                              T.C. Memo. 2013-279



                        UNITED STATES TAX COURT



     JAMIL E. ABDALLAH AND MAJEDA J. ABDALLAH, Petitioners v.
        COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 8023-11.                        Filed December 9, 2013.



      D. Douglas Metcalf, for petitioners.

      Rachael J. Zepeda, for respondent.



            MEMORANDUM FINDINGS OF FACT AND OPINION


      LARO, Judge: The petition in this case involves petitioners’ Federal

income tax for 1999 through 2004. In a notice of deficiency dated February 3,
                                          -2-

[*2] 2011, respondent determined deficiencies and fraud penalties1 under section

66632 as follows:

                     Year       Deficiency       Penalty sec. 6663

                    1999          $27,021             $19,898
                    2000           47,340              35,225
                    2001           66,722              49,637
                    2002           59,905              44,929
                    2003           69,996              52,497
                    2004           85,479              50,644

      The issues for decision are:

      (1) whether petitioners failed to report income of $94,669 for 1999,

$156,616 for 2000, $213,561 for 2001, $206,192 for 2002, $225,434 for 2003, and

$270,020 for 2004. We hold that petitioners did fail to report certain income for

all years at issue, but only to the extent stated herein;

      (2) whether any part of any of petitioners’ underpayments of tax for 1999

through 2003 was due to fraud, such that under section 6501(c) tax may be

assessed at any time. We hold that it was for all years;




      1
          Respondent does not assert the fraud penalty against Mrs. Abdallah.
      2
       Unless otherwise indicated, section references are to the Internal Revenue
Code in effect for the years at issue, and Rule references are to the Tax Court
Rules of Practice and Procedure.
                                        -3-

[*3] (3) whether petitioner husband is liable for the fraud penalty for 1999

through 2004. We hold that he is for all years;

      (4) whether petitioners are entitled to refunds of payments of $45,669 for

2002, $47,381 for 2003, and $31,959 for 2004. We hold that they are not.

      Petitioners resided in Arizona when they filed their petition.

                               FINDINGS OF FACT

      Mr. Abdallah was born in Israel, but has dual citizenship by virtue of his

father’s American citizenship. In Israel Mr. Abdallah attended high school where

he was trained as an electrician. After high school he did not go on to college nor

take any courses in bookkeeping.

      In 1990 Mr. Abdallah came to the United States. While Mr. Abdallah’s

primary language is Arabic, he also speaks some English and Spanish. Mr.

Abdallah is the sole provider for his wife and four children.3

Supermat #16

      In 1991 Mr. Abdallah opened a laundromat which he named Supermat #16

(Supermat). Supermat provided coin-operated self-service laundry machines, dry

cleaning services, and wash-and-fold services. In addition to its laundry services,


      3
       Petitioners claimed three children as dependents on their 1999 through
2002 returns and claimed a fourth child on their 2003 and 2004 returns.
                                       -4-

[*4] Supermat also sold laundry supplies, phone cards, money grams, and various

food items. Mr. Abdallah had an office in the corner of Supermat, which was

separated from the rest of the laundromat by a bulletproof window. At that

window, customers made all merchandise purchases, dropped off laundry, and

paid for dry cleaning and wash-and-fold services. Supermat’s regular business

hours were 7 a.m. to 10 p.m.

      In 1996 Mr. Abdallah sold Supermat but reclaimed it shortly thereafter

when the purchaser failed to make the purchase payments. With the exception of

that brief period, Mr. Abdallah was the sole owner of Supermat. In addition, Mr.

Abdallah and an office cleaner who came once a week were Supermat’s only

employees. Finally, Mr Abdallah maintained bank accounts for Supermat’s

operations, which were separate from petitioners’ personal bank accounts.

Petitioners’ Check Cashing Activity

      Mr. Abdallah began cashing checks out of Supermat’s corner office in 1998.

His customers primarily cashed payroll checks and were primarily of Hispanic

descent. At trial Mr. Abdallah explained that these customers could not go to a

bank because they did not have valid government-issued identification. Mr.

Abdallah further acknowledged that many of his customers may have been illegal

immigrants. For his check cashing services Mr. Abdallah charged a .75% fee.
                                        -5-

[*5] For the years at issue Mr. Abdallah cashed millions of dollars’ worth of

checks, thereby generating substantial fees, which constituted petitioners’ primary

source of income. Petitioners did not report these fees, which are as follows:4

                 Year         Total deposits1     Unreported income

                1999            $13,988,074            $59,349
                2000             20,736,707            104,533
                2001             26,713,928            146,496
                2002             28,751,965            154,655
                2003             28,839,442            169,592
                2004             30,542,372            155,702
                 Total          149,572,488            790,327
      1
        Although calculating the total amount of checks cashed requires certain
credit and debit adjustments to be made to total deposits, these adjustments are
negligible and do not detract from demonstrating the sheer magnitude of Mr.
Abdallah’s check cashing activities.

      Mr. Abdallah maintained bank accounts for his check cashing activity

separate from petitioners’ personal accounts and separate from Supermat’s

operating accounts. Every week the bank would deliver a cash shipment to

Supermat in an armored vehicle. Mr. Abdallah then deposited the checks that he


      4
        For 1999 through 2001, respondent calculated total deposits by adding
together all check deposits in petitioners’ check cashing bank accounts.
Respondent then determined petitioners’ unreported income by applying a .75%
fee to the total deposits and adjusting for bank fees and bad checks. For 2002
through 2004 respondent based Mr. Abdallah’s total check deposits and
unreported income on petitioners’ amended 2002, 2003, and 2004 returns, further
discussed infra.
                                        -6-

[*6] cashed daily. Mr. Abdallah did not keep records of the checks he cashed, his

fees earned, nor any other records for his check cashing activity.

      For the years at issue, two signs at Supermat advertised Mr. Abdallah’s

check cashing services. The first sign was directly above the office window

through which Mr. Abdallah cashed checks, sold merchandise, and received

clothing for dry cleaning. This sign was approximately three feet by two feet, had

a yellow background, and advertised check cashing in both English and Spanish in

red font. The second sign was on the front door, was approximately the same size

as the door, and was also red and yellow.

Petitioner Hires Essex Peters as Accountant

      After opening Supermat in 1991 Mr. Abdallah began filing Federal income

tax returns. Mr. Abdallah has always relied on an accountant to prepare his

returns.

      Essex Peters is an accountant of 25 years’ experience. He is not a certified

public accountant (C.P.A.), nor an enrolled agent with the Internal Revenue

Service (IRS), nor does he have any other official license that allows him to

prepare tax returns. Further, Mr. Peters has no experience or training in forensic

accounting.
                                        -7-

[*7] In 2000 Mr. Peters began taking his laundry to Supermat for wash-and-fold

services every month. In 2002 Mr. Abdallah learned that Mr. Peters was the

accountant for a nearby bar, Patrick’s. At the time, having ended his relationship

with his prior accountant in 1999, Mr. Abdallah was three years behind in filing

his Federal income tax returns. After learning that Mr. Peters was an accountant,

Mr. Abdallah hired him to prepare his 1999, 2000, and 2001 Federal income tax

returns.

      In December 2002 Mr. Peters also helped Mr. Abdallah incorporate

Supermat as an S corporation called Vuvo, Inc. (Vuvo). Mr. Peters further

prepared Mr. Abdallah’s 2002, 2003, and 2004 Federal income tax returns, as well

as Vuvo’s 2003 and 2004 Federal income tax returns.

      Mr. Abdallah signed the returns Mr. Peters prepared, thereby certifying for

each that “[u]nder penalty of perjury, I declare that I have examined this return and

accompanying schedules and statements, and to the best of my knowledge and

belief, they are true, correct, and complete.” Mr. Abdallah’s returns for the years

1999 through 2004 reported gross income, income tax, and total tax liability as

follows:
                                       -8-

[*8]

                                  Income tax             Total tax
          Year     Total income (before credits) (including FICA/SECA)

          1999        $13,883            -0-                 $979
          2000          9,718            -0-                   748
          2001          9,337            -0-                 1,078
          2002          9,217            -0-                 1,075
          2003         34,090            -0-                   503
          2004         30,035            -0-                    81
           Total      106,280            -0-                 4,464

       In addition to his Federal tax returns, Mr. Abdallah also employed Mr.

Peters to prepare Supermat’s financial statements, City of Tempe sales tax returns,

and State of Arizona sales tax returns on a monthly basis starting in 2003. Mr.

Abdallah further employed Mr. Peters to prepare his annual State of Arizona

income tax returns. To prepare Mr. Abdallah’s City, State, and Federal tax

returns, as well as Supermat’s financial statements, Mr. Abdallah allegedly gave

Mr. Peters a box filled with Supermat’s bank statements, commission checks from

money grams, purchase receipts for laundry supplies, and check stubs for expenses

paid. According to Mr. Peters, most of Supermat’s expenses were documented by

check stubs or bank statements.

       Every month, Mr. Peters would visit Supermat to drop off his laundry,

Supermat’s financial statements, and Mr. Abdallah’s City and State sales tax
                                        -9-

[*9] returns for a prior month. During these visits Mr. Peters would also pick up a

box of Supermat’s bank statements and various receipts to prepare the next

month’s books and records. Mr. Peters returned Supermat’s bank statements by

attaching them to the financial statements he had prepared. Mr. Abdallah then

placed the financial statements and bank records in a binder. While the record is

unclear whether Mr. Peters ever returned the various receipts and check stubs to

Mr. Abdallah, these records are no longer available. Finally, Mr. Peters admitted

that he often drank at Patrick’s before making these monthly visits.

      Before July 2004 Supermat’s financial statements did not include

petitioners’ check cashing income. Mr. Abdallah never told Mr. Peters his fee for

check cashing services, nor did Mr. Peters inquire as to the fee even after he

learned of the check cashing income.

Criminal Case for 2004 Return and Resulting Plea Agreement

      In September 2005 the IRS began a criminal investigation relating to

petitioners’ 2004 return.

      On October 13, 2005, Mr. Abdallah was interviewed by IRS Special Agent

Ken Hudson and Supervisory Special Agent Iris Bohannon. The interview lasted

nearly two hours, and Mr. Abdallah voluntarily answered the IRS Agents’

questions. Also during that interview, Mr. Abdallah turned over the binder of
                                        - 10 -

[*10] financial statements that Mr. Peters had prepared for Supermat in 2003 and

2004. After the interview with the IRS, Mr. Abdallah terminated his business

relationship with Mr. Peters.

        The IRS also interviewed Mr. Peters in October 2005. According to Mr.

Peters, the IRS never requested from him a copy of petitioners’ records during the

October 2005 interview; and because his computer was later stolen, these records

were no longer available when the IRS interviewed him again approximately two

years later.

        Mr. Abdallah understood that he could go to prison if convicted of criminal

tax fraud. On August 5, 2008, Mr. Abdallah entered into a plea agreement with

the Government in order to avoid going to prison and to put an end to the criminal

case.

        In the plea agreement Mr. Abdallah pleaded guilty to violating section

7206(1), “Willfully Making and Subscribing a Materially False Return, Statement

or Other Document”. As part of the plea agreement, Mr. Abdallah admitted that

he “knowingly and intentionally underreported [his] income to the Internal

Revenue Service in order to pay less in taxes.” In addition, the plea agreement

provided that “this agreement does not preclude the United States from instituting

any other civil or administrative proceedings” but that “[n]othing in this agreement
                                         - 11 -

[*11] shall be construed to satisfy, settle, or compromise any civil tax liability,

including additions to tax, interest and penalties, that the defendant may owe to the

IRS as to his federal income tax returns.” The plea agreement further provided

that “the defendant shall retain the right to assert any and all defenses in any civil

tax audit, controversy, appeal or litigation.” Finally, the plea agreement required

Mr. Abdallah to file amended returns for 2002, 2003, and 2004.

      On December 24, 2008, the U.S. District Court for the District of Arizona

entered a judgment and a fine of $10,000 against Mr. Abdallah. The judgement

provided that Mr. Abdallah “[has] been sentenced in accordance with the terms of

the plea agreement and that * * * [he has] waived * * * [his] right to appeal and to

collaterally attack this matter.”

      Mr. Abdallah hired Joel Ruben, a C.P.A. with 47 years’ experience in

accounting and a partner at Pater & Ruben, to prepare his amended returns for

2002, 2003, and 2004. According to Mr. Ruben, the records for those years were

“very shallow” and Mr. Abdallah’s income and expenses for those years had to be

recreated. He also testified that there was no evidence that a system for keeping

track of check cashing income had been in place. Mr. Abdallah’s amended returns

reported taxable income and tax liability as follows:
                                        - 12 -

[*12]

                Total income    Income tax (amended)   Total tax (amended)
        Year     (amended)         (before credits)  (including FICA/SECA)

        2002     $166,694              $31,333                   $46,206
        2003      192,872               32,696                    47,632
        2004      173,164               26,369                    32,040

        On March 13, 2009, petitioners made voluntary payments of $45,669

towards their 2002 tax liability, $47,381 towards their 2003 tax liability, and

$31,959 towards their 2004 tax liability.

Petitioners’ Other Assets

        In late 1998 petitioners purchased a piece of real property on W. Dublin St.

in Chandler, Arizona. In early 2000 petitioners purchased another piece of

property, on E. Pueblo Ave. in Chandler, Arizona. Petitioners purchased this

property for $138,000 and made a downpayment of $7,500. In early 2003

petitioners purchased yet another piece of property, on E. Scorpio Place in

Chandler, Arizona. Petitioners purchased this property for $234,384 and made a

downpayment of $46,877. In mid-2003 petitioners sold their W. Dublin St.

property.

Petitioners’ Loan Applications

        In 2002 Mr. Abdallah submitted a “Uniform Residential Loan Application”

(Freddie Mac Form 65) to Spectrum Financial Group, in which he reported his
                                         - 13 -

[*13] monthly income from Supermat as $9,000. In 2003 Mr. Abdallah submitted

yet another “Uniform Residential Loan Application” (Freddie Mac Form 65) to

Spectrum Financial Group, in which he also reported his monthly income from

Supermat as $9,000. In both applications Mr. Abdallah disclosed that he had

monthly mortgage payments on his W. Dublin St. property of $852 and additional

monthly loan payments of $792. Finally, Mr. Abdallah signed the applications,

thereby certifying “that the information provided in this application is true and

correct as of the date set forth opposite * * * [his] signature[] on this application”

and acknowledging his “understanding that any intentional or negligent

misrepresentation(s) of the information contained in this application may result in

civil liability and/or criminal penalties including, but not limited to, fine or

imprisonment or both under the provisions of Title 18, United States Code,

Section 1001, et. seq.”.

                                      OPINION

      The primary issue in this case is whether Mr. Abdallah fraudulently

underreported his income with regard to his 1999 through 2004 returns. The

parties have stipulated or otherwise conceded on brief that Mr. Abdallah failed to

report income of $59,349 for 1999, $104,533 for 2000, $146,496 for 2001,

$154,655 for 2002, $169,592 for 2003, and $155,702 for 2004.
                                       - 14 -

[*14] I.     Perception of Witnesses

      We observe the candor, sincerity, and demeanor of each witness in order to

evaluate his testimony and to assign weight to that testimony for the primary

purpose of finding disputed facts. HIE Holdings, Inc. v. Commissioner, T.C.

Memo. 2009-130, 97 T.C.M. (CCH) 1672, 1733 (2009), aff’d without published

opinion, 521 Fed. Appx. 602 (9th Cir. 2013). We determine the credibility of each

witness, weigh each piece of evidence, draw appropriate inferences, and choose

between conflicting inferences in finding the facts of a case. Id. We will not

accept a witness’ testimony at face value if we find that our impression of the

witness, coupled with our review of the credible facts at hand, conveys to us an

understanding contrary to the spoken word. Id. (citing Neonatology Assocs., P.A.

v. Commissioner, 115 T.C. 43, 84-87 (2000), aff’d, 299 F.3d 221 (3d Cir. 2002)).

      During trial we heard the testimony of four fact witnesses: Mr. Peters, Mr.

Abdallah, Revenue Agent John Schiffer (Agent Schiffer), and Mr. Ruben. As

explained more fully below, we found that Mr. Peters and Mr. Abdallah lacked

credibility as to the material issues. Also more fully explained below, we found

Agent Schiffer’s and Mr. Ruben’s testimony to be of limited helpfulness.

Therefore, we rely primarily on the record built by the parties through their

stipulation of facts and exhibits.
                                        - 15 -

[*15] A.     Mr. Peters

      As to Mr. Peters, petitioners’ accountant, we perceived him to be generally

untrustworthy and found his testimony to be incredible with regard to material

aspects of this case. Mr. Peters’ testimony was internally inconsistent and

contradicted by the documentary evidence and stipulated facts. In addition, Mr.

Peters demonstrated a lack of understanding of Federal tax laws. We illustrate

these observations through the following examples.

      First, of significance to this case is whether Mr. Abdallah fraudulently

underreported income from check cashing. Mr. Abdallah claims that he provided

information on check cashing income to Mr. Peters so that Mr. Peters could report

petitioners’ correct income. Mr. Peters essentially denies this and states that he

was, for the most part, unaware that petitioners had substantial check cashing

income. Mr. Peters claimed that he never saw any check cashing signs while at

Supermat. We find this claim to be highly improbable given the size, prominent

location, and prominent color scheme of the two check cashing signs, the regular

line of customers outside the check cashing and laundry dropoff window, and Mr.

Peters’ frequent and regular visits over many years. Further, Mr. Peters noticed

that the establishment across the street offered check cashing service but

incredibly failed to notice that his own client offered the same service.
                                       - 16 -

[*16] Second, Mr. Peters testified that he first learned of Mr. Abdallah’s check

cashing activities in July 2004, when he came across a bank statement from

petitioners’ check cashing account ending in 4406. However, Schedule C, Profit

and Loss from Business, of petitioners’ 2003 return shows income from

“Phonecards, Moneygrams, [and] Checking Cashing [sic]”. When questioned

about this, Mr. Peters admitted that he was aware of a small amount of check

cashing activity before 2004 and that he saw customers cashing checks as early as

2002. Mr. Peters further testified that after discovering the check cashing account

ending in 4406, he began reporting check cashing income in subsequent months,

but did not do so for prior months because the July 2004 bank statement showed

an opening balance of zero. In reality, the July 2004 bank statement showed an

opening balance of nearly $150,000, and prior bank statements from that account

showed deposits were made as early as April of 2003. When questioned about the

July 2004 opening balance, Mr. Peters admitted that his prior statement had been

false, and that although he should have asked for earlier bank statements, he failed

to do so. Mr. Peters also claimed that he was not aware of petitioners’ other check

cashing accounts; however, the bank statement for petitioners’ check cashing

account ending in 7687 was attached to Supermat’s November 2004 financial

statements. Finally, Mr. Peters testified that although he knew Mr. Abdallah
                                       - 17 -

[*17] incurred significant expenses for cash shipments by armored vehicle, Mr.

Peters never questioned what those expenses were for. The contradictory and

ever-changing nature of Mr. Peters’ testimony severely undermines his credibility.

      Third, Mr. Peters assisted Mr. Abdallah with a dubious method for reducing

self-employment taxes. Mr. Peters testified that Mr. Abdallah asked him to

incorporate Supermat in order to reduce Mr. Abdallah’s Federal tax liability and

that he advised Mr. Abdallah that by incorporating Supermat as an S corporation

(i.e., Vuvo), Mr. Abdallah would not be required to pay self-employment taxes.

Although incorporating and becoming an employee of Vuvo would relieve Mr.

Abdallah of filing self-employment tax returns under section 1401, Vuvo and Mr.

Abdallah would be required to pay Social Security and Medicare taxes on Mr.

Abdallah’s wages pursuant to sections 3101 and 3111 at the same rates. Mr.

Peters attempted to avoid the taxes imposed by sections 3101 and 3111 by

reporting no wages for Mr. Abdallah and reporting all of Vuvo’s profit as

distributions of income for 2003 and 2004. Given that Mr. Abdallah worked long

hours at Supermat each day, Mr. Peters’ advice to disguise wages as distributed

earnings in order to avoid payroll taxes runs contrary to Federal tax laws. See

Spicer Accounting, Inc. v. United States, 918 F.2d 90, 93 (9th Cir. 1990) (holding

that a taxpayer should not be permitted to evade FICA and FUTA by
                                         - 18 -

[*18] characterizing compensation paid to its shareholder as dividends, rather than

wages); Veterinary Surgical Consultants, P.C. v. Commissioner, 117 T.C. 141,

145-146 (2001) (holding that where an officer of an S corporation performs

substantial services, the remuneration received for those services is wages subject

to Federal employment tax and not distributions of corporate income), aff’d sub

nom. Yeagle Drywall Co. v. Commissioner, 54 Fed. Appx. 100 (3d Cir.2002).

      Finally, the cavalier manner in which Mr. Peters practices accounting does

not inspire our confidence in his testimony. Mr. Peters testified that he was not

sure whether sales of phone cards were taxable for sales tax purposes and admitted

that instead of researching the issue, he merely guessed. Mr. Peters’ careless

practice further contributes to the numerous errors in the financial statements and

tax returns that he prepared. For example, Supermat’s July and August 2003 profit

and loss statements showed sales of $3,286 and $2,320, respectively, yet its City

of Tempe sales tax returns reported sales of only $1,000 and $899, respectively.

As another example, Supermat’s February 2004 profit and loss statement showed

total sales of $4,164, yet its State of Arizona sales tax return reported total sales of

only $560. When questioned about these discrepancies, Mr. Peters admitted that

he filed the city and State sales tax returns before creating the profit and loss
                                       - 19 -

[*19] statements and that he merely guessed what the sales amounts would be.

For the reasons stated above, we choose not to credit Mr. Peters with reliable

testimony.

      B.     Mr. Abdallah

      As to Mr. Abdallah, we found portions of his testimony to be incredible as

to material aspects of this case. For example, Mr. Abdallah testified that he never

looked at his tax returns and that he would just write a check for whatever Mr.

Peters told him he owed. We find it highly unlikely that Mr. Abdallah, an

experienced businessman who operated a profitable business for many years,

signed his returns under penalty of perjury without taking notice of his reported

gross income.5

      C.     Other Witnesses

      As for Agent Schiffer and Mr. Ruben, we found their testimony to be

credible but of limited helpfulness. Agent Schiffer’s testimony was not helpful

because he was neither involved in the investigation nor otherwise personally



      5
       On his 1999 through 2004 returns Mr. Abdallah reported income of
$13,883 for 1999, $9,718 for 2000, $9,337 for 2001, $9,217 for 2002, $34,090 for
2003, and $30,035 for 2004, for total reported income of $106,280. For those
same years Mr. Abdallah failed to report check cashing income of $59,349 for
1999, $104,533 for 2000, $146,496 for 2001, $154,655 for 2002, $169,592 for
2003, and $155,702 for 2004, for total unreported income of $790,327.
                                        - 20 -

[*20] familiar with the case. Mr. Ruben’s testimony was not helpful because his

factual knowledge was limited to events that occurred after the years at issue.

II.   Statute of Limitations on Assessment

      A central issue in this case is whether the periods of limitations on

assessment have expired for the 1999 through 2003 returns. It is undisputed that

petitioners omitted substantial income on all five returns such that the six-year

limitations period set forth in section 6501(e) would apply. It is further

undisputed that as to those years, more than six years have elapsed between when

the returns were filed and when respondent issued the notice of deficiency.

      The issuance of a valid notice of deficiency is an essential prerequisite to

the jurisdiction of this Court in a deficiency action. Laing v. United States, 423

U.S. 161, 165 n.4 (1976). For a notice of deficiency to be valid, it must be sent to

the taxpayer before the period of limitations for assessment has expired. See sec.

6213(a). Therefore, whether respondent has issued a valid notice of deficiency,

and consequently, whether this Court has deficiency jurisdiction over these five

years, depends on whether the limitations periods on assessment are lifted under

section 6501(c) upon a finding of fraud.
                                        - 21 -

[*21] III.   Section 6663 Fraud Penalty

      Section 6663(a) provides that “[i]f any part of any underpayment of tax

required to be shown on a return is due to fraud, there shall be added to the tax an

amount equal to 75 percent of the portion of the underpayment that is attributable

to fraud.”

      A.     Underpayment of Tax

      In order to establish liability for the fraud penalty under section 6663(a), the

Commissioner must prove by clear and convincing evidence that an underpayment

of tax exists. See sec. 7454(a); Rule 142(b).

      Petitioners’ underpayment of tax arises from their unreported income. In

the Court of Appeals for the Ninth Circuit, to which this case is appealable absent

the parties’ stipulation otherwise, see sec. 7482(b), the Commissioner’s

determination as to unreported income in a notice of deficiency is presumed

correct only when it is supported by a minimal evidentiary foundation,

Weimerskirch v. Commissioner, 596 F.2d 358, 360-361 (9th Cir. 1979), rev’g 67

T.C. 672 (1977); see also Delaney v. Commissioner, 743 F.2d 670, 671 (9th Cir.

1984) (stating that the Commissioner must produce some substantive evidence

demonstrating that the taxpayer received unreported income), aff’g T.C. Memo.

1982-666.
                                        - 22 -

[*22] On the basis of our review of the entire record, we find that respondent has

produced sufficient evidence to establish that petitioners did not report income of

$59,349 for 1999, $104,533 for 2000, $146,496 for 2001, $154,655 for 2002,

$169,592 for 2003, and $155,702 for 2004. For 1999 through 2003 the parties

have stipulated the above-stated amounts of unreported income. For 2004

petitioners have admitted, by virtue of their 2004 amended return, that they failed

to report $155,702 of income. The parties have also conceded on brief this

unreported income amount for 2004. To put things in perspective, for the six

years at issue, petitioners reported on their original returns total income of only

$106,280, i.e., 12%, of their actual total income of $896,607.

      On the basis of the parties’ stipulations and concessions, we hold that

respondent has clearly and convincingly established the underpayment element of

section 6663.6

      B.     Fraudulent Intent

      The Commissioner must prove by clear and convincing evidence that the

taxpayer fraudulently intended to underpay his taxes. See sec. 7454(a); Rule



      6
       Pursuant to sec. 1.6664-2(c)(2), Income Tax Regs., for purposes of
ascertaining the underpayment on which the sec. 6663 penalty is based, the tax
shown on an amended return is not substituted for the tax shown on the return as
originally filed if the original return was fraudulent.
                                          - 23 -

[*23] 142(b). Whether an underpayment of tax is attributable to fraud is a

question of fact to be resolved on the basis of the record as a whole. Parks v.

Commissioner, 94 T.C. 654, 660 (1990); Gajewski v. Commissioner, 67 T.C. 181,

199 (1976), aff’d without published opinion, 578 F.2d 1383 (8th Cir. 1978).

Fraud is defined as the intentional commission of an act or acts for the specific

purpose of evading tax believed to be owing. Petzoldt v. Commissioner, 92 T.C.

661, 698 (1989). Fraudulent intent is never imputed nor presumed but must

always be established by independent evidence. Id. at 699.

               1.     20047

      Mr. Abdallah admitted to fraud on his 2004 return in connection with his

criminal case. As an initial matter, we address whether the judgment against Mr.

Abdallah in the criminal case estops him from litigating the existence of fraud for

2004. We hold that it does not.

      The Arizona District Court judgment held Mr. Abdallah criminally liable

under section 7206(1). Section 7206(1) provides that any person who “[w]illfully

makes and subscribes any return * * * which contains or is verified by a written

declaration that it is made under the penalties of perjury, and which he does not




      7
          The parties agree that the notice of deficiency is timely for 2004.
                                        - 24 -

[*24] believe to be true and correct as to every material matter * * * shall be guilty

of a felony”.

      In Considine v. United States, 683 F.2d 1285, 1287 (9th Cir. 1982), the

Court of Appeals for the Ninth Circuit held that a prior criminal conviction under

section 7206(1) will not estop a party from later contesting civil fraud because an

“intent to evade taxes” was not a necessary element of the criminal conviction.

Thus, Mr. Abdallah’s criminal conviction under section 7206(1) does not estop

him from challenging the penalty for civil fraud under section 6663(a).

      The Arizona District Court judgment, however, also incorporated the terms

of the plea agreement, and as part of the plea agreement Mr. Abdallah admitted

that he “intentionally underreported [his] income * * * in order to pay less in

taxes”. Therefore, Mr. Abdallah has admitted to fraud--i.e., that he intentionally

underreported income for the specific purpose of evading tax. See Petzoldt v.

Commissioner, 92 T.C. at 698 (“Fraud is defined as an intentional wrongdoing

designed to evade tax believed to be owing.”).

                2.   1999 to 2003

      Since fraud is rarely admitted and the taxpayer’s intent is rarely available,

fraud may be proven by circumstantial evidence and reasonable inferences drawn

from the facts. Bradford v. Commissioner, 796 F.2d 303, 307 (9th Cir. 1986),
                                         - 25 -

[*25] aff’g T.C. Memo. 1984-601. Whether fraud exists in a given situation is a

factual determination that must be made after reviewing the particular facts and

circumstances of the case. Bussell v. Commissioner, T.C. Memo. 2005-77, 89

T.C.M. (CCH) 1032, 1038 (2005), aff’d, 262 Fed. Appx. 770 (9th Cir. 2007).

      The intent to conceal or mislead may be inferred from a pattern of conduct.

See Spies v. United States, 317 U.S. 492, 499 (1943). From 1999 through 2004

Mr. Abdallah’s business practices and pattern of behavior did not materially

change. Therefore, Mr. Abdallah’s admission that he intentionally underreported

income for the specific purpose of evading tax for 2004 is circumstantial evidence

of his fraudulent intent for 1999 through 2003.

      In determining whether a taxpayer had the requisite fraudulent intent, courts

have also relied on certain indicia (badges) of fraud. These badges include: (1)

understating income; (2) maintaining inadequate records; (3) failing to file tax

returns; (4) giving implausible or inconsistent explanations of behavior; (5)

concealing assets; (6) failing to cooperate with tax authorities; (7) engaging in

illegal activities; (8) attempting to conceal illegal activities; and (9) dealing in

cash. Bradford v. Commissioner, 796 F.2d at 307-308. The presence of several

badges is persuasive circumstantial evidence of fraud. Bussell v. Commissioner,
                                         - 26 -

[*26] 89 T.C.M. (CCH) at 1038. Several badges of fraud exist in this case which

clearly and convincingly establish fraud in all five years.

                    a.     Understating Income

      Mr. Abdallah cashed millions of dollars’ worth of checks totaling

$13,988,074 in 1999, $20,736,707 in 2000, $26,713,928 in 2001, $28,751,965 in

2002, and $28,839,442 in 2003. Petitioners admit that they failed to report check

cashing income of $59,349 for 1999, $104,533 for 2000, $146,496 for 2001,

$154,655 for 2002, and $169,592 for 2003. In contrast, on their original returns

petitioners reported income of only $13,883 for 1999, $9,718 for 2000, $9,337 for

2001, $9,217 for 2002, and $34,090 for 2003. To put things in perspective,

petitioners reported merely 19% of their income for 1999, 9% for 2000, 6% for

2001, 6% for 2002, and 17% for 2003. Petitioners’ omitted income, which

completely dwarfs the income that they did report, constitutes strong evidence of

fraud. Parks v. Commissioner, 94 T.C. at 664 (“A pattern of consistent

underreporting of income, especially when accompanied by other circumstances

showing an intent to conceal, justifies the inference of fraud.”); Branson v.

Commissioner, T.C. Memo. 2012-124, 103 T.C.M. (CCH) 1680, 1686 (2012) (“A

pattern of substantially underreporting income for several years is strong evidence

of fraud, particularly if the reason for the understatements is not satisfactorily
                                        - 27 -

[*27] explained or due to innocent mistake.”); Powerstein v. Commissioner, T.C.

Memo. 2011-271, 102 T.C.M. (CCH) 497, 515 (2011) (finding strong evidence of

fraudulent intent where, over a period of five years, “petitioners failed to report or

account for more than $450,000 of income”).

      Moreover, Mr. Abdallah certified under penalty of perjury that he reviewed

his returns and that to the best of his knowledge his returns were true, correct, and

complete.8 Having reviewed his returns, Mr. Abdallah must have seen that he

reported significantly less income than he was actually making.

      Mr. Abdallah knew his check cashing income was substantial for the

following reasons. First, Mr. Abdallah knew that fees generated from his check

cashing business were his primary source of income, with which he

singlehandedly supported his wife and three children (four children in 2003 and

2004). Second, petitioners made substantial investments, partially with their own

funds. For example, in 2000 and 2003 petitioners purchased two pieces of real

property for $138,000 and $234,384 and made downpayments of $7,500 and

$46,877, respectively, with their own funds. Third, petitioners made monthly



      8
       By signing the returns, Mr. Abdallah certified that “[u]nder penalties of
perjury, I declare that I have examined this return and accompanying schedules
and statements, and to the best of my knowledge and belief, they are true, correct,
and complete.”
                                        - 28 -

[*28] mortgage payments of $852--i.e., annual payments of $10,224--on their

residence at W. Dublin St. To put things in perspective, during 1999 through

2003 petitioners paid more in mortgage and downpayments alone than they

reported as income.

                   b.     Maintaining Inadequate Records

      Taxpayers are required to keep such records as are necessary for the

determination of tax. See sec. 6001. We find that Mr. Abdallah’s records were

poor, inadequate, and incomplete. On brief, petitioners concede that Mr. Abdallah

“did not keep contemporaneous records of the fees he collected when he cashed

checks”, that his recordkeeping was deficient, and that “[t]here is no doubt that

Mr. Abdallah was a poor record keeper”. Further, Mr. Abdallah testified that

every month he threw all of Supermat’s records--i.e., bank statements, commission

checks, purchase receipts, and check stubs--together in a box which he then gave

to Mr. Peters. With the exception of some bank statements, these records are now

lost. At all times before they were lost, these records were either in Mr.

Abdallah’s possession or in the possession of an agent under his control. Further,

Mr. Abdallah failed to keep records of the checks he cashed, his fees earned, or

any other records for his check cashing activity. Mr. Abdallah’s failure to

maintain adequate records is indicative of fraud. See, e.g., Scott v. Commissioner,
                                          - 29 -

[*29] T.C. Memo. 2012-65, 103 T.C.M. (CCH) 1310, 1317 (2012) (finding

taxpayer’s “failure to keep or produce adequate records to support his tax return

positions to be an indicium of fraud”).

                    c.     Giving Implausible or Inconsistent Explanations of
                           Behavior

      As we stated earlier, Mr. Abdallah claimed incredibly that he never looked

at his tax returns. Mr. Abdallah, however, certified under penalty of perjury that

he reviewed his returns and that to the best of his knowledge, his returns were true,

correct, and complete. Thus, either he lied to the IRS on his returns or he lied to

this Court during trial.

      Even if we were to credit Mr. Abdallah’s testimony that he did not review

his returns (which we do not), experience and common sense render it difficult for

us to believe that a reasonable person would not have noticed that his reported tax

liabilities were orders of magnitude lower than what one would expect from his

earnings. For the six years at issue, Mr. Abdallah paid zero income tax but had

nearly $900,000 of total income. Willful ignorance and reckless disregard of the

truth are circumstantial evidence of fraud. See United States v. Henderson, 721

F.2d 276, 279 (9th Cir. 1983) (finding that willful ignorance instructions have

been found appropriate in fraud cases) (citing United States v. Hanlon, 548 F.2d
                                          - 30 -

[*30] 1096, 1100 n.7 (2d Cir. 1977) (holding that a fact finder may infer fraud

from reckless disregard of the truth)).

      Finally and significantly, Mr. Abdallah submitted loan applications to

Spectrum Financial Group in 2002 and 2003 wherein he represented that he was

making $9,000 a month--i.e. $108,000 a year--through Supermat. In contrast, Mr.

Abdallah submitted tax returns in 2002 and 2003 representing that he made only

$9,217 and $34,090 through Supermat, respectively. Strong evidence of

fraudulent intent exists where the taxpayer reports substantially higher income on

his loan applications than on his Federal income tax returns. See Powerstein v.

Commissioner, 102 T.C.M. (CCH) at 151.

      Moreover, by signing both applications, Mr. Abdallah twice certified that

the information he provided was correct and twice acknowledged that

misrepresentations could result in a violation of 18 U.S.C. sec. 1001.9 In essence,

Mr. Abdallah either made fraudulent representations to the IRS under penalty of

perjury or he made fraudulent representations to Spectrum Financial Group in

violation of 18 U.S.C. sec. 1001, or both.



      9
        We note that a violation of 18 U.S.C. sec. 1001 (2006) is a Federal criminal
offense, which could result in imprisonment for up to five years. However, as the
issue is not before the Court, we do not address whether Mr. Abdallah’s loan
applications resulted in such a violation.
                                        - 31 -

[*31] Having established that Mr. Abdallah knew he was underreporting income,

we need not make a great leap to conclude that Mr. Abdallah intended to underpay

his taxes. When financial incentives existed for him to report high income, such

as on loan applications, Mr. Abdallah reported significant monthly income. When

financial incentives existed for him to report low income, such as on his tax

returns, Mr. Abdallah reported minimal income.

      For the foregoing reasons, respondent has clearly and convincingly

established that Mr. Abdallah harbored fraudulent intent.

      C.     Portion of Underpayment Attributable to Fraud

      Once the Commissioner “establishes that any portion of an underpayment is

attributable to fraud, the entire underpayment shall be treated as attributable to

fraud, except with respect to any portion of the underpayment, which the taxpayer

establishes (by a preponderance of the evidence) is not attributable to fraud.” Sec.

6663(b); see also Scharringhausen v. Commissioner, T.C. Memo. 2012-350, at

*35 (“[The Commissioner] need only prove clearly and convincingly that there is a

deficiency and ‘at least some part of the deficiency was due to fraud.’” (quoting

Clark v. Commissioner, 266 F.2d 698, 717 (9th Cir.1959), remanding T.C.

Memo.1957-129)). Respondent has established by clear and convincing evidence

that at least part of each of Mr. Abdallah’s underpayments is attributable to fraud.
                                        - 32 -

[*32] In addition, Mr. Abdallah has failed to establish by a preponderance of the

evidence that any portion of any underpayment is not attributable to fraud. Thus,

Mr. Abdallah’s entire underpayment for each of 1999 through 2004 is attributable

to fraud.

      Finally, because we find that petitioners’ returns for 1999 through 2003

were fraudulent, the limitations period on assessment is lifted under section

6501(c). Therefore, the notice of deficiency was valid and the Court has

deficiency jurisdiction over these five years.

IV.   Refund of Petitioners 2002, 2003, and 2004 Payments

      Under the tax regime Congress created, “Congress has * * * established a

detailed refund scheme that subjects complaining taxpayers to various

requirements before they can bring suit.” United States v. Clintwood Elkhorn

Mining Co., 553 U.S. 1, 11 (2008). In postpayment circumstances, “[a] taxpayer

seeking a refund of taxes erroneously or unlawfully assessed or collected may

bring an action against the Government either in United States district court or in

the United States Court of Federal Claims.” Id. at 4 (citing 28 U.S.C. sec.

1346(a)(1)). In contrast, the Tax Court’s principal jurisdiction is over prepayment

“deficiency cases”, pursuant to section 6213(a).
                                        - 33 -

[*33] With regard to the Tax Court’s overpayment jurisdiction, section 6512(b)(1)

provides:

      [I]f the Tax Court finds that there is no deficiency and further finds
      that the taxpayer has made an overpayment of income tax for the
      same taxable year * * * or finds that there is a deficiency but that the
      taxpayer has made an overpayment of such tax, the Tax Court shall
      have jurisdiction to determine the amount of such overpayment * * *

      The existence of deficiencies for 2002, 2003, and 2004 is undisputed.

Rather, the parties dispute the existence of an overpayment of tax. Section

6665(a)(2) provides that “any reference in this title [26 of the United States Code

(to which section 6512 belongs)] to ‘tax’ imposed by this title shall be deemed

also to refer to the additions to the tax, additional amounts, and penalties provided

by this chapter.”10 Therefore, an overpayment of tax under section 6512(b)(1)

requires payment in excess of the deficiency plus any penalties and additions to

tax. Petitioners’ voluntary payments of $45,669 for 2002, $47,381 for 2003, and

$31,959 for 2004 do not come close to covering their deficiencies of $45,669 for

2002, $47,381 for 2003, and $31,959 for 2004 plus the 75% fraud penalties.11

Consequently, there is no overpayment of tax for 2002, 2003, or 2004, and this


      10
      “[T]his chapter” refers to Chapter 68, Additions to the Tax, Additional
Amounts, and Assessable Penalties, to which sec. 6663 belongs.
      11
       On brief, respondent concedes these reduced deficiency amounts for 2002,
2003, and 2004.
                                        - 34 -

[*34] Court lacks jurisdiction to order a refund of petitioners’2002, 2003, or 2004

payment. See sec. 6512(b)(1) and (2).

V.    Mr. Peters’ Subpoena

      Respondent subpoenaed Mr. Peters to compel him to testify at trial.

Respondent served Mr. Peters with the subpoena but did not provide petitioners or

the Court with proof of service. Petitioners allege that respondent failed to follow

the Tax Court Rules of Practice and Procedure, claim resulting prejudice, and seek

to strike Mr. Peters’ testimony. Respondent argues that he issued Mr. Peters’

subpoena in accordance with the Rules.

      Respondent served Mr. Peters with the subpoena but did not provide proof

of service to the Court. Rule 21(b)(3) provides that the person serving a subpoena

“shall make proof thereof to the Court promptly and in any event within the time

in which the person served must respond.” Rule 21(b)(3) further provides that

“Failure to make proof of service does not affect the validity of the service.”

      We find that respondent violated Rule 21 by not providing proof of service

to the Court. However, we decline to strike Mr. Peters’ testimony because

petitioners were not prejudiced. Respondent listed Mr. Peters as a potential

witness in his pretrial memorandum. Further, absent a claim of privilege, which
                                        - 35 -

[*35] petitioners have not asserted, nothing bars Mr. Peters from testifying on

respondent’s behalf without being subpoenaed.

         In reaching our holdings, we have considered all arguments made, and, to

the extent not mentioned above, we conclude they are moot, irrelevant, or without

merit.

         To reflect the foregoing,


                                                 Decision will be entered under Rule

                                        155.
