                  T.C. Summary Opinion 2006-49



                     UNITED STATES TAX COURT



            MICHAEL AND PENNY RHODES, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 17280-03S.              Filed April 11, 2006.



     Douglas E. Johnston, for petitioners.

     Timothy A. Lohrstorfer, for respondent.




     COUVILLION, Special Trial Judge:    This case was heard

pursuant to section 7463 in effect when the petition was filed.1




     1
      Unless otherwise indicated, subsequent section references
are to the Internal Revenue Code in effect for the years at
issue, and all Rule references are to the Tax Court Rules of
Practice and Procedure.
                                  - 2 -

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

and this opinion should not be cited as authority.

     Respondent determined the following deficiencies in Federal

income taxes and the penalties for fraud under section 6663(a):


                                                  Penalty
     Year            Deficiency                 Sec. 6663(a)

     1994              $3,360                      $2,520
     1995               2,623                       1,967


     The issues for decision are:     (1) Whether petitioners are

entitled to deduct on Schedules C, Profit or Loss From Business,

losses in the amounts of $19,738.50 and $17,125.39, respectively,

for 1994 and 1995, and (2) whether petitioner wife Penny Rhodes

(Ms. Rhodes) is liable for section 6663(a) penalties for fraud

with respect to the joint 1994 and 1995 Federal income tax

returns of her and her spouse.

     Some of the facts were stipulated.     Those facts, with the

annexed exhibits, are so found and are incorporated herein by

reference.   Petitioners’ legal residence at the time the petition

was filed was Garrett, Indiana.

     During the years at issue, petitioners lived and worked in

Garrett, Indiana.   Petitioner husband (Mr. Rhodes) was a railroad

brakeman and conductor for CSX Transportation, Inc., during the

years at issue.   Beginning in 1993 and during the years at issue,

Ms. Rhodes operated Keepsake Designer Creations (Keepsake), a
                                 - 3 -

sewing, crafts, and floral arrangement activity.     Ms. Rhodes’s

background consisted of high school and 1 year of a vocational

school where she studied medical assisting.    She has no formal

training in sewing or floral arrangements.2    Petitioners also

became Amway sale distributors on January 29, 1990, and continued

in this activity during the years at issue.    Ms. Rhodes primarily

conducted the Amway activity.    Ms. Rhodes was responsible for

maintaining the books and records for both Keepsake and Amway.

     Petitioners timely filed joint Federal income tax returns

for 1994 and 1995.     They reported the following amounts from the

aforesaid activities on their Schedules C for 1994 and 1995:


Keepsake                       1994                     1995

Gross income                $18,396.42              $ 6,286.58
Expenses
     Car and truck           10,035.16                3,772.80
     Insurance                  396.74                  378.00
     Office expenses            110.87                   97.32
     Supplies                24,564.98               10,973.16
     Utilities                  623.64                  237.14
     Other expenses             148.00                  658.19
Total expenses               35,879.39               16,116.61
Net loss                    $17,482.97              $ 9,830.03




     2
      Ms. Rhodes enrolled in a continuing education class for
floral designing through Indiana-Purdue University after the tax
years in question.
                                 - 4 -

Amway                          1994                    1995

Gross income               $   157.49              $   999.17
Expenses
     Car and truck          1,672.43                 6,830.70
     Insurance                396.74                   378.00
     Office expenses           75.37                   -0-
     Legal                    -0-                       25.00
     Supplies                 -0-                      127.67
     Utilities                211.48                   873.16
     Other expenses            57.00                    60.00
Total expenses              2,413.02                 8,294.53
Net loss                   $2,255.53                $7,295.36


     In the notice of deficiency, respondent disallowed the

losses resulting from the claimed deductions for the reported

expenses because petitioners (1) were not operating for profit a

business under section 183, or, in the alternative (2) failed to

substantiate the expenses of the two activities.   Additionally,

respondent determined all documentation submitted by petitioners

in support of the reported expenses was false and determined the

section 6663 fraud penalty with respect to those activities.3

     Deductions are a matter of legislative grace, and the

taxpayer bears the burden of proving entitlement to any

deductions claimed.    Rule 142(a); INDOPCO, Inc. v. Commissioner,

503 U.S. 79, 84 (1992).   The taxpayer is required to identify


     3
      The notice of deficiency is addressed jointly to both
petitioners. In the determination of fraud, the notice of
deficiency does not specify that it is determined only as to Ms.
Rhodes. As such, the Court construes the notice of deficiency as
a determination of fraud against both petitioners; however, at
trial and on brief, respondent asserts that the fraud penalty is
only against Ms. Rhodes. Respondent, therefore, is deemed to
have conceded the fraud penalty as to Mr. Rhodes.
                                   - 5 -

each deduction available and show that all requirements have been

met.       New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440

(1934).       It is also the taxpayer’s responsibility to maintain

records sufficient to enable the Commissioner to determine the

correct tax liability.      Sec. 6001; sec. 1.6001-1(a), Income Tax

Regs.4

       The first issue is whether petitioners are entitled to

deduct the expenses that created net operating losses.

Respondent asserts that petitioners did not engage in the

activities with the requisite profit objectives, and,

alternatively, that, if petitioners operated the businesses for

profit, they failed to substantiate the expenses reported on

their Schedules C in excess of the reported gross income.         The

Court agrees with respondent.5

       Section 162 allows a deduction for ordinary and necessary

expenses that are paid or incurred during the taxable year in




       4
      Under sec. 7454(a), the burden of proof as to fraud is on
the Commissioner. As to all other issues, sec. 7491(a), in some
instances, shifts the burden of proof to the Commissioner but
only as to the examination of taxpayers’ returns that commenced
after July 22, 1998. The examination in this case commenced in
1996; therefore, the Court does not need to address sec. 7491(a).
       5
      Because the Court holds that petitioners may not deduct the
excess of the claimed Schedule C expenses so as to create net
operating losses for the years at issue due to lack of
substantiation, it is not necessary to address whether
petitioners were in fact operating a business for profit.
                               - 6 -

carrying on a trade or business.   Sec. 162(a); Deputy v. duPont,

308 U.S. 488, 495 (1940).

     Petitioners deducted $24,564.98 and $10,973.16 for supplies

for Keepsake in 1994 and 1995, respectively.   In the examination

of the 1994 return, Ms. Rhodes presented numerous receipts to

substantiate the claimed deductions.   Those receipts totaled

almost $31,000, $6,000 more than what was claimed on the 1994 tax

return.   For 1995, Ms. Rhodes’s receipts from the purported

suppliers, Frank’s Nursery and Crafts, Inc. (Frank’s), alone

totaled $2,557.14 more than the amount claimed for supplies on

that year’s return.

     When respondent’s examining agent questioned Ms. Rhodes

about her receipts, she claimed to have purchased the bulk of her

supplies from Frank’s, a significant amount from a craft store

named the Silk Shop, and the remainder from various stores such

as Michael’s or Wal-mart.

     With respect to purchases at Frank’s, Ms. Rhodes submitted

to the examiner and entered into evidence at trial purchase

orders from 1994 and 1995 totaling $24,076 and $13,530.30,

respectively.   The purchase orders were generic and bore Frank’s

name and address typed in the upper left-hand corner.   The

transactions were handwritten and reflected that Ms. Rhodes paid

cash in amounts between $2,500 and $9,000 to an individual

referred to as “C.O.” for flowers, greenery, and other craft
                               - 7 -

products.   Ms. Rhodes stated that C.O. was a Frank’s employee

whose name was Chloe.   At trial, several employees and managers

of Frank’s testified that the purchase orders presented by Ms.

Rhodes were not from Frank’s, the store only sold items wholesale

from corporate headquarters, and the locations from which Ms.

Rhodes stated she bought the supplies did not have enough cash

receipts on the days in question to support purchases in the

amounts petitioners claimed.   Additionally, the corporate human

resources manager for Frank’s during the years in question

testified that he and another human resources employee verified

that no Chloe, Chloe O., or C.O. had ever worked at the Frank’s

locations where Ms. Rhodes claimed she made her purchases.

     Although Ms. Rhodes told the examiner that all her purchases

were made inside the Frank’s store, she testified at trial that

she purchased her merchandise in the parking area of the store

off the back of a large truck that was attended to by Chloe, whom

she believed was a Frank’s employee.    She testified that,

although Frank’s had refused to sell merchandise wholesale to

her, Chloe approached her and offered to sell the merchandise to

her at wholesale prices.   Ms. Rhodes claimed that Chloe would

call her whenever a new “shipment” arrived and then she would

meet Chloe in the parking lot of Frank’s and complete the sale.

Chloe dealt only in cash and gave Ms. Rhodes a Frank’s purchase

order at the end of each transaction.    Ms. Rhodes testified she
                               - 8 -

was not suspicious as to the manner her transactions were handled

and stated the products were “cheaper than Frank’s and better

quality”.   She acknowledged, however, that, although she believed

she was dealing with Frank’s at the time, “to my knowledge now,

looking back, hindsight, I guess I wasn’t”.

     Several Frank’s employees testified at trial that it would

not have been possible for Ms. Rhodes to purchases items

wholesale from Chloe in the parking lot of Frank’s without

drawing the attention of the other employees.    Frank’s employees

often worked outside in the warmer months selling lawn items, and

none of them ever saw a woman matching Chloe’s description, or

anyone else, selling items from a large white truck.   Also, there

are several large windows in the front of every Frank’s where

employees may look out onto the parking lot, and no one ever

witnessed the transactions Ms. Rhodes claimed.   Finally, Frank’s

employees testified that Ms. Rhodes could not have been able to

drive “around back” of Frank’s and purchase items off the loading

dock, because that area was restricted from customers and

monitored by employees.   If a customer attempted to drive behind

Frank’s, an employee would immediately notice and investigate.

     With respect to purchases Ms. Rhodes claimed she made at the

Silk Shop, she testified that the Silk Shop was no longer in

business when she was audited but had been located in Coldwater,

Michigan.   Ms. Rhodes, however, could offer no specific address
                                 - 9 -

or telephone number for the Silk Shop either to the examiner or

at trial.   The examiner investigated her claim and found that

there had never been a business called the Silk Shop in or around

Coldwater, Michigan, and neither the Chamber of Commerce nor the

County Clerk’s office had any record of a store by that name.

Furthermore, respondent offered evidence at trial from area

telephone books and city directories for the years 1993, 1994,

and 1995; none had a listing for a Silk Shop in or around

Coldwater, Michigan.

     The Court finds that Ms. Rhodes at no time purchased items,

either retail or wholesale, from Frank’s, the Silk Shop, or any

other store.    Moreover, the Court also finds that Ms. Rhodes did

not purchase items “off the back of a truck” from someone who she

“believed worked for Frank’s”.    The Court finds that the

transactions never occurred.

     On their Schedules C for Keepsake, petitioners deducted car

and truck expenses of $10,035.16 and $3,772.80 for 1994 and 1995,

respectively.    With respect to travel expenses and certain other

expenses, such as expenses relating to the use of listed

properties under section 280F(d)(4)(A), including passenger

automobiles and any other property used as a means of

transportation, section 274(d) imposes stringent substantiation

requirements to document particularly the nature and amount of

such expenses.   For such expenses, substantiation of the amounts
                              - 10 -

claimed by adequate records or by other sufficient evidence

corroborating the expenses is required.   Sec. 274(d); sec. 1.274-

5T(a)(1), Temporary Income Tax Regs., 50 Fed. Reg. 46014 (Nov. 6,

1985).   To meet the adequate records requirements of section

274(d), a taxpayer “shall maintain an account book, diary, log,

statement of expense, trip sheets, or similar record * * * and

documentary evidence * * * which, in combination, are sufficient

to establish each element of an expenditure”.   Sec. 1.274-

5T(c)(2)(i), Temporary Income Tax Regs., 50 Fed. Reg. 46017 (Nov.

6, 1985).   These substantiation requirements are designed to

encourage taxpayers to maintain records, together with

documentary evidence substantiating each element of the expense

sought to be deducted.   Sec. 1.274-5T(c)(1), Temporary Income Tax

Regs., 50 Fed. Reg. 46016 (Nov. 6, 1985).

     Ms. Rhodes’s records with respect to her car and truck

expenses for Keepsake do not satisfy the requirements of section

274(d) and the regulations cited.   Ms. Rhodes testified she often

drove to numerous stores searching for the best prices for

supplies, and, in addition, she drove to a variety of locations

to meet with clients and then later drove to wedding or funeral

locations to deliver flowers and other decorative arrangements.

She kept track of her mileage by writing locations and/or miles

driven on a daily calendar.   The total miles recorded on her

calendars for both years, however, do not match the mileage she
                               - 11 -

reported on the 1994 and 1995 tax returns.      In addition,

respondent pointed out numerous inconsistencies in petitioners’

records at trial.   Several times, Ms. Rhodes listed a mileage

amount that she claimed was to give a wedding estimate, but there

was no location listing where she drove.      At trial, Ms. Rhodes

was unable to identify any of these missing locations, nor could

she remember the names of people she purportedly met for wedding

estimates.   Other times, Ms. Rhodes listed travel to a particular

store to buy supplies but could furnish no receipts to support

the purchases.   Several transactions, such as supplies trips,

were listed twice on her calendar.      Finally, Ms. Rhodes often

grossly overestimated the miles she drove to a particular

location.    For instance, she claimed she drove from Garrett to

Toledo to give a wedding estimate.      The calendar listed mileage

of 542.4; however, the distance between Garrett and Toledo is 133

miles; therefore, the round trip distance would be 266 miles.

Ms. Rhodes offered no explanation for these inconsistencies.

     Ms. Rhodes claims she and Mr. Rhodes never purchased new

tires, had any repair work done, or paid for oil changes, nor did

she have any documentation of her odometer readings for 1994 or

1995.   Thus, petitioners failed to present any independent

evidence supporting the mileage claims.      The Court finds that all

of Ms. Rhodes’s records relating to mileage reported in support

of Keepsake are false based on the absence of records and other
                               - 12 -

testimony at trial.   Petitioners’ car and truck expenses were not

properly substantiated under the cited legal authority.

     On the other Schedules C of the tax returns for 1994 and

1995, petitioners deducted car and truck expenses, supplies,

insurance, office expenses, and utilities for an Amway activity.

Ms. Rhodes was also responsible for all record keeping for this

activity.   Petitioners deducted car and truck expenses of

$1,672.43 and $6,830.70, respectively, for 1994 and 1995.    The

extent of the records substantiating the mileage reported for

Amway trips was a total mileage number listed at the top of

monthly calendars.    On Ms. Rhodes’s monthly calendars for 1995,

she listed 27,135 miles driven in support of the Amway activity

but only reported 22,769 miles on their 1995 return.    Similarly,

Ms. Rhodes’s monthly calendars for 1994 listed total mileage of

10,239.7; however, only 5,767.4 miles for travel was reported on

their 1994 return.    Ms. Rhodes offered no explanation for the

discrepancies at trial.   In addition, Ms. Rhodes’s records for

the Amway activity were as vague as the records for Keepsake.

When Ms. Rhodes went out to recruit distributors, she would

simply write “Prospecting Day” and a list of first names with

mileage amounts beside them.    She could offer up no more

specifics on people or locations; however, Ms. Rhodes claimed she

had turned over a log book containing specific records to the

examiner.   The examiner testified that a log book was never
                                - 13 -

presented to him, and the Court finds his testimony credible.

Therefore, as above, petitioners failed to properly substantiate

their car and truck expenses.

     As for petitioners’ office expenses and utilities, their

personal residence is listed on the Schedules C for both

activities as the business address.      Petitioners offered no

documentation or testimony showing they were entitled to

deductions for a home office, nor was any evidence offered to

substantiate the deductions for either year.      Therefore, the

claimed deductions are disallowed in their entirety.

     Finally, petitioners claimed supplies deductions for 1994

and 1995.    Ms. Rhodes offered scant documentation supporting

these particular business expenses but submitted a few receipts

that were purportedly signed by her upline distributor, Kelli

Kaufman.    Ms. Kaufman, however, denied it was her signature on

those receipts.    Some of the receipts Ms. Rhodes alleged were

signed by Ms. Kaufman are dated after Ms. Kaufman ceased

participating in Amway.    In light of the other false

documentation Ms. Rhodes presented, the Court finds Ms. Kaufman’s

testimony credible and finds that all documents submitted by

petitioners in support of their Amway expenses are false.

Petitioners are not entitled to the deductions for the expenses

claimed on their return relating to this activity.
                              - 14 -

     The Court accordingly finds that petitioners failed to

substantiate any of the expenses in connection with either the

Keepsake or Amway activity.   The deductions claimed with respect

to these activities, for both years, are disallowed to the extent

they exceed the income reported for the activities on

petitioners’ Schedules C.

     Although the record is not entirely clear as to the extent

petitioners operated their activities and generated expenses, in

the notice of deficiency, respondent did not determine that the

reported gross receipts for the 2 years were false or fictitious.

Respondent only determined that the expenses claimed in excess of

the gross income were false, fictitious, and fraudulent.    In

fact, respondent allowed deductions for business expenses for

Keepsake and Amway to the extent of the reported gross receipts,

$18,553.91 and $7,285.75 for 1994 and 1995, respectively.     As

respondent does not challenge whether petitioners received income

from either activity, it follows that petitioners generated some

expenses in the operation of both Keepsake and Amway.   Therefore,

respondent’s determination is sustained and petitioners are not

entitled to any of the Schedule C losses for either Keepsake or

Amway for tax years 1994 and 1995.
                              - 15 -

     The final issue is whether Ms. Rhodes6 is liable for fraud

under section 6663(a)7 for the years at issue.    Respondent has

the burden of proving by clear and convincing evidence that (1)

Ms. Rhodes underpaid her tax each year at issue, and (2) that

some part of the underpayment is due to fraud.    Sec. 6663(a);

Parks v. Commissioner, 94 T.C. 654, 660-661 (1990).

     Fraud means actual, intentional wrongdoing, and the intent

required is the specific purpose to evade a tax believed to be

owing.   Candela v. United States, 635 F.2d 1272 (7th Cir. 1980);

Stoltzfus v. United States, 398 F.2d 1002, 1004 (3d Cir. 1968);

Mitchell v. Commissioner, 118 F.2d 308 (5th Cir. 1941), revg. 40

     6
      As previously noted, respondent conceded at trial that Mr.
Rhodes was not liable for the sec. 6663(a) penalty for the 2
years at issue.
     7
      Sec. 6663 provides:

         SEC. 6663. IMPOSITION OF FRAUD PENALTY
            (a) Imposition of Penalty.--If any part of any
         underpayment of tax required to be shown on a return
         is due to fraud, there shall be added to the tax an
         amount equal to 75 percent of the portion of the
         underpayment which is attributable to fraud.
            (b) Determination of Portion Attributable to
         Fraud.--If the Secretary establishes that any
         portion of an underpayment is attributable to fraud,
         the entire underpayment shall be treated as
         attributable to fraud, except with respect to any
         portion of the underpayment which the taxpayer
         establishes (by a preponderance of the evidence) is
         not attributable to fraud.
            (c) Special Rule for Joint Returns.--In the case
         of a joint return, this section shall not apply with
         respect to a spouse unless some part of the
         underpayment is due to the fraud of such spouse.
                              - 16 -

B.T.A. 424 (1939); Wilson v. Commissioner, 76 T.C. 623, 634

(1981).   The Commissioner must show that the taxpayer intended to

evade taxes by conduct calculated to conceal, mislead, or

otherwise prevent the collection of taxes.     Stoltzfus v. United

States, supra; Marcus v. Commissioner, 70 T.C. 562, 577 (1978),

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

     Fraud is a question of fact that must be considered based on

an examination of the entire record and the taxpayer’s entire

course of conduct.   Petzoldt v. Commissioner, 92 T.C. 661, 699

(1989); Recklitis v. Commissioner, 91 T.C. 874, 910 (1988);

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

never presumed and must be established by independent evidence of

fraudulent intent.   Petzoldt v. Commissioner, supra at 699;

Recklitis v. Commissioner, supra at 910.     Fraud is never imputed

or presumed, and courts will not sustain fraud on circumstances

that at most create only suspicion.    Olinger v. Commissioner, 234

F.2d 823, 824 (5th Cir. 1956), affg. in part and revg. in part

T.C. Memo. 1955-9; Davis v. Commissioner, 184 F.2d 86, 87 (10th

Cir. 1950); Green v. Commissioner, 66 T.C. 538, 550 (1976).      Mere

suspicion does not prove fraud, and the fact that the Court does

not find the taxpayer’s testimony wholly credible is not

sufficient to establish fraud.   Cirillo v. Commissioner, 314 F.2d

478, 482 (3d Cir. 1963), affg. in part and revg. in part T.C.
                               - 17 -

Memo. 1961-192; Shaw v. Commissioner, 27 T.C. 561, 569-570

(1956), affd. 252 F.2d 681 (6th Cir. 1958).

     Although mere suspicion is not enough, fraud may be proven

by circumstantial evidence, and reasonable inferences may be

drawn from the facts because direct evidence is rarely available.

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

(2d Cir. 1992); Petzoldt v. Commissioner, supra at 699;

Delvecchio v. Commissioner, T.C. Memo. 2001-130, affd. 37 Fed.

Appx. 979 (11th Cir. 2002).

     Circumstantial evidence that may give rise to a finding of

fraud includes:   (1) Understatement of income; (2) inadequate

records; (3) failure to file tax returns; (4) providing

implausible or inconsistent explanations of behavior; (5)

concealment of assets; (6) failure to cooperate with taxing

authorities; (7) filing false Forms W-4, Employee’s Withholding

Allowance Certificate; (8) failure to make estimated tax

payments; (9) dealing in cash; (10) engaging in illegal activity;

(11) attempting to conceal illegal activity; (12) engaging in a

pattern of behavior that indicates an intent to mislead; and (13)

filing false documents.    Bradford v. Commissioner, 796 F.2d 303,

307 (9th Cir. 1986), affg. T.C. Memo. 1984-601; Niedringhaus v.

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

Commissioner, T.C. Memo. 2003-130.      These “badges of fraud” are

not exclusive.    Niedringhaus v. Commissioner, supra at 211;
                                - 18 -

Miller v. Commissioner, 94 T.C. 316, 334 (1990).    Additionally,

the taxpayer’s background may be examined to establish fraud.

Spies v. United States, 317 U.S. 492, 497 (1943); Niedringhaus v.

Commissioner; supra at 211; Walters v. Commissioner, T.C. Memo.

1995-543.

     A consistent pattern of understating income may be strong

evidence of fraud.     Delvecchio v. Commissioner, supra (citing

Holland v. United States, 348 U.S. 121, 137 (1954)); Camien v.

Commissioner, 420 F.2d 283, 287 (8th Cir. 1970), affg. T.C. Memo.

1968-12; Williams v. Commissioner, T.C. Memo. 1992-153

(“petitioner has consistently and substantially understated his

income, a fact that even, ‘standing alone, is persuasive evidence

of fraudulent intent to evade taxes.’” (quoting Estate of Beck v.

Commissioner, 56 T.C. 297, 364 (1971))), affd. 999 F.2d 760 (4th

Cir. 1993).   It has been held that discrepancies of 100 percent

or more between the correct net income and the reported net

income for 3 successive years provide strong evidence of

fraudulent intent.     Hargis v. Godwin, 221 F.2d 486, 490 (8th Cir.

1955); Rogers v. Commissioner, 111 F.2d 987, 989 (6th Cir. 1940);

Adams v. Commissioner, T.C. Memo. 1979-305.    Moreover, fraudulent

understatement of income may be established by overstatement of

Schedule C expenses.     Drobny v. Commissioner, 86 T.C. 1326, 1349

(1986), affd. 113 F.3d 670 (7th Cir. 1997); Clark v.

Commissioner, T.C. Memo. 1991-313.
                                - 19 -

      Because the Court concludes that Ms. Rhodes did not

purchase items wholesale from Frank’s, or anyone claiming to be

associated with Frank’s, it follows that Ms. Rhodes manufactured

fake purchase orders solely to inflate her Schedule C expenses

for Keepsake.   In addition, Ms. Rhodes went to great lengths to

increase her expenses by fabricating trips for both Amway and

Keepsake to purchase supplies, give estimates, make deliveries,

and “prospect”, even going as far as to write places and mileage

on a monthly calendar.   She then claimed deductions for car and

truck expenses for both Amway and Keepsake.    Ms. Rhodes’s gross

overstatement of her Schedule C expenses establishes fraud.

Drobny v. Commissioner, supra at 1349; Clark v. Commissioner,

supra.   Furthermore, the Court has held that keeping inadequate

records, providing implausible or inconsistent explanations of

behavior, dealing in cash, engaging in a pattern of behavior that

indicates an intent to mislead, and failing to cooperate with tax

authorities provides circumstantial evidence that may give rise

to a finding of fraud.   Bradford v. Commissioner, supra;

Christians v. Commissioner, supra; Niedringhaus v. Commissioner,

supra.   Respondent showed at trial that Ms. Rhodes did each of

these.   She fabricated records that were inconsistent with her

claimed deductions.   When asked at trial to substantiate the

claimed expenses and deductions, Ms. Rhodes’s explanations were

vague and highly implausible.    She claimed to have dealt with
                              - 20 -

Chloe and her customers solely in cash, but there were no large

cash withdrawals from her bank account, and the only deposits

came from Mr. Rhodes’s paycheck.   She gave one explanation of her

buying relationship with Chloe to the examiner but a completely

different account at trial.   The evidence satisfies the Court

that there was no individual by the name of Chloe, and no other

individual sold Ms. Rhodes supplies for Keepsake.   In addition,

Ms. Rhodes’s documentation supporting her expense deductions was

fabricated solely to increase her Schedule C deductions and

create net operating losses for both Keepsake and Amway.

     Respondent determined that Ms. Rhodes’s actions constituted

fraud, and the Court sustains that determination.   Therefore, Ms.

Rhodes is liable for the section 6663(a) penalties for tax years

1994 and 1995.8

     Reviewed and adopted as the report of the Small Tax Case

Division.

                                    Decision will be entered

                               for respondent, except as to the

                               section 6663(a) penalty against

                               petitioner Michael Rhodes.


     8
      Ms. Rhodes presented evidence that the criminal division of
the IRS investigated her and declined to prosecute for criminal
fraud. This fact, while considered, is not dispositive as the
Court considered the entire record and Ms. Rhodes’s entire course
of conduct in its determination. Petzoldt v. Commissioner, 92
T.C. 661, 699 (1989); Recklitis v. Commissioner, 91 T.C. 874, 910
(1988); Rowlee v. Commissioner, 80 T.C. 1111, 1123 (1983).
