                        T.C. Memo. 2009-233



                     UNITED STATES TAX COURT



         JAMES R. AND CAROL K. MCCORMACK, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 21722-07.               Filed October 8, 2009.



     Keith Wolak, for petitioners.

     Justin D. Scheid, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     THORNTON, Judge:   Respondent determined deficiencies of

$9,908 and $7,734 in petitioners’ Federal income taxes for 2000

and 2001, respectively.1    Respondent also determined that Carol K.

McCormack (petitioner) is liable for fraud penalties under



     1
      All dollar amounts are rounded to the nearest dollar.
                                - 2 -

section 6663 of $7,431 and $5,801 for 2000 and 2001,

respectively.2

     The issues for decision are:    (1) Whether petitioner is

liable for fraud penalties under section 6663; and (2) whether

respondent is time barred from assessing petitioners’ tax

liabilities for the subject years.

                          FINDINGS OF FACT

     When they filed their petition, petitioners resided in

Indiana.    The parties have stipulated some facts, which we so

find.

A.   Petitioner’s Educational and Professional Experience

     In 1982 petitioner graduated from Purdue University, Calumet

Campus, with a concentration in general management accounting,

which included a semester course in tax accounting.    Since then,

she has held various accounting and auditing jobs.    For instance,

beginning about 1986, she was controller for Petrolink, Inc., a

fuel oil marketing and trading operation with sales of $50 million

per year.   In this position she supervised staff accountants,

prepared financial statements on both the accrual and cash basis

methods, and filed State and Federal fuel oil tax and payroll

reports.



     2
      Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the years in issue, and
all Rule references are to the Tax Court Rules of Practice and
Procedure.
                                - 3 -

     In 1989 petitioner went to work for the United Food and

Commercial Workers Local 100-A Health and Welfare Fund (the Fund).

As administrative assistant to the managing director and

president, she was second in command of the Fund and responsible

for managing it when the managing director and president were

absent.   She was also controller and director of personnel, with

responsibilities that included managing the entire financial and

accounting function for the Fund, supervising the accounting

staff, preparing and filing the Fund’s quarterly and annual

payroll taxes and Federal unemployment tax returns, and ensuring

the accuracy of Forms W-2, Wage and Tax Statement, for all Fund

employees.

B.   Petitioner’s Embezzlement Activities

     Between 1997 and October 2001 petitioner embezzled over

$110,000 from the Fund.    She used the embezzled funds for personal

purposes to pay her mortgage and vehicle loans, monthly bills, and

everyday expenses.   She maintained no records of the cash she

embezzled or the manner in which she spent it.   She reported none

of these embezzled funds on her tax returns.

      As described in more detail below, the funds that petitioner

embezzled came from union members’ health insurance premium

payments and copayments.
                                 - 4 -

     1.    Embezzlement of Premium Payments

     As required by the Consolidated Omnibus Budget Reconciliation

Act (COBRA), the Fund offered continued health insurance coverage

to union members who lost their jobs or had their work hours

reduced.    Most of these union members made monthly COBRA premium

payments to the Fund in cash.    Petitioner was responsible for

depositing these cash payments into the Fund’s bank account.         She

was also responsible for recording and depositing certain

reimbursement checks the Fund received from health insurance

companies.

     Each month one of the Fund’s accounting clerks (or

occasionally petitioner herself) would prepare an original and a

carbon copy deposit slip for the COBRA payments and record the

deposit in the Fund’s journal.    Petitioner would remove some of

the COBRA-payment cash and substitute reimbursement checks in the

same amount.    She would destroy the original deposit slip and

prepare a new one showing the deposit of the checks she had

substituted for the cash she had taken.       She would retain the

carbon copy of the original deposit slip and attach it to the bank

deposit receipt.    She would destroy the vouchers for the

substituted checks so that they were never recorded on the

accounting records of the Fund.    In this manner petitioner

embezzled $27,623 in 2000 and $20,085 in 2001.
                               - 5 -

     2.   Embezzlement of Mammogram Copayments

     The Fund operated the Union Medical Center, which provided

health care services to union members who contributed to the Fund.

Fund plan participants were required to make $20 cash copayments

for mammograms performed at the Union Medical Center.    Petitioner

was responsible for accounting for the copayments and depositing

them into the Fund.   Petitioner embezzled mammogram copayments

totaling $3,360 in 2000 and $3,660 in 2001.

C.   Criminal Conviction

     In 2005 petitioner pleaded guilty to embezzling approximately

$110,310 from her employer.   She was convicted, sentenced to 12

months and 1 day of imprisonment, and ordered to pay $91,654 in

restitution.

D.   Petitioners’ Tax Returns and the Notice of Deficiency

     Petitioner prepared and timely filed petitioners’ joint Forms

1040, U.S. Individual Income Tax Return, for 2000 and 2001.3   They

did not report the embezzled funds as income.

     By notice of deficiency dated June 21, 2007, respondent

determined that petitioners had failed to report embezzled funds

of $30,983 and $23,745 in 2000 and 2001, respectively.   Respondent

also determined that petitioner was liable for the section 6663

fraud penalty.


     3
      The record does not indicate the exact dates petitioners
filed their returns.
                              - 6 -

                             OPINION

     Petitioners do not dispute the deficiencies resulting from

their failure to report the embezzled funds as income.   They

dispute the fraud penalty imposed against petitioner and contend

that respondent is time barred from assessing their 2000 and 2001

tax liabilities.

A.   Fraud

     Section 6663(a) imposes a penalty on the taxpayer if any part

of a tax underpayment is due to fraud.   The burden of proof is

upon the Commissioner to show by clear and convincing evidence

that the fraud penalty applies.   Sec. 7454(a); Rule 142(b).    To

satisfy his burden of proof, the Commissioner must establish both

that (1) an underpayment exists for each year, and (2) some part

of the underpayment is due to fraud.   See DiLeo v. Commissioner,

96 T.C. 858, 873 (1991), affd. 959 F.2d 16 (2d Cir. 1992).

     It is well settled that embezzled funds are taxable income.

See, e.g., James v. United States, 366 U.S. 213, 219 (1961);

Rappaport v. United States, 583 F.2d 298, 302 (7th Cir. 1978).

Petitioners have stipulated that they failed to report $30,983 and

$23,745 of embezzled funds on their 2000 and 2001 Federal income

tax returns, respectively, and that these omissions gave rise to

understatements of their taxes as respondent determined.

Accordingly, there is no question as to the existence of
                                 - 7 -

underpayments.    The question is whether the underpayments are due

to fraud.

      Because fraudulent intent can seldom be established by direct

proof of the taxpayer’s intention, fraud may be proved by

circumstantial evidence.    See Toushin v. Commissioner, 223 F.3d

642, 647 (7th Cir. 2000), affg. T.C. Memo. 1999-171; Pittman v.

Commissioner, 100 F.3d 1308, 1319 (7th Cir. 1996), affg. T.C.

Memo. 1995-243.   Badges of fraud include but are not limited to:

Making a substantial and consistent understatement of income;

dealing in cash; failing to maintain adequate records; giving

implausible or inconsistent explanations of behavior;

participating in an illegal activity; and attempting to conceal

such activity.    Petzoldt v. Commissioner, 92 T.C. 661, 700 (1989).

While no single factor is necessarily conclusive, the existence of

several indicia is persuasive circumstantial evidence of fraud.

Id.

      The evidence convincingly establishes that the underpayments

for 2000 and 2001 were due to petitioner’s fraud.     Petitioner is

an intelligent and educated woman with nearly two decades of

accounting experience.     As part of her professional duties, she

prepared and filed payroll and unemployment tax returns and

verified the accuracy of employees’ Forms W-2.    She also prepared

her family’s income tax returns.
                                  - 8 -

      Petitioner pleaded guilty to embezzling approximately

$110,310 from 1997 to 2001.   Her multistep embezzlement scheme

evinces a high level of sophistication and a profound breach of

fiduciary responsibilities.   She successfully concealed her

embezzlement scheme for a number of years before getting caught.

Her failure to report any of the embezzled funds as income

resulted in recurring and substantial understatements of income.

     Petitioner testified that she “just kept thinking [she would]

be able to put the money back somehow.”    This testimony is

difficult to square, however, with her admission that she kept no

records of the amounts of cash she embezzled and the fact that it

was only during her criminal trial that for the first time she saw

some “figures” as to the amount of her embezzlement.    These

implausible or inconsistent explanations of her behavior, as well

as her failure to keep records, are indicia of fraud.

     Petitioner’s primary defense is that her failure to report

the embezzled cash was not due to fraud because she did not know

she was required to report it.4    She claims she “never thought

about it.”   When a claim of ignorance or honest mistake is


     4
      Although the distinction does not affect the result in this
case, we note that respondent is not required to show that
petitioner knew tax to be owing on the embezzled funds but rather
that she believed tax to be owing. See McGee v. Commissioner, 61
T.C. 249, 256 (1973), affd. 519 F.2d 1121 (5th Cir. 1975); see
also Toushin v. Commissioner, 223 F.3d 642, 647 (7th Cir. 2000)
(“To establish fraud, the IRS must demonstrate by clear and
convincing evidence that the taxpayer intended to evade taxes
that he knew or believed he owed.”), affg. T.C. Memo. 1999-171.
                                 - 9 -

asserted, we consider the taxpayer’s intelligence, education, and

tax expertise in determining whether the requisite fraudulent

intent has been established.     Drobny v. Commissioner, 86 T.C.

1326, 1349 (1986).    In the final analysis, we cannot accept that a

person of petitioner’s intelligence, training, and experience

could have systematically embezzled more than $110,000 over 5

years and never have thought about the tax consequences.

         On the basis of all the evidence, we conclude and hold that

respondent has met his burden of proving by clear and convincing

evidence that the fraud penalty applies to petitioner.

B.   Statute of Limitations

     Generally, the Commissioner must assess tax within 3 years

after a return is filed.     Sec. 6501(a).   As an exception to this

general rule, “In the case of a false or fraudulent return with

the intent to evade tax, the tax may be assessed * * * at any

time.”    Sec. 6501(c)(1).   We have held that petitioner committed

fraud.    Accordingly, the period of limitations on assessment of

petitioners’ 2000 and 2001 taxes is lifted with respect to both

petitioners.    See Pert v. Commissioner, 105 T.C. 370, 378-379

(1995).

     To reflect the foregoing,


                                             Decision will be entered

                                      for respondent.
