The opinion of the court was delivered by: John E. Miller, District Judge.
This is a suit by the plaintiff to recover fraud penalties
assessed against him and paid for the calendar years 1944, 1945,
1946 and 1947. The correctness of the deficiency assessments for
the said years paid by the plaintiff is not here attacked, and
the sole issue before the court is whether civil fraud penalties
were properly assessed and collected by the Commissioner of
Internal Revenue. To resolve this issue the court must determine
whether the admitted deficiencies for the years in question were
due to "fraud with intent to evade tax" within the meaning of
Title 26, U.S.C. § 293(b).
Plaintiff is a physician and surgeon and has practiced his
profession at Harrison, Arkansas, since 1922. In 1935 he and Dr.
J.T. Gladden, as partners, opened a clinic, which by 1940 was
expanded to a 20 bed hospital, and operated as a combined clinic
and hospital throughout the years in question. It was their
practice for each to operate the institution for six months, pay
all bills and expenses, and at various intervals during the
period, depending on income and the necessary reserve for
operating expenses, to account for and pay to the other half of
In 1943 and prior thereto there were approximately 20 doctors
in the five county area of which Harrison in Boone County was the
center. In the town and vicinity of Harrison itself there were
seven active doctors. In addition to the institution operated by
the plaintiff and Dr. Gladden there were one or two other small
clinics in Harrison, and small clinics at Marshall in Searcy
County and Berryville in Carroll County, Arkansas. Thus, patients
requiring hospitalization and surgery from the surrounding
territory were usually referred to the plaintiff and Dr. Gladden.
After 1943 there was a rapid decline in the number of doctors in
the area by reason of death, retirement and calls to Army service
so that during the war years of 1943 to 1946 the plaintiff, Dr.
Gladden and a Dr. Fowler were the three most active doctors, that
is, the ones upon whom the bulk of the workload fell, in the
area, which, during that period, consisted of some 40,000 people.
Prior to 1943 the plaintiff maintained a normal social and
recreational life, taking off one day per week from his work and
taking the usual two weeks' vacation during the year. After that
time, however, he experienced a marked change in the relationship
between his social and business life. The demands of those in
need of medical aid were such as to require him to work an
average of 14 to 16 hours per day, and often it was necessary to
remain on duty at the clinic and hospital all or a major portion
of the night. He saw and administered to an average of 35 to 40
patients per day during the period involved herein.
Also, until 1945, he served as secretary and a member of the
Board of State Medical Examiners, which position, although not in
and of itself unduly burdensome, added to the stress of his
However, during the period involved he did not find it
necessary to give up all social and recreational activities, but,
as stated above, his recreational activities were severely
curtailed, and his extended vacation was usually limited to one
week a year. Apparently, the situation reflected here was in
common with other and all reputable, able, conscientious and
zealous physicians and surgeons.
During the period involved the principal source of plaintiff's
income was his practice and the hospital-clinic. In addition he
made various investments in real estate, purchasing one or two
buildings, one of which he converted in part to an apartment
house, and at least one filling station. He also owned certain
stocks and bonds, from which he derived some income, and
purchased stock in and became a director of a bank in Harrison.
His revealed bookkeeping methods were comparatively simple. It
was his practice for a daily pad or sheet to be filled out on
each patient and a notation made of any charges and of any
collections received for the patient's treatment. These pads were
made by himself, or the nurse or other employee on duty who
received the patient. In this regard, as is usual, the majority
of the routine office treatments were administered by his nurse.
At the end of each day, or as soon thereafter as time permitted,
the plaintiff entered the daily pad entries in a log book that he
kept. All entries in this log were made personally by the
plaintiff. If the fee was not collected, or in the case of all
charge treatments, an entry was made in the main ledger kept for
that purpose. At the end of each day the daily receipts were
either deposited in the bank by the
plaintiff, or were placed in his safe and deposited, ordinarily
by the plaintiff when he found time to go to the bank.
Plaintiff's regular nurse left his employment in 1943. She was
replaced by a young lady from Siloam Springs, who remained with
him for 8 or 10 months. She in turn was replaced by a Miss
Jeffers who stayed for approximately one year. Next was a Mrs.
Campbell who remained for approximately one year. None of these
employees were experienced in handling accounts or financial
Separate bank accounts were maintained by the plaintiff and by
the hospital-clinic. Often money was deposited in his personal
account which belonged to the hospital-clinic or to another
doctor. For instance a patient might be referred to the clinic by
another doctor living in the surrounding territory, and when
leaving, the patient would pay his entire bill by one check.
After depositing the check it would be necessary for the
plaintiff to write checks paying the hospital-clinic and the
other doctor the respective portions of the fee owing to each.
Plaintiff also maintained a safety deposit box but kept no cash
there. Plaintiff handled all financial matters through his bank
account. All income was deposited there and all payments of any
consequence were made by check. He obtained a bank statement at
the end of each month and it was his practice to compare the
statement with his check stubs, which were studiously and
carefully filled out on each check written. He was very careful
to keep an accurate account of his bank balance. For instance,
his wife and daughter wrote individual checks during the month on
the account, and at the end thereof he would total the amount of
checks written by them and subtract this total from the balance
shown by his check stubs. Also, on several occasions he would
have the bank clarify errors in deposits reflected by the
statement, as when a deposit was shown on his statement when it
should have appeared to the credit of the clinic. The various
real estate transactions mentioned above were consummated by his
personal check. All in all his bank account records disclosed an
extremely accurate picture of his financial condition, income and
expenditures over the period in question.
At the end of each year in question the plaintiff calculated
his gross income from his practice by totaling the entries in his
log book, previously referred to, and adding thereto his outside
income, such as rents, State Board of Medical Examiners salary,
etc. These totals were handed to Mr. Smith Henley, an attorney at
Harrison, who, from the figures given him, computed plaintiff's
income tax. Plaintiff's books and records were not turned over to
Mr. B.M. Lindsey, Internal Revenue Agent, and Mr. Francis B.
Reynolds, Special Agent, Intelligence Unit, Bureau of Internal
Revenue, conducted an investigation of plaintiff's records in
1949 to check the correctness of his income tax returns for the
years 1944, 1945, 1946 and 1947.
They used the bank account method in making the investigation,
and due to the manner in which plaintiff had kept his bank
account records, previously discussed, their task was a
comparatively simple one. They checked all deposits,
expenditures, expenses and investments item by item in
determining his net income and deductions. Plaintiff made his
other records, such as check stubs, office records, etc.,
available to them when advised of the investigation. It was found
that plaintiff had understated his net income from 100% to 300%
each year, and that for each year there had been a similar
understatement of his allowable deductions. Also, it was shown
that plaintiff's investments during each year involved exceeded
the amount of his reported net income for each year. In arriving
at their final figures plaintiff was given all deductions which
The following figures reveal the results of their investigation
Deductions per Deductions as
Period return adjusted
1944 $7,367.31 $10,934.54
1945 8,811.71 24,016.94
1946 11,989.95 26,046.98
1947 11,207.76 23,731.91
Period Per Return Corrected ...