T.C. Mem o. 2 01 3- 24 5

UNITED STAT ES TAX COURT

TERRY L. ELL IS AND SHEILA K. E LLIS, Pet it io ne rs v. COMM ISSI ONER OF INTERNAL REVENUE, Resp on de nt

Doc ke t No . 12 96 0- 11 . Fi le d Oct ob er 2 9, 2 01 3. Troy Renk en m ey er, fo r pe ti ti on ers . Eli zab eth Ab ig ai l Ra in es , forres po nd en t.

MEMORANDUM OPINION PARIS , Ju dg e: On Ma rch 28 , 20 11 , res po nd en t i ss ue d ano ti ce o f de fic ie nc y

fortax y ears 20 05 an d 2 00 6 t o p et it io ne rs Terry L. Elli s an d S he il a K. Ell is , tak in g a lt ern at iv e p os it io ns forth es e two tax y ears . The n ot ic e d et erm in eda de fic ie nc y

inpe ti ti on ers ’ Fed eral in co m e ta x fo r ta x year 20 05 of $ 13 5,9 36 an d a n- 2 -

[* 2] accu racy-rela te d p en al ty und er s ect io n 6 66 2( a) of $ 27 ,18 7. Inth e 1 al te rn at iv e, th e n ot ic e d et erm in eda de fic ie nc y inpe ti ti on ers ’ Fed eral in co m e ta x fo r ta x year 20 06 of $ 13 3,0 67 , an a dd it io n t o t ax un de r se ct io n 6 65 1( a)(1 ) of $1 9,7 31 , andanaccuracy-rela te d p en al ty und er s ect io n 6 66 2( a) o f $2 6,6 13 . Pet it io ne rs see k re de te rm in at io n o f th e ab ov e-s ta te d d efi ci en ci es , pen al ti es , an d a dd it io ns to tax . The i ss ue s fo r de ci si on are: (1 ) whe th er p et it io ne r Terry L . Elli s p art ic ip at edinon e o r m or e p ro hi bi te d tra ns act io ns un de r se ct io n 4 97 5 wi th hi s i nd iv idua l re ti rem en t ac co un t (I RA) i n 20 05 when he di rect edhi s IRA to in ve stinCST In ve st m en ts , LLC (CST), pu rs ua ntto anarrang em en t o r un de rs tand in g wh ereb y he was d es ig na te d the ge ne ral m an ag er an d wo ul d s ub se qu en tl y rece iv e co m

pe ns at io n a ndothe r be ne fit s fro m th atco m pa ny; (2 ) whe th er Mr . Elli s p art ic ip at edinon e o r m or e p ro hi bi te d tran sa ct io ns un de r se ct io n 4 97 5 wh enhe cau se d C ST to pa y hi m co m pe ns at io n o f $9 ,75 4 i n t ax y ear 2 00 5;

All sec ti on refe ren ces are t o the Int ern al Rev enue Co de ineffe ctforth e ta x 1 y ears at i ss ue , andall Ru le refe ren ces are t o the Tax C ou rt R ul es of P ract ic e an d Pro cedur e, un le ss othe rwis e in di cat ed .- 3 -

[* 3] (3 ) whe th er Mr . Elli s p art ic ip at edinon e o r m or e p ro hi bi te d tran sa ct io ns un de r se ct io n 4 97 5 wh enhe cau se d C ST to pa y hi m co m pe ns at io n o f $2 9,2 63 in ta x year 20 06 ; (4 ) whe th er Mr . Elli s p art ic ip at edinon e o r m or e p ro hi bi te d tran sa ct io ns un de r se ct io n 4 97 5 wh enhe cau se d C ST to pa y ren t t o C DJ, LLC, anen ti ty owne d by pet it io ne rs an d the ir c hi ldren , intax y ear 2 00 6; (5 ) whe th er p et it io ne rs rece iv edun rep orte d re ti rem en t i nc om e as a res ul t o f Mr. Ell is ’ parti ci pa ti on ina pr oh ib it edtra ns act io n u nd er s ect io n 4 97 5 wi th hi s IRA i n 2 00 5, o r, inth e al te rn at iv e, 20 06 ; (6 ) whe th er p et it io ne rs are l iabl e fo r th e 1 0% a dd it io na l t ax un de r se ct io n 72 (t) for tax y ear 2 00 5, o r, inth e al te rn at iv e, 20 06 ; (7 ) whe th er p et it io ne rs are l iabl e fo r th e acc ur acy-rela te d p en al ty und er se ct io n 6 66 2( a) fo r ta x year 20 05 , or, i n the alt ern at iv e, 20 06 ; an d (8 ) whe th er p et it io ne rs are l iabl e fo r anad di ti on to tax un de r se ct io n 66 51 (a)( 1) for

tax y ear 2 00 6. Bac kg ro un d The pa rti es subm itte d thi s ca se forde ci si onful ly sti pu la te d u nd er Ru le 12 2( a). The st ip ul at io n o f fac ts fil edon Ju ne 12 , 20 12 , is in co rp or at edhe rei n b y th is refe ren ce. Pet it io ne rs res id edinMi ss ou ri a t the ti m e th ei r pe ti ti on was fi le d.- 4 -

[* 4] I. Tax Yea r 20 05 A. Form at io n o f CST By 20 05 pe ti ti on er Terry

L. Elli s h adaccu m

ul at eda si zab le am ou ntinhi s se ct io n 4 01 (k ) ret ire m en t p lan a cco un t fr om hi s m any y ears of s erv ic e as an em pl oyee at Av en ti s Ph arm aceu ti cal s, In c. On o r ab ou t Ap ril 19 , 20 05 , Mr. Ell is en ga ge d the form er l aw fi rm of p et it io ne rs ’ cu rren t co un se l o f rec or d i n thi s ca se to advi se hi m

reg ard in g the res tru ctur in g o f hi s i nv es tm en t h ol di ng s. OnMay 25, 20 05 , th e fi rm

he lp edpe ti ti on ers to org an iz e CST, a Mi ss ou ri l im it edli ab il ity co m pa ny. The o pe rat in g a gr eem en t o f CST, al so da te d M ay 25 , 20 05 , was s ig ne d 2 by Mr. Elli s o n b eh al f of

Fir stTrus t Co . of On ag a FBO Terry Ell is IRA, anen ti ty th atdi d n oty etex is t. The ag reem en t l is te d the ori gi na l m em be rs of C ST to be Fi rs t Tru stCo . of On ag a FBO Terry Ell is IRA, own in g 9 80 ,00 0 m em be rs hi p u ni ts or98 % inex ch an ge foranin it ia l capi ta l co ntrib ut io n o f $3 19 ,50 0, an d am em be r no t a p arty

to th is act io n o wni ng th e rem ai ni ng 20 ,00 0 m em be rs hi p u ni ts or 2 %. Mr. Ell is als o re qu es te d aFed eral tax pa y er i de nt ifi cat io n n um be r fo r CST o n a Fo rm SS-4 , App li cat io n fo r Em pl oyer Ide nt ifi cat io n Nu m be r, whi chwas d at ed

Des pi te it s n am e, CST In ve st m en ts , LLC is no t a r eg is te redin ve st m en t 2 co m pa ny un de r th e In ve st m en t Co m pa ny Act of

19 40 .- 5 -

[* 5] May 16, 2 00 5. OnJune 2, 2 00 5, a F ed eral tax id en ti fic at io n n um be r was as si gn edto CST. CST was form edto en ga ge inth e b us in es s o f us edve hi cl e sa le s. It co nduc te d i ts op erat io ns inHarri so nv il le , Mis so ur i. At a ll rel ev an t t im es du rin g ta x years 2 00 5 a nd20 06 , Mr. Ell is was the ge ne ral m an ag er o f CST an d, i n ad di ti on , work edat t he co m pa ny in i ts us edcar b us in es s. 3 On o r ab ou t Jun e 7 , 20 05 , Mr. Ell is subm it te d a n app li cat io n t o e st ab li sh an IRA wit h F irs t Tru stCo . of On ag a (Fi rs t Tru st ). On o r ab ou t J un e 1 4, 2 00 5, M r. Ell is , as g en eral m an ag er o f CST, fi le d aFo rm 88 32 , Ent ity

Cla ss ifi cat io n Elec ti on , onbe ha lf o f CST, in whi chitele ct edto be tre at edas a n a ss oc ia ti on ta xabl e as a co rp or at io n. 4 On o r ab ou t Jun e 2 2, 2 00 5, M r. Ell is rece iv eda di st rib ut io n o f $2 54 ,20 6.4 4 fro m th e se ct io n 4 01 (k ) acc ounthe ha d a ccu m ul at edwith h is form er em pl oyer,

Mr. Ell is was the de si gn at edge ne ral m an ag er i n the op erat in g a gr eem en t 3 fo r CST. Arti cl e II o f th e o pe rat in g a gr eem en t fu rth er s ta te d: “ The Gene ral Man ag er s ha ll have ful l au th or ity to actonbe ha lf o f th e Lim it edLiab il ity Co m pa ny”. See al so Mo . Rev . Stat. s ecs . 34 7.0 65 , 34 7.0 69 (20 12 ). Mo . Rev . Sta t. s ec. 3 47 .18 7.2 (20 12 ) pr ov id es th ata Mi ss ou ri l im it ed 4 li ab il ity co m pa ny andit s m em

be rs sh al l b e cl as si fie d a ndtre at edon a ba si s co ns is te ntwith the li mit edli ab il ity co m pa ny’ s cl as si fic at io n fo r Fed eral in co m e ta x p ur po se s.- 6 -

[* 6] Aven ti s Ph arm aceu ti cal s. Mr. Ell is to okth e d is tri bu ti on ch eckfro m hi s 5
se ct io n 4 01 (k ) acc ou ntan d d ep os it edth e en ti re $ 25 4,2 06 .44 in to hi s n ewly op en edIRA. On o r ab ou t J un e 2 3, 2 00 5, M r. Ell is cau se d h is IRA to acqui re

6 77 9,1 41 m em

be rs hi p u ni ts of C ST inex ch an ge fora cas h p aym en t o f $2 54 ,00 0 fro m th e IRA t o C ST. 7 On o r ab ou t Au gu st19 , 20 05 , Mr. Ell is rece iv eda se co nddi st rib ut io n o f $6 7,1 38 .81 fro m

th e se ct io n 4 01 (k ) acc ou nthe ha d a ccu m ul at edat Av en ti s Ph arm aceu ti cal s. As with the fir stdi strib ut io n c he ck , Mr. Ell is de po si te d the 8 9
en ti re $ 67 ,13 8.8 1 i nt o h is IRA. On o r ab ou t Au gu st23 , 20 05 , Mr. Ell is cau se d h is IRA t o a cqui re 2 00 ,85 9 m em be rs hi p u ni ts of C ST, inex ch an ge fora pa ym en t o f
The di st rib ut or , T. Rowe Pri ce, i ss ue d t o p et it io ne rs a Fo rm 10 99 -R, 5 Dis tri bu ti on s Fr om

Pen si on s, An nu it ie s, Re ti rem en t o r Pro fit -Sh ari ng Plans , IRA’s, In su ran ce Co nt ract s, et c., fo r ta x year 20 05 to rep ort the $2 54 ,20 6.4 4 di st rib ut io n. Thi s tran sa ct io n was rep orte d a s a r ol lo ve r co nt rib ut io n b y T. Rowe Pr ic e. 6 Afte r th is pa ym en t t o C ST an d app li cab le fees , $1 91 incas h re m ai ne d i n 7 th e IRA ac co un t. The di st rib ut or , T. Rowe Pri ce, i ss ue d t o p et it io ne rs a se co ndFo rm 10 99 -R 8 fo r 20 05 to rep ort the $6 7,1 38 .81 di st rib ut io n. The reco rdals o re fle ct s tha t, atso m e p oi ntdu rin g t ax y ear 2 00 5, M r. Ell is 9 rece iv eda th irddi st rib ut io n o f $2 1 fr om th e se c. 40 1( k) acco un t h e h ad accu m ul at edwith Av en ti s Ph arm aceu ti cal s. Th is di strib ut io n was als o re po rte d b y T. Rowe P ric e o n aFo rm 10 99 -R fo r ta x year 20 05 .- 7 -

[* 7] $6 5,5 00 fro m

th e IRA t o C ST. Fol lo win g the co m pl et io n o f th e $ 31 9,5 00 1 0 cap it al co nt rib ut io n, a s in gl e m em be rs hi p c ert ifi cat e fo r 98 0,0 00 un it s was is su ed to Fir stTrus t FB O Terry

Ell is IRA o n J un e 2 3, 2 00 5. On o r ab ou t No ve m

be r 28 , 20 05 , Firs t Tru st , th e cu st od ian o f Mr. El li s’ IRA, reque st eda cu rren t es ti m at e o f th e fai r m ark etva lu e o f th e IRA’s
m em be rs hi p i nt eres t i n C ST. On Dece m be r 20 , 20 05 , Mr. Ell is pro vi de d acurren t va lu at io n o f CST t o the IRA cu st od ian. Subs eque nt ly, on or abo utJune 20 , 20 06 , Fi rs t Tru stis su edto Mr. Ell is an d t o re sp on de nta Fo rm 54 98 , IRA Co ntrib ut io n In fo rm at io n, fo r ta x year 20 05 refl ect in g afai r m ark etva lu e o f th e IRA ac co un t o f $3 21 ,25 3. Th is am ountco ns is te d o f $3 19 ,48 0 o f va lu e in th e 9 8% i nt eres t i n C ST an d the rem ai ni ng cas h b al an ce o f $1 ,77 3. 1 1 Dur in g t ax y ear 2 00 5 C ST pa idMr. Ell is $9 ,75 4 a s co m pe ns at io n fo r hi s ro le as g en eral m an ag er o f CST. CST m ad e th es e p aym en ts th ro ug h c he ck s i ss ue d fro m it s co rp or at e ch eck in g a cco un t, an d n otfro m th e cu st od ia l ac co un t o f Mr. Ell is ’ IRA. On o r be fo re Ma rch 15 , 20 06 , CST fil eda Fo rm 11 20 , U.S. Co rp or at io n In co m e Tax Return, fo r ta x year 20 05 . CST cla im eda de du ct io n fr om Afte r th is pa y

m en t t o C ST an d app li cab le fees , $1 ,79 4 i n c as h re m ai ne d i n 1 0 th e IRA ac co un t. The cas h b al an ce was reduc edby app ro xi m at el y $2 1 i n c us to di al fees 1 1 be twee n Au gu st23 an d Dec em be r 20 , 20 05 .- 8 -

[* 8] co rp or at e in co m e fo r co m pe ns at io n p ai d t o c or

po rat e o ffi cers , whi ch co ns is te d o nl y

of the $9 ,75 4 p ai d t o M r. Ell is . In a dd it io n t o wh atap pe ars to be 1 2
no rm al op erat in g e xp en se s, CS T als o l is te d a dd it io na l d educ ti on s o f $1 2,1 06 for pa yro ll expe ns es , $5 ,46 2 fo r ba nkservi ce ch arg es , and$8 ,91 0 fo r le ga l fe es . 1 3 B. Fo rm at io n o f CDJ , LLC On o r ab ou t Jun e 2 4, 2 00 5, p et it io ne rs ’ co un se l’s fo rm er fi rm als o or ga ni zedCDJ, LLC (CDJ ), a Mi ss ou ri l im it edli ab il ity co m pa ny, on b eh al f of

Mr. Ell is . From th atpo in t t o the date th e p art ie s ex ecu te d the st ip ul at io n o f fac ts , th e m em be rs of C DJ were Terry

L. Elli s (5 0%) , She il a Ell is (12 .5%), an d the ir t hr ee ch il dr en : Ch ris to ph er Ell is (12 .5%), Do ug la s El li s (1 2.5 %), an d J am ie Ell is (1 2.5 %). CDJ d idno t fi le a Fo rm 88 32 an d d idno t o th erwi se ele ctto be cla ss ifi ed as anass oc ia ti on tax ab le as aco rp or at io n.

Thi s amoun t was rep orte d o n aFo rm W -2 , W ag e an d Tax Sta te m en t, 1 2 is su edto Mr. Ell is fortax y ear 2 00 5 a ndsubs eque nt ly repo rte d b y pe ti ti on ers on th ei r 20 05 Fed eral in co m e ta x re tu rnas wa ge s. As di sc us se d b el ow, the ori gi na l op erat in g a gr eem en t o f CST au th or iz edMr. Ell is to be pa idgu aran te edpa ym en ts by the co m

pa ny in h is rol e as ge ne ral m an ag er. Itis un cl ear wh ethe r th is am ou nt pa idas “ of

fic er co m pe ns at io n” was i ss ue d u nd er the gu aran te edpaym en t pr ov is io n o f th e o pe rat in g a gr eem en t o r was is su edas wa ge s t o M r. Ell is . The ori gi na l en ga ge m en t l et te r with p et it io ne rs ’ co un se l’s fi rm li st eda 1 3 le ga l fe e o f “ 3% o f th e am ou ntacce ss edfro m de ferr edco m

pe ns at io n a cco un ts * * * p ay ab le up on th e in ve st m en t b y y ou r IRA i nt o the co rp or at io n.”- 9 -

[* 9] The pu rp os e o f CDJwas t o a cqui re i nv es tm en t p ro pe rty andto ren t s uc h pr op erty th ro ug h the is su an ce o f co m m erci al lea se s. OnDecem be r 28 , 20 05 , CDJ acqui redti tl e to a parcel of r eal pro pe rty at 2 36 21 S. Sta te Ro ut e 2 91 , Harri so nv il le , Mis so ur i (Harri so nv il le pa rcel ). The p ur ch as e p ric e fo r th e Harri so nv il le pa rcel was $ 14 2,0 00 . CDJ p ai d $ 12 ,00 0 d own an d o bt ai ne d a
m ortg ag e fo r th e b al an ce o f $1 30 ,00 0 fr om th e Ban k o f Lee’s Su m

m it . On o r be fo re Ap ril 15 , 20 06 , a Fo rm 10 65 , U.S. Retu rnof P artne rs hi p In co m e, was fil edon be ha lf o f CDJfortax y ear 2 00 5. Th is return re po rte d n ei th er gr os s i nc om e n orrece ip ts bu t d idrep ort ex pe ns e d educ ti on s o f $3 ,59 8, re su lt in g i n a rep orte d n etlo ss of $ 3,5 98 . C. Pet it io ne rs ’ 20 05 Return On o r ab ou t M ay

6, 2 00 6, p et it io ne rs fil edth ei r joi ntFed eral in co m e ta x return fo r ta x year 20 05 . Peti ti on ers rep orte d t ot al in co m e o f $7 5,2 70 , con si st in g of wage s o f $7 6,0 46 , tax ab le refu nd s o f St at e an d l oc al in co m e ta xe s o f $1 ,47 3, 1 4
an d alo ss on Sch edul e E, Sup pl em en ta l In co m e an d Lo ss , fro m CDJ o f $2 ,24 9. 1 5 Pet it io ne rs rep orte d tha t M r. Ell is ha d wag e in co m e fro m Aven ti s 1 4 Ph arm aceu ti cal s o f $2 5,7 13 an d C ST of $9 ,75 4, wh il e Mrs . Elli s h adwage in co m e fro m anun rel at edem

pl oyer inth e am ou ntof $ 40 ,57 9. Thi s l os s co ns is te d o f th e $ 1,7 99 all oc ab le to Mr. Ell is an d the $4 50 1 5 al lo cab le to Mrs . Elli s o utof C DJ’s n etlo ss of $ 3,5 98 fortax y ear 2 00 5. (co nt in ue d...)- 10 -

[* 10 ] On the return, p et it io ne rs als o re po rte d p en si on di st rib ut io ns of $ 32 1,2 66 bu t di d n otrep ort an y

po rti onof the se di st rib ut io ns as t ax ab le . Accor di ng ly, pe ti ti on ers rep orte d the ir g ro ss in co m e as $7 7,5 19 fortax y ear 2 00 5. Pe ti ti on ers di d n otrep ort tha t M r. Ell is ’ IRA p ur ch as eda to ta l o f 98 0,0 00 m em be rs hi p u ni ts of CST in tax y ear 2 00 5. Pe ti ti on ers li ke wis e d idno t d is cl os e th atCST, anen ti ty th atha d p ai d c om

pe ns at io n t o M r. Ell is in20 05 , was thu s o wne d p rimaril y by his IRA. II. Tax Year 2 00 6 A. CST andCDJ Op erat io ns On J anua ry

1, 2 00 6, CS T ent eredin to anag reem en t t o l eas e th e Harri so nv il le pa rcel fro m CDJ fr om

Jan ua ry 1, 2 00 6, t o J anua ry

1, 2 01 6. CS T us edth is real est at e to op erat e it s u se d c ar b us in es s. Thro ug ho uttax y ear 2 00 6 CST m ad e m on th ly rentpa ym en ts to CDJ fo r us e o f th e Harri so nv il le pa rcel as i t op erat edit s u se d c ar b us in es s. Th es e ren t p aym en ts to ta le d $ 21 ,80 0 fo r ta x year 20 06 . Als o dur in g t ax y ear 2 00 6 C ST pa id$2 9,2 63 of c om pe ns at io n t o M r. Ell is fo r hi s ro le as g en eral m an ag er o f CST i n o pe rat io n o f it s u se d c ar b us in es s. Bo th (...co nt in ue d) 1 5 Pet it io ne rs ’ Sch edul e A, Ite m iz edDedu ct io ns , di d n otrefl ectan y leg al fees as a n ex pe ns e p ai d fo r th e p ro du ct io n o f in co m e.- 11 -

[* 11 ] th e ren t p aym en ts to CDJ andth e co m pe ns at io n p aym en ts to Mr. Ell is were m ad e fro m

CST’s co rp or at e ch eck in g a cco un t an d n otfro m th e cu st od ia l ac co un t of Mr. Ell is ’ IRA. On o r be fo re J ul y

6, 2 00 7, CS T fil edit s co rp or at e in co m e ta x re turnfortax y ear 2 00 6. Onth is return C ST cla im eda de du ct io n fr om co rp or at e in co m e fo r co m pe ns at io n p ai d t o c or

po rat e o ffi cers , con si st in g o nl y of t he $2 9,2 63 pa idto Mr. Ell is . On o r be fo re the same dat e, a p artne rs hi p i nf orm at io n re tu rnwas fi le d on be ha lf o f CDJfortax y ear 2 00 6. Th e fi rs t p ag e o f th is return re po rte d z ero in co m e an d c la im edzero de du ct io ns . Howev er, the form lat er re po rte d n etren ta l in co m e fro m

real est at e o f $8 30 , subjec t t o the fol lo win g a ll oc at io n t o the
m em be rs of C DJ: $4 14 to Terry Ell is , $1 04 to Sh ei laEll is , and$1 04 each to pe ti ti on ers ’ th ree c hi ldren , Chr is to ph er, Do ug la s, an d J am ie . B. Pet it io ne rs ’ 20 06 Return On o r ab ou t Jul y

6, 2 00 7, p et it io ne rs fil edth ei r joi ntFed eral in co m e ta x return fo r ta x year 20 06 . Peti ti on ers di d n ot , bef or e Apr il 15 , 20 07 , fil e a reque st fo r ex te ns io n o f ti m e to fil e. Pet it io ne rs rep orte d the ir t ot al in co m e to be $7 2,7 05 fo r ta x year 20 06 . Peti ti on ers rep orte d tha t M r. Ell is ha d wag e in co m e fro m CST of $2 9,2 63 , whi le Mrs . Elli s h adwage in co m e fro m anun rel at edem

pl oyer of $4 1,9 67 . Peti ti on ers als o re po rte d tha t the y ha d t ax ab le refu nd s o f St at e an d l oc al- 12 -

[* 12 ] in co m e ta xe s o f $8 63 , pen si on in co m e to Mr. Ell is fro m T. Rowe Pr ic e o f $9 3, an d S ch edul e E in co m e fro m CDJ o f $5 19 . 1 6 1 7 Pet it io ne rs di d n otrep ort an y pe ns io n i nc om e o th er tha n the $9 3 fr om T. Ro we Pri ce. Pet it io ne rs ag ai n d idno t d is cl os e th atCST, anen ti ty tha t h adpa id co m pe ns at io n t o M r. Ell is in20 05 , was o wne d p rimaril y by his IRA. III. The Not ic e o f Defi ci en cy On M arch 28 , 20 11 , res po nd en t i ss ue d t o p et it io ne rs a no ti ce o f de fic ie nc y fo r ta x years 2 00 5 a nd20 06 . This no ti ce re fle ct edres po nd en t’s d et erm in at io n o f a de fic ie nc y

inin co m e ta x o f $1 35 ,93 6 fo r ta x year 20 05 , or, i n the alt ern at iv e, a de fic ie nc y

inin co m e ta x o f $1 33 ,06 7 fo r ta x year 20 06 . The n ot ic e fu rth er refl ect edres po nd en t’s d et erm in at io n t o i m po se on pe ti ti on ers anaccu racy-rela te d pe na lty un de r se ct io n 6 66 2( a) o f $2 7,1 87 fortax y ear 2 00 5, o r, inth e al te rn at iv e, $2 6,6 13 fortax y ear 2 00 6. Th e n ot ic e al so refl ect edres po nd en t’s d et erm in at io n o f

Pet it io ne rs als o re po rte d the ir l iabi li ty for anearl y di st rib ut io n t ax un de r 1 6 se c. 72 (t) of $ 9 (1 0% o f $9 3) . Thi s i nc om e co ns is te d o f th e $ 41 5 a ll oc ab le to Mr. Ell is an d the $1 04 1 7 al lo cab le to Mrs . Elli s o utof C DJ’s n etin co m e o f $8 30 fortax y ear 2 00 5.- 13 -

[* 13 ] anad di ti on to tax forfai lu re t o t im el y fil e a return u nd er s ect io n 6 65 1( a)(1 ) of $1 9,7 31 fortax y ear 2 00 6. 1 8 Res po nd en t’s d et erm in at io ns inth e n ot ic e o f de fic ie nc y were b as edon th e pr em is e th atat o ne of afew al te rn at iv e p oi nt s dur in g t ax y ears 20 05 an d 2 00 6, M r. Ell is en ga ge d i n apro hi bi te d tran sa ct io n u nd er s ect io n 4 97 5 wi th hi s IRA. Res po nd en t fu rth er d et erm in edth atas o f th e fi rs t d ay of t he tax ab le y ear i n wh ic h th e p ro hi bi te d tran sa ct io n o ccu rred , Mr. Ell is ’ IRA cea se d t o b e an“ el ig ib le ret ire m en t p lan” un de r se ct io n 4 02 an d the fai r m ark etva lu e o f th e IRA was de em eddi strib ut edto hi m on th e fi rs t d ay

of t ha t t ax ab le y ear u nd er s ect io n 4 08 . Res po nd en t d et erm in edth ata pr oh ib it edtra ns act io n u nd er s ect io n 4 97 5 oc cu rredat o ne of t he fol lo win g p oi nt s: (1) when Mr. Ell is cau se d h is IRA to en ga ge inth e sa le an d e xc ha ng e o f m em be rs hi p i nt eres ts inCST in tax y ear 2 00 5; (2 ) whe n M r. Ell is cau se d C ST, an e nt ity own edby his IRA, to pa y hi m co m pe ns at io n i n t ax y ear 2 00 5; (3) when Mr. Ell is cau se d C ST, an e nt ity own ed by his IRA, to pa y

hi m co m pe ns at io n i n t ax y ear 2 00 6; or ( 4) when Mr. Ell is

Pet it io ne rs ’ return a s o rig in al ly file d re fle ct edanov erp aym en t o f $1 ,52 7 1 8 fo r ta x year 20 06 . Res po nd en t h as ass ert edth atpe ti ti on ers wil l b e li ab le forth e ad di ti on to tax un de r se c. 66 51 (a)( 1) on ly to the ex te ntth e Co urt d et erm in es a de fic ie nc y

fortax y ear 2 00 6.- 14 -

[* 14 ] cau se d C ST, an e nt ity own edby his IRA, to en te r in to a le as e ag reem en t with C DJ, anen ti ty owne d b y bo th pe ti ti on ers an d the ir c hi ldrenintax y ear 2 00 6. The no ti ce o f de fic ie nc y

als o re fle ct edres po nd en t’s d et erm in at io n tha t, fo r th e y ear i n wh ic h the pro hi bi te d tran sa ct io n o ccu rredpe ti ti on ers are l iabl e fo r th e ad di ti on al tax un de r se ct io n 7 2( t) f orearl y di st rib ut io ns fro m

a qu al ifi ed ret ire m en t p lan. On J un e 1 , 20 11 , pet it io ne rs fil eda pe ti ti on inth is Co urt fo r rev ie w of res po nd en t’s d et erm in at io ns with re sp ectto tax y ears 20 05 an d 2 00 6. Dis cu ss io n I. Sect io n 4 97 5 A. Intro du ct io n Sect io n 4 97 5 s et s fo rth cert ai n p ro hi bi te d tran sa ct io ns with re sp ectto a qu al ifi edret ire m en t p lan, i nc lu di ng anIRA d es cri be d i n s ect io n 4 08 (a). Sec ti on 49 75 (c) d efi ne s the se pro hi bi te d tran sa ct io ns as a ny dir ector i nd ire ct : (1 ) sa le or ex ch an ge , or l eas in g, o f an y pro pe rty betweena pl anan d adi squa li fie d p ers on ; (2 ) le nd in g o f m on ey

or o th er ex te ns io n o f cred itbe twee n apl anan d adi squa li fie d pe rs on ; (3 ) fu rn is hi ng of g oo ds , servi ces , or fa ci li ti es be twee n apl anan d a di squa li fie d p ers on ; (4 ) tr an sf er t o, o r us e b y

or f orth e b en efi t o f, a d is qu al ifi ed pe rs on of t he in co m e o r as se ts of apl an ; (5 ) actby a dis qu al ifi edpe rs on who is a- 15 -

[* 15 ] fiduc iary

wher eb y he de al s wi th th e in co m e o r as se ts of apl aninhi s o wn in te res ts or f

orhi s o wn ac co un t; or ( 6) rece ip t o f any co ns id erat io n fo r hi s o wn pe rs on al acco un t b y

an y di squa li fie d p ers on who is a fi du ci ary fro m an y pa rty de al in g wi th th e p lan i n c on ne ct io n wi th a tr an sa ct io n i nv ol vi ng th e in co m e o r as se ts of t he pl an . Thes e enum erat edpro hi bi te d tran sa ct io ns are n otm utua ll y ex cl us iv e; on e tr an sa ct io n m ay fal l wi th in th e p aram et ers of m or e th anon e o f th e id en ti fie d tran sa ct io ns un de r se ct io n 4 97 5. J anpo l v . Comm is si on er, 1 01 T.C. 51 8, 52 5 (1 99 3) . The pu rp os e o f se ct io n 4 97 5, i n p art , is to pre ve nttax pay ers in vo lv edina qu al ifi edret ire m en t p lan fr om us in g the pl anto en ga ge intra ns act io ns for th ei r own acco un t tha t co ul d p la ce p lan a ss et s an d i nc om e atris k o f lo ss be fo re ret ire m en t. See ge ne ral ly sec. 4 97 5; S. Rep t. No . 93 -3 83 (19 74 ),19 74 -3 C.B. (Supp .) 80 ; H.R. Re pt . No. 9 3- 80 7 (1 97 4) , 19 74 -3 C.B. (Supp .) 23 6. Th e enum erat edtra ns act io ns setforth insec ti on 49 75 are m ean t t o e xh ib itpe r se ex am pl es of t hi s k in d o f se lf- de al in g, an d p art ic ip at io n i n s uc h p ro hi bi te d tra ns act io ns is jus t tha t -- pro hi bi te d. Se e Lei b v . Comm is si on er, 8 8 T.C. 1 47 4, 14 81 (19 87 ). The fa ctth ata tr an sa ct io n wo ul d qua li fy as apru de ntin ve st m en t whe n ju dg edun de r th e h ig he stfiduc iary st an da rd s i s o f no co ns eque nc e. Id .- 16 -

[* 16 ] B. Fiduc iary

an d Di squa li fie d P ers onSta tu s Fo r th e p ur

po se s o f se ct io n 4 97 5, a f iduc iary is de fin edas a ny pers on who : (1 ) ex erci se s an y

di sc ret io na ry

au th or ity or d is cret io na ry

co nt ro l re sp ect in g m an ag em en t o f su chpl anor e xe rci se s an y au th or ity or c on tro l re sp ect in g m an ag em en t o r di sp os it io n o f it s as se ts ; (2 ) ren de rs in ve st m en t ad vi ce fo r a fee or ot he r co m

pe ns at io n, d ire ctor i nd ire ct , with re sp ectto an y m on ey s o r ot he r pr op erty of s uc h p lan, o r ha s an y

au th or ity or r es po ns ib il ity

to do so ; o r (3 ) ha s an y di sc ret io nary

au th or ity or d is cret io na ry

res po ns ib il ity

inth e adm in is tra ti on of su chpl an . Sec. 4 97 5( e)(3 ). Furth er, a fi du ci ary with re sp ectto a qu al ifi ed ret ire m en t p lan i s al so a di squa li fie d p ers on forth e p ur po se s o f se ct io n 4 97 5. Se c. 49 75 (e)( 2) (A). Mr. Ell is cert ai nl y

ex erci se d d is cret io nary

au th or ity ov er h is IRA an d li ke wis e ex erci se d c on tro l o ve r th e d is po si ti on of i ts ass et s. Mr . Elli s s eed edhi s pl aninJu ne of 2 00 5 wi thth e p ro ceed s fr om hi s s ect io n 4 01 (k ) pl anacco un t wi th hi s fo rm er em

pl oyer. Mr. Ell is th enex ert edco ntro l o ve r hi s IRA incau si ng itto en ga ge inth e p ur ch as e o f m em be rs hi p u ni ts of C ST. Acco rd in gl y , Mr. Ell is was a fi du ci ary of

hi s IRA withi n the m ean in g o f se ct io n 4 97 5 a ndco ns eque nt ly a di squa li fie d p ers on with re sp ectto th atpl an .- 17 -

[* 17 ] C. Fo rm at io n o f CST As p rev io us ly stat ed , sec ti on 49 75 pro hi bi ts an y di rector i nd ire ctsal e o r ex ch an ge of a ny pro pe rty betweena pl anan d adi squa li fie d p ers on . Sec. 49 75 (c)( 1) (A). Inad di ti on to a fi du ci ary as de fin edab ov e, th e te rm “ di squa li fie d pe rs on ” und er s ect io n 4 97 5( e)(2 ) al so in cl ud es a co rp or at io n o r a p artne rs hi p o f whi ch50 % or m or e o f (1 ) th e co m bi ne d v ot in g p owe r of

all cla ss es of s to ck en ti tl edto vo te or t he to ta l v al ue of s ha res of a ll cla ss es of s to ckof aco rp or at io n, or(2) th e cap it al in te res t o r pr of it s i nt eres t o f a p artne rs hi p, i s o wne d d ire ct ly or in di rect ly or he ldby a fiduc iary as d es cri be d i n s ect io n 4 97 5( e)(2 )(A). Sec . 49 75 (e)( 2) (G). Sect io n 4 97 5( e)(4 ) in co rp or at es th e co ns tru ct iv e o wne rs hi p ru le of se ct io n 2 67 (c)( 1) , whi chpro vi de s tha t “ [s ]toc k o wne d, d ire ct ly or in di rect ly, by or fo r a co rp or at io n, p artne rs hi p, es ta te , or tru stsh al l b e co ns id eredas b ei ng own ed pr op orti on at el y

by or fo r it s s ha reh ol de rs , partn ers , or b en efi ci ari es ”. Pet it io ne rs arg ue th atMr. Ell is di d n oten ga ge ina pr oh ib it edtra ns act io n b y cau si ng hi s IRA to in ve stinCST. Pet it io ne rs rel y onSwan so n v . Comm is si on er, 10 6 T.C. 7 6, 8 8 (1 99 6) , to sh ow tha t CS T was n ota di squa li fie d p ers on at t he ti m e th e in ve st m en t was m ad e. InSwan so n, the tax pa y er o rg an iz eda do m es ti c- 18 -

[* 18 ] in te rn at io na l s al es co rp or at io n kn own as S wan so n’s Worl dwi de , Inc . 1 9 (World wid e). The tax pa y er the n e st ab li sh edanIRA atFlo rid a Nat io na l Ba nkan d subs eque nt ly execu te d asubs cri pt io n a gr eem en t fo r th e ex ch an ge of I RA fu nd s fo r 2,5 00 sh ares of Worl dwi de ori gi na l i ss ue st oc k. Th e Co urt s ta te d tha t a

“ co rp or at io n wi th ou t s ha res or s ha reh ol de rs do es no t fi t wi th in th e d efi ni ti on of a di squa li fie d p ers on un de r se ct io n 4 97 5( e)(2 )(G).” Id . The Co urt co nc lu de d tha t i t was on ly after Worl dwi de is su edit s s to ckto th e ta xp ay er’s IRA tha t Worl dwi de ha d b eco m e a d is qu al ifi edpe rs on un de r se ct io n 4 97 5( e)(2 )(G). The Co urt fi nd s i n thi s co nt ex t tha t anLLC th atele ct s t o b e tr eat edas a co rp or at io n anddo es no t yet ha ve m em be rs or m em

be rs hi p i nt eres ts is su ffi ci en tl y an al og ou s t o a“ co rp or at io n wi th ou t s ha res or s ha reh ol de rs ”. Mr. Ell is org an iz ed CST wit ho uttak in g a ny owne rs hi p i nt eres t i n the co m pany. In the ori gi na l 2 0 op erat in g a gr eem en t, d at edMay 25, 2 00 5, M r. Ell is ’ IRA i s s ho wn as anin ve st in g m em be r with a98 % own ers hi p i nt eres t i n C ST inex ch an ge foranin it ia l capi ta l co nt rib ut io n o f $3 19 ,50 0. Mr . Elli s’ IRA was subs eque nt ly creat edon June 7,

Dom es ti c in te rn at io na l s al es co rp or at io n i s co m m on ly referre d t o a s 1 9 “ DISC” . Und er Mo . Rev . Stat. s ec. 3 47 .03 7 (2 01 2) , “ [a]ny pe rs on , whet he r or no t a 2 0 m em be r orm an ag er, m ay

form a li m it edli ab il ity

co m pa ny by si gn in g a ndfil in g art ic le s o f in co rp or at io n fo r su chli m it edli ab il ity co m pa ny with th e se cret ary. ”- 19 -

[* 19 ] 20 05 , andth e in it ia l capi ta l co nt rib ut io n was effe ct edth ro ug h the tra ns fer o f fund s t o C ST inpa ym en ts of $ 25 4,0 00 an d $ 65 ,50 0 o n J un e 2 3 a ndAug us t 2 3, 20 05 , res pe ct iv el y . The en d re su ltof t hi s tran sa ct io n was th e cre at io n o f a n ew en ti ty, CST, with M r. Ell is ’ IRA as a fo un di ng m em be r with a98 % own ers hi p in te res t. CST h adno ou ts tand in g o wne rs or o wne rs hi p i nt eres ts be fo re the in it ia l cap it al co nt rib ut io n a ndth eref or e co ul d n otbe a di squa li fie d p ers on at the ti m e o f th e in ve st m en t b y

Mr. Ell is ’ IRA. Acco rd in gl y , pet it io ne rs di d n oten ga ge ina pr oh ib it edtra ns act io n wh enth ey cau se d M r. Ell is ’ IRA t o i nv es t i n C ST. 2 1 D. Com pe ns at io n p ai d b y

CST to Mr. Ell is The di rector i nd ire cttra ns fer t o, o r us e b y or f orth e b en efi t o f, a di squa li fie d p ers on of t he in co m e o r as se ts of apl anis a pr oh ib it edtra ns act io n un de r se ct io n 4 97 5( c)(1 )(D). Si m il arl y , an a ctby a dis qu al ifi edpe rs on who is a fiduc iary wher eb y he di rect ly or in di rect ly deal s wi th th e in co m e o r as se ts of a pl aninhi s o wn i nt eres t o r fo r hi s o wn ac co un t i s a p ro hi bi te d tran sa ct io n u nd er se ct io n 4 97 5( c)(1 )(E).
Res po nd en t h as als o a rg ue d tha t M r. Ell is en ga ge d i n apro hi bi te d 2 1 tra ns act io n wh enhe cau se d h is IRA to in ve stinCST b ecau se th e in ve stm en t was m ad e as part o f anarrang em en t wh ereb y itwas e xp ect edth ata pr oh ib it ed tra ns act io n wo ul d l at er o ccu r un de r se c. 49 75 (c)( 1) (D) o r (E). Inli gh t o f th e fo ll owi ng an al y si s, the Co urt fi nd s i t u nn eces sa ry to ad dr es s the se arg um en ts at th is ti m e.- 20 -

[* 20 ] As d et ai le d abo ve , Mr. Ell is was afiduc iary of h is IRA an d the refo re a di squa li fie d p ers on . In ad di ti on , Mr. Ell is was the so le in di vi du al forwho se be ne fitth e IRA was est ab li sh edan d the refo re the be ne fic ia l o wne r of 98 % of t he ou ts tand in g m em

be rs hi p i nt eres ts of C ST. See s ecs . 49 75 (e)( 4) , 26 7( c)(1 ). Bec au se Mr. Ell is , a fiduc iary of h is IRA, was th e b en efi ci al sh areh ol de r of m or e th an50 % of t he ou ts tand in g o wne rs hi p i nt eres t i n C ST, CST m etth e d efi ni ti on of a d is qu al ifi edpe rs on un de r se ct io n 4 97 5( e)(2 )(G). See Swan so n v . Co m m is si on er, 1 06 T.C. at 8 8 n .15 . Dur in g t ax y ear 2 00 5 C ST pa id$9 ,75 4 t o M r. Ell is . On CST’s co rp or at e in co m e ta x re tu rnfortax y ear 2 00 5, thi s amoun t i s re fle ct edas o ffi cer co m pe ns at io n. Se ct io n 2 .3 o f th e o pe rat in g a gr eem en t fo r CST s ta te s tha t “ th e Gen eral Man ag er s ha ll be en ti tl edto su chGuar an te edPaym en t as is ap pr ov edby th e m em be rs .” It i s u nc le ar wh ethe r Mr. El li s was is su edco m pe ns at io n u nd er thi s gu aran te edpa ym en t p ro vi si on or a s wag es . Howev er, as th e fi du ci ary of hi s IRA-- a m em be r of CST with 9 8% o f th e o ut st an di ng own ers hi p i nt eres t-- an d the ge ne ral
m an ag er o f CST, Mr. El li s u lt im at el y ha d d is cret io na ry

au th or ity to de te rm in e th e am ountof h is co m

pe ns at io n a ndeffe ctit s i ss uanc e in eit he r ci rcu m st an ce. Pet it io ne rs arg ue th atMr. Ell is di d n oten ga ge ina pr oh ib it edtra ns act io n whe n h e cau se d C ST to pay hi m co m pe ns at io n b ecau se th e am ou nt s i t p ai d t o h im- 21 -

[* 21 ] di d n otco ns is t o f pl anin co m e o r as se ts of h is IRA b utm erel y th e in co m e o r as se ts of aco m

pa ny in wh ic h h is IRA h adin ve st ed . Howev er, CST was fun de d al m os t ex cl us iv el y

by the ass et s o f Mr. El li s’ IRA. Furth erm or e, th e as se ts of M r. Ell is ’ IRA co ns is te d o nl y of i ts own ers hi p i nt eres t i n C ST, val ue d at $ 31 9,4 80 , an d $ 1,7 73 incas h. To say tha t CS T was m erel y a co m pa ny in wh ic h M r. Ell is ’ IRA i nv es te d i s a c om

pl et e m is ch arac te riz at io n wh eninreal ity CST an d M r. Ell is ’ IRA were subs tant ia ll y

th e sa m e en ti ty. In c au si ng CST to pa y hi m co m pe ns at io n, Mr. Ell is en ga ge d i n the tra ns fer o f pl anin co m e o r as se ts forhi s o wn b en efi t i n vi ol at io n o f se ct io n 4 97 5( c)(1 )(D). Fu rth erm or e, in au th or iz in g a ndeffe ct in g thi s tra ns fer, M r. Ell is de al t wi th th e in co m e o r as se ts of h is IRA fo r hi s o wn i nt eres t o r fo r hi s o wn ac co un t i n v io la ti on of s ect io n 4 97 5( c)(1 )(E). Pet it io ne rs als o arg ue th atsec ti on 49 75 (d )(1 0) ex em pt s the pa ym en t o f co m pe ns at io n b y

CST to Mr. Ell is intax y ear 2 00 5 fr om be in g c la ss ifi edas a pr oh ib it edtra ns act io n. Th atsec ti on pro vi de s tha t the pro hi bi te d tran sa ct io ns set fo rth un de r se ct io n 4 97 5( c) s ha ll no t ap pl y to rece ip t b y

a di squa li fie d p ers on of an y reas on ab le co m

pe ns at io n fo r se rv ic es ren de red , or fo r th e rei m bu rs em en t o f ex pe ns es pro pe rly andactua ll y in cu rred , inth e p erfo rm an ce o f hi s dut ie s wi th th e pl an . Howev er, the am ou nt s C ST pa idas c om pe ns at io n t o M r. Ell is were n otfor se rv ic es pro vi de d i n the adm in is tra ti on of aqu al ifi edret ire m en t p lan i n m an ag in g- 22 -

[* 22 ] it s i nv es tm en ts , bu t ra th er fo r hi s ro le as g en eral m an ag er o f CST i n co nn ect io n wi th it s u se d c ar b us in es s. Acco rd in gl y , sec ti on 49 75 (d )(1 0) do es no t ap pl y . See Lo wenv. To wer Ass etMg m t., In c., 82 9 F .2d12 09 , 12 16 (2dCir . 19 87 ) (fi nd in g tha t s ect io n 4 08 (c)( 2) of t he Em pl oyee Ret ire m en t In co m e Sec ur ity Act o f 19 74 (ERISA), the pa ral le l p ro vi si on to sec ti on49 75 (d )(1 0) , exe m pt s the fees an d c om

pe ns at io n p ai d p ur su an t t o apl an ’s in ve st m en t m an ag em en t ag reem en t, b utno t o th er co m pe ns at io n fr om

co m pa ni es inwhi chth e p lan i s in ve st ed ). 2 2 Iness en ce, Mr . Elli s fo rm ul at eda pl aninwhi chhe wou ldus e h is ret ire m en t sa vi ng s as st artup cap it al fora us edcar b us in es s. Mr . Elli s wo ul d o pe rat e th is bu si ne ss an d u se itas h is pri m ary so ur ce o f in co m e b y pay in g h im se lf co m pe ns at io n fo r hi s ro le init s d ay -to -d ay op erat io n. Mr . Elli s ef

fect edth is pl an by est ab li sh in g the us edcar b us in es s as anin ve st m en t o f hi s IRA, att em pt in g t o pr es erv e th e in te gr ity

of t he IRA as a qu al ifi edret ire m en t p lan. Ho wev er, thi s i s pr eci se ly the ki ndof s el f-d eal in g tha t s ect io n 4 97 5 was en act edto pre ve nt . For
The Co urt h as pre vi ou sl y fou ndth atto th e m ax im

um ex te ntpo ss ib le th e 2 2 pr oh ib it edtra ns act io n ru le s ar e id en ti cal inth e labo r an d t ax pro vi si on s, s o the y wil l ap pl y

inth e sa m e m an ne r to th e sam e tr an sa ct io n. Thus , th e cas el aw in te rp ret in g ERI SA is in st ru ct iv e wit h re ga rdto in te rp ret in g the pro hi bi ti ve tra ns act io ns un de r se c. 49 75 . See Lei b v . Commis si on er, 8 8 T.C. 1 47 4, 1 48 0- 14 81 (19 87 ).- 23 -

[* 23 ] th e fo reg oi ng reas on s, the Co urt s us ta in s re sp on de nt ’s det erm in at io n tha t Mr. Ell is en ga ge d i n p ro hi bi te d tran sa ct io ns un de r se ct io n 4 97 5( c)(1 )(D) an d (E) whe n h e cau se d C ST to pay hi m co m pe ns at io n o f $9 ,75 4 i n t ax y ear 2 00 5. 2 3 2 4 II. Effectof t he Pro hi bi te d Tra ns act io n A. Incl us io n i n Gro ss Inc om e If, dur in g a ny tax ab le y ear o f anin di vi du al forwho se be ne fitan y IRA is es tabl is he d, tha t i nd iv idua l o r hi s b en efi ci ary en ga ge s i n apro hi bi te d tran sa ct io n un de r se ct io n 4 97 5, the acco un t wi ll ceas e to be anIRA as of t he fir stda y of t he ta xabl e y ear. Se c. 40 8( e)(2 )(A). Insu cha cas e, th e IRA i n que st io n wi ll no lo ng er b e ex em

ptfro m tax un de r se ct io n 4 08 (e)( 1) . Furt he r, whe re s uc h a n acco un t ce as es to be anIRA b y reas on of s ect io n 4 08 (e)( 2) (A), th e acc ou ntis de em edto have be endi strib ut edon th e fi rs t d ay of the tax ab le y ear i n a n a m ou nt equa l t o the fai r m ark etva lu e o f al l the ass et s o f th e acc ou nton th atfir stda y . Sec. 40 8( e)(2 )(B) ; s ec. 1 .40 8- 4( d) (1 ), In co m e Tax Reg s.
Si nc e th e Co urt h as de te rm in edth ata pr oh ib it edtra ns act io n o ccurredin 2 3 ta x year 20 05 , itis un ne ces sary to co ns id er wh ethe r an y

lat er tran sa ct io ns en ga ge d in by pet it io ne rs were p ro hi bi te d u nd er s ec. 4 97 5. Unl ik e th is cas e, th e Co urt i n P eekv. Co m m is si on er, 1 40 T.C. __ , __(sl ip 2 4 op . at 3 n.2 ) (Ma y

9, 2 01 3) , con cl ud editdi d n otne edto reac h the ad di ti on al qu es ti on of wh ethe r pr oh ib it edtra ns act io ns oc curredun de r se cs . 49 75 (c)( 1) (D) an d (E) when th e co m

pa ny m ad e p aym en ts of wa ge s t o the tax pa y ers .- 24 -

[* 24 ] Sect io n 6 1( a) d efi ne s g ro ss in co m e as all in co m e fro m what ev er s ou rce de riv ed , in cl ud in g (b utno t l im it edto ) an nu it ie s an d p en si on s. See sec . 61 (a)( 9) , (1 1) . Sect io n 4 08 (d )(1 ) pr ov id es : “ Exc ep t as othe rwis e p ro vi de d i n thi s subs ect io n, an y

am ountpa idor d is tri bu te d o utof an i nd iv idua l re ti rem en t p lan sh al l b e in cl ud edingro ss in co m e b y th e p ay ee o r di st rib ut ee, as th e cas e m ay be , in th e m an ne r pr ov id edun de r se ct io n 7 2.” See Arn ol d v . Commis si on er, 1 11 T.C. 25 0, 2 53 (19 98 ); s ec. 1 .40 8- 4( a), In co m e Tax Reg s. As d et ai le d abo ve , pet it io ne rs en ga ge d i n apro hi bi te d tran sa ct io n u nd er se ct io n 4 97 5 i n t ax y ear 2 00 5. Acco rd in gl y , th e en ti re am ountof $ 32 1,3 66 .25 co nv ert edfro m

Mr. Ell is ’ se ct io n 4 01 (k ) pl anacco un t i s d eem eddi st rib ut edon Ja nu ary 1, 2 00 5, u nd er s ect io n 4 08 (e)( 2) (A). Thatam ountis th eref or e in cl ud ib le in pe ti ti on ers ’ gr os s i nc om e fo r ta x year 20 05 un de r se ct io ns 40 8( d) (1 ) an d 7 2( a). Bec au se res po nd en t d et erm in edalt ern at iv e d efi ci en ci es fortax y ears 20 05 an d 20 06 , pet it io ne rs are the refo re n otli ab le forres po nd en t’s d et erm in at io ns with res pe ctto tax y ear 2 00 6. 2 5

Thi s i nc lu de s the en ti re d efi ci en cy as we ll as t he ass oc iate d a dd it io n t o t ax 2 5 un de r se c. 66 51 (a)( 1) an d the accu racy-rela te d p en al ty und er s ec. 6 66 2( a).- 25 -

[* 25 ] B. Sect io n 7 2( t) Sect io n 7 2( t) p ro vi de s fo r a 1 0% a dd it io na l t ax on earl y di st rib ut io ns fro m qu al ifi edret ire m en t p lans un le ss th e d is tri bu ti on fal ls withi n ast atut ory ex em pt io n. Th e m os t co m

m on of t he se ex em

pt io ns in cl ud e d is tri bu ti on s tha t ar e m ad e o n o r aft er the da te on whi chth e ta xp ay er at ta in s ag e 5 91⁄2 an d d is tri bu ti on s th atare at tri bu tabl e to th e ta xp ay er’s b ei ng di sabl ed . Sec. 7 2( t). The pa rti es ha ve st ip ul at edth atMr. Ell is ha d n otatt ai ne d the ag e o f 59 1⁄2 b y Ja nu ary 1, 2 00 5. Pe ti ti on ers all eg e n o o th er ex em pt io n u nd er wh ic h the y

wou ld es cap e th e ad di ti on al tax im po se d b y sec ti on 72 (t) . Accor di ng ly, pe ti ti on ers are li ab le forth e 1 0% a dd it io na l t ax on th e $ 32 1,3 66 .25 de em eddi st rib ut io n fo r ta x y ear 2 00 5. III. Sec ti on 66 62 (a) Pe na lty Sect io n 6 66 2( a) an d (b )(1 ) an d (2 ) im po se s an accu racy-rela te d p en al ty equa l t o 2 0% o f anun de rp aym en t at tri bu tabl e to an y subs tant ia l u nd ers ta te m en t o f in co m e ta x o r to ne gl ig en ce o r di sr eg ardof rul es or r eg ul at io ns . Und er s ect io n 74 91 (c), the Co m

m is si on er h as th e b ur de n o f pr oduc ti on to sh ow tha t the im po si ti on of ape na lty

un de r se ct io n 6 66 2( a) i s ap pr op ria te . Sect io n 6 66 2( d) de fin es a “ subs tant ia l u nd ers ta te m en t o f in co m e ta x” as a n un de rs ta te m en t tha t ex ceed s the gre at er o f: (1 ) 10 % of the am ou ntof t ax requi red- 26 -

[* 26 ] to be sh own on th e return, o r (2 ) $5 ,00 0. “Neg li ge nc e” i nc lu de s an y fai lu re to m ak e a rea so nabl e at te m ptto co m pl y with the pro vi si on s o f th e Co de , and

“ di sr eg ard ” in cl ud es an y

care le ss , reck le ss , or i nt en ti on al di sr eg ardof rul es or reg ul at io ns . Sec. 6 66 2( c). On the ir 2 00 5 t ax return p et it io ne rs rep orte d t ot al in co m e ta x due of $ 4,9 86 . Res po nd en t h as de m on st rat edth atth e am ountof t ax requi redto be sh ownon pe ti ti on ers ’ 20 05 return was $1 40 ,92 2. Pet it io ne rs ’ un de rs ta te m en t o f $1 35 ,93 6 2 6 is th eref or e g reat er tha n 1 0% o f th e ta x re qu ire d t o b e sh own on th e return, wh ic h is gre at er than $ 5,0 00 . Accor di ng ly, res po nd en t h as m ethi s b ur de n o f pr oduc ti on un de r se ct io n 7 49 1( c). No p en al ty w il l b e im

po se d u nd er s ect io n 6 66 2( a) i f th e ta xp ay er es tabl is he s th athe act edwith re as on ab le cau se an d i n g oo d fa ith. Se c. 66 64 (c)( 1) . Ci rcu m st an ces th atin di cat e rea so nabl e cau se an d g oo d fa ith i nc lu de rel ianc e o n th e advi ce o f a t ax pro fes si on al or a n h on es t m is un de rs tand in g o f th e la w th atis reas on ab le inli gh t o f al l the fact s an d c irc um st an ces . Sec. 1 .66 64 -4 (b ), In co m e Tax Reg s. Th e ta xp ay er h as th e b ur de n o f pr ov in g tha t h e act edwith re as on ab le cau se an d i n g oo d fa ith. Ru le 14 2( a); Hig be e v . Comm is si on er, 1 16 T.C. 43 8, 44 6- 44 7 (2 00 1) . Reg ul at io ns pro m ul ga te d u nd er s ect io n 6 66 4( c) fu rth er p ro vi de Thi s amoun t i nc lu de s the ad di ti on al tax of $ 32 ,13 7 u nd er s ec. 7 2( t). 2 6- 27 -

[* 27 ] th atth e d et erm in at io n o f rea so nabl e cau se an d g oo d fa ith “ is m ad e o n a cas e-b y -cas e b as is , tak in g i nt o a cco un t al l p ert in en t fa ct s an d c irc um st an ces .” Sec. 1.6 66 4- 4( b) (1 ), In co m e Tax Reg s. The pa rti es ha ve ag reedinth e st ip ul at io n o f se tt le d i ss ue s fi le d o n J un e 1 2, 20 12 , th atpe ti ti on ers ha ve no t p ro vi de d s uf fic ie ntev id en ce an d h av e n ot ot he rwis e p ro ve n re as on ab le cau se forrel ie f fro m th e p en al ty det erm in edun de r se ct io n 6 66 2( a). Acco rd in gl y , pet it io ne rs are l iabl e fo r th e se ct io n 6 66 2( a) accu racy-rela te d p en al ty for t ax y ear 2 00 5. All othe r ad

jus tm en ts fortax y ear 2 00 5 re fle ct edon pe ti ti on ers ’ no ti ce o f de fic ie nc y

are co m pu ta ti on al . The Co urt h as co ns id eredall of t he arg um en ts m ad e by the pa rti es an d, t o the ex te ntth ey are n otad dr es se d h erei n, the y are co ns id ered un ne ces sary , m oo t, i rrel ev an t, o r witho utm eri t. To re fle ctth e fo reg oi ng , An ap pr op ria te de ci si on wil l b e en te red .