Stanley J. & Shirley A. Zaban, Petitioner

ADM.

RECORDED SERVICE CAL. s TAT. . T.

JUDGE Q/ FILES T. C. Memo. 1997-479 UNITED STATES TAX COURT STANLEY J. ZABAN AND SHIRLEY A. ZABAN, Petitioners y. COMMISSIONER OF INTERNAL REVENUE, Resporídent Docket No. 27119-93.

Filed October 21, 1997.

Paula M. Junghans and Caroline D. Klepper, for petitioners.

Alan R. Peregoy, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

JACOBS,

Judge:

Respondent determined the following deficiencies in, and additions to, petitioners' Federal income .

taxes:

SERVED

OCT 2 1 1997

After concessions,¹ the following issues remain for decision:

(1) Whether respondent properly determined that petitioners had cash on hand in the amount of $115,100 as of December 31, 1989, as part of the 1989 net worth calculation; (2) whether petitioner Shirley A. Zaban (Mrs. Zaban) qualifies for innocent spouse relief pursuant to section 6013(e) for 1986 through 1990; (3) whether Mrs.

Zaban is liable for the fraud additions to tax for 1986 and 1987 pursuant to section 6653(b)(1)(A) and (:B) and for 1988 pursuant to section 6653(b)(1) and for the fraud penalty for 1989 pursuant to section 6663; (4) whether Mrs. Zaban is liable for the additions to tax for negligence or disregard of rules or regulations for 1986 and 1987 pursuant to section 6653(a)(1)(A) and (]B) and for 1988 pursuant to section 6653(a)(1) and for the accuracy-related penalty for 1989 pursuant to section 6662; (5) whether petitioners are Petitioners concede the deficiencies relating to all of • the unreported income, except for $115,100 determined as cash on hand as part of respondent's 1989 net worth calculation. also concede the fraud additions to tax and penalty for 1986 through 1989 with respect to Mr. Zaban. Moreover, petitioners concede that they are not entitled to the $98,000 deduction for forfeited funds for 1990. Finally, petitioners are entitled to a $56,622 mortgage interest deduction for 1990.

the parties have agreed that They Respondent disallowed petitioners' 1987 and 1988 deductions lies with petitioners on this issue, we hold for for certain miscellaneous expenses. Although petitioners disputed this determination in their petition, address this issue either at trial or on brief. Because the burden of proof respondent. Rule 142(a). Additionally, and for the same reasons, we hold for respondent on the innocent spouse issue relating to the miscellaneous expense deductions. Respondent, however, did not present any evidence on the fraud additions to tax relating to the miscellaneous expense deductions, and given our finding that no fraud existed with respect to other issues,. we hold for Mrs. Zaban on that issue. Rule 142(b).

they did not .

positions, including rater for insurance policies, receptionist at a nursing home, salesclerk at a department store, and interior decorator.

A. Business Interests of Mr. Zaban During 1985 and/or 1986, Mr. Zaban was a shareholder in the .

following entities: G&Z Corp., doing business as the Parlay Cafe (1985 through 1990); Graymar Co., Inc., which sold business equipment and supplies (1986 through 1990); Putty Hill Printing, Inc. , which provided printing and copying services (1985 through 1990); and OPCZ, Inc., doing business as Zingaro's restaurant (1985 through 1987).

In 1986, upon the recommendation of Francis E. Fidati, CPA, petitioners' personal and business accountant, Mr. Zaban formed and was the sole shareholder of Zaban Enterprises, Inc., a subchapter S corporation, for the purpose of paying himself a salary, as well as distributions, from interests in his other business entities.

Mrs .

Zaban was an of f icer of Zaban Enterprises ; she signed corporate employment and income tax returns, signed the election to become a subchapter S corporation, maintained the corporate checking account, and wrote substantially all the checks from that account.

In or about August 1985, Mrs. Zaban, along with Gary Genovese, a shareholder with Mr.

Zaban in the Parlay Cafe, filed an application for a liquor license for the Parlay Cafe with the Board of Liquor License Commissioners for Baltimore County.

'The application falsely stated that Mrs.

Zaban had a 50-percent On or about June 25, 1992, the U.S. Attorney for the District of Maryland filed a four-count information charging Mr. Zaban with illegal gambling and bookmaking, money laundering, bank fraud, and tax evasion (for 1989 only). Mr. Zaban pled guilty to each count as part of a plea bargain with the U.S. Attorney's Office, and judgment was entered by the U.S. District Court for the District of Maryland on October 27, 1992.

The plea agreement also included a stipulation that Mr. Zaban had engaged in skimming cash from the Parlay Cafe.

Mr. Zaban's accountant, Mr. Fidati, also pled guilty to assisting in the preparation and filing of a false tax return by failing to report the income from the illegal bookmaking and gambling activities, as well as the income skimmed from the Parlay Cafe.

1.

Illegal Gambling and Bookmaking Pursuant to the Federal information to which Mr. Zaban pled guilty in October 1992, Mr. Zaban admitted that from May 1, 1986, through March 23, 1992, he was engaged in illegal gambling and bookmaking activities out of his home and in other locations within the State of Maryland. He engaged in these bookmaking operations with Mr. Neumyer . and others.

The bookmaking operations were confined to sports betting, primarily on collegiate and professional basketball and football.

Mr. Zaban's role in the operation was to obtain customers, record bets, distribute winnings, and collect losses. Mr. Zaban also placed bets on his own account several times a week and often $62,700 in Bethlehem Steel bearer bonds, 590 $100 bills, and 20 $50 bills. Although the toolbox was somewhat obscured while in petitioners' basement, the tape recorders were in plain sight on Mr. Zaban's desk.

From petitioners' basement, Mr.

Zaban made and received telephone calls to and from Mr. Neumyer and others involved in the gambling and bookmaking activities. Mrs.

Zaban occasionally answered the telephone in their home and at times spoke with Mr.

Neumyer.

Sometime in 1991, the Baltimore County Police Department .

obtained an order from the Circuit Court for Baltimore County to place a dialed number recorder (DNR) on the two phone lines at petitioners' residence in Lutherville, Maryland, for the purpose of recording the number of incoming and outgoing activations on those lines.

The DNR analysis performed by the Baltimore County Police Department between November 21, 1991, and January 30, 1992, revealed 3,360 activations on one line, of which 3,231 were outgoing and 129 were incoming, and 1, 097 activations on the other line, of which 635 were outgoing and 462 were incoming.

The first line had an average of 47 telephone calls per day, and the second line had an average of 15 telephone calls per day.

.

2. Money Laundering Mr. Zaban engaged in two different schemes to launder the money he obtained from his illegal gambling and bookmaking activities.

The first scheme involved alleged loan payments to Mr.

Fidati. Mr. Zaban gave Mr. Fidati $4,000 per month in cash during 1986, 1987, and 1988, and Mr. Fidati repaid Mr. Zaban by writing (To a large extent Mrs. Zaban negotiated the terms of the loan with Ms. Gerling.)

On February 26, 1988, petitioners submitted an application to Midstate for a $101, 000 acquisition loan to purchase a residential lot in Lutherville, Maryland. The loan application listed monthly income of $12,200, assets of $683,293.65, and a net worth of $520,325.65.

On or about August 23, 1988, petitioners submitted an application to Midstate for a $528,700 construction loan to build their home on the lot in Lutherville, Maryland, pursuant to a $660,923 construction contract.

The loan application listed monthly income of $13,750, assets of $819,293.65, and a net worth of $555,325.65.

As part of the loan application process, petitioners were required to submit their Federal income tax returns for 1986 and 1987. The returns that were hand delivered to Ms. Gerling by either Mr. or Mrs. Zaban reported gross income before adjustments of $160,115 for 1986 and $165,263 for 1987, even though the returns prepared and filed with the Internal Revenue Service (IRS) reported gross income before adjustments of $66,195 for 1986 and $101,963 for 1987. Mr..Zaban prepared the fraudulent returns submitted to Midstate for the purpose of persuading the savings and loan to approve the loan applications.

These fraudulent returns were the basis for the bank fraud charge to which Mr. Zaban pled guilty.

Petitioners completed construction of the Lutherville, Maryland, home and began occupying it in or about June 1989. The Frank Culotta, a friend.

In 1988, $30,626 of.the aforementioned loan was repaid upon the sale of an Ocean City, Maryland, condominium that petitioners owned together with Mr. Culotta.

The balance of the loan to Mr. Culotta remained unpaid as of December 31, 1989. During 1987, Mr. Zaban lent $52,000 in cash to Keith Vazquez (who is married to Mr. Zaban' s niece) , which remained unpaid as of December 31, 1989.

Sometime prior to December 31, 1985, Mr. Zaban lent James Donohue $10,000 in cash, which remained unpaid as of December 31, 1989.

During 1988, Mr. Zaban lent Splenanne, Ltd. $4,623.87, of which $1,824 was repaid in 1989, and the balance remained unpaid as of December 31, 1989. Mrs. Zaban was not involved in any of these loan transactions.

E. Petitioners' Lifestyle In 1978, petitioners acquired a home in Phoenix, Maryland, for $96,899, which was financed through a mortgage.

The property was sold on February 1, 1990, for $185, 000, with a $46, 901 balance on the mortgage.

The mortgage payment on the Phoenix, Maryland, residence was approximately $500 per month.

Following construction of petitioners' home in Lutherville, Maryland, in mid-1989, the monthly mortgage payment became $4,935.32, with a balloon payment of $445,213.99 due on October 1, 2003. Mrs. Zaban was aware of the mortgage payments on the home.

In 1989, petitioners furnished their home with $29, 893.38 in furniture from three stores and, in 1990, acquired a $12, 800 Andy Warhol painting.

During 1989 and 1990, petitioners acquired several other paintings, including: Lily Pond, appraised for with Baker, Watts & Co. with a portfolio value of $136,426.26 as of December 31, 1985, and a portfolio value of $333,507.66 as of December 31, 1989. Mr. Zaban maintained a brokerage account with Thompson McKinnon with a portfoli.o value of $7,954.92 as of December 31, 1985, and a portfolio value of $22,183.09 as of December 31, 1989.

Mrs. Zaban was aware of these brokerage ac count s .

Between 1986 and 1989, petitioners paid for their daughter's college education at Loyola College in the amount of $6,679.16 in 1986, $7,830.97 in 1987, $8,073.13 in 1988, and $4,062.50 in 1989.

Between 1986 and 1989, petitioners held memberships at Chestnut Ridge Country Club, Merritt Racquetball Club (where Mr.

Zaban played racquetball) , and Greenspring Racquet Club (where Mrs.

Zaban played tennis) .

.

Between 1986 and 1989, petitioners had credit card payments on 14 credit cards totaling $7,522.23 in 1986, $11,747.41 in 1987, • $31,371.12 in 1988, and $33,238.49 in 1989.

In 1988, petitioners paid $3,368.70 to World Travel for a trip, and in 1989, petitioners paid $7,088.75 on jewelry at Radcliff & Co.

Mrs.

Zaban participated in the purchase of the home furnishings, artwörk, flatware, and jewelry, in addition to clothes and fur coats, and was aware of other expense items.

F. Preparation and Filing of Federal Tax Returns Petitioners' 1984 and 1985 Federal joint income tax returns (which are not in issue) were prepared by petitioners' attorney, .

In October 1990, Mr. Zaban entered into a closing agreement with the IRS, terminating the 1990 tax year as of March 24, 1990.4 Mr. Zaban agreed to report the net profits from his gambling and bookmaking activities.

The 1990 return (signed by both petitioners) reported gross income before adjustments of $289,560 and gambling income of $240,700 (before expenses) on Schedule C in accordance with the closing agreement.

Mrs. Zaban provided Messrs. Breschi and Fidati with records and other information necessary to prepare petitioners' returns for 1984 through 1990. She never reviewed their work to. determine whether the returns were true and accurate. At times, Mr. Fidati would provide Mrs. Zaban with returns prepared in pencil and would have her sign blank returns.

• As of October 1990, at a time in which Mrs. Zaban was aware of Mr. Zaban's gambling and bookmaking activities, Mrs. Zaban knew she should not rely on Mr. Fidati to prepare their returns. Despite this concern, Mrs. Zaban signed the 1989 and 1990 joint returns without reviewing them.

G. Notice of Deficiency Pursuant to a reconstruction of petitioners' income under the net worth method, respondent determined that petitioners had Closing agreements resolve liability issues only for .the taxable years covered by the agreements. 601.202 (a) , Statement of Procedural Rules. of the 1990 tax year on March 24, 1990, conclusively resolved, for purposes of the closing agreement, only the issues for that period. Respondent was permitted to issue notices of deficiency relating to issues and time periods not covered by the agreement.

Sec. 7121; sec.

the termination Thus, and do not maintain adequate books and records. Holland v. United States, 348 U.S. 121 (1954) ; Lias v. Commissioner, 235 F.2d 879, 880 (4th Cir. 1956), affg. 24 T.C. 280 (1955); Estate of Beck v.

Commissioner, 56 T.C. 297, 353-354 (1971). Deficiencies determined by indirect methods generally are presumed correct, Mills v.

Commissioner, 399 F.2d 744, 749 (4th Cir. 1968), affg. T.C. Memo.

1967-67, and taxpayers bear the burden of proving that such deficiencies are erroneous, Rule 142 (a) ; Parks v. Commissioner, 94 T.C. 654, 658-659 (1990).

The net worth method requires a finding of both the beginning and ending net values of a taxpayer's assets.

Holland v. United States, supra at 125.

Mr. Zaban asserts that the contents of box 3567, in which the $115,100 cash was found, belonged to Mr. Neumyer. Mr. Zaban claims that Mr. Neumyer gave him between $155, 000 and $175, 000 in 1984 to hold for safekeeping. According to Mr. Zaban, Mr. Neumyer gave him the money because Mr. Neumyer was going to Las Vegas for several weeks; and while there, Mr. Neumyer wanted Mr. Zaban to be in a position to pay off Mr. Neumyer's obligations to certain individuals in connection with Mr. Neumyer's bookmaking operations.

Mr. Zaban testified that after Mr. Neumyer's return from Las Vegas, Mr. Neumyer never asked him to return the funds.⁵ Mr. Zaban's testimony was self-serving and lacked credibility.

The evidence reflects that on January 2, 1990, $40, 000 in cash was transferred from box 3567, a box controlled by Mr. Zaban to which Mr. Neumyer died prior to the date of trial.

entitled to such relief for 1986 through 1990. Respondent argues that Mrs. Zaban fails to meet three of the four statutory elements for relief .

Spouses who file a joint income tax return generally are jointly and severally liable for its accuracy and the tax due, including any additional taxes, interest, or penalties determined on audit of the return.

Sec. 6013(d)(3).

However, pursuant to section 6013 (e) , a spouse (commonly referred to as an innocent spouse) can be relieved of tax liability if that spouse proves:

(1) A joint income tax return was filed; (2) the return contained a substantial understatement of tax attributable to grossly erroneous items of the other spouse; (3) in signing the return, the spouse seeking relief did not know, and had no reason to know, of the substantial understatement; and (4) under the circumstances it would be inequitable to hold the spouse seeking relief liable for the understatement.

Sec. 6013(e).

The spouse seeking relief bears the burden of proving that each of the four elements of the statute has been satisfied, and failure to prove any one of the elements will prevent innocent spouse relief.

Bokum v. Commissioner, T.C. 126, 138-139 (1990), affd. 992 F.2d 1132 (11th Cir. 1993).

Respondent concedes that a joint return was filed for each of the years in issue, and thus the first element is not disputed.

The innocent spouse issue can be disposed of on the third and fourth elements.

received unusually high volumes of telephone calls. Further, Mrs.

Zaban knew that Mr. Zaban worked only in their basement where he kept betting records and other gambling paraphernalia, tape recorders hard-wired to the telephone lines, and a toolbox for storing large amounts of cash, all of which were readily visible to anyone who passed through the basement.

Mrs. Zaban testified that she never reviewed any of the tax returns, liquor license applications, or loan applications she signed. Her testimony that she was unaware of any of the contents in these documents lacks credibility.

In any case, the fact that Mrs. Zaban failed to review any tax returns she signed, or to sign blank tax returns that were completed at a later time, does not permit Mrs. Zaban to plead ignorance and does not absolve her of liability for her husband's omissions.

See Hayman v. Commissioner, 992 F.2d 1256, 1262 (2d Cir. 1993), affg. T.C. Memo. 1992-228; Edmondson v.

Commissioner, T.C.

Memo.

1996-393; Cohen v.

Commissioner, T.C. Memo. 1987-537.

Had Mrs. Zaban reviewed the 1984 and 1985 joint returns, she would have discovered that nearly two-thirds of the reported gross income before adjustments resulted from gambling; and had she reviewed the 1986, 1987, and 1988 joint returns, she would have found that no such gambling income was reported in those years.

See Zimmerman v. Commissioner, T. C. Memo.

1996-223.

Further, she would have discovered that the reported income for 1986 and 1987 was inconsistent with the figures reported on the loan applications submitted to Midstate, the savings and loan institution with which she personally negotiated and discussed condominium share and seven automobiles, two of which were new Mercedes Benzes; paid for their daughter's entire private college education; become members of three country or racquet clubs; and taken a $3,300 vacation.

During the latter part of 1988 and through 1990, this lavish lifestyle became even more apparent.

Mrs. Zaban was directly involved in the process of negotiating a $101, 000 residential lot loan, as well as a $528,700 construction loan for the building of their Lutherville, Maryland, home. Following completion of the new home in which the monthly mortgage payment increased from approximately $500 per month to nearly $5, 000 per month, which was .

paid by Mrs. Zaban, she participated in the furnishing of that home, which included about $60,000 in purchases. Mrs. Zaban was also involved in the purchase of over $7, 000 in jewelry during 198.9 and accumulated a wardrobe filled with fur coats and other clothes throughout the period in issue.

Given all of the facts and circumstances, we are convinced, and thus hold, that Mrs. Zaban knew or should have known of the substantial understatement on petitioners' returns for 1986 through 1990 and thus is not entitled to innocent spouse relief.

.

b.

Inequity in Holding Mrs. Zaban Liable It would also not be inequitable to hold Mrs. Zaban liable for the deficiencies for the years in issue.

The record demonstrates that Mrs. Zaban significantly benefited from the underreported income and from the impermissible deductions (e.g., the large home and furnishings, cars, fur coats and other clothings, club 1111, 1123 (1983).

Fraud is never presumed, Beaver v.

Commissioner, 55 T. C. 85, 92 (1970) , and cannot be imputed from one spouse to another, Stone v. Commissioner,

Respondent has failed to sustain the burden of proof.

Respondent has not established that Mrs.

Zaban knew of the understatement on petitioners' joint returns given her failure to review any of the returns or her signing of blank returns.

See Ewell v. Commissioner, supra. Additionally, there was no evidence presented that Mrs. Zaban was involved in preparing the returns, other than providing documentation to the accountant, Mr. Fidati.

Even though we believe Mrs. Zaban knew of Mr. Zaban's illegal gambling and bookmaking activities, we cannot conclude from the record that Mrs. Zaban knew that income from such activities was not being reported.

See Flynn v. Commissioner, T. C. Memo. 1981- 491.

On the basis of the entire record in this case, we are not persuaded that Mrs. Zaban intended to evade taxes and defraud the Government.

Thus, we hold that Mrs. Zaban is not liable for the additions to tax and penalty for fraud for 1986 through 1989.

Issue 4. Negligence or Disregard of Rules or Regulations The fourth issue for decision is whether Mrs. Zaban is liable for additions to tax and penalty for negligence or disregard of rules or regulations.

As an alternative to the fraud additions to tax and penalty for 1986 through 1989, respondent determined additions to tax for negligence or disregard of rules or regulations pursuant to sections 6653 (a) (1) (A) and (a) (1) (B) for additions to tax for the substantial understatement of tax pursuant to section 6661 for 1986, 1987, and 1988, and an accuracy-rel·ated penalty pursuant to section 6662 for 1990.7 Mrs. Zaban asserts that she had reasonable cause and acted in good faith for those years and thus is excepted from the substantial understatement addition to tax and the accuracy-related penalty pursuant to section 6664(c).

.

Mrs. Zaban's argument is without merit.

The reasonable cause exception to the addition to tax for the substantial understatement of tax and the accuracy-related penalty for substantial understatement of tax are not applicable to taxpayers filing tax returns prior to December 31, 1989. Omnibus Budget Reconciliation Act of 1989 (OBRA), Pub. L. 101-239, sec. 7721(a), 103 Stat. 2106, 2395. Thus, the reasonable cause exception does not apply to petitioners' 1986, 1987, and 1988 returns.

In any case, Mrs. Zaban lacks reasonable cause and good faith for each of the years in issue.

Mrs. Zaban never reviewed the returns prepared by Mr.

Fidati and occasionally signed blank returns.

Her failure to review the returns and her blind reliance on Messrs. Zaban and Fidati were not reasonable.

See Bollaci v. Commissioner, T.C.

For tax years 1986, 1987, and 1988, sec. 6661 imposed additions to tax of 25 percent of the amount of any underpayment attributable to a substantial understatement. understatement greater of 10 percent of the tax required to be shown on the return or $5,000.

is defined as an understatement which exceeds the A substantial Sec. 6661(b).

For tax year 1990, sec. 6662 imposed an accuracy-related penalty of 20 percent of the underpayment attributable to a substantial understatement.

filed after the prescribed filing date.

An exception is provided for reasonable cause not the result of willful neglect.

IdçL Petitioners were granted an extension for filing their 1989 joint return to August 15, 1990, but did not file the return until October 18, 1990. Petitioners di.d not establish reasonable cause for the failure to timely file their 1989 return, and thus they failed to meet their burden of proof. Rule 142(a). We hold that petitioners are liable for the addition to tax under section 6651(a)(1).

To reflect the foregoing and the concessions of the parties, Decision will be entered under Rule 155.

56. T. C. 213, 227-228 (1971) .