                       T.C. Memo. 1995-585



                      UNITED STATES TAX COURT



    C. RICHARD ROOSE, JR. AND BETTY B. ROOSE, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 4185-94.              Filed December 6, 1995.



     John Kennedy Lynch, for petitioners.

     John E. Budde, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION

     COHEN, Judge:   In a notice sent December 28, 1993,

respondent determined deficiencies in, and additions to,

petitioners' Federal income taxes as follows:
                                            - 2 -
                                           Additions to Tax
                   Sec.         Sec.           Sec.           Sec.              Sec.
Year Deficiency 6653(b)(1) 6653(b)(2)         6653(b)(1)(A)   6653(b)(1)(B)    6661(a)
                                       1
1984 $50,374.00 $25,187.00                          --               --       $12,593.50
                                       2
1985   15,577.00    7,788.50                        --               --         3,894.25
                                                                     3
1986   24,752.00          --       --          $18,564.00                       6,188.00

       1
        50 percent of the interest due on $50,374.
       2
        50 percent of the interest due on $15,577.
       3
        50 percent of the interest due on $24,752.

Unless otherwise indicated, all section references are to the

Internal Revenue Code in effect for the years in issue, and all

Rule references are to the Tax Court Rules of Practice and

Procedure.

       After concessions by both parties, we must decide whether

petitioners are liable for the additions to tax for fraud for

1984, 1985, and 1986; whether petitioners are liable for the

additions to tax for substantial understatement of liability for

1984 and 1986; and whether the statute of limitations bars the

assessment of deficiencies and additions to tax for 1984, 1985,

and 1986.

                                 FINDINGS OF FACT

       Petitioners C. Richard Roose (Mr. Roose) and Betty B. Roose

(Mrs. Roose) resided in Middlefield, Ohio, when their petition

was filed.     During the years in issue and at the time of trial,

petitioners were husband and wife.

       Mr. Roose was a pharmacist at all relevant times.

Mrs. Roose also attended pharmacy school but did not complete her

pharmacy degree.           As part of their pharmacy school course work,
                                 - 3 -

petitioners completed a 3-month bookkeeping class directed solely

at learning an accounting system for use in a drugstore setting.

     Mr. Roose owned and operated Roose Drug Store (the store) as

a cash basis sole proprietorship during the years in issue.     He

worked 60 to 70 hours per week in the store, and Mrs. Roose

worked 20 to 30 hours per week.

     Petitioners shared the accounting and bookkeeping

responsibilities of the store.    The store used a single-entry

accounting system known as "Drug Topics", created especially for

use by drugstores.   At the end of a typical day, Mr. Roose would

close out one of the two cash registers in the store.    The totals

from the first register would be entered in the other cash

register.   The second register would then be closed out,

reflecting all of the day's activities.    Mr. Roose used the

information from this cash register tape to prepare the Daily

Cash Report.   The Daily Cash Report is a form containing various

blanks to be filled in with information from the cash register

tape.   Various items were represented on the Daily Cash Report,

including "Received on Account", "Cash Paid Out", and five

categories of "Cash Sales".   Mr. Roose generally recorded all of

the sales under "Cash Sales (I)" and the amounts received on

account through in-person payments under "Cash Sales (II)".     The

"Received on Account" blank on the Daily Cash Report form was not

utilized.
                               - 4 -

     After the Daily Cash Report was finished, a deposit slip

would be completed to reflect the day's transactions, and

Mr. Roose would usually make the bank deposit the following

business day.   Mr. Roose also maintained the store's checkbook.

He recorded deposits on the check stubs and "looked at" the bank

statements.

     Mrs. Roose used the Daily Cash Reports that were prepared by

Mr. Roose to complete entries in the Drug Topics book.    The Drug

Topics book compiled the daily information into month-by-month

income and expense reports.   Mrs. Roose prepared the Drug Topics

book at the end of each month or shortly thereafter.    Both the

Daily Cash Reports and the store's checkbook were used to record

expense items in the Drug Topics book.   Certain deposits not

reflected on the Daily Cash Reports appear in the Drug Topics

book entries prepared by Mrs. Roose.

     Although Mr. Roose knew that Mrs. Roose relied on the Daily

Cash Reports to complete the Drug Topics book, some transactions

were omitted from the Daily Cash Reports.    The store accepted

manufacturers' coupons and received rebates in the form of checks

from the manufacturers.   The amount of the coupon rebates was not

included in the Daily Cash Report total.    The amounts received

from the coupons were not deposited into the store's business

account at Middlefield Banking Co. (the Middlefield account) but

were instead deposited into various accounts at Peoples Savings,

some of which were in the names of petitioners' children.
                                - 5 -

     The Daily Cash Reports also did not include credit card

sales.   The credit card receipts were deposited into an account

at Bank One or Huntington Bank, not into the Middlefield business

account.

     The Daily Cash Reports did not always reflect what

petitioners referred to as "special deposits".    Special deposits

consisted of payments on accounts received from customers or

third parties, such as insurance companies, through the mail.

In-person payments on accounts were included in the Daily Cash

Report total.    If one or two checks were received in the mail,

the payments were rung up on the cash register and were included

in the Daily Cash Report total.    If more than one or two checks

were received by mail, the checks were totaled using an adding

machine, a separate deposit slip was completed, and the practice

varied as to whether a corresponding entry was made in the Daily

Cash Report.    All special deposits were eventually recorded on

the checkbook stubs but not at the time that each special deposit

was made.

     As examples of the omissions from the Daily Cash Reports,

during January and March 1984, no special deposits were recorded

in the Daily Cash Reports or the Drug Topics book.    Only one

special deposit was recorded for February 1984, and one special

deposit was recorded for April 1984.    From January through April

1984, however, customers and third parties were still making

payments on their accounts through the mail.
                                - 6 -

     Similar omissions occurred in 1985.    In February 1985,

petitioners failed to record six special deposits; in May 1985,

petitioners failed to record eight special deposits.

     Petitioners employed Theodore W. Reed (Reed) to prepare

their personal income tax returns and the store's employment tax

returns for 1984, 1985, and 1986.    Reed was paid $300 per year

and was not expected to audit petitioners' books and records.

Reed was provided only the Drug Topics book to use in preparing

the returns.   Reed did not receive the check stubs, Daily Cash

Reports, cash register tapes, or bank statements.    Although

petitioners knew that income omitted from the Drug Topics book

would not be reported on their tax return, petitioners did not

inform Reed that all coupon redemption receipts and all credit

card sales receipts were not reflected in the Drug Topics book.

Reed was not aware that certain special deposits were not

reflected in the Drug Topics book.

     The Internal Revenue Service (IRS) began an examination of

petitioners in May 1987.    During the course of the IRS

examination, petitioners were questioned about their accounting

practices, including their failure to report coupon rebates as

income.   Mr. Roose explained to the revenue agent that it was

industry practice not to report coupon rebates as income and that

he did not report the coupon rebates because he was trying to

create a retirement fund.
                                - 7 -

     The IRS also inquired about petitioners' failure to report

credit card sales receipts.    Petitioners explained that, because

they did not consider credit card sales as cash-on-hand, they did

not enter credit card sales into the cash register or include

those amounts as part of the Daily Cash Report total.     Mr. Roose

falsely represented to the revenue agent that he wrote checks

from the Bank One account to the Middlefield account to transfer

funds back to the store.

     The use of the manual accounting system for certain payments

on accounts received by mail was also questioned during the

examination.   Mr. Roose told the revenue agent that the manual

system saved time when numerous checks arrived in the mail.       In

the same conversation, Mr. Roose stated that the use of the cash

registers allowed him to keep accurate records of how much money

came in and went out of the store.

     In September 1987, the case was referred to the criminal

investigation division.    Mr. Roose was indicted for attempted

income tax evasion relating to petitioners' 1984 and 1985

returns.   After a trial, Mr. Roose was found not guilty.

                               OPINION

     Section 6501(a) generally provides that income tax must be

assessed within 3 years after the filing of a return or the due

date for the return, whichever is later.     Section 6501(c)(1)

provides for an exception to the general period of limitations in

the instance of a fraudulent return.     Respondent's burden of
                               - 8 -

showing that respondent comes within the exception to the period

of limitations is the same as that which she bears in sustaining

the addition to tax for fraud under section 6653(b).      Botwinik

Bros. of Mass., Inc. v. Commissioner, 39 T.C. 988, 996 (1963).

     The addition to tax in the case 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).      For 1984 and

1985, section 6653(b)(1) provides for an addition to tax equal to

50 percent of the entire underpayment when any part of an

underpayment is due to fraud, and section 6653(b)(2) provides for

an addition to tax equal to 50 percent of the interest payable

under section 6601 for that portion of the underpayment that is

attributable to fraud.   For 1986, section 6653(b)(1)(A) provides

for an addition to tax equal to 75 percent of the underpayment

attributable to fraud, and section 6653(b)(1)(B) provides for an

addition to tax equal to 50 percent of the interest payable under

section 6601 for that portion attributable to fraud.

     Respondent has the burden of proving, by clear and

convincing evidence, that some part of an underpayment for each

year was due to fraud.   Sec. 7454(a); Rule 142(b).    For 1984 and

1985, respondent must prove the specific portion of the

underpayment of tax attributable to fraud for purposes of section

6653(b)(2).   For 1986, section 6653(b)(2) provides:
                                - 9 -

          (2) 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 is not attributable to
     fraud.

     Respondent's burden with respect to fraudulent intent is met

if it is shown that the taxpayer intended to conceal, mislead, or

otherwise prevent the collection of such taxes.     Stoltzfus v.

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

Commissioner, 394 F.2d 366, 377 (5th Cir. 1968), affg. T.C. Memo.

1966-81.    The existence of fraud is a question of fact to be

resolved upon consideration of the entire record.     Gajewski v.

Commissioner, 67 T.C. 181, 199 (1976), affd. without published

opinion 578 F.2d 1383 (8th Cir. 1978).    Fraud will never be

presumed.    Beaver v. Commissioner, 55 T.C. 85, 92 (1970).     Fraud

may, however, be proved by circumstantial evidence because direct

proof of the taxpayer's intent is rarely available.    The

taxpayer's entire course of conduct may establish the requisite

fraudulent intent.    Stone v. Commissioner, 56 T.C. 213, 223-224

(1971); Otsuki v. Commissioner, 53 T.C. 96, 105-106 (1969).

     Petitioners contend that respondent has failed to prove

fraud.    Petitioners argue that they maintained adequate records

and provided those records in the form of the Drug Topics book to

Reed, their accountant, for each of the years in issue.

Petitioners attempt to blame Reed for their underreporting of

income.    They argue that Reed should have asked for supporting
                              - 10 -

documentation, such as bank statements, for the Drug Topics book

totals.   Petitioners also argue that they did not conceal or

attempt to divert cash without recording cash receipts.

     Fraudulent intent may be inferred from various kinds of

circumstantial evidence, or "badges of fraud", including

understatement of income, inadequate records, or implausible or

inconsistent explanations of behavior.    Bradford v. Commissioner,

796 F.2d 303, 307 (9th Cir. 1986), affg. T.C. Memo. 1984-601.

The record in this case is replete with clear and convincing

evidence of petitioners' fraudulent intent.

     Petitioners understated their income in each of the years in

issue by intentionally failing to report receipts from credit

card sales that were deposited in the Bank One and Huntington

Bank accounts, intentionally failing to report receipts from

coupon redemptions that were deposited in various Peoples Savings

accounts, and intentionally failing to report numerous special

deposits during the years in issue.    See Webb v. Commissioner,

supra at 379; Marcus v. Commissioner, 70 T.C. 562, 577 (1978),

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

     Although petitioners had each received 3 months of training

in the accounting system that they used in the store, they failed

to utilize the system to keep accurate and adequate records.

They deliberately distorted the accounting system by failing to

record certain store receipts.   By providing the distorted
                              - 11 -

records to Reed, petitioners succeeded in understating their

income in each of the years in issue.

     Petitioners have made various implausible and false

statements.   Mr. Roose falsely stated to a revenue agent in the

course of the IRS examination that he wrote checks from the Bank

One account to the Middlefield account to place the credit card

sales receipts back into the business account.   Mr. Roose also

stated during the IRS examination that it was an industry

practice not to report coupon redemption income and, in an

attempt to explain his failure to report, that he was using these

funds to build a retirement account.    Both of these arguments are

without merit and, moreover, indicate a fraudulent intent.

Petitioners' special manual system for depositing payments on

accounts received by mail has not been reasonably explained.

Mr. Roose's explanation that he used the manual system because it

"saved time" is implausible in light of his admission that he

used cash registers in the store because they produced accurate

records.   Furthermore, Mrs. Roose stated that she used only the

Daily Cash Reports to complete the Drug Topics book but could not

offer an explanation as to how certain deposits not appearing on

the Daily Cash Report appeared in the Drug Topics book.

     Petitioners state that their reliance on Reed to prepare

their tax returns shows a lack of fraudulent intent.   For

petitioners to prevail on their reliance argument, however, they

must have provided the accountant with full and correct
                               - 12 -

information from which to prepare the returns.    See Morris v.

Commissioner, T.C. Memo. 1992-635, affd. without published

opinion 15 F.3d 1079 (5th Cir. 1994); Merlo v. Commissioner, T.C.

Memo. 1987-570.    In this case, petitioners' alleged reliance on

Reed does not excuse them from the fraud addition to tax.

     Petitioners hired Reed to prepare their personal income tax

returns and the store's employment tax returns.   Petitioners did

not intend for Reed to determine their gross receipts or their

expenses or to audit the store's books, as indicated by the

amount that petitioners paid Reed and Mr. Roose's testimony at

trial.   Although petitioners contend that they did not have time

to review their returns before they were filed, Mr. Roose's

testimony at trial suggested that this pattern did not change

even after he was indicted for tax fraud.   No evidence has been

presented to indicate that petitioners' returns did not

accurately reflect the information petitioners provided to Reed.

Because of petitioners' intentional failure to report credit card

sales receipts, coupon redemption receipts, and certain special

deposits and due to no fault of his own, Reed was without the

information necessary to reflect accurately petitioners' income

on their tax returns for the years in issue.

     This case is comparable to Estate of Temple v. Commissioner,

67 T.C. 143 (1976).   We incorporate the same analysis here.   The

Court's statements in Estate of Temple, may be adapted to this

case as follows:
                             - 13 -

          [Petitioners contend] that * * * [they], being
     unversed in matters of accounting, relied totally upon
     * * * [Reed] to insure the accuracy of * * * [their]
     records and prepare * * * [their] tax returns. * * *
     [Petitioners] further contend that the resultant
     understatements are not such as would cause * * *
     [petitioners] to be aware that * * * [their] income was
     underreported. We cannot agree with either contention.

          At the outset we are not impressed with * * *
     [petitioners'] attempt to characterize * * *
     [themselves] as * * * unknowledgeable * * *
     [businesspeople]. * * * the record shows that * * *
     [the Rooses had their] fingers on the pulse of the
     financial affairs of * * * [Roose Drug Store].

          * * * [Petitioners'] conduct was intimately
     entwined with the inaccurate recording of * * * [their]
     business income. * * *

          While a taxpayer's reliance upon his accountant to
     prepare accurate returns may indicate an absence of
     fraudulent intent, John Marinzulich [v. Commissioner],
     31 T.C. 487, 490 (1958), this is true in the first
     instance only if the accountant has been supplied with
     all the information necessary to prepare the returns.
     Petitioner[s] [argue] in this regard that * * * [Reed]
     had total access to all of * * * [petitioners'] books
     and records, so that even though the * * * [Drug Topics
     book] was inaccurate, a thorough professional job of
     accounting would have uncovered the inaccuracies. Of
     course the thorough audit by respondent's agents did
     discover many omitted and erroneous entries. However,
     we cannot conclude on the basis of the record before us
     that * * * [Reed] was retained to check with * * *
     [petitioners'] customers in order to find out whether
     they made payments to * * * [petitioners] which were
     not recorded in the * * * [Drug Topics book] or to
     otherwise doublecheck the * * * [Drug Topics book]
     entries made by * * * [Mrs. Roose]. The evidence
     points to the contrary. * * * [Id. at 162-163; fn.
     ref. omitted.]

     Considering the entire record, we conclude that respondent

has proven by clear and convincing evidence that the entire

amount of the underpayments of tax on petitioners' returns for
                             - 14 -

the years in issue was due to fraud.    The statute of limitations,

therefore, does not bar assessment of the deficiencies or the

additions to tax for fraud for the years in issue.

     Petitioners have presented no evidence or argument regarding

the additions to tax under section 6661(a) for 1984 and 1986.

The exceptions under section 6661(a)(2)(B) regarding substantial

authority for the tax treatment and adequate disclosure in the

return do not apply in this instance.   Therefore, respondent's

determination will be sustained.

     To reflect the foregoing and concessions of the parties,

                                   Decision will be entered

                              under Rule 155.
