Unpublished Disposition, 914 F.2d 261 (9th Cir. 1978)

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U.S. Court of Appeals for the Ninth Circuit - 914 F.2d 261 (9th Cir. 1978)

William R. BEYER, Petitioner-Appellant,v.COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.

No. 89-70071.

United States Court of Appeals, Ninth Circuit.

Argued and Submitted Jan. 10, 1990.Decided Sept. 14, 1990.

Before JAMES R. BROWNING, BEEZER and RYMER, Circuit Judges.


MEMORANDUM* 

The Commissioner of Internal Revenue (Commissioner) assessed a tax deficiency and penalties against William R. Beyer. The United States Tax Court upheld the deficiency. Beyer appeals, and we affirm.

Petitioner Beyer operates and holds ninety-nine percent of the stock of the Pend Oreille Cheese Company (Pend Oreille), a small corporation in the business of the manufacture and sale of cheese, as well as the purchase of bulk cheese for packaging and resale. In addition to receipts from cheese sales, Pend Oreille received interest and rents from real estate during the years at issue. Pend Oreille was Beyer's only source of income.

For 1974 through 1978, the tax years at issue, Beyer filed individual returns on which he reported taxable incomes (or losses) and tax liabilities as follows:

Year Taxable Income Tax Liability 1974 $8,438 $1,481 1 1975 (6,422) 0 1976 1,588 0 1977 4,227 0 1978 (41,360) 0

Pend Oreille's returns for the tax years ending August 31, 1974 through August 31, 1978, reflect losses each year, except in fiscal 1974, when Pend Oreille reported a net income of $16,244.

After interviewing Beyer and auditing the returns of both Beyer and Pend Oreille, revenue agents undertook to determine Beyer's income for the years at issue by reconstructing Pend Oreille's income using the net worth method.2 

In due course, the Commissioner issued a statutory notice of deficiency, determining that Beyer had underreported income of $288,533.55 over the five years in question, and assessed a tax deficiency of $107,686.31 and a $53,843.14 penalty pursuant to 26 U.S.C. § 6653(b).

Beyer filed a petition in the United States Tax Court contesting this determination. The tax court held the Commissioner's use of the net worth method to determine income in this case was proper, and that the Commissioner had proven fraud by clear and convincing evidence. The tax court affirmed the Commissioner's deficiency determination, with adjustments for the Commissioner's concessions as to the deductibility of certain disputed expenses. Accordingly, the tax court filed a decision declaring Beyer had underreported $268,599.64 of income over the five years in question and owed a tax deficiency of $101,245.79 and an additional penalty of $50,622.90.

On appeal, Beyer argues use of the net worth method of determining income was improper in his case, and there was insufficient evidence to support a finding of fraud.

Findings of the tax court, "although perhaps a mixed issue of fact and law, [are] reviewable under the clearly erroneous standard because [they are] essentially a factual determination.' " Enrici v. Commissioner, 813 F.2d 293, 295 (9th Cir. 1987) (quoting Thompson v. Commissioner, 631 F.2d 642, 646 (9th Cir. 1980). Further, inferences drawn by the tax court from factual findings are upset on appeal only if clearly erroneous. Geneva Drive In Theatre, Inc. v. Commissioner, 622 F.2d 995, 996 (9th Cir. 1980). A finding of fraud is factual and will be reversed only if clearly erroneous. Akland v. Commissioner, 767 F.2d 618, 621 (9th Cir. 1985).

The net worth method is acceptable if the taxpayer's records do not accurately reflect income. United States v. Stonehill, 702 F.2d 1288, 1296 (9th Cir. 1983). Beyer's own expert testified that Pend Oreille's records were inadequate in view of the size of the business. The problem was exacerbated because Beyer restricted access to his books. Even Beyer's accountant was provided only summaries of his accounts. Beyer's employees handled large amounts of cash without knowing what was done with it. Beyer kept no list of his retail customers.

To establish taxable income using the net worth method, the government must (1) accurately establish the taxpayer's opening net worth, (2) identify a likely source of taxable income from which it may be inferred that the taxpayer's increase in net worth arose, and (3) conduct a reasonable investigation of any leads that suggest the taxpayer properly reported his income. E.g., United States v. Greene, 698 F.2d 1364, 1370 (9th Cir. 1983). "Once the Commissioner has introduced some evidence that a taxpayer received unreported income, the burden shifts to the taxpayer to prove by a preponderance of the evidence that the deficiency determination is arbitrary or excessive." Edelson v. Commissioner, 829 F.2d 828, 831 (9th Cir. 1987).

Beyer contends that in determining his initial net worth, the Commissioner failed to take into account a cash hoard he claims to have accumulated prior to 1974. "This favorite defense asserts that the cache is made up of many years' savings which for various reasons were hidden and not expended until the prosecution period." Holland v. United States, 348 U.S. 121, 127 (1954). Beyer's own testimony was inconsistent regarding the size of his alleged cash hoard, varying from $1,000 to $224,000. Even if Beyer were believed that he possessed a cash hoard in 1961 when he moved from Michigan to Idaho, there was substantial circumstantial evidence that any funds possessed in 1961 were depleted by 1974.3  The tax court did not err in rejecting Beyer's contention regarding his alleged cash hoard.

Beyer further argues the Commissioner failed to show Pend Oreille constituted a likely source of his alleged underreported income. To demonstrate Pend Oreille was not capable of producing this income, Beyer presented testimony from his accountant, an inspector for the Idaho Bureau of Dairying, a cheesemaker who worked for Pend Oreille from 1968 until 1973 and an expert with a doctorate in food science. In United States v. Hom Ming Dong, 436 F.2d 1237 (9th Cir. 1971), we rejected a similar argument that the taxpayer's grocery could not have generated the income attributed to him. We held that since the taxpayer's witnesses lacked "actual knowledge of the operation of [the] grocery," id. at 1239, the trial court had not erred in ruling their testimony did not negate the reasonable inference that the taxpayer's net worth increased from the grocery. Id. at 1241. We reject Beyer's argument for the same reason. Although his cheesemaker may have had knowledge of his area of expertise while in Beyer's employ, no one but Beyer had knowledge of Pend Oreille's financial affairs, not even his accountant. It is undisputed Pend Oreille was Beyer's sole source of income during the tax years in question. Once Beyer's assertion of a cash hoard was properly rejected, the tax court did not err in concluding Pend Oreille was the likely source of Beyer's unreported income.

Beyer claims the Commissioner was obligated to follow up leads that would have further substantiated his contention Pend Oreille could not have generated the income attributed to it. Beyer gave revenue agents the names of four wholesale cheese sellers within approximately 160 miles who allegedly accounted for 95% of Pend Oreille's purchases and therefore, presumably, its corresponding sales. The Commissioner's obligation is limited to tracking down relevant leads reasonably susceptible of being checked, which, if true, would establish Beyer's innocence. Holland, 348 U.S. at 135-36; Greene, 698 F.2d at 1371. It is not at all clear how discussions with the four wholesalers would have established Beyer's innocence. Beyer did not offer a method for verifying that these merchants in fact accounted for 95% of his total volume, nor for verifying his profits on the resale transactions. Moreover, Pend Oreille's income came not from cheese sales alone, but from real estate ventures as well.

To support a finding of tax fraud, the Commissioner must show by clear and convincing evidence the taxpayer intended to evade taxes he knew or believed to be owing. Akland, 767 F.2d at 621. Fraud may be shown if some part of the deficiency is fraudulent. Id.

The tax court inferred Beyer's fraudulent intent from various factors which have been recognized by the courts to indicate fraud, including: the amount of the understatement, the consistent failure to report a substantial portion of income, the inadequacy of the records kept, the extensive use of cash, failure to supply the return preparer sufficient information, and inconsistent testimony during trial. Edelson, 829 F.2d at 832; Patton v. Commissioner, 799 F.2d 166, 171 (5th Cir. 1986); Bradford v. Commissioner, 796 F.2d 303, 308 (9th Cir. 1986).

Beyer was found to have understated his taxable income by $228,969.64, a considerable amount. The tax court noted he was "a reasonably intelligent, highly competent and experienced businessman," and he had "omitted substantial amounts of income." He kept his records to himself, and even his accountant had no idea of the accuracy of the books. The tax court found Beyer had failed to maintain adequate books and records. He used cash extensively. He made conflicting and inconsistent statements regarding his alleged cash hoard. The evidence supports the tax court's determination that Beyer intended to evade taxes.

AFFIRMED.

 *

This disposition is not appropriate for publication and may not be cited to or by the courts of this circuit except as provided by 9th Cir.R. 36-3

 1

An amended return was filed for 1974 to carry back a net operating loss from the 1975 return and an unused investment credit from the 1976 return. The amended return for 1974 shows a taxable income of $2,337 and a tax liability of zero

 2

The net worth method seeks to derive taxable income in any given year by determining from all available evidence of assets and liabilities the increase (or decrease) in the taxpayer's net worth over a twelve month period, adding to it the taxpayer's nondeductible expenses for that year, and subtracting from the sum any amount attributable to nontaxable sources. United States v. Colacurcio, 514 F.2d 1, 2 n. 2 (9th Cir. 1975)

 3

There was no showing that Beyer's income from 1961 through 1974 was sufficient to permit the accumulation of any substantial amount of cash. Further, the 1967 property settlement between Beyer and his ex-wife does not include any part of a cash hoard. Prior to the tax years at issue, both Beyer and Pend Oreille incurred substantial business indebtedness to various financial institutions without disclosing any substantial cash on hand. Beyer's extensive dealings with banks contradicts his testimony that he did not deposit his cash hoard because he mistrusted banks

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