                        T.C. Memo. 1997-282



                      UNITED STATES TAX COURT



          JAMES E. AND CHUNG H. PEACOCK, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 14094-94.             Filed June 23, 1997.



     Robert J. Chicoine and Larry N. Johnson, for petitioners.

     Robert S. Scarbrough, Gregory M. Hahn, and Roy Wulf, for

respondent.



              MEMORANDUM FINDINGS OF FACT AND OPINION


     COLVIN, Judge:   Respondent determined deficiencies in and

additions to petitioners' Federal income tax as follows:
                                    -2-

                                       Additions to Tax
                           Sec.          Sec.         Sec.      Sec.
    Year    Deficiency   6653(b)(1)1 6653(b)(1)(B) 6653(b)(2)   6661
                                                        2
    1983     $101,744     $50,872                             $25,436
                                                        2
    1984       21,946      10,973                               5,487
                                                        2
    1985        7,233       3,617                               1,808
                                           2
    1986       34,075      25,556                               8,519
                                           2
    1987        7,387       5,540                               1,847
1
    Sec. 6653(b)(1)(A) for 1986 and 1987.
2
    Fifty percent of the interest due on the underpayment due to fraud.

       After concessions,1 the issues for decision are:

       1.      Relating to respondent's use of the net worth method:

               a.   Whether respondent's determination was arbitrary.

We hold that it was not.

               b.   Whether respondent adequately investigated leads

relating to petitioners' cash hoard.        We hold that respondent

did.

       2.      Relating to petitioners' cash on hand on December 31,

1982, 1983, 1984, 1985, 1986, and 1987:

               a.   Whether petitioners had $140,000 in cash on

December 31, 1982, as respondent contends; more than $660,000, as

petitioners contend; or some other amount.        We find that

petitioners had $279,000 in cash on December 31, 1982.


       1
       Respondent concedes that for 1983 to 1987, petitioners may
deduct additional depreciation of $3,631, $9,255, $11,902,
$11,736, and $11,736, respectively, on their property at 3600
Glenstone Avenue, Springfield, Missouri. Respondent also
concedes that petitioners had a $896 capital gain in 1986.
Respondent concedes that $9,000 that respondent had determined
was taxable in 1986, is not taxable. Respondent concedes that in
respondent's calculation of their unreported income, petitioners'
1987 personal expenses are overstated by $50.
                                  -3-

          b.      Whether, as petitioners contend, $90,000 was

stolen from them in January 1985.       We hold that it was not.

          c.      Whether respondent overstated petitioners' 1985

personal expenses by $25,060.    We hold that respondent did not.

          d.      Whether petitioners had $40,000 in cash on hand on

December 31, 1983, 1984, 1985, 1986, and 1987, as respondent

contends; about $385,000, $340,000, $250,000, $182,500, $123,000,

as petitioners contend; or some other amount.       We hold that they

had $40,000 in cash on hand on December 31, 1983, 1984, 1985,

1986, and 1987.

     3.   Whether petitioners had unreported income of $221,961

in 1983, $45,598 in 1984, $8,608 in 1985, $69,788 in 1986, and

$29,872 in 1987, as respondent contends; zero for 1983 to 1987,

as petitioners contend; or some other amount.       We hold that

petitioners had unreported income of $82,961 in 1983, $45,598 in

1984, $8,608 in 1985, $60,788 in 1986, and $29,822 in 1987.

     4.   Whether petitioners are liable for additions to tax for

fraud under section 6653(b) for tax years 1983 to 1987.       We hold

that they are.

     5.   Whether the statute of limitations bars assessment of

tax for the years in issue.    We hold that it does not.

     6.   Whether petitioners are liable for additions to tax for

substantial understatement of tax under section 6661.       We hold

that they are for the years they substantially underpaid tax.
                                 -4-

       7.   Whether petitioners are liable for self-employment tax

under section 1401 for the years in issue.      We hold that they

are.

       Section references are to the Internal Revenue Code in

effect for the years in issue.    Rule references are to the Tax

Court Rules of Practice and Procedure.

                          FINDINGS OF FACT

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

A.     Petitioners

       Petitioners lived in Tacoma, Washington, when they filed the

petition in this case.    Petitioners are married and filed joint

Federal income tax returns for each of the years in issue.

       James E. Peacock (petitioner-husband) served in the U.S.

Army for a total of 20 years over a 26-year period.      He had tours

of duty in Korea, Germany, and Vietnam.      His duties included

managing clubs for enlisted personnel, noncommissioned officers,

and officers.    Petitioner-husband retired from the Army in 1976.

       Petitioner-husband met Chung H. (Judy) Peacock (petitioner-

wife) in 1958 while serving a tour of duty in Korea.      Petitioners

were married in Korea in 1961.    Petitioner-wife immigrated to the

United States in 1963.
                                  -5-

B.   Petitioners' Family

     1.      Petitioner-Husband's Parents

     Wilma MacFarland and Tobey Peacock were petitioner-husband's

parents.     They were divorced before June 1957.    In June 1957,

Wilma MacFarland married Winston MacFarland (MacFarland).       Wilma

and MacFarland were divorced in 1973.       Wilma MacFarland died in

1979.

     Wilma MacFarland lived in a mobile home.       When she and

MacFarland were divorced in 1973, she had almost no assets.

MacFarland was required by court order to make support payments

to her of $150 a month.     Wilma MacFarland reported no wage or

self-employment income on her tax returns for tax years 1968 to

1979.     She reported less than $28,500 as wages or self-employment

income during her life and never more than $3,600 in any one

year.

     MacFarland had almost no assets when he and Wilma MacFarland

were divorced in 1973.     After 1973, MacFarland never earned more

than $11,439 a year.     After 1978, he reported no wage or self-

employment income on his income tax returns.      From 1980 until the

mid-1980's, MacFarland worked as an apartment manager for

petitioner-husband in exchange for free rent.       MacFarland used

his income from social security to pay his expenses.       He was

careful not to spend more than the amount of his Social Security

checks.     Petitioner-husband sometimes gave MacFarland small

amounts of money.     In the mid-1980's, MacFarland moved into a
                                    -6-

two-bedroom cement house that he built.       The house was unfinished

and had very little furniture.       In 1985, MacFarland deeded the

house to a friend, Kathleen Griffin (Griffin), but he lived in

the house until just before he died in February 1989.        After he

died, Griffin sold the house for $14,000.

       Tobey Peacock married Donna Peacock in 1960.       Tobey Peacock

died in 1973.       Tobey Peacock owned a 40-acre dairy farm, drove a

dairy truck, and raised and bred animals.       Tobey Peacock lived

frugally.       Tobey Peacock reported less than $3,000 as wages or

self-employment income during his life, and never more than

$1,200 in any one year.       Tobey Peacock disapproved of

petitioners' lifestyle.

       2.      Petitioner-Wife's Mother

       Il Nam Lee was petitioner-wife's mother.     Il Nam Lee died in

1982.       Chang Un MacFarland is Il Nam Lee's sister.   Chang Un

MacFarland married MacFarland, petitioner-husband's stepfather.

       Ki Chong Kim is Chang Un MacFarland's son.       In 1983, Chang

Un MacFarland and Ki Chong Kim came to the United States for a

short time, and then returned to Korea.

       3.      Petitioner-Wife's Brothers and Sisters

       Kil Lee, Song Lee, and James Suil Peacock, Jr. (Suil

Peacock) are petitioner-wife's brothers.       Kyu Lee is Song Lee's

son.    Okhee Cho and K.C. Urbon are petitioner-wife's sisters.

       Petitioners told U.S. immigration officials that Suil

Peacock and K.C. Urbon were their adopted children so Suil
                                  -7-

Peacock and K.C. Urbon could immigrate to the United States.

However, at that time, petitioners had not adopted Suil Peacock

or K.C. Urbon.

     Kil Lee and Kiye Oglesby have lived together for many years,

but are not married.   Kyu Im Koon is petitioner-wife's niece.

She is married to Michael Koon.

C.   Petitioners' Businesses

     1.   Background

     Petitioners owned a massage parlor known as "Flamingo" in

Spanaway, Washington, from 1972 to 1976.

     Petitioners owned and operated massage parlors known as

"Tokyo Sauna" during the years in issue.      They opened a Tokyo

Sauna in Joplin, Missouri, in 1975, a second Tokyo Sauna in

Springfield, Missouri, in 1977, and a third Tokyo Sauna in

Billings, Montana, in 1984.    They closed the Tokyo Sauna in

Joplin late in 1986.   At least one of the Tokyo Saunas had a sign

with petitioners' home phone number stating that if a customer

were dissatisfied he should call petitioner-wife.

     2.   Operation of the Tokyo Saunas

     The masseuses who worked at each of petitioners' Tokyo

Saunas were female Korean immigrants.      They engaged in illegal

prostitution with their customers.      Petitioners told the

masseuses how to operate the business and provide services to

customers.   Petitioners regularly telephoned each Tokyo Sauna.
                                -8-

     At each Tokyo Sauna, one of the masseuses was the manager.

The manager was responsible for ensuring that petitioners got

their share of each masseuse's receipts.    The manager was not

paid extra for her managerial work.

     Petitioner-wife instructed each masseuse to record the time

she spent with each customer and the price of the service on a

daily sheet under the masseuse's name or initial.    Petitioner-

wife instructed the masseuses to divide the total amount of money

they collected from customers by two, because one-half of the

receipts belonged to petitioners.     If a masseuse was very busy,

one of the other masseuses wrote some of the information on the

daily sheet for her.   At the end of the day, the daily sheet was

wrapped around the day's receipts and put in the safe.    The Tokyo

Saunas were primarily cash businesses.

     Petitioner-husband visited each Tokyo Sauna about once a

month, except when he was in jail in 1987.    Petitioner-wife often

went to the saunas with him.   Petitioner-husband collected the

daily sheets and petitioners' share of the money during his

visits.   While petitioner-husband was in jail in 1987, K.C. Urbon

or Kil Lee went to the saunas to collect the money and records

for him and gave them to petitioner-wife.

     3.   Masseuses

     Myong Cha Jackson was a masseuse at the Joplin Tokyo Sauna

for 1 year starting in 1983 and at the Springfield Tokyo Sauna
                                    -9-

for 2 years thereafter.       She made about $35,000 a year working

for petitioners.

     Young Ju Lee (Young Ju Burnett) worked as a masseuse at the

Springfield Tokyo Sauna intermittently from 1978 or 1979 through

1983.     She made about $4,000 a month working for petitioners.

She is Kiye Oglesby's sister.

     4.      Record Keeping

     Petitioner-husband brought the daily sheets to Tacoma and

gave them to Kil Lee.     Kil Lee reviewed them to see how many

masseuses were working, how much money each masseuse earned, and

the number of customers each masseuse had.       Kil Lee stored the

daily sheets in a file cabinet.       In 1986, petitioner-wife told

Kil Lee to burn the daily sheets he was storing.       Thereafter, Kil

Lee or petitioner-husband burned the daily sheets after reviewing

them.

     Rheda Amoroso (Amoroso) worked for Kootz Accounting as a

bookkeeper during the years in issue.       She prepared monthly

statements, profit and loss statements, and tax returns for

petitioners.

     Petitioners prepared weekly receipt reports for each sauna

and sent them to Amoroso.       Petitioners did not send the daily

sheets to Amoroso.     Amoroso used the weekly receipt reports to

compute the Tokyo Saunas' annual revenue and to prepare

petitioners' tax returns.       She did not know that the masseuses
                                -10-

kept half of the gross receipts or that petitioners did not

report all of their gross receipts to her.

     Petitioner-husband signed, and directed each masseuse to

sign, papers showing that masseuses were paid about $200 a week.

Petitioner-husband told the masseuses to give those payroll

papers to Amoroso.    Petitioners issued Forms W-2 showing that

each masseuse earned substantially less than petitioners knew

they earned.   Petitioners withheld a fixed amount of taxes from

the masseuses regardless of the amount they earned.

D.   The Daily Sheets Kil Lee Gave to Respondent

     In November 1987, Kil Lee found four sets of daily sheets

that he had not burned and gave them to respondent.   Those daily

sheets show the following:

                              Number    Number of
Tokyo Sauna     Dates         of days   masseuses   Gross receipts
Joplin          10/29/83-       35         5           $42,696
                  12/2/83
Springfield     10/29/83-       35         5            39,030
                  12/2/83
Billings        3/28/87-        28         3            25,700
                  4/24/87
Springfield     3/28/87-        28         5            50,306
                  4/24/87

E.   Petitioners' Net Worth

     1.    Overview

     Petitioners concede that respondent computed their net worth

correctly except for the amount of their cash on hand on December

31, 1982, 1983, 1984, 1985, 1986, and 1987.
                                -11-

     Respondent did not include petitioners' personal living

expenses in the net worth calculation on which the notice of

deficiency was based.    During the years in issue, petitioners

gave gifts and support to Suil Peacock and his family, had a

live-in maid, took trips to Florida, and gambled.    Respondent did

not include those expenses in the net worth calculation.

     In the net worth calculation, respondent took into account

the fact that $4,000 was stolen from petitioners in 1983.

Petitioners did not deduct a theft loss on their 1983 tax return.

     2.    Petitioners' Pre-1983 Use of Banks and Other Financial
           History

     Petitioners borrowed $28,000 in 1977 and $13,630 in 1978

from the North Pacific Bank in Tacoma, Washington.   Petitioners

submitted a statement of joint financial condition with their

1978 loan application.   After adjustment to show actual cost and

accumulated depreciation and to correct for minor errors, it

states that petitioners had a net worth of about $70,640 on April

7, 1978.   Petitioners did not state that they had a cash hoard on

either the application they submitted for their 1977 loan or

their statement of joint financial condition.   In 1978,

petitioners reported $410 of interest income from Great Northwest

Savings and Loans and North Pacific Bank, and $4,237 of interest

expense on loans from First Interstate Bank of Washington (home

mortgage), Great Northwest Savings and Loans, Rainier Bank, and

North Pacific Bank.   On April 7, 1978, petitioners owed several
                                   -12-

thousand dollars on a motor home loan with a 17-percent interest

rate.

       From 1978 to 1982, petitioners (a) bought four properties

for a total of $372,252, financing $255,7002 of that amount; (b)

spent $163,518 on insurance, mortgage payments, licensing fees,

taxes, and other items, which they deducted on their tax returns;

and (c) provided some support for family members, including Suil

Peacock and his family, Song Lee, Kil Lee, K.C. Urbon, and Il Nam

Lee.       Petitioners reported that their adjusted gross income for

that period was $264,799.

        From 1978 to 1982, petitioners did not receive any gifts or

inheritances that had significant value.

        In early 1983, petitioners had outstanding loans from

Northwest Federal, Puget Sound National Bank, and First

Interstate Bank of Washington.

        3.     Petitioners' Cash Hoard

       Many people saw petitioners with large amounts of cash from

1978 to 1982.      None of them counted all of the cash.   In 1978,

Michael Koon, petitioner-wife's nephew-in-law, counted about

$100,000 of petitioners’ cash.      A large amount of other cash was

present that he did not count.

       Petitioners buried some cash in a 5-gallon bucket under a

cement walkway in their backyard in 1979, and dug it up in 1981.

       2
       The parties agree that the amount financed was $246,994.
However, the record shows that the amount financed was $255,700.
                                 -13-

     As discussed in par. B-3-e of the opinion, we find that

petitioners had $279,000 in cash on hand and a net worth of

$622,478 on December 31, 1982.

     4.   The Glenstone and Valley Road Properties

     Petitioner-husband obtained powers of attorney from Kiye

Oglesby and Ki Chong Kim dated October 11, 1982, to deal with the

property at 3600 Glenstone Avenue, Springfield, Missouri (the

Glenstone property) on their behalf.    On April 1, 1983,

petitioner-husband contracted with Ed O. Day to buy the Glenstone

property for $325,000.   Petitioner-husband paid Ed O. Day

$100,000 in cash as a downpayment on the property.

     On May 25, 1983, petitioners agreed to buy property at 1541

Valley Water Mill Road (the Valley Road property), adjacent to

the Glenstone property, for $80,000.    Of that amount, $70,000 was

due on August 1, 1983.

     On May 26, 1983, the Glenstone property transaction closed

and petitioner-husband gave Ed O. Day $134,000 in cashier's

checks and a $90,000 note.    Twelve of the 13 cashier's checks he

gave Ed O. Day were in amounts less than $10,000.    Ki Chong Kim

was listed as the buyer of two of the cashier's checks that

petitioner-husband bought.

     The record owners of the Glenstone property were

petitioners, Kiye Oglesby, and Ki Chong Kim.    Neither Kiye

Oglesby nor Ki Chong Kim knew that title to the Glenstone

property was in their name.   On September 12, 1983, petitioner-
                                -14-

husband signed a quitclaim deed transferring Kiye Oglesby's and

Ki Chong Kim's interests in the Glenstone property to himself.

     In October 1983, petitioner-husband paid the $70,000 that

was due on the Valley Road property with seven cashier's checks,

six of which were in amounts less than $10,000.

     5.     Petitioners' Other Use of Cash To Buy Property

     In 1981, petitioners bought Suil Peacock a house in Colorado

for $67,320 in cash.

     In January 1983, petitioners paid $45,002 in cash to buy a

motor home.   Petitioners made payments on the Glenstone and

Valley Road properties with 20 cashier's checks totaling

$204,000.   Of those checks, one was for $33,000, one was for

$18,000, and 18 were for $9,000 or less.   Petitioner-husband

bought all of the cashier's checks at different banks on the same

day or the same bank on different days.

     In the mid-1980's, petitioners bought property in Bremerton,

Washington, by assuming a mortgage and paying $15,000 in cash on

a second mortgage on the property.
                                -15-

     6.   Summary of Petitioners' Use of Cash or Cashier's Checks
          in 1983

     Petitioners used cash or cashier's checks to make the

following payments in 1983:

      Date       Amount          Description
     Jan. 28     $45,002   Purchase of Pace Arrow
     Feb. 24       2,780   Purchase of 1983 Bellew Trailer
     Mar. 29      20,362   Payments to IRS & property taxes
     Apr. 1      100,000   Downpayment for Glenstone property
     May 25       10,000   Downpayment for Valley Road property
     May 26      134,000   Second payment for Glenstone property
     June 16       7,500   Payment to IRS
     Sept. 16      7,500   Payment to IRS
     Oct. 31      70,000   Final payment for Valley Road property
        Total   $397,144

     7.   1983 to 1987

     Petitioners reported income from their saunas of $43,501,

$37,269, $95,595, $22,625, and $1,169 and deducted wages of

$60,300, $64,140, $82,623, $74,530, and $66,515, on the Schedules

C they filed with their tax returns for 1983 to 1987,

respectively.   Petitioners did not pay wages.

     Petitioners did not receive gifts or inheritances of

substantial value from 1983 to 1987.

     In January 1985, petitioner-wife reported to the Tacoma

police that $90,000 in cash had been stolen from their home.

Petitioners did not deduct a theft loss on their 1985 tax return.

     Petitioners had bank accounts which paid $30,807 in interest

from 1983 to 1987 ($12,831 in 1983, $8,330 in 1984, $5,717 in

1985, $1,852 in 1986, and $2,077 in 1987).   Petitioners also had

IRA accounts during the years in issue.
                                 -16-

F.      Skim Formula

     K.C. Urbon picked up the daily sheets and cash from the

saunas for 3 months in 1987.    Pursuant to petitioner-husband's

instructions, K.C. Urbon reported 3/7 of petitioners' share of

those receipts to petitioners' bookkeeper.

G.   Petitioners' Convictions for Income Tax Evasion

     Both petitioners pleaded guilty to income tax evasion for

1987.

     On January 18, 1990, during respondent's criminal

investigation, District Counsel Attorney Milton J. Carter

(Carter) informed petitioners and their attorney, Montie Day

(Day), that respondent believed that petitioners understated

their taxable income by a total of $336,729 for 1983, 1984, 1986,

and 1987.     After a recess in which Day talked with petitioners,

Day told Carter that petitioners buried about $353,000 under a

concrete walkway behind their home in 1979, and dug up the money

in 1981.     Day said that petitioners had (1) $228,000 from money

petitioner-wife had in 1963 and an inheritance of $125,000 that

petitioners were holding for Suil, and (2) about $125,000 from

Tobey Peacock.

                                OPINION

A.   Net Worth Method

     1.      Background

     Respondent used the net worth method to determine

petitioners' income for the years in issue.    Under the net worth
                                -17-

method, income is computed by determining a taxpayer's net worth

(excess of the cost of assets over liabilities) at the beginning

and end of a year.    The difference between the two amounts is the

increase in net worth.    This difference is increased by adding

nondeductible expenditures, including living expenses, and by

subtracting gifts, inheritances, loans, and the like.     Holland v.

United States, 348 U.S. 121, 125 (1954).     An increase in a

taxpayer's net worth, plus his or her nondeductible expenditures,

less nontaxable receipts, may be considered taxable income.       Id.

     In a net worth case, respondent must:    (a) Establish the

taxpayer's opening net worth with reasonable certainty, and (b)

either show a likely income source or negate possible nontaxable

sources.    Holland v. United States, supra at 132-138; Brooks v.

Commissioner, 82 T.C. 413, 431-432 (1984), affd. without

published opinion 772 F.2d 910 (9th Cir. 1985).    Courts must

closely scrutinize use of the net worth method.     Holland v.

United States, supra at 125.    Its use requires the exercise of

great care and restraint to prevent a taxpayer from being

ensnared in a system which is difficult for the taxpayer to

refute.    Id.

     2.     Whether Respondent's Determinations of the Amount of
            Cash Petitioners Had on December 31, 1982, 1983, 1984,
            1985, 1986, and 1987 Are Arbitrary

     Respondent determined that petitioners had $140,000 in cash

on December 31, 1982, and $40,000 on December 31, 1983, 1984,
                                -18-

1985, 1986, and 1987.   Petitioners contend that respondent's

determinations are arbitrary.   We disagree.

     Day did not give respondent's agent a net worth statement as

requested.   Respondent's agent gathered evidence to compute

petitioners' net worth.   He reviewed financial statements that

petitioner-husband gave to banks to obtain loans.    He learned

that petitioners paid $45,002 in cash for a motor home in January

1983, made a $100,000 cash downpayment on the Glenstone property

in April 1983, and made other large cash expenditures in 1983.

Respondent's agent concluded that petitioners paid the first two

large expenses from a cash hoard and the rest from their earnings

in 1983.   He concluded that petitioners had $140,000 in cash on

December 31, 1982, and that it came from the Tokyo Saunas.

     Petitioners contend that respondent's determination about

their income in 1983 is arbitrary because respondent determined

that their income with only two saunas operating was larger than

their income in later years with three saunas operating.    We

disagree that this makes respondent's determination arbitrary.

The only documentary evidence showing the number of employees

petitioners had are the daily sheets that were not burned.     They

show that petitioners had 10 employees who worked 35 days in 1983

and 8 employees who worked 28 days in 1987.    The number of

employees at each sauna appears to have varied from one to five

during the years in issue.   The record does not show how many

employees worked at each sauna in each year in issue.    Thus, the
                                 -19-

fact that the number of saunas changed may not have affected the

total number of employees in any year and does not show that

respondent's determination was arbitrary.   However, as discussed

at paragraph B-3-b below, we agree in part with petitioners that

more of petitioners' 1983 expenditures were made with funds they

had before 1983 than allowed by respondent.

     Respondent also determined that petitioners had $40,000 in

cash on hand on December 31, 1983, 1984, 1985, 1986, and 1987.

The daily sheets for the 4 months that were admitted in evidence

show that petitioners' average monthly gross receipts were about

$40,000.   Based on that, Hughes reasonably estimated that

petitioners earned $40,000 in cash each month from their Tokyo

Sauna businesses during the years in issue.

     Petitioners point out that a senior agent who was teaching

respondent's agent interview techniques testified that he

suspected that petitioners made about $25,000 per month.

However, he also said that this estimate was not based on the

investigation in this case.   His thoughts on this matter are made

irrelevant by respondent's determination which was the result of

an investigation in this case.

     We conclude that respondent's determinations are not

arbitrary.
                                -20-

     3.    Whether Respondent Adequately Investigated Leads

     Petitioners contend that respondent failed to investigate

adequately leads they provided relating to their cash on hand on

December 31, 1982.   We disagree.

     Petitioners point out that respondent did not investigate

whether petitioners' cement walkway had been relaid even though

petitioners told respondent that they had buried cash in their

backyard, built a cement walkway over it, and relaid the cement

after they broke it to get the cash.     Petitioners argue that

respondent should have checked to see if the cement had been

relaid.   We disagree.   Respondent does not dispute that

petitioners buried cash in a 5-gallon bucket under the walkway in

1979 and dug it up in 1981, but verifying that the walkway had

been relaid would not show how much cash petitioners buried or

had on hand on December 31, 1982.

     Petitioners argue that respondent did not sufficiently

interview witnesses who saw petitioners' cash.     We disagree.

Respondent's agent attempted to determine how much cash

petitioners had.   No witness counted more cash in petitioners'

possession than respondent determined petitioners had, and

respondent would have learned nothing definite by interviewing

witnesses who saw uncounted cash.      Petitioners did not offer any

worthwhile leads which respondent failed to investigate.     We

conclude that respondent did all that was required to check

leads.
                               -21-

B.   Opening Net Worth and Cash on Hand

     The parties agree about petitioners' opening net worth for

the years in issue except for the amount of cash they had on hand

on December 31, 1982, 1983, 1984, 1985, 1986, and 1987.

Respondent contends that petitioners had a cash hoard of $140,000

on December 31, 1982.   Petitioners contend that they had more

than $660,000 in cash on that date ($250,000 from Wilma

MacFarland, $150,000 from Tobey Peacock, $200,000 from black

market sales and skimming from slot machines in Vietnam, and more

than $60,000 from previously taxed income).

     We conclude that petitioners had much less than $660,000 in

cash on hand on December 31, 1982, from the sources they claimed,

but that they had more than respondent determined.    As discussed

above at par. A-2, and below at par. B-3-e, we conclude that

petitioners had $279,000 in cash on hand on December 31, 1982,

and $40,000 on December 31, 1983, 1984, 1985, 1986, and 1987.

     1.   Cash Hoard Sources Asserted by Petitioners

          a.   Wilma MacFarland

     Petitioners claim that they received $250,000 in cash from

Wilma MacFarland.   Petitioners claim that the $250,000 includes a

$125,000 loan that Wilma MacFarland made to petitioner-husband on

July 30, 1979, with the understanding that the money would be

repaid on demand without interest, but that any balance due when

Wilma MacFarland died would be considered paid in full.    Wilma

MacFarland died a few months after July 30, 1979.    Petitioner-
                                 -22-

husband testified that he had not repaid any of the $125,000 when

she died.

     There is no credible evidence that Wilma MacFarland had a

significant amount of money.     She had few assets when she and

MacFarland were divorced in 1973.       MacFarland was required by

court order to make support payments to her of $150 a month.         She

reported receiving less than $28,000 as wages or self-employment

income on her income tax returns during her life, and never more

than $3,600 in any year.    She did not report any wages or self-

employment income on her income tax returns for 1973 to 1979.         We

conclude that Wilma MacFarland was not the source of a

significant amount of petitioners' cash hoard.

            b.   Tobey Peacock

     Petitioners claim that they received $150,000 in cash from

Tobey Peacock as follows:    (1) $70,000 in 1971, for Suil

Peacock's education; (2) $50,000, which, right before Tobey

Peacock died in 1973, he told petitioner-husband that he had

hidden on his farm and that he wanted petitioner-husband to have;

and (3) $30,000 at various times over the years.      Petitioners

point out that petitioner-husband was Tobey Peacock's only son.

     There is no credible evidence in the record that Tobey

Peacock had a significant amount of money.      Tobey Peacock

reported less than $3,000 as wages or self-employment income on

his income tax returns during his life and never reported more

than $1,200 in any year.    We do not believe that he gave
                                -23-

petitioners money, especially considering that he disapproved of

their lifestyle.    We conclude that Tobey Peacock was not a source

of a significant amount of petitioners' cash hoard.

           c.   Winston MacFarland

     Petitioners claim that MacFarland gave them $75,000 in 1983

to buy an interest in the Glenstone property for his stepson, Ki

Chong Kim, because he thought the gift would help save his

marriage to Chang Un MacFarland.     The documents relating to

petitioners' purchase of the Glenstone property do not show that

MacFarland was involved in the transaction.      Ki Chong Kim's name

was on a deed to the Glenstone property, but he never knew he had

an interest in the property.   Petitioners transferred Ki Chong

Kim's interest in the Glenstone property to themselves a few

months after they bought it.   Petitioners claim they transferred

the property to themselves because MacFarland told them to do so

after Chang Un MacFarland and Ki Chong Kim moved to Korea and

MacFarland lost hope of reconciliation.      We disagree.

     MacFarland had few assets when he and Wilma MacFarland were

divorced in 1973.   After 1973, MacFarland never reported on his

income tax returns that he had earnings of more than $11,439 per

year.   After 1978, he did not report any wage or self-employment

income on his income tax returns.      MacFarland worked as an

apartment manager for petitioner-husband from 1980 until the mid-

1980's in exchange for free rent.      MacFarland used his Social

Security income to pay his expenses.      He was careful not to spend
                                -24-

more than the amount of his Social Security checks.   Petitioner-

husband occasionally gave MacFarland small amounts of money.    The

two-bedroom house that MacFarland built and occupied was

unfinished and had very little furniture.   There is no credible

evidence that MacFarland contributed $75,000 to buy the Glenstone

property.    The documents associated with petitioners' purchase of

the Glenstone property do not show that MacFarland was involved.

The person for whom MacFarland allegedly bought the property, Ki

Chong Kim, did not know he had an interest in the property.    We

conclude that MacFarland did not contribute $75,000 to buy the

Glenstone property.

            d.   Petitioner-Husband's Claimed $200,000 From
                 Skimming and Black Market Sales in Vietnam

     Petitioner-husband claims that he brought $200,000 in cash

to the United States when he returned from Vietnam.   He testified

that he got the $200,000 in Vietnam during 1970 and 1971 by

skimming money from U.S. Army slot machines and by selling beer

and soda on the black market.   Petitioner-husband testified that

he did not tell anyone except petitioner-wife about his

activities in Vietnam because he did not want people to know he

had a lot of cash, and that they did not make this claim when he

was being prosecuted for income tax evasion for 1987 because he

knew that his actions had been illegal.   Petitioners first made

this claim during the trial of this case.   We are not convinced

by petitioners' belated claim that petitioner-husband brought a
                                 -25-

significant amount of cash to the United States from Vietnam or

that they still had it on December 31, 1982.

            e.   Petitioners' Claimed Cash Hoard From Previously
                 Taxed Income

       Petitioners' claim that they had more than $60,000 on

December 31, 1982, that they had saved from previously taxed

income was vague and unsubstantiated.     We believe, however, that

they had saved a substantial amount of cash from previously

untaxed, skimmed income since they had been operating massage

parlors since 1972.

            f.   Physical Evidence of Petitioners' Cash Hoard

       Petitioners contend that they have shown that they had more

than $660,000 of cash on hand at the beginning of 1983 because at

least $500,000 could fit into a 5-gallon plastic bucket like the

one they buried in their yard or a grocery bag like Michael Koon

saw.    We disagree.   Respondent does not dispute that $500,000

could fit into a 5-gallon bucket or a grocery bag if the

denomination of the bills were large.     However, there is no

evidence that more than $100,000 was ever counted.

       Many people saw that petitioners had a large amount of cash.

However, the only witness who said he counted any of petitioners'

cash, Michael Koon, said that he counted $100,000 and that he

believed he had counted about one-third of the cash that was

present.
                                 -26-

     Petitioners contend that the fact that they used an ice

chest to transport cash to Las Vegas establishes that they had a

large amount of cash on hand.    Petitioners' proof is vague at

best.     There is no credible evidence about the amount of cash in

the ice chest.    Petitioners did not prove the denominations of

the bills in the bucket, grocery bag, or ice chest.

     Petitioners contend that the $287,000 difference between the

listed liquid assets and the $590,000 subtotal for liquid assets

on a loan application dated April 15, 1985, shows that they had a

large cash hoard at that time.    We disagree.   The difference is a

mistake, not evidence of a cash hoard.     Petitioners make a

similar mistake under nonliquid assets where they report that

$590,000 for liquid assets plus $80,000 for automobiles, and

$100,000 for furniture and personal property equals total assets

of $921,000.

             g.   Conclusion Regarding Cash Hoard Sources Alleged by
                  Petitioners

     We conclude that petitioners vastly exaggerated the amount

of cash they received from these sources.

     2.     Respondent's Skim Formula

     K.C. Urbon picked up the daily sheets and cash from the

saunas for 3 months in 1987.    Pursuant to petitioner-husband's

instructions, K.C. Urbon reported 3/7 of petitioners' share of

the receipts to petitioners' bookkeeper.    Applying the 3/7
                                    -27-

formula to the receipts shown on the four daily sheets in

evidence produces the following results:

                      Joplin     Springfield     Springfield     Billings
                     Nov. 1983    Nov. 1983       Apr. 1987      Apr. 1987
Total receipts        $42,696     $39,030         $50,306        $25,700
Petitioners' share     21,348      19,515          25,153         12,850
Multiplied by 3/7       9,149       8,363          10,780          5,507
Reported amounts        8,944       8,124          10,779          5,189
Difference               $205        $239              $1           $318

Thus, petitioners told their bookkeeper about 3/7 of their one-

half share of the gross receipts shown on these four daily

sheets.

     Petitioners contend that there is no proof that they used

the skim formula in other months.          We disagree.   K.C. Urbon

testified that petitioner-husband instructed her to use it and

that she did for 3 months in 1987.

     Respondent did not determine petitioners' sauna income by

applying the 3/7 formula.        However, the application of the skim

formula to the 4 months for which daily sheets exist shows that

respondent's determination is reasonable.

     3.    Petitioners' Tokyo Sauna Income

     Petitioners argue that respondent's determination of the

amount of petitioners' income from the Tokyo Saunas for 1983 is

too large compared to the other years in issue because there is

no evidence that the two Tokyo Saunas petitioners owned in 1983

had greater total earning capacity than the three they owned in

1984 and 1985.       We agree with petitioners in part.
                                 -28-

             a.   Petitioners' 1983 Income From the Tokyo Saunas

     The following chart shows the amount of petitioners' income

from Tokyo Saunas as implied (1) from respondent's determination

that petitioners had $140,000 cash on hand on December 31, 1982,

and (2) from our conclusion that they had $279,000 cash on hand

on that date:

                          Income from Saunas

                        1983     1984       1985      1986       1987

Reported by
petitioners          $43,501   $37,269    $95,595   $22,625     $1,169

Unreported income
from saunas
if petitioners       221,961    45,598      8,608    69,788     29,872
had $140,000 in
cash on Dec. 31,
1982

     Total          $265,462   $82,867   $104,203   $92,413    $31,041

Sauna income if
petitioners had
$279,000            $126,462   $82,867   $104,203   $92,413    $31,041
in cash on Dec.
31, 1982

             b.   Petitioners' Large Cash Purchases Early in 1983

     Hughes concluded that petitioners had cash on hand on

December 31, 1982, of $140,000 based on the fact that petitioners

spent $45,002 in January 1983 and $100,000 in April 1983.        He

also concluded that the Tokyo Saunas did not produce that much

income for petitioners in the first 4 months of 1983.         We think

that analysis is correct, except as discussed next.      We believe
                                 -29-

the Tokyo Saunas did not provide funds in 1983 for (1) the

$45,002 expenditure on January 28, 1983; (2) the $100,000

expenditure on April 1, 1983; and (3) the $134,000 petitioners

spent in May 1983 for the Glenstone property.       We believe that

the May 1983 amount was paid before petitioners could have saved

enough cash to have paid it from their 1983 earnings.       We believe

that petitioners' saunas produced income to make their other

$118,142 of cash purchases in 1983.       Where the Commissioner has

determined a deficiency using the net worth method, we may adjust

a determination of opening net worth shown by the trial record to

be unrealistic.     Hoffman v. Commissioner, 298 F.2d 784, 786 (3d

Cir. 1962), affg. in part on this issue T.C. Memo. 1960-160;

Baumgardner v. Commissioner, 251 F.2d 311, 313-314 (9th Cir.

1957), affg. T.C. Memo. 1956-112; Potson v. Commissioner, 22 T.C.

912, 928-929 (1954), affd. sub nom. Bodoglau v. Commissioner, 230

F.2d 336 (7th Cir. 1956).    Thus, we conclude that petitioners had

cash on hand of $279,000 on December 31, 1982.       We also conclude

that petitioners saved most of the $279,000 from unreported

income they received before 1983.       Based on our holding, Tokyo

Saunas produced income for petitioners in 1983 of $126,462.

          c.      Petitioners' Use of Credit Cards

     Petitioners contend that respondent did not properly account

for credit card receipts in determining that petitioners had

$40,000 in cash each year because petitioners had to pay the
                                -30-

masseuses their one-half of the credit card receipts in cash.       We

disagree.   First, petitioners have not shown that the volume of

credit card sales is significant.      Petitioners contend that the

credit card receipts were up to 40 percent of their total

receipts.   We disagree.   Petitioners only accepted credit card

payments for about 1 year.    There is no convincing evidence of

the total amount of petitioners' credit card receipts.       The

unburned daily sheets show that the amount of credit card

receipts was for less than 16 percent of total Billings receipts

for 28 days in 1987, and there are no credit card receipts for

the Springfield daily sheets for 1987.     Petitioners and

respondent agree that petitioners had considerably less income in

1987 than the other years in issue.     Thus, we are not convinced

that the credit card volume was significant.

     Second, petitioners contend that each credit card sale

reduced the amount of cash they received from the business

because petitioners paid the masseuse her share in cash.       We

disagree.   If a customer paid 2x dollars by credit card, and

petitioners paid 1x dollars in cash to the masseuse, petitioners

would receive all of the credit card payments.     The fact that

petitioners did not split the credit card payment with the
                                -31-

masseuse offsets the fact that petitioners paid the masseuse her

one-half in cash.3

          d.   Masseuses' Average Earnings

     Petitioners contend that respondent determined that

petitioners received more income from the Tokyo Saunas than the

total amount the masseuses earned, which petitioners contend

shows that respondent's determination is in error since

petitioners and the masseuses each got one-half of the payments.

Petitioners based this contention on the assumption that there

were 7 masseuses in 1983, 8 in 1984, 10 in 1985, 9 in 1986, and 6

in 1987, and based on what petitioners claim to be a high average

of $36,000 per year per masseuse.      We disagree.   Petitioners'

approach is accurate only if petitioners' assumption about the

number of masseuses and their average income is accurate.       No

reliable records are available that show how many masseuses

worked at the saunas.    Petitioner-husband testified that they had

six masseuses in 1983.   On brief, petitioners estimate that they

had seven masseuses in 1983.   The unburned daily sheets show that

they had 10 masseuses in November 1983.      Petitioner-husband

testified that one to five masseuses worked at each sauna at any

given time.




     3
       Petitioners do not contend that Tokyo Saunas paid a
significant amount of credit card merchant fees.
                                 -32-

     Petitioners argue that petitioners did not have more income

than the total amount reported as income on Federal income tax

returns filed by the masseuses.4    We disagree.   The masseuses

reported their income based on inaccurate Forms W-2 that they

received from Tokyo Saunas.     Thus, petitioners have not

established that the masseuses' returns show how much income

petitioners received.

            e.    Opening Net Worth-Conclusion

     The parties agree that petitioners' opening net worth was

$343,478 before considering the amount of their cash on hand.      We

have found that petitioners had $279,000 in cash on December 31,

1982.     Therefore, we conclude that petitioners had an opening net

worth of $622,478 on December 31, 1982.

     4.      Petitioners' 1985 Theft Claim

     Petitioners claim that $90,000 in cash was stolen from them

in January 1985, and that respondent's $40,000 opening cash on

hand figure on January 1, 1985, is understated by that amount.

In January 1985, petitioner-wife reported to the Tacoma police

that $90,000 in cash had been stolen from her home.     Petitioner-

wife told the police that it had been her mother's money.




     4
       Before trial, in response to an order of the Court,
respondent gave petitioners the amount of income each masseuse
had reported without showing the masseuses' names.
                                 -33-

     We do not believe that the $90,000 was stolen from

petitioners.     The record gives us several grounds on which to

doubt petitioner-wife's credibility.       Petitioners concede that Il

Nam Lee never gave them any money.       Petitioners contend that

petitioner-wife was referring to petitioner-husband's mother, not

her own mother.     We find that to be an implausible attempt to

evade the effect of her prior reference to her mother.

Petitioner-wife admits to giving false information to U.S.

immigration officials to help Suil Peacock and K.C. Urbon

immigrate to the United States.     She testified that she never saw

any of the financial records from the saunas, but she received

the sheets and the money when petitioner-husband was in jail in

1987.     We are not convinced that $90,000 was stolen from

petitioners in January 1985.

     5.      Petitioners' 1985 Personal Expenditures

     Respondent concedes that petitioners gave Suil Peacock

$48,940 in 1985, instead of $74,000 (a reduction of $25,060) as

respondent determined in the notice of deficiency.5      Petitioners

contend that respondent's $25,060 concession results in an

overpayment for 1985.     We disagree.    Respondent did not include

petitioners' living expenses in respondent's net worth

calculation and contends that this offsets respondent's


     5
       Petitioners' net worth is increased by the amount of the
funds they transferred to Suil Peacock.
                               -34-

concession.6   Petitioners argue that respondent already included

living expenses in respondent's determination.   We disagree.

Respondent did not include petitioners' living expenses in the

original net worth calculation.   We conclude that those expenses

offset respondent's $25,060 concession and that respondent did

not overstate petitioners' 1985 personal expenditures.

     6.   Petitioners' Unreported Taxable Income

     Respondent determined that petitioners had unreported income

of $221,961 in 1983, $45,598 in 1984, $8,608 in 1985, $69,788 in

1986, and 29,872 in 1987.   Based on respondent's concessions and

the foregoing, we conclude that petitioners had unreported

taxable income of $82,961 in 1983, $45,598 in 1984, $8,608 in

1985, $60,788 in 1986, and $29,822 in 1987.


     6
       Respondent does not contend that petitioners are liable
for larger deficiencies than respondent determined in the notice
of deficiency for any of the years in issue due to the omission
of petitioners' personal living expenses from respondent's net
worth calculation. Respondent bears the burden of proof under
Rule 142(a) if respondent raises new matter which either alters
the original deficiency or requires the taxpayers to present
different evidence. Seagate Tech. Inc. v. Commissioner, 102 T.C.
149, 169 (1994); Vetco, Inc. v. Commissioner, 95 T.C. 579, 588
(1990); Achiro v. Commissioner, 77 T.C. 881, 890 (1981). We
conclude, and petitioners do not contend otherwise, that this is
not new matter under Rule 142(a) for which respondent bears the
burden of proof because raising those expenses as offsets does
not require petitioners to offer any different evidence and does
not increase the original deficiency.
                                 -35-

C.   Additions to Tax for Fraud Under Section 6653(b)

     1.     Background

     Respondent determined that petitioners are liable for

additions to tax for fraud for 1983, 1984, 1985, 1986, and 1987.

For 1983, 1984, and 1985, if any part of a tax underpayment is

due to fraud, the addition to tax under section 6653(b)(1) is 50

percent of the underpayment, and the addition to tax under

section 6653(b)(2) is 50 percent of the interest payable under

section 6601 for that part of the underpayment that is due to

fraud.    For 1986 and 1987, the addition to tax for fraud under

section 6653(b)(1)(A) is 75 percent of the part of the

underpayment that is due to fraud, and the addition to tax under

section 6653(b)(1)(B) is 50 percent of the interest payable under

section 6601 for that part of the underpayment that is due to

fraud.    Under section 6653(b)(1)(A) and (B), if respondent

establishes that part of the underpayment is due to fraud, the

additions to tax apply to the entire underpayment except with

respect to any part that petitioners show is not due to fraud.

Sec. 6653(b)(2).

     Respondent has the burden of proving fraud by clear and

convincing evidence.     Sec. 7454(a); Rule 142(b).   For purposes of
                                -36-

section 6653(b), fraud means actual, intentional wrongdoing,

Mitchell v. Commissioner, 118 F.2d 308, 310 (5th Cir. 1941),

revg. 40 B.T.A. 424 (1939), or intentionally committing an act

specifically to evade a tax believed to be owing, Webb v.

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

1966-81.   Respondent must prove the existence of an underpayment.

Parks v. Commissioner, 94 T.C. 654, 660 (1990).    Respondent may

not rely on petitioners' failure to carry their burden of proof

as to the underlying deficiency.    Parks v. Commissioner, supra at

660-661; Petzoldt v. Commissioner, 92 T.C. 661, 700 (1989).

Respondent must also prove that petitioners intended to evade

taxes by conduct intended to conceal, mislead, or otherwise

prevent tax collection.    Stoltzfus v. United States, 398 F.2d

1002, 1004 (3d Cir. 1968); Parks v. Commissioner, supra at 661;

Castillo v. Commissioner, 84 T.C. 405, 408-409 (1985); Rowlee v.

Commissioner, 80 T.C. 1111, 1123 (1983).    Respondent must prove

that each spouse is liable for the additions to tax for fraud.

Sec. 6653(b)(4) (for 1983, 1984, and 1985); sec. 6653(b)(3) (for

1986 and 1987).    Thus, respondent must prove that each spouse

committed fraud.    Hicks Co. v. Commissioner, 56 T.C. 982, 1030
                                 -37-

(1971), affd. 470 F.2d 87 (1st Cir. 1972); Stone v. Commissioner,

56 T.C. 213, 227-228 (1971).

     2.     Underpayment of Tax for the Years in Issue

     Petitioners argue that respondent has not proven by clear

and convincing evidence that petitioners underpaid tax.

     Respondent may prove that an underpayment exists by proving

that the taxpayer had a likely source of unreported income,

Holland v. United States, 348 U.S. at 137-138; or, if a taxpayer

alleges that he or she had a nontaxable income source, by

disproving the alleged nontaxable source, United States v.

Massei, 355 U.S. 595 (1958).

     Petitioners underreported their income by $82,961 in 1983,

$45,598 in 1984, $8,608 in 1985, $60,788 in 1986, and $29,822 in

1987.     Petitioner-husband testified that petitioners earned about

$20,000 per month from their saunas.    Petitioners reported

significantly less than that amount each year in issue.    We

conclude that respondent has proven by clear and convincing

evidence that petitioners unreported their income for each of the

years in issue.

     3.      Fraudulent Intent

     Fraudulent intent may be proven by circumstantial evidence.

Edelson v. Commissioner, 829 F.2d 828, 832 (9th Cir. 1987), affg.

T.C. Memo. 1986-223; Rowlee v. Commissioner, supra; Stephenson v.

Commissioner, 79 T.C. 995, 1006 (1982), affd. 748 F.2d 331 (6th
                                 -38-

Cir. 1984).     The courts have developed a number of objective

indicators or "badges" of fraud.     Recklitis v. Commissioner, 91

T.C. 874, 910 (1988).    Several badges of fraud are present in

this case:    (a) Substantially underreporting income for several

years; (b) receiving income from illegal sources; (c) maintaining

inadequate records; (d) destroying records; (e) providing

incomplete or false information to the tax return preparer; (f)

filing false payroll tax returns; (g) giving implausible or

inconsistent explanations of behavior; and (h) using cash and

cashier's checks extensively.     Bradford v. Commissioner, 796 F.2d

303, 307-308 (9th Cir. 1986), affg. T.C. Memo. 1984-601; Ruark v.

Commissioner, 449 F.2d 311, 312-313 (9th Cir. 1971), affg. T.C.

Memo. 1969-48.

           a.     Pattern of Large Understatements of Income

     Consistently underreporting income for several years,

especially with discrepancies of 100 percent or more between net

income and net income reported on tax returns, is a badge of

fraud.   Holland v. United States, supra at 137-139; Estate of

Mazzoni v. Commissioner, 451 F.2d 197, 202 (3d Cir. 1971), affg.

T.C. Memo. 1970-37 and T.C. Memo. 1970-144.    Petitioners reported

income of $38,334 in 1983, $37,161 in 1984, $94,187 in 1985,

$32,873 in 1986, and $6,720 in 1987.    They underreported their

income by $82,961 in 1983, $45,598 in 1984, $8,608 in 1985,

$60,788 in 1986, and $29,822 in 1987.    They both knew that they
                                 -39-

were substantially underreporting their income.     This badge of

fraud applies to both petitioners for each year in issue.

           b.     Income From Illegal Sources

     A taxpayer's receipt of illegal income is a badge of fraud.

Bradford v. Commissioner, supra at 308; United States v.

Hamilton, 620 F.2d 712, 716-717 (9th Cir. 1980).     Both

petitioners knew that their income in the years in issue was from

an illegal source.

           c.     Inadequate Records, Destroying Records, and
                  Reporting False Information to their Tax
                  Return Preparer

     Failing to maintain accurate records is a badge of fraud.

Merritt v. Commissioner, 301 F.2d 484, 487 (5th Cir. 1962), affg.

T.C. Memo. 1959-172; Reaves v. Commissioner, 295 F.2d 336, 338

(5th Cir. 1961), affg. 31 T.C. 690 (1958); see Alexander Shokai,

Inc. v. Commissioner, T.C. Memo. 1992-41, affd. 34 F.3d 1480 (9th

Cir. 1994).     Destroying records and providing incorrect

information to a tax return preparer are also badges of fraud.

Spies v. United States, 317 U.S. 492, 499 (1943) (destroying

records); Estate of Temple v. Commissioner, 67 T.C. 143, 162-163

(1976) (giving incorrect information to tax return preparer).

Petitioner-wife told Kil Lee to burn the daily sheets he was

storing.   Petitioner-husband destroyed daily records of receipts

and gave false weekly summaries of their receipts and false

information about their expenses to their tax return preparer.
                               -40-

This badge of fraud applies to both petitioners for each year in

issue.

          d.    Filing False Payroll Tax Returns

     Filing false payroll tax returns is an indication of fraud.

See Estate of Santuccio v. Commissioner, a Memorandum Opinion of

this Court dated April 11, 1952.   Petitioner-husband directed

that pre-signed payroll papers be prepared and provided to

petitioners' income tax return preparer showing that masseuses

were paid about $200 a week.   Petitioner-husband withheld taxes

from the masseuses at a fixed amount regardless of how much money

the masseuses earned and issued Forms W-2 which he knew showed

substantially less income than the masseuses earned.   This badge

of fraud applies to petitioner-husband for each year in issue.

          e.    Implausible or Inconsistent Explanations

     Implausible or inconsistent explanations of behavior by a

taxpayer can show fraudulent intent.   Bradford v. Commissioner,

supra at 307.   Many of petitioners' explanations of their

behavior are implausible or inconsistent.   Petitioner-husband

testified that the Joplin Tokyo Sauna closed due to zoning

changes; however, it closed because prostitution was occurring on

its premises.   Petitioner-husband stated that he did not keep

money in banks, yet petitioners maintained bank accounts which

paid $30,800 in interest from 1983 to 1987 and IRA accounts

during the years in issue.   Petitioner-wife denied that she
                                 -41-

reviewed any daily sheets, yet K.C. Urbon gave the sauna expense

records to petitioner-wife.    Petitioners contend that petitioner-

wife was too sick to run the business and that she did not visit

the saunas after 1982.    However, the masseuses testified that

petitioner-wife visited the saunas after 1982.    Petitioners'

claim that $400,000 of their cash on hand on December 31, 1982,

came from Wilma MacFarland, Tobey Peacock, and MacFarland is

implausible.

       Petitioner-wife admitted that she lied to U.S. immigration

officials so her relatives could enter the United States.

Petitioner-husband testified that he made money in Vietnam on the

black market and by skimming cash from slot machines.

Petitioner-husband testified that when his father died, he

removed $50,000 from his stepmother's property without telling

her.    Both petitioners instructed the masseuses not to tell

others of the correct amount of income they earned.      Petitioners'

testimony frequently was implausible, inconsistent, or showed

that they had a propensity for unscrupulous behavior.

       This badge of fraud applies to both petitioners for each

year in issue.

            f.   Dealings in Cash and Cashier's Checks

       Petitioners dealt extensively in cash to avoid scrutiny of

their finances, a factor which can suggest fraud.     Bradford v.

Commissioner, 796 F.2d at 308.    Petitioner-husband used cashier's
                                 -42-

checks under $10,000 to avoid reporting requirements.       See sec.

6050I.   Petitioner-wife received cash from the masseuses in

petitioner-husband's absence.     Petitioners bought properties with

cashier's checks in both petitioners' names.       This badge of fraud

applies to both petitioners for each year in issue.

             g.   Petitioners' Other Contentions

     Petitioners contend that petitioner-wife was too sick and

distraught by her mother's death to have intended to evade taxes

or be liable for fraud in the years in issue.      We disagree.

Petitioner-wife clearly participated in supervising the saunas

and in the scheme to skim cash from them in the years in issue.

          h.      Conclusion

     Respondent has shown by clear and convincing evidence that

both petitioners fraudulently intended to underpay tax for each

of the years in issue.

          4.      Items Attributable to Fraud

     Respondent has shown by clear and convincing evidence that

petitioners' entire underpayment of tax for each year in issue

was intentional and due to fraud.       Thus, petitioners are liable

for the additions to tax under section 6653(b)(1) and (2) for

1983, 1984, and 1985 and under sections 6653(b)(1)(A) and (B) for

1986 and 1987 with respect to the entire underpayment of tax for

each year.
                                 -43-

        5.   Whether Petitioners Are Collaterally Estopped From
             Denying Fraud for 1987

     Petitioners contend that they are not collaterally estopped

from denying fraud for 1987 because the government violated their

rights under Brady v. Maryland, 373 U.S. 83 (1963) by failing to

disclose exculpatory evidence during their criminal prosecution.

     Federal and State prosecutors must disclose all evidence

that exculpates defendants in a criminal prosecution.       Id.   Both

petitioners pleaded guilty to tax evasion for 1987.    Taxpayers

who have been convicted of income tax evasion for a tax year

generally are collaterally estopped from denying fraud for that

year.    Gray v. Commissioner, 708 F.2d 243, 246 (6th Cir. 1983),

affg. T.C. Memo. 1981-1.    Petitioners contend that memoranda of

interviews of witnesses, such as Kil Lee and Kiye Oglesby, are

exculpatory.    Petitioners contend that they did not consider

whether there were Brady violations in their decision to plead

guilty because they first learned about Brady violations at the

trial in this case.

     Petitioners contend that they are not collaterally estopped

from denying that they are liable for additions to tax for fraud

for 1987.    We disagree.   First, the memoranda of interviews are

not in the record.    Second, the memoranda of interviews are not

exculpatory.    Third, it generally is not appropriate to

collaterally attack a criminal proceeding in a later civil
                                  -44-

proceeding.    See Armstrong v. United States, 173 Ct. Cl. 944, 354

F.2d 274, 291 (1965); Ochs v. Commissioner, T.C. Memo. 1986-595.

We conclude that petitioners are collaterally estopped from

denying that they are liable for the addition to tax for fraud

for 1987.

     6.     Conclusion

     We conclude that respondent proved by clear and convincing

evidence that both petitioners are liable for additions to tax

for fraud for each of the years in issue.

D.   Statute of Limitations

     Petitioners allege that the statute of limitations bars

assessment and collection of tax for the years at issue.

Respondent argues that the 3-year limit on the time to assess tax

under section 6501(a) does not apply here because petitioners'

underpayments were due to fraud.      We have found that petitioners

committed fraud; thus, there is no limit on the time respondent

may assess tax.    Sec. 6501(c)(1); Vannaman v. Commissioner, 54

T.C. 1011, 1018 (1970).      We hold that the statute of limitations

does not bar respondent from assessing and collecting tax for the

years in issue.

E.   Substantial Underpayment of Tax Under Section 6661

     Respondent determined that petitioners are liable for the

addition to tax for substantial understatement of income tax

under section 6661.      If assessed after October 21, 1986, the
                                 -45-

addition to tax is 25 percent of any underpayment attributable to

the understatement.     Sec. 6661(a); Pallottini v. Commissioner, 90

T.C. 498, 503 (1988).    A substantial understatement is one which

exceeds the greater of 10 percent of the tax required to be shown

on the return or $5,000.    Sec. 6661(b)(1).   The Commissioner may

waive this addition to tax if the taxpayer had reasonable cause

for the understatement and acted in good faith.    Sec. 6661(c).

     Petitioners contend that they did not substantially

understate their income for 1983, 1984, 1985, 1986, or 1987.

Petitioners raise no other defense.     We hold that petitioners are

liable for the addition to tax under section 6661 if the Rule 155

computation shows that there is a substantial understatement.

F.   Self-Employment Tax Under Section 1401

     Section 1401 imposes a tax on net earnings from self-

employment, defined as gross income derived from carrying on a

trade or business, less allowable deductions.    Sec. 1402(a); sec.

1.1401-1(c), Income Tax Regs.    Petitioners did not argue this

issue at trial or on brief.    We find that petitioners are liable

for self-employment tax for the years in issue.

     To reflect the foregoing,


                                                Decision will be

                                           entered under Rule 155.
