24 T.C.M. (CCH) 858 (1965)
T.C. Memo. 1965-162
CARMINE BOLLELLA and TERESA BOLLELLA, Petitioners,
COMMISSIONER OF INTERNAL REVENUE, Respondent.
United States Tax Court.
June 18, 1965
The petitioners in the conduct of their grocery business did not keep adequate books and records for the taxable years 1956 through 1959, but did keep correct records for the years 1960 and 1961. The respondent reconstructed the petitioners' gross profit from the operation of the business for the years 1956 through 1959 upon the basis of the petitioners' experience during the taxable years 1960 and 1961, determining that gross profit was substantially understated in the income tax returns for each of the taxable years 1956 through 1959.
Held, that the respondent's method of reconstructing the total purchases, total sales, and gross profit from the business was reasonable.
Held, further, that the petitioners have not shown error in the respondent's action in increasing the gross profit for the years in question on account of merchandise withdrawn from the business for personal consumption by the petitioners and the families of their two sons.
Held, further, that some part of the underpayment in tax for each of the taxable years 1956 through 1959 was due to fraud and that the petitioners are liable for additions to tax on account thereof.
Anthony L. Lutomski, for the petitioners.
Ronald S. Supena, for the respondent.
FINDINGS OF FACT AND OPINION
The respondent determined deficiencies in income tax, and additions to the tax under section 6653(b) of the Internal Revenue Code of 1954, for the taxable years and in amounts as follows:
|| Section 6653
|| $ 4,409.24
|| $ 2,204.62
The issues are: (1) whether petitioners understated their taxable income from the operation of a grocery stores in each of the taxable years 1956, 1957, 1958, 1959, and 1961; and (2) whether any part of any underpayment of tax for any of the years 1956 through 1959 is due to fraud. FINDINGS OF FACT. Some of the facts have been stipulated and are incorporated herein by this reference. The petitioners are husband and wife residing in Detroit, Michigan. For each of the taxable years 1956 through 1961 they filed a joint income tax return with the district director of internal revenue at Detroit, Michigan. Teresa Bollella is a petitioner only by reason of having filed joint returns with her husband and hereinafter Carmine Bollella will be referred to as the petitioner. Petitioner, a citizen of the United States, was born in Italy. His formal education was limited to one year. He came to the United States about 1910, at the age of 15, and began working as a water boy for a motor company. In 1930 he began selling fruit as a street vendor. In 1941 he purchased, for $3,000, a retail grocery business in Detroit known as the A. & E. Market (hereinafter referred to as the store). Since that time, and up until the time of trial, he has owned and operated this business. His wife did not participate in the conduct of the business. For several years following 1941 petitioner, with the help of his daughter, purchased whatever merchandise was needed. In 1949 petitioner's son, Oswald, began to help his father in the management of the business. Petitioner's other son works full time at the store and, in addition, petitioner employs cashiers. During the years in question, and thereafter, petitioner went down to the store every day, made whatever purchases were necessary, worked for three or four hours, and then went home. In the years in question, petitioner's son Oswald was manager of the store and either Oswald or his brother collected the day's receipts at the close of business. A checking account was maintained for the business and receipts therefrom were deposited in such account weekly. Both the petitioner and Oswald were authorized to draw checks on this account, but Oswald customarily signed the checks, including those in payment of sales taxes and income taxes. Oswald maintained whatever books and records the store had, but for none of the years 1956 through 1959 were such records adequate to establish the amount of sales or purchases. For the years 1960 and 1961 Oswald maintained substantially correct records of purchases and sales made. For 1960 the petitioner's total sales amounted to cost plus 22% of cost, and for 1961 they amounted to cost plus 24% of cost. Under Michigan law, monthly sales tax returns were required to be filed by retail and wholesale businesses. Oswald prepared all such returns for the period 1956 through 1961, and the petitioner signed them. Oswald picked figures ‘ out of the air’ in preparing such sales tax returns. In the latter part of 1959, the State of Michigan conducted an audit of petitioner's sales tax returns and found the books and records of the business to be inadequate for the purpose of determining the sales tax due. For the period August through November 1959, Oswald and a State of Michigan auditor maintained a daily record of all purchases and sales. It was found that 40.78% of the purchases made in that period were made from 4 grocery suppliers who kept complete records of purchases made by the petitioner. Such auditor determined the volume of purchases made by petitioner from such 4 suppliers in 1957 and 1958 and, upon the assumption that such purchases represented 40.78% of petitioner's total purchases, calculated such total purchases for the years 1957 and 1958. To the total so computed, he added a markup of 21% (representing an excess of selling price over cost of 18%, plus the 3% Michigan sales tax), which was agreed upon between him and Oswald as being reasonable. By this method gross sales for 1957 and 1958 were computed to be $474,048.21, which represented an increase of 114.06% over the sales reported in the sales tax returns for those years. This percentage was applied to the reported sales over the period July 1954 through November 30, 1959, which resulted in an aggregate deficiency in Michigan sales taxes for the period of $20,604.60, to which the petitioner and Oswald agreed. Throughout the course of his audit the state auditor dealt primarily with Oswald, but on some occasions the petitioner was present. The petitioner paid such deficiency in February 1960 with $10,000 of cash which he had on hand and $10,604.60 which he borrowed. In July 1961 an agent of the respondent began an audit of the petitioner's books for the taxable year 1959. Oswald presented to the agent certain Michigan business activities and sales tax returns, certain employment tax returns, a bank deposit book, and a ledger. The agent asked for supporting documents, namely, purchase and sales records and expense records, but none was furnished him. The agent examined the petitioner's records relating to the operation of the business for the taxable years 1960 and 1961. He contacted the petitioner's suppliers and determined that the petitioner's records for those two years were substantially correct. He then contacted the suppliers to determine the amount of purchases made by the petitioner for all the years 1956 through 1959. He found that some of the suppliers were able to furnish the desired information and others were not, either because they had destroyed the records for earlier years or because the purchases represented cash sales of which no detailed records had been kept. He found, however, that 7 of the suppliers who had furnished approximately 50% of the petitioner's total purchases for the years 1960 and 1961 had records of supplies furnished the petitioner for the years 1956 through 1959. The agent concluded that the total purchases made by the petitioner from the 7 suppliers in each of the years 1956 through 1959 constituted 50% of the petitioner's total purchases for those years (as in 1960 and 1961) and in that manner computed the petitioner's total purchases for each of those years. In order to arrive at the amount of sales for those years, he added to the computed cost of goods sold a markup of 23% of such cost (including 3% Michigan sales tax) which was the average excess of petitioner's total sales over cost of goods for the years 1960 and 1961. At some undisclosed time, the petitioner's counsel voluntarily presented to the revenue agent a statement purporting to show the petitioners' net worth during the years in question. The agent requested that the petitioner verify certain of the items contained therein, including cash on hand and cost of living, but such verification was not furnished, other than the fact that in February 1960 the petitioner paid $10,000 of sales tax in cash. During the years 1956 through 1961, the petitioner, in the operation of the business, made purchases in the following amounts from the following listed suppliers:
|| Purchases Made for the Years 1956 Through 1961
| Name of Supplier
| Lee and Cady
|| $ 42,272.85
|| $ 50,552.07
|| $ 53,366.37
|| $ 54,394.15
|| $ 59,623.17
| Arthur A. Anderson
| Cherrin Bros
| Land O'Lakes Creameries