Opinion ID: 357068
Heading Depth: 3
Heading Rank: 1

Heading: Intentional understatement of income, substantial in amount

Text: 164 2. Intentional overstatement of deductions, substantial in amount . . .3. Recurrence of the understatement of income or overstatement of deductions for more than one tax year. 165 4. Secret bank deposits for income . . . 166 5. Undisclosed source of income from other than taxpayer's regular business . . . 167 6. Undisclosed income derived from illegal business . . . 168 7. Lack of adequate books and records which one would expect of the particular taxpayer, based on his business experience, education, knowledge of books and records, etc. 169 8. False entries and other falsifications in books . . . 170 9. No reasonably acceptable explanation made by the taxpayer . . . as to why falsity appeared in the return . . . 171 10. Conviction of the taxpayer on criminal evasion . . . 172 Webb, 394 F.2d at 378, n. 11 adopting criteria set forth in Balter, Tax Fraud and Evasion (3rd ed. 1963), pp. 8-54 and 8-55. 173 Of these ten criteria, only numbers one, two, three and seven truly are applicable herein. The lack of any substantial attempt to hide the clearing operation from public scrutiny and the fact that recordkeeping was begun prior to the initiation of the audit suggests that those criteria relating to a concerted cover-up criteria five, six, eight and nine are inapposite to a consideration of Loftin's actions. Clearly, criteria four and ten are inapplicable on their face. 174 Criterion three the recurrence of an understatement subsumes criteria one and two for present purposes. It is vitiated largely because the understatement recurred here for only three years and the existence of a constructive dividend in those years is now uncertain. For both 1963 and 1964, the bulk of the understatement was comprised of the constructive dividend found in connection with the clearing operation. That is why, for the most part, there was no deficiency in 1965. Under the district court's analysis, payments exceeded costs in that year. Thus, the ambiguity which presently surrounds the constructive dividend issue undercuts its use as a significant component of a finding of fraud. If Loftin honestly believed that the value of the clearing performed would be established at fifty dollars per acre (i. e. the fair market value testified to at trial), there would have been no constructive dividend in this case and, therefore, the use of the constructive dividend as a foundation for the finding of fraud would have been rendered nugatory. 175 Secondly, we note that two years in succession do not a pattern make. In any event, case law does not indicate that consistent and substantial understatement of income is sufficient, by itself, to support a finding of fraud. 176 The mere understatement of income, standing alone, is not enough to carry the burden cast upon the Commissioner in seeking to recover fraud penalties. But each case is to be considered in the light of its own facts. Consistent and substantial understatement of income is by itself strong evidence of fraud. This proof, coupled with the showing that the records were both incomplete and inaccurate, and that the petitioner did not supply the bookkeeper with all of the data necessary for maintaining complete and accurate records, is enough to warrant the Tax Court in finding fraud. 177 Merritt, 301 F.2d at 487. (emphasis added). Ours is not the type of situation which the courts meant to encompass within a rule linking a finding of fraud to the consistent and substantial understatement of income by a taxpayer. See, Merritt v. Commissioner of Internal Revenue, 301 F.2d 484 (5th Cir. 1962); Holland v. United States, 348 U.S. 121, 75 S.Ct. 127, 99 L.Ed. 150 (1954). 178 Thus, only criterion number seven remains in our review of the propriety of the fraud finding in connection with the constructive dividend. It is true that the books kept by the taxpayers were not as thorough as they should have been. However, given the custom of this taxpayer to defray initial corporate expenses of a project among ongoing expense categories from other projects, this point is somewhat blunted. Very little work was performed from January 1, 1963 to December 31, 1963 the first of two calendar years utilized by the lower court in support of its finding of fraud; and by the end of 1964, the only other year in which the district court found Loftin to be fraudulent, an entry already had been made upon the partnership books. 179 In short, Loftin and Woodard do not fit within the mold cast by the courts in this area, as may be seen by comparing this case to Estate of Upshaw v. Commissioner of Internal Revenue, 416 F.2d 737 (7th Cir. 1969). There, fraud was found only after taxpayer had consistently and materially understated his income; had failed to maintain adequate books; and had made a material misstatement to an Internal Revenue Agent. The only similarity to Upshaw that may be found in the present case is taxpayer's failure to declare a significant amount of income for three tax years and even this is not present if the constructive dividend found to have arisen atop the land clearing operation is deleted on remand. Loftin and Woodard were keeping records of these operations. Though those records were not impeccable, they did not reflect a concerted effort to conceal the nature of these operations. Even the failure to declare the initial expenses and income was explicable as part of a consistent pattern of conduct engaged in by the corporation on almost every project it undertook. In addition, the understatement of income, even with the presence of the constructive dividend from the land clearing operation, was not consistent. Finally, unlike Upshaw, neither taxpayer made material misstatements to the Internal Revenue Service. 180 Thus, we conclude that the clearing operation and the constructive dividend found in relation thereto cannot supply the foundation to support a finding of fraud as to any part of the deficiency for 1963 and 1964, given the record as it now stands. There are, however, other sources of undeclared income in those two years which must be considered in assessing the propriety of the district court's finding.