                  T.C. Memo. 1998-187



                UNITED STATES TAX COURT



      ANTHONY AND GLORIA DONNORA, Petitioners v.
     COMMISSIONER OF INTERNAL REVENUE, Respondent



Docket No. 9470-97.                       Filed May 21, 1998.



     R determined deficiencies and fraud additions to tax
against H and W for 1988, 1989, and 1990. R’s answer
asserts in par. 7 affirmative allegations of fraud against
both H and W. R’s answer also asserts in par. 8 information
regarding H’s conviction under sec. 7201, I.R.C. 1986, for
1988, 1989, and 1990, and contends that H is collaterally
estopped to deny civil tax fraud for these years. Ps’ reply
responds to par. 8 (collateral estoppel) of R’s answer but
ignores par. 7. Under Rule 37(c) of the Tax Court Rules of
Practice & Procedure, the affirmative allegations in par. 7
are deemed admitted. R filed a motion for summary judgment
on the entire case based on H’s convictions and the par. 7
assertions deemed admitted. Ps moved for leave to file an
amended reply in order to deny certain of the overlooked
affirmative allegations in R’s answer. R concedes that if
we grant Ps’ motion for leave to file an amended reply, then
R is not entitled to summary judgment, but contends that we
should grant partial summary judgment as to H, because H is
collaterally estopped by his criminal convictions from
                                 - 2 -


     denying that (1) H had an underpayment of tax for each of
     the years in issue and (2) this underpayment was due to
     fraud.

          1. Held: Ps’ motion for leave to file an amended reply
     will be granted. Rule 41(a) of the Tax Court Rules of
     Practice & Procedure.

          2. Held, further, H is collaterally estopped from
     denying that (1) H had an underpayment of tax for each year
     in issue and (2) this underpayment was due to fraud. R’s
     summary judgment motion will be granted to the extent of
     this collateral estoppel; in all other respects, R’s summary
     judgment motion will be denied. Rule 121 of the Tax Court
     Rules of Practice & Procedure.


     Moshe Schuldinger, for petitioners.

     Alan R. Peregoy, for respondent.



                          MEMORANDUM OPINION


     CHABOT, Judge:     The instant case is before us on

petitioners’ motion under Rule 411 for leave to file an amended

reply and on respondent’s motion under Rule 121 for summary

judgment.

Background--Procedure

     1. Notice of Deficiency; Petition

     Respondent determined deficiencies in Federal individual

income tax and additions to tax under sections 6653(b)(1)2

     1
          Unless indicated otherwise, all Rule References are to
the Tax Court Rules of Practice and Procedure.
     2
            Unless indicated otherwise, all section references are
                                                     (continued...)
                                 - 3 -


(fraud), 6661 (substantial understatement of tax liability), and

6663 (fraud) against petitioners as follows:

                                     Additions to Tax
Year       Deficiency   Sec. 6653(b)(1)    Sec. 6661    Sec. 6663

1988         $9,090        $6,818          $2,273
1989         20,791                                     $15,593
1990         31,436                                      23,577

       Petitioners Anthony and Gloria Donnora, hereinafter

sometimes referred to as Anthony and Gloria, respectively,

invoked this Court’s jurisdiction by filing a timely petition

from the notice of deficiency, disputing the entire amounts of

the deficiencies and additions to tax.

       2.    Answer

       Respondent filed an answer to the petition, including

specific allegations with regard to the fraud determinations.       In

paragraph 7 of the answer respondent alleges among other things

that both Anthony and Gloria (1) failed to deposit substantial

amounts of the cash receipts of Forkston Fireworks Mfg. Co.,

Inc., hereinafter sometimes referred to as Forkston, into

Forkston’s bank account, (2) used the undeposited cash receipts

for personal expenses, and (3) failed to inform their accountant

of the undeposited Forkston cash receipts.    Further, in paragraph

7 respondent alleges that petitioners’ extensive use of cash and


       2
      (...continued)
to sections of the Internal Revenue Code of 1986 as in effect for
the years in issue.
                                  - 4 -


diversion of large amounts of Forkston’s cash receipts for their

personal use was fraudulent with intent to evade tax.    Further,

in paragraph 7 respondent alleges that, as a result of

petitioners’ diversion of part of Forkston’s cash receipts to

their personal use, petitioners understated their taxable income

and their tax liabilities by the amounts shown in table 1.

                                 Table 1

                       Understatement of       Understatement of
          Year           Taxable Income          Tax Liability

          1988             $43,114                   $9,090
          1989              82,582                   20,791
          1990             112,934                   31,436

These are the same amounts as those in the notice of deficiency.

In paragraph 7 respondent also alleges that Anthony was convicted

under section 7206(2)3 for aiding and assisting in the filing of

false income tax returns for Forkston for 1988, 1989, and 1990.



     3
          SEC. 7206.   FRAUD AND FALSE STATEMENTS.

          Any person who--

          *      *     *     *       *     *   *

               (2) Aid or assistance.--Willfully aids or assists
          in, or procures, counsels, or advises the preparation
          or presentation under, or in connection with any matter
          arising under, the internal revenue laws, of a return,
          affidavit, claim, or other document, which is
          fraudulent or is false as to any material matter,
          whether or not such falsity or fraud is with the
          knowledge or consent of the person authorized or
          required to present such return, affidavit, claim, or
          document;
                                - 5 -


     In paragraph 8 respondent alleges that Anthony was convicted

under section 72014, criminal tax fraud, for his 1988, 1989, and

1990 joint tax returns, and that, as a result, Anthony is

estopped to deny civil fraud as to 1988, 1989, and 1990.

Paragraph 7 of the answer is three pages long; paragraph 8 is six

pages long.

     3.   Reply

     Petitioners filed a reply admitting that Anthony had been

convicted of criminal tax fraud as to their 1988, 1989, and 1990

joint tax returns, but denying the estoppel subparagraphs of

paragraph 8, as follows:

          8(h)-(i). Denies that the respondent [sic] is
     liable for the additions to the tax imposed by I.R.C.
     § 6653(b)(1) for 1988, and by I.R.C. § 6663 for 1989
     and 1990 as determined by respondent on the statutory
     notice of deficiency, for the reason that the
     respondent [sic] is not liable for tax for the years in
     issue to which such penalties would attach.

     The reply failed to admit or deny any of the allegations in

paragraph 7 of the answer.

     4.   Rule 37(c); Motions



     4
           SEC. 7201.   ATTEMPT TO EVADE OR DEFEAT TAX.

          Any person who willfully attempts in any manner to
     evade or defeat any tax imposed by this title or the payment
     thereof shall, in addition to other penalties provided by
     law, be guilty of a felony and, upon conviction thereof,
     shall be fined not more than $100,000 ($500,000 in the case
     of a corporation), or imprisoned not more than 5 years, or
     both, together with the costs of prosecution.
                               - 6 -


     About 3 weeks after the reply was filed, the instant case

was noticed for trial.   Under Rule 37(c),5 if a reply is filed,

then affirmative allegations in the answer that are not expressly

denied are deemed admitted.   About 7 weeks after the instant case

was noticed for trial, respondent filed a Motion for Summary

Judgment based on the deemed admissions.6   Petitioners filed a

Motion for Leave to File an Amended Reply and a response to

respondent’s summary judgment motion.

     Petitioners concede that Anthony is collaterally estopped

from denying liability for fraud additions to tax, but contend

that Anthony is not estopped from contesting the amounts of the

     5
          Rule 37(c) provides, in pertinent part, as follows:

                          RULE 37. REPLY

             *     *      *     *      *    *     *

          (c) Effect of Reply or Failure Thereof: Where a
     reply is filed, every affirmative allegation set out in
     the answer and not expressly admitted or denied in the
     reply shall be deemed to be admitted. Where a reply is
     not filed, the affirmative allegations in the answer
     will be deemed denied unless the Commissioner, within
     45 days after expiration of the time for filing the
     reply, files a motion that specified allegations in the
     answer be deemed admitted. * * *
     6
          In this motion, respondent states that respondent
determined in the notice of deficiency that there was a
“substantial understatement addition to tax of $6,818.00 for the
tax year ended December 31, 1988.” In the notice of deficiency
respondent actually determined the amount of this addition to tax
is $2,273, about 25 percent of the determined deficiency of
$9,090. We regard respondent’s statement on motion to be a
typographical error and not a claim under sec. 6214(a) for an
increased deficiency or for an increased addition to tax.
                                 - 7 -


deficiencies, and thus the amounts of the fraud additions to tax.

Respondent concedes that if the Court grants petitioners’ amended

reply motion, then summary judgment is not proper, but contends

that respondent will be entitled to partial summary judgment that

Anthony is collaterally estopped to deny that (1) he is liable

for fraud additions to tax and (2) there are underpayments of tax

on his joint tax returns for 1988, 1989, and 1990.

     Our findings are based entirely on those matters that are

admitted in the pleadings or that are admitted or deemed admitted

in the motion papers in the instant case.

Background--Facts

     Anthony and Gloria are husband and wife; they were residents

of Mehoopany, Pennsylvania, when the petition was filed in the

instant case.   During the years in issue, petitioners were

shareholders7 and employees of Forkston.    Forkston was engaged in

the business of selling fireworks to the public.

     Anthony was indicted and tried for criminal tax fraud under

section 7201, and for aiding or assisting the filing of false tax

returns under section 7206(2).    The criminal tax fraud charges

were as to petitioners’ 1988, 1989, and 1990 joint tax returns.

The false tax return charges were as to Forkston’s 1988, 1989,




     7
          The parties’ pleadings do not indicate the percentages
of Forkston that Anthony and Gloria each owned.
                               - 8 -


and 1990 tax returns.   A jury convicted Anthony of all these

section 7201 and 7206(2) charges.

Discussion

     1.   Rule 41(a)--Amended Reply

     Rule 41(a)8 provides that after a case has been noticed for

trial, a party may amend a reply only by leave of Court or by

written consent of the adverse party, and “leave shall be given

freely when justice so requires.”     In the instant case respondent

has not consented to petitioners’ proposed amended reply.

     Petitioners contend that justice requires the Court to allow

the proposed amended reply because petitioners inadvertently

failed to deny the affirmative allegations in paragraph 7 of the

answer, and petitioners should be permitted to litigate the

amount of their tax liabilities.

     Respondent contends that respondent’s counsel had drawn

petitioners’ counsel’s attention to Rule 37 and the desirability


     8
           Rule 41(a) provides, in pertinent part, as follows:

     RULE 41.   AMENDED AND SUPPLEMENTAL PLEADINGS

           (a) Amendments: A party may amend a pleading once
     as a matter of course at any time before a responsive
     pleading is served. If the pleading is one to which no
     responsive pleading is permitted and the case has not
     been placed on a trial calendar, then a party may so
     amend it at any time within 30 days after it is served.
     Otherwise a party may amend a pleading only by leave of
     Court or by written consent of the adverse party, and
     leave shall be given freely when justice so requires.
     * * *
                                - 9 -


of petitioners’ responding to the affirmative allegations of

fraud in the answer, and that this was only 4 days before the

reply was filed.    Respondent argues from this that petitioners’

failure to deny the affirmative allegations was not an

inadvertent mistake.   Respondent also asserts that, if

petitioners are allowed to amend their reply, and if the Court

then denies respondent’s summary judgment motion, then discovery

will be required.   Respondent argues that so little time remained

for discovery before the then-impending trial date that

respondent will be prejudiced if petitioners are allowed to amend

their reply.

     We agree with petitioners that they should be allowed to

file an amended reply.

     The first three sentences of Rule 41(a), set forth supra

note 8, “are derived from FRCP 15(a), and reflect a liberal

attitude toward amendment of pleadings.”   Explanatory Note to

Rule 41(a), 60 T.C. 1089.   This Court has looked to cases decided

under rule 15(a) of the Federal Rules of Civil Procedure for

guidance on the interpretation of Rule 41(a).    Kramer v.

Commissioner, 89 T.C. 1081, 1084-1085 (1987).    Rule 15(a) of the

Federal Rules of Civil Procedure also states that leave to amend

“shall be freely given when justice so requires.”   Rule 15(a) of

the Federal Rules of Civil Procedure reflects a generous attitude

toward amendment; however, the leave petitioners seek is not a
                               - 10 -


matter of right but is within the discretion of the Court.

Zenith Radio Corp. v. Hazeltine Research, 401 U.S. 321, 330-333

(1971); Foman v. Davis, 371 U.S. 178, 182 (1962); Kramer v.

Commissioner, 89 T.C. at 1085; Law v. Commissioner, 84 T.C. 985,

990 (1985).   The trial court’s ruling on this matter will not be

reversed unless the trial court abuses its discretion.     Wood v.

Santa Barbara Chamber of Commerce, Inc., 705 F.2d 1515, 1520 (9th

Cir. 1983); Law v. Commissioner, 84 T.C. at 990.

     Denials of motions for leave to amend are generally based on

undue delay, and the possibility of bad faith.     Wood v. Santa

Barbara Chamber of Commerce, Inc., 705 F.2d at 1520; Kramer v.

Commissioner, 89 T.C. at 1085; see Charpentier v. Godsil, 937

F.2d 859, 863-864 (3d Cir. 1991).   In determining the justice of

a proposed amendment, we must examine the particular

circumstances in the case before us, for the exercise of

discretion “`may never be arbitrary and must be controlled by

sound reason and fairness.’”   Law v. Commissioner, 84 T.C. at 990

quoting California Brewing Association v. Commissioner, 43 B.T.A.

721, 725 (1941).

     Petitioners’ counsel should have seen paragraph 7 in the

answer.   Although paragraph 8 is twice as long as paragraph 7,

paragraph 7 covers all the income adjustments and applies to both

petitioners, while paragraph 8 covers collateral estoppel as to

only Anthony and only as to one issue.   If paragraph 7 is
                              - 11 -


ignored, then paragraph 8 hardly matters.    Thus it is clear that,

if a reply was to be filed at all (see second sentence of Rule

37(c), supra note 5), then paragraph 7 must be dealt with.     Yet,

petitioners’ counsel filed a reply that dealt with paragraph 8 in

some detail, but ignored paragraph 7.

     Respondent does not suggest that petitioners or their

counsel had any improper purpose in ignoring paragraph 7.    We do

not discern from the record any improper purpose.   We conclude

that petitioners’ failure to deny the affirmative allegations in

paragraph 7 of the answer was inadvertent.

     Because of the critical role these paragraph 7 allegations

play in the instant case, as emphatically shown by respondent’s

motion for summary judgment based largely on these allegations,

justice would be served by allowing petitioners to deny the

paragraph 7 allegations, or some of them, unless such denial

would be unduly prejudicial to respondent.

     In the instant case, petitioners’ proposed amendment seeks

to deny important allegations stated in respondent’s answer and

deemed admitted by petitioners’ failure to deny the allegations

in petitioners’ reply.   A pleading may be amended to withdraw a

previous admission where the other party is not prejudiced.    See

also Beeck v. Aquaslide “N” Dive Corp., 562 F.2d 537, 540 (8th

Cir. 1977) (“The burden is on the party opposing the amendment to
                                - 12 -


show such prejudice.”); cf. Kramer v. Commissioner, 89 T.C. at

1086.

     Respondent contends that due to the then-impending trial

date respondent would be prejudiced if petitioners are allowed to

amend their reply.    However, the instant case was stricken from

the then-impending trial session.    Both sides will have an

adequate opportunity to do the necessary informal consultation

and, if appropriate, formal discovery before the instant case is

tried.     We conclude that respondent will not be unduly prejudiced

by this Court’s allowing petitioners to amend their reply.

     Accordingly, we conclude that petitioners will be allowed to

amend their reply to deny respondent’s affirmative allegations.

     We hold for petitioners on this issue.

     2.    Rule 121--Summary Judgment

     The    parties appear to be essentially in agreement about the

application of collateral estoppel and summary judgment in light

of our conclusion that petitioners are to be permitted to amend

their reply, and so it is not necessary to discuss in detail the

operation of these doctrines.

     Because of his conviction of criminal tax fraud under

section 7201 for each of the years 1988, 1989, and 1990, Anthony

is estopped to deny that he committed civil tax fraud for 1988

(within the meaning of sec. 6653(b)) and for 1989 and 1990
                               - 13 -


(within the meaning of sec. 6663).      E.g., Amos v. Commissioner,

43 T.C. 50, 55 (1964), affd. 360 F.2d 358 (4th Cir. 1965).

     Respondent contends that partial summary judgment should

also be granted because Anthony is collaterally estopped from

denying that there is an underpayment of his joint tax liability

for 1988, 1989, and 1990.   The underpayment need not be addressed

separately, because under section 6653(b) for 1988 and section

6663 for 1989 and 1990 the existence of an underpayment is an

element of fraud.

     Both sides recognize that Anthony is permitted to litigate

the amount of the underpayment.   Also, based on the materials

thus far submitted, it does not appear that Gloria is estopped

from disputing any matter that relates to her liability in the

instant case, including (if it turns out to be relevant)

Anthony’s fraud.    Moore v. United States, 360 F.2d 353, 357-358

(4th Cir. 1966); Rodney v. Commissioner, 53 T.C. 287, 306-311

(1969).

     Respondent also contends that partial summary judgment

should be granted to collaterally estop Anthony from denying that

there was a willful omission of income on Forkston’s income tax

return.   This contention is raised for the first time in

respondent’s Reply to Petitioners’ Response to Respondent’s

Motion for Summary Judgment.   The collateral estoppel portion of

respondent’s answer (par. 8) did not refer to any conviction of
                                - 14 -


Anthony relating to section 7206(2).     Respondent’s initial

summary judgment motion papers did not refer to any conviction of

Anthony relating to section 7206(2) in connection with any

collateral estoppel argument.    We will not allow this expansion

of respondent’s contentions at this stage of the proceedings.     If

this issue is relevant to the instant case (see Meier v.

Commissioner, 91 T.C. 273, 283-286 (1988); Wright v.

Commissioner, 84 T.C. 636, 643-644 (1985)), then it will have to

be presented at an appropriate time, when petitioners will have a

practical opportunity to respond.    A related motion in a

companion case is discussed in our opinion in Forkston Fireworks

Mfg. Co.   v. Commissioner, T.C. Memo. 1998-188.

     Accordingly, we conclude that respondent is entitled to

partial summary judgment that Anthony is estopped to deny that he

committed civil tax fraud for each of the years 1988, 1989, and

1990.   In all other respects, respondent’s summary judgment

motion will be denied.



                                     An appropriate order will be

                                issued granting petitioners’ motion

                                for leave to amend their reply.

                                     An appropriate order will be

                                issued granting respondent’s motion

                                for summary judgment, but only to
- 15 -


the extent described hereinabove,

and denying respondent’s motion for

summary judgment in all other

respects.
