                          T.C. Memo. 2000-279



                      UNITED STATES TAX COURT



                   DERECO, INC., Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 893-98.                         Filed August 30, 2000.




     Herbert W. Linder, for respondent.



                          MEMORANDUM OPINION


     PARR, Judge:   This case is before us on respondent's motion

to dismiss for lack of prosecution.    Because of the relief sought

therein, we treat the motion as a motion to dismiss for lack of

prosecution as to the deficiencies and a motion for default as to

the additions to tax for fraud.

     Respondent determined the following deficiencies in
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petitioner's Federal income taxes, and additions to tax for

fraud, for petitioner's tax years ended September 30:

                                           Additions to Tax
                                   Sec.              Sec.           Sec.
     Year       Deficiency     6653(b)(1)(A)      6653(b)(1)(B)    6653(b)
                                                        1
     1988        $247,112        $185,334                             --
     1989         195,154           --                 --         $139,746
     1
         50 percent of the interest due on $247,112.

     All section references are to the Internal Revenue Code in

effect for the taxable years in issue, and all Rule references

are to the Tax Court Rules of Practice and Procedure, unless

otherwise indicated.

     At the time the petition in this case was filed by D.J.

Marino, an officer of petitioner, petitioner's office was located

in Cleveland, Ohio.

                                  Background

     The petition filed in this case generally disputed

respondent's adjustments to petitioner's income.            Respondent's

answer denied the material allegations of the petition and

further alleged:

          6. FURTHER ANSWERING the petition, and in support
     of the determination that the underpayments of tax
     required to be shown on petitioner's tax returns for
     the tax years ending September 30, 1988, and September
     30, 1989, are due to fraud, the respondent alleges:
          (a) Donald J. Marino was the president and major
     shareholder of, and had direct control over, petitioner
     during the years at issue.
          (b) Petitioner paid certain personal expenses of
     Donald J. Marino and his family.
          (c) On December 22, 1987, petitioner's president
     Donald J. Marino purchased a diamond necklace, diamond
     tennis bracelet, and two sets of diamond earrings from
                         - 3 -

a company known as Merka Jewelry and Trophies, Inc.,
for $29,550.00.
     (d) On December 22, 1987, petitioner's president
Donald J. Marino paid $25,000.00 of the purchase price
described in subparagraph (c), above, with petitioner's
corporate check.
     (e) When questioned by respondent's agent
regarding the payment described in subparagraph (d),
above, petitioner's president Donald J. Marino stated
that the purchase was for trophies.
     (f) The $25,000.00 payment described in
subparagraph (d), above, was included in petitioner's
cost of goods sold on its tax return for the year ended
September 30, 1988.
     (g) Petitioner provided funds to its president
Donald J. Marino to pay his and his family members'
personal expenses during the tax year ended September
30, 1988, in the amount of $253,602.00.
     (h) Petitioner deducted $148,282.00 of the amount
described in subparagraph (g), above, as travel and
entertainment expenses on its tax return for the year
ended September 30, 1988.
     (i) Petitioner deducted $105,320.00 of the amount
described in subparagraph (g), above, as research and
development expense on its tax return for the year
ended September 30, 1988.
     (j) Petitioner directly paid and provided funds
to its president Donald J. Marino to pay his and his
family members' personal expenses during the tax year
ended September 30, 1989, in the amount of $152,706.00.
     (k) Petitioner deducted the $152,706.00 amount
described in subparagraph (j), above, as travel and
entertainment expenses on its tax return for the year
ended September 30, 1989.
     (l) Petitioner's president Donald J. Marino
endorsed and deposited a check in the amount of
$27,716.00 payable to petitioner from J&L Steel into
his personal bank account.
     (m) The $27,716.00 described in subparagraph (l),
above, constitutes taxable income to petitioner for the
tax year ended September 30, 1988, which income was not
reported on its tax return.
     (n) Petitioner deducted on its tax return for the
year ended September 30, 1988, subcontractor expenses
in the amount of $651,871.00.
     (o) Petitioner only paid or incurred $294,801.00
of the subcontractor expenses described in subparagraph
(n), above.
                         - 4 -

     (p) The remaining $357,070.00 of the
subcontractor expenses described in subparagraph (n),
above, were never paid or incurred by petitioner.
     (q) Petitioner deducted a depreciation expense in
the amount of $93,208.00 on its tax return for the year
ended September 30, 1989.
     (r) Of the depreciation expense described in
subparagraph (q), above, $37,058.00 was taken on
equipment not owned by petitioner and/or not in
existence.
     (s) Petitioner deducted repairs and maintenance
expenses in the amount of $254,708.00 on its tax return
for the year ended September 30, 1989.
     (t) Of the repairs and maintenance expense
described in subparagraph (s), above, $37,780.00 was
neither paid nor incurred.
     (u) Petitioner deducted a telephone expense in
the amount of $8,128.00 on its return for the year
ended September 30, 1989.
     (v) Of the telephone expense described in
subparagraph (u), above, $4,860.00 was neither paid nor
incurred.
     (w) Petitioner deducted an advertising expense in
the amount of $88,102.00 on its tax return for the year
ended September 30, 1989.
     (x) Of the advertising expense described in
subparagraph (w), above, $20,307.00 was neither paid
nor incurred.
     (y) Petitioner deducted a dues and education
expense in the amount of $7,913.00 on its tax return
for the year ended September 30, 1989.
     (z) Of the dues and education expense described
in subparagraph (y), above, $3,130.00 was neither paid
nor incurred.
     (aa) Petitioner deducted as other costs equipment
rental in the amount of $48,438.00 on its tax return
for the year ended September 30, 1989.
     (ab) Of the equipment rental cost described in
subparagraph (aa), above, $28,500.00 was neither paid
nor incurred.
     (ac) Petitioner deducted on its tax return for
the year ended September 30, 1989, subcontractor
expenses in the amount of $563,402.00.
     (ad) Petitioner only paid or incurred $366,822.00
of the subcontractor expenses described in subparagraph
(ac), above.
     (ae) The remaining $196,580.00 of the
subcontractor expenses as described in subparagraph
                               - 5 -

     (ac), above, were never paid or incurred by petitioner.

     Finally, in subparagraphs (af) through (am), respondent

asserted that the omission of income and erroneous deductions

were due to fraud, and that petitioner understated its tax

liabilities for its taxable years 1988 and 1989 with the intent

to evade tax.

     Petitioner did not file a reply.   Respondent filed a motion

under Rule 37(c) asking the Court to deem admitted the

affirmative allegations set forth in paragraph 6 of his answer.

On October 27, 1998, petitioner was served with that motion

together with notice that if petitioner filed its reply as

required by Rule 37(a) and (b) on or before November 20, 1998,

respondent's motion would be denied; however, if petitioner did

not file a reply as directed, the Court would grant respondent's

motion and deem admitted the affirmative allegations in the

answer.

     Petitioner did not respond to respondent's motion or the

Court's notice.   Petitioner never filed its reply.   Accordingly,

on November 27, 1998, the Court granted respondent's Rule 37(c)

motion and deemed admitted the affirmative undenied allegations

of respondent's Answer.   On November 30, 1998, a copy of that

order was served upon petitioner.

     On October 19, 1999, the Court served its notice setting

this case for trial on March 20, 2000, at a trial session of this
                                 - 6 -

Court in Cleveland, Ohio.   The notice, in pertinent part, states:

"YOUR FAILURE TO APPEAR MAY RESULT IN DISMISSAL OF THE CASE AND

ENTRY OF DECISION AGAINST YOU.    * * *   YOUR FAILURE TO COOPERATE

MAY ALSO RESULT IN DISMISSAL OF THE CASE AND ENTRY OF DECISION

AGAINST YOU."

     Petitioner did not appear when the case was called from the

calendar.   When petitioner did not appear at trial, respondent

advised the Court that he would not present any testimony on the

issue of the additions to tax for fraud; instead, respondent

would rely on the deemed admissions to carry his burden of proof

on this issue.

     All material allegations in the petition have been denied in

respondent's answer.   No issues have been raised as to petitioner

upon which the burden of proof is on respondent except the fraud

issue, and respondent has not conceded any error assigned in the

petition.

                            Discussion

Deficiency Determination

     Respondent's determinations of fact are presumptively

correct, and petitioner bears the burden of proving otherwise.

See Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933).

Petitioner has clearly failed to meet its burden and, in any

event, the deemed admitted affirmative allegations in

respondent's answer establish the deficiencies.    See Doncaster v.
                                - 7 -

Commissioner, 77 T.C. 334, 336 (1981); Gilday v. Commissioner, 62

T.C. 260, 261 (1974).    Accordingly, we sustain respondent's

determinations as to the deficiencies.

Determination of Fraud

     Respondent also moved for judgment on the fraud issue based

on the affirmative allegations of fact contained in respondent's

answer, which were deemed admitted by the order of this Court

pursuant to Rule 37(c).    Respondent has the burden of proving

that some portion of each underpayment is due to fraud by clear

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

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

     The facts deemed admitted establish that during the years at

issue, petitioner regularly deducted expenses that it had not

paid or incurred, including expenses of equipment that petitioner

did not own or that did not exist; that petitioner deducted as

business expenses amounts that were paid to its president for

expenses of his family; that petitioner omitted income; and that

petitioner, through its president, intentionally made false and

misleading statements to respondent's agents during the

examination of petitioner's income tax returns.    Finally,

petitioner has failed to comply with the Court's pretrial orders

or the Court's other orders and failed to appear for the

scheduled trial--additional indications of deliberate efforts by

petitioner to conceal the facts concerning its tax liability.
                                 - 8 -

See Collins v. Commissioner, T.C. Memo. 1997-291.

     Rule 123 provides that the failure of a party to appear at

trial or other hearing may result in an entry of decision against

such party.1   We find the facts deemed admitted sufficient to

satisfy respondent's burden of proving fraud.    The foregoing

circumstances and above-pleaded admitted facts clearly establish

that petitioner fraudulently underpaid its Federal income taxes

for the years at issue.   See Smith v. Commissioner, 91 T.C. 1049,

1058-1059 (1988), affd. 926 F.2d 1470 (6th Cir. 1991); Doncaster

v. Commissioner, supra at 337.     Accordingly, we are satisfied

that the additions to tax for fraud should be sustained by entry

of an order pursuant to Rule 123.

     To reflect the foregoing,

                                 An appropriate order and decision

                          will be entered.




     1
      Rule 123 provides in part:

          (a) Default: If any party has failed to plead or
     otherwise proceed as provided by these Rules or as
     required by the Court, then such party may be held in
     default by the Court either on motion of another party
     or on the initiative of the Court. Thereafter, the
     Court may enter a decision against the defaulting
     party, upon such terms and conditions as the Court may
     deem proper, or may impose such sanctions * * * as the
     Court may deem appropriate. * * *
