                        T.C. Memo. 2009-222



                      UNITED STATES TAX COURT



   JAMES L. TARPO AND MARLA J. TARPO, ET AL.,1 Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket Nos. 10338-03, 10303-04,    Filed September 24, 2009.
                 12819-04.



     James L. and Marla J. Tarpo, pro sese.

     Kevin Coy and Sherri Wilder, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     HOLMES, Judge:   James and Marla Tarpo wanted to protect as

much of their income from taxation as they could.   There’s

nothing wrong with that if done legally, but the Tarpos fell in


     1
       Cases of the following petitioners are consolidated
herewith: James L. Tarpo and Marla J. Tarpo, docket No. 10303-
04, and Paderborn Trust, Marla J. Tarpo, Trustee, docket No.
12819-04.
                                - 2 -

with a specialist in abusive tax shelters.    Following his advice,

they put James’s business into a trust, manufactured spurious

deductions, and misreported large amounts of capital gains as

capital losses--when they reported the transactions at all.

     We wade through the available records to determine what the

Tarpos owe and whether they should be penalized.

                         FINDINGS OF FACT

     The Tarpos were a dual-income family during the years at

issue--1999, 2000, and 2001.    Most of their income came from

James, a computer programmer who contracted his services to

corporations in the name of his sole proprietorship, ATE

Services.   Although he had several clients during 1999-2001, he

worked mostly for a corporation named MaxSys.    MaxSys and most of

James’s other clients paid their invoices with checks made out to

ATE Services.   Marla Tarpo was an independent beauty consultant

whose primary financial contribution during those years was the

deductions in excess of income she reported on their joint tax

return from her own unnamed sole proprietorship.

     James Mattatall became a part of the Tarpos’ life when a

friend recommended his services, perhaps as early as 1997.

Mattatall, as the Tarpos admitted they knew, is neither an

attorney nor an accountant.    He earned his living by setting up

tax shelters for his clients.    He is now out of that business:

In 2004, the U.S. District Court in Los Angeles enjoined him from
                               - 3 -

organizing, selling, or recommending tax shelters; or even from

offering tax advice to clients.   United States v. Mattatall, No.

CV 03-07016 DDP (PJWx) (C.D. Cal., Aug. 17, 2004)   (order

granting plaintiff’s motion for contempt and second amended

injunction).   Back in 1999, Mattatall recommended that the Tarpos

create an elaborate scheme to route James’s ordinary income into

a trust, move it offshore, and then retrieve it with credit

cards.

     Here’s how it was supposed to work:

          •     The Tarpos would create a “business
                trust,” naming Mattatall as the trustee
                and the Tarpos as managers. The Tarpos
                would get a separate mailing address for
                the trust to lend it credibility.

          •     James would then transfer ATE Services
                into the trust, thereby removing himself
                as the sole owner of his business and
                assigning all of the income earned from
                his business to the trust.

          •     The trust would give a portion of the
                income James earned back to him as
                wages.

          •     The stated beneficiary of the trust
                would be Prosper International, Ltd.
                (PIL),2 an offshore company specializing
                in multilevel marketing schemes and low-
                cost foreign grantor trusts. Any money
                the trust didn’t give back to James
                would go to PIL and be deposited in a


     2
       The principals of PIL, Pierre J. Gauthier and Jean Jay
Gauthier, a.k.a. Earl L. Savoy, have agreed to a permanent
injunction barring them from offering tax shelters. United
States v. Gauthier, No. 6:05-cv-1431-Orl-I8JGG (M.D. Fla., Apr.
3, 2006) (stipulated final judgment of permanent injunction).
                               - 4 -

               foreign grantor trust established for
               the benefit of the Tarpos.

          •    PIL would then give the Tarpos a credit
               card that they could use, with the bills
               paid from the money in the foreign
               grantor trust.

     In July 1999, the Tarpos created Paderborn Trust3 with PIL

as its sole beneficiary, and shortly thereafter leased a post

office box at a Mailboxes, Etc. to be Paderborn’s address.4   They

also “transferred” ATE Services to Paderborn by getting an

employer identification number (EIN) for ATE Services and having

Paderborn claim income reported under that EIN on a Schedule C

attached to its tax return.5   They then paid $2,000 to PIL to get

a Freedom Card (also known as a Horizon MasterCard), and a PIL

Plus Quick Start Trust (PIL Trust), which was an offshore trust

specifically designed to eliminate income taxes.   For an




     3
       No trust documents were actually offered into evidence, so
it is not clear what the terms of the trust were. We find that
Mattatall was named trustee and the Tarpos were named comanagers
of the trust, because we do have documents that they signed using
those titles. James claimed, however, that he never received a
copy of any documents and didn’t know what his duties as manager,
or what Mattatall’s duties as trustee, were.
     4
       The Tarpos used this address only in official government
documents; at all other times they used their home as the mailing
address for both Paderborn and ATE Services.
     5
       Toward the end of 1999 James contacted most of the
corporations that used his services and asked that they report
all his future income, as well as his income for 1999, to the new
EIN.
                                 - 5 -

additional $200, PIL even provided the Tarpos with a foreign

grantor for their foreign trust.

     James received compensation from Paderborn, and any money

that he didn’t immediately get from Paderborn went into the PIL

Trust.     The Horizon MasterCard directly linked to the Trust, and

the Trust used money deposited by Paderborn to pay the Tarpos’

Horizon credit-card debt each month.     The Tarpos were free to use

the Horizon card however they wanted and only received an expense

summary, never a bill.

     The plan had one large hitch at the start.    The Tarpos,

unable to get a separate bank account set up for Paderborn until

2000, decided instead to deposit checks payable to ATE Services

into their personal bank account just as they’d always done.     One

big exception was the checks from MaxSys, which the Tarpos

cashed, depositing most of that cash into their personal account

but keeping the rest.6    Once they set up the Paderborn bank

account, they began depositing all checks made out to ATE

Services into it, though on at least one occasion Marla withdrew

money from that account to pay the Tarpos’ personal debts

directly.    Some money also sloshed between the Tarpos’ Paderborn

bank accounts over half a dozen times for no reason that we could

discern.



     6
       Neither the Commissioner nor the Tarpos ever established
exactly what was done with the cash they kept.
                               - 6 -

     Another of the Tarpos’ big mistakes was the way that they

reported their income and deductions.   Each year, James prepared

a Schedule C listing the income paid back to him from Paderborn,

but he didn’t list Paderborn anywhere on the form.   Instead, he

indicated that the money came through his own sole

proprietorship, ATE Services, just as he always had.   Both James

and Marla also claimed extensive business deductions--without any

records to substantiate them--which brought their taxable income

down to almost nothing.   They used the same tactic on Paderborn’s

tax return--again, without any substantiation--only there any

remaining income was claimed as an income-distribution deduction7

so that there was no taxable income.8

     James was also a very active day trader during these years,

often buying and selling stocks hundreds of times per week.   He

did not keep any records of his bases in these stocks or his net

gains and losses, and in fact he didn’t even report these


     7
       A trust is generally allowed to deduct taxable income
distributed to its beneficiaries. See secs. 651, 661. This
income-distribution deduction implements the he-who-gets-the-
income-pays-the-tax principle. If a trust keeps income, the
trust is supposed to pay tax on it. But if a trust distributes
income, the beneficiary is supposed to pay the tax. (Unless
otherwise indicated, all section references are to the Internal
Revenue Code in effect for the years in issue.)
     8
       Paderborn’s taxable income was actually negative $300 each
year because the Tarpos claimed a $300 exemption for the trust
pursuant to section 642(b), the provision allowing a trust which
distributes all of its income a “personal exemption” of $300
yearly.
                               - 7 -

transactions on his 1999 and 2000 tax returns until he submitted

amended returns in February 2003.9     The Commissioner has conceded

that the Tarpos are entitled to a $3,000 capital loss deduction

for both 2000 and 2001.   A major question is how much in capital

gains or losses they had at the end of 1999.

     Our finding on James’s 1999 capital gains or losses has two

parts--the loss carryforward and sale proceeds.     Neither James

nor the Commissioner was able to provide a precise accounting of

the Tarpos’ capital gains or losses for 1999, so we pieced

together the information from what was in the record.     James’s

1999 amended return included a $34,794 short-term capital loss

carryforward, but he offered no substantiation for it at trial.

A taxpayer’s returns alone do not substantiate deductions or

losses because they are nothing more than a statement of his

claims.   Wilkinson v. Commissioner, 71 T.C. 633, 639 (1979);

Roberts v. Commissioner, 62 T.C. 834, 837 (1974).     To hold

otherwise would undermine our presumption that the Commissioner’s

determination is correct.   See Rule 142; Halle v. Commissioner, 7

T.C. 245, 247 (1946), affd. 175 F.2d 500 (2d Cir. 1949).     We

therefore find that James had no short-term capital loss

carryforward to apply to his 1999 short-term capital gains.




     9
       We treat any income reported on the actual and amended
returns as admissions by the Tarpos.
                                      - 8 -

        We next turn to figuring out the sale proceeds from James’s

day trading in 1999.        The Commissioner subpoenaed E*Trade

Financial Corporation and obtained Forms 1099 listing all of

James’s trades in 1999.        We entered the trades into a spreadsheet

and calculated the gain or loss for each company he invested in

and found the aggregate gain to be $91,709.            The table below

shows the gain or loss for each company.10            James closed out his

position in most of the companies by the end of 1999, but he

still held shares in the italicized companies at the end of the

year.        Since we could not match the shares that were sold with

their respective purchase date for such companies, we applied the

so-called “FIFO Rule,” where the basis in the first lot or share

that needs to be identified, on account of a sale, equals the

basis of the earliest of those lots purchased.            See sec. 1.1012-

1(c), Income Tax Regs.

    Company              Sale Price           Basis           Gain/(Loss)
At Home                $27,204.14        $25,671.15         $1,532.99
Advanced Fibre          11,553.46         12,096.15           (542.69)
Amazon                 387,918.52        386,840.35          1,078.17
Applied Mic             15,154.54         13,194.95          1,959.59


        10
       For shares of stock for which we had no purchase
information (other than unsubstantiated estimates), we set the
basis at zero. (The taxpayer bears the burden of showing he is
not liable for tax on all the proceeds received, and if he fails
to do so, we treat the full amount as taxable gain. Rockwell v.
Commissioner, 512 F.2d 882, 886-87 (9th Cir. 1975), affg. T.C.
Memo. 1972-133; Golub v. Commissioner, T.C. Memo. 1999-288.)
                                  - 9 -

    Company          Sale Price             Basis       Gain/(Loss)
Conexant             $95,655.69           $89,606.00   $6,049.69
Systems

Cyberian             145,361.71           144,499.60      862.11
Outpost
E*Trade              368,554.48           355,703.58   12,850.90
Earthlink             41,808.70            43,314.90   (1,506.20)
Network
Equity                21,354.33                 0.00   21,354.33
Residential
IKOS Systems          19,979.38            16,727.40     3251.98
KN Energy Peps        35,133.92                 0.00   35,133.92
Netsilicon            20,545.70            17,977.40     2568.30
Purchasepro           33,795.26            38,559.85   (4,764.59)
RealNetworks         281,266.28           281,935.30     (669.02)
Sharper Image         16,729.49            11,207.45    5,522.04
Sportsline.com        16,459.54            17,364.90     (905.36)
Track Data               586.27               707.45     (121.18)
Uroquest               2,266.50                 0.00    2,266.50
Medical
VISX Delaware         96,743.15            90,956.00    5,787.15
   TOTAL           1,638,071.06      1,546,362.43      91,708.63


     In 2002, the Commissioner chose the Tarpos’ 1999 return for

audit.    The Tarpos showed up with Mattatall, but didn’t bring any

of the requested documentation and didn’t answer any questions.

Instead, they simply handed the examiner affidavits attesting to

the truth of the items claimed on their tax returns.       They also

brought amended tax returns for 1999 and 2000 which included
                               - 10 -

previously unreported stock transactions as well as unreported

dividends and interest.

     In an effort to get some documentation other than the

affidavits, the examiner set up another meeting.    This time,

Marla showed up alone with a box full of disorganized receipts.

She again refused to answer any questions, so the examiner

subpoenaed records from the Tarpos’ banks, their brokers, and the

companies that had used James’s services.    The Commissioner

finally sent a notice of deficiency for 1999 in April 2003.      It

was signed by an IRS employee with the title Technical Services

Territory Manager.

     The Tarpos’ conduct during the audit of their 1999 return

sparked an audit of their 2000 and 2001 returns, which the

Commissioner quickly extended to Paderborn’s returns for those

years.    The Tarpos did not respond to any of the examiner’s

requests for information, and more third-party summonses

followed.

     In the notices of deficiency, the Commissioner disallowed

all of the Tarpos’ claimed deductions and set up a whipsaw

position, attributing the same income to both Paderborn and the

Tarpos.   The notices of deficiency for the 2000 and 2001 tax

years of both the Tarpos and Paderborn were also signed by the

same IRS employee.
                               - 11 -

     The Tarpos timely petitioned us for review of all three

notices.   The cases were tried together in Los Angeles, where the

Tarpos resided when they filed their cases.

                               OPINION

I.   Jurisdiction

     The Tarpos open with a frivolous jurisdictional argument.

They claim that the notices of deficiency are invalid because a

“Technical Services Territory Manager” is not authorized to issue

them.   Statutory notices of deficiency are valid only if issued

by the Secretary of the Treasury or his delegate.    Kellogg v.

Commissioner, 88 T.C. 167, 172 (1987); see also secs. 6212(a),

7701(a)(11)(B), (12)(A)(i).    The Technical Services Territory

Manager position is part of the Small Business/Self-Employed

(SB/SE) division of the IRS.    SB/SE Territory Managers were

specifically delegated the authority to send notices of

deficiency in Delegation Order No. 77 (Rev. 28), 61 Fed. Reg.

30937 (June 18, 1996) (effective May 17, 1996).    That delegated

authority was re-authorized in Delegation Order 4-8, Internal

Revenue Manual pt. 1.2.43.2 (Feb. 10, 2004).    There is no

question that the IRS employee who signed the notices of

deficiency had the authority to do so.    We therefore hold that we

have jurisdiction.
                               - 12 -

II.   Validity of Paderborn Trust

      The Commissioner views Paderborn as a fat target, and fires

three weapons at it: arguments that Paderborn is a sham trust,

that it is a grantor trust, and that Tarpo was just assigning his

income to it.    We begin by describing how Paderborn worked.

      A.   Operation of Paderborn

      The purpose of the Paderborn/PIL Trust/Horizon MasterCard

arrangement was to reduce or eliminate income taxes.    By

transferring ATE Services to Paderborn and calling James an

independent contractor of ATE Services rather than its sole

proprietor, James claims he could be paid a fixed amount which he

could then offset with unreimbursed Schedule C expenses.

Paderborn deducted what it paid to James as “contracted

development.”    Everything that remained in Paderborn at the end

of the year was transferred to the PIL Trust, shipped from the

United States, and placed in the hands of foreigners not subject

to the Code.    By using the Horizon MasterCard, which was paid

directly by the PIL Trust, the Tarpos could access the money

without repatriating it.

      On paper, most of the earned income was reported somewhere.

The money which would have been reported on James’s Schedule C

before the trusts were established was instead reported for 1999-

2001 as follows:
- 13 -
                               - 14 -

     Since Paderborn had no separate bank account in 1999,

everything that was designated as going to Paderborn was actually

cashed by the Tarpos and deposited in their personal checking

account.   For the other years, anything noted as paid to

Paderborn was actually deposited in Paderborn’s checking account.

Whenever PIL received money, it deposited that money into the PIL

Trust.

     B.    Improper Income Assignment

     A basic income tax principle is that a taxpayer is taxed on

the income that he earns, and that income cannot be assigned to

another.   Commissioner v. Banks, 543 U.S. 426, 433-34 (2005);

Lucas v. Earl, 281 U.S. 111, 114-15 (1930).   When a taxpayer

tries to assign the right to future income to another person, the

IRS and courts ignore the attempt for tax purposes; the assignor

pays all the taxes he would have paid had he not assigned the

income.    Banks, 543 U.S. at 433-34; see also Burnet v. Leininger,

285 U.S. 136 (1932) (can’t escape tax on profits by assigning

them); Wesenberg v. Commissioner, 69 T.C. 1005, 1010-11 (1978)

(conveyance of earned income ineffective when taxpayer retains

“ultimate direction and control over the earning of the

compensation”).

     Transferring ATE Services to Paderborn didn’t actually

change anything other than which taxpayer identification number

the income was reported under.   James still did all the business
                                 - 15 -

development, performed all the work, and signed all the

timesheets.   He was still the one earning the income, and it

never left his control.    At one point during the trial, James

testified that he was assigning his income to Paderborn:

               COURT: Okay. So what you were doing then,
          if I can understand this right, is you would go to
          a company like MACSIS [sic] or N.H. Services, you
          would contract with them, and then the idea was
          for you to assign the income to the Paderborn
          Trust?

                  JAMES TARPO:   Right.

It doesn’t get much simpler than that.

     We therefore find that the Tarpos improperly assigned

James’s earned income to Paderborn.       We must disregard Paderborn,

and will treat James as ATE Services’ sole proprietor.

     C.   Grantor Trust

     The Commissioner also argues that Paderborn and PIL were

grantor trusts.    A grantor trust is created when a person

contributes cash or property to a trust, but continues to be

treated as owner of it at least in part.      See secs. 671-679.   The

Code tells us to disregard such a trust as a separate taxable

entity to the extent of the grantor’s retained interest.      Sec.

671; sec. 1.671-2(b), Income Tax Regs.      And the grantor of a

grantor trust is supposed to report his portion of the trust’s

income and deductions on his own tax return, not the trust’s.

     We find that the Tarpos retained ownership of all of the

assets in Paderborn and the PIL Trust.      Sections 674, 676, 677,
                                - 16 -

and 67911 state that the grantor will be treated as the owner of

a trust when he keeps certain powers or takes certain actions.

Here’s a summary of what the Tarpos did that makes their trusts

grantor trusts:

          •       A grantor may dispose of the trust’s income
                  without the approval or consent of an adverse
                  party. Sec. 674(a). The Tarpos had
                  unfettered access to all of Paderborn’s
                  assets as comanagers with signatory authority
                  on the Paderborn bank account.

          •       A grantor can revest title over the property
                  in himself. Sec. 676(a). The Tarpos could
                  revest title of Paderborn assets in
                  themselves at any time; Marla proved this
                  when she purchased a cashier’s check payable
                  to James’s broker, Computer Clearing
                  Services, to pay off personal debt.

          •       A grantor trust’s income can be distributed
                  or accumulated for future distribution to the
                  grantor or the grantor’s spouse. Sec.
                  677(a). All of the money paid into Paderborn
                  was paid back out to either the Tarpos
                  directly or to PIL, which then distributed
                  the money to the Tarpos via the Horizon card.

          •       The grantor directly or indirectly transfers
                  property to a foreign trust. Sec. 679(a).
                  The Tarpos transferred property directly to a
                  foreign trust when they set up the PIL Trust,
                  and they transferred property indirectly to
                  the same trust every time Paderborn sent it
                  money.




     11
       Each of these sections lists exceptions, but none of
those exceptions applies in this case.
                               - 17 -

We therefore find in the alternative that Paderborn and the PIL

Trust should be disregarded for income tax purposes as nothing

more than grantor trusts.12

III. Income and Deductions

     Having decided that all Paderborn’s income properly belongs

to the Tarpos, we turn to figuring out what that income was.    We

then discuss the deductions claimed by both James and Marla on

their respective Schedules C that might reduce the portion of

that income that is taxable.

     A.   Income for 1999, 2000, and 2001

     The Commissioner did not contest Marla’s reported income for

any of the years at issue, so we go straight to the question of

what income James should have reported on his Schedule C.   Since

the Tarpos did not produce any records during the audit, the

Commissioner relied on bank statements.   Through these

statements, he discovered the names of the companies that paid

James for his services, and was able to find out exactly how much

they paid ATE Services each year.   From there, the Commissioner

was able to compare the bank statements for the Tarpos, ATE

Services, and Paderborn to determine where the money was going

and how much the Tarpos were actually making.   Summarizing the




     12
       As we said at the beginning of this section, the
Commissioner had a third theory--that the trusts were shams--but
we won’t pile on.
                             - 18 -

information in tabular form shows how much each client paid

James:

                                 1999

               CLIENT                                 AMOUNT
Alcon Laboratories, Inc.                $8,840
Winsoft Inc.                             5,400
USANA, Inc.                                988
N.H. Resources, Inc.                    15,115
MaxSys Technologies                     21,710
    Total                               52,053

                                 2000

               CLIENT                                 AMOUNT
MaxSys Technologies                 $110,663
    Total                               110,663

                                 2001

               CLIENT                                 AMOUNT
MaxSys Technologies                 $87,141
Vektrek Electronic Sys                     375
    Total                               87,516

     By using these methods, the Commissioner determined that the

Tarpos had gross income which should have been reported on

James’s Schedule C as follows:

                    1999         2000              2001
                  $52,053    $110,663             $87,516
                                - 19 -

We agree with the Commissioner and find that these totals are

accurate.13

     B.      Deductions for 1999, 2000, and 2001

     Expenses are allowable if they are “ordinary and necessary,”

but a taxpayer must keep records to show the connection between

the expenses and his business.     Sec. 162(a); Gorman v.

Commissioner, T.C. Memo. 1986-344; sec. 1.6001-1(a), Income Tax

Regs.     If the taxpayer has no records, but we find he must have

incurred some expenses, we can estimate the amounts of those

expenses as long as there is something in the record to support

the estimate (the Cohan rule).     Williams v. United States, 245

F.2d 559, 560 (5th Cir. 1957); Cohan v. Commissioner, 39 F.2d

540, 543-44 (2d Cir. 1930).     The Cohan rule does not apply to

expenses that the Code lists in section 274(d); taxpayers have to

meet special substantiation requirements for these listed

expenses.     Sec. 1.274-5T(a), Temporary Income Tax Regs., 50 Fed.

Reg. 46014 (Nov. 6, 1985); Sanford v. Commissioner, 50 T.C. 823,

827-28 (1968), affd. 412 F.2d 201 (2d Cir. 1969).

     The Tarpos claim a great many business expenses, including

those claimed by Paderborn on its return.     These include expenses

we can estimate under the Cohan rule--cost of goods sold,

depreciation, interest, supplies, business use of their home,



     13
        To this must be added the capital gains that the Tarpos
should have reported on their Schedule D. See supra pp. 8-9.
                              - 20 -

cleaning, equipment, gifts, training, sales promotion--as well as

section 274(d) items that we can’t estimate under Cohan, like

car-and-truck expenses, travel, and meals and entertainment.    At

no point during audit or pretrial discovery did the Tarpos

provide any receipts or explanations for any of these items.

During the trial itself, Marla didn’t testify at all and James

never testified about the disputed deductions.

     All the Tarpos ever provided were unsupported affidavits

swearing to the truth of each item on each tax return.   They did

this at Mattatall’s suggestion, but as other Mattatall clients

have discovered, self-serving affidavits are not substantiation.

See Doudney v. Commissioner, T.C. Memo. 2005-267; Kolbeck v.

Commissioner, T.C. Memo. 2005-253.

     Since we have nothing on which to base any Cohan estimate,

we hold that all but one of the Schedule C deductions claimed by

the Tarpos are disallowed for lack of substantiation either

because they are section 274(d) deductions subject to a higher

substantiation standard, or because there was no evidence

provided from which this Court could make a reasonable estimate

of expenses.   The one deduction which we will allow as an

ordinary and necessary business expense under Cohan is the $108

licensing fee Marla incurred in 2000.   We allow this one because

we realize that a beauty consultant requires a license to operate

and we are convinced that she actually paid the licensing fee.
                                - 21 -

IV.   Penalties

      A.    Fraud Penalty

      Section 6663 imposes a penalty equal to 75 percent of the

underpayment when that underpayment is attributable to fraud.

The Commissioner has the burden of proving fraud, and he has to

prove by clear and convincing evidence that the taxpayer

underpaid and that the underpayment was attributable to fraud.

Sec. 7454(a); Rule 142(b); Miller v. Commissioner, T.C. Memo.

1989-461.    If the Commissioner succeeds in proving that even part

of the underpayment is due to fraud, then “the entire

underpayment shall be treated as attributable to fraud, except

with respect to any portion of the underpayment which the

taxpayer establishes (by a preponderance of the evidence) is not

attributable to fraud.”     Sec. 6663(b).

      The Commissioner easily passes the first part of this test.

He proved there was an underpayment when he proved that the

Tarpos didn’t report the additional income they tried to assign

to Paderborn.

      But was a portion of that underpayment due to fraud?   Fraud

is the “willful attempt to evade tax,” and we make that

determination by looking at the entire record of a case.     Beaver

v. Commissioner, 55 T.C. 85, 92 (1970).     There are many factors

which can indicate fraud, including:
                               - 22 -

   •     understatement of income

   •     inadequate records

   •     concealing assets

   •     failure to cooperate with tax authorities

   •     mischaracterizing the source of income

   •     implausible or inconsistent explanations of behavior.

See Spies v. United States, 317 U.S. 492 (1943); Bradford v.

Commissioner, 796 F.2d 303 (9th Cir. 1986), affg. T.C. Memo.

1984-601; Meier v. Commissioner, 91 T.C. 273 (1988).    Although

James Tarpo exhibited each and every one of these factors, the

most telling was his attempt to conceal assets offshore with PIL.

The only plausible reason he had to set up such a foreign grantor

trust, where the sole beneficiary was a company which James knew

very little about, was to try to hide assets from the IRS to

avoid paying taxes.    We therefore find that, at least in respect

to the income assigned to Paderborn, the Commissioner has proven

fraudulent intent by clear and convincing evidence.

       Since a portion of the underpayment is attributable to

fraud, all of the underpayment will be subject to the fraud

penalty unless the Tarpos can show by a preponderance of the

evidence that some of the underpayment was not due to fraud.     We

find that James has met this burden in regard to the capital

gains for 1999.    We therefore hold that the underpayment

attributable to his understating his capital gains is not subject
                                - 23 -

to the fraud penalty.     We also find that the Commissioner has met

his burden of proof only with regard to James; he has not shown

that Marla acted with fraudulent intent--about her intent there

was no evidence or argument at all.

     James asserts that he had reasonable cause for his return

position and that he acted in good faith.     Sec. 6664(c).   He

claims that the entire fiasco is Mattatall’s fault, and that his

good faith reliance on Mattatall reasonably caused him to act the

way he did.     While that excuse might work when a licensed and

reputable tax professional offers the advice, it doesn’t work

here.

     James never once asked for any credentials from Mattatall,

and in fact admitted under oath that he knew Mattatall was

neither an attorney nor an accountant.     James also knew that the

foreign trust setup was specifically created to hide the true

ownership of assets and income from the IRS.     We therefore find

that James has not proved a defense to fraud.

     B.      Accuracy-related Penalty

        Section 6662(a) and (b)(1) and (2) permits the imposition of

an accuracy-related penalty equal to 20 percent of the

underpayment when that underpayment is due to negligence or a

substantial understatement.     Because the Tarpos were negligent in

their recordkeeping and showed intentional disregard of the tax

rules and regulations even in their reporting of their capital
                                - 24 -

gains and supposed expenses, we find that the entire underpayment

not attributable to fraud is subject to the accuracy-related

penalty.

     The same defense of reasonable cause and good faith applies

to this penalty, see sec. 6664(c), and the Tarpos must show they

acted as reasonable and prudent people would, see Allen v.

Commissioner, 925 F.2d 348, 353 (9th Cir. 1991), affg. 92 T.C. 1

(1989).     This, we find, they failed to do.   James didn’t keep any

regular records of his day-trading activities despite knowing

that he would owe tax on any capital gains he made.      He is

business savvy and should have known better.       And neither Tarpo

claims to have kept any other sort of business records.

Reasonable people usually keep records to show their entitlement

to deductions or at least to track income and expenses.      The

Tarpos are either not acting reasonably or are not telling the

truth.     Either way, they do not have a credible defense to the

accuracy-related penalty.

     For the above reasons,

                                      Decisions will be entered

                                 under Rule 155.
