Opinion
18226-22
07-23-2024
SIMON JALAS, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
ORDER
Ronald L. Buch, Judge
This is a deficiency case brought pursuant to section 6213(a). Pending before us is the Commissioner's Motion for Summary Judgment in which he asks us to sustain the determinations made in the notice of deficiency, which include tax, additions to tax, and penalties for 2008, 2009, 2010, and 2011.
Unless otherwise indicated, statutory references are to the Internal Revenue Code, Title 26 U.S.C, in effect at all relevant times, regulatory references are to the Code of Federal Regulations, Title 26 (Treas. Reg.), in effect at all relevant times, and Rule references are to the Tax Court Rules of Practice and Procedure. All monetary amounts are rounded to the nearest dollar.
During those years, Mr. Jalas received income but did not file income tax returns or pay taxes. The Commissioner created substitutes for returns and issued a notice of deficiency that determined a deficiency in tax plus additions to tax for failure to file, failure to pay, and failure to make estimated tax payments. The Commissioner asserted the failure to file addition at the increased rate for a fraudulent failure to file. The Commissioner also determined an accuracy-related penalty as an alternative to the failure to file addition to tax.
A taxpayer who receives income above the filing threshold and fails to file a return and pay taxes may be subject to various additions to tax. To establish fraudulent failure to file, however, the Commissioner must establish intent by clear and convincing evidence, which the record lacks notwithstanding deemed admissions. Regarding the accuracy-related penalty, such penalties only apply when there is an amount of tax shown on a return (sec. 6662(d)(2)(A)), but Mr. Jalas did not file returns for the years at issue. Therefore, we will grant the Commissioner's Motion as to the deficiency and additions to tax for failure to file, failure to pay, and failure to make estimated tax payments. We will deny it as to the increased addition to tax for a fraudulent failure to file and as to the substantial understatement penalty.
Background
The following information is drawn from the parties' pleadings as well as any declarations or exhibits attached thereto. See Rule 121(c). We also rely on facts deemed admitted pursuant to Rule 90(c). This background is stated solely for the purpose of resolving the present Motion and is not stated as findings of fact in this case. See Sundstrand Corp. v. Commissioner, 98 T.C. 518, 520 (1992), aff'd, 17 F.3d 965 (7th Cir. 1994). At the time this Petition was filed, Mr. Jalas resided in Brooklyn, New York.
During the years at issue, Mr. Jalas was the sole shareholder or a majority shareholder of various entities, including: Fantastic Industries, Inc.; Creative Gold, LLC; LDMARK MANUFAL URLN LNL; and Goldmark II, Inc. The Commissioner did not receive any income tax returns from Mr. Jalas for the years at issue. An examination ensued.
The first revenue agent assigned to the examination attempted to communicate with Mr. Jalas about his missing tax returns. The first revenue agent sent a Letter 964, Income Tax Filing Requirements, to Mr. Jalas, informing him that the Commissioner had no record of his tax returns for the relevant years. The letter also invited Mr. Jalas to provide additional information or file the delinquent returns within 15 days. Mr. Jalas did not respond.
In the absence of any communication from Mr. Jalas, the first revenue agent performed a bank deposits analysis. After obtaining bank records, the first revenue agent determined that Mr. Jalas received substantial deposits for all years at issue.
The first revenue agent continued to attempt to reach Mr. Jalas. He sent Mr. Jalas a Letter 3798, Non-Filer Appointment, which reiterated that Mr. Jalas had not filed a return for the years at issue and sought to set up a meeting. The letter also invited Mr. Jalas to contact the revenue agent in the event he had questions or needed to reschedule the meeting. Mr. Jalas did not attend the meeting or otherwise communicate with the revenue agent.
For various reasons, including Mr. Jalas's failure to cooperate, the first revenue agent determined to assert a penalty for fraudulent failure to file. The revenue agent also asserted an alternative penalty for substantial understatement of tax pursuant to section 6662(d). These penalties, as well as the addition to tax for failure to pay and failure to pay estimated income tax, were submitted for and received supervisory approval.
Three years later, the case was assigned to a second revenue agent. The second revenue agent re-evaluated Mr. Jalas's income for the years at issue. The second revenue agent determined that the bank deposits analysis had inappropriately attributed income to Mr. Jalas. Instead of relying on that analysis, the second revenue agent determined Mr. Jalas's unreported income based on third-party information returns, some of which were issued by entities owned by Mr. Jalas. Based on this information, the second revenue agent determined that Mr. Jalas had received substantial monthly deposits. Mr. Jalas received $509,841, $412,104, $411,910, and $502,545 for 2008, 2009, 2010, and 2011, respectively. The income came in the form of wages, interest, pensions and annuities, and partnership income. The wages and partnership income came from entities that Mr. Jalas either owned or held a majority stake in. Mr. Jalas also received additional income from other sources, such as pensions and annuities reported by third parties.
The second revenue agent had limited success communicating with a representative of Mr. Jalas. The second revenue agent spoke with Mr. Jalas's representative, who explained that Mr. Jalas was delinquent in his filing obligations because he had moved and lost records in the process. The representative suggested that Mr. Jalas may be able to claim net operating losses for the years at issue. The representative and the revenue agent set up a subsequent telephone conference, but when the revenue agent initiated the call, the person answering the phone advised that the representative had left town. The revenue agent did not hear from the representative again.
The second revenue agent also had limited success communicating with Mr. Jalas. Several months after losing contact with Mr. Jalas's representative, Mr. Jalas reached out to the revenue agent to discuss the examination of one of the entities he owned, Goldmark, Inc. Mr. Jalas explained that Goldmark had not filed income tax returns because the corporation had gone out of business due to a customer stealing from the corporation. Mr. Jalas also explained that he did not file personal income tax returns because he was waiting for account transcripts. He explained to the revenue agent that he was not earning any income during the years at issue. When the revenue agent asked about partnership distributions from another entity he owned, Fantastic Industries, Inc., Mr. Jalas responded that he knew nothing about distributions and that he had only earned about $1,000 a month from that source. He also claimed he owned no other businesses. The revenue agent asked Mr. Jalas about Creative Gold, LLC, which he claimed to know nothing about. Mr. Jalas refused to provide a number where he could be reached and abruptly ended the call.
The second revenue agent prepared substitutes for returns for Mr. Jalas. Before the second revenue agent created these substitutes for returns, he made a final attempt to communicate with Mr. Jalas. The revenue agent sent a revised 30-day letter to Mr. Jalas, to which Mr. Jalas never responded. The second revenue agent also sought and received supervisory approval for the assertion of the fraudulent failure to file penalty or, alternatively, a substantial understatement penalty.
Discussion
I. Summary Judgment
Summary judgment serves to "expedite litigation and avoid unnecessary and expensive trials." Fla. Peach Corp. v. Commissioner, 90 T.C. 678, 681 (1988). We may grant summary judgment when there is no genuine dispute as to any material fact, and a decision may be rendered as a matter of law. See Rule 121(a)(2); Sundstrand Corp., 98 T.C. at 520. In deciding whether to grant summary judgment, we construe factual materials and inferences drawn from them in the light most favorable to the nonmoving party. Sundstrand Corp., 98 T.C. at 520 . The nonmoving party may not rest upon mere allegations nor denials and must set forth specific facts showing that there is a genuine dispute for trial. Rule 121(d).
Mr. Jalas has not disputed any facts. In response to the Commissioner's Motion for Summary Judgment, Mr. Jalas alleges that he has not been able to obtain his bank records to enable him to dispute the Commissioner's determinations. He further alleges that the Commissioner has not provided him with discovery. But nowhere in the record of this case is there any indication that Mr. Jalas has sought any discovery from the Commissioner. Mr. Jalas did not provide copies of any informal discovery requests or formal discovery requests in support of his allegations. And the record of this case does not contain any motions to compel discovery or requests to set a date on which subpoenas to third parties might be returnable.
II. Deemed Admissions
Pursuant to Rule 90, the Commissioner served the First Request for Admissions on November 3, 2023. Rule 90(c) provides that each request for admission "is deemed admitted unless, within 30 days after service of the request," the party to whom the request is directed serves an appropriate answer or objection as required by the Rules. Mr. Jalas did not serve a response on the Commissioner within 30 days or at any time since, and pursuant to Rule 90(c), the facts in the First Request for Admissions are deemed admitted and considered "conclusively established." Rule 90(f). The facts deemed admitted pursuant to Rule 90 may be relied upon in deciding whether to grant the Commissioner's Motion for Summary Judgment. See Essel Eyeware, Inc. v. Commissioner, T.C. Memo. 2024-11, at *6 (citing Marshall v. Commissioner, 85 T.C. 267, 272-73 (1985)). At no time has Mr. Jalas sought to be relieved from those deemed admissions. See Rule 90(f) (regarding motions to withdraw or modify admissions).
The First Request for Admissions (and thus the deemed admissions) contain several errant internal cross-references. In the declaration of Valerio, the Commissioner explained that the discrepancies were due to a formatting issue and clarified the internal cross-references in the matters deemed admitted. The internal cross-references only served to enhance readability and therefore the errors do not affect the substance of the deemed admissions.
III. Analysis
A. Gross Income
The calculation of a taxpayer's taxable income begins with determining their gross income. Gross income "means all income from whatever source derived," including compensation for services such as wages or salaries, income derived from business, and dividends. I.R.C. § 61(a); Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 429-30 (1955). Ordinarily, the statutory notice of deficiency carries with it a presumption of correctness and the burden is on the taxpayer to show that the Commissioner's determination is erroneous. Rule 142(a); Helvering v. Taylor, 293 U.S. 507, 515 (1935). For the presumption to apply to unreported income, however, the Commissioner must establish an evidentiary foundation connecting the taxpayer with the income-producing activity, see Llorente v. Commissioner, 649 F.2d 152, 156 (2d Cir. 1981), aff'g in part, rev'g and remanding in part 74 T.C. 260 (1980), or demonstrate that the taxpayer actually received income. Edwards v. Commissioner, 680 F.2d 1268, 1270-71 (9th Cir. 1982). "Once the Commissioner makes the required threshold showing, the burden shifts to the taxpayer to prove by a preponderance of the evidence that the Commissioner's determinations are arbitrary or erroneous." Essel Eyeware, Inc., T.C. Memo. 2024-11, at *7.
The facts deemed admitted pursuant to Rule 90(c) raise the presumption of correctness to the notice of deficiency. The deemed admissions show that Mr. Jalas had income of $509,841, $412,104, $411,910, and $502,545, respectively, for each year at issue.
The Commissioner is permitted to reconstruct income based on third-party reporting. Taxpayers must maintain books and records sufficient to establish their income and expenses. See I.R.C. § 6001; Treas. Reg. § 1.6001-1(a). If they fail to do so, the Commissioner may reconstruct income through any method that is "reasonable in light of all surrounding facts and circumstances." Petzoldt v. Commissioner, 92 T.C. 661, 687 (1989). Indeed, the Commissioner has great latitude in reconstructing a taxpayer's income. Petzoldt, 92 T.C. at 687, 693. The Commissioner may reconstruct a taxpayer's income using third-party information returns. Cox v. Commissioner, T.C. Memo. 2013-75, at *8. The Commissioner may also use bank records and other third-party records to reconstruct a taxpayer's income. Id. Thus, the burden switches to Mr. Jalas.
Mr. Jalas has not shown the Commissioner's determinations to be arbitrary or erroneous. Although the Commissioner may not rely solely on a third-party's reporting of income if the taxpayer raises a reasonable dispute concerning the accuracy of the report, Mr. Jalas has not raised a reasonable dispute. Ecret v. Commissioner, T.C. Memo. 2024-23, at *5; see I.R.C. § 6201(d). Mr. Jalas has not argued that any income reported by third-parties was nontaxable. See Rule 121(d); Vallone v. Commissioner, 88 T.C. 794, 801 (1987). Nor has Mr. Jalas raised any genuine dispute with respect to the unreported gross income. Although Mr. Jalas disputes the accuracy of the gross income calculated by the revenue agent, a party opposing summary judgment may not rest upon mere allegations or denials. Rule 121(d). Instead, he must set forth specific facts showing there is a genuine factual issue for trial. Id. Mr. Jalas contends that he is unable to accept or deny the Commissioner's conclusions because he does not have access to his complete bank records. But it is Mr. Jalas' responsibility to maintain adequate books and records. I.R.C. § 6001; Treas. Reg. § 1.6001-1(a). He cannot defeat the Commissioner's Motion by simply claiming he does not have access to his own bank records. Accordingly, we will grant summary judgment for the Commissioner on the issue of Mr. Jalas's unreported gross income.
B. Deductions
In his Objection to the Motion for Summary Judgment, Mr. Jalas states that he may be entitled to deductions not previously allowed by the Commissioner. Deductions are a matter of legislative grace, and taxpayers generally bear the burden of proving that deductible expenses were actually incurred. I.R.C. § 162(a); see also INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992). Taxpayers must keep and maintain adequate records sufficient to establish any claimed deduction. I.R.C. § 6001; Treas. Reg. § 1.6001-1(a); see also Higbee v. Commissioner, 116 T.C. 438, 440 (2001).
Mr. Jalas has not raised a genuine dispute as to the amount of any deductions to which he may be entitled. As previously stated, a person opposing summary judgment may not rest upon mere allegations (Rule 121(d)), and that is all Mr. Jalas has offered. And although the Court may invoke the "Cohan rule" to estimate the amount of a deduction, there must be an appropriate evidentiary basis for doing so. See Cohan v. Commissioner, 39 F.2d 540, 543-44 (2d Cir. 1930); Vanicek v. Commissioner, 85 T.C. 731, 742-43 (1985). Mr. Jalas has offered nothing.
C. Additions to Tax and Penalties
The Commissioner asserted that Mr. Jalas is liable for the section 6651(a)(1) addition to tax for failure to file at the increased rate under section 6651(f)(1) for a fraudulent failure, or in the alternative, the accuracy-related penalty for substantial understatement of income tax pursuant to section 6662(d). The Commissioner also determined that Mr. Jalas is liable for section 6651(a)(2) failure to pay additions to tax for the taxable years at issue, and section 6654(a) addition to tax for underpayment of estimated tax. Where appropriate, the Commissioner may rely on deemed admissions to support the imposition of penalties, including on the issue of fraud. Marshall v. Commissioner, 85 T.C. 267, 272-73 (1985) (citing Doncaster v. Commissioner, 77 T.C. 334 (1981)). We will address the additions to tax and penalties in turn.
In general, the Commissioner bears the burden of production with respect to the liability of any penalty, addition to tax, or additional amount imposed. I.R.C. § 7491(c). The Commissioner's burden of production under section 7491(c) includes establishing compliance with section 6751(b), which requires that penalties be "personally approved (in writing) by the immediate supervisor of the individual making such determination." I.R.C. § 6751(b); Chai v. Commissioner, 851 F.3d 190, 217, 221-22 (2d Cir. 2017), aff'g in part, rev'g in part T.C. Memo. 2015-42. Supervisory approval is not required, however, for "any addition to tax under section 6651, 6654, 6655, or 6662." I.R.C. § 6751(b)(2)(A). Thus, the Commissioner is not required to provide proof of supervisory approval to carry his burden of production with respect to these additions to tax.
1. Section 6651(a)(1) and (f)(1) Fraudulent Failure to File
As his primary position, the Commissioner determined that Mr. Jalas is liable for an addition to tax for failure to file under section 6651(a)(1), but at the increased rate of section 6651(f)(1) for a fraudulent failure to file. The record establishes a failure to file and the applicability of the addition to tax for a failure to file. We must decide whether the increased rate for a fraudulent failure to file applies.
Section 6651(f)(1) imposes an addition to tax of 15 percent per month of the amount required to be shown as tax on the return, not to exceed 75 percent, if the failure to file a return is fraudulent. A substitute for return prepared by the Commissioner pursuant to section 6020(b) does not qualify as a return for purposes of section 6651(f). I.R.C. § 6651(g)(1). The Commissioner has the burden of proving fraud by clear and convincing evidence. I.R.C. § 7454(a); Rule 142(b); Clayton v. Commissioner, 102 T.C. 632, 646 (1994). Fraud may not be imputed or presumed, and mere suspicion is insufficient to sustain a finding of fraud. Beaver v. Commissioner, 55 T.C. 85, 92 (1970). To prove fraud, the Commissioner must show by affirmative evidence that the taxpayer intended to conceal, mislead, or otherwise prevent the collection of tax. Clayton, 102 T.C. at 647. The Commissioner may rely on deemed admissions pursuant to Rule 90 to prove fraud. Marshall, 85 T.C. at 272-73. However, summary judgment on the ultimate issue of fraud is generally inappropriate when issues of motive and intent are material. See Espinoza v. Commissioner, 78 T.C. 412, 417 (1982).
Circumstances that may indicate fraudulent intent, often called "badges of fraud," include but are not limited to (1) understating income, (2) keeping inadequate records, (3) giving implausible or inconsistent explanations of behavior, (4) concealing income or assets, (5) failing to cooperate with tax authorities, (6) engaging in illegal activities, (7) supplying incomplete or misleading information to a tax return preparer, (8) providing testimony that lacks credibility, (9) filing false documents (including false tax returns), (10) failing to file tax returns, and (11) dealing in cash. Muhammad v. Commissioner, T.C. Memo. 2023-124, at *8.
The Commissioner's Motion for Summary Judgment relies on the deemed admission that "[f]or [the taxable years at issue], petitioner is liable for the penalty for fraudulent failure to file under I.R.C. § 6651(f) in the amounts determined in the statutory notice of deficiency . . . ." Under Rule 90(a), a request for admission must "relate to statements or opinions of fact or of the application of law to fact." Certain categories of questions are considered improper in requests for admissions, including those that would require the defendant to admit legal conclusions. See, e.g., Cement and Concrete Workers Dist. Council Welfare Fund v. Manny P Concrete Co., Inc., No. 19-CV-2145 (WKF) (SJB), 2023 WL 3948751, at *6 (E.D.N.Y. June 12, 2023) (citing Coach, Inc. v. Horizon Trading USA Inc., 908 F.Supp.2d 426, 432 (S.D.N.Y. Nov. 7, 2012)); see also Fossil Grp., Inc. v. Angel Seller LLC, 2022 WL 1216256, at *3 (E.D.N.Y. Feb. 28, 2022) (citing Coach, Inc., 908 F.Supp.2d at 433) (explaining that requests for admission that ask the opposing party to admit legal conclusions will not be deemed admitted due to the failure to respond). The Commissioner's request for admissions asks Mr. Jalas to admit that he is liable for the section 6651(f) penalty, which is, at a minimum, a mixed question of law and fact. Moreover, the deemed admission would default Mr. Jalas into the concession of an ultimate issue; it is inappropriately conclusory. We decline to grant summary judgment on the question of fraud based solely on the default of a conclusory admission.
Absent the conclusory deemed admission, the record before the Court does not support the imposition of the fraudulent failure to file penalty under section 6651(f)(1). The Commissioner has not set forth specific facts that reflect the motive and intent necessary to support summary judgment. See Rules 121(d), 142(b). Accordingly, we will deny summary judgment with respect to the additions to tax at the increased rate of section 6651(f)(1) for the years at issue.
2. Section 6651(a)(2) Failure to Pay
Section 6651(a)(2) imposes an addition to tax for the failure to timely pay the amount shown as tax due on a return. The addition applies at a rate equal to 0.5 percent of the amount required to be shown as due on the return for each month the failure to pay persists, up to a maximum of 25 percent. The addition to tax under section 6651(a)(2) applies when an amount of tax is shown on a return. See, e.g., Cabirac v. Commissioner, 120 T.C. 163, 170 (2003). A return made by the Secretary under section 6020(b)-i.e., a substitute for return-is treated as "the return filed by the taxpayer for purposes of determining the amount of the addition" under section 6651(a)(2). I.R.C. § 6651(g)(2). The addition to tax under section 6651(a)(2) applies unless such failure to pay was due to reasonable cause and not willful neglect. See El v. Commissioner, 144 T.C. 140, 150.
The failure to pay addition to tax applies. The Commissioner has shown, and it has also been deemed admitted, that Mr. Jalas failed to pay any taxes for the years at issue. Mr. Jalas has not asserted that his failure to pay was due to reasonable cause and not willful neglect. Additionally, he has not raised a genuine issue of material fact with respect to this issue. See Rule 121(d). Accordingly, we sustain the additions to tax under section 6651(a)(2).
3. Section 6654 Failure by an Individual to Pay Estimated Tax
Section 6654 provides that "there shall be added to the tax" additions to tax when there is a failure by an individual to pay estimated tax. Section 6654 has no "reasonable cause" exception. See, e.g., ATL & Sons Holdings, Inc. v. Commissioner, 152 T.C. 138, 150 (2019). Again, Mr. Jalas has not raised a genuine dispute as to a material fact with respect to this issue. See Rule 121(d). Thus, we sustain the additions to tax under section 6654.
4. Section 6662(d) Substantial Understatement Penalty
In the alternative, the Commissioner asserts an accuracy related penalty under section 6662(b)(2) and (d). Section 6662 imposes a 20 percent penalty on the portion of any underpayment attributable to a "substantial understatement of income tax." I.R.C. § 6662(a), (b)(2). The penalty under section 6662(a) only applies where a taxpayer has filed a return. I.R.C. § 6664(b). The filing of a return, for this purpose, does not include a substitute for return pursuant to section 6020(b). Id. Because Mr. Jalas did not file a return for any year at issue, the substantial understatement penalty cannot apply, and therefore, he is not liable for the section 6662(d) penalty.
Conclusion
We will grant in part and deny in part the Commissioner's Motion for Summary Judgment. We sustain the Commissioner's tax liability determinations, as well as the imposition of additions to tax under sections 6651(a)(1), 6651(a)(2), and 6654. However, we deny the Commissioner's Motion for Summary Judgment with respect to the increased rate for a fraudulent failure to file addition to tax under section 6651(f), as well as the Commissioner's alternative position for an accuracy-related penalty under section 6662. To give effect to the foregoing, it is
ORDERED that the Commissioner's Motion for Summary Judgment is granted in part as set forth above.