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until 1988 because the embezzled funds were not disbursed
directly to Gherman family members but were funneled into the FIP
account and used to pay FIP's operating expenses or were used to
make loans to Gherman family members or other individuals or were
used to make investments. We do not agree. Mr. Gherman
received, and should have included on his tax returns, income
from embezzlement at the time he converted the funds from the
accounts of FIP's clients. See James v. United States, supra;
Estate of Geiger v. Commissioner, supra. Accordingly, we sustain
respondent's position that petitioners received unreported income
from embezzlement for the years in issue. However, we believe
that some adjustment is required in the amount of unreported
income determined in the notices of deficiency.
Computation of Unreported Income
We begin our computation of unreported income for the years
in issue with the amounts reflected on the CD schedule for those
years, which petitioners do not challenge. We use the net amount
reflected for each year to account for embezzled funds that were
returned to accounts of FIP's clients. The repayments to
accounts of FIP's clients appear to be an integral part of the CD
scheme. The repayments helped to perpetuate the fraud over a
number of years. Consequently, we treat them as expenses of the
illegal activity. Additionally, for the year ended 1988, we
exclude any withdrawal from, or repayment to, a client account
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