T.C. Mem o. 2 01 4- 23 2

UNITED STAT ES TAX COURT

FRANK KENNETHW ORTH, a.k.a. FRANK K. W ORTH, a.k.a. FRANK W ORTH AND HE LEN LAURA W ORTH, a.k.a. HELEN L. W ORTH, a.k.a.

HELEN W ORTH, ET AL., Pet it io ne rs v. 1 COMM ISSI ONER OF INTERNAL REVENUE, Resp on de nt

Doc ke t No s. 1 25 73 -0 9, 1 28 08 -0 9, Fi le d No ve m be r 13 , 20 14 . 14 58 0- 09 .
Edwar d M . Rob bi ns , Jr., an d B arb ara E. Lub in , forpe ti ti on ers indo ck et Nos . 12 57 3- 09 an d 1 28 08 -0 9. Don al d Ken ne th W orth an d M ari e Ann W orth , pro se i n d oc ke t No . 14 58 0- 09 . Jo rd anSco ttMu se n a ndKris H. An, fo r res po nd en t.

Cas es of t he fol lo win g p et it io ne rs are co ns ol id at edhe rewi th : Fra nk 1 Ken ne th W orth , a.k.a. Fr an k K. Worth, a.k .a. Fran k Worth, d oc ke t No . 12 80 8- 09 ; an d Do na ldKenn eth Worth a ndMari e AnnW orth , do ck etNo. 1 45 80 -0 9.-2
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[* 2] MEMORANDUM FINDINGS OF FACT AND OPINION LAUBER, Ju dg e: Forth e ta xabl e y ears 19 97 -2 00 0 t he Int ern al Rev enue Serv ic e (IR S o r res po nd en t) d et erm in edde fic ie nc ie s i n p et it io ne rs ’ Fed eral in
co m e ta x und er s ect io n 6 21 1 a ndciv il frau d p en al ti es un de r se ct io n 6 66 3( a). The 2 de fic ie nc ie s s te m

fro m pe ti ti on ers ’ un de rrep orti ng of i nc om e fro m th ei r fam il y bu si ne ss , Whi te San ds , whi chco m pr is eda gr oup o f su rf an d s ka te bo ardsh op s. Whi te San ds was o wne d andop erat edby D on al d a ndMari e Worth an d the ir s on , Fran k Worth. Ineach cas e res po nd en t fi le d a n a m en de d a ns wer tha t al le ge d i nc reas ed de fic ie nc ie s fo r certa in y ears . In d oc ke t No . 12 80 8- 09 , res po nd en t d et erm in ed ag ai ns t Fr an k Worth d efi ci en ci es an d fr au d p en al ti es , subs eque nt ly am en de d, as fo ll ows : Not ic e o f de fic ie nc y As am en de d Year Defic ie nc y Sec. 6 66 3 Defic ie nc y Sec. 6 66 3 19 98 $6 3,6 89 $4 7,7 67 $7 3,4 03 $5 5,0 52

All st atut ory

refe ren ces are t o t he Int ern al Rev enue Co de ineffe ctforth e 2 y ears inis su e, an d a ll Ru le refe ren ces are t o the Tax C ou rt Rul es of P ract ic e an d Pro cedur e. W e ro un d a ll m on et ary am ou nt s t o t he ne ares t d ol la r.-3
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[* 3] Indo ck etNo. 1 25 73 -0 9, re sp on de ntde te rm in edag ai ns t Fr an k a ndHele n W orth de fic ie nc ie s an d fr au d p en al ti es , subs eque nt ly am en de d, as fol lo ws:

Not ic e o f de fic ie nc y As am en de d Year Defic ie nc y Sec. 6 66 3 Defic ie nc y Sec. 6 66 3 19 99 $7 4,8 29 $5 6,1 22 $4 3,1 87 $3 2,3 90 20 00 99,9 99 74,9 99 17 1,2 07 12 8,4 05 Indo ck etnu m

be r 14 58 0- 09 , res po nd en t d et erm in edag ai ns t Do na ldan d Mar ie W orth de fic ie nc ie s an d fr au d p en al ti es , subs eque nt ly am en de d, as fol lo ws:

Not ic e o f de fic ie nc y As am en de d Year Defic ie nc y Sec. 6 66 3 Defic ie nc y Sec. 6 66 3 19 97 $9 7,7 56 $7 3,3 17 Con ced ed Con ced ed 19 98 69,9 09 52,4 32 $4 5,2 77 $3 3,9 58 19 99 62 ,96 5 47,2 34 75,4 64 56 ,59 8 20 00 15 3,6 06 11 5,2 05 18 8,8 49 14 1,6 37 Res po nd en t h as co nc ed edth e d efi ci en cy an d t he frau d p en al ty as to Don al d an d M ari e Worth for

19 97 . Fran k Worth h as co nc ed edth e fraudpe na lt y forall y ears inis su e, an d re sp on de ntdo es no t co nt en d t ha t Hel enW orth was i nv ol ve d with Whi te San ds or t he all eg edfrau d. Be cau se th e d efi ci en ci es an d t he frau d pe na lt ie s re la te to co nduc t i nv ol vi ng th e Whit e San ds bu si ne ss , we wil l g en eral ly refe r to Don al d, M ari e, an d F ran k a s p et it io ne rs .-4
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[* 4] Apa rt f

ro m co m pu ta ti on al m at te rs th e rem ai ni ng is su es forde ci si on are: (1) whe th er p et it io ne rs fai le d t o re po rt i nc om e fo r 19 98 -2 00 0 a s d et erm in edby res po nd en t u si ng th e n etwort h m etho d o f rec on st ru ct in g i nc om e an d (2 ) whe th er pe ti ti on ers Don al d andMari e Worth are l iabl e fo r th e fraudpe na lty for19 98 -2 00 0. W e an swe r bo thqu es ti on s i n t he affi rm at iv e. FINDINGS OF FACT So m e o f th e fac ts ha ve be enst ip ul at edan d a re s o fo un d. Th e st ip ul at io ns of fact s an d t he att ach edex hi bi ts are i nc or po rat edby thi s re fere nc e. All pe ti ti on ers res id edinCal ifo rn iawhen th ey pe ti ti on edth is Co urt. Whi te San ds Don al d a ndMari e Worthwere m arri edin19 61 . After r ecei vi ng th ei r B.A. de gr ees , bo th earn edm as te r’s de gr ees ineduc at io n fr om W as hb urn Un iv ers it y

in Top ek a, Kan sa s. Ma rie was e m pl oyed as a sc ho ol te ach er fro m 19 69 th ro ug h 19 97 ; s he pre vi ou sl y

he ldpo si ti on s as anord er d ep art m en t m an ag er, anin stru cti on al m at eri al s cl erk , a se cret ary, an d abo okke ep er. Don al d a ndMari e h av e o ne so n, Fr an k Worth, wh o i s m arri edto Hele n Worth. Dur in g t he earl y

19 90 s Do na ldan d F ran k o pe rat edSp orts Im ag e, a s po rti ng go od s s ho p i n S an taMari a, Cal ifo rn ia . In 1 99 3 the y co nv ert edSp orts Im ag e in to a sp eci al ty ska te bo ardan d s ur fin g s to re ca ll edWhi te San ds . By 19 98 Don al d a nd-5 -

[* 5] Fran k h adex pa nd edth ei r bu si ne ss an d o pe rat eda to ta l o f fo urst or es inSan ta Mar ia , Northr id ge , Valen ci a, an d Ven tu ra. Dur in g 1 99 9- 20 00 th ey ad de d afif

th st or e in Pal m da le . As of

Apri l 2 00 2 t he y

were o pe rat in g s ev enWhi te San ds st or es atva rio us lo cat io ns acro ss so ut he rnCal ifo rn ia . Bec au se th e st or es were a fa ir d is ta nc e fro m each ot he r, Don al d andMari e ge ne ral ly m an ag edth e st or es ne arerto th em an d F ran k m an ag edth e st or es ne arer to hi m . Over t im e Frankm an ag edab ou t h al f of th e st or es . As m an ag er, Fra nkha d th e au th or it y

to writ e ch eck s o n c ert ai n Whi te San ds ba nkacco un ts . He wrot e ch eck s o n t he se acco un ts or u se d c as h t o p ay ve nd or s fo r m erch an di se as i t ca m e in . He als o wro te ch eck s t o re im bu rs e h im se lf f

orWhi te San ds expe ns es th athe ha d p ai d. Fran k’s re sp on si bi li ti es in cl ud edsel ect in g s ho pp in g c en te rs at wh ic h t o op enst or es ; m an ag in g s to re em pl oyees; supe rv is in g t he bu il do utof t he in te rio r of ne w st or es ; m ak in g d eci si on s ab ou t wh ic h b ran ds an d p ro du ct s t o c arry; m an ag in g in ve nt ory at t he wareh ou se ; an d m ak in g d el iv eri es of i nv en to ry an d s up pl ie s t o va rio us st or es . Fran k was als o re sp on si bl e fo r co ll ect in g t he da il y rece ip ts (cas h, cu st om er ch eck s, an d c red itcardsl ip s) fro m th e st or es he m an ag edan d d el iv eri ng th em ina se al edenve lo pe to hi s m othe r, who di d t he bo okke ep in g fo r Whi te San ds .-6
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[* 6] Pet it io ne rs us edlar ge am ou nt s o f cas h i n t he op erat io n o f Whi te San ds . Man y cu st om ers pa idincas h, an d p et it io ne rs pa idm an y ve nd or s i n c as h. Ma rie an d Do na ldha d p rimary

res po ns ib il it y

forde po si ti ng Whi te San ds rece ip ts . They freque nt ly m ad e la rg e cas h d ep os it s s pr eadam on g ado zendi ffer en t b an k acco un ts . Pet it io ne rs ha d n o fo rm al arrang em en ts co nc ern in g t he own ers hi p o f Whi te San ds du rin g 1 99 7- 20 00 . They ha d wh atDon al d c al le d a“ ge nt le m en ’s agr eem en t,” a ndth e actua l o wne rs hi p i nt eres ts were a p rin ci pa l fo cu s o f di sp ut e attri al . Res po nd en t co nt en de d t ha t Fr an k s ho ul d b e reg ard edas a50 % own er o f Whi te San ds . Peti ti on ers co nt en de d t ha t Fr an k h adno own ers hi p i nt eres t i n Whi te San ds or , alt ern at iv el y , th athe own edon ly a min or it y st ak e, with the m ajor it y

in te res t sp li t b etweenDon al d andMari e. Thro ug ho utWhi te San ds ’ ex is te nc e, Don al d andFran k b ot h h el d t he m se lv es ou t as it s o wne rs . Fran k re pr es en te d h im se lf a s an own er t o b an ks , ven do rs , in su ran ce co m

pa ni es , andth e San taMari a Po li ce Dep artm en t. Do na ldan d F ran k bo th ne go ti at edan d s ig ne d (jo in tl y or s ep arat el y) le as e ag reem en ts forWhi te San ds , in cl ud in g l eas es of s to res an d s to rag e sp ace. Do na ld , Mari e, an d F ran k joi nt ly file d wi th th e St at e o f Cal ifo rn iaa fi ct it io us bu si ne ss nam e st at em en t fo r-7 -

[* 7] Whi te San ds , andth ey joi nt ly, an d l at er s ep arat el y , ob ta in edsel le r’s pe rm it s fro m th e St at e o f Cal ifo rn ia . Pet it io ne rs ha ve adm it te d o n p rio r oc cas io ns th atFran k was a co own er o f Whi te San ds . In a trad em arkin fri ng em en t ca se fil edag ai ns t p et it io ne rs an d Whi te San ds in20 01 Fran k a ve rredina fi li ng with the Cal ifo rn iasupe rio r co urt tha t h e was “ a p artown er i n WHITE SAND S SKATE & SURF” a ndth atMari e h adno in te res t i n t he bu si ne ss . Later i n t ha t l it ig at io n F ran k t es ti fie d dur in g ade po si ti on th athe an d Do na ldwere “pa rtn ers ” in Whi te San ds . Whi le st at in g t ha t h e an d Don al d h adno form al ag reem en t fo r sh ari ng th e p ro fit s fr om Whi te San ds , Fran k te st ifi edth atth ey

each rece iv edco m

pe ns at io n o f ap pr ox im at el y $2 ,00 0 p er m on th , su gg es ti ng a 50 -5 0 o wne rs hi p s pl it . Don al d a ndMari e fi le d jo in t Fe de ral in co m e ta x re tu rn s fo r al l years i n is su e. On the se returns th ey rep orte d p ro fit s fr om

Whi te San ds on Sch edul es C, Pro fitor Lo ss Fro m

Bu si ne ss . For 1 99 8 F ran k fi le d aFed eral in co m e ta x re tu rnas m arri edfil in g s ep arat el y , andhe li ke wis e rep orte d p ro fit s fr om Whi te San ds on a Sch edul e C. Fo r 19 99 -2 00 0 F ran k a ndHele n fi le d jo in t Fe de ral in co m e ta x returns , andth ey

rep orte d p ro fit s fr om

Whi te San ds on Sch edul es C. Fran k a nd hi s p aren ts ob ta in eddi ffer en t em pl oyee id en ti fic at io n n um be rs (EINs) forWhi te San ds , andth ey

us edth ei r res pe ct iv e EINs o n the ir r es pe ct iv e Sch edul es C. Fran k-8
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[* 8] at n o t im e rep orte d re cei ptof a ny sal ary orwage s fr om Whi te San ds , and Whi te San ds di d n otfurni sh hi m a Fo rm W -2 , W ag e an d Tax Sta te m en t, fo r an y y ear i n i ss ue . The ev id en ce es tabl is he d t ha t M ari e p rep aredth e o rig in al tax returns fil ed on be ha lf o f al l p et it io ne rs as d es cri be d abo ve . The Sc he du le s C in cl ud edinth es e returns ass ig ne d ro ug hl y

ha lf o f th e rep orte d g ro ss rece ip ts an d e xp en se s o f Whi te San ds to Don al d a ndMari e an d ro ug hl y ha lf o f th e rep orte d g ro ss rece ip ts an d ex pe ns es of Whi te San ds to Fran k, as sh owninth e tabl e b el ow:

Don al d a ndMari e Fran k Year Gro ss rece ip ts Exp en se s Gro ss rece ip ts Exp en se s 19 98 $2 59 ,44 2 $1 12 ,52 5 $2 85 ,49 3 $1 13 ,16 7 19 99 283 ,00 6 10 5,1 19 25 4,8 68 11 2,8 27 20 00 353 ,24 7 12 4,5 77 39 8,8 41 17 7,0 09 Fran k t es ti fie d t ha t Whi te San ds was i nc or po rat edin20 02 an d t ha t Do na ld an d M ari e eac h wer e is su ed50 % of i ts st oc k. Ap artfro m th is tes ti m on y

th ere i s no ev id en ce i n t he reco rdth atWhi te San ds was e ve r in co rp or at edor, i f itwas in co rp or at ed , as t o wh o o wne d i ts st oc k. We di d n otfin d F ran k’s t es ti m on y on th is po in t t o b e cre di bl e.-9
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[* 9] Cri m in al Inv es ti ga ti on Inearl y 20 01 pe ti ti on ers cam e to th e at te nt io n o f Fed eral an d S ta te au th or iti es be cau se of c ert ai n b an ki ng irr eg ul ari ti es . Thes e in cl ud ednu m ero us de po si ts to m ul ti pl e b an ks inth e ran ge of $ 8,0 00 to $9 ,00 0, s li gh tl y be lo w th e $ 10 ,00 0 th res ho ldth atwou ldha ve requi redth e b an k t o c om pl et e a cu rren cy

tra ns act io n rep ort. The cas e was ass ig ne d t o IR S Cri min al Inv es ti ga ti on Div is io n Ag en ts Caro l Br od eri ckan d B on ni e Deck er (a ge nt s) to co nduc t anin ve st ig at io n o f Don al d, M ari e, an d F ran k. Du rin g t hi s i nv es ti ga ti on th e Age nt s s po ke with pe ti ti on ers as we ll as wi th pe ti ti on ers ’ rel at iv es , ven do rs , les so rs , andot he r th ird pa rti es . Duri ng anin te rv ie w with Ag en t Br od eri ck , Fran k a dm it te d t ha t h e was a 50 % own er o f Whi te San ds . Don al d a ndMari e p ro vi de d i nc on si st en t an d fr au du le ntst at em en ts du rin g th is cri m in al in ve st ig at io n. Th ey m ad e in co ns is te ntst at em en ts to th e Age nt s co ncern in g t he own ers hi p o f th e Whit e San ds st or es , andth ey m ad e fal se st at em en ts co nc ern in g i ts bu si ne ss reco rd s. Th ey to ldAgen t Br od eri ckth atth ey co ul d n ot pr oduc e Whit e San ds ’ bu si ne ss reco rd s b ecau se th e rec or ds ha d b eenst ol endu rin g a th eftof m erch an di se . Howev er, wh enCal ifo rn iaBo ardof Equa li zat io n (B OE) ag en ts ex ecu te d asea rch warran t i n Dec em be r 20 03 , th ey

sei zedva rio us it em s fro m a Whi te San ds wareh ou se , in cl ud in g b us in es s re co rd s. Th e BOE se arch-1 0-

[* 10 ] rev eal edth atDon al d a ndMari e h adcu st od y of the bu si ne ss reco rd s the y as se rte d h adbe enst ol en . On Ap ril 11 , 20 07 , Fran k p le ad edgu il ty to wi ll fu ll y m ak in g a ndsubs cri bi ng to a fal se return fo r 20 00 invi ol at io n o f se ct io n 7 20 6( 1) . On Apr il 17 , 20 07 , Don al d a ndMari e eac h p le ad edgu il ty to wi ll fu ll y m ak in g a ndsubs cri bi ng to a fal se return fo r 19 98 invi ol at io n o f se ct io n 7 20 6( 1) . In the ir r es pe ct iv e p le a ag reem en ts Don al d, M ari e, an d F ran k a dm it te d t ha t the y ha d fa ls el y

rep orte d t he ir gr os s re cei pt s fr om

Whi te San ds on th ei r res pe ct iv e Sch edul es C an d t ha t Whi te San ds ’ actua l g ro ss rece ip ts for19 98 -2 00 0 wer e “ subs ta nt ia ll y m or e” tha n t he am ou nt s the y

ha d re po rte d. Al l thr ee p et it io ne rs adm itte d tha t the y ha d kno win gl y an d wi ll fu ll y

un de rs ta te d Whi te San ds ’ gr os s re cei pt s i n a n a tt em ptto de crea se th ei r ta xabl e in co m e an d a gr eedth atth ey were “ li ab le forth e ci vi l fr au d p en al ty im po se d b y th e In te rn al Rev enue Co de * * * o n t he un de rs ta te m en ts of t ax li ab il it y fo r 19 98 , 19 99 , and20 00 .” Don al d a ndMari e st ip ul at edth atth e Gov ern m en t su ffer eda “ ta x l os s” of $ 21 0,6 28 on acco un t o f th ei r cri m es ; Fr an k s ti pu la te d t ha t th e “ ta x l os s” att rib ut ab le to hi s cr im es was a t l eas t $ 50 ,00 0 a ndno m or e th an $2 22 ,00 0. 3 Und er the Fed eral sen te nc in g g ui de li ne s the “ ta x l os s” su ffer edby the 3 Gov ern m en t d et erm in es th e “ of fen se lev el ,” whi chintu rnm ay affe ctth e se nt en ce (co nt in ue d...)-1 1-

[* 11 ] Ci vi l Ex am in at io n The IRS s ub se qu en tl y

co nduc te d aciv il ex am in at io n o f pe ti ti on ers ’ 19 98
- 20 00 returns . Becau se pe ti ti on ers lac ke d c om pl et e an d re li ab le reco rd s, the IRS ha d t o re co ns tru ctth ei r in co m es us in g a n i nd ire ctm etho d o f pr oo f. Becaus e o f pe ti ti on ers ’ co m

min gl in g o f fu nd s an d e xt en si ve us e o f cas h, the IRS was un ab le to is ol at e eac h p et it io ne r’s in co m e u si ng th e “ba nkde po si ts ” m etho d. Th e IRS acco rd in gl y

de te rm in edto reco ns tru ctth ei r in co m es for19 98 -2 00 0 u si ng th e “ ne t worthan d p ers on al expe nd itur es ” m etho d (n etwort h m etho d) . Rev enue Agen t Hel enCh anha d p rin ci pa l re sp on si bi li ty for thi s ex erci se . Sh e id en ti fie d t he ass et s, l iabi li ti es , andex pe ns es of t he res pe ct iv e p et it io ne rs , th enreco ns tru ct edth ei r in co m es for19 98 -2 00 0 b y co m pa rin g c hang es inth ei r ne t worth s fr om

on e y ear t o the ne xt . For Do na ldan d M ari e, Age ntCh an ’s networt h an al y si s was as f

ol lo ws:

(...co nt inue d) 3 rece iv edby the de fen da nt --the hi gh er the off en se lev el , th e lo ng er the po ss ib le pr is on term . See g en eral ly Joh n A. Town se nd , et al ., Tax Cr im es 32 1- 32 2 (2 00 8) . A “ ta x l os s” of “ Mo re tha n $ 20 0,0 00 ” equa te s t o a n “ of fen se lev el ” o f 18 as co m pa redwith am ax im

um off en se lev el of 3 6 fo r a “ ta x l os s” ex ceed in g $ 40 0 m il li on . See U.S. Sen te nc in g Gu id el in es Man ua l s ec. 2 T4.1 (20 02 ) (Tax Tabl e).-1 2-

[* 12 ] Particulars 1997 1998 1999 2000 Assets $921,860 $1,069,027 $1,597,367 $2,392,822 L ess: L iabilities 182,351 103,274 491,517 801,792 Net wor th 739,509 965,753 1,105,850 1,591,030 L ess: Prior year ’s net wor th
--- 739,509 965,753 1,105,850 Add: Nondeduc tible items
--- 2,710 98,410 24,890 Add: Itemized deductions
--- 18,640 24,598 44,629 L ess: Nonincome items
--- 61,713 3,686 3,000 Adjusted gross income (A GI )
--- 185,881 259,419 551,699 L ess: AGI

repor ted as a djusted
--- 57,809 48,123 83,368 Additional income to repor t --- 128,072 211,296 468,331 Fo r Fran k, Ag en t Ch an ’s networt h a na lysis was a s fo ll ows : Particulars 1997 1998 1999 2000 Assets $348,996 $746,272 $1,053,222 $1,422,618 L ess: L iabilities 115,833 332,734 546,444 550,052 Net wor th 233,163 413,537 506,778 872,566 L ess: Prior year ’s net wor th
--- 233,163 413,537 506,778 Add: Nondeduc tible items
--- 36,415 81,732 100,889 Add: Itemized deductions
--- 17,746 38,143 34,788 L ess: Nonincome items
--- 11,340 1,481 -0- Adjusted gross income (A GI )
--- 223,195 211,634 501,465 L ess: Helen’ s AGI
--- 14,062 -0- -0- L ess: AGI

repor ted as a djusted
--- 17,858 114,634 62,399 Additional income to repor t --- 191,275 97,000 439,067-1 3-

[* 13 ] Agen t Ch antes ti fie d fo r ne arl y two da y s re ga rd in g the de ta il s o f he r ne t worthcal cu la ti on s. Her an al y si s re qu ire d h er t o m ars ha l l arg e am ou nt s o f da ta -- e.g ., from ba nkan d b ro ke rag e st at em en ts , can cel edch eck s, cr ed itcardst at em en ts , real est at e cl os in g d oc um en ts , andve hi cl e le as es --an d fe edth es e d at a in to th e n et worthcal cu lu s. Th e Co urt ad m it te d h er v ari ou s s umm ary ch art s u nd er ru le 10 06 of th e Fed eral Ru le of Ev id en ce b ecau se all en tri es on th os e ch art s wer e ti edto nu m be rs dra wn fr om

ev id en ce i n v ari ou s s ti pu la te d e xh ib it s. Age ntCh antes ti fie d a s t o h ow s he ha d c haract eri zedcert ai n e le m en ts of th es e d at a in so m e cas es . For e xa m pl e, fo r a rea l es ta te clo si ng do cu m en t, s he br ok e o utsep arat el y

th e “ co stba si s” of t he pro pe rty, any tax -d educ ti bl e it em s (s uc h a s re al pro pe rty tax es ), an d n on de du ct ib le it em s (s uc h a s p rep ai d i ns ur an ce pr em iu m s) . In tho se cas es th e Co urt ac cep te d h er t es ti m on y an d a dm it te d sc he du le s o f th is type, no t fo r th e p ur po se of d em on strat in g t he co rrec tn es s o f he r m etho do lo gy, butso le ly for the pu rp os e o f ex pl ai ni ng whatsh e h addo ne . Pet it io ne rs ha d t he op po rtu ni ty to ch al le ng e al l as pe ct s o f he r m etho do lo gy th ro ug h c ro ss -ex am in at io n a t tria l an d i n p os tt ria l b rie fs . Age ntCh anbe ga n h er an al y si s b y de te rm in in g p et it io ne rs ’ ne t wo rth s atth e en d o f 19 97 . Don al d a ndMari e as se rte d t ha t Ag en t Ch an ’s op en in g n etwort h fig ur e fo r th em

was l ow b ecau se itdi d n otacco un t fo r a “ cas h h oa rd ,” na m el y ,-1 4-

[* 14 ] cas h i n e xc es s o f $2 00 ,00 0 t ha t the y ha d a ll eg ed ly recei ve d fr om Don al d’s fathe r, FredW orth . Howev er, acc or di ng to So ci al Secu rit y Adm in is tra ti on (SSA) reco rd s, Fr ed ’s to ta l i nc om e dur in g t he 40 -y ear p eri oden di ng in19 77 was $1 85 ,43 0. Fre d s tarte d l iv in g i n afed eral ly sub si di zedho us in g u ni t fo r lo w-in co m e se ni or s i n 1 98 5, an d b y 19 86 hi s i nc om e co ns is te d s ol el y of S oc ia l Secu rit y an d re ti rem en t p aym en ts to ta li ng ap pr ox im at el y $1 ,00 0 am on th . Agen t Ch ande te rm in edth atth e “ cas h h oa rd ” le adth atpe ti ti on ers su gg es te d was no t reas on ab le , andsh e d idno t ad jus t Do na ldan d M ari e’s op en in g n etwort h o n t hi s acco un t. Pet it io ne rs als o a ss ert edth atth ey ha d o n h an d l arg e am ou nt s o f cas h d eriv edfro m

Whi te San ds ’ op erat io ns . Agen t Ch andi d n otdi sp ut e th atass ert io n, bu t s he was u nabl e to de te rm in e ex actch an ge s i n c as h b al an ces be cau se of p et iti on ers ’ in co m

pl et e rec or ds an d c omm in gl in g o f fu nd s. Sh e th eref or e u se d the

“ flo at in g c as h” or “ da sh m etho d” as app ro ve d i n Un it edSta te s v . Giaca lo ne , 57 4 F.2 d 3 28 , 33 3 (6 th Cir . 19 78 ). Und er thi s fo rm ul a Age ntCh anass um edth atth e am ou nt s o f cas h p et it io ne rs ha d o n h an d wer e rel at iv el y co ns is te ntfro m

y ear t o y ear a ndth us di d n otaffe ctth e an nu al ch an ge inth ei r res pe ct iv e n etwort hs . Inde te rm in in g p et it io ne rs ’ res pe ct iv e as se ts Agen t Ch anid en ti fie d p ro pe rty th atin cl ud edba nkacco un ts , bro ke rag e st at em en ts , m utua l fu nd s, re al est at e, ve hi
--1 5-

[* 15 ] cle s, an d i nv en to ry . The p rin ci pa l u nc ert ai nt y co nc ern edho w Whi te San ds ’ as se ts sh ou ldbe all oc at edam on g p et it io ne rs . Agen t Ch ande te rm in edth at50 % of it s as se ts sh ou ldbe all oc at edto Don al d a ndMari e an d 5 0% t o F ran k. Sh e b as ed th is all oc at io n o n (am on g o th er thi ng s) th e fac ts th at : (1 ) Fran k a ndDon al d h el d th em se lv es ou t t o n um ero us th irdpa rti es as c oo wne rs of Whi te San ds ; (2 ) Fran k an d Do na ldadm it te d i n c iv il li ti ga ti on th atth ey were co own ers of ( or

“partn ers ” in ) Whi te San ds ; (3 ) Fran k a dm it te d t o Ag en t Br od eri ckth athe was a50 % own er of Whi te San ds ; (4 ) Fran k m an ag edab ou t h al f of th e Whit e San ds st or es ; (5 ) Fran k a ndhi s p aren ts each ob ta in edEINs fo r Whi te San ds ; (6 ) Fran k a ndhi s pa ren ts each rep orte d s ha res of Whi te San ds ’ pr of it s o n t he ir r es pe ct iv e Sch edul es C; an d (7 ) th e Whit e San ds gro ss rece ip ts an d e xp en se s re po rte d o n t ho se Sch edul es C were d iv id edrou gh ly 50- 50 be twee n F ran k o n t he on e h an d a nd Don al d a ndMari e o n t he ot he r. 4 Fran k’s co ns tru ct io n o f a h ou se inSan taBarb ara dur in g 1 99 8- 20 00 ev id en cedsi gn ifi can t i nc reas es to hi s n etwort h. He p ur ch as edth e lo t fo r $4 00 ,00 0 a ndto re d own th e ex is ti ng dwel li ng un it . He th enbe gan c on st ru ct io n o f a 5 ,00 0- square-f

oo t h om e th aten ta il edat l eas t $ 40 0,0 00 inco ns tru ct io n c os ts , as Inon e in st an ce, Ag en t Ch andi d n otall oc at e to Fran k a ny po rti on of t he 4 fund s i n aba nkacco un t o pe ne d i n Whi te San ds ’ na m e b ecau se he lac ke d s ig na to ry au th or it y ov er tha t ac co un t.-1 6-

[* 16 ] rep orte d t o S an taBarb ara C ou nt y au th or it ie s. Ag en t Ch anall oc at edth e co ns tru ct io n c os ts to tax y ear 1 99 8, 1 99 9, o r 20 00 pri m ari ly on t he ba si s o f in
vo ic es fro m

co nt ract or s o r si m il ar ev id en ce. Sh e al lo cat edco st s fo r whi chsh e d id no t h av e in vo ic es to tax y ear 2 00 0, the y ear c on stru ct io n was co m pl et ed . All c on st ru ct io n c os ts serve d t o i nc reas e Frank ’s networt h fo r th e rel ev an t year. Age ntCh anne xtde te rm in edpe ti ti on ers ’ res pe ct iv e li ab il it ie s fo r eac h year. The se li ab il it ie s i nc lu de d m ortg ag es on real est at e, cred itcardde bt , andve hi cl e lo an s. Fo r eac h year in is su e Age ntCh ansubt ract edli ab il it ie s fr om ass et s t o pr oduc e cl os in g n etwort h, the n o ffs etth e p rio r y ear’s cl os in g n etwort h t o pr oduc e th e an nu al ch an ge inne t wo rth . The ne xtst ep inAgen t Ch an ’s ana lysis was t o “ ta x e ffec t” th e an nu al ch an ge s i n n etwort h t o p ro du ce AGI fi gu res foreach y ear. Sh e th eref or e ad de d

“ no nd educ ti bl e it em s” an d “ it em iz edde du ct io ns ” an d s ub tra ct ed“ no n- in co m e it em s.” Fo r th e m os t p art“no nd educ ti bl e it em s” co ns is te d o f pe rs on al li vi ng ex pe ns es . Suc h e xp en se s m us t b e p ai d fr om

so m e so ur ce an d, u nd er the ne t wo rth th eo ry , Agen t Ch anass um edth atpe ti ti on ers de frayed the se ex pe ns es us in g un rep orte d i nc om e. Inad di ng ba ck“ no nd educ ti bl e it em s” to pe ti ti on ers ’ an nu al ch an ge s i n n etwort h, Ag en t Ch anin cl ud edon ly tho se it em s (s uc h a s re ntor c ar le as e p aym en ts ) fo r whi chsh e h adcle ar ev id en ce o f th e am ou ntan d p ur po se , as-1 7-

[* 17 ] ev id en cedby cance le d c he ck s, i nv oi ces , or c red itcardst at em en ts . For t hi s reas onhe r im

pl em en ta ti on of t he ne t wo rth m etho do lo gy con si st en tl y un de rs ta te d pe ti ti on ers ’ actua l p ers on al li vi ng ex pe ns es an d h en ce u nd ers ta te d t he ir AGI fo r each y ear. Fo r ex am pl e, Age ntCh anha d e vi de nc e th atpe ti ti on ers pa idres id en ti al wate r bi ll s, an d s he in cl ud edth es e ex pe ns es as “ no nd educ ti bl e it em s” inhe r cal cu la ti on . Howev er, s he di d n otad d b ackan y othe r res id en ti al ut il it y

ch arg es -- e.g ., for t el ep ho ne , cab le , gas , or e le ctric servi ce-- be cau se sh e d idno t h av e de fin it iv e ev id en ce o f su chpaym en ts . Furt he r, al th ou gh Agen t Ch anha d b an k st at em en ts form os t o f Don al d a ndMari e’s acc ou nt s, s he ha d c an cel edch eck s sh owi ng th e p ay ee fo r on ly a sm al l num be r of th e ch eck s tha t cl eare d the se acco un ts . In co m

pu ti ng “no nd educ ti bl e it em s” sh e ad de d b ackon ly tho se ex pe ns es forwhi chsh e h ada can cel edch eckde no ti ng a pe rs on al type o f ex pe nd itur e (e.g ., a che ckpa y ab le to a ph arm acy). The effe ctwas t o t reatall ot he r ch eck s as al lo cab le to de du ct ib le bu si ne ss ex pe nd itur es . Sim il arl y , Agen t Ch andi d n otad d ba ckany ex pe ns es forit em s l ik e g ro ceri es , res taur an t m eal s, cl ot hi ng , or g as ol in e fo r whi chpe ti ti on ers pa idcas h. Inall th es e res pe ct s s he res ol ve d unc ert ai nt ie s i n pe ti ti on ers ’ fav or , con si st en tl y un de rs ta te d t he ir “ no nd educ ti bl e it em s,” a ndco rres po nd in gl y

un de rs tate d t he ir AGI fo r eac h year in is su e.-1 8-

[* 18 ] Afte r ad di ng ba ckno nd educ ti bl e expe ns es an d p et it io ne rs ’ rep orte d i te m iz edde du ct io ns , Agen t Ch ansubt ract ed“ no n- in co m e it em s,” t ha t i s, re cei pt s fr om no nt ax ab le so ur ces . Fran k a ss ert edth atcert ai n fu nd s h e h adrece iv edfro m hi s pa ren ts co ns ti tu te d alo anrathe r th ana di vi si on of Whi te San ds ’ pr of it s an d h en ce th atth es e fu nd s s ho ul d h av e b eentre at edas a“ no n- in co m e it em .” Howev er, Fran k fa il edto pre se ntAgen t Ch anor t he Co urt wi th an y do cu m en ta ti on of s uc h a lo an , any loa n t erm s, o r an y pro of of r ep aym en t. With ou t an y pro of th atth e tra ns ferr edfun ds were n on ta xabl e, Age ntCh ande cl in edto subt ractth is am ou ntin de te rm in in g F ran k’s AGI fo r th e rel ev an t year. At thi s s te p Ag en t Ch anals o m ad e as su m pt io ns th atbe ne fit edpe ti ti on ers . Fo r ex am pl e, du rin g o ne y ear i n i ss ue , Fran k s ol d aho us e an d re al iz eda ga in of $6 0,0 00 . Agen t Ch antre at edth is as n on ta xabl e g ai n fr om th e sa le of apri nc ip al res id en ce u nd er s ect io n 1 21 an d t hu s s ub tra ct editwhen co m pu ti ng Fran k’s AGI fo r th aty ear. Ag en t Ch anlat er l earn edth atth e h ou se m ay no t i n fa ctha ve qu al ifie d a s Fr an k a ndHele n’s p rin ci pa l re si de nc e atth e ti m e th ey so ldit . Agen t Ch an ne ve rth el es s l eftth is as ano nt ax ab le it em , gi vi ng th em th e b en efi t o f th e d oubt . Tria l Don al d a ndMari e, who ap pe aredpro se a t tria l, re qu es te d t ha t the y be al lo wedto pre se ntth ei r cas e aft er re sp on de ntha d p uton hi s ca se . The Co urt-1 9-

[* 19 ] gra nt edth is reque st . After r es po nd en t re st ed , Don al d a ndMari e d eci de d t o res t wi th ou t p ut ti ng on anaffi rm at iv e cas e. The C ou rt n ot edth atDon al d a nd Mar ie ha d i nc lu de d i n the st ip ul at io n o f fac ts a nu m be r of do cum en ts to whi ch res po nd en t h adres erv edob jecti on s an d e xp la in edth atth es e d oc um en ts co ul d n ot co m e in to ev id en ce u nl es s the y pu t o n t he ir c as e. They sti ll wis he d t o re st . The Co urt, o n i ts ownin it ia ti ve , th enex am in edth e d oc um en ts inqu es ti onan d adm it te d i nt o e vi de nc e th os e fo r whi chth ere wer e n o h ears ay ob jecti on s. Afte r tr ia l re sp on de ntfil eda m ot io n t o a m en d t o c on fo rm th e p le ad in gs to th e p ro of . The p ur po se of t hi s m ot io n was to rev is e Age ntCh an ’s networt h cal cu la ti on to co rrec t two m in orerro rs th atcam e to li gh t dur in g h er t es ti m on y . Sp eci fic al ly, res po nd en t re vi se d h er ca lc ul at io n: (1) to m ov e fro m 19 99 to 20 00 , in de te rm in in g F ran k a ndHele n’s n etworth i nc reas es forth os e y ears , con stru ct io n ex pe ns es of $ 7,2 68 on th e San taBarb ara h om e an d (2 ) to subt ract , inde te rm in in g Fran k a ndHele n’s AGI fo r 19 99 , an a dd it io na l n on ta xabl e it em of $ 48 1. Th e rev is edde fic ie nc ie s an d fr au d p en al ti es forFran k a ndHele n a re as fol lo ws: Pen al ty Year Defi ci en cy se c. 66 63 19 99 $3 9,7 93 $2 9,8 45 20 00 17 4,3 27 13 0,7 45-2 0-

[* 20 ] Bec au se th e Co urt i ns tru ct edres po nd en t t o m ak e th es e ch an ge s o n t he ba si s of th e ev id en ce h eardat t ria l, we wi ll gra ntres po nd en t’s m ot io n. OPINION I. Bu rd enof P ro of The IRS’ det erm in at io ns ina no ti ce o f de fic ie nc y are g en eral ly pres um ed co rrec t, an d t he tax pa y er b ears th e b ur de n o f pr ov in g tho se de te rm in at io ns erro ne ou s. Ru le 14 2( a); W el chv. Hel ve rin g, 2 90 U.S. 11 1, 1 15 (19 33 ). Forth e p resu m pt io n t o a dh ere i n c as es in vo lv in g re cei ptof unr ep orte d i nc om e, th e d efi ci en cy de te rm in at io n m

us t b e supp orte d b y

“ so m e ev id en ti ary fo un da ti on li nk in g the ta xp ay er t o t he all eg edin co m e-p ro du ci ng act iv ity .” See Weim ers ki rch v. Co m m is si on er, 5 96 F.2d35 8, 3 62 (9t h C ir. 1 97 9) , rev ’g 67 T.C. 67 2 (1 97 7) . Once res po nd en t h as pro du cedev id en ce l in ki ng th e ta xp ay er t o a n i nc om e-p ro du ci ng act iv ity , th e b ur de n o f pr oo f sh ift s t o t he tax pa y er t o p ro ve by a prep on de ran ce o f th e ev id en ce tha t re sp on de nt ’s det erm in at io ns are arbi trary or e rro ne ou s. Hel ve rin g v . Tay lo r, 29 3 U.S. 5 07 , 51 5 (1 93 5) ; To kars ki v. Co m m is si on er, 8 7 T.C. 7 4 (1 98 6) . To s at is fy hi s i ni ti al bu rd enof p ro du ct io n, re sp on de ntin tro du cedreco rd s th athe ob ta in eddu rin g t he cri m in al in ve st ig at io n a ndth e ci vi l ex am in at io n. Tho se reco rd s es tabl is h t ha t p et it io ne rs rece iv eddu rin g 1 99 8- 20 00 , bu t d idno t-2 1-

[* 21 ] rep ort, s ub st an ti al am ou nt s o f ad di ti on al in co m e fro m op erat io n o f Whi te San ds . On th e b as is of t hi s cr ed ib le ev id en ce, we are sat is fie d t ha t the IRS’ de te rm in at io ns as s etforth inth e n ot ic es of d efi ci en cy are en ti tl edto th e g en eral pr es um pt io n o f co rrec tn es s. See Hardy v. Co m m is si on er, 1 81 F.3d10 02 , 10 04 (9 th Cir . 19 99 ) (d efi ci en cy de te rm in at io ns are en ti tl edto pre su m pt io n o f co rrec tn es s i f th e IRS rel ie s o n “ subs ta nt iv e ev id en ce tha t the tax pa y er re cei ve d un rep orte d i nc om e”), af

f’g T.C. Mem o. 1 99 7- 97 ; Po wers te in v. Co m m is si on er, T.C. Mem o. 2 01 1- 27 1. As re le va nthe re, the pre su m pt io n o f co rrec tn es s i s m od ifi edinon e res pe ct . Res po nd en t i n h is an swe rs ass ert edin crea se d d efi ci en ci es as t o Do na ldan d M ari e fo r 19 99 an d 2 00 0, as to Fran k fo r 19 98 , andas t o F ran k a ndHele n fo r 20 00 . Res po nd en t b ears th e b ur de n o f pr oo f as to th es e in crea se d d efi ci en ci es . See Ru le 14 2( a)(1 ). As ex pl ai ne d m or e fu ll y be lo w, we fin d t ha t re sp on de nt ’s po si ti on on al l fa ctua l i ss ue s i s s up po rte d b y th e p rep on de ran ce o f th e ev id en ce. The al lo cat io n o f th e b ur de n o f pr oo f th us m ak es no di ffer en ce. II. Ana lysis A. Net Wort h F ram ewo rk Sect io n 6 1( a) d efi ne s g ro ss in co m e as “ al l i nc om e fro m what ev er s ou rce de riv ed ,” in cl ud in g i nc om e d eri ve d fr om bu si ne ss . A tax pay er m

us t m ai nt ai n-2 2-

[* 22 ] bo ok s an d re co rd s es tabl is hi ng th e am ou ntof h is or h er g ro ss in co m e. See se c. 60 01 . Whe n atax pa y er k eep s n o b oo ks of a cco un t o r ke ep s b oo ks th atare d em on st rab ly ina ccu rat e, th e IRS m ay de te rm in e h is in co m e “ un de r su chm etho d a s, in th e o pi ni on of t he Secr et ary, do es cle arl y refl ectin co m e.” Sec . 44 6( b) ; s ee Pet zo ld t v . Commis si on er, 9 2 T.C. 6 61 , 69 3 (1 98 9) . Whe n atax pay er fa il s t o m ai nt ai n o r pr oduc e ad equa te reco rd s, the IRS m ay reco ns tru cthi s i nc om e u si ng anin di rectm etho d o f pr oo f. Ch oi v. Co m mis si on er, 3 79 F.3d63 8, 6 39 -6 40 (9t h Ci r. 20 04 ), aff’g T.C. Me m o. 2 00 2- 18 3. The IRS h as gre atlat itud e in reco ns tru ct in g atax pa y er’s i nc om e, an d the reco ns tru ct io n “ ne edon ly be rea so nabl e in li gh t o f al l s urro un di ng fact s an d c ircu m st an ces .” Pet zo ldt, 9 2 T.C. at68 7. On e m etho d o f rec on st ru ct in g i nc om e, lo ng reco gn iz edby cou rts as r eas on ab le , is th e n etwort h m etho d. Se e Hol la ndv. Uni te d S tate s, 3 48 U.S. 12 1, 1 31 (19 54 ). By it s n atur e th e n etworth m etho d s eek s anap pr ox im at io n, ra th er tha n apre ci se de te rm in at io n, o f th e ta xp ay er’s g ro ss in co m e. A lackof e xa ct itud e is in ev it ab le wher e, as he re, “ [t]he * * * [I RS] was fo rcedto us e th e im

pr eci se ne t wo rth m etho d o f es ti m at in g i nc om e b ecau se th e ta xp ay ers ’ reco rd s wer e unr el iabl e an d d idno t ac cu rat el y refl ectin co m e.” Uni te d St at es v. St on eh il l, 7 02 F.2d12 88 , 12 96 (9t h C ir. 1 98 3) .-2 3-

[* 23 ] Und er the ne t wo rth m etho d t he IRS re co ns tru ct s a t ax pa y er’s i nc om e b y de te rm in in g h is ne t wo rth (ex ces s o f as se ts at c os t o ve r li ab il it ie s) at t he be gi nn in g an d e ndof e achy ear i n i ss ue . The d iff eren ce b etweenth os e am ou nt s i s the tax pa y ers ’ annu al ne t wo rth in crea se (orde crea se ). The n etwort h i nc reas e fo r eac h y ear i s the n a dju st edby add in g n on de du ct ib le expe ns es (su chas e ve ry day li vi ng co st s) an d s ub tra ct in g re cei pt s fr om no nt ax ab le so ur ces (su chas g ift s, i nh eri
ta nc es , andlo an s) . See Ho ll an d, 3 48 U.S. at 1 25 . An in crea se inne t wo rthfora gi ve n year crea te s an in fere nc e o f ad di ti on al gro ss in co m e fo r th aty ear, p ro vi de d th atth e IRS : (1 ) es tabl is he s the tax pa y er’s o pe ni ng ne t wo rth with re as on ab le cert ai nt y an d (2 ) ei th er s ho ws a l ik el y so ur ce o f un rep orte d i nc om e o r ne ga te s po ss ib le no nt ax ab le so ur ces . Id. at13 2- 13 8; Bro ok s v . Comm is si on er, 8 2 T.C. 41 3, 4 31 -4 32 (19 84 ), aff’d wi th ou t p ub li sh edop in io n, 7 72 F.2d91 0 (9 th Cir . 19 85 ). 5 Inth e in st an t ca se s p et it io ne rs fai le d t o m ai nt ai n a ccu rat e b oo ks or r eco rd s fro m whi chth ei r Fed eral tax li ab il it ie s co ul d b e co m pu te d. Fra nkadm it te d dur in g Bec au se th e g oa l o f th e n etworth m etho d i s t o g en erat e anap pr ox im at io n 5 of th e ta xp ay er’s AGI fo r a g iv eny ear, an y it em iz edde du ct io ns cla im edby the ta xp ay er, wh ic h s erv e to reduc e AGI, are i ni ti al ly add edba ckalo ng with p ers on al li vi ng ex pe ns es inord er t o c al cu la te om it te d g ro ss in co m e. See B razwe ll v. Co m m is si on er, T.C. Mem o. 1 99 2- 46 3. Aft er AGI is de te rm in ed , tax ab le in co m e is de te rm in edinth e n orm al way by sub tra ct in g i te m iz edde du ct io ns an d a ll owi ng for pe rs on al ex em

pt io ns .-2 4-

[* 24 ] tri al an d i n p os tt ria l b rie fs th athe fai le d t o re po rt a t l eas t $ 20 0,0 00 of in co m e fro m

Whi te San ds . In the ir c riminal tax cas e Don al d a ndMari e st ip ul at ed th atth e ta x l os s at tri bu tabl e to th ei r un de rrep orti ng of i nc om e fro m Whi te San ds was $2 10 ,62 8. Al th ou gh th is pri orst ip ul at io n d oe s n otco ll at eral ly esto p t he m fro m ch al le ng in g the sp eci fic tax de fic ie nc ie s as se rte d h ere, i t d oe s co ns ti tu te an adm is si on th atth ei r ta x re tu rn s o m it te d s ub st an ti al am ou nt s o f gr os s i nc om e. See Liv in gs to n v . Comm is si on er, T.C. Mem o. 2 00 0- 12 1, 7 9 T.C.M . (CCH) 1 82 8, 18 33 . Use o f th e n etworth m etho d i s cl earl y pro pe r whe re, as he re, the “ ta xpa y er’s rec or ds do no t ac cu rat el y refl ectin co m e.” Uni te d S ta te s v . She tt y , 13 0 F.3 d 1 32 4, 1 33 1- 13 32 (9th C ir. 1 99 7) . Pet it io ne rs do no t que st io n re sp on de nt ’s us e o f th e n etwort h m etho d t o re co ns tru ctth ei r in co m es for19 98 -2 00 0. Th ey li ke wis e d o n otch al le ng e th e an alytic al ap pr oa chth atAgen t Ch anad op te d i n i m pl em en ti ng th is m etho do lo gy or th e m an ne r inwhi chsh e res ol ve d m os t s ub si di ary is su es . Peti ti on ers co nt es t re sp on de nt ’s po si ti onon fiv e m ai n g ro un ds . Firs t, the y co nt en d tha t Ag en t Ch an te st ifi edas a n e xp ertan d t ha t h er t es ti m on y an d e xh ib it s wer e in adm is si bl e be cau se res po nd en t d idno t fo ll ow Tax Co urt Ru le s re ga rd in g t he subm is si on of ex pe rt t es ti m on y . Seco nd , pet it io ne rs co nt en d tha t Ag en t Ch andi d n otaccu rat el y cal cu la te th ei r ne t wo rth s b ecau se sh e fai le d t o t ak e in to acco un t “ cas h h oa rd s”-2 5-

[* 25 ] th atth ey

all eg ed ly deri ve d fr om

gi fts an d/ orfro m

op erat io n o f Whi te San ds . Thi rd , Fran k c on te nd s tha t the in crea se inhi s n etwort h d eri ve d i n p artfro m a no nt ax ab le so ur ce, n am el y , a lo anfro m hi s p aren ts . Fou rth , Fran k c on te nd s tha t Age ntCh anerre d i n d et erm in in g t ha t h e was a 50 % own er o f Whi te San ds . Fi na ll y , Don al d a ndMari e co nt en d t ha t the ne t wo rth cal cu la ti on di d n ottak e in to acco un t the ir o ut st an di ng li ab il it y forCal ifo rn iasal es tax . W e ad dr es s the se co nt en ti on s b el ow. B. Age ntCh an ’s Test im on y Pet it io ne rs arg ue th atAgen t Ch antes ti fie d a s an ex pe rt b y pro vi di ng sci en ti fic , tec hn ic al , andsp eci al iz edkn owl ed ge . See Fed . R. Evi d. 7 02 . Becau se Age ntCh anwas n otde si gn at edanex pe rt a nddi d n otfurni sh anex pe rt r ep ort as requi redby T ax Co urt Ru le s, p et it io ne rs co nt en d t ha t h er t es ti m on y sh ou ldha ve be enrul edin adm is si bl e. See R ul e 1 43 (g ) (ex pe rt r ep ort); Ru le 10 2 (c on ti nu in g du ty to d is cl os e ex pe rt) . Res po nd en t co un te rs th at“ [i]n c iv il tax cas es , esp eci al ly in un rep orte d i nc om e cas es , res po nd en t’s re ve nu e ag en ts tes ti fy , no t as expe rts , bu t ra th er t o d es cri be th e m etho do lo gy use d b y res po nd en t t o a sc ert ai n t he ta xp ay ers ’ un rep orte d i nc om e.” We agre e wit h re sp on de nt . 6 Pet it io ne rs als o c on te ndth atAgen ts Bro de ric k a ndDeck er were im pr op erl y 6 al lo wedto tes ti fy

as e xp ert s. Th ere i s n o s ub st an ce wh at ev er t o t hi s ar gu m en t. (co nt in ue d...)-2 6-

[* 26 ] Ru le 70 2 o f th e Fed eral Ru le s o f Evi de nc e d efi ne s an ex pe rt a s a “ witne ss who is qu al ifi edas an e xp ertby kno wled ge , sk il l, ex pe rie nc e, tr ai ni ng , or e du cati on .” An ex pe rt m ay

tes ti fy inth e fo rm

of a n o pi ni on or o th erwi se if h er “ sc ie nti fic , tec hn ic al , or o th er s pe ci al iz edkn owl ed ge wil l h el p t he tri er o f fac t t o u nd erst an d t he ev id en ce.” Id . Con ve rs el y , a lay witn es s m ay no t o fferanop in io n b as ed on sci en ti fic , tec hn ic al , or o th er s pe ci al iz edkn owl ed ge . Id. 7 01 . An IR S rev enue ag en t wh o re co ns tru ct s a t ax pa y er’s i nc om e an d l at er t es ti
fie s as to th e m etho do lo gy she em pl oyed g en eral ly is n otanex pe rt wi tn es s. Fo r ex am pl e, in Gud en sc hwa ge r v. C omm is si on er, T.C. Mem o. 1 98 9- 6, 5 6 T.C.M . (CCH) 10 10 , an I RS re ve nu e ag en t d et erm in edth e ta xp ay er’s u nr ep orte d i nc om e by usi ng Bureauof Lab or Sta ti st ic s t ab le s fo r a s im il arl y si zedfam il y

with a n in te rm ed ia te st an da rdof l iv in g i n t he same m etro po li ta n a rea. Th e ta xp ay er ob jecte d t o t he ag en t’s t es ti m on y , ass ert in g t ha t s he was n otqu al ifi edas a n e xp ert to tes ti fy co nc ern in g t he fig ur es us ed . The Co urt o ve rru le d t hi s o bjec ti on : [T]he wit ne ss was n ottes ti fy in g a s an ex pe rt wh ensh e d es cri be d t he m etho do lo gy use d b y

res po nd en t t o a sc ert ai n p et it io ne r’s un rep orte d in co m e. The wi tn es s t es ti fie d re ga rd in g wh atm etho do lo gy was u se d, no t the va li di ty of th atm etho do lo gy. Si nc e th e wit ne ss was n otpro vi di ng sci en ti fic , tec hn ic al , or o th er s pe ci al iz edkn owl ed ge to ass is t (...co nt inue d) 6 Bo th ag en ts tes ti fie d s ol el y as f actwitne ss es by recou nt in g e ve nt s tha t o ccurred du rin g t he cri m in al in ve st ig at io n o f pe ti ti on ers .-2 7-

[* 27 ] th e co urt t o u nd ers ta ndth e ev id en ce i n t hi s ca se , rul e 7 02 * * * is no t ap pl ic ab le an d t he witne ss ’s tes ti m on y wil l n otbe tre at edas ex pe rt t es ti m on y . Id ., 56 T.C.M. (CCH) a t 1 01 2 (f n. re f. om it te d) . W e ag ree wi th th e Co urt’s re as on in g i n Gu de ns ch wag er. Age ntCh andi d no t o fferan y

op in io n b as edon sci en ti fic , tec hn ic al , or o th er s pe ci al iz edkn owle dg e. Rathe r sh e te st ifi edas t o t he fact s o f th e ci vi l t ax au di t tha t s he co nduc te d, in cl ud in g t he do cu m en ts sh e co ll ect ed , th e in te rv ie ws s he he ld , andth e o bs erv ati on s s he m ad e. Sh e al so ex pl ai ne d i n d et ai l the m etho do lo gy she fol lo wed , whi ch is expl ic it ly laidou t i n t he Int ern al Rev enue Man ua l (I RM) . See IRM pt . 4.1 0.4 .6.7 (Ju ne 1, 2 00 4) . In al lo win g h er t o t es ti fy , th e Co urt re pe at ed ly stat ed th athe r te st im on y

wou ldbe acce pt ed , no t fo r th e p ur po se of d em on st rat in g t he co rrec tn es s o f he r m etho do lo gy, butso le ly for the pu rp os e o f ex pl ai ni ng whatsh e di d. Be cau se Agen t Ch anwas n otqu al ifi edas a n e xp ertan d d idno t t es ti fy as a n ex pe rt, re sp on de ntwas n otrequi redto fol lo w th is Co urt’s ex pe rt wi tn es s ru le s. 7 InUni te d S ta te s v . Fran tz , No. CR 0 2- 01 26 7( A)-MM M, 2 00 4 WL 7 56 42 90 9, at*1 2 (C .D. Cal. Ap r. 23 , 20 04 ), th e Dis tri ctCo urt fo r th e Cen tra l Dis tri ctof C al ifo rn iahe ldth at : [p ]urs ua ntto Ru le 70 1, * * * [th e IRS ag en ts ] m ay ex pl ai n t he ir r ol e as au di to rs an d t es ti fy

ab ou t h ow an au di t i s g en eral ly con du ct ed . The y m ay als o t es ti fy

to th e d oc um en ts an d i nf orm at io n t he y ob ta in ed , th e res earc h the y co nduc te d, the co nv ers at io ns th ey ha d, (co nt in ue d...)-2 8-

[* 28 ] Inth e cri m in al tax co nt ex t, “ te st im on y by an IRS ag en t tha t al lo ws the wit
ne ss to ap pl y

th e b as ic ass um

pt io ns an d p rin ci pl es of t ax acco un ti ng to pa rti cu la r fact s i s ap pr op ria te .” Uni te d S ta te s v . Sti erh of f, 54 9 F .3d19 , 28 (1s t Ci r. 20 08 ). Co urts ha ve he ld , andpe ti ti on ers co nc ed e, th ata la y su m m ary witne ss m ay

off er ta x c al cu la ti on s i f th e cal cu la ti on s ar e “ strai gh tfo rwardan d t ran sp aren t.” Se e, e.g ., Uni te d S tate s v . Diez, 5 15 F.2d89 2, 9 05 (5th C ir. 1 97 5) ; Un it edSta te s v . Baras , CR 1 1- 00 52 3 YGR, 2 01 3 WL 65 02 84 6, at*4 n.4 (N.D. Cal. Dec . 11 , 20 13 ). “ The ke y to adm is si bi li ty is tha t the su m m ary witne ss ’s tes ti m on y do es no m or e th an an al yze fa ct s al read y

in tro du cedin to ev id en ce an d s pe ll ou t the tax co ns eque nc es th atne ces sa ril y

flo w fro m

th os e fac ts .” Sti erh of

f, 54 9 F .3dat 2 8. InSti erh of

f, a ta x e va si on cas e, th e Gov ern m en t p res en te d t he tes ti m on y of IRS Ag en t Pl es ha w as asu m m ary witne ss . The d efen da ntob jecte d t o Ag en t Pl es ha w’ s t es ti m on y

on th e g ro un d t ha t h e was no t qua li fie d a s an ex pe rt. Th e Co urt o f App eal s fo r th e Fi rs t Ci rcu itdi sa gr eed , ho ld in g tha t Ag en t Pl es ha w cou ld te st ify as a s umm ary witne ss to ex pl ai n t he “un rem ark ab le ” m etho do lo gy, id. at 27 , th athe em

pl oyed t o re co ns tru ctth e ta xp ay er’s i nc om e: (...co nt inue d) 7 an d t he factua l o bs erv at io ns th ey m ad e dur in g the co ur se of t he ir au di t, t o t he ex te ntth es e m at te rs are b as edonth ei r rat io na l p erce pt io n of in fo rm at io n a ndev en ts , anddo no t re ly on s pe ci al iz edor t ech ni cal kn owl ed ge . * * *-2 9-

[* 29 ] Usi ng bankde po si t re co rd s, Pl es ha w com pu te d t he de fen da nt ’s gr os s re cei pt s * * * . He th ensetto on e si de no n- ta xabl e rec ei pt s (s uc h a s l oan p ro ceed s) an d s ub tra ct edbu si ne ss ex pe ns es (tr eat in g a ll no n- cas h wi th dr awal s fr om th e d efen da nt ’s acco un ts as d educ ti bl e) * * *. To t he 20 02 to ta l, h e ad de d t he cas h fo un d dur in g t he sea rch (wh ic h t he de fen da ntha d a dm it te d * * * em an at edfro m hi s b us in es s de al in gs ). Inth atm an ne r, Ple sh aw arri ve d a t an est im at e o f th e de fen da nt ’s netpro fit s fo r eac h year. There aft er, h e ad jus te d fo r se lf- em pl oym en t t ax es , to okth e st an da rdde du ct io n, an d fa ct or edin pe rs on al ex em

pt io ns . Thes e co m

pu ta ti on s yield edth e d efen da nt ’s pu ta ti ve tax ab le in co m e fo r eac h o f th e fo ury ears inqu es ti on . * * * The Co urt o f App eal s h el d t ha t the ch arac te riz at io ns Agen t Pl es ha w had m ad e enrou te to hi s co nc lu si on s, e.g ., clas si fy in g re cei pt s as “ in co m e” an d wi th
dr awal s as “ expe ns es ,” di d n otrep res en t i m pe rm is si bl e le ga l o pi ni on s, b utrathe r

“ were p artof am ech an ic al so rti ng of e nt rie s” un de r th e m etho do lo gy he h ad em pl oyed. St ie rh of

f, 54 9 F .3dat 2 8. Th e Co urt o f App eal s co nc lu de d t ha t i t was withi n t he Dis tri ctCo urt’s d is cret io n t o a ll ow Ag en t Pl es ha w to tes ti fy witho ut fir stqu al ifyin g h im

as a n e xp ertbe cau se he “ si m pl y di d t he m ath.” Id. at29 . W e rea chth e sam e co nc lu si on he re. Age ntCh antes ti fie d abo utfact s an d nu m eri cal da tath atwere ad m it te d i nt o e vi de nc e, ge ne ral ly by st ip ul at io n. Sh e te st ifi edas t o t he m etho do lo gy she em pl oyed i n re co ns tru ct in g p et it io ne rs ’ in co m es on th e b as is of t he se da ta . This m etho do lo gy occa si on al ly requ ire d h er t o ch arac te riz e certa in da ta , e.g., t o b reakou t co stba si s, t ax -d educ ti bl e it em s, an d-3 0-

[* 30 ] no nd educ ti bl e it em s fr om a real est at e cl os in g d oc um en t. Bu t i n s o d oi ng sh e was no t o ffer in g l eg al op in io ns . She was s im pl y ex pl ai ni ng th e “ m ech an ic al so rti ng of e nt rie s” inwhi chsh e en ga ge d u si ng th e m etho do lo gy she ha d em pl oyed. St ie rh of

f, 54 9 F .3dat 2 8. Pet it io ne rs co nt en d t ha t the an al y si s s etforth ab ov e “ st em s fr om cas e la w th atha s b eensupe rs ed edby an am en dm en t t o t he Fed eral Ru le s o f Evi de nc e.” Acco rd in g t o p et it io ne rs , bef or e 2 00 0 c ou rts rou ti ne ly allo wedlay witn es se s t o of fer o pi ni on tes ti m on y

intax cas es un de r ru le 70 1 o f th e Fed eral Ru le s o f Evi de nc e. In20 00 , ho wev er, tha t ru le was a m en de d t o d is al lo w lay opi ni on te st im on y th atis ba se d o n “ sc ie nt ifi c, te ch ni cal , or o th er s pe ci al iz edkn owl ed ge withi n t he sco pe of Rul e 7 02 .” See Fe d. R. Ev id . 70 1. Th is am en dm en t re qu ire d al l o pi ni on tes ti m on y

ba se d o n awitne ss ’ sc ie nt ifi c, te ch ni cal , or o th er s pe ci al iz ed kn owl ed ge to be ren de redby a pro pe rly qu al ifi edexpe rt. In pe ti ti on ers ’ vi ew, Gud en sc hwa ge r an d c ert ai n o th er ca se s ci te d abo ve ha ve be ensupe rs ed edby thi s am en dm en t. Pet it io ne rs are m is ta ke n. Ru le 70 1 o f th e Fed eral Ru le s o f Evi de nc e as am en de d d is al lo ws a l ay

witne ss ’ te st im on y

on ly if itis “ba se d o n s ci en ti fic , te ch ni cal , or o th er s pe ci al iz edkn owl ed ge .” The C ou rt i n Gu de ns ch wag er, 5 6 T.C.M. (CC H) at10 12 , hel d t ha t the IRS re ve nu e ag en t wh o t es ti fie d a s a s um --3 1-

[* 31 ] m ary witne ss “was no t p ro vi di ng sci en ti fic , tec hn ic al , or o th er s pe ci al iz ed kn owl ed ge ”; th athe r te st im on y was the refo re o ut si de th e sc op e o f ru le 70 2 o f th e Fed eral Ru le s o f Evi de nc e; an d t ha t h er t es ti m on y “ wil l n otbe tre at edas e xp ert te st im on y .” The same con cl us io n fo ll ows he re. Si nc e Age ntCh an ’s tes ti m on y was n ot ba se d o n s ci en ti fic , tec hn ic al , or o th er s pe ci al iz edkn owl ed ge , itfel l o ut si de th e sc op e o f ru le 70 2 o f th e Fed eral Ru le s o f Evi de nc e. The 2 00 0 a m en dm en t t o ru le 70 1 t hu s h as no effe ctonth e adm is si bi li ty of he r te st im on y or o n t he co nt in ui ng vi ta li ty of th e Gud en sc hwa ge r li ne of c as es . Und er es tabl is he d c as el aw Age nt Ch anwas c om

pe te ntto tes ti fy

as asu m m ary witne ss to ex pl ai n h er im pl em en ta ti on of t he ne t wo rth m etho d, an d h er t es ti m on y was p ro pe rly adm it te d fo r th atpu rp os e. 8

Pet it io ne rs co nt en d tha t Ag en t Ch an ’s networt h s ch edul es were i na dm is
8 si bl e und er Fe d. R. Ev id . 10 06 . W e adm it te d t he se sch edul es as s umm ary ch art s t o as si stth e Co urt i n e va lu at in g t he ev id en ce b ecau se of the vo lu min ou s s ti pu la te d ex hi bi ts . See Un it edSta te s v . Anekwu, 6 95 F.3d96 7, 9 81 -9 82 (9t h C ir. 2 01 2) (h ol di ng th attri al co urt d idno t ab us e it s d is cret io n i n a dm it ti ng su m m ary ch art s an d u nd erl y in g re co rd s i nt o e vi de nc e). Pet it io ne rs als o c on te ndth atth e su m m ary ch art s ar e in adm is si bl e h ears ay . They do no t d ev el op th is arg um en t, an d t he Co urt fin ds itm eri tl es s. All of t he en tri es on Agen t Ch an ’s cha rts were l in ke d t o a dm is
si bl e ev id en ce, an d s he tes ti fie d abo utth e m ath s he em pl oyed i n c reat in g t he se ch art s o n t he ba si s o f th atev id en ce.-3 2-

[* 32 ] C. Cas h o n Han d Pro pe r im pl em en ta ti onof t he ne t wo rth m etho d re qu ire s the IRS t o e st ab li sh th e ta xp ay er’s o pe ni ng ne t wo rthwith re as on ab le cert ai nt y . Hol la nd , 34 8 U.S. at 13 2. Do na ldan d M ari e co nt en d t ha t Ag en t Ch an ’s ana lysis fai ls th is th res ho ld te stbe cau se sh e d idno t g iv e th em cred itfora larg e “ cas h h oa rd .” Thi s co nt en ti on is no t wi th ou t p rece de nt . “ A fav or it e d efen se inne t wo rth cas es is th attax pa y er ha d alar ge am ou ntof u nd ep os it edcas h o n h an d at the be gi nn in g o f th e in ve st ig at io n p eri od . This m ay ex pl ai n t he di sp ro po rti on at e in crea se inne t wo rth ov er the in crea se of t ax ab le in co m e.” Sch warzk op f v. C omm is si on er, 2 46 F.2d 73 1, 7 34 (3dCir . 19 57 ), aff’g an d re m an di ng T.C. Mem o. 1 95 6- 15 5; Lig htv. Co m m is si on er, T.C. Mem o. 1 98 7- 57 2. Th e cl ai m th ata subs ta nt ia l ca sh ho ard ex is ts is oft en“ m etwith s om e su sp ic io n.” De Venn ey v. Co m m is si on er, 8 5 T.C. 92 7, 9 33 (19 85 ). W e are m or e th anso m ewh atsu sp ic io us of p et it io ne rs ’ cl ai m s. Don al d a ndMari e al le ge th atth ey ha d a n und ep os it edcas h h oa rdof abo ut $2 00 ,00 0 a t the en d o f 19 97 , supp os ed ly resu lt in g fr om a gi ft f ro m Don al d’s fathe r, Fred . The ev id en ce es tabl is he d, h owe ve r, th atFredwas n otina fi na nc ia l po si ti onto m ak e su cha gi ft. Acc or di ng to SSA rec or ds Fred ’s to ta l i nc om e du rin g t he 40 -y ear p eri oden di ng in19 77 was $ 18 5,4 30 . Fredret ire d i n 1 98 5 a nd m ov edin to a fed eral ly sub si di zedho us in g uni t fo r lo w-in co m e se ni or s. By 198 6-3 3-

[* 33 ] hi s i nc om e co ns is te d s ol el y of S oc ia l Se cu rity

an d re ti rem en t p aym en ts to ta li ng ab ou t $ 1,0 00 a m on th . This ev id en ce was cle arl y su ffi ci en t t o s up po rt t he in fere nc e th atFredlac ke d t he wher ewit ha l t o m ak e a $ 20 0,0 00 cas h g iftto Don al d an d M ari e. See Un it edSta te s v . Giaca lo ne , 57 4 F .2d32 8, 3 33 (6t h C ir. 1 97 8) ; McGarry v. Un it edSta te s, 3 88 F.2d86 2 (1 stCir . 19 67 ); Un ge r v. C ommis si on er, T.C. Mem o. 2 00 0- 26 7. Th ere was no ev id en ce t o s up po rt t he ex is te nc e o f su cha gi ft apart f

ro m Don al d’s t es ti m on y , whi chth e Co urt d idno t fi ndcred ib le . Fran k m ak es a so m ewh atdi ffer en t ar gu m en t co nc ern in g h is all eg edun de
po si te d c as h. He co nt en ds th athe de riv edlar ge am ou nt s o f cas h fr om Whi te San ds ’ op erat io ns an d t ha t Ag en t Ch an ’s networt h a na lysis fai le d t o t ak e th is in to acco un t. The pri nc ip al supp ort fo r Fran k’s “ cas h h oa rd ” arg um en t was hi s o wn te st im on y , whi chwe di d n otfin d c red ib le . Havi ng ob se rv edhi s d em ean or on th e witne ss st an d, we fo un d h im ev as iv e an d l ack in g i n c an do r. W e h av e co ns id ered hi s co nv ic ti on forwil lfu ll y m ak in g a ndsubs cri bi ng to fal se returns as a n ad di ti on al fact orbe ari ng on hi s cr ed ib il it y . Cred ib il it y

ap art , Fran k’s “ cas h h oa rd ” arg um en t h as no supp ort i n t he reco rd . Alth ou gh Fran k u se d c as h t o p ay Whi te San ds ’ ex pe ns es , th ere i s n o e vi
de nc e th athe accu m

ul at eda cas h h oa rdfro m

Whi te San ds ’ op erat io ns . Qui te th e co nt rary: Fran k t es ti fie d t ha t h e co ll ect edth e d ai ly recei pt s fr om th e st or es he-3 4-

[* 34 ] m an ag ed , pu t the m

in to a se al eden ve lo pe , andga ve th e en ve lo pe to hi s m ot he r. The b es t ev id en ce was th atth e st or e rec ei pt s co ns ti tu ti ng Whi te San ds ’ pr of it s wer e d ep os it edby Marie or Do na ldin to vario us ba nkacco un ts . There was no ev id en ce tha t Fr an k “ sk imm ed ” p ro fit s fr om th e st or es he m an ag edbe fo re de li ve rin g t he sea le d e nv el op es to Mari e. Whi te San ds was acas h- in te ns iv e b us in es s, an d p et it io ne rs ke ptsubs ta nt ia l am ou nt s o f cas h o n h an d t o p ay it s v en do rs an d e xp en se s. Ch an ge s i n t he se cas h ba la nc es th eo ret ic al ly cou ldaffe ctan nu al ch an ge s i n t he ir n etwort hs . Butth e reco rd s p et it io ne rs supp li ed , whi chwere i nc om pl et e an d o fte n u nr el iabl e, di d n ot en ab le Agen t Ch anto de te rm in e wit h a ny prec is io n ann ua l ch an ge s i n c as h ba la nc es . Peti ti on ers canha rd ly com pl ai n o f th is . As th e Co urt o f App eal s fo r th e Nin thCir cu itpu t i t: “ Arit hm et ic pre ci si on was o rig in al ly andex cl us iv el y in* * * [th e ta xp ay er’s] han ds , andhe ha d ast atut ory du ty to p ro vi de it . * * * [H]avi ng de
fau lt edinhi s dut y , he c anno t frus tra te th e Co m m is si on er’s rea so nabl e at te m pt s b y co m pe ll in g i nv es ti ga ti on an d re co m pu ta ti onun de r ev ery m ean s o f in co m e de te rm in at io n.” Adam so n v . Comm is si on er, 7 45 F.2d54 1, 5 48 (9t h C ir. 1 98 4) (quo ti ng W eb b v . Comm is si on er, 3 94 F.2d36 6, 3 73 (5th C ir. 1 96 8) ), aff’g T.C. Mem o. 1 98 2- 37 1.-3 5-

[* 35 ] Fo r th es e rea so ns Agen t Ch anrel ie d o n t he so -cal le d d as h m etho d o f acco un ti ng for

un de po si te d c as h. In st eadof try in g t o c al cu la te an nu al cas h b al an ces , Age ntCh anass um edth atth e am ou nt s o f cas h p et it io ne rs ke pton ha ndfor us e in th ei r bu si ne ss were re la ti ve ly con st an t fr om y ear t o year. In h er n etworth c al cu la ti on s, s he acco rd in gl y

pl aceda da sh , or z ero , inth e co lu m n l ab el ed“ cas h o n ha nd .” As a re su ltth e an nu al ch an ge inpe ti ti on ers ’ ne t wo rth s was no t af fect ed , po si ti ve ly or ne ga ti ve ly, by the un de po si te d c as h t he y he ld . Becau se itis im

po ssi bl e to asc ert ai n, i n unr ep orte d i nc om e si tu at io ns , pre ci se ly how m uc h c as h a ta xp ay er h as at a ny part ic ul ar t im e, co urts ha ve co ns is te nt ly app ro ve d t he us e o f th e “ da sh m etho d.” See Gi acal on e, 57 4 F .2dat 3 32 -3 33 ; Ro be rts v. Co m m is sio ne r, T.C. Mem o. 1 98 7- 18 2; Uni te d S ta te s v . Goi ch m an , 40 7 F . Sup p. 9 80 , 99 5 (E.D. Pa. 19 76 ), aff’d, 5 47 F.2d77 8 (3 d C ir. 1 97 6) . W e co nc lu de th atAgen t Ch an es tabl is he d p et it io ne rs ’ op en in g n etwort hs with re as on ab le cert ai nty an d t ha t s he pr op erl y acco un te d fo r th e cas h the y ke ptonha ndinsubs eque nty ears . D. All eg edLoan s Pro pe r im pl em en ta ti onof t he ne t wo rth m etho d re qu ire s the IRS t o a dju st an nu al ne t wo rthin crea se s b y subt ract in g a m ou nt s re cei ve d fr om no nt ax ab le so ur ces , su chas g ift s, i nh eri ta nc es , andlo an s. See Hol la nd , 34 8 U.S. at12 5, 1 37
- 13 8. Th e Co urt o f App eal s fo r th e Nin th Cir cu itha s n otrequi redth e IRS to run-3 6-

[* 36 ] do wn ev ery co nc ei vabl e rab bi t h ol e whe n i nv es ti ga ti ng lea ds ab ou t p os si bl e no nt ax ab le rece ip ts . Rath er, “ [t]he go ve rn m en t m us t i nv es ti ga te an d n eg at e a ta xp ay er’s ex pl an at io n o nl y if i t i s ‘reas on ab le ’ an d ‘reas on ab ly sus cep ti bl e o f be in g c he ck ed .’ ” Uni te d S ta te s v . And ers on , 64 2 F .2d28 1, 2 85 (9t h C ir. 1 98 1) (quo ti ng Hol la nd , 34 8 U.S. at13 5) . Fran k c on te nd s tha t h e “ to okou t a v ari ety of s ho rt- te rm

pe rs on al lo an s fr om Whi te San ds or h is pa ren ts th atwere al way s re pa id .” A lo anis “ anag reem en t, ei th er ex pr es s o r im

pl ie d, wh ereb y

on e p ers on adva nc es m on ey to th e o th er an d th e o th er ag rees to rep ay

itup on su chterm s as to ti m e an d ra te of i nt eres t, o r witho utin te res t, as th e p art ie s m ay ag ree.” Cal lo way

v. Co m m is si on er, 1 35 T.C. 26 , 36 -3 7 (2 01 0) . A tran sf er o f fu nd s co ns ti tu te s a l oa n o nl y if, wh enth e fu nd s were ad vanc ed , th e p art ie s ac tu al ly int en de d re pa ym en t. See Cla rkv. Co m m is si on er, 2 66 F.2d69 8, 7 10 -7 11 (9t h C ir. 1 95 9) , rem an di ng T.C. Mem o. 19 57 -1 29 . Age ntCh anth or ou gh ly inv es ti ga te d t he trans fers to Fran k fr om hi s p aren ts an d d et erm in edth atth es e tr an sf ers were n otlo an s. Th ere was no ev id en ce wha ts oe ve r, ap artfro m

pe ti ti on ers ’ un co rro bo rat edtes ti m on y , th atth e su m s tran sferr edwere l oa ns as o pp os edto a di vi si on of Whi te San ds ’ pr of it s. No pro m is so ry no te s wer e ex ecu te d. Th ere was no ev id en ce o f a s ta te d i nt eres t ra te . There was-3 7-

[* 37 ] no in st ru m en t es tabl is hi ng a rep aym en t s ch edul e. Andth ere was no ev id en ce tha t Fr an k e ve r rep ai d h is pa ren ts or tha t h is pa ren ts ev er s ou gh t rep aym en t. We fou ndFran k’s t es ti m on y on th is po in t t o b e v ag ue , con cl us ory , an d u nwo rth y

of b el ie f. Co ns id eri ng all th e fac ts an d c irc um st an ces , we fin d t ha t Age ntCh anco rrec tl y

de te rm in edth atth es e tr an sf ers were n otlo an s. E. Owner sh ip of Whi te San ds Fran k c on te nd s tha t Ag en t Ch anerre d i n a ll oc at in g h al f of Whi te San ds ’ as se ts to hi m . Befo re the IRS cr im in al in ve st ig at io n b eg an , Fran k re pe at ed ly rep res en te d h im se lf a s a c oo wne r of Whi te San ds to ve nd or s, l an dl or ds , ban ks , le ss or s, i ns ur an ce co m

pa ni es , m un ic ip al off

ic ia ls , andth e St at e o f Cal ifo rn ia . Dur in g t he cri min al in ve st ig at io n F ran k a dm it te d i n an i nt erv ie w with Ag en t Bro de ric k t ha t h e was a 50 % own er o f Whi te San ds . He rep orte d Whi te San ds ’ pr of it s o n h is Sch edul es C, an d i ts rep orte d g ro ss rece ip ts an d e xp en se s wer e di vi de d ro ug hl y

50 -5 0 b etweenhi s Sc he du le s C an d h is pa ren ts ’ Sch edul es C. Co ns id eri ng all th is ev id en ce, Ag en t Ch anreas on ab ly con cl ud edth at50 % of Whi te San ds ’ as se ts sh ou ldbe all oc at edto Fran k. Fran k t es ti fie d i nc on si st en tl y on th is po in t attri al . He in it ia ll y ass ert edth at he ha d n o o wne rs hi p i nt eres t i n Whi te San ds bu t was a m ere e m pl oyee. Co nf ro nt edwith the fact s tha t Whi te San ds di d n otpa y hi m a reg ul ar s al ary an d-3 8-

[* 38 ] ne ve r is su edhi m

a Fo rm W -2 , he a dm it te d t ha t h e m ig htha ve ha d s om e own ers hi p i nt eres t i n t he bu si ne ss . He th ensu gg es te d t ha t h is own ers hi p i nt eres t was , at m os t, o ne -th ird , with t he rem ai ni ng two -th ird s s pl itbe twee n h is pa ren ts . His tes ti m on y

to th is effe ctwas i m

pe ach edby his av erm en t, i n a20 01 fil in g wi th th e Cal ifo rn iasupe rio r co urt, tha t h is m ot he r ha d n o o wne rs hi p i nt eres t i n t he bu si ne ss . All i n a ll we fin d t ha t the ev id en ce co nc lu si ve ly sup po rts Agen t Ch an ’s de te rm in at io n t ha t 5 0% o f Whi te San ds ’ as se ts sh ou ldbe all oc at edto Fran k fo r pu rp os es of t he ne t wo rth an al y si s. F. Reduc ti on forAll eg edSal es Tax Li ab il it ie s Don al d a ndMari e co nt en d t ha t Ag en t Ch anerre d, i n d et erm in in g t he ir li ab il it ie s, b y

fai li ng to co ns id er the ir “ unpa id , ou ts ta nd in g d eb ts to th e Cal ifo rn ia St at e Bo ardof Equa li zat io n.” Don al d a ndMari e p res en te d n o a ffi rm at iv e cas e at tri al an d i nt ro du cedno ev id en ce t o e st ab li sh th e fac t o f th es e li ab il it ie s. Th e o nl y ev id en ce the y

po in t t o i s a o ne -p ag e ex hi bi t capt io ne d “ Sal es Tax Sc he du le .” Thi s sc he du le is no t an off

ic ia l BOE d oc um en t an d app ears to ha ve be encrea te d u si ng a Mi cro so ft Ex cel pro gr am . The ev id en ce d oe s n otest ab li sh th atth es e am ou nt s were b on a fi de li ab il it ie s tha t wer e due bu t u np ai d. Ab se ntsu chpro of , th ey ha ve fai le d t o s ho w any erro r in Agen t Ch an ’s cal cu la ti on s.-3 9-

[* 39 ] G. Co nc lu si on Res po nd en t h as sh own , by a p rep on de ran ce o f th e ev id en ce, tha t Ag en t Ch an ’s networt h c al cu la ti on s wer e rea so nabl e an d fr ee o f arb it rari ne ss an d e rro r. If an yth in g, h er ca lc ul at io ns were g en ero us to pe ti ti on ers : s he res ol ve d n um ero us do ub ts inth ei r fav or , andsh e m ad e as su m pt io ns th atun ifo rm ly ten de d t o u nd erst at e th ei r AGIs. Sh e es tabl is he d p et it io ne rs ’ op en in g n etworths with re as on ab le cert ai nt y ; re as on ab ly det erm in edth atWhi te San ds was the li ke ly sou rce o f th ei r om itte d i nc om e; an d n eg at edall pl au si bl e n on ta xabl e so ur ces of i nc om e. Pet iti on ers ha ve id en ti fie d n o e rro rs inhe r im pl em en ta ti on of t he ne t wo rth m etho d, ot he r th anth e m in orerro rs th atres po nd en t co nc ed edinhi s p os ttria l m ot io n t o am en d t o c on fo rm

pl ead in gs to pro of

. As th us ad

jus te d we s us ta in res po nd en t’s de te rm in at io ns of p et it io ne rs ’ un rep orte d i nc om e fo r 19 98 , 19 99 , and20 00 an d h is as se rti on s o f in crea se d d efi ci en ci es forcert ai n o f th es e y ears . III. Ci vi l Fr au d P en al ty Res po nd en t d et erm in edfrau d p en al ti es ag ai ns t p et it io ne rs for19 98 , 19 99 , an d 2 00 0. Fra nkco nc ed edth e fraudpe na lt ie s d et erm in edag ai ns t h im , and res po nd en t d oe s n otco nt en d t ha t an y of t he un de rp aym en ts were due to frau d pe rp etrat edby H el en . See s ec. 6 66 3( c) (“ Inth e cas e o f a joi ntreturn, thi s s ect io n sh al l n otap pl y

with re sp ectto a sp ou se un le ss so m e p artof the un de rp aym en t i s-4 0-

[* 40 ] du e to th e fraudof s uc h s po us e.”). Do na ldan d M ari e co nt es t the frau d pe na lt ie s d et erm in edag ai ns t the m . In the ir 2 00 7 p le a ag reem en ts Don al d a nd Mar ie ag reedth atth ey

were “ li ab le for

th e ci vi l fr au d p en al ty im po se d b y th e In te rn al Rev enue Co de * * * o n t he un de rs ta te m en ts of t ax li ab il it y for19 98 , 19 99 , and20 00 .” The e vi de nc e attri al cle arl y est ab li sh edth atth ey

are i nd eed li ab le forth es e fraudpe na lt ie s.

“ If an y pa rt o f an y

un de rp aym en t o f ta x re qu ire d t o b e sh own on a return i s du e to frau d,” sec ti on66 63 (a) i m po se s a p en al ty of 75 % of t he po rti on of the un de rp aym en t due to frau d. Re sp on de ntha s the bu rd enof p ro vi ng frau d, an d h e m us t p ro ve itby clearan d c on vi nc in g e vi de nc e. Sec. 7 45 4( a); Ru le 14 2( b) ; Ri ch ard so n v . Commis si on er, 5 09 F.3d73 6, 7 43 (6t h C ir. 2 00 7) , aff’g T.C. Mem o. 20 06 -6 9. To su st ai n h is bu rd enres po nd en t m us t es tabl is h t wo el em en ts : (1 ) th at th ere was so m e und erp aym en t o f ta x fo r eac h t ax ab le y ear i n i ss ue ; an d (2 ) th atat le as t s om e p orti on of t he un de rp aym en t fo r eac h year was du e to frau d. Heb ran k v. Co m m is si on er, 8 1 T.C. 6 40 , 64 2 (1 98 3) . As ex pl ai ne d abo ve , res po nd en t h as carr ie d h is bu rd enof p ro vi ng th atDon al d a ndMari e und erre po rte d the ir i nc om e an d u nd erp ai d t he ir t ax for19 98 , 19 99 , and20 00 . The remaini ng qu es ti on is whe th er the se un de rp aym en ts were due to frau d.-4 1-

[* 41 ] Frau d i s i nt en ti on al wron gd oi ng de si gn edto ev ad e ta x b el ie ve d t o b e o win g. Neel y v. Co m m is si on er, 1 16 T.C. 79 , 86 (20 01 ). The ex is te nc e o f frau d i s a que sti onof f actto be res ol ve d upo n c on si de rat io n o f th e en ti re re co rd . Esta te of Pi tt ardv. Co m

m is si on er, 6 9 T.C. 3 91 , 40 0 (1 97 7) . Frau d i s n otto be pre su m edor ba se d upo n m ere s us pi ci on . Petz ol dt , 92 T.C. at 6 99 -7 00 . Howev er, b ecau se di rectpro of

of atax pa y er’s i nt en t i s ra rel y av ai labl e, frau du le ntin te ntm ay be es tabl is he d b y

cir cu m st an ti al ev id en ce. Gro ss m anv. Co m mis si on er, 1 82 F.3d 27 5, 2 77 -2 78 (4t h C ir. 1 99 9) , aff’g T.C. Mem o. 1 99 6- 45 2. Ci rcu m st an ces th atm ay

in di cat e frau du le ntin te nt , comm on ly referre d t o a s

“ba dg es of f

rau d,” in cl ud e b utare n otli m it edto : (1 ) un de rs ta ti ng in co m e; (2 ) m ai nt ai ni ng in ad equa te reco rd s; (3) gi vi ng im pl au si bl e o r in co ns is te nt ex pl an at io ns of b eh av io r; ( 4) co nc eal in g i nc om e o r as se ts ; (5 ) fai li ng to co op erat e with t ax au th or it ie s; (6) en ga gi ng inil le ga l ac ti vi ti es ; (7 ) pr ov id in g t es ti m on y th at la ck s cr ed ib il it y ; (8 ) fi li ng fal se do cu m en ts , in cl ud in g fa ls e in co m e ta x re tu rn s; (9) fai li ng to fil e ta x re turn s; an d (1 0) de al in g e xt en si ve ly in ca sh . Spi es v. Un it ed St at es , 31 7 U.S. 4 92 , 49 9 (1 94 3) ; M or se v. Co m m is si on er, T.C. Mem o. 2 00 3- 33 2, 86 T.C.M. (CCH) 6 73 , 67 5, af f’d, 41 9 F .3d82 9 (8 th Cir . 20 05 ). No s in gl e fac to r is di sp os it iv e; ho wev er, the ex is te nc e o f se ve ral fact or s “ is pe rs ua si ve-4 2-

[* 42 ] cir cu m st an ti al ev id en ce o f frau d.” Vano ve r v. C omm is si on er, T.C. Mem o. 20 12 -7 9, 1 03 T.C.M. (CCH) 1 41 8, 1 42 0- 14 21 . Don al d a ndMari e p le ad edgu il ty to wi ll fu ll y m ak in g a ndsubs cri bi ng to a fal se tax return fo r 19 98 . In the ir p le a ag reem en t the y adm it te d tha t the “ m is ta ke s” th ey m ad e o n t he ir 1 99 9 a nd20 00 returns were the same as th os e th ey ha d m ad e on th ei r 19 98 return. Whil e wil lfu ll y m ak in g a ndsubs cri bi ng to a fal se return do es no t i n i ts el f es tabl is h l iabi li ty for the civ il frau d p en al ty, su chact iv ity m ay pr op erl y be co ns id eredinco nn ect io n wi th ot he r fac ts inde te rm in in g wh ethe r an un de rp aym en t o f ta x was du e to frau d. Se e Wrigh t v . Comm is si on er, 8 4 T.C. 6 36 , 64 3- 64 4 (1 98 5) ; Un ge r v. C omm is si on er, T.C. Mem o. 2 00 0- 26 7 (c it in g S to lt zfu s v. Un it edSta te s, 3 98 F.2d10 02 , 10 04 (3dCir . 19 68 )). Co ns is te ntan d s ub st an ti al un de rs ta te m en t o f in co m e is it se lf e vi de nc e o f frau d. Se e Lau rin s v . Co m m is si on er, 8 89 F.2d91 0, 9 13 (9t h C ir. 1 98 9) , aff’g No rm anv. Co m m is si on er, T.C. Mem o. 1 98 7- 26 5. Num ero us ba dg es of f

rau d d em on st rat e th atDon al d a ndMari e in te nt io na ll y ev ad edth e p aym en t o f ta x the y kn ew to be owed . They subs ta nt ia ll y un de rs ta te d th ei r in co m e fo r al l thr ee years i n i ss ue . See St on e v . Comm is si on er, 5 6 T.C. 2 13 , 21 4, 2 24 -2 26 (19 71 ). They m ai nt ai ne d i na de qu at e rec or ds . See Ark . Oil & Gas , In c. v. Co m

m is si on er, T.C. Mem o. 1 99 4- 49 7. Th ey ga ve IRS ag en ts in co ns is te nt-4 3-

[* 43 ] ex pl an at io ns co nc ern in g o wne rs hi p o f Whi te San ds an d m ad e fal se st at em en ts co nc ern in g t he ir p os se ss io n o f it s b us in es s re co rd s. See Mo rs e, 41 9 F.3 d a t 8 33 . Thei r te st im on y at t ria l l ack edcred ib il it y co nc ern in g t he ir a ll eg ed rece ip t o f a $ 20 0,0 00 gi ft f ro m FredW orth . See Sco ttv. Co m m is si on er, T.C. Mem o. 2 01 2- 65 , sl ip op . at 3 3. Th ey de al t ex te ns iv el y

incas h t hr ou gh ou t the y ears inis su e. See Ev an s v . Comm is si on er, T.C. Mem o. 2 01 0- 19 9, af f’d, 50 7 F ed . App x. 6 45 (9th C ir. 2 01 3) . They at te m pt edto co nc eal ass et s b y

stru ctur in g b an k de po si ts be lo w th e $ 10 ,00 0 t hr es ho ldto av oi d b an k re po rti ng to th e IRS . See McC le ll anv. Co m

m is si on er, T.C. Mem o. 2 01 3- 25 1, at*2 7- *2 8. An d the y fil eda fal se in co m e ta x re tu rnforeach y ear. Se e Po tt er v . Commis si on er, T.C. Mem o. 20 14 -1 8. W e fi ndth atth e fac ts , tak enas awho le , cle arl y an d c on vi nc in gl y

est ab li sh th atDon al d a ndMari e act edwith fr au du le ntin te ntan d t ha t ea chof t he ir un de rp aym en ts of t ax for 19 98 , 19 99 , and20 00 was due to frau d. We acco rd in gl y su st ai n re sp on de nt ’s im

po si ti on of t he civ il frau d p en al ty und er s ect io n 6 66 3( a) fo r eac h year.-4 4-

[* 44 ] To re fle ctth e fo reg oi ng , An ap pr op ria te ord er an d d eci si on wil l b e en te red .