T.C. Mem o. 2 01 6- 20

UNITED STAT ES TAX COURT

BRINKS GILSON & LIONE A PROFESS IONAL CORPORATION, FORM ERLY BRINKS HOFER GILSON & LIONE A PROFESSIONAL

CORPORATION, Peti ti on er v . COMM ISSI ONER OF INTERNAL REVENUE, Resp on de nt

Doc ke t No . 14 41 4- 13
. Fi le d F eb ru ary 10 , 20 16
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Held : P, anin co rp or at edlaw fi rm , li ab le foraccu racy-rela te d pe na lt ie s fo r m is ch arac te riz in g, as co m pe ns at io n fo r se rv ic es , di vi de nd s p ai d t o s ha reh ol de r at to rn ey s. P l ack edsubs ta nt ia l au th or ity forit s treat m en t o f pa ym en ts as c om pe ns at io n a ndha s fa il ed to sh ow re as on ab le cau se forth e res ul ti ng un de rp aym en ts of i nc om e ta x a ndth atP act edingo odfai th
.
Bri anT. Gale an d J ay

Howar d Zi m

bl er, fo r pe ti ti on er. Ja m es M. Cas ci no , Tracy M. Hog an , andEli zab eth Y. Will ia m s, fo r res po nd en t.- 2 -

[* 2] MEMORANDUM FINDINGS OF FACT AND OPINION HALPERN, Ju dg e: Res po nd en t d et erm in edde fic ie nc ie s o f $2 45 ,76 0 a nd $1 22 ,35 3 i n p et it io ne r's 20 07 an d 2 00 8 F ed eral in co m e ta x, re sp ect iv el y , and
accu racy-rela te d p en al ti es of $ 22 1,9 30 an d $ 20 3,1 55 forth os e y ears , res pe ct iv el y . The parti es en te redin to a st ip ul at io n o f se tt le d i ss ue s, an d t he on ly iss ue rem ai ni ng forde ci si on is whet he r pe ti ti on er i s l iabl e fo r acc ur acy-rela te d p en al ti es on un de rp aym en ts of t ax rel at in g t o a m ou nt s i t d educ te d a s o ffi cer c om pe ns at io n th atitno w agr ees were n on de du ct ib le di vi de nd s. Un le ss ot he rwis e in di cat ed , all
se ct io n re fere nc es are t o t he Int ern al Rev enue Co de ineffe ctforth e y ears inis su e, an d a ll Ru le refe ren ces are t o t he Tax C ou rt Rul es of P ract ic e an d P ro cedur e. FINDINGS OF FACT Gen eral Back gr ou ndon Pet it io ne r Pet it io ne r is anin te ll ectua l p ro pe rty law fi rm org an iz edas aco rp or at io n. Whe n i t fi le d t he pe ti ti on , itm ai nt ai ne d i ts pri nc ip al off ic es inCh ic ag o, Il li no is . It
co m pu te s i ts tax ab le in co m e o n t he ba si s o f a cal en dar y ear, u si ng th e cas h m etho d of acco un ti ng . For t he y ears inis su e, itpre paredit s fi na nc ia l s ta te m en ts on th at ba si s an d u si ng th atm etho d. Du rin g tho se y ears , item pl oyed ab ou t 1 50 att orne y s, of who m ab ou t 6 5 wer e sh areh ol de rs . It al so em pl oyed a n on at to rn ey

st aff o f- 3 -

[* 3] ab ou t 2 70 . Its bu si ne ss an d a ffai rs are m an ag edby a bo ardof d ire ct or s (b oa rd ). Owner sh ip of P et it io ne r's Sto ck Pet it io ne r's sh areh ol de rs ho ldth ei r sh ares inth e co rp or at io n i n c on ne ct io n with t he ir e m

pl oym en t b y

th e co rp or at io n a s at to rn ey s. Each sh areh ol de r at to rn ey acqui redhi s o r he r (wit ho utdi st in ct io n, h is ) sh ares at apri ce equa l t o t he ir b oo k
va lu e an d i s re qu ire d t o s el l h is sh ares ba ckto pe ti ti on er ata pr ic e d et erm in ed
un de r th e sa m e fo rm

ul a upo n t erm in at in g h is em pl oym en t. Subjec t t o m in or ex cep ti on s re la te d t o the firm 's " na m e p artne rs ", eac h s ha reh ol de r at to rn ey 's pr op orti on at e o wne rs hi p o f pe ti ti on er's sh ares (sh are- own ers hi p p erce nt ag e) equa ls hi s p ro po rti on at e sh are o f co m pe ns at io n p ai d b y

pe ti ti on er t o i ts sh areh ol de r at to rn ey s. Fo r th e y ears inis su e, as forpre vi ou s years, the bo ardset th e y earl y co m pe ns at io n t o b e p ai d t o s ha reh ol de r at to rn ey s an d t he n d et erm in ed th e ad jus tm en ts inth e sh areh ol de r at to rn ey s' s ha re-o wne rs hi p p erce nt ag es ne ces sa ry to refl ectch an ge s i n p ro po rti on at e co m pe ns at io n. Ad

jus tm en ts inactua l sh are o wne rs hi p wer e m ad e b y sh are r ed em

pt io ns an d re is su an ces . Pet it io ne r's sh areh ol de r at to rn ey s ar e en ti tl edto di vi de nd s as an d wh en de cl aredby the bo ard . For a t l eas t 1 0 years b efo re an d i nc lu di ng th e y ears in- 4 -

[* 4] is su e, ho wev er, p et it io ne r ha d n otpa ida di vi de nd . Upo n ali qu id at io n o f pe ti ti on er, i ts sh areh ol de r at to rn ey s wo ul d s ha re i n t he pro ceed s. Co m pe ns at io n M ech an ic s Fo r th e y ears inis su e, th e b oa rdm etto setco m pe ns at io n a ndsh areown ers hi p p erce nt ag es inlat e Nov em be r or earl y Decem be r of th e y ear p rece di ng th e co m pe ns at io n year. Befo re tho se m eet in gs , th e b oardset tl edon a bu dg etfor th e co m pe ns at io n year. On the ba si s o f th atbu dg et , th e b oa rdde te rm in edth e am ou ntav ai labl e fo r al l s ha reh ol de r at to rn ey co m pe ns at io n fo r th aty ear. With th atam ou ntinmin d, i t s eteach sh areh ol de r at to rn ey 's e xp ect edco m pe ns at io n us in g anu m

be r of cri te riain cl ud in g h ou rs bi ll ed , col le ct io ns , bu si ne ss ge ne rat ed , an d o th er co nt rib ut io ns to th e wel fare of t he co rp or at io n. Be fo re fi na li zi ng it s co m pe ns at io n d eci si on s, the bo ardsh aredit s es ti m at es of t ot al sh areh ol de r at to rn ey co m pe ns at io n a ndeachsh areh ol de r at to rn ey 's e xp ect edpo rti on with a ll of th e sh areh ol de r atto rn ey s. Be cau se th e b oa rd 's e st im at e o f th e am ou ntav ai labl e fo r co m pe ns at io n- y ear p aym en ts to sh areh ol de r at to rn ey s was on ly an es ti m at e, each sh areh ol de r at to rn ey rece iv eddu rin g t he co ur se of t he co m pe ns at io n year on ly a perc en ta ge of h is expe ct edco m pe ns at io n (d raw), wit h t he expe ct at io n o f
rece iv in g an a dd it io na l am ou nt(y eare ndbo nu s) at t he en d o f th e y ear. Th e b oa rd in te nd edth e su m

of the sh areh ol de r at to rn ey s' yearen d b on us es (bo nu s p oo l) t o- 5 -

[* 5] ex haus t b oo k i nc om e. W ith l im it edex cep ti on s fo r certa in ol de r, le ss act iv e sh areh ol de r at to rn ey s, s ha reh ol de r at to rn ey s s ha redinth e b on us po ol in pr op orti on to th ei r dr aws (an d, l ik ewis e, in pro po rti on to th ei r sh are- own ers hi p pe rcen ta ge s) . Spe ci fic al ly, fo r eac h o f th e y ears inis su e p et it io ne r cal cu la te d t he y eare ndbo nu s p oo l-- $8 ,98 6,6 08 in20 07 an d $ 13 ,73 6,3 31 in20 08 --t o e qu al it s bo okin co m e fo r th e y ear a fte r subt ract in g a ll ex pe ns es ot he r th anth e b onus es . Thu s, p et it io ne r's bo okin co m e was zero foreach y ear: Its in co m e st at em en ts sh owe d re ve nu e ex act ly equ al to ex pe ns es . Pet it io ne r tr eat edas e m

pl oyee co m

pe ns at io n t he am ou nt s i t p ai d t o i ts sh areh ol de r at to rn ey s, i nc lu di ng th e y eare ndbo nu se s. Inparti cu la r, pe ti ti on er withh el d app li cab le in co m e an d e m pl oym en t t ax es , pai d t he em pl oyer's s ha re o f
em pl oym en t t ax es , andfil edap pr op ria te rep orti ng form s, s uc h a s Fo rm W -2 , W ag e an d Tax Sta te m en t, an d F orm 94 1, Em pl oyer's Qu art erl y

Fed eral Tax Return. Anin de pe nd en t p ayro ll pro ces si ng firm pre pa redpe ti ti on er's Fo rm s W-2 fo r 20 07 an d 2 00 8 u si ng reco rd s an d i nf orm at io n t ha t p et it io ne r pr ov id ed
. Pet it io ne r th enpro vi de d t he Fo rm s W-2 t o M cGla dr ey & Pu ll en(McGl adrey), pe ti ti on er's acco un ti ng firm . Gary Ro ps ki , pet it io ne r's pre si de ntdu rin g the y ears in is su e, te st ifi edat t ria l tha t p et it io ne r's bo arddi d n otco ns id er atall th e Fed eral in co m e ta x i m

pa ctof p ay in g t he y eare ndbo nu se s. Mr . Rop sk i ac kn owl ed ge d,- 6 -

[* 6] ho wev er, tha t p et it io ne r's ch ie f fi na nc ia l o ffi cer, Lee Ren di no , andit s acco un ta nt s wer e res po ns ib le forco ns id eri ng th e ta x i m pa ctof p et it io ne r's act iv it ie s. Pet it io ne r's Inv es te d C ap it al Pet it io ne r ha d i nv es te d c ap it al , m eas ur edby the bo okva lu e o f it s sh areh ol de rs ' equi ty, of

ab ou t $ 8 m il li on at t he en d o f 20 07 an d abo ut$9 .3 m il li on atth e en d o f 20 08
. Pet it io ne r's ba la nc e sh eet s fo r th e y ears inis su e d o n otsh ow 1 go od wil l o r ot he r in ta ng ib le ass et s. At t ria l, p et it io ne r's ex pe rt wi tn es s, l eg al in du st ry co ns ul ta ntBrad fo rdHil de br an dt , qu es ti on edwhet he r th e g oo dwi ll of a la w firm 's b us in es s i s an ass etof t he firm or, i ns te ad , of i ts in di vi du al pa rtn ers . He op in edth atcli en ts ba se hi rin g d eci si on s o n t he rep ut at io ns of i nd iv idua l l awy ers rathe r th anth os e o f th e fi rm s atwhi chth ey pra ct ic e. Non ethe le ss , up on qu es ti on in g b y

th e Co urt, Mr . Hil de br an dtadm it te d t ha t a f irm's rep ut at io n a nd
cu st om er l is ts co ul d b e v al uabl e en ti ty-lev el ass et s, ev enth ou gh de te rm in in g t he ir pr eci se wort h m ig htbe di ffi cu lt
.

Bec au se pe ti ti on er re po rte d z ero bo okin co m e fo r 20 08 , th e in crea se in 1 sh areh ol de rs ' equi ty between20 07 an d 2 00 8 was att rib ut ab le no t t o re ta in ed earn in gs bu t i ns te adto cap it al co nt rib ut io ns an d t he ne t o f pr oc eed s o f sh are is su an ces an d a m ou nt s p ai d i n re de m pt io n.- 7 -

[* 7] Pet it io ne r's Tax R eturns forth e Years inIss ue McGl adrey pr ep aredpe ti ti on er's U.S. cor po rat e in co m e ta x re tu rn s fo r th e y ears inis su e. At tha t t im e, McGl adrey was th e fi fth lar ge stpubl ic acco un ti ng firm inth e Uni te d S ta te s an d h el d i ts el f ou t as a le ad in g p ro vi de r of acco un ti ng , ta x, an d c on su lt in g s erv ic es to m id dl e-m ark etbu si ne ss es . Peti ti on er el ectro ni cal ly fil edit s re tu rn s fo r 20 07 an d 2 00 8 i n S ep te m be r 20 08 an d 2 00 9, re sp ect iv el y . In each return, p et it io ne r in cl ud edth e y eare ndbo nu se s i t p ai d t o i ts sh areh ol de r at to rn ey s i n t he am ou ntitcla im edas ade du ct io n fo r of fic er co m pe ns at io n. Be fo re fil in g i ts return fo r eac h year, pe ti ti on er d idno t s pe ci fic al ly askMcGl adrey whe th er the ful l am ou ntof t he y eare ndbo nu se s i t p ai d t o s ha reh ol de r at to rn ey s was de du ct ib le as c om

pe ns at io n fo r se rv ic es , andMcGl adrey di d n otco m m en t o n th e d educ ti bi li ty of th e b on us es . Pet it io ne r's 20 07 return re po rte d t ot al in co m e o f $9 1,7 42 ,81 9, t ax ab le in co m e o f $5 39 ,90 2, an d t ax li ab il ity of $ 18 8,9 66 . Its 20 08 return re po rte d t ot al in co m e o f $1 07 ,01 9,8 12 , tax ab le in co m e o f $5 61 ,07 5, an d t ax li ab il ity of $1 96 ,37 6. Be cau se pe ti ti on er's bo okin co m e was zero foreach y ear, the tax ab le in co m e p et it io ne r rep orte d was att rib ut ab le en ti rel y to it em s tha t wer e tr eat ed di ffer en tl y

forbo okan d t ax pu rp os es .- 8 -

[* 8] Res po nd en t's Exam in at io ns of P et it io ne r's Returns Pet it io ne r's return fo r 20 06 , bef or e th e y ears inis su e inth e p res en t ca se , had be enex am in edby Inte rn al Rev enue Agen t Ra y Berg . Duri ng th e co ur se of tha t ex am in at io n, p et it io ne r pr ov id edbo ardm in ut es an d fi na nc ia l s ta te m en ts to Mr. Berg . Upo n t he co m

pl et io n o f th e ex am in at io n, p et it io ne r rec ei ve d alet te r advi si ng itth atno ch an ge s h adbe enm ad e to it s re po rte d t ax li ab il ity as ares ul t o f th e ex am in at io n. Whe n re sp on de ntlat er ex am in edpe ti ti on er's returns for20 07 an d 2 00 8, h e di sa ll owe d v ari ou s d educ ti on s, i nc lu di ng th e y eare ndbo nu se s p et it io ne r pa idto it s sh areh ol de r at to rn ey s. Aft er n eg ot ia ti on s, the pa rti es en te redin to a cl os in g ag reem en t tha t p ro vi de s, am on g o th er thi ng s, tha t p orti on s o f pe ti ti on er's off ic er co m pe ns at io n d educ ti on s fo r th e y ears inis su e--$ 1,6 27 ,00 0 i n 2 00 7 a nd $1 ,85 9,0 00 in20 08 --" sh ou ldbe di sa ll owe d a ndre-c ha ract eri zedas n on -d educ ti bl e di vi de nd s" . As a res ul t o f co nc es si on s tha t p et it io ne r m ad e in set tl em en t, i ts ag reedtax li ab il ity

is $1 ,29 8,6 18 for20 07 an d $ 1,2 12 ,15 2 fo r 20 08 , res ul ti ng in
un de rp aym en ts of $ 1,1 09 ,65 2 a nd$1 ,01 5,7 76 for20 07 an d 2 00 8, re sp ect iv el y . 2 The de fic ie nc ie s d et erm in edby resp on de ntwere b as edon reduc ed 2 un de rp aym en t am ou nt s b ecau se , inacco rd an ce wi th th e cl os in g a gr eem en t, res po nd en t em

pl oyed " ro ug h ju st ic e ad

jus tm en ts " tha t t ak e in to acco un t the refu nd s o f in co m e an d e m pl oym en t t ax es th atwou ldothe rwis e h av e b eendu e to (co nt in ue d...)- 9 -

[* 9] OPINION I. Bac kg ro un d Bec au se th e p art ie s' c lo si ng ag reem en t p ro vi de s tha t a p orti on of p et it io ne r's of fic er co m pe ns at io n d educ ti on s fo r th e y ears inis su e "s ho ul d b e d is al lo wedan d
re-c haract eri zedas n on -d educ ti bl e d iv id en ds ", th e d educ ti bi li ty of pe ti ti on er's y eare ndbo nu se s i s n otinis su e. The s ol e is su e rem ai ni ng forou r de ci si on is 3 whe th er p et it io ne r is li ab le foraccu racy-rela te d p en al ti es un de r se ct io n 6 66 2 o n th e und erp aym en ts of t ax rel at in g t o i ts de du ct io n o f th os e p orti on s o f th e y eare nd bo nu se s tha t i t h as no w agr eedwere n on de du ct ib le di vi de nd s. Sect io n 6 66 2( a) an d (b )(1 ) pr ov id es foranaccu racy-rela te d p en al ty of 20 % of th e p orti on of a n u nd erp aym en t o f ta x a ttrib ut ab le to ne gl ig en ce o r di sr eg ardof
ru le s an d re gu la ti on s (wi th ou t d is ti nc ti on , neg li ge nc e). Sec ti on66 62 (a) and(b) (2 ) pr ov id es forth e sa m e p en al ty on the po rti on of a n u nd erp aym en t o f ta x (...co nt inue d) 2 pe ti ti on er an d i ts sh areh ol de rs as ares ul t o f th e rec ha ract eri zat io n o f co m pe ns at io n as di vi de nd s. Sec. 1 62 (a) a ll ows a de du ct io n fo r or di na ry an d n eces sa ry

bu si ne ss 3 ex pe ns es , in cl ud in g re as on ab le all owa nc es forsal ari es . To be de du ct ib le , ho wev er, am ou nt s p ai d a s s al ary m us t b e fo r se rv ic es "ac tu al ly rend ered ." Sec
. 16 2( a)(1 ); s ee al so sec . 1.1 62 -7 (a), In co m e Tax Reg s. (s tati ng th atto be de du ct ib le , com

pe ns at io n p aym en ts m

us t b e rea so nabl e an d t he y m us t b e "i n fa ct pa ym en ts pu rel y

forservi ces "). Os te ns ib le sal ary pa ym en ts to sh areh ol de r em pl oyees tha t ar e actua ll y

di vi de nd s ar e th us no nd educ ti bl e.- 10 -

[* 10 ] att rib ut ab le to "[a]ny subs ta nt ia l u nd ers ta te m en t o f in co m e ta x" . Sect io n 66 62 (d )(2 )(A) d efi ne s the term "u nd ers ta te m en t" as t he ex ces s o f th e ta x re qu ire d to be sh ownon th e return o ve r th e am ou ntsh own on th e return a s fi le d. Inth e cas e o f a co rp or at io n, an un de rs ta te m en t i s " subs ta nt ia l" if, as rel ev an t h ere, i t ex ceed s the les se r of

(1) 10 % of t he tax requi redto be sh ownon th e return fo r th e ta x year or(2) $1 0 m il li on . Sec. 6 66 2( d) (1 )(B) . An und ers ta te m en t i s re du ced , ho wev er, b y

th e p orti on attrib ut ab le to th e tr eat m en t o f anit em for whi chth e ta xp ay er h ad"s ub st an ti al auth or ity ". Sec . 66 62 (d )(2 )(B) (i) . Sect io n 6 66 4( c)(1 ) pr ov id es anex cep ti onto th e im po si ti on of t he sec ti on 66 62 (a) a ccu racy-rela te d pe na lty if i t i s s ho wn tha t the re was reas on ab le cau se forth e und erp aym en t an d t he ta xp ay er ac te d i n g oo d fa ith. Pet it io ne r do es no t d is pu te th atth e d efi ci en cy to whi chitha s ag reedfor each of t he y ears inis su e ex ceed s 1 0% o f th e ag reedin co m e ta x i t was requi redto sh ow o n i ts return fo r th e y ear. Pet it io ne r arg ue s, h owe ve r, th atitha d s ub st an ti al 4
au th or ity forde du ct in g i n fu ll th e y eare ndbo nu se s i t p ai d t o i ts sh areh ol de r at to rn ey s. Inad di ti on , pet it io ne r arg ue s tha t, b ecau se itrel ie d o n t he servi ces of a rep ut ab le acco un ti ng firm to pre pa re i ts returns forth e y ears inis su e, itha d Bec au se th e ta x re qu ire d t o b e sh own on pe ti ti on er's return fo r eac h o f th e 4 y ears inis su e was les s tha n $ 10 m il li on , th e 1 0% thr es ho ldof s ec. 66 62 (d )(1 )(B) (i) ap pl ie s.- 11 -

[* 11 ] reas on ab le cau se to de du ctth os e am ou nt s an d a ct edingo odfai th indo in g so . If pe ti ti on er i s co rrec t tha t i t h adsubs ta nt ia l au th or ity forit s p os it io n, the di sa ll owa nc e o f a p orti on of i ts cla im edoff ic er co m pe ns at io n d educ ti on foreach y ear wo ul d n otin crea se it s " un de rs ta te m en t" withi n t he m ean in g o f se ct io n 66 62 (d )(2 )(A). Inth atcas e, th e subs ta nt ia l u nd ers ta te m en t p en al ty w ou ldno t ap pl y to th e p orti on of t he un de rp aym en t fo r eac h year at tri bu tabl e to th e di sa ll owa nc e o f pa rt o f th os e d educ ti on s, re ga rd le ss of wh ethe r pe ti ti on er h ad
reas on ab le cau se an d a ct edingo odfai th . Mor eo ve r, a d et erm in at io n t ha t pe ti ti on er h adsubs ta nt ia l au th or ity forit s p os it io n wo ul d p rev en t i m po si ti on of t he
ne gl ig en ce p en al ty as wel l. Tak in g apo si ti on th atha s a " reas on ab le ba si s" is no t ne gl ig en t, s ec. 1 .66 62 -3 (b )(1 ), In co m e Tax Reg s., an d s ub st an ti al au th or ity is a m or e st rin ge ntst an da rdth anreas on ab le ba si s, s ec. 1 .66 62 -4 (d )(2 ), In co m e Tax Reg s. Th eref

or e, we be gi n b y

co ns id eri ng whethe r pe ti ti on er h adsubs ta nt ia l
au th or ity forit s d educ ti onof t he y eare ndbo nu se s. II. Subs ta nt ia l Au th or ity The de te rm in at io n o f subs ta nt ia l au th or ity requi res a weig hi ng of t he
au th or it ie s tha t s up po rt the tax pay er's tre atm en t o f anit em ag ai ns t the co nt rary au th or it ie s. Id . subp ara. (3 )(i ). A tax pa y er ca n h av e subs ta nt ia l au th or ity fora po si ti onth atis un li ke ly to p rev ai l, as lo ng as t he weig htof the auth or it ie s i n- 12 -

[* 12 ] supp ort o f th e ta xp ay er's po si ti on is subs ta nt ia l i n re lati on to th e wei gh t o f
an y co nt rary autho rit ie s. See id . subp ara. (2 ) (s ub st an ti al au th or ity st an da rdis les s st rin ge ntth anth e m or e li ke ly than n otst an dard ). The re gu la ti on s d es cri be th e requi redweig hi ng as f

ol lo ws: The weig htacco rd edanau th or ity de pe nd s o n i ts rel ev an ce an d pe rs ua si ve ne ss , andth e type o f do cum en t p ro vi di ng th e au th or ity . Fo r ex am pl e, a cas e o r rev enue rul in g h av in g s om e fac ts inco m m on with t he tax tre atm en t atis su e is no t p art ic ul arl y rel ev an t i f th e au th or ity is m at eri al ly dis ti ng ui sh ab le onit s fa ct s, o r is ot he rwis e in ap pl ic ab le to th e ta x t reat m en t atis su e. Id . subp ara. (3 )(i i). Th e d et erm in at io n o f whe th er a t ax pa y er's po si ti onha s subs ta nt ia l au th or ity

is m ad e as of t he las t d ay of t he tax ab le y ear t o wh ic h t he return re late s an d a t the ti m e th atreturn i s fi le d. Se e id . subd iv . (iv )(C) . If th e po si ti onha s s ub st an ti al au th or ity on eit he r da te , th e ta xp ay er's un de rs ta te m en t i s reduc ed . Id. A. The Part ie s' Arg um en ts Pet it io ne r rel ie s o n Law Offi ces --Ri ch ardAsh are, P.C . v. Co m mis si on er, T.C. Mem o. 1 99 9- 28 2, 1 99 9 WL 63 98 66 , as the pri nc ip al au th or ity insupp ort o f it s d educ ti on of yearen d b on us es pa idto it s s ha reh ol de r at to rn ey s tha t el im in at ed it s b oo k i nc om e fo r th e y ears inis su e. InAsh are, thi s C ou rt a ll owe d aco rp or at e la w firm to de du ctanam ou ntitpa idto it s s ol e sh areh ol de r as co m pe ns at io n t ha t- 13 -

[* 13 ] ex ceed edth e fi rm 's re ve nu es forth e y ear. Pe ti ti on er al so cla im s tha t s ect io n 83 an d i ts acco m

pa nyin g re gu lati on s, d eal in g wi th tra ns fers of p ro pe rty in
co nn ect io n wi th servi ces , supp ort the pro po si ti on th atall am ou nt s i t p ay s t o i ts sh areh ol de r at to rn ey s s ho ul d b e tr eat edas c om pe ns at io n fo r se rv ic es . Furt he r, pe ti ti on er ci te s au th or it ie s i n o th er ar eas of c urren t o r pr io r la w th atpu rp ort t o es tabl is h t ha t capi ta l i s n ota m at eri al in co m e-p ro du ci ng fact or ina pr of es si on al
se rv ic es bu si ne ss . See Hubb ard -Rag sd al e Co . v. Dean , 15 F.2d41 0 (S .D. Ohio 19 26 ), aff'dpe r curia m , 15 F.2d10 13 (6t h C ir. 1 92 6) ; sec . 1.7 04 -1 (e)( 1) (iv ), 5 In co m e Tax Reg s.; sec . 1.9 11 -3 (b )(3 ), In co m e Tax Reg s.; sec . 1.1 34 8- 3( a)(3 )(i i), 6 7
Hub ba rd -Rag sd al e Co . v. Dean , 15 F.2d41 0 (S .D. Ohio 19 26 ), aff'dpe r 5 cu ria m , 15 F.2d10 13 (6t h C ir. 1 92 6) , ho ld s tha t a c or po rat io n e ng ag edinbuy in g an d s el li ng li ve st oc k o n c omm is si onwas n ota "p ers on al servi ce co rp or at io n" en ti tl edto be tax edas apartn ers hi p u nd er p ro vi si on s o f th e Rev enue Act o f 19 18 , ch . 18 , 40 Sta t. 1 05 7. Th e Dis tri ctCo urt fo un d t ha t, b ecau se cap it al was a m at eri al in co m e-p ro du ci ng fact orinth e co rp or at io n's bu si ne ss , th e ta xp ay er d id no t m eetth e st atut ory

de fin it io n o f pe rs on al servi ce co rp or at io n. Th e co urt di st in gu is he d the tax pay er's bu si ne ss fro m servi ce b us in es se s, s uc h a s l aw fi rm s an d m ed ic al pra ct ic es , forwhi ch"the us e o f cap it al is m erel y in ci de nt al ." Id . at 41 1. Sec. 1 .70 4- 1( e)(1 )(i v) , Inc om e Tax Reg s., p ro vi de s: "Inge ne ral , cap it al is

6 no t a m at eri al in co m e-p ro du ci ng fact orwher e th e in co m e o f th e b us in es s co ns is ts pr in ci pa ll y

of f ees , comm is si on s, o r ot he r co m pe ns at io n fo r pe rs on al servi ces pe rfo rm edby m em

be rs or e m

pl oyees o f th e p artne rs hi p." Sec. 9 11 (a)( 1) ex cl ud es fro m gro ss in co m e al l o r a p orti on of aqu al ifyin g 7 in di vi du al 's " fo rei gn earn edin co m e". Se c. 1.9 11 -3 (b )(3 ), In co m e Tax Reg s., (co nt in ue d...)- 14 -

[* 14 ] In co m e Tax Reg s.; sec . 1.1 36 1- 2( e)(2 ), In co m e Tax Reg s. (b efo re re m ov al 8 by T. D. 81 04 , 19 86 -2 C.B. 1 53 ). Fin al ly, pe ti ti on er ar gu es th at , un de r subs ta nc e- 9
ov er-f orm pri nc ip le s, the st oc k h el d b y it s s hareh ol de r atto rn ey s s ho ul d b e tr eat ed
as de bt , so th atth e p orti on of t he y eare ndbo nu se s d et erm in edto be no nd educ ti bl e as co m pe ns at io n s ho ul d n on ethe le ss ha ve be ende du ct ib le as i nt eres t.
(...co nt inue d) 7 tre at s as "ea rn edin co m e" " al l fe es rece iv edby an in di vi du al en ga ge d i n a pr of es si on al oc cupa ti on (su chas d oc to r orlawyer) inth e p erfo rm an ce o f pr of es si on al act iv it ie s." The treat m en t o f th e fee s as earn edin co m e ap pl ie s " ev en th ou gh th e in di vi du al em pl oys as si st an ts to pe rfo rm pa rt o r al l o f th e se rv ic es , pr ov id edth e p at ie nt s o r cl ie nt s ar e th os e o f th e in di vi du al an d l oo k t o t he in di vi du al as t he pe rs on res po ns ib le forth e se rv ic es ren de red ." Id
. Sec. 1 .13 48 -3 (a)( 3) (i) , Inc om e Tax Reg s., l im it edto 30 % th e p orti on of a n 8 in di vi du al 's i nc om e fro m anun in co rp or at edbu si ne ss th atco ul d b e tr eat edas earn edin co m e, fo r pu rp os es of s ec. 1 34 8, wh ic h (b efo re i ts rep eal in19 81 ) li m it ed th e rat e o f ta x app li cab le to earn edin co m e. The 3 0% l im iton th e am ou ntof bu si ne ss in co m e th atco ul d b e tr eat edas e arn edin co m e ap pl ie d i f "b ot h p ers on al se rv ic es an d c ap it al are m at eri al in co m e-p ro du ci ng fact or s" . Id. Sec . 1.1 34 8- 3( a)(3 )(i i), In co m e Tax Reg s., p ro vi de s tha t " th e p ract ic e o f hi s p ro fes si on by a do ct or , den ti st , lawyer, arch it ect , or a cco un tantwil l n ot , as s uc h, b e tr eat edas a tra de or b us in es s i n wh ic h c ap it al is a m at eri al in co m e-p ro du ci ng fact or ". Sec. 1 36 1 o f th e In te rn al Rev enue Co de of 1 95 4 (b efo re ad op ti on of t he 9 m od ernsubc hapt er S ru le s) all owe d u ni nc or po rat edbu si ne ss es th atm etsp eci fie d co nd it io ns to ele ctto be tax edas d om es ti c co rp or at io ns . Sec. 1 .13 61 -2 (e)( 2) , In co m e Tax Reg s., p ro vi de d t ha t " anen te rp ris e en ga ge d i n re nd eri ng pro fes si on al se rv ic es su chas l aw, acco un ti ng , m ed ic in e, oren gi ne eri ng , ord in ari ly is n otan en te rp ris e in whi chcap it al is a m at eri al in co m e-p ro du ci ng fact or ." The refo re, th es e en te rp ris es were g en eral ly noteli gi bl e to ele ctto be tre at edas d om es ti c co rp or at io ns . See s ec. 1 36 1( b) (4 ) (b efo re re pe al in19 66 ).- 15 -

[* 15 ] Pet it io ne r sp en ds m os t o f it s ef fo rt, h owe ve r, tryin g t o d is ti ng ui sh th e au th or it ie s re li edon by resp on de nt . Res po nd en t cl ai m s tha t am ou nt s p ai d t o sh areh ol de r em

pl oyees o f a co rp or at io n d o n otqu al ify as d educ ti bl e co m pe ns at io n to th e ex te ntth atth e p aym en ts are fu nd edby earni ng s at tri bu tabl e to th e se rv ic es of no ns ha reh ol de r em

pl oyees o r to th e u se of t he co rp or at io n's in ta ng ib le ass et s o r ot he r cap it al . Ins te ad , says res po nd en t, am ou nt s p ai d t o s ha reh ol de r em pl oyees th atare at tri bu tabl e to th os e so ur ces m us t b e n on de du ct ib le di vi de nd s. Insupp ort of it s p os it io n, re sp on de ntrel ie s p rimaril y on th is Co urt's op in io n i n P ed ia tri c Surg ic al Ass oc s., P.C. v . Commis si on er, T.C. Mem o. 2 00 1- 81 , andth atof the U.S. Co urt o f App eal s fo r th e Sev en th Cir cu itinMu lc ah y , Pau rit sc h, Sa lv ad or& Co . v. Co m m is si on er, 6 80 F.3d86 7 (7 th Cir . 20 12 ), aff'g T.C. Mem o. 2 01 1- 74 . In Ped iatri c Surg ic al , we det erm in edth atco m pe ns at io n p aym en ts to sh areh ol de r em pl oyees a ttrib ut ab le to th e se rv ic es of n on sh areh ol de rs were n on de du ct ib le di vi de nd s. InMu lc ah y , th e Co urt o f App eal s fo r th e Sev en th Cir cu itde ni eda co rp or at io n's de du ct io n o f co ns ul ti ng fees pa idto en ti ti es own edby the tax pa y er's fo un di ng sh areh ol de rs . The t ax pa y er s ou gh t t o ju st ify the de du ct io n o f th e co ns ul ti ng fees on th e g ro un ds th atth ey were, i n e ffec t, ad di ti on al co m pe ns at io n to it s s ha reh ol de rs . The Co urt o f App eal s uph el d thi s C ou rt' s d is al lo wan ce o f th e de du ct io n, re as on in g t ha t " [t]reat in g * * * [th e co ns ul ti ng fees ] as sal ary reduc ed- 16 -

[* 16 ] th e fi rm 's i nc om e, an d t hu s the return t o t he equi ty inv es to rs , to zero or be lo w intwo of t he th ree t ax y ears at i ss ue , eve n t ho ug h * * * th e fi rm was d oi ng fin e." Mu lc ah y , Paurit sc h, Sa lv ad or& Co . v. Co m m is si on er, 6 80 F.3dat 8 72
. "[W] he n ath riv in g fi rm

th atha s n on tri vi al cap it al rep orts no co rp or at e in co m e," th e co urt o bs erv ed , "itis ap pa ren t tha t the firm is un de rs ta ti ng it s t ax li ab il ity ." Id
. at87 4. Pre su m ab ly, res po nd en t em ph as iz es Mu lc ah y

be cau se , abs en t a s ti pu la ti on to th e co nt rary, app eal of t he pre se ntcas e wou ldli e wit h t he Co urt o f App eal s fo r th e Sev en th Cir cu it . See s ec. 7 48 2( b) (1 )(B) (ve nu e o f ap pe al of Tax Co urt de ci si on in vo lv in g aco rp or at io n i s the U.S. Cou rt o f App eal s fo r th e ci rcu itin whi chth e ta xp ay er's pri nc ip al pl ace o f bu si ne ss or p rin ci pa l o ffi ce i s l oc at ed ). Pet it io ne r arg ue s tha t i ts cas e is di st in gu is habl e fro m Ped ia tri c Su rg ic al be cau se any

"p ro fit " i t m ak es fro m

th e se rv ic es of n on sh areh ol de r at to rn ey s ca n jus ti fiabl y

be pa idto it s s ha reh ol de r at to rn ey s i n c on si de rat io n fo r bu si ne ss ge ne rat io n a ndot he r no nb il labl e se rv ic es . Peti ti on er at te m pt s t o d is ti ng ui sh Mu lc ah y on th e b as is of t he all eg ed ly uni qu e n atur e o f it s s ha reh ol de r at to rn ey s' in te res ts . In p art ic ul ar, p et it io ne r arg ue s tha t, b ecau se it s s ha reh ol de r at to rn ey s rece iv e th ei r st oc k i n c on ne ct io n wi th th ei r em pl oym en t an d m

us t s el l i t b ackto pe ti ti on er ata pr ic e equa l t o i ts cas h b oo k v al ue , th e sh ares th ey ho lddo no t rep res en t " real " equi ty int eres ts th aten ti tl e th em to a return o n t he ir i nv es te d- 17 -

[* 17 ] cap it al . In ad di ti on , pet it io ne r ob se rv es th at , bec au se Mu lc ah y was d eci de d aft er i t fi le d i ts returns forth e y ears inis su e, th e cas e can no t b e ta ke n i nt o a cco un t in ass es si ng th e rel at iv e wei gh t o f au th or it ie s fo r an d a ga in stit s p os it io n. Se e se c. 1.6 66 2- 4( d) (3 )(i v) (C), In co m e Tax Reg s. B. The Cen tra li ty of th e "In de pe nd en t In ve st or Test " The pri nc ip le ap pl ie d i n M ul cah y is well est ab li sh edinth e law and gr ou nd edinba si c eco no m ic s: The o wne rs of a n e nt erp ris e with s ig ni fic an t capi ta l
are e nt it le d t o areturn o n the ir i nv es tm en ts . Thu s, a c or po rat io n's co ns is te nt pa ym en t o f sa la rie s t o s ha reh ol de r em pl oyees i n a m ou nt s tha t l eav e in su ffi ci en t fund s av ai labl e to pro vi de anad equa te return t o t he sh areh ol de rs on th ei r in ve st ed cap it al in di cat es th ata po rti on of the am ou nt s p ai d a s s al ari es is actua ll y di st rib ut io ns of e arn in gs . W el l b efo re the y ears inis su e, anin crea si ng nu m be r of Fed eral Co urts of Ap pe al s, i nc lu di ng th e Co urt o f App eal s fo r th e Sev en th Cir cu it , were m ov in g a way

fro m a m ul ti fact oran al y si s i n a ss es si ng th e d educ ti bi li ty of
am ou nt s p ai d a s co m

pe ns at io n t o s ha reh ol de r em pl oyees a ndfoc us in g o n t he effe ctof t he pa ym en ts on th e returns av ai labl e to th e sh areh ol de rs onth ei r cap it al
. See Ex act o S pr in g C or

p. v . Comm is si on er, 1 96 F.3d83 3, 8 38 (7t h C ir. 1 99 9) , rev 'g Hei tz v. Co m

m is si on er, T.C. Mem o. 1 99 8- 22 0; Rap co , Inc . v. Co m m is si on er, 8 5 F .3d95 0, 9 54 -9 55 (2dCir . 19 96 ), aff'g T.C. Mem o. 1 99 5- 12 8;- 18 -

[* 18 ] Ell io tt s, In c. v. Co m m is si on er, 7 16 F.2d12 41 , 12 45 (9t h C ir. 1 98 3) , rev 'g
an d re m an di ng T.C. Mem o. 1 98 0- 28 2; see als o Es cro w Con ne ct io n, In c. v. Co m m is si on er, T.C. Mem o. 1 99 7- 17 , 19 97 W L 57 91 . There fo re, the factth at Mu lc ah y it se lf i s n ot"au th or ity " fo r pr es en t p ur po se s i s o f li tt le co ns eque nc e. The Co urt o f App eal s fo r th e Sev en th Cir cu itan d t he ot he r co urts th atha ve as se ss edco m

pe ns at io n p ai d t o s ha reh ol de r em pl oyees b y

it s ef fecton th e returns av ai labl e to sh areh ol de rs ' cap it al refe r to th e g ov ern in g i nqui ry as t he "i nd ep en de ntin ve st ortes t" . Exact o S pr in g C or p. v . Comm is si on er, 1 96 F.3dat 83 8; Dexs il Co rp . v. Co m m is si on er, 1 47 F.3d96 , 10 0- 10 1 (2 d C ir. 1 99 8) , vac at in g an d re m an di ng T.C. Mem o. 1 99 5- 13 5. Th e te streco gn iz es th atsh areh ol de r em pl oyees m ay

be eco no m ic al ly ind iff

eren t t o wh ethe r pa ym en ts th ey rece iv e fro m th ei r co rp or at io n a re l ab el edas c om pe ns at io n o r di vi de nd s. Fro m a ta x st an dp oi nt , ho wev er, o nl y co m pe ns at io n i s d educ ti bl e to th e co rp or at io n; di vi de nd s ar e n ot . There fo re, the sh areh ol de r em pl oyees andth ei r co rp or at io ns ge ne ral ly hav e a b ia s t owa rdlab el in g p aym en ts as c om pe ns at io n ra th er tha n di vi de nd s, wi th ou t the arm 's- le ng thch eckth atwou ldbe inpl ace i f no ne m pl oyees own edsi gn ifi can t i nt eres ts inth e co rp or at io n. Owen sb y & Krit ik os , Inc . v. Co m m is si on er, 8 19 F.2d13 15 , 13 22 -1 32 3 (5 th Cir . 19 87 ), aff'g T.C. Mem o. 1 98 5- 26 7; Ell io tt s, In c. v. Co m mis si on er, 7 16 F.2dat 1 24 3. Thus , th e co urts co ns id er- 19 -

[* 19 ] whet he r os te ns ib le sal ary pa ym en ts to sh areh ol de r em pl oyees m eetth e st an da rd s fo r de du ct ib il ity by tak in g t he pe rs pe ct iv e o f a h y po th et ic al "i nd ep en de ntin ve st or " wh o i s n otals o a n e m pl oyee. C. App li cat io n o f th e In de pe nd en t In ve st orTest Ost en si bl e co m

pe ns at io n p aym en ts m ad e to sh areh ol de r em pl oyees b y

a co rp or at io n wi th si gn ifi can t capi ta l tha t ze ro ou t the co rp or at io n's in co m e an d le av e n o re tu rnon th e sh areh ol de rs ' in ve st m en ts fai l the in de pe nd en t i nv es to r te st . As the Co urt o f App eal s fo r th e Nin th Cir cu itob se rv edinEll io tt s, In c. v. Co m m is si on er, 7 16 F.2dat 1 24 7: "If the bu lkof t he co rp or at io n's earn in gs are be in g p ai d o utinth e fo rm of c om pe ns at io n, s o t ha t the co rp or at e p ro fit s, af te r pa ym en t o f th e co m

pe ns at io n, d o n otrep res en t a r eas on ab le return o n t he sh areh ol de r's equi ty in the co rp or at io n, the n a n i nd ep en de ntsh areh ol de r wou ld pr ob ab ly notap pr ov e o f th e co m pe ns at io n a rran ge m en t." See al so Dexs il Co rp . v. Co m m is si on er, 1 47 F.3dat 1 01 ; Es cro w Con ne ct io n, In c. v. Co m m is si on er, 1 99 7 W L 57 91 , at * 10 (return o n e qu ity of 0 % wou ldno t s at is fy

anin de pe nd en t in ve st or ); No r-Ca l Ad

jus te rs v. Co m

m is si on er, T.C. Mem o. 1 97 1- 20 0, 1 97 1 Tax Ct . Mem o LEXIS 1 32 , at * 21 (in act iv e sh areh ol de r wou ldno t h av e fo rg on e a return o n i nv es te d c ap it al whi le ne arl y all of t he co rp or at io n's in co m e was pa idou t as sal ari es an d b on us es ), aff'd , 50 3 F .2d35 9 (9 thCir . 19 74 ).- 20 -

[* 20 ] The reco rdest ab li sh es th atpe ti ti on er h adsubs ta nt ia l capi ta l ev enwitho ut reg ardto an y

in tang ib le ass et s. At t ria l, p et it io ne r's ex pe rt wi tn es s, M r. Hil de br an dt , adm it te d tha t a f irm's rep ut at io n a ndcu st om er l is ts co ul d b e v al uabl e en ti ty-lev el ass et s. Fo r pr es en t p ur po se s, h owe ve r, we ne edno t i de nt ify and at te m ptto va lu e in tang ib le ass et s tha t b el on g t o p et it io ne r rathe r th anit s sh areh ol de r at to rn ey s. Re ga rd le ss of t he po ss ib il ity th atpe ti ti on er m ig htown va lu ab le in ta ng ib le ass et s, i t h adin ve st edcap it al , m eas ur edby the bo okva lu e o f it s s ha reh ol de rs ' equi ty, of ab ou t $ 8 m il li on at the en d o f 20 07 an d abo ut$9 .3
m il li on at the en d o f 20 08
. 1 0 In ve st edcap it al of t hi s m ag ni tu de can no t b e d is reg ard edinde te rm in in g whe th er o st en si bl e co m

pe ns at io n p ai d t o s ha reh ol de r em pl oyees i s re al ly a di st rib ut io n o f earni ng s. We do no t b el ie ve th atpe ti ti on er's sh areh ol de r at to rn ey s, were the y no t al so em

pl oyees, wo ul d h av e fo rg on e an y return o n i nv es te d c ap it al th atat l eas t ap pr oa ch ed , if i t d idno t ex ceed$1 0 m il li on . Thu s, p et it io ne r's pr act ic e o f pa y in g o uty eare ndbo nu se s t o i ts sh areh ol de r at to rn ey s tha t el im in at ed it s b oo k i nc om e fai ls th e in de pe nd en t i nv es to r te st .

Bec au se pe ti ti on er u se d the cas h m etho d i n k eep in g i ts bo ok s, i ts 1 0 sh areh ol de rs ' equi ty didno t i nc lu de an y ex ces s o f rec ei vabl es ov er p ay ab le s.- 21 -

[* 21 ] D. Pet it io ne r's Cla im edExem pt io n F ro m

th e In de pe nd en t In ve st orTest The sp eci fic cir cu m st an ces of t he pre se ntcas e d o n otpre ve ntth e ap pl ic at io n o f th e in de pe nd en t i nv es to r te st . Peti ti on er o bs erv es th atit s sh areh ol de r at to rn ey s h ol d t he ir s to ckinth e co rp or at io n i n c on ne ct io n wi th th ei r em pl oym en t, the y

acqui re the ir s to ckat apri ce equa l t o i ts cas h b oo k v al ue , and th ey m us t s el l the ir s to ckba ckto pe ti ti on er ata pr ic e d et erm in edun de r th e sa m e fo rm ul a upo n t erm in at in g t he ir e m pl oym en t. Pet it io ne r su gg es ts th at , as ares ul t o f th is arrang em en t, i ts sh areh ol de r at to rn ey s l ackth e n orm al rig ht s o f equi ty owne rs . Co nt rary to p et it io ne r's arg um en t, the us e o f bo okva lu e as a pr ox y for
m ark etva lu e fo r th e is su an ce an d re de m pt io n o f sh ares ina cl os el y he ld
co rp or at io n t o a vo idth e p ract ic al di ffi cu lt ie s o f m or e p reci se va lu at io n h ard ly
m ean s tha t the sh areh ol de r at to rn ey s d o n otreal ly own the co rp or at io n a ndare n ot en ti tl edto a return o n t he ir i nv es te d c ap it al . Any sh areh ol de rs who are n otals o em pl oyees wo ul d g en eral ly dem an d s uc h areturn. The pro vi si on s o f se ct io n 8 3 a ndit s ac co m panyin g re gu la ti on s, ra th er tha n supp orti ng pe ti ti on er's arg um en t, ac tu al ly und erm in e it . Peti ti on er p ur po rts to rel y on rul es th atde te rm in e whe n p ro pe rty is c on si de redto have be en"tran sf erre d" by
anem pl oyer to anem

pl oyee. Und er tho se rul es , a tra ns fer m ay no t h av e o ccu rred if, upo n t erm in at io n o f hi s o r he r em pl oym en t, the em

pl oyee is requi redto return- 22 -

[* 22 ] th e p ro pe rty to t he em pl oyer fora pr ic e th at"d oe s n otap pr oa chth e fai r m ark etva lu e o f th e p ro pe rty at th e ti m e o f su rren de r." Sec . 1.8 3- 3( a)(3 ), (5 ), In co m e Tax Reg s. Pet it io ne r su gg es ts th atth e o bl ig at io n tha t i ts sh areh ol de r at to rn ey s s el l b ackth ei r st oc k upo n t erm in at io n o f th ei r em pl oym en t i n e xc ha ng e fo r th e b oo k v al ue of t he st oc k m ean s tha t the st oc k was ne ve r "tran sf erre d"
. Co ns eque nt ly, acco rd in g t o p et it io ne r, al l am ou nt s i t p ay s t o i ts sh areh ol de rs --ev en an y am ou nt s ac tu al ly des ig na te d a s d iv id en ds --m us t b e tr eat edas c om

pe ns at io n fo r se rv ic es . See i d. s ec. 1 .83 -1 (a)( 1)
. Bu t p et it io ne r is m is ta ke n i n i ts cla im th atth e b oo k v al ue of o ne of i ts sh ares do es no t ap pr oa chit s fa ir m ark etva lu e. Sect io n 1 .83 -5 (a), In co m e Tax Reg s., p ro vi de s: "If s to ckina co rp or at io n i s s ub ject t o ano nl ap se res tri ct io n whi chrequi res th e tr an sf eree to sel l s uc h s to ckon ly at a fo rm ul a p ric e b as edon bo okva lu e * * * , th e p ric e so de te rm in edwil l o rd in ari ly be reg ard edas de te rm in at iv e o f th e fai r m ark etva lu e o f su chpro pe rty for p ur po se s o f se ct io n 8 3." Thu s, the ex am

pl es cit edby pet it io ne r, se ct io n 1 .83 -3 (a)( 7) , Exam pl es (3) an d (4 ), In co m e Tax Reg s., are read il y di st in gu is habl e. They inv ol ve requi rem en ts to res el l s to ckup on term in at io n o f em pl oym en t fo r am ou nt s tha t ar e d em on st rab ly be lo w th e st oc k's fai r m ark etva lu e. Sect io n 1 .83 -5 (c), Ex am pl e (1 ), In co m e Tax Reg s., i s m or e o n p oi nt . In tha t ex am pl e, anem

pl oyee's o bl ig at io n t o re se ll st oc k- 23 -

[* 23 ] to hi s emplo y er atit s the n- ex is ti ng bo okva lu e d idno t p rev en t re co gn it io n o f th e tr an sf er o f th e st oc k t o t he em

pl oyee. Mo re g en eral ly, pe ti ti on er's arg um en t tha t i ts sh areh ol de r at to rn ey s h av e n o real equi ty int eres ts inth e co rp or at io n t ha t wo ul d ju st ify a returnon in ve st ed cap it al pro ve s t oo m

uc h. If p et it io ne r's sh areh ol de r at to rn ey s ar e n otit s o wne rs , who are? If th e sh areh ol de r at to rn ey s d o n otbe ar the ris k o f lo ss fro m de cl in es in th e v al ue of i ts ass et s, wh o d oe s? The u se of b oo k v al ue as apro xy for fa ir m ark et va lu e d ep riv es th e sh areh ol de r at to rn ey s o f th e ri gh t t o s hare i n u nr eal iz ed ap pr eci at io n upo n s el li ng th ei r st oc k- -al th ou gh th ey are co rres po nd in gl y

no t requi redto pa y

forun real iz edap pr eci at io n upo n b uyin g t he st oc k. Bu t ac cep ta nc e of th es e co nc es si on s t o a vo iddi ffi cu ltva lu at io n i ss ue s d oe s n otco m pe l the sh areh ol de r at to rn ey s t o fo rg o, i n a dd it io n, an y curren t re tu rnon th ei r in ve st m en ts ba se d o n t he co rp or at io n's pro fit ab le us e o f it s as se ts inco nduc ti ng it s b us in es s. Pet it io ne r's arrang em en t ef fect iv el y pro vi de s i ts sh areh ol de r at to rn ey s wi tha return o n t he ir c ap it al th ro ug h am ou nt s d es ig na te d a s co m pe ns at io n. Were th is no t th e cas e, we do no t b el ie ve th e sh areh ol de r at to rn ey s wo ul d b e wil li ng to for go an y return o n t he ir i nv es tm en ts .- 24 -

[* 24 ] E. Oth er Au th or it ie s C it edby Peti ti on er The ot he r au th or it ie s p et it io ne r ci te s d o n otrefu te th e g en eral pri nc ip le th at th e o wne rs of a n e nt erp ris e wit h s ig ni fic an t capi ta l ar e eco no m ic al ly ent it le d t o a return o n t he ir i nv es tm en ts . Con tra ry to pe ti ti on er's cla im , Law Office s- -Ri ch ard Ash are, P.C . v. Co m

m is si on er, 1 99 9 WL 63 98 66 , do es no t d em on st rat e th atan in co rp or at edlaw fi rm

with s ig ni fic an t capi ta l ca n p ay ou t co m pe ns at io n t ha t el im in at es bo okin co m e. Altho ug h we a ll owe d t he tax pa y er i n As ha re t o d educ t co m pe ns at io n t ha t ex ceed edth e fi rm 's re ve nu es forth e y ear i n i ss ue (19 93 ), th e ta xp ay er i n t ha t ca se di d n otco ns is te nt ly pay co m pe ns at io n t ha t h adth e in te nd ed effe ctof e li m in at in g b oo k i nc om e. The fi rm ha d re po rte d s ub st an ti al in co m e fo r 19 90 , th ree years b efo re the y ear i n i ss ue . Thu s, as we ob se rv ed : "[ T] he bo ard kn ew ho w to li m itMr. Ash are's co m pe ns at io n t o the va lu e o f hi s unc om pe ns at ed
se rv ic es as o f th e en d o f eac h year." Id . at * 9. Th e fai lu re o f th e fi rm "t o i nf la te Mr. As ha re's co m

pe ns at io n" , des pi te ha vi ng "the op po rtu ni ty, th e m ean s, an d a st ro ng tax in cen ti ve " t o d o s o, i nd ic at edth at"the bo ardwas s etonest ab li sh in g Mr. As ha re's co m

pe ns at io n a t i ts fai r va lu e." Id . The fi rm 's d efi ci t i n re ta in ed
earn in gs an d i ts fai lu re t o p ay di vi de nd s s ug ge st edth at , ona cu m ul at iv e b as is , if
no t year by y ear, the firm di d p ay ou t al l o f it s ea rn in gs as c om pe ns at io n. Bu t, i n- 25 -

[* 25 ] co ntras t t o p et it io ne r in th e p res en t ca se , th e fi rm inAsh are h adm in im al cap it al : It s s ha reh ol de r ha d i nv es te d o nl y $1 ,00 0 i n t he co rp or at io n. 1 1 The au th or it ie s tha t p ur

po rt t o e st ab li sh th atcap it al is no t a m at eri al in co m epr oduc in g fa ct or

ina pr of es si on al servi ces bu si ne ss de se rv e li tt le or n o wei gh t. Non e o f th os e au th or it ie s ad dr es s the de du ct ib il ity of c om pe ns at io n p ai d t o sh areh ol de r em

pl oyees. Sev eral in vo lv e st atut ory pro vi si on s tha t h av e lo ng 1 2 As p et it io ne r ob se rv es , th e ta xp ay er i n Law Offi ces --Ri ch ardAsh are, P.C
. 1 1 v. Co m m is si on er, T.C. Mem o. 1 99 9- 28 2, 1 99 9 WL 63 98 66 , inco nn ect io n wi th an au di t o f it s re tu rn s fo r 19 90 , 19 91 , 19 92 , agr eedto tre atas c on st ru ct iv e d iv id en ds a p orti onof t he co m

pe ns at io n i t p ai d t o i ts sh areh ol de r in each of t ho se y ears . Pet it io ne r rea so ns th atth e ta xp ay er's co nc es si on de m on st rat es th e ex is te nc e o f "t an gi bl e o r in tang ib le cap it al ." In st ead , th e ta xp ay er's ret ai ne d e arn in gs fro m th e en d o f 19 90 to th e b eg in ni ng of 1 99 3 re su lt edfro m it s b oa rd 's d eci si on to ret ai n a po rti onof t he pro fititearn edin19 90 "fo r 'th e rea so nabl y an ti ci pa te d n eed s o f th e bu si ne ss forth e fo rth co m in g years.'" Id., 1 99 9 WL 63 98 66 , at * 5. Th e ta xp ay er's pr of itin19 90 refl ect edth e se tt le m en t o f it s p rin ci pa l ca se . After t he set tl em en t, ho wev er, a " tre m en do us am ou ntof wo rk " remaine d t o b e d on e adm in is te rin g t he se tt le m en t fu nd . Id. at*3 . The b oa rd 's a ct io n p ro ve d t o b e far si gh te d: By th e en d of 19 93 , th e ta xp ay er h adin cu rredex pe ns es su ffi ci en t t o e li m in at e it s re ta in ed earn in gs an d p ro du ce a d efi ci t o f $8 9,8 55 . Id. at*2 . Thu s, the tax pay er's ret ai ne d earn in gs were ap pa ren tl y att rib ut ab le no t t o c ap it al in ve st edby its sh areh ol de r bu t to it s re cei ptof l eg al fees fro m th e se tt le m en t o f it s p rin ci pa l ca se be fo re the pe rfo rm an ce o f al l o f th e work fo r whi chth os e fee s s erv edas c om pe ns at io n. If t he ta xp ay er h addi st rib ut edto it s s ha reh ol de r th e earni ng s i t re ta in edat the en d o f 19 90 , itwou ldhave be enlef t wi th in su ffi ci en t re so ur ces to pa y all of i ts expe ns es be fo re wi nd in g up. Pet it io ne r m ay

be co rrec t tha t, as a res ul t o f se c. 1.9 11 -3 (b )(3 ), In co m e 1 2 Tax Reg s., the ex cl us io n o f fo rei gn pro fes si on al fees un de r se c. 91 1( a)(1 ) ap pl ie s to am ou nt s at tri bu tabl e to in ve st edcap it al . Butth e p os si bi li ty tha t, i n s om e (co nt in ue d...)- 26 -

[* 26 ] si nc e b eenrep eal ed
. Mo stsi m pl y m ak e o bs erv at io ns ab ou t wh atis 1 3 ge ne ral ly the cas e in reg ardto pro fes si on al servi ce b us in es se s. Thu s, n on e o f th e 1 4 (...co nt in ue d) 1 2 co nt ex ts , th e la w for go es aneffo rt t o d et erm in e th atpo rti on of a n a tt orne y 's pr of es si on al servi ces in co m e at tri bu tabl e to cap it al do es no t ju st ify treat in g a s de du ct ib le co m

pe ns at io n p aym en ts m ad e b y a co rp or at e la w firm

to sh areh ol de r at to rn ey s tha t el im in at e it s b oo k i nc om e an d l eav e n o re tu rnto th e sh areh ol de rs on m at eri al am ou nt s o f in ve st edcap it al . Cf. Exac to Sp rin g C or p. v . Comm is si on er, 19 6 F .3d83 3, 8 35 (7t h C ir. 1 99 9) ("[T]he p rimary pu rp os e o f se ct io n 1 62 (a)( 1) * * * i s t o p rev en t d iv id en ds * * * wh ic h a re n otde du ct ib le fro m co rp or at e in co m e, fro m

be in g d is gu is edas s al ary, whi chis ."), rev 'g Hei tz v. Co m m is si on er, T.C. Mem o. 1 99 8- 22 0. Hub ba rd -Rag sd al e Co ., 15 F.2d41 0, ad dr es se d p ro vi si on s o f th e Rev enue 1 3 Act o f 19 18 . Anal og ou s p ro vi si on s wer e in cl ud edinth e Rev enue Act o f 19 21 , bu t n otsubs eque ntact s. Sec . 13 61 of t he Int ern al Rev enue Co de of 1 95 4 was rep eal edin19 66 . Act o f Apr . 14 , 19 66 , Pub . L. No. 89 -3 89 , sec . 4(b )(1 ), 80 Sta t. at11 6. Th e li m iton th e rat e o f ta x app li cab le to earn edin co m e p ro vi de d b y sec . 13 48 was re pe al edby the Econ om ic Reco ve ry Tax Actof 1 98 1, Pub. L. No. 9 7- 34 , sec . 10 1( c)(1 ), 95 Sta t. at18 3. The ob se rv at io n, i n d ic tu m , of the U.S. Dist ric t Co urt fo r th e So ut he rn 1 4 Dis tri ctof Oh io inHub ba rd -Rag sd al e, 15 F.2dat 4 11 , th atth e u se of c ap it al by la w firm s an d s im il ar s erv ic e b us in es se s i s " m erel y in ci de nt al " d oe s n otest ab li sh th ata la w firm

th atinfactha s s ig ni fic an t capi ta l n eedno t p ro vi de it s o wne rs with a return o n t ha t capi ta l. Sec. 1 .70 4- 1( e)(1 )(i v) , Inc om e Tax Reg s., an d s ec. 1 .13 61 -2 (e)( 2) , Inc om e Tax Reg s. (b efo re re m ov al by T .D. 81 04 , 19 86 -2 C.B. 1 53 ), si m pl y pro vi de ge ne ral iz at io ns ab ou t the m at eri al ity of c ap it al ina pe rs on al servi ces bu si ne ss as anin co m e-p ro du ci ng fact or . As a res ul t o f se c. 1.7 04 -1 (e)( 1) (iv ), In co m e Tax Reg s., the saf

e h arb orof s ec. 7 04 (e)( 1) wil l g en eral ly notap pl y to requi re the reco gn it io n a s a p artne r of an y pe rs on who own s a c ap it al in te res t i n apa rtn ers hi p who se in co m e co ns is ts pri m ari ly of co m pe ns at io n fo r pe rs on al servi ces pe rfo rm ed (co nt in ue d...)- 27 -

[* 27 ] au th or it ie s s up po rt t he pro po si ti on th ata co rp or at io n wi th subs tant ia l capi ta l
canpa y de du ct ib le co m

pe ns at io n t o i ts sh areh ol de r em pl oyees i n a m ou nt s tha t le av e n o re tu rnto th e sh areh ol de rs on th ei r in ve st m en ts inth e co rp or at io n. F. Pet it io ne r's Cla im

ThatIts Sto ckIs R eal ly D eb t W e can read il y

di sm is s p et it io ne r's cla im th atth e p orti onof t he y eare nd bo nu se s d et erm in edto be no nd educ ti bl e as co m pe ns at io n s ho ul d n on ethe le ss ha ve be ende du ct ib le as i nt eres t. We hav e al read y reject edpe ti ti on er's arg um en t tha t i ts st oc k i s n otreal equi ty. Desp it e a d ep art in g s ha reh ol de r's ob li ga ti on to sel l h is st oc k b ackto pe ti ti on er atcas h b oo k v al ue , sh ares of p et it io ne r's st oc k l ackth e ha ll m arkch arac te ris ti cs of d eb t. Cf. Gi lb ertv. Co m m is si on er, 2 48 F.2d39 9, 4 02 (2 d C ir. 1 95 7) ("Th e cl as si c d eb t i s anun qu al ifi edob li ga ti on to pa y a su m cert ai n ata reas on ab ly clo se fix edm atur ity da te alo ng with afix edpe rcen ta ge inin te res t (...co nt in ue d) 1 4 by its m em

be rs or e m

pl oyees. Bu t the ap pl ic at io n o f se c. 70 4( e)(1 ) to a la w firm pa rtn ers hi p wo ul d s el do m m at te r, gi ve n t ha t the pri m ary pu rp os e o f th atsec ti on is to va li da te in te res ts infam il y pa rtn ers hi ps acqui redby gift . S. Rep t. No . 82 -7 81 (1 95 1) , 19 51 -2 C.B. 4 58 , 48 5- 48 7; H.R. Rep t. No . 82 -5 86 (19 51 ), 19 51 -2 C.B. 35 7, 3 80 -3 81
. The cla ss ifi cat io n o f a l aw pr act ic e as a bu si ne ss inwhi chcap it al is no t a m at eri al in co m e-p ro du ci ng fact orby sec. 1 .13 48 -3 (a)( 3) (ii ), In co m e Tax Reg s., di d n otm eanth atall of a n a tt orne y 's i nc om e fro m hi s p ract ic e was tre at edas earn edin co m e an d tha t an y return o n i nv es te d c ap it al was i gn or ed . It s im pl y ren de redin ap pl ic ab le th e 3 0% l im it at io n i m po se d b y sec . 1.1 34 8- 3( a)(3 )(i ), In co m e Tax Reg s., o n the am ou ntth atco ul d b e tr eat edas e arn edin co m e.- 28 -

[* 28 ] pa y ab le reg ard le ss of t he de bt or 's i nc om e o r la ckth ereo f."), re m an di ng T.C. Mem o. 1 95 6- 13 7. 1 5 G. W ei gh in g t he Autho rit ie s Hav in g e ng ag edinth e wei gh in g p ro ces s re qu ire d b y sec ti on 1.6 66 2- 4( d) (3 )(i i), In co m e Tax Reg s., we co nc lu de th atth e au th or it ie s tha t s up po rt pe ti ti on er's de du ct io n o f th e fu ll am ou ntof t he y eare ndbo nu se s i t p ai d t o sh areh ol de r at to rn ey s ar e n otsubs ta nt ia l wh enweig he d a ga in stth e co nt rary au th or it ie s. Th e in de pe nd en t i nv es to r te stweig hs stro ng ly agai ns t the cla im ed de du ct io ns . Peti ti on er's effo rts to ch arac te riz e it s s itua ti on as uni qu e d o n ot pe rs ua de us . If th e h y

po th et ic al in de pe nd en t i nv es to r ha d p ro vi de d t he cap it al de m on st rat edby the cas h b oo k v al ue of p et it io ne r's sh ares --ev enlea vi ng asi de th e po ss ib il ity

of v al uabl e fi rm -o wne d i nt an gi bl e as se ts --the in ve st orwou ldha ve de m an de d areturn o n t ha t capi ta l an d wo ul d n otha ve to le rat edpe ti ti on er's
co ns is te ntpra ct ic e o f pa y in g c om pe ns at io n t ha t ze ro edou t i ts in co m e. By
co nt ras t, the au th or it ie s ci te d b y pe ti ti on er ar e ei th er "materi al ly dis ti ng ui sh ab le on
W il sh ire & W . San dwi ch es , Inc . v. Co m m is si on er, 1 75 F.2d71 8 (9 th Cir
. 1 5 19 49 ), rev 'g T.C. Me m o. 1 94 8- 12 3, ci te d b y pe ti ti on er, i s re ad il y

di st in gu is habl e. Inth atcas e, th e U.S. Co urt o f App eal s fo r th e Nin thCir cu it , inup ho ld in g i nt eres t de du ct io ns cla im edon adva nc es m ad e b y th e sh areh ol de rs of aco rp or at io n i n pr op orti on to th ei r st oc k o wne rs hi p, fo un d " al l the ele m en ts of ade bt oran d cred it orrel at io ns hi p" . Id. at72 0.- 29 -

[* 29 ] * * * [t he ir] fact s, o r * * * [a re] othe rwis e in ap pl ic ab le to th e ta x t reatm en t atis su e." Cf

. id . There fo re, tho se au th or it ie s ar e n ot"p art ic ul arl y rel ev an t" . Id. W e d o n otdo ub t the cri ti cal va lu e o f th e se rv ic es pro vi de d b y em pl oyees o f a p ro fes si on al servi ces firm . Ind eed , th e em pl oyees' s erv ic es m ay

be far m or e im po rta nt , as afact orof p ro du ct io n, than t he cap it al co ntrib ut edby the firm 's
own ers . Reco gn it io n o f th os e b as ic eco no m ic real it ie s m ig htjus ti fy th e p aym en t of co m pe ns at io n t ha t co ns ti tu te s the va stm ajor ity of t he firm 's p ro fit s, af

te r pa ym en t o f ot he r ex pe ns es --as lo ng as t he rem ai ni ng ne t i nc om e st il l p ro vi de s an ad equa te return o n i nv es te d c ap it al . Butpe ti ti on er d idno t h av e subs ta nt ia l
au th or ity forth e d educ ti on of am ou nt s p ai d a s co m pe ns at io n tha t co m

pl et el y el im in at edit s i nc om e an d l eftit s s ha reh ol de r at to rn ey s wi th no return o n t he ir in ve st edcap it al
. Bec au se pe ti ti on er d idno t h av e subs ta nt ia l au th or ity forit s treat m en t o f th e y eare ndbo nu se s i t p ai d dur in g t he y ears inis su e, th e ag reeddi sa ll owa nc e o f a po rti onof t he de du ct io ns pe ti ti on er cl ai m edforth os e p aym en ts in crea se d a "s ub st an ti al un de rs tate m en t" , withi n t he m ean in g o f se ct io n 6 66 2( d) (1 )(B) , for each y ear. Th eref

or e, we ne edno t d et erm in e whe th er the un de rp aym en ts res ul ti ng fro m th atdi sa ll owa nc e are att rib ut ab le to ne gl ig en ce. Cf. s ec. 6 66 2( b) (1 ). The
accu racy-rela te d p en al ti es ass ert edby resp on de ntwil l ap pl y un le ss pe ti ti on er h ad- 30 -

[* 30 ] reas on ab le cau se forit s treat m en t o f th e y eare ndbo nu se s an d a ct edingo od fai th inpu rs ui ng th attre atm en t. III. Rea so nabl e Cau se an d Go odFai th Pet it io ne r arg ue s tha t, ev enif i t l ack edsubs ta nt ia l au th or ity forde du ct in g i n fu ll th e y eare ndbo nu se s i t p ai d t o i ts sh areh ol de r at to rn ey s dur in g t he y ears in is su e, res po nd en t erredinim po si ng th e acc ur acy-rela te d p en al ty of se ct io n 66 62 (a) b ecau se pe ti ti on er h adreas on ab le cau se an d a ct edingo odfai th in cl ai min g t he de du ct io ns . See s ec. 6 66 4( c)(1 ). In t ha t re gard , pet it io ne r al le ge s th atit s re li an ce o n M cGla dr ey to pre pa re i ts returns forth e y ears inis su e co ns ti tu te d re as on ab le cau se an d d em on st rat edgo odfai th
. Pet it io ne r's arg um en t tha t i t re as on ab ly reli edon McGl adrey fai ls fortwo reas on s. Fi rs t, the reco rdpro vi de s n o e vi de nc e th atMcGl adrey advi se d p et it io ne r reg ard in g t he de du ct ib il ity of t he y eare ndbo nu se s. Sec on d, i n c ha ract eri zi ng as co m pe ns at io n fo r se rv ic es am ou nt s tha t h av e b eende te rm in edto be di vi de nd s, pe ti ti on er fa il edto pro vi de McGl adrey with a ccurat e in fo rm at io n. A tax pa y er's rel ia nc e o n t he pro fes si on al advi ce o f anatt orne y or a n acco un ta ntm ay

co ns ti tu te reas on ab le cau se an d g oo d fa ith. As a ge ne ral rul e, "[t ]he d et erm in at io n o f whe th er a t ax pa y er ac te d wi th reas on ab le cau se an d i n go odfai th is m ad e o n acas 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- 31 -

[* 31 ] an d c irc um st an ces ." Sec . 1.6 66 4- 4( b) (1 ), In co m e Tax Reg s. Inm ak in g t ha t de te rm in at io n, the "m os t i m po rta ntfact or " i s u su al ly "th e ex te ntof t he tax pa y er's effo rt t o a ss es s the tax pa y er's pro pe r ta x l iabi li ty." Id. Rel ia nc e o n t he advi ce o f a pr of es si on al tax advi se r m ay

co ns ti tu te reas on ab le cau se an d g oo d fa ith " if, u nd er al l the cir cu m st an ces , su chrel ia nc e was reas on ab le an d the tax pa y er ac te d i n g oo d fai th ." Id
. Pet it io ne r arg ue s tha t M cGla dr ey 's fa il ur e to ap pr is e itof a ny iss ue co nc ern in g t he de du ct ib il ity of t he y eare ndbo nu se s co ns ti tu te d " advi ce" on whi ch itreas on ab ly reli ed . The reg ul at io ns de fin e advi ce as "an y co m m un ic at io n * * *
se tt in g fo rth th e an al y si s o r co nc lu si on of ape rs on , othe r th anth e ta xp ay er, pr ov id edto (orforth e b en efi t o f) the tax pa y er an d o n wh ic h t he tax pay er re li es * * * wi th res pe ctto th e im po si ti onof t he sec ti on 66 62 accuracy-rela te d p en al ty." Id . par a. (c)( 2) . The p art ie s h av e st ip ul at edth at , bef or e fi li ng it s re tu rnforeach of th e y ears inis su e, pe ti ti on er d idno t s pe ci fic al ly askMcGl adrey whe th er the ful l
am ou ntof t he y eare ndbo nu se s i t p ai d t o s ha reh ol de r at to rn ey s was de du ct ib le as co m pe ns at io n fo r se rv ic es an d M cGla dr ey di d n otco m

m en t o n t he de du ct ib il ity of th e b on us es . In ef

fect , pet it io ne r arg ue s tha t s il en ce ca n b e a "c omm un ic at io n" . In th atreg ard , pet it io ne r ob se rv es th atth e reg ul at io ns do no t re qu ire advi ce t o t ak e "an y parti cu la r fo rm ." See id
.- 32 -

[* 32 ] Whi le th e reg ul at io ns all ow fl ex ib il ity reg ard in g t he form

of a dv ic e, th ey pr ov id e d et ai le d re qu ire m en ts forth e co nt en t o f advi ce tha t ca n c on st itut e reas on ab le cau se an d g oo d fa ith. Fo r ex am pl e, rel iabl e advi ce m

us t b e "b as ed up on all pe rti ne ntfact s an d c irc um st an ces ", itm us t t ak e in to acco un t the ta xp ay er's pu rp os es forit s ac ti on s, an d i t ca nn otbe ba se d o n u nr eas on ab le
as su m pt io ns . Id. s ub pa ra. (1 )(i ) an d (i i). Inpre sc rib in g d et ai le d ru le s re ga rd in g t he co nt en t o f pr of es si on al advi ce o n whi cha ta xp ay er ca n re ly, th e reg ul at io ns ne ces sa ril y co nt em pl at e advi ce tha t, i n so m e fo rm , in vo lv es anex pl ic itco m m un ic at io n. Si le nc e can no t qua li fy as a dv ic e be cau se th ere i s n o way to kno w whethe r anadvi se r, infai li ng to rai se anis su e, co ns id eredall of the rel ev an t fa ct s an d c irc um st an ces , in cl ud in g t he tax pa y er's
subjec ti ve m ot iv at io n. In de ed , an a dv is er's fai lure t o ra is e anis su e d oe s n otpro ve th atth e advi se r ev enco ns id eredth e is su e, m uc h l es s en ga ge d i n a ny anal y si s, o r reac he d aco nc lu si on . As we o bs erv edinNeon at ol og y Ass oc s., P.A. v. Co m m is si on er, 1 15 T.C. 43 , 10 0 (2 00 0) , aff'd , 29 9 F .3d22 1 (3 d C ir. 2 00 2) : "Th e m ere f actth ata cert ifi edpubl ic acco un ta ntha s p rep areda ta x re tu rndo es no t
m eanth athe or s he ha s o pi ne d o n a ny or al l o f th e it em s re po rte d t he rei n." Thu s, we co nc lu de th atMcGl adrey's fai lu re t o ra is e co nc ern s ab ou t the de du ct ib il ity of- 33 -

[* 33 ] th e y eare ndbo nu se s d idno t co ns ti tu te "ad vi ce" withi n t he m ean in g o f
se ct io n 1 .66 64 -4 (c), In co m e Tax Reg s. Altho ug h p rep arat io n o f a t axpa y er's return b y a cert ifi edpubl ic acco un ta nt do es no t p ro vi de cart e b la nc he pro te ct io n a ga in stsubs ta nt ia l u nd ers ta te m en t o r ne gl ig en ce p en al ti es , ou r cas es reco gn iz e th at , inso m e ci rcu m st an ces , a tax pa y er's rel ia nc e o n aco m

pe te ntan d e xp eri en cedacco un ta ntinth e p rep arat io n o f th e ta xp ay er's return m ay

co ns ti tu te reas on ab le cau se an d g oo d fa ith. To sh ow g oo d fai th rel ia nc e, ho wev er, "t he tax pa y er m us t es tabl is h t ha t the return p rep arerwas supp li edwith a ll ne ces sa ry in fo rm at io n andth e in co rrec t re turnwas ares ul t o f th e pr ep arer 's m is ta ke s." W ei s v . Comm is si on er, 9 4 T.C. 4 73 , 48 7 (1 99 0) ; s ee al so W es tb ro okv. Co m

m is si on er, 6 8 F .3d86 8, 8 81 (5t h C ir. 1 99 5) , aff'g T.C. Mem o. 19 93 -6 34 ; En oc h v . Comm is si on er, 5 7 T.C. 7 81 , 80 2 (1 97 2) ("Th e u lt im at e res po ns ib il ity

fora co rrec t re tu rnli es with t he tax pay er, wh o m us t atlea stfurni sh th e n eces sa ry

in fo rm at io n t o h is ag en t wh o p rep aredth e return." ). Pet it io ne r co ul d n otha ve rel ie d i n g oo d fa ith o n M cGla dr ey 's p rep arat io n o f it s re tu rn s fo r th e y ears inis su e b ecau se itpro vi de d M cGla dr ey with i na ccu rat e in fo rm at io n. Th e err orth atledto th e cl ai min g o f th e d is al lo wedde du ct io n was , in th e fi rs t i ns ta nc e, pe ti ti on er's
.- 34 -

[* 34 ] Pet it io ne r co ns is te nt ly foll owe d asyste m of c om pu ti ng y eare ndbo nu se s th atdi sr eg ard edth e v al ue of i ts sh areh ol de r at to rn ey s' i nt eres ts inth e cap it al of t he firm an d i napp ro pr ia te ly treat edas c om pe ns at io n a m ou nt s tha t el im in at edth e firm 's b oo k i nc om e. The re co rdpro vi de s n o e vi de nc e th atpe ti ti on er b as edth at pr act ic e o n t he advi ce o f McGl adrey orany ot he r qu al ifi edtax pro fes si on al
. Altho ug h p et it io ne r of

fere d n o e vi de nc e as to why itad op te d i ts pra ct ic e o f pa y in g y eare ndbo nu se s, i t i s d iff ic ul t t o i m ag in e rea so ns th atare n ottax rel at ed . Becau se th e p ro po rti on at e o wne rs hi p i nt eres ts of p et it io ne rs ' sh areh ol de r at to rn ey s ar e (wit h m in orex cep ti on s) id en ti cal to th ei r pr op orti on at e sh ares of c om pe ns at io n, th e ch arac te riz at io n o f a d is tri bu ti on as e ithe r a d iv id en d o r ad di ti on al
co m pe ns at io n h as no ap pa ren t ec on om ic co ns eque nc e. Pet it io ne r's sh areh ol de r at to rn ey s wo ul d re cei ve th e sa m e am ou nt s ei th er way. Pet it io ne r arg ue s tha t the bo ardaward edy eare ndbo nu se s tha t ex act ly zeroe d o utbo okin co m e "b ecau se th e Bo ardbe li ev edth is ap pr oa chwas an app ro pr ia te m an ne r inwhi chto co m pe ns at e it s s ha reh ol de rs forth ei r se rv ic es ." Bu t i t wo ul d b e a s tri ki ng co in ci de nc e if , y ear aft er y ear, the actua l v al ue of the servi ces pro vi de d b y pe ti ti on er's sh areh ol de r at to rn ey s ex act ly equ al edth e am ou nt s n eces sa ry to eli m in at e p et it io ne r's bo ok in co m e. The o nl y

ap paren t co ns eque nc e o f ch arac te riz in g a s ad di ti on al
co m pe ns at io n a m ou nt s tha t wo ul d o th erwi se be av ai labl e fo r di st rib ut io n a s- 35 -

[* 35 ] di vi de nd s i s t o re du ce p et it io ne r's co rp or at e in co m e ta x l iabi li ty. Ther efo re, whi le itm ay

be tru e, as pe ti ti on er cl ai m s, tha t the bo arddi d n otco ns id er the Fed eral in co m e ta x c on se qu en ces of i ts m etho d o f de te rm in in g yearen d b on us es , we do ub t tha t t ax es were i gn or edinth e in it ia l d es ig n o f th atm etho d. Bec au se pe ti ti on er i ni ti at edforit s o wn re as on s- -wh at ev er tho se reas on s m ig htha ve be en --the pra ct ic e o f pa y in g yearen d b on us es th ateli m in at edit s b oo k in co m e, any

cu lp ab il ity

of M cGla dr ey

was s eco nd ary, infai li ng to reco gn iz e pe ti ti on er's erro ne ou s ch arac te riz at io n o f part o f th e y eare ndbo nu se s. As a ge ne ral m at te r, inth e fu lfi ll m en t o f pr of es si on al res po ns ib il it ie s, an acco un ta nt pr ep ari ng or s ig ni ng a return i s en ti tl edto rel y on in fo rm at io n fu rn is he d b y th e ta xp ay er an d h as on ly a lim it edob li ga ti on to m ak e in qu iri es inth e cas e o f
m an ife sterro rs . See 3 1 C .F.R. se c. 10 .34 (d ) (2 00 8) (du ti es of r eturn p rep arer s un de r ru le s g ov ern in g p ract ic e b efo re In te rn al Rev enue Serv ic e, effe ct iv e fo r returns fil edaft er Se pt em be r 26 , 20 07 ); i d. s ec. 1 0.3 4( c) (s am e, be fo re am en dm en t by T. D. 93 59 , 20 07 -2 C.B. 9 31 ); Am eri canIns ti tu te of C ert ifi edPubl ic Acco un ta nt s, St at em en t o n S ta nd ard s fo r Tax Serv ic es No. 3 , Cert ai n P ro cedur al Asp ect s o f Prep ari ng Returns (20 00 ); s ee al so Whi te ho us e Hot el Ltd . P'sh ip v. Co m m is si on er, 1 39 T.C. 30 4, 3 59 -3 60 (20 12 ) (t ak in g i nt o a cco un t re le vant pr of es si on al st an da rd s i n e va lu at in g atax pa y er's ab il ity to rel y onreturn p rep arer ),- 36 -

[* 36 ] aff'dinpart, v acat edinpart a ndrem an de d, 7 55 F.3d23 6 (5 th Cir . 20 14 ). McGl adrey's fai lu re t o b rin g t o p et it io ne r's att en ti onth e p os si bl e m is ch arac te riz at io n o f th e y eare ndbo nu se s d oe s n otab so lv e p et it io ne r of
res po ns ib il ity

be cau se th e m is ch arac te riz at io n was pe ti ti on er's do in g i n t he fir st pl ace. In de ed , pet it io ne r pr ov id edto McGl adrey Fo rm s W-2 tha t ch arac te riz edth e am ou nt s p ai d t o s ha reh ol de r at to rn ey s as em pl oyee co m

pe ns at io n. Th eref

or e, pe ti ti on er's rel ia nc e o n M cGla dr ey inpre parin g i ts returns forth e y ears inis su e do es no t co ns ti tu te reas on ab le cau se an d g oo d fa ith a nddo es no t re li ev e p et it io ne r of li ab il ity forth e acc ur acy-rela te d p en al ty. Pet it io ne r arg ue s tha t the "n o- ch an ge " l et te r itrece iv edat t he co nc lu si on of th e au di t o f it s 2 00 6 re tu rnhe lp s t o s ho w th atit s treat m en t o f th e y eare ndbo nu se s was no t " to o g oo d t o b e true ", an d t ha t, co ns eque nt ly, it s re li an ce o n M cGla dr ey was reas on ab le . Peti ti on er co nc ed es , ho wev er, tha t the no -ch an ge let te r is no t " of it se lf * * * su ffi ci en t t o e st ab li sh reas on ab le cau se an d g oo d fa ith." The re co rd pr es en ts no ev id en ce tha t M r. Berg , th e ag en t wh o e xa m in edpe ti ti on er's 20 06 return, s pe ci fic al ly con si de redth e d educ ti bi li ty of an y y eare ndbo nu s p ai d i n t ha t y ear. Mo reo ve r, th e ev id en ce i nt ro du ceddo es no t cl earl y est ab li sh th atMr. Ber g was pro vi de d wi th su ffi ci en t i nf orm at io n t o b rin g t he is su e to hi s at te nt io n. Pet it io ne r fai le d t o i nt ro du ce the bo ardm inut es pro vi de d t o M r. Berg th at- 37 -

[* 37 ] pe ti ti on er's ch ie f fi na nc ia l o ffi cer, M r. Ren di no , all eg edwou ldha ve de sc rib edpe ti ti on er's pra ct ic e o f award in g yearen d b onus es de si gn edto zero ou t bo okin co m e. Sim il arl y , pet it io ne r fai le d t o i nt ro du ce the fin an ci al st at em en ts pr ov id edto Mr. Ber g. Ev enass um in g t ha t p et it io ne r's in co m e st at em en t fo r 20 06 , li ke th os e fo r 20 07 an d 2 00 8, s ho wedrev enue ex act ly equ al to ex pe ns es , itwou ld
no t n eces sa ril y

ha ve id en ti fie d t he y eare ndbo nu se s as th e fac to r th atpro du cedth at co in ci de nc e. Mo reo ve r, reg ard le ss of t he 20 06 no -ch an ge let te r, we ha ve alr eady co nc lu de d t ha t p et it io ne r's rel ia nc e o n M cGla dr ey di d n otco ns ti tu te reas on ab le
cau se or g oo d fa ith b ecau se McGl adrey di d n otpro vi de pe ti ti on er wi th advi ce reg ard in g t he de du ct ib il ity of t he y eare ndbo nu se s, wh il e th e in fo rm at io n t ha t pe ti ti on er p ro vi de d t o M cGla dr ey was i na ccurat e in ch arac te riz in g a s co m pe ns at io n fo r se rv ic es am ou nt s tha t h av e b eende te rm in edto be di vi de nd s. IV. Co nc lu si on Fo r th e rea so ns ex pl ai ne d abo ve , pet it io ne r fai le d t o s ho w th atitha d
reas on ab le cau se forde du ct in g i n fu ll th e y eare ndbo nu se s i t p ai d t o i ts sh areh ol de r at to rn ey s i n t he y ears inis su e o r th atitact edingo odfai th incla im in g th os e d educ ti on s. Th eref or e, se ct io n 6 66 4( c)(1 ) pr ov id es pe ti ti on er wi th no de fen se to th e im

po si ti on of a ccu racy-rela te d p en al ti es . Becau se we ha ve de te rm in edth atpe ti ti on er d idno t h av e subs tant ia l au th or ity forth e d educ ti on s i n- 38 -

[* 38 ] is su e an d b ecau se , con se qu en tl y , th e p art ie s' a gr eedtre atm en t o f pa rt o f th e bo nu s i n e achy ear a s a n on de du ct ib le di vi de ndin crea se d a"s ub st an ti al
un de rs ta te m en t" , withi n the m ean in g o f se ct io n 6 66 2( d) (1 )(A), the accu racyrel at edpe na lty

ap pl ie s t o the po rti on of p et it io ne r's un de rp aym en t fo r eac h year at tri bu tabl e to th e rec ha ract eri zat io n o f pa rt o f th e b onus es . Deci si on wil l b e en te redun de r Ru le 15 5.