394 F.2d 366 (5th Cir. 1968), 24112, Webb v. C.I.R.

Docket Nº:24112.
Citation:394 F.2d 366
Party Name:Bolen WEBB and Cornelia Webb, Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Appellee.
Case Date:April 23, 1968
Court:United States Courts of Appeals, Court of Appeals for the Fifth Circuit
 
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Page 366

394 F.2d 366 (5th Cir. 1968)

Bolen WEBB and Cornelia Webb, Appellants,

v.

COMMISSIONER OF INTERNAL REVENUE, Appellee.

No. 24112.

United States Court of Appeals, Fifth Circuit.

April 23, 1968

Page 367

Robert L. Blumenthal, Jack Gray Johnson, John Andrew Martin, Robert L. Blumenthal, Carrington, Johnson & Stephens, Dallas, Tex., for appellants.

Lester R. Uretz, Chief Counsel, I.R.S., Eugene F. Colella, Atty., I.R.S., Mitchell Rogovin, Asst. Atty. Gen., Lee A. Jackson, Joseph M. Howard, Lawrence B. Silver, Jonathan Cohen, Attys., Dept. of Justice, Washington, D.C., for appellee.

Before RIVES, GOLDBERG and AINSWORTH, Circuit Judges.

GOLDBERG, Circuit Judge:

We have for review a two-pronged decision of the Tax Court. Bolen Webb and Cornelia Webb, T.C. Memo 1966-81 (April 20, 1966). One prong relates to deficiencies in reporting income tax liability, and the other relates to their sometimes consort, the 50% Fraud penalty. The taxpayers, Bolen Webb and his wife Cornelia Webb (hereinafter Webb), seek our disavowal of the Tax Court's findings and conclusions on both prongs. We see no reason for such disavowal as to either the deficiency or the fraud and affirm.

The years during which Webb's income is in question are 1958, 1959, and 1960. The aggregate dollar amounts in question are $30,076.34 for the deficiency and $15,038.17 for the concomitant fraud penalty. 26 U.S.C. § 6653(b). 1

Webb has been in the retail liquor business in Dallas, Texas, since 1946. During the years involved in this controversy, 1958 to 1960, he operated three retail liquor stores; and in July, 1960, he began operating a fourth store.

The Webbs' first encounter with the Commissioner occurred in 1958, when he challenged their joint returns for the years 1956 and 1957. These returns had reported income from Webb's three liquor stores as follows:

1956 1957
Sales $76,713.00 $65,701.90
Cost of Sales 57,450.00 46,949.70
------------
Gross Profit 19,263.00 18,752.20
Expenses 19,746.97 18,212.00
------------
($ 483.97) $ 525.20 2

Page 368 The returns were investigated by Internal Revenue Agent Fred A. Bush between August of 1958 and June of 1960. Finding Webb's books and records inadequate, Agent Bush reconstructed his income, using a 20% Mark-up on the known cost of sales. As Bush later testified, the 20% Mark-up was a compromise adjustment agreed upon by Bush, Webb, and J. L. Lobdell who operated a tax and bookkeeping service and who had prepared Webb's 1956 and 1957 returns. Bush thus reconstructed Webb's Net Profit and Unreported Net Income for the years 1956 and 1957 as follows:

1956 1957
Sales $128,861.32 $141,538.02
Cost of Sales 107,384.44 117,948.35
-------------
Gross Profit 21,476.88 23,589.67
Expenses 10,608.28 13,088.89
-------------
Net Profit 10,868.60 10,500.78
Net Profit Reported ( 483.97) 525.20
-------------
Unreported Net Income $11,352.57 $ 9,975.58

Based on these figures, the Webbs were assessed the following additional taxes and a 50% Fraud penalty:

1956 1957
Tax Deficiency $1,760.46 $1,654.60
Fraud Penalty under 26 U.S.C. § 6653(b) 880.23 827.30
---------
Total $2,640.69 $2,481.90
Webb signed a Form 870 agreement (Waiver of Restrictions on Assessment and Collection of Deficiency in Tax and Acceptance of Overassessment) regarding the assessment for the years 1956 and 1957. The prophetic sting of the $5,122.59 tax assessment was reenforced by several warnings for Webb to keep better records. In June of 1959 Agent Bush advised Webb that the Internal Revenue laws require all taxpayers to keep sufficient records and that Webb should keep in permanent form a daily record of the money which he took in and of all purchase invoices and receipts. A month later the District Director of Internal Revenue in Dallas, Texas, sent Webb a letter advising him of his duty to keep accurate and complete business records and reprimanding Webb for his past failure to do so. The letter reads as follows:

'Your current records were found to be inadequate in the following respects: No books and records of any sort were maintained. Receipts were not deposited or recorded. Inventories were based on loose estimates rather than actual physical count and valuation. Rental income and expenses were not recorded.

Each taxpayer is required by law to make a return of his true income. He must, therefore, maintain such accounting records as will enable him to do so. * * * Page 369 This notice to you of the requirements of the law and regulations with respect to maintaining such permanent books of account and records * * * as will enable you to make a return of your true income and also will enable examining officers of the Internal Revenue Service to determine the correct amount of income subject to tax.' Moreover, on several occasions in 1958 and 1959 Lobdell talked to Webb about the necessity of maintaining adequate records. He recommended that Webb keep a detailed record of receipts for all expenditures and purchases and a daily record of all sales from each store. Despite the above presagements Webb refused to alter his bookkeeping in any significant manner. In the latter part of 1958 he did begin keeping part of his invoices in a whiskey box. However, some of the invoices were lost or misplaced, so that he was unable to furnish the revenue agent who conducted a subsequent examination with a complete record of his purchases during 1958, 1959, and 1960. During 1960 Webb kept a 'cash receipts book' containing weekly entries of his sales for that year. Not only was the book incomplete, containing entries for only 48 weeks of the year 1960, but also it was totally disregarded in determining Webb's taxable income for 1960. The gross sales which Webb reported for the taxable year 1960 were approximately $18,000 less than the gross sales recorded in the admittedly incomplete 'cash receipts book.' Webb did not ring up all cash sales on the cash registers of his business, and he did not deposit all of his receipts in bank accounts. Although he maintained accounts in one bank during the three-year period and in a second bank for six months during the period, he was unable to locate all of his canceled checks and other banking records for 1958, 1959, and 1960. The Webbs' joint income tax returns for 1958, 1959, and 1960 reported income from their retail liquor business as follows:

1958 1959 1960
Sales $101,218.73 $101,121.62 $110,381.12
Cost of Sales 3 91,345.05 91,000.58 100,150.70
------------ -----------
Gross Profits 9,873.68 10,121.04 10,230.42
Expenses 10,001.13 10,008.60 9,622.36
------------ -----------
Net Profit $( 127.45) $ 112.44 $ 608.06

These returns reported the following inventories and inventory purchases, with the resulting cost of sales:

1958 1959 1960
Opening Inventory $10,000.00 $10,000.00 $ 10,000.00
Inventory Purchases 88,419.30 87,551.00 97,670.00
---------- ----------
Total 98,419.30 97,551.00 107,670.70
Ending Inventory 10,000.00 10,000.00 12,000.00

----------
Costs of Sales $88,419.30 $87,551.00 $ 95,670.70

Page 370 In September of 1961 Revenue Agent Larry Kelley was assigned to investigate the Webbs' 1958, 1959, and 1960 returns. He found Webb's books and records to be totally inadequate. Likewise, after examining Webb's canceled checks and his primary bank's microfilm of Webb's canceled checks, bank statements, and deposit slips, Agent Kelley was no more enlightened. He thus estimated Webb's liquor income by the percentage mark-up method, as had been done regarding the 1956-57 settlement. Kelley examined the records of all of Webb's wholesalers and found that Webb had reported about one-half of the actual purchases on his tax returns. His actual inventory purchases had been as follows:

1958 1959 1960
Liquor and Wine $151,773.13 $173,006.08 $179,055.34
Beer 12,949.16 16,417.88 23,641.60
----------- -----------
Total $164,722.29 $189,423.96 $202,696.94

There was also a discrepancy between the opening inventory reported on the 1958 return and the closing inventory agreed to in the 1956-57 settlement; therefore, Kelley recomputed Webb's cost of sales using both the new purchase figures and the opening inventory determined by the 1956-57 settlement. His computations resulted in the following statement of cost of sales:

1958 1959 1960
Opening Inventory $ 13,000.00 $ 10,000.00 $ 10,000.00
Inventory Purchases 164,722.29 189,423.90 202,696.94
----------- -----------
Total $177,722.29 $199,423.96 $212,696.94
Ending Inventory 10,000.00 10,000.00 12,000.00
----------- -----------
Cost of Sales $167,722.29 $189,423.96 $200,696.94

Using a 25% Mark-up from cost of sales (the...

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