Opinion
Docket No. 54456.
1956-05-28
ABRAHAM GALANT AND MOLLY GALANT, HUSBAND AND WIFE, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Joseph L. Alioto, Esq., for the petitioners. Aaron S. Resnik, Esq., for the respondent.
Joseph L. Alioto, Esq., for the petitioners. Aaron S. Resnik, Esq., for the respondent.
1. Deficiencies determined by means of net worth method held approved except with respect to a portion of petitioners' claim respecting cash on hand. Michael Potson, 22 T.C. 912, affirmed sub nom. Bodoglau v. Commissioner, (C.A. 7) 230 F.2d 336.
2. Some part of deficiencies for each year held, on facts, due to fraud.
3. Petitioners' conviction after trial for fraudulent tax evasion for identical years held admissible as some evidence of the facts. Lillian Kilpatrick, 22 T.C. 446,affd. (C.A. 5) 227 F.2d 240, distinguished.
Respondent determined deficiencies in income tax and 50 per cent additions to tax under section 293(b), Internal Revenue Code of 1939, for the calendar years 1945 through 1949, as follows:
+-------------------------------+ ¦ ¦ ¦Addition ¦ +------+-------------+----------¦ ¦Year ¦Deficiency ¦to tax ¦ +------+-------------+----------¦ ¦1945 ¦$379.00 ¦$189.50 ¦ +------+-------------+----------¦ ¦1946 ¦1,850.55 ¦925.28 ¦ +------+-------------+----------¦ ¦1947 ¦9,940.16 ¦4,970.08 ¦ +------+-------------+----------¦ ¦1948 ¦3,835.28 ¦1,917.64 ¦ +------+-------------+----------¦ ¦1949 ¦3,859.04 ¦1,929.52 ¦ +-------------------------------+
The deficiencies were computed by the net worth method. Whether the income as reported was understated is the first issue. Also in issue is whether any part of each deficiency is due to fraud with intent to evade tax.
FINDINGS OF FACT.
Certain facts were stipulated orally at the trial and are hereby found.
Petitioners, hereafter referred to as Abraham and Molly, are residents of Los Gatos, California. They filed joint income tax returns for the years in controversy with the collector of internal revenue for the first district of California.
Abraham was born within the 3-mile limits on March 8, 1899, aboard a ship bringing his family from Europe. Until 1917, he lived with his family at Ansonia, Connecticut. His first employment was pumping gas at the age of 9. Prior to American entry into World War I, he worked for ‘American Brass and Copper’ where he became a foreman. He retained that job until he enlisted in the Army in 1918. He left military service after 9 months due to postwar reduction in military strength.
During the years in Ansonia, Abraham lost some money in a bank failure.
After returning from service, Abraham resided in New York City. Before he purchased his own taxicab on a time payment plan in 1920, he drove for Yellow Cab Company. He drove his own cab in Manhattan for more than 3 years. He worked long hours and earned as much as $200 a week.
In 1924 or 1925, Abraham took a job as a streetcar conductor in Brooklyn which he retained for more than a year. He held several other jobs including that of a messenger on Wall Street and one with Sears, Roebuck & Co. in Chicago before he migrated to California in 1927.
His family had preceded him from Ansonia to California. During the entire time following his return from military service, Abraham saved much of his earnings by sending postal money orders to his father.
Abraham's father brought the family to San Francisco, where he established a mattress-renovating factory at 24 Clara Street under the name ‘Galant Mattress Co.’ When Abraham came to California he went to work for his father in that business. He continued working there until after he married Molly in 1929.
Abraham's father had accumulated $12,000 of his son's savings during all the working years through 1929. Shortly after his marriage, Abraham requested and received the money in cash. His father handed him the money in bills of $5, $10, and $20 denominations bundled into a box. The transfer occurred on the corner of 16th and Mission Streets. Abraham counted the cash and immediately gave it to Molly.
Before their marriage, Molly Galant accumulated about $3,500 saved from her earnings. After the marriage, she took this money and the $12,000 entrusted to her by her husband and hid it in coffee cans, pots, and other places around the house.
Petitioners established their first home in a rented apartment. Soon after, they purchased a home on 17th Avenue for $7,200, paying $500 down, the remainder financed by two loans secured by deeds of trust. Petitioners lived in the basement while renting out the upper portion. At that time, Molly kept their accumulated cash under the sink in a small garbage pail, and in other places.
After his marriage, Abraham entered the mattress-renovating business for himself. To avoid confusion with his father's concern, he called his business ‘Molly's Comfort and Mattress Company.’ A certificate of fictitious name was filed sometime thereafter. He opened this business, at his father's suggestion, at 24 Clara Street, since the father was moving to larger quarters.
In 1935, Abraham leased, with an option to purchase, property on Mission Street at Lilac Alley in San Francisco consisting of a vacant shop and an upstairs apartment. He exercised the option the following year. Abraham paid $500 down and executed notes totaling $10,250 secured by a mortgage on the property. Later, he moved the mattress business to the Mission Street location. He deposited the daily receipts of the mattress business in a checking account in a bank at Hayes Street and Divisadero. Although Molly often helped, Abraham primarily conducted the mattress business.
In 1935, Abraham constructed a vault in a passageway to the lavatory at the rear of the Mission Street store. The vault consisted of a small garbage pail, less than 18 inches in diameter, cemented into a hole in the floor. Over the metal lid to the pail he placed a concrete disc with a hole for insertion of a one-half inch bolt to be used as a handle to open the container. Over the disc he placed a board and surmounted the entire assembly with a workbench. In this buried vault, petitioners placed the accumulated savings formerly kept around the house by Molly. Customers used the lavatory in question, the only one on the premises.
Equipment used in Abraham's mattress business included 2 rolled-edge machines, each costing $4,900; 2 trucks; 3 Union special sewing machines, costing about $90 each; tables for use with the sewing machines at a cost of $80; 3 pickers; motors; and other machinery. Total cost of the machinery and equipment was $12,000 to $13,000. Abraham purchased 1 rolled-edge machine on an installment basis, with payments to the Wells-Fargo Bank. He purchased machinery gradually as needed. He began the business with an original investment of about $150.
As early as 1935, Abraham wanted to leave the mattress business for health reasons. Due to short supplies and wartime priority regulations, he could not secure certain needed equipment, and finally decided to quit the business. From 1939 through 1942, he sold machinery piecemeal for cash. By late 1943 he had sold everything. He never reported the sales of machinery on his tax returns, nor had he ever taken depreciation deductions for the machinery. The total proceeds from the sales of machinery were approximately $8,500. Abraham deposited those proceeds in the pail buried in the Mission Street store.
During the gradual liquidation, Abraham kept only a very small inventory of mattress materials. He paid his bills promptly, but was not on a cash basis. He included the mattress business inventory, costing less than $150, in the inventory figures on the returns for 1940 and 1941, the remainder representing baby shop merchandise.
In 1939, petitioners purchased property at Mission and 26th Streets with $10,000 borrowed at 5 per cent. In 1943, they purchased other property at Mission and 25th Streets with $18,000 borrowed at 6 per cent.
Petitioners established a baby goods store in the building on Mission Street and Lilac Alley using the name ‘Molly's Baby Shop.’ Abraham built the fixtures for the store, and they purchased a secondhand cash register. Relying on the credit of the mattress business, they purchased a small stock of merchandise, which they augmented as the business progressed. Stock included Taylor-Tots, diapers, blankets, bottles, and infant clothing. Molly primarily ran the business, especially while the mattress business was still in operation. During those years, baby shop bills were paid with mattress business checks.
About 1939, Howard Galant, petitioners' son, began working around the baby shop. He started by sweeping floors after school at the age of 9. As he grew up and learned the business, he became a salesman and window dresser.
Early in 1942, his parents informed Howard, then 11 years old, of the buried garbage can. They took him to the rear of the store and uncovered the vault. After insisting on secrecy, Molly told him that the money, which covered the top of the pail, was to be used for his education and his future if anything should happen to them. She pointed out an unmarked envelope lying on the money and told Howard that if something were to happen to them, he was to take the envelope from the vault to his maternal grandfather, Sol Felser.
On December 7, 1941, petitioners took possession of their new home in Los Gatos, California, an all-year bungalow type with an attached garage. Thereafter, petitioners drove there every Saturday night after the store closed at 9 p.m. They returned to San Francisco early Monday morning, to get Howard to school on time.
One Wednesday, soon after moving in, Abraham loaded some tools and cement on his truck and drove to the Los Gatos home. He dug a hole in the garage floor toward the left end of the back wall, and buried a small garbage pail in the hole. He cemented the pail into the ground in a fashion similar to that in the Mission Street store, but used a somewhat smaller pail. Along the same wall he erected wood shelving. He attached a 4-inch board to the shelving supports perpendicular to the floor, and on that he laid the removable bottom shelf, leaving the buried can hidden but accessible.
Early in World War II, petitioners commenced a gradual transfer of the cache from the buried can in their Mission Street store to the one in their Los Gatos home. On the regular Saturday night trip to Los Gatos, Molly would carry some cash from the store vault in a large handbag. The transfer continued over a period of 2 or 3 months.
When petitioners showed Howard the ‘vault’ on Mission Street, they noticed that some bills were developing an odor suggestive of rotting. Petitioners had been accustomed to examining the money every 3 months. Molly replaced the more deteriorated bills, dollar for dollar, with fresher ones from the cash register, the rotting bills going into the register for deposit as receipts from the business. During these exchanges, either Abraham or Howard would unobtrusively stand guard at the door to warn Molly if anyone approached and to keep the customers occupied in the store. The money from the cache was kept separate from the receipts from the baby shop business except for these exchanges.
In 1944, petitioners sold their Los Gatos home and moved back over the Mission Street store. When they moved out, Abraham sealed up the buried garbage can with cement, after the money had been returned to the can in the store. From then until October 1955 petitioners did not enter that house or its garage.
During the years 1945 through 1949, petitioners maintained a total of 3 commercial and 6 savings accounts. Cash in banks totaled almost $25,000 in 1947, but none of the accounts ever contained materially more than $5,000, the amount insured by the Federal Deposit Insurance Corporation.
In 1947, petitioners began to construct another house in Los Gatos. Later, they began building a motel there. As the work progressed they used their hoarded cash as well as their bank accounts to pay construction bills. Some were paid in cash and others by check after depositing cash in the account. They obtained receipts for all payments. The construction was completed in 1949, by which time they had exhausted their hoard. In addition to a $55,000 mortgage loan, they found it necessary to use $4,000 belonging to Howard.
In 1950, they closed the baby shop and the premises were occupied by an auto parts dealer. Before vacating, Abraham sealed the can into the floor with cement.
Special agents Marshall and McGrath began investigating petitioners' tax liability on February 7, 1950. They interviewed petitioners on March 16, 1950, when they requested information as to petitioners' financial status. Molly supplied almost all the answers. Abraham was usually present, but left them from time to time to serve customers. He read the answers as recorded by Marshall. Petitioners denied having received any gifts. Molly claimed never to have kept any cash on hand except a $1,000 bill on hand at the end of 1944.
At that time, petitioners gave to the special agents, for their investigation, a disbursement record showing invoices paid, the dates paid, and discounts taken. They also produced a composition book showing daily cash receipts, and a number of canceled checks and bank statements.
On comparing, Marshall found that the receipts in the salesbook and the receipts recorded on the returns did not coincide. The expenses deducted on the returns exceeded the receipts in the salesbook. About July 10, 1950, the disbursement record was compared with the expenses listed on the returns. Some items were identical, and there were only minor discrepancies on the others. No Internal Revenue employee made any notations of the contents of the salesbook after Marshall discovered the book did not reconcile with the returns.
On March 21, 1950, Marshall and McGrath met with Molly at the motel. On September 6, 1950, Marshall met with Molly who again denied ever having had any cash on hand except the $1,000 bill for medical expenses. She denied that Abraham ever had any cash. On September 19, 1950, Marshall and agent Tyrell conferred with Molly. Abraham was present during portions of the conversation. The agents requested additional records due to inability to reconcile those they already had. They received more bank statements and canceled checks.
Tyrell began his examination of petitioners' returns for 1945 through 1949 during 1950. He met with petitioners approximately 30 times at their motel in Los Gatos, at which times Molly was present, but Abraham rarely attended. Tyrell explained that the net worth method was being used and that cash was an asset to be considered. She persisted in her claim that she had had just one $1,000 bill, which is reflected on the net worth statement on which respondent's determination is based. Molly said her only source of funds was baby shop earnings and that the daily receipts were regularly deposited. An inventory of her safe-deposit box was made, and Molly claimed she never had any cash there in prior years.
Tyrell attempted the use of three methods of reconstruction of income. He was unable to reconcile the records given to him by petitioners with the bank deposits. He received certain adding machine or cash register tapes, but made no attempt to reconcile them with either the salesbook or the returns. Petitioners turned over to him a large number of invoices. He segregated them as to their relation to the baby business, the motel, personal expenses, and other categories. The expenditures claimed on the returns were supported by the canceled checks. Molly made the purchases claimed on the returns.
From his investigation, Tyrell developed the following net worth computation:
+----------------------------------------------------------------------------------+ ¦NET WORTH STATEMENT ¦ +----------------------------------------------------------------------------------¦ ¦ ¦1944 ¦1945 ¦1946 ¦1947 ¦1948 ¦1949 ¦ +--------------+----------+----------+----------+----------+-----------+-----------¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ +--------------+----------+----------+----------+----------+-----------+-----------¦ ¦Assets: ¦ ¦ ¦ ¦ ¦ ¦ ¦ +--------------+----------+----------+----------+----------+-----------+-----------¦ ¦Cash on hand ¦$1,000.00 ¦ ¦ ¦ ¦ ¦$905.63 ¦ +--------------+----------+----------+----------+----------+-----------+-----------¦ ¦Cash in banks ¦22,239.78 ¦$21,379.72¦$25,121.84¦$24,524.26¦$5,434.83 ¦1,501.45 ¦ +--------------+----------+----------+----------+----------+-----------+-----------¦ ¦Inventories ¦3,222.00 ¦3,809.45 ¦7,600.00 ¦13,858.50 ¦10,500.00 ¦16,685.00 ¦ +--------------+----------+----------+----------+----------+-----------+-----------¦ ¦Land ¦23,195.00 ¦22,069.00 ¦22,069.00 ¦22,069.00 ¦22,069.00 ¦22,744.86 ¦ +--------------+----------+----------+----------+----------+-----------+-----------¦ ¦Improvements, ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦furniture and ¦17,554.19 ¦8,073.05 ¦8,176.19 ¦26,530.20 ¦71,240.26 ¦140,968.97 ¦ ¦fixtures ¦ ¦ ¦ ¦ ¦ ¦ ¦ +--------------+----------+----------+----------+----------+-----------+-----------¦ ¦Total assets ¦$67,210.97¦$55,331.22¦$62,967.03¦$86,981.96¦$109,244.09¦$182,805.91¦ +--------------+----------+----------+----------+----------+-----------+-----------¦ ¦Liabilities: ¦ ¦ ¦ ¦ ¦ ¦ ¦ +--------------+----------+----------+----------+----------+-----------+-----------¦ ¦Accounts ¦$10,412.44¦ ¦ ¦ ¦$4,000.00 ¦$4,000.00 ¦ ¦payable ¦ ¦ ¦ ¦ ¦ ¦ ¦ +--------------+----------+----------+----------+----------+-----------+-----------¦ ¦Mortgage ¦5,000.00 ¦ ¦ ¦ ¦ ¦55,000.00 ¦ ¦payable ¦ ¦ ¦ ¦ ¦ ¦ ¦ +--------------+----------+----------+----------+----------+-----------+-----------¦ ¦Building ¦ ¦ ¦ ¦ ¦ ¦2,572.58 ¦ ¦contract ¦ ¦ ¦ ¦ ¦ ¦ ¦ +--------------+----------+----------+----------+----------+-----------+-----------¦ ¦Total ¦$15,412.44¦ ¦ ¦ ¦$4,000.00 ¦$61,572.58 ¦ ¦liabilities ¦ ¦ ¦ ¦ ¦ ¦ ¦ +--------------+----------+----------+----------+----------+-----------+-----------¦ ¦Net worth ¦$51,798.53¦$55,331.22¦$62,967.03¦$86,981.96¦$105,244.09¦$121,233.33¦ +--------------+----------+----------+----------+----------+-----------+-----------¦ ¦ ¦ ¦51,798.53 ¦55,331.22 ¦62,967.03 ¦86,981.96 ¦105,244.09 ¦ +--------------+----------+----------+----------+----------+-----------+-----------¦ ¦Increase in ¦ ¦$3,532.69 ¦$7,635.81 ¦$24,014.93¦$18,262.13 ¦$15,989.24 ¦ ¦net worth ¦ ¦ ¦ ¦ ¦ ¦ ¦ +--------------+----------+----------+----------+----------+-----------+-----------¦ ¦Living expense¦ ¦2,000.00 ¦2,000.00 ¦2,400.00 ¦2,400.00 ¦2,400.00 ¦ ¦allowance ¦ ¦ ¦ ¦ ¦ ¦ ¦ +--------------+----------+----------+----------+----------+-----------+-----------¦ ¦Life insurance¦ ¦1,207.98 ¦1,207.98 ¦1,312.85 ¦1,312.85 ¦1,312.85 ¦ ¦premiums ¦ ¦ ¦ ¦ ¦ ¦ ¦ +--------------+----------+----------+----------+----------+-----------+-----------¦ ¦Total income ¦ ¦$6,740.67 ¦$10,843.79¦$27,727.78¦$21,974.98 ¦$19,702.09 ¦ +--------------+----------+----------+----------+----------+-----------+-----------¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ +--------------+----------+----------+----------+----------+-----------+-----------¦ ¦Income ¦ ¦(708.85) ¦ ¦ ¦ ¦ ¦ ¦reported ¦ ¦ ¦ ¦ ¦ ¦ ¦ +--------------+----------+----------+----------+----------+-----------+-----------¦ ¦Long-term ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦capital gain ¦ ¦1,994.80 ¦ ¦ ¦ ¦ ¦ ¦exclusions ¦ ¦ ¦ ¦ ¦ ¦ ¦ +--------------+----------+----------+----------+----------+-----------+-----------¦ ¦Reported ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦income as ¦ ¦$1,285.95 ¦3,313.18 ¦3,437.60 ¦6,006.03 ¦(5,473.94) ¦ ¦adjusted ¦ ¦ ¦ ¦ ¦ ¦ ¦ +--------------+----------+----------+----------+----------+-----------+-----------¦ ¦Unreported ¦ ¦$5,454.72 ¦$7,530.61 ¦$24,290.18¦$15,968.95 ¦$25,176.03 ¦ ¦income ¦ ¦ ¦ ¦ ¦ ¦ ¦ +--------------+----------+----------+----------+----------+-----------+-----------¦ ¦Gross capital ¦ ¦2,636.06 ¦ ¦ ¦ ¦ ¦ ¦gain increase ¦ ¦ ¦ ¦ ¦ ¦ ¦ +--------------+----------+----------+----------+----------+-----------+-----------¦ ¦Net adjustment¦ ¦$2,818.66 ¦ ¦ ¦ ¦ ¦ +--------------+----------+----------+----------+----------+-----------+-----------¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ +----------------------------------------------------------------------------------+ The parties have stipulated that the entire statement is correct except for cash on hand at the end of 1944, and the resulting figure for net worth as of that date, which are in dispute.
On March 11, 1952, Marshall and Tyrell spoke to Molly at the motel. Tyrell had almost completed his net worth statement, which they showed her. They arranged for a meeting at the Internal Revenue office the following Tuesday.
On March 17, 1952, petitioners met Marshall at the Bureau of Internal Revenue office. Marshall showed or told petitioners the amounts on Tyrell's net worth statement for the years 1944 through 1949. Molly agreed to some items and objected to others. They went over in detail the items to which she objected. Although Abraham was present, the conversation was primarily with Molly.
On April 8, 1952, Marshall handed them a statement of ‘Assets and Liabilities.’ This document was identical to the preliminary net worth statement discussed on the preceding March 17, except for the elimination of two small payments. Petitioners went over the items in a general way and signed the statement. The following paragraph, worded by Marshall, appeared just above the signatures:
We have carefully examined the above schedule which lists our assets and liabilities as of the close of each of the years 1944 to 1949 inclusive. The amounts of these assets and liabilities and the dates acquired are correct. We did not have any assets or liabilities during these years which are not listed on this schedule. We have also examined the schedules which show in detail how the cost was determined of the various items listed on the schedule. These assets were acquired solely with funds derived from Molly's Baby Shop, 2955 Mission Street, San Francisco and 45 Main Street, Los Gatos, and from rental receipts, and from the sale of property. During these years we did not receive any bequests or gifts other than personal gifts of nominal value.
On June 5, 1952, in response to a letter from the Acting Regional Counsel, Internal Revenue Service, a meeting was held with attorneys Maxwell and Hall of the Penal Division of the Office of Regional Counsel. Petitioners were informed of their constitutional rights and advised to secure an attorney. They decided to forego counsel to save the expense, since, as they stated, the examining agents had done a thorough and honest job.
On petitioners' request they again discussed the net worth statement in detail, with special emphasis on the item cash on hand. Molly insisted she had none at any time, that they invested any cash immediately. She blamed errors in her returns on poor bookkeeping. She was told, in response to her inquiry, that the only compromise available was full payment of the civil liability and a plea of guilty to at least one major count in any proposed indictment. Molly related the story of their difficulties with her brother, and their desire to avoid trials. She said her husband was innocent of any wrongdoing.
During a part of 1949 and 1950, Molly employed Samuel Felser, her brother, as manager of the baby shop on a commission basis. For the month of December 1949, Samuel recorded on an adding machine tape the sales by days totaling $6,239.77. While there employed he recorded sales in a book, as well as on a tape. After a dispute over the amount of gross sales for that month, he sued Molly in Superior Court of San Francisco for the commissions allegedly due him.
Samuel's attorneys retained an accountant to prepare financial statements to be used in that suit. The accountant prepared a schedule of monthly sales for 1945, 1948, 1949, and part of 1950, from various records of the baby shop consisting of tapes, sales slips, and a book showing gross sales, all of which the Court had ordered turned over to the accountant. He received no formal accounting records and no records of any kind for 1946 and 1947. The schedule prepared by him showed total annual sales of $31,664.40 for 1945, $46,863.53 for 1948, $32,590,73 for 1949, and $7,144.30 for the first 4 months of 1950.
For the month of December 1949, the accountant prepared, from the records he had received and from the tape belonging to Samuel, a schedule showing comparative daily sales. That schedule shows a monthly total ‘Per Tapes on Sales' of $2,701.55, total ‘Per ‘Composition’ Book' of $2,806.96, and of $6,239.77 ‘Per Tape of Sam Felser.’ In determining the amounts appearing under the heading ‘Per Tapes on Sales,‘ he found no records showing sales made by Samuel.
Molly's father, Sol Felser, had been a tailor from the age of 9 until his death in 1950. After having lost some money in a bank failure in 1929, neither Sol nor his wife used the banks. In 1933, he traveled in the course of his employment. At that time, Molly and Minnie, an older sister, were married, Hanna, another sister, lived with her parents, and the younger brothers and sisters were residing in Homewood Terrace, a children's home. During World War II, Sol worked in Washington, D.C. Being an able workman, he was steadily employed during the years his children were at Homewood Terrace.
The Internal Revenue Service has no record of a gift tax return having been filed for Sol from 1932 through 1949. It has no record of a donee's information return filed by Molly during those years reporting gifts received from Sol.
Sol died in 1950 in Escondido, California. Each of the 8 equal shares distributed to his children in 1954 from his estate amounted to $403.
Internal Revenue records in New York do not disclose any income tax returns having been filed for or by Abraham for any year. Records in San Francisco reveal that petitioners filed no returns for 1930 and 1931, and that they filed returns for the years 1932 through 1939 showing no tax due.
Joint income tax returns filed by petitioners show taxable income and tax due, as follows:
+------------------------------+ ¦Year ¦Net income ¦Tax due ¦ +------+-------------+---------¦ ¦1940 ¦$2,997.75 ¦$13.11 ¦ +------+-------------+---------¦ ¦1941 ¦3,072.48 ¦104.96 ¦ +------+-------------+---------¦ ¦1942 ¦1,128.62 ¦ ¦ +------+-------------+---------¦ ¦1943 ¦3,678.07 ¦36.46 ¦ +------+-------------+---------¦ ¦1944 ¦3,846.56 ¦398.15 ¦ +------+-------------+---------¦ ¦1945 ¦(1 ) ¦ ¦ +------+-------------+---------¦ ¦1946 ¦3,313.18 ¦284.00 ¦ +------+-------------+---------¦ ¦1947 ¦3,437.60 ¦397.00 ¦ +------+-------------+---------¦ ¦1948 ¦6,006.03 ¦703.80 ¦ +------+-------------+---------¦ ¦1949 ¦(1 ) ¦ ¦ +------+-------------+---------¦ ¦ ¦ ¦ ¦ +------------------------------+ On the 1945 return, petitioners reported sales of $33,367.91, on the 1948 return, sales of $56,863.53, and for 1949, sales of $36,461.07.
The returns for 1945 through 1949 were prepared by Melba Reith, a registered public accountant, from information submitted by Molly on an adding machine tape. The accountant saw no books or records that may have been kept. She signed each return for 1946 through 1949 as the person preparing the return.
On two or three occasions, she advised petitioners to employ a full-time bookkeeper or a part-time accountant to ensure proper records for internal revenue purposes. Agent Heuring, who had audited petitioners' 1939 and 1940 returns, after finding understatements of income of about $3,500 for each year, went over their records and explained how they should have been kept for income tax purposes.
Petitioners were each indicted on four counts for violation of section 145(b), Internal Revenue Code of 1939, each count representing one of the years from 1946 through 1949. Both pleaded not guilty. During the course of that trial, no evidence for the defense except from character witnesses was presented. After trial, the District Court, Northern District of California, Southern Division, convicted Molly on all counts and sentenced her to pay a fine of $7,500 for each, fines to run concurrently. Abraham was acquitted on all counts.
As of December 31, 1944, petitioners had cash on hand in excess of that allowed on respondent's net worth statement in the amount of $24,000. That cash hoard was used for paying bills incurred in construction of the motel, beginning in 1947.
Petitioners understated their income, as follows:
+------------------------+ ¦Year ¦Understatement ¦ +------+-----------------¦ ¦1945 ¦$2,818.66 ¦ +------+-----------------¦ ¦1946 ¦7,530.61 ¦ +------+-----------------¦ ¦1947 ¦15,386.18 ¦ +------+-----------------¦ ¦1948 ¦10,112.95 ¦ +------+-----------------¦ ¦1949 ¦15,936.03 ¦ +------------------------+
Part of each deficiency is due to fraud with intent to evade tax.
OPINION.
OPPER, Judge:
Respondent was not prevented from resorting to the net worth computation of petitioners' income by reason of the maintenance of some books and records by petitioners. ‘ * * * if properly applied, the net worth method merely evidences income apparently received. Estate of W. D. Bartlett, 22 T.C. 1228. Nor is its use banned simply because a taxpayer maintains a set of books from which an income can be computed.’ Harry Gleis, 24 T.C. 941, 949.
Except in one respect petitioners have entirely failed to sustain their burden of disproving the deficiency. Their admission of the correctness of all other items on the net worth statement leaves only the existence and amount of cash in dispute. Between their claim to the possession of about $42,000 in cash and respondent's determination of $1,000, we have found the fact to be that they had at the beginning of the period in dispute the amount of $24,000. This is neither as large as petitioners claim nor as little as respondent allowed. See Michael Potson, 22 T.C. 912, affirmed sub nom. Bodoglau v. Commissioner, (C.A. 7) 230 F.2d 336. Although perhaps leaning in petitioners' favor, this is the largest amount of cash as to the existence of which we can ascertain even moderately reliable evidence. Molly's conviction of a felony combined with the other circumstances leads us to place no reliance upon her unsupported testimony. See Lillian Kilpatrick, 22 T.C. 446, affd. (C.A. 5) 227 F.2d 240. Those items, however, as to which Abraham claimed to have firsthand knowledge, we have accepted with some doubts.
According to the petitioners' own account, all of their cash was used during the years 1947 through 1949. There being no evidence as to the precise amounts expended in each year, we have redetermined the amount of cash on hand during each of those years and the consequent increase in net worth as best we can from the evidence on hand. Cohan v. Commissioner, (C.A. 2) 39 F.2d 540. The results appear in our Findings of Fact. Except to this extent, respondent's determination is approved.
With respect to the issue of fraud, there are two sets of admissions that militate heavily against petitioners. The first is that all items on the net worth statement prepared by the revenue agent, as detailed in our findings, were stipulated by petitioners as correct except for the item of cash on hand. With this must be coupled their testimony that no part of that cash found its way into other assets until in 1947 they began paying for the construction of their motel. The consequence is admitted understatements of income for the year 1945 of almost $3,000, and for the year 1946 of more than $7,500. No explanation whatever appears in petitioners' testimony at the hearing as attempting to justify this admitted failure to report income. And although the amounts may not seem of immense size, they bulk in large proportion to the reported income which showed a loss in 1945 and only $3,313.18 in 1946.
The other admission is that even on petitioners' own story, the largest amount of cash on hand claimed was about $42,000. For the 5 years in controversy the total understatement of income as computed by the net worth method was some $75,000. Emphasizing again that petitioners accept the correctness of the net worth statement in all respects except as to cash, the result would be a net understatement even by their own account of over $30,000 during the 5-year period. Again there is no explanation for understatements which must either have been of considerable size if concentrated in one year, or must have been made with regularity and consistency if spread over the entire period. Such large or consistent failures to report income without a suggested excuse are at least some evidence of a fraudulent intent. Frank A. Weinstein, 33 B.T.A. 105; Drieborg v. Commissioner, (C.A. 5) 225 F.2d 216.
Without attempting to enumerate all additional facts which have led to our conclusion that some part of the deficiencies were due to fraud, the following may be listed as examples:
Petitioners' failure to improve the adequacy of their records after both a revenue agent and their own accountant had warned them of their insufficiency;
The fact that at least Molly was an intelligent and capable business woman with a capacity to understand the figures involved and the consequence of any failures to report income received;
The statements made to the agents and inconsistencies and contradictions in the statements and between them and testimony at the hearing;
The testimony of Molly's brother as developed in the litigation between those two leading to the inference that recorded sales were consistently understated; and
The conviction of Molly for fraudulent understatements of income for 4 of the 5 years involved in this proceeding— a circumstance which might well by itself furnish prima facie,
see Stagecrafters' Club v. District of Columbia Division, (D.D.C.) 11 F.Supp. 127, if not conclusive, evidence, see Julian Lentin, 23 T.C. 112, affd. (C.A. 7) 226 F.2d 695, certiorari denied 350 U.S. 934; Stagecrafters' Club v. District of Columbia Division, supra; cf. Eugene Vassallo, 23 T.C. 656, on the issue of fraud
In 1945, a loss of $708.85 is shown, and in 1949, a loss of $5,473.94.
Judge Keech's excellent opinion in the case of Stagecrafters' Club v. District of Columbia Division, (D.D.C.), 111 F.Supp. 127, contains the following statement (at pp. 128, 129):However, where the issue in the criminal case was clear, the defendant appeared, was represented by counsel, had an opportunity to testify and present his witnesses and to cross-examine the witnesses against him, and was duly convicted, there is no sound reason why the judgment of conviction should not be admitted in a civil case based on the same facts as at least prima facie evidence of those facts.It may be argued that in prosecutions for some misdemeanors the offense charged is not of sufficient importance to warrant the defendant's contesting it to the fullest extent, and that under such circumstances the conviction should not estop the defendant to challenge the same facts in a civil proceeding. This objection is met if one holds the criminal conviction to be only prima facie evidence in the civil case, subject to rebuttal and to be given such weight as the trier of the facts deems proper. Where the criminal prosecution has been actively defended and no rebutting evidence is offered, the court is warranted in holding the conviction conclusive proof of the facts in the civil action. 2. Evidence of a conviction after trial as opposed to a plea of nolo contendere was clearly admissible. Stagecrafters' Club v. District of Columbia Division, supra; cf. Lillian Kilpatrick, 22 T.C. 446, affd. (C.A. 5) 227 F.2d 240. The effect of section 7453, Internal Revenue Code of 1954, combined with the Stagecrafters' Club case, is to remove any question of admissibility. Such evidence would be admissible ‘in accordance with the rules of evidence applicable in trials without a jury in the United States District Court of the District of Columbia.’ We leave open as unnecessary to the decision of this case the effect of that section upon the weight to be accorded to the evidence.
as to those years.
On the entire record we have accordingly made the finding resulting from our conviction that respondent has sustained his burden of proof on the fraud issue. These factors are by no means overcome by the evidence that petitioners maintained a receptacle where some amount of money for some period of time may well have been hidden. Even if, bearing in mind respondent's burden of proof, we assume that the amount was not exaggerated, and even if it existed on the critical date, some part of all of the deficiencies must still be held to be attributable to petitioners' fraud.
Decision will be entered under Rule 50.