McDonald v. Commissioner of Internal Revenue, 022896 FEDTAX, 13218-93
| Opinion Judge | GERBER, Judge |
| Party Name | BILL MCDONALD, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent RICHARD D. MAYNARD, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent |
| Attorney | Roderick L. MacKenzie, for petitioners. Kathryn K. Vetter and Daniel J. Parent, for respondent. |
| Case Date | February 28, 1996 |
| Court | U.S. Tax Court |
MEMORANDUM FINDINGS OF FACT AND OPINION
Respondent determined deficiencies in 1989 income tax, and penalties as follows:
Petitioner
Deficiency
Fraud Penalty Sec. 6663
McDonald
$53,041
$39,781
Maynard
71,380
53,535
After considering the parties' concessions and stipulations to be bound by the outcome of other cases, the issues remaining for our consideration are: (1) Whether petitioners' partnership's 1989 income was understated; (2) whether petitioners correctly reported their distributive shares of partnership income; (3) whether either petitioner failed to report income with respect to various items respondent determined to be includable in his income; (4) whether either petitioner is liable for additional self-employment tax; and (5) whether either petitioner is liable for the fraud penalty under section 6663.1
FINDINGS OF FACT2
Petitioners Bill McDonald (McDonald) and Richard D. Maynard (Maynard) resided in California at the times each of their petitions was filed in these cases. McDonald and Maynard each filed his 1989 income tax return reflecting that his filing status was "single". Although McDonald and Maynard were each married as of the close of 1989, they, along with their respective spouses, filed for and received annulments of their marriages during 1994. The question of whether McDonald and Maynard were married or single for Federal income tax purposes, considering the annulments of their respective marriages, was decided by this Court in McDonald v. Commissioner, T.C. Memo. 1994-607, and Shackelford v. Commissioner, T.C. Memo. 1995-484, respectively.3 Respondent and petitioners agreed to be bound by the outcome of the above-referenced opinions. The above-referenced opinions hold that the taxpayers were married for Federal income tax purposes, although they had subsequently obtained annulments of their marriages under the laws of the State of California. Accordingly, petitioners' filing status should have been "married filing separately" for purposes of their 1989 tax year.
Petitioners, at all pertinent times, were certified public accountants, with more than 60 years of experience between them, practicing together in an accounting partnership known as Maynard & McDonald (M&M). There was no written partnership agreement through the 1989 tax year. McDonald is also an attorney licensed to practice in the State of Oklahoma. M&M is a cash basis partnership that petitioners formed in 1976 and operated during the 1989 taxable year in Sacramento, California. M&M's principal activities are tax return preparation, assistance to clients in tax-related matters, providing accounting services, and representing clients before various administrative levels of the Internal Revenue Service. In addition, McDonald also filed clients' petitions with this Court. McDonald was familiar with the requirement that tax return preparers are to keep copies of prepared returns or a list of clients. Petitioners' accounting practice specialized in the field of taxation.
M&M's 1989 U.S. Partnership Return of Income (Form 1065), which McDonald prepared, reflected gross receipts of $24,590 and a single deduction of $24,590 attributable to "Guaranteed payments to partners". Other than on the Schedules K-1, no other information was reflected on the partnership return (i.e., the balance sheet was left blank, and the Schedule M for reconciliation of partners' capital was marked "NA"). The Schedules K-1 revealed that Maynard and McDonald were 50-50 partners, but that McDonald was allocated $3,457 of the guaranteed payments to partners, and the remaining $21,133 was allocated to Maynard. McDonald's $3,457 share of M&M's 1989 income was based on Maynard's estimate. Petitioners did not maintain records of the number of hours worked or number of returns prepared by each partner.
M&M's returns for the fiscal year ended September 30, 1987, the period October 1 through December 31, 1987, and the 1988 calendar year each reflect that petitioners shared profits and losses in a 50-50 ratio. These three returns reflect income and guaranteed payments to petitioners, as follows:
Taxable Period
Income
McDonald
Maynard
FYE 9/30/87
$5,520
$3,670
$1,850
10/01 to 12/31/87
750
500
250
Calendar 1988
24,469
3,711
20,758
Accordingly, for two of the reporting periods, McDonald received about two-thirds and Maynard about one-third of M&M's income. In the third reporting period, Maynard received about 85 percent and McDonald about 15 percent.
Respondent's agents analyzed the ratio of hours spent during 1989 by Maynard and McDonald in preparing returns of M&M's clients and found it to be about 60 percent for Maynard and 40 percent for McDonald. Respondent, in the notices of deficiency, determined $214,393 of 1989 partnership income and attributed $79,661 to McDonald and $134,732 to Maynard.
M&M did not have any employees, and petitioners were solely responsible for maintaining M&M's books and records. Petitioners' billing approach was to send a bill for services to clients and retain a copy for M&M's records. When they received payment of a particular bill, M&M's retained copy of the bill was discarded. Petitioners' billing approach made it virtually impossible to verify whether M&M's income was accurately reflected on its books and Federal partnership tax return and on petitioners' Schedules K-1.
M&M's rate schedule, as of January 1, 1989, was $130 per hour for tax consulting or compliance work and a $275 minimum rate for individual tax return preparation. Petitioners would charge for giving advice, including advice given during telephone calls, with a one-tenth-hour minimum charge. The printed rate schedule contained the notation that, where advice resulted in substantial savings or was out of the ordinary, the billing might reflect petitioners' experience and expertise, rather than the posted rates. Occasionally, petitioners sent no bill because they decided to provide gratuitous services. Actual charges to M&M clients reflect that some clients were billed at a rate in excess of and some less than M&M's minimum rate.
During respondent's examination of their 1989 tax years, petitioners did not provide books, records, copies of M&M's bills to clients, or any other information from which petitioners' clientele could be identified or respondent could verify petitioners' income for 1989. Respondent's computers reflect that M&M was shown as the preparer on more than 300 Federal tax returns for the 1989 processing year. In addition, McDonald filed 13 clients' petitions with this Court during 1989.
Petitioners sought the protection of the Bankruptcy Code, McDonald in December 1980 and Maynard in April 1981. To avoid the possibility of attachment of their accounts receivable, petitioners formed a California corporation, Gold Country Financial, Inc. (Gold), to conduct a tax accounting business concurrently with and at the same location as M&M. Gold also provided petitioners with a means to obtain credit after their bankruptcies because they were employees of Gold. Moreover, Gold's sole shareholder was shown as Terry Feil, a friend of Maynard's.
Corporate Federal income tax returns were filed for Gold's fiscal years ended July 31, 1989 and 1990. Gold's income and expenses were reported on the accrual method of tax accounting. Petitioners maintained the books and records of Gold. M&M did not claim expenses, and any expenses concerning petitioners' tax accounting businesses were paid and/or deducted by Gold. Gold had no employees other than petitioners.
Similar to M&M, petitioners maintained no cash receipts journal, accounts receivable list, or client list for Gold. Also paralleling the practices at M&M, copies of client billing invoices were discarded after payment was received from the clients. Petitioners, however, maintained cash disbursements records for Gold during 1989.
Petitioners maintained a bank account in Gold's name at the Merchants National Bank (Merchants Bank), and some, but not all, of the receipts from clients were deposited into that account. Petitioners' method of determining Gold's annual income for tax purposes began by totaling the Merchants Bank deposits and reducing the total by reimbursements for health insurance. The difference was then adjusted by picking up net increases or decreases in accounts receivable to convert to the accrual method. Finally, the accrual method amount was reduced by expenses that petitioners had billed to and collected from clients.
For the 1989 and 1990 fiscal years, Gold's income was computed and reported by petitioners as follows:
Item
1989
1990
Deposits to bank
$68,975.82
$70,669.74
Less:
Auto expenses
10,710.25
-
Insurance reimbursed
2,591.84
5,211.40
Accounts payable
13,338.00
-
Dues/publications
49.50
-
Outside services
505.83
-
Refunds
175.00
Accounts receivable
(825.00)
15,469.78
Total
26,545.42
20,681.18
Income per petitioners
142,430.40
49,988.56
1 The parties stipulated that the amount of income computed by petitioners for the 1989 fiscal year was $42,430.10, whereas the supporting amounts stipulated by the parties results in income of $42,430.40.
Petitioners also maintained a bank account for Gold at the Bank of Lodi. The existence of Gold's Bank of Lodi account was not brought to the attention of respondent's...
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