TAX COURT OPINION

Case: Thomas J. Barrow
Docket Number: 14551-02
Judge: Holmes
Opinion Type: memo
Filed: 11/25/2008
Pages: 70

CAL. STAT. (cid:16)042 (cid:16)042JT.TDGE T.C. Memo. 2008-264 F2!|[2S UNITED STATES TAX COURT THOMAS J. BARRÖW, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent BARROW, ALDRIDGE & CO. , Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent Docket Nos. 14551-02, 14716-02. Filed November 25, 2008. Clarence B. Tucker, Sr., for petitioners. Alexandra E. Nicholaides and Kimberly Webb, for respondent. MEMORANDUl¼ FINDINGS OF FACT AND OPINION HOLMES, Judge: Thomas J. Barrow was .a pioneer for African- AmeriCans in the accounting profession, creating what was for a time the nation's largest minority-owned accounting firm. Despite his 1mpress1ve leadership, Barrow ran into trouble with i SERVED NOV 2 5 2008 - 2 - the IRS when audits revealed that he was not. reporting all of the business income that he received. The IRS also disallowed various deductions he took during the years at issue . Barrow was convicted at a criminal trial of filing false tax returns, bank fraud, and income tax evasion. We must decide whether Barrow and his firm are liable for tax deficiencies and associated penalties for. the years 1984-89. I. The Early Years FINDINGS OF FACT Barrow grew up in Detroit, graduated from high school there, and then attended Wayne State University. He majored in accounting while .working as an intern for Arthur Andersen when that firm was still one of the Big Eight national accounting f irms . He earned his bachelor' de~g^r'e'e in accounting in 1971- and became a certified public accountant in 1973. Upon graduation from college, Barrow was promoted by Andersen and he began working on financial audits. He rose through the ranks, and eventually became an experienced senior auditor. His job was to plan audit engagements, execute them, write . the audit procedures, review the audit work papers, and then draft the client's financial statements to make sure they complied with Generally Accepted Accounting Principles (GAAP) . He worked only on financial audits, and was never involved with - 3 - Andersen's tax department. He also found time to continue his education by earning an MBA in finance, again'from Wayne State. II. Formation of Barrow, Aldridge, & Co. In March 1975, Barrow and two of his colleagues from Andersen, William Aldridge and Ron Coleman *founded their .own accounting firm, named Barrow, Coleman, Aldridge & Co. They organized it as a corporation in which eachtowned a one-third . interest. The firm aimed to build a client list of small businesses, individuals, -and nonprofits, and it soon had a number of clients in the health2care .industry. And it didn't just do the financial audits Barrow specialized in -it also offered bookkeeping, recordkeeping, and·tax-return preparation. The firm quickly took off and, as its revenues grew, it took on more employees. Most were CPAs, but,the firm needed staff, - too, and one of its f irst was C t h i a Nobles . She began work in 1976, as'secretary to all three partners. Over the course of her employment at the-firm,. her responsibilities-grew until she became both the firm's office manager -and its bookkeeper. Barrow taught Nobles some basi&accounting^skills, such as recording journal entries, working with a general ledger,. and reconciling the. bank account. At.first, he closely supervised her and was able to correct any mistakes she made . Barrow soon.emerged as the firm''s.star.. At- first this just meant he had to work^harder, because the companyvgenerally followed the eat-what-you-kill model, with each of the senior partners working mostly for those clients that he brought to the firm. Barrow proved to be the superior rainmaker, though, and was soon bringing in far more clients than he could handle himself, shifting some of the work to the other partners. The principals began to specialize-:Aldr-idge in tax, and Barrow on audit and financial services but with an increasing focus on client development. When equal partners generate unequal revenues, trouËle usually ·ensues. And in the early '80s, Barrow became dissatisfied with what he thought was the less-than-equal effort . of both of his partners, but especially of Coleman.· Barrow didn't feel that he had the power to fire Coleman, so he decided to leave the firm. The only problem was that the firm wanted to leave with him--the clients were predominantly Barrow's, and the employees said they would follow Barrow out the door. So. Coleman decided to leave instead, and Aldridge.-agreed.to make some adjustments so that he and Barrow.could continue to work together, thus forming Barrow, Aldridge & Co. (BACO) in 1981. After the shakeup, Barrow became the majority owner with 54-. percent dontrol and was in charge of the firm's finances. BACO, like its predecessor, had always. managed its finances using the "modified cash basis of accounting." At trial, Barrow first defined the plain-vanilla "cash method of ·accounting" as one where a company.records revenues when it receives cash or a cash equivalent. Likewise, a company using this method records expenses only when money goes out the door. Barrow described the limitations of this method, saying that a company cannot account for, depreciation under it. But as Barrow explained, BACO used the modified cash method of accounting, which allowed the company to record certain expenses when all the events that.surround that. expense had occurred.1 When BACO paid its employees, for example, it would accrue and deduct the related FICA payments at that time instead of waiting to deduct those taxes when it actually paid them over to~the government. Barrow increasingly came to think of BACO as "his" firm and took it upon himself to lend it money when blips in its cashflow made meeting payroll a problem. He. did not formally approve these loans in writing on behalf of BACO, but both Aldridge and Nobles knew of them and credibly testified that they occurred. Nobles also credibly testified that she would make journal entries in the ordinary course of business., adjusting the amount of the loans outstanding.both when BACO received-money and when 1 BACÒ's tax returns had a box that required a choice of accounting method: cash, accrual or "other (specify)." Commissioner points' out that BACO checked that it used the cash method of accounting while Barrow now claims BACO used the modified cash method. Checking.the box for cash method seems reasonable, however, given that "[r]elatively minor deviations in the form of accruals will not change the taxpayer from the basic cash method." (LexisNexis 2007). 1 Alkire Tax Accounting, sec. 3.01[3] The it paid Barrow back. We specifically find these journal entries a generally reliable record of Barrow's loans to BACO.and their repayment. BACO required all employees and owners to abide by a noncompete agreement. Barrow testified that it was BACO's policy "that if it [was] a service that [BACO] offer[ed]," then a BACO employee couldn't "perform that service outside of the firm's purview." Donna West, initially a BACO audit manager and.later a principal,. credibly testified that she knew that this was BACO's policy even though she never saw it in writing. She explained that she "would not have been able to work for a competitor" because "ás a.CPA [she] would not work for one of the other" accounting firms." She also explained that she could work in- house for a client, but that under the policy she would still be a BACO employee receiving her compensation from BACO. III. Complete Information Systems The second business whose finances are at issue in this case is Complete Information Systems (CIS). Started in 1979 by BACO's principals, CIS leased mainframe time which it resold to its clients.2 That time would then be available for BACO clients to automatè their bookkeeping. Barrow completed all the paperwork 2 In those bygone days before personal computers became a commodity, companies could actually make.money by buying time on a mainframe computer wholesale and reselling it to clients. For the various uses (or the.misuses) of Odeneal, Computer Time Sharing for Managers 17 (1975). the term "time sharing", see to set up CIS, and at first all.the partners of Barrow, Coleman, Aldridge & Co. owned it, but with the understanding that distributions from revenues would be unequal and dependent on who brought the client in. All the clients of CIS were also clients of BACO, and the partñers would routinely try to.cross-sell the services of both firms. Over time, CIS also began to lease cars to BACO's owners. Barrow signed the lease agreements for CIS, and Aldridge and Nobles signed for BACO. After the shakeup from which BACO emerged, Barrow became the sole proprietor of CIS, though Nobles - continued to do its bookkeeping. For tax years 1984, 1985, 1987, and 1988, Barrow called this business CIS or CIS Leasing; on his 1986 tax return, Barrow called!it "BARCO leasing." For all of these tax years, Barrow reported its business income and expenses on his own Schedule C, using the cash method of accounting, under which he recorded CIS's income!and expenses in the calendar year in which they occurred. IV. BACO'=s Success and Barrow' si Community Involvement BACO continued to grow, and in 1981 it opened a satellite office in Illinois. The firm also negotiated a deal with Coopers & Lybrand that was essentially a right of first refusal. If BACO wanted to partner with a large accounting firm, it had to ask Coopers first, and likewise if Coopers wanted to partner with a minority-owned firm. This agreement gave BACO access to large clients that it would not have otherwise been able to work with. Barrow negotiated this joint venture, and it was the first of its kind among accounting firms.in Detroit. Barrow successfully increased the client base of the BACO satellite offices by marketing his experience and learning to manage client relationships remotely. In an effort to bring in new clients and to raise his stature in both thé business and financial communities, Barrow became active in many professional associations. He was the Detroit chapter president for the National Association of Black Accountants (NABA), which became the largest chapter in the country under his leadership.. ·He later became the national.NABA president, and in that role he visited many U.S. cities to organize additional chapters. He served on an advisory board to the ·Commissioner of Internal Revenue, and the governor of Michigan appointed him to the State Board of Accountancy, which he eventually chaired. He was also a member of the Accounting Aid Society of Metropolitan Detroit, and was on the advisory board to the Small Business As.sociation and the Advisory,Council of the Wayne. State University Department of Accounting. . . But the community involvement that plays the biggest role in this case began with Barrow's appointment to the board of . trustees for New Center Hospital (NCH) in 1981. NCH was a troubled institution, as Barrow quickly discovered after he arrived. This prompted him to start asking tough'questions of Alan Weiner, the hospital's executive consultant. Weiner reacted by trying to find ways to decrease the strength of the hospital board, but Barrow led a countercoup in 1984 in which the board ousted Weiner, and elected Barrow as chairman of NCH. Barrow's prominence and reputation in Detroit was growing. But 1985x proved to be its apogee . That year, Barrow decided to heedt the urging of his friends and run for mayor of the city against the formidable incumbent Coleman Young. He believed--and we speci f ically f ind his . claim of naive te credible - - that this would simply mean putting. his name on the ballot and campaigning for awhile. Instead, it began a long downward slide in his personal and financial fortunes. The first sign was.neither subtle nor long in coming--BACO's largest client in 1985 was the City of Detroit, and the City swiftly decided to cut off its business with the firmi leaving BACO with a huge revenue shortfall. But there were also subtler effects. As Barrow. grew more occupied.with politics and community work, he. did not have the time he needed to supervise 3 At Hospital. Detroiti Center Hospïtal had a poor image in the coinmunity. the time, New Center Hospital was named Detroit Center The board decided to change the name in 1984 because _ 10 - Nobles adequately. Mistakes she made in recording entries in the books of both BACO and CIS remained uncorrected and leached into Barrow's.and BACO's tax returns. Many of the problems that led to this case, though, began with Barrow's work on the.NCH board. His duties started out as routine trustee chores--attending meetings and cursorily reviewing Weiner's proposals. Bút after Weiner's ouster, Barrow and the hospital bòard decided in 1985 to seek outside advice, which led them to put the hospital and some affiliates under a holding company. This new company, callediCentral Cities Health Services (CCHS), with Barrow as chairman of its board of directors, planned to acquire clinics throughout Detroit. These clinics'could refer patients needing.specialized or acute care to the hospital, giving its patient population a muchaneeded boost. He also increased his efforts at the. hospital while running for mayor that year--in fact, the then-chairman of CCHS stepped down and let Barrow take his place because he knew it would be valuable for Barrow's mayoral 'campaign. Barrow stayed on the hospital's board, too, and was.the only director common to both NCH and CCHS. The two boards began paying their members a fee of $100 for each monthly board meeting attended, and $50 for each subcommittee meeting. They also.paid Barrow a separate annual chairman's fee of $4000. CCHS's plan began to work, and it became the parent company of New Center Clinic-East!+New Center Clinic-West, and New Center Clinic- - 11 - Central. The NCH board of trustees hired a chief operáting officer The new man wäs to run the hospital's billing, personnel, and patient care departments, but after a couple years it became obvious- that he didn'-t know how to· run' the f inancial side' of the hospital. The result was a cashflow problem serious enough to prompt the board to remove him. By then, NCH was collecting substantially less than what it was billing. Some insurance companies and Medicaid were srefusing to pay bills because of avoidable paperwork problems, but instead of correcting and resubmitting the bill, the billing department did nothing. The result was a perpetual cash crisis. The board also.discovered that the hospital had á mortgage with HUD on which it was not cùrrent . which then triggèred violations of NCH's corresponding regulatory agreement connected to.that - mortgage. And, to add to the-hospital's woes, it also had a payroll-tax problem because it hadn't'been.paying over withheld taxes to the IRS. Sometime between 1985 and 1988,i CIS.began providing computer services to NCH. These services includëd aiding the hospital with its billing system It's unclear whether and to what extent Barrow disclosed his ownership of CIS--a potential conflict of interest--to the other board members. But Barrow credibly - 12 - testified on this tangential point that every board member did business with the hospital and its affiliates. Barrow understood the hospital's financial problems and, so he began to get more involved in the.hospital's day-to-day operations. In September 1987, while still a partner at BACO, Barrow began functioning as a full7time manager to try to bring order to the chaos in the hospital's financial departments. The board agreed in exchange to pay Barrow the same $52,000 (as a chairman's fee) that the previous chief operating officer·had received as salary. Between February 1986 and late 1987, NCH signed two deals with BACO. The first was a professional compilation-accounting services agreement, a service that BACO.routinely performed for its clients. After receiving bids for contracts from other accounting firms.that the hospital couldn't afford, BACO essentially "lent" -some of its employees at,reduced rates to NCH to help with the billing and finances. These employees acted like NCH employees--they worked at NCH every day, and they were . actively involved in reconciling the bank accounts, building and maintaining relationship with the hospital's vendors, and creating the quarterly requests for reimbursement from Medicare, Medicaid, and Blue Cross.Blue Shield. NCH paid BACO directly, and BACO deposited this money into BACO checking accounts. Donna - 13 - West was the lead on this engagement, and Barrow's work on this project did not extend beyond supervising her. In Sept~ember 1987, at about the time that Barrow took on his greatly expanded role in managing the hospital, BACO started the second engagement, which was to reconstruct cost reports, business records, and other accounting records back to the 1970s. This project was much more complex: The money at risk amounted to several million dollars and the hospital's survival was at' stake. Barrow got personally involved, but since the hospital paid him a chairman's fee, he did not have BACO bill NCH for his time. Barrow's involvement on this engagement came within the penumbra of the noncompete agreement, and he admits that the fee paid to him as NCH' s chairman should have belonged to BACO under that agreement.4 All during these yeårs.that he was spending so much time at CCHS and NCH; Barrow continued to have several outstanding loans with BACO. He would often deposit checks-from BACO's clients that were payable to BACO into his own personal account. On this important point we specifically find, based on the testimony and exhibits in evidence, that Barrow had Nobles record in the BACO general ledger upon receipt of each check a journal entry that decreased the loan payable to him (a debit) and increased BACO'S 4 There was also a draft agreement between CCHS and BACO for similar consulting services, but agreement or acted upon it. the parties neÝer signed the - 14 - revenues from the engagement (a credit). The only check not properly recorded in the BACO ledger was one for $8,352 from Ernst & Whinney: During this time, Barrow was still receiving a board stipend from NCH in,addition to his chairman's fee. Barrow credibly testified thats there. was a substantial. difference between his role as NCH chairman and his role as NCH boar& member. He received the NCH board stipend for'attending and conducting . meetings, and considered it (like the other board stipends and the CCHS chairman's fee) to be his own income. The hospital consistently paid BACO and Barrow, although not all -the other . vendors, and for a time Barrow himself managed the hospital's cashflow by approving all payments before they were sent to the , vendors. This gave him a very detailed knowledge of the state of NCH's cash position, and he would sometimes refrain from cashing his board stipend or chairman's fee checks because he knew the hospital didn't have the cash on hand to pay him. While occupied at the hospital and CCHS, Barrow also had to deal with another outbreak of change at BACO--Aldridge's decision to leave the firm in December of 1987. Even though Barrow had been president of BACO from its start, Aldridge's departure left, him with near total responsibility over administrative and financial decisionmaking. It also left him--with the exception of some partners who owned about 3 percent of the firm's outstanding shares-üas the firm's owner Even more than before, - 15 - BACO's fate depended -on Barrow. V. Personal and Professional Trouble Despite all his responsibilities, Barrow chose to run for mayor again in 1989. This second campaign was especially brutal because Barrow was by then a legitimate threat to the inòumbent" mayor. Calling his mayoral run."life-altering," Barrow experi- enced things he only thought happened in fiction, credibly testi- fying that someone broke·into his home and stole only his brief- case. And that he föund someone pulling documents from his trash. And that police began to sit outside his homè to observe who was coming and going. The 1989 òampaign began tö founder after the Detroit Free Press ran a series of - articles about Barrow, a BACO, CIS, and their connections with NCH. Because NCH consistently paid BACO and Barrow but not its other vendors, the paper questioned whether Barrow had a conflict of interèst. On one occasion, a repörter at the paper called Barrow. and askedi whether he had ever received payment from NCH for his services. Barrow"lied and said that he had not. And. even though he thought no one would ever find out, he stamped the back of his chairman's-fee checks, which he had already deposited into his personal account, ,with the BACO endorsement stamp. . Barroid also kept quiet about the ownership of CIS--Joseph Valenti, a friend bf Barrow's. and' fellow hospital - 16 - board member, testified credibly that-even he.didn't know CIS and Barrow were connected until a reporter did an investigative.piece - on Barrow during the campaign. Barrow lost his run for the mayoralty and then lost a race for Congress in 1990. He resigned from the NCH board in July 1990, and pulled the BACO staff out of the engagement with the hospital at that time as well. VI. The Collapse: Audit and Criminal Trial In September 1989, IRS Agent Stephen Bulik began investigating BACO's tax return for the year ending March 31, 1988. One of the first things he did in his audit was to reconcile the general ledger to the tax return. Many of the general ledger accounts did not agree. The audit soon expanded to BACO's tax year ending March 31,..1989, and to Barrow's personal taxes for 1984 through 1988. Because Bulik was not able to reconcile the return to the general ledger, he began a specific-items analysis5 for both BACO and Barrow personally for all years at.issue. Bulik performed a bank-deposits analysis to determine the CIS portion of Barrow's understatement. A specific-items analysis is a direct method of proof used (When when án IRS agent can find a taxpayer's sources of the IRS can't find a taxpayer's sources of indirect.method of proof such as an analysis of bank deposits.) See generally Garbis et al., Tax Procedure and Tax Fraud 618 (3d ed. 1992). income. income,. it uses an - 17 - After years of investigåtion and a referral from the civil to the criminal side of the IR$, a grand jury indicted Barrow in October 1993 on one count of bank fraud, one count of making false statements on a loan application, five counts of.tax evasion under section 7201 for tax years 1984 through 1988, and five counts under section 7206(1).of willfully submitting false tax returns for tax years 1984 through 1988.* Barrow was also indicted on three counts of willfully submitting false corporate tax returns on behalf of BACO for tax years 198T through 1989. During-the crimina·l trial, the government pursued a theory that Barrow had cheated on his taxes by not reporting on.his individual returns the fees thàt NCH and CCHS pa.id to him as the chairman of the board and a trustee. ' Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the years in issue, ánd all Rule references are to the. Tax Court's Rules of.Practice and Procedure. 7 Neither party chose to introduce the transcript of the to affokd testimony of the taxpayer and other the criminal trial); but see Costa v. Commissioner, criminal trial into evidence. Cf. Oliver v. Commissioner, T.C. Memo. 1993-508 .(where we allowed admission"of a transcript from the criminal trial and held;that we had discretion,in deciding the weight witnesses at T.C. Memo. 1990-572 (where we disallowed admission of an affidavit from the criminal trial since it wasn't made under Fed. R. Evid. 801(d) (1)). indictment case of what happened in the criminal case, and the concessions of each party. Barrow did include massive excerpts from the criminal trial transcript in his posttrial brief. Rule 143(b), however, says that statements in briefs are not evidence.- And we have ,previously held that parties cannot attempt We therefore rely where relevant on the (which was introduced), credible testimony in this to supplement (continued. .) - 18 - In 1994, a jury convicted Barrow on eight of the twelve counts.against him:. (cid:16)042 Making false statements in connection with a bank loan application under 18 U.S.C. 1014; (cid:16)042 Bank fraud under 18 U.S.C. 1344; (cid:16)042 Income tax evasion for tax years 1985, 1987, and 1988 under section 7201;. and (cid:16)042 Willfully filing false income tax returns for years 1985, 1987, and 1988 under section 7206(1). . Barrow was also convicted under section 7206(1) for willfully filing a false corporate income tax return for BACO in tax years ending March 31, 1988 and 1989. VII. Barrow and BACO Tax Returns Barrow would collect.all of the yearend adjusting entries and the calculated ending balances for each of the general ledger accounts. Then Aldridge (at first) or Barrow (after Aldridge left) would prepare BACO's tax returns. Both Barrow and BACO routinely filed their returns late during the years 1984-1989. Just as often, the -returns were later amended after Barrow discovered reporting mistakes made by Nobles or remembered income. or expenses that he had previously been too busy to write down. 7(...continued) the record with new material provided in the post-trial briefs. See Snyder v. Commissioner, 93 T.C. 529, 533 (1989); Hartford -v. Commissioner, T.C. Memo. 1995-351. We therefore do not.use that information in reaching our decision. - 19 - Barrow' s Pers:>nal Income Tax Returns Form 1040 1040 1040 1040X 1040X 1040 1040X 1040 Date Filed 7/13/87 1/11/88 1/14/88 2/04/88 4/10/90 12/29/89 1/10/90 1/10/90 . Tax Year 1984 1985 1986 1987 1988 3ACO' s : ncome Tax RÊtur is Fiscal Year Ending 3/31 Form Date Filed 1988 1989 1120 1120 1120X 1120X 1120 1120X 7/18/88 9/20/89 1/10/90 4/10/90 10/04/89 4/10/90 VIII. The Civil Trial The IRS began a civil examination of Barrow and BACO in 1998. After several years of investigationf the Commissioner sent notices of deficiency to Barroffor tax years 1984 through 1988, and to BACO for tax years ending March 31, 1988 and 1989. The Commissioner determined deficiencies arising from the following unreported income: - 20 - 3ACO s Unrsport ed Income Year -NCH CCHS NCC-W NCC-E Ernst & Whinney 1988 1989 $63, 955 . 66 $64, 811. 55 - - - - - - 63, 513 . 66 54563 . $4 , 500 $9, 000 $8, 352 Barro ' s Unreported >Income Year Bank-Deposit Portion Due to BACO Portion Due to Method Distributions Wages . . 1984 1985 1986 1987 1988 $10 7, 337 . 34 $7, 694 . 07 $76, 015 . 84 4,410 92,457.05 27, 176 . 0 8 137, 237.15 14, 600 70,232.58 121, 965 . 1.6 167, 271.27 ---- --- - - - -.-- Instead of attributing the NCH and CCHS fees to Barrow personally, the Commissioner now argues that they belonged to BACO, and that Barrow diverted . them by depositing them into his own personal checking account. The. Commissioner treats this income and diversion for tax purposes as income to BACO, followed by a constructive dividend to Barrow. Even though the government now believes this is the proper way to treat the fees,. it used a completely different theory at Barrow's criminal trial--an important change, as it will turn out . The Commissioner also disallowed several deductions. Some of these were expenses connected with Barrow's plane. Because he - 21 - traveled so often to meet with clients spread throughout Michigan and Illinois, and to visit various other cities for his work with NABAL Barrow--an instrument-rated pilot--had begun flying himself to save time. The FAA requires pilots to keep a logbook of all their flights and to record the purpose of each. But dùring the initial audit, Barrow gave the logbooko to the IRS without making a copy. The IRS lost it, and Barrow was unable to·reproduce its content . Both Barrow and BACO petitioned this Court for relief . The main issues for decision are: (cid:16)042 Did Barrow or BACO engage in fraud, thereby tolling the 3-year statute of limitations? (cid:16)042 Does collateral or judicial estoppel bar any claims or issues in this case? (cid:16)042 Did. Barrow or BACO understate income? (cid:16)042 May Barrow or BACO take the income tax deductions disallowed by the Commissioner? (cid:16)042 Is Barrow or BACO liable for the fraud penalty under former section 6653(b) (1)? Barrow resided in Detroit throughout the events of this case, including the day he filed his petition. ,BACO is now a defunct corporation originally headquartered in Detroit.8 8 Michigan law provides that a dissolved corporation "may sue and be sued in its corporate name and process may issue by and against had not occurred." Mich Comp. Laws Serv. sec. 450.1834 (e) (Lexis-Nexis 1973); see also id. sec. 450.1833; Freeman v. Hi Temp Prods . the corporat.ion in the same manner as if dissolution , 580 N. W . 2d 918, 921 (Mich . Ct . App . 1998) . . - 22 -- OPINION I . Fraud This case hinges on whether Barrow committed fraud. On this question hangs the Commissioner' s ability to redetermine Barrow' s and BACO's deficiencies for 1984-89, because the Commissioner generally has .only three years after a taxpayer files a return to. assess a deficiency or issue a notice of deficiency. Sec. 6501(a). Barrow filed all original personal and business returns for the years in question by the end of 1990,' but the Commissioner waited until 2002 to send notices of deficiency. Barrow urges us to apply the three-year statute of limitations, but the Commissioner points us to section 6501(c) (1), which says that [i]n the case of a false or fraudulent return with the intent to evade tax, proceeding in court for collection of such tax may be begun without assessment, at any time. the tax may be assessed, or a 8(. . .continued) (Lexis-Nexis 1973); see also id. sec. 450.1833; Freeman v. Hi Temp Prods., 580 N.W.2d 918, 921 (Mich. Ct. App. 1998). * We look to the date that Barrow filed the original . in applying section 6501(c) (1) . returns, not any amended returns, Badaracco v. Commissioner, 464 U.S. 386, 394 (1984), ("[0]nce a fraudulent return has been filed, false or fraudulent return,' revised conduct, under section 6653 (b) . purposes of 6501 (c) (1) . ") .. the unlimited assessment period specified by section It likewise should remain such a case for regardless of the taxpayer's later the case remains one 'of'a for purposes of * * * civil fraud liability Whether we get to decide the merits of each year depends on the success of his assertion. Fraud is an intentional wrongdoing, .and the Commissioner must prove by clear and convincing evidence that Barrow specifically intended to *evade a tax that he .believed he or BACO owed "by conduct intended to conceal, thislead, or otherwise prevent the collection of taxes." See Niedringhäus v. e Comtnissioner, 99 T. C. 202, 210 (1992) ; accord, Wright v. - Commissioner, 84 T.C. 636, 639 (1985) . We look to Barrow's actions to détermine whether any BACO=underpayment resulted from fraud because "corporate fraud necessarily depends on the fraudulent intent of the corporate officers." DiLeo v. Commissioner, 96 T.C: 858, 875 (1991), affd.-959 F.2d 16 (2d Cir. 1992) .' We do not impute or presume fraud--the Commissioner must prove that: there is an 'underpayment of year at stake; and tax for each (cid:16)042 some part of that underpayment is due to fraud. Sec . 7454 (a) ; Rule 142 (b) ; Wright 84 T . C. at 639 . A. Underpayment To prove an underpayment, the Commissioner can use methods different from those the taxpayer used to calculate income when the taxpayer's method of accounting doesn't. clearly refléct income. Sec. 446(b); Parks v..Commissioner, 94 T.C. 654, 658 - 24 - (1990). - Barrow has-the burden to prove that the Commissioner's determination of unreported income is unfair or inaccurate. DiLeo, 96 T.C. at 871; Parks, 94 T.C. ·at 658. The Commissioner argues that Barrow underpaid his personal tax liability for tax years 1984-88,. and that Barrow caused BACO to underpay its tax due in 1988 and 1989. We need not delve into the details in this part of our opinion, because Barrow concedes at least some underpayment for 1984 (due to using the wrong Form W-2), and 1985 (due to a missing Form 1099 for CCHS income). We have also held that.a taxpayer admits an underpayment by filing an amended return that increases his tax liability. Badaracco,. 464 U.S. at 399; Delvecchio v. Commissioner, T.C. Memo. 2001-130, affd. 37 Fed. Appx..979 (11th Cir. 2002). That's just what Barrow did for 1986 when he filed a Form 1040X for 1986 that showed an increase in tax liability. We therefore find with . little difficulty that Barrow had at -least some underpayment :'u2 1984, 1985, and 1986. Whether an underpayment existed for 1987 and 1988, and for BACO in 1988 and 1989, is a more difficult question. Barrow did file an amended return for 1987--but it decreased his tax liability by $28,750. BACO's 1988 and 1989 amended returns show no increase in tax liability because of the availability of net- operating-loss carryforwards. So we can't use these amended returns as admissions. - 25 - But we . can use the fact that he filed all four of these returns late. The version of section 6653 (c) (1) effective for Barrow' s 1987 and 1988, and BACO' s 1988 and 1989, returns states that For purposes of this section the term "underpayment" means * * a deficiency as defined in [section 6211] (except. that return referred to in section.6211(a) (1) (A) shall be taken into account only if such return was f iled on or before the last day prescribed for the filing of such return * the tax shown on a forythis purpose, * * * And for purposes of section 6653(c) (1), a taxpayer will automatical.ly create an "underpaymerit" irr the amount of the correct tax simply because he * * * files an untimely return. '" Campbell~v. Commissioner, T. C. Memo. 1997-415 (quoting Emmons v. Commissioner, 92 T.C. 342, 349 (1989), affd. 898 F.2d 50 (5th Cir. 1990) ) . This means that, to answer the question of whether the Commissioner has proven that there were underpayments for the 1987, 1988, and 1989 tax years, we can simply look to see if Barrow reported any nonzero tax due for those years. See sec. 301. 6653-1(c) (1) (ii) , Proced. & Admin. Regs . Even if Barrow contests the Commissioner's deficiency, a late-filed return is an admission that one owes at least the amount of tax shown due on it, making it an. admission of underpayment. And even if we assumed the accuracy of the tax reduction shown on the amended 1987 return, Barrow would still be deemed to have admitted that he owed some tax for 1987. We therefore conclude that there was - 26 - - at least some underpayment as defined in section 6653(c).(1) for Barrow in 1987 and 1988. The Commissioner can find no comfort in this reasoning for the BACO returns in this case. BACO's original returns for 1988 and 1989 show zero.tax liability because of a net-operating-loss carryforward that eliminates any tax. that would've otherwise been due. The notice of deficiency for these years recalculated and reduced the net operating loss available for 1988 and 1989,. and included Barrow's hospital board fees and chairman's fees in BACO's income during those years. This created a tax deficiency, and as we said above, an underpayment for purposes of section 6653(c) (1) .includes a deficiency as defined in section 6211. Rather than make findings on the merits. that an underpayment- exists, we move along to the second part of the fraud test for these two years as well. B. Collateral'Estoppel, Judicial Estoppel, and BACO's Noncompete Policy Before deciding whether Barrow had the required fraudulent intent, we must first consider whether we need to decide the question at all. Each party vigorously argued that the other is estopped on the issue. We'll start with the Commissioner. He contends that Barrow is collaterally estopped from contesting that he had the required fraudulent intent when he filed his 1985, 1987, and 1988 returns, because he was convicted for criminal tax evasion under section - 27 - 7201 for those years. . The Commissioner is right that a conviction under section 7201 for taxuevasion necessarily carrles with it the factual determinationnthát some part of the resulting de f ic iency was due to - f raud, and as a general rule we collaterally estop a taxpayer fi-om arguing any defenses tò the civil f raud penal ty for the same year . Niedringhaus , 99 T . C. at 214; see also Gray v. Commissioner, 708 F.2d 243, 246 (6th Cir. 1983), affg. T.C. Memo. 1981-1 It's possible, however, that the Commissioner's procedural missteps bar him from succeeding on this argument . . The possible misstep here is that we require a party asserting an affirmative defense--here, .collateral estoppel--to raise the issue in his pleading. Rule 39. The Commissioner didn't do that. He argues, however; that there was implied consent because Barrow didn't object to his collateral-estoppel defense at trial, and Rule 41(b).(1) says that when.an issue is tried by express or implied . consent, we are to streat the issue as if it was raised in the pleadings. In Pierce v. Commissioner T.C. Memo. 2003-188 [citations omitted].,. Our Court held that this rule applies to collateral -estoppel [we have] cons:idered whether the consent [I]n deciding whether tö apply the principle of consent, results in unfair surprise or prejudice toward the consenting party and prevents that party from presenting evidence that might have been introduced if the issue had been timely raised. implied - 28 - In Estate of Huntsman v. Commissioner, 66 T.C. 861, 871-72 (1976) , we held that there was no implied consent. where the taxpayer had no notice of the Commissioner's. tardy argument, the Commissioner didn't raise the issue at trial, and we found that the taxpayer had no opportunity to.defend against the Commissioner' s claim. Barrow's case is different. The. Commissioner raised the issue in his pre-trial memo, putting Barrow on notice of his collateral-estoppel defense. Barrow does argue -that the - (cid:16)042 Commissioner never filed a posttrial motion to conform the pleadings to the proof presented, and therefore we should bar the Commissioner from relying on collateral estoppel now. But Rule 41 (b) (1) says that . The Court, upon motion, of any party at any time, may allow such amendment of necessary to cause them to conform to the evidence and to raise these issues, but failure to amend does not affect the result of the trial of these issues. the pleadings as may be (Emphasis added) . We therefore . will address the collateral- estoppel issue on its merits.1° We. use collateral estoppel to prevent parties from litigating issues that were necessarily'decided in a prior suit. 1° Barrow also argues that he notified our Court at trial of the Commissioner's failure to raise collateral estoppel as an affirmative defense. He cites the trial record in one .of his post-trial briefs, but his citation is incorrect. - 29 - Peck v. Commissioner, 90 T.C. 162, 166-67 (1988), affd. 904 F.2d 525 (9th Cir. 1990). There are five conditions: The issue in the second suit must be.identical in all respects with the one decided in the first suit. (cid:16)042 There must be a final judgment rendered by a court of competent jurisdiction. (cid:16)042 Collateral estoppel may be applied against parties and their privies to the prior judgment. . (cid:16)042 The parties must actually have litigated the issues and the resolution of have been essential to the prior decision. these issues must (cid:16)042 The controlling facts and applicable legal rules must remain·unchanged from those in the ' prior litigation. Both'parties agree that this case meets the second and third conditions: the District Court in the criminal case rendered a final judgment and the parties to each case are the same." Because they contest the remaining criteria we analyze them, in turn, for 1985, 1987, and 1988. 1. Are the Issues Identical in All Respects? The Commissioner simply asserts that the issues in each case are the same. Niedringhaus, 99 T.C. at 217 ("'willfully' as used The Commissioner limits his estoppel argument to the three years in which Barrow was individually convicted of evasion.under section 7201. We've previously held that a corporation--even if it's closely held--that was not a part of the criminal case cannot be collaterally estopped from denying fraud based on a majority shareholder's conviction for tax evasion. C.B.C. Super Mkts., 894 (1970). Inc. v. Commissioner, 54 T.C. 882, tax - 30 - in section 7201 encompasses all. the elements of fraud which are envisioned in section 6653 (b)") . ' But Barrow says the issues are different because the Commissioner uses a new theory of corporate diversion, a position that he says contradicts the theory of personal income-tax evasion the government used in winning the criminal case. Barrow argues that the new theory was not before the jury in the criminal case and that, if it had been, the government would have had to prove at that trial both that (1) the income belonged to BACO and (2) Barrow deliberately diverted the income to himself . Because these issues weren' t considered at the criminal trial and Barrow never had a chance to challenge them there, Barrow says that collateral estoppel cannot apply. The government admits that its theory is dif ferent in this case from what it argued in the criminal case: * *. By doing so, the clearest presentation of In the criminal case, the United. States presented to an unsophisticated jury that the unreported income was the direct income of Thomas J. Barrow * the United States cast facts to the jury_ so as to avoid any confusion the jurors may have had with the concept. of double taxation. introduced suf f icient evidence to show that was also the corporate earnings of adding the double tax component> that was omitted in the criminal case. attributable to [Barrow] . In the instant case, In both instances, the income is [the Commissioner] the the income [BACO,] therefore Reply Brief for Respondent, at 5. In other words, the government successfully persuaded the District Court jury in the criminal case to find that all- of the unreported income was directly - 31 - received by Barrow." The Commissioner argues that this direct- income theory is consistent with his corporaterdiversion theory because in both cases, the income is taxable to Barrow. The Commissioner says he is simply adding.anòther layer by determining that the income is also taxable to BACO." Even though we agree with Barrow that.the government's position has changed between the criminal case and this one (as we explain later in discussing judicial estoppel), there are relatively minor items of unreported income or incorrect expenses whose'consequences for Barrów's tax liability are unaffected by the switch in government theories between the cases. At the criminal trial,.the government had the burden to establish willful tax evasion beyond a reasonable doubt. Because the jury didn't have to return a verdict detailing which items of income Barrow hadn't reported or which items of expense he hadn't Recall that the government had to prove an underpayment in the .criminal case . But prove the specific amount óf the underpayment, underpayment of F.2d 353, 356-57 (4th Cir. 1965); Wapnick v. Commissioner, T.C. Memo. 1997-133. the government wasn' t required to See Moore v. United States, 360 tax existed. .just that an " Corporations are subject to double taxation because the Code taxes income first when the company receives it and then .again when the company distributes it to its shareholders. Prescott v. Commissioner, 66 T.C. 128, 138 (1976), affd. 561 F.2d 1287 (8th Cir 1977). the development "Is Double Taxation a Scapegoat for of double taxation, see Bank, Declining Dividends? Evidence From History", 56 Tax L. Rev. 463, 479-516 (2003). For a histórical account of See - 32 - substantiated, we have no way of figuring out any precise de f ic iency f rom the judgment in the criminal case . We do know that the Commissioner's burden to prove fraud here by clear and convincing evidence is a lower standard than the U.S. attorney's burden of proving Barrow's willful evasion beyond a reasonable doubt. And we know from the j.ury's verdict that at least some part of Barrow's underpayment for 1985, 1987, and 1988 is attributable.to fraud. We have also previously stated: it is now well settled that the criminal conviction requires application of collateral estoppel and that * unde.rpayment for the prosecution years must be deemed already to have been judicially determined to be "due to fraud" within the meaning of section 6653 (b). the doctrine of judgment of * * at least part of any C.B.C. Super Mkts., 54.T.C. at 893; see also Rodney v. Commissioner, 53 T.C. 287, 305 (1969). Because a portion of the deficiencies that were at issue in the criminal case remains at issue in this case, we cannot say that the fraud issue as it related to the individual deficiencies is different. 2. Did the Parties Actually Litigate the Issues and Was There a Resolution Essential Decision? to the Prior The issue of whether or not Barrow evaded tax was litigated in the criminal case. The jury agreed with the Government that Barrow evaded tax in 1985, 1987, and 19,88.. Because we have held that a conviction for evading tax decided the issue of whether some part óf Barrow's underpayment was due to fraud, we agree - 33 - with the Commissioner that the parties actually litigated the issue and there was a resolution in the Government's favor. 3. Have the Controlling Facts and Applicable Legal Rules. Remained Unchanged From Those in the Criminal Case? The.applicable legal rules remain unchanged--both criminal tax evasion and civil tax fraud require proof of an underpayment. Sec. 7201; United States v. Heath, 525 F.3d 451, 456 (6th Cir. 2008); Niedringhaus, 99 T.C.'at 210. The controlling facts relevant to Barrow's criminal tax evasion are also the same as those the Commissioner argues apply in this case--at least with regard to part of Barrow's individual income-tax deficiency not attributable to the new theory of corporate diversion. And there are no new facts that weren't available to the parties in the criminal case. Barrow urges us to consider Boulware v. United States, 552 U.S.. , 128 S. Ct. 1168 (2008), as a change in the applicable legal rules sufficient to defeat the application of collateral estoppel." Boulware held that a shareholder in a criminal tax evasion case can claim that distributions from his company were a return of capital, without producing evidence that he or the company intended this type of distribution. Id. But On April 15, 2008, Barrow filed a motion asking us to take judicial notice of Boulware, a motion which in effect allowed him to cite supplemental authority for his case. asked for a response from the Commissioner, argued that the proper venue for deciding the impact of Boulware decision is District Court. the in which he correctly We . - 34 - the Commissioner is correct in asserting that the theory pursued by the government in Barrow's criminal, case didn't involve this . 1s sue . We therefore collaterally estop Barrow from denying fraud for tax years 1985, 1987, and 1988. This means we can redeter- mine Barrow' s tax liability for those years . The Commissioner, however, must still prove fraud for Barrow' s individual income tax in years 1984 and 1986, an issue, that we analyze below in redetermining the deficiency. for all five years.15 The Commissioner is. not alone ,in urging estoppel. Barrow, too, raises the issue. But the theory he argues for is. judicial estoppel.« Judicial estoppel is a doctrine that prevents a party from winning judicial acceptance. of a theory in one case, only'to pursue a contradictory theory later. New Hampshire v. Maine, 532 U.S.: 742, 749 (2001); Fazi v. Commissioner, 105 T.C. 436, 445. (1995) (citing Huddleston v. Commissioner,s 100 T. C. 17, 28-29 (1993) ) . The rule' s purpose is to "protect the integrity of the judicial process . . . by prohibiting parties from deliberately changing positions according to the exigencies of the moment." New Hampshire v. Maine, 532 U. S.. at 749-50· (citations and quotation marks omitted). "Judicial estoppel does not bar a party from contradicting itself, but from contradicting a court's . 15 Because we have found no underpayment for BACO, see infra p. 50., we need not consider whether its 1988 and 1989 returns were f raudulent . - 35 - determination that was based on that party's position.". Teledyne Indus., Inc. v. NLRB 911 Fa2d 1214, 1217 n.3 (6th Cir. 1990). This doctrine generally requires us to. accept the earlier of the two inconsistent positions. Huddleston, 100 T.C. at 26. Factors that may lead-us tio judicially estop the Commissiòner from adopting a new pòsition in this case include,. but are not limited to, the following: (cid:16)042 Is the góvernment's later pòsition "clearly inconsistent" with its earlier one? (cid:16)042 Did the government succeed in. persuading the criminal court position? to accept . its earlier (cid:16)042 Would the Commissioner derive an unfair advantage or 1mpose an unfair detriment if not estopped? Maine v . New Hampshire , · 532 U. S . at 750 -51; Bus se11 v . Commissioner, T.C. Memo. 2005-77, affd. 262 Fed. Appx. 770 (9th Cir. 2007) . It's Barrow's burden to show that the government ook a contrary position in a prior proceeding and that this position was accepted by the court . Teledyne Indus . , 911 F . 2d at 1218 . Barrow has easily borne this burden by pointing to the Commissioner's rather startling admission that the government changed theories because it didn' t think the jury was smart enough to understand what he now says really happened--the diversion by Barrow of money owed to BACO. The Commissioner says he' s merely adding the double tax component to the previous determination. We disagree. The - 36 - government's positions in the two cases are.inconsistent because the corporate-diversion theory doesn't simply increase Barrow's deficiencies, it changes both the nature of the income and the computation.of the tax owed by both BACO and Barrow. We find this case similar to Warda v. Commissioner, 15 F.3d 533 (6th Cir. 1994)~, affg. T.C. Memo. 1992-43,.in which a taxpayer argued in a will contest case that she was the owner of certain real estate and in a later.tax case argued that her son was the owner, in order to claim that the transfer of real estate to her son was a tax-free gift.. The appeals court determined that the outcome of the earlier case turned on the question of the property's ownership--the taxpayer.benefiting from being the owner in the first case--so that her change in theory represented a "knowing assault on the integrity of the judicial system." Id. at 539 (citation and quotation marks omitted). Although we won't accuse the IRS of trying to "assault *** the integrity of the judicial system,".it remains true that IRS witnesses helped convict Barrow with the simple story that he was receiving income directly from NCH and CCHS that he.didn't report on his income tax returns and are now trying to help the IRS win by testifying .t that Barrow was really taking ~money from his firm that wasn't owed to him personally--a theory that would allow the Commissioner to tax BACO on that income and then tax Barrow again on what the government now calls dividends. We should probably - 37 - be flattered that the Commissioner thinks us more intelligent than the jury, but we hold that áuch flattery only gets him estopped here. We also hold, in the alternative, that money Barrow earned from his hospital chairman's fees was not actually a "corporate diversion." The commissioner argues that all compensation Barrow earned from his relationship^ with the hospital should be taxed as corporate income because BACO's noncompete policy allowed BACO to claim as corporate income any-compensation earned by BACO employees performing competing services. The Commissioner offers little explanation for why'money that never reached BACO, and to which BACO never.had unfettered access, should nonetheless have been claimed on BACO's corpo ate tax return rather than Barrow's individual return. The problem with this argument is that BACO's noncompete policy appears to be, in the words of Captain Barbossa, "more what you' d call guidelines than actual rules . " Pirates of the Caribbean: The Curse of the Black Pearl (Walt Disney Pictures 2003). The trial e.xhibits show no sign of a written policy. And though trial testimony was more useful in fleshing out the boundaries of the policy,~it still gave us no clear sense of when BACO's interest in-the money might have attached, potentially leaving us adrift in the ocean of contract law. Further complicating this issue is the fact that at least one court has - 38 - found that a corporate interest in the form of a constructive trust attaches immediately upon a fiduciary's misappropriation of corporate funds. See, e.g., Murphree v. United States, 867 F.2d 883, 885 (5th Cir. 1989). If Michigan follows similar law, the Commissioner would have a colorable argument that Barrow's hospital income was actually attributable to BACO, if the government can prove that this was a misappropriation of a corporate opportunity. The Commissioner argued none of this, however, and so we. find that the policy simply affirmed BACO's adherence to the common-law doctrine of the fiduciary.duty of loyalty., as codified in Mich. Comp.rLaws Ann. secs: 450.1541 (West 1973), commonly known as the Michigan Business Corporation Act (MBCA). -Because BACO was incorporated in Michigan, we look to Michigan common. law and the MBCA to determine whether a breach of duty occurred,and if so, when BACO's interest in the money attached. We look_to the laws in place at the time of the behavior in question; in this instancé, the version of the law in effect from 1977 through the.end of 1989..would control. . Under Michigan common law, an officer or director misappropriates a corporate opportunity and thereby breaches his fiduciary duties when there is presented.to a corporate officer or director a business opportunity which the corporation is financially able to undertake which is, nature, the corporation's business and in the line of from its - 39.- is of practical advantage to it, and which is .one in which the corporation has an interest or a reasonable expectancy, and if, by embracing the opportunity, the self interest of the officer or director will be brought *** into conflict with that of this corporation Prod. Finishing Corp. v. Shields,405 N.W.2d 171, 174 (Mich. Ct. App. 1987) (citations and quotation marks omitted). In cases of such a breach, "all profits made and advantage gained by the agent in the execution of the agency belong to the principal." Mechem, 1 Mechem on Agency (2d Ed.), sec. 1224 (cited in Prod. Finishing, 158 Mich. App. at 486). For all periods before September 1987, when Barrow became a full-time manager, it is not clear that Barrow's hospital income was "in the line of the corporation's business" or that BACO had "an interest or.a reasonable expectancy" in the income. During that time Barrow served only as director and chairman.of the hospital. We think it illogical to assume that an accounting firm would want or benefit from a position as director or chairman of a troubled hospital; we therefore find these activities to be mere civic activities for Barrow. Our reasoning is different for the period from September 17, 1987 through March 31, 1989, a. time during which Barrow provided accounting.services and BACO staff to help the hospital's billing and accounting departments. Barrow admits that during this time income he earned from the hospital should have been turned over to BACO. Therefore, the.only time in which BACO may have had an - 40 - interest in Barrow's income would be September 17, 1987, through March 31,.1989. But we find it unnecessary to reach the,question of whether Barrow actually breached a fiduciary duty during that time, because even if Barrow breached his fiduciary duty by misappropriating the hospital income, under Michigan law BACO should have filed suit against Barrow to recover the alleged interest in the misappropriation."within 3 years after the cause of action has accrued, or within 2 years after the time when the cause of action [was] discovered." Mich. Comp. Laws Ann. sec. 450.1541(2) (West 1989). Therefore, even if Barrow did breach his fiduciary duty and violate the noncompete policy, BACO never actually filed suit, either within the following 3 years or within 2 years after his criminal conviction in which his alleged misappropriation was revealed. Such a suit was never brought, and the money remained with Barrow under an undisputed claim of . right. Therefore, we find that Barrow correctly put this money on his 1040 rather than on the BACO corporate return. C. Fraudulent Intent The Commissioner must prove fraud separately for Barrow's 1984 and 1986 tax years, and for BACO's 1988 and 1989 tax years. See Temple v. Commissioner, T.C. Memo. 2000-337, affd. 62 Fed. Appx. 605 (6th Cir. 2003). The Commissioner may use circumstantial evidence to.meet his burden--this includes using . Barrow's entire course of conduct during the tax years at issue. - 41 - Parks, 94 T.C. at.664. But we.won't find fraud where the circumstances merely lead to a suspicion of fraud. Id. To show fraud by circumstantial evidence, the Commissioner may point to what we have identified as "badges of fraud"--factors which tend to show the required intent to evade tax. These include these badges which the Commissioner argues apply to this case: (cid:16)042 Pattern of consistent underreporting of income, Miller v. Commissioner, T.C. Memo. 1989-461; (cid:16)042 Failure to keep adequate books and records,. Richardson v. Commissioner, 509 F.3d 736, 743 (6th Cir. 2007), affg. T.C. Memo. 2006-69; Bradford v. Commissioner, 796 F.2d 303, 308 (9th Cir. 1986), affg. T.C. Memo. 1984-601; (cid:16)042 Diverting corporate assets for personal use, Solomon v. Commissioner, 732 F.2d 1459, 1462 (6th Cir. 1984), affg. T.C. Memo. 1982-603; (cid:16)042 Education and.business knowledge of.the id. 1461; taxpayer, Solomon, 732 F.2d at (cid:16)042 Prior tax-related convictions, Wright, 84 T.C. at 643-44; and (cid:16)042 Dishonest' dealings with others, Solomon, 732 F.2d at 1462. As we noted in discussing the effects of Barrow's conviction, the Commissioner doesn't have to prove the exact amount of the underpayment resulting.from the fraud, only that fraud contributed to a portion of the underpayment. See Miller v. Commissioner, T. C. Memo. 1989-461. No single factor is necessarily sufficient to establish fraud by itself, but a combination of factors may be persuasive. Ferguson v. - 42 - Commissioner, T.C. Memo. 2004-90. We address each of the Commissioner's arguments in favor·of finding fraud. 1. . Consistent Pattern ofm Understating Income The Commissioner claims that Barrow--and;consequently BACO-- engaged in a consistent pattern of understating.income, and that this habit is an indicator of fraud.i There are two categories of . BACO income that the Commissioner believes the company excluded which relate to adjustments made to Barrow's individual income. The first category includes all checks payable to BACO but deposited into Barrow's personal account. Barrow's response is that.they represent repayment of loans he made.to BACO. The Commissioner says that, despite the repayment theory, it remains income to BACO because the payor's intent was. to pay BACO. But no one disagrees: The Commissioner admits that, after a thorough examination of the available records, BACO reported all but one of the checks in this category as income on its books. Only the $8,352 check from Ernst & Whinney was not included. The Commissioner does claim that the money Barrow deposited in his personal checking account as loan repayments should be income to Barrow because there were no written loan agreements in place between Barrow and his company. Although no written loan agreement existed between Barrow and BACO, Cynthia Nobles, William Aldridge, and even IRS agent Stephen Wernert all testified that they knew Barrow made loans to BACO. Because - 43 there were never any written loan documents.and Barrow maintained authority.over BACO's general.ledger, the Commissioner argues that it's possible that Barrow was simply lending BACO its own funds and that Ms. Nobles couldn't have known the actual source of funds for the loans." But this is sheer speculation. Based on credible testimony at trial; we find that.Barrow made loans to his own business from his own funds during hard times. But, even so, the.Commissioner says, Barrow should have posted loan fepayments to.BACO's general register.and issued a check as repayment of the debt. This may have been better business practice, but its absence is not a plausible marker.of fraudulent intent in this case. Given Barrow's hectic schedule.during those years and the fact that BACO was closely owned, there is no way we can find he had fraudulent intent when he deposited funds directly iñto his own account..after recording the funds as income on the BACO ledger. The second category of purported BACO income consists of the checks'paid to Barrow from NCH and ·its affiliates.for board of directors' and chairman's fees2 The Commissioner points to BACO's policy that all income earned.by its officers and employees from clients for services the firm also offered was income to BACO. But we've already found the. Commissioner's " We must note that the Commissioner includes imputed interest income resulting from these contested loans in the notice of deficiency. - 44 - position on corporate diversion.is judicially estopped, and in the alternative, that he cannot.now enforce BACO's noncompete policy,to recategorize the income without showing that BACO itself successfully sought to recover it. The Commissioner also claims two additional types of .underreporting by Barrow individually. . One involves unreported wages from BACO, and another comes from CIS.. The Commissioner used the bank-deposits.method--a method long approved bygour Court, see Estate of Mason v. Commissioner, 64 T.C. 651, 656 (1975), affd. 566 F.2d 2 (6th Cir. 1977)--to reconstruct what he believes to be CIS's true income. ",The bank deposits method assumes that all money deposited in a.taxpayer's bank account e during a given period constitutes taxable income." DiLeo v., Commissioner, 96 T.C. at 868. Barrow argues that. the Commissioner uses a'different method of accounting than he did to construct his CIS income making it is impossible for him to determine where his- own errors may lie. But Barrow is coñfusing method of accounting with method of proof. The Code requires the Commissioner to use a taxpayer's method of accounting (i.e. cash or accrual) as long as it clearly reflects income. Sec. 446(a). But the Commissioner can use a variety of methods, including the bank-deposits method, to prove that Barrow underreported his income. Holland v. United States, 348 U.S. 121, 130-132 (1954); Goichman v. Commissioner, T.C. Memo. 1987-489. - 45 - Barrow agrees that he und htated his income for several years, but he also claims that the understatements were much smaller than the Commissioner alleges and due to unintentional errors. Because of the importance of this issue, we will analyze each year that is not subject to collateral estoppel individually to determine what portion of the understatements Barrow can credibly defend. But we are aware he need not prove errors in the deficiency determinations themselves. As we have previously explained, we will not "bootstrap a finding of fraud upon a taxpayer's failure to prove [the. Commissioner's] deficiency determinations erroneous." Parks, 94 T.C. at 661. Barrow only needs to prove by a preponderance of the evidence that he lacked fraudulent intent to remove this as a badge of fraud. a. 1984 The following chart summarizes changes the Commissioner made to Barrow' s individual adjusted gross income (AGI) during the audit for 1984, and reflects the. changes that Barrow concedes: RN - 46 - Change to(Barrow' s . AGI 19847 per IRS 1984 r Êar^row BACO dividends NCH board fees CCHS board fees $7 , 694 . 0 7 --- - - - $785 3, 536 CIS schedule C receipts 23, 627 . 43 23, 627 . 43 BACO salary 76,015.84. 76,015.84 Total understatement 107,337.34 103,964.27 Although he admits an understated amount similar to the one calculated by the Commissioner, Barrow contends he didn' t commit f raud with regard to any portion of it in 1984 . He claims the amounts the Commissioner calculates as BACO dividends were actually loan repayments . As for the missing NCH board fees, he argues that the original NCH Form 1099 reported fees of only $3,373.07. After reviewing payment records, Barrow now concedes he should've reported $785 more but says his was an honest mistake caused by his using the number reflected on the original Form 1099. He also now concedes that his CCHS fees began in December 1984., but he says he,didn't receive a Form 1099 from CCHS for that first payment,. and as a result he unintentionally failed to include those fees on his 1984 return. He also admits that he underreported the CIS receipts but says that it is a result of errors made by Nobles when she prepared the CIS books . These errors included deposits omitted from the CIS ledger. Finally, Barrów agrees'that he underreported his BACO -..47 alary, but he says this was because he mistakenly used 'his 1985 W-2 instead of 'the 1984 W-2. He'explains that he kept a separate older for each tax year and that soåehow the 1985 W-2 got into he 1984 fólder. This led Nobles to use'the 1985 figure- when preparing the ledger Barrow later used to prepare his táxes. Barrow's assertion that he received an incorrect Form 1099 from CCHS in 1984 is credible. We've recounted the chronic disorganizatiion at the hospital alreadyí-a problem that later led BACO to step in and start helping in 1987. It's reasonable that Barrow unintentionally made mistakes reporting his CCHS board fees because of the hospital's disorganization and Barrow's own preoccupation with the mayoral race during those years. We are also convinced that Nobles made significant mistakes and that Barrow unintentionally missed many of them. Nobles t-estified that Barrow was her supervisor and generally the person reviewing her work. Donna. West, a frincipal who started at BACO in 11988,~ testi.fied that she had the opportunity to review some of Nobles's work and thought Nobles some'times didn't pay ~enough attention to detail. The Commissionër argues that Barrow "turned a blind eye" to Nobles's mistakes. Ít's true.that Barrow probably should have taken steps, such as hiring a tax accountant, to ensure proper reporting. But "turning a blind bye" indicates negl'igence, and "[f]raud 'does not include - 48 - negligence, carelessness, misunderstanding or unintentional understatement>. of income.'" · Zhadanov v. Commissioner, T.C. Memo. 2002-104 (citation and quotation marks omitted) . Also, Nobles worked closely with Barrow and credibly.testified that he never- asked her to do anything improper or that she felt she shouldn' t do . We will· not ,use the underpayment in 1984 as a badge of £raud'. - b. 1986 The following chart reflects income changes made during. the IRS audit for 1986 that amounts to understated income and Barrow' s· re sponse : Change to Barrow's AGI 1986 per IRS 1986 per Barrow BACO dividends $66 , 60 7 . 58 - - - - CIS schedule C receipts 24,399.47 24,399.47 BACO capital gains 1,450 --- Total understatement 92,457.05 24,399.47 Barrow says he didn't commit fraud with regard to any portion of his underreported income in 1986. He claims the IRS's dividends and capital gains calculation improperly includes board fees that he already included on his Form 1040 because they were not earned in violation of BACO's policy. It also includes repayment to Barrow of BACO loans . He accounts for the additional CIS income by explaining that the IRS included in CIS's 1986 income two deposits made in - 49 - January 1987. Because they were made in the following year, Nobles didn' t record them as 1986 income . He concedes that these payments are income in 1986, but he argues that this was an honest mistake, not due to fraud. We've .already dismissed the Commissioner's arguments regarding corporate diversion and determined that Barrow's loan repayments weren' t f raudulent . For reasons similar to those discussed earlier, we believe Nobles made mistakes and that Barrow' s explanation of those mistakes f or 1986 are credible . We thus won't credit the underpayment from 1986 as circumstantial evidence of Barrow.' s fraudulent intent We do find that there was a pattern òf underreporting because Barrow failed to report some taxable personal income to . the IRS each year from 1984 until 1988. For the several reasons provided in- this section, however, we do not f ind this pattern of underreporting to be a badge of fraud. c . BACO' s 1988 and 1989 Income The Commissioner claims that Barrow understated BACO s income by not including the following items: BACO' s Unreported Incòn e Year : NCH . CCHS NCC-W NCC-E . Ernst & Whinney 1988 1989 $63,955.66 $64,811.55 --- --- 63,513.66 54,563.80 $4,500 9,000 8,352 - 50 - We've already found that the fees paid to Barrow relating to NCH and its affiliates do not belong to BACO but Barrow individually. This eliminates all of the income the Commissioner claims BACO failed to report for these two years except the Ernst & Whinney check. .Barrow concedes that he should've included this check in BACO's 1989 income, but he says Nobles mistakenly omitted it.from the general ledger. We believe. him; and though the omission of this check from the general ledger was mistaken, and might be negligent, we find its omission was not fraud. 2.. Failure To Keep,Adequate Books and Records " The Commissioner contends that the books for BACO were so poorly maintained that he'was unable to reconcile the expenses reported on BACO's tax return to BACO's'general ledger. He also n repeats this argument that the general ledger omitted large amounts of gross income, including hospital chairman's fees paid to Barrow for accounting services. The Commissioner again^ points out that BACO failed to include in gross revenues a check for $8,352 from Ernst & Whinney in 1989. Barrow again admits that he The elimination of the hospital fees from BACO's income also means·that BACO likely didn't understate its income for these two years either. The Commissioner looked back to tax years 1983-87 to recalculate.BACO's net operating loss.available for 1988 and 1989. While he is able to use this method of recalculation, see Hill v. Commissioner, 95 T.C. 437, 441 (1990), he shouldn't have included the hospital fees in BACO's income fpr purposes of did so, he also improperly reduced the net operating loss carryforward available for 1988 and 1989. the recalculation in those.years either. Becaush he . - 51 - hould've repörted this check on BACO' s return 'instead of his ówn. But Barrow-also says tïhat this was a mistake, .one of many mall oversights thàt thë IRS is addins to(cid:0)541ether to portray intentional misconduct. And because we aren't considerihg BACO's returns at all for this examination- óf fraud,. many of the Commissioner's arguments fall outside of our analysis. The Commissioner also takes"issue with Baf'row's recordkeeping for items relating to his personal income tax. To support this argument he refers us generally to. the record, and says that often Barrow's ívages; dividends and corporate distributions wereinot accounted for in his personal checkbook But we ' ve alreådy detailed Barrow' s credible response - -he istakenly used the wrong W 2, relied on an incorrect Form 1099 and received nontaxable loan repayments from.BACO. 'And we've dismissed the Commissioner's corporate-diversion theory so the ospital fees were properly counted as his personal income. The _Commissioner also argues that Barrow' s CIS checkbook failed to reconcile with his Schedule C gross receipts. After completing a bank-deposits analysis,'the Commissioner claims he discovered that gross bank deposits exceeded gross receipts . $arrow* admits problems with hisnCIS"ledger, but mainly attributes these mistakes to errors made by Nobles. Again, we believe Barrow was negligent in his reliance on'Noblés;· but we foundithat he didn't intentionally doctor the CIS books to hide income. - 52 - Although Barrow may have been careless with his.bookkeeping, there is no evidence that he attempted to conceal assets or withheld information from the IRS during the audit. In fact, we find that Barrow cooperated with the IRS audit at all times. See Kemp v. Commissioner, T.C. Memo. 2004-153; McGowan v Commissioner, T.C. Memo. 2004-146 affd. 187 Fed. Appx. 915, (11th Cir. 2006). Barrow credibly. testifîed that when IRS Agent Bulik went to the BACO offices for.information, he "went to the files and gave him everything that was in the file," even copies of draft agreements never put into place. IRS Agent Bulik was asked (cid:16)042 at trial about the condition·of Barrow',s business records, and his response was that "[t]hey were easy. to follow * * * .[t]hey were in order." Barrow's cooperation.and Bulik's testimony about his organization cut against any inference of fraud we might otherwise draw from mistakes in his bookkeeping. 3. Diverting Corporate Assets for Personal Use The Commissioner argues that Barrow diverted BACO funds for his own use, and that this is evidence of fraud. But we've already determined that the Commissioner cannot pursue this theory. The Commi'ssioner also points out that Barrow tried to. conceal the receipt of NCH checks÷into hïs personal account by stamping BACO's endorsement onto the canceled checks. While we agree that this behavior was deceptive, we find that it was intended to deceive.Barrow's journalisticvinquisitors, not the - 53 - IRS. 4. Barrow's Bducation and Business Knowledge The Commissioner portrays. Barrow as someone sophisticated in . tax matters. We agree that Barrow was highly educated and experiencednin accounting and finance. But.Barrow maintains that his speciálty was in auditing and financiál' reporting,. and that a CPA is not necessarily an expert in everý area in which he has a license to practice. Heweven suggests that if he had a deéper knowledge of tax law, he wouldn't have permitted himself to be áonvicted on the basis of explainable transactions in the riminal trial. Barrow was an tentrepreneur and budding olitician, mainly>focused on the nontáx activities of saving a struggling hospital and expanding:his reputation as a civic leader'in Detroit...And even ln cases that involve attorneys or ccountants with a proven knowledge of tax law, we have not found raud where the specific intent- to evade tax didn t exist. See, e.g., Daios v. Commissioner, T.C. Memo. 1986-330. 5. Prior Tax-Related :ConviCtioñs . A criminal court convicted Barrow for tax evasion and illfully filing false individual tax returns for 1985, 1987, and 1988, and for doing the.same with respect to BACO's corporate tax returns- in fiscal years 1988 and 1989. The Commissioner contends that,. although not dispositive, these.convictions are evidence of - 54 - fraudulent intent in other years Barrow argues that his convictions were wrongly decided, but since we don't have the . power to overturn them,.we must take them at face value. We agree that this factor weighs against Barrow. 6. Dishonest Dealings With Others The Commissioner claims that.Barrow engaged in a pattern of deceptive conduct that reflects his fraudulent intent. The Commissioner argues the following.behavior supports his claim: First, the Commissioner says Barrow. madë. false statements to procure loans. Barrow submitted unfiled tax returns to financial companies showing more income than reported to the IRS in order - to obtain bank loans. And a jury did convict him for making false statements in connection with-a bank loan application and for bank fraud. See 18 U.S.C. secs. 1014, 1344 (2006). Second, the Commissioner says Barrow made false -statements to business associates. The Commissioner claims Barrow concealed his ownership of CIS from his colleagues on the board of NCH. Barrow credibly testified that although he may not have specifically disclosed CIS to be his personal Schedule C business, he informed.both NCH and the bankruptcy court that CIS was affiliated with BACO. We find that Barrow honestly thought . this somewhat.analogous disclosure was enough. The Commissioner also claims Barrow hid the same information from the.*Bankruptcy court while serving as trustee of Salem - 55 - Mortgage, causing the court to approve a contract between Salem lViortgage and CIS. The application instead says that BACO.owned a minority interest in CIS.. Although this information isn't accurate, it is consistent with Barrow' s explanation that he considered CIS to be part of the BACO business plan. We find that this half-hearted disclosure(cid:16)042doesn't indicate that Barrow had a pattern of dishonest dealings. The Commissioner next argues that Barrow engaged in self - dealing by approving NCH' s bills payable to BACO while requiring his consent to pay other vendors in hard ~financial times. Barrow claims that while NCH had cashflow problems, he extended the þayment due dates of many of NCH s creditors . And we already have discussed how _Barrow waited to cash some of the chairman' s fee checks until NCH had cash in the bank to actually pay those obligations. In this light, and with knowledge that BACO was already reducing its normal rates for BACO employees working at NCH, we find no evil intent or malicious purpose .behind Barrow's dealings with the hospital. Finally, the Commissioner points out . that Barrow made false statements while campaigning The Commissioner cites, and Barrow ådmits to, lying to the media during Barrow' s campaign by t elling one reporter that NCH wasn' t paying him for his work on the board Salem Mortgage was one of BACO' s clients . When it slipped into bankruptcy, Barrow became its court-appointed trustee. and with the hospital affilìates. Barrow admits that he wasn't . always forthright with the media during his campaigns in 1988 .and 1989, but. again we attribute this more to fear of candor's effect on his political career than proof of an intent to' defraud the IRS. Despite Barrow's many mistakes, we find that the. . Commissioner of fers no clear and convincing proof that Barrow possessed the specific intent to evade a tax that he believed,he owed for 1984 or 1986, or that BACO owed for 1988 or ,1989.. We therefore find, -not just that the Commissioner has failed to. show by clear and convincing evidence that Barrow f iled his 1984 and 1986 tax.returns, and BACO's 1988 and 1989 tax returns, with fraudulent intent, but that Barrow had no' fraudulent intent with. regard to any portion of his .1984 and 1986 underpayments, or BACO' s 1988 and 1989 underpayments . We therefoi-e hold that the statute of limitations imposed by section 6501(a) precludes the Commissioner from 'assessing the deficiencies and additions to tax that might otherwise be due for those years. II . Determination of Barrow' s 1985, 1987, and 1988 Tax Liability Our task for the years in which Barrow is collaterally estopped from denying fraud is to redetermine the amount of . Barrow's deficiency. . As a general rule, we presume that the Commissioner's determinations in a notice of deficiences are correct, and Barrow bears the burden of proving those - 57 - determinations wrong. See Rule 142(a) (1); Welch v. Helvering, 290 U.S. 111, 115 (1933) . We begin by discussing the categories of income in dispute for all three years-. First, as we-have already found, the Commissioner is judicially estopped from pursuing his corporate diversion. theory here. Therefore, all=of the NCH and CCHS fees are income to Barrow directly. Barrow claims that he would sometimes refrain from cashing the hospital's checks when they were issued because he knew the hospital didn't have the money to pay him. Some of the checks the hospital issued near the end of a calendar year were held over until the next year because of this. Barrow reported those checks in the year he cashed them because he believed the hospitäl's lack of cash on hand was a restriction on his ability to get.paid. We'agree with Barrow. We have held that when a payee knows there are insufficient funds and that knowledge causes him to refrain from cashing a check, the payment is income' to him in the later year rather than the earlier. Blumeyer v. Commissioner, T.C. Memo. 1992-647 (dîscussing knowledge of insufficient funds as an exception to the relation back doctrine). To the extent Barrow reported fees in a year subsequent to the. check's issue date because óf insufficient funds, we find him taxäble in the. later year. Second, we find that all of the checks made payable to BACO that Barrow deposited into his account as loan repayments are - 58 - neither capital gains nor ordinary income taxable to Bar:row. See Theodore v. Commissioner, 38 T.C. 1011, 1040-41 (1962) . . The Commissioner admits that all of the checks were recorded in the BACO ledger and although Barrow should've deposited them into a BACO account and then issued a check for loan repayment, we find that this mistake doesn' t change the character - of this income . A. Issues for 1985 After resolution of the . corporate-diversion and loan- repayment issues above, there(cid:16)042remainonly these challenged items from his 1985 tax return: Disputed 1985 Adjustments Item Per IRS Per'Barrow Schedule C Depre c iat ion ^$11, 777 . 3§ $8 , 8 77 . 3 6 Schedule C Receipt-s - CIS . 1, 000 -- Barrow claimed $2900 Schedule C depreciation for his 1977 Cessna airplane. in 1985, ·which the Commissioner denied. He and Barrow now argue over substantiation and whether Barrow used the plane for business, rather than personal, reasons . Barrow says . that he .provided trip and engine logbooks, as well as time slips and other substantiation of the plane expenses, to Agent Bulik. Initially, Bulik testified that Barrow showed him some records relating to his airplane, but that .Barrow wouldn't let him. take 3 them or make copies . Later on, Bulik recalled that durings the audit he used copies of documents showing the use of the plane, ecords of places traveled, and an engine log to deny the expenses . Barrow claims the Commissioner lost the material he handed over for substantiation and argues that he's entitled to n inference that if the records were available, they would favor him. He also asks us to apply the Cohan rule and estimate the ámount of the expenses . See Cohan v . Commissioner, n39 F . 2d 540 (2d Cir . 1930) . It is a rote statement for this Court to declare that the t axpayer bears the burden of proving a claimed deduction. NDOPÖO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992) . The taxpayer must maintain records sufficiënt tovsubstantiate such ámounts . Sec . 6001;- sec . 1. 6001-1 (a) , Income Tax Ress . But when the taxpayer is ünable to meet this burden because -the IRS loses is records, we may-estimate the allowable amount The wrinkle here is that section 274 (d) t expressly (cid:16)042overruledCohan f or certain ypes of business deductions (including, travel) by 1mposing trict substantiation requirements See Sanford v. Commissioner, 50 T.C. 823, 827 (1968), affd.jper curiam 412 F.2d 201 (2d Cir. 1969) . Barrow appears to have lproVided documentation the logbook - - that would have complied with^ se ct ion 274 (d) , but i t was ost by the IRS and there are no backup copies avai'lable Section 1.274-5A(c) (5), Income Tax Regs , exempts a taxpayer from these strict requirements when there is a loss of records beyond his control. That's what haþpened here Faced with such - 60 - difficulties, we believe Barrow'·s and Nobles's testimony that the logbook verifies that, deductions taken in conjunction with the plane were for business use, .and characterize as a credible substantiation their testimony that the logbook would also.have verified their amount. We therefore sustain the amounts claimed by Barrow on.his returns. Barrow also contests the Commissioner's upward adjustment of CIS's income by $1,000. Barrow says he is unable to determine which deposit contains an error and account for the difference because the IRS switched from the "bank deposits method of accounting" to the "taxable checks" method in order to make this adjustment, and in any case didn't reconcile their method of accounting with the cash method that he used for CIS in the same year. We've already.pointed out'that the Commissioner may use a variety.of methods.of proof to uncover a taxpayer's unreported income. And Barrow's complaint »about this isn't enough to meet his burden to refute the Commissioner's determination, so we find that he is liable for the $1,000 difference. There are two additional 1985. computations that Barrow disputes--the addition of self-employment tax and the AMT. Barrow admits that he failed to include the self-employment tax calculation when he filed his 1985 tax return, and that he was liable for the tax. Since both items are computational, they will be recalculated under Rule 155. But Barrow also seems to - 61 - dispute whether these items can be counted as part of the 1985 deficiency for purposes of the fraud penalty if all of the information needed to calculate them was available on his original return as filed. We think this issue is directly related to the computation of the fraud; penalty, and we address it below. B. Issues for 1987 Barrow concedes that his 1987 CIS income should increase by 11, 279 because he is now unable to find his ledger for that ýear, and agrees with other adjustments made by the Commissioner. We have found against the Commissioner on the issue of .whether Barrow was receiving corporate distributions rather than repayments of loans . There remain only these challenged items from his 1987 tax return: Disputed 1987 Adjustments Item Per IRS Per Barrow Sch C Depreciation . $8 , 803 . 49 $5, 903 . 49 Sch C Expenses Cost of Sales . Imputed Interes t Income Pas sive Partnership /1120S 13, 799 6,500 3, 693 . 03 5, 658 . 75 10 , 237 . 28 --- - - - - - - Barrow claimed Schedule C depreciation .and expenses for his car, boat, and plane in 1987. The Commissioner denied all of the éxpenses and Barrow now contests only those related to his airplane -- $2900 for depreciation, and $3561.72 for other - 62 - expenses. He makes the same argument that he did for his 1985 airplane expenses, we agree with him again. Barrow provides a recalculation..of his tax liability for 1987 in a simple chart.. As part of this effort, he determines that ithere should be no adjustment for cost of sales, imputed interest income, or passive partnership income. The notice of deficiency explains that the cost of goods.sold was reduced by $6500 because Barrow didn't establish that the amount was paid or incurred during 1987 or that the expense was ordinary and necessary. The notice of deficiency also determines that "since [Barrow] made loans to [BACO] at below market interest rates, interest income is imputed to [him] for 1987 and 1988."1' Finally, the passive partnership;adjustment stems from a determination that the losses from Hambrose Leasing, an entity on Bar'row's return not othérwise involved in this case, are subject to at-risk limitations and passive-loss limitations for 1987 and 1988. Barfow fails to explain why he disputes these items. Therefore, he doesn't meet his burden to show that the notïce of deficiency is wrong, and so we cannot relieve him of. liability . for these items. C. Issues for 1988 " Although this adjustment is inconsistent with the Commissioner's theory in this case, findings that Barrow did in fact make loans to BACO. it is consistent with our There remain only t hese challenged items from his 1988 tax - 63 - eturn: - D spûted 1988 Adjùstments Item Per IRS Per Barrow Interest Income . Itemized Deductions Sch C Expenses (cid:16)042 Imputed Interest Income Loss on Sale of Asset $ (1, 692) 6, 097 . 55 2, 751 2,728.52 9,040 4 , 750 844 - -- . --- --- The Commissioner denied Barrow' s Schedule C airplane xpenses of $1,906.45. He makes the same argument that he did in 985 and 1987, and we reach the same result . Barrow also contests the adjustments to his interest income, temized deductions, imputed-interest income, and loss on sale of sset. The Commissioner claims that Barrow received $1,692 less n interest than reported, and we are unsure why Barrow disputes this adjustment. In any event, we will sustain the Commissioner n this. The Commissioners reduces Barrow' s itemized deductions by $6, 097 . 55 . Based on the notide of . def iciency, it appears as though Barrow agrees only with the reduction in his charitable ontributions to the extent of $4750 . Since Barrow makes no rgument with regard to any other of these$changes, we find that e doesn't meet his burdenuof proof. "Thet Commissioner also adds mputed interest income, which we uphold for the . same reasons we did for the similar 1987 adjustment. · Finally, the Commissioner denies Barrow a loss on the sale of an asset because Barrow failed to prove it was a loss he sustained. Barrow makes no additional showing here, so we must also uphold the Commissioner's adjustment of this item. III. Fraud Penalty We've held that Barrow is collaterally estopped from denying fraud for 1985, 1987, and 1988 for purposes of former section 6653(b). This makes for an interesting question: to what extent can we determine the portion of the deficiency subject to this penalty for these years? In 1985, section 6653(b) read as follows: SEC 6653 (b) . Fraud -- (as defined in subsection tax required to be shown on a In general.--If any part of any (1) underpayment (c))of 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 the underpayment described in paragraph(1) which is attributable to fraud,.and to the portion of for the period beginning on (B) the last day prescribed by law for payment of such underpayment - 65 - (determining without regard to any extension)and ending on the date of the assessment of earlier, the tax). the payment of the date of the t'ax ·(or, if The 1985 statute leaves no-room to determine that some part of the deficiency was not due to fraud. We also must address the issue of the computational adjustments made to Barrow's 1985 tax liability for the AMT and elf-employment tax. The Commissioner will recalculate Barrow's 1985 tax liability after we file this opinion and adjust the AMT and self-employment tax calculations based on our findings, so we need not settle disputes over the correct amounts of those calculations now. But because we are bound by the 1985 version of section 6653 (b) to apply the fraud penalty to the entire underpayment for that year, the question arises: Does the fraud penalty also attach to adj.ustments that are purely computational n nature? We begin with the language of the Code: SEC.6653 (c). Definition of Underpayment.-- For purposes of the section,the term "underpayment" means-- (1) Income, estate, gift,' and certain excise taxes.--In the case of a tax to which section 6211 (relating to income, estate, gift, and certain excise taxes) 1s applicable, a deficiency as defined in that section (except that, for this purpose, referred to in section 6211(a) (1) (A) shall be taken into account only if such the tax shown on a return - 66 - return ;was filed on or before the last day prescribed for the filing of such return, determined with regard to any extension pf time for such filing)*** * * * * * * * This tells us that an underpayment for purposes of section 6653 (b) equals the deficiency as def.ined in section 6211. And section 6211 provided: income,.estate, and In General.--For purposes of SEC. 6211(a). this title.in the case of gift taxes imposed by subtitles A and B and excise taxes imposed by chapters 41, 42, 43, 44, and 45 the term "deficiency" means the amount by which the tax imposed by subtitle A or B, or chapter 41, 42, 43, 44, or 45 exceeds the excess of-- (1) the sum of the amount shown as the tax by (A) the taxpayer upon his= return, return was made by the taxpayer and an amount was shown as the tax by the taxpayer thereon, plus if a the amounts previously (B) assessed (or collected without assessment) as a deficiency, over-- .the amount of rebates, as defined (2) in subsection (b) (2), made. Because the Commissioner included the AMT and self-employment tax in the notice of deficiency, we find that if they still exist after the computations called for by Rule 155, they are part of the underpayment for purposes of the fraud penalty·in 1985. In 1987, the Code provided: SEC. 6653 (b). Fraud.-- In general.--If any part of any ' (as defined in subsection (1) underpayment (c)) of return is due to fraud, added to the tax an amount equal sum of-- tax required to be shown on a there . shall be to the 75 percent of (A) the underpayment which is attributable to fraud, and the portion of . - to such to 50 percent an. amount equal the interest payable under (B) of section 6601 with. respect portion 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 earlier, the tax. the assessment of the date of the tax or, if the payment of . . is attributable to fraud, (2) Determination of portion attributable to Fraud . - -If the Secretary establishes that any portion of an underpayment the entire underpayment shall be treated as attributable to fraud, except with respect underpayment which the taxpayer establishes is not attributable to fraud. to any portion of the (Emphasis added) . The 1987 statute . may leave room for a determination of which part of the underpayment is due to fraud. In 1988, the statute read as follows: SEC. 6653 (b) . Fraud. -- In general.--If any part of any (1) underpayment (c) ) of (as defined in subsection tax required to be shown on a - 68 - return is due to fraud, there shall be added to the tax an amount equal to 75 percent of underpayment which is attributable to fraud. the portion of the is attributable to fraud, (2) Determination of Portion Attributable to Fraud.--If the Secretary establishes that any portion of an underpayment the entire underpayment shall be treated as attributable to fraud, except with respect underpayment which the taxpayer establishes is not attributable to fraud. to any portion of the (Emphasis added). As with 1987's, the 1988 fraud section ·also allows a more precise determination of the amount of the . underpayment due to fraud. The question remains:( can we determine that there is no deficiency due to fraud for 1987 and 1988 in the light of our application of collateral estoppel in this case? We find the answer in our opinion ïn Franklin v. . Commissioner, T.C. Memo. 1993-184. In that case, we found that while the Commissioner had proven that the taxpayer had underpaid his taxes, and that he had underpaid with fraudulent intent, neither the taxpayer nor the Commissioner provided evidence of the specific amount of that underpayment. We said that "to adjudicate an addition to tax under section 6653(b) (2), first we must examine the ,evidence and satisfy ourselves as to the amount that clearly and convincingly is an underpayment. Then, we must etermine whether any or all of; such amount clearly and áonvincingly is due to fraud." Id. We also recognized that estimating the taxpayer' s underpayment at zero or a nominal amount would be inconsistent with a guilty plea by the . same t axpayer to obtaining "substantial income" from certain illegal activities. Instead, we estimated the underpayment due to fraud for each of the years at issue. We face a similar. task in this case. While we acknowledge hat in the criminal case the government proved beyond a reasonable doubt that some part of Barrow' s underpayments for 1987 and 1988 were due to fraud, the Commissioner in this case failed to prove to us that any particular underpayments were áctually due to fraud. We.recognize that it would be inconsistent to hold no part of the underpayment due to fraud, so as we did in Franklin, we estimate that $500 in 1987 and 1988 was due to fraud for purposes of applying the fraud penalty. Conclusion No part of any underpayment of Barrow' s 1984 or 1986, or BACO's 1988 and 1989, deficiencies was due to fraud and so we do not sustain the Commissioner's determination for those. years. The parties will, however, need to compute Barrow' s 1985, 1987, and.1988 deficiencies, so - 70 - Decisions will be entered under Rule 155 ..