McDonald v. Commissioner

Decision Date12 December 1994
Docket NumberDocket No. 25835-91.,Docket No. 14892-91.,Docket No. 14893-91.,Docket No. 13120-92.,Docket No. 13119-92.
Citation68 T.C.M. 1400
PartiesBill McDonald, et al.<SMALL><SUP>1</SUP></SMALL> v. Commissioner.
CourtU.S. Tax Court

Roderick L. McKenzie, 906 "G" St., Sacramento, Calif., for the petitioners. Kathryn K. Vetter and Bruce E. Gardner, for the respondent.

Memorandum Findings of Fact and Opinion

PARR, Judge:

In these consolidated cases respondent determined deficiencies in and additions to the Federal income taxes of the individual petitioners and the corporate petitioner as follows:

                Petitioner Bill McDonald: Docket Nos. 14892-91; 13119-92
                                                                                  Additions to Tax
                                                                             Sec.            Sec.         Sec
                Year                                        Deficiency   6653(b)(1)(A)   6653(b)(1)(B)    6661
                1987 ....................................    $65,629       $49,222            1          $16,407
                1988 ....................................     40,070        30,053            --          10,018
                1 50 percent of the interest due on the portion
                of the underpayment attributable to fraud
                Petitioner Richard D. Maynard: Docket Nos. 14893-91; 13120-92
                                                                                  Additions to Tax
                                                                              Sec.             Sec.       Sec
                Year                                        Deficiency   6653(b)(1)(A)   6653(b)(1)(B)    6661
                1987 ....................................    $69,618       $52,439            1          $17,480
                1988 ....................................     46,897        35,173            --          11,724
                1 50 percent of the interest due on the portion
                of the underpayment attributable to fraud
                Petitioner Gold Country Financial, Inc.: Docket No. 25835-91
                                                                                  Additions to Tax
                Taxable                                           Sec.           Sec.           Sec.        Sec
                Year Ended                        Deficiency   6653(a)(1)(A)   6653(a)(1)   6653(a)(1)(B)    6661
                1988 ..........................     $10,650         $533         $ --             1         $2,663
                1989 ..........................      20,764          --           1,038           --         5,191
                1 50 percent of the interest due on the portion
                of the underpayment attributable to negligence.

After concessions,2 the issues for decision are: (1) Whether petitioner Gold Country Financial, Inc.'s (hereafter GCF, Inc.) corporate status should be disregarded for Federal income tax purposes. We hold that it should not be disregarded. (2) Whether petitioner GCF, Inc., is entitled to deduct expenses in excess of the amounts allowed in the notice of deficiency. We hold that it may not. (3) Whether petitioners have unreported client-fee income. We hold that they do to the extent stated herein. (4) Whether petitioners have unreported non-client-fee income. We hold that they do to the extent stated herein. (5) Whether the allocation of M & M partnership income was proper. We hold that it was proper. (6) Whether petitioner McDonald's filing status for the years in issue was married filing separate or single. We hold that his status was married filing separate. (7) Whether petitioner Maynard may deduct a net operating loss and claim a general business credit carryforward. We hold that he may not. (8) Whether petitioners McDonald and Maynard are liable for the addition to tax for fraud pursuant to section 6653(b).3 We hold that they are liable for fraud. (9) Whether petitioner GCF, Inc., is liable for the addition to tax for negligence pursuant to section 6653(a). We hold that it is liable for negligence. (10) Whether petitioners are liable for the addition to tax for substantial understatement of income pursuant to section 6661. We hold that they are liable for substantial understatement of income to the extent stated herein.

Findings of Fact

Some of the facts have been stipulated. The stipulation of facts and attached exhibits are incorporated herein by this reference. At the time the petition herein was filed, petitioner McDonald resided in Sacramento, California, petitioner Maynard resided in Roseville, California, and petitioner GCF, Inc., a California corporation, had its principal place of business in Sacramento, California. Petitioners McDonald and Maynard filed individual income tax returns for all years in issue. Petitioner GCF, Inc., filed a corporate income tax return using a fiscal year ending July 31 for the years in issue. Petitioner GCF, Inc., is an accrual method taxpayer. References to petitioner(s) are to either McDonald, Maynard, GCF, Inc., or any combination thereof, as the context requires.

Petitioner McDonald is a certified public accountant with over 40 years of experience in accounting. He is also an attorney licensed to practice law in the State of Oklahoma. Petitioner Maynard is a certified public accountant with over 20 years of experience in accounting.

During the taxable years in issue, McDonald and Maynard were partners in the Maynard and McDonald (hereafter M & M) partnership. There was no written partnership agreement. M & M is in the business of preparing tax returns, providing assistance to clients in tax-related matters, and providing accounting services. Maynard and McDonald represented clients during audits by the Internal Revenue Service and at Appeals conferences. McDonald also files Tax Court petitions on behalf of clients. McDonald prepared the tax returns for M & M for the years in issue.

The books and records for M & M for each of the years consisted of a single sheet of paper reflecting the income on a monthly basis. M & M did not provide copies of bills, client ledger cards, or any other records of income to respondent's agent. M & M did not keep a cash receipts journal, a cash disbursements journal, a general journal, purchase invoices, or a client list. M & M did not maintain a business checking account. M & M sent bills or statements to some (but not all) of its clients for services rendered. M & M did not keep these billing statements after they were paid. M & M performed some services gratuitously.

In 1980, both Maynard and McDonald were experiencing financial difficulties. McDonald filed a petition in bankruptcy in December 1980 and Maynard filed a petition in bankruptcy in April 1981. Maynard asked his friend, Terry Feil, to set up GCF, Inc., GCF, Inc., was formed to separate petitioners' professional billings and avoid the risk of attachment by creditors. GCF Inc., prepared tax returns and provided accounting services. Feil, a stockbroker, was the president and sole shareholder. Feil never received any dividends. McDonald kept the books and prepared the tax returns for GCF, Inc. GCF, Inc., opened a bank account at Merchant's National Bank on or about August 16, 1980. The books for GCF, Inc., consisted of a cash disbursements journal and a ledger showing yearend entries that adjusted income to reflect deposits into the bank account. The deposits consisted of payments from clients of M & M and GCF, Inc. The gross receipts reported on GCF, Inc.'s tax return were calculated by adding up the deposits to the bank account, adjusting for changes in accounts receivable and accounts payable, and subtracting insurance reimbursements, auto expenses, dues and publications, outside services, and refunds.

In May 1986, GCF, Inc., opened another bank account at the Bank of Lodi. Feil did not know about this account.4 The amounts deposited into this account consisted of checks made out to M & M and GCF, Inc., representing payments received from clients. Deposits into the account were not included in gross income on the returns filed by GCF, Inc., for the years ended 1988 or 1989. Checks written on the account were written to Maynard and McDonald, except for two checks that were written to Mary Lee Sharer (McDonald's daughter) in 1987. Petitioners did not disclose this bank account to respondent's agent.

On or about August 26, 1985, GCF, Inc., opened an account at Bateman, Eichler, Hill and Richards (BEHR account). On October 13, 1988, James A. and Norma Jean Mclssac (the Mclssacs) borrowed $75,000 from GCF, Inc., Mary Charles McDonald, Mary Lee Sharer, and Betty Shackelford. The McIssacs executed a note in the principal amount of $75,000 and bearing an 11.5-percent rate of interest to the noteholders. Each holder had a one-quarter interest. The note provided for monthly payments of interest only. Deposits into the BEHR account for the years in issue represent 25 percent of the interest paid on the McIssac note. GCF, Inc., did not report these amounts as interest income on its tax return. Petitioners did not disclose the BEHR account to respondent's agent.

On or about January 5, 1987, M & M opened a checking account at the Bank of Alex Brown in the name Maynard and McDonald Trust (hereafter M & M Trust). In 1988, the M & M Trust account earned interest that was not reported by Maynard or McDonald on their tax returns. Petitioners did not disclose this bank account to respondent's agent.

Petitioners maintained accounts known as the Clamper Investment Club account, M & B Investments Club account, and P & M Investment Club account. Deposits were made into the accounts during the years at issue. The income from these investment accounts was not reported on a partnership return, corporate return, or other information return.

Maynard was the general partner in Denver Associates and Nolan Associates, limited partnerships which operated eight submarine sandwich...

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