                        T.C. Memo. 2000-213



                      UNITED STATES TAX COURT



           MANUEL AND MARGARET KARCHO, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 14400-96.                       Filed July 13, 2000.



     Erwin A. Rubenstein and Robert W. Siegel, for petitioners.

     Timothy S. Murphy, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     GALE, Judge:   Respondent determined the following

deficiencies, additions to tax, and penalties with respect to

petitioners' Federal income taxes:
                                    - 2 -


                              Additions to Tax and Penalties
                            Sec.           Sec.        Sec.    Sec.
Year       Deficiency   6653(b)(1)(A) 6653(b)(1)(B) 6653(b)    6663

1987        $59,943       $44,957           *           --       --
1988         53,843           --            --       $40,382     --
1989         55,476           --            --          --   $41,607
1990         47,368           --            --          --    35,526
1991          2,842           --            --          --     2,132

* 50 percent of the interest due on $59,943.00 for the taxable
year 1987.

       Unless otherwise noted, all section references are to the

Internal Revenue Code in effect for the years in issue, and all

Rule references are the Tax Court Rules of Practice and

Procedure.

       After concessions,1 the remaining issues for decision are:

(1) Whether petitioners failed to report income from petitioner

Manuel Karcho's wholly owned S corporation of $143,552 for 1987,

$149,458 for 1988, $160,600 for 1989, $137,976 for 1990, and

$21,603 for 1991; (2) whether petitioners are liable for

additions to tax for fraud for 1987 and 1988, and for fraud

penalties for 1989, 1990, and 1991; and (3) whether the period of




       1
        Respondent concedes decreases in the deficiencies of
$21.10 for 1988, $916.73 for 1989, and $733.00 for 1991.
Petitioners concede that they failed to report gross receipts
from the sale of soft drinks, candy, and miscellaneous items of
$16,428.50 for 1987, $21,230.90 for 1988, $14,241.27 for 1989,
and $9,269.70 for 1990. Respondent concedes that petitioners are
entitled to additional costs of goods sold with respect to these
sales of $9,630.25 for 1987, $11,892.45 for 1988, $8,529.64 for
1989, and $5,981.85 for 1990.
                                - 3 -


limitations on assessment bars respondent’s determinations for

each year at issue.

                           FINDINGS OF FACT

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

incorporate by this reference the stipulation of facts,

supplemental stipulation of facts, and attached exhibits.

Petitioners Manuel Karcho and Margaret Karcho are husband and

wife who resided in Southfield, Michigan, at the time they filed

their petition.   Petitioners filed joint returns for the years in

issue.

     Mr. Karcho had emigrated from Iran at age 12 and had very

little formal education.    Mrs. Karcho, who emigrated from Malta

at age 11, completed a high school education in the United States

and during the years in issue was employed as a membership and

billing system analyst for a health insurance provider.

     During the years in issue Mr. Karcho, through his wholly

owned S corporation, Banner Amusement Enterprises, Inc. (Banner),

owned and operated an amusement arcade called the Space Station.

Mr. Karcho had previously been employed as a manager of the Space

Station before purchasing all of the stock of Banner in 1985 for

$25,000 in cash and a $25,000 note to the seller.    Mr. Karcho

continued to manage the operations of the arcade during the years

in issue, with some part-time help.     The arcade was open 7 days a

week.
                                - 4 -


       The arcade generated income primarily through the operation

of approximately 40 to 45 electronic games maintained for

customers, as well as from the sale of soft drinks, candy, and

miscellaneous items.    Customers purchased tokens to operate the

games from two token machines on the premises.    The token

machines accepted $5 and $1 bills, as well as quarters, and

dispensed a corresponding number of tokens.    The token machines

contained meters designed to record each insertion of a bill or

coin.

Meter Readings

       Twice each day, Mr. Karcho recorded the readings from the

meters in the token machines on a document labeled "Token

Machines-Meter Readings" (Meter Readings Sheet).    Each Meter

Readings Sheet listed the total number of times the meters

recorded the insertion of a $5 bill, $1 bill, or quarter during a

day.    The sheet in addition converted these currency totals into

a total cash figure.    Some of the Meter Readings Sheets also

contained entries at the bottom for individual electronic games

and for items identified only with initials.    Dollar figures were

recorded for these entries, which were added to the total cash

figure recorded for the day.    Mr. Karcho made such recordings on

the Meter Readings Sheets generally every day for each of the

years at issue.
                               - 5 -


Daily Income and Cash Receipt Records

     For each business day during the years in issue, Mrs. Karcho

prepared a document entitled “Daily Income Report” that recorded

a dollar figure equal to the amount of cash that Mr. Karcho

deposited into Banner’s bank account for that business day.    A

bank receipt for the amount of the deposit for each business day

was also retained.   The dollar figure on the “Daily Income

Report”, which was equal to the bank deposit, was substantially

less than the total cash figure recorded on the Meter Readings

Sheet for the same day.   In addition, Mrs. Karcho prepared daily

records labeled “Cash Receipts” which listed the daily figure for

the bank deposit (under “Bank Deposit”) and purported to break

this figure down into components, based on the source of the

income, labeled “Arcade Game Income”, “Food & Pop Sales”, as well

as other sales, cash amounts, and receipts.   The daily amounts

recorded for “Arcade Game Income” by Mrs. Karcho were

substantially less than the corresponding daily total cash

figures recorded on the Meter Readings Sheets by Mr. Karcho.

With respect to the amounts recorded by Mrs. Karcho as “Food &

Pop Sales”, petitioners have now conceded that these amounts

understated the proceeds from Banner’s sale of food items by

$16,428.50 in the 1987 taxable year, $21,230.90 in 1988,

$14,241.27 in 1989, and $9,269.70 in 1990.
                                 - 6 -


     The foregoing Daily Income and Cash Receipts records were

provided by petitioners to their accountant for purposes of

preparing Banner’s Federal income tax returns covering each of

the years in issue.    The returns reported Banner’s gross receipts

as equal to the amounts deposited into Banner’s bank account.

Reconciliation Sheets

     Petitioners maintained another set of records during the

years in issue, also labeled “Daily Income Report”.    These

records, which for the sake of clarity we shall refer to as the

Reconciliation Sheets, generally contained entries, for each

business day, under headings labeled “Daily Income”, “Deposit”,

“Part-Time”, and “Net Income”.    In contrast with the “Daily

Income” figures recorded on the Daily Income Report/Cash Receipts

records described above, which treated the day’s bank deposit as

equal to “Daily Income”, the entries under “Daily Income” on the

Reconciliation Sheets generally match the total cash figure from

the Meter Readings Sheet for the same day.    The entries under

“Deposit” generally match the day’s bank deposit.    The entries

under “Net Income” reflect the difference; i.e., the amount by

which the “Daily Income” entry exceeded the “Deposit” entry, less

any amount entered under “Part-Time” (which only occasionally

contained an entry).
                                 - 7 -


Representative Sample of Records

     A representative sampling of the various types of records

kept by petitioners, all covering the period March 9-15, 1987,

follows.

     The Meter Readings Sheets for this period contain, inter

alia, the following entries:

             Day                 Date          Total cash figure

           Monday        March    9,    1987        $558.25
           Tuesday       March   10,    1987         613.00
           Wednesday     March   11,    1987         577.00
           Thursday      March   12,    1987         609.00
           Friday        March   13,    1987         813.25
           Saturday      March   14,    1987       1,174.00
           Sunday        March   15,    1987         937.25

The “Daily Income Report” and “Cash Receipts” entries for the

same period were:

                       Daily Income Report

             Day                 Date          Total Deposit

           Monday        March   9, 1987          $375.00
           Tuesday       March   10, 1987          352.00
           Wednesday     March   11, 1987          369.00
           Thursday      March   12, 1987          393.00
           Friday        March   13, 1987          413.14
           Saturday      March   14, 1987          400.00
           Sunday        March   15, 1987          394.62
                                        - 8 -



                                   Cash Receipts1
                                             Arcade    Food        Other Cash
             Deposit     Day of     Bank      Game     & Pop        Receipts
 Day           Date     Business   Deposit   Income    Sales    Amount Description

Monday       03/12/87   03/09/87   $375.00   $375.00    ---       ---    ---
Tuesday      03/12/87   03/10/87    352.00    352.00    ---       ---    ---
Wednesday    03/16/87   03/11/87    369.00    369.00    ---       ---    ---
Thursday     03/16/87   03/12/87    393.00    393.00    ---       ---    ---
Friday       03/16/87   03/13/87    413.14    413.14    ---       ---    ---
Saturday     03/16/87   03/14/87    400.00    350.00   $50.00     ---    ---
Sunday       03/19/87   03/15/87    394.62    394.62    ---       ---    ---
       1
        The entries under the "Food & Pop Sales" column of the cash receipts
records appeared each Saturday and generally showed a round figure between $30
and $70. Entries under the "Other Cash Receipts" column appeared infrequently
and generally recorded public telephone commissions or proceeds from the sale
of an arcade game.
      The record in this case contains only the “Cash Receipts” records for
1987, 1988, and 1989. Nonetheless, petitioners have stipulated that they
provided similar records to their accountant for each of the years in issue.

       The Reconciliation Sheets (which petitioners actually

labeled as “Daily Income Report”) contain the following entries

for the same period:

                Daily Income Report [Reconciliation Sheet]

                                     March 1987

                               Daily                            Part-       Net
                               Income           Deposit         Time       Income1

Monday, March 9               $558.00           $375.00          ---      $183.00
Tuesday, March 10              613.00            352.00          ---       261.00
Wednesday, March 11            577.00            369.00          ---       208.00
Thursday, March 12             609.00            393.00          ---       216.00
Friday, March 13               813.00            413.14        $59.50      340.36
Saturday, March 14          1,174.00             400.00        300.00      474.00
Sunday, March 15              957.62             394.62          ---       563.00

                          $5,301.62          $2,696.76     $359.50      $2,245.36
       1
           In some instances, this column was labeled “Net Cash”.
                                - 9 -


A review of the foregoing sampling shows that, on the

Reconciliation Sheet, the “Daily Income” figure ties to the daily

total cash figure on the corresponding day’s Meter Readings

Sheet, whereas the Daily Income Report and Cash Receipt entries

tie in only to the bank deposit figure.   Further, the Daily

Income Report and Cash Receipt entries tie in to each other in

the sense that the latter appears to be a breakdown, by source,

of the figures on the former.   Petitioners kept similar records

covering all of the periods in issue.

Search of Petitioners’ Premises and Records Seizure

     All of the records previously described were confiscated in

connection with a search of Banner’s business premises and

petitioners’ residence by respondent’s Criminal Investigative

Division (CID) in February 1991.   Also found among petitioners'

records was an adding machine tape prepared and labeled by Mrs.

Karcho as follows:



                          Pocket Money
                         #8*2386.......

                         7  9,643.46 +
                         6  9,530.22 +
                         5  7,505.18 +
                         4  9,567.25 +
                         3 10,945.88 +
                         2  8,971.98 +
                         1  7,857.06 +
                         12 7,075.68 +
                         11 7,245.60 +
                            78,342.31*
                                 - 10 -


                            Meter Reading

                           7     21,254.37   +
                           6     21,835.31   +
                           5     18,254.49   +
                           4     20,463.36   +
                           3     21,646.46   +
                           2     19,004.57   +
                           1     18,787.77   +
                           12    17,315.88   +
                           11    17,674.56   +
                                176,236.77   *

The amounts listed under “Pocket Money” are equal to the monthly

totals for the “Net Income” column of the Reconciliation Sheets

for 1987.    The amounts under “Meter Reading” are equal to the

1987 monthly totals for “Daily Income” on the Reconciliation

Sheets (which mirror the cash totals recorded on the daily Meter

Readings Sheets for that period).

     In addition to the seized documents, the CID found a safe

built into the basement floor of petitioners’ residence, which

was empty.    Elsewhere in the residence, the CID found

approximately $10,000 in cash.

Cash Expenditures and Cashier's Checks

     During the years in issue, petitioners had substantial

amounts of cash at their disposal, and Mr. Karcho frequently used

cash and cashier's checks to carry on his personal affairs.    On

or about June 4, 1988,    Mr. Karcho purchased an automobile in

exchange for which he provided another automobile and $14,000 in

cash.   Also in June of 1988, Mr. Karcho sold a 1973 Rolls Royce
                               - 11 -


for $27,500. Mr. Karcho requested that the purchaser pay the

$27,500 in the form of three cashier's checks for $9,500, $9,500,

and $8,500.   During 1989, Mr. Karcho purchased 22 cashier's

checks, all in amounts less than $8,000, totaling $65,942.30.

The checks were payable to Mr. Karcho, and he purchased at least

19 of them with cash.    During 1990, Mr. Karcho purchased 17

cashier's checks, all in amounts less than $7,000, totaling

$59,100.00.   These checks were also payable to Mr. Karcho, and he

paid for them in cash.    From approximately late-July to mid-

August 1990, Mr. Karcho purchased four cashier's checks:    three

for $9,000 and one for $3,000.    These checks he used for the

purchase of a 1986 Excaliber automobile.    In addition, Mr. Karcho

made a downpayment on a residence with 13 cashier's checks, each

for an amount less than $3,000, that he purchased between

August 24, 1990, and January 16, 1991.

Criminal Investigation and Guilty Plea

     The search and records seizure noted earlier resulted from a

criminal investigation of Mr. Karcho initiated in 1991.    Mr.

Karcho was ultimately charged with one count of attempted income

tax evasion for the 1987 taxable year, in violation of section

7201, and one count of structuring transactions with intent to

evade currency reporting requirements, in violation of 31 U.S.C.

sec. 5324(3) (1994), in connection with the purchase of 13

cashier’s checks between August 24, 1990, and January 16, 1991.
                              - 12 -


He pleaded guilty to each, in connection with which he admitted

the following:

     I provided my accountant with false information
     regarding my 1987 income which caused him to prepare a
     false return that substantially underreported my income
     for that year. I signed the return and then filed it
     with the IRS. I also structured a transaction in which
     I bought real estate * * * by purchasing 13 cashiers
     [sic] checks from various banks each less than
     $3,000.00 to avoid the reporting requirements under
     Federal law.

Arcade Operations

     Banner would often rent out the arcade on weekend mornings

for children’s private parties in which participants were allowed

unlimited play on the games for 1 to 2 hours for a set fee.    To

supply the participants with tokens, Mr. Karcho would unlock the

token machines and trigger a switch that caused the release of

tokens.   Mr. Karcho would then hand out tokens to the

participants on an as needed basis.    Mr. Karcho kept the keys to

the token machines; when he was not present for private parties,

he would provide an employee with cash for the purpose of

obtaining tokens from the token machines to distribute.

     Mr. Karcho employed part-time help at the arcade whom he

paid with cash that was not reported on Banner's returns.

Banner claimed deductions for “salaries and wages” on its returns

for the fiscal years ended February 28, 1987, and February 29,

1988, but not on its returns for the years ended February 28,

1989 and 1990.
                              - 13 -


     During 1984 and 1985, the arcade industry began facing

competition from home video games that caused many arcades in the

area surrounding Banner to go out of business.   However, although

Banner’s business declined, Mr. Karcho kept the arcade in

business and continued to run it through the time of trial, some

6 years after the last of the years in issue in this case.

     In applying for a City of Royal Oak, Michigan, business

license in 1987, Mr. Karcho knowingly failed to report 8

electronic games maintained on Banner’s business premises.    By so

doing, Mr. Karcho temporarily evaded licensing fees of $100 per

game, until an inspection by the City revealed the undisclosed

games.

Notice of Deficiency

     On April 8, 1996, respondent issued a notice of deficiency

covering petitioners’ 1987, 1988, 1989, 1990, and 1991 taxable

years.   Respondent determined the unreported income for each year

at issue by treating Banner’s gross receipts as equal to the

total of the daily Meter Readings Sheets for each year, plus

estimated receipts from the sale of food and miscellaneous items,

and subtracting the gross receipts reported on Banner’s return

for each year.2


     2
        The records examined by respondent did not contain Meter
Readings Sheets for January and February of 1991; as a result,
respondent did not determine that there was any unreported arcade
                                                   (continued...)
                              - 14 -


                              OPINION

Deficiency

     The record in this case amply demonstrates that petitioners

maintained two sets of books with respect to the operations of

Banner.   One set, provided to their accountant each year for

purposes of preparing Banner’s Federal income tax returns,

recorded gross receipts as an amount equal to the deposits made

to Banner’s corporate bank account.     These records also purported

to provide a breakdown of the daily bank deposit figure into

categories by source of income (e.g., “Arcade Game Income”, “Food

& Pop Sales”) which, at least in the case of the “Food & Pop

Sales”, petitioners have conceded substantially understated gross

receipts.3   The other set of records, which came to light as a


     2
      (...continued)
game income with respect to those months in 1991. In addition,
there were no records with respect to food sales for Banner’s
1991 taxable year, and as a result respondent did not determine
any unreported income with respect to food sales for that year.
     The parties have reached agreement with respect to the
amount of gross receipts, as well as additional costs of goods
sold, attributable to Banner’s food sales in 1987, 1988, 1989,
and 1990. See supra note 1. Accordingly, the unreported income
that remains in dispute concerns arcade game receipts only.
     3
       The record in this case contains the “Daily Income
Records”, which treat a day’s bank deposit amount as that day’s
gross receipts, covering all of the years in issue except 1991.
The “Cash Receipts” records in evidence, which purport to break
down the bank deposit amount into components such as arcade game
and food sales, cover all years except 1990 and 1991. However,
petitioners have stipulated that they provided similar records to
their accountant for each year at issue for purposes of preparing
                                                   (continued...)
                               - 15 -


result of being seized during the execution of a search warrant

covering petitioners’ business premises and residence, recorded

gross receipts as an amount equal to the daily cash totals

compiled by Mr. Karcho based on daily readings of the token

meters as entered on the Meter Readings Sheets.   The gross

receipts figures so recorded are substantially greater than those

recorded in the other set of records.   Moreover, these records

illustrate that petitioners were tracking the cash that was not

being deposited into Banner’s bank account (or reported to their

accountant); that is, the records list, for each business day, an

amount corresponding to the total cash figure recorded on the

Meter Readings Sheet, the amount deposited into Banner’s bank

account, and the difference between these figures, frequently

denominated as “net”.4

     Respondent determined that petitioners had unreported income

from Banner by treating the Meter Readings Sheets as an accurate

measure of Banner’s gross receipts from arcade game sales.

Specifically, respondent determined Banner had unreported income

in each year from arcade game sales equal to the amount by which




     3
      (...continued)
Banner’s income tax returns.
     4
       Certain monthly totals of this daily “net” figure were
labeled “pocket money” on one of the seized documents.
                              - 16 -


the total cash receipts recorded on the Meter Readings Sheets

exceeded the amount reported on Banner’s return.

     The record in this case demonstrates an evidentiary

foundation for respondent’s determination of unreported income.

Petitioners do not dispute that Mr. Karcho wholly owned Banner,

an S corporation that operated a cash-based amusement arcade.

Thus, petitioners have the burden of showing error in

respondent’s determination of unreported income.   See Pittman v.

Commissioner, 100 F.3d 1308, 1313 (7th Cir. 1996), affg. T.C.

Memo. 1995-243; United States v. Walton, 909 F.2d 915, 918 (6th

Cir. 1990).

     Taxpayers are required to keep such records as are

sufficient to establish taxable income.   See sec. 1.6001-1(a),

Income Tax Regs.   If the taxpayer does not keep such records or

the records are inaccurate, the Commissioner has “great latitude”

to reconstruct the taxpayer’s income by any reasonable means.

Giddio v. Commissioner, 54 T.C. 1530, 1532-1534 (1970); see

Harbin v. Commissioner, 40 T.C. 373, 377 (1963).   In the instant

case, petitioners are in a largely untenable position with

respect to their records, it having been discovered that they

kept two sets of books, each appearing to record the income of

Banner.   Petitioners have effectively conceded that the Daily

Income/Cash Receipts records did not accurately record Banner’s

gross income and expenses, due to their stipulation that the
                               - 17 -


amounts recorded on those records from the sale of food and

miscellaneous items understated income by substantial amounts.

Also, in connection with his guilty plea for attempted income tax

evasion for 1987, Mr. Karcho admitted, in reference to the Daily

Income/Cash Receipts records, that such records were false, and

petitioners have stipulated that similar records were provided to

their accountant for each year in issue for purposes of preparing

Banner’s income tax returns.   Finally, petitioners argue on brief

that although the Daily Income/Cash Receipts records did not

record all of Banner’s gross receipts, they are nevertheless

substantially accurate as to Banner’s net income because they

also did not record numerous expenses that were paid with

unrecorded cash.   As for the other set of records (the Meter

Readings Sheets and the Reconciliation Sheets that tie in to

them), petitioners attempt to dismiss them as entirely

fictitious.   In these circumstances, respondent is entitled to

reconstruct petitioners’ income by any reasonable means.    See

Giddio v. Commissioner, supra; Harbin v. Commissioner, supra, and

cases cited therein.   On the basis of this record, we believe

respondent’s use of the Meter Readings Sheets to reconstruct

petitioners’ income is reasonable.

     Petitioners mount various assaults on respondent’s use of

the Meter Readings Sheets in an attempt to show error in the

income reconstruction.   First, as noted, Mr. Karcho testified
                               - 18 -


that the Meter Readings Sheets were entirely fictitious,

maintained and deliberately inflated by him in order to mislead

prospective purchasers as to the profitability of the arcade.

This self-serving testimony is uncorroborated and improbable, and

we need not accept it.   Other than his testimony, there is no

evidence that Mr. Karcho attempted to sell the arcade, and he

still owned it at the time of trial, some 6 years after the last

of the years in issue.   Further, examination of the Meter

Readings Sheets shows that they, along with the Reconciliation

Sheets that reconciled them with Banner’s bank deposits, were

meticulously kept on a daily basis for several years.    We do not

believe that petitioners would have gone to these lengths merely

to mislead a prospective purchaser.     Petitioners’ contention that

the Meter Readings and Reconciliation Sheets were mere

concoctions is not credible.

     As a fallback, petitioners adduced various testimony to the

effect that the token machine meters were inaccurate because (i)

they frequently malfunctioned, (ii) Mr. Karcho routinely unlocked

the machines and manually released tokens to give out at private

parties at the arcade, or (iii) Mr. Karcho, when he could not be

present to unlock the machines, would give as much as $200 in

cash to a Banner employee who would use it to obtain tokens from

the machines to give out at private parties.
                              - 19 -


     We accord little weight to this testimony.   Only Mr. Karcho

testified that the malfunctions of the token machines or the

manual release of tokens resulted in the meters recording the

insertion of cash when it did not occur; no other witness

corroborated this point.   As for the use of business cash to

obtain tokens for private parties, the employee who corroborated

this practice worked at the arcade for no more than 4 months of

the 46 months5 covered by respondent’s income adjustments, and

the practice only occurred on those weekends when Mr. Karcho was

not present.   We are satisfied in the circumstances of this case

that the Meter Readings Sheets are a reasonably accurate record

of Banner’s gross receipts for the years at issue, which is

sufficient to sustain the deficiency determination.   Respondent’s

reconstruction of petitioners’ income need only be reasonable;

precision is not required.   See Harbin v. Commissioner, supra;

Campise v. Commissioner, T.C. Memo. 1980-130.

     The probability that the Meter Readings Sheets are

reasonably accurate is enhanced by other factors.   The higher

gross receipts reflected on them provide a plausible explanation

of the source of the substantial cash that Mr. Karcho had at his

disposal during the years in issue.    Mr. Karcho’s explanation for



     5
        No adjustments were made with respect to the last 2
months of Banner’s fiscal year ended Feb. 28, 1991, due to the
absence of Meter Readings Sheets covering that period.
                              - 20 -


this cash-–that he had a cash hoard saved since childhood-–is not

credible.6   Also, petitioners concede on brief that Banner had

unreported income.   Finally, the nature of the Meter Readings

Sheets themselves, the figures on which are detailed and

meticulous, not rounded or repetitive, lend support to their

authenticity.

     Petitioners’ next argument proceeds on the concession that

Banner had unreported gross receipts from arcade game sales.

Petitioners argue that even if Banner had gross receipts in

excess of the amounts recorded on the Daily Income/Cash Receipts

records and reported on Banner’s returns, the returns nonetheless

accurately reflected taxable income because Banner paid expenses

with unreported cash, such as for part-time workers, food and

miscellaneous supplies, and game parts and repairs.   Except in

the case of part-time workers (discussed infra), petitioners’

claim of unreported expenses is supported only by vague

testimony.   They provided no basis on which any amount of such

expenses might be estimated,7 let alone an amount equal to the


     6
        We note in this regard that Mr. Karcho purchased Banner
in 1985 for $25,000 cash and a $25,000 note to the seller. If
Mr. Karcho had a cash hoard predating his acquisition of Banner
of the size that would account for his cash transactions during
the years in issue, we wonder why he found it necessary to
finance one-half of the acquisition price.
     7
        On brief, petitioners argue that a comparison of the
deductions taken on the last tax return filed by Banner under its
                                                   (continued...)
                              - 21 -


unreported income determined by respondent.   Cf. Cohan v.

Commissioner, 39 F.2d 540, 543-544 (2d Cir. 1930)(court may

estimate the amount of deductible expenditures if convinced such

expenditures were made); Vanicek v. Commissioner, 85 T.C. 731,

742-743 (1985) (court must have some basis on which to make an

estimate under the Cohan rule).   Petitioners’ argument fails,

among other reasons, for lack of substantiation.

     There is one respect in which respondent’s reconstruction of

petitioners’ income from Banner is not reasonable, however.    The

Reconciliation Sheets consistently list a gross receipts amount

for each day (which corresponds to the cash total for that day on

the Meter Readings Sheet), from which is subtracted (i) a bank

deposit amount and (ii) an amount, generally once or twice a

week, labeled “part”, “part time”, or “part/full workers” to

produce a net figure generally labeled “net” or “net income” or

“net cash”.   Petitioners contend that the amounts in the “part

time” columns represent the payment of cash to workers at the

arcade, which should give rise to a deduction.   That workers were

sometimes paid in cash and sometimes by check is corroborated by



     7
      (...continued)
previous ownership with the deductions claimed by Banner during
the years in issue provides support for their contention that
Banner understated deductions during the years in issue because
they were paid in cash. We reject this argument. As far as the
record reveals, the return filed by the previous owner was never
audited, and return positions are not evidence.
                                - 22 -


other testimony.    Respondent has not allowed any offset for these

amounts in his income reconstruction and contends that it cannot

be ascertained whether all or part of these amounts was already

deducted on Banner’s returns.

     We disagree with respondent in part.    Examined as a whole,

the Reconciliation Sheets produce a strong inference that

petitioners maintained them to keep track of their net unreported

cash from the business.    The “part time” amounts were recorded

nearly as meticulously over a period of years as the totals from

the Meter Readings Sheets.    Respondent’s reconstruction of

Banner’s income effectively treats the Reconciliation Sheets8 as

accurate insofar as they record cash receipts but disregards them

insofar as they record cash expenses that might reduce income.

An examination of Banner’s tax returns reveals that for some of

the years in issue, Banner took no deduction for “salary and

wages”.    We conclude that for certain years in which Banner did

not claim a deduction for wages (Banner’s fiscal years ended

February 28, 1989 and 1990) a reasonable reconstruction of

Banner’s income requires an offset for the amounts recorded under

“part time”; namely, $28,914 in 1989 and $28,410 in 1990.9     We


     8
        Although respondent’s income reconstruction employed the
Meter Readings Sheets and not the Reconciliation Sheets, the
gross receipts figures on each are the same.
     9
          One month (March 1989) is missing from the Reconciliation
                                                     (continued...)
                             - 23 -


agree with respondent that for 1987 and 1988, no such adjustment

would be reasonable, because Banner deducted amounts for wages in

those years and the record does not indicate whether these

amounts were paid by cash or check.   With respect to 1991, we do

not believe any offset is appropriate because the reconstruction

of gross receipts for that year is obviously incomplete.   That

is, there were no Meter Readings Sheets for the last 2 months of

fiscal year 1991 and no food sales records for the entire year;

as a consequence, respondent did not determine any additional

gross receipts from those sources for those periods.

     Accordingly, we sustain respondent’s determination that

petitioners had unreported income from Banner of $143,552 for

1987, $149,458 for 1988, and $21,603 for 1991.   We further hold

that petitioners had unreported income from Banner of $131,686

for 1989 (i.e., respondent’s reconstruction of $160,600 less an

offset of $28,914 for wages paid with unreported cash) and

$109,566 for 1990 (i.e., respondent’s reconstruction of $137,976

less an offset of $28,410 for wages paid with unreported cash).




     9
      (...continued)
Sheets for Banner’s fiscal year ended Feb. 28, 1990, in the
record.
                                - 24 -


Fraud

        Respondent also determined that petitioners are liable for

(i) additions to tax for fraud under section 6653(b)(1)(A) and

(B) for 1987, (ii) an addition to tax for fraud under section

6653(b) for 1988, and (iii) a penalty for fraud under section

6663 for 1989, 1990, and 1991.

        Respondent bears the burden of proving fraud and must

establish it by clear and convincing evidence.      Thus, we do not

bootstrap a finding of fraud upon a taxpayer’s failure to

disprove the Commissioner’s deficiency determination.      See Parks

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

        To carry his burden of proof, respondent must show by clear

and convincing evidence both (1) that an underpayment of tax

exists for each year in issue and (2) that at least some part of

the underpayment was due to fraud.       See secs. 6653(b), 6663(a),

7454(a); Rule 142(b); DiLeo v. Commissioner, 96 T.C. 858, 873

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

Commissioner, 81 T.C. 640, 642 (1983).       If the Commissioner

establishes that some portion of the underpayment is attributable

to fraud, the entire underpayment shall be treated as

attributable to fraud, except with respect to any portion of the
                               - 25 -


underpayment which the taxpayer establishes is not attributable

to fraud.10   See secs. 6653(b)(2), 6663(b).

     Where joint returns are filed, the fraud of one spouse is

not automatically attributed to the other; the other spouse is

not liable for fraud unless the Commissioner shows that some part

of the underpayment is due to the fraud of such other spouse.

See secs. 6653(b)(3), 6663(c).

     The Commissioner meets his burden of proof if it is shown

that the taxpayer intended to evade taxes known to be owing by

conduct intended to conceal, mislead, or otherwise prevent the

collection of such taxes.   See Hagaman v. Commissioner, 958 F.2d

684, 696 (6th Cir. 1992) (citing United States v. Walton, 909

F.2d 915, 926 (6th Cir. 1990)), affg. and remanding T.C. Memo.

1987-549; Rowlee v. Commissioner, 80 T.C. 1111, 1123 (1983).     A

conviction for the willful attempt to evade or defeat income

taxes under section 7201 precludes a taxpayer in a subsequent

civil proceeding from denying that an underpayment in his income

tax for the taxable year of conviction was due to fraud.   See

Gray v. Commissioner, 708 F.2d 243 (6th Cir. 1983), affg. T.C.

Memo. 1981-1; Plunkett v. Commissioner, 465 F.2d 299 (7th Cir.




     10
        Sec. 6663(b), applicable to petitioners’ 1989, 1990, and
1991 taxable years, clarifies that petitioners need only
establish by a preponderance of the evidence that some portion of
the underpayment is not attributable to fraud.
                              - 26 -


1972), affg. T.C. Memo. 1970-274; Tomlinson v. Lefkowitz, 334

F.2d 262, 265 (5th Cir. 1964).

     Absent such estoppel, the existence of fraud is a question

of fact to be decided on consideration of the entire record.       See

Gajewski v. Commissioner, 67 T.C. 181, 199 (1976), affd. without

published opinion 578 F.2d 1383 (8th Cir. 1978).    Because direct

proof is seldom available, fraud may be proven by circumstantial

evidence.   See Stephenson v. Commissioner, 79 T.C. 995, 1005-1006

(1982), affd. 748 F.2d 331 (6th Cir. 1984); Otsuki v.

Commissioner, 53 T.C. 96, 105-106 (1969).    Moreover, the

taxpayer's entire course of conduct may establish fraud, see

Spies v. United States, 317 U.S. 492 (1943), and in determining

fraud, we take into account the taxpayer's experience and

education; see Solomon v. Commissioner, 732 F.2d 1459, 1461-1462

(6th Cir. 1984), affg. per curiam T.C. Memo. 1982-603.

     Keeping a second set of false records creates an especially

strong inference of an intent to defeat or evade taxes.      See

Spies v. United States, supra at 499; Lee v. Commissioner, T.C.

Memo. 1995-597; Raeder v. Commissioner, T.C. Memo. 1965-230; 57

Herkimer St. Corp. v. Commissioner, T.C. Memo. 1961-223, affd.

per curiam 316 F.2d 726 (5th Cir. 1963).    Other indicia or

"badges" of fraud include: (1) Understating income; (2) failure

to report income over an extended period of time; (3) giving

implausible or inconsistent explanations of behavior; (4)
                              - 27 -


concealing assets; (5) engaging in illegal activities; and (6)

dealing in cash.   See Bradford v. Commissioner, 796 F.2d 303,

307-308 (9th Cir. 1986), affg. T.C. Memo. 1984-601; Recklitis v.

Commissioner, 91 T.C. 874, 910 (1988); Rowlee v. Commissioner,

supra at 1125.   A showing of the taxpayer’s willingness to

defraud others is also relevant in determining whether he

committed fraud with respect to his income tax obligations.    See

McGee v. Commissioner, 61 T.C. 249, 260 (1973), affd. 519 F.2d

1121 (5th Cir. 1975).   Moreover, engaging in conduct to avoid

currency-reporting provisions also evidences the type of

concealment indicative of tax fraud.   See Parks v. Commissioner,

94 T.C. 654, 665 (1990); Podolece v. Commissioner, T.C. Memo.

1992-227; Savage v. Commissioner, T.C. Memo. 1992-129; Sea Sports

Center, Inc. v. Commissioner, T.C. Memo. 1991-209, affd. without

published opinion 979 F.2d 1537 (11th Cir. 1992); Morris v.

Commissioner, T.C. Memo. 1990-580.

     On the basis of our review of the entire record, we believe

respondent has shown by clear and convincing, indeed

overwhelming, evidence that both petitioners committed fraud for

each of the years in issue.   An examination of the dual sets of

records maintained by petitioners, together with the

circumstances under which such records came to light and Mr.

Karcho’s recurrent dealings in large amounts of cash (which led

to a structuring conviction), leads inescapably to the conclusion
                                - 28 -


that petitioners kept two sets of books for the specific purpose

of concealing large portions of Banner’s income to avoid paying

tax thereon.   One set of records, which was provided to their

accountant for purposes of preparing Banner’s tax returns,

purported to demonstrate that Banner’s gross receipts were equal

to the amounts deposited into its bank account, which was not the

case.   The other set, which recorded substantially higher

receipts for each year in issue, creates a very strong inference

that the cash deposited into Banner’s bank account did not

constitute the business’ entire gross receipts.

     As for the establishment of an underpayment in each year,

petitioners have stipulated that they had substantial amounts of

unreported gross receipts from the sale of food items for every

year in issue except 1991, conclusively establishing an

underpayment for those years.    With respect to the 1991

underpayment, as well as the remainder of each underpayment in

the other years, we believe that the evidence establishes clearly

and convincingly that the Meter Readings Sheets accurately

recorded gross receipts from arcade game sales, demonstrating

that there was an underpayment arising from the understatement of

gross receipts from this source as well.    Petitioners efforts to

portray the Meter Readings Sheets as fictitious or erroneous are

implausible, inconsistent, and unpersuasive, and they have not
                              - 29 -


offered a credible explanation of the source of the very large

amounts of cash at Mr. Karcho’s disposal during this period.

     As for fraudulent intent for each of the years in issue, we

believe petitioners’ maintenance of two sets of books, and their

providing the erroneous version to their accountant for tax

reporting purposes in each year, is virtually conclusive on the

question of fraudulent intent in each year.   In any event, there

are additional indicia of fraud, including the extended period in

which income was understated, the extensive dealings in cash and

cashier’s checks that were obviously designed to circumvent

currency-reporting requirements, and Mr. Karcho’s admitted

misrepresentations to local authorities in an effort to reduce

his licensing fees.   Finally, Mr. Karcho’s section 7201

conviction with respect to 1987 estops him from denying

fraudulent intent in that year.

     We also conclude that respondent has established that some

portion of the underpayment is attributable to the fraud of each

petitioner.   Although petitioners argue that Mrs. Karcho did not

commit fraud, we believe the evidence shows that Mrs. Karcho was

intimately involved in the fraudulent record keeping in each

year.   It was Mrs. Karcho, who was employed as a billing system

analyst, who prepared the false records given to the accountant,

which records were designed to deceive because they purported to

break down the bank deposit amounts into fictitious subtotals
                             - 30 -


based on the source of receipts.   Also, among the records seized

by respondent’s agents was an adding machine tape on which Mrs.

Karcho had labeled the unreported monthly cash tallies as “pocket

money”.

     We hold that respondent has established by clear and

convincing evidence that the underpayments in each of the years

in issue are attributable to the fraud of each petitioner and

that petitioners have not established that any portion of such

underpayments is not attributable to fraud.   Accordingly, the

period for assessment with regards to those years remains open.

See sec. 6501(c)(1); Sisson v. Commissioner, T.C. Memo. 1994-545

(fraud for purposes of section 6501(c) is the same as fraud for

penalty purposes), affd. without published opinion 108 F.3d 339

(9th Cir. 1996).

     We have considered all of petitioners’ remaining arguments

and, to the extent not addressed herein, find them meritless.

     To reflect the foregoing,

                                         Decision will be entered

                                    under Rule 155.
