Court Opinion

ID: 4332288
Source: CourtListenerOpinion
Date Created: 2018-11-14 00:37:50.108057+00
Date Added: 2024-06-11T14:20:32.246548
License: Public Domain

MARK D. PRIDGEN AND KAY D. PRIDGEN, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent DEWEY GASKINS AND FRANCINE P. GASKINS, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentPridgen v. CommissionerNo. 2048-97; No. 2075-97United States Tax CourtT.C. Memo 1999-188; 1999 Tax Ct. Memo LEXIS 225; 77 T.C.M. 2117; T.C.M. (RIA) 99188; June 9, 1999, Filed 1999 Tax Ct. Memo LEXIS 225">*225  Decisions will be entered for respondent.  1999 Tax Ct. Memo LEXIS 225">*226 Trawick H. Stubbs, Jr. and J. Douglas McCullough, forpetitioners.J. Craig Young, for respondent.  Whalen, Laurence J.WHALENMEMORANDUM FINDINGS OF FACT AND OPINION1999 Tax Ct. Memo LEXIS 225">*227 WHALEN, JUDGE: Respondent determined the following deficiencies in, and penalties with respect to, the Federal income tax of petitioners Mark and Kay Pridgen, in the case at docket No. 2048-97:                           Penalty   Year         Deficiency         Sec. 6662(a)   ____         __________         ____________   1990         $ 129,169          $ 25,834   1991          232,416           46,4831999 Tax Ct. Memo LEXIS 225">*228 Unless stated otherwise, all section references are to the Internal Revenue Code as in effect during the years in issue. Respondent also determined the following deficiencies in, addition to, and penalties with respect to the Federal income tax of petitioners Dewey and Francine Gaskins, in the case at docket No. 2075-97:              1999 Tax Ct. Memo LEXIS 225">*229              Addition to Tax                 Penalty      _______________Year      Deficiency     Sec. 6662(a)     Sec. 6651(a)(1)____      __________     ____________     _______________1990      $ 131,723       $ 26,345           --1991       240,086        48,017         $ 12,004References in this opinion to "petitioners" are references to Mr. Pridgen and Mr. Gaskins. Petitioners and their wives resided in the State of North Carolina at the time the subject petitions were filed.The above-captioned cases were consolidated for trial, briefing, and opinion by an order of the Court issued pursuant to Rule 141, Tax Court Rules of Practice and Procedure. In this opinion, all Rule references are to the Tax Court Rules of Practice and Procedure.After concessions, the issues for decision are: (1) Whether a partnership, Beaufort Leaf Tobacco Co. (hereinafter referred to as Beaufort Leaf), in which each petitioner held an interest, failed to report tobacco sales of $ 888,528 in 1990 and $ 1,054,576 in 1991; (2) whether respondent erred in disallowing alleged tobacco purchases of $ 429,421 in 1990 and $ 1,173,2031999 Tax Ct. Memo LEXIS 225">*230  in 1991 that were included in Beaufort Leaf's cost of goods sold; and (3) whether petitioners are liable for the penalties and addition to tax determined by respondent. The parties have stipulated that Mrs. Pridgen and Mrs. Gaskins are entitled to innocent spouse relief "under section 6013(e)". Thus, it appears that respondent concedes that Mrs. Pridgen and Mrs. Gaskins are eligible for relief from joint and several liability with respect to their joint returns for 1990 and 1991 under section 6015(a)(1), assuming that an appropriate election is made as required by section 6015(b)(1)(E).The deficiencies determined in the notices of deficiency are based upon adjustments to each petitioner's distributive share of the net income of Beaufort Leaf for taxable years 1990 and 1991. Respondent adjusted Beaufort Leaf's net income without a proceeding at the partnership level. See generally section 6221 through 6233. It appears that all parties agree that Beaufort Leaf is a small partnership, as defined under section 6231(a)(1)(B), and is exempt from the partnership audit and litigation procedures.FINDINGS OF FACTIn 1987, petitioners and another individual who is now deceased, Mr. Harry Lee1999 Tax Ct. Memo LEXIS 225">*231  Roberts, formed Beaufort Leaf, a North Carolina general partnership, to engage in the purchase and sale of tobacco. The three partners agreed that petitioners would finance the partnership's operations and, for that purpose, that petitioners would cosign a note in the principal amount of $ 300,000. The partners also agreed that Mr. Roberts would be responsible for the day-to-day management and operation of the partnership and would be paid approximately $ 20,000 per year in addition to his share of any partnership income. There was no written partnership agreement, but the partners orally agreed that each partner would have a one-third distributive share of all partnership income, gain, loss, deduction, or credit. Petitioners initially intended that Beaufort Leaf would be in business for only 1 year, but it continued to conduct business until 1992.During the time Beaufort Leaf was in business, Mr. William H. Dawson, Jr., a licensed accountant, maintained its books and prepared its Federal income tax returns. The partnership's returns for 1988, 1989, and 1990 respond to the question "which accounting method" by indicating that the partnership is on the "cash" method of accounting. 1999 Tax Ct. Memo LEXIS 225">*232  The partnership's return for 1991 indicates that the partnership is on the "accrual" method of accounting. The final return of the partnership for 1992 does not respond to that question.Beaufort Leaf's returns for 1988 through 1992 report the following items on Schedule K, Partner's Shares of Income, Credits, Deductions, Etc.:          1988     1989     1990     1991     1992          ____     ____     ____     ____     ____Ordinary income from trade or business acti- vities     $ 6,595.45 $ 15,075.65 $ 47,204.60 $ 46,952.60   $ 30.33Interest income   2,471.80   6,734.72    -0-    3,286.00    -0-Guaranteed payments to partners     30,000.00  30,000.00  30,000.00  30,000.00 17,000.00Net long-term capital gain    267.33    -0-     -0-     -0-     -0-         _________  _________  _________  _________ _________         39,334.58  51,810.37  77,204.60  80,238.60 17,030.33The above-guaranteed payments of $ 30,000 per year for 1988 through 1991 and $ 17,000 for 1992 were paid entirely to Mr. Roberts. The record does not explain why Mr. Roberts was paid $ 30,000 per year after the partners had1999 Tax Ct. Memo LEXIS 225">*233  initially agreed that he would be paid $ 20,000 per year.According to Beaufort Leaf's returns, the share of each of the partners in the net income of the partnership is as follows:           NET INCOME OF BEAUFORT LEAFYear     Gaskins      Pridgen      Roberts       Total____     _______      _______      _______       _____1988    $ 3,111.53    $ 3,111.53    $ 3,111.51    $ 9,334.571989     7,270.12     7,270.12     7,270.12     21,810.361990     15,734.87     15,734.87     15,734.86     47,204.601991     16,746.20     16,746.20     16,746.20     50,238.601991       10.11       10.11       10.11       30.33      _________     _________     _________    __________      42,872.83     42,872.83     42,872.80    128,618.46For 1991, the second of the 2 years in issue, the above net income, $ 50,238.60, is composed of ordinary income from trade or business activity of $ 46,952.60 and interest income of $ 3,286.Beaufort Leaf's returns report the following withdrawals and distributions:          WITHDRAWALS AND DISTRIBUTIONSYear     Gaskins   1999 Tax Ct. Memo LEXIS 225">*234     Pridgen      Roberts      Total____     _______      _______      _______      _____1988    $ 11,414.60    $ 10,000.00    $ 10,546.70    $ 31,961.301989     3,111.53     3,111.53     2,500.00     8,723.061990     7,270.12     19,270.12     22,220.15     48,760.391991     32,481.07     20,481.07     16,746.20     69,708.341992       -0-       -0-        -0-       -0-     __________    __________    __________    __________      54,277.32     52,862.72     52,013.05    159,153.09Set out below is a summary of the income and deductions reported on Beaufort Leaf's income tax returns for the years in issue, 1990 and 1991:                    1990           1991                    ____           ____Gross receipts or sales       $ 1,264,701       $ 2,849,451Cost of goods sold           1,123,852        2,661,781Gross profit               140,849         182,670Salaries and wages     $ 6,604         $ 10,638Guaranteed payments to partners        30,000    1999 Tax Ct. Memo LEXIS 225">*235        30,000Rent             2,652           6,000Interest          18,257          16,721Taxes            1,132           1,629Repairs           1,619           3,692Depreciation         1,079           1,186Other deductions      32,302          65,851Total deductions             93,644         135,717                    ______         _______Ordinary income (loss)          47,205          46,953Mr. Dawson, the partnership's accountant, computed the gross receipts of the partnership for Federal income tax purposes based on the aggregate deposits made to Beaufort Leaf's bank account, less certain deposits identified as repayments of loans or cash advances. Mr. Dawson computed Beaufort Leaf's cost of goods sold for 1990 and 1991 based on canceled checks and some accounting adjustments. His computation of the cost of goods for each year is as follows:                      1990       1991                      ____       ____Inventory at beginning of year     1999 Tax Ct. Memo LEXIS 225">*236   $ 199,602    $ 132,914Purchases                 1,057,163    2,713,562Other costs (wholesale commissions)     -0-       47,429                    _________    _________ Total                  1,256,765    2,893,905Inventory at end of year          132,914     227,124                    _________    _________Cost of goods sold            1,123,851    2,666,781Mr. Dawson kept a "journal" and "ledger" for Beaufort Leaf. He used bank statements, deposit slips, and checks from Beaufort Leaf's bank account to post entries to the journal. The record of these consolidated cases contains the journal for 1991. It does not include the journal for 1990 or the ledger for 1990 or 1991. The journal for 1991 shows that the sales and purchases reported for Federal income tax purposes on the partnership's 1991 return include the sales and purchases booked in the journal on a monthly basis, together with substantial yearend adjusting entries. Beaufort Leaf's journal for 1991 shows the following sales and purchases:   Month          Sales          Purchases 1999 Tax Ct. Memo LEXIS 225">*237    _____          _____          _________   1/91        $ 25,336.74        $ 64,244.28   2/91         39,716.55          1,461.20   3/91           -0-            283.00   4/91           781.78          4,242.75   5/91           -0-           4,813.52   6/91           -0-           4,563.52   7/91         116,348.66           -0-   8/91         184,228.86         77,757.50   9/91         195,899.47         133,243.66   10/91         609,273.97         82,953.54   11/91         349,861.40         214,793.94   12/91          7,215.00         501,845.96            ____________        ____________            1,528,662.43        1,090,202.87Adjusting entries    1,320,788.88        1,273,359.59Adjusting entry        -0-          350,000.00            ____________        ____________ Totals per journal   2,849,451.31        2,713,562.46Beaufort Leaf's return for 1991 reports sales1999 Tax Ct. Memo LEXIS 225">*238  and purchases in the same amounts; i.e., $ 2,849,451.31 and $ 2,713,562.46, respectively.Neither the journal for 1991 nor anything else in the record explains the nature of the "adjusting entries" shown in the journal increasing sales in the amount of $ 1,320,788.88 and increasing purchases in the amount of $ 1,273,359.59. The adjusting entry to purchases of $ 350,000 is labeled "Accts Payable--OK Leaf" without any other explanation.We note that Beaufort Leaf's journal for 1991 shows the following checks issued by the partnership to "HLRoberts" or "HLR":     Date         Check No.         Amount     ____         _________         ______     1/05/91          663          $ 946.00     2/26/91          681          1,500.00     3/18/91          690          1,000.00     3/21/91          693          2,600.00     4/05/91          702          1,500.00     4/05/91          705           300.00     4/10/91          707           200.00     4/15/91          708          1,200.00   1999 Tax Ct. Memo LEXIS 225">*239    4/16/91          709          5,000.00     4/19/91          712          2,000.00     4/19/91          713           500.00     4/19/91          714          1,777.96     4/26/91          720          7,500.00     5/01/91          727          1,000.00     5/03/91          734          1,054.43     5/03/91          735          1,000.00     5/13/91          742          1,000.00     5/23/91          744           500.00     5/29/91          749           599.77     5/29/91          750           500.00     6/07/91          762           500.00     6/07/91          764          2,200.00     6/17/91          768          1,375.00     6/17/91          769          1,200.00     6/25/91          772           300.00     7/02/91          775           500.00     7/16/91          783          1,200.00    1999 Tax Ct. Memo LEXIS 225">*240  7/18/91          786           900.00     7/24/91          797           300.00     8/01/91          808           500.00     8/07/91          818          3,500.00     8/07/91          820          1,200.00     8/16/91          833           500.00     8/29/91          850          1,500.00     8/29/91          851           150.00     9/19/91          874          1,500.00     9/25/91          878          5,835.00    10/03/91          887          5,000.00    10/14/91          904          4,580.00    10/18/91          907          2,520.00    10/24/91          917          1,120.00    10/25/91          920          1,500.00    10/31/91          921          13,500.00    11/07/91          934          1,500.00    11/18/91          938          1,000.00    11/20/91          940          2,000.00Total  87,558.161999 Tax Ct. Memo LEXIS 225">*241  The nature of the above payments is not described in the journal or elsewhere in the record of these cases.As mentioned above, Beaufort Leaf was in the business of buying and selling tobacco. The marketing of tobacco is subject to Government regulation under the Agricultural Adjustment Act of 1938, ch. 30, secs. 311-314, 52 Stat. 45, current version at 7 U.S.C. secs. 1311-1316 (1994), which includes a record-keeping mechanism that is designed to account for all tobacco sales and purchases. See generally, Cole v. USDA, 33 F.3d 1263">33 F.3d 1263, 33 F.3d 1263">1265-1266 (11th Cir. 1994). As part of that record-keeping mechanism, dealers, like Beaufort Leaf, are required to maintain a Dealer's Record on Form MQ-79 issued by the U.S. Department of Agriculture. The Form MQ-79 is a comprehensive record of each purchase and resale of tobacco including the date, the amount of tobacco, the identity of the seller or purchaser, and a running balance of the amount of tobacco on hand after each transaction. In the case of purchases or resales at auction, the Form MQ-79 lists the warehouse at which the purchase or sale took place and requires a warehouse representative1999 Tax Ct. Memo LEXIS 225">*242  to sign the dealer's Form MQ- 79.Dealers are required to file their Dealer's Record with the Agriculture Stabilization and Conservation Service (ASCS) on a weekly basis. The amount of tobacco marketed is controlled by a quota system that establishes an allotment of tobacco for each tobacco- producing farm. See 33 F.3d 1263">Cole v. USDA, supra. The marketing of tobacco in excess of a producer's allotment, so-called excess-quota tobacco, is subject to a penalty. See id.In the notices of deficiency issued to petitioners, respondent made two principal adjustments to Beaufort Leaf's returns for 1990 and 1991. First, respondent increased the gross sales reported by the partnership. The explanation of that adjustment in the subject notices of deficiency is as follows:     It is determined that the partnership had additional income   from tobacco sales for tax years 1990 and 1991 that was not   reported on the returns. It has been determined that tobacco   sales totaled $ 2,153,228.00 in 1990 and $ 3,904,027.00 in 1991   instead of the amounts of $ 1,264,700.00 and $ 2,849,451.00 as   shown on the returns. Accordingly, the partnership net income is1999 Tax Ct. Memo LEXIS 225">*243     increased $ 888,528.00 in 1990 and $ 1,054,576.00 in 1991. (See   attached.)The attachment referred to in the above explanation states that Beaufort Leaf's tobacco sales for 1990 were recomputed as follows:   (1) Sales of flue-cured tobacco          $ 1,225,535   (2) Sales of burley tobacco              853,015   (3) Sales of tobacco "not in the form"         74,678                            __________   TOTAL TOBACCO SALES FOR 1990             2,153,228   Claimed on return                  1,264,700                            __________   Net adjustment to gross income             888,528The parties have stipulated that the Forms MQ-79 filed on behalf of Beaufort Leaf for 1990 report aggregate sales of flue-cured tobacco of $ 1,225,535, the amount used by respondent in computing the partnership's sales. Similarly, the parties have stipulated that the Forms MQ-79, filed on behalf of Beaufort Leaf for 1990, report aggregate sales of burley tobacco of $ 853,015, the amount used by respondent in recomputing the partnership's sales. Thus, 1999 Tax Ct. Memo LEXIS 225">*244  the additional income from sales of flue-cured and burley tobacco computed by respondent for 1990 is based upon the sales reported in the Forms MQ-79 filed on behalf of Beaufort Leaf. Respondent determined the amount of unreported sales from so-called pickens tobacco on the basis of three receipts which state that Beaufort Leaf sold pickens tobacco to H.D. Pegram on June 5, 1990, in the aggregate amount of $ 74,678.The attachment referred to in the explanation accompanying the notices of deficiency also states that the unreported tobacco sales of Beaufort Leaf for 1991 were recomputed on the basis of "checks written to Beaufort Leaf Tobacco Company from auction sales of tobacco but not deposited to the business account" in the aggregate amount of $ 1,054,576 and not included in the gross income reported by the partnership for 1991. The record of this case contains a list of the undeposited checks showing the date of each auction sale, the name and location of the warehouse in which the sale took place, the amount of the check, and other information. Beaufort Leaf is listed as the dealer for each sale and was the payee of each undeposited check. All of the undeposited checks were endorsed1999 Tax Ct. Memo LEXIS 225">*245  by Mr. Roberts on behalf of Beaufort Leaf to other persons who endorsed the checks, so-called second endorsers. The following is a summary of the list of undeposited checks grouped according to the second endorsers:   Second Endorser            Total Received   _______________            ______________   A.H. Pruit                 $ 5,428   Albert E. Vaughan              16,442   Bobby W. Griffin              256,360   Cash N/A Flash               159,538   Classic Pawn Shop              45,444   Coastal Tobacco               19,758   Day & Nite, Inc.              235,590   Estel D. Simmons              72,232   Greenville TV                2,780   Harold Simmons               63,301   James L. Vaughan              151,134   Martin Van Lee               16,813   Pawn & Shoppe, Inc.             9,756                      _________    Total unreported tobacco     sales for 1991            1,054,576The list of undeposited checks, 1999 Tax Ct. Memo LEXIS 225">*246  described above, consists of 247 transactions. Of those transactions, 75 occurred at the Big Dixie Warehouse and 6 occurred at Bob Clark's Warehouse. These transactions are shown below: Date      Warehouse       Amount       Second Endorser ____      _________       ______       _______________09/11/91     Big Dixie     $ 3,533.25      Classic Pawn Shop09/17/91     Big Dixie      5,222.93      Bobby W. Griffin10/10/91     Big Dixie       928.97      Estel D. Simmons10/10/91     Big Dixie       251.07      Estel D. Simmons10/10/91     Big Dixie      4,056.35      Day & Nite, Inc.10/10/91     Big Dixie      7,680.98      Day & Nite, Inc.10/10/91     Big Dixie      5,657.07      Day & Nite, Inc.10/10/91     Big Dixie      5,553.79      Day & Nite, Inc.10/10/91     Big Dixie      5,053.79      Day & Nite, Inc.10/10/91     Big Dixie      3,475.33      Estel D. Simmons10/10/91     Big Dixie      3,214.88      Day & Nite, Inc.10/10/91     Big Dixie      2,856.89      Day & Nite, Inc.10/10/91     Big Dixie      3,310.14      Estel1999 Tax Ct. Memo LEXIS 225">*247  D. Simmons10/10/91     Big Dixie      4,340.97      Day & Nite, Inc.10/10/91     Big Dixie      3,679.90      Estel D. Simmons10/10/91     Big Dixie      6,311.83      Estel D. Simmons10/10/91     Big Dixie      1,061.84      Harold Simmons10/10/91     Big Dixie      4,664.55      Harold Simmons10/10/91     Big Dixie      2,209.76      Harold Simmons10/14/91     Big Dixie      1,794.68      Cash N/A Flash10/14/91     Big Dixie      1,671.69      Cash N/A Flash10/14/91     Big Dixie      2,779.71      Greenville TV10/16/91     Big Dixie      5,250.06      Cash N/A Flash10/16/91     Big Dixie      6,109.56      Cash N/A Flash10/16/91     Big Dixie      2,481.27      Cash N/A Flash10/16/91     Big Dixie      6,437.98      Cash N/A Flash10/16/91     Big Dixie      4,895.64      Cash N/A Flash10/16/91     Big Dixie      2,606.77      Day & Nite, Inc.10/16/91     Big Dixie      2,296.31      Cash N/A Flash10/16/91     Big Dixie      6,400.79      Cash N/A Flash10/17/91     Big Dixie      3,708.50      Cash N/A1999 Tax Ct. Memo LEXIS 225">*248  Flash10/17/91     Big Dixie      5,677.61      Cash N/A Flash10/17/91     Big Dixie      6,568.49      Cash N/A Flash10/17/91     Big Dixie      5,947.32      Cash N/A Flash10/17/91     Big Dixie      5,281.77      Cash N/A Flash10/17/91     Big Dixie      5,495.07      Cash N/A Flash10/17/91     Big Dixie      4,974.55      Cash N/A Flash10/17/91     Big Dixie      5,062.22      Cash N/A Flash10/17/91     Big Dixie      5,166.51      Cash N/A Flash10/17/91     Big Dixie      5,428.28      A.H. Pruit10/17/91     Big Dixie      7,189.61      Day & Nite, Inc.10/17/91     Big Dixie       216.78      Day & Nite, Inc.10/21/91     Big Dixie      6,723.67      Cash N/A Flash10/21/91     Big Dixie      3,079.56      Cash N/A Flash10/21/91     Big Dixie      1,081.65      Cash N/A Flash10/21/91     Big Dixie      1,943.41      Cash N/A Flash10/21/91     Big Dixie      2,959.36      Cash N/A Flash10/21/91     Big Dixie      4,231.81      Cash N/A Flash10/21/91     Big Dixie      3,495.18      Cash N/A Flash10/21/911999 Tax Ct. Memo LEXIS 225">*249      Big Dixie      5,101.46      Cash N/A Flash10/21/91     Big Dixie      5,910.94      Cash N/A Flash10/21/91     Big Dixie      6,367.52      Cash N/A Flash10/21/91     Big Dixie       301.81      Cash N/A Flash10/21/91     Big Dixie      6,549.17      Cash N/A Flash10/21/91     Big Dixie      7,190.33      Cash N/A Flash10/21/91     Big Dixie      6,726.40      Cash N/A Flash10/21/91     Big Dixie      6,725.89      Cash N/A Flash10/22/91     Big Dixie      1,119.27      Harold Simmons10/22/91     Big Dixie      6,531.59      Estel D. Simmons10/22/91     Big Dixie      2,651.59      Estel D. Simmons10/22/91     Big Dixie      3,319.38      Estel D. Simmons10/22/91     Big Dixie      4,698.06      Estel D. Simmons10/22/91     Big Dixie      4,858.18      Estel D. Simmons10/22/91     Big Dixie      4,258.52      Harold Simmons10/22/91     Big Dixie      6,601.78      Estel D. Simmons10/22/91     Big Dixie      4,113.32      Harold Simmons10/22/91     Big Dixie      3,000.10      Pawn & Shoppe10/22/91 1999 Tax Ct. Memo LEXIS 225">*250      Big Dixie      5,605.59      Harold Simmons10/22/91     Big Dixie      4,561.06      Harold Simmons10/22/91     Big Dixie      4,530.43      Harold Simmons10/22/91     Big Dixie       998.80      Harold Simmons10/23/91     Big Dixie       927.19      Pawn & Shoppe10/23/91     Big Dixie      4,132.13      Harold Simmons10/23/91     Big Dixie       802.81      Estel D. Simmons10/23/91     Big Dixie      5,828.91      Pawn & Shoppe                ___________               $ 313,432.3310/07/91     Bob Clark's    $ 7,155.92      Harold Simmons10/07/91     Bob Clark's     3,673.92      Estel D. Simmons10/21/91     Bob Clark's     6,926.55      Estel D. Simmons10/07/91     Bob Clark's     7,286.44      Estel D. Simmons10/07/91     Bob Clark's     6,980.13      Harold Simmons10/21/91     Bob Clark's     2,439.72      Cash N/A Flash                ___________                $ 34,462.07Mr. Gaskins purchased the Big Dixie Warehouse in 1990. Set out below is a summary of the transactions reported1999 Tax Ct. Memo LEXIS 225">*251  on the Forms MQ- 79 filed on behalf of Beaufort Leaf for 1990 and 1991 that took place at the Big Dixie Warehouse:        Purchases       Resales     __________________ ____________________ Date   Pounds   Dollars   Pounds   Dollars     Executed By ____   ______   _______   ______   _______     ___________9/12/90   --     -0-     4,017   $ 7,017    Linda Mercer9/18/90   --     -0-     3,772    6,619    Linda Mercer9/24/90   --     -0-    11,145   17,063    Mary D. Lancaster9/25/90   --     -0-     7,866   13,841    Mary D. Lancaster9/26/90   --     -0-    10,465   18,105    Mary D. Lancaster9/27/90   --     -0-     2,811    5,005    Mary D. Lancaster10/01/90   --     -0-     9,721   17,374    Mary D. Lancaster10/02/90   --     -0-    11,033   19,509    Mary D. Lancaster10/03/90   --     -0-     5,881   10,138    Mary D. Lancaster10/04/90   --     -0-     7,723   13,284    Mary D. Lancaster10/09/90   --     -0-    11,006   19,368    Mary D. Lancaster10/09/90   --     -0-    18,037   22,210    Dewey Gaskins10/10/90   --     -0-     5,287    8,9611999 Tax Ct. Memo LEXIS 225">*252     Mary D. Lancaster10/15/90   --     -0-    15,412   26,632    Mary D. Lancaster10/16/90   --     -0-    16,730   28,080    Mary D. Lancaster10/17/90   --     -0-     1,529    2,373    Mary D. Lancaster10/18/90   --     -0-     6,167    9,606    Mary D. Lancaster10/22/90   --     -0-     7,149   12,137    Mary D. Lancaster10/23/90   --     -0-    19,525   29,897    Mary D. Lancaster10/24/90   --     -0-     7,896   12,532    Mary D. Lancaster10/25/90   --     -0-     8,294   12,804    Mary D. Lancaster10/29/90   --     -0-    19,184   28,528    (No Signature)10/30/90   --     -0-    11,500   17,730    (No Signature)10/31/90   6,784  $ 6,784     --     -0-    Dewey Gaskins8/01/91   --     -0-     6,784    6,784    Dewey Gaskins8/01/91   --     -0-    27,421   31,534    Dewey Gaskins9/11/91   --     -0-     3,447    6,157    Dewey Gaskins9/17/91   --     -0-     4,588    8,402    Dewey Gaskins9/19/91   --     -0-     4,517    8,176    Dewey Gaskins10/10/91   --     -0-    40,477   72,727    Dewey Gaskins10/15/91   --     -0-    39,632  1999 Tax Ct. Memo LEXIS 225">*253   69,381    Mary D. Lancaster10/16/91   --     -0-    38,125   66,787    Mary D. Lancaster10/17/91   --     -0-    39,421   69,278    Mary D. Lancaster10/21/91   --     -0-    40,135   70,572    Dewey Gaskins10/22/91   --     -0-    39,694   67,379    Dewey Gaskins10/23/91   --     -0-    28,387   47,586    Dewey Gaskins     ______   ______   _______   _______      6,784   6,784   534,778   883,576As shown above, in 1990 and 1991, Mr. Dewey Gaskins, acting on behalf of Big Dixie Warehouse, executed 11 of the Forms MQ-79 filed on behalf of Beaufort Leaf to document transactions at the Big Dixie Warehouse.Mr. Gaskins also had a relationship with the Big Burley Warehouse, but the record does not state the precise nature of that relationship. The Forms MQ-79 filed on behalf of Beaufort Leaf report the following transactions at the Big Burley Warehouse:              Resales           ___________________   Date        Pounds    Dollars      Executed By   ____        ______    _______      ___________  1/08/90        5,922    $ 9,890     Jennie E. Tingle  1/09/901999 Tax Ct. Memo LEXIS 225">*254        14,910     24,900     Jennie E. Tingle  1/10/90       11,168     18,710     Dewey Gaskins  1/11/90        6,504     10,907     Dewey Gaskins  1/16/90       20,211     33,788     Jennie E. Tingle  1/17/90         290      484     Jennie E. Tingle  1/22/90        3,702     6,193     Dewey Gaskins  1/23/90        4,218     7,044     Dewey Gaskins  1/24/90         602     1,014     Dewey Gaskins  1/25/90        4,550     7,652     Dewey Gaskins  1/29/90        7,306     12,263     Dewey Gaskins  1/30/90        6,212     10,418     Dewey Gaskins 12/06/90       40,136     70,490     Dewey Gaskins 12/12/90       40,265     70,308     Jennie E. Tingle 12/13/90         440      770     (No Signature)  1/30/91       12,030     21,293     Dewey Gaskins           _______    _______           178,466    306,124As shown above, Mr. Gaskins, acting on behalf of Big Burley Warehouse, executed 10 of the Forms MQ-79 filed by Beaufort Leaf during 1990 and 1991 to document transactions1999 Tax Ct. Memo LEXIS 225">*255  at the Big Burley Warehouse.It appears that during 1990 and 1991, Mr. Mark Pridgen had a relationship with Bob Clark's Warehouse, but the record does not describe the precise nature of that relationship. The Forms MQ-79 filed on behalf of Beaufort Leaf for 1990 and 1991 report the following transactions at Bob Clark's Warehouse:        Purchases       Resales     __________________ ____________________ Date   Pounds   Dollars   Pounds   Dollars     Executed By ____   ______   _______   ______   _______     ___________7/30/90  42,362  $ 61,425    --     -0-     Mark Pridgen7/31/90   --     -0-     4,474   $ 6,899    Mark Pridgen8/02/90   --     -0-    14,515   22,217    Mark Pridgen8/03/90  12,325   17,748    --     -0-     Mark Pridgen8/22/90   --     -0-     7,713   11,630    Louise W. Broome8/27/90   --     -0-     2,649    4,550    Louise W. Broome8/28/90   --     -0-     5,608    9,594    Louise W. Broome8/29/90   --     -0-     1,998    3,304    Louise W. Broome8/30/90   --     -0-     3,314    5,704    Louise W. Broome9/06/90   --     -0-     7,679   13,100 1999 Tax Ct. Memo LEXIS 225">*256     Louise W. Broome9/10/90   --     -0-     2,042    3,257    Louise W. Broome9/18/90   --     -0-     6,279   11,009    Louise W. Broome9/25/90   --     -0-     6,271   10,945    Louise W. Broome10/04/90   --     -0-    25,297   37,440    Mark Pridgen10/24/90   --     -0-     2,836    3,511    Mark D. Pridgen10/29/90   --     -0-     5,717    6,509    Mark D. Pridgen7/15/91   --     -0-    63,025   75,630    Louise W. Broome9/02/91  63,182   91,614     --     -0-    Louise W. Broome9/24/91   --     -0-    63,498   88,262    Mark Pridgen10/07/91   --     -0-    18,146   33,034    Louise W. Broome10/09/91   --     -0-     2,973    4,402    Louise W. Broome10/21/91   --     -0-     1,650    2,521    Louise W. Broome     _______   _______   _______   _______     117,869   170,787   245,684   353,519As shown above, during 1990 and 1991, Mr. Mark Pridgen, acting on behalf of Bob Clark's Warehouse, executed eight of the Forms MQ-79 filed on behalf of Beaufort Leaf to document transactions at Bob Clark's Warehouse.It is not evident from the record of this case whether any of 1999 Tax Ct. Memo LEXIS 225">*257  the 247 transactions set out on the list of undeposited checks, including the 81 transactions at the Big Dixie Warehouse and Bob Clark's Warehouse, were reported in any of the Forms MQ-79 filed on behalf of Beaufort Leaf.The second adjustment to Beaufort Leaf's 1990 and 1991 returns that was made by respondent in the subject notices of deficiency is the disallowance of certain purchases included as cost of goods. The explanation of that adjustment in the notices of deficiency is as follows:     The amount of $ 1,057,163.00 and $ 2,173,562.00 [sic] shown   on your respective 1990 and 1991 tax returns as tobacco   purchases is reduced by $ 429,421.00 and $ 1,173,203.00 because it   has not been established that any amount more than $ 627,742.00   and $ 1,000,359.00 was for an ordinary and necessary business   expense, or was expended for the purpose designated. Therefore,   the partnership income is increased $ 429,421.00 in 1990 and  $ 1,173,203.00 in 1991.We note that Beaufort Leaf's 1991 return includes purchases of $ 2,713,562.46 in computing cost of goods sold, rather than "$ 2,173,562.00", as stated in the notices of deficiency. Set out below is a1999 Tax Ct. Memo LEXIS 225">*258  list of the date, check number, payee, and amount of each check disallowed by respondent:           1990 DISALLOWED PURCHASES  Date     Check No.        Payee          Amount  ____     _________        _____          ______1/17/90     2777      Blue Ridge Tobacco     $ 9,500.001/17/90     2778      Blue Ridge Tobacco      9,500.001/21/90     2782      Blue Ridge Tobacco      9,500.001/21/90     2783      Blue Ridge Tobacco      9,500.001/21/90     2785      Blue Ridge Tobacco      9,500.001/21/90     2786      Blue Ridge Tobacco      9,500.001/21/90     2787      Blue Ridge Tobacco      9,500.001/21/90     2788      Blue Ridge Tobacco      7,717.701/31/90     2797      Blue Ridge Tobacco      7,000.001/31/90     2798      Blue Ridge Tobacco      7,012.141/31/90     2799      Blue Ridge Tobacco      5,100.001/31/90     2800      Blue Ridge Tobacco      4,710.922/28/90     2810      James V. Wells        8,000.002/28/90     2811      Blue Ridge Tobacco      8,000.002/28/90     28121999 Tax Ct. Memo LEXIS 225">*259       Blue Ridge Tobacco      8,000.002/28/90     2813      Blue Ridge Tobacco      7,908.006/29/90     2844      Blue Ridge Tobacco     93,000.009/24/90      545      Blue Ridge Tobacco      1,700.0011/22/90      586      Blue Ridge Tobacco      8,000.0011/22/90      587      Blue Ridge Tobacco      2,021.2512/19/90      643      James Vaughn         9,000.0012/19/90      644      Albert Vaughn        9,000.0010/03/90      553      Coastal Tobacco       7,000.0010/04/90      554      Coastal Tobacco       8,000.0010/05/90      555      Coastal Tobacco       9,500.0010/05/90      558      Coastal Tobacco       8,746.7210/09/90      566      Coastal Tobacco       9,000.0010/10/90      567      Coastal Tobacco       8,000.0010/17/90      577      Coastal Tobacco       9,000.0010/17/90      578      Coastal Tobacco       9,000.0010/17/90      579      Coastal Tobacco       9,000.0010/25/90      591      Coastal Tobacco       9,500.0012/04/90      635      Graham Day      1999 Tax Ct. Memo LEXIS 225">*260     54,004.0812/14/90      640      Tammy Short         9,000.0012/14/90      639      Dennis Hawley        9,000.0012/21/90      646      Dennis Hawley        9,000.0012/26/90      652      Dennis Hawley        9,000.00                           __________                           429,420.81           1991 DISALLOWED PURCHASES  Date     Check No.        Payee          Amount  ____     _________        _____          ______8/22/92      836      Coastal Tobacco        $ 9,8008/22/91      837      Coastal Tobacco         9,8008/23/91      838      Coastal Tobacco         3,7008/28/91      847      Coastal Tobacco         9,8008/03/91      854      Cash              9,0008/03/91      855      Cash              9,0009/03/91      856      Coastal Tobacco          5719/30/91      881      Martin Lee           9,50010/01/91      882      Martin Lee           9,50010/01/91      883     1999 Tax Ct. Memo LEXIS 225">*261  Martin Lee           4,99110/09/91      897      Martin Lee           9,80010/09/91      898      Martin Lee           9,80010/10/91      899      Martin Lee           8,00010/18/91      910      Martin Lee           9,80010/18/91      911      Martin Lee           9,80010/18/91      912      Martin Lee           9,80010/18/91      913      Martin Lee           5,54111/20/91      939      Okay Leaf           200,00012/19/91      953      Okay Leaf           200,00012/31/91      963      Okay Leaf           150,00012/12/91      954      Coastal Tobacco        35,00012/31/91      962      C.L. Gurganus Whse      100,000                             _______                             823,203Accounts payable -- "OK Leaf"               350,000                            _________                            1,173,203On his income tax returns for 1990 and 1991, each petitioner1999 Tax Ct. Memo LEXIS 225">*262  included one-third of the net income reported by Beaufort Leaf. Mr. Pridgen's returns were prepared by the certified public accounting firm of Anthony & Tabb or its predecessor. Mr. Gaskins' returns were prepared by a certified public accountant, Mr. Frank Harper.The two adjustments that respondent made to Beaufort Leaf's 1990 and 1991 returns, described above, increased the partnership's income and increased each partner's one-third distributive share of the partnership's income by the following amounts:                    1990       1991                    ____       ____Amount reported             $ 47,205     $ 46,953Unreported gross receipts        888,528    1,054,576Disallowed purchases           429,421    1,173,203                  __________    __________Adjusted income            1,364,154    2,274,732One-third share             455,051     758,244Less: amounts reported          15,735      15,651                  __________    __________Increase in partner's share       439,316     742,593Based on1999 Tax Ct. Memo LEXIS 225">*263  the adjustments to the partnership's income, respondent issued a notice of deficiency to each petitioner adjusting his individual income as follows:   Mr. Pridgen             1990       1991   ___________             ____       ____Share of partnership income      $ 439,316    $ 741,498Self-employment tax deduction        (461)     (1,027)Deduction for exemptions                 4,300                  __________    __________ Total adjustments           438,855     744,771Reported income              56,863      64,890                  __________    __________Adjusted income             495,718     809,661  Mr. Gaskins              1990       1991  ___________              ____       ____Share of partnership income      $ 439,316    $ 742,593Self-employment tax deduction       (1,635)     (4,971)Deduction for exemptions                 8,600                  __________    __________Total adjustments            437,681     746,2221999 Tax Ct. Memo LEXIS 225">*264  Reported income              27,753      42,626                  __________    __________Adjusted income             465,434     788,848OPINIONUNREPORTED SALESThe first issue for decision is whether unreported income in the amount of $ 888,528 in 1990 and $ 1,054,576 in 1991 should be included in Beaufort Leaf's gross receipts, as determined by respondent. If Beaufort Leaf's gross receipts are increased as determined by respondent, then a one-third distributive share of the additional partnership income attributable to this adjustment is includable in the income of each petitioner. See sec. 702(a); United States v. Basye, 410 U.S. 441">410 U.S. 441, 410 U.S. 441">453-454, 35 L. Ed. 2d 412">35 L. Ed. 2d 412, 93 S. Ct. 1080">93 S. Ct. 1080 (1973).Petitioners advance two arguments in support of their position that respondent erred by increasing Beaufort Leaf's gross receipts. First, they argue that the sales that are the source of the unreported income were outside the scope of the business of Beaufort Leaf. Accordingly, petitioners argue that the unreported income is the income of Mr. Roberts, not the income of Beaufort Leaf, and there is no basis to assess tax on the unreported income against petitioners1999 Tax Ct. Memo LEXIS 225">*265  as partners of Beaufort Leaf. In support of this argument, petitioners assert that the unreported income was derived from "illegal sales of nonexistent or over-quota tobacco * * * contrary to Federal law" and were made by Mr. Roberts without the knowledge, consent, or ratification of petitioners.According to petitioners, under North Carolina partnership law, activities are outside the scope of the partnership unless expressly authorized by the partnership agreement or the other partners. See, e.g., Shelton v. Fairley, 86 N.C. App. 147">86 N.C. App. 147, 356 S.E.2d 917">356 S.E.2d 917 (N.C. Ct. App. 1987); Investors Title Ins. Co. v. Herzig, 83 N.C. App. 392">83 N.C. App. 392, 350 S.E.2d 160">350 S.E.2d 160 (N.C. Ct. App. 1986), revd. on other grounds 320 N.C. 770">320 N.C. 770, 360 S.E.2d 786">360 S.E.2d 786 (N.C. 1987); see also Reed Coal Co. v. Fain, 171 N.C. 646">171 N.C. 646, 89 S.E. 29">89 S.E. 29 (N.C. 1916). Petitioners assert that Beaufort Leaf's oral partnership agreement did not authorize Mr. Roberts to engage in such illegal activities. Thus, petitioners argue that the income realized is not includable in Beaufort Leaf's gross receipts.In further support of this argument, petitioners assert that neither Beaufort Leaf nor petitioners knew of or received1999 Tax Ct. Memo LEXIS 225">*266  any economic benefit from Mr. Roberts' illegal sales of tobacco, and, therefore, only Mr. Roberts is subject to tax on the income from such sales. Petitioners rely on Commissioner v. Smith, 285 F.2d 91">285 F.2d 91 (5th Cir. 1960), affg.  Griffin v. Commissioner, T.C. Memo 1958-210. The taxpayer in that case had received "over-ceiling payments" from the purchasers of bottled whiskies. See 285 F.2d 91">id. at 92. The whiskies were owned by partnerships of which the taxpayer was a partner. See id. The Court of Appeals affirmed the finding of this Court that the "overceiling payments" were income to the taxpayer and not to the partnerships. See 285 F.2d 91">id. at 98. Petitioners argue that the Court of Appeals "ruled that there was no evidence suggesting that the partnership agreement in question 'comprehended' illegal transactions or 'entitled' the other partners 'to part of the illegal payments * * *'". (Petitioners' brief quoting from Commissioner v. Smith, supra 285 F.2d 91">285 F.2d at 97.)Second, petitioners argue that, even if the Court finds that the unreported income was partnership income, it was derived by Mr. Roberts from illegal activities, involving the "sale of excess1999 Tax Ct. Memo LEXIS 225">*267  or non-existent quota tobacco", and respondent has failed "to establish any foundation linking petitioners with the underlying illegal activity." Petitioners cite Williams v. Commissioner, 999 F.2d 760">999 F.2d 760, 999 F.2d 760">764 (4th Cir. 1993), affg. T.C. Memo 1992-153; Portillo v. Commissioner, 932 F.2d 1128">932 F.2d 1128 (5th Cir. 1991), affg. in part and revg. in part T.C. Memo 1990-68; Petzoldt v. Commissioner, 92 T.C. 661">92 T.C. 661 (1989); and Tokarski v. Commissioner, 87 T.C. 74">87 T.C. 74 (1986). Petitioners acknowledge that there is evidence linking the unreported income to Beaufort Leaf, such as the fact that each of the undeposited checks for 1991 was made payable to Beaufort Leaf. Nevertheless, petitioners argue that such evidence is not sufficient to satisfy respondent's burden of proof under the cases cited above. According to petitioners, respondent must introduce "significantly more compelling evidence, such as proof that the Petitioners received the proceeds of Robert's [sic] over-quota transactions."At the outset, we note that there is evidence that, during1999 Tax Ct. Memo LEXIS 225">*268  the years in issue, Mr. Roberts joined a group of persons headed by Mr. James V. Wells to engage in a fraudulent scheme to acquire and sell excess-quota tobacco. In paragraph 5(d) of both petitions, petitioners describe the scheme as a widespread scheme, involving Mr. Roberts and "numerous other bogus dealers and/or legitimate dealers". Paragraph 5(d) of the subject petitions states as follows:     In 1990 and 1991, the managing partner entered into an   illegal scheme to fraudulently use Dealer Books, MQ-79, of the   Company for his own personal gain. Roberts became involved with   numerous other bogus dealers and/or legitimate dealers to   defraud the U.S. Department of Agriculture by selling excess   quota or nonexistent quota. The bogus dealers and/or legitimate   dealers conspired to create nonexistent quota by entering false   purchases on the bogus dealer's MQ-79 dealer books. The   participants then secured tobacco inventory directly from   farmers who had produced excess farm quota. These were cash   transactions. With the actual receipt of new tobacco and a MQ-79   dealer book reflecting legitimate purchases the various bogus  1999 Tax Ct. Memo LEXIS 225">*269  and legitimate dealers were able to sell excess quota and profit   there from [sic].Respondent admitted that Mr. Roberts engaged in the above "illegal scheme" but denied that he did so "for his own personal gain."In order to describe the scheme further, petitioner introduced into evidence the report of an agent of the Internal Revenue Service who audited Mr. Wells' returns for 1988 through 1991. That report describes the scheme as follows:   Wells is believed to be a key figure in a fraudulent scheme   within the tobacco industry. The source of the omitted income is   excess tobacco which is sold via a tobacco dealer card. Because   tobacco is a highly regulated commodity, the sales of excess   tobacco (without imposition of penalty on the farmer's   subsequent year quota) are illegal. Wells uses individuals and   corporate entities as nominees and/or alter egos. No one in the   conspiracy reports the receipts. Essentially, the fraud is   perpetrated by fictitious purchases on the tobacco dealer's   weekly report to the Agricultural Stabilization and Conservation   Service (ASCS). Against these purchases the dealer is allowed   sales at auction1999 Tax Ct. Memo LEXIS 225">*270  of an equal number of pounds. In actuality, it   is the excess tobacco purchased from farmers that is sold on the   dealer's card.   Wells used individuals by recruiting people to register with   ASCS as a dealer in tobacco, which allowed them to purchase and   resell tobacco. Primarily, purchases were from individuals and   resales were primarily at warehouses, but a few exceptions were   entered. When the tobacco is sold at the warehouses, the checks   are written to the dealer who is the owner of record. The   dealers endorse the checks and turn them over to Wells or one of   his nominees/alter egos who handled his money. Often they would   cash the checks and turn the cash over to Wells or one of his   moneymen. Alternatively, the check will be deposited into a   nominee/alter ego corporate account, or the warehouse check may   be endorsed over to a co-conspirator, or used directly to   purchase an asset.   The dealers are required to file with ASCS weekly reports of all   their purchases and sales of tobacco, form MQ-79. Wells and his   inner circle of associates actually prepared and submitted to   ASCS the false MQ-79's. 1999 Tax Ct. Memo LEXIS 225">*271  A few of the individuals in the   conspiracy were Bud Howard, Albert Earl Vaughan, James Brake,   Rodney Howard, Graham Lee Day, Milton J. Elder, Ronald Bowen,   Harvey Moore and Harry Lee Roberts.               * * * * * * *   In addition, other individuals and their controlled corporations   were used to launder money and/or hold assets. These include:     Harry Lee Roberts and Beaufort Leaf Tobacco Dennis Hawley     and Coastal Tobacco Co. C. L. Gurganus and Gurganus Tobacco     Warehouse H. D. Pegram and Pegram Tobacco Co.According to the audit report involving Mr. Wells, various checks made payable to Beaufort Leaf were deposited into accounts controlled by Mr. James V. Wells. Set out below are the dates, amounts, and payors of these checks:CENTURA (PLANTERS) BANK ACCOUNT: Date      Amount       Payor         Payee ____      ______       _____         _____9/26/91    $ 7,265.90   Farmers Whse       Beaufort Leaf9/26/91     5,424.50   Farmers Whse       Beaufort Leaf9/24/91     6,685.14   New Independent Whse   Beaufort Leaf9/24/91     4,553.33   New Independent1999 Tax Ct. Memo LEXIS 225">*272  Whse   Beaufort Leaf9/23/91     5,043.50   New Independent Whse   Beaufort Leaf9/23/91     6,957.42   New Independent Whse   Beaufort Leaf9/23/91     4,982.96   New Independent Whse   Beaufort Leaf9/23/91     4,892.93   New Independent Whse   Beaufort Leaf9/25/91     6,391.56   New Independent Whse   Beaufort Leaf9/25/91     5,820.56   New Independent Whse   Beaufort Leaf9/26/91     2,785.54   New Independent Whse   Beaufort Leaf9/25/91     6,623.22   Farmers Whse       Beaufort Leaf9/23/91     6,648.22   Farmers Whse       Beaufort Leaf9/23/91     5,686.96   Farmers Whse       Beaufort Leaf9/24/91     6,422.40   Farmers Whse       Beaufort Leaf       _________       86,184.14BB & T ACCOUNT: Date      Amount      Payor          Payee ____      ______      _____          _____10/23/91    $ 5,567.10   Big Dixie Whse      Beaufort Leaf10/23/91     2,514.26   Big Dixie Whse      Beaufort Leaf10/23/91     6,549.91   Big Dixie Whse      Beaufort Leaf10/23/91     6,682.55   Big Dixie Whse      Beaufort Leaf10/23/91   1999 Tax Ct. Memo LEXIS 225">*273    2,828.85   Big Dixie Whse      Beaufort Leaf10/23/91     3,609.56   Big Dixie Whse      Beaufort Leaf10/23/91     5,404.87   Big Dixie Whse      Beaufort Leaf10/23/91     5,333.97   Big Dixie Whse      Beaufort Leaf10/23/91     4,347.10   Big Dixie Whse      Beaufort Leaf       __________       42,838.17FIRST CITIZENS BANK ACCOUNT: Date      Amount      Payor           Payee ____      ______      _____           _____11/06/91    $ 4,974.55   Big Dixie Whse      Beaufort Leaf11/06/91     6,568.49   Big Dixie Whse      Beaufort Leaf11/06/91     3,079.56   Big Dixie Whse      Beaufort Leaf11/06/91     6,726.40   Big Dixie Whse      Beaufort Leaf11/06/91     5,101.46   Big Dixie Whse      Beaufort Leaf11/06/91     1,081.65   Big Dixie Whse      Beaufort Leaf11/06/91      301.81   Big Dixie Whse      Beaufort Leaf11/06/91     6,723.67   Big Dixie Whse      Beaufort Leaf11/06/91     3,495.18   Big Dixie Whse      Beaufort Leaf11/06/91     4,231.81   Big Dixie Whse      Beaufort Leaf11/06/91     5,910.94   Big Dixie1999 Tax Ct. Memo LEXIS 225">*274  Whse      Beaufort Leaf11/06/91     6,367.52   Big Dixie Whse      Beaufort Leaf11/06/91     2,959.36   Big Dixie Whse      Beaufort Leaf11/06/91     7,190.33   Big Dixie Whse      Beaufort Leaf11/06/91     6,725.89   Big Dixie Whse      Beaufort Leaf11/06/91     1,943.41   Big Dixie Whse      Beaufort Leaf11/06/91     6,549.17   Big Dixie Whse      Beaufort Leaf11/06/91     3,708.50   Big Dixie Whse      Beaufort Leaf11/06/91     1,671.69   Big Dixie Whse      Beaufort Leaf11/06/91     1,794.68   Big Dixie Whse      Beaufort Leaf11/06/91     5,166.51   Big Dixie Whse      Beaufort Leaf11/06/91     2,296.31   Big Dixie Whse      Beaufort Leaf11/06/91     5,062.22   Big Dixie Whse      Beaufort Leaf11/06/91     5,495.07   Big Dixie Whse      Beaufort Leaf11/06/91     4,895.64   Big Dixie Whse      Beaufort Leaf11/06/91     6,437.98   Big Dixie Whse      Beaufort Leaf11/06/91     5,250.06   Big Dixie Whse      Beaufort Leaf11/06/91     2,481.27   Big Dixie Whse      Beaufort Leaf11/06/91     6,109.56   Big Dixie Whse      Beaufort Leaf11/06/911999 Tax Ct. Memo LEXIS 225">*275      2,439.72   Bob Clark's Whse     Beaufort Leaf11/07/91     3,490.26   New Greenville      Beaufort Leaf11/07/91     5,947.32   Big Dixie Whse      Beaufort Leaf11/07/91     6,400.79   Big Dixie Whse      Beaufort Leaf11/07/91     5,281.77   Big Dixie Whse      Beaufort Leaf11/07/91     5,677.61   Big Dixie Whse      Beaufort Leaf       __________       159,538.16Respondent concedes that the above checks, totaling $ 288,560.47, were included in Beaufort Leaf's unreported income for 1991, as determined by respondent. There is no evidence that any other unreported income was related in any way to the scheme to sell excess-quota tobacco.As a preliminary matter, several comments about the facts of these cases are in order. First, we disagree with petitioners' assertion that the source of all of the unreported income at issue was the "illegal scheme engineered by Harry Lee Roberts whereby Roberts was engaged in numerous sales of over-quota tobacco, in violation of federal law and Department of Agriculture regulations." Petitioners assert that respondent's answer acknowledged that the unreported sales of tobacco were "the direct1999 Tax Ct. Memo LEXIS 225">*276  result" of the illegal scheme. Contrary to petitioners' assertion, respondent's answer admitted only that Mr. Roberts engaged in such a scheme, but it did not admit that the scheme was the source of all or any of the unreported income determined in these cases. As discussed above, there is no evidence that any of the unreported income in 1990 or 1991 was related in any way to the scheme, except for $ 288,560 in 1991 that was deposited into accounts controlled by Mr. Wells. Even as to this amount, there is nothing in the audit report involving Mr. Wells which suggests that such amount is not includable in Beaufort Leaf's gross income in 1991. In passing, we note that petitioners do not claim that such amount is a deductible expense in 1991.Second, we do not credit the testimony of each petitioner suggesting that he did not know of or approve Beaufort Leaf's participation in the scheme. Both petitioners owned or had a financial interest in tobacco warehouses and were actively engaged in the tobacco business. They are knowledgeable and sophisticated members of the relatively small community of persons who engage in that business. We do not believe that Mr. Roberts' activities in furtherance1999 Tax Ct. Memo LEXIS 225">*277  of the scheme that petitioners describe as widespread, could have escaped the attention of both petitioners. Indeed, we note that some of the unreported sales were made at the warehouses in which petitioners had an interest. Furthermore, we do not accept the testimony of each petitioner that he agreed to finance the operation of Beaufort Leaf by cosigning a note for $ 300,000 and he took no action to supervise those operations by reviewing the partnership's Forms MQ-79 or taking any other action.Third, we do not accept petitioners' assertion that Beaufort Leaf or petitioners realized no proceeds of, or economic benefit from, Beaufort Leaf's participation in the scheme. The testimony of both petitioners focuses on the list of unreported checks for 1991. Each petitioner testified that he never received the proceeds or economic benefit from those specific checks. Each petitioner also testified that he did not receive moneys or economic benefit from Beaufort Leaf other than what is shown on his income tax returns. However, the testimony of both petitioners leaves open the possibility that moneys or economic benefit was received by other persons or entities related to them. It also leaves1999 Tax Ct. Memo LEXIS 225">*278  open the possibility that moneys or economic benefit was received from someone other than Beaufort Leaf.In sum, petitioners have not established the facts underlying their argument that the unreported sales determined by respondent were outside the scope of the business of Beaufort Leaf or that petitioners did not know of or receive any economic benefit from the unreported sales of tobacco.We also disagree with petitioners' argument that respondent failed to meet the Government's burden of establishing a link between petitioners and the underlying illegal activity. While it is by no means clear that respondent bears such a burden in this case, there is ample evidence that Beaufort Leaf received the unreported income determined by respondent for 1990 and 1991. Respondent determined the unreported income for 1990 on the basis of the Forms MQ-79 filed by the partnership for that year. Respondent determined the unreported income for 1991 on the basis of checks made payable to Beaufort Leaf and given to the partnership's managing partner. Petitioners admit that they were partners in Beaufort Leaf and as partners received withdrawals of moneys from the partnership. In light of those facts, 1999 Tax Ct. Memo LEXIS 225">*279  which are not disputed, there is no basis to conclude that there is an inadequate evidentiary foundation for respondent's determination of unreported income in the subject notices of deficiency or that the notices of deficiency are arbitrary or without rational foundation. Cf.  Williams v. Commissioner, 999 F.2d 760">999 F.2d 760 (4th Cir. 1993); Portillo v. Commissioner, 932 F.2d 1128">932 F.2d 1128 (5th Cir. 1991).SUBSTANTIATION OF PURCHASESWe turn to the second issue. Petitioners take the position that respondent erred in reducing Beaufort Leaf's cost of goods sold by disallowing purchases in the amount of $ 429,421 in 1990 and $ 1,173,203 in 1991. Petitioners acknowledge that "they bear the burden of proof as to substantiation", but they claim in their posttrial brief to have substantiated the subject purchases based upon the following grounds:(1) All of the disallowed checks "were issued to individuals or entities that were known tobacco vendors."(2) The Forms MQ-79 filed on behalf of Beaufort Leaf "list tobacco pounds for the transactions challenged by Respondent that correspond to the pounds of tobacco represented by the disallowed purchases."(3) 1999 Tax Ct. Memo LEXIS 225">*280  The subject checks were honored by the banks at which they were presented.(4) Beaufort Leaf's accountant, Mr. Dawson, testified that the account payable from Okay Leaf of $ 350,000 was for tobacco purchases and that testimony is corroborated by the Forms MQ-79 which show tobacco purchases from Okay Leaf in 1991 in excess of $ 700,000.(5) All available books and records of Beaufort Leaf properly record the disputed transactions as purchases of tobacco.We do not agree that petitioners have substantiated the amounts disallowed by respondent as purchases of tobacco. None of the points that they advance prove that any of the disallowed checks or the accounts payable to Okay Leaf was used to purchase tobacco. Petitioners' evidence in the form of the audit report covering Mr. Wells' returns for 1988 through 1991 suggests that Beaufort Leaf sold excess-quota tobacco after having filed fraudulent Forms MQ-79 and paid some of the proceeds of the sales to Mr. Wells or members of his organization. The checks disallowed by respondent are payable to persons identified in the audit report as persons associated with Mr. Wells. The same is true of the account payable to Okay Leaf, a company identified1999 Tax Ct. Memo LEXIS 225">*281  in the audit report as controlled by Mr. Wells. Therefore, petitioners' own evidence suggests that the Forms MQ-79 filed by Beaufort Leaf were falsified to document purchases of tobacco when, in fact, purchases of tobacco were not made by Beaufort Leaf. The audit report suggests that the checks were issued to persons related to Mr. Wells in order to transmit proceeds of the scheme to Mr. Wells. Furthermore, we note that petitioners did not seek testimony from any of the check payees or Okay Leaf to show the nature of the payments made. See Wichita Terminal Elevator Co. v. Commissioner, 6 T.C. 1158">6 T.C. 1158 (1946), affd.  162 F.2d 513">162 F.2d 513 (10th Cir. 1947). We also note that petitioners do not claim that the checks were paid for any purpose other than to purchase tobacco or that they are deductible in connection with an activity other than Beaufort Leaf's business of purchasing and selling tobacco. Cf.  Brizell v. Commissioner, 93 T.C. 151">93 T.C. 151 (1989).PENALTIES AND ADDITIONS TO TAXThe third issue for decision is whether petitioners are liable for the penalties and addition to tax determined in the notices of deficiency. 1999 Tax Ct. Memo LEXIS 225">*282  Respondent determined an accuracy-related penalty under section 6662(a) with respect to each petitioner's returns for 1990 and 1991. Section 6662 imposes a penalty of 20 percent of the portion of an underpayment of tax related to, inter alia, "Negligence or disregard of rules or regulations" or "Any substantial understatement of income tax". For this purpose, the term "negligence" includes any failure to make a reasonable attempt to comply with the provisions of the income tax, and the term "disregard" includes any careless, reckless, or intentional disregard. Sec. 6662(c). In substance, an understatement of income tax is the excess of the amount of tax required to be shown on the taxpayer's return over the amount that is shown on the return. See sec. 6662(d)(2)(A). A substantial understatement is defined by section 6662(d)(1)(A) as an understatement exceeding the greater of "10 percent of the tax required to be shown on the return for the taxable year, or * * * $ 5,000."Petitioners' answering brief addresses the penalties under section 6662(a) determined by respondent in the following sentence:   Finally, if the Court rules in favor of the Respondent, the   Petitioners request1999 Tax Ct. Memo LEXIS 225">*283  that the Court waive penalties and interest   associated with the understatement of income as the Petitioners   filed their tax forms in good faith, reasonably relying on the   managing partner and the partnership bookkeeper's expertise to   file a complete and accurate tax return for the partnership.This Court has jurisdiction over interest determinations to the limited extent provided by section 7481(c), which is not applicable here. Nor does section 6404(i) apply in the absence of a determination by respondent not to abate interest. See Melin v. Commissioner, 54 F.3d 432">54 F.3d 432 (7th Cir. 1995). Therefore, we shall not consider petitioners' request that this Court "waive" the "interest associated with the understatement."We interpret petitioners' request that this Court "waive penalties * * * associated with the understatement" as an assertion that they qualify to be relieved of liability for the subject penalties under the reasonable cause exception set forth in section 6664(c). Section 6664(c)(1) provides as follows:   (1) In General. -- No penalty shall be imposed under this part   with respect to any portion of an underpayment if it 1999 Tax Ct. Memo LEXIS 225">*284  is shown   that there was a reasonable cause for such portion and that the   taxpayer acted in good faith with respect to such portion.Petitioners have not shown that there was reasonable cause for the underpayment in this case or that they acted in good faith. In this regard, we point to the earlier discussion in this opinion in which we did not accept petitioners' testimony that they did not know of or approve Beaufort Leaf's participation in the scheme.Respondent also determined that Mr. Gaskins is liable for an addition to tax under section 6651(a)(1) for failing to timely file his 1991 tax return on the ground that the return was filed after October 15, 1992, the due date of the return. Respondent's determination is based upon the postmark on the envelope in which Mr. Gaskins' return was mailed to the Internal Revenue Service. Petitioners did not address this issue at trial or mention it in their posttrial briefs. Accordingly, we hereby sustain respondent's determination and find Mr. Gaskins liable for the addition to tax under section 6651(a)(1).In light of the foregoing,Decisions will be entered for respondent.