## Facts

- Charles Y. Choi and Jin Yi Choi, married taxpayers, owned and operated an Arizona grocery store.
- In addition to grocery sales, the store cashed customers’ payroll checks without charging a fee; the store deposited payroll checks and paid customers cash from the register.
- The parties agreed the Chois did not keep adequate business records, permitting the IRS to reconstruct income using an indirect method under 26 U.S.C. § 446(b).
- The IRS reconstructed income using the “bank deposits plus cash expenditures” method, which treats bank deposits as gross income, subtracts nontaxable amounts, and adds cash expenditures made from undeposited cash.
- Over the years at issue, the Chois deposited about $2 million in checks and withdrew about $1.4 million in cash to supply cash registers.
- The IRS treated all cash withdrawals as nontaxable, maximizing the portion of deposits that could reflect payroll-check-cashing activity rather than taxable receipts.
- The IRS assessed income tax deficiencies for 1991 and 1992 and asserted civil fraud penalties under 26 U.S.C. § 6663.
- In 1996, Mr. Choi pleaded guilty to criminal tax evasion for the 1992 tax year.

## Issues

1. Whether the IRS properly used the bank-deposits-plus-cash-expenditures method under 26 U.S.C. § 446(b), including whether it adequately accounted for potentially nontaxable deposits related to payroll-check-cashing.
2. Whether the evidence supported a civil fraud penalty for 1991 under 26 U.S.C. § 6663.
3. Whether collateral estoppel, based on Mr. Choi’s guilty plea to criminal tax evasion for 1992, barred him from contesting civil fraud for 1992.

## Decision

- The Ninth Circuit affirmed the Tax Court’s judgment in all respects.
- The court upheld the IRS’s use of the bank-deposits-plus-cash-expenditures method and sustained the resulting 1991 and 1992 deficiency determinations.
- The court affirmed the 1991 civil fraud penalty, holding the Tax Court did not clearly err in finding fraudulent intent proved by clear and convincing evidence.
- The court affirmed application of collateral estoppel to preclude Mr. Choi from disputing the 1992 civil fraud penalty due to his criminal tax-evasion guilty plea for that year.

## Legal Principles

- When a taxpayer fails to maintain adequate records, the IRS may reconstruct income using an indirect method under 26 U.S.C. § 446(b).
- Under the bank-deposits-plus-cash-expenditures method, gross income is determined by totaling bank deposits, subtracting nontaxable amounts, and adding cash expenditures made from undeposited cash.
- The taxpayer bears the burden to keep adequate records and to show error in the IRS’s reconstruction; the possibility that some deposits were nontaxable does not, by itself, invalidate a reasonable reconstruction.
- Civil fraud penalties under 26 U.S.C. § 6663 require the government to prove, by clear and convincing evidence, that an underpayment was attributable to fraud.
- A criminal conviction (including a guilty plea) for tax evasion for a given year can collaterally estop the taxpayer from relitigating fraudulent intent for that same year in a later civil fraud-penalty proceeding.

## Conclusion

The Ninth Circuit held that inadequate recordkeeping permitted the IRS to reconstruct the Chois’ income using the bank-deposits-plus-cash-expenditures method, sustained the resulting deficiencies, affirmed a 1991 civil fraud penalty based on clear and convincing evidence of intent, and applied collateral estoppel to uphold the 1992 civil fraud penalty in light of Mr. Choi’s tax-evasion guilty plea for that year.


Choi v. Comm’r, 379 F.3d 638 (9th Cir. 2004)