Badges of fraud analys - also loan vs dividend

Attached is most of the discussion of two issues. The badges of fraud analysis is classic, but it helps in cases where there is a filed retun and only one or two "badges of fraud." I think the dividend result should have been avoided by an argument that the funds received were "compensation" for services.

Mohammad Enayat v. Commissioner. Woodbury Rug Company, Inc., v. Commissioner., U.S. Tax Court, CCH Dec. 57,988(M), T.C. Memo. 2009-257, (Nov. 10, 2009)


U.S. Tax Court, Dkt. Nos. 1488-07, 1489-07, TC Memo. 2009-257, November 10, 2009.

A rug dealer, who operated his business as a wholly owned C corporation in some years and as a single-member limited liability company (LLC) in other years, had unreported constructive dividend income and unreported officer's compensation from the corporation and additional income from the LLC, and the corporation had unreported gross receipts. Checks made payable to the corporation that were deposited in his personal accounts were constructive dividends and he offered insufficient evidence to refute this determination. The IRS used the bank deposit method to reconstruct income since his records were extremely sloppy. Although he argued that the bank deposit analysis was flawed, he failed to show that any distributions he received were repayments of loans rather than compensation. He was denied a capital loss deduction on the sale of investment real estate because he failed to substantiate any additions to basis beyond the purchase price of the real estate. He was liable for an addition to tax for his failure to timely file his tax returns for the four years at issue since he did not show that he exercised reasonable care. In addition, he was liable for the fraud penalty for three of those years because he failed to report income that he later conceded he should have reported, namely gambling winnings, rental income, business interruption insurance payments, and misappropriated funds from a stolen check. Although the IRS issued notices of deficiency more than three years after the personal returns were filed, the assessments were not barred because the filed returns were fraudulent. In the case of the nonfraudulent return, assessment is not barred because the rug dealer omitted more than 25 percent of the gross income stated on the return. Even though the corporate return was not timely filed in the first year, an additional deduction for the amount of the compensation determined paid to the rug dealer brought the tax liability to zero; therefore, any addition to tax and penalty would also be zero since based on a percentage of the zero underpayment. The corporation was liable for the penalty for fraudulent failure to file a tax return in the second tax year. The IRS could assess at any time with regard to the corporation since gross receipts were fraudulently understated on one return and no return was filed for the other tax year. The rug dealer did not have additional income from money transferred to him that was actually a debt he owed to the transferror since he remained obligated on the debt.
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OPINION
I. Unreported Income of Woodbury and Sutter
Mr. Enayat operated his rug business through Woodbury in 1998 and 1999 and through Sutter in 1999 through 2001, kept sloppy records for both entities, and failed to report much of their income. Taxpayers bear the responsibility to maintain books and records that are sufficient to establish their income. See sec. 6001; DiLeo v. Commissioner, 96 T.C. 858, 867 (1991), affd. 959 F.2d 16 (2d Cir. 1992); sec. 1.446-1(a)(4), Income Tax Regs. (26 C.F.R.); see also Estate of Mason v. Commissioner, 64 T.C. 651, 656 (1975), affd. 566 F.2d 2 (6th Cir. 1977). Mr. Enayat failed to fulfill that responsibility both as to himself and as to his C corporation, Woodbury.
A. The IRS's Use of the Bank Deposits Method
When a taxpayer fails to keep adequate books and records, the IRS is authorized to determine the existence and amount of the taxpayer's income by any method that clearly reflects income. Sec. 446(b); Mallette Bros. Constr. Co. v. United States, 695 F.2d 145, 148 (5th Cir. 1983); Webb v. Commissioner, 394 F.2d 366, 371-372 (5th Cir. 1968), affg. T.C. Memo. 1966-81; see also Holland v. United States, 348 U.S. 121, 131-132 (1954). The IRS's reconstruction of a taxpayer's income need only be reasonable in light of all surrounding facts and circumstances. Schroeder v. Commissioner, 40 T.C. 30, 33 (1963); see also Giddio v. Commissioner, 54 T.C. 1530, 1533 (1970). The IRS is given latitude in determining which method of reconstruction to apply when taxpayers fail to maintain adequate books and records. Boyett v. Commissioner, 204 F.2d 205, 208 (5th Cir. 1953), affg. a Memorandum Opinion of this Court; Kenney v. Commissioner, 111 F.2d 374, 375 (5th Cir. 1940), affg. a Memorandum Opinion of this Court; Petzoldt v. Commissioner, 92 T.C. 661, 693 (1989).
II. Income Mr. Enayat Did Not Report
Whether a withdrawal of funds by a shareholder from a corporation or an advance made by a shareholder to a corporation creates a true debtor-creditor relationship is a factual question to be decided on the basis of all of the relevant facts and circumstances. Haag v. Commissioner, 88 T.C. 604, 615 (1987), affd. without published opinion 855 F.2d 855 (8th Cir. 1988); see also Haber v. Commissioner, 52 T.C. 255, 266 (1969), affd. 422 F.2d 198 (5th Cir. 1970); Roschuni v. Commissioner, 29 T.C. 1193, 1201-1202 (1958), affd. 271 F.2d 267 (5th Cir. 1959). For disbursements to constitute true loans, there must have been, at the time that the funds were transferred, an unconditional obligation on the part of the transferee to repay the money and an unconditional intention on the part of the transferor to secure repayment. Haag v. Commissioner, supra at 615-616; see also Haber v. Commissioner, supra at 266. Direct evidence of a taxpayer's state of mind is generally unavailable, so courts have focused on certain objective factors to distinguish repayments of bona fide loans from disguised dividends, compensation, and returns of capital. The factors considered relevant for purposes of identifying bona fide loans include (1) the existence or nonexistence of a debt instrument; (2) provisions for security, interest payments, and a fixed payment date; (3) treatment of the funds on the corporation's books; (4) whether repayments were made; (5) the extent of the shareholder's participation in management; and (6) the effect of the “loan” on the shareholder/employee's salary. Haber v. Commissioner, supra at 266; see also United States v. Stewart ( In re Indian Lake Estates, Inc.), 448 F.2d 574, 578-579 (5th Cir. 1971); Haag v. Commissioner, supra at 616-617 & n.6. When the individuals are in substantial control of the corporation, as Mr. Enayat was in this case, such control invites a special scrutiny of the situation. Haber v. Commissioner, supra at 266; Roschuni v. Commissioner, supra at 1202. For the reasons set forth below, we conclude that the facts of record do not support Mr. Enayat's attempt to characterize the distributions that he received from Woodbury in 1998 and 1999 as repayments of bona
That is, we conclude that Mr. Enayat did not give and receive transfers pursuant to a true debtor-creditor relationship with Woodbury. Rather, Mr. Enayat treated Woodbury's bank accounts as if they were his personal accounts, depositing and withdrawing funds at will. Accordingly, we find that the transfers made from Woodbury to Mr. Enayat during 1998 and 1999 did not constitute repayments of bona fide loans, but instead represented compensation to Mr. Enayat. Therefore, we find, as the IRS determined, that Woodbury paid Mr. Enayat officer's compensation income of $349,356 in 1998 and $67,200 in 1999 by transferring funds to his personal accounts. 34 (This finding is adverse to Mr. Enayat but is favorable to his C corporation Woodbury, as we explain below.)
B. Transfer From Dr. Willitts
We have found that in 1998 Mr. Enayat received $455,485 from Dr. Willitts, which Mr. Enayat was obliged to pay back to Dr. Willitts at his instruction (originally expected to be in rials in Iran). Mr. Enayat freely used the money for his rug business and his own options trading, and he substantiated repayments of only $148,899. The IRS determined that Mr. Enayat's use of those funds for his own purposes demonstrates that he embezzled, stole, or misappropriated those funds from Dr. Willitts and that once he did so the funds became income to him. Under section 61(a), “gross income means all income from whatever source derived”. The Supreme Court “has given a liberal construction to the broad phraseology of the ‘gross income’ definition statutes in recognition of the intention of Congress to tax all gains except those specifically exempted.” James v. United States, 366 U.S. 213, 219 (1961) (citing Commissioner v. Jacobson, 336 U.S. 28, 49 (1949), and Helvering v. Stockholms Enskilda Bank, 293 U.S. 84, 87-91 (1934)). The Supreme Court held that embezzled funds and, more generally, “wrongful appropriations” are includable in gross income. Id. at 219-220.
However, Mr. Enayat's uncontradicted explanation of his arrangement with Dr. Willitts was that he was to deliver rials in Iran in exchange for dollars received in the United States, without any restriction on his use of the dollars he received because both parties understood that the rials provided in Iran would come from a different source. The record indicates an express obligation by Mr. Enayat to repay the money to Dr. Willitts—in rials if Dr. Willitts had made it to Iran, or if not then in dollars as affirmed in the November 1999 Agreement and Release. Mr. Enayat repaid some of the funds on demand and a portion later. None of these facts demonstrates that Mr. Enayat wrongfully appropriated Dr. Willitts's money; rather, he owed a debt to Dr. Willitts.
Generally, a taxpayer must recognize income from the discharge of indebtedness. Sec. 61(a)(12); United States v. Kirby Lumber Co., 284 U.S. 1 (1931). “The moment it becomes clear that a debt will never have to be paid, such debt must be viewed as having been discharged.” Cozzi v. Commissioner, 88 T.C. 435, 445 (1987). There is no evidence that such a moment had arrived during the years in issue with respect to Mr. Enayat's obligation to repay Dr. Willitts. On the contrary, Dr. Willitts petitioned a New Hampshire State court in late 1999 for attachment of Mr. Enayat's assets. Mr. Enayat had not fully repaid Dr. Willitts during the years in issue, but there is no evidence that Dr. Willitts had released Mr. Enayat from his repayment obligation in any year before us.
. Enayat is liable for the section 6651(a)(1) addition to tax for all four of those years. Section 6651(a)(1) imposes an addition to tax for failure to file a timely return, unless the taxpayer establishes that the failure did not result from “willful neglect” and that the failure was due to “reasonable cause”. “Willful neglect” has been interpreted to mean a conscious, intentional failure or reckless indifference. United States v. Boyle, 469 U.S. 241, 245-246 (1985). “Reasonable cause” requires the taxpayer to demonstrate that the taxpayer exercised ordinary business care and prudence and was nevertheless unable to file a return within the prescribed time. Id. at 246; sec. 301.6651-1(c)(1), Proced. & Admin. Regs.
Mr. Enayat has not shown or even argued that he exercised reasonable care with regard to his failure to file his returns. We find that Mr. Enayat is liable for the section 6651(a)(1) addition to tax for taxable years 1998, 1999, 2000, and 2001.
2. Fraud Penalty Under Section 6663(a)
The IRS determined that Mr. Enayat is liable for the fraud penalty under section 6663(a) for fraudulently understating his income on his 1998, 1999, 2000, and 2001 income tax returns. Section 6663(a) imposes a penalty equal to 75 percent of the portion of any underpayment attributable to fraud.
a. Legal Principles Regarding Fraud
Respondent has the burden of proving fraud by clear and convincing evidence. See sec. 7454(a); Rule 142(b); Parks v. Commissioner, 94 T.C. 654, 660 (1990). Respondent must prove by clear and convincing evidence (1) that Mr. Enayat underpaid his taxes in each year and (2) that Mr. Enayat intended to evade taxes by conduct intended to conceal, mislead, or otherwise prevent tax collection. See Parks v. Commissioner, supra at 660-661. Fraud is an actual wrongdoing with an intent to evade a tax believed to be owing. Marshall v. Commissioner, 85 T.C. 267, 272 (1985). Fraud is never presumed and must be established by independent evidence of fraudulent intent. Petzoldt v. Commissioner, 92 T.C. at 699. Accordingly, the existence of fraud is a question of fact that a court must consider on the basis of an examination of the entire record and the taxpayer's entire course of conduct. Id. However, “Fraud ‘does not include negligence, carelessness, misunderstanding or unintentional understatement of income.’” Zhadanov v. Commissioner, T.C. Memo. 2002-104 (quoting United States v. Pechenik, 236 F.2d 844, 846 (3d Cir. 1956)). If respondent shows that any part of an underpayment is due to fraud, the entire underpayment is treated as due to fraud unless Mr. Enayat shows by a preponderance of the evidence that part of the underpayment is not due to fraud. See sec. 6663(b).
Courts have developed a nonexclusive list of factors that demonstrate fraudulent intent. These “badges of fraud” include: (1) understating income; (2) maintaining inadequate records; (3) implausible or inconsistent explanations of behavior; (4) concealment of income or assets; (5) failing to cooperate with tax authorities; (6) engaging in illegal activities; (7) an intent to mislead which may be inferred from a pattern of (3) conduct; (8) lack of credibility of the taxpayer's testimony; (9) filing false documents; (10) failing to file tax returns; and (11) dealing in cash. Spies v. United States, 317 U.S. 492, 499 (1943); Douge v. Commissioner, 899 F.2d 164, 168 (2d Cir. 1990); Bradford v. Commissioner, 796 F.2d 303, 307-308 (9th Cir. 1986), affg. T.C. Memo. 1984-601; Recklitis v. Commissioner, 91 T.C. 874, 910 (1988). Although no single factor is necessarily sufficient to establish fraud, the combination of a number of factors constitutes persuasive evidence. Solomon v. Commissioner, 732 F.2d 1459, 1461 (6th Cir. 1984), affg. per curiam T.C. Memo. 1982-603.
Respondent contends that the following badges of fraud are present with respect to Mr. Enayat: (1) understating income, (2) maintaining inadequate records, (3) implausible or inconsistent explanations of behavior, (4) concealment of assets, (5) engaging in illegal activities, (6) lack of credibility in testimony, (7) dealing extensively in cash, (8) pattern of conduct which implies an intent to mislead, and (9) failing to file tax returns.
b. Mr. Enayat's Underpayments Due to Fraud
We find some of those badges of fraud to be present in this case. First, Mr. Enayat understated his income for every year at issue. Second, Mr. Enayat admittedly maintained inadequate records. Third, Mr. Enayat engaged in illegal activities (i.e., theft). Fourth, Mr. Enayat dealt extensively in cash. Fifth, Mr. Enayat has exhibited a pattern of conduct which implies an intent to mislead by admittedly receiving income in 1998, 2000, and 2001 that he did not report on his income tax returns, yet offering no explanation for his failure to do so. Lastly, Mr. Enayat failed to timely file his tax return for every year at issue. As a result, we find Mr. Enayat's actions were intended to conceal, mislead, or otherwise prevent tax collection.
Specifically, we find that Mr. Enayat's failure to report income he now concedes he should have reported—i.e., $16,800 in gambling income in 1998, $2,000 in rental income in 1998, $201,929 in insurance proceeds in 2000, and $113,800 in theft income in 2001—was fraudulent. These were not trivial amounts that might have been overlooked or forgotten. Mr. Enayat offered no explanation for how he could have filed a tax return for any of these years and omitted these items out of carelessness or negligence. On the basis of Mr. Enayat's concession and our finding of fraud, we find that respondent has shown that some portion of Mr. Enayat's underpayment in each of the three years involving those items—1998, 2000, and 2001—was due to fraud. As a result, the entire underpayment for each of those years is treated as due to fraud unless Mr. Enayat shows by a preponderance of the evidence that part of the underpayment is not due to fraud. See sec. 6663(b).
c. Mr. Enayat's Underpayments Not Due to Fraud
i. Capital Loss
As for taxable year 1998, we have already found that failure to report $16,800 in gambling income and $2,000 in rental income was fraudulent. With respect to the capital loss claimed by Mr. Enayat on the sale of the Elm Street property but disallowed in the notice of deficiency and in this opinion, we do not find Mr. Enayat's actions to be fraudulent. Mr. Enayat disclosed the sale of the property on his return by claiming a loss, and it was his failure to prove his basis in the property that resulted in the capital gain. Mr. Enayat's failure to report this capital gain was due to his negligence in not properly substantiating his renovation expenses. As a result, we do not find fraud in this particular issue.
ii. Woodbury Checks and Transfers
The rest of Mr. Enayat's underreporting of income for taxable year 1998 results from our finding that he received $203,273 in dividend income from checks payable to Woodbury, as well as $349,356 in officer's compensation transferred to him from Woodbury, totaling $552,629. On the totality of facts, we do not find these transactions to be fraudulent, despite their magnitude.
In 1998 money flowed back and forth between Woodbury and Mr. Enayat in roughly equal amounts. In 1998 Woodbury gave Mr. Enayat a total of $552,629, while Mr. Enayat gave Woodbury $548,188 ($346,238 in capital contributions mistakenly characterized as shareholder loans by Mr. Enayat, and $201,950 in redeposits of diverted checks). While we do not approve of the haphazard flow of money between the two, or of Mr. Enayat's using Woodbury's accounts as his personal checking accounts, we have addressed those issues in deciding whether these transactions resulted in taxable income to Mr. Enayat. Under our opinion, Mr. Enayat is liable for income tax on his end of those transfers, and we have held that the rough balance in money given and received does not excuse his liability. However, what cannot be ignored is that of all the money that flowed between the two, the total amounts going either way were very close—$552,629 versus $548,188. As a result, we do not find that Mr. Enayat intended to conceal, mislead, or otherwise prevent tax collection in his dealings with Woodbury in taxable year 1998. His error—i.e., his assumption that the rough equivalence of the back-and-forth transfers eliminated their taxability—amounted to negligence but not fraud.
We likewise find that to be so for the year 1999. Throughout 1999 Woodbury made transfers to Mr. Enayat totaling $98,723 (i.e., $67,200 in direct transfers and $31,723 in diverted checks), while Mr. Enayat made transfers to Woodbury totaling $164,429 (all in capital contributions mistakenly considered shareholder loans by Mr. Enayat, because Mr. Enayat did not redeposit any of the diverted checks in 1999). Again, because throughout 1999 he actually transferred more money to Woodbury than he received—$164,429 versus $98,723—we find that Mr. Enayat's non-reporting of this income was negligent but not fraudulent.
The only other unreported income in taxable year 1999 was $1,228 in gross receipts for Sutter. In the broader context of the facts of this case, these receipts were de minimis, and we do not find that Mr. Enayat fraudulently tried to hide this small amount. As a result, we do not find any fraud with respect to taxable year 1999.
However, the same cannot be said for Mr. Enayat's underreporting of Sutter's gross receipts in taxable year 2000. As we already decided, Mr. Enayat fraudulently failed to report $201,929 in insurance proceeds in 2000. As a result, the entire underpayment will be treated as attributable to fraud, absent proof as to non-fraudulent portions. See sec. 6663(b). This places the burden on Mr. Enayat to show that his failure to report $252,721 in gross receipts for Sutter in 2000 was not fraudulent. He has failed to do so. Mr. Enayat did argue that the IRS's bank deposits analysis was flawed and that he accurately reported Sutter's gross receipts because he reported the figure shown on his sales report, but we have already disposed of those challenges and found them to be without merit. Mr. Enayat has introduced no other evidence to persuade us that such a substantial understatement of Sutter's gross receipts would be anything other than fraudulent. As a result, we find Mr. Enayat's understatement of Sutter's gross receipts in taxable year 2000 to be fraudulent.
B. Whether Woodbury Is Liable for the Additions to Tax and Penalty As Determined by the IRS
1. Failure-To-File Addition to Tax Under Section 6651(a)(1) and Fraud Penalty Under Section 6663(a) in 1998
The IRS determined that Woodbury is liable for the section 6651(a)(1) addition to tax for taxable year 1998 because Woodbury failed to timely file its tax return for that year, and that Woodbury is liable for the fraud penalty under section 6663(a) for fraudulently understating its gross receipts on its 1998 income tax return. It is true that Woodbury filed its 1998 Form 1120 late (i.e., more than four years late on September 10, 2003), that Woodbury has not shown that it exercised reasonable care in this matter, and that the return Woodbury eventually filed did understate its gross receipts. However, because we find (as the IRS determined) that Woodbury paid additional compensation to Mr. Enayat in the form of the Woodbury-to-Enayat transfers totaling $349,356, and because we hold (as the IRS concedes) that Woodbury was entitled to an additional deduction in the amount of those transfers, Woodbury ends up with no net income in 1998, but rather a loss. Woodbury therefore has no income tax liability for 1998. Since the addition to tax and penalty at issue would be a percentage of the underpayment of Woodbury's now-zero income tax liability, the addition to tax and penalty are also zero.
2. Fraudulent Failure-To-File Addition to Tax Under Section 6651(f) in 1999
The IRS determined that Woodbury was liable for the addition to tax pursuant to section 6651(f) for fraudulently failing to file a timely income tax return for taxable year 1999. In failing to file that return, the IRS determined, Woodbury failed to report $162,050 in gross receipts for taxable year 1999. To determine whether Woodbury fraudulently failed to file its tax return for taxable year 1999, we examine the same badges of fraud we used when considering the imposition of the fraud penalty against Mr. Enayat under section 6663(a), see Clayton v. Commissioner, 102 T.C. at 653, but we necessarily focus on Woodbury's decision not to file its return when due. If that decision was made with the intent to evade tax, then the addition to tax under section 6651(f) may properly be imposed. Again, respondent has the burden of proving fraud by clear and convincing evidence. See sec. 7454(a); Rule 142(b); Parks v. Commissioner, 94 T.C. at 660-661. To find tax fraud against the corporation, respondent is required to prove that Mr. Enayat engaged in fraudulent conduct on behalf of the corporation. E.J. Benes & Co. v. Commissioner, 42 T.C. 358, 382 (1964), affd. 355 F.2d 929 (6th Cir. 1966).
Respondent contends that the following badges of fraud are present in 1999 with respect to Woodbury: (1) maintaining inadequate records, (2) concealment of assets, (3) dealing extensively in cash, and (4) failing to file tax returns. Mr. Enayat infused the corporation with his personal funds and withdrew funds at will, and he admittedly did not keep accurate books for Woodbury. Mr. Enayat, as the operator and sole shareholder of Woodbury, abdicated his responsibility to accurately report Woodbury's financial dealings and tax obligations. We have found that Woodbury failed to file its return or report gross receipts of $162,050 for taxable year 1999, and when the IRS determined that Woodbury had gross receipts in that amount, Mr. Enayat did not introduce any evidence to prove Woodbury's gross receipts were other than as the IRS determined. Woodbury failed to file its return for 1999 altogether after filing its return for 1998 four years late. In view of all these facts, Mr. Enayat's management of Woodbury went beyond haphazard and was fraudulent. Mr. Enayat undoubtedly knew that a tax return was required to be filed for Woodbury, and his failure to file one indicates that he was trying to evade taxes. As a result, given Mr. Enayat's pattern of filing his own tax returns late, as well as his filing Woodbury's 1998 tax return late, we do not find that his failure to file Woodbury's 1999 tax return was unintentional.
Therefore, on the basis of our examination of the entire record and Mr. Enayat's entire course of conduct, we find that Woodbury fraudulently failed to file its tax return for taxable year 1999. However, because we find (as the IRS determined) that Woodbury paid additional compensation to Mr. Enayat in the form of the Woodbury-to-Enayat transfers totaling $67,200 in 1999, and because we hold (as the IRS concedes) that Woodbury is entitled to an additional deduction in the amount of those transfers, Woodbury ends up with less income (i.e., $162,050 minus $67,200, or $94,850)—and therefore a lower tax liability—than the amount the IRS used in calculating the penalty.
IV. Whether the Statute of Limitations Bars Assessment of Mr. Enayat's or Woodbury's Tax Liabilities
Generally, the IRS must assess tax within three years after the return is filed. 35 Sec. 6501(a). This general rule would provide that assessments against Mr. Enayat would be restricted as follows:
Tax Year Due Date Return Filed 3-Year Limitation on Assessment
1998 Apr. 15, 1999 Apr. 14, 2000 Apr. 14, 2003
1999 Apr. 15, 2000 Oct. 9, 2002 Oct. 9, 2005
2000 Apr. 15, 2001 Oct. 22, 2002 Oct. 22, 2005
2001 Apr. 15, 2002 Oct. 22, 2002 Oct. 22, 2005
The IRS issued to Mr. Enayat a notice of deficiency for 1998, 1999, 2000, and 2001 on October 17, 2006. This was well after the three-year period of limitations on assessment had expired for each of these years, so respondent bears the burden of proving that an exception to the three-year limit on the time to assess tax applies. See Wood v. Commissioner, 245 F.2d 888, 893-895 (5th Cir. 1957), affg. in part and revg. in part on other grounds T.C. Memo. 1955-301; Bardwell v. Commissioner, 38 T.C. 84, 92 (1962), affd. 318 F.2d 786 (10th Cir. 1963). Respondent has shown that Mr. Enayat filed fraudulent returns by fraudulently underreporting his income for taxable years 1998, 2000, and 2001. Because section 6501(c)(1) allows assessment at any time in the case of a fraudulent return, we conclude that the statute of limitations does not bar assessment of Mr. Enayat's tax for 1998, 2000, or 2001.
With respect to taxable year 1999, respondent failed to prove Mr. Enayat filed a fraudulent return, but we nevertheless conclude on other grounds that the statute of limitations does not bar assessment of Mr. Enayat's tax for 1999. Section 6501(e) permits a six-year period of limitations for assessment in the case of a taxpayer who omits from gross income an amount properly includable therein which is more than 25 percent of the amount of gross income stated on the return. On his 1999 return, Mr. Enayat reported his gross income, i.e., total income, to be $301,904. The IRS determined (and we have found) that Mr. Enayat understated his income for 1999 by $100,151—i.e., $31,723 in constructive dividends from Woodbury, $67,200 in compensation from Woodbury, and $1,228 from Sutter's additional gross receipts. The IRS will be afforded a six-year period of limitations for assessment if Mr. Enayat's understatement of income ($100,151) exceeds 25 percent of $301,904 (i.e., $75,476). We find that it does.
As for Woodbury, the IRS issued a notice of deficiency for taxable year 1998 on October 17, 2006, which was more than three years after Woodbury had filed its return for that year. 36 However, because we find that Woodbury fraudulently understated its gross receipts on its return, section 6501(c)(1) permits the IRS to assess at any time. As for taxable year 1999, Woodbury failed to file a tax return. Section 6501(c)(3) likewise permits the IRS to assess at any time where no return is filed. As a result, we conclude that the statute of limitations does not bar assessment of Woodbury's tax for 1998 or 1999.
V. Summary of Findings
To resolve the issues presented in this case, we find as follows with respect to Mr. Enayat:
(1) He received unreported gambling income of $16,800 in 1998, which he concedes.
(2) He received unreported rental income of $2,000 in 1998, which he concedes.
(3) He received unreported constructive dividends from Woodbury totaling $203,273 in 1998.
(4) He received unreported compensation from Woodbury totaling $349,356 in 1998.
(5) He did not receive unreported income during any year in issue from the funds Dr. Willitts transferred to him in 1998.
(6) He is not entitled to a capital loss of $118,619 (or any other amount) on the 1998 sale of the Elm Street house, and accordingly, the capital gains he offset in 1998 and 1999 are taxable; but he is not liable for tax on capital gain from that sale.
(7) He received unreported constructive dividends from Woodbury of $31,723 in 1999.
(8) He received unreported compensation from Woodbury of $67,200 in 1999.
(9) He received unreported Schedule C income from Sutter of $1,228 in 1999.
(10) He received unreported income from insurance proceeds of $201,929 in 2000, which he concedes.
(11) He received unreported Schedule C income from Sutter of $252,721 in 2000.
(12) He received unreported theft income of $113,800 from a stolen check in 2001, which he concedes.
(13) He is liable for failure-to-file additions to tax under section 6651(a)(1) for taxable years 1998, 1999, 2000, and 2001.
(14) He is liable for the fraud penalty under section 6663(a) on the portion of his underpayment attributable to the following items:
1998: $16,800 in gambling income and $2,000 in rental income;
2000: $201,929 in insurance proceeds and $252,721 in gross receipts from Sutter;
2001: $113,800 in theft income from the stolen check.
(15) He is not liable for the fraud penalty on the portion of his underpayments attributable to the following items:
1998: $203,273 in constructive dividends from Woodbury;
$349,356 in compensation from Woodbury; and
$118,619 in disallowed capital loss from the sale of the Elm Street house;
1999: $31,723 in constructive dividends from Woodbury;
$67,200 in compensation from Woodbury; and
$1,228 in additional gross receipts from Sutter.
As for Woodbury, we find as follows:
(1) Woodbury had no taxable income in 1998 and therefore is not liable for tax, additions to tax, or penalties in that year.
(2) Woodbury had unreported net taxable income of $94,850 in 1999.
(3) Woodbury is liable for the fraudulent failure-to-file addition to tax under section 6651(f) for 1999.
To reflect the foregoing and to allow the parties to resolve the computational issues that will be affected by these findings,
Decisions will be entered under Rule 155.