Gerardo v. C.I.R.

• Decision Date: 18 March 1977
• Docket Number: No. 76-1825,76-1825
• Citation: 552 F.2d 549
• Parties: 77-1 USTC P 9322 Andrew GERARDO, Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Appellee.
• Court: U.S. Court of Appeals — Third Circuit

Page 549

552 F.2d 549

77-1 USTC P 9322

Andrew GERARDO, Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Appellee.

No. 76-1825.

United States Court of Appeals Third Circuit.

Argued Feb. 15, 1977.

Decided March 18, 1977.

Edwin Fradkin, John J. O'Toole, Starr, Weinberg & Fradkin, Newark, N.J., for appellant.

Scott P. Crampton, Asst. Atty. Gen., Gilbert E. Andrews, Ann Belanger Durney, Gilbert S. Rothenberg, Attys., Tax Div., Dept. of Justice, Washington, D.C., for appellee.

Before ALDISERT and GARTH, Circuit Judges, and McCUNE, ^* District Judge.

OPINION OF THE COURT

GARTH, Circuit Judge.

Appellant Andrew Gerardo appeals from a decision of the United States Tax Court determining deficiencies in income tax due for the taxable years 1966 and 1967 based upon unreported income from illegal gambling activity in Newark, New Jersey. Specifically, we are called upon to determine whether the evidence supports the Tax Court's finding that Gerardo received income from a lottery operation from April 4, 1966 through February 3, 1967, and whether the Tax Court erred in upholding the Commissioner's decision to assess appellant on the entire income of the gambling operation. Although we uphold the Commissioner's issuance of alternative deficiency assessments ¹ for the total tax due, we have determined that no evidence supports the Tax Court's finding that Gerardo was involved in the lottery operation during the entire period covered by the deficiency assessment. We therefore reverse.

I.

During the years in issue, Andrew Gerardo was the controlling officer of two related corporations engaged in trucking and excavation activities. He maintained no checking account and dealt almost exclusively in cash.

From August 5, 1966 through February 3, 1967, the Internal Revenue Service conducted an undercover investigation of an illegal lottery operation in the north Newark area. Surveillance activities focused on various small, retail establishments as well as on persons who frequented such establishments. In addition, Special Agent Germano of the Internal Revenue Service, posing as a bettor, frequented the Ben Thomas luncheonette where he observed the workings of the operation, and where he gained the confidence of Joe Cipriano, a member of that organization.

The Tax Court, in its opinion, made the following findings (among others), all of which are supported by the evidence:

In the course of his undercover surveillance, respondent's agent (Germano) frequented a certain dining establishment known as the Ben Thomas luncheonette, a frequent meeting place of several of the conspirators. There respondent's agent placed bets regularly, with Joseph Cipriano, a convicted co-conspirator who accepted and recorded bets for the organization. ³

3. In all, the agent placed a total of 68 bets. 34 T.C.M. 1480, 1481 (1975).

Respondent's agent gained the confidence of Cipriano who freely discussed the operation with the agent and told him that petitioner (Gerardo) was third in the chain of the organization's command. Cipriano further informed the agent that the organization was extremely prompt in paying winning bettors, that petitioner was responsible in this capacity and could be consulted should a problem arise.

Petitioner was a regular visitor to the luncheonette and was observed there by respondent's agent on at least thirteen occasions. Respondent's agent placed bets with Cipriano in petitioner's presence. Petitioner was frequently observed as party to discussions concerning wagering operations. On one occasion respondent's agent overheard petitioner inform the alleged chief of the operation that "the heat was on," and "they (the authorities) are going to give it their raid treatment."

On February 2 and 3, 1967, Special Agents of the Intelligence Division of the Internal Revenue Service obtained search warrants and conducted searches of five residences allegedly used as lottery "offices" or meeting places of the conspirators. A number of automobiles were also searched at this time.

During the raids, respondent's agents seized gambling paraphernalia in the form of betting slips comprising the recorded daily tallies of each of the group's bet recorders for three days' operation.

An analysis of the seized slips revealed a correlation showing that slips seized from the several different locations were part of a single wagering operation.

On the basis of the seized evidence and the surveillance activities, in 1969, Gerardo and eighteen others were convicted of conspiracy to operate a lottery between August 5, 1966 and February 3, 1967, in a New Jersey state court prosecution. ²

On June 23, 1972, the Commissioner of Internal Revenue, having determined deficiencies for the years 1966 and 1967 in the amount of $899,249.63 plus fraud penalties of $449,624.81 (totalling $1,348,874.44), forwarded a Notice of Deficiency to Gerardo. ³ Deficiencies arising from the same wagering activities and in the same amount were also assessed against two other individuals. ⁴ The gambling deficiencies were computed in the following manner: from the betting slips seized on February 2 and 3, 1967, the Commissioner determined the average daily gross receipts of the lottery operation. The Commissioner then projected that amount over the period from April 4, 1966 (four months prior to the commencement of the undercover investigation) through February 3, 1967, and, assuming net profits equal to 30% of the gross wagering receipts, calculated that Gerardo received gambling income, not reported in his returns, in the amount of $1,167,443.55 in 1966 and $139,694.10 in 1967.

Gerardo petitioned the Tax Court for a review of the deficiencies and penalties assessed by the Commissioner. The Tax Court upheld the Commissioner's determination in all respects except that it reduced the percent figure used by the Commissioner in determining the lottery's net profit from 30% to 20%, thereby reducing Gerardo's tax liability. ⁵

II.

We begin by noting the appropriate standards of review. In the Tax Court, the Commissioner's determination carries a presumption of correctness, see Baird v. Commissioner of Internal Revenue, 438 F.2d 490, 492 (3d Cir. 1971), and the taxpayer has the burden of proving that determination "to be arbitrary (i. e., without rational foundation in fact and based upon unsupported assumptions). . . . " Harry Gordon, 63 T.C. 51, 73 (1974), modified, 63 T.C. 501 (1975) appeal pending; see Baird v. Commissioner of Internal Revenue, supra at 492. On appeal, our scope of review "is limited by the general principle that all findings of facts made by the Tax Court and all inferences drawn by it from these facts are binding on the appellate courts unless 'clearly erroneous.' " Costantino v. Commissioner of Internal Revenue, 445 F.2d 405, 407 n. 5 (3d Cir. 1971). By the same token, "(o)nce the method of (reconstructing a taxpayer's income) is found acceptable the Tax Court's factual findings in the course of applying that method must be upheld unless clearly erroneous." ⁶ Agnellino v. Commissioner of Internal Revenue, 302 F.2d 797, 799 (3d Cir. 1962).

Gerardo, however, argues that the evidence does not support the Tax Court's finding of his involvement in the lottery operation during the period covered by the assessment. Therefore, he contends that the Commissioner's deficiency assessment for the period from April 4, 1966 through February 3, 1967 was arbitrary and the Tax Court's finding was "clearly erroneous."

Gerardo's argument with respect to the period August 5, 1966 through February 3, 1967 is unpersuasive. First, Agent Germano's testimony, his personal observations, his activities and his conversations with Cipriano, all during this period, provide ample support for the Tax Court's findings. ⁷ Second, the observations made by agents other than Germano add additional substantiation to the wagering activities of Gerardo during this time. Finally, Gerardo's indictment and conviction (with others) of conspiracy to violate New Jersey's criminal wagering statutes between the same dates August 5, 1966 and February 3, 1967, with no mitigating explanation afforded, give substantial content to the Tax Court's finding that he was involved in wagering activities during this period.

In the Tax Court, Gerardo's only attempt to meet his burden of rebutting the Commissioner's evidence consisted of self-serving denials of his involvement. The Tax Court, in concluding that Gerardo had realized substantial income from the gambling operations during this period and that he had failed to report this income, did not give and need not have given credence to Gerardo's testimony. See Simon v. Commissioner of Internal Revenue, 285 F.2d 422, 424-25 (3d Cir. 1960).

While we fully approve the Tax Court's findings and conclusions as they pertain to the period August 5, 1966 through February 3, 1967, we are troubled by the extent of the Tax Court's determinations which reach back beyond August 5, 1966 to attribute income to Gerardo from the date of April 4, 1966 up to February 3, 1967. Our concern here is that no evidence appears in the record which links Gerardo to the gambling operation during the period April 4, 1966 through August 5, 1966.

We observe that "the absence of adequate tax records (as in the case here) does not give the Commissioner carte blanche for imposing Draconian absolutes." See Webb v. Commissioner of Internal Revenue, 394 F.2d 366, 373 (5th Cir. 1968). Furthermore, where the Commissioner issues a "naked" assessment, his determination of tax due may be " 'without rational foundation and excessive,' and not properly subject to the usual rule with respect to the burden of proof in tax cases." See United States v. Janis, 428 U.S. 433, 441, 96 S.Ct. 3021, 3026, 49 L.Ed.2d 1046 (1976).

In Pizzarello v. United States, 408 F.2d 579 (2d Cir. 1969), cert. denied, 396 U.S. 986, 90 S.Ct. 481, 24 L.Ed.2d 450 (1970), the Second Circuit considered a situation involving an...