Opinion ID: 545523
Heading Depth: 1
Heading Rank: 2

Heading: The Net Worth Method and the Burden of Proof

Text: 7 The Treasury Regulations on Procedure and Administration require each taxpayer to maintain records sufficient to enable the Commissioner to determine his tax liabilities. 26 C.F.R. Sec. 1.6001-1(a). When a taxpayer keeps no books, or keeps books that are inadequate or demonstrably inaccurate, section 446(b) of the Internal Revenue Code authorizes the IRS to compute the taxpayer's income by any method that clearly reflects his income. 26 U.S.C. Sec. 446(b). The net worth method used to ascertain Walton's personal tax liability has been accepted by the courts as satisfying the legislative mandate. See Holland v. United States, 348 U.S. 121, 75 S.Ct. 127, 99 L.Ed. 150 (1954). The method has not changed since it was described by the Supreme Court in Holland: 8 In a typical net worth prosecution, the Government, having concluded that the taxpayer's records are inadequate as a basis for determining income tax liability, attempts to establish an opening net worth or total net value of the taxpayer's assets at the beginning of a given year. It then proves increases in the taxpayer's net worth for each succeeding year during the period under examination and calculates the difference between the adjusted net values of the taxpayer's assets at the beginning and end of each of the years involved. The taxpayer's nondeductible expenditures, including living expenses, are added to these increases, and if the resulting figure for any year is substantially greater than the taxable income reported by the taxpayer for that year, the Government claims the excess represents unreported taxable income. 9 348 U.S. at 125, 75 S.Ct. at 130. See also United States v. Blandina, 895 F.2d 293, 295 (7th Cir.1989); United States v. Wirsing, 719 F.2d 859, 861 n. 4 (6th Cir.1983). 10 The Commissioner's determination of tax liability, if calculated according to an acceptable procedure, such as the net worth method, is presumptively correct and places the burden of producing contrary evidence upon the taxpayer. Helvering v. Taylor, 293 U.S. 507, 515, 55 S.Ct. 287, 290, 79 L.Ed. 623 (1935); Traficant v. Commissioner, 884 F.2d 258, 263 (6th Cir.1989); Calderone v. United States, 799 F.2d 254, 258 (6th Cir.1986); Schrader v. Commissioner, 420 F.2d 443, 444 (6th Cir.1970). Generally, the taxpayer will bear not only the burden of production, but also the burden of proving by a preponderance of the evidence that the Commissioner's assessment is arbitrary and excessive. Helvering, 293 U.S. at 515, 55 S.Ct. at 290; Traficant, 884 F.2d at 263; Calderone, 799 F.2d at 258. When, for example, the IRS bases an assessment on the disallowance of deductions, placing the burden of proof on the taxpayer is reasonable because the taxpayer has better access to evidence of the underlying transactions. Note, Proving a Negative--When the Taxpayer Denies Receipt, 70 Cornell L.Rev. 141 (1984). Where the taxpayer is confronted with the daunting task of proving that he did not receive income attributed to him in an assessment, however, this circuit has established a less severe rule. In United States v. Besase, 623 F.2d 463, 465 (6th Cir.), cert. denied, 449 U.S. 1062, 101 S.Ct. 785, 66 L.Ed.2d 605 (1980), we wrote: 11 Where it is a negative assertion that a successful taxpayer would have to prove ... the law imposes much less of a burden upon a taxpayer. Weir v. Commissioner of Internal Revenue, 283 F.2d 675, 679 (6th Cir.1960). Reasonable denials of the assessment's validity have sufficed in such cases to shift the burden back to the government. Id. The government then bears the task of substantiating its assessment in cases of this type. 12 As in Weir, the defendants ultimately had to prove their non-receipt of income in order to prevail. They denied the existence of, and the receipt of income from, a common partnership. They characterized the nature of their relationship as social, and offered testimony to support the explanation. The nature of their proof justified use of the lighter burden and allocation of the ultimate risk of nonpersuasion to the government. 13 (Citation omitted). See also Sharwell v. Commissioner, 419 F.2d 1057, 1060 (6th Cir.1969); Weir v. Commissioner, 283 F.2d 675, 679 (6th Cir.1960). 14 Whether the issue in dispute is the taxpayer's receipt of income, in which case the government must bear the ultimate burden of persuasion, or the payment of expenses, in which case the burden of persuasion remains with the taxpayer, the government can never rest its case on an assessment that lacks a minimal evidentiary foundation. In Helvering, 293 U.S. at 514, 55 S.Ct. at 290, the Supreme Court wrote: We find nothing ... that gives any support to the idea that the commissioner's determination, shown to be without rational foundation and excessive, will be enforced unless the taxpayer proves he owes nothing or ... shows the correct amount. In United States v. Janis, 428 U.S. 433, 96 S.Ct. 3021, 49 L.Ed.2d 1046 (1976), the Court explained that debates between the circuits over shifts in the burden of persuasion do not extend to the situation where the assessment is shown to be naked and without any foundation.... Certainly, proof that an assessment is utterly without foundation is proof that it is arbitrary and erroneous. Id. at 442, 96 S.Ct. at 3026. 2 15 It is a sound principle that [a] deficiency determination which is not supported by the proper foundation of substantive evidence is clearly arbitrary and erroneous, Weimerskirch v. Commissioner, 596 F.2d 358, 362 (9th Cir.1979), and that the Commissioner cannot rely on the presumption in the absence of a minimal evidentiary foundation even when the taxpayer offers no concrete evidence. Id. at 361. See also United States v. Zolla, 724 F.2d 808, 809 (9th Cir.) (no presumption of correctness attaches to deficiency determinations in which the IRS charges a taxpayer with additional income but provides no factual showing that the taxpayer actually received the income in question.) (dicta), cert. denied, 469 U.S. 830, 105 S.Ct. 116, 83 L.Ed.2d 59 (1984); Llorente v. Commissioner, 649 F.2d 152, 156 (2d Cir.1981) (the evidence of record must at least link the taxpayer with some tax-generating acts....); Gerardo v. Commissioner, 552 F.2d 549 (3rd Cir.1977) (in order to give effect to the presumption ... some evidence must appear....). In fact, the Tax Court has held that it will entertain a taxpayer's bare allegation of arbitrariness if the Commissioner has relied solely on the presumption of correctness and does not submit any direct evidence in support of the assessment. See Llorente v. Commissioner, 74 T.C. 260, 264 (1980), aff'd in part and rev'd in part on other grounds, 649 F.2d 152 (2d Cir.1981); Jackson v. Commissioner, 73 T.C. 394, 410 (1979). 16 Here, the government placed certificates of assessment in evidence, to which the presumption of correctness attached, and thereby established a prima facie case. United States v. Stonehill, 702 F.2d 1288, 1293 (9th Cir.1983), cert. denied, 465 U.S. 1079, 104 S.Ct. 1440, 79 L.Ed.2d 761 (1984). Both taxpayers, therefore, bore the initial burden of producing credible evidence that they did not earn the taxable income attributed to them or of presenting an argument that the IRS deficiency calculations were not grounded on a minimal evidentiary foundation. 17 The district court found that the taxpayers failed to meet their burden with regard to any of the assessments at issue. That finding is factual and will not be set aside unless clearly erroneous. Fed.R.Civ.P. 52(a); Traficant, 884 F.2d at 263. Because of its unique opportunity to judge the demeanor of witnesses, we accord particular deference to the district court's findings based on assessments of credibility. Fed.R.Civ.P. 52(a); Anderson v. Bessemer City, 470 U.S. 564, 575, 105 S.Ct. 1504, 1512, 84 L.Ed.2d 518 (1985). 18