Opinion
Docket Nos. 41427 and 42452.1
1955-06-30
MORRIS NEMMO, ET AL., PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Sol Goodman, Esq., for the petitioners. 2 R. G. de Quevedo, Esq., and Lyman G. Friedman, Esq., for the respondent.
Sol Goodman, Esq., for the petitioners.
R. G. de Quevedo, Esq., and Lyman G. Friedman, Esq., for the respondent.
The petitioners' co-counsel who appeared at the trial of these proceedings are as follows: Morris Weintraub, Esq.; Eugene Meacham, Esq.; Daniel W. Davies, Esq.; Ed. T. Dixon, Esq.; Geo. J. Kaufmann, Esq.; and Those. D. Hirschfeld.
1. The petitioners were partners in an enterprise which conducted, inter alia, a handbook operation for the acceptance of bets on horse races. Held, on the facts, the books and records maintained by the partnership correctly set forth the ‘hits' or amounts payable by the partnership to winning bettors, and the respondent erred in determining that the partnership realized bookmaking income in each of the taxable years in an amount equal to 12 per cent of the wagers received.
2. Held, the respondent's determination of fraud penalties under the provisions of section 293(b) of the 1939 Code is disapproved.
The Commissioner has determined deficiencies in income tax and penalties as follows:
+------------------------------------------------------+ ¦Docket No.¦Year ¦Deficiency¦Sec. 293 (b)¦Sec. 294 (d)¦ +----------+------+----------+------------+------------¦ ¦41427 ¦1946 ¦$11,853.21¦$5,926.61 ¦ ¦ +----------+------+----------+------------+------------¦ ¦41444 ¦1946 ¦19,324.92 ¦ ¦ ¦ +----------+------+----------+------------+------------¦ ¦41445 ¦1946 ¦17,728.52 ¦ ¦ ¦ +----------+------+----------+------------+------------¦ ¦41490 ¦1946 ¦17,852.01 ¦ ¦ ¦ +----------+------+----------+------------+------------¦ ¦41491 ¦1946 ¦17,671.40 ¦ ¦ ¦ +----------+------+----------+------------+------------¦ ¦ ¦( 1946¦18,780.63 ¦ ¦ ¦ +----------+------+----------+------------+------------¦ ¦41639 ¦( 1948¦19,067.39 ¦ ¦ ¦ +----------+------+----------+------------+------------¦ ¦42372 ¦1947 ¦12,866.21 ¦6,433.11 ¦ ¦ +----------+------+----------+------------+------------¦ ¦ ¦( 1946¦12,579.81 ¦6,289.91 ¦ ¦ +----------+------+----------+------------+------------¦ ¦ ¦( 1948¦12,528.14 ¦6,264.07 ¦ ¦ +----------+------+----------+------------+------------¦ ¦42373 ¦( 1949¦28,318.46 ¦14,159.23 ¦ ¦ +----------+------+----------+------------+------------¦ ¦ ¦( 1950¦5,852.16 ¦2,926.08 ¦ ¦ +----------+------+----------+------------+------------¦ ¦42452 ¦1947 ¦10,322.10 ¦5,161.05 ¦ ¦ +----------+------+----------+------------+------------¦ ¦ ¦( 1948¦4,696.70 ¦2,348.35 ¦ ¦ +----------+------+----------+------------+------------¦ ¦42616 ¦( 1949¦10,422.32 ¦5,211.16 ¦ ¦ +----------+------+----------+------------+------------¦ ¦ ¦( 1950¦3,219.42 ¦1,609.71 ¦ ¦ +----------+------+----------+------------+------------¦ ¦ ¦ ¦ ¦ ¦ ¦ +----------+------+----------+------------+------------¦ ¦ ¦( 1946¦27,049.09 ¦13,531.93 ¦$4,707.68 ¦ +----------+------+----------+------------+------------¦ ¦ ¦( 1947¦22,950.68 ¦11,475.34 ¦3,892.06 ¦ +----------+------+----------+------------+------------¦ ¦42674 ¦( 1948¦11,460.14 ¦5,730.07 ¦2,072.75 ¦ +----------+------+----------+------------+------------¦ ¦ ¦( 1949¦25,530.28 ¦12,765.14 ¦4,455.89 ¦ +----------+------+----------+------------+------------¦ ¦ ¦( 1950¦6,651.40 ¦3,325.70 ¦1,064.22 ¦ +----------+------+----------+------------+------------¦ ¦ ¦ ¦ ¦ ¦ ¦ +----------+------+----------+------------+------------¦ ¦ ¦( 1946¦10,182.80 ¦5,091.40 ¦ ¦ +----------+------+----------+------------+------------¦ ¦42768 ¦( 1947¦8,878.56 ¦4,439.28 ¦ ¦ +----------+------+----------+------------+------------¦ ¦42769 ¦1948 ¦3,902.43 ¦1,951.22 ¦ ¦ +----------+------+----------+------------+------------¦ ¦ ¦( 1949¦12,597.50 ¦6,298.75 ¦ ¦ +----------+------+----------+------------+------------¦ ¦42770 ¦( 1950¦3,120.07 ¦1,560.04 ¦ ¦ +----------+------+----------+------------+------------¦ ¦ ¦( 1949¦11,588.60 ¦5,794.30 ¦ ¦ +----------+------+----------+------------+------------¦ ¦43245 ¦( 1950¦3,077.38 ¦1,538.69 ¦ ¦ +----------+------+----------+------------+------------¦ ¦ ¦( 1946¦12,830.79 ¦6,415.40 ¦ ¦ +----------+------+----------+------------+------------¦ ¦43246 ¦( 1947¦11,032.02 ¦5,516.01 ¦ ¦ +----------+------+----------+------------+------------¦ ¦ ¦( 1948¦12,937.61 ¦6,468.81 ¦ ¦ +----------+------+----------+------------+------------¦ ¦43340 ¦1950 ¦$3,624.22 ¦$1,812.11 ¦ ¦ +----------+------+----------+------------+------------¦ ¦ ¦( 1946¦13,505.28 ¦6,752.64 ¦ ¦ +----------+------+----------+------------+------------¦ ¦ ¦( 1947¦16,785.00 ¦8,392.50 ¦ ¦ +----------+------+----------+------------+------------¦ ¦43341 ¦( 1948¦13,510.78 ¦6,755.39 ¦ ¦ +----------+------+----------+------------+------------¦ ¦ ¦( 1949¦33,751.65 ¦16,875.83 ¦ ¦ +----------+------+----------+------------+------------¦ ¦ ¦ ¦ ¦ ¦ ¦ +----------+------+----------+------------+------------¦ ¦ ¦( 1948¦17,560.60 ¦8,780.30 ¦ ¦ +----------+------+----------+------------+------------¦ ¦43682 ¦( 1949¦50,152.92 ¦25,076.46 ¦ ¦ +----------+------+----------+------------+------------¦ ¦ ¦ ¦ ¦ ¦ ¦ +----------+------+----------+------------+------------¦ ¦ ¦( 1950¦16,297.50 ¦8,148.75 ¦ ¦ +----------+------+----------+------------+------------¦ ¦ ¦( 1946¦30,624.03 ¦15,312.02 ¦ ¦ +----------+------+----------+------------+------------¦ ¦43683 ¦( 1947¦33,023.28 ¦16,511.64 ¦ ¦ +----------+------+----------+------------+------------¦ ¦ ¦( 1946¦15,338.33 ¦7,669.16 ¦$2,741.85 ¦ +----------+------+----------+------------+------------¦ ¦43828 ¦( 1947¦5,665.87 ¦2,832.93 ¦1,198.73 ¦ +----------+------+----------+------------+------------¦ ¦ ¦( 1948¦2,708.56 ¦1,354.28 ¦635.69 ¦ +----------+------+----------+------------+------------¦ ¦43829 ¦( 1949¦3,854.06 ¦1,927.03 ¦695.79 ¦ +----------+------+----------+------------+------------¦ ¦46488 ¦1947 ¦19,892.31 ¦10,694.15 ¦4,372.50 ¦ +----------+------+----------+------------+------------¦ ¦ ¦( 1948¦11,354.35 ¦6,222.98 ¦2,929.41 ¦ +----------+------+----------+------------+------------¦ ¦46489 ¦( 1949¦17,641.36 ¦9,193.85 ¦3,207.64 ¦ +----------+------+----------+------------+------------¦ ¦ ¦( 1950¦21,631.22 ¦10,815.61 ¦3,491.59 ¦ +----------+------+----------+------------+------------¦ ¦46573 ¦1947 ¦15,807.62 ¦ ¦ ¦ +----------+------+----------+------------+------------¦ ¦ ¦( 1948¦8,835.69 ¦ ¦ ¦ +----------+------+----------+------------+------------¦ ¦46574 ¦( 1949¦15,582.16 ¦ ¦ ¦ +----------+------+----------+------------+------------¦ ¦ ¦( 1950¦22,362.56 ¦ ¦ ¦ +----------+------+----------+------------+------------¦ ¦ ¦( 1948¦8,677.19 ¦ ¦728.36 ¦ +----------+------+----------+------------+------------¦ ¦46576 ¦( 1949¦14,804.22 ¦ ¦ ¦ +----------+------+----------+------------+------------¦ ¦ ¦( 1950¦18,499.28 ¦ ¦ ¦ +----------+------+----------+------------+------------¦ ¦46577 ¦1947 ¦15,617.31 ¦ ¦ ¦ +----------+------+----------+------------+------------¦ ¦46716 ¦1950 ¦6,466.66 ¦ ¦ ¦ +----------+------+----------+------------+------------¦ ¦46717 ¦1950 ¦6,466.66 ¦ ¦ ¦ +----------+------+----------+------------+------------¦ ¦46718 ¦1950 ¦15,826.66 ¦ ¦ ¦ +----------+------+----------+------------+------------¦ ¦48466 ¦1947 ¦16,341.51 ¦8,170.76 ¦ ¦ +------------------------------------------------------+
The respondent, by amended answers, made claim for 50 per cent penalties under section 293(b) of the Code and for additions to tax under section 294(d), in each of the consolidated cases in which such penalties and additions to tax were not determined in the statutory notices of deficiency, other than Docket Nos. 46716 and 46718.
The principal issue to be decided is whether the petitioners realized income from a bookmaking and gambling partnership in each of the taxable years in excess of the amounts reported in their income tax returns. The second question to be decided is whether any part of any deficiency is due to fraud with intent to evade tax. Also in issue are the additions to tax determined by the respondent under the provisions of section 294(d) for failure to file declarations of estimated tax and for substantial underestimates of estimated tax. Some of the petitioners also contend that the deficiencies for 1946, 1947, and 1949 are barred by the statute of limitations. Other issues originally raised by the pleadings have been settled by stipulation of the parties.
FINDINGS OF FACT.
The facts which have been stipulated are found as facts; the stipulations of fact are incorporated herein by this reference.
Morris and Velma Nemmo, George and Freda Bregel, Freda Bregel S ger, Fred and Freda Hallam, Mary and Claude M. Hines, Jr., Albert R. and Kathryn Masterson, and Maurice A. and Zoe Ryan were residents of Kentucky and filed their returns for the taxable years with the collector of internal revenue for the district of Kentucky. Samuel Tucker is a resident of Miami Beach, Florida, and filed his returns for 1046 and 1947 with the collector of internal revenue for the district of Kentucky. Alfred and Minnie Goltsman, George and Mildred Gordon, Ruby and Esther Kolod, Charles A. Polizzi, and Max S. Gladstone were residents of Ohio and filed their returns for the taxable years with the collector of internal revenue for the eighteenth district of Ohio. Samuel and Martha Gutterman and Abe and Sarah Schneider were residents of Ohio and filed their returns for the taxable years with the collector of internal revenue for the first district of Ohio.
During one or more of the years 1946 to 1950, inclusive, Morris Nemmo, George Bregel, Freda Bregel Stager (then Freda Bregel), Alfred Goltsman, George Gordon, Samuel Gutterman, Fred Hallam, Claude M. Hines, Jr., Ruby Kolod, Albert R. Masterson, Charles A. Polizzi, Maurice A. Ryan, Abe Schneider, and Samuel Tucker (hereinafter referred to as the petitioners) were partners in a gambling venture known as the Yorkshire Club (hereinafter referred to as the Yorkshire).
The Yorkshire's premises were located in Newport, Kentucky. It operated a dining room, a bar, a casino where various types of gambling were carried on, and a bookmaking operation for the acceptance of bets on horse races. The Yorkshire kept its books on the cash basis for calendar years, and filed partnership returns for the taxable years with the collector of internal revenue for the district of Kentucky.
The wagers on horse races accepted by the Yorkshire were received and recorded by ‘sheet writers,‘ or clerks, who were stationed in the portion of the premises devoted to bookmaking. When the clerk received a wager, he entered the amount waged on a printed, numbered ticket, in one of three boxes representing win, place, and show bets, respectively. The clerk also entered a code number indicating the track, race, and name of the horse bet on. The ticket, one of 20 on a pad, was then detached from the pad and given to the bettor. A carbon impression of the data recorded on each of the 20 tickets was made on a single back-up sheet retained by the clerk. As the results of the races became known, the clerk placed a circle around each winning wager recorded on his carbon back-up sheets and also entered the amount of the ‘hit,’ or amount payable to the winning bettor. The clerks also paid the winning bettors upon presentation of their winning tickets.
The wagers accepted by the Yorkshire ranged in amount from 50 cents to $200. The odds paid by the Yorkshire to winning bettors were the same odds as prevailed at the race tracks, for the first $2 bet on a horse; for the next $8 bet, the maximum odds paid were 30 to 1; for all amounts in excess of $10, the maximum was 15 to 1. Some bettors desiring to wager substantial amounts on a single horse would ‘spread’ their bet among all the sheet writers on duty, in order to obtain the benefit of the higher maximum odds payable on the first $10 wagered.
The Yorkshire accepted wagers on horse races being held at tracks in various parts of the country. The pertinent information regarding these races was received from a wire service to which the Yorkshire subscribed, and on any day wagers were accepted only for tracks on which information was being carried by the wire service. The service supplied information for about six tracks each day.
The Yorkshire permitted bettors to place wagers on a race after the race had started and until the horses were announced to be at the ‘first quarter.’
A large part of the betting was done at this late time. Because many of the bettors were also patrons of the gambling activities carried on in the casino, the Yorkshire did not refuse horse race bets very often.
It is not clear whether the ‘quarter’ referred to is the first quarter mile or the first quarter of the race.
About noon of each day, when the sheet writers were preparing to accept bets, they were given a sum of money, or ‘bankroll,‘ by Robert Clark, who was Yorkshire's bookmaking supervisor. Clark was salaried, and had no interest in Yorkshire's profits. The total bankroll distributed by Clark was $6,000, which was obtained by him from a safe on the premises. The bankroll was not evenly divided among the sheet writers; one or two sheet writers, to whom the larger bettors were expected to go, received larger portions of the $6,000; the other sheet writers were each given about $500.
At the conclusion of the day's racing activities, at about 6 o'clock in the evening, the sheet writers totaled the wagers, or ‘play,‘ and the hits shown on each of their retained carbon back-up sheets. The average number of bets accepted by each sheet writer varied from 500 to 600, and therefore, each might have as many as 25 or 30 back-up sheets. Each sheet writer then reported to Clark with his back-up sheets and bankroll. Clark, with the help, of another employee, Richard Kearn, and an adding machine, added the play and hit totals on each of the writer's sheets and subtracted the larger number from the smaller; if a writer's total play exceeded his total hits, the writer was required to return a bankroll equal to the sum of the bankroll he received from Clark earlier in the day, plus the excess of play over hits recorded on his carbon back-up sheets. If hits exceeded play, the original bankroll, less the excess of hits over play, had to be accounted for. With the exceptions set forth below, the final bankroll surrendered in the evening by each of the sheet writers corresponded to his opening bankroll as adjusted by the net win or loss for the day shown on his carbon back-up sheets.
After Clark had determined the total play, hits, and net win or loss figures, he transferred the totals for each sheet writer to a daily summary sheet, on which he also computed the over-all win or loss from the day's bookmaking, and expenses. The daily summary sheet had printed lines and columns. The following is illustrative of the entries made by Clark on the summary sheets:
+-----------------+ ¦Jan. 1, 1947 ¦ +-----------------¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ +-----------------+
Play Hits W L Mac $7,826 $7,062 $764 Steve 4,796 5,966 $1,170 Dick 1,792 914 878 Lefty 592 478 114 15,006 14,420 1,756 14,420 1,170 $586 Win $586 Expense 117 $469
Expenses Glen Hughes Or $100 Food check 17 $117
Clark would take his completed summary sheet into the Yorkshire office, where one or more of the partners would review the figures. If the summary sheet showed an over-all win for the day, Clark was required to turn in an amount of money equal to the winnings; if the day's activity resulted in a loss, he received cash equal to the loss from the partners in the office. After paying over the daily win or receiving an amount equal to the loss, Clark's horse bankroll again equaled $6,000, with the exception of certain small discrepancies for uncollected winnings or cash shortages.
In the event the payouts on winning wagers were not collected during the day by the winning bettors, the cash turned over to Clark by the sheet writers in the evening would exceed the amount of the final bankroll indicated by the play and hits on their carbon back-up sheets. The failure of a bettor to collect his winnings on the same day as the race was not a frequent occurrence. The cash required to pay uncollected winning wagers was placed in an envelope by Clark together with the details of the wager. The uncollected winnings were retained until claimed by the bettor, or until shortages developed in Clark's bankroll as a result of errors by the sheet writers in making change or paying off winning bettors. The shortages were not in substantial amounts, usually about $3 or $4 per day. The shortages were not listed as hits on the daily sheets. When the accumulated shortages amounted to $25 or $30, Clark would restore the bankroll to $6,000 by removing the necessary cash from the enveloped containing unclaimed winnings.
The Yorkshire did not accept bets placed on the telephone.
On occasion, one partner may have worked as a sheet writer. However, no partner participated in the handling of the bankroll, either when it was distributed to the sheet writers at the beginning of the day or when it was collected at the end of the day, and no partners took any part in preparing the daily summary sheet of bookmaking activity.
On many occasions, the entire $6,000 bankroll was lost during the day, and Clark had to obtain additional funds from the partners.
The daily summary sheet of bookmaking activity was prepared by Clark about 95 per cent of the time. In his absence, the sheet was prepared by Richard Kearn, a sheet writer.
Clark retained the carbon back-up sheets for a period of 20 to 30 days, and then disposed of them. The daily summary sheets prepared by Clark from the carbon back-up sheets were retained by the partners. One of the partners copied the net play, hit, win or lose, and expense figures to another summary sheet, on which also were recorded win and lose figures for the various gambling games located in the casino. About once each month, the two sets of daily summary sheets prepared by Clark and by the partners were given to Jack Kuresman, an accountant. Kuresman made journal and ledger entries from these sheets to the Yorkshire books maintained by him, and prepared the partnership returns. In the taxable years, the partnership tax returns reported gross receipts, cost of goods sold, other income, deductions, expenses, and net income, as follows:
+-----+ ¦¦¦¦¦¦¦ +-----+
1946 1947 1948 1949 1950 Gross receipts $637,838.28 $685,967.37 $670,370.00 $856,604.09 $289,250.03 Cost of goods sold 444,425.20 479,663.80 403,675.00 509,285.41 180,718.93 Gross profit $193,413.08 $206,303.57 $266,695.00 $347,318.68 $108,531.10 Other income 427.00 525.00 670.00 Total income $193,840.08 $206,828.57 $267,365.00 $347,318.68 $108,531.10 Deductions 45,162.79 62,047.03 82,631.66 104,454.43 76,191.60 Net income $148,677.29 $144,781.54 $184,733.34 $242,864.25 $32,339.50
The results of Yorkshire's bookmaking operations were included by Kuresman in the figure reported for gross receipts, as follows:
+-----+ ¦¦¦¦¦¦¦ +-----+
1946 1947 1948 1949 1950
Bookmaking: Take $5,030,474.00 $3,880,828.00 $3,490,654 $5,060,046.00 $1,936,996.00 Hits 4,882,260.00 3,818,661.00 3,373,407 4,989,680.00 1,963,472.00 Bookmaking $148,214.00 $62,167.00 $117,247 $70,366.00 ($26,476.00) win Other 384,720.00 575,188.00 553,123 785,628.00 310,517.00 games—win Total $532,934.00 $637,355.00 $670,370 $855,994.00 $284,041.00 wins—gambling Food sales 52,039.65 24,174.80 Bar sales 52,701.82 24,351.66 Coffee shop 601.76 5,197.77 sales Other income 162.81 85.91 8.33 11.26 Gross $637,838.28 $685,967.37 $670,370 $856,604.09 $289,250.03 receipts
The totals for ‘take,‘ or play, and hits used to compute the Yorkshire's gross receipts are the same as the amounts shown on the daily summary sheets prepared by Clark, the sheets prepared by the partners, and in the journal and ledger kept by Kuresman.
During the taxable years, Clark was in charge of making lay-off bets for the Yorkshire. These lay-off bets were bets which the Yorkshire had accepted from its clients and which were passed on by the Yorkshire because an excessive element of risk was believed to be involved. The Yorkshire's lay-off bets were placed by Clark with H.R.S., a bookmaking partnership located on the second floor of the building occupied by the Yorkshire. In Clark's absence, or if he was too busy overseeing the sheet writers' activities, the lay-off bets were placed with H.R.S. by a sheet writer. The Yorkshire did not place lay-off bets elsewhere than with H.R.S.
H.R.S. refused to accept Yorkshire's lay-off of some bets which had been placed close to, or after post time, because it was then too late for H.R.S. in turn to lay off the bets.
The books maintained by Kuresman contained no separate capital accounts for the individual partners. The ledger, however, did contain accounts for ‘Partners Drawings' and ‘Partners Investment,‘ and Kuresman maintained summary records which listed each partner's percentage interest, capital investment at the beginning of the year, drawings, share of profits, and capital investment at the end of the year. The Federal partnership returns prepared by Kuresman for the Yorkshire reported for each partner the percentage interest and share of profits recorded in Kuresman's summary records, and each partner reported as his distributive share of Yorkshire income the amount reported on the Yorkshire's partnership return.
The Yorkshire's books and records for bookmaking show the following totals for play, hits, net win or loss, and the percentage of net win or loss to total play:
+----+ ¦¦¦¦¦¦ +----+
Percentage Net win of win Year Total play Total hits (loss) (loss) to total play 1946 $5,030,474 $4,882,260 $148,214 2.946 1947 3,880,828 3,818,661 62,167 1.601 1948 3,490,654 3,373,407 117,247 3.358 1949 5,060,046 4,989,680 70,366 1.390 1950 1,936,996 1,963,472 (26,476) (1.376) Totals $19,398,998 $19,027,480 $371,518 1.915
The respondent redetermined the partnership's net income for each of the taxable years by disallowing, as unsubstantiated and excessive, all hits in excess of 88 per cent of play. No other adjustments were made to the partnership's reported income. The net income as reported, the amount of hits disallowed, and the net income as redetermined by the respondent are as follows:
+----------------------------------------------+ ¦ ¦ ¦ ¦Net income ¦ +------+-----------+-------------+-------------¦ ¦Year ¦Net income ¦Hits ¦as determined¦ +------+-----------+-------------+-------------¦ ¦ ¦reported ¦allowed ¦by respondent¦ +------+-----------+-------------+-------------¦ ¦1946 ¦$148,677.29¦$455,422.00 ¦$604.119.29 ¦ +------+-----------+-------------+-------------¦ ¦1947 ¦144,781.54 ¦403,532.00 ¦548,313.54 ¦ +------+-----------+-------------+-------------¦ ¦1949 ¦242,864.25 ¦536,840.00 ¦779,704.25 ¦ +------+-----------+-------------+-------------¦ ¦1950 ¦32,339.50 ¦258,915.52 ¦291,255.02 ¦ +------+-----------+-------------+-------------¦ ¦Totals¦$753,395.92¦$1,956,360.52¦$2,709,756.44¦ +----------------------------------------------+
In Docket Nos. 41727, 41444, 42372, 42373, 42452, 42768, 42769, 42770, 43245, 43246, 43340, 43341, 43682, and 43683, the statutory notices of deficiency state that the partnership's net income was increased in the amount representing unsubstantiated losses because of a failure to maintain adequate accounting records from which the partnership's net income could be accurately determined. A similar explanation is contained in the deficiency notices in Docket Nos. 43828 and 43849. No explanation was given for the adjustment to partnership income in the deficiency notices involved in the balance of the consolidated proceedings.
On November 28, 1952, after all the deficiency notices involved in these proceedings, other than in Docket No. 48466, had been mailed, the director of internal revenue, Louisville, Kentucky, sent to the partnership a report of examination prepared by an agent of respondent. The report was dated January 29, 1952, and contained the following explanation for the agent's determination that all hits in excess of 88 per cent of play should be disallowed:
During 1946 horse players bet $5,030,474.00 with The Yorkshire. Two of its partners, who are active in the management of The Yorkshire, have testified that detailed records of each bet were made but were later destroyed. Thus The Yorkshire is unable to substantiate its claimed losses of $4,882,260.00. Since its losses in proportion to its gross take are excessive, only losses which would constitute a reasonable percentage of gross take should be allowed. Actual statistics prepared by Churchill Downs show that less than 86 per cent of its gross bets is returned to the bettors at its track. Since The Yorkshire's operations were similar to those of Churchill Downs in that it had a comparatively large clientele of non-professional bettors and because it had various contacts where it could lay off large or undesirable bets, it would seem therefore that any allowance of losses in the case of The Yorkshire in excess of 86 per cent would be reasonable. Accordingly, this report recommends the disallowance of all losses which exceed 88 per cent of gross take.
The Yorkshire's bookmaking operations sustained hits in excess of 88 per cent of play in each of the taxable years. The books and records retained by the Yorkshire accurately set forth the hits sustained in each of the taxable years. Uncollected winnings, not in excess of $2,000 in each of the taxable years, were retained by the bookmaking operation and used to make up cash shortages which had developed in the bankroll.
The Yorkshire began operations about January 1943. In examinations of the partnership's returns for years prior to the taxable years, respondent's agents did not make any objections to the adequacy of the records kept for the bookmaking operations, including the failure to retain the back-up sheets.
No part of any deficiency is due to fraud with intent to evade tax.
Several of the petitioners have pleaded the statute of limitations as a bar to the deficiencies determined by the respondent for the years 1946, 1947, and 1948. Certain of these executed consent agreements extending the applicable period for assessment of tax. The following table lists the dates on which tax returns were filed; the dates on which consent agreements, if any, were executed; the last date for assessment fixed by the consent agreements; and the date on which the respondent's statutory notice of deficiency was issued:
+-----------------------------------------------------------------------------+ ¦ ¦ ¦Year ¦Date ¦Date ¦Last date for ¦Date of ¦ ¦Docket¦Petitioner ¦ending ¦return ¦consent ¦assessment per ¦deficiency ¦ ¦ ¦ ¦12/31 ¦filed ¦executed ¦consent ¦notice ¦ +------+-----------+--------+--------+----------+-----------------+-----------¦ ¦43341 ¦M. A. Ryan ¦1947 ¦1/15/48 ¦1/10/51 ¦6/30/52 ¦5/20/52 ¦ +------+-----------+--------+--------+----------+-----------------+-----------¦ ¦ ¦ ¦1948 ¦1/15/49 ¦1 2/19/ ¦6/30/53 ¦5/20/52 ¦ ¦ ¦ ¦ ¦ ¦52 ¦ ¦ ¦ +------+-----------+--------+--------+----------+-----------------+-----------¦ ¦43683 ¦F. Hallam ¦1947 ¦1/15/48 ¦1/9/51 ¦6/30/52 ¦6/11/52 ¦ +------+-----------+--------+--------+----------+-----------------+-----------¦ ¦ ¦Est. of C. ¦ ¦ ¦1 2/12/ ¦ ¦ ¦ ¦43246 ¦M. Hines, ¦1948 ¦3/15/49 ¦52 ¦6/30/53 ¦5/16/52 ¦ ¦ ¦Jr. ¦ ¦ ¦ ¦ ¦ ¦ +------+-----------+--------+--------+----------+-----------------+-----------¦ ¦41639 ¦C. A. ¦1948 ¦ ¦ ¦ ¦3/11/52 ¦ ¦ ¦Polizzi ¦ ¦ ¦ ¦ ¦ ¦ +------+-----------+--------+--------+----------+-----------------+-----------¦ ¦41444 ¦S. Tucker ¦1946 ¦2 3/15¦ ¦ ¦3/5/52 ¦ ¦ ¦ ¦ ¦/47 ¦ ¦ ¦ ¦ +------+-----------+--------+--------+----------+-----------------+-----------¦ ¦41445 ¦R. Kolod ¦1946 ¦3/15/47 ¦ ¦ ¦3/6/52 ¦ +------+-----------+--------+--------+----------+-----------------+-----------¦ ¦41490 ¦G. Gordon ¦1946 ¦3/15/47 ¦ ¦ ¦3/6/52 ¦ +------+-----------+--------+--------+----------+-----------------+-----------¦ ¦41491 ¦A. Goltsman¦1946 ¦3/15/47 ¦ ¦ ¦3/6/52 ¦ +------+-----------+--------+--------+----------+-----------------+-----------¦ ¦41469 ¦C. A. ¦1946 ¦5/15/47 ¦ ¦ ¦3/11/52 ¦ ¦ ¦Polizzi ¦ ¦ ¦ ¦ ¦ ¦ +------+-----------+--------+--------+----------+-----------------+-----------¦ ¦43341 ¦M. A. Ryan ¦1946 ¦1/15/47 ¦1 2/19/ ¦6/30/53 ¦5/20/52 ¦ ¦ ¦ ¦ ¦ ¦52 ¦ ¦ ¦ +------+-----------+--------+--------+----------+-----------------+-----------¦ ¦43683 ¦F. Hallam ¦1946 ¦4/3/47 ¦3/8/52 ¦6/30/53 ¦6/11/52 ¦ +------+-----------+--------+--------+----------+-----------------+-----------¦ ¦ ¦Est. of C. ¦ ¦ ¦ ¦ ¦ ¦ ¦43246 ¦M. Hines ¦1946 ¦1/15/47 ¦2/12/52 ¦6/30/53 ¦5/16/52 ¦ ¦ ¦Jr. ¦ ¦ ¦ ¦ ¦ ¦ +------+-----------+--------+--------+----------+-----------------+-----------¦ ¦ ¦ ¦1947 ¦1/15/48 ¦ ¦ ¦5/16/52 ¦ +------+-----------+--------+--------+----------+-----------------+-----------¦ ¦46488 ¦R. Kolod ¦1947 ¦3/15/48 ¦ ¦ ¦10/27/52 ¦ +------+-----------+--------+--------+----------+-----------------+-----------¦ ¦46573 ¦A. Goltsman¦1947 ¦3/15/48 ¦ ¦ ¦10/27/52 ¦ +------+-----------+--------+--------+----------+-----------------+-----------¦ ¦46577 ¦G. Gordon ¦1947 ¦3/15/48 ¦ ¦ ¦10/27/52 ¦ +------+-----------+--------+--------+----------+-----------------+-----------¦ ¦48466 ¦S. Tucker ¦1947 ¦2 3/15¦ ¦ ¦3/20/53 ¦ ¦ ¦ ¦ ¦/48 ¦ ¦ ¦ ¦ +------+-----------+--------+--------+----------+-----------------+-----------¦ ¦46489 ¦R. & E. ¦1948 ¦3/17/49 ¦ ¦ ¦10/27/52 ¦ ¦ ¦Kolod ¦ ¦ ¦ ¦ ¦ ¦ +------+-----------+--------+--------+----------+-----------------+-----------¦ ¦46574 ¦A. & M. ¦1948 ¦3/17/49 ¦ ¦ ¦10/27/52 ¦ ¦ ¦Goltsman ¦ ¦ ¦ ¦ ¦ ¦ +------+-----------+--------+--------+----------+-----------------+-----------¦ ¦46576 ¦G. & M. ¦1948 ¦3/17/49 ¦ ¦ ¦10/27/52 ¦ ¦ ¦Gordon ¦ ¦ ¦ ¦ ¦ ¦ +-----------------------------------------------------------------------------+
1 The consents were executed on or about the listed dates.
2 Tucker's returns were filed on or before March 15, 1947, and March 15, 1948, respectively.
OPINION.
HARRON, Judge:
The principal question to be decided is whether the respondent correctly determined that the petitioners understated their distributive shares of income from the Yorkshire Club, a partnership, in each of the taxable years. Also to be decided is whether the respondent correctly determined that the petitioners are liable for penalties and additions to tax under the provisions of sections 293(b) and 294(d) of the 1939 Code. Several of the petitioners have also raised the 3-year statute of limitations, section 275(a) of the Code, as a bar to the deficiencies determined for 1946, 1947, and 1948.
Under the general issue, the narrow question is whether the Yorkshire, in the course of its bookmaking activities, paid out to winning bettors the amounts claimed in the computation of its reported net income. The parties are in agreement as to each petitioner's percentage interest in the Yorkshire profits, and the respondent has made no adjustment to the partnership's income other than the disallowance of a portion of the hits claimed in its bookmaking operations.
The respondent's determination that the Yorkshire did not sustain hits in excess of 88 per cent of play, or conversely, that the partnership realized a gross profit of 12 per cent on all wagers placed, is prima facie correct, and the petitioners have the burden of proving that the respondent's determination was erroneous. The respondent's disallowance of all hits in excess of 88 per cent of play is predicated upon the partnership's asserted failure to maintain records adequate to substantiate the hits. Specifically, the respondent points to the destruction of the back-up sheets containing carbon copies of the information written by the clerks on the individual betting tickets. In dealing with a comparable situation, this Court has said:
True, petitioner had destroyed the sixty-line sheets and thus has made the Commissioner's task of auditing the returns immeasurably more difficult than it should be. This is conduct that is not to be condoned. Perhaps the Treasury should seek and the Congress should provide it with appropriate and effective sanctions, civil or criminal or both, against taxpayers who fail to keep or who do away with important records bearing on their liability. But, under the law as it now stands we are not empowered to approve deficiencies merely because records have been destroyed. Of course, the destruction of records is a factor that may be taken into account in various circumstances such as the determination of fraud, and it may justify the Commissioner in using some reasonable method of reconstructing a taxpayer's income, with the burden upon the taxpayer to show that the Commissioner is in error. * * *
H. T. Rainwater, 23 T.C. 450, 456.
We have found as facts on the basis of the entire record that the Yorkshire's bookmaking operation sustained hits in excess of 88 per cent of play during the taxable years, and that the hits sustained are correctly recorded in the partnership's retained books and records. These records consist of the daily summary sheets of bookmaking activity, which were prepared, usually by Robert Clark, from the sheet writers' carbon back-up sheets; the partners' summary sheets of all gambling activity, the bookmaking data which was taken from Clark's summary sheets; and the journal and ledger entries made by Kuresman, the accountant, from the two sets of summary sheets. Basically, the issue is the reliability and accuracy of the daily summaries of bookmaking activity, since no discrepancies in the hit totals appear as these figures were successively transcribed first to the partners' sheets and then to Kuresman's books.
The question is one of fact, and must be decided on the weight of the evidence adduced. Cf. Jack Showell, 23 T.C. 495; H. T. Rainwater, supra. Clerk, who was a salaried employee without any interest in the partnership's earnings, testified at length as to each step leading to the completion of his daily summary sheet. He distributed the $6,000 bankroll each day among the sheet writers, physically supervised the activities of the sheet writers while they wrote bets and made payoffs on hits, and totaled the cash they turned in at the end of each day as an additional check on the accuracy of the back-up sheets. There is no evidence in the record indicating, as suggested by respondent, that the sheet writers may have falsified the back-up sheets, or that they may have written tickets on winning horses after a race had been run. Clark further testified that after he verified his play and hit totals by counting the cash turned in by the sheet writers, he carefully and honestly transcribed the play and hit totals to his summary sheet. We have carefully considered his testimony and his demeanor, and conclude that his testimony is credible and should be believed. The reliability of Clark's summary sheets also is indicated by the partners' acceptance of his figures as the basis on which they disbursed cash to him to replenish his $6,000 bankroll, in the event of a losing day, and accepted cash from him, on a winning day.
The explanation offered at the hearing of these proceedings and on brief for the increases in partnership income determined by the respondent is that the Yorkshire could not substantiate any of the hits shown on its records, and, pursuant to the rule in Cohan v. Commissioner, 39 F.2d 530, 88 per cent of play was determined by respondent to be a reasonable allowance for hits. The agent or agents of the respondent who determined that the 88 per cent allowance was ‘reasonable’ did not testify in these proceedings, and the record does not establish how this percentage was determined, except that the agent's report referred to 86 per cent as the percentage of gross bets which is returned to bettors as payoffs on winning bets at Churchill Downs, Kentucky. The agent's report was furnished to the partnership. The evidence establishes that the operations of a track do not provide a reasonable comparison for the determination of a bookmaker's profits. The eventual winner of a race is of no concern to the track. The track removes its percentage from the total fund wagered, regardless of the winner, and then distributes the balance of the wagers to winning bettors.
On the other hand, the bookmaker is not guaranteed any percentage of profit or even that he will have any profit; the amount of payoffs he will be required to make is not limited to a portion of the wagers he has accepted, but is dependent upon the amount of wagers he has accepted on the eventual winner. See H. T. Rainwater, supra, pp. 456-7. Furthermore, the Yorkshire accepted bets on various tracks throughout the country, depending, each day, on the information being furnished by the wire service.
In states where the track is required to make a minimum payoff to winning bettors, the track will actually sustain a loss on a race in the event a disproportionately large portion of the wagers is placed on the eventual winner. The evidence indicates this is not a frequent occurrence.
Even apart from a consideration of the operations at Churchill Downs, we think the record establishes that the 12 per cent gross win figure determined by respondent is erroneous and cannot be sustained. The respondent's expert witness, Edward J. Price, Chief Auditor for the Nevada Tax Commission, testified that bookmaking was legal in Nevada during the taxable years and that bookmakers in Nevada, paying track odds without limitation, realized an average gross profit of about 8.6 to 8.8 per cent of wagers accepted. Price admitted on cross-examination, however, that bookmakers in Nevada may not take bets after post time, and that a bookmaker certainly runs some danger of losing by accepting such late bets. Price at first claimed that he could not give an opinion as to whether a bookmaker allowing such practices would experience the same percentage of profits as the Nevada average, but later admitted that a bookmaker who accepts all bets until the horses are at the first quarter is running a ‘charitable institution’ and would naturally have a lower percentage of profit than the Nevada average. Price also admitted that a bookmaker ‘foolish enough’ to accept lay-off bets or big bets at the last moment would possibly be ‘stuck’ on some occasions; and that a bookmaker who has no opportunity to either handicap bets or lay-off bets is ‘certainly a Godsend to the rest of the business' and could not continue operating for any length of time. These factors were all present in the Yorkshire's bookmaking operations; a large part of the wagers were accepted after a race had started and until the horses had reached the first quarter, as an accommodation to the clients of the casino's gambling games. It is pertinent to note, in this connection, that the partnership's solicitude for the patrons of the casino does not appear to have been without a good purpose. As set forth in the Findings of Fact, the partnership reported net winnings of $2,980,694 during the taxable years from the games in the casino. This amount is many times larger than the reported winnings from the horse operation, and even considerably in excess of the bookmaking profit as redetermined by the respondent. Also, H.R.S., the bookmaking partnership with which the Yorkshire's lay-off bets were placed, sometimes refused these lay-off bets because it was too late for H.R.S. in turn to lay off the bets elsewhere, and the amount of lay-off bets placed by the Yorkshire was insignificant in comparison to the total wagers it accepted. On this state of the evidence, we think the 12 per cent margin determined by the respondent is unreasonable and bears no relation to the operations of the Yorkshire during the taxable years; and further, that there is no basis in the record for applying the 8.6 or 8.8 per cent margin purportedly realized by Nevada bookmakers, or any other percentages, to redetermine the partnership's income from bookmaking.
The evidence indicates that an adjustment should be made to the partnership income to reflect the retention and use by the bookmaking operation of bettor's uncollected winnings. Winning wagers were marked as his when the racing results became known, regardless of whether or how soon the bettor appeared to collect his winnings. Although the unclaimed winnings were put aside by Clark for payment to claimants, the partnership controlled and used the funds as its own in restoring cash shortages which developed in the $6,000 bookmaking bankroll. The partnership kept its books on the cash basis, and under these circumstances, it was improper to treat the unclaimed winnings as hits in computing bookmaking profit. The evidence indicates that the failure to claim winnings was not a frequent occurrence and that the amounts involved were small. Using our best judgment on the evidence before us, we have found that these unclaimed winnings did not exceed $2,000 in each of the taxable years.
The respondent determined 50 per cent penalties for each of the taxable years in each of the consolidated proceedings, under the provisions of section 293(b). The respondent has the burden of proving that part of any deficiency is due to fraud with intent to evade tax, and the evidence necessary to establish fraud must be clear and convincing. Snell Isle, Inc. v. Commissioner, 90 F.2d 481, certiorari denied 302 U.S. 734; Wiseley v. Commissioner, 185 F.2d 263. We conclude from the entire record that respondent has not discharged this burden, and our finding of fact is dispositive of this issue. In each of these proceedings, a small deficiency results from the adjustment to the Yorkshire's income referred to above. The deficiencies will be larger in several of the consolidated cases as a result of stipulations entered into by the parties, or the failure of petitioners to allege error in other of the adjustments determined by respondent. As indicative of fraud, the respondent points to the admittedly deliberate destruction or disposal of the individual back-up sheets, which contained the details of the wagers accepted by the bookmaking operation. The disposal of these records properly raises a suspicion that the partnership intended to conceal the true facts concerning the amount of hits claimed. On the other hand, the bookmaking operation, of which the back-up sheets constituted evidence, was illegal under state law,
and the disposal of the back-up sheets is equally suggestive of the desire to avoid seizure by police authorities of evidence pertaining to the unlawful activity. Even more significant is the circumstance that respondent's agents, in auditing the partnership returns for years prior to the taxable years, made no objection to the absence of the back-up sheets. Under these circumstances we do not consider the destruction of the back-up sheets as clear and convincing evidence that part of the deficiencies were due to fraud.
Kentucky Revised Statutes (1946, 1948 eds.):
Chapter 436. OFFENSES AGAINST MORALITY.— 436.490 (1328a) Betting on or transmitting bets on horse races other than authorized Kentucky races. (1) Any person who, either for himself or as agent or employee of another, wagers money or anything of value on a horse race run or about to be run or advertised, posted or reported as being run at any race track in or out of this state, or who engages in the occupation of receiving, making, transmitting or negotiating, either in person or by messenger, telephone or telegraph, wagers on horse races run or about to be run or advertised, posted or reported as being run at any race track in or out of the state, shall, except in the case of wagers made within the enclosure of a race track licensed by the State Racing Commission during an authorized race meeting at that track, or an enclosure during regular meetings in which running, trotting, or pacing races are being conducted by associations regularly organized for that purpose, be imprisoned for not less than one nor more than twelve months.
See also 436.440 (3914b-1; 3914b-3) and 436.450 (3914b-2).
Several of the petitioners have pleaded the 3-year statute of limitations, section 275(a) of the 1939 Code, as a bar to the deficiencies determined by the respondent for 1946, 1947, and 1948. In three of these proceedings, Docket Nos. 43341, Maurice A. Ryan (for 1947 and 1948); 43683, Fred Hallam (1947); and 43246, Estate of Claude M. Hines, Jr. (1948), we have found that, within 3 years after the time the returns were filed or were due, see section 275(f), the petitioners executed consent agreements extending the period for assessment, and that the statutory notices of deficiency were mailed within the extended period. In Docket No. 43246, the consent agreement was executed by the petitioner's decedent and the latter's wife. We hold that the respondent's determinations in the foregoing proceedings are not barred by the statute of limitations. In Docket No. 41639, Charles A. Polizzi, petitioner's pleadings affirmatively allege that the notice of deficiency for 1948 was mailed on March 11, 1952, within 3 years of the date the return was due. Sec. 275(f). Accordingly the statute of limitations does not bar respondent's determination for 1948 in this proceeding. In the other proceedings, in which the statute of limitations has been pleaded, the deficiency notices were mailed more than 3 years and less than 5 years from the later of the filing date or due date of the return, or within the extended period provided in consents which were executed by the petitioners more than 3 years and less than 5 years from the later of the filing or due date of the return. These proceedings are: For the year 1946, Docket Nos. 41444, Samuel Tucker; 41445, Ruby Kolod; 41490, George Gordon; 41491, Alfred Goltsman; 41639, Charles A. Polizzi; 43341, Maurice A. Ryan; and 43683, Fred Hallam; for the years 1946 and 1947, Docket No. 43246, Estate of Claude M. Hines, Jr.; for the year 1947, Docket Nos. 46488, Ruby Kolod; 46573, Alfred Goltsman; 46577, George Gordon; and 48466, Samuel Tucker; and for the year 1948, Docket Nos. 46489, Ruby Kolod and Esther Kolod; 46574, Alfred Goltsman and Minnie Goltsman; and 46576, George Gordon and Mildred Gordon. In each of these proceedings, the respondent claims that the deficiency notices and consent agreements
were timely under the 5-year statute of limitations provided in section 275(c) of the Code.
SEC. 275. PERIOD OF LIMITATION UPON ASSESSMENT AND COLLECTION.
SEC. 276. SAME— EXCEPTIONS.
(b) WAIVER.— WHERE before the expiration of the time prescribed in section 275 for the assessment of the tax, both the Commissioner and the taxpayer have consented in writing to its assessment after such time, the tax may be assessed at any time prior to the expiration of the period agreed upon. The period so agreed upon may be extended by subsequent agreements in writing made before the expiration of the period previously agreed upon.
For section 275(c) to be applicable, the taxpayer must have omitted from gross income an amount in excess of 25 per cent of the gross income reported. A decision under Rule 50 is required by our holding on the principal issue and also to give effect to certain stipulations entered into by the parties. Accordingly, the parties will, under Rule 50, compute the amounts and percentages of gross income omitted by the respective petitioners, in order that the applicability of section 275(c) in each proceeding may be ascertained, and the parties will, under Rule 50, make application of the provision of section 275(c) where proper. The parties can agree upon the application or the nonapplication of section 275(c).
SEC. 275. PERIOD OF LIMITATION UPON ASSESSMENT AND COLLECTION.
(c) OMISSION FROM GROSS INCOME.— IF the taxpayer omits from gross income an amount properly includible therein which is in excess of 25 per centum of the amount of gross income stated in the return, the tax may be assessed, or a proceeding in court for the collection of such tax may be begun without assessment, at any time within 5 years after the return was filed.
It is the understanding of the Court that the issues relating to the additions to tax determined by the respondent under the provisions of section 294(d) will be disposed of under Rule 50.
Decisions will be entered under Rule 50.