                  T.C. Memo. 2000-22



                UNITED STATES TAX COURT



            JOSEPH J. HOUSE, Petitioner v.
     COMMISSIONER OF INTERNAL REVENUE, Respondent

         JOSEPH J. HOUSE INC., Petitioner v.
     COMMISSIONER OF INTERNAL REVENUE, Respondent



Docket Nos. 8664-98, 8665-98.          Filed January 19, 2000.


     P is a former revenue agent with the Internal
Revenue Service and has been a return preparer for over
28 years. P set up J-Co., a wholly owned corporation,
purportedly to conduct his accounting business. P also
set up C-Co. to hide his assets from the Internal
Revenue Service and X-Co. for his wife’s arts and
crafts business. P conducted his accounting business
at his personal residence. P’s clients hired him
individually to prepare their returns. P was not an
employee of J-Co. and was not acting on J-Co.’s behalf
when servicing clients. J-Co. did not engage in a
substantive business activity. Neither P nor his
family members maintained personal checking accounts.
P deposited all his gross receipts into J-Co.’s account
and paid all his business and personal expenses from
this account without maintaining adequate records to
differentiate between business and personal items. P
                                - 2 -

     also transferred funds from this account to the
     accounts of C-Co. and X-Co. to allow other family
     members to use the funds for personal purposes. P
     reported all receipts from his accounting services on
     J-Co.’s return, then deducted all business and personal
     items therefrom, disguising most of the items as “cost
     of goods sold”. J-Co. paid no tax. P did not report
     any income from J-Co. on his return for 1994, nor did
     he report income from the payment of personal expenses.
     Held: J-Co. is a sham, and we disregard it for tax
     purposes. Petitioner’s gross receipts, less allowable
     business expenses, are includable in his income. Held,
     further: P is liable for the fraud penalty under sec.
     6663, I.R.C.



     Joseph J. House, pro se.

     John J. Comeau, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     LARO, Judge:   These cases are before the Court consolidated

for purposes of trial, briefing, and opinion.    Joseph J. House

(petitioner) and Joseph J. House, Inc. (JJH) separately

petitioned the Court to redetermine respondent’s determinations

of the following deficiencies in Federal income tax, addition to

tax, and accuracy-related penalties:

     Joseph J. House, docket No. 8664-98

                                           Accuracy-related penalty
     Year                 Deficiency            Sec. 6662(a)

     1994                  $32,921                 $6,584
                                - 3 -

     Joseph J. House Inc., docket No. 8665-98

Year ended               Addition to tax    Accuracy-related penalty
 June 30       Deficiency Sec. 6651(a)(1)          Sec. 6662(a)

   1994         $39,723        $9,931                  $7,945

     By amendment to answer in docket No. 8664-98, respondent

affirmatively asserted that petitioner was liable for an

increased deficiency in tax and that petitioner was liable for

the fraud penalty.1    On brief, respondent conceded the deficiency

in tax, addition to tax, and accuracy-related penalty in docket

No. 8665-98.    Following concessions of the parties, we decide the

following issues:

     1.   Whether petitioner had unreported income for 1994

related to his accounting business.     We hold he did to the extent

set forth herein.

     2.   Whether petitioner is liable for the fraud penalty.   We

hold he is.

     Unless otherwise indicated, section references are to

applicable provisions of the Internal Revenue Code, Rule

references are to the Tax Court Rules of Practice and Procedure,

and dollar amounts are rounded.



     1
      Respondent asserted in his amendment to answer that
petitioner failed to report $156,197 in gross receipts instead of
$77,550 as determined in the notice of deficiency, and he
asserted that the entire deficiency resulting therefrom was
attributable to fraud. Respondent did not set forth a specific
dollar amount for the increased deficiency or the fraud penalty,
stating that the amounts were computational.
                               - 4 -

                         FINDINGS OF FACT

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

The stipulated facts and exhibits submitted therewith are

incorporated herein by this reference.    Petitioner resided in

Lockport, Illinois, when he petitioned the Court.

     Petitioner has been an accountant and tax return preparer

for over 28 years, and he has a bachelor’s degree in accounting

from Lewis College in Lockport, Illinois.    Petitioner worked as a

revenue agent for the Internal Revenue Service (the Service) for

5 years in the 1970's.   While he was at the Service, his duties

included auditing Federal income tax returns of individuals and

corporations.   Petitioner has prepared thousands of Federal

income tax returns in his career, and he is knowledgeable about

the Federal income tax laws.   Petitioner has also set up hundreds

of corporations for various individuals, and he serves as

registered agent for at least 163 of these corporations.

     Petitioner is married to Charlene House (Charlene), and they

have two sons, Craig House (Craig) and Tim House (Tim).    Craig

was a construction worker in 1994, and he built at least two

homes during 1992 through 1994.   Tim was a college student at the

University of Central Florida in 1994.    During all relevant

times, petitioner, Charlene, and Craig lived at 210 Muehl,

Lockport, Illinois (Muehl residence).    The Muehl residence was
                               - 5 -

owned by Lewis Simmons (Simmons), who rented the residence to

petitioner.

     Petitioner incorporated JJH in 1985 purportedly to conduct

his tax return preparation business.    At all relevant times,

JJH’s address and business location were at the Muehl residence.

The Muehl residence has three levels:    A basement, a main floor,

and an upstairs floor where the bedrooms are located.    Petitioner

conducted his return preparation business in the basement, and he

saw clients at his office in the basement.

     Tim has been collecting Walt Disney toys and characters

since he was very young, and his collection today includes

numerous figurines and other collectible items of a variety of

sizes and types (Disney collection).    Petitioner is similarly

intrigued with Mickey Mouse, Donald Duck, and the Walt Disney

fantasy, and he enjoys sharing his affinity for these characters

with others.2   When Tim left home for college, he left behind his

Disney collection, and petitioner displays the Disney collection

throughout the basement where he meets tax and accounting

clients.

     During all relevant periods, petitioner was the beneficial

owner of all JJH’s stock.   Petitioner did not have an employment

contract with JJH, and he was not an employee of JJH.    JJH had no



     2
      For example, petitioner submitted his brief to the Court on
a diskette bearing Mickey Mouse’s image.
                                 - 6 -

employees and no officers or directors.   When clients obtained

petitioner’s services, they did not execute an engagement

contract with JJH, and the clients did not recognize JJH as the

service provider.   JJH did not have a rental agreement for its

office space from Simmons; Simmons had a verbal agreement with

petitioner to rent the entire house to petitioner.   JJH did not

engage in a business activity.

     Charlene made fabric and wood country crafts that she sold

to craft malls.   Petitioner and Charlene incorporated Char’s

Country Accents, Inc. (CCA), in 1986 to operate this business.

Charlene and Craig were the owners and officers.   CCA’s address

and location were at the Muehl residence.

     In 1987, petitioner incorporated an entity he called Coastal

Leasing (Coastal) to conceal his assets from the Service.

Coastal’s address was the Muehl residence.   Coastal did not

conduct any business activity, and petitioner used Coastal to

circulate funds among and between his other entities and his

family members.   By 1994, petitioner allowed Craig to operate his

construction activities under the Coastal name to give the

appearance that Craig was a mature individual with his own

construction company.
                                - 7 -

The Bank Accounts

     Neither petitioner, Charlene, nor Craig maintained any

personal checking accounts of any kind.    Petitioner transferred

funds freely among JJH, CCA, and Coastal, as he saw fit.

     1.   JJH Account—Petitioner opened an account in the name of

JJH in 1985 (JJH account) over which he had signature authority,

and this account remained open throughout 1994.    Petitioner used

the JJH account as his personal and business account, and he paid

all business and personal expenses from this account.   Charlene

also had access to the account and used it to pay some of her

personal expenses.   Petitioner deposited all income generated from

his return preparation business into the JJH account.   Petitioner

did not designate what amounts in the account, if any, were salary

or other income to him, and he did not document whether expenses

paid from the account were business or personal.   Petitioner

commingled his personal income and expenses with his business

income and expenses without limitation.

     As relevant herein, petitioner wrote a total of $150,208 in

checks from the JJH account.   Of the total, $47,105 related to

expenses of operating petitioner’s return preparation business, and

the $103,103 balance related to personal living expenses of

petitioner and his family.

     For 1994, total deposits to the JJH account were $176,547,

comprising $144,812 in gross receipts and $31,735 in transfers

from CCA’s and Coastal’s accounts.   Petitioner withdrew virtually
                                 - 8 -

all of those deposits by either check or withdrawal, leaving a 1994

ending balance of $853.    The following is a summary of the checks

drawn on the JJH account during 1994:
     PAYEE/CATEGORY        AMOUNT        PERSONAL   BUSINESS

Petitioner                  $4,680        $4,680       -0-
Charlene                     7,725         7,725       -0-
Coastal                     18,525        18,525       -0-
CCA                          8,375         8,375       -0-
Craig                        1,950         1,950       -0-
Tim                         14,454        14,454       -0-
Walt Disney World            4,869         4,869       -0-
Utilities1                   6,768         4,125     $2,643
Lewis Simmons2               8,780         5,853      2,927
Internal Revenue Service     4,570         4,570       -0-
Other3                      63,514        21,979     41,535
  Total                    144,210        97,105     47,105
     1
      The total electric, gas, and water bills of the Muehl
residence were $3,948. We allocate one-third to business use and
two-thirds to personal use as there are no separate meters for
the basement of the residence, and petitioner has provided no
credible evidence that this allocation, which was proffered by
respondent, is improper. The balance of the utilities expense
comprises telephone expenses allocated $1,362 to personal use and
$1,458 to business use.
     2
      This represents rent for the Muehl residence, allocated
one-third to business and two-thirds to personal.
     3
      We allocate the following payment categories 100 percent to
personal: River Park Apts, $1,360; insurance, $8,631; medical,
$2,130; misc. expenses petitioner admits are personal, $3,621.
We allocate the following payment categories 100 percent to
business: Charles Losa, $5,276; Tax Court, $300; Dir. of Labor,
$39; misc. payments, $10,581; Office Max, $598; S.W. Financial,
$1,818; various individuals, $3,677; Cindy Manzzi, $4,485;
Postmaster, $2,526. On the basis of a reasonable estimation and
lack of exact substantiation in the record, we allocate the
following payment categories 50 percent to business and 50
percent to personal (amount stated is the total expense): Credit
cards, $6,468; Hintze Auctions, $4,360; cable, $953; automotive
related, $12,690.
                               - 9 -

None of the above personal expenses were ordinary and necessary

business expenses of JJH or petitioner.   The checks to

petitioner, Charlene, Coastal, CCA, and Craig were for the

personal use of petitioner and his family.   The checks to Tim and

the University of Central Florida were for Tim’s tuition, room

and board, and other college expenses.    The automotive expenses

included petitioner’s monthly car payments, payments for gas, and

car maintenance expenses.   The payments to the IRS were payments

for petitioner’s and Craig’s Federal income tax obligations.

     2.   CCA’s Account—CCA had a checking account over which

petitioner and Charlene had signatory authority.    Charlene used

this account as her personal checking account.    The deposits to

this account during 1994 included $16,100 in checks from JJH

written to Charlene and CCA and $9,000 in checks from Coastal.

Charlene also deposited receipts from her craft business into

this account, but she did not know what portion of the deposits

these receipts were.   During 1994, Charlene wrote approximately

$30,569 in checks from this account, including $9,400 in checks

to JJH, $7,700 in checks to Charlene or Coastal, and other

miscellaneous checks to cover personal living expenses.

     3.   Coastal’s Account—Coastal had a checking account over

which Charlene and Craig had signatory authority, but petitioner

was in control of the account, and Charlene and Craig obtained

petitioner’s approval before using the funds.    The Coastal
                               - 10 -

account served primarily as a “clearing account” through which

petitioner circulated funds for the purpose of paying Craig’s

personal and construction expenses, and other personal expenses

of petitioner’s family.    During 1994, the deposits into Coastal’s

checking account consisted of primarily checks written from JJH

and also included checks from CCA and a small amount of

unidentified deposits.    The transfers from JJH’s account were not

loans, and the transfers were not related to petitioner’s

accounting business.3    Craig used the funds in the Coastal

account to pay some of his personal living and construction

expenses and to funnel money to other family members.    During

1994, Craig wrote a total of $39,863 in checks from this account,

including $22,335 in checks to JJH and $11,920 in checks to

petitioner, Charlene, CCA, and Craig.

Tax Reporting

     Petitioner—Petitioner filed a 1994 income tax return

claiming married filing separate status.    Charlene did not file a

return for 1994.   On his 1994 return, petitioner reported no

salary, wages, dividends, or other compensation from JJH.      He

reported total income of $31,500, comprising $1,000 Schedule C

income, $10,000 rent income, $3,000 capital gain income, and

$17,500 as income from a covenant not to compete.    On the



     3
      Petitioner admitted these transfers were made “on the basis
of an affinity, of a relationship” between him and his family.
                                - 11 -

Schedule C attached to his return, petitioner stated that he was

an “accountant”, and that his business name was “House

Accountant”.   Petitioner failed to provide a complete business

address but stated his office was in Lockport, Illinois.

     JJH—Petitioner prepared and filed returns for JJH for the

fiscal years ending June 30, 1994 and 1995, reporting that the

business activity of JJH was “sales” and the product or service

was “process”.     For these years, petitioner reported the gross

receipts from his accounting business on JJH’s returns, reporting

gross receipts of $156,197 and $152,340, respectively.     These

gross receipts equaled the total deposits into the JJH account

for both years.4    In reporting the total bank deposits as gross

receipts, petitioner was aware he was including transfers from

CCA’s and Coastal’s accounts.     In each year, petitioner claimed

on JJH’s return deductions and cost of goods sold in excess of

the gross receipts, and JJH paid no tax in either year.     The

claimed deductions and cost of goods sold included the checks

drawn for business and personal items of $150,208 as set forth

above for calendar year 1994.

     CCA’s Returns—Petitioner prepared and filed a return on

behalf of CCA for 1994, reporting gross receipts of $66,994,

expenses and cost of goods sold of $68,358, and no taxable



     4
      For the calendar year 1994, the reported gross receipts
equal the $176,547 in deposits identified above.
                               - 12 -

income.   Charlene had no idea what these figures comprised or

whether the reported gross receipts, expenses, and cost of goods

sold were accurate.   Most of the $68,358 claimed on CCA’s return

was listed as cost of goods sold, and a large portion of the cost

of goods sold figure represented personal living expenses of

petitioner and Charlene.5

     Coastal’s Return—Petitioner prepared and filed Coastal’s

returns for fiscal years ended June 30, 1994 and 1995, reporting

as gross receipts $23,056 and $94,952, respectively.    In both

years, the reported expenses exceeded the reported gross

receipts, and Coastal reported no taxable income and paid no tax.

Craig signed the returns but had no idea where the reported

income came from or whether it was accurate.    The reported gross

receipts comprised primarily checks and transfers from JJH’s

account to Coastal.

The Audit

     Revenue Agent Ruby Townsend (Townsend) conducted the audits

of petitioner’s and JJH’s returns at issue.    Petitioner was

uncooperative with Townsend.   Townsend repeatedly requested to

meet with petitioner and requested that petitioner provide

documents to substantiate the items on his return and JJH’s



     5
      Charlene admitted that she used the funds in the CCA
account for personal purposes, and there is insufficient evidence
in this record to determine what items, if any, were business
related.
                               - 13 -

return.   After refusing several times to meet with Townsend,

petitioner reluctantly appeared for a meeting wherein he provided

no documents.

Respondent’s Determination

     Respondent determined petitioner had unreported income in

1994 of $81,879, computed as follows:

     Deposits to JJH’s account                     $176,547
     Less: Transfers from CCA                        (9,400)
     Less: Transfers from Coastal                   (22,335)
     Total gross receipts                           144,812

     Less: Business expenses                        (31,433)
     Taxable income                                 113,379

     Less:   Reported income                        (31,500)
                                                     1
     Unreported Income                                81,879
     1
      This figure is respondent’s revised determination set forth
on brief and is less than the amount he set forth by amendment to
answer.

Respondent determined that JJH is a sham and should be

disregarded for tax purposes, or, alternatively, that petitioner

improperly assigned his income to JJH.

                               OPINION

Economic Reality of JJH

     Petitioner was a knowledgeable former Internal Revenue

Service agent who devised a deceitful plan to divert and disguise

his income and used his insight and skill in an attempt to avoid

detection.
                               - 14 -

     We first decide whether JJH should be disregarded for tax

purposes.   According to respondent, it should because it lacked

economic substance and is a sham.    We agree.   The burden of proof

is split in this case.    Petitioner has the burden of proof as to

the $77,550 in unreported income respondent determined in the

notice of deficiency.    See Rule 142(a).   Respondent has the

burden of proof as to the $4,328 increase in unreported income6

and as to fraud.   See Rule 142(a) and (b).

     There is no dispute that JJH was properly organized under

Illinois law.   However, even though a corporation is organized

under the laws of a State, we may disregard it for Federal tax

purposes if it is no more than a vehicle for tax avoidance and

void of a legitimate business purpose.      See Gregory v. Helvering,

293 U.S. 465 (1935); American Sav. Bank v. Commissioner, 56 T.C.

828, 838 (1971); Aldon Homes, Inc. v. Commissioner, 33 T.C. 582

(1959).   While a taxpayer is free to adopt the corporate form of

doing business, a corporation must engage in some meaningful

business activity to be recognized as a separate entity for tax

purposes.   See Moline Properties, Inc. v. Commissioner, 319 U.S.

436 (1943); Achiro v. Commissioner, 77 T.C. 881 (1981).     Avoiding

taxation is not a business activity.    See National Carbide Corp.



     6
      On brief, respondent maintains that petitioner’s unreported
income was $81,879, leaving respondent with the burden of proof
on $4,328, the excess over the $77,550 determined in the notice
of deficiency.
                              - 15 -

v. Commissioner, 336 U.S. 422, 437 n.20 (1949); Higgins v. Smith,

308 U.S. 473 (1940); Gregory v. Helvering, supra.    On this

record, we find that JJH lacked economic substance and was merely

a paper entity that engaged in no meaningful business activity.

     The purported purpose of JJH was to render accounting

services, yet it had no employees to carry out this purpose.7

Petitioner admits he was not an employee of JJH, testifying at

trial:   "As Joseph J. House, the individual, I was not an

employee.   I did not consider myself an employee of Joseph J.

House, Inc.   I considered myself an independent contractor”.      To

the extent petitioner suggests he was acting on behalf of JJH as

an independent contractor, we are not persuaded.    Petitioner was

acting on behalf of himself individually when he rendered

services to clients.   There was no employment or agency contract

between petitioner and JJH.   There is no credible evidence that

there was a relationship between JJH and petitioner’s clients or

that the clients recognized JJH as the service provider.     The

relationship was directly between petitioner and his clients.

Petitioner’s clients paid petitioner directly.   JJH did not pay

petitioner compensation for his services and did not issue him a

Form 1099 or W-2.   To embrace petitioner’s argument, we would


     7
      Petitioner reported a negligible amount of wages paid on
JJH’s returns but does not argue these wages were paid to him,
and the record does not disclose who purportedly earned them.
Petitioner has not suggested that JJH’s payment of personal
expenses constitutes compensation.
                                - 16 -

have to find that he worked for JJH without compensation.       We

decline to do so.

     Petitioner did not respect the separateness of JJH, and he

commingled his income and expenses with JJH’s.     Petitioner

maintained no personal checking accounts, and he treated JJH’s

account as his own.    Petitioner had dominion and control over the

account, and he readily admits that he used it as his own,

boasting at trial:    “my home, my style of living, is paid for by

Joseph J. House, Inc.”, and that "personal checkbooks are not a

good thing".    See Denali Dental Services v. Commissioner, T.C.

Memo. 1989-482 (corporation a sham where its checking account was

used as a “pocketbook” for payment of shareholder’s personal

expenses).     JJH did not keep separate books and records of the

deposits, checks, transfers, or withdrawals from JJH’s account to

differentiate between business and personal income and expenses.

Instead, petitioner treated his affairs as one and the same with

JJH’s.

      JJH had no management other than petitioner, and petitioner

acknowledged that he was in complete control of JJH.

Petitioner’s contention that Charlene and Craig were officers of

JJH does not stand up in the face of the evidence, which shows

that they had nothing to do with its activities.     In discussing

the use of the family corporations, petitioner admitted that

"This whole operation, this whole function, is my responsibility
                              - 17 -

* * *. These people [Charlene and Craig] don't understand what's

going on.   They're part of it, they benefit from it, and they

don't understand”.   Charlene’s testimony corroborates

petitioner’s admission as she was obviously unfamiliar with JJH.

Charlene did not know what JJH’s assets were, and she had no idea

whether it operated at a profit or loss.    What Charlene did know

about JJH was that it had a checking account from which she could

withdraw funds.   Her knowledge about JJH’s affairs stopped there.

Craig knew even less about JJH, admitting that he does not recall

how or why he became an officer and that petitioner just said

“this is what we’ll do”.   Petitioner’s attempt to lend legitimacy

to the arrangement by naming his family members as officers of

JJH is unavailing.

     JJH did not contract with Simmons for rental of the Muehl

residence; petitioner did, and Simmons believed the rent checks

were personal payments from petitioner.    Petitioner prepared

Simmons’ tax returns, and Simmons considered petitioner

individually his “tax person”.   JJH did not have services or

utilities (e.g., telephone and electric) billed in its name, and

there is no other credible evidence that it contracted with third

parties or held itself out to the public as a business.    The only

activity in which JJH engaged was receiving, spending, and

circulating the funds earned by petitioner.    JJH was essentially

a conduit through which petitioner moved funds.    Petitioner
                                - 18 -

admitted JJH “repetitively and continuously, in the normal course

of its business, transfers money to account of Coastal Leasing;

it transfers money to the account of Char’s Country Accents;

transfers money to and from Joseph Craig House, the individual”.

We find no business purpose for this circular flow of funds.

     In substance, there really was no JJH; there was only

petitioner.   Petitioner recognized JJH once a year, at tax time,

and the fact that petitioner so recognized it and filed returns

on its behalf fails to legitimize its existence.   As outlined

above, JJH was little more than a clearing account through which

petitioner moved funds, and the returns were the vehicle through

which petitioner improperly reported the flow of funds and

payment of personal expenses to avoid taxes.   Petitioner did not

respect the separateness of JJH, nor do we.    We disregard JJH for

tax purposes, and we hold that petitioner had unreported income

in the amount of $66,207 determined as follows:

     Deposits to JJH’s account                      $176,547
     Less: Transfers from CCA                         (9,400)
     Less: Transfers from Coastal                    (22,335)
     Total gross receipts                            144,812

     Less: Business expenses                         (47,105)
     Taxable income                                   97,707

     Less:    Reported income                        (31,500)
                                                      1
     Unreported income                                 66,207
     1
      This figure is less than the unreported income figure of
$81,879 advanced by respondent on brief because of our finding
petitioner is entitled to additional business expenses.
                              - 19 -

We sustain respondent’s determination of unreported income to the

extent of $66,207.

     Petitioner maintains that buried somewhere in JJH’s large

cost of goods sold figure are several other business expenses

which are deductible, in addition to the expenses of $47,105

allowed above.   We have carefully reviewed all arguments made by

petitioner as to his expenses, and we are unpersuaded that he had

business expenses greater than the amounts decided herein.     For

example, petitioner argues that in 1990, JJH obtained a covenant

not to compete from petitioner for $105,000 to be paid over a 6-

year period, and that $17,500 of the cost of goods sold

represents a payment under the covenant.   Purportedly, petitioner

sold his stock in JJH to a friend, Charles Losa (Losa), in

exchange for $1,000 and a covenant not to compete.8   We are

unpersuaded and find petitioner’s testimony and documentary

evidence on this point not credible.   We have already found that

petitioner remained the beneficial owner of the JJH stock at all

times, and petitioner’s contention that he transferred anything

other than nominal title to the stock is not credible.    Losa

admitted that he was a shareholder in “name only” and that the

transfer was effected to get assets out of petitioner’s name


     8
      The purported covenant provides that petitioner will not
compete with JJH for 6 years within a 50-mile radius of the Muehl
residence. Petitioner is precluded from engaging in the
following activities: “Accounting Work, Bookkeeping, Financial
Consulting, Tax Preparation & Advice, Consulting, Service”.
                               - 20 -

because of his tax problems.   Further, the purported covenant is

an unsigned document with no effective date, and it does not

identify to whom the covenant is granted.     Most telling,

petitioner’s conduct belies the existence of the covenant.      He

engaged in an accounting and tax business within the prohibited

territory during the entire prohibited period.     Petitioner’s

contentions as to the covenant are meritless.

     Petitioner attempts to legitimize the payments made by JJH

to Tim and the University of Central Florida by arguing the

payments were attributable to a lease between JJH and Tim for the

use of Tim’s Disney collection.   Petitioner asserts that JJH made

payments for the lease of Mickey Mouse, Donald Duck, Goofy, and

other colorful Disney characters in his basement office as bona

fide business expenses.   Petitioner’s story is as fantastic as

the Disney characters themselves.   Petitioner did not know the

value of the collection or how many items were in the collection,

and there is no evidence the Disney collection furthered any

advertising goal.   Charlene’s testimony that she engaged in bona

fide negotiations with Tim with respect to a lease price on New

Year’s Day in 1993 is not credible.     The lease document is

concocted and back dated, and the stated rent of $1,000 per month

bears no relation to the actual payments made to Tim or to the

University of Central Florida.
                              - 21 -

     Petitioner argues that the payments by JJH to CCA, Coastal,

and Craig were deductible because JJH transferred funds to these

entities “in the normal course of its business”.    We disagree.

Petitioner has put forth no credible evidence that these payments

by JJH to these entities or to Craig are deductible.    To the

contrary, petitioner’s own statements support our finding that

the funds were circulated without a business purpose to fund

petitioner’s personal expenses.    We reject petitioner’s argument

that the amounts paid to Simmons are deductible interest

payments.   Simmons admitted he rented the Muehl residence to

petitioner, and the fact that Simmons reported the payments from

petitioner as “interest” on his return is unpersuasive since it

was petitioner who prepared this return.   Finally, petitioner

argues generally that all amounts paid by JJH are deductible

because “Personal living expenses, when provided by an employer,

are not income to the person who receives it”.   Petitioner’s

argument is without merit, and, on the basis of his knowledge and

experience, petitioner knows it.    We find all other testimony and

evidence not discussed herein in favor of additional deductions

to be unpersuasive or incredible.

Fraud Penalty Under Section 6663

     We turn now to the fraud penalty.   Respondent bears the

burden of proving by clear and convincing evidence that

petitioners are liable for the penalty for fraud.    See sec.
                               - 22 -

7454(a); Rule 142(b); Toussaint v. Commissioner, 743 F.2d 309,

312 (5th Cir. 1984), affg. T.C. Memo. 1984-25; Wright v.

Commissioner, 84 T.C. 636, 639 (1985).    Respondent must meet this

burden through affirmative evidence because fraud is never

imputed or presumed.    See Toussaint v. Commissioner, supra at

312; Beaver v. Commissioner, 55 T.C. 85, 92 (1970).    The

existence of fraud is a question of fact to be resolved from the

entire record.   See Gajewski v. Commissioner, 67 T.C. 181, 199

(1976), affd. without published opinion 578 F.2d 1383 (8th Cir.

1978).    Petitioners’ entire course of conduct can be indicative

of fraud.    See Stone v. Commissioner, 56 T.C. 213, 224 (1971);

Otsuki v. Commissioner, 53 T.C. 96, 105-106 (1969).

     To satisfy his burden of proof, respondent must show two

things.    First, respondent must prove that an underpayment

exists.    Respondent may not rely on petitioner’s failure to

disprove a deficiency determination to satisfy this element.      See

Drieborg v. Commissioner, 225 F.2d 216, 218 (6th Cir. 1955),

affg. in part a Memorandum Opinion of this Court; Parks v.

Commissioner, 94 T.C. 654, 660-661 (1990); Petzoldt v.

Commissioner, 92 T.C. 661, 700 (1989).    Second, respondent must

show that petitioners intended to evade taxes known to be owing

by conduct intended to conceal, mislead, or otherwise prevent the

collection of taxes.    See Stoltzfus v. United States, 398 F.2d

1002, 1004 (3d Cir. 1968); DiLeo v. Commissioner, 96 T.C. 858,
                              - 23 -

874 (1991), affd. 959 F.2d 16 (2d Cir. 1992); Rowlee v.

Commissioner, 80 T.C. 1111, 1123 (1983).

     To satisfy the first prong, there must be clear and

convincing evidence to support respondent’s determination of an

underpayment; i.e., clear and convincing evidence that JJH was a

sham and that the income generated from petitioner’s accounting

services belonged to him.   This prong must be satisfied with

affirmative proof, and a taxpayer’s failure to meet his or her

burden of proof alone will not suffice.    We find such clear and

convincing evidence here.   Much of this evidence came directly

from petitioner’s own testimony, including petitioner’s

admissions that:   He was not an employee of JJH; he paid his

personal expenses from JJH’s account; the purported officers of

JJH, Charlene and Craig, knew nothing about JJH; he moved funds

in a circular manner among the accounts of JJH, CCA, and Coastal;

and he fabricated the numbers and categories on his 1994 return

(see discussion of fraud below).   These admissions together with

the other evidence detailed under our discussion of the

deficiency are clear and convincing affirmative evidence that

petitioner underpaid his 1994 taxes.

     With respect to the second prong of the fraud test; i.e.,

that petitioner had the requisite fraudulent intent, fraud may be

proven by circumstantial evidence because fraud can rarely be

established by direct proof of the taxpayer’s intention.   See
                                - 24 -

Rowlee v. Commissioner, supra at 1123.    Courts have developed

various factors or “badges” which tend to establish fraud.      Some

of the “badges of fraud” are:    (1) Understating income, (2)

maintaining inadequate records, (3) failing to file tax returns,

(4) giving implausible or inconsistent explanations of behavior,

(5) concealing assets, (6) failing to cooperate with tax

authorities, (7) engaging in illegal activities, (8) attempting

to conceal activities, (9) dealing in cash, and (10) failing to

make estimated tax payments.    See Bradford v. Commissioner, 796

F.2d 303, 307-308 (9th Cir. 1986), affg. T.C. Memo. 1984-601;

Clayton v. Commissioner, 102 T.C. 632, 647 (1994).    We consider

this list nonexclusive, and we take into account all the unique

facts and circumstances of every case in determining whether

fraudulent intent exists.

     After examination of some of the applicable factors above as

well as other factors in this case, we conclude respondent has

satisfied his burden of proving fraud.    Petitioner is a former

Internal Revenue Service agent, which gives him insight into

audit techniques and the Service’s means of detecting inaccurate

returns.   He has practiced as a return preparer and accountant

for over 20 years, and he is knowledgeable about tax law.

Petitioner put his knowledge and insight to use and tried to

disguise his income to underpay his taxes, and he tried to

circumvent detection of his deceit by the Service.    In filing his
                              - 25 -

return for 1994, petitioner knew he was not reporting his income

from his accounting business or the income attributable to JJH’s

payment of his personal expenses, and he knew this was contrary

to the tax law.   See Taxpayers Assistance Corp. v. Commissioner,

T.C. Memo. 1988-343 (taxpayer’s background and experience taken

into account as evidence of fraud).

     Petitioner used JJH, CCA, and Coastal to conceal his income

and personal expenses.   The corporations were a critical part of

his scheme.   Petitioner frequently circulated funds among JJH,

Coastal, and CCA for no business purpose and then used the funds

in these accounts to pay personal expenses.   JJH’s and Coastal’s

bank accounts were petitioner’s and Charlene’s personal

pocketbook.   CCA’s bank account was also Charlene’s personal

pocketbook, and petitioner funneled money from JJH and Coastal to

this account to fund Charlene’s expenditures.   The use of a

corporation to disguise the personal nature of income and

expenses is evidence of fraud.   See Truesdell v. Commissioner, 89

T.C. 1280, 1302-1303 (1987); Benes v. Commissioner, 42 T.C. 358,

383 (1964), affd. 355 F.2d 929 (6th Cir. 1966).

     Petitioner claimed the living expenses detailed in our

findings of fact as business expenses on JJH's return, concealing

them as cost of goods sold.   Petitioner deliberately

mischaracterized JJH’s business activity on its returns to create

the appearance JJH was a merchandise business rather than a
                                - 26 -

service business, stating that JJH’s business activity was

“sales”, and that the product or service was “process”.     In so

mischaracterizing, petitioner intended that a large portion of

the personal expenses be buried in cost of goods sold, minimizing

the possibility that the personal nature of the expenses would be

detected.9    These claims were false and petitioner knew it.10

Petitioner’s testimony that “any personal expenses that are paid

by the corporation are not deducted by the corporation" is not

credible.    Finally, petitioner’s failure to include in his income

JJH’s payment of his personal expenses resulted in a large

understatement of his income.

     Petitioner failed to maintain adequate records of his income

and expenses.    Petitioner maintained three corporate checking

accounts from which he paid all business and personal expenses,

and he maintained no records to determine which expenses were

business or personal.    The records petitioner did keep were

inadequate.    Petitioner purportedly maintained a ledger for his

“draw account” from JJH.    This ledger recorded negligible amounts

as “drawn” by petitioner, did not include JJH’s payment of the


     9
      Petitioner was aware that the largest expense of a
merchandising business is generally cost of goods sold, and he
knew a large cost of goods sold was less likely to “red flag” his
return than larger expenses elsewhere on the return.
     10
      As just one example, petitioner admitted that the
insurance paid by JJH to Prudential was a personal expense, and
that he deducted it anyway, stating: “It’s not probably
technically, in the truest accounting sense a good thing to do”.
                               - 27 -

personal expenses, and did not correlate with the numbers on

petitioner’s return.

     Petitioner admits he engaged in a pattern of concealing

assets from the Service, and he was not reluctant to acknowledge

his disdain for paying taxes, bragging at trial that he formed

Coastal to hide his assets from the Service.

     Petitioner failed to cooperate during the audit, and his

claim that the flood of the Muehl residence prevented him from so

doing is not credible.   The flood did not destroy relevant

documents requested by respondent, such as bank statements,

canceled checks, or deposit slips, as evidenced by the fact

petitioner was able to produce these documents close to trial.

     Petitioner precisely included in the income of JJH all

amounts deposited into its bank account, notwithstanding the fact

that he knew he was including transfers between accounts and

double counting income.11   Petitioner points to this as evidence

there was no intent to deceive.   To the contrary, this was part

of the deception plan.   Petitioner admitted that he knew a tax

auditor would always compare bank statements with reported

receipts.   Petitioner’s ensuring that the numbers matched was his

attempt to deceive the Service into believing his return and



     11
      Petitioner testified: “Now, the problem with that income
is that it includes transfers and/or loans and/or exchanges of
money between those corporations of Joseph House, Coastal Leasing
and Char’s”.
                              - 28 -

JJH’s return were accurate.   This double counting of income was

of no consequence to petitioner since he managed to manipulate

the numbers on all returns to the point where there was little to

no taxable income.

     Petitioner intentionally mischaracterized items of income on

his 1994 return.   He reported total income of $31,500, comprising

$1,000 Schedule C income, $10,000 rent income, $3,000 capital

gain income and $17,500 as income from a covenant not to compete.

At trial, he admitted these categories were all concocted,

stating: “I don't mind giving you [IRS] the elbow, but I'm not

going to lie to him [the Court]”.   Petitioner mischaracterized

his income to avoid self-employment tax and to deter the Service

from discovering unreported income related to JJH.   Petitioner’s

lack of candor was prevalent throughout the discovery process and

trial.12

     Petitioner filed a separate return to avoid payment of taxes

on the unreported income in the event he got caught.13



     12
      By interrogatory, respondent asked why JJH paid the
University of Central Florida, and petitioner stated the payments
were for “equipment rental”. When questioned on cross-
examination about why JJH paid petitioner’s personal living
expenses, petitioner stated: “I've got to live somewhere".
     13
      Charlene did not file and testified that she bought her
husband out of JJH and took his name off everything including the
CCA signature card because of the IRS collection activity. In
avoiding the joint and several liability of a joint return,
petitioner hoped to remain free to transfer assets and income to
Charlene to frustrate the Service’s collection activities.
                                - 29 -

Petitioner’s attempt to legitimize JJH’s payment of personal

expenses with his fabricated Disney collection lease story and

the covenant not to compete story is further evidence of

petitioner’s fraudulent intent.     These concocted stories show

petitioner does not hesitate to manufacture facts and events to

further his interests.14

     Petitioner’s fraudulent scheme was not just a family affair,

and he recommended it to others.     He set up 163 corporations for

other taxpayers.     In at least one such case where the Service

challenged the personal expenses paid by the corporation and

deducted as cost of goods sold, petitioner advised his clients to

settle, stating: “Hey, we got away with it for ten years, it's

time”.     At trial, petitioner proudly stood by his prior

statement, bragging: “it was good advice then and I stand by it

now”.

     We conclude on this record that “it’s time” for petitioner

also.     Respondent has proven by clear and convincing evidence

that petitioner underreported his income in 1994 with the

fraudulent intent of evading taxes.      We sustain respondent’s

determination as to fraud.



     14
      Petitioner similarly disliked having to pay out-of-State
tuition for Tim at the University of Central Florida, so he
perpetuated the Disney collection lease scheme to create the
appearance that Tim was self-sufficient and had fixed income.
This allowed Tim to obtain residency status for tuition purposes.
                             - 30 -

     We have considered all other arguments advanced by

petitioner for a contrary result and, to the extent not discussed

herein, find them to be irrelevant or without merit.

                                   Decision will be entered under

                              Rule 155 in docket No. 8664-98;

                              decision will be entered for

                              petitioner in docket No. 8665-98.
