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Ms. Pavlak believed that petitioners had misrepresented the
profitability of the limousine business on the Top Play income
tax returns that she had reviewed and relied upon in purchasing
Top Play. On July 8, 1990, she met with petitioners and proposed
that they repurchase Top Play for $340,000. Petitioners did not
respond to her proposal. Thereafter, Ms. Pavlak sued petitioners
for fraud and misrepresentation with respect to her purchase of
Top Play. She received a judgment in the amount of $95,000.
Because Ms. Pavlak believed that a portion of Top Play’s
cash receipts in 1989 had likely been derived from illegal
activities, she contacted the U.S. Drug Enforcement
Administration (DEA). The DEA referred Ms. Pavlak to the
Criminal Investigation Division of the Internal Revenue Service
(IRS).
In July of 1990, Tom Fisher, an IRS special agent assigned
to the Federal narcotics task force, began investigating
petitioners’ business activities. Agent Fisher determined that
petitioners had unreported income. He believed that narcotics
and/or gambling activities were the possible sources for this
income.
Agent Fisher reconstructed petitioners’ incomes using the
net worth method. Agent Fisher chose the net worth method to
compute petitioners’ incomes because (1) excessive cash had been
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