Mauch v. Commissioner

RUSSELL C. MAUCH AND BESSIE MAUCH, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Mauch v. Commissioner Docket No. 72269. United States Board of Tax Appeals 35 B.T.A. 617; 1937 BTA LEXIS 855; March 10, 1937, Promulgated *855 1. The allegations of fraud contained in the Commissioner's answer are deemed to be admitted by reason of the failure of the petitioner to file a reply within the time prescribed by the rules of practice. 2. Assuming that the petitioner denied all the facts relating to fraud alleged by the Commissioner, the penalties are sustained on the ground that the evidence affirmatively establishes that a part of each deficiency is due to fraud with intent to evade tax. 3. The evidence establishes that the petitioner, with intent to evade tax, not only grossly understated the amount of attorney fees received by him, but also that he failed to report substantial sums of money received from unnamed clients, which were deposited in his bank account along and commingled with other funds belonging to him and were used freely for his own use and enjoyment, and which constituted income to the petitioner and represented neither a gift nor a return of capital. Everett Kent, Esq., and Milton J. Goodman, Esq., for the petitioners. I. Graff, Esq., for the respondent. MURDOCK *618 The Commissioner determined deficiencies in income tax of the petitioners, *856 together with penalties, as follows: Year Deficiency Penalty — 1929 — $2,349.55 $1,174.78 — 1930 — 3,996.88 1,998.44 The issues submitted for decision by the Board are (1) whether any part of the deficiencies is due to fraud with intent to evade tax, and (2) the amount of the taxable net income of the petitioner, Russell C. Mauch, for the years 1929 and 1930. FINDINGS OF FACT. The petitioners, Russell C. Mauch and Bessie Mauch, are husband and wife and residents of Hellertown, Pennsylvania. They had five children, all of whom were dependents in 1929 and 1930. Bessie Mauch had no taxable income in 1929 and 1930. Russell C. Mauch, hereinafter referred to as the petitioner, filed his income tax returns for the calendar years 1929 and 1930 with the collector of internal revenue for the twelfth district of Pennsylvania. The return for 1929 was filed March 14, 1930, and the return for 1930 was filed March 13, 1931. Consents were duly executed, extending the time for assessment of taxes for 1929 and 1930 to June 30, 1934. The notice of deficiencies for 1929 and 1930 was mailed to "Russell C. Mauch and wife, Bessie Mauch" on March 13, 1933. The Commissioner*857 made a jeopardy assessment for 1929 on January 30, 1933. The petitioner reported his income for both years on the basis of cash received and disbursed. Such records as he kept were kept on this same basis. A part of the deficiency for the year 1929 was due to fraud with intent to evade tax. A part of the deficiency for the year 1930 was due to fraud with intent to evade tax. Russell C. Mauch is a lawyer. He has been actively engaged in the practice of his profession since 1911. During 1929 and 1930 he was district attorney of Northampton County, Pennsylvania; attorney for the borough of Hellertown, the school district of the borough of Hellertown, the Bethlehem Building & Loan Association, the Saucon Valley Building & Loan Association, and the Bethlehem National Bank of Bethlehem, Pennsylvania; but he devoted the *619 greater part of his time to the duties of the office of district attorney and the representation of two estates. The petitioner maintained several bank accounts. The principal one was a checking account with the Bethlehem National Bank, hereinafter referred to as his general account. The other accounts, with the same bank, were a checking account*858 designated "special account", and a small savings account. It was the practice of the petitioner for some years to deposit in his general account all funds received in his office. These consisted of moneys derived from salaries as district attorney and as attorney for the borough of Hellertown and the school district of the borough of Hellertown; attorney fees; commissions on bail bonds and rent allowances received from the county; other moneys belonging to the petitioner; and moneys belonging to clients and the county, including advances by clients for costs and expenses, which were from time to time disbursed by checks drawn on the account. The petitioner made gross deposits in his general account in 1929 amounting to $90,863.26. He deducted $300 in cash from checks deposited in the account. The balance in the account was $1,705.39 on January 1, 1929, and $2,640.90 on December 31, 1929. The petitioner received income in 1929 from the following sources, which he deposited in his general account: Attorney fees $11,507.38 Interest 26.40 Rent 389.03 The petitioner received, in addition to the above income, the following amounts in cash (except for the*859 $5,000 item received by check) from clients in 1929, and deposited the amounts in his general account: Date of deposit Amount Jan. 19, 1929 $2,000 Aug. 1, 1929 — 704 — Sept. 10, 1929 1,000 Sept. 18, 1929 5,000 Oct. 29, 1929 4,900 Nov. 2, 1929 $600 Dec. 6, 1929 3,000 Dec. 13, 1929 4,300 Total 21,504 The $5,000 deposited on September 18, 1929, was received by check from E. H. Maglathery, a client of the petitioner. The record does not disclose the exact source of the other funds included in the above list nor the precise purpose for which any of the funds were paid to the petitioner. The funds included in the above list were commingled by the petitioner with other funds belonging to him and were used by him for his own purposes. He did not have to and he did not account for any of the funds to any person in any way. None of these funds represented a return of capital to the petitioner *620 or a gift to him. The amount of $21,504 was income to the petitioner received in 1929. The petitioner made gross deposits in his special account during 1929 in the amount of $1,480. Of that amount $387.50 was received by the petitioner as dividends*860 in 1929. The record does not disclose the source from which the petitioner obtained the remainder of the funds in the amount of $1,092.50. This latter amount was used by the petitioner for his own purposes, was not a return of capital to him, and was not a gift, but was income to him received by him in 1929. The petitioner in 1929 purchased stock of the Saucon Valley Trust Co. for $1,370, and stock of the Industrial Loan Society $275for. These purchases were not paid for by checks drawn on any of the petitioner's accounts. The record does not disclose when the funds used to purchase the stocks were received or the source from which they were derived. The petitioner in 1929 made expenditures for the following purposes in carrying on his private practice: Miscellaneous office expenses $332.34 Advertising 145.00 Stationery and printing 130.23 Cleaning 100.00 Rent 175.00 Salaries $725.00 Telephone 284.54 Total 1,892.11 The petitioner received $520.26 in 1929 from Northampton County to reimburse him for a part of his office expenses. The petitioner purchased a Dodge automobile in the latter part of February 1929, for $1,845. It was used in*861 the conduct of his private practice and in the performance of his duties as district attorney. During 1929 he expended $751.21 for operation and repair of the automobile. One-half of that amount, or $375.60, constituted an ordinary and necessary expense of carrying on his private practice. The depreciation sustained on the automobile from the date of purchase to December 31, 1929, amounted to $384.38. A reasonable allowance to the petitioner for such depreciation sustained is $192.19. The petitioner used furniture and fixtures in his private practice which were acquired at a cost of $3,007.25. A reasonable allowance for depreciation of such property sustained in 1929 is $300.73. The petitioner paid $278.42 as interest and $238.26 as property taxes in 1929. The petitioner paid various amounts totaling $212 in 1929. The record does not disclose that any of these amounts were contributions within the meaning of that term as defined in section 23(n) of the Revenue Act of 1928. The petitioner paid $600 to the Hart Laboratories, Inc., on January 5, 1929. This was a payment of 60 percent of his subscription *621 to the capital stock of that corporation. The corporation*862 was organized in 1926 and discontinued operations some time before 1929. The evidence does not show that the petitioner sustained a loss of $600 in 1929. The Saucon Valley Building & Loan Association, prior to October 4, 1929, made a loan to Glassmire, secured by a mortgage on certain real estate. The petitioner, as attorney for the association, had caused the title to be examined and had certified that there were no existing encumbrances on the property. The Dodson Realty Co. issued execution in 1929 on a prior mortgage covering the same property. The petitioner thereupon reexamined the title and discovered that the Dodson mortgage had priority over the mortgage given to the association. The Dodson mortgage was also a second mortgage upon another piece of property. The petitioner purchased the Dodson mortgage on October 4, 1929, for $2,646.06, in order to protect the interest of the association. The Dodson mortgage was foreclosed in 1929. The association purchased the property at the foreclosure sale and acquired title to the property in December 1933, but it paid nothing to the petitioner as mortgagee. The petitioner then executed a release of the Dodson mortgage. Glassmire*863 later reacquired the property and voluntarily executed a mortgage to the petitioner for the amount expended by him. The petitioner did not sustain a deductible loss on this transaction in 1929. The petitioner reported taxable net income of $4,706.08 in his return for 1929. He reported gross income from fees of $6,622.71, deductions for business expenses and depreciation of $2,922.87, and net income from his profession of $3,699.84, exclusive of the salary received as district attorney. He did not claim any deduction for contributions or for losses in connection with the Hart Laboratories stock and the Glassmire mortgage. The Commissioner determined the petitioner's taxable net income to be $35,951.13. In making that determination he found that the petitioner received fees in the amount of $11,606.67, exclusive of his salary as district attorney, allowed deductions for business expenses and depreciation in the amount of $2,367.05, and determined the net income from fees to be $9,239.62. He accordingly increased the net income reported by the amount of $5,539.78. The Commissioner also increased the net income reported by the amount of $28,221.59 representing "cash and other*864 items unexplained." The latter amount included the bank deposits of $21,504 in the general account, deposits of $1,092.50 made in the special account, and the amount of $1,645 paid for stock of the Saucon Valley Trust Co. and the Industrial Loan Society. The correct taxable net income of the petitioner for 1929 is $33,794.76. *622 The petitioner made gross deposits in his general account in 1930 amounting to $66,370.96. The balance in the account was $2,640.90 on January 1, 1930, and $745.82 on December 31, 1930. The petitioner received income in 1930 from the following sources, which he deposited in his general account. Attorney fees $15,745.10 Interest 147.46 Rent 401.66 He also received in 1930 as a refund by the county for stationery and postage the amount of $163.10 which he deposited in his general account. The petitioner received in addition to the above income, the following amounts in cash from clients in 1930, and deposited the amounts in his general account: Date of deposit Amount April 24, 1930 $3,090 April 25, 1930 3,941 May 16, 1930 — 500 — July 5, 1930 1,800 Sept. 6, 1930 $5,500 Dec. 1, 1930 4,900 Total 19,731 *865 The record does not disclose the exact source of the funds included in the above list nor the precise purpose for which any of the funds were paid to the petitioner. The funds were not a return of capital to the petitioner nor a gift to him. The funds included in the above list were commingled by the petitioner with other funds belonging to him and were used by him for his own purposes. He did not have to and he did not account for any of the funds to any person in any way. The amount of $19,731 was income to the petitioner received in 1930. The petitioner made gross deposits in his special account during 1930 in the amount of $2,786.14. Of the amount so deposited $360 was received by him as dividends in 1930, and $116.79 was transferred to the special account from his general account. The record does not disclose the source from which the remainder of the deposits in the amount of $2,309.35 was derived nor the purpose for which it was received by the petitioner. This $2,309.35 was used by the petitioner for his own purposes and was income to him received in the year 1930. The petitioner in 1930 received two mortgages, one from Anthony Shelbo for $5,000 and one from*866 Theresa Stoschek for $3,300. He paid $300 to Shelbo and $2,392.92 to Stoschek by checks in 1929. The balance of these mortgages, namely, $5,607.08, was not paid to the mortgagors by checks drawn on any of the petitioner's accounts. The record does not disclose when the amount of $5,607.08 was received or the source from which it was derived by the petitioner. *623 The petitioner in 1930 made expenditures for the following purposes in carrying on his private practice: Miscellaneous office expenses $385.78 Advertising 36.50 Stationery and printing 36.75 Cleaning 120.00 Insurance 30.81 Rent $676.51 Salaries 660.55 Telephone 326.83 Total 2,273.73 The petitioner received $332.78 in 1930 from Northampton County to reimburse him for a part of his office expenses. The petitioner in 1930 used the Dodge automobile, purchased in 1929, in the conduct of his private practice and in the performance of his duties as district attorney. He expended $737.46 in 1930 in the operation and repair of the automobile. One-half of that amount, or $368.73, constituted an ordinary and necessary expense of carrying on the petitioner's private practice. The*867 depreciation sustained on that automobile during 1930 amounted to $461.25 and a reasonable allowance to the petitioner for depreciation sustained thereon is $230.63. The petitioner used certain furniture and fixtures in his private practice. A reasonable allowance for depreciation sustained thereon in 1930 is $344.62. The petitioner paid $118.60 as interest and $370.43 as property taxes in 1930. The petitioner paid $215 in 1930 to or for the use of organizations of the kind described in section 23(n) of the Revenue Act of 1928. The petitioner paid $400 to the Hart Laboratories, Inc., on August 9, 1930, for the balance due on his subscription to the capital stock of that corporation. The evidence does not show that the petitioner sustained a loss of $400 in 1930. The petitioner reported taxable net income of $10,824.17 in his return for 1930. He reported gross income from fees of $13,178.96, deductions for business expenses and depreciation of $3,257.03, and net income from his profession of $9,921.93. He did not include in the computation his salary as district attorney. He claimed a deduction $200of for contributions, but did not claim any loss in connection with*868 the Hart Laboratories stock. The Commissioner determined the petitioner's taxable net income to be $44,891.24. In making that determination he found that the petitioner received fees in the amount of $5,218.03 and paid costs of $1,592.12, or net fees of $3,625.91. He allowed deductions for business expenses (less $332.78 reimbursed by the county) and depreciation in the amount of $2,090.98, and, after making certain additional adjustments not here material, he determined the net income from fees to be $1,391.58. He accordingly reduced the net income reported from fees ($9,921.93) by the amount of $8,530.35. The Commissioner *624 otherwise increased the net income reported by the amount of $42,880.69, representing "cash and other items unexplained." The latter amount included, among other items, the amount of $12,350 received as fees, the cash deposits in the amount of $19,731, deposits made in the special account in the amount of $2,309.35, and the balance of $5,607.08 on the Shelbo and Stoschek mortgages. The correct taxable net income of the petitioner for 1930 is $40,875.79. The petitioner was indicted in the Middle District of Pennsylvania on October 18, 1933, for*869 willfully attempting to evade or defeat taxes upon his net income for the years 1929 and 1930, in violation of section 146(b) of the Revenue Act of 1928. He filed a plea of not guilty. A directed verdict of not guilty was entered on February 13, 1935. OPINION. MURDOCK: The evidence shows that the petitioner, Bessie Mauch, had no income for 1929 and 1930 and took no part in filing the returns. The respondent no longer contends that she is liable for any part of the deficiencies or penalties; therefore, decisions will be entered holding that there are no deficiencies or penalties for either year as to her. Russell C. Mauch, herein referred to as the petitioner, contended in his petition that the determination of the deficiency for the year 1929 was barred by the statute of limitations. However, consents were duly executed extending the statutory period so that the statute of limitations in no way bars the Commissioner in respect of deficiencies or penalties due from Russell C. Mauch for the years 1929 and 1930. The petitioner no longer argues this point and it needs no further discussion. The petitioner contends that, since he was indicted in the United States District*870 Court for willfully attempting to evade or defeat taxes upon his net income for the years 1929 and 1930 in violation of section 146(b) of the Revenue Act of 1928 and was found not guilty by a directed verdict, the imposition of the fraud penalties here is barred. A similar question was considered and decided adversely to the contention of the petitioner in . The Board here adheres to the position which it took in the Mitchell case. See also . The principal issue in this case is the one relating to fraud. The petitioner made no assignment of error relating to fraud in his amended petition, but sought to avoid the effect of the Commissioner's determination solely on the ground that the additions to income were improper and, consequently, no deficiencies could exist. He failed to reply to the allegations of fraud contained in the Commissioner's *625 answer. Long after the time to reply had passed, he asked leave to file a reply at the time of the hearing. He gave no valid reason for being permitted to file a reply at that late date denying the Commissioner's allegations, *871 and his request was denied. Thus, he came to trial with the allegations of fraud contained in the answer deemed to be admitted. See Board's Rules 14, 15, and 18. . There is a strong intimation in the pleadings that the petitioner does not contest the fraud penalties except by way of defending against the deficiencies. But, however that may be, the allegations of fraud in the Commissioner's answer which are deemed to be admitted, together with the evidence in the case, establish in a clear and convincing fashion that a part of each of the deficiencies is due to fraud with intent to evade tax. Moreover, the Commissioner does not have to rely in this case upon the petitioner's failure to reply. The statute imposes the penalty where any part of the deficiency is due to fraud with intent to evade tax. Sec. 293(b), Revenue Act of 1928. The Commissioner has the burden of proof (sec. 907(a), Revenue Act of 1924, amended by sec. 601), but does not have to prove that all of the understatements were fraudulent. It can be assumed that the petitioner has denied all of the facts relating to fraud and that the Commissioner has not been relieved*872 in the slightest in his burden of proof on the fraud issue by the petitioner's failure to plead properly; nevertheless, the evidence establishes affirmatively that a part of each deficiency is due to fraud with intent to evade tax. Thus the Commissioner did not err in determining that the fraud penalties are due. The petitioner's failure to keep adequate books and records from which his correct income tax liability for these years could be determined forced the Commissioner to resort in his investigation to bank records and other available sources of information. The petitioner received and deposited in his general account at various times during both of these years large sums of money which he did not report in his income tax returns, and the receipt of which he has repeatedly refused to explain. The petitioner admits that he received most of these amounts in cash and commingled them with his own funds by depositing them in his bank account. He says that these amounts were received from clients, and, when he was confronted with the evidence and was asked whether he had not used the funds for his own purposes, he replied that it looked that way. There is, for the purpose of*873 deciding the fraud issue, no material difference between the parties in regard to the purposes for which withdrawals from the petitioner's accounts were made or in regard to the deductions to which he is entitled. That is, their differences *626 are slight compared with the amounts here involved. The evidence clearly shows that the petitioner freely used all of the funds now under discussion as his own property. The real question in the case is to determine whether or not the evidence shows that these funds were income to the petitioner. If it does not, then the Commissioner has failed to prove fraud. But if the evidence shows that these sums were income to the petitioner, then the only serious challenge to the Commissioner's determination of the fraud penalties has been successfully met. The Commissioner has been unable to determine the exact source from which the petitioner obtained the funds or the precise purpose for which they were paid to the petitioner. The petitioner was a witness in the case and was asked to explain their receipt and to show, if he could, that they were not income to him for these years. He refused to make any explanation except to say that*874 they were trust funds, and a confidential relationship between himself and his clients prevented him from making further disclosures. He did not refer to any trust instrument, grantor, or beneficiary. A proper fiduciary relationship may be sufficiently disclosed for the purpose of a case like the present without violating any confidence placed in the fiduciary. 5 Wigmore on Evidence, §§ 2286, 2296. If the petitioner meant to use the phrase "trust funds" in a straightforward manner and to say that the funds were received by him in a fiduciary capacity rather than in an individual capacity for his own uses and purposes, then, speaking bluntly as the necessity of the case requires, we do not believe the petitioner on his oath. He has not told "the truth, the whole truth, and nothing but the truth" as he was sworn to do. We have not failed to believe him in this respect without good reason, but have been led to the conclusion by observing him on the stand, by considering the manner in which he gave his testimony, and by considering his testimony in the light of the uncontroverted evidence in the case. He did not keep separate account of the funds, as a fiduciary would be required*875 to do, and he used the funds for his own purposes, which a fiduciary could not do without violating his trust. Nor do we believe that his failure to testify fully in regard to these matters was due to any pure or altruistic motive springing from a proper confidence placed in him as an attorney by a client. Cf. 5 Wigmore on Evidence, § 2292; . If, however, when he used the phrase "trust funds", he meant to give it some subtle meaning, such, for example, as ill-gotten gains which he was not lawfully entitled to receive, nevertheless, his position would be no better for gains of that kind, retained without adverse claim, represent income. Cf. . *627 The taxpayer, of course, did not have to make out a case of fraud against himself. His refusal to explain and his failure to make any valid affirmative defense does nothing to support the Commissioner's burden of affirmatively proving fraud, except, perhaps, in one respect. The fact that large unexplained amounts passed through the petitioner's accounts in these years is not alone sufficient to justify the*876 conclusion that the funds were all income, yet it is substantial evidence to be considered in determining the question. . The fact that he used the funds for his own private purposes is likewise important. . In such cases the conclusion that the receipts were income is sometimes drawn from the evidence as a whole because no other conclusion seems reasonable. . If the receipt by the petitioner of the funds in question did not represent either a gift to him or a return to him of his capital, then their receipt must represent income to him. Not only has the petitioner never contended that the receipt of the funds represented a gift to him or a return of his capital, but he has made an explanation which is wholly inconsistent with the funds being either a gift or a return of capital. The defense of a gift or a return of capital would have been so simple and so effective that the failure of the petitioner to raise it and the fact that he has given another and wholly inconsistent explanation of the receipt of the funds may be taken as*877 a concession on his part that the funds were neither a gift nor a return of capital. The foregoing conclusion may be logically drawn even though we do not believe the petitioner's testimony that the funds were trust funds. The rule that a statement of a witness may not be disbelieved for one purpose and believed for another is not being violated. We are not believing his statement for any purpose, but are simply reasoning that, since he gave one explanation, it is fair to assume that the factual basis for a wholly inconsistent and yet effective explanation did not exist. The evidence is that at the beginning of these taxable years the petitioner's estate did not include these funds in any form whatsoever. The fair deduction from all of the evidence is that the petitioner did not receive the funds either as a gift or as a return of capital. Thus the respondent has made out this case on the fraud issue; the petitioner received substantial sums in each year from unnamed clients; these sums were not the return of capital or a gift to the petitioner; they were deposited by the petitioner in his bank account along and commingled with other funds belonging to him; and they were used*878 freely by him for his own benefit and enjoyment. The statutory definition of income clearly includes items such as these. *628 The petitioner not only failed to keep proper records of the receipt of these funds, but he failed to report them as income. The evidence of fraud is clear and convincing in respect of these items. There is other evidence entirely separate from that above discussed sufficient to establish fraud in this case. The Commissioner not only alleges that there was fraud in failing to report the amounts discussed above, but he also alleges that attorney fees were fraudulently omitted. The petitioner reported attorney fees for 1929 in the amount of $6,622.71 and for 1930 in the amount of $13,178.96. The evidence clearly establishes that the petitioner received fees of $11,507.38 in 1929 and of $15,745.10 in 1930. These are entirely separate from his salary as district attorney which is in no way involved in this proceeding. The petitioner said that the figures shown in his return were prepared by his stenographer and a man whom he had employed to make his returns. He said that these two went over all his records, including his check books and deposit*879 slips, and he signed the returns without going over them "with any degree of care." The petitioner's witness Margolis, a certified public accountant, went over these same records in 1933 and found fees of $11,507.38 for 1929 and $15,745.10 for 1930. He testified that generally the items were designated as fees on the deposit slips or original records. The petitioner was on a cash receipts and disbursements basis. After due allowance for deductible expenses of his business, a gross understatement of attorney fees remains. His failure to report these fees is not relieved of its force as proof of fraud by a showing on the part of the petitioner of any ameliorating circumstances. Cf. ; ; ; . Other understatements not discussed have not been considered in deciding the fraud issue. The issue relating to the deficiencies is quite different from that relating to fraud in this respect; the Commissioner's determination of the deficiencies is presumed to be correct and the taxpayer has the burden*880 of showing that it is incorrect. Here again the principal items in controversy are the unexplained amounts deposited in his bank accounts. Obviously he can not avoid the effect of the Commissioner's determination by refusing to explain how he obtained the amounts or the purposes for which he received them. As has been stated, we do not believe his statement that they were trust funds. Consequently, it has not been shown that the Commissioner committed any error in including these amounts in income for the purpose of determining the deficiencies. On the contrary, the evidence supports the determination of the Commissioner, as already appears from the foregoing discussion. The petitioner has failed to show *629 that other additions made by the Commissioner were not income, such as the amounts paid in cash for stock and mortgages. The petitioner received $520.26 in 1929 and $332.78 in 1930 from Northampton County to reimburse him for part of his office expenses. The reason for this was that the county failed to supply him with an office for his work as district attorney and, therefore, made this adjustment. The petitioner, however, got at least a part of his office space*881 rent free, as compensation for representing the owner of the building. The Commissioner has adjusted the petitioner's income for each year by reducing the petitioner's business expenses by the above amounts. The petitioner does not contest these adjustments and they are proper, despite the fact that the money was received from the county. If the petitioner had paid the owner of the building the portion of the rent borne by the county and had been paid a like amount by the owner of the building for legal services, the result would be exactly the same. The findings of fact indicate the correct treatment of other items. The determination of the Commissioner has been modified or changed in some minor respects, in several instances by concessions of the respondent's counsel. The petitioner has been given the benefit of every adjustment which the evidence justifies. Reviewed by the Board. Decision will be entered under Rule 50. BLACK, ARUNDELL, VAN FOSSAN, and ARNOLD concur only in the resuly.