T.C. Memo. 1998-337

UNITED STATES TAX COURT

ROBERT E. ILES and MONICA M. ILES, Petitioners v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 38917-87. Filed September 22, 1998.

Petitioners (Ps) were (1) trustees for several trusts

and (2) principal owners of numerous business entities, some

of which were incorporated. The business entities provided

financial and tax planning services. Many of the trusts

held money that people invested in the tax shelters that Ps’

businesses offered. During the years in issue, Ps caused

many of the trusts and some of the business entities to

write checks directly to Ps or to third parties on Ps’

behalf to pay for Ps’ investments and personal expenses. By

amendment to answer, respondent asserted Ps had omitted

additional items of income. Ps did not timely file tax

returns for 1980, 1981, or 1982. When those returns were

finally filed, Ps did not report as income most of the

payments those entities made to Ps or to third parties on

Ps’ behalf. Petitioner husband (H) was the driving force,

with petitioner wife (W) providing computer and accounting

skills to their joint activities. Respondent and W filed a

Stipulation of Settled Issues which conditionally disposed

of all issues concerning W’s liabilities in this case.

1. Held: Ps had substantial underpayment for 1980,

1981, and 1982. Sec. 6653(c)(1), I.R.C. 1954.
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1 The substance of sec. 6653(b) as in effect for 1980 and

1981, and sec. 6653(b)(1) as in effect for 1982, appears in secs. 

6651(f) and 6663 of present law.

Unless indicated otherwise, all section references are to

sections of the Internal Revenue Code of 1954 as in effect for

the years in issue, and all Rule references are to the Tax Court

Rules of Practice and Procedure. 

2 On Sept. 15, 1987, respondent issued a joint notice of

deficiency to petitioners for 1980, and, in the absence of

previously filed tax returns for 1981 and 1982, separate notices

of deficiency to each petitioner for 1981 and 1982.

2. Held, further, H is liable for additions to tax for

civil fraud for 1980, 1981, and 1982. Secs. 6653(b) and

6653(b)(1), I.R.C. 1954.

3. Held, further, H is liable for additional additions

to tax for 1982 based on the portion of the deficiency

attributable to fraud; amounts redetermined. Sec.

6653(b)(2), I.R.C. 1954.

Robert E. Iles and Monica M. Iles, pro sese.

James D. Hill and Matthew J. Fritz, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

CHABOT, Judge: Respondent determined deficiencies in

Federal individual income tax and additions to tax under sections

6653(b)1 (fraud), 6654 (failure to pay estimated tax), and 6661

(substantial understatement of income tax) against petitioner

Robert E. Iles2 as follows (amounts rounded to nearest dollar): 

 Additions to Tax 

 Sec. 6653 Sec. 6653

Year Deficiency Sec. 6653(b) (b)(1) (b)(2) Sec. 6654 Sec. 6661

1980 $103,197 $54,369 - - $6,221 -

1981 253,014 126,507 - - 19,387 -

1982 605,062 - $302,531 1 58,908 $151,266

1 50 percent of the interest due on the entire deficiency.
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By amendment to answer, respondent asserts in the

alternative that, if petitioner Robert E. Iles is not liable for

part or all of the additions to tax for fraud for any of the

years in issue, then he is liable for additions to tax under

sections 6653(a) (negligence) and 6651(a) (failure to timely file

tax returns) for those years.

On April 14, 1988, after respondent issued the notices of

deficiency and a joint petition was filed as to all 3 years,

petitioners Robert E. Iles, hereinafter sometimes referred to as

Robert, and Monica M. Iles, hereinafter sometimes referred to as

Monica, filed joint tax returns for 1981 and 1982. See Phillips

v. Commissioner, 86 T.C. 433 (1986), affd. on this issue and

revd. on another issue 851 F.2d 1492, 1496-1498 (D.C. Cir. 1988),

discussing the effect of filing joint tax returns under such

circumstances. In the above-noted amendment to answer,

respondent recomputed the deficiencies for 1981 and 1982 by

combining the adjustments to income determined in the separate

notices of deficiency and using joint filing rates. Respondent’s

recomputation also reflects respondent’s position regarding

income reported and deductions claimed on petitioners’ late-filed

tax returns, makes certain concessions, and increases some income

items. See sec. 6214(a). The results of respondent’s

recomputation are as follows:
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3 The settlement is conditional in that respondent and

Monica agree that, if Robert’s deficiencies or additions to tax

for the years in issue are redetermined, either by settlement or

trial, to be less than Monica’s as set forth in the Stipulation

of Settled Issues, then Monica is entitled to the lesser amounts

of deficiencies or additions to tax. Although Monica and

respondent do not have an ongoing dispute in the instant case,

Monica technically remains a party petitioner. DeLucia v.

Commissioner, 87 T.C. 804 (1986).

 Additions to Tax 

 Sec. 6653 Sec. 6653

Year Deficiency Sec. 6653(b) (b)(1) (b)(2) Sec.6654 Sec. 6661

1981 $273,262 $139,382 - - $21,047 -

1982 1,013,989 - $508,509 1 98,720 $253,497

1 50 percent of the interest due on the entire deficiency.

Respondent and Monica have filed a Stipulation of Settled

Issues which conditionally disposed of all issues concerning

Monica’s liabilities in this case.3 This case was dismissed for

lack of prosecution as it relates to the issues on which Robert

has the burden of proof, except that respondent’s concessions and

our determinations which conflict with the notice of deficiency

are also to be given effect. After respondent’s concessions and

the events described above, the overarching issue for decision is

whether Robert is liable for civil fraud additions to tax under

section 6653(b) (for 1980 and 1981), and under sections

6653(b)(1) and 6653(b)(2) (for 1982) and, as to section

6653(b)(2), in what amount. Because of our determinations as to

fraud, we need not, and we do not, deal with respondent’s

alternative assertions as to additions to tax under sections

6651(a) and 6653(a).
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FINDINGS OF FACT

Some of the facts have been stipulated; the stipulations and

the stipulated exhibits are incorporated herein by this

reference.

When the petition was filed in the instant case,

petitioners, then husband and wife, resided in Edgewater,

Florida. By the time of the trial in the instant case,

petitioners were divorced.

A. Robert’s Background

Robert was born in 1939 and was reared in the Cincinnati,

Ohio, area. After being graduated from high school in Covington,

Kentucky, in 1956, Robert served 5 years in the United States

Army. He attained the rank of staff sergeant and became an

honors student in the Army’s Noncommissioned Officer School. 

During his service in the Army, Robert attended Officer Candidate

School. Before leaving the Army in 1961, Robert started school

at Santa Rosa Junior college. Robert continued his studies at

that school until 1964, concentrating on courses in marketing. 

At a later date, while he was in prison (see infra T.

Indictments; Criminal Convictions), Robert took accounting,

psychology, and biology classes at Eastern Kentucky University. 

In 1964, Robert joined Bookkeeper’s Business Service Co.,

hereinafter sometimes referred to as BBS, as a salesman. BBS

provided bookkeeping and tax services to various small- and

medium-sized businesses. Between 1964 and 1969, Robert was
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promoted to sales manager, interim branch manager (Cincinnati

area), district sales manager (Cincinnati/Dayton area), and

national new business manager, operating from the home office, in

California. In February 1970, Robert returned to Cincinnati,

where he began to work on insurance claims in the accounting

department at General Electric. In March 1970, Profit

Management, Inc., hereinafter sometimes referred to as PMI,

acquired BBS. PMI operated the same type of business as BBS. 

Sometime during 1970, Robert began to work at PMI. In September

1970, Robert became national new business manager for PMI’s

sister corporation, Profit Controls, Inc., doing the same sort of

work as he had done for BBS. 

Monica was born in 1952. About 1972 Monica left college,

without receiving a degree, and went to work for Profit Controls,

Inc. Petitioners met each other at work, and, in October 1973,

they got married. Petitioners had two children from this

marriage--Adria, born in 1974, and Margo, born in 1976. Robert

had two children from a previous marriage--Robert, Jr., born in

1959, and Billie Marie, born about 1961.

B. Associates; Consultants

In January 1973, Robert started R. Iles and Associates,

(hereinafter sometimes referred as Associates), a sole

proprietorship. Associates operated a bookkeeping and tax return

preparation service. Robert offered franchises in Associates. 
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At the high point of the business, Associates had 20 franchises

in the Greater Cincinnati area, 1 in Michigan and 1 in Florida. 

Most of Associates’ franchisees’ clients were small- and mediumsized businesses. Associates provided services, including the

following, to its franchisees’ clients: (1) Tax and business

consulting; (2) tax return preparation; (3) monthly and annual

financial statements; (4) cash-flow and inventory analyses; (5)

source and application of funds reports; (6) expense, purchase,

and payroll ledgers; (7) Forms W-2 and 1099 preparation; and (8)

audit work. Associates represented to its clients that it had

“the most knowledgeable consultants and advanced technology

available in the accounting field.” The cover of Associates’

1979 advertising brochure invited clients to “Maximize [their]

profits by Minimizing [their] taxes.” In time, other entities

took over some of Associates' activities. However, Associates

continued as a sole proprietorship for one facet of business or

another until the early 1980's. Associates maintained a bank

account at the Central Trust Co. until at least December 1980.

About 1979, R. Iles Tax Consultant, Inc., hereinafter

sometimes referred to as Consultants, took over the bookkeeping

and tax return preparation services previously performed by

Associates. Robert was president and Thomas Ney, (hereinafter

sometimes referred to as Ney), an accountant, was vice president
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4 The parties have stipulated that Consultants “was

comprised of” Robert, Monica, and Ney. However, Monica did not

own any of Consultants’ stock, and she was not a compensated

officer for Consultants’ fiscal years ending May 31 of 1979,

1980, and 1981. Consultants’ corporate tax return for its fiscal

year ending May 31, 1979, declares that Consultants was not

incorporated until June 1, 1979, even though it had business

income and business expenses reportable by it for the fiscal year

before it was incorporated. 

5 So stipulated. However, stipulated exhibits show that

SSC was incorporated in late June or early July 1981. One of

those exhibits shows that SSC was operated as a partnership from

June 1, 1981, to Aug. 1, 1981. The parties also have stipulated

that “Structured Shelters of Cincinnati was formed in the late

1970’s by Robert and Monica Iles and others.” It may be that

Structured Shelters of Cincinnati was a partnership which was

somehow a predecessor of SSC, the corporation, even though the

chronology does not seem to fit. As shown infra in table 1,

Robert was a prolific creator of business entities. SSC figures

more importantly infra items M. and N.

of Consultants. Robert owned 75 percent of the stock of

Consultants and Ney owned 25 percent.4

During 1977, 1978, and 1979, Robert worked full time at his

various duties at Consultants, including soliciting new clients,

servicing existing clients by evaluating their business

performance, reviewing clients’ financial and tax records, and

preparing draft tax returns. At the height of its business,

Consultants had about 100 clients.

C. SSI and Its Chartered Representatives

In 1980, Robert founded and became president of Structured

Shelters of Cincinnati, Inc., hereinafter sometimes referred to

as SSC, which took over the functions of Consultants.5

Initially, SSC served as a prototype for Structured Shelters,
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Inc., hereinafter sometimes referred to as SSI, which was

incorporated on or about August 28, 1980. SSI was a subchapter S

corporation. During 1981 and 1982, Robert was chairman of SSI’s

board of directors, Monica was secretary and treasurer, and

Adrian Doyle (hereinafter sometimes referred to as Doyle) was

president. Doyle was in charge of SSI’s marketing operations. 

During 1981 and 1982, Robert owned 52 percent of SSI’s common

stock, and Monica and Doyle each owned 24 percent.

Robert had SSI incorporated under Ohio law to market “a

nationwide tax planning system.” SSI’s principal business was

tax shelter investigation and management. During the years in

issue, SSI marketed various tax shelters throughout the United

States through a network of “Chartered Representatives”. At the

height of its business operations, SSI had 115 Chartered

Representatives in 33 States and had about 7,000 clients, about

half of whom invested in tax shelters. After SSI was founded,

SSC became a Chartered Representative for SSI, to market SSI’s

products in the Cincinnati area. 

Robert oversaw SSI from both financial and business

standpoints. He worked extensively with SSI’s Chartered

Representatives. Robert also conducted or participated in client

seminars outside of Ohio where he discussed SSI’s organization,

functions, and products.
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Chartered Representatives were people or entities that had

the right to represent SSI in specific geographic areas. To

become an SSI Chartered Representative, a person or entity had to

pay $14,500 for a computer and operating software, and $18,500

for the “SSI System” which included use of financial planning

software. The Chartered Representative also had the option to

buy the financial planning software program from SSI for a

$152,000 promissory note. Under the standard agreement, each

Chartered Representative was required to earn $100,000 in gross

volume, net of any fees to SSI, during the first year of the

agreement, and to maintain that volume of business. If a

Chartered Representative did not meet that requirement, then SSI

reserved the right to terminate the agreement and refund the

original cash investment. Other amounts that Chartered

Representatives paid to SSI included (1) “set-up” fees that

Chartered Representatives charged their clients for putting those

clients into the computer system, (2) “options” fees that

Chartered Representatives paid in order to reserve office

locations, (3) “due-diligence” fees that the Chartered

Representatives’ clients paid, as a percentage of a client’s

investment in a tax shelter, for SSI’s efforts in investigating

that shelter, and (4) “management” fees that were charged to the

Chartered Representatives' clients for managing the tax shelters

in which those clients invested. Hereinafter, the term Chartered
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Representative Fees refers to all of the money SSI collected from

Chartered Representatives.

SSI represented to its Chartered Representatives that each

investment it promoted was carefully selected for its investment

potential and tax-sheltering features; forbade its Chartered

Representatives to offer to their clients any investment

opportunities other than those offered by SSI; and agreed “to

defend any suit in any federal tax court based upon an attempt by

the Internal Revenue Service to deny the tax deferring features

resulting from SSI’s investments.” SSI promoted its services as

a means of sheltering clients’ incomes from “unnecessary taxes”,

and described its products as tax shelters. Each individual

client of SSI (1) created an investment company as a sole

proprietorship that executed a Declaration of Trust naming SSI as

Trustee and (2) executed a Management Agreement naming SSI as

manager of its investment company. The purpose of the

Declaration of Trust was to allow SSI to acquire tax shelters for

the client, and the Management Agreement obligated the client to

pay SSI 1 percent of the client’s gross income on a quarterly

basis and 10 percent of the proceeds from all SSI-recommended

investments.

Under the Management Agreement, each client was to receive a

“Random Report”--a periodic statement of the client’s financial

position. Random Processing Services, Inc., a subchapter C
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6 So stipulated. In Cunningham v. Commissioner, T.C.

Memo. 1989-260, which involved tax liabilities of clients of some

of Robert’s and Monica’s entities, we found, based on the record

made by the parties in that case, that Random Processing

Services, Inc., was a corporation formed by Monica. Also see the

extensive discussion of SSI’s operations in Rybak v.

Commissioner, 91 T.C. 524 (1988).

corporation formed and owned by Robert, prepared the Random

Reports.6 Robert designed the output portion of the Random

Processing System that analyzed SSI’s client’s financial

information and produced the Random Reports. The fee for the

first Random Report was $155; each quarterly Random Report

thereafter cost $20.

Robert directed SSI’s board of directors meetings and some

of the shareholder meetings. Robert (1) worked directly with

third parties who presented tax shelter proposals to SSI and (2)

performed due diligence work in connection with the tax shelter

offerings. Robert worked with attorneys to determine how SSI’s

tax shelter programs would be put together and offered. Robert

had veto power over which tax shelters would be offered to SSI’s

clients. 

Periodically, Robert asked Monica, SSI’s treasurer, about

SSI’s financial performance. By letter dated March 8, 1982,

Monica informed Robert and Doyle that SSI’s 1981 gross receipts

and net receipts on a cash basis were $2,384,052 and $893,312,
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7 Monica’s memorandum states that the report was prepared

on a cash basis. This one-page memorandum was introduced through

Monica on direct examination by respondent. Later the same day,

on cross-examination by Robert, Monica testified that SSI used an

accrual method of accounting; we have so found. The parties have

stipulated, and we have found, infra, that SSI prepared and

maintained substantially all of its books and records

contemporaneously. We have not found in the record an

explanation of why Monica would have produced a cash basis report

while contemporaneously maintaining, or overseeing the

maintenance of, accrual basis records.

8 The parties’ stipulation lists 40 checks and 1 wire

transfer. Respondent’s proposed finding omits three of the

checks. We treat this as respondent’s implicit concession of the

$8,797.39 total of these three checks.

Respondent’s proposed finding lists each of the remaining 37

checks and 1 wire transfer, but incorrectly shows the total

amount as $120,285.67. The parties stipulated to the amount of

each check and wire transfer. The $9,000 error in the total

probably stems from a transposition of two digits during the

(continued...)

respectively.7 By memorandum dated September 13, 1982, SSI’s

controller, Tom Basti, hereinafter sometimes referred to as

Basti, listed petitioners’ income from SSI for 1981 and for the

first 6 months of 1982 as $206,336.60 and $437,592.15,

respectively.

SSI’s principal bank account was in Central Trust Co.; it

was used primarily as a depository for Chartered Representative

Fees and SSI client funds. SSI also had accounts in other banks. 

In 1981, 37 checks and 1 wire transfer, totaling $129,285.67,

were drawn on SSI’s Southern Ohio Bank account to petitioners or

to third parties on petitioners’ behalf; the entire amount was

1981 income to petitioners.8
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8(...continued)

process of adding the stipulated amounts. We do not have any

reason to believe that petitioners were misled or in any way

prejudiced by respondent’s arithmetic error on brief. As a

result, we do not treat respondent’s proposed finding on this

point as an implicit concession of $9,000.

9 The parties’ stipulation lists 42 checks and 1 wire

transfer. Respondent’s proposed finding omits six of the checks

and the one wire transfer. We treat this as respondent’s

implicit concession of the $23,108.30 total of these six checks

and the wire transfer.

On October 30, 1981, two checks totaling $23,000, were drawn

on SSI’s Gradison Cash Reserves Account to third parties on

petitioners’ behalf as performance bonuses for Robert. The

$23,000 was 1981 income to petitioners.

In 1982, 36 checks, totaling $198,850, were drawn on SSI’s

Southern Ohio Bank account to petitioners or to third parties on

petitioners’ behalf; the entire amount was 1982 income to

petitioners.9

In addition, in 1982, six checks, totaling $170,500, were

drawn on SSI’s Southern Ohio Bank account to Structured Shelters

Securities, Inc., hereinafter sometimes referred to as SSSI; they

constituted capital contributions to SSSI on behalf of Robert (52

percent), Monica (24 percent), and Doyle (24 percent). Also in

1982, four checks, totaling $59,237.27, were drawn on that

account to Finkelstein, Thompson, and Levenson, a Washington,

D.C., law firm; they, too, constituted capital contributions to

SSSI on behalf of Robert, Monica, and Doyle in the same
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proportions. SSSI is discussed further infra at item Q. Also in

1982, a check in the amount of $18,716 was drawn on that account

to one Howard Blumenthal; it, too, constituted a capital

contribution to SSSI on behalf of Robert, Monica, and Doyle in

the same proportions. 

In addition, in 1982, two checks, totaling $14,000, were

drawn on SSI's Southern Ohio Bank account to Structured Shelters

Financial Management, Inc., hereinafter sometimes referred to as

SSFMI; they, too, constituted capital contributions to SSFMI on

behalf of Robert (52 percent), Monica (24 percent), and Doyle (24

percent). SSFMI is discussed further infra at item R.

As a result, petitioners had 1982 income in the amount of

$199,464.49 on account of SSI's 1982 payments of capital

contributions to SSSI and SSFMI on petitioners' behalf. 

1. SSI's Financial Books and Records

SSI used an accrual method of accounting and had a fiscal

year ending July 31. SSI prepared and maintained a

contemporaneous balance sheet, a general ledger, a check

disbursement schedule, a journal, and profit and loss statements

during its fiscal years 1981 and 1982. SSI prepared and

maintained a contemporaneous cash receipts journal for the period

September 19, 1980, through July 31, 1982. SSI prepared and

maintained contemporaneous profit and loss statements and journal

entries related to bank statement debits during its fiscal year
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1982. SSI kept its books and records at SSI's headquarters,

where Robert had an office and worked on a daily basis. SSI

maintained a comprehensive tax library. 

2. SSI's 1981 Undistributed Taxable Income

For its fiscal year ended July 31, 1981, SSI received, and

deposited into the Structured Shelters bank account, $436,400 in

gross income, consisting of $374,000 from Chartered

Representative Fees, $8,900 from setup fees, and $53,500 from

options. SSI's deductible expenses for this fiscal year total

$252,663.06. As a result, SSI's taxable income for this fiscal 

year is $183,736.94. In addition, during this fiscal year SSI

made $75,498.55 in payments to or for the benefit of its

shareholders--$30,069.75 as to petitioners and $45,428.80 as to

Doyle. As a result, SSI's undistributed taxable income for its

1981 fiscal year is $108,238.39. Petitioners' 76-percent share

(Robert--52 percent, Monica--24 percent) of this amount is

$82,261.18. 

SSI's fiscal 1981 tax return is discussed infra S. Tax

Returns. 

3. SSI's 1982 Undistributed Taxable Income

For its fiscal year ended July 31, 1982, SSI had gross

income of $6,371,589. SSI's deductible expenses for this fiscal

year, plus SSI payments to or for the benefit of its

shareholders, total $4,958,269.90. As a result, SSI's
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undistributed taxable income for its 1982 fiscal year is

$1,413,319.10. Petitioners' 76-percent share (Robert--52

percent, Monica--24 percent) of this amount is $1,074,122.52. 

D. Free Enterprise Trust

SSI marketed some tax shelters under the name "Free

Enterprise Trust", hereinafter sometimes referred to as the FE

Trust. Petitioners, as trustees, maintained the FE Trust's

Southern Ohio Bank account, which was used predominantly by SSI

clients as a depository for investments. Amounts disbursed from

the account were used mainly to buy tax shelter investments for

SSI's clients. During the period December 1, 1981, through

February 24, 1982, a total of $8,827,197.09 was deposited into

the FE Trust's Southern Ohio Bank account, and $8,564,090.55 was

disbursed from this account. The FE Trust did not file a tax

return. 

A $176,500 withdrawal from this account is discussed infra

under I. Lincoln American Securities. 

E. Riago Trust

In 1980, Robert suggested to Monica that petitioners

transfer all of their assets to a trust. On May 4, 1981,

petitioners, as grantors, executed a Declaration of Trust

establishing Riago Revocable Trust, hereinafter sometimes

referred to as the Riago Trust. Robert was the principal author

of the Declaration of Trust establishing the Riago Trust. The
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Declaration of Trust states that the Riago Trust was created for

the benefit of petitioners and their daughters, Adria and Margo. 

(The word "Riago" is coined from the last letters of petitioners'

daughters' names.) Petitioners were the trustees of the Riago

Trust. The Riago Trust was revocable by the grantors jointly, or

by the surviving grantor. Petitioners, as grantors, had the

power, at any time, to withdraw any portion of the net income or

principal of the trust. 

Petitioners conveyed all of their real, personal, and

business property to the Riago Trust, including the following: 

Their residence; life insurance death benefits; jewelry;

household furnishings; stock or proprietary interests in

Associates (also discussed supra item B), Green, Inc., Random

Processing Services, Inc., Consultants (also discussed supra item

B), Robert Iles Computer Services, Inc., SSI (also discussed

supra item C), and SSC (also discussed supra item C); and "Any

and all other business endeavors." Before and after they

conveyed their property to the Riago Trust, petitioners lived in

the same house in Cincinnati. By letter dated August 18, 1982,

Monica, as cotrustee, informed Robert, as cotrustee, that the

Riago Trust's assets include a 1980 Rolls Royce, new residential

rental property, office furniture and equipment, a 76-percent

interest in the Rise Trust, a Saberliner Jet, jewelry,

improvements on their home, and miscellaneous household
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furnishings and fixtures, and asked that the letter be added to

schedule A of the Declaration of Trust. The jewelry Robert

bought and transferred to the Riago Trust during 1982, included a

$3,780 gold bracelet, $1,600 gold and diamond earrings, a $7,050

diamond ring, and a $7,950 Rolex watch. 

On October 20, 1983, about 1-2 months after petitioners and

their daughters moved from Ohio to Florida, the Declaration of

Trust for the Riago Trust was filed in Florida. On December 19,

1983, petitioners amended the Riago Trust's Declaration of Trust. 

Among other changes, the amendment purported to make the Riago

Trust irrevocable. A commentary and attachment to the Riago

Trust's financial statement, signed by Robert on October 23,

1984, lists the trust assets as having a total value of

$10,194,060.08, liabilities of $367,336.49, and a net value of

$9,826,723.59. The listed assets include the following: A 1981

Rolls Royce, a 1979 Cadillac Eldorado, a 1954 Corvette, a 1984

Chrysler LeBaron, a Russian Sable coat and jewelry valued at

$67,000, a $270,000 home, a $110,000 home, a $300,000 home, a

$361,000 interest in a Saberliner Jet, and a $25,000 interest in

Lincoln American Securities, Inc. Robert bought the Corvette,

Cadillac, and sable coat. Monica wore the sable coat.

On August 20, 1983, Robert, as trustee for the Riago Trust,

bought two homes in Edgewater, Florida. Petitioners and their

daughters lived in one of the homes. On February 13, 1984,
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petitioners, as trustees for the Riago Trust, bought another home

in Edgewater; then they moved their family into that home. At

about this time, petitioners, as trustees for the Riago Trust,

sold the first two homes. A plaque on the front door of the home

bought in 1984 stated that the property was owned by the Riago

Trust. 

A general ledger was maintained for Associates. When

Associates, as Robert's sole proprietorship, paid a personal

expense of petitioners, then that was recorded as a draw on

Associates' general ledger. On and after May 4, 1981, when the

Riago Trust owned Associates, such payments were shown on

Associates' general ledger and also on the Riago Trust's books as

payments by the Riago Trust, through Associates, for petitioners'

personal purposes. 

During 1981 and 1982, Associates paid for a variety of

petitioners' expenses including jewelry, suntanning equipment,

scuba gear, private school tuition, record and tape clubs, a lawn

tractor, mortgage payments, home remodeling bills, utility bills,

real estate taxes, homeowner's insurance, clothing and household

bills, dry cleaning, groceries, toys, pet supplies, furniture,

donations, and medical bills. After petitioners moved to

Florida, a separate bank account was established for the Riago

Trust. From 1984 through 1987, the Riago Trust continued to pay

for petitioners' personal items and expenses. 
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F. The Florida Collection Suit

Glenn Storch, hereinafter sometimes referred to as Storch,

is a Florida attorney who represented David Ellsworth and James

Morrison in a judgment collection suit, hereinafter sometimes

referred to as the Florida collection suit, filed in 1984,

against Robert, the Riago Trust, and various entities controlled

by Robert. Before that suit, David Ellsworth and James Morrison

had obtained an out-of-State judgment against Robert. Storch

obtained a domestication of foreign judgment against Robert to

pursue the out-of-State judgment. 

After filing the Florida collection suit, Storch began

formal discovery against Robert and the Riago Trust. During

discovery, Storch found that all of Robert's property was held by

the Riago Trust. As part of that discovery, Storch deposed

Robert on several occasions, at which time Robert told Storch

that it was fruitless for Storch's clients to try to collect on

their judgment because neither he nor Monica owned anything, not

even the clothes on their backs. Whenever Robert or Monica

attended depositions, they arrived in a Rolls Royce. At

Storch's meetings with petitioners, petitioners wore jewelry,

including a Rolex watch and a diamond ring. During the course of

discovery, Storch saw a 1954 Corvette, extensive exercise

equipment, and a Jacuzzi at petitioners' home. Robert told

Storch that petitioners did not pay any rent to the Riago Trust,
-22-

even though it owned their home; Robert explained that this was

because their daughters lived there and their daughters were the

Riago Trust's beneficiaries. 

In 1989, Storch obtained a Florida judgment which permitted

his clients to collect their prior judgment from assets held by

the Riago Trust. Storch was able to seize only clothing,

exercise equipment, and "some odds and ends" from petitioners'

home; he was unable to locate some assets, and some assets were

so heavily liened that Storch did not believe there was enough

unencumbered equity to make it worthwhile to pursue them. 

G. Cocoa Trusts

During 1980 and 1981, Robert acted as a trustee for Cocoa

Trust I, II, III, IV, V, and VI, hereinafter sometimes

collectively referred to as the Cocoa Trusts. The Cocoa Trusts

were established in 1980, as vehicles for various individuals'

investments in certain patents and to help fund Continental Dutch

Cocoa, Inc. The Cocoa Trusts Escrow Fund, an account in Southern

Ohio Bank, served as a depository account for the Cocoa Trusts'

investors' funds and as the general operating fund for the

project that included Continental Dutch Cocoa, Inc., and the

patents. SSI solicited investors for the Cocoa Trusts, and

served as the manager of the Cocoa Trusts' project.
-23-

10 In the notice of deficiency as to 1980, respondent had

determined that eight specified checks drawn on the Cocoa Trusts

Escrow Fund, in amounts totaling $143,260, constituted unreported

1980 income from the Cocoa Trusts to petitioners. Respondent has

conceded four of these checks, totaling $43,260. Our findings

relate only to the remaining four checks totaling $100,000. 

11 In the notice of deficiency, respondent determined that

eight checks, totaling $31,300, were 1981 income to Robert. By

stipulation, respondent conceded the eighth check, a $2,000 check

to Maximum Management, an entity described infra at L. 

In 1980, Monica wrote four checks totaling $100,000 to

Robert from the Cocoa Trust Escrow Fund.10 One of these checks,

for $90,000, is discussed infra at item H. All $100,000 was 1980

income to Robert. 

In 1981, seven checks totaling $29,300 were written to

Robert from the Cocoa Trusts Escrow Fund.11 All $29,300 was 1981

income to Robert. 

H. Robert Iles, et al.

In 1978, Robert and Robert C. McCormick, hereinafter

sometimes referred to as McCormick, formed the partnership Robert

Iles, et al. Robert Iles, et al., was a "computer company",

providing data processing and other services. Robert had a 65-

percent interest in Robert Iles, et al., and was the

partnership's managing partner. McCormick had a 35-percent

interest in Robert Iles, et al. Both partners contributed

capital and both partners were authorized signatories on the

partnership's loan account at Central Trust. Robert and Monica
-24-

12 The stipulated Dec. 1, 1978, agreement between Robert

Iles, et al., and CAGI states that the only two partners in

Robert Iles, et al., are Robert and Peter J. Reil. Yet, both the

stipulated partnership agreement of Nov. 18, 1978, and the

stipulated partnership 1979 income tax return show Robert and

McCormick as the only two partners in Robert Iles, et al. It

appears that Reil and Robert were supposed to create this

partnership. Reil decided not to participate. McCormick learned

of this development and stepped in. 

were the only authorized signatories on the partnership's

checking account at Central Trust. 

On December 1, 1978, Robert Iles, et al., acquired the

assets and business of Computing and Accounting Group, Inc.,

hereinafter sometimes referred to as CAGI.12 Before this

transfer, CAGI offered computer services, computer programming

and design, computer installation, and other related computer

services. 

In February 1979, Robert Iles, et al., bought a computer,

peripherals, and software from Monitor Information Systems for

$166,500. This purchase was financed in part by a loan from 

Central Trust. Under the financing agreement, Central Trust 

acquired a security interest in the computer and in all the

fixtures and equipment located at petitioners' personal residence

and their business offices, in Cincinnati. Petitioners,

McCormick, and McCormick's wife were personally liable on the

loan. McCormick stopped being associated with Robert Iles, et

al., in 1980 or later. 
-25-

Certain loan payments with respect to the computer were not

made, and Central Trust threatened foreclosure on the computer. 

On December 5, 1980, a $90,000 check payable to Robert was drawn

on the Cocoa Trusts Escrow Fund. See supra item G. Cocoa Trusts. 

On December 9, 1980, a $92,000 deposit was made to Associates'

bank account in Central Trust. Immediately before this deposit,

this bank account had a balance of $569.52. Monica thereupon

drew a check on Associates' Central Trust account, dated December

9, 1980, in the amount of $89,215.22, to Central Trust, to pay in

full the remaining balance on the Robert Iles, et al., loan that

had been taken out to finance the computer, etc., purchase. 

Petitioners' primary motive to repay the loan was to remove the

security interest Central Trust had in assets in their personal

residence and business office. The $89,215.22 check cleared

Associates' Central Trust account on December 10, 1980. After a

$74.10 charge to the account, this left a balance of $3,280.20. 

After that payment, Central Trust's security interest terminated. 

The $90,000 Cocoa Trusts Escrow Fund withdrawal was used by

petitioners to pay the debt from the computer, etc., purchase. 

I. Lincoln American Securities

In 1981, Robert began to search for a broker-dealership he

could buy in order to facilitate sales of investment products and

in order to comply with applicable securities laws. Robert also

wanted an entity which could act as surety on his appeal bonds in
-26-

13 The preamble of the Agreement of Acquisition shows the

buyer as "Lincoln American Holding Company" but it is clear from

the rest of that document and from other documents that both

Robert and Lincoln Securities' seller considered Robert to be the

buyer. See infra table 1. 

a breach-of-contract suit that he had lost at the trial level. 

In order to carry out these plans, on August 7, 1981, Robert,

bought all the stock of Lincoln American Securities, Inc.

(hereinafter sometimes referred to as Lincoln Securities), for

$65,000, with $25,000 due at the closing and the balance, with

interest, payable in three equal annual installments, which

Robert personally guaranteed.13 A check drawn on SSI's Gradison

Cash Reserves account paid the $25,000 that was due at the

closing. The notation "R. Iles personal draw" was on the check. 

On August 10, 1981, Robert and Lincoln Securities executed

three stay-of-execution bonds for the appeal in the above-noted

litigation. The bonds totaled $176,500. Lincoln Securities was

surety on all three bonds. After the execution of the three

appeal bonds, it was discovered that Lincoln Securities did not

have enough capital to act as surety on the bonds. On December

17, 1981, $176,500 was withdrawn from the FE Trust's Southern

Ohio Bank account and shortly thereafter was placed in an

interest-bearing escrow account in Robert's name in the same bank

to fund Robert's appeal bonds. See supra D. Free Enterprise

Trust. In a net worth statement that petitioners submitted in

connection with a 1983 loan application, petitioners listed the
-27-

14 This bank account is different from the SSI bank

account described supra, which was used primarily as a depository

for Chartered Representative Fees and SSI client funds; the two

accounts are in the same bank. 

escrow account (which by then had grown to $181,280) as their own

asset. On the application, this was offset by a $176,000

[$176,500?] "contingent liability". There is no indication that

petitioners understood they had any obligation to return the

money to the FE Trust. 

The $176,500 withdrawn from the FE Trust's Southern Ohio

Bank account on December 17, 1981, was 1981 income to

petitioners. 

J. Random Processing Services

Random Processing Services' bank account was the principal

bank account for Random Processing Services, Inc., and served as

a depository account for the Random Report fees paid by SSI

clients.14 In 1980, five checks totaling $8,675 were drawn on

Random Processing Services' bank account to petitioners. All

$8,675 was 1980 income to petitioners. On March 17, 1981, a

$1,000 check was drawn on this account to Monica. This $1,000

was 1981 income to petitioners. In 1982, two checks totaling

$15,000 were drawn on this account to Monica. All $15,000 was

1982 income to petitioners. 

K. Monica Iles Shelters Trustee Account

The Monica Iles Shelters Trustee account served as a

depository account for investors in various tax shelters promoted
-28-

15 One of these checks, number 214, is in the amount of

$1,500. The check stub shows $609.11 of this amount as "Cash". 

Respondent included only this $609.11 in the notice of deficiency

determination. 

16 One of these checks, number 245, is in the amount of

$450. In the ledger for this account, $154 of this amount is

distributed to "Iles draw". Respondent included only this $154

in the notice of deficiency determination. 

17 Respondent's proposed finding of fact asks that we find

that the check to Monica was for $500. However, the only source

that respondent cites for this proposition shows that the entire

check was for $300. 

18 Respondent's proposed finding of fact departs in

(continued...)

or managed by SSI. In 1980, 38 checks totaling $45,631.78, drawn

on the Monica Iles Shelters Trustee account, were written to

petitioners or to third parties on petitioners' behalf.15 All

$45,631.78 was 1980 income to petitioners. In 1981, 29 checks

totaling $42,961.11, were drawn on the Monica Iles Shelters

Trustee account to petitioners or to third parties on

petitioners' behalf.16 All $42,961.11 was 1981 income to

petitioners. 

L. Maximum Management

Petitioners formed Maximum Management, as Monica's sole

proprietorship, to pay payroll and other expenses of SSI and

other entities petitioners controlled. Maximum Management

received the funds to pay these expenses through intercompany

billings to various entities controlled by petitioners. During

1981, Maximum Management wrote 1 $300 check to Monica17 and 44

checks totaling $5,225.9218 to Jacqueline B. Watkins, hereinafter
-29-

18(...continued)

amounts as to 8 of these 44 checks from the only source that

respondent cites. Our finding is in accordance with the sum of

the amounts in the cited exhibit, which is $125.37 less than the

sum of the amounts in respondent's proposed finding of fact. 

19 The cited source for respondent's proposed finding of

fact shows that five other checks, totaling $562.51, were written

by Maximum Management to Watkins between Jan. 16, 1981, and Feb.

13, 1981. Respondent has not included these checks in the

proposed finding of fact; we treat this as respondent's

concession that these five payments by Maximum Management to

Watkins did not result in income to petitioners. 

20 Respondent's proposed findings of fact list three

additional checks to Watkins, totaling $352.97, and ask us to

find that those checks also gave rise to income to petitioners. 

The first of these checks does not appear in the exhibit that

respondent cites as the sole source for the proposed finding. 

The second of these checks does appear in the cited exhibit, but

was voided; indeed the next check, which respondent also includes

in the proposed finding of fact, shows that it was written to

replace the voided check. The third of these checks, is shown in

respondent's proposed finding of fact as being made out to

Watkins in the amount of $119.83; in the cited exhibit it is made

out to Central Trust Co. in the amount of $3,874.05. We conclude

that none of these three checks is income to petitioners. 

sometimes referred to as Watkins.19 During 1982, Maximum

Management wrote 47 checks totaling $6,049.81 to Watkins.20

These 1981 and 1982 payments by Maximum Management to Watkins

were for Watkins' services in taking care of petitioners'

children. 

All $5,525.92 ($300 to Monica, plus $5,225.92 to Watkins)

was 1981 net profit of Maximum Management, and so was 1981 income

to petitioners. All $6,049.81 was 1982 net profit of Maximum

Management, and so was 1982 income to petitioners. 
-30-

21 As noted supra, petitioners filed their 1981 and 1982

joint tax returns after respondent issued the notices of

deficiency for these years. In the notice of deficiency to

Robert, respondent determined that Robert had $10,000 ordinary

income from this transaction. By their 1981 joint tax return,

petitioners have conceded that the correct amount is $10,953,

$953 greater than the amount respondent determined. Respondent

has conceded, on brief, that petitioners are entitled to treat

the income as long-term capital gain. 

M. First Sale of Interest in Structured Shelters of Cincinnati

As noted supra, SSC became a Chartered Representative for

SSI, to market SSI's products in the Cincinnati area. SSC's

principal business activity was financial planning. In March

1981, when Robert entered into an agreement to sell an interest

in SSC to Gary Elliot, hereinafter sometimes referred to as

Elliot, SSC was wholly owned by Robert. 

By letter dated September 25, 1981, Robert told Elliot that

the purchase price of a 50-percent interest in SSC was $250,000,

which included a $50,000 down payment. As of that date, Elliot

had paid $10,000 of the down payment. Later, the sale was

rescinded. On Schedule D of their 1981 tax return, petitioners

reported $10,953 as a long-term gain from the attempted sale of

Structured Shelters of Cincinnati, Inc. 

Petitioners are taxable on this $10,953 as a 1981 long-term

capital gain.21 

N. Second Sale of Interest in Structured Shelters of Cincinnati

On March 22, 1982, Robert entered into an agreement to sell

SSC to Kent Maerki, hereinafter sometimes referred to as Maerki,
-31-

and SSI consented to Robert's transfer of SSC to Maerki. On that

same day, a certificate for 255 shares of SSC stock was issued to

Christina M. Gambetta (Maerki's sister), and a certificate for

245 shares of SSC stock was issued to John A. Gambetta (Maerki's

brother-in-law). Maerki was to pay Robert $150,000, in three

equal installments on May 1, August 1, and November 1, 1982. 

On or about April 29, 1982, Maerki lent $55,000 to SSC, of

which (1) SSC paid $50,000 to SSI as the May 1, 1982, required

installment, and (2) SSC paid $1,923.29 to SSI as the required

interest, under the Maerki-Robert sales agreement. On September

1, 1982, SSC paid $10,000 to Robert. On Schedule D of their 1982

tax return, petitioners reported $61,923 as a long-term capital

gain from partnerships and fiduciaries, related to Robert's sale

of SSC. 

Petitioners received $60,000 long-term capital gain income

and $1,923.29 interest income for 1982 on account of Robert's

sale of SSC. 

O. Rolls Royce

On February 12, 1982, Robert, as trustee for the Riago

Trust, bought a Rolls Royce car for $79,000. SSI paid the

$10,000 deposit on the car on February 10, 1982, and the $69,000

balance on the car on February 16, 1982. SSI also paid the

$4,345 Ohio sales tax on the car on March 12, 1982. SSI's

general ledger listed the $79,000 in wire transfers and the
-32-

22 There was not any declaration of trust or other formal

document establishing the Rise Trust. There were not any Rise

Trust bank accounts. The record does not indicate any "activity"

of Rise Trust other than being the named purchaser of the Jet. 

As far as we can tell from the fragments of information in the

record, the Rise Trust is merely a name used by petitioners and

Doyle as a "straw man" in connection with their intended

coownership of the Jet, with Robert having a 52-percent interest,

Monica having a 24-percent interest, and Doyle having a 24-

percent interest. 

$4,345 in sales tax that SSI paid on the Rolls Royce as

performance bonuses to Robert. 

On February 16, 1983, title to the Rolls Royce was

transferred as a gift from Robert, as trustee for the Riago

Trust, to Robert individually. 

Petitioners listed the Rolls Royce, valued at $90,000, as a

personal asset in the net worth statement that they submitted in

connection with a 1983 loan application. After the $30,000 loan

was approved, the bank took a security interest in the Rolls

Royce. 

The $83,345 that SSI paid in 1982 to buy the Rolls Royce

($10,000 plus $69,000 plus $4,345) was 1982 income to

petitioners. 

P. Saberliner Jet Aircraft

On February 5, 1982, Robert, acting individually and on

behalf of the Rise Trust, entered into an agreement to buy a

Saberliner Jet Aircraft, hereinafter sometimes referred to as the

Jet,22 for $1,205,000. This total was to be paid as follows: 

$25,000 as a deposit that day, $375,000 at delivery, and a 1-year
-33-

note for $700,000 plus $105,000 interest--in the amount of

$17,500 a month starting 6 months after delivery. Robert, acting

on behalf of the Rise Trust, signed the security agreement in

connection with the $700,000 note. Robert individually

guaranteed the note. SSI paid the $25,000 deposit on February 5,

1982. Robert, acting on behalf of the Rise Trust, accepted

delivery of the Jet on February 16, 1982. The FE Trust paid the

$375,000 that was due at delivery. 

Petitioners, as 76-percent owners of the Rise Trust, had

1982 income in an amount equal to 76 percent of the $400,000 of

1982 payments made by their controlled entities ($25,000 by SSI,

plus $375,000 by the FE Trust) for the Jet, or $304,000. 

Q. Structured Shelters Securities

In August 1982, petitioners and Doyle formed Structured

Shelters Securities, Inc., hereinafter sometimes referred to as

SSSI. SSSI was incorporated in Delaware. SSSI was formed on the

advice of Finkelstein, Thompson, and Levenson in order to bring

SSI's investment offerings into compliance with Federal

securities laws and regulations. SSSI was to act as a registered

broker-dealer of securities; it was to locate investments for,

and to act as an investment adviser and financial planner to,

SSI's clients. 

As we have found (supra C. SSI and Its Chartered

Representatives), in 1982 SSI paid $229,737.27 as capital

contributions to SSSI ($170,500 directly to SSSI and $59,237.27
-34-

to Finkelstein, Thompson, and Levenson), and these contributions

were allocated among Robert (52 percent), Monica (24 percent),

and Doyle (24 percent). 

Petitioners listed $263,260.11 paid-in capital for SSSI as a

personal asset in the net worth statement that they submitted in

connection with a 1983 loan application. Supra O. Rolls Royce. 

A July 31, 1983, SSSI balance sheet shows total paid-in capital

of $448,665. 

The capital contributions by SSI to SSSI on behalf of

petitioners are 1982 income to petitioners. 

R. Structured Shelters Financial Management

In August 1982, petitioners and Doyle formed Structured

Shelters Financial Management, Inc., hereinafter sometimes

referred to as SSFMI. SSFMI was incorporated in Delaware at the

same time as SSSI. SSFMI was formed on the advice of

Finkelstein, Thompson, and Levenson to act as an investment

adviser to SSI's clients. 

As we have found (supra C. SSI and Its Chartered

Representatives), in 1982 SSI paid $14,000 as capital

contributions to SSFMI, and these contributions were allocated

among Robert (52 percent), Monica (24 percent), and Doyle (24

percent). Petitioners listed $43,103.69 paid-in capital for

SSFMI as a personal asset in the net worth statement that they

submitted in connection with a 1983 loan application. Supra O.
-35-

Rolls Royce. The capital contributions by SSI on behalf of

petitioners are 1982 income to petitioners. 

S. Tax Returns

Petitioners are cash basis taxpayers.

1. Petitioners' 1980 Tax Return

On April 15, 1981, petitioners filed for an extension of

time to file their 1980 tax return. Respondent granted to

petitioners an extension to June 15, 1981. Additional extensions

for petitioners' 1980 tax return were neither sought by

petitioners, nor granted by respondent. Petitioners filed their

joint 1980 tax return on September 18, 1981. 

On their 1980 tax return, petitioners reported (1) $79,989

gross income and $71,154 net profit from Associates, (2) $19,010

gross income and $39,128 net loss from Robert Iles Computer

Services, and (3) a $13,860 net loss from Robert Iles, et al. 

Petitioners reported their total 1980 tax liability as $5,541

($1,283 income tax, $1,471 self-employment tax, and $2,787 tax

from recomputing prior-year investment credit). Below their

signatures, petitioners wrote the following: "This return was

prepared under duress due to summons and it will be amended." 

However, petitioners never amended their 1980 tax return. 

2. Petitioners' 1981 Tax Return

On April 15, 1982, petitioners filed for an extension of

time to file their 1981 tax return. Respondent granted to
-36-

petitioners an extension to June 15, 1982, a further extension to

August 15, 1982, and a final extension to October 15, 1982. 

Petitioners filed their 1981 tax return on April 14, 1988, after

the notices of deficiency were issued and the petition was filed. 

On their 1981 tax return, petitioners reported (1) $44,107

gross income and $24,585 net profit from Associates, (2) $15,298

gross income and $16,285 net loss from Robert Iles Computer

Service, (3) $68,529 gross income and net profit from Robert's

role as business manager of Riago Trust, (4) $35,451 gross income

and $4,770 net loss from Maximum Management, (5) $35,648 as

grantor trust income from Riago Trust, and (6) $10,953 long-term

capital gain from the attempted sale of SSC. Supra M. First Sale

of Interest in Structured Shelters of Cincinnati. Petitioners

reported their total tax liability as $5,501 ($1,304 income tax,

$2,762 self-employment tax, and $1,435 alternative minimum tax). 

3. Petitioners' 1982 Tax Return

On April 15, 1983, petitioners filed for an extension of

time to file their 1982 tax return. Respondent granted to

petitioners an extension to August 15, 1983. Petitioners did not

seek, and respondent did not grant, any additional extensions for

petitioners' 1982 tax return. Petitioners filed their 1982 tax

return on April 14, 1988, after the notices of deficiency were

issued and the petition was filed. 
-37-

On their 1982 tax return, petitioners reported (1) $121,918

gross income and $106,416 net profit from Robert's role as trust

manager (presumably from Riago Trust), (2) $7,899 gross income

and $154 net profit from Maximum Management, (3) $178,658 as

grantor trust loss from Riago Trust, (4) $61,923 long-term

capital gain from the sale of SSC, and (5) a $3,589 short-term

capital gain pass-through from Riago Trust. Supra N. Second Sale

of Interest in Structured Shelters of Cincinnati. Petitioners

reported their total tax liability as $3,029, all from selfemployment tax. 

4. Structured Shelters' and Riago Trust's 1981

 and 1982 Tax Returns

On its tax return for its fiscal year ended July 31, 1981,

filed on April 6, 1982, SSI reported gross income of only $8,347

and undistributed taxable income as a loss of $353,185.56. This

tax return was signed by Monica. Petitioners did not report any

pass-through income or loss from SSI on their tax return for

1981. SSI did not file a tax return for its fiscal year ending

July 31, 1982. 

Fiduciary tax returns for the Riago Trust for 1981 and 1982

were filed on September 10, 1988, several months after

petitioners filed their 1981 and 1982 tax returns. The Riago

Trust's tax returns for these years treated the Riago Trust as a

grantor trust, with Robert as the grantor. Petitioners' 1981 and

1982 tax returns include flow-through income and losses from the
-38-

Riago Trust. Respondent agrees that the Riago Trust was a

grantor trust. 

T. Indictments; Criminal Convictions

On April 9, 1987, a Federal grand jury indicted petitioners

on 139 counts of criminal tax violations. Two of the counts

applied only to Monica. The 137 counts against Robert only, or

Robert and Monica, are as follows: (1) One count of conspiracy to

defraud the United States and investors in connection with

certain tax shelter sales in violation of 18 U.S.C. sec. 371

(1994); (2) 133 counts of aiding and assisting in the preparation

of false tax returns in violation of 26 U.S.C. sec. 7206(2); (3)

one count of willfully filing an income tax return which was

false as to a material fact (petitioners' 1980 tax return) in

violation of 26 U.S.C. sec. 7206(1); and (4) two counts of

willfully failing to file income tax returns for 1981 and 1982 in

violation of 26 U.S.C. sec. 7203. 

In late 1987, Robert was found guilty on all 137 counts that

he was charged with. On May 13, 1988, Robert was sentenced to 13

years imprisonment and fined $940,000 as a result of his

convictions. Robert appealed the convictions relating to the tax

shelters, but not the convictions for false tax return (for 1980)

and for willfully failing to file tax returns (for 1981 and

1982). Robert's convictions were affirmed. United States v.

Iles, 906 F.2d. 1122 (6th Cir. 1990). 
-39-

23 In the instant case we are not called upon to determine

whether and, if so, then to what extent, any of these

underpayments were due to Monica's fraud. Supra note 3. Any

such fraud on Monica's part does not diminish Robert's fraudulent

responsibility for the underpayments. 

_______________________

In general, and in the case of each of the arrangements

described supra, Robert provided the initiating ideas and the

force necessary to put the arrangements into effect, while Monica

provided or oversaw the necessary administrative and technical

work to carry out the arrangements. 

For each of the years 1980, 1981, and 1982, respondent has

shown by clear and convincing evidence that petitioners had an

underpayment of income tax required to be shown on their joint

tax return; the underpayment for each of these years was due to

Robert's fraud.23 

OPINION

Respondent contends that (1) petitioners underpaid their

taxes for 1980 through 1982, (2) petitioners' underpayments for

these years are due in whole or in part to Robert's fraud, and

thus (3) Robert is liable for the fraud additions to tax under

section 6653(b). Robert contends that he never had any intent to

deceive the Federal Government. 

We agree with respondent. 
-40-

24 Sec. 6653(b) provides, in pertinent part, as follows:

SEC. 6653. FAILURE TO PAY TAX.

* * * * * * *

(b) Fraud.--

(1) In general.--If any part of any underpayment

(as defined in subsection (c)) of tax required to be

shown on a return is due to fraud, there shall be added

to the tax an amount equal to 50 percent of the

underpayment. 

(2) Additional amount for portion attributable to

fraud.--There shall be added to the tax (in addition to

the amount determined under paragraph (1)) an amount

equal to 50 percent of the interest payable under

section 6601--

(A) with respect to the portion of the

underpayment described in paragraph (1) which is

attributable to fraud, and 

(B) for the period beginning on the last day

prescribed by law for payment of such underpayment

(determined without regard to any extension) and

ending on the date of the assessment of the tax

(or, if earlier, the date of the payment of the

tax). 

For 1980 and 1981, the fraud addition to tax is provided for

in sec. 6653(b), the first sentence of which is the same as the

above-quoted sec. 6653(b)(1). 

Par. (2) was added by sec. 325(a) of the Tax Equity and

Fiscal Responsibility Act of 1982, Pub. L. 97-248, 96 Stat. 324,

616, and was effective for taxes the payment of which (determined

without regard to any extension) is due after Sept. 3, 1982. In

the instant case, par. (2) is applicable to the additions to tax

determined against petitioners for 1982. 

(continued...)

When respondent seeks to impose the additions to tax under

section 6653(b),24 respondent has the burden of proof. To carry
-41-

24(...continued)

The later amendments of this provision by sec. 1503 of the

Tax Reform Act of 1986 (Pub. L. 99-514, 100 Stat. 2085, 2742), by

sec. 1015(b)(2)(B) of the Technical and Miscellaneous Revenue Act

of 1988 (Pub. L. 100-647, 102 Stat. 3342, 3569), and by sec.

7721(a) of the Omnibus Budget Reconciliation Act of 1989 (OBRA

89--Pub. L. 101-239, 103 Stat. 2106, 2395) do not affect the

instant case. 

As a result of OBRA 89, the revised fraud addition to tax

now appears in secs. 6663 and 6651(f). 

25 SEC. 7454. BURDEN OF PROOF IN FRAUD, FOUNDATION

MANAGER,

 AND TRANSFEREE CASES. 

(a) Fraud.--In any proceeding involving the issue

whether the petitioner has been guilty of fraud with intent

to evade tax, the burden of proof in respect of such issue

shall be upon the Secretary. 

this burden for a year, respondent must prove the following: (1)

Robert has an underpayment of tax for that year, and (2) some

part of that underpayment is due to Robert's fraud. Sec.

7454(a);25 Rule 142(b); e.g., Carter v. Campbell, 264 F.2d 930,

936 (5th Cir. 1959); Stone v. Commissioner, 56 T.C. 213, 220

(1971); Otsuki v. Commissioner, 53 T.C. 96, 105, 106 (1969). 

Each of those elements must be proven by clear and convincing

evidence. DiLeo v. Commissioner, 96 T.C. 858, 873 (1991), affd.

959 F.2d 16 (2d Cir. 1992); Parks v. Commissioner, 94 T.C. 654,

663-664 (1990); Hebrank v. Commissioner, 81 T.C. 640, 642 (1983). 

For this purpose, respondent need not prove the precise

amount of the underpayment resulting from fraud, but only that

there is some underpayment and that some part of it is
-42-

attributable to fraud. E.g., Lee v. United States, 466 F.2d 11,

16-17 (5th Cir. 1972); Plunkett v. Commissioner, 465 F.2d 299,

303 (7th Cir. 1972), affg. T.C. Memo. 1970-274. In carrying this

burden, respondent may not rely on Robert's failure to meet his

burden of proving error in respondent's determinations as to the

deficiencies. E.g., Petzoldt v. Commissioner, 92 T.C. 661, 700

(1989); Habersham-Bey v. Commissioner, 78 T.C. 304, 312 (1982),

and cases cited therein. 

Where fraud is determined for each of several years,

respondent's burden applies separately for each of the years. 

Estate of Stein v. Commissioner, 25 T.C. 940, 959-963 (1956),

affd. sub nom. Levine v. Commissioner, 250 F.2d 798 (2d Cir.

1958); McLaughlin v. Commissioner, 29 B.T.A. 247, 249 (1933). A

mere understatement of income does not establish fraud. However,

a pattern of consistent underreporting of income for several

years is strong evidence of fraud. Estate of Mazzoni v.

Commissioner, 451 F.2d 197, 202 (3d Cir. 1971), affg. T.C. Memos.

1970-144 and 1970-37; Adler v. Commissioner, 422 F.2d 63, 66 (6th

Cir. 1970), affg. T.C. Memo. 1968-100; Otsuki v. Commissioner, 53

T.C. at 108. 

The issue of fraud is a factual question that is to be

decided on an examination of all the evidence in the record. 

Plunkett v. Commissioner, 465 F.2d at 303; Mensik v.
-43-

Commissioner, 328 F.2d 147, 150 (7th Cir. 1964), affg. 37 T.C.

703 (1962); Stone v. Commissioner, 56 T.C. at 224. 

In order to establish fraud as to Robert, respondent must

show that Robert intended to evade taxes, which he knew or

believed were owed, by conduct intended to conceal, mislead, or

otherwise prevent the collection of taxes. E.g., Webb v.

Commissioner, 394 F.2d 366, 377 (5th Cir. 1968), affg. T.C. Memo.

1966-81; Powell v. Granquist, 252 F.2d 56, 60 (9th Cir. 1958);

Danenberg v. Commissioner, 73 T.C. 370, 393 (1979); McGee v.

Commissioner, 61 T.C. 249, 256-257 (1973), affd. 519 F.2d 1121

(5th Cir. 1975). This intent may be inferred from circumstantial

evidence, Powell v. Granquist, 252 F.2d at 61; Gajewski v.

Commissioner, 67 T.C. 181, 200 (1976), affd. without published

opinion 578 F.2d 1383 (8th Cir. 1978), including the

implausibility of Robert's explanations, Bradford v.

Commissioner, 796 F.2d 303, 307 (9th Cir. 1986) (and cases

therein cited), affg. T.C. Memo. 1984-601; Boyett v.

Commissioner, 204 F.2d 205, 208 (5th Cir. 1953), affg. a

Memorandum Opinion of this Court dated Mar. 14, 1951. 

We consider first whether petitioners have an underpayment

of tax for one or more of the years in issue, and then we

consider whether any part of any underpayment is due to Robert's

fraud. 
-44-

A. Underpayments of Tax

For purposes of the fraud addition to tax, the term

"underpayment" means a "deficiency", as defined in section 6211,

except that the tax shown on the tax return is taken into account

only if that tax return was filed on or before the last day

prescribed for filing that tax return, determined with regard to

any extension of time for that filing. Sec. 6653(c)(1). In the

instant case, each of petitioners' 1980, 1981, and 1982 tax

returns was filed after the extended due dates, and thus the tax

shown on each of these returns is not taken into account in

determining the existence or amount of an underpayment. Secs.

6653(c)(1) and 6211(a)(1)(A). 

On their late-filed tax returns, petitioners reported tax

liabilities for each of the years 1980, 1981, and 1982. These

admissions (Fed. R. Evid. 801(d)(2)(A)) have not been effectively

disputed by Robert. In these circumstances, we conclude that

respondent has thereby carried the burden of proving by clear and

convincing evidence that petitioners have an underpayment of tax

for each of the years in issue. See, e.g., Bank of the West v.

Commissioner, 93 T.C. 462, 468 (1989), and cases cited therein. 

However, we examine into additional sources of underpayments for

each of these years in order to assist in determining whether any

parts of these underpayments are due to Robert's fraud. 
-45-

Respondent's determinations in the notices of deficiency are

based primarily on respondent's contention that petitioners had

unreported income from money petitioners appropriated for their

personal benefit from accounts that petitioners purported to

manage as trustees or fiduciaries for others. We proceed to

consider the elements of this contention. 

Table 1, drawn largely from a stipulated exhibit that Robert

prepared, shows many of the business entities Robert was

associated with between 1973 and 1983. Robert also was the sole

shareholder of Audio Research Analysts, Inc., and Super Swirl,

Inc., during part of the period before the Court. 
-46-

Table 1

 End Date Robert's

Business Start Date (if applicable) Activity Legal Form Interest 

Associates 1973 Early Bookkeeping Sole Owner

 1980s & Tax Related Proprietorship

Robert Iles Computer July 1982 Computer Corporation 90% Shareholder

 Services, Inc. Services 

Consultants 1979 Bookkeeping Corporation 75% Shareholder 

 & Tax Return

 Preparation

Robert Iles, et al. 1978 1980 Computer Partnership 65% Partner1

 Software

The Cocoa Trusts May 1980 Investment Trusts Trustee

SSC2 1980 3-22-82 Financial Corporation Sole

Shareholder

 (Sold) Planning/

 Chartered Rep.

SSI 1980 Financial S Corporation 52% Shareholder

 Planning/ (plus Monica's 24%)

 Market Tax

 Shelters

Random Processing By 1980 Prepared Corporation Sole Shareholder3

 Service, Inc. Financial 

 Reports

Free Enterprise Trust 1981 Investments Trust Trustee

Riago Revocable Trust May 1981 Held all of Trust Trustee

 Ps' Assets

 

Lincoln American Aug. 1981 Securities Corporation Sole

Shareholder

 Securities Dealer
-47-

SSSI Aug. 1982 Broker- Corporation 52% Shareholder

 Dealer (plus Monica's 24%)

SSFMI Aug. 1982 Investment Corporation 52% Shareholder

 Adviser (plus Monica's 24%)
-48-

26 This rule is independent of the general rule applicable

to civil cases, in which the taxpayer has the burden of proving

entitlement to deductions before they may be allowed. Rule

142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). 

1 Robert states that he was a 52-percent partner. The

partnership's 1979 tax return shows, and we have found, that

Robert was a 65-percent partner. Supra H. Robert Iles, et al.,

note 12.

2 Supra note 5 deals with the inconsistencies in the record

as to when SSC was incorporated. Our finding is in accordance

with the parties' stipulations. In addition, Robert's impression

was that he sold SSC on Mar. 19, 1982; we have found that it was

3 days later. Supra N. Second Sale of Interest in Structured

Shelters of Cincinnati. 

3 In an earlier case, based on the record in that case we

had found that Random Processing Services, Inc., was Monica's

corporation. In the instant case, the parties have stipulated,

and we have found, that it was Robert's corporation. Supra note

6. 

Respondent need not prove that petitioners did not have

offsetting deductions. Once the Commissioner has presented clear

and convincing evidence of unreported gross receipts, the

taxpayer has the burden of coming forward with evidence as to

offsetting deductions claimed by the taxpayer, even in criminal

cases where the Government must prove a deficiency beyond a

reasonable doubt. E.g., United States v. Hiett, 581 F.2d 1199,

1202 (5th Cir. 1978); United States v. Campbell, 351 F.2d 336,

338-339 (2d Cir. 1965); Elwert v. United States, 231 F.2d 928,

933 (9th Cir. 1956); see also Reiff v. Commissioner, 77 T.C.

1169, 1175 (1981).26 

(1) 1980
-49-

In the notice of deficiency for 1980, respondent determined

that petitioners had unreported income from (1) the Cocoa Trusts,

(2) the Monica Iles Shelters Trustee account, and (3) Random

Processing Services, Inc. 

In 1980, Monica wrote four checks totaling $100,000 to

Robert from the Cocoa Trusts Escrow Fund. As our Findings of

Fact show (supra H. Robert Iles, et al.), $90,000 of this total

went to pay off a loan by a partnership in which Robert had a 65-

percent interest. Monica testified, without contradictory

testimony by Robert, that the primary motive was to remove the

lender's security interest in assets in petitioners' personal

residence and business office. Another check to Robert, for

$6,000, was a commission payment. We have found that all

$100,000 was 1980 income to Robert. 

Pursuant to the parties' stipulation, we have found that in

1980, 38 checks totaling $45,631.78 drawn on the Monica Iles

Shelters Trustee account were written to petitioners or on their

behalf. We have found that the entire amount was income to

petitioners. Supra K. Monica Iles Shelters Trustee Account. 

Pursuant to the parties' stipulation, we have found that in

1980 five checks totaling $8,675 drawn on Random Processing

Services' bank account were written to petitioners. We have

found that the entire amount was income to petitioners. Supra J.

Random Processing Services. 
-50-

None of the foregoing amounts were reported on petitioners'

1980 tax return. 

There is no indication of offsetting deductions or credits. 

We conclude, and we have found, that respondent has shown by

clear and convincing evidence that petitioners had an

underpayment of tax for 1980. 

(2) 1981

In the notices of deficiency for 1981, respondent determined

that petitioners had unreported income from (1) the Cocoa Trusts,

(2) the Monica Iles Shelters Trustee account, (3) Random

Processing Services, Inc., (4) the FE Trust, (5) SSI, and (6)

Maximum Management, and had unreported capital gain from the

attempted sale of SSC. 

Pursuant to the parties' stipulation, we have found that in

1981, seven checks totaling $29,300 were written to Robert from

the Cocoa Trusts Escrow Fund. We have found that the entire

amount was 1981 income to petitioners. Supra G. Cocoa Trusts. 

Pursuant to the parties' stipulation, we have found that in

1981, 29 checks totaling $42,961.11 were drawn on the Monica Iles

Shelters Trustee account to Robert or to third parties on

petitioners' behalf. We have found that the entire amount was

1981 income to petitioners. Supra K. Monica Iles Shelters

Trustee Account. 
-51-

Pursuant to the parties' stipulation, we have found that a

$1,000 check was drawn on the Random Processing Services' bank

account to Monica. We have found that the entire amount was 1981

income to petitioners. Supra J. Random Processing Services. 

We have found that, on December 17, 1981, $176,500 was

withdrawn from the FE Trust's Southern Ohio Bank account, and

shortly thereafter deposited in an escrow account to help fund

Robert's appeal bonds. We have found that the entire amount was

1981 income to petitioners. Supra I. Lincoln American

Securities. 

Pursuant to the parties' stipulation, we have found that 37

checks and 1 wire transfer totaling $129,285.67 were drawn on

SSI's Southern Ohio Bank account to petitioners or on their

behalf. We have found that the entire amount was 1981 income to

petitioners. Supra C. SSI and Its Chartered Representatives. 

We have also found that two checks totaling $23,000, written

to third parties on petitioners' behalf as performance bonuses

for Robert, and one check for $25,000, with the notation "R. Iles

personal draw", were drawn on SSI's Gradison Cash Reserves

Account and are 1981 income to petitioners. Supra C. SSI and Its

Chartered Representatives, and I. Lincoln American Securities. 

We have found, based on SSI's books and records, that for

its fiscal year ended July 31, 1981, SSI received, and deposited

into the Structured Shelters bank account, $436,400 in gross
-52-

27 These rules were substantially revised effective for

taxable years beginning after Dec. 31, 1982. Secs. 2 and 6(a) of

the Subchapter S Revision Act of 1982, Pub. L. 97-354, 96 Stat.

1669, 1697. The revisions (see especially secs. 1366-1368) do

not apply to SSI's taxable years ending July 31, 1981, and 1982,

and so do not affect the instant case. 

income, consisting of $374,000 from Chartered Representative

fees, $8,900 from setup fees, and $53,500 from options. SSI's

own fiscal 1981 subchapter S corporation tax return reported only

$8,347 in gross income. We have found that SSI's undistributed

taxable income for its fiscal 1981 was $108,238.39, and

petitioners' 76-percent share of this is $82,261.18, which is

taxable to petitioners for 1981. Supra C. SSI and Its Chartered

Representatives. 

Under the law then in effect, the undistributed taxable

income of a subchapter S corporation for a taxable year was

required to be included in the gross incomes of those persons who

were shareholders of the corporation on the last day of that

taxable year of the corporation, in proportion to those

shareholdings. Sec. 1373(b). In general, undistributed taxable

income was taxable income minus dividends distributed. See

1373(c).27

Our findings take into account the distributions that SSI

made to its shareholders in SSI's fiscal year ended July 31,

1981. These distributions reduce the amount of SSI's fiscal 1981

undistributed taxable income. The distributions made later in
-53-

1981 are 1981 income to petitioners but reduce the amount of

SSI's undistributed taxable income for SSI's fiscal 1982. 

We have found that, during 1981, Maximum Management wrote a

$300 check to Monica, and wrote $5,225.92 in checks to Watkins to

pay for Watkins' services in taking care of petitioners'

children. We have found that Maximum Management was Monica's

sole proprietorship. Supra L. Maximum Management. The notices

of deficiency refer to Maximum Management as one of "several

business accounts, over which you exercised control." 

Petitioners' 1981 tax return, on which petitioners characterized

Maximum Management as Monica's sole proprietorship, was filed

more than 6 months after the notice of deficiency was sent to

Monica. Ordinarily, a personal diversion of funds from a sole

proprietorship is not directly an income item to the proprietor--

however, such a diversion of funds may not be treated as an

allowable deduction in calculating the sole proprietorship's net

income or loss. The net income or loss is then taken into

account in determining the sole proprietor's adjusted gross

income. In the instant case, neither side attempted to

reconstruct Maximum Management's income and deductions. However,

Monica testified that, the way Maximum Management was intended to

operate, it "should have zero at the end". Under the

circumstances of the instant case, we treat the $300 check to

Monica and the $5,225.92 in checks to Watkins as leading to a
-54-

1981 net profit of $5,525.92 to Maximum Management, which results

in $5,525.92 additional 1981 income to petitioners. Although

self-employment taxes are generally the liability of the taxpayer

earning the income, under section 1.6017-1(b)(2), Income Tax

Regs., the liability with respect to these taxes in the case of a

joint return is joint and several. Thus, Robert, too, is liable

for self-employment tax on the $5,525.92, even though Monica had

the self-employment income. 

We have so found, and we so hold.

As we have found, petitioners are taxable on $10,953 of 1981

long-term capital gain resulting from Robert's effort to sell an

interest in SSC to Elliot. Supra M. First Sale of Interest in

Structured Shelters of Cincinnati. In the notice of deficiency,

respondent had determined that "the benefits of capital gains

treatment are not available to you [Robert]." Petitioners, in

their belated 1981 tax return, provided the information that the

gain was $10,953, not the $10,000 determined in the notice of

deficiency. Respondent concedes on brief that the income is

long-term capital gain and that, as a result, 60 percent of the

gain is excluded from income and so only $4,381 is includable in

petitioners' 1981 adjusted gross income on account of this

transaction. This is in accord with petitioners' 1981 tax

return. 
-55-

Thus, (1) petitioners' gain on the transaction is $953 more

than the amount determined in the notice of deficiency, but (2)

because of the 60-percent exclusion, petitioners' adjusted gross

income from the transaction is $5,619 less than the amount

determined in the notice of deficiency. 

Petitioners failed to file a timely 1981 tax return. In

fact, petitioners' 1981 tax return was filed after the notices of

deficiency were issued in the instant case. In their late-filed

1981 tax return, petitioners acknowledged a tax liability of

$5,501. Our findings show that petitioners' 1981 income subject

to tax is far greater than what they reported on their 1981 tax

return. 

There is no indication of offsetting deductions or credits. 

We conclude, and we have found, that respondent has shown by

clear and convincing evidence that petitioners had an

underpayment of tax for 1981. 

(3) 1982

In the notices of deficiency for 1982, respondent determined

that petitioners had unreported income from (1) Random Processing

Services, Inc., (2) SSI, (3) the FE Trust, and (4) Maximum

Management, and had unreported capital gain from the sale of SSC. 

Pursuant to the parties' stipulation, we have found that in

1982 two checks totaling $15,000 were drawn on the Random

Processing Services' bank account to Monica. We have found that
-56-

the entire amount was 1982 income to petitioners. Supra J.

Random Processing Services. 

Pursuant to the parties' stipulation, we have found that 36

checks totaling $198,850 were drawn on SSI's Southern Ohio Bank

account to petitioners or on their behalf. We have found that

the entire amount was 1982 income to petitioners. Supra C. SSI

and Its Chartered Representatives. 

Pursuant to the parties' stipulations, we have found that in

1982 SSI paid $170,500 to SSSI as capital contributions to SSSI,

and that SSI paid $59,237.27 to Finkelstein, Thompson, and

Levenson as capital contributions to SSSI. 

The parties did not stipulate the status of check no. 3205,

written to Howard Blumenthal in the amount of $18,716, dated

September 30, 1982. However, the parties stipulated a

memorandum, also dated September 30, 1982, by Monica to Basti. 

In this letter, Monica directs Basti to treat this check and two

other checks as follows: 

These funds should be posted as contributed capital to

the broker/dealer. [SSSI] * * * The capital

contribution on behalf of Adrian Doyle, Robert Iles,

Sr., and Monica Iles is 24%, 52% and 24% respectively. 

Neither side has drawn our attention to anything in the record

contradicting the clear import of this evidence, and we have not

found any such contradicting evidence. We conclude, and we have

found, that respondent has shown by clear and convincing evidence

that SSI paid $18,716 to Howard Blumenthal as a 1982 capital
-57-

contribution to SSSI. We have found that in 1982 SSI paid

$14,000 to SSFMI as capital contributions to SSFMI. 

All the foregoing contributions were on behalf of Robert,

Monica, and Doyle. Robert held 52-percent interests in all three

corporations (SSI, SSSI, and SSFMI), and Monica and Doyle each

held 24-percent interests in all three corporations. Respondent

concedes on brief, and we agree, that petitioners' income does

not include the 24 percent allocable to Doyle. Thus, petitioners

had 1982 income in the amount of 76 percent (52 plus 24) of

$262,453.27 ($170,500 plus $59,237.27 plus $18,716 plus $14,000),

or $199,464.49, on account of SSI's 1982 payments of capital

contributions to SSSI and SSFMI on petitioners' behalf. We have

so found. 

Respondent also asks us to conclude that--

An additional nineteen SSI checks, totalling $2,408.00,

represent payments for state registration fees or

accounting services for SSSI or SSFMI, and are also

contributions to the capital of SSSI or SSFMI. (RPFF

¶¶ 255, 263, 264) All of these amounts were payments

by SSI to fund the personal acquisition by Robert Iles,

Monica Iles, and Adrian Doyle of individual ownership

interests in SSSI or SSFMI. 

The cited proposed findings of fact direct our attention to one

$550 SSI check to Kolbinski and Kling, and two statements by

Kolbinski and Kling to SSSI for services rendered, in the amounts

of $300 and $750. Respondent does not direct our attention to

anything in the record, including respondent's tables and

explanations, that would show that in 1982 SSI paid any debt of
-58-

SSSI or SSFMI, and we have not found anything in the record that

would so show. 

We conclude, and we have found, that petitioners' 1982

income on account of SSI's payments that constitute capital

contributions to SSSI and SSFMI is $199,464.49. 

We have found that in February 1982, Robert, as trustee for

the Riago Trust, bought a Rolls Royce car for $79,000; that SSI

paid the $79,000 purchase price; and that a month later SSI paid

the $4,345 sales tax. We have found that the entire $83,345 was

recorded on SSI's books as performance bonuses to Robert and is

1982 income to petitioners. Supra O. Rolls Royce. 

We have found, based largely on SSI's books and records,

that SSI's undistributed taxable income for its fiscal year ended

July 31, 1982, is $1,413,319.10. This is after giving effect to

deductions under section 1373(c) on account of more than $850,000

of SSI payments to or for the benefit of petitioners and Doyle

during that fiscal year. We have found that petitioners' share

of SSI's undistributed taxable income is $1,074,122.52; under

section 1373(b), this is taxable to petitioners for 1982. Supra

C. SSI and Its Chartered Representatives. 

We have found that on February 5, 1982, Robert bought the

Jet, acting individually and on behalf of the Rise Trust. It

appears that the Rise Trust was merely a name used by Robert,

Monica, and Doyle (in their by-then usual ownership interest
-59-

ratios of 52, 24, and 24, respectively) in which to own the Jet. 

We have found, pursuant to the parties' stipulations that in

February 1982, SSI paid the $25,000 deposit on the Jet and FE

Trust paid the $375,000 delivery installment on the Jet. A

dispute then developed between the Jet's seller and the Rise

Trust trio. It is not clear what eventually happened to the Jet. 

However, in March 1983, on a net worth statement petitioners

submitted in connection with a loan application, petitioners

claimed that their 76-percent interest in the Jet was worth

$361,000. Also, on a net worth statement dated October 23, 1984,

the Riago Trust claimed that its 76-percent interest in the Jet

was worth $361,000. We have found that 76 percent of SSI's

($25,000) and FE Trust's ($375,000) 1982 payment--$304,000--is

1982 income to petitioners. Supra P. Saberliner Jet Aircraft. 

We have found that, during 1982, Maximum Management wrote

$6,049.81 in checks to Watkins to pay for Watkins' services in

taking care of petitioners' children. For reasons set forth

supra note 20, we conclude that three other checks, totaling

$352.97 do not constitute 1982 income to petitioners. For

reasons set forth in our analysis of petitioners' 1981 income

from Maximum Management, supra, we conclude that Maximum

Management had a 1982 net profit of $6,049.81, which results in

$6,049.81 additional 1982 income to petitioners. 

We so hold. 
-60-

We have found that Robert sold SSC to Maerki. In 1982, SSC

paid $51,923.29 to SSI, of which $1,923.29 was interest. In

1982, SSC paid $10,000 to Robert. On their late-filed 1982 tax

return, petitioners acknowledged $61,923 gain from this

transaction, thereby conceding that they did not have any as-yetunrecovered basis in SSC. Also, petitioners do not contend that

they should be taxable on only 76 percent of the SSI receipts,

because of Doyle's 24-percent interest in SSI. Respondent does

not contend that petitioners had any additional income from the

transaction and agrees with petitioners' long-term capital gain

treatment of all but the interest component. We conclude that

the record clearly shows that $1,923.29 of SSC's payment to SSI

was interest, and we have so found. Supra N. Second Sale of

Interest in Structured Shelters of Cincinnati. 

We hold for respondent on this issue. 

Petitioners failed to file a timely 1982 tax return. In

fact, petitioners' 1982 tax return was filed after the notices of

deficiency were issued in the instant case. In their late-filed

1982 tax return petitioners acknowledged a tax liability of

$3,029. Our findings show that petitioners' 1982 income subject

to tax is far greater than what they reported on their 1982 tax

return. 

There is no indication of offsetting deductions or credits.
-61-

28 Oh, what a tangled web we weave, 

When first we practice to deceive!

 --Sir Walter Scott, Marmion, canto VI, 

 stanza 17 (1808).

We conclude, and we have found, that respondent has shown by

clear and convincing evidence that petitioners had an

underpayment of tax for 1982. 

(4) Summary

We hold that petitioners had an underpayment of tax for each

of the years 1980, 1981, and 1982. 

We hold for respondent on this issue. 

B. Fraudulent Intent

As Robert's own listing of his business enterprises (supra

table 1) suggests, and as our Findings of Fact amply confirm,

Robert wove a marvelously tangled web.28

Throughout the period before us Robert created and managed

or supervised entities designed to produce or manage cash-flows. 

Robert saw to it that he and Monica tapped into these cash-flows

to satisfy their own personal standard-of-living needs, or their

investment or legal defense needs, without regard to whether

those "tap-ins" were legitimate expenditures by the entities

whose cash was used. In most instances it appears that the

entities did not file Federal income tax returns. Some entities

were little more than misleading names on bank accounts. 
-62-

These freewheeling activities generated income subject to

tax for petitioners. Robert understood enough about Federal

income tax laws to understand this. Many of the entities he

created were advertised as entities that could facilitate tax

shelter investments, or that could prepare or assist in preparing

Federal income tax returns. Yet Robert failed to report

substantial amounts of the income thus generated. Petitioners

filed their 1980 tax return about 3 months late. They did not

file their 1981 and 1982 tax returns until after the notices of

deficiency were issued, many years late. Even then, they failed

to report substantial amounts of their income. 

In his opening statement Robert claimed as follows: 

As to the 1981, 1982, failure to file, under advice of

counsel because of an ongoing fraud investigation by a

Norman Heidleberger, it was -- the advice was given to

us by counsel not to file income tax returns. That to

file the tax return could adversely affect us in the

way of a criminal investigation so therefore following

counsel's advice we did not file. 

Robert testified, but he did not repeat under oath this

contention from his opening statement. 

Monica testified as follows: 

the advice from Mr. Moore was to clear up the criminal

investigation which had already ensued before filing

another tax return. 

The following colloquy then occurred: 

BY MR. HILL:

Q. Mrs. Iles, you testified as to advice from Mr.

Moore with respect to the filing of tax returns and
-63-

29 The "Mr. Moore" referred to by Monica and respondent's

counsel is John N. Moore, who filed the petition in the instant

case and was petitioners' counsel herein until Apr. 29, 1991,

when he withdrew from the case. None of the documents filed by

Moore on petitioners' behalf in the instant case during the 3-1/2

years before Moore's withdrawal indicated that Moore had advised

petitioners to delay filing any of their tax returns. Moore was

not called as a witness in the instant case. 

that he advised that the return should not be filed

until the criminal investigation was cleared up. When

is it your recollection that Mr. Moore provided you

with that advice?

A. Right after I moved to Florida. In fact, so

it would be around September of '83. 

However: (1) Petitioners' 1980 tax return was filed about 3

months after the extended due date; it was filed, petitioners

wrote, "under duress due to summons and it will be amended"; and

it was not amended during the 2 years between the filing of this

tax return and the receipt of the asserted advice about not

filing tax returns. (2) The asserted advice was not given until

about 11 months after the extended due date for the 1981 tax

return. (3) The asserted advice was not given until about 1

month after the extended due date for the 1982 tax return. Thus,

even if we credit the accuracy of Monica's testimony as to the

precise advice that petitioners understood they received,29 this

advice still would not explain petitioners' failure to timely

file their tax returns for any of the years in issue. Nor would

this advice affect petitioners' failure to report substantial
-64-

30 We had dismissed Robert's case insofar as he had the

burden of proof. However, in addition to respondent's

concessions, in a few instances the record clearly shows that the

notices of deficiency were wrong. Our determinations in the

instant report in this regard supersede our previous order of

dismissal. 

amounts of income on each of the tax returns they actually filed

for the years in issue. 

Based on the foregoing summary, our observations of Robert

at and in connection with the trial, and the record as a whole,

we conclude (and we have found) that respondent has shown by

clear and convincing evidence that the underpayment of tax for

each of the years in issue was due to Robert's fraud. 

In order to take account of (1) the effect of petitioners'

late-filed joint tax returns for 1981 and 1982 (see supra, our

discussion of Phillips v. Commissioner, 86 T.C. 433 (1986), affd.

on this issue and revd. on another issue 851 F.2d 1492, 1496-1498

(D.C. Cir. 1988)), (2) respondent's concessions, and (3) our

determinations in the instant report that (a) certain items were

not income to petitioners,30 and (b) respondent carried the

burden of proof in certain assertions that petitioners had income

items in addition to those determined in the notices of

deficiency,

Decision will be entered

under Rule 155.