                              T.C. Memo. 2018-212



                        UNITED STATES TAX COURT



                 RICHARD C. MATHEWS, Petitioner v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket Nos. 24673-14, 2939-15.               Filed December 26, 2018.



      Richard C. Mathews, pro se.

      William F. Castor and H. Elizabeth H. Downs, for respondent.



            MEMORANDUM FINDINGS OF FACT AND OPINION


      VASQUEZ, Judge: In these consolidated cases, respondent determined

deficiencies and section 6663 civil fraud penalties for tax years 2007 and 2008 as

follows:
                                            -2-

[*2]                                                        Civil fraud penalty1
            Year                 Deficiency                      sec. 6663
            2007                   $6,556                        $4,917.00
            2008                   16,405                        12,303.75

               1
                  In the deficiency notices respondent also determined that
         petitioner is liable for sec. 6662(a) accuracy-related penalties “if it is
         determined that any portion of the underpayment of tax is not due to
         fraud”.

         The issue for decision is whether petitioner, fraudulently and with the intent

to evade tax, omitted income from his 2007 and 2008 Federal income tax returns.

All section references are to the Internal Revenue Code in effect for the years in

issue, and Rule references are to the Tax Court Rules of Practice and Procedure.

                                  FINDINGS OF FACT

         Some of the facts have been deemed stipulated under Rule 91(f) and are so

found. We incorporate the stipulation of facts and the attached exhibits by this

reference. Petitioner resided in Arkansas when the petitions in these cases were

filed.

Petitioner’s Background

         Petitioner dropped out of high school after completing the 10th grade. He

then joined the U.S. Army and discovered he had a knack for computers. Using
                                        -3-

[*3] his computer skills, petitioner helped conduct electronic surveillance for a

military unit until he was honorably discharged in 1977.

Petitioner’s Multilevel Marketing Business

      In the late 1980s or early 1990s petitioner began participating in multilevel

marketing, a sales strategy in which distributors recruit secondary distributors to

sell products. See Signature Mgmt. Team, LLC v. Doe, 876 F.3d 831, 834 n.1

(6th Cir. 2017). Distributors earn money from direct sales to customers; they also

receive revenue from sales made by the secondary distributors. Id. Doing

business as Mathews Multi-Sales, petitioner participated in numerous multilevel

marketing ventures over the years, selling coffee, vitamins, and other physical

products.

      Petitioner eventually shifted his multilevel marketing activity to the internet.

Doing business as Mathews Multi-Service out of his home, petitioner operated

several internet-based, multilevel marketing programs including Wealth Team

International Association (WTIA), Fortune 5 Minutes, Glad Club, $20 Miracle,

and It’s No Miracle (collectively, Multi-Service programs). Under most of the

Multi-Service programs, people would join with the intention of recruiting new

members. If they were successful, they would receive a percentage of the

membership fees paid by their recruits and the recruits of their recruits (and so
                                        -4-

[*4] on).1 For example, WTIA had a membership fee of $99. Of that $99,

petitioner was required to “pay out” $90 to the member-recruiters.

      Petitioner created accounts with several online payment systems to receive

membership fees. These online payment systems included Paypal, Storm Pay,

Safepay Solutions, E-Bullion, E-Gold, and Internet Gold.

      After receiving the membership fees in the online payment systems,

petitioner remitted portions of the fees to the member-recruiters who were owed

commissions. Petitioner then moved some of the remaining funds to a joint

checking account he held with his former wife, Donna Mathews (Mrs. Mathews).2

He generally did so by depositing checks from the online payment systems. For at

least one of the online payment systems, petitioner also moved funds to his bank

accounts via direct deposit.

      Petitioner wanted to establish an international business presence for the

Multi-Service programs. He believed that being headquartered in the United

States would limit his ability to do business worldwide. Unsure how to operate



      1
         Members who joined the Multi-Service programs initially received
software, but it is unclear what function the software served. Respondent has not
alleged that the Multi-Service programs violated Federal or State law.
      2
          Petitioner and Mrs. Mathews divorced on a date not established by the
record.
                                         -5-

[*5] internationally, petitioner turned to the internet. His online research

eventually led him to a Panamanian entity whose representatives advised him to

establish a trust in Belize. Petitioner believed that the establishment of a trust in

Belize would allow him to do business anywhere.

      Accordingly, in September 2000 petitioner paid a fee and signed a trust

instrument establishing the Centurion Trust. The trust instrument designated First

Pacific Trust Services, Ltd., as the trustee and Mathews Multi-Service, petitioner,

Mrs. Mathews, and their children as beneficiaries.3 Petitioner never funded the

Centurion Trust. Nor did he have the necessary education, experience, or acumen

to understand how, if at all, the existence of the Centurion Trust could affect his

Federal income tax liability. Petitioner has never visited Belize and does not have

an office there.




      3
         Paragraph 18 of the deemed stipulation of facts states: “Petitioner insisted
[during respondent’s civil examination of his 2005 return] that one of his
businesses was actually the beneficiary of a trust in Belize, when in fact the true
beneficiaries of the trust were relatives of petitioner.” However, the trust
document attached to the stipulation states that Mathews Multi-Service was the
trust beneficiary “so long as he/she [sic] lives”, after which time petitioner and his
family would become beneficiaries. Under Rule 91(e), the Court may relieve
parties of a stipulation if justice so requires. We will relieve petitioner of
stipulated paragraph 18 because it is contrary to the record. See Cal-Maine Foods,
Inc. v. Commissioner, 93 T.C. 181, 195 (1989).
                                         -6-

[*6] Petitioner’s Tax Returns (2004, 2005, and 2006)

      Using tax preparation software, petitioner prepared his and Mrs. Mathews’

joint Federal income tax returns for tax years 2004, 2005, and 2006. Although he

does not have bookkeeping, accounting, or taxation experience, petitioner thought

he could “[just] buy the software, fill in the blanks, and file * * * [his] taxes.” For

2004, 2005, and 2006, Mrs. Mathews received Forms W-2, Wage and Tax

Statement, from her employer. Petitioner received Forms 1099-MISC,

Miscellaneous Income, which reported commissions petitioner had earned selling

physical products as Mathews Multi-Sales.

      On their 2004 return, petitioner and Mrs. Mathews reported Mrs. Mathews’

wage income. The 2004 return also included a Schedule C, Profit or Loss From

Business, for petitioner reflecting the principal business as “networking” and the

business name as “Mathews MultiSales”. The 2004 Schedule C reported gross

receipts of $3,560, cost of goods sold (COGS) of $900, gross profit of $2,660, no

expenses, and net profit of $2,660. To calculate his gross receipts, petitioner used

the amounts listed on Forms 1099-MISC he had received.

      Petitioner and Mrs. Mathews reported Mrs. Mathews’ wage income on their

2005 return. The return also included a Schedule C-EZ, Net Profit From Business,

for petitioner reflecting the principal business as “networking” and the business
                                       -7-

[*7] name as “Mathews MultiService”. The 2005 Schedule C-EZ reported gross

receipts of $3,318, no expenses, and net profit of $3,318. To calculate his gross

receipts, petitioner used the amounts listed on Forms 1099-MISC he had received.4

      On their 2006 return, petitioner and Mrs. Mathews reported Mrs. Mathews’

wage income. The 2006 return did not include a Schedule C for petitioner and did

not report business income or losses for either Mathews Multi-Sales or Mathews

Multi-Service.

      Petitioner believed that 90% of the funds he received through the Multi-

Service programs belonged to the other member-recruiters. Petitioner also

believed that he had deductible expenses with respect to the Multi-Service

programs. On the basis of these beliefs, petitioner did not report any income from

the Multi-Service programs on his 2004, 2005, and 2006 returns.

Civil Examination

      In October 2007 respondent selected petitioner’s 2005 return for

examination. Revenue Agent (RA) Thurman Crawford was assigned to

      4
         Because petitioner had earned the reported gross receipts as Mathews
Multi-Sales, it appears that the reference to Mathews Multi-Service on the 2005
Schedule C was in error. Respondent has not alleged that petitioner’s reference to
Mathews Multi-Service was intended to confuse the Internal Revenue Service
(IRS) or thwart a governmental investigation. Cf. Yu v. Commissioner, T.C.
Memo. 1973-188 (holding that the use of an alias in conducting business affairs in
order to thwart a governmental investigation is evidence of fraud).
                                        -8-

[*8] petitioner’s examination. Before his initial meeting with petitioner, RA

Crawford visited WTIA’s website.5 A few things caught his eye.

      For one, the website described WTIA as a compensation program. Second,

the “Associate Terms & Conditions” page stated that the agreement was governed

under the laws of Belize. On the basis of these discoveries, RA Crawford began to

suspect that WTIA was: (1) a source of income to petitioner and (2) an offshore

business designed to shield petitioner’s income from Federal taxation.

      On November 29, 2007, RA Crawford met with petitioner at his home.

Over the next two days, RA Crawford interviewed petitioner, who admitted that

his taxes were a “mess”. RA Crawford asked petitioner about the nature of

Mathews Multi-Service, which petitioner had reported as the business name on his

2005 Schedule C. Petitioner stated that the reference to Mathews Multi-Service

was a mistake, that he had really meant his other business, Mathews Multi-Sales,

and that the income reported on the Schedule C related to his coffee sales.

Petitioner described Mathews Multi-Service as an online network-marketing

business for which he wrote marketing material. Petitioner stated that he received

no income from Mathews Multi-Service, that it was a beneficiary of a Belize

Trust, and that “all taxes were handled in Belize.”

      5
          WTIA was the most prominent of the Multi-Service programs.
                                       -9-

[*9] In response to a question about WTIA, petitioner stated that the program

was part of Mathews Multi-Service. Petitioner also stated that WTIA used PayPal,

Internet Gold, and Storm Pay in 2005 and that he had sole access to these online

payment accounts. Petitioner admitted that he used some of the funds in the

online payment accounts for personal or “other” expenses. He also stated that he

could not recall whether funds were transferred from the Paypal account to bank

accounts but that he never provided personal bank information to Paypal.

      In an information document request issued to petitioner before the

interview, RA Crawford had requested all bank statements, debit and credit

memoranda, and canceled checks for all personal and business accounts from

December 1, 2004, through January 31, 2006. On the first day of the interview,

petitioner offered RA Crawford access to his online banking accounts. RA

Crawford declined. The following day petitioner provided RA Crawford with

paper statements for a joint account at First Security Bank, account number ending

6961 (FSB 6961 account).

      RA Crawford scheduled a third meeting with petitioner for January 7, 2008.

Before the meeting, RA Crawford reviewed petitioner’s Paypal account records,

which referenced an account at First Community Bank, account number ending

7186 (FCB 7186 account). At the January 7, 2008, meeting, RA Crawford asked
                                       - 10 -

[*10] petitioner about this account. Petitioner told RA Crawford that First

Community Bank had become First Security Bank, where he maintained his joint

account with Mrs. Mathews. Petitioner did not immediately identify the FCB

7186 account as his and stated that he did not give online payment systems his

personal bank account information. Later that afternoon, petitioner called RA

Crawford and stated that he had spoken with a First Security Bank representative

and now remembered that the FCB 7186 account was a closed Mathews Multi-

Service bank account. RA Crawford believed that petitioner had deliberately

concealed the account. He informed petitioner that the examination would be

expanded to tax year 2006.

      Sometime thereafter, petitioner asked to record all future meetings with RA

Crawford. RA Crawford countered with an offer to redo and record the initial

interview at the local IRS office; petitioner accepted. On February 22, 2008, RA

Crawford interviewed petitioner, asking the same questions as in the initial

interview. Petitioner provided many of the same answers during the second

interview as the first interview. However, he provided different details about his

role with WTIA.

      RA Crawford also asked petitioner additional questions about the Centurion

Trust. Petitioner stated that he learned about foreign trusts from the IRS, the
                                       - 11 -

[*11] internet, law firms, and offshore businesses. Petitioner, however, did not

identify who at the IRS had told him about foreign trusts. He also did not identify

the law firm that purportedly created the trust. After the interview, RA Crawford

noticed that the “Associate Terms & Conditions” on the WTIA website had been

altered to reflect that WTIA was a subsidiary of the Centurion Trust.

      In July 2008 RA Crawford expanded the examination to tax years 2003 and

2004 and scheduled another meeting with petitioner for early September. RA

Crawford then met with a fraud technical adviser at the IRS. After this meeting,

RA Crawford referred petitioner’s case to respondent’s Criminal Investigation

Division (CID). Several days later petitioner left a message for RA Crawford

asking whether “the 2005 year amount in dispute was down to zero”. In a return

phone call to petitioner, RA Crawford canceled the September meeting.

2007 Return

      Petitioner prepared his 2007 return and filed it on October 15, 2008. In a

break with past practice, petitioner and Mrs. Mathews filed separate returns.

Petitioner’s return included a Schedule C for “Centurion Trust/Mathews Multi-

Service” with a principal business of “Online Admin/Facilitation/Consultation”.

The 2007 Schedule C reported gross receipts of $5,323, depreciation of $1,611,

and net profit of $3,712.
                                        - 12 -

[*12] CID’s Initial Research and Search Warrant

      In November 2008 CID accepted RA Crawford’s referral. Special Agent

(SA) Erica Williams was assigned as the lead special agent for CID’s criminal

investigation of petitioner. Through internet research and an undercover

operation, SA Williams confirmed that petitioner was the owner of Mathews

Multi-Service and that he received income from the Multi-Service programs. SA

Williams found it significant that one of the program websites had a quotation

from Al Capone, signaling to her that petitioner may have intended to evade tax.6

      On the morning of July 21, 2009, CID executed a search warrant at

petitioner’s home. During the execution of the search warrant, petitioner agreed to

submit to an interview with SA Williams.

      In response to a question about his cash on hand, petitioner stated that he

had $20 in his pocket but no other cash in his home. Later that morning, special

agents uncovered two fire safes. One fire safe had $3,000 in cash and the other

had $10,000. Petitioner stated that he had forgotten about the first fire safe and

that he had never seen the second fire safe. When SA Williams threatened to




      6
        Al Capone was convicted of tax evasion. See United States v. Ytem, 255
F.3d 394, 397 (7th Cir. 2001).
                                        - 13 -

[*13] question Mrs. Mathews about the second fire safe, petitioner admitted that

the $10,000 in the second safe was his.7

      SA Williams asked petitioner about his online multilevel marketing

business. Petitioner stated that he operated several programs under Mathews

Multi-Service including WTIA, $20 Miracle, Fortune 5 Minutes, the Glad Club,

and It’s No Miracle. Petitioner explained that Mathews Multi-Service was the

beneficiary of the Centurion Trust in Belize. He admitted that Mathews Multi-

Service received funds through Paypal, E-Gold, Internet Gold, SafePay Solutions,

and Storm Pay. Additionally, petitioner acknowledged that he had not reported

income from WTIA on returns for at least 17 years but contended that the gross

receipts from the Multi-Service programs were not his income. At another point

in the interview, petitioner stated he did not know how to report income from the

Multi-Service programs. When the civil examination came up, petitioner stated

that RA Crawford had determined that his unreported income for all of the years

under examination totaled $9,000. Petitioner also stated that RA Crawford had

not yet taken deductions into consideration.




      7
        It appears from the record that petitioner was fearful that the special
agents would seize the cash. The special agents photographed the cash but
allowed petitioner to keep it.
                                         - 14 -

[*14] Responding to a question about the status of his 2008 Federal income tax

return, petitioner stated that he had filed a request for an extension of time to file

because he “didn’t know what to do for his 2008 taxes”.

2008 Return

      Petitioner prepared his 2008 return and filed it on October 15, 2009.

Petitioner and Mrs. Mathews again filed separate returns. Petitioner’s return

included a Schedule C for “Mathews Multi-Service” with a principal business of

“internet advertising”. The 2008 Schedule C reported gross receipts of $10,000

and no expenses. The $10,000 petitioner declared as income pertained to a Form

1099 he had received from I-Net Enterprises, which was neither owned by

petitioner nor affiliated with Mathews Multi-Service. Thus, petitioner did not

report any income from the Multi-Service programs on his 2008 Schedule C.

      Petitioner attached to his 2008 return a typed statement, in which he wrote:

              I have prepared this 1040 to the best of my ability.

            In July of this year * * * [CID] took ALL my paperwork,
      financial statements, 1099s, receipts, credit card statements, bank
      statements, statements from charities, business expenses, receipts for
      business expenses and personal deductions, etc [sic], and even my tax
      preparation software disk! In other words, EVERYTHING I would
      need in order to file income taxes for the year 2008, leaving me with
      nothing!

      *           *          *          *          *          *           *
                                        - 15 -

[*15]         So, this is my very best effort to file this return from memory!

               I know for a fact that I have other deductions, both for home
        office expenses, personal deductions, charitable contributions, and
        much more, but I do not have access to the records * * * [CID] took
        from my home and flatly refuse to return!

               Therefore, I reserve the right to amend my returns, whenever
        the items are returned to me.

CID Additional Research and Bank Deposits Analysis

        After the execution of the search warrant, SA Williams summoned

petitioner’s bank records for 2004 through 2008. Using the bank records, SA

Williams performed a bank deposits analysis. SA Williams’ analysis included

only amounts received in petitioner’s bank accounts; her analysis did not include

amounts received in petitioner’s online payment system accounts. SA Williams

determined that petitioner had unreported gross receipts as follows:


                 Gross receipts per   Gross receipts as        Unreported gross
    Year           SA Williams           reported                  receipts

    2004             $67,359.67             $3,560                $63,799.67
    2005              39,179.32              3,318                 35,861.32
    2006              57,036.27                ---                 57,036.27
    2007              27,359.46              5,323                 22,036.46
    2008              54,365.70             10,000                 44,365.70

        In the course of her investigation, SA Williams suspected that petitioner

was starting to withdraw cash from a business checking account at Centennial
                                       - 16 -

[*16] Bank, account number ending 4175 (CB 4175 account), and deposit similar

amounts of cash into the FSB 6961 account. Petitioner and Mrs. Mathews paid

their living expenses out of the FSB 6961 account.

      SA Williams also obtained a car loan application, dated May 23, 2008,

signed by petitioner. Therein petitioner stated that he was employed by Mathews

Multi-Service as a “network consultant” and that his “Gross Monthly Salary” was

$3,600.

Criminal Prosecution

      At the conclusion of the investigation, SA Williams referred petitioner’s

case to the U.S. Department of Justice (DOJ) with a recommendation to prosecute

petitioner for tax evasion. The DOJ forwarded the case to the U.S. Attorney’s

Office in the Eastern District of Arkansas. On April 6, 2011, petitioner was

indicted for tax evasion under section 7201 and subscribing to a false return under

section 7206(1) for tax years 2004 through 2008.

      After the indictment was issued, a new prosecutor took over the case and

abandoned the tax evasion charges. In a superseding indictment, petitioner was

charged with subscribing to false income tax returns under section 7206(1) for
                                        - 17 -

[*17] 2004 through 2008.8 Petitioner was also charged with impeding

administration of the internal revenue laws under section 7212.

      After a jury trial, petitioner was convicted of all charges in the superseding

indictment and sentenced to a 27-month prison term. Petitioner appealed his

conviction to the U.S. Court of Appeals for the Eighth Circuit. The Court of

Appeals affirmed the District Court’s criminal judgment in a published opinion.

United States v. Mathews, 761 F.3d 891 (8th Cir. 2014).

Notices of Deficiency (2007 and 2008)

      RA Crawford was assigned to respondent’s civil examination of petitioner’s

2007 and 2008 tax returns. After obtaining petitioner’s bank statements and

account statements from the online payment systems, RA Crawford determined

that petitioner had gross receipts for 2007 as follows:




      8
         SA Williams testified that the new prosecutor believed the sec. 7206(1)
charges would make for a “cleaner case” than the sec. 7201 charges. As discussed
infra, sec. 7206(1) does not require the Government to prove that the defendant
intended to evade tax. See United States v. Tsanas, 572 F.2d 340, 343 (2d Cir.
1978); see also United States v. DiVarco, 484 F.2d 670, 673-674 (7th Cir. 1973);
Siravo v. United States, 377 F.2d 469, 472 n.4 (1st Cir. 1967); Wright v.
Commissioner, 84 T.C. 636, 643 (1985).
                                         - 18 -

[*18]               Account                                       Amount

                  Storm Pay, Inc.                              $3,780.98
                  FSB 6961 account                             79,155.12
                  SafePay Solutions                            15,700.00
                  E-Gold                                       43,989.00
                  CB 4175 account                               4,371.51
                   Total deposits                             146,996.61

              Transfer from Safepay
                                                          1
                Solutions                                     (15,700.00)
                                                              2
              Transfer from E-Gold                                (7,270.52)
                                                          3
              Nontaxable bank deposits                        (56,842.17)

                  Total gross receipts                        67,183.92

              1
                 After determining that petitioner’s Safepay Solutions deposits
        were transferred to petitioner’s bank accounts, RA Crawford debited
        this amount to avoid double-counting income.
               2
                 After determining that some of petitioner’s E-Gold deposits
        were transferred to petitioner’s bank accounts, RA Crawford debited
        this amount to avoid double-counting income.
               3
                 This amount is the sum of Mrs. Mathews’ deposited wage
        income and nontaxable deposits.

        On the basis of this analysis, RA Crawford determined that petitioner had

unreported gross receipts of $61,861, the difference between $67,184 and the

gross receipts reported on petitioner’s return. RA Crawford also identified a

number of outgoing transfers from petitioner’s accounts as potential business
                                       - 19 -

[*19] expenses. RA Crawford characterized these expenses as cost of goods sold

(COGS) and determined that, for 2007, petitioner had COGS of $36,827.

      For 2008 RA Crawford determined that petitioner had gross receipts as

follows:

                 Account                                   Amount

                E-Gold                                    $56,626.06
                CB 4175 account                            46,522.45
                 Total                                    103,148.51

      On the basis of this analysis, RA Crawford determined that petitioner had

unreported gross receipts of $93,149, the difference between $103,149 and the

gross receipts reported on petitioner’s return. As he did for 2007, RA Crawford

also identified a number of outgoing transfers from petitioner’s accounts as

potential business expenses. RA Crawford characterized these expenses as COGS

and determined that, for 2008, petitioner had COGS of $39,062.

      Respondent issued petitioner notices of deficiency for 2007 and 2008

reflecting these adjustments.9 Respondent determined that petitioner was liable for


      9
         It is unclear from the record why respondent did not concurrently issue
notices of deficiency for tax years 2004, 2005, and 2006. On February 24, 2015,
petitioner sought redetermination of alleged deficiencies for 2003, 2004, 2005,
and 2006. See Mathews v. Commissioner, T.C. Dkt. No. 6799-15 (Nov. 17,
2015). In a motion to dismiss for lack of jurisdiction, respondent’s counsel stated
                                                                       (continued...)
                                         - 20 -

[*20] fraud penalties for both years under section 6663. Respondent determined,

in the alternative, that petitioner was liable for section 6662(a) accuracy-related

penalties. Petitioner timely sought redetermination in this Court, and a trial was

held in Little Rock, Arkansas.

                                       OPINION

      While petitioner does not dispute respondent’s determinations that he had

unreported income for 2007 and 2008, he argues that the periods of limitation

have expired.10 Petitioner also disputes the applicability of the section 6663 fraud

penalties.

      Section 6501(a) provides, generally, that the amount of any tax must be

assessed within three years of the filing of a return. The notices of deficiency in

these cases were issued more than three years after the relevant returns were filed.

Therefore, the periods of limitation for the years in issue have expired and

assessment is barred unless an exception to the general limitation period applies.



      9
        (...continued)
that, as of June 19, 2015, no notices of deficiency for those years had been issued.
The Court granted respondent’s motion and dismissed the case for lack of
jurisdiction.
      10
          Petitioner raised the periods of limitation at the calendar call of the trial
session, and respondent did not object. Accordingly, we find that the issue was
tried by consent. See Rule 41(b).
                                         - 21 -

[*21] Respondent relies on the section 6501(c)(1) fraud exception.11 Under

section 6501(c)(1), if a taxpayer files “a false or fraudulent return with the intent

to evade tax, the tax may be assessed * * * at any time.”

      The Commissioner has the burden of proving exceptions to the general

limitation period. See, e.g., Harlan v. Commissioner, 116 T.C. 31, 39 (2001). To

satisfy his burden in these cases, respondent must show by clear and convincing

evidence that: (1) an underpayment exists for each year and (2) petitioner

intended to evade taxes known to be owing by conduct intended to conceal,

mislead, or otherwise prevent the collection of taxes. Sec. 7454(a); Rule 142(b);

Parks v. Commissioner, 94 T.C. 654, 660-661 (1990). This is the same as his

burden under section 6663 to prove applicability of the civil fraud penalty (which

is also at issue). See, e.g., Browning v. Commissioner, T.C. Memo. 2011-261,

2011 WL 5289636, at *10.

A.    Underpayment

      Petitioner conceded that he underreported income for 2007 and 2008. We

are satisfied that respondent has established by clear and convincing evidence an

underpayment of tax by petitioner for each of the years in issue.


      11
          At trial respondent conceded that no other exceptions to the general
limitation period apply for 2007 and 2008.
                                       - 22 -

[*22] B.    Fraudulent Intent

      The second prong of the fraud test requires the Commissioner to prove that,

for each year in issue, at least some portion of the taxpayer’s underpayment of tax

is due to fraud. See Parks v. Commissioner, 94 T.C. at 661; Butler v.

Commissioner, T.C. Memo. 2002-314, slip op. at 8, aff’d sub nom. McGraw v.

Commissioner, 384 F.3d 965 (8th Cir. 2004). Fraud for this purpose is defined as

intentional wrongdoing, with the specific purpose of avoiding a tax believed to be

owing. See, e.g., DiLeo v. Commissioner, 96 T.C. 858, 874 (1991), aff’d, 959

F.2d 16 (2d Cir. 1992). The Commissioner must therefore prove that the taxpayer

intended to evade tax believed to be owing by conduct intended to conceal,

mislead, or otherwise prevent the collection of tax. See, e.g., Browning v.

Commissioner, 2011 WL 5289636, at *13. Fraudulent intent must exist at the

time the taxpayer files the return. Gleis v. Commissioner, 24 T.C. 941, 952

(1955), aff’d, 245 F.2d 237 (6th Cir. 1957). The existence of fraud is a question of

fact to be resolved from the entire record. Gajewski v. Commissioner, 67 T.C.

181, 199 (1976), aff’d without published opinion, 578 F.2d 1383 (8th Cir. 1978).

Because direct proof of a taxpayer’s intent is rarely available, fraud may be proven

by circumstantial evidence and reasonable inferences may be drawn from the

relevant facts. Spies v. United States, 317 U.S. 492, 499 (1943); Stephenson v.
                                         - 23 -

[*23] Commissioner, 79 T.C. 995, 1006 (1982), aff’d, 748 F.2d 331 (6th Cir.

1984). A taxpayer’s entire course of conduct can be indicative of fraud. Stone v.

Commissioner, 56 T.C. 213, 223-224 (1971); Otsuki v. Commissioner, 53 T.C. 96,

105-106 (1969). The sophistication, education, and intelligence of the taxpayer

are relevant to determining fraudulent intent. See Niedringhaus v. Commissioner,

99 T.C. 202, 211 (1992); Stephenson v. Commissioner, 79 T.C. at 1006; Iley v.

Commissioner, 19 T.C. 631, 635 (1952).

      Over the years, 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 conduct, (8) lack of credibility of

the taxpayer’s testimony, (9) filing false documents, (10) failing to make estimated

tax payments, and (11) dealing in cash. See Spies v. Commissioner, 317 U.S. at

499; McGraw v. Commissioner, 384 F.3d at 971; Douge v. Commissioner, 899

F.2d 164, 168 (2d Cir. 1990); Bradford v. Commissioner, 796 F.2d 303, 307-308

(9th Cir. 1986), aff’g T.C. Memo. 1984-601; Recklitis v. Commissioner, 91 T.C.

874, 910 (1988). Although no single factor is necessarily sufficient to establish
                                         - 24 -

[*24] fraud, the combination of a number of factors constitutes persuasive

evidence. Solomon v. Commissioner, 732 F.2d 1459, 1461 (6th Cir. 1984), aff’g

per curiam T.C. Memo. 1982-603; Petzoldt v. Commissioner, 92 T.C. 661, 700

(1989).

      We find that respondent has failed to prove by clear and convincing

evidence that petitioner had the specific intent to evade tax believed to be owing

when he filed his 2007 and 2008 returns.

      Before proceeding with our analysis, we will comment on the credibility of

the parties’ witnesses. “As a trier of fact, it is our duty to listen to the testimony,

observe the demeanor of the witnesses, weigh the evidence, and determine what

we believe.” Kropp v. Commissioner, T.C. Memo. 2000-148, 2000 WL 472840,

at *3. In Diaz v. Commissioner, 58 T.C. 560, 564 (1972), we observed that the

process of distilling truth from the testimony of witnesses, whose demeanor we

observe and whose credibility we evaluate, is the daily grist of judicial life. These

statements regarding our role as a trier of fact are particularly apt here.

      Petitioner lied on numerous occasions to RA Crawford and SA Williams

during respondent’s civil examination and criminal investigation. However, we do

not believe he did so in this proceeding. Before trial, petitioner had served a

substantial prison sentence stemming in large part from his behavior during the
                                         - 25 -

[*25] audit and criminal investigation. We believe this experience impressed

upon petitioner the importance of telling the truth. At trial petitioner admitted to

making mistakes; he was respectful towards respondent and respondent’s

witnesses; and he was cooperative with the Court. His testimony was convincing

and withstood cross-examination. We will therefore credit, as specified below,

portions of petitioner’s testimony.

      RA Crawford and SA Williams also testified at trial. We found each of

them to be honest, forthright, and credible. However, we disagree with their

conclusions about petitioner’s fraudulent intent.

      Petitioner is not a sophisticated taxpayer or financially astute. He dropped

out of high school after the 10th grade and has no training or experience in

bookkeeping, taxation, or accounting. At trial he appeared confused about the

nature of his tax liabilities and, at one point, credibly testified: “[I]t’s over my

head.”

      Given petitioner’s lack of sophistication, we question whether he knew

there was a “tax owing” from the Multi-Service programs when he prepared his

2007 and 2008 returns. Petitioner consistently maintained throughout trial that he

“didn’t know” how to report income from the Multi-Service programs. This

testimony is consistent with his statements to SA Williams during the July 2009
                                        - 26 -

[*26] interview. Petitioner’s testimony also accords with the general confusion

petitioner expressed in the typed statement he attached to his 2008 return.

      From the record, it appears that the source of petitioner’s confusion was his

belief that 90% of the funds he received through the Multi-Service programs

belonged to the member-recruiters. Petitioner testified to this belief at trial, and

SA Williams confirmed that the Multi-Service programs required payouts to its

members.12 The record also reflects that petitioner believed he had deductible

expenses with respect to the Multi-Service programs.

      Notes taken by RA Crawford and SA Williams during their respective

investigations corroborate petitioner’s confusion about the taxability of the Multi-

Service program income. In an activity log dated August 21, 2008, RA Crawford

described a voice message from petitioner in which petitioner asked whether “the

2005 year amount in dispute was down to zero”. In a memorandum recounting the

July 2009 interview, SA Williams noted petitioner’s statement that, for all years

under examination at the time (2004 through 2006), his total unreported income




      12
          SA Williams testified: “Wealth Team International Association [WTIA],
I believe, was maybe a $99 fee, one-time fee for one entry, and then once you
* * * recruit others to join and you help them recruit, based on your level in the
program, you would get payouts for * * * your efforts.”
                                       - 27 -

[*27] was no more than $9,000 before taking deductions into consideration.13 SA

Williams also recounted petitioner’s statement that he “didn’t know what to do for

his 2008 taxes”.

      It is respondent’s burden to prove that petitioner underreported gross

receipts on his 2007 and 2008 returns with the specific purpose of avoiding a tax

“known to be owing”. See DiLeo v. Commissioner, 96 T.C. at 874. Because

petitioner has demonstrated genuine confusion about the calculation of his tax

liabilities, respondent must negate the possibility that the underreporting was

attributable to a misunderstanding. See Cheek v. United States, 498 U.S. 192, 202

(1991); Niedringhaus v. Commissioner, 99 T.C. at 216-217; McCulley v.

Commissioner, T.C. Memo. 1997-285. The misunderstanding need not be

objectively reasonable, though reasonableness may be relevant for purposes of

assessing the credibility of the claim. See Cheek, 498 U.S. at 202-204;

Niedringhaus v. Commissioner, 99 T.C. at 216-217.

      In these cases, the misunderstanding was petitioner’s belief that his gross

receipts from the Multi-Service programs did not generate tax liabilities because

90% was owed to other members and because he had other deductible expenses.


      13
         SA Williams later determined that petitioner’s unreported gross receipts
for 2004, 2005, and 2006 totaled $156,697.26.
                                       - 28 -

[*28] Having observed petitioner at trial, we find petitioner’s misunderstanding

credible in the light of his background and sophistication level. After a thorough

review of the record, we also find that petitioner’s misunderstanding was not

corrected before he filed his 2007 and 2008 returns.14

      To be sure, this is a close case. As the Court of Appeals for the Eighth

Circuit observed in its opinion affirming petitioner’s convictions under sections

7206(1) and 7212, petitioner’s “reported gross receipts were a small fraction of the

receipts deposited into his bank account.” Mathews, 761 F.3d at 894.

Furthermore:

             Mathews [petitioner] repeatedly lied to IRS agents during the
      audit. He failed to disclose one of his bank accounts and denied
      receiving compensation from one of his businesses. During the
      search of his home, he lied about the presence of $13,000 in cash. He
      was misleading and evasive about his business operations,
      continually changing key details about his role and the flow of funds.
      He claimed money from one of his businesses was actually income
      from a trust in Belize. * * * [Id. at 894-895.]


      14
         At trial respondent introduced a March 2008 car loan application in
which petitioner reported a monthly “Gross Salary” of $3,600 as evidence that
petitioner knew his income from Mathews Multi-Service was taxable. However, it
is unclear from the record what “Gross Salary” means in this context, as neither
party contends petitioner was a salaried employee of Mathews Multi-Service.
Given this gap in the record, we decline to draw any inferences from this
document. Furthermore, if “Gross Salary” means “gross receipts”, this document
does not establish that petitioner knew he had positive net income from the Multi-
Service programs.
                                        - 29 -

[*29] In many cases, these facts might support an inference that petitioner filed

false and fraudulent returns with the intent to evade tax. See, e.g., Ruark v.

Commissioner, 449 F.2d 311 (9th Cir. 1971) (holding that gross understatement of

income, coupled with misstatements during audit, is a sufficient basis for a finding

of fraud), aff’g per curiam T.C. Memo. 1969-48; Fuller v. Commissioner, T.C.

Memo. 2007-62 (holding that understated income, overstated deductions, and

failure to cooperate with the Commissioner justify a finding of fraud); see also sec.

6501(c)(1). However, the existence of fraud is a question of fact to be resolved

from the entire record, Gajewski v. Commissioner, 67 T.C. at 199, and the

sophistication, education, and intelligence of the taxpayer are relevant to

determining fraudulent intent, see Niedringhaus v. Commissioner, 99 T.C. at 211;

Stephenson v. Commissioner, 79 T.C. at 1006; Iley v. Commissioner, 19 T.C. at

635. Moreover, conduct of the taxpayer, even though reprehensible, will not

justify a finding of fraud unless the fraudulent intent is shown to have existed

when the return was made. Holmes v. Commissioner, T.C. Memo. 2012-251, at

*37, aff’d, 593 F. App’x 693 (9th Cir. 2015); Barrier v. Commissioner, T.C.

Memo. 1983-258; Semple v. Commissioner, a Memorandum Opinion of this Court

dated Aug. 28, 1951, 1951 Tax Ct. Memo LEXIS 124, at *18.
                                       - 30 -

[*30] In these cases, the record establishes that petitioner was an unsophisticated

taxpayer with little, if any, financial acumen. While petitioner behaved

reprehensibly during respondent’s civil examination and criminal investigation

(which, for the most part, pertained to tax years not in issue), we believe he was

genuinely confused about the taxability of the Multi-Service program income

when he filed his 2007 and 2008 returns. See Cheek, 498 U.S. at 202-204.

Accordingly, his misconduct during respondent’s civil examination and criminal

investigation does not establish that his 2007 and 2008 returns were fraudulent.

      With respect to petitioner’s criminal case, a section 7206(1) conviction does

not collaterally estop a taxpayer from denying that his returns were fraudulent.

Wright v. Commissioner, 84 T.C. 636 (1985); Wheadon v. Commissioner, T.C.

Memo. 1992-633; Cox v. Commissioner, T.C. Memo. 1985-324. Under section

7206(1) it is a crime to willfully make and submit any return verified by a written

declaration that is made under penalties of perjury which the taxpayer does not

believe to be true and correct as to every material matter. The intent to evade

taxes is not an element of the crime charged under section 7206(1), which

“penalizes the filing of a false return even though the falsity would not produce

tax consequences.” United States v. Tsanas, 572 F.2d 340, 343 (2d Cir. 1978); see

also United States v. DiVarco, 484 F.2d 670, 673-674 (7th Cir. 1973); Siravo v.
                                         - 31 -

[*31] United States, 377 F.2d 469, 472 n.4 (1st Cir. 1967); Wright v.

Commissioner, 84 T.C. at 643. Thus, although petitioner’s conviction under

section 7206(1) may be evidence of fraudulent intent, it does not establish as a

matter of law that he intended to evade taxes. See Wright v. Commissioner, 84

T.C. at 643.

      Having considered all of the facts and circumstances of these consolidated

cases, we find that respondent failed to prove by clear and convincing evidence

that petitioner filed false and fraudulent returns with the intent to evade tax for

2007 and 2008. We now address whether we will relieve petitioner of four

stipulated paragraphs that say otherwise.

C.    Stipulated Paragraphs 63, 64, 65, and 66

      Before trial and pursuant to Rule 91(f), we deemed stipulated, inter alia,

paragraphs 63, 64, 65, and 66 after petitioner did not respond to our order to show

cause why proposed facts and evidence should not be accepted as established.

Paragraph 63 states that petitioner “fraudulently and with intent to evade tax,

omitted income from his 2007 and 2008 income tax returns”. Paragraph 64 states

that the deficiencies in these cases “are due to petitioner’s fraudulent intent to

evade tax.” Paragraphs 65 and 66 state that, for 2007 and 2008, petitioner is liable
                                        - 32 -

[*32] for deficiencies of $6,556 and $16,405, respectively, and for section 6663

penalties of $4,917 and $12,303.75, respectively.15

      Generally, the Court “will not permit a party to a stipulation to qualify,

change, or contradict a stipulation in whole or in part, except * * * where justice

requires”, Rule 91(e), or “good cause is shown”, Saigh v. Commissioner, 26 T.C.

171, 176 (1956); see also Bail Bonds by Marvin Nelson, Inc. v. Commissioner,

820 F.2d 1543, 1547 (9th Cir. 1987) (stipulations should be enforced “unless

manifest injustice would result”), aff’g T.C. Memo. 1986-23. In deciding whether

to allow a party to set aside or modify a stipulation, we look at factors such as

inconvenience to the Court and possible injustice to the moving party if the

stipulation were enforced. Dorchester Indus. Inc. v. Commissioner, 108 T.C. 320,

334-335 (1997) (citing Adams v. Commissioner, 85 T.C. 359 , 375 (1985)), aff’d

without published opinion, 208 F.3d 205 (3d Cir. 2000).




      15
           At the calendar call respondent’s counsel stated that the deemed
stipulation of facts “establishes both the deficiency and the civil fraud penalty in
the case.” However, respondent’s counsel also stated that respondent was
prepared to try the case if the Court was not willing to determine deficiencies and
civil fraud penalties on the basis of the stipulation. The Court informed the parties
that a trial would be necessary, and a full-day trial commenced later that week.
                                        - 33 -

[*33] In the cases at bar, stipulated paragraphs 63 through 66 are legal

conclusions and/or statements of ultimate fact16 which we have found to be

contrary to the record. If we enforced the deemed stipulated paragraphs against

petitioner, we would effectively preclude him from contesting respondent’s

determinations. Because we doubt that petitioner filed false and fraudulent returns

with the intent to evade tax for the years in issue, this result would be manifestly

unjust. Accordingly, we will relieve petitioner of stipulated paragraphs 63, 64, 65,

and 66.

D.    Conclusion

      Having failed to establish by clear and convincing evidence that petitioner

filed false and fraudulent returns with the intent to evade tax for 2007 and 2008,

respondent is barred by the section 6501(a) limitations period from assessing

deficiencies and alternative section 6662(a) accuracy-related penalties against

petitioner for those years.17 In reaching our decision, we have considered all




      16
        An ultimate fact generally refers to “a factual conclusion derived from
intermediate facts.” See Black’s Law Dictionary 711 (10th ed. 2014).
      17
         After trial, respondent filed a motion to reopen the record to introduce
evidence of compliance with the written supervisory approval requirement under
sec. 6751(b). We will deny respondent’s motion as moot.
                                       - 34 -

[*34] arguments made by the parties, and to the extent not mentioned or

addressed, they are irrelevant, moot or without merit.

      To reflect the foregoing,


                                                An appropriate order will be

                                       issued, and decisions will be entered for

                                       petitioner.
