On Appeal from the Decision of the United States Tax Court. (Tax Ct. No. 6583-77)
Before GIBBONS, BECKER, Circuit Judges, and KATZ, District Judge*fn*
Unreported income from illegal gambling is a frustrating problem for the tax collector. Estimates show that such income is substantial.*fn1 The Internal Revenue Service has sometimes overreacted by imposing arbitrary assessments.*fn2 The presumption of correctness which attaches to the Commissioner's assessment of a tax deficiency is, however, an important tool for recovering taxes on unreported income.*fn3
In unreported income cases, the presumption of correctness imposes on the taxpayer the difficult burden of proving a negative, that he did not earn the income the government claims he earned. The burden usually arises, however, from the taxpayer's own failure to keep business records of transactions known only to him.*fn4 Nevertheless, the taxpayer's record keeping failures do not justify "a naked assessment without any foundation whatsoever." United States v. Janis, 428 U.S. 433, 441, 49 L. Ed. 2d 1046, 96 S. Ct. 3021 (1976).*fn5
In United States v. Gerardo, 552 F.2d 549 (3d Cir. 1977), this Court struck a balance between the tax collector's legitimate interest in assessing tax on illegal gambling income and the taxpayer's right to be free from oppressive and arbitrary assessments. Gerardo requires that the Commissioner's reliance on the presumption of correctness rest on "some evidence . . . which would support an inference of the taxpayer's involvement in gambling activity during the period covered by the assessment. Without that evidentiary foundation, minimal though it may be, an assessment may not be supported even where the taxpayer is silent. " United States v. Gerardo, 552 F.2d at 554. In DeCavalacante v. Commissioner of Internal Revenue, 620 F.2d 23, 27 (3d Cir. 1980), this Court reiterated that "the 'Commissioner [must] provide some predicate evidence connecting the taxpayer to the charged activity.'"*fn6
Appellant L. Jay Walker appeals from a decision of the Tax Court upholding the Commissioner's assessment of tax deficiencies for the years 1973 and 1974. The Tax Court found that Walker derived illegal income of $192,448 in 1973 and $123,880 in 1974 from his involvement in an illegal "numbers" operation. The tax deficiency assessed against him for 1973 was $122,708 and for 1974 was $73,598.*fn7 The Tax Court's factual findings are binding upon us unless clearly erroneous. DeCavalcante v. Commissioner, 620 F.2d at 26.
During the summer of 1974, the Pennsylvania State police conducted an undercover investigation of an illegal numbers operation in Harrisburg, Pennsylvania.*fn8 Part of the investigation focused on two Harrisburg cafes, the Blue Note and the Lounge. The taxpayer was the titleholder of the Lounge. An undercover policeman assigned to the investigation occasionally placed bets with the owner of the Blue Note Cafe. On several occasions, a numbers runner from the Harrisburg area visited the Blue Note bar, learned what bets had been placed at the bar that day and then used the telephone to report this information. August 7, 1974, the undercover policeman watched the numbers runner dial the telephone. Observing from fifteen to twenty feet away, the investigator believed that the runner dialed the number "233-4477." Appellant Walker's number at the time was "234-4473."
On September 19, 1974, the Pennsylvania State Police executed a number of search warrants relating to their investigation. Records were seized from the taxpayer's home and from the home of John L. Barbee, who admitted at the Tax Court hearing that he was the "processor" for a numbers game.*fn9 Mr. Barbee was a meticulous record keeper.
The Commissioner's comparison between the records seized from Barbee and those seized from Appellant Walker is the foundation for the deficiency assessment in this case. Two types of records seized in the raid on Barbee's home were introduced into evidence at the Tax Court proceeding: calendars summarizing daily income and "tally sheets" showing the daily transactions of seventeen numbers runners. Walker's records showed the same information as Barbee's "tally sheets" for four of these seventeen runners on September 17 and 18, 1974.
The government introduced Barbee's calendars for the years 1972 through 1974. Each Monday through Saturday on the calendars from January, 1972 through September 17, 1974 was marked with three figures: the total amount of bets collected by all runners less the runner's twenty-five percent commission; the winning number for the day; and the amount of winnings paid out for that day.
The government also introduced Mr. Barbee's "tally sheets" for September 17 and 18. From these slips of paper, Barbee derived the figures to enter on his calendar. These tally sheets contained codes identifying the seventeen numbers runners. Next to the codes, Barbee entered the amount collected by each runner less his twenty-five percent commission.*fn10 The tally sheets also contained the winning ...