                        T.C. Memo. 2003-216



                      UNITED STATES TAX COURT



                EDDIE LEE WILLIAMS, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 27662-91.               Filed July 22, 2003.



     Eddie Lee Williams, pro se.

     Elizabeth Downs, for respondent.



                        MEMORANDUM OPINION

     DAWSON, Judge:   This case was assigned to Special Trial

Judge Daniel J. Dinan pursuant to the provisions of section

7443A(b)(4), in effect at the time the petition was filed in this

case, and Rules 180, 181, and 183.1   The Court agrees with and


     1
        Unless otherwise indicated, section references are to the
Internal Revenue Code in effect during the years in issue and
                                                   (continued...)
                               - 2 -

adopts the opinion of the Special Trial Judge, as set forth

below.

               OPINION OF THE SPECIAL TRIAL JUDGE

     DINAN, Special Trial Judge:    For the taxable years 1989 and

1990, respondent determined deficiencies in petitioner’s Federal

income taxes of $37,806 and $2,579, section 6651(a)(1) additions

to tax of $9,452 and $516, and section 6654(a) additions to tax

of $2,557 and $170.

     The issues for decision are:   (1) Whether petitioner

received unreported income from cocaine sales in the amounts

determined by respondent and, if so, whether this income is

subject to Federal income taxation, and (2) whether petitioner is

liable for the additions to tax for failure to file timely

returns and for failure to make estimated income tax payments.

                           Background

     Some of the facts have been deemed stipulated pursuant to

Rule 91(f) and are so found.   These stipulations of fact and the

attached exhibits are incorporated herein by this reference.    On

the date the petition was filed in this case petitioner resided

in the Federal Correctional Institution at El Reno, Oklahoma.

     During the years in issue, petitioner resided in Ardmore,

Oklahoma and was married to Sherry L. Williams.   Petitioner filed


     1
      (...continued)
Rule references are to the Tax Court Rules of Practice and
Procedure.
                               - 3 -

joint Federal income tax returns with his wife for the years

1986, 1987, and 1988, reporting gross income of $1,637, $6,798,

and $2,068, respectively.   The gross income reported on these

returns consisted solely of wages earned by petitioner’s wife.

Petitioner’s return for 1988 reflected zero income tax liability.

     In February 1991, petitioner and several codefendants were

indicted under Federal law on 27 counts of drug offenses and

money laundering.   In June 1991, petitioner was convicted on 17

counts of the indictment and received a 30-year sentence of

imprisonment.   Petitioner’s conviction reflects that, during 1989

and through April 1990, petitioner managed a continuing criminal

enterprise involving cocaine distribution, and that he received

and spent the proceeds of that enterprise.   Petitioner kept no

records of his income or expenses with respect to his purchase

and sale of cocaine during the years in issue.

     Petitioner did not file Federal income tax returns for

taxable years 1989 and 1990.   After petitioner was convicted, he

was issued a notice of jeopardy assessment followed by a

statutory notice of deficiency for 1989 and 1990.   In the notice

of deficiency, respondent determined petitioner’s tax liabilities

and deficiencies, based upon a filing status of married filing

separately, as follows:
                                  - 4 -
                                                1989       1990

     Unreported income                       $111,991    $11,747
     Personal exemption deduction              (2,000)    (2,050)
     Standard deduction                        (2,600)    (2,725)
     Self-employment income tax deduction         -0-       (830)
     Taxable income                           107,391      6,142

     Income tax                                31,556        919
     Self-employment income tax                 6,250      1,660
     Total tax liability (deficiency)          37,806      2,579

Respondent determined the total amounts of unreported income by

analyzing petitioner’s cash transactions during the years in

issue.   The notice of deficiency reflects the following

reconstruction of petitioner’s income:

                                             1989        1990

     Cash bank deposits                     $64,166      $6,415
     Cash wires                              13,110         500
     Cashier’s checks                           820         -0-
     Money orders                             4,504       2,831
     Cash expenditures
        1987 Hyundai                          4,725         -0-
        1989 Hyundai                          4,322         -0-
        Refrigerator                          1,606         -0-
        Home improvements                     5,900         -0-
        Underground sprinkler                 3,400         -0-
        New sod                               2,600         -0-
        Security system                       3,637         -0-
        Mercedes downpayment                 13,000         -0-
        Tennis bracelet                       3,200         -0-
        Attorney fees                           -0-       2,000
     Total cash transactions                124,990      11,746
     Less duplicated items                  (13,000)        -0-
     Total income                           111,990      11,746

In addition to the deficiencies, respondent determined that

petitioner was liable for additions to tax under section

6651(a)(1) and section 6654(a).         For both of the years in issue,

respondent based his determination of petitioner’s liability for

the section 6654(a) addition to tax on a required annual payment

of 90 percent of petitioner’s current year tax liability as

determined in the notice of deficiency.
                                - 5 -



                              Discussion

     The first issue for decision is whether petitioner received

unreported income from cocaine sales in the amounts determined by

respondent and, if so, whether this income is subject to Federal

income taxation.

     Section 1 of the Internal Revenue Code imposes a Federal tax

on the taxable income of every individual.      Section 61(a) defines

gross income for purposes of calculating taxable income as “all

income from whatever source derived.”      This broad definition

includes income obtained from illegal sources.      James v. United

States, 366 U.S. 213, 218 (1961); sec. 1.61-14(a), Income Tax

Regs.    Separately, section 1401 imposes a tax “on the self-

employment income of every individual”.      Self-employment income

is defined generally as “net earnings from self-employment”,

which in turn means “the gross income derived by an individual

from any trade or business carried on by such individual, less

the deductions allowable by this subtitle which are attributable

to such trade or business”.    Sec. 1402(a) and (b).    “Trade or

business” as used in this context has been construed to encompass

not only legal but also illegal business activities.      Peyton v.

Commissioner, T.C. Memo. 2003-146.2

     2
        The provisions of secs. 1401 and 1402 differed
significantly from 1989 to 1990. We have reviewed respondent’s
calculations in both years and find them to be correct under the
applicable provisions of the Code. We note that the sec.
                                                   (continued...)
                               - 6 -

     Taxpayers are required to maintain records sufficient to

establish the amounts of income, deductions, and other items

which underlie their Federal income tax liabilities.   Sec. 6001;

sec. 1.6001-1(a), (e), Income Tax Regs.    If a taxpayer fails to

keep adequate records, the Commissioner may reconstruct the

taxpayer’s income by any method that is reasonable under the

circumstances.   Petzoldt v. Commissioner, 92 T.C. 661, 687

(1989); see also United States v. Fior D’Italia, Inc., 536 U.S.

238, 243 (2002) (stating that the assessment authority of the IRS

is not exceeded “when the IRS estimates an individual’s tax

liability--as long as the method used to make the estimate is a

‘reasonable’ one”).   The reconstruction need not be exact, so

long as it is reasonable and substantially correct.    Petzoldt v.

Commissioner, supra at 693; Meneguzzo v. Commissioner, 43 T.C.

824 (1965).   The bank deposit and cash expenditure method is

recognized as a reasonable method of reconstructing income.

Parks v. Commissioner, 94 T.C. 654, 658 (1990); Nicholas v.

Commissioner, 70 T.C. 1057, 1065 (1978).    This method is premised

on the assumption that the taxpayer has disposed of unreported

income by depositing part of it into bank accounts and by making

cash expenditures of the other part.




     2
      (...continued)
164(f)(1) self-employment income tax deduction was not applicable
in 1989. Social Security Amendments of 1983, Pub. L. 98-21, sec.
124(d)(2), 97 Stat. 91.
                                - 7 -

       As a general rule, the taxpayer bears the burden of proving

the Commissioner’s determinations to be in error.    Rule 142(a).3

Certain courts have recognized a limited exception to the general

rule where the notice of deficiency determines that the taxpayer

failed to report income, particularly income derived from illegal

activities.    Llorente v. Commissioner, 649 F.2d 152, 156 (2d Cir.

1981), affg. in part and revg. in part 74 T.C. 260 (1980);

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

67 T.C. 672 (1977).    In such circumstances, the Commissioner must

come forward with evidence establishing a minimal foundation,

which may consist of evidence linking the taxpayer with an

income-producing activity.    Petzoldt v. Commissioner, supra at

689.

       Because respondent has shown that petitioner was convicted

of the illegal distribution of cocaine, and that petitioner

received and spent proceeds from the sale thereof, respondent has

linked petitioner to the relevant income-producing activity.

Respondent provided this Court with summary documents evidencing

the various cash deposits and expenditures underlying his

determination of the amounts of unreported income.    These

summaries generally were produced by respondent during the

criminal investigation and prosecution of petitioner.    Although


       3
        Sec. 7491, which shifts the burden of production and/or
proof under certain circumstances, does not apply in the present
case because the underlying examination commenced prior to July
22, 1998. Internal Revenue Service Restructuring & Reform Act of
1998, Pub. L. 105-206, sec. 3001(c), 112 Stat. 727.
                               - 8 -

not all of the supporting documents are in the record, nothing in

the record calls into question the accuracy of these summaries.

Petitioner himself does not dispute their accuracy.   In

petitioner’s Objections to Respondent’s Stipulations, he

summarizes his position in this case, stating that he

     does not contest that he received the amount of * * * money
     of $111,991.00 and $11,747.00 for the years of 1989 and
     1990. Petitioner does object to these amounts being
     described as taxable income and subject to tax penalties
     under IRC 6651(a)(1) and 6654 * * * . Also Petitioner * * *
     from 1980 to 1986 * * * took out large cash advancements
     from numerous credit card accounts, which totaled in excess
     of $250,000 * * * . Additionally, Petitioner will show this
     Court and the Respondent that he can produce documentation
     (Credit Card Information), that will make up the difference
     of $76,769.24, to balance out the total amount of $123,738,
     that the Respondent claims is earned and or gross income
     that is subject to taxation, but that the Petitioner rebutts
     [sic] as being income at all and not subject to taxation by
     the Internal Revenue. That said claim by the respondent is
     arbitrary and exaggerated in that said monies were not
     derived from any type of income that could be subject to any
     tax by the federal government.

Petitioner’s testimony at trial in support of this argument can

be summarized as follows:   The cash petitioner used for the

majority of the various deposits and expenditures during the

years in issue was obtained through credit card cash advances.

Petitioner obtained these advances in or before 1986; he then

gave the cash to his father, who kept it in a suitcase in the

trunk of a car in his backyard.   Petitioner retrieved the cash

from his father in 1987, but held onto it until the years in

issue when he began making periodic cash deposits of varying

amounts into several different checking accounts.   Petitioner
                               - 9 -

kept the cash through this period of time despite attempts by

credit card issuers to collect from him on outstanding debts.

     Our evaluation of petitioner’s testimony is founded upon

“the ultimate task of a trier of the facts--the distillation of

truth from falsehood which is the daily grist of judicial life.”

Diaz v. Commissioner, 58 T.C. 560, 564 (1972); see also Tokarski

v. Commissioner, 87 T.C. 74, 77 (1986).   We do not find to be

credible petitioner’s uncorroborated testimony concerning the

credit card cash advances.   We find it unlikely that petitioner

was able to secure such large cash advances, that petitioner with

the help of his father then hoarded these cash advances for

several years, and that petitioner then began depositing this

money in small amounts into bank accounts.

     We find that petitioner did not have a cash hoard prior to

the years in issue, and that he instead was using proceeds from

the drug sales to make the cash expenditures and cash bank

deposits in question.   Accordingly, we sustain respondent’s

determination that petitioner received unreported income in the

amounts reflected in the notice of deficiency, income which is

includable in petitioner’s gross income and subject to Federal

income taxation under sections 1 and 1401.4



     4
        Petitioner has cited various statutes and cases in
support of his contention that the income at issue is not
taxable. We need not address these arguments in detail.
Respondent’s determinations are in accordance with the law, as
discussed above, and the law cited by petitioner is not
applicable to the case at hand.
                               - 10 -

     The second issue for decision is whether petitioner is

liable for the additions to tax for failure to file timely

returns and for failure to make estimated income tax payments.

     Section 6651(a)(1) imposes an addition to tax for failure to

file a timely return.   This addition to tax equals 5 percent of

the amount required to be shown as tax on the return for each

month, or fraction thereof, during which the failure to file

continues, up to a maximum of 25 percent.    A taxpayer may avoid

this addition to tax if he establishes that the failure to file

is due to reasonable cause and not due to willful neglect.      Sec.

6651(a)(1).   “Reasonable cause” exists where a taxpayer is unable

to file a return within the prescribed time despite the exercise

of ordinary business care and prudence.     United States v. Boyle,

469 U.S. 241, 246 (1985).   “Willful neglect” means a conscious,

intentional failure or reckless indifference.     Id. at 245.

     Petitioner did not file a return in either 1989 or 1990.

Petitioner does not assert, and there is nothing in the record

which indicates, that petitioner had reasonable cause for his

failure to file the returns.   Consequently, we sustain

respondent’s determination that petitioner is liable for the

section 6651(a)(1) addition to tax for each year in issue.

     Section 6654(a) provides for an addition to tax in the event

of an underpayment of a required installment of individual

estimated tax.   As relevant here, each required installment of

estimated tax is equal to 25 percent of the “required annual

payment”, which in turn is equal to the lesser of (1) 90 percent
                               - 11 -

of the tax shown on the individual’s return for that year (or, if

no return is filed, 90 percent of the individual’s tax for such

year), or (2) if the individual filed a return for the

immediately preceding taxable year, 100 percent of the tax shown

on that return.    Sec. 6654(d)(1)(A) and (B).   There are two

mechanical exceptions to the applicability of the section 6654(a)

addition to tax.    First, as relevant to this case, the addition

is not applicable if the tax shown on the individual’s return for

the year in question (or, if no return is filed, the individual’s

tax for that year) is less than $500.    Sec. 6654(e)(1).    Second,

the addition is not applicable if the individual’s tax liability

for the preceding taxable year was zero.    Sec. 6654(e)(2).

     Respondent’s determination that petitioner underpaid his

estimated taxes is based on petitioner’s tax liability as

determined in the statutory notice of deficiency.     This

determination is correct with respect to taxable year 1990

because petitioner did not file a return for taxable year 1989 or

1990.   Sec. 6654(d)(1)(B).   However, this determination is

incorrect with respect to taxable year 1989.     Petitioner and his

wife filed a joint Federal income tax return for taxable year

1988 which reflected gross income of $2,068 and a tax liability

of zero.   Thus, because 100 percent of petitioner’s 1988 tax

liability as shown on his filed return was zero, petitioner was

not required to make estimated tax payments for 1989.     Sec.

6654(d)(1)(B)(ii).
                                - 12 -

     Finally, we briefly address an issue raised by respondent at

trial concerning the application of the statute of limitations on

collections.     A period of limitations on collections begins when

an assessment of tax has been made, including a jeopardy

assessment, and generally runs for 10 years.        Sec. 6502(a)(1).

However, where a taxpayer petitions this Court in response to a

statutory notice of deficiency, the period of limitations for

collection of the deficiency is suspended until 60 days after the

Court’s decision becomes final.       Sec. 6503(a)(1).   Thus, the

period of limitations on collections has not expired in this

case.     See Estate of Iaconi v. Commissioner, T.C. Memo. 1961-106.

        To reflect the foregoing,

                                         Decision will be entered for

                                    respondent except with respect to

                                    the section 6654(a) addition to

                                    tax for 1989.
