Joan Walters, f.k.a. Joan Gherman, and Henry Gherman - Page 40

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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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