                         T.C. Memo. 2011-101



                       UNITED STATES TAX COURT



                F. JEFFREY RAHALL, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket Nos. 6028-06, 21710-07.     Filed May 16, 2011.



     F. Jeffrey Rahall, pro se.

     Michael D. Zima, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     COHEN, Judge:    Respondent determined deficiencies,

penalties, and additions to tax as follows:

Docket No. 6028-06

                                           Penalty
               Year      Deficiency       Sec. 6663

               1999      $343,344        $257,508.00
               2000       965,278         723,958.50
                               - 2 -

Docket No. 21710-07

                                Penalty        Addition to Tax
     Year     Deficiency       Sec. 6663       Sec. 6651(a)(1)

     2001     $986,869       $740,151.75          $246,717.25
     2002    1,280,782        960,586.50           320,195.50
     2003    1,013,949        760,461.75              ---

After concessions, the issues for decision are:    (1) Whether

petitioner is liable for tax on amounts he received from two

domestic trusts; (2) whether petitioner is liable for tax on

capital gain from a domestic trust; (3) whether petitioner is

liable for tax on amounts he received from two foreign trusts;

(4) whether petitioner is liable for tax on credit card payments

of his personal expenses by a foreign trust; (5) whether

petitioner is liable for tax on unexplained deposits made into

his accounts; (6) whether petitioner is entitled to deduct

capital losses relating to two alleged business ventures; (7)

whether petitioner is entitled to a deduction for a theft loss;

(8) whether petitioner is liable for an addition to tax under

section 6651(a)(1) for years 2001-03; (9) whether petitioner is

liable for the fraud penalty under section 6663 for all years in

issue.   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.
                                - 3 -

                          FINDINGS OF FACT

     Some of the facts have been stipulated, and the stipulated

facts are incorporated in our findings by this reference.      At all

material times, petitioner resided in Florida.

     Petitioner is the only son of Farris E. Rahall and Victoria

B. Rahall.    After graduating from college, petitioner was

employed as a stockbroker.    Petitioner married Cary B. Rahall in

1982, and they have three children.     Petitioner’s parents

accumulated millions of dollars throughout their lives, mostly

through the operation and sales of several television and radio

stations.    As a result, petitioner’s father established a number

of trusts to hold his family’s wealth, much of it for the benefit

of petitioner and his children.

     The trust instrument for the “Farris E. Rahall Trust” (1964

Trust), an irrevocable trust, was executed November 2, 1964, in

Pennsylvania.    Petitioner’s father was the settlor, and N. Joe

Rahall and Sam G. Rahall (petitioner’s uncles) were the initial

trustees.    Petitioner’s mother was subsequently added as a

trustee.    Section II(a) of the trust instrument states:

     Trustees may withhold a portion or all of net
     income subject to the childrens’ needs for living
     or education or investments in businesses in which
     they may participate in management. Trustees may
     distribute any portion of net income or principal
     to Settlor’s wife or children on an annual or
     quarterly basis.
                               - 4 -

Thus, the trust could accumulate income or distribute all income

or any of the corpus as the trustees deemed necessary.

     The trust instrument for the “Farris Jeffrey Rahall 1978

Trust” (1978 Trust) was executed October 14, 1978, and

established a revocable trust under Florida law.   An amendment

executed December 14, 1995, named petitioner as the grantor and

one of the trustees.   Petitioner was the only beneficiary during

his lifetime.   An amendment executed December 20, 2001, made

petitioner the sole trustee.   Article III of the 1995 amendment

states:

          During the lifetime of the Grantor, the Trustees
     shall pay to, or apply in behalf of, the Grantor such
     portion of the net income and/or principal of the trust
     and at such time or times as shall be required, in the
     sole and sound discretion of the Trustees, to allow the
     Grantor to be properly supported and maintained and to
     enable the Grantor to meet all medical expenses and
     emergency or untoward circumstances during the
     Grantor’s lifetime. Notwithstanding the foregoing, the
     Trustees shall pay or apply so much of the net income
     and/or principal of the trust to the Grantor or to such
     person or persons as the Grantor may from time to time
     direct for any purpose whatsoever.

Thus, petitioner could direct the trustees to pay any amount of

income or trust corpus he desired.

     The Declaration of Trust for Tee Holdings, Ltd. (Tee

Holdings), purported to establish an irrevocable trust under

Cayman Islands law on June 26, 1991.   The Cayman Overseas Trust

Co. was the original trustee and had the “absolute discretion” to

distribute or accumulate income for the benefit of the
                                 - 5 -

beneficiaries.     Petitioner was a beneficiary throughout the years

in issue.    The corpus was to be distributed to living

beneficiaries upon termination of the trust.        Tee Holdings was

later renamed South West Coast Holdings at the request of

petitioner.    (For simplicity, all references will be to Tee

Holdings.)

     The Wheels Trust was established in 1995 under Channel

Islands law.     The donor, the Wheels Foundation, transferred

property into the trust, and the assets were held in the Channel

Islands.    Petitioner controlled the Wheels Trust bank accounts

throughout the years in issue.

     Petitioner’s parents’ health deteriorated significantly over

the years prior to 2000.     In 2000, petitioner obtained powers of

attorney with respect to the financial affairs of his parents.

Using these powers of attorney, he was able to transfer funds

among their accounts and his own.        Between 1999 and 2003,

petitioner requested and received distributions from each of the

above-named trusts and from many other sources in at least the

following amounts:     $335,315 in 1999, $1,079,668 in 2000,

$2,303,755 in 2001, $3,232,837 in 2002, and $2,682,117 in 2003.

     In addition to what he received from the various trusts,

petitioner incurred numerous charges on a Cayman National Bank

credit card.    The credit card charges were paid by Tee Holdings.
                                 - 6 -

The total charges the trust paid on petitioner’s credit card were

as follows:

                  Year            Total Payments

                  1999              $403,551.00
                  2000               657,000.00
                  2001               164,500.00
                  2002                60,212.00
                  2003                30,217.50

Disputed Deductions and Losses

     In 1998, petitioner met Brooks Rose (Rose) when he hired her

as an escort.     They subsequently developed a personal

relationship.   Throughout the years in issue, petitioner

transferred hundreds of thousands of dollars to Rose and paid

many of her expenses, including travel expenses, school tuition

for her children, vehicles, and medical expenses.

     In addition to their personal relationship, from 1999

through 2002 petitioner engaged in various purported business and

charitable activities with Rose under the purported corporations

“Angels for Angels” and/or “Angel Quest”.    (It is unclear from

the record whether Angel Quest and Angels for Angels existed as

entities or were entirely fictitious or in any event to which one

petitioner transferred money.)    With his 2002 Form 1040, U.S.

Individual Income Tax Return, petitioner included a list of

expenditures on two credit cards, indicating the charges related

to Angel Quest.    These expenses totaled $61,470 in 1999, $290,726

in 2000, and $40,248 in 2001.    Most of these expenses were
                               - 7 -

charges made for travel and at restaurants around the world,

including $10,177.01 at the Ritz Carlton in Cancun over several

days in 1999 and $9,366.36 at hotels in Tahiti in 2000.

Petitioner deducted $392,444 in theft losses for these

expenditures on his belatedly filed 2002 income tax return,

discussed below.

     Petitioner also purchased numerous items for Rose.   In 2000,

petitioner purchased property in Boca Raton, Florida, for Rose to

live in with her family.   The property was purchased in the name

of Angel Heaven, Inc. (Angel Heaven), a corporation petitioner

formed for the sole purpose of holding title to the property.

     Petitioner also gave Rose money for “Attitude Hair Salon”

(Attitude), a purported business Rose and her friend David

Giordano (Giordano) developed in 2001.   With respect to Attitude,

petitioner made thousands of dollars in wire transfers to Rose

and indicated on the documentation included with his 2002 tax

return charges to his credit cards, mostly for meals and travel

expenses.   Petitioner deducted a long-term capital loss of

$246,354 for worthless stock with respect to his contributions to

Attitude on his 2002 tax return.

     In 2003, petitioner engaged in another real estate

transaction for the benefit of another personal female friend.

Under the name of Oak Hill Stables, Inc., petitioner purchased

property in Ocala, Florida, where this friend lived with her
                                   - 8 -

daughter.   In addition, petitioner purchased a horse trailer for

use at the property.    The trailer was titled in petitioner’s

mother’s name.

     On his 2000 tax return, petitioner deducted $100,000 as a

capital loss relating to Webtank, Inc. (Webtank).    At some point,

petitioner paid Webtank $18,000 for a Web site Webtank had

created at his request.

     During all years in issue, petitioner owned all of the

outstanding stock of FJR Investments, Inc. (FJR Investments), an

S corporation.   During this time the company did not conduct any

identifiable business activity and did not have any employees.

Expenses charged to the FJR Investments accounts include

satellite television for petitioner’s residence, automobile

insurance for his family’s personal vehicles, yacht club

membership fees, travel expenses, magazine subscriptions, and

diamonds for Rose.     The total amounts of these items were:

                            Year            Amount

                            1999           $41,960
                            2000            75,581
                            2001            28,518
                            2002            29,224
                            2003             9,385

Petitioner deducted those amounts on his tax returns as business

expenses.

     During all years in issue, petitioner deducted large amounts

of medical expenses.    The returns for the years in issue included
                                  - 9 -

on Schedule A, Itemized Deductions, the following medical

expenses:

                           Year            Amount

                           1999           $77,846
                           2000           101,062
                           2001           112,613
                           2002            32,330
                           2003            37,974

IRS Examination

       In 2002, the Internal Revenue Service (IRS) began an audit

of petitioner’s tax returns for 1999 and 2000.      The audit was

precipitated by petitioner’s use of the Cayman National Bank

credit card, paid using funds from Tee Holdings.

       During the audit with respect to 1999 and 2000, the IRS

requested numerous documents from petitioner regarding the

foreign trusts, the domestic trusts, and petitioner’s personal

finances.    Among other things, petitioner denied knowledge of the

Wheels Trust.    As the audit progressed, petitioner’s personal

assistant gathered the relevant documents together into 13 boxes.

Petitioner hired Gray Gibbs (Gibbs), an attorney who had worked

for petitioner and his father, to represent him during the audit.

The 13 boxes of records were delivered to Gibbs’ office, but only

some of the documents from those boxes were ever provided to the

IRS.

       The documents that petitioner supplied included limited

financial statements from the trusts, canceled checks from his
                               - 10 -

personal accounts and the FJR Investments account, and credit

card statements from the Cayman National Bank card.     Also among

the documents was a letter dated February 11, 1999, to

petitioner’s father from Deutsche Bank Offshore DMG Trust

(Deutsche Bank), the bank that held the Wheels Trust account.

The letter included a handwritten note from petitioner’s father

to petitioner requesting his advice about a change the bank was

making with respect to the Wheels Trust.

     Cary B. Rahall, who was estranged from petitioner at the

time of the audit, hired separate counsel to represent her in

relation to the audit.    She cooperated with the examining agents

and provided some relevant documentation that she obtained from

petitioner’s residence.    These documents included correspondence

dated July 10, 2001, from petitioner to Deutsche Bank seeking a

distribution from the Wheels Trust.     The IRS granted Cary B.

Rahall innocent spouse relief.

     While the audit was continuing, the IRS began a program

called the Offshore Voluntary Compliance Initiative, also known

as the Last Chance Compliance Initiative (LCCI) for taxpayers

that had used offshore payment cards (including credit, debit, or

charge cards) or offshore financial arrangements to avoid U.S.

income tax.   See Rev. Proc. 2003-11, 2003-1 C.B. 311.    The

program offered to limit imposition of the civil fraud and

Foreign Bank and Financial Accounts penalties against a taxpayer
                              - 11 -

on condition that the taxpayer provide documentation requested by

the IRS.   That documentation included, but was not limited to:

Copies of previously filed returns (on which reported tax due

must have been fully paid); descriptions of offshore payment

cards and accounts; descriptions of the sources of foreign

income; and complete and accurate amended or delinquent original

Federal tax returns with full payment of taxes due for all years

in issue (regardless of whether related to offshore accounts).

     On November 24, 2003, the IRS sent petitioner a letter

offering him the opportunity to participate in the LCCI program.

In order to participate, he was required to provide the requested

information about his foreign accounts.     The IRS also expanded

the audit to include the years 2001-03, for which petitioner had

not yet filed returns.   Although the terms of the LCCI offer

required that he supply requested documents within 150 days,

petitioner did not provide the requested information.

     Participation in the LCCI also required petitioner to submit

amended tax returns to address the deficiencies the IRS had

determined for all years in issue.     Ultimately the IRS determined

that the amended returns for 1999-2000 and the tax returns

petitioner eventually filed for 2001-03 on July 7, 2004, raised

many of the same concerns his original returns for 1999 and 2000

had raised.   He continued to deduct business expenses arising

from his use of the FJR Investments account, deduct thousands of
                              - 12 -

dollars in medical expenses he could not substantiate, and

substantially underreport his income.   He did not provide any

documentation to substantiate the original corpus or income of

the trusts or the theft or capital losses he deducted in 2002.

He did not explain deposits to his accounts of $43,400 in 1999,

$516,580 in 2001, $759,349 in 2002, and $914,412 in 2003

uncovered by the IRS during the course of the audits.   Petitioner

identified the source of a $4,752 deposit and a $19,237 deposit,

both made in 2002, as Fidelity Brokerage Services (Fidelity) and

“Rahall Realty”, respectively, but he did not identify the reason

for those deposits.

     On July 14, 2004, the IRS sent petitioner a second letter

outlining the remaining documents he was required to submit to

comply with the offer.   On November 2, 2005, the IRS determined

that petitioner had not complied with the terms of the LCCI and

withdrew the offer.



                              OPINION

     Prior to trial, the parties made a number of concessions.

Petitioner conceded that his medical expenses should be reduced

by $58,712, $49,491, $96,745, $18,346, and $28,720 for 1999-2003

respectively, the amounts he was unable to substantiate.

Furthermore, in 2003 he is not entitled to a short-term capital

loss and is subject to a 10-percent penalty under section 72(t)
                                - 13 -

on a distribution he received from a qualified plan.    Petitioner

also conceded that the deductions claimed for supposed business

expenses with respect to FJR Investments were improper.

Respondent conceded that petitioner’s parents, not petitioner,

are taxable on the income of the foreign trusts in 1999 and 2000.

Respondent has also conceded that petitioner is not taxable on a

capital gain adjustment for 1999 or $858,945 of an adjustment

determined for 2000 in the notice of deficiency for those years.

Deposits to Petitioner’s Accounts

     A taxpayer is required to maintain adequate books and

records sufficient to establish his or her income.    See sec.

6001; DiLeo v. Commissioner, 96 T.C. 858, 867 (1991), affd. 959

F.2d 16 (2d Cir. 1992).    When a taxpayer fails to maintain these

records, the Commissioner may determine income under the bank

deposits method.   Id.    A bank deposit is prima facie evidence of

income.   Id. at 868; Tokarski v. Commissioner, 87 T.C. 74, 77

(1986).   Once respondent has made this prima facie case,

petitioner bears the burden of showing that the deposits made

into his account represent nontaxable income.    See DiLeo v.

Commissioner, supra at 868.    As to income and deduction items,

petitioner must present credible evidence to shift the burden to

respondent under section 7491(a).    He has not done so.
                             - 14 -

     Of the deposits to petitioner’s accounts the IRS uncovered

during the audit, the following remain in issue for 1999:

              Source                    Amount

          1964 Trust                    $19,650
          1978 Trust                    107,050
          Unknown sources                43,400

The following deposits remain in issue for 2000:

            Source                      Amount

          1978 Trust                    $99,970
          Tee Holdings                  590,000

The following deposits remain in issue for 2001:

              Source                   Amount

          1964 Trust                  $449,000
          Tee Holdings                 560,000
          Fidelity                       8,000
          Cash                          16,800
          Unknown sources              516,580

The following deposits remain in issue for 2002:

                Source                 Amount

          1964 Trust                  $105,000
          1978 Trust                    52,315
          Wheels Trust                 444,914
          Fidelity Brokerage Services    4,752
          Rahall Realty                 19,237
          Cash                           3,700
          Unknown sources              731,660

The following deposits remain in issue for 2003:

              Source                   Amount

          1964 Trust                  $151,500
          1978 Trust                    95,475
          Tee Holdings                 449,144
          Wheels Trust                 513,262
          Unknown sources              914,412
                                - 15 -

Domestic Trusts

     The definition of gross income under section 61(a) broadly

encompasses any accession to a taxpayer’s wealth.      Commissioner

v. Schleier, 515 U.S. 323, 327-328 (1995).      Gross income

specifically includes “Income from an interest in an estate or

trust.”   Sec. 61(a)(15).

     1964 Trust

     Section 662 governs the tax obligations of trust

beneficiaries as to distributions from trusts which may

accumulate income or distribute corpus.    Beneficiaries are

required to include in income any amounts the trust is required

to distribute currently and any other distributions to the extent

they represent income earned by the trust; to the extent those

distributions represent corpus, the beneficiary does not need to

include the amount in income.    Sec. 662(a).

     Because the 1964 Trust can accumulate income and distribute

corpus, its beneficiaries are taxed according to section 662.

Therefore, to the extent that the amounts petitioner received

represented trust income, he must include them in his taxable

income.   Petitioner has failed to provide supporting

documentation that would distinguish between corpus and income

and has failed to meet his burden of proving that he received

amounts representing trust principal rather than income.       He must
                                - 16 -

therefore include the entire amounts in income for the years

1999, 2001, 2002, and 2003.

     1978 Trust

     Respondent argues that the 1978 Trust is a grantor trust

that meets the requirements of sections 671-679 and is to be

disregarded as a separate taxable entity to the extent of the

grantor’s retained interest.     See sec. 1.671-2(b), Income Tax

Regs.    Respondent contends that petitioner, as a grantor of a

grantor trust, must therefore report his portion of the trust’s

income and deductions on his own tax return.

     For purposes of the grantor trust provisions, a grantor

includes any person to the extent that person either creates a

trust or gratuitously transfers property, directly or indirectly,

to a trust.    Sec. 1.671-2(e)(1), Income Tax Regs.      If one person

creates or funds a trust on behalf of another person, both

persons are treated as grantors of the trust.      Id.    The trust

instrument, as amended, indicates that petitioner is the grantor

of the 1978 Trust.

     The grantor of the trust is taxed on the income of the trust

under the grantor trust provisions if any of certain conditions

apply.    First, the grantor possesses a disqualifying reversionary

interest.    Sec. 673.   Second, the trust can be revoked by the

grantor or a nonadverse party.     Sec. 676.   Third, trust income

can be distributed to the grantor or the grantor’s spouse or be
                                - 17 -

used to pay for insurance on their lives without the consent of

an adverse party.   Sec. 677.   Fourth, specified powers to control

beneficial enjoyment of the corpus or income are vested in the

grantor or certain other persons.    Sec. 674.   Fifth, certain

administrative powers are exercisable by the grantor or a

nonadverse party.   Sec. 675.

     Petitioner had full control over the 1978 Trust as indicated

by the trust instrument.   None of the other trustees nor any

other party could limit the distribution of either principal or

income to petitioner.   Furthermore, petitioner ultimately became

the only trustee after a 1995 modification of the trust

instrument.   The trust is therefore disregarded as an entity for

tax purposes, and trust income is attributable to petitioner.

     Petitioner has taxable income to the extent that the amounts

he received were attributable to income the trust earned, rather

than the corpus of the trust.    Petitioner again bears the burden

of proving that the payments he received were not taxable income.

He has not provided evidence that would distinguish income from

corpus, and he is liable for tax on all amounts he received in

the years 1999, 2000, 2002, and 2003.

     Because petitioner is liable for tax on the income of this

trust, he is also liable for tax on net capital gain of $32,204,

which he included on the amended return for 2000 he submitted

during the audit.
                              - 18 -

Foreign Trusts

     Tee Holdings

     Because Tee Holdings, like the 1964 Trust, may distribute

income or corpus at the trustee’s discretion, distributions are

taxable according to section 662.   Respondent also contends that

because petitioner failed to provide documentation as to the

character of the distributions, they are taxable to petitioner.

Section 6048(c)(2)(A) provides:   “If adequate records are not

provided to the Secretary to determine the proper treatment of

any distribution from a foreign trust, such distribution shall be

treated as an accumulation distribution includible in the gross

income of the distributee”.

     Petitioner has not provided evidence that would prove

whether the amounts he received exceeded the income the trust

earned.   He could not demonstrate what capital was placed into

the trust or the extent of the income earned and retained.

Without this evidence, petitioner is liable for tax on his

receipts from Tee Holdings in 1999, 2000, 2001, and 2003.

     Additionally, Tee Holdings paid the Cayman National Bank

credit card charges that petitioner incurred.   These indirect

payments are taxable to petitioner for the same reasons the

direct payments were taxable to him.   See Traylor v.

Commissioner, T.C. Memo. 1990-132, affd. without published

opinion 959 F.2d 970 (11th Cir. 1992).
                                - 19 -

     Wheels Trust

     Similarly, petitioner has not provided evidence regarding

the Wheels Trust sufficient for us to classify amounts he

received as income or principal.     The documents petitioner

provided are incomplete; they do not provide sufficient detail to

determine all of the income the trust earned and therefore do not

meet the requirements of section 6048.     The amounts petitioner

received from the Wheels Trust in 2002 and 2003, including

amounts deposited into a joint account with his wife, are taxable

to him.

Unexplained Deposits

     Respondent argues that because petitioner is unable to

demonstrate that several deposits made into his personal accounts

are nontaxable, he is liable for tax on those amounts.

Respondent has made a prima facie case using the bank deposits

method with respect to deposits from two specific sources--

Fidelity and Rahall Realty--and other deposits from entirely

unknown sources.

     Fidelity

     Petitioner has not demonstrated that the $4,752 deposit made

to his account in 2002 from Fidelity is nontaxable.     Fidelity

held at least one of the trusts from which petitioner received

taxable income.     He has not met his burden with respect to the

deposit from Fidelity and is liable for tax on that amount.
                               - 20 -

     Rahall Realty

     Petitioner deposited $19,237 from Rahall Realty in 2002.    He

has provided no evidence as to the nature of this entity or the

purpose of the payment.    Petitioner has likewise not met his

burden with respect to this deposit.

     Unknown Sources

     Additional deposits were made to petitioner’s accounts in

cash or from entirely unknown sources in 1999, 2001, 2002, and

2003.   Petitioner presented no evidence as to who made these

deposits or why they were made and therefore has not met his

burden of proof for those deposits.

Capital Losses

     Webtank

     Petitioner has failed to demonstrate that he is entitled to

the $100,000 capital loss deduction relating to Webtank.    He has

provided what he represents to be a stock certificate, which

reflects only ownership in Webtank by another trust, and evidence

that Tee Holdings, not petitioner, also holds an interest in

Webtank.   The only evidence of invested funds was a canceled

check to Webtank from FJR Investments for $18,000, which

petitioner admits was payment for a Web site that he hired

Webtank to produce.    None of this documentation shows that

petitioner owned stock in Webtank and had a basis of $100,000, or

any amount, for capital loss purposes.    Thus, petitioner has not
                              - 21 -

demonstrated that he is entitled to the $100,000 capital loss he

deducted for 2000.

     Attitude

     Petitioner deducted a long-term capital loss of $246,354 for

his purported investment in Attitude in 2002, and he claimed a

capital loss carryover of $202,892 in 2003.   He bases his claimed

loss on credit card charges by hotels and restaurants, but he has

failed to substantiate the business purpose of the expenses as

required by section 274(d).   Petitioner claims that the purpose

of the travel reflected in the charges was for Rose and Giordano

“to be traveling the country doing hair extensions”.

Petitioner’s testimony suggested that Rose made little effort to

start or operate the alleged business and that the expenses were

paid as a result of petitioner’s personal relationship with Rose.

Petitioner has not met his burden and may not deduct any capital

loss with respect to Attitude.

Theft Loss Deduction

     Respondent disallowed petitioner’s 2002 itemized deduction

for a theft loss related to his alleged charitable contributions

to Angel Quest.   In order to sustain a theft loss deduction, a

taxpayer has the burden of proving that he discovered a loss in

the taxable year in issue as a result of a theft, as defined by

the law of the jurisdiction in which the claimed loss took place,

and the amount of the loss.   Axelrod v. Commissioner, 56 T.C.
                               - 22 -

248, 256 (1971); Monteleone v. Commissioner, 34 T.C. 688, 692

(1960).   A taxpayer must also prove that he was the owner of the

property stolen.    Draper v. Commissioner, 15 T.C. 135, 135-136

(1950); see Kim v. Commissioner, T.C. Memo. 1995-598.

     Petitioner claims that Rose tricked him into providing money

to Angel Quest, which she apparently claimed to be a charitable

organization.    He asserts that he believed Angel Quest was

developing a calendar using photographs of models posed in exotic

locations, and the profits from the calendar and any other

ventures the organization undertook would be given to charity.

Neither petitioner nor Rose had any experience in creating this

type of calendar, but petitioner argues that he paid large sums

of money to allow himself, Rose, her children, and others to

produce a calendar.    No calendar was ever created, and petitioner

produced only a handful of pictures which he contends were taken

through this operation.

     The expenses charged to petitioner’s credit card in relation

to Angel Quest are almost exclusively for food and beverages,

travel expenses, and hotel charges.     The travel was generally to

vacation destinations for himself, Rose, her children, and

occasionally others.    Given this context, his claim that he

believed these expenses were legitimate costs of a charity is

implausible.    Furthermore, petitioner offered no proof that he

actually paid the expenses he charged to the credit card.      In any
                              - 23 -

event, we are not persuaded that the payments and purchases he

made for Rose, a person with whom he admittedly had a personal

relationship, were stolen from him.    Petitioner has failed to

meet his burden of demonstrating that he is entitled to a theft

loss deduction in 2002.

Section 6651(a)(1) Addition to Tax

     Section 6651(a)(1) provides that in the case of failure to

file a tax return on the date prescribed for filing (including

any extension of time for filing), there shall be added to the

tax required to be shown on the return an amount equal to 5

percent of that tax for each month or fraction thereof that the

failure to file continues, not exceeding 25 percent in the

aggregate, unless it is shown that the failure to file timely is

due to reasonable cause and not due to willful neglect.    A

taxpayer has the burden of proving that the failure to timely

file was due to reasonable cause and not to willful neglect.      See

Higbee v. Commissioner, 116 T.C. 438, 446 (2001).    Under section

7491(c), respondent has the burden of production and met his

burden when the parties stipulated that the returns for 2001 and

2002 were filed late, both on July 7, 2004.

     Petitioner has not demonstrated reasonable cause for filing

late returns.   See sec. 301.6651-1(c), Proced. & Admin. Regs.

Petitioner’s only justification for late filing was that issues

regarding income from the foreign trusts arose during an ongoing
                                - 24 -

audit and he was unable to file his returns until those issues

were resolved.   The ongoing audits or other actions before the

IRS, even when the issues raised for those prior years are

similar to an issue raised for the year in issue, do not provide

petitioner with reasonable cause.    See Owens v. Commissioner,

T.C. Memo. 2001-143; Likes v. Commissioner, T.C. Memo. 1991-286.

Petitioner is liable for the addition to tax under section

6651(a)(1) for 2001 and 2002.

Section 6663 Fraud Penalty

     The penalty 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); Sadler v.

Commissioner, 113 T.C. 99, 102 (1999).   The Commissioner has the

burden of proving, by clear and convincing evidence, an

underpayment for each year in issue and that some part of the

underpayment for each of those years is due to fraud.    Sec.

7454(a); Rule 142(b).   If the Commissioner establishes that any

portion of the underpayment is attributable to fraud, the entire

underpayment is treated as attributable to fraud and subject to a

75-percent penalty, unless the taxpayer establishes that some

part of the underpayment is not attributable to fraud.    Sec.

6663(a) and (b).   The Commissioner must show that the taxpayer
                               - 25 -

intended to conceal, mislead, or otherwise prevent the collection

of taxes.    Katz v. Commissioner, 90 T.C. 1130, 1143 (1988).

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

upon consideration of the entire record.     King’s Court Mobile

Home Park, Inc. v. Commissioner, 98 T.C. 511, 516 (1992).       Fraud

will never be presumed.    Id.; Beaver v. Commissioner, 55 T.C. 85,

92 (1970).    Fraud may, however, be proved by circumstantial

evidence and inferences drawn from the facts because direct proof

of a taxpayer’s intent is rarely available.     Niedringhaus v.

Commissioner, 99 T.C. 202, 210 (1992).     The taxpayer’s entire

course of conduct may establish the requisite fraudulent intent.

Stone v. Commissioner, 56 T.C. 213, 223-224 (1971).     Fraudulent

intent may be inferred from various kinds of circumstantial

evidence, or “badges of fraud”, including the consistent

understatement of income, inadequate records, implausible or

inconsistent explanations of behavior, concealing assets, and

failure to cooperate with tax authorities.     Bradford v.

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

1984-601.    An additional badge of fraud includes a taxpayer

disguising nondeductible personal expenditures as business

expenses.    See Romer v. Commissioner, T.C. Memo. 2001-168.

     Respondent points to petitioner’s pattern of underreporting

his income over the course of the 5 years at issue as a badge of

fraud.   Petitioner has conceded that he underreported his income
                                - 26 -

and overstated his deductions by $104,623 in 1999, $216,193 in

2000, $125,263 in 2001, $47,570 in 2002, and $425,906 in 2003.

The pattern of understatements is evidence of fraud.

     Petitioner failed to maintain records that would disclose

his correct taxable income.    During 4 of the 5 years at issue,

deposits in amounts totaling over $2 million for which he cannot

identify the sources were made to his accounts.    Petitioner did

not have records to justify many of the medical and business

expenses he deducted or to justify the capital losses he claimed.

     Further badges of fraud in this case include petitioner’s

failure to disclose offshore trusts used to conceal income and

the accompanying record of implausible and inconsistent

explanations of behavior.     Petitioner failed to comply with the

reporting requirements for the foreign trusts in which he had

interests.   Although he claims that he had no knowledge of these

trusts until the audit began, his claims are not credible.

Petitioner at one time worked as a stockbroker and was a

sophisticated investor.   By his own admission he spent a

significant amount of time trading securities and watching the

financial markets.   We do not believe that he received millions

of dollars from these trusts without knowledge of their nature.

     Petitioner’s wife was able to procure from his home office

and turn over to the IRS documentation regarding the foreign

trusts that petitioner did not supply during the audit.
                               - 27 -

Petitioner’s father sought advice from petitioner about

investment decisions regarding the Wheels Trust in February 1999.

Additionally, petitioner changed the name of Tee Holdings to

South West Coast Holdings for no apparent purpose other than to

conceal the offshore funds.    Petitioner’s behavior with respect

to the foreign trusts is evidence of the intent to avoid the

payment of taxes.

       Another badge of fraud is petitioner’s use of nominees to

hold assets.    He titled the house he purchased for Rose under the

name of Angel Heaven, a corporation with no purpose other than to

hold that property.    He purchased the ranch house he owned in

Ocala under the name Oak Hill Stables despite treating the

property as his own and purchased a horse trailer under his

mother’s name despite her ill health and inability to enjoy its

use.

       Petitioner used his FJR Investments account to pay personal

expenses for his family, and he deducted those expenses as

business expenses.    FJR Investments conducted no substantial

business in any of the years at issue, claiming de minimis income

and thousands of dollars in expenses.    Nearly all of these

expenses were undeniably personal, including country club

memberships, satellite television bills, and gasoline for family

vehicles.    He justified the diamonds he purchased for Rose with

this account as an investment that required him “to buy diamonds
                               - 28 -

and actually use them in jewelry to be worn for a year before

donating them to a charity that used precious stones”, but never

made such a donation.   Petitioner’s claimed losses arising from

fictitious business relationships are evidence of fraud.

     Petitioner claimed additional personal expenditures as theft

losses and capital losses.    The travel and meal expenses he

deducted with respect to his dealings with Rose were plainly

personal and nondeductible.    Deducting such expenses under the

guise of investments he never made is another clear indication of

fraud.

     Finally, petitioner failed to cooperate with the examining

agents.   As described above, petitioner either did not retain or

chose not to turn over documents that would explain many of the

deposits to his accounts or the expenses that he deducted.

Although petitioner asserts that he believed he had complied with

the terms of the LCCI, the erroneous and fraudulent amended

returns, standing alone, were grounds for withdrawal of the

offer.

     Respondent has shown by clear and convincing evidence that

petitioner intended to avoid taxes by concealing income in

foreign accounts, deducting expenses he knew to be improper, and

failing to comply with his reporting and documentation

requirements.   Petitioner’s explanations and excuses are
                                - 29 -

implausible and unpersuasive.    Petitioner is liable for the fraud

penalty under section 6663 for all of the years in issue.

     We have considered the other arguments of the parties, and

they either are without merit or need not be addressed in view of

our resolution of the issues.    To reflect petitioner’s and

respondent’s concessions,


                                         Decisions will be entered

                                 under Rule 155.
