                  T.C. Summary Opinion 2003-127



                     UNITED STATES TAX COURT



                DARRELL L. GAINES, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 8751-01S.               Filed September 11, 2003.



     Vic Devlaeminck, for petitioner.

     Nhi T. Luu-Sanders, for respondent.


     CARLUZZO, Special Trial Judge:     This case was heard pursuant

to the provisions of section 7463 of the Internal Revenue Code

in effect at the time the petition was filed.    Unless otherwise

indicated, subsequent section references are to the Internal

Revenue Code in effect for the years in issue.    Rule references

are to the Tax Court Rules of Practice and Procedure.    The
                                - 2 -

decision to be entered is not reviewable by any other court, and

this opinion should not be cited as authority.

       In a notice of deficiency mailed on April 13, 2001,

respondent determined deficiencies in petitioner’s Federal income

taxes and imposed penalties as follows:

Year        Deficiency    Sec. 6662 Penalty     Sec. 6663 Penalty

1993          $9,177             ---                $6,882.75
1994           5,701         $1,140.20               4,275.75
1995           4,172            834.40               3,129.00

       Different amounts are asserted in respondent’s amended

answer.    After discovery of unspecified errors in the

calculations of those amounts, the parties agree that, as

properly computed, the deficiencies and penalties here in dispute

are as follows:

Year        Deficiency     Sec. 6662 Penalty    Sec. 6663 Penalty

1993          $6,952             ---                $5,214.00
1994           6,147         $1,282.00               4,808.00
1995           6,824          2,103.00               7,887.00

       The issues for decision are:   (1) Whether petitioner

underreported his income during each year in issue; and, if so,

(2) whether the underpayment of tax required to be shown on

petitioner’s return for each year is due to fraud or, for 1994

and 1995, as an alternative to fraud, whether the underpayment of

tax required to be shown on petitioner’s return is due to

negligence.
                                - 3 -

Background

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

the time the petition was filed, petitioner resided in Vancouver,

Washington.

       Petitioner began working as a paper boy at the age of nine.

Upon graduation from high school, he enlisted in the United

States Marine Corps.    After being discharged from the Marines he

worked for a variety of companies and eventually became self-

employed.    His earnings from these various occupations as

reported to the Social Security Administration are listed below:

Year             Employer                       Wages

1962        Seaside Assembly of God            $183.48
            U.S. Marine Corps                    93.60
            Nicolai Co.                          66.72
1963        U.S. Marine Corps                   789.19
1964        U.S. Marine Corps                 1,106.48
1965        U.S. Marine Corps                 1,469.10
1966        U.S. Marine Corps                   716.60
            Intl. Paper Co.                      12.00
            Boise Cascade Corp.                 302.92
            Nu-Lam Wood Products, Inc.            5.00
            Van-Port Panel Co.                   81.60
1967        John A. Sundwall                     40.50
            Pacific Wood Treating Corp.          59.00
            Brand-S Corp.                         6.80
1968        Fort Vancouver Plywood Co.           71.55
            Kilpatrick, Inc.                    419.13
            Young Gabco, Inc.                    73.78
            Pacific Maritime Assoc.             807.42
            Brimer Construction Co.             199.50
1969        Brimer Construction Co.              83.00
            John Barchek                         25.20
            Portco Corp.                         49.55
            Vanply, Inc.                          8.46
            Precision Wood Products, Inc.        80.75
            Wheels of Man, Inc.                 527.43
            Metal Tech Corp.                     84.80
                           - 4 -

       Swan Mfg. Co.                           44.10
       George Zent & Sons                      23.60
       Del Monte Corp.                        385.28
       James River Corp. of Nevada             26.08
       Jarman Co. Corp.                       258.19
       Floating Marine Ways, Inc.             133.40
1970   Fort Vancouver Plywood Co.             216.64
       Timber Inspection Bureau, Inc.          22.50
       Pacific Southern Foundries              26.92
       Western Wirebound Box Co. Corp.         59.48
       Alpine Veneers, Inc.                   162.68
1971   Fort Vancouver Plywood Co.           7,800.00
1972   Fort Vancouver Plywood Co.           9,000.00
1973   Fort Vancouver Plywood Co.          10,800.00
1974   Fort Vancouver Plywood Co.          13,200.00
1975   Fort Vancouver Plywood Co.          14,100.00
1976   Fort Vancouver Plywood Co.          15,300.00
1977   Fort Vancouver Plywood Co.          16,500.00
1978   Fort Vancouver Plywood Co.          17,700.00
1979   Fort Vancouver Plywood Co.           6,389.38
1980   ---                                       ---
1981   Stevenson Co Ply, Inc.              13,691.34
1982   Stevenson Co Ply, Inc.               4,916.25
1983   ---                                       ---
1984   CA Miami Elevator Co.                3,773.06
1985   Kelly Services, Inc.                    28.00
       High Cascade Lumber Corp.              158.34
1986   ---                                       ---
1987   Vanalco, Inc.                          340.00
1988   Timberline Forest Products             678.00
1989   Lamplighter Homes, Inc.              2,479.96
1990   Lamplighter Homes, Inc.              1,154.68
       Loren Enterprises                    1,165.42
       D & R Remodeling-Decorating            426.79
       All States Plastic Co., Inc.           681.00
       K-M Services, Inc.                     112.75
       Multnomah Plywood Corp.                890.76
1991   Fort Vancouver Plywood Co.           1,350.00
1992   ---                                       ---
1993   Self-employed, Grand Video           2,369.00
1994   Self-employed, Grand Video           1,833.00
1995   Self-employed, Grand Video           3,924.00

                              Total:     $159,484.16
                                - 5 -

     Petitioner purchased a house in 1972.    On January 22, 1982,

he mortgaged the house to secure a loan of approximately $22,400.

The above table suggests that petitioner was not employed for the

entire year in 1982 and was not employed at all during 1983.

Soon after obtaining the loan, petitioner stopped making the

required monthly payments.    On March 18, 1984, with a loan

repayment arrearage of approximately $4,000, petitioner’s house

was sold in a foreclosure sale.    Petitioner lived with a friend

for several months thereafter, but soon moved in with his parents

at their house.    In 1993, while petitioner was living with his

parents, they deeded their house and a rental property that they

owned to petitioner.    Later in 1993, petitioner’s father was

denied State-assisted medical benefits because, according to

State authorities, he transferred assets without adequate

consideration.

     Petitioner and another individual formed a partnership in

1979 for the purpose of constructing several houses on land owned

by petitioner.    Petitioner obtained financing for the

construction projects from a local bank.    The truck that

petitioner had purchased for use in the partnership’s business

was repossessed.    On his 1979 and 1980 Federal income tax

returns, petitioner reported adjusted gross incomes of $3,758 and

($45,697), respectively.
                                - 6 -

     On March 16, 1991, petitioner traded an unimproved 5-acre

parcel of land that he owned for Grand Video, a video rental

business with a store located in Vancouver, Washington.    The

selling price for the business, which did not include the land or

building in which the store was located, was $30,000.   On his

1991 Federal income tax return, petitioner reported a $53,000

basis in the land and claimed a long-term capital loss of $23,000

as a result of the acquisition of Grand Video.   Petitioner owned

and operated Grand Video as a sole proprietorship from the date

he acquired it throughout the years in issue.

     Grand Video’s store was typically open from 10:30 in the

morning until midnight, 7 days a week.   Initially, petitioner was

the only person who worked in the store.   He eventually hired

employees to assist him.   At first, petitioner paid his employees

“under the table”; that is, in cash, without withholding for

Federal and State income and employment taxes.   He failed to file

the requisite Federal and State employment tax forms until

examined by State employment tax authorities.    As a result of the

State audit, petitioner was determined to be an unregistered

employer from June 1993 through July 1995.   He was fined $500,

plus penalties and interest.

     Petitioner used unnumbered, duplicate receipts to track

video rentals at Grand Video.   When a video was rented,
                                - 7 -

petitioner filled out a receipt, gave one copy to the customer,

and placed the other copy in a drawer.   When the video was

returned, petitioner matched it to the receipt and wrote the

letter “R” on the receipt to indicate that the video had been

returned.   These receipts were examined each month by Washington

State officials to determine petitioner’s Washington State excise

tax liability, which apparently was based in some part on gross

receipts.

     During the years in issue, Grand Video’s video rental prices

ranged from $1 to $3.50 per day.   Many customers paid by check,

but most transactions were in cash; credit cards were not

accepted.   The cash register in Grand Video’s store was used to

hold cash and make change, but not to record income from rental

and sales transactions.

     Petitioner maintained several bank accounts during the years

in issue.   One checking account was dedicated to Grand Video (the

business account).   Many business expenses, including rent,

utilities, and store maintenance were paid by checks drawn on the

business account.    Other business expenses were paid by cash and

recorded in a cash journal, but income received in cash was not.

Entries in the cash journal, including the cost of the journal

itself (i.e., $5.25), range from $.89 for a drill bit to $879.39

for “new carpet”.
                                 - 8 -

       Typically, petitioner made two or three deposits per week

into the business account.    Business account deposits made during

the years in issue are summarized below:

Year        Check Deposits       Cash Deposits         Total

1993          $11,604.36          $12,175.06        $23,779.42
1994           19,210.40            9,962.16         29,172.56
1995           16,771.64           12,680.29         29,451.93
Total         $47,586.40          $34,817.51        $82,403.91

       Deposits into petitioner’s other bank accounts are

summarized as follows:

Year        Check Deposits       Cash Deposits         Total

1993            $74.16            $52,204.35         $52,278.51
1994            300.00             44,401.00          44,401.00
1995             ---               39,004.00          39,004.00
Total          $374.16           $135,609.35        $135,683.51

       Before the years in issue, petitioner’s investments were

generally limited to real estate.    During this time, he

purchased, rented, and sold several houses.      In 1993, petitioner

began investing in securities.    In January 1993, petitioner

purchased three U.S. Savings Bonds, each with a face value of

$10,000.    Between July 1993 and October 1995, petitioner invested

approximately $158,000 in various mutual funds.     Thereafter, it

appears that petitioner’s interest in investing in securities

faded rapidly.    On December 5, 1995, petitioner redeemed mutual

fund shares with a net asset value of $119,187.30.     On December

20, 1995, petitioner purchased real property for approximately

$83,000.
                                  - 9 -

     Petitioner timely filed his Federal income tax returns for

each year in issue.   He reported adjusted gross income of

($1,914) in 1993, $1,844 in 1994, and $3,559 in 1995.

Petitioner’s reported tax liabilities were $362 in 1993, $280 in

1994, and $600 in 1995.      Each of the returns petitioner filed

during the years in issue, as well as those filed in 1991 and

1992, includes a Schedule C, Profit or Loss From Business, for

Grand Video.   Income, deductions, and profits or losses reported

on the Schedules C are as follows:

                      1991        1992       1993      1994     1995

Gross income      $19,459       $27,998    $47,722   $47,488   $43,956
Deductions         19,629        28,103     45,157    45,504    39,713
Net profit (loss)    (170)         (105)     2,565     1,984     4,248

     With the possible exception of 1995, no deductions are

claimed for wages paid in cash to petitioner’s employees during

any of the years listed above.

     Each return was prepared by a paid income tax return

preparer.   With respect to the items listed on the Schedules C,

petitioner provided the return preparer with the cash journal and

bank records for the business account.      For at least 1995, the

return preparer relied upon petitioner’s statement as to the

amount of income he earned through Grand Video.
                                  - 10 -

        The examination of petitioner’s returns for the years in

issue began in 1996.1      Petitioner failed to report interest

income, rental income, dividend income, and capital gains on his

original returns.       On May 7, 1997, petitioner filed Forms 1040X,

Amended U.S. Individual Income Tax Return, for 1993, 1994, and

1995.       On the amended returns, petitioner reported additional

income as follows:
                               1993        1994      1995

Interest income                $869      $133        $449
Sch. E net income               199     2,137         677
Dividend income                 777     2,377       2,844
Capital gain                  1,547     1,518      22,898
Sch. C net income             1,715       ---         ---
Total                        $5,107    $6,165     $26,868

On each amended return, petitioner indicated that he had

“inadvertently omitted” these items of income.

        On an application to open an investment account in 1993,

petitioner indicated that his income for that year was between

$30,000 and $49,999.       On an application for a credit card that

petitioner applied for in 1995 he indicated that his monthly

gross income from Grand Video was $7,000.

        Revenue Agent Keinle (Agent Keinle) conducted the

examination of petitioner’s returns.        During the course of the

examination, petitioner provided her with business and personal




        1
       The provisions of sec. 7491 are not applicable to this
proceeding.
                                - 11 -

expense records, the cash journal, asset records, and personal

and business bank records.    Agent Keinle concluded that

petitioner’s income for each year in issue could not be

accurately determined from his records, and she decided to

reconstruct petitioner’s income for each year using the net worth

method.

     During her examination, Agent Keinle interviewed petitioner

on at least five occasions.    Relying upon information that

petitioner provided during these interviews, information

contained in his records, and information obtained from third

parties, she computed his net worth and unreported income as

follows (For convenience, amounts are rounded to the nearest

dollar.):

Year ending          12/31/92      12/31/93   12/31/94      12/31/95

Total assets         $164,346     $240,370    $308,216    $378,660
Total liabilities     (16,120)     (52,367)    (85,077)   (114,270)
Net worth             148,226      188,003     223,139     264,389
Beginning net worth       ---     (148,226)   (188,003)   (223,139)
Net worth increase        ---       39,777      35,136      41,251
Adjustments               ---      (21,765)    (12,970)     (6,299)
Corrected AGI             ---       18,011      22,166      34,951
AGI per original return   ---       (7,964)     (4,408)     (2,841)
Unreported income         ---       25,975      26,574      37,792

     The assets included in the above computations are as

follows:
                                  - 12 -

Year ending            12/31/92      12/31/93   12/31/94   12/31/95

Cash on hand               $200          $200      $200        $200
Cash in banks2           55,201        98,859   142,041     109,560
Personal residence          ---           459       459         459
Investment property         ---           ---       ---      83,189
Rental property          20,000        20,306    20,306      20,306
Business assets          87,145       107,099   132,063     151,128
Goodwill                  1,000         1,000     1,000       1,000
Prepaid expenses            ---           ---       ---         670
Automobiles                 800        12,447    12,147      12,147

     The increases in petitioner’s net worth from year to year

are not attributable to gifts, inheritances, or nontaxable

sources of income.    In one interview, petitioner told Agent

Keinle that at the beginning of 1993 he had $60,000 in cash in a

safe in his house and approximately $40,000 in cash in that safe

at the end of 1995 (petitioner’s cash hoard).      At a subsequent

interview, petitioner estimated that he had $165,000 in cash in

his safe, but later suggested that this figure was a lifetime

high, rather than the amount in the safe at the start of 1993.

Agent Keinle interviewed third parties, reviewed petitioner’s

financial records, and examined petitioner’s tax returns, but she

was unable to corroborate petitioner’s claim that he had

accumulated a cash hoard.    She rejected petitioner’s claim of the

existence of a cash hoard and gave him no credit for such in her

net worth analysis.




     2
       The parties stipulated that “cash in banks” includes
petitioner’s investment accounts and securities.
                              - 13 -

     Petitioner’s returns for the years in issue also gave rise

to a criminal tax investigation conducted by Special Agent Dan

Wardlaw.   Petitioner told Special Agent Wardlaw that he had

approximately $140,000 in cash in his safe at the beginning of

1993, but only $5,000 to $10,000 at the end of 1995.

Discussion

     A taxpayer has a duty to maintain adequate records to show

whether or not the taxpayer is liable for Federal income tax.

Sec. 6001.   If a taxpayer fails to maintain or produce such

records, 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.   See,

e.g., Holland v. Commissioner, 348 U.S. 121 (1954); Petzoldt v.

Commissioner, 92 T.C. 661 (1989).

     Petitioner’s records for Grand Video consist of the business

account and a cash journal.   The cash journal does not record

income, and by comparing the annual business account deposits to

the gross income reported on Grand Video’s Schedule C it is clear

that not all of the income from Grand Video was deposited into

the business account.   Furthermore, although there was a cash

register in Grand Video’s store, it was not used to record rental

and sales transactions.   Because petitioner’s records do not

adequately demonstrate the amount of income he earned each year,

it was appropriate for respondent to use an indirect method to
                                - 14 -

reconstruct petitioner’s income for those years.    See Giddio v.

Commissioner, 54 T.C. 1530 (1970).

     According to respondent, the increase in petitioner’s net

worth from year to year is attributable to unreported income

received by petitioner during those years.    Respondent contends

that one likely source of omitted income is Grand Video.

Petitioner contends that respondent’s net worth analysis is

flawed because it fails to take into account petitioner’s cash

hoard.   According to petitioner, respondent’s failure to account

for his cash hoard results in an overstatement of the increase in

his net worth for each year in issue, which in turn results in an

overstatement of his income for those years.    Otherwise,

petitioner agrees with the items included in respondent’s net

worth analysis for each year.

     At trial, petitioner estimated that as of the beginning of

1993 he had approximately $150,000 in cash in his safe at home.

He claims that he saved between 80 and 90 percent of his earnings

over the years and that those savings were reduced to cash and

placed into his safe.   He further claims that he profited from

various real estate transactions and other investments over the

years, and that those profits were likewise converted to cash and

placed into his safe.   This claim, however, is contradicted by

other evidence in the record.    For example, petitioner claims

that the partnership he established in 1979 was profitable, but
                                - 15 -

his Social Security records, his Federal income tax returns for

1979 and 1980, and his former partner, who testified at trial,

indicate otherwise.

     A claim of the existence of a cash hoard is often “met with

some suspicion”, De Venney v. Commissioner, 85 T.C. 927, 933

(1985), and we are more than somewhat suspicious of petitioner’s

claim in this case.   Ignoring for the moment petitioner’s

inconsistent statements as to the amount of his cash hoard, after

careful consideration of other evidence in the record we, like

respondent, reject his claim.

      His earning history over the years, as indicated by Social

Security and income tax records, does not support the

accumulation of cash in any amount claimed by petitioner.    See

Petzoldt v. Commissioner, supra at 692.   According to petitioner,

he led a frugal lifestyle for most of his adult life and was able

to accumulate cash savings to the extent claimed.   Although they

do not provide a complete picture of his earnings, petitioner’s

Social Security records, when coupled with information in the

record regarding his Federal income tax returns filed in years as

far back as 1967, make petitioner’s claim that his frugal

lifestyle allowed him to accumulate a substantial cash hoard

completely incredible.   Moreover, if petitioner had access to the

amount of cash he claimed, we think it highly unlikely that he

would have allowed his house to be sold in a foreclosure sale in
                               - 16 -

1984, or allowed his truck to be repossessed in 1990.    It is

equally unlikely that petitioner, who behaved parsimoniously3

with respect to Grand Video, would be willing, as he claimed at

trial, to forgo the interest that he would have earned on his

cash accumulation if that cash were deposited into an interest-

bearing account, especially in those years where his Social

Security and income records indicate that he had little, if any,

income.

     The pattern in which cash deposits were made to petitioner’s

bank accounts also undermines petitioner’s claim to a substantial

cash hoard.   According to petitioner, he removed cash from his

safe from time to time and deposited the cash into his personal

bank accounts.   His explanation is in sharp contrast to the

pattern of cash deposits revealed by his bank records.    Those

records indicate that petitioner made frequent cash deposits into

his personal accounts at regular intervals during the years in

issue.

     The foregoing reasons to reject petitioner’s claim that he

had a substantial amount of cash in his safe at the beginning of

1993 are made more compelling after considering that, at the

beginning of 1993, he had in excess of $55,000 on deposit in



     3
       Petitioner recorded   in the cash journal many items costing
less than $1 and testified   that even if a Grand Video receipt had
been erroneously completed   he would not discard it because each
receipt cost approximately   $.20.
                              - 17 -

banks.   Accepting petitioner’s claim would require a finding

that, at the beginning of 1993, petitioner had cash savings that

substantially exceeded the total amount of his earnings during

the prior 30 years.   To the extent that petitioner was able to

accumulate cash savings over the years, we are satisfied that the

$55,201 credit for “cash in banks” that petitioner was given in

respondent’s net worth analysis adequately accounts for those

savings.

     We reject petitioner’s claim that respondent’s net worth

analysis is flawed.   We find no error in respondent’s failure to

take into account any cash accumulation not already accounted for

in the net worth analysis.   Petitioner does not claim that the

analysis is incorrect in any other way.   Furthermore, statements

made by petitioner in investment account and credit card

applications support respondent’s computations of petitioner’s

income for at least two of the years in issue.   Consequently,

respondent’s determination of the deficiency, as stipulated,4 for

each year in issue is sustained.

     Respondent determined that the underpayment of tax required

to be shown on petitioner’s return for each year is issue is due

to fraud.   Section 6663(a) imposes a 75-percent penalty on the

portion of any underpayment of tax that is attributable to fraud.


     4
       The stipulation effectively satisfies the provisions of
sec. 6214(a) with respect to respondent’s claims for increased
deficiencies for 1994 and 1995.
                              - 18 -

The Commissioner bears the burden of proof with respect to the

imposition of the fraud penalty for each year.   Sec. 7454(a);

Rule 142(b).   The Commissioner must establish by clear and

convincing evidence:   (1) There is an underpayment of tax; and

(2) some part of the underpayment of tax is due to fraud.

Bradford v. Commissioner, 796 F.2d 303, 307 (9th Cir. 1986),

affg. T.C. Memo. 1984-601; Powell v. Granquist, 252 F.2d 56, 60-

61 (9th Cir. 1958); Hebrank v. Commissioner, 81 T.C. 640, 642

(1983).   If the Commissioner establishes that any portion of an

underpayment is attributable to fraud, then the entire

underpayment is treated as being attributable to fraud, except

with respect to any portion of the underpayment which the

taxpayer establishes by a preponderance of evidence is not

attributable to fraud.   Sec. 6663(b).

     To prove the existence of an underpayment, the Commissioner

may not rely on a taxpayer’s failure to carry his or her burden

of proof with respect to the underlying deficiency.     Parks v.

Commissioner, 94 T.C. 654, 660-661 (1990).   However, the

Commissioner need not prove the precise amount of the

underpayment, but only that an underpayment exists.     Niedringhaus

v. Commissioner, 99 T.C. 202, 210 (1992); Petzoldt v.

Commissioner, 92 T.C. 661, 699-700 (1989).

     The amended return filed for each year in issue in this case

demonstrates that petitioner underpaid his tax on the original
                              - 19 -

return filed for each of those years.   In addition to the amended

returns, an underpayment of tax for each year is further

demonstrated by respondent’s net worth analysis, the validity of

which is supported by evidence in the record that establishes

both the existence of a likely source of unreported income (i.e.,

Grand Video), and the implausibility of petitioner’s claim to the

existence of a cash hoard not taken into account in the net worth

analysis.   See Parks v. Commissioner, supra at 661.    Respondent

has met his burden of establishing an underpayment of tax for

each year in issue by clear and convincing evidence.

     Respondent must also establish that a portion of the

underpayment of tax for each year is due to fraud.     Fraud will be

found if, at the time petitioner filed his return for each year

in issue, he “intended to evade taxes known to be owing by

conduct intended to conceal, mislead, or otherwise prevent the

collection of such taxes.”   Rowlee v. Commissioner, 80 T.C. 1111,

1123 (1983).

     Because fraudulent intent is seldom established by direct

evidence, it may be reasonably inferred from circumstantial

evidence, including evidence of a taxpayer’s course of conduct.

See United States v. Walton, 909 F.2d 915, 926 (6th Cir. 1990);

Rowlee v. Commissioner, supra; Stone v. Commissioner, 56 T.C.

213, 224 (1971).   Conduct that may indicate fraudulent intent,

commonly referred to as “badges of fraud”, includes, but is not
                                - 20 -

limited to:   (1) Repeated understatements of income over a period

of years, (2) inadequate books and records, (3) implausible or

inconsistent explanations of behavior, (4) concealment of

income or assets, (5) dealing in cash, and (6) engaging in

illegal activities.   See Bradford v. Commissioner, supra;

Niedringhaus v. Commissioner, supra at 211.    In one manner or

another, petitioner’s course of conduct throughout the years in

issue is described by these badges of fraud.

     Petitioner consistently understated his income for the 3

years before us in this case.    In 1993, the income he reported on

his Federal income tax return is substantially less than the

income he listed on an application to open an investment account.

Similarly, the gross income that petitioner reported on the

Schedule C included with his 1995 return is substantially less

than the business income he listed on a credit card application.

     Petitioner’s principal source of income during the years in

issue was his sole proprietorship, Grand Video.   Most of Grand

Video’s rentals and sales were cash transactions.   The store had

a cash register, but it was not used to record rental and sales

income.   Petitioner did not deposit all of the income from Grand

Video into the business account, and his cash journal does not

record cash income.   Petitioner could have tracked Grand Video’s

cash income through the use of the cash register, the business

account, or his cash log, but he elected not to do so.   The
                              - 21 -

business records that petitioner maintained for Grand Video are

hardly adequate to establish the amount of Grand Video’s gross

income for any of the years in issue.   Petitioner’s failure to

keep adequate books and records of his predominately cash

business provides strong support for the imposition of the fraud

penalties in this case.

     Additional support for the imposition of the fraud penalties

is found in the inconsistent and implausible claims that

petitioner made as to the existence of a substantial accumulation

of cash in his safe.   Petitioner made no less than three

different estimates of the amount of cash he had accumulated in

his safe at the beginning of 1993 and the amount that remained at

the close of 1995.   We note that his initial claim, i.e., $60,000

at the beginning of 1993 and $40,000 at the close of 1995, even

if true, would have had only a slight effect on respondent’s net

worth computations when spread over the 3-year period.    Our view

of petitioner’s cash hoard claim has been set forth above, and

there is no point in repeating it here.   Suffice it to say that

petitioner’s inconsistent and implausible claims that he

possessed a substantial cash hoard strongly support the

imposition of the fraud penalties in this case.

     Lastly, we cannot ignore petitioner’s practice of paying his

employees “under the table” until he was examined and fined by

Washington State authorities in 1995.   His conduct in this regard
                              - 22 -

suggests that he had little respect for Federal and State tax

requirements.   Furthermore, petitioner concealed these cash

payments not only by his failure to file the requisite Federal

and State employment tax returns, but by not claiming such

payments as deductible expenses on Grand Video’s Schedules C.

Petitioner’s willingness to give up what would otherwise be

allowable deductions strongly suggests the existence of

unreported cash income.

     After careful consideration, we find that respondent has

satisfied his burden of showing that the underpayment of tax

required to be shown on petitioner’s return for each year in

issue is due to fraud.

     Reviewed and adopted as the report of the Small Tax

Division.

     To reflect the foregoing,

                                         Decision will be

                                    entered for respondent.
