                        T.C. Memo. 2003-130



                      UNITED STATES TAX COURT



                  KYL CHRISTIANS, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 9814-01.              Filed May 5, 2003.



     Ted E. Merriam and Kevin A. Planegger, for petitioner.

    Richard D. D’Estrada and Frederick J. Lockhart, Jr., for

respondent.


              MEMORANDUM FINDINGS OF FACT AND OPINION


     GERBER, Judge:   In a statutory notice of deficiency, mailed

on May 4, 2001, respondent determined deficiencies in

petitioner’s Federal income tax and penalties for the taxable

years 1992, 1993, and 1994 as follows:
                                  - 2 -

                                               Penalty
     Year            Deficiency               Sec. 6663

     1992              $4,831                 $3,623.25
     1993              12,115                  9,086.25
     1994              18,912                 14,184.00

     Petitioner contends that respondent is barred from assessing

the income tax deficiencies because the notice of deficiency was

mailed after the expiration of the 3-year period for assessment

provided for in section 6501(a).1     Respondent contends that the

period for assessment remains open under section 6501(c)(1)

because petitioner filed false and fraudulent returns for the

years in question.   In the alternative, respondent contends, and

petitioner concedes, that the period for assessment remained open

for 1994 because of the substantial understatement of gross

income by more than 25 percent.     In such circumstances, section

6501(e) provides for a 6-year period for assessment.

     We consider here whether petitioner’s understatements for

taxable years 1992, 1993, and 1994 were due to fraud.     In the

event we do not find petitioner’s understatement for taxable year

1994 was due to fraud, respondent may assess the deficiency under

section 6501(e).




     1
       Unless otherwise indicated, 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.
                               - 3 -

                         FINDINGS OF FACT2

     Petitioner resided in Loveland, Colorado, at the time his

petition was filed in this case.    For taxable years 1992, 1993,

and 1994, petitioner owned and operated a construction business,

which did business under the name of K&L Exteriors Trim (K&L

Exteriors).   The business of K&L Exteriors was residential

construction, in particular house framing and siding work.

     Petitioner graduated from high school in 1986 and then began

employment as a construction laborer.    After 1 year, petitioner

began full-time attendance at Aims Community College.    Following

his first year, petitioner transferred to the University of

Northern Colorado, which he attended for 1 year.

     After his second year of college, petitioner moved to

Minnesota to work for his grandfather, who owned and operated an

electric motor repair business.    He worked for his grandfather

for approximately 1 year.   He subsequently moved back to Colorado

and re-enrolled in the University of Northern Colorado.    He

attended for two quarters and then transferred for an additional

semester to Colorado State University for an additional semester,

where he studied a specialized curriculum on construction.

Petitioner did not earn a college degree.




     2
       Some facts have been stipulated by the parties and are
herein incorporated by this reference.
                               - 4 -

     During his final semester at Colorado State University,

petitioner worked part time for George Moore Construction earning

between $6 and $7 per hour.   Petitioner acquired first-hand

knowledge of the need for residential construction services and

believed he could earn more money by operating his own

construction business.   During 1992, when petitioner was

approximately 24 years old, his father lent him approximately

$500 to $600 to start a construction business, under the name K&L

Exteriors Trim (K&L Exteriors).   K&L Exteriors began with two to

three employees, and business was generated by word of mouth or

by petitioner’s contacts with other contractors at job sites.

K&L Exteriors did not maintain any inventory, and its business

consisted of providing services in the form of labor.

     During 1993, petitioner organized a corporation called Four

Square Construction, Inc. (Four Square), for the sole purpose of

providing payroll services for K&L Exteriors.   K&L would transfer

funds to Four Square each month, and then Four Square would

distribute the funds to the employees.

     Petitioner did not have the business acumen to manage the

administrative side of the business.   Petitioner managed and

performed the construction services, and he relied on his father

to manage the administrative matters, including the bookkeeping.

Petitioner trusted his father and was aware of his father’s prior

experience in administrative business matters, including his
                                - 5 -

father’s management of petitioner’s mother’s cleaning service

business.    Petitioner did not question his father and would sign,

without careful consideration, documents his father had prepared.

     The administrative business services for petitioner’s and

his mother’s businesses were performed in petitioner’s parents’

home, where the books and records were maintained.   Petitioner

lived with his parents in that home until sometime during 1994.

When the number of documents necessary for petitioner’s business

became voluminous, petitioner’s father requested a facsimile

stamp of petitioner’s signature for use on business documents.

     A business checking account was maintained for K&L

Exteriors.   That account was used for payment of petitioner’s

personal and business expenses.   During the period under

consideration, petitioner was provided by his father with

approximately $350 a week for living expenses.   Petitioner was

aware that K&L Exteriors’ weekly receipts exceeded $350, and he

thought that the excess was being retained and/or used for

operating expenses.

     Petitioner’s father also managed the preparation of

petitioner’s individual and business tax returns.    Petitioner’s

father retained Doneta Layland, owner-operator of Tax

Consultants, to prepare petitioner’s tax returns.    Petitioner’s

father would provide the information necessary to prepare the tax

returns to Ms. Layland.   Petitioner had no contact with Ms.
                               - 6 -

Layland, and she did not find it unusual that petitioner’s father

handled the tax matters because that type of situation occurred

with other clients.

     Ms. Layland was often frustrated by the inadequate and

inaccurate tax preparation records petitioner’s father submitted

to her.   For example, the cashflow statement for K&L Exteriors

for the taxable year 1993 reflected gross receipts of $160,397,

while the Forms 1099 filed by clients of the business reflected a

lesser amount ($111,516).   Through communications with

petitioner’s father, Ms. Layland came to realize that the

cashflow statement figure was incorrect.   Accordingly, she

reported the amount reflected on the Forms 1099.    Petitioner’s

father also commingled petitioner’s personal and business

expenses, which Ms. Layland attempted to distinguish and

separate.   Ms. Layland did not contact petitioner about any of

these matters.   She dealt exclusively with petitioner’s father,

who resolved these matters to Ms. Layland’s satisfaction.     On one

occasion, Ms. Layland questioned petitioner’s father about a loss

on petitioner’s 1993 Schedule C, Profit or Loss From Business.

Petitioner’s father responded with new figures which reflected a

small profit.

     For taxable years 1993 and 1994, Ms. Layland also prepared

Four Square’s corporate returns for petitioner.    Because Four

Square was incorporated solely for K&L Exteriors’ payroll
                                - 7 -

needs, Four Square’s receipts matched its expenses, and its

corporate returns did not reflect taxable income.

     Petitioner’s 1992, 1993, and 1994 income tax returns were

filed on May 4, 1993, May 16, 1994, and May 8, 1995,

respectively.   The Schedules C attached to petitioner’s 1992,

1993, and 1994 income tax returns reflected taxable income of

$635, $304, and $360, respectively.     All three returns were

signed by petitioner and dated April 29, 1993, May 8, 1994, and

May 3, 1995, respectively.   As with other documents relating to

K&L Exteriors and Four Square, petitioner did not read or review

them before signing.   At the time of signing the 1992, 1993, and

1994 returns, petitioner believed the information reported was

accurate.

     Petitioner now agrees that the gross income from his

construction business was understated by $9,690, $37,204, and

$52,440 for 1992, 1993, and 1994, respectively.     He also agrees

that interest income was understated by $24 and $11 for 1992 and

1993, respectively.

     During August 1994, petitioner, in the process of obtaining

a personal loan, estimated his monthly income to be $3,200.      At

this time, petitioner was receiving a $350 weekly check from his

father.   In December 1994, petitioner sought another loan in

order to purchase a home.    Petitioner knew that he had to have a

certain level of income to qualify for a home loan.     In response
                                - 8 -

to the loan officer’s questions, petitioner estimated that his

monthly income was $5,217.    Petitioner signed and dated the loan

application.   In mid-March 1995, petitioner entered into a

contract to purchase a home for $140,000.

     The mortgage company requested petitioner’s income tax

returns from the previous 2 years.      Petitioner telephoned his

father and requested copies of his income tax returns for taxable

years 1993 and 1994.   Petitioner obtained copies of his income

tax returns from his father and submitted them to the mortgage

company without reviewing them.    The 1993 return submitted to the

mortgage company reflected Schedule C net income of $51,297.

This return differed in the amount of income from the one filed

with the Internal Revenue Service.      There were also differences

in petitioner’s signatures.    The date reflected on the return

provided to the mortgage company was April 15, 1994, and was not

in petitioner’s handwriting.

     The 1994 income tax return submitted to the mortgage company

reflected Schedule C net income of $50,685, an amount different

from that reported to respondent.    These returns also contained

differences in petitioner’s signatures.      The date reflected on

the 1994 return provided to the mortgage company was February 2,

1995, and was in petitioner’s handwriting.

     Petitioner did not read any of the loan documents relating

to the purchase of the home.    Instead, the loan officer explained
                               - 9 -

the documents, and then petitioner signed them.   The closing date

for petitioner’s home purchase was July 28, 1995.   On that date,

petitioner signed a Universal Residential Loan Application, which

reflected that his monthly income was $4,137.   Petitioner

believed this figure was derived from his income tax returns.

     In the course of an examination of another taxpayer

regarding employee wage deductions, respondent began an

examination of petitioner’s returns.   For taxable year 1991,

petitioner admitted to respondent’s agent that he did not report

approximately $2,000 in wages he had received for part-time

construction work.

     Respondent’s examining agent referred petitioner’s tax

examination to the Criminal Investigation Division.    In the

course of the investigation, respondent’s special agent

(1) interviewed contractors to determine whether K&L had reported

all of its income through a specific item analysis, (2)

interviewed Ms. Layland regarding the preparation of petitioner’s

income tax returns, and (3) sought out other potential sources of

income.   In so doing, the special agent discovered:   (1)

Petitioner’s mortgage applications, (2) that petitioner’s father

had sole contact with Ms. Layland, (3) that petitioner timely

filed his income tax returns, (4) that petitioner’s return for

1992 did not include income received from a contractor, (5) that

petitioner’s return did not include $11 of interest income, (6)
                             - 10 -

that petitioner did not deal in cash, (7) that K&L Exteriors was

one of the least sophisticated operations he had seen, (8) that

petitioner paid approximately $90 in self-employment tax for

taxable year 1992 and a minimal amount of income tax, and (9)

that petitioner reported no income tax or self-employment tax

liability for taxable years 1993 and 1994.

     The special agent did not discover evidence showing an

overstatement of expense deductions or illegal activities or that

Four Square was used for any improper purposes.    At the

conclusion of the criminal investigation, the special agent

recommended criminal prosecution of petitioner and petitioner’s

father for taxable years 1993 and 1994.   The record does not

reflect the disposition of these matters.


                             OPINION

     The parties have narrowed the focus of this case.

Petitioner agrees that there was unreported income and, hence,

underpayments of tax for 1992, 1993, and 1994.    However, the 3-

year period for assessment, provided for in section 6501(a), had

expired with respect to all 3 taxable years at the time

respondent mailed the notice of deficiency to petitioner.

Respondent, in his answer, affirmatively alleged that the

understatement of tax for each of the 3 years is due to fraud

and, therefore, that the period for assessment remained open at

the time the notice was mailed.   See sec. 6501(c)(1).
                                 - 11 -

Accordingly, the initial and principal question we consider is

whether “any portion of * * * [the underpayments] is attributable

to fraud”.    Sec. 6663(b).

I.    Whether Petitioner Filed Fraudulent 1992, 1993, or 1994
      Income Tax Returns

       For purposes of defining fraud, it is important to note that

the definitions of fraud in sections 6663 and 6501 have been held

to be interchangeable.     Rhone-Poulenc Surfactants v.

Commissioner, 114 T.C. 533, 548 (2000) (and cases cited therein);

Murphy v. Commissioner, T.C. Memo. 1995-76.     Fraud is an

intentional wrongdoing on the part of the taxpayer with the

specific purpose to evade a tax believed to be owing.         McGee v.

Commissioner, 61 T.C. 249, 256 (1973), affd. 519 F.2d 1121 (5th

Cir. 1975); Terrell Equip. Co. v. Commissioner, T.C. Memo. 2002-

58.    The Commissioner bears the burden of proving fraud by clear

and convincing evidence.      Sec. 7454(a); Rule 142(b); Zell v.

Commissioner, 763 F.2d 1139, 1142-1143 (10th Cir. 1985), affg.

T.C. Memo. 1984-152; Terrell Equip. Co. v. Commissioner, supra.

       To satisfy his burden, the Commissioner must show that (1)

an underpayment exists; and (2) the taxpayer intended to evade

taxes known to be owing by conduct intended to conceal, mislead,

or otherwise prevent the collection of taxes.      Parks v.

Commissioner, 94 T.C. 654 692 (1970).     The existence of fraud is

a question of fact to be resolved from the entire record.         DiLeo

v. Commissioner, 96 T.C. 858, 874 (1991), affd. 959 F.2d 16 (2d
                               - 12 -

Cir. 1992).   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 the relevant facts.

Spies v. United States, 317 U.S. 492, 499 (1943); Stephenson v.

Commissioner, 79 T.C. 995, 1006 (1982), affd. 748 F.2d 331 (6th

Cir. 1984).   Mere suspicion, however, does not prove fraud.   Katz

v. Commissioner, 90 T.C. 1130, 1144 (1988).

     Courts have developed a nonexclusive list of so-called

badges of fraud which demonstrate fraudulent intent:

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

providing implausible or inconsistent explanations of behavior,

(4) concealing income or assets, (5) failing to cooperate with

taxing authorities, (6) engaging in illegal activities, (7)

engaging in a pattern of behavior which indicates an intent to

mislead, (8) testifying with a lack of credibility, (9) filing

false documents, (10) failing to file tax returns, and (11)

dealing in cash.    Bradford v. Commissioner, 796 F.2d 303, 307-308

(9th Cir. 1986), affg. T.C. Memo. 1984-601; Recklitis v.

Commissioner, 91 T.C. 874 (1988); Middleton v. Commissioner, T.C.

Memo. 2002-164.    The sophistication, education, and intelligence

of the taxpayer are relevant in determining fraudulent intent.

Niedringhaus v. Commissioner, 99 T.C. 202, 211 (1992).
                                - 13 -

     A.   In General

     The record in this case reflects a general pattern of

dereliction, but not one of deceit and fraud.     There can be no

doubt that petitioner’s reliance upon his father was misplaced

and in no way relieved petitioner of his obligation to correctly

report his tax liability.     Petitioner may not avoid his duty to

accurately report by placing the responsibility on an agent.       See

United States v. Boyle, 469 U.S. 241, 250-251 (1985).        There is

ample evidence, as observed by his return preparer, that

petitioner’s tax records were inaccurate and inadequate and

commingled personal and business items.     Petitioner knew that his

earnings exceeded the $350 received weekly from his father for

personal expenses.     But petitioner was not aware of the

particulars of his tax reporting, including the amount of income

reported on his Federal income tax returns.     In spite of his

laxity and inattention to the administration of his business,

petitioner did not intend to evade tax by conduct intended to

conceal, mislead, or prevent the collection of tax.

     Petitioner’s forte was in the operational side of his

construction business.     He was young and inexperienced regarding

the administrative necessities of his business.     As a result,

petitioner relied exclusively on his father to look after the

administrative matters, including tax reporting.     Petitioner

perfunctorily signed documents, including tax returns, that his
                               - 14 -

father prepared and placed before him for signature.

Additionally, there has been no showing that petitioner

collaborated or colluded with his father to defraud the

Government.    Respondent has not shown, on this record, that

petitioner attempted to defraud.    We have reached this conclusion

after considering the specific criteria for fraud and whether the

“badges of fraud” existed in this case.

     Fraud may be proven by circumstantial evidence and

reasonable inferences drawn from the facts.    Spies v. United

States, supra.    A taxpayer’s course of conduct or a pattern of

conduct may establish, by inference, the intent to conceal or

mislead.    Id. at 499; Otsuki v. Commissioner, 53 T.C. 96, 105-106

(1969).    Respondent contends that the 3-year pattern of

underreporting income is evidence from which we should infer

petitioner’s intent to conceal or mislead.    It has been held that

a pattern of underreporting of income over an extended period may

be indicative of fraud, but the mere failure to report is not

sufficient to establish fraud.     Petzoldt v. Commissioner, 92 T.C.

661, 700 (1989) (and cases cited thereat).

     Petitioner concedes that his income was underreported for

the 3 years.    Petitioner, however, contends that he relied

(reasonably or unreasonably) upon his father and that he was

without sufficient knowledge to be culpable and/or that he did

not formulate a specific intent to evade tax, conceal, or
                              - 15 -

defraud.   We have carefully considered the evidence, including

petitioner’s testimony, which we found credible.     We hold that

the under reporting here does not, when considered in light of

the record in its totality, show or raise an inference that

petitioner intended to conceal or mislead.

     We find the circumstances here to be somewhat unusual.      The

combination of petitioner’s inexperience, immaturity, and

reliance on his father make his position plausible.     It must be

noted that the three Federal income tax returns under

consideration represent some of the first ones that petitioner

filed, and he continued to live with his parents throughout most

of the period under consideration.     In addition, this was

petitioner’s first self-employment business experience.

     The Commissioner has relied upon taxpayers’ understatements

of income to circumstantially show fraudulent intent and has been

successful in numerous fraud penalty cases where such

understatements were coupled with other badges of fraud.       In a

few cases, however, the Commissioner has failed to establish a

link between understatements and fraudulent intent.     In Rao v.

Commissioner, T.C. Memo. 1996-500, the fraud penalty was not

sustained even though the taxpayer, a doctor, had substantial and

consistent understatements of gross income.     In that case, the

taxpayer relied on his accountant, in the same manner as

petitioner has relied on his father.     In another case, involving
                              - 16 -

a doctor whose income was consistently and substantially

understated, the taxpayer’s reliance on his accountant was a

factor in the Court’s holding that the Commissioner failed to

clearly and convincingly prove fraud.   Zipp v. Commissioner, T.C.

Memo. 1998-371.

     B.   Whether There Was a Pattern of Behavior Which Indicates
          an Intent To Mislead

     Respondent points out that petitioner, in the process of

applying for loans, provided monthly income figures to lenders

that reflected that he knew that he was underreporting his

income.   During 1994, petitioner sought a $5,100 personal loan,

and he estimated that his monthly income was $3,200.    A few

months later petitioner began the process of purchasing a home,

and in documents submitted to secure a $140,000 mortgage loan, he

estimated that his monthly income was $5,217 on one occasion and

$4,137 on another.

     When the home loan was being finalized, the mortgage company

requested copies of petitioner’s 2 prior years’ Federal income

tax returns.   Petitioner obtained the copies of the returns from

his father and provided them to the mortgage company.    Unlike the

returns filed with respondent, which reported insignificant

amounts of net income from the construction business, the copies

supplied to the mortgage company reflected annual net income in

the low $50,000's.   In addition, there were some discrepancies
                               - 17 -

with respect to the signatures on the returns supplied to the

mortgage company.

     Respondent argues that these circumstances indicate

petitioner’s knowledge that the income reported to the Government

was understated.    Petitioner does not deny that there were

discrepancies and that the amounts reported to respondent

differed from the amounts contained in the return documents

provided to the mortgage company.    Petitioner, consistent with

his approach to business documents and procedures, was not

cognizant of the contents of the returns presented to the various

recipients or of the taxable income that was being earned from

his business activity.    Petitioner did not have working knowledge

of the administrative side of his business and followed his

father’s guidance on those aspects of his business.

     There has been no evidence, circumstantial or otherwise,

that would lead us to find that petitioner was aware of the

discrepancies or that he colluded with his father in an attempt

to deceive the Government or the mortgage company.    Even if

petitioner’s father intended to conceal, deceive, and defraud,

such a finding would not automatically be imputed to petitioner.

     Respondent, relying on United States v. Bornfield, 145 F.3d

1123, 1129 (10th Cir. 1998), contends that petitioner cannot, by

burying his head in the sand, avoid blame for any deception by

his father.   Bornfield, a criminal case, involved a “deliberate
                               - 18 -

ignorance instruction” to a jury.     It was held that such an

instruction “is appropriate if the defendant denies knowledge of

an operative fact and the evidence demonstrates or creates the

inference that the defendant deliberately avoided actual

knowledge of that fact.”    Id. (citing United States v. Lee, 54

F.3d 1534, 1538 (10th Cir. 1995)).      As we have found, petitioner

did not collude with his father or deliberately avoid knowledge

to avoid culpability.   Accordingly, United States v. Bornfield,

supra, is not analogous to our circumstances.

     In conjunction with that approach, respondent also argues

that petitioner’s father’s actions should be imputed to

petitioner.   Respondent’s position derives from joint and several

liability cases.   In those cases, both spouses by the filing of a

joint return were liable for any fraud penalty, irrespective of

which spouse intended to evade the tax.     We note that the cases

respondent relies on are dated and have been superseded by

statute.   See, e.g., sec. 6663(c).

     More importantly, the cases relied upon by respondent

involve situations where one spouse was found to have

intentionally evaded tax.   There has been no showing by clear and

convincing evidence that petitioner’s father intended to file a

fraudulent return on his son’s behalf.     Accordingly, there is no

need to consider whether the concept of joint and several

liability would apply in this case.
                               - 19 -

      C.   Remaining Badges of Fraud

      Petitioner points out that factually, respondent’s case

rests on the understatements and the information provided to

lenders.    There has been no showing or allegation that petitioner

(1) knowingly concealed income or assets, (2) failed to cooperate

with respondent, (3)engaged in illegal activities, (4) attempted

to mislead, (5) dealt in cash, (6) lacked credibility, or (7)

knowingly filed false documents.

      On this record we conclude and hold that respondent has

failed to prove by clear and convincing evidence that petitioner

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

conceal, mislead, or otherwise prevent the collection of taxes.

Accordingly, the exception for fraud did not serve to keep the

assessment period for 1992, 1993, or 1994 open under section

6501(c).

II.   Respondent’s Alternative Argument Concerning Section
      6501(c)(1)

      Respondent also argues that, for purposes of indefinitely

extending the period for assessment under section 6501(c)(1),

petitioner’s state of mind is irrelevant.    Section 6501(c)(1)

provides for an exception to the 3-year period for assessment of

section 6501(a), as follows:

            False Return. In the case of a false or
            fraudulent return with the intent to evade
            tax, the tax may be assessed, or a proceeding
            in court for collection of such tax may be
            begun without assessment, at any time.
                              - 20 -

Respondent argues that the statute requires only an “intent to

evade tax.”   Under respondent’s position the intent to evade may

be imputed to the taxpayer from a third person.    In the setting

of this case, respondent would have us impute to petitioner any

intent to evade tax that petitioner’s father may have had.     Under

respondent’s interpretation, the period for assessment would

remain open indefinitely in a situation where, as here, a

taxpayer is found not to have intended to evade tax, but some

third person involved in the reporting of income did so intend.

     Assuming arguendo that respondent’s interpretation of

section 6501(c)(1) is correct, for respondent to be successful in

this case, he first would have to establish the factual predicate

that petitioner’s tax preparer/father had an “intent to evade

tax”.   With respect to extending the period for assessment,

respondent bears the burden of proof.     Mecom v. Commissioner, 101

T.C. 374 (1993), affd. without published opinion 40 F.3d 385 (5th

Cir. 1994).   We have found that respondent has not shown by clear

and convincing evidence that petitioner intended to evade tax

when he signed the returns in question.    We have also found that

respondent has not shown that petitioner’s father/return preparer

intended to evade tax.   Therefore, the question of whether

respondent’s interpretation of section 6501(c)(1) is correct is

rendered moot.
                              - 21 -

     Accordingly, the period for assessment for 1992, 1993, or

1994 did not remain open under the provisions of section

6501(c)(1).   Because of petitioner’s concession that the 1994

assessment period was open under section 6501(e), petitioner

remains liable for an income tax deficiency based on the agreed

underpayment for his 1994 tax year.

     To reflect the foregoing,

                                      Decision will be entered

                                 under Rule 155.
