48 T.C.M. (CCH) 938
HERBERT M. STEPHENS AND BARBARA K. STEPHENS, Petitioners
COMMISSIONER OF INTERNAL REVENUE, Respondent
United States Tax Court
August 27, 1984
Herbert M. Stephens and Barbara K. Stephens, pro se.
Beth L. Williams, for the respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
Respondent determined the following deficiencies in and additions to petitioners' Federal income taxes:
|| Sec. 6653(b)1
Issues relating to the deficiencies having already been disposed of, as indicated below, entry of decision was deferred pending resolution of the issues relating to respondent's imposition of the fraud addition. The issues remaining for decision are: (1) whether petitioners are liable for the section 6653(b) fraud addition with respect to their 1972, 1973, and 1974 taxable years, and (2) whether the statute of limitations bars assessment of the deficiencies and additions to tax for any of those taxable years. FINDINGS OF FACT Some of the facts have been stipulated and are so found. The stipulation of facts, first supplemental stipulation of facts, second supplemental stipulation of facts, and exhibits attached thereto are incorporated herein by this reference. In addition, by order dated December 5, 1979, specified affirmative allegations of fact set forth in respondent's answer to the amended petition and the amendment to amended petition filed herein were deemed admitted pursuant to respondent's motion under Rule 37(c), Tax Court Rules of Practice and Procedure, and are incorporated herein. Also, by orders dated December 8, 1980 and January 26, 1981, which relate in detail the convoluted prior history of this case, those issues relating to the deficiencies asserted herein and as to which petitioners bore the burden of proof were dismissed by the Court for failure properly to prosecute. Rule 123(b), Tax Court Rules of Practice and Procedure. Petitioners Herbert M. Stephens (Mr. Stephens) and Barbara K. Stephens (Mrs. Stephens), husband and wife, resided in Sault Ste. Marie, Michigan, when they filed the petition herein and also when they filed the amended petition and amendment to the amended petition. Petitioners filed joint U.S. Individual Income Tax Returns (Forms 1040) for each of the years 1972, 1973, and 1974, 
using the cash receipts and disbursements method of accounting. Petitioners had five children who were born prior to the years at issue herein and two more born during these years. The children lived in petitioners' household at all times during the years before the Court. Mr. Stephens received a Bachelor of Science Degree from Western Michigan University and also studied one year of accounting at Bob Jones University. Petitioners began buying motels in 1962. During the years 1972 through 1974, petitioners were in the business of operating motels as sole proprietorships and as partners with third parties. During these years petitioner owned and operated the following motels as sole proprietors: International Motel (International) Commodore Motel (Commodore) Airport Motel (Airport) Petitioners were also partners in the operation of the following motels in these years: Skyline Motel King Motel (a/k/a Crown Motel) Viking Motel Aquarama Motor Lodge (a/k/a Pine Shores, Inc.) Mr. Stephens had a 50 percent interest in the Skyline and Viking Motels and a one-third interest in Aquarama.
Petitioners purchased the King Motel on February 16, 1967, by a land contract from Alton King (Mr. King) at a cost of $300,000. By December 31, 1970, petitioners had reduced the principal on the land contract only to the amount of $267,476.74. Mr. King obtained a judgment against Mr. Stephens in December 1971 in the amount of $300,000, which amount included the unpaid balance owing on the land contract together with interest thereon. Mr. Stephens and Mr. King reached a settlement of that judgment in December 1971. Pursuant to their settlement, Mr. King received $285,000 from petitioners in satisfaction of the judgment. The $285,000 used by petitioners to pay off the land contract was borrowed from Paul Johnson (Mr. Johnson). In return for the loan, petitioners deeded a one-half interest in the King Motel to Mr. Johnson on December 14, 1971. The King Motel, also known as the Crown Motel, was conducted as a partnership by Mr. Stephens and Mr. Johnson from December 14, 1971 and throughout the three years before the Court. Mr. Stephens maintained the books of the partnership and prepared the partnership returns. During the years 1972 through 1974, petitioners derived substantial income from the operation of the various motels. Mr. Stephens personally managed the Commodore until the spring of 1975, subsequent to the years here at issue. During the years 1971 through 1974, petitioners also personally managed the International and had their personal living quarters there. Mrs. Stephens was actively involved in the day-to-day operations of the International. When guests registered at the three motels operated and personally managed by petitioners, they were asked to complete registration cards that indicated, inter alia, the type of room rented and the rental charge. No other entries as to rental income were made in any type of daily ledger book. At some point in time, monthly summaries were purportedly made from the registration cards, purporting to reflect the total gross receipts for a particular month for the Commodore, International, and Airport Motels, respectively. These monthly summaries were entered in a spiral notebook. The monthly summaries consisted of entries of total amounts pertaining to the categories " room," " use tax," " wages," " S.T." (sales or state tax), and sometimes " rest." (restaurant). Each month was recorded on a separate page. The monthly entries for each category were separately set forth for the Commodore, International, and Airport; then the three were totalled into one combined figure. The monthly summaries contain no reference to, or reconciliation with, any records of original entry for the recording of motel receipts. Mr. Stephens personally maintained these monthly summaries of the Commodore, International, and Airport and used them in preparing petitioners' joint income tax returns.
In the daily conduct of the motel businesses that petitioners personally managed, Mr. Stephens often used cash receipts from these motels to discharge various expenses incurred in their operation. No record of these cash disbursements was maintained. During the years in issue, petitioners also engaged in numerous real estate transactions. In addition to purchasing additional real estate, petitioners also sold numerous parcels held by them primarily for sale. Mr. Stephens used cash receipts from the motel businesses and also negotiated small-denomination checks received from motel customers to make down payments on various parcels of the purchased real estate. During the years in issue, petitioners maintained accounts at numerous banks in the Sault Ste. Marie, Michigan area, but petitioners dealt extensively in cash transactions. During the course of the audit herein, petitioners repeatedly told respondent's agents that all net receipts after cash payouts from the Commodore, International, and Airport were deposited in these accounts. Petitioners' statements were false. Mr. Stephens told the IRS agent that in April of 1974, he and his wife began to experience problems in dealing with these banks,
and then opened a savings account with the Imperial Bank of Commerce in Sault Ste. Marie, Ontario, and began to deposit some receipts of the motels into that account.
This savings account was not petitioners' primary commercial account. Instead, petitioners maintained an account at the Royal Bank of Canada which served as their primary commercial account. During 1975, petitioners instructed two of their young male children to deposit relatively large amounts of cash from a paper bag into a Canadian bank. This was an attempt to hide assets and taxable income from the years 1972 through 1974. On February 26, 1973, Mr. Stephens sold timber on certain realty he owned to the Kimberly-Clark Corp. for $16,000. In March of 1973, Kimberly-Clark Corp. issued a check to Mr. Stephens in payment of the purchased timber. Petitioners did not include any of this amount as income on their 1973 joint return. During the years 1971 through 1973, inclusive, Mr. Stephens filed financial statements with various banks. These financial statements showed that Mr. Stephens' total net worth was increasing over this period of time. According to his own financial statements, Mr. Stephens' net worth increased from approximately $475,090 to $1,213,341, or an increase of approximately $738,000, in the period from September 1, 1971 to December 31, 1973. On their 1972, 1973, and 1974 joint returns, petitioners claimed losses each year in the amounts of ($43,859.08), ($75.08), and ($18,208.38), respectively. Petitioners repeatedly informed respondent's agents that they had reported all of their income for the years at issue. Petitioners' statements were false. Utilizing the net worth expenditures method of reconstructing income, respondent determined that petitioners had understated their income for 1972, 1973, and 1974 in the amounts of $124,710.95, $69,829.10, and $108,090.48, respectively, as follows:
|| DEC. 31, 1971
|| DEC. 31, 1972
|| DEC. 31, 1973
|| DEC. 31, 1974