Opinion
Docket No. 36679.
1954-07-14
HYMAN B. STONE AND GOLDE STONE, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Christopher Del Sesto, Esq. , and Edward V. Healey, Jr., Esq. , for the petitioners. James R. McGowan, Esq. , for the respondent.
Petitioners filed joint estimates of income but no return for 1943. Returns signed by the husband alone and naming both as taxpayers were filed for 1944 and 1945. Books for 1943 were not produced, records for 1944 and 1945 did not show sales, and some receipts could not be traced. Income was computed for 1943 from increase in net worth plus living expenses. Income for 1944 and 1945 was computed by applying 1943 rate of markup to 1944 and 1945 cost of goods sold.
Held: 1. Deficiencies determined from income as computed are not arbitrary and unreasonable and are sustained with minor modifications;
2. Taxpayers are jointly liable for deficiencies and additions to the tax for all years; and
3. Deficiency for 1943 was not due to fraud with intent to evade tax. Christopher Del Sesto, Esq., and Edward V. Healey, Jr., Esq., for the petitioners. James R. McGowan, Esq., for the respondent.
The respondent determined deficiencies in income tax against both petitioners for the calendar years 1943, 1944, and 1945, in the respective amounts of $12,161.34, $16,111.76, and $18,061.74, together with additions to the tax for 1943 for fraud in the amount of $6,080.67 and for delinquency in the amount of $2,675.02 and 5 per cent additions for negligence for 1944 and 1945 in the respective amounts of $805.59 and $903.09.
There are several issues for decision. They concern the amount of the net income of the petitioners in the taxable years, whether the petitioners are jointly and severally liable for the taxes thereon, and whether the several additions to tax determined by the respondent are proper. A partial stipulation of facts was filed. The returns were filed with the collector of internal revenue at Providence, Rhode Island.
FINDINGS OF FACT.
The stipulated facts are so found and the exhibits to the stipulation are incorporated by this reference.
The petitioners are husband and wife. They are citizens of the United States. During the years 1943, 1944, and 1945 they resided in Providence, Rhode Island.
The petitioners have three children, Jacob, born about 1918; Leo, born about 1921; and Claire, born about 1925. Jacob, in 1943, was a student at Georgetown Medical School in Washington, D. C.; in 1944 he was an intern in New Haven; and in 1945 he was a resident physician in Mount Sinai Hospital in New York. Leo, in 1943, was a student at Tufts Dental College in Boston, and in 1944 and 1945 was a practicing dentist in Providence. Claire was a student at Pembroke College in Providence in the taxable years and worked on a part-time basis in Hyman Stone's meat market. She was claimed as a dependent in the 1944 and 1945 income tax returns signed by Stone.
Golde Stone was the owner of improved property at 125 Manton Avenue in Providence. Hyman B. Stone operated a meat market on the ground floor and the upper floor was rented to a tenant. This property had an assessed value in 1943 of $4,460 for the land and $6,000 for the building. On January 1, 1943, the value of this property was $5,135. The depreciation charges amounted to $195 per year. The rental income from the property was as follows:
+--------------------------------------------+ ¦ ¦1943 ¦1944 ¦1945 ¦ +--------------+---------+---------+---------¦ ¦Gross rent ¦$1,800.00¦$1,260.00¦$1,380.00¦ +--------------+---------+---------+---------¦ ¦Depreciation ¦195.00 ¦195.00 ¦195.00 ¦ +--------------+---------+---------+---------¦ ¦Repairs ¦ ¦286.00 ¦ ¦ +--------------+---------+---------+---------¦ ¦Other expenses¦ ¦65.00 ¦65.00 ¦ +--------------+---------+---------+---------¦ ¦Taxes ¦261.50 ¦ ¦246.00 ¦ +--------------+---------+---------+---------¦ ¦Net rental ¦$1,343.50¦$714.00 ¦$874.00 ¦ +--------------------------------------------+
The petitioners as joint tenants owned property at 100 Eaton Street in Providence. They lived on the first floor and rented the second floor to tenants. The property had a basis of $15,000 to the petitioners in 1930 and of $12,300 on January 1, 1943. Its assessed value in 1943 was $1,780 for the land and $10,000 for the building. Depreciation charges for the rented portion of the building amounted to $225 per year. Deducting taxes and other expenses, the net rental income from the rented portion of this property was as follows:
+--------------------------------------+ ¦ ¦1943 ¦1944 ¦1945 ¦ +--------------+-------+-------+-------¦ ¦Gross rents ¦$660.00¦$660.00¦$660.00¦ +--------------+-------+-------+-------¦ ¦Depreciation ¦225.00 ¦225.00 ¦225.00 ¦ +--------------+-------+-------+-------¦ ¦Taxes ¦149.25 ¦ ¦145.00 ¦ +--------------+-------+-------+-------¦ ¦Repairs ¦ ¦200.00 ¦225.00 ¦ +--------------+-------+-------+-------¦ ¦Other expenses¦ ¦35.00 ¦35.00 ¦ +--------------+-------+-------+-------¦ ¦Net rental ¦$285.75¦$200.00¦$30.00 ¦ +--------------------------------------+
During the years 1942 through 1945, Hyman B. Stone was the sole owner of a meat business operated under the trade names of ‘Stone's Meat Market’ and ‘R. I. Dressed Beef Co.’ at 125 Manton Avenue. This business was both wholesale and retail. Stone also bought and sold dairy cattle. During the summer months of the taxable years Stone made trips to Canada to buy and import dairy cows. These he sold to dairy farmers in Massachusetts or Rhode Island or exchanged for beef cattle. In 1943 he imported 68 dairy cows from Ontario. He also bought beef cattle through a Chicago broker. He bought meat from several packing companies and groceries from various grocery supply concerns. He had cattle slaughtered for his account and during 1944 and 1945 collected subsidies from Defense Supplies Corporation, a Government agency, for cattle slaughtered for his account between June 1943 and December 1945. In 1944 he received subsidy checks totaling $4,710.07 and in 1945, $2,585.13. Subsidy checks amounting to $2,547.24 received in 1944 were cashed and the others were deposited in Stone's bank accounts. Subsidy checks received in 1945 were all deposited in Stone's bank accounts. In 1947 Stone refunded $839.47 to Defense Supplies Corporation.
During 1943 Stone maintained a checking account with the National Bank of Commerce & Trust Company, Providence, Rhode Island, under the name of ‘R. I. Dressed Beef Company.’ According to the bank's records, the balance in this account on January 1, 1943, was $1,237.94, and on December 31, 1943, it was $2,999.33.
During 1943 Stone maintained another checking account in his own name with the same bank. According to the bank's records the balance in this account on January 1, 1943, was $4,052.25 and on December 31, 1943, it was $9,736.27.
Stone also had a Canadian bank account in the Bank of Nova Scotia. The balance in this account was $95.28 on January 1, 1943, and was $11.94 on December 31, 1943.
During 1943, 1944, and 1945, Hyman B. Stone maintained savings accounts in his own name with the National Bank of Commerce & Trust Company (#459) and with the Peoples Savings Bank, Providence, Rhode Island (#75066). During 1943 Stone opened a savings account (#0–5980) in his own name, with the Rhode Island Hospital Trust Company, and another (#432342) with the Providence Institution for Savings. During 1943, 1944, and 1945, Golde Stone maintained a savings account (#7357) in her own name, with the National Bank of Commerce & Trust Company. The balances in these accounts at the end of the years 1942 to 1945 were as follows:
+-------------------------------------------------+ ¦Year¦#459 ¦#75066 ¦#0–5980 ¦#432342 ¦#7357 ¦ +----+--------+--------+--------+--------+--------¦ ¦1942¦$300.43 ¦$9.63 ¦ ¦ ¦$5.11 ¦ +----+--------+--------+--------+--------+--------¦ ¦1943¦503.23 ¦964.81 ¦$500.00 ¦$550.00 ¦250.00 ¦ +----+--------+--------+--------+--------+--------¦ ¦1944¦507.61 ¦976.92 ¦1,757.19¦619.28 ¦2,109.36¦ +----+--------+--------+--------+--------+--------¦ ¦1945¦4,512.70¦2,991.62¦1,774.81¦1,424.29¦2,222.62¦ +-------------------------------------------------+
On January 1, 1943, petitioners owned no war bonds. During 1943 petitioners purchased war bonds in their own names, costing $1,275. Petitioners did not redeem any bonds during 1943.
On January 1, 1943, Stone owed his son, Jacob, $2,448.10. During 1943 Stone paid off $49.27 of this indebtedness, leaving a balance of $2,398.83 owed as of December 31, 1943. During 1944 no payments were made. During 1945 Stone paid off $1,119.89. All such payments were made by deposits in joint savings account, #52895, maintained with the Union Trust Company, Providence, Rhode Island, in the name of ‘Hyman B. Stone or Jacob Stone.’
On January 1, 1943, the petitioners owed $4,000 on a mortgage held by Citizens Savings Bank, Providence, Rhode Island, covering the property at 125 Manton Avenue. Both petitioners were liable on the mortgage. The petitioners made the following payments against principal:
+--------------------------------+ ¦Date ¦Principal payments¦ +-------------+------------------¦ ¦Mar. 13, 1943¦$1,000 ¦ +-------------+------------------¦ ¦Apr. 15, 1943¦1,000 ¦ +-------------+------------------¦ ¦July 24, 1943¦1,900 ¦ +-------------+------------------¦ ¦Feb. 16, 1944¦100 ¦ +-------------+------------------¦ ¦Total ¦$4,000 ¦ +--------------------------------+
The petitioners made the following payments against principal during 1943 paying in full a mortgage loan held by the Home Owners Loan Corporation covering the property at 100 Eaton Street:
+----------------------------------------------+ ¦Date ¦Principal payments¦ +---------------------------+------------------¦ ¦Jan. 23, 1943 ¦$113.86 ¦ +---------------------------+------------------¦ ¦Mar. 3, 1943 ¦57.35 ¦ +---------------------------+------------------¦ ¦Apr. 27, 1943 ¦115.14 ¦ +---------------------------+------------------¦ ¦June 9, 1943 ¦116.00 ¦ +---------------------------+------------------¦ ¦July 17, 1943 ¦58.44 ¦ +---------------------------+------------------¦ ¦Aug. 20, 1943 ¦$58.65 ¦ +---------------------------+------------------¦ ¦Sept. 22, 1943 ¦58.87 ¦ +---------------------------+------------------¦ ¦Oct. 21, 1943 ¦59.10 ¦ +---------------------------+------------------¦ ¦Dec. 6, 1943, final payment¦3,961.56 ¦ +---------------------------+------------------¦ ¦Total ¦$4,598.97 ¦ +----------------------------------------------+
In 1944 Stone opened a new checking account with the Rhode Island Hospital National Bank and Claire Stone was given authority to draw checks on this account.
In selling cattle to farmers Stone sometimes accepted notes. Some of these he discounted at one of the banks. He also borrowed money from a bank. In January 1943 he paid $1,800 in full payment of a loan made in July 1942. In October 1942 he discounted a note of G. Cunetta in the amount of $203.03. This note was paid on the due date in January 1943. Helen S. Franklin, who was in the dairy business, bought dairy cows from Stone and sold him calves and beef cows. On January 1, 1943, she owed Stone $1,725. Most of this account was paid during the year 1943. On December 31, 1943, she owed Stone a balance of $134.50.
Stone's meat market inventory was $1,875 on January 1, 1943, and $2,200 on December 31, 1943. His store equipment had a depreciated value of $1,00 on January 1, 1943, and depreciated in the amount of $300 during the year 1943.
Abraham Press is a brother of Golde Stone. Press was a practicing accountant prior to 1942, and since then has devoted his time to United Packing Company of which he is treasurer. Until 1942 Press kept books for Stone, calling at the Stones' residence once each week to post the records, and he prepared the tax returns each year. The records kept were not a double entry system. There was a cash receipts and disbursements record for the meat business and a separate record for the cattle dealings. The cattle purchases were recorded by ‘lots,’ a lot of 20 or so shown on a page, with costs, expenses, and sales recorded on the page. Press did not keep Stone's records in 1943, but prepared the declarations of estimated tax filed by the petitioners in 1943. In December 1943 while visiting the petitioners he learned that the earlier estimate was too low and suggested that they file an amended estimate. He prepared such an estimate which was filed on December 27. Press also drew a check dated December 15, 1943, on the ‘Hyman B. Stone’ account payable to the collector in the amount of $791.15, and noted on the check ‘Final Payment on 1943 Estimated Tax Return.’ Stone signed the check, which was duly honored. Press did not prepare a return for 1943 for the petitioners.
Edward Walsh began keeping the records of Stone's market and cattle businesses in 1943. He kept separate records for each of the two businesses. He spent one or two hours one evening each week on this work. He recorded cash receipts and payments, and made out checks to pay bills from packing houses. Stone gave him the figures for weekly sales. He kept a journal for the dairy cow business recording as to each animal the cost, expenses, and proceeds of sale. Walsh quit before the end of 1943. He did not prepare a tax return for 1943 for the petitioners. He kept no records of accounts payable.
After Walsh left, Stone's daughter, Claire, drew checks for payment of Stone's bills. She kept no records.
Henry Eisenberg kept books for Stone beginning about January 1944. He went to Stone's house once a week for a few hours in the evening. He found among Stone's records a copy of a 1942 return, but no copy of a return for 1943, and no bookkeeping records for 1943. Eisenberg prepared the taxpayers' returns for 1944 and 1945. The 1944 return was prepared on March 14, 1945, and the reported figure for profit on the milk cow business was the difference between the opening and closing balances in the bank account used in that business. Detailed records were available but Eisenberg did not take the time to make a computation from them. The figure he used was an estimate. Eisenberg was given a figure each week by Stone representing the deposits made at the bank. Eisenberg computed the store sales by adding to this figure the payroll paid out of the cash register and personal withdrawals by Stone. These figures were used in making out the income tax returns for 1944 and 1945.
Stone made a practice of cashing checks for employees of mills in the vicinity of the store, whether they were customers of his or not. On days when such employees were paid, Stone drew extra cash from the bank to have on hand for this purpose. Later the checks he cashed were deposited to his account.
Stone's checking account under the name of ‘R. I. Dressed Beef Company’ was used primarily for his meat market business. The checking account under the name of ‘Hyman B. Stone’ was used primarily in connection with his purchases of dairy cows. When funds were low in one account, Stone would transfer funds from other accounts to maintain sufficient balances. The rental income was deposited in the ‘R. I. Dressed Beef Company’ account.
In 1943 the petitioners expended $20 per week, or $1,040 in the year, in cash for personal and living expenses. In addition they expended for personal and living expenses $5,113.50 through checks drawn on the ‘R. I. Dressed Beef Company’ bank account and $841.15 through checks drawn on the ‘Hyman B. Stone’ checking account.
In 1943 Stone's bank deposits in his checking accounts, less redeposits, amounted to $132,277.56. He paid cash wages in the amount of $6,338. His opening inventory of the meat market was $1,875 and closing inventory $2,200. His purchases and other costs on account of the meat market and cattle dealing businesses together paid by checks amounted to $106,088. He sustained deductible depreciation on his business equipment of $300 and had other deductible business expenses of $6,203.59. The petitioners had income of $4.30 from bank interest.
The percentage of gross business profit over cost of goods sold in 1943 from the meat market and dairy cow businesses combined was 38 per cent.
In 1944 Stone had an opening inventory of $2,200, and closing inventory of $750. His purchases and other costs paid from the ‘Hyman B. Stone’ and ‘R. I. Dressed Beef Company’ accounts were $99,719.47 in connection with both businesses. His gross profit from meat market and cattle dealing was $38,444.56. He paid businesses expenses of salaries, taxes, and miscellaneous expenses of $8,703.67 and had depreciation of $300 on his business equipment, leaving a net business income of $29,440.89. In addition he received income from meat subsidies in the amount of $4,710.07. The petitioners also had net rental income of $914.
In 1945 Stone's opening inventory was $750 and his closing inventory $750. His purchases and other costs paid from his ‘R. I. Dressed Beef Company’ and ‘Hyman B. Stone’ checking accounts were $113,222.71. His gross profit from meat market and cattle dealing was $43,024.63. He paid salaries and other business expenses amounting to $7,985.19 and had depreciation on his business equipment of $300, leaving a net business income of $34,739.44. In addition he had income from meat subsidies in the amount of $2,585.13. The petitioners also had net rental income of $904.
The petitioners filed a joint income tax return for the calendar year 1942. The return showed total income of $6,990.05, part from rents, part from operating of a meat market, and part as farm income involving sale of dairy cattle. The tax shown on the return was $870.13. The return was signed by both petitioners.
On September 25, 1943, the petitioners filed a joint declaration of estimated tax for 1943 and on December 27, 1943, they filed an amended joint declaration of estimated tax for 1943. These declarations showed the following:
+-----------------------------------------------------------------------------+ ¦ ¦September¦December ¦ ¦ ¦25 ¦27 ¦ +---------------------------------------------------------+---------+---------¦ ¦Estimated income and Victory Tax 1943 ¦$870.13 ¦$1,461.28¦ +---------------------------------------------------------+---------+---------¦ ¦Estimated income tax withheld and to be withheld during ¦None ¦None ¦ ¦entire year 1943 ¦ ¦ ¦ +---------------------------------------------------------+---------+---------¦ ¦Estimated tax after deducting estimated tax withheld ¦870.13 ¦1,461.28 ¦ +---------------------------------------------------------+---------+---------¦ ¦Total payments to collector in 1942 ¦470.13 ¦670.13 ¦ +---------------------------------------------------------+---------+---------¦ ¦Unpaid balance of estimated tax ¦400.00 ¦791.15 ¦ +---------------------------------------------------------+---------+---------¦ ¦Amount paid with this declaration ¦200.00 ¦791.15 ¦ +-----------------------------------------------------------------------------+
The petitioners filed no income tax returns for the calendar year 1943.
Income tax returns for the calendar years 1944 and 1945 were filed giving the taxpayers' names as ‘Hyman B. and Golde Stone,’ but signed only by Human B. Stone. These returns reported the following items:
+-------------------------------------------+ ¦ ¦1944 ¦1945 ¦ +-----------------------+---------+---------¦ ¦Income ¦$6,311.88¦$8,221.90¦ +-----------------------+---------+---------¦ ¦Tax ¦899.97 ¦1,808.23 ¦ +-----------------------+---------+---------¦ ¦Income from rents (net)¦914.00 ¦904.00 ¦ +-----------------------+---------+---------¦ ¦Meat market business ¦3,897.88 ¦5,840.98 ¦ +-----------------------+---------+---------¦ ¦Milk cow business ¦1,600.00 ¦1,476.92 ¦ +-----------------------+---------+---------¦ ¦Deductions ¦1,168.00 ¦ ¦ +-------------------------------------------+ Deductions included depreciation on the rental property owned by Golde Stone. A computation attached to the 1945 return showed milk cow sales at $20,510, costs $18,733, farm rent $300, and net gain $1,476.92. The return for 1944 showed gross meat market sales of $79,719.20, opening inventory $2,200, closing inventory $750, merchandise bought $68,622.87, and expenses of $5,748.45. For 1945, the meat market figures were: Gross sales $101,228.90, opening inventory $750, closing inventory $750, merchandise bought $87,283.95, and expenses $6,160.
The petitioners filed joint Federal income tax returns for 1944 and 1945.
The petitioners' failure to file an income tax return for 1943 was without reasonable cause.
No part of the deficiency for 1943 was due to fraud with intent to evade tax.
The deficiencies for 1944 and 1945 were due at least in part to negligence or intentional disregard of rules and regulations.
OPINION.
TIETJENS, Judge:
We will first dispose of the contention made in a separate brief by petitioner Golde Stone. She argues that the respondent's determinations are invalid as against her since she did not sign a return for any of the taxable years and that she did not take part in her husband's businesses.
It is not essential that a return be signed by both spouses to be a joint return. Kann v. Commissioner, (C. A. 3, 1953) 210 F. 2d 247, affirming 18 T. C. 1032, certiorari denied 347 U. S. 967; Myrna S. Howell, 10 T. C. 859 (1948), affd. (C. A. 6, 1949) 175 F. 2d 240; Joseph Carroro, 29 B. T. A. 646. The issue depends upon the intent of the taxpayers when they omitted to file a return for 1943 and at the times the returns for 1944 and 1945 were filed.
Hyman and Golde Stone signed a joint return for 1942 and two joint declarations of estimated tax for 1943. Their failure to file a return for 1943 is explained as due to confusion about the new system of tax collection then inaugurated and they imply that they believed the joint estimates were all that was required of them. Manifestly their intention was to file a joint return. The returns filed for 1944 and 1945 gave the names of ‘Hyman B. and Golde Stone’ as the taxpayers and included items of income from rentals which it is now contended were Golde's income. She contributed indirectly to earning the business income, for her husband used her property at 125 Manton Avenue for his market rent free. She has never filed a separate return for any of these years reporting separate income; and, if the 1944 and 1945 returns were not hers, she is delinquent as to those years as well as to 1943. The respondent determined that these taxpayers were jointly liable for the deficiencies for 1943, 1944, and 1945. The burden is upon them to show error in this determination. Hyman Stone did not testify as to 1943, his counsel restricting his testimony to matters concerning the years 1944 and 1945. Golde Stone did not testify at all. There was no evidence to rebut the presumption that the respondent's determination as to joint liability for 1943 was correct. See Joseph Calafato, 42 B. T. A. 881 (1940), affd. (C. A. 3, 1941) 124 F. 2d 187. Nor was any evidence presented to show that Golde Stone regarded the returns for 1944 and 1945 as unauthorized joint returns. The taxpayers believed these returns had been signed by both of them until at the hearing of the case it was disclosed that Golde's signature was lacking. Then, for the first time, it was contended that they were not joint returns. The respondent accepted these returns as joint and determined that the taxpayers were jointly liable for the deficiencies for 1944 and 1945. The taxpayers have not shown that they did not intend these as joint returns. We conclude that the taxpayers filed joint returns for 1944 and 1945 and that they are jointly liable for any deficiency and additions to the tax for 1943 as well.
The deficiency for 1943 was determined upon the net worth basis. Upon investigation, the respondent's agent was unable to find the taxpayers' books and records for that year. The taxpayers did not produce such records and asserted that the records were lost except for canceled checks and bank statements which were produced. The agent made two computations of the taxpayers' income for 1943, one on the basis of their increase in net worth plus living expenses, and the other on the basis of records procured from banks and other sources showing the taxpayers' receipts and disbursements. The computation on the receipts and disbursements basis was reconcilable with the net worth computation. The deficiency was based upon a taxable net income of $28,324.20 as computed on the net worth increase basis, which computation resulted in the lesser tax. The tax was computed at $12,161.34. The estimated tax on the last estimate filed was $1,461.28 upon the basis of an estimated income of $7,000. The respondent determined additions to the tax of 50 per cent for fraud and 25 per cent for failure to file a return.
The petitioners complain that the deficiency notice did not afford them enough information as to the respondent's position to enable them fully to prepare their case. The notice showed the net income attributed to the petitioners for each year and the amount of tax determined to be due. The respondent's answer to the petition stated that income attributed to the petitioners for 1943 was computed on the net worth basis. The adjustments for 1944 and 1945 were stated in the deficiency notice to constitute unreported business income and unreported meat subsidies. The loss of the records for 1943 may have been a handicap to the petitioners, but the respondent's investigation was painstaking and the petitioners admit the correctness of most items of the net worth increase determined. The petitioners made no attempt to invoke Rule 18 of this Court to require a better statement of the nature of the claim or defense. Nor did the petitioners testify as to the income for 1943. They do not suggest that they might have presented other evidence had the respondent's proof been disclosed to them earlier.
The respondent's computation of the net worth increase of the petitioners for 1943 shows a net increase in assets of $10,827.55 and a decrease in liabilities of $10,502, a total of $21,329.55. Most of the bank balances were increased and mortgages and loans were largely paid off. To this were added $1,040 used for living expenses estimated at $20 per week upon the basis of Stone's statement that he gave his wife $20 to $25 per week for living expenses, and $5,954.65 in checks drawn by Stone which appeared to be for personal use, making a taxable income of $28,324.20. The petitioners present various computations to point out errors in that of the respondent. The computations relating to the joint net worth of the petitioners are in most items identical with the respondent's figures, but show the following differences which we now resolve.
(1) The joint account of Stone and his son, Jacob, which the respondent treated as an asset of the petitioners represented an asset of Jacob from which Stone had borrowed and was obligated to repay. This has now been stipulated. The net income is not affected by this difference.
(2) It is shown by the evidence, and we have found, that Stone had a bank account in the Bank of Nova Scotia with a balance of $95.28 on January 1, and of $11.94 on December 31, 1943. Apparently the respondent does not contest this.
(3) The petitioners show as a note receivable on January 1, 1943, an amount of $203.03. This apparently represents a note Stone accepted in 1942 in payment for a sale of cattle and which he discounted at his bank in 1942. This note was paid in 1943 apparently by the maker. Since Stone had the cash for the item prior to 1943 the note was not an asset of his on January 1 of that year. On the other hand, the respondent treats it as a liability on January 1 which was reduced during the year. Stone's liability was indirect, as he endorsed the note in discounting it. Hence, this should not be treated as a liability at the beginning of the year or as having been reduced during 1943.
(4) The petitioners allege that there were accounts receivable in the amount of $10,186 on January 1, 1943, and $1,538 on December 31, 1943. Stone had no records of these accounts. We have found that Helen S. Franklin owed $1,725 at the beginning of 1943 and $134.50 at the end of the year. There were no records of the other accounts, but testimony of witnesses was given as to them. The accounts arose upon sales of cattle by Stone. The witnesses who testified were attempting to recall amounts owing at a date nearly 10 years prior to the hearing. The testimony was vague, and sometimes contradictory. Except for the debt due from Helen S. Franklin we have concluded that the evidence is not sufficient to support a finding that any of these amounts were owing to Stone on the dates given. We deem it unnecessary to discuss this testimony in detail.
Except for the minor corrections noted in the preceding paragraphs, the evidence presented by the petitioners fails to show error in the respondent's determination of their taxable income for 1943. Adjustment for the items described may be made in a computation under Rule 50.
The respondent asserted the 25 per cent addition to the tax provided in section 291(a) of the Internal Revenue Code for failure, without reasonable cause, to file a return for 1943. The petitioners contend that they were confused as to the required returns at the inauguration of the new system of collecting taxes by withholding and declarations of estimate and thought they had complied with all the requirements in filing the last estimate in December 1943. They further contend, on brief, that they depended on Press to take care of their income tax requirements. Press testified that he suggested the filing of the December estimate so the amounts paid pursuant to the estimates would be more in line with the ‘tax bill that would come up for 1943.’ The check prepared by Press showed that it was in payment of ‘Estimated Tax.’ Press did not prepare a 1943 return for the petitioners and apparently did not consider it his responsibility. The petitioners neglected to see that a return for the year was filed. Even if we assume that petitioners relied upon Press to prepare their return for 1943, such reliance upon an agent does not constitute reasonable cause for delinquency. Malcolm Clifton Davenport, 6 T. C. 62; Berlin v. Commissioner, (C. A. 2, 1932) 59 F.2d 996, affirming a Memorandum Opinion of this Court. We are not convinced that there was reasonable cause for the failure to file a return for 1943.
The burden is upon the respondent to prove that the deficiency for 1943 is, at least in some part, due to fraud with intent to evade tax. Sec. 1112, I. R. C. It is shown that the petitioners estimated their income at $7,000 and tax at $1,461.28 in December of 1943, whereas their income was over $26,000 and their tax over $11,000. While a gross understatement is strong evidence of fraud, Rogers v. Commissioner, (C. A. 6, 1940) 111 F. 2d 987; Halle v. Commissioner, 175 F. 2d 500, affirming 7 T. C. 245, certiorari denied 338 U. S. 949, this fact alone and with reference to a single tax year does not convince us that there was fraud with intent to evade tax in this instance.
The deficiencies for 1944 and 1945 were computed on a different basis. The respondent's agent was unable to verify the sales reported on the returns, but was able from the bank checks to ascertain purchases and expenses. He computed the percentage of gross business profit over cost of goods sold in 1943 from the meat market and the dairy cow businesses combined, which he found to be 40.2 per cent, and applied it to the cost of goods sold as computed for 1944 and 1945. The subsidy checks received were added to the income thus computed. As finally determined by the respondent the adjusted net income for 1944 was $35,820.19 and the adjusted gross income for 1945 was $40,493. For comparison, the net income shown on the returns was $5,143.88 for 1944 and $8,221.90 for 1945. The deficiencies were determined on the basis of the income computed by the respondent.
The petitioners have the burden of proving error in these determinations. They assert that the respondent's action is arbitrary and unreasonable and therefore is invalid and that under the rationale of Helvering v. Taylor, 293 U. S. 507 (1935), they are not obliged to prove the correct tax. They say that the returns fully and correctly reported their income. They refer to testimony of the revenue agent, that he made a net worth computation but did not rely upon it as the results were ‘out of line’ with the determination for 1943, as showing that the computation by means of the profit markup was unreasonable and arbitrary.
The agent found that the deposits to the checking accounts greatly exceeded the sales reported. This was attributable to Stone's practice of cashing payroll checks for customers and others and depositing these checks in his accounts. But it had the effect of making the computation of sales difficult, if not impossible. The agent found that in a number of instances when a deposit was made a part of the amount taken to the bank was withdrawn in cash and could not be traced. With one exception, the subsidy checks received in those years by Stone did not appear on his books and the agent could not trace them. The agent was unable to ascertain which deposits represented sales or receipts and which did not. Stone's bookkeeper said that he treated deposits as sales, but the sales reported in the tax returns were considerably less than the deposits. The bookkeeper maintained no record of store sales. There was no detailed record of the dairy cattle part of Stone's business. There was no record at all for 1944 and merely a summary of total sales, costs, and farm rent for 1945. In the 1944 return Stone's bookkeeper made an estimate of the profit from cattle sales based upon the difference in the opening and closing balances of the account used in that business. Although the bookkeeper said he maintained detailed records of the cattle sales, there were no records from which the agent could verify this or the summary which appeared in the 1945 return. The method used by the bookkeeper in computing this income in the 1944 return was not sound, as Stone transferred money from one account to another as it became needed and the difference in balances would thereby be affected. The agent could not make a reliable receipts and expenditures statement because the cash receipts could not always be traced. Although it developed at the hearing that most of the subsidy checks received in 1944 and all those received in 1945 were deposited in Stone's bank accounts, this would not affect the method of computation used.
Where a taxpayer's records are inadequate to permit verification of the returns or if the records are unreliable the respondent may determine income by other reasonable means. A net worth computation was made here but was not adopted by the respondent. The increase in net worth shown thereby bore no similarity to the increase which certainly occurred in 1943 and the respondent may have considered the net worth increase method unreliable because of the possibility that assets were concealed. The manner in which the records were kept facilitated concealment of income because the amount of sales was not shown. The cost of goods sold could be ascertained. In this situation it was a reasonable method to compute the business profit upon the assumption that Stone realized the same rate of profit on his business as in 1943, the preceding year. The petitioners have not produced persuasive proof that the business profit for 1944 and 1945 was substantially less, either in amount or in percentage of profit, than that resulting in 1943. We do not find this computation excessive and without rational foundation within the meaning of Helvering v. Taylor, supra. However, the adjustments we have made or approved as to 1943 would have the effect of reducing the markup ratio used. We have therefore recomputed the income on the basis of a lesser markup. The income as recomputed is shown in our Findings of Fact. The deficiencies are to be recomputed under Rule 50.
The respondent asserted the 5 per cent addition to the tex provided by section 293(a) of the Code for negligence or intentional disregard of rules and regulations with reference to the years 1944 and 1945. The taxpayers relied upon their bookkeeper to keep the records and prepare their returns for these years. While Stone may have had little knowledge of bookkeeping he was negligent in failing to have his bookkeeper maintain adequate records and to furnish the bookkeeper with correct figures as to the volume of sales. The taxpayers must bear the responsibility for their agent's failure. We think the circumstances warrant imposition of this addition to the tax. This addition is subject to recomputation.
Decision will be entered under Rule 50.