1 All section references are to the Internal Revenue Code

in effect for the year in issue, and all Rule references are to

(continued...)

T.C. Memo. 1998-255

UNITED STATES TAX COURT

NEIL J. CHRISTAL, II & KATHRYN E. CHRISTAL, Petitioners v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 12793-96. Filed July 13, 1998.

Dana C. Christian and David Prince, for petitioners.

Laurel Robinson and Thomas G. Schleier, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

VASQUEZ, Judge: Respondent determined a deficiency of

$36,856, an addition to tax under section 6651(a)(1) of $9,193,

and a penalty under section 6662(a) of $7,371 in petitioners'

1992 Federal income tax.1
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1(...continued)

the Tax Court Rules of Practice and Procedure.

2 The statutory notice of deficiency sets forth numerous

adjustments. In their briefs, petitioners only address whether

United Sovereigns was a nullity or sham trust and fail to address

any other adjustments in the notice of deficiency. Therefore, we

find that petitioners have abandoned all issues other than

whether United Sovereigns was a nullity or sham trust. Petzoldt

v. Commissioner, 92 T.C. 661, 683 (1989).

The issue for decision is whether United Sovereigns "A

Trust" (United Sovereigns) is a nullity or sham trust.2

FINDINGS OF FACT

Some of the facts have been stipulated and are so found. 

The stipulation of facts and the attached exhibits are

incorporated herein by this reference. Petitioners Neil J.

Christal (Mr. Christal) and Kathryn E. Christal (Mrs. Christal),

husband and wife, resided in Belmont, California, at the time

they filed their petition.

In 1986, Mr. Christal, Gregory Phelps (Mr. Phelps), and Dan

Cantore formed a corporation named United Sovereigns, Inc. 

United Sovereigns, Inc., was a "multi-level" organization which

promoted the principles of network marketing and offered services

and activities to customers including, but not limited to, a

monthly newsletter, tax services, and estate planning. The

customers of United Sovereigns, Inc., paid $50 a month to receive

these services. Customers of United Sovereigns, Inc., could have

the monthly fee withdrawn automatically from their bank account
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3 Although the record is unclear, it appears that Dan

Cantore owned the remaining 33a shares of United Sovereigns,

Inc.

by Electronic Funds Transfer Services (EFTS) which would transmit

the payment to United Sovereigns, Inc.

Mr. Christal and Linda Menon (Ms. Menon) were the

signatories on the bank account of United Sovereigns, Inc. In

1990, United Sovereigns, Inc., reported total income of $150,194

on its Form 1120 tax return. In 1989 and 1990, Mr. Christal

received income from United Sovereigns, Inc., in the amounts of

$41,927 and $35,225, respectively. During this time, Mr.

Christal was the president of United Sovereigns, Inc. 

During 1990, United Sovereigns, Inc., used 2228 S. El Camino

Real #400, San Mateo, California, as its mailing address. United

Sovereigns, Inc., used office space at 1941 O'Farrell Street,

Room 8, San Mateo, California. 

On November 10, 1990, United Sovereigns, Inc., ceased doing

business. On December 15, 1990, Mr. Christal and Mr. Phelps

commenced dissolving and winding up the affairs of United

Sovereigns, Inc. At the time of the closure of United

Sovereigns, Inc., Mr. Christal and Mr. Phelps each held 33a

shares of United Sovereigns, Inc.3
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4 We use the words "trust", "trust document", "trustee",

"grantor", and "form" in our findings of fact for convenience

only. We do not intend our use of these terms to indicate any

conclusion about the substance of the transactions at issue.

5 According to the trust document, the only property placed

into United Sovereigns was "checking and savings accounts". This

appears to be a mistake, which neither of the parties clarifies,

as only one bank account was placed into United Sovereigns. 

On October 30, 1990, United Sovereigns "A Trust" was

formed.4 United Sovereigns' stated purpose was: "To provide for

the administration of the assets by natural or corporate persons

acting in a fiduciary capacity to preserve, conserve, maintain,

invest, and develop the assets for the benefit of the certificate

holders and in a manner designated in this instrument." 

The trust document listed Mr. Phelps as the grantor of

United Sovereigns. Mr. Christal was appointed as trustee of

United Sovereigns. Mr. Christal then selected and appointed Ms.

Menon as a United Sovereigns trustee. United Sovereigns'

trustees were to act as "unbiased, independent fiduciaries in the

best interests of the certificate holders, and in strict

conformity with the guidelines and requirements of this trust

instrument." During 1992, Mr. Christal and Ms. Menon were the

trustees of United Sovereigns. 

The funds of United Sovereigns, Inc., including its bank

account, were placed into United Sovereigns' checking account.5

Mr. Christal and Ms. Menon were the signatories on United

Sovereigns' checking account. 
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Amaranth Holding Trust (Amaranth) held the 100 certificates

of interest issued by United Sovereigns. In 1989, petitioners

formed Amaranth. Amaranth issued 100 certificates of interest--

50 to Mr. Christal and 50 to Mrs. Christal. Petitioners

continued to hold the Amaranth certificates up to and through

1992. Thus, petitioners, through Amaranth, were the ultimate

beneficiaries of United Sovereigns. 

Mr. Christal had the power to distribute the principal or

income of United Sovereigns to Amaranth or to convert the trust

property into cash and distribute it to its certificate holders

for their support, care, maintenance, education, medical

expenses, or emergencies. Additionally, United Sovereigns could

only be terminated with the approval of its current

beneficiaries. 

United Sovereigns promoted the principles of network

marketing and offered services and activities to customers

including, but not limited to, a monthly newsletter, tax

services, and estate planning. Customers of United Sovereigns

paid $50 a month to receive these services. The customers could

have the monthly fee withdrawn automatically from their bank

account by EFTS which would transmit the payment to United

Sovereigns. In 1992, United Sovereigns reported total income of

$144,976 on its Form 1041. 
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During 1992, Mr. Christal was the president of United

Sovereigns, and as such he had the day-to-day, hands-on

responsibility for the operation of United Sovereigns. Mr.

Christal wanted to maintain uniformity between United Sovereigns

and United Sovereigns, Inc. United Sovereigns took over the

client base of United Sovereigns, Inc. United Sovereigns

maintained the same policies and procedures as United Sovereigns,

Inc. United Sovereigns used the forms and stationery of United

Sovereigns, Inc., in conducting its business, although it

sometimes crossed out "Inc." In 1992, United Sovereigns used the

same mailing address and office space that United Sovereigns,

Inc., used in 1990. 

During 1992, Alta Business Services (Alta), which Ms. Menon

owned and operated, provided bookkeeping services to United

Sovereigns. Alta provided the same services to United

Sovereigns, Inc., and to other business entities. 

United Sovereigns did not have a formal system for Ms.

Menon, as trustee, to inform Mr. Christal that she disagreed with

his United Sovereigns expenditures except through a bookkeeping

system in which expenses were recorded and reports were generated

and reviewed.

From January through May of 1992, Alta issued bookkeeping

reports prepared by Ms. Menon and Yury Bajgrowicz (Mr.

Bajgrowicz) which requested information about certain United
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Sovereigns checks (such as the amount, or category, of the check)

written on United Sovereigns' checking account. After May of

1992, Alta issued bookkeeping reports prepared only by Mr.

Bajgrowicz. Alta issued the bookkeeping reports only to Mr.

Christal. There is no indication that Ms. Menon ever challenged

any of United Sovereigns' expenditures. 

During 1992, the employees of United Sovereigns were Mr.

Christal and Jacqueline Johanson (Ms. Johanson). Ms. Johanson

was the administrative assistant. In 1992, United Sovereigns

paid (as cash disbursements) approximately $4,800 to Mr. Christal

and approximately $17,100 to Ms. Johanson. Mr. Christal reported

$6,000 in wages from United Sovereigns on his 1992 Form 1040 tax

return. 

In 1992, the only vehicle used for United Sovereigns'

business was a 1984 Volvo (the Volvo). Mr. Christal did not

provide a mileage log for the use of the Volvo. Amaranth owned

the Volvo and a 1989 Dodge Caravan (the Caravan). 

In 1992, United Sovereigns claimed automobile expenses in

the amount of $2,600 representing lease payments made to Amaranth

for the Volvo. Amaranth and United Sovereigns, however, did not

have a written rental agreement with respect to the lease of the

Volvo. 

On March 16, 1992, Ms. Menon signed United Sovereigns' check

2239 which was payable to Redwood City Dodge in the amount of
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$543.45. The receipt listed Mr. Christal, and not United

Sovereigns, as the customer. The automobile repaired was the

Caravan, and the receipt was stamped "paid" with check 2239 noted

on the receipt. Mrs. Christal signed the receipt. 

In 1992, United Sovereigns paid for automobile work

completed on the Caravan in the amount of $429.05 with United

Sovereigns' check 3103. United Sovereigns claimed the $429.05

spent on the Caravan as a business expense. 

In 1992, United Sovereigns claimed $559.97 it paid to

Competition Motors as an automobile expense. The Competition

Motor receipt listed Mr. Christal, and not United Sovereigns, as

the customer. 

On January 10, 1991, Mr. Christal signed a Pioneer Health

insurance application. In 1992, United Sovereigns paid for the

Pioneer Health insurance which covered petitioners and their

children, and it deducted the policy's full cost on its 1992 tax

return. United Sovereigns did not pay health insurance premiums

for Ms. Menon or Ms. Johanson. 

In 1992, United Sovereigns paid for a Price Club membership. 

Mr. and Mrs. Christal's names were on the Price Club application. 

No other names were on the Price Club application. United

Sovereigns claimed the Price Club membership fee as a supply.

In 1992, United Sovereigns paid for a Reader's Digest

subscription for Mrs. Christal and claimed the subscription as a
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dues and publications expense. Additionally, Reader's Digest

billed Mr. Christal for Condensed Books at his home address. 

United Sovereigns paid the outstanding bill and claimed the

expense as a dues and publications expense. 

Mr. Christal submitted receipts from restaurants or grocery

stores for food purchases as substantiation for United

Sovereigns' office supplies and "promo" expenses. Additionally,

Mr. Christal submitted receipts, which referenced Mrs. Christal,

from Matol Botanical International for the purchase of five

bottles worth $35 each as substantiation of United Sovereigns'

office expenses. 

Throughout 1992, $6,900 was withdrawn as petty cash from

United Sovereigns' checking account. Petitioners maintained no

record of how that cash was spent. 

OPINION

Petitioners contend that United Sovereigns is a valid

entity, legally independent and separate from Mr. Christal as an

individual, and that United Sovereigns and the transactions in

which it took part should be respected for Federal tax purposes. 

Respondent contends that United Sovereigns is a sham, it has no

economic substance, and United Sovereigns existed for no purpose

aside from being used to obtain tax benefits for petitioners;

thus, the income of United Sovereigns is taxable wholly to

petitioners. We agree with respondent.
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A fundamental principle of tax law is that income is taxed

to the person who earns it. Commissioner v. Culbertson, 337 U.S.

733, 739-740 (1949); Lucas v. Earl, 281 U.S. 111 (1930). An

assignment of income to a trust is ineffective to shift the tax

burden from the taxpayer to a trust when the taxpayer controls

the earning of the income. Vnuk v. Commissioner, 621 F.2d 1318,

1320 (8th Cir. 1980), affg. T.C. Memo. 1979-164.

Taxpayers have the right to conduct their transactions in

such a manner and form as to minimize or altogether avoid the

incidence of taxation by whatever means the law permits. Gregory

v. Helvering, 293 U.S. 465, 469 (1935). This right, however,

does not bestow upon taxpayers a right to structure a paper

entity to avoid taxation when that entity is without economic

substance. Zmuda v. Commissioner, 79 T.C. 714, 719 (1982), affd.

731 F.2d 1417 (9th Cir. 1984). The Commissioner is not required

to apply the tax laws in accordance with the form a taxpayer

employs where that form is a sham or inconsistent with economic

reality. Higgins v. Smith, 308 U.S. 473, 477 (1940). 

Application of these principles requires us to look beneath the

surface of the entity and transactions at issue to examine their

reality. Professional Servs. v. Commissioner, 79 T.C. 888, 924

(1982).

Where an entity is created that has no real economic effect

and which affects no cognizable economic relationships, the
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substance of a transaction involving this entity will control

over its form. Zmuda v. Commissioner, 731 F.2d at 1420-1421;

Markosian v. Commissioner, 73 T.C. 1235, 1241 (1980). If a trust

has no economic substance apart from tax considerations, the

trust is not recognized for Federal tax purposes. Markosian v.

Commissioner, supra at 1244-1245; Furman v. Commissioner, 45 T.C.

360, 364 (1966), affd. per curiam 381 F.2d 22 (5th Cir. 1967). 

These principles apply even though an entity may have been

properly formed and have a separate existence under applicable

local law. Zmuda v. Commissioner, 79 T.C. at 720.

Whether a trust lacks economic substance for tax purposes is

a factual question to be decided on the basis of the facts before

the Court. Paulson v. Commissioner, T.C. Memo. 1991-508, affd.

per curiam 992 F.2d 789 (8th Cir. 1993) (citing United States v.

Cumberland Pub. Serv. Co., 338 U.S. 451 (1950)). Additionally,

when the settlor is trustee and the beneficiaries are the settlor

and his family, such trust arrangements must be closely

scrutinized for economic substance. Markosian v. Commissioner,

supra at 1245; see Helvering v. Clifford, 309 U.S. 331, 334

(1940). Petitioners bear the burden of proof. Rule 142(a).

We consider the following factors to determine whether a

purported trust lacks economic substance for Federal income tax

purposes: (1) Whether the taxpayer's relationship, as grantor,

to the property differed materially before and after the trust's
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formation; (2) whether the trust had an independent trustee; (3)

whether an economic interest passed to other beneficiaries of the

trust; and (4) whether the taxpayer felt bound by any

restrictions imposed by the trust itself or the law of trusts. 

See Zmuda v. Commissioner, 79 T.C. at 720-722; Markosian v.

Commissioner, supra at 1243-1245; Hanson v. Commissioner, T.C.

Memo. 1981-675, affd. per curiam 696 F.2d 1232 (9th Cir. 1983).

With respect to the first factor, we look to the economic

reality of a purported arrangement to determine who actually is

the settlor of a trust, whether or not named as settlor in the

related documents. Zmuda v. Commissioner, 79 T.C. at 720. 

Although the documents list Mr. Phelps as the settlor of United

Sovereigns, it appears that Mr. Phelps acted merely as a "straw

man" to form United Sovereigns. We note that Mr. Phelps, the

supposed grantor of United Sovereigns, was not called as a

witness. We infer that his testimony would not have been

favorable to petitioners. Wichita Terminal Elevator Co. v.

Commissioner, 6 T.C. 1158, 1165 (1946), affd. 162 F.2d 513 (10th

Cir. 1947). 

Mr. Christal had signatory authority over the bank account

of United Sovereigns, Inc., before and after its transfer to

United Sovereigns. Mr. Christal claims that his portion of the

United Sovereigns, Inc., moneys left over at its dissolution was

used to pay off the debts of United Sovereigns, Inc. There is no
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evidence, however, of the amount of the debts that existed, what

the debts entailed, or how these debts were paid. Furthermore,

petitioners have not produced any documentation or records of how

the assets of United Sovereigns, Inc., were divided among its

shareholders. We again infer that Mr. Phelps' testimony

regarding these facts would not have been favorable to

petitioners. Id.

United Sovereigns' business was the same as that of United

Sovereigns, Inc. Mr. Christal made all important business

decisions with little or no input from anyone else, he controlled

United Sovereigns' earning of income, and he dealt with that

income as his own. This factor points to a sham.

We find likewise with respect to the second factor; i.e.,

United Sovereigns lacked a bona fide independent trustee. The

failure of a nominal trustee to have any meaningful role in the

operation of the trust has been repeatedly cited by this Court as

evidence that the entity lacks economic substance. See, e.g.,

Zmuda v. Commissioner, 79 T.C. at 720-721; Para Techs. Trust v.

Commissioner, T.C. Memo. 1994-366, affd. without published

opinion sub nom. Anderson v. Commissioner, 106 F.3d 406 (9th Cir.

1997). Additionally, Mr. Christal had signature authority over

United Sovereigns' bank account, which meant that he had access

to the funds contained therein. Contrary to the assertions of

Mr. Christal and Ms. Menon, Ms. Menon could not and did not
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prevent Mr. Christal from using United Sovereigns' property for

his own purposes.

As to the third factor, we find no probative evidence in the

record to indicate that petitioners transferred an economic

interest to a third party. Based on our review of the record, we

are satisfied that petitioners are the beneficiaries of United

Sovereigns.

As to the fourth factor, we find that Mr. Christal was not

in practice bound by any restrictions imposed by United

Sovereigns' trust instrument or the law of trusts as to the use

of the transferred property. His unrestricted use of United

Sovereigns' property leads us to believe that Mr. Christal was

not in fact restricted in any meaningful manner, including

fiduciary restraints.

Additionally, petitioners presented no credible evidence

that any purpose other than tax avoidance was served by the

entity to which Mr. Christal transferred his business activities. 

From the foregoing, we conclude there was no nontax purpose for

the creation of United Sovereigns, and in accordance with

Markosian v. Commissioner, supra, and the numerous opinions

relying thereon, we conclude that United Sovereigns lacked

economic substance for Federal tax purposes. Accordingly, we

hold that the trust structure of United Sovereigns shall not be
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respected for Federal income tax purposes, and the income from

United Sovereigns is taxable wholly to petitioners.

In reaching all of our holdings herein we have considered

all arguments made by the parties, and to the extent not

mentioned above, we find them to be irrelevant or without merit.

To reflect the foregoing,

Decision will be entered

under Rule 155.