Court Opinion

ID: 4332109
Source: CourtListenerOpinion
Date Created: 2018-11-14 00:32:11.109118+00
Date Added: 2024-06-11T14:47:45.457625
License: Public Domain

T.C. Memo. 1999-16

                         UNITED STATES TAX COURT

   AJF TRANSPORTATION CONSULTANTS, INC., ET AL.,1 Petitioners
         v. COMMISSIONER OF INTERNAL REVENUE, Respondent

         Docket Nos.   12590-95,   24190-96,    Filed January 28, 1999.
                       24482-96,   24483-96.

          J is a corporation engaged in furniture delivery
     services. F is J's sole shareholder and president. J's
     client issued checks to J for its delivery services and for
     fuel costs. F cashed the checks personally and diverted the
     funds for his own personal benefit. None of the diverted
     funds were reported as income on F's individual tax returns
     or on J's corporate tax returns for the 1988, 1989, and 1990
     taxable years. J did not timely file its corporate tax
     returns for the years at issue. R determined that the full
     amount of the diverted funds was taxable to both J and F.
     R's deficiency notices were issued more than 3 years after J
     and F's income tax returns were filed.
          1.   Held: The period of assessment is unlimited
     because J and F filed fraudulent tax returns. Sec.
     6501(c)(1), I.R.C.

     1
      Cases of the following petitioners are consolidated
herewith: AJF Transportation Consultants, Inc., docket No. 24190-
96; Anthony J. Ferrentino, docket No. 24482-96; and Anthony J.
Ferrentino and Carol L. Ferrentino, docket No. 24483-96.
                                 - 2 -

            2.   Held, further, the diverted funds were
       constructive dividends and taxable to F in the manner
       provided by secs. 301(c) and 316(a), I.R.C.
            3.   Held, further, the diverted funds were properly
       includable in J's income. Sec. 61(a), I.R.C.; Commissioner
       v. Glenshaw Glass Co., 348 U.S. 426, 431 (1955).
            4.   Held, further, J and F are liable for additions to
       tax and penalties under secs. 6653(b) and 6663, I.R.C.
            5.   Held, further, J is liable for additions to tax
       under sec. 6651(a), I.R.C.

       Gary D. Borek, for petitioners.

       Jerome F. Warner and Raymond M. Boulanger, for respondent.

               MEMORANDUM FINDINGS OF FACT AND OPINION

       NIMS, Judge:   Respondent determined deficiencies, additions

to tax, and penalties for 1988, 1989, and 1990 with respect to

petitioner AJF Transportation Consultants, Inc.'s (AJF) Federal

income taxes as follows:

                                 Additions to Tax            Penalty
Year        Deficiency      Sec. 6653(b)   Sec. 6651(a)      Sec. 6663
1988         $90,137         $45,751.50      $7,284
1989          66,240                         16,560          $36,099.75
1990          46,694                         11,674           32,841.75

       Respondent also determined deficiencies, an addition to tax,

and penalties for 1988 and 1989 with respect to petitioners

Anthony J. and Carol L. Ferrentino's Federal income taxes, and

for 1990 with respect to petitioner Anthony J. Ferrentino's

Federal income taxes, as follows:

                            Addition to Tax     Penalty
Year        Deficiency      Sec. 6653(b)        Sec. 6663
1988         $53,480         $38,440.50
1989          54,048                            $32,292.75
1990         110,581                             34,201.50
                               - 3 -

     The parties have agreed that petitioner Carol L. Ferrentino

is entitled to innocent spouse relief under the provisions of

sections 6013(e) and 6015 for the 1988 and 1989 taxable years.

     Unless otherwise indicated, all section references are to

the Internal Revenue Code in effect for the years in issue, and

all Rule references are to the Tax Court Rules of Practice and

Procedure.

     After concessions by both parties, the remaining issues for

decision are: (1) Whether an exception under section 6501(c) to

the general 3-year period of limitations on assessment under

section 6501(a) applies to petitioners' 1988, 1989, and 1990

taxable years; (2) if so, whether petitioners must include

diverted corporate funds in gross income; (3) whether petitioners

are liable for the additions to tax for fraud under section

6653(b) for 1988, and the penalties for fraud under section 6663

for 1989 and 1990; and (4) whether petitioner AJF is liable for

additions to tax imposed by section 6651(a) for failing to file

timely 1988, 1989, and 1990 income tax returns.

                         FINDINGS OF FACT

Background of Petitioners

     Anthony J. Ferrentino (Ferrentino) was the president and

sole shareholder of AJF during the years at issue.   Ferrentino

resided in Williamsville, New York, at the time the petitions

were filed.   Ferrentino married Carol Ferrentino on December 30,
                               - 4 -

1954.   They separated in the fall of 1985, and on April 6, 1989,

they entered into a Separation Agreement, Support and Property

Settlement (Separation Agreement).

     Under the Separation Agreement, Ferrentino was obligated to

pay Carol $376,000 over 8 years.   Specifically, Ferrentino was

required to pay Carol Ferrentino $22,000 per year from 1989 to

1992, and was thereafter obligated to pay at least $22,000 per

year until the remainder of the obligation was satisfied.

Ferrentino has not paid all the amounts reflected in the

Separation Agreement.   At various times between 1989 and 1991,

Ferrentino asked Carol to modify their Separation Agreement, or

forbear his obligation to pay the required amounts.   Ferrentino

told Carol that she would recognize a greater return on her money

if she allowed Ferrentino to keep the funds owed invested in AJF.

Their divorce became final on May 4, 1990.

     AJF is a New York corporation with principal offices in

Williamsville, New York, at the time the petitions were filed.

AJF is involved in the business of furniture delivery and is a

cash receipts and disbursement method taxpayer.   AJF's employees

were mainly drivers, helpers for loading, helpers for drivers of

home deliveries, and tractor-trailer drivers.

     During the years in issue, AJF earned income by performing

services for J.C. Penney Company, Inc. (J.C. Penney), pursuant to

a Delivery Service Agreement (Contract) dated March 6, 1987.   The

Contract required AJF to deliver furniture to customers of J.C.

Penney and transport furniture for J.C. Penney from various
                                - 5 -

locations, including the Buffalo, New York, and Toledo, Ohio,

distribution centers of J.C. Penney.     AJF also performed delivery

work for J.C. Penney in other States and delivered fabricated

goods for the Buffalo Custom Decorating Division of J.C. Penney.

     AJF used the trucks of J.C. Penney to perform its contract

services from 1988 to October 1990.     Thereafter, AJF supplied

both the drivers and the trucks.   J.C. Penney reimbursed AJF for

fuel purchased by AJF in performing its delivery services under

the Agreement.   AJF employees used cash and corporate credit

cards for the purchase of fuel used in the delivery of J.C.

Penney products.

     AJF's delivery employees, generally a driver and sometimes a

helper, maintained a "trip sheet" which was a diary of their

deliveries.    The trip sheet formed the basis of AJF's payroll and

billing to J.C. Penney.   The drivers would also maintain a

delivery manifest which listed tasks the drivers were to perform

for the day.

     When AJF's employees delivered the furniture, they would

sometimes collect a COD (Cash on Delivery) from J.C. Penney's

customer.   Under the Contract, AJF was responsible for the

collection of COD's and maintained a COD account which was an

account of cash collected from J.C. Penney's customers. The

delivery manifest reflected all the COD's collected and the form

in which those COD's were paid, e.g., checks, cash, or money

orders.   The trip sheet or manifest contained the name or names

of employees on the particular delivery and listed expenses
                                - 6 -

incurred by the driver.   As of the time of trial, AJF did not

retain the delivery manifests or the trip sheets for the years in

issue.

     The drivers were authorized to and did use COD cash funds to

pay for any expenses such as towing charges or anything out of

the ordinary and would insert the invoice for the services in an

envelope.

     When AJF suffered a shortage of drivers for its scheduled

deliveries, it hired leased labor from Manpower Temporary

Services.   During 1988, 1989, and 1990, AJF claimed expenses for

leased labor in the amounts of $5,074, $16,946, and $22,332,

respectively.   AJF also claimed deductions for "driver expenses"

for 1988, 1989, and 1990 in the amounts of $37,172, $68,157, and

$60,596, respectively.    Respondent has allowed these deductions.

Circumstances Surrounding Ferrentino's Cashing of AJF's Delivery
Service and Fuel Reimbursements Checks

     During the years in issue, Ferrentino controlled all the

checks issued from J.C. Penney to AJF.    Ferrentino determined

whether he would cash checks personally or have them deposited

into AJF's corporate operating account.    Ferrentino knew that AJF

corporate income was determined by its accountants by examining

deposits into AJF's bank account.    AJF's gross income was

determined from deposits to the bank account which were reflected

in the cash receipts journal.    He also knew that if the checks
                                 - 7 -

for fuel reimbursement and delivery services were not deposited

into AJF's bank account, then corporate income tax returns would

not reflect these amounts.

      J.C. Penney Custom Decorating Divisions (Custom Decorating)

issued checks to "AJF and/or A.J. Ferrentino" for services

performed.   Ferrentino cashed checks issued by Custom Decorating

in the following amounts:

     Year                   Amount Cashed by Ferrentino

     1988                          $70,721.02
     1989                           57,680.35
     1990                           53,030.51

AJF did not include these amounts in gross income on its Federal

income tax returns.

     The J.C. Penney Buffalo distribution center issued checks

for fuel reimbursement solely to Ferrentino.    During the years at

issue, Ferrentino cashed all but two fuel reimbursement checks

from the Buffalo distribution center.    The cashed check proceeds

totaled:

     Year                   Amount Cashed by Ferrentino

     1988                          $66,194.16
     1989                           65,725.26
     1990                          109,684.97

     The J.C. Penney Toledo distribution center issued checks for

fuel reimbursement to "Anthony J. Ferrentino/AJF Trans. Inc."

Ferrentino cashed these checks in the following amounts:
                                - 8 -

     Year                  Amount Cashed by Ferrentino

     1988                          $26,457.17
     1989                           26,163.56
     1990                              148.34

     AJF maintained a cash disbursements journal which tracked,

among other things, fuel expenses, but the journal did not

account for fuel reimbursements from J.C. Penney.    Employees of

AJF would prepare an invoice entitled Fuel Billing which would be

sent to J.C. Penney for fuel reimbursement.     These Fuel Billings

also included amounts for tolls and truck repairs.    AJF's

accountants would use the cash disbursements journal to prepare

AJF's tax returns and financial statements.

     AJF claimed deductions for "gas, oil and tires" expenses in

1988 and 1989 in the amounts of $184,621 and $183,651,

respectively.    In 1990, AJF claimed a deduction for fuel expenses

of $195,035.    AJF did not include any amounts relating to fuel

reimbursements in gross income.

Ferrentino's Cash Hoard

     AJF maintained a business operating account at Manufacturers

Hanover Trust Co. (subsequently purchased by Fleet Bank).

Ferrentino cashed checks on approximately a weekly basis, usually

averaging $7,000 to $9,000 per transaction and paid in $100

denominations.    On January 11, 1991, Ferrentino presented for

exchange $122,600 in water-damaged currency to the Federal

Reserve Bank in Buffalo.    Of the amount presented, $75,000 was in

denominations of $100 or larger.
                               - 9 -

Ferrentino's Guilty Plea to Filing a False Tax Return

     On April 13, 1995, Ferrentino pleaded guilty to a one count

information charging him with willfully making and subscribing to

a false and fictitious U.S. income tax return for the year 1988

in violation of section 7206(1).   On January 29, 1996, Ferrentino

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

the taxable years 1988, 1989, and 1990, which reported additional

income in the amounts of $30,975, $28,870, and $32,572,

respectively.

Respondent Issued Notices of Deficiency After the 3-Year Period
of Limitations on Assessment Had Expired

     Ferrentino filed timely tax returns for the 1988, 1989, and

1990 taxable years.   AJF, on the other hand, filed its tax

returns late.   AJF filed its 1988 and 1989 tax returns on May 10,

1991, and its 1990 return on July 17, 1991.

     Respondent mailed notices of deficiency on August 13, 1996,

with respect to petitioners' 1988, 1989, and 1990 income tax

returns.   The general 3-year period of limitations on assessment

under section 6501(a) expired before the issuance of the notices

of deficiency in these consolidated cases.

Circumstances Surrounding the Late Filing of AJF's Tax Returns

     John Witkowski, C.P.A. (Witkowski), prepared AJF's tax

returns during the years in issue.     When preparing the returns,

Witkowski relied on AJF's books and records, which included

receipts journals, disbursement journals, payroll records, and

bank reconciliations.   Witkowski determined AJF's gross income
                                - 10 -

from AJF's cash receipts journal.    Expenses were determined using

check registers and cash-paid-out journals.    AJF's books and

records did not disclose amounts pertaining to the fuel

reimbursement checks from the J.C. Penney distribution centers,

nor did they disclose the Custom Decorating checks for delivery

services.

      In general, after the returns were prepared for clients

including petitioners, Witkowski's office would contact the

client, who would normally pick them up.    If the client had not

picked them up after a reasonable length of time, Witkowski's

office would again contact the client.

      Witkowski signed AJF's corporate returns for 1988, 1989, and

1990 on June 15, 1989, June 1, 1990, and July 8, 1991,

respectively.    For some unexplained reason, the 1988 and 1989

corporate returns reflect that Ferrentino signed them on May 6,

1991.    He signed the 1990 corporate return on July 12, 1991.

                                OPINION

I.   Fraudulent Return Exception

        Since the 3-year period of limitations on assessment under

section 6501(a) has expired with respect to the taxable years at

issue, respondent is barred from assessing the deficiencies

unless an exception to section 6501(a) applies.

However, section 6501(c) provides exceptions to the general rule.

The pertinent exception in this case is found in section

6501(c)(1) which provides that "In the case of a false or
                              - 11 -

fraudulent return with the intent to evade tax, the tax may be

assessed, or a proceeding in court for collection of such tax may

be begun without assessment, at any time."

     Where respondent asserts that a taxpayer has filed a

fraudulent return with the intent to evade tax, the burden of

proof is on the respondent.   Sec. 7454(a); Rule 142(b).

Respondent must satisfy his burden of proof with "clear and

convincing evidence".   Rule 142(b); Fox v. Commissioner, 61 T.C.
704, 717 (1974).   To establish fraud, respondent must prove, by

clear and convincing evidence, for each year and with respect to

each petitioner, that: "(1) petitioner underpaid his income tax

and (2) some part of the underpayment was due to fraud."

Recklitis v. Commissioner, 91 T.C. 874, 909 (1988) (citations

omitted); see also Hebrank v. Commissioner, 81 T.C. 640, 642

(1983).

     Although respondent need not prove the precise amount of the

underpayment resulting from fraud, respondent may not carry his

burden by merely relying on a taxpayer's failure to carry the

burden of proof on the underlying deficiency.   DiLeo v.

Commissioner, 96 T.C. 858, 873 (1991), affd. 959 F.2d 16 (2d Cir.

1992); Otsuki v. Commissioner, 53 T.C. 96, 106 (1969).

     A.   Underreporting of Tax

     Respondent asserts that petitioners had unreported income

arising from the checks issued by J.C. Penney for delivery

services rendered by AJF to Custom Decorating and fuel

reimbursements for fuel expenses incurred by AJF.
                              - 12 -

     Petitioner AJF concedes that checks which were cashed by

Ferrentino, received from Custom Decorating for delivery

services, should have been included in AJF's gross income.

However, petitioners argue that the fuel reimbursements are not

includable in gross receipts of AJF, and the proceeds from

Ferrentino's check cashing are not includable in his gross income

because he used the proceeds to pay "casual labor" for

performance of services for which the checks were issued,

entitling him to deduct such amounts from gross income resulting

in no underpayment.

          1.   Fuel Reimbursement Checks

     The first question is whether the fuel reimbursement checks

should be included in AJF's gross income.   Section 61(a) defines

the term "gross income" as "all income from whatever source

derived", except as otherwise provided by law.    Income has been

defined as "undeniable accessions to wealth, clearly realized,

and over which the taxpayers have complete dominion."

Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 431 (1955).

Unless specifically excluded by another provision of the Internal

Revenue Code, all income is subject to tax.   Id. at 430.

Therefore, reimbursed expenses must be included in gross income,

but these expenses may be deducted only if allowed under other

provisions of the Internal Revenue Code and if adequately

substantiated.   Rietzke v. Commissioner, 40 T.C. 443, 453 (1963);

Vaughn v. Commissioner, T.C. Memo. 1992-317, affd. without

published opinion 15 F.3d 1095 (9th Cir. 1993).
                              - 13 -

     Petitioners argue that the unreported fuel reimbursement

checks should not be included in gross income because the checks

were repayments of a loan made from AJF to J.C. Penney for

expenses incurred by AJF on behalf of J.C. Penney.   It is true

that we have previously held that "'where a taxpayer makes

expenditures under an agreement that he will be reimbursed

therefor, such expenditures are in the nature of loans or

advancements and are not deductible as business expenses.'"

Canelo v. Commissioner, 53 T.C. 217, 224 (1969) (quoting Patchen

v. Commissioner, 27 T.C. 592, 600 (1956)), affd. 447 F.2d 484

(9th Cir. 1971).

     Nevertheless, as respondent points out, AJF deducted amounts

for fuel reimbursement expenses on its 1988, 1989, and 1990 tax

returns which persistent course of action is inconsistent with

petitioners' assertion that the reimbursements were repayments of

a loan.   We have also held that "Taxpayers are entitled to attack

the form of their transactions only when their tax reporting and

other actions have shown an honest and consistent respect for

what they argue is the substance of the transactions."    FNMA v.

Commissioner, 90 T.C. 405, 426 (1988), affd. 896 F.2d 580 (D.C.

Cir. 1990).

     Neither AJF's cash disbursements journal nor other

accounting records treated the fuel reimbursements as loan

repayments.   Had AJF intended to treat the fuel reimbursement

arrangement as a loan, it would not have claimed deductions for

fuel expenses.
                              - 14 -

     In sum, AJF's tax reporting and other actions have not shown

an honest and consistent respect for what petitioners argue is

the substance of these reimbursements.   Therefore, respondent has

shown by clear and convincing evidence that the fuel

reimbursement checks should be included in AJF's gross income.

          2. Inclusion of AJF's Custom Decorating Checks and
          Fuel Reimbursement in Ferrentino's Gross Income

     The next question is whether Ferrentino, as president and

sole shareholder of AJF, must include the Custom Decorating and

fuel reimbursement checks in gross income because he cashed the

checks personally.   Generally, "income that is subject to a man's

unfettered command and that he is free to enjoy at his own option

may be taxed to him as his income, whether he sees fit to enjoy

it or not."   Corliss v. Bowers, 281 U.S. 376, 378 (1930).

     Respondent argues that Ferrentino should include the

diversions as ordinary income.   Ferrentino, on the other hand,

argues that the cashed checks do not represent income to him

because he received the checks on behalf of AJF as its "agent"

and that the cash was held in "constructive trust" to pay a

business expense of AJF.

     Generally, "a taxpayer need not treat as income moneys which

he did not receive under a claim of right, which were not his to

keep, and which he was required to transmit to someone else as a

mere conduit."   Diamond v. Commissioner, 56 T.C. 530, 541 (1971),

affd. 492 F.2d 286 (7th Cir. 1974).    No tax is imposed upon the

receipt of money in a fiduciary or agency capacity.    Stone v.
                                - 15 -

Commissioner, 865 F.2d 342, 343 (D.C. Cir. 1989); Heminway v.

Commissioner, 44 T.C. 96, 101 (1965).    However, where a

shareholder uses corporate property for his personal benefit, not

proximately related to corporate business, the shareholder must

include the value of the benefit in income as constructive

dividends to the extent of the corporation's earnings and

profits.   DiZenzo v. Commissioner, 348 F.2d 122, 125 (2d Cir.

1965), revg. in part and remanding for additional findings to

support the Tax Court's holding, T.C. Memo. 1964-121, remanding

T.C. Memo. 1966-16; Truesdell v. Commissioner, 89 T.C. 1280, 1294

(1987); Falsetti v. Commissioner, 85 T.C. 332, 356 (1985).

     Ferrentino argues that he used the check proceeds to pay for

"casual labor" needs of AJF during certain peak times or when

additional help was needed.   Respondent counters that any

additional labor needs of AJF were satisfied by the use of leased

helpers from Manpower Services.

     The burden of proof to establish the existence of cash

payments to casual labor is on petitioners.    Once respondent

establishes the existence of unreported income and allows the

deductions claimed on the return, he does not have the further

burden of proving the negative that the taxpayer did not have any

additional deductions.   See Perez v. Commissioner, T.C. Memo.

1974-211 (citations omitted).    One Court of Appeals has stated

that "This rule is grounded on the realization that it would be

virtually impossible for the Government to show the negative fact
                               - 16 -

that a taxpayer had no unreported deductions or exclusions."

United States v. Bender, 218 F.2d 869, 871 (7th Cir. 1955).

Respondent is entitled to rely on the

          presumption that the deductions and exclusions listed
          by a taxpayer in his return are all that exist. This
          presumption is based upon reasonable experience * * *
          and has the effect of shifting the burden of going
          forward with the evidence to the * * * [taxpayer], when
          the Government has shown unreported income. [United
          States v. Lennon, 246 F.2d 24, 27 (2d Cir. 1957)
          (quoting United States v. Bender, supra at 871-872).]

     In this case, Ferrentino has admitted, by filing amended

returns for the years in issue, that he had unreported income.

AJF has conceded that it should have reported the amounts earned

from delivery services for Custom Decorating.   Furthermore,

respondent has shown that the fuel reimbursement check amounts

should have been included in AJF's gross income.   Therefore,

since respondent has shown that petitioners had unreported

income, the burden of proving the existence of cash payments to

casual labor lies with Ferrentino.

     Relying on Perez v. Commissioner, supra; Richardson v.

Commissioner, 264 F.2d 400 (4th Cir. 1959), affg. in part, revg.

in part T.C. Memo. 1958-59, and H.J. Feinberg & Co., Inc. v.

Commissioner, a Memorandum Opinion of this Court dated Sept. 20,

1950, Ferrentino argues that respondent should be required to

present affirmative evidence disputing Ferrentino's claim of

"casual labor" expenditures.   In these cases, the courts

recognized that understatements of gross receipts did not

establish that a taxpayer had fraudulently intended to evade tax
                                 - 17 -

where the taxpayer also showed that he had offsetting deductions

relating to such receipts that he failed to claim on his return.

Zack v. Commissioner, T.C. Memo. 1981-700, affd. 692 F.2d 28 (6th

Cir. 1982).

     The taxpayers in Perez, Richardson, and H.J. Feinberg & Co.,

Inc. submitted positive proof that unreported deductible payments

were in fact made and were related to their respective unreported

receipts.   Zack v. Commissioner, supra.    Based on such proof, the

courts shifted the burden of going forward to the Commissioner to

prove that at least some unreported net income resulted from the

unreported transactions.   Id.    Therefore, to shift such burden to

respondent, Ferrentino must submit credible evidence of whether

and to what extent he made such payments.

     The underlying support for Ferrentino's claimed "casual

labor" cash payments rests on Ferrentino's credibility, on the

testimonial credibility of AJF's employees, and on a report

authored by Elaine Brittain (Brittain), AJF's office manager.

     It is well established that we are not required to accept

self-serving testimony in the absence of corroborating evidence.

Niedringhaus v. Commissioner, 99 T.C. 202, 212 (1992); Tokarski

v. Commissioner, 87 T.C. 74, 77 (1986).    Ferrentino testified

that he cashed the checks when he needed funds to pay for casual

labor.   Brittain testified that she obtained cash from Ferrentino

to cover shortages of COD funds received by the drivers.    But

Brittain's testimony indicates that she did not have personal

knowledge of a casual laborer ever working at AJF.    Donald
                              - 18 -

Travis, an employee of AJF, testified that he could recall hiring

his son, Doug, and a person named Harold.   Andrew Davis, another

employee, testified that he had once hired his ex-brother-in-law,

and a "big Indian gentleman" whose name started with a "C" and

was "7 foot tall."

     For the reasons stated below, we hold that Ferrentino has

not submitted credible evidence of any cash payments made to

casual labor.

     Petitioners have presented no documentation to corroborate

the oral testimony of the above-mentioned witnesses.   AJF did not

maintain any records of alleged payees who received cash for

services performed as casual laborers during the 1988, 1989, and

1990 taxable years.   AJF did not retain the trip sheets or

delivery manifests which might have verified the existence of

casual labor.   AJF did not maintain any lists of names of any

casual laborers, records reflecting casual labor hours worked, or

records of individual earnings in a given year of any casual

laborer.   Employment tax returns prepared by Brittain did not

show casual laborers being paid in cash.    AJF did not maintain

records of how many alleged casual laborers were paid in cash.

Finally, AJF did not require receipts from alleged casual

laborers when they were paid in cash.

     A factor which dilutes the credibility of Ferrentino and

Brittain's testimony is that casual labor was never mentioned

during audit.   Revenue Agent Kathleen Oswald, who conducted the

audit of AJF, testified that neither Ferrentino nor Brittain had
                              - 19 -

disclosed casual labor expenses during audit.    Had Ferrentino

actually paid cash for casual labor, we think that Ferrentino or

Brittain would have disclosed the payments during the audit

process instead of waiting until litigation commenced.

     Petitioners did not introduce testimony of any purported

casual laborer.   The rule is well established that the failure of

a party to introduce evidence within his possession and which, if

true, would be favorable to him, gives rise to the presumption

that, if produced, it would be unfavorable.     Wichita Terminal

Elevator Co. v. Commissioner, 6 T.C. 1158, 1165 (1946), affd. 162
F.2d 513 (10th Cir. 1947).   Donald Travis testified that his son

Doug was used as casual labor.   Andrew Davis testified that he

hired his ex-brother-in-law as a casual laborer.    We think that

petitioners could have called these people to testify, under

subpoena, if necessary, without undue hardship.    Therefore, we

presume that these alleged casual laborers would have testified

unfavorably.

     Petitioners' most strenuous effort to establish cash

payments for casual labor took the form of a report (Report)

authored by Brittain which attempted to illustrate the use by AJF

of cash payments in very large amounts for casual labor.    If the

Report were to be believed, AJF expended cash for casual labor in

the respective amounts of $98,670.65, $138,220.40, and $102,480

in 1988, 1989, and 1990, respectively.

     Petitioners claim that Brittain's Report accurately computed

the number of hours attributable to the alleged casual labor by
                              - 20 -

comparing AJF's payroll figures to the billing invoices for

services rendered by AJF to J.C. Penney.   Brittain used the

billing invoices to determine the total number of manpower hours

AJF employees actually rendered to J.C. Penney.   She used AJF's

payroll records to determine the number of manpower hours

attributable to AJF employees as reflected on the payroll

records.   The Report attributed the difference between the

payroll and billing invoice figures to "casual labor".    For

example, the Report concludes that for the second quarter of 1988

the manpower hours attributable to casual labor totaled 2464.3

hours.   The Report derived this figure by subtracting 41,670.3

manpower hours shown on AFJ's payroll records from the manpower

hours of 44,134.6 shown on the invoices.

     Brittain's Report is laced with flaws.   For purposes of

computing payroll manpower hours, the Report treated all

employees listed in the Report as drivers, even though they had

helpers who were also on the payroll.   The record indicates that

a delivery truck required two people: a driver and a helper.

Brittain testified that she had no way of knowing which

individual was a driver or a helper.    In fact, she had no way of

knowing, in her Report and the records it was based on, the

capacity in which a particular employee was employed.    Thus,

drivers listed in the Report could instead have been helpers.

The Report thus arbitrarily assumes that the helper on any given

delivery truck crew must have been a casual laborer not listed on

the payroll who was paid in cash.   It follows that the hours
                               - 21 -

attributed to casual labor--if any were in fact hired--were

erroneously increased because payroll manpower hours were

erroneously treated as drivers' hours alone.    Moreover, the

Report does not account for the hours attributable to leased

labor which AJF had deducted on its tax returns.    This omission

further erroneously inflates the hours attributable to casual

labor.    Therefore, we cannot trust the accuracy of the Report.

     The credibility of Brittain's Report is further challenged

by other evidence.    Brittain admitted on direct examination that

her Report was prepared specifically for this litigation to

support her theory that there must have been substantially more

manpower hours than shown on AJF's payroll records, and which

therefore must have been worked by casual laborers paid solely in

cash.    As we have observed, AJF failed to produce records which

could have verified the existence of casual labor and the numbers

used in the Report.   Brittain testified that the trip sheets that

drivers used, nonexistent as of the time of trial, would have

shown whether casual labor was used.    Since the Report bases

manpower hours attributable to delivery services on the trip

sheets, these key figures in the Report cannot be verified.

Brittain did not keep any records on the number of alleged casual

laborers used.

     Brittain testified that she had knowledge of casual labor

being paid in cash, but did not include the amount paid to casual

labor on employment tax returns and did not withhold amounts from

laborers' wages.   Brittain also testified that she knows
                              - 22 -

everything about the business of AJF, with the exception of how

to drive a truck, but does not know how many casual laborers were

used. Finally, Brittain's testimony indicates that she herself

doubts the accuracy of her Report.     When asked whether the

Buffalo office hired casual laborers, Brittain replied,

"probably, yes."   The tentativeness of her response suggests a

significant lack of confidence in her Report.

     Based on the foregoing, we reject the Report in its entirety

due to its flawed analysis and lack of credibility.     Since

Ferrentino cannot show that payments were made for casual labor,

we conclude that Ferrentino used the funds derived from cashing

the delivery service and fuel reimbursement checks solely for his

own benefit.

     Since Ferrentino used the check proceeds solely for his

personal benefit, we must then decide whether Ferrentino must

include the value of the check proceeds as dividends in gross

income.   Under sections 301(c) and 316(a), dividends are taxable

to the shareholder as ordinary income to the extent of the

corporation's earnings and profits, and any amount received by

the shareholder in excess of earnings and profits is considered a

nontaxable return of capital to the extent of the shareholder's

basis in his stock.   Any amount received in excess of both the

earnings and profits of the corporation and the shareholder's

basis in his stock is treated as gain from the sale or exchange

of property.   Truesdell v. Commissioner, 89 T.C. 1280, 1294-1295

(1987).
                               - 23 -

     Dividends may be formally declared or they may be

constructive.   A constructive dividend is found where a

corporation confers a benefit upon its shareholder in order to

distribute available earnings and profits without expectation of

repayment.   Truesdell v. Commissioner, supra at 1295.     Therefore,

if Ferrentino is to be required to include the constructive

distribution in gross income as a dividend, AJF must have had

earnings and profits sufficient to support the distribution of a

dividend.

     The U.S. Court of Appeals for the Second Circuit, the Court

to which this case would normally be appealable, has held that in

cases where the Commissioner alleges fraudulent intent to evade

income tax with respect to the diversion of corporate funds which

is not per se unlawful, the burden of proof is on the taxpayer to

establish that the corporation did not have earnings and profits

equal to the amounts diverted.    DiZenzo v. Commissioner, 348 F.2d

at 127.

     Section 312(a) provides that a corporation's earnings and

profits are reduced by, among other things, the amount of money

distributed with respect to its stock.    Earnings and profits for

a particular period include tax-exempt income, as well as items

included in gross income under section 61.    Sec. 1.312-6, Income

Tax Regs.    We are required to make a finding as to whether AJF

had sufficient earnings and profits to sustain a dividend.

DiZenzo v. Commissioner, supra at 127 (remanding to the Tax Court
                              - 24 -

to make a finding with respect to whether amounts of accumulated

earnings and profits were at least equal to a constructive

distribution).

     The only evidence with respect to AJF's earnings and profits

is AJF's tax returns for 1988, 1989, and 1990.    The tax returns

reveal that AJF reported taxable income of $151,199 and $247,037

in 1988 and 1989, respectively.   AJF's 1990 tax return reports a

$2,169 loss.   Since we have held that AJF should have included

the amounts of the checks cashed by Ferrentino in gross income,

earnings and profits for 1988, 1989, and 1990 must be increased

by $163,372.35, $135,458.78, and $162,863.82, respectively.    If

distributed funds constitute constructive dividends, earnings and

profits should be reduced by such amount under section 312(a).

Enoch v. Commissioner, 57 T.C. 781, 800 (1972).    Because AJF is

on the cash receipts and disbursements method of accounting,

accrued tax liabilities and penalties do not reduce earnings and

profits until paid.   Sec. 1.312-6(a), Income Tax Regs.

Petitioners have presented no credible evidence requiring the

further reduction of AJF's earnings and profits.

     We conclude that petitioners have not shown that AJF had

insufficient earnings and profits to sustain a dividend to

Ferrentino for each of the years in issue.   The evidence shows

that AJF had sufficient current earnings and profits to sustain a

dividend in each of the 1988 and 1989 taxable years.    Although

AJF shows a deficit of $2,169 in taxable income for the 1990

taxable year, AJF had sufficient accumulated earnings and profits
                                - 25 -

to sustain a dividend.    Therefore, the constructive distributions

from AJF to Ferrentino must be included in Ferrentino's income as

a dividend.

     Accordingly, we hold that respondent has shown by clear and

convincing evidence that Ferrentino had underpayments in tax for

the years in issue due to unreported dividend income in the

amounts he diverted from AJF by cashing the Custom Decorating and

fuel reimbursement checks.

     B.   Underpayments Due to Fraud

     Since we have found that respondent has shown by clear and

convincing evidence that petitioners had underpayments of tax for

the years in issue, the next issue is whether some part of

petitioners' underpayment each year was due to fraud with the

intent to evade tax.     Fraud is established by showing that the

taxpayer intended "to evade tax believed to be owing by conduct

intended to conceal, mislead, or otherwise prevent the collection

of such tax."   Recklitis v. Commissioner, 91 T.C. 909.    Tax

evasion need not be a primary motive, but the respondent may

satisfy his burden by showing that a "'tax-evasion motive

[played] any part' in petitioner's conduct".     Id.   Respondent

must establish fraud on the part of each petitioner for each

taxable year involved by clear and convincing evidence.      Otsuki

v. Commissioner, 53 T.C. 96, 105 (1969).

     The fraud of a sole or dominant shareholder can be

attributed to the corporation.     Benes v. Commissioner, 42 T.C.
358, 383 (1964), affd. 355 F.2d 929 (6th Cir. 1966); see also
                              - 26 -

DiLeo v. Commissioner, 96 T.C. 875 (1991), ("[C]orporate fraud

necessarily depends upon the fraudulent intent of the corporate

officers."), affd. 959 F.2d 16 (2d Cir. 1992).    In these cases,

Ferrentino is the sole shareholder and president of AJF.    He

exercised total control over all the checks issued from J.C.

Penney to AJF.   Ferrentino determined whether he would cash

checks personally or have them deposited into AJF's corporate

operating account.   We think Ferrentino exercised sufficient

control over the affairs of AJF to justify imputing to AJF any

fraud committed by Ferrentino.

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

upon examination of the entire record.   Parks v. Commissioner, 94
T.C. 654, 660 (1990); Recklitis v. Commissioner, supra at 909.

Fraud is never presumed, but it must be established by

independent evidence.   Beaver v. Commissioner, 55 T.C. 85, 92

(1970); Otsuki v. Commissioner, supra at 105.     Fraud may be

proven by circumstantial evidence because direct evidence of the

taxpayer's intent is rarely available.   Recklitis v.

Commissioner, supra at 910; Rowlee v. Commissioner, 80 T.C. 1111,

1123 (1983).

     Circumstantial evidence of fraud includes:

          (1) Consistent and substantial understatement of
          income, (2) failure to maintain adequate records, (3)
          failure to cooperate with an IRS investigation, (4)
          inconsistent or implausible explanations of behavior
          and (5) awareness of the obligation to file returns,
          report income and pay taxes. [Douge v. Commissioner,
          899 F.2d 164, 168 (2d Cir. 1990) (citing Bradford v.
          Commissioner, 796 F.2d 303, 307-308 (9th Cir. 1986),
          affg. T.C. Memo. 1984-601).]
                              - 27 -

Other badges of fraud include concealing assets, extensive

dealings in cash, Recklitis v. Commissioner, supra at 910,

failure to file timely returns, Kotmair v. Commissioner, 86 T.C.
1253, 1261 (1986), and failure to provide tax return preparers

with complete and accurate information, Korecky v. Commissioner,

781 F.2d 1566, 1569 (11th Cir. 1986), affg. T.C. Memo. 1985-63.

     Ferrentino presented a cash hoard of $122,600 to the Federal

Reserve Bank in Buffalo, New York.     According to the required

Currency Transaction Report, $75,000 of the amount presented was

in bills of $100 or higher.   The record indicates that when

Ferrentino cashed the Custom Decorating and fuel reimbursement

checks, Manufacturer's Hanover would generally cash the checks in

$100 denominations.   During audit, Ferrentino told Revenue Agent

Oswald: (1) He did not report the cash hoard as income, (2) he

knew that the source of the cash hoard constituted taxable

income, and (3) he called the cash hoard pocket monies.     At

trial, Ferrentino explained that he had accumulated the cash

hoard over a period of 15 to 18 years.     He further testified that

the cash hoard resulted from the selling and restoration of

furniture and that he accumulated the cash hoard in anticipation

of his divorce.

     Based on the amount of $100 bills presented to the Federal

Reserve Bank and the fact that Ferrentino received $100 bills

when cashing the checks at Manufacturer's Hanover, we may

justifiably infer that part of Ferrentino's cash hoard was

attributable to the cashed checks.     We may further infer that
                               - 28 -

Ferrentino hoarded the cash to conceal income from his wife,

Carol Ferrentino, in order to avoid meeting the obligations

enumerated in the Separation Agreement.    It is therefore fair to

apply to Ferrentino and his devious course of conduct what we

said in a prior case; namely, "that a man who will misappropriate

another's funds to his own use through * * * concealment will not

hesitate to * * * conceal his receipt of those same funds from

the Government with intent to evade tax."    McGee v. Commissioner,

61 T.C. 249, 260 (1973), affd. 519 F.2d 1121 (5th Cir. 1975).

     Ferrentino's extensive use of cash is a further badge of

fraud because it indicates a desire to avoid detection of income-

producing activities.    Bradford v. Commissioner, T.C. Memo. 1984-

601, affd. 796 F.2d 303 (9th Cir. 1986).    Petitioners have not

presented credible evidence of cash payments to casual labor.

Furthermore, Ferrentino did not disclose during audit that the

delivery service and fuel reimbursement checks were issued and

cashed.   Instead, respondent became aware of Ferrentino's

dealings only through contacts with J.C. Penney and Wittlin,

Ferrentino's accountant at the time.    The circumstances here

suggest that Ferrentino was attempting to conceal income.

     Ferrentino pleaded guilty to violating section 7206(1) for

the taxable year 1988.   Section 7206(1) makes it a crime for a

taxpayer to willfully make and submit any return verified by a

written declaration that it is made under the penalties of

perjury which he does not believe to be true and correct as to

every material matter.    Wright v. Commissioner, 84 T.C. 636, 639
                                - 29 -

(1985).    While not dispositive on the issue of fraud, it is a

factor we may consider relevant.    See id. at 639-640.     The

Supreme Court has defined "willfully", as used in section

7206(1), as "a voluntary, intentional violation of a known legal

duty."    United States v. Pomponio, 429 U.S. 10, 12 (1976).      We

think Ferrentino's intentional filing of a false tax return for

1988 is strong indicia of fraudulent intent with respect to the

1988 taxable year.

     The failure to provide tax return preparers with complete

and accurate information is also an indication of fraud.

Witkowski determined AJF's gross income from AJF's cash receipts

journal.     AJF's books and records did not disclose the fuel

reimbursement checks from the J.C. Penney distribution centers,

nor did they disclose the delivery service checks from Custom

Decorating.     Ferrentino knew that AJF's corporate income was

determined by deposits to its operating account.       He also knew

that by not depositing the Custom Decorating and fuel

reimbursement checks, AJF's corporate tax returns would not

report these amounts.     Under these circumstances, Ferrentino's

failure to provide accurate information to Witkowski is strong

indicia of fraud with the intent to evade tax.

         Petitioners' failure to maintain adequate books and records

of alleged casual labor is further evidence of fraudulent intent.

See Spies v. United States, 317 U.S. 492, 500 (1943);

Grosshandler v. Commissioner, 75 T.C. 1, 20 (1980); Zack v.

Commissioner, T.C. Memo. 1981-700.       Petitioners failed to
                              - 30 -

maintain records of trip sheets and manifests which would have

verified the existence of casual labor and cash payments to the

alleged casual labor.   Petitioners failed to keep a list of the

names and Social Security numbers of alleged casual laborers.       We

think petitioners intentionally chose not to maintain adequate

records of their activities in order to conceal income.

     Finally, petitioners AJF and Ferrentino have deliberately

failed to report $442,138 and $475,805.34, respectively, in

cashed checks over the course of the 3 taxable years in issue.

     We conclude that respondent has proven by clear and

convincing evidence that at least part of petitioners'

underpayment for each taxable year involved is attributable to

fraud with the intent to evade tax.    Therefore, the fraudulent

return exception under section 6501(c)(1) applies.

II. The Additions to Tax and Fraud Penalties Under Secs. 6653(b)
and 6663(a)

     Respondent has determined that petitioners owe additions to

tax and penalties under sections 6653(b) and 6663(a).     Section

6663(a) provides:   "If any part of any underpayment of tax

required to be shown on a return is due to fraud, there shall be

added to the tax an amount equal to 75 percent of the portion of

the underpayment which is attributable to fraud."    Once the

Secretary establishes that a part of an underpayment is due to

fraud, "the entire underpayment shall be treated as attributable
                               - 31 -

to fraud, except with respect to any portion of the underpayment

which the taxpayer establishes (by a preponderance of the

evidence) is not attributable to fraud."     Sec. 6663(b).

       The burden that respondent bears in proving fraud under

section 6501(c)(1) is the same burden that he bears in

establishing fraud for purposes of the section 6663(a) penalty.

Ruidoso Racing Association, Inc. v. Commissioner, 476 F.2d 502,

507 (10th Cir. 1973), affg. in part and remanding in part T.C.

Memo. 1971-194; DeBrouse v. Commissioner, T.C. Memo. 1988-119,

affd. 878 F.2d 379 (4th Cir. 1989).     Since respondent has met his

burden for purposes of section 6501(c)(1), we hold that

respondent has established that a portion of petitioners'

underpayment is due to fraud for purposes of section 6663(a).      We

further hold that petitioners have not presented credible

evidence that any portion of their underpayment was not due to

fraud.    Accordingly, we sustain respondent's determination for

additions to tax and penalties imposed by sections 6653(b) and

6663(a).

III.    Additions to Tax Under Sec. 6651

       Respondent determined that petitioner AJF was liable for the

additions to tax imposed by section 6651(a).     Section 6651(a)

imposes an addition to tax for failing to file a timely income

tax return, unless such failure to file is due to reasonable

cause and not due to willful neglect.      The addition to tax is 5

percent of the amount required to be reported on the return for

each month or fraction thereof during which such failure to file
                               - 32 -

continues, but not to exceed 25 percent in the aggregate.     Sec.

6651(a).    In this case, AJF's 1988, 1989, and 1990 tax returns

were due on March 15, 1989, 1990, and 1991, respectively.     Sec.

6072(b).    AJF filed its 1988 and 1989 returns on May 10, 1991,

and its 1990 return on July 17, 1991.   Unless AJF can show that

its failure to timely file its returns was due to reasonable

cause and not due to willful neglect, respondent's determination

will be sustained.

     The term "reasonable cause" as set forth in section 6651(a)

has been defined as the exercise of ordinary business care and

prudence.   Sec. 301.6651-1(c)(1), Proced. & Admin. Regs.

"Willful neglect" means a "conscious, intentional failure or

reckless indifference."    United States v. Boyle, 469 U.S. 241,

246 (1985).    The question of whether a failure to file timely is

due to reasonable cause and not willful neglect is one of fact,

on which petitioners bear the burden of proof.      Rule 142(a); Lee

v. Commissioner, 227 F.2d 181, 184 (5th Cir. 1955), affg. a

Memorandum Opinion of this Court dated July 31, 1953; BJR Corp.

v. Commissioner, 67 T.C. 111, 131 (1976).

     Taxpayers have a nondelegable duty to file timely tax

returns.    United States v. Boyle, supra at 250.    Reasonable cause

for the failure to timely file the return cannot be established

merely by stating that such return was in the hands of the agent.

Lynch v. Commissioner, T.C. Memo. 1983-173 (citing Logan Lumber

Co. v. Commissioner, 365 F.2d 846, 854 (5th Cir. 1966), affg.

T.C. Memo. 1964-126).
                              - 33 -

     In this case, AJF neglected to retrieve its tax returns from

its return preparer, Witkowski, and timely file them with

respondent.   Therefore, we find that AJF's untimely filing of its

returns was not due to reasonable cause.    Accordingly, we sustain

respondent's determination with respect to the additions to tax

imposed by section 6651(a) for AJF's 1988, 1989, and 1990 taxable

years.

     Contentions not addressed are either irrelevant or without

merit.

     To reflect the foregoing,

                                     Decisions will be entered

                                 under Rule 155.