T.C. Memo. 2002-24

UNITED STATES TAX COURT

MICHAEL GRAHAM, Petitioner v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 18341-99. Filed January 24, 2002.

Andrew G. Shebay III and Robert B. Higgs, for petitioner.

Shelly T. Van Doran and Ronald B. Weinstock, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

FOLEY, Judge: By notice dated September 8, 1999, respondent

determined deficiencies in, and a penalty relating to,

petitioner’s Federal excise taxes as follows: 
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1 All section references are to the Internal Revenue Code

in effect for the years in issue.

 Deficiencies Penalty

Year Sec. 4941(a)(1)1 Sec. 4941(b)(1) Sec. 6684

1993 $ 9,894 -- --

1994 14,156 -- --

1995 17,531 -- --

1996 20,756 -- --

1997 23,981 -- --

1998 27,206 -- --

1999 30,431 $1,217,240 $1,361,195

The issue for determination is whether petitioner was a

substantial contributor who engaged in prohibited acts of selfdealing with the Irene Cafcalas Hofheinz Foundation (Foundation)

during the years in issue.

FINDINGS OF FACT

Petitioner resided in Houston, Texas, when he filed his

petition. 

On December 1, 1989, Bluff Creek Corporation (Bluff Creek)

was incorporated pursuant to Texas law. Petitioner’s wife,

Rosalind Graham, was the sole beneficial owner of Bluff Creek’s

stock until November 1992, when she became the sole shareholder. 

On December 8, 1989, Bluff Creek purchased a house (the

residence) for $630,000. Petitioner and his wife lived in the

residence from that date through 1998. 

Beginning in mid-1992, petitioner developed a business

relationship with Fred Hofheinz. Mr. Hofheinz was a businessman

and attorney in Houston. Mr. Hofheinz was also the trustee of
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the Foundation, which was created in 1983, out of the trust

created by his mother’s will. As of the end of 1992, the

Foundation had received contributions and bequests of $2,371,589.

 Mr. Hofheinz participated in several of petitioner’s business

deals. Beginning in mid-1992, Mr. Hofheinz also made several

unsecured personal loans to petitioner, totaling more than $1

million (i.e., ranging from $20,000 to $352,137). 

On September 28, 1992, petitioner was indicted for Federal

income tax evasion. After the indictment, petitioner needed

$200,000 to pay his attorney. He sought, but Mr. Hofheinz was

unwilling to extend, another unsecured personal loan to

petitioner. Petitioner and Mr. Hofheinz, however, entered an

oral purchase agreement (agreement) for the Foundation to

purchase the residence. At Mr. Hofheinz’s direction, the

Foundation purchased the residence, which had a fair market value

of $535,000. The agreement provided that in exchange for the

residence petitioner: (1) Would receive $250,000 to pay his

criminal attorney and other debts; (2) could later ask for, and

receive, an additional $135,000; and (3) could continue to live

in the residence rent-free for 3 years. Petitioner was

responsible for payment of taxes and insurance on the residence,

but he failed to pay the 1993 property taxes. 

Mr. Hofheinz believed that purchasing the residence was a

good deal for the Foundation and that the purchase price was far
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enough below its $630,000 tax assessment value that it would

allow the Foundation a substantial profit. 

In 1992, petitioner entered into a plea bargain relating to

the Federal income tax evasion indictment. The plea bargain

required him to pay fines and back taxes of $135,000. Pursuant

to the purchase agreement, on June 3, 1993, Mr. Hofheinz

transferred to petitioner an additional $135,000 of Foundation

funds. 

Petitioner and Mr. Hofheinz’s relationship deteriorated in

1995. In 1996, after Mr. Hofheinz began proceedings to evict

them from the residence, Mrs. Graham filed a bankruptcy petition. 

In the bankruptcy proceeding, Mrs. Graham contended that the sale

was invalid because petitioner had no interest in the residence

owned by Bluff Creek and, therefore, could not sell it. 

Although a backdated document (i.e., signed by Mr. Hofheinz

and petitioner sometime after June 3, 1993) stated that the

$135,000 payment was for the Grahams’ furniture, the furniture

remained in their possession. During Mrs. Graham’s bankruptcy

proceeding, the Foundation did not file a claim relating to the

furniture, and Mr. Hofheinz testified that the additional

$135,000 was consideration provided to the Grahams in exchange

for the residence. The bankruptcy court concluded that the 1992

transaction was a sale of the residence to the Foundation but did

not determine what constituted the consideration exchanged for
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the residence. Mrs. Graham appealed the ruling. On November 16,

2000, in an unpublished opinion, the Court of Appeals for the

Fifth Circuit affirmed the bankruptcy court’s decision. 

Respondent determined that petitioner sold the property at a

“bargain” price, resulting in a contribution to the Foundation

sufficient to make petitioner a substantial contributor. 

Consequently, respondent determined deficiencies pursuant to

section 4941 and a section 6684 penalty, as set forth earlier. 

OPINION

Section 4941(a)(1) imposes an excise tax on acts of selfdealing between a private foundation and a disqualified person. 

Section 4941(b)(1) imposes a second-tier tax on an act of selfdealing that is not corrected within the taxable period. Selfdealing transactions include sale and leases of property and

loans between a disqualified person and a private foundation, as

well as transfers of a foundation’s assets to a disqualified

person. Sec. 4941(d)(1). 

Disqualified persons include substantial contributors to a

foundation, as defined in section 507(d)(2). Sec. 4946(a)(1)(A),

(2). A substantial contributor is a person who, in the

aggregate, contributed “more than $5,000 to the private

foundation, if such amount is more than 2 percent of the total

contributions * * * received by the foundation before the close

of the taxable year of the foundation in which the contribution 
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* * * is received by the foundation from such person.” Sec.

507(d)(2)(A); Dupont v. Commissioner, 74 T.C. 498, 502 (1980). 

Contributions are valued at their fair market value when received

by the foundation. Sec. 507(d)(2)(B)(i); sec. 1.507-6(c)(2),

Income Tax Regs.

Respondent contends that the sale was completed on November

10, 1992, for $250,000; the difference between the fair market

value of the residence and the consideration petitioner received

for such residence was a contribution to the Foundation; and, as

a result, petitioner is a substantial contributor to the

Foundation, liable for first- and second-tier excise taxes

pursuant to section 4941. Petitioner contends that he lacked

donative intent and, thus, was not a substantial contributor. 

Petitioner further contends that the consideration for the sale

included the initial $250,000, the subsequent payment of

$135,000, and 3 years of rent-free occupation of the residence.

We agree with the bankruptcy court and respondent that the

sale was completed on November 10, 1992, when the residence was

transferred to the Foundation. We, however, agree with

petitioner that the consideration for the sale included the

initial payment made on November 10, 1992, the subsequent payment

made on June 3, 1993, and the 3-year period of rent-free

occupation of the residence.
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2 The present value was adjusted to take into account the

value of the tenants’ payment of property taxes and insurance.

On November 10, 1992, petitioner sold the residence to the

Foundation. The Foundation gave petitioner $250,000, and

petitioner and his wife continued to live in the residence, rentfree for 3 years. On June 3, 1993, the Foundation transferred an

additional $135,000 to petitioner. Respondent’s expert testified

that on November 10, 1992, the present value of 3 years of rent

was $111,371,2 and the present value of the additional $135,000

payment was $131,905. Thus, according to the uncontradicted

testimony of respondent’s expert, on November 10, 1992, the fair

market value of the residence was $535,000 and the present value

of the $250,000 payment, the $135,000 payment, and the rent-free

occupation of the residence was $493,276.

Petitioner may be a substantial contributor only if the

transfer to the Foundation exceeds $47,432, which is 2 percent of

the total contributions received by the Foundation at or before

the end of 1992 (i.e., $2,371,589). Sec. 507(d)(2)(A). 

Petitioner’s net transfer of $41,724 (i.e., the difference

between the $535,000 fair market value of the residence and the

$493,276 consideration received from the Foundation) was

insufficient to make him a substantial contributor to the

Foundation. At trial, respondent conceded that petitioner would

not be a substantial contributor if the Court found that the
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consideration exchanged for the residence included the $250,000

and $135,000 payments and 3 years of rent-free occupancy of the

residence. Thus, we need not determine whether petitioner’s

transfer of the residence to the Foundation was a contribution,

or whether petitioner had donative intent relating to such

transaction. Accordingly, petitioner is not liable for any

excise tax pursuant to section 4941(a)(1) or (b)(1). 

Section 6684 imposes a penalty on a person who becomes

liable for a chapter 42 excise tax (i.e., such as those imposed

by section 4941) where the act or omission was not due to

reasonable cause and the person had been previously liable. The

penalty is also imposed when the act or omission was both willful

and flagrant. Because petitioner is not liable for tax pursuant

to chapter 42, petitioner is not liable for this penalty.

Contentions we have not addressed are moot, irrelevant, or

meritless. 

To reflect the foregoing,

Decision will be entered

for petitioner.