William R. Wallace and Nancy L. Wallace v. Commissioner., United States Tax Court - Memorandum Decision, T.C. Memo. 1993-620, Docket No. 24201-91., Filed December 23, 1993

William R. Wallace and Nancy L. Wallace v. Commissioner.

United States Tax Court - Memorandum Decision

T.C. Memo. 1993-620

Docket No. 24201-91.

Filed December 23, 1993.

Stephen Neubeck, for the respondent.

Memorandum Opinion

FAY, Judge: This case was called at the Court's trial calendar in Cincinnati, Ohio, on November 1, 1993. Petitioners did not appear. At that time, respondent filed a Motion for Default Judgment. In her motion, respondent seeks an order of decision against petitioners reflecting the following:

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^* 50 percent of the interest payable under sec. 6601 with respect to the portion of the underpayment attributable to fraud.

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¹ The notice of deficiency determined deficiencies in the amounts of $27,402 and $45,916 for 1986 and 1987, respectively, and corresponding additions to tax not restated here. In the amended answer, respondent alleged deficiencies in the amounts of $19,187.38 and $95,512.52 for 1986 and 1987, respectively, along with the corresponding additions to tax which are not restated here. The deficiencies and additions to tax sought in respondent's motion for default judgment constitute the lesser amounts determined against petitioners in the amended answer and the notice of deficiency for 1986 and 1987, respectively.

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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, unless otherwise indicated.

Respondent was heard, whereupon the Court took respondent's motion under consideration.

Background

A timely petition was filed on October 22, 1991. At the time of filing the petition herein, petitioners resided in Hamilton, Ohio. Respondent's answer, filed December 30, 1991, asserted affirmative allegations of fact in support of the determination that petitioners are liable for the additions to tax for fraud pursuant to section 6653(b)(1)(A) and (B). Petitioners did not file a reply, and respondent filed a motion for entry of order that undenied allegations in the answer be deemed admitted under Rule 37(c). The Court notified petitioners of the filing of this motion and advised them that, if they did not file a reply to respondent's affirmative allegations of fact, the motion would be granted. Petitioners thereafter filed a reply on March 3, 1992, addressing respondent's affirmative allegations of fact set forth in the answer.

Respondent's Answer, filed December 30, 1991, alleging specific affirmative facts constituting fraud, reads, in pertinent part, as follows: ²

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² The Amendment to Answer to Petition, filed Oct. 22, 1992, alleges facts in its paragraph 8 which, while asserted to support an increased deficiency, give further insight to the questionable conduct of petitioners. These alleged facts, also deemed admitted here, support the existence of fraud during the years in question.

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7. FURTHER ANSWERING the petition and in support of the determination that a part of the underpayment of tax required to be shown on petitioners' income tax returns for the taxable years 1986 and 1987 is due to fraud, the respondent alleges:

(a) Petitioner William R. Wallace is a dentist, and claims that he is in the business of providing financial and tax return preparation services to clients for fees.

(b) Petitioner Nancy L. Wallace is employed in the business of providing financial and tax return preparation services to clients for fees, and has represented herself to both the respondent and to the public to be a Certified Public Accountant.

(c) Petitioner Nancy L. Wallace provided bookkeeping and tax return preparation services for her husband's dental practices.

(d) Petitioner Nancy L. Wallace is not a Certified Public Accountant in the State of Ohio, and, when asked by respondent to establish that she was certified and thus authorized to represent taxpayers before respondent, she failed to do so.

(e) During the taxable years 1986 and 1987, the petitioners received unreported taxable income from the petitioners' business activities.

(f) The petitioners failed to maintain, or to submit for examination by the respondent, complete and adequate books and accounts of their income producing activities for each of the taxable years 1986 and 1987, as required by the applicable provisions of the Internal Revenue Code and the regulations promulgated thereunder.

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(j) The petitioners filed their income tax returns for 1986 and 1987 only after contact by respondent regarding the filing of the returns.

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(n) Prior to the 1986 cessation of the dental business as a corporation, petitioner William R. Wallace made certain distributions, in a net amount of $56,005.00 as of December 31, 1986, from the corporation to himself, which distributions he characterized as loans at the time each such distribution was made. Upon the "liquidation" of the corporation in 1986, it made no provision for petitioner's repayment of the loans, resulting in a forgiveness of debt in the amount of $56,005.00.

(o) During the course of the respondent's examination of the subject returns, petitioner Nancy L. Wallace misrepresented the facts surrounding the above described corporate loans when she claimed that no forgiveness of debt occurred because the various distributions were repayments of loans made to the corporation by petitioner William R. Wallace.

(p) The petitioners altered the employee copy of the 1986 Form W-2 from the financial and accounting business, Wallace Accounting Services, to William R. Wallace. The business is a sole proprietorship operated by the petitioner Nancy L. Wallace as described in paragraph 7. (b). The Form W-2 originally filed by the business at the conclusion of the 1986 taxable year reflected that William R. Wallace was an employee who received the wages set forth thereon. No Form W-2 was filed by this business for the petitioner Nancy L. Wallace. When the income tax return was filed, petitioners claimed that the business was the sole proprietorship of the petitioner William R. Wallace, and that the petitioner Nancy L. Wallace was the employee. Such alteration to the Form W-2 was made solely for purposes of eliminating the self-employment tax liability of William R. Wallace, and the Form W-2, as altered, misrepresents the true ownership and operation of the business.

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(t) The petitioners' failure to maintain complete and accurate records of their income-producing activities and their failure to produce complete and accurate records to the respondent in connection with the examination of petitioners' income tax returns for the taxable years 1986 and 1987 was fraudulent with the intent to evade tax.

(u) Petitioners fraudulently and with intent to evade tax made false and misleading statements to respondent's agent during the examination of petitioners' income tax returns for the years 1986 and 1987.

(v) Petitioner Nancy L. Wallace, in holding herself out to the public as providing tax return preparation and financial accounting services, was fully aware of the requirement to file federal income tax returns on time.

(w) Petitioners fraudulently and with intent to evade tax failed to timely file their income tax returns for the taxable years 1986 and 1987.

(x) Petitioners fraudulently and with intent to evade tax omitted from their tax returns for the taxable years 1986 and 1987 amounts of income as follows:

(y) Petitioners fraudulently and with intent to evade tax understated their income tax liability on their 1986 and 1987 returns as follows:

(z) A part of the understatement of tax required to be shown on petitioners' returns for each of the taxable years 1986 and 1987 is due to fraud.

This case was set for trial for the October 26, 1992, Cincinnati, Ohio, trial session. At that time, a recall date of October 28, 1992, was set. When the case was recalled, petitioners' counsel filed a motion to withdraw as counsel; this motion was granted, and the case was thereafter continued. By order dated February 1, 1993, this case was restored to the general docket for trial. By notice dated May 26, 1993, this case was reassigned to the November 1, 1993, Cincinnati, Ohio, trial session.

Throughout the proceedings subsequent to withdrawal of counsel, petitioners have refused to cooperate with respondent. Pursuant to respondent's second ³ motion to compel production of documents, by order dated October 6, 1993, the Court ordered petitioners to produce the requested documents or be sanctioned under Rule 104 for failure to comply. Petitioners did not comply with the Court's order. Furthermore, because petitioners did not return telephone messages from the Court and respondent, the Court issued an order dated October 13, 1993, ordering petitioners to make telephone contact with the Court so that a conference call could be conducted. Petitioners complied.

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³ On Sept. 28, 1992, respondent filed a motion to compel answers to interrogatories and her first motion to compel production of documents due to petitioners' failure to respond to direct requests from respondent. These motions were granted by order dated Sept. 30, 1992, wherein petitioners were ordered to comply with respondent's requests.

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Although petitioners did comply with the Court's October 13, 1993, order by establishing telephone contact, they failed to comply with the Court's oral order during the conference call held October 15, 1993, ordering them to meet with respondent on October 18, 1993. This, once again, necessitated the issuance of an order dated October 20, 1993, ordering petitioners to meet with respondent so as to facilitate compliance with the Court's Pretrial Rules of Practice and Procedure. In the days just before trial, petitioners sent to respondent and the Court a notice entitled "Petitioners' Voluntary Dismissal and Withdrawal of All Charges Against the Commissioner of Internal Revenue". In this notice, petitioners attempt to withdraw their petition and dismiss their "charges" against respondent. Petitioners' notice, received by the Court, was returned to them as an improper pleading. Petitioners then failed to appear when their case was called for trial. ⁴

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⁴ By notice dated May 26, 1993, the Court set this case for the Nov. 1, 1993, Cincinnati, Ohio, trial session. This notice specifically stated, inter alia, that "YOUR FAILURE TO APPEAR MAY RESULT IN DISMISSAL OF THE CASE AND ENTRY OF DECISION AGAINST YOU."

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The Court now finds that petitioners have clearly indicated, as shown by their conduct and the overall record in this case, that they no longer wish to contest the fraud issue or any other issue involved in this case. Moreover, we find that petitioners' failure to cooperate with respondent during the pretrial period made it impossible for respondent to conduct negotiations, exchange information, and stipulate mutually agreeable facts as required by Rule 91(c) ⁵ . The standing pretrial order has not been complied with by petitioners, nor have petitioners complied with the mandates of the Court in Branerton Corp. v. Commissioner [Dec. 32,479], 61 T.C. 691 (1974).

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⁵ The notice setting this case for trial, supra n.4, specifically stated, inter alia, that "YOUR FAILURE TO COOPERATE MAY ALSO RESULT IN DISMISSAL OF THE CASE AND ENTRY OF DECISION AGAINST YOU." A one-page partial stipulation of facts was filed on Oct. 28, 1992, in which a joint stipulation was entered as to one fact. This fact is insignificant and inconsequential to the disposition of these proceedings; thus, in light of the various issues present in this case, we find that petitioners have failed to cooperate with respondent in the period subsequent to the withdrawal of their counsel.

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The issues remaining for decision are (1) whether a default judgment should be entered against petitioners as to the deficiencies and the additions to tax determined against petitioners for which petitioners bear the burden of proof, and (2) whether petitioners are liable for the addition to tax for fraud pursuant to section 6653(b)(1)(A) and (B).

Discussion

Rule 123(a) provides, in pertinent part, that a party may be held in default when he has failed to proceed as provided by our Rules or as required by this Court. Rule 123(a); Smith v. Commissioner [Dec. 45,211], 91 T.C. 1049, 1056 (1988), affd. [91-1 USTC ╤ 50,127] 926 F.2d 1470 (6th Cir. 1991). The action or nonaction on the part of a taxpayer that constitutes sufficient grounds to apply Rule 123(a) in proceedings before us is a matter within this Court's discretion. Smith v. Commissioner, supra at 1056. Petitioners' failure to proceed as provided by the Rules of this Court and their failure to cooperate with this Court and respondent constitute more than sufficient grounds for the entry of a default judgment against them. For these reasons, respondent's November 1, 1993, Motion for Default Judgment as to the issues for which petitioners bear the burden of proof is granted.

Section 6653(b) provides for an addition to tax for fraud. In order to sustain her determination as to the fraud addition to tax for a year, the Commissioner must prove, by clear and convincing evidence, that some part of the underpayment for that year is due to fraud with the intent to evade tax. Sec. 7454(a); Rule 142(b); Akland v. Commissioner [85-2 USTC ╤ 9593], 767 F.2d 618, 621 (9th Cir. 1985), affg. [Dec. 40,092(M)] T.C. Memo. 1983-249; Habersham-Bey v. Commissioner [Dec. 38,826], 78 T.C. 304, 311 (1982); Doncaster v. Commissioner [Dec. 38,135], 77 T.C. 334, 336 (1981); Tschudy v. Commissioner [Dec. 49,440(M)], T.C. Memo. 1993-567. The Commissioner must show that the taxpayer intended to evade taxes by conduct calculated to conceal, mislead, or otherwise prevent the collection of such taxes. Wedvik v. Commissioner [Dec. 43,595], 87 T.C. 1458, 1468-1469 (1986); Rowlee v. Commissioner [Dec. 40,228], 80 T.C. 1111, 1123 (1983). Fraud will never be presumed. Beaver v. Commissioner [Dec. 30,380], 55 T.C. 85, 92 (1970). Fraud may, however, be proven by circumstantial evidence and reasonable inferences drawn from the facts, because presentation of direct proof of a taxpayer's intent is seldom possible. Wedvik v. Commissioner, supra at 1469; Rowlee v. Commissioner, supra at 1123. A taxpayer's entire course of conduct is examined to establish the requisite fraudulent intent. Recklitis v. Commissioner [Dec. 45,154], 91 T.C. 874, 909-910 (1988).

To meet her burden, the Commissioner must show that (1) there was an underpayment, and (2) the taxpayer intended to evade taxes known to be owing by conduct intended to conceal, mislead, or otherwise prevent the collection of taxes. Sec. 7454(a); Rule 142(b); Recklitis v. Commissioner, supra at 909. We find, in light of the record, that there was an underpayment of tax for each of the tax years in issue. We now turn to the element of petitioners' intent.

Respondent is entitled to satisfy her burden by relying on facts deemed admitted, as a consequence of imposed sanctions, or by a clear indication on the part of the taxpayer that he no longer would contest the fraud issue. Smith v. Commissioner, supra at 1052-1053; see also Marshall v. Commissioner [Dec. 42,301], 85 T.C. 267 (1985); Doncaster v. Commissioner [Dec. 38,135], 77 T.C. 334 (1981).

The entry of default under Rule 123(a) has the effect of admitting all well-pleaded facts in respondent's answer and amended answer. Smith v. Commissioner, supra at 1056-1058; see also Bosurgi v. Commissioner [Dec. 43,554], 87 T.C. 1403, 1409 (1986); Stanko v. Commissioner [Dec. 49,381(M)], T.C. Memo. 1993-513. This is true even when a reply has been filed by a taxpayer which addresses the facts pleaded by respondent in her answer. Smith v. Commissioner [91-1 USTC ╤ 50,127], 926 F.2d 1470, 1478 (6th Cir. 1991), affg. [Dec. 45,211] 91 T.C. 1049 (1988); Rechtzigel v. Commissioner [Dec. 39,204], 79 T.C. 132, 142 n.11 (1982) ("the necessary effect of defaulting petitioner is to deem admitted the affirmative allegations in the answer irrespective of petitioner's denial [in the reply]. The sanction thus converts the denial into an admission."), affd. [83-1 USTC ╤ 9281] 703 F.2d 1063 (8th Cir. 1983); see Gordon v. Commissioner [Dec. 36,748], 73 T.C. 736 (1980); Walden v. Commissioner [Dec. 48,864(M)], T.C. Memo. 1993-56; Byars v. Commissioner [Dec. 48,093(M)], T.C. Memo. 1992-169. Entry of a default decision for the fraud addition is appropriate upon a determination, which is within this Court's discretion, that the pleadings set forth sufficient facts to support such a judgment. Smith v. Commissioner [Dec. 45,211], 91 T.C. at 1058-1059. The Commissioner's pleadings must, however, allege specific facts sufficient to sustain a finding of fraud before she will be entitled to a decision that includes an addition to tax for fraud upon the failure of a taxpayer to appear for trial. Smith v. Commissioner [Dec. 45,211], 91 T.C. at 1058. We must now decide whether respondent's specific allegations of fact in the instant case, taken to be true by petitioners' default, are sufficient to establish the existence of fraud. Smith v. Commissioner [Dec. 45,211], 91 T.C. at 1059.

The decision of the Court of Appeals for the Sixth Circuit, in Solomon v. Commissioner [84-1 USTC ╤ 9450], 732 F.2d 1459 (6th Cir. 1984), affg. [Dec. 39,427(M)] T.C. Memo. 1982-603, sets forth a nonexclusive list of the "`badges' of fraud" that demonstrate fraudulent intent. These badges include: (1) The failure to file tax returns, (2) the failure to report, and understatement of, income, (3) the taxpayer's failure to give the Government access to his records, (4) the taxpayer's failure to keep adequate books and records, (5) the taxpayer's experience and knowledge of tax laws, and (6) concealment of assets. Solomon v. Commissioner, supra at 1461-1462. Implausible or inconsistent explanations of behavior are additional indicia of fraud. Bradford v. Commissioner [86-2 USTC ╤ 9602], 796 F.2d 303, 307-308 (9th Cir. 1986) affg. [Dec. 41,615(M)] T.C. Memo. 1984-601. Additionally, as in Smith, petitioners failed to appear for trial. Smith v. Commissioner [Dec. 45,211], 91 T.C. at 1059-1060.

A taxpayer's failure to file a return, standing alone, does not establish fraud. Recklitis v. Commissioner, supra at 910-911. When, however, the failure to file is coupled with other badges or circumstances that establish an intent to conceal or mislead, an inference of fraud is justified. Recklitis v. Commissioner, supra at 911; Kotmair v. Commissioner [Dec. 43,122], 86 T.C. 1253, 1260-1261 (1986), and cases cited therein. In the instant case, petitioners did not file returns for the years in question until after respondent solicited such returns. We have, therefore, examined the record to identify the presence or absence of other indicia of fraud.

Petitioners are deemed to have admitted all the affirmative allegations of fact in respondent's answer. Furthermore, we find that the affirmative allegations of fact contained in the answer and amended answer, and now deemed admitted, are factually sufficient to establish the existence of fraudulent conduct by petitioners. The badges of fraud we find significant are, inter alia, as follows: (1) Petitioners' false and misleading statements to respondent's agent during the course of the examination of the tax years in question; (2) their failure to keep adequate books and records; (3) their receipt of and failure to report income; (4) their failure to file returns, until prompted by respondent, for the years in question; (5) their knowledge of the requirement to file tax returns, especially in light of their experience with respect to tax and financial matters; (6) the existence of altered W-2 forms in light of the structure within which petitioners chose to run their business, a sole proprietorship; and (7) their failure to appear and contest the determinations against them.

In light of the record taken as a whole and reasonable inferences therefrom, we now find that the facts in this case show, by clear and convincing evidence, that petitioners intended to evade taxes known to be owing for both tax years in question by conduct intended to conceal, mislead, or otherwise prevent the collection of taxes. Our review of the entire record in this case, including the well-pleaded facts contained in respondent's answer, satisfies us that the additions to tax for fraud should be sustained by both the entry of a default against petitioners and the dismissal of their case pursuant to Rule 123(a).

To reflect the foregoing,

Respondent's motion will be granted, and decision will be entered for respondent.

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