                         T.C. Memo. 2009-257



                     UNITED STATES TAX COURT



                 MOHAMMAD ENAYAT, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent

            WOODBURY RUG COMPANY, INC., Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent


     Docket Nos. 1488-07, 1489-07.     Filed November 10, 2009.



     William E. Christie, for petitioners.

     Daniel P. Ryan and Erika B. Cormier, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     GUSTAFSON, Judge:   Petitioner Mohammad Enayat operated a

Persian rug business, in some years through his wholly owned

C corporation, petitioner Woodbury Rug Company, Inc. (Woodbury),

and in later years through his single-member limited liability

company (LLC), Sutter & Hayes.   In 1998 through 2001, business
                                    - 2 -

revenues and other receipts were deposited into and transferred

among various personal and business bank accounts, and Mr. Enayat

admits that his bookkeeping was “horrible”.           For those years

Mr. Enayat filed his own returns late and the C corporation’s

returns late or not at all.        The Internal Revenue Service (IRS)

issued to Mr. Enayat a statutory notice of deficiency on October

17, 2006, pursuant to section 6212,1 showing the following

deficiencies in income tax and additions to tax, respectively,

for tax years 1998 to 2001:

                                       Addition to tax     Fraud Penalty
         Year          Deficiency      Sec. 6651(a)(1)      Sec. 6663(a)

         1998           $349,442            $87,361           $262,082
         1999             65,632             16,408             49,224
         2000            110,080             27,520             82,560
         2001             29,231              7,308             21,923

On the same date the IRS also issued a notice of deficiency to

Woodbury, showing the following deficiencies in income tax and

additions to tax, respectively, for tax years 1998 and 1999:

                              Additions to Tax             Fraud Penalty
 Year     Deficiency   Sec. 6651(a)(1) Sec. 6651(f)         Sec. 6663(a)

 1998       $74,010        $18,503             ---             $55,505
 1999        46,499          ---             $34,837             ---




     1
      Unless otherwise indicated, all citations of sections refer
to the Internal Revenue Code of 1986 (26 U.S.C.), as amended, and
all citations of Rules refer to the Tax Court Rules of Practice
and Procedure.
                                - 3 -

     After concessions, the issues for decision are:2

                       Business Income Issues

     (1)    Whether Mr. Enayat had unreported constructive dividend

income of $203,273 in 1998 and $31,723 in 1999, as a result of

his depositing into his personal accounts checks payable to

Woodbury.    We find that he did.

     (2)    Whether Mr. Enayat had unreported officer’s

compensation of $349,356 in 1998 and $67,2003 in 1999, as a

result of transferring funds from Woodbury accounts to his

personal accounts.    We find that he did, and that Woodbury is

therefore entitled to deductions in those same amounts.

     (3)    Whether Woodbury had unreported gross receipts of

$246,352 for taxable year 1998.     We find that it did.

     (4)    Whether Woodbury had unreported gross receipts of

$162,050 for taxable year 1999.     We find that it did.




     2
      Mr. Enayat does not dispute the following adjustments to
income in the notice of deficiency: gambling income of $16,800
in 1998; rental income of $2,000 in 1998; income from insurance
proceeds of $201,929 in 2000; and gross receipts on Schedule C,
Profit or Loss From Business, in the amount of $113,800 in 2001.
The other adjustments set forth on the Form 4549-B, Income Tax
Examination Changes, that is attached to the notice of deficiency
issued to Mr. Enayat are computational, and their resolution will
follow automatically from the Court’s determinations with regard
to the issues resolved in this opinion.
     3
      Respondent concedes that Mr. Enayat transferred only
$67,200 from Woodbury’s accounts to his personal accounts in
1999, not $85,200 as reflected in the notice of deficiency.
                                - 4 -

     (5)    Whether Mr. Enayat received additional income of $1,228

in 1999 and $252,721 in 2000 from his LLC, Sutter & Hayes.     We

find that he did.

                         Other Income Issues

     (6)    Whether Mr. Enayat received additional income of

$305,101 in 1998 as a result of a transfer from Dr. William

Willitts.    We find that he did not.

     (7)    Whether Mr. Enayat is entitled to deduct capital losses

of $71,8124 in 1998 and $46,807 in 1999, from the sale of the Elm

Street property.    We find that he is not.

                 Additions to Tax and Penalty Issues

     (8)    Whether Mr. Enayat is liable for additions to tax under

section 6651(a)(1) for the failure to timely file his tax returns

for taxable years 1998 through 2001.    We hold that he is.

     (9)    Whether Mr. Enayat is liable for the fraud penalty

under section 6663(a) for the four years 1998 through 2001.      We

hold that he is liable for the fraud penalty for the three years

1998, 2000, and 2001, but in amounts less than those determined

in the notice of deficiency.    We hold that Mr. Enayat is not

liable for the fraud penalty for the year 1999.




     4
      The correct amount for the capital gains adjustment in 1998
is $71,812, not $74,812 as stated in the notice of deficiency.
See infra note 23.
                                - 5 -

     (10)    Whether Woodbury is liable for the addition to tax

under section 6651(a)(1) for the failure to timely file its tax

return for 1998.    We hold that it is not.

     (11)    Whether Woodbury is liable for the fraud penalty under

section 6663(a) for the year 1998.      We hold that it is not.

     (12)    Whether Woodbury is liable for the addition to tax

under section 6651(f) for the fraudulent failure to file its tax

return for the year 1999.    We hold that it is.

                          FINDINGS OF FACT

     This case was tried in Boston, Massachusetts, on March 19-

20, 2009.    The stipulation of facts filed October 20, 2008, the

supplemental stipulation of facts filed March 19, 2009, and the

attached exhibits are incorporated herein by this reference.      At

the time Mr. Enayat filed his petition in docket No. 1488-07, he

resided in Massachusetts.    At the time Woodbury filed its

petition in docket No. 1489-07, it was no longer actively engaged

in business but had an address in Massachusetts.

Background

     Mr. Enayat began working in the Persian rug business when he

was 18 years old, and he owned his own store from 1994 through

the date of trial.    During each of the years at issue, Mr. Enayat

was in the business of selling Persian rugs from a retail store

in Bedford, New Hampshire.    During taxable years 1998 and 1999,

Mr. Enayat operated and was the sole shareholder of Woodbury, a
                                - 6 -

C corporation.   Towards the end of 1999, Mr. Enayat formed a

limited liability company known as Sutter & Hayes, LLC (Sutter),

and began operating his business through this entity.     During the

years 1999 through 2001, Mr. Enayat was the sole member of

Sutter.   Mr. Enayat maintained various bank accounts in his own

name and in the names of Woodbury and Sutter.     However, in the

manner described below, business receipts were sometimes

deposited in personal accounts, and money was transferred between

business and personal accounts without documentation being

maintained to justify or explain the transfers.      Mr. Enayat

admits, “I treated both myself and Woodbury, and [his investment

accounts at] Oppenheimer, and Merrill Lynch, and Citibank and –-

I treated it all as one.”

Unreported Income of Woodbury

     As a retail seller of Persian rugs, Woodbury acquired rugs

from wholesale vendors and then sold them to its own customers,

making its money from those sales.      Petitioners--Mr. Enayat and

Woodbury--did not offer into evidence any records of Woodbury

sufficient to show the amount of its sales in 1998 or 1999.

Woodbury reported gross sales receipts of $1,168,759 on its

return for 1998, but at trial Mr. Enayat did not explain how he

had arrived at this figure; and Woodbury’s return preparer

testified that he did not recall what he was given to support the
                               - 7 -

sales total.   For 1999 Woodbury did not file a return and

therefore did not report receipts in any amount for that year.

     In its examination, the IRS performed a bank deposits

analysis to determine the amount of Woodbury’s gross receipts for

1998 and 1999.   The IRS began with the gross deposits into

Woodbury’s bank accounts and reduced them by any identifiable

non-taxable5 item (e.g., cash deposits,6 transfers between

accounts, deposits whose source could not be identified or which

were not readily apparent as business receipts, insurance

proceeds, and returned checks) to get net taxable deposits.    The

IRS then added to the net deposits all the checks payable to

Woodbury that were deposited in Mr. Enayat’s personal account

(discussed infra beginning at page 10 as “diverted” checks)

because those checks should have been deposited into Woodbury’s

accounts (and thereby should have shown up as gross receipts).


     5
      The IRS classified as “non-taxable” the money flowing into
Sutter’s accounts that should have been excluded from gross
receipts for various reasons (e.g., receipts that were actually
non-taxable, receipts that should be excluded to avoid double
counting, and unidentified money). However, that classification
does not necessarily mean that all items excluded from Woodbury’s
gross receipts under the IRS’s method were non-taxable under the
Internal Revenue Code.
     6
      Excluding cash deposits was appropriate to the extent that
the cash might have been obtained by cashing checks that had
already been counted, or by withdrawing the cash from another
bank account whose deposits had already been counted. However,
cash deposits might also have resulted from cash sales, so the
exclusion of all cash deposits may be unduly favorable to
Woodbury where cash sales are a possibility, but the IRS’s
analysis gives Woodbury the benefit of this doubt.
                               - 8 -

However, to accurately reflect Woodbury’s gross receipts, the IRS

then reduced its calculation for any transfers Mr. Enayat made

from his personal accounts to Woodbury’s corporate accounts, so

as to prevent double-counting or the taxing of any clearly non-

taxable items.   These reductions included money flowing from

Mr. Enayat to Woodbury that were capital contributions, see infra

note 34, or that were transfers from Mr. Enayat to repay diverted

Woodbury checks that Mr. Enayat had deposited in his personal

account, since the diverted checks had already been added to net

deposits.

     By its bank deposits analysis, the IRS determined that

Woodbury had additional gross receipts in taxable year 1998, as

follows:

    Bank Account      Gross Deposits   Non-Taxables   Net Deposits

Fleet Bank
  Account No. 9632     $162,289.53    $151,743.53       $10,546.00
Granite Bank
  Account No. 0540      778,408.49     611,664.78       166,743.71
Bank of NH
  Account No. 7435    2,193,660.33   1,271,624.11       922,036.22
Granite Bank
  Account No. 0492      145,074.14      31,520.98        113,553.16
  Total               3,279,432.49   2,066,553.40      1,212,879.09
Less: Gross receipts per 1998 Form 1120               (1,168,759.00)
Unreported gross receipts                                 44,120.09
Plus: Diverted checks                                    203,273.00
  Total unreported gross receipts for 1998               247,393.09
                               - 9 -

As is shown above, that $247,393 represents the difference

between Woodbury’s reported gross receipts on its 1998 Form 1120,

U.S. Corporation Income Tax Return, and the net taxable deposits

as calculated in the IRS’s bank deposits analysis, plus the

checks made out to Woodbury and diverted into Mr. Enayat’s

personal accounts (which should have been deposited into

Woodbury’s accounts but were not).     We find that the IRS’s

analysis was reasonable and that Woodbury had additional receipts

of $246,352.7

     The IRS did an equivalent analysis for 1999.    For that year

Woodbury had failed to file its Form 1120, so there is no

Woodbury-generated number against which to compare the IRS’s

analysis.   As it had for 1998, the IRS totaled Woodbury’s gross

deposits for 1999, reduced them by any identifiable non-taxable

item (including any transfers from Mr. Enayat’s personal

accounts), and then added any Woodbury checks that Mr. Enayat had

deposited into his personal account, yielding the following sum:




     7
      In preparation for trial, respondent had an IRS revenue
agent prepare another bank deposits analysis. This second bank
deposits analysis revealed that Woodbury had additional gross
receipts of $247,393.09 in taxable year 1998 instead of the
additional $246,352 previously determined. However, respondent
never accounted for this difference, so we find that Woodbury had
additional receipts in the year 1998 in the lesser amount of
$246,352, as reflected on the notice of deficiency.
                                - 10 -

    Bank Account      Gross Deposits     Non-Taxables   Net Deposits

Bank of NH
  Account No. 7435    $347,489.73    $244,918.77        $102,570.96
Fleet Bank
  Account No. 9632     205,358.91     177,602.46          27,756.45
  Total                552,848.64     422,521.23         130,327.41
Plus: Diverted checks                                     31,723.00
  Total unreported gross receipts for 1999                162,050.41


Again, because we find the IRS’s bank deposits analysis to be

reasonable, and because Mr. Enayat has not introduced any

evidence to refute those findings, we find that Woodbury had

unreported gross receipts of $162,050 for taxable year 1999.

Diverted Woodbury Checks Deposited Into Mr. Enayat’s Accounts

     As was noted above, in 1998 and 1999 Mr. Enayat deposited

into his personal bank accounts checks that were made out to

Woodbury.   He argues that these deposits are not taxable to him

because they were made--and were repaid--pursuant to a procedure

dictated by business necessity, arising from the manner in which

he purchased rugs for resale.    Mr. Enayat testified that he

regularly went to New York, picked out the merchandise he wanted

to buy for Woodbury, and negotiated a price and term for payment.

The payments Woodbury owed to the vendors were usually due 90,

120, or 180 days after the date of sale.     He wrote a Woodbury

check to the vendor for the purchase price, post-dated the check

to correspond to the payment term (e.g., if payment was due in 90
                              - 11 -

days, he would post-date the Woodbury check by 90 days), and took

the merchandise with him.

     However, Mr. Enayat testified that he learned that vendors

would often try to cash or deposit these post-dated checks before

their date, and that if there were sufficient funds in the

Woodbury account, the bank would usually honor the check even

though it was post-dated.8   He says that, in order to avoid the

premature negotiation of the Woodbury checks, he adopted the

practice of delaying the deposit of sufficient funds into the

Woodbury account on which the check was drawn until the day

before the post-dated check would mature.

     In the meantime, however, Mr. Enayat wanted to negotiate

promptly the corresponding checks that had been written to

Woodbury by its customers.   He testified that since he did not

want to put the funds into the Woodbury account, he would deposit

checks from Woodbury customers into his personal accounts, as a

sort of escrow, to be held there until he transferred the funds

to the Woodbury account in order to cover the post-dated checks

as they came due.   Thus, Mr. Enayat contends that the presence of




     8
      Consistent with Mr. Enayat’s account, it appears that under
New Hampshire law (where Woodbury did its banking), a bank may
honor a post-dated check unless its customer provides the bank
reasonable advance notice of the post-dating and describes the
check with reasonable certainty. N.H. Rev. Stat. Ann.
382-A:4-401(c) (Butterworth 1994).
                              - 12 -

the deposits in his personal accounts was an accommodation to

Woodbury, and not an appropriation of Woodbury funds.

     Mr. Enayat’s explanation seems superficially plausible for

tax year 1998 in the aggregate--since he diverted $203,273 of

Woodbury’s checks but redeposited almost the same amount

($201,950) into Woodbury’s account.    However, in 1999 he did not

redeposit any of the $31,723 he diverted from Woodbury.

Moreover, even for 1998 the more detailed facts do not line up

with his story but rather include these six anomalies and

contradictions:

     First, Mr. Enayat’s alleged plan of depositing money into

the Woodbury account only as the post-dated checks came due would

have required him to maintain a rather sophisticated system to

anticipate the negotiation of each post-dated check and to keep

in the account just enough money--but no more--to cover the

checks as they came due.   Mr. Enayat offered no evidence of any

such system, and he made no showing that the deposits into this

account actually corresponded to the post-dated due dates of the

checks.   Instead, it appears that Mr. Enayat wrote checks on

Woodbury’s account (for anything and everything, including but

not limited to the post-dated vendor checks, as we show below)

until the account became overdrawn; and that he would then

deposit enough money back into the account to bring the balance

back into the black.
                              - 13 -

     Second, Mr. Enayat gave no explanation for how his system

could actually have achieved its supposed goal even if he had

been able somehow to keep track of his check dates and make

deposits to cover the checks only as they became due.   If vendors

really did tend to present checks prematurely, and if the bank

did honor prematurely presented checks, then there would be no

way to assure that the funds he carefully deposited would be used

to pay the anticipated and timely presented check rather than an

unanticipated but prematurely presented check.   If funds were in

the account but a premature check arrived that the bank honored,

then a timely submitted check presented thereafter would bounce.

     Third, although Mr. Enayat’s testimony suggested that

premature negotiation of checks was a persistent risk in his

business, most of the Woodbury checks deposited into his personal

accounts were in fact deposited in February and March 1998, and

the deposits largely tailed off thereafter.   The record includes

no information to the effect that the situation changed, and no

explanation for this irregularity.

     Fourth, the purpose Mr. Enayat alleges would have naturally

called for the use of a single account, from which funds could be

swept as necessary.   But throughout 1998 Mr. Enayat diverted

Woodbury checks into not one but four separate personal accounts

(acct. Nos. 0495, 4702, 1027, and 9215).   If Mr. Enayat had truly
                               - 14 -

intended to hold these checks in a sort of escrow, there would

have been no reason to deposit these checks in multiple accounts.

     Fifth, on the other hand, the money Mr. Enayat redeposited

into Woodbury’s account did not come from all four of those

personal accounts into which Woodbury checks had been deposited,

but rather only two of them (i.e., acct. Nos. 0495 and 1027).    If

Mr. Enayat’s story were true, he would have redeposited money

from all four of the accounts to which it had been diverted, but

he did not.    Furthermore, from one of those personal accounts--

No. 1027--Mr. Enayat redeposited $36,500 into Woodbury’s account

even though he had diverted only $3,094 into that account in the

first place.   Even if Mr. Enayat could logically explain the

necessity of using multiple accounts in this manner, the money

flowing back to Woodbury should have been equivalent to the money

diverted, not just in the aggregate, but account-for-account.    It

was not.

     Sixth, the transaction history of Woodbury’s corporate

account No. 0540 simply fails to correspond to Mr. Enayat’s

story.   While Woodbury did maintain a low or negative balance in

this account at most times (which would seem to support

Mr. Enayat’s story), a review of the account statements shows

that Mr. Enayat also used this account to pay personal expenses

and to buy stock options.   Had Mr. Enayat truly been holding

these diverted checks in escrow to prevent the premature
                                  - 15 -

depositing of post-dated checks, he would have needed to keep the

balance of Woodbury’s account near zero and would have used the

account only for these post-dated check transactions.       Using the

account as a general checking account--and depositing in it funds

that were intended to cover other expenses--would (if his story

were true) enable a rug business payee to raid these other moneys

that were put into the account.       If Mr. Enayat really had run his

accounts in the manner he alleged with the purpose of preventing

depletion of Woodbury funds by premature negotiation of Woodbury

checks, he would not have put non-Woodbury money at the same

risk.

           The evidence does not show that Mr. Enayat held the

proceeds from Woodbury checks in an escrow-like fashion or used

his personal account to “sweep” these diverted checks in any

orderly fashion.       We find that he did not do so, but simply

deposited Woodbury checks into his personal accounts for general

use.

       Mr. Enayat did not treat any of the diverted Woodbury checks

as income on his own Form 1040, U.S. Individual Income Tax

Return, for 1998 or 1999.       In its notice of deficiency, the IRS

effectively treated each Woodbury check deposited in a personal

account as if it were a constructive dividend to Mr. Enayat;9 and


       9
      The IRS’s notice of deficiency characterized the income
Mr. Enayat derived from depositing Woodbury checks as dividend
                                                   (continued...)
                             - 16 -

the IRS did not reduce its adjustment by the equivalent amounts

that Mr. Enayat had transferred to Woodbury during 1998.10

Transfers From Woodbury to Mr. Enayat

     In addition to the Woodbury checks deposited by Mr. Enayat

into his personal accounts, Woodbury made transfers of funds to

Mr. Enayat throughout 1998 and 1999.    Woodbury transferred

$349,356 to Mr. Enayat in 1998 and $67,200 in 1999, either by

checks written to Mr. Enayat or by direct transfers.    Mr. Enayat

did not report any of these amounts as income on his Forms 1040,

because (he says) he considered them to be repayments of loans he

had previously made to Woodbury.   He testified that he advanced

funds to Woodbury when the business needed them to cover expenses

or inventory, or whenever there were cash flow problems for



     9
      (...continued)
income. Although Mr. Enayat disputed the characterization of
these amounts as income to him, he did not offer any evidence to
show that, if income, they were officer’s compensation rather
than dividends. Consequently, because we find that these amounts
were income to Mr. Enayat, we accept the IRS’s characterization
as dividend income.
     10
      As is explained supra p. 7, for purposes of calculating
Woodbury’s taxable income the IRS added the amounts of these
diverted checks to Woodbury’s gross receipts. However, Wood-
bury’s gross bank deposits included transfers from Mr. Enayat,
some of which remitted to Woodbury the proceeds of the diverted
checks. To avoid double-counting the diverted checks as Woodbury
income, the IRS subtracted from Woodbury’s net deposits
Mr. Enayat’s transfers that remitted the amounts of the diverted
checks. Thus, these amounts were treated only once as taxable
income to Woodbury. They were also treated as taxable income to
Mr. Enayat. This double taxation--of the corporation and the
shareholder--is discussed infra pt. II.A.1.
                               - 17 -

Woodbury.    And he insisted that all the money transferred from

Woodbury to his personal accounts in 1998 and 1999 was for the

repayment of these types of loans; that for every transfer from

Woodbury to Mr. Enayat (i.e., the repayment) there would have

been a preceding transfer from Mr. Enayat to Woodbury (i.e., the

loan); and that Woodbury repaid the loans to him as funds became

available.    The evidence does show--broadly consistent with this

account--that Mr. Enayat did make transfers11 to Woodbury from

his personal accounts in amounts totaling $346,238.1112 in 1998

(when the Woodbury-to-Enayat transfers totaled $349,356) and

totaling $164,429.17 in 1999 (when the Woodbury-to-Enayat

transfers totaled only $67,200).    These, he says, were the loans

for which Woodbury repaid him with the transfers now at issue,

and the two-year total of these Enayat-to-Woodbury transfers did

substantially exceed the amounts of the Woodbury-to-Enayat

transfers.




     11
      There is no indication of how the IRS classified the money
flowing from Mr. Enayat to Woodbury, but we assume it was treated
as contributions to capital.
     12
      These 1998 transfers totaling $346,238 were in addition to
the transfers in that year totaling $201,950 (see supra p. 12), a
few from account No. 1027 and most from account No. 0495, by
which Mr. Enayat transmitted to Woodbury the amounts of the
Woodbury checks that he had deposited in his personal accounts.
In the aggregate, Mr. Enayat’s transfers to Woodbury in 1998 and
1999 totaled $712,617 (i.e., $346,238 plus $164,429 plus
$201,950).
                               - 18 -

     However, there were no notes or loan agreements executed

between Mr. Enayat and Woodbury for any of these alleged loans,

and he could point to no entries in corporate minutes or

corporate financial records reflecting any such loans.

Mr. Enayat did not charge Woodbury interest on these loans or set

any maturity dates.   Moreover, his assertion that the Woodbury-

to-Enayat transfers were always preceded by Enayat-to-Woodbury

transfers is not supported by the evidence.    When pressed about a

specific transaction in which $10,000 seemed to go first from

Woodbury to Mr. Enayat, he admitted that it is possible that

Woodbury might have lent him money, and that a later $10,000

Enayat-to-Woodbury transfer may have been a repayment by

Mr. Enayat of a loan made by Woodbury.    The Court invited

Mr. Enayat to present in his post-trial brief a detailed analysis

of the bank records to show (if he could) that each Woodbury-to-

Enayat transfer was preceded by an Enayat-to-Woodbury loan; but

he did not do so, and instead limited his presentation to the

aggregate numbers.    At one point in the trial, Mr. Enayat

candidly testified that he just treated himself, Woodbury, and

all the bank accounts as one, and we find that to be true.    He

did not have a practice or routine that suggests that the

Woodbury-to-Enayat transfers were repayments of prior bona fide
                               - 19 -

loans.    We therefore find that these amounts were additional

officer’s compensation to Mr. Enayat.13

Unreported Income of Sutter in 1999 and 2000

     Sometime in 1999 Mr. Enayat formed Sutter & Hayes as a

single-member LLC and began to operate his rug business through

this entity.    On the Schedule C, Profit or Loss From Business,

for Sutter attached to Mr. Enayat’s 1999 Form 1040 he did not

report any gross receipts for Sutter.     However, the IRS performed

a bank deposits analysis on the bank accounts of Sutter to

determine Sutter’s gross receipts for 1999 and 2000,14 and the

analysis disclosed two deposits in 1999.    Mr. Enayat has now

stipulated that Sutter received two customer checks during

taxable year 1999 totaling $1,228 which were deposited into

Sutter’s bank account.   We find that these checks constituted

gross receipts that were taxable in 1999.

     In 2000 Mr. Enayat maintained a detailed sales report for

Sutter, which purported to list the date of every sale Sutter

made with the corresponding customer’s name and the amount of the


     13
      The IRS’s notice of deficiency issued to Mr. Enayat
characterized Woodbury’s transfers to him as officer’s
compensation. Although Mr. Enayat disputed the characterization
of these amounts as income to him, he did not offer any evidence
to contend that, if income, they were anything other than
officer’s compensation. Consequently, because we find that these
amounts were income to Mr. Enayat, we accept the IRS’s
characterization as officer’s compensation.
     14
      The record does not show whether the IRS performed a bank
deposits analysis for Sutter for its 2001 year.
                                - 20 -

sale.     Sutter’s 2000 gross receipts as recorded on the detailed

sales report totaled $691,170.     Mr. Enayat alleges that the

detailed sales report is a complete list of all sales for Sutter

in 2000, and that it therefore represents Sutter’s entire gross

receipts for 2000.     Mr. Enayat reported the gross receipts of

Sutter to be $671,92015 on his 2000 Form 1040.

     However, the totals reflected on the sales report and

reported on the return were not consistent with the information

that Sutter included on its claim for business interruption

insurance.    In making that claim Sutter reported that, in the

23 weeks preceding the flood that interrupted its business, it

had average weekly sales of $30,099.     The 23-week total was

therefore $692,277--a part-year total that already exceeded the

gross receipts Sutter reported for its full year.     Clearly

Sutter’s insurance claim left Mr. Enayat with much explaining to

do and rendered the sales report suspect.

     To determine the correct figure for Sutter’s gross receipts

in 2000, the IRS conducted a bank deposits analysis.     Its agent

totaled the deposits made into Sutter’s accounts in that year and

reduced that amount by any identifiable “non-taxable” item (e.g.,

transfers between accounts, cash deposits, returned checks,



     15
      Mr. Enayat did not explain the $19,250 difference between
the gross sales of $691,170 reported on the detailed sales report
and the gross receipts of $671,920 reported on Mr. Enayat’s
Schedule C.
                              - 21 -

refunds, and any unidentifiable deposits) to calculate Sutter’s

net taxable deposits.   Bank deposits do not reflect all of

Sutter’s revenues because, as Mr. Enayat stipulated, some of

Sutter’s receipts for 2000 were never deposited into a Sutter

account or in any of Mr. Enayat’s personal accounts.16    For that

reason the IRS compared Mr. Enayat’s detailed sales report--on

which Mr. Enayat supposedly recorded every sale Sutter made--to

actual deposits made into the known accounts.   Any customer

payment appearing on the detailed sales report that did not have

a corresponding deposit into a Sutter account or one of

Mr. Enayat’s personal accounts was added to Sutter’s net taxable

deposits to account for total gross receipts for 2000.17   The IRS

also made an adjustment to account for Sutter’s accounts

receivable at the beginning of 2000 compared to the end of 2000,


     16
      Mr. Enayat stipulated that $428,637.83 in payments
received from customers of Sutter was never deposited into a
Sutter account or in any of Mr. Enayat’s personal accounts.
Undeposited checks totaling this amount were either cashed or
endorsed over to Sutter’s creditors.
     17
      Where no corresponding deposit could be found for a
reported sale, and where the transaction did not involve the
exchange of money (e.g., an October 14, 2000, entry of $8,560 for
K.N.C. Investments, where Sutter exchanged a rug for the payment
of rent), the IRS added that sale to Sutter’s gross receipts. We
find no fault with this approach. The value that Sutter received
in kind in exchange for a rug should have been included in gross
receipts. At best there might have been an occasion for an
offset (e.g., as a cost of goods sold or as a deduction for the
rent for which the rug was payment), but Mr. Enayat did not show
that the offset had not already been claimed, and he did not
allege or prove his entitlement to further deductions or costs of
goods sold.
                              - 22 -

because Sutter had used an accrual method of accounting.    On the

basis of this analysis the IRS determined that Mr. Enayat had

understated Sutter’s gross receipts for 2000 by $252,722.08, and

we find that this determination was not refuted.

Money Dr. Willitts Entrusted to Mr. Enayat

     On July 13, 1998, Mr. Enayat received, in his Oppenheimer

investment account, a wire transfer of $455,485 from a Cayman

Islands account controlled by Dr. William Willitts.   Mr. Enayat

testified that Dr. Willitts entrusted this money to Mr. Enayat

pursuant to an arrangement used by Iranian-Americans because it

is impractical or impossible to transfer dollars from the United

States to Iran.   A practice has developed under which a transfer

is made indirectly by paying dollars to an American who has a

friend or relative in Iran, and then having the American direct

his friend or relative to make an equivalent transfer in rials

(the Iranian currency) to the ultimate payee in Iran.

Dr. Willitts paid Mr. Enayat $455,485 in the United States with

the understanding that the equivalent amount in rials would be

made available to Dr. Willitts in Iran from the proceeds of the

sale of property owned by Mr. Enayat’s family in Iran.

Dr. Willitts never made it to Iran and never received the

equivalent of $455,485 in rials.

     Mr. Enayat testified that once Dr. Willitts wired the funds

into his account, Mr. Enayat had free use of the money.
                               - 23 -

Dr. Willitts expected Mr. Enayat or his family in Iran to provide

rials in Iran to Dr. Willitts from the proceeds of an unrelated

real estate transaction; he did not expect Mr. Enayat to purchase

rials with the dollars wired into the Oppenheimer investment

account.    Mr. Enayat used some of the money to fund his business

and the rest for options trading.   By April 30, 1999, the balance

of Mr. Enayat’s Oppenheimer account was zero, indicating that

Mr. Enayat had spent, transferred, or lost (through diminution in

the value of the securities he held) all of the funds in that

account, including Dr. Willitts’s money.

     At some point Dr. Willitts’s wife, Dr. Roofeh (who is

Mr. Enayat’s friend), asked Mr. Enayat for $54,000 in the United

States, and Mr. Enayat promptly returned that portion of the

$455,485.   Subsequently, Mr. Enayat paid additional sums to or at

the direction of Dr. Willitts, and he testified that he had

returned a total of $270,000 as of the date of trial.   However,

there is a dispute over how much Mr. Enayat repaid.   An Agreement

and Release which Mr. Enayat, Dr. Willitts, and Dr. Roofeh each

signed in November 1999 characterizes the $454,000 as a debt owed

to Dr. Willitts by Mr. Enayat, and it identifies a dispute in

which Mr. Enayat claimed he owed $285,000, and Dr. Willitts

claimed the outstanding debt was $305,000.   Dr. Willitts filed a

Petition for Ex Parte Attachment and Trustee Process in the

Hillsborough County (New Hampshire) Superior Court on or about
                               - 24 -

December 17, 1999, in which he alleged that Mr. Enayat had repaid

$148,899 of the total sum due of $454,000, and alleged a balance

due of $305,101.18   Dr. Willitts’s petition does not allege

theft, conversion, embezzlement, or misappropriation.   On the

record before us, there is no evidence of any wrong by Mr. Enayat

in receiving or using Dr. Willitts’s money.   The only wrong even

alleged is his failure to pay the money back after the parties

could not conclude the intended transactions in Iran.

     Mr. Enayat alleges that he has repaid the much greater

amount of $310,000--i.e., $270,000 in cash and rugs plus $40,000

from the settlement on the building where Sutter was located--

leaving a balance due of approximately $145,000.   However,

Mr. Enayat did not provide any evidence other than his own

testimony to substantiate the repayment of $310,000 of the money

Dr. Willitts transferred to him.   As a result, to the extent that

such a finding is needed, we find that, at most, Mr. Enayat had

repaid $148,899 (the amount Dr. Willitts conceded in his

petition).

     Mr. Enayat did not report the receipt of the $455,485, or

any portion thereof, on his Form 1040 for 1998 (or any other year

at issue).   The IRS determined that Mr. Enayat had repaid a


     18
      The record does not indicate why the amount recited in the
Agreement and Release was $454,000 or why Dr. Willitts indicated
in his petition that the total balance he entrusted to Mr. Enayat
was $454,000 instead of the $455,485 he wired to Mr. Enayat’s
account.
                                 - 25 -

portion of the money owed to Dr. Willitts, but to the extent

Mr. Enayat had failed to repay the money--$305,101--the notice of

deficiency referred to it as “income from theft” and “embezzled

funds” income to Mr. Enayat.19

     Mr. Enayat contends that respondent is estopped from

asserting that he embezzled money from Dr. Willitts because, in a

criminal case against Dr. Roofeh,20 the Government called

Mr. Enayat as a witness in 2001 and evoked testimony from him to

the effect that he did not take or steal the money that

Dr. Willitts had transferred to him.      However, without finding

that the Government is estopped from asserting that Mr. Enayat

stole the money,21 we simply find on the preponderance of the


     19
      Although respondent concedes that some of the money
Mr. Enayat repaid to Dr. Willitts may have been repaid in years
later than taxable year 1998, the adjustment to Mr. Enayat’s
income nets the alleged embezzlement and all the repayments as if
they happened in taxable year 1998, evidently for the sake of
simplicity.
     20
      United States v. Roofeh, No. 1:00CR00112 (D. N.H.
dismissed Feb. 28, 2001).
     21
      Mr. Enayat’s estoppel argument is not well grounded. To
be judicially estopped, the Government “must have succeeded in
persuading a court to accept its prior position”, Alternative
Sys. Concepts, Inc. v. Synopsys, Inc., 374 F.3d 23, 33 (1st Cir.
2004), but Mr. Enayat has not shown that in the Roofeh case the
Government actually took the position that he did not commit
theft or that it succeeded in persuading the Court to accept that
position. Mr. Enayat cites United States v. Kattar, 840 F.2d
118, 128 (1st Cir. 1988)(quoting Napue v. Illinois, 360 U.S. 264,
269 (1959)), for the inapposite proposition that “conviction must
fall when the prosecution, ‘although not soliciting false
evidence, allows it to go uncorrected when it appears’”.
                                                   (continued...)
                              - 26 -

evidence that Mr. Enayat received the money not by theft or

misappropriation but in the transaction that he described.    We

find that he therefore owed a debt to Dr. Willitts in that

amount, and during the years at issue the money Dr. Willitts had

transferred to Mr. Enayat and that Mr. Enayat had yet to repay

remained a debt that Mr. Enayat continued to owe Dr. Willitts.

Sale of the Elm Street Property

     Until early May 1998, Mr. Enayat rented and resided in a

house on Elm Street in Manchester, New Hampshire.   He moved out

in May 1998;22 and about two months later on July 24, 1998, he

purchased the Elm Street house for $210,000 as an investment.

After Mr. Enayat bought the house in July, he began renovating

it; and he sold the house five months later on December 30, 1998,

for $274,000.   That the renovation occurred is established not



     21
      (...continued)
(Emphasis added.) We cannot tell, but perhaps that proposition
could have been helpful to the criminal defendant who was being
prosecuted in Roofeh. However, this deficiency case in the Tax
Court is not a criminal case; Mr. Enayat is not being prosecuted;
and his complaint is not that the Government relies here on
“false evidence” but that it attempts to contradict Mr. Enayat’s
testimony that (he insists) constituted true evidence in another
case. Kattar has no application here.
     22
      Respondent called Mr. Enayat’s former girlfriend as a
witness at trial to testify that Mr. Enayat had lived at the Elm
Street property from July to December 1998 (i.e., after
Mr. Enayat had purchased the house). However, when pressed on
this issue, the witness admitted that she may have been confusing
December 1997 with December 1998. We find that Mr. Enayat did
not reside at the Elm Street property after he purchased it in
July 1998.
                              - 27 -

only by Mr. Enayat’s testimony but also by the fact that the

December 1998 sale price was $64,000 higher than Mr. Enayat’s

July 1998 purchase price.   However, at trial he offered no

substantiation for any expenditures incurred in the renovation,

and he gave only the most general testimony about the nature of

the renovation.

     On his 1998 return Mr. Enayat reported $71,812 in capital

gains from securities transactions and a $118,619 capital loss

identified as “Investment Property/House”.   To compute this loss,

we assume that Mr. Enayat included the supposed cost of

renovations in his basis for the house.   (With a purchase price

of $210,000 and a sale price of $274,000, it would have taken

more than $182,000 in renovation costs to yield a loss of

$118,619.   Mr. Enayat did not substantiate costs of $182,000 or

any other amount.)   Mr. Enayat fully offset his 1998 capital gain

of $71,812 with his purported real estate capital loss.    He

entered a $3,000 capital loss on line 13 of his 1998 Form 1040,

but because he reported negative adjusted gross income, he did

not actually obtain the benefit of any deduction for capital loss

for 1998.   Rather, Mr. Enayat carried forward a $46,807 capital

loss (i.e., $118,619 minus $71,812), and he used that amount to

offset some of his $338,202 net capital gains in 1999.23


     23
      The parties stipulated that Mr. Enayat claimed his
purported $118,619 real estate capital loss by claiming $74,812
                                                   (continued...)
                              - 28 -

     In the notice of deficiency the IRS disallowed these capital

loss deductions for both 1998 and 1999.   We find that Mr. Enayat

substantiated his purchase price of $210,000 but not any

additional basis derived from renovations, and that therefore he

did not prove his capital loss.

Mr. Enayat’s Concessions

     Mr. Enayat conceded the following four matters:

     1.   Gambling Income.   During taxable year 1998 Mr. Enayat

received gambling income of $16,800 from Foxwoods Casino.

Mr. Enayat did not report the receipt of this gambling income on

his 1998 Form 1040.   Mr. Enayat does not dispute that he received

this income or that it should have been reported on his 1998 Form

1040.

     2.   Rental Income.   During taxable year 1998 Mr. Enayat

received rental income of $2,000 from Shorty’s Mexican Roadhouse.

Mr. Enayat did not report the receipt of this rental income on



     23
      (...continued)
of the loss in 1998 and carrying $46,807 of the loss forward into
1999. The sum of these amounts is $121,619, not $118,619; and
the $74,812 stipulated as claimed in 1998 appears mistakenly to
include the $3,000 Mr. Enayat entered on line 13 of his Form 1040
but that he was unable to deduct. We may disregard stipulations
between parties where justice requires, if the evidence contrary
to the stipulation is substantial or the stipulation is clearly
contrary to facts disclosed by the record. See Cal-Maine Foods,
Inc. v. Commissioner, 93 T.C. 181, 195 (1989); Jasionowski v.
Commissioner, 66 T.C. 312, 318 (1976). The tax returns show that
Mr. Enayat applied $71,812 (not $74,812) to offset capital gains
in 1998 and $46,807 to offset net capital gains in 1999, totaling
$118,619 (not $121,619).
                                   - 29 -

his 1998 Form 1040.    Mr. Enayat does not dispute that he received

this income or that it should have been reported on his 1998 Form

1040.

     3.      Insurance Proceeds.    During taxable year 2000 Sutter

was unable to operate for a time because of a flood in the

building.     In July 2000 Mr. Enayat filed an insurance claim and

received business interruption insurance payments of $201,929

from Safeco Insurance Co. (Safeco).         (As to the amount, see infra

note 29.)     Mr. Enayat did not report the receipt of these

insurance proceeds on his 2000 Form 1040.        Mr. Enayat does not

dispute that he received this income or that it should have been

reported on his 2000 Form 1040.

        4.   Stolen Check.   During taxable year 2001 Mr. Enayat

received a Bank of America check in the amount of $113,800, which

was from a company called QAD, Inc., and issued to Innuendo, LLC.

Mr. Enayat misappropriated the funds by negotiating the check

with the help of a friend, and he was convicted of receipt of

stolen securities under 18 U.S.C. section 2315 in the U.S.

District Court for the District of New Hampshire.        Mr. Enayat did

not report the receipt of the $113,800 on his 2001 Form 1040, and

he does not dispute that this $113,800 should have been reported

as gross receipts on his 2001 Schedule C.
                               - 30 -

Mr. Enayat’s Federal Income Tax Returns and the Results of the
IRS’s Examination

     A.    Taxable Year 1998

     Mr. Enayat filed his Form 1040 for taxable year 1998 a year

late on April 14, 2000.   He reported no wage or salary income.

He claimed a capital loss of $71,812 from the sale of real estate

(the Elm Street property) and carried over $46,807 to his 1999

Form 1040.   As a result, he reported no taxable income for 1998.

After examining Mr. Enayat’s 1998 return, the IRS made the

following adjustments to his income:

     (1)   a $74,812 increase in taxable income, arising from the
           disallowance of a capital loss with respect to the sale
           of the Elm Street property;

     (2)   a $16,800 increase in taxable income derived from
           gambling;

     (3)   a $349,356 increase in officer’s compensation income,
           to account for transfers of money from Woodbury’s
           accounts to his personal accounts;

     (4)   a $305,101 increase in taxable income, to account for
           the transfer from Dr. Willitts;

     (5)   a $203,273 increase in constructive dividend income, to
           account for checks made out to Woodbury but deposited
           into his personal accounts;

     (6)   a $2,000 increase in taxable rental income; and

     (7)   an $8,100 increase in taxable income, resulting from
           the disallowance of personal exemptions because of
           Mr. Enayat’s corrected adjusted gross income (AGI)
           resulting from the adjustments above.
                                - 31 -

     B.     Taxable Year 1999

     Mr. Enayat filed his Form 1040 for taxable year 1999 on

October 9, 2002.    He reported no wage or salary income, and he

claimed the capital loss of $46,807 that was carried over from

his 1998 Form 1040.24   He attached to his 1999 return a Schedule

C for Sutter.    He reported that Sutter had no gross receipts in

1999 but that it had $38,024 in expenses, resulting in a claimed

loss of $38,024 from Sutter.    He reported taxable income of

$234,688.    Following an examination of Mr. Enayat’s 1999 return,

the IRS made the following adjustments to his income:

     (1)    a $46,807 increase in taxable income, arising from the
            disallowance of a capital loss with respect to the sale
            of the Elm Street property;

     (2)    a $85,20025 increase in officer’s compensation income,
            to account for transfers of money from Woodbury’s
            accounts to his personal accounts;

     (3)    a $31,723 increase in constructive dividend income, to
            account for checks made out to Woodbury but deposited
            into his personal accounts;

     (4)    a $1,228 increase in the gross receipts reported on his
            Schedule C, to reflect Sutter’s correct gross receipts;
            and

     (5)    a $5,184 increase in taxable income, resulting from the
            disallowance of itemized deductions because of



     24
      Mr. Enayat also had other capital gains and losses that
resulted in his claiming a total capital gain of $291,395 on his
1999 return.
     25
      The IRS later determined--and has conceded in this case--
that the actual amount of Woodbury-to-Enayat transfers was
$67,200. See supra note 3.
                               - 32 -

           Mr. Enayat’s corrected AGI resulting from the
           adjustments above.

     C.    Taxable Year 2000

     Mr. Enayat filed his Form 1040 for taxable year 2000 on

October 22, 2002.   He reported no wage or salary income.   He

attached to his 2000 return a Schedule C for Sutter.    He reported

that in 1999 Sutter had gross receipts of $671,920 but had

$332,159 in cost of goods sold plus $457,826 in additional

expenses, resulting in a claimed loss of $118,065 from Sutter.

He reported zero taxable income.   After examining that return,

the IRS made the following adjustments to his income:

     (1)   a $201,929 increase in taxable income to account for
           the receipt of insurance proceeds;

     (2)   a $252,721 increase in the gross receipts reported on
           his Schedule C, to reflect Sutter’s correct gross
           receipts;

     (3)   a $9,232 decrease in taxable income, to allow the
           increased deduction for one-half of Mr. Enayat’s self
           employment tax;26

     (4)   an $11,169 increase in taxable income, resulting from
           the disallowance of itemized deductions because of
           Mr. Enayat’s corrected AGI resulting from the
           adjustments above; and

     (5)   a $2,800 increase in taxable income, resulting from the
           disallowance of personal exemptions because of


     26
      Because Mr. Enayat’s self-employment (Schedule C) income
increased, so did his self-employment tax. That self-employment
tax increase is not reflected on the adjustments to Mr. Enayat’s
income, but his deduction for one-half of that higher amount is.
Although Mr. Enayat challenges the IRS’s year 2000 income
adjustment, he did not offer any argument that the amount, if
income, should not be characterized as self-employment income.
                               - 33 -

           Mr. Enayat’s corrected AGI resulting from the
           adjustments above.

     D.    Taxable Year 2001

     Mr. Enayat filed his Form 1040 for taxable year 2001 on

October 22, 2002.   He reported no wage or salary income and

reported a $30,059 loss from Sutter.    He reported no taxable

income for 2001.    Following an examination of Mr. Enayat’s 2001

return, the IRS made the following adjustments to his income:

     (1)   a $113,800 increase in the gross receipts reported on
           his Schedule C, to include the amount of a stolen
           check; and

     (2)   a $5,917 decrease in taxable income, to allow the
           increased deduction for one-half of Mr. Enayat’s self
           employment tax.

Woodbury’s Federal Income Tax Returns and the Results of the
IRS’s Examination

     For the year 1998 Woodbury filed its Form 1120 more than

four years late on September 10, 2003, reporting, inter alia,

gross receipts of $1,415,111 and, after deductions, a net loss of

$13,633.   After examination the IRS adjusted Woodbury’s 1998

gross receipts upwards by $246,352.

     For the year 1999 Woodbury filed no tax return.    After

examination the IRS determined Woodbury’s gross receipts--and its

taxable income--to be $162,050 for 1999.

     Although the IRS had determined that Mr. Enayat had received

compensation from Woodbury of $349,356 in 1998 and $67,200 in

1999 (a correction from an earlier $85,200), the notice of
                              - 34 -

deficiency reflected no allowance of deductions for Woodbury in

these amounts.   (As we show infra in part I.B.3 and 4, if such

deductions are allowed, the 1998 income adjustment is entirely

offset and the 1999 income adjustment is offset in part.)

The Statutory Notices of Deficiency and the Commencement of These
Cases

     On October 17, 2006, the IRS mailed separate statutory

notices of deficiency to Mr. Enayat and Woodbury.   In

Mr. Enayat’s notice the IRS determined a deficiency based on the

adjustments of income described above and also determined both

additions to tax for his failure to timely file his returns and

fraud penalties for taxable years 1998, 1999, 2000, and 2001.     In

Woodbury’s notice the IRS determined deficiencies for taxable

years 1998 and 1999 based on the adjustments to its gross

receipts as described above and also determined additions to tax

for its failure to timely file its tax return for taxable year

1998 and for its fraudulent failure to file for taxable year 1999

and a fraud penalty for taxable year 1998.   Mr. Enayat and

Woodbury both timely petitioned this Court for a redetermination

of their respective deficiencies.

                              OPINION

I.   Unreported Income of Woodbury and Sutter

     Mr. Enayat operated his rug business through Woodbury in

1998 and 1999 and through Sutter in 1999 through 2001, kept

sloppy records for both entities, and failed to report much of
                              - 35 -

their income.   Taxpayers bear the responsibility to maintain

books and records that are sufficient to establish their income.

See sec. 6001; DiLeo v. Commissioner, 96 T.C. 858, 867 (1991),

affd. 959 F.2d 16 (2d Cir. 1992); sec. 1.446-1(a)(4), Income Tax

Regs. (26 C.F.R.); see also Estate of Mason v. Commissioner, 64

T.C. 651, 656 (1975), affd. 566 F.2d 2 (6th Cir. 1977).

Mr. Enayat failed to fulfill that responsibility both as to

himself and as to his C corporation, Woodbury.

     A.   The IRS’s Use of the Bank Deposits Method

     When a taxpayer fails to keep adequate books and records,

the IRS is authorized to determine the existence and amount of

the taxpayer’s income by any method that clearly reflects income.

Sec. 446(b); Mallette Bros. Constr. Co. v. United States, 695

F.2d 145, 148 (5th Cir. 1983); Webb v. Commissioner, 394 F.2d

366, 371-372 (5th Cir. 1968), affg. T.C. Memo. 1966-81; see also

Holland v. United States, 348 U.S. 121, 131-132 (1954).    The

IRS’s reconstruction of a taxpayer’s income need only be

reasonable in light of all surrounding facts and circumstances.

Schroeder v. Commissioner, 40 T.C. 30, 33 (1963); see also Giddio

v. Commissioner, 54 T.C. 1530, 1533 (1970).   The IRS is given

latitude in determining which method of reconstruction to apply

when taxpayers fail to maintain adequate books and records.

Boyett v. Commissioner, 204 F.2d 205, 208 (5th Cir. 1953), affg.

a Memorandum Opinion of this Court; Kenney v. Commissioner, 111
                              - 36 -

F.2d 374, 375 (5th Cir. 1940), affg. a Memorandum Opinion of this

Court; Petzoldt v. Commissioner, 92 T.C. 661, 693 (1989).

     In the instant cases, the IRS chose to apply the bank

deposits method.   A bank deposit is prima facie evidence of

income.   Tokarski v. Commissioner, 87 T.C. 74, 77 (1986); see

also Clayton v. Commissioner, 102 T.C. 632, 645 (1994); DiLeo v.

Commissioner, supra at 868; Estate of Mason v. Commissioner,

supra at 656.   When a taxpayer keeps no books or records and has

large bank deposits, the IRS is not acting arbitrarily or

capriciously by resorting to the bank deposits method.      DiLeo v.

Commissioner, supra at 867.   The bank deposits method of

reconstruction assumes that all of the money deposited into a

taxpayer’s account is taxable income unless the taxpayer can show

that the deposits are not taxable.     See id. at 868; see also

Price v. United States, 335 F.2d 671, 677 (5th Cir. 1964).     The

IRS need not show a likely source of the income when using the

bank deposits method, but the IRS must take into account any

nontaxable items or deductible expenses of which the IRS has

knowledge.   See Price v. United States, supra at 677; Tokarski v.

Commissioner, supra at 77.

     Using the bank deposits method, the IRS identified

unreported gross receipts for Woodbury for taxable years 1998 and

1999, as well as unreported gross receipts for Sutter

(Mr. Enayat’s LLC) for taxable years 1999 and 2000.    As a general
                               - 37 -

rule, the IRS’s determinations are presumed correct, and the

taxpayer has the burden of establishing that the determinations

in the notice of deficiency are erroneous.   Rule 142(a); Welch v.

Helvering, 290 U.S. 111, 115 (1933).    As is explained above, we

find that the IRS reasonably reconstructed petitioners’ income

under the bank deposits method for all the years in issue.

     B.    Petitioners’ Challenge to the Bank Deposits Analysis

     Mr. Enayat contends that the IRS’s bank deposits analysis is

faulty.   The burden is on the taxpayer to show that the IRS’s

analysis is unfair or inaccurate.    Price v. United States, supra

at 677.   Petitioners must show either that the IRS’s computation

of their income is inaccurate or that the deposits made into

their bank accounts are not taxable.    See Marcello v.

Commissioner, 380 F.2d 509, 511 (5th Cir. 1967), affg. T.C. Memo.

1964-303 and T.C. Memo. 1964-304; Price v. United States, supra

at 678; DiLeo v. Commissioner, supra at 871.    We consider each of

the years at issue, taking them out of order to begin with the

year in which Mr. Enayat makes his most serious challenge.

           1.   Sutter’s Year 2000

     For taxable year 2000 Mr. Enayat introduced a detailed sales

report of Sutter which purported to list the date of every sale

Sutter made with the corresponding customer’s name and the amount

of the sale.    Mr. Enayat alleges that the detailed sales report

is a complete list of all sales for Sutter in 2000 and that it
                                  - 38 -

therefore represents Sutter’s gross receipts for 2000.

Mr. Enayat reported the gross receipts of Sutter to be $671,92027

on his 2000 Form 1040.     However, when the IRS completed its bank

deposits analysis of Sutter’s bank accounts, it found that

Mr. Enayat had understated the LLC’s gross receipts by

$252,722.08.

     To determine the correct figure for Sutter’s gross receipts

in 2000, the IRS performed a bank deposits analysis by looking at

the total deposits into Sutter’s accounts and reducing that

amount by any identifiable non-taxable item (e.g., transfers

between accounts, cash deposits, returned checks, and tax

refunds) to get Sutter’s net taxable deposits.      Because

Mr. Enayat has stipulated that some of Sutter’s receipts for 2000

were never deposited into a Sutter account or in any of

Mr. Enayat’s personal accounts,28 the IRS then compared

Mr. Enayat’s customer payment summary to actual deposits made

into the known accounts.       Any reported customer payment that did

not have a corresponding deposit into a Sutter account or one of

Mr. Enayat’s personal accounts was added to Sutter’s net taxable

deposits to account for total gross receipts for 2000.        The IRS


     27
      The gross receipts as calculated on the detailed sales
report were $691,170. As indicated supra note 15, Mr. Enayat did
not explain the difference between the gross sales reported on
the detailed sales report and the gross receipts reported on his
Schedule C.
     28
          See supra note 16.
                              - 39 -

then made an adjustment to account for accounts receivable at the

beginning of 2000 compared to the end of 2000 and for a deposit

from Lynk Systems which was treated as non-taxable.    Following

this methodology the IRS determined that Sutter had gross

receipts of $924,624.55 for the year 2000.    Because Mr. Enayat

reported Sutter’s gross receipts to be $671,920.47 on his 2000

Schedule C, the IRS determined that Mr. Enayat understated

Sutter’s gross receipts for taxable year 2000 by $252,722.08.      We

find the IRS’s bank deposits analysis to be credible.    Therefore,

the burden lies with Mr. Enayat to show any flaws in the IRS’s

methodology.   Price v. United States, supra at 677.

     Mr. Enayat argues that the IRS’s bank deposits analysis on

Sutter’s accounts is flawed because it included in gross receipts

items that had otherwise been counted and should have been

excluded to avoid double-counting--(i) insurance proceeds from

Safeco that had already been attributed as income to Mr. Enayat

and (ii) loans from third parties.     Furthermore, Mr. Enayat

argues that he reported Sutter’s gross receipts accurately

because he reported the figure shown on the sales report which

recorded every sales transaction.    We do not find any of

Mr. Enayat’s arguments to have merit.
                              - 40 -

     First, Mr. Enayat alleges that the inclusion of the

$266,65229 of Safeco insurance proceeds in the IRS’s bank

deposits analysis for Sutter was wrong because the IRS had

already counted those proceeds as income to him personally.     That

is, Mr. Enayat asserts that the IRS did not treat these Safeco

deposits as non-taxable in its analysis and reduce the gross

deposits by these amounts.   He does not support this assertion by

an analysis of the bank deposits or a detailed critique of the

IRS’s analysis, and the assertion is wrong as a matter of fact.

Mr. Enayat deposited three checks from Safeco into Sutter’s Fleet

account No. 3078 totaling $226,652.    In addition to these three

checks, a fourth check from Safeco in the amount of $40,000 was

evidently negotiated through a third party, so that $40,000 in

Safeco insurance proceeds reached Sutter’s accounts as a cash

deposit.   In its analysis of Fleet account No. 3078, the IRS

determined that in 2000 there were gross deposits of $465,179.29

(presumably including the Safeco payments).   Of that total, the

IRS treated $322,327.88 as non-taxable items, leaving net taxable




     29
      The record shows that $266,652 from Safeco was deposited
into Sutter’s Accounts. However, the parties have stipulated
that the insurance proceeds Mr. Enayat received for business
interruption in 2000 totaled $201,929. We do not attempt to
resolve this unexplained discrepancy. Rather, we use the larger
number when that favors Mr. Enayat (i.e., in his critique of the
bank deposits analysis), and we use the smaller number when that
favors Mr. Enayat (i.e., in accepting the stipulated smaller
number as the amount of the income adjustment).
                               - 41 -

deposits of only $142,831.41, an amount too small to include the

much larger Safeco proceeds.

     The IRS specifically identified cash as a non-taxable item

in its analysis.   Therefore, the $40,000 cash portion of the

Safeco payments was necessarily treated as non-taxable.    Had the

IRS failed to remove the insurance checks totaling $226,652 as

non-taxable items, then the net deposit total for Fleet account

No. 3078 would have had to include that amount, but it clearly

does not.   The net taxable deposits for Fleet account No. 3078 is

only $142,831.41, which is much less than the $226,652 (or the

$266,652 with the $40,000 cash deposit included) that Mr. Enayat

accuses the IRS of ignoring, and thereby treating as taxable.

The IRS treated $322,327.88 from this account as non-taxable

items, and it was Mr. Enayat’s burden to prove that the Safeco

checks and cash were not among these items.   He failed to do so.

     Second, Mr. Enayat alleges that $200,168 of the deposits

found in Sutter’s accounts was not taxable income but rather was

the proceeds of loans by third parties.   However, other than his

own testimony, Mr. Enayat provided no proof of these third-party

loans--no loan documents of any kind, no testimony from any of

the alleged lenders, and no minutes or financial entries

reflecting such loans.   None of the checks deposited from these

third parties had any markings on them (such as the designation

“loan” written on the front of the check) to indicate that they
                               - 42 -

were intended as loans.   On the contrary, two of the pertinent

checks had markings on them that indicate that they were not

loans (i.e., one check for $10,000 had “9x13” written in the

“memo” area, apparently indicating that the check was for the

purchase of a 9- by 13-foot rug; and one wire transfer for

$25,000 had “1982 Rolls Royce” written on it, indicating that the

transaction involved a car).   We find that Mr. Enayat has not

provided credible evidence to prove that any loans were made and

their proceeds deposited into Sutter’s bank accounts in 2000, and

we therefore find no fault in the IRS’s declining to reduce net

deposits to account for these unsubstantiated loans.

     Third, Mr. Enayat argues that Sutter’s gross receipts were

not understated because he reported the gross receipts as shown

on the sales report summary that (he says) recorded every sale.

However, the gross receipts he reported did not correspond

precisely to the total amount on the sales report; and more

important, Sutter’s bank accounts received many thousands of

dollars more than Mr. Enayat reported.   The IRS determined by its

analysis that Sutter had understated its gross receipts by

$252,722.08.   Mr. Enayat’s burden was to prove where that extra

$252,722.08 in deposits came from (if not sales), and he did not

meet that burden simply by insisting that the sales report was

accurate.
                                - 43 -

       We find that Mr. Enayat failed to carry his burden of

refuting the IRS’s bank deposits analysis, and we find that

Sutter had additional gross receipts of $252,722.08 for the year

2000.

             2.   Sutter’s Year 1999

        Mr. Enayat has stipulated that Sutter received two customer

checks during taxable year 1999 totaling $1,228 which were

deposited into Sutter’s Bank of New Hampshire account No. 8876.

However, the Schedule C for Sutter attached to Mr. Enayat’s 1999

Form 1040 reported zero gross receipts.     We find that the

customer deposits made into Sutter’s account in 1999 indicate

that Sutter did have gross receipts of $1,228 in the year 1999.

This corresponds with the bank deposits analysis performed by the

IRS.

             3.   Woodbury’s Year 1998

        Woodbury filed its Form 1120 for taxable year 1998 on

September 10, 2003.     It reported gross receipts of $1,168,759.

However, Woodbury’s return preparer testified that he did not

recall where that figure came from or how it was computed.

Mr. Enayat offered no sales report summary for Woodbury’s 1998

year as he did for Sutter’s 2000 year.     Because we find the IRS’s

bank deposits analysis to be credible, and because Mr. Enayat has

not introduced any evidence to refute it, we find that Woodbury

had additional gross receipts of $246,352 for taxable year 1998.
                                - 44 -

However, as respondent acknowledged in his brief, Woodbury is

entitled to a deduction in 1998 for the compensation imputed to

Mr. Enayat.     The amount of this deduction is $349,356, which more

than offsets Woodbury’s additional income in that year.

           4.     Woodbury’s Year 1999

      Woodbury proffered no sales report summary for the year 1999

and failed to file its Form 1120 for that year.     As a result, the

IRS prepared for Woodbury a substitute for return pursuant to

section 6020(b).     That substitute for return reported gross

receipts of $162,050 for taxable year 1999, as determined by the

IRS’s bank deposits analysis.     Again, because we find the IRS’s

bank deposits analysis to be credible, and because Mr. Enayat has

not introduced any evidence to challenge that analysis, we find

that Woodbury had unreported gross receipts of $162,050 for

taxable year 1999.     However, as in 1998, Woodbury is entitled in

1999 to a deduction of $67,200 for the compensation imputed to

Mr. Enayat, thereby reducing Woodbury’s taxable income in that

year to $94,850.

II.   Income Mr. Enayat Did Not Report

      A.   Income From the Rug Business

           1.     Woodbury Checks Deposited to His Personal Accounts

      In the notice of deficiency the IRS determined that

Mr. Enayat had additional constructive dividend income of

$203,273 in 1998 and $31,723 in 1999, as a result of his
                              - 45 -

depositing into his personal accounts checks made out to

Woodbury.   Mr. Enayat did not treat any of the diverted checks as

income on his Forms 1040 for 1998 and 1999.

     Mr. Enayat acknowledges that he deposited checks made out to

Woodbury in his personal accounts, but he contends that he was

holding the money for the corporation, in a sort of trust or

escrow arrangement, in order to prevent vendors from prematurely

negotiating Woodbury’s post-dated checks, and that he transferred

the funds to Woodbury’s accounts to cover its checks when they

were actually due.   It is true that in 1998 in the aggregate

Mr. Enayat deposited into his personal accounts $203,273 worth of

checks payable to Woodbury and transferred $201,950 back into

corporate accounts, leaving a difference of only $1,323 in his

personal accounts.   Moreover, it is also true that funds received

in trust by a trustee are excludable from gross income when:

(i) the funds are subject to a restriction that they be expended

for a specific purpose and (ii) the taxpayer does not profit,

gain, or benefit in spending the funds for the stated purpose.

Ford Dealers Adver. Fund, Inc. v. Commissioner, 55 T.C. 761, 771

(1971) (citing Seven-Up Co. v. Commissioner, 14 T.C. 965 (1950),

Broad. Measurement Bureau, Inc. v. Commissioner, 16 T.C. 988

(1951), Angelus Funeral Home v. Commissioner, 47 T.C. 391 (1967),

affd. 407 F.2d 210 (9th Cir. 1969), and Dri-Powr Distribs.

Association Trust v. Commissioner, 54 T.C. 460 (1970)), affd. 456
                                - 46 -

F.2d 255 (5th Cir. 1972).    On the other hand, funds that are

misappropriated from a trust by a trustee are includable in the

trustee’s gross income.     Webb v. IRS, 15 F.3d 203 (1st Cir.

1994); Adams v. Commissioner, T.C. Memo. 1970-104, affd. 456 F.2d

259 (9th Cir. 1972).

     We have found that Mr. Enayat did not establish the factual

predicate for his argument.    In 1999 he made no transfers to

Woodbury to compensate for its checks, and even in 1998 his

narrative simply does not line up with the facts in the record.

We therefore hold that Mr. Enayat had additional constructive

dividend income of $203,273 in 1998 and $31,723 in 1999.

Mr. Enayat did not attempt to show that Woodbury lacked earnings

and profits sufficient to support a taxable dividend.    Cf.

secs. 301(a), (c)(1), 316(a).    We find these transfers to be

taxable income to Mr. Enayat.

     A consequence of our finding is that the Woodbury checks

Mr. Enayat deposited are taxable income both to him and to

Woodbury.   Thus, for a year (such as 1999) in which Woodbury has

positive taxable income rather than loss, Woodbury is liable for

tax on these amounts at its corporate rate, and Mr. Enayat is

liable for income tax on the same amounts at his individual rate.

One could observe that a corporation is a legal fiction (i.e., a

fictitious person created pursuant to State law) and could

complain that this double taxation is therefore founded on a
                                - 47 -

fiction; but if so, it is a fiction that Mr. Enayat chose when he

incorporated Woodbury.    Use of the corporate form entails certain

advantages (chiefly, limited liability for shareholders), and the

business operator who wants those advantages is free to apply to

the State to charter a corporation.      However, while the law

grants legal rights and privileges to corporations, it also

confers on them certain duties and obligations--including, in

this instance, being taxable under subchapter C

(sections 301-385).30    For Federal tax purposes, we respect

Mr. Enayat’s creation of Woodbury Rug Company, Inc., and we

acknowledge its distinct existence.      As the Supreme Court stated

in Moline Props., Inc. v. Commissioner, 319 U.S. 436, 438-439

(1943):

          The doctrine of corporate entity fills a useful
     purpose in business life. Whether the purpose be to
     gain an advantage under the law of the state of
     incorporation or to avoid or to comply with the demands
     of creditors or to serve the creator’s personal or
     undisclosed convenience, so long as that purpose is the
     equivalent of business activity or is followed by the
     carrying on of business by the corporation, the


     30
      It is often possible to achieve the State law advantages
of incorporation while avoiding the status of being a separately
taxable entity for Federal tax purposes. One such means is for
an entity to be disregarded pursuant to the so-called check-the-
box regulations, sec. 301.7701-3(b), Proced. & Admin. Regs.
(26 C.F.R.), see Med. Practice Solutions, LLC v. Commissioner,
132 T.C. ____ (2009), and in the later years at issue in this
case, Mr. Enayat did achieve this disregarded treatment for his
LLC, Sutter, when he organized it to replace Woodbury. Another
common means is to elect subchapter S status for a corporation,
see secs. 1361-1379, but Mr. Enayat made no such election as to
Woodbury for the years in issue.
                                - 48 -

     corporation remains a separate taxable entity. * * *
     [Fn. refs. omitted.]

Woodbury is therefore a taxpayer distinct from Mr. Enayat in 1998

and 1999, and each of these two taxpayers must bear his or its

own liability.

          2.     Transfers From Woodbury

     We have found that Woodbury transferred to Mr. Enayat--

either by direct transfers to his personal accounts or by

Woodbury checks made payable to Mr. Enayat--$349,356 in 1998 and

$67,200 in 1999, totaling $416,556.      Respondent argues

(consistent with the notice of deficiency) that these amounts

constitute officer’s compensation.       Mr. Enayat acknowledges that

he transferred money from Woodbury’s accounts into his personal

accounts, but he claims that these transfers were repayments by

Woodbury of money Mr. Enayat had lent Woodbury throughout 1998

and 1999.31    Mr. Enayat argues that since these transfers


     31
      Mr. Enayat’s only contention against the taxability of
these amounts is that they were repayments of loans. Mr. Enayat
makes much of the fact that in 1998 and 1999 he transferred to
Woodbury a substantially greater amount--$712,617--than the
transfers he received from Woodbury, see supra note 12, and he
urges that he can hardly have been enriched by these two-way
transfers when in fact he suffered a net deficit. However, he
does not assert that if these transfers are not recognized as
non-taxable loan repayments, then they are dividends rather than
compensation. The reason may be that this characterization, if
successful, would deprive Woodbury of deductions for $416,556 in
compensation paid, thereby increasing its corporate income tax
and penalties. (Dividends would be nondeductible to Woodbury,
and pursuant to section 301(c) they would be: income to
Mr. Enayat, to the extent of Woodbury’s earnings and profits;
                                                   (continued...)
                              - 49 -

represent the repayment of a shareholder loan, they are not

income to him.

     Whether a withdrawal of funds by a shareholder from a

corporation or an advance made by a shareholder to a corporation

creates a true debtor-creditor relationship is a factual question

to be decided on the basis of all of the relevant facts and

circumstances.   Haag v. Commissioner, 88 T.C. 604, 615 (1987),

affd. without published opinion 855 F.2d 855 (8th Cir. 1988); see

also Haber v. Commissioner, 52 T.C. 255, 266 (1969), affd. 422

F.2d 198 (5th Cir. 1970); Roschuni v. Commissioner, 29 T.C. 1193,

1201-1202 (1958), affd. 271 F.2d 267 (5th Cir. 1959).   For

disbursements to constitute true loans, there must have been, at

the time that the funds were transferred, an unconditional

obligation on the part of the transferee to repay the money and

an unconditional intention on the part of the transferor to

secure repayment.   Haag v. Commissioner, supra at 615-616; see

also Haber v. Commissioner, supra at 266.   Direct evidence of a

taxpayer’s state of mind is generally unavailable, so courts have

focused on certain objective factors to distinguish repayments of



     31
      (...continued)
then nontaxable return of capital, to the extent of Mr. Enayat’s
basis in his Woodbury stock; then gain from the sale or exchange
of property for the balance. Mr. Woodbury has also not presented
any evidence of Woodbury’s earnings and profits nor of his basis
in its stock.) In the absence of any contention that the
payments were dividends rather than compensation, we do not
address this issue.
                               - 50 -

bona fide loans from disguised dividends, compensation, and

returns of capital.   The factors considered relevant for purposes

of identifying bona fide loans include (1) the existence or

nonexistence of a debt instrument; (2) provisions for security,

interest payments, and a fixed payment date; (3) treatment of the

funds on the corporation’s books; (4) whether repayments were

made; (5) the extent of the shareholder’s participation in

management; and (6) the effect of the “loan” on the

shareholder/employee’s salary.     Haber v. Commissioner, supra at

266; see also United States v. Stewart (In re Indian Lake

Estates, Inc.), 448 F.2d 574, 578-579 (5th Cir. 1971); Haag v.

Commissioner, supra at 616-617 & n.6.    When the individuals are

in substantial control of the corporation, as Mr. Enayat was in

this case, such control invites a special scrutiny of the

situation.   Haber v. Commissioner, supra at 266; Roschuni v.

Commissioner, supra at 1202.     For the reasons set forth below, we

conclude that the facts of record do not support Mr. Enayat’s

attempt to characterize the distributions that he received from

Woodbury in 1998 and 1999 as repayments of bona fide loans.

     First, no note or other evidence of indebtedness reflecting

the amount or existence of the shareholder loans was given to

Mr. Enayat by Woodbury.   Furthermore, in the absence of explicit

evidence of indebtedness, Mr. Enayat did not even provide an

analysis of the transactions to support his assertion that every
                                - 51 -

payment from Woodbury to Mr. Enayat was preceded by a loan from

Mr. Enayat to Woodbury, despite the Court’s invitation to him to

do so.    Instead, Mr. Enayat provided only gross numbers for the

transfers for the entire year.32    Although his arithmetic is

correct, his reasoning is not:     Where the Enayat-to-Woodbury

transfers only sometimes preceded the Woodbury-to-Enayat

transfers and other times followed them, it cannot be said that

the pattern of the money transfers corroborates the existence of

loans from Mr. Enayat to Woodbury.

     Second, Mr. Enayat’s position that these transfers from

Woodbury represented the repayment of loans is further belied by

his testimony admitting that he treated himself, Woodbury, and

all the bank accounts as one.

     Third, no evidence indicates that Woodbury provided any

collateral or security for repayment of these purported loan

amounts or that Woodbury made any agreement with Mr. Enayat as to

the time of repayment or the interest to be paid.

     Fourth, Mr. Enayat offered no evidence to show whether

Woodbury treated his transfers as loans (rather than as

contributions) on the company’s books.     And, as the examining IRS



     32
      Mr. Enayat alleges that he received net compensation of
only $3,117.89 in 1998 (i.e., the $349,356 in Woodbury-to-Enayat
transfers minus the $346,238.11 in Enayat-to-Woodbury transfers)
and that he received no compensation at all in 1999 (since the
$67,200 in Woodbury-to-Enayat transfers minus the $164,429.17 in
Enayat-to-Woodbury transfers yields a negative number).
                              - 52 -

agent observed, the Schedule L, Balance Sheets per Books, on

Woodbury’s 1998 return showed no loans to or from shareholders.

     Fifth, Mr. Enayat’s position requires the unlikely

conclusion that he was entitled to zero compensation for working

full time at Woodbury.   Mr. Enayat has worked in the Persian rug

business since he was 18 years old and has owned his own store

since 1994.   He testified that he was actively engaged in his

business, e.g., traveling to New York to purchase inventory,

managing the store, selling his inventory, and so on.    However,

despite the flow of funds from Woodbury to Mr. Enayat, he

reported zero wage income on his 1998 and 1999 Forms 1040, and

Woodbury claimed zero deductions for officer’s compensation (in

1998, the one year for which it did file a return).     We find that

some of the money paid to him by Woodbury must have been

compensation for his labor,33 and in the absence of his carrying

his burden to prove a reasonable alternative, the IRS’s

determination stands.

     That is, we conclude that Mr. Enayat did not give and

receive transfers pursuant to a true debtor-creditor relationship



     33
      See Spicer Accounting, Inc. v. United States, 918 F.2d 90,
93 (9th Cir. 1990) (an officer who performs substantial services
for a corporation is an employee, and corporate payments to him
are wages); Joseph Radtke, S.C. v. United States, 712 F. Supp.
143, 145-146 (E.D. Wis. 1989) (corporate payments to employees in
remuneration for services are wages, and the corporation may not
evade employment taxes by characterizing such compensation as
dividends), affd. 895 F.2d 1196 (7th Cir. 1990).
                               - 53 -

with Woodbury.    Rather, Mr. Enayat treated Woodbury’s bank

accounts as if they were his personal accounts, depositing and

withdrawing funds at will.    Accordingly, we find that the

transfers made from Woodbury to Mr. Enayat during 1998 and 1999

did not constitute repayments of bona fide loans, but instead

represented compensation to Mr. Enayat.    Therefore, we find, as

the IRS determined, that Woodbury paid Mr. Enayat officer’s

compensation income of $349,356 in 1998 and $67,200 in 1999 by

transferring funds to his personal accounts.34   (This finding is

adverse to Mr. Enayat but is favorable to his C corporation

Woodbury, as we explain below.)

     B.   Transfer From Dr. Willitts

     We have found that in 1998 Mr. Enayat received $455,485 from

Dr. Willitts, which Mr. Enayat was obliged to pay back to

Dr. Willitts at his instruction (originally expected to be in

rials in Iran).    Mr. Enayat freely used the money for his rug

business and his own options trading, and he substantiated

repayments of only $148,899.    The IRS determined that

Mr. Enayat’s use of those funds for his own purposes demonstrates

that he embezzled, stole, or misappropriated those funds from

Dr. Willitts and that once he did so the funds became income to



     34
      Because we do not find any creditor-debtor relationship to
exist between Woodbury and Mr. Enayat, we find that any transfer
of money from Mr. Enayat to Woodbury was not a loan, but rather a
contribution to capital.
                               - 54 -

him.    Under section 61(a), “gross income means all income from

whatever source derived”.    The Supreme Court “has given a liberal

construction to the broad phraseology of the ‘gross income’

definition statutes in recognition of the intention of Congress

to tax all gains except those specifically exempted.”     James v.

United States, 366 U.S. 213, 219 (1961) (citing Commissioner v.

Jacobson, 336 U.S. 28, 49 (1949), and Helvering v. Stockholms

Enskilda Bank, 293 U.S. 84, 87-91 (1934)).     The Supreme Court

held that embezzled funds and, more generally, “wrongful

appropriations” are includable in gross income.     Id. at 219-220.

       However, Mr. Enayat’s uncontradicted explanation of his

arrangement with Dr. Willitts was that he was to deliver rials in

Iran in exchange for dollars received in the United States,

without any restriction on his use of the dollars he received

because both parties understood that the rials provided in Iran

would come from a different source.     The record indicates an

express obligation by Mr. Enayat to repay the money to

Dr. Willitts--in rials if Dr. Willitts had made it to Iran, or if

not then in dollars as affirmed in the November 1999 Agreement

and Release.    Mr. Enayat repaid some of the funds on demand and a

portion later.    None of these facts demonstrates that Mr. Enayat

wrongfully appropriated Dr. Willitts’s money; rather, he owed a

debt to Dr. Willitts.
                               - 55 -

     Generally, a taxpayer must recognize income from the

discharge of indebtedness.    Sec. 61(a)(12); United States v.

Kirby Lumber Co., 284 U.S. 1 (1931).     “The moment it becomes

clear that a debt will never have to be paid, such debt must be

viewed as having been discharged.”      Cozzi v. Commissioner, 88

T.C. 435, 445 (1987).    There is no evidence that such a moment

had arrived during the years in issue with respect to

Mr. Enayat’s obligation to repay Dr. Willitts.     On the contrary,

Dr. Willitts petitioned a New Hampshire State court in late 1999

for attachment of Mr. Enayat’s assets.     Mr. Enayat had not fully

repaid Dr. Willitts during the years in issue, but there is no

evidence that Dr. Willitts had released Mr. Enayat from his

repayment obligation in any year before us.

     Throughout the years in issue, Mr. Enayat remained obligated

to repay Dr. Willitts.    As a result, we hold that Mr. Enayat did

not have income from the transfer he received from Dr. Willitts.

     C.   Capital Loss on the Sale of the Elm Street Property

     We have found that Mr. Enayat purchased the Elm Street house

as an investment in July 1998 for $210,000; that he performed

some renovations on the house, but did not substantiate

expenditures in any amount; and that he sold the house in

December 1998 for $274,000.    Mr. Enayat reported a total capital

loss of $118,619 from the sale of the Elm Street property

(thereby implicitly claiming renovation expenses of more than
                              - 56 -

$182,000), offset $71,812 in 1998 capital gains with part of this

purported capital loss, and offset $46,807 in 1999 capital gains

with the remaining purported real estate loss.   See supra note

23.   In the notice of deficiency the IRS disallowed these capital

loss deductions.

       Because we find that Mr. Enayat did not substantiate his

basis in the property above his cost basis of $210,000, we find

that Mr. Enayat is not entitled to a capital loss in 1998 or 1999

based on his sale of the Elm Street property.

      In his post-trial brief respondent asserted for the first

time that Mr. Enayat “received, if anything, a short term capital

gain in the amount of $64,000” (i.e., the difference between his

July purchase price and his December sale price).   No capital

gain adjustment was proposed in the notice of deficiency, nor in

respondent’s answer, nor in respondent’s pretrial memorandum; and

respondent did not argue this adjustment at trial nor evoke

testimony that could be recognized as specifically directed to

the issue.   We therefore hold that the issue was not timely

raised and that, if it had been, it would have been a new matter

on which respondent bore the burden of proof, see Rule 142(a)(1),

which he did not carry.

      D.   Issues Mr. Enayat Conceded

      As we noted above, Mr. Enayat concedes that he received, did

not report, and should have reported:   $15,800 of gambling income
                                - 57 -

in 1998; $2,000 in rental income in 1998; $201,929 in business

interruption insurance proceeds in 2000; and $113,800 from a

stolen check in 2001.   These amounts are taxable income to

Mr. Enayat.

III. Additions to Tax and Penalties

     In addition to deciding the tax liability that Mr. Enayat

and Woodbury will bear on the foregoing amounts, we must decide

their liability for additions to tax and penalties.

     A.    Mr. Enayat’s Liability for the Additions to Tax

           1.    Failure-To-File Addition to Tax Under Section
                 6651(a)(1)

     Mr. Enayat does not dispute that he failed to timely file

his Forms 1040 for taxable years 1998 through 2001.    The due

dates and filing dates were as follows:

      Tax Year                 Due Date           Return Filed

          1998               Apr.   15,   1999    Apr. 14,   2000
          1999               Apr.   15,   2000     Oct. 9,   2002
          2000               Apr.   15,   2001    Oct. 22,   2002
          2001               Apr.   15,   2002    Oct. 22,   2002

The IRS determined that Mr. Enayat is liable for the section

6651(a)(1) addition to tax for all four of those years.      Section

6651(a)(1) imposes an addition to tax for failure to file a

timely return, unless the taxpayer establishes that the failure

did not result from “willful neglect” and that the failure was

due to “reasonable cause”.    “Willful neglect” has been

interpreted to mean a conscious, intentional failure or reckless
                                - 58 -

indifference.   United States v. Boyle, 469 U.S. 241, 245-246

(1985).   “Reasonable cause” requires the taxpayer to demonstrate

that the taxpayer exercised ordinary business care and prudence

and was nevertheless unable to file a return within the

prescribed time.     Id. at 246; sec. 301.6651-1(c)(1), Proced. &

Admin. Regs.

     Mr. Enayat has not shown or even argued that he exercised

reasonable care with regard to his failure to file his returns.

We find that Mr. Enayat is liable for the section 6651(a)(1)

addition to tax for taxable years 1998, 1999, 2000, and 2001.

          2.    Fraud Penalty Under Section 6663(a)

     The IRS determined that Mr. Enayat is liable for the fraud

penalty under section 6663(a) for fraudulently understating his

income on his 1998, 1999, 2000, and 2001 income tax returns.

Section 6663(a) imposes a penalty equal to 75 percent of the

portion of any underpayment attributable to fraud.

                a.     Legal Principles Regarding Fraud

     Respondent has the burden of proving fraud by clear and

convincing evidence.    See sec. 7454(a); Rule 142(b); Parks v.

Commissioner, 94 T.C. 654, 660 (1990).    Respondent must prove by

clear and convincing evidence (1) that Mr. Enayat underpaid

his taxes in each year and (2) that Mr. Enayat intended to

evade taxes by conduct intended to conceal, mislead, or otherwise
                                - 59 -

prevent tax collection.    See Parks v. Commissioner, supra at 660-

661.    Fraud is an actual wrongdoing with an intent to evade a tax

believed to be owing.     Marshall v. Commissioner, 85 T.C. 267, 272

(1985).    Fraud is never presumed and must be established by

independent evidence of fraudulent intent.       Petzoldt v.

Commissioner, 92 T.C. at 699.       Accordingly, the existence of

fraud is a question of fact that a court must consider on the

basis of an examination of the entire record and the taxpayer’s

entire course of conduct.     Id.    However, “Fraud ‘does not include

negligence, carelessness, misunderstanding or unintentional

understatement of income.’”     Zhadanov v. Commissioner, T.C. Memo.

2002-104 (quoting United States v. Pechenik, 236 F.2d 844, 846

(3d Cir. 1956)).    If respondent shows that any part of an

underpayment is due to fraud, the entire underpayment is treated

as due to fraud unless Mr. Enayat shows by a preponderance of the

evidence that part of the underpayment is not due to fraud.         See

sec. 6663(b).

       Courts have developed a nonexclusive list of factors that

demonstrate fraudulent intent.      These “badges of fraud” include:

(1) understating income; (2) maintaining inadequate records;

(3) implausible or inconsistent explanations of behavior;

(4) concealment of income or assets; (5) failing to cooperate

with tax authorities; (6) engaging in illegal activities; (7) an

intent to mislead which may be inferred from a pattern of
                                 - 60 -

conduct; (8) lack of credibility of the taxpayer’s testimony;

(9) filing false documents; (10) failing to file tax returns; and

(11) dealing in cash.      Spies v. United States, 317 U.S. 492, 499

(1943); Douge v. Commissioner, 899 F.2d 164, 168 (2d Cir. 1990);

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).      Although no single factor is necessarily

sufficient to establish fraud, the combination of a number of

factors constitutes persuasive evidence.       Solomon v.

Commissioner, 732 F.2d 1459, 1461 (6th Cir. 1984), affg. per

curiam T.C. Memo. 1982-603.

     Respondent contends that the following badges of fraud are

present with respect to Mr. Enayat:       (1) understating income,

(2) maintaining inadequate records, (3) implausible or

inconsistent explanations of behavior, (4) concealment of assets,

(5) engaging in illegal activities, (6) lack of credibility in

testimony, (7) dealing extensively in cash, (8) pattern of

conduct which implies an intent to mislead, and (9) failing to

file tax returns.

                 b.     Mr. Enayat’s Underpayments Due to Fraud

     We find some of those badges of fraud to be present in this

case.    First, Mr. Enayat understated his income for every year at

issue.    Second, Mr. Enayat admittedly maintained inadequate

records.    Third, Mr. Enayat engaged in illegal activities (i.e.,
                               - 61 -

theft).    Fourth, Mr. Enayat dealt extensively in cash.   Fifth,

Mr. Enayat has exhibited a pattern of conduct which implies an

intent to mislead by admittedly receiving income in 1998, 2000,

and 2001 that he did not report on his income tax returns, yet

offering no explanation for his failure to do so.    Lastly,

Mr. Enayat failed to timely file his tax return for every year at

issue.    As a result, we find Mr. Enayat’s actions were intended

to conceal, mislead, or otherwise prevent tax collection.

     Specifically, we find that Mr. Enayat’s failure to report

income he now concedes he should have reported--i.e., $16,800 in

gambling income in 1998, $2,000 in rental income in 1998,

$201,929 in insurance proceeds in 2000, and $113,800 in theft

income in 2001--was fraudulent.    These were not trivial amounts

that might have been overlooked or forgotten.    Mr. Enayat offered

no explanation for how he could have filed a tax return for any

of these years and omitted these items out of carelessness or

negligence.   On the basis of Mr. Enayat’s concession and our

finding of fraud, we find that respondent has shown that some

portion of Mr. Enayat’s underpayment in each of the three years

involving those items--1998, 2000, and 2001--was due to fraud.

As a result, the entire underpayment for each of those years is

treated as due to fraud unless Mr. Enayat shows by a

preponderance of the evidence that part of the underpayment is

not due to fraud.   See sec. 6663(b).
                                  - 62 -

                  c.    Mr. Enayat’s Underpayments Not Due to Fraud

                        i.    Capital Loss

     As for taxable year 1998, we have already found that failure

to report $16,800 in gambling income and $2,000 in rental income

was fraudulent.    With respect to the capital loss claimed by

Mr. Enayat on the sale of the Elm Street property but disallowed

in the notice of deficiency and in this opinion, we do not find

Mr. Enayat’s actions to be fraudulent.         Mr. Enayat disclosed the

sale of the property on his return by claiming a loss, and it was

his failure to prove his basis in the property that resulted in

the capital gain.      Mr. Enayat’s failure to report this capital

gain was due to his negligence in not properly substantiating his

renovation expenses.      As a result, we do not find fraud in this

particular issue.

                        ii.   Woodbury Checks and Transfers

     The rest of Mr. Enayat’s underreporting of income for

taxable year 1998 results from our finding that he received

$203,273 in dividend income from checks payable to Woodbury, as

well as $349,356 in officer’s compensation transferred to him

from Woodbury, totaling $552,629.      On the totality of facts, we

do not find these transactions to be fraudulent, despite their

magnitude.

     In 1998 money flowed back and forth between Woodbury and

Mr. Enayat in roughly equal amounts.         In 1998 Woodbury gave
                              - 63 -

Mr. Enayat a total of $552,629, while Mr. Enayat gave Woodbury

$548,188 ($346,238 in capital contributions mistakenly

characterized as shareholder loans by Mr. Enayat, and $201,950 in

redeposits of diverted checks).   While we do not approve of the

haphazard flow of money between the two, or of Mr. Enayat’s using

Woodbury’s accounts as his personal checking accounts, we have

addressed those issues in deciding whether these transactions

resulted in taxable income to Mr. Enayat.   Under our opinion,

Mr. Enayat is liable for income tax on his end of those

transfers, and we have held that the rough balance in money given

and received does not excuse his liability.   However, what cannot

be ignored is that of all the money that flowed between the two,

the total amounts going either way were very close--$552,629

versus $548,188.   As a result, we do not find that Mr. Enayat

intended to conceal, mislead, or otherwise prevent tax collection

in his dealings with Woodbury in taxable year 1998.   His error--

i.e., his assumption that the rough equivalence of the back-and-

forth transfers eliminated their taxability--amounted to

negligence but not fraud.

     We likewise find that to be so for the year 1999.

Throughout 1999 Woodbury made transfers to Mr. Enayat totaling

$98,723 (i.e., $67,200 in direct transfers and $31,723 in

diverted checks), while Mr. Enayat made transfers to Woodbury

totaling $164,429 (all in capital contributions mistakenly
                              - 64 -

considered shareholder loans by Mr. Enayat, because Mr. Enayat

did not redeposit any of the diverted checks in 1999).      Again,

because throughout 1999 he actually transferred more money to

Woodbury than he received--$164,429 versus $98,723--we find that

Mr. Enayat’s non-reporting of this income was negligent but not

fraudulent.

     The only other unreported income in taxable year 1999 was

$1,228 in gross receipts for Sutter.    In the broader context of

the facts of this case, these receipts were de minimis, and we do

not find that Mr. Enayat fraudulently tried to hide this small

amount.   As a result, we do not find any fraud with respect to

taxable year 1999.

     However, the same cannot be said for Mr. Enayat’s

underreporting of Sutter’s gross receipts in taxable year 2000.

As we already decided, Mr. Enayat fraudulently failed to report

$201,929 in insurance proceeds in 2000.    As a result, the entire

underpayment will be treated as attributable to fraud, absent

proof as to non-fraudulent portions.    See sec. 6663(b).    This

places the burden on Mr. Enayat to show that his failure to

report $252,721 in gross receipts for Sutter in 2000 was not

fraudulent.   He has failed to do so.   Mr. Enayat did argue that

the IRS’s bank deposits analysis was flawed and that he

accurately reported Sutter’s gross receipts because he reported

the figure shown on his sales report, but we have already
                              - 65 -

disposed of those challenges and found them to be without merit.

Mr. Enayat has introduced no other evidence to persuade us that

such a substantial understatement of Sutter’s gross receipts

would be anything other than fraudulent.   As a result, we find

Mr. Enayat’s understatement of Sutter’s gross receipts in taxable

year 2000 to be fraudulent.

     B.   Whether Woodbury Is Liable for the Additions to Tax and
          Penalty As Determined by the IRS

          1.   Failure-To-File Addition to Tax Under Section
               6651(a)(1) and Fraud Penalty Under Section 6663(a)
               in 1998

     The IRS determined that Woodbury is liable for the

section 6651(a)(1) addition to tax for taxable year 1998 because

Woodbury failed to timely file its tax return for that year, and

that Woodbury is liable for the fraud penalty under section

6663(a) for fraudulently understating its gross receipts on its

1998 income tax return.   It is true that Woodbury filed its 1998

Form 1120 late (i.e., more than four years late on September 10,

2003), that Woodbury has not shown that it exercised reasonable

care in this matter, and that the return Woodbury eventually

filed did understate its gross receipts.   However, because we

find (as the IRS determined) that Woodbury paid additional

compensation to Mr. Enayat in the form of the Woodbury-to-Enayat

transfers totaling $349,356, and because we hold (as the IRS

concedes) that Woodbury was entitled to an additional deduction

in the amount of those transfers, Woodbury ends up with no net
                                - 66 -

income in 1998, but rather a loss.       Woodbury therefore has no

income tax liability for 1998.    Since the addition to tax and

penalty at issue would be a percentage of the underpayment of

Woodbury’s now-zero income tax liability, the addition to tax and

penalty are also zero.

          2.   Fraudulent Failure-To-File Addition to Tax Under
               Section 6651(f) in 1999

     The IRS determined that Woodbury was liable for the addition

to tax pursuant to section 6651(f) for fraudulently failing to

file a timely income tax return for taxable year 1999.       In

failing to file that return, the IRS determined, Woodbury failed

to report $162,050 in gross receipts for taxable year 1999.       To

determine whether Woodbury fraudulently failed to file its tax

return for taxable year 1999, we examine the same badges of fraud

we used when considering the imposition of the fraud penalty

against Mr. Enayat under section 6663(a), see Clayton v.

Commissioner, 102 T.C. at 653, but we necessarily focus on

Woodbury’s decision not to file its return when due.       If that

decision was made with the intent to evade tax, then the addition

to tax under section 6651(f) may properly be imposed.       Again,

respondent has the burden of proving fraud by clear and

convincing evidence.     See sec. 7454(a); Rule 142(b); Parks v.

Commissioner, 94 T.C. at 660-661.    To find tax fraud against the

corporation, respondent is required to prove that Mr. Enayat

engaged in fraudulent conduct on behalf of the corporation.
                                - 67 -

E.J. Benes & Co. v. Commissioner, 42 T.C. 358, 382 (1964), affd.

355 F.2d 929 (6th Cir. 1966).

     Respondent contends that the following badges of fraud are

present in 1999 with respect to Woodbury:    (1) maintaining

inadequate records, (2) concealment of assets, (3) dealing

extensively in cash, and (4) failing to file tax returns.

Mr. Enayat infused the corporation with his personal funds and

withdrew funds at will, and he admittedly did not keep accurate

books for Woodbury.   Mr. Enayat, as the operator and sole

shareholder of Woodbury, abdicated his responsibility to

accurately report Woodbury’s financial dealings and tax

obligations.   We have found that Woodbury failed to file its

return or report gross receipts of $162,050 for taxable year

1999, and when the IRS determined that Woodbury had gross

receipts in that amount, Mr. Enayat did not introduce any

evidence to prove Woodbury’s gross receipts were other than as

the IRS determined.   Woodbury failed to file its return for 1999

altogether after filing its return for 1998 four years late.    In

view of all these facts, Mr. Enayat’s management of Woodbury went

beyond haphazard and was fraudulent.     Mr. Enayat undoubtedly knew

that a tax return was required to be filed for Woodbury, and his

failure to file one indicates that he was trying to evade taxes.

As a result, given Mr. Enayat’s pattern of filing his own tax

returns late, as well as his filing Woodbury’s 1998 tax return
                               - 68 -

late, we do not find that his failure to file Woodbury’s 1999 tax

return was unintentional.

      Therefore, on the basis of our examination of the entire

record and Mr. Enayat’s entire course of conduct, we find that

Woodbury fraudulently failed to file its tax return for taxable

year 1999. However, because we find (as the IRS determined) that

Woodbury paid additional compensation to Mr. Enayat in the form

of the Woodbury-to-Enayat transfers totaling $67,200 in 1999, and

because we hold (as the IRS concedes) that Woodbury is entitled

to an additional deduction in the amount of those transfers,

Woodbury ends up with less income (i.e., $162,050 minus $67,200,

or $94,850)--and therefore a lower tax liability--than the amount

the IRS used in calculating the penalty.

IV.   Whether the Statute of Limitations Bars Assessment of
      Mr. Enayat’s or Woodbury’s Tax Liabilities

      Generally, the IRS must assess tax within three years after

the return is filed.35   Sec. 6501(a).   This general rule would

provide that assessments against Mr. Enayat would be restricted

as follows:




      35
      If a return is filed before its due date, it is treated as
being filed on its due date for the purposes of section 6501(a).
Sec. 6501(b)(1).
                                 - 69 -

                                                    3-Year Limitation
 Tax Year     Due Date           Return Filed         on Assessment

   1998     Apr.   15,   1999    Apr. 14, 2000        Apr. 14, 2003
   1999     Apr.   15,   2000    Oct. 9, 2002         Oct. 9, 2005
   2000     Apr.   15,   2001    Oct. 22, 2002        Oct. 22, 2005
   2001     Apr.   15,   2002    Oct. 22, 2002        Oct. 22, 2005


The IRS issued to Mr. Enayat a notice of deficiency for 1998,

1999, 2000, and 2001 on October 17, 2006.        This was well after

the three-year period of limitations on assessment had expired

for each of these years, so respondent bears the burden of

proving that an exception to the three-year limit on the time to

assess tax applies.      See Wood v. Commissioner, 245 F.2d 888,

893-895 (5th Cir. 1957), affg. in part and revg. in part on other

grounds T.C. Memo. 1955-301; Bardwell v. Commissioner, 38 T.C.

84, 92 (1962), affd. 318 F.2d 786 (10th Cir. 1963).        Respondent

has shown that Mr. Enayat filed fraudulent returns by

fraudulently underreporting his income for taxable years 1998,

2000, and 2001.    Because section 6501(c)(1) allows assessment at

any time in the case of a fraudulent return, we conclude that the

statute of limitations does not bar assessment of Mr. Enayat’s

tax for 1998, 2000, or 2001.

     With respect to taxable year 1999, respondent failed to

prove Mr. Enayat filed a fraudulent return, but we nevertheless

conclude on other grounds that the statute of limitations does

not bar assessment of Mr. Enayat’s tax for 1999.        Section 6501(e)
                               - 70 -

permits a six-year period of limitations for assessment in the

case of a taxpayer who omits from gross income an amount properly

includable therein which is more than 25 percent of the amount of

gross income stated on the return.      On his 1999 return,

Mr. Enayat reported his gross income, i.e., total income, to be

$301,904.   The IRS determined (and we have found) that Mr. Enayat

understated his income for 1999 by $100,151--i.e., $31,723 in

constructive dividends from Woodbury, $67,200 in compensation

from Woodbury, and $1,228 from Sutter’s additional gross

receipts.   The IRS will be afforded a six-year period of

limitations for assessment if Mr. Enayat’s understatement of

income ($100,151) exceeds 25 percent of $301,904 (i.e., $75,476).

We find that it does.

     As for Woodbury, the IRS issued a notice of deficiency for

taxable year 1998 on October 17, 2006, which was more than three

years after Woodbury had filed its return for that year.36

However, because we find that Woodbury fraudulently understated

its gross receipts on its return, section 6501(c)(1) permits the

IRS to assess at any time.   As for taxable year 1999, Woodbury

failed to file a tax return.   Section 6501(c)(3) likewise permits

the IRS to assess at any time where no return is filed.       As a




     36
      Woodbury filed its return for 1998 on September 10, 2003.
The general three-year period of limitations on assessment
expired on September 10, 2006.
                              - 71 -

result, we conclude that the statute of limitations does not bar

assessment of Woodbury’s tax for 1998 or 1999.

V.   Summary of Findings

     To resolve the issues presented in this case, we find as

follows with respect to Mr. Enayat:

     (1)   He received unreported gambling income of $16,800 in
           1998, which he concedes.

     (2)   He received unreported rental income of $2,000 in 1998,
           which he concedes.

     (3)   He received unreported constructive dividends from
           Woodbury totaling $203,273 in 1998.

     (4)   He received unreported compensation from Woodbury
           totaling $349,356 in 1998.

     (5)   He did not receive unreported income during any year in
           issue from the funds Dr. Willitts transferred to him in
           1998.

     (6)   He is not entitled to a capital loss of $118,619 (or
           any other amount) on the 1998 sale of the Elm Street
           house, and accordingly, the capital gains he offset in
           1998 and 1999 are taxable; but he is not liable for tax
           on capital gain from that sale.

     (7)   He received unreported constructive dividends from
           Woodbury of $31,723 in 1999.

     (8)   He received unreported compensation from Woodbury of
           $67,200 in 1999.

     (9)   He received unreported Schedule C income from Sutter of
           $1,228 in 1999.

     (10) He received unreported income from insurance proceeds
          of $201,929 in 2000, which he concedes.

     (11) He received unreported Schedule C income from Sutter of
          $252,721 in 2000.
                              - 72 -

     (12) He received unreported theft income of $113,800 from a
          stolen check in 2001, which he concedes.

     (13) He is liable for failure-to-file additions to tax under
          section 6651(a)(1) for taxable years 1998, 1999, 2000,
          and 2001.

     (14) He is liable for the fraud penalty under section
          6663(a) on the portion of his underpayment attributable
          to the following items:

           1998:     $16,800 in gambling income and $2,000 in
                          rental income;
           2000:     $201,929 in insurance proceeds and $252,721
                          in gross receipts from Sutter;
           2001:     $113,800 in theft income from the stolen
                          check.

     (15) He is not liable for the fraud penalty on the portion
          of his underpayments attributable to the following
          items:

           1998:     $203,273 in constructive dividends from
                          Woodbury;
                     $349,356 in compensation from Woodbury; and
                     $118,619 in disallowed capital loss from the
                          sale of the Elm Street house;

           1999:     $31,723 in constructive dividends from
                          Woodbury;
                     $67,200 in compensation from Woodbury; and
                     $1,228 in additional gross receipts from
                          Sutter.

As for Woodbury, we find as follows:

     (1)   Woodbury had no taxable income in 1998 and therefore is
           not liable for tax, additions to tax, or penalties in
           that year.

     (2)   Woodbury had unreported net taxable income of $94,850
           in 1999.

     (3)   Woodbury is liable for the fraudulent failure-to-file
           addition to tax under section 6651(f) for 1999.
                             - 73 -

     To reflect the foregoing and to allow the parties to resolve

the computational issues that will be affected by these findings,


                                      Decisions will be entered

                                under Rule 155.
