1 All section references are to the Internal Revenue Code

in effect for the year in issue, and all Rule references are to

the Tax Court Rules of Practice and Procedure.

T.C. Memo. 1997-329

UNITED STATES TAX COURT

 DENNIS J. AND TERESA DENEAULT, Petitioners v. 

 COMMISSIONER OF INTERNAL REVENUE, Respondent

 Docket No. 14717-94. Filed July 21, 1997.

 Dennis J. and Teresa Deneault, pro se.

Michael D. Zima, for respondent.

MEMORANDUM OPINION

DAWSON, Judge: This case was assigned to Chief Special

Trial Judge Peter J. Panuthos pursuant to the provisions of

section 7443A(b)(4) and Rules 180, 181, and 183.1 The Court
- 2 -

 

2 At the time the imperfect petition was filed, petitioner

Dennis J. Deneault was incarcerated at Eglin Air Force Base,

Florida, and petitioner Teresa Deneault resided in Florida. 

agrees with and adopts the opinion of the Special Trial Judge,

which is set forth below.

OPINION OF THE SPECIAL TRIAL JUDGE

PANUTHOS, Chief Special Trial Judge: This matter is before

the Court on respondent's Motion for Judgment on the Pleadings,

filed May 15, 1997. As explained in greater detail below, we

will grant respondent's motion.

Background

Respondent issued a notice of deficiency to petitioners

determining a deficiency in their Federal income tax for 1991 in

the amount of $61,304 and an addition to tax for fraud under

section 6663 in the amount of $45,978. Petitioners invoked the

Court's jurisdiction by filing a timely (but imperfect) petition

for redetermination, followed by a proper amended petition.2

Respondent filed an answer to the amended petition,

including therein specific allegations regarding the method of

income reconstruction that respondent relied upon in determining

the deficiency in this case, as well as specific allegations in

support of respondent's determination that petitioners' entire

underpayment of tax for 1991 is attributable to fraud.

Petitioners failed to file a reply to respondent's answer. 

Consequently, respondent filed a motion pursuant to Rule 37(c)
- 3 -

that undenied allegations in respondent's answer to the amended

petition be deemed admitted. The Court issued an order to

petitioners advising them of the filing of respondent's motion

under Rule 37(c) and directing petitioners to file a reply to

respondent's answer on or before April 6, 1997.

Petitioners failed to file a reply to respondent's answer or

otherwise respond to the Court's order. Consequently, we granted

respondent's Rule 37(c) motion, and the undenied allegations set

forth in respondent's answer were deemed to be admitted. See

Doncaster v. Commissioner, 77 T.C. 334, 336 (1981); Gilday v.

Commissioner, 62 T.C. 260, 261 (1974).

 As indicated, respondent now moves for judgment on the

pleadings with respect to petitioners' liability for the

deficiency and the fraud penalty set forth in the notice of

deficiency. By order dated May 20, 1997, petitioners were

notified that respondent's motion was calendared for hearing at

the motions session of the Court in Washington, D.C., on June 25,

1997. In addition, petitioners were directed to file a written

response in opposition to respondent's motion. Petitioners did

not respond to the Court's order.

 Counsel for respondent appeared at the hearing and presented

argument in support of the motion. No appearance was made by or
- 4 -

3 Petitioners were reminded of the applicability of Rule

50(c) in the Court's order dated May 20, 1997, and expressly that

they could submit a written statement in lieu of (or in addition

to) attendance at the hearing.

on behalf of petitioners at the hearing, nor did petitioners file

a statement with the Court pursuant to Rule 50(c).3

Facts Deemed Admitted

By virtue of the Court's granting of respondent's motion

under Rule 37(c), petitioners are deemed to have admitted the

following facts:

1. During 1991, the petitioners lived in Ft.

Pierce, Florida. They have three daughters: Mandy,

Crystal, and Sarah Deneault.

2. Dennis J. Deneault is a wire lather by trade,

and engaged in a wire lathing sole proprietorship

during 1991.

3. Teresa Deneault worked for Cale of Ft. Myers,

Inc., doing business as Kirby Auto during 1991, earning

$3,177.06 in wages.

4. During 1991, Dennis J. Deneault was engaged

in the illegal trafficking and sale of narcotics and,

as such, made illegal unrecorded cash sales of

narcotics.

5. Petitioners realized substantial cash sums of

income generated from the illegal narcotic trafficking

business, which substantial cash sums enabled

petitioners to maintain a standard of living

inconsistent with the income reported from all other

legal sources on their joint 1991 Federal income tax

return. Petitioners also failed to report $9,725 of

income which was prematurely withdrawn from an

individual retirement account and placed in a joint

savings account by the petitioners. Neither the income

from marijuana sales nor the withdrawals from the IRA

account were included on the petitioners' joint Federal

income tax return for the year 1991.
- 5 -

6. Petitioners maintained no sales invoices or

other records relating to the illegal sales of

narcotics during 1991.

7. On June 18, 1991, Dennis J. Deneault was

arrested by the St. Lucie County Sheriff's Office for

the possession and attempted sale of marijuana.

8. During questioning by the St. Lucie County

Sheriff's officers on June 18, 1991, Dennis J. Deneault

disclosed that on June 17, 1991, he had purchased ten

pounds of marijuana for $18,500, and that on June 18,

1991, he had purchased 17 pounds of marijuana for

$25,000.

9. During the execution of a search warrant in

1991, $300.00 in cash was seized from a pickup truck on

the petitioners' real property.

10. The petitioners filed a joint 1991 Federal

income tax return on April 15, 1992, on which they

reported adjusted gross income of $5,882.00. The

petitioners reported $3,177.00 in wages, and $2,976.00

of business income from Dennis J. Deneault's business

as a wire lather.

11. The respondent has determined petitioners'

correct taxable income for 1991 on the basis of the

source and application of funds method based on

information provided from petitioners' joint 1991

Federal income tax return, information secured from

files relating to the arrest and conviction of Dennis

J. Deneault in 1991, and information provided by

petitioners during a hearing with the Appeals Division,

as follows:

SOURCES

(a) Petitioners reported taxable interest

income of $3.00 on their joint 1991 Federal income tax

return.

(b) Petitioners reported gross receipts of

$4,500 from their Schedule C activity for 1991 on their

joint 1991 Federal income tax return.

(c) During 1991, the petitioners received a

Federal tax refund in the amount of $1,253.00, relating

to the taxable year 1989.
- 6 -

(d) The petitioners reported $3,177.00 of

wage income on their joint 1991 Federal income tax

return.

(e) The petitioners received $6,142.00 by

closing out their bank account at First Union National

Bank of Florida on August 12, 1991.

(f) The petitioners cashed in a certificate

of deposit for $4,681 during 1991.

APPLICATIONS

(g) Respondent determined that petitioners'

living expenses for 1991 were in the amount of $13,962.

(h) During a search of petitioners' property

during 1991, local law enforcement officers found and

seized $300.00 in cash from a pickup truck.

(i) On February 1, 1991, the petitioners

purchased two lots in St. Lucie County, for a total

purchase price of $9,000.00. They paid cash for the

real properties on that date.

(j) The petitioners made payments on their

1989 Lincoln automobile in an amount totaling $3,206.00

during 1991.

(k) On June 17, 1991, Dennis J. Deneault

purchased ten pounds of marijuana for $18,500. On June

18, 1991, Dennis J. Deneault purchased seventeen pounds

of marijuana for $25,000.

(l) According to the joint 1991 Federal

income tax return, during 1991 Dennis J. Deneault

incurred $1,524 in business expenses relating to his

wire lathing sole proprietorship.

(m) During 1991, Federal income tax was

withheld from Teresa Deneault in the amount of $291.79. 

Social security tax was withheld from Mrs. Deneault in

the amount of $196.97. Medicare tax was withheld from

Teresa Deneault in the amount of $46.07.

(n) The petitioners paid a $60.00 penalty to

Barnett Bank on June 21, 1991.
- 7 -

(o) According to their federal income tax

return, during 1991 the petitioners incurred medical

expenses of $1,590, paid property taxes of $1,148.00,

and paid $4,319 in interest payments. Per the return,

they also incurred $20 in miscellaneous deductions. 

All of these amounts were reflected on schedule A of

the 1991 joint Federal income tax return.

(p) Federal tax payments were made during

1991 totaling $2,744.

(q) According to the public records of St.

Lucie County, the petitioners paid $2,500 relating to a

seizure of property during 1991.

(r) During 1991, the petitioners placed

$117,000 into a safety deposit box in the name of a Mr.

and Mrs. Peter Boyle.

(s) The net change in the petitioners' joint

account balance at Riverside National Bank during 1991

was a plus $1,100.

12. Petitioners have no non-taxable sources of

funds or excludible receipts which would require

adjustments in respondent's source and application

method for determining petitioners' 1991 taxable

income, such as loans or inheritances.

13. The petitioners made misleading statements to

agents of the respondent during their investigations

relative to the asset acquisitions and illegal narcotic

trafficking transactions as engaged in by the

petitioners during the taxable year 1991. In an

interview with Internal Revenue Service Revenue Agent

John Halligan at an Internal Revenue Service office

occurring January 6, 1993, Mrs. Teresa Deneault told

Mr. Halligan that the information on the petitioners'

Federal income tax return for the year 1991 was

correct. When asked if the petitioners ever possessed

or had access to safe deposit boxes, Mrs. Deneault

responded in the negative, despite there being bank

records of the petitioners' leasing such boxes during

the year 1991. Mr. Dennis Deneault also answered

negatively to this question. 

14. The petitioners attempted to conceal assets

by using nominees to hold their money. They rented

safety deposit boxes from banks, and placed substantial
- 8 -

 

4 At the hearing on this matter, respondent's counsel

stated that the reference to "1993" in par. 18 of the Answer to

Amended Petition is a typographical error and should be "1991".

portions of their drug proceeds into them. The

petitioners' neighbors, Mr. and Mrs. Peter Boyle, held

$117,000.00 for the taxpayers in a safety deposit box

which was opened in 1991. Dennis J. Deneault's mother

held approximately $25,000.00 in a safety deposit box

for the petitioners which was opened in 1991.

15. The safety deposit boxes were opened by the

petitioners in 1991. Keys to the safety deposit boxes

were held only by the petitioners. The nominees knew

that they were holding the money for the petitioners,

and were not permitted to withdraw any portion of the

money.

16. When their Internal Revenue Service audit

began, the petitioners continued to attempt to conceal

assets from the Service. Upon receiving notice by

letter of the examination of their 1991 income tax

return, the petitioners inquired of acquaintances as to

how to hide assets from the Internal Revenue Service. 

They were told to place assets into an irrevocable

trust, and actually took steps to complete such an

instrument.

17. The petitioners have made implausible or

inconsistent explanations of their conduct during 1991. 

They have made statements denying the existence of any

safety deposit boxes to which they had access during

1991. These are implausible statements, in light of

the fact that they opened the safety boxes and were the

only parties with keys to the boxes. The petitioners'

explanations have been inconsistent with their

behavior, such as their inquiring of acquaintances as

to how to hide assets from the Internal Revenue

Service.

18. Petitioners fraudulently understated their

taxable income during the 1993[4] taxable year in the

amount of $182,752, with the intent to evade the

payment of taxes on such income.

19. All of the underpayment of tax required to be

shown on petitioners' joint 1991 Federal income tax

return is due to fraud.
- 9 -

Discussion

Rule 120(a) provides that after the pleadings are closed and

within such time as not to delay the trial, any party may move

for judgment on the pleadings. A motion for judgment on the

pleadings is appropriate only where the pleadings do not raise a

genuine issue of material fact, but rather involve issues that

may be decided as a matter of law. Thus, respondent's motion is

to be granted only if, on the admitted facts, respondent is

entitled to decision as a matter of law. Anthony v.

Commissioner, 66 T.C. 367 (1976), affd. without published opinion

566 F.2d 1168 (3d Cir. 1977). The determinations made by

respondent in the notice of deficiency are presumed correct; the

burden of proof is on petitioners to show that these

determinations are erroneous. Rule 142(a); Welch v. Helvering,

290 U.S. 111 (1933); Rockwell v. Commissioner, 512 F.2d 882, 887

(9th Cir. 1975), affg. T.C. Memo. 1972-133.

 The factual allegations deemed admitted under Rule 37(c)

establish that petitioners failed to report income in the amount

of $182,752 for the taxable year 1991, an amount that is

primarily attributable to petitioner Dennis J. Deneault's sales

of illegal narcotics. In addition, petitioners failed to

maintain, or submit to respondent for examination, adequate books

or records regarding the income and expenses relating to their

income during the year in issue. Consistent with these deemed
- 10 -

admissions, it follows that respondent is entitled to judgment on

the pleadings that petitioners are liable for the deficiency in

tax for 1991 as set forth in the notice of deficiency.

Respondent also determined that petitioners are liable for

the penalty for fraud under section 6663(a) for 1991. Section

6663(a) provides that if any part of the underpayment of tax

required to be shown on the return is due to fraud, there shall

be added to the tax an amount equal to 75 percent of the portion

of the underpayment that is attributable to fraud.

 Fraud is defined as an intentional wrongdoing designed to

evade tax believed to be owing. Zell v. Commissioner, 763 F.2d

1139, 1142-1143 (10th Cir. 1985), affg. T.C. Memo. 1984-152; Webb

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

Memo. 1966-81, and cases cited therein. Respondent has the

burden to prove fraud by clear and convincing evidence. Sec.

7454(a); Rule 142(b). Fraud is a question of fact to be resolved

upon consideration of the entire record and is never presumed. 

Estate of Pittard v. Commissioner, 69 T.C. 391, 400 (1977). 

Respondent's burden of proving fraud can be met by facts deemed

admitted pursuant to Rule 37(c). Doncaster v. Commissioner, 77

T.C. 334, 337 (1981); see Marshall v. Commissioner, 85 T.C. 267,

272-273 (1985).

 In the instant case, petitioners are deemed to have

admitted, pursuant to Rule 37(c), that they attempted to conceal

from respondent the source and amount of the income that
- 11 -

 

5 See also Marshall v. Commissioner, 85 T.C. 267 (1985);

Davis v. Commissioner, T.C. Memo. 1993-324; Cruise v.

Commissioner, T.C. Memo. 1992-688; Asher v. Commissioner, T.C.

Memo. 1992-377; Eisenstein v. Commissioner, T.C. Memo. 1987-241;

Dimsdale v. Commissioner, T.C. Memo. 1987-53; Ricotta v.

Commissioner, T.C. Memo. 1986-508; Twist v. Commissioner, T.C.

Memo. 1986-497; Siravo v. Commissioner, T.C. Memo. 1986-482;

Jackson v. Commissioner, T.C. Memo. 1986-15.

petitioner Dennis J. Deneault realized from sales of illegal

drugs in 1991. Further, petitioners are deemed to have admitted

that they fraudulently and with the intent to evade taxes

understated their taxable income for 1991 in the amount of

$182,752, and that the underpayment of tax required to be shown

on their income tax return for 1991 is due to fraud.

We hold that the facts deemed admitted pursuant to Rule

37(c) satisfy respondent's burden of proving fraud. Doncaster v. 

Commissioner, supra at 337.5 Those facts constitute clear and

convincing evidence that petitioners failed to report the income

derived from sales of illegal drugs during 1991 fraudulently and

with the intent to evade taxes known to be owing and that the

entire underpayment of taxes required to be shown on petitioners'

1991 income tax return is due to fraud. Consequently, respondent

is entitled to judgment on the pleadings that petitioners are

liable for the penalty for fraud under section 6663(a) for the

taxable year 1991.

 To reflect the foregoing,
- 12 -

 An order granting 

respondent's Motion for

 Judgment on the Pleadings and 

decision for respondent will b 

entered.