Mikelberg v. Commissioner

Henry B. Mikelberg and Rose R. Mikelberg, Petitioners, v. Commissioner of Internal Revenue, Respondent. Henry B. Mikelberg, Petitioner, v. Commissioner of Internal Revenue, Respondent. Rose R. Mikelberg, Petitioner, v. Commissioner of Internal Revenue, Respondent Mikelberg v. Commissioner Docket Nos. 45524, 45525, 45526 United States Tax Court 23 T.C. 342; 1954 U.S. Tax Ct. LEXIS 39; November 23, 1954, Filed *39 Decisions will be entered under Rule 50. 1. Use of net worth method approved where husband and wife commingled assets and filed joint returns for some of the years involved. As to years in which separate returns were filed, held, that the total net income for both spouses for each year as shown by the net worth method may be allocated between them where a reasonable basis for such allocation exists. 2. Various items in net worth statement determined. 3. The Commissioner's determination of fraud approved. Eldridge Hood Young, Esq., for the petitioners. Edward Pesin, Esq., for the respondent. Raum, Judge. RAUM *343 The respondent determined the following deficiencies in income tax, and additions to tax under section 293 (b) of the Internal Revenue Code of 1939: Year Petitioner Deficiency Additions to tax [1944] Henry B. and Rose R. Mikelberg $ 10,739.88 $ 5,369.94 [1945] Henry B. and Rose R. Mikelberg 10,093.64 5,046.82 [1946] Henry B. Mikelberg 4,357.98 3,033.40 [1946] Rose R. Mikelberg 625.35 127.96 [1947] Henry B. Mikelberg 4,946.44 3,718.11 [1947] Rose R. Mikelberg 682.12 14.28 [1948] Henry B. and Rose R. Mikelberg 578.28 672.47 [1949] Henry B. and Rose R. Mikelberg 3,144.86 1,572.43 *40 The issues concern the propriety of using the net worth method of computing the income of petitioners; of making an allocation of the joint income so found between the petitioners for the years 1946 and 1947; the amount of various items to be included in the computation of income by the net worth method; the correctness of respondent's determination of fraud; and the statute of limitations. FINDINGS OF FACT. A stipulation of facts filed by the parties, together with accompanying exhibits, and facts stipulated during the course of the trial are incorporated herein by this reference. Petitioners Henry B. Mikelberg and Rose R. Mikelberg are husband and wife, residing in Philadelphia, Pennsylvania. They filed joint income tax returns for the taxable years 1944, 1945, 1948, and 1949 and separate income tax returns for the taxable years 1946 and 1947 with the collector of internal revenue for the first district of Pennsylvania at Philadelphia. Both petitioners are doctors of medicine and are licensed to practice medicine in Pennsylvania. Henry was born in 1894 and received his license to practice in Pennsylvania in 1920. Although not certified as a specialist, his practice during the*41 taxable years was largely in the fields of gynecology and obstetrics. Rose was born in 1903 and received her license to practice in Pennsylvania in 1930. Her practice during the taxable years was limited to pediatrics, but she has not been certified as a specialist in that field. They were married in 1929 *344 and have one daughter, Elinor, who at the time of the hearing was 23 years old and was attending medical school. Henry was graduated from medical school in 1917, where he had received some financial assistance from scholarships. He also worked as a clerk in a haberdashery during the period 1907-1917, beginning at $ 3 a week and later earning as much as $ 35 to $ 50 a week, depending upon the amount of time worked. During this period he lived at home with his family. His father worked in a factory as a cigar-maker. Four other children also resided at home and contributed to the support of the household. Henry served his internship from 1917 to 1918, and thereafter entered the Army. He returned from France and was discharged in August 1919. Thereafter, he opened an office for the private practice of medicine. For the years 1925-1937, inclusive, Henry filed individual*42 income tax returns. The number of dependents reported thereon, tax reported as due, and tax paid were as follows: Number of Tax Year dependents reported reported and paid [1] 1 $ 0 [1] 1 0 [1] 3.68 [1] 1 0 [1] 1 0 [1] 1 0 [2] 1 0 [2] $ 64.94 [2] 23.17 [2] 36.03 [2] 8.16 [2] 23.29 For the years 1918-1930, inclusive, he claimed his mother, Emma Mikelberg, as his only dependent. For the years 1929-1937, he reported his wife, Rose, as an exemption, and for the years 1931 and 1933-1937, he claimed his mother and daughter as dependents. Up to and including the taxable year 1937, Rose never filed an individual income tax return either jointly or separately. For the years 1938-1940, inclusive, Henry and Rose filed joint returns. The number of dependents reported thereon, the taxes reported as due and paid were as follows: Taxes Year Number of dependents reported and paid [1938] 2 (Emma and Elinor) $ 12.62 [1939] 1 (Elinor) 9.18 [1940] 1 (Elinor) 29.70 *345 Petitioners*43 also filed joint returns for the years 1941-1943, inclusive, reporting net income as follows: Year Net income [1941] $ 2,587.08 [1942] 3,573.63 [1943] 3,944.14 On June 22, 1929, a judgment was entered against Henry, in favor of the Felix Building and Loan Association in the amount of $ 25,000. This judgment arose out of a bond and mortgage transaction between Henry's brother and the association wherein Henry was surety for his brother's obligation of $ 25,000. This judgment was satisfied on or about May 15, 1946, by Henry's payment of $ 200 to United Trading Corporation, successor in interest to the association. During the period that the judgment was in effect, Henry attempted to conceal assets in order to prevent an execution to satisfy the judgment. In carrying out this attempt, property was purchased in his wife's name; however, other property was purchased in both of their names jointly, and some securities and property were purchased by him in his own name. In 1944, Henry was advised by counsel that a settlement could be made on the judgment. During the taxable years, Henry had office hours morning and afternoon, and made few outside calls. He also delivered about *44 50 or 60 babies a year. Rose devoted less time to her practice than Henry spent in his practice. She had regular visiting hours during the week from 2 o'clock to 4 o'clock every afternoon. She also made house calls and devoted some time to work in hospital clinics. She received no compensation for her work in clinics. All of the receipts from her practice were turned over by her to her husband. Petitioners have no books and records showing the receipts from or expenses incurred in their medical practices. It is stipulated by the parties that on January 1 of each of the years indicated petitioners owned assets acquired with their own funds, as follows: January 1 [1947] Bank accounts -- First National Bank $ 341.77 $ 405.32 $ 1,788.39 $ 7,305.56 U. S. Savings Bonds -- Cost 1,912.50 2,475.00 3,225.00 3,318.75 Real estate 63,150.00 120,113.53 143,659.36 155,659.36 Stocks 8,610.13 Depreciable personal property (office furniture and equipment, x-ray machines, air conditioner, and automobile) 2,400.00 2,400.00 5,299.77 4,899.77 January 1 [1950] Bank accounts -- First National Bank $ 1,859.27 $ 1,276.43 $ 779.61 U. S. Savings Bonds -- Cost 3,393.75 3,543.75 3,618.75 Real estate 179,264.36 188,794.14 204,094.14 Stocks 8,274.29 Depreciable personal property (office furniture and equipment, x-ray machines, air conditioner, and automobile) 9,034.77 9,034.77 7,304.56 *45 *346 The above schedule does not reflect cash on hand, or other assets which petitioners might have acquired with their own funds in the name of another. The real property owned by petitioners on January 1, 1944, consisted of one parcel purchased in 1919, two in 1936, one in 1940, two in 1941, and one in 1943. During various months of 1944, petitioners purchased eleven other parcels of real property. No mortgages were payable by petitioners on any of the properties purchased by them during 1944. Petitioners had accumulated cash on hand on January 1, 1944, in the amount of $ 22,000. The following schedules show deposits into a school savings account, and balance there as of the end of each year existing in the name of petitioners' daughter, Elinor Mikelberg: Schedule of Deposits in the Philadelphia Saving Fund Society Account No. S. S. 7745 in Name of Elinor Mikelberg [1947] Date Amount Date Amount Date Amount 10-16-45 $ 3.00 3-6-46 $ 1.00 1-7-47 $ 9.00 11-21-45 27.95 3-13-46 2.00 1-14-47 28.00 11-27-45 3.00 3-20-46 2.50 2-25-47 25.00 12-4-45 2.00 3-27-46 2.50 3-5-47 25.00 4-10-46 2.50 3-12-47 25.00 4-24-46 2.50 3-19-47 25.00 5-22-46 2.00 3-26-47 30.00 6-5-46 0.95 4-9-47 25.00 6-12-46 1.00 4-16-47 25.00 10-22-46 7.00 4-23-47 27.00 10-29-46 3.00 4-30-47 25.00 11-12-46 7.00 5-7-47 25.00 11-19-46 6.00 5-14-47 25.00 11-26-46 2.00 5-21-47 25.00 12-10-46 6.00 5-28-47 25.00 12-17-46 7.00 6-4-47 40.00 7-2-47 92.89 10-15-47 25.00 10-22-47 25.00 10-29-47 25.00 11-19-47 25.00 11-26-47 25.00 12-3-47 25.00 12-17-47 25.00 Total Deposits $ 35.95 $ 54.95 $ 676.89 Balance, Jan. [0] 35.95 90.90 1. Balance, Dec. $ 35.95 $ 90.90 $ 767.79 31. *46 Schedule of Deposits in the Philadelphia Saving Fund Society Account No. S. S. 7745 in Name of Elinor Mikelberg [1948] Date Amount 2-25-48 $ 31.00 3-3-48 25.00 3-10-48 25.00 3-17-48 25.00 3-31-48 25.00 4-7-48 25.00 4-14-48 25.00 4-21-48 25.00 5-12-48 26.00 5-19-48 25.00 5-26-48 25.00 8-24-48 51.00 Total Deposits $ 333.00 Balance, Jan. 767.79 1. Balance, Aug. $ 1,100.79 26, 1948. On August 26, 1948, the above account was closed; the entire balance therein, $ 1,100.79, was transferred to a regular savings account in Elinor's name. The following schedule shows the deposits into the new account and balance therein at the end of each year: *347 Schedule of Deposits in the Philadelphia Saving Fund Society Account No. M 12,750 in Name of Elinor Mikelberg [1949] Date Amount Date Amount 8-26-48 $ 1,100.79 1-12-49 $ 50.00 9-7-48 42.00 2-15-49 70.00 9-20-48 44.30 3-4-49 95.00 10-19-48 60.00 3-11-49 100.00 11-4-48 30.00 4-20-49 140.00 12-15-48 110.00 5-25-49 200.00 6-27-49 100.00 8-10-49 200.00 10-26-49 440.00 12-12-49 200.00 Total deposits $ 1,387.09 $ 1,595.00 Balance, Jan. 1 [0] 1,387.09 Balance, Dec. 31 $ 1,387.09 $ 2,982.09 *47 All of the deposits in both accounts were made with funds furnished Elinor by petitioners. The following amounts (at cost) of United States Government Bonds (Series E) were in the name of petitioners' daughter, Elinor, as of January 1 of the years indicated: [1944] $ 468.75 [1945] 675.00 [1946] 1,050.00 [1947] 2,362.50 [1948] $ 3,731.25 [1949] 3,787.50 [1950] 3,825.00 All such bonds were paid for with funds belonging to the petitioners. The parties have stipulated that petitioners had liabilities (including reserves for depreciation) on January 1, of the years indicated, which, in total, are as follows: [1944] $ 25,949.57 [1945] 34,529.02 [1946] 38,315.70 [1947] 30,289.64 [1948] $ 28,520.97 [1949] 23,753.16 [1950] 26,353.26 The $ 25,000 judgment against Henry is not reflected in the above schedule. Petitioners made the following payments by check to Morris Minkin, the father of Rose Mikelberg, who resided in California, for his support: [1947] $ 900 [1948] 1,200 [1949] 1,500 They also furnished funds for his support during the years 1944, 1945, and 1946 in the amount of $ 600 for each of those years. During 1949, the petitioners also furnished $ 500 for the support *48 of Anna Ball, a sister of Henry. *348 During the taxable years petitioners resided on the second floor of a building which they owned, and maintained their offices on the first floor. They had a part-time maid, who worked 4 or 5 hours per day throughout the taxable years. Her duties included cleaning the offices as well as doing personal laundry of the petitioners and their daughter. Her salary was between $ 15 and $ 20 per week throughout the taxable years. The petitioners' daughter spent each summer during the taxable years with an aunt in Nebraska. The round-trip railroad fare was paid for by the petitioners. Rose also made three trips to Nebraska during the taxable years. In 1949, Rose and Elinor made a trip to California. The expenses of this trip were paid for by petitioners. Henry was a member of the Masonic Order and paid $ 39 per year in Masonic dues during each of the taxable years. Petitioners paid insurance premiums of $ 151 per year during each of the taxable years for an endowment policy for their daughter and a life insurance policy on Rose's life. In 1948, furniture for Elinor's bedroom was purchased by them at a cost of $ 800, and in 1949, they paid $ *49 350 for tuition on her behalf. Respondent determined that petitioners' living expenses were as follows: [1944] $ 2,500 [1945] 2,800 [1946] 3,100 [1947] $ 3,400 [1948] 3,700 [1949] 4,000 They incurred living expenses during the taxable years in amounts at least as great as those determined by respondent. Petitioners' net worth was as follows on January 1 of each of the years indicated: [1944] $ 72,933.58 [1945] 91,539.83 [1946] 116,742.77 [1947] 143,347.20 [1948] $ 169,530.22 [1949] 184,070.52 [1950] 204,525.18 Petitioners made the following Federal income tax payments to the collector of internal revenue at Philadelphia, Pennsylvania, in the taxable years 1944 through 1949: Year Payments [1944] $ 1,324.71 [1945] 1,101.66 [1946] 2,518.69 [1947] $ 4,987.88 [1948] 4,714.88 [1949] 5,668.30 During the taxable years 1944 through 1949 the petitioners realized the following long-term capital gains: Capital Year gains [1944] $ 945.98 [1945] 1,078.90 [1948] $ 2,995.74 [0] *349 For Federal income tax purposes during those taxable years, 50 per cent of such long-term capital gains is taken into account. Petitioners had a combined net income in*50 the following amounts during the years stated: [1944] $ 21,957.97 [1945] 28,565.15 [1946] 32,223.12 [1947] $ 34,570.90 [1948] 21,457.31 [1949] 30,122.96 For the years 1946 and 1947 the combined net income shown above is allocable to Henry and Rose as follows: Henry Rose [1946] $ 22,556.18 $ 9,666.94 [1947] 24,199.63 10,371.27 Petitioners reported net income as follows in their joint income tax returns for the years 1944, 1945, 1948, and 1949: [1944] $ 7,961.71 [1945] 9,523.34 [1948] 18,960.69 [1949] 18,822.44 Petitioners reported net income as follows on their separate income tax returns for the years 1946 and 1947: Henry Rose [1946] $ 11,657.05 $ 5,212.45 [1947] 13,895.41 6,300.00 The following "Consents Fixing Period of Limitation upon Assessment of Income and Profits Tax" (Form 872) were filed by petitioners: Period of Tax year Petitioner Date limitations executed extended until [1945] Henry B. and Rose R. Mikelberg 2-1-51 6-30-52 [1945] Henry B. and Rose R. Mikelberg 1-8-52 6-30-53 [1946] Henry B. Mikelberg 1-8-52 6-30-53 [1946] Rose R. Mikelberg 1-8-52 6-30-53 [1947] Henry B. Mikelberg 2-1-51 6-30-52 [1947] Henry B. Mikelberg 1-8-52 6-30-53 [1947] Rose R. Mikelberg 2-1-51 6-30-52 [1947] Rose R. Mikelberg 1-8-52 6-30-53 [1948] Henry B. and Rose R. Mikelberg 1-8-52 6-30-53 *51 The notices of deficiency herein were mailed on August 29, 1952. A part of the deficiency for each of the taxable years is due to fraud with intent to evade tax. OPINION. 1. The deficiencies in controversy have been determined by the use of the so-called net worth method. Petitioners maintained no books or records of receipts from their practice of *350 medicine, and although there was testimony as to records reflecting unpaid charges or fees owing to petitioners no such records were produced. Nor were there produced any books or records detailing the rather large expenses which petitioners claimed as deductions on their returns. In the circumstances, it was entirely proper to resort to the net worth method, since an increase in net worth, after making appropriate adjustments for nondeductible living expenses, and the like, substantially in excess of income shown on the returns, may be persuasive evidence of understated net income. Cf. Morris Lipsitz, 21 T. C. 917, 931. The fact that there are two taxpayers here presents no insuperable problem. Petitioners are husband and wife, and were such throughout the taxable years. The evidence shows*52 that they pooled their assets; and whether a particular piece of property was acquired by them in both names, or in the name of one of them, does not appear to have any significance in this respect in the light of the evidence before us. The cases were consolidated for trial pursuant to motion consented to by petitioners, and indeed, during the course of the trial, when a question was raised as to which petitioner was the maker of certain checks, petitioners' counsel indicated that it was not material since the cases had been consolidated. Moreover, during 4 of the 6 taxable years involved herein petitioners filed joint returns (1944, 1945, 1948, and 1949). Certainly as to those 4 years, it was entirely appropriate to determine the increase in net worth of the composite assets in computing the net income to be attributed to both petitioners jointly. And even as to the other 2 years, 1946 and 1947, the increase in net worth of the petitioners' composite assets could be used in determining their composite net income for each of those years, thereby leaving merely the problem of allocating that composite net income between them, a problem which presents no insurmountable difficulties, *53 provided that there is a reasonable basis for such allocation. We think that a reasonable basis exists in the evidence before us. Henry testified that Rose devoted to her practice about one-fifth of the time which he devoted to his. Evidence as to office hours kept by each and house calls made by Rose suggests a higher percentage; and in the returns actually filed by them for 1946 and 1947, the net income reported by Rose was about 45 per cent of the net income reported by Henry. In the circumstances, we think that respondent's position that 30 per cent of the composite net income be allocated to Rose is reasonable and in accord with the evidence. Our findings of fact as to the amounts of Rose's and Henry's net income for the years 1946 and 1947 reflect our conclusion that such allocation is factually justified and reasonable. *351 2. In applying the net worth method here the parties have stipulated many of the important items, including bank accounts, real estate, depreciable personal property, securities, liabilities, and depreciation. The parties, however, are not in agreement on (a) the amount of cash on hand as of January 1, 1944; (b) the source of deposits made into*54 two savings accounts existing in the name of petitioners' daughter, Elinor; (c) the source of funds used to purchase United States Savings Bonds issued in Elinor's name; and (d) the amount of nondeductible personal living expenses incurred by the taxpayers in the taxable years. (a) We heard considerable testimony regarding petitioners' contention that they had about $ 82,000 in cash on hand on January 1, 1944. Such testimony was at variance with admissions made by Henry to investigating agents on at least two occasions that petitioners had no accumulation of cash at the beginning of the taxable period. Henry testified at length as to the sources for the alleged accumulation, and Rose undertook to corroborate some of the details. We had ample opportunity to observe them on the witness stand, and it is our conclusion that their testimony was unreliable and unworthy of belief in many respects. Henry's testimony that he had accumulated $ 30,000 by 1921 or 1922 which he at that time turned over to one Samuel S. Lear for investment was, in our opinion, incredible and false. To explain an accumulation in the amount of $ 30,000 at that time, he testified that he had substantial savings*55 derived from earnings while working as a haberdashery clerk for the period ending with his graduation from medical school, that he earned a considerable amount of money treating civilian patients in France while in the Army, and that he had disproportionately high earnings during his first year or two of practice in Philadelphia. We think that much of that testimony was exaggerated or untruthful. Henry testified that Lear returned $ 26,500 to him in 1940. The details of the Lear transaction were so vague that we have little confidence in the entire story. 1 *56 The petitioners also assert, on brief, that "$ 2,500 a year would be a conservative and reasonable sum for them to have saved" producing a total of $ 37,500 for the years 1929-1943. The income tax returns filed during that period by petitioners make such a claim wholly *352 unreliable, and no evidence was introduced to show that this or any other amount was accumulated from earnings in those years. We do not find it necessary to set forth and analyze all the evidence relating to the alleged accumulation of $ 82,000. Much of it is, in our judgment, false or exaggerated. However, we think, on all the evidence, that petitioners did have some accumulation of cash as of January 1, 1944, and it is our best judgment, based on the entire record, that the amount was $ 22,000. Cf. Cohan v. Commissioner, 39 F. 2d 540, 544 (C. A. 2). We have made a finding of fact to that effect. (b) There is also disagreement between the parties on the source of some of the funds which were deposited into the two savings accounts existing in the name of petitioners' daughter. Petitioners contend that some of the funds deposited were received as gifts from petitioners' *57 patients and unidentified relatives. Respondent's argument is that all of the money was given to Elinor by petitioners. We agree with respondent. Petitioners themselves admit furnishing Elinor with some of the money. Their vague testimony as to Elinor's unidentified benefactors was not credible. Moreover, the regularity of the deposits during the school year and the almost identical amounts of a considerable number of those deposits strongly suggest a consistent source, namely, Elinor's parents. The stipulated facts and the evidence are convincing that petitioners supplied the funds for the deposits in Elinor's accounts. (c) The petitioners contend that some of the Government bonds issued in the name of their daughter were gifts from their patients and relatives, and admit that the others were purchased by them. The respondent has determined that all of such bonds were purchased with petitioners' funds. The evidence tending to support the petitioners' contentions is based upon their own testimony. We have considered that testimony and do not believe their story that some of the bonds were purchased by others. We are satisfied on this record that petitioners furnished the *58 money with which to purchase the bonds in question. (d) The respondent determined that the petitioners had nondeductible living expenses as follows during the taxable years: [1944] $ 2,500 [1945] 2,800 [1946] 3,100 [1947] $ 3,400 [1948] 3,700 [1949] 4,000 Petitioners contend that such expenses incurred by them were not in amounts as great as those determined by respondent. We think, however, that the respondent's determination is correct. The petitioners testified that during the taxable years they had living expenses in minor amounts; that they lived frugally; never *353 entertained; bought almost no clothes for themselves or their daughter; and that most of their personal needs were satisfied by gifts from patients and others. We have not accepted all such testimony as fact. We think it highly improbable that petitioners spent as little as they would have us believe during the taxable years. Although they may have entertained little and received some gifts, the record fully supports the respondent's determination. In addition to normal day-to-day living expenses, the record shows such other nondeductible personal expenses as travel expense, insurance premiums, support*59 payments to Rose's father and Henry's sister, 2 furniture purchased, and the like. We have found as a fact that petitioners incurred living expenses during the taxable years in amounts at least as great as those determined by the respondent. 3. The respondent has determined that a part of the deficiencies for each of the taxable years was due to fraud with intent to evade tax. We think that he has sustained his burden of proof in establishing such fraud. Petitioners are both doctors of medicine and intelligent persons. They maintained no books and records from which their income could be determined. There is evidence to the effect that they were not cooperative with the investigating agents. Their testimony at the trial was frequently vague and evasive. Their net income*60 was substantially understated in each of the taxable years. There is evidence that their explanations of their assets varied from time to time. We think the evidence is clear and convincing that the deficiencies are due at least in part to fraud with intent to evade tax, and we have so found. 3 Decisions will be entered under Rule 50. Footnotes 1. No tax due as reported on the return.↩ 2. No return filed for this year.↩ 1. The unreliability of Henry's testimony as to the Lear transaction is accentuated by the testimony of a former attorney of petitioners to the effect that Henry had stated to him that he received $ 18,000 from Lear in 1940. At the trial, objection was made to the former attorney's testimony on the ground that it was in violation of the attorney-client privilege. It was admitted only after the Court had been thoroughly satisfied that Henry's statement to the attorney was made for the purpose of having the attorney relate such information to Government agents. In the circumstances there was no confidential communication between client and attorney. In any event, the conclusions that we have reached herein are independent of the attorney's testimony, which we have treated merely as corroborative.↩ 2. Such support payments were, of course, not deductible in determining net income under the Internal Revenue Code of 1939. However, after net income has been determined, appropriate exemptions may be allowable for dependents in computing the tax.↩ 3. In view of this finding, the issues raised concerning the applicability of the statute of limitations must be decided in favor of respondent. Sec. 276 (a), I. R. C. 1939↩.