Opinion
Docket No. 63317.
1958-10-10
NATHAN BILSKY AND SARAH BILSKY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
William J. Costello, Esq., for the petitioners. Ray H. Garrison, Esq., and H. Tracy Huston, Esq., for the respondent.
William J. Costello, Esq., for the petitioners. Ray H. Garrison, Esq., and H. Tracy Huston, Esq., for the respondent.
1. Deficiencies determined by means of new worth and expenditures method, held, approved except for respondent's concessions.
2. Some part of deficiencies for each year, held, on the facts, due to fraud.
3. Additions to tax under sections 294(d)(1)(A) and 294(d)(2), held, properly imposed.
Respondent determined deficiencies in income tax and additions to tax for the years 1949 through 1951 as follows:
+-----------------------------------------------------------------------------+ ¦ ¦ ¦Additions to tax-I. R. C. ¦ ¦ ¦ ¦ ¦ ¦1939 ¦ ¦ ¦ +----+----------+-------------------------------------------------------------¦ ¦Year¦Deficiency¦ ¦ +----+----------+-------------------------------------------------------------¦ ¦ ¦ ¦Sec. 293 (b) ¦Sec. 294 (d) (1) ¦Sec. 294 (d) ¦ ¦ ¦ ¦ ¦(A) ¦(2) ¦ +----+----------+---------------------------+------------------+--------------¦ ¦1949¦$5,760.72 ¦$2,880.36 ¦ ¦ ¦ +----+----------+---------------------------+------------------+--------------¦ ¦1950¦9,136.00 ¦4,568.00 ¦$1,101.87 ¦$734.58 ¦ +----+----------+---------------------------+------------------+--------------¦ ¦1951¦11,814.71 ¦5,907.35 ¦ ¦ ¦ +-----------------------------------------------------------------------------+
The deficiencies were computed by the net worth method. The issues are:
(1) Whether respondent correctly determined petitioners' income by the net worth and expenditures method.
(2) Whether any part of any deficiency is due to fraud with intent to evade tax.
(3) Whether petitioners are liable for additions to tax under sections 294(d) (1)(A) and 294 (d)(2).
FINDINGS OF FACT.
Some of the facts were stipulated and are hereby found.
Petitioners Nathan Bilsky and Sarah Bilsky are husband and wife residing in University City, Missouri. They filed joint income tax returns for the years in controversy, including an amended return for 1950, with the collector of internal revenue for the first district of Missouri. Petitioners executed timely waivers extending the time for assessment of their income tax for the years 1949, 1950, and 1951 until June 30, 1956. Respondent mailed the deficiency notice on May 18, 1956.
Petitioner Nathan Bilsky, sometimes hereafter referred to as petitioner or as Nathan, was born on September 30, 1898, in Poland and emigrated to the United States in 1906. He became a naturalized citizen in 1943. He married Sarah in 1920. Beatrice and Lester, their two children, were born in 1926 and 1935, respectively. Nathan graduated from the University of Missouri in 1922. In 1924 he received a degree of M.D. at the University of Oklahoma, and thereafter served his internship in Louisiana. From 1924 to 1943 he was a general practitioner in St. Louis, Missouri. During 1943 and 1944 he served as a captain in the United States Army Medical Corps. He was discharged in 1944 due to a dislocated disc and heart condition. After a 6 months' rehabilitation period he resumed his medical practice specializing in diseases of metabolism and endocrinology. He taught at St. Louis University, completed postgraduate work in endocrinology at Northwestern University, and attended numerous medical conventions and clinical conferences. During the years involved he was engaged in writing a book. He is a member of numerous professional, fraternal, and other organizations.
Nathan operated a one-doctor obesity clinic with approximately 80 per cent of his patients being obesity cases. He conducted about 99 per cent of his practice in the office and on some days had 100 or more patients. His office hours were from 9 a.m. to 6 p.m., 4 days per week.
Petitioners filed no income tax returns for any year prior to 1938 nor for the years 1941 and 1943. For 1939 petitioners filed a return showing no tax due. Their returns for 1940, 1942, and 1944 through 1948, together with audit adjustments thereto, indicate that petitioners' aggregate net income did not exceed $130,000.
In 1949 respondent examined petitioners' returns for the years 1946 through 1948 and found understatements of adjusted gross income in the amounts of $7,673.21, $11,382.24, and $20,238.96, respectively. On July 1, 1949, petitioners agreed to a $13,606.47 assessment for these years consisting of deficiencies, negligence penalties, and interest, and paid this amount on July 27, 1949, $13,307.75 coming from the redemption of United States Series E. bonds.
Prior to August 1949 Nathan maintained no books of account or patient record cards. Respondent's agents, on July 1, 1949, advised Nathan that his records were inadequate and his bank deposits exceeded income reported on the returns. As a result he hired one Spilker, a former deputy collector of internal revenue, who set up his first formal system of bookkeeping.
The procedure created by Spilker, and in force from August 1949 through 1951, consisted of maintaining patient record cards and a cash receipts book for recording the name of the patient, fee charged, and fee collected. From August 1, 1949, through August 1950, he maintained a duplicate cash receipts book. Having no accounts receivable ledger, unpaid accounts were recorded on the patient's record card with a metal clip attached thereto. His customary fee for services from 1949 through 1951 was $3. Some patients paid more if they received drugs or extra treatment and a few were charged only $2. Ninety per cent of the fees was paid in currency and kept in a cash box in his private office. He personally collected all fees and opened all mail. He sometimes entered the fee charged or collected on the patient record card which the receptionist filed. Absent such an entry the receptionist assumed a $3 fee and marked it accordingly. The receptionist posted in the cash receipts book the amounts reflected on the patient record cards. During the receptionist's absences, Nathan made postings in the cash receipts book.
Upon Spilker's death in August 1950, Nathan employed one Hollenbach, Spilker's son-in-law. Hollenbach, who was 23 years old, was inexperienced. Both accountants totaled the medical receipts as recorded in the cash receipts book, and entered the amount thereof for each day in the book. They also recorded his disbursements by cash and check for medical items. Spilker went weekly to his office. Hollenbach at first went weekly but later reduced his visits to once a month. Spilker prepared petitioners' return for 1949. Hollenbach prepared original and amended returns for 1950. These returns were prepared from the cash receipts book and information orally supplied by Nathan. Petitioners did not give complete information to the accountants. Both Spilker and Hollenbach received $25 per month for their services.
Hollenbach did not reconcile actual cash received by Nathan against the medical receipts book. He suggested to Nathan the possibility that his bank account contained receipts not reflected on the cash receipts book and that his income was not being reported correctly. He questioned the 1950 sale of securities without a gain or loss, but did not check Nathan's statement with his broker. He did not know that Sarah received dividend checks. Nathan kept his own investment records. Hollenbach used Spilker's $7,000 office equipment figure in 1949 for depreciation purposes. Due to an arithmetical error by Hollenbach and Nathan's claim for additional deductions, Hollenbach prepared an amended return for 1950. Hollenbach did not go into details with Nathan as to the additional deductions, although he disagreed with a deduction for prepaid insurance premiums. The amended return resulted in a greater tax liability because of the original arithmetical error. Hollenbach was discharged in February 1951.
In 1951 Nathan himself performed all bookkeeping duties and prepared the 1951 return. From 1949 through 1951 he never made, or caused to be made, any reconciliation of bank deposits with book receipts nor actual cash received with book receipts. He did reconcile his checking account against his own checkbooks. Under the bookkeeping system used by Nathan there were no checks and balances which would insure correct reporting of medical receipts.
Petitioners reported income on their returns for 1949 through 1951 as follows:
+-----------------------------------------------------------------------------+ ¦ ¦Professional¦ ¦ ¦ ¦Capital¦Adjusted ¦Net ¦ +-------+------------+---------+-------+--------+-------+----------+----------¦ ¦Year ¦income ¦Dividends¦Rent ¦Interest¦gain ¦gross ¦income ¦ +-------+------------+---------+-------+--------+-------+----------+----------¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦income ¦ ¦ +-------+------------+---------+-------+--------+-------+----------+----------¦ ¦1949 ¦$17,039.97 ¦$424.00 ¦0 ¦0 ¦0 ¦$17,463.97¦$16,463.97¦ +-------+------------+---------+-------+--------+-------+----------+----------¦ ¦1950 ¦18,703.56 ¦96.97 ¦$779.22¦0 ¦0 ¦19,579.75 ¦16,811.34 ¦ +-------+------------+---------+-------+--------+-------+----------+----------¦ ¦1950 ¦18,467.08 ¦96.97 ¦442.61 ¦0 ¦0 ¦19,006.66 ¦16,231.55 ¦ ¦1 ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ +-------+------------+---------+-------+--------+-------+----------+----------¦ ¦1951 ¦19,592.22 ¦122.10 ¦616.74 ¦0 ¦$14.75 ¦20,345.81 ¦18,431.83 ¦ +-----------------------------------------------------------------------------+
On Schedule C for 1949 through 1951 gross receipts from medical practice were reported as $34,117.82, $31,567.50, and $35,309.75. During the same years petitioners deposited in their joint checking account at First National Bank of Clayton, Missouri, $46,200.54, $67,024.85, and $53,513.27, respectively.
During the period from April 4, 1952, to May 18, 1956, Internal Revenue Agent Julius G. Taake investigated petitioners' returns for 1949 through 1951. Respondent determined petitioners' unreported income to be $16,624.29, $23,623.19, and $25,535.90, respectively. This was based upon Taake's investigation, statements of Nathan at various conferences, and a net worth chart computed by respondent, of which the following is a summary:
+-------------------------------------------------------------------------+ ¦ ¦December 31 ¦ +------------------------------------+------------------------------------¦ ¦Dr. Nathan Bilsky ¦ ¦ +------------------------------------+------------------------------------¦ ¦ ¦1948 ¦1949 ¦1950 ¦1951 ¦ +------------------------------------+-------+-----------+------+---------¦ ¦Assets: ¦ ¦ ¦ ¦ ¦ +------------------------------------+-------+-----------+------+---------¦ ¦1. Cash in bank—checking and savings¦$769.68¦($1,522.79)¦$90.27¦($533.57)¦ +-------------------------------------------------------------------------+
2. Securities: (a) Miscellaneous stocks 8,302.87 16,565.28 1,681.93 7,724.93 Boatman's National Bank stock 5,875.00
(b) Bonds: (1) State of Israel 102.00 (2) U.S. Series “E” 19,931.25 11,100.00 1,125.00 375.00 (c) First deed of trust 7,000.00 (d) Annuity 5,408.28 6,357.62 7,413,74 8,613.05 3. Insurance: (a) Surrender value of life 23,859.78 31,585.04 39,957.76 48,391.60 policies (b) Prepaid insurance 1,707.62 1,854.71 4. Real estate 30,992.61 34,530.42 107,038.62 107,038.62 (includes building, 2 lots, filling station, personal residence, and improvements). 5. Office equipment and supplies: (a) Inventories 5,000.00 1,834.00 1,756.00 1,628.30 (b) Typewriter 132.48 132.48 132.48 (c) Air conditioning 2,196.00 2,196.00 2,196.00 (d) Acme Visible Records 460.10 870.85 1,635.10 (e) Cabinet 173.00 (f) Adding machine 166.42 (g) Physician's bag and contents 250.00 250.00 (h) Microscope 1,171.03 (i) Physician's bag and contents 250.00 6. Other personal property: (a) Furniture for personal 6,870.71 residence (b) Silverware 1,500.00 1,500.00 (1) Buick-1942 1,598.02 (2) Lincoln-1949 3,878.80 3,878.80 3,878.80 Total assets 102,862.49 107,116.95 169,599.07 199,293.18
Liabilities: 7. Reserve for depreciation 239.81 1,306.38 2,914.75 8.Mortgages 41,420.49 38,183.13 9. Account payable—Acme Visible 764.25 Records, Inc. Total liabilities 239.81 42,726.87 41,862.13 Net worth 102,862.49 106,877.14 126,872.20 157,431.05 10. Amount of increase in net worth 4,014.65 19,995.06 30,558.85 11. Plus: (a) Federal income taxes 14,018.46 1,856.90 5,696.74 (b) Personal living expenses: (1) By check 4,753.11 4,999.49 5,699.14 (2) Estimated 4,800.00 4,000.00 4,500.00 (c) Gift to daughter and son-in-law—Mr. & Mrs. Allan Garber 7,500.00 (d) Excess of life insurance premiums paid over increase in cash surrender values 3,243.35 1,978.03 2,281.08 (e) Mink coat—October 5, 1949 2,433.00 (f) Mink coat—October 22, 1951 2,000.00 (g) Unallowable loss on personal 98.02 automobile traded 12. Total of lines 10 and 11 1 1 1 33,088.26 39,854.74 43,967.73 13. Minus: (a) Capital gain 3.21 98.54 28.35 (b) Excess of increase in value of certificates of Investors 264.34 371.12 514.31 Diversified Services, Inc., overpayment made (c) Cash dividends received on life 4.78 5.08 125.42 insurance (d) Lester's postal savings 2,500.00 (e) Funds received from the sale of 3,600.00 personal furniture Net income 33,088.26 39,854.74 43,967.73
In addition, they had underreported their net income for the 3 preceding years. These amounts are of sufficient size to demonstrate that they could not have been unintentionally omitted, and the repetition demonstrates a pattern which in itself indicated that their omission was intentional.
1Respondent made a typographical error on line 12. The corrected figures for 1949 through 1951 should be $33,360 59, $40,329.48, and $50,735.81, respectively.
In a conference held October 8, 1952, Taake and another agent explained to Nathan the net worth method and that it was being used by respondent for the computation of the correct tax liabilities for 1949 through 1951. They showed and explained to him a net worth statement which did not contain items numbered 5(g), 5(h), 5(i), 6(b), 11(e), and 11(f). Nathan stated at the conference that he thought all his assets and liabilities were represented thereon and that he had not received during 1949 to 1951 any funds from inheritances, loans, or insurance policies. Nathan fully cooperated with the agents.
In 1943 petitioners received approximately $5,000 from two endowment policies, under which his daughter, Beatrice, was the insured. Sarah received $5,000 in the same year as an inheritance from her father whose estate was never probated. Nathan used this $10,000 for resumption of medical practice upon discharge from the Army.
As of December 31, 1948, petitioners owned capital stock as follows:
+----------------------------------------------------------+ ¦Number of shares ¦Name of corporation ¦Cost ¦ +------------------+-----------------------------+---------¦ ¦130 ¦Massachusetts Investors Trust¦$3,570.40¦ +------------------+-----------------------------+---------¦ ¦10 ¦United States Steel Corp. ¦734.95 ¦ +------------------+-----------------------------+---------¦ ¦129 ¦Broad Street Investing Corp. ¦2,294.82 ¦ +------------------+-----------------------------+---------¦ ¦160 ¦United Funds, Inc. ¦1,702.70 ¦ +----------------------------------------------------------+
Except for United Funds these securities were purchased during 1947 and 1948 with petitioners' checks. During 1949 petitioners purchased by check more securities. As of December 31, 1949, petitioners owned capital stock as follows:
+-------------------------------------------------------------+ ¦Number of shares ¦Name of corporation ¦Cost ¦ +------------------+--------------------------------+---------¦ ¦150 ¦Massachusetts Investors Trust ¦$4,104.13¦ +------------------+--------------------------------+---------¦ ¦30 ¦United States Steel Corp. ¦734.95 ¦ +------------------+--------------------------------+---------¦ ¦199 ¦Broad Street Investing Corp. ¦3,417.22 ¦ +------------------+--------------------------------+---------¦ ¦100 ¦Capital Administration Co., Ltd.¦5,432.05 ¦ +------------------+--------------------------------+---------¦ ¦100 ¦Southern Company ¦1,195.00 ¦ +------------------+--------------------------------+---------¦ ¦160 ¦United Funds, Inc. ¦1,681.93 ¦ +-------------------------------------------------------------+
All above stock certificates were issued in the name of Mrs. Sarah Bilsky.
Petitioners reported on their return for 1950 sales of stock during the year as follows:
+----------------------------------------------------------------------+ ¦Number of shares¦Name of corporation ¦Cost ¦Sales price¦ +----------------+-------------------------------+---------+-----------¦ ¦199 ¦Broad Street Investing Corp. ¦$3,357.50¦$3,357.50 ¦ +----------------+-------------------------------+---------+-----------¦ ¦100 ¦Capital Administration Co., Ltd¦5,432.05 ¦5,432.05 ¦ +----------------+-------------------------------+---------+-----------¦ ¦10 ¦United States Steel Corp. ¦734.95 ¦734.95 ¦ +----------------+-------------------------------+---------+-----------¦ ¦150 ¦Massachusetts Investors Trust ¦4,106.80 ¦4,106.80 ¦ +----------------------------------------------------------------------+
The actual sales, cost, sales price, and gain or loss were:
+---------------------------------------------------------------------+ ¦Name of corporation ¦Cost ¦Sales price¦Gain (or loss)¦ +--------------------------------+---------+-----------+--------------¦ ¦Broad Street Investing Corp. ¦$3,417.22¦$3,354.14 ¦($63.08) ¦ +--------------------------------+---------+-----------+--------------¦ ¦Capital Administration Co., Ltd.¦5,432.05 ¦5,533.05 ¦101.00 ¦ +--------------------------------+---------+-----------+--------------¦ ¦United States Steel Corp ¦734.95 ¦866.60 ¦131.65 ¦ +--------------------------------+---------+-----------+--------------¦ ¦Massachusetts Investors Trust ¦4,104.13 ¦4,196.88 ¦92.75 ¦ +--------------------------------+---------+-----------+--------------¦ ¦Southern Company ¦1,195.00 ¦1,267.73 ¦72.73 ¦ +---------------------------------------------------------------------+
Petitioners understated on both their original and amended returns for 1950 their net gains from the sale of securities.
In 1951 petitioners purchased $6,043 of stock in joint names. They paid $1,078 in cash for stock in Mercantile Trust Co. In addition Nathan purchased in the name of his son, Lester, 140 7/8 shares of Boatman's National Bank. The stock cost $5,875, part of which was paid by Nathan in cash, and $2,500 was paid by Lester from his own postal savings account.
Petitioners reported dividends for 1949 through 1951 in the amounts of $424, $96.97, and $122.10, respectively. Omitted from the respective tax returns were $88.46, $114.03, and $157.74. The 1949 and 1950 dividend checks were payable to Sarah with the exception of Capital Administration which was in both names. The 1951 dividend checks were payable to both petitioners except United Funds which was payable to Sarah.
As of December 31, 1948, petitioners owned 82 United States Series E bonds totaling $19,931.25. The majority of these bonds was owned either by Nathan, individually, or petitioners, jointly. Twenty-two were owned by ‘Lester Bilsky or Mrs. Sarah Bilsky.’ One was owned by ‘Miss Beatrice Bilsky or Mrs. Sarah Bilsky.’ Petitioners redeemed several bonds in 1949 and 1950 receiving $13,307.75 and $15,318.25, respectively. They failed to report $201.50 and $843.25 which constituted interest income. Petitioners endorsed bonds that were redeemed. Bonds in the name of the children and Sarah were endorsed by Sarah. At the close of 1949, 1950, and 1951 petitioners' bondholdings were $11,100, $1,125, and $375, respectively.
Nathan owned during the calendar years over 100 life insurance policies, 87 of which he had in his safety-deposit box. He paid insurance premiums in the following amounts:
+--------------------------------+ ¦Year ¦Amount of premiums paid ¦ +------+-------------------------¦ ¦1949 ¦$10,968.61 ¦ +------+-------------------------¦ ¦1950 ¦10,350.75 ¦ +------+-------------------------¦ ¦1951 ¦10,714.92 ¦ +--------------------------------+
Respondent conceded to be incorrect items 5(h), 11(e), and 11(f) on his net worth statement which represented purchases of a microscope in 1951, a mink coat in 1949, and a second mink coat in 1951, respectively.
Petitioners paid certain household and living expenses during the controversial years by check. In addition, Nathan gave Sarah weekly amounts in cash for living expenses from 1949 and 1951.
In 1950 Nathan gave Beatrice a $7,500 gift and paid for her music lessons. From 1949 through 1951 he supported Lester who attended Taylor and Phillips-Andover preparatory schools. Petitioners owned a personal residence and operated a Lincoln automobile. They took 1 to 2 weeks' annual vacation, usually in Florida, with the best in hotel accommodations.
On October 11, 1948, petitioners sold four lots. The consideration was a first deed of trust of $7,000 secured by a $7,000 promissory note and two $210 promissory notes representing interest. On April 25, 1949, Sarah received $210 in payment of the first interest note. The second interest note was released and canceled upon its payment on September 12, 1949. Petitioners failed to report as income for 1949 the $420 interest received.
Petitioners rented part of a building to Herder Book Company under a lease agreement which prohibited subleasing without petitioners' consent. Eisenstadt Manufacturing Co. desired to sublease certain space. Nathan granted Eisenstadt the necessary permission and received from the latter $500. Eisenstadt was not a tenant of petitioners'. Nathan entered the word ‘gift’ on both his deposit slip and check stub and did not report the payment as income.
During 1949, 1950, and 1951, various attorneys paid fees to Nathan for medical bills in personal injury cases paid at the time the cases were finally settled and closed in the respective amounts of $127, $375, and $300. He failed to report such fees on his returns. At a conference on January 27, 1954, with Agent Taake and Special Agent John W. Dale, Nathan stated he could not recall the receipt of large fees, that he had done no work with lawyers and that he did not have any idea what the checks represented.
On or about October 10, 1955, Dale submitted to the Intelligence Division a net worth analysis for 1949 through 1951. The net income for the 3 years was less than that computed in the chart prepared by Taake. Dale's analysis was revised between October 10, 1955, and February 23, 1956, and the revision was the basis of a criminal information filed against petitioner. On February 23, 1956, in the United States District Court for the Eastern District of Missouri, Nathan was convicted, upon his plea of nolo contendere, of the offenses of willfully and knowingly attempting to evade income tax from 1949 through 1951. The court imposed fines totaling $15,000, and placed petitioner on probation for 18 months.
A part of the deficiency for each year is due to fraud with intent to evade tax.
In 1950 petitioners without reasonable cause failed to file a declaration of estimated tax and substantially underestimated their estimated tax.
OPINION.
OPPER, Judge:
Petitioners virtually concede understatements of income in the 3 years before us averaging more than $10,000 a year.
+--------------------------------------+ ¦1949 ¦$8,035.78 ¦ +---------------------------+----------¦ ¦1950 ¦15,056.78 ¦ +---------------------------+----------¦ ¦1951 ¦8,857.66 ¦ +---------------------------+----------¦ ¦Total unreported net income¦$31,950.22¦ +--------------------------------------+ Upon which additional taxes in the amount of $10,901.20 are owing.' (Petitioner's main brief.)‘Petitioner here has gone further perhaps than necessary in demonstrating that under a reasonably correct net worth determination he would owe some $10,901.20 in additional taxes * * * ’ (Petitioners' reply brief).
‘As the Tax Court very well puts it in its opinion, ‘as evidenced by the amounts of income which petitioner earned, he was a man of considerable business acumen and one of more than average intelligence. He offered no plausible explanation which would tend to excuse his failure to report the large sums of income which he in fact received. The amounts by which he understated his income are too large and such understatements occurred consistently over too long a period of time for us on this record to believe that they were due to anything other than a deliberately fraudulent attempt to evade taxes. In addition to taxpayer's consistently large understatement of income, we believe that his method of reporting income was a deliberate attempt to conceal the true amount thereof. * * * ‘ Woodham V. Commissioner, (C.A. 5, June 5, 1958) 256 F.2d 201.Petitioner's wife and son were not called by him as corroborating witnesses although references to them appear in his testimony. See Wichita Terminal Elevator Co., 6 T.C. 1158, affd. (C.A. 10) 162 F.2d 513.