Opinion
Docket Nos. 40161 40162.
1955-08-29
HARRY GLEIS AND ANN GLEIS, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.HARRY GLEIS, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Harry Stickney, Esq., for the petitioners. R. G. de Quevedo, Esq., and Lyman G. Friedman, Esq., for the respondent.
1. Respondent's computation of income by means of the so-called increase in net worth method approved subject to certain adjustments.
2. Held, some part of the deficiency for the year 1947 was due to fraud with intent to evade tax.
3. Held, the statute of limitations bars assessment and collection of the a deficiency for certain of the taxable years. Harry Stickney, Esq., for the petitioners. R. G. de Quevedo, Esq., and Lyman G. Friedman, Esq., for the respondent.
The respondent determined deficiencies in income and Victory taxes of petitioners and additions thereto for fraud for years and in amounts as follows:
+--------------------------------+ ¦Harry Gleis—Docket No. 40162 ¦ +--------------------------------¦ ¦ ¦ ¦ ¦ ¦ +--------------------------------+
Year Tax Deficiency Addition for fraud 1943 Income and Victory $11,300.14 $6,014.43 1945 Income 1,291.55 550.28 1946 Income 60,062.56 30,574.29
Harry and Ann Gleis—Docket No. 40161 1947 Income $53,712.78 $26,856.39 1948 Income 8,159.24 4,079.62 1949 Income 1,964.18 982.09 1950 Income 607.00 303.50
In his pleadings, respondent now claims an increased deficiency in each of the taxable years. Also, by amendment to his amended answer, respondent claimed an addition to tax in each of the years for substantial understatement of estimated tax for such years, which claim he now, on brief, waives. The issues presented are:
(1) Whether respondent was justified in resorting to the so-called increase in net worth method to determine the income of Harry Gleis for the years 1943, 1945, and 1946, and that of petitioners Harry Gleis and Ann Gleis for the years 1943, 1945, and 1946, and that of petitioners Harry Gleis and Ann Gleis for the years 1947 through 1950;
(2) Whether, in computing net income for the years 1946 through 1950, petitioners may amortize the cost of certain leasehold improvements made by them in lieu of deducting an allowance for depreciation thereof;
(3) Whether, in computing net income for 1949, petitioners may deduct as farm expenses the cost of certain bulldozing and of constructing a lake;
(4) Whether any part of the deficiency determined by respondent for each year is due to fraud with intent to evade tax;
(5) Whether the taxable years 1943, and 1945 to 1947, inclusive, are barred by the statute of limitations.
FINDINGS OF FACT.
The stipulation of part of the facts filed by the parties, with exhibits attached, is adopted, and, by this reference, made a part hereof.
The petitioner in Docket No. 40162 is Harry Gleis, an individual residing in Norwood, Ohio, who filed his individual tax returns for the years 1943, 1945, and 1946 with the collector of internal revenue for the first district of Ohio. Gleis also filed an amended return for the year 1946 with the same collector.
The petitioners in Docket No. 40161, Harry Gleis and Ann Gleis, are husband and wife, residing in Norwood, Ohio, who filed joint income tax returns for the years 1947, 1948, 1949, and 1950 with the collector of internal revenue for the first district of Ohio. For convenience, Harry Gleis will hereinafter be referred to as petitioner in both proceedings.
Prior to the years here involved, petitioner was in the business of operating pinball machines, so-called jukeboxes, and slot machines. In April 1941, petitioner formed a partnership with two other individuals to conduct the business theretofore conducted by him. This partnership was known as the Park Novelty Co. (hereinafter called Novelty), and the net profits thereof were divided between petitioner and the other two individuals on the basis of 75 per cent, 12 1/2 per cent, and 12 1/2 per cent, respectively. Thereafter, in April 1942, a new partnership agreement between petitioner and the two partners was entered into wherein the division of net profits was changed to 50 per cent for petitioner and 25 per cent for each of the other. Petitioner served in the Army of the United States from August 1942, to September 1944, when he received an honorable discharge with ‘character-excellent.’ At the time of his discharge, he had the grade of sergeant, to which grade he was promoted on February 20, 1943. Novelty continued to be operated as a partnership until April 1947, when the partnership was dissolved. Thereafter, Novelty became, and was operated by petitioner as, a sole proprietorship.
The books and records of Novelty were kept by Ann Walsh, who later became Ann Gleis, a petitioner herein, who will hereinafter be called Ann. From 1942 through March 31, 1947, Ann maintained a single entry system of bookkeeping for Novelty, consisting of a cash receipts and disbursements book. Beginning, April 1, 1947, a double entry system of bookkeeping was installed and maintained, including a cash journal, a ledger, and payroll books.
A bank account for Novelty was first opened in 1947. Before this time its money was put in the safe at petitioner's home.
Edward Gleis and Robert Meyer, who were petitioner's partners and later his employees, made collections. At the end of each week these men would ‘check in’ with Ann, producing their collection checks, payout slips, and money, and she would enter the receipts in the books. The collection slips were generally retained for over a year. Petitioner also frequently made collections.
On April 1, 1946, petitioner leased property known as Stacey's Bowling Alley's, and purchased the equipment and fixtures contained therein from George Stacey.
Petitioner made extensive alterations and improvements to the property, including the addition of a second floor to the building. He also purchased an additional 15 feet of land in order to get 10 bowling alleys on the second floor. The total cost of these improvements was $249,434.53. On their income tax returns for each of the taxable years 1947 through 1950, petitioner and Ann depreciated these improvements based upon their probable life. During these same years the monthly payments made by petitioner and Ann to the lessor were deducted by them as interest. From April 1, 1946, through December 31, 1946, Ann kept a single entry bookkeeping system for Stacey Recreation and Bowling Center (hereinafter called the Center). At the beginning of 1947 a double entry bookkeeping system was installed, including cash journal, ledger, and payroll books.
The men in charge of the bowling alleys and the pool room at the Center were trusted employees who had worked for the previous owner, and both had access to the safe. Ann checked periodically with these men and entered receipts in the books. When Ann was unavailable and there was no one to receive the money at the end of the day, both men would put the receipts in the safe.
Ann took trial balances monthly from the books of both Novelty and the Center and at the end of the year took the books, trial balances, and inventories to Cecil L. Hall to make out the income tax returns. Hall prepared the income tax returns for the petitioners from 1942 to 1946, inclusive and the joint income tax returns for the petitioner and Ann for 1947 and for all subsequent years, as well as the partnership returns for Novelty when it was a partnership.
Petitioner's investment in the Center as at December 31, 1946, 1947, 1948, 1949, and 1950, was as follows:
+--------------------------+ ¦December 31 ¦Amount ¦ +--------------+-----------¦ ¦1946 ¦$142,843.93¦ +--------------+-----------¦ ¦1947 ¦212,623.84 ¦ +--------------+-----------¦ ¦1948 ¦227,921.11 ¦ +--------------+-----------¦ ¦1949 ¦242,109.84 ¦ +--------------+-----------¦ ¦1950 ¦249,434.53 ¦ +--------------------------+
Certain capital items properly includible in the investment account in each of the foregoing years were omitted therefrom. Some of the items thus omitted were entered on the books in the following year. The omissions totaled $23,864.27 in 1946; $38,922.02 in 1947; $28,410.42 in 1948, 1949, and 1950, respectively. Among the items omitted in each year were $4,800 for goodwill and $6,000 for the aforementioned additional land purchased by petitioner in 1946.
In October 1943, petitioner purchased a farm located in Warren County, Ohio, including farm implements, livestock, and grain, for the sum of $26,000 and paid cash (currency). The farm was thereafter operated for petitioner by Jacob Shutter under a written agreement dated October 2, 1943, which agreement is still in effect. Books and records were kept on all farm operations by Shutter. These books were single entry and contained no assets accounts. Schutter had his own income tax returns prepared by a firm in Lebanon, Ohio, and a copy of the same was given to petitioner. The copy would then be turned over to Hall by Ann, together with notations as to the interest on the mortgage and amount of payments thereon, which payments were verified by Hall with the Standard Building Association. At the end of the year, an accounting was had between Schutter and Ann on the farm operations, and the share of profits was then distributed. Ann would take the share belonging to petitioner and put it on the books and in the bank account of the Center. Losses were sustained each year on the farm until 1947. One item of income recorded on the farm books and representing the sale of cattle in 1950 was omitted by error from Schutter's return for that year. In 1949, petitioner and Ann spent $657 for clearing 35 acres of farm land and $2,708.15 in the construction of a lake.
Upon the acquisition by petitioner, in or about the year 1947, of a garage known as the Shoemaker Garage, a separate account was opened and maintained especially therefor. All rents derived therefrom were deposited in this account. All expenses and payments on the notes pertaining thereto were made from this account. At the end of the year, Ann would give Hall information as to how much money was taken in by the garage as rent and how much was paid for various items. There is no other money from any other account that figures in the operation of this garage property.
On July 19, 1946, petitioner entered into a partnership agreement with Arthur Russotto for the operation of a cafe and restaurant, known as Jo's Tap Room (hereinafter called the Tap Room). At petitioner's instruction's an undivided one-half interest in the property then owned by Russotto was transferred and put into the name of Edward Gleis (hereinafter called Edward). The petitioner devoted no time to the business of the Tap Room. It was managed and conducted by Russotto, who received a salary for same before the division of profits between the partners. The partnership books of the Tap Room were kept by Russotto and its income tax returns were prepared by the accounting firm of Bernstein & Bernstein. Petitioner was furnished with reports of Bernstein & Bernstein and also a copy of the partnership tax returns which were used by Hall in preparing petitioner's tax returns.
During the existence of the Tap Room partnership, Russotto made monthly payments on the mortgage directly to the Seventh Ward Loan and Building Co. (hereinafter called the Seventh Ward). This mortgage had been given by Russotto to the Seventh Ward under date of June 11, 1946.
The partnership between Russotto and petitioner was terminated in November 1948 by written agreement added to the original partnership agreement. At the termination of the partnership, in the settlement between the partners, the legal title to the other one-half interest in the real estate was transferred and put in the name of Edward. The balance owed petitioner by Russotto was evidenced by a note to Edward dated November 24, 1948, which note was on the same date assigned to petitioner by writing on the face thereof. Also on November 24, 1948, Russotto entered into a lease agreement with Edward whereby the above property was leased back to Russotto for a period of 5 years at a monthly rate of $200. The rent checks from Russotto were made payable to Edward and turned over to petitioner, who had authority to endorse the same. The practice of the petitioner was to forward these checks to the Seventh Ward to be applied as payments on the mortgage loan, and the same procedure was still being followed at the time of the hearing.
The rental income derived from the Tap Room property and certain deductions relating thereto were reported on the 1950 joint income tax return filed by petitioner and Ann. The rental income from the Tap Room and any deductions relating thereto for 1 month for 1948 and for the entire year 1949 were omitted from the income tax returns filed for those years by petitioner and Ann. One year's interest amounting to $400 on the Russotto note was omitted from the 1949 tax return of petitioner and Ann.
On December 17, 1947, the petitioner and Ann cashed United States Government Bonds for the sum of $18,484.31, which amount was contemporaneously entered in the books of the Center and deposited in its account. Included in the proceeds of $18,484.31 was taxable interest income of $1,093, which was omitted from the income tax return of petitioner and Ann for that year.
In or about the year 1948, petitioner loaned money to George Sarros, who was operating a cafe and restaurant known as the Royal Chef. Petitioner took over the Royal Chef property in 1949 and the legal title thereto was placed in the name of Fred G. Reiners, Trustee. At approximately the same time, a mortgage was placed upon the property to secure a loan of $15,000, which he borrowed from the Standard Building and Loan Company (hereinafter called Standard). Petitioner and Ann received no income from the Royal Chef property nor did they take any deductions with respect thereto in the 1949 or 1950 tax returns.
The income tax returns of petitioner and those of petitioner and Ann for the years involved were, in the case of each return, filed on or before March 15 of the succeeding year. The deficiency notices for the years involved were mailed January 31, 1952.
In April 1952, petitioner was indicted by a Federal grand jury in the United States District Court, Southern District of Ohio, Western Division, in Criminal Case No. 8199 on the docket of that court, for tax evasion covering the years 1946 to 1950, inclusive. The case was tried before a jury and lasted from November 10 to November 25, 1952, upon which latter date the jury was discharged because it was unable to agree. Under date of December 19, 1952, petitioner pleaded guilty to the second count involving the year 1947, and the other four counts of the indictment covering the years 1946, 1948, 1949, and 1950 were nolle prossed. Petitioner was also indicted under sections 13054 and 13066 of the General Code of Ohio in August 1947 and pleaded guilty to a violation of section 13066 of the statutes. He was fined $250 and sentenced to 10 days in jail, which jail sentence was suspended. These two sections of the General Code of Ohio cover misdemeanors, not felonies. There was no plea, trial, or conviction on the other count under section 13054 of the General Code of Ohio.
Petitioner made the first annual payment of $10,000 on account of the $100,000 privilege of purchase price stipulated in the lease from Mabel L. Stacey on the Center property in 1947 and has made no payments on account thereof since. This $10,000 payment is reflected in a ‘property account’ on the books and records of the Center. When the second and third annual payments were due, petitioner requested the lessee to forego them, which she orally agreed to do. There was no written contract or agreement between the lessor and lessee about making these payments, other than in the lease. Petitioner and Ann, in their tax returns for the years 1947 to 1950, inclusive, deducted depreciation instead of amortization on the improvements, equipment, and fixtures in the Center at the usual depreciation rates but took no deduction in the year 1946. The respondent, in his determination, did not change the rates and did not disturb the depreciation reserve on the books. The fair market value of the Center, on the basis of a fee title, land, building, and improvements, is $70,000 for the real estate and $4,800 for the personal property, or a total of $74,800.
Ann had a strong box at her home in which she kept money and at various times she kept some money in safe-deposit boxes in banks. Petitioner had a safe at his residence which was used by both petitioner and Ann for personal needs. It was also used for Novelty receipts until a bank account was opened therefor in 1947. Ann had a safe-deposit box at the Second National Bank from June 11, 1937, to June 15, 1939, and from June 30, 1943, to March 11, 1947. Petitioner had a safe-deposit box which Ann was deputy at the Norwood Savings Bank from September 23, 1942, to September 21, 1951.
Subsequent to the levying of the jeopardy assessments herein, petitioner and Ann made certain payments on account of the deficiencies and penalties involved. Of the payments so made, $942.38 was, on January 24, 1952, applied to the year 1950 in full payment of the deficiency and penalty determined for that year, together with interest thereon. The remainder of the payments was applied in reduction of the determined deficiency and penalty for the year 1943 and interest thereon.
During the years from April 1947 through 1950, petitioner operated a horse race book at the Center. The room in which this activity was conducted was approximately 20 by 30 feet and contained approximately 20 seats arranged in tiers, facing a wall upon which was posted a number of horse track sheets giving the names of various race tracks, together with notations as to the races and names of the horses.
Prior to the formation of the partnership between Russotto and petitioner in 1946 for the operation of the Tap Room, Russotto operated the business as a sole proprietorship. Beginning in about October 1945, and thereafter Russotto operated a race horse book, in connection with operation of which he made certain payments to petitioner in 1945 and/or early 1946. The books maintained by Russotto for the race horse book operation for the period of his partnership with petitioner were sometimes later inadvertently destroyed. On the partnership returns filed by the Tap Room for the years 1946 and 1947, income from this source is reported in the amounts of $2,487.47 and $2,335.35, respectively.
Petitioner's distributable share of the income of the Tap Room for 1946 was $1,758.74. On his original return for 1946, petitioner reported no income therefrom. In his amended return for 1946, filed October 7, 1947, petitioner reported income from the Tap Room in the foregoing amount of $1,758.74. Petitioner's distributable share of the income for the Tap Room for 1947 was $2,123.74, which amount was reported on the joint return filed by petitioner and Ann for that year.
In 1943, when petitioner was in the Army, he gave Ann and her mother a mortgage on his farm in the amount of $20,000. He actually borrowed no money from them nor received anything in return therefor. Such mortgage was given as a protection to Ann in case of petitioner's death. In his return for 1943, petitioner took a deduction of $333.33 for interest paid to Ann and her mother, which interest he never actually paid. During the years involved, petitioner owned certain income-producing assets held in the names of others. Petitioner filed with respondent balance sheets and statements of his net worth as at December 31, 1946, and 1950, which did not reflect all assets owned by him.
Some part of the deficiency in the year 1947 was due to fraud with intent to evade tax.
OPINION.
VAN FOSSAN, Judge:
At the outset petitioner protests respondent's resort to the increase in net worth and expenditures method of computing income for the years involved. It is petitioner's contention that the books and records maintained for him by Ann were and are sufficient for the purpose of determining income; that had the necessary effort been made, an accurate computation of income could have been made therefrom; and that respondent's failure so to do was arbitrary and capricious. Precisely, petitioner repeatedly insists that his books of account adequately reflect his income for the years in dispute if all proper entries were properly made therein. Petitioner, admits, however, that various items pertaining to his capital account were omitted. Petitioner's business is essentially a cash business. Such a business, by its very nature, lends itself easily to the omission, whether or not intentional of items of income from recordation. Moreover, such books as were maintained have never been completely audited.
Furthermore, there is nothing in section 41 of the Internal Revenue Code of 1939,
on which section respondent relies as authority for his action in the premises, which makes mandatory a showing by respondent that books maintained by a taxpayer are wholly inadequate or that he has exhausted all efforts to compute income therefrom before he may properly exercise the broad authority granted him in the statute. As we have heretofore held, the net worth method is not a method of accounting within the scope and meaning of section 41, supra. It is not a substitution for any recognized system of keeping books of account. Morris Lipsitz, 21 T.C. 917. Rather, 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. To the contrary, when there is an inconsistency between the taxpayer's increase in net worth and the income as reflected in his books and reported by him on his tax returns, the net worth method, if approved, provides clear and convincing evidence that such books are not trustworthy, and that all income has not been reported. Morris Lipsitz, supra.
SEC. 41. GENERAL RULE.The net income shall be computed upon the basis of the taxpayer's annual accounting period (fiscal year or calendar year, as the case may be) in accordance with the method of accounting regularly employed in keeping the books of such taxpayer; but if no such method of accounting has been so employed or if the method employed does not clearly reflect the income, the computation shall be made in accordance with such method as in the opinion of the Commissioner does clearly reflect the income. * * *
Accordingly, we must reject petitioner's contention that respondent's use of the net worth method was arbitrary and unjustified, and sustain respondent as to this point.
Petitioner, however, stoutly maintains that even if respondent be justified in resorting to the net worth method he has erred in his application thereof to the instant facts. It is petitioner's position that respondent's failure, in his computation of net worth, to reflect cash on hand at any date and to take into account any nontaxable income is arbitrary and without reasonable foundation in fact.
Petitioner first decries respondent's failure to make allowances for exempt income received for services in the Army and for certain terminal leave bonds allegedly received as mustering-out pay. Respondent does not dispute the fact that petitioner was in the military service during a portion of the period before us nor that certain income resulting from military service is exempt. But, respondent argues, nowhere does the record disclose the amount petitioner received for such service, nor when it was received, and for these reasons he is unable with any degree of certainty to determine such amounts.
The evidence of record bearing upon this question leaves much to be desired. However, it does show that petitioner served in the Army from August 1942 to September 1944, and that upon his discharge he held the grade of sergeant to which grade he was promoted in February 1943. Thus, any pay received by him for such service in 1943 or thereafter is exempt from tax under section 22(b) (13)(B) of the 1939 Code.
True, as respondent points out, there is no positive evidence as to the exact amount so received by petitioner in 1943 and 1944. But doing the best we can with the evidence at hand and taking judicial notice of the Federal statute in force during those years governing the base pay of the members of the armed services we have determined that petitioner received approximately $838 in 1943 and approximately $637 in 1944 as a result of his service in the Army. Se Act of June 16, 1942, ch. 13, sec. 9, 56 Stat. 363, 37 U.S.C. sec. 109 (Supp. IV, 1941-45). As set out above, such income is exempt from taxation and proper allowance therefor will be made in the Rule 50 recomputation consequent hereon.
SEC. 22. GROSS INCOME.(b) EXCLUSIONS FROM GROSS INCOME.— The following items shall not be included in gross income and shall be exempt from taxation under this chapter:(13) ADDITIONAL ALLOWANCE FOR MILITARY AND NAVAL PERSONNEL.—(B) Compensation received prior to January 1, 1949, during any taxable year, for active service as a member below the grade of commissioned officer (or commissioned warrant officer) in the military or naval forces of the United States during the present war.
The meager evidence with respect to terminal leave bonds which petitioner is suppose to have received, in the aggregate, presents no basis upon which to make an independent determination. Moreover, it should be noted in passing, petitioner's discharge from the Army, a photostatic copy of which is in evidence, reads on its face that he was ‘Not Entitled to Mustering-Out Pay.’ It is our conclusion, therefore, that respondent did not err by his failure to make an allowance for the alleged receipt and subsequent cashing of a terminal leave bond, and we so hold.
Petitioner next attacks as arbitrary respondent's failure to give credit in his net worth computation for cash on hand at any date over and above that deposited in banks. Respondent's position with respect to this item is that the evidence does not justify allowing any greater amount of cash on hand during any of the years involved than has already been allowed.
The evidence with respect to this item shows that in October 1943, petitioner paid $26,000 cash (in currency) for a farm. It is fair to assume that some part of this amount was on hand at the end of 1942. Particularly is this true in view of the facts found by us on this record to the effect that the business carried on by Novelty was essentially a cash business; that it had no bank account prior to 1947; and that until that time its receipts were kept in a safe petitioner's home.
The logical inference follows from these facts and from other evidence bearing on the point, that petitioner probably did, in fact, have a substantial amount of undeposited cash on hand at the end of each of the years immediately preceding 1947. Accordingly, we have made the best approximation we can on the evidence before us and have determined that petitioner had undeposited cash on hand, for which he should be given credit in respondent's net worth computation, at the end of each of the years 1942 through 1946, in the respective amounts of $16,000, $2,000, $9,000, and $7,000. Coham v. Commissioner, 39 F.2d 540.
Petitioner further claims to have received, in or about 1946 or 1947, approximately $25,000 from his father and approximately $47,000 from Ann, both of which amounts were expended on improvements made to the Center. With respect to the latter amount, Ann, so the story goes, supposedly received the greater part of the $40,000 in cash from her father or his deathbed in or about 1928 or 1929 for the purpose of caring for her mother. The remaining amount represents bonds owned and cashed by Ann sometimes around 1947. As to the alleged gift to petitioner by his father, there is no evidence in support excepting petitioner's bare statement. It was not developed that petitioner's father ever possessed any such sum of money or had an earning capacity that would permit such an accumulation. We have closely scrutinized all the evidence touching upon this point, including that with respect to the ability of the donors to have made such gifts, the length of time since the alleged gifts were made, and, after carefully weighing all the probabilities and the improbabilities, we find ourselves unable to give any credence or weight to such testimony. Respondent, in his computation, has taken into account a net worth for Ann of $27,641.69 at the time of her marriage to petitioner, and the evidence does not justify disturbing such figure.
The next item in respondent's net worth computation that petitioner would dispute is the manner in which the cost of the capital improvements, made to the Center in the aggregate amount of $249,434.53, is treated therein. Originally, on their tax returns, petitioner and Ann claimed an allowance for depreciation of the various improvements involved based upon the respective useful lives thereof. Such allowances were left undisturbed and were so reflected in respondent's computations.
Petitioner now asserts that the cost of the foregoing improvements should properly be amortized over the 10-year term of the lease involved. In this connection, it is petitioner's position that, although he fully intended to purchase the property at the time the lease was executed, as well as when the initial payment on account of the privilege to purchase contained therein was made, he thereafter abandoned such intention and that at the present time there is no reasonable certainty that such privilege will ever be exercised. As evidencing his abandonment of any intention to purchase the property, petitioner points to the fact that he requested and received from the lessor-grantor permission to forego making the second and third payments on account of the option to purchase at the time they respectively fell due and that he has made no further payments on account thereof. Petitioner has also introduced evidence showing that the fair value of the property in dispute is considerably below the amount required to be paid under the privilege to purchase.
After considering the lease agreement here in controversy in the light of the facts surrounding its execution, it is our opinion that the parties thereto fully intended to and did, in fact, effect a sale of the property involved subject to the performance of certain conditions subsequently, namely, the making of payments in specified amounts on specified dates. Robert A. Taft, 27 B.T.A. 808. Cf. also Truman Bowen, 12 T.C. 446. We think, further, that the lessor-grantor's waiver of payments to be applied on the purchase price as requested by petitioner did not abridge petitioner's right to exercise the privilege to purchase at any time prior to the lease's termination in 1956. This view is amply supported by the testimony of the lessor grantor that she felt herself bound to follow through with the sale should the petitioner seek to exercise his option to purchase. That petitioner felt it necessary to seek the waivers in question evidences a continued intention on his part to purchase the property. Further, petitioner has continued to deduct the so-called rent payments, amounting each year to 5 per cent of the unpaid balance due on the purchase price, as interest, and is carrying the initial payment made by him in a property account on the Center's books.
Under the circumstances, therefore, we feel that the option to purchase is still open and will be until 1956, and that no definite action has been taken which abridges that right. This being true, petitioner has its exclusively within his power to extend the use of the improvements in dispute over the remaining useful lives thereof. In such a situation it is proper to depreciate them over the period of such lives rather than to amortize the cost thereof over the period of the lease. See Leonard Refineries, Inc., 11 T.C. 1000, 1010. Accordingly, we so hold.
The next issue involves the proper tax treatment to be accorded certain expenditures made by petitioner and Ann in 1949 in connection with the farm theretofore purchased by petitioner. The items in dispute are the expenditure of $657 for clearing land preparatory to farming it, and the expenditure of $2,708.15 for construction of a lake on the property. Petitioner maintains that these items are to be treated as deductible farm expenses. It is respondent's view that such expenditures are properly to be capitalized. We agree with respondent.
We turn now to the question of fraud. Fraud implies bad faith, a deliberate and calculated intention on the part of the taxpayer at the time the returns in question were filed fraudulently to evade the tax due. E. S. Iley, 19 T.C. 631. Such an intention is never presumed. Rather, its presence must be demonstrated by clear and convincing evidence, as to which the burden is with respondent. Involving, as it does, the personal intent of the taxpayer, and intent being a state of mind, seldom may any one specific act be pointed to as evidencing an intent to defraud. The presence, or absence, of such an intent is usually to be determined by a close examination of the taxpayer's whole course of conduct. Thus, whether or not a taxpayer harbors a fraudulent intention to evade tax at any time is a fact to be found, as any other fact from a careful consideration of all evidence on the record, together with any inferences properly to be drawn therefrom. Charles E. Mitchell, 32 B.T.A. 1093, affirmed sub nom. Helvering v. Mitchell, 303 U.S. 391. If a thorough study of the entire record, made with the care a case of this nature requires, and with due consideration for the inferences, leaves the trier of fact with the firm conviction, based upon clear and convincing evidence, that fraud has been perpetrated, only then may the imposition of the so-called fraud penalty, provided in section 293(b)
of the 1939 Code, be sustained.
SEC. 293. ADDITIONS TO THE TAX IN CASE OF DEFICIENCY.(b) FRAUD.— If any part of any deficiency is due to fraud with intent to evade tax, then 50 per centum of the total amount of the deficiency (in addition to such deficiency) shall be so assessed, collected, and paid, * * *
On consideration of the record before us, with the exception of the year 1947, we find ourselves unconvinced as to the proof of fraud. It is not enough that we entertain a feeling that the taxpayer may have been guilty of fraud in other years or that petitioner was engaged in illegal businesses. We cannot say that the evidence of fraud is clear and convincing.
As to the year 1947, the evidence is much stronger and a different conclusion is clearly indicated. In addition to the other items suggesting fraud, we have the record of the plea of guilty to fraud in the criminal proceedings in the District Court. Petitioner's attempt to explain away his plea of guilty is wholly unconvincing. When coupled with the other evidence, the record is clear and convincing that petitioner was guilty of filing a fraudulent return for 1947. We have accordingly so found as a fact.
The consequence of the above finding is that the statute of limitation bars assessment and collection of the tax for the years preceding 1947, unless, upon recomputation under Rule 50, the amount of tax omitted as to 1946 exceeds the statutory percentage (25 percent) fixed by section 275(c), which allows 5 years assessment and collection of the tax in such an event.
Decisions will be entered under Rule 50.