Bank of Springfield. He was also convicted of misappropriating 1. The judgment convicting Fox of having embezzled $10,000 in 2. Petitioners did not carry their burden of proving that Fox's income from embezzlements in 1966 was less than the amount of $30,500 determined by respondent; 3. The complete reimbursement of the Bank of Otterville in 1967 by a bonding company does not serve to reduce petitioner's embezzlement income in that year; 4. In addition to the $124,250 restored to the Bank of Springfield in 1967, petitioner is entitled to a deduction under sec. 165 (c) (2), I.R.C. 1954, for $58,250, the amount of the embezzled funds used to purchase the Bank of Otterville stock which was surrendered to the Otterville Investment Corp. after petitioner's misappropriations were discovered; 5. Petitioner Nancy A. Fox has not shown that she did not know of the 1966 embezzlements and did not benefit from them; therefore, she is not relieved of liability for the joint deficiency for 1966 under sec. 6013 (e), I.R.C. 1954; and 6. Respondent has not carried his burden of proving that part of the underpayment of tax for 1966 and 1967 was due to fraud within the meaning of sec. 6653 (b), I.R.C. 1954. John J. Mitchell, William J. Koehn, and Donald J. Brown, for the petitioners. Robert J. Murray and Charles Lomax, for the respondent. FEATHERSTON, Judge: Respondent determined a deficiency in the income tax of petitioners Blaine S. and Nancy A. Fox for 1966 in the amount of $6,372.53 and an addition to tax under section 6653 (b)1 in the amount of $3,186.27. At the trial, respondent conceded that Nancy A. Fox is not liable for the addition to tax but did not make a similar concession as to Blaine S. Fox. Respondent also determined a deficiency in the income tax of Blaine S. Fox for 1967 in the amount of $42,248.88 and an addition to tax under section 6653 (b) in the amount of $21,124.44. The issues for decision are as follows: (1) Whether the judgment convicting petitioner Blaine S. Fox on charges of embezzling $10,000 during 1966 collaterally estops respondent from determining that Blaine S. Fox realized additional embezzlement income in that year; (2) Whether petitioner Blaine S. Fox realized taxable income of $30,500, or any lesser amount, as a result of embezzlements from the Bank of Springfield in 1966; (3) Whether petitioner Blaine S. Fox's taxable income for 1966 and 1967 from his embezzlements should be adjusted for any reim 1 All section references are to the Internal Revenue Code of 1954, as in effect during the tax years in issue, unless otherwise noted. bursements other than the $124,250 which he returned to the Bank of Springfield in 1967; (4) Whether petitioner Blaine S. Fox is entitled to an ordinary or capital loss on the surrender of the Bank of Otterville stock to the Otterville Investment Corp.; (5) Whether petitioner Nancy A. Fox is relieved of liability for the joint deficiency for 1966 as an "innocent spouse" under section 6013(e); and (6) Whether any part of petitioner Blaine S. Fox's underpayment of tax for years 1966 and 1967 was due to fraud within the meaning of section 6653(b). FINDINGS OF FACT Petitioners Blaine S. and Nancy A. Fox were legal residents of Humboldt, Iowa, at the time they filed their petitions. They filed a joint Federal income tax return for 1966 with the district director of internal revenue at Des Moines, Iowa. Petitioner Blaine S. Fox (hereinafter sometimes referred to as Fox) filed a separate Federal income tax return for 1967 with the same office. During the last 5 months of 1966 and the first 4 months of 1967, Fox was employed as executive vice president of the Bank of Springfield, Springfield, Ill. In this capacity he was in charge of the day-today operations of the bank and was authorized to execute cashier's checks and bank drafts. Between August 31, 1966, and April 22, 1967, Fox withdrew and converted to his own use funds totaling $124,250 belonging to the Bank of Springfield, including moneys derived from the following cashier's checks and a draft on another bank: The proceeds of the bank draft dated April 10, 1967, in the amount of $58,250 were used by Fox as a downpayment on a contract to purchase 12712 shares of stock of the Bank of Otterville (hereinafter sometimes referred to as "the bank stock") in Otterville, Mo., from the Otterville Investment Corp. for a total price of $118,250. The $60,000 balance owing under the contract was covered by a promissory note executed by petitioners and secured by a pledge of 11212 shares of the bank stock. Ten shares of the Bank of Otterville stock were unencumbered by the pledge so that petitioners could qualify as directors of that bank. The other 5 shares of the 12712-share total were issued to Robert Dorsey, the president of the Otterville Investment Corp., with the understanding that petitioners would receive them after satisfying the promissory note. During April of 1967, Fox became president and a member of the board of directors of the Bank of Otterville, and he continued to serve as an officer of the Bank of Springfield. During his tenure as president of the Bank of Otterville, Fox was in charge of the day-to-day operations of the bank. Between April 10 and April 19, 1967, Fox caused a series of 11 bank drafts of the Bank of Otterville to be drawn on some of its correspondent bank accounts in the total sum of $124,250 as follows: Type of instrument Draft on American Nat. Bank, Chicago Fox caused the proceeds of these bank drafts to be transferred to the Bank of Springfield as repayment of the funds which he had previously misappropriated from that bank. Fox's misappropriations of funds from the Bank of Springfield and the Bank of Otterville were initially discovered by bank examiners in late April of 1967. On or about July 31, 1967, Fox was indicated in the United States District Court for the Southern District of Illinois, criminal docket No. 6693, on five counts of embezzlement and five counts of issuing bills of exchange with intent to defraud the Bank of Springfield during 1966 and 1967 in violation of sections 656 and 1005 of title 18 of the United States Code. The indictment referred to the $5,000 cashier's check dated August 30, 1966; the $5,000 cashier's check dated September 15, 1966; and the $25,000 cashier's check dated March 16, 1967; the cashier's check for $1,100 dated March 31, 1967; and the bank draft for $58,250 dated April 10, 1967, all described in the first of the foregoing tables. Subsequently, this indictment was transferred to the Western District of Missouri and consolidated with criminal docket No. 22525, where Fox entered a plea of guilty to all 10 counts on November 3, 1967. He was sentenced to prison for 3 years on count 1 and for 3 years on each of counts 2 through 10, inclusive, the sentences to run concurrently. During 1967, Fox was also charged by information in the United States District Court for the Western District of Missouri, criminal docket No. 22490, with 11 counts of misapplying funds and 11 counts of issuing bills of exchange with intent to defraud the Bank of Otterville in violation of sections 2, 656, and 1005 of title 18 of the United States Code. The items referred to in this information are described in the latter of the two tables set forth above. Fox entered a plea of guilty to all 22 counts of the indictment. He was sentenced to prison for 1 year on count 1, 3 years on count 2, and 3 years on each of counts 3 through 22, inclusive, the sentences to run concurrently. On May 2, 1967, the Bank of Otterville made a claim against the Western Casualty & Surety Co. (hereinafter Western) on its Bankers Blanket Bond No. 295366 for the loss of $124,250 sustained by reason of Fox's transfer of the funds to the Bank of Springfield. After making payment of the loss under the bond, Western brought suit in November 1967 against the Bank of Springfield for damages in the amount of $124,250, alleging that, as a result of the payment of the loss claim, it was subrogated to the rights of the Bank of Otterville. The Bank of Springfield, on February 24, 1969, filed a thirdparty complaint in that proceeding against the Otterville Investment Corp. and Fox, joining them as third-party defendants. The thirdparty complaint alleged that on or about April 10, 1967, Fox had wrongfully caused a bank draft of $58,250 to be drawn against the Bank of Springfield's account and paid to Otterville Investment Corp. as part of the consideration for shares of the Bank of Otterville. It further alleged that if the Bank of Springfield was liable to Western on its claim, then Otterville Investment Corp. was liable to the Bank of Springfield for the $58,250. The third-party complaint further alleged that if the Bank of Springfield was liable to Western, Fox was liable to the bank for the $124,250 misappropriated from it. After the misappropriations were discovered in April of 1967, petitioners surrendered their 11211⁄2 pledged and 10 unpledged shares of the Bank of Otterville stock to the Otterville Investment Corp. The transfer of the stock was made at the direction of Western, and the execution of the stock transfers was witnessed by the bank examiners. Otterville Investment Corp. did not foreclose on the stock; it retained petitioners' uncanceled $60,000 promissory note, and paid petitioners nothing on the surrender of the bank stock. On December 8, 1969, the Bank of Springfield and Western executed a Covenant Not To Sue And Agreement in which Western assigned to the Bank of Springfield all claims, demands, and causes of action which it had as subrogee and assignee of the Bank of Otterville against Fox and others arising out of Fox's misappropriations from the Bank of Otterville in the amount of $124,250, referring specifically to the instruments described in the latter of the two foregoing tables. The Bank of Springfield paid Western $65,000 and agreed that Western also would receive the first $30,000 of any sum which the Bank of Springfield recovered from Otterville Investment Corp. On January 26, 1971, the Bank of Springfield recovered a judgment of $58,250 against Otterville Investment Corp. on grounds of unjust enrichment. On May 2, 1973, the Bank of Springfield obtained a judgment against Fox in the amount of $66,000 (the balance of the $124,250 originally claimed) plus interest as provided by law. At the time of the trial, Fox had not repaid out of his own funds any portion of the funds he misappropriated. Prior to beginning his employment with the Bank of Springfield in 1966, Fox had worked about 10 years as a banker. In his work he was asked questions about Federal taxation from time to time by bank customers. He prepared the joint return of petitioners for 1966 which was filed on or about January 23, 1967. Fox's separate return for 1967 was prepared by A. W. Hafner, Bookkeeping and Tax Service, with information that Fox had furnished while he was incarcerated. Attached to the 1967 return, which was filed on June 18, 1968, is the following statement that was prepared by Fox: BLAINE FOX 3 Rainbow Drive Schedule to 1040 STATEMENT OF EMBEZZLED FUNDS Amount of alleged mis-appropreation [sic] according to indictment- $218, 600. 00 Actual amount of loss suffered by bonding company to cover shortage $124, 250.00 Amount received by Bank of Springfield, Illinois on mis-appropreation [sic] of Funds_. $ 66, 100.00 Amount received by Otterville Investment Corporation, Otterville, - Amount received by Blaine S. Fox and regarded as personal income_ $ 58, 250.00 0 Less Bank of Springfield---- $124, 250.00 -66, 100. 00 Sub-total Less Otterville Investment_---- Amount received by Blaine S. Fox--- $ 58, 250.00 -58,250.00 0 |