Catalano v. Comm'r of Internal Revenue

• Decision Date: 07 July 1983
• Docket Number: 5723–80,16000–80,7896–80,7272–80,8828–82.,7894–80,7266–80,7297–80,7274–80,7281–80,7290–80,4886–80,17451–80,7265–80,4987–80,21889–80,4976–80,5729–80,7294–80,10529–80,2690–82,16304–80,7276–80,7284–80,5722–80,7270–80,12186–80,7891–80,7897–80,5738–80,6404–80, Docket Nos: 2506–80,5735–80,8329–80,4985–80,7895–80,7283–80,7264–80,2878–80,4990–80,7411–80,7280–80,5725–80,5730–80,7898–80,4983–80,12185–80,14733–80,7269–80,7277–80,4982–80,7282–80,7288–80,7285–80,7263–80,7279–80,7292–80,8327–80,10530–80,5736–80,7268–80,4981–80,7275–80,14734–80,4988–80,4480–81,5727–80,10532–80,9097–80,7893–80,17900–80,5267–80,5732–80,7261–80,5265–80,7414–80,4978–80,4885–80,5734–80,5266–80,7267–80,9562–80,7287–80,18464–80,4979–80,5733–80,7291–80,5726–80,5721–80,11516–80,11109–80,7289–80,4989–80,4986–80,7413–80,7286–80,9096–80,7278–80,5724–80,7273–80,4977–80,8991–80,8328–80,7296–80,9563–80,4984–80,7260–80,7262–80,7892–80,8384–80,14302–80,7295–80
• Parties: JOHN CATALANO and RUTH CATALANO, ET AL.,1 Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent
• Court: U.S. Tax Court

81 T.C. 8

81 T.C. No. 2

JOHN CATALANO and RUTH CATALANO, ET AL.,1 Petitioners,

v.COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket Nos: 2506–80

2878–80

4885–80

4886–80

4976–80

4977–80

4978–80

4979–80

4981–80

4982–80

4983–80

4984–80

4985–80

4986–80

4987–80

4988–80

4989–80

4990–80

5265–80

5266–80

5267–80

5721–80

5722–80

5723–80

5724–80

5725–80

5726–80

5727–80

5729–80

5730–80

5732–80

5733–80

5734–80

5735–80

5736–80

5738–80

6404–80

7260–80

7261–80

7262–80

7263–80

7264–80

7265–80

7266–80

7267–80

7268–80

7269–80

7270–80

7272–80

7273–80

7274–80

7275–80

7276–80

7277–80

7278–80

7279–80

7280–80

7281–80

7282–80

7283–80

7284–80

7285–80

7286–80

7287–80

7288–80

7289–80

7290–80

7291–80

7292–80

7294–80

7295–80

7296–80

7297–80

7411–80

7413–80

7414–80

7891–80

7892–80

7893–80

7894–80

7895–80

7896–80

7897–80

7898–80

8327–80

8328–80

8329–80

8384–80

8991–80

9096–80

9097–80

9562–80

9563–80

10529–80

10530–80

10532–80

11109–80

11516–80

12185–80

12186–80

14302–80

14733–80

14734–80

16000–80

16304–80

17451–80

17900–80

18464–80

21889–80

4480–81

2690–82

8828–82.

United States Tax Court

Filed July 7, 1983.

At all relevant times, petitioners in these 112 consolidated cases were employed as dealers at Caesar's Palace, a gambling casino in Las Vegas, Nev. Dealers at the casino engaged in a pooling arrangement whereby all tokes were divided equally between the dealers on the basis of length of shifts during each 24-hour period. Pursuant to an elaborate surveillance program conducted at Caesar's Palace on 48 days during the period February 9, 1976 through January 26, 1977, respondent determined petitioners underreported their toke income during the relevant years. Respondent also asserted additions to tax for negligence. Held: Respondent's determinations of petitioners' toke income made on the basis of information collected during an elaborate surveillance program are sustained. Held further: Petitioners are also liable for additions to tax under sec. 6653(a), I.R.C. 1954, for unjustifiably failing to maintain adequate records of their toke income during each year at issue. John D. Gubler, for the petitioner in docket No. 6404–80.

Jerome L. Blut, for the petitioners in docket Nos. 8384–80, 12185–80, 12186–80, 14733–80, and 14734–80.

David H. Lum, pro se in docket No. 8991–80.

Dominic A. Tegano, pro se in docket No. 10530–80.Alan R. Harter, for the petitioners in all remaining docket Nos.Scott N. McCallum and Craig D. Platz, for the respondent.FAY, Judge:

In these 112 consolidated cases, respondent determined deficiencies ranging from $197.82 to $5,790.87 in and additions to petitioners' Federal income tax for the years 1976–1979.² The issues are (1) whether petitioners understated their “toke” income by the amounts determined by respondent, and (2) whether petitioners are liable for additions to tax under section 6653(a)³ for negligence.

FINDINGS OF FACT

Some of the facts are stipulated and found accordingly.

All petitioners resided in Nevada when they filed their petitions herein.

At all relevant times, petitioners⁴ were employed as blackjack dealers, roulette dealers, and Big Wheel dealers at Caesar's Palace, a gambling casino in Las Vegas, Nev. In the course of their employment petitioners received “tokes” from players at the gaming tables.⁵ Dealers at the casino participated in a pooling arrangement whereby all tokes were placed in common” toke boxes.” At approximately 11:00 a.m. every morning, selected dealers carried these toke boxes to the dealers' lounge where the chips were counted and arranged in racks according to color. Each rack contained five rows and held 100 chips when full.⁶ Black chips, green chips, red chips, and silver chips were worth $100, $25, $5, and $1, respectively. ⁷ After completing their count, the total cash value of the tokes was recorded on a yellow sheet of paper. Then the racks were placed in a box and taken to the cashier's cage which was located in a public area of the casino. The racks were removed from the box and placed on the counter of the cashier's cage wherein the cashier separated the racks according to color and counted them. If a row was not full, the cashier spread the chips on the counter and separately counted them. Once the cashier completed his count, the chips were cashed in, and the money was subsequently divided between the dealers on the basis of length of shifts during the preceding 24-hour period.

In connection with a surveillance project at Caesar's Palace, Internal Revenue Service agents observed the dealers' exchange of tokes at the cashier's cage on 48 days during the period February 9, 1976 through January 26, 1977. Respondent rotated 13 revenue agents on the project. The revenue agents watched most of these exchanges from a guest telephone located just to the right of the cashier's cage from which they were able to gain an unobstructed view of the exchange. Occasionally, the revenue agents watched from nearby slot machines or from the next cashier's window.⁸ Every toke exchange observed by the revenue agents occurred at the far right window of the cage. To avoid detection, the revenue agents either engaged in a conversation on the guest telephone, played the slot machines, or stood in line at the next cashier's window.

The revenue agents were instructed to count only those racks which they were able to identify clearly. If the agent saw a row of chips that was not full, he did not include that row in his count unless he was able to determine the exact number of chips in that row. Frequently the agents were able to get close enough to the cashier's cage to read the yellow sheet of paper on which was written the total cash value of that day's tokes. The agents recorded these observations on “surveillance memos” immediately after the toke exchanges were completed.

Based on data gathered from the surveillance project, respondent determined that the average daily toke rate for a dealer working at Caesar's Palace was $63.45. Since a daily shift is eight hours, respondent computed an hourly toke rate of $7.93. Of the 48 days of surveillance, 12 of the days fell on weekends. Days on which special promotional events occurred were also conservatively represented during the 48 surveillance days. All but four of the surveillances took place in 1976.

Petitioners maintained no records from which their toke income could be determined. They merely reported an arbitrary amount of such income on their returns for the years at issue. With one adjustment, respondent reconstructed petitioners' toke income by multiplying the average hourly toke rate which had been determined on the basis of the surveillance data ($7.93) by the number of hours petitioners worked as dealers at Caesar's Palace during the relevant years.⁹ Respondent determined petitioners had unreported toke income to the extent this figure exceeded the amounts reported by petitioners on their returns. Respondent also asserted additions to tax for negligence.

OPINION

I. Reconstruction of toke income

It is well settled that “tokes” must be included in gross income. Olk v. United States, 536 F.2d 876 (9th Cir. 1976). The issue is whether petitioners understated their toke income by the amounts determined by respondent. The burden of proof is on petitioners to overcome the presumption of correctness that attaches to respondent's determinations. Welch v. Helvering, 290 U.S. 111 (1933); Rule 142(a).¹⁰ Since petitioners failed to maintain records from which their toke income could be accurately determined and the amounts of toke income they reported were merely estimates, respondent was entitled to reconstruct petitioners' toke income using a method which in his opinion would clearly reflect that income. Meneguzzo v. Commissioner, 43 T.C. 824 (1965).

Respondent has great latitude in adopting a method for reconstructing a taxpayer's income. Giddio v. Commissioner, 54 T.C. 1530, 1533 (1970). It is sufficient if the reconstruction is reasonable in light of all the surrounding facts and circumstances. Schroeder v. Commissioner, 40 T.C. 30, 33 (1963). Here, petitioners contend the data collected during the surveillance project was unreliable and there were defects in respondent's statistical analysis of that data. For the following reasons, we reject petitioners' assertions, and we conclude respondent's determinations were neither arbitrary nor excessive.

We disagree with petitioners' first argument that the revenue agents could not have made accurate counts while observing the toke exchanges from a distance. The exchanges took place in plain view at the cashier's cage located in a public area. The chips were arranged in racks according to their easily identifiable colors. During the exchanges the racks were placed on the counter of the cashier's cage where they remained for several minutes while the cashier counted them. By standing at the next cashier's window, playing the nearby slot machines, or, in most cases, engaging in a conversation on the guest telephone located just to the right of the cage, the revenue agents were able to observe the exchanges from nearby vantage points. Frequently, the agents were even able to get close enough to the exchanges to read the yellow sheet of paper which had the total cash value of that day's tokes written on it.¹¹ Based on these circumstances we are convinced the revenue agents' counts were highly reliable.

Admittedly, respondent's surveillance methods were not foolproof. Petitioners point out that on the few occasions when two revenue agents made simultaneous counts from two different vantage points, they came up with somewhat different totals. For instance, on March 2, 1976, one of the revenue agents counted 13 racks of red chips, 2 racks of green chips, and 14 racks of silver chips ($12,900) from the vantage point of the guest telephone. The other revenue agent counted 13 racks of red chips and 2 racks of green chips ($11,500) from the vantage point of the slot machines. The “surveillance memo” for that day states that the revenue agent standing at the slot machines “was unable to count the...