Thomas v. Commissioner of Internal Revenue

• Decision Date: 14 June 1955
• Docket Number: No. 12175-12178.,12175-12178.
• Citation: 223 F.2d 83
• Parties: Anthony V. THOMAS, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent. ESTATE of Joseph M. THOMAS, Deceased, Anthony V. Thomas, Administrator, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent. George J. THOMAS, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent (two cases).
• Court: U.S. Court of Appeals — Sixth Circuit

223 F.2d 83 (1955)

Anthony V. THOMAS, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent. ESTATE of Joseph M. THOMAS, Deceased, Anthony V. Thomas, Administrator, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.

George J. THOMAS, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent (two cases).

Nos. 12175-12178.

United States Court of Appeals Sixth Circuit.

June 14, 1955.

Everett H. Davidson, Lorain, Ohio, O. D. Eshelman, Cleveland, Ohio, on brief, for petitioners.

S. Dee Hanson, Washington, D. C., H. Brian Holland, Ellis N. Slack, Washington, D. C., on brief, for respondent.

Before MARTIN, McALLISTER and STEWART, Circuit Judges.

STEWART, Circuit Judge.

Anthony V. Thomas, Joseph M. Thomas and George J. Thomas were brothers engaged in the operation of a number of partnership enterprises in Lorain, Ohio, until the death of Joseph Thomas on September 17, 1949, aboard the steamship "Noronic." Upon his death, more than $180,000 in cash was found in his safe deposit box. That discovery occasioned an investigation by Internal Revenue agents of the income tax returns filed by the three brothers during the immediately preceding years. That investigation, in turn, led to separate determinations by the Commissioner that they had failed to report income in the total amount of $232,882.11 for the years 1946 to 1949, inclusive, resulting in income tax deficiencies of $113,620.55 for those years. The Commissioner's determinations were upheld by the Tax Court, and Anthony, George, and the Estate of Joseph Thomas are petitioners here in an effort to set aside the Tax Court's decisions.

In determining that the taxpayers had understated their taxable incomes for the four years in question, the Commissioner utilized the now familiar method of computing the increases in the net worth of the taxpayers in each of the four years, adding to those increases the taxpayers' nondeductible expenses in each year, and thereby circumstantially reconstructing their incomes for each year.

The petitioners list in their brief sixteen separate questions allegedly involved on this review. These so-called questions are stated in a repetitive, overlapping, partial, and argumentative form, and upon examination, the two basic questions which emerge are: (1) whether or not the Commissioner was warranted in resorting to the net worth method of proving taxable income under the circumstances in these cases, and (2) whether or not the net worth computations as made, which are the basis of the Commissioner's determinations and the Tax Court's redeterminations, were clearly erroneous.

As to the first question, we think the Commissioner was not unjustified in resorting to the net worth method of reconstructing the petitioners' incomes under the circumstances revealed by the record. Those circumstances, commencing with the death of the petitioners' father in 1924, are reviewed at length in the memorandum opinion of the Tax Court (Paragraph 53,346 Prentice Hall, Memo. T.C.), and no useful purpose would be served by repeating them here in detail. The record shows that the taxpayers during the taxable years involved owned and operated several income producing businesses, the Thomas Grill, the Thomas 333 Bar, and Thomas Properties, Inc. They also were engaged in purchasing and renting real estate, and lending money on mortgages and notes. In addition, Joseph Thomas was engaged as an individual in stock market transactions, and George Thomas was working for wages.

The income tax returns for the taxpayers for 1946 were prepared by an accounting firm. The books of the taxpayers for that and prior years were destroyed in 1947 by a fire. During 1947, 1948, and 1949, a different firm of accountants kept certain books for the 333 Bar and the Thomas Grill, and prepared the tax returns for the taxpayers and their partnerships. The entries made in the books were based upon data supplied by Joseph Thomas. These entries accurately reflected the data submitted, which included cancelled checks, check stubs, bank statements, and petty cash items. The entries made with respect to the receipts for the businesses were made from slips on which were listed summaries of the daily receipts. The accounting firm did not verify the accuracy of the amounts appearing on the slips, nor did it verify the amounts of opening or closing inventories as supplied by Joseph Thomas. No ledger was maintained nor were any ledger accounts kept with respect to assets or liabilities. No records were maintained concerning any cash on hand, except petty cash and the amounts in the cash registers. No formal books were kept with respect to the loans made by Joseph Thomas. He did keep a card index which contained sufficient information to identify the debtor, and the date and amount of the loan.

The partnership returns filed by the 333 Bar for the years 1946, 1947, and 1948 showed Joseph and Anthony Thomas as the partners, with distributive shares of twenty per cent and eighty per cent respectively. The partnership returns filed for the Thomas Grill for 1946 and 1947 showed Joseph and George Thomas as the partners, with distributive shares of sixty per cent and forty per cent, respectively. During 1948 George, because of a pending divorce suit, concealed his connection with the business enterprises conducted by him and his brothers. Thereafter, so far as the records of the businesses show, George had no interest in any of the enterprises, and no partnership return was filed for the Thomas Grill for 1948. Only Joseph Thomas reported income from that business for that year, even though George actually continued to own an interest in the business and admitted that by not reporting any income from the Grill for 1948 he substantially understated his income for that year.

During the course of the administration of Joseph Thomas' estate, the question of the ownership of the money found in Joseph Thomas' safe deposit box, of the 333 Bar, of the Thomas Grill, and of certain loans made by Joseph Thomas was litigated. Joseph, George and Anthony Thomas were each adjudged the owners of a one-third interest therein.

Upon a consideration of the method by which the taxpayers had operated and had reported income, and finding that during 1948 the expenditures, investments, and bank deposits of the taxpayers greatly exceeded the incomes reported by them for that year and also exceeded their incomes from disclosed sources, and further finding that no record had been maintained with respect to undeposited cash on hand, which was part of the stock-in-trade of their loan business, the Commissioner concluded that the taxpayers' books and records did not correctly reflect their incomes for the years 1946 through 1949. In accordingly resorting to the net worth method, the Commissioner constructed a comparative year-end net worth schedule which included all the taxpayers' known jointly owned assets for the five-year period 1945 through 1949, and the resulting year-end joint net worth figures were then divided by three, which gave the separate net worth computations made for each of the individual taxpayers. To each of the taxpayers' joint net assets thus ascertained, the Commissioner added the separately owned assets of each, thus determining the yearly increase in net worth of each taxpayer for each of the taxable years involved. To the latter resulting figures, the Commissioner added certain known personal expenditures, including income taxes paid, and estimated amounts for living expenses for each taxable year. The Commissioner allowed as subtractions from the amounts thus arrived at, all permissible deductions taken by the taxpayers in their tax returns filed for the years in question.

The petitioners contend that the Commissioner was unwarranted in using the net worth method of computing their income because they did keep certain records of their various business activities, because their income tax returns for the years in question accurately reflected the cash register tapes and other business records turned over to the accounting firm by Joseph Thomas, and because the Commissioner failed to prove any additional source of income. These contentions are not enough. The fact that the taxpayers' books and other records were consistent with their income tax returns proves nothing more than that they were consistent; it does not establish that they were truthful. Similarly, the failure of the Government to find any source of the alleged unreported income does not necessarily establish anything more than that the source was well-hidden. Nor does the fact that books and records were kept prevent the Commissioner from resorting to the net worth method if he properly determined that those books and records did not accurately reflect the taxpayers' true income. That was expressly decided in Holland v. United States, 1954, 348 U.S. 121, 131, 75 S.Ct. 127, a criminal case. There is no reason why use of the net worth method should be more circumscribed in the case of a deficiency determination, involving neither criminal nor even civil fraud penalties.

We conclude therefore that the Tax Court was correct in finding that the respondent Commissioner did not err "in determining that the books and records maintained by petitioners for the years in controversy did not correctly reflect their income and in further determining that the income of the petitioners was to be computed on the basis of their increases in net worth, plus other items for the respective years."

The petitioners take issue with several aspects of the net worth computations as actually made by the Commissioner and upheld by the Tax Court. Some of the petitioners' contentions raise entirely factual questions, as to which we cannot say that the findings of the Tax Court were clearly erroneous. Specifically, we think the Tax Court was not in error in finding that the Broadway Recreation Bowling Alley and the mortgage note acquired...