T.C. Memo. 1998-45

UNITED STATES TAX COURT

DWIGHT L. MCKENNA AND BEVERLY S. MCKENNA, Petitioners v.

 COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 26334-92. Filed February 5, 1998.

Edward B. Mendy, for petitioners.

Kathleen O. Lier, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

WRIGHT, Judge: Respondent determined deficiencies in

petitioners' Federal income taxes and additions to tax, as

follows:

 Additions to Tax 

Year Deficiency Sec. 6653(b)(1)(A) Sec. 6653(b)(1)(B) Sec. 6653(b)(1) Sec. 6661

1987 $67,485 $50,614 1 $16,871

1988 49,419 $37,064 12,355

1 50 percent of the interest due on $67,485.
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Respondent determined, in the alternative to the fraud additions

to tax, that petitioners are liable for the negligence additions

to tax under section 6653(a)(1)(A) and (B) for 1987 and section

6653(a)(1) for 1988.

Unless otherwise indicated herein, all section references

are to the Internal Revenue Code in effect for the years 1987 and

1988, and all Rule references are to the Tax Court Rules of

Practice and Procedure.

In respondent's answer filed on January 29, 1993, it is

conceded that the fraud additions to tax for 1987 and 1988 are

not due from petitioner Beverly S. McKenna.

The issues for decision are:

1. Whether voluntary payments made by petitioners were

properly assessed when they were received by respondent along

with unsigned amended Federal income tax returns for 1987 and

1988 prior to sending the notice of deficiency.

2. Whether petitioners failed to report Schedule C income

from petitioner Dwight L. McKenna's medical practice in the

amounts of $175,285 for 1987 and $191,979 for 1988.

3. Whether petitioner Dwight L. McKenna is liable for the

additions to tax under section 6653(b)(1)(A) and (B) for the

fraudulent underpayment of his Federal income taxes for 1987, and

under section 6653(b)(1) for the fraudulent underpayment of his

Federal income taxes for 1988.
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4. Whether petitioners are liable for the substantial

understatement additions to tax under section 6661.

5. If petitioner Dwight L. McKenna is not liable for the

fraud additions to tax, whether petitioners are liable for the

negligence additions to tax.

6. Whether the assessment of petitioners' Federal income

taxes for 1987 is barred by the statute of limitations.

FINDINGS OF FACT

Some of the facts are stipulated and are so found. The

stipulations of facts and the exhibits attached thereto are

incorporated herein by this reference.

Petitioners Dwight L. McKenna and Beverly S. McKenna resided

in New Orleans, Louisiana, at the time they filed their petition

in this case. Their joint Federal income tax returns for 1987

and 1988 were filed with the Internal Revenue Service on August

15, 1988, and September 5, 1989, respectively.

Dwight L. McKenna's Background

Dwight L. McKenna (hereinafter petitioner) was born and

raised in New Orleans. He attended elementary, high school, and

college there. He received his medical training at Meharry

Medical College in Nashville, Tennessee, from which he graduated

in 1966. He interned at the University of Missouri, Kansas City

General Hospital, and later took his residency in surgery at

Howard University in Washington, D.C. After a tour of duty as a
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surgeon in the U.S. Army, he returned to New Orleans in 1973 to

begin his medical practice. He was associated as an independent

contractor with Flint-Goodrich Hospital, then the only black

owned hospital in the city of New Orleans. He then treated

mostly poor people who had either Medicaid or Medicare. He also

worked in neighborhood health clinics and as an assistant

coroner. When Flint-Goodrich Hospital was closed in 1983,

petitioner obtained privileges at St. Claude General Hospital,

now known as United Medical Center, and he started a private

medical practice at 1827 Gentilly Boulevard in New Orleans. 

During 1987 and 1988, the years involved in this case, the

Gentilly location was petitioner's principal place of business.

Petitioner became a prominent citizen in New Orleans. He

was a founding member of the Black Economic Development Council,

the purpose of which was to advocate the establishment and

progress of African American business in New Orleans. To that

end, the Council met with state and local agencies, asking them

to involve minorities in business decisions. In 1987 and 1988

petitioner was a member of the board of directors of the First

Federal Savings Bank of New Orleans. In 1986 he was elected a

member of the Orleans Parish School Board to fill a vacated seat,

and he was elected in 1988 for a full 4-year term. In 1988, he

was elected president of the School Board by the other members of

the board. As a member of the School Board, he received campaign
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contributions, and he was required to file a report declaring

those contributions. He made copies of each check for purposes

of reporting the contributions on the report. He reported the

total amount of his contributions.

Petitioner's Medical Practice in 1987 and 1988

For 1987 and 1988, petitioner's income and expenses of his

medical practice were reported on Schedule C, Profit or (Loss)

From Business or Profession. He was the stated proprietor.

During 1987 and 1988, and for several prior years, many of

petitioner's patients were referred to him by personal injury

attorneys. These patients had been involved in some type of

accident and required medical attention. Petitioner would

generally treat each patient and send the patient's bill directly

to the patient's attorney. He received payments for these

services from the patient's attorney, and the payments were taken

from the settlement proceeds of, or recoveries from, the personal

injury case.

In 1987 petitioner received 990 checks from 63 attorneys,

insurance companies, and governmental agencies, in the total

amount of $577,285.94. He knew that each of these checks was

income to him.

In 1988 petitioner received 864 checks from 65 attorneys,

insurance companies, and governmental agencies, in the total
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amount of $441,662.05. He knew that each of these checks was

income to him.

In 1987 and 1988 petitioner knew that he had an obligation

to report all of his income on his Federal income tax returns,

whether received by check or cash.

Petitioner knew that he would receive a Form 1099

representing income he received for services rendered to Medicare

and Medicaid patients. He knew that this information would be

sent to the Internal Revenue Service. He also knew that he was

not going to receive Forms 1099 from about 98 percent of the

attorneys who were issuing checks to him for payment of medical

services to their clients.

Petitioner made a copy of each check he received from an

attorney in 1987 and 1988. He would then add the checks each

week and make a notation to himself. He would keep a running

total for the entire year.

Although petitioner claimed that he kept a handwritten list

of the amounts of the various checks he received in 1987 and

1988, he never gave the list to Michael Bruno (Mr. Bruno), his

certified public accountant.

Petitioner usually hand delivered his bill for medical

services on behalf of certain patients to attorney Louis Gerdes

(Mr. Gerdes). This occurred during 1987 and 1988 when petitioner

received 278 and 188 checks, respectively, from Mr. Gerdes.
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In addition to the checks received by petitioner in 1987 and

1988, he would also receive cash from some patients, usually $50

to $100 per week. He did not include this cash in the

calculation of his income.

In the Schedule C for petitioner's medical practice, gross

income was reported in the amounts of $402,000 for 1987 and

$250,000 for 1988.

Petitioner understated the Schedule C gross income from his

medical practice in the amounts of $175,285 for 1987 and $191,979

for 1988. The correct gross income received from his medical

practice was $577,285 for 1987 and $442,262 for 1988. There was

a 30-percent omission of gross income in 1987 and a 43-percent

omission in 1988.

Petitioners' Return Preparers

From 1978 through 1990 petitioners' Federal income tax

returns were prepared by their accountant, Mr. Bruno, and his

accounting firm, Bruno and Tervalon. Mr. Bruno was managing

partner of the firm. Marie Walters, a C.P.A., assisted Mr. Bruno

in preparing petitioners' income tax returns for 1987 and 1988.

Petitioner's Banking Practices at First Federal Savings Bank

Petitioner had a checking account in his name at First

Federal Savings Bank (First Federal) in which he deposited checks

received from personal injury lawyers. Prior to 1987, he

deposited into that account all the checks he received. But he
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changed that practice in 1987 when he began transacting business

at the Read Branch of First Federal, primarily with two tellers,

Marilyn Clark and Ann Hattier, who both knew him as a customer

and as a member of the bank's board of directors. Petitioner

usually visited the Read Branch three or four times each week. 

On each occasion he would bring in a group of third party checks

made payable to him. He would tell either Ms. Clark or Ms.

Hattier that he wanted to exchange the checks for a First Federal

bank check, but he did not want them or cash deposited to his

checking account. A First Federal bank check was one that was

drawn on the bank's own account.

To exchange the third party checks for bank checks, the

teller would add the amounts of the checks, determine a total,

and deposit them to the First Federal suspense account, not to

petitioner's checking account. She would then issue a First

Federal bank check in the same amount as the total of the third

party checks. This procedure was followed each time the teller

issued a First Federal bank check to petitioner. By exchanging

the third party checks for bank checks in this manner, the total

amount of the third party checks or the bank check would not be

reflected in petitioner's bank account or in his bank statement. 

Of all the First Federal bank checks the tellers issued to

petitioner, only one was ever brought back to the teller for

deposit to his checking account or to be cashed.
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On some occasions petitioner would deposit a group of third

party checks. He would tell Ms. Clark, and she would write his

account number on the checks. He never had a deposit slip, so

Ms. Clark prepared one for him. The deposits of these third

party checks into his checking account were reflected in his bank

account and in his bank statements.

Except for petitioner, Ms. Hattier never handled a

transaction for any other customer or board member where she

accepted third party checks, deposited them into the First

Federal suspense account, and then issued a First Federal bank

check in the total amount of the third party checks.

Petitioner's Use of First Federal Bank Checks

All of the First Federal bank checks were made payable to

petitioner, and none of them were reflected in his First Federal

checking account.

In 1987, petitioner procured at least 52 bank checks from

First Federal which were made payable to him in the total amount

of $189,211.97.

In 1988, petitioner procured at least 29 bank checks from

First Federal which were made payable to him in the total amount

of $116,646.73.

Petitioner endorsed each First Federal bank check. Of the

First Federal bank checks, he deposited 39 of them with

Shearson/American Express for investments during 1987 and 1988. 
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He also deposited 30 bank checks with Howard, Weil, Labouisse,

Friedrichs, Inc., another investment company, during 1987 and

1988. In 1988 petitioner also deposited two First Federal bank

checks with Trans American, and one bank check with New York Life

Insurance Company. The proceeds from the bank checks were used

by the investment companies to buy tax free bonds and stocks.

Petitioner's Cashing of Checks at Circle Food Store

Betty Hebert was employed by Circle Food Store in 1987 and

1988. In 1988, she was the financial manager.

During 1987 and 1988, as well as other years, Circle Food

Store offered a check cashing service. It would charge a fee to

cash a check. The fee would range from 75 cents to $3.50,

depending upon the amount of the check being cashed. Once Circle

Food Store cashed the person's check, it would deposit that check

into its own bank account.

During 1987 petitioner cashed 135 income checks at Circle

Food Store which were written by attorneys or other third

parties. The total amount of these checks was $85,493. During

1988 petitioner cashed 63 third party checks at Circle Food

Store. The total amount of these checks was $30,629.50.

During 1987 and 1988, as well as other years, Circle Food

Store had an arrangement with attorney Louis Gerdes by which his

checks could be cashed at Circle Food Store. During 1987 and
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1988 some of Mr. Gerdes' checks were returned to Circle Food

Store for non-sufficient funds, or NSF.

Circle Food Store would assess Mr. Gerdes a $15 NSF charge. 

Ms. Hebert or another employee of Circle Food Store would usually

go to Mr. Gerdes' office, and he would issue a replacement check

to Circle Food Store, which included the amount of the check and

the NSF fee. At some point in 1988, Circle Food Store stopped

cashing Mr. Gerdes' checks because he refused to pay the NSF

charge, although he would issue another check for the amount of

the overdraft check. Circle Food Store never approached

petitioner and told him that he had to repay the amount he

received from one of Mr. Gerdes' checks.

Petitioner's Cashing of Checks at Liberty Bank

During 1987 petitioner cashed 60 income checks at Liberty

Bank which were written by attorneys or other third parties. The

total amount of these checks was $37,540. During 1988 petitioner

cashed 40 third party checks at Liberty Bank. The total amount

of these check was $23,005.

Petitioner Beverly McKenna's Newspaper Business

On their 1987 and 1988 joint Federal income tax returns,

petitioners filed a second Schedule C for a newspaper business

operated by Beverly McKenna. For 1987 and 1988, the gross income

and deductions were correctly reported.
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The operation of the newspaper was an expensive venture,

which was financed by petitioner. In 1987 the newspaper had a

net loss of $8,184 and in 1988 it had a net profit of $6,046. 

Mrs. McKenna was able to operate the newspaper and continue to

maintain her lifestyle, household, and children's education

because of petitioner's medical practice.

Mr. Bruno and his accounting firm performed full accounting

services for Mrs. McKenna's newspaper business. This service

included a compilation of the accounting records, general ledger,

and annual financial statements. For 1988, the compilation work

was performed by Marie Walters.

When Mrs. McKenna started her newspaper in 1985, she decided

to have full accounting services performed. This decision was

made because she did not feel comfortable handling this aspect of

the business by herself. Once Mrs. McKenna turned the newspaper

records over to Bruno and Tervalon, she relied upon the

accounting firm to process the records properly.

When Mrs. McKenna received revenues from the sale of

advertisements in her newspaper, she deposited those revenues

into her bank account. By giving her bank statements to Bruno

and Tervalon, it was her belief that Mr. Bruno's firm had

sufficient information to determine the newspaper's income.
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These accounting records were prepared based on bank

statements and canceled checks brought to Bruno and Tervalon by

Mrs. McKenna throughout each year.

In preparing the Schedule C for the newspaper business, Mr.

Bruno's firm would rely upon the information on the year-end

financial statement or the trial balance.

To determine the income derived by the newspaper business,

Bruno and Tervalon relied upon the deposits reflected on the

newspaper's bank statements.

In addition to these services, Bruno and Tervalon also

prepared the payroll returns for the newspaper.

Petitioner's Medical Practice and Types of Records Maintained for

That Business

Mr. Bruno's firm did not perform full accounting services

for petitioner's medical practice. Bruno and Tervalon only

performed payroll tax preparation for the medical practice. The

payroll tax returns were handled separately from the income tax

return preparation.

At different times prior to the Internal Revenue Service's

examination, Mr. Bruno had suggested to petitioner that Bruno and

Tervalon perform full accounting services for the medical

practice. Petitioner, however, never retained Bruno and Tervalon

to perform such services. Petitioner told Mr. Bruno that it

would be difficult to use his bank statements to generate the
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compilations because the account contained too much personal type

information, including other income from investments.

In New Orleans, where petitioner practices medicine, an

occupational license tax was due to the city. This occupational

license tax was computed based upon a certain percentage of the

gross income of the business. Bruno and Tervalon did not prepare

petitioner's 1987 and 1988 occupational license tax forms.

Petitioner told Mr. Bruno that he deposited all of his

income into his First Federal checking account. He further

stated that he maintained a total of his income throughout the

year. When he brought his tax information to Mr. Bruno,

petitioner gave him a total gross income figure for the year.

Petitioner did not tell Mr. Bruno that he was cashing some

of his income checks at Circle Food Store, and that he did not

deposit such funds into his checking account.

Petitioner did not tell Mr. Bruno that he was cashing some

income checks at Liberty Bank, and that he did not deposit such

funds into his checking account.

Petitioner did not tell Mr. Bruno that he took income checks

to First Federal and that he exchanged those checks for bank

checks drawn on First Federal's suspense account.

Preparation of Petitioners' 1987 and 1988 Income Tax Returns

In preparing the Schedule C for the newspaper business for

1987 and 1988, Mr. Bruno's firm relied upon the information on
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the yearend financial statement or the trial balance. This had

been prepared as a part of its full accounting services and was

based upon information furnished by Mrs. McKenna.

For the remaining items on petitioners' Federal income tax

returns, petitioner always brought the information necessary for

the preparation of the returns to Mr. Bruno. This would include

the information relating to his medical practice, all Forms W-2

and 1099, all information regarding rental property, and all

other information relating to personal items.

For petitioners' 1987 and 1988 returns, Marie Walters took

the information given by petitioner to Mr. Bruno, compiled that

information, prepared the tax returns, and returned them to Mr.

Bruno for review.

For the taxable years 1987 and 1988, Mr. Bruno had

discussions with petitioner advising him that petitioners' total

income had to be reported on their tax returns and that there

should be an attempt to reconcile the income going into

petitioner's bank account with the income being reported. 

Petitioner was told that income taxable to him would include

checks and cash that he received from his medical practice for

the payment of services.

For the preparation of the income tax return for 1987,

petitioner gave Mr. Bruno a sheet on which he had written the

words "Income Statement". He orally told Mr. Bruno that his
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total income for 1987 was $410,000, and this was the income

reported to the city of New Orleans for occupational license

purposes. On the sheet marked by petitioner as the Income

Statement, Mr. Bruno wrote: "$410,000 (includes 1099s) to City of

NO (for the payment of license)."

On the 1987 income tax return, line 1a of the Schedule C for

the medical practice reflected gross receipts or sales of

$376,206. Since petitioner told Mr. Bruno that the total income

figure of $410,000 included his Form 1099, the total amount of

the Forms 1099 in the amount of $25,794 was reported on line 4 of

the Schedule C. The gross income for the Schedule C reflected on

line 5 was $402,000.

Petitioner told Mr. Bruno that the amount of $410,000

included $8,000 shown on a Form W-2. Thus, the remaining $8,000

of the $410,000 was shown on line 7 of the first page of

petitioners' return. Since the actual amount of income shown on

that Form W-2 was $8,972.53, this was rounded to $8,973 and

listed on line 7.

For the taxable year 1988 petitioner gave Mr. Bruno a single

sheet of paper on which he wrote "Income, 250,000 office income."

Since petitioner gave Mr. Bruno certain Forms 1099

reflecting income from his medical practice, the Form 1099 income

was again segregated from the other medical practice income. Mr.

Bruno's firm added the Forms 1099 and attached the adding machine
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tape on the page furnished by petitioner which stated his office

income. The Form 1099 income was then placed on line 4 of the

Schedule C for other income, while the remaining income was

included on line 1 of the 1988 Schedule C reflecting gross

receipts. The gross income stated on line 5 of the Schedule C

was $250,283.

For the preparation of the returns for 1987 and 1988,

petitioner did not give Mr. Bruno copies of any of the checks

representing income he had received from the various personal

injury attorneys. He only gave Mr. Bruno the canceled checks

representing expenses. The first year he furnished copies of

these income checks to Mr. Bruno was during the preparation of

the 1989 income tax return, after the commencement of the

Internal Revenue Service examination.

When petitioner gave Mr. Bruno the amount of income for 1987

and 1988, he did not furnish him with any bank statements or

other books or records to support his determination of income. 

Petitioner had told Mr. Bruno that he determined his income from

information maintained on patient billings in his files. He did

not tell Mr. Bruno that the income amounts were only estimates.

In addition to petitioner's income from his medical

practice, he also told Mr. Bruno the amount of income petitioners

had received on each piece of their rental properties.
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Mr. Bruno and his firm determined the expenses and

deductions for the 1987 and 1988 income tax returns based upon

information furnished by petitioner, who labeled a group of white

envelopes with different types of expenses. These expenses

included those for the medical practice and the rental property. 

After petitioner segregated his canceled checks by expense

category and placed them in the appropriate envelopes, he gave

the envelopes to Mr. Bruno when they met to discuss the

preparation of petitioners' 1987 and 1988 income tax returns.

After his meetings with petitioner regarding the 1987 and

1988 income tax returns, Mr. Bruno gave the Income Statement and

various envelopes to Ms. Walters. She added the various

expenses, determined the deductible expenses, and included those

on the income tax return. Ms. Walters prepared the 1987 and 1988

income tax returns based on the submitted information, and the

returns were subsequently reviewed by Mr. Bruno with Ms. Walters

present. Ms Walters had no direct discussions with petitioner

regarding the preparation of the 1987 and 1988 income tax

returns. Mr. Bruno ultimately signed the returns.

On one occasion, Ms. Walters asked Mr. Bruno if petitioner

could furnish his bank statements. Mr. Bruno advised that he had

requested the bank statements, but petitioner never furnished

them.
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After Mr. Bruno reviewed and signed the 1987 and 1988

returns, he met with petitioner, and they reviewed the completed

returns together, including the Schedules C for the medical

practice. Petitioner never indicated that there was an error on

the 1987 and 1988 income tax returns, particularly with respect

to the amounts reported as income on the medical business

Schedules C.

Bruno and Tervalon also prepared petitioners' income tax

returns for 1989 and 1990. For these years, petitioner did not

furnish one lump-sum figure to Mr. Bruno or Ms. Walter. Instead,

he submitted copies of the checks he had received as income from

the various personal injury attorneys.

Internal Revenue Service's Civil Examination

Susan Davis was a revenue agent employed by the Internal

Revenue Service from October 1987, through May 1994. She had an

accounting degree and had also received extensive training

throughout the course of her employment with the Service.

In October 1989, Ms. Davis was assigned to conduct an

examination of petitioners' 1987 Federal income tax return. She

initially contacted petitioner by telephone on October 5, 1989,

and advised him that his and his wife's 1987 return had been

selected for examination. When Ms. Davis asked that an

appointment be scheduled, petitioner told her that she would have

to contact his certified public accountant, Mr. Bruno. Since no
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power of attorney form had been filed, she asked that Mr. Bruno

contact her. He telephoned her the same day, and they confirmed

an appointment date.

On October 5, 1989, Ms. Davis sent a letter to petitioners

confirming the initial appointment on October 27, 1989. To that

letter, she attached an Information Document Request, Form 4564,

(hereafter IDR) dated October 5, 1989. The IDR requested, among

other items, all of the petitioners' bank statements, canceled

checks, and duplicate deposit slips, as well as information with

respect to invested funds. Petitioner provided Mr. Bruno with a

copy of the letter and the IDR.

When Ms. Davis first met with Mr. Bruno, petitioner was not

present. Mr. Bruno appeared to have a limited knowledge of and

records for petitioner's medical practice and the income and

expenses claimed for 1987 and 1988. However, he was familiar

with Mrs. McKenna's newspaper business and made the records

available. After examining the newspaper business records, Ms.

Davis determined that each Schedule C for the newspaper for 1987

and 1988 was correct and no adjustment was made. Similarly,

after examining the information regarding petitioners' rental

property and the income derived therefrom, Ms. Davis determined

that the income was correctly reported and there were no

adjustments with respect to the rental property.
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Mr. Bruno advised Ms. Davis that similar full accounting

services were not performed by his firm for petitioner's medical

practice. To determine income, he stated that petitioner kept

such information and that he relied upon the total dollar figures

furnished to him by petitioner. Based upon such representations

to him, Mr. Bruno advised Ms. Davis that he thought all of the

income was deposited into petitioner's bank account. To

determine expenses for the medical practice, unlike his method

for giving an income figure to Mr. Bruno, petitioner gave Mr.

Bruno envelopes that contained canceled checks and expense

receipts.

Because Mr. Bruno had a limited knowledge of petitioner's

medical practice income, and additional information was needed,

Ms. Davis requested that Mr. Bruno schedule an appointment with

petitioner so that information could be obtained about the

medical practice and how petitioner determined the income figures

on his Schedule C.

At Ms. Davis' first meeting with Mr. Bruno, she submitted to

him a second IDR dated October 27, 1989, which requested: "All

other statements for all bank accounts. This includes checking,

savings, and investment accounts". Mr. Bruno sent a copy of this

IDR to petitioner and told him the requested documents had to be

produced.
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Information from the statements regarding deposits was

essential because Ms. Davis was attempting to verify the income

claimed by petitioner through the bank deposit method. Absent

such information she would not be able to correctly determine if

petitioner's income was accurately reported. At some point

during the examination, Mr. Bruno became aware that Ms. Davis was

attempting to verify the medical practice income through the bank

deposit method.

On November 2, 1989, Ms. Davis met with petitioner and Mr.

Bruno at Mr. Bruno's office to conduct her initial interview of

petitioner. At that meeting petitioner told her that during 1987

and 1988 most of his patients were personal injury patients. 

When he received checks for payment of his services, he stated

that he deposited them into his First Federal checking account. 

He stated that he kept up with his income in his head. 

On November 22, 1989, Ms. Davis submitted a third IDR to Mr.

Bruno. It again requested: "All bank statements (not previously

submitted) for all accounts. This includes checking, savings and

investment accounts. Canceled checks and deposit slips should be

presented with the bank statements". Mr. Bruno sent a copy of

this IDR to petitioner and advised him that the requested

documents had to be produced.

On December 8, 1989, Ms. Davis met with petitioner, Mr.

Bruno, and two of petitioner's attorneys at petitioner's medical
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office. The purpose of the meeting was to tour the medical

practice. At that meeting Ms. Davis asked for canceled checks,

which had been listed in the three IDR's. Petitioner told her

that he had given the checks to Mr. Bruno, he had returned them,

and then the checks were stolen out of his automobile. Also

during that meeting petitioner stated that each patient's medical

file contained copies of each check he had received from the

patient's attorney for the payment of medical services rendered.

Ms. Davis requested access to petitioner's patient files and

a list of the attorneys who had made payments to him. The

purpose of the request was to locate the attorneys who had paid

petitioner and independently verify the amounts paid to him

during 1987. Petitioner would not release the patient files

because of the patient-physician privilege. He told Ms. Davis

that he did not possess a list of the attorneys with whom he

dealt, and he did not offer to write down the names of the

attorneys for her. He again stated that he kept a running total

of his income in his head.

Up to and immediately after the December 8, 1989, meeting,

Ms. Davis had received no information regarding any of

petitioner's investment accounts, despite three IDR's requesting

that information. Mr. Bruno relied on petitioner to furnish him

with the documents requested in each of the three IDR's. To the

extent Mr. Bruno had the requested documentation in his
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possession, he gave it to Ms. Davis. Despite three separate

requests for investment accounts, Ms. Davis discovered one of the

investment accounts herself when she was reviewing certain

canceled checks. On one of these checks, she saw the name

"Shearson Lehman". When asked about the investment accounts, Mr.

Bruno told her there was an investment account with Shearson. He

further stated that he believed all of the money in the Shearson

account represented transfers from petitioner's checking account. 

This categorization of the Shearson deposits as transfers from

the checking account was significant because, if accurate, they

would have represented nontaxable income already considered as

income by Ms. Davis in her review of the account.

Petitioners' 1987 income tax return did show interest

received from Shearson. Ms. Davis did not receive an IRP

document, which is a document internally processed by the Service

and lists interest income, capital gains, et cetera, reported to

the Service. However, neither the interest amount reported on

the return nor the IRP document would have provided or given

access to the detailed statements. Without these detailed

statements, Ms. Davis would not have been able to determine

whether income had been deposited or withdrawn from that account,

and whether the interest income or capital gains were earned from

moneys placed in the account 10 years before or during the same

year.
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The IDR's did ask for specific documents for specific bank

accounts. None of the accounts specifically listed on each of

the IDR's was the Shearson account.

Ms. Davis then specifically asked for and, in January 1990,

received the Shearson account records. When she received and

analyzed the records, she discovered that the majority of the

deposits to the investment account were not transfers or

traceable from petitioner's checking account or any other

account. Thus, she determined that petitioner did not deposit

all of his income into his checking account.

After reviewing the Shearson accounts, Ms. Davis' bank

deposit analysis showed that petitioner had understated his

medical practice income in 1987 by $250,000. She gave this

calculation to Mr. Bruno, asked that he review it with

petitioner, and asked that he identify any nontaxable deposits

she had not previously identified. At that point, Mr. Bruno

attempted to reconcile and explain the difference.

During the period when Mr. Bruno was attempting to reconcile

the $250,000 difference, petitioner did not inform him that,

rather than making deposits in his bank account, he was cashing

checks at Circle Food Store and Liberty Bank, or that he was

exchanging income checks for First Federal bank checks. Instead,

Mr. Bruno continued to work with the incorrect belief that

petitioner deposited all of his income checks into his First
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Federal checking account. Mr. Bruno did not know petitioner was

cashing and exchanging checks until testimony was given before

the grand jury on May 25, 1990.

Throughout the course of Ms. Davis' examination, petitioner

never told Mr. Bruno that the income figures he gave to him for

1987 and 1988 were incorrect. Similarly, throughout the ensuing

criminal investigation in which Mr. Bruno assisted in the

representation of petitioner, Mr. Bruno was never told that the

income figures were incorrect.

Mr. Bruno subsequently furnished Ms. Davis with information

which attempted to establish the nontaxable nature of $100,000 of

the understatement. Since the amount of $150,000 still remained

unexplained, Ms. Davis determined that it represented unreported

income. She then explained that the Service likely would want to

begin an examination of petitioners' 1988 income tax return. 

After consulting with her supervisor, Ms. Davis told Mr. Bruno

that the subsequent year examination would be commenced.

In March 1990, two attorneys, Mr. White and Mr. Gray,

representing petitioners with a valid power of attorney, went to

Ms. Davis' office and requested that they meet with her and her

manager. Mr. White thought Ms. Davis had completed the

examination for both 1987 and 1988, although she had not begun

the examination for 1988. Although the then proposed deficiency

for 1987 was approximately $50,000, Mr. White stated that
- 27 -

petitioners wanted to agree to the liability because it was

"pocket change". Mr. White also expressed concern that the case

would be referred to the Criminal Investigation Division.

Shortly after the March 1990 meeting, Ms. Davis was advised

to suspend her examination because petitioner had become the

subject of a criminal investigation.

During her examination of petitioners' returns, Ms. Davis

was not told that petitioner had an investment account with the

brokerage firm of Howard, Weil, Labouisse Friedrichs, Inc., and

she received no investment account information pertaining to that

company.

During the examination petitioner did not tell Ms. Davis

that he had cashed checks and had not deposited them into his

checking account.

During the examination petitioner did not tell Ms. Davis

that he was going to First Federal and exchanging income checks

he had received from personal injury attorneys for First Federal

bank checks.

Petitioner's Criminal Conviction Under Section 7206(1).

On September 19, 1991, petitioner was indicted by the Grand

Jury for the United States District Court for the Eastern

District of Louisiana on two counts of violating section 7206(1)

for the taxable years 1987 and 1988. The indictment charged

petitioner with making false statements on his Federal income tax
- 28 -

returns by underreporting his income for 1987 and 1988 in the

respective amounts of $175,285 and $191,979. 

After a plea of not guilty and a criminal trial, a jury, on

February 15, 1992, found petitioner guilty of both charges of

violating section 7206(1) as contained in Counts 1 and 2 of the

Indictment.

Subsequent to the jury's verdict in the criminal case,

petitioner filed a motion for a new trial which was denied.

McKenna v. United States, 791 F. Supp. 1101 (E.D. La. 1992),

affd. without published opinion 980 F.2d 1443 (5th Cir. 1992).

On April 29, 1992, U.S. District Judge Charles Schwartz,

Jr., executed the Judgment and Probation/Commitment Order in

petitioner's criminal case. The Court sentenced petitioner to be

imprisoned for 15 months, fined him $4,000, assessed him with

costs of prosecution in the amount of $5,064.49, and ordered him

to pay a special assessment of $100. In addition, petitioner was

ordered to cooperate with the Internal Revenue Service to resolve

his tax indebtedness.

Petitioner appealed the judgment of conviction. In an

unpublished opinion, the Court of Appeals for the Fifth Circuit

affirmed the judgment of conviction on December 2, 1992, at 980

F.2d 1443 (5th Cir. 1992). Petitioner did not file a petition

for writ of certiorari with the Supreme Court of the United

States. 
- 29 -

Petitioner subsequently filed a pro se application seeking

issuance of a writ of habeas pursuant to 28 U.S.C. sec. 2255. On

July 29, 1993, U.S. District Judge Schwartz entered an Order and

Reasons denying petitioner's motion. Petitioner appealed the

District Court's denial of his motion under 28 U.S.C. sec. 2255

to the Court of Appeals for the Fifth Circuit. On June 3, 1994,

the Court of Appeals filed its opinion affirming the District

Court's denial of petitioner's motion.

Amended Returns Prepared by Petitioners and Their Additional Tax

Payments.

On June 29, 1992, the Internal Revenue Service received

Forms 1040X, Amended U.S. Individual Income Tax Returns, for

petitioners' 1987 and 1988 tax years. The 1987 Form 1040X

reflected additional income in the amount of $177,285, and the

1988 Form 1040X reflected additional income in the amount of

$191,979. The Internal Revenue Service Center rejected both the

1987 and 1988 Forms 1040X and did not file them because

petitioners did not sign them.

On June 29, 1992, the Internal Revenue Service received,

along with unsigned amended returns (Forms 1040X), petitioners'

voluntary payments in the following amounts:

Taxable Designated Payment Designated Payment

 Year of Tax of Interest 

1987 $93,548.78 $38,011.24

1988 61,533.72 19,618.23
- 30 -

Pursuant to the 1987 and 1988 unsigned amended returns and

voluntary payments, respondent assessed additional taxes in the

amounts of $68,255 on September 17, 1992, for 1987, and $48,887

on September 1, 1992, for 1988.

OPINION

Issue 1. Assessments of Voluntary Payments

Petitioners contend that their voluntary payments submitted

with unsigned amended income tax returns were improperly

assessed. After entry of the judgment of conviction in the

criminal tax case against petitioner, and while it was on appeal,

petitioners made the voluntary payments to respondent. 

In the notice of deficiency dated September 4, 1992,

respondent determined that there were deficiencies in income

taxes due from petitioners in the amounts of $67,485 and $49,419

for 1987 and 1988, respectively. In paragraph 3 of their

petition filed on November 27, 1992, petitioners conceded the

deficiencies in income taxes for 1987 and 1988.

On August 10, 1994, petitioners filed an amended petition. 

In paragraph 2 they alleged that the deficiencies for 1987 and

1988 were in dispute. In paragraph 3 of the amended petition,

however, they limited this "dispute" to an alleged error by

respondent in assessing the deficiencies. The facts stated in

paragraph 4 of the amended petition and the prayer for relief are

centered around respondent's assessments of the taxes.
- 31 -

Prior to the issuance of respondent's notice of deficiency,

petitioners submitted unsigned amended income tax returns to

respondent for 1987 and 1988. The 1987 amended income tax return

showed an increase in tax of $68,255. The 1988 amended income

tax return showed an increase in tax of $48,887. Respondent

received these returns on June 29, 1992. However, the amended

returns were not signed by petitioners, but only by their return

preparer, T.E. Mitchel. Respondent rejected both amended returns

because they were not signed by petitioners.

Along with the unsigned amended returns, petitioners made

voluntary payments to respondent in the total amounts of

$131,560.02 and $81,151.95. As a result of these voluntary

payments, respondent assessed additional tax in the amounts of

$68,255 on September 17, 1992, for 1987, and $48,887 on September

1, 1992, for 1988. The amounts of these assessed deficiencies

were determined based upon the increased tax liabilities

reflected on petitioners' amended, albeit unsigned, returns.

Section 6213(b)(4) permits the assessment of tax that has

been paid by a taxpayer regardless of the restrictions set forth

in section 6213(a). Petitioners do not dispute that the

assessments were of amounts paid as a tax or in respect of a tax

within the meaning of section 6213(b)(4). Accordingly,

respondent's assessments of the increased taxes for 1987 and 1988

were proper. In any event, petitioners will receive credit for
- 32 -

their voluntary payments against any deficiencies and additions

to tax determined by this Court to be due for 1987 and 1988.

Issue 2. Unreported Income

Petitioner has the burden of proving that he did not

understate his gross income from his medical practice by $175,285

for 1987 and $191,979 for 1988, as determined by respondent. 

Rule 142(a); Welch v. Helvering, 290 U.S. 111 (1933). He failed

to carry that burden.

Paragraph 16 of the first stipulation of facts filed with

the Court on the first day of trial states as follows:

The Schedule C gross income was understated from

petitioner Dwight McKenna's medical practice for the taxable

years 1987 and 1988 in the respective amounts of $175,285.00

and $191,979.00. The correct gross income for the medical

practice Schedules C was $577,285.00 for 1987 and

$442,262.00 for 1988.

Moreover, the testimonial and documentary evidence, contrary to

petitioner's assertion, fully supports the stipulation with

respect to the substantial amounts of unreported income for both

years.

Issue 3. Additions to Tax for Fraud

Respondent determined that petitioner is liable for the

fraud addition to tax under section 6653(b)(1)(A) and (B) for

1987, and under section 6653(b)(1) for 1988. Section

6653(b)(1)(A) and section 6653(b)(1) both provide that if any

part of any underpayment of tax required to be shown on a return

is due to fraud, then an amount equal to 75 percent of the
- 33 -

portion of the underpayment due to fraud shall be added to the

tax. Section 6653(b)(1)(B) also provides for an additional

addition to tax of 50 percent of the interest payable under

section 6601 for that part of the underpayment that is due to

fraud. If respondent proves that any part of the underpayment is

due to fraud, the entire underpayment shall be treated as due to

fraud unless petitioner can show by a preponderance of the

evidence that part of it is not due to fraud. Sec. 6653(b)(2). 

Fraud is defined as an intentional wrongdoing designed to

evade tax believed to be owing. Edelson v. Commissioner, 829

F.2d 828, 833 (9th Cir. 1987), affg. T.C. Memo. 1986-223. 

Respondent has the burden of proving fraud by clear and

convincing evidence. Sec. 7454(a); Rule 142(b). To satisfy this

burden, respondent must prove that petitioner intended to evade

taxes known to be owing by conduct intended to conceal, mislead,

or otherwise prevent the collection of taxes. Parks v.

Commissioner, 94 T.C. 654, 661 (1990).

The existence of fraud is a question of fact to be resolved

upon consideration of the entire record. DiLeo v. Commissioner,

96 T.C. 858, 874 (1991), affd. 959 F.2d 16 (2d Cir. 1992). Fraud

is not presumed and must be established by independent evidence

of fraudulent intent. Edelson v. Commissioner, supra. Fraud may

be shown by circumstantial evidence because direct evidence of

the taxpayer's fraudulent intent is seldom available. Gajewski
- 34 -

v. Commissioner, 67 T.C. 181, 199 (1976), affd. without published

opinion 578 F.2d 1383 (8th Cir. 1978). The taxpayer's entire

course of conduct may establish the requisite fraudulent intent. 

Stone v. Commissioner, 56 T.C. 213, 223-224 (1971); Otsuki v.

Commissioner, 53 T.C. 96, 105-106 (1969).

Courts have developed several indicia or badges of fraud

which include: (1) Understatement of income, (2) inadequate

books and records, (3) failure to file tax returns, (4)

implausible or inconsistent explanations of behavior, (5)

concealment of income or assets, (6) failure to cooperate with

tax authorities, (7) filing false returns, (8) failure to make

estimated tax payments, (9) dealing in cash, (10) engaging in

illegal activity, and (11) attempting to conceal illegal

activity. Bradford v. Commissioner, 796 F.2d 303, 307 (9th Cir.

1986), affg. T.C. Memo. 1984-601; Recklitis v. Commissioner, 91

T.C. 874, 910 (1988). This list is nonexclusive. Miller v.

Commissioner, 94 T.C. 316, 334 (1990). Although petitioner

contends otherwise, several indicia of fraud are present in this

case.

a. Petitioner's Sophistication and Experience

The sophistication and experience of a taxpayer are relevant

in deciding whether fraud exists. Stephenson v. Commissioner, 79

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

Petitioner was a highly intelligent, astute, and successful
- 35 -

physician and businessman. He was thoroughly familiar with his

business and financial interests, and he controlled them. 

Consequently, it is unlikely that he would not have realized that

his Federal tax liabilities were substantially underreported for

1987 and 1988.

b. False Returns

Respondent contends, and correctly so, that the doctrine of

collateral estoppel bars petitioner from contesting any issues

actually litigated during his criminal trial. Considine v.

United States, 683 F.2d 1285 (9th Cir. 1982). He was found

guilty of willfully subscribing to a false return for 1987 and

1988. Thus, this indicium of civil fraud is conclusively

established. Stobaugh v. Commissioner, T.C. Memo. 1984-112.

c. Understatements of Income

Substantial understatements of income in successive years,

when coupled with other circumstances showing an intent to

conceal or misstate income, justifies the inference of fraud. 

Holland v. United States, 348 U.S. 121, 137 (1954); Patton v.

Commissioner, 799 F.2d 166, 171 (5th Cir. 1986), affg. T.C. Memo.

1985-148.

In this case petitioner intentionally failed to report gross

income from his medical practice in the amounts of $175,285 for

1987 and $191,979 for 1988. These understatements represented a

30-percent omission of income for 1987 and a 43-percent omission
- 36 -

for 1988. Petitioner admitted that he knew this omitted income

was taxable. He also admitted that he made copies of the checks

he received from various attorneys who paid him for medical

services rendered to numerous personal injury patients. These

understatements are strong evidence of fraud. Truesdell v.

Commissioner, 89 T.C. 1280, 1302 (1987).

d. Inadequate Books and Records

A taxpayer's failure to maintain adequate and accurate

records is indicative of fraud. Merritt v. Commissioner, 301

F.2d 484, 487 (5th Cir. 1962), affg. T.C. Memo. 1959-172.

Here petitioner maintained certain records that were

convenient for his use, he destroyed other records, and he failed

to maintain records that would have accurately reflected his

income in 1987 and 1988. We think his records were intentionally

incomplete. He had patients sign a sheet when they arrived at

his office. The retention of these sheets could have assisted

him in determining his income each year. But, instead, the

sheets were destroyed each day. Further, there was no evidence

of any ledger cards maintained to assist in recordkeeping. 

Petitioner only copied the checks from attorneys, and he stated

that the purpose for this action was to assure that he was paid. 

By comparison, he obviously was not concerned with having an

accurate tax record of the income he received from those

attorneys.
- 37 -

e. Concealment of Income or Assets

The concealment of income or assets is an indicium of fraud. 

Bradford v. Commissioner, supra at 307-308.

The facts clearly show that petitioner concealed substantial

amounts of income by his actions. During the civil examination

by Ms. Davis, the revenue agent, petitioner did not furnish any

statements to her pertaining to his Shearson investment account

until she discovered a canceled check payable to Shearson. In

addition, he never provided statements to Ms. Davis regarding his

investment account at the Howard, Weil Company, despite

substantial deposits made to it.

Petitioner intended to conceal income by cashing some 300

checks at Circle Food Store and Liberty Bank, rather than First

Federal, his own bank, and then telling Mr. Bruno, his

accountant, and Ms. Davis that all income checks he received from

attorneys were deposited into his First Federal checking account.

Furthermore, petitioner did not tell Mr. Bruno or Ms. Davis

that he exchanged checks from attorneys for First Federal bank

checks, that the exchange would not be reflected in his First

Federal checking account, and that he deposited the bank checks

into his investment accounts. Without such information neither

Mr. Bruno nor Ms. Davis would have known that the income existed. 

Thus, petitioner withheld necessary information that misled his

accountant and the revenue agent.
- 38 -

f. Implausible or Inconsistent Explanations of Behavior

Petitioner maintains that he did not intend to fraudulently

understate his income for 1987 and 1988. His actions, however,

are consistent with those of a person possessing the intent to

defraud. For example, petitioner asserts that he gave Mr. Bruno

net income figures for his medical practice and that Mr. Bruno

made a mistake by placing net income on the gross income line of

Schedule C. This assertion is factually implausible and

unsupported by the evidence. Mr. Bruno repeatedly testified, and

we think truthfully so, that the income figures given to him by

petitioner for 1987 and 1988 were the amounts of petitioner's

total gross income for each year. Petitioner not only failed to

tell Mr. Bruno there was a mistake on the gross income line of

the Schedule C, but he also never mentioned this error to Ms.

Davis during the civil examination. Consequently, it is

difficult to believe that petitioner could have failed to notice

that the total amount of the checks he received from personal

injury attorneys so greatly exceeded his reported gross income. 

The more plausible explanation of his alleged discovery of this

so-called mistake, however, is that there was no mistake. It was

merely petitioner's explanation designed to shift the culpability

and blame away from himself.

As further support for his reliance argument, petitioner

emphasized that he knew nothing about taxes, recordkeeping, or
- 39 -

bookkeeping. Yet his testimony illustrated that his feigned

ignorance was nothing more than an attempt to conceal his

knowledge of his intentional understatement of income. Moreover,

he admitted that he knew that all of the checks from the various

attorneys were income to him and that he was required to report

this income on his returns. He stated that he knew almost all of

the attorneys would not file Forms 1099 with the Internal Revenue

Service, reporting their payments of income to petitioner. As

such, it was imperative that he maintain adequate records. See

Aflalo v. Commissioner, T.C. Memo. 1994-596.

In fact, petitioner made a copy of each check, and at trial

he testified that he kept a list containing a running tally of

the checks. Although these records were more than adequate to

determine gross income, petitioner conveniently failed to give

such records to Mr. Bruno. We note that after respondent's

examination began, the same types of records were given to Mr.

Bruno for the preparation of the 1989 and 1990 returns. When

questioned why the list and copies of the income checks were not

given to Mr. Bruno for the preparation of the 1987 and 1988

returns, especially since he gave Mr. Bruno all the canceled

checks necessary to substantiate expenses, petitioner's only

response was that Mr. Bruno did not ask him for his income

records. The more believable explanation is that petitioner did

not give Mr. Bruno the list and copies of his income checks

because he intended to understate his income for 1987 and 1988.
- 40 -

g. Failure To Cooperate With Respondent's Agent

Failure to cooperate in the examination and investigation of

tax liabilities is an indicium of fraud. Gajewski v.

Commissioner, 67 T.C. at 200. This record is replete with

evidence that petitioner did not cooperate with Ms. Davis during

her civil examination. He withheld records and documents. He

misled her. He did not intend to cooperate. We think he only

did what he thought was necessary to keep respondent's agent from

discovering his fraudulent scheme to hide his unreported income.

h. Conclusion as to Fraud

Accordingly, after considering all the facts and

circumstances present in this record, we find and hold that

petitioner is liable for the additions to tax for fraud with

respect to the amounts of the underpayments for 1987 and 1988.

Issue 4. Additions to Tax for Substantial Understatements

Section 6661(a), as applicable to 1987 and 1988, provides

for an addition to tax if there is a substantial understatement

of income tax for any taxable year. The addition to tax is in

the amount of 25 percent of the underpayment attributable to the

substantial understatement. Respondent determined that

petitioners substantially understated their income tax for 1987

and 1988, resulting in section 6661(a) additions to tax in the

amounts of $16,871 and $12,355, respectively.

Section 6661(b)(1) provides that an understatement is

substantial if (1) it exceeds 10 percent of the tax required to
- 41 -

be shown on the return, or (2) $5,000. By this definition the

understatements for both years were substantial and the 25

percent addition to tax applies.

Under section 6661(b)(2), which defines an understatement,

petitioners' deficiencies in the amounts of $67,485 for 1987 and

$49,419 for 1988 constituted understatements. Section

6661(b)(2)(B) provides for a reduction for an understatement (1)

if there was substantial authority for the tax treatment of the

subject item, or (2) if the subject item's tax treatment was

adequately disclosed on the return. Petitioners' understatements

do not qualify for any reductions under this definition.

Accordingly, respondent's determination on this issue is

sustained. Petitioners are liable for the section 6661(a)

additions to tax.

Issue 5. Additions to Tax for Negligence

Having found that petitioner is liable for the fraud

additions to tax for 1987 and 1988, it follows, as conceded by

respondent, that neither petitioner nor Mrs. McKenna is liable

for the additions to tax for negligence.

Issue 6. Statute of Limitations for 1987

Petitioners have affirmatively pleaded in their petition and

contend that the assessment of additional taxes for 1987 is

barred by expiration of the 3-year period of limitations under

section 6501(a). However, as provided in section 6501(c)(1), the

tax may be assessed at any time in the case of a false or
- 42 -

fraudulent return with the intent to evade tax. Because we have

found that petitioner's 1987 income tax return was fraudulent, it

follows that the assessment of additional taxes for that year is

not barred by expiration of the period of limitations.

In view of the foregoing,

Decision will be entered

under Rule 155.