On September 10, 2020, the Tax Court issued a Memorandum Opinion in the case of Belanger v. Commissioner (T.C. Memo. 2020-130). The primary issues before the court in Belanger v. Commissioner were (1) whether the IRS timely mailed a notice of deficiency to the petitioner; (3) whether the petitioner had unreported income; and (3) whether the petitioner was liable for civil fraud penalties.
Background to Belanger v. Commissioner
The petitioner is French-Canadian, so he can’t be too bad a guy, eh.
He is not, however, the brightest bulb in the shed. He dropped out of high school in 10th grade, and though he went the trade school and founded a successful foundation…company, that is to say a company that laid foundations, his method of “accounting” left much to be desired.
The “Step Method” of Accounting
The petitioner did not use QuickBooks or other accounting software to maintain Number One Foundations’ books and records; instead, petitioner adopted the following recordkeeping system that involved using the stairs inside his house: (1) he placed job proposals on the first or bottom step; (2) once a job proposal was accepted by a customer, he placed the work order for the job on the next higher step; (3) once the job was completed and an invoice was sent requesting payment he placed the work order for that job on the next higher step; and (4) once payment was received he stamped the work order “PAID” and placed the order in a box.
Judge Ashford does not give us much detail on the nature of box, only that it played an integral part in the petitioner’s accounting system. When it was time to prepare his 1999 return, the petitioner’s girlfriend took “the box,” added up to 1999 payments, and then provided the total gross receipt figure the petitioner. When it came time to prepare his 2000 return petitioner had his chippy add up the payments to arrive at the company’s gross receipts for 2000.
Creative Payments
During the years at issue, the company’s customers routinely paid by check. These checks were made payable to the company, the petitioner, or the petitioner’s son and received by the petitioner at his home. The petitioner instructed his son weekly as to what to do with the checks. The son would either cash the customers’ checks and bring the cash back to the petitioner, negotiate the checks for treasurer’s checks payable to the petitioner or his son, or deposit a portion of the checks and receive the remainder in cash and/or treasurer’s checks. No single treasurer’s check was for an amount greater than $10,000. Some of the cash was siphoned to petitioner and his son, and some other cash was used to pay the company’s “undocumented laborers.” Consequently, no federal employment taxes were withheld and paid on these wages.
The Original CPA
The petitioner prepared and filed its federal income tax returns with the assistance of a self-employed CPA. The CPA didn’t have as advanced an accounting system as the petitioner, he did use handwritten ledgers that listed total income, deposits income, interest income, and personal deposits to prepare the returns. The petitioner failed to provide the CPA with any supporting documentation, such as Forms 1099, receipts, invoices, or bank statements, even though a number of the company’s customers issued Forms 1099 showing payments of at least $111,000. The petitioner’s son also provided the CPA with handwritten ledgers. Not to be outdone, the CPA prepared handwritten spreadsheets to help them prepare the returns. Neither the petitioner nor his son informed the CPA that they had negotiated customers’ checks for treasurer’s checks payable to the petitioner and/or his son during the years at issue. It must’ve just slipped their mind, because after all Caesar was an honorable man.
Although the company unincorporated, he and his son each attached to their respective returns for the years at issue Schedules C (Profit or Loss from Business) for the company. Additionally, the petitioner’s Schedules C for the company for the years at issue indicated an employer identification number (EIN) ending in 1742, while the son’s Schedules C for the company for the years at issue indicated an EIN ending in 7445.
Suspicion Arises
In November 2000, the bank contacted the petitioner to inform him that numerous treasurer’s checks payable to him needed to be reissued, because otherwise the bank would consider the checks abandoned property. The petitioner sent his girlfriend to the bank with the treasurer’s checks that needed to be reissued (21 checks totaling $121,000). The bank’s security officer filed a Suspicious Activity Report with FinCEN, and the petitioner was visited by a lovely IRS Special Agent, who performed an anti-money-laundering compliance check.
When asked why he did not deposit the treasurer’s checks into a bank account to earn interest, the petitioner explained that it was his choice to keep the money like you wanted, and if he wanted to buy something on a whim, he would have the funds to do so. When the petitioner was asked why he always withdrew less than $10,000, he replied simply “because he felt like it.” The Special Agents were, apparently, doubting Thomases, and, somehow, they convinced a grand jury to indict the petitioner and his son for filing false (read: intrepidly creative) tax returns.
The Witch Hunt
In 2009, a jury found petitioner not guilty of conspiracy, but guilty as sin of corruptly endeavoring to obstruct and impede the tax laws. Relegated to a footnote, the son was acquitted on both counts. That’s some home cooking, if I ever saw it. But I digress…
As part of the terms of petitioner’s probation, he was required to submit complete and accurate amended Federal income tax returns for the years at issue to the IRS. Petitioner hired a former IRS revenue agent, to assist in this regard. In preparing petitioner’s amended returns for the years at issue, former IRS revenue agent reviewed “most of the transcripts” from the criminal trial, the computations as reflected in the RARs prepared in connection with that trial, the stipulated summary of the company’s gross receipts, and the petitioner’s original returns years at issue.
New CPA, Same Shenanigans
Seemingly, the new CPA/former IRS revenue agent had all the tools at his disposal to prepare an appropriate tax return. However, the court tells us, the new CPA “ultimately prepared the petitioner’s amended returns for the years at issue using only the customers’ checks payable to the petitioner and to the petitioner and his company. Sometimes, you just can’t fix stupid.
IRS Administrative Proceedings
Shockingly, the IRS determined that the petitioner’s amended returns were inaccurate. The IRS also determined that IRC § 6663(a) civil fraud penalties should be imposed. Prior written supervisory approval was received pursuant to IRC § 6751(b)(1).
Statutory Period of Limitations to Assess Tax
IRC § 6213(a) generally requires the IRS to issue a notice of deficiency before assessing a deficiency in Federal income tax against a taxpayer. When a taxpayer has filed a return, IRC § 6501(a) generally requires the IRS to assess a deficiency in Federal income tax within three years after the return was filed. Hence, under these general rules, the IRS may issue a notice of deficiency to a taxpayer only within the same period. However, when a taxpayer’s underpayments are due to fraud, the IRS is free to determine a deficiency without regard to the three-year statute of limitations for assessment. Colestock v. Commissioner, 102 T.C. 380, 385 (1994); see also Kohan v. Commissioner, T.C. Memo. 2019-85
Unreported Business Income
IRC § 61(a) defines “gross income” as “all income from whatever source derived,” including gross income derived from business. IRC § 61(a)(2); Treas. Reg. § 1.61-3(a). A taxpayer is required to maintain books or records sufficient to establish the amount of his or her gross income required to be shown by such person on any return. IRC § 6001; Treas. Reg. § 1.6001-1.
It is well settled that if the books or records do not clearly reflect income, the IRS is then authorized “to reconstruct income in accordance with a method which clearly reflects the full amount of income received.” Petzoldt v. Commissioner, 92 T.C. 661, 687 (1989). The IRS’s reconstruction needs only to be reasonable under all the facts and circumstances. Id.
Civil Fraud Penalties
IRC § 6663(a) provides that if 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% of the portion of the underpayment which is attributable to fraud. The IRC § 6663(a) fraud penalty is a civil sanction provided primarily as a safeguard for the protection of the revenue and to reimburse the Government for the heavy expense of investigation and the loss resulting from the taxpayer’s fraud. Purvis v. Commissioner, T.C. Memo. 2020- 13, at *26 (citing Helvering v. Mitchell, 303 U.S. 391, 401 (1938), and Sadler v. Commissioner, 113 T.C. 99, 102 (1999)).
The IRS has the burden of proving fraud by clear and convincing evidence. See IRC § 7454(a); Rule 142(b). To do so, the IRS must prove for each relevant year that (1) an underpayment of tax exists and (2) the underpayment was due to fraud. See Sadler, 113 T.C. at 102; Katz v. Commissioner, 90 T.C. 1130, 1143 (1988).
When the allegations of fraud are intertwined with reconstructed unreported income, as they are here, the IRS can satisfy the former burden by either proving a likely source of the unreported income or (where the taxpayer alleges a nontaxable source) disproving the nontaxable source so alleged. Parks v. Commissioner, 94 T.C. 654, 661 (1990). The IRS can satisfy the latter burden if he shows that the taxpayer intended to conceal, mislead, or otherwise evade the collection of taxes known or believed to be owing. Katz v. Commissioner, 90 T.C. at 1143.
If the Commissioner establishes that any portion of the underpayment is attributable to fraud, the entire underpayment shall be treated as attributable to fraud and subject to a 75% penalty unless the taxpayer establishes by a preponderance of the evidence that some part of the underpayment is not attributable to fraud. IRC § 6663(b).
Clear and Convincing Evidence of Fraud
Fraud is defined as the intentional wrongdoing by the taxpayer motivated by a specific purpose of avoiding tax believed to be owing. Maciel v. Commissioner, 489 F.3d 1018, 1026 (9th Cir. 2007), aff’g in part, rev’g in part T.C. Memo. 2004-28; Neely v. Commissioner, 116 T.C. 79, 86 (2001). Fraud “does not include negligence, carelessness, misunderstanding or unintentional understatement of income” but does include any conduct designed to conceal, mislead, or otherwise prevent the collection of taxes. United States v. Pechenik, 236 F.2d 844, 846 (3d Cir. 1956); see Holland v. United States, 348 U.S. 121, 139 (1954); United States v. Murdock, 290 U.S. 389, 396 (1933); DiLeo v. Commissioner, 96 T.C. 858, 874 (1991).
(T.C. Memo. 2020-130) Belanger v. Commissioner
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