Opinion
25974-17
01-23-2023
MICHAEL ZORN, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
ORDER OF SERVICE OF TRANSCRIPT
Courtney D. Jones, Judge.
Pursuant to Rule 152(b), Tax Court Rules of Practice and Procedure, it is hereby
ORDERED that the Clerk of the Court shall transmit herewith to petitioner and to the Commissioner a copy of the pages of the transcript of the trial in this case before the undersigned judge at the December 12, 2022, Baltimore, Maryland trial session containing the Court's oral findings of fact and opinion rendered at the trial session at which the case was heard. In accordance with the oral findings of fact and opinion, decision will be entered under Tax Court Rule 155 in due course. It is further
ORDERED that, on or before April 19, 2023, the parties shall submit computations under Tax Court Rule 155.
Pages: 1 through 34
Place: Baltimore, Maryland
Date: December 14, 2022
Garmatz United States Courthouse Courtroom 9B 101 West Lombard Street Baltimore, Maryland 21201
December 14, 2022
The above-entitled matter came on for bench opinion, pursuant to notice at 1:31 p.m.
BEFORE: HONORABLE COURTNEY D. JONES Judge
APPEARANCES:
For the Petitioner:
No Appearance
For the Respondent:
No Appearance
PROCEEDINGS (1:31 p.m.)
THE CLERK: Calling docket 25974-17, Michael Zorn.
(Whereupon, a bench opinion was rendered.)
Bench Opinion by Judge Courtney D. Jones, Judge December 14, 2022
Michael Zorn v. Commissioner of Internal Revenue Docket No. 25974-17
THE COURT: The Court has decided to' render the following as its oral findings of fact and opinion in this case. The oral findings of fact and opinion shall not be relied upon as precedent in any other case. The oral findings of fact and opinion are made pursuant to the authority granted by section 7459(b) of the Internal Revenue Code and Tax Court Rule 152. Unless otherwise indicated, all statutory references are to the Internal Revenue Code, Title 26 U.S.C., in effect at all relevant times, all regulatory references are to the Code of Federal Regulations, Title 26 (Treas. Reg.), in effect at all relevant times, and all Rule references are to the Tax Court Rules of Practice and Procedure. All monetary amounts are rounded to the nearest dollar.By notice of deficiency dated September 21, 2017, the Internal Revenue Service (IRS) determined deficiencies and additions to tax pursuant to sections 6651(f), 6651(a)(2), and 6654 against petitioner,- Michael D. Zorn, for taxable years 2005, 2006, 2007, 2008, 2009, 2010, 2011, 2012, 2013, 2014, and 2015 (Tax Years at Issue). The amount of the deficiencies and additions to tax are all set forth in Exhibit 1-J, the statutory notice of deficiency, and those amounts are incorporated herein by this reference. In the alternative, respondent argues that if Mr. Zorn is not liable for the fraudulent failure to file additions to tax under section 6651(f), then' he is liable for failure to file additions to tax under section 6651 (a) (1) .
The issues for decision are: (1) whether, for the Tax Years at Issue, Mr. Zorn received unreported gross income in the amounts stated in the notice of deficiency, or whether some of the amounts received were a non-taxable loan; (2) whether Mr, Zorn is entitled to schedule C business expense deductions for the Tax Years at Issue; (3) whether Mr. Zorn is liable for fraudulent failure' to file additions to tax under section 6651(f) for the Tax Years at Issue, or in the alternative, whether Mr. Zorn is liable for failure to file additions to tax under section 6651(a) (1) for the Tax Years at Issue; (4) whether Mr. Zorn is liable for failure to pay additions to tax under section 6651(a)(2) for the Tax Years at Issue; and (5) whether Mr, Zorn is liable for failure to pay estimated income tax additions to tax for the Tax Years at Issue.
Trial in this case was conducted in three parts. First, on November 3, 2021, the Court held a remote . partial trial during the Court's Baltimore, Maryland trial session that began on November 1, 2021. Second, on May 27, 2022, the Court held a partial trial during a special'' trial session in Washington, D.C, Third, on December 12, 2022, the Court held another remote partial trial during the Court's Baltimore, Maryland trial session that began the same day; the Court did not take additional testimony. Mr. Zorn represented himself. 'Respondent was represented by David A. Indek, Elizabeth C. Mourges, and Bradley C. Plovan.
The parties' jointly submitted First Stipulation of Facts (as amended), Second Stipulation of Facts/ and' Third Stipulation of Facts were admitted into evidence along with exhibits attached thereto. Additionally, at respondent's request, the Court takes judicial notice of the state and bankruptcy court records reproduced as Exhibits 69-R through 73-R. See Petzoldt v. Commissioner, 92 T.C. 661, 674-75 (1989). However, the Court only takes notice of Exhibit 71-R for the limited purpose of showing that the Office of the Attorney General of Maryland made the allegations therein, and not to establish the truth of the allegations therein for the purposes of this proceeding. See Estate of Reis, 87 T.C. 1016 (1986).
Additionally, the Court reserved ruling on the admissibility of a number of exhibits; we will address them now.
First, the Court reserved ruling on Exhibit 74-P, the Affidavit of Patrick E. Tormey from Anne Arundel County and attached "Plaintiff's Exhibit 1." The Court sustains respondent's objection and rejects Exhibit 74-P"' under Federal Rule of Evidence 802.
Next, the Court reserved ruling on Exhibit 77-P, Letter to Mary Jewett re Loan Payments dated October 18, 2017. Exhibit 77-P is already included in the record as a portion of jointly stipulated Exhibit 9-J, and so the Court rejects Exhibit 77-P as duplicative and overrules respondent's objections as moot.
Next, the Court reserved ruling on Exhibit 78-P, Letter from Ms. Torney dated January 31, 2018. The Court sustains respondent's objection and rejects Exhibit 78-P under Federal Rule of Evidence 802.
Finally, the Court reserved ruling on Exhibit 82-P, Office Depot/Office Max receipt for USPS Priority Mail and associated tracking information, dated October 15, 2021. The Court sustains respondent's objection and rejects Exhibit 82-P because the exhibit was not exchanged with respondent's counsel 14 days prior to the first day of the trial session, which occurred on November 1, 2021, in accordance with the Court's Standing Pretrial Order issued on June 2, 2021. See Rule 131(b).
On the evidence before us, and using the burden of proof principles explained below, the Court finds the following facts.
FINDINGS OF FACT
Mr. Zorn resided in Maryland at the time he' filed his Petition for redetermination. Since 1992, Mr. Zorn primarily made a career in insurance sales and financial planning, although he also engaged in other ventures. Mr. Zorn received his license to act as a life and health insurance producer from the state of Maryland on August 7, 1992. Mr. Zorn has owned and operated Value Insurance Group (Value IG) since 2001. Mr. Zorn has filed four separate articles of incorporation for Value IG since 2001, forfeiting each charter about two years after formation. The stated purpose on each corporate charter was the sale and marketing of financial products and instruments, and Mr. Zorn served as each corporation's resident agent and lone director.
On August 31, 2017, Mr. Zorn filed articles of incorporation with the state of Maryland for Value Insurance Professionals, Inc. (Value IP), and served as the corporation's resident agent and lone director. It is unclear whether Value IP is the successor in interest to Value IG. The articles of incorporation for Value IP state that its primary purpose is to "sell insurance products." Value IP, as of May 20, 2019, the date the First Stipulation of Facts was filed, was not in good standing with the state of Maryland and had not filed its annual report for 2018.
Additionally, Mr. Zorn also appears to have operated a tour company, Value Travel Service, Inc. (Value Travel). Mr. Zorn filed articles of incorporation with the state of Maryland for Value Travel on November 21, 1990, and Mr. Zorn was listed as the company's resident agent. He forfeited the Value Travel corporate charter on October 5, 1992. Subsequently, on September 10, 1993, Robin L. (Britt) Zorn, Mr. Zorn's former spouse, filed a Trade Name Registration with the state of Maryland. The Trade Name Registration lapsed on October 19, 1998. Mr. Zorn's businesses have never filed federal income tax returns.
Mr. Zorn last filed an individual federal income tax return for taxable year 1996. The IRS previously prepared section 6020 substitutes for returns (SFR) for Mr. Zorn's taxable years 2000, 2001, 2002, and 2004; the IRS did not prepare a SFR for taxable year 2003. On February 14, 2006, the IRS issued Mr. Zorn a notice of deficiency for taxable year 2002, and on September 11, 2007, the IRS issued Mr. Zorn a notice of deficiency for taxable years 2000, 2001, and 2004. Mr. Zorn did not petition this Court in response to these notices of deficiency. Mr. Zorn had a considerable balance for'each-of these years, but the collection period has since expired and these years are not at issue in the present" case.
The IRS initiated an audit of Mr. Zorn for taxable years 2005, 2006, 2007, 2008, 2009, and 2010, ■ and the audit was conducted by Revenue Agent Marilyn Zimmer (RA Zimmer). On December 7, 2011, the IRS notified Mr. Zorn that it had not received his tax returns for the same taxable years under audit. The scope of the audit was subsequently expanded to include taxable years 2011, 2012, 2013, 2014, and 2015.
Throughout the audit process, RA Zimmer issued numerous information document requests pertaining to the initial audit years, as well as the subsequent expansion years. Mr. Zorn did not provide any books or records throughout the audit, failed to appear for numerous appointments with RA Zimmer, and was generally uncooperative throughout the audit process. Mr. Zorn also retained multiple representatives during the audit process, but the representatives only provided RA Zimmer with an incomplete list of the financial institutions that Mr. Zorn was using, did not provide any books or records, and were unable to provide any information that would allow RA Zimmer to complete the audit.
However, Mr. Zorn unexpectedly contacted RA Zimmer on one occasion. On July 16, 2012, Mr. Zorn called RA Zimmer and stated that he knew he owed taxes and he was delinquent in filing his returns. During the call, RA Zimmer asked Mr. Zorn why he had not filed his tax returns, and Mr. Zorn responded that he would come in and explain everything, that he would check his schedule, and that he would call back to set up an appointment within 45 minutes. Mr. Zorn, however, did not call back.
RA Zimmer summoned Mr. Zorn's bank and financial records for the Tax Years at Issue and conducted the audit of Mr. Zorn through a direct method of income reconstruction known as the "specific-item method." Mr. Zorn possessed at least 14 separate bank accounts during the Tax Years at Issue, mixed personal and business funds, and frequently used business accounts for personal expenses.
During the audit, RA Zimmer also noticed a number of large purchases, including a $22,620 cashier's check to Sea Gate Investors LLC for a property located in Seagate Square, Chesapeake Beach, Maryland, multiple cruise line tickets, an international airline ticket, a vehicle purchased in cash, season tickets for a Major League Baseball team, and a series of trips throughout the United States, including to Disney World, New York City, New Orleans, and Las Vegas.
RA Zimmer also noticed that Mr. Zorn engaged in substantial cash dealings during the Tax Years at Issue. Mr. Zorn's cash withdrawals ranged from a low of $13,400 in 2006 to a high of $148,346 in 2007, and averaged more than $50,000 per year between 2005 and 2012.
In 2012, the amount of income reported to the' IRS by third party information returns dropped significantly. This appears to have been precipitated by the suspension of Mr. Zorn's license to sell insurance in the state of Maryland on two separate occasions. First, On April 14, 2011, Mr. Zorn's license was revoked because he failed to timely report an arrest to the Maryland Insurance Commission. Pending resolution of the charges, Mr. Zorn's license was briefly reinstated from September 1, 2011, through October 13, 2011, the date when Mr. Zorn agreed to a one-year suspension of his license by consent order, retroactive to April 14, 2011, with the exception of the aforementioned period of reinstatement.
Mr. Zorn's license was suspended a second time because he conducted multiple sales appointments and submitted an annuity application for a consumer during the period of his first suspension, and he incorrectly answered questions relating to his first suspension on Value IG's application for license renewal. By consent order agreed to on February 27, 2013, Mr. Zorn agreed to a three-year suspension of his license, retroactive to July 1, 2012.
However, while the amount of income reported by third parties dropped significantly, RA Zimmer noticed that Mr. Zorn received an unusual number of large deposits from Mrs. Mary Jewett, an elderly client with terminal' cancer and early-stage dementia. Mr. Zorn befriended Mrs. Jewett in the early 2010s, earned her trust, and became' her friend and financial advisor.
Mr. Zorn persuaded Mrs. Jewett to switch her investment portfolio from Merrill Lynch into an annuity product sold by Value IG. Mr. Zorn never informed Mrs. Jewett about his suspensions. Bank records show that during the Tax Years at Issue Value IG received deposits from Mrs. Jewett totaling $437,078, including: $5,822 in 2012; $163,001 in 2013, $96,834 in 2014; and $171,421 in 2015. Value IG also received additional deposits from Mrs. Jewett subsequent to the Tax Years at Issue. The funds received by Value IG were not invested, but rather were personally used by Mr. Zorn. Additionally, in 2015 Mrs. Jewett's children were removed as the beneficiaries of her Allianz annuity and Mr. Zorn was substituted as the sole beneficiary on the account.
During the audit, RA Zimmer sought to determine whether Mr. Zorn's deposits from Mrs. Jewett were a loan, a gift, or income. RA Zimmer thought that the amounts deposited from Mrs. Jewett might be loans because many of the checks had "loan" inscribed on the memo line. -On1 '' August 25, 2016, RA Zimmer conducted an in-home interview with Mrs. Jewett, who was accompanied by Ron Smallman, Mrs. Jewett's son, Ron's wife Carol, and Barbara Stevanus, a friend who helped Mrs. Jewett manage her household and finances, and who Mrs. Jewett subsequently authorized to act on her behalf with a power of attorney.
RA Zimmer asked Mrs. Jewett whether she loaned any money to Mr. Zorn, or whether she intended to invest in Mr. Zorn's company as a partner or financial backer. Mrs. Jewett emphatically explained to RA Zimmer that she did not loan any money to Mr. Zorn, but rather Mr. Zorn was supposed to invest the money in her Allianz annuity, and she thought that Allianz and Value IG were one in the same. RA Zimmer asked Mrs. Jewett why some of the checks had the word "loan" inscribed on the memo line, and Mrs. Jewett stated that she wrote things in accordance with Mr. Zorn's directions, and she generally did what Mr. Zorn told her to do because she trusted him.
RA Zimmer determined, based on her interview with Mrs. Jewett, that the amounts Mr. Zorn received from Mrs. Jewett were not loans, but rather were income that he used to finance his lifestyle. Mr. Zorn did make some payments described as "loan payments" to Mrs. Jewett, but the payments were made in inconsistent intervals and -amounts; Mr. Zorn did not send any financial statements to Mrs. Jewett and there was no written loan agreement or' documentation of any kind. The deposits received from Mrs. Jewett represent in excess of 75 percent of the amounts RA Zimmer determined as Mr. Zorn's taxable income" for taxable years 2013 through 2015.
On October 7, 2016, Mrs. Jewett authorized Ms.' Stevanus to act on her behalf with a power of attorney. On December 23, 2016, Mrs. Jewett, in response to her worsening financial situation, sent a letter to Mr. Zorn seeking a copy of her Allianz annuity contract, annual statements for her Allianz annuity, a summary of the payments she made to Mr. Zorn, an explanation of where all of her money was invested, copies of beneficiary designations, copies of powers of attorney, and copies of authorizations for Mr. Zorn to make investment decisions on her behalf. Additionally, Mrs. Jewett queried whether she had loaned Mr. Zorn any money over the years, and if so, asked for him to summarize the date, the amount loaned, whether the loan had been repaid, and to provide the balance on any outstanding loans. Mr. Zorn seemingly did not respond to Mrs. Jewett's letter.
On January 9, 2017, Mrs. Jewett and Ms. Stevanus filed a complaint against Mr. Zorn with the Maryland Insurance Administration. Additionally, the Consumer Protection Division of the Office of the Maryland 'Attorney General initiated an investigation into Mr. Zorn's dealings with Mrs. Jewett. On November 27, 2017, Mrs. Jewett authorized her daughter, Susan Torney, to act on her behalf with a power of attorney. Mrs. Jewett died on February 28, 2018.
On January 4, 2019, the Consumer Protection Division of the Office of the Maryland Attorney General filed a civil action on behalf of Mrs. Jewett's estate against Mr. Zorn and Value IG in the Circuit Court for Anne Arundel County, Maryland. The Consumer Protection Division alleged that Mr. Zorn knowingly and willfully obtained by deception, intimidation, or undue influence the property of a vulnerable adult or a person over the age of 68 years old, with the intent to deprive the individual of such property, in violation of Maryland Criminal Law § 8-801 (b).
Mr. Zorn filed for chapter 7 bankruptcy in the United States Bankruptcy Court for the District of Maryland on February 10, 2020. By order dated February 11, 2020, the Circuit Court for Anne Arundel County, Maryland, declined to stay the pending litigation, and on February 19, 2020, that court entered a judgment against Value IG. On October 14, 2020, the Circuit Court for'Anne Arundel County, Maryland, entered a judgment against Mr. Zorn. On November 12, 2020, the United States Bankruptcy Court, District of Maryland, granted a default judgment against Mr. Zorn, ordering that the judgments obtained on behalf of Mrs. Jewett's estate against Mr. Zorn are nondischargeable under 11 U.S.C. § 523(a)(2)(A) and (a)(4) as the debt resulted from money obtained as the result of false pretenses, false representation, and actual fraud, and fraud while acting in a fiduciary capacity. Additionally, in 2021 the Maryland Insurance Administration revoked both Mr. Zorn's individual license, as well as the license for Value IP, due to his dealings with Mrs. Jewett.
Mr. Zorn has not filed a Form 1040, U.S. Individual Income Tax Return, for the Tax Years at Issue, and he last filed a Fo rm 1040 for taxable year 1996. On May 15, 2019, when the case was recalled from the calendar during the Court's Baltimore, Maryland Trial session, which began on May 13, 2019, Mr. Zorn handed respondent's counsel unfiled copies of tax returns for the Tax Years at Issue. These unfiled returns are included in the record as part of the Third Stipulation of Facts, but as discussed further below, there is no evidence that these returns have been properly filed with the IRS.
No amounts were withheld on Mr. Zorn's income, he did not pay estimated taxes, and he has not made any payments towards his federal liabilities for any of the Tax Years at Issue, excluding a nominal refundable credit for taxable year 2009.
Accordingly, the IRS prepared section 6020 (b) SFR for each of the Tax Years at Issue. Each SFR is dated November 3, 2016, and the accompanying certification is dated November 5, 2016. On September 21, 2017, the IRS issued Mr. Zorn a statutory notice of deficiency pertaining to the Tax Years at Issue. Mr. Zorn timely filed a Petition for redetermination with this Court on December 14, 2017.
Subsequent to the Tax Years at Issue, Mr. Zorn has failed to file a Form 1040 for taxable years 2016, 2017, 2018, 2019, 2020, and 2021.
OPINION
Generally, the Commissioner's determinations in a notice of deficiency are presumed correct, and the taxpayer bears the burden of proving those determinations erroneous. Rule 142(a)(1); Welch v. Helvering, 290 U.S. 111, 115 (1933); see also INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992). In an unreported income case, such as this one, if the Commissioner introduces evidence that the taxpayer received unreported income, the taxpayer must show by a preponderance of the evidence that the deficiency determination was arbitrary and erroneous. See Hardy v. Commissioner, 181 F.3d 1002, 1004 (9th Cir. 1999), aff'g T.C. Memo. 1997-97.
In order to shift the burden of proof as to a factual issue under section 7491(a), taxpayers must, among other things, introduce credible evidence as to the factual issue and maintain required records. § 74 91(a)(1), (2), Mr. Zorn has failed to do so.
However, with respect to the fraudulent failure to file penalties under section 6651(f), respondent bears the burden of proof by clear and convincing evidence. § 7454(a); Rule 142(b); Clayton v. Commissioner, 102 T.C. 632, 646 (1994).
I. Deficiency
Section 61(a) provides that gross income includes "all income from whatever source derived." See Commissioner v. Glenshaw Glass Co., 348 U.S. 426 (1955). Every person liable for tax must maintain books and records sufficient to establish the amount of his gross income. § 6001; Estate of Mason v. Commissioner, 64 T.C. 651, 656 (1975), aff'd, 566 F.2d 2 (6th Cir. 1977). When a taxpayer fails to keep sufficient records, the Commissioner may compute taxable income through a method that "does clearly reflect income." § 446(b); Cole v. Commissioner, 637' F.3d 767, 774-75 (7th Cir. 2011), aff'g T.C. Memo. 2010-31; Flynn v. Commissioner, T.C. Memo. 2021-43, at *23.
RA Zimmer employed the specific items method of proof and the bank deposits method of proof to reconstruct Mr. Zorn's income. The specific items method is 'a direct method of proof that has been approved by this Court, and the bank deposits method of proof is well established. See Price v. Commissioner, T.C. Memo. 2004-103, 2004'WL 859198, at *10; see also DiLeo v. Commissioner, 96 T.C. 858, 867 (1991), aff'd, 959 F.2d 16 (2d Cir. 1992). Bank deposits are prima facie evidence' of income. Tokarski v. Commissioner, 87 T.C. 74, 77 (1986); Estate of Mason v.' Commissioner, 64 T.C. at 656-57. When using the bank deposits method, the Commissioner is not required to show that each deposit or part thereof constitutes income or prove a likely source. Price v. Commissioner, 2004 WL 859198, at *11. When employing the bank deposits method, "the Government must take into account any non-taxable source or deductible expense of which it has knowledge." Price v. United States, 335 F.2d 671, 677 (5th Cir. 1964). The taxpayer bears the burden of establishing that items "should be excluded from income or allowed as deduction." Gemma v. Commissioner, 46 T.C. 821, 833 (1966); see also Clayton v. Commissioner, 102 T.C. at 654.
Mr. Zorn argues that the deposits he received from Mrs. Jewett in taxable years 2012, 2013, 2014, and 2015 were non-taxable loan proceeds, and RA Zimmer should not have included the amounts in calculating his income. In tax law, a loan is "an agreement, either express or implied, whereby one person advances money to the other and the other agrees to repay it upon such terms as to time and rate of interest, or without interest, as the parties may agree." Welch v. Commissioner, 204 F;3d 1228, 1230 (9th Cir. 2000) (quoting Commissioner v. Valley Morris Plan, 305 F.2d 610, 618 (9th Cir. 1962}), aff'g T.C. Memo. 1998-121. It is well settled that loan proceeds are not included in gross income. Commissioner v. Tufts, 461 U.S. 300, 307 (1983). Whether a particular transaction constitutes a loan is a question of fact to be determined by considering all of the pertinent facts in the case. Fisher v. Commissioner, 54 T.C. 905, 909 (1970).
Courts consider various factors in determining whether the parties intended a bona fide loan, such as: (1) the ability of the borrowes to repay; (2) the existence or nonexistence of a debt instrument; (3) security, . interest, a fixed repayment date, and a repayment schedule; (4) how the parties' records and conduct reflect the transaction; (5) whether the borrower made repayments; (6) whether the lender demanded repayment; (7) the likelihood the loan was disguised compensation for services; and (8) the testimony of the purported borrower and lender. Welch v. Commissioner, 204 F.3d at 1230; Frierdich v. Commissioner, 925 F.2d 180, 182 (7th'Cir. 1991), aff'g T.C. Memo. 1989-393; see also Todd v. Commissioner, T.C. Memo. 2011-123, aff'd, 486 Fed.Appx. 423 (5th Cir. 2012). These factors are "non-exclusive" and provide a "general basis upon which courts may analyze a transaction." Stanley v. Commissioner, T.C. Memo. 2016-196, at *8 (quoting Welch v. Commissioner, 204 F.3d at 1230).
First, Mr. Zorn's ability to repay the amounts of the purported loans is doubtful. Mr. Zorn's license to sell insurance was suspended for nearly the entire period between April 14, 2011 and July 1, 2015, with limited exception, and as a consequence, Mr. Zorn's ability to generate income was severely hampered. The deposits from Mrs. Jewett represent a significant portion of the deposits into Mr. Zorn's accounts during taxable years 2012 through 2015.
Next, during trial Mr. Zorn stated that "anything I ever did with Mary, I mean, I did in writing." Contrary to his statement, however, there was no note or debt instrument evidencing any type of loan arrangement between Mr. Zorn and Mrs. Jewett. The only contemporaneous indication that the deposits from Mrs. Jewett were a loan is that some of the checks had the word "loan" inscribed on the memo line, but this writing is hot determinative. See e. g., Alhadi v. Commissioner, "T.C. '' Memo. 2016-74, at *19. Further, this inscription on the checks is further complicated by the fact that Mrs. Jewett wrote things in accordance with Mr. Zorn's instructions. Additionally, there was no security interest, stated' interest rate, fixed repayment date, or repayment' schedule.
Furthermore, Mrs. Jewett believed that Mr. Zorn was investing all of the money she gave to him, and that she did not loan any money to Mr. Zorn. This fact is further confirmed by the testimony of Ms. Stevanus. Mrs. Jewett's December 23, 2016 letter further evidences the fact that she was unaware of the existence of any loan arrangement with Mr. Zorn. The only record that Mr. Zorn has produced to date is an October 18, 2017 letter to Mrs. Jewett, which is of questionable authenticity, that reflects his characterization of the purported arrangement with Mrs. Jewett.
Mr. Zorn did make a number of payments described as "loan payments" to Mrs. Jewett, but the payments did not begin until more than 18 months after Mr. Zorn first accepted money from Mrs. Jewett, were paid'at inconsistent intervals, and were made in inconsistent amounts. Further, the payments to Mrs. Jewett frequently occurred after she transferred a considerable sum of money to-Mr. Zorn.
This Court is not required to accept a taxpayer's self-serving testimony. See Tokarski v. Commissioner, 87 T.C. at 77. Mr. Zorn has failed to corroborate his claim of bona fide loans with sufficient reliable evidence. The testimony of Ms. Stevanus, Mrs. Jewett's POA, was persuasive given her personal knowledge of Mrs. Jewett1s finances. Conversely, the testimony of Raymond Jewett, Mrs. Jewett's step son, was not persuasive, especially in light of his admission that he did not know much about Mrs. Jewett's finances and he had never looked at her financial documents.
Accordingly, the amounts that Mr. Zorn received from Mrs. Jewett are not loans and the IRS properly determined that they constitute taxable income.
Next, in his petition Mr. Zorn asserts that the IRS erred by not permitting deductions for certain business expenses. Deductions are a matter of legislative grace, and the taxpayer generally bears the burden of .. proving entitlement to any deduction claimed. Rule 142(a); INDOPCO, Inc. v. Commissioner, 503 U.S. at 84. Additionally, certain deductions such as vehicle and travel expenses require adherence to the strict substantiation requirement of section 274 (d) (1) and (3). In short, Mr. Zorn has not substantiated his entitlement to any such deductions. Mr. Zorn has not provided any documentation and did not provide any testimony to substantiate the existence of ordinary and necessary business expenses.
Mr. Zorn has not met his burden of proof to show that the amounts received from Mary Jewett constitute a loan and has not otherwise presented evidence to show that the IRS erred in determining the amounts due. Mr. Zorn received numerous payments and commissions from insurance companies, as well as the amounts from Mrs. Jewett, and he has not substantiated any claimed expenses. Therefore, we sustain the deficiencies determined in respondent's notice of deficiency.
II. Additions to Tax
A. Fraudulent Failure to File under Section 6651(f)
The IRS determined that Mr. Zorn's failure to file was fraudulent and that he is liable for additions to tax under section 6651(f) for each of the Tax Years at Issue. When any failure to file a return is fraudulent, section 6651(f) imposes an addition to tax of up to 75 percent of the amount of tax required to be shown on the return. A substitute for return prepared by the Commissioner under section 6020 (b) does not qualify as a return for purposes of sections 6651 (a) (1) and (f) . See § 6651(g) (1) .
The Commissioner bears the burden of proving fraud by clear and convincing evidence, and must show that: (1) the taxpayer underpaid his income tax for each year at issue; and (2) at least some portion of each underpayment was due to fraud. § 7454(a); Rule 142(b); see also Clayton v. Commissioner, 102 T.C. at 646; DiLeo v. Commissioner, 96 T.C. at 873. Mr. Zorn has stipulated that he has not filed a Form 1040 income tax return for any of the Tax Years at Issue. Respondent has met his initial burden of showing that Mr. Zorn had an obligation to file tax returns showing a tax liability for each of the years in issue. See §§ 1; 6011(a), 6012(a)(1)(A); Clayton v. Commissioner, 102 T.C. at 653.
The existence of fraud is a question of fact to be determined from the entire record. See DiLeo v. Commissioner, 96 T.C. at 874. Because direct evidence of a taxpayer's fraudulent intent is seldom available, fraud may be shown through circumstantial evidence, including the well-established "badges of fraud" on which Courts often rely. See Petzoldt v. Commissioner, 92 T.C. at 699; Porter v. Commissioner, T.C. Memo. 2015-122. A taxpayer's entire course of conduct may establish the requisite fraudulent intent. Stone v. Commissioner, 56 T.C. 223, 224 (1971).
The Court looks to the following badges of fraud to determine fraudulent intent: (1) failure to file tax returns; (2) maintenance of inadequate books and records; (3) understatement of income; (4) implausible or inconsistent explanations of behavior; (5) concealment of income or assets; (6) failure to cooperate with tax authorities during the audit; (7) engaging in illegal activities; (8) an intent to mislead which may be inferred from a pattern of conduct; (9) lack of credibility of the taxpayer's testimony; (10) filing false documents; and (11) dealing in cash.
The additions to tax for fraud have frequently been imposed on taxpayers "who were knowledgeable about their taxpaying responsibilities *** [and] consciously decided to unilaterally opt out of our system of taxation." Miller v. Commissioner, 94 T.C. 316, 335 (1990); see also Niedringhaus v. Commissioner, 99 T.C.A 212, 217-19 (1992).
While the mere failure to file a return, standing alone, is not sufficient to support a finding of fraud, an extended pattern of failing to file returns is a badge of fraud and may provide persuasive circumstantial evidence of the intent to evade tax. Porter v.' Commissioner, T.C. Memo. 2015-122, at *53-54'(citing Bradford v. Commissioner, 796 F.2d 303, 308 "(9th" Cir; 1986)). Mr. Zorn has not filed an individual" tax return since taxable year 1996, he has not filed any tax return for the Tax Years at Issue, and subsequently he has not filed a tax return for taxable years 2016, 2017, 2018, 2019, 2020, or 2021. During this case Mr. Zorn handed respondent's counsel completed copies of Form 1040 for the Tax Years at Issue, but "hand delivery of a return to counsel for respondent does not constitute the filing- of that return," and there is no evidence that Mr. Zorn has ever properly filed those returns with the IRS. § 6091(b)(1); Treas. Reg. § 1.6091-2 (d) (1), -1(C); Smyth v. Commissioner, T.C. Memo. 2017-29, at *9 (quoting Quarterman v. Commissioner, T.C. Memo. 2004-241, 2004 WL 2361672, at *3 n.6). Furthermore, none of Mr. Zorn's businesses have ever filed a federal income tax return.
Mr. Zorn stated that he has "been audited by the IRS every year from 1991 forward." Mr. Zorn was clearly aware of his obligation to file a tax return because he had done so previously; the record clearly shows that Mr. Zorn filed an individual income tax return for taxable years 1990 through 1996. Additionally, Mr. Zorn was aware of his obligation to file a tax return because the IRS issued numerous notices to Mr. Zorn, prepared SFRs, issued notices of deficiency for taxable years 2000, 2001, 2002, and 2004, and Mr. Zorn held himself out as a financial' advisor. This factor weighs against Mr. Zorn for each of the Tax Years at Issue.
Additionally, Mr. Zorn failed to report substantial sums of gross income during the Tax Years at Issue. Mr. Zorn had a legal duty to report this income and he has not satisfactorily explained his' failure to do so. See § 6012(a)(1)(A). In fact, Mr, Zorn's unfiled copies of tax returns for the Tax Years at Issue reflect the same amount of gross income as found on the SFRs. This Court has held that "consistent understatements of income in substantial amounts over a number of years by knowledgeable taxpayers, standing alone, are persuasive evidence of fraudulent intent to evade taxes." Asbu'ry v. Commissioner, T.C. Memo. 2011-107, 2011 WL 1990541, at *8 (quoting Otsuki v. Commissioner, 53 T.C. 96, 108 (1969)). This factor weighs against Mr. Zorn for each Tax Year at Issue.
Further, Mr. Zorn failed to cooperate with RA Zimmer during the audit. The relevant inquiry is Mr. Zorn's level of compliance, or lack thereof, during the audit process. Porter v. Commissioner, T.C. Memo. 2015-122, at *55-56. In his Reply to Answer, Mr. Zorn admitted that he did not provide any records to the IRS for any of the Tax Years at Issue, and there is no evidence in' the record to establish that Mr. Zorn actually maintained"any books and records. Additionally, Mr. Zorn did not meet with RA Zimmer and he failed to appear for multiple appointments with her, Mr. Zorn failed to cooperate' during the audit and this factor weighs against him for each of the Tax Years at Issue.
Further, the Circuit Court of Anne Arundel County, Maryland, entered judgments against Mr. Zorn and Value IG for his dealings with Mrs. Jewett, finding that Mr. Zorn obtained Mrs. Jewett's money through deception, intimidation, or undue influence, in violation of Maryland Criminal Law § 8-801 (b). Additionally, the United States Bankruptcy Court, District of Maryland, held that Mr. Zorn's debt to Mrs. Jewett's estate was non-dischargeable because the debt resulted from money obtained as the result of false pretenses, false representation, and actual fraud, and fraud while acting in a fiduciary capacity. This factor weighs against Mr. Zorn with respect to taxable years 2012, 2013, 2014, and 2015.
Additionally, Mr. Zorn regularly dealt in large sums of cash, averaging more than $50,000 per year from taxable years 2005 through 2012. Dealing in cash to avoid the Commissioner's scrutiny is another badge of fraud, and this factor weighs against Mr. Zorn with respect to taxable years 2005 through 2012. See, e.g., Reynoso v. Commissioner, T.C. Memo. 2016-185, at *26.
On this record, respondent has clearly and' convincingly established Mr. Zorn's fraudulent intent under section 6651(f). Accordingly, we will sustain the additions to tax pursuant to section 6651(f), and we need not address respondent's alternative argument under section 6651(a)(1).
B. Failure to Pay Under Section 6651 (a) (2)
Next, the IRS determined that Mr. Zorn is liable for the failure to pay additions to tax under section 6651(a)(2) for each of the Tax Years at Issue. Section 6651(a) (2) imposes an addition to tax on taxpayers for their failure to timely pay the amount of tax shown on a return. See also § 6651(g)(2). When a taxpayer has not filed a valid return, the section 6651(a) (2) addition to tax may not be imposed unless the secretary has prepared a substitute for return. See Wheeler v. Commissioner, 127 T.C. 200, 210 (2006), aff'd, 521 F.3d 1289 (.10th Cir. 2008).
The addition to tax is calculated as 0.5 percent of the amount shown as tax on the return but not paid, with an additional 0.5 percent for each month or fraction thereof during which the failure to pay continues up to a maximum of 25 percent. § 6651(a)(2). With regard to taxable years 2012, 2013, 2014, and 2015, the notice of deficiency provides that the additions to tax under section 6651(a)(2) will "be computed later." The notice of deficiency did not calculate the amounts of the section 6651(a)(2) additions to tax for taxable-years 2012, 2013, 2014, and 2015 because the period necessary to support the assertion of the maximum penalty amount under section 6651(a) (2) had not yet been attained. See. e.g., Gardner v. Commissioner, T.C. Memo. 2013-67; Good v. Commissioner, T.C. Memo. 2012-323.
To carry his burden that imposition of section 6651(a) (2) additions to tax is appropriate, the Commissioner must introduce evidence that the tax was shown on a federal income tax return and not paid. Cabirac v. Commissioner, 120 T.C. 163, 170-72 (2003), aff'd without published opinion, 94 A.F.T.R. 2d (RIA) 2004-5490 (3d. Cir. 2004). Respondent has met its burden by showing that the IRS prepared SFRs that satisfy the requirements of section 6020(b), providing Forms 4549, 886-A, and 13496 for each of the Tax Years at Issue. See Cabirac v. Commissioner, 120 T.C. at 170-72. Respondent has also shown that Mr. Zorn has failed to pay his federal income tax obligations for the Tax Years at Issue. Mr. Zorn did not argue and has not shown reasonable'cause, and thus we will sustain the additions to tax pursuant'"to section 6651(a)(2). See Lloyd v. Commissioner, T.C. Memo. 2020-92.
C. Failure to Pay Estimated Tax Under Section 6654
Finally, the IRS determined that Mr. Zorn is liable for failure to pay estimated tax additions to tax under section 6654. The section 6654(a) addition to tax is imposed on underpayments of estimated tax unless an exemption applies. A taxpayer must pay estimated tax for any year in which he has a "required annual payment." § 6654 (d) . Pursuant to section 6654(d) (1) (B), a "required annual payment" is defined as "the lesser of (i) 90 percent of the tax shown on the return for the taxable year (or, if no return is filed, 90 percent of the tax' for such year)", or (ii) if the individual filed a return for the preceding taxable year, then "100 percent of the tax shown on the return of the individual for the preceding taxable year."
Respondent has met his burden of production under section 7491 by producing evidence that Mr. Zorn was required to make annual payments under section 6654(d) for the Tax Years at Issue. Mr. Zorn has stipulated to the fact that he did not make any estimated income tax payments for the Tax Years at Issue, excluding taxable year 2009. With regard to taxable year 2009, Mr. Zorn received a $2 refundable credit that has been applied towards his tax liability, which is substantially less than the estimated payments required under section 6654(d) (1) (B), and Mr. Zorn has made no other payments towards his tax liabilities for the Tax Years at Issue.
Generally, no reasonable cause exception exists for the section 6654(a) addition to tax. Treas. Reg. § 1.6544-1 (a) (1) . There are exceptions to the section 6654(a) addition to tax, but Mr. Zorn does not meet the requirements of these exceptions. See § 6654(e). Accordingly, we will sustain the additions to tax pursuant to section 6654 (a).
III. Conclusion
We have considered the parties' remaining arguments, and to the extent not discussed, conclude that those arguments are irrelevant, moot, or without merit. This concludes the Court's oral Findings of Fact and Opinion in this case. A decision will be entered under Rule 155.
(Whereupon, at 2:24 p.m., the above-entitled . matter was concluded.)
CERTIFICATE OF TRANSCRIBER AND PROOFREADER
CASE NAME: Michael Zorn v. Commissioner
DOCKET NO.: 25974-17
We, the undersigned, do hereby certify that the foregoing pages, numbers 1 through 34 inclusive, are the true, accurate and complete transcript prepared from the verbal recording made by electronic recording by Gary Baldwin on December 14, 2022 before the United States Tax Court at its session in Baltimore, MD, in accordance with the applicable provisions of the current verbatim reporting contract of the Court and have verified the accuracy of the transcript by comparing the typewritten transcript against the verbal recording.
Amelia Mastandrea, CDLT-210 1/13/23
Transcriber Date
Susan Patterson, CDLT-174 1/13/23
Proofreader Date