Waterman, Smith and Feinberg, Circuit Judges.
The Estate of William Kahr, deceased, James F. Dalton, Executor, and William Kahr's surviving wife, now Mary Zangerle, petitioned the Tax Court for a redetermination of deficiencies in income tax and fraud additions, in the aggregate amounts of $25,575.19 and $13,803.62 respectively, assessed jointly against the estate and the wife for the taxable years 1958 and 1959. The Tax Court, 48 T.C. 929 (1967), sustained the assessed deficiencies except for the civil fraud addition assessed for the taxable year 1959. Five judges would have sustained the entire 1959 assessment, 48 T.C. at 938. The Commissioner of Internal Revenue appeals from that part of the Tax Court decision which held that Kahr's estate and wife were not subject to any 1959 civil fraud additions. No appeal has been taken from the 1958 determination and no cross appeal has been filed by appellees with reference to the 1959 determination. Jurisdiction is conferred on this court by 26 U.S.C. § 7482. The facts found by the Tax Court are not disputed by the parties. We reverse in part and affirm in part that portion of the order of the Tax Court which the Commissioner has appealed.
William Kahr (hereinafter referred to as "Kahr") and Mary Zangerle were husband and wife during the calendar years 1958 and 1959. Kahr died in January 1960. Joint federal income tax returns were filed for Kahr and his wife for 1958 and 1959, the 1959 return having been filed out of time after Kahr's death. The 1959 return was signed by Mary Kahr and by Kahr's executor, James F. Dalton.
In 1958 and 1959 Kahr held a 50 per cent partnership interest in the Hamilton News Company (News), a newspaper and periodical distributor in Albany, New York. During these two years Kahr, the managing resident partner, ran this business. Leon Mohill, who held the other 50 per cent interest in News, lived in Pittsfield, Massachusetts, about 35 miles away, and came to the News offices only once or twice a year.
Normally the News bookkeeper opened all mail, recorded on a daily cashier's report all checks received, and posted the amounts to the proper ledger accounts. In 1958 and 1959, however, Kahr, through carefully controlling the incoming mail, was able to remove checks before they could be recorded and thus was able to divert large amounts of partnership income to himself. The checks removed from the normal flow of mail were from three companies: Union News Company, Holland Paper Stock Co., Inc., and Time, Inc. A single check from Caterpillar Tractor Co. was also removed.*fn1
Acting upon orders from Kahr, Charles Fruscione, the manager of News who was under the direct supervision of Kahr, sorted all mail before it was given to the bookkeeper for processing. Fruscione was able to do this because his primary duty was to see that all operations were running smoothly and therefore his work included the supervising of the daily receipts and the disbursements of cash. Whenever Fruscione came across an envelope from one of the three above mentioned companies he would keep it and then give the rest of the mail to the bookkeeper unopened. Fruscione would then extract any checks in these envelopes until, upon order from Kahr, he would cash the accumulated checks and hand the proceeds to Kahr.
Beginning in September 1959 Fruscione and Kahr were both ill and unable to be at the office for approximately eight weeks. During this period the bookkeeper was ordered to send a delivery boy to Kahr's home each day with the unopened mail and she received at least a part of it back unopened. In fact, during the latter part of 1959, six checks sent by Union News, totaling $14,821.62, reached the bookkeeper for processing and actually were recorded on the company records of receipts.
Normally News kept records of the amounts due it from customers and its billing department made up and sent out statements showing the amount due News. Copies of these statements were given to the bookkeeper, who used them as an accounts receivable control ledger. No records, however, were kept by News of the amounts due it from Holland Paper, Caterpillar Tractor, or Time, Inc. These companies were trusted to keep accurate records of their own indebtednesses and to pay periodically the sums they owed News. And, in the case of Union News, although records were kept by News of that account, Fruscione upon order from Kahr, received the copy of the customer billing statement instead of the bookkeeper. These billing statement copies were separately filed in Kahr's office where they were kept until late 1959 or early 1960 when Fruscione, on Kahr's orders, destroyed them.
At all times Fruscione acted pursuant to Kahr's personal orders. Once Fruscione questioned the propriety of the orders and at that time he was told by Kahr "to mind * * * [his] own business." After Kahr died Fruscione discontinued the practice of extracting the checks and all checks received by News from all of its accounts were recorded on News's books.*fn2
News's partnership income tax returns for 1958 and 1959 were prepared by certified public accountants from News's books and records and as the diverted amounts retained by Kahr had not been recorded in News's books and records the filed returns understated the partnership income by the withheld amounts. The 1958 partnership return, signed by Kahr as partner, showed Kahr's share of the partnership income to have been $11,715.70, and this figure was then set forth on the joint return filed by Kahr and his wife for the year 1958 as Kahr's personal total adjusted gross income. The 1959 partnership return, signed by Mohill and filed subsequent to Kahr's death, showed Kahr's share of the partnership income to have been $16,065.95. This amount was then entered as Kahr's distributive share on the 1959 joint return of the Kahrs, signed by the executor for Kahr and by Mary Kahr as surviving spouse.
The Commissioner determined deficiencies in Kahr's distributive shares of partnership income to be one half of the sum of the checks diverted and kept by Kahr during the respective tax years plus one half of disallowed partnership expenses of $1,040 (a deduction not in issue) in each year. The Commissioner also determined that the taxpayer had additional unreported income, the income obtained through the embezzlement of his partner Mohill's distributive share, the other one half of the purloined partnership checks.*fn3 Fraud penalties were assessed for each year in issue, and for 1959 the "underpayment" to which the 50 per cent addition was applied was determined to be the corrected tax liability rather than the liability computed upon the underpayment, because the 1959 return was not timely filed. 26 U.S.C. § 6653(c).
The Tax Court sustained the deficiencies for 1958 and 1959 and the civil fraud addition for 1958. It held, however, that as the return for 1959 was not executed and filed by Kahr himself the civil fraud addition for 1959 was improperly assessed. 48 T.C. 929. Only the civil fraud additions assessed against Kahr's adjusted 1959 taxable income are in issue on appeal. For reasons stated below, we reverse the Tax Court and uphold the Commissioner's assessment of the civil fraud addition on Kahr's 1959 distributive share of the unreported partnership income, and we affirm the Tax Court decision for different reasons than those advanced by the Tax Court that no civil fraud addition could properly be assessed against Kahr's 1959 income received by his embezzlement from Mohill.
The direct end result of Kahr's systematic embezzlement activities in 1959 was the understatement of the News partnership income; this proximately caused the filing of a personal income tax return signed by his wife and his executor which grossly understated his personal 1959 taxable income. It is undisputed that if Kahr himself had not died and had filed the same identical personal 1959 tax return, the Commissioner properly could have assessed a 50 per cent civil fraud addition to the tax due on Kahr's unreported taxable share of the partnership income. 26 U.S.C. § 6653; see Jackson v. Commissioner of Internal Revenue, 380 F.2d 661 (6 Cir.), cert. denied, 389 U.S. 1015, 88 S. Ct. 591, 19 L. Ed. 2d 661 (1967). Kahr, however, died in January 1960, after the close of the 1959 tax year, but before April 15, 1960, when the 1959 return was finally due, and did not file or sign the 1959 personal tax return which understated his share of the partnership income during that year. Petitioners therefore reason that the civil fraud addition cannot attach and be assessed unless at the time of the filing of the return the person ...