                          T.C. Memo. 1995-543



                        UNITED STATES TAX COURT



              ANTHONY AND LINDA WALTERS, Petitioners v.
            COMMISSIONER OF INTERNAL REVENUE, Respondent



       Docket No. 11784-93.       Filed November 16, 1995.



       Gerard P. Martin and Paula M. Junghans, for petitioners.

       Clare J. Brooks, for respondent.



               MEMORANDUM FINDINGS OF FACT AND OPINION


       WRIGHT, Judge:   Respondent determined deficiencies in and

additions to tax and a penalty with respect to petitioners'

Federal income taxes as follows:

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

1987     $10,832         $8,124                -             $2,708
1988      35,158         26,369                -              8,790
1989      37,450            -              $28,088              -
                                - 2 -

The issues for decision are:

     (1)   Whether petitioners had embezzlement income during

taxable years 1987, 1988, and 1989.     We hold that they did not.

     (2)   Whether the amount of petitioners' unreported income

for taxable years 1987, 1988, and 1989 should be calculated using

a formula advanced by respondent or a similar formula advanced by

petitioners.   We hold that the amount of unreported income is to

be calculated using the formula proposed by petitioners.

     (3)   Whether petitioners are liable for additions to tax and

the penalty for fraud under section 66531 for 1987 and 1988 and

under section 6663 for 1989.    We hold that Anthony Walters is

liable for the section 6653 addition to tax for taxable years

1987 and 1988 and the section 6663 penalty for taxable year 1989;

Linda Walters is not liable for such additions or penalty.

     (4)   Whether petitioners are liable for the addition to tax

under section 6661 for a substantial understatement of income tax

for taxable years 1987 and 1988.    We hold that they are to the

extent stated herein.

                           FINDINGS OF FACT

     Some of the facts have been stipulated and are found

accordingly.   The stipulation of facts and the attached exhibits

are incorporated herein.    At the time the petition was filed,

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

petitioners resided in Baltimore, Maryland.   Petitioners timely

filed joint Federal income tax returns for taxable years 1987,

1988, and 1989.   All references to petitioner are to Anthony

Walters.

     During the years at issue, petitioner and his brother,

Carlton Walters (Carlton), were partners in a Maryland general

partnership located in Baltimore County, Maryland.   The

partnership operated a store under the name of Fruitland Produce

(Fruitland) and sold fresh produce and seafood to its customers.

During the winter holiday season, Fruitland also sold Christmas

trees.

     Both petitioner and Carlton grew up in the produce business.

At age 16, petitioner quit school in order to work in his

father's produce store.   Similarly, Carlton dropped out of school

while in the 11th grade and began working in his father's produce

store.   In approximately 1968, petitioner formed Fruitland as a

sole proprietorship.   Sometime thereafter, petitioner and Carlton

united and began operating Fruitland as an equal partnership.

From its inception, the partnership has been based upon oral

agreements and has always been operated on a cash basis.    Early

on, petitioner and Carlton agreed that Fruitland's interests

would be best served if petitioner controlled the partnership's

financial affairs.   This arrangement was in response to Carlton's

affinity for gambling and remained in effect throughout the years

at issue.
                                  - 4 -

     During the years at issue, petitioner maintained a checking

account at a local institution on behalf of Fruitland.     Both

petitioner and Carlton were listed as owners of the account.

While petitioner made deposits to this checking account as needed

to conduct Fruitland's daily activities, he collected and stored

much of the cash generated by Fruitland's operation in paper

bags.   Petitioner transported these bags of cash to and from

Fruitland's place of business each day.     Often, while at his

residence, petitioner stored the bags of cash under his bedroom

mattress.   When the quantity of cash got too burdensome,

petitioner used the cash to purchase cashier's checks.     Each

cashier's check listed petitioner as the sole payee.     Petitioner

stored these cashier's checks in two safety deposit boxes

maintained at a local bank.     Although Carlton was aware of the

existence, contents, and location of these safety deposit boxes,

he did not have authorized access to them.     Only petitioners had

access to the contents of the safety deposit boxes.     During the

years at issue, petitioner purchased cashier's checks in the

following amounts and on the following dates:

                    Taxable Year 1987

                   Date           Amount

            June 2, 1987          $5,000
            July 9, 1987           5,000
            July 9, 1987           5,000
            July 17, 1987          5,000
            July 17, 1987          5,000
            Aug. 25, 1987          5,000
            Aug. 25, 1987          5,000
            Aug. 25, 1987          5,000
                Total             40,000
                              - 5 -


                Taxable Year 1988

               Date           Amount

           Jan. 7, 1988       $5,000
           Jan. 7, 1988        5,000
           July 7, 1988        9,990
           Sept. 9, 1988       9,990
           Sept. 16, 1988      9,990
           Sept. 30, 1988      9,995
           Oct. 3, 1988        9,995
           Oct. 4, 1988        9,995
           Oct. 5, 1988        9,995
           Nov. 3, 1988        9,995
           Nov. 7, 1988        9,995
           Dec. 28, 1988       9,995
               Total         109,935

                Taxable Year 1989

               Date           Amount

           May 18, 1989      $9,995
           May 19, 1989       9,995
           May 25, 1989       9,995
           May 26, 1989       9,995
           June 7, 1989       9,995
           June 8, 1989      10,000
           June 16, 1989     10,000
           June 28, 1989      9,995
           June 30, 1989      9,975
           July 13, 1989      9,975
           July 28, 1989      9,995
           July 31, 1989      9,995
           Aug. 4, 1989       9,995
           Aug. 10, 1989      9,995
           Aug. 16, 1989      9,995
           Aug. 21, 1989      9,995
               Total        159,890


During 1989, petitioner negotiated cashier's checks amounting to

$59,985 on behalf of Fruitland.

     Petitioner denies any knowledge of the Currency and Foreign

Transaction Reporting Act, the relevant portion of which is now
                                 - 6 -

codified at 31 U.S.C. sec. 5313(a) (1988), and its supporting

regulation2 requiring that financial institutions report currency

transactions in excess of $10,000.       Petitioner explained that

many of the cashier's checks were slightly under the $10,000

threshold simply because the institution from which the cashier's

checks were purchased assessed a $5 fee for the purchase of

cashier's checks in amounts equal to or greater than $10,000.

     As part of their partnership agreement, petitioner and

Carlton had orally agreed that their compensation with regard to

the services provided to Fruitland was to be equal.

Nevertheless, neither petitioner nor Carlton had devised a method

for ensuring that this agreement would be carried out with any

degree of precision.     Their agreement was simply based on trust.

Carlton received a salary, payable biweekly, in exchange for the

services he provided to Fruitland.       Petitioner, on the other

hand, did not receive a salary.     Instead, in exchange for the

services he provided to Fruitland, petitioner was authorized to

draw checks against the partnership's checking account for

personal purposes.     During the years at issue, petitioner wrote

checks against the partnership's account in order to pay personal

living expenses in the following amounts:

                         Year       Amount

                         1987      $30,691
                         1988       44,969

     2
         31 C.F.R. sec. 103.22(a) (1994).
                                 - 7 -

                      1989          59,454


     Neither petitioner nor Carlton maintained formal records of

Fruitland's financial affairs.    Although the partnership owned a

cash register, it was not systematically used to reflect

Fruitland's sales activity.   Reports of daily revenues were not

maintained.   Invoices reflecting Fruitland's purchases were

informally collected in paper bags.

     For each year at issue, a professional accountant prepared

both Fruitland's Federal partnership returns and petitioners'

Federal income tax returns.   In computing Fruitland's gross

receipts for a given taxable year, the accountant applied a gross

markup rate to Fruitland's cost of goods sold.      The accountant

determined cost of goods sold from receipts provided by

petitioner.   These were the same receipts petitioner claims to

have accumulated in paper bags.

     On their Schedule E for each taxable year at issue,

petitioners reported the following distributive share amounts:

          Item                   1987        1988     1989

     Ordinary income from
       business activity      $6,748     $7,281      $5,360

     Guaranteed payment       33,800     36,800      34,500
          Total               40,548     44,081      39,860

Schedule K-1 of Fruitland's Federal partnership returns lists the

following amounts as having been allocated to Carlton with

respect to each taxable year at issue:
                                - 8 -

           Item                 1987      1988       1989

     Ordinary income from
       business activity       $6,747    $7,280     $5,359

     Guaranteed payment        29,900    32,900     31,500
          Total                36,647    40,180     36,859

     In 1990, petitioner was the target of a criminal

investigation.    Petitioner was charged with three counts of

willfully and knowingly attempting to evade Federal income tax by

filing false and fraudulent returns.    Count 1 pertained to

taxable year 1987, while the second and third counts pertained to

taxable years 1988 and 1989, respectively.    Petitioner entered a

guilty plea to count 3.

     Petitioners concede that they underreported income in each

taxable year at issue.    Petitioners maintain, however, that the

amount of unreported income for each taxable year at issue is

equal to the amount of personal living expenses which petitioner

paid by drawing checks against Fruitland's checking account, plus

one-half of the cashier's checks purchased by petitioner during

the taxable year, less one-half of the amount of cashier's checks

negotiated during the taxable year, less the amount of income

reported as received from Fruitland on petitioners' tax return.

The following table illustrates petitioners' computation of

unreported income for each taxable year at issue:
                               - 9 -

                                       1987        1988         1989

     Personal expenses
       from Fruitland's
                                  1
       checking account            $30,691     $44,969      $59,454

     One-half of the
       cashier's checks               20,000       54,967       79,955

     One-half of the negotiated
                                                            2
       cashier's checks                  -            -      (29,993)

     Amount reported on
                                               3
       petitioners' return        (40,548)      (44,081) (39,860)

     Unreported income                10,143       55,855       69,556

     1
       On brief, petitioners incorrectly list $30,961 as the
amount of personal expenses which petitioner paid by writing
checks against Fruitland's checking account in 1987.
Accordingly, unreported income for taxable year 1987 is reduced
by $270.
     2
       On brief, petitioners incorrectly list $29,979 as equal to
one-half of the cashier's checks which were negotiated during
1989. Accordingly, this correction results in a decrease to
unreported income of $14 for taxable year 1989.
     3
       On brief, petitioners erroneously list $59,454 as the
income received from Fruitland and reported on their return.
Accordingly, unreported income for 1988 is increased by $15,373.


     Respondent determined that petitioner embezzled the money

which he used to purchase the cashier's checks, and that such

embezzled funds constitute income to petitioners.         Respondent

also determined that petitioners' income for the taxable years at

issue is equal to the amount petitioner drew against the

partnership's checking account used to pay for personal living

expenses.   Consequently, respondent further determined that

petitioner had unreported income for the taxable years at issue

equal to the amount of personal living expenses petitioner paid
                             - 10 -

by writing checks against Fruitland's checking account, plus the

entire amount of the cashier's checks purchased by petitioner

during the taxable year, less the entire amount of cashier's

checks negotiated during the taxable year, less the amount of

income reported as received from Fruitland on petitioners' tax

return in the form of a guaranteed payment.   Respondent's

calculation of petitioners' unreported income for each taxable

year may be summarized by the following table:

                                   1987        1988         1989

     Personal expenses
       from Fruitland's
       checking account           $30,691     $44,969      $59,454

     Cashier's
       checks                      40,000     109,934      159,910

     Negotiated
       cashier's checks                -          -        (59,985)

     Amount reported on
       petitioners' return
       as a guaranteed
       payment                    (33,800)    (36,800)     (34,500)

     Unreported income             36,891     118,103      124,879



                             OPINION

     The parties agree that petitioners have unreported income

with respect to each taxable year at issue.   A dispute exists,

however, as to the amount of unreported income.       Each party has

advanced a particular formula which each contends should be used

to compute the amount of petitioners' unreported income.
                               - 11 -

Although the two formulas have many similarities, their

differences are distinct.   The principal difference stems from

each proponent's treatment of the cashier's checks purchased by

petitioner.   Respondent's formula has as its basis the theory

that petitioner purchased the cashier's checks with embezzled

funds, and therefore all funds are attributable to petitioners as

embezzlement income.   In contrast, petitioners argue that the

cashier's checks remained partnership property, belonging equally

to petitioner and Carlton, and therefore, pursuant to section

702, only one-half of the funds is attributable to petitioners.

     Respondent also contends that the deficiencies resulting

from petitioners' unreported income are subject to the civil

fraud penalty.   Petitioners disagree and maintain that respondent

has failed to carry her burden of establishing fraud on the part

of either Anthony Walters or Linda Walters with respect to

taxable years 1987 and 1988.   Petitioners further maintain that

respondent has failed to establish fraud on the part of Linda

Walters with respect to taxable year 1989.   In light of

petitioner's guilty plea to criminal tax fraud with regard to his

1989 return, petitioners recognize the doctrine of collateral

estoppel and concede that the deficiency resulting from their

unreported income for taxable year 1989 is subject to the civil

fraud penalty.   Petitioners contend, however, that only Anthony

Walters is liable for the civil fraud penalty for taxable year

1989.
                                - 12 -

     We find that petitioners did not receive embezzlement income

and, as a consequence, that their method of computing the amount

of their unreported income is correct.     However, while we agree

that respondent has failed to prove fraud on the part of Linda

Walters for any taxable year at issue, we disagree with

petitioners' contention that respondent has failed to establish

fraud on the part of Anthony Walters with respect to the taxable

years at issue.

Issue 1.     Embezzlement Income

     The first issue for our consideration is whether petitioners

received embezzlement income stemming from petitioner's purchase

and control of the cashier's checks during the taxable years at

issue.     It is necessary for us to resolve this issue as its

resolution guides our analysis of how petitioners' unreported

income for each taxable year at issue is to be computed.     More

specifically, respondent's computation requires a finding that

petitioner's handling of the cashier's checks gave rise to

embezzlement income.     In contrast, petitioners' computation

requires a finding that petitioner's handling of the cashier's

checks did not give rise to embezzlement income.

     Respondent's determinations are presumed correct, and

petitioners bear the burden of proving otherwise.     Rule 142(a);

Welch v. Helvering, 290 U.S. 111 (1933).     Respondent asserts that

petitioner embezzled funds belonging to Fruitland and converted

those funds into cashier's checks for his personal use.
                                 - 13 -

Accordingly, respondent contends that the alleged embezzled funds

constitute gross income to petitioners in the year of

embezzlement.    It is well established that profits or gains

earned illegally constitute gross income within the meaning of

section 61.     James v. United States, 366 U.S. 213 (1961).

Embezzled funds, therefore, constitute income to the embezzler.

Id.   In James, the Supreme Court explained that a taxpayer has

income when he or she "acquires earnings, lawfully or unlawfully,

without the consensual recognition, express or implied, of an

obligation to repay and without restriction as to their

disposition".     Id. at 219.   Embezzlement income results from a

taxpayer's embezzlement activity if such activity "enriches" the

taxpayer.     Id. at 221.

      Petitioners contend that an application of the principles

enunciated in James v. United States, supra, necessitates a

conclusion that petitioners did not realize embezzlement income

as a result of petitioner's using the Fruitland funds to purchase

cashier's checks.    Petitioners argue that Carlton was fully aware

of the cashier's checks and that he had approved of petitioner's

exclusive handling of them.     Petitioner testified that he

considered the cashier's checks to be owned jointly by himself

and Carlton, and the cashier's checks represented their life

savings.    Petitioner further testified that he was the sole payee

of each cashier's check simply for reasons of administrative

convenience given his responsibility to manage the financial
                                - 14 -

affairs of the partnership.   Petitioner also testified that, with

one exception, the negotiation of all cashier's checks was

performed on behalf of Fruitland.    The sole exception involved

the negotiation of a single cashier's check on behalf of another

venture engaged in by petitioner and Carlton.

     Carlton's testimony is consistent with petitioner's

testimony.   Carlton testified that, while he was unaware of the

exact amount represented by the cashier's checks, he was aware of

their existence and location.    Carlton further testified that he

never questioned, nor had reason to question, petitioner's

handling of the cashier's checks.    Carlton went on to testify

that he considered the cashier's checks to belong equally to

himself and petitioner.   Carlton also testified that he

considered the cashier's checks to represent both his and

petitioner's life savings that were to be used only in the event

of an emergency.

     Respondent does not dispute that Carlton consented to

petitioner's exclusive control of the partnership's financial

affairs.   Respondent contends, however, that the facts of this

case clearly indicate that petitioner surreptitiously diverted

portions of Fruitland's receipts for his personal use without

Carlton's consent.   Respondent maintains that this is evidenced

by petitioners' exclusive control of the cashier's checks.

Specifically, respondent explains that the cashier's checks could

be negotiated only by petitioner and that only petitioners had
                               - 15 -

authorized access to the safety deposit boxes that contained the

cashier's checks.

     Although respondent's determinations are presumed to be

correct, we think petitioners have sufficiently rebutted that

presumption with regard to this issue.      Petitioner's handling of

the funds used to purchase the cashier's checks and his

subsequent control of those cashier's checks is indeed

unconventional.   But it is nonetheless consistent with the

partnership agreement.    Furthermore, this unorthodox management

of financial assets is consistent with testimony provided by both

petitioner and Carlton.   Carlton, perhaps naively, consented to

petitioner's control of the money which he used to purchase the

cashier's checks.   Moreover, although he was uncertain of the

amount invested in cashier's checks, Carlton testified that he

knew the cashier's checks existed.      Additionally, Carlton

testified that petitioner would inform him of his plans to

purchase additional cashier's checks prior to purchasing them.

     When the evidence is considered in the aggregate, the

outcome is unfavorable to respondent.      Petitioners have presented

corroborated and uncontradicted testimony that necessitates a

conclusion that petitioner did not embezzle funds from Fruitland.

Carlton's testimony is the most compelling evidence in this

regard.   If this Court were to sustain respondent's

determination, it would be necessary for us to conclude that the

victim of respondent's embezzlement theory committed perjury when
                                - 16 -

he testified that petitioner did not embezzle partnership funds.

This we are unprepared to do.    Furthermore, while there may be an

appearance of impropriety associated with the facts surrounding

petitioner's control of the cashier's checks, such facts are

consistent with petitioner's and Carlton's agreement that

petitioner manage the financial assets of the partnership.

Accordingly, we find that the cashier's checks remained assets of

the partnership and that petitioners did not receive embezzlement

income resulting from petitioner's purchase and control of them.

Issue 2.   Computation of Unreported Income

     While the parties agree that petitioners failed to report

various amounts of income received from Fruitland during the

taxable years at issue, they remain in disagreement with respect

to the amount of unreported income.      Petitioners contend that the

amount of unreported income for each taxable year at issue is

equal to the amount of personal living expenses petitioner paid

by drawing checks against Fruitland's checking account during the

taxable year, plus one-half of the cashier's checks purchased by

petitioner during the taxable year, less one-half of the amount

of cashier's checks negotiated during the taxable year, less the

amount of income reported as received from Fruitland on

petitioners' tax return.

     Relying on the theory that petitioner purchased the

cashier's checks with embezzled funds, respondent contends that

the amount of unreported income for each taxable year at issue is
                              - 17 -

equal to the amount of personal living expenses petitioner paid

by drawing checks against Fruitland's checking account during the

taxable year, plus the entire amount of the cashier's checks

purchased by petitioner during the taxable year, less the entire

amount of the cashier's checks negotiated during the taxable

year, less the amount of income reported as received from

Fruitland on petitioners' tax return in the form of a guaranteed

payment.

     With three exceptions, these two formulas are equivalent.

Respondent's formula differs from petitioners' formula in that it

includes in the computation the entire amount of the cashier's

checks purchased and maintained by petitioner.   Petitioners, on

the other hand, contend that the computation should consider only

one-half of that amount.   Whereas respondent's proposal is

consistent with her theory that petitioner purchased the

cashier's checks with embezzled funds, the proposal advanced by

petitioners is consistent with their argument that the cashier's

checks represent partnership property.   In any event, as a

consequence of having concluded that the cashier's checks

remained partnership assets and that petitioner did not embezzle

the funds that he used to purchase such checks, we find that only

one-half of the amount of the cashier's checks is to be

considered in the computation of unreported income for each

taxable year.
                              - 18 -

     The second area in which the two formulas differ pertains to

the reduction for those cashier's checks negotiated by petitioner

during the taxable years at issue.3    Respondent's proposed

reduction equals the entire amount of cashier's checks negotiated

during a particular taxable year, while petitioners' proposed

reduction equals one-half of that amount.    Each proposal,

however, is at least arguably consistent with each proponent's

theory of the case.   Petitioners maintain that the cashier's

checks negotiated during a particular taxable year should not be

treated any differently than the cashier's checks that were not

negotiated during that taxable year because all of the cashier's

checks constituted partnership property.    In contrast,

respondent's proposed reduction does not recognize petitioners'

section 702 distributive share recognition obligation with

respect to any portion of the funds used to purchase the

cashier's checks.   That is, respondent characterizes the funds

petitioner used to purchase the cashier's checks as giving rise

entirely to embezzlement income, none of which is recognized or


     3
      With respect to both petitioners' and respondent's
computation of unreported income, this particular variable is
potentially oversimplified and misleading. Both parties include
it in their computation solely to account for cashier's checks
which petitioner negotiated during taxable year 1989. Neither
party contends that any cashier's checks were negotiated during
earlier taxable years. The record does not support a conclusion
that the cashier's checks negotiated in 1989 were actually
purchased in 1989. Yet, both parties presume this to be the
case. Accordingly, we too will presume that the checks
negotiated in 1989 were purchased in 1989.
                               - 19 -

taken into account pursuant to section 702.    Although this is

arguably consistent with respondent's embezzlement theory, we

have resolved the embezzlement issue in petitioners' favor and

need consider it no further.

     The effect of petitioners' argument should be appreciated.

The necessary consequence of arguing for a smaller reduction is

that unreported income will be higher.    Such an argument,

however, is necessary if consistency is to be maintained with

their theory that the cashier's checks belonged equally to

Carlton and petitioner.    In any event, as a result of having

resolved the embezzlement issue in petitioners' favor, we find

that only one-half of the negotiated cashier's checks should be

considered in the computation of petitioners' unreported income

for each taxable year at issue.

     The final area in which respondent's formula for calculating

petitioners' unreported income differs from the formula advanced

by petitioners involves the amount of the reduction necessary to

account for partnership income reported on petitioners' returns.

Petitioners maintain that this reduction should equal the entire

amount of income identified on their Schedules E as having been

received from Fruitland.    In contrast, respondent contends that

the amount of this reduction should be limited to the amount

petitioners listed on their returns as income received in the

form of guaranteed payments.    Respondent maintains that limiting

the amount of this reduction to the amount petitioners list on
                               - 20 -

their returns as guaranteed payments is appropriate for two

reasons.   We decline to accept respondent's first explanation

supporting partial recognition because it is a product of her

embezzlement theory.     However, respondent also argues that such

partial recognition is appropriate despite her embezzlement

theory.    Respondent contends that petitioners have not

established whether and to what extent the unreported income

stemming from the cashier's checks and personal expenses is

included in the numbers provided on their Schedules E.     As a

consequence, respondent has elected to recognize only those

amounts identified by petitioners as guaranteed payments.

     We are unpersuaded by respondent's fleeting explanation of

her rationale for making this election.    Accordingly, we find

that the computation to be used in calculating petitioners'

unreported income must involve a reduction for the entire amount

of gross income identified by petitioners as received from

Fruitland on their Schedule E for each taxable year at issue.

Issue 3.   Civil Fraud

     We now turn to the question of whether petitioners are

liable for the addition to tax for civil fraud for the taxable

years at issue.    In light of petitioner's guilty plea to criminal

tax fraud with respect to his return for taxable year 1989,

petitioners concede that the doctrine of collateral estoppel

operates to prevent petitioner from contesting the civil fraud

issue with respect to taxable year 1989.    This concession is
                              - 21 -

proper.   The doctrine of collateral estoppel is intended to avoid

repetitious litigation by precluding a second litigation of an

issue of fact or law that was actually litigated and that

culminated in a valid and final judgment.    Niedringhaus v.

Commissioner, 99 T.C. 202, 213 (1992).    The doctrine applies

equally to posttrial convictions and convictions based upon a

guilty plea.   Stone v. Commissioner, 56 T.C. 213 (1971);

Cleveland v. Commissioner, T.C. Memo. 1983-299.    Accordingly, we

focus our attention on taxable years 1987 and 1988.

     Section 6653(b)(1) provides that if any part of any

underpayment of tax required to be shown on a return is due to

fraud, there shall be added to the tax an amount equal to 75

percent of the portion of the underpayment which is attributable

to fraud.   When a joint return is filed, however, it is necessary

for the Commissioner to establish that some part of the

underpayment was due to fraud on the part of both spouses if she

seeks to hold both spouses liable for additions to tax for fraud.

Sec. 6653(b)(3); Stone v. Commissioner, supra at 226-227.

     Fraud is defined as an intentional wrongdoing designed to

evade tax believed to be owing.   Miller v. Commissioner, 94 T.C.

316, 332 (1990).   The Commissioner bears the burden to prove

fraud by clear and convincing evidence.   Sec. 7454(a); Rule

142(b); Grosshandler v. Commissioner, 75 T.C. 1, 19 (1980).      The

Commissioner must show that the taxpayer intended to evade taxes

known to be owing by conduct intended to conceal, mislead, or
                                - 22 -

otherwise prevent the collection of taxes.      Rowlee v.

Commissioner, 80 T.C. 1111, 1123 (1983).     When fraud is

determined for more than 1 taxable year, the Commissioner must

show that an underpayment exists and that some part of the

underpayment was due to fraud for each year.      Otsuki v.

Commissioner, 53 T.C. 96, 105 (1969).

      The existence of fraud is a factual question to be

determined upon a consideration of the entire record.

Grosshandler v. Commissioner, supra at 19.      Fraud cannot be

presumed or imputed but must be established by clear and

convincing evidence.     Id. at 19.   Fraud cannot be found if the

circumstances only create a suspicion of its existence.       Petzoldt

v. Commissioner, 92 T.C. 661, 700 (1989).     Because direct proof

of a taxpayer's intent is rarely available, fraud may be proved

by circumstantial evidence.     Spies v. United States, 317 U.S. 492

(1943).   Fraud may be properly inferred where a taxpayer's entire

course of conduct establishes the requisite fraudulent intent.

Kotmair v. Commissioner, 86 T.C. 1253, 1260 (1986).     The intent

to conceal or mislead may be inferred from a pattern of conduct.

See Spies v. United States, supra at 499; Guinan v. Commissioner,

T.C. Memo. 1991-190.

      Courts rely on a number of indicia of fraud when they decide

civil tax fraud cases.    Edwards v. Commissioner, T.C. Memo. 1995-

77.   Although no single factor is necessarily sufficient to

establish fraud, the existence of several indicia is persuasive
                               - 23 -

evidence of fraud.    Johnson v. Commissioner, T.C. Memo. 1993-227.

These indicia or badges of fraud include:    (1) Understating

income; (2) maintaining inadequate records; (3) giving

implausible or inconsistent explanations of behavior; (4)

concealing assets; and (5) dealing in cash.     Meier v.

Commissioner, 91 T.C. 273 (1988); Bragg v. Commissioner, T.C.

Memo. 1993-479.    These badges of fraud are nonexclusive.     Miller

v. Commissioner, supra at 334.     Both the taxpayer's background

and the context of the events in question may be considered as

circumstantial evidence of fraud.     Spies v. United States, supra

at 497.    However, the mere failure to report income is not

sufficient to establish fraud.     Rowlee v. Commissioner, supra at

1123.    On the other hand, consistent and substantial

understatements of large amounts of taxable income over a period

of years have been held to be strong evidence of fraud.      Smith v.

Commissioner, 32 T.C. 985, 987 (1959).

     Considering petitioner's entire course of conduct, the

record provides us with ample basis for finding that the

underpayment of tax for each taxable year at issue is due to

fraud on the part of petitioner.    See Kotmair v. Commissioner,

supra at 1260.

     Respondent has shown the existence of multiple indicia of

fraud.    Petitioners concede that they underreported income

resulting in underpayments of tax for each taxable year at issue.

The unreported income in each year is most conspicuous here with
                               - 24 -

petitioners' agreeing that the gross income in their returns for

1987, 1988, and 1989 was understated in the amounts of $10,143,

$55,855, and $69,556, respectively.     These amounts are

substantial when compared to the total gross income of $40,548,

$44,081, and $39,860 reported as received from Fruitland during

1987, 1988, and 1989, respectively.     There is little doubt that

petitioner knew that his income for each taxable year at issue

exceeded the amount reflected on his return for that year.

Petitioner was the partner responsible for managing the financial

affairs of the partnership.    All transactions involving the

partnership checking account, including those transactions

relating to petitioner's personal expenditures, were reflected on

bank statements which petitioner received.     Petitioner was also

the partner who purchased and maintained the cashier's checks.

Despite possessing knowledge of this information, petitioner

refrained from sharing it with his accountant.     Instead,

petitioner filed the returns as prepared by his accountant.      The

frequency and magnitude of the unreported income conceded by

petitioners is probative evidence that supports our finding that

the understatements of income were fraudulent, rather than

inadvertent or accidental.    Such a pattern of consistent

underreporting of income is strong evidence of fraud.       Otsuki v.

Commissioner, supra at 106-108; Smith v. Commissioner, supra.

This evidence justifies the inference of fraud.     See Holland v.

United States, 348 U.S. 121, 137 (1954).
                              - 25 -

     In addition to the consistent pattern of substantial

understatements, petitioner, being the partner responsible for

managing the financial affairs of the partnership, did not

maintain adequate records documenting such financial affairs.

Additionally, although Fruitland operated almost exclusively on a

cash basis, petitioner frequently transacted business without

using the partnership's cash register.    The failure to maintain

addequate financial records is an additional indicium of fraud.

See Bragg v. Commissioner, supra.

     Petitioner routinely used large sums of cash to purchase

cashier's checks, often within days of each other, in amounts

slightly less than $10,000.   Petitioner's self-serving testimony

concerning his unfamiliarity with the Federal currency

transaction reporting requirements lacks credibility.    Moreover,

we give little credence to petitioner's testimony pertaining to

his aversion to financial institutions.    Such explanations are

implausible.   In a manner virtually undetectable by anyone

concerned, petitioner kept large sums of money in the form of

non-interest-bearing instruments for an extended period of time.

These circumstances suggest that petitioner's behavior was

motivated not by an aversion to financial institutions, but

rather an intent to conceal the existence of the money

represented by the cashier's checks.   Providing implausable

explanations, dealing in large amounts of cash, and the
                              - 26 -

concealment of assets are additional indicia of fraud.    See Meier

v. Commissioner, supra.

     Petitioners contend that even if this Court finds that the

fraud penalty can be properly imposed against that portion of the

deficiency arising from petitioner's personal use of the

partnership's checking account, this Court must nevertheless find

that the fraud penalty cannot be properly imposed against that

portion of the deficiency resulting from the cashier's checks.

We disagree.   Petitioners' argument in this regard is wanting in

substance.   Petitioners have offered no credible evidence to

refute respondent's proof of fraud with respect to any portion of

the understatements.   Hence, section 6653(b)(2) can provide

petitioners with no refuge.

     Although we conclude that the record provides ample basis

for finding that the entire underpayment of tax for each taxable

year at issue is due to fraud on the part of petitioner, the

record lacks a sufficient basis for us to conclude that any

portion of the underpayment for any taxable year at issue was due

to fraud on the part of petitioner Linda Walters (Linda).    The

fraud of one spouse cannot be attributed to the other spouse.

Stone v. Commissioner, 56 T.C. 213 (1971).     Respondent has the

burden of proving by clear and convincing evidence that Linda

intended to evade taxes.   Rule 142(b); Stone v. Commissioner,

supra.   Respondent has not met this burden.   While Linda may have

known, or had reason to know, of petitioner's tax evasion scheme,
                              - 27 -

respondent has failed to present clear and convincing evidence of

such knowledge.   Aside from her status as petitioner's spouse,

the record is essentially devoid of evidence concerning Linda.

     Not only has respondent failed to establish fraud on the

part of Linda with respect to taxable years 1987 and 1988; she

has likewise failed with respect to taxable year 1989.    Although

the doctrine of collateral estoppel prevents petitioner from

contesting the civil fraud penalty with respect to taxable year

1989, the doctrine does not effect an estoppel against Linda

because she was not a party to the prior criminal proceeding.

Randolph v. Commissioner, 74 T.C. 284 (1980); Stone v.

Commissioner, supra.

     In sum, the facts of this case clearly and convincingly

establish that petitioner, but not his spouse, had an intent to

evade the Federal income tax with respect to each year at issue.

Accordingly, we find that petitioner is liable for the addition

to tax for fraud under section 6653(b)(1) for taxable years 1987

and 1988.   We also find that petitioner is liable for the civil

fraud penalty under section 6663 for taxable year 1989.   We

further find that Linda is not liable for the civil fraud

addition to tax under section 6653(b)(1) for taxable years 1987

or 1988; nor is Linda liable for the civil fraud penalty under

section 6663 for taxable year 1989.
                              - 28 -

Issue 4.   Addition to Tax, Section 6661

     Respondent determined that petitioners are liable for the

addition to tax pursuant to section 6661 for taxable years 1987

and 1988 due to a substantial understatement of income tax.

Respondent's determination carries with it the presumption of

correctness.   Rule 142(a).

     The addition is 25 percent of any underpayment attributable

to a substantial understatement.    Sec. 6661(a); Pallottini v.

Commissioner, 90 T.C. 498 (1988).    A substantial understatement

is one which exceeds the greater of 10 percent of the tax

required to be shown on the return or $5,000.    Sec.

6661(b)(1)(A).   Petitioners make no argument or showing with

regard to substantial authority or adequate disclosure.       Sec.

6661(b)(2)(B).   Petitioners' alternative argument, which is

grounded on a theory of ignorance, is without substance.

     The applicability of this addition to tax turns on the

recomputation of petitioners' tax liabilities for 1987 and 1988

in accordance with this opinion.    If such recomputation reflects

substantial understatements, petitioners are liable for these

additions to tax.

     To reflect the foregoing,

                                           Decision will be

                                     entered under Rule 155.
