Appeal from the United States District Court for the Eastern District of Wisconsin. No. 76-C-789 -- Robert W. Warren, Judge .
Before Wood and Cudahy, Circuit Judges, and Campbell, Senior District Judge.*fn*
This appeal presents two issues: whether the taxpayers successfully overcame the Commissioner of Internal Revenue's determination of a tax deficiency; and whether the Commissioner established, by clear and convincing evidence, that these deficiencies were the result of fraud. The plaintiffs-taxpayers have the burden of proof on the first issue, the Commissioner on the latter. The District Court, after a bench trial, concluded that the taxpayers had failed to rebut the deficiency determinations, and that the deficiencies were the product of fraud. While we concur with the District Court's finding as to the deficiencies, we do not believe that the record supports a finding of fraud. We, therefore, reverse.
The plaintiffs, Filippo Candela and Providenza Candela, reside in Lomira, Wisconsin. They were married in 1925 and emigrated to this country from Italy the following year. The Candelas lived in Ohio at first and then moved to Wisconsin in 1939. In April of 1941 Filippo started working at the Grande Cheese Company. The Candelas and their two children, Antoinette and John, lived in a house owned by the cheese company. They paid no rent. Since there was no hotel in town, they would provide lodging for customers and suppliers of the cheese company, for which they were compensated by the company.
The Candelas apparently lived very frugally. Filippo worked seven days a week, and they did not mix socially with other members of the community. They grew their own vegetables which served as a major source of their food. The Candelas did send their two children to parochial schools, and then on to college. Their daughter, Antoinette, testified that for seven years after she graduated from college and was working, she lived either at home or with relatives, and routinely sent a portion of her income home to her father.
In 1967 Filippo and his son John, who was approximately twenty-one years old, purchased the Grande Cheese Company from the Di Bella family for $60,000. Filippo paid for the stock of the company with a money order in the amount of $46,004.78, and a check from the Gourmay Cheese Company in the amount of $13,995.22. The check from Gourmay was a partial payment of a $20,000 debt owed by the Grande Cheese Company to Filippo. The money order was purchased with a $40,000 withdrawal from Filippo's checking account at the Brownsville State Bank, and the remaining $6,004.78 was in cash.
Filippo Candela never learned to read or write, nor did he learn much English. His daily contact was limited to his family and fellow workers at the cheese company. Thus, there was little need for English in his daily life. The preparation of Filippo's annual tax returns was handled by his barber until 1968. In 1968 the barber died, and his return for that year and subsequent years was prepared by Herbert Hauptman, the accountant for the cheese company.
In April of 1975 the Commissioner sent the Candelas notice of a tax deficiency for the years 1967, 1968 and 1969. They paid the deficiencies together with penalties for fraud and, on November 29, 1976, instituted this action for a refund. The deficiencies asserted by the Commissioner were for $6,280.71 in 1967, $12,561.02 in 1968, and $13,547.00 in 1969. In addition, fraud penalties of 50% of deficiencies were assessed. The entire amount at issue, including interest, is $60,606.88.
It should be noted at the outset that the finding of fraud is crucial to the outcome of this case. Normally, the Commissioner is barred from assessing a tax deficiency more than three years after any part of such tax was paid. 26 U.S.C. § 6501(a). However, the three year limitation does not apply in cases where the taxpayer files a "fraudulent return with the intent to evade tax." 26 U.S.C. § 6501(c)(1). Thus, the Commissioner is barred from collecting anything unless he can establish the requisite fraudulent intent of the taxpayer. The standard by which fraud must be established is one of clear and convincing evidence. Gromacki v. Commissioner, 361 F.2d 727, 731 (7th Cir. 1966).
In the instant case, the Commissioner does not rely on any direct evidence to establish an understatement of income for the years in question. Rather, the Internal Revenue Service has employed a net worth method of determining income. Under that method a taxpayer's net worth is established as of the beginning of the period under scrutiny. This is done by subtracting the value of the taxpayer's liabilities from the value of his assets. Once the taxpayer's net worth for the beginning of the taxable period is determined, that figure is subtracted from his net worth for the following year. The difference is the taxpayer's income for that year. To determine income for subsequent years, the Commissioner simply subtracts the taxpayer's net worth at the beginning of the year from the end of the year. Using this method the Commissioner determined that Candela's adjusted gross income for 1967 was $40,870.89 rather than the reported amount of $11,796.28; $54,421.19 for 1968 rather than $16,111.81; and $48,526.86 in 1969, rather than the $31,485.15 reported on that year's return.
The taxpayers' primary attack on the use of the net worth theory is that the initial figure for their net worth is erroneous, thus rendering each successive determination of annual income incorrect. The taxpayers claim that the Commissioner's initial net worth figure of $96,807.13 failed to take into account approximately $70,000 in cash on hand as of December 31, 1966. This cash was allegedly kept in a safe deposit box at the National Exchange Bank in Fond du Lac, Wisconsin; in another safe deposit box at the Brownsville State Bank in Lomira; and in a milk can in the basement of the Candelas' home. The source of the cash was allegedly savings over the years and money sent home by their daughter Antoinette prior to her marriage. According to the testimony of his son John, Filippo Candela kept large amounts of cash in his home out of a general distrust of banks based on his first hand experience of the 1929 depression.
In support of their cash hoard argument, the Candelas rely on Filippo's own testimony and the testimony of their son John regarding the large sums of money kept in the basement and in the safe deposit boxes; the testimony of Antoinette describing her contribution to the family income; the Commissioner's failure to consider additional income from providing room and board to visitors of the cheese company; and the fact that Filippo had over six thousand dollars in cash when he purchased the Grande Cheese Company in April of 1967. The Commissioner argues that based on the Candelas' income and expenditures between 1945 and 1967, they could not have saved $40,000 in that period.*fn1
The District Court's finding that the taxpayers had failed to overcome the deficiency assessments is based largely on credibility determinations. With the exception of Filippo Candela whose deposition was introduced, the District Judge had the benefit of observing the witnesses testify, and made findings as to their credibility. Credibility determinations are clearly within the province of the trier of fact. United States v. Stein, 437 F.2d 775, 778 (7th Cir. 1971). We find nothing in the record to suggest that the finding of deficiencies for the years in question is clearly erroneous.
Had this case been brought within the three-year period for civil tax deficiency suits, our review of the proceedings below would go no further. However, because the Commissioner's deficiency assessment is time barred unless fraud is established, we must ...