                         T.C. Memo. 2011-68



                       UNITED STATES TAX COURT



   ELIZABETH J. PRATER, Petitioner v. COMMISSIONER OF INTERNAL
                       REVENUE, Respondent

    CHARLES B. PRATER, Petitioner v. COMMISSIONER OF INTERNAL
                       REVENUE, Respondent



     Docket Nos. 9314-06, 9317-06.      Filed March 24, 2011.



     David De Coursey Aughtry and George B. Abney, for

petitioners.

     Brianna B. Taylor, for respondent.



               MEMORANDUM FINDINGS OF FACT AND OPINION


     GOEKE, Judge:     Respondent determined deficiencies in

petitioners’ Federal income tax and penalties as follows:
                                    - 2 -

                                             Penalties
           Year        Deficiency           Sec. 6663(a)

           1991          $24,905            $18,678.75
           1992           83,746             62,809.50
           1993          437,444            328,083.00

     After concessions1 the issues for decision are:

     (1)   Whether petitioners failed to report income of $78,000,

$262,281, and $1,178,428 for 1991, 1992, and 1993, respectively,

related to a trucking business of which Mr. Prater was part

owner; and

     (2)   whether Mr. Prater is liable for section 66632 civil

fraud penalties of $18,678.75, $62,809.50, and $328,083 for years

1991, 1992, and 1993, respectively.

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

     The record in this case also includes a lengthy trial record

and voluminous exhibits.    Many of these exhibits had previously

been admitted in a criminal prosecution of Mr. Prater and other

defendants, but much of the evidence was first admitted in the

present case.     Both this case and the prior criminal case against

Mr. Prater center on his activities as coowner and manager of

     1
      Respondent concedes that Mrs. Prater is not liable for the
sec. 6663(a), I.R.C., fraud penalty. Mrs. Prater concedes her
sec. 6015, I.R.C., innocent spouse claim.
     2
      Section references are to the Internal Revenue Code in
effect for the years at issue, and Rule references are to the Tax
Court Rules of Practice and Procedure.
                                - 3 -

Carpet Transport, Inc. (CTI).    There is no doubt that Mr. Prater

caused receipts from CTI’s business to be omitted from CTI’s

books and records and also from CTI’s income tax returns.      What

Mr. Prater caused to happen to the cash is factually complex, and

the extent to which he is deemed the recipient of the income is

determined herein.    On the record before us, we also determine

that Mr. Prater is subject to the 75-percent fraud penalty.

                          FINDINGS OF FACT

      At the time of filing their petitions, petitioners resided

in Georgia.    Mr. Prater served as a member of the city council in

Plainville, Georgia, for 8 years.    He also served as mayor of

Plainville, Georgia, for 8 years.    Mr. Prater operated a number

of businesses before CTI, including a dump truck business and a

used car business.    He is an intelligent and hard–working

businessman.

1.   Carpet Transport, Inc.

      In 1978 Mr. Prater acquired a one-third ownership interest

in CTI.    The company had approximately 600 trucks and 1,000

employees by the early 1990s.    CTI was headquartered in Calhoun,

Georgia.    CTI operated as a common carrier providing motor

freight transportation through the 48 States of the continental

United States.    CTI’s primary cargo was carpet.
                                 - 4 -

     Mr. Prater acquired a one-third interest in CTI in January

1978, with Lynwood S. Warmack (Mr. Warmack) and Gary Owens (Mr.

Owens).    In the early 1990s Mr. Owens passed away, and Mr. Prater

and Mr. Warmack purchased Mr. Owens’ interest and became the sole

owners of CTI.

     (a)   CTI:   Backhaul

     After CTI completed a delivery from its headquarters to

another destination, CTI would try to arrange a “backhaul” trip.

A backhaul is the delivery of cargo from as close to the first

delivery as possible to as close to CTI’s headquarters in

Calhoun, Georgia, as possible.    The goal of a backhaul is to

avoid having a truck travel long distances without any cargo.

Mr. Prater arranged all backhaul trips for CTI.      The checks

received for backhauls were given to Mr. Prater by the drivers

when they returned from their trips.      The checks would be paper

clipped to the outside of the trip envelopes, and Mr. Prater

would then pay the drivers 25 percent of the backhaul amounts.

Mr. Prater would place the freight bills that were attached to

the backhaul checks in garbage bags.      He would then endorse the

checks and take control over them.       Generally, Mr. Prater would

give the checks to CTI employees to have the checks cashed and

the cash distributed as he directed.
                                  - 5 -

       From 1991 to 1993 backhaul checks totaling $3,553,446 were

not deposited into CTI’s bank accounts.      Specifically,

$544,822.82, $821,886.67, and $2,186,735.86 in backhaul checks

were not deposited into CTI’s bank accounts in 1991, 1992, and

1993, respectively.      A portion of the cash from the backhaul

checks was used to pay the drivers, and large amounts were

provided to W.J. Plemons Insurance, Inc. (PI), and held in a

prepaid insurance account in CTI’s name.

       (b)   CTI:   Department of Transportation Regulations

       The Department of Transportation (DOT) regulated and limited

the number of hours that truck drivers could drive.      The DOT

required truck drivers to keep logs, which were then inspected by

DOT.    The logs would provide the driver’s departure time, when

the driver stopped, and for how long.      A driver would be “off-

log” if he drove miles or hours not recorded as required.      The

DOT would then compare the drivers’ logs for consistency against

other documents, such as toll or gas receipts, which often had a

timestamp.     The DOT shut down CTI at least once for having too

many drivers driving “off-log”.      The DOT also fined CTI several

times with penalties as high as $70,000.
                                 - 6 -

     (c)    CTI:   Off-Log Hours and Expenses

     Legally, truck drivers could work only 60 hours per week.

Mr. Prater would pay the drivers in cash for work beyond 60 hours

per week.    Mr. Prater did not require the workers to sign any

documentation when he gave them cash payments, and he did not

appear to keep any record of the cash payments made.     CTI kept

two sets of timecards and separately recorded work done by a

driver when he worked over 60 hours a week.

     A driver submitted a trip envelope at the end of each trip

listing expenses for the trip on the outside of the envelope and

placing the receipts from the trip inside the envelope.     If a

driver had either fuel or toll tickets that did not match the DOT

logs, Mr. Prater would give the driver cash for those receipts in

lieu of having the driver submit the expense in the trip

envelope.    Mr. Prater claims that he paid these expenses in cash

to conceal from the DOT the off-log driving.     Mr. Prater would

then take the receipts for which he had paid cash and place them

into a garbage bag which was taken to storage.     Sometimes the

dates on the receipts were changed to avoid discovery of the

violation of the DOT regulations.     The receipts retrieved from

the garbage bags in storage totaled $22,060.63, $661,382.85, and

$252,294.60 for tax years 1991, 1992, and 1993, respectively.
                                - 7 -

     (d)   CTI: Cashing of Advance and Payroll Checks for Drivers
           by Mr. Prater

     CTI provided drivers pretyped advance checks of $50 before

they departed on deliveries.    This allowed the drivers to get

started right away without having to stop somewhere to cash their

advance checks.    The checks were drawn on a CTI special account

and were pretyped so the dispatchers could not write the checks

for different amounts.    The dispatchers cashed these checks for

the drivers.   Mr. Prater also cashed advance checks for the

drivers and sometimes cashed the drivers’ paychecks for them.

     Many of the first endorsements on the CTI special and

payroll checks were not made by the payees.    Many of the checks

were cashed by the drivers’ wives or roommates while drivers were

out of town driving for CTI because the drivers were not

available to sign the checks.

     (e)   CTI:   Other Cash Payments

     Mr. Prater would sometimes reimburse drivers for expenses

after trips with cash.    Mr. Prater would also pay cash bonuses to

drivers for “hot loads”, which were shipments that needed to be

shipped as soon as possible.    No record of such cash bonuses was

maintained.    Further, CTI employees, such as dispatchers, were

paid in cash on occasion.    For example, Mr. Wright, a full-time

dispatcher, was originally paid $300 weekly by check and $100 in
                                 - 8 -

cash.    Mr. Prater told Mr. Wright not to worry about being paid

in cash “because everyone cheats the IRS”.

     Mr. Prater testified that he paid the drivers in cash as an

incentive to keep them with CTI; he further explained that the

drivers wanted to be paid in cash.       Often the drivers drove more

hours than the DOT allowed, and cash payments concealed these

violations.

     (f)    CTI:   Other Cash Income or Cash To Pay Expenses

     Mr. Prater would arrange trips for CTI clients who paid for

exclusive-use loads, whereby the client would have use of a whole

trailer.    The clients would pay for this service in cash, which

was given to Mr. Prater.

        As a result of these cash dealings, there were occasions

when a substantial amount of cash was lying around Mr. Prater’s

office.

     (g)    Side Business

     CTI had a side business of selling carpet.      If a cargo of

carpet was damaged in shipment, the carpet retailer might not

accept it.    As a result, CTI would often have to absorb the cost

of the damaged carpet and sold the excess carpet to wholesalers

or smaller companies.
                                - 9 -

2.   W.J. Plemons Insurance

     William J. Plemons owned PI, an insurance agency working

primarily with freight carriers.   PI customers would pay PI, and

PI in turn would pay the insurance carriers after deducting

commissions.   PI wrote insurance policies for CTI and personal

insurance policies for Mr. Prater.      PI provided various insurance

policies for CTI, including automobile and truck liability

insurance, cargo insurance, workers compensation insurance, and

terminal coverage insurance.    PI would set up multiple accounts

for larger clients, like CTI.   CTI paid fees for liability and

cargo insurance based upon gross miles driven or gross receipts.

The premiums paid were based on estimates.     Since CTI operated

hundreds of trucks, a number of claims could arise; and

consequently PI arranged to hold funds for CTI to pay the

deductibles as accidents or as insured incidents arose.     This

reserve account was also used to hold large amounts of off-book

receipts of CTI.   On occasion Mr. Prater and CTI borrowed money

against the CTI reserve accounts on deposit with PI.     To borrow

money, Mr. Prater would contact Mr. Plemons, who would then

require Mr. Prater to sign a note.      If the note was paid off, PI

employees would document in PI’s books and records that it had

been paid.
                               - 10 -

3.   PI:   Third-Party Checks and Backhaul Deposits

      In addition to insurance for CTI, PI also handled personal

insurance for Mr. Prater and Chris Frix, Mr. Prater’s stepson.

Mr. Frix worked for PFW, a real estate company created in late

1991 that rented apartments, built houses, and developed land.

PFW was owned one-third each by Mr. Prater, Mr. Frix, and Bill

Walraven.    Mr. Prater and Mr. Frix had client account numbers at

PI distinct from the corporate accounts for CTI.

      Mr. Frix and Mr. Walraven managed PFW’s day-to-day

operations.    PFW rented housing to CTI employees.   If a CTI

employee owed PFW rent, CTI would write an advance check payable

to the employee.    Mr. Frix would then pick up the check from CTI

as payment to PFW for the employee’s rent.    Typically while a

driver was on the road, CTI would issue a check in the driver’s

name and give the check to Mr. Frix.

4.   Other Companies

      Mr. Prater coowned A&P Transportation (A&P) and Chase Truck

Brokers (CTB), a truck brokerage company that brokered freight.

In addition, he cofounded CPCF, Inc., to purchase a Gold’s Gym.

5.   Mr. Prater’s Criminal Conviction

      Mr. Prater was a defendant in a criminal tax case in the

U.S. District Court for the Northern District of Georgia

beginning in 1995 and ending in 1998.    On October 16, 1995, a
                              - 11 -

grand jury indicted Mr. Prater on multiple felony counts.      Some

of Mr. Prater’s associates were also indicted by the grand jury.

The charges were based upon the assertion that more than $3.5

million of backhaul and other checks payable to CTI was diverted

and not reflected on CTI’s records.    A portion of the $3.5

million was cashed and another portion was funneled through PI,

CTI’s insurance company.

     On March 11 1998, the indictment was redacted.   Counts 13,

15, and 17 of the redacted indictment all related to charges of

violation of section 7201, the evasion of personal income tax for

1991 through 1993, the same years as are here in issue.    On March

16, 1998, a jury found Mr. Prater guilty on counts 1 through 19

and count 21 of the redacted indictment, which included the 3 tax

evasion counts.   The jury found Mr. Prater not guilty on counts

23 through 26 of the redacted indictment, which related to

charges of obstruction of justice.

     Mr. Prater’s defense against the individual tax offenses was

that there was no underpayment of income tax because, although

the backhaul checks were unreported income, the money derived

from these checks was used to fund corporate expenses.

     On May 18, 1998, the District Court overturned the jury’s

convictions on counts 1 through 7, which were embezzlement

charges.   On July 1, 1998, the court entered its judgment
                              - 12 -

pursuant to the verdict.   Mr. Prater appealed the remaining

convictions to the Court of Appeals for the Eleventh Circuit.        On

June 6, 2001, the Court of Appeals in an unpublished opinion

overturned the jury’s verdicts on counts 8 through 11.     Mr.

Prater filed a motion for a hearing en banc before the Court of

Appeals; this motion was denied on January 16, 2002.

      On April 16, 2002, Mr. Prater filed a petition for a writ of

certiorari with the U.S. Supreme Court, which was denied.       On

August 22, 2002, the District Court amended its judgment pursuant

to the Court of Appeals’ findings.     After all appeals were

exhausted, Mr. Prater’s conviction for evasion of his individual

income tax for each of the years 1991 through 1993 remained.

6.   The Present Case

      Lance Lobar (Mr. Lobar), CTI’s primary outside accountant,

prepared Mr. and Mrs. Prater’s personal income tax returns.       Mr.

Lobar worked primarily with Mr. Warmack in gathering the

necessary information for their returns.     In early 1993 Mr. Lobar

was diagnosed with multiple sclerosis, which resulted in his

inability to continue working as an accountant.     In addition, Mr.

Warmack became semiretired as of 1992.     Mr. Prater asked his

accountants to include an additional $100,000 of income on his

1993 personal income tax return.   Respondent accounted for the

$100,000 in calculating petitioners’ deficiency for 1993.
                                  - 13 -

     The notices of deficiency determined that petitioners failed

to report income of $78,000, $262,281, and $1,178,428 for the

years at issue.    Respondent classified this unreported income

into three broad categories:      (1) Checks written from PI

(Schedule 1 adjustments); (2) other transactions (Schedule 2

adjustments); and (3) deposits of CTI payroll and other checks

(Schedule 3 adjustments).       The amounts by reference to Schedules

1, 2, and 3 in the notices are as follows:

      Other Income                    1991       1992        1993
Checks written from PI
  (Sch. 1)                             -0-     $79,750.00   $551,918.40
Other transactions (Sch. 2)            -0-       3,000.00    332,000.00
Deposits of CTI payroll and
  other checks (Sch. 3)              $78,000   179,530.68    294,509.53


      Schedule 1                     1991        1992        1993
Check #21767 dtd 3/26/92
  payable to Chris Frix                          $9,750
Check #24141 dtd 12/28/92 for
  loan to Billie Bearden                         70,000
Check #25003 dtd 3/19/93 for
  loan to Billie Bearden                                    $50,000.00
Check #25300 dtd 4/16/93 for
  loan to PFW Properties                                     60,000.00
Check #25412 dtd 4/29/93 for
  purchase of building in
  Dalton from RBG Properties,                               360,979.82
  Inc.
                                 - 14 -

Check #26119 dtd 12/21/93 to
  Charles Prater used to
  purchase Gold’s Gym                                $300,000.00
Less A&P Check #6224
  included in Notes Rec.
  Stockholder Acct.                                  -109,996.59
Less A&P Check #6412
  included in Notes Rec.
  Stockholder Acct.                                  -109,094.83


  Total                             -0-    $79,750   551,918.40



          Schedule 2               1991     1992         1993
Wright CTI installment sale
  payment to PFW paid in
  capital, GB&T deposit on
  7/2/93, Acct. #10132                                 $6,000
Blaize CTI installment sale
  payment to GB&T personal
  Acct. #303752 on 4/6/93                               5,000
Wable CTI installment sale
  payment to Calhoun FNB
  personal Acct. #0631612106
  on 3/1/93                                             5,000
Hudson CTI installment sale
  payment to PFW paid in
  capital, First Union deposit
  on 6/9/93, Acct.                                      6,000
  #56540029209
Loan to Check-It-Out using
  checks payable to CTI                               300,000
Frick’s furniture payments                 $3,000      10,000
  Total                              -0-    3,000    332,000
                                - 15 -

             Schedule 3              1991          1992          1993
Deposits of CTI payroll and
  other checks into PFW
  Properties Bank Acct.
  #10132 at GB&T                                               $4,286.35
Deposits of CTI payroll and
  other checks into PFW
  Properties Bank Acct.
  #5540029209 at First Union                    $179,530.68       371.62
Less deposit amounts not
  shown as paid in capital                                     -1,401.74
Less deposit amounts not
  shown as paid in capital                                     -3,535.25
Deposits of CTI income checks
  into PFW bank accounts                                      294,788.55
Deposits of CTI income checks
  into Prater’s Acct. #302752
  at GB&T                        $78,000


     Total                        78,000         179,530.68   294,509.53



                                OPINION

I.    The Parties’ Basic Arguments

       Mr. Prater designed and directed a scheme which caused

receipts of over $3.5 million from CTI, the trucking business in

which he was a part owner, to be left off the books of the

company over the 3 years at issue.          Mr. Prater controlled the

cash generated by this scheme and diverted the funds for various

purposes, many of which were related to CTI’s business but some

of which were personal to him.       With the help of CTI’s insurance

agent, W.J. Plemons, he caused over $1.4 million to be held in a
                              - 16 -

prepaid insurance account for CTI, and he directed the use of the

account for loans to individuals or entities he selected.    He

also used large amounts of the diverted CTI cash to provide

unrecorded cash payments to CTI’s drivers, ostensibly to conceal

excess hours of driving from the DOT but actually also to hide

such payments to the drivers from the IRS.   This scheme resulted

in a criminal case against Mr. Prater and several others with

multiple counts including tax fraud; and ultimately, he was

convicted of three counts of income tax evasion under section

7201 regarding the joint Federal income tax returns he filed with

his spouse for 1991, 1992, and 1993.   Respondent would now have

us sustain the civil fraud penalty for all 3 years and also

include roughly $1.5 million of the amounts diverted as Mr.

Prater’s taxable income subject to the 75-percent penalty.

Respondent maintains that the amounts included in income are

based upon specific items.

     Petitioners’ representatives counter that Mr. Prater

received no additional income as a result of the diversions and

that any amounts he did receive are offset by payments he made on

behalf of CTI.   Before we address the parties arguments, we will

explain the procedural posture of this case.
                               - 17 -

II.   Procedural History

      After the criminal case and the expiration of the 3-year and

6-year periods of limitation, respondent issued a separate notice

of deficiency to each petitioner.   These notices of deficiency

(collectively, the notices) were identical in the amounts

determined.   The notices relied heavily upon information

developed in the criminal case, more specifically upon a schedule

used to track the money diverted from CTI’s books which was

introduced as an exhibit in the criminal case.   However, the

explanation of the adjustments in the notices was cryptic at

best.   It read:   “It is determined that you received additional

income from W.J. Plemons Insurance Agency for services rendered

and such income represents taxable income realized by you as

shown in Exhibit A.”

      This statement was augmented by affirmative allegations in

the answer which more fully described respondent’s assertions

regarding the money flowing through PI.   Nevertheless, the

explanation in the notices is not accurate regarding the nature

of the flow of funds which originated in the operations of CTI.

We find that respondent has the burden of proof regarding the

affirmative allegations and the question of how much income Mr.

Prater received.
                              - 18 -

     Before trial respondent filed a motion for partial summary

judgment based upon Mr. Prater’s criminal conviction of income

tax evasion for 1991 through 1993.     Mr. Prater opposed that

motion, arguing that he was denied access to witnesses during the

criminal trial because the prosecution placed potentially

favorable witnesses under threat of prosecution, preventing their

testifying on his behalf.   We ruled in January 2009 that

arguments challenging the criminal conviction which could have

been raised on appeal of the criminal case cannot be the basis

for disputing the application of collateral estoppel in the civil

case.   See Wapnick v. Commissioner, T.C. Memo. 1997-133; Lilley

v. Commissioner, T.C. Memo. 1989-602; Klein v. Commissioner, T.C.

Memo. 1984-392, affd. 880 F.2d 260 (10th Cir. 1989).

Accordingly, we placed the burden of proof on Mr. Prater to show

by a preponderance of the evidence what portions of the

underpayments of tax, if any were established, are not

attributable to fraud.   However, respondent retained the burden

to show that there were underpayments of tax in accord with the

affirmative allegations in the answer.     On brief, Mr. Prater’s

representatives revisit the significance of the criminal

conviction and argue that changes in the law of criminal

procedure raise questions about the use of the conviction for

collateral estoppel.   We do not address these arguments because
                               - 19 -

we analyze the fraud issue hereinafter upon the evidence at trial

without considering the criminal conviction.

III.    Civil Fraud

       The penalty in cases of fraud is a civil sanction provided

primarily as a safeguard for the protection of the revenue and to

reimburse the Government for the heavy expense of investigation

and the loss resulting from the taxpayer’s fraud.     Helvering v.

Mitchell, 303 U.S. 391, 401 (1938).     Under section 6663(a), that

part of the underpayment of tax which is due to fraud is subject

to a 75-percent addition to tax.

       In applying the penalty under section 6663, we consider the

same elements, or long-recognized “badges of fraud”, discussed in

cases applying section 6651(f) and former section 6653(b)(1).

Clayton v. Commissioner, 102 T.C. 632, 647-653 (1994); see

Niedringhaus v. Commissioner, 99 T.C. 202, 211-213 (1992).      Fraud

may be proved by circumstantial evidence, and the taxpayer’s

entire course of conduct may establish the requisite fraudulent

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

       The existence of fraud is a question of fact to be resolved

upon consideration of the entire record.     DiLeo v. Commissioner,

96 T.C. 858, 874 (1991), affd. 959 F.2d 16 (2d Cir. 1992).      Since

direct evidence of fraud is rarely available, fraud may be proved

by circumstantial evidence and reasonable inferences from the
                                - 20 -

facts.   Petzoldt v. Commissioner, 92 T.C. 661, 699 (1989).

Courts have developed a nonexclusive list of factors or “badges

of fraud” that demonstrate fraudulent intent.     Niedringhaus v.

Commissioner, supra at 211.     These badges of fraud include:   (1)

Understatement of income; (2) inadequate records; (3) implausible

or inconsistent explanations of behavior; (4) concealment of

income or assets; (5) failure to cooperate with tax authorities;

(6) filing false documents; (7) failure to make estimated tax

payments; (8) dealing in cash; (9) engaging in illegal

activities; and (10) engaging in a pattern of behavior that

indicates an intent to mislead.     Vogt v. Commissioner, T.C. Memo.

2007-209, affd. 336 Fed. Appx. 758 (9th Cir. 2009).    No single

factor is necessarily sufficient to establish fraud; however, a

combination of several of these factors may constitute persuasive

evidence of fraud.   Niedringhaus v. Commissioner, supra at 211.

     Mr. Prater intentionally caused funds to be unreported on

the books and records of CTI.    These actions were fraudulent and

meet the traditional elements of fraud such as concealment and

dealing in cash.   The issue presented is whether Mr. Prater’s

fraud only affected CTI’s income or whether it also resulted in

his fraudulently underreporting his personal income by concealing

funds he diverted from CTI for his own use.    The answer to this
                               - 21 -

question requires an analysis of the facts surrounding each of

the adjustments in the notices issued to him.

IV.   Respondent’s Specific Adjustments

      A.   Schedule 1 Adjustments

      Respondent determined that checks totaling $79,750 in 1992

and $551,918.40 in 1993 should be included in Mr. Prater’s

income.    The insurance agency characterized these checks as loans

from an advance premium account of CTI.   Mr. Plemons and Mr.

Prater conspired to have CTI backhaul checks deposited with PI.

However, the evidence does not support respondent’s position that

all the diversions were income to Mr. Prater.   Rather, CTI was

credited with the funds on PI’s books.    Although Mr. Prater may

have influenced who received the funds as loans from the CTI

advance premium account, he repaid the funds he himself borrowed

and with one exception did not personally benefit from the loans.

      The record simply does not support a finding that Mr. Prater

took dominion and control over all these funds for his own use or

that he diverted all these funds to himself from CTI.   Rather,

while the funds were not shown on CTI’s corporate accounting

records, they were with one exception reflected as credited to

CTI by PI.
                               - 22 -

     Mr. Prater’s actions were generally consistent with the

treatment as advance premium payments by CTI and the subsequent

checks being loans from the CTI credited account at PI.    The

exception to the treatment of funds as property of CTI is the

$360,979.82 check to purchase a building in Dalton, Georgia, for

the company Mr. Prater coowned with his stepson and PFW.     This

amount was the subject of a loan agreement Mr. Prater signed, but

this loan was not repaid.   The record does not support

characterizing this amount as a loan Mr. Prater intended to

repay.   A similar check to buy real estate for a Gold’s Gym was

repaid by Mr. Prater, but according to his testimony the purchase

of the building in Dalton for use as a carpet warehouse was for

CTI’s business.    However, he had title to the building in Dalton

placed with PFW.   Despite his testimony, we find that Mr.

Prater’s arrangement of PFW as the building’s owner was

intentional.

     Mr. Prater’s business decisions were not haphazard but

rather careful and calculated.   He alone directed that funds in

the CTI advance premium account at PI be used to buy property for

a different entity in which he and his stepson held a controlling

interest.   Therefore, we find that respondent has established
                               - 23 -

that the check for $360,979.82 was income to Mr. Prater in 1993

but has failed to establish the other Schedule 1 amounts were Mr.

Prater’s income.

     B.    Schedule 2 Adjustments--Other Transactions

     The second phase of respondent’s income adjustments includes

(a) $3,000 and $10,000 of payments for furniture in 1992 and

1993, respectively, (b) four checks deposited in 1993 into PFW

accounts or Mr. Prater’s personal accounts totaling $22,000 which

related to sales of CTI vehicles, and (c) a 1993 payment of

$300,000 to a check-cashing business called Check-It-Out (CIO)

which was made with CTI funds.

     We will first address the $300,000 item.    Mr. Prater

maintains this was a loan by CTI.    Whether the CIO payment was a

loan or a payment to facilitate the conversion of CTI checks to

cash, the payment was not made on behalf of Mr. Prater personally

but rather for CTI.    Even if the payment was made for the illegal

purpose of facilitating the concealment of CTI income, it was not

paid for the primary benefit of Mr. Prater and thus is not his

income.

     The payments for furniture, however, were made on behalf of

PFW, the business in which Mr. Prater had an interest with his

stepson.    Respondent has also established a sufficient connection

between the $22,000 of deposits and the proceeds of the sales of
                                - 24 -

vehicles to carry the burden of proving that these deposits were

also income to Mr. Prater.     The record establishes that the

vehicles were not Mr. Prater’s property but rather belonged to

CTI.    Two of the payments for vehicles were made to PFW accounts

but were credited as paid-in capital of Mr. Prater.

       Accordingly, the items apart from the $300,000 payment to

CIO are income to Mr. Prater.

       C.   Schedule 3 Adjustments--Deposits to PFW Accounts and
            Mr. Prater’s Personal Account

       The first group of deposits in respondent’s last schedule of

adjustments to income is $78,000.80 of CTI income checks which

was deposited into Mr. Prater’s personal account in 1991.       The

record establishes the deposits of CTI checks were made to the

personal account, and therefore we uphold this income adjustment.

       Respondent also determined that a group of CTI-related

checks totaling over $475,000 deposited into PFW accounts in 1992

and 1993 is Mr. Prater’s income.     Respondent offsets these

adjustments by roughly $5,000 in 1993 for deposit amounts not

shown as paid-in capital to Mr. Prater in PFW.     However, the

lion’s share of respondent’s adjustment in 1993 was not reflected

as paid-in capital on the PFW books until many years after 1992

and 1993.     PFW had business relationships with CTI providing

rental properties to CTI truckers and was often paid directly by
                               - 25 -

CTI.   Accordingly, we find that respondent has not carried the

burden of proving that the items in question are Mr. Prater’s

income as opposed to the income of PFW.

V.   The Offset Claim

       Mr. Prater established that CTI expenses in excess of

respondent’s income adjustments to Mr. Prater’s income were paid

during the years at issue in cash.      Through his representatives,

Mr. Prater reasons that these cash payments should offset all of

the income adjustments and he should prevail.     The record does

not reflect, however, a loan or account receivable arrangement

between CTI and Mr. Prater regarding the cash funds flowing

between CTI and Mr. Prater; and because of the success of Mr.

Prater’s efforts to hide the flow of CTI’s receipts converted to

cash, there is not a specific record to track the source of the

cash used to make the payments to drivers that are offered to

support the claimed offsets.    Regardless of Mr. Prater’s scheme

to cause CTI receipts to be off the books and to be reduced to

cash in his control, we do not accept that he is the source of

all the cash payments for CTI.    We have presumed that CTI is a

separate entity that must be respected in determining the amounts

of income Mr. Prater received.    Likewise, Mr. Prater’s calculated

efforts to reduce CTI’s unrecorded receipts to his unfettered

control should not work to his advantage.     Accordingly, Mr.
                                - 26 -

Prater has failed to establish that the income adjustments

sustained should be offset by the cash used to pay CTI’s

expenses.

VI.    Whether the Civil Fraud Penalty Is Applicable

       Dealing in cash and hiding receipts are clearly badges of

fraud, and it is difficult to imagine a record with greater

evidence of such activities.    The income adjustments to Mr.

Prater are among the CTI receipts he sought to shield from the

IRS and other regulatory agencies.       The fact that he did not

receive all of the unrecorded CTI receipts he caused to be

converted to cash does not relieve him of the fraud penalty for

the amounts he did receive or use for his personal benefit.

Accordingly, Mr. Prater is subject to the fraud penalty for each

of the years at issue.

VII.    Mrs. Prater

       Mrs. Prater is jointly liable for the deficiencies in income

tax which result from our analysis, but by agreement she is not

liable for the fraud penalty.

       To reflect the foregoing,


                                        Decisions will be entered

                                   under Rule 155.
