Manzoli v. C.I.R., 89-1607

CourtUnited States Courts of Appeals. United States Court of Appeals (1st Circuit)
Citation904 F.2d 101
Docket NumberNo. 89-1607,89-1607
Parties-5030, 90-1 USTC P 50,290 Leo MANZOLI and Mary Ann Manzoli, Petitioners, Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent, Appellee. . Heard
Decision Date11 January 1990

Ronald J. McDougald, Boston, Mass., was on brief for petitioners, appellants.

Doris D. Coles, Attorney, Tax Div., Dept. of Justice, with whom Shirley D. Peterson, Asst. Atty. Gen., Washington, D.C., were on brief for respondent, appellee.

Before BREYER, Chief Judge, TORRUELLA and ALDRICH, Circuit Judges.

TORRUELLA, Circuit Judge.

Leo and Mary Ann Manzoli appeal from the Tax Court's decision sustaining tax deficiencies assessed against them by the Commissioner of Internal Revenue ("Commissioner"). The issues are various and will be discussed seriatim.


On June 13, 1984, the Grand Jury of the United States District Court for the District of Massachusetts indicted Leo Manzoli and Mary Ann Manzoli for willfully attempting to evade and defeat their federal income tax liabilities for the taxable years of 1977 and 1978 in violation of 26 U.S.C. Sec. 7201. On January 3, 1985, Mr. Manzoli pled guilty to attempted evasion of income tax for the taxable year 1978. Judgment was entered against Mr. Manzoli on January 4, 1985, and fifteen days later the indictment against Mrs. Manzoli was dismissed.

Prior to the years at issue, both Mr. and Mrs. Manzoli had long records of employment, although neither had earned a substantial annual income. They lived frugally, and saved money from earnings, gifts, and other sources. With the money they had saved, on November 17, 1975, the Manzolis purchased land in Lynnfield, Massachusetts, on which they planned to build their residence. For this purpose, they obtained a bank mortgage for $65,000 and Mr. Manzoli took a leave of absence from his insurance business. The excavation began in March 1976, and the house was completed by December of that year.

Meanwhile, Mr. Manzoli entered the massage parlor business doing business as Lion Enterprises Inc. In November 1976, Mr. Manzoli leased part of a building in Peabody, Massachusetts. In early January 1977, the Parisienne Sauna massage parlor opened. The massage parlor sold "sessions" of one half hour, one hour, and one hour and fifteen minutes for $20, $30, and $40, respectively. Customers paid either in cash, check or credit cards. If a tip was charged on a credit card, Mr. Manzoli immediately paid the tip to the masseuse out of the cash receipts. This cash was also used to pay suppliers. 1

During 1978 the Manzolis participated in various deals that came to the attention of the Commissioner. For example, on February 1, 1978, at the instance of Mr. Manzoli, a brokerage account was opened with E.F. Hutton in the name of James Spinale, Mrs. Manzoli's father. On February 6, 1978, Mrs. Manzoli drew a check for $20,000 on a bank account of Lion Enterprises Inc., payable to herself. She endorsed the check and used the proceeds to purchase three

cashier's checks, two for $7,500, and one for $5,000, all payable to E.F. Hutton. A month later, Mrs. Manzoli purchased a Mercedes Benz 450 SLC for $28,605. And on June 15, 1978, Mr. Manzoli purchased a Rolls Royce for $48,000. Both automobiles were purchased, registered and insured in the corporation's name and were paid in part or in full with Lion Enterprises' undeposited cash. Mrs. Manzoli's business records did not indicate these withdrawals

After the indictment, on September 25, 1986, the Commissioner sent a notice of deficiency to petitioners for the taxable years 1977 and 1978, and determined understatements of petitioner's taxable income for 1977 and 1978 of $47,517.63 and $301,315.43, respectively, based on the net worth method of computation. He also determined that all or part of petitioners' underpayment of tax for each year was due to fraud.

The Manzolis filed a petition before the Tax Court, which held that the Manzolis had not shown error in the government's net worth analysis. The Tax Court further found that the government had failed to show fraud but, because of his guilty plea in the prior criminal case, Mr. Manzoli was collaterally estopped in the civil case to deny fraud for 1978.


The Tax Court's findings of fact, as in the case of the net worth method assessment, are subject to review under the "clearly erroneous" standard. United States v. Gypsum Co., 333 U.S. 364, 395, 68 S.Ct. 525, 542, 92 L.Ed. 746 (1948); Connor v. Commissioner, 847 F.2d 985, 989 (1st Cir.1988); In Re Tully, 818 F.2d 106, 109 (1st Cir.1987). This "standard adheres with undiminished force to inferences which the judge below has drawn from facts of record." Commissioner v. Duberstein, 363 U.S. 278, 290, 80 S.Ct. 1190, 1199, 4 L.Ed.2d 1218 (1959). We note also that "where there are two permissible views of the evidence, the factfinder's choice between them cannot be clearly erroneous." Anderson v. Bessemer City, 470 U.S. 564, 574, 105 S.Ct. 1504, 1511, 84 L.Ed.2d 518 (1985); In Re Tully, 818 F.2d at 109 (quoting Irons v. FBI, 811 F.2d 681, 684 (1st Cir.1987)).

When asked to review decisions denying discretionary motions, such as motions for continuance and motions for leave to amend, we will do so only for abuse of discretion. Abatti v. Commissioner, 859 F.2d 115 (9th Cir.1988). When reviewing under this standard, we will focus on the reasons given by the court for its conclusions to determine whether the Tax Court's determination was reasonable. See Zinniel v. Commissioner, 883 F.2d 1350 (7th Cir.1989).


A. Net Worth Method

Appellants dispute both the application of the net worth method and the government's net worth figures. Essentially, they allege that the present case falls under the rule established in Thomas v. Commissioner, 232 F.2d 520, 523-24 (1st Cir.1956). In that case the Tax Court's findings of fact were found to be in error because its net worth figures were reached arbitrarily and because it required the taxpayers to establish a correct amount.

We disagree with appellants' contentions. First, our determination in Thomas rested on the fact that there was no substantial evidence on the record to support the Commissioner's conclusions. 2 That is not the case on the present appeal. In this case the record supports the Tax Court's conclusions. The findings with respect to the taxpayers' net worth are findings of fact, and should not be disturbed unless clearly erroneous. United States v. Sorrentino,

726 F.2d 876, 881 (1st Cir.1984). We find no clear error. 3

Second, in reviewing the application of the net worth method, this court has stated:

[t]he Government makes out a prima facie case under the net worth method of proof if it establishes the [taxpayer's] opening net worth (computed as assets at a cost basis less liabilities) with reasonable certainty and then shows increases in his net worth for each year in question which, added to his nondeductible expenditures and excluding his known nontaxable receipts for the year, exceed his reported taxable income by a substantial amount.

United States v. Sorrentino, 726 F.2d at 879; see also Holland v. United States, 348 U.S. 121, 125, 75 S.Ct. 127, 130, 99 L.Ed. 150 (1954); McGarry v. United States, 388 F.2d 862, 864 (1st Cir.1967). The net worth increase creates an inference of taxable income, if the government is able to show a likely source of unreported income or negates all possible nontaxable sources. See United States v. Massei, 355 U.S. 595, 78 S.Ct. 495, 2 L.Ed.2d 517 (1958). We agree with the Tax Court's holding that the Commissioner established a prima facie case and that taxpayers failed to negate the inference established by the net worth method.

1. Cash Hoard

Appellants claim that the Commissioner and the Tax Court failed to note that they had received a substantial amount of cash from loans, gifts and other receipts of money. Appellants argue that the correct sum of cash on hand and undeposited in banks as of December 31, 1976, amounted to at least $200,000, rather than the $23,629.53 determined by the Commissioner. The Tax Court was not persuaded that the Manzolis saved or obtained cash from the sources identified by appellants, and found that the evidence presented by the Manzolis did not support their assertion. We agree with the Tax Court's findings.

The record is devoid of documentary evidence with regard to the alleged loans, gifts or receipts of money. As to the amount of the loans, particularly those made by Mrs. Manzoli's father, Mr. Spinale, the Tax Court found a series of inconsistencies. 4 The Tax Court further found that even assuming that appellants had accumulated cash for the purpose of the construction of their home, as they alleged, by the time of completion of said project, the cash on hand would have been substantially depleted. Finally, the Tax Court concluded that the Manzolis' borrowing of money more clearly indicates the absence rather than the presence of a large accumulation of cash. See Davis v. Commissioner, 239 F.2d 187, 190 (7th Cir.1956), cert. denied, 353 U.S. 984, 77 S.Ct. 1284, 1 L.Ed.2d 1143 (1957); Thomas v. Commissioner, 223 F.2d 83, 88 (6th Cir.1955).

The findings as to the cash hoard are findings of fact which may not be reversed unless clearly erroneous. United States v. Sorrentino, 726 F.2d at 881. The record shows little or no evidence to support appellants' assertions, thus the Tax Court had to base its decision on appellants' testimony. That being the case, the Tax Court was entitled to evaluate what weight should be given to that testimony and to consider the credibility of the witnesses. Because due regard should be given to the opportunity of the trial court to judge the credibility of witnesses, we must defer to its judgment. Anderson v. Bessemer City, 470 U.S. at 575, 105 S.Ct. at 1512; Glasser v. United States, 315 U.S. 60, 80, 62 S....

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