Peter S. Pau and Susanna H. Pau - Page 14

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          not give this analysis to Clement.  Among the records petitioner            
          used to reconstruct Sand Hill's income were monthly statements              
          from its Bank of America account.                                           
               On October 31, 1995, Clement met with petitioner and his               
          accountant to review records for Sand Hill's expenses and                   
          petitioners' deductions disallowed in the notice of deficiency.             
          For recording Sand Hill's expenses, petitioner used a spiral-               
          bound notebook with accounting paper.  Using this notebook,                 
          petitioner verified each and every expense paid by Sand Hill for            
          which deductions were claimed by petitioners on their Schedules             
          C.  Clement determined that petitioner kept the notebook in the             
          ordinary course of business during 1990 and that it was an                  
          adequate record for petitioners' business.  Petitioner, however,            
          did not present records of Sand Hill's income to Clement, so the            
          agent used petitioners' bank records to analyze deposits and                
          transfers to reconstruct Sand Hill's income.                                
               In their petition, the Paus denied that they had received              
          income of $840,000 that they did not report on their 1990 return.           
          Respondent's answer asserted that petitioners failed to report              
          additional Schedule C income of $616,789, including the $150,000            
          consultation fee received by Susanna.  Respondent further                   
          asserted that the underpayment of petitioners' tax for 1990                 
          attributable to their unreported income was due to fraud, and               
          that any deficiency stemming from that income is subject to the             

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