Goodwill-Oikerhe v. Commissioner

The Tax Pro's 'Flood' Defense Washes Out

At stake: over $70,000 in tax deficiencies and civil fraud penalties. The Tax Court confronted a brazen attempt by a tax professional—armed with a master’s degree in accounting and pursuing a PhD—to evade taxes by fabricating a story about a flood that supposedly destroyed crucial financial records. The IRS successfully argued that the "flood" was a complete fabrication, and the court, unimpressed with the taxpayer’s credibility, sustained the full amount of the civil fraud penalties under Section 6663 of the Internal Revenue Code.

Basement Offices and Phantom Records

Following the issuance of the NOD, Revenue Agent Kevin Cascante (RA Cascante) examined the petitioner’s 2015, 2016, and 2017 tax returns, along with those of his S corporation, Golden Express International, Inc. (GEI). The petitioner, a highly educated individual with a master’s degree in accounting and finance, operated GEI, offering tax return preparation and consolidation and shipping services. During the years in question, the petitioner resided in a three-story house on Antanna Avenue in Baltimore, Maryland. He used the top two stories as living quarters and the basement exclusively as GEI’s office. The residence was owned by the petitioner’s brother, Austin Oparanma, who lived in Nigeria, with a verbal agreement in place for the petitioner's use of the property.

Adding to the complexity, the petitioner claimed his two nephews, Chisa and Chinda Oparanma, as dependents for the tax years in question. These nephews, born in 1997 and 1998, attended school in Ukraine, with their father (the petitioner’s brother) covering at least some of their school fees.

GEI’s business activities involved both tax return preparation and a consolidation and shipping operation. The latter consisted of consolidating various-sized items into freight containers and shipping them via cargo ships, along with transporting vehicles, primarily to Africa and the Caribbean.

During the examination, RA Cascante met with the petitioner four times at the Antanna Avenue residence. He requested documentation to support the deductions claimed on both the individual and GEI tax returns. The petitioner provided limited documentation. He claimed that a flood at the Antanna Avenue property in early 2017 destroyed many of his records. To support this claim, he showed RA Cascante work proposals from a plumber for drain cleaning and sewer line replacement. However, these proposals were unsigned, and the petitioner acknowledged that the work was never completed. RA Cascante testified that he saw no evidence of a flood during his visits, including his walkthrough of the basement. The petitioner did not provide photographs of alleged flood damage or file an insurance claim.

Deductions Denied: The Legal Breakdown

After the Revenue Agent found no evidence of a flood despite the plumber's proposals, the court turned to the disallowed deductions.

The petitioner first claimed dependency exemption deductions for his nephews, Chisa and Chinda. Section 151(c) allows a taxpayer to deduct an exemption for each dependent, as defined in Section 152. Under Section 152(c)(1), a qualifying child must bear a specific relationship to the taxpayer, live with the taxpayer for more than half the year, meet certain age requirements, not provide more than half of their own support, and not file a joint return. The IRS conceded that Chisa and Chinda met the relationship, age, support, and non-filing requirements for a qualifying child, and also the relationship, gross income, and non-qualifying child requirements for a qualifying relative under Section 152(d). However, the IRS argued that the petitioner failed to prove that his nephews lived with him for more than half of each year or that he provided over half of their support. The court agreed, noting that the petitioner's testimony about the nephews' stays during winter and summer breaks was unsupported by any documentary evidence or testimony from the nephews themselves. Therefore, the court disallowed the dependency exemptions.

The court then addressed the $4,630 personal property tax deduction claimed for 2016. Section 164 allows itemized deductions for state and local personal property taxes and state and local real property taxes paid during the year. The IRS argued that the petitioner provided no substantiation for any personal property tax expenses. Moreover, to the extent the petitioner intended to claim a deduction for real property taxes on the Antanna Avenue residence, the IRS argued that the deduction should be disallowed because the only receipt provided was dated 2017, and because the petitioner did not own the residence. The court agreed with the IRS on all counts, finding no evidence that the petitioner paid any personal property taxes in 2016. The court explained that as a cash basis taxpayer, the petitioner must recognize income when "actually or constructively" received and take deductions in the year the expense was paid, according to Sections 451 and 461 and related Treasury Regulations. The court noted that the only documentary evidence of real property taxes was a 2017 receipt. Furthermore, even if the petitioner had paid real property taxes in 2016, the court stated that the deduction would still be disallowed because the petitioner's brother owned the property. The court cited Treasury Regulation § 1.164-1(a), which generally allows tax deductions only by the person upon whom they are imposed.

For 2015 and 2016, the petitioner claimed unreimbursed employee expenses of $9,505 and $8,188, respectively, including vehicle and cell phone expenses. Section 162(a) allows deductions for ordinary and necessary expenses paid during the year in carrying on any trade or business. The IRS argued that these expenses were neither ordinary nor necessary, and that the petitioner failed to substantiate them. The IRS further asserted that the expenses were unreasonable and implausible. The court sided with the IRS. The court found BDF discouraged the petitioner from incurring such expenses. Furthermore, the court stated, there was no credible evidence that any of these expenses related to employment with another “agency” or GEI. The court observed the implausibility of $9,505 and $8,188 in unreimbursed expenses given that his total reported wages were only $4,343 and $9,230. The court also found that the vehicle expenses were subject to the strict substantiation requirements of Section 274(d), requiring the amount, time and place, business purpose, and business relationship to be shown through adequate records or corroborating evidence. The court determined the petitioner had not met this standard, as his claimed mileage log was allegedly destroyed in the flood.

Finally, the court considered the flowthrough deductions from GEI, including bad debts and rent. GEI claimed bad debt deductions under Section 166(a), which allows a deduction for any debt that becomes worthless within the year. However, Treasury Regulation § 1.166-1(e) states that worthless debts arising from unpaid fees, wages, salaries, rents, and similar items are not deductible unless the taxpayer has included the amount in income for the year the bad debt is deducted or for a prior year. As a cash basis taxpayer, GEI would not have included the fees in income before they were actually or constructively received, making the bad debt deductions improper. GEI also claimed rent deductions of $9,000 per year, but the petitioner provided no evidence that he was making rental payments.

The petitioner sought to invoke the Cohan rule from Cohan v. Commissioner, which allows the court to estimate expenses when a taxpayer proves they incurred some deductible expense but cannot fully substantiate the amount. However, the court refused to apply the Cohan rule, citing a lack of sufficient evidence and calling an estimate “unguided largesse.”

Badges of Fraud: Education Meets Evasion

The IRS also asserted accuracy-related penalties for fraud under Section 6663, which imposes a penalty equal to 75% of the underpayment if any portion of it is due to fraud. To impose this penalty, the IRS must first meet the requirements of Section 6751(b)(1). Section 6751(b)(1) requires written supervisory approval of the "initial determination" of the penalty assessment. Then, the IRS must prove by clear and convincing evidence that an underpayment exists and that some portion of the underpayment is due to fraud.

The court first addressed whether the IRS met the procedural requirements of Section 6751(b)(1). Revenue Agent Cascante’s supervisor, Ms. Gunn, signed both the 30-day letter and the Civil Penalty Approval Form on April 26, 2019, which was the first time the penalties were communicated to the petitioner. The court agreed that Ms. Gunn was the appropriate supervisor and that her approval was timely. The petitioner argued that Ms. Gunn should have spoken with him before forming her opinion, but the court emphasized that Section 6751(b)(1) requires only written supervisory approval. The court concluded that the IRS had complied with Section 6751(b)(1).

Turning to the substance of the fraud penalty, the court outlined that the IRS must prove both an underpayment exists and that the petitioner intended to evade taxes known to be owing by conduct intended to conceal, mislead, or otherwise prevent the collection of taxes. Fraud is defined as intentional wrongdoing designed to evade tax believed to be owing. Because direct evidence of fraud is rare, the court relies on "badges of fraud," a nonexclusive list of factors that demonstrate fraudulent intent. These include understating income (including by overstating deductions), keeping inadequate records, giving implausible or inconsistent explanations, failing to cooperate with tax authorities, filing false documents, dealing in cash, engaging in a pattern of behavior that indicates an intent to mislead, and providing testimony that lacks credibility. The taxpayer’s intelligence, education, and tax expertise are also relevant.

The IRS argued that the petitioner’s sophistication, substantial understatements of income tax, lack of records, failure to cooperate, dealings in cash, and inconsistent statements demonstrated fraudulent intent. The court agreed, pointing out the petitioner's education and experience as a businessman and tax return preparer. Despite this, he significantly overstated deductions on his and GEI’s returns. He also made implausible and inconsistent statements, including the incredible assertion that his records were destroyed in a flood. The court also noted GEI's extensive cash dealings.

Given the totality of the evidence, the court concluded the IRS had clearly and convincingly established that at least some portion of the underpayment for each year was attributable to fraud. The court found the petitioner’s assertion that he did not knowingly or intentionally defraud anyone incredible, particularly given his education and experience. Consequently, the entire underpayment for each year was treated as attributable to fraud, and the Section 6663 fraud penalties were sustained.