit for the Bijou.

Petitioner did not deposit all of the Bijou's cash receipts into

the corporate bank account.    At times, petitioner deposited only

one-half of the day's receipts.

     On a few occasions when petitioner was on vacation, Walter

Killeen, the unofficial manager of the Bijou from 1979 until

1981, collected the drop envelopes and deposited the Bijou's

receipts.    Petitioner instructed Killeen to use deposit slips

previously prepared by petitioner and to deposit only up to the

amount already listed on the deposit slip for any particular

date.    Petitioner instructed Killeen to put the rest of the

receipts aside for petitioner.

     The Screening Room operated in a similar fashion to the

Bijou.    Petitioner was not present on a daily basis at the

Screening Room, so Killeen, who became the Screening Room's
                                 - 6 -


manager upon its opening in 1981, collected the daily drop

envelopes and daily sheets.    Killeen deposited all of the

Screening Room's daily receipts.    Killeen kept some records

pertaining to the Screening Room despite petitioner's

instructions not to keep records and to destroy any previously

created records.

Internal Revenue Service's (IRS) Criminal Investigation
of Petitioner

     During 1982, the IRS began a criminal investigation of

petitioner.   Petitioner instructed Killeen to avoid the IRS.

     Petitioner coached Killeen on how to answer questions from

the IRS.   Additionally, when Killeen became nervous about the

IRS's investigation, petitioner sent Killeen on vacation to Long

Beach, California, for about 2 months.

Petitioner's Cash Dealings

     Petitioner dealt in cash.    Petitioner paid many of his

personal expenses with cash.

     On occasion, petitioner used cash from the Bijou's drop

envelopes to pay his personal expenses.    These expenses included

a downpayment of at least $23,000 on a condominium located at

3530 North Lake Shore Drive in Chicago (the 3530 condo) and the

babysitter's weekly salary.
                               - 7 -


Petitioner's Cash Sources and Uses

     Petitioner had the following cash sources in 1981 and 1982:1

                                 1981       1982

Loans from E&A of IL                 $0   $11,110

Withdrawal from petitioner's
  personal savings account
  #143263-2                      5,221

Cash back on deposits              600

Paychecks cashed                 1,151

Checks cashed conceded
  by respondent                    936         178

Capital gains                   26,500      40,350

Cash received from
  money orders                   5,756       3,843

Rental income                                2,500

   Total cash sources          $40,164     $57,981

     Petitioner had the following cash uses in 1981 and 1982:

                                 1981       1982

Cash deposited into
  petitioner's personal
  checking account
  #501-344                      $6,551     $3,260

Cash deposited into
  Walter Killeen Co.
  checking account
  #332-232                      23,129      2,100




     1
       For convenience, all numbers are rounded to the nearest
dollar.
                                - 8 -


Cash deposited into
  Anthony J. Medina, Jr. Co.
  account #541-834                  100      12,285

Sheila Buralli, babysitter        3,000

Mercedes Benz                    18,015

Ultimo, clothing store            1,100

Parking space rental                156         156

Sylvia Dawson, housekeeper        2,400

Tiffany's                           742       1,559

Personal money orders            28,697      82,478

Gold Coast Travel Corp.           1,165

Susan Toushin's "walking
  around" money                  12,000

     Total cash uses            $97,055    $101,838


Petitioner's Plea Agreement

       On August 8, 1991, petitioner pleaded guilty to filing a

false income tax return for 1980 in violation of section 7206(1).

In his plea agreement, petitioner admitted to skimming cash

proceeds from E&A of IL through his operation of the Bijou.

Petitioner admitted his unreported skimmed cash income totaled

$59,411 for 1980.

                               OPINION

I.   Unreported Income

       The first issue presented is whether petitioner had

unreported income for 1980, 1981, and 1982.    Petitioner bears the
                               - 9 -


burden of proof as to any underlying deficiency.   See Rule

142(a).

     A.   Respondent's Indirect Method of Proof

     When a taxpayer fails to keep sufficient records to enable

respondent to determine his correct tax liability, respondent may

compute the taxpayer's income by any method that clearly reflects

income.   See secs. 446(b), 6001; Sutherland v. Commissioner, 32

T.C. 862 (1959).

     Respondent used the cash method to indirectly prove that

petitioner had unreported income for the years in issue.   The

Court of Appeals for the Seventh Circuit has held that the cash

method is an acceptable method for calculating a taxpayer's

unreported income.   See United States v. Hogan, 886 F.2d 1497,

1509 (7th Cir. 1989).   In United States v. Hogan, supra at 1508-

1509, the Court of Appeals stated:

     [The cash method] is a variation on the "cash
     expenditures" method * * *. The cash expenditures
     method determines the amount of unreported income by
     "establishing the amount of [defendant's] purchases and
     services which are not attributable to the resources at
     hand at the beginning of the year or to non-taxable
     receipts during the year." If the amount of purchases
     and services exceeds defendant's reported income,
     resources on hand, and nontaxable receipts, the jury
     may infer that the defendant underreported income.

          Like the cash expenditures method, the cash method
     focuses on the taxpayer's sources and uses of income.
     Unlike the cash expenditures method, however, the tax
     expert considers only coin and currency when using the
     cash method, ignoring assets and purchases that do not
     generate cash.12 * * * Sources for cash include cash
                                - 10 -


     returned on deposits, checks written to "cash," * * *,
     cash contents of safe deposit boxes, in addition to
     money on hand at the beginning of the taxable year.
     The expert then adds cash received from nontaxable
     sources of income--including loans, advances from
     credit cards, gifts, and inheritances--to cash
     generated by sources and compares this total to the
     amount of purchases and services for which the taxpayer
     paid cash. If the cash expenditures exceed the
     sources, the tax expert infers that the taxpayer failed
     to report income. [Citations omitted.]
     12
        Although the term "cash" is often intended to
     include purchases made with checks, the cash method, as
     defined by the government, does not include checks as a
     type of cash. * * *


See also 1 Fink, Tax Fraud, sec. 17.03[7], at 17-30 (1998).

     Utilizing this method, respondent determined that petitioner

had unreported income of $59,411, $57,656, and $43,857 in 1980,

1981, and 1982, respectively.

     B.    Petitioner's Cash On Hand as of January 1, 1980

     Petitioner does not challenge respondent's authority to use

the cash method.    Rather, petitioner contends that respondent

incorrectly used the cash method because respondent failed to

account for petitioner's beginning cash on hand.

     Respondent determined petitioner had no cash on hand as of

January 1, 1980.    Petitioner claims he had a cash hoard of at

least $80,000 in his home safe as of that date.

     Petitioner admitted in his guilty plea that he had

unreported skimmed income from the Bijou in 1980 totaling

$59,411.    This figure was computed based on cash on hand of $0 as
                               - 11 -


of January 1, 1980.   By his plea, petitioner thus implicitly

admitted that he had no cash hoard as of January 1, 1980.

Additionally, there is ample evidence that petitioner experienced

serious financial problems between 1976 and 1978 when his assets

were in receivership.    Petitioner's allegation of a cash hoard

was inconsistent, implausible, and not supported by objective

evidence in the record.    See Parks v. Commissioner, 94 T.C. 654,

661 (1990).

     We therefore conclude that petitioner did not have a cash

hoard as of January 1, 1980.

     C.   Petitioner's Sale of Poppers

     Petitioner alternatively argues that his unreported income

was attributable to his sale of "poppers"2 on behalf of the

Screening Room and that E&A of CA, and not petitioner, should be

taxed on the income from the sale of poppers.

     From petitioner's testimony, it is unclear how petitioner

acquired the poppers, if and how petitioner transferred the

poppers to the Screening Room, the quantity sold, and the price

at which they were sold.    Petitioner's testimony was vague and

contradictory as to this matter.    See Tokarski v. Commissioner,

87 T.C. 74, 77 (1986).    Even if we were to believe that

petitioner, acting as a representative of the Screening Room,


     2
       "Poppers" consist of a substance which a person inhales
"to get high".
                                 - 12 -


sold poppers, we would not be able to conclude how much of the

unreported income was attributable to these sales.

       D.    Petitioner's Unreported Income

       Petitioner admitted in his plea agreement and we find that

he had unreported income of $59,411 in 1980.          As for 1981 and

1982, based upon the above findings, we conclude that petitioner

had the following unreported income:

                                     1981           1982

Cash on hand at beginning
  of year                                 $0           $0

Add:    cash sources                40,164         57,981

Cash available for year            $40,164        $57,981

Less:       cash uses              (97,055)      (101,838)

Unreported income                  $56,891        $43,857

II.    Addition to Tax for Fraud

       For 1980 and 1981, section 6653(b), and for 1982, section

6653(b)(1) provide for an addition to tax of 50 percent of the

underpayment if any part of the underpayment of tax required to

be shown on a return is due to fraud.          Additionally, for 1982,

section 6653(b)(2) provides for an addition to tax equal to 50

percent of the interest payable under section 6601 with respect

to the portion of the underpayment attributable to fraud.          In

this case, respondent alleges that the entire underpayments are

due to fraud.
                                 - 13 -


     Respondent bears the burden of proof to show by clear and

convincing evidence that (1) an underpayment exists, and (2) some

part of the underpayment is due to fraud.    See Rule 142(b).

Where fraud is determined for each of several years, respondent's

burden applies separately for each of the years.    See Estate of

Stein v. Commissioner, 25 T.C. 940, 959-963 (1956), affd. per

curiam sub nom. Levine v. Commissioner, 250 F.2d 798 (2d Cir.

1958).

     A.    Underpayment of Tax

     Where the allegations of fraud are intertwined with

unreported and indirectly reconstructed income, respondent may

prove an underpayment either (1) by proving a likely source of

the unreported income or (2) where the taxpayer alleges a

nontaxable source, by disproving the nontaxable source so

alleged.    See Parks v. Commissioner, supra.

     Respondent contends that petitioner's unreported income in

the years in issue was the result of petitioner's skimming from

the Bijou's cash receipts, and such skimmed receipts constitute

constructive dividends which are taxable to petitioner.

     Respondent carefully reconstructed the procedures used at

the Bijou for dealing with its daily cash receipts in 1980, 1981,

and 1982 and petitioner's unfettered access to those receipts.

Petitioner was the sole person with access to the drop safe at

the Bijou.    Petitioner collected the drop envelopes from the
                              - 14 -


safe.   Petitioner deposited the Bijou's cash receipts; however,

petitioner sometimes deposited only one-half of those cash

receipts.

     Petitioner routinely was seen making personal purchases with

large sums of cash.   Petitioner was even seen making some

personal purchases with cash removed from a duffle bag in

envelopes resembling the drop envelopes used by the Bijou.

Petitioner also routinely sent large sums of cash and money

orders to the Screening Room in order to pay that business's

weekly expenses.   Before its remodeling in 1982, the Screening

Room did not generate enough income to cover its expenses.

     Furthermore, in his plea agreement, petitioner admitted that

his unreported income in 1980 was from skimmed cash receipts of

the Bijou.

     From the entire record, we conclude that petitioner

routinely took cash from the Bijou's drop safe in 1980, 1981, and

1982 for his own personal use and to pay for the Screening Room's

expenses.

     Generally, where a shareholder diverts corporate funds to

his own use, those funds constitute constructive dividends to him

and are ordinary income to the extent of the corporation's

earnings and profits.   See secs. 301(c), 316; Truesdell v.

Commissioner, 89 T.C. 1280, 1295 (1987).
                                - 15 -


     Respondent has shown that E&A of IL had sufficient earnings

and profits during the years in issue to account for all of

petitioner's unreported income in those years.     Petitioner has

presented no evidence to the contrary.

     We conclude that respondent has established by clear and

convincing evidence an underpayment of tax for 1980, 1981, and

1982.

     B.     Fraudulent Intent

        Respondent must also show that for each of the years in

issue the taxpayer intended to evade taxes known to be owing by

conduct intended to conceal, mislead, or otherwise prevent the

collection of taxes.     See Parks v. Commissioner, 94 T.C. at 661;

Rowlee v. Commissioner, 80 T.C. 1111, 1123 (1983).

        Because direct proof of a taxpayer's intent is rarely

available, fraud may be proven by circumstantial evidence and

reasonable inferences may be drawn from relevant facts.     See

Spies v. United States, 317 U.S. 492, 499 (1943).     Over the

years, courts have developed a nonexclusive list of factors that

demonstrate fraudulent intent.     These badges of fraud include:

(1) Understating income, (2) maintaining inadequate records, (3)

failing to cooperate with tax authorities, (4) an intent to

mislead which may be inferred from a pattern of conduct, (5)

filing false documents, (6) failing to file tax returns, and (7)

dealing in cash.     See id.
                              - 16 -


     The evidence establishes that petitioner consistently and

substantially understated his income in 1980, 1981, and 1982.

Petitioner maintained inadequate records for both of his

businesses.   Petitioner destroyed existing records at the Bijou

and instructed Killeen to destroy any records kept at the

Screening Room.   Petitioner attempted to disrupt the IRS's

criminal investigation by sending Killeen on vacation and

counseling Killeen to lie to agents when questioned.   Petitioner

dealt extensively in cash both personally and in his businesses.

     We also consider it significant that petitioner pleaded

guilty to a violation of section 7206(1) for 1980.   Although his

plea does not, in and of itself, establish a fraudulent intent,

we consider the crime as probative evidence that he intended to

evade taxes, especially when combined with other factors taken

from the record as a whole.   See Wright v. Commissioner, 84 T.C.

636, 643-644 (1985); McGee v. Commissioner, 61 T.C. 249, 260

(1973), affd. 519 F.2d 1121 (5th Cir. 1975).

     We conclude that petitioner possessed the requisite

fraudulent intent to evade taxes known to be owing for 1980,

1981, and 1982.

     C.   Conclusion

     We find that respondent has clearly and convincingly proven

that the entire underpayments of tax for 1980, 1981, and 1982

were due to fraud.
                                - 17 -


III.    Substantial Understatement of Income in 1982

       Section 6661 imposes an addition to tax of 10 percent of the

amount of any underpayment attributable to a substantial

understatement of income tax.    A substantial understatement is

one which exceeds the greater of 10 percent of the tax required

to be shown on the return or $5,000.     See sec. 6661(b)(1)(A).

       If the taxpayer has substantial authority for the tax

treatment of any item on the return, the understatement is

reduced by the amount attributable to it.     See sec.

6661(b)(2)(B)(i).    Similarly, the amount of the understatement is

reduced for any item adequately disclosed either on the

taxpayer's return or in a statement attached to the return.       See

sec. 6661(b)(2)(B)(ii).

       Petitioner bears the burden of proving that the addition to

tax under section 6661 does not apply.     See Rule 142(a);

Tweeddale v. Commissioner, 92 T.C. 501, 506 (1989).      Petitioner

has offered no evidence or argument that he is not liable for the

addition to tax under section 6661(a).     We conclude that

petitioner is liable for the section 6661(a) addition to tax for

1982.

IV.    Statute of Limitations

       Where a fraudulent return is filed with the intent to evade

tax, the tax may be assessed at any time.     See sec. 6501(c).

Petitioner argues that respondent's assessment of deficiencies
                             - 18 -


and penalties for each of the years in issue is time barred

because respondent failed to issue the notice of deficiency

within the 3-year period prescribed by section 6501(a).

     As we found herein, petitioner is liable for the additions

to tax for fraud for 1980, 1981, and 1982; therefore, the period

of limitations on assessment for those years remains open.

     To reflect the foregoing,

                                        Decision will be entered

                                   under Rule 155.
