                          T.C. Memo. 2002-77



                        UNITED STATES TAX COURT



             ZACHARIA HADRI AND RAWA HADRI, Petitioners v.
              COMMISSIONER OF INTERNAL REVENUE, Respondent



         Docket No. 4954-00.             Filed March 27, 2002.


     Zacharia Hadri and Rawa Hadri, pro sese.

     Kelley A. Blaine, for respondent.


                MEMORANDUM FINDINGS OF FACT AND OPINION



     GERBER, Judge:     Respondent determined a deficiency in income

tax and a fraud penalty for petitioners’ 1993 tax year as

follows:

                                        Penalty
             Year      Deficiency     Sec. 6663(a)1

             1993      $103,559       $77,668.50


     1
       All section references are to the Internal Revenue Code as
amended and in effect for the year under consideration, and all
Rule references are to this Court’s Rules of Practice and
Procedure, unless otherwise indicated.
                               - 2 -


     Respondent amended his answer to assert an increased

deficiency and an increased penalty for fraud.    Subsequently,

respondent, having received additional information, conceded a

portion of the increase.2   Remaining in dispute are a $157,822

income tax deficiency and a $118,365.75 section 6663(a) penalty.

                         FINDINGS OF FACT

     At the time the petition was filed, petitioners resided in

Anaheim, California.   For taxable year 1993, petitioners

conducted five separate income-producing business activities as

follows:   Harrington Automotive (Automotive), Harrington Rentals

(Rentals), Harrington Auto Sales (Auto Sales), Sports Card

Connection (Card Connection), and Pacific Seed & Feed (Seed &

Feed).   For 1993, petitioners disclosed Automotive and Rentals on

their Federal income tax return, but concealed Auto Sales, Card

Connection, and Seed & Feed.   Petitioners reported $177,360 in

Schedule C, Profit or Loss From Business, gross receipts for

Automotive, $17,133 in Schedule E, Supplemental Income and Loss,

income for Rentals, and $84 in interest income.

     Through information obtained from the Bank of America,



     2
       In an amendment to answer, respondent asserted a $155,687
increase in petitioners’ unreported income for a total unreported
income of $562,033. Subsequent to the amendment to answer
respondent received information from petitioners which indicated
that $18,661 in deposits to one bank account were nontaxable. On
the basis of this information, respondent reduced the unreported
income amount to $543,372. Respondent also disallowed a net
operating loss of $51,520.
                                - 3 -

respondent discovered petitioners’ bank loan application and a

version of petitioners’ 1993 Federal income tax return which had

not been filed with respondent.    On this return, as opposed to

the one filed with respondent, petitioners reflected $247,000 in

Schedule C gross receipts.    In related financial information,

petitioners reflected business income from Card Connection and

Seed & Feed.   In an attempt to explain the inconsistent returns,

petitioners told respondent the return given to the Bank of

America in connection with the loan application was a “phony”.

     Despite petitioners’ effort to conceal their other

activities, respondent discovered Auto Sales through petitioners’

sales tax returns for the 1993 taxable year.    Petitioners had not

only failed to report their Auto Sales activity to respondent but

also concealed its existence from their representative.    From

discovering Auto Sales, respondent also discovered a previously

undisclosed bank account.    It was only after these discoveries

that petitioners admitted to Auto Sales’s existence.    In so

doing, however, petitioners claimed that they did not report Auto

Sales’s gross receipts because it sustained a loss.

     Moreover, despite respondent’s requests, petitioners failed

to produce statements or records for Auto Sales.    Respondent

ultimately obtained   both by means of a summons.   However,

because petitioners’ records were incomplete and poorly

maintained,    respondent had to reconstruct Auto Sales’s financial
                                 - 4 -

records by using the bank statements and the little information

available on petitioners’ records.       After allowing $114,657 in

previously unclaimed expenses in connection with Auto Sales,

respondent determined that Auto Sales had generated a profit for

its taxable year 1993.

     Following the discovery of Auto Sales and its corresponding

bank account, respondent independently discovered a second

undisclosed bank account.   Altogether, respondent’s

reconstruction of petitioners’ income resulted in taxable

deposits of $737,949 for 1993.    This net taxable amount is

$543,372 greater than the amount of income reported by

petitioners.

     In a statutory notice of deficiency, respondent determined a

$103,559 income tax deficiency and a $77,668.50 fraud penalty

under section 6663.   After the filing of a timely petition,

respondent filed an answer and an amendment to the answer.

Respondent, by amendment to answer, sought an increased income

tax deficiency of $165,211 and an increased fraud penalty of

$123,907.50.   After petitioners failed to communicate with him or

reply to the amendment, respondent filed a motion for entry of

order that undenied allegations be deemed admitted for both the

answer and the amendment to the answer.       These motions were

granted.

     After making a small concession and decreasing petitioners’
                                 - 5 -

income tax deficiency and fraud penalty to $118,365.75 and

$157,822, respectively, respondent sent petitioners a proposed

stipulation of facts and discovery requests.    Petitioners did not

respond, and the proposed stipulation of facts was deemed

established under Rule 91(f).    The Court granted respondent’s

motions to compel with respect to the discovery requests and

issued an Order limiting petitioners’ ability to put on evidence

with respect to matters sought by means of the discovery

requests.

     Petitioners failed to appear at the October 15, 2001, Los

Angeles, California, trial session.

                                OPINION

     While petitioners must show that respondent erred in

determining the income tax deficiency of $103,559, respondent

must prove the increased deficiency of $54,263.3   See Rule

142(a); Achiro v. Commissioner, 77 T.C. 881, 889-891 (1981); Beck

Chem. Equip. Corp. v. Commissioner, 27 T.C. 840, 856 (1957).      We

find petitioners have not shown that respondent erred in his

initial determination, and respondent has proven that the

increased deficiency is correct.

     At the onset, we note that respondent’s proposed stipulation



     3
       This amount is the excess of the $157,822 increased
deficiency over the $103,559 deficiency determined in the
statutory notice of deficiency.
                                   - 6 -

of facts was deemed established under a Rule 91(f) motion, and

accordingly we have based most of our fact findings on these

established facts.       In addition to this, respondent reconstructed

petitioners’ income from a bank deposit analysis.            This analysis

was made from petitioners’ bank accounts, Forms 1040, California

sales tax returns, financial statements relating to the Bank of

America loan application, and other materials provided by

petitioners.    This reconstruction resulted in the following net

taxable deposits:

Account          Total Deposit             Non-Taxable      Net Taxable
                                           Amount           Deposit

Wells Fargo       $215,586                   $192.00        $215,394.00

Bank of
America (I)           298,220                -0-             298,220.00

Bank of
America (II)          182,345               5,358.00         176,987.00

Bank of
America (III)         30,034               20,545.78           9,488.22

Security
Pacific (I)            4,744                 -0-               4,744.00

Security
Pacific (II)          41,616                8,500.00          33,116.00

Net taxable deposit                                         $737,949.22

Based on the reconstruction, we hold that respondent has shown

petitioners are liable for the increased deficiency.

     We now consider whether respondent has shown that

petitioners’ understatement of income was fraudulent.            Fraud must

be shown by clear and convincing evidence.             Section 6663 provides

that if any part of an underpayment of tax is due to fraud, an
                               - 7 -

amount equal to 75 percent of the underpayment which is

attributable to fraud shall be added to the tax.    While

respondent ultimately has the burden of proving fraud, it can

seldom be shown by direct proof of the taxpayer’s intention.

Spies v. United States, 317 U.S. 492, 499 (1943).    However, fraud

can be established by circumstantial evidence and by reasonable

inferences drawn from the taxpayer’s entire course of conduct.

Id.   Such inferences may be drawn from the so-called badges of

fraud including, but not limited to, understated or unreported

income, inadequate records, intentional concealment of income and

assets, and failure to cooperate with taxing authorities.

Bradford v. Commissioner, 796 F.2d 303 (9th Cir. 1986), affg.

T.C. Memo. 1984-601.

      Based on the evidence, including the facts established under

Rule 91(f) and the evidence at trial, we find that petitioners

intended to conceal, mislead, or otherwise prevent the collection

of their taxes.   Petitioners failed to report a substantial

amount of income.   Petitioners concealed two bank accounts with

$513,614 in taxable deposits from their own representative and

respondent.   Petitioners kept and maintained inadequate records

which did not reflect all income or expenses.    Petitioners

concealed a substantial business activity from their own

representative and from respondent.    In an attempt to explain

this concealment, petitioners claimed that the activity had
                                 - 8 -

produced a loss; however, respondent’s reconstructions revealed

that the activity had, in fact, produced a profit.

     We accordingly hold that respondent has shown by clear and

convincing evidence that petitioners’ understatement of income

was fraudulent.

     To reflect the foregoing,

                                         Decision will be entered

                                 for respondent.
