T.C. Memo. 1998-195

UNITED STATES TAX COURT

PHILLIP VAZZANA AND ESTATE OF YVONNE VAZZANA, DECEASED, PHILLIP

VAZZANA, EXECUTOR, Petitioners v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

JOSEPH M. VALENZA AND MILDRED VALENZA, Petitioners v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket Nos. 914-96, 915-96. Filed May 27, 1998.

Ira M. Burman and Richard L. Manning, for petitioners.

Rogelio A. Villageliu and David S. Weiner, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

FOLEY, Judge: Respondent determined the following

deficiencies in and additions to petitioners' Federal income

taxes:
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Phillip Vazzana and Estate of Yvonne Vazzana, docket No. 914-96

 Additions to Tax 

Year Deficiency Sec. 6653(a) Sec. 6653(b)(1) Sec. 6661 Sec. 6663(a)

1988 $69,781 $1,786 $25,550 $17,445 -- 

1989 190,002 -- -- -- $14,251

Joseph M. Valenza and Mildred Valenza, docket No. 915-96

 Additions to Tax 

Year Deficiency Sec. 6653(a) Sec. 6653(b)(1) Sec. 6661 Sec. 6663(a)

1988 $28,383 $112 $19,609 $7,096 -- 

1989 20,941 -- -- -- $15,706 

All section references are to the Internal Revenue Code in effect

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

Court Rules of Practice and Procedure. After concessions, the

issues for decision are as follows:

1. The extent to which petitioners underreported the gross

receipts of Valenza & Vazzana Construction Co. (V&V). We hold

that they underreported such receipts by $121,289 for 1988 and

$101,029 for 1989.

2. Whether petitioners have substantiated certain V&V 

expenditures. We hold that they have to the extent provided

below. 

3. Whether petitioners are each entitled to a depreciation

deduction relating to their rental property. We hold that they

are not.
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4. Whether Phillip Vazzana and Estate of Yvonne Vazzana

correctly reported a capital gain they recognized on the sale of

a house. We hold that they did not. 

5. Whether Joseph M. Valenza and Mildred Valenza are

entitled to deduct $2,485 of business expenses. We hold that

they are not.

6. Whether petitioners are liable for additions to tax for

fraud. We hold that they are to the extent provided below.

7. Whether petitioners are liable for additions to tax for

negligence. We hold that they are to the extent provided below.

8. Whether petitioners are liable for additions to tax for

substantial understatements of income tax. We hold that they are

to the extent provided below.

9. Whether assessment and collection of the deficiencies

and additions to tax are barred by expiration of the statutory

period of limitations. We hold that they are not.

FINDINGS OF FACT

Some of the facts have been stipulated and are so found. At

the time they filed their respective petitions, Phillip Vazzana

resided in Lockport, Illinois, and Joseph and Mildred Valenza

resided in Burr Ridge, Illinois. 

During the years in issue, Messrs. Vazzana and Valenza each

owned a 50-percent interest in V&V, an Illinois general

partnership located in Chicago, Illinois. V&V constructed and
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remodeled commercial and residential property. It maintained a

bank account at Lakeside Bank. Messrs. Vazzana and Valenza did

not deposit all of V&V's gross receipts into V&V's bank account. 

Instead, they cashed a substantial number of customer checks at

other neighborhood banks. 

On its 1988 and 1989 Forms 1065 (U.S. Partnership Return of

Income), V&V reported gross receipts of $373,483, and $548,863,

respectively. The returns were prepared by V&V's accountants,

Barbara Charal and Michael J. Baumhart. Messrs. Vazzana and

Valenza knew that their accountants calculated V&V's gross

receipts by totaling the deposits in V&V's account and that the

cashed checks would not be reported on V&V's income tax returns. 

In early 1991, respondent audited V&V's returns and Revenue

Agent John Lee was assigned to the case. Mr. Lee asked Messrs.

Vazzana and Valenza to provide records of V&V's income and

customer accounts. They failed to cooperate with Mr. Lee, so he

summoned V&V's bank records and obtained information directly

from V&V's customers. Based on these documents, Mr. Lee

determined that V&V underreported its gross receipts by $132,046

for 1988 and $111,734 for 1989. 

Messrs. Vazzana and Valenza each owned a one-half interest

in rental property valued at $200,000. The building was

previously owned by Shield Development Corp. (SDC), a company in

which Messrs. Vazzana and Valenza were stockholders. In 1987,
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SDC liquidated and distributed the property to Messrs. Vazzana

and Valenza. During 1988 and 1989, they each received unreported

gross receipts from the property of $32,162 and $8,730,

respectively. 

In 1988, Mr. and Mrs. Vazzana sold a house they had

constructed. On their joint 1988 Federal income tax return, they

reported the $348,000 realized on the sale, a cost basis of

$333,158, and a capital gain of $14,842. 

The Vazzanas filed their 1988 and 1989 Federal income tax

returns on April 17, 1989, and April 9, 1990, respectively, and

reported adjusted gross income of $31,719 for 1988 and $32,115

for 1989. The Valenzas filed their 1988 and 1989 Federal income

tax returns on April 14, 1989, and April 9, 1990, respectively,

and reported adjusted gross income of $18,397 for 1988 and

$38,197 for 1989. On April 12, 1995, petitioners executed Forms

872, extending the time for assessment of their 1988 taxes to

October 31, 1995. On October 27, 1995, respondent issued notices

of deficiency to petitioners.

OPINION

I. Unreported V&V Gross Receipts

Petitioners have conceded that they underreported V&V's

gross receipts by $70,935 for 1988 and $69,494 for 1989. 

Respondent, however, contends that V&V received additional

unreported gross receipts of $80,915 for 1988 and $43,656 for
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1989. Respondent's additional gross receipts computation was

based, in part, on documents (i.e., customer contracts and

illegible checks), which were not probative evidence that V&V

received income. As a result, respondent's computation

overstated V&V's gross receipts by $30,561 for 1988 and $12,121

for 1989. Accordingly, we hold that Messrs. Vazzana and Valenza

underreported V&V's gross receipts by $121,289 for 1988 and

$101,029 for 1989. 

II. V&V Expenses

Petitioners contend that V&V made substantial cash

expenditures to subcontractors for which they did not claim

deductions. Specifically, they contend that V&V paid J. B.

Johnson, a handyman, $40,000 in 1988 and $36,000 in 1989. 

Petitioners have failed, however, to provide any documentation to

establish that V&V paid Mr. Johnson such funds. Mr. Johnson's

testimony was contradictory and unpersuasive. He first stated

that he had received the income and reported it on his tax

returns. He later stated that he did not report the income, had

no records of receiving such income, and may not have received

the amounts petitioners contend V&V paid him. 

Petitioners contend that V&V paid Frank Schmitt, a

carpenter, $9,320 in 1988 and $11,960 in 1989. Mr. Schmitt

testified that he received these amounts and reported them as

income on his Federal income tax returns. Petitioners provided
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copies of Mr. Schmitt's tax returns, and respondent does not

dispute their authenticity. V&V issued Forms 1099 stating that

it paid Mr. Schmitt $1,470 in 1988 and $1,579 in 1989. Mr.

Schmitt explained that V&V reported on the Forms 1099 only the

payments made by check, not cash. As a result, we conclude that

V&V made cash payments to Mr. Schmitt of $7,850 in 1988 and

$10,381 in 1989. Petitioners have failed, however, to establish

the amount of any other cash expenditures that V&V made to

subcontractors. 

III. Depreciation Deduction for Rental Property

Petitioners contend that for 1988 they are each entitled to

a depreciation deduction of $3,269 for their rental property. 

Respondent contends that petitioners have failed to establish

their basis in the property. We agree. Accordingly, we hold

that petitioners are not entitled to the depreciation deductions.

IV. The Capital Gain From the Sale of the House

On their joint 1988 Federal income tax returns, Mr. and Mrs.

Vazzana reported $348,000 realized from the sale of a house, a 

basis of $333,158, and a capital gain of $14,842. Respondent

contends that their basis should be limited to $282,788 and that

their gain should be $65,212. The Vazzanas have established

(i.e., through testimony, checks, and invoices), however, that
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their basis was $314,849. Accordingly, we hold that the Vazzanas

recognized a capital gain of $33,151 on the sale of their house.

V. Unreimbursed Business Expense Deduction

On their joint 1989 Federal income tax returns, Mr. and Mrs.

Valenza claimed a $2,485 itemized deduction for unreimbursed

business expenses. We hold that petitioners are not entitled to

this deduction because they have failed to present any evidence

relating to this issue. 

VI. Additions to Tax for Fraud

Respondent determined that petitioners, pursuant to sections

6653(b)(1) and 6663(a), were liable for additions to tax for

fraud. Section 6653(b)(1), applicable to petitioners' 1988

returns, and section 6663(a), applicable to petitioners' 1989

returns, provide for additions to tax equal to 75 percent of the

portion of the underpayment of tax that is attributable to fraud. 

If respondent establishes that any portion of an underpayment is

attributable to fraud, the entire underpayment is treated as

attributable to fraud except to the extent petitioners establish

otherwise. Secs. 6653(b)(2), 6663(b). To prove fraud,

respondent must establish, by clear and convincing evidence, that

for each year in issue an underpayment of tax exists and that

some portion of the underpayment is due to fraud. Sec. 7454(a);

Rule 142(b); Petzoldt v. Commissioner, 92 T.C. 661, 699 (1989). 

A. Underpayment
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Petitioners have conceded that they failed to report

significant amounts of income that they received from V&V and

their rental property. In addition, they have failed to

establish that such amounts are offset by unreported expenses. 

Therefore, we conclude that respondent has presented sufficient

evidence that petitioners underpaid their taxes for the years in

issue.

B. Fraudulent Intent

To prove fraud, respondent must establish that petitioners

intended to evade taxes through conduct designed to conceal,

mislead, or otherwise prevent the collection of taxes. Rowlee v.

Commissioner, 80 T.C. 1111, 1123 (1983). Fraudulent intent is

not to be imputed or presumed, but may be established by

circumstantial evidence and reasonable inferences drawn from the

facts. Spies v. United States, 317 U.S. 492, 499 (1943);

Petzoldt v. Commissioner, supra; Stephenson v. Commissioner, 79

T.C. 995, 1006 (1982), affd. 748 F.2d 331 (6th Cir. 1984). The

mere existence of deficiencies in tax liability does not

establish fraud. Otsuki v. Commissioner, 53 T.C. 96, 106 (1969). 

Exceedingly large, unexplained discrepancies between a taxpayer's

actual income and reported income, however, do evidence fraud. 

Stone v. Commissioner, 56 T.C. 213, 224 (1971).

Respondent has provided sufficient evidence that petitioners

failed to report V&V gross receipts of $121,289 for 1988 and
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$101,029 for 1989. This underreporting resulted from Messrs.

Vazzana and Valenza cashing a substantial number of V&V customer

checks, rather than depositing them into V&V's account. Messrs.

Vazzana and Valenza knew that their accountants calculated V&V's

gross receipts by adding the deposits in V&V's account and that

the cashed checks would not be reported on V&V's income tax

returns. 

Messrs. Vazzana and Valenza contend that they used the cash

proceeds to pay for unreported V&V expenses and that the

unreported receipts and expenses netted out. Respondent,

however, has established that, with the exception of the cash

payments to Mr. Schmitt (i.e., $7,850 in 1988 and $10,381 in

1989), Messrs. Vazzana and Valenza did not substantiate any

unreported cash expenditures. Therefore, we reject their 

contention. Messrs. Vazzana and Valenza concede that they each

failed to report gross receipts from their rental property of

$32,162 for 1988 and $8,730 for 1989. They have offered no

explanation for their failure to report this income. 

Accordingly, we hold that the portions of the deficiencies

relating to V&V's gross receipts and the rental property were due

to fraud and that Messrs. Vazzana and Valenza are liable for the

additions to tax for fraud relating to such portions. 

Respondent, however, has not established that Mrs. Vazzana and

Mrs. Valenza acted with fraudulent intent. As a result, Mrs.
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Valenza and Mrs. Vazzana's estate are not liable for the

additions to tax for fraud. See secs. 6653(b)(3), 6663(c). 

Petitioners have established that the remaining portions of the

deficiencies did not result from their fraudulent intent. 

VII. Additions to Tax for Negligence

Respondent determined that petitioners, pursuant to section

6653(a), are liable for additions to tax for negligence for 1988. 

Petitioners concede that they were negligent. Accordingly, we

hold petitioners liable for the negligence additions to tax

relating to the portions of the deficiencies that are not

attributable to fraud. See sec. 6653(a)(2).

VIII. Additions to Tax for Substantial Understatement

Respondent determined that petitioners were liable, pursuant

to section 6661, for additions to tax for substantial

understatements relating to 1988. Section 6661 provides that if

there is a substantial understatement of income tax, there shall

be added to the tax an amount equal to 20 percent of the amount

of any underpayment attributable to such understatement. Sec.

6661(a). An understatement is the difference between the amount

of tax required to be shown on the return and the amount of tax

actually shown on the return. Sec. 6661(b)(2). An

understatement is substantial if it exceeds the greater of $5,000

or 10 percent of the amount of tax required to be shown on the

return. Sec. 6661(b)(1). The understatement is reduced,
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however, to the extent that it is based on substantial authority,

or adequately disclosed in the return. Sec. 6661(b)(2)(B). 

Petitioners have failed to establish that their understatements

in tax were based on substantial authority or adequately

disclosed. Accordingly, if the recomputed deficiencies satisfy

the statutory percentage or amount, petitioners will be liable

for such additions to tax. See, e.g., Cluck v. Commissioner, 105

T.C. 324, 340 (1995). 

IX. Period of Limitations

Petitioners contend that assessment and collection of the

deficiencies and additions to tax are barred by expiration of the

statutory period of limitations. We disagree. Where returns are

filed fraudulently with the intent to evade tax, the tax may be

assessed at any time. Sec. 6501(c)(1). Accordingly, we hold

that assessment and collection are not barred.

All other contentions raised by the parties are either

irrelevant or without merit.

To reflect the foregoing,

Decisions will be entered

under Rule 155.