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2. Badges of Fraud
Courts have developed several objective indicators, or
"badges", of fraud. Recklitis v. Commissioner, 91 T.C. 874, 910
(1988). The following badges of fraud are present in this case
as to petitioner for the years shown: (a) Substantially
understating his income by diverting it to his children (1995,
1998, 1999), attorney (1998), C.P.A. (1998), and office manager
(1995, 1998); (b) concealing income from petitioners' tax return
preparer (1998); (c) having false or inadequate books and
records; (d) creating false legal documents and concealing assets
from potential creditors (1995); (e) disguising personal expenses
as business expenses (1998, 1999); (f) concealing income through
complex series of transactions and nominees (1995, 1998); and (g)
giving implausible or inconsistent explanations to respondent’s
examiner and in court about events during the years in issue.
a. Substantially Understating Income
A pattern of substantially underreporting income for several
years is strong evidence of fraud. Holland v. United States, 348
U.S. 121, 137-139 (1954); Spies v. United States, 317 U.S. 492,
499 (1943). Petitioners substantially underreported their income
in 1995, 1998, and 1999.
Petitioner testified that he thought the partnership income
was not taxable to him because it was “vested” in the partnership
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