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1. Clear and Convincing Evidence of Underpayment
To prove an underpayment, the Commissioner must establish
that the taxpayer received unreported income that resulted in a
tax deficiency. United States v. Campbell, 351 F.2d 336, 338 (2d
Cir. 1965); Elwert v. United States, 231 F.2d 928, 931 (9th Cir.
1956); United States v. Bender, 218 F.2d 869, 871-72 (7th Cir.
1955); Langworthy v. Commissioner, T.C. Memo. 1998-218.
When the allegations of fraud are based on reconstructed
income, respondent can satisfy his burden of proving the
underpayment in one of two ways: (1) By proving a likely source
of the unreported income; or (2) where the taxpayer alleges a
nontaxable source, respondent may meet his burden by disproving
the taxpayer’s alleged nontaxable source. DiLeo v. Commissioner,
96 T.C. at 873-874.
Mr. Sowards alleged that the funds transferred by STL to WPA
were loans and that the unreported law firm income was composed
of nontaxable items. As we have previously found, respondent
proved that the payments from STL were income, that there was no
valid loan agreement between Mr. Sowards and Mr. Strong/STL, that
WPA was a sham, and that there were no nontaxable items for which
respondent did not account. Thus, respondent has met his burden
of proving an underpayment by clear and convincing evidence.
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