T .C. Mem o. 2 01 3- 13 4

UNITED STAT ES TAX COURT

ALAN J. POW ERS AND SUSAN E. POW ERS, Pet it io ne rs v. COMM ISSI ONER OF INTERNAL REVENUE, Resp on de nt

Doc ke t No . 12 63 4- 10

. Fil edMay 29, 2 01 3.

Alan J. Po wers an d S us an E. Powers , pro ses e. Heat he r K. McCl us ke y

forres po nd en t.

MEMORANDUM FINDINGS OF FACT AND OPINION
LARO, Ju dg e: The i ns ta nt pe ti ti on in vo lv in g p et it io ne rs ’ 20 04 , 20 05 , and 20 06 Fed eral in co m e ta x re tu rn s s eek s re de te rm in at io n o f res po nd en t’s de te rm in at io ns of d efi ci en ci es an d a ccu racy-rela te d p en al ti es as f ol lo ws:-2

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[* 2] Year Defi ci en cy Pen al ty se c. 66 62 20 04 $1 65 ,63 8 $3 3,1 27 .60 20 05 11 ,91 7 2,3 83 .40 20 06 4,2 89 85 7.8 0 Afte r pe ti ti on ers ’ co nc es si on , we de ci de th e fo ll owi ng is su es : (1 ) whe th er 1 pe ti ti on ers were en ti tl edto a lo ss de du ct io n o f $9 98 ,14 9 c la im edon Sch edul e E, Supp le m en ta l In co m e an d Lo ss , for20 04 . W e h ol d t he y were n ot ; (2 ) whe th er pe ti ti on ers ha d u nr ep or te d i nc om e o f $9 3,6 66 .44 th atsh ou ldha ve be en rep or te d

on Sch edul e C, Pro fit or Lo ss Fro m Bu si ne ss , for20 04 an d $ 58 ,85 5.8 2 fo r 20 05

. W e h ol d t he y

di d; (3) whet he r pe ti ti on ers were en ti tl edto ne t o pe rat in g l os s

carr y ov ers of $ 58 5,5 87 for20 04 , $1 ,14 1,2 60 for20 05 , and$1 ,15 0,2 60 for 20 06

. W e h ol d t he y

were n ot ; (4 ) whe th er p et it io ne rs are l iabl e fo r acc ur acy-rela te d pe na lt ie s fo r th e su bjec t years. We ho ld th ey are. All sec ti on refe ren ces are t o t he Int ern al Rev en ue Co de (Co de ) in effe ctfor th e y ears in is 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 ced ur e.

Pet it io ne rs ha ve co nc ed edth atth ey ha d u nr ep or te d i nt eres t i nc om e o f $5 01 1 fo r 20 06

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[* 3] FINDINGS OF FACT The pa rti es fil edwit h t he Co ur t a s ti pu la ti on of f act s an d re la te d e xh ib it s. The st ip ul at edfact s an d t he acco m pa nyin g e xh ib it s ar e in co rp or at edhe rei n b y th is refe ren ce. We fin d t he fact s ac co rd in gl y . Peti ti on ers res id edin Cal ifo rn ia when th ey fil edth e p et it io n. I. Pet it io ne rs ’ Bu si ne ss Deal in gs A. One St ar En ti ti es At al l re le va nt ti m es OneS ta r Lon g Di st an ce, In c. (On eSt ar) was a te le ph on e

co m pa ny whol ly owne d b y

OneS ta r Hol di ng , Inc . (One St ar Ho ld in g) , an S

co rp or at io n. Du rin g t he y ears in is su e Mr. Po wers , who was On eSt ar Ho ld in g’s la rg es t s ha reh ol de r, own ed23 .50 22 6% o f it s s to ck an d M s. Po wers own ed 4.7 19 99 % of i ts st oc k. On eSt ar fi le d fo r ba nk rupt cy in Decem

be r 20 03

. B. Nex es Befo re On eSt ar fi le d fo r ba nk rupt cy , pet it io ne rs an d s om e o th er i nd iv id ua ls ha d fo rm edNexe s Gro up , LLC (Nexe s) , a tel ep ho ne co m pa ny. At al l re le va nt ti m es Nexe s was a pa rtn ers hi p fo r Fed eral in co m e ta x p ur po se s. Pet it io ne rs

2

At t ria l an d t hr ou gh ou t t he ir b rie fs pe ti ti on ers ha ve refe rred to th ei r 2 in te res ts in Nexe s as “ st oc k” an d t he m se lv es as s ha reh ol de rs or s to ck ho ld ers of Nex es . Howev er, t he re i s n ot hi ng in ev id en ce s ho win g Nex es was a C co rp or at io n oran S co rp or at io n fo r Fed eral in co m e ta x p ur po se s. Un de r th e ch eck -th e-b ox

(co nt in ue d...)-4

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[* 4] su bm it te d a n u nf

il edFo rm 10 65 , U.S. Retu rn of P art ne rs hi p In co m e, fo r 20 04 fo r Nex es bu t d idno t p ro vi de an y Sch edul es K-1, Pa rtn er’s Sh are o f In co m e, Deduc ti on s, Cr ed it s, et c. Nex es ha d o wne rs hi p i nt eres ts in nu m ero us en ti ti es , so m e o f whi ch pr ov id edgo od s an d s erv ic es to Nexe s. Nex es own edat l eas t t he fol lo win g

en ti ti es : Ic eNet , C-Tel , CTS Man ag em en t, LLC, Van ta ge Fu nd , LLC, andV Net. C. AJP a nd SEP Sev eral m on th s b efo re On eSt ar fi le d fo r ba nk rupt cy , pet it io ne rs alo ng wit h fo urNexe s p art ne rs , who were al so Nexe s’ off ic ers an d d ire ct or s, ea ch ha d fo rm ed

se pa rat e co m

pa ni es in to whi ch th ei r co m pe ns at io n fr om

Nexe s wo ul d fl ow. The

reas on forfor m in g t he sep arat e en ti ti es was t wof ol d. Fi rs t, p et it io ne rs an d t he
ot he r pa rtn ers want edto in su la te th em se lv es fro m th e One St ar b an krup tc y . Seco nd , th ey

als o wan te d asec ti on 40 1K/pr of it -s ha rin g p la n t ha t wo ul d g en erat e a (...co nt in ue d) 2 reg ul at io ns , “ a b us in es s en ti ty w it h t wo o r m or e m em be rs is cla ss ifi edforfed eral ta x p ur po se s as eit he r a co rp or at io n o r a p art ne rs hi p.” Sec. 3 01 .77 01 -2 (a), Pr oc ed

. & Ad m in . Reg s. If n o e le ct io n i s m ad e, an en ti ty w it h t wo o r m or e m em be rs is a pa rtn ers hi p b y

de fau lt . Sec. 3 01 .77 01 -3 (b )(1 )(i ), Pro ced . & Adm in . Reg s. To m ak e an ele ct io n, a t ax pa y er m us t fi le th e Fo rm

88 32 , Ent it y

Cla ss ifi cat io n Elec ti on , wit h t he Co m

m is si on er. Sec . 30 1.7 70 1- 3( c)(1 ), Pro ced . & Adm in . Reg s. Nex es ha d m or e th an on e st ak eh ol de r. Pet it io ne rs di d n ot su bm it a Fo rm 88 32 , if th ere was on e, to sh ow Nex es ele ct edto be so m et hi ng ot he r th an a pa rtn ers hi p. In st ead , pet it io ne rs subm it te d a Nexe s p art ne rs hi p re tu rn . W e th us fin d Nex es to be a pa rtn ers hi p fo r Fed eral in co m e ta x p ur po se s.-5

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[* 5] ta x d educ ti on bu t wo ul d e xc lu de th e 5 0 Nex es em pl oyees. To th is en d, pe ti ti on ers for m edAJP, In c. (AJP ), an d S EP, Inc . (SEP), whi ch were Del aware

co rp or at io ns th atth ey

who ll y own edat a ll rel ev an t t im es . AJP an d S EP ele ct edS

co rp or at io n s ta tu s ef

fect iv e Dece m

be r 20 03 . Mr. Po wers tes ti fie d t ha t h e d id no t kn ow h is an d M s. Po wers ’ pe rcen ta ge sh ares of o wne rs hi p i n AJ P an d S EP.

1. AJP AJP d id no t u nd ert ak e an y bu si ne ss act iv it y

du rin g t he rel ev an t t im es . Its Fo rm 11 20 S, U.S. Inc om e Tax Ret ur n fo r an S Co rp or at io n, fo r 20 04 rep or te d $4 04 ,38 7 o f gr os s re cei pt s. Of t ha t am ou nt , $3 96 ,98 0 was Mr. Po wers ’

co m pe ns at io n fr om

Nexe s, wh ic h h e rep or te d o n h is 20 04 in di vi du al ret ur n. The 3
at ta ch edSch edul e L, Bal an ce Sh eet pe r Bo ok s, s ta te d t ha t t he S co rp or at io n h ad $1 45 ,24 5 o f ad di ti on al pa id -in cap it al

. AJP’s re tu rn s fo r 20 05 an d 2 00 6 d idno t re po rt a ny inc om e o r de du ct io ns . 2. SEP Pet it io ne rs cla im edth ey

form edSEP to ho ld th ei r pa rtn ers hi p i nt eres ts in Nex es , bu t t he y

ne ve r tr an sf

erre d t he ir p art ne rs hi p i nt eres ts to SEP. The re co rdis

Pet it io ne rs ha d s in ce s ub m it te d, b utdi d n ot fil e, an am en de d F or m 11 20 S 3 fo r AJP an d a n a m en de d i nd iv id ua l re tu rn for20 04 . The am en de d re tu rn s re po rte d $3 96 ,98 0 a s wag es , bu t t he re i s n ot hi ng in th e rec or d t o s ug ge st th atAJP t reat ed th e am ou nt s p ai d a s wag es .-6

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[* 6] de vo id of a ny det ai ls as t o wh attype o f bu si ne ss act iv it ie s i t u nd ert oo k d ur in g th e rel ev an t p eri od . Its Fo rm 11 20 S fo r 20 04 rep or te d g ro ss rece ip ts or s al es of -$ 94 4,6 69 . SEP rep or te d z ero in co m e an d d educ ti on s fo r 20 05 an d 2 00 6. D. Mr. Po wers an d M s. Po wers Mr. Po wers earn eda ba ch el orof s ci en ce d eg ree i n a cco un ti ng fro m Ind ia na Uni ve rs it y

an d b ecame a cert ifi edpu bl ic acco un ta nt (C.P.A.) in 19 72 . Sin ce t he n, he ha s ac qu ire d a fai r am ou nt of a ud it in g e xp eri en ce. Bet ween 19 73 an d 1 98 1 h e

wor ke d a s an acco un ta nt at a lo cal acco un ti ng fir m wit h abo ut 30 em

pl oyees, whe re h e ev en tu al ly became a part ne r in 19 77 . Mr. Po wers ha d a ls o o wne d

se ve ral bu si ne ss es , in cl ud in g Go df at he r’s Piz za re st au ran ts whi ch ha d l oc at io ns in th ree S ta te s. Be gi nn in g a ro un d 2 00 0 M r. Po wers be cam e in vo lv edin OneS ta r an d Nex es . Mr. Po wers was l is te d a s a C EO on pe ti ti on ers ’ 20 04 ret ur n a nd as a

“ Man ag er” o n t he 20 05 an d 2 00 6 re tu rn s. Ms . Powe rs was l is te d a s a h om em ak er o n p et it io ne rs ’ 20 04 th ro ug h 2 00 6 ret urns . II. Pet it io ne rs ’ In di vi du al Ret ur ns A. 20 03 Pet it io ne rs ’ 20 03 return c la im eda to ta l l os s o f $1 59 ,00 6 a nd a ne ga ti ve ad jus te d g ro ss in co m e (l os s) of $ 16 2,0 06 . Con tri bu ti ng to pe ti ti on ers ’ lo ss was-7

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[* 7] th ei r no np as si ve lo ss fro m OneS ta r Hol di ng of $ 73 6,0 23 rep orte d o n t he Sch edul e E att ach edto th e return. Pe ti ti on ers als o c la im eda de du ct io n fo r a $3 45 ,80 3 n etop erat in g l os s (NOL) fr om 20 00 th atwas c arri edto 20 03

. B. 20 04 Pet it io ne rs cla im eda to ta l l os s o f $1 ,07 4,7 20 an d a ne ga ti ve ad jus te d g ro ss in co m e o f $1 ,08 9,4 86 for20 04 . Am on g t he in co m e it em s p et it io ne rs rep or te d was $3 96 ,98 0 o f bu si ne ss in co m e o n t he Sch edul e C-EZ, Net P ro fit Fro m Bu si ne ss , whi ch li st edbu si ne ss co ns ul ti ng as M r. Po wers ’ pr in ci pa l b us in es s; th e rep or te d bu si ne ss in co m e was Mr. Po wers ’ co m pe ns at io n fr om

Nexe s. Pet it io ne rs ’ Sch edul e E for

20 04 rep or te d $ 1,0 57 ,38 2 o f no np as si ve in co m e fro m OneS ta r Hol di ng an d c la im eda $1 ,02 2,3 17 no np as si ve lo ss fro m AJP an d S EP. Peti ti on ers al so de du ct edan NOL of $ 60 6,4 50 th atwas c arri edov er t o 2 00 4. C. 20 05 The on ly repo rte d i nc om e it em on pe ti ti on ers ’ 20 05 ret urn was an NOL

carr y ov er o f $1 ,14 1,2 60 . Howev er, p et it io ne rs rep or te d t he y ha d a ne ga ti ve ad jus te d g ro ss in co m e o f $1 ,14 0,2 60 . W e at tri bu te th e d iff eren ce t o a typo gr ap hi cal erro r.-8

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[* 8] D. 20 06 Pet it io ne rs ’ 20 06 return re po rte d a ne ga ti ve ad jus te d g ro ss in co m e o f $1 ,10 0,2 60 ba se d o n acal cu la ti on pro vi de d i n a st at em en t t he y att ach edto th e ret urn. Th e st at em en t i nd ic at edth e ret ur n was on ly “ an est im at ed20 06 TAX ret urn * * * du e to in su ffi ci en t d at a an d/ orin co m pl et e in fo rm at io n a nd /o r fi le s an d

an IRS i n p ro ces s au di t ex am in at io n.” The re tu rn st at em en t es ti m at edpe ti ti on ers ’ in co m e to be $5 0,0 00 for20 06 an d c la im eda de du ct io n fo r an NOL carry ov er fro m 20 05 of $ 1,1 50 ,26 0. ($ 1,1 50 ,26 0 - $ 50 ,00 0 = $1 ,10 0,2 60 ). Pet it io ne rs di d

no t ex pl ai n wh y

th e NOL carryove r fro m 20 05 was $ 1,1 50 ,26 0 i ns te adof t he $1 ,14 1,2 60 rep or te d o n t he ir 2 00 5 re tu rn . III. Aud it Res po nd en t’s re ve nu e ag en t, J ul ie Gray , con du ct edpe ti ti on ers ’ au di t fo r th e ta x years i n i ss ue . As pa rt o f th e au di t, re sp on de nt su m m on edpe ti ti on ers ’ ba nk

reco rd s i n o rd er t o p rep are a ba nkde po si ts an al y si s fo r th e au di te d years. Th e

acco un ts Ms . Gray

ex am in edin cl ud edpe ti ti on ers ’ pe rs on al acco un ts , an AJ P b an k

acco un t wi th an acco un t n um be r en di ng in 99 31 , a Nexe s b an k a cco un t wi th an

acco un t n um

be r en di ng in 88 99 , a C-Tel ba nkacco un t wi th anacco un t n um be r

en di ng in 89 81 , and an IceNet ba nkacco un t wi th an acco un t n um be r en di ng in 87 17

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[* 9] A. Dep os it s In to Pet it io ne rs ’ Pers on al Ban k Acc ou nt s Usi ng th e b an k re co rd s, M s. Gray was ab le to de te rm in e th e to ta l am ou nt of

m on ey de po si te d i nt o p et it io ne rs ’ pe rs on al acco un ts in 20 04 an d 2 00 5. Sh e th en

rem ov edall no nt ax ab le it em s fr om th e d ep os it s an d re ach edth e to ta l am ou nt of
ta xa bl e d ep os it s fo r eac h year.

1. 20 04 Fo r 20 04 Ms . Gray

de te rm in edth atpe ti ti on ers ha d g ro ss rece ip ts of $4 90 ,64 6.4 4 fr om

co ns ul ti ng servi ces . Peti ti on ers ’ ta xa bl e d ep os it s ar e so ur cedas fo ll ows : Ban k Tax ab le de po si ts Int eg ra Ba nk(acc ou nt nu m be r en di ng in 83 80 ) $4 53 ,96 3.4 5 Unio n P la nt ers Ban k R eg io ns (acc ou nt nu m

be r en di ng in 35 64 ) 1 18 ,45 2.2 2 Evan sv il le Teach ers Fed eral Cred it Uni on (acc ou nt nu m be r en di ng in 70 73 ) 18 ,23 0.7 7 Tot al 49 0,6 46 .44

Pet it io ne rs co nc ed edat t ria l t ha t t hi s d ep os itis tax ab le to th em . 1 The tax ab le de po si ts in to pe ti ti on ers ’ In te gr a acc ou nt in cl ud edtwo types of de po si ts : ch eck s an d a cco un t t ran sf ers . All t he ch eckde po si ts in vo lv edch eck s-1 0-

[* 10 ] is su edby A JP or Ne xe s an d t ot al ed$3 69 ,87 8.4 5. Th e acc ou nt tra ns fers

co ns is te d o f tr an sf

ers fro m th e AJP ba nkacco un t o f $5 6,3 85 , fro m th e Ice Net b an k

acco un t o f $1 9,7 00 , fro m th e C-Tel ba nkacco un t o f $7 ,00 0, an d fr om th e Nex es ba nkacco un t o f $1 ,00 0, t ot al in g $ 84 ,08 5. The tax ab le de po si t i nt o t he Evan sv il le Teach ers Fed eral Cred it Uni on

acco un t co ns is te d o f on e ch eckde po si t d at edJan ua ry 14 , 20 04 , of $ 18 ,23 0.7 7. AJP i ss ue d t he ch eck

.

2. 20 05 Fo r 20 05 Ms . Gray

de te rm in edth atpe ti ti on ers ha d g ro ss rece ip ts of $5 8,8 55 .82 fro m

co ns ul ti ng ser vi ces , no ne of wh ic h was rep or te d o n p et it io ne rs ’ 20 05 ret urn. Ms . Gray

so ur cedpe ti ti on ers ’ ta xa bl e d ep os it s as fol lo ws: Ban k Tax ab le de po si ts Int eg ra Ba nk(acc ou nt nu m be r en di ng in 83 80 ) $1 6,2 62 .46 Unio n P la nt ers Ban k R eg io ns (acc ou nt nu m

be r en di ng in 35 64 ) 42 ,59 3.3 6 Tot al 58 ,85 5.8 2 The tax ab le de po si ts in to pe ti ti on ers ’ In te gr a acc ou nt were al l ch eck de po si ts . All t he ch eck s wer e is su edby eith er AJ P, $5 ,00 0, o r Nex es , $1 1,2 62

.-1 1-

[* 11 ] The tax ab le de po si ts in to pe ti ti on ers ’ Uni on Pla nt ers Ban k R eg io ns acco un t were al l wi re t ran sf

ers : $ 14 0.8 0 fr om

Nexe s; $3 ,27 5.5 2 fr om

C-Tel ; $ 11 4.1 3 fr om IceNe t; an d $ 39 ,06 2.9 1 fr om “ Gran de Co m

m un .” Ther e is no th in g i n t he reco rd ab ou t Gra nd e Co m

m un . B. AJP B an k Acc ou ntW it h Acc ou nt Num be r End in g i n 9 93 1 Ms . Gray als o e xa m in edAJP’s b an k a cco un t wi th an acco un t n um be r

en di ng in 99 31 . In 2 00 4 $ 55 0,2 07 .36 was d ep os it edin to th e AJP ba nkacco un t,

an d $ 53 9,7 26 .13 was wi th dr awn fro m th e sa m e acc ou nt . Of th e to ta l wi th dr awal

am ou nt , $5 03 ,22 2 was pe ti ti on ers ’ pe rs on al wit hd rawal s co ns is ti ng of c he ck s is su edto Mr. Po wers an d/ orMs . Powe rs , wire t ran sf ers to pe ti ti on ers ’ pe rs on al In te gr a Ban k a cco un t wi th an acco un t n um be r en di ng in 83 80 , and ot he r pe rs on al wit hd rawal s. The m on th -b y -m on th bre ak do wn o f wit hd rawal s i s i ll us tra te d i n t he

4 fo ll owi ng tab le :

Two t ran sf

ers to ta li ng $5 3,0 00 were m ad e to un kn own in di vi du al s an d 4 en ti ti es in Octo be r 20 04 . Becau se pe ti ti on ers be ar t he bu rd en of p ro vi ng th e na tu re o f th es e wit hd rawal s an d h av e fai le d t o e xp la in it as t o t he se two wit hd rawal s, we d eem

th es e wit hd rawal s t o b e p ers on al

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[* 12 ] Mo nt h Dep os it s W it hd rawal s Pers on al wit hd rawal s Jan ua ry $3 8,4 61 .54 $37 ,46 1.5 4 $3 7,4 61 .54 Feb ru ary 38 ,66 3.1 6 38 ,52 3.1 6 37 ,66 3.1 6 March 63 ,53 8.6 2 61 ,13 8.0 0 61 ,07 8.0 0 Apri l 39 ,81 9.2 2 39 ,50 0.0 0 39 ,50 0.0 0 May 39 ,85 1.1 5 43 ,30 7.0 0 43 ,30 7.0 0 Ju ne 79 ,35 9.9 6 78 ,47 7.8 5 76 ,76 1.0 0 Ju ly 40 ,55 6.6 4 40 ,00 0.0 0 38 ,00 0.0 0 Aug us t --- 800 .00 80 0.0 0 Sept em be r 30 ,14 6.1 6 29 ,00 0.0 0 29 ,00 0.0 0 Octo be r 11 1,9 81 .99 102 ,40 0.0 0 77 ,40 0.0 0 Nov em be r 12 ,00 0.0 0 23 ,66 6.6 6 16 ,80 0.0 0 Decem be r 55 ,82 8.9 2 45 ,45 1.9 2 45 ,45 1.9 2 Total 55 0,2 07 .36 539 ,72 6.1 3 50 3,2 22 .62 IV. Not ic e o f Defi ci en cy On J un e 1 7, 2 01 0, re sp on de nt is su eda no ti ce o f de fic ie nc y for20 04 th ro ug h 20 06

. A. 20 03 Fo r 20 03 , a y ear n ot su bjec t t o t he no ti ce o f de fic ie nc y , Ms . Gray di sc ov ered du rin g t he au di t t ha t p et it io ne rs ha d d educ te d $ 58 5,5 87 of S ch edul e E lo ss es in ex ces s o f th ei r al lo wab le ba si s i n On eSt ar Ho ld in g. Th is di sc ov ery le d-1 3-

[* 13 ] res po nd en t t o a ll ow $ 32 4,9 40 of t he 20 00 NOL to b e carrie d t o 2 00 3,

res ul ti ng in on ly $20 ,86 3 ($ 34 5,8 03 - $3 24 ,94 0) of t he NOL to b e carrie d o ve r to 20 04

. B. 20 04

1. Sch edul e C In co m e As a re su lt of t he ba nkde po si ts an al y si s, re sp on de nt de te rm in edpe ti ti on ers ha d $ 49 0,6 46 .44 of t ax ab le de po si ts in 20 04 . Becau se pe ti ti on ers rep or te d $3 96 ,98 0 o f Sch edul e C i nc om e o n t he ir 2 00 4 re tu rn , res po nd en t i nc reas ed pe ti ti on ers ’ Sch edul e C i nc om e b y $9 3,6 66 .44

. 2. Sch edul e E Los s Res po nd en t d et erm in edth atpe ti ti on ers ’ ad jus te d b as es in AJP an d S EP were $ 10 0 a nd $2 4,0 68 , res pe ct iv el y . Res po nd en t’s d et erm in at io n re su lt edin th e di sa ll owa nc e o f pe ti ti on ers ’ no np as si ve lo ss es in ex ces s o f th ei r ad jus te d b as es as fo ll ows : AJP SEP Non pa ss iv e lo ss pe r ret urn $8 3,4 79 $9 38 ,83 8 Adju st edba si s d et erm in edin NOD 10 0 24 ,06 8 Sus pe nd edlo ss es 83,3 79 91 4,7 70-1 4-

[* 14 ] 3. Deduc ti on for NOL Bec au se res po nd en t al so de te rm in edpe ti ti on ers di d n ot in cu r an NOL for 20 03 , res po nd en t l im it edpe ti ti on ers ’ de du ct io n fo r th e NOL carri edov er t o 2 00 4 to th e am ou nt of t he un us edNOL carri edfor wardfro m 20 00 , or $ 20 ,86 3, as op po se d t o t he $6 06 ,45 0 p et it io ne rs cla im edfor20 04 . This res ul te d i n a n i nc reas e in pe ti ti on ers ’ ta xa bl e in co m e fo r 20 04 by $58 5,5 87 ($6 06 ,45 0 - $ 20 ,86 3)

. C. 20 05 1. Sch edul e C In co m e As a re su lt of t he ba nkde po si ts an al y si s, re sp on de nt de te rm in edpe ti ti on ers ha d $ 58 ,85 6 o f un rep or te d S ch edul e C i nc om e.

2. Deduc ti on for

NOL Bec au se res po nd en t d et erm in edpe ti ti on ers di d n ot in cu r an y NOL in 2 00 4, he di sa ll owe d p et it io ne rs ’ de du ct io n fo r th e NOL carryforwar d t ha t t he y cla im ed

on th e ret urn. Th e d is al lo wan ce i nc reas edpe ti ti on ers ’ ta xa bl e in co m e b y $1 ,14 1,2 60

. D. 20 06 Res po nd en t d et erm in edth atpe ti ti on ers rece iv edin te res t i nc om e o f $5 01 fro m th e Ru th Ann Po wers Ch il dr en ’s Trus t, wh ic h p et it io ne rs fai le d t o re po rt o n-1 5-

[* 15 ] th ei r 20 06 return. Pe ti ti on ers ha ve si nc e co nc ed edth atth ey rece iv edth e in te res t i nc om e. Res po nd en t’s d et erm in at io n t ha t p et it io ne rs di d n ot in cu r an y NOL in 2 00 5

res ul te d i n t he di sa ll owa nc e o f th e NOL carryforwar d c la im edon th e 2 00 6 re tu rn

an d t hu s i nc reas edpe ti ti on ers ’ ta xa bl e in co m e b y $1 ,15 0,2 60

. OPINION 5 I. Ban krup tc y

Pro ceed in gs Pet it io ne rs cla im

th atdu rin g On eSt ar’s b an kr up tc y pro ceed in gs , see In r e One St ar Lo ng Dis ta nc e, In c., No. 0 3- 72 69 7 (B an kr . S.D. Ind . fil edDec. 31 , 20 03 ), th e b an krup tc y

co ur t s ei zedor i ss ue d o rd ers to sei ze t he ir r eco rd s t ha t ar e rel ev an t to pro ve th e cl ai m s s ta te d i n t he ir p et it io n. Ci ti ng sp eci fic do ck eten tri es , pe ti ti on ers arg ue th atth ey ha ve be en di sa dv an ta ge d b ecau se th ey no lo ng er h av e th e rel ev an t d oc um en ts to pro ve th ei r cas e. Pet it io ne rs fur th er as se rt t ha t t he y ha ve co m pl ie d wi th th e rec or dk eep in g re qu ire m en ts un de r th e in te rn al rev en ue la ws an d t he rul es an d re gu la ti on s an d t ha t t he y are n ot cu lp ab le forno t h av in g t he

reco rd s i n t hi s d efi ci en cy cas e.

At t he en d o f th e tr ia l t he Co ur t p ro vi de d s pe ci fic bri efi ng in st ru ct io ns . 5 The Co ur t d ire ct edeach pa rty to s ub m it a rep ly brie f fo ll owi ng th e o pe ni ng bri ef an d i ns tru ct edeach pa rty to o nl y “ po in t o ut an y

di sc rep an ci es in op po si ng pa rty’ s fin di ng s o f fac t” an d “ m ak e n o l eg al arg um en t” in th e se co nd bri ef. Pet it io ne rs ’ rep ly brie f is pe rv ad edwit h a rg um en ts . Con si st en t wi th ou r br ie fin g i ns tru ct io ns to th e p art ie s, we wi ll di sr eg ardan y arg um en ts in pe ti ti on ers ’ rep ly brie f.-1 6-

[* 16 ] Afte r rev ie win g t he ba nk rupt cy co ur t’s d oc ke t en tri es an d t he un de rlyin g do cu m en ts , we de cl in e to acce pt pe ti ti on ers ’ cl ai m as a m at te r of

fact . W e fi nd 6 th e fo ll owi ng do ck eten tri es pa rti cu la rly enl ig ht en in g:
Docke t Entry Summary ECF No. 420 Orde r direc ting One Star to produce and make available for c opy ing cer tain documents. ECF Nos. 677 & 708 Trustee ’s motion and bankruptc y court’s or der a

uthorizi ngtrustee to enter into lease of stora g e spac e to store 130 boxes of documents. ECF No. 719 Trustee ’s motion for turnover of har d drives, ser

vers, a nd related computer ha

rdwa re ( Har d Drives) in Mr. Powers’ posse ssion that contained r ecor ds of or re g ardingOneStar. ECF No. 739 Ba

nkruptcy court’s minute e ntry

/order va catingtrustee’ s motion for turnover of

Har d Drives in ECF N o. 719, per a g ree ment betwee n the parties. ECF No. 756 Ag ree d entry reg ardingtrustee’ s motion for turnover in ECF No. 719. I t stated that Mr. Power s was coope ratingand produc ed the Ha rd Drive s “for the copy ing of the computer

data.” Trustee ’s motion for turnover of Ha rd Drive s was thus resolve d. On Ap ril 26 , 20 13 , th e Co ur t i ss ue d a n o rd er (Ap ril 26 ord er) d ire ct in g t he 6 pa rti es to fil e a res po ns e d is cu ss in g t he ir v ie ws o n t he Co ur t’s t ak in g ju di ci al no ti ce o f th e b an krup tc y

co ur t’s p ro ceed in gs , th e d oc ke t en tri es rel at in g t o t he pr oc eed in gs , and th e u nd erl y in g d oc um en ts in In r e One St ar Lo ng Dis ta nc e, In c., No. 0 3- 72 69 7 (B an kr . S.D. Ind . fil edDec. 31 , 20 03 ). The C ou rt i s en ti tl edto tak e jud ic ia l n ot ic e o f su ch ad jud ic at iv e fac ts . See Fed . R. Evi d. 2 01 ; M cTern an v. Ci ty of Yor k, Pa ., 57 7 F .3d 52 1, 5 26 (3d Cir . 20 09 ) (“ [A] cou rt m ay tak e jud ic ia l no ti ce o f a p rio r jud ic ia l o pi ni on .”); Man gi afi co v. Bl um en th al , 47 1 F .3d 39 1, 3 98 (2 d C ir. 2 00 6) (“ [D]ock etsh eet s ar e p ub li c rec or ds of wh ic h t he co ur t co ul d t ak e jud ic ia l n ot ic e”.); Uni te d S ta te s v . Est ep , 76 0 F .2d10 60 , 10 63 (10 th Cir . 19 85 ) (h ol di ng th ata co ur t m ay tak e jud ic ia l n ot ic e o f co ur t re co rd s o f cl os el y rel at ed pr io r li ti ga ti on ). The p art ie s fi le d a joi nt res po ns e to ou r Apr il 26 ord er ag reei ng th atth e Co ur t m ay

pro pe rly tak e jud ic ia l n ot ic e o f th e m at te rs st at edin th e o rd er, an d we wi ll do so .-1 7-

[* 17 ] W e fo un d n ot hi ng in th e b an krup tc y co ur t’s re co rd s t ha t i nd ic at es th e co ur t

or de redth e se iz ur e o f pe ti ti on ers ’ do cu m en ts or c om pu te rs . It i s u nc le ar fro m th e

m ov in g p ap ers an d t he co ur t o rd ers whet he r or ig in al do cu m en ts were p ro du cedor whe th er o nl y

co pi es of t he req ue st eddo cu m en ts were p ro vi de d. In de ed , th e ba nk rupt cy

co ur t’s o rd er i n ECF No. 4 20 su gg es ts th atdo cu m en ts were m ad e

av ai labl e o nl y

forco pyin g- -th atis , th e o rig in al s wer e n ot tu rn edov er. Reg ard in g t he tru st ee’s m ot io n fo r th e tu rn ov er o f Mr. Po wers ’ ha rddri ve s, th e b an krup tc y

co ur t’s d oc ke t en tri es co nt rad ic t p et it io ne rs ’ cl ai m th atth e ba nk rupt cy

co ur t co nf

is cat edth ei r co m

pu te r equi pm en t co nt ai ni ng th e rel ev an t

reco rd s i n t hi s ca se . The t ru st ee h adm ov edth e b an krup tc y co ur t t o d ire ctMr. Po wers to tu rn ov er h is ha rddri ve s. See ECF No. 7 19 . But ECF Nos . 73 9 a nd 75 6 s ho w th atth e p art ie s wo rk edou t a s ol ut io n fo r th e trus te e to co py dat a o ff t he ha rddri ve s, re nd eri ng it un ne ces sa ry forMr. Po wers to su rren de r th e co m pu te r eq ui pm en t an d p eri ph eral s. Th us , we ser io us ly dou bt th e b an krup tc y co ur t o r th e ba nk rupt cy

tru st ee ac tu al ly seiz edpe ti ti on ers ’ or ig in al bo ok s an d re co rd s o r th ei r

co m pu te rs . Mo reo ve r, th e b an krup tc y pro ceed in gs rel at edto OneS ta r, an d t he di sc ov ery

m ot io ns in th e p ro ceed in gs ha d t o d o wi th OneS ta r’s bo ok s an d re co rd s. So ev en-1 8-

[* 18 ] if On eSt ar’s rec or ds were co nf is cat edan d a re n o l on ge r in pe ti ti on ers ’ po ss es si on , th ey

wou ld ha ve li tt le rel ev an ce i n t hi s d efi ci en cy cas e. Andwe fin d

no in di cat io ns th atan y

of t he reco rd s b el on gi ng to AJP, SEP, o r an y of t he Nexe s

en ti ti es were i m

pl ic at edin OneS ta r’s ba nk rupt cy pro ceed in gs . In o th er wo rd s,

7 pe ti ti on ers ha ve fai le d t o e xp la in why reco rd s t ha t wo ul d a ctua ll y m at te r in th is

cas e, su ch as r eco rd s p ert ai ni ng to th ei r ba se s i n AJ P an d S EP, wou ld be tak en away in OneS ta r’s ba nk rupt cy pro ceed in gs , when Nexe s, AJ P, an d S EP were

en ti ti es un rel at edto OneS ta r. 8 The re ar e al so in co ns is te nc ie s i n p et it io ne rs ’ st at em en ts . Duri ng di sc ov ery pe ti ti on ers to ld res po nd en t t ha t t he y ha d “ lo cat edan d re vi ewedap pr ox im at el y 1,2 50 bo xe s an d fi le cab in et s o f do cu m en ta ti on ” whi ch th ey us edin th ei r di sc ov ery res po ns es . At tri al Mr. Po wers tes ti fie d t ha t h e h adtu rn edov er al l o f

In de ed , Mr. Po wers tes ti fie d t ha t Nex es , AJP, an d S EP were cr eat edto 7 in su la te pe ti ti on ers fro m

OneS ta r’s ba nk rupt cy . Giv en Mr. Po wers ’ bu si ne ss acu m en , on e wou ld th in k M r. Po wers wou ld ha ve care fu ll y sep arat edth e b us in es s reco rd s o f Nex es , AJP, an d S EP fro m th os e o f One St ar i n o rd er t o n ot ti e pe ti ti on ers to th e b an krup tc y pro ceed in gs . In t he ab se nc e o f sp eci fic ev id en ce sh owi ng ot he rwis e, th is factua l i nf eren ce s up po rts ou r be li ef t ha t re co rd s o f Nex es , AJP, an d S EP were n ot im pl ic at eddu rin g On eSt ar’s b an krup tc y . Mr. Po wers tes ti fie d t ha t t he tru st ee h adan ord er fro m th e b an kr

up tc y co ur t 8 an d “ cam e wit h a m ov in g t ru ckan d t he m en go t o ut , th ey em pt ie d t he fil e cab in et s an d p ut th e st uf

f in th ere.” W it ho ut an y

ev id en ce t o c or ro bo rat e th e as se rti on , we de cl in e to acce pt Mr. Po wers ’ se lf- se rv in g t es ti m on y th atwe de em

ge ne ral ly un rel iabl e. See i nf

ra p . 21

.-1 9-

[* 19 ] hi s re co rd s t o t he ba nk rupt cy tru st ee. So , we do no t k no w th e rel at io ns hi p be twee n t he 1,2 50 bo xe s i n p et it io ne rs ’ po ss es si on an d t he reco rd s h e al le ge dl y

su rren de redin th e b an krup tc y cas e. Fu rth er, the do ck eten tri es forECF Nos . 67 7

an d 7 08 sh ow t ha t o nl y

13 0 b ox es of r eco rd s- -an d a ga in we do no t k no w whet he r th es e were o rig in al s o r co pi es --were in th e trus te e’s po ss es si on , a nu m be r far l es s th atth e 1 ,25 0 b ox es pe ti ti on ers cla im edth ey ha d. Fi na ll y , asi de fro m

pe ti ti on ers ’ se lf- se rv in g t es ti m on y , th ere i s n o e vi de nc e to sh ow wi th pa rti cu la rit y th e rel ev an t d oc um en ts th atwere s ei zedan d t he types of effo rts pe ti ti on ers act ua ll y m ad e to ret rie ve an y

co nf is cat edreco rd s. It ap pe ars th e tru st ee h ad13 0 b ox es of f il es . Accor di ng to pe ti ti on ers , th ey ha d e xa m in ed1,2 50 bo xe s o f rec or ds . W e d o n ot kn ow wh et he r th ere was an y ov erl ap be twee n t he se two bo di es of r eco rd s. No r do we kn ow wh et he r th e trus te es ha d a ny reco rd s o f Nex es or a ny reco rd s o f pe ti ti on ers ’ who ll y own edsu bs id ia rie s. The re ar e m an y

un kn own s an d i nc on si st en ci es in pe ti ti on ers ’ cl ai m s. Th us , we de cl in e to fin d a s a f

actth atth e b an krup tc y

co ur t co nf

is cat edth ei r or ig in al

reco rd s t ha t ar e rel ev an t t o t hi s p ro ceed in g. II. Perc ep ti on of P et it io ne rs ’ W it ne ss Thi s ca se in vo lv es pri m ari ly dis pu te d fa ct s ra th er t ha n o pp os in g l eg al pr op os it io ns . The l eg al is su es he re ar e cl ear a ndno t n ov el . Becau se pe ti ti on ers-2 0-

[* 20 ] ch os e to st ru ctur e th ei r bu si ne ss de al in gs th ro ug h a co m pl ex web o f m or e th an a do zen pa ss th ro ug h e nt it ie s, an y ev id en ce t ha t m ay

res ol ve th e d is pu te d fact ua l i ss ue s, s uc h a s p et it io ne rs ’ ba se s i n t he en ti ti es an d t he ir i nc om e fro m th es e

en ti ti es , wil l n eces sa ril y

co m e fro m

pe ti ti on ers . Com

pl ic at in g t he m at te r is th e

sc arci ty of rel ev an t an d c red ib le do cu m en ta ry ev id en ce t ha t ca n s ub st an ti at e pe ti ti on ers ’ cl ai m s. Th us , itis ev er m or e so im po rta nt for

pe ti ti on ers to pro vi de cred ib le , per su as iv e, an d d et ai le d t es ti m on y to sh ow re sp on de nt ’s det erm in at io ns

were er ro ne ou s. Pet it io ne rs ’ pr es en ta ti on at t ria l fa il edin th is reg ard

. In all cas es , we ob se rv e th e can do r, si nc eri ty, an d d em ean orof e ach wit ne ss in ord er t o e va lu at e h is tes ti m on y an d t o a ss ig n wei gh t t o t ha t t es ti m on y forth e pr im ary pu rp os e o f fi nd in g d is pu te d fa ct s. We det erm in e th e cre di bi li ty of eac h wit ne ss , weig h e ach pi ece o f ev id en ce, d raw ap pr op ria te in fere nc es , and ch oo se be twee n c on fli ct in g i nf

eren ces in fin di ng th e fac ts of a cas e. The m ere f act th at

on e p art y pre se nt s u no pp os edtes ti m on y on hi s b eh al f do es no t n eces sa ril y m ean th atth e el ic it edtes ti m on y wil l re su lt in a fi nd in g o f fac t i n t ha t p art y ’s fav or . W e wil l n ot acce pt a wit ne ss ’ te st im on y on it s fa ce i f we fi nd th atou r im pr es si on of th e wit ne ss co up le d wi th ou r rev ie w of t he cred ib le fact s atha ndco nv ey s t o u s an

un de rs ta nd in g c on tra ry

to th e sp ok en word . See Neo na to lo gy Asso ci at es , P.A. v. Co m m is si on er, 1 15 T.C. 43 , 84 -8 7 (2 00 0) , aff’d, 2 99 F.3d 22 1 (3 d C ir. 2 00 2) ; HIE-2 1-

[* 21 ] Hol di ng s, In c. v. Co m m is si on er, T.C. Mem o. 2 00 9- 13 0, 9 7 T.C.M . (CCH) 16 72 , 17 33 (20 09 ), aff’d, _

__Fed . App x. _

__ , 20 13 W L 13 65 35 4 (9 th Cir . Apr. 5 , 20 13 ). Mr. Po wers tes ti fie d. We fin d M r. Po wers ’ te st im on y to be ge ne ral ly

un rel iabl e an d u nh el pf

ul as t o t he cri ti cal fact s u nd erl y in g t he is su es at h an d. Fi rs t, Mr . Powe rs ’ te st im on y lac ke d t he lev el of d et ai l an d c la rit y , rel at iv e to pe ti ti on ers ’ co m

pl ex bu si ne ss de al in gs , su ffi ci en t t o a ll ow a r eas on ab le fact fin de r to fin d t he di sp ut edfact s i n p et it io ne rs ’ fav or . Mor eo ve r, Mr. Po wers see m edto be co nf us edab ou t s om e o f th e m at eri al fact s an d o ffer edin te rn al ly inc on si st en t te st im on y . For e xa m

pl e, Mr. Po wers att em

pt edto ch arac te riz e al l ac co un t tra ns fers m ark edby Inte gr a Ban k a s “ Adv ic e o f Cre di t” as “ tra ns fers of l oa ns ba ck

an d fo rth .” Bu t wh en qu es ti on edby resp on de nt ab ou t a $ 9,0 00 de po si t m ad e o n Aug us t 4 , 20 04 , th atwas m ark ed“ Adv ic e o f Cre di t” , Mr. Po wers fir st tes ti fie d th atit was n ota lo an tra ns fer. Bu t m om en ts lat er, h e rec an te d wi th ou t o ffer in g

an y ex pl an at io n a ndst at edth e d ep os it was alo an tra ns fer. When pre ss edby

res po nd en t as to why he be li ev edth e d ep os it was alo an tra ns fer, M r. Po wers si m pl y sai d: “ Bec au se th at ’s what I th in k i t i s” an d a dm it te d h e h adno do cu m en ta ry

ev id en ce t o s up po rt h is be li ef. In de ed , Mr. Po wers rev ers edhi s-2 2-

[* 22 ] tes ti m on y

or e qu iv oc at edin hi s s ta te m en ts in a si m il ar m an ne r on m ul ti pl e

oc cas io ns du rin g h is di rect an d c ro ss -ex am in at io n. Ms . Powe rs was p res en t at tri al bu t ch os e n otto tes ti fy . This cau se d u s t o dr aw an ad ve rs e in fere nc e fro m he r fai lu re t o t es ti fy . See Ba xt er v . Pal m ig ia no , 42 5 U.S. 3 08 , 31 8- 31 9 (1 97 6) ; Pe tz ol dt v. Co m m is si on er, 9 2 T.C. 6 61 , 68 5 (1 98 9) . At th e sa m e ti m e, Mr. Po wers ’ te st im on y was fo r th e m os t p art

se lf- se rv in g, v ag ue , elu si ve , un co rro bo rat ed , and/o r in co ns is te nt wit h d oc um en ta ry

orot he r rel iabl e ev id en ce. Co rres po nd in gl y , we are n ot req ui redto , and we ge ne ral ly do n ot , rel y

on th e n ak edor o th erwi se un rel iabl e te st im on y of M r. Po wers to su pp or t o urde ci si on in th is op in io n. Se e Neo na to lo gy Asso ci at es , P.A. v. Co m m is si on er, 1 15 T.C. at 8 7; HIE Hol di ng s, In c. v. Co m m is si on er, 9 7 T.C.M

. (CCH) at 1 73 3. III. Bu rd en of P ro of Gen eral ly, th e Co m

m is si on er’s d et erm in at io ns in a no ti ce o f de fic ie nc y are pr es um edco rrec t, an d t ax pa y ers be ar t he bu rd en of p ro vi ng by a prep on de ran ce o f th e ev id en ce t ha t t he Co m m is si on er’s d et erm in at io ns are er ro ne ou s. Ru le 14 2( a); INDOPCO, In c. v. Co m

m is si on er, 5 03 U.S. 79 (19 92 ); Welc h v . Helv eri ng , 29 0 U.S. 11 1, 1 15 (19 33 ); R oc kwe ll v. Co m m is si on er, 5 12 F.2d88 2, 8 85 -8 87 (9t h C ir. 19 75 ), aff’g T.C. Me m o. 1 97 2- 13 3.-2 3-

[* 23 ] Bu t i n c ert ai n c as es , th e b ur de n o f pr oo f m ay sh ift to th e Co m

m is si on er wi th

res pe ctto a fact ua l i ss ue rel ev an t t o t he tax pa y er’s t ax li ab il it y . See s ec. 74 91 (a)( 1) . Suc h a sh ift m ay oc cu r whe n t he reco rdest ab li sh es th atth e ta xp ay er pr od uc edcred ib le ev id en ce re la ti ng to th e is su e an d t ha t t he tax pa y er m etth e req ui si te su bs ta nt ia ti on req ui rem en ts , m ai nt ai ne d a ll req ui si te reco rd s, an d

co op erat edwit h t he Co m m is si on er’s rea so na bl e req ue st s fo r in fo rm at io n, do cu m en ts , in te rv ie ws, wit ne ss es , and m eet in gs . Sec. 7 49 1( a)(1 ) an d (2 ).

“ Cred ib le ev id en ce” c on no te s “ ‘the qu al it y of e vi de nc e whi ch , aft er cr it ic al

an al y si s, t he co ur t wo ul d fi nd su ffi ci en t u po n wh ic h t o b as e a d eci si on on th e is su e if n o c on tra ry

ev id en ce were su bm it te d’”. Hig be e v . Comm is si on er, 1 16 T.C. 43 8, 44 2 (2 00 1) (qu ot in g H.R. Co nf . Rep t. No . 10 5- 59 9, at 24 0- 24 1 (1 99 8) , 19 98 -3 C.B. 7 47 , 99 4- 99 5) ). Bu t we n eedno t co ns id er t he tes ti m on y of awit ne ss to be cred ib le si m

pl y be cau se itis un op po se d. Se e HIE Hol di ng s, In c. v. Co m m is si on er, 9 7 T.C.M . (CCH) at 17 33

. W e d ecl in e to sh ift th e b ur de n o f pr oo f to res po nd en t i n t hi s ca se . As di sc us se d e ls ewh ere i n t he op in io n, we d o n ot fin d a s a f act ua l m at te r th atth e ba nk rupt cy

co ur t s ei zedpe ti ti on ers ’ reco rd s t ha t ar e p ert in en t t o t hi s ca se ; i n t he

sa m e v ei n, we re fu se to fin d p et it io ne rs ha ve m ai nt ai ne d t he ne ces sa ry bo ok s an d

reco rd s. We hav e al so no te d e ls ewh ere t ha t M r. Po wers ’ te st im on y is un rel iabl e-2 4-

[* 24 ] an d t ha t we wo ul d d raw a n eg at iv e in fere nc e fro m Ms . Powe rs ’ fai lu re t o te st ify. A nd th ere i s s can t d oc um en ta ry ev id en ce i n t he reco rdfro m pe ti ti on ers th atis cred ib le . Thu s, u nd er s ect io n 7 49 1( a), t he bu rd en of p ro of wil l re m ai n wi th pe ti ti on ers . IV. Sch edul e E Los se s C la im edfor20 04 Deduc ti on s ar e a m at te r of leg is la ti ve gra ce, an d a tax pa y er b ears th e b ur de n of pro du ci ng su ffi ci en t ev id en ce t o s ub st an ti at e an y all owabl e d educ ti on un de r th e Co de . Sec. 6 00 1; Ru le 14 2( a); INDOPCO, In c. v. Co m m is si on er, 5 03 U.S. at 8 4;

se c. 1.6 00 1- 1( a), In co m e Tax Reg s. A. Los s Fr om

SEP In ge ne ral , a sh areh ol de r of an S co rp or at io n m ay

de du cthi s p ro rat a sh are of th e co rp or at io n’s s ep arat el y co m pu te d a ndno ns ep arat el y

co m pu te d l os se s an d de du ct io ns . Sec. 1 36 6( a). Bu t t he sh areh ol de r m ay de du cthi s p ro rat a sh are o f th e co rp or at io n’s l os se s an d d educ ti on s fo r an y tax ab le y ear o nl y

to th e ex te nt of hi s b as is of h is st oc k i n t he S co rp or at io n (i .e., cap it al ba si s) an d h is ad jus te d b as is in an y in de bt ed ne ss of t he S co rp or at io n t o h im (di sr eg ard in g a ny adjus tm en t

un de r se ct io n 1 36 7( b) (2 )) (i .e., no te ba si s) . Sec. 1 36 6( d) (1 ); s ee al so sec . 13 67 (a)

an d (b ). Sect io n 1 36 6( d) (2 ) su sp en ds an y lo ss es or d educ ti on s d is al lo wedas a

res ul t o f th e sh areh ol de r’s ba si s l im it at io n a nd all ows th em in a la te r y ear wh en th e-2 5-

[* 25 ] sh areh ol de r ha s s uf fic ie nt cap it al ba si s o r no te ba si s t o d educ t t he lo ss es or cl ai m th e d educ ti on s. Pet it io ne rs ha ve ack no wled ge d a t t ria l an d o n b rie f th atth ey ha d o nl y $1 ,00 0 o f cap it al ba si s an d d idno t h av e an y no te ba si s i n S EP in 20 03 an d 2 00 4. Thu s, p et it io ne rs di d n ot ha ve su ffi ci en t s to ckba si s o r no te ba si s t o d educ t t he lo ss fro m SEP. See s ec. 1 36 6( d) (1 ). To cl ai m th e lo ss , pet it io ne rs arg ue on bri ef t ha t th ei r Sch edul e E lo ss fro m SEP was act ua ll y

a lo ss flo win g fr om

Nexe s an d t ha t we sh ou ld di sr eg ardSEP an d a ll ow t he m to de du ctth e lo ss di rect ly as Nex es ’ pa rtn ers . To s etup th is arg um en t, p et it io ne rs po in t o ut th atth ey ne ve r tr an sf

erre d th ei r pa rtn ers hi p i nt eres ts in Nexe s t o S EP an d t ha t t he ir Ne xe s p art ne rs hi p in te res ts rem ai ne d u nd er t he ir n am es at a ll ti m es . They al so co nt en d t ha t SEP’s 20 03 an d 2 00 4 re tu rn s wer e in co rrec tl y pre pa redin th atth e SEP ret ur ns sh ou ld no t ha ve rep orte d t he pa ss th ro ug h l os se s fr om Nexe s. Be cau se pe ti ti on ers cla im th ey ha d b as is in Nexe s o n t he ba si s o f Nex es ’ pu rp or te d i nd eb te dn es s t o t he m , th ey cl ai m th ey were en ti tl edto de du ctth ei r di st rib ut iv e sh are o f Nex es ’ lo ss es . Pet it io ne rs ’ co nt en ti on th atwe sh ou ld di sr eg ardSEP an d a ll ow t he m to de du ctth ei r lo ss es as Ne xe s’ par tn ers ap pe ars to ha ve be en rai se d fo r th e fi rs t t im e

on bri ef. The y

di d n ot rai se th is is su e in th ei r pe ti ti on forred et erm in at io n o f th e-2 6-

[* 26 ] de fic ie nc y . Nor d id th ey am en d t he ir p et it io n t o i nc lu de th e arg um en t. Pet it io ne rs were re qu ire d t o fi le a pr et ria l m em or an du m wher e th ey

co ul d h av e

m ad e th is arg um en t, b ut th ey di d n ot fil e an y

m em or an du m

be fo re t ria l. Pet it io ne rs di d n ot art ic ul at e th is arg um en t at tri al . It ap pe ars th atth e o nl y ti m e pe ti ti on ers m ad e th is po in t b efo re b rie fin g was in a on e-p ag e se lf- pr ep ared

“ Su m m ary an d F act s C on cern in g t he Pet it io ne rs ’ Bas is ” th atwas b ur ie d i n o ve r 30 0 p ag es of d oc um en ts th atth ey pro du cedto res po nd en t d ur in g d is co ve ry . It i s wel l s et tl edth atwe do no t co ns id er i ss ue s ra is edforth e fi rs t t im e in po st tri al bri efs wher e th ere i s s ur pr is e an d p reju di ce t o t he op po si ng pa rty. D iLeo v. Co m m is si on er, 9 6 T.C. 8 58 , 89 1, 8 92 , aff’d, 9 59 F.2d 16 (2d Cir . 19 92 ); Sel ig m an v. Co m

m is si on er, 8 4 T.C. 1 91 , 19 8- 19 9, af f’d, 79 6 F .2d 11 6 (5 th Cir

. 19 86 ); R en de l v . Comm is si on er, T.C. Mem o. 1 99 5- 59 3, 7 0 T.C.M . (CCH) 1 57 1, 15 76 n.5 (19 95 ), aff’d wi th ou t p ub li sh edop in io n, 1 29 F.3d12 7 (9 th Cir . 19 97 ). Bec au se pe ti ti on ers di d n ot gi ve res po nd en t an y no ti ce o f th ei r arg um en t t ha t t he y sh ou ldbe all owe d t o d educ t t he pa ss th ro ug h l os se s fr om Nexe s as th e pa rtn ers hi p’s p art ne rs , res po nd en t was no t ab le to pro du ce ev id en ce o r el ic it rel ev an t t es ti m on y

fro m pe ti ti on ers to di sp ut e th atcla im an d t hu s was pre

jud ic ed

. Fo r ex am pl e, th ere i s n o t es ti m on y or o th er ev id en ce i n t he reco rdto sh ow h ow

m uc h o f th e lo ss SEP rep or te d fo r 20 04 was l os s fl owi ng fro m Nexe s. Fu rth er, we-2 7-

[* 27 ] ne edno t d eci de whet he r pe ti ti on ers ’ “ Su m m ary an d F act s C on cern in g t he Pet it io ne rs ’ Bas is ” p ro du cedto res po nd en t dur in g d is co ve ry wou ld co ns ti tu te

su ffi ci en t n ot ic e to res po nd en t. Thi s i s b ecau se pe ti ti on ers ha ve fai le d i n a ny

ev en t t o p ro du ce en ou gh ev id en ce t o s up po rt t he cla im th atth ey ha d s uf fic ie nt ba se s i n Nex es to de du ctth e lo ss cla im ed

. Si m il ar t o a sh areh ol de r of an S co rp or at io n, a p art ne r of a pa rtn ers hi p c an de du cthi s d is tri bu ti ve sh are o f pa rtn ers hi p l os s, i nc lu di ng cap it al lo ss , to th e

ex te nt of h is ad

jus te d b as is in hi s p art ne rs hi p i nt eres t (i .e., ou ts id e b as is ) atth e en d of th e p art ne rs hi p year in whi ch su ch lo ss oc cu rred . Sec. 7 04 (d ). Thu s, fo r pe ti ti on ers to de du ctth ei r di st rib ut iv e sh ares of Ne xe s’ lo ss , th ey m us t s ho w th ey ha d s uf fic ie nt ou ts id e b as es at t he en d o f 20 04

. Bu t u nl ik e a s to ck ho ld er o f an S co rp or at io n, a p art ne r do es no t d eri ve hi s ba si s i n h is pa rtn ers hi p i nt eres t fr om th e p art ne rs hi p’s i nd eb te dn es s t o h im in th e

sa m e m an ne r. The s ta rti ng po in t o f ou r an al y si s i s t ha t a p art ne r’s ou ts id e b as is in a p art ne rs hi p i s i nc reas edby his sh are o f th e p art ne rs hi p l iabi li ti es . Secs . 72 2, 75 2( a). Bec au se sec ti on 70 7( a) t reat s a p art ne r pr ov id in g a lo an to hi s p art ne rs hi p

as a no np art ne r wit h re sp ect to th e lo an tra ns act io n, t he tax co ns eq ue nc es are de te rm in edin th e sa m e way as i f th e tr an sa ct io n o ccu rred wit h a no np art ne r. In-2 8-

[* 28 ] ot he r wor ds , a pa rtn er’s l oa n t o h is pa rtn ers hi p i s t reat edjus t l ik e an y pa rtn ers hi p l iabi li ty to a t hi rdpa rty. To d et erm in e h ow t he Nexe s n ot es to pe ti ti on ers wou ld affe ctpe ti ti on ers ’

ou ts id e b as es in Nexe s, i t i s t hu s n eces sa ry to de te rm in e h ow t o a ll oc at e th e pa rtn ers hi p l iabi li ti es am on g a ll Nexe s p art ne rs . The al lo cat io n o f an y pa rtn ers hi p li ab il it y de pe nd s o n t he reco ur se na tu re o f th e in de bt ed ne ss , sec . 1.7 52 -2 , Inc om e Tax Reg s., an d t he same rul e ap pl ie s t o a ny part ne rs hi p l iabi li ty tha t i s an in de bt ed ne ss to a pa rtn er, s ec. 7 07 (a). If t he pa rtn er’s l oa n i s re co ur se , each pa rtn er’s s ha re o f su ch pa rtn ers hi p l iabi li ty (inc lu di ng th e le nd er p art ne r’s sh are) eq ua ls th e p or ti on of t he li ab il it y forwhi ch th e p art ne r orrel at edpe rs on be ars th e

eco no m ic ris k o f lo ss . Sec. 1 .75 2- 2( a), In co m e Tax Reg s. A pa rtn er b ears th e

eco no m ic ris k o f lo ss forth e p art ne rs hi p l iabi li ty to t he ex te nt th at , if t he pa rtn ers hi p c on st ru ct iv el y li qu id at ed , th e p art ne r (o r rel at edpe rs on ) wou ldbe ob li ga te d t o m ak e a p aym en t t o a ny pers on wit h n o ri gh t t o re im bu rs em en t. Sec

. 1.7 52 -2 (b )(1 ), In co m e Tax Reg s. A va rie ty of factua l co ns id erat io ns de te rm in es th e ex te nt to whi ch a pa rtn er b ears th e eco no m ic ris k o f lo ss forth e p art ne rs hi p li ab il it y . See g en eral ly sec. 1 .75 2- 2( b) , Inc om e Tax Reg s. If a pa rtn er m ak es a

no nr eco ur se lo an to th e p art ne rs hi p a nd no pa rtn er b ears th e eco no m ic ris k o f lo ss fo r th atpa rtn ers hi p l iabi li ty, th e p art ne r m ak in g t he no nr eco ur se lo an be ars th e-2 9-

[* 29 ] eco no m ic ris k o f lo ss forth e en ti re n on reco ur se lo an , and th e p art ne rs hi p li ab il it y is all oc at eden ti rel y

to hi m . Sec. 1 .75 2- 2( c)(1 ), In co m e Tax Reg s. In ev id en ce re la ti ng to th is is su e are th e Nex es pro m is so ry no te s i ss ue d t o pe ti ti on ers . Ass um in g t he y were g en ui ne de bt s, t he y do no t i nf

or m us on th ei r face whet he r th ey

were re co ur se or n on reco ur se . Excep t fo r th e fac t t ha t Nex es

was a li m it edli ab il it y

co m pa ny, the re i s n o e vi de nc e to su gg es t o ne way or t he
ot he r. If we were to tre atth em as r eco ur se no te s fo r th e sa ke of a rg um en t, t he re i s

no th in g i n t he reco rdth atwou lden ab le us to all oc at e th e p art ne rs hi p l iabi li ti es to pe ti ti on ers be cau se we do no t h av e th e fac ts ne ces sa ry to de te rm in e th e ex te nt to whi ch pe ti ti on ers be ar t he eco no m ic ris k o f lo ss forth e n ot es . The reg ul at io ns

co nt em pl at e a p art ne r’s ob li ga ti on to m ak e a p aym en t t o a ny pers on when th e pa rtn ers hi p’s l iabi li ti es be co m e due an d p ay ab le in a de em edli qu id at io n o f th e pa rtn ers hi p. Se c. 1.7 52 -2 (b )(1 ), In co m e Tax Reg s. In a de em edli qu id at io n, t he pa rtn ers hi p i s t reat edas d is po si ng of a ll of i ts ass et s, wh ic h a re t reat edas

wor th le ss ex cep t t ho se co nt rib ut edto sec ur e a p art ne rs hi p l iabi li ty, in a fu ll y ta xa bl e tr an sa ct io n fo r no co ns id erat io n a nd all it em s o f in co m e, ga in , lo ss , or de du ct io n a re al lo cat edam on g a ll th e p art ne rs . Id.; see als o s ec. 1 .75 2- 2( b) (2 ), In co m e Tax Reg s. (s ta ti ng th e ex te nt to whi ch ga in or l os s i s re co gn iz edup on-3 0-

[* 30 ] de em eddi sp os it io n) . The d et erm in at io n o f whi ch pa rtn er o r rel at edpe rs on ha s an ob li ga ti on to m ak e a p aym en t i s “ ba se d o n t he fact s an d c irc um st an ces at th e ti m e o f th e d et erm in at io n.” Sec. 1 .75 2- 2( b) (3 ), In co m e Tax Reg s. Su ch fact s

an d c irc um st an ces tak e in to acco un t al l s ta tu to ry an d c on tra ctua l o bl ig at io ns rel at in g t o t he pa rtn ers hi p l iabi li ty, in cl ud in g c on tra ctua l o bl ig at io ns ou ts id e o f th e pa rtn ers hi p a gr eem en t s uc h a s g ua ran ti es , in de m ni fic at io n a gr eem en ts , and rei m bu rs em en t ag reem en ts . Id. Fu rth er, t he reg ul at io ns ass um e th atall pa rtn ers

an d re la te d p ers on s wh o h av e o bl ig at io ns act ua ll y pe rfo rm th os e o bl ig at io ns ,

“ un le ss th e fac ts an d c irc um st an ces in di cat e a p la n t o c irc umve nt or a vo id th e ob li ga ti on .” Sec. 1 .75 2- 2( b) (6 ), In co m e Tax Reg s. Bu t h ere, t he re i s n ot ev en a sc in ti ll a o f ev id en ce b efo re u s t ha t wo ul d

en ab le us to m ak e an y

of t he se fact ua ll y

in te ns iv e d et erm in at io ns . At a m in im um , pe ti ti on ers ne ed edto pro vi de th e n um be r of pa rtn ers Nexe s h adin 20 04 , th e pa rtn ers hi p a gr eem en t o r th e o pe rat in g a gr eem en t, Nex es ’ ba la nc e sh eet an d cap it al acco un ts , Sch edul es K-1 o f th e Nex es pa rtn ers , any relev an t co nt ract s o r

ev id en ce o f th e ab se nc e o f th es e co nt ract s, an d UCC -1 fin an ci ng st at em en ts if a ny. Pet it io ne rs ha ve no t p ro vi de d a ny evi de nc e o n t he se cri ti cal fact s. If we were to tre atth e Nex es no te s as no nr eco ur se no te s, p et it io ne rs st il l fai le d t o s ho w th atno ot he r pa rtn er ac tu al ly bor e th e eco no m ic ris k o f lo ss for th e-3 1-

[* 31 ] de bt s s in ce t he re i s n o e vi de nc e o r te st im on y sh owi ng pe ti ti on ers di d n ot

en te r in to ot he r ag reem en ts th atwou lden ti tl e th em to so m e type o f in de m ni fic at io n. And ev en if we wer e to tre atth e Nex es no te s as ful ly non reco ur se an d al lo cat e th e li ab il it ie s s ol el y to pe ti ti on ers , th ere r em ai n o th er m at eri al

co ns id erat io ns forwhi ch pe ti ti on ers ha ve no t p ro du cedan y ev id en ce. Aft er al lo cat in g t he len de r pa rtn er’s s ha re o f th e p art ne rs hi p l iabi li ti es to in crea se hi s

ou ts id e b as is , itis ne ces sa ry to ad jus t t he pa rtn er’s o ut si de ba si s o n t he ba si s o f hi s di st rib ut iv e sh are o f va rio us tax att rib ut es of t he pa rtn ers hi p. Se c. 70 5. In ad di ti on , any liq ui da ti ng or n on li qu id at in g d is tri bu ti on wou ldals o a ffec t t he pa rtn er’s ad

jus te d b as is in hi s p art ne rs hi p i nt eres t. See ge ne ral ly sec. 7 33 . Asid e fro m th e u ns ig ne d p art ne rs hi p re tu rn forNexe s fo r 20 04 an d s om e sc at te red do cu m en ts rel at in g t o Nex es th atare i rrel ev an t t o o urin qu iri es un de r se ct io ns 70 5

an d 7 33 , pet it io ne rs di d n ot in tro du ce an yth in g i nt o e vi de nc e, no t ev en Sch edul es K-1 , th atare n eces sa ry

to asc ert ai n t he ir b as es in Nexe s. We do no t kno w whet he r Nex es ha d a ny ite m s o f in co m e, lo ss , ded uc ti on s, an d o th er t ax att rib ut es . Nor do es th e rec or d t el l u s wh et he r Nex es ha d a ny liq ui da ti ng or n on li qu id at in g di st rib ut io n, an d i f th ere was a di st rib ut io n, h ow Nex es ’ cas h a nd pro pe rti es were di st rib ut ed . Even un de r Co ha n v . Comm is si on er, 3 9 F .2d 54 0 (2 d C ir. 1 93 0) , and-3 2-

[* 32 ] it s p ro ge ny, the fact ua l re co rdth atpe ti ti on ers ha ve de ve lo pe d h ere d oe s n ot pr ov id e an y

gro un d, n ot to m en ti on a reas on ab le gro un d, fo r us to est im at e th ei r ba se s i n t he ir Ne xe s p art ne rs hi p i nt eres ts

. Fo r th es e rea so ns , we su st ai n re sp on de nt ’s det erm in at io n t o d is al lo w pe ti ti on ers ’ Sch edul e E lo ss of $ 91 4,7 70 fro m SEP. B. Los s Fr om

AJP To d educ t t he ir S ch edul e E lo ss fro m AJP, p et it io ne rs m

us t h av e su ffi ci en t cap it al ba se s an d/ orno te ba se s t o abs orb t he lo ss . See s ec. 1 36 6( d) . Res po nd en t

su sp en de d t he lo ss cla im edbe cau se he de te rm in edpe ti ti on ers di d n ot ha ve th e req ui si te ba se s i n AJ P in 20 04

. Pet it io ne rs pri m ari ly rais e two is su es on bri ef wi th res pe ctto th ei r ba se s i n AJP. Fi rs t, p et it io ne rs cla im th atAJP h adm ad e cer ta in lo an s t o Nex es in 20 04 , to ta li ng $8 4,8 67 , and th atth e in de bt ed ne ss of Ne xe s was lat er as si gn edto SEP. Seco nd , pet it io ne rs co nt en d t ha t ce rta in de po si ts in to AJP’s b an k a cco un t i n 2 00 4

can sh ow t he y

ha d c ap it al ba se s i n AJ P. Thes e d ep os it s t ot al in g $ 14 5,8 75 were:

• $5 00 cas h;

• a $ 11 .52 ch eckfro m Pru de nt ia l Fi na nc ia l d at edApri l 1 4, 2 00 4;

• a $ 43 .45 ch eckfro m Lesl ie ’s Poo l M art , Inc . dat edMay 11, 2 00 4;-3 3-

[* 33 ] • $9 5,7 98 .79 pe ti ti on ers wit hd rew fro m th ei r ret ire m en t s av in gs acco un t an d t he n d ep os it edin AJP’s b an k a cco un t o n Oct ob er 1 5, 20 04 ;

• $1 ,44 0.1 0 a nd $1 ,43 3.1 0 i n e le ct ro ni c tr an sf ers fro m Refu nd s No w on Octo be r 14 , 20 04 , and$6 97 .60 in anele ct ro ni c tr an sf er fro m Refu nd s Now o n Oct ob er 2 8, 2 00 4;

• $5 74 in anele ct ro ni c tr an sf er fro m th e U.S. Treas ury

on Octo be r 29 , 20 04 ; an d

• a ch eckfor$4 5,3 77 fro m Ro be rt Woo dwa rdwhi ch was p ur po rte dl y th e p ro ceed s fr om

th e sa le of p et it io ne rs ’ ve hi cl e. Pet it io ne rs see k t o b ol st er t he ir c on te nt io n t ha t t he se de po si ts am ou nt edto th ei r cap it al co nt rib ut io ns to AJP b y po in ti ng ou t t ha t M s. Gray hadearl ie r de te rm in ed du rin g t he ir a ud it th atth es e d ep os it s wer e n on bu si ne ss de po si ts . Oth er t ha n t he pu rp orte d $ 1,0 00 in it ia l capi ta l co nt rib ut io n t o AJ P, ho wev er, p et it io ne rs di d n ot

m en ti on at t ria l t ha t t he y

m ad e ad di ti on al cap it al co nt rib ut io ns to AJP. Pet it io ne rs ’ fir st arg um en t re lying on Nexe s’ no te s t o AJ P m us t fa il . There is no th in g i n t he reco rdto su gg es t AJ P was a pa rtn er o f Nex es . Thu s, AJ P d id no t acq ui re b as is fro m

len di ng Nexe s m on ey ; AJ P h adpro m is so ry no te s fr om

Nexe s

as be twee n a len de r an d a bo rro wer, n ot hi ng m or e. The fa ctth atth e n ot es were la te r as si gn edto SEP do es no t ch an ge th is co nc lu si on . Furt he r, th e is su e h ere i s-3 4-

[* 34 ] whe th er p et it io ne rs ha d e it he r cap it al ba se s o r no te ba se s i n AJ P to cla im th e Sch edul e E lo ss fro m

AJP. Whet he r AJP ha d b as is in Nexe s i s i rrel ev an t. 9 W it h re sp ect to pe ti ti on ers ’ cl ai m th atth ey ha d s uf fic ie nt cap it al ba se s i n AJP t o d educ t t he rep or te d l os s, we fi nd th atpe ti ti on ers ha ve fai le d t o c arry the ir

ev id en ti ary bu rd en to pro ve th e d ep os it s i nt o AJ P’s ba nkacco un t wer e in te nd edto be cap it al co nt rib ut io ns . Of al l t he de po si ts forth e AJP ba nkacco un t i n 2 00 4, t ot al in g $ 55 0,2 07 .36 , pe ti ti on ers cla im

th at$1 45 ,87 5 c on st it ut edth ei r ad di ti on al cap it al co nt rib ut io n be cau se itori gi na te d fr om th em pe rs on al ly. Fo r a co up le of r eas on s, t he fact th at th es e d ep os it s ca m e fro m pe ti ti on ers ’ pe rs on al fun ds do es no t n eces si ta te a

co nc lu si on th atth e p ers on al de po si ts co ns ti tu te d t he ir c ap it al co nt rib ut io ns to AJP. Fi rs t, p et it io ne rs m ad e p ers on al wit hd rawal s t ot al in g $ 50 3,2 22 .62 (ou t o f $5 39 ,72 6.1 3 t ot al wit hd rawal s) in 20 04 . Becau se pe ti ti on ers ’ pe rs on al wit hd rawal s fa r ex ceed edall th e p ers on al de po si ts in to th e AJP ba nkacco un t, i t

Pet it io ne rs ’ so m et im es co nt rad ic to ry po si ti on s t ak en on bri ef co m pe l t hi s 9 co nc lu si on . Peti ti on ers st at e o n b rie f: “ The Pet it io ne rs are i n e rro r on th ei r te st im on y to ha vi ng ba si s i n n ot es in AJP, In c. They on ly hav e cap it al ba si s i n AJP, In c.” Bu t at a la te r po in t o n t he ir b rie f, pe ti ti on ers cla im th atth e sa m e n ot es wit h t he same agg reg at e am ou nt were n ot es fro m AJP o wedto pe ti ti on ers . Howev er, o urreco rdco nt ai ns on ly not es Nexe s i ss ue d t o AJ P. If p et it io ne rs ’ po si ti on is th atth e m on ey AJP l en t t o Nex es was m on ey AJP b orro wedfro m pe ti ti on ers , th ey

ha ve no t p ro du cedan y

ev id en ce t o s up po rt t ha t p os it io n.-3 5-

[* 35 ] wou ld be m or e th an reas on ab le to co nc lu de th atin 20 04 pe ti ti on ers wit hd rew ev ery pe nn y

th atth ey ha d p ers on al ly dep os it edin to th e AJP ba nk

acco un t t ha t year. Ind eed , itde fie s re as on th ata bu si ne ss m an wou ld m ak e m or e th an $1 45 ,00 0 c ap it al co nt rib ut io n i nt o a n S co rp or at io n t ha t d oe s n ot hi ng m or e th an co ll ect in g h is earn edin co m e fro m so m eo ne els e. 1 0 Seco nd , th e su m

of t he no np ers on al wit hd rawal s ($ 36 ,50 3.5 1) pl us th e AJP ba nkacco un t’s re m ai ni ng ba la nc e aty eare nd ($1 0,4 81 .23 ) was m uc h l es s t ha n t he

am ou nt of t he y ear’s d ep os it s ($ 40 4,3 32 .36 ) th atdi d n ot co m e fro m pe ti ti on ers . In ot he r wor ds , what co ul d p os si bl y be AJP’s wo rk in g c ap it al for20 04 ($3 6,5 03 .51 + $1 0,4 81 .23 = $4 6,9 84 .74 ) co ul d h av e co m e fro m so ur ces ot he r th an pe ti ti on ers ’ pe rs on al fun ds

. 1 1

See i nf ra n ot e 1 1. 1 0 As a m at te r of

fact , we do ub t AJ P h adan y ne edfor work in g c ap it al

. 1 1 Pet it io ne rs tes ti fie d a t t ria l t ha t AJ P was set up to rece iv e Mr. Po wers ’ co m pe ns at io n fr om

Nexe s an d was no t ca rry in g a ny bu si ne ss act iv it ie s o th erwi se . In de ed , pet it io ne rs ’ rep ly brie f st at es th at“ th e b us in es s ac ti vi ty of AJP , Inc . was al way s cl ear a nd th atwas t o re cei ve co m pe ns at io n fr om

Nexe s fo r Pet it io ne rs --t o gi ve th e Pet it io ne rs th e p ro te ct io n o f a co rp or at e v ei l an d t o p ro vi de a pr of it sh ari ng pl an forth e Pet it io ne rs ,” an d t ha t AJ P was ne ve r en ga ge d i n a ny “ act iv e bu y in g a nd/o r se ll in g o f so m e th in gs .” The m ere f act th atAJP’s b an k a cco un t h ad a b al an ce at th e en d o f th e y ear d oe s n ot m ean it was AJ P’s work in g c ap it al when th ere i s n o e vi de nc e sh owi ng AJP n eed edan y work in g c ap it al

.-3 6-

[* 36 ] In t he li gh t o f th es e rea so ns , pet it io ne rs m us t s ho w m or e th an th e fac t t ha t th ey de po si te d p ers on al fun ds in to th e AJP ba nkacco un t; th ey m us t al so pro du ce

so m e ev id en ce, d oc um en ta ry or o th erwi se , to co rro bo rat e th ei r cl ai m th atth e de po si te d fu nd s wer e in te nd edto be AJP’s capi ta l. With ou t m or e, it is im po ss ib le
to de te rm in e whe th er an y of p et it io ne rs ’ pe rs on al de po si ts were i nt en de d a s a cap it al co nt rib ut io n o r m ean t t o b e fu nn el edels ewh ere. Bec au se pe ti ti on ers fai le d t o s ho w th atth ey ha d s uf fic ie ntcap it al ba se s o r

no te ba se s i n AJ P in 20 04 , we su st ai n re sp on de nt ’s det erm in at io n t o d is al lo w pe ti ti on ers ’ Sch edul e E lo ss of $ 83 ,37 9 fr om AJP. V. Pet it io ne rs ’ Unr ep or te d In co m e Gro ss in co m e in cl ud es all in co m e fro m what ev er s ou rce d eri ve d, u nl es s ot he rwis e sp eci fic al ly excl ud ed . Sec. 6 1( a). The de fin it io n o f gr os s i nc om e br oa dl y in cl ud es an y

in st an ce o f un de ni ab le acce ss io ns to weal th , cle arl y real iz ed ,
an d o ve r whi ch th e ta xp ay er h as co m pl et e d om in io n a nd co nt ro l. Co m m is si on er v . Glen sh aw Glas s C o., 3 48 U.S. 42 6, 4 31 (19 55 ). In th e Co ur t o f App eal s fo r th e Nin th Cir cu it , to whi ch th is cas e is ap pe al ab le ba rri ng writ te n s ti pu la ti on to th e co nt rary, see s ec. 7 48 2( b) (1 )(A), the pr es um pt io n o f co rrec tn es s i n t he Co m m is si on er’s d et erm in at io ns as t o u nr ep or te d in co m e in a no ti ce o f de fic ie nc y ari se s o nl y

if i t i s s up po rte d b y

a m in im al-3 7-

[* 37 ] ev id en ti ary fo un da ti on . W ei m ers ki rch v. Co m m is si on er, 5 96 F.2d 35 8, 3 60

- 36 2 (9 th Cir . 19 79 ), rev ’g 67 T.C. 67 2 (1 97 7) ; s ee al so Dela ne y v. Co m m is si on er, 74 3 F .2d 67 0, 6 71 (9t h C ir. 1 98 4) (st at in g t ha t t he Co m m is si on er m

us t p ro du ce

“ ‘som e su bs ta nt iv e ev id en ce * * * de m on st rat in g t ha t t he tax pa y er re cei ve d

un rep or te d i nc om e’”), aff’g T.C. Mem o. 1 98 2- 66 6 (q uo ti ng Edward s v . Co m m is si on er, 6 80 F.2d 12 68 , 12 70 (9t h C ir. 1 98 2) ). Once th e Co m m is si on er

m eet s h is bu rd en of p ro du ct io n, “ th e ta xp ay er m us t es tabl is h b y

a pr ep on de ran ce of th e ev id en ce t ha t t he de te rm in at io n i s arbi tra ry or e rro ne ou s.” Del an ey

v. Co m m is si on er, 7 43 F.2d at 6 71 ; Un it edSta te s v . Sto ne hi ll , 70 2 F .2d 12 88 , 12 93

- 12 94 (9t h C ir. 1 98 3)

. In a cas e whe re a t ax pa y er h as fai le d t o m ai nt ai n a de qu at e rec or ds to all ow th e Co m m is si on er t o d et erm in e h is in co m e ta x l iabi li ty, se e se c. 60 01 ; s ec. 1 .60 01

- 1( a), In co m e Tax Reg s., t he Co m m is si on er m ay

reco ns tru ctth e ta xp ay er’s i nc om e

us in g a ny reaso na bl e m et ho d, i nc lu di ng th e b an k d ep os it s m et ho d, s ee Ho ll an d v

. Uni te d S ta te s, 3 48 U.S. 12 1, 1 32 -1 33 (19 54 ); Un it edSta te s v . Hall , 65 0 F .2d 99 4, 99 6 n .4 (9 th Cir . 19 81 ) (“ The ba nkde po si ts m et ho d o f pr oo f is als o a ci rcu m st an ti al way

of e st ab li sh in g u nr ep orte d i nc om e.”). Un de r th e b an k d ep os it s

m et ho d, t he Co m

m is si on er m

us t s ho w th atth e ta xp ay er was en ga ge d i n i nc om e pr od uc in g a ct iv it ie s, t ha t h e m ad e reg ul ar d ep os it s o f fu nd s i nt o h is ba nkacco un ts ,-3 8-

[* 38 ] an d t ha t an ad equa te an d fu ll in ve st ig at io n o f th os e acc ou nt s was co nd uc te d
to di st in gu is h t ax ab le in co m e fro m no nt ax ab le de po si ts . Uni te d S ta te s v . Sto ne , 77 0 F .2d 84 2, 8 44 (9t h C ir. 1 98 5) . “ The cri ti cal qu es ti on is whet he r th e go ve rn m en t's in ve st ig at io n h as pro vi de d s uf fic ie nt ev id en ce t o s up po rt a n in fere nc e th atan un ex pl ai ne d e xc es s i n b an k d ep os it s i s at tri bu tabl e to tax ab le in co m e.” Id . at 8 44 -8 45 . Whe n u si ng th e b an k d ep os it s m et ho d, t he Co m m is si on er as su m es a sp eci al res po ns ib il it y of b ei ng th or ou gh an d p art ic ul ar i n hi s i nv es ti ga ti on an d p res en ta ti on . Hall , 65 0 F .2d at 9 99 (ci ti ng Hol la nd , 34 8 U.S.
at13 5- 13 6)

. W e fi nd th atres po nd en t h as m ethi s ev id en ti ary bu rd en as t o p et it io ne rs ’

un rep or te d i nc om e in th is cas e. W e fu rth er co nc lu de pe ti ti on ers ha ve fai le d t o pr ov e b y a pr ep on de ran ce o f th e ev id en ce t ha t re sp on de nt ’s det erm in at io ns as t o pe ti ti on ers ’ un rep orte d i nc om e fo r 20 04 an d 2 00 5 wer e arb it rary or erro ne ou s. A. 20 04 Dur in g a ll rel ev an t t im es Mr. Po wers was a bu si ne ss co ns ul ta nt who alo ng wit h M s. Po wers ha d o wne rs hi p i nt eres ts in AJP an d Nex es . For 2 00 4, M s. Gray

su m m on edpe ti ti on ers ’ ba nkreco rd s an d a gg reg at edth e d ep os it s m ad e fo r eac h o f pe ti ti on ers ’ ba nkacco un ts . Ms. Gra y th en pa in st ak in gl y

ex am in edeach de po si t

an d re m ov edth os e th atsh e d et erm in edto be fro m no nt ax ab le so ur ces . She was-3 9-

[* 39 ] th en ab le to co m

pu te th e am ou nt of t ax ab le de po si ts for each acco un t. All th e d ep os it s t ha t M s. Gray det erm in edto be tax ab le cam e fro m AJP, Nex es , or Nex es ’ su bs id ia rie s, Ic eNetan d C -Tel . Viewi ng th es e fac ts to ge th er, we co nc lu de th atres po nd en t h as pro du cedam pl e cre di bl e ev id en ce al lo win g ave ry st ro ng in fere nc e th at$4 90 ,64 6.4 4 d et erm in edto be tax ab le de po si ts were al l i nc om e to pe ti ti on ers . Pet it io ne rs do no t d is pu te th atth es e d ep os it s i nt o t he ir p ers on al ba nk

acco un ts were m ad e. They argu e o nl y th at$9 2,7 40 of t he de po si ts were

no nt ax ab le rep aym en ts on de bt s. The fo ll owi ng tab le sh ows th e d ep os it s t ha t 1 2 pe ti ti on ers see k t o c ha ract eri ze as no nt ax ab le rep aym en ts on in de bt ed ne ss :

D a t e o f d e p o s i t A m o u n t P a y o r P a r t i e s t o t h e p u r p o r t e d d e b t / d e n o t a t i o n s 1
5 / 1 4 / 0 4 $ 4 , 3 0 7 A J P U n k n o w n / “ [ A J P , I n c . ] ” 7 / 2 / 0 4 1 0 , 0 3 3 N e x e s A J P ( l e n d e r ) a n d N e x e s ( b o r r o w e r ) /

“ R e p m t / V e r a z N o t e ” 8 / 4 / 0 4 9 , 0 0 0 I c e N e t A J P ( l e n d e r ) a n d N e x e s ( b o r r o w e r ) 8 / 4 / 0 4 1 , 0 0 0 I c e N e t A J P ( l e n d e r ) a n d N e x e s ( b o r r o w e r ) 8 / 5 / 0 4 5 0 0 A J P U n k n o w n 8 / 9 / 0 4 1 , 0 0 0 C

- T e l A J P ( l e n d e r ) a n d N e x e s ( b o r r o w e r ) /

“ L o a n P a y b a c k t o C

- T e l ” 8 / 1 6 / 0 4 4 , 0 0 0 I c e N e t A J P ( l e n d e r ) a n d N e x e s ( b o r r o w e r ) /

“ P a r t i a l R e p a y m e n t N e x e s L o a n ”
At t ria l M r. Po wers os te ns ib ly trie d t o h ed ge hi s t es ti m on y by stat in g t ha t 1 2 th e d is pu te d d ep os it s wer e “ no te tra ns fers ,” whi ch co ul d t ech ni cal ly m ean eit he r lo an rep aym en ts or a dv an ces . At no po in t d idhe off er t o c la rif

y whi ch on es were de bt pa ym en ts an d wh ic h o ne s wer e ad va nc es . As th e ta bl e imm ed ia te ly bel ow il lu st rat es , pet it io ne rs ha ve co ns is te nt ly chara ct eri zedth e d ep os it s as rep aym en ts on in de bt ed ne ss owed to th em . To th e ex te nt th atpe ti ti on ers att em pt to rai se an al te rn at iv e cl ai m

th atth es e d ep os it s wer e lo an ad va nc es of wh ic h t he y were t he de bt or s, t he y

ha ve no t p ro du cedan y

ev id en ce t o s up po rt s uc h c la im

.-4 0-

[ * 4 0 ] 8 / 1 6 / 0 4 2 , 0 0 0 I c e N e t A J P ( l e n d e r ) a n d N e x e s ( b o r r o w e r ) /

“ P a r t i a l R e p a y m e n t N e x e s L o a n ” 8 / 2 3 / 0 4 1 , 0 0 0 N e x e s A J P ( l e n d e r ) a n d N e x e s ( b o r r o w e r ) /

“ O t h e r I n c : L o a n P a y B a c k ” 8 / 2 4 / 0 4 6 , 0 0 0 C

- T e l A J P ( l e n d e r ) a n d N e x e s ( b o r r o w e r ) /

“ O t h e r I n c : L o a n P a y B a c k ” 8 / 2 5 / 0 4 1 , 5 0 0 I c e N e t A J P ( l e n d e r ) a n d N e x e s ( b o r r o w e r ) /

“ O t h e r I n c : L o a n P a y B a c k ” 8 / 2 7 / 0 4 2 , 2 0 0 I c e N e t A J P ( l e n d e r ) a n d N e x e s ( b o r r o w e r ) /

“ P a r t i a l R e p a y m e n t N e x e s L o a n ” 1 0 / 1 2 / 0 4 2 , 0 0 0 A J P U n k n o w n / “ [ A J P , I n c . ] ” 1 0 / 2 0 / 0 4 5 0 0 A J P U n k n o w n / “ [ A J P , I n c . ] ” 1 0 / 2 1 / 0 4 1 , 9 0 0 A J P U n k n o w n / “ [ A J P , I n c . ] ” 1 0 / 2 2 / 0 4 6 , 0 0 0 A J P U n k n o w n / “ [ A J P , I n c . ] ” 1 0 / 2 7 / 0 4 3 , 0 0 0 A J P U n k n o w n / “ [ A J P , I n c . ] ” 1 1 / 2 / 0 4 4 , 0 0 0 A J P U n k n o w n / “ [ A J P , I n c . ] ” 1 1 / 3 / 0 4 2 0 0 A J P U n k n o w n / “ [ A J P , I n c . ] ” 1 1 / 4 / 0 4 6 0 0 A J P U n k n o w n 1 1 / 9 / 0 4 2 , 0 0 0 A J P U n k n o w n / “ [ A J P , I n c . ] ” 1 2 / 8 / 0 4 1 , 0 0 0 A J P U n k n o w n / “ [ A J P , I n c . ] ” 1 2 / 9 / 0 4 1 , 0 0 0 A J P U n k n o w n / “ [ A J P , I n c . ] ” 1 2 / 1 0 / 0 4 1 , 0 0 0 A J P U n k n o w n / “ [ A J P , I n c . ] ” 1 2 / 2 1 / 0 4 5 , 0 0 0 A J P U n k n o w n / “ M i s c D e p ” 1 2 / 2 2 / 0 4 2 2 , 0 0 0 A J P U n k n o w n T o t a l 9 2 , 7 4 0 U n l e s s o t h e r w i s e n o t e d , t h e i d e n t i t i e s o f t h e p a r t i e s t o t h e p u r p o r t e d d e b t a r e l i s t e d o n N e x e s ’ n o t e s c h e d u l e 1 p r o v i d e d b y p e t i t i o n e r s , a n d t h e d e n o t a t i o n s a r e t h o s e f r o m p e t i t i o n e r s ’ p u r p o r t e d c a s h d i s b u r s e m e n t j o u r n a l s u b m i t t e d a s p a r t o f t h e p a r t i e s ’ s t i p u l a t i o n . Oth er t ha n Nex es , th e rec or d d oe s n ot sh ow an y of t he pa y or s fr om

who m th es e d ep os it s o rig in at edowedan y de bt to pe ti ti on ers . Mor eo ve r, in m an y cas es pe ti ti on ers ha ve be en un ab le to id en ti fy th e in de bt edne ss on whi ch a pa y m en t was pu rp orte dl y

m ad e. In cas es wher e p et it io ne rs ha ve be en ab le to id en ti fy th e d eb t, th e d eb t was be twee n AJ P as th e le nd er an d Nex es as t he bo rro wer. Not hi ng in th e rec or d c ou ld ex pl ai n wh y an y de po si ts in to pe ti ti on ers ’ pe rs on al acco un ts of pu rp orte d p aym en ts on lo an s b et ween AJP an d Nex es wou ld no t b e in co m e to pe ti ti on ers .-4 1-

[* 41 ] As t o t he de po si ts ori gi na te d fr om Nexe s, p et it io ne rs ha ve id en ti fie d c ert ai n de bt s b et ween AJP an d Nex es as t ho se to whi ch th e d ep os it s p ur po rte dl y rel at ed

. Aga in , th ere i s n o e xp la na ti on as t o wh y Nexe s’ paym en ts to pe ti ti on ers on de bt s i t

owe d t o AJ P wou ld no t b e in co m e to pe ti ti on ers . Eve n i f we were t o c on st ru e p et it io ne rs ’ arg um en t t o m ean th atth e d ep os it s fro m Nexe s wer e rep aym en ts on it s i nd eb te dn es s t o p et it io ne rs , th is arg um en t

m us t al so fai l. Pet it io ne rs ha ve tak en th e p os it io n o n b rie f th atth ei r lo an s t o Nex es crea te d b as es in th ei r pa rtn ers hi p i nt eres ts in Nexe s. Th ey ha ve arg ue d t ha t th e fac e am ou nt of t he ir l oa ns to Nexe s wo ul d c reat e b as es bu t h av e n ot ot he rwis e in ti m at edth atwe ne edto reduc e su ch ba se s t o a cco un t fo r an y rel ie f fro m

th e pa rtn ers hi p l iabi li ti es be cau se Nexe s h adm ad e p aym en ts on it s n ot es . Im pl ic it in th is cla im is th atNexe s n ev er m ad e an y pa y m en t o n i ts no te s t o p et it io ne rs . Abs en t an y

ev id en ce t o c orro bo rat e p et it io ne rs ’ cl ai m th atth e p aym en ts fro m Nex es were i nt en de d t o s at is fy it s d eb t o bl ig at io ns to pe ti ti on ers , com po un de d wit h p et it io ne rs ’ in te rn al ly inc on si st en t p os it io ns tak en on bri ef, we d ecl in e to fin d th atth es e p aym en ts fro m Nexe s wer e n on ta xa bl e rep aym en ts on it s d eb ts

. In su m , th e rec or d d oe s n ot su pp ort p et it io ne rs ’ se lf- se rv in g, v ag ue , and in te rn al ly inc on si st en t cl ai m th atth e refe ren cedde po si ts were p aym en ts on-4 2-

[* 42 ] in de bt ed ne ss to th em an d t hu s n on ta xa bl e. Acco rd in gl y , we su st ai n

res po nd en t’s d et erm in at io n t ha t p et it io ne rs ha d $ 93 ,66 6.4 4 o f un rep or te d i nc om e fo r 20 04

. B. 20 05 Pet it io ne rs di d n ot rep or t an y in co m e fo r 20 05 . Whi le th ey att ach eda Sch edul e C-EZ to th ei r 20 04 ret urn fo r an un na m edco ns ul ti ng bu si ne ss , no su ch

sc he du le was a tt ach edto th ei r 20 05 ret ur n. In th e ab se nc e o f ad eq ua te reco rd s,

res po nd en t re co ns tru ct edpe ti ti on ers ’ 20 05 in co m e u si ng th e sa m e b an k d ep os it s

m et ho d u se d t o d et erm in e th ei r 20 04 in co m e. At t he co nc lu si on of t he au di t,

res po nd en t d et erm in edpe ti ti on ers ha d $ 58 ,85 5.8 2 o f un rep or te d i nc om e. Tog et he r th is is su ffi ci en t t o m eet res po nd en t’s ev id en ti ary bu rd en . At t ria l p et it io ne rs ad m it te d t ha t t he y di d n ot an al y ze t he ir u nr ep or te d in co m e fo r 20 05 . Nor d id th ey pro vi de an y

tes ti m on y

to ch al le ng e res po nd en t’s

un rep or te d i nc om e d et erm in at io n fo r th aty ear. Bu t p et it io ne rs arg ue on bri ef t ha t th e q ue st io ne d d ep os it s wer e n ot tax ab le in co m e b ecau se (1) pe ti ti on ers were n ot

em pl oyed i n 2 00 5 t o re cei ve an y earn edin co m e an d b ecau se (2) th e d ep os it s wer e rep aym en ts on Nexe s’ no te s t o p et it io ne rs . W e fi rs t n ot e th atpe ti ti on ers de ci de d n ot to pro vi de an y tes ti m on y

du rin g tri al ab ou t t he 20 05 un rep or te d i nc om e. W e wil l t hu s d raw a n eg at iv e in fere nc e-4 3-

[* 43 ] fro m

pe ti ti on ers ’ fai lu re t o t es ti fy an d t o p res en t ev id en ce wh en

res po nd en t’s p ro ba ti ve ev id en ce ag ai ns t p et it io ne rs on th is pa rti cu la r is su e is so

co m pe ll in g. Se e Bax te r, 42 5 U.S. at 31 8- 31 9; Pet zo ld t v . Comm is si on er, 9 2 T.C.
at68 5 (d rawi ng ad ve rs e in fere nc e fro m fai lu re t o t es ti fy

pe rm it te d i n c iv il cas e). In ot he r wor ds , we gi ve no ev id en ti ary weig ht to pe ti ti on ers ’ arg um en ts on bri ef th atth ey were u ne m

pl oyed i n 2 00 5 a nd th atth e d is pu te d d ep os it s wer e d eb t rep aym en ts

. Eve n i f we co ns id er p et it io ne rs ’ cl ai m s fo r arg um en t’s s ak e, th ey su fferth e

sa m e in fir m it ie s t ha t h av e cau se d u s t o re ject t he ir a rg um en ts co nc ern in g t he ir 20 04 un rep or te d i nc om e. Fo r on e, pe ti ti on ers ha ve tak en th e p os it io n t ha t t he ful l face am ou nt of t he Nexe s n ot es sh ou ld gi ve th em ba se s i n Nex es , im

pl y in g t ha t Nex es ha d n ot rep ai d a ny po rti on of i ts no te s. Th us , pet it io ne rs can no t al so arg ue ha t t he de po si ts ori gi na te d fr om Nexe s wer e lo an rep aym en ts . In ad di ti on , pe ti ti on ers ha ve fai le d t o e xp la in why pa ym en ts fro m no n- Nex es en ti ti es , whi ch

were n ot in de bt edto pe ti ti on ers , cou ldbe rep aym en ts on Nexe s’ deb ts or a ny de bt s. Fi na ll y , pet it io ne rs ’ se lf- se rv in g s ta te m en ts in th ei r br ie f th atso m e o f th es e de po si ts were re im

bu rs em en ts for

ex pe ns es th ey

pre vi ou sl y

pa id on so m eo ne el se ’s beh al f are si m

pl y no t s up po rte d b y

th e rec or d. To ge th er, p et it io ne rs ha ve-4 4-

[* 44 ] fai le d t o c arry the ir b ur de n o f sh owi ng res po nd en t’s d et erm in at io n o f

un rep or te d i nc om e fo r 20 05 was e rro ne ou s. Acco rd in gl y , we su st ai n re sp on de nt ’s det erm in at io n t ha t p et it io ne rs ha d $5 8,8 55 .82 of u nr ep or te d i nc om e in 20 05

. 1 3 VI. NOL Sect io n 1 72 all ows a ta xp ay er t o d educ t an NOL for a t ax ab le y ear t ha t eq ua ls th e su m

of t he NOL carry ov ers pl us NOL carry ba ck s t o t ha t year. Sec. 17 2( a). A tax pa y er cl ai m in g a n NOL d educ ti on be ars th e b ur de n o f su bs ta nt ia ti ng th e d educ ti on by esta bl is hi ng bo th th e ex is te nc e o f th e NOL and th e am ou nt of a ny NOL tha t m ay

be carr ie d o ve r to th e su bjec t years. Ru le 14 2( a)(1 ); Un it edSta te s v. Ol ym pi c Rad io & Tele vi si on , Inc ., 34 9 U.S. 2 32 , 23 5 (1 95 5) ; Gre en v. Co m m is si on er, T.C. Mem o. 2 00 3- 24 4, 8 6 T.C.M . (CCH) 2 73 , 27 4- 27 5 (2 00 3) . As pa rt o f m eet in g t ha t b ur de n, t he tax pa y er m us t fi le wit h h is ret ur n fo r th aty ear a

co nc is e st at em en t s et ti ng for th th e am ou nt of t he NOL deduc ti on cla im edan d a ll

Pet it io ne rs rai se forth e fi rs t t im e o n b rie f th atwe ne edto de te rm in e 1 3 whe th er an y

po rti on of t he tax ab le de po si ts for 20 04 an d 2 00 5 s ho ul d b e tr eat edas di st rib ut io n fr om

an S co rp or at io n, s el f-em pl oym en t i nc om e, orearn edin co m e. W it h o ne ex cep ti on , pet it io ne rs di d n ot m ak e th is anis su e b efo re b rie fin g a nd we de cl in e to co ns id er i t. Pet it io ne rs su bm it te d a n u nf il edam en de d re tu rn for20 04 to st at e th atth ey

in co rrec tl y

rep or te d t he ir wa ge in co m e as Sch edul e C i nc om e, bu t th ey di d n ot pro du ce an y

ev id en ce t o s up po rt t he ass ert io n. In all , th e rec or d be fo re u s i s i ns uf

fic ie nt to m ak e th e d et erm in at io n t ha t t he un rep or te d i nc om e was an yth in g o th er t ha n S ch edul e C i nc om e as pe ti ti on ers ori gi na ll y rep or te d.-4 5-

[* 45 ] m at eri al an d p ert in en t fa ct s, i nc lu di ng a de ta il edsch edul e sh owi ng th e

co m pu ta ti on of t he NOL deduc ti on . Sec. 1 .17 2- 1( c), In co m e Tax Reg s. Thu s, t o s up po rt t he cla im edde du ct io n fo r th e NOL carri edov er t o 2 00 4, pe ti ti on ers m

us t b e ab le to pro ve th ey

in cu rred NOLs in ot he r y ears th atcan be

carr ie d t o 2 00 4. Re sp on de nt ag rees th atpe ti ti on ers ha d a n NOL carry ov er fro m 20 00 of $ 34 5,8 03 th atco ul d b e carrie d t o 2 00 3. Bu t re sp on de nt de te rm in edth at pe ti ti on ers di d n ot est ab li sh su ffi ci en t capi ta l b as es or n ot e b as es in OneS ta r Hol di ng to de du ct$5 85 ,58 7 o f th e Sch edul e E lo ss flo win g fr om th e S co rp or at io n fo r 20 03 . Con se qu en tl y , res po nd en t u se d $ 32 4,9 40 of t he 20 00 NOL in 2 00 3, al lo win g o nl y

$2 0,8 63 to be carr ie d o ve r to 20 04 (as op po se d t o t he $6 06 ,45 0 pe ti ti on ers cla im edon th ei r ret ur n)

. The no ti ce o f de te rm in at io n e xp la in edth atbe cau se pe ti ti on ers di d n ot in cu r

an NOL for 2 00 3, re sp on de nt li m it edth e NOL deduc ti on for20 04 to th e $ 20 ,86 3

carr ie d fr om

20 00 , effec ti ve ly inc reas in g p et it io ne rs ’ ta xa bl e in co m e fo r 20 04 by $5 85 ,58 7. Ag ai n i n h is pre tri al m em or an du m , res po nd en t s ta te d t ha t h e h ad di sa ll owe d t he cla im edNOL carri edfro m 20 03 forlac k o f su bs ta nt ia ti on . Ind eed , Ms . Gray ex pl ai ne d t hi s d et erm in at io n c le arl y to pe ti ti on ers in th e fo ll owi ng pa ss ag e in he r wor kp ap ers fro m th e au di t: [W] hi le co m

pu ti ng Sh areh ol de r’s Bas is in OneS ta r Hol di ng , Inc . for th e au di t year of 2 00 4, i t was di sc ov ered [pe ti ti on ers ] ha d d educ te d-4 6-

[* 46 ] $5 85 ,58 7 p as s- th ru Los s o n S ch edul e E in ex ces s o f hi s al lo wab le Bas is . There fo re, t hi s h as a di rect effe cton th e Net Ope rat in g Lo ss ge ne rat edin 20 03 an d c arri edfor wardto th e au di t y ear 2 00 4. [Em

ph as is ad de d]. Ms . Gray co nt in ue d t o e xp la in in a su bs eq ue nt pa ss ag e: Alan J Po wers rece iv eda Fo rm 10 99 -C fo r $5 85 ,58 7 i n h is SSN fo r 20 03 fro m

OldNati on al Ban k. A can cel la ti on of De bt do es no t res to re Lo an Bas is or i nc reas e St oc k B as is . If an yth in g, t hi s s ho ul d ha ve be en rep orte d a s C OD in co m e o n h is pe rs on al 20 03 tax ret urn. [Em ph as is ad de d]. In st eadof p ro du ci ng ev id en ce t o s ho w th ey ha d s uf fic ie ntba se s i n On eSt ar Hol di ng to de du ctth e lo ss cla im ed , pet it io ne rs foc us th ei r arg um en t s ol el y on th ei r ap pa ren t m is ta ke n n ot io n t ha t re sp on de nt ha d i nc reas edpe ti ti on ers ’ 20 03 in co m e by inc lu di ng th e am ou nt of C OD in co m e rep or te d o n t he Fo rm 10 99 -C, Can cel la ti on of De bt , th atMs . Gray refer redto in he r wor kp ap ers , whi ch 1 4 pe ti ti on ers be li ev e in tu rncau se d re sp on de nt to di sa ll ow a p or ti on of t he NOL

carr y ov er fro m

20 03 to 20 04 . Peti ti on ers m ai nt ai n t ha t t he Fo rm 10 99 -C

erro ne ou sl y

rep or te d t he ir C OD in co m e in th atth ey ha d o nl y $2 54 ,81 2 o f COD in co m e an d t he rem ai ni ng ba la nc e o f th e COD was in co m e to OneS ta r Hol di ng

1 5 be cau se OneS ta r Hol di ng was a ll eg ed ly liab le forth atpo rti on of t he de btth atwas

The Fo rm 10 99 -C i s n ot in ev id en ce. 1 4 Pet it io ne rs rep orte d t hi s amoun t o f COD in co m e as m is cel la ne ou s i nc om e 1 5 on th ei r 20 03 ret urn.-4 7-

[* 47 ] can cel le d. Pe ti ti on ers fur th er co nt en d t ha t an y COD in co m e to th em

wou ld be ex cl ud edun de r se ct io n 1 08 (a) b ecau se th ey were i ns ol ve nt

. 1 6 Bu t re sp on de nt di d n ot di sa ll ow a p or ti on of t he NOL from 20 03 be cau se he in cl ud edth e am ou nt of C OD rep or te d o n t he Fo rm 10 99 -C i n p et it io ne rs ’ in co m e fo r 20 03 . Res po nd en t h as alwa y s cl ai m edon ly tha t p et it io ne rs fai le d t o

su bs ta nt ia te th ei r cap it al or n ot e b as es in OneS ta r Hol di ng in 20 03 to ab so rb all th e rep or te d S ch edul e E lo ss es fro m th aty ear. Desp it e h av in g a m pl e n ot ic e o f 1 7

res po nd en t’s ar gu m en t u nd erl y in g t he di sa ll owa nc e, pe ti ti on ers fai le d t o p ro du ce

an y rel ev an t an d c red ib le ev id en ce t o s ho w th ey ha d t he su ffi ci en t b as es in One St ar Ho ld in g t o t ak e th e d is al lo wedlo ss for20 03

. In ad di ti on , as M s. Gray corr ect ly poi nt edou t d ur in g t he au di t, an y COD in co m e to pe ti ti on ers wou ld no t re st or e th ei r cap it al ba se s o r no te ba se s i n One St ar. Eve n i f we were t o c on st ru e p et it io ne rs arg um en t t o m ean th atth e

The re i s n o e vi de nc e to su bs ta nt ia te pe ti ti on ers ’ cl ai m th atth ey were 1 6 in so lv en t i n 2 00 3. In th ei r rep ly brie f pe ti ti on ers ap pe ar t o b e su rp ris edby thi s cl ai m of 1 7 res po nd en t’s. Bu t an y

cla im of s ur pr is e is no t s up po rte d b y

th e rec or d. Ms . Gray st at edrep eat ed ly in h er wo rk pape rs th atth e d is al lo wan ce o f th e NOL carryove r to 20 04 was a res ul t o f pe ti ti on ers ’ de du ct in g l os se s fr om OneS ta r Hol di ng in ex ces s of th ei r ba se s. Re sp on de nt ’s pre tri al m em or an du m cle arl y st at edth atth e NOL is su e was on e o f subs ta nt ia ti on , no t u nr ep or te d C OD in co m e. As a fa ctua l m at te r, we fi nd Mr. Po wers , who is an ex pe rie nc edC.P.A., and Ms . Powe rs ha d a de qu at e no ti ce o f res po nd en t’s cl ai m un de rlyin g t he di sa ll owa nc e.-4 8-

[* 48 ] rem ai ni ng $3 30 ,77 5 C OD in co m e was in co m e to OneS ta r Hol di ng an d t hu s

an it em of i nc om e p as se d t o i ts sh areh ol de rs , su ch COD in co m e wou ld no t 1 8

ne ces sa ril y

in crea se pe ti ti on ers ’ ba se s i n On eSt ar Ho ld in g u nd er s ect io n 13 67 (a)( 1) be cau se an S co rp or at io n’s COD i nc om e ex cl ud edun de r se ct io n 1 08 (a) is no t an it em

of i nc om e to it s s ha reh ol de rs un de r se ct io n 1 36 6( a). See sec . 10 8( d) (7 )(A). There is no th in g i n t he reco rdto su gg es t wh et he r an y COD 1 9 in co m e to OneS ta r Hol di ng wou ld be ex cl ud edun de r se ct io n 1 08

. Fo r th e fo reg oi ng reas on s, we s us ta in res po nd en t’s d et erm in at io n t o di sa ll ow $ 58 5,5 87 of t he NOL tha t was carr ie d o ve r to 20 04 . Becau se ou r fin di ng s t od ay

sh ow t ha t p et it io ne rs di d n ot in cu r an NOL for 2 00 4, we s us ta in

res po nd en t’s d et erm in at io n t o d is al lo w th e cl ai m edNOLs fo r 20 05 . Becau se th e NOL ded uc ti on was t he on ly item rep or te d o n t he 20 05 ret ur n, we al so su st ai n

The reco rddo es no t h av e an y ev id en ce t o s ho w th atOneS ta r Hol di ng ha d 1 8 COD in co m e. In de ed , OneS ta r’s Fo rm 11 20 S an d S ch edul e K-1 for20 03 di d n ot sh ow an y COD in co m e. Thu s, we d ecl in e to m ak e a fac tu al fin di ng as t o t hi s al le ga ti on . On M arch 9, 2 00 2, t he Jo b C reat io n a nd W or ke r Ass is ta nc e Actof 2 00 2, 1 9 Pub. L. No. 1 07 -1 47 , sec . 40 2( a), 1 16 Sta t. at 40 , was s ig ne d i nt o l aw, pr oh ib it in g sh areh ol de rs of a n S co rp or at io n fr om in crea si ng ba si s fo r th ei r pr o ra tash ares of th e S co rp or at io n’s ex cl ud edCOD in co m e fo r di sc ha rg es of i nd eb te dn es s af te r Octo be r 11 , 20 01 . This effe ct iv el y ab ro ga te d t he Supr em e Co ur t’s d eci si on in Git li tz v. Co m

m is si on er, 5 31 U.S. 20 6 (2 00 1) , to all ow s uc h a ba si s i nc reas e. See Bal l ex rel . Bal l v . Comm is si on er, T.C. Mem o. 2 01 3- 39 , at * 23 -* 24

.-4 9-

[* 49 ] res po nd en t’s d et erm in at io n t o d is al lo w th e d educ ti on of t he NOL carry ov er fro m 20 05 cla im edfor20 06

. VII. Accu racy-Rel at edPen al ti es Res po nd en t d et erm in edth atpe ti ti on ers are l iabl e fo r acc ur acy-rela te d pe na lt ie s fo r 20 04 , and 20 05 , and 20 06 on two alt ern at iv e g ro un ds : (1 ) pe ti ti on ers

su bs ta nt ia ll y

un de rs ta te d t he ir i nc om e ta x o r (2 ) th ey were n eg li ge nt or di sr eg ard edrul es or r eg ul at io ns . See s ec. 6 66 2( a) an d (b )(1 ) an d (2 ). Ther e is a

su bs ta nt ia l u nd ers ta te m en t o f in co m e ta x i f th e u nd ers ta te m en t am ou nt forth e ta xa bl e y ear e xc eed s t he gre at er o f 10 % of t he tax req ui redto be sh own on a ret urn fo r a t ax ab le y ear o r $5 ,00 0. Se c. 66 62 (d )(1 )(A). Alt ern at iv el y , we wil l s us ta in th e Co m m is si on er’s d et erm in at io n t o i m po se an accu racy-rela te d p en al ty if we de te rm in e th atth e ta xp ay ers fai le d t o m ak e a rea so na bl e at te m pt to co m pl y wit h pr ov is io ns of t he in te rn al rev en ue laws or d is reg ard edrul es or r eg ul at io ns by
act in g c arel es sl y , reck le ss ly, orwit h i nt en ti on al di sr eg ard . Sec. 6 66 2( c); sec . 1.6 66 2- 3( b) (1 ) an d (2 ), In co m e Tax Reg s. On ly one accu racy-rela te d p en al ty m ay be im po se d fo r a g iv en po rti on of a n u nd erp aym en t ev en th ou gh th atpo rti on im pl ic at es m or e th an on e fo rm of m is co nd uc t d es cri be d i n s ect io n 6 66 2. Se c. 1.6 66 2- 2( c), In co m e Tax Reg s. Th e Co m m is si on er b ears th e b ur de n o f pr od uc ti on

as to th e im

po si ti on of p en al ti es . Sec. 7 49 1( c).-5 0-

[* 50 ] A. Res po nd en t’s Pri m a Fac ie Cas e Ourde ci si on to da y

sh ows th atth ere was a su bs ta nt ia l u nd ers ta te m en t o f in co m e ta x fo r 20 04 an d 2 00 5. Fo r 20 04 pe ti ti on ers un de rs ta te d t he ir i nc om e ta x li ab il it y by $16 5,6 38 , whi ch far ex ceed ed10 % of t he tax req ui redto be sh own on th e 2 00 4 re tu rn . For 2 00 5 p et it io ne rs un de rs ta te d t he ir i nc om e ta x l iabi li ty by $1 1,9 17 , whi ch ex ceed edth e $ 5,0 00 th res ho ld

. Thu s, re sp on de ntha s m ad e h is 2 0 pr im a fac ie cas e fo r im

po si ng th e acc ur acy-rela te d p en al ti es for20 04 an d 2 00 5. Res po nd en t h as m ad e h is pri m a fac ie cas e wit h re sp ect to th e acc ur acyrel at edpe na lt ie s as se rte d fo r 20 04 , 20 05 , and 20 06 als o b y ha vi ng pro du ced

ev id en ce o f pe ti ti on ers ’ ne gl ig en ce an d d is reg ardof rul es an d re gu la ti on s. Th is is

so be cau se ou r rec or d s ho ws p et it io ne rs di d n otke ep ad eq ua te bo ok s an d re co rd s to su bs ta nt ia te th ei r cl ai m s. We hav e al read y no te d t ha t we d o n ot gi ve m uc h cred en ce t o p et it io ne rs ’ cl ai m th atth e b an krup tc y

co urt h adsei zedth ei r rec or ds be cau se an y

su ch cla im

is no t s up po rte d b y

what act ua ll y

tra ns pi redin th e ba nk rupt cy

pro ceed in gs on th e b as is of o urrev ie w of t he ba nk rupt cy co ur t’s do ck eten tri es an d v ari ou s d is co ve ry ord ers . In an y

ev en t, p et it io ne rs ha ve no t pr od uc edan y

ev id en ce, as id e fro m

Mr. Po wers ’ se lf- se rv in g a nd co nc lu so ry te st im on y , to sh ow wh atreco rd s wer e se iz edan d wh ateffo rts th ey m ad e to

Ten pe rcen t o f th e ta x re qu ire d t o b e sh own for20 05 is ab ou t $ 1,1 00

. 2 0-5 1-

[* 51 ] ret rie ve th os e rec or ds . It al so ap pe ars pe ti ti on ers ha ve be en ab le to tu rn up

so m e rec or ds foris su es no t i m po rta nt in th is cas e so th atth ey co ul d c la im

th ey ha ve co m pl ie d wi th th e rec or dk eep in g re qu ire m en ts . But in fact , what pe ti ti on ers ha ve pro du cedin th e co ur se of t hi s l it ig at io n h as no t b een ve ry he lp fu l an d

oc cas io na ll y

am ou nt edto a di st ract io n. Mo reo ve r, we in fer fr om

Mr. Po wers ’ ex pe rie nc e as an acco un ta nt th athe

un de rs ta nd s wh atth e ru le s an d re gu la ti on s re qu ire of p et it io ne rs as t ax pa y ers . In th e li gh t o f th is ob se rv at io n, we ar e p uz zl edby Mr. Power s’ tes ti m on y th athe di d

no t k no w hi s an d M s. Po wers ’ pe rcen ta ge sh ares of t he ir r es pe ct iv e o wne rs hi p in te res ts in AJP an d S EP. W e are als o t ro ub le d b y th e fac t t ha t p et it io ne rs fil ed th e SEP ret urns as i f th ey ha d t ran sf

erre d t he ir i nt eres ts in Nexe s t o S EP when th ey kn ew th ey

ha d n ot

. Pet it io ne rs ha ve als o a dm it te d t ha t t he y un de rrep orte d 2 1 $1 8,4 52 .22 of S ch edul e C i nc om e fo r 20 04 an d $ 50 1 i nt eres t i nc om e fo r 20 06

. Thi s t y pe of b eh av io r is no t co ns is te nt wit h o ne th atwe wou ld ex pe ctfro m an

ex pe rie nc edacco un ta ntwho cla im s t o b e d il ig en t i n h is co m pl ia nc e wit h t he in te rn al rev en ue laws an d t he ir rul es an d re gu la ti on s.

Mr. Po wers ’ te st im on y

th atan in di vi du al at Nex es pre pa redso m e o f hi s 2 1 ret urns do es no t ch an ge ou r co nc lu si on . Peti ti on ers ha d a du ty to re vi ew th ei r ta x ret urns be fo re s ig ni ng an d fi li ng th em . See Ma gi ll v. Co m m is si on er, 7 0 T.C. 4 65 , 47 9- 48 0 (1 97 8) , aff’d, 6 51 F.2d 12 33 (6t h C ir. 1 98 1)

.-5 2-

[* 52 ] In su m , res po nd en t h as pro du cedam pl e ev id en ce t o s ho w cul pa bl e co nd uc t

on th e p artof p et it io ne rs th atsu pp or ts th e im po si ti on of t he accu racy-rela te d pe na lt ie s u nd er s ect io n 6 66 2( a). B. Pet it io ne rs ’ Reb ut ta l Onc e res po nd en t h as pro ve d h is pri m a fac ie cas e fo r im po si ng th e p en al ty

un de r se ct io n 6 66 2( a), p et it io ne rs be ar t he bu rd en of p ro vi ng th atth e p en al ty is

un warra nt edby esta bl is hi ng an affi rm at iv e d efen se su ch as r eas on ab le cau se or

su bs ta nt ia l au th or it y . See s ecs . 66 64 (c)( 1) , 66 62 (d )(2 )(B)

. Pet it io ne rs ha ve no t ra is edan y affi rm at iv e d efen se ; t he y arg ue on ly tha t th ey were n ot ne gl ig en t i n fa il in g t o c om pl y wit h t he rul es an d re gu la ti on s an d t ha t th ey di d n ot di sr eg ardth es e ru le s an d re gu la ti on s. In su pp or t o f th ei r co nt en ti on , th ey po in t t o a lo ng hi st ory

of c om pl ia nc e. Whi le pe ti ti on ers ’ al le ge d 4 4 years o f
ta x c om pl ia nc e is no te worth y

an d m ay workas c irc um st an ti al ev id en ce t o s ho w th ey di d n ot actne gl ig en tl y

or d is reg ardth e ru le s an d re gu la ti on s i n t he y ears in is su e, it is in su ffi ci en t s ta nd in g a lo ne to ov erco m e res po nd en t’s p rima facie cas e he re. Acco rd in gl y , we su st ai n re sp on de nt ’s det erm in at io n t o i m po se th e acc ur acyrel at edpe na lt ie s fo r th e ta x years i n i ss ue .-5 3-

[* 53 ] VIII. Epi lo gu e W e h av e co ns id ered all of p et it io ne r’s arg um en ts fora co nt rary hol di ng , and
to th e ex te ntno t d is cu ss edhe rei n we c on cl ud e th ey are i rrel ev an t, m oo t, o r la ck in g in m eri t. To re fle ctth e fo reg oi ng ,
Deci si on wil l b e en te redfor

res po nd en t.