                               T.C. Memo. 2013-21



                         UNITED STATES TAX COURT



                    OWEN G. FIORE, Petitioner v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 12790-07.                          Filed January 17, 2013.



      Owen G. Fiore, pro se.

      Andrew R. Moore, John M. Wall, and Michael Skeen, for respondent.



            MEMORANDUM FINDINGS OF FACT AND OPINION


      HOLMES, Judge: Owen Fiore was a tax lawyer with a small but prominent

practice. He went to prison for evasion of his 1999 taxes--he admitted to fraud--

but the Commissioner now claims he can prove Fiore filed fraudulent 1996 and
                                         -2-

[*2] 1997 returns. The parties agree on the deficiencies and dispute only the

existence of fraud.

                               FINDINGS OF FACT

A.    Fiore’s Rise in the Legal Profession

      Fiore graduated from Loyola University of Los Angeles (now Loyola

Marymount University) in June 1956 with an accounting degree. He enrolled in the

University’s law school that summer. After a short stint preparing income tax

returns at Ernst & Ernst (now Ernst & Young), he was ordered to active duty with

the U.S. Air Force in fall 1956. He trained to be an auditor in Texas, and then

returned to Los Angeles to work for the Air Force Auditor General and worked

there until he finished law school in 1961.

      Fiore started his legal career at the Los Angeles firm of Kindel & Anderson

in 1961. The firm elected him to partnership in 1966, and his practice came to

focus on estate planning. He moved to another L.A. firm--Agnew, Miller &

Carlson--in 1969 and remained there until 1982, when he moved to Northern

California and joined Hopkins, Mitchell & Carley. In 1987 he formed a new law

partnership with Robert Hales. As he moved from firm to firm, his clients

followed. He became well known in his field, and as the decades flowed by he

gained national prominence, speaking at numerous conferences across the country
                                          -3-

[*3] and, more importantly to his partners, he made it rain--bringing in substantial

business for every firm he worked for. He rarely appeared at the office, and his

days were a whirl of client meetings and conferences. Administrative details and

accounting were someone else’s problem--that is, until he dissolved his partnership

with Hales to form a solo practice in 1988. He hired Pat Sadler as his legal

secretary. Fiore describes her as “my gal Friday”--a loyal, long-term employee who

did her best to administer the firm effectively. She answered the phone, opened the

mail, made appointments with Fiore’s clients, took dictation and--this will be

important--made bank deposits. She did not, however, have the time or expertise to

handle the firm’s accounting. She also wasn’t much of a “computer person” and

failed to take advantage of the software that could improve firm recordkeeping. But

the new firm prospered, and Fiore hired two associate attorneys--John Ramsbacher

and Leslie Daniels.

B.    Accounting at the Fiore Law Group

      Fiore himself took on the responsibility for his firm’s accounting. But he

neglected that responsibility, choosing at every opportunity to focus on client

development, marketing, and the sophisticated pleasure of solving his clients’

complex problems.
                                          -4-

[*4] His sophistication did not extend to his management of the firm’s finances.

Fiore came to rely on a three-checkbook method of accounting--one for the general

account, one for the client trust fund,1 and one for minor expenses such as filing

fees. The preponderant flow of dollars was thus through the general account.

Client billings went into the general account; payroll, office rent, and the firm’s

other expenses came out of that account. Fiore even handled payroll in a way that

would have been familiar to lawyers of a hundred years before--writing out checks

to each associate and employee by hand on paydays. At the end of each year, he

would write out a W-2 for each employee by hand.

      Fiore gave only himself access to the general account. Only he was allowed

to open the general-account bank statements, even though he often failed to do so.

(We find this otherwise unbelievable finding true because the IRS revenue agent

conducting the audit of Fiore’s returns received several unopened bank statements in

response to his request for documents.)




      1
         California law requires that attorneys maintain a client trust-fund account.
Retainers remain in the account until earned. Any interest earned is taken by the
State to pay for legal services to the indigent. Cal. Bus. & Prof. Code sec. 6211
(West 2003 & 2013 Supp.). Because Fiore rarely obtained retainers--he preferred
to bill clients after work was complete--the client trust fund had very little money in
it.
                                          -5-

[*5] Fiore did use legal billing software known as the Tussman Program. The

Tussman Program can track billable hours, generate bills, and produce financial

reports--but Fiore failed to use all, or even much, of its potential. Fiore and his

associates did enter their billable hours into the program, and Sadler did print out

computer-generated bills to send to clients each month. But Fiore adjusted the

computer-generated bills--sometimes billing more and sometimes less--before

sending them out. He took the time to write a letter with each bill to explain what

work was done; he didn’t take the time to update the program’s database to reflect

what was actually billed after adjustments. This meant that the firm’s computer

records did not reflect the amounts actually billed to clients. But it was the

program’s financial-reporting feature that was left most spectacularly underused.

Bills were mailed out to the clients, and the clients would send checks to Fiore.

Sadler would then deposit the checks into the general account. But she kept track

of the deposits in a WordPerfect document on her computer--listing the client

name, client number, and amount of payment. She would then put a copy of the bill

and deposit slip in a three-ring binder, organized alphabetically by client. Each

year, she or another employee would set up a new three-ring binder, often with

the help of temporary file clerks. Sadler never used the binders to add up the
                                          -6-

[*6] annual fees and never used them for financial reports with the Tussman

Program--she didn’t know how.

      And she never added up the annual deposits from the general-account bank

statements.

C.    The Road to Prison

      By the end of the century, Fiore’s practice was flourishing. But in 1995 his

personal expenses started to swell: He paid $150,000 to settle a malpractice claim,

and $85,000 in cash for a cabin in Idaho. (He was still a resident of Idaho when he

filed his Tax Court petition years later.) He sold his principal residence in Portola

Valley that same year and moved to a home he owned in Sea Ranch--150 miles

from the San Jose office. He had a mortgage, and of course a tax bill for that house,

but instead of enduring epic commutes every day, he rented an apartment closer to

his office for more than $2,000 a month. And flashing on the horizon was the

prospect of retirement.

      The storm broke in 1996, when the Commissioner began an audit of Fiore’s

1993-95 tax returns. Revenue Agent Lila Wong--a relatively recent IRS hire--

asked Fiore for an appointment in June 1996; the meeting didn’t happen until

October. Fiore brought only handwritten deposit records to that first meeting.

Wong asked Fiore to try again, and this time to bring bank records and
                                           -7-

[*7] substantiation for his business expenses. Fiore brought only payroll records

and a calendar, but no bank records or other documents to substantiate income and

expenses. Wong was new, but not newborn, and pressed Fiore again and again.

Fiore promised to get his bank statements together and reconstruct his business

expenses by January 1997, but ended up canceling that meeting--he said he had

hired a CPA to handle the audit. But he never provided any power of attorney to

Agent Wong, so she couldn’t discuss the audit with anyone other than Fiore. She

wanted to move the audit along, but here her inexperience showed, and she skipped

a critical step for an audit like this one: She did not try to verify Fiore’s income.

She did not conduct (or arrange for) a bank-deposits analysis, but closed the audit

after denying the business-expense deductions for lack of substantiation. The

Commissioner sent Fiore a notice of deficiency for more than $1.2 million in

September 1997. Fiore settled in 1999 for roughly $200,000.

      Fiore did not let the audit swamp him. He continued to bring in clients, and

he began buying up Idaho real estate. He bought five lots near his cabin for

$100,000 cash in 1997. He bought a log house for $200,000 and built a $150,000

barn--with $75,000 down and financing for the rest--in 1998. He wrote--tellingly--

in a letter asking for a loan that his firm “generates over 1.5 million in legal fees

each year.” We can also be sure he had a reasonable notion of his income from
                                         -8-

[*8] other evidence, especially his talks in 1999 with Ramsbacher--one of the

associates he had hired--when he decided to promote the younger man to partner.

In early 1999 Fiore laid out discussion points for the proposed partnership in a

memo. He wrote that “we will continue to be able to develop monthly fees in

excess of $100,000 per month (1998 results, over $1.5 million in gross receipts).”

He emphasized his plans to transition to a “less active role in the firm” by 2002. To

back up his firm-income estimates, Fiore had a staff member produce a Tussman-

generated report for Ramsbacher’s review in January 1999. The report showed over

$1.5 million in income for 1998. In the course of the partnership discussions,

Ramsbacher expressed his concerns about the shipwreck that was the firm’s

bookkeeping. Fiore agreed to allow Ramsbacher to clean it up if he were made

partner.

      In July 1999 Ramsbacher and Fiore agreed to form a partnership.

Ramsbacher took immediate steps to put the firm’s affairs in order. He started out

by hiring Paychex to handle payroll. Then he tried to use Quickbooks for firm

accounting, only to discover that he wasn’t a “computer person” either. But he at

least recognized his shortcoming and hired someone to run Quickbooks for the

firm. He also dealt with any staff issues and oversaw the day-to-day management
                                          -9-

[*9] of the firm. This arrangement actually seemed to work. It allowed Fiore to do

what he did best--bring in the business--while Ramsbacher took care of the rest.

        The firm looked steady, but Fiore had not tied down his administrative

problems after his first close call with the IRS. In the years immediately before

Ramsbacher took over the accounting--1996 through 1999--Fiore did not report all

his taxable income on his returns:

               Actual income         Reported income         Unreported income
 1996             $476,923               197,225                   279,698
 1997              572,291               215,750                   356,541
 1998              534,851               192,069                   342,782
 1999              572,108                57,442                   514,666

        This time the IRS caught on. Verna Scott was the revenue agent that the

Commissioner assigned to audit Fiore’s 1998 return. She had years of experience

in bookkeeping and business before going to the IRS, and with her more

experienced eye immediately spotted something unusual about Fiore’s return: His

reported expenses were mostly rounded to the nearest hundred. She wrote Fiore to

ask for his 1997 and 1999 returns, and for the firm’s payroll reports, bank

statements, books and records, and substantiation for business expenses. She set a
                                           -10-

[*10] date for their first meeting and gave Fiore a deadline to call if he needed to

reschedule. Fiore hewed to the same tack he had in the earlier audit, and said he

needed to reschedule. He explained that he was in Idaho and would call her back in

mid-July when he returned to his office in California. He never called Scott back,

so she called his office in late July to learn that he had been in the office earlier that

month, but had returned to Idaho. She was persistent, and asked the firm to call him

in Idaho and tell him to call her. Fiore did call her, but said he didn’t know when

they could meet, but that he would send documents by August 15. He instead sent

her--after August 15--his 1997 and 1999 returns, the firm’s 1998 payroll reports,

and a handwritten list of checks. He did not send the other documents she had

asked for and that he had promised to give.

       Scott tried again. She set a meeting for September 22 and asked him again

to bring the rest of the documents. Fiore brought 1998 bank statements for the

general law-firm account--except for July’s. Scott did a bank-deposits analysis

and discovered that the deposits were “quite a bit higher” than the reported

income, even using only 11 months of statements. When asked why this was the

case, Fiore was less than forthright. He claimed that the excess deposits were

attributable to transfers and nontaxable deposits. They weren’t. Scott then asked

Fiore how he calculated his law-firm income, and he replied that he used a
                                        -11-

[*11] spreadsheet--which he never provided. As for business expenses, the

handwritten check register Fiore provided previously didn’t match most of his

expenses. He brought an Amex year-end summary to the meeting, but it didn’t have

enough information for Scott to verify the deductibility of the expenses he claimed.

      Fiore had sailed into a maelstrom. Scott scheduled another meeting for

October 5. Fiore asked to reschedule. Scott agreed. Fiore called to reschedule for

October 30, and then called to reschedule again. Scott issued a summons for

Fiore’s bank records. She got them and determined that Fiore had failed to report

over $300,000 in income for 1998. She told him of her findings and opened an audit

of his 1999 tax year. Out went an information document request for 1999. Fiore

didn’t respond. Out went a summons for his 1999 bank records. In came a bank-

deposits analysis, and Scott again discovered a substantial amount of unreported

income.

      This was too much. Scott decided to refer the case to the Criminal

Investigation Division of the IRS to determine whether there was fraud. Special

Agent Lisa Sasso took over the investigation. She started by requesting copies of

Fiore’s 1996 and 1997 tax returns from IRS Service Center--but they were missing

the Schedules C. Unlike the civil agents, Sasso didn’t ask for meetings--she just
                                        -12-

[*12] showed up unannounced at Fiore’s office in March 2002. She read Fiore his

rights and asked him questions about his billing procedures, books and records, and

business expenses. After her initial visit, she requested documents for the 1996 and

1997 tax years. Fiore sent her some documentation, but didn’t cough up any work

papers to tie his information to his return. So Sasso sent a summons to Fiore’s bank

and then she did a bank-deposits analysis for 1996 and 1997. She determined that

he had failed to report taxable income for those years, but chose to exclude Fiore’s

possible inflation of his business expenses from her case against him. She

explained:

      [I]t’s a lot more difficult to prove in a criminal case expense items on
      the tax return, especially if the taxpayer doesn’t know or have books
      and records to show where he determined the numbers came from. So
      what I would have had to do is recreate all his books and records in
      order to determine the numbers on the tax return. * * * So I was trying
      to find specific expenses and show [a] pattern. But it was too difficult
      to do that for a criminal case and the burden of proof, so we just went
      with the income.

      The bottom was now in sight. In November 2003, a grand jury indicted

Fiore on four counts of tax evasion, one for each year from 1996 through 1999.

He pled guilty only to the count arising from the 1999 tax year--and admitted to

“knowingly and willfully understat[ing] the business receipts” for that year. In

exchange, the government dropped the charges for 1996-98. He agreed, however,
                                         -13-

[*13] that the 1996-98 understatements were “relevant conduct” for the purposes of

sentencing. He also agreed to pay restitution for the underpayments from 1996-99.

On the other hand, in his plea agreement he preserved his right to contest civil IRS

penalties:

      Though I have agreed to an amount of restitution and tax loss amount
      as part of the agreed-upon disposition of this case, I agree that this
      agreement with respect to restitution and tax loss amount does not bar
      the Internal Revenue Service from making a civil determination with
      respect to additional taxes, interest and penalties for which I may be
      liable, nor will it bar me from civilly contesting any liabilities as
      determined by the Internal Revenue Service including asserting the
      statute of limitations as a bar to liability.

At his 2005 sentencing hearing, Fiore emphasized that his 1999 guilty plea didn’t

apply to 1996-98:

      I recognize that I brought this on myself relating to one year, 1999. I
      deny strongly as I can in this situation that the prior years, other than
      being relevant conduct for purposes of determining apparently the so-
      called tax loss, which I’ve fully paid, that the prior years have anything
      to do with or anywhere near the same conduct that I pled guilty to.

Fiore was sentenced to 18 months in the federal prison at Lompoc, California. He

was released in October 2006. He is no longer a member of the bar.

D.    Civil Penalties

      After closing out the criminal case, the IRS got back to work on Fiore’s civil

tax liability. Scott had never opened an examination of the years at issue in
                                         -14-

[*14] this case--1996 and 1997. She thought that she couldn’t open the 1996 tax

year because the statute of limitations had expired. And by the time she got through

the 1998 audit, she thought that she would have trouble completing an audit of the

1997 tax year before the statute of limitations expired for it as well. After

consulting with her manager, she decided not to audit the 1997 return. But Fiore’s

guilty plea made the Commissioner think he had a way back to those years.

Revenue Agent Charles Tonna helped put together the notice of deficiency. He

explained at trial:

       Well, primarily, of course, was the fact that Mr. Fiore had actually pled
       guilty to tax evasion in regards to the last year, 1999, and I reviewed,
       of course, his plea agreement, which gave details on what he admitted
       as to how he had committed that crime, and since the facts were pretty
       much the same in the earlier three years, I relied partially on the plea
       agreement to establish that he had the same fact pattern in the first
       three years as well. * * * [T]he plea agreement was the primary or the
       most important factor in determining that fraud applied.

In addition to tax evasion in a year not at issue, he looked to the loan application

disclosing $1.5 million in annual receipts from 1998. And he cited the 1993-95

deficiencies, Fiore’s pattern of undereporting income, and Fiore’s perhaps

intentional failure to use his computer program’s full capabilities as other factors

showing fraud.
                                         -15-

[*15] Tonna mailed out a notice of deficiency in March 2007. It determined

deficiencies in tax and the fraud penalty for 1996-99. During pretrial preparation

Fiore conceded the underpayments for all four years and the fraud penalty for 1998

and 1999. But he contests the fraud penalty for 1996 and 1997.

                                     OPINION

      Section 66632 imposes a penalty equal to 75% of an underpayment that is

attributable to fraud. The Commissioner has the burden of proving fraud, and he

can meet it only with clear and convincing evidence that the taxpayer underpaid and

that the underpayment was attributable to fraud. Sec. 7454(a); Tax Court Rule

142(b). If the Commissioner succeeds in proving that even part of the

underpayment is due to fraud, “the entire underpayment shall be treated as

attributable to fraud, except with respect to any portion of the underpayment which

the taxpayer establishes (by a preponderance of the evidence) is not attributable to

fraud.” Sec. 6663(b). Fraud also extends the statute of limitations on assessment

indefinitely. Sec. 6501(c)(1).

      Fraud is the “willful attempt to evade tax,” and we make that determination

by looking at the entire record of a case. Beaver v. Commissioner, 55 T.C. 85, 92


      2
      Unless otherwise indicated, all section references are to the Internal
Revenue Code in effect for the years in issue.
                                         -16-

[*16] (1970). Did Fiore commit tax fraud in 1996 and 1997? Or, more precisely,

did the Commissioner establish by clear and convincing evidence that Fiore willfully

attempted to evade tax in 1996 and 1997? There are many factors which can

indicate fraud, including:

      • understatement of income,

      • inadequate records,

      • concealing assets,

      • failure to cooperate with tax authorities,

      • mischaracterizing the source of income, and

      • implausible or inconsistent explanations of behavior.

See Spies v. United States, 317 U.S. 492, 499 (1943); Bradford v. Commissioner,

796 F.2d 303, 307-08 (9th Cir. 1986), aff’g T.C. Memo. 1984-601; Meier v.

Commissioner, 91 T.C. 273, 297-98 (1988). We won’t find fraud where the

circumstances merely lead to a suspicion of fraud. Parks v. Commissioner, 94 T.C.

654, 664 (1990). But we may use circumstantial evidence--including Fiore’s entire

course of conduct. See id.

      With these background principles in mind, we look at the factors that the

Commissioner and Fiore point us to.
                                         -17-

[*17] Education and business knowledge

      One of the most important, if only because it floats over everything else, is

that Fiore was, until his conviction, a highly respected tax attorney. And he was a

highly respected tax attorney with a solid accounting background as well.

Failure to keep adequate books and records

      This is especially important here, because Fiore’s main defense is that he was

a horrible recordkeeper. The three-checkbook method of accounting, handwritten

employee paychecks, and other misuse of 1970s-era technology clearly show a

failure to keep adequate books and records. And we have often cited bad

recordkeeping as a factor in favor of finding fraud. See, e.g., Robleto v.

Commissioner, T.C. Memo. 2008-195, 2008 WL 3833661, at *10, aff’d, 471 Fed.

Appx. 576 (9th Cir. 2012); Kim v. Commissioner, T.C. Memo. 2000-83, 2000 WL

267777, at *6; Lee v. Commissioner, T.C. Memo. 1995-597, 1995 WL 750122, at

*8. But maybe something else was going on here. Sadler credibly testified

regarding Fiore’s hectic-yet-successful attempts at client development. And Fiore

was accustomed to relying on the support of larger law firms and their well-

organized accounting departments.
                                         -18-

[*18] Failure to cooperate with tax authorities

      If the Commissioner had only chaotic books to offset Fiore’s expertise, we

would not find clear and convincing evidence of fraudulent intent. But the proof of

how Fiore reacted to the civil audits advances the Commissioner’s case. Fiore was

a master of delay during the audits and the criminal investigation, repeatedly

rescheduling meetings and giving up documents only grudgingly or not at all. He

offered implausible explanations about nontaxable deposits and transfers into his

general account. Still, he was constantly traveling to develop business, to set up his

Idaho retirement, and to advise his clients. He shouldn’t have canceled so many

meetings with the IRS, but--though it edges the Commissioner closer to proof of

fraud here--it’s not quite clear and convincing given Fiore’s consistency in poor

recordkeeping.

Pattern of consistent underreporting

      This case is about fraud for two years--1996 and 1997. Much of the

Commissioner’s case is built upon Fiore’s behavior in years other than 1996 or

1997. But a pattern of underreporting in years not at issue does tend to show

fraud. See Ferguson v. Commissioner, T.C. Memo. 2004-90, 2004 WL 605224, at

*15; Plunkett v. Commissioner, T.C. Memo. 1970-274, 1970 Tax Ct. Memo

LEXIS 83, at *25, aff’d, 465 F.2d 299 (7th Cir. 1972). The Commissioner
                                          -19-

[*19] specifically identifies the 1993-95 deficiencies as the start of the pattern of

noncompliance. But there’s a problem with this argument--the 1993-95 deficiencies

were based only on inflated expenses;3 the 1996 and 1997 deficiencies were based

only on unreported income.4 So while there’s some ground for suspicion of fraud,

there wasn’t much of a pattern yet--Fiore wasn’t alerted to the possibility of

unreported income by the earlier deficiencies, because only disallowed expenses

were at issue. And unlike 1993-95, no expenses were disallowed for 1996-97.

      Fiore’s underreporting of his income gained momentum in 1998. The

amount of the deficiency increased and there was written evidence of Fiore’s

knowledge of actual receipts--the loan application and the Tussman printout for

partnership negotiations. And Fiore admitted in a plea agreement to criminal tax

evasion for the 1999 tax year. The Commissioner points to Fiore’s plea agreement

as an admission of fraud for 1996 and 1997. See, e.g., Marretta v. Commissioner,




      3
        The lack of unreported income from 1993-95 may be due to Agent Wong’s
oversight--she failed to perform a bank-deposits analysis. But it’s the
Commissioner’s burden here, and we decline to make any finding that Fiore had
unreported income in 1993-95 when the IRS didn’t look for it.
      4
         As explained in the facts section, the 1996 and 1997 tax years were never
subjected to full audit because of IRS oversight, so there may have been improper
expenses here as well. But we won’t draw inferences in favor of finding fraud when
it’s the Commissioner’s burden.
                                          -20-

[*20] T.C. Memo. 2004-128, 2004 WL 1172873, at *4, aff’d, 168 Fed. Appx. 528

(3d Cir. 2006); Ferguson, 2004 WL 605224, at *16; Price v. Commissioner, T.C.

Memo. 1996-204, 1996 WL 204504, at *5. In those cases, however the taxpayers

got indicted for tax evasion for several years, agreed to plead guilty for the last year,

and then got the other years dismissed. In the plea agreements in those cases, the

taxpayers expressly admitted an intent to evade taxes for all the years of the

indictment, despite being convicted for the last year alone.

      Fiore was shrewder in his negotiation. He anticipated the government’s

strategy and crafted his plea accordingly. He didn’t admit to tax evasion for any

year other than 1999--the year of his conviction. Of course, the lack of an

admission in the plea agreement doesn’t foreclose a finding of fraud--but Fiore’s

plea agreement doesn’t help the Commissioner establish fraud clearly and

convincingly, either. And his 1999 conviction doesn’t clearly establish that his

returns for 1996 or 1997 were fraudulent. See Corson v. Commissioner, T.C.

Memo. 1965-214, 1965 Tax Ct. Memo LEXIS 115, at *18 (“Petitioner’s conviction

for filing false and fraudulent returns for the later years * * * carries no presumption

of fraud as to the earlier years”), aff’d, 369 F.2d 367 (3d Cir. 1966) This factor is

neutral.
                                        -21-

[*21] Willful Blindness

      So far, then, it’s not clear whether Fiore had fraudulent intent. But underlying

all the factors discussed above is another important question--was Fiore willfully

blind to the unreported income?

      Willful blindness is a relatively underdeveloped area of law in Tax Court

jurisprudence--at least in fraud cases. In Fields v. Commissioner, T.C. Memo.

1996-425, 1996 WL 530108, at *14, we mentioned willful blindness. Fields

received advice from his attorney that he should report commission income and

ignored the advice. Id. We reasoned that Fields’s “lack of regard for [his

attorney’s] advice was for the primary purpose of evading taxes.” Id. We added

that, although not necessary to the conclusion,

      fraudulent intent can be found by reasonable inference drawn from
      proof that a taxpayer deliberately closed his or her eyes to what would
      otherwise have been obvious to him or her * * * a trier of fact may
      infer that an individual knew of his or her evasion of tax from his or her
      willful blindness to the existence of that fact.

Id. Fields doesn’t offer much guidance on how to apply the willful blindness

standard to Fiore. Willful blindness wasn’t the focus of the case and was mentioned

only in passing.

      We have addressed willful blindness--without calling it that--in the context of

the failure to use available records in fraud cases. In Cole v. Commissioner,
                                        -22-

[*22] T.C. Memo. 1998-452, 1998 WL 892751, the taxpayer ran a medical practice

that received cash and check payments daily. The business receipts were recorded

daily on “day sheets” and totaled for each day, month, and year by his secretary.

Id., 1998 WL 892751, at *2. They included the patient name, the service provided,

the fee for that service, and whether the patient paid by cash or check. Id. Cole had

access to the day sheets, as well as the business bank statements, but did not use

them in preparing his return. Id. We found fraud based in part upon his failure to

use the business records that were available to him. Id., 1998 WL 892751, at *6.

      And in Spill v. Commissioner, T.C. Memo. 1989-213, 1989 Tax Ct. Memo

LEXIS 213, the taxpayer owned Filly’s Fashions, a clothing store in Brooklyn.5

Filly’s employed a bookkeeper who kept two sets of books. Id., 1989 Tax Ct.

Memo LEXIS, at *4. The first set purported to record daily cash receipts, but

merely recorded what was deposited into the business bank account. Id. The




      5
        Fraud was not the only mischief going on--after a business dispute, a
competitor threatened to “bury” Spill, and Filly’s soon burned to the ground. Spill
v. Commissioner, T.C. Memo. 1989-213, 1989 Tax Ct. Memo LEXIS 213, at *18.
Spill found a new location for his store, but shortly after he moved there, it was
firebombed. Id. We were careful to note that the competitor was killed before the
trial when, after defaulting on a loan from an unregulated segment of the financial
industry, he was killed in an “accident”. See id., 1989 Tax Ct. Memo LEXIS, at
*18 n.6. (Brooklyn was apparently rough before it became hip.)
                                         -23-

[*23] second set of books included a record of all daily sales--including amounts

diverted elsewhere. Id. We reasoned that “fraud is evidenced by the fact that

petitioners kept a record of daily sales which they did not use in preparing their

returns.” Id. at *17.

      Willful-blindness fraud is more thoroughly described in criminal law. See

generally Ira P. Robbins, “The Ostrich Instruction: Deliberate Ignorance as a

Criminal Mens Rea,” 81 J. Crim. L. & Criminology 191 (1990). An old English

case, Regina v. Sleep, 169 Eng. Rep. 1296 (1861), was the first to name the

concept, but it made its way to America by the late 19th century. See, e.g., People

v. Brown, 16 P. 1 (1887). Willful blindness started showing up more frequently in

the 1970s. The Comprehensive Drug Abuse Prevention and Control Act of 1970,

Pub. L. No. 91-513, sec. 401, 84 Stat. at 1260 (current version at 21 U.S.C. sec.

841(a) (2006)), prohibits the knowing importation of controlled substances and the

knowing possession of such substances with intent to distribute. 21 U.S.C. sec.

841(a)(1) (emphasis added). Savvy drug traffickers saw a convenient defense to the

knowledge element in deliberate ignorance. Prosecutors got around this problem

through jury instructions equating deliberate ignorance with actual knowledge. The

instruction spread to other prosecutions, including tax crimes. United States v.

Egenberg, 441 F.2d 441, 444 (2d Cir. 1971).
                                          -24-

[*24] United States v. Jewell, 532 F.2d 697 (9th Cir. 1976), has been widely

adopted as a framework for evaluating willful-blindness crimes.6 Jewell and a

friend drove a rented car from Los Angeles to Tijuana to “have a good time.” While

they were enjoying themselves at a Tijuana bar, a man who identified himself as

“Ray” approached them and offered marijuana for sale. They declined. Ray then

offered to pay them $100 for driving a car north across the border. Jewell accepted

the offer, but his friend didn’t want any part of it and drove the rented car back to

L.A. alone. When Jewell picked up the car, he opened up the trunk and noticed a

secret compartment. He didn’t check what was inside, even though he suspected

contraband was there. He got busted when a border patrol agent found 110 pounds

of marijuana in the secret compartment, and was charged with knowingly possessing

marijuana. 21 U.S.C. sec. 841(a)(1). The trial court gave a willful-blindness jury

instruction,7 and Jewell was convicted.

      6
        “Since Jewell was decided in 1976, every circuit--with the exception of the
D.C. Circuit--has adopted its central holding. Indeed, many colloquially refer to the
deliberate ignorance instruction as the ‘Jewell instruction.’” United States v.
Heredia, 483 F.3d 913, 918 (9th Cir. 2007) (en banc).
      7
        The instruction allowed the jury to find that the government met its burden if
“the defendant was not actually aware that there was marijuana in the vehicle he
was driving when he entered the United States his ignorance in that regard was
solely and entirely a result of his having made a conscious purpose to disregard the
nature of that which was in the vehicle, with a conscious purpose to avoid learning
                                                                        (continued...)
                                          -25-

[*25] See Jewell, 532 F.2d at 699. On appeal, Jewell argued that positive

knowledge of the hidden marijuana was necessary to convict him. The Ninth

Circuit affirmed the trial court, adopting the Model Penal Code definition of

“knowingly”.8 The court also noted that, “the required state of mind differs from

positive knowledge only so far as necessary to encompass a calculated effort to

avoid the sanctions of the statute while violating its substance.” Id. at 704.

      Later cases listed three elements for willful blindness:

      •      awareness of a high probability of criminal circumstances,

      •      deliberate avoidance of steps to confirm these criminal circumstances
             and

      •      the deliberate avoidance be motivated by a desire to avoid criminal
             responsibility.




      7
        (...continued)
the truth.”
      8
         “To act ‘knowingly’ * * * is not necessarily to act only with positive
knowledge, but also to act with an awareness of the high probability of the existence
of the fact in question.” United States v. Jewell, 532 F.2d 697, 700 (1976).
                                        -26-

[*26] See, e.g., United States v. Heredia, 429 F.3d 820, 824 (9th Cir. 2005). But

courts applied the factors inconsistently. Some courts required only the first two

elements,9 others all three.10

      The Ninth Circuit--where appeal of this case would lie--revisited willful

blindness in United States v. Heredia, 483 F.3d 913 (9th Cir. 2007) (en banc).

Heredia borrowed her aunt’s car to drive her mother to a nearby town. She

suspected that drugs might be in the car because it reeked of laundry detergent, the

passengers carried a lot of cash and acted nervous, and her aunt’s boyfriend was a

pothead. At a border-control checkpoint, an officer stopped the vehicle and

discovered 350 pounds of marijuana wrapped in dryer sheets (an odor-masking

technique). Heredia was charged with possession of a controlled substance with

intent to distribute under 21 U.S.C. section 841(a)(1). The court gave the jury a




      9
        See, e.g., United States v. Stadtmauer, 620 F.3d 238, 257 (3d Cir. 2010);
United States v. Sdoulam, 398 F.3d 981, 993 n.8 (8th Cir. 2005); United States v.
Jaffe, 387 F.3d 677, 681 (7th Cir. 2004); United States v. Espinoza, 244 F.3d 1234,
1242 (10th Cir. 2001); United States v. Scott, 159 F.3d 916, 922 (5th Cir. 1998).
      10
        See, e.g., United States v. Puche, 350 F.3d 1137, 1148-49 (11th Cir. 2003);
United States v. Willis, 277 F.3d 1026, 1031-32 (8th Cir. 2002); United States v.
Delreal-Ordones, 213 F.3d 1263, 1268-69 (10th Cir. 2000); United States v. Pac.
Hide & Fur Depot, Inc., 768 F.2d 1096, 1098 (9th Cir. 1985).
                                         -27-

[*27] deliberate-ignorance instruction11–without the motivation-to-avoid-criminal-

responsibility element--and she was convicted. Prior to rehearing the case en banc,

a majority of a three-judge panel from the Ninth Circuit overturned Heredia’s

conviction because they concluded the government had failed to establish that

Heredia “deliberately avoided confirming her suspicion in order to provide herself

with a defense.” Heredia, 429 F.3d at 828. Judge Kozinski dissented, arguing that

the third prong was not necessary for a finding of willful blindness. Id. at 830-35.

Upon rehearing en banc, the court held that the “two-pronged instruction * * * met

the requirements of Jewell and, to the extent some of our cases have suggested more

is required * * * they are overruled.” Heredia, 483 F.3d at 920. It reasoned that

“the requirement that defendant have deliberately avoided learning the truth,

provides sufficient protections for defendants.” Id. In other words, the third

element--that the deliberate avoidance be motivated by a desire to avoid criminal

responsibility--need not be met for a willful blindness finding in the Ninth Circuit.




      11
          The relevant part of the jury instruction read as follows: “You may find
that the defendant acted knowingly if you find beyond a reasonable doubt that the
defendant was aware of a high probability that drugs were in the vehicle driven by
the defendant and deliberately avoided learning the truth.” Heredia, 483 F.3d at
917.
                                         -28-

[*28] Judge Easterbrook has weighed in on the debate as well. In United States v.

Ramsey, 785 F.2d 184 (7th Cir. 1986), scamsters running a Ponzi scheme

“portray[ed] themselves as more gullible than the victims” and invoked a willful-

blindness defense. Id. at 186. The trial court’s jury instruction was upheld, but

Judge Easterbrook did one better--offering a better instruction that would be

“simple, but sufficient”:

      You may infer knowledge from a combination of suspicion and
      indifference to the truth. If you find that a person had a strong
      suspicion that things were not what they seemed or that someone had
      withheld some important facts, yet shut his eyes for fear of what he
      would learn, you may conclude that he acted knowingly, as I have used
      that word.

Id. at 190. Judge Easterbrook’s approach forgoes the motivation-to-avoid-criminal-

prosecution element as well.

      Of course, the case before us is a civil, rather than criminal, matter. But we

do look to Jewell and similar cases for guidance about willful blindness. See, e.g.,

Christians v. Commissioner, T.C. Memo. 2003-130, 2003 WL 21000920, at *7;

Medieval Attractions N.V. v. Commissioner, T.C. Memo. 1996-455, 1996 WL

583322, at *59. And since the beyond-a-reasonable-doubt standard of criminal

law is more stringent than the Commissioner’s clear-and-convincing burden for

finding civil fraud, we think meeting the criminal standard is more than sufficient
                                        -29-

[*29] to show the fraudulent intent behind false statements on tax returns that we’re

looking for here. We therefore hold that the Commissioner can meet his burden of

showing fraudulent intent to evade taxes with clear and convincing evidence that a

taxpayer was:

      •      aware of a high probability of unreported income or improper
             deductions, and

      •      deliberately avoided steps to confirm this awareness.

      There is clear and convincing evidence that Fiore was aware of a high

probability of unreported income for 1996 and 1997. Notwithstanding his busy

schedule and administrative shortcomings, he must have known that there was a

very high probability that he wasn’t reporting all of his income. His educational

background and work experience would alert him to the likely outcome of his

haphazard income-estimation method--that he was likely failing to report substantial

amounts of income. Fiore knew he was neglecting firm administration and running a

high risk of not reporting taxable income.

      And more importantly Fiore was certainly aware he was burning through a

lot of cash. In 1995 he paid $150,000 to settle a malpractice claim and $85,000

for his Idaho cabin. He also started renting his closer-to-work apartment in 1995

for over $2,000 a month (while paying a mortgage at the same time). The pattern
                                          -30-

[*30] continued into 1997, when he paid $100,000 for Idaho land, and then into

1998--when he paid $350,000 for a log house and barn. We find that he was

thinking about his not-enough-cash problem in 1996 and 1997. And not paying all

his taxes was a convenient solution--at least temporarily.

      We also find that Fiore deliberately avoided steps to confirm the possibility of

unreported income. He could have easily confirmed whether his estimates of gross

income were correct by checking his business-account bank statements. He also

had a three-ring binder for each taxable year that included a copy of all the bills and

deposit slips. Fiore’s failure to check the bank statements and binders before

accounting for his income and preparing his taxes makes his case analogous to Cole

and Spill--Fiore, like the taxpayers in those cases, had access to available records

that he failed to use in preparing his returns.

      Fiore in fact admitted to willful blindness “not for the purpose of defrauding

the government, but rather, sadly, for the purpose of getting and keeping clients.”

At the very least, this is an admission that he believed his time was better spent on

getting clients than confirming whether he reported all his income--even when he

suspected that at least some taxable income wasn’t being properly reported. We

therefore find that Fiore was willfully blind, weighing in favor of finding fraud.
                                         -31-

[*31] And with particular weight given to this willful blindness we find that the

Commissioner has met his burden of proving by clear and convincing evidence that

Fiore filed fraudulent returns. We cannot accept that a person of Fiore’s

intelligence, training, and experience was not aware when he filed his returns for

1996 and 1997--at a time when he knew his need for cash was ballooning--that there

was a high probability that he was underreporting his income. And we find that he

deliberately avoided steps that would have confirmed that underreporting, since all

he had to do was read his monthly bank statements to verify the accuracy of his

estimates of taxable income that he put on his returns.


                                                      Decision will be entered under

                                                Rule 155.
