                          T.C. Memo. 2008-215



                        UNITED STATES TAX COURT



          LOWELL ALAN BAISDEN, ET AL.,1 Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket Nos. 9613-05, 1436-06,     Filed September 16, 2008.
                 2387-06.


     Lowell Alan Baisden, pro se.

     Mindy S. Meigs, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     SWIFT, Judge:   Respondent determined deficiencies in

petitioners’ Federal income taxes, additions to tax, and fraud

penalties as follows:




     1
      Cases of the following petitioners are consolidated
herewith: Lowell A. Baisden, docket No. 1436-06; and Lowell A.
Baisden and Theresa A. Mawson, docket No. 2387-06.
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                              Additions To Tax/Penalties
Year        Deficiency     Sec. 6651(a)(1)     Sec. 6663(a)

2001         $36,013             ---             $27,010
2002          20,976           $5,244             15,732
2003          62,938            3,114             47,204

       After a settlement largely in respondent’s favor of the

income and expense adjustments determined in respondent’s notices

of deficiency, the issue for decision in these consolidated cases

is whether Lowell Alan Baisden (petitioner) is liable for the

fraud penalty under section 6663 or alternatively for the

negligence penalty under section 6662(b)(1).

       All section references are to the Internal Revenue Code, and

all Rule references are to the Tax Court Rules of Practice and

Procedure.

                          FINDINGS OF FACT

       Facts stipulated by the parties are so found.   At the time

the petition was filed, petitioners resided in California.

       In 1976 petitioner graduated with a bachelor’s degree from

the University of Southern California with an emphasis in

accounting.

       Since 1978 petitioner has been a licensed certified public

accountant in California and in Utah.    For over 20 years

including 2001, 2002, and 2003, through his accounting firm

petitioner has been engaged as a sole proprietor in providing

accounting and tax return preparation services for clients.
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     Petitioner typically charged clients monthly retainer fees

ranging from $800 to $2,500 for preparing detailed trial balances

and quarterly financial statements and for providing Internal

Revenue Service audit representation.   Petitioner charged clients

fees ranging from $300 to $800 for preparation of Federal income

tax returns.

     Petitioner and his wife Theresa Mawson were married in 1998.

Mrs. Mawson has worked as an interior designer but never for

petitioner.

     Petitioner’s books and records for 2001, 2002, and 2003 were

not properly maintained.   In a ledger which petitioner

maintained, petitioner intermingled business expenses with

personal and family expenses such as payments relating to his

children’s education and to a housekeeper.   Petitioner’s books

and records apparently reflected all fees received from clients

each year, but the books and records also showed zero net income

for the accounting firm for each year in issue.

     In an effort to explain his bookkeeping and accounting

methods, petitioner explained that since approximately 1998 he

had developed for his use and for the use of his clients a novel

and insightful tax strategy that may be described generally as

follows:

     (1) Booked sole proprietorship income would be totally
     or almost totally offset by the payment by the sole
     proprietorship of “royalties” to the owner of the
     business;
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     (2) the so-called royalties would not be paid directly
     to the owner but rather would consist of payments by
     the sole proprietorship of the owner’s personal and
     family expenses;

     (3) the “royalty” payments would be treated as fully
     deductible by the sole proprietorship, and they would
     reduce the booked net income of the sole proprietorship
     to zero; and

     (4) the owner would report “royalties” paid with regard
     to personal and family expenses as “other income” not
     subject to employment taxes.

     The primary savings were apparently intended to be derived

from petitioner’s tax strategy through the conversion of sole

proprietorship business income subject to self-employment taxes

into royalties not subject to self-employment taxes.

     Petitioner had no written royalty agreement with his

accounting firm.

     Petitioner maintained 10 different bank accounts-–8 in his

own name and 2 joint accounts with his wife.   For the years in

issue, total deposits into petitioner’s bank accounts were as

follows:
                                Total
               Year            Deposits

               2001            $131,518
               2002             206,168
               2003             336,397


     In 2001 petitioner purchased a 1999 Lexus LS400.   In 2002

petitioner purchased a new 2002 Lexus SC430.   In 2003 petitioner

purchased a new family residence for $799,000.
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     On the joint Federal income tax returns that petitioner and

his wife timely filed for 2001 and untimely filed for 2003, and

on his individual Federal income tax return that petitioner

untimely filed for 2002, each of which petitioner prepared,

petitioner did not include a Schedule C, Net Profit from

Business, relating to his sole proprietorship accounting firm,

and petitioner did not otherwise report more than a fraction of

the so-called royalty income his accounting firm paid on his

behalf.

     Rather, petitioner used the above-described royalty strategy

for each year to offset to zero or to almost zero the substantial

booked income for his accounting firm.   Petitioner filed with his

Federal income tax return for each year no Schedule C, and

petitioner reported zero income relating to his accounting

practice.   Additionally, on each of his Federal income tax

returns petitioner reported only a portion of the so-called

royalty payments his accounting firm purportedly paid on his

behalf for personal and family expenses (namely, $1,224 for 2001,

$20,750 for 2002, and $49,250 for 2003).

     Also, on the Federal income tax return for each year,

because petitioner reported no net income from his accounting

practice, petitioner reported no self-employment tax liability.

     Even though petitioner’s wife did not sign the 2002 Federal

income tax return, and even though petitioner’s wife had no
                                 - 6 -

business of her own and performed no paid services for

petitioner, the 2002 Federal income tax return shows petitioner’s

wife as a joint filer, and petitioner attached a Schedule C for

his wife showing her as engaged in an accounting practice and as

receiving $10,351 from petitioner for “contract services”.

     The above 2001, 2002, and 2003 Federal income tax returns

reported the following tax liabilities, credits, and

overpayments:

                                          Payments
                Total Reported           or Credits   Tax Overpayment
     Year       Tax Liability              Claimed        Claimed

     2001          $1,488                 $3,910          $2,422
     2002            -0-                    ---             ---
     2003           4,351                  5,000             649


     For 2001 and 2003 petitioners received refunds of the

claimed overpayments.

     In June 2004 respondent initiated an audit of petitioner and

his wife’s joint Federal income tax returns for 2001 and 2003 and

of petitioner’s individual Federal income tax return for 2002.

During respondent’s audit, petitioner often was unresponsive to

respondent’s requests for financial information.      For 2001

petitioner did not give respondent records of his business

expenses, and petitioner refused to extend the period of

limitations on assessment.
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     For all 3 years petitioner provided incomplete records, and

those records respondent did obtain were largely received from

third parties.

     To redetermine petitioner’s income, respondent generally

used the bank deposits method of proof, and respondent determined

that petitioner had unreported gross receipts from his accounting

practice of $121,790, $156,800, and $276,006 for 2001, 2002, and

2003, respectively.   Respondent determined the failure to timely

file addition to tax under section 6651(a)(1) against petitioner

for 2002 and against petitioner and his wife for 2003.

     Respondent mailed three separate notices of deficiency with

respect to the years at issue.    For 2001 and 2003 respondent

mailed joint notices of deficiency to petitioner and his wife.

For 2002 respondent mailed a notice of deficiency only to

petitioner.

     With regard to the so-called royalties paid by his

accounting firm, petitioner offered respondent’s agent a number

of inconsistent explanations.    In conversations with respondent’s

agent, petitioner explained that because corporations are allowed

deductions for certain employee education expenses, an individual

taxpayer/sole proprietor also was entitled to deduct children’s

school expenses on his/her individual Federal income tax returns.

     Petitioner claimed he was entitled to business expense

deductions for 2001, 2002, and 2003 in the amounts of $97,560,
                              - 8 -

$156,800, and $276,006, respectively.    On the basis of

substantiation provided, respondent allowed petitioner business

expense deductions of zero for 2001 (because no records were

provided), $43,768 for 2002, and $44,024 for 2003.

     Respondent charged petitioner with self-employment tax on

petitioner’s redetermined Schedule C income.

     In an effort to delay respondent’s audit, petitioner filed a

spurious complaint with the Taxpayer Advocate’s Office.

     In his answer to petitioner’s complaint, respondent charged

petitioner with the fraud penalty under section 6663 and

alternatively with the negligence penalty under section

6662(b)(1) for 2001, 2002, and 2003.

     The parties have now stipulated and agreed that for the

years in issue, petitioner’s sole proprietorship accounting

practice had the following total Schedule C gross receipts,

allowable business expense deductions, and net income:


                                2001        2002       2003

Schedule C gross receipts     $121,790    $156,800   $276,006
Business expense deductions     41,791      43,768     44,006
  Total Schedule C net income   79,999     113,032    232,000


     As part of the settlement, petitioner has agreed that he is

liable for the section 6651(a)(1) late filing addition to tax for

2002 and 2003, and respondent concedes that petitioner’s wife is
                               - 9 -

entitled to relief from joint liability under section 6015(f)

with regard to any tax deficiency and additions to tax we sustain

herein for 2003.


                              OPINION

     Under section 6663(a) if it is established that any part of

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

fraud, there is added to the tax a penalty equal to 75 percent of

the portion of the underpayment that is attributable to fraud.

     Fraudulent intent is defined as “‘actual, intentional

wrongdoing, and the intent required is the specific purpose to

evade a tax believed to be owing.’”     Estate of Temple v.

Commissioner, 67 T.C. 143, 159 (1976) (quoting Mitchell v.

Commissioner, 118 F.2d 308, 310 (5th Cir. 1941), revg. 40 B.T.A.

424 (1939)).   To prove a taxpayer’s tax fraud, the Commissioner

must establish by clear and convincing evidence:    (1) The

existence of an underpayment of tax; and (2) the taxpayer’s

fraudulent intent.   Akland v. Commissioner, 767 F.2d 618, 621

(9th Cir. 1985), affg. T.C. Memo. 1983-249; Parks v.

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

     Whether petitioner’s fraudulent intent has been established

is to be analyzed on the basis of all of the facts and

circumstances in evidence.   See Stratton v. Commissioner, 54 T.C.

255, 284 (1970).
                               - 10 -

     Fraud is never to be imputed or presumed; however, “its

proof may depend to some extent upon circumstantial evidence, and

may rest upon reasonable inferences properly drawn from the

evidence of record.”    Stone v. Commissioner, 56 T.C. 213, 224

(1971); see also Rowlee v. Commissioner, 80 T.C. 1111, 1123

(1983); Stephenson v. Commissioner, 79 T.C. 995, 1006 (1982),

affd. 748 F.2d 331 (6th Cir. 1984).

     Courts have developed several objective “badges” of fraud,

including:    (1) Understatements of income; (2) the absence of

records; (3) implausible or inconsistent explanations of

behavior; (4) asset concealment; (5) cash dealings; and (6) lack

of cooperation with tax authorities.    Bradford v. Commissioner,

796 F.2d 303, 307-309 (9th Cir. 1986), affg. T.C. Memo. 1984-601;

Paschal v. Commissioner, T.C. Memo. 1994-380, affd. without

published opinion 76 AFTR 2d 95-7975, 96-1 USTC par. 50,013 (3d

Cir. 1995).

     A taxpayer’s experience and education may also be

considered.    Niedringhaus v. Commissioner, 99 T.C. 202, 211

(1992); Grosshandler v. Commissioner, 75 T.C. 1, 19-20 (1980).

     Consistent, substantial understatements of income over

several years are highly persuasive evidence of intent to defraud

the Government, particularly when combined with other indicia of

fraud.    As the U.S. Court of Appeals for the Ninth Circuit has

stated:    “repeated understatements in successive years when
                               - 11 -

coupled with other circumstances showing an intent to conceal or

misstate taxable income present a basis on which the Tax Court

may properly infer fraud.”    Furnish v. Commissioner, 262 F.2d

727, 728-729 (9th Cir. 1958) (citing Anderson v. Commissioner,

250 F.2d 242, 249-250 (5th Cir. 1957), affg. in part and

remanding T.C. Memo. 1956-178), affg. in part and remanding in

part Funk v. Commissioner, 29 T.C. 279 (1957).

     The evidence supports imposition against petitioner of the

fraud penalties for each year.   Petitioner’s use of so-called

royalty payments to pay personal expenses and to offset or reduce

business income is patently improper and nothing more than a

fantasy creation of petitioner in an effort to evade the payment

of taxes due and owing.

     In spite of petitioner’s education, training, and experience

as an accountant, on the 2001, 2002, and 2003 Federal income tax

returns in issue petitioner failed to report substantial income

from his business activities and claimed obvious personal

expenses as deductible business expenses.    Further, petitioner

failed to otherwise report (as royalty income) substantial

business income.

     Petitioner’s books and records intermingled business and

personal items.    Petitioner provided ridiculous explanations for

his tax return treatment of income and expenses, and petitioner

did not cooperate with respondent’s audit.
                             - 12 -

     Petitioner’s use of so-called royalty expenses to offset

business gross receipts and to eliminate or minimize reported

income, income taxes, and self-employment taxes is unfounded and

improper.

     Petitioner’s liability for the fraud penalties determined by

respondent is sustained, and the fraud penalty for each year

applies to the entire tax deficiency for each year.

     For the reasons stated, we sustain respondent’s imposition

on petitioner of the fraud penalty for each of the years in

issue.



                                        Decisions will be

                                   entered under Rule 155.
