                         T.C. Memo. 1996-415



                       UNITED STATES TAX COURT



               CHARLES L. WYNN, JR., Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 3416-92.                  Filed September 16, 1996.



     Charles L. Wynn, Jr., pro se.

     Diane D. Helfgott, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION

     CHIECHI, Judge:    Respondent determined the following defi-

ciencies in, and additions to, petitioner's Federal income tax:
                                               - 2 -
                                                Additions to Tax
                           Section        Section        Section        Section       Section
Year       Deficiency   6653(a)(1)(A)1 6653(a)(1)(B) 6653(b)(1)(A)   6653(b)(1)(B)      6661

1986       $40,946          $8             *           $30,584            **          $10,195
1987        15,889          15             *            11,692            **            3,897

* 50 percent of the interest due on the portion of the underpayment attributable to
negligence or disregard of rules or regulations.

** 50 percent of the interest due on the portion of the underpayment attributable to
fraud.

              The issues remaining for decision are:2

              (1)    Does petitioner have unreported income for 1986?            We

   hold that he does to the extent stated herein.

              (2)    Is petitioner entitled for 1986 to an exemption for a

   dependent child under section 151(a) and (c)?                 We hold that he is

   not.

              (3)    Is petitioner liable for 1986 for the additions to tax

   under section 6653(a)(1)(A) and (B)?                We hold that he is to the

   extent stated herein.


       1
       Unless otherwise indicated, all section references are to the
   Internal Revenue Code in effect for the years at issue. All Rule
   references are to the Tax Court Rules of Practice and Procedure.
       2
       At trial, respondent conceded the additions to tax for fraud
   for 1986 and the deficiency in, and additions to, tax for 1987.
   Respondent also concedes on brief $95 of the $1,282 State and
   local income tax refund that petitioner received during 1986 and
   did not report as income in his 1986 Federal income tax return
   (return) and that respondent determined was income for that year.
   On brief, petitioner concedes that for 1986 he has unreported
   income of $1,187 attributable to that State and local income tax
   refund. Although respondent argues for the first time on brief
   that petitioner is liable for the addition to tax under sec.
   6651(a) because he filed his 1986 Federal income tax return
   (return) on or after Dec. 1, 1988, on brief, petitioner does not
   dispute that he filed his 1986 return at that time, and he
   concedes that he is liable for that addition to tax. See Rule
   41(b).
                                 - 3 -

     (4)    Is petitioner liable for 1986 for the addition to tax

under section 6661(a)?     We hold that he is to the extent stated

herein.

                           FINDINGS OF FACT

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

     At the time the petition was filed, petitioner resided in

Washington, D.C.

     During 1984, petitioner was employed as general manager of

Linea Pitti (Linea Pitti), an exclusive clothing store located in

the Georgetown Park shopping center (Georgetown Park) in Washing-

ton, D.C., and received $23,428.85 from that employment.     During

that year, petitioner was also employed by Eduardo, Inc., another

clothing store located in Georgetown Park, and received $4,127.99

from that employment.

     In July 1984, petitioner purchased a residence located on

West Beach Drive, N.W., in Washington, D.C.     In connection with

that purchase, petitioner borrowed $156,750 that he was to repay

in monthly installments of $1,672.93.

     Petitioner reported the total wages that he received during

1984 from Linea Pitti and Eduardo, Inc. in the return that he

filed for that year.     He reported no other income in his 1984

return.     In that return, petitioner claimed the following deduc-

tions:     $4,009 in home mortgage interest, $530 in credit card

interest, $2,131 in State and local income, real property, and

sales taxes, and $108 in charitable contributions.
                                - 4 -

       During 1985, petitioner was employed by Eduardo, Inc. and

received $23,121.56 from that employment.    During that year, he

also received $7,102 of income from other sources.

       At the end of 1985, petitioner purchased a 1986 Jeep for

$9,500 by paying $1,500 as a down payment and borrowing $8,000

that he was to repay in monthly installments of $198.81.

       Petitioner reported the wages and the additional income that

he received during 1985 in his return for that year.    He reported

no other income in his 1985 return.     In that return, petitioner

claimed the following deductions:    $19,576 in home mortgage

interest, $550 in credit card interest, $139 in interest paid to

Ford Motor Credit Company, $4,099 in State and local income,3

real property, and sales taxes, and $156 in charitable contribu-

tions.

       On November 24, 1986, petitioner, Ihsan Dura, and Lee Thack

incorporated C & I, Inc. (C & I) for the principal purpose of

operating a retail clothing business.    Petitioner and Ihsan Dura

each subscribed for 50 percent of the common stock of C & I for

$100,000, or a total subscription of $200,000 ($200,000 stock

subscription).    During all relevant periods, including 1986,

petitioner was president, and Ihsan Dura was vice president, of C

& I.



 3
    Petitioner deducted $1,445 of State and local income taxes in
his 1985 return.
                                - 5 -

     The $200,000 stock subscription was paid or otherwise

satisfied during 1986.   On various dates during December 1986,

petitioner and Ihsan Dura deposited funds totaling $149,337.50

into the bank account of C & I at Central Fidelity Bank (C & I

bank account).   The source of $23,800 of the amount so deposited

by petitioner was petitioner's mother, Gloria M. Wynn.   During

1986, petitioner and Ihsan Dura also paid one of C & I's accounts

payable totaling $20,000 (C & I account payable).

     Certain financial workpapers of C & I (C & I's financial

workpapers) dated as of December 31, 1986, recorded $149,337.50

of the deposits into the C & I bank account, $10,662.50 of the

$20,000 payment of C & I's account payable,4 and a loan receiv-

able of $40,000 as reductions of the $200,000 stock subscription.

     On October 6, 1986,5 C & I offered to purchase the business

known as Linea Pitti for $175,000, of which $30,000 was allocable

to inventory and $145,000 was for the assumption of the lease of

the premises.    That purchase offer was approved, and C & I began

operating Linea Pitti in late 1986.

     After C & I began operating Linea Pitti in late 1986, it

employed petitioner and Ihsan Dura full-time and compensated them



 4
    C & I's financial workpapers recorded $9,337.50 of the
$20,000 payment of C & I's account payable in an account desig-
nated "Loan--officers" (officers' loan account).
 5
    The record does not disclose how C & I, which was not incor-
porated until Nov. 24, 1986, could have offered to purchase Linea
Pitti on Oct. 6, 1986. Presumably that offer was made in the
name of C & I in anticipation of its being incorporated.
                                 - 6 -

for their services.    Petitioner's responsibilities at that store

included buying and selling clothes and assisting in the mainte-

nance of its books, and the responsibilities of Ihsan Dura, who

was a tailor, included buying and selling, and supervising the

tailoring of, clothes.

     In order to purchase inventory for Linea Pitti, during 1986,

a third party made a $108,312 payment to a clothing manufacturer

on behalf of C & I.    In January 1987, $53,000 was deposited into

the C & I bank account, and C & I's financial workpapers recorded

that deposit in the officers' loan account.      By March 31, 1987,

the officers' loan account in C & I's financial workpapers

reflected funds advanced by C & I's officers in the total amount

of $128,193.71.    As of March 31, 1987, the officers' loan account

shown in C & I's financial workpapers included a security deposit

in the amount of $25,365.21 that had been advanced by petitioner

on behalf of that corporation.       The corporate income tax return

(Form 1120) filed by C & I for its taxable year ended September

30, 1987, showed that, as of that date, C & I's account desig-

nated "Loans from stockholders" had a balance of $122,246.

     During 1986, petitioner spent at least the following amounts

on the items indicated:

                       Expenditure               Amount

                  Home mortgage                 $19,800
                  State and local taxes           2,371
                  Car payments                    2,340
                  Credit card payments            2,400
                     Total                       26,911
                                - 7 -

Petitioner's total cash expenditures during 1986 equaled at least

$126,911.

     Petitioner filed his 1986 return on or after December 1,

1988.   In that return, petitioner reported that he received the

following items of gross income from the payors indicated:

                       Payors                   Amount

            Mingles, Inc.                      $3,651.50
            Eduardo, Inc.                         298.07
            Eduardo, Inc.                       1,400.00
            Britex, Inc. T/A Linea Pitti          457.14
            C & I, Inc. T/A Linea Pitti         3,542.86
            State and local income
               tax refund                         258.00
               Total                            9,607.57

     During 1986, petitioner received $26,000 in gross income

from operating a car wash business that his father and he owned

and that was known as Custom Car Salon.    Petitioner did not

report any portion of that $26,000 in the return that he filed

for 1986.

     Petitioner did not maintain any books or records for 1986

relating to his income-producing activities.    In examining

petitioner's taxable year 1986, respondent reconstructed peti-

tioner's income pursuant to the cash expenditures method and

determined in the notice of deficiency (notice) that petitioner

had unreported income of $122,461 for that year.

     On May 25, 1989, a Federal grand jury indicted petitioner

on, inter alia, over 50 counts of violating 18 U.S.C. sections

1956(a)(1)(B)(i) and 1957 (1994) involving the laundering of

proceeds of specified unlawful activity and criminally derived
                                - 8 -

proceeds (money-laundering).   The indictment alleged, inter alia,

(1) that beginning on or about January 1, 1985, and continuing

through April 15, 1989, Rayful Edmond III and Tony Lewis operated

a large scale unlawful narcotic drug trafficking organization and

(2) that shortly after C & I began operating Linea Pitti, peti-

tioner (a) maintained customer accounts at Linea Pitti for the

benefit of Rayful Edmond III and Tony Lewis on which purchases of

merchandise and payments thereon were recorded; (b) assisted them

in laundering the proceeds from their unlawful narcotic drug

organization in the purchase, on account and with cash, of in

excess of $400,000 worth of merchandise from Linea Pitti; and (c)

assisted them in further laundering their narcotic drug organiza-

tion's unlawful proceeds in the purchase of luxury automobiles

with those proceeds and in registering the automobiles in peti-

tioner's name as nominee.

     On October 15, 1991, petitioner was convicted of 34 of the

counts set forth in the indictment, including about half of the

counts involving money-laundering.      On appeal, the U.S. Court of

Appeals for the District of Columbia Circuit affirmed as to 32 of

those counts, but reversed as to two counts of illegal struc-

turing of financial transactions under 31 U.S.C. section 5324

(1994).

                               OPINION

     Petitioner has the burden of showing that respondent's

determinations in the notice for 1986 that remain at issue are
                               - 9 -

erroneous.6   Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115

(1933).

Unreported Income

     Section 6001 requires taxpayers to maintain sufficient

records to determine their correct tax liabilities.   Petitioner

does not dispute that he did not maintain any books or records

for 1986 relating to his income-producing activities.   If a

taxpayer fails to keep the required books and records, or if the

books and records maintained do not clearly reflect income,

respondent is authorized by section 446 to reconstruct income in

accordance with a method that clearly reflects the full amount of

income received, Petzoldt v. Commissioner, 92 T.C. 661 (1989),


 6
    Respondent raised for the first time in the answer, as an
alternative position, that if the Court were to determine that
petitioner is not liable for the additions to tax for fraud for
the years at issue, petitioner would be liable for the additions
to tax for negligence on the entire underpayment for each of
those years, and not, as determined in the notice, only on the
portion of the underpayment attributable to certain determina-
tions in that notice that are discussed below. Rule 142(a). As
indicated supra note 2, respondent conceded at trial the addi-
tions to tax for fraud for 1986 and the deficiency in, and
additions to, tax for 1987. Respondent generally would have the
burden of proof on her alternative position in the answer with
respect to the additions to tax for negligence for 1986. In
arguing the additions to tax for negligence on brief, respondent
does not make clear to the Court whether or not she is advancing
her alternative position that petitioner is liable for the
additions to tax for 1986 on the entire underpayment for that
year. In this connection, however, respondent's counsel advised
the Court in her opening statement before trial that, after
respondent's concession of the additions to tax for fraud, no
issues remain in this case on which respondent has the burden of
proof. Given the state of the record, we conclude that respon-
dent has abandoned her alternative position in the answer with
respect to the additions to tax for negligence for 1986.
                              - 10 -

provided that the reconstruction is reasonable in light of all

the surrounding facts and circumstances, id.; Giddio v. Commis-

sioner, 54 T.C. 1530, 1533 (1970).

     Respondent reconstructed petitioner's income for 1986 by

using the cash expenditures method.    That method is based on the

assumption that the amount by which a taxpayer's expenditures

during a taxable year exceeds his or her reported income for that

year is taxable, absent some explanation by the taxpayer.

Petzoldt v. Commissioner, supra at 694; DeVenney v. Commissioner,

85 T.C. 927, 930 (1985); Burgo v. Commissioner, 69 T.C. 729, 742

(1978).   To overcome that assumption, a taxpayer must show either

that someone else made the expenditures or that the funds

expended were obtained from nontaxable sources such as loans,

gifts, inheritances, or assets on hand at the beginning of the

taxable period in question.   Petzoldt v. Commissioner, supra at

695; DeVenney v. Commissioner, supra at 931.

     Petitioner does not dispute that during 1986 he spent at

least $26,911 for personal living expenses and that he trans-

ferred $100,000 to C & I to purchase 50 percent of its stock.7

However, petitioner claims that he obtained the funds that he

transferred to C & I during 1986 from nontaxable sources, i.e.,

 7
    Nor does petitioner dispute (1) that during 1986 over
$100,000 was paid by a third party on behalf of C & I in order to
purchase inventory for Linea Pitti, (2) that during January 1987
petitioner and Ihsan Dura transferred in excess of $50,000 to C &
I, and (3) that, as of Mar. 31, 1987, they had transferred in
excess of $70,000 in additional funds to that company, at least
$25,365.21 of which was transferred by petitioner.
                              - 11 -

from third-party loans.   With one exception, petitioner did not

introduce into the record any evidence supporting his claim that

we found reliable and persuasive.8     For example, petitioner did

not proffer any notes or other evidence of indebtedness relating

to, any evidence of security for, or any books reflecting such

loans.9   We are, however, persuaded by the record before us that

petitioner's mother, Gloria M. Wynn, provided $23,800 of the

total amount that petitioner transferred to C & I during 1986 and

that, to that extent, the funds that petitioner spent during that

year were obtained from a nontaxable source.10

      Based on our examination of the entire record before us, we


 8
    To support his position that he obtained the funds that he
transferred to C & I during 1986 as loans from third parties,
petitioner relies on certain alleged sales receipts from Linea
Pitti that purport to show that the store provided clothing at a
discount to certain customers who, he alleges, were the individu-
als who lent him the money that he invested in C & I. None of
the alleged purchasers of the clothing to which those purported
receipts pertain testified on petitioner's behalf, and we are
unwilling to accept petitioner's uncorroborated testimony about
them or those documents. In this regard, it appears to the Court
that the purported receipts in question are consistent with
petitioner's illegal money-laundering activities of which he was
convicted and that those activities, as well as the car wash
business that petitioner and his father owned, are the likely
sources of the funds that, during 1986, petitioner spent on
personal living expenses and transferred to C & I.
 9
    Indeed, C & I's financial workpapers belie petitioner's
contention that the funds in question were loans. These
workpapers indicate that the officers of C & I (viz., petitioner
and Ihsan Dura) were the individuals who, during 1986 (and the
first three months of 1987), transferred funds to C & I.
 10
    Respondent concedes as much on brief when she states: "Only
one of the documents * * * a check in the amount of $23,800 from
Gloria Wynn, petitioner's mother, appears to support the infer-
ence that petitioner received funds from a nontaxable source."
                              - 12 -

find that, except to the extent of $23,800, petitioner has not

established that respondent's determination in the notice of

unreported income for 1986, as reduced by her concession on

brief, is wrong.11

Dependency Exemption

      Although petitioner contends on brief that his son, Charles

McClaine, lived with him during 1986 and that petitioner is

therefore entitled to claim him as a dependent for that year, the

record is devoid of evidence supporting that contention.

      On the record before us, we find that petitioner has failed

to establish that he is entitled for 1986 to an exemption for a

dependent child under section 151(a) and (c).

Additions to Tax--Section 6653(a)(1)(A) and (B)

      Respondent determined in the notice that petitioner is

liable for 1986 for the additions to tax under section

6653(a)(1)(A) and (B) with respect to the underpayment for that

year that is attributable only to the following determinations:

(1) Disallowance of a personal exemption in the amount of $1,080,


 11
    Respondent determined in the notice pursuant to the cash
expenditures method that petitioner had $122,461 of unreported
income for 1986. On brief, respondent takes the position that
petitioner's unreported income for 1986 calculated pursuant to
that method is $117,208. We construe respondent's position on
brief as a concession by respondent that the amount of unreported
income for 1986 determined in the notice should be reduced by
$5,253. In making the computation required under Rule 155, the
parties shall, inter alia, use $117,208 as the starting point for
computing the amounts of the deficiency in, and additions to,
petitioner's income tax for 1986 that result from this Opinion
and other concessions of the parties.
                              - 13 -

(2) increase in income in the amount of $1,282 because of a State

and local income tax refund, and (3) partial disallowance in the

amount of $858 of a mortgage interest deduction.   Respondent

concedes on brief (1) that the income for 1986 resulting from the

State and local income tax refund that petitioner received during

that year should be $1,187, and not $1,282 as determined in the

notice, and (2) that during 1986 petitioner paid mortgage inter-

est of $19,800, and not $17,862 as determined in the notice.     In

light of the foregoing concessions of respondent, the underpay-

ment for 1986 on which the additions to tax under section

6653(a)(1)(A) and (B) may be imposed may be eliminated entirely.

      In the event that that underpayment is not eliminated,

section 6653(a)(1)(A) generally imposes an addition to tax equal

to five percent of the entire underpayment if any part of it was

due to negligence or disregard of rules or regulations.   Section

6653(a)(1)(B) imposes a further addition to tax in an amount

equal to 50 percent of the interest payable with respect to the

portion of the underpayment that is attributable to negligence or

disregard of rules or regulations.12   For purposes of section

6653(a)(1), the term "negligence" includes any failure to make a

reasonable attempt to comply with the provisions of the Code, and

the term "disregard" includes any careless, reckless, or inten-


 12
    For purposes of sec. 6653(a)(1)(A) and (B), the underpayment
otherwise determined shall be reduced by any portion of such
underpayment that is attributable to fraud with respect to which
an addition to tax under sec. 6653(b) is imposed.
                               - 14 -

tional disregard.    Sec. 6653(a)(3).   Negligence also has been

defined as a lack of due care or failure to do what a reasonable

and prudent person ordinarily would do under similar circum-

stances.    See Crocker v. Commissioner, 92 T.C. 899, 916 (1989);

Neely v. Commissioner, 85 T.C. 934, 947-948 (1985).

       Failure by a taxpayer to keep adequate records may justify

imposition of the additions to tax for negligence.     See Lysek v.

Commissioner, 583 F.2d 1088, 1094 (9th Cir. 1978), affg. T.C.

Memo. 1975-293; Crocker v. Commissioner, supra at 917.     Failure

to maintain adequate records also indicates disregard of the

rules or regulations that require a taxpayer to keep permanent

records sufficient to establish, inter alia, the taxpayer's gross

income and deductions.    See Crocker v. Commissioner, supra at

917.    Failure to file timely a return without reasonable cause

also may be evidence that an underpayment of tax was attributable

to negligence or disregard of rules or regulations.     See Emmons

v. Commissioner, 92 T.C. 342, 350 (1989), affd. 898 F.2d 50 (5th

Cir. 1990).

       Petitioner concedes that he failed to keep adequate records

for 1986 and that he failed to file timely his 1986 return

without reasonable cause.    Petitioner also concedes that he

failed to report $1,187 of income for 1986 that is attributable

to a refund of State and local income taxes that he received

during that year.
                              - 15 -

     On the instant record, we find that petitioner has failed to

show error in respondent's determination in the notice, as

reduced by her concessions on brief, that for 1986 he is liable

for the additions to tax under section 6653(a)(1)(A) and (B).

Addition to Tax--Section 6661(a)

     Respondent determined in the notice that petitioner is

liable for 1986 for the addition to tax under section 6661(a)

only with respect to the $122,461 understatement of income for

that year determined in the notice pursuant to the cash expendi-

tures method.   Respondent concedes on brief that petitioner's

unreported income for 1986 calculated pursuant to that method is

$117,208, and not $122,461 as determined in the notice.    In light

of the foregoing concession of respondent, and as stated infra,

the understatement for 1986 with respect to which the addition to

tax under section 6661(a) may be imposed shall be correspondingly

reduced.

     If there is a substantial understatement of income tax for a

taxable year, section 6661(a) imposes an addition to tax equal to

25 percent of the underpayment attributable to that understate-

ment.   An understatement exists where the amount of tax shown in

the taxpayer's return is less than the amount required to be

shown in that return.   Sec. 6661(b)(2)(A).   In the case of

individuals, an understatement is substantial if it exceeds the

greater of $5,000 or 10 percent of the tax required to be shown.
                              - 16 -

Sec. 6661(b)(1)(A).   Except for items attributable to tax shel-

ters, the amount of the understatement is reduced by items with

respect to which the taxpayer has or had substantial authority

for his or her position or for which relevant facts affecting the

tax treatment were adequately disclosed in his or her return.

Sec. 6661(b)(2)(B).

      Petitioner has not attempted to show that there is substan-

tial authority for the items contributing to the understatement

at issue or that the facts establishing the tax treatment of

those items were adequately disclosed.   His only position is that

he did not have an understatement for 1986 because he obtained

the funds that he transferred to C & I during that year from

third parties as loans, and, consequently, those funds are not

income to him.

      On the record before us, we have found that, except for

$23,800, petitioner has failed to establish error in respondent's

determination in the notice, as reduced by her concession on

brief, that he has unreported income for 1986.   On that record,

we further find that, except for $29,05313 of the understatement

determined in the notice with respect to which respondent deter-

mined the addition to tax under section 6661(a), petitioner has


 13
    This amount is the total of (1) $23,800 that petitioner
showed that he received from a nontaxable source during 1986 and
(2) $5,253 that respondent concedes on brief should reduce the
amount of unreported income for 1986 that she determined in the
notice pursuant to the cash expenditures method.
                             - 17 -

failed to show error in respondent's determination in the notice

that he is liable for 1986 for that addition to tax.

     To reflect the foregoing and the concessions by the parties,



                              Decision will be entered

                         under Rule 155.
