T.C. M em o . 2 0 2 1 -8 8

UNITED STATES TAX COURT
ERNEST S. RYDER & ASSOCIATES, INC., APLC, ET AL., 1 Pet i t i o n ers v . COM M ISSIONER OF INTERNAL REVENUE, Res po n d en t

Do ck etNo s . 1 4 6 1 9 -1 0 , 1 4 68 7 -1 0 , Fi l edJ u l y 1 4, 2 0 21
.

7 52 7 -1 2 , 9 9 2 1 -1 2, 9 92 2 -1 2 , 9 9 7 7 -1 2, 3 0 1 9 6-1 4 , 3 1 4 8 3 -1 5
.

Ern es tS. Ry d er an d Ri ch ardV. Verm azen , fo r p et it i o n ers . Kev i n W . Co y , Han s Fam u l aro , Bl ak e J . Co rry , an dCh ri s to p h er J
. Ri ch m o n d , fo r res p on d en t.

1 W e co n s o l i d at edm an y

cas es fo r d i s co v ery an d o t h er p ret ri al p ract i ce. Th e p art i es s et t l edqui t e a few, b u twe co n t i n u edth e co n s o l id at i o n th ro u g h tri al an d b ri efi n g fo r Ern es tS. Ry d er & As s o ci at es , In c., APLC, d o ck etn u m b ers 1 46 1 9 -1 0 an d 9 9 7 7 -1 2 ; Ern es tS. Ry d er an dPat ri ci a A. Ry d er, d o ck etn u m b ers 1 4 6 8 7 -1 0 , 9 9 2 1 -1 2 , 3 0 1 9 6 -1 4 , an d3 1 48 3 -1 5 ; Ry d er Ran ch es , LLC, Ern es tS. Ry d er, Tax M at ters Part ner, d o ck etn u m b er 7 5 2 7 -1 2 ; an d Fi rs tCo u n sel Cap i t al , In c., d o ck et n u m b er 9 9 2 2 -1 2
. Served 07/14/21- 2
-

[* 2 ] CONTENTS
FINDINGS OF FACT
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 I. Ry d er & As s o ci at es , APLC
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 A. Ho w R&A M ad e M o n ey . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 B. Wh atR&A Di dW i t h th e M o n ey . . . . . . . . . . . . . . . . . . . . . . 2 8 1
. Pract i ce Fu n d i n g Ag reem en tW i t h BFA
. . . . . . . . . . . 2 8 2
. Es t ab l i s h m en to f Ry d er Law Co rp . . . . . . . . . . . . . . . . 2 9 II. Ry d er Go es Ran ch i n g . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 4 A. So u rces o f M o n ey

fo r Ran ch es . . . . . . . . . . . . . . . . . . . . . . . 3 6 1
. Co u n s el o r Cap i t al as Bl o ck er En t i t y fo r Ran ch es . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 6 2
. Fi rs tCo u n s el Cap i t al as Bl ock er En t i t y fo r Ran ch es . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 7 3
. Us e o f Fo u r Ad d i t i o n al Bl o ck er En t i t i es . . . . . . . . . . 3 9 4
. RLC an dIt s St o ckSub s cri p t i o n Ag reem en t . . . . . . . . 4 1 B. Ry d er Ran ch Co ., LLC Pro p ert i es . . . . . . . . . . . . . . . . . . . . . 4 2 C. Pat t ern Farm s , LLC
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 3 D. Can y o n Vi ew Ran ch , LLC
. . . . . . . . . . . . . . . . . . . . . . . . . . 4 4 E. Ry d er Red Ro ckRan ch , LLC
. . . . . . . . . . . . . . . . . . . . . . . . 4 4 F. Ro d eo Ho l d i n g s , LLC
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 5 III. Au d it , Cas hfl o w, an d Tri al
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 6 A. Au d it
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 6 B. Cas h fl o w . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 8 1
. Fo l l owi n g th e M o n ey . . . . . . . . . . . . . . . . . . . . . . . . . 4 8 2
. Gro s s In co m e . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 9 3
. “ Oth er Dedu ct i on s ” fo r 2 00 5 -0 6
. . . . . . . . . . . . . . . . . 6 8 4
. Di v i den dTreat m en t . . . . . . . . . . . . . . . . . . . . . . . . . . 6 8 i
. Fro m

R&A Th ro u g h RLC
. . . . . . . . . . . . . . . . . 6 9 i i
. Fro m

Tax Pro duct s t o Ran ch En t i t i es . . . . . . . . 6 9 i i i
. Fro m

R&A’ s Ban kAcco u nt s t o Th i rd Part i es fo r t h e Ry d ers ’ Ben efi t . . . . . . . . . . . . . 7 0 5
. Th e Co m

m i s si o n er’ s Al t ern at i v e Arg u m en t s . . . . . . . 7 2- 3
-

[* 3 ] 6
. Di s al l o wedDedu ct i o n s . . . . . . . . . . . . . . . . . . . . . . . . 7 3 i
. Sub s t an t i at i o n o f R&A Ex pen ses . . . . . . . . . . . 7 3 i i
. Ry d er Ran ch Co
. , LLC Lo s s es . . . . . . . . . . . . . 7 6 7
. Cal i fo rn ia Pas t el eri a . . . . . . . . . . . . . . . . . . . . . . . . . . 7 9 8
. Oth er Lo s s es . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 0 C. Pen al t ies
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 3 D. Tri al
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 3 OPINION
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 4 I. Bu rd en o f Pro o f
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 4 II. R&A’ s Un rep ort edIn co m e . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 6 A. As s i gn m en to f In co m e b y Ry d er & As s o ci at es . . . . . . . . . . 8 7 1
. Wh atR&A Lo o k edLi ke t o Cl i en t s . . . . . . . . . . . . . . 9 2 2
. Wh atServ i ces R&A Pro vi d ed
. . . . . . . . . . . . . . . . . . 9 3 3
. In co m e Pro du cedTh ro ug h Th es e Serv i ces . . . . . . . . 9 5 i
. Gro up Tax Pro du ct s In co m e . . . . . . . . . . . . . . . 9 6 i i
. St an d -Al o n e Pro du ct s In co m e . . . . . . . . . . . . 1 1 2 B. Ad d it i on al At t em

p t edAs s i g n m en t s o f In co m e . . . . . . . . . . 1 1 9 1
. As s i gn m en to f Fee In co m e t o BFA Th ro u g h t h e PFA
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 2 1 2
. As s i gn m en to f St affi ng In co m e t o ESOP Leg al Co n s u l tan t s . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 2 5 3
. As s i gn m en to f GCO Pro du ctIn co m e t o In d i vi du al Gen eral Co u n s el Offi ces . . . . . . . . . . . . . 1 2 8 C. “ Oth er Dedu ct i on s ”
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 2 9 1
. RLC an dth e Em

p l o y ee Leas i n g Ag reem en t . . . . . . 1 2 9 2
. Rem ai n i n g Deduct i o n s . . . . . . . . . . . . . . . . . . . . . . . 1 3 2 III. Di v i den dAd

ju s t m en t: Th e Ry d ers ’ Li ab il i ty fo r Tax o n Un rep o rt edCo n s t ru ct i ve Di v i d en dIn co m e . . . . . . . . . . . . . . . . . 1 3 4 A. Di v i den d s Fro m

R&A Th ro ug h RLC
. . . . . . . . . . . . . . . . . 1 3 7 B. Di v i den dIn co m e Fro m Paym en t s M ad e To Acqu i re an dOp erat e t h e Ran ch Pro p ert i es . . . . . . . . . . . . . . . . . . . . 1 4 1 1
. Ry d er Ran ch Co
. , LLC
. . . . . . . . . . . . . . . . . . . . . . . 1 4 3 2
. Pat t ern Farm s , LLC
. . . . . . . . . . . . . . . . . . . . . . . . . . 1 5 4- 4
-

[* 4 ] 3
. Can y o n Vi ew Ran ch , LLC
. . . . . . . . . . . . . . . . . . . . 1 5 6

4
. Ry d er Red Ro ck Ran ch , LLC
. . . . . . . . . . . . . . . . . . 1 5 7 5
. Ro d eo Ho ld i n gs , LLC
. . . . . . . . . . . . . . . . . . . . . . . . 1 5 8 C. Di v i den dIn co m e Fro m Paym en t s t o Am eri can Ex p res s an dBen Lel an dCo n s t ru ct i o n , In c. . . . . . . . . . . . . 1 6 1 D. Su m

m ary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 6 3 IV. Rem ai n i n g Is s u es . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 6 4 A. Ry d er Ran ch Lo s s es . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 6 4 1
. J u ri s d i ct i o n . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 6 5 2
. M at eri al Part ici p at io n . . . . . . . . . . . . . . . . . . . . . . . . 1 6 9 3
. Sub s t an t iat i o n . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 7 3 B. Ord i n ary

Lo s s es Fro m Cal i fo rn i a Pas t el eri a fo r 2 00 3 an d 2 0 0 4
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 7 4 C. In v es t m en t In t eres tEx p en s e fo r 2 0 0 5 an d Un rei m b urs edEm

p l o y ee Ex p en s es fo r 2 0 0 6 Th ro ug h 2 0 0 8
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 7 5 V. Pen al t ies
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 7 6 A. M rs . Ry d er . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 8 3 B. Ry d er an dR&A
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 8 5
M EM ORANDUM FINDINGS OF FACT AND OPINION
HOLM ES, J u d g e: Ry d er & As s o ci at es , In c., APLC (R&A), m ark et eds i x t ax -red u ct i o n s t rat eg ies t h atp ro du cedo ver $ 3 1 m i l l i o n i n rev en u e b et ween 2 0 0 3
an d 2 0 1 1 . Th e fi rm ’ s fi x edco st s were l o w, an d i t s o u t -o f-p o ck et ex pen ses n o t
v ery l arg e. Yet y ear aft er y ear i tp ai d n o i n co m e t ax . It s rev en u e fl owedi n s t ead- 5
-

[* 5 ] i n t o 5 6 0 acco u n t s an d i n t o Ry d er Law Co rp o rat i o n , a rel at edS co rp o rat i o n . 2 It fl o wedi n t o m ore t h an 1 ,1 0 0 ESOPs , 3 o t her S co rp o rat i o n s , LLCs , an do t h er p as s th ro u g h s . Itfl o wedi n t o ran ch es i n Ari zo n a, an di tfl o wedi n t o o t h er ran ch es i n New M ex i co . An d t h en i tm o s tl y s eem edt o p oo l i n p l aces wh ere i two ul d b en efi tErn es tS. Ry d er an dh i s wi fe Pat ri ci a, wh o recei v edm ore t h an $ 1 5 m i l l i o n i n d i s tri b u t i o n s b et ween 2 0 0 2 an d2 0 1 1 b u t p ai d o n l y $ 3 1 , 0 00 i n i nco m e t ax du ri n g th e y ears ati s su e. Or s o th e Co m

m i ss i o n er s ay s . FINDINGS OF FACT Ern es tRy d er i s t h e o wn er o f R&A. He an d h i s wi fe Pat ri ci a l i v e i n Po way , Cal i fo rn i a, an dth ey

are l o n g ti m e Cal i fo rn i an s . Aft er g radu at in g fro m San Di eg o St at e Co ll eg e i n 1 9 6 8 wi t h a d eg ree i n acco u n t i n g , Ry d er s t art ed l aw s ch oo l atth e Un i vers it y

o f Cal ifo rn i a, Has t i n g s . Wh il e i n l aw s ch o o l h e p uth i s acco u n t i n g

2 If a b u s i n es s m eet s the req u i rem en t s o f s ect io n 1 3 6 1, i t m ay el ectt o b eco m e an “ S co rp o rat i o n ” an dp ay n o co rp o rat e t ax . Secs . 1 36 2 (a), 1 3 6 3 (a); s ec. 1 .1 36 1 -1 (b )(1 ), In co m e Tax Reg s . AnS co rp o rat i o n’ s i n co m e an dl os s es , l i k e a p art n ers hi p ’ s , fl ow t h ro u gh t o i t s o wn ers , wh o th en p ay i nco m e t ax . See s ec. 1 3 6 3 (b ); s ee al s o Gi t li t z v . Co m m i s s i o n er, 5 3 1 U.S. 2 0 6, 2 0 9 (2 0 0 1 ). (Un l es s we s ay o th erwi s e, s ect io n referen ces are t o th e In t ern al Rev en u e Co d e i n effect fo r t h e y ears ati s s u e, an dal l Ru l e referen ces are t o t h e Tax Co u rtRu l es o f Pract i ce an d Pro cedure.)

3 See i n fra n o t e 4 8
.- 6
-

[* 6 ] d eg ree t o u s e at To u ch e Ro s s & Co . Th ere h e l earn edab o u tag ri cu l tu ral
co o perat i v es an d“ h o w co op erat i v es wo rk .” Th ree y ears l at er h e h ada l aw d eg ree
an d was ad m i t tedt o p ract i ce i n Cal ifo rn i a. He wen t t o wo rkat Pri ce W at erh o u s e & Co
. i n San Di eg o , Cal i fo rn i a. W i t h i n a y ear, h e m o v ed b ackt o To u ch e Ro s s , b u tth i s t im e i n San Di eg o . 4 He t h en m o v ed to New Yo rk an den ro ll edatNYU fo r h i s m as ter’ s d eg ree i n t ax at io n , al l th e wh il e co n t i n u in g t o wo rkfo r To u ch e Ro s s i n i t s M an hat t an o ffi ce. Hi s t i m e o n the eas tco as twas s h o rtl i v ed , an dh e ret u rn edt o Cal i fo rn i a t o jo i n Ral p h Gan o M i l l er o n a t em p o raryjo b t o h el p p rep are an dp res en t a p ap er atth e NYU In st i tu t e o n Fed eral Tax at i o n . When th is was d o n e, h e b eg an h i s career as a p ract i ci n g t ax l awy er atHewi t t & Sh aw, a t ax an db u s i n es s l aw fi rm al s o i n San Di eg o . Hi s t i m i n g was fo rtu n at e--h e was atth e s t em -cel l s t ag e o f h i s career t h e y ear t h atCo n g res s en act edth e Em p l o y ee Ret i rem en tIn co m e Secu ri t y Act o f 1 9 7 4 (ERISA). Wh en th ere’ s an av ul s i ve ch an ge i n th e l aw l i k e ERISA, y o u n g l awy ers
can d ev el o p v al u ab le ex pert i s e i n an en v i ro n m en t u n cl u t tered wi t h m o re s en i o r
co m p et i t o rs .

4 Ry d er was al read y

a CPA atth is t i m e, th o u gh th e reco rdd o es n ’ tt el l u s wh en h e b ecam e o n e. Hi s l icen s e was can cel edi n 1 9 9 6 wh en h e fai l edt o p ay h i s du es .- 7
-

[* 7 ] Kn o w l ed g eab le as s o ci at es i n a fas t-g ro wi n g fi el d are a h otco m m o d i t y , an d i n 1 9 7 5 Ry d er was h i redaway b y Harri g an , Ru ff & Os b o rn e t o h el p th atfi rm ’ s cl i en ts g etth ei r ret i rem en t p l an s qu al i fi edu n d er t h e n ew l aw. “ [T] h at ’ s wh en m y career real l y

t o o ka tu rn ,” Ry der ex pl ai n ed , an dh e was wel l o n h i s way t o b eco m i n g an ex p erti n qu al ifi edret i rem en tp lan s . He s tay edatth e Harri g anfi rm ;
an d wh en h e ro s e t o b eco m e a s h areh o l d er, t h e n am e o f t h e fi rm ch an g edt o Harri g an , Ru ff, Ry d er & Sb ard el l at i
. 5 He ran t he fi rm ’ s p en si on d ep art m en tfo r
m an y y ears , an dth ati s wh ere h e s tart edwo rk i n g o n m an y o f th e ag gres s i v e t ax redu ct i o n s t rat eg i es th atl edt o t h es e cas es . Th e Ry d ers h av e b een m arri edfo r m o re t h an a qu art er cen tu ry . Un li k e h er h u s b an d , M rs . Ry der i s n ei th er a t ax at t o rn ey n o r a CPA, b u ts h e d o es thi n ks h e h as “ a b et t er u n ders t an d i n g o f t ax th [a] n m o stp eo p le wal ki ng aro un d o n th e
s treet .” Sh e co m

p l et edfo u r y ears o f co l l eg e cl as s es --two atth e Un iv ers it y o f Cal i fo rn i a, Ri v ers i d e, an dtw o atSan Di eg o St at e--b u t n ev er o b t ai n eda b ach el o r’ s d eg ree. Aft er co l l eg e an dup u n t i l th e t i m e o f t ri al s he h ad an as s o rt m en to f jo b s th ati n cl u d edwo rk ata jewel ry s t o re an d Bro o k s Bro t h ers ; an ds h e o wn edh er o wn b u s i n es s es th ati n cl u deda b ri d al s al o n an d s o m e co ok i e s t o res --s t ores th atare at

5 Cal i fo rn i a i s p arto f t h e W es t i n s o m e s en s e, an d t h e fi rm referred t o i t s el f as “ Ru ff Ry d er.”- 8
-

[* 8 ] i s su e i n th es e cas es . Sh e cl ai m s t o wo rkatth e m an y d i fferen tran ch es s h e
o wn s wi th h er h us b an d , wh ere s h e s ay s h er t as k s i n cl u de “ t ak [i n g ] i nv en t ory * * *
o f t h e an i m al s ” an d b ei n g “ i n v o l v edi n thei r h eal th .” Sh e al s o h el p eden s u re t h e cat t le g o tth e n eces s ary

s h o t s , ear t ag s , an db ran d s ; an d “ k ep ttracko f t h e b reed i n g p ro g ram ” fo r t hem
. I. Ry d er & As s o ci at es , APLC Th e ag g res s i v en es s o f Ry d er’ s t ax -red u ct io n s t rat eg i es s eem s t o h av e
cau s ed s om e t en s io n wi t h h i s p art n ers atRu ff Ry d er, an d h e was as kedt o l eav e t h e fi rm s o m et i m e i n 1 9 9 5 . Ru ff Ry d er’ s en t i re p en s i o n d ep art m en tan di ts p ro fi t s h ari ng cl i en t s l eftwi t h h im
. 6 W i t h am p l e ex p eri en ce an da fu l l y s t affed p en s i o n p ract i ce, Ry der d eci dedt o o p en up h i s o wn fi rm i n earl y 1 9 9 6. An d h ere b eg i n s th e Ry ders ’ t ax p ro b l em s . R&A i s a p ro fes s i o n al l aw
co rp o rat i o n 7 an dh as al way s b een t ax edas a C co rp o rat i o n . 8 Ry d er h as o wn ed

6 Ry d er was carefu l t o n o t e t h ath e rem ai n ed co rd i al wi th h i s fo rm er p art n ers , an dev en s h ared cl i en t s wi t h th em fo r d i fferen t t y p es o f wo rki n l at er y ears . 7 Pro fes si o nal co rp orat i o n s are b u s i n es s es o rg an i zedas co rp o rat i o n s u n d er th e l aws o f a s peci fi c s t at e, ty p i cal l y co ns i s ti n g o f l i cen s ed p ro fes s i on al s wo rk i n g i n fi el d s l i k e acco un t i n g , arch i tect u re, en g i n eeri n g, h eal t h , l aw, o r s ci en ce.

8 Th i s m ean s th atR&A i t s el f i s t ax eds ep arat el y fro m i ts o wn ers u n d er s ub ch ap t er C o f t h e Co d e. So Ry d er’ s i n co m e fro m th e fi rm wo ul d face t w o l ay ers (co n ti n u ed ...)- 9
-

[* 9 ] 1 0 0 %, an d h as act edas p res i d en t , o f R&A s i n ce i t s creat i o n . W e fi n dth at Ry d er al s o p ro vi d ed 1 0 0 % o f h i s l eg al s erv i ces t o cl i en t s t h ro u g h R&A du ri n g th e y ears ati s s u e. Des p i t e i t s s u cces s an dl o n g ev i t y , R&A rep o rt edzero t ax ab l e i n co m e fro m 2 0 0 2 thro u g h 2 0 1 1 . Th e Ry d ers al s o rep o rt edm i ni m al t ax ab l e i n co m e o n th ei r i n d i v i du al retu rn s fo r t h o s e y ears . A. Ho w R&A M ad e M o n ey Al th ou g h R&A was n ’ tcl i en t l es s wh en i t o p en edi t s d o o rs , i t“ s tart edfres h” wi th n o m o n ey

i n the b an k o r cas h fl o w fro m wo rkd o ne b y Ry d er an dh i s t eam

at Ru ff Ry der. Ry der b eg an a qu i etb u ts ub s t an t ial m ark et i n g cam p ai g n fo r t h e n ew fi rm . R&A p i t ch edi ts t ax -s av in g p ro du ct s as “ nex t g en erat i o n t ax m an ag em en t
s erv i ces ” t o p ro s p ero u s p ro fes si o n al s an den trep ren eu rs wh o wan t edt o s av e fo r ret i rem en tu s in g “ u n i qu e” p l an s th atwo u l d “ d efer a m u ch g reat er p o rt io n o f t h ei r i n co m e th an th ey

ev er d ream edp o s s i b l e, an d , as a res u l t , s ub s t an t i al ly redu ce t h ei r t ax l i ab i l i t y .” Aft er m eet i n g wi t h Ry d er i n p ers o n an drecei v i n g a fo l lo wup l et t er l ay in g o u tth e t ax b en efi t s o f R&A’ s s erv i ces , m an y t o o k t h e b ai t , an dR&A b eg an reel in g i n th e cl i en t s . R&A d i d ev eryt h i ng i t s cl i en t s n eed edt o fu l fi l l wh ati th ad

8 (...co n t in u ed ) o f t ax : o n e atth e co rp o rat e l ev el , an dth e o t h er wh en t h e fi rm d i s t ri bu t es p ro fi ts i n th e fo rm o f d i v i den d s t o h i m .- 1 0 -

[* 1 0 ] p ro m i s ed : Its etup the n eces s ary en t i t i es , h an d ledal l fi l i n g s wi t h t h e IRS
an d an y s t at e ag en ci es , creat edret i rem en tp lan s , draft edag reem en ts t o l in ki t s cl i en ts t o th e co m

p an i es thath el dth e ret i rem en tacco u nt s , h el p edcl ien t s m o v e
m o ney fro m o ne acco u n t to an ot h er as n eed ed , an drev i ewedt ax retu rn s t o m ak e
ev erythi n g l o o kas p ro p er as co u l db e. R&A earn eds o m e o f i t s fees b y s et t i ng up trad it i on al em p l o y ee s av i n g s p l an s an dd o i n g cert ai n n o n co n t ro v ers i al co rp o rat e wo rk . M o s t o f i t s fees , h o wev er, were earn edth ro u g h th e s al e o f t h e s ev eral “ u n i que” t ax p l an s . Th i s
en t i re cl ad e o f s i x p l an s th ro u g h o u tth ei r en t i re ev o lu t i o n i s t raceab l e t o Ry d er h i m s el f. Bu t t o m ak e o u r d i s cu s s i o n o f th em ev en m i n i m al l y u n d ers t an d ab l e we wi l l fi rs td es cri b e s o m e s i s ter cl ad es an d t h ei r s peci es , then d i s s ecteach s peci es i n
s o m e d et ai l
. Th e fi rs td i v i s i o n i s b et ween g ro up -t ax an d s t an d -al o n e p ro duct s . Th e g ro up-t ax p ro du ct s are ! a fo rm

o f i n s uran ce cal l edASIG,
! fact o ri n g , an d
! em p l oy ee l eas i n g . Th e s tan d-al on e p ro du ct s are ! i n d iv i du al s t affi n g,- 1 1 -

[* 1 1 ] ! g en eral co u n s el o ffi ces , an d
! a So n -o f-Bo ss v ari at i o n . 9 Th e k ey d i s t i n ct i o n b et ween th e g ro up an d s tan d -al on e p ro du ct s i s t hat b u y ers o f t h e g ro up p ro du cth adco n t ract s wi t h a t h i rden t it y th atR&A wo u l ds et
up . Bu y ers o f s t an d-al on e p ro du ct s each h ada co n t ract wi t h R&A i t sel f. W e s t artwi t h th e g ro up p ro du ct s . AS IG . R&A s o ld t h is p ro du ctth ro u g h Am eri can Sp eci al ty In s uran ce Gro up , Lt d . (ASIG), a cap t iv e i n s u ran ce 1 0 co m p an y th atwas i ts el f o wn ed b y
an o th er co m

p an y n am edCap i t al M ex i can a. ASIG was o rg an i zedu n d er t h e l aws
o f t h e Tu rk s an dCai co s an d , l i k e Cap i t al M ex i can a, was creat eddu ri n g Ry d er’ s t i m e atRu ff Ry d er. Bo t h ASIG an dCap i t al M ex i can a h adb een i n b u s i nes s s i n ce atl eas t 1 9 9 1
. 1 1 Wh en Ry d er l earn edo f cap t i ve i n s u ran ce, h e wan t edt o s el l th e

9 See i n fra n o t e 1 9
. 1 0 As we ex p l ai n edi n Ho s p . Co rp . o f Am . & Sub s . v . Co m m i s s i o n er, T.C. M em o. 1 9 9 7 -4 8 2 , s l i p o p . at8 :

Th e i n su ran ce l aws o f s o m e St at es p ro v id e fo r a cat eg o ry o f l i m i t edp u rp os e i n s uran ce co m p an i es , p o p ul arl y cal l edcap t i v e i n s u ran ce co m

p an i es o r cap t i v e i ns u rers . Cap t i v e i n su ran ce co m p an y s t atu t es g en eral l y ap pl y

t o co m p an ies th ati ns u re o n a d i rectb as i s o n l y th e ri s ks o f co m

p an i es rel at edb y

o wn ers h i p t o th e i n s u rer. 1 1 Ry d er o rg an i zed Cap i tal M ex i can a as an Iri s h n o n res id en tco m p an y i n (co n ti n u ed ...)- 1 2 -

[* 1 2 ] p ro du ctt o h i s cl ien t s . To d o th is , Ru ff Ry d er h adh i redth e Tu rk s an d Cai co s acco u n t in g fi rm

M o rri s Co t ti n gh am fo r t he p u rp o s e o f creat in g a Tu rk s an d Cai co s co m

p an y --ASIG. ASIG’ s m ai n o ffi ce was l o cat edat M o rri s Co tt i ng h am ’ s Co rp o rat e Serv i ces , b u tRy d er al s o ren t eda p o s to ffi ce b o x fo r ASIG i n Las Veg as . An y

m ai l s en tt o th e P.O. b o x was fo rward edt o Ru ff Ry d er (c/ o Ern es t Ry d er). On ce ASIG was i n p l ace, R&A co u l dp ro v i d e i t s cl i en t s wi t h wh ati tcal l ed

“ Di s ab i l i ty

an dPro fes s i o n al Li ab i l i t y In co m e In s u ran ce” p o l i ci es . Th es e p o l i ci es req u i redth atth e cl i en t s p ay p rem i um s t o ASIG fo r t h e i n s u ran ce, wi t h th e p rem i u m s t o b e p h y s i cal l y m ai ledt o R&A. Ont op o f t h i s, th e p o l i cyh o l d er was req u i redt o p ay

an an nu al 2 % p o l i cy

fee, wh i ch was d ep os i t edi n ASIG’ s Ch arl es Sch w ab b an kacco u n ten d i n g i n 5 3 3 7 du ri ng th e y ears ati s su e. In retu rn fo r al l o f

1 1 (...co n t i nu ed ) Dub l i n . Iri s h n o n res i d en tco m p an i es were co m

p an i es es t ab l i s h edi n Irel an dwh os e m an ag em en twas l o cat edel sewh ere. Un der Iri s h t ax l aw atth e t i m e, s u ch a co m p an y wo u l db e s ub

ject t o i n co m e t ax o n l y

i n t h e co u n t ry

o f t h e m an ag em en t ’ s res i den ce. An di f t hatm an ag em en twas l ocat edi n a t ax h av en l ik e t h e Tu rk s an d Cai co s , i two u l dn o to we t ax t o th e Tu rk s an dCai co s g o v ern m en tei t h er. Th i s m ean tth ata co rp o rat i o n s etup i n Irel an dwh os e m an ag em en t was i n th e Tu rk s an d Cai co s wo u l d n o t o we i nco m e t ax an ywh ere i n th e wo rl d . Ry d er m ad e s u re Cap it al M ex ican a was s u ch a co m p an y . Irel an dl at er ch an g edi t s l aw t o el i m i n at e n o n res i d en tco m

p an i es (wi t h a few ex cep t i o n s). See Bri an M cDo n al d& J o h n Ho m an , “ Fi n an ce ActTarg et s Iri s h No n res i d en t Co m p an i es ,” 1 9 9 9 J . o f In t ’ l Tax ’ n 4 2.- 1 3 -

[* 1 3 ] th i s , th e p o l i cyh o l d er was en t i t ledt o 9 8 % o f th e cas h v al u e o f t h e p o l i cy wh en cert ai n ev en t s o ccu rred(i .e., d i s ab il i t y , s ep arat i on fro m em p l o ym en t, tu rn in g 6 0 , o r t h e i ns u red ’ s t erm i nat i o n o f t h e p o l i cy ). W e’ v e al read y an al y zed t h es e p o l i ci es i n Es t at e o f Barn h o rs t v . Co m m i s s i o n er, T.C. M em o . 2 0 1 6 -1 7 7 . Li k e o th er ASIG p o l i ci es , Barn h ors t ’ s p o l i cy was t i t l ed“ Di s ab i l i t y

In co m e In s u ran ce Po l i cy ” an do s t en s i b l y p ro v i d ed b en efi t s t o h i m

i f h e b ecam e t o t al l y

o r p art i al ly

d i sab l ed , wh i ch wo u l dm ak e an y p ay o u tex cl u dab l e u n d er s ect i o n 1 05 as b ei n g fro m an em p l o y er-fu n d edacci d en t
o r h eal th p lan . See i d . at* 3
. Wh atm ak es s u ch p o l i ci es s t an do u t was thatth ey wo u l d al s o p ay o u twh en th e p o li cyh o ld er reach edag e 6 0 o r d i edo r was n o l on g er em p lo y ed . See i d . at* 3
-
* 6 . A cl o s e l o o katth e p o l i cy i n Es t at e o f Barn h o rs ts h o wedth atp ay o u t s weren ’ t
co rrel at edwi t h actu al m ed i cal ex p en s es o r “ co m p u t edwi t h referen ce t o t h e n ature
o f t h e i n jury .” See i d . at* 1 4 , * 1 8 (qu o t i n g s ect i on 1 0 5 (c)(2 )). W e fo u ndi tqu i t e t el l i n g th atal t h o u g h th e p o l i cy s ai di two u l dt erm i n at e o nce Barn h o rs t tu rn ed6 0 , ASIG ren ewedth e p ol icy each y ear. See i d . at* 6 -* 7 . No n ew p rem i u m s were
ev er p ai dd es p i t e t h es e ren ewal s , an d o nl y t hree p rem i u m p aym en t s were ev er
m ad e. Th es e were m ai l edt o R&A an dth en p l aced i n a s eg reg at edacco u n tth at Ry d er m ai n t ai n ed . Id . at* 6 . Ry d er t h en “ in v es tedth e p rem i u m s i n a d i vers i fi ed- 1 4 -

[* 1 4 ] p o rt fo l i o o f m

u tual s t o ckan d b o ndfu n ds wh ere t h ey co u ldb u i ldv al u e o v er th e y ears u n t i l b en efi t s h adt o b e p ai d .” Id . W e fo u ndth atth e p o l i cy was real l y

a d eferred -co m

p en s at i on p l an , d es p i t e i ts s t at edt i t le. Id . at * 16
. Th es e cas es d o n o t req u i re u s t o rev is i t o u r an al y si s i n Es t at e o f Barn h o rs t . Th ey d o req ui re u s t o fi n dh ere t h atfro m s tartt o fi ni s h R&A d i d ev eryt h i n g i t
co u ldt o m ak e ASIG wo rk . An dth ere were s ev eral o f t h es e ASIG p ol i ci es th at p ro duced m o ney

fo r R&A du ri n g t h e y ears at i s su e. W e s u m m ari ze t h e n u m

b ers :

Year Nu m

b er o f p o l i ci es p ay i n g fees i n t o acco u n t 5 3 3 7 T o t al rev en ue 1 2 2 0 0 3 2 0 $ 1 3 8,3 2 2 .2 8 2 0 0 4 1 4 2 6 8 ,4 7 7 .2 9 2 0 0 5 1 5 3 1 1 ,5 8 5 .3 4 2 0 0 6 1 1 1 0 1 ,6 1 9 .0 3 2 0 0 7 1 0 1 1 4 ,9 1 7 .8 4 2 0 0 8 8 8 6 ,6 5 4 .3 3 2 0 0 9 1 1 1 8 1 ,5 1 3 .4 1

1 2 W e n o t e t h ati n cl u d ed i n s o m e o f t h es e am o u n t s i s i n t eres t o n d ep o s i t s i n th e fo rm o f “ Sch wab M on ey

M ark etFu n d -Di v i d en d s .” Th es e d iv i d en d s are d i fferen t fro m

th e o t h er, n o n tax ab l e d i v i d en d s t h atth e Co m m i s s i o n er ex cl u d ed fro m h i s b an k -d ep o s i tan al y s i s . (See i n fra p p . 8 6 -8 7 fo r o u r d i s cu s s i o n o f h o w th e Co m m i s s i o n er co n duct edthi s an al y s i s.)- 1 5 - 2 0 1 0 5 6 3 ,1 7 2 .7 6 2 0 1 1 1 1 4 ,2 9 7 .7 8 To t al 2 8 $ 1 ,2 8 0,5 6 0 .0 6 Gr o u p Fa ct o r i n g . Th e s eco n dg ro up p ro du ctwas s o m et h i n g we’ l l cal l

“ g ro up fact o ri n g .” W e an al y zedth i s tran s act i o n i n Paci fi c M an ag em en t Gro up v . Co m m i s s i o n er, T.C. M em o . 2 0 1 8 -1 3 1 . As we ex p l ai n edth ere,

“ Fact o ri ng ” i s a fi n an ci al tran s act i o n b y wh i ch o n e p arty

(t h e fact o r) p ro v i d es s erv i ces t o an o t h er p art y (t h e cl i en t ) an d i s co m

pen s at edb y p aym en to f fact o ri n g fees . Th e s erv i ces t h atth e fact o r p ro v id es ty p i cal l y i n cl ud e: (1 ) p u rch as i n g th e cl i en t ’ s acco u n t s recei vab l e fo r cas h , (2 ) co l lect i n g o n the acco u n ts recei v ab l e fro m th e acco u n t d eb t ors , an d(3 ) as s u m i n g th e d o wn s i de ri s k i f an acco u n td eb t o r b eco m es i n s o l v en t . Fact o ri n g b en efi t s th e cl i en t b y en ab l i n g i t t o m o n et i ze an i l li qu i d as s eti m m ed i at el y . Inex ch an g e fo r i t s s erv i ces th e fact o r recei v es a fee, t y p i cal l y co m

p u tedas a d is co u ntfro m t h e face am o u n to f t h e recei v ab l es . Id . at* 1 7 . Inan arm ’ s -l en g t h rel at i o n s h i p , fact o ri n g i s p erfect ly l eg i ti m at e. Fact o rs p ro v i d e wo rk i n g cap i t al an dl i qu i d it y t o th ei r cl i en t s an dd o th e wo rk
n eed edt o co l l ectth e acco u n ts th ath av e b een as s i g n edt o th em . Th ey al so p erfo rm th e s o m et i m es v ery i m

p o rt an tjo b o f m o v i n g t h e cred i t ri s ko f t h e acco un td eb t o r fro m th ei r cl i en t s t o th em s el v es . See i d . at* 4 6 -* 48
. As wi t h ASIG’ s “ d i s ab i li t y ” p o l ici es , h o wev er, “ g ro up fact o ri n g ” u s edth e
wo rd s as so ci at edwi t h a l eg i t im at e p ract ice an dm ad e i t i nt o s o m ethi n g d i fferen t --a ci rcu l ar fl o w o f fu n d s fro m R&A’ s cl ien t s b ackt o th o s e cl ien t s , wi t h s o m e l eak in g [* 1 5 ]- 1 6 -

[* 1 6 ] o u tt o R&A i t s el f. See i d. at* 4 6
. In s t ead o f fact o rs th atp ai dfo r t h es e
acco u n t s an dth enco ll ect edth em , th e cl i en t s th em s el ves co n t in u ed t o b i l l an d
co l l ectth es e acco u n t s as i f th ey ’ dn ev er s o l dth em . Th e fact o rs were s t raw m en wh o recei v edn o m ean i ng fu l eco n o m i c b en efi ti n return fo r t he m on ey th ey p ai d
o u tt o th e cl ien t s . See i d . at* 49
. If a cl i en twas i n t eres t ed , R&A wo u l dcreat e th e n eed ed en t it i es . Th e
ev o lu t i o n o f t h es e en t i t i es i s qu i t e co m pl ex an d wen tth ro u gh fo u r d i fferen t g en erat i on s , wi t h s o m e o v erl ap b et ween th em . Here’ s th e l i s t : ! Ben efact o r Fu n di ng As s oci at i o n (BFA) (1 9 9 6 -2 0 02 );
! Un i t edSt at es Fact o ri ng As s o ci at i on , LLC (USFA) (2 00 2 -0 4);
! W es tern Fu n d i n g Gro up , In c. (W es t ern Fu nd i n g ) (2 0 0 4-0 7 ); an d
! W FG, In c. (W FG) (2 0 0 8 -1 1 ) Each o f t h es e fo u r s h aredm an y el em en t s i n b o t h th ei r s etup an d ex ecu t i o n . On e o f t h es e s i m il ari t i es was th e way th ey co l lect edfees p ai db y cl i en t s i nt o a g en eral acco u n to wn edb y the en t i t y , b u twh ich R&A co n t ro l l ed
. Here’ s a s u m

m ary o f th e g ro s s recei p t s R&A recei vedi n t h e fo rm o f fees fro m th es e p ro du ct s i n to th o s e acco un t s :- 1 7 -

Acco un t (s ) en d i n g i n 84 9 7 (BFA) 4 5 6 4 & 2 6 53 (USFA) 1 3 2 93 5

(W es t ern Fu n d i n g) 6 8 74 (W FG) To t al n u m

b er o f fee p aym en t s 1 4 5 8 3 4 7
--- --- Gro s s recei p ts $ 3 7 6 ,4 6 5 .1 0 $ 8 4 9 ,5 19 .8 3 $5 4 9 ,3 51 .9 7 $ 7 0 ,4 4 0 .7 0 Th e Co m m is s i o n er was u n ab l e t o i d en t i fy an y s p eci fi c d ep os i ti n t o th e W es t ern Fu n d i n g an d W FG, In c. o p erat i ng acco u n t s as g ro ss recei p t s t o R&A, b ecau s e m an y

o f th e d ep o s i t s b el o ng edt o R&A’ s cl i en ts . He th erefo re i n cl u d edas i n co m e o n l y

th o s e fu n d s th atl eftthe acco u n t s an d en d edup i n R&A’ s o wnb an k
acco u n t en d in g i n 9 8 1 5 , BFA’ s Di v i s i o n 1 0 1 ’ s b an kacco u n ten d i ng i n 0 4 4 9 , o r th e Ry d ers ’ p ers o nal b an kacco u n ten d i n g i n 4 4 6 1 . Th i s m ean s we can ’ t t el l h o w
m an y o th er cl i en t s u s edW es tern Fu n d i n g an dW FG o r h o w m an y fee p aym en t s [* 1 7 ]

1 3 Th e Co m

m i s s i o n er al s o i d en t i fi eda b an k acco u n tfo r U.S. Fact o ri n g M an ag ers , In c., en d i n g i n 8 6 2 0 th atd ep o s i t ed$ 1 9 ,9 5 0.0 3 i n t o th e R&A b an k acco u n t en d in g i n 9 8 1 5 i n 2 0 0 3 . U.S. Fact ori n g M an ag ers , In c., was a co rp o rat io n o wn edb y Ry d er’ s b ro t h er-i n -l aw, Ro b ert Pan ch eri . W e ag ree wi t h the Co m m i s s i o n er t hatth i s $ 1 9 ,9 5 0 .0 3 i s p arto f th e fact o ri ng co m p an i es ’ g ro s s recei p t s fo r t h aty ear, an dwe i n cl u d e i ti n USFA’ s g ro s s recei p t s .

1 4 No t e t h at t h es e n u m

b ers are n o tth e n u m

b ers o f cl i en t s p ay i n g fees , b u t th e n u m b ers o f d ep o s i t s t h atwe fi n dwere fee p aym en t s t o R&A. Th e g ro s s v al ues o f t h e d ep o s i ts were q u it e l arg e. In o n e em p l o y ee’ s es t i m at i o n , th ere were ab o u t “ 6 0 req u es t s t o h av e acco u n t s recei v ab l e fact o red ” each m o n t h , an dp o s si b l y m o re b ecau s e “ s o m e cu s t o m ers fact o redtwi ce a m o n t h .”- 1 8 -

[* 1 8 ] th ey

m ad e, wh i ch m ak es o u r fi n d in g s ab ou t R&A’ s i n co m e fro m th i s p ro ductco n serv at iv e. Th e acco u n t en d i ng i n 8 4 9 7 was u s edb y R&A’ s cl i en ts atl eas tfro m 2 0 0 4- 1 0 . Th e acco u nten d i n g i n 2 6 5 3 ap p ears t o h av e b een u sedo n l y i n 2 0 0 3 , wh i l e t h e
o th er acco u n tfo r t he USFA p ro du ctan d en di n g i n 4 5 6 4 was u s edfro m 2 0 0 3 -1 0
. Th e W es t ern Fu n d i n g acco u n ten d i n g i n 2 9 3 5 was u sedfro m 2 0 0 4 -0 8 , an d fi n al ly , th e W FG, In c., acco u n ten d i n g i n 6 8 7 4 o p en edi n 2 00 8 an dwas u sedb y R&A’ s cl i en ts u n t i l 2 0 1 1
. Emp l o yee Lea s i ng . Th e t h i rdg ro up p ro du ct was em p lo y ee l eas i ng , an dth i s
o n e was (t o m ak e t he reco rds t i l l m o re co m p l i cat ed ) o ft en co m

b i n edwi t h t h e fact ori n g p ro du ct . As i s tru e o f fact o ri n g , em p l o y ee l eas in g i s p erfect l y l eg i t i m at e wh en d o ne t h e p ro p er way . In a l eg i t i m at e em pl o y ee-l eas e d eal , o ne b u si nes s
co n tract s wi th an o t h er t o s up p l y i twi t h wo rk ers . Th e l eas in g co m p an y g en eral l y
as s u m es res p on s i b i l i t y

fo r p ay i n g th e wo rk ers ’ wag es an d em p l o ym en tt ax es , wh i le t h e o p erat i ng -b u si n es s o wn er k eep s co nt ro l o v er h ow t h e wo rk ers p erfo rm th ei r jo b s an d pay s th e l eas i n g co m p an y fo r p ay ro l l , t ax es , b en efi t s , an d an y ad m i n is trat i v e fees . See, e.g
. , Garav ag l i a v . Co m m i s s i o n er, T.C. M em o . 2 01 1
- 2 2 8 , 2 0 1 1 W L 4 4 4 8 9 1 3 , at* 3, aff’ d , 5 2 1 F. Ap p ’ x 4 7 6 (6 th Ci r. 2 01 3 ).- 1 9 -

[* 1 9 ] Th i s i sn ’ th o w R&A’ s em p l oy ee-l eas i n g d eal s wo rk ed . Ini t s d eal s cl i en t s
s i gn edwh at Ry d er l ab el ed“ A g reem en t s o f Em p l o ym en t ” wi t h o n e o f m u lt i p l e
en t i t i es th atR&A creat ed . Th e cl ien t s wo u l dth en l eas e t h em s el v es b ackt o th ei r real b us i n es ses --ei t h er d i rect ly o r t h ro u g h an i n t erm ed i ary --wi t h th e d i fferen ce b et ween th e l eas e p aym en tan dth e wag es recei v edb eco m i n g a fo rm o f
co m p en s at i o n t h atwas s upp o s ed l y i m m un e fro m cu rren t t ax at i o n . R&A u s edfi v e
en t i t i es : ! W o rl dwi d e Career M an ag em en t , Lt d . (Iri s h ).;
! W o rl dwi d e Career M an ag em en t , In c. (U.S.);
! Ex ecu t i ve Pl acem en t , In c.; ! W es tra Cap i tal M an ag em en t , In c.; an d
! Ex ecu Pro Sp eci al t y Serv i ces , In c. Each o f t h es e co m

p an i es h ada n um

b er o f b an kacco u n t s t hatR&A an di t s cl i en ts wo u l du s e:- 2 0 - Acco u n tty

p e Nu m b er o f acco u nt s W o rl dwi d e Career M an ag em en tacco un t s 2 W es tra Cap i tal M an ag em en t acco u nt s 3 W CM QSub acco u n t s 45 Ex ecu t i ve Pl acem en tacco u n t s 16 Ex ecu Pro acco u n t s 4 Ex ecu Pro Sp eci al t y

Serv i ces acco un t s 27 W CM QSub & Ex ecu Pro Cl i en t acco u n t s 62 ESOP Cl i en tacco u n t s 21 An dh ere are R&A’ s g ro s s recei p t s fro m th i s g ro up -l eas i n g p ro du ctfo r each t ax y ear: [* 2 0 ]- 2 1 - Year Gro s s recei p t s 1 5 2 0 0 3 $ 4 0 9 ,1 7 6 .1 1 2 0 0 4 3 5 8 ,8 6 8 .7 5 2 0 0 5 1,1 8 8 ,4 7 0 .0 0 2 0 0 6 4 0 4 ,2 8 8 .0 7 2 0 0 7 6 8 4 ,6 6 3 .3 9 2 0 0 8 6 0 ,3 75 .3 5 2 0 0 9 5 1 ,4 50 .0 0 2 0 1 0 1,4 8 7 ,8 3 5 .0 0 2 0 1 1 5 2 4 ,8 6 5 .1 9 To t al $ 5 ,1 6 9 ,9 9 1.8 6 Sta f fi n g Pr od u ct . Fo r t h e t h ree rem ai n in g ty p es o f d eal s we d o n ’ th av e t o
wo rkas h ardt o fi ndi tm o re l i k el y than n o t t h atR&A was i n v o lv ed . Th ey are al l d eal s wh ere R&A s i g n edag reem en t s wi t h i t s cl i en t s i n i t s o wn n am e. Each cl i en t i n thes e d eal s recei v edm o re s p eci fi cal l y t ai l o reds erv i ces . An dwi t h th es e s t an d
al o n e d eal s i twas the cl ien t s th em sel v es wh o act edas o ffi cers o f t he en t i t i es i n v o l v ed
. [* 2 1 ]

1 5 W e n o t e t h atd ep o s i t s i n th es e acco u n t s d o n o tequ al R&A’ s fees , b u to n l y i t s g ro ss recei p t s. Th es e acco u n t s an dp ro du ct s were up an dru n n i n g b efo re 2 0 0 3 an d m ay h av e accu m

u l at ed m o n ey

th atwas n o td eb i tedu n t il a l at er y ear. W e fi n d th atth e b es tway

t o trackth e fl o w o f fu n d s i n t o R&A i s t o trace m o n ey as i tl eft th es e en t i t i es ’ acco un t s an d m o v edi n t o o th er acco u n t s m o re d i rect l y l i n k edt o R&A, s u ch as th e l aw fi rm ’ s m ai n acco u n t s .- 2 2 -

[* 2 2 ] Th e s t an d -al on e s t affi n g p ro du cti s th e fi rs twe’ l l l o o k at
. Itcl os el y
res em b l es th e em

p l oy ee-l eas i n g d eal s we’ v e al read y d es cri b ed --i n deed , th ere ap p ears t o b e s o m e o verl ap i n t h e cl i en ts th atu s edth em . R&A’ s s t affi ng s erv i ces g en eral l y l o o k eds o m et h i n g l i k e t h i s : ! R&A wo u l dcreat e a co rp o rat i o n an dfi l e an S co rp o rat i o n el ect i o n o n i t s b eh al f;
! R&A wo u l des t ab l i s h an ESOP t o o wnth e S co rp o rat i o n ; an d
! R&A’ s cl ien t s wo u l ds o m eh o w tran s fer fu nd s fro m th ei r b u s i nes s es t o th e ESOP-o wn edco rp o rat io n . R&A s o l d t h es e d eal s u nt il 2 0 11
. Here’ s a b reak d o wno f t h e g ro s s recei pt s s t emm i n g fro m th e s t an d -al o n e
s t affi n g s erv i ces :- 2 3 - Acco u n ten d i n g i n (an dy ears u s ed ) 0 4 4 9 (2 0 0 3 ) 3 1 4 9 (2 0 04 -1 1 ) Gro s s recei p t s 1 6 $ 2 ,3 7 8 ,5 3 9 .0 5 $ 4 ,3 1 5,8 8 0 .3 0 Nu m b er o f fee p aym en t s 5 7 1 9 0 Gen er a l Co u n sel

Of f i ce (GCO) . Ry d er’ s GCO d eal s were u n u s u al l y creat i v e. He creat edh un dred s o f n ew co rp orat i o n s , n o n e o f wh i ch h adan y
ex i s t en ce ex cep to n p ap er, wi t h t h e p l an t o draft t hem i nt o a res erv e army

awai t i ng d ep lo ym en ti n h i s cl i en t s ’ b at t le ag ai n s tt ax at i o n . He cam e up wi t h a u ni fo rm p at t ern --h e h ad each S co rp o rat i o n ’ s b o ard(o f wh i ch h e h im sel f was th e s o l e d i rect o r) ap p o i n th i m

as v i ce p res i d en t/ g en eral co un s el , an dR&A em p l o y ee DeAu n Cas t ro as v ice p res i d en t/ ESOP ad m i n i s trat i o n . Ry d er t h enfi l ed2 0 0 1 fed eral i n co m e t ax retu rn s as o f Decem b er 3 1, 2 0 01 fo r t h e co rp o rat i o n s n o ty et
as s i g n edt o a cl i en t . Ev ery retu rn rep o rt edg ro ss recei p ts o f $ 1 0 0 an dex p en s es o f $ 9 7 . No ne rep o rt edo w i n g an y t ax o n th e res u lt i n g $ 3 i n t ax ab l e i n co m e. [* 2 3 ]

1 6 W e s t res s ag ai n th atg ro s s recei p t s d o n o t equal R&A’ s t ax ab l e i n co m e fro m th es e acco u n t s , b u t m erel y s h o w th e m o n ey co m i ng i n fro m th e p ro du ct . R&A’ s t ax ab l e i n co m e d ep en d s o n wh en m o n ey l eftth es e acco u nt s an dwh ere i t en d edup . Our wo rkwas h i n dered b ecau s e d ep o s i td es cri p t i o n s were m is si n g fo r th e acco u n ten d i n g i n 0 4 4 9 , s o we co u ldn o t b e s ure wh i ch d ep os i t s were s p eci fi cal l y

rel at edt o t h e s taffi n g p ro du ct . An dthi s acco u n th as d ep os i t s fro m th e fact ori n g p ro du ct as wel l . St i ll , th e am o u n to f m o n ey fl o wi n g i n t o t he acco u n t fo r ju s t o n e y ear s h ows h o w m u ch m o n ey

was m ad e fro m

ju s ttwo o f R&A’ s p ro du ct s . See i n fra p p . 5 3 -6 4 fo r an al y s i s o f ju s twh atR&A’ s i n co m e was fro m th i s p ro du ct .- 2 4 -

[* 2 4 ] An y

R&A cl ien twh o wan t edi n o n t h i s ty p e o f d eal co u l d l earn ab o u ti t
o n ce t h ey b o u g h t i n t o a GCO arran g em en tan d s ig n ed an “ Acces s Ag reem en t .” Th e Acces s Ag reem en t was b as i cal l y th e s am e as the l et t ers o f rep res en t at i o n u s ed fo r t h e s t affi n g-co m

p an y cl i en t s , b u twi t h d i fferen tn o m en cl atu re. Th i s ag reem en t g ran t edth e cl ien t s acces s t o o n e o f R&A’ s co rp o rat i o ns an d i t s rel at edESOP th at R&A h ads i t t i ng i n i t s i n v en t o ry . A cl i en t ag reedi n retu rn t o p ay a p ercen t ag e o f h i s o p erat i n g b u s i n es s ’ s rev en u e as a fee. Th i s fee fi rs t fl o w edth ro u g h th e
em pl o y ee-l eas i n g p ro du ct i n t o h i s as s ig n ed S co rp o rat i o n an dth enwas p u m p ed i n t o h i s as s i g n edESOP. Each cl i en t al s o h ad t o p ay a $ 25 ,0 0 0 d ocu m en t at i o n fee t o y et an o t h er Wy om i n g co rp o rat i o n , Pres ci en t Pl an n i n g, wh i ch Ry d er h adal s o fo rm edn o t l o n g aft er h i s i n co rp o rat i o n -p al o o za i n earl y 2 0 0 1 . Inth e o ri g i n al Acces s Ag reem en t s , GCO cl ien t s p ro m i s edt o p ay al l th e fees th atthey

o wed d i rect l y t o Pres ci en tPl an ni ng . Th i s p ro du ctwas fai rl y

s h o rtl iv edb ecau s e t h e IRS l earn ed ab o u t s u ch d eal s
an d m ad e t h em

a l i st edtran s act i o n . 1 7 See Rev . Ru l. 2 00 3 -6 , 2 0 0 3 -1 C.B. 2 8 6
.

1 7 A l i st edtran s act i on i s o n e t h ath as b een i d en t i fi edas a “ t ax av oi d an ce tran s act io n .” See s ec. 6 70 7 A(c)(2 ). Tax pay ers are req u i redt o d i s cl os e t h es e tran s act io n s o n th ei r retu rn s , an dp ro m o t ers o f t h es e t ran s act i o n s m u s treg i s t er th em wi th th e IRS. Sch wab v . Co m m i s si o n er, 1 3 6 T.C. 1 2 0 , 1 2 3 (2 01 1 ), aff’ d , 7 1 5 F.3 d1 1 69 (9 t h Ci r. 2 0 13 ).- 2 5 -

[* 2 5 ] Ry d er an dR&A res p o nd edwi t h a rev i s edAcces s Ag reem en t . Th e ch an g es
weren ’ ts m al l : ! In cl u s i o n o f a n ew s ect i o n d eal i ng wi t h th e creat i o n o f t h e g en eral co u n s el o ffi ce; ! A n ew s ect i o n req u i ri n g th e cl i en t’ s S co rp o rat i on t o en t er i n to an Ag reem en t o f Em

p l o ym en t wi t h Ry d er fo r h i s s erv i ces as th e v i ce p res i d en t/g en eral co u n s el o f t he co rp o rat i o n; ! A n ew s ect i o n req u i ri n g th e cl i en t co rp o rat io n t o p ay an an n u al b ud g etfo r t h e g en eral co u n s el o ffi ce i n th e s am e p ercen tag e as th e fee i n th e o ri g i n al ag reem en t ; ! A ret i t leds ect io n t h atrev i s es “ Th e Paym en to f Percen t ag e Fees ” t o s ay “ Fu n d i ng o f An n u al Bu d g et ; ”
! A ret i t leds ect io n t h atrev i s es th e “No Redu ct io n o f Percen t ag e Fees ” t o s ay “No Redu ct i o n o f An n u al Bu dg et ; ” an d
! A n ew s ect i o n d eal i n g wi th th e d et erm i n at i o n an d n eg o t i at i on o f l eg al fees o w edt o Pres ci en tPl an ni n g o r R&A. Ry d er s u m

m ari zed t h e ch an g es b es ti n h i s l et t er t o a cl i en t : Pl eas e n o t e t hatth e Acces s Ag reem en th as b een rev i s edt o p ro v id e th atth e am o u n tth ato t h erwi s e wo u l dh av e b een p ai das Percen tag e Fees t o Pres ci en twi l l i n s t eadb e b u d get edt o th e Co rp o rat i o n’ s n ew Gen eral Co u ns el ’ s Offi ce. In th i s reg ard , I am d es i g n at edas th e Vi ce Pres id en t/ Gen eral Co u n sel o f t h e co rp o rat i o n , an dDeAu n Cas t ro i s d es i gn at edas Vi ce Pres i d en t/ E SOP Ad m i n i s t rat io n . Ry d er m ad e o n e es p eci al l y n ot ab l e ch an g e--h e b ack d at edth es e n ew ag reem en t s , wh i ch h e as k edh i s cl i en t s t o s i g n . Th es e n ew ag reem en t s ch an g edth e way th e- 2 6 -

[* 2 6 ] GCO p ro du ctrecei v ed i t s g ro s s recei p t s , wi t h t h e t o rren t s o f cas h fl owi n g i n t o ei th er Pres ci en t Pl an n i ng o r Fi rs tCo u n s el Cap i t al ’ s 1 8 b an kacco u n t s , n o w rel ab el ed“b u d g etal l ot m en t s .” Th e Co m m i s s io n er d et erm i ned , an dwe fi n d , th at th es e d eal s g en erat eda t o tal o f m o re t h an $ 3 .5 m i l l i o n . S h o r t -S a l e Str a t eg

y . Th e fi n al p ro ducti s o n e th ati s n o s t ran g er t o o u r Co u rt --t he So n -o f-Bo ss d eal
. 1 9 See, e.g ., BLAK In v s . v . Co m m i s s i o n er, 1 33 T.C. 4 3 1 (2 00 9 ). Bet ween 1 9 9 8 an d2 0 0 2 , R&A s o ldi t s o wn So n -o f-BOSS v ari at i o n . So n -o f-BOSS d eal s are i n fi n it el y fl ex i b l e i n t h e t ax s av i n gs they p ro m i s e. Fo r t ax p ay ers wh o h av e l arg e cap i t al g ai n s o n wh i ch t hey wi sh t o p ay

n o t ax , s u ch d eal s can b e cu s t o m i zedt o p ro du ce o ffs et t i n g cap i t al l os s es i n an y am o u n t. See 6 6 1 1 , Lt d . v . Co m

m i s s i o n er, T.C. M em o. 2 0 13 -4 9 , at* 1 1
. Th e fees R&A ch arg edi t s cl i en t s fo r t h i s p ro du ctwere h el d i n t wo
acco u n t s--acco u n t s en d i n g i n 9 1 5 6 an d9 2 1 4 --t i t led“ Ern es tS. Ri d er, APLC,

1 8 See i n fra p p . 3 7 -3 9.
1 9 So n -o f-BOSS d eal s were g en eral ly u sedt o art i fi ci al l y

i nfl at e s o m eo n e’ s b as i s i n a p art n ers h i p i n t eres tb y co n t ri b ut i n g as s et s wi t h l arg e co n t i n gen t l i ab i l i t i es (wh i ch were i g n o red i n co m p u t i n g b as i s ) an dth ens el l i ng th is i n t eres tat fai r m ark etv al u e fo r a h u ge t ax (b u tn o eco n o m i c) l os s . See, e.g ., RJ T In v s . X v
. Co m m i s s i o n er, 4 9 1 F.3 d7 3 2 (8 t h Ci r. 2 0 07 ) (i n vo l vi n g ty p i cal So n -o f-BOSS tran s act io n ); Kl i g fel dHo ld i n g s v . Co m m i s s i o n er, 1 28 T.C. 1 9 2 (2 0 0 7 ). Th ere are o th er v ari at i o n s. See, e.g ., Ho m e Co n cret e & Sup p ly , LLC v . Un i t edSt at es , 6 3 4 F.3 d2 4 9 (4 t h Ci r. 2 0 1 1), aff’ d , 5 6 6 U.S. 4 78 (2 01 2 ). W e’ v e n ev er fo un da So n -o f-BOSS t ran s act io n thatwo rk ed
.- 2 7 -

[* 2 7 ] At to rn ey

Tru s tAcco u n t ,” an d“ Ern es t S. Ry d er & As s o c., In c. At t orn ey Cl i en tTru s t Acco u n t.” Th e t o t al am o u n to f fees fro m th e p ro du cti nt o each
acco u n t is as fo l l o ws : M et h o d o f d et erm i ni n g g ro s s

in co m e 9 1 5 6 9 21 4 To t al fees d ep os i t edfro m 2 00 3 -2 0 1 1 2 0 $ 6 9 8,6 9 6 .5 8 $ 8 6 1,4 7 8 .3 8 Co m m i s si o ner’ s d et erm in at i o n o f t ax ab l e wi t h drawal s du ri ng 2 0 03 -2 0 1 1 2 1 $ 1 ,1 4 0,9 5 9 .7 6 $ 4 9 8,6 8 0 .9 1 S u mma r y o f Fees
. Aft er g o i n g th ro u g h each o f t h e p ro duct s s o ldb y R&A, i t ’ s u s efu l t o s ee t h e fee s t ru ctu re u s edfo r each o n e. Th e d o cu m en t at i o n fee was ch arg ed fo r t h e o rg an i zat i o n al p ap erwo rkan ds et t i n g up cl i en ts wi th th e ap p ro p ri at e b an kacco u n t s. Th e an n u al p ercen t ag e fee was fo r u s e o f t h e p ro du ct s ,

2 0 Th es e am o un t s refl ectth e d ep os i t s g o i n g i n t o th e acco u n t s , an dex cl u d e n o n t ax ab l e d ep o s it s .

2 1 Th e Co m

m i s s i o n er d et erm i n edi n co m e fro m the cl ien ttru s t fu ndacco u n t s t o R&A an dth e Ry d ers b as edo n th e fi n al d es t i n at io n o f d eb i t s an d ch eck s drawn o n th e acco u n t s . He d et erm i n edth atth e t ot al am o u n to f t ax ab l e i nco m e t h atl eft th e acco u n ten d i n g i n 9 1 5 6 was $ 1 ,1 4 0 , 9 5 9 .7 6 . Th e t ax ab l e i n co m e t h atl eftth e acco u n t en d in g i n 9 2 1 4 was $ 4 9 8 ,6 8 0 .9 1 . W e s u sp ect t hatm os to f th e m o n ey i n th es e acco u n t s was d ep o s i t edb efo re 2 0 0 3
.- 2 8 -

[* 2 8 ] cl i en t s ’ acces s t o fu n d s i n cert ai n acco u n t s , an dth e u l ti m at e t ax b en efi tth ey g ai n ed . Th e p ercen t ag e v ari edfro m p ro du ct t o p ro du ct : Pro du ct An n u al fee Fee cl as s i fi cat i o n ASIG 2 % Ch aract eri zedas “p ol i cy fee” an dd ep o s i t ed i n to ASIG g en eral acco u n t Gro up fact o ri n g 9% Ch aract eri zedas “ l eg al fee” an dd ep o s i t ed i n to fact o ri n g co m

p an y g en eral o r o p erat i n g acco un t Gro up l eas i n g 6 -8 % Ch aract eri zedas “ ret en t i o n fee” an dd ep o s i t ed i n to l eas i n g co m

p an y g en eral acco u nt St affi n g 6 -8 % Percen t ag e p ai dfro m s taffi n g co m p an y t o o t her R&A acco un t s an d en t i t i es , s u ch as ESOP Leg al Co n s ul t an t s GCO 6 -8 % Ch aract eri zedas a “ b u d g et ” an d d ep o s i t ed i n to 1 8 s ep arat e g en eral co u n s el o ffi ce acco un t s Sh o rt -s al e s trat eg y 6 -2 / 3 % Ch aract eri zedas a co n t i n g en t fee an d d ep o si t edi n t o d es i g n at edat t o rn ey -cl i en ttru s t acco un t B. Wh atR&A Di dW i t h th e M o n ey 1
. Pract i ce Fu n d i n g Ag reem en tW i t h BFA As d i ffi cu l tas i ti s t o t race rev en u es fro m cl i en t s t o R&A, i t i s ev en h ard er t o fo l l o w the cas h as i tfl o wedt o th e Ry d ers th em s el ves . Our d i ffi cu l t y b eg i n s wi th R&A’ s o wnm o ney

m an ag em en t . Al th o u g h R&A h adn o res o u rces o t h er th an i t s “ t i m e, en erg y , an ds k i l l ” wh en i to p en ed , Ry d er en s u redth i s was n o tth e- 2 9 -

[* 2 9 ] cas e fo r l o n g . He qu i ck l y en t eredi n t o a “ p ract i ce fu n d i ng ag reem en t ” (PFA) wi th BFA, o n e o f R&A’ s o wnfact o ri n g co m p an i es , t o g etth e s t artup cas h i t
n eed ed . Th i s PFA t o o kth e fo rm o f a fact ori n g ag reem en t , i n wh ich R&A “ s o l d ” i t s acco u n t s recei v ab l e an d o t h er co n t ract s fro m th e l aw p ract ice i n ex ch an g e fo r BFA’ s ag reem en tt o p ro v i d e fu n d i n g as n eed edt o R&A. R&A an d BFA en t ered i n t o th es e PFAs each y ear b et w een 1 9 9 6 an d2 0 0 3
.

2
. Es t ab l is h m en to f Ry d er Law Co rp . In 2 0 0 2 R&A’ s m o n ey

m an ag em en t b ecam e ev en m ore co nv o l u t ed
. Ry d er i n co rp o rat edRy d er Law Co rp . (RLC) as an S co rp o rat i o n i n J an u ary o f t h aty ear. Th e o ri g in al art i cl es o f i n co rp o rat i o n fo r RLC au t h ori zedth e i s s u an ce o f 1 0 0 ,0 0 0
s h ares o f co m

m on s t o ckan d res t ri ct edo wn ers h ip o f an y o u ts t an d i n g s h ares t o
em pl o y ees o f RLC o r an ESOP. On t h e s am e d ay Ry d er i n co rp o rat edRLC, i t
ex ecu t eda s t o ck -s ub s cri p t i o n ag reem en twi th th e “ Ry d er Law Co rp o rat io n Em p l o y ee St o ckOwn ers h i p Pl anan dTru s t ” (RLC ESOP). Un d er th i s ag reem en t , RLC ESOP b o u g h t 1 0 ,0 00 s h ares o f RLC co m m o n s t o ckfo r $ 1 a s h are, wh i ch
m ad e i tth e 1 00 % o wn er o f RLC. RLC ESOP t hen t ran s ferred thes e s h ares t o
s o m et h in g cal l edth e “ Ry d er Law Co rp o rat i o n Pro fi t Sh ari n g Pl an an dTru s t ” o n Oct o b er 1 6 , 2 0 0 3
. Th at s am e d ay , Ry d er an dBrad l ey Am m on , an ot h er at t o rn ey at R&A, t h em s el v es b o u g h t s to cki n RLC t h ro u g h t h ei r o wn s to ck -s ubs cri pt i o n- 3 0 -

[* 3 0 ] ag reem en t s . Am

m o n dro p p edo u ts o m et i m e l at er an d b y 2 0 0 5 , Ry d er h i m s el f o wn edn earl y

al l th e s hares . W e t ab ul at e al l th e t wi s ts an dtu rn s o f RLC’ s
o wn ers hi p fro m

2 00 2 -0 9 : Sh areh o l der 2 0 0 2 2 0 0 3 2 0 0 4 2 0 0 5 -0 9 Ern es tRy d er --- 1 0
. 3 8% 6 6 .9 8 % 9 8 .5 9 % RLC ESOP 10 0 % 7 9
. 1 7%
--- --- Brad l ey J . Am

m o n --- 1 0
. 3 8% 3 0 .9 6 %
--- RLC Pro fi tSh ari n g Pl an an dTru s t --- 0
. 0 7% 2 .0 6 % 1 .4 1 % Ry d er cl ai m edthath is i nt en t i n al l th i s was fo r RLC t o b eco m e th e
em pl o y ee-s t affi ng co rp orat i o n fo r R&A. He t es ti fi ed t hatal l o f R&A’ s em p l o y ees
m o vedfro m

R&A t o RLC, an dth atRLC t h en l eas ed t h em b ackt o R&A th ro u g h ou tal l thes e y ears . Bu th i s t es t i m o n y i s th e o n l y

ev i d en ce we h av e o f t h i s . M u l t ip l e em

p l o y ees cred ib ly

t es t i fi ed t h atth ey

were em p l o y ees o f R&A. Nei t h er th ey n o r an y o t h er R&A em

p l o y ees h adwri t t en em

p l o ym en t ag reem en t s t o s h o w th ey were n o w RLC’ s em

p lo y ees . Al l t h es e em

p lo y ees s t i l l l o g g edth ei r t im e
u s i n g R&A t i m es l i p s . Th e reco rdd o es s h o wth at t h es e em p l o y ees recei v edth ei r W -2 ’ s fro m

RLC ev ery y ear; b utas far as th e res t o f th e wo rl dco u l d t el l , n o t h i n g el s e ch an g edfo r t h es e em p l o y ees .- 3 1 -

[* 3 1 ] Ry d er was try i n g t o s o l v e t h e s am e p ro b l em m an y o wn ers o f a p ro fi t ab l e C
co rp o rat i o n h av e--o n e l ay er o f i n co m e t ax atthe co rp o rat e l ev el , fo l l owedb y
an o th er i f i tp ay s o u ti ts p ro fi t s i n th e fo rm o f d iv i d en d s . Ry d er s eth i m s el f t o fi gu ri n g o u ts o m e way

o f m o v i n g R&A’ s p ro fi t s t o RLC s o h e co u l dt ak e t h em as d i s tri b u t i o n s fro m

an S co rp o rat i o n . 2 2 Hi s s o lu t i o n was an u n ort h o d o x o n e--h e t o l dR&A’ s b o o kk eep er, Am y Herau f, t o m ak e m

u lt i pl e ad ju st in g jo u rn al en t ri es 2 3 t o s h i fti n co m e fro m R&A t o RLC. Th es e ad ju s t i n g jo u rn al en tri es wo ul ds h o w R&A’ s m o ney g o i n g t o Ry d er i n wh ath e l ab el ed“ l o an s”--“ l o an s ” fro m o n e o f t h e fi n an ci al acco u n t s o f a g ro up t ax p ro du cto r “ lo an s ” fro m R&A i t s el f (an dh e wo ul di n cl u d e i n th es e “ l o an s ”
m o ney th atwen t fro m R&A t o p ay Ry d er’ s o r o n e o f Ry d er’ s ran ch ’ s cred i t -card

2 2 Ry d er ex p l ai n edth atd i s t ri b u t i o n s fro m S co rp o rat io n s aren ’ tco n s i d ered i n co m e--an dare t herefo re t ax free--s o l o ng as th e s h areh o l d er h as b as i s an dth e d i s tri b u t i o n s d o n otex ceedth atb as i s . (He’ s ri gh tab o u tth i s --s ect i o n 1 3 6 8 s ay s s o .)
2 3 Anad

ju s ti n g jo u rn al en t ry

i s “ [a] n acco u n t i n g en t ry m ad e i n t o a s ub s i d i ary

l ed g er cal l edth e Gen eral jo u rn al t o acco un tfo r a p eri o d [’ s ] ch an g es , o m is s i o n s o r o t h er fi nan ci al d at a req u i red t o b e rep o rt ed‘ i n th e b o o k s ’ b u tn o t u s u al l y p o s t ed t o th e jo urn al s u s edfo r t y p i cal p eri o d t ran s act i o ns .” Acco u n t i n g Term in o l o g y

Gu i d e, New Yo rkSt at e So ci et y o f CPAs , h t tp s : //www.n y s s cp a.o rg /p ro fes s i o n al -res ou rces / acco u nt i n g -t erm i n o l o g y -g u i d e# s t h as h
. O M J ATGaN.Bo mMs j PI.dp b s (l as tv i s i t edJ u n e 2 1, 2 0 21 ).- 3 2 -

[* 3 2 ] b i l l s ). 2 4 Atth e en d o f t h e y ear, Ry d er wo u l d m eetwi t h Herau f an d R&A’ s retu rn p rep arer Do n Lan g t o t el l th em o n wh i ch acco u n t s h e wan t edth em t o m ak e th es e ad ju s t i n g jo u rn al en t ri es . If h e wan t edm o n ey

earn edfro m

s al es o f a g ro up p ro du ct , th en Herau f o r Lan g wo ul dreco rdan as s eti n t h e fo rm o f a n o t e recei v ab l e fro m Ry d er h i m s el f o n th e b o ok s o f wh i ch ev er en ti t y h adcas h th ath e wan t ed . Th ey wo u ldal s o en t er o n th aten t i ty ’ s b o o k s an o ffs et t i n g o b l i g at i o n t o p ay R&A fo r Ry der’ s s erv i ces as th ei r at t o rn ey . Th e en t i t y wo u l dtran s fer t h e n o t e recei v ab l e du e fro m Ry d er t o R&A t o p ay R&A’ s at to rn ey ’ s fees
. Th e n o t e o n wh i ch Ry d er was l i ab l e wo u l db e en t eredas an as s eto n R&A’ s b o o k s . Rem em

b er t h o u g h t h atRy der h ad p ap eredRLC t o ap p ear t o s el l
em pl o y m en ts erv ices t o R&A. R&A wo ul dp ay fo r t ho s e s erv i ces t h ati th ad
s up p os ed l y

b o ug h tb y

tran s ferri n g th e n o t e t o RLC. Ry der wo u l dd i s t ri b u t e t h e
n o t e t o h i m s el f fro m RLC. As th e n ot e was n o w i n t h e h an d s o f i t s p u tat i v e
m ak er, i twen t“po o f” as a m at t er o f t ax l aw wi t h n o m ore t ax co n seq u en ce t o Ry d er t h an t o s o m eo n e wh o wri t es a ch eckt o h i m s el f o n o n e acco un tt o d ep o s i t i n t o an o th er.

2 4 See i n fra p p . 1 6 1 -6 3
.- 3 3 -

[* 3 3 ] Atl eas tth at ’ s t h e p o s i ti o n Ry d er t o o k --h e d i dn o trep o rtth es e n ot es as i n co m e o n h i s i n d i v i du al retu rn s . He ex p l ai n edth ath e d i ds o b ecau s e d i s tri b u t i o n s fro m

S co rp o rat i o n s are n o t i n co m e u n les s th ey ex ceed edth ei r
o wn er’ s b as i s , s ee s up ra n o t e 2 2 , an dh e treat edeach tran s fer fro m RLC as a
n o n t ax ab l e ret u rn o f b as is . Wh ere d i dth is b as i s co m e fro m ? Th e b as i s Ry d er cl ai m edwas fro m

th e s eri es o f s t o ck -s ub scri p ti o n n o t es th ath e h adco n t ri b u t ed
. Th e i n i t i al s t o ck -s ub s cri p t i o n ag reem en tb et ween Ry der an dRLC fo r 1 5 0 ,0 0 0
s h ares at$ 10 .1 0 5 p er s h are was fi n an cedwi t h p ro m i ss o ry n o t es t o RLC fro m Ry d er i n wh ich h e p ro m i s ed t o p ay m o re t h an $ 8 ,0 0 0 a m o n t h o v er 3 6 0 m o n t h s . He s i g n eda s eco n ds t o ck -s ubs cri p t i o n ag reem en twi t h RLC i n M ay 2 0 0 4 fo r 3 0 0 ,0 0 0 s h ares atthe s am e p ri ce p er s h are. He al s o fi n an cedth at s ub s cri p t i o n wi th a p ro m is s ory

n o t e. Th e s am e m o n t h h e s i g n eda t h i rds ub s cri p t i o n ag reem en t wi th RLC fo r an o t h er 1 0 0 ,0 0 0 s h ares atth e s am e p ri ce an dfi n an cedwi t h a t h i rd p ro m i s s o ry

n o t e. An dfi n al l y

i n 2 0 0 5 Ry d er cl ai m s h e b o u g h t Am m o n ’ s 1 5 0 ,0 0 0
s h ares i n RLC fo r $ 1 0 ,0 0 0 i n cas h an dan o t h er n o t e fo r al m o s t$ 1.5 m i l l io n . Here i s a s u m

m ary : Dat e RLC s h ares Am o u n t Paym en tm et h o d 1 0 /1 6 / 0 3 15 0 ,0 0 0 $ 1 ,5 1 5 ,7 50 No t e 5 /1 0 / 0 4 30 0 ,0 0 0 3 ,0 3 1 ,5 00 No t e- 3 4 -

5 /1 2 / 0 4 10 0 ,0 0 0 1 ,0 1 0 ,5 00 No t e 1 /1 / 0 5 15 0 ,0 0 0 1 0 ,0 00 1 ,4 9 0 ,0 63 Cas h

No t e Ry d er cl ai m s th ath e m ad e p aym en t s o n th es e n ot es , b u t t h e Co m m i s s i o n er
s ay s that h e d i d n o tan dth atwh atl o o k edl i k e p aym en t s were act u al l y d i s t ri b u t i o n s fro m RLC t h atRy d er wo u l dl en db ackt o RLC. Th ere were m o re th an 6 0 o f t h es e p aym en t s t hatv o l ley edb ackan dfo rt h b et ween Ry der an d RLC an dt o t al edal m o s t $ 2 .6 m i l l i o n . II. Ry d er Go es Ran ch in g Th e rev en u es an d cas h fl o w o f R&A an d RLC m ay b e b aro qu e i n th ei r
co m p l ex i t y . Wh en we ap p ro ach th e Ry d ers ’ ran ch es , th ey b eco m e ro co co . Ry d er h i m s el f v i ews th e co u n t ry l ife as a wel co m e res p i t e fro m th e d ai ly g ri n do f h i s
o ffi ce l i fe. He g rew up o n a ran ch wh ere h e l earn edh o w t o b u t ch er, h ow t o h erd cat t le, an dh ow t o farm . So we d o fi n dth at t h e ran ch l ife al way s ap p eal ed t o h i m . Du ri n g a ro ad t ri p wi t h h i s wi fe t h ro u g h s o ut h eas tAri zo n a an ds o ut h wes tNew M ex i co , Ry d er n ot icedfo r-s al e s i g n s o n ran ch p ro p ert i es an dco m m en t edt o M rs . Ry d er t h at“ t hey

were g i v i ng * * * th e real es t at e away .” Th i s l edthem

t o s tartb u y i n g ran ch es . OnJ an u ary 1 0 , 2 00 3 , Ry d er Ran ch Co ., LLC, fi l edi t s art i cl es o f o rg an i zat i o n, an dth e Ry ders ’ ran ch l i fe b eg an . Th e [* 3 4 ]- 3 5 -

[* 3 5 ] ran ch es ’ h i st o ry

i n cl u d es a l o n g l i s t o f fi li n g s, am en d m en t s , an d
am en d m en t s t o am en d m en t s o f LLC art i cl es al l d o n e i n an at tem ptt o al t er--o r at l eas t gi v e t h e ap p earan ce o f al teri n g --t hei r o wn ers h i p . By th e t i m e we t ri edth es e cas es , th e Ry d ers h aden d edup wi th n i n e p ro p ert i es :
Ran ch LLC Pro p ert i es pu rch as ed Dat e

pu rch as ed Co s t Ry d er Ran ch Co m

p an y , LLC Lazy BK Ran ch 1 / 1 6 / 0 3 $ 35 5 ,0 0 0 Varn u m p ro p erty 1 0 / 8 / 0 8 3 2 5 ,0 0 0 Pat t ern Farm s, LLC Sh u m ak er Farm s 4 / 1 8 / 0 3 4 2 0 ,0 0 0

Bo g g s p ro p ert y 6 / 1 0 / 0 3 1 6 2 ,0 0 0 M o o re p ro p ert y 2 / 1 6 / 0 5 5 3 7 ,5 0 0 Can y o n Vi ew Ran ch , LLC Ri v ers p ro p erty 5 / 1 9 / 0 3 1 5 0 ,0 0 0 Ry d er Red Ro ckRan ch , LLC Co o n Ran ch 4 / 2 8 / 0 3 6 5 0 ,0 0 0 Ro d eo Ho l d i n g s , LLC Gal l ery Bu i l d in g 3 / 1 5 / 0 6 7 0,0 0 0 Es carceg a Ho u se 8 / 3 1 / 0 6 1 8 0 ,0 0 0- 3 6 -

[* 3 6 ] A. So u rces o f M o n ey fo r Ran ch es 1
. Co u n s el o r Cap i t al as Bl o ck er En t i t y fo r Ran ch es On e o f R&A’ s “ s erv i ces p ro v i d ed ” was t o h el p i t s cl i en t s ret ri ev e t he m o n ey th atth ey h adp u t i n t o o n e o f t h e p ro du ct s . By “ h el pi n g th em

ret ri ev e t h ei r
m o ney ,” we d o n o t m ean fi ll i n g o u twi t h drawal s l i p s . W e m ean th e m o re
s o p h is t i cat eds erv i ce o f s h u n t in g m o ney th ro ug h d i fferen t acco u n t s h el d b y th es e
en t i t i es , fro m

wh i ch m o n ey

co ul dfl o w b ackt o the cl ien t s as wh atl o o k edl i k e l o an s . Ry d er cal l edth i s ty p e o f acco u n ta “ b lo ck er en t i t y ”--Ry d er’ s t erm fo r an
en t i ty b et ween a p ay o r an d p ay ee t h atd i s g u is edth e t ru e fl ow o f m on ey , o r t h ath e
u s ed to “ i s o l at e t h e t ax -ex em p ten t i t y fro m b ei ng en g ag ed [wi t h ] an u n rel at ed trad er.” Co u n s el o r Cap i t al , fo r ex am pl e, was a b l o ck er en ti t y

u s edm ai n l y

b y USFA cl i en t s . M on ey fro m cl i en t s wo u l dfi n di t s way i n t o Co u ns el o r Cap i t al ’ s b an k acco u n t , an dth e cl i en ts wo u l dth en“b orro w” t h ei r o wnm o n ey fro m Co u n s el o r Cap i t al . Ry d er h adacces s t o th es e acco u n t s , an d u s edth em t o fu n dth e
ran ch en ti t i es . Ry d er b o o k edth i s as an i n v es t m en tb y Co u n s el o r Cap i t al i n
an o th er co m

p an y cal l ed Fi rs tCo u n s el Cap i tal , wh i ch Ry d er atl eas t o ccas io n al l y p ap ered to l o o k l i k e i twas p arto wn er o f Ry d er Ran ch Co ., LLC.- 3 7 -

[* 3 7 ] 2
. Fi rs tCo u n s el Cap i t al as Bl ock er En t i t y fo r Ran ch es To u s e Fi rs t Co un s el Cap i t al as a b l o ck er, Ry d er h ad t o ad ju s ta n um

b er o f d i fferen t en t it i es . He h ad , fo r ex am p l e, fi l edart i cl es o f o rg an i zat i o n fo r Ex ecu t i v e Pl acem en tServ i ces - 1 0 6 , LLC, wi t h th e Wy o m i n g s ecret ary o f s tat e i n No v em

b er 2 0 0 2 . Th es e art i cl es i den t i fi edEx ecu t i v e Pl acem en tServ i ces , In c. (a Ut ah
co rp o rat i o n) as th e LLC’ s m an ag er. In Sep t em b er 2 0 0 3 Ry d er fi l edan am en d m en t t o s ub s t i tu t e Fi rs t Co u ns el Cap i t al , LLC, a Cal i fo rn i a LLC, as m an ag er. Wy o m i n g th en d is s o l v ed Ex ecu t i v e Pl acem en t Serv i ces - 1 0 6 , LLC, fo r fai l ure t o fi l e i t s
an n ual rep o rtan dp ay

t ax , an d t h e co m

p an y s t ay ed d i s s o l v edu nt i l Ap ri l 2 0 0 6
. No tw i ths t an d i n g th i s d i s s o lu t i o n , Ry d er fi l eda 2 0 0 3 i n co m e-t ax retu rn fo r Ex ecu t iv e Pl acem en tServ i ces - 1 0 6 , LLC, i n Oct ob er 2 0 0 4 . Bu tth atretu rn l i s t ed th e p art n ers h i p as Fi rs tCo u n s el Cap i t al , LLC, wi t h a Wy o m in g ad dres s . Th i s
s eem s t o h av e an t i ci p at ed an o th er n am e ch an g e, b ecau s e i n Ap ri l 2 0 06 Ry d er fi led p ap erwo rk wi t h the Wy o m i n g s ecret ary o f s t at e t o ch an g e t h e n am e o f Ex ecu t i v e Pl acem en tServ i ces - 1 0 6 , LLC, t o Fi rs tCo un s el Cap i t al , LLC. Th i s am en d m en t al s o ch an g edth e m an ag i n g m em b er fo r t h e LLC t o h im sel f i n h i s cap aci t y as an at t o rn ey fo r R&A. 2 5 Ry d er h adal read y o p en eda b an kacco u n tfo r Fi rs tCo u n s el

2 5 W e n o t e t h atth is ch an g e t o t h e m an ag i n g m em b er av o i d ed Fi rs tCo u n sel Cap it al , LLC, o f Wy om i n g h av i n g as i t s m an ag i n g m em b er Fi rs tCo u n s el Cap i t al ,

(co n ti n u ed ...)- 3 8 -

[* 3 8 ] Cap i t al , LLC (Wy o m i n g ), o n Oct o b er 2 0 , 2 0 0 3, al m os tthree y ears b efo re an LLC wi th th at n am e ex i s t ed . (Ry d er Ran ch Co
. , LLC, al so fi l edi t s 2 0 05 retu rn
s h o wi n g o n e o f i t s m em

b ers as Fi rs t Co u ns el Cap i t al , LLC (Wy o m i n g ), b efo re an y LLC h adth atn am e.) Th ats am e m o n t h --Ap ri l 2 0 0 6 --Ry d er co n v ert edth e Wy o m i n g LLC t o a C co rp o rat i o n : Fi rs tCo un s el Cap i t al , In c. W i t h Fi rs t Co u n s el Cap i t al , In c., i nco rp o rat ed an d atl eas t o n p ap er
s o m et i m es o wn i n g an i n t eres ti n Ry d er Ran ch , Ry der b eg an t o u s e i tas a “ b l o ck er
en t i ty ” t o fu n n el m o n ey

o uti n t o th e ran ch es . Th i s m ean tth ath e ag ai n d eci d edt o
m ak e ad ju s t i n g jo urn al en tri es t o reco rdm o n ey wh o s e real o ri g i n l ay

i n 1 8 GCO
acco u n t s, ESOP Leg al Co n su l tan t s , In c., Co u n s el o r Cap i t al , an d g ro up -l eas i n g p ro duct s as m o n ey

thatcam e fro m

Fi rs tCo u n s el Cap it al , In c. Th es e t ran s fers were al l o p aqu e, an d Ry d er m ad e t h em ei th er t h ro u g h th e “ ad

ju s t i n g jo u rn al en t ry ” p ro ces s al read y

d es cri b edo r t h ro u g h a s l ig h t ly d ifferen t “ lo an p ay ab l e” m et h o d
. In th i s s eco n dm et h o d , th e i n i ti al jo u rn al en t ri es wo u ldl is t as an as s et o n th e g ro up p ro duct ’ s b al an ce s h eeta recei v ab l e du e fo r t h e am o un to f a l o an fro m th e ran ch
en t i ty , an dl i s t as a l i ab i l i ty o n t h e ran ch en t it y ’ s b al an ce s h eeta l o an p ay ab l e fo r th e s am e am o u n t . Ry d er wo u l d ad ju stth es e en t ri es atth e en d o f t h e y ear. He

2 5 (...co n t i nu ed ) LLC, o f Cal i fo rn i a.- 3 9 -

[* 3 9 ] wo u l d ad

ju stth e g ro up p ro du ct ’ s b o o k s t o s h o wth e l o an recei v ab l e du e fro m th e ran ch en t i t y

as an equ i t y

i n v es t m en ti n Fi rs tCo u n s el Cap i t al , In c. Onth e b o o k s fo r t h e ran ch en ti t y , h e wo u l drecl as s i fy t h e l o an p ay ab l e as a co n t ri b u t i o n b y Fi rs tCo u n s el Cap i tal , In c. OnFi rs tCo u n s el Cap i t al , In c.’ s b o ok s , th e i n v es t m en tfro m

th e g ro up p ro du ctwas reco rd edas a l i ab i l it y an d t h e l o an recei v ab l e due fro m

th e ran ch en t i ty

was reco rd edas an as s et . Th en th e l o an recei v ab l e due fro m

th e ran ch en t i ty

was can cel edb y

recl as s i fy i n g i tas an i n v es t m en ti n t h e ran ch en t i t y .

3
. Us e o f Fo u r Ad d i t i o n al Bl o ck er En t i t i es Ry d er ex p an d ed h i s u s e o f “ b l o ck er en t i t i es ” wi t h fo u r ad di t i o n al i n v es t m en tco m

pan i es thath e u s edt o g etm o n ey fro m R&A’ s at t orn ey -cl i en ttru s t
acco u n t en d in g i n 9 1 5 6 --th e acco un th e creat edt o h o l d fees fro m cl i en t s wh o h ad b o u g h tth e So n -o f-BOSS s h ort -s al e p ro du ctwe’ v e al read y d es cri b ed --o u tt o th e
ran ch en ti t i es . Th es e fo u r co m p an i es were: ! Tu rn ou r In v es tm en t s , In c.; ! Al s t er In v es t m en t s , In c.; ! M BSP In ves tm en t s , In c.; an d
! Sp an ky

In v es t m en t s , In c.- 4 0 -

[* 4 0 ] Ry d er fi l edth e art i cl es o f i n co rp orat i o n fo r Tu rn o u r In v es t m en t s , In c., wi t h Wy o m i n g i n No vem

b er 2 00 2 ; an dfo r Al s t er In ves t m en t s , In c., M BSP In v es t m en t s , In c., an d Sp an ky

In v es t m en t s , In c., i n Decem b er 2 0 0 2
. He l i s t edR&A as th e m ai l i ng ad dres s fo r each i n th e an n ual rep ort s thateach co m p an y fi l ed
. On ce t h es e co m

p an i es were s etup , Ry d er m ad e a s eri es o f t ran s fers o n Decem b er 2 4 , 2 0 02 , fro m

R&A’ s at t o rn ey -cl i en ttru s tacco un ten d i n g i n 9 1 5 6 t o
acco u n t s t i t l edt o t h es e n ew co m p an i es . Th e fi rs ttran s fer was t o a b an k acco u n t t i tl ed“ Sp an ky

In v es tm en t s , In c.” fo r $ 7 5 ,0 0 0 . Th e s eco n d was t o a b an kacco u n t t i tl ed“ M BSP In v es t m en t s, In c.” fo r $ 9 0 0,0 0 0 . Th e t h i rdwas t o a b an kacco u n t t i tl ed“ Al s t er In v es t m en ts , In c.” fo r $ 1 7 5 ,0 00 . An dth e fo u rt h was t o a b an k
acco u n t ti t l ed“ Tu rn o u r In v es t m en t s , In c.” fo r $ 2 0 5 ,0 0 0 . Ry d er p ro duced s t o ck cert ifi cat es d at edDecem

b er 3 0 , 2 0 0 2 , a weekb efo re t ri al th at s ho wedBFA as th e reg i s tered h o l d er o f s h ares i n each o f t h es e fo u r co m p an ies . Here are t h e n u m b er
o f s h ares h el db y

BFA i n each : In v es t m en tco m

p an y Sh ares i s s u ed Sp an ky In v es t m en t s , In c. 7 5 ,0 0 0 M BSP In v es t m en t s , In c. 9 0 0,0 0 0 Al s ter In v es t m en t s, In c. 1 7 5,0 0 0 T u rn o u r In v es t m en t s , In c. 2 0 5,0 0 0- 4 1 -

[* 4 1 ] So fo r each d o l l ar t ran sferred i n t o th e acco u n t s fo r t h e i n v es tm en t
co m p an i es , BFA recei v edo n e s h are. Ry d er cl ai m s th atth e t ran s fer o f fu n d s fro m th e tru stacco u n t t o th es e i n v es t m en tco m

pan i es refl ect edp aym en t s u n d er th e p ract i ce fu n d in g ag reem en t b et ween R&A an dBFA t h at we’ v e al read y d es cri bed . Th e t ru stacco u n t h el dth e fees earn edb y R&A t h ro ug h th e s h o rt -s al e s t rat eg y p ro du ct s . Un d er th e fu n d i n g ag reem en t , BFA s up p o s ed ly h adth e ri g h tt o th es e fees , wh i ch m ad e i tth e b en efi ci al o wn er o f t h e fu n d s i n th e t ru s t acco u n t . Wh en Ry d er m o v edth e fu n d s fro m th i s acco u n t t o th e co m

pan i es , i twas t h erefo re BFA t h atrecei veds h ares i n each o f t h em . Ry der cl ai m edth es e were p aym en t s u n d er t h e p ract i ce fu n d i n g ag reem en t . On ce Ry d er t ran s ferredth es e fu n d s i n t o th e co m p an i es ’ acco u n t s , th es e fo u r
co m p an i es wo u lds en dth e m o ney t o th e ran ch en t i t i es an dt o Ry d er Ran ch Co ., LLC, t o fu n d t h e ran ch act i v i t ies
.

4
. RLC an dIt s St o ckSub s cri p t i o n Ag reem en t R&A u s edRLC an d RLC’ s ESOP as an o t her wayt o g etm o n ey o u to f t h e g ro up p ro du ct s. Rem em

b er t h atwh en Ry d er o rg an i zed RLC h e h adRLC’ s ESOP
s i gn a s t o cks ubs cri p ti on ag reem en tt o b u y 1 0 ,0 00 s h ares o f co m m o n s t o ckan d RLC ESOP n o m i n al l y h el d 1 0 0 % o f the RLC s h ares . When Ry der an d Am m o n- 4 2 -

[* 4 2 ] b o u g h tth ei r i n teres t s i n RLC, t h e 1 0 ,0 0 0 s h ares o f RLC s to ckth atRLC’ s ESOP h el dwere n o m i n al l y t ran s ferred t o th e “ RLC Pro fi t Sh ari ng Pl an .” Ry d er
ev en tu al l y

wen t o n t o acq u i re n earl y al l o f t h e s h ares o f RLC. Di st ri b u t i o n s fro m RLC t o Ry d er were m ad e t h ro u g h th e ad ju s t in g jo u rn al en t ri es al read y d es cri b ed
. An do n ce ag ai n, Ry d er t reat edth es e p aym en t s fro m RLC as a n o n t ax ab l e ret u rn o f b as i s i n an S co rp o rat i o n b y cl ai m i n g b as i s fro m

th e s ub s cri p t i o n n o tes h e
co n tri b u t edt o RLC. B. Ry d er Ran ch Co ., LLC Pro p ert i es OnJ an u ary

1 6 , 2 0 0 3 , th e Ry ders b o u g h t th e Lazy BK Ran ch i n Co ch i s e Co u n ty , Ari zo n a. Th e p ri ce was $ 3 5 5 ,0 0 0 , wi t h a $ 1 00 ,0 0 0 d ownpaym en tan dth e
rem ai n i n g $ 2 5 5 ,0 00 fi n an cedb y a l o an . Th e Ry d ers p utth e p ro pert y i n t h e n am e
o f Ry d er Ran ch Co ., LLC. Ry d er Ran ch Co ., LLC, b o u g htm ore Co ch i s e Co u n t y l an dfro m

Terry l Varn u m i n Oct o b er 2 0 0 8 . Th e p ri ce was $ 3 2 5 ,0 0 0, an da d o wnp aym en tan d cl o s i ng co s t s o f m o re t h an $ 1 2 6 ,0 0 0 wen t fro m Co u n s el or Cap i t al , In c.’ s b an k
acco u n t to Pi o n eer Ti t l e Ag en cy . Ry d er Ran ch Co ., LLC, u s eds el l er fi n an ci n g fo r th e res t .- 4 3 -

[* 4 3 ] C. Pat t ern Farm s , LLC Ry d er al s o o rg an i zedPat t ern Farm s , LLC. 2 6 He fi l edi t s art i cl es o f
o rg an i zat i o n i n J an uary2 0 0 3 wi t h t h e Ari zo n a Co rp o rat i o n Co m m is s i o n an dth en , as wi th Ry d er Ran ch Co ., LLC, dro ve i tth ro ug h a wh i rl w i n do f am en d m en t s an d refi l i ng s . In Ap ri l 2 0 0 3 Pat tern Farm s , LLC, p urch as edtwo p arcel s o f l an d i n Co ch i s e Co u n ty fro m

W el d on an d M arjo ri e Sh u m ak er. Th e p ri ce was $ 4 2 0,0 0 0 , an dth e d o wnp aym en tcam e fro m th e Ry d ers ’ p ers o n al acco u n t. Pat t ern Farm s , LLC, g o t fi nan ci n g fro m

th e Sh u m ak ers an dg av e t h em a p ro m i s s o ry

n o te i n wh i ch i t p ro m i s edt o p ay

th em $ 2 1 0 ,0 0 0 i n two an n u al i ns t al l m en t s o f $ 10 5 ,0 0 0 p l u s i n t eres t . Wh en t i m e cam e t o s en dth es e p aym en t s , al m o st al l th e m o ney wen tt o th e Sh um ak ers fro m

b an kacco u n ts t i tl ed“ Al s t er In v es t m en t s , In c.” an d“ M BSP In v es t m en t s , In c.” In J u n e 2 0 03 Pat t ern b ou g h ttwo m o re p arcel s o f l an di n Co ch i s e Co u n t y . Th e d ownp aym en t cam e fro m t h e Ry d ers ’ p ers o n al acco u n t. Th e reco rds h o ws at l eas t on e p aym en to n th e n o t e cam e fro m an acco u n tt i tl edM BSP In v es t m en t s , In c.

2 6 Th e n am e “ Pat t ern Farm s ” i s a p o rt m an t eau o f th e Ry d ers ’ fi rs t n am es , Pat ri ci a an dErn es t .- 4 4 -

[* 4 4 ] In Feb ru ary

2 0 0 5 Pat t ern b o u g h tfo u r m o re p ro p ert i es i n Co ch i s e Co u n t y . Th i s p urch as e was al s o m o s t l y s el ler-fi n an ced , an d t h e m o n ey fo r i tag ai n d i dn o t
co m e fro m

th e Ry d ers d irect l y . Th i s t i m e t h e m o n ey cam e fro m an acco u n tfo r Fi rs t Co u n s el Cap i tal , LLC (Wy o m i ng ). D. Can y o n Vi ew Ran ch , LLC Ry d er n ex tfo rm edCan y o n Vi ew Ran ch , LLC. He fi l edi t s art icl es o f
o rg an i zat i o n wi t h the Ari zo n a Co rp o rat i o n Co m m i s s i o n o n Ap ri l 2 4 , 2 0 0 3 , an d fo l l o w edup wi t h t he u s u al am en d m en ts h en an i g an s . OnM ay 1 9 , 2 0 0 3 , Can y o n Vi ew Ran ch , LLC, co m p l et edth e p u rch as e o f two p arcel s o f l an di n Co ch i s e Co un t y , Ari zo n a, fro m Edward Ri vers . Th e
co n tract p ri ce was $ 1 5 0 , 0 0 0 , wi t h ad d i t i o n al cl o si n g co st s o f $ 4 21 .5 0 . Can y o n Vi ew Ran ch , LLC, g av e Ri v ers a p ro m i s s o ry n o t e fo r $ 1 2 0,0 0 0 wi t h an an n u al i n t eres trat e o f 6 %. A b an kacco u n t t i t led“ Tu rn o u r In v es t m en ts , In c.” al s o
s up p li ed$ 3 1 ,0 0 0 fo r t h i s p u rch as e. E. Ry d er Red Ro ck

Ran ch , LLC Ry d er al s o wan t edt o b u y ran ch l an di n New M ex i co . He fi rs to rg an i zeda
n ew en t i ty , Ry d er Red Ro ckRan ch , LLC, i n Ap ri l 2 0 0 3 , an d t h en fo l l o wedth e
s am e p at t ern as b efo re.- 4 5 -

[* 4 5 ] OnAp ri l 2 8 , 2 0 0 3, Ry d er Red Ro ckRan ch , LLC, co m p l et ed i t s p urch as e o f fo u r p arcel s o f l an d(p ro p erty fo rm erl y kn o wn as Co o n Ran ch ) i n New M ex i co ’ s Gran tan d Hi d al g o Co u n t i es . Th e co n t ract p ri ce was $ 6 5 0 , 0 0 0 , wi t h ad d i t i o n al cl o s i ng co s t s an d s t at e t ax es o f $ 1 ,8 1 1.5 5 . Tentho u s an d d o l lars cam e fro m a b an k
acco u n t ti t l ed“ M BSP In v es t m en t s , In c.” Th is s am e “ MBSP In v es t m en t s , In c.” b an k acco u n tal s o tran s ferred $ 6 4 5 ,0 0 0 t hatwe fi n dm o re l i kel y t h an n o t wen tt o th e Co o n s . Si nce t hes e p aym en t s t o t al edm o re t h an the co n tract -p l u s -cl o s i n g
co s t s , Ry d er Red Ro ckRan ch recei v ed a refu ndfro m th e Hi d al g o Co u n ty

Ab s t ract Es cro w Tru s t . F. Ro d eo Ho l d i n g s , LLC Th e l as to f Ry d er’ s real -es t at e LLCs i s Ro d eo Ho l d i n g s, LLC. He d i dn ’ t
o rg an i ze Ro deo Ho l d i n g s u nt i l Feb ru ary 2 0 0 6. It bo u gh ttwo b u i ld i n g s i n Hi d al g o Co u n t y , New M ex ico . Th e fi rs twas th e

“ Gal l ery Bu i l d i n g .” Th e d o wnp aym en tcam e fro m th e Ry d ers ’ p ers on al b an k
acco u n t w i t h th e rem ai n d er fro m an acco u n tt i t l edt o Ex ecu Pro . Th e s eco ndwas th e “ E s carceg a Ho u s e.” A s m al l p arto f t h e p ri ce cam e fro m th e Ry d ers ’ p ers o n al ch eck i n g acco un twi t h t h e res tfro m acco u n t s t i t l edEx ecu Pro an dW es t ra Cap i t al M an ag em en t.- 4 6 -

[* 4 6 ] III. Au d it , Cas hfl o w, an d Tri al A. Au d it Th e IRS b eg an a s ect i o n 6 7 0 0 i n v es t i g at i o n 2 7 i n to R&A’ s u s e o f ESOPs o n Au g u s t2 6 , 2 0 0 3 , aft er s o m eo n e n o t icedth atthe fi rm h adap p l i edt o h av e m o re th an 8 00 ESOPs qu al i fi edatth e s am e t i m e. Th en , l i k e an t i bo d ies s warm i n g t o an i n fect i o n , two m o re i nv es t i g at io n s l at ch edo n t o t h e p ro m o t i o n al act iv i t i es o f Ro b ert Pan ch eri an d Karen Bak er--fo rm er R&A em pl o y ees wh o m

Ry d er h adu sed t o “ m an ag e” m an y

o f t h e d i fferen t en t i t i es . Th es e co n verg edi n t o a fu l l-b l own
au d ito f t h e Ry d ers an dh i s l aw fi rm . Th i s üb erau d i ts p an n edn earl y a d ecad e an d
ex p an d edb ack wardan dfo rwardt o the Ry ders ’ 2 0 0 2 -1 1 an dR&A’ s 2 00 5 -0 9 t ax y ears . Wh en qu es t i o n ed b y IRS ag en t s , Ry d er p l ead edth e Fi ft h an d refu sedt o
an s wer an y

qu es t io n s reg ard i n g th e t ax s tru ctu res s ol db y h i s l aw fi rm . Ry d er’ s
s i len ce l eftth e Co m

m i s si o n er wi th n o ch o i ce b u tt o u s e s ubp o en as an dth i rd -p art y i n t erv i ews . Rev en ue Ag en t Hu o n g Ph an --t h e fi rs trev en u e ag en t o n th i s cas e--

2 7 Sect io n 6 70 0 i m

p o s es a ci v i l p en al t y

fo r t h e p ro m o t i o n o f ab u s iv e t ax s h el t ers . A s ect i o n 6 7 0 0 i n v es t i g at i o n “ is co n duct edi n d ep en d en t l y o f, an d wi th o u treg ardt o, t he d et erm in at i o n o n [an ] i n co m e t ax cas e,” s ee In t ern al Rev enu e M an u al p t . 2 0 .1
. 6 .1 .2 (3 ) (J u l y 8 , 1 9 9 9 ), an dfo cu s es o n l y o n wh et h er t h e p ro m o t er/p rep arer i s s ub

jectt o p en al t i es o r ani n

j u n ct i o n fo r h i s i n v ol v em en ti n ab u si v e act i vi t i es .- 4 7 -

[* 4 7 ] i s s u edo v er 3 0 s umm on s es t o v ari o u s fi n an ci al i ns t i tu t i o n s an d t hi rd p art i es --es sen t i al l y

an y p art y th ath e was ab l e t o reco g n i ze. M o re i n v es t ig at i o n s b ro k e o u t . Th e Cal ifo rn ia Fran ch i se Tax Bo ard
ex ecu t eda s earch warran t o f R&A’ s o ffi ce i n Ap ri l 2 0 10 . Th e IRS t h en ex p an d ed i t s au d i tt eam

t o ad d Rev en u e Ag en tJ o s ep h Haynes . He fo cu s edo n i den t i fy i n g wh atp aym en t s an d d ep os i ts h adm o v edth ro u gh al l th es e en t it i es an d acco u n t s . It
was a s tag g eri n g jo b--RA Hayn es h i m s el f i s s u edo v er 3 0 0 s umm o n s es t o fi n an ci al i n s t i tu t i o n s an do t h er t hi rdp art i es duri n g t h e co u rs e o f h i s i n ves t i g at i o n . He ev en h ad a s umm o n s s erv edo n th e Fran ch i s e Tax Bo ardt o g etacces s t o t h e reco rd s th at i t hads ei zedi n i t s i n ves ti gat i o n . Th e Co m m is si o n er fo u nda t an g l e o f 5 6 0 fi nan ci al acco u nt s u s edb y h u nd red s o f en t i t i es creat edb y Ry d er t h ro u gh R&A. Ry d er h im s el f h ads i g n atu re au t h o ri t y o v er ap p ro xi m at el y

two -t h i rd s o f t h es e
acco u n t s; th e fract i o n ri ses t o n earl y 9 5 % i f o n e i n cl u d es acco u n t s wh ere Ry d er’ s
em pl o y ees h ads i g natu re au t ho ri t y . RA Hay n es al so traced th e fl o w o f fu n d s th ro u g h R&A’ s acco u n t s t o i d en t i fy wh i ch were fo r th e Ry d ers ’ b en efi t . Aft er t h i s
wo rkwas co m

p l et ed , RAs Hayn es an d Ph anb o t h an al y zedth e i t em s g o in g th ro u g h th e acco u n t s t o i d en ti fy wh i ch acco u n t s were u s edt o co l l ectR&A’ s fees
. An d , fi nal l y , Rev en u e Ag en t Ni s th a Bo y er--wh o t o oko v er t h e wo rko f RA Ph an aft er RA Ph anch an g edro l es wi t h i n t h e IRS--co m pl et eda b an k -d ep o s i tan al y s i s- 4 8 -

[* 4 8 ] (BDA) t o i d en t i fy

R&A’ s g ro s s recei p t s. RA Bo y er al s o d et erm i nedth atth e Ry d ers were t ak i n g fu n d s o uto f t h es e acco u n t s t o p ay p ers o n al ex p en s es an d l i nk edth es e fu n d s t o R&A’ s g ro s s recei p ts . B. Cas h fl o w 1
. Fo l l owi n g th e M o n ey W e can b eg i n wi th a g en eral ex p l an at i o n o f t hi s co m p l ex an al y s i s b y

th e Co m m i s s i o n er’ s rev en u e ag en t s . Th ei r wo rku n co v ered 4 1 o f R&A’ s fi n an ci al
acco u n t s an d1 0 o f t h e Ry d ers ’ . Th ey i d en t i fi edan ds o rt edth e s p eci fi c i t em s o f i n co m e d ep o s i t edi n t o th es e acco u n t s , an dth en s o rt edthe acco u n t s i nt o two

“ b o x es ”. Th e fi rs tco n t ai n edth e 4 1 R&A acco u n t s . Th i s i s t h e l aw-fi rm b o x , an dth e ag en ts d et erm i n edth atan y m o n ey co m i ng i n to th atb o x was i n co m e o f R&A. Bu t i f m o n ey ju s ts l o s h edaro u n dfro m o n e acco u n t t o an o t h er i n si d e t hi s b ox th e ag en ts d i dn ’ t co un ti t as R&A i n co m e. W e fi n dth atthi s i s a g en eral l y reas o n ab l e way fo r u s t o i den t i fy

R&A’ s i n co m e. Th e s eco n db o x h el d t h e Ry d ers ’ p ers o n al acco u n t s . Wh en m o n ey cam e i n t o th i s “ p ers on al b o x ” fro m th e l aw-fi rm

b o x , o r l eftth e l aw-fi rm

b ox t o g o t o a th i rd p art y

fo r t h e b en efi to f Ry d er o r h is fam i l y , th e ag en t s treat edi t as a d i s tri b u t i o n t o Ry d er, u n l es s th e m o n ey was al read y

i n cl ud edi n thei r rep o rt ed- 4 9 -

[* 4 9 ] i n co m e. J u s tas wi t h t h e l aw-fi rm b o x , th e Co m

m i s si o n er d idn o t ad d t o th e Ry d ers ’ i n co m e an y

d ep o s i ts an dwi t h drawal s b et w een acco u nt s wi t h i n th e p ers o n al b o x . W e al s o fi n dthi s t o b e a g en eral l y reas o n ab l e way

fo r u s t o i d en t i fy th e Ry d ers ’ p o s s i bl y

t ax ab l e d i s t ri bu t i o n s . 2
. Gro s s In co m e Th i s b an k -d ep os i t an al y s i s i s th e h eart o f t h es e cas es . An d g i v en th e
as t o n i s h i ng co m

p lex i t y o f t h e cas h fl o ws i n an d o u t o f th e acco u n t s , we n ex t d es cri b e i n s o m e d et ai l th e l i n k s b et ween R&A’ s t ax p ro du ct s an d t hes e acco u n ts . AS IG . Th e ASIG p ro du ctwas th e o n e t h atm o ck edup d eferred
co m p en s at i o n t o l o okl i ke d i sab i l i t y -i n su ran ce p o l ici es . R&A wo u ldas s i g n each cl i en t wh o b o ug htth es e p o l i ci es a p o l i cy n u m b er, d rafta p o li cy , an d o pen a d ed icat edb an kacco u n tfo r t he cl i en t ’ s u s e. W e fi n dfro m th e reco rd s we h av e t h at wh en ev er a cl i en t fi l edfo r b en efi t s u n d er an ASIG p ol i cy , h e wo u l d co m p l et e a cl ai m p ack ag e an dp ay

a t erm i n at i o n fee. Th i s t erm in at i o n fee wo u l ds h o w up as a d ep os i ti n t o th e ASIG b an kacco u n t en d in g i n 5 3 3 7 . M o re m o n ey wo u l d l eav e th es e d ed i cat edacco u n t s twi ce a y ear an d en dup i n th e s am e acco u nten d i n g i n 5 3 3 7 . Cl i en ts ag reedth atth es e t ran s fers were Ry der’ s l eg al fees fo r t he s erv i ces p ro v id ed . R&A g en erat eda t o t al o f m o re t h an $ 1.2 8 m i l l i o n i n rev en u e t hro u g h th es e ASIG d eal s . See s up ra p p . 1 4-1 5
.- 5 0 -

[* 5 0 ] Th i s i s n o tal l th e i n co m e t h atR&A earn edfro m s al es o f ASIG p o l i ci es . Fro m 1 9 9 8 th ro u g h 2 0 0 2, m o s to f t h e m on ey fro m ASIG d eal s b y

pas s edR&A’ s b o o k s an dwen tt o Ry d er as “ l o an s ” wh o s e rep aym en th e o wedt o R&A. Th es e

“ l o an s ” wo u l d m o v e fro m R&A t o RLC an db ackt o Ry d er h i m s el f i n 2 0 0 5 th ro u g h th e ad

ju s t i n g jo urn al en t ri es al read y d es cri b ed . See s up ra p p . 3 1-3 4
. Fro m 2 00 4 t h ro u g h 2 0 1 0 R&A’ s i n co m e fro m ASIG p o l i ces th atwen ti n t o th e 5 3 37 acco u n tt o t al edm o re t h an$ 1 m i ll i o n . A l arg e s h are, $ 1 8 8 ,5 1 4 , l eftth e
acco u n t by

ch eck t o M o rri s Co t t i n g ham Co rp o rat e Serv i ces , Lt d., o f t h e Tu rk s an d Cai co s , an dtwo ch eck s wen tt o Cap i t al M ex i can a, Lt d . Nearl y al l th e rem ai n i n g fu n d s i n th e 5 3 3 7 acco un twere t ran s ferredi n Oct o ber 2 0 1 0 t o a b an kacco u n t
en t i t l ed“ Ex ecup ro Sp eci al t y Serv ices , In c., ESOP Des ig n at ed Ro t h Co n t ri b u t i on Acco u n t .” Th i s rep ai dtwo o f R&A’ s cl ien t s fo r ad v an ces t h ey h adm ad e t o Co u n s el o r Cap i t al , In c., fro m 2 0 0 7 t h ro u g h 2 0 1 0 th atRy d er h adu s ed t o fu n dth e
ran ch en ti t i es . Th e n ex ty ear, i n Sep t em b er 2 0 1 1 , th e 5 3 37 acco un twas drai n ed o f $ 6 1 ,0 0 0 th atwen tt o Co un s el o r Cap i t al , In c., ag ai n as fu n d s fo r Ry d er’ s u s e i n h i s
ran ch en ti t i es . In t o t al , th e Co m

m i s s i o n er t raced $ 1 , 0 2 7 ,8 1 1 .4 9 o f t h e as s ert ed$ 1 ,2 8 0 ,5 6 0
o f ASIG i n co m e recei v edfro m 2 0 0 3 t o 2 01 1 d i rect ly

t o R&A, o r i n d irect l y

t o p ay
o ff t h e Co u n s el o r Cap i t al , In c.’ s l o an fo r t h e b en efi to f Ry d er as s t at edab ov e. W e- 5 1 -

[* 5 1 ] ag ree an d fi n dth atth is $ 1 ,0 2 7 ,8 1 1 .4 9 i s i ncl u d ab l e i n R&A’ s g ro s s i n co m e fo r t h e y ears i n wh i ch i twas d ep o s i t ed
. Gr o u p Fa ct o r i n g Pr o d

u ct s . R&A co m

m i ng l ed t h e m on ey

i tearn eds el l i n g th e g ro up fact o ri n g p ro du ctwi t h i t s cl i en ts ’ o wnfu n d s wi t h in each o f t he p ro duct ’ s b an kacco u n t s . W e can trace R&A’ s earn i n g s , h o wev er, b ecau se i t l ab el edi t s fees fo r two o f t he co m p an i es i tu s ed --BFA an dUSFA--ei t h er d i v i d en d s o r fees . Th es e “ d i v i d en ds ” o r fees m o v ed o u to f t h e i n d i v i du al cl i en t s ’

“ co l l ect i o n acco u n ts ” each qu art er i n t o t h e p ro du ct s ’ g en eral b an kacco u n t s . Fro m th ere, t he fu n d s m o v ed --ei t her d i rect ly o r t h ro u g h BFA’ s Di v i s io n 1 0 1 b an k
acco u n t en d in g i n 0 4 4 9 --i n t o acco u nt s o wn edb y R&A o r Ry d er, o r i n s om e cas es t o thi rdp art i es fo r thei r b en efi t. Th e Co m m i s s i o n er al s o m ap p edthe fee fl o w t o R&A fro m

th e o t her g ro up -fact o ri n g en t i t i es th atR&A creat ed --W es tern Fu n d in g Gro up an dW FG. Th i s m ean th e i n cl ud edam o u n t s fro m th o s e p ro du ct s th aten d ed
up i n R&A’ s b an kacco un to r th e BFA Di v i s i o n 1 0 1 acco u n t . 2 8 Th e Co m m is s i o n er d et erm i n edth e fo l l o wi n g am ou n t s as i n co m e t o R&A th ro u g h th e g ro up fact o ri n g p ro duct s :

2 8 W FG h adan acco un t o f i ts o wnen di n g i n 6 8 7 4 , b utth e Co m m i s s i o n er d o es no targ u e t h atd ep o s it s i n t o th atacco u ntb ecam e g ro s s recei p t s o f R&A u n ti l th ey were d ep o si t edi n t o R&A’ s o wnb an kacco u n t.- 5 2 - R&A g ro s s i n co m e Year BFA (8 4 9 7 ) U SFA (4 56 4 & 2 6 5 3) W es t ern

Fu n d in g (2 9 3 5 ) W FG (6 8 7 4 ) 20 0 3 -0
- $ 6 26 ,7 4 0 .5 7 -0
- -0
- 20 0 4 $ 1 0 8 ,6 7 1
. 3 8 2 02 ,7 6 5 .1 1 $ 29 ,1 7 6 .1 8 -0
- 20 0 5 8 4 ,7 1 4
. 2 2 9 ,0 2 9 .1 8 1 55 ,2 3 8 .7 3 -0
- 20 0 6 6 1 ,2 8 6
. 7 4 7 ,5 1 2 .9 8 1 36 ,7 2 1 .3 7 -0
- 20 0 7 2 3 ,0 0 3
. 8 2 2 ,6 4 6 .6 3 2 17 ,4 5 4 .7 2 -0
- 20 0 8 1 9 ,9 1 0
. 0 3 8 2 5 .3 6 10 ,7 6 0 .9 7 $ 7 0 ,4 4 0 .7 0 20 0 9 -0
- -0
- -0
- -0
- 20 1 0 7 8 ,8 7 8 .9 1 -0
- -0
- -0
- 20 1 1 -0
- -0
- -0
- -0
- To t al 37 6 ,4 6 5 .1 0 8 49 ,5 1 9 .8 3 5 4 9 ,3 51 .9 7 7 0 ,4 4 0 .7 0 Gr o u p Lea s i n g

Pr o d u ct s . Th e co m

m i n g l i n g o f R&A’ s fees wi t h cl i en t s ’
m o ney was an ev enb i gg er p ro b l em wi t h in th e g ro up l eas i n g p ro du ct s . Inth e en d , th e p ro b l em

was s o s ev ere t h ati n s t ead o f fi g u ri n g o utR&A’ s i n co m e fro m th e
m o ney th at en t er ed t h e b an k acco u n t s o f t h e l eas i n g p ro du ct s, 2 9 th e Co m m i s s i o n er [* 5 2 ]

2 9 Th es e acco u n t s were Ex ecu Pro ESOP’ s b an kacco u n t en d i n g i n 8 1 6 6 ; Ex ecu Pro Sp eci al t y

Serv ices , In c.’ s b an kacco u n ts en d i n g i n 6 17 0 , 4 6 0 4, 0 5 1 7 , an d 7 2 5 7 ; Ex ecu ti v e Pl acem en t , In c.’ s b an k acco u n ten d i n g i n 6 67 0 ; W o rl dwi d e Career M an ag em en t ’ s b an kacco u n ten di n g i n 4 8 7 0 ; an dW es tra Cap i tal M an ag em en t’ s b an k acco u n t en d i ng i n 3 2 09 . Th ere was al s o an acco u n ten d i n g i n 0 3 9 2 i n t h e n am e o f Ex ecu Pro Sp eci al t y Serv i ces , LP, th atp ai d o n e ch eckfo r $ 8 5 t o BFA’ s Di vi s i o n 1 0 1 ’ s b an kacco u nten d i n g i n 0 4 4 9 i n 2 0 08 . Nei t h er p art y (co n ti n u ed ...)- 5 3 -

[* 5 3 ] fo u n d i n co m e t o R&A o n l y wh en m o n ey l ef

t t h e l eas i n g -p ro du ctb an k
acco u n t s an dm o v edi n t o o ne o f R&A’ s o wnb an k acco u nt s o r a t hi rd -p art y b an k
acco u n t fo r t h e b en efi to f Ry d er o r R&A. 3 0 Th e Co m m i ss i o n er d et erm i n edth at th i s p ro du ctg en erat ed m o re t h an $ 5 m i l li o n i n rev en u e t h ats h o u l db e i n cl ud edi n R&A’ s g ro s s i n co m e. See s up ra p . 2 1 . W e ag ree wi t h h i s d et erm in at i o n . Sta n d -Al o n e Sta

f f in g Pr o d uct s . Aft er t he Co m

m i ss i o n er b eg an h i s s ect i o n 6 7 0 0 i nv es t i g at i o n , Ry d er d rew up an “ Ag reem en to f As s i g n m en tan d As s um p t i o n ” d at ed J anu ary

1 , 2 0 0 4 , wi th wh i ch h e t ri edt o as s i g n al l o f t h e i n co m e fro m

R&A’ s s t affi n g p ro du ctt o ESOP Leg al Co n s u lt an t s , In c. Th e ag reem en ts ay s i twas an as si g nm en to f R&A’ s ri g h t s t o i n co m e o n ly fo r t ax y ears 2 0 0 4 -0 6 , b u tRy d er k ep tu s i ng ESOP Leg al Co n s u l tan t s ’ b an k acco u n ten d i n g i n 3 1 4 9 al l th e way

up u n t i l 2 01 1 . In2 0 04 al o n e R&A m o v edm ore t h an $ 6 0 0 ,0 0 0

2 9 (...co n t i nu ed ) ex p lai n s th e o ri g i n o r fu n ct i o n o f Ex ecu Pro Sp eci al t y Serv i ces , LP, o r i t s rel at i o n t o Ex ecu Pro Sp eci al ty

Serv i ces , In c. W i t h n o t h i n g el s e i n th e reco rdt o g u i d e u s , we wi l l treat Ex ecu Pro Sp eci al t y Serv i ces , LP, as p arto f Ex ecu Pro Sp eci al t y Serv i ces , In c.

3 0 W e i n cl u d e as R&A’ s i n co m e ch eck s an dd i rect tran s fers fro m th e g ro up l eas i ng p ro du ctacco u n t s i n t o Ry d er’ s en t i t i es , t o Ry d er’ s ch i ld ren , o r fo r Ry d er’ s p ers o n al b en efi t . Th es e i ncl u d e ch eck s an dtran s fers i nt o th e Ry ders ’ p ers on al b an k acco u n ten d i n g i n 4 4 6 1 ; R&A’ s b an k acco u n ten di n g i n 9 8 15 ; BFA’ s Di v is i o n 1 0 1 ’ s b an kacco u nten d i n g i n 0 4 4 9 ; RLC’ s b an k acco u n ten d i ng i n 8 1 6 8 ; Ry d er Ran ch Co ., LLC’ s b an kacco u n ten d i n g i n 5 6 9 5 ; an dPat t ern Farm s, LLC’ s b an k acco u n ten d i n g i n 9 4 4 6
.- 5 4 -

[* 5 4 ] i n t o i t . Dep o s i ts cam e fro m b us i n es s es s u ch as “ Paci fi c M an ag em en t Co m p an y ,” “ M cM ah o n St affi n g , In c.,” an d “ Sen t ry Fu n d i n g , In c.” R&A wo u l d th en m o v e t h i s m on ey

fro m ESOP Leg al Co n s u l t an t s ’ b an kacco u n tt o acco u n t s o f RLC, R&A, t h e Ry d ers ’ ran ch en ti t ies , th e Ry d ers th em s el ves , an d t h i rdp art i es l i kel y fo r t h e b en efi to f R&A. 3 1 Ry d er d i d n o to b jectt o an y

o f t h e s p eci fi c
n u m b ers i n th i s p arto f t h e Co m m is s i o n er’ s an al y si s, an dwe fi n dth atth ey are
m o re l i k el y

th an n o ttru e. Here i s a s u m m ary :

3 1 Fo r ex am

p l e, p aym en t s were m ad e t o Seas i d e Acco un t i n g So l ut i o n s (f.k .a. Acco u n t i n g b y

th e Sea, In c.), wh ere Herau f, R&A’ s b o o kk eep er, wo rk edatth e t i m e.- 5 5 -

[* 5 5 ] Year Dep os i ts Deb i t s Pai dt o wh o m 2 0 0 4 $ 6 3 8 ,3 3 1 .8 8 $ 6 2 3 ,2 18 .7 0 RLC R&A Ern es tRy d er Ry d er Ran ch Co
. , LLC Pat t ern Farm s , LLC Can y o n Vi ew Ran ch , LLC Acco u n t i n g b y

th e Sea, In c. Li p pa As s o ci at es , In c. Cap i t al An al y st s o f San Di eg o , LLC Wy o m i n g s ecret ary

o f s tat e Ad am s W i l s hi re En g rav i n g In c. Su n g ard Co rb el , In c. 2 0 0 5 1 ,2 3 2 ,5 2 8 .5 5 1 ,2 4 7 ,4 2 8 .6 8 RLC R&A Fi rs tCo u n s el Cap i t al Acco u n t i n g b y

th e Sea, In c./ Seas i de Acco u nt i n g So l u t i o n s Os m u n d o Bern ak e En han ced Acco un t i n g So ft ware, In c. ESOP t o R&A ESOP t o RLC St at e Bar o f Cal i fo rn i a- 5 6 -

2 0 0 6 1 ,1 7 8 ,6 2 2 .5 2 1 ,1 7 8 ,1 6 9 .8 5 ESOP t o RLC ESOP t o R&A Cl ear Vi s u al In k Li p pa As s o ci at es , In c. Cap i t al An al y st s o f San Di eg o , LLC Can y o n Vi ew Ran ch , LLC Pat t ern Farm s , LLC Ry d er Ran ch Co
. , LLC Ry d er Red Ro ck Ran ch , LLC W ach o vi a Ban k St at e Bar o f Cal i fo rn i a Cl ear Vers e, In c. 2 0 0 7 5 4 3 ,9 8 3 .3 0 5 4 4 , 4 40 .9 4 ESOP t o RLC ESOP t o R&A Cap i t al An al y st s o f San Di eg o , LLC Cl ear Vers e, In c. St at e Bar o f Cal i fo rn i a 2 0 0 8 7 8 ,6 6 0 .5 6 7 8 , 7 41 .9 0 Cl ear Vers e, In c. R&A 2 0 0 9 3 7 6 ,9 9 3 .0 2 3 7 7 , 0 54 .3 0 Cl ear Vers e, In c. R&A RLC W es t ra Cap i t al M an ag em en t , In c. St at e Bar o f Cal i fo rn i a 2 0 1 0 3 0 6 ,9 5 8 .2 9 3 6 4 , 6 80 .4 7 R&A RLC Lan g & As s oci at es , In c. Cl ear Vers e, In c. Cal ifo rn ia s ecret ary

o f s t at e [* 5 6 ]- 5 7 -

2 0 1 1 5 7 ,7 8 1 .7 2 1 2 5 .0 0 Un kn o wn To tal 4 ,4 1 3 ,8 5 9 .8 4 4 ,4 1 3 ,8 5 9 .8 4 Gen er a l Co u n sel

Of f i ce. Th e Co m

m i s s i o n er’ s BDA fo r t h e g en eral co u n s el
o ffi ce d eal s rev i ewedth e 1 8 GCO acco un t s an d l o o k ed atth e fl o w o f m o n ey i n t o
an d o u to f t h em du ri n g each o f t h e y ears ati s s ue. Each GCO cl i en t co rp o rat i o n h ad two acco u nt s : o n e fo r an ESOP S co rp o rat i o n th atthe cl ien tco n t ro ll edan da
s ep arat e GCO acco u n tatCh arl es Sch wab th at R&A co n t ro l l ed . A cl i en t wo u l d
m o ve m o n ey

fro m h i s o perat i n g b u s in es s i n t o h i s ESOP S co rp orat io n’ s acco u n t . Ab o u to n ce a y ear, h e wo ul dm ak e a t ran s fer fro m th e S co rp o rat i o n ’ s acco u n ti n t o th e GCO acco u n t atCh arl es Sch wab . Th i s m ad e t raci n g rev enu e m u ch eas i er, an d th e am o un t s tran s ferredwere t iedt o th e s u m o f t h e d o cu m en t at i o n fee an dan n u al p ercen t ag e fee (co m

p u t edas a p ercen t ag e o f t h e m o n ey the cl ien tm o v edi n t o th e ESOP S co rp o rat i on ) t h at R&A ch arg edfo r i t s s erv i ces . Th e am o u n t s i n th es e GCO acco un ts were ev en tu al l y d i s b u rs ed t o o n e o f Ry d er’ s “bl o ck er” en t i t i es -- ei th er Fi rs tCo u n s el Cap i t al , LLC (Wy o m i n g ), o r Fi rs tCo u n s el Cap i t al , In c.--as d es cri b edearl i er. See s up ra p p . 3 6 -3 8 . Th e b reak d o wn fo r each GCO cl i en t : [* 5 7 ]- 5 8 - Go l d s t ei n Law Co rp o rat i o n Year R&A g ro s s recei p t s 2 0 0 3 $1 0 5 ,7 58 .8 0 2 0 0 4 2 7 , 4 22 .7 7 2 0 0 5 -0
- 2 0 0 6 3 2 , 7 21 .9 0 2 0 0 7 6 4 , 1 23 .1 4 2 0 0 8 -0
- 2 0 0 9 -0
- To t al 2 3 0 , 0 26 .6 1 Gram p a’ s Pro gramm i ng , In c. Year R&A g ro s s recei p t s 2 0 0 3 $ 4 0 ,0 2 3
. 6 8 2 0 0 4 3 0 .0 0 2 0 0 5 1 2 9 ,8 5 7
. 4 7 2 0 0 6 -0
- 2 0 0 7 8 3 2 .2 4 2 0 0 8 4 ,5 1 4 .7 3 2 0 0 9 2 ,7 5 5 .0 0 To t al 1 7 8 ,0 1 3
. 1 2 [* 5 8 ]- 5 9 - Bo rreg o M an ag em en tServ i ces , In c. Year R&A g ro s s recei p t s 2 0 0 3 $1 0 0 ,0 00 .0 0 2 0 0 4 -0
- 2 0 0 5 2 5 4 , 6 96 .1 1 2 0 0 6 -0
- 2 0 0 7 1 5 0 , 0 00 .0 0 2 0 0 8 1 2 5 , 0 00 .0 0 2 0 0 9 1 2 5 , 0 64 .3 5 To t al 7 5 4 , 7 60 .4 6 V an t ag e 1 , In c. Year R&A g ro s s recei p t s 2 0 0 3 $1 8 2 ,4 63 .5 5 2 0 0 4 -0
- 2 0 0 5 5 7 , 6 44 .0 6 2 0 0 6 2 3 , 6 17 .1 3 2 0 0 7 5 6 5 .1 8 2 0 0 8 4 ,4 5 2 .2 5 2 0 0 9 -0
- To t al 2 6 8 , 7 42 .1 7 [* 5 9 ]- 6 0 - W es t ern Head In v es t m en t s , In c. Year R&A g ro s s recei p t s 2 0 0 3 -0
- 2 0 0 4 -0
- 2 0 0 5 $ 5 7 ,6 4 4 .0 6 2 0 0 6 -0
- 2 0 0 7 5 ,4 5 0 .0 0 2 0 0 8 4 ,1 2 2 .5 6 2 0 0 9 7 3 8 .9 9 To t al 6 7,9 5 5 .6 1 Bi g h o rn 2 , In c. Gen eral Co u n s el Year R&A g ro s s recei p t s 2 0 0 3 -0
- 2 0 0 4 $ 4 7 ,3 6 3
. 6 8 2 0 0 5 1 ,3 4 4 .7 2 2 0 0 6 1 ,7 5 2 .4 7 2 0 0 7 -0
- 2 0 0 8 1 0 0.2 2 2 0 0 9 -0
- To t al 5 0,5 6 1 .0 9 [* 6 0 ]- 6 1 - Ori o n 1 , In c. Year R&A g ro s s recei p t s 2 0 0 3 $ 2 9 ,4 4 4
. 8 7 2 0 0 4 1 2 4 ,1 4 1
. 0 0 2 0 0 5 -0
- 2 0 0 6 3 1 2 ,7 8 1
. 8 5 2 0 0 7 -0
- 2 0 0 8 5 ,3 0 4 .2 3 2 0 0 9 -0
- To t al 4 7 1 ,6 7 1
. 9 5 Co n s u l tan t s 1 , In c. Year R&A g ro s s recei p t s 2 0 0 3 -0
- 2 0 0 4 $ 3 9 ,3 2 4
. 8 0 2 0 0 5 3 7 ,1 1 6
. 8 4 2 0 0 6 6 3 ,9 9 8
. 4 2 2 0 0 7 -0
- 2 0 0 8 -0
- 2 0 0 9 -0
- To t al 1 4 0 ,4 4 0
. 0 6 [* 6 1 ]- 6 2 - Rel at i vi t y , In c. Year R&A g ro s s recei p t s 2 0 0 3 -0
- 2 0 0 4 $1 0 9 ,5 27 .9 2 2 0 0 5 -0
- 2 0 0 6 -0
- 2 0 0 7 -0
- 2 0 0 8 1 ,1 5 8 .8 5 2 0 0 9 -0
- To t al 1 1 0 , 6 8 6 .7 7 Paci fi c St ar 5 , In c. Year R&A g ro s s recei p t s 2 0 0 3 -0
- 2 0 0 4 -0
- 2 0 0 5 $ 2 2 ,0 4 7
. 1 2 2 0 0 6 -0
- 2 0 0 7 -0
- 2 0 0 8 -0
- 2 0 0 9 -0
- To t al 2 2,0 4 7 .1 2 [* 6 2 ]- 6 3 - Bu en a Ven tu ra 1 , In c. Year R&A g ro s s recei p t s 2 0 0 3 $ 7 4 ,2 4 7
. 2 0 2 0 0 4 3 ,7 6 7 .5 1 2 0 0 5 -0
- 2 0 0 6 -0
- 2 0 0 7 -0
- 2 0 0 8 -0
- 2 0 0 9 -0
- To t al 7 8 ,0 1 4
. 7 1 A m eri can Pas s io n , In c. Year R&A g ro s s recei p t s 2 0 0 3 -0
- 2 0 0 4 -0
- 2 0 0 5 -0
- 2 0 0 6 -0
- 2 0 0 7 -0
- 2 0 0 8 -0
- 2 0 0 9 -0
- To t al -0
- [* 6 3 ]- 6 4 - To rn ad o Co n s u l t in g , In c. Year R&A g ro s s recei p t s 2 0 0 3 -0
- 2 0 0 4 -0
- 2 0 0 5 -0
- 2 0 0 6 -0
- 2 0 0 7 -0
- 2 0 0 8 $ 1 4 ,0 0 0
. 0 0 2 0 0 9 5 ,5 0 0 .0 0 To t al 1 9 ,5 0 0
. 0 0 Ed g ewo o d Di s t ri b u t o rs & M an ag em en t , In c. Year R&A g ro s s recei p t s 2 0 0 3 $1 5 0 ,0 00 .0 0 2 0 0 4 7 0 , 0 00 .0 0 2 0 0 5 -0
- 2 0 0 6 1 ,6 4 2 .2 8 2 0 0 7 -0
- 2 0 0 8 2 4 0 .0 0 2 0 0 9 -0
- To t al 2 2 1 , 8 82 .2 8 [* 6 4 ]- 6 5 - Reg en t1 , In c. Year R&A g ro s s recei p t s 2 0 0 3 -0
- 2 0 0 4 -0
- 2 0 0 5 -0
- 2 0 0 6 $1 1 8 ,3 02 .3 1 2 0 0 7 5 0 , 0 00 .0 0 2 0 0 8 9 1 , 5 83 .0 0 2 0 0 9 2 5 , 0 00 .0 0 To t al 2 8 4 , 8 85 .3 1 L.I.P. In v es t m en t s , In c. Year R&A g ro s s recei p t s 2 0 0 3 $ 3 6 ,0 9 4
. 6 9 2 0 0 4 5 6 ,8 0 5
. 1 8 2 0 0 5 8 2 ,6 6 5
. 2 9 2 0 0 6 1 1 9 ,8 8 1
. 7 7 2 0 0 7 -0
- 2 0 0 8 -0
- 2 0 0 9 -0
- To t al 2 9 5 ,4 4 6
. 9 3 [* 6 5 ]- 6 6 - M an i Pad m e Co rp o rat i o n Year R&A g ro s s recei p t s 2 0 0 3 $ 2 6 ,1 8 5
. 0 3 2 0 0 4 2 5 ,0 2 1
. 8 1 2 0 0 5 9 0 ,1 6 0
. 4 0 2 0 0 6 8 9 ,6 6 9
. 0 0 2 0 0 7 -0
- 2 0 0 8 -0
- 2 0 0 9 -0
- To t al 2 3 1 ,0 3 6
. 2 4 Carl s b ad Co m

p o n en t s , In c. Year R&A g ro s s recei p t s 2 0 0 3 $ 3 4 ,7 3 8
. 9 6 2 0 0 4 4 9 ,0 3 1
. 8 4 2 0 0 5 -0
- 2 0 0 6 3 9 ,3 1 2
. 2 3 2 0 0 7 -0
- 2 0 0 8 -0
- 2 0 0 9 -0
- To t al 1 2 3 ,0 8 3
. 0 3 [* 6 6 ]- 6 7 -

[* 6 7 ] S o n -o f -BOS S . R&A u s edQu i ck Bo o ks t o k eep tracko f t h e i n co m e fro m i t s
s h o rt -s al e s t rat eg y . Traci n g th e fl o wo f m o ney fro m th es e s al es was d i ffi cu l t b ecau s e R&A was n’ ten t i tl edt o i t s fee u n t i l i t s cl ien th ades cap edIRS s cru t i n y l o n g en o u g h fo r t he s t atu te o f l i m i tat i o ns t o h av e ru n , s ee i n fra p . 1 1 7 -1 8
. M u ch
o f R&A’ s wo rk o n th es e d eal s was d o n e b efo re th e y ears ati s s u e, an d t h e Co m m i s s i o n er s ay s h e can ’ t trace al l th e m o n ey th at R&A earn ed fro m

th ei r s al es . Bu t h e d i d m an ag e t o tracka l i t t l e o v er $ 2
. 8 m i ll i on , wh i ch we fi n d i s i n cl u d ab l e i n R&A’ s i n co m e fo r t h e y ears ati s su e. W e m ak e fi n d i n gs o n th es e fl o ws o f fu n d s kn o wi n g th at an y n av i g at i o n o f th e l ab yri n t h o f en t i t i es an dacco u n ts th atRy d er b u i l t wi l l n eces sari l y b e i m p erfect . Det ect i n g , d is s ect i n g , an dd et erm i n i ng th e l i n k s b etween th es e d ep o s i t s
an d d eb i t s an dth ei r co rrects o urces i s co m p l ex . Bu tth e co m

p l ex i t y , an dh en ce
an y i m p erfect i on , was n o to n l y

creat edb y Ry der h im s el f, b utal s o ag g rav at edb y h i s l acko f co o p erat i on i n o rg an i zi n g h i s fi rm ’ s reco rd s an dh i s p ro du ci ng th em
s o m et i m es o n l y

a v ery s ho rtt i m e b efo re t ri al
. See Laws o n v . Co m m i s s i on er, T.C. M em o. 2 0 1 5 -2 1 1 , at * 2 5 (“ In th e l i g h to f t h e u t t er l acko f co o p erat i o n fro m p et i t i o n ers du ri n g th e au d i t, RA En ri qu ez an dres p o nd en ts h o weds ubs t an t i al an d
reas on ab l e effo rt s i n co m pi l i n g th e BDA an dm ak in g s u re t h e fi n d i ng s are
co rrect ”); s ee al s o Gl eas o n v . Co m m i ss i on er, T.C. M em o . 2 01 1 -1 54- 6 8 -

[* 6 8 ] (Co m

m i ss i o n er en t i t l edt o an y

reas o n ab le m et h o dt o reco n st ru cti nco m e wh ere t ax p ay er fi les n o retu rn s an drefu s es t o co o p erat e).

3
. “ Oth er Dedu ct i on s ” fo r 2 00 5 -0 6 Th e Co m m is s i o n er d et erm i n edn o to nl y t o i n creas e R&A’ s i n co m e b u tt o d i s al lo w a v ery

l arg e n u m

b er o f d edu ct i o ns o n R&A’ s 2 0 0 5 an d2 0 0 6 t ax retu rn s . Ry d er cal l edthes e “ cl i en tad m i n i s t rat i v e s erv i ces ,” “ l eg al an dp ro fes si on al ,” an d

“ m eal s an den t ert ai nm en t .” Th e Co m m i s s i o n er cl ai m edthatR&A fai l edt o
es t ab l i s h i t s en t it l em en tt o th e d educt i o n s . He al s o cl ai m edth at t o th e ex t en tth e d educt i o n s were fo r p aym en t s t o RLC u n d er t h e em p l oy ee-l eas i n g ag reem en t , we
s h o u ldd i s al l o wth em

b ecau s e t h atag reem en twas a s h am . 4
. Di v i den dTreat m en t An y d et erm i n at i o n ab o u tR&A’ s g ro s s i n co m e i s o n l y o n e p arto f t h e s t o ry . Th e Co m m i ss i o n er al s o wan t s u s t o d eci d e h o wm uch i n co m e t h e Ry d ers th em s el v es d eri v ed fro m

th e fi rm . He as s ert s th atRy d er recei vedal m o s t $ 1 6
m i l l io n i n co n st ru ct i v e d i v i den d s fro m R&A fo r 2 0 0 3 -1 1
. Th es e fu n ds , h e s ay s , fl owed t o Ry d er i n t h ree d i fferen t way s:

! fro m R&A t h ro u g h RLC fro m 2 0 0 3 -0 9,
! fro m R&A’ s s ev eral t ax p ro du ct s t o th e ran ch en t i t i es , an d- 6 9 -

[* 6 9 ] ! fro m R&A’ s b an kacco u n t s t o th i rdp art i es fo r t h e Ry d ers ’

b en efi t. i
. Fro m

R&A Th ro u g h RLC Th e Co m m is s i o n er d et erm i n edth at t he Ry d ers recei v edn earl y $ 8 .3 m i l l i o n i n d i v i d en di n co m e fro m

R&A t h ro u g h RLC. He reach edth i s co ncl u s io n b y p o ri n g th ro u g h th e K-1 s thatRLC i s s u edt o Ry der. He ad d edup th e m o n ey th at RLC d i s tri b u t ed , an dex cl u d edan y ci rcu lar fl ow o f t h es e fu n ds
. 3 2 He i ncl u d edth e

“ i n -k i n d” d i s t ri bu ti o n s th at RLC m ad e t o Ry d er wh en Ry der l i qui d at ed ESR o f Co u n s el , LLC, i n 2 0 0 4
. 3 3

i i
. Fro m

Tax Pro duct s t o Ran ch En t i t i es Th e Co m m is s i o n er al s o t raced th e m o ney th atwen tfro m R&A i n to th e
v ari o u s ran ch en t i t i es th atRy d er s etup t o b u y l an di n Ari zo n a an d New M ex i co . Hi s fi rs ts t ab at th e p ro b lem was RA Bo y er’ s an al y s i s i n wh i ch h e ad dedup t h e d ep os i t s fro m

th e acco u n ts o f th e v ari ou s t ax p ro du ct s th atwen ti n t o the Ry d ers ’

3 2 Ex cl u d in g th e “ ci rcu l ar fl o w o f fu n d s ” was i m p o rt an tb ecau s e Ry d er u s ed ad ju s t i n g jo u rn al en t ri es t o m ak e i ts eem h e was m ak i n g p aym en ts o n th e n o t es th ath e g av e t o RLC t o “p ay ” fo r t h e s t o cki n RLC t h ath e h ads i g n ed s ub s cri p t i o n ag reem en t s fo r i n 2 00 3 -0 5 . See s up ra p p . 2 9 -3 4
.

3 3 ESR o f Co u n s el , LLC, was a wh o l l y o wn eds ub s i d iaryo f RLC t h atRy d er creat ed i n 2 0 0 2 . So m e o f th e rev en ue g en erat edfro m th e So n -o f-BOSS p ro du ct was d iv ert edt o ESR o f Co u n s el an d t h en p as s edo n t o R&A an dth e Ry ders
. Wh en ESR o f Co u n s el d i s s o l v ed , i t s as s et s (p ri m ari l y i n th e fo rm

o f n o t es recei v ab l e) were as s u m edb y RLC, wh i ch t h en d i s tri b u t edth em t o t h e Ry ders
.- 7 0 -

[* 7 0 ] p ers o n al acco u n t s , i nt o acco u n t s fo r t h e ran ch en t i t i es , o r t o th i rdp art i es (e.g ., cred i t -card co m

p an i es ) t o p ay

th e Ry d ers ’ p ers o n al b i l l s . Bu t then --o n l y a weekb efo re t h e Ph o en i x p arto f t h e t ri al --Ry d er fi n al l y p ro duced th e fi n an ci al s fo r Ry d er Ran ch Co ., LLC. Th i s i n fo rm at i o n i n cl u d edreco rd s o f co nt ri b u t i on s an d l o an s th atwen ti n to Ry d er Ran ch acco u n t s . Th es e were p art i cu larl y h el p fu l , s ay s th e Co m m i s s i o n er, b ecau s e t h ey

s h o wedth e ex actam o u nt s th atwen ti n to t h e d i fferen t ran ch en t i ti es , an ds o el i m i n at edwh atm i g h t h av e b een d o ub l e-co u n t i n g . Us i n g th es e n ew fi nan ci al s an dRy d er’ s o wnt es t i m on y , th e Co m m i s s i o n er ad ju s t edh i s an al y s i s o f t h i s fo rm o f d i v i d en di n co m e. Th i s n ew i n fo rm at io n h el p edh i m

tweak t h e t i m i n g o f t ran s fers t o Ry d er Ran ch t o m ak e s u re t h ath e
co u nt ed i tas i nco m e wh eni t en t eredRy d er Ran ch ’ s acco un t s . Ital s o h el p edh i m
av o idd o ub l e co u n t in g i n co m e as m o n ey fl o wedfro m

o n e acco u n tt o an o t her wi th i n th e “ p ers o n al b o x .”

i i i
. Fro m

R&A’ s Ban kAcco u nt s t o Th i rdPart i es fo r th e Ry d ers ’ Ben efi t Th e Co m m is s i o n er al s o t reat edas d i v id en d s t h o se p aym en t s th atR&A m ad e t o thi rdp art i es fo r the b en efi to f t h e Ry d ers . Fo r y ears b efo re 2 0 10 , th es e p aym en t s were fi rs t ru n th ro ug h RLC an dreco rd edo n i t s b o o ks an d t ax retu rn s as d i s tri b u t i o n s o r ad v an ces . Bu t wh et h er fro m R&A d irect l y

o r fro m R&A t h ro u g h- 7 1 -

[* 7 1 ] RLC, t h es e al l eg edd i v i d en d s i ncl u d edp aym en t s t o Am eri can Ex p res s fo r th e Ry d ers ’ cred i t -card b i ll s an dt o th ei r p ers o n al co n tract o r. Th e s p eci fi c b an kacco u n t s fro m wh ich th i s m o n ey fl o w edwere t i t l ed

“ Ern es tS. Ry d er A Pro fes s i o n al Law Co rp o rat i o n ,” “ E SOP Leg al Co n s u l t an t s , In c.,” “ Co u n s el o r Cap i t al In c.,” an d“ W es tra Cap i tal M an ag em en tRet i rem en t Sav in g s Pl an .” Th e Co m m is s i o n er as s ert s th atth e n earl y $ 4 0 0 ,0 00 th at cam e fro m th es e acco u n t s was t raceab l e t o R&A’ s g ro s s recei p t s an d h adn o tb een b o o k edas l o an s o n Ry d er Ran ch Co m p an y ’ s fi n an ci al s . Th e Co m m is s i o n er al s o as s ert s th atRy d er u s edm o n ey fro m R&A t o p ay Ben Lel an dCo n s t ru ct i o n , In c., fo r wo rkd o ne o n t h e Ry d ers ’ h o m e. He traced th is
m o ney b y m at ch i n g am o u n t s ch arg edo n i n v o ices fro m th e co n s t ru ct i o n co m

p an y wi th ch eckn u m

b ers an dam o u n t s fro m

v ari o u s Ry der acco u n t s . Th e acco u n t s
u s ed to p ay

th es e i n v o ices were “ Co u n s el o r Cap i t al , In c.,” “ W es t ra Cap i t al M an ag em en t, In c. Ret i rem en tSav i n g s Pl an ,” “ Ben efact o r Fu n d i ng As s oc., In c.-- Gen eral Acco u n t,” “ Ex ecu Pro Sp eci al t y Serv i ces , In c.--Gen eral Acco un t ,” “ Ry d er Law Co rp .,” an d“ Ern es t S. Ry d er & As s o ci at es , In c., APLC.” An dfo r t ax y ears 2 0 1 0 an d2 0 1 1 th e Co m

m i s s i o n er fo u n d m o re t han $ 4 0 0 ,0 0 0 i n R&A fee i n co m e th atwen t t o p ay

Ben Lel an dCo n s t ru ct i o n. Th es e cred i t -cardan dco n t ract o r p aym en t s t o t al ed$ 8 4 9,5 47 .4 9
.- 7 2 -

[* 7 2 ] 5
. Th e Co m m is s i o ner’ s Al t ern at i v e Arg u m en t s Th e Co m m is s i o n er al s o as s ert edi n the al tern at i v e t hatev en i f we d o n ’ tfi n d th ati n co m e fl o wedt o Ry d er fro m R&A, i tcert ai n l y

fl o wedfro m

RLC t o Ry d er. Th e Co m m i ss i o n er th en ad d edup tran s fers fro m RLC t hath e s ai dwere i n co m e t o Ry d er: ! u nrep o rt edd i s t ri b u t i o n s fro m RLC co m

p u t edfro m

th e i n creas e i n Ry d er’ s d i st ri b u t i v e s h are fo r t ax y ears 2 0 0 5 -0 9 ; ! u nrep o rt edd i s t ri b u t i o n s fro m W es t ra Cap i t al M an ag em en tco m p u t ed fro m t h e i n creas e i n Ry d er’ s d i s t ri bu t iv e s h are fo r t ax y ears 2 0 0 5 -0 7 ; ! an u n rep o rt eds h o rt -t erm cap i t al g ai n d is t ri b u t i o n fro m W es t ra Cap i t al M an ag em en tfo r 2 0 0 5 ; ! u nrep o rt edwag es fo r 2 0 0 9 ; ! u nrep o rt edo t h er i n co m e fo r 2 0 0 4 , 2 0 1 0 an d 2 0 1 1 ; an d
! u nrep o rt edi n t eres ti n co m e fro m RLC. 3 4

3 4 Th e Co m

m i s s i o n er ackn owl ed ges th atm an y o f t hes e al t ern at i ve p o s i t i o n s are al read y

the s ub j ect o f s et t l em en t s o r p ri o r as s es s m en t s . Th e Co m m is s i o n er wi l l h av e t o ab at e an y

as s es s m en t s as req u i redt o av o i dd o ubl e t ax at io n .- 7 3 -

[* 7 3 ] 6
. Di s al l o w edDedu ct i o n s

i
. Sub s t an t iat i o n o f R&A Ex pen ses Al th ou g h m

u ch o f th e fi g h tb et ween Ry d er an d t he Co m m i s si on er was ab o utu n rep ort edi n co m e, t h e Co m m i s s i o n er al s o d i s al l o wedm an y o f t h e d educt i o n s th atRy d er an dh i s v ari o u s en t i ti es h adcl ai m ed . Th es e i n cl u d e:

Year Di sal l o wedd edu ct i o n s 2 0 0 4 $ 5 7 9 , 3 30 2 0 0 5 4 ,1 5 4 , 0 85 2 0 0 6 1 6 7 , 2 4 3 2 0 0 7 3 6 3 , 2 1 5 2 0 0 8 6 6 1 , 3 6 1 2 0 1 0 1 1 3 , 3 0 7 To t al 6 ,0 3 8 , 5 41 2 0 0 5 In ves tmen t

In ter es t Exp en s e . Ry der cl ai m ed a d edu ct i o n fo r i n v es t m en ti nt eres to f n earl y $ 3 5 0 , 0 0 0 o n h i s Sch edu l e A fo r 2 0 0 5
. Th e Co m m i s s i o n er d i s al l o wedthi s ex p en s e b ecau s e Ry d er rep o rt edi tas a fl o w t h ro u gh
ex p en s e fro m

RLC, b u tRLC’ s K-1 t o h i m i n cl u d ed n o s u ch am ou n t. Ry d er arg u es th i s was a m i s t ak e--h e s ay s th e d edu ct i o n was l eg i t , b u tth ath e s h ou l dh av e rep o rt edi to n h i s Sch edu l e E as “b u s i n es s i n teres t ” i n s t ead
.- 7 4 -

[* 7 4 ] 2 0 0 6-0 8 Un rei mb u r s ed Emp l o yee Exp en ses . Ry der cl ai m ed“ u n rei m b u rs ed
ex p en s es ” o n h i s Fo rm s 1 0 4 0 fo r 2 0 0 6 th ro u gh 2 0 0 8 o f:

Year Am o u n t 2 0 0 6 $ 1 6 7 , 1 33 2 0 0 7 3 5 7 , 3 1 3 2 0 0 8 5 8 8 , 8 3 6 To t al 1 ,1 1 3 , 2 82 Th e Co m m i ss i o n er d i s al l o wedth es e fo r th e s am e reas on as th e i n teres tex p en s e-- Ry d er cl ai m edthem

as fl o wth ro u g h ex p en s es fro m RLC, b u tth ey

were n o wh ere t o b e fo u ndo n RLC’ s o wn retu rn s . Ry d er n o w cl ai m s th atth es e “ u n rei m b u rs ed
em pl o y ee ex p en s es ” were al s o real l y “b us i n es s i n t eres t ” t h at h e s h o u l dh av e rep o rt edo n h i s Sch edu l e E. 2 0 0 4 , 2 0 0 5 , a n d 2 0 1 0 Ordi n a r y Lo s s es Fr o m RLC. Th e Co m m i s s i o n er d i s al lo wedl arg e am o u n ts o f o rd i n ary l o s s es t h atRy d er cl ai m edfl o wedth ro u g h fro m RLC: Year Am o u n t

2 0 0 4 $ 57 9 ,3 3 0 2 0 0 5 1 4 3 ,2 5 3 2 0 1 0 1 1 3,3 0 7 To t al 8 3 5,8 9 0- 7 5 -

[* 7 5 ] Th e Co m

m i s si o ner’ s p ri m ary

p o si t i o n i s t hatRy d er fai l edt o p ro v e t h ath e h ad en o u g h b as is i n RLC t o d edu ctth es e as o rd i n ary l os s es . Hi s b ackup arg u m en t i s thatRLC i ts el f d id n ’ tad equ at el y p ro ve t h ati t s u ffered th e l o s ses th ati tp as s ed th ro u g h t o Ry der. 2 0 0 8 Pr i or -Y

ea r Ad j u s tmen t Ba s is Ca r r

yo ver . Ry d er cl ai m edo n h i s 2 0 0 8 t ax return th ath e h ads u ffi ci en t b as i s i n RLC t o cl ai m a l o s s o f m ore t h an $ 7 0 ,0 0 0 th ath e co u l dn’ tcl ai m

earl i er fo r fai l u re t o h av e en o u g h b as is . See s up ra n o t e 2 2 ;
s ee al so s ec. 1 3 6 6 (d ). Un co n t es ted

W es tr a Ca p i ta l Ma n a g emen t

It ems . Th e Co m

m i ss i o n er al s o
as s ert ed th atRy d er h adm i s rep o rt eds ev eral i t em s fro m an o t her o f h i s p as s t h ro u g h
en t i t i es , W es t ra Cap i t al M an ag em en t : ! a l o n g -t erm

cap i t al l o s s o f n earl y

$ 4 9 m i ll i on fo r W es t ra Cap i t al M an ag em en ti n 2 0 0 5 ; ! a co n s equ en tl o ng -t erm cap i t al l o s s o f $ 1 3 m i l l i o n fo r Ry d er i n 2 0 0 5 ; ! l o n g-t erm

cap i t al l o s s es fo r Ry d er o f $ 1 0 8 i n 2 0 06 an d $ 5 ,8 0 6 i n 2 00 7 ; an d
! s m al l o rd in ary

l o s s es fo r Ry d er i n 2 00 5 thro u g h 2 0 0 7 thatt o t al ed $ 2,7 7 8.- 7 6 -

[* 7 6 ] Becau s e Ry d er d i d n o t co n t es tan y o f th es e i n h i s p o s tt ri al b ri ef, we d eem th em co nced ed . See M en d es v . Co m m i s s i o ner, 1 2 1 T.C. 3 0 8 , 3 1 2 -1 3 (2 0 0 3 ); Ry b akv . Co m

m i s s i o ner, 9 1 T.C. 5 2 4 , 5 6 6 (1 9 8 8 ). i i
. Ry d er Ran ch Co
. , LLC Lo s s es Th e Co m m is s i o n er al s o d i s al l o w edl os s es cl ai m edb y th e Ry d ers fo r Ry d er Ran ch Co ., LLC. He qu es t i o n s wh eth er t h e Ry d ers m at eri al l y p art i ci p at edi n th e
ran ch b u s i n es s an d wh et h er t hatb u s i n es s s ub s t an t i at edcert ai n ex p en s es . Here i s a
s u m m ary o f t h es e co nt es t edl os s es : Reas o n fo r d i s al l o wan ce
Year A d

j u s t m en t Sec. 1 6 2

(Lacko f s ub s t an t iat i o n ) Sec. 4 6 9

(Pas si v e l o s s ) 2 0 0 3 $ 5 3 1 ,5 8 3 X 2 0 0 4 9 2 7 ,4 9 7 X 2 0 0 5 1 ,0 5 4,7 25 X X 2 0 0 6 9 7 9 ,4 5 4 X X 2 0 0 7 5 7 5 ,8 7 8 X Ma t er i a l Pa r t i ci p a t i on . Th e Co m

m i s s i o n er arg u es th atan y l o s s s us t ai n ed b y Ry d er Ran ch i s p as si v e b ecau s e th e Ry d ers fai ledt o m at eri al l y p art i ci p at e i n i t s- 7 7 -

[* 7 7 ] act i v i t i es fo r t h e t ax y ears . 3 5 Th e ran ch es are i n s o u t heas tAri zo n a an d
s o u th wes tNew M ex ico , an dth e Co m m is s i o n er fi n d s i t h ard t o b el i ev e t h atth e Ry d ers co u l db e v ery

act i v e ran ch ers wh en th ey l i v edi n Po way , Cal i fo rn i a, an d Ry d er wo u l d dri v e o u tfro m R&A’ s o ffi ce i n San Di eg o. He b o l s t ers h i s arg u m en t wi th th e o b s erv at i o n th atth e Ry d ers em p l o y edan o n s i te m an ag er t o ru n th em . Th atwas J aco b W ard , wh o was th e o n si te m an ag er fro m Sep t em b er 2 0 0 4 t o Oct o b er 2 0 0 9 an dwh o o v ers aw t h e ran ch o p erat io n . W ardcred i b l y t es t i fi edth at h e wo u l ds ee Ry d er o ut atthe ran ch es atl eas to n ce a m o n t h wh i le h e was wo rk i n g th ere. Ry d er cl ai m edt o k eep an act i v it y l o g th ath e p ro du ceda week b efo re t h e Ph o en i x p arto f t h i s tri al . Th ere was n o t es t im on y ab o u th o w i twas creat ed , wh o creat ed i t, o r wh en i twas creat ed
.

3 5 Th e Co m

m i s s i o n er’ s p res en t at io n o f t h i s arg u m en th as b een i nco n s i s t en t o v er t h e l i v es o f t h es e cas es . Hi s n o t i ces o f d efi ci en cy fo r t h e Ry d ers al l eg e t h at th ey fai l edt o m at eri al l y p art i ci p at e i n Ry d er Ran ch Co ., LLC, o n l y fo r t ax y ears 2 0 0 3 , 2 0 0 4 , an d 2 0 0 7. Hi s n o t i ce o f fi n al p art n ers h ip ad m i n is t rat i v e ad ju s t m en t (FPAA) fo r Ry d er Ran ch Co
. , LLC, al s o m ak es th is arg u m en tfo r 2 0 05 an d2 0 0 6
. He m ai nt ai n s thi s arg u m en t fo r 2 0 0 3 , 2 0 0 4 , an d2 0 07 i n h i s o p en i n g b ri ef, an d rai s es i tfo r th e fi rs tt im e as t o 2 0 0 8 -1 1, b u t m ak es n o m en ti on o f 2 00 5 o r 2 0 0 6
. He al s o fi l eda m o t i o n t o co n fo rm h i s p lead i n g s s o th atwe m i g h t co n s id er th e s ect i on 4 6 9 i s s u e fo r 2 0 0 8-1 1. Wh i le we d en iedth at m o t i o n , we wi l l co n s i d er t he 4 6 9 i s s u e fo r 2 0 0 5 an d2 0 0 6, as Ry d er s p eci fi cal l y res p o n d edt o i ti n h i s an s weri n g b ri ef, m ak i n g i ttri edb y co ns en t . See Ru le 4 1 (b ).- 7 8 -

[* 7 8 ] S u b s ta nt i a t i on . Th e Co m

m i s s i on er i s s u edan FPAA 3 6 t o Ry d er as t ax
m at t ers p art n er o f Ry d er Ran ch Co ., LLC, o n Decem b er 2 0 , 2 0 1 1 , fo r Ry d er Ran ch ’ s 2 0 0 5 an d2 0 0 6 t ax y ears . 3 7 In i th e d is al lo wedal l farm l o s ses . Th e Ry d ers arg u e t hatthey

can s ub s t an t i at e t h es e d edu ct i o n s as o rd i naryan d
n eces s ary . Th e d i s p u t e ari s es fro m two Sch edul es F, Pro fi t o r Lo ss Fro m Farm i n g , Ry d er Ran ch Co ., LLC, at t ach edt o i t s 2 0 0 5 Fo rm 1 0 6 5 , U.S. Return o f Part ners h i p In co m e. On e o f t h es e Sch edu l es F rep o rt eda n etl o s s o f $ 9 6 7 ,5 5 1 ; th e
o th er a l o s s o f $ 87 ,1 74 . Th e fi rs tal l o cat ed t o Ry d er Ran ch Co ., LLC, th e d ep reci at i o n o f Pat t ern Farm s , LLC’ s Bo g g s , M o o re, an dSh u m ak er p ro p ert i es ; Can y o n Vi ew Ran ch , LLC’ s Ri v ers p ro p erty ; an d Ry d er Ran ch Co ., LLC’ s Lazy BK Ran ch p ro p ert y . Th e s eco n dSch edu l e F al l o cat edth e d ep recat i o n rel at edt o

3 6 If t h e IRS d eci d es t o ad ju s tan y p art n ers hi p i t em s o n a p art ners h i p retu rn , i t m u s tn o t ify th e i n d i v i du al p art n ers o f t h e ad ju s t m en t s b y

i s s u i n g an FPAA. See s ec. 6 2 31 (a). An FPAA g en eral l y i n cl ud es : (1 ) a n o t i ce o f fi n al p art n ers h i p ad m i n is trat i v e ad

ju st m en t; (2 ) Fo rm

8 7 0 -PT, Ag reem en tfo r Part n ers h ip It em s an d Part ners h i p Lev el Det erm i n at i o n s as t o Pen al t i es , Ad d i ti o n s t o Tax , an d Ad d i t i o n al Am o un t s , i ncl u d in g a Sch edul e o f Ad ju s tm en t s ; an d(3 ) a Fo rm 8 8 6 -A, Ex p lan at i o n o f It em s , l i s t i n g th e Co m m i s s io n er’ s o t h er ad

ju s t m en t s o r d et erm i n at i o n s.

3 7 He al s o i s s uedan FPAA fo r Ry d er Ran ch ’ s 2 0 0 7 t ax y ear i n Decem b er, 2 0 1 8 , aft er t he co m

p l et i on o f the t ri al fo r t h es e cas es . Th atFPAA i s n o tati s s u e h ere.- 7 9 -

[* 7 9 ] Ry d er Red Ro ckRan ch , LLC’ s Co o n Ran ch p ro p erty . Th e Sch edu les F al s o i n cl u d e d ep reci at io n ex p en s es fo r m u l t i p l e t rai l ers an da p o rt ab le ch uck wag o n . Fo r t h e t ax y ears 2 0 0 5 an d2 0 0 6, t he Co m m i ss i o n er arg u es th at Ry d er Ran ch Co ., LLC, cl ai m ed ex p en s es t h atwere act u al l y i ncu rredb y

Ry d er’ s o t h er
ran ch en ti t i es . He al s o arg ues t h atRy d er Ran ch i n fl at edth e b as es i n m an y o f t h e
as s et s fo r wh i ch i t cl ai m edd ep reci at i o n .

7
. Cal i fo rn i a Pas t el eri a Th e Ry d ers al s o cl ai m edl o s s es o n M rs . Ry d er’ s co o k i e b u si n es s . Duri n g th e y ears ati s s u e s h e o wn edan do p erat edCal ifo rn i a Pas t el eri a, In c. Sh e h el dal l th e s t o cko f t h e co m

p an y an dal l th e o ffi cer p o s i t i on s i n the b u s i n es s , ex cep tth at Ry d er h im s el f was i t s co u n s el
. Th e Co m m is s i o n er d i s al l o wedd edu ct i o ns atth e S co rp o rat i o n l ev el fo r t ax y ears 2 0 0 3 , 2 0 0 4, an d2 00 6 . On l y t h e fi rs ttwo y ears are s t i l l ati s su e, an dal l the tro ub l e co m es fro m

Cal i fo rn i a Pas t el eri a’ s fai l u re t o s ub s tan t i at e m an y o f i t s cl ai m edd edu ct i on s fo r i t em s s uch as l eg al fees , au t o m ob i l e ex p en s es , trav el
ex p en s es , an dt el ep h o n e ex p en s es . 3 8

3 8 Th e Co m

m i s s i o n er al s o d et erm i n edthati n th e 2 00 6 t ax y ear, M rs . Ry d er recei v eda $ 3 6 ,3 0 0 d i s tri b u t i o n i n ex ces s o f h er b as i s i n t h e co m pan y . Th e Ry d ers d i drep o rto n t h ei r 2 0 0 6 Sch edu l e D a $ 2 ,7 7 7 g ai n o n rep aym en t o f a l o an fro m Cal i fo rn i a Pas tel eri a, s o t h e Co m m is s io n er as s ert edthe d i fferen ce o f $ 3 3 ,5 2 3 as (co n ti n u ed ...)- 8 0 -

[* 8 0 ] 8
. Oth er Lo s s es Th ere are al s o n u m ero u s o th er m i scel l an eo u s l o s s i s s u es . Th e Co m m i s s i o n er d i s al l o wedthem i n fu l l :

Year Al ph a Do g M an ag em en t l o s s es Ry d er

In v es t m en t Part n ers l o s s es Net

o perat in g l o s ses Co v en t ry

M o t o rs l o s ses To t al 20 0 2 -0
- -0
- $ 2 7 2 ,6 4 4 -0
- $ 27 2 ,6 4 4 20 0 3 -0
- -0
- 1 3 4 ,4 0 0 -0
- 1 3 4 ,4 0 0 20 0 5 -0
- -0
- -0
- $ 2 ,8 1 9 2 ,8 1 9 20 0 6 $1 5 ,9 9 5 -0
- -0
- 3 ,4 0 2 1 9,3 9 7 20 0 7 3 9,2 2 1 $ 3 ,5 9 7 -0
- 7 ,1 3 8 4 9,9 5 6 20 0 8 3 ,7 2 6 -0
- -0
- -0
- 3 ,7 2 6 20 1 0 -0
- -0
- 1 4 8 ,3 6 8 -0
- 1 4 8 ,3 6 8 20 1 1 -0
- -0
- 3 1 1 ,9 1 7 -0
- 3 1 1 ,9 1 7 Al p h a Do g Ma n a g emen t Lo s s es . Al p h a Do g M an ag em en t , LLC, i s a l i m i t ed l i ab i l i ty co m

p an y thatRy d er o rg an i zedi n Wy o m i n g . He rep ort edn o np as s i v e l o s s es fro m

th e co m p an y fo r t h e t ax y ears 2 00 6 t hro u g h 2 00 8
. Th e Co m m i s s i o ner d i s al lo wedal l o f t h es e b ecau se Ry d er d i dn ’ tex p lai n h o wh e co m p u t edh i s b as i s .

3 8 (...co n t i nu ed ) u n rep o rt edi n co m e. Th e Ry d ers ag ree t h atth ey are l i ab l e fo r t ax o n t h e d i s tri b u t i o n s fro m

Cal i fo rn i a Pas t el eri a t o th e ex t en t th at t h ey ex ceed thei r b as i s , b u tth en th ey

fai l edt o d efen dth atb as i s. W e d eem th i s a co n ces s i o n . See M en d es , 1 2 1 T.C. at3 12 -1 3 ; Ry

b ak , 9 1 T.C. at5 6 6
.- 8 1 -

[* 8 1 ] Ryd

er In ves tmen t

Pa r tn er s Lo s s es . Ry d er cl ai m eda carry fo rwardl os s fro m Ry d er In v es t m en t Part ners , Lt d ., o n h i s 2 0 07 retu rn th atth e Co m m i s s i o n er d i s al lo wedb ecau s e Ry d er h ad n ’ ts ub s tan t i at edh i s b as is
. Net Op er a t i n g Lo s s es f

o r 2 0 0 2 , 2 0 0 3 , 2 0 1 0, a n d 2 0 1 1 . Th es e l os s es d ep en d edo n p ro o f o f l o s s es fro m o t h er t ax y ears : Th e Ry d ers ’ cl ai m edl o s s fo r 2 0 0 2 d ep en d edo n a carry fo rwardl o s s fro m 1 99 7 an da carryb ackl o s s fro m 2 0 0 4. Th i s 2 00 3 l o s s d ep en d edo n th e carryb ackl o s s fro m 2 0 0 4 as wel l . An dth ei r 2 0 1 0
an d 2 0 1 1 l o s s es d ep en d edo n carry fo rwardl o s s es as wel l . Th e Co m m i s s i on er d i s al lo wedth em

al l fo r l acko f s ub s t an t iat i o n . Co ven tr y Mo t o r s Lo s s es . Ry d er cl ai m ed p as s t h ro u g h l o s s es fro m Co v en t ry M o t o rs , Lt d., a p art n ers h i p t h ath e creat edt o o wnh i s co l l ect i o n o f cl as s i c cars . Th es e were rel at i vel y

s m al l. Th e Co m

m i s s i o n er d i s al l owedth em fo r t h ree
reas on s : ! l acko f p ro fi tm ot i v e u n d er s ect i o n 1 8 3 , ! l acko f s ub s t an t iat i o n o f h i s b as is i n th e p art n ers h i p , an d
! ab s en ce o f en o u g h p as s i v e i n co m e t o cl ai m th em u n d er s ect io n 4 6 9
. Th i s m et i cu l ou s nes s ju s tearn edth e Co m m i s s io n er a p ret ri al m o t i o n t o d i s m i s s fo r l acko f ju ri s d i ct i o n b ecau s e Ry d er arg uedth at TEFRA ap p l i ed t o an y
ex am i n at i o n o f Co v en t ry M o t o rs . He arg u edth atth e Co m m i s s i o ner n eed edt o- 8 2 -

[* 8 2 ] ch al l en g e i t s rep o rt i n g i n a s ep arat e p artn ers h i p-l ev el p ro ceed i n g . 3 9 Preced en tfo rcedu s (an dth e Co m m is s io n er co n ced edth ati twas ap p ro pri at e) t o g ran tRy d er’ s m ot i o n as t o wh eth er Co v en t ry M o to rs l ack eda p ro fi tm ot i v e, s ee GAF Co rp . & Sub s . v . Co m m i s s i o n er, 1 1 4 T.C. 5 1 9 , 5 27 -2 8 (2 0 00 ); cf. Gi n s b u rg
v . Co m m i s s i o n er, 1 2 7 T.C. 7 5, 8 3 (2 0 0 6 ), b u twe k ep t t h e o t h er t wo i s s u es fo r t ri al i n thes e cas es . Ry d er p u t al l o f t h es e d i s al l o wedd edu ct i o n s ati s s u e, b u tthen fai l edt o ad dres s th em i n h i s p o s t t ri al b ri ef. W e d eem th i s a co n ces si o n . See M en d es , 1 2 1 T.C. at3 1 2 -1 3 ; Ry

b ak , 9 1 T.C. at5 6 6
. C. Pen al t ies Al s o s t i l l ati s s u e i n th es e cas es i s t h e l i ab i l it y o f R&A an d t h e Ry d ers fo r
n u m ero u s p en al ti es an d ad d i t i on s t o t ax . Th es e are:

! s ect i o n 6 6 5 1(a)(1 ) ad d i t io n s t o t ax fo r fai l u re t o t i m el y fi l e,

3 9 Befo re i t s rep eal , s ee Bi p art i s an Bu d g etAct o f 2 01 5 , Pub . L. No . 1 1 4 -7 4 , s ec. 1 1 01 (a), 1 2 9 St at . at6 25 , p arto f t h e Tax Equ i t y an d Fi s cal Res p o n s i b i l i t y Act o f 1 9 82 (TEFRA), Pub . L. No . 9 7 -2 4 8 , s ecs . 4 0 1 -4 0 7 , 9 6 St at . at6 4 8 -6 7 1 , g o v ern edth e t ax treat m en tan dau d i tp ro cedures fo r m an y p artn ers h i p s . TEFRA p art n ers hi p s are s ubjectt o s p eci al t ax an dau d i t ru l es . See s ecs . 6 22 1 -6 2 34
. TEFRA req u i res th e u n i fo rm treat m en to f al l “part n ers h i p i t em [s ] ”--a t erm d efi n ed b y s ect i o n 6 2 3 1 (a)(3 )--an d i t s g en eral g oal i s t o h av e a s i n g l e p o i n t o f ad j u s t m en t fo r t h e IRS rat h er t h an h av i n g i tm ak e s ep arat e p art n ers h i p -i t em ad ju s tm en t s o n each p art n er’ s i n d i v i du al retu rn . See H.R. Co n f. Rep t . No
. 9 7 -7 6 0 , at 5 9 9 -6 0 1 (1 9 8 2), 1 9 82 -2 C.B. 6 0 0 , 6 6 2 -6 3
.- 8 3 -

[* 8 3 ] ! s ect i o n 6 6 5 1(a)(2 ) ad d i t io n s t o t ax fo r fai l u re t o t i m el y p ay , ! s ect i o n 6 6 5 1(f) p en al t i es fo r frau du len t fai l u re t o fi l e, ! s ect i o n 6 6 5 5 p en al t ies fo r fai lu re t o p ay es t im at edco rp o rat e i n co m e t ax , an d
! s ect i o n 6 6 6 2 accu racy -rel at edp en al t i es . Th e Co m m is s i o n er as s ert eds o m e o f t h es e ag ai n s to n l y R&A, an ds o m e ag ai n s to n l y t h e Ry ders ; h e as s ert eds o m e o n l y fo r s o m e y ears an d n o t o th ers ; an d
s o m e h e as s ert edo nl y

i n th e al t ern at i v e. An d , as i s co m m o n, s o m e we h av e t o d i s cu s s o n th ei r m eri t s an d s o m e we d o n otb ecau s e o f p ro cedu ral fl ub s . D. Tri al Th e Ry d ers fi l edt i m el y

p et i t i o n s , an dwe tri edth e cas es i n two s es s i o n s
o v er t wo m o n t hs
. 4 0 Th e reco rds p rawl edo v er 8 m i l l i o n p ag es . Attri al th e Co m

m i s s io n er i n t ro du cedtwo BDAs b y RA Bo y er. Th es e BDAs are wh atth e Co m

m i s s i o n er rel i es o n fo r h i s p o s i t i o n s o n h is ad ju s t m en t s t o g ro s s recei p t s an d u n rep o rt edd i v i d en d s . As we h av e m en t i o ned , th e Co m m i s s i o n er d i d tweakth es e an al y ses a b i tas Ry d er p ro du cedm ore i n fo rm at i o n .

4 0 Atal l rel ev an tt im es , p et i t i o n ers ei t h er res i dedo r h adth ei r p ri nci p al p l aces o f b us i n es s i n Cal i fo rn i a o r Ari zo n a, wh i ch m ak es th e d eci si o n s i n th es e cas es p res u m

p t i vel y ap p eal ab l e t o th e Ni n t h Ci rcu i t . See s ec. 7 48 2 (b )(1 )(A), (B), (E).- 8 4 -

[* 8 4 ] Th e p art i es co n ced eda n u m b er o f i s s u es , b u ttwo v ery l arg e ad ju s t m en t s
rem ai n : u n rep o rt ed g ro s s recei p t s fro m R&A fo r 2 0 0 5 th ro u g h 2 0 09 an d
u n rep o rt edd i v id en d i n co m e t o th e Ry d ers fo r 2 0 0 3 th ro u gh 2 0 1 1 . W e’ l l t ack l e th o s e fi rs tan d t h en ru n th ro u g h a n u m b er o f t h e u n s et t l edm i s cel l an eo us i s s u es . OPINION I. Bu rd en o f Pro o f Th e p art i es b i ck er ab o u tth e b u rd en o f p ro o f, b u t wi t h m o re t han 8 m i l l i o n p ag es o f ev i d en ce an d2 ,3 0 0 p ag es o f t ran s cri p twe can d eci d e al m o s tal l th e i s s u es
o n th e p rep o n d eran ce o f t he ev i d en ce. On e ex cep t i o n i s th e i s su e o f frau d --s ect i o n 7 4 5 4 an dRu le 1 4 2(b ) requi re t h e Co m m i s s i o n er t o p ro v e frau db y cl ear an d
co n vi n ci n g ev id en ce. W e n o te Ry d er’ s at t ack s o n th e p res u m p t i o n o f co rrect n es s th atwe’ v e s ai d at t ach es t o th e Co m

m i s s i o n er’ s n o t i ces o f d efi ci en cy an db an k -d ep o s i tan al y s es . W e d o n ’ tn eedt o ru l e o n th es e o b ject io n s --t he p ro fu s io n o f ev i d en ce, wh i ch fo r th e BDAs i n cl ud es cred i b l e t es t i m o n y fro m the rev enu e ag en t s wh o co m pi l ed th o s e an al y s es t o g et her wi t h t hei r s o u rce m at eri al --m ak es th em m oo t . W e d o n o t e th atth es e cas es p o s e ques ti o n s o f u n rep o rt edi n co m e, an dth e Ni n t h Ci rcu i th as h el dth ati n s u ch cas es the Co m m i s s i o n er m

us tes t ab li s h s o m e co n n ect i o n b et ween a t ax p ay er an d i n co m e-p ro du ci n g act i v i t i es . See W ei m ers k i rch v . Co m m i s s i o n er,- 8 5 -

[* 8 5 ] 5 9 6 F.2 d3 58 , 3 6 2 (9 t h Ci r. 1 9 7 9 ), rev ’ g 6 7 T.C. 6 7 2 (1 9 77 ). A “ m in i m al
ev i d en t i ary

fo u n d at i o n ” i s al l th ati s req u i red . See i d . at 3 6 1. Th e Co m m i s s i o n er’ s i n tro du ct i o n o f v o l um es o f ev i d en ce--wh i ch h e ap t l y referred t o as “b u ck et s ”--an d th e ex t en s i v e b ackup t o h is BDAs s h ow m u ch m ore t han a m i ni m al ev i d en t i ary fo u n dat i o n t o l i nkRy d er an d R&A t o th i s i n co m e. W e al s o n o t e o u r ev er m o re el ab o rat e ru l es o n th e b u rd eno f p ro duct i o n fo r p en al t i es . Sect i o n 7 4 9 1(c) p l aces th i s b u rd en o n t h e Co m m i s s i on er fo r p en al t i es th ath e as s ert s ag ai n s t i n d iv i du al s . W e h el di n Graev v . Co m m is s i o n er (Graev III), 1 4 9 T.C. 4 8 5 (2 01 7 ), s up pl em en t i n g an do v erru l in g i n p art1 47 T.C. 4 6 0 (2 0 1 6 ), th atth is m ean s th e Co m

m i s s io n er h as t o p ro du ce ev id en ce t h at“ t h e i ni t i al d et erm i n at i o n o f s u ch as s es s m en t[i .e., o f t he p en al t i es ] [wa] s p ers o n al ly ap p ro v ed (i n wri t i n g ) b y

the i m m ed iat e s up erv i so r o f t h e i n d iv i du al m ak i ng s u ch d et erm i n at i o n . ” See i d . at4 9 2 -9 3 . Sect i o n 6 7 5 1 (b )(2 ) ex cep t s cert ai n p en al t i es fro m th i s wri t t en s up erv i s o ry ap p ro v al req u i rem en t--i n cl u d i n g t h o se u n d er
s ect i on s 6 6 5 1 , 6 6 54 , an d6 6 5 5
.- 8 6 -

[* 8 6 ] II. R&A’ s Un rep ort edIn co m e 4 1 Th e Co m m is s i o n er al l eg es th atR&A m as s i v el y u n d errep o rt edi t s i n co m e fo r t ax y ears 2 0 05 -0 9 b y

as s i gn i n g i n co m e t o o t her en t i t ies 4 2 an dt ak i n g v ery l arg e
an d u n s up p o rt ab l e d edu ct i o n s fro m wh ati n co m e i t d i drep o rt . Hi s k ey p ro o f i s the BDAs , wh i ch s tartb y equ at in g d ep o s i t s wi t h i n co m e, b u tth en s ub t ract an y

i den t i fi ab l e n o n tax ab l e i t em s, d edu ct i bl e ex p en s es , o r i n co m e th atwas rep ort ed
. See Cl ayt o n v . Co m m i s si o n er, 1 0 2 T.C. 6 3 2 , 6 4 5 -4 6 (1 9 9 4). Th e Co m

m i s s i o n er al s o i n t ro du cedev i d en ce t hats o m e s p eci fi c R&A d ep os i t s i n t o R&A’ s acco u nt s were t ax ab l e i n co m e. Th atl eav es u s wi t h a m i x o f
s p eci fi c-i t em

an db an k -d ep os i tan al y s es --s p eci fi c-i t em s an al y ses o n 5 acco u n t s

4 1 So m e o f t h e i n co m e t h at t h e Co m m i s si on er al l eg es i s p ro perl y rep o rt ab l e b y R&A h as b een at t ri b u t edt o cert ai n en t i t i es b y way o f co n ces s i o n s , s et t l em en t s , an d p ri o r as s es s m en t s. Th e Co m m i s s i o n er h as ag reedt o ab at e as s es s m en t s o n co n ced i ng en t it i es t o th e ex t en tth e Co u rtfi n d s th e i n co m e i n ques t i o n t o b e R&A’ s. See s upra n o t e 3 4
.

4 2 As we ex p l ai n b el o w, th e Co m m i s s i o n er al s o arg u es th atth es e en t i t i es were act u al l y

ju s t t ax p ro du ct s th atR&A s o l dt o i ts cl i en ts . Wh eth er t h e en t i t i es were “ s h am s ” o r were i n factl eg i t i m at e b u ts i m p ly d i d n o t hi n g t o earn fees th at were p ro perl y

at t ri b u tab l e t o R&A i s o f l i tt l e co n s equ en ce, as “ th e effect wo u l db e t o ren d er [t h e en t i t i es ] a n u ll i t y fo r Fed eral i n co m e t ax p u rp o ses .” See Kel l er v . Co m m i s s i o n er, 7 7 T.C. 1 01 4 , 1 0 3 1 (1 9 81 ), aff’ d7 2 3 F.2 d5 8 (1 0t h Ci r. 1 9 8 3 ). M o reo v er, i ti s n ’ tn eces s ary t o fi n dth atth e en t i t i es were s ham s i n o rd er t o fi n d th atth ey g en erat edi n co m e fo r R&A. See Haag v . Co m m i s s i o n er, 8 8 T.C. 6 0 4 , 6 1 1 (1 98 7 ), aff’ d wi t h o ut p ub l is h edo p in i o n, 8 5 5 F.2 d8 5 5 (8 t h Ci r. 1 9 8 8 ).- 8 7 -

[* 8 7 ] u s edb y

Ry der an dR&A, an db an k-d ep o s i tan al y s es o n 4 6 acco u nt s u s edb y Ry d er an d R&A. Here’ s a s u m m ary o f th e co m

b in edres u l t s : Year Per ret u rn Per Co m m i ss i o n er Ad

ju s t m en t 2 0 0 5 $ 1 , 57 1 ,2 8 6 $4 ,5 1 1 ,3 31 $ 2 ,9 40 ,0 4 5 2 0 0 6 1 , 66 6 ,8 1 0 3 ,7 1 8 ,4 35 2 ,0 51 ,6 2 5 2 0 0 7 -0
- 2 ,6 3 5 ,6 75 2 ,6 35 ,6 7 5 2 0 0 8 -0
- 2 ,1 0 8 ,4 66 2 ,1 08 ,4 6 6 2 0 0 9 -0
- 1 ,8 2 3 ,8 33 1 ,8 23 ,8 3 3 To t al 3 , 23 8 ,0 9 6 1 4 ,7 9 7 ,7 40 1 1 ,5 59 ,6 4 4 R&A fai l edt o fi l e ret u rn s fo r 2 0 0 7 th ro ug h 2 0 0 9 . Th e Co m m i s s io n er p rep areda s ub s t i tu te fo r retu rn fo r each o f t h es e y ears u n d er s ect i o n 6 0 2 0 (b ). Ry d er l at er g av e RA Ph an retu rn s fo r R&A’ s 2 00 7 an d2 0 0 8 t ax y ears . Th es e
were v ery l at e, an dwe n o t e t h atth e g ro s s recei p t s rep ort edwere n ots ubt ract ed fro m th e BDAs fo r t h o s e y ears . (Th ey weren ’ tad dedt o th em

ei t her.) A. As s i g n m en t o f In co m e b y Ry d er & As s o ci at es W e as kfi rs t wh et h er i ti s R&A t h ats h o u l db e t ax edo n t he m o n ey th atwen t i n t o th es e acco u nt s . Th e p ro bl em i s o n e o f th e o ld es ti n t ax l aw, an dev ery l as t- 8 8 -

[* 8 8 ] s tu d en ti n In t ro Tax l earn s th ati t was s o l vedl o n g ag o b y J u st i ce Ho lm es i n Lu cas v . Earl , 2 8 1 U.S. 1 1 1 , 1 1 4 -1 5 (1 9 3 0 ): 4 3 Th ere i s n o d o ubt t h at t h e s tatu t e co u ldt ax s al ari es t o th os e wh o earn edth em

an d p ro v i d e t h atth e t ax co u ldn o t b e es cap edb y an t i ci p at o ry

arran g em en t s an dco n t ract s h o wev er s k i l fu l l y d ev is edt o p rev en tthe s al ary

wh en p ai dfro m v es t i n g ev en fo r a s eco n d i n th e m an wh o earn edi t . Th ats eem s t o u s t h e i m p o rto f th e s t atu te b efo re u s an dwe th i n kth atn o d i s t i n ct i o n can b e t ak en acco rd in g t o t h e m o t i v es l ead in g t o t h e arran g em en t b y wh i ch t h e fru i t s are at t ri b u t ed t o a d i fferen ttree fro m

th ato n wh i ch th ey g rew. Th i s “ trees an dfru i ts ” m et ap ho r h as l o n g s i n ce ri p en edi n t o cl i ch e, b u ti ti s s t i l l g en eral l y th o u g ht t o b e an accu rat e s t at em en t o f t h e l aw. In co m e s h o u l d b e t ax ed

4 3 Th ere i s n o ev i d en ce t h at t h e co n tract an al y zedi n Earl was m o ti vat edb y th e i n co m e t ax , s i n ce t h e Earl s ag reedt o i ttwel v e y ears b efo re t h e ad o p t i o n o f t h e Si x t een th Am en dm en t . An d , s i n ce t h ey were Cal ifo rn i an s , M rs . Earl wo u l dh av e h ad an i nt eres ti n an y

aft er-acq u i redp ro p ert y

an d i n co m e u n d er t h at s tat e’ s co m m u n it y -p ro p ert y

l aw. Wh enthe Earl s cam e b efo re o ur p red eces s o r, th e Bo ard o f Tax Ap p eal s , they

arg u edth atth ei r o n l y

i n t en t was t o t ak e al l th ei r i n co m e an d p ro p erty o u t o f t h e co m

m u n i ty -p ro p ert y

ru l es . Earl v . Co m

m i s s i o n er, 1 0 B.T.A. 7 2 3 , 7 2 4 (1 9 2 8), rev ’ d , 3 0 F.2 d8 9 8 (9 t h Ci r. 1 9 2 9 ), rev ’ d , 2 8 1 U.S. 1 11 (1 9 3 0 ). Th en , as n o w, Cal i fo rn i a m ak es th e co m m u n i t y -p ro p erty

ru l es a d efau l t , b u to n e th ata m arri edco up le can ag ree b et ween th em s el v es t o s up p l an t t o m ak e t hei r fu tu re i n co m e an dp ro pert y s ep arat el y

o wn edo r o wn edas jo i n tt en an t s wi t h th e ri gh t o f s u rv i vo rs h ip
. See In re M arri ag e o f Val li , 3 24 P.3 d 2 7 4 , 2 7 6 (Cal . 2 0 1 4 ). M r. Earl t es t i fi edb efo re u s th atb acki n 1 9 01 h e h adt ak en i l l , an dthe ag reem en t was a s im p l e an d el eg an tway

o f p l an n i n g fo r h i s es t at e. Earl , 1 0 B.T.A. at7 2 3
. Had M r. Earl d i ed , an dco u rt s res p ect edth ei r ag reem en t , M rs . Earl wo u l dh av e h ad o wn ers h i p o f al l th ei r p ro p ert y wi t h o u tan y

n eedfo r p ro b at e. No wad ay s th at ’ s a res u l tp eo p le ach i ev e (i n p art ) wi t h rev o cab l e t ru s t s . Th e s to ry was u n eart h ed an d d es cri b edi n d et ai l i n Pat ri ci a A. Cai n, “ Th e St o ry o f Earl : Ho w Ech o es (an d M et ap h o rs ) fro m

th e Pas tCo n t i n u e t o Sh ap e th e As s i gn m en t o f In co m e Do ct ri n e,” i n Tax St o ri es 3 0 5 (Pau l L. Caro n ed ., 2 ded . 2 0 0 9 ).- 8 9 -

[* 8 9 ] t o h i m

wh o earn s i t , s ee Co m

m i s s i o n er v . Ban ks , 5 4 3 U.S. 4 2 6, 4 3 3 (2 0 0 5 ),
an d o n e can ’ tes cap e t ax b y as si g n i n g i nco m e t o an o t h er i n ad v an ce, s ee i d .; s ee al s o Un i tedSt at es v . Bas y e, 4 1 0 U.S. 4 41 , 4 4 9 -5 2 (1 9 7 3 ) (p art n ers h i p m em b ers
can n otav o i dt ax at i on b y

d i v ert i n g i n co m e t o ret i rem en ttru s tfu n d); Co m m i s s i o n er
v . Su n n en , 3 3 3 U.S. 5 9 1 , 6 04 (1 9 48 ); Tro us d al e v . Co m m i s s i o n er, 1 6 T.C. 1 0 5 6 , 1 0 6 5 (1 9 5 1 ) (“ [I] th as l o n g b een h el d t hata t ax pay er m ay n o t av o i dh i s t ax l i ab i l i ty on i n co m e wh ich h e h as earn edb y th e s i m p l e ex p ed i en t o f drawi n g up l eg al p ap ers an das s i g n i ng th ati n co m e t o o th ers ”), aff’ d , 2 1 9 F.2 d5 6 3 (9 t h Ci r. 1 9 5 5 ). Ry d er ag rees wi t h th i s g en eral s tat em en t o f l aw, b u t arg u es th ath e carefu l l y p l an t eda g reat m an y t rees i n h i s o rch ard an dth atfru i t actu al ly g rew o n them . Or t o d i s p en s e wi t h t h e m et ap ho r, th atwe s h o u l d fi n d t h atth e m an y , m an y s ep arat e
en t i t i es h e creat edearn edth ati n co m e th em s el ves . Ry der co n t en d s we m u s t
res p ectthes e s ep arat e en t i t ies u n d er M o li n e Pro p s ., In c. v . Co m m i s s io n er, 3 1 9 U.S. 4 3 6 , 4 3 8 -3 9 (1 9 4 3 ), i n wh i ch th e Sup rem e Co u rt h el d :

Th e d o ct ri n e o f co rp o rat e en t i t y fi ll s a u s efu l p u rp o s e i n b u s i n es s l i fe. Whet h er t he p u rp o s e b e t o g ai n an ad v an t ag e u n d er t h e l aw o f t h e s t at e o f i nco rp o rat i o n o r t o av o ido r t o co m p ly wi t h th e d em an d s o f cred i to rs o r t o s erv e t h e creat o r’ s p ers o nal o r u n d i s cl o sed co n v en ien ce, s o l o n g as th atp u rp o s e i s th e eq u iv al en to f b u s i nes s act i v i t y o r i s fo l l o wed b y th e carry i n g o n o f b u s in es s b y th e co rp orat i o n , th e co rp orat i o n rem ai n s a s ep arat e t ax ab l e en t it y .- 9 0 -

[* 9 0 ] Ry d er arg u es th ati twas th es e en t i t i es th atearn edan d recei v edth e i n co m e fo u n d b y t h e Co m

m i s s i o n er’ s rev en u e ag en t s , an dth atR&A was ju stth ei r l awy er. Al th ou g h the Co m

m i s s i o n er fai l edt o d o s o h im sel f, we m u s tal s o ack n owl ed ge t h e s t atu t o ry av en u e g en eral l y

av ai l ab le i n cert ai n s i tu at i on s t o real lo cat e i n co m e am o n g t ax p ay ers . Sect i o n 4 8 2 p ro v i des i n rel ev an tp artth at : In an y cas e o f t w o o r m o re o rg an i zat i o n s , trad es , o r b u s i n es s es (wh et h er o r n o ti n co rp o rat ed , wh et h er o r n o to rg an izedi n t he Un i t ed St at es , an d wh et h er o r n o taffi l i at ed ) o wn edo r co n t ro l l ed d irect l y o r i n d i rect l y b y the s am e i n t eres ts , th e Secret ary m ay d i s t ri b ut e, ap p o rt io n , o r al l o cat e g ro s s i nco m e, d edu ct i o n s, cred i t s , o r al l o wan ces b et ween o r am o n g s u ch o rg an i zat i o n s, trad es , o r b u s i n es s es , i f h e d et erm in es th ats u ch d i s t ri b u t i on , ap po rt i o n m en t , o r al l o cat i o n i s n eces s ary

i n o rd er t o p rev en tev as i o n o f t ax es o r cl earl y t o refl ectth e i n co m e o f an y o f s uch o rg an i zat io n s , trad es , o r b u s i n es s es . Th e co m m o n -l aw as s i gn m en t -o f-i n co m e d o ct ri n e an ds ect io n 4 82 o v erl ap
co n si d erab l y , as th e l at t er was d ev i sedt o p ro v i d e a “ d et ai l edm ech an i sm t o d eal wi th th e t ax -av o i d an ce p ro bl em s wh i ch s p u r t h e as s ig n m en t o f i n co m e d o ct ri n e.” Kel l er v . Co m

m i s si o ner, 7 7 T.C. 1 0 1 4 , 1 0 3 4 (1 9 8 1 ), aff’ d , 7 2 3 F.2 d5 8 (1 0 t h Ci r. 1 9 8 3 ); cf. St ewartv . Co m m i s s i o n er, 4 3 T.C.M . (CCH) 1 1 1 9 , 1 1 24 n .1 0 (1 9 8 2 ), aff’ d , 7 1 4 F.2 d9 7 7 (9 t h Ci r. 1 9 8 3 ). An al y s i s u n d er t h e two th eo ri es , therefo re,
s h o u ldg en eral ly

n o tl eadt o d i fferen tres u l t s. Kel l er, 7 7 T.C. at1 0 3 4. Tran s act i o ns v u l n erab l e t o at t acku n d er o n e t heo ry are g en eral l y

equ al l y- 9 1 -

[* 9 1 ] v u l n erab l e u n d er t he o th er, an db o t h t h eo ri es are t y p i cal l y i nv o k ed t o g et h er. 4 4 Cf. Bo ri s I. Bi t t ker, “ Perv as i ve J u d i ci al Do ct ri nes i n th e Co n s tru ct i o n
o f t h e In t ern al Rev enu e Co d e,” 2 1 Ho w. L.J . 6 9 3 , 7 0 9 (1 97 8 ). Des p i t e th es e
s i m i l ari t i es , s o m e co u rt s h av e h el dth ats ect i o n 4 8 2 i s t h e b et ter t o o l t o real l o cat e i n co m e am o n g t ax p ay ers , atl eas ti n ci rcu m st an ces n o t “ heav il y frei g h t edwi t h t ax
m o ti v es .” See Ru b i n v . Co m m i s s i o n er, 4 2 9 F.2 d6 50 , 6 5 3 (2 d Ci r. 1 9 7 0 ), rev ’ g
an d rem an di n g 5 1 T.C. 2 5 1 (1 9 6 8 ); s ee al s o Fo g l es on g v . Co m m i ss i o n er, 6 2 1 F.2 d 8 6 5 , 8 7 2 (7 t h Ci r. 1 9 8 0 ), rev ’ g an drem an d i n g T.C. M em o . 1 9 7 6 -2 94
. Bu tch o os i ng b et ween thes e t wo t o ol s i s n o t s om et h i n g we m u s td o h ere, b ecau s e th e Co m

m is s i o n er l efts ect i o n 4 8 2 i n th e s h edb y fai l i n g t o m en t i o n i ti n
an y o f h i s rel ev an tn o t i ces o f d efi ci en cy , p l ead i n g s, m em o ran d a, o r b ri efs --an dth e Ry d ers d i dn o to b

ject . Th e Ni n t h Ci rcu ith as h el dth at“ n o rel ian ce m ay b e p l aced
o n Sect i o n 4 8 2 t o ju s t i fy

a d eci s i o n [wh en ] th e Co m m i s s i o n er d i dn o trel y

up o n i t
an d g [a] v e n o n o t i ce o f s u ch i s s u es i n h i s No ti ce o f Defi ci en cy t o [t he t ax p ay er] .” M ax wel l Hard ware Co . v . Co m m i s s i o n er, 3 4 3 F.2 d 7 1 3 , 7 21 (9 t h Ci r. 1 9 6 5).

4 4 Th ere i s o n e s i tu at io n wh ere s ect io n 4 82 can no tb e i n vo k edb u tth e co m m o n -l aw m et h odcan , i
. e., “ wh ere t h e t ran sact i o n ati s s u e was n otb et ween two o r m ore ‘ o rg an i zat i o n s , trad es , o r b u s in es s es ’ wi t h i n th e m ean i n g o f t h e p ro v is i o n .” St ewart , 7 1 4 F.2 d at9 8 9 (ci t i n g Fo g l es o n g v . Co m m i s s i o n er, 6 9 1 F.2 d 8 4 8 (7 th Ci r. 1 9 82 )).- 9 2 -

[* 9 2 ] Th erefo re o u r an al y s i s h as t o s t ickt o th e co m m o n -l aw as s i g n m en t -o fi n co m e d o ct ri n e. Th i s i s a n ew b at t le i n an o l dfi g h t , an dt o referee i twe m u s td eci d e i f R&A
was th e t ru e earn er o f t h i s i nco m e. To d o s o , we l o okath o wR&A’ s cl i en ts p ercei v edth e s erv i ces th atR&A p ro v i d ed , wh atth es e s erv i ces actual l y were, an d h o w the i n co m e was p ro du ced
.

1
. Wh atR&A Lo o k edLi ke t o Cl i en t s Fro m th e t i m e i to p en edi t s d o o rs , R&A m ark et edt ax -s av i n g p ro du ct s t o p o t en t i al cl i en ts . R&A h i redem p l o y ees s p eci fi cal l y

t o p ro m ot e i t s p ro du ct s t o h i g h -i n co m e earn ers an dth ei r CPAs . Itwas R&A’ s n am e t h at was o n t h e p ro m o t io n al m at eri al s an dl et t ers t o p ro s p ect i ve cl ien t s --b ro ch u res , v i d eo s , an d wri t ten l eg al o p i n i o n s ab o u tth e t ax b en efi t s th atth ey co u l do b t ai n . Ry der h i m s el f
wo u l dm eetwi t h cl ien t s t o d i s cu s s th es e s erv i ces , an d h e h i m s el f wo u l d fo l l o w up wi th l et t ers t o ex p l ai n t h es e p l an s an dth ei r p ro p o s ed co st s . Th e cl i en t s al l ap p eared o n p ap er t o b e d oi n g b u s i nes s wi t h o n e o f t h e d i fferen t g ro up p ro du ct s . Th ere were, h owev er, al way s s i d e ag reem en ts b et ween th e cl i en t s an dR&A t h atwere al m o s tal l o ral --atl eas tfo r t h es e g ro up p ro du ct s . Th ere were wri t t en fee ag reem en t s , b utth es e were s i g nedb y a cl i en tan d a g ro up p ro ducten t i t y

th atR&A co n t ro l l edan dwh i ch R&A u s edt o ex ecu t e t he u n i qu e t ax- 9 3 -

[* 9 3 ] p l an . W e s p eci fi cal ly fi n dth at t h e cl ien t s th em s el v es tho u gh t t h ey were h i ri n g R&A t o p ro v i d e ret i rem en tp l an s. Fo r ex am p l e, M i ch ael Go ld s t ei n , a GCO p l an cl i en to f R&A, cred i bl y t es t i fi ed t hath e wen tt o s ee Ry d er “ fo r s o m e ad v i ce
as far as ret i rem en t p l an ni n g ” an dRy d er en dedup p ro v id i n g h i m “ at t o rn ey
s erv i ces i n th atreg ard .” Kev i n W i n dh am , an ASIG cl i en t o f R&A, t es t i fi edth at th e fees h e p ai d t o Ry d er were p arto f h i s ret i rem en tp l an . Ry d er s t at edth atth es e p ro duct s were es t ab l i s h ed t o creat e al t ern at iv e way s fo r cl i en t s t o accu m u lat e ret i rem en ts av i n g s . R&A i t s el f i n v en t ed t hes e g ro up p ro du ct s an dm ad e t hem ru n . R&A i t s el f m ark et edthe s erv i ces t o s etth em up . R&A em pl oy ees b i l l edcl i en t s , an d R&A em

p l o y ees co n t ro l l edth e cl i en ts ’ acco un t s. As far as th e cl i en t s kn ew, th ey were o n l y

ev er wo rk i n g d i rect ly

wi t h R&A. 2
. Wh atServ i ces R&A Pro vi d ed W e al s o l o o k edatth es e d eal s fro m R&A’ s p ers p ect i v e. An dfro m th i s p ers p ect i v e, o n e s ees R&A i t s el f p u t t i n g i n t o p l ace t h e “ an ci ll ary affi l i at ed b u s i n es s es ” t h ati tu s edt o ex ecu t e t he d i fferen t“ u n i qu e t ax p l an s . ” Itwas R&A th atcreat edth e n u m ero u s co rp o rat i o n s , p art ners h i p s , an d l i m i t edl i ab i l i t y
co m p an i es th atth es e t ax p l an s req u ired . Itwas R&A t h atfi l edth e n eces s ary p ap erwo rk wi t h the IRS t o el ecth o wth es e en t i ti es wo u l db e t ax ed . On ce t h e
s tru ctu res were i n p l ace, i t was R&A t h atwen to utt o fi n dth e cl i en t s t o b u y th em .- 9 4 -

[* 9 4 ] Ry d er arg u es th ateach o f t h es e an ci l l ary affi l i at edb u s i n es ses i s an en t i t y
u n t o i t s el f t h atwe m

us t res p ect . W e t h i n kth is co n fu ses th e co n cep t o f res p ectfo r th e co rp o rat e fo rm

an dthe co n cep t th ati n co m e i s t ax edt o th e o ne wh o earn s i t . Ry d er s ay s thateach o f th es e co rp o rat i o n s was act i v el y en g ag edi n a t rad e o r b u s i n es s an dearn edi t s o wni n co m e t h ro ug h th i s trad e o r b u s in es s . Inh i s v i ew, R&A m erel y

p ro vi dedl eg al an dad m i n is t rat i v e s erv i ces t o t h es e an ci l lary b u s i n es s es , b utth os e b u s i n es s es th em s el ves g o t p ai dfo r s erv i ces th ey p ro v i d ed
. Th e Co m m i ss i o n er s ay s th atth es e an ci l l ary b u s i n es s es ju s tm i m ick edl eg i ti m at e b u s i n es s act i v i t i es t o creat e t h e i l l u s i o n thatth e t ax p ro du ct s R&A s o l d were real b u s i n es s es . An d h ere we m ak e a k ey

fi n d i n g an dex t en dth e u su al m et ap h or a b i t m o re: R&A was l es s l ik e t h e o rch ard i s twh o p l an t s the s eed s o f t rees an dth en s t ep s b ack t o wat ch th em

g ro w th an itwas l i k e a s et d es i g n er wh o b u i l ta p ap i er-m âch é fo res t
an d p ai n t edi t t o l o o kl i k e real trees . R&A n ev er s to p p edt i n k eri n g wi t h th es e
en t i t i es . Itco nt in u al l y fi l edp ap erwo rkwi th th e IRS o r s t at e ag en ci es as n eed ed
. It draft edad d i t i on al d o cu m en t s fo r i t s cl i en t s t o co n n ectacco u n t s an d en t i t i es t o ju s t ify th e m o v em en to f fu n d s i n t o each acco u n t . Ith el p edcl ien t s m o v e m o n ey wi th i n th e v ari o u s acco u n t s an den t i t i es . An di trev i ewedth e cl i en t s ’ t ax retu rn s- 9 5 -

[* 9 5 ] fo r co n s i s t en cy

wi t h ap p earan ces an d t o h an d l e an y au d i t th ataro s e reg ard i n g th es e acco u n t s . W e fi n dfro m

th i s co n si s t en tp ract i ce t h atR&A was s el l i n g ret i rem en t p l an n i n g s erv i ces . R&A d i rect l y ad v ert i sedth es e s p eci al t ax s t ru ctures t o s etup th es e ret irem en tp lan s . R&A em p l o y ees atth e o ffi ce o f R&A d i d t h e wo rk
n eces s ary t o o perat e an dm ai nt ai n th em --wh i ch i n cl u dedact i n g as ad m i n i s t rat o r o f th e en t i t i es an dm o n i t ori n g l aws t o en s u re t hatth e p l an s ad h eredt o an y req u i rem en t s . Ry d er an dR&A em p l o y ees h el ds i g natu re au t h o ri t y o ver t h e fi nan ci al acco u nt s o f t h e ret i rem en tp ro du ct s . Ry d er m ai n t ai n edau t ho ri t y o v er
em pl o y ees an dag en t s thath el d p o s i t i o n s wi th th e t ax s t ru ctu re en t i t i es . 4 5 Th e fi ng erp ri n t s o f R&A can b e fo u n dal l o ver t h e s erv ices th at were p ro v id edt o th e cl i en ts . W e t h erefo re fi n dthatR&A was the o n e act u al l y p ro v i d i n g t h e s erv i ces . 3
. In co m e Pro du cedTh ro ug h Th es e Serv i ces W i t h o u t o n ce ag ai n g o i n g i nt o g reat d et ai l , we can s ay t h atcl i en t s t h at p u rch as edt ax p ro du ct s g o tacces s t o b an k acco u n t s s etup b y R&A i n th e n am e o f
o n e o f t h e t ax p ro du ct s, wh i l e R&A m ad e s u re t h e p ap erwo rk was d o n e an dth e
cas h fl o wedfro m t h e cl i en t ’ s o p erat i n g b u s i n es s i n t o th e en t i t y ’ s acco u ntwi t h a

4 5 Ry d er, fo r ex am

p l e, h ired an dth en fi redRo b ertPan ch eri --h i s o wn b ro th er-i n -l aw--wh o Ry d er cl ai m edwas p res i d en to f m an y o f t h e fact o ri n g en t i t i es .- 9 6 -

[* 9 6 ] p o rt i o n s en to n t o i t s el f o r o ne o f t h e en ti t ies th at i t co nt ro l l ed . R&A s t ro v e t o m ak e t h e en t i t i es l oo kreal --t o l oo kl i k e a g ro up i n su ran ce co m p an y , a co rp o rat e fact or, an ex ecu ti v e-l eas i n g co m p an y , o r a s taffi n g co m

p an y . Th es e en t i t i es wo u l d rep o rti n co m e fro m

thei r d eal i n g s , b utth en p as s i to n t o t ax -ex em p ten t i t i es th at R&A al so s etup . W e can t ak e a cl o s er l o okath o w R&A d i d t h i s .

i
. Gro up Tax Pro du ct s In co m e R&A s etup th es e p ro du ct s --ASIG i n s u ran ce p o l i ci es , fact o r co m pan i es , an d
em pl o y ee-l eas i n g fi rm s --t o ru n th ro u g h m as t er en t i t i es th atco n tro l l edth e fi n an ci al
acco u n t s as s o ci at edwi t h th em acco rd i n g t o wri t t en ag reem en t s en t eredi n t o wi t h th ei r cl i en t s . Bu tth es e wri t t enfee ag reem en t s b et ween cl i en ts an dth e m as t er
en t i t i es th atR&A creat edan dco n t ro l l edt o ru n th e t ax p ro du ct s were n o ti n fact p ro m i s es t o p ay

fo r s erv i ces pro v i d edb y th o se en t i ti es . W e i ns t eadfi ndth at , fo r each p ro du ct , th e real ag reem en t s were t ho s e en t eredi n to o ral l y b et ween R&A an d i t s cl i en t s t o p ro v i d e wh atthe cl i en t s u n d ers t oo d t o b e t ax o r ret i rem en t -p l an n i n g
s erv i ces . W e can h ard l y

fi n do t h erwi s e. Th e fi rs tm o v e fo r cl i en t s wh o b o ug h tth es e g ro up p ro du ct s was t o m o v e m o n ey i n t o an acco u nth el d b y

th e m as ter en t i t y

fo r th atp art i cu l ar g ro up p ro du ct . Th i s was n ’ tan acco u ntfo r t h e en t i ty ’ s o wn u s e i n- 9 7 -

[* 9 7 ] i t s o wn b us i n es s . It was ju s t a co l l ect i o n acco u n tfo r each p ro du ct . Itwas R&A t h atk ep tthes e acco u n t s an d R&A em pl o y ees wh o h ad s ig n atu re au t h o ri ty
o v er t h em . AS IG Pr o du ct . R&A’ s fi n g erp ri n t s were al l o v er th e ASIG p ro du ctfro m th e b eg in n i n g. Itwas R&A t h atag g res s i v el y m ark et edth es e p o li ci es . As far as i t s cl i en ts kn ew, th ey

were o nl y

ev er wo rk i ng d i rect l y

wi th R&A. Bu to n ce a cl i en t ag reedt o b u y

an ASIG p o l icy , R&A’ s s t aff fax eda co p y o f t h e p ap erwo rkt o M o rri s Co t t i n g h am t o s i g n , an d o n e wo u l ds earch i n v ai n t o s ee an y m en t i o n o f R&A o n th e p o l icy

i ts el f. Cl ien t s n ev ert hel es s knew t h ati f an y p ro b l em s aro s e wi th th e p o l i ci es , th ey

s h o u l dcal l R&A t o wo rki to u t . It w as al s o R&A’ s em

p l o y ees wh o b i l l edth e cl i en t s , co n t ro l l edth ei r ASIG
acco u n t s, an d m ad e s u re fees were p ai d. Th es e fees were “ cal cu l at edtwi ce a y ear [at ] 1 % o f t h e t o t al b an kb al an ce + t h e l o an b al an ces ,” an dR&A wo u l d wo rkwi t h M o rri s Co t t i n g h am t o m ak e s u re t hey were co l l ect ed . Ev en th i s was d o n e i n a
ro u n dab o u tway : R&A s en tfo rm l et t ers o f au t h o ri zat i o n o n i t s l et t erh eadt o M o rri s Co t t i n g h am fo r i t s s i g n atu re. M o rri s Co t t i n gh am wo u l ds en dth e l et t ers b ack to R&A, wh ich wo u ldfax th e l et t ers t o Ch arl es Sch wab . Ch arl es Sch wab
wo u l dth en m o v e m o n ey

fro m t h e acco u n tn o m in al l y i n ASIG’ s n am e (b u t
s eg reg at ed i n an acco u n t fo r t h e cl i en t’ s b en efi t ) t o a d i fferen tSch wab acco u n t- 9 8 -

[* 9 8 ] en di n g i n 5 33 7
. 4 6 Th is “ ASIG” acco u n twas i n Ry d er’ s n am e. Th e i n v o i ces
s en tt o thes e cl i en ts were o n ASIG l et t erh ead b utwere p rep ared b y R&A, wh i ch we kn o w b ecau s e we can t race t h e co m pu t er t ag l i n e fo u n d i n th e b o tt o m l eft
co rn er o f t h e i n v o i ces b ackt o R&A. An ds o m eo n e atR&A k ep t a reco rdo f t h e p o l i cy fees fro m

the ASIG cl i en t s , s om et im es wi th a n o t at i o n wh i ch read“p ym t b y p as s ed[R&A’ s ] b o o k s . ” Th e p ap erwo rk

b et ween cl i en tan dASIG s t at ed t h atth es e “ p o l i cy fees ” were t o rei m

b u rs e ASIG fo r i t s co s t s an ds erv i ces , as wel l as t o al l o wi tt o “p ro fi t th ereo n .” Bu twe fi n d t h at ASIG i t s el f d i dn o t h i n g fo r t h i s . It was al l fo r t h e wo rk d o n e b y R&A an di t s em

p l o y ees . See Ro ub ikv . Co m m is s i o n er, 5 3 T.C. 3 6 5 , 3 7 9
- 8 1 (1 96 9 ); Tro u sd al e, 1 6 T.C. at1 0 6 5 . W e th erefo re fi n dth atth i s was R&A fee i n co m e. Gr o u p Fa ct o r i n g Pr o d

u ct . W e fo u n di n Paci fi c M an ag em en tGro up v . Co m m i s s i o n er, at* 1 7 -* 1 8 , th atth e g ro up -fact o ri n g en t i t i es d i dn ’ two rkfo r R&A’ s cl i en t s . No w we h av e t o s ee wh et h er t h ey p ro du cedi n co m e fo r R&A. Th es e d eal s o n p ap er were b etween a s ep arat e fact ori n g co m pan y an d o n e o f R&A’ s cl i en t s . Bu tl et ’ s l o okfi rs tatwh o m ark et ed t hem . Itcert ai n l y was n ’ ta

4 6 Th es e s eg reg at edacco u n t s h el di n th e p ol i ci es ’ n am es were i n real i t y ju s t t ax -d eferred an dt ax -d edu ct i bl e p i g g y b an k s fo r t h e cl i en t s.- 9 9 -

[* 9 9 ] fact o ri n g co m

p an y . R&A i t s el f h i red Pat ri ckSco t t M cKee t o m ark etg ro up fact ori n g t o p o t en t i al b u y ers th ro u g h CPAs
. M cKee d i st ri bu t ed i n fo rm at i o n al
m at eri al s o n th e p ro du ct s , i n cl ud i n g v i d eo s an dan R&A t ax o p i n i on , an do ffered t o arran g e m eet i n g s wi t h Ry der i f an y CPAs o r t hei r cl i en t s h adu n an s wered qu es ti o n s . Fo r t h e g ro up fact o ri ng p ro du cti n al l i t s d ifferen t g en erat i o n s, R&A creat ed th e en t i t i es t o u s e as g en eral co l l ect i o n acco u n t s . Ag ai n , th es e acco u n t s were t i tl edt o BFA, USFA, W es t ern Fu n d i n g , an dW FG. Bu tR&A o wn edan d
co n tro l l edeach o f t h em . A co m m o n el em en ti n al l o f t h es e “ g en erat i o ns ” was a p ap er t rai l th atm ad e i t lo o kl ik e t h ere was a real fact o ri n g co n t ract b et ween an R&A cl i en tan d o n e o f th es e co m

p an i es . Co n t ract s b et ween cl i en t s an d BFA an dUSFA al s o ai m edt o ci rcu m v en tco n t ri b u t i on l i m i t s t o Ro t h IRAs . Or, as R&A s p un i t , i t s fact o ri n g p ro g ram was p art o f t h e “ n ex tg en erat i o n o f t ax p l an n in g s t rat eg i es ” t h atwas

“ d es i g n edt o t ak e ad v an t ag e o f th e t ax -free d i s t ri b u ti o n ru les affo rd edt o Ro t h IRA’ s [s i c] .” Th i s i s h o w BFA an dUSFA wo rk edfo r R&A’ s cl i en t s . BFA o r USFA
wo u l des t ab li s h a s ep arat e “ d i vi s i o n ” fo r each cl i en t . A cl ien two u l dal so s etup a Ro th IRA t o o wnth ats ep arat e “ d i v i s i o n ”. Th e cl i en two u l d “ s el l ” i t s acco u n t s- 1 0 0 -

[* 1 0 0] recei vab l e t o th i s d i v is i o n . Th e cl i en two ul dth en co l l ecti ts i n v o i ces an d d ep os i tth e fu n d s i n t o i t s d i v is i o n acco u n tu s i n g d ep o s i ts l i p s thatR&A g av e i t . Th e d iv i si o n wo u l d m ak e p aym en t s b ackt o the cl ien t ’ s b u si nes s ata d i s co u n t . Th e d ifferen ce b et ween t h i s am o u n tan dth e am o u n t th ati tactu al l y co l l ect ed
wo u l dres twi t h th e cl i en t ’ s “ di v i s i o n ” wi t h i n BFA o r USFA. Atth e en do f t h e y ear t h e “ d i v is i on ” wo u l d t ran s fer i t s fu n d s t o BFA’ s o r USFA’ s g en eral acco u n t . Fro m th ere, t h e m o n ey

d ep o s i t edfro m

each d i v i si o n wo u l db e p ai do u t(m i n u s a fee ret ai n edb y

R&A) as a d i vi d en d t o th e d i v i s i o n ’ s o wn er--t h e cl i en t ’ s Ro t h IRA--wh i ch wo u l d s up p o s ed l y m ak e t h i s “ d i v i den d ” an di t s u l t i m at e d i s t ri b u t i o n t o the cl ien tt ax free. Th ere was n o tt o o m uch t o d is t in g ui s h BFA fro m USFA i n th e way th i s wo rk ed . BFA was fo rm edi n th e Tu rk s an dCai co s i n 1 9 9 6 , an dm o s t
o f R&A’ s cl ien t s u sed i tfro m th att i m e u n t i l 2 0 0 2 . Becau se i t was a Tu rk s an d Cai co s co rp o rat i o n, i t was n ot s ub jectt o U.S. t ax . A few cl i en t s co n t i n u edt o u s e BFA u n t il 2 0 1 0 . Th e creat io n o f USFA b ecam e n eces s ary i n 2 0 01 wh en Co n g res s
en act edth e Pat ri o tAct , 4 7 wh ich m ad e i tm o re d i ffi cu l tfo r Am eri can s t o m o v e
m o ney o ffs h o re. Un l i k e BFA, USFA u s edd o m es t ic fi n an ci al acco un t s as wel l as
a n ew “ b lo ck er en t i t y ” cal l edCo u n s el o r Cap i tal . Co u n s el o r Cap i t al wo u l d ret u rn

4 7 Un i t in g an dSt ren g t hen i n g Am eri ca b y Pro v i d in g Ap pro p ri at e To o l s Req ui redt o In t ercep tan dOb s t ru ctTerro ri sm Acto f 2 0 0 1 (USA PATRIOT Act ), Pub . L. No . 1 0 7 -5 6 , s ec. 3 0 2 , 1 1 5 St at . at 2 9 6 -9 8.- 1 0 1 -

[* 1 0 1] fu n d s t o cl ien t s --fu n d s wh i ch th e cl i en t s h adal read y d ep o s it edi n a d o m es t ic acco u n t --i n th e fo rm o f l o an s . A cl ien to f R&A wo u l d , fo r ex am p l e, draft a l et t er t o Ry d er req u es t i n g th ath e (an d t h e fi rm ) “ faci l it at e a l o an * * * fro m
m y s eg reg at ed i n v es t m en t acco u n t ” t o h i m . USFA was g en eral l y u s ed b y R&A’ s cl i en ts fro m

2 0 0 2 t o 2 0 0 4 , b u t ju stas wi t h BFA, a h an dfu l o f cl i en t s co n ti n u edt o
u s e i tu n t i l 2 0 1 0
. Th e Co m m is s i o n er s p ot tedth i s as an ab u s i v e t ran sact io n b acki n 2 0 0 4 --i t
was , aft er al l , l i t t l e m o re t h an m o v i n g m o n ey fro m o n e p o ck ett o an o t h er wi t h
s o m e s tu ffedi nt o an IRA al o ng th e way . He i d en t i fi edi ti n No t i ce 2 0 0 4-8 , 2 0 0 4 -1 C.B. 3 3 3 , an dRy d er reco g ni zedth atth i s m ean th e co u ldn o l o n g er s el l i t . En t er W es tern Fu nd i n g an dW FG. Th es e p ro du ct s o p erat edi n es s en t i al l y th e s am e m an n er as BFA an dUSFA, b u twi th th ree n o t ab le d i fferen ces . Fi rs t , cl i en ts s o l dth ei r acco u n t s recei v ab l e d i rect l y t o W es t ern Fu n d in g o r W FG, rat h er th an a d iv i s i o n o r s ub s i d i ary o f th o s e fi rm s . Th ey

s t i ll co l l ect edo n th os e acco u n t s , th o u g h , an dd ep o si t edth e fu n d s i n t o s eg reg at edacco u n t s o wn ed b y W es t ern Fu n d i n g an dW FG. Seco nd , al t h o ug h th ei r b us i n es s es were s t i l l res p o ns i b l e fo r
co l l ect i n g o n th e acco u n t s , th e cl i en t s th em sel v es s i g n ed“ Ag reem en ts o f Em p l o ym en t ” wi t h W es t ern Fu n d i n g o r W FG, wh i ch s up p os ed l y was en o u g h t o
m ak e t h em

em p l o y ees o f o ne o f t h o s e fi rm s . An dth i rd , W es t ern Fu n d i n g an d- 1 0 2 -

[* 1 0 2] W FG were each o wn edb y em p l o y ee s t o cko wn ers hi p p lan s (ESOP), rat h er th an Ro th IRAs
. 4 8 R&A em p l oy ees m an ag edth es e ESOPs an dap p li edfo r d et erm i n at i o n l et t ers fro m th e IRS t o g etth em

reco g n i zedas qu al i fi edp l an s . Th ey al s o fi ledwi t h th e IRS al l n eces s ary ap p l i cat i o n s fo r s ep arat e em p l o y ee i d en t i fi cat i o n n u m

bers fo r W es t ern Fu n d i n g an dW FG an d cau s edth em t o b e t ax edas s m al l b u s i n es s co rp o rat i o ns . 4 9 Th e co l l ect i o n o n th e acco u n t s an d t h e d ep o s i t s th en o ccu rredi n the s am e way as wi t h BFA an dUSFA. Th e fi rm wo u l dk eep p arto f t h e m o n ey fo r i t s el f an d p as s th e res to n t o th e ESOP, wh ere ag ai n i tco u ldg ro w wi t h ou tp ay i n g t ax u n t i l d i s tri b u t edb ackt o t h e cl i en t . W es t ern Fu n di n g an d W FG el ect edt o b e S
co rp o rat i o ns , s o thatan y

i n co m e earn edb y

th em --aft er co l lect in g o n t h e cl i en t s ’

4 8 “ AnESOP i s an em

p l o y ee s t o ck b o n u s ret irem en t p l anthatp ri m ari l y i s i n v es t edi n em

p l o y er s ecu ri t i es .” J o s ep h G. De An g el i s & Dan i el L. Si m m o n s , “ ESOP-Own edSubch ap t er S Co rp o rat i o n s : A M i s t ak e i n Needo f a Fi x , ” 8 2 Tax No t es 1 3 2 5 (1 9 9 9 ). ESOPs are u s efu l d ev i ces fo r co rp o rat e fi n an ce as th ey can b o rro w fro m

o u t s i d e l en d ers t o p u rch as e an em p l oy er’ s s t ockan den ab l e t h e co rp o rat i o n t o d edu ctth e co n t ri b ut i o n s an d d i v i d en d s wh en th ey are rep ai d
. Qu al i fi edESOPs are al so ex em p t fro m t ax u n der s ect io n 5 0 1 (a).
4 9 A s m al l b u s i n es s co rp o rat i o n i s a co rp o rat i o n wi t h n o m ore t h an 1 0 0 s h areh o ld ers , al l o f wh o m are i n d i v i dual s an d n o n e o f wh o m are n o n res id en t al i en s, an d wh i ch h as o n l y o n e cl as s o f s t o ck . Sec. 1 36 1 (b )(1 ). Befo re J an u ary 1 , 2 0 0 5 , wh i l e W es t ern Fu n d i ng Gro up was act iv e, t h e s t atut e cap p edth e nu m b er o f s h areh o ld ers at7 5 . See Am eri can J o b s Creat i o n Acto f 2 0 0 4, Pub
. L. No . 1 0 8
- 3 5 7 , s ec. 2 32 , 1 1 8 St at . at1 4 3 4 . Sec. 1 3 6 2(a)(1 ) al lo ws a s m al l b u si nes s co rp o rat i o n t o el ect S co rp o rat i o n s t atu s fo r t ax p u rp os es .- 1 0 3 -

[* 1 0 3] b u s i n es s es ’ acco u nt s recei v ab l e, o r recei v i n g fact o ri ng fees --wo u l dfl o w th ro u g h t o th e t ax -ex em

p t ESOPs . Th i s al l o wedfo r t h e t ax -free accu m u l at i o n o f
cas h wi th i n the S co rp orat i o n s . W es tern Fu nd i ng was u s edb y R&A’ s cl ien t s fro m 2 0 0 4 t o 2 0 0 8 , wh i l e W FG was u s edfro m 2 00 8 t o 2 0 1 1 . “ W FG, In c. [was ] ex act l y th e s am e as W es t ern Fu n d i n g Gro up . Th e o n l y reas o n i t was creat edwas t o al l o w fo r t h e p eo pl e wi t h m o n ey i n the ESOP i n W es t ern Fu n d in g Gro up a v eh i cl e t o t ak e t h ei r m on ey

o u t .” On ce W es t ern Fu n d i n g was en d ed , al l th e em p lo y ees were t ech n i cal l y

t erm i nat edfro m

W es t ern Fu n d i n g , tri g g eri n g a “ d i s t ri bu t ab le ev en t ” th atal lo wed fo r t h e ESOPs t o p ay o u t th e acco u n t s t o th e cl i en ts . 5 0 As wi t h th e ASIG i n s u ran ce p o l ici es , R&A’ s fi ng erp ri n ts were al l o v er t h e tran s act io n s , ev enth ou g h i t s n am e was n o t o n th e p ap erwo rk . Ry d er’ s b ro t h er-i nl aw Ro b ertPan ch eri cl ai m s h e was t ech n i cal l y an em p lo y ee o f h i s o wnco n s u l t i ng fi rm , Cal v i n J . Pan ch eri & As s o ci at es , b u th e wo rk edcl o s el y wi th Ry d er an do t h er R&A em p l o y ees t o s el l th es e fact o ri n g arran g em en t s . Hi s m ai n jo b , h owev er, was ap p aren tl y

t o s i g n d o cu m en t s es t ab l i s h i n g th e cl i en t s ’ l i n k s t o th e p ro du ct s . Li s a Qu i n t an ar was al s o h i redi n 1 9 9 9 t o h el p wi t h th e d ay -t o -d ay
o p erat i o n s . Al t h o u g h s h e carefu l l y t es t i fi edth ath er i n i t i al em p l o ym en twas wi t h

5 0 Un d er s ect i o n 4 0 9 (d ), al l th e fu n d s al l o cat edt o an ESOP p art i ci p an t ’ s acco u n t m

us trem ai n i n th e acco u n tfo r 8 4 m o n t h s , u n l es s a d i s t ri b u t i on ev en t o ccu rs , s u ch as d eat h o r s ev eran ce fro m em p l o ym en t . See s ec. 4 09 (d )(1 ).- 1 0 4 -

[* 1 0 4] th e fact o ri n g co m

p an i es , we fi n dth ats h e was wo rk i n g o n b eh al f o f R&A al l al o ng . Sh e u s edR&A’ s o ffi ce s p ace an dequ i p m en t t o p erfo rm h er wo rk , an d
s h e t es t i fi edth ati f Pan ch eri was ab s en t , s h e wo u l d g o t o Ry d er fo r i n s t ru ct i o n . Ry d er an d Pan ch eri ev en tual l y h ada fal l i n g o u t , b u tn o t h i n g ch an g edfo r Qu i nt an ar--s h e co n t i n u edt o wo rki n th e s am e p l ace o n th e s am e o ffi ce eq u i p m en t t o s el l an d m an ag e t h e s am e p ro du ct s fo r Ry d er d i rect l y . Bu th o w d i dth i s b en efi tR&A? Al l o f th es e fact o ri n g ag reem en t s were
s ub s t an t i al l y

s i m i l ar i n th at t h ey

m em o ri al i zed a n eg o t i at ed“ ad m i n i s t rat i ve” fee t o b e p ai db y

th e cl i en t (o r t h e cl i en t ’ s “ d i v i s i o n ”) i nt o t h e g en eral acco u n to f BFA, USFA, W es t ern Fu n d i n g, o r W FG. Th es e acco u n t s en d ed i n 0 4 4 9 , 8 4 9 7 , 4 5 6 4 , 2 6 5 3 , 2 9 3 5 , an d 6 8 7 4--an d i ti s t h es e acco un t s th at we s p eci fi cal l y fi n dwere
o wn edan dco nt ro l l edb y

R&A. 5 1 Bo t h Pan ch eri an dRy d er h ads i g n atu re au t h o ri ty
o v er t h es e o p erat i n g acco u nt s . “ Th e t y p i cal fee was n i ne p ercen t ” o f t h e n etfu n d s each cl i en t ’ s b us i n es s m o vedi nt o th atcl i en t ’ s res p ect i ve d i v i si o n du ri n g th e y ear. An dwe s ee t he s am e p at t ern o f m o n ey co m i n g o u tfro m t hes e s eg reg at edacco u nt s i n t o a s i ng l e acco u n t --m o n ey fo r wh atwas p ap eredt o b e t h e fact ors ’ “ fee” b u tn o t i n ex ch an g e fo r an yt h i ng th e fact o r i t sel f d i d
. An di t was a fee co m p u t edas a

5 1 So m e o f t h es e fees were al s o rero u t edel s ewh ere, i n cl u di n g i n t o acco u n t s fu n d in g th e m

u l t i p l e ran ch es o wn edb y th e Ry d ers .- 1 0 5 -

[* 1 0 5] p ercen t ag e o f th e n etfu n d s th atth e cl i en t s m o v edi n t o thei r s eg reg at ed
acco u n t s du ri n g t h e y ear. W e fi n d t h atth es e fees were i n fact co m p en s at i o n t o R&A fo r t h e wo rkth ati td i di n s et t i n g up t hi s t ax p ro du ct . See Ro ub i k , 5 3 T.C. at3 7 9 -3 8 1
. W e t h erefo re fi nd t h i s was R&A’ s o wnfee i n co m e. Emp l o yee-Lea s i n g

Pr o d u ct
. Th e s t o ry

fo r t h e em

p l o y ee-l eas i n g p ro du cti s th e s am e. R&A u sedfi v e en t i t i es : W o rl dwi d e Career M an ag em en t , Lt d . (Iri s h ); W o rl dwi d e Career M an ag em en t , In c. (U.S.); Ex ecu t i ve Pl acem en t , In c.; W es t ra Cap it al M an ag em en t , In c.; an d Ex ecu Pro Sp eci al t y Serv i ces , In c. W o rl dwi d e Career M an ag em en t , Lt d . (Iri s h ), was an Iri s h co rp o rat i o n . R&A’ s ad v ert i s em en t s s u m m ari zedfo r cl i en t s h o w em p l o y ee l eas i n g wo u ldwo rk
u s i n g a h y

p o t h et i cal cl i en tn am edM ark : 1
. M arken t ers i n t o an Ag reem en to f Em p l o ym en twi th W o rl dwi d e Career M an ag em en t , Lt d . (“ W CM ”) fo r h i s wo rl dwi d e s erv i ce o n an ex cl u s i v e b as i s . Th e Ag reem en t o f Em

p l o ym en t p ro v i d es fo r M ark ’ s W -2 co m p en s at i o n , an dco n tri b ut i o ns t o a n o n-q u al i fi ed d eferred co m

p en s at i o n p l an (t h e W CM Deferred Co m pen s at i o n Pl an ) o n h i s b eh al f. 2
. W CM ‘ l o an s o u t ’ M ark ’ s s erv ices t o Ex ecu Pro M an ag em en tServ i ces , In c. * * * p u rs u an tt o an Em p lo y ee Lo an Ou tAg reem en tfo r t h e co n t ract in g , co n s u l ti n g , en g i n eeri n g an d/o r m an ag em en ts erv i ces o f M ark . Un d er t h e Em

p lo y ee Lo an Ou tAg reem en t ,- 1 0 6 - Ex ecu Pro ag rees t o p ay M ark ’ s W -2 co m p en sat i o n an d cert ai n am ou n t s t o W CM
. 3
. Ex ecu Pro p ro v i d es M ark ’ s s erv i ces t o [M ark ’ s co m p an y ] p urs u an tt o a Co n s u l t in g an dM an ag em en tServ ices Ag reem en t . 4
. Ex ecu Pro p ay s M arkh i s W -2 co m pen s at i o n . 5
. W CM m ak es co n t ri b ut i o n s t o th e W CM Deferred Co m pen s at i o n Pl an o n M ark ’ s b eh al f. Th e p it ch wo rk ed , an dR&A s o l dth e d eal t o m an y cl i en ts . Th e k ey

was th at cl i en ts ’ real b u s in es s es wo u l dd edu ctl arg e “ l eas i ng ” p aym en t s t h at en d edup i n a
co rp o rat i o n t h atd i dn o t p ay t ax du e t o th e Iri s h n o nres i den t l o op h o l e. See s up ra
n o t e 1 1. A g u s h er o f m on ey s t art ed fl o w i ng t o Irel an d , an do n l y s o m e wo u l d tri ck le b ackt o th e Un i tedSt at es . Cl i en t s wo u l dp ay t ax o n l y o n th e am o un t s th at were k ep ti n th ei r b u s i nes ses o r wh atwas rep o rt ed o n th ei r W -2 s . Th e rem ai n i n g fu n d s i n Irel an dwo u ldaccu m u l at e t ax free fo r t he cl ien t s ’ b en efi t . W o rl dwi d e Career M an ag em en t , In c. (U.S.), was a v ery s i m i l ar v ari at i o n
s t art edi n 1 9 9 9 , b u twh i ch u s eda co rp o rat i o n o rg an i zedi n Wy o m in g i n s t eado f Irel an d . R&A s et i tup t o b e fu l l y o wn ed b y

an ESOP t o m ak e i tm ore t ax fri en d l y , i f n o tqu i t e as t ax fri en d l y as an Iri s h n o n res i den tco rp o rat io n . [* 1 0 6]- 1 0 7 -

[* 1 0 7] W e al s o an al y zedthi s d eal i n Paci fi c M an ag em en t Gro up , T.C. M em o . 2 0 1 8 -1 3 1 . Inth atcas e R&A h adcreat eda p artn ers h i p 5 2 wh os e “ p ri m ary p u rp o s e”
was “ t o p ro v i d e b u si n es s , m an ag em en t , an dfi n an ci al s erv i ces t o cl i en t s o f t h e Part ners h i p .” Id . at* 1 5 . Th is p art n ers h i p co n t ract edwi t h R&A’ s cl i en t s t h ro u g h th ei r s ep arat e S co rp o rat i o n s t o s up p l y t he p art n ers h i p wi t h t h ei r s erv i ces . Id
. at* 1 5 -* 1 6 . Th e p art n ers hi p t h en l eas edthe cl ien t s b ackt o th ei r o wn b u s i n es s es th ro u g h ag reem en t s fo r “ m an ag em en ts erv i ces .” Id
. Th e co n t ract s b et w een th e p art n ers h i p an d t h e cl i en t s ’ b u s i n es s es req u i red th e b u si n es s es t o p ay

m on t h l y “ m an ag em en tfees ” t o th e p art n ers h i p . Id . Th e cl i en ts ’ b u s i n es s es wo u l d d edu ctth es e fees o n t h ei r o wnreturn s , i d . at* 2 8 , an d th e fees wo u l dth en fl o w i n t o t h e cl i en ts ’ ESOPs wh ere t h ey wo u l d b eco m e a
res erv o i r o f cas h o n wh ich t ax was d eferred , s ee i d . at* 2 3 . Th e em p l o ym en t ag reem en t s o n p ap er al l o wedthe p art ners hi p t o p ro v i d e s erv ices t o o th er b u s i n es s es , b utth is n ev er h ap p en ed . Id . at* 1 6 -* 1 7. In th e b eg i n n i n g , o nl y

Ry d er’ s fam i l y an dR&A were i n v o l vedi n W o rl dwi d e Career M an ag em en t , In c. (U.S.) (W o rl dwi d e (U.S.). He an dh i s wi fe
an d ch i l dren were i ts o n l y em p l o y ees an dwere al s o th e o n l y p art ici p an t s i n th e

5 2 Th i s p art n ers h i p was al s o th e “ fact o r” wh i ch “p u rp o rt ed l y p u rch as edfro m th e [cl ien t s ’ co m

p an ies ] acco u n t s recei v ab l e th atth ey as s ig nedt o i t . ” Id . at* 1 8
.- 1 0 8 -

[* 1 0 8] ESOP thato wn edi t . Itwas n ’ tu n ti l aft er Sep t em b er 1 1 , 2 0 0 1 , th at R&A
m ad e m o re u se o f W orl dwi de (U.S.), ag ai n b ecau s e i tb ecam e h ard er t o m o v e
m o ney o ffs h o re aft er t h e p as s ag e o f t h e Pat ri o tAct . See s upra p . 1 0 0 . Itwas at th i s p o i n tth atW o rl dwi d e (U.S.) creat eda s ep arat e qu al i fi eds ubch ap t er S s ub s id i ary co rp o rat i o n (QSUB) fo r each cl i en t . 5 3 An d each QSUB was
u l t i m at el y

o wn edb y

th e W o rl dwi d e (U.S.) ESOP. Co rp o rat i on s n eedan o ffi cer,
s o Ry d er i n s t al l edan R&A em pl o y ee, Karen Bak er, t o b e p res i d en t o f each o f th es e QSUBs
. Ex ecu t i ve Pl acem en t , In c., em erg edi n No v em b er 2 0 0 2 aft er Ry d er h adm et wi th s o m e fel l o w ret i rem en t-p lan n i n g at t o rn ey s i n Ut ah . Th es e s am e at t o rn ey s h ad b een en

jo in edb y th e Ju s ti ce Dep art m en tfro m o fferi n g em

p l oy ee l eas i n g t o th ei r o wn cl i en t s , b utch ari tab l y referred t h em t o R&A s o t h ey co u l d co n t i n u e i n th e t ax -m i n i m izi n g l ifes t y l e t o wh i ch th ey h adb eco m e accu st o m ed
. An dR&A d el i v eredo n th i s, p l aci n g them u n d er Ex ecu t i v e Pl acem en t ’ s p l an ni n g u m b rel l a.

5 3 A QSUB i s s ubs i di ary

co rp orat i o n 1 0 0 % o wn edb y an S co rp o rat i on th at th e S co rp o rat io n el ect s t o treatas a QSUB. Sec. 1 3 6 1(b )(3 )(B). A QSUB’ s s ep arat e ex i s t en ce i s i g n ored , s o al l o f i t s as set s , l i ab i l i t i es , an di t em s o f i nco m e are co n s i d eredtho s e o f i t s p aren t . It s s ep arat e i d en ti t y fo r fed eral i n co m e t ax p u rp os es i s t erm i nat edup o n i t s el ect i o n, an d“ d eb ti s s u edt o i t s p aren tS co rp o rat i o n’ s s h areh o l d er i s treat edas th e p aren t’ s d eb tt o d et erm i n e t h e am o u n to f l o s s es th atm ay fl o w th ro u g h t o th e p aren t ’ s s h areh ol d ers .” M es s in a v . Co m m i s s i o n er, T.C. M em o . 2 0 1 7 -2 1 3 , at* 2 6 -* 2 7 , aff’ d , 7 9 9 F. Ap p ’ x 4 66 (9 t h Ci r. 2 0 19 ).- 1 0 9 -

[* 1 0 9] W es t ra Cap i t al M an ag em en t, In c., was th e s am e co rp o rat i o n as W o rl dwi d e (U.S.), b u ti n 2 0 0 3 Ry der t h ou gh ta n ew n am e m i g h t b e i n o rd er wh en o ne o f R&A’ s cl i en t s was co n v i ct edo f a cri m i n al t ax ch arg e aft er h e u n d errep o rt edh i s i n co m e--i n co m e t hath adb een fu n n el ed t h ro u g h W o rl dwi d e (U.S). Ry d er an d R&A were d eep l y

i n vo l v edi n W es t ra Cap i t al . St art i n g i n 2 0 0 3 , Ry d er’ s d au g h t er b ecam e i t s v i ce p res i d en t --jo i n i n g R&A em p lo y ee Karen Bak er wh o s erv edas i t s p res i den tas wel l as p res i d en tfo r al l th e QSUBs we m en t i o n edab o ve. Bak er’ s s o n jo i n edW es t ra Cap i t al as i t s treas u rer “ o r o t h er fi scal ag en t ,” as h e s i gn edth e QSUBs ’ an n u al rep o rt s . In2 0 09 , h o wev er, Ry d er h i m s el f b ecam e b o t h t h e p res i den tan dtreas urer, rep l aci n g Bak er. An d b y 2 0 1 0 , Ry d er h adas s u m edal l th e
o ffi cer p os i t i o ns atW es tra Cap i t al
. R&A was n o tal on e i n s el l i n g t h es e s ch em es . Earl y i n 2 0 0 4 , th e Co m m i s s i o n er i ss u edRev en u e Ru l i n g 2 0 0 4 -4 , 2 0 0 4 -1 C.B. 4 1 4, wh i ch i d en t i fi ed W es tra Cap i t al ’ s ty

pe o f QSUB arran g em en tas an ab u s i v e t ax -av o i dan ce tran s act io n . Ry der h ada way aro u n dth i s , t o o . Each o f R&A’ s cl i en t s ’ QSUBs h ad b een au t h o ri zedt o i s s u e 1 0,0 00 s h ares , b u t o n l y 1 0 0 s h ares were act u al l y i s su edt o W es tra Cap i tal . Each cl ien th el d an o p t i o n t o p u rch as e t h e rem ai n i n g 9 ,9 00 s h ares at$ 1 each . Wh en i tcam e t i m e t o u n wi n dW es t ra Cap i t al i n 2 0 0 5 , th e cl i en ts “b o u g h t ” th e 1 0 0 s h ares o f s t o cko f t h ei r QSUBs b ackfro m W es t ra Cap i t al- 1 1 0 -

[* 1 1 0] fo r wh atRy der cl ai m edwas th ei r fai r m ark etv al u e: 1 % o f t h e as s etv al u e i n each QSUB. As th e s o l e o wn er o f t h ei r QSUB’ s 1 00 i s s ueds h ares o f s t o ckan d 9 ,9 00 u n ex erci s eds t ocko p t i o n s , each cl i en tth en m erg edi t s QSUB’ s as s et s i n t o a
n ew en t i ty

creat edb y

R&A. Th u s , R&A t ran s ferreda t o t al o f ap p ro x i m at el y $ 6 9
m i l l io n t ax free t o ab o u t two d ozen o f i ts cl i en t s i n ex ch an g e fo r a 1 % fee t o W es tra Cap i t al
. Fi n al l y , th ere was Ex ecu Pro Sp eci al t y Serv ices , In c.--a W y o m i n g
co rp o rat i o n 5 4 th at R&A creat edi n 2 0 0 4 . It s creat io n was p ro m pt edb y t h e req u i rem en ti n n ew s ect i o n 4 0 9(p ) t hatan ESOP s p o n s o redb y an S co rp o rat i o n h av e m o re t h an t en p art ici p an t s. Eco n om i c Gro wth an dTax Rel i ef Reco nci l i at i o n Acto f 2 0 0 1, Pub
. L. No . 1 0 7 -1 6 , s ec. 6 5 6 (a), 1 15 St at . at1 3 1 -3 3 . Th i s wo u l d h av e b een l es s th an o p ti m al fo r R&A’ s cl i en ts wh o wan t edo n ly t o av oi dt ax , n o t
s h are t h ei r b u si n es s i n co m e wi t h th ei r em p l o y ees . Ry der’ s s o l u ti o n was t o en l i s t R&A’ s o wnem

p l o y ees t o recei v e s m al l s al ari es an dFo rm s W -2 fro m Ex ecu Pro
s t art i n g i n 2 0 0 5 t o reach th e p art i ci p an tn um b er n eed ed . W i t h Ex ecu Pro i n p l ace
an d th e n ew s ect i o n 4 0 9 (p ) req u i rem en t s m et , th e s h ow co u l d g o o n . Ex ecu Pro

5 4 W e n o t e t h atth e reco rdal s o h o l d s th e art icl es o f i n co rp o rat i o n fo r a Cal i fo rn i a-b as edEx ecu Pro Sp eci al t y Serv i ces , In c., d at ed2 0 0 1 an ds t am p edas recei v edb y

th e Cal ifo rn i a s ecret ary

o f s t at e du ri n g th ats am e y ear. Th is was th e s eco n di t erat i o n o f an earl i er v ers i o n th ati s referred t o i n R&A’ s ad v ert i s em en t s p l u g g i n g W o rl dwi de Career M an ag em en t , Lt d . (Iri s h ).- 1 1 1 -

[* 1 1 1] g l o m

m edo n t o th e em

pl o y ee-l eas i n g arran g em en ts al read y i n p lace, p u rp ort i n g t o ex cl u si v el y l eas e each cl ien t ’ s s erv i ces b ackt o th e cl i en t ’ s b u s i n es s . Each o f R&A’ s cl i en t s p ai dan an n u al “ ret en t i o n fee” o f 8 % o f t he n etfu n d s cl i en ts m o v edi n t o each o f t h es e g ro up l eas i n g s tru ctu res . As wi t h th e o t h er g ro up p ro du ct s, thes e em p l o y ee-l eas in g d eal s l oo k edo n p ap er as i f R&A h adl it t l e t o d o wi t h th em . Bu tev en a l i gh ts p ri n k l i n g o f t h e Co m m i s s i o n er’ s i nv es ti g at i v e du s tag ai n s h o wedR&A’ s fi ng erp ri n t s . As we’ v e al read y fo u n d , i ts em

p l o y ees m an ag edm an y

o f t h e en t it i es n eces saryfo r t h es e d eal s . R&A al s o creat ed , o r cau s edth e creat i o n o f, th e en t i t i es u s edi n th e
em pl o y ee-l eas i n g d eal s an dthe ESOPs t hato wn edthem . Ry d er s i g n edth e art i cl es
o f i n co rp o rat i o n as t h e i n co rp o rat o r fo r t h es e en t i t i es , an dh e was l i s t edas th e
co n tactn am e. R&A al s o fi l edp ap erwo rk wi th the IRS co n cern i n g i t s ret i rem en t p l an s an ds o u g h tl et t ers o f d et erm i n at i o n thatth ey were q u al i fi edem

pl o ym en t p l an s . Bu tm o sti m

p o rt an ti s th e m o n ey

trai l : R&A o p en ed an dco n tro l ledth e
m an y b an kacco u n ts h el di n th e n am es o f t h es e l eas i n g en t it i es . Cl ien t s wh o b o u g h tth e l eas i ng p ro duct s wo u l dm o v e t h ei r o wnm on ey i n to thes e en t i t i es ’
acco u n t s. M os to f t h i s m o n ey was i n v es t edo n b eh al f o f t he cl ien t , b u t we
s p eci fi cal l y

fi n dth ata p o rt i o n was s i p h o n edo ff t o R&A as a fee fo r p u t t i n g th e
arran g em en ti n t o p l ace an d m o n i to ri n g i tt o k eep i t g o i n g . Th o s e fees were- 1 1 2 -

[* 1 1 2] cal cu l at edas a p ercen t ag e o f t h e n etfu n d s t hatth e cl i en t s h adm ov edi n t o th e g ro up -l eas i n g s tru ctu re. Ry d er rat i o n al i zedth i s fee t o th e cl i en t s b y s tat i n g th atei th er t h ey

co u ldp ay

h i g h fed eral an ds t at e i n co m e t ax , o r th ey co ul dp ay

8 %
o f t h e am o u nt s th at (h e cl ai m ed ) wo u l d n o tb e s ub jectt o i m m ed i at e t ax at i o n . W e fi ndth atth es e were fees p ai dfo r s erv i ces th at R&A p ro v i d ed . See Ro ub i k, 5 3 T.C. at3 7 9 -8 1 . W e t h erefo re fi n d i twas R&A’ s fee i n co m e.

i i
. St an d-Al o n e Pro du ct s In co m e Th e R&A t ax p ro duct s th atwe cal l “ s t an d -al o ne” are t h e s t affi n g p ro du ct , th e g en eral -co un s el -o ffi ce p ro du ct , an dth e So n -o f-BOSS p ro du ct . Fo r each o f th es e p ro du ct s , R&A h adwri t t en ag reem en t s wi t h i t s cl i en t s, n o tth e o ral ag reem en t s th at i th adwi t h cl i en t s wh o b o u g h t a g ro up p ro du ct . R&A t ai l o red th es e p ro du ct s t o a s p eci fi c cl i en t , an d a cl i en two u l d h av e i t s o wn d i rect
co n nect io n t o th e p ro du ct . A cl i en two u l dal s o co n t ro l i t s o wnfi n an ci al acco u n t th atRy d er s etup fo r each
. Bu twh en we p eeku nd er t h e p ap er fl o at i n g o n th e
s u rface, we ag ai n fi n da d i fferen treal it y . Sta f fi n g Pr od u ct
. J u s tas i th ad wi th al l t h e “ gro up ” p ro du ct s , R&A d i dal l th e fro n t -en dwo rkn eces s ary fo r t h e s t an d -al on e s t affi n g p ro du ct . It creat edth e ESOPs th ato wn edth e S co rp o rat i o n s t h atth en acq u ireda cl i en t ’ s em p l o y ees an d l eas edth em

b ack t o the cl ien t . R&A al s o m ark et edthes e d eal s th e s am e way i td i d- 1 1 3 -

[* 1 1 3] al l th e o t h ers . As wi t h al l o t h er Ry d er d eal s , we al s o fi n dm o n ey th at fl owed i n t o the d eal an da p ercen t ag e t h atwas s l ui cedt o R&A. Th ere were a co upl e way s th i s h ap p en ed . M on ey cam e t o R&A t h ro u g h a

“ fai r an dreas o n ab l e” d o cu m en t at i o n fee o f $ 1 2 , 5 0 0 , as wel l as an an n u al fee
co m p u t edas a p ercen t ag e o f a cl i en t ’ s S co rp o rat i o n ’ s an n u al K-1 i n co m e. Ry d er’ s s al es m en wo u lds el l p ro s p ect s o n t h i s arran g em en tb y al l u d i n g t o h i s
ex p ert i s e i n redu ci n g th ei r t ax es t o wh at ev er t h ey fel tco m fo rt ab l e wi t h p ay i n g : W i th o u tR&A’ s “p lan n i n g an dex p ert i s e, [t h e cl i en t ’ s ] fed eral an d s tat e i n co m e
an d p ayro l l t ax es co u l d b e as h i g h as 4 5 % o r m o re.” W it h R&A’ s s erv ices , a cl i en t’ s co s t s wo u l do n l y “b e t h e ag reedp ercen tag e, b u ti n th e fo rm o f fees [o r,
m o ney t o R&A] rat h er th an t ax es .” Th e earl y v ers i o ns o f t h i s d eal m ak e a fi n d i n g th atth e d eal s p ro du cedi n co m e t o R&A eas y --R&A s en t i n v o ices d i rect l y t o i t s cl i en ts o n R&A l et terh ead
. Bu tth en th i n gs g o tco m

p l i cat ed , as Ry d er g o o p edi t up wi t h ex tra l ay ers o f p ap er. At th e s t arto f 2 0 0 4, R&A “ as s i gn ed ” al l o f i t s s t affi n g-p ro du ctcl i en t s t o ESOP Leg al Co n s u l t an t s, In c. Un s u rp ri si n g l y , i twas a Wy o m i n g co rp o rat i o n , an d a refas h i on edo n e atth at . Itwas o ri gi n al l y “ Bi k eri der 2 ” an do rg an i zedi n J an u ary 2 0 0 1 as o n e o f 1 ,1 00 Wy o m i n g co rp o rat i o n s Ry d er o rg an izedi n a s ho rtt i m e fo r
u s e i n th e t ax d eal we d es cri b e i n the n ex t s ect i o n . Bi k eri der 2 k ep t a l o wp ro fi l e- 1 1 4 -

[* 1 1 4] wi t h Ry d er as i t s o n l y d i rect o r an dju s tth ree y ears o f t ax fi li n g s o n Fo rm s 1 1 2 0 S, U.S. In co m e Tax Retu rnfo r an S Co rp o rat i o n , fro m 2 0 0 1 t o 2 0 0 3
. It w as n ’ tu n t i l Decem

b er 2 0 0 3 th at Ry der g o tBi k eri d er 2 i n to g ear an d
ren am edi tESOP Leg al Co n su l t an t s , In c. Onth ats am e d ay , h o w ev er, Ry d er al s o
o rg an i zedESOP Leg al Co ns u l t an t s , In c., APLC, a Cal ifo rn i a co rp o rat i o n , an d th en m erg edi t s Wy o m i n g p red eces s o r i nt o i t . Th e Cal i fo rn i a ESOP Leg al Co n s u l t an t s , In c., APLC, em erg edas th e s u rv i v i n g S co rp o rat i o n, an dret ai n ed Bi k eri d er 2 ’ s em

p l o y ee i d en t i fi cat i o n n u m b er (EIN). Itwas s o l el y

o wn edb y

an ESOP duri n g al l y ears ati s s u e an dfi l ed Fo rm s 1 1 20 S fo r cal en d ar y ear 2 0 04 an d fo r t h e s h o rtt ax y ear o f J an uary1 th ro u gh No vem b er 3 0 , 2 00 5 , b efo re i tco n v ert ed t o a C co rp o rat i on aft er n ew s ect i o n 4 0 9(p ) t oo keffect . Th ats ect i o n ’ s en act m en t
en d edR&A’ s ab i l i t y t o s el l th e em p l o y ee-s taffi n g d eal as i t h adb een . Bu tESOP Leg al Co n s ul t an t s , In c., APLC, (ESOP Leg al Co n s u l t an t s )
s u cceed edt o m an y

o f R&A’ s ex i s t i n g cl i en t s . An dfro m thi s p oi n tfo rward , cl i en ts ’ p aym en t s m ad e b efo re R&A’ s “ as s i gn m en t ” o f ri g h t s t o ESOP Leg al Co n s u l t an t s were d ep o s i t edi n t o th e BFA Di v i s i o n 1 0 1 b an kacco u nt en d i n g i n 0 4 4 9 , an dan y

p aym en ts th atfo l l o wedwere d ep o s i t edi nt o th e ESOP Leg al Co n s u l t an t s acco u n t en d i ng i n 3 1 4 9
.- 1 1 5 -

[* 1 1 5] As t h e Co m

m i s s i on er p o i n t s o u t , th e reco rdi s d ev o ido f ev i d en ce th at ESOP Leg al Co n s u l t an t s h adan y cap i t al wh eni ts t art ed
. Fo ll o wi ng th i s al l eg ed

“ as si g n m en t , ” Ry d er co n t i n u edt o p ro v i d e s erv i ces th ro u g h R&A, as ESOP Leg al Co n s u l t an t s h adn o o ffi ce s p ace o r em pl o y ees o f i t s o wn --m o re s i g n s t h atR&A i t sel f earn ed t hi s i nco m e. See Ro ub i k , 5 3 T.C. at3 7 9 (h o l d i n g thata co rp o rat i on th at“ d i d n o to wnan y equ i p m en t , i n cu r an y d eb t s fo r ren t , o ffi ce o r m ed ical
s up p li es o r s erv ices o r fo r s al ari es ” d i dn’ tearn i nco m e, b u t i t s o wn ers --wh o cl ai m edt o b e em

p l o y ees --d i d ). 5 5 An dESOP Leg al Co n s u l t an ts fai l edt o co n du ct b u s i n es s . See i d . W e t h erefo re fi n dth atth i s was R&A’ s fee i n co m e. Gen er a l Co u n sel

Of f i ce Pr o d u ct
. Rem em

b er th at Co n gres s en act eds ect i o n 4 0 9 (p ) t o p rev en td eal s l i k e R&A’ s em pl o y ee-l eas in g d eal b y

req u i ri n g ESOPs
s p o n so redb y

S co rp o rat i o n s t o h av e m o re t h an t en p art i ci p an ts o r face s ev ere
s an ct i o n s . Bu tCo n g res s d el ay edthe n ew s ect i o n ’ s effect i ve d at e u n t i l Decem b er

5 5 In Kel l er, 7 7 T.C. at1 03 1 , th e Co u rtch o s e n o tt o at t ri b u t e i n co m e o f a p at h o l o g y

co rp o rat i o n t o an i nd i v i dual wh en th e i n di vi dual was th e o n ly p ers o n p erfo rm i n g th e s erv i ces fo r t h e co rp o rat i o n , ev en th o u gh th e co rp orat i o n “ di dn o t p ay ren t , p u rch as e o r o wnp ro p ert y , em pl o y n u rs es , t ech ni ci an s o r o th er cl eri cal em pl o y ees , i n cu r an y

b u s in es s i n d eb t ed n es s, p ay i n t eres t , o r l o an an y m o n ey .” In Kel l er, h o wev er, th e co rp o rat i o n “ cl earl y carri edo n th e b u s i n es s o f p ro vi d i n g m ed i cal s erv i ces ,” i d ., an dth e Co u rts t at edth at“ i ti s ax i o m at i c t h ata co rp o rat i o n can o nl y p erfo rm s erv i ces th ro u g h i t s ag en t s ,” i d . at1 0 3 2. Th at i s n o tth e s i tu at i o n h ere. R&A, n ot t h e S co rp o rat i o n s , was p ro v i d in g th e s erv ices i n qu es t i o n , an d R&A was n o tan ag en to f t hes e S co rp o rat i o n s .- 1 1 6 -

[* 1 1 6] 2 0 0 4 t o g i ve S co rp orat i o n s th atwere o wn edb y s m al ler ESOPs t i m e t o
co m p l y . See Eco n o m i c Gro wth an dTax Rel i ef Reco nci l iat i o n Acto f 2 0 0 1 , s ec. 6 5 6 (d ), 1 1 5 St at . at1 3 5. Ry d er i s a can n y

t ax l awy er an dfo res aw wh atCo n g res s wo u ldd o . He al s o fo res aw t h ats o m e g ran d fat h eri n g was l i k el y , i ncl u d in g th e g ran dfat h eri n g
o f “ an y s tru ctu res i n ex i st en ce b efo re M arch 1 4 , 2 0 0 1 ,” as “ co m p l et el y l eg al .” As R&A’ s ad v ert i s in g s t at es : “ [It ] an t i ci p at ed t h e t ax l aw ch an g es an di nv en t o ri eda l i m i ted n um

b er o f t h e S-Co rp + s t ru ctu res b efo re M arch 1 4 , 2 0 0 1 . Each i s a p ro p erl y d o cu m en t edan dd ecl areds t ru ctu re o ffered t o cl i en t s wh o wi s h t o d efer
an u n l im it edam o un to f i n co m e t h ro u g h 2 0 05 .” Bu tRy d er was m o des ti n cal l i ng h i s i n v en t o ry

“ l i m i ted ”: He h adcreat edro u g h l y 1 ,1 0 0 Wy o m i n g co rp o rat i o n s an d
s ub m i t t edS co rp o rat io n el ect i o n s an dESOP p l an d o cu m en ts t o th e IRS o n t h ei r b eh al f wi t h th e h o p e o f o b t ai n in g ap p ro v al o f t h es e em p l o y ee s av i ng s p l an s . R&A al s o s etal l the p lan y ears t o en do n No vem b er 3 0
. Th i s m ean tth atth e fi rs td at e th atn ewl y

en act eds ect i o n 4 0 9 (p ) wo u ldb e i n effect fo r t h e ESOPs was th e p l an y ear b eg i n n i n g Decem

b er 1 , 2 00 5
. A cl i en twh o wan t edi n o n o n e o f th es e d eal s h adt o ag ree t o d i vert i n co m e fro m h i s o p erat i n g b u s i n es s t o an S co rp o rat i on th at l eas edh i s s erv i ces b ackt o h i s
o p erat i n g b u s i nes s. Th i s creat eda s p o tt o s tas h cu rren t ly u n t ax edi n co m e, as i n- 1 1 7 -

[* 1 1 7] th e em

pl o y ee-l eas i n g d eal s . Bu tth e GCO d eal s feat u reda co up l e ad d it i o n al s t ep s : Th e cl i en th adt o ag ree t o p ay a p ercen t ag e o f t he S co rp o rat i o n ’ s i n co m e t o a g en eral co u n s el o ffi ce as i ts “ b u dg et ”, an dag ree t h atRy d er wo u l db e th e S co rp o rat io n’ s g en eral co un s el . Th i s “b ud g et ” am o u n t was cal cu l at edwi th o u t ap p ly i n g th e l eg al fees o f Ry der an dR&A. Th e n eti n co m e u s edi n cal cu l at i n g t h e

“ b u d g et ” am o un tco u l dn ’ tb e reduced b y th e ex p en s es o f t h e GCO--i n cl ud i n g fees
o wedt o R&A--an dth e “ b u d get ” co u l dn ’ t b e redu cedas l o n g as R&A was wi l l i n g t o p ro v i d e s erv i ces t o th e GCO. W e fi n dth atwh at Ry der cal l s a l i n e i t em i n a
co rp o rat e “ b u d g et ” was i n real it y a fee t h atR&A ch arg edi t s cl i en t s fo r s erv i ces R&A i t s el f p ro v i d ed . See Tro u s d al e, 1 6 T.C. at1 0 6 5. W e t h erefo re fi nd t h at t h i s was R&A’ s fee i n co m e. S h o r t -S a l e Str a t eg

y Pr o d u ct . An dfi n al l y t h ere are R&A’ s So n -o f-BOSS d eal s . R&A o p en edtwo acco u n t s t o b e u s edi n th i s p ro du ct --o n e t i tl ed“ Ern es tS. Ry d er, APLC, At t o rn ey

Tru s tAcco u n t ,” an dth e o t h er “ Ern es t S. Ry d er & As s o c., In c. At t o rn ey

Cl i en t Tru s tAcco u n t .” R&A ch arg edcl ien t s wh o b o u g h t i n t o th i s d eal a d o cu m en t at i o n fee an dan an nu al p ercen t ag e fee o f 6 -2 / 3 % o f t h e cap i t al l o s s es creat edi n the t ran s act io n . Th e co n n ect i o n b et ween th es e fees an dR&A i s
m u ch m o re p lai n l y v i s i b l e. In wh atm ay h av e b een a u ni qu e co nces s i o n , R&A’ s
an n ual fee was co n ti n g en to n the t ran sact i o n’ s u l t i m at e s u cces s i n av oi d in g IRS- 1 1 8 -

[* 1 1 8] s cru t i n y

p as t th e s t atu te o f l i m i t at i o n s , an drem ai nedco nt i n g en tu n t i l th e
s t atu te o f l i m i tat i o n s ex pi redfo r t h e y ear t hatth e cl i en twas cl ai m i n g th e t ax b en efi t . Th es e fees ch arg edwere fo r t h e wo rkd on e b y R&A. See Ro ub i k , 5 3 T.C. at3 7 9 -8 1
. W e fi n dth atth i s was al s o R&A’ s fee i nco m e. S u mma r y . Al l o f t h es e fees p ai db y th e cl i en t s o f t h e d i fferen t t ax p ro du ct s
were co m p en s at i on t o R&A fo r i t s s erv ices i n s p i n n i n g web s o f en t i t i es an d
s qu i rt i n g b arrel s o f i n kt o h i d e t h e co nn ect i on b et ween i ts el f an dth e fees i t ch arg ed
. W e o f co u rs e reco g n i ze t h atRy d er d iv ert ed t hes e p aym en t s th ro u g h
co n tract s an d en t i t i es , an dth e acco u n t s an dd i v i s i on s wi t h in en t i t i es . W e al s o
reco g n ize t h e i n vo cat i on o f M o l i n e Pro p ert i es th atco rp orat e fo rm s m u stb e
res p ect ed . Bu tth e as s i g n m en t -o f-i n co m e d o ct ri ne d o es n o t i m m u n i ze as s i g n m en t s
o f i n co m e t o co rp o rat i on s o r o t h er en t i t i es . See Bas y e, 4 1 0 U.S. 4 4 1; J o n es v . Co m m i s s i o n er, 6 4 T.C. 1 06 6 , 1 0 7 6 -7 7 (1 9 7 5); Ro ub i k , 5 3 T.C. at3 7 9 -8 1 . Th e i n co m e th atR&A p ro du cedfro m s al es o f t h es e d eal s t o i ts cl i en t s was i nco m e t o R&A b ecau s e i twas R&A i t s el f t h atd i dthe wo rk . See Ro ub i k , 5 3 T.C. at3 7 9 -8 1 ; Tro u s d al e, 1 6 T.C. at1 0 6 5 . Ry d er al s o ci teda n um b er o f cas es , i n cl u d i ng Ach iro
v . Co m m i s s i o n er, 7 7 T.C. 8 8 1 (1 9 8 1 ); Dav is v . Co m m i s s i o n er, 6 4 T.C. 1 0 3 4 (1 9 7 5); an dBel l v . Co m

m i s s i on er, T.C. M em o . 1 9 8 2 -6 60 , wh ere t h e- 1 1 9 -

[* 1 1 9] Co m

m i s s i o n er at t em

p t edt o at t ri b u t e i n co m e rep o rt edb y l eg i t i m at e
co rp o rat i o ns t o o t h er p ers o n s o r en t i t i es . Bu ti n each o f t he cas es ci tedb y Ry d er, th ere were q u es t i on s ab o ut wh o was th e t ru e earn er o f t h e i n co m e i n ques t i o n . Here t h ere i s n o reas on ab l e d i s p u t e ab o u twh o earn edwh at --i t was R&A’ s i n co m e,
an d h i di n g i ti n o t h erwi s e n o n fu n ct i o n in g en t i t i es d o es n ’ tm ak e i tan y l es s an
as s i g n m en to f i n co m e. Ou r fi n d i ng h ere d o es n o tev en rel y o n at t ri b u ti n g t o R&A i n co m e t h atwas rep o rt edb y

d i fferen t b u s i n es s es --o r d et erm in i n g th e “ t ru e earn er,” as i n the cas es th atRy d er ci t es . Rat h er, we are act u al l y at t ri b ut i n g t o R&A d ep o s i t s i n to b an k
acco u n t s--d ep o s it s t h atwere fu n n el edth ro u g h t ax s ch em es b u t t hatwere al way s p aym en t s fo r t h e s erv i ces p ro v i d edth ro u g h R&A. Th e qu es t i o n o f wh et h er t h es e
s tru ctu res were s ep arat e fro m R&A o r were act ual l y

co n duct i n g l eg i t i m at e b u s i n es s act i v i t i es i s i rrel ev an tt o th i s d et erm i n at i on . Al l th atm at ters i s th atth e fees that wen t i n t o th es e acco u n t s were fees fo r s erv i ces th atR&A p ro v i ded
. B. Ad d i t i o n al At t em

p t edAs s i g n m en t s o f In co m e Ry d er n ex targ u es thatR&A al s o as s i g n edi t s ri g h t t o th e fee i n co m e fro m th e d i fferen t t ax p ro du ct s t h ro u g h v ari o us co n t ract u al ag reem en t s , i n cl u d i n g th e

“p ract i ce fu n di n g ag reem en t ” wi t h BFA, t h e “ as s i g n m en tag reem en t s ” wi t h ESOP- 1 2 0 -

[* 1 2 0] Leg al Co n s u lt an t s , an d t h e “ acces s ag reem en t s ” wi t h t h e i nd i v i du al g en eral
co u ns el o ffi ces . Th e s am e d o ct ri n e ap p l i es : Tax p ay ers “ can n o tav o i dt ax at i on b y en t eri n g i n t o a co n t ract u al arran g em en twh ereb y th at i nco m e i s d i v ert ed t o s o m e o t h er p ers o n o r en t i t y .” Bas y e, 4 10 U.S. at4 4 9
. Th e Sup rem e Co u rti n Su n n en , 3 3 3 U.S. at6 0 4 , h el dth atwh en d et erm i n i n g i f an as s i g n m en to f co n t ractu al ri g h t s
ren d ers a t ax p ay er i m

m u n e fro m i n co m e t ax l i ab i l i t y , “ [t ] h e cru ci al ques t i o n
rem ai n s wh et h er t h e as s i g no r ret ai n s s u ffi ci en tp o wer an dco n t ro l o v er t h e
as s i g n edp ro p ert y

o r o v er recei p to f t h e i n co m e t o m ak e i t reas o n ab l e t o treat h i m
as th e reci p i en to f t he i n co m e fo r t ax p u rp o s es .” See al s o CM A Co n s o l ., In c. & Sub s . v . Co m

m i s s i on er, T.C. M em o . 2 0 0 5 -1 6 , 2 00 5 W L 2 0 9 9 51 , at* 4 3 (“ To s h i ft th e t ax l iab i l i t y , th e as s i g n o r m u s t rel i n qu is h h is co n t ro l o v er t h e act i v it y th at g en erat es th e i n co m e; th e i n co m e m u s tb e t he fru i to f t h e co n t ract o r th e p ro p ert y i t sel f, an dn o to f h i s o n g o in g i n co m e-p ro du ci n g act i vi t y * * * [an d ] the du t y

t o p ro duce t h e i n co m e [m

u s tb e] as s i gn edal s o, s o th atth e as s ig n o r i s o u to f t he i n co m e-p ro du ci n g p i ctu re” (q u o t i ng Un i t edSt at es v . Newel l , 2 3 9 F.3 d9 17 , 9 1 9
- 2 0 (7 th Ci r. 2 0 0 1))). An di n W es en b erg v . Co m m is s i o n er, 6 9 T.C. 1 0 0 5, 1 0 1 0 -1 1 (1 9 7 8), we d et erm i nedthata p ro fes s o r’ s co n v ey an ce o f t h e u s e o f h i s l i fet i m e
s erv i ces --an dth e i n co m e res ul t i n g fro m i t --t o a t ru s twas i n effect i v e t o s h i ftth e- 1 2 1 -

[* 1 2 1] t ax b u rd enas s o ci at edwi t h th atco m p en s at io n wh en , aft er l o o ki n g atth e fact s an dci rcu m s t an ces o f t h e cas e, “ t h e u l t i m at e d i rect i o n an dco n tro l o v er t h e
earn i n g o f t h e co m

pen s at i o n res t edi n [t h e Pet i t i on er] an dn o ti n t h e Tru s t . ” 1
. As s i gn m en to f Fee In co m e t o BFA Th ro u g h th e PFA Ry d er arg u es thatR&A as s i g n edi t s ri g h ts t o an y fees t o BFA u n der t h e Pract i ce Fu n d i n g Ag reem en ts th atRy d er d raft edeach y ear fro m 1 9 9 6 t o 2 0 0 3
. Acco rd in g t o Ry d er, th e PFAs m ean tth at R&A d i dn o tu n d errep o rti t s g ro ss recei p t s s i n ce i t d i dn o th av e t h e ri g h t s t o th ati n co m e. Wh en R&A was creat ed , Ry d er l o ok edfo r a m ean s t o o b t ai n t h e cap i t al
n eces s ary t o ru n a b u si n es s , an dh e s et t l edo n BFA as th e s o urce. Ry d er creat ed BFA i n th e Tu rk s an d Cai co s i n 1 9 9 6 , ju s taft er R&A’ s es t ab l i s h m en t . BFA d i d
n o th av e m

u ch cap it al i t sel f, b u tl u ck i l y i t s p aren t co m

pan y , th e t ax -free Iri s h
n o n res i d en tco m

p an y Cap i tal M ex i can a t h atRy d er h ads etup y ears b efo re, d i d
. Cap it al M ex ican a o wn ed1 0 0 % o f BFA fro m BFA’ s creat i o n u n t il BFA wo u n d d o wni n 2 0 1 1 , an dth atco m p an y was th e u l t i m at e s o u rce o f t h e fu n ds th atBFA p as s edo n t o R&A. Th e PFAs en t eredi nt o each y ear fro m 1 9 9 6 t h ro u gh 2 0 0 3 were n o m o re
s t an d ardfact o ri n g ag reem en t s th an th e o n es BFA h adwi t h R&A’ s o wncl i en t s . R&A i n i ti al l y

p u rp o rt edt o s el l i t s acco u n ts recei v ab l e an dco n tract ri g h t s t o BFA- 1 2 2 -

[* 1 2 2] fo r a fi x edam o u n tev ery y ear, wh i ch i n creas edan n u al l y . Bu tb y 2 0 0 3 , Ry d er s t o p p edd efi n in g a fi x edl i n e o f cred i t , i n s t ead h av i n g BFA p ro m i se t o p ro v id e a “ ran g e o f fu n d i n g ” fo r R&A. Ry d er ex p l ai n edth i s as a co n s equ en ce o f R&A’ s i n ab i l i t y t o accu rat el y fo recas tb o t h th e cap i t al n eed s o f a l aw fi rm an dth e
am ou n to f recei v ab l es th ati two u ldcreat e. Th i s ag reem en t al s o p ro v i dedR&A wi th p ro tect io n fro m cred i t o rs b y rem o v i n g i t s m o s tv al u ab l e as s et s--i t s acco u n t s recei v ab l e--fro m

i t s b o o k s . An o th er u n u s u al feat u re o f t h e PFA i s t h at R&A d i dn o tp ro m i s e t o g en erat e
a m in i m u m v al u e o f acco u n t s t o tran s fer t o BFA. Ry d er d ids ay t h atBFA wo u l d b en efi tfro m

an i m p l i ed co v en an to f g o o d fai t h th at R&A wo u l dg en erat e t h es e fu tu re acco u nt s recei v ab l e an d co n t ract ri gh t s , b utth ere were n o ex pres s
co n tract ual p ro t ect i o ns fo r BFA. Th e res u l ti s wh ato n e m i g h tex p ect --BFA p u m p edi n m o re m on ey

each y ear t h an i trecei v edb ack fro m R&A. Itn ev ert h el es s
ren ewedth e d eal fro m

y ear t o y ear. Th e PFA al s o d ev i at edfro m s t an d ard fact o ri n g co n t ract s b y fai l i n g t o h av e
an y way fo r recei v ab les t o b e t ran s ferred t o BFA o r fo r an y n o ti ce t o b e s en tt o the d eb to rs th atBFA was th e o wn er o f t h e recei v ab les . Fact o rs u s u al l y req ui re s u ch a
n o t i ce t o th e d eb t ors t o en s u re t h atth ey recei v e wh atthey are o wed . Th e PFAs h ere, h o wev er, s t at edth at R&A was n o t req ui redt o s en dan y s o rto f n o t i fi cat i o n t o- 1 2 3 -

[* 1 2 3] an y

acco u ntd eb t o r t h atBFA n o w o wn edth es e recei v ab l es . Th ere are n o t
ev en an y n o t at i o n s i n R&A’ s b o o k s t h atBFA o wn edth e recei vab l es . Leg i t i m at e fact o rs u s ual l y d o wh at i tt ak es t o g eta s ecu ri t y i n t eres ti n th ei r d eb to r’ s acco u n t s recei v ab l e. See Pac. M g m t. Grp ., at* 4 4
. BFA d idn o td o s o . Al th o u g h a p ro v i s i o n o f t h e PFA s t at edth at R&A g ran t edBFA a co n ti n u in g
s ecu ri ty i n t eres ti n al l of R&A’ s p res en t an d fu tu re recei v ab l es , we fi n dth atth ere i s n o ev id en ce t h atBFA ev er p erfect edth ati n t eres tb y ex ecu t i n g an y

o f t h e
n eces s ary UCC fi n an ci n g s t at em en ts . No r d i dR&A ex ecu t e t hem o n BFA’ s b eh al f, as i th ad p ro m i s edi n t h e PFA. Acco rd i ng t o th e PFAs --wh i ch i n t h i s reg ardtrack edth e arran g em en t s R&A p ap ered fo r i t s o wncl i en t s wh o b o u g h t i n to fact o ri n g d eal s --R&A i ts el f was req u i redt o actas BFA’ s co l l ect i o n ag en t an d es t ab l i s h a co l l ect i o n acco u n tt o h o l d
an y p aym en ts o n an y

o f t he recei v ab l es . W e d o fi n dth atPan ch eri an d Ry d er
o p en edan acco u n tu n d er t h e n am e “ Ben efact o r Fu n d in g As s o c. In c. Co l l / Acct : Ern es tS Ry d er APLC.” Th e s i g n ature card fo r t h e acco un tp erm i t t edb o t h t o h av e
acces s t o th e acco u n t ’ s fu n ds . Al th o u g h Pan ch eri was i n ch arg e o f t h e d ay -t o -d ay
o p erat i o n s o f BFA an dwas t ech n ical l y a s i gn er o n th e co l l ect io n acco u nt , h e d i d
n o tactu al l y

o v ers ee o r h av e acces s t o thi s co l l ect i o n acco un t . As Ry d er cred i b l y
s t at ed , “ i treal l y was n ’ t[Bo b Pan ch eri ’ s ] b u s i n es s , h o w wel l the l aw fi rm was- 1 2 4 -

[* 1 2 4] d o i n g o r n o td o i n g .” Ry d er fu rth er ex pl ai n ed t h atPan ch eri “ n ev er real l y h ad acces s t o [R&A] fi n an ci al i n fo rm at i o n . ” Th i s h el p s u s fi n di t m o re l i k el y th an
n o tth atRy d er an dR&A were t h e o n es tru l y i n co n t ro l o f t h i s BFA co l lect i o n
acco u n t . Ont o p o f al l thes e co m

m erci al i rreg u l ari ti es wi t h the PFA i t s el f was R&A
an d BFA’ s fai l u re t o ad here t o th e t erm s o f th e PFA. Fo r ex am p l e, BFA p ro v i d ed $ 2 ,8 4 0 ,0 7 2 .8 3 i n fu n d i n g t o R&A du ri ng 2 0 0 3 , wh en th e PFA s up p os ed l y cap p ed th e fu n d i n g ran g e at$ 2.2 5 m i l l i o n . Th e PFA was al so cl ear t h atal l recei v ab l es fro m R&A were d u e t o BFA an dwere t o b e d ep os i t edi n t o BFA’ s “ Co ll ect i o n Acco u n t .” W i t h Ry d er an dR&A i n co n t ro l o f t h e acco u n t , h o wev er, fees
ro u t i nel y en d ed up i n R&A’ s b an kacco u n t s , R&A’ s at t o rn ey -cl i en ttru s tacco u n t , o r RLC’ s acco u n t , o r wen tt o th e Ry d er Ran ch es . In2 0 03 , fo r ex am p l e, R&A d ep os i t edi n t o i ts o wn W el l s Farg o Ban kacco un tm o re th an $ 1 3 0 ,0 0 0 fro m i t s cl i en ts th ats h o u l dh av e b een d ep o si t edi n t o t he co l l ect i on s acco u n tu n d er t h e PFA. W e al s o fi n dth ati t d i dn ’ tm at t er wh et h er t h o s e recei pt s h adb een d ep o s i t ed i n t o BFA’ s acco u n t , fo r al m o s tal l th e m o ney th atd i dg eti n t o BFA’ s co l lect i o n
acco u n t ul t i m at el y

en d edup i n R&A’ s o wnb an kacco u n t. W eek l y acco u n t b al an ce rep o rt s p rep aredfo r R&A an d Ry der b y DeAu n Cas t ro ev enwen tas far as referri n g t o th e BFA acco u ntas th e “ co l l ect i o n acco u n tfo r Ern es tRy der.”- 1 2 5 -

[* 1 2 5] Lo ok i n g atth es e s u rro u n d in g fact s an d ci rcu m s t an ces , we fi ndth atth i s PFA was m erel y

an o t h er o n e o f R&A’ s u ns u cces s fu l at t em p ts t o as si g n i ts i n co m e. Th e u lt i m at e d irect i o n an dco n t ro l o f th e fee i nco m e rem ai n edwi t h R&A d es p i t e th e PFA. An d s in ce R&A i t s el f p ro du cedth at i n co m e, t hi s i n co m e was R&A’ s .

2
. As s i gn m en to f St affi ng In co m e t o ESOP Leg al Co n su l t an t s Ry d er d i d m

u ch t h e s am e wi t h th e i n co m e t h atR&A earn edfro m i t s s t an d
al o n e s t affi n g d eal s . Fro m 2 0 0 4 th ro u g h 2 01 1 , Ry d er h adth e fees fro m th es e d eal s d ep o s i t edi n t o ESOP Leg al Co n s u l t an t s ’ b an kacco u n ten d i n g i n 3 1 4 9 . He arg u es th atth i s was d o n e u n d er an “ as s i g n m en t ” ag reem en tb et ween ESOP Leg al Co n s u l t an t s an dR&A, i n wh i ch R&A t ran s ferred al l o f i t s ri g h t s , du ti es , an d
o b l i g at i o ns fro m

th e s t an d -al o ne s t affi n g p ro du ct t o ESOP Leg al Co n s ul t an t s , wh i ch was t o t ak e o v er fro m R&A an y o th er ch o res n eed edt o k eep th e d eal s g o i n g . W e h av e l et t ers o f rep res en t at i o n t hatcl i en t s wh o b o u g h ti n to th ei r d eal
s i gn ed . Th ey

s t at e t h atR&A was h i redt o s et up t h e ESOP-o wn edS co rp o rat i o n s th atai m edt o s uperch arg e t he cl i en t s ’ ret i rem en ts av in g s . R&A em p l o y ees
es t ab l i s h edth es e en t i t ies , draft edal l th e n eces s ary p ap erwo rk , an dco n t i n u edt o
m o ni t o r th e arran gem en t s . Th e act i o n s o f Ry d er an dR&A aft er t h e s i g n i n g o f t h i s

“ as si g n m en t ” ag reem en ts h o wth atRy der an dR&A’ s em pl o y ees co n t in u edt o b e- 1 2 6 -

[* 1 2 6] th e o n es p ro v i d i ng s erv i ces t o th e cl i en ts . Ry der arg u es thatR&A as s i g n ed al l o f i t s o b l i g at i o n s t o i t s s t affi n g -p ro du ctcl i en t s t o ESOP Leg al Co n s ul t an t s . Th es e o b l i g at i o n s wo u ldh av e i n cl u d ed h an d l i ng al l d eal i n g s wi t h th e IRS, rep res en t i n g cl i en ts wi th res p ectt o an y au d i t , an d p ro v i d i n g an y l eg al s up po rt
n eces s ary , i n cl ud i n g l i t i g at io n i n th e Tax Co u rt . No n e o f t h i s actu al l y o ccu rred
. R&A n ev er l eftth e “ i n co m e p ro du ci n g p i ctu re” an d m ai n t ai n edco n t ro l o v er t h e
s t affi n g p ro du ct . See Newel l, 2 3 9 F.3 dat9 1 9 -2 0. Th ere i s n o th i n g i n t h e reco rdt o s h o w th atth e cl i en ts an dESOP Leg al Co n s u l t an t s s i g n ed n ew l et t ers o f rep res en tat i o n aft er t h e “ as si gn m en t ” ag reem en t
was ex ecu t ed . W e d o n o t e t h ataft er J an u ary 1 , 2 0 0 4 , b i ll s t o cl ien t s wh o u s edth e
s t an d -al on e s t affi ng p ro ductwere s en to n ESOP Leg al Co n s u l t an t s ’ l et t erh ead , wh i ch i n cl u d edth e n am es o f s i x i n d i v i dual s an dthei r s up p o s edp o s i t io n s . Bu t du ri n g tri al , two o f t h es e em p l oy ees t es t ifi edb u tfai ledt o m en t i o n ev er h av i n g
wo rk edfo r ESOP Leg al Co n su l t an t s . On e was u n ab l e ev en t o d es cri b e t he wo rk th atESOP Leg al Co n s ul t an t s s up p o s ed l y d i d . An R&A p aral eg al was as s i g n edt o th e t ax p ay ers i n Paci fi c M an ag em en tGro up . R&A i t s el f co n t i n u ed t o s en dl et t ers ab o utth i s p ro du ctt o the Paci fi c M an ag em en tGro up t ax p ay ers . An dan R&A at t o rn ey ap p eared fo r them

i n t h e cas e. ESOP Leg al Co n s ul t an t s was n owh ere t o b e fo u nd . Yet t h i s al l o ccu rredev en aft er R&A h adal l eg ed l y as s i g n edal l ri g h t s- 1 2 7 -

[* 1 2 7] an db urd en s ari s in g fro m th e s tan d -al o n e s t affi n g p ro du ct t o ESOP Leg al Co n s u l t an t s . An d , fi nal l y , i f ESOP Leg al Co ns u lt an t s h adwan t edt o p ro v i d e an y
s erv i ces t o th es e cl i en t s , i th adn o m ean s t o d o s o . Ith adn o o ffi ce, n o em p l o y ees , an d n o o th er res o u rces . Carl os To rres was a cl i en twh o u s edth e s t affi n g p ro du ctb o t h b efo re an d aft er R&A’ s s upp os edas s i g n m en t t o ESOP Leg al Co n s u l t an t s atth e s t art o f 2 0 0 4
. He g o tau d i t ed ; R&A rep res en t edh i m . R&A s i g n eda p o wer o f at t orn ey i n Feb ru ary 2 0 0 6 t o rep res en th i m

fo r t h e 2 00 3 , 2 0 0 4, an d2 00 5 t ax y ears . R&A’ s
s erv i ces were co v eredu n d er R&A’ s fi x ed -p ercen t ag e fee arran g em en t . To rres ’ s p aym en t , h o w ev er, was d ep o s it edi n t o ESOP Leg al Co n s ul t an t s ’ b an k acco u n t
en d in g i n 3 1 4 9 . An dwe fi n dth i s t o b e en t i rel y t y p ical o f wh ath ap p en edaft er t h e
s up p os edas s i g n m en t . R&A co n t in u ed t o rep res en t i t s cl i en t s as i th adp ro m i s edi n i t s l et t ers o f rep res en tat i o n . R&A co n t i n u edt o p ro v i d e al l s erv ices t o t h o se cl i en ts . Bu t R&A wo u l dd i v ertth e fees t o ESOP Leg al Co n s u l t an t s b y d ep o s i t i n g th e fees i tearn edi n t o ESOP Leg al Co n s u lt an ts ’ b an k acco u n t. W e fi n dthatth i s
was al l ju s tan at t em

p t b y R&A t o as s i gn i t s i n co m e. See Bas y e, 4 1 0 U.S. at4 4 9; CM ACo n s o l ., 2 0 0 5 W L 2 0 9 9 51 , at* 4 3
. Ev en i f th e “ as s i g n m en t ” ag reem en twere v al i do r ESOP Leg al Co ns u l t an t s d i dp ro v i d e s erv ices t o th e cl i en t s i n v o l v ed , an y s erv i ces t h atESOP Leg al- 1 2 8 -

[* 1 2 8] Co n s u l t an ts p ro v i d edwo u l dn o th av e g en erat edan y n ew fees
. Th e l et t ers
o f rep res en t at i on s t at e t h atR&A’ s ri g h ts t o t he p ercen t ag e fee was es t ab l is h ed
o n ce R&A creat edth e t ax s t ru ctu res an d es tab l i s h edth e co n n ect i o n b etween th e cl i en ts an dth e en t i t i es . Itwas R&A t h atwas en t i t l edt o th i s p ercen t ag e fee as l o n g
as th e cl i en t s u s i n g th i s p ro du ctrem ai n edi n v es t ed i n i t . An d t h i s p ercen t ag e was
co m p u t edo n the am ou n to f m on ey i n v es t edi n t h e s t ru cture, n o to n th e am o u n to f
wo rkd o n e b y

R&A. W e t h erefo re fi n dth atal l th e fees th atwere d ep o s i t edi n ESOP Leg al Co n s u l t an t s’ b an kacco u n ten d i n g i n 3 1 4 9 are i nco m e t o R&A.

3
. As s i gn m en to f GCO Pro du ctIn co m e t o In d i v i du al Gen eral Co u n s el Offi ces An o th er as s i g n m en to f i n co m e aro s e fro m th e “ b u d g etfees ” p ai db y cl i en t s wh o s i g n edup fo r t h e GCO p ro du ct . Th es e “ fees ” wen tt o th e i n d i v i du al g en eral
co u ns el o ffi ces , as if t h o s e o ffi ces were p ro v i d i n g s erv i ces t o t h e cl i en t s u n d er an

“ acces s ag reem en t.” W ere t h es e l eg i t ? Th e t es t , as we’ v e al read y s ai d , i s wh et her th e as s i g n o r h as rel i n qu i s hedco n t ro l o v er t he i n co m e-p ro du ci n g act i vi t i es , wh i ch h ere wo u l db e t he GCO p ro duct . See CM A Co n s o l
. , 2 0 0 5 W L 2 0 9 9 51 , at* 4 3
. Th e p ro b l em fo r Ry d er h ere i s th atth es e GCO “ o ffi ces ” were n o t h in g m o re t h an 1 8 s ep arat e b an k acco un t s o p en edu n d er th e n am es o f S co rp orat io n s creat edb y R&A. Th es e en t i ti es co u ldn o t h av e p ro v i d edth e “ i n -h o u s e co u n s el ” s erv i ces fo r- 1 2 9 -

[* 1 2 9] each o f t h es e s ep arat e co rp o rat i o n s. Ry d er cl ai m s th atth e GCOs en d edup p ay i n g RLC t o u s e i t s em p lo y ees t o p erfo rm

thes e s erv i ces . Bu tth i s arg u m en t fai l s as wel l , as we h av e fo u n dth at t h e em p l oy ee-l eas i n g ag reem en tb et ween RLC
an d R&A d i dn o tm ak e R&A em p lo y ees an yt h i n g o t h er t h an R&A em p l o y ees . So h ere ag ai n we fi n dth atR&A earn edth e fees at tri b u t ab l e t o th e GCO p ro du ctan d
m u streco g n i ze t h o s e fees as i t s i n co m e. C. “ Oth er Deduct i o n s ” Year Per ret u rn Per ex am Ad ju s t m en t 2 0 0 5 $ 1 , 54 6 ,4 2 3 -0
- $ 1 ,5 46 ,4 2 3 2 0 0 6 1 ,4 9 9 ,5 4 4 -0
- 1 ,4 9 9 , 5 4 4 To t al 3 ,0 4 5 ,9 6 7 -0
- 3 ,0 4 5 , 9 6 7 Th ere s t i l l rem ai n s t h e i ss u e o f wh et h er R&A was en t i t l edt o “ ot h er d educt i o n s ” u s edt o o ffs etth e i n co m e t h ati td i drep o rtfo r 2 0 0 5 an d 2 0 0 6 . R&A cl ai m edd edu ct i on s fo r cl i en t ad m i n i s t rat i v e-s erv ices ex p en s es , fo r l eg al an d p ro fes s i on al ex p en s es , an dfo r m eal s an den tert ai n m en t . W e l o o kateach
.

1
. RLC an dth e Em

p l o y ee Leas i n g Ag reem en t Th e cl i en tad m i n i s t rat i v e-s erv i ces ex p en s es are p aym en t s m ad e t o RLC
u n d er t h e em

p l o y ee-l eas i n g ag reem en ten tered i n t o b y R&A an dRLC. Th e Co m m i s s i o n er arg u es th atth i s ag reem en tb et ween RLC an dR&A was a s h am th at- 1 3 0 -

[* 1 3 0] l ack eds ub s tan ce. He b el i ev es th atth e em p l oy ee-l eas i n g ag reem en t b et ween R&A an dRLC was ju s to n e co g i n th e m ach i n e b ui l tb y Ry d er t o as s i g n R&A’ s i n co m e t o o t her en t i t i es . RLC s erv edm

u l ti p l e fu n ct i o n s i n Ry d er’ s m as t er p l an o f t ax av o i d an ce. He’ ds etup h i s l aw p ract i ce--R&A--as a C co rp o rat i o n. See s up ra n o t e 8 . Iti s
en t i rel y l eg i t i m at e fo r a b u s i n es s o wn er t o s wi tch fro m C co rp o rat i o n s t atus t o S
co rp o rat i o n s t atu s . 5 6 Bu tRy der rarel y ch o s e t h e wel l -t ro d p at h . He i ns t eadfo rm ed RLC as an S co rp orat i o n . An d t h en h e s t art edd oi n g th i n g s wi t h i t t o m o v e i n co m e away fro m

R&A t o i t .

5 6 As l o n g as the co rp o rat i o n m eet s s ect io n 1 36 1 ’ s req u i rem en t s fo r S co rp o rat i o n s t atu s , i tcan co n v ertfro m a C co rp o rat i o n t o an S co rp o rat io n --an d recei v e t he t ax b en efi t s o f d o i n g s o , s ee s up ra n o t e 2 --b y fi li n g a Fo rm

2 5 5 3 , El ect i o n b y

a Sm al l Bu s i n es s Co rp o rat i o n , n o l at er t h an th ree m o n t h s an d1 5 d ay s aft er t h e b eg i n n i n g o f t h e t ax y ear t h e el ect i o n i s t o t ak e p l ace, s ec. 1 .1 3 6 2-6 (a)(2 ), In co m e Tax Reg s . Bu tth is co n v ers i o n m ay h av e n eg at i v e co n s equ en ces . If wi th i n fi v e y ears o f t h e co n v ers i o n , s ee s ec. 1 3 7 4(d )(7 ), th e S co rp o rat io n s el l s ata p ro fi t as s et s i tacq u i redwh i l e a C co rp o rat i on , i twi l l h av e t o p ay a “ b u i l t -i n g ai n s ” t ax i n ad d i t i o n t o t h e t ax p ai db y th e S co rp orat i o n s hareh o l d ers o n th e t o t al g ai n fro m th e s al e. Sec. 1 3 7 4. (AnS co rp o rat i o n co n v ert ed i n 2 0 0 2 --t h e y ear o f RLC’ s i n co rp o rat io n --wo u ldh av e h adt o wai ts ev en y ears t o s el l i t s as s et s t o av o i d p ay i n g th i s t ax . See Am eri can Reco v ery an dRei n v es t m en t Acto f 2 00 9 , Pub . L. No . 1 1 1
- 5 , s ec. 1 2 5 1(a), 1 2 3 St at . at3 4 2.) A C co rp o rat i o n al s o can n o tav o i dd o ub l e t ax at io n o n i t s b u i l t -up p ro fi t s b y co nv ert i n g t o an S co rp o rat i o n. In s t eadi tm u s t trackthe S co rp o rat i o n an dC co rp orat i o n p ro fi t s fo r d i s t ri b u t i o n p u rp o s es . Sec. 1 3 6 8 . An di f t h e S co rp o rat i o n h as ex ces s i v e am o u n t s o f p as s i v e i n co m e p ro fi t accu m ul at edas a C co rp o rat i o n , th ere i s t he p o t en t i al fo r t h e S co rp orat i o n t o b e s ub jectt o t ax es atthe co rp o rat e l ev el an d h av e i ts S s t atu s t erm in at ed . Sec. 1 3 6 2 (d )(3 ).- 1 3 1 -

[* 1 3 1] On e o f t h e m o sti m p o rt an twas the em

p l o y ee-l eas i ng ag reem en t th atRy der draft ed . Un d er i t s t erm s , RLC wo u l db eco m e a s t affi n g co rp o rat i o n th atp ro v i d ed
s up p ortfo r R&A. R&A wo u l dp ay RLC fo r t h e “ s t affi n g s erv i ces ” th ati t p ro v id ed . Th es e “paym en t s ” wo u l dth en g en erat e b i g d edu ct i o n s fo r R&A an d
m o ve i n co m e t o RLC wh i ch , as an S co rp o rat i o n, wo u l d n o tb e t ax edo n i t. Bu t fo r t h i s t o wo rkwe’ d h av e t o b el i ev e Ry d er wh en h e t es t i fi edth atal l o f R&A’ s
em pl o y ees h adb eco m e em

p l o y ees o f RLC ri gh tb efo re th i s ag reem en tt o o keffect
. Th e Co m m i ss i o n er u rg es u s t o l o o kt o th e ev id en ce o n th e reco rds h o w i n g t h at
v ery l i t t l e actu al l y

ch an g edreg ard i n g t hes e em p l o y ees wh en th e em

pl o y ee-l eas i n g ag reem en twas en t eredi n to . Th e Co m m i s s i o ner b el iev es thatth i s ag reem en t l ack edan y

s ub s t an ce an dwas m erel y a m ech an i s m

fo r t ran s ferri n g v al u e an d
o b t ai n i n g t ax ad v an t ag es . W e g en eral l y ag ree. Ry d er i s n o t th e fi rs tt o t ry thi s , an do u r ru l e i s t o l o o k p as tth e l ab el s u s ed b y a t ax p ay er an d fo cu s o n wh atwas real l y g o i n g o n . See CM A, 2 0 0 5 W L 2 0 9 9 5 1 , at* 4 3 ; s ee al s o Su m m a Ho l d i n g s , In c. v . Co m m i s s i o ner, 8 4 8 F.3 d7 7 9 , 7 8 7 -8 8 (6 t h Ci r. 2 0 17 ), rev ’ g T.C. M em o. 2 0 1 5 -1 19 . InRep et t o v . Co m m i s s i o n er, T.C. M em o . 2 01 2 -1 6 8 , 2 0 1 2 W L 2 1 6 0 4 40 , at* 9 , fo r ex am p l e, we h el dth at

“ s erv i ces ag reem en t s [b et w een th e t ax p ay ers ’ co ns t ru ct i o n co m p an y an dth ei r t ax free s hel l en t i ti es ] an dth e res u l t i n g p aym en t s were n o t h in g m o re th an a- 1 3 2 -

[* 1 3 2] m ech an i sm

fo r t ran sferri n g v al u e.” Th ey d idn o tch an g e wh o actu al l y d i d th e wo rk , an dth e o ri g in al em p lo y ees co n ti n u edt o d o al l th e wo rk as th ey h ad b efo re t h e ag reem en t . No wri t t en ag reem en t was ev er en t eredi n t o b et ween th e p art i es an dth e p art i es fai ledt o k eep co n t em p oran eo u s t im e reco rd s o f th e
em pl o y ees . Id
. In th i s i n s tan ce, t h e o n l y

th i ng th atch an gedaft er R&A s i g n edth e ag reem en twi t h RLC i s th atRLC b eg an s en d in g th e em p l oy ees W -2 s . R&A an d RLC h adn o wri tt en ag reem en tt o s h o w th at t h e R&A em p lo y ees were n o w RLC
em pl o y ees . Th e s up p o s edRLC em p l oy ees b o ok edth ei r t i m e u s i n g R&A’ s Ti m es li p s p ro g ram . Sev eral em p l o y ees cred i b ly

t es t i fi edth atth ey

were em p l o y ees
o f R&A, n o tRLC, du ri n g th e y ears ati s su e. An d t h es e em p l o y ees s en tl et t ers t o cl i en ts o n R&A l et terh eadwi t h R&A t i t l es u n d er t he em p l o y ees ’ s i g n atu re l i n es . Al l o f t hi s l ead s u s t o fi n dth at t h i s em p l o y ee-l eas i n g ag reem en twas n o t h i n g m o re th an a m ech an is m

t o p ro du ce d edu ct i o n s fo r R&A. W e fi n d t h atth os e d edu ct i o n s
s h o u ldb e d i s al l o wed
.

2
. Rem ai n i n g Dedu ct i o n s Th e Co m m is s i o n er al s o d i s al l o w edd edu ct i on s fo r p ro fes s i o nal s erv i ces th at R&A cl ai m ed fo r 2 0 0 5 an d2 0 0 6 , an ds o m e fo r m eal s an d en tert ai n m en tex p en s es th ati tcl ai m ed fo r 2 0 0 5
. Sect i o n 1 6 2 al l o ws a d educt i o n fo r o rd i n ary an d- 1 3 3 -

[* 1 3 3] n eces s ary

b u s i n es s ex p en s es , b u tt ax p ay ers h av e t h e b urd en o f p ro o f t o
s ub s t an t i at e t h es e d educt i o n s . INDOPCO, In c. v . Co m m i s s i o n er, 5 03 U.S. 7 9 , 8 3
- 8 4 (1 99 2 ); s ee al s o s ec. 1 .6 00 1 -1 (a), In co m e Tax Reg s. Cl ai m i n g d edu ct i o n s o n a retu rn i s n o ts ub s t an ti at i o n . See, e.g ., W il k i n s on v . Co m m i s s i o n er, 7 1 T.C. 6 3 3 , 6 3 9 (1 97 9 ). Wh en a t ax pay er fai l s t o s ub s t an t i at e h i s d edu ct i o n s wi t h p reci s i o n,
we m ay es ti m at e cert ai n k i nd s o f ex p en ses b u t o n l y i f h e p ro v i d es atl eas ts o m e
ev i d en ce t o s up po rtan es ti m at e. W i l l i am s v . Un i t edSt at es , 2 45 F.2 d 5 5 9 , 5 6 0 (5 th Ci r. 1 9 5 7 ); Fi n n ey

v . Co m m i s s i o n er, T.C. M em o . 1 9 6 8 -2 8 3 , 2 7 T.C.M
. (CCH) 1 5 1 0 , 1 5 1 6 (1 9 6 8 ); cf. Co han v . Co m m i s s i o ner, 3 9 F.2 d5 4 0 , 5 43 -4 4 (2 d Ci r. 1 9 30 ). Th ere are s o m e ex p en s es we can n o tes t i m at e, i n cl u d i n g th o s e fo r m eal s an d
en t ert ai n m en t . A t ax p ay er wh o cl ai m s th es e m u s t“ s ub s t an t i at e[] b y

ad equ at e
reco rd s o r b y

s u ffi ci en tev i d en ce” t h e am o un t , t i m e an dp l ace, an db u s in es s p u rp os e o f each ex pen d i tu re. Sec. 2 7 4 (d ). R&A’ s p ro b lem

i s th ati tfai ledt o i n t ro du ce an y ev i d en ce ab o u t an y o f t h es e
ex p en s es . Inth e an s w eri ng b ri ef i tb ro ad ly cl ai m edth atwe h av e t h e b o o ks an d
reco rd s an dfi n an ci al s t at em en t s fo r al l o f t h e en t i t i es i nv o l v edi n thes e cas es . It ci t es no th i n g i n p art i cu l ar i n s up p orto f t h es e d edu ct i o n s, an d we h av e fo u ndn o
ev i d en ce i n the reco rdth atev en m en t i on s th em .- 1 3 4 -

[* 1 3 4] W e t h erefo re fi n dth atR&A i s n o ten t i t l ed t o th es e “ o t her d edu ct i o n s .” III. Di v i den dAd

ju s t m en t : Th e Ry d ers ’ Li ab il i ty fo r Tax o n Un rep o rt ed Co n st ru ct iv e Di v id en dIn co m e Th e o t her m ajo r i s s u e i s wh et h er Ry d er recei v edco n s t ru ct i v e d i v i d en d s fro m R&A. Th e Co m

m is s i o n er d et erm i n edthatRy d er h ad v ery l arg e u n rep o rt ed d i v i d en d i n co m e fro m

2 0 0 3 th ro u g h 2 0 1 1 . Th i s i n co m e d ro p p edi n t o t h ree d i fferen t g ro up s : ! m on ey fu n n el ed fro m R&A t h ro u g h RLC b y m ak i n g y ear-en d ad ju s t i ng jo u rn al en t ri es ; ! m on ey fro m

R&A u s edfo r t h e ran ch p ro p ert i es t h atd i dn ot p as s t h ro u g h RLC; an d
! m on ey fro m

R&A u s edt o p ay Am eri can Ex p res s an dBen Lel an d Co n s t ru ct i o n . Ry d er d i s ag rees o n each p o i n t . He d i s ag rees wi t h the Co m m i ss i o ner t h at th e m o n ey

th atfl o wedi n t o 4 1 d i fferen tacco un t s were R&A’ s earn in gs an dp ro fi t s , an d n o ti n v es t m en t s an dcap i t al co n tri b u ti o n s m ad e b y o t h er en t i t i es . W e h av e fo u n d t h atth i s m o n ey

was i n co m e t o R&A. W e n o w h av e t o ad dres s wh eth er i t th en b ecam e t ax ab l e d i v i d en di n co m e t o Ry d er. A co n s tr u ct i ve d i v i d en do ccu rs wh en “ a co rp o rat i o n co nfers an eco n o m i c b en efi to n a s h areh o l der wi t h o u tth e ex p ect at io n o f rep aym en t .” M ag n o n v . Co m m i s s i o n er, 7 3 T.C. 9 80 , 9 9 3 -9 4 (1 9 8 0 ); s ee al s o No b l e v . Co m m i s s i o n er, 3 6 8- 1 3 5 -

[* 1 3 5] F.2 d 4 3 9 , 4 4 3 (9 t h Ci r. 1 9 6 6 ). W e l o o k fo r th e o bject i v e fact s t o fi g u re o u t wh et h er a b en efi ti s a co n st ru ct i v e b en efi t ; wh at t he p art i es m ig h ts ub ject i v el y h av e i n t en d ed d o es n ’ t co n t ro l . See No b l e, 3 6 8 F.2 d at4 4 3 ; Cl arkv . Co m m i s s i o n er, 2 6 6 F.2 d6 9 8 , 7 1 0 -1 1 (9 t h Ci r. 1 9 59 ). Th ere i s a t wo -p art t es t : Th e ex p en s e m us tb e n o n d edu ct i b l e t o the
co rp o rat i o n an d i tm

u s tb e an eco n o m i c g ai n o r b en efi tt o th e s hareh o l d er. M eri d i anW o o d Pro d s . Co ., In c. v . Un it edSt at es , 7 2 5 F.2 d1 1 83 , 1 19 1 (9 th Ci r. 1 9 8 4 ) (ci t i n g Pal o Al t o To wn & Co u n t ry Vi l lag e, In c. v . Co m

m i ss i o ner, 5 65 F.2 d 1 3 8 8 , 1 3 9 1 (9 th Ci r. 1 9 7 7 )). Tax p ay ers wh o co n t ro l th ei r o wnco rp o rat i o n s d o fai rl y o ft enrecei v e co ns t ru ct iv e d i vi d en ds i f t h ey are n o t carefu l i n k eep i ng
co rp o rat e as set s s ep arat e fro m th ei r o wn . A co m

m o n s i tuat i on o ccu rs wh en a
co rp o rat i o n p ay s t o co n s t ru cto r o t h erwi s e i m p ro ve i t s s h areh o l d er’ s real p ro p ert y wi th o u tth e co rp o rat i o n’ s ex p ect i n g ev er t o b e rep ai d
. See, e.g ., M ag n on , 7 3 T.C. at9 9 4 ; Es t at e o f Cl ark e v . Co m m i s s i o n er, 5 4 T.C. 1 1 4 9, 1 1 6 1 (1 9 7 0 ); As h er v . Co m m i s s i o n er, T.C. M em o . 1 9 9 8 -2 1 9 , 1 9 98 W L 3 2 8 4 4 0, at* 6 . W e al s o ro u t i nel y fi ndco n s t ru ct i v e d i v i d en d s wh en a s h areh o l d er’ s co rp o rat io n p ay s h i s p ers o n al
ex p en s es . See, e.g ., Do bb e v . Co m m i s s i o n er, 6 1 F. Ap p ’ x 3 4 8 (9 th Ci r. 2 00 3 ), aff’ g T.C. M em o . 2 0 0 0 -3 3 0
.- 1 3 6 -

[* 1 3 6] Th ere i s o n e i m

p o rt an to b s t acl e t hatm i g h t n o tb e ap p aren t t o a n on t ax l awy er: Di v id en d s m

u s tco m e fro m

a co rp orat i o n ’ s earn i n g s an dp ro fi ts . If a
co rp o rat i o n d o es n ’ th av e en o u g h earn i n g s an dp ro fi ts , th en th es e n o n d edu ct i b l e
u n co m p en s at edp aym en t s are a n o nt ax ab l e ret u rn o f cap i t al t o the ex t en t o f t h e
s h areh o ld er’ s b as is u n d er s ect io n s 3 0 1 (c) an d 3 1 6 (a). Go y akv . Co m m i ss i o n er, T.C. M em o . 2 01 2 -1 3 , 2 0 1 2 W L 8 6 6 0 3 , at* 1 4
. An di f a t ax p ay er t ak es s o m u ch
m o ney fro m h is co rp orat i o n as t o u s e up b ot h al l th e earn i n g s an d p ro fi t s , an dal l
o f h i s accu m

u lat edb as i s i n h i s s h ares , thatm o n ey can ag ai n b eco m e t ax ab l e as a cap i t al g ai n . Tru es d el l, 8 9 T.C. at1 2 9 4 -9 5. Ou r fi n d i n g t h atR&A h adv ery l arg e
am ou n t s o f u n rep ort edi n co m e en ab l es u s t o fi n di t m ore l i k el y th an n o t th at R&A’ s accu m

u l at edearn in g s an dp ro fi ts were s u ffi ci en tt o s up p o rt al l o f th e d i s tri b u t i o n s th atth e Co m m i s s i o n er al l eg es fo r each y ear at i ss u e. W e’ l l l o o ki n tu rnatal l th ree way s t h at t he Co m m i s si on er s ay s Ry d er was
co l l ect i n g d i v i den d s fro m R&A.- 1 3 7 -

[* 1 3 7] A. Di v i d en d s Fro m R&A Th ro ug h RLC Year Tax ab le d i s tri b ut i o n am ou n t 2 0 0 3 $ (3 2 ,7 7 5 .0 0 ) 2 0 0 4 9 5 , 4 80 .1 2 2 0 0 5 6 ,3 4 8 ,6 6 7 .5 9 5 7 2 0 0 6 1 ,3 12 ,6 4 5 .8 0 2 0 0 7 5 85 ,2 0 5 .4 0 2 0 0 8 (2 05 ,7 0 4 .5 5 ) 2 0 0 9 1 51 ,5 8 3 .7 0 To t al 8 ,2 5 5,1 0 3 .0 6 Th e l eas t reco g n i zab l e d i v i d en ds t ream was wh atth e Co m m i s si o n er arg u es fl owed fro m

RLC t o Ry d er. W e’ v e al read y fo u ndth at t h e s o u rce o f t h i s m o n ey
was R&A’ s i n co m e n o m at ter wh ere i t p o ol ed , i n acco u n t s n o m i n al l y b el o n g i n g t o a GCO o r ASIG o r RLC o r an y o f t h e o t h er m an y

ci s t ern s th atRy d er i n s t al l edt o
co l l ecti t . Th e qu es t i o n n o w i s wh eth er i tfo u n d i t s way a b i tfu rt h er t o th e Ry d ers th em s el v es . As we h av e al read y d es cri b edi n d et ai l --s ee s upra p p . 3 1 -3 4 --Ry d er
u n d o ub t ed l y

m o vedth i s m o n ey

fro m R&A t o h i m s el f. It ’ s ju s t th at h e tri edt o
m ak e i tn o n t ax ab l e t h ro u g h the m ul t i p l e y ear-en dad

ju s t in g jo u rn al en t ri es t o th e

5 7 Th i s i s $ 1 0 ,0 0 0 l es s t h an th e am o u ntthe Co m m i s s i o n er d et erm i n ed , wh i ch d i dn ’ tacco u n t fo r th e $ 10 ,0 0 0 Ry d er p ai d Am m on fo r h i s 1 5 0 ,0 0 0 s h ares i n RLC.- 1 3 8 -

[* 1 3 8] b o o k s o f R&A, RLC, an dth e v ari o u s o t h er en t i t i es h e’ ds etup t o co l l ect wh atwe’ v e n o w fo u ndt o b e R&A’ s i n co m e. He s en ta l arg e ch u nko f t h i s i n co m e t o RLC fo r wh atR&A cl ai m edwere d edu ct i b le “ s erv i ces ” t h atRLC s up p os ed l y p ro v id edt o R&A u n der t h e t erm s o f t h ei r s taffi n g arran g em en t . Ry d er was
m ean wh il e “ b o rro wi ng ” m on ey fro m R&A fo r wh ich h e wo u l dg i v e R&A n o t es . R&A wo u ldp ay

RLC wi t h t h es e n o t es , an dRLC wo u l dp as s t hem o n t o Ry d er as d i s tri b u t i o n s wh i ch Ry d er d i dn ’ trep o rtb ecau s e i n h i s v i ew “ di s t ri b u ti o n s fro m S
co rp s aren ’ ti n co m e * * * u n l es s they ex ceed b as is
. ” Th i s co m p l i cat edad

ju s t in g -jo u rn al -en t ry

m eth o d d ep en dedo n t he v al i d i t y
o f each tran s act i o n i n v o l v ed . An dthi s i s wh ere t h e wh eel s fal l o ff t h i s t ax av o id an ce v eh icl e. Th e “ em p l o y ee-l eas i n g ag reem en t ” b et ween RLC an d R&A d i dn ’ tactu al l y

l eas e an y em p l o y ees . Al l d i s t ri b ut io n s m ad e b y RLC were ju s t tran s fers fro m

R&A t o Ry d er weari n g a fl im sy p ap er d i s g u i s e. If t h ere’ s an y

d o ub tab o u tth i s , we’ l l m ak e an al t ern at i v e fi n d i n g t o o . Ry d er cl ai m s thath e h ads u ffi ci en to u t s i d e b as is i n h i s RLC s h ares t o m ak e t h es e d i s tri b u t i o n s a t ax -free ret u rno f cap i t al . Ry der cl ai m s t h ath e g o tb as is i n RLC fro m th e p ro m i s so ry

n o t es th ath e s i g n edan d m ad e p ay ab l e t o RLC fo r i t s s t o ck
. Th es e n o t es are t h e o n l y s ou rce o f b as i s th atRy der h as ev er cl ai m ed
.- 1 3 9 -

[* 1 3 9] Th e p ro b l em

fo r Ry d er i s th atp ap er p ro m i s es n o tb ack edb y cas h d o n ’ t creat e b as i s . Bas i s i s th e co s to f p ro p ert y , s ec. 1 0 1 2 , an da s h areh o l der g et s b as i s i n h i s s h ares i n a co rp o rat i o n wh en h e p urch as es th o s e s h ares o r co n t ri b ut es cap i t al t o that co rp o rat i o n , s ecs . 3 5 1 (a), 3 58 (a)(1 ); s ee al so M ag u i re v . Co m m i ss i o n er, T.C. M em o . 2 01 2 -1 6 0 , 2 0 1 2 W L 2 0 3 6 1 53 , at* 4 . Fo r a s h areh o l d er i n an S
co rp o rat i o n t o i n creas e h i s b as i s , h e m u s tm ak e an actu al eco n om i c o u t lay . Oren
v . Co m m i s s i o n er, T.C. M em o . 2 0 0 2 -1 7 2 , 2 0 0 2 W L 1 5 8 7 2 1 6 , at* 8 , aff’ d , 3 5 7 F.3 d8 5 4 (8 t h Ci r. 2 0 0 4). He m ak es an “ eco n o m i c o u t l ay ” wh en h e i n cu rs a co s t
o r co n tri b u t es m o ney

o r p ro p ert y

o r i s o t herwi s e l eftp o orer i n a m at eri al s en s e aft er h i s co n t ri b u t i o n . See Pu t n am v . Co m m i s s i o n er, 3 5 2 U.S. 8 2 , 8 5 (1 9 56 ); Ru ckri eg el v . Co m

m i s s io ner, T.C. M em o . 2 0 0 6-7 8 , 2 0 0 6 W L 1 0 07 6 2 8 , at* 7
. Ry d er cl earl y

m ad e an eco n o m i c o u t l ay t o Am m o n b y p ay i n g $ 1 0,0 0 0 cas h , g i v i n g h i m $ 1 0 ,0 0 0 b as i s i n th e s t o ckth ereb y acq u i red . Bu twh et h er h e h adan y ad d it i o n al b as i s creat edth ro u g h h i s p ro m i s s ory n o t es an d s ub scri pt io n ag reem en t s i s a d i fferen tqu es t i o n. Ry d er rel i es o n Peracch i v . Co m m i s si on er, 1 4 3 F.3 d 4 8 7 (9 t h Ci r. 1 9 9 8 ), fo r h i s arg u m en tthath e h ads u ffi ci en tb as i s i n RLC. Peracch i d i d h ol d t h ata C
co rp o rat i o n’ s s h areh o l d er can g etb as is i n h i s s h ares wi t h th e co n t ri b u t i o n o f a
n o t e, b uti tal s o m ad e cl ear t h atth i s h o l d i ng d o es n o tap p l y t o S co rp orat i o n s . Id
.- 1 4 0 -

[* 1 4 0] at4 9 4 n .1 6 . W e o u rs el v es h av e m ad e co m p l et el y cl ear t h ata s h areh o l d er d o es n’ tg etb as i s i n h i s S co rp o rat i o n’ s s t o ck b y g i v i n g i ta n o t e u n t i l an du n l es s h e ad v an ces fu n d s o n th e n o te. See Perryv . Co m m i s s i on er, 5 4 T.C. 1 2 9 3 , 1 2 9 5 -9 6 (1 9 7 0), aff’ dwi t h o utp ub li s h edo p i n i o n , 2 7 A.F.T.R.2 d 7 1 -1 4 6 4 (8 th Ci r. 1 9 7 1 );
s ee al so Un d erwo o d v . Co m m i s s i o n er, 6 3 T.C. 4 68 , 4 7 7 (1 9 7 5 ), aff’ d , 5 3 5 F.2 d 3 0 9 (5 th Ci r. 1 9 76 ); Oren , T.C. M em o . 2 0 0 2 -1 7 2
. Th ere’ s n o ad d i t i on al b as i s h ere. Ry d er was ju stm o v i ng u n fu n d ed p ro m i s s o ry

n o t es an ds ub scri p t i o n ag reem en ts aro u n dan daro u ndth ro u g h
o ffs et t i n g b o o ken t ri es , i l lu so ry ag reem en t s, an dth e l o an “ rep aym en t s ” t o RLC th atm at ch edd is t ri b u t i on s fro m i t . Ry d er u s edth i s ci rcu l ar fl o w o f fu n d s t o p ay fo r t h e m ul t i p l e s t o ck
s ub s cri p t i o n s o f RLC. Ry d er fi n an cedh i s p u rch as e o f s h ares o f RLC wi th p ro m i s s o ry

n o t es th atcal l edfo r m on t h l y p aym en t s o v er a n u m b er o f y ears . As we’ v e al read y

fo u n d, t here i s n o ev i d en ce o n th e reco rdthatRy d er ev er p ai dreal
cas h o n t h es e n ot es . He i n s t eadu s edd i s t ri b u t i o n s fro m RLC t o m ak e p aym en t s t o RLC. 5 8 He’ drecy cl e t h es e p aym en t s o v er an d o ver t o m ak e i tap p ear as i f

5 8 Th e d is t ri b u ti o n am o u n t s fo r 2 0 0 3 an d2 0 0 8 are n eg at i v e b ecau s e o f t i m i ng i s su es i n Ry d er’ s ci rcu l ar fl o w o f fu n d s , res u l t i n g i n h ig h er p aym en t s i n t o RLC t h an th ere were d i s t ri b u t io n s o u to f RLC du ri n g th o s e y ears . See t ab l e s up ra p . 1 37
.- 1 4 1 -

[* 1 4 1] p ri n ci p al were b ei n g p ai do n th e n o t es . Th en h e m ad e i tm o re co nv o l u t ed i n 2 0 0 4 b y g et t i n g m o n ey fro m RLC, b u t wri t i n g ch eck s i n t h e s am e am o u n tt o ESR Of Co u n s el . ESR Of Co u n s el wo u ldth en s en dth o s e ch eck s b ackt o RLC t o
m ak e wh at i t cal l edp aym en t s o n two “ rel at edp art y l o an s ” th atwere o n R&A’ s b o o k s . W e fi n dth atn o n e o f t h i s wo rk s . B. Di v i d en dIn co m e Fro m Paym en ts M ad e To Acqu i re an dOp erat e t h e Ran ch Pro p ert i es Year Am o u n t 2 0 0 3 $ 1 , 4 4 7,4 0 7 .8 9 2 0 0 4 7 1 7 ,1 4 0 .0 0 2 0 0 5 1 ,4 3 0 ,9 0 0 .5 6 2 0 0 6 7 9 0 ,2 9 9 .7 6 2 0 0 7 1 ,0 7 4 ,8 3 0 .5 5 2 0 0 8 4 8 0 ,1 1 2 .6 0 2 0 0 9 1 8 3 ,8 0 0 .0 0 2 0 1 0 3 9 6 ,4 0 0 .0 0 2 0 1 1 3 2 6 ,5 0 2 .7 5 To t al 6 ,8 4 7 ,3 9 4 .1 1 Th e Co m m is s i o n er n ex ts ay s Ry d er t oo km o n ey o uto f R&A t o b u y

ran ch es . W e h av e al read y

fo u ndth atth e fees s t emm i n g fro m t h e t ax p ro du ct s are R&A’ s- 1 4 2 -

[* 1 4 2] o wng ro s s recei p t s . When ev er t h es e were u s edfo r t h e p ers o n al b en efi to f Ry d er, t h ey

b ecam e d i s t ri bu t i o n s fro m R&A. Becau s e, acco rd i ng t o th e Co m m i s s i o n er, t h e Ry d ers o wn ed1 0 0 % o f t he ran ch en t i t i es d i rect l y o r i n d i rect l y , al l d i s tri b u t i o n s fro m

R&A t o p ay

fo r t h e ran ch es o r t h ei r ex p en ses are t ax ab l e d i v i d en d s t o Ry der. Ry d er cl ai m s , th o ug h , th ath e b ui l ta p ap er d am s t ro n g en o u g h t o b l o ckth i s rech aract eri zat i o n . Onp ap er, Ry d er Ran ch Co ., LLC, was th e 1 0 0% o wn er o f each o f t h e o th er ran ch en t i t ies --Pat t ern Farm s , LLC; Can y on Vi ew Ran ch , LLC; Ry d er Red Ro ck

Ran ch , LLC; an dRo d eo Ho l d i ng s , LLC. Ry d er al so arg u es th at h e h as no equi ty

i n Ry der Ran ch Co ., LLC. An dthe fu n d s co n tri b u t edt o th e
ran ch es as cap it al wo u l dn ’ tb e cl as s i fi edas d i v i d en d i n co m e o f t h e Ry ders ei t h er
s i nce t hey d i d n o to wno r co n t ro l th atm on ey . Ry d er s u g g es t s th atwe “ fo l l o w th e
m o ney ” t o d et erm i n e t h e tru e o wn ers o f Ry der Ran ch Co ., LLC, an dth e o t h er
ran ch en ti t i es . Th ati s a g o o d s ug g es t i o n . Wh at we fi n dwh en we ad o p ti ti s l es s a h i g h way th an cu n n i n g p as s ag es an d co n t ri v edco rri d o rs i n a wi ld ern es s o f m i rro rs . Al o n g th e way are m

u lt i pl e ESOPs , GCO acco u n t s, b lo ck er en t i t i es , an dtru s ts . Ry d er at t em p t edt o p ap er h u n dred s an dth o u s an d s o f t ran s act io n s b et ween th es e en t i t i es t o m ak e t h em

ap p ear t o b e u n rel at ed , each h av in g d ifferen t o wn ers h ip an d m ak in g- 1 4 3 -

[* 1 4 3] i n v es t m en t s i n each o t her. Co n s i d er, fo r ex am pl e, Fi rs t Co u n sel Cap i t al
. Ry d er at t em

p t edt o m ak e i t ap p ear as i f Fi rs t Co u ns el Cap i t al was o wn edb y th e
v ari o u s GCOs an do t h er t ax p ro du ct s s o ldb y R&A. M o n ey

p l aced i n th e GCO p ro duct s ’ b an kacco u n t s wo ul d b e “ i nv es t ed ” i n FCC, wh ich wo u ldthen m ak e

“ cap i t al co n t ri b ut io n s ” t o t h e ran ch en t i t ies . Ry d er s i m i l arl y arg u es th at t he fo u r

“ b l ock er” en t i t i es --Al s t er, M BSP, Tu rn o ur, an dSp an ky --were o wn edb y BFA, s o
an y m o ney m o vi n g i n t o th es e b l o ck er en t i t i es was p aym en t o n th e PFA b etween BFA an d R&A. Th en s o m e o f t h i s m on ey i n th e b l o ck er en t i t i es wo u l db eco m e cap i t al co n t ri b u t i on s i n th e ran ch en t i ti es . Bu t h ere we can m ak e o u t a l o des t ar t o h el p u s n av i g at e o u r way --o n e way o r an o t h er, a l l th e mo n ey b el on g ed

t o R& A
. W e’ v e fo u ndthatthe i n co m e fro m th e s al es o f t h e t ax p ro du ct s fro m wh i ch Ry d er
m ad e h i s fo rtu n e b el o n g edt o th e l aw fi rm th atd i dth e wo rk . Th e m o n ey th atwen t t o the GCOs cam e fro m

R&A. Th e m o ney

th atwen ti n t o Al s ter cam e fro m R&A. Th e m o n ey

th atwen t i n t o M BSP, Tu rn ou r, an dSp an ky al l cam e fro m

R&A. An d t h i s m o n ey , g u s hi n g fro m R&A an dru s hi ng th ro u g h th es e m u lt i p l e
en t i t i es , al l fo u n d i t s way t o th e Ry d ers fo r t h ei r o wn b en efi t .

1
. Ry d er Ran ch Co ., LLC W e wi l l b eg i n wi t h Ry d er Ran ch Co ., LLC. Ry d er fi ledi t s o ri g i n al art i cl es
o f o rg an izat io n i n J an u ary 2 0 0 3 . Th ey

i d en t i fi edb o t h Ry der an dh is wi fe as th e- 1 4 4 -

[* 1 4 4] LLC’ s m an ag ers , an dRy d er In ves t m en tPart n ers , Lt d .--wh i ch th ey wh o l l y
o wn ed --as th e o n ly

o t h er m em

b er wi t h a 2 0 % o r g reat er i n t eres ti n i t s cap i t al o r p ro fi ts . Ry d er am en d edth es e art i cl es o f o rg an i zat i on i n Feb ru ary 2 00 7 an dag ai n i n J u n e 2 00 9 . Th e o n l y

ch an g e t h ath e m ad e i n Feb ru ary 2 0 0 7 was t o ren am e t h e LLC as Ry d er Ran ch es , LLC. Th e J u n e 2 0 09 am en d m en tch an g edth e n am e b ack t o Ry d er Ran ch Co
. , LLC, an dn o l o n g er l i s tedRy d er In v es t m en t Part n ers , Lt d ., as
an o wn er o f a 2 0 % i n t eres t . Th i s am en d m en t m ad e s u re t h at t h ere were n o
m em b ers b es i d es t h e Ry d ers th em s el v es wh o o wn eds u ch l arg e s h ares . Th e o ri g i nal o p erat in g ag reem en tl i s t ed t h e Ry d ers ’ o wn ers h i p p ercen t ag e
as 9 .0 9 %, wh i le Ry d er In v es t m en t Part n ers , Lt d ., was l is t edas h av in g a 9 0 .9 1 % i n t eres t . Inth i s o p erat i n g ag reem en t , th e p ercen tag e i n t eres t o f Ry d er In v es t m en t Part ners , Lt d ., “ s h al l i n al l ev en t s b e 9 0 .9 1 %,” n o m at t er t h e am o u n t o f fu tu re cap i t al fu n d in g actu al l y

p ro v i d edb y

th e p art ners h i p . Ital s o s t at edthat“ an i m p o rt an tp u rp o s e” o f Ry der Ran ch Co ., LLC, was t o “pro v i de a m ean s fo r
m em b ers o f t he ERNEST S. RYDER an dPATRICIA A. RYDER fam i ly t o acq u ire an i n t eres ti n [t h e LLC’ s ] b u s i n es s an d/ o r i n v es tm en tact i v i t ies ,” an dth e
o p erat i n g ag reem en tres t ri ct ed t ran s fers o f i n t eres t s o u t s i d e th e Ry der fam i l y .- 1 4 5 -

[* 1 4 5] Th e ag reem en tal lo cat edn etp ro fi ts t o m em b ers b y th ei r p ercen t ag e o f
o wn ers hi p . Bu tRy d er p ro v i dedth atal l l o s s es were al l o cab l e t o th e Ry d ers al o n e
an d th end eb it edt o t h ei r res p ect i v e i n co m e acco u n t s , ev en th o u g h th ey were o n l y 9 .0 9% o wn ers . He co m

p li cat edth i n g s s o m e m o re b y th en al l o cat in g t o h i m s el f
an d h i s wi fe al l n et p ro fi t s t o the ex t en to f an y n etl o s s es th ey cl ai m ed
. Ry d er’ s fi rs tam en d m en t t o th i s 2 0 0 3 o p erat i n g ag reem en ts t at edth ati twas effect i v e as o f J an u ary 1 0 , 2 0 0 3. Th i s am en d m en t ad d ed Al s t er In v es tm en t s , In c.; Ben efact o r Fu n di ng As s o ci at i o n , In c.; Fi rs tCo u n s el Cap i t al , LLC; M BSP In v es t m en t s , In c.; Sp an ky In ves t m en t s , In c.; an dTu rn o u r In v es t m en ts , In c., as
n ew m em b ers an d k ep tth e o ri gi n al m em b ers --th e Ry ders an dRy d er In v es t m en t Part ners , Lt d . Th e am en d m en tch an g edh o w p ercen t ag e i n t eres t s an di n it i al cap i t al co n t ri b u t i on s were t o b e d et erm i n edfo r t h e m em b ers . Each m em

b er’ s p ercen t ag e i nt eres ti n Ry d er Ran ch Co ., LLC, was t o b e b as edo n t h e m em b er’ s t o t al cap i t al co n t ri b u t i o n , redu cedb y an y cap i t al wi t hd rawal s , an d co m p aredt o th e t o t al co n tri b u t i o n s o f al l m em b ers , al s o redu cedb y

an y cap i t al wi t hd rawal s . An da
m em b er’ s cap i t al co n t ri b u t i o n was n o w d efi n edas “ [f] u tu re cap i t al fu n di n g fo r Co m p an y o p erat i on s , as d et erm i n edb y a M ajo ri t y i n In t eres t o f t h e M em

b ers .” Th e l o s s -al l o cat i o n cl au s e i n th e o ri g i nal o p erat i n g ag reem en twas ch an g edt o s t at e th atwh en ev er n etl o s s es t o Ry d er Ran ch Co ., LLC, cau s edth e Ry d ers ’ cap i t al t o- 1 4 6 -

[* 1 4 6] g o n eg at i v e, t h e Ry d ers wo u l dh av e an i m m ed i at e fi n an ci al o b l i g at i o n t o Ry d er Ran ch Co ., LLC, fo r t hatam o u n t . Ry d er arg u es th atth is o b l i g at io n i n creas edh i s b as i s i n Ry d er Ran ch Co
. , LLC, an d al l o wedh i m an dh i s wi fe t o
co n ti n u e t o cl ai m

the l o ss es th atk ep tfl o wi n g fro m th e co m p an y . An d y etan o t h er p arag rap h i n th e am en d m en ts t at edth atwh atwas n o tch an g edb y th e am en d m en t

“ s h al l rem ai n th e s am e,” wh i ch m ean tth atm em b ers hi p was s t i l l l i m i t edt o o n l y th e Ry d ers , th ei r d es cen d an t s , an den t it i es o wn ed b y th e Ry d ers o r t h ei r d es cen d an t s . An dthe LLC’ s s t at edm at eri al p u rp o s e rem ai n edRy d er fam i l y es tat e p l an n i n g . Ry d er g av e a co p y

o f t h is am en d m en tt o the Co m m i s s i o n er’ s co un s el o n l y

a weekb efo re t ri al . Th e Co m m i s s i o n er n ow qu es t i on s i t s tru e d at e. Th e
am en d m en ts t at es i t s effect i v e d at e i s J an u ary 1 0 , 2 00 3 --t h e s am e d at e as th e
o ri g i nal o p erat in g ag reem en t --b u tth e s i gn atu res o n i tare al l u n d at ed . Ry d er ad m i t s th atth i s am en d m en twas n o ts i g n edth atd ay b u tcl ai m s i n s t eadth ati twas a ret ro act i v e am en d m en tm em o ri al i zi n g earl i er o ral ag reem en t s t o ch an g e t h e
o p erat i n g ag reem en t . Bes i des t h i s t es t i m o n y , th ere i s n o p ro of o f an y s u ch o ral ag reem en t . W e fi n di to d d t h atFi rs tCo u n s el Cap i t al , LLC, an dBFA b ecam e n ew
m em b ers as o f J an u ary

2 0 0 3 --i f t h i s am en d m en t i s t o b e b el i ev ed --as n ei t h er was l i st edi n Ry d er Ran ch ’ s Gen eral Led g er as co n tri b ut i ng m on ey t o i ti n 2 0 0 3
. Ry d er Ran ch Co ., LLC’ s 2 00 3 Fo rm 1 06 5 fai l s t o l i stei t h er Fi rs tCo un s el Cap i t al ,- 1 4 7 -

[* 1 4 7] LLC, o r BFA as a m em b er. Wh en as k ed ab o u tth i s o p erat i n g ag reem en t at tri al , Ry d er s ug g es t ed “ l o o k[i n g ] atth e h arddri v e [t o ] s ee wh enth atd o cu m en t
was creat ed .” W e d i d. Th e h arddri v e co n t ai n s m u l t i p l e v ers i o n s o f t h i s fi rs t
am en d m en t , b u t t h e o n e t h atm o s tcl o s el y res em bl es th e o ne we h av e was l as t
m o di fi edo n Feb ru ary

1 3, 2 0 07 , two m o n t h s b efo re Ry d er Ran ch Co ., LLC, fi n al l y fi led it s 2 0 0 3 Fo rm 1 0 6 5. Th en there’ s t h e s eco n dfu l l Am en d edan d Res t at edOp erat i n g Ag reem en t , wi th an effect i ve d at e o f J an uary1 , 2 0 0 7 , b u t s i g n edo n Ap ri l 2 0 , 2 0 1 1. Th i s
o p erat i n g ag reem en ts t at es t h ati s was ex ecu t edt o el i m i n at e t h e co n fu s i o n t h at
aro s e s u rro u nd i n g tru e o wn ers h i p o f t h e co m p an y an dth e fu n d s th at h adb een i n v es t edi n i t . Itp u rp o rt s t o res o l v e t hes e i ss ues aft er h av in g co n duct ed“ a
co m p l et e acco u nt i n g an dreco n ci l i at i o n o f t h e fu n d s i nv es t edi n th e Co m p an y .” It
s t at es th e co m

pan y ’ s n am e i s Ry d er Ran ch Co ., LLC, an dl i s t s th e Ry d ers an d Fi rs t Co u n s el Cap i tal , In c., as i t s m em bers
. Itl ack s an y

referen ce t o the o ri g i n al ’ s
s t at em en tth ati t s p urp o s e was t o h el p th e Ry d ers p l anthei r es t at e, an do m i t s th e
o ri g i nal ag reem en t ’ s res tri ct i o n s o n t ran s fer o f o wn ers h i p . Th e l o ss -al l o cat i o n p ro v is i o n an dth e Ry d ers ’ s up po s edo b l i g at io n t o fu n dth e co m p an y wh en th ei r cap i t al acco u n t b al an ce wen tn eg at i v e d i dm ak e th e m o ve fro m th e al l eg edfi rs t
am en d m en tt o thi s s eco n do p erat i n g ag reem en t . Th e Co m m i s si o n er fi rs t l earn ed- 1 4 8 -

[* 1 4 8] o f t hi s s eco n do p erat i ng ag reem en twh en Ry d er p ro du cedi tt o o n e o f t h e
rev en u e ag en t s wh o was au d i t in g h i m , ju s ta few d ay s aft er t h e Ry d ers s i g n edi t . Th i n g s g etev en cu ri o u s er wi t h t h e s eco ndal l eg ed am en d m en t t o th e
o p erat i n g ag reem en t , wh i ch o n p ap er s t at es th ati twas effect iv e Feb ru ary 1 2 , 2 0 0 7 , b u twh o se s i gn atu res are u n d at ed . It s o n l y m ajo r al t erat i o n was t o ch an g e th e n am e o f t h e co m

p an y t o Ry d er Ran ch es , LLC, i n acco rd an ce wi t h th e am en d ed art i cl es o f o rg an i zat i o n th atwere fi l edaro u ndth at t im e. Bu t th e l i s to f m em b ers
m at ch es th ato f t h e fi rs tam en d m en t . Th i s i t s el f i s o d d s in ce Fi rs t Co u n s el Cap i t al , LLC , d i dn ’ tex i s ti n 2 0 0 7--i th adb een co n v ert edi n t o a co rp orat i o n , Fi rs tCo u n s el Cap it al , In c. , b acki n Ap ri l 2 0 06 . An db es i d es , Ry der Ran ch es , LLC’ s Fo rm 1 06 5 fo r 2 0 0 7 l i s t s o n l y

two m em b ers , Ry d er an dFi rs tCo u n s el Cap i t al , In c. To p p i n g i tal l o ff i s Ry d er Ran ch ’ s th i rd o perat i n g ag reem en t . Ith as an effect i v e d at e o f M ay

2 8 , 2 00 9 , ab o u ta weekb efo re t he co m p an y fi l edi t s s eco n d
am en d m en tt o i ts art icl es o f o rg an i zat i on . Th i s th i rdo perat in g ag reem en tl i s t s
o n l y the Ry d ers as m em

b ers , each wi th a 5 0% i n teres tan dan i n i t i al co n t ri b u t i o n
o f “ $ 5 0 ,0 0 0 .0 0 Pl u s Fu tu re Cap i t al Fu n d i n g as Req u i redfo r Co m p an y Op erat i o n s .” Fu rt h er cal l i n g i n t o qu es t i o n t he rel i ab il i t y o f t h e p rev i o u s
am en d m en t s i s t h e factth atthi s v ers i o n i n cl ud es as an at t ach m en tthe o ri g i n al
o p erat i n g ag reem en tb u tm ak es n o referen ce t o an y o f t h e s ub s equ en tam en d m en t s .- 1 4 9 -

[* 1 4 9] Th ere i s an o b v i o u s reas o n fo r t h i s o p erat i ng ag reem en t. It w as ad o p t edl es s th an a m o nt h aft er t h e d et erm i n at i o n o f t h e Co ch i s e Co u n ty Farm

Serv i ce Ag en cy

(FSA) 5 9 co m

m i t tee t h atRy d er Ran ch Co ., LLC,
co u ld n ’ trecei v e fed eral -g o v ern m en t s ub s i d i es b ecau s e each o f i t s m em b ers d i d
n o tm ak e a co n t ri b u t i o n o f act i v e p ers o n al l ab o r o r act i v e p ers on al m an ag em en tt o th e farm i n g o p erat i o n s . 6 0 Ry d er was n o t h ap p y ab o u tth i s d et erm i n at i o n , s o o n J u n e 3 , 2 0 0 9 , h e s en ta l et t er as k i n g fo r reco n s id erat i o n . In t h i s l et ter, Ry d er s t at ed th atth e o p erat i n g p l an th ath e’ d s ub m i t t edwi t h Ry d er Ran ch Co ., LLC’ s req u es t fo r s ub s i dy

p aym en t s h adm i st ak en l y n otrefl ect edth atRy d er In v es tm en tPart n ers
was “ n o l o n ger i n v ol v edi n an y m an n er wh at so ev er wi t h Ry der Ran ch Co m p an y , LLC.” Two d ay s l at er, Ry d er fi l edam en d edart i cl es o f o rg an i zat i o n , t ak i ng care

5 9 Th e FSA i s an ag en cy

u n d er t h e U.S. Dep art m en to f Ag ri cu l tu re wi t h a n et wo rko f n at i o n al o ffi ces thatp ro v i des a s eri es o f p ro g ram s t o farm ers , ran ch ers , an d ag ri cu l tural p art n ers . Th e FSA ad m in i s t ers farm co m m o d i t y an d d i s as t er p ro g ram s , as wel l as cred i t , l oan , an d m ark et i n g p ro g ram s . See Farm Serv i ce Ag en cy Pro g ram s , Un i t edSt at es Dep art m en to f Ag ri cu l tu re (Au g us t2 0 1 6 ), h t tp s : //www.fs a.u s d a.g o v / As s et s /USDA-FSA-Pu b l i c/us d afi l es / Fact Sh eet s / 2 0 1 6/ farm

_ s erv i ce_ ag en cy

_ p ro g ram s .p d f.
6 0 Ry d er In v es t m en t Part n ers , Lt d ., wh i ch up t o th en was i den t i fi edi n th e o p erat i n g ag reem en tas a m em ber o f t h e co m

p an y , co u l d n o tp art i ci p at e i n act i v e p ers o n al l ab o r o r act i v e p ers on al m an ag em en t , as o n ly th e Ry d ers were m an ag ers o f t h e co m

p an y acco rd i ng t o th e art icl es o f o rg an i zat io n .- 1 5 0 -

[* 1 5 0] t o s t at e t h atth e o n l y m em b ers were t h e Ry d ers th em s el v es , an d“ Ry d er In v es t m en tPart ners , Lt d . i s n o t a m em b er o f t h e LLC.” Th i s was n o tth e fi rs t t i m e t h atth e Ry d ers were l i s tedas th e o wn ers o f Ry d er Ran ch Co ., LLC, i n th e co m p an y ’ s fi l i n g s t o t h e U.S. Dep art m en to f Ag ri cu ltu re. On Ap ri l 8 , 2 0 0 3 , M rs . Ry d er s ub m it t edt o th e U.S. Dep art m en to f Ag ri cu ltu re a fo rm

fo r “ Farm

Op erat i n g Pl an fo r Paym en tEl i g i b i l i t y Rev i ew fo r Co rp o rat i o n s , Li m i t edPart n ers h i p s o r Oth er Si m il ar En t i t i es .” Th e fo rm
s ub m i t t edl i s t edth e m em b ers o f Ry der Ran ch Co ., LLC, as th e Ry d ers an dRy d er In v es t m en tPart ners , Lt d ., the s am e as were l i s t edo n th e 2 0 0 3 o p erat in g ag reem en t . Th e fo rm

l i s t s th e Ry ders p ers on al l y as th e o wn ers o f Ry der In v es t m en tPart ners , Lt d . Th en ag ai n o n Ap ri l 1 , 2 0 0 4 , a fo rm en t i t l ed“ M em

b er’ s In fo rm at i o n ” was fi l ledo utfo r Ry d er Ran ch Co
. , LLC, b y an em p l o y ee o f t h e
co m p an y wh o wo rk ed as i t s l i ai s o n wi t h d i fferen tg o v ern m en tal en t i ti es . Th i s fo rm l i s tedth e m em

b ers o f Ry d er Ran ch Co ., LLC, as t h e Ry d ers an dRy d er In v es t m en tPart ners , Lt d . Li k e t h e Farm Op erat i n g Pl an fo rm fro m 2 0 0 3 , th i s fo rm s t at edth atth e Ry d ers each o wn ed4 .5 45 % o f t h e co m p an y , wh il e Ry d er In v es t m en tPart ners , Lt d ., o wn ed9 0 .9 1 %. An o th er em

p l o y ee o f Ry d er Ran ch Co ., LLC, n am edJ aco b W ardwo rk edas th e ran ch m an ag er fro m

2 00 4 t o 2 0 0 9 an dh an d ledth e d ay -t o-d ay act i v i t ies o n th e- 1 5 1 -

[* 1 5 1] ran ch es . Part o f h i s jo b was s ub m i t t i n g p ap erwo rk t o th e U.S. Dep art m en t
o f Ag ri cu l tu re s o Ry d er Ran ch Co ., LLC, co ul d recei v e g o v ern m en ts ubs i d i es . Befo re W ardd i dth is , h e wo u l dch eckwi th th e Ry d ers t o h av e t h em v eri fy th at
n o th i n g h adch an g edth atwo u l dreq u i re ch an g es o n an y fo rm s fro m wh ath ad p rev i o u s l y b een s ub m i t t ed . W ardcred ib l y t es t ifi edth at h e was n ev er t ol db y Ry d er t h atan yt h i n g h adch an g ed , s o each y ear h e wo u l dm erel y recert i fy th e fo rm s
an d s en dth em

i n. On e s u ch fo rm was a “ Farm Op erat i n g Pl an fo r an En t i t y ” fo r th e “ 20 0 9 an dSub s equen tPro g ram Years ” fi ll ed o u to n M arch 1 1, 2 0 09 . Onth i s fo rm , W ardl i s t ed t h e m em b ers o f Ry d er Ran ch Co
. , LLC as th e Ry d ers an dRy d er In v es t m en tPart ners , Lt d
. Th e p i ctu re o f o wn ers h i p p ercen t ag es fo r Ry d er Ran ch Co
. , LLC, g et s ev en
m u dd i er wh en o n e l o o k s at t h e d i fferen tFo rm s 1 06 5 fi l edb y Ry d er. Th e Fo rm s 1 0 6 5 fo r t ax y ears 2 0 0 3 -1 1 l is tth e fo l l o wi n g m em b ers an dth ei r al l eg edo wn ers h i p p ercen t ag es :- 1 5 2 -

[* 1 5 2] M em b er 2 0 0 3 20 0 4 20 0 5 2 0 0 6 2 00 7 2 00 8 2 00 9 2 01 0 2 0 1 1 Ern es t Ry d er 1 2 .0 7 1 1 .8 5 1 1 .6 2 1 5 .3 3 2 6.5 1 2 6.6 8 2 8.3 7 2 7.1 1 2 6 .7 1 Pat ri ci a Ry d er 1 2 .0 7 1 1 .8 5 1 1 .6 2 1 5 .3 3 N/ A N/ A N/ A N/ A N/ A Al s t er In v s ., In c. 9 .5 6 6 .3 0 3 .6 9 2
. 9 7 N/ A N/ A N/ A N/ A N/ A M BSP In v s ., In c. 4 8 .9 1 3 2 .2 7 1 8 .9 1 1 5 .1 8 N/ A N/ A N/ A N/ A N/ A Tu rn ou r In v s ., In c. 1 7 .2 8 1 2 .1 7 7 .1 5 5
. 7 4 N/ A N/ A N/ A N/ A N/ A Ry d er In v . Part n ers , Lt d. 0 .1 2 0 .0 9 0 .3 6 0
. 2 9 N/ A N/ A N/ A N/ A N/ A Sp an ky In v s . , In c. N/ A 2 .1 6 1 .2 7 1
. 0 2 N/ A N/ A N/ A N/ A N/ A Fi rs t Co u n s el Cap i t al , LLC/ In c. N/ A 2 3 .3 2 4 4 .5 5 4 3 .4 9 7 3.4 9 7 3.3 2 7 1.6 3 7 2.8 9 7 3 .2 9 Pat t ern Part n ers N/ A N/ A 0 .8 4 0
. 6 7 N/ A N/ A N/ A N/ A N/ A- 1 5 3 -

[* 1 5 3] Each an d ev ery

Fo rm 1 0 6 5 was fi l edu n ti m el y

fo r t he 2 0 0 3 th ro u g h 2 0 11 t ax y ears b ecau s e, acco rd i n g t o Ry d er, i ti s b et t er t o co m m i ta m i sd em ean or t h an a fel o n y . Fo rm

1 0 65 t ax y ear D at e fi l ed 2 0 0 3 4 / 5 /2 0 0 7 2 0 0 4 4 / 5 /2 0 0 7 2 0 0 5 1 / 2 1 / 2 00 9 2 0 0 6 8 / 1 8 / 2 00 9 2 0 0 7 1 / 2 6 / 2 01 6 2 0 0 8 1 / 2 6 / 2 01 6 2 0 0 9 2 / 1 1 / 2 01 6 2 0 1 0 2 / 2 4 / 2 01 6 2 0 1 1 5 / 2 7 / 2 01 6 Th e l at e-fi l i n g i s s u es fo r thes e fo rm s were n o tth e o n ly p ro b l em . Th ere were i n co n s i s t en ci es wh en co m p ari ng th e m em

b ers h ip s l i s t edi n th e v ari o u s i t erat i o n s
o f t h e art i cl es of o rg an i zat i o n t o the Fo rm 1 0 6 5 K-1 s . Th e fi rs twas th atth e
o ri g i nal art i cl es o f o rg an i zat i o n an di ts fi rs tam en d m en t, t o get h er effect iv e fro m 2 0 0 3 t o 2 0 0 9 , l i st edRy d er In v es t m en tPart n ers , Lt d ., as th e o n l y m em b er h av i n g atl eas t a 2 0 % i n t eres ti n Ry d er Ran ch Co ., LLC; b u t t h e 1 0 6 5 s n ev er s ho wedi t h av in g m o re t h an a 0
. 4 % i n t eres t , wh i l e M BSP In v es t m en t s , In c., an d Fi rs t Co u n s el Cap i t al , LLC (l at er In c.), b o t h h adm o re t han a 2 0 % i n t eres tdu ri n g th at- 1 5 4 -

[* 1 5 4] t i m e. Th e s eco n dwas th at t h e s eco ndam en dm en tt o th e art i cl es o f
o rg an i zat i o n , effect i v e as o f 2 0 0 9 , l i s t ed t h e Ry ders as the o n l y m em b ers h av i n g at l eas t a 2 0 % i nt eres t i n th e LLC; b u tth e 1 0 65 s fo r 2 0 0 9 -1 1 s h owedFi rs tCo u n s el Cap it al , In c., wi t h m o re t h an a 7 0 % i n t eres tdu ri n g th o s e y ears , an d d i dn’ tl i s tM rs . Ry d er as h av i n g an y i n t eres tatal l
.

2
. Pat t ern Farm s , LLC Wh en Pat tern Farm s, LLC, was o rg an i zed , Ry d er rep o rt edh i m s el f an dh i s wi fe as m an ag ers an d Ry d er In v es t m en tPart n ers , Lt d ., as a m em b er. Th e
o p erat i n g ag reem en twas co n s i s t en twi t h th e art i cl es , wh ich al s o rep o rt ed b o t h th e Ry d ers an dRy d er In ves tm en tPart n ers , Lt d ., as m em b ers . Pat t ern ’ s o ri g i n al
o p erat i n g ag reem en t , l i k e Ry d er Ran ch ’ s, h ada “ Fam i l y Es t at e Pl an n i n g Ob ject i ves ” s ect i o n . Do cu m en t s s tat i n g t h e m em b ers hi p o f Pat t ern Farm s , LLC, were fi rs tfi l ed wi th th e U.S. Dep art m en to f Ag ri cu ltu re o n Ap ri l 1 , 2 0 0 4 . Th i s i n i t i al fi li n g l i s t ed th e Ry d ers an dRy d er In v es t m en tPart n ers , Lt d., as th e m em b ers i n 2 0 0 4 . Ju s tas h e h adfo r Ry der Ran ch Co ., LLC, J aco b W ardch eck edwi t h Ry d er t o m ak e s u re
n o th i n g h adch an g edth atwo u l dreq u i re t h e i n fo rm at io n o n t h e fo rm s t o b e
up d at ed
. Si n ce h e was n o t t o l dth atan yt h i ng h adch an g ed , h e cert ifi edth es e- 1 5 5 -

[* 1 5 5] d o cu m en t s an drefi l edth em i n 2 0 0 9 u s i n g a p o wer o f at t o rn ey fo r Pat t ern Farm s, LLC. Th i s refi l in g l i s t edth e s am e m em b ers h ip as fo r 2 00 4
. Th en cam e an o t h er l et ter fro m th e Co ch i s e Co u n t y FSA Co m m i t t ee i n M ay 2 0 0 9 thatwarn edth e s ub si dy p aym en t s t o Pat tern wo u l dh av e t o s t o p b ecau s e al l
o f i t s m em

b ers d i dn o tco nt ri bu t e act i v e p ers o n al l ab o r, m an ag em en t , o r a
co m b i nat i o n o f t h e t wo t o th e ran ch ’ s o p erat i on . Ry d er am en d edPat t ern ’ s art i cl es
o f o rg an izat io n t o cert i fy th atth e Ry d ers were s t i l l m em b er-m an ag ers b u tth at Ry d er In v es t m en t Part ners , Lt d ., n o l o n g er was . Two y ears l at er h e s i gn edan d d at edan am en dedo p erat i n g ag reem en t , th o u g h t h e am en d m en t s tat edi t was

“ en t eredi n t o an dm ad e effect i v e as o f J an u ary 1 0 , 2 0 0 3
. ” It rem o v edth e “ Fam i l y Es t at e Pl an n in g Ob

ject i ves ” s ect i o n an d s tat edth atth e o n l y m em b er o f Pat t ern Farm s, LLC, was Ry d er Ran ch Co
. , LLC. Th en i n 2 0 1 3 h e am en d ed Pat t ern ’ s art i cl es o f o rg an i zat i o n t o co nfo rm wi t h th e am en d edo p erat i n g ag reem en tan d
rem o v e b o t h h i m s el f an d h i s wi fe as m em b ers an dm ak e o n ly

Ry d er Ran ch Co ., LLC, a m em

b er. Ry d er al s o fi l eda n ew “ M em ber’ s In fo rm at i o n” fo rm

wi th th e U.S. Dep art m en to f Ag ri cu l tu re o n M ay 2 4 , 2 01 1 , th atl is tedRy d er Ran ch Co ., LLC, as th e 1 0 0 % o wn er an do n l y m em b er o f Pat t ern Farm s , LLC. Th i s s am e fo rm l i s tedth e m em

b ers o f Ry d er Ran ch Co ., LLC, as t h e Ry d ers an dFi rs t- 1 5 6 -

[* 1 5 6] Co u n s el Cap i t al , In c., wh i ch i s t h e s am e m em b ers h ip l i st edo n Ry d er Ran ch Co ., LLC’ s fi l i n g wi t h th e U.S. Dep art m en to f Ag ri cu ltu re fo r t h aty ear. W e d o n’ tkno w h o w Pat t ern wo ul dh av e rep o rt edal l th es e fl u ctu at i on s o n i t s t ax retu rn s fo r t h e y ears ati s s u e b ecau s e i t d id n ’ tfi l e an y . Ry d er arg u es th at th e l as t b i to f p ap erwo rk

h e fi led --t h e am en d edart i cl es o f o rg an i zat i on th atm ad e Ry d er Ran ch the s o l e m em b er o f Pat t ern --m ad e Pat t ern i n t o a d is reg ard eden t i t y 6 1 th atd i dn ’ th av e t o fi l e. Bu t an am en d m en tfi ledi n 2 0 13 d o es n o tch an g e Pat t ern ’ s
o wn ers hi p fo r p ri o r t ax y ears . Rat h er, we wi ll h ol dth e Ry d ers t o t h ei r p ap erwo rk --th e art icl es o f o rg an i zat i o n , th e o p erat i n g ag reem en t s, an dth e fi l i n g s wi th th e U.S. Dep art m en to f Ag ri cu ltu re--wh i ch s h o ws th at Ry der Ran ch Co m p an y , LLC, was n o ta m em b er u n t i l 2 0 1 1 , an dth e Ry d ers t h em s el ves were t h e
o n l y m em b ers fro m M ay 2 8 , 2 0 0 9 , t o 2 01 1
. 3
. Can y o n Vi ew Ran ch , LLC Can y o n Vi ew Ran ch , LLC’ s art i cl es , fi l ed i n Ap ri l 2 0 0 3 , l i st edth e Ry d ers
as m an ag ers an d s t at edthatn o o t h er m em b ers h adatl eas ta 2 0 % i n t eres ti n i t s cap i t al o r p ro fi t s. It s o p erat i ng ag reem en t , effect i ve t hats am e m o n th , l i s tedo n l y th e Ry d ers an dRy d er In v es t m en tPart n ers , Lt d., as i t s m em b ers . Th i s o perat i n g

6 1 Fo r i n co m e t ax p urp os es , an LLC wi t h o n l y o n e m em b er m ay b e t reat edas th e m em b er’ s s o l e p ro p ri et o rs hi p --o t h erwi s e kn o wnas a “ d i s reg ard eden t i ty .” See s ec. 3 0 1.7 7 0 1 -3 , Pro ced . & Ad m i n . Reg s.- 1 5 7 -

[* 1 5 7] ag reem en ti n cl u d eda “ Fam i l y Es t at e Pl an n i n g Ob ject i v es ” s ect i o n l ay i n g
o u tth ata m at eri al p u rp o s e o f t h e co m p an y i s t o fu rth er t h e es t at e p l an ni ng
o b ject i ves o f th e Ry d ers . Ry d er ex ecu t ed i n Ap ri l 2 0 1 1 an am en dedo p erat i n g ag reem en twi t h a p u rp ort edeffect i v e d at e o f Ap ri l 2 0 0 3 . Itrem o v edth e “ Fam i ly Es t at e Pl an n i n g Ob ject i ves ” s ect i o n an dl i s tedRy d er Ran ch Co ., LLC, as th e o n l y m em b er o f Can y o n Vi ew Ran ch , LLC.

4
. Ry d er Red Ro ckRan ch , LLC Ry d er fi l edRy d er RedRo ckRan ch , LLC’ s art i cl es o f o rg an i zat i o n i n Ap ri l 2 0 0 3 . Th ey

l i st edRy d er as th e co m

p an y ’ s reg is t eredag en tan ds t at edthatth e
co m p an y ’ s m an ag em en ti s 1 00 % v es t ed i n a m an ag er. Bu t t h ey l i s tedn o s p eci fi c
m an ag ers o r m em

b ers . Th e co m

p an y ’ s o p erat i n g ag reem en td ids t at e t hatth e Ry d ers an dRy d er In ves tm en tPart n ers , Lt d ., were i ts m em bers . Th is o p erat i n g ag reem en tag ai n co n t ai n eda “ Fam i l y Es t at e Pl an n i n g Ob

ject iv es ” s ect io n , as h ad th e o th er 2 00 3 o p erat i n g ag reem en t s o f Ry d er Ran ch Co m p an y , Pat t ern Farm s , an d Can y o n Vi ew. In 2 0 1 1 , Ry d er b eg an ret ro act i v el y am en d i n g ag ai n. He s i g n edan am en d ed
o p erat i n g ag reem en tth ath ada p u rp o rt edeffect i v e d at e o f Ap ri l 2 00 3
. Th i s
o p erat i n g ag reem en tn o l o n g er co n t ai n eda “ Fam i l y Es t at e Pl an ni n g Ob

ject i v es ”- 1 5 8 -

[* 1 5 8] s t at em en tan dl is t ed Ry der Ran ch Co ., LLC, as th e o n l y m em ber o f Ry d er Red Ro ckRan ch , LLC.

5
. Ro d eo Ho l d i n g s , LLC Ry d er fi l edRo d eo Ho l d i n g s , LLC’ s art i cl es o f o rg an i zat i o n i n Feb ru ary 2 0 0 6 . Th ey

d i d n o t l i s tan y

m an ag ers o r m em

b ers . Bu tRy d er k ep t t in k eri n g . W e d o n ’ th av e Ro d eo Ho l d i n g s ’ s o ri g i n al o p erat i n g ag reem en t , b u tth ere i s a 2 0 1 1
am en d edo p erat i n g ag reem en tth at s tat es Ry d er Ran ch i s th e o n l y m em ber. It ’ s d at edAp ri l 2 0 , 2 0 1 1 , b ut rat h er dub i o u s l y cl ai m s t o b e effect i v e as o f Ap ri l 2 0 0 3
-- th ree y ears b efo re Ro d eo Ho l d i n g s was o rg an i zed . W e m ak e t he s am e fi n d i n g -- th e 2 0 11 am en dedo p erat i n g ag reem en ti s n o t effect i ve fo r t ax y ears b efo re 2 0 1 1
. Wh atcan o ne t el l fro m

al l th i s ? Fi rs t , we n o t i ce t h atRy d er d el et edal l th e

“ Fam i l y Es t at e Pl an n i n g Ob j ect i v es ” p ro v i s i o n s i n each o p erat i ng ag reem en ti n 2 0 1 1 . By th en Ry d er ai m edt o h av e p ap erwo rkth ats h o wedm u lt i pl e u n rel at ed p art i es h o l d i n g m em

b ers h i p i n t eres t s i n t h es e ran ch en t i t i es . W e fi n di tm o re l i kel y th an n o tth ath e d el et edfam i l y es tat e p l an ni n g as an o b

j ect i ve o n ly

b ecau s e i t w o u ldb e s o o ddfo r s up p o sed l y u nrel at edco m

pan i es t o p ro v i d e h u n dred s o f th o u s an ds --o r m i l l io ns --o f d o l l ars t o en t i t i es th ath adth e s t at edp u rp o s e o f h el p i n g th e Ry d er fam i l y .- 1 5 9 -

[* 1 5 9] Th enco m e Ry der’ s as sert i o ns th atal l th es e LLCs were d i s reg ard ed
en t i t i es o f Ry d er Ran ch Co ., LLC, b ecau s e o f am en d m en t s h e d raft edi n 2 0 1 1 t o p ap ers th ath e h adfi l edei g h ty ears b efo re. Th i s d o es n ’ two rk , b ecau s e t h es e
am en d m en t s were n o tag reedt o b efo re t he du e d at e o f t h e p art ners h i p retu rn fo r th e t ax y ear t he m o di fi cat i o n s affect . See s ec. 7 61 (c). An d t h en t h ere i s Ry d er’ s ques tt o k eep o pen th e s p i g o t fo r g o v ern m en t
s ub s i d i es . Th e recei pt o f t hes e s ub s i d i es d ep en d edo n each LLC’ s m em b ers ’
m ak i n g p ers o n al co n tri b u ti o n s o f l ab o r o r m an ag em en tt o t h e farm i ng o p erat i o n s . W e fi n di tm o re l i k el y t h an n o tth ata d es i re fo r t h es e s ub si d i es was wh atcau s ed Ry d er t o s ub m i td o cu m en t s t o t h e U.S. Dep art m en t o f Ag ri cu l tu re t h at s ai d t h e
o n l y m em b ers o f th e ran ch en t it i es were t h e Ry d ers . W e al s o fi n d i t m o re l i k el y th an n otth atRy der am en dedth e p ap erwo rki n 2 0 1 1 t o s h o w Fi rs tCo u n s el Cap i t al
as a m em b er o f Ry d er Ran ch wh en h e wan t edt o m ak e i t s eem th ere were t h i rd
p art y i n v es t o rs . Ev en th i s d o es n ’ two rk --h e s t at edth atth e o wn er o f Fi rs tCo u n s el Cap it al was Co u n s el o r Cap i tal , In c., wh i ch was o wn edb y R&A (wh i ch was i t s el f
o wn edb y th e Ry d ers ), an d“ Tru s tfo r t h e In t eres t s o f Ern es tS. Ry d er Un d er t h e Ry d er Law Co rp o rat i o n Ret i rem en tSav i n g s Pl an ,” wh i ch t he Ry d ers al s o o wn ed
. Ry d er’ s at t em

pt s t o k eep ch an gi n g t h e p ap er o wn ers h ip o f Ry d er Ran ch
-- th e wh o l e m ael st ro m

o f co n t rad i ct o ry

s ub si dy fo rm s, t ax fo rm s , m em

b ers h i p- 1 6 0 -

[* 1 6 0] ag reem en t s , an dth e o perat i n g ag reem en t s --d o n ’ tp ers u ad e u s . W e fi n d i n s t eadth atth e t ru e o wn ers o f Ry d er Ran ch were u l t i m at el y th e Ry d ers th em s el v es . Th e ev i d en ce o n th e reco rds h o ws i t s o wn ers h ip fo r t h e y ears ati s s u e t o b e: Dat es Mem b ers Jan . 1 0 , 2 0 0 3 , t o M ay 2 7 , 2 0 0 9 Ern es tRy d er Pat ri ci a Ry d er Ry d er In v es t m en t Part n ers , Lt d
. M ay 2 8 , 2 0 0 9 , t o Dec. 3 1 , 2 0 1 0 Ern es tRy d er Pat ri ci a Ry d er J an . 1 , 2 01 1 , t o Dec. 3 1 , 2 0 1 1 Ern es tRy d er Pat ri ci a Ry d er Fi rs tCo u n s el Cap it al , In c. W e t h erefo re h o l dthatthe Ry d ers o wned1 0 0 % o f Ry der Ran ch Co ., LLC, ei th er d i rect ly

o r i n di rect l y

fo r t h e y ears at i s s ue. Th ey al s o th en o wn ed , d i rect l y
o r i n d i rect l y , Pat tern Farm s, LLC; Can y o n Vi ew Ran ch , LLC; Ry d er RedRo ck Ran ch , LLC; an d Ro deo Ho l di n g s , LLC. Th e fu n d s b ei n g co n t ri b u t ed t o th es e
ran ch en ti t i es cam e fro m

R&A an ds h o u l db e t reat edas d i v id en d i nco m e t o th e Ry d ers fo r al l th e y ears ati s s u e. See Ak l an d v . Co m m i s s io ner, 7 6 7 F.2 d6 1 8 , 6 2 0
- 2 1 (9 th Ci r. 1 9 8 5), aff’ g T.C. M em o . 1 9 8 3-2 4 9 ; M eri d i an W o odPro ds . Co ., 7 2 5 F.2 dat 1 19 1
.- 1 6 1 -

[* 1 6 1] C. Di v i d en dIn co m e Fro m Paym en ts t o Am eri can Ex p res s an d Ben Lel an dCo n s tru ct i on , In c.

2 0 10 an d2 0 1 1 Des cri p t i o n Am o u n t A m eri can Ex p res s Paym en ts $3 9 2 ,5 58 .8 2 Paym en t s t o Ben Lel an dCo n s t ru ct i o n 4 5 6 , 9 88 .6 7

To t al 8 4 9 , 5 47 .4 9 Th e Co m m is s i o n er as k s u s t o fi n dth at t he Ry d ers recei v edco n st ru ct i v e d i v i d en d s wh en R&A p ai dth ei r b i l ls fro m Am eri can Ex p res s an da co n t ract o r wh o
wo rk edo n th ei r h o m e. He arg u es th atth es e p aym en t s cam e fro m th e earn i n g s an d p ro fi ts o f R&A an dwere m ad e fo r Ry d er’ s p ers on al b en efi t . See s ec. 3 01 (c)(1 );
s ee al so Ak l an d , 7 6 7 F.2 dat 6 2 0 ; Eri ck s o n v . Co m m is s i o n er, 5 9 8 F.2 d5 2 5 , 5 3 1 (9 th Ci r. 1 9 7 9 ), aff’ g i n p art , rev ’ g i n p artT.C. M em o . 1 9 7 6 -1 4 7. Ry d er h as s ev eral co u nt erarg u m en t s . He cl ai m s t h ats o m e o f t he m o n ey t h at th e Co m m i s s i o n er i d en t i fi edi s traceab l e t o an i n su ran ce p aym en to n t h e Ry d ers ’ h o m e fo r wat er d am ag e. Th i s m o n ey was d ep o s i t ed i n t o R&A’ s b an k acco u n t du ri n g 2 0 1 0 an d2 0 1 1 an d u s edt o p ay fo r t he h o u s e rep ai rs n eed ed . He al s o s t at ed th atth e ch arg es o n t h e Am eri can Ex p res s cardwere i n cl ud edi n the ad v an ces t o Ry d er, wh i ch were t ran s ferred fro m R&A t o RLC as co m p en s at i o n fo r Ry d er’ s
s erv i ces ren d ered
. Th e acco un t s u s edi n th e Co m m i s si o n er’ s BDA wh en- 1 6 2 -

[* 1 6 2] an al y zi n g th e Am eri can Ex p res s s t at em en t s d o n o tex p l i ci tl y s h o w th e p aym en t s co m in g fro m

R&A, b u tRy d er’ s b ri ef ad m i t s t o th is . Ry d er i n st eadju s t cl ai m s thatth ey

s t i ll d o n o tn eedt o b e i n cl ud edi n h i s i n co m e. Befo re 2 0 1 0 Ry d er h adru n s i m i l ar p aym en t s fro m R&A t h ro u g h RLC an d
reco rd edth em

as ad van ces o n co m

p en sat i o n t o RLC fo r Ry d er’ s s erv ices . Ry d er cl ai m s thi s i s wh ato ccu rredfo r t h es e 2 0 1 0 an d2 0 1 1 ex p en s es as wel l, b utfai l ed t o ci t e t o an y

ev i d en ce i n t h e reco rd t o b ackup t h es e as s ert i o n s. 6 2 W e al s o fi n d th atth es e p aym en t s t o Ben Lel an d Co n st ru ct io n fo r t h e y ears 2 0 1 0 an d2 0 1 1 are d i v i d en d i n co m e t o the Ry d ers . See M eri d i an W o o dPro d s . Co ., 7 2 5 F.2 dat1 1 9 1
. Ry d er p o in t s t o a s m al l n u m b er o f t h e Am eri can Ex p res s p aym en t s an d cl ai m s thatth ey

were co n nect edwi t h h is h o us e’ s co n s t ru ct i o n , b u tthi s cl ai m i s n o t
s up p ort edb y

th e reco rd . Th e Am eri can Ex p res s s t at em en ts o n reco rd --wh i ch th e Co m m i s s i o n er u s edi n co m

p u t in g th e am o u n to f d i v id en di nco m e t o b e i n cl u d ed b y th e Ry d ers --s h o w p aym en t s m ad e fo r p ers o n al ex p en s es . So m e o f t h es e i n cl u d e g ro cery -s t o re p aym en t s an dch arg es fo r res t au ran tm eal s an dg as o l i n e.

6 2 Fo r t h es e earl i er y ears , th es e t y p es o f p aym en t s were i n cl u d edi n t h e d i v i d en d i n co m e co m in g t h ro u g h RLC. Bu tRLC’ s 2 0 1 0 an d 2 0 1 1 t ax retu rn s are n o ti n th e reco rd , s o th e Co m m i s s i o n er i n cl ud ed t h es e p aym en t s as d i v i den d i n co m e t o th e Ry ders
.- 1 6 3 -

[* 1 6 3] Th e m o n ey

cam e fro m

R&A, an dth e Ry d ers u s edi tt o p ay th ei r p ers o n al
ex p en s es . It i s d i v i d en di nco m e t o th em fo r 2 0 1 0 an d2 0 1 1
. D. Su m

m ary W e fi n dth atth e Co m

m i s s i o n er accu rat el y t raced fu n d s th ro u g h Ry d er’ s
n u m ero u s acco u nt s an d av o i dedd oub l e-co u n t i n g the d i fferen t cat eg o ri es o f
co n st ru ct i v e d iv i d en ds thatRy d er recei v ed . W e n o te es p eci al l y th atth e Co m m i s s i o n er’ s an al y s es el i m in at edth e ci rcu lar fl ow o f fu n d s t h atRy d er s eti n
m o ti o n t o creat e t h e ap p earan ce t h ath e was b o o st i n g h i s b as is i n RLC b y
co n tri b u t i n g cap i tal t o i t . Th ere i s al m os tal way s s o m e i m p reci s i o n wh enth e Co m

m i s s i o n er co n du ct s b an k-d ep o s i tan al y s es . Tax p ay ers are free t o p o i nto u tt o u s i t em s o r cat eg o ri es o r t i m es o r acco u nt s t h at fo r s o m e s peci fi c reas o n we s ho u l dfi n d are n o tt ax ab l e. Ry d er’ s ch al l en g es , h o wev er, l ack edan y s p eci fi ci t y . He arg u edi n s t eadatth e wh o l es al e l ev el --t h at we m u s ttreat each o f t h e m an y en t i ti es h e b reat h edi n t o l i fe
as wh ath e l ab el edth em an dn o tas wh atth ey real l y were. On ce t h i s arg u m en t fai l ed --as i td i dwh en we h el dth atthe i n co m e fro m t h e t ax p ro du ct s was g ro s s recei p t s o f R&A--h i s fal l backarg u m en twas thath e h adm an ag ed t o s h i ft
o wn ers hi p o f th e ran ch es away fro m h i m s el f an dh i s wi fe. He fi n al l y ch al l en g ed th e am o un to f t h e d i v i d en dad ju s tm en to n t h e p ro cedu ral g ro u n dth at t he- 1 6 4 -

[* 1 6 4] Co m

m i s s i o n er as s u m edth e b urd en o f p ro o f o n th e i s s u e wh en h e ch an g ed h i s cal cu l at i o n o f t h i s co n s t ru ct i v e d i v i den daft er t ri al
. Th i s d o es n ’ t m at t er. W e fi n db y a p rep o n d eran ce o f t he ev i d en ce th atth e Ry d ers are l iab l e fo r t ax o n th e u n rep o rt edd i v i den di n co m e recei v eddu ri n g th e t ax y ears 2 0 0 3 -1 1 i n t h e fo l l o wi n g am o u n t s :
Year RLC Ran ch p ro p ert y AM EX/ Ben Lel an d To t al 2 00 3 ($ 3 2,7 7 5.0 0 ) $ 1 , 4 4 7 ,4 0 7 .8 9
--- $ 1,4 1 4 ,6 3 2 .8 9 2 00 4 9 5,4 8 0.1 2 7 17 ,1 4 0
. 0 0
--- 8 1 2 ,6 2 0 .1 2 2 00 5 6 ,3 4 8 ,6 6 7 .5 9 1 ,4 30 ,9 0 0
. 5 6
--- 7 ,7 7 9 ,5 6 8 .1 5 2 00 6 1 ,3 1 2 ,6 4 5 .8 0 7 90 ,2 9 9
. 7 6
--- 2 ,1 0 2 ,9 4 5 .5 6 2 00 7 5 8 5 ,2 0 5 .4 0 1 ,0 74 ,8 3 0
. 5 5
--- 1 ,6 6 0 ,0 3 5 .9 5 2 00 8 (2 0 5 ,7 0 4 .5 5 ) 4 80 ,1 1 2
. 6 0
--- 2 7 4 ,4 0 8 .0 5 2 00 9 1 5 1 ,5 8 3 .7 0 1 83 ,8 0 0
. 0 0
--- 3 3 5 ,3 8 3 .7 0 2 01 0
--- 3 96 ,4 0 0
. 0 0 $ 26 0 , 7 0 5 .7 5 6 5 7 ,1 0 5 .7 5 2 01 1
--- 3 26 ,5 0 2
. 7 5 5 8 8 ,8 4 1.7 4 9 1 5 ,3 4 4 .4 9 To t al 8 ,2 5 5 ,1 0 3 .0 6 6 ,8 47 ,3 9 4
. 1 1 8 4 9 ,5 4 7.4 9 1 5,9 5 2 ,0 4 4 .7 0 IV. Rem ai n i n g Is s u es A. Ry d er Ran ch Lo s s es Th e Ry d ers cl ai m edp as s -t h ro u g h l o s s es fro m Ry d er Ran ch Co
. , LLC, fo r
ev ery t ax y ear fro m

2 0 0 3 th ro u g h 2 0 1 1 (wi th the ex cep t i o n , cu ri o u sl y , o f 2 0 0 8 ).- 1 6 5 -

[* 1 6 5] W e m

u s t d eci d e o nl y

wh et h er t o d i s al l o w Ry der Ran ch ’ s l o s s es fo r 2 0 0 3
- 2 0 0 7 . Th e Co m

m i ss i o n er s ay s th atRy der Ran ch was a p as s i ve act i v i ty fo r t h e Ry d ers du ri n g th o s e y ears an dth at , fo r 2 0 0 5 an d2 0 0 6, Ry der Ran ch fai l edt o
s ub s t an t i at e i t s d edu ct i o ns . See s up ra p p . 7 6 -7 9
.

1
. J u ri s d ict i o n Befo re we can d et erm i n e wh et her t he Ry d ers an dRy d er Ran ch can cl ai m th es e d edu ct i o n s , we m

u s td eci d e t h e t h res h o l dqu es t i o n o f o u r ju ri s di ct i o n . Th e Tax Co u rti s a co u rto f l im i tedjuri s d i ct i o n , s ec. 7 4 4 2 , an d m ay ex erci s e juri s d i ct i o n o n l y

t o the ex ten tex p res s l y

au t ho ri zedb y Co n gres s , Gray v . Co m m i s s i o n er, 1 3 8 T.C. 2 9 5 , 2 9 8 (2 0 1 2). W e h av e ju ri s d i ct i o n t o d et erm i n e t h e t ax l i ab i l i t y

o f an i n d i v i du al t ax p ay er i f an do n l y i f t h e Co m

m i s s i o ner i ss u es a
v al i dn o t i ce o f d efi ci en cy t o t h e t ax p ay er an dth e t ax p ay er ch al l en g es th atn o t i ce b y t i m el y fi l i n g a p et i t i o n wi th th i s Co urt . Secs . 6 2 1 2 an d6 2 1 3 ; Freytag v . Co m m i s s i o n er, 1 1 0 T.C. 3 5 , 3 9 (1 9 9 8 ). “ O u r ju ri sd i ct i o n i s b as edo n th e s n ap s h o t i n t im e wh en [a] p et i t i o n er t i m el y fi l e[s ] th e p et i t i on .” Fi s h er v . Co m m i s s i o n er, T.C. M em o . 2 00 8 -2 5 6 , 2 0 0 8 W L 4 9 0 7 2 05 , at* 2 . As a g en eral p ro p os i t i o n, o n ce
o u r ju ri s di ct i o n i s i n vo k ed , i t“ rem ai n s u n i m p ai redu n t il th e co n t ro v ers y i s d eci d ed
. ” Id
. (ci t i n g Frey t ag , 1 1 0 T.C. at3 9 ).- 1 6 6 -

[* 1 6 6] Bu t Ry d er Ran ch i s n o t a t ax p ay er; i t ’ s a l im it edl iab i li t y co m pan y th ati s treat ed as a p art n ers h i p fo r t ax p u rp o ses . Part n ers h ip s fi l e i nfo rm at i o n retu rn s , wh i ch i t s p art ners are s up po s edt o u s e t o fi l l o u t thei r o wni n d i v i dual retu rn s . See
s ecs . 6 0 31 , 6 2 2 2 (a). TEFRA, s ee s up ra n o t e 3 9 , es t ab l i s h eda “ u n i fi edreg u l at o ry
s ch em e fo r co n tro l l i n g th e au d i tan dl i t i g at i o n o f p art n ers h i p i n t eres t s . ” See Ad k i s o n v . Co m

m i s s i o n er, 5 92 F.3 d1 0 5 0 , 1 0 5 3 (9 t h Ci r. 2 01 0 ). Rath er than au d i t each p art n er’ s i n d i v i du al retu rn , th e Co m m i s s i o ner ad

ju s t s “ p art n ers h i p i t em [s ] ”--a t erm d efi n edb y

s ect io n 6 2 3 1 (a)(3 )--at th e p art n ers h i p l ev el . See Ro b ert s v . Co m m i s s i o n er, 9 4 T.C. 8 53 , 8 5 9 -6 0 (1 9 9 0 ). Th os e ad ju s t m en t s are t h en b i n d i n g
o n al l p art n ers . See i d .; s ee al s o Carri n o v . Co m m i ss i o n er, T.C. M em o . 2 0 1 4 -3 4 , at* 9 n . 1 1 . As p art o f a p art n ers h i p p ro ceed in g , th e Co m m i s s i o ner m

u sti s s u e an FPAA t o th e p art n ers h i p ’ s t ax m at t ers p art ner. See s ec. 6 2 2 3 ; Gu st in v . Co m m i s s i o n er, T.C. M em o . 2 0 0 2 -6 4 , 2 0 0 2 W L 3 5 9 9 9 9 , at* 2 . Th e p artn ers th en h av e 1 5 0 d ay s t o p et i t i o n t h i s Co u rt fo r read ju st m en t , g i v in g u s ju ri s d i ct i o n t o d et erm i n e an y

p artners h i p i t em

fo r t h e y ear t o wh i ch th e FPAA rel at es , as wel l as

“ th e p ro p er al l o cat i o n o f s u ch i t em s am o n g t h e p art n ers , an dth e ap p l i cab i l i t y o f
an y p en al t y , ad d i t i o n t o t ax , o r ad d i t i o n al am o un twh i ch rel at es t o an ad ju s t m en tt o a p art ners h i p i t em .” See s ec. 6 2 2 6 (f); s ee al s o 4 3 6 , Lt d
. v . Co m m i s s i o n er, T.C. M em o. 2 0 1 5 -2 8 , at* 2 8 . W e can n o td et erm i n e “ n onp art ners h i p i t em s ”--wh i ch are- 1 6 7 -

[* 1 6 7] s i m

p l y th o se i t em s th at are n o tp art n ers h i p i t em s --i n a p art n ers hi p -l ev el p ro ceed in g . See 6 6 1 1 , Lt d . v . Co m m i s s io n er, T.C. M em o . 2 0 1 3-4 9 , at* 4 6 . No r
can we d et erm i n e “ affect edi tem s ,” wh i ch are n o np art n ers h ip i tem s t hatare

“ affect edb y

th e d et erm i n at io n o f a p art n ers h ip i tem . ” Id . Det erm i n at i o n s o f
n o np art n ers h ip i t em s m

us tb e m ad e atth e p artn er l ev el , 4 3 6 , Lt d
. , T.C. M em o . 2 0 1 5 -2 8 , at* 2 9, an dd et erm i n at i o ns o f affect edi tem s, b ecau s e t hey d ep en do n p art n ers hi p -l ev el d et erm i nat i o n s , can n otb e m ad e wh i l e a p artn ers h ip -l ev el p ro ceed in g i s p en d in g , s ee M eru el o v . Co m m i s s i o n er, 6 9 1 F.3 d1 10 8 , 1 1 1 6 (9 th Ci r. 2 0 12 ) (qu ot i n g Adk i s o n , 5 9 2 F.3 d at1 0 5 3 ). An y n o ti ce o f d efi ci en cy

i s s u ed wh i le a p art n ers h ip -l ev el p ro ceed i n g i s p en d i n g i s i n val i dt o th e ex t en ti tad ju s ts
an y affect edi t em . Id . at1 1 1 5 . Th e Co m m is s i o n er m ay , h o wev er, “ i s s ue an affect ed -i t em s n ot i ce o f d efi ci en cy wi t h o uto p en i n g an dcl o s i ng a p art n ers h i p l ev el p ro ceed i n g as l o n g as th e Co m m i s s i o n er i s b ou n db y

th e p art n ers hi p i t em s as refl ect edo n th e p artn ers h i p ’ s retu rn .” M ai n es v . Co m m is s i o n er, 1 44 T.C. 1 2 3 , 1 2 6 n .4 (2 0 1 5 ). Ry d er Ran ch Co ., LLC, was a TEFRA en t it y atl eas tdu ri n g 2 0 0 3 -0 7 . Th e Co m m i s s i o n er i ss u edan FPAA fo r Ry d er Ran ch ’ s 2 0 0 5 an d2 0 0 6 t ax y ears o n Decem b er 2 0 , 2 0 11 . Ry d er Ran ch t i m el y fi l edi t s p et i t i o n fo r read

ju s t m en to f i t em s o n th atFPAA, s o we h av e ju ri s d i ct i o n t o d et erm in e an y p art ners h i p i t em s fo r- 1 6 8 -

[* 1 6 8] th o s e y ears . See s ec. 6 22 6 . Th e Co m m i ss i o n er al s o i s su edan FPAA fo r Ry d er Ran ch ’ s 2 0 0 7 t ax y ear o n Decem b er 1 9 , 2 0 1 8, b u tth atcas e h as n otb een
co n so l i d at edh ere an dwe th erefo re can n o td et erm i n e an y p art ners h i p i tem s fo r t h at y ear. Th e fact th atth e Co m m i s s i o n er n ev er i ss u ed an FPAA fo r 2 0 0 3 o r 2 0 0 4 i n d i cat es th ath e accep t s Ry d er Ran ch ’ s p artn ers h i p return s fo r t h o se y ears as fi l ed
an d p u t s th e p artn ers h i p i t em s fo r t h o se y ears b ey o n do u r ju ri s di ct io n t o d et erm i n e. See M eru el o , 6 9 1 F.3 d at1 11 6 -1 7
. Bu twh at ab o u tth e affect edi t em s ? Th e Co m m i s s i o n er i s su eda n ot i ce o f d efi ci en cy

t o the Ry d ers fo r th ei r 2 0 0 2 -0 4 t ax y ears o n M arch 2 6 , 2 0 1 0 . Th e Ry d ers t i m el y fi leda p et i ti o n ch al l en gi n g t h atn o t i ce, s o we h av e juri s di ct i o n t o d et erm i n e an y

affect edi t em s fo r t h o s e t h ree y ears . See s ec. 6 21 3 . Th e Co m m i s s i o n er al s o i s s u eda n o t i ce o f d efi ci en cy t o t h e Ry d ers fo r t h ei r 2 0 05 -0 7 t ax y ears o n J an u ary 1 7 , 2 0 1 2 , ju s tu n d er o ne m on t h aft er h e i s s u edth e FPAA fo r 2 0 0 5 an d2 0 0 6 , an dn earl y s i x y ears b efo re h e i s s u edth e FPAA fo r 2 0 0 7
. 6 3 Th e Ry d ers ag ai n t i m el y

p et it i o n edth i s co u rtaft er t h ey g o tth atn o t i ce, b u tb ecau s e th ere was a p artners h i p-l ev el p ro ceed i n g p en di n g fo r 2 0 0 5 an d2 0 0 6 wh en t h e Co m m i s s i o n er i ss u edi t , we l ackjuri s d i ct i o n t o d et erm i ne an y affect edi t em s fo r

6 3 W e d o n ’ tfau l tth e Co m m i s s i o ner fo r wai ti n g t o i s su e t h e FPAA fo r 2 0 0 7 ; Ry d er Ran ch d i dn ’ tfi l e i t s p artn ers h ip retu rn fo r t h aty ear u n t i l 2 0 16 , s h o rt l y b efo re t h e fi rs t tri al fo r t h es e cas es b eg an .- 1 6 9 -

[* 1 6 9] th o s e y ears . W e d o h av e ju ri s d i ct io n , th o u g h, fo r 2 0 0 7 b ecau s e t h e FPAA fo r t h aty ear h adn o ty etb een i s s u edwh en t h e p et i t io n was fi led
.

2
. M at eri al Part i ci p at i o n Th e fi rs ti s su e we’ l l l o o kati s wh et h er t h e Ry d ers m at eri al l y p art i ci p at edi n Ry d er Ran ch ’ s o p erat i o n s . Th i s i s p o t en t i al ly d eci s i v e b ecau s e s ect i o n 4 6 9
s h arp l y l im i t s a t ax p ay er’ s ri gh tt o d edu ctth e o rd in ary an dn eces s ary

ex p en s es o f carry i n g o n a t rad e o r b u s i n es s wh en th e ex p en ses are fo r a “ p as s i v e act i v i t y ”. A

“p as s i v e act i v i t y ” i s “ an y act iv i t y * * * wh i ch i n v o l v es th e co n ducto f an y trad e o r b u s i n es s , an d* * * i n wh i ch th e t ax p ay er d o es n o tm at eri al l y p art i ci p at e.” Sec. 4 6 9 (c)(1 ). Th e qu es t i o n o f wh et h er a l o s s i s du e t o a p as s i v e act i v i t y u n d er s ect i o n 4 6 9 i s an affect edi tem , Es t at e o f Qu i ckv . Co m m is s i o n er, 1 1 0 T.C. 1 7 2, 1 8 8 (1 9 9 8), s up p l em en t edb y

1 10 T.C. 4 4 0 (1 9 88 ), s o we l i m i t o u r an al y s i s t o t h e Ry d ers ’ i n vo lv em en t i n t ax y ears 2 0 0 3 , 2 0 0 4, an d 2 00 7
. Th e Co d e t el l s u s t h at“ m at eri al p art i ci p at i o n ” m ean s b ei ng “ i n v o l vedi n th e
o p erat i o n s o f t h e act iv i t y ” o n a reg u l ar, co n t i n uo u s , an ds ub s t an t i al b as i s . Sec. 4 6 9 (h )(1 ). If a m arri edco up l e g o es i n t o b u s i nes s t o g et h er, we l o o katthei r
co m b i nedact i v i ty

t o d eci de i f i tam o u n ts t o m at eri al p art i ci p at i o n . Id . p ara. (5 ). Th e reg u lat i on s p ro v i d e s ev en --an do n ly s ev en --way s a t ax p ay er can p ro v e t h ath e
m at eri al l y

p art i ci p at ed
. See s ec. 1 .4 6 9 -5 T (a), Tem p o raryIn co m e Tax Reg s ., 5 3- 1 7 0 -

[* 1 7 0] Fed . Reg . 5 7 2 5 -2 6 (Feb . 2 5 , 1 98 8 ). Th e Ry d ers rel y o n p arag rap h (a)(1 ), wh i ch creat es a qu an t i t at iv e t es t ; th ats ect i o n t el l s u s t o fi n d “ m at eri al p art i ci p at i o n ” i f a t ax p ay er “ p art i ci p at es i n th e act i v i t y fo r m o re t h an5 0 0 h o u rs du ri n g s u ch y ear.” Th e reg u l at i o n s al s o t el l u s wh att o co u n t : “ [A] n y wo rkd o n e b y an i n d i v i du al * * * i n co n n ect i o n wi t h an act i v it y i n wh i ch th e i n d i v i dual o wn s
an i n t eres tat t h e t i m e t h e wo rki s d o n e s h al l b e t reat ed* * * as p art i ci p at i o n o f t h e i n d i v i du al i n th e act i v i t y .” Sec. 1 .4 69 -5 (f)(1 ), In co m e Tax Reg s . Th i s i s a g o o d , cl ear, b ri g h t -l i n e t es t , b u ti td em an d s p ro o f o f t h e n u m b er o f h o u rs th ata p ers o n s p en d s o n an act i v i t y . See s ec. 1 .4 6 9 -5 T(f)(4 ), Tem p o rary In co m e Tax Reg s ., 5 3 Fed . Reg . 5 7 2 7 (Feb . 2 5 , 1 98 8 ). W e n o rm al l y s ee th i s i n th e fo rm o f act i v i t y l o g s . Ry der d i dn o tp ro du ce an y l o g s du ri n g th e l o n g au d i t s th at l edt o th es e cas es , b u td i dco m e up wi t h o ne a weekb efo re t h e Ph o en i x p o rt i o n o f th e t ri al . He al s o h adt es t i m o n y fro m s ev eral wi t n es s es th ath e m etth e 5 0 0 -h o u r req u i rem en tfo r each y ear. Th e Co m m i s s i o n er q u es ti o ns th e cred i b il i ty o f Ry d er’ s l o g s an dal s o cl ai m s t h atm u ch o f t h e t im e i ncl u d edcan n o tco u n tt o wardm at eri al p art i ci p at i o n . M rs . Ry der fai l edt o k eep an y l og o f h er act i v i t i es , b u t s he t es t i fi ed th ats h e wo rk ed atth e ran ch es o n a reg u l ar, co n t i nu o us , an ds ub st an t i al b as i s . Th e reg u l at i o n s d o s tat e t h at“ [c] o n t em p o ran eo u s d ai l y t i m e rep o rt s , l o g s , o r
s i m i l ar d ocu m en t s are n o treq u i redi f t h e ex t en to f s u ch p art i ci p at i on m ay b e- 1 7 1 -

[* 1 7 1] es t ab l i s h edb y

o t her reas o n ab le m ean s .” Id . An d “ [r] eas o n ab l e m ean s
* * * m ay i n cl u de b u tare n otl i m i t edt o t he i d en t i fi cat i o n o f s erv i ces p erfo rm ed
o v er a p eri odo f t im e an d t h e ap p ro x i m at e nu m b er o f h o urs s p en tp erfo rm i n g s u ch
s erv i ces * * * b as ed on ap p o i n t m en tb o o k s , cal en d ars , o r n arrat i v e s u m m ari es .” Id . Bu twe h av e o ft en h el d t h at“ we d o n ’ th av e t o accep tu n v eri fi ed , u n d o cu m en t edt es ti m o n y

ab o uth o w a t ax p ay er s p en t h er t i m e.” Es t at e o f Ram i rez v . Co m m i s s i o n er, T.C. M em o . 2 0 1 8 -1 9 6 , at* 1 7 ; s ee al s o Ro b i so n v . Co m m i s s i o n er, T.C. M em o . 2 01 8 -8 8 , at* 2 6 . W i t h th es e s t an d ard s i n m i nd , l et ’ s l oo katth e l o g . W e fi rs tn o t i ce t h at t h es e l o g s are fl awedo n thei r face. Ry d er’ s d es cri p t i o n
o f h i s wo rki s o ft en m is s i n g --e.g ., o n M ay 2 5 , 2 6 , an d2 7 , 2 0 0 7 , th e l o gs l is t9 , 8 , an d 8 h o u rs o f wo rkeach d ay , res p ect i v el y , acco m p an i ed b y “ [n o d es cri p ti o n ] ”--
an d o ther t im es th e d es cri p t i o n i s a b i tv ag u e--e.g ., o n Ap ri l 5 , 6 , an d7 , 2 0 0 7 , th e l o g s rep o rt2 5 t o t al h o u rs wi t h th e d es cri pt i on “ Ran ch m at ters .” W e fi n dth at h o u rs d es cri b edi n s o l aco n i c a m an n er d o n o t co un tt o wardth e 5 0 0 h o u rs th at Ry d er s ay s h e can p ro v e. Th en there’ s t h e p ro b l em thatRy d er’ s l o g s l i stm an y act i v it i es thatare m o re th o s e o f an i nv es t o r t h ana ran ch er. “ W o rkd o n e b y an i nd i v i du al i n th e i n d i v i du al ’ s cap aci t y

as an i n v es t o r i n an act i v it y s h al l n o tb e t reat edas p art i ci p at i o n i n th e act i v i t y * * * u n l es s th e i n di v i du al i s d i rect l y i n vo l v edi n th e- 1 7 2 -

[* 1 7 2] d ay -t o -d ay

m an ag em en to r o p erat i o n s o f t h e act i v i t y .” Sec. 1
. 4 6 9
- 5 T(f)(2 )(i i )(A), Tem

p o raryIn co m e Tax Reg s ., s up ra; s ee al s o Sh aw v . Co m m i s s i o n er, T.C. M em o . 2 0 0 2 -3 5 , 2 0 0 2 W L 1 8 7 5 1 5 , at* 8 (h o l d i n g th ata t ax p ay er’ s t i m e s p en tp erfo rm i n g “ i n v es t or t y p e act i v it i es ” was n’ tm at eri al p erfo rm an ce wh ere o t hers m an ag edd ay -t o -d ay o p erat i o n s ). Bu t Ry der was n o t

“ d i rect l y i n v o l v edi n t h e d ay -t o -d ay m an ag em en t ” o f t h e ran ch es --h e p ai da fu l l
t i m e d ay -t o -d ay

m an ag er b eg i n n i n g i n 2 0 04 t o d o th ati n st ead . Ry d er’ s l o g s i n cl u d e t i m e en t ri es wo rk in g o n “p ro j ect i o n s ”, res earch , rev iewi n g reco rd s , an d
s i m i l ar act i v i t i es . Th e reg u l at i o n t el l s u s th atth i s m ak es th em i n v es to r-t y

p e act i vi t i es , s ee s ec. 1 .4 6 9 -5 T(f)(2 )(i i )(B), Tem po raryIn co m e Tax Reg s . , s upra, s o th es e h o u rs d o n ’ tco u n tt o wardth e 5 0 0 ei t h er. W e al s o h av e a s eri o u s p ro b l em wi t h th e l o g s ’ au t h en t i ci t y . Th ey were p ri n t edo n J u ne 6 , 2 0 16 . W e u n d ers t an d t h atth i s d o es n otp ro v e th atRy d er creat ed them i n 2 0 1 6 , b u t h e p ro v i d edn o p ro o f as t o ex act l y wh enh e d i d . W e al s o
u n d ers t an dth atth e Co d e an dreg s d o n o t req u i re co n t em p o ran eo u s rep o rt s , an d th atan i nd i v i du al can es t ab l i s h h i s p art i ci pat i o n b y o t h er reas o n ab le m ean s. Id
. s ub p ara. (4 ). Bu tRy d er’ s l og s are n o treas o n ab l e. Li t t eredth ro u gh th em are
m an y en tri es we fi n dh ardt o b el i ev e--s u ch as Ry d er’ s wo rk i n g a 2 1 -h ou r d ay , i n cl u d i n g a 9 -h o u r dri v e--o r th atare cl earl y u nrel at edt o t he ran ch ’ s o p erat i o n s --- 1 7 3 -

[* 1 7 3] s u ch as th e 1 .2 h o urs o n J u n e 2 6, 2 0 07 , wh en Ry d er “ t o o ka n ap .” Al l o f th i s m ak es i tex t rem el y

d i ffi cu l tt o fi g u re o u th o wm an y h o u rs Ry der was
m at eri al l y

p art i ci p at i n g, an du nd erm i n es o u r co nfi d en ce i n th e v eraci t y o f t h es e l o g s an dth e t es t i m on y

ab o u tth em . W e t h erefo re fi nd t h e p as s t h ro u g h l o s s es fo r t h e y ears 2 0 0 3 , 2 0 0 4, an d2 0 0 7 are p as s i v e u n d er s ect i o n 4 6 9 , wh i ch m ean s th e Ry d ers m ay n o t d edu ctan y

o f th em . 3
. Sub s t an t i at i o n W e n ex ttu rnt o wh et her Ry der Ran ch can s ub s tan t i at e t h e ex p en s es i t d educt edo n i t s Fo rm s 1 06 5 fo r 2 0 05 an d2 0 0 6 . Th i s i s a p art n ers h ip i tem t h at we h av e juri sd i ct i o n t o d et erm i n e. See Su g arl o af Fu n d , LLC v . Co m m i s s i on er, T.C. M em o. 2 0 1 8 -1 8 1 , at * 1 9 , aff’ d , 9 5 3 F.3 d4 3 9 (7 t h Ci r. 2 0 2 0). J u stl i ke R&A, s ee
s up ra p . 1 3 1 -3 2, Ry d er Ran ch fai l edt o i n t ro du ce an y ev i d en ce ab o utan y

o f t h es e
ex p en s es . Ry d er m ak es a g en eral cl ai m th at“ [t ] h e reco rdi n [t h es e cas es ] i s rep l et e wi t h th e b oo k s an d reco rd s an d fi n an ci al s tat em en t s o f t h es e en t i t i es ,” b u t fai l s t o p o i n tu s t o wh i ch reco rd s s p eci fi cal l y s ub s t an t iat e h i s cl ai m s . He al s o
u rg es u s t o rel y

o n th e Co h an ru l e t o es t i m at e Ry d er Ran ch ’ s ex p en s es i f we are
u n ab le t o cal cu l at e t h ei r ex actam o u n t s . See Co han , 3 9 F.2 d at5 4 3 -4 4 ; s ee al s o
s up ra p . 1 3 3
. Bu t th i s wo u l d req u i re h i m t o p ro v i d e atl eas ts o m e reas on ab l e- 1 7 4 -

[* 1 7 4] ev i d en ce fro m

wh i ch t o es ti m at e a d edu ct i b le am o un t . See Ob o tv . Co m m i s s i o n er, T.C. M em o . 2 0 0 5 -1 9 5 , 2 0 05 W L 2 0 7 8 5 08 , at* 3 . W i th a reco rdo f
m o re th an 8 m i l l i on p ag es , g en eral referen ces t o “ t h e reco rd ” are en t i rel y
u n h el p fu l an dreq u es t s t o es t i m at e ex p en s es u n warran t ed . Ry d er’ s fai l u re t o ad dres s th e s peci fi c d edu ct io n s i n qu es t i o n l ead s u s t o fi n dthath e h as co nced ed th e i s s ue. See M en d es , 1 2 1 T.C. at3 1 2 -1 3; Ry b ak , 9 1 T.C. at5 6 6
. B. Ord i naryLo s s es Fro m Cal i fo rn i a Pas t el eri a fo r 2 0 0 3 an d2 0 0 4

Year Sh are o f i n co m e

p er ret u rn Ad

ju s t m en t s fro m d i s al lo wed d edu ct i o n s Sh are o f i n co m e

p er ex am 2 0 0 3 ($ 1 6 8 ,4 2 3 ) $1 8 5 ,4 48 .8 3 $ 1 7 ,0 2 5 .8 3 2 0 0 4 6 ,2 4 7 1 2 1 , 1 0 9 .6 0 8 3 ,5 8 0 .6 0 M rs . Ry d er’ s co o k i e b u s i n es s --Cal i fo rn i a Pas t el eri a, In c.--al s o cam e u n d er th e Co m m i s s i o n er’ s s cru t i n y . He d i s al l o wedd edu ct i o n s fo r l o s s es fro m t he b u s i n es s ’ s 2 0 0 3, 2 0 0 4 , an d 2 0 0 6 t ax y ears . Ry d er co n ced edth i s i ss u e fo r t h e 2 0 0 6 t ax y ear--s ee s up ra n o te 3 8 --wh i ch s eem edt o l eav e u s t o fi g u re o u t the 2 0 0 3 an d 2 0 0 4 t ax y ears . Bu t as wi t h R&A an dRy d er Ran ch , Ry d er n ev er ad dres s edth es e d educt i o n s i n h i s an s weri n g b ri ef wi t h an y p art i cu l ari t y . W e ag ai n fi n d t h ath e h as
co n ced edth e i s s u e. See M en d es , 1 2 1 T.C. at3 1 2 -1 3 ; Ry b ak , 9 1 T.C. at 5 6 6
.- 1 7 5 -

[* 1 7 5] Ev enwi t h o u t a co n ces s i o n , we’ ds t i l l fi ndfo r t h e Co m m is s i o n er o n th es e d educt i o n s . Wh et h er an ex p en s e i s o rd in ary an dn eces s ary

i s g en eral l y a qu es t i o n
o f fact . Co m

m i s s i o n er v . Hei n i n g er, 3 20 U.S. 4 6 7 , 4 7 5 (1 9 4 3 ). It ’ s “ o rd i nary ” i f

“ th e tran s act i o n wh i ch g i ves ri s e t o i t[i s ] o f co m m o n o r freq uen to ccu rren ce i n th e ty p e o f b u s i n es s i nv o l v ed .” Dep u ty v . DuPo n t , 3 0 8 U.S. 4 8 8 , 4 9 5 (1 94 0 ) (ci t i n g W el ch v . Hel v eri n g , 2 9 0 U.S. 1 1 1 , 1 1 4 (1 9 3 3)). It ’ s “ n eces s ary ” i f i ti s

“ ap p ro p ri at e an dh el p fu l ” t o th e t ax pay er’ s b u s i n es s . W el ch , 2 9 0 U.S. at1 1 3
. Ex p en s es m

u s tal so b e reas o n ab l e i n am o u n t . Bo s er v . Co m m i s s io n er, 7 7 T.C. 1 1 2 4 , 1 1 3 3 (1 98 1 ). No t h i n g i n th e en o rm o u s reco rdwo u l dh el p u s m ak e fi n d i n g s
o f fact ab o utth es e el em en t s fo r t h es e d edu ct i o n s . Ry d er fai l ed t o carry h i s b u rd en t o s h o w th atCal i fo rn i a Pas t el eri a was
en t i t l edt o th es e d edu ct i o n s. C. In v es t m en tIn t eres tEx p en s e fo r 2 0 0 5 an dUn rei m b u rs edEm

p l o y ee Ex p en s es fo r 2 0 06 Th ro u g h 2 0 0 8 Th e Co m m is s i o n er d i s al l o wedo t her d edu ct i o n s t ak enb y Ry d er fo r t ax y ears 2 0 0 5 , 2 0 0 6 , 2 0 0 7, an d2 00 8 . Ry d er l ab el edth e co n tes t ed 2 0 05 d edu ct i o n as i n v es t m en ti nt eres t , an d t h e 2 0 0 6 , 2 0 0 7 , an d2 00 8 d edu ct i o n s as u n rei m b u rs ed
em pl o y ee b u s i n es s ex p en s es . Inh i s an s weri n g b ri ef, Ry d er cl ai m ed fo r t h e fi rs t t i m e t h at h e s h o ul dh av e l ab el edth es e ex pen s es “ b u si nes s i n teres t .” Th i s was th e- 1 7 6 -

[* 1 7 6] fi rs tt i m e h e rai s edth i s i s s u e. An d t h ere i s n o t h i ng o n th e reco rds h o wi n g th atth es e am o u n t s o f “ b u s i n es s i n t eres t ” were act ual l y p ai do r i n cu rred --Ry d er d i d
n o tev enat t em

ptt o p o i n tth e Co u rti n th e ri g h t d irect i o n fo r wh ere t h es e co s t s
co u ldb e s ub s t an t i at ed
. W e wi l l d en y

th e d edu ct i o n s . V. Pen al t i es Th i s l eav es p en al t i es . As wi th m os to f t he i s s u es i n t h es e cas es , wh et h er R&A an dth e Ry d ers o we p en al t i es i s rat her co m p l i cat ed
. 6 4 W e’ l l b eg i n b y
s u m m ari zi n g wh atth e Co m

m i s s i o n er d et erm i n ed , th en wh ati s l eftaft er
co n ces si o n s . So m e o f t h e rem ai n in g p en al ti es ev ap o rat e fo r th e Co m m i s s i o n er’ s p ro cedural fai l u res , wh i ch wi l l l eav e o n l y a h an d fu l fo r u s t o d i scu s s . Th e cl eares tway

t o s u m m ari ze wh atth e Co m

m i s s i o n er p u ti n p l ay

i s wi t h a l i teral ch eck li s t o f y ear an d t y p e o f p en al t y :

6 4 W e h av e fo u n dthatth e m o n ey fro m cl i en t s i s t ax ab l e i n co m e o f R&A, an d th e Co m

m i s s i o n er ag rees th ati ti s n ott ax ab le i n co m e o f Fi rs t Co u n s el Cap i t al , In c. W e t h erefo re fi ndth at Fi rs tCo u n sel o wes n o n e o f th e p en al t ies th e Co m m i s s i o n er as sert ed ag ai ns ti t .- 1 7 7 - R&A

Tax y ear Fai l u re t o

fi l e6 6 5 1 (a)(1 ) Fai l u re t o

p ay 6 6 5 1 (a)(2 ) Fai l u re t o

p ay 6 6 5 5 Frau d
6 66 3 Frau d66 5 1 (f) Accu racy rel at ed
6 6 6 2 “ Oth er Dedu ct i o n s ” 2 0 0 3 2 0 0 4 2 0 0 5 T T T T T T 2 0 0 6 T T T T T T 2 0 0 7 T T T T T 2 0 0 8 T T T T T 2 0 0 9 T T T T T 2 0 1 0 2 0 1 1 [* 1 7 7]- 1 7 8 - Ry d ers Tax y ear Frau d 66 6 3 Frau d6 6 5 1 (f) Accu racy -rel at ed 6 66 2 Fai l u re t o fi l e6 6 5 1 (a)(1 ) 2 00 2 T T T 2 00 3 T T T T 2 00 4 T T T T 2 00 5 T T T T 2 00 6 T T T T 2 00 7 T T T T 2 00 8 T T T T 2 00 9 T T T T 2 01 0 T T T 2 01 1 T T T Ry d er h as co n ced edm an y o f th es e p en al t i es ati ss u e b y fai li n g t o d i scu s s th em i n h i s p o s t t ri al b ri ef. See M en d es , 1 2 1 T.C. at 3 12 -1 3 ; Ry b ak , 9 1 T.C. at 5 6 6 . Th es e are: ! t h e accu racy -rel at edp en al t i es u n der s ect io n 6 66 2 ag ai n s tR&A fo r 2 0 0 5 an d2 0 0 6 an dag ai n s t th e Ry d ers i n d i v idu al l y fo r 2 0 0 2 th ro u g h 2 0 1 1 ; ! t h e ad d i t i o n s t o t ax ag ai n s tR&A u n der s ect io n 6 65 1 (a)(1 ) fo r 2 0 0 5 t h ro u g h 2 0 0 9 , u n d er s ect i o n 6 6 51 (a)(2 ) fo r 2 0 05 th ro u g h 2 0 09 , an d u n d er s ect i o n 6 6 55 fo r 2 0 0 7 t h ro u g h 2 0 0 9 ; 6 5 an d [* 1 7 8]

6 5 R&A d i dn ’ tad dres s t h e s ect i o n 6 6 55 ad d i t i on s t o t ax fo r 2 00 5 an d2 0 0 6, (co n ti n u ed ...)- 1 7 9 -

! t h e ad d i t i o n s t o t ax ag ai n s tth e Ry d ers u n d er s ect i o n 6 6 5 1 (a)(1 ) fo r 2 0 0 3 th ro u g h 2 0 0 9
. W e h av e al so m ad e cl ear t h atth e Co m m i s s io n er can n o tas serta p en al t y i n a
n o t i ce o f d efi ci en cy

o r an am en d edan s wer u n l es s i t i s “pers o n al ly ap p ro v ed(i n wri t in g ) b y

th e i m m ed i at e s up erv i s o r o f t h e i n d iv i dual m ak i n g s u ch d et erm i n at i o n , ” s ee Graev III, 1 4 9 T.C. at4 9 3 (q u o t i n g s ect io n 6 7 5 1 (b )(1 )) (ci t i n g Ch ai v. Co m

m is s i o n er, 8 5 1 F.3 d1 9 0 , (2 dCi r. 2 0 1 7 ), aff’ g i n p art , rev ’ g i n p art T.C. M em o . 2 01 5 -4 2 ), u n l es s th e d et erm i nat i o n fal l s wi t h i n s ect i o n 6 7 5 1 (b )(2 )’ s
ex cep t i o n s , s ee W al qu is t v. Co m m i s s i o ner, 1 5 2 T.C. 6 1, 6 9 (2 0 1 9 ). 6 6 Th e Co m m i s s i o n er b ears t h e b u rd en o f p ro du ct i o n t o s h o w co m p l i an ce wi th th i s req u i rem en t . See s ec. 7 4 91 (c). Graev III l edth e Co m m i s s i o n er t o co n ced e t h e
s ect i on 6 6 6 3 frau dp en al t y ag ai n s t b o t h R&A an dth e Ry d ers i n d i v idual l y fo r each y ear at i s s u e. He al s o co n ced edth e frau dp en al ty ag ai n s tthe Ry d ers u nd er s ect i o n 6 6 5 1 (f) fo r al l y ears ex cep t2 00 9 , an dth e accu racy -rel at edp en al ty ag ai n stth e [* 1 7 9]

6 5 (...co n t i nu ed ) wh i ch we d eem

a co n ces s i o n . 6 6 Th es e ex cep t io ns are fo r ad d i t i o n s t o t ax u n der s ect i o n s 6 6 5 1 , 6 6 5 4 , o r 6 6 5 5 . See s ect i o n 6 7 5 1 (b )(2 )(A); Beam v . Co m m i s si o n er, T.C. M em o . 2 0 1 7 -2 0 0 , at* 1 4 (s ect i o n 6 7 51 (b )(2 ) m ean s wh at i ts ay s ).- 1 8 0 -

[* 1 8 0] Ry d ers u n der s ect i o n 6 6 6 2 fo r 2 00 5 t hro u g h 2 00 9
. 6 7 So t o up d at e o u r ch eck l i s twi th “ CR” fo r t h e i s s u es th atR&A o r t h e Ry d ers co n ced ed , an dwi t h

“ CC” fo r t h e i ss ues t h at t h e Co m m i s s io n er co n ced ed : R&A

Tax y ear Fai l u re t o

fi l e6 6 5 1 (a)(1 ) Fai l u re t o

p ay 6 6 5 1 (a)(2 ) Fai l u re t o

p ay 6 6 5 5 Frau d
6 66 3 Frau d66 5 1 (f) Accu racy rel at ed
6 6 6 2 “ Oth er Dedu ct i o n s ” 2 0 0 3 2 0 0 4 2 0 0 5 CR CR CR CC T CR 2 0 0 6 CR CR CR CC CC CR 2 0 0 7 CR CR CR CC T 2 0 0 8 CR CR CR CC T 2 0 0 9 CR CR CR CC T 2 0 1 0 2 0 1 1

6 7 Th e Ry d ers al s o co n ced edth e 6 6 6 2 p en al ti es , b u tb ecau s e th e Co m m i s s i o n er b ears t h e b u rd en o f p ro du ct i o n , s ee s ec. 7 4 9 1(c), we wi ll i g no re t h e Ry d ers ’ co nces s i o n s an dfi n di n th ei r fav o r.- 1 8 1 - Ry d ers Tax y ear Frau d 66 6 3 Frau d6 6 5 1 (f) Accu racy -rel at ed 6 66 2 Fai l u re t o fi l e6 6 5 1 (a)(1 ) 2 00 2 CC CC CR 2 00 3 CC CC CR CR 2 00 4 CC CC CR CR 2 00 5 CC CC CC CR 2 00 6 CC CC CC CR 2 00 7 CC CC CC CR 2 00 8 CC CC CC CR 2 00 9 CC T CC CR 2 01 0 CC CC CR 2 01 1 CC CC CR Th e o n l y p en al t i es l eft ati s s u e as as s ert edag ai n s t R&A are t h e frau du l en t fai l u re t o fi l e p en al t i es as sert edu n d er 6 6 51 (f) fo r t h e t ax y ears 2 0 0 5 an d2 0 0 7 th ro u g h 2 0 0 9
. 6 8 Th e o n l y p en al t y l eft ati s s u e ag ai n s t th e Ry d ers i s t he frau d p en al ty u n d er s ect i o n 6 6 5 1 (f) fo r t h e t ax y ear 2 0 0 9
. Th e Co m m is s i o n er h as th e b u rd en o f p ro o f, an dh e h as t o p ro ve frau db y cl ear an dco n v i n ci n g ev i d en ce. See s ec. 7 45 4 (a); Ru l e 1 4 2 (b ); Cl ayt o n , 1 0 2 T.C. [* 1 8 1]

6 8 Th e Co m

m i s s i o n er as sert eda 6 6 51 (f) p en al t y fo r t ax y ear 2 00 6 , b u tn ev er al l eg edth atR&A fai l edt o t i m el y fi l e i t s retu rn fo r t h aty ear. W e d eem t h i s a co n ces si o n .- 1 8 2 -

[* 1 8 2] at6 4 6 ; M o h am edv . Co m m i s s io n er, T.C. M em o . 2 0 1 3 -2 55 , at* 1 8
. Frau d fo r t ax p u rp o s es i s “ an i n ten t i o n al wro n g d o i n g d es i g n edt o ev ad e t ax b el i ev edt o b e o wi n g ,” Di Leo v . Co m m i s s i o n er, 9 6 T.C. 8 5 8 , 8 74 (1 9 9 1 ), aff’ d , 9 5 9 F.2 d1 6 (2 dCi r. 1 9 9 2), an d“ is es tab l i s h edb y p ro v i ng th at a t ax p ay er i nt en d edt o ev ad e t ax b el i ev edt o b e o wi ng b y co n du cti nt en d edt o co n ceal , m i sl ead , o r o t h erwi s e p rev en t th e co l l ect i o n o f s u ch t ax ,” Cl ayt on , 1 02 T.C. at 6 4 7
. Wh en we an al y ze wh et h er a t ax p ay er frau dul en t l y fai l edt o fi l e a t ax retu rn
u n d er s ect i o n 6 6 5 1 (f), we fo cu s o n h i s “ d ecis i o n n o tt o fi l e [h i s ] retu rn wh en du e. If t h at d ecisi o n was m ad e wi th th e i n ten tt o ev ad e t ax , th enth e ad d i t io n t o t ax
u n d er s ect i o n 6 6 5 1 (f) m ay pro perl y b e i m p o s ed .” En ay atv . Co m

m is s i o n er, T.C. M em o. 2 0 0 9 -2 5 7 , 2 0 09 W L 3 7 6 3 0 8 5 , at* 2 4 (em ph as i s ad d ed ). W e’ v e l o n g h ada cu st o m o f cal l i n g t h e b i t s o f ev id en ce t h ats up p o rta fi nd i ng o f frau du l en ti n ten t“bad g es ” o f frau d , an do v er t h e y ears we’ v e d ev el o p ed a p reci n ct fu l o f t h em . Th es e b ad g es i n cl u d e: ! u n d ers tat i n g i n co m e; ! m ai n t ai n i n g i n ad equ at e reco rd s ; ! fai l in g t o fi l e t ax retu rn s ; ! g i v i n g i m

p l au s i b l e o r i nco n s i s t en t ex p l an at i o ns o f b eh av i o r; ! co n ceal i n g as s et s ;- 1 8 3 -

! fai l in g t o co o perat e wi t h t ax au t h o ri t i es ; ! en g ag i ng i n i l l eg al act i v i t i es ; ! at t em

p t i ng t o co n ceal i l leg al act iv it i es ; ! edu cat io n an dex p eri en ce; ! wi l l fu l b l i n dn es s ; ! d eal i n g i n cas h ; ! fai l in g t o m ak e es t i m at edt ax p aym en t s; an d
! fi li n g fal s e d ocu m en t s . See Brad fo rdv . Co m

m i s s io n er, 7 9 6 F.2 d 3 0 3 , 3 0 7 -0 8 (9 t h Ci r. 1 98 6 ), aff’ g T.C. M em o. 1 9 8 4 -6 0 1 ; M o ham ed , T.C. M em o . 2 0 1 3 -2 5 5 , at* 3 2 -* 3 3; Fi o re v . Co m m i s s i o n er, T.C. M em o . 2 0 1 3 -2 1 , at* 2 1
. A. M rs . Ry der W e fi rs tl o o katth e as s ert i o n o f frau dag ai n s t M rs . Ry d er. Th e Co m m i s s i o n er’ s arg u m en tag ai n s tM rs . Ry d er cen t ers o n h er al l eg edwi l l fu l b l i n dn es s t o th e t ax -av o i d i n g act i v i t i es th atwere g o in g o n. W i l l fu l b li n dn es s can i n d i cat e frau du l en ti n t en t wh en a t ax p ay er was “ aware o f a h i g h p ro b ab i l it y o f
u n rep o rt edi n co m e o r i m

p ro p er d educt i o n s , an d d el i b erat el y av o i d eds t ep s t o
co n fi rm th i s awaren es s .” Fi o re, T.C. M em o . 2 0 13 -2 1 , at* 2 9
. Th e Co m m is s i o n er p o i n t s t o M rs . Ry der’ s l u x u ri o u s l ifes t y l e an darg u es th at t h i s s h o u l dh av e t i p p ed [* 1 8 3]- 1 8 4 -

[* 1 8 4] h er o ff t h at so m et h i n g was up wh en h er t ax retu rn s --o r l acko f t ax retu rn s -- s h o wedl i t t l e t o n o t ax ab l e i n co m e. Th e Co m m is s i o n er al s o as sert s th at M rs . Ry d er i s a “ s o p h i st i cat edb us i n es s wo m an ,” an d t h i s s h o u ldl eadu s t o fi n d t h ath er fai l u re t o fi l e was frau dul en t . W e are u np ers uad ed
. W e d o n o tb el i ev e t h e ev i d en ce o n th e reco rds h o ws cl ear an dco n vi n ci n g
ev i d en ce t h atM rs . Ry d er was i n o n h er h u s b an d ’ s t ax -av o i d an ce s ch em es o r was wi l l fu l l y b l i n d t o th em . Wh i l e M rs . Ry der d o es h av e ex p eri en ce as a b u s i n es s wo m an , s h e h as n o wh ere n ear t h e t ax ex p ert is e o f h er h us b an d . Her l i fes ty l e m ig h th av e b een a s i g n t o M rs . Ry d er t h ats h e s h o u l dh av e rep o rt eds o m e t ax ab l e i n co m e, b u t we fi n di tju s tas l i k el y th ati f s he t h o u g htab o uti t atal l , s h e
co u ldh av e fi g u red h e was ju stas g o o das h e t ol dh is cl i en ts h e was atl o weri n g th ei r t ax b i l l s l eg i ti m at el y . W i t h o u tm o re, we wi l l n o tfi n dth atth e Co m m i s s i o n er h as s h own cl ear an dco n v i nci n g ev i d en ce o f h er frau du l en ti n ten ti n fai l i n g t o fi l e. Sh e i s n otl i ab l e fo r a s ect i o n 6 6 5 1 (f) p en al ty .- 1 8 5 -

[* 1 8 5] B. Ry d er an dR&A As fo r R&A an dRy d er h i m s el f, th i n gs are rat her d i fferen t . 6 9 Ry d er i s ab ou tas wel l -edu cat edas o n e can b e i n t ax l aw. Itwas h i s t ax
ex p ert i s e th atb ro u g h t cl i en t s i nt o R&A, an di twas h is u s e o f t h atex p ert i s e t h at
m ad e t h e m o n ey

th at we’ v e fo u n dt ax ab l e, fi rs tt o R&A an dth en t o h im . W e ack n owl ed ge h i s p o s i t io n thath e d i dn o ti n t en dt o ev ad e t ax , b uto n ly t o s eek
s h el t er i n th e g ray

areas i n th e Co d e. W e ag ree t h atth ere are g ray areas i n t ax l aw. Bu t o ne area t h atn o o n e
s h o u ldco n s i d er g ray

i s m i s rep res en t i n g fact s . Es p eci al l y m at eri al fact s . An d i n s t eado f l i s t i n g ev ery

p o s s i bl e b ad g e o f frau d an dfi nd i ng wh et her i ti s p res en t h ere, we’ l l s t art wi t h a p ro b e o f wh et h er t h ere i s cl ear an dco n v in ci n g ev i d en ce th atRy d er m i s rep res en t edm at eri al fact s t o ev ad e t h e fi l i n g o b l ig at i o n s o f R&A
an d h i m s el f. Here are s o m e ex am

p l es . ! Al t h o u g h Ry der cl ai m edth ath i s b ro t h er-i n -l aw, Pan ch eri , co n t ro l l ed BFA, Ry d er n eg o t i at edth e t erm s o f t he PFA an d k ep ts i g n atu re au t h ori t y o v er BFA’ s b an kacco u n t h im s el f.

6 9 Ry d er i s t h e 1 00 % o wn er an d p res i d en to f R&A, s ee s up ra p p . 8 -9 , s o we l o o kt o wh ath e d i d t o g au g e wh et h er R&A’ s fai l u re t o fi l e was frau du len t . See Ben av i d es & Co ., P.C. v . Co m m i s si o ner, T.C. M em o . 2 0 1 9 -1 1 5, at* 35
.- 1 8 6 -

! Ry d er cl ai m ed t h atth e em p l o y ees o f R&A b ecam e RLC em p l o y ees t h atwere l eas edb ackt o i tth ro u gh an em p l o y ee l eas i n g ag reem en t , b u th is l et t ers t o cl i en t s were s en to n R&A l et t erh ead , t i m e was k ep t o n R&A’ s b o o k s , an dm an y R&A em p l o y ees cred i b ly

t es t i fi edth at t h ey were em p l o y ees o f R&A, n o tRLC.
! Ry d er cl ai m ed t h atu n rel at edth i rdp art i es o wn edi n teres t s i n th e ran ch en t i t i es , y et t h e o p erat i n g ag reem en t s fo r t h e ran ch en t i t i es s t at edth at a m at eri al p u rp o s e o f t h e ran ch en t i t i es was t o ad v an ce t h e fam i l y es t at e p l an n i n g o b

ject i v es o f th e Ry d ers . ! Ry d er l i s t edM ich ael Go l d s tei n as th e t ax m at t ers p artn er fo r Fi rs t Co u n s el Cap i t al , an en t i t y th at Ry der cl ai m edo wn edan i n teres ti n th e ran ch en t i t i es , y etGo l d s t ei n cred i b ly t es t i fi edh e was u naware o f t h e ran ch en t i t i es o r Fi rs tCo un s el Cap i tal
. ! Ry d er b ack d at edthe ran ch o p erat i n g ag reem en t s t o creat e ap p earan ces o f d i fferen to wn ers h i p o f t hes e en t i t i es an dcau s e co n fu s io n o ver t h ei r t ru e o wn ers h i p . ! Ry d er ex ecu t eda frau du l en t d eedo f tru s tag ai n st h i s an dh i s wi fe’ s Cal i fo rn i a p ers o n al res i d en ce i n fav o r o f Co n s t ru ct i o n Fu n d i n g Serv ices , LLC, wh i ch res u l t edi n Ry d er’ s rep o rt i n g an o b l i gat i o n o f $ 2 .7 m i l l i o n. Co n s t ru ct i o n Fu n d i n g Serv i ces , LLC, h as n ev er ex i s t ed
. ! Ry d er creat ed hu n dred s o f ESOPs an dS co rp o rat i o n s i n Wy o m i n g wi t h fak e ret u rn s th ateach l i st ed$ 3 i n i n co m e--d es p it e Ry d er’ s b ei n g aware t h atn o n e o f t h es e en t i t i es h aden g ag edi n eco n o m i c act iv i t i es -- i n h o pes t h at t h ey wo u l d b e g ran d fat hered u n d er am en dm en t s t o s ect i o n 4 0 9 an du sab l e t o s el l h i s GCO p ro du ct . Th es e s p eci fi c ex am

p les o f Ry d er an dR&A’ s m at eri al m i s rep res en t at i o n s o f fact
es t ab l i s h a p at t ern o f co n du ctth atRy d er an dR&A co n ti n u eddu ri n g t h e y ears at i s su e. [* 1 8 6]- 1 8 7 -

[* 1 8 7] Ry d er al s o m i sch aract eri zeds o u rces o f i n co m e b y i g n o ri n g wel les t ab l i s h edl aw ab o u tth e as s i g n m en to f i n co m e. W e h av e al read y fo u n di n th es e
cas es th atal l t h e wo rk d o n e b y R&A an d Ry der was es sen t i al l y o n e g i an t s ch em e t o h i d e s o u rces o f i n co m e. He acco m p l i s h edth i s t h ro u g h th e u s e o f m u l t ip l e t ax p ro duct s , th e creat io n o f t h ou s an d s o f d i fferen t en t it i es an db an kacco u n t s , an dth e tran s fer o f fu n d s b etween thes e acco u n ts an dwh ath e cal l ed“b l o ck er en t i t i es .” Ry d er arg u es thath e l ack edfrau dul en t i n t en t , an db el i ev edi n g o o d fai t h th atn o n e
o f t h e i n co m e at i s s u e i n th es e cas es was actu al l y R&A’ s . Ry d er co n t rad i ct s h i m s el f t ho u g h . He ad m i t s thatth e So n -o f-BOSS t ax -s hel t er s ch em e was d i s ap p ro v edb y

th e Tax Co urt atl eas tas far b ackas Sal i n a Part n ers h i p L.P. v
. Co m m i s s i o n er, T.C. M em o . 2 0 0 0 -3 5 2 , wh en we h el dth at o b li g at i o n s t o cl o s e
s h o rts al es an dd el i v er o n o p t i on s co n s t i tu t e l i ab i l i t i es fo r t ax p u rp os es . R&A an d Ry d er t h en co nt i n u edt o p ro m ot e an ds el l i t s s ubs t an ti al l y s i m i l ar s h o rt -s al e p ro ductfo r n earl y

two y ears aft erward
. Th i s h ard l y ex h i b i ts g o o dfai t h b el i ef t h at th es e t ax p ro du ct s were v al i du n d er t he Co d e. Th i s fact o r s t ro n g l y fav o rs a fi nd i ng o f frau dfo r R&A an dRy d er. W e h av e o u t l i n ed i n g reat d et ai l i n th i s o p i n io n h ow Ry d er an dR&A
wo rk edt o co n ceal th e i n co m e o f b o th R&A an dth e Ry d ers i n d i v i du al l y th ro u g h th e s al e o f t ax p ro duct s , creat i o n o f en t i t i es , m o v em en t o f fu n d s , an das s i g n m en t- 1 8 8 -

[* 1 8 8] o f i nco m e du ri n g th e y ears ati s s ue. Ry d er’ s creat i o n o f co m p l ex b us i n es s
s tru ctu res an d co m

p l icat ed t ax -av o i d an ce s t rat eg i es was d o ne wi t h wi l l fu l i n t en t. W e are o f co u rs e n ot s ay i n g t h atev ery co m p l ex b u s in es s s t ru ctu re i s frau du l en t , b u ti n s t eadem

p h as i ze h o wRy d er’ s d ev el o p m en to f t h e t ax s t rat eg i es o ffered t o R&A cl ien t s an dh is u se o f t h em t o av o i dh is o wn t ax req u i reda g reatd eal o f p rep arat i o n an d wo rko v er t h e co u rs e o f m o re t h an 2 0 y ears . Th e am o u n to f effo rt Ry d er p uti n t o t h es e t ax s t rat eg i es s h ows th atth ey were creat edwi t h t h e wi l l fu l i n t en tt o p rev en t th e co l l ect i o n o f t ax . R&A an dRy d er creat edth es e n um ero u s t ax s t ru ctu res an dag reem en t s t o
m i s l eadth e Co m

m i s s i on er an dev ad e t ax du ri n g th e y ears ati s su e. Ry d er an d R&A u s edh u n dred s o f en t it i es t o m i m i c real b u s i n es s es t o h el p p ro du ce m u ch h i g h er ret i rem en ti n co m es fo r t h e cl i en t s . R&A an dRy d er p ro fi t edg reat l y fro m th es e act i v i t i es , th en tu rn edaro u n dan d u s ed m an y o f t h e s am e t ech n i qu es t o
m i s l eadth e Co m

m i s s i on er an dev ad e t ax th ey o wed . R&A en t eredi nt o a s h am p ract i ce fu n d i n g ag reem en twi t h BFA i n o rd er t o m o v e m o re o f i t s m o n ey aro u n d
an d av o i dreco g ni zi n g i n co m e. Th en m o n ey was fu nn el edth ro u g h b l o ck er en t i t ies
an d co m p l i cat edad

ju s t i n g jo urn al en t ri es t h atd i s t an cedR&A an dRy d er fro m th i s i n co m e ev enfu rt h er, al l i n an at t em p tt o cau s e co n fu s i o n as t o t h e t ru e s o u rce o f th e i n co m e.- 1 8 9 -

[* 1 8 9] Co ns i s t en t l y

u n ders t at in g i n co m e i s s t ro n g ev i d en ce o f frau d , es p eci al l y wh en th ere are o t h er ci rcu m s t an ces s h o wi n g an i n t en tt o co nceal i nco m e. See Bran s o n v . Co m

m i s s io n er, T.C. M em o . 2 0 1 2 -1 2 4 , 2 0 12 W L 1 4 48 4 73 , at* 8 ; s ee al s o Park s v . Co m

m i s s i o n er, 9 4 T.C. 6 5 4, 6 6 4 (1 9 9 0). R&A p ai dn o co rp o rat e i n co m e t ax fo r a d ecad e. An dth e Ry d ers p ai da g ran dt ot al o f $ 31 ,1 4 3 i n i n d i v i du al i n co m e t ax o v er t h ats am e t en -y ear p eri o d --d es p i t e t h e t en s o f m i l l i o n s R&A b ro u g h ti n an d p as s edo n t o t h em . Acco rd i n g t o th e Ni n t h Ci rcu it --wh ere th es e cas es are ap p eal ab l e--“ rep eat edu n d ers tat em en t s i n s u cces s i ve y ears wh en
co upl ed wi t h o t her ci rcu m s t an ces s h o w i n g an i nt en tt o co nceal o r m i s s t at e t ax ab l e i n co m e p res en ta b as i s o n wh i ch th e Tax Co u rtm ay p ro p erl y i n fer frau d .” Fu rn i s h
v . Co m m i s s i o n er, 2 6 2 F.2 d7 2 7 , 7 2 8 -2 9 (9 t h Ci r. 1 95 8 ), aff’ g i n p art , rem an d i n g i n p art Fu n kv . Co m

m i s s i on er, 2 9 T.C. 2 7 9 (1 9 5 7). Ry d er arg u es thath is p ro m o t i o n o f t ax -av o i dan ce s ch em es d o es n o ts up p o rt
an i n feren ce o f an i n t en t t o m i sl ead . Ry d er ci t es Kern an v . Co m m i s s i o n er, T.C. M em o. 2 0 1 4 -2 2 8 , aff’ d , 6 7 0 F. Ap p ’ x 9 4 4 (9 t h Ci r. 2 0 1 6 ), t o s upp o rt h is
co n ten t i o n . In Kern an , h o wev er, we s t at ed t h atp ro m o t i n g t ax -av o i dan ce p ro du ct s i s n o tev i d en ce o f i l l eg a l

a ct i vi t y , a co m p let el y d i fferen tb ad g e o f frau d . Id . at
* 2 6 . W e h av e i n ferred an i n t en tt o m is l eadfro m th e p ro m o ti o n o f t ax -av o i d an ce
s ch em es . See Ch i l d v . Co m m i s s i o n er, T.C. M em o . 2 0 1 0 -5 8 , 2 0 1 0 W L 1 1 4 1 2 0 8 ,- 1 9 0 -

[* 1 9 0] at* 9 (“ Th e s h am

tran s act i o n s p et i t i o n er p art i ci p at edi n were d es i gn edb y Ev an s o n t o m i s l eadth e In t ern al Rev en ue Serv i ce (IRS) i n t o treat i ng o t h erwi s e t ax ab l e i n co m e as n o n tax ab l e”). R&A’ s an d Ry d er’ s creat i o n o f an dp art i ci p at i o n i n thes e s ch em es , co up l edwi th th e act i on s t ak en t o ex ecu t e t h em , i s cl ear an d
co n vi n ci n g ev id en ce o f an i n t en tt o m i s l ead
. R&A fai l edt o fi l e i t s co rp o rat e t ax retu rn s fo r t he 2 0 0 7 , 2 0 08 , an d 2 0 0 9 t ax y ears , an dth e Ry d ers fai l edt o fi l e t h ei r i nd i v i du al t ax retu rn fo r t h e 2 0 0 9 t ax y ear. Th e reco rdi n th es e cas es i n cl u d es fi l edt ax retu rn s o f R&A fo r t h e 2 0 0 5 an d2 0 0 6 t ax y ears , as wel l as fi ledt ax retu rn s o f t h e Ry d ers fo r t h e 2 0 0 2 th ro u g h 2 00 8 an d 2 0 1 0 thro u g h 2 0 1 1 t ax y ears . No n fi l i n g b y t ax p ay ers can wei gh h eav i ly ag ai n s t th em wh en thei r fi l i n g h i s t o ry s h o ws awaren es s o f t h e req u i rem en tt o fi l e. See Cas ti l l o v . Co m

m is s i o n er, 8 4 T.C. 4 0 5, 4 0 9 (1 9 8 5). Bu tag ai n , th e d eci s io n o f t h e t ax p ay ers n o tt o fi l e m

u s tb e wi t h th e i nt en t t o ev ad e t ax . If a t ax p ay er can
es t ab l i s h t h ath i s fai l u re t o fi le was du e t o reas o n ab l e cau s e an dn o t wi l l fu l
n eg lect , th en h e d o es n o t o we a s ect i o n 6 6 5 1 (f) p en al t y . M oh am edv . Co m m i s s i o n er, T.C. M em o . 2 0 1 3 -2 5 5 , at* 2 2
. Bu tth at ’ s n o t t h es e cas es . No t
o n l y d i dRy d er fai l t o s h o w reas o n ab l e cau s e; h e t es t i fi edth ath e m ad e t h e ch o i ce
n o tt o fi le. Ry d er cl ai m s th ath e l earn eddu ri n g h i s t i m e i n NYU’ s LL.M . p ro g ram th at“ wh ere y o u ’ re u n cert ai n as t o h o w y o u s h o ul dres p o n do r rep ort , y o u ’ re b et t er- 1 9 1 -

[* 1 9 1] o ff n o tfi l i n g th an fi li ng atal l .” An d wh en d i s cu s s i n g wh y h e h adfi l ed
o th er ret urn s l at e i n th e p as t , Ry d er s t at ed : “ [I] t’ s b et ter t o h av e a m i s dem ean o r th an a fel o ny .” It ’ s h ardt o b el i ev e t h atRy d er’ s d eci s i o n n o tt o fi le was d o n e wi t h
an y o th er p u rp o s e t han t o ev ad e t ax . Th e Co m m is s i o n er wi ns o n th i s o n e.
Anap p ro p ri at e o rd er wi l l b e i s s u ed
.