T.C. M em o . 2 0 2 0 -1 5 4

UNITED STATES TAX COURT

G URPREET S. PADDA AND PAM ELA B. KANE, Pet i t i o ners v . COM M ISSIONER OF INTERNAL REVENUE, Res po n d en t

Do ck etNo . 1 7 3 38 -1 6
. Fi l edNo vem b er 1 6 , 2 02 0
.

J am es A. Ku t t en , fo r p et i t i on ers . Teri L. J ack s on an dW i l l i am R. Peck , fo r res p o n d en t .

M EM ORANDUM FINDINGS OF FACT AND OPINION
M ORRISON, J u d g e: Th e p et i t i o ners , Gu rp reet S. Pad da an dPam el a B. Kan e, fi l edjo i n tretu rn s fo r 2 0 1 0 , 2 0 1 1 , an d2 01 2 . Th e res p o nd en t (referred t o h ere as th e IRS) i ss u eda n o t i ce o f d efi ci en cy d et erm i ni n g t h e fo l l owi n g d efi ci en ci es i n i n co m e t ax , ad d i t i o n s t o t ax , an d p en al t i es :- 2
-

Year Defi ci en cy Ad d i t i o n t o t ax s ec. 6 6 5 1(a)(1 ) Pen al ty

s ec. 6 6 6 2 (a) 2 0 1 0 $ 3 8 0 ,9 3 4 $ 9 4 ,5 7 9
. 7 5 $ 7 6 ,1 8 6 .8 0 2 0 1 1 2 7 0 ,4 7 9 -0
- 5 4 ,0 9 5 .8 0 2 0 1 2 4 2 4 ,9 6 3 2 0 ,9 3 1.8 5 8 4 ,9 9 2 .6 0 Pad d a an d Kan e fi l eda t i m el y p et i t i o n . W e h av e ju ri s d i ct i o n u n der s ect i o n 6 2 1 3 (a). 1 Pad d a an d Kan e h av e co n ced edth e s ect i on 6 6 5 1(a)(1 ) ad d it i on t o t ax fo r l at e fi l in g fo r t he 2 01 0 y ear. Tak i n g th is co n ces s io n i n t o acco u n t, h ere are t h e
rem ai n i n g i s s u es fo r d eci si o n: (1 ) Di dPad d a m eetthe m at eri al -p art i ci p at io n req u irem en t s o f s ect i o n 4 69 fo r t h e act i vi ti es o f fi v e res t au ran t s an d a b rewery ? W e h o l dh e d id m eetth e req ui rem en t s . (2 ) Di dPad d a recei v e a co ns tru ct i v e d i v i d en di n 2 0 10 b ecau s e h i s wh o l l y
o wn edm ed i cal co rp o rat i o n 2 p ai d $ 8 1 ,8 2 8 o f h i s ex p en s es ? W e h o l d h e d i drecei v e a co n s tru ct i v e d i v i d en d
. [* 2 ]

1 Un l es s o th erwi s e i nd i cat ed , al l s ect i o n referen ces are t o th e In t ern al Rev enu e Co de i n effect fo r t h e y ears ati s s u e, an dal l Ru l e referen ces are t o th e Tax Co u rtRu l es o f Pract i ce an dPro cedu re.

2 In t erv en ti o n al Cen t er fo r Pai n M an ag em en t , In c. (In t erv en t i o n al Cen t er).- 3
-

[* 3 ] (3 ) Are Pad d a an d Kan e l i ab l e fo r a s ect i o n 6 65 1 (a)(1 ) ad d i ti o n t o t ax fo r

fai l i ng t o t i m el y

fi l e t h ei r 2 0 1 2 return ? W e h o ldth ey are l i ab le. (4 ) Are Pad d a an d Kan e l i ab l e fo r accu racy -rel at edp en al t i es u n d er
s ect i o n 6 6 6 2(a) fo r 2 0 1 0 , 2 01 1 , an d2 0 12 ? W e h o l dth ey are l i ab l e fo r t h e p en al ty

u n d er s ect io n 6 6 6 2 (a) fo r 2 01 0 fo r t h e p o rt i o n o f t h e
u nd erp aym en t rel at ed t o th e co n s tru ct i ve d i v i den d
.

FINDINGS OF FACT Th e p art i es h av e s t ip ul at eds o m e o f t h e fact s . Th es e fact s are ad o p tedb y th e Co u rtas fi nd i n g s o f fact
. Pad d a an d Kan e res i d edi n M i ss o u ri wh en th ey fi l edth ei r p et i t i o n . Pad d a an d Kan e are b o th m ed i cal d o ct o rs . Kan e p ract i ces m ed i ci n e ata p ed iat ri c cl i ni c. Pad d a p ract i ces m ed i ci n e th ro u g h h i s wh o l l y o wn edC co rp o rat i o n , In t erv en t i o n al Cen t er, a p ai n -m an ag em en t cl i n i c i n St . Lo u i s , M i s s o u ri , th ath e i n co rp o rat edi n t h e l at e 1 9 9 0 s. Pad d a i s th e p res id en to f In t erv en ti o n al Cen t er an d h as p ri m ary

res p o n s i bi l i ty

fo r i t s o p erat i o n s . In t erv en t i o nal Cen t er em p l o y eda
n u m b er o f p h y s ici an s , nurs e p ract i t i o n ers , ch i ro p ract o rs , an dp h y s i cal therap i s t s du ri n g th e y ears ati s su e.- 4
-

[* 4 ] Du ri n g 2 0 1 0 an d2 0 1 1 , In t erv en t i o n al Cen t er’ s h o urs o f o p erat i o n were 8 a.m . t o 5 p . m ., M o nd ay th ro u g h Fri d ay , an d 1 0 a.m . t o 1 p .m . o n Satu rd ay . In 2 0 1 2 , In t erv en t i o n al Cen t er s h o rt en edi t s Fri d ay h o urs t o 8 a.m . t o 1 p .m . Pad d a
wo u l dty pi cal l y wo rkatIn t erv en t i o n al Cen t er fo r ap p ro x i m at el y three ei g ht -h o u r
wo rk d ay s an dtwo fo u r-h ou r wo rk d ay s , M o n d ay th ro u g h Fri d ay . On ce ev ery few
m o nt h s h e wo rk eda few h o u rs o n a Satu rd ay . In 2 0 0 6 , Am i Gri m es b ecam e t h e ch i ef fi n an ci al o ffi cer o f In t erv en ti o n al Cen ter. Sh e m ai n t ai n ed In t erv en t io n al Cen t er’ s b oo k s o f acco u n t s u s in g th e Qu i ck Bo o k s p ro g ram . Sh e en t eredIn t erv en t io n al Cen t er’ s ex p en ses an dch eck s i n t o th e p ro g ram . Du ri n g th e y ears ati ss u e, Pad d a was the s o l e s h areh o l d er an dco rp o rat e p res i den to f M as al a, In c., an S co rp o rat i on th at o perat eda m ed i cal b i l l in g s erv i ce fo r In terv en t i o nal Cen t er u nd er t h e n am es ePro Bi l l an dePro Co l l ect . ePro Bi l l h an dl ed al l o f th e m ed i cal b i l l i n g fo r In t erv en t io n al Cen ter, an dePro Co l l ect h an dl ed th e co l l ect io n o f o v erdu e p aym en t s . Pad d a an do th er In t erv en ti o n al Cen ter em

p l o y ees p erfo rm edal l o f M as al a’ s fu n ct io n s. Pad da s p en t b et ween 2 1 0
an d 2 2 0 h o u rs p er y ear ex cl u s i v el y o n wo rkfo r M as al a duri n g 2 0 1 0 , 2 0 1 1 , an d 2 0 1 2
.- 5
-

[* 5 ] Pad d a al s o o perat ed an o th er cl i n i c cal l edth e Pad d a In s t i tu te Cen t er fo r Aes th et i c an d Las er M ed i ci n e (Pad d a In s t itu t e). Th e Pad d a In st itu t e was a
m ed i cal s p a s p eci al i zi n g i n s ki n care an d l as er h ai r rem o v al treat m en t s . Itwas
o p en fo r b u s i n es s M on d ay th ro u g h Sat u rd ay . Pad d a d i d n o t s pen d s i gn i fi can t h o u rs wo rk i ng o n th e b u s in es s o f t h e Pad d a In s t i tu t e i n 2 0 1 0, 2 0 1 1 , o r 2 0 1 2 . Th e
co rp o rat e fo rm

u n d er wh i ch th e Pad d a In st i tu t e o p erat edi s n o trev eal edb y th e
reco rd
. Bet ween 2 0 0 8 an d2 0 1 2 , Pad d a an dGri m es o pen edfi v e res t au ran t s i n th e St . Lo u is area. Each o f t h e fi v e res t au ran t s was o p erat edb y a s ep arat e p art n ers hi p . Thu s : ! CA Gro up, LLC, 3 o p erat ed a fu l l -s erv i ce res t au ran t an db ar u n d er t h e n am e Ch u y

Arzo l as . Ito p en edi n 2 0 0 9 an d cl o sedi n 2 01 3
. ! Cafe Ven t an a, LLC, o p erat eda cafe s erv i n g fo o dan db ev erag es . It o pen ed in 2 0 08
. ! Ag av e STL, LLC, o p erat eda fu l l -s erv ice res t au ran tan db ar cal l ed San ctu ari a. Ito p en edi n 2 0 0 9
. ! Hen dri ck s BBQ, LLC, o p erat eda fu l l -s erv i ce res t au ran tan db ar. It o pen ed in Au g u st2 0 1 2 al th o u g h p l an n i n g fo r i t s o p erat i o n s o ccu rred i n 2 0 1 0 an d2 0 1 1
.

3 Al l l i m it edl iab i l i ty

co rp o rat i o ns , o r LLCs , m en t i o n edi n th is o p i n i on are en t i t i es treat ed as p art n ers h i p s fo r fed eral t ax p urp o s es .- 6
-

[* 6 ] ! Di at in a, LLC, o p erat eda fu l l-s erv i ce res t au ran tan db ar cal l ed

Di ab li to s Can t in a. Ito p en ed i n 2 0 1 1 an d cl os edi n 2 0 17
. Du ri n g th e rel ev an ty ears , Pad d a o wn eda 5 0 % i n t eres ti n each o f th e fi v e
res t au ran tp art ners h i ps ; Gri m es o wn ed th e o th er 5 0 %. Gri m es d i d n o tco n tri b u t e
cas h o r o th er p ro p ert y

t o acq ui re h er i n teres t s i n the p art n ers h i p s . Al th o u g h Pad d a
o wn edo nl y

5 0 % o f each of t h e fi v e res tau ran tp art n ers h i p s, h e was al l ocat ed 1 0 0 % o f t h e l o s s es . Gri m es w as n o tal l ocat edan y l o s s es . Th e IRS d o es n o t ch al l en g e t h i s l o s s al lo cat i on . Pad d a al s o i n v es t edi n a b reweryo p erat edb y Ni nk as i , LLC. Duri n g th e y ears ati s s u e, Pad d a o wn eda 9 0 % i n t eres t i n Ni nk as i ; Gri m es o wn ed5 % an d Pad da’ s b ro th er (wh o was al s o h i s at t orn ey ) o wn edthe rem ai n in g 5 % . Ni n k as i
o p en edfo r b u s i nes s i n 2 0 08 an do p erat edu n d er t he n am e Cat h ed ral Squ are Brewery
. Al th o u g h Pad d a o wn ed9 0% o f Ni n kas i , h e was al l o cat ed1 0 0 % o f t h e l o s s es . Gri m es an dPad d a’ s b ro th er were n o t al l o cat edan y o f th e l o s s es . Th e IRS d o es no tch al l en ge t h i s l o s s al l o cat i o n . Pad d a was th e s ol e s h areh o l der o f Pad d a Equ ip m en tCo ., an S co rp o rat i o n th ro u g h wh i ch h e p u rch as edth e fu rn i ture, fi x tu res , d eco r, an dm ach in ery fo r t h e fi ve res t au ran t s an dthe b rewery . Pad da s p en ts o m e t i m e ex cl us i v el y o n i t s
o p erat i o n s .- 7
-

[* 7 ] Du ri n g 2 0 1 0 , Pad d a u s edIn t erv en t io n al Cen t er’ s co rp orat e cred i tcardt o p ay fo r $ 8 1 ,8 2 8 o f ex p en s es fo r t rav el , m eal s , an d ev en tt i ck et s . Onth ei r 2 0 1 0, 2 0 1 1 , an d2 0 1 2 t ax retu rn s , Pad d a an dKan e rep ort edth e fo l l o w i n g l o s s es fro m

th e res t au ran t s an dth e b reweryas n o npas s i v e (an dth ey
n et t edth e l o s s es ag ai n s t th ei r n o np as s i v e i n co m e): Co m p an y n am e 20 1 0 2 01 1 2 01 2 CA Gro up $ 3 7 5 ,3 9 0 $ 1 8 6 ,2 9 8 $ 4 9,4 1 8 Cafe Ven t an a 3 2 3 ,7 7 6 2 1 0 ,8 48 3 2 3,7 6 3 Hen dri ck s BBQ 2 5 ,3 4 4 7 2 , 1 9 2 2 1 1,4 7 0 Ni n k as i 1 4 9 ,6 5 7 3 8 , 6 9 2 2 1 4,0 1 9 Ag av e STL 2 7 8 ,7 3 9 4 7 , 6 7 7 1 0 0,6 6 5 Di at i n a n/ a 3 1 7 ,3 9 4 3 2 9,0 0 2 To t al 1,1 5 2,9 06 8 7 3 ,1 01 1,2 2 8 ,3 3 7 Pad d a an d Kan e h i reda cert i fi edp ub li c acco u n t an t , Sy l v i a A. Eh ren rei ch , t o p rep are t hei r 2 0 10 , 2 0 1 1 , an d2 0 1 2 fed eral i n co m e t ax retu rn s . Sh e h adp rep ared Pad da an dKan e’ s retu rn s s i n ce atl eas t2 0 06
. Eh ren rei ch al s o p rep aredth e co rp o rat e fed eral i n co m e t ax retu rn s fo r In t erv en t i o n al Cen t er fo r 2 01 0 , 2 0 1 1 , an d 2 0 1 2 . Eh ren rei ch rel i edo n the t ri al b al an ce s h o wni n Qu i ckb o o k s fo r t h e am o u nt s o f m eal s an den t ert ai n m en t an d trav el ex p en ses th atwere d edu ct edo n In t erv en t i o nal Cen t er’ s 2 0 1 0 retu rn . Sh e
was n otas k ed t o rev iew an y d o cu m en t at i o n rel at edt o t h es e ex p en s es , n o r was s h e- 8
-

[* 8 ] as k edt o d et erm i n e wh eth er an y o f t he ex p en s es p ai dwere p ers o nal o r were p ro p erl y s ub s t an t i at ed
. Eh ren rei ch al s o p rep aredth e fed eral i nco m e t ax retu rn s fo r t h e fi v e
res t au ran tp art ners h i ps an dth e b reweryp art ners h i p fo r th e y ears ati s s u e. Onth ei r 2 0 1 0 ret u rn , Pad d a an dKan e fi l edan “ El ect i o n t o Gro up Act i v i t i es ”. Th ey

el ect edt o g ro up th e fo l lo wi n g act i v i t i es : (1 ) Ni n k as i wi th 3 9 1 4 Li n d el l , LLC; an d(2 ) Cafe Ven t an a wi th 3 9 1 9 W es tPi n e, LLC. Th e b u s i n es s act i vi t i es o f 3 9 1 4 Li n d el l an d 3 9 1 9 W es tPi n e are n o t refl ect edi n th e reco rd
. 4 Fo r t ax y ears 2 0 06 th ro u g h 2 0 1 2 , wi th th e ex cep ti o n o f 2 0 1 1 , Pad d a an d Kan e’ s fed eral i n co m e t ax retu rn s were fi l edwi th th e IRS aft er t h e p res cri b eddu e d at es (i n cl u d i n g ex ten s i on s ). Pad d a an d Kan e’ s 2 0 1 2 fed eral i n d i vi dual i n co m e t ax retu rn was du e Oct o b er 1 5 , 2 0 1 3
. OnOct o b er 1 5 , 2 0 1 3 , Pad d a an dKan e s i g n edIRS Fo rm 8 8 7 9 ,

“ IRS e-fi l e Si g n atu re Au tho ri zat i o n ” t o au th o ri ze Eh ren rei ch ’ s acco u n ti n g fi rm t o el ect ro ni cal l y

fi l e t h ei r 2 0 1 2 Fo rm

1 0 4 0 , “ U .S. In d i v i dual In co m e Tax Retu rn ”. OnOct o b er 1 5 , 2 01 3 , Eh ren rei ch ’ s acco u n t i n g fi rm was el ect ro n i cal l y fi l i n g
s ev eral t ax return s ju s tb efo re m i dn i g h t . Eh ren rei ch ’ s acco u n t i n g fi rm creat edan

4 Bo th 3 91 4 Li n d el l an d3 9 1 9 W es tPi n e are l i s t edo n Sch edu l e E, Sup p l em en t al In co m e an dLo s s, o f Pad d a an dKan e’ s 2 01 0 retu rn i n Part 1 , In co m e o r Lo s s Fro m

Ren t al Real Es t at e an dRo y al t i es .- 9
-

[* 9 ] el ect ro n i c v ers i o n o f Pad d a an dKan e’ s retu rno n Oct o ber 1 5 , 2 0 13 , at 1 1 : 5 9 p .m . Ittran s m i t t edth e el ect ro n i c v ers i o n t o the IRS o n Oct o ber 1 6, 2 0 1 3 , at 1 2 a.m . OnOct o b er 1 6 , 2 0 1 3 , th e IRS reject edth e ret u rnas a dup li cat e
s ub m i s si o n . Eh ren rei ch ’ s acco u n t i ng fi rm el ect ro n i cal l y

res en t the ret u rno n Oct o b er 2 5 , 2 0 1 3 , an di t was recei v edan d accep t edb y th e IRS t h e s am e d ay . OnM ay 2 , 2 0 1 6 , th e IRS i s s u eda n o t i ce o f d efi ci en cy t o Pad d a an dKan e fo r t h e 2 0 1 0 , 2 0 11 , an d2 0 1 2 t ax ab l e y ears . Th e n o t i ce d et erm i nedd efi ci en ci es fo r al l th ree y ears b as edo n t h e fo l l o wi n g d et erm in at i o n s : (1 ) t h e res t au ran t s an d th e b rewerywere p as s i v e act iv i t i es fo r al l three y ears an d(2 ) Pad d a an dKan e fai l edt o rep o rtco n s tru ct i v e-d iv i d en d i n co m e fo r 2 0 1 0 . As i n d i cat edatthe b eg in n i n g o f t h e o p i ni on , th e n o t i ce o f d efi ci en cy d et erm in eds ect i o n 6 6 62 (a) p en al t i es fo r al l th ree y ears . Befo re t h e IRS i s s u edth e n o ti ce o f d efi ci en cy , th e g ro up m an ag er res p o ns i bl e fo r t h e ex am i n at i on o f Pad da an dKan e’ s retu rn s fo r th e t h ree y ears ap p ro v edi n wri t i n g th e d et erm i n at i o n o f t h e s ect io n 6 6 6 2(a) p en al t i es fo r t h o se y ears . OPINION Th e IRS’ s d et erm i n at i o n s i n th e n o t i ce o f d efi ci en cy are g en eral ly

p res u m ed
co rrect , an dt ax pay ers g en eral ly b ear t h e b urd en o f p ro v i n g o th erwi s e. Ru l e- 1 0 -

[* 1 0 ] 1 4 2 (a)(1 ); W el ch v . Hel v eri n g , 2 9 0 U.S. 1 1 1 , 1 15 (1 9 3 3 ). Pad d a an d Kan e
co n ced e i n th ei r o p en i n g b ri ef t h atthey b ear t h e b u rd en o f p ro o f. 1
. Pad d a m at eri al l y

p art i ci pat edi n th e b u s i n es s o p erat i on s o f th e fi v e res t au ran t s an dth e b reweryduri n g 2 0 1 0 , 2 0 1 1, an d2 01 2
. a. Th e rel ev an tl eg al t es t s Tax p ay ers are al l o w edd edu ct i o n s fo r cert ai n b u s i nes s an d i nv es t m en t
ex p en s es u n d er s ect i o n s 1 6 2 an d2 1 2
. Ho wev er, a t ax p ay er m ay n o td edu ctl o s s es fro m p as s i v e act i v i t i es t o t he ex t en tthe l o s s es ex ceed th e t ax p ay er’ s i n co m e fro m p as s i v e act i v i t ies
. Sec. 4 6 9 (a)(1 ), (d )(1 ); s ec. 1 .4 6 9-1 T(a)(1 )(i ), Tem p o rary In co m e Tax Reg s ., 5 3 Fed . Reg . 5 7 0 0 -5 7 0 1 (Feb . 2 5 , 1 9 8 8). A p as s i v e act i v i t y i s g en eral l y an act i v i ty i n v o lv i n g th e co n du cto f a trad e o r b u s i n es s i n wh i ch th e t ax p ay er d o es n o t m at eri al ly p art i ci p at e. Sec. 4 6 9 (c)(1 ). Gen eral ly , t ax p ay ers m at eri al l y p art i ci p at e i n an act i v i ty i f t h ey are i n v o l v ed i n the o p erat i o n s o f t h e act i v i ty o n a reg u l ar, co n t in u o u s , an ds ub st an t i al b as i s . Sec. 4 6 9(h )(1 ). M at eri al p art i ci p at i o n i n an act i v i ty m ay b e es t ab l i s hedb y

an y
reas on ab l e m ean s . Sec. 1
. 4 6 9 -5 T(f)(4 ), Tem po raryIn co m e Tax Reg s ., 5 3 Fed
. Reg
. 5 7 2 7 (Feb
. 2 5 , 1 9 8 8 ). Gen eral l y , “ reas o n ab l e m ean s ” i n cl u de t h e

“ i d en t i fi cat i o n o f s erv i ces p erfo rm ed o v er a p eri o do f t i m e an d th e ap pro x i m at e
n u m b er o f h o u rs s p en t p erfo rm i n g s u ch s erv i ces du ri ng s u ch p eri o d , b as edo n- 1 1 -

[* 1 1 ] ap po i n t m en tb oo k s , cal en d ars , o r n arrat iv e s u m m ari es .” Id . Whi l e d ai l y t i m e rep o rt s , l o g s , o r s i m i l ar d o cu m en t at io n are n o treq u i red , a t ax p ay er m u s t p ro v id e o th er reas o nab l e m ean s t o es t ab l i s h p art i ci p at i o n i n th e act iv it y . Id
. A t ax p ay er can es t ab l i s h m at eri al p art i ci p at i o n i n an act i v it y b y s at i s fy i n g
an y o n e o f s ev en t es t s s etfo rt h i n s ect i o n 1 .4 6 9-5 T(a), Tem p o rary In co m e Tax Reg s., 5 3 Fed . Reg . 5 7 2 5 -5 7 2 6 (Feb . 2 5 , 1 9 8 8). Parag rap h (a)(4 ) p ro v i d es th atth e fo u rt h t es ti s m eti f t h e “ act i vi ty i s a s i g ni fi can t p art i ci p at i o n act i v i ty * * * fo r t h e t ax ab l e y ear, an dth e i nd i v i dual ’ s ag g reg at e p art i ci pat i on i n al l s ig n i fi can t p art i ci p at i o n act i v i t i es du ri n g s u ch y ear ex ceed s 5 0 0 h o u rs ”. A s i gn i fi can t p art i ci p at i o n act i v i ty

i s a t rad e o r b u s i n es s act i v i ty i n wh i ch the i nd i v i du al p art i ci p at es fo r m o re t han 1 0 0 h o u rs du ri n g the y ear. Id
. p ara. (c), 5 3 Fed
. Reg
. 5 7 2 6
. Fo r t h e p u rp o ses o f d et erm i n i n g wh ether t h e fi v e res t au ran t s an d t h e b rewerywere p as s i ve act i v i t i es , we as s u m e wi th o u t d eci d i n g th atthe fi v e
res t au ran t s an dth e b reweryeach co u n tas s ep arat e act i v it i es . A t ax p ay er m ay treat
o n e o r m o re t rad e o r b us i nes s act i v it i es as a s i n g l e act i v it y i f t he act iv i ti es
co n st i tu t e anap pro pri at e eco n o m i c u n i tfo r t h e m eas u rem en t o f g ai n o r l o s s fo r p u rp os es o f t he p as s i v e-act iv i ty ru l es . Sec. 1 .4 69 -4 (c)(1 ), In co m e Tax Reg s . On ce a t ax p ay er h as g ro up edact i v i t i es , th e t ax pay er m ay n o treg ro up t h e act i v i t i es- 1 2 -

[* 1 2 ] i n l at er t ax ab l e y ears u nl es s th e t ax pay er co m pl i es wi th d i s cl o s u re req u i rem en t s p res cri b edb y th e IRS. Id . p ara. (e)(1 ). Onth ei r 2 0 1 0 retu rn Pad da
an d Kan e el ect edt o g ro up Ni n k as i wi th 3 9 14 Li n d el l (an en t it y n ot ati s su e), an d Café Ven t an a wi th 3 9 1 9 W es tPi n e (an en t it y n otati s su e). Th ey

d id n o t el ectt o treat as a s i n gl e act iv i ty an y co m b i n at i o n o f t h e fi v e res t au ran t s an dth e b rewery . Th e IRS arg u es th atPad da an dKan e can no t , fo r t h e p u rp o s es o f t h i s l i t i g at i o n , m ak e a ret ro sp ect iv e el ect i o n t o reg ro up t h ei r act i v i t i es fo r t h e y ears at i s s u e. Becau s e (as we ex p l ai n b el ow) t h e t i m e s p en tb y Pad d a o n each o f th e s ix act i vi t i es ex ceed ed1 0 0 h o u rs fo r each y ear wi th ou tg ro up i n g an y o f t h e act i v i t i es t o g et h er, we n eedn o t d et erm i n e wh et h er Pad d a an d Kan e are en t i t l edt o reg ro up th e act i v i t i es . 5 b
. Pad d a’ s n o n trav el h o urs Pad d a p res en t edt es t i m o n y t o es tab l i s h h i s h o u rs s p en t o n th e res t au ran tan d th e b reweryact i v i t i es . He p ers o n al l y t es t i fi edfo r an en t i re d ay o f t ri al , ex p l ai n i n g i n d et ai l h i s n o n trav el i n v o l v em en ti n each res t au ran tan dth e b rewery . Pad d a
s t at edth e n o n trav el h o u rs h e s pen two rk i n g o n th e res tau ran t s an dth e b rewery each y ear.

5 Fo r al l h o u rs cal cu l at i o n s , we ex cl u d e t h e y ear 2 0 1 0 fo r Di at i n a b ecau s e n o l o s s es were cl ai m edfo r Di at in a fo r 2 0 1 0
.- 1 3 -

[* 1 3 ] Fo l l owi n g Pad d a’ s t es ti m o n y , 1 2 i n d iv i dual s t es t i fi edreg ard in g Pad d a’ s
n o n trav el i n v o l v em en ti n th e res t au ran t s an dth e b rewery . Th ey ex p l ai n edh o w Pad da was i n v ol v ed in ev ery as p ecto f t h e res t au ran t s an dth e b rewery . Th i s i n cl u d edh an d s-o n wo rk

an do n s i t e i n st ru ct io n . Pad d a’ s t es t i m o n y

was al s o d irect edt o h o w m an y h o u rs h e s p en to n each act i vi ty fo r each y ear. Fo r ex am p l e, Pad d a t es t ifi edth ath e s p en t4 0 0 h o u rs i n 2 0 1 1 o n Cafe Ven t an a, o f wh i ch 2 0 0 h o u rs were s p en t o n ren o vat i on s . Onth e b as is o f th e t es t i m o n y we d es cri b edfro m

Pad d a an dth e
co rro b o rat in g wi tn es s es , we fi n dth atthe n o n trav el t i m e Pad da s p en t o n each act i vi ty ex ceed ed1 0 0 h o u rs fo r each y ear at i ss u e. Becau s e t here are s i x act i v i t ies i n v o l v ed i n th i s cal cu l at i o n , o u r fi n d i n g
m ean s th atPad d a an n u al l y d ev o t ed m o re t h an 6 0 0 h o u rs (i
. e., 6 × 1 0 0 ' 6 0 0 ) o f
n o n trav el t i m e t o th e fi v e res tau ran t s an dth e b rewery . Th i s co n cl u s i on i s v al i d d es p it e t h e IRS’ s s kep t i ci s m th atPad d a co u ldh av e s p en ts i g ni fi can tt im e o n th e
res t au ran t s an dth e b reweryg i ven th e d em an d s o f h i s wo rk at h is m ed i cal p ract i ce (wh ich was h i g h l y

s u cces s fu l) an dthe l acko f d o cu m en t ary ev i den ce o f h i s p ers o n al i n v o l vem en t in th e res t au ran t s an dth e b rewery . Th es e reas o n s fo r
s k ep ti ci sm m i g h tb e wel l p l aced i n an o th er cas e. Bu tth e reco rdi n th i s cas e i s
co n si s t en twi th o u r co n cl u s i o n s ab o utPad d a’ s h o u rs . Pad d a d i dn o tu s e- 1 4 -

[* 1 4 ] co rres po n d en ce o r em ai l s wi th res p ectt o the res t au ran t s an dth e b rewery . In s t eadh e u s edth e t el ep h on e an dface-t o-face m eet i n g s. Us in g th es e m ean s o f
co m m u n icat io ns , Pad d a ex erci s ed t i g h t co n tro l o f m an y as p ect s o f t h e res t au ran t s
an d th e b rewery . Inp art i cu l ar, h e p ai dcl o se at ten t i o n t o the q u al i ty an d i n g red i en t s o f t h e fo o dan db ev erag es . He al s o ri g o ro u s ly co n tro l l edth e d eco r an d ap p earan ce o f t h e es t ab l i sh m en t s . Hi s em p l o y ees co nfi rm edh i s h eav y i n v o l v em en t . Th ey

co m p lai n edi n th ei r t es t i m o n y ab o u t h i s m i cro m an ag em en t . Perh ap s as a res ul to f Pad da’ s effo rt s , th e res tau ran t s an dth e b rewerywere l av i s hl y ap p oi n t ed . Th e fo o dan db ev erag es were o f t h e h i g hes tqu al i ty . Th e
res t au ran t s an dth e b rewerywere al s o co s t l y t o o p erat e. Year aft er y ear, t h ey p ro duced m as s i v e fi n an ci al l o s s es th at l arg el y wi p edo u tPad d a’ s p ro fi t s fro m h i s
m ed i cal p ract i ce. Th u s i twas th atPad d a was a s u cces s fu l d oct o r an d atth e s am e t i m e s p en ts i g ni fi can tt i m e o n th e res t au ran t s an dthe b rewery . c. Pad d a’ s trav el h o u rs In ad d i t i o n t o th e n on trav el t i m e h e s p en two rk i n g o n the fi v e res t au ran t s
an d th e b rewery , Pad d a s p en t t i m e t rav el i n g . Gri m es acco m p an i ed Pad da o n m o s t
o f h i s tri p s . Gri m es t es t i fi edatl en g th ab o utth e b u si n es s n atu re o f t h e t ri p s u s i n g h er p ers o n al kn o wl ed g e. Cred i b l e t es t i m o ny b y Pad d a an d b y

Gri m es es t ab l i s h ed th atth e tri ps were fact fi n d in g t ri p s fo r t h e fi v e res t au ran ts an dth e b rewery . Th ey- 1 5 -

[* 1 5 ] t es t i fi ed ab o u th o wv i s it s t o p art i cu lar es t ab l i s h m en t s were rel at edt o p art i cu l ar Pad d a-o wn ed res t au ran t s o r t h e b rewery . Fu rt herm o re, Gri m es creat edth ree s pread s h eet s b efo re tri al t o s u m m ari ze Pad da’ s trav el du ri n g 2 0 1 0 , 2 0 1 1 , an d2 01 2 , res pect i vel y . Th e s p read s h eet s
s h o wedd at es o f t rav el , d es ti n at i o n ci t i es , an dth e n am es o f b ars , res t au ran t s , an d b reweri es v i si t ed . Gri m es t es ti fi edex t en s i v el y ab o utthe s p read s h eet s . Pad d a an d Kan e ex ch an g edwi th IRS co u n s el the d o cu m en t at i o n o n wh i ch th e s p read sh eet s were b as ed(cred i t -card recei pt s an di n vo i ces ). Th e p art i es s t i p ul at edth e ad m i s s i b i l i ty

o f t h e s p read s h eet s , an dth ey were ad m i t t ed
. Acco rd i ng t o th e s pread sh eet s an dGri m es ’ s t es t i m o ny , Pad d a’ s trav el t i m e rel at ed t o the fi ve res t au ran t s an dth e b rewerywas 1 ,9 0 0 h o u rs i n 2 0 1 0 , 1 ,9 0 0 h o u rs i n 2 0 1 1 , an d1 , 1 0 0 h o u rs i n 2 0 1 2 . Th es e h o u rl y am o u n t s are b as edo n a 2 4 -h ou r d ay , m ean i n g th atfo r a p art i cu l ar t ri p , ev ery h o u r o f each d ay

o f t h e t ri p
was co u n t ed , i n cl ud i n g t i m e Pad d a s p en t n o two rk in g (i .e., s l eep in g ). If o n e were t o d i v i d e t h e an n u al trav el t i m e t o t al s b y three t o acco u n t fo r a t y

p i cal ei g ht -h o u r
wo rkd ay , Pad d a’ s res t au ran t an db rewerytrav el t i m e b eco m es 6 3 3 h o u rs i n 2 0 1 0; 6 3 3 h o u rs i n 2 0 1 1 ; an d 3 6 6 h o u rs i n 2 0 1 2 . W e fi n dth es e trav el t i m e t o t al s rel i ab l e wh en ad ju s t edas d es cri b ed
.- 1 6 -

[* 1 6 ] Th e p rep o n d eran ce o f ev i d en ce, wh i ch i n cl u d es th e s p read sh eet s , Pad d a’ s t es t i m o ny reg ard in g h i s trav el , an dGri m es ’ t es t i m o n y reg ard i n g Pad d a’ s t rav el , s h o ws th atPad d a s p en tat l eas t2 5 h o u rs o f trav el t i m e du ri n g each y ear at i s s u e o n each o f t h e fi v e res t au ran t s an dth e b rewery . Th is i s i n ad d i t i o n t o m o re th an 1 0 0 h o u rs o f n o n trav el t i m e t h atwe fi n dPad d a s p en teach y ear ati s su e o n each o f t h e fi ve res t au ran t s an dthe b rewery . d
. Pad d a’ s t o t al h o u rs , trav el an dn o n trav el Fo r each act i v i ty

fo r each y ear (i .e., fo r each o f t he res t au ran t s an dth e b rewery ), Pad d a’ s h o u rs ex ceed edth e 1 0 0 -h o ur t hres h o ldreq u i redfo r an act i v i t y t o b e a s i g n i fi can t p art i ci p at i o n act i v i ty . 6 Th i s i s b ecau s e fo r each act i v i ty an dfo r each y ear h i s n o nt rav el h o u rs ex ceed ed1 0 0 h o u rs an d h i s trav el h o u rs ex ceed ed

6 No tal l t i m e s pen to n a b u s i n es s act i v i ty co u n t s as p art i ci p at i o n fo r t h e p u rp os es o f t hes e ru l es . W ork p erfo rm edi n an i n d i v idu al ’ s cap aci ty as an i n v es to r d o es no tqual i fy

as p art i ci p at io n u n l es s th e i nd i v i du al i s d i rect l y i n v ol v edi n th e d ay -t o -d ay

m an ag em en to r o perat i o n s . Sec. 1 .4 6 9 -5 T(f)(2 )(i i)(A), Tem p o rary In co m e Tax Reg s ., 5 3 Fed . Reg . 5 7 2 7 (Feb . 2 5 , 1 98 8 ). Sec. 1 .4 6 9 -5 T(f)(2 )(i i )(B), Tem p o raryIn co m e Tax Reg s ., 5 3 Fed . Reg . 5 7 27 (Feb
. 2 5 , 1 9 8 8 ), en u m erat es th e ty p es o f i n v es to r act i v i t ies ex cl u d edfro m m at eri al p art i ci p at i on . In v es t o r-ty p e wo rki n cl u d es s tu dy i n g an drev i ewi n g fi n an ci al s t at em en t s o r rep o rt s o n o p erat i o n s o f t h e act iv i ty ; p rep ari n g o r co m pi l i n g s umm ari es o r an al y s es o f t h e fi nan ces o r o p erat i o n s fo r t h e i nd i v i dual ’ s o wnu se; an dm o n it o ri n g th e fi n an ces o r o p erat i o n s i n a n o nm an ag eri al cap aci ty . Id . No n e o f Pad d a’ s act i v i t i es are t h o s e l i st edi n s ub d i v . (i i )(B). Th erefo re, we fi n d th atPad d a’ s p art i ci p at i o n i n the fi v e res t au ran t s an dth e b reweryi s n o tex cl ud edas i n v es t o r-t y p e wo rk as th e IRS al l eg es .- 1 7 -

[* 1 7 ] 2 5 h ou rs . Each act i v i ty was th erefo re a s i g n i fi can tp art ici p at i o n act i v i ty fo r each y ear. See s ec. 1 .4 6 9 -5 T(c), Tem p oraryIn co m e Tax Reg s . , s up ra. Becau s e fo r each y ear Pad d a h adatl eas tth es e s ix s i gn i fi can t p art i ci p at i o n act i v i t i es , 7 h i s ag g reg at e p art ici p at i on i n al l s i g n i fi can t p art i ci p at i o n act iv i t i es du ri n g th e y ear
ex ceed edth e 5 0 0 -h o u r thres h o l do f s ect i o n 1 .4 69 -5 T(a)(4 ), Tem po raryIn co m e Tax Reg s ., s up ra. Th e fi v e res t au ran t s an dth e b rewerywere n o tp as si ve act i v i t i es . 2
. Pad d a an d Kan e fai ledt o rep o rtd i v i den di n co m e i n 2 01 0 fo r ex p en s es p ai d b y In t erv en t i on al Cen t er. A d i s tri b ut io n o f p ro pert y m ad e b y a co rp orat io n t o a s h areh ol d er wi th
res p ectt o i t s s t o cki s g o vern edb y s ect io n 3 0 1 (c). Sec. 3 0 1 (a). Un d er s ect i o n 3 0 1 (c)(1 ), a d i s tri bu t i o n th at i s a “ d i v i d en d” i s i n cl u d ab l e i n th e s h areh o l d er’ s i n co m e. See al s o s ec. 6 1 (a)(7 ). A d i v i d en d i s an y d i st ri bu t i o n a co rp o rat i o n
m ak es t o i t s s h areh ol d ers o u to f earn i n g s an dp ro fi t s . Sec. 3 16 (a). On e t y p e o f d is tri b u t i o n g o v ern edb y s ect i o n 3 0 1 (c) i s a co n s tru ct i v e d i s tri b u t i o n . Un i t ed St at es v . Sm i th , 4 1 8 F.2 d 5 8 9 , 5 9 3 (5 th Ci r. 1 9 6 9 ). To d et erm i n e wh eth er a s h areh o ld er recei v eda co n s tru ct i v e d i s tri b ut i o n , th i s Co u rt l o o k s t o wh et h er t h e d i s tri b u t i o n was p ri m ari l y fo r t h e s h areh ol d er’ s b en efi trat h er th an fo r t h e co rp o rat i o n ’ s b en efi t . Ho o d v . Co m m i s s i o ner, 1 1 5 T.C. 1 7 2 , 1 7 9 -1 8 0

7 Fo r 2 0 1 0 , Pad d a h adn o act i v i t i es fo r Di at i n a, an d th erefo re t here were fi v e s i gn i fi can tp art i ci pat i o n act i v i ti es rat h er t h an s i x .- 1 8 -

[* 1 8 ] (2 0 0 0 ). Th e d et erm i n at i o n o f wh et h er t h e s hareh o l d er o r t h e co rp o rat i o n p ri m ari l y b en efi t s i s a qu es t i o n o f fact . Id . at1 8 0
. Du ri n g 2 0 1 0 , Pad d a (In terv en t i o n al Cen t er’ s s o l e s hareh o l d er) u s ed In t erv en t i o n al Cen t er’ s co rp o rat e cred i tcard t o p ay $ 8 1 ,8 2 8 o f t rav el , d i n i n g , an d
en t ert ai n m en tex p en s es fo r h im s el f, h i s fam i l y , an dh i s fri en d s . Pad d a an d Kan e d o n o t d i s p u t e t h atIn t erv en t i o n al Cen t er h ad s uffi ci en t earn i n g s an dp ro fi t s t o
cau s e t h e $ 8 1 , 82 8 o f ex p en ses i n 2 0 1 0, i f ch aract eri zedas a d i st ri b u t i o n , t o b e d i v i d en d s. In t erv en t i on al Cen t er rep o rt edd edu ct i o n s o f t hes e am o u n t s o n i t s co rp o rat e retu rn . Pad d a an dKan e arg u e t h atth e IRS en t eredi n t o an ag reem en t wi th In t erv en t i o n al Cen t er wh ereb y i twas al l o weda b u s i n es s ex pen s e d edu ct i o n fo r al l
o r s o m e o f t h e $ 8 1 ,8 2 8 . Pad d a an dKan e co n t en dth at th e IRS i s l eg al ly b arred fro m t ak i n g th e p o s i t i on i n th i s p ro ceed i n g thatth e $ 8 1 ,8 2 8 i n p aym en t s i s a
co n st ru ct i v e d is tri b u t i on t o th e ex t en tth e s am e p aym en t s were al l owedas a d educt i o n t o In t erv en t i o n al Cen t er as p arto f t h e s et t l em en tag reem en tb et ween th e IRS an dIn t erv en ti o n al Cen t er. It is u n d i s pu t ed th atth e IRS ex am i n edIn terv en t io n al Cen t er’ s co rp orat e i n co m e t ax retu rn fo r 2 0 10 an dth atth e IRS reach edan ag reem en twi th In t erv en t i o n al Cen t er ab o u ti t s i n co m e t ax l i ab i l i ty fo r t h aty ear. Bu tth at- 1 9 -

[* 1 9 ] s et t l em en th as n o effect o n the d et erm in at i o n o f Pad d a an dKan e’ s i n co m e. Fi rs t , th e s et tl em en t ex p res s l y g o v ern edo nl y the q u es t io n o f wh ether In t erv en t i o n al Cen t er was en t i t l edt o d edu ct i o ns . Th e s et t l em en t d i dn otp u rp o rtt o ad dres s th e qu es t i o n o f wh at am o un t s are i n cl ud ab l e i n Pad d a an dKan e’ s i n co m e. Seco n d , In terv en t i o n al Cen ter was a p art y t o t h e s et t l em en tag reem en t , an dPad d a
an d Kan e were n ot . Attri al , Pad d a an d Kan e at t em p t edt o i nt ro du ce i n t o th e reco rdd o cu m en t s
m ark edas Ex h i b i t s 2 0 -P, 4 9 -P, 5 0 -P, 5 1 -P, an d 5 2 -P an d rel at edt es t i m o ny (Tr. 2 5 0 -2 5 6 , 7 5 8 -7 6 1 ) t o p ro v e wh i ch p aym en t s were g o v ern edb y th e s et t l em en t . Th e IRS o b

ject ed . Th e Co u rtres erv edru l i n g o n th e o b ject i o n. W e n eedn o tru l e
o n th e o bject i on . Th e ev i d en ce wo u l dh av e n o effect o n t h e o u t co m e o f t h i s cas e. Th e s et t l em en th as n o effect o n Pad d a an dKan e’ s i nco m e, as ex p l ai n edab o v e. 8 Th e qu es ti o n o f wh et h er In t erv en t i o n al Cen t er’ s p aym en to f t he $ 8 1,8 2 8 o f Pad da’ s ex p en s es i s a co n s tru ct i v e d i v i d en dd ep en d s o n wh et her In t erv en t i o n al

8 Pad d a an d Kan e al s o arg u e t h atth e IRS i s b ou n db y a du ty o f co n s i s t en cy t o treatth e rei m

b u rs em en t s as o th er t h an d i st ri bu t i o n s . Th e du ty o f co ns i s t en cy

i s an o b l ig at i o n b y

wh i ch a rep res en t at i o n m ad e b y a t ax p ay er t o th e IRS m ay b e b i n d i n g o n th e t ax p ay er i f t he IRS rel i es o n th e rep res en t at i on t o i ts d et ri m en t . See, e.g
. , Bel t zer v . Un i t ed St at es , 4 9 5 F.2 d2 1 1 , 2 12 (8 th Ci r. 1 9 7 4 ). Ev en i f t h e du ty o f co n s i s ten cy

g o v ern s th e IRS (as o pp o sedt o t ax pay ers ), th e reco rd d o es n o t s h o w th atth e IRS m ad e a rep res en t at i o n t o Pad d a an dKan e o n wh i ch th ey d et ri m en t al l y

rel i ed
.- 2 0 -

[* 2 0 ] Cen t er p ri m ari l y

b en efi t edfro m

p ay in g th e ex pen ses . If i td idp ri m ari l y b en efi t , th en th e p aym en ti s n o ta co n s tru ct i ve d i v i den d . If i td idn o t , th enth e p aym en t i s a co n s tru ct iv e d iv i d en d
. Pad d a t es t i fi edthatas a g en eral m at t er t h ere was a b u s i n es s p u rp o s e fo r t h e $ 8 1 ,8 2 8 i n ex p en ses . Ino u r v i ew, th e t es t i m o n y s u g g es t edth at th e b u s i nes s p u rp os e o f t h e $ 8 1 ,8 2 8 i n ex pen s es was rel at edt o th e fi v e res t au ran t s an d t h e b rewery , n o tIn t erv en t i o n al Cen t er. W e al s o o b s erv e t h ata p o rt i o n o f th e $ 8 1 ,8 28 i n ex p en s es co rres p o n ds t o the t rav el act i v it i es co ndu ct edb y Pad da fo r t h e fi v e
res t au ran t s an dth e b rewerydu ri n g 2 01 0 . See s up ra Part 1 .c. Gri m es an dPad d a b o th t es t i fi edab o u t th es e t rav el act i v i t ies , an d Gri m es creat eda s p read s h eetfo r each y ear ab ou tth em . W e co n cl u d eds up ra Part 1 .c t hatth e t rav el act i v it i es were rel at ed t o the fi ve res t au ran t s an dth e b rewery . Th e ev i d en ce we d es cri b edi n th e p arag rap h ab o ve i s t h e o n ly ev i d en ce reg ard i n g th e $ 8 1 ,8 2 8 i n ex p en s es . Th e p rep o nd eran ce o f t h e ev i d en ce s h o ws that th e $ 8 1,8 2 8 d i dn o tb en efi tIn t erv en ti o n al Cen ter. Th erefo re, we co n cl ud e th atPad d a an dKan e recei vedan $ 8 1 , 8 28
co n st ru ct i v e d iv i d en d i n 2 0 1 0 fo r t h e t rav el , d i n i n g, an den t ert ai n m en t ex pen s es p ai db y In t erv en t io nal Cen t er.- 2 1 -

[* 2 1 ] 3
. Pad d a an d Kan e are l i ab l e fo r a s ect i on 6 6 5 1(a)(1 ) ad d it i o n t o t ax fo r

fai l i ng t o t i m el y

fi l e t h ei r 2 0 1 2 return . Sect io n 6 6 5 1 (a)(1 ) i m

p o s es an ad d i t io n t o t ax fo r fai lu re t o fi l e a t ax retu rn b y i t s fi l i n g d ead l in e (as ex ten d ed ) u n l es s th e t ax p ay er can es t ab l i s h thatth e fai l u re t o t im el y

fi l e i s du e t o reas o n ab l e cau se an d n otdu e t o wi l l fu l n eg l ect . Th e
s ect i on 6 6 5 1 (a)(1 ) ad d it i o n t o t ax i s 5 % o f t h e am o u n treq u i redt o b e s ho wno n th e retu rn i f t h e fai l u re i s fo r n o tm o re t h an o n e m o n th . Sec. 6 6 51 (b )(1 ). Th e IRS b ears the b u rd en o f p ro du ct i o n fo r ad d i t i on s t o t ax d et erm i n ed
u n d er s ect i o n 6 6 5 1 (a)(1 ). See s ec. 7 4 9 1 (c); Hi g b ee v . Co m m i ss i o n er, 1 1 6 T.C. 4 3 8 , 4 4 6 -4 4 7 (2 0 01 ). Th e IRS s at i s fi es i t s b u rd en b y p ro du ci n g s u ffi ci en t
ev i d en ce t o es t ab l i s h th atth e t ax p ay er fai l edt o t i m el y fi l e a req u i redreturn . See Wh eel er v . Co m

m i s s i on er, 1 2 7 T.C. 2 0 0 , 2 0 7 -2 0 8 (2 0 06 ), aff’ d , 5 2 1 F.3 d 1 2 8 9 (1 0 th Ci r. 2 0 0 8 ); Hi gb ee v . Co m m i s s i o n er, 1 1 6 T.C. at4 4 7
. On ce t h e IRS h as
s at i s fi edi t s b u rd en o f p ro du ct i o n , th e t ax p ay er h as the b u rd en o f p ro v in g th atth e l at en es s was du e t o reas o n ab le cau s e an dn ot wi l l fu l n eg l ect . Hi g bee v
. Co m m i s s i o n er, 1 1 6 T.C. at4 4 7. Reas o n ab le cau s e ex cu s i n g a fai l u re t o t i m el y fi l e
ex i s t s i f t h e t ax p ay er ex erci s edo rd i naryb u s i n es s care an dp ru d en ce b u t
n ev erth el es s was u n ab le t o fi le t h e ret u rn b y th e d ead l in e. See s ec. 3 0 1 .6 6 51
- 1 (c)(1 ), Pro ced . & Ad m i n . Reg s . W i l l fu l n eg lectm ean s a co n s ci o u s,- 2 2 -

[* 2 2 ] i n t en t i o n al fai l u re, o r reck l es s i n d i fferen ce. Un i t edSt at es v . Bo y le, 4 6 9 U.S. 2 4 1 , 2 4 5 (1 9 8 5). Pad d a an d Kan e’ s 2 0 1 2 retu rn was du e o n Oct o b er 1 5 , 2 0 1 3. Th e p art i es h av e s ti p u l at edth atthe ret u rn was fi l edo n Oct o b er 2 5 , 2 0 1 3. Pad d a an dKan e
s eekt o av o i dthe ad d i t i o n t o t ax b ecau s e th ey cl ai m th atEh ren rei ch ’ s acco u n t i ng fi rm was res po n s i bl e fo r t h e u n t i m el i n es s . In co n s i deri n g wh et h er a t ax p ay er h as ex erci s ed reas o n ab l e care an d p ru d en ce, co u rt s h av e h el d t h atth e t ax p ay er’ s du ty t o fi l e a t im el y retu rn can n o tb e
av o id ed b y

d el eg at i n g t o an o th er p art y , i n cl u d in g an acco u n t an t , th e res p o ns i b i li t y fo r p rep ari n g an dfi l i ng th e ret u rn . M au l d i n v . Co m m i s s i o n er, 6 0 T.C. 7 4 9 , 7 6 2 (1 9 7 3); s ee al so Bo y l e, 4 6 9 U.S. at2 5 1 -2 52 (h o l di n g t h atrel i an ce o n an ag en tt o fi le a ret u rn d o es n o t es t ab l i s h reas o n ab l e cau se b ecau s e “ [i ] treq ui res n o s p eci al trai n in g o r effo rtt o as cert ai n a d ead l i n e an dm ak e s ure t h ati ti s m et ”). 9 Pad d a an d Kan e arg u e t h atth e reas o n th atth ei r 2 0 1 2 retu rnwas fi l edl at e was th at

9 As ex p lai n ed i n th e t ex t, rel i an ce o n an acco u n t an tt o fi le a ret u rn i s n o t reas on ab l e cau s e fo r t h e fai l u re t o fi l e o n t i m e. Reas o n ab le cau s e fo r fai l u re t o fi l e m ay b e es t ab l i s h edwh en a t ax pay er rel i es o n a co m p et en t ad vi s er wh o ad vi s es th at th e t ax p ay er i s n o treq u iredt o fi l e a ret u rn . Ev an s v . Co m m is s i o n er, T.C. M em o . 2 0 1 6 -7 , at* 43
. Th ere i s n o ev i d en ce t h atPad d a an dKan e recei v edthi s ty p e o f ad v ice. See Un i t edSt at es v . Bo y l e, 4 6 9 U.S. 2 4 1 , 2 5 1 -2 5 2 (1 9 8 5 ); M au l di n v . Co m m i s s i o n er, 6 0 T.C. 7 49 , 7 6 2 (1 9 7 3 ); Ni v v . Co m m i s s io n er, T.C. M em o . 2 0 1 3
- 8 2 , at* 2 4 ; Owu s u v . Co m m i s s i o n er, T.C. M em o. 2 0 10 -1 8 6 , s l i p o p. at 1 3.- 2 3 -

[* 2 3 ] (1 ) Eh ren rei ch ’ s acco u n t i n g fi rm p res s eda b u t to n o nl y a few s eco n d s l at e, (2 ) t h ey rel i ed o n Eh ren rei ch ’ s acco u nt i ng fi rm t o t i m el y fi l e t h e retu rn , an d (3 ) t h ey th em s el v es co u l d n o th av e p res s edth e b u tt o n t o t i m el y fi l e t h e ret u rn . Ev en i f s o m et i m es i tm i g h tb e reas o n ab l e fo r a t ax p ay er t o rel y o n h i s o r h er
acco u n t an tt o t i m el y fi le h i s o r h er ret u rn s (co n trary t o the cas el aw), i t was n o t
reas on ab l e i n t h i s p art i cu l ar cas e fo r Pad d a an dKan e t o rel y o n Eh ren rei ch ’ s fi rm t o t im el y fi l e t h ei r retu rn . Pad d a an dKan e h av e rel i ed o n Eh ren rei ch ’ s fi rm t o fi l e th ei r retu rn s ev ery

y ear s i n ce atl eas t2 0 0 6 . An d ev ery y ear s i n ce t h en , ex cep tfo r 2 0 1 1 , th ei r retu rn was fi l ed l at e. Yetthey h av e co n t i nu ed t o u s e Eh ren rei ch ’ s fi rm t o fi l e t h ei r return y ear aft er y ear. Pad d a an dKan e’ s fai l ure t o en s u re t h at Eh ren rei ch ’ s fi rm t i m el y

fi l edth ei r 2 0 1 2 retu rn d em o n st rat es a l acko f o rd i n ary b u s i n es s care, p art icu l arl y i n th e l i g h t o f t he fi rm ’ s h i s t o ry o f d el i n qu en tfi l i n g s . W e fi n dth atPad d a an dKan e d o n o th av e reas o n ab le cau s e, o n th e b as i s o f
an y rel i an ce o n Eh ren rei ch ’ s fi rm fo r t h ei r u n t i m el y

2 0 1 2 retu rn , an d we h o l dth at Pad da an dKan e are l i ab le fo r t h e s ect i o n 6 6 5 1 (a)(1 ) ad d i t i o n t o t ax fo r fai l i n g t o t i m el y fi l e t h ei r 2 0 1 2 retu rn .- 2 4 -

[* 2 4 ] 4
. Pad d a an d Kan e are l i ab l e fo r a s ect i on 6 6 6 2 p en al ty fo r 2 0 1 0 , b u tn o t 2 01 1 an d 2 0 12
. Sect io n 6 6 6 2 (a) an d(b )(1 ) an d(2 ) i m p o s es a p en al ty

equ al t o 2 0 % o f an y p o rt i on o f an u n d erp aym en to f t ax th ati s at tri bu t ab l e t o n eg l i g en ce o r t o a
s ub s t an t i al u n ders t at em en to f i nco m e t ax . Anu nd erp aym en t i s th e d i fferen ce b et ween th e co rrect t ax an dthe t ax rep ort edo n th e ret u rn , wi th ex cep t i o n s n o t rel ev an t h ere. Sec. 6 66 4 (a). Neg l i g en ce i n cl u des an y fai l u re t o m ak e a reas o n ab l e at t em p tt o co m p l y wi th th e p ro v i s i on s o f t h e i n t ern al rev en u e l aws o r t o ex erci s e
o rd i n ary an dreas on ab l e care i n t h e p rep arat i o n o f a t ax retu rn . Sec. 6 6 6 2 (c);
s ec. 1 .6 6 62 -3 (b )(1 ), In co m e Tax Reg s . Neg l ig en ce m ay al s o i ncl u d e th e fai l u re t o p ro p erl y s ub s t an t i at e an i t em . Hi g b ee v . Co m m i ss i o ner, 1 16 T.C. at4 4 9 ;
s ec. 1 .6 6 62 -3 (b )(1 ), In co m e Tax Reg s . A s ubs t an ti al u nd ers t at em en to f i n co m e t ax ex i s t s i f (1 ) t h e u n d ers t at em en tex ceed s 1 0 % o f t h e t ax req u i redt o b e s h o wn
o n th e ret u rn an d(2 ) t h e u n d ers t at em en tex ceed s $ 5 ,0 0 0. Sec. 6 6 6 2 (d )(1 )(A). An
u n d ers t at em en ti s th e d i fferen ce b et ween th e co rrect t ax an dth e t ax rep o rt edo n th e ret urn , wi th ex cep t i on s n o trel ev an th ere. Sec. 6 6 62 (d )(2 )(A). Fo r an y p en al ty th e IRS d et erm i n es ap p l i es t o an i n di v i du al , s ect i on 7 4 9 1 (c) i m p o s es th e b u rd eno f p ro du ct i o n o n th e IRS. Hi g b ee v . Co m m i s si on er, 1 1 6 T.C. at4 4 6
. Th i s m ean s thatthe IRS i s req u i redt o co m e fo rwardwi th s u ffi ci en t- 2 5 -

[* 2 5 ] ev id en ce t h at i ti s ap p ro p ri at e t o i m p o s e t h e p en al ty . Sec. 7 4 9 1 (c); Hi g b ee
v . Co m m i s s i o n er, 1 1 6 T.C. at4 4 6
. No s ect i o n 6 66 2 p en al ty

i s i m p o s ed wi th res p ect t o an y p o rt i o n o f an
u n d erp aym en t i f i t is s h own th atth ere was a reas on ab le cau s e fo r s u ch p o rt i o n an d th atth e t ax p ay er act edi n g o odfai th wi th res p ectt o s u ch p o rt i o n . Ci rcu m s t an ces th ati n di cat e reas o n ab l e cau s e an dg o o d fai th i n cl u d e rel i an ce o n th e ad v i ce o f a t ax p ro fes s i o n al . Sec. 1 .6 6 64 -4 (b ), In co m e Tax Reg s . Th e t ax p ay er h as th e b u rd eno f p ro vi ng th ath e o r s h e act edwi th reas on ab l e cau s e an di n g oo dfai th
. Ru l e 1 4 2 (a); Hi g b ee v . Co m m i s s i o n er, 1 16 T.C. at4 4 6 -4 4 7
. Th e n o t i ce o f d efi ci en cy

d et erm i nedth at Pad d a an dKan e were l i ab l e fo r p en al t i es u n d er s ect i o n 6 6 6 2 (a) fo r 2 0 1 0 , 2 0 1 1 , an d 2 0 1 2
. Th e u n d erp aym en t s fo r al l th ree y ears , as cal cu lat edi n th e n o t ice o f d efi ci en cy , were du e t o Pad d a’ s fai l u re t o m eet th e m at eri al -p art i ci p at i o n req u i rem en t s . Th e u n d erp aym en tfo r 2 0 1 0 was du e al s o to Pad d a an dKan e’ s fai l u re t o rep o rtas th ei r i n co m e t h e $ 8 1 ,1 2 8 i n Pad d a’ s cred i t -cardex p en s es th at In t erv en t io n al Cen t er p ai d
. Ho wev er, we h av e co n cl u d eds up ra Part1 th atPad da m et th e m at eri al
p art i ci p at i o n req u i rem en t s . Th erefo re, Pad d a an d Kan e’ s p o t en t i al p en al ty u n d er
s ect i on 6 6 6 2 i s l i m i t edt o th e t ax y ear 2 0 1 0 . An dth e u nd erp aym en t fo r th aty ear- 2 6 -

[* 2 6 ] rel at es t o Pad d a an dKan e’ s fai l u re t o rep o rt the $ 8 1 ,8 2 8 o f Pad d a’ s cred i t cardex p en s es p ai db y

In t erv en t i o n al Cen t er. Th e IRS s at i s fi edi ts b urd en o f p ro du ci n g ev i d en ce th atPad da an d Kan e act edn eg l i g en tl y

i n fai l i n g t o rep o rtth e $ 81 ,8 2 8
. Pad d a an dKan e fai l edt o p ro v id e t h ei r acco u nt an t , Eh ren rei ch , wi th th e i n fo rm at io n n eces saryt o as cert ai n wh et h er In t erv en t i on al Cen t er’ s $ 8 1 ,8 2 8 p aym en t o f cred i t -card ex p en s es was i n cl u d ab l e i n th ei r i n co m e as a co n s tru ct i v e d i v i den d . Th ey d i dn o t s o li ci t o r recei v e ad v i ce fro m

Eh ren rei ch o n th e t ax co n s equ en ces o f p ay i n g the ex p en s es wi th In t erv en t i o n al Cen t er fu n d s . Pad d a an d Kan e, wh o b ear t h e b u rd en o f p ers u as i o n , h av e n o tad du ced
s u ffi ci en tev i d en ce t h atth e IRS’ s n eg l i g en ce d et erm i nat i on was i n co rrect . No r h av e th ey arg u edth atth e n eg l i g en ce d et erm i nat i o n was i n co rrect . 1 0 W e co ncl u d e t h at th e u n d erp aym en tfo r 2 0 1 0 i s du e t o n eg l i g en ce. Th erefo re, Pad d a an dKan e are l i ab l e fo r t h e s ect i o n 6 6 6 2 p en al ty fo r 2 0 1 0 , al th o u g h i n a l es s er am o u n t th an th e am ou n tco m p u t edi n t h e n o t i ce o f

1 0 Fo r ex am

pl e, Pad d a an dKan e d o n ot arg u e t h atth ey h ad reas o n ab l e cau s e an d g o o dfai th wi th res p ectt o th e $ 8 1 ,8 2 8 b ecau se t h ey rel i edo n Eh ren rei ch
. Su ch a d efen s e wo u l d b e wi tho u tm eri tan yway b ecau s e, as we ex p lai n i n t h e t ex t , th ey fai l edt o s upp l y

Eh ren rei ch wi th n eces s ary i nfo rm at i on ab o u tth e cred i t -card ex p en s es an d recei v ed n o ad v i ce fro m h er reg ard i ng th e t ax co n s equ en ces o f p aym en t o f t h e ex p en s es b y In t erv en t io n al Cen t er.- 2 7 -

[* 2 7 ] d efi ci en cy . 1 1 Co m

p u t at i o n s u n d er Ru l e 1 5 5 wi l l d et erm i n e t h e am o u n to f th e u n derp aym en t an dth e am o u n to f t h e p en al ty . Co m p u t at i o n s u n d er Ru l e 1 5 5 wi l l al so d et erm i n e wh et h er th ere i s a s ub st an t i al u n d ers t at em en t fo r 2 0 1 0 . If th ere i s a s ub s t an t i al u n d ers t at em en t, th atwi l l s erv e as an al t ern at i v e b as i s fo r l i ab i l i t y fo r t h e p en al ty . To refl ectthe fo reg o i n g , Deci s i o n wi ll b e en t eredu n d er Ru l e 1 5 5
.

1 1 Th e p art i es s t i p u l at edth atth e IRS s at i s fi edth e p en al ty -ap p ro v al req u i rem en ti n s ec. 6 75 1 (b ) wi th res p ectt o th e p en al t i es u n d er s ec. 6 6 6 2
.