
    THEODORE A. MEYERS AND WIFE, ALICE V. MEYERS v. THE UNITED STATES
    [No. 581-52.
    Decided October 4, 1955]
    
      
      Mr. Ellsworth T. Simpson for the plaintiffs.
    
      Mr. H. S. Fessenden, with whom was Mr. Assistant Attorney General H. Brim Holland, for the defendant. Messrs. Andrew< D. Sharpe and Ellis N. Slack were on the brief.
   LittletoN, Judge,

delivered the opinion of the court:

The plaintiffs sue to recover $29,439.33, representing income tax deficiency, negligence penalty and interest thereon, for the calendar year 1948, and $269.16, with interest thereon, which sum represents a conceded overpayment for the calendar year 1950. The issue presented is whether the Commissioner of Internal [Revenue properly employed the net worth method in determining plaintiff’s income tax liability for the calendar year 1948. The plaintiff challenges the propriety of the use of the net worth method under the circumstances of this case and also the defendant’s determination of cash on hand on December 31, 194T, by the use of that method.

From 1925 to 1934, the plaintiff operated gambling establishments in Washington, D. C. From 1937 to September 1947, the plaintiff operated a gambling establishment in Maryland. At this latter place of business plaintiff employed from 10 to 35 people and specialized in dice, horses and blackjack. His establishment was open daily from 1:00 p. m. to 6:00 a. m., and he served food and drink. He established a loss limit of $2,000 for each race and sometimes accepted wagers on as many as 30 races daily. He estimated that he needed about $100,000 working capital to cover bets.

In May 1948, plaintiff loaned Walter Novak $19,000 to open a gambling business in Maryland, known as Bockway Towers. This business had been in operation for about five weeks when it was raided on June 5, 1948. The plaintiff was arrested, with others, charged, found guilty and received a prison sentence of one year. The plaintiff was in prison the latter part of 1948 and the first part of 1949. During this period the Bureau of Internal Bevenue examined the plaintiff’s returns for 1942 through 1947. These returns had been filed on a cash and calendar year basis. After investigation, preparation of a partial net worth statement and conferences with the plaintiff, his returns for those years were accepted as correct.

The plaintiff had no gambling income in 1948 after his arrest on June 5. On his return for 1948, he reported $56,600 as income from wagering and testified that this represented successful private bets on the horses. His 1948 return disclosed taxable net income of $22,489.87 and a tax liability of $4,837.10. His return for 1949 disclosed a taxable net income of $27,768.49 and a tax liability of $6,688.88. His return for 1950 disclosed a net taxable income of $3,346.88 and a tax liability of $269.16, a five percent delinquency penalty of $13.46, and one month’s interest of $1.35, or a total of $283.97.

During the latter part of 1951 and the early part of 1952, plaintiff’s returns for 1948,1949, and 1950 were examined by agents of the Bureau of Internal Bevenue. For the year 1948, the Commissioner, employing the net worth method, found unreported income of $49,394.63. A deficiency for 1948 in the amount of $24,052.82 and a five percent negligence penalty of $1,202.64 were determined. These sums, with interest thereon of $4,183.87, were assessed and the total of $29,439.38 was paid on February 20, 1952. Over-assessments were found by the same method for 1949 and 1950. The overpayment for 1949 has been refunded and the overpayment for 1950 is conceded. The plaintiff filed a timely claim for refund for 1948. More than six months have elapsed without any action by the Commissioner and this suit followed.

The necessity and danger of the net worth method of determining unreported income was fully discussed by the Supreme Court in Holland v. United States, 348 U. S. 121. The plaintiff contends that the use of the net worth method in determining his income for the year 1948 was improper and arbitrary. He contends that his records were adequate and that the sole reason for the use of the method was because the Commissioner had erroneously classified him as a racketeer, when in fact he had not engaged in the gambling “business” during the taxable year 1948. The revenue agent testified that the reason why plaintiff’s income was determined by the use of the net worth method was because substantially all his income was received from gambling activity. For the taxable year the plaintiff reported as income $56,600 as his net winnings from gambling. He stated that he won this money by successful betting on the horses. His record reflecting his winnings and losses consists of a piece of paper setting forth certain dates with the amount he won or lost on those dates. This record may or may not have been complete. The Commissioner decided that it was incomplete, based on his computation of plaintiff’s income by the use of the net worth method. The necessity of establishing the incompleteness or inadequacy of the taxpayer’s records is not a condition precedent to the use of the net worth method. The net worth technique is a method of determining income which may be employed by the Commissioner in his discretion, Holland v. United States, supra. Whether or not the court will agree with the Commissioner’s determination that there is unreported income is another question.

If an increase in net worth is established for the taxable year and the facts are such that give rise to an inference that this increase was income, the method is appropriate. The determination and assessment of the Commissioner in such, cases are presumed to be correct. When suing for a refund the taxpayer must not only prove that the Commissioner’s determination is wrong, but also must prove the facts upon which the correct tax can be determined. Reinecke v. Spaulding, 280 U. S. 227; Helvering v. Taylor, 293 U. S. 507, 514; Decker et al. v. Korth, 219 F. 2d 732, 737; Harvey v. Early et al., 189 F. 2d 169, 171.

We turn now to the Commissioner’s determination based upon the net worth method, that plaintiff had unreported income for the calendar year 1948 in the amount of $49,394.63. The plaintiff takes issue with the Commissioner on only one item. That item is the cash on hand on December 31, 1947. The plaintiff contends that he had cash on hand in excess of $70,000. The Commissioner found that he had $19,211.39 cash on hand. The only evidence that plaintiff had $70,000 cash on hand on December 31, 1947, is his own testimony. The $19,000 that he loaned Walter Novak in May 1948, could have been taken out of plaintiff’s reported winnings of $39,000 on January 22,1948. The $40,000 cash used to pay taxes in 1948 was taken into account in the Commissioner’s net worth statement. Also, the Commissioner reduced the cash on hand on December 31, 1948, to zero, which had the effect of reducing the plaintiff’s income for that year.

On the other hand, the evidence in the record to support the defendant’s position that the plaintiff only had $19,211.39 cash on hand on December 31, 1947, is very weak. Revenue Agent Thomas, who examined plaintiff’s returns for 1948, 1949, and 1950, testified that Revenue Agent Kennedy, who examined plaintiff’s returns for the years 1943 through 1947, had prepared a partial net worth statement to check those returns which reflected cash on hand on December 31, 1942, of $50,000. In computing plaintiff’s income for 1948, Thomas used Kennedy’s $50,000 figure as the cash on hand on December 31, 1942, and by ascertaining the income plaintiff reported each year and the other undisputed changes in plaintiff’s net worth arrived at the $19,211.39 figure as cash on hand on December 31, 1947. The plaintiff does not dispute Thomas’ computation assuming the correctness of $50,000 cash on hand on December 31,1942. But the plaintiff testified that be bad cash on band on December 31,1942,. in the amount of $100,000, which if worked through the same computation would result in the payment of the correct taxes for the intervening years and no deficiency for 1948. The plaintiff contends that Agent Kennedy’s partial net worth statement shows $40,000 as cash on hand on December 31, 1947.

Although Agent Thomas used Agent Kennedy’s net worth statement to ascertain the cash on hand on December 31, 1942, he could not remember whether or not the $40,000 figure was on that statement as the cash on hand on December 31, 1947. Also, although the defendant had been requested in open court to produce Agent Kennedy’s partial net worth statement it failed to do so. Further it failed to call that agent as a witness, and objected to his testifying when plaintiff called him as his witness. The trial commissioner sustained this objection. This was erroneous. On the evidence that is in the record, the partial net worth statement and the testimony of Agent Kennedy is necessary for either party to establish its case. No explanation whatsoever has been given by defendant as to how the $50,000 cash on hand as of December 31,1942, was ascertained. Whether or not it was correct or the reason for it being $50,000 rather than $100,000 we do not know and have no way of determining because defendant has failed to put any evidence in the record to support it. The most important part of a net worth computation is the beginning net worth and the most important part of that is the cash on hand. Defendant has not offered a scintilla of evidence to support its cash on hand figure. The record as it stands therefore unequivocally leaves the $50,000 determination in the category of being arbitrary. On the record defendant’s determination lacks the presumption of correctness. The fact the defendant failed to put into evidence the proper proof to justify or support its determination to show that it was not arbitrary does not mean the plaintiff is entitled to recover. The evidence for the plaintiff is not clear or complete enough to justify a decision for him. The case cannot be disposed of without further proof.

The case is therefore remanded to the commissioner of the court to take the testimony of Agent Kennedy relative to the cash on hand on December 31,1947, and on December 31,1942, and to have his partial net worth statement put in evidence and the taking of such further proof as either party may desire to offer, and for a supplemental report on the record so made.

It is so ordered.

Laramore, Judge; MaddeN, Judge; Whitaker, Judge; and JoNes, Chief Judge, concur.

FINDINGS OF FACT

The court, having considered the evidence, the hriefs and argument of counsel, and the report of Commissioner Marion T. Dennett, makes the following findings of fact:

1. During the years here involved plaintiffs were citizens of the United States and residents of Silver Hill, Maryland. They have filed joint Federal income tax returns for the years here concerned. Hereafter, for convenience, Mr. Meyers will be referred to as the plaintiff as his activities resulted in this controversy.

2. From 1925 to 1934 plaintiff operated gambling establishments in Washington, D. C.

3. From 1937 to September 1947 plaintiff operated a gambling establishment at Silver Hill, Prince Georges County, Maryland. He employed from 10 to 35 people and specialized in dice, horses, and blackjack. The gambling establishment was open daily from 1:00 p. m. to 6: 00 a. m. and served food and drink. The plaintiff estimated that he had to have about $100,000 working capital to cover bets made at his place. He established a loss limit of $2,000 for each race and sometimes accepted wagers on as many as 30 races daily.

4. In May 1948, plaintiff loaned Walter Novak the sum of $19,000 with which to open a gambling business at a night club on the Baltimore Boulevard known as Eockway Towers. The gambling at Eockway Towers consisted of a dice game which was in operation from 9: 00 p. m. to 2: 30 a. m. This business had been in operation about five weeks when it was raided on June 5, 1948. The plaintiff was arrested along with 19 other men. They were all charged, found guilty and received prison sentences of one year.

. 5. During the latter part of 1948 and early 1949, plaintiff’s Federal income tax returns for the years 1942 to 1947, inclusive, were examined by agents of the Bureau of Internal [Revenue. These returns were filed on a cash and calendar year base. No changes were made in the net taxable income reported on the returns filed for such years and the taxes computed and paid thereon.

6. The plaintiff had no gambling income in 1948 after his arrest on June 5. However, on his 1948 Federal income tax return he reported the sum of $56,600 as income from wagering and testified that this represented successful private bets on the horses. The 1948 return disclosed taxable net income of $22,489.87 and a tax liability of $4,837.10. As the taxpayers had paid $20,000 by payments on their 1948 declaration of estimated tax, the excess payment of $15,162.90 was refunded together with interest thereon of $37.30.

7. The return filed for the year 1949 disclosed taxable net income of $27,768.49 and a tax liability of $6,688.88 of which $3,000 was paid on declaration of estimated tax and $3,688.88 was paid on April 3,1950.

8. The return filed for the year 1950 disclosed a net taxable income of $3,346.88 and a tax liability of $269.16, a five percent delinquency penalty of $13.46 and one month’s interest of $1.35 or a total of $283.97. Since the taxpayers had paid $1,200 on their declaration of estimated tax, the excess of $916.03 was credited on the 1951 estimated tax.

9. The plaintiff’s Federal tax returns for 1948, 1949, and 1950 were examined by agents for the Bureau of Internal [Revenue during the latter part of the year 1951 and the early part of 1952. The agents employed the so-called net worth method in determining a deficiency in 1948 in the sum of $24,052.82 in tax and $1,202.64 in penalty. These amounts together with interest thereon of $4,183.87 were assessed against plaintiff on February 8,1952. The total of $29,439.33 was paid by plaintiff on February 20, 1952.

10. On March 6,1952, a 90-day letter setting forth computations of tax liabilities for 1948,1949, and 1950 was mailed to plaintiff. This letter disclosed an overassessment of $1,665.66 in tax for 1949 and $269.16 with $13.46 overassessment of penalty for 1950, a total of $1,934.82 exclusive of the $13.46. The net worth method was also used for these two years.

11. On March 14, 1952, plaintiff filed a claim for refund in the amount of $34,276.43 for the year 1948. Final action on this claim has not been taken by the Commissioner of Internal Revenue.

On April 11, 1952, plaintiff filed claims for refund for the years 1949 and 1950 for $1,665.66 and $269.16 respectively. The refund claim for 1949 together with interest of $58.03 was allowed and paid to plaintiff on November 12, 1952. Action on the refund claim for 1950 has been suspended because of the filing of this suit.

12. The agent of the Bureau of Internal Revenue resorted to use of the net worth method of estimating income tax liability because, in his opinion, the returns and the records furnished to support them were inadequate and because the principal source of income was from gambling. The records made available for verification of the sources of income and expenditures reported were the books of the Quonset Inn, a book on the operation of a tobacco farm in 1950, a sheet of paper approximately 3%" x 6" in size, torn from a notebook and showing in pencil certain notations described by plaintiff as his winnings and losses from wagering in 1948, with net winnings of $56,600, and some records on payment of interest. There were no bank statements, cancelled checks, check stubs or other records.

13. The claim for refund for 1948, referred to in finding 11 above, asked for a return of the $4,837.10 tax paid for that year (finding 6). It was alleged that through error the taxpayer had failed to claim the following deductions: Payment of Maryland income tax, $1,848.96; loss on stolen hogs, $1,500; and loss on financing the Quonset Inn, $43,159.99, a total of $46,508.95. The figure on the Quonset Tun was claimed as a business bad debt.

The claim also asked for refund of the sum of $29,439.33 representing additional taxes, penalty and interest assessed and paid as described in finding 9. The claim protested the jeopardy assessment and liens put upon tbe taxpayers’ real and personal property because plaintiff was classed as a racketeer by the Bureau of Internal Revenue, the merit of this classification being denied. The determination of a deficiency by the net worth method was also attacked as arbitrary.

14. The revenue agent was unable to obtain any information concerning the claimed income of $5,051.95 from hog raising nor was he able to verify the inadequate records showing income from wagering of $56,600 in 1948. On the net worth statement prepared by the revenue agent no value for hogs was included for 1948. By reason of such exclusion there would be no deductible loss from hog raising as claimed.

As to the claimed deduction of $1,848.96 for Maryland income taxes paid during 1948, this was allowed by the revenue agent in his net worth method of determining taxable income. By not adding this sum back to the net worth in 1948 it was unnecessary then to show the sum as a deduction in determining taxable net income under the net worth method since one adjustment would merely be an offset to the other.

15. In December 1946, plaintiff, although never a stockholder, loaned to the Quonset Inn, Inc., a restaurant and nightclub, the sum of $49,100. During the year 1947, plaintiff loaned further sums totaling $54,516.40 to the aforesaid corporation and in January 1948 he made a further loan of $10,000. As of February 1, 1948, the Quonset Inn was indebted to plaintiff in the total sum of $113,616.40, at which time he took over all the corporate assets and assumed its liabilities. On such date, February 1, 1948, the debt exceeded the net book value of the assets by $43,159.99. Plaintiff continued to operate the restaurant and nightclub as an individual proprietorship until April 30,1949, at which time he sold its inventories of food and liquors and leased the equipment and premises to other parties at a stipulated rental. The business was not profitable when operated by the corporation or during the time plaintiff operated it as a single proprietorship, for he continued to advance funds to pay the debts incurred after taking over the assets and before April 30,1949.

16. The Commissioner determined that the excess of $43,159.99 of the Quonset Inn debt to plaintiff as of February 1, 1948, over the net book value of the corporate assets, was a nonbusiness bad debt allowable as a capital loss deduction to plaintiff to the extent provided by the Internal Eevenue Code. In the determination of plaintiff’s taxable income for the years 1948, 1949, and 1950, the Commissioner allowed the capital loss as a deduction from income up to the limit provided in the Internal Eevenue Code of $1,000 for each of said years.

17. The detailed net worth statement attached to the deficiency notice of March 6, 1952, started as of December 31, 1942, since administrative files of the Internal Eevenue Service disclosed a partial net worth statement was previously used when the determination was made to accept the returns filed by the taxpayers for the years 1943 through 1947 as correctly reporting income for such years. This statement disclosed that as of December 31, 1942, the taxpayers had cash on hand of $50,000. The revenue agent started his net worth statement with this amount of cash as of December 31, 1942, and adjusted cash on hand at the end of each year so that the net result would be the same amount of net taxable income as reported on the returns for each of the years 1943 through 1947. The net worth statement required $19,211.39 cash on hand as of December 31,1947, to make the net income coincide with the $71,579.04 taxable income reported on the return filed for the year 1947 which was accepted without adjustment by the Commissioner of Internal Eevenue. To give the taxpayers all possible benefits of cash, or the source of cash, it was reduced to zero as of December 31,1948.

However, the defendant has failed to offer any evidence to support its determination of cash on hand on December 31,1947, or December 31,1942. The testimony of the revenue agent who examined plaintiff’s returns for 1948, 1949, and 1950 based his beginning cash on hand figure on a revenue agent’s earlier partial new worth statement. This earlier partial net worth statement was not put in evidence and there is no proof to support the correctness of the $50,000 cash on hand figure on December 31,1942. The revenue agent who prepared the earlier partial net worth statement was not called by the defendant to explain how he arrived at the $50,000 figure.

18. If the Commissioner’s determination of cash on hand on December 31, 1942, was correct, any increase in the cash on hand as of December 31,1947, would result in an understatement of the taxable net income reported on the return for the year 1947 by the amount of such increase. Likewise, any increase of cash on hand as of December 31,1948, would result in a like increase in taxable net income for the year 1948.

19. For the year 1948, the Commissioner found unreported income on the net worth basis of $49,394.63, and net overstatement of reported income of $1,000 for 1949, and $11,-583.12 for 1950. The penalty assessed for the year 1948 was a negligence penalty of five percent of the deficiency under the provisions of section 293 (a) of the Internal Revenue Code of 1939.

20. In computing the taxpayers’ taxable net income of $71,884.50 for the year 1948 prior to deducting personal exemption and credit for dependents, there was added to the reduction in visible net worth of $24,329.32 between December 31,1947 and December 31,1948, Federal income tax paid during 1948, bail bond and attorney fees, nondeductible losses, personal checks of Mrs. Meyers, and estimated personal cash expenses, from which was deducted capital loss of $1,000. This resulted in the determination of an income tax liability of $28,889.92 for the year 1948. Since the taxpayers had reported a tax liability of $4,837.10, the deficiency in income tax due for the year was $24,052.82, upon which a five percent penalty of $1,202.64 was determined. The deficiency, and interest thereon of $4,183.87, together with the penalty or a total of $29,439.33, was paid by the taxpayers on February 20,1952, as shown in finding 9.

21. The detailed net worth statement covering the years from 1942 to 1950, upon which the additional taxable income and deficiency were determined by the Commissioner for the year 1948 and overassessments for the years 1949 and 1950, is attached to exhibit I which has been received in evidence and is included herein by reference.

22. Plaintiff contests the decision of the revenue agent in concluding that there was only $19,211.39 in cash on hand as of December 31, 1947, and urges that the administrative file shows the sum of $40,000. This file was not offered in evidence. The figure of $40,000 is not established by the evidence.

The plaintiff says he is not liable for additional taxes, penalties, and interest in 1948, for which he claims a full refund, and further that his returns for 1948, 1949, and 1950 were true and correct and he is not entitled to refund for the two latter years, claims for such refunds having been filed upon defendant’s instructions and to protect the plaintiff’s statutory rights.

23. There is no proof that at the time here in question the plaintiff was dissipating his assets or about to leave the country, or that the assets were insufficient to pay the deficiency.

On the basis of the record, as it now stands, the use of the net worth method to determine plaintiff’s income may be proper; however, defendant’s determination of cash on hand on December 31, 1947, is not supported by any evidence in the record and is therefore arbitrary. 
      
       Mr. and Mrs. Meyers filed joint returns for the years in question. Since it was Mr. Meyers’ activity that resulted in the controversy, he will, for convenience, be hereafter referred to as the plaintiff.
     