                                T.C. Memo. 2013-83



                         UNITED STATES TAX COURT



              HOWARD MUI AND PEI YI MUI, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 28155-08.                          Filed March 25, 2013.



      Mark C. Heling, Alan F. Segal, and Ryan M. Borgmann, for petitioner

Howard Mui.

      Pengtian Ma, for petitioner Pei Yi Mui.

      Grubert Roger Markley, Justin D. Scheid, and Andrew Gordon, for

respondent.



              MEMORANDUM FINDINGS OF FACT AND OPINION


      FOLEY, Judge: The issues for decision, relating to 2002, 2003, and 2004,

are whether petitioners are liable for tax relating to underreported income; whether
                                           -2-

[*2] petitioners are liable for section 6663(a)1 fraud, or section 6662(a) accuracy-

related, penalties; and whether Pei Yi Mui, pursuant to section 6015, is entitled to

relief from joint and several liability.

                                 FINDINGS OF FACT

       In June 2000 Pei Yi Mui immigrated to the United States on a three-month

visa. Soon thereafter, she married Howard Mui, they purchased a home, and she

applied for permanent resident status. To bolster the application, Mr. Mui added

her as a joint account holder to his Pacific Global Bank account (business account).

       Mr. Mui was a compulsive gambler. To fund his habit he operated, as a sole

proprietorship, Chinatown Communication, which sold international telephone

calling cards. Mr. Mui considered this an ideal business because vendors allowed

him to receive the cards in bulk and pay two months after receipt. He used calling

card sales proceeds (i.e., received prior to the repayment date) to gamble. Under

constant pressure to meet vendors’ due dates, he typically paid vendors with

postdated checks drawn on the business account. When the balance in this

account approached zero, he deposited checks drawn on petitioners’ Charter One



       1
       Unless otherwise indicated, all section references are to the Internal Revenue
Code in effect during the years in issue, and all Rule references are to the Tax Court
Rules of Practice and Procedure.
                                        -3-

[*3] Bank account (personal account). Undaunted by persistent cashflow problems,

he borrowed from friends and family when gambling resources dwindled.

      Mr. Mui accepted customer payments in cash and deposited these payments

into the business account and the personal account. Petitioners closed their personal

account in 2004. Mr. Mui would often direct Ms. Mui to sign checks relating to

Chinatown Communication, and on several occasions, Mr. Mui signed his wife’s

name on certain checks. Ms. Mui was not involved in the operation of Chinatown

Communication and supported herself with funds from her parents and personal

savings.

      Mr. Mui had numerous encounters with law enforcement authorities. In

2002 and 2003 he was arrested for domestic violence incidents relating to Ms.

Mui, who obtained a restraining order and ultimately separated from him in 2003.

Mr. Mui also had problems relating to the sale of cigarettes upon which State and

local excise taxes had not been paid (contraband cigarettes). In 1999 the Ohio

State Highway Patrol (Highway Patrol) stopped him and seized 1,905 cartons of

contraband cigarettes. The Highway Patrol stopped him again in 2002 (i.e.,

finding no contraband cigarettes in his possession) and 2003 (i.e., finding two

packs of contraband cigarettes in his possession). In May 2008 Mr. Mui, after
                                         -4-

[*4] pleading guilty to charges relating to the sale of contraband cigarettes in 2005

through 2008, was sentenced to 30 months in prison.

      Petitioners timely filed joint 2002, 2003, and 2004 Forms 1040, U.S.

Individual Income Tax Return, on which they, respectively, reported $113,135,

$134,627, and $138,493 of gross receipts and $67,881, $74,635, and $72,499 of

cost of goods sold. The 2003 and 2004 returns were professionally, yet sloppily,

prepared. On all three returns petitioners reported that they were entitled to a

refund and Mr. Mui signed Ms. Mui’s name.

      After petitioners’ 2002, 2003, and 2004 (years in issue) returns were

selected for audit, Mr. Mui, who had limited proficiency in the English language,

told the examining revenue agent (first RA) about Chinatown Communication’s

use of the business account. Mr. Mui further informed the first RA that he had

only limited business records and had estimated Chinatown Communication’s

reported gross receipts and costs of goods sold. The first RA proceeded to

perform a bank deposits analysis and reconstruct Chinatown Communication’s

income. During this process he identified several gambling loans the proceeds of

which were deposited into the business account. Prior to completion of the

examination, he retired but left workpapers of his analysis.
                                        -5-

[*5] Revenue Agent Nevita Williams (RA Williams) was assigned to complete the

examination. Upon a review of the deposits into the business account, RA Williams

noticed that certain checks drawn on the personal account were deposited into the

business account. As a result, she determined that an analysis of the personal

account was necessary and proceeded to analyze deposits. During the audit Mr.

Mui told RA Williams, but did not submit any supporting documentation, that he

routinely borrowed money to support his gambling habit. Without scrutiny, RA

Williams incorporated the first RA’s analysis of the business account into her

examination report. She also incorporated her analysis of the personal account.

      Petitioners divorced on May 14, 2008. On September 2, 2008, respondent

received Ms. Mui’s Form 8857, Request for Innocent Spouse Relief, in which she

requested relief pursuant to section 6015(b), (c), and (f). Respondent denied Ms.

Mui’s request. On September 11, 2008, respondent issued petitioners a notice of

deficiency, which incorporated RA Williams’ examination report. Respondent

determined that petitioners had an additional $883,162, $583,564, and $321,346 of

gross receipts and $520,356, $320,655, and $138,739 of costs of goods sold

relating to 2002, 2003, and 2004, respectively. As a result of these adjustments,

respondent determined that petitioners had $362,536, $270,505, and $176,160 of
                                          -6-

[*6] unreported income relating to 2002, 2003, and 2004, respectively. Respondent

further determined that petitioners were liable for section 6663(a) fraud penalties,

or, in the alternative, section 6662(a) accuracy-related penalties, relating to these

years. On November 19, 2008, petitioners, while residing in Illinois, filed their

petition with the Court.

                                       OPINION

I.    The Statutory Notice Is Valid

       Petitioners contend that the notice of deficiency lacks a rational foundation

and is arbitrary and excessive. We disagree. See Pittman v. Commissioner, 100

F.3d 1308, 1313 (7th Cir. 1996) (holding that a determination is presumed correct

if it has a rational foundation and is not arbitrary and excessive), aff’g T.C. Memo.

1995-243; see also Golsen v. Commissioner, 54 T.C. 742, 757 (1970), aff’d, 445

F.2d 985 (10th Cir. 1971). First, respondent’s use of the bank deposits method

(i.e., to reconstruct petitioners’ income) was appropriate because Mr. Mui

accepted customer payments in cash, reported estimates on his Federal income tax

returns, and failed to maintain records. See sec. 446(b); Petzoldt v. Commissioner,

92 T.C. 661, 686-687 (1989); sec. 1.446-1(a)(4), Income Tax Regs. Second, Mr.

Mui readily acknowledges that he owned and operated Chinatown Communication

and, thus, was linked to the income-producing activity. See Pittman v.
                                          -7-

[*7] Commissioner, 100 F.3d at 1313-1314. Third, and most importantly,

respondent’s determination is solidly grounded on an extensive review of

petitioners’ activities and bank accounts, which bear a direct relationship to

petitioners’ tax liabilities. See Zuhone v. Commissioner, 883 F.2d 1317, 1325 (7th

Cir. 1989) (stating that the arbitrary and excessive doctrine is a challenge to the

Commissioner’s determination “on the basis that it bears no factual relationship to

the taxpayer’s liability”), aff’g T.C. Memo. 1988-142. While we recognize that RA

Williams could have performed an independent review of the first RA’s analysis and

more thoroughly analyzed petitioners’ personal account, the notice was not arbitrary

or excessive. See id. Indeed, petitioners failed to delineate any inaccuracies in the

first RA’s analysis. On their tax returns relating to the years in issue petitioners

reported gross receipts totaling $386,255 and costs of goods sold totaling $215,015.

Respondent determined, however, that petitioners’ cumulative understatements of

gross receipts and costs of goods sold were $1,788,070 and $979,750, respectively.

Although the parties stipulated numerous checks totaling more than $100,000,

petitioners did not provide any testimony or credible evidence establishing that these

checks related to costs of goods sold or deductible expenses. See Rule 142(a);

Goldsmith v. Commissioner, 31 T.C. 56, 62 (1958).
                                          -8-

[*8] II.     Petitioners Underreported Their Income

       Petitioners have the burden, but failed, to prove that the deposits at issue are

not income.2 See Tokarski v. Commissioner, 87 T.C. 74, 77 (1986). We recognize

that Mr. Mui borrowed funds, but there is no credible evidence relating to the

amount he borrowed. Moreover, there is insufficient evidence establishing that the

deposits were nontaxable or that petitioners are entitled to any cost of goods sold or

deductible expenses exceeding the amount respondent allowed. See Goldsmith v.

Commissioner, 31 T.C. at 62. During cross-examination petitioners presented RA

Williams with checks (i.e., totaling more than $90,000), which respondent’s

determination did not take into account. Petitioners have not, however, established

that these checks related to costs of goods sold. See id. Indeed, they failed to offer

any testimony or additional documentary evidence relating to these checks, costs of

goods sold, or deductible expenses.

III.   Petitioners Are Liable for Accuracy-Related Penalties

       Respondent determined, but failed to establish by clear and convincing

evidence, that petitioners are liable for fraud penalties pursuant to section 6663(a).


       2
        Pursuant to sec. 7491(a), the burden of proof may shift to respondent if
petitioners introduce credible evidence with respect to any factual issue. This
section is inapplicable because petitioners failed to maintain business records. See
sec. 7491(a)(2).
                                         -9-

[*9] See secs. 6663(a), 7454(a); Rule 142(b); Pittman v. Commissioner, 100 F.3d

at 1319; Petzoldt v. Commissioner, 92 T.C. at 699. Respondent’s primary

contention is that petitioners sold contraband cigarettes during the years in issue

and concealed the proceeds to evade tax. To support his flimsy fraud contention,

respondent cites a 1999 traffic stop and contraband cigarette sales in 2005 through

2008--all years not in issue. The evidence relating to the years in issue (i.e., two

Highway Patrol stops of Mr. Mui yielding only two packs of contraband

cigarettes) is woefully insufficient. In addition, petitioners cooperated during the

audit. Respondent asserts that Mr. Mui failed to disclose the personal account

when asked through which bank account he conducted business. Mr. Mui did not

reference the personal account because it had previously been closed. Any

misunderstanding relating to this issue was more likely the result of Mr. Mui’s

limited proficiency in English rather than an intent to mislead respondent. Finally,

respondent contends that Mr. Mui’s pattern of cash deposits and failure to

maintain business records was “intentionally calculated to make the unreported

income harder to detect.” Pressured to make vendor’s payment due dates and

compelled to assuage his gambling fever, Mr. Mui frantically shuffled money

between bank accounts, calling card vendors, and casinos. Respondent

established that Mr. Mui’s business practices were imprudent but failed to
                                          - 10 -

[*10] establish that any portion of the underpayment was attributable to fraud or that

petitioners intended to evade tax. See secs. 6663(a), 7454(a); Rule 142(b); Pittman

v. Commissioner, 100 F.3d at 1319; Petzoldt v. Commissioner, 92 T.C. at 700

(stating that the existence of fraud may not be found under “‘circumstances which at

the most create only suspicion’” (quoting Davis v. Commissioner, 184 F.2d 86, 87

(10th Cir. 1950), remanding a Memorandum Opinion of this Court)).

      Petitioners are not liable for fraud penalties but are liable for accuracy-

related penalties. They substantially understated their income tax and failed to

exercise due care in the preparation of their tax returns. See secs. 6662(a), (b)(1)

and (2), (c), and (d), 7491(c); Higbee v. Commissioner, 116 T.C. 438, 446 (2001);

sec. 1.6662-3(b)(1), Income Tax Regs. The 2003 and 2004 returns were prepared

by professionals, but petitioners failed to establish or even assert that their

preparers had sufficient expertise to justify reliance, that they provided them with

necessary and accurate information, or that they relied in good faith on their

judgment. See sec. 6664(c)(1); Neonatology Assocs., P.A. v. Commissioner, 115

T.C. 43, 99 (2000), aff’d, 299 F.3d 221 (3d Cir. 2002); sec. 1.6664-4(b)(1),

Income Tax Regs. Thus, they have not, pursuant to section 6664(c)(1), established

reasonable cause for the underpayments or that the returns were prepared in good
                                          - 11 -

[*11] faith. Accordingly, we sustain respondent’s determination relating to section

6662(a) penalties.

IV.    Ms. Mui Is Entitled to Innocent Spouse Relief

       Married taxpayers may elect to file a joint Federal income tax return. Sec.

6013(a). Each spouse filing the return is jointly and severally liable for the

accuracy of the return and the entire tax due. Sec. 6013(d)(3). Pursuant to section

6015(a), however, a taxpayer may seek relief from joint liability. Ms. Mui

qualifies for relief pursuant to section 6015(c). As a result, Mr. Mui is liable for

the entire tax liability relating to each year in issue. Ms. Mui was divorced from

Mr. Mui when she filed her election for relief. In addition, she sought relief less

than two years after the first collection activity relating to these liabilities. See

sec. 6015(c)(3)(A) and (B). Moreover, Mr. Mui signed Ms. Mui’s name on the

returns, and, at the time the returns were signed, she did not have actual

knowledge of the items giving rise to the deficiencies. See sec. 6015(c)(3)(C);

Cheshire v. Commissioner, 115 T.C. 183, 195 (2000) (stating that “the knowledge

standard for purposes of section 6015(c)(3)(C) is an actual and clear awareness

* * * of the existence of an item which gives rise to the deficiency”), aff’d, 282

F.3d 326 (5th Cir. 2002).

       Contentions we have not addressed are irrelevant, moot, or meritless.
                                  - 12 -

[*12] To reflect the foregoing,


                                                 Decision will be entered

                                           under Rule 155.
