                          T.C. Memo. 1996-87



                        UNITED STATES TAX COURT



                  BILL MCDONALD, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent

                RICHARD D. MAYNARD, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket Nos. 13218-93, 13220-93.     Filed February 28, 1996.



     Roderick L.    MacKenzie, for petitioners.

     Kathryn K. Vetter and Daniel J.     Parent, for respondent.



                MEMORANDUM FINDINGS OF FACT AND OPINION

     GERBER, Judge:     Respondent determined deficiencies in 1989

income tax, and penalties as follows:

                                           Fraud Penalty
     Petitioner             Deficiency       Sec. 6663

     McDonald                $53,041              $39,781
     Maynard                  71,380               53,535
                                 - 2 -

After considering the parties’ concessions and stipulations to be

bound by the outcome of other cases, the issues remaining for our

consideration are:     (1) Whether petitioners’ partnership’s 1989

income was understated; (2) whether petitioners correctly

reported their distributive shares of partnership income;

(3) whether either petitioner failed to report income with

respect to various items respondent determined to be includable

in his income; (4) whether either petitioner is liable for

additional self-employment tax; and (5) whether either petitioner

is liable for the fraud penalty under section 6663.1

                          FINDINGS OF FACT2

     Petitioners Bill McDonald (McDonald) and Richard D. Maynard

(Maynard) resided in California at the times each of their

petitions was filed in these cases.      McDonald and Maynard each

filed his 1989 income tax return reflecting that his filing

status was “single”.    Although McDonald and Maynard were each

married as of the close of 1989, they, along with their

respective spouses, filed for and received annulments of their

marriages during 1994.    The question of whether McDonald and

Maynard were married or single for Federal income tax purposes,

considering the annulments of their respective marriages, was

decided by this Court in McDonald v. Commissioner, T.C. Memo.


     1
       Section references are to the Internal Revenue Code in
effect for the year under consideration. Rule references are to
this Court’s Rules of Practice and Procedure.
     2
       The parties’ stipulation of facts and exhibits are
incorporated by this reference.
                                - 3 -

1994-607, and Shackelford v. Commissioner, T.C. Memo. 1995-484,

respectively.3   Respondent and petitioners agreed to be bound by

the outcome of the above-referenced opinions.    The above-

referenced opinions hold that the taxpayers were married for

Federal income tax purposes, although they had subsequently

obtained annulments of their marriages under the laws of the

State of California.   Accordingly, petitioners’ filing status

should have been “married filing separately” for purposes of

their 1989 tax year.

     Petitioners, at all pertinent times, were certified public

accountants, with more than 60 years of experience between them,

practicing together in an accounting partnership known as Maynard

& McDonald (M&M).   There was no written partnership agreement

through the 1989 tax year.    McDonald is also an attorney licensed

to practice in the State of Oklahoma.    M&M is a cash basis

partnership that petitioners formed in 1976 and operated during

the 1989 taxable year in Sacramento, California.    M&M’s principal

activities are tax return preparation, assistance to clients in

tax-related matters, providing accounting services, and

representing clients before various administrative levels of the

Internal Revenue Service.    In addition, McDonald also filed

clients’ petitions with this Court.     McDonald was familiar with


     3
       Petitioners were either the parties in the underlying
cases or referenced in several recent opinions issued by this
Court. See Bill McDonald, et al. v. Commissioner, T.C. Memo.
1994-607; Denver W. McDonald v. Commissioner, T.C. Memo. 1995-
359; Betty J. Shackelford v. Commissioner, T.C. Memo. 1995-484;
and Mary C. McDonald v. Commissioner, T.C. Memo. 1995-503.
                                - 4 -

the requirement that tax return preparers are to keep copies of

prepared returns or a list of clients.      Petitioners’ accounting

practice specialized in the field of taxation.

     M&M’s 1989 U.S. Partnership Return of Income (Form 1065),

which McDonald prepared, reflected gross receipts of $24,590 and

a single deduction of $24,590 attributable to “Guaranteed

payments to partners”.    Other than on the Schedules K-1, no other

information was reflected on the partnership return (i.e., the

balance sheet was left blank, and the Schedule M for

reconciliation of partners’ capital was marked “NA”).        The

Schedules K-1 revealed that Maynard and McDonald were 50-50

partners, but that McDonald was allocated $3,457 of the

guaranteed payments to partners, and the remaining $21,133 was

allocated to Maynard.    McDonald's $3,457 share of M&M’s 1989

income was based on Maynard’s estimate.      Petitioners did not

maintain records of the number of hours worked or number of

returns prepared by each partner.

     M&M’s returns for the fiscal year ended September 30, 1987,

the period October 1 through December 31, 1987, and the 1988

calendar year each reflect that petitioners shared profits and

losses in a 50-50 ratio.    These three returns reflect income and

guaranteed payments to petitioners, as follows:

Taxable Period             Income       McDonald   Maynard

FYE 9/30/87                $5,520       $3,670      $1,850
10/01 to 12/31/87             750          500         250
Calendar 1988              24,469        3,711      20,758
                               - 5 -

Accordingly, for two of the reporting periods, McDonald received

about two-thirds and Maynard about one-third of M&M’s income.      In

the third reporting period, Maynard received about 85 percent and

McDonald about 15 percent.

     Respondent’s agents analyzed the ratio of hours spent during

1989 by Maynard and McDonald in preparing returns of M&M's

clients and found it to be about 60 percent for Maynard and 40

percent for McDonald.   Respondent, in the notices of deficiency,

determined $214,393 of 1989 partnership income and attributed

$79,661 to McDonald and $134,732 to Maynard.

     M&M did not have any employees, and petitioners were solely

responsible for maintaining M&M’s books and records.

Petitioners’ billing approach was to send a bill for services to

clients and retain a copy for M&M’s records.    When they received

payment of a particular bill, M&M’s retained copy of the bill was

discarded.   Petitioners’ billing approach made it virtually

impossible to verify whether M&M’s income was accurately

reflected on its books and Federal partnership tax return and on

petitioners’ Schedules K-1.

     M&M’s rate schedule, as of January 1, 1989, was $130 per

hour for tax consulting or compliance work and a $275 minimum

rate for individual tax return preparation.    Petitioners would

charge for giving advice, including advice given during telephone

calls, with a one-tenth-hour minimum charge.    The printed rate

schedule contained the notation that, where advice resulted in

substantial savings or was out of the ordinary, the billing might
                                - 6 -

reflect petitioners’ experience and expertise, rather than the

posted rates.   Occasionally, petitioners sent no bill because

they decided to provide gratuitous services.   Actual charges to

M&M clients reflect that some clients were billed at a rate in

excess of and some less than M&M’s minimum rate.

     During respondent’s examination of their 1989 tax years,

petitioners did not provide books, records, copies of M&M’s bills

to clients, or any other information from which petitioners’

clientele could be identified or respondent could verify

petitioners’ income for 1989.   Respondent’s computers reflect

that M&M was shown as the preparer on more than 300 Federal tax

returns for the 1989 processing year.   In addition, McDonald

filed 13 clients’ petitions with this Court during 1989.

     Petitioners sought the protection of the Bankruptcy Code,

McDonald in December 1980 and Maynard in April 1981.    To avoid

the possibility of attachment of their accounts receivable,

petitioners formed a California corporation, Gold Country

Financial, Inc. (Gold), to conduct a tax accounting business

concurrently with and at the same location as M&M.    Gold also

provided petitioners with a means to obtain credit after their

bankruptcies because they were employees of Gold.    Moreover,

Gold’s sole shareholder was shown as Terry Feil, a friend of

Maynard’s.

     Corporate Federal income tax returns were filed for Gold’s

fiscal years ended July 31, 1989 and 1990.   Gold’s income and

expenses were reported on the accrual method of tax accounting.
                                - 7 -

Petitioners maintained the books and records of Gold.    M&M did

not claim expenses, and any expenses concerning petitioners’ tax

accounting businesses were paid and/or deducted by Gold.    Gold

had no employees other than petitioners.

     Similar to M&M, petitioners maintained no cash receipts

journal, accounts receivable list, or client list for Gold.    Also

paralleling the practices at M&M, copies of client billing

invoices were discarded after payment was received from the

clients.   Petitioners, however, maintained cash disbursements

records for Gold during 1989.

     Petitioners maintained a bank account in Gold’s name at the

Merchants National Bank (Merchants Bank), and some, but not all,

of the receipts from clients were deposited into that account.

Petitioners’ method of determining Gold’s annual income for tax

purposes began by totaling the Merchants Bank deposits and

reducing the total by reimbursements for health insurance.     The

difference was then adjusted by picking up net increases or

decreases in accounts receivable to convert to the accrual

method.    Finally, the accrual method amount was reduced by

expenses that petitioners had billed to and collected from

clients.

     For the 1989 and 1990 fiscal years, Gold’s income was

computed and reported by petitioners as follows:
                                 - 8 -

           Item                1989           1990

Deposits to bank            $68,975.82     $70,669.74
Less:
  Auto expenses               10,710.25        -
  Insurance reimbursed         2,591.84     5,211.40
  Accounts payable            13,338.00        -
  Dues/publications               49.50        -
  Outside services               505.83        -
  Refunds                        175.00        -
  Accounts receivable           (825.00)   15,469.78
      Total                   26,545.42    20,681.18
                            1
Income per petitioners        42,430.40    49,988.56
     1
       The parties stipulated that the amount of income computed
by petitioners for the 1989 fiscal year was $42,430.10, whereas
the supporting amounts stipulated by the parties results in
income of $42,430.40.


Petitioners also maintained a bank account for Gold at the Bank

of Lodi.   The existence of Gold’s Bank of Lodi account was not

brought to the attention of respondent’s agent by petitioners.

Respondent’s agent discovered the Bank of Lodi account from a

review of canceled checks obtained from third-party sources

(Gold’s clients).     Petitioners deposited some clients’ payments

for services by both M&M and Gold in the Bank of Lodi account for

the fiscal years 1987, 1988, 1989, and 1990.     Petitioners did not

report the Bank of Lodi deposits in Gold’s income.      For 1989,

checks were written on the Bank of Lodi account to Maynard and

McDonald in the total amounts of $20,421 and $6,024,

respectively.     Neither Maynard nor McDonald reported funds for

1989 from Gold’s account with the Bank of Lodi.

     Respondent determined that Gold’s income for the 1989 fiscal

year was understated by $63,581 and that $29,292 of deductions

were not allowable.    Gold’s petition to this Court was dismissed
                               - 9 -

due to lack of capacity after the State of California had

suspended its charter.

     Respondent’s agent, Arthur Pease (Pease), examined M&M’s

partnership returns for the taxable year ended September 30,

1987, and the calendar years 1987, 1988, and 1989.   Petitioners

did not provide the identification of their clients, and Pease

was forced to reconstruct client information by using Internal

Revenue Service computer data (return preparer information) and

by canvassing third parties (petitioners’ clients and banks).

Pease obtained copies of clients’ returns prepared by petitioners

that reflected the fee for tax preparation.   Pease also received

a rate sheet for M&M from one of petitioners’ clients.   In

addition, Pease received numerous letters that contained

information about the fees charged for return preparation.     Pease

also engaged in numerous telephone conversations with

petitioners’ clients concerning the fees that petitioners charged

them.

     Based on his research, Pease prepared a schedule of clients,

referencing the accumulated information along with references to

sources for respondent’s reconstruction of petitioners’ income

for the 1989 taxable year.   Where Pease determined that an

individual return had been prepared and that no invoice, deposit

information, canceled check, or client information was available

to reflect the fee charged, he used a $275 preparation fee, the

minimum charge for an individual return reflected on M&M’s rate

schedule.   Based on the information available to him, Pease
                              - 10 -

determined that the average 1989 return preparation fee was $482

for an individual return, $1,400 for a corporate return, and

$1,250 for a partnership return.   In his reconstruction, Pease

also accounted for the fact that some returns were prepared

gratuitously.   Pease determined total 1989 fees of $192,201.

Based on information provided by petitioners during trial

preparation, respondent conceded on brief that total combined

reconstructed 1989 fees were $185,128.

     To determine M&M’s income for 1989, deposits into Gold’s

Merchants Bank account for the first 7 months were eliminated in

the total amount of $33,388 because Gold had reported that amount

for its taxable year ended July 31, 1989.    No adjustment for

Merchants Bank deposits was made for the last 5 months of 1989

because petitioners did not provide income and accounts

receivable records for that period.    There was no consistency

about which entity prepared a particular client’s return (it

would indiscriminately vary between M&M and Gold from year to

year).

     Petitioners, in their respective 1989 income tax returns,

did not report the $250 monthly payments for automobile expenses

received from Gold during 1989.    Petitioners reduced the amount

of the Merchants Bank deposits reported in Gold’s income by the

amount petitioners paid for automobile expenses.    Petitioners did

not submit any documentation to Gold in support of their

automobile mileage or expenses for 1989.    Maynard conceded that

the 1989 automobile reimbursement received from Gold was income
                              - 11 -

to him for 1989.   Maynard testified that all payments to

petitioners for 1989 from the Bank of Lodi were his income or

expense reimbursement.

     Gold, during 1989, paid the California Society of Certified

Public Accountants $16,325.36 for health insurance for several

individuals, including petitioners.    One of those individuals was

McDonald’s former accounting partner, who reimbursed Gold

$2,765.44 for his portion of the insurance.   The remaining

insured individuals were petitioners and members of their

families.   Although petitioners prepared returns on behalf of

Gold, they claim to have not received any compensation other than

the monthly automobile reimbursement and insurance coverage.

     Maynard did not have a personal bank account, and he paid

bills with cash or checks from the checking account of another

individual.   McDonald and Maynard, during 1989, made cash

purchases of numerous cashier’s checks in amounts of $10,000 or

less for various purposes.   Maynard purchased two $7,500

cashier’s checks on June 8, 1989, from two separate banks.     On

that same date, McDonald purchased a $9,000 and a $10,000

cashier’s check from separate banks.   A series of cashier’s

checks, including the ones purchased on June 8, 1989, was used as

part of the purchase price of a residence which was placed in the

name of McDonald’s wife.   McDonald purchased numerous cashier’s

checks, mostly with cash, during 1989.   The dates, amounts, and

bank locations were as follows:
                                  - 12 -

     1989 Date         Amount           Location Purchased

     Apr.   20        $3,000            Commerce Savings
     June   8          9,000            Commerce Savings
     June   8         10,000            Bank of Alex Brown
     June   12         9,000            Wells Fargo
     June   14         1,432            Wells Fargo
     June   14         2,594            Wells Fargo

Respondent concedes that the source of the $10,000 cashier’s

check would not result in income to McDonald.

     McDonald’s wife remitted three checks to Maynard during 1989

in the following amounts:       $995.90, $550, and $699.50.

McDonald’s daughter also remitted a $2,500 check to Maynard

during 1989.

                                  OPINION

     Procedural Question--Initially, we consider petitioners’

procedural argument that the notices of deficiency are "arbitrary

and capricious".    Petitioners argue that respondent should have

the burden of going forward with the evidence because

respondent’s determination is arbitrary and capricious and that

respondent’s determination should not enjoy a presumption of

correctness.     See Jackson v. Commissioner, 73 T.C. 394, 403

(1979); Weimerskirch v. Commissioner, 596 F.2d 358, 361 (9th Cir.

1979), revg. 67 T.C. 672 (1977).       By contending that the notices

are arbitrary, petitioners are essentially asking us to look

behind the notices of deficiency to examine the evidence used by

respondent in making her determinations.       Riland v. Commissioner,

79 T.C. 185, 201 (1982); Jackson v. Commissioner, supra at 400;

Greenberg's Express, Inc. v. Commissioner, 62 T.C. 324, 327
                              - 13 -

(1974); Weimerskirch v. Commissioner, supra.     We have looked

behind the notice in those rare instances where respondent relied

upon a "'naked' assessment without any foundation whatsoever".

United States v. Janis, 428 U.S. 433, 441 (1976); Jackson v.

Commissioner, supra at 401.

     In Weimerskirch v. Commissioner, supra, and Dellacroce v.

Commissioner, 83 T.C. 269 (1984), the Government possessed no

evidence linking the taxpayers to illegal income.    In Dellacroce,

we held the notice of deficiency to be arbitrary because the

reconstruction of income did not link the taxpayer to the income-

generating activity.

     In this case, by contrast, there is ample evidence,

including numerous concessions by petitioners, reflecting that

petitioners’ income was not fully reported.    Respondent has shown

a clear and direct linkage to sources of unreported income in

this case.   See Adamson v. Commissioner, 745 F.2d 541 (9th Cir.

1984), affg. T.C. Memo. 1982-371.   Accordingly, we find that

respondent’s determination is not arbitrary.

     Income Reconstruction--Where, as here, taxpayers have failed

to provide adequate records substantiating their income, an

indirect method may be used to reconstruct their income.     Holland

v. United States, 348 U.S. 121 (1954).     Petitioners bear the

burden of proving that the determinations made by respondent in

the notices of deficiency are erroneous.    Rule 142(a); Cracchiola

v. Commissioner, 643 F.2d 1383 (9th Cir. 1981) (citing Welch v.

Helvering, 290 U.S. 111 (1933)), affg. per curiam T.C. Memo.
                               - 14 -

1979-3; Webb v. Commissioner, 394 F.2d 366, 372 (5th Cir. 1968),

affg. T.C. Memo. 1966-81.    Taxpayers are required to maintain

records--transactions should be documented, contracts provided,

and expenses substantiated.    Sec. 6001; Norgaard v. Commissioner,

939 F.2d 874, 878 (9th Cir. 1991), affg. in part and revg. in

part T.C. Memo. 1989-390.

     The Commissioner is entitled to use a reconstruction method

where a taxpayer’s books and records are either inadequate or

nonexistent.   Holland v. United States, supra; United States v.

Johnson, 319 U.S. 503 (1943); Campbell v. Guetersloh, 287 F.2d

878, 880 (5th Cir. 1961); Adamson v. Commissioner, supra; Keogh

v. Commissioner, 713 F.2d 496 (9th Cir. 1983), affg. Davies v.

Commissioner, T.C. Memo. 1981-438; United States v. Stonehill,

702 F.2d 1288 (9th Cir. 1983).   Petitioners do not dispute that

respondent is entitled to use a reconstruction method.

Petitioners argue that the method of reconstruction used by

respondent was flawed and/or arbitrary.4

     Petitioners, who are tax professionals, failed to keep any

record of cash receipts, although they did maintain records of

their cash expenditures.    Petitioners intentionally discarded the

only records from which their income could have been verified.

Although petitioners’ tax accounting business activity has been



     4
       Respondent's reconstruction of petitioners’ income
included any income earned through the M&M partnership. The
corporate income of Gold was the subject of another case. That
case was dismissed due to Gold’s loss of its corporate status
and, hence, capacity to file a petition in this Court for relief.
                                - 15 -

continuous from 1976 through 1989, the year at issue, it was

operated through several entities.       Until both petitioners had

financial difficulties and went through bankruptcy, they had

operated their business as a partnership.       After the financial

difficulties, petitioners interposed a corporate entity partly to

deceive creditors and others.    The corporate entity allegedly

paid all expenses of petitioners’ tax accounting business, and

only a part of the income from such activity was reported by the

corporate entity.   Allegedly, the corporate entity did not pay

petitioners’ salary for their return preparation activity.

Instead, petitioners allegedly received benefits such as

insurance and automobile allowances, and their business overhead

was borne by the corporation.

     After the corporate formation, the partnership entity

continued to operate and report some of the business income, but

none of the expenses.   The income reported on the partnership

return was distributed as guaranteed payments to partners in

unequal amounts, even though petitioners were shown in the

Schedules K-1 as 50-50 partners and no partnership agreement was

in existence.   Petitioners, by commingling these entities and

their business activities, created a murky environment in which

it is difficult to discern the sources of income or the entity by

which an expense had been incurred.       Petitioners’ discarding

records of income made this situation even more difficult to

unravel.   Finally, petitioners did not cooperate in the

examination process, forcing respondent’s agent to seek third-
                               - 16 -

party records from banks and clients in order to reconstruct

income.

     Under these circumstances, Pease was able to specifically

determine the identity of some clients and a range of the fees

charged.   Where the amount of a client’s fee was not available,

Pease used the minimum fee.    In instances where it was possible

to discern that specific income had been reported on Gold’s

return (the corporate return), Pease eliminated that amount from

his reconstruction of the partnership return.     Where the

corporate income, if any, could not be discerned or verified,

Pease, in order to protect the Government’s interest, attributed

the income to the M&M partnership.      In those instances, there may

have been duplication between the income reported for Gold and

the income determined for petitioners through M&M.     With respect

to one of those instances, respondent conceded on brief that the

amount of partnership income determined for 1989 should be

reduced by $4,938 for the deposits in Gold’s Merchants Bank

account during the last 5 months of 1989.

     Courts have approved methods of reconstruction which project

or extrapolate from a limited amount of information.     See, e.g.,

Gerardo v. Commissioner, 552 F.2d 549 (3d Cir. 1977), affg. in

part and revg. in part T.C. Memo. 1975-341; Adamson v.

Commissioner, supra.   In Adamson v. Commissioner, supra at 548,

the court stated as follows:

          Where the government has introduced evidence
     linking the taxpayer to the illegal activity, the
     taxpayer should not be allowed to avoid paying taxes
                               - 17 -

     simply because he keeps incomplete records. The
     absence of tax records cannot automatically deprive the
     Commissioner of a rational foundation for the income
     determination. As the Fifth Circuit recognized in Webb
     v. C.I.R., 394 F.2d 366, 373 (5th Cir. 1968):

          [T]he absence of adequate tax records does not
          give the Commissioner carte blanche for imposing
          Draconian absolutes .... [However,] such absence
          does weaken any critique of the Commissioner's
          methodology.

               Arithmetic precision was originally and
          exclusively in [the taxpayer's] hands, and he had
          a statutory duty to provide it .... [H]aving
          defaulted in his duty, he cannot frustrate the
          Commissioner's reasonable attempts by compelling
          investigation and recomputation under every means
          of income determination. Nor should he be overly
          chagrined at the Tax Court's reluctance to credit
          every word of his negative wails.

See also Figueiredo v. Commissioner, 54 T.C. 1508 (1970), affd.

per order (9th Cir., Mar. 14, 1973); Estate of Mason v.

Commissioner, 64 T.C. 651 (1975), affd. 566 F.2d 2 (6th Cir.

1977); Bradford v. Commissioner, 796 F.2d 303 (9th Cir. 1986),

affg. T.C. Memo. 1984-601.   Petitioners in this case have not

provided records or a more reasonable or accurate method of

reconstructing their income.

     Petitioners attacked respondent’s reconstruction method by

arguing that duplication occurred and by testifying that the

reconstruction was in error based on petitioners’ recollections

that certain clients were charged lesser fees or no fees.

Petitioners, though they are tax professionals, failed to keep

adequate records and thus created this situation in which

respondent is unable to specifically verify or reconstruct the

fees charged to certain clients or to determine whether, in some
                               - 18 -

instances, the corporation or partnership had earned or received

fees.   As a result of the failure to maintain adequate records,

petitioners’ testimony is uncorroborated and rendered less

credible.   Although petitioners pointed out situations where they

contended that no fee or a lesser fee was charged, when asked

whether Pease understated any fees, petitioners’ recollection

failed them.

     Moreover, Pease was not able to secure the names of all of

petitioners' clients.    Petitioners were either unable or

unwilling to disclose the identity of clients missed or not

located by Pease.   Finally, petitioners were evasive and vague

when confronted by the Court with inconsistencies in their

testimony or evidence.   Considering all these circumstances, we

find petitioners’ testimony to be uncorroborated and without

credibility.

     Petitioners also argue that some of their clients may have

failed to pay for services performed.    In those instances,

petitioners argue that M&M, which is on the cash method of

accounting, should not include those amounts for the 1989 year.

Petitioners’ argument has several fatal weaknesses.    Initially,

petitioners have no proof (because they discarded the billing and

receivable records) of who actually paid and who did not.      It was

the absence of those records that forced respondent to

reconstruct petitioners’ income for 1989.    A reconstruction

method is not a direct method of accounting, but an indirect

method which can, to some extent, be based on judgment.      Again,
                               - 19 -

petitioners’ attack on the judgmental aspects of respondent’s

reconstruction are dependent on information that petitioners

knowingly and intentionally discarded.5

     We must emphasize that petitioners have not performed a

reconstruction of their corporate, partnership, or individual

income by which we could test the accuracy of respondent’s

method.   Petitioners have provided only their self-serving

testimony, which is both uncorroborated and contradictory to the

record in this case.    Accordingly, we hold that the

reconstruction is appropriate, as modified through the

concessions made by respondent.

     Division of Partnership Income--Respondent contends that the

reconstructed partnership income should be split equally by

Maynard and McDonald.   Petitioners have, by designation as

“guaranteed payments”, divided M&M’s $24,590 of reported income

$3,457 to McDonald and $21,133 to Maynard.   That division equals

approximately 14 percent for McDonald and 86 percent for Maynard.

Through 1989, petitioners did not have a written partnership



     5
       Petitioners also argued that the doctrine of judicial
estoppel should be applied in this case to preclude respondent
from making the alternative determination that income from the
tax accounting practice could, in some instances, be attributed
to Gold and M&M. That doctrine is inappropriate in this setting.
Because of petitioners’ lack of adequate records, respondent has
taken alternative positions with respect to income that
petitioners could not verify or show belonged to either the
corporation or the partnership. Respondent is permitted to take
such positions, and it is petitioners’ obligation to show which
of the entities, if any, is obligated to report the income. The
mere reporting of the income on the corporate return does not
enable petitioners to meet their burden.
                               - 20 -

agreement, and all of their Schedules K-1 reflect that their

partnership interests were 50 percent each.      Three other M&M

returns reflect conflicting and varying divisions of profits by

Maynard and McDonald.   Two of them divide M&M’s profit about two-

thirds for McDonald and one-third for Maynard.      The third return

reflects a division of profit of about 85 percent for Maynard and

15 percent for McDonald.    This erratic pattern does not lend much

support for petitioners’ argument.      Respondent contends that

petitioners manipulated their income between them depending on

the circumstances.   For example, respondent contends that a large

portion of the income for 1988 and 1989 was shifted to Maynard

because he had claimed large carryover losses from prior years.

     Section 702(a) requires that a partner account for her

distributive share of partnership income.      In the absence of a

partnership agreement, a partner’s distributive share is to be

determined in accord with the partner’s interest in the

partnership.   Sec. 704(b).   Petitioners argued that their oral

partnership agreement was that McDonald’s income was not to

exceed $6,000.   In their testimony, however, petitioners admitted

that no record of work completed or other measure of their

efforts was maintained.    Further, petitioners testified that

Maynard would estimate an amount for McDonald at the end of each

year.

     Respondent, in the notices of deficiency, determined

$214,393 of partnership income, attributing $79,661 to McDonald

and $134,732 to Maynard.    That determination hypothesizes that
                               - 21 -

McDonald and Maynard split partnership profits by a ratio of

approximately 37 to 63 percent.

     More in line with the statutory notices, Agent Pease’s

analysis reflected that the 1989 return preparation ratio between

Maynard and McDonald was about 60 percent to 40 percent,

respectively.    McDonald, however was responsible for the

administrative duties, including billing, banking, record

keeping, etc.    Other than their self-serving testimony,

petitioners have not produced any evidence of a partnership

agreement.   In addition, petitioners’ financial transactions,

which included shifting relatively large amounts of cash between

petitioners and their families, combined with petitioners'

indiscriminate use of reported and unreported bank deposits for

personal purposes, and their failure to distinguish between

interests in the partnership and corporate entities, severely

weaken petitioners’ credibility regarding their alleged

partnership arrangements.

     Petitioners’ position that Maynard was entitled to the

partnership profits in excess of $6,000 defies belief and is

wholly unsupported by the evidence in the record.    On the other

hand, respondent, although determining in the notices of

deficiency a ratio of about 37 percent to 63 percent for McDonald

and Maynard, respectively, argues on brief that the partnership

income should be split 50 percent-50 percent, as reflected on the

Schedules K-1.    We do not find the 50 percent-50 percent reported

position of petitioners to be any more persuasive or less self-
                              - 22 -

serving than their testimony that McDonald was to receive no more

than $6,000.   Based on the evidence, including the flow of funds

between petitioners and petitioners’ family members, we hold that

the 37 percent to 63 percent ratio determined in the statutory

notices is the best approximation of petitioners’ partnership

arrangement to share profits and losses.

     Payments From Gold to Petitioners--Respondent determined

that the 1989 payments by check, totaling $8,774 for McDonald and

$23,671 for Maynard, from Gold were income to petitioners and

should have been reported.   Gold also paid for insurance for

petitioners and some of their family members, for which

respondent did not make a determination or adjustment to

petitioners’ 1989 income.

     Petitioners contend that a part of the amounts paid by Gold

represented a $250 monthly automobile allowance and that the

remainder, whether received and cashed by McDonald or Maynard,

was Maynard’s funds.   In that regard, Maynard testified that all

of these check payments from Gold, both for automobile and

otherwise, are either income or expense reimbursement to him,

with the exception of the $250 per month automobile allowance

from Gold to McDonald.

     With respect to McDonald’s automobile expenses, McDonald did

not submit any records or documentation to Gold contemporaneously

with the monthly payments during 1989.   For purposes of trial,

McDonald submitted documentation reflecting over $3,000 for

automobile expenses, including gasoline charge receipts, repair
                               - 23 -

and maintenance bills, and a letter from his automobile insurance

provider noting the annual premium.      McDonald testified that,

during 1989, he drove his automobile 8,000 miles, 90 percent of

which represented business miles.

     Under section 274(d), taxpayers are required to meet certain

substantiation requirements in order to be entitled to a

deduction for certain business expenses.      Section 274(d)(4)

(which is effective for taxable years beginning on or after

January 1, 1986) requires substantiation for a taxpayer to be

entitled to deduct travel expenses.      McDonald’s substantiated

expenditures connected with his automobile for the 1989 year

exceed the total of the $250 monthly payments received from Gold.

McDonald offered no records or other evidence, however, of the

business use of his automobile other than his testimony, which

was expressed in terms of a rough estimate without any meaningful

detail or contemporaneous support.      McDonald has not met the

section 274(d) requirements necessary to show entitlement to

transportation deductions, and, accordingly, respondent’s income

determination regarding the monthly payments from Gold is

sustained.   Rule 142(a).

     Maynard and McDonald both contend that the remainder of

payments from Gold to petitioners is attributable to Maynard,

even though $6,024 of the checks was written to McDonald from

Gold’s Bank of Lodi account.   Petitioners, here again, bear the

burden of showing error regarding respondent’s determination that

$6,024 is income to McDonald and $20,421 is income to Maynard.
                                - 24 -

Rule 142(a).    Petitioners have failed to carry their burden.   We

find petitioners’ explanation that the $6,024 in Gold checks was

written to McDonald and cashed by him for Maynard to be

incredible.    The credibility of petitioners’ position is further

strained by the grossly disproportionate division of M&M’s income

to them.   Accordingly, respondent’s determination is sustained.

     Miscellaneous Controverted Items Determined by Respondent To

Be Income--McDonald’s wife remitted three checks to Maynard

during 1989 in the following amounts:    $995.90, $550, and

$699.50.   McDonald’s daughter also remitted a $2,500 check to

Maynard during 1989.    Respondent determined that these payments

constitute income to Maynard.    In addition, Maynard purchased,

with cash, two $7,500 cashier’s checks from different banks

during 1989, and respondent determined that the source of the

cash was untaxed income from clients that had not been deposited

into the bank or otherwise reported as income for financial or

tax purposes.

     McDonald purchased numerous cashier’s checks, mostly with

cash, during 1989.    The dates, amounts, and bank locations were

as follows:
                              - 25 -

     1989 Date       Amount         Location Purchased

     Apr.   20       $3,000         Commerce Savings
     June   8         9,000         Commerce Savings
     June   8        10,000         Bank of Alex Brown1
     June   12        9,000         Wells Fargo
     June   14        1,432         Wells Fargo
     June   14        2,594         Wells Fargo
     1
       Respondent conceded that the $10,000 cashier’s check was
from a source that was not taxable to McDonald.

Respondent determined that these amounts, along with $1,000 cash

deposited by McDonald in the M&M trust account, constitute income

to McDonald because the source of the cash was untaxed income

from clients that had not been deposited into the bank or

otherwise reported as income for financial or tax purposes.

     With respect to the $2,500 item from McDonald’s daughter to

Maynard, petitioners argue that Maynard first gave the $2,500 to

McDonald’s daughter, who, in turn, gave it to McDonald to

purchase the $2,594 cashier’s check that went to purchase the

home placed in McDonald’s wife’s name.   Ultimately, petitioners

would have us believe that this circuitous route for the $2,500

was concluded when McDonald’s daughter repaid Maynard.    Other

than the $2,500 item, petitioners make no particular argument

with respect to the cash items that respondent determined were

income to Maynard.   With respect to McDonald, it is contended

that he had available to him from both taxable and nontaxable

sources almost $21,000 with which to purchase the cashier’s

checks remaining in controversy.   Ostensibly, the $21,000

represents all of McDonald’s sources from which he was able to

make applications, which would include, in addition to purchasing
                              - 26 -

cashier’s checks for the purchase of a home placed in his wife’s

name, living and other personal expenditures.

     The controverted cashier’s checks total $25,000, which,

initially, would indicate a shortfall of about $4,000 between

McDonald’s sources and applications.   Further, McDonald’s

analysis does not account for living expenses.   Finally,

McDonald’s analysis of the possible sources is offered in a

vacuum and does not account for undeposited receipts from

clients.   Again, petitioners’ intentional discarding of the

accounts receivable information and the concealment of the

identity of their clients is the reason the source analysis is

not complete or reliable.

     Under these circumstances, we find that petitioners have not

carried their burden.   Hence, respondent’s determination that the

various checks and cash items are income to petitioners is

sustained.

     Self Employment Tax--To the extent that additional income is

determined in these cases, petitioners agreed on brief that any

increase in self-employment tax is merely computational.

Respondent determined that additional income was derived from

petitioners’ practice of tax accounting.   Such income of

petitioners is subject to self-employment tax.

     Taxability of McDonald’s Social Security Benefits--This

appears to be a computational item that is dependent on the

parties’ agreement to be bound by the final outcome of an earlier

case regarding whether McDonald was married for tax purposes
                               - 27 -

during the period in question.    The outcome of that case, along

with the holdings herein regarding the amount of unreported

income, will dictate the amount of McDonald’s taxable Social

Security benefits.

     Fraud Penalty--Respondent determined, pursuant to section

6663, that each petitioner is liable for a fraud penalty with

respect to the entire income tax deficiency determined for their

respective 1989 tax years.    Section 6663(a) imposes a 75-percent

addition to tax on any portion of an underpayment attributable to

fraud.   Under section 6663(b), if the Commissioner establishes

that any portion of an underpayment is attributable to fraud,

then the entire underpayment is treated as attributable to fraud,

except to the extent that a taxpayer can establish by a

preponderance of the evidence that any portion of the

underpayment is not due to fraud.

     Respondent has the burden of proving, by clear and

convincing evidence, that each petitioner fraudulently intended

to evade his tax.    Sec. 7454(a); Rule 142(b).   To meet this

burden, respondent must show that there was intent to evade taxes

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

prevent tax collection.    Rowlee v. Commissioner, 80 T.C. 1111,

1123 (1983).    Respondent must also show (1) that there is an

underpayment of tax, and (2) that part of such underpayment is

due to fraud.    Hebrank v. Commissioner, 81 T.C. 640, 642 (1983).

     Based on our holdings regarding respondent’s reconstruction

of partnership income, miscellaneous items of income, and several
                               - 28 -

concessions by petitioners, there can be no doubt that there was

an underpayment of tax in each petitioner’s 1989 tax year.    Thus,

we must decide for each petitioner whether any portion of such

underpayment was due to fraud.    Id.

     Fraudulent intent is seldom proven by direct evidence;

hence, the courts have relied on certain indirect evidence in

determining whether or not fraudulent intent existed.   These

"badges of fraud" include:    (1) Understating income; (2) keeping

inadequate records; (3) failing to file tax returns; (4)

providing implausible or inconsistent explanations of behavior;

(5) concealing assets; and (6) failing to cooperate with tax

authorities.   Bradford v. Commissioner, 796 F.2d at 307.

     Respondent contends that in these consolidated cases all of

the above-referenced badges of fraud exist, except that

petitioners did not fail to file returns.    Petitioners contend

that respondent has not shown fraud by clear and convincing

evidence and that Maynard “believed that he was entitled to a

large net operating loss carryforward which would alleviate any

income tax liability and that he would not be able to utilize the

balance of the loss carryforward within the statutory time.”     We

find petitioners’ explanation to be disingenuous considering that

they are tax professionals.    We find that respondent has shown

that each petitioner’s underpayment of tax for 1989 was due to

fraud within the meaning of section 6663.    We also find that

petitioners have not shown that any part of the underpayments was

not due to fraud.
                                  - 29 -

       The record here is replete with evidence of petitioners’

fraudulent intent.       Petitioners, tax professionals who prepare

tax returns for a living and represent clients before the

Internal Revenue Service, were aware of the need for

documentation and records to support the items reported on tax

returns.       In light of their having that knowledge, coupled with

other evidence, we find that their discarding of their supporting

income and client documentation was an intentional act designed

to conceal and evade the reporting and payment of Federal income

tax.       Other factors that support a finding of fraud include the

relatively large underpayments, use of the corporate entity to

conceal information from creditors (including respondent),

manipulation of deductions and income between the corporate and

partnership entities, dealing in cash (including the purchase of

multiple cashier’s checks on the same date in amounts less than

$10,0006), failure to deposit and account for payments for

services from clients, use of multiple bank accounts and failure

to disclose their existence to respondent’s agent, failure to

cooperate with respondent’s agent (including refusal to divulge

the names of clients), attempts to obtain corporate deductions by

making monthly payments as travel reimbursement when such travel

was both undocumented and not for business purposes, and

manipulation of income between petitioners and their family

members.


       6
       Financial institutions are required to report to the
Federal Government cash transactions in excess of $10,000. See
31 U.S.C. sec. 5313(a) (1994); 31 C.F.R. sec. 103.22 (1995).
                             - 30 -

     In addition to the items specifically proven by respondent,

petitioners conceded numerous adjustments determined by

respondent to be unreported income or deductions to which

petitioners were not entitled.

     To the extent no settlement or concession was made regarding

any other item determined by respondent, petitioners have not

come forward with arguments or evidence from which we could find

that respondent’s determinations are in error.     Regarding the

fraud penalty, respondent has shown by clear and convincing

evidence that petitioners' underpayments of 1989 tax were due to

fraud.

     To reflect the foregoing,

                                      Decisions will be entered

                                 under Rule 155.
