Opinion
Docket Nos. 28256, 28257, 28258, 28259.
Promulgated June 30, 1953.
Petitioners L. Glenn Switzer and Howard A. Switzer were partners in the Transit Mixed Concrete Company during 1944 and 1945. Petitioner Ida H. Switzer is the wife of L. Glenn Switzer; and petitioner Florence M. Switzer is the wife of Howard A. Switzer. One-half of each husband's partnership interest constituted community property of said spouses under California law. A partnership return of income for each of the years 1944 and 1945 was filed on or before March 15, 1945, and March 15, 1946, respectively. Individual income tax returns were filed by each of the four petitioners for each of the years 1944 and 1945 on or before the 15th day of March following such year. The respondent determined deficiencies and a 5 per cent negligence penalty under section 293 (a) against all four petitioners, and asserted fraud penalties for both years against the two husbands.
1. Held, no part of any of the deficiencies for either of the taxable years determined with respect to the two husbands was due to fraud with intent to evade tax.
2. Held, further, no part of any of the deficiencies for either of the taxable years determined against the wives was due to negligence.
3. Held, further, part of the deficiencies for each of the taxable years determined against the husbands was due to negligence.
4. Held, further, each of the petitioners for each of the taxable years omitted gross income in excess of 25 per cent of the gross income stated in his or her respective return, and the deficiencies were timely asserted within the 5-year period provided by section 275 (c) of the Code.
William A. Cruikshank, Jr., Esq., and John I. Bolen, Esq., for the petitioners.
R. E. Maiden, Jr., Esq., for the respondent.
These consolidated proceedings involve Federal income tax deficiencies and penalties for the calendar years 1944 and 1945 as follows:
Includes claimed increased deficiencies.
Negligence penalty asserted in Docket Nos. 28256 and 28258, in event Court should hold fraud not established.
The 5 per cent addition to the tax under section 293 (a) was pleaded affirmatively by the respondent in amendments to his answers. In Docket Nos. 28256 and 28258, it was an alternative plea to the allegation of fraud. The statutory period for assessment was not extended by any waivers.
Some of the facts were stipulated.
FINDINGS OF FACT.
The stipulated facts are so found and are incorporated herein.
The petitioners L. Glenn Switzer and Howard A. Switzer were partners during the years 1944 and 1945, carrying on their partnership business under the firm name of Transit Mixed Concrete Company in Pasadena, California. The interests of said L. Glenn Switzer and Howard A. Switzer in that partnership were two-thirds and one-third, respectively.
During said years L. Glenn Switzer was married to Ida H. Switzer; said two-thirds partnership interest constituted the community property of said spouses under the laws of the State of California. During said years Howard A. Switzer was married to Florence M. Switzer; said one-third partnership interest constituted the community property of said spouses under the laws of the State of California.
All of the income of the petitioners during the years 1944 and 1945 was derived from said partnership, Transit Mixed Concrete Company.
A partnership return of income for each of the years 1944 and 1945 was filed on or before March 15, 1945, and March 15, 1946, respectively. Individual income tax returns were filed by each of the four petitioners for each of the years 1944 and 1945 on or before the 15th day of March following such year. The notice of deficiency in each proceeding, covering both taxable years, was mailed on February 24, 1950. The respective deficiencies were, therefore, determined and asserted beyond 3 but within 5 years after the respective returns were filed.
The income of said partnership, as reported on the partnership returns and as corrected, is as follows:
Year Reported Corrected Reported Corrected gross gross net net 1944 .... $384,905.04 $405,394.12 $13,936.73 $34,425.81 1945 .... 526,068.71 594,262.31 15,332.71 83,526.31The gross receipts of the partnership, as reported and as corrected, together with the amount omitted expressed as a percentage, are as follows:
Year Reported Corrected Percentage omitted 1944 ....... $1,271,448.34 $1,291,937.40 1.5% 1945 ....... 1,729,486.97 1,797,680.57 3.9% Each petitioner's share of net partnership income, as reported and as corrected, is as follows: 1944 1945 Petitioner Reported Corrected Reported Corrected L. Glenn Switzer ....... $4,645.58 $11,475.26 $5,110.91 $27,842.11 Ida H. Switzer ......... 4,645.58 11,475.27 5,110.91 27,842.11 Howard A. Switzer ...... 2,322.79 5,737.63 2,555.45 13,921.05 Florence M. Switzer .... 2,322.78 5,737.63 2,555.45 13,921.05 The following deficiencies are due in the event that the Court holds that the assessment of such deficiencies, or any of them, is not barred by the statute of limitations: Petitioner 1944 1945 L. Glenn Switzer ........... $2,258.86 $11,074.91 Ida H. Switzer ............. 2,258.86 11,074.91 Howard A. Switzer .......... 809.91 3,768.68 Florence M. Switzer ........ 779.91 3,653.68 The statutory notices issued to petitioners, Howard A. Switzer, Docket No. 28258, and L. Glenn Switzer, Docket No. 28256, contain the following determination of the additional income giving rise to the deficiencies:The following adjustments to the ordinary net income of the Transit Mixed Concrete Company, a partnership, for its taxable years ended December 31, 1944 and December 31, 1945, are based upon an audit made of the books of the partnership * * * as shown below: 1944 1945
Ordinary net income as disclosed by partnership return .................. $13,936.73 $15,332.71 Additional income: California-Portland Cement Co. — special discounts ................ 6,082.29 19,265.66 Discounts not taken by customers .... 4,152.63 17,249.20 Sales tax omitted on invoices ....... 20,864.23 36,776.34 Unidentified items .................. 1,872.98 1,872.96 Corona Nov.-Dec. sales omitted ...... 17,298.31 ----------- ------------ Total ............................... $46,908.86 $107,795.18 Nontaxable Income: Hollywood cash sales entered twice ............................. 14,661.50 26,442.09 ----------- ------------ Ordinary net income adjusted .......... $32,247.36 $81,353.09Each of the petitioners and the individual who prepared the returns of the partnership and of the petitioners for each of the taxable years were either present in the courtroom at the time of the hearing of these proceedings, or else were available on call, in response to subpoenas issued at the request of the respondent. Neither the respondent nor the petitioners called any of said parties as a witness. All of the books and records of the partnership were in the courtroom and available as evidence, but were not offered in evidence by any of the parties.
The respondent offered a short stipulation of facts and the deficiency notices in evidence, together with the partnership returns and the petitioners' individual returns for the taxable years, and rested. The petitioners also rested without offering any further evidence.
No part of any of the deficiencies for either of the taxable years determined against the husbands was due to fraud with intent to evade tax.
No part of any of the deficiencies for either of the taxable years determined against the wives was due to negligence within the purview of section 293 (a) of the Internal Revenue Code.
Part of the deficiencies for each of the taxable years determined against the husbands was due to negligence within the purview of section 293 (a) of the Internal Revenue Code.
Each of the petitioners for each of the taxable years omitted gross income in excess of 25 per cent of the amount of gross income stated in his or her respective income tax return, and the deficiencies were timely asserted within the 5-year period provided by section 275 (c) of the Internal Revenue Code.
OPINION.
In amended answers the respondent asserted fraud penalties against L. Glenn Switzer and Howard A. Switzer, but not against their wives. The wives were not partners in the business but merely had a community interest in the income therefrom.
The respondent argues that for the taxable years 1944 and 1945 the net distributable income of the business was $34,425.81 and $83,526.31, respectively; and that since petitioners and their wives, in the aggregate, reported only $13,936.73 on their 1944 returns and $15,322.72 on their 1945 returns, they understated the income from their business by $20,489.08 for 1944 and $68,203.59 for 1945; and that, expressed in percentages, each of the petitioners failed to account for his or her true income in 1944 by 147.01 per cent and in 1945 by 444.01 per cent. He states that, even in the face of a charge of fraud, the two brothers chose to remain silent and to let go wholly unexplained the reasons for such gross discrepancies between their real and their reported income for 2 straight years.
He points out that the additions determined in the deficiency notices represent an understatement of discounts received in the amounts of $6,082.29 in 1944 and $19,265.66 in 1945; an overstatement of discounts taken by customers in the amounts of $4,152.63 in 1944 and $17,249.20 in 1945; the omission of sales in 1945 to the extent of $17,298.31; sales taxes that had not been included in invoices and, consequently, not in sales, resulting in an understatement in 1944 of $20,864.23 and in 1945 of $36,776.34; and other minor omissions of unidentified items in both years.
He contends that the courts have consistently held that the unsatisfactory accounting, or no accounting, for omissions of income in consecutive years in excess of 100 per cent of true income is sufficient proof of fraudulent intent to sustain the 50 per cent penalty of section 293 (b), citing Rogers v. Commissioner, 111 F.2d 987 (C. A. 6, 1940); Arlette Coat Co., 14 T.C. 751 (1950); and a Memorandum Opinion of this Court. He concludes by arguing that it is unreasonable that the two brothers should have honestly believed that their business had profited in 2 tax years only to the extent of $39,259.44 when the actual profits of the business were $117,952.12, and that the only conclusion to be drawn, in the absence of any explanation from petitioners, is that petitioners were aware that they were not reporting their true income and intended to evade their correct tax liabilities.
SEC. 293. ADDITIONS TO THE TAX IN CASE OF DEFICIENCY.
(b) FRAUD. — If any part of any deficiency is due to fraud with intent to evade tax, then 50 per centum of the total amount of the deficiency (in addition to such deficiency) shall be so assessed, collected, and paid, in lieu of the 50 per centum addition to the tax provided in section 3612 (d) (2).
The cases filed by respondent for the proposition that "omissions of income in consecutive years in excess of 100% of true income is sufficient proof of fraudulent intent to sustain the 50% penalty" do not so hold. The holdings in those cases are based on the entire record and not on the omission of income alone. In addition, such cases are distinguishable on their facts. It appears from the deficiency notices in this case that there were errors which resulted from large overstatements of income as well as large understatements.
The burden of proof in fraud cases is, of course, upon the respondent. It must be clear and convincing proof. Evidence of inefficiency and ignorance of accounting methods are not sufficient to establish fraud. Walter M. Ferguson, Jr., 14 T.C. 846 (1950); W. F. Shawver Co., 20 B. T. A. 723 (1930). Here, we are not even advised that there was inefficiency or ignorance. We are shown merely that there was a large understatement of income, and, on that showing the respondent rests his case. That is not enough to carry his burden of proof to establish fraud. The Commissioner cannot sustain his burden of proof on a fraud issue by statements made in his notice of deficiency. Oscar G. Joseph, 32 B. T. A. 1192, 1204 (1935). That fraud is not established by the mere understatement of taxable income is shown by our holding in James Nicholson, 32 B. T. A. 977, 989 (1935), affd. 90 F.2d 978 (C. A. 8, 1937), where we said:
Here fraud is not admitted. The mere fact that his return showed a net income for the taxable year 1929 in the sum of $40,424,66 and the respondent, in recomputing his tax liability, determined that the net income for that year was $73,435.38, by itself, does not establish fraud. If it did, then all taxpayers against whom deficiencies are determined would be guilty of fraud and subject to the imposition of a fraud penalty. * * *
Fraud implies bad faith, intentional wrongdoing, and a sinister motive. It is never imputed or presumed. Mere suspicion of fraud and mere doubts as to the intentions of the taxpayer are not sufficient proof of fraud. Sharpsville Boiler Works Co., 3 B. T. A. 568 (1925); J. William Schultze, 18 B. T. A. 444 (1929); Arthur M. Godwin, 34 B. T. A. 485 (1936); Arthur S. Barnes, 36 B. T. A. 764 (1937); Nicholas Roerich, 38 B. T. A. 567 (1938), affd. 115 F.2d 39 (C.A.D.C., 1940), certiorari denied 312 U.S. 700 (1941); L. Schepp Co., 25 B. T. A. 419 (1932).
Respondent's amendments to his answers in this case allege no facts in support of the fraud charge except that petitioners received net taxable income in excess of the amount set forth, and respondent's conclusion that the petitioners knowingly and fraudulently failed to report such amounts.
Reading between the lines of the record made in this case could lead one to a number of conclusions as to why the understatement of income occurred. We are not, however, permitted to speculate. The burden is that of the respondent, and he has failed to sustain it. The reports are replete with cases where the Commissioner has offered a considerable amount of evidence other than the deficiency notice and the returns to sustain his burden of proving fraud but has fallen short thereof. The witnesses subpoenaed by the respondent were in the courtroom at the hearing of these proceedings or were available on short notice. They included the petitioners and the bookkeeper who prepared the returns, but they were not called as witnesses. The books and records of the partnership were also in the courtroom, but they were not offered in evidence either. To hold that there was fraud with intent to evade taxes under these facts would be tantamount to a holding that fraud may be presumed. See Henry S. Kerbaugh, 29 B. T. A. 1014 (1934), affd. 74 F.2d 749 (C. A. 1, 1935). We, therefore, hold for petitioners on this issue.
The respondent, by amendments to the answers, affirmatively alleged that a part of each deficiency for each taxable year in the case of each petitioner was due to negligence, and that, therefore, the 5 per cent addition to the tax provided by section 293 (a) is applicable.
SEC. 293. ADDITIONS TO THE TAX IN CASE OF DEFICIENCY.
(a) NEGLIGENCE. — If any part of any deficiency is due to negligence, or intentional disregard of rules and regulations but without intent to defraud, 5 per centum of the total amount of the deficiency (in addition to such deficiency) shall be assessed, collected, and paid in the same manner as if it were a deficiency, except that the provisions of section 272 (i), relating to the prorating of a deficiency, and of section 292, relating to interest on deficiencies, shall not be applicable.
As to the two wives, it is stipulated that their interest in the partnership income arises from the community property law of the State of California. Under that law, the management and control of the community property is vested in the husband. The record does not show that the wives participated in any way in the business of the partnership, in the management of its affairs, in the accounting of the income produced therefrom, or in the preparation of the returns. We, therefore, conclude that as to the wives, the respondent has not sustained his burden of proof; and the 5 per cent addition to the tax may not be asserted against them. See Harold B. Franklin, 34 B. T. A. 927, 941-942 (1936).
Sec. 172, Civil Code of California.
With respect to the two husbands, the record shows that they understated their income in 1944 by 147.01 per cent and in 1945 by 444.01 per cent. The deficiency notices show numerous adjustments in large amounts to the net income of the partnership. Such large discrepancies between real net income and reported income and numerous adjustments are strong evidence of negligence and, in our opinion, are sufficient to establish a prima facie case shifting the burden of going forward with the evidence to these petitioners. See Morrisdale Coal Mining Co., 13 T.C. 448 (1949); Estate of L. E. McKnight, 8 T.C. 871 (1947); Robinette v. Commissioner, 139 F.2d 285 (C. A. 6, 1943), certiorari denied 322 U.S. 745 (1944); B. F. Edwards, 39 B. T. A. 735 (1939); Commissioner v. Renyx, 66 F.2d 260 (C. A. 2, 1933); C. A. Hutton, 21 B. T. A. 101 (1930), affd. 59 F.2d 66 (C. A. 9, 1932). No explanation for such large discrepancies between actual and reported income was offered to the Court, and the only fair inference on this record is that the adjustments were necessary primarily because these petitioners were negligent in keeping their accounts and rendering their returns, and that the deficiencies, in part, resulted from their negligence. It, therefore, follows that the 5 per cent addition to the tax against these petitioners must be upheld. See Watson-Moore Co., 30 B. T. A. 1197 (1934).
Section 275 (c) of the Internal Revenue Code provides that if the taxpayer omits from gross income an amount properly includible therein which is in excess of 25 per centum of the amount of gross income stated in the return, the tax may be assessed, or a proceeding in court for the collection of such tax may be begun without assessment, at any time within 5 years after the return was filed. The deficiencies in this case were determined and asserted beyond 3 but within 5 years after the respective returns were filed.
The petitioners argue that a partner's gross income is his proportionate share of partnership gross income; or, stated another way, that for the purposes of section 275 (c) the gross income of a partner is his share of partnership gross income, and not his share of partnership net income. They contend that, under this concept, L. Glenn Switzer and his wife, for example, should be considered the owners and operators of 75 per cent of the partnership business as if it were a separate business operated by them as a sole proprietorship. They state that, if that is correct, their gross income would be total sales, less the cost of goods sold, plus any income from investments and from incidental or outside operations or sources. On this basis, they argue that the omissions in each of these proceedings and for each of the years do not exceed 25 per cent of the gross income reported.
They also argue that this partnership gross income is "stated in the return"; that it is presented in the manner and on the forms prescribed by the Code and the Commissioner's regulations; that the partnership returns, as informational returns for administrative convenience, disclose data incorporated into the individual returns by reference; that these data are stated in the individual returns as surely as information contained on Schedule C of Form 1040 which is set forth on a separate unattached schedule, furnished by the Commissioner and adopted by him, since 1951, for the sake of convenience, citing Maurice H. Van Bergh, 18 T.C. 518 (1952), on appeal C. A. 2, February 6, 1953; and that, since the basis of taxing the income of partnership operations requires that the partner be treated as if he were a sole proprietor to the extent of his share of the business, except in a few situations covered expressly by statute, there seems to be no justification for applying section 275 (c) differently to a partner than to a sole proprietor.
Section 182 of the Code charges to each partner his distributive share of the net income or capital gain of the partnership. That income is required to be reported by each partner on his individual return and is necessarily a part of all of his income which must be included under the broad, general definition of gross income contained in section 22 of the Code. If the petitioners' argument is correct, an anomalous situation would present itself in a case where a partnership has gross income but sustains a net loss for the year. If a partner in such partnership had gross income from other sources which he reported but failed to include therein his proportionate share of the partnership gross income, and such omission resulted in an omission in excess of 25 per cent of the amount of gross income stated in his return, petitioners' argument would require a holding that section 275 (c) applied. Merely to state such a proposition shows the fallacy of petitioners' argument.
In Anna Eliza Masterson, 1 T.C. 315 (1942), reversed on other grounds 141 F.2d 391 (C. A. 5, 1944), we had occasion to construe section 275 (c) in connection with an omission in excess of 25 per cent of gross income shown on a taxpayer's individual return and an estate return in which the taxpayer showed the balance of her income, which should have been reported in her individual return. We there said at page 324:
That section is explicit in its reference to "the taxpayer." The "gross income" from which an omission brings the section into play must be the gross income of that taxpayer and "the return" referred to must be his return. If the provision were to be construed so that an omission from one taxpayer's return would be without effect upon a showing that the unreported income was contained in the return of some other taxpayer, its effect would be largely nullified. In other words, it does not comport with the purpose or language of the statute to say that the gross income shown on the return of another taxpayer is the same as "the gross income" of "the taxpayer."
The petitioners also cite Treasury Regulations 111, section 29.422-2, interpreting section 422 (a) of the Code relating to "Unrelated Business Net Income" of exempt organizations; and a 1949 Bureau ruling under section 251 of the Code relating to "Income From Sources Within Possessions of the United States," I. T. 3981, C. B. 1949-2. We have carefully considered both authorities, which deal with special provisions of the Code, and are of the opinion that they do not help in solving the problem presented here.
We, therefore, hold that the net income of the partnership distributable to petitioners is a part of their gross income for purposes of section 275 (c), and the deficiencies were timely asserted.
Decision will be entered under Rule 50.