T.C. Memo. 2009-80

UNITED STATES TAX COURT

PETER ACKERMAN AND JOANNE LEEDOM-ACKERMAN, Petitioners v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket Nos. 13947-06, 26400-06. Filed April 15, 2009.

George W. Connelly, Jr., Linda S. Paine, and Pamela E.

Powers, for petitioners.

Christopher A. Fisher and Richard S. Bloom, for respondent.

Table of Contents

FINDINGS OF FACT ...................... 4 

Background ......................... 5 

Peter Ackerman ..................... 5 

Perry Lerner ...................... 7 

Don Ackerman ...................... 8 

Jason Ackerman ..................... 8 

Jeffrey Deutschman ................... 9 
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Somerville S Trust and Certain

 Other Entities That It Owned .......... 9 

Deena Patriarca ................... 11 

Rockport Advisors .................. 11 

Crown Capital .................... 13 

Petitioners’ Tax Returns ............... 15 

Notices of Deficiency ................ 16 

Claimed Business Expense Deductions ............ 16 

Claimed Deduction for the

 Protection of Business Reputation ........... 32 

Funds Advanced to ECC ................ 33 

Book and Tax Treatment of the $7,850,000 of 

 Advanced Funds by Somerville and by Santa Monica . 37 

Claimed Losses With Respect to ISI ............ 40 

Claimed Theft Loss Deduction ............... 42 

Accuracy-Related Penalty Under Section 6662(a) ...... 49 

OPINION .......................... 54 

Burden of Proof ....................... 54 

Evaluation of Evidence on Which Petitioners Rely ..... 56 

Testimonial Evidence ................. 56 

Mr. Ackerman’s Testimony ............ 57 

Mr. Lerner’s Testimony ............. 57 

Don Ackerman’s Testimony ............ 57 

Jason Ackerman’s Testimony ........... 58 

Mr. Deutschman’s Testimony ........... 58 

Ms. Patriarca’s Testimony ............ 58 

Mr. Braddock’s Testimony ............ 59 

Mr. Levinton’s Testimony ............ 59 

Documentary Evidence ................. 59 

Claimed Business Expense Deductions ............ 60 

Petitioners’ Cost Company or Agency Argument ..... 61 

Petitioners’ Compensation Argument .......... 71 

Claimed Deduction for the

 Protection of Business Reputation ........... 88 

Claimed Losses With Respect to ISI ............ 96 

Claimed Theft Loss Deduction ............... 104 
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1All section references are to the Internal Revenue Code in

effect for the years at issue. All Rule references are to the

Tax Court Rules of Practice and Procedure.

2Issues (2), (3), and (4) set forth below are affirmative

issues that petitioners raised in the pleadings and that do not

relate to any determinations in the notices of deficiency.

Accuracy-Related Penalty Under Section 6662(a) ...... 108 

APPENDIX A ........................ 117 

APPENDIX B ........................ 119 

MEMORANDUM FINDINGS OF FACT AND OPINION

CHIECHI, Judge: Respondent determined the following deficiencies in, an addition under section 6651(a)(1)1 to, and

accuracy-related penalties under section 6662(a) on petitioners’

Federal income tax (tax):

Year Deficiency

 Addition to Tax 

Under Sec. 6651(a)(1)

 Accuracy-Related Penalty 

 Under Sec. 6662(a) 

 

1997 $1,022,612 -- --

1998 163,350 -- --

2000 657,877 -- --

2002 771,330 $20,959.40 $154,266.00

2004 206,239 -- 41,247.80

The issues remaining for decision are:2

(1) Are petitioners entitled for each of their taxable years

1997, 1998, 2000, 2002, and 2004 to deduct certain claimed

business expenses under section 162(a)? We hold that they are

not.
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3We found the record in these cases to have been not well

developed, inconclusive, and/or not reliable in many respects,

including certain material respects. Although the gaps in the

record are substantial in many instances, and therefore our

findings of fact are incomplete and/or disconnected in those

instances, we have not undertaken to note every instance in which

the record does not contain reliable evidence that would have

enabled us to find all the facts relevant to our deciding the

issues presented.

(2) Are petitioners entitled for their taxable year 1997 to

deduct under section 162(a) certain funds that they claim petitioner Peter Ackerman advanced to a certain corporation in order

to protect his business reputation? We hold that they are not.

(3) Is a certain loss with respect to a company in which

petitioner Peter Ackerman indirectly owned an interest a passive

activity loss within the meaning of section 469(a) for each of

petitioners’ taxable years 1998 and 2000? We hold that it is.

(4) Are petitioners entitled for their taxable year 2002 to

deduct a claimed theft loss under section 165(a)? We hold that

they are not.

(5) Are petitioners liable for each of their taxable years

2002 and 2004 for the accuracy-related penalty under section

6662(a)? We hold that they are. 

FINDINGS OF FACT3

Some of the facts have been stipulated and are so found

except as stated below.

Petitioners resided in Washington, D.C., at the time they

filed the petition in each of these cases. 
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4While at Drexel, Mr. Ackerman worked on, inter alia, the

restructuring of Penn Central Railroad and Resorts International 

and the formation and the financing of a company for the purpose

of taking over a certain other company that operated supermarkets. 

Background

Peter Ackerman

Petitioner Peter Ackerman (Mr. Ackerman) received a bachelor’s degree from Colgate University and a master’s degree in law

and diplomacy and a Ph.D. degree from the Fletcher School of Law

and Diplomacy of Tufts University (Fletcher School). 

From the mid-1970s until January 1990, Drexel Burnham

Lambert (Drexel) employed Mr. Ackerman in various positions.4

The first position that Mr. Ackerman held at Drexel was assistant

to the president. From 1978 to 1989, Mr. Ackerman was in charge

of Drexel’s so-called special projects group. As head of that

group, Mr. Ackerman worked on, inter alia, the restructuring and

the financing of various businesses. Drexel received various

types of fees, equity interests, and investment opportunities in

connection with its special projects work. 

In early 1990, Mr. Ackerman moved to London, England (London), where he became a visiting scholar at the International

Institute for Strategic Studies, a premier think tank that

concentrated on issues relating to international security. 

While living in London, Mr. Ackerman registered with English

authorities as a person undertaking a business and formed, owned
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with petitioner Joanne Leedom-Ackerman (Ms. Ackerman), and served

as the director of a company known as Rockport Capital Limited. 

The principal activity of that company was providing certain

consulting services. 

From 1990 to 1992, Ms. Ackerman owned a company known as

Rockport Consultants, Inc. (Rockport Consultants), that was

incorporated as a Delaware corporation on September 5, 1990, and

that filed an election to be taxed as an S corporation on or

about January 1, 1991. Rockport Consultants was engaged in the

business of providing certain consulting services. While residing in London, Mr. Ackerman served as the director of Rockport

Consultants and acted on behalf of that company in providing

certain consulting services. The consulting services that

Rockport Consultants provided included certain consulting services provided to Saatchi & Saatchi Company Plc. (Saatchi &

Saatchi) with respect to, inter alia, its financing and its

capital structure. In exchange for those services, Rockport

Consultants received from Saatchi & Saatchi fees of more than $5

million. 

On or about January 3, 1992, Rockport Consultants changed

its name to Rockport Financial, Inc. (Rockport Financial). 
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5As discussed below, on or about Apr. 15, 1996, Rockport

Financial changed its name to Rockport Capital, Inc. (Rockport

Capital). 

During each of Rockport Financial’s taxable years 1992, 1993, and

1994, Ms. Ackerman was its sole stockholder.5

At the end of 1995, Mr. Ackerman left London and returned to

the United States. Thereafter, as discussed in more detail

below, Mr. Ackerman became interested in and explored various

investment opportunities. 

During each of the years 1997, 1998, 2000, 2002, and 2004,

the years at issue, Mr. Ackerman devoted 40 to 50 percent of his

time to social and charitable causes. For example, Mr. Ackerman

served on the respective boards of CARE and Freedom House and as

chairman of the Fletcher School. 

Perry Lerner

While Mr. Ackerman was living in London, he met Perry Lerner

(Mr. Lerner). Mr. Lerner received a bachelor’s degree from

Claremont McKenna College and a law degree from Harvard University. From approximately 1980 to 1996, Mr. Lerner practiced law

as a tax attorney with the law firm of O’Melveny & Myers, LLP

(O’Melveny & Myers). In that capacity, Mr. Lerner represented

Mr. Ackerman with respect to various legal matters. Around 1996,

Mr. Lerner resigned from O’Melveny & Myers in order to provide

certain legal services for Mr. Ackerman on a full-time basis. 
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In February 1996, Mr. Lerner formed Rockport Advisors, Inc.

(Rockport Advisors). In January 1997, he formed Crown Capital

Group, Inc. (Crown Capital). As discussed in more detail below,

Mr. Lerner used Rockport Advisors and Crown Capital in order to

provide certain services with respect to certain investment

opportunities that Mr. Ackerman wanted to explore and/or pursue. 

Don Ackerman

Don Ackerman is the older brother of Mr. Ackerman. From

around 1965 to around the end of 1997, Don Ackerman managed the

business operations of Economy Color Card, Inc. (ECC), a supplier

of wallpaper sample books and sample cards for paint, rugs, and

wood pieces. 

Jason Ackerman

Jason Ackerman is the son of Don Ackerman and the nephew of

Mr. Ackerman. Jason Ackerman received an undergraduate degree in

economics and business management from Boston University. 

Beginning around 1990, Jason Ackerman worked as an investment

banker (1) for about a year at Drexel and (2) for about seven

years at Donaldson Lufkin Jenrette. While serving as an investment banker, Jason Ackerman worked on several business deals that

involved the formation of companies for the purpose of taking

over certain other companies that operated supermarkets. 
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Jeffrey Deutschman

Jeffrey Deutschman (Mr. Deutschman) received a bachelor’s

degree in history and economics from Columbia University and a

master’s degree in business administration from the Graduate

School of Management of the University of California, Los Angeles. From 1981 through 1997, Mr. Deutschman worked for or was

a partner in various private equity firms. 

Mr. Deutschman first met Mr. Ackerman in 1981 while Mr.

Ackerman was working for Drexel. At that time, Mr. Deutschman

had been working for a private equity firm for which Drexel had

been interested in financing an acquisition. 

Somerville S Trust and Certain

Other Entities That It Owned 

During each of the years at issue, Mr. Ackerman was treated

as the owner of Somerville S Trust, a so-called grantor trust

under section 671. For all relevant taxable years of petitioners, all of the income, deductions, and credits of Somerville S

Trust were includible in the computation of their taxable income

and credits. During each of the years at issue, Mr. Lerner was

the trustee of Somerville S Trust and was fully empowered to

transfer or invest its assets. 

On or about April 15, 1996, Rockport Financial changed its

name to Rockport Capital. During each of the years at issue,
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6The record does not disclose when or how Somerville S Trust

acquired its interest in Rockport Capital. 

7Somerville was a “disregarded” entity under secs. 301.7701-

2(a) and 301.7701-3(a) and (b)(1)(ii), Proced. & Admin. Regs.,

and was not required to file a tax return for any of the years at

issue. Nonetheless, as discussed in more detail below, it

prepared Form 1065, U.S. Return of Partnership Income (Form

1065), for each of those years. 

Somerville S Trust was the sole stockholder of Rockport Capital.6

Pursuant to a limited liability company agreement dated

December 10, 1996, Rockport Capital and Mr. Lerner formed Santa

Monica Pictures, LLC (Santa Monica). Since its formation, Santa

Monica has been subject to the unified partnership provisions of

sections 6221 through 6234. On December 11, 1996, Somerville S

Trust became a member of, and received a 99.882-percent profits

interest in, Santa Monica. During 1997 and thereafter, the

members of Santa Monica were Somerville S Trust, Rockport Capital, and Mr. Lerner. 

Pursuant to a limited liability company agreement dated

December 15, 1997, Somerville S Trust formed Somerville, LLC

(Somerville). From its formation until December 29, 1997,

Somerville S Trust was the sole member of Somerville. On December 29, 1997, Somerville S Trust contributed its interest in

Somerville to Santa Monica, and Santa Monica became, and has

remained, the sole member of Somerville.7 
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8For several months after Ms. Patriarca left Drexel, she

provided certain unidentified services for Mr. Ackerman in his

personal capacity. 

9The record is very sparse as to the activities of Rockport

Advisors during each of the years at issue. The record, however,

does establish that (1) as of Aug. 25, 1995, Somerville S Trust

was a member of, and had agreed to make capital contributions

totaling $100 million to, Cumberland Investment Partners, LLC

(Cumberland Investment), (2) the purpose of Cumberland Investment

was to invest in securities and other similar investments, and

(3) on Mar. 1, 1996, Rockport Advisors agreed to provide certain

unidentified administrative services to Cumberland Investment.

The record also establishes that on Mar. 1, 1996, Rockport

Advisors and two individuals entered into an employment agreement

(Rockport Advisors employment agreement) under which Rockport

Advisors was to, and did, employ those two individuals (two

Rockport Advisors employees). That agreement provided that

Somerville S Trust was to “bear the costs of the services performed by * * * [the two Rockport Advisors employees] on behalf

of Rockport Advisors.” The Rockport Advisors employment agreement further provided the following mechanism by which Somerville

S Trust was to recoup those costs:

(continued...)

Deena Patriarca

From 1984 until February 1990, Drexel employed Deena

Patriarca (Ms. Patriarca) as an assistant to Mr. Ackerman. 

Shortly thereafter, Rockport Capital or one of its predecessors

employed her.8 During each of the years at issue, Ms. Patriarca

handled (1) the bookkeeping, accounting, payroll, and similar

functions for Rockport Capital and (2) the bookkeeping for

Somerville S Trust. 

Rockport Advisors

As discussed above, in February 1996, Mr. Lerner formed

Rockport Advisors, which was located in Washington, D.C.9 During
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9(...continued)

To allow Somerville [S Trust] to recoup these costs, 

* * * [the two Rockport Advisors employees were to]

cause to be paid to Somerville [S Trust] 25% of any

performance-based fees * * * [they] receive in the

future while * * * employed by Rockport Advisors from

clients other than Cumberland [Investment], until

Somerville [S Trust] has received an amount equal to

the unrecovered balance in its “Recoupment Account.” 

* * *

The record further establishes that in 2000 and 2001 the two

Rockport Advisors employees caused $60,000 and $100,031.73,

respectively, to be paid to Rockport Advisors in order for

Somerville S Trust to recoup the costs that it had incurred with

respect to the services performed by them. 

10The record does not disclose whether Rockport Advisors

filed Form 1120 for any of the other taxable years at issue.

each of the years at issue, Mr. Lerner was the sole owner of

Rockport Advisors. At all relevant times, Rockport Advisors

maintained books and records, had employees, and generated

income. 

Rockport Advisors filed Form 1120, U.S. Corporation Income

Tax Return (Form 1120), for each of its taxable years 1997, 1998,

and 2000.10 In each of those returns, Rockport Advisors showed

its business activity as “ADVISORY SERVICES” and its product or

service as “CONSULTING”. 

In Form 1120 for its taxable year 1997, Rockport Advisors

reported total income of $1,600,196, total deductions of

$1,909,634, and a loss of $309,438. In Form 1120 for its taxable

year 1998, Rockport Advisors reported total income of $951,395,

total deductions of $1,144,857, and a loss of $193,462. In Form
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11From 1997 until early 2002, Sheila Innes, an employee of

Crown Capital, maintained Crown Capital’s books and records. 

Around early 2002, Crown Capital began winding down its business

operations and shipped its books and records to Ms. Patriarca. 

1120 for its taxable year 2000, Rockport Advisors reported total

income of $1,296,676, total deductions of $1,239,039, and taxable

income of $57,637. 

Crown Capital

As discussed above, in January 1997, Mr. Lerner formed Crown

Capital, which was located in New York City. On or about January

1, 1998, Crown Capital filed an election to be taxed as an S

corporation. At all relevant times, Mr. Lerner owned 49 percent

and petitioners’ nephew Jason Ackerman owned 51 percent of Crown

Capital. Crown Capital never issued any of its stock to Mr.

Ackerman. 

At all relevant times, Crown Capital maintained books and

records, had employees, and generated income.11 As discussed

below, during at least certain of the years at issue, Crown

Capital provided certain services, including “consultation,

advice and direct management assistance * * * with respect to

operations, strategic planning, [and] financing”, to certain

companies in which Mr. Ackerman indirectly invested. In exchange

for those services, those companies agreed to pay certain management fees to Crown Capital. 
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12The record does not disclose when Don Ackerman began

working for Crown Capital. We presume that shortly after Don

Ackerman stopped managing the operations of ECC, which was

sometime around the end of 1997, he began working for Crown

Capital. 

13The record does not disclose whether Crown Capital filed

Form 1120S for any of the other taxable years at issue.

Mr. Ackerman, whose reputation in finance far exceeded the

respective reputations of the employees of Crown Capital, was

involved in the hiring of Crown Capital’s employees in that he

told Crown Capital whom to hire or consented to its hiring of

certain employees. By the end of 1997, Crown Capital had about

15 employees, including Mr. Lerner, Jason Ackerman, and Don

Ackerman.12 In 1998, Mr. Deutschman joined Crown Capital and

served as its managing director. It was Mr. Deutschman’s understanding that Crown Capital was established to provide certain

services regarding the various companies in which Mr. Ackerman

invested or intended to invest. 

Mr. Lerner, Jason Ackerman, and Mr. Deutschman were the key

employees of Crown Capital. Mr. Ackerman negotiated the respective salaries that Crown Capital was to pay to those key employees. 

Crown Capital filed Form 1120 for its taxable year 1997 and

Form 1120S, U.S. Income Tax Return for an S Corporation (Form

1120S), for each of its taxable years 1998 and 2000.13 In each 
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of those returns, Crown Capital showed its business activity as

“CONSULTING” and its product or service as “INVESTMENT ADVICE”. 

In Form 1120 for its taxable year 1997, Crown Capital

reported total income of $1,754,632, total deductions of

$1,735,293, and taxable income of $19,339. In Form 1120S for its

taxable year 1998, Crown Capital reported total income of

$5,649,920, total deductions of $5,549,062, and “Ordinary income

* * * from trade or business activities” of $100,858. In Form

1120S for its taxable year 2000, Crown Capital reported total

income of $6,509,302, total deductions of $6,194,276, and “Ordinary income * * * from trade or business activities” of $315,026.

Petitioners’ Tax Returns

Petitioners jointly filed Form 1040, U.S. Individual Income

Tax Return (joint return), for each of their taxable years 1997,

1998, 2000, 2002, and 2004. 

Petitioners included Schedule C, Profit or Loss From Business (Schedule C), as part of the 1997 joint return (1997 Schedule C), the 1998 joint return (1998 Schedule C), the 2000 joint

return (2000 Schedule C), the 2002 joint return (2002 Schedule

C), and the 2004 joint return (2004 Schedule C). In each of

those schedules, petitioners showed the “Principal business or

profession, including product or service” as “INVESTMENTS AND

BANKING” and the “Business name” as “PETER ACKERMAN”. 
- 16 -

14For convenience, instead of referring to what was reported

by petitioners as Somerville S Trust’s allocable share of any

income or loss, including any dividend income, from each of the

limited liability companies in which that trust directly or

indirectly invested, we shall generally refer only to the tax

reporting by those limited liability companies which are involved

in certain of the issues presented and in which Somerville S

Trust was a direct or indirect investor. 

Petitioners also included Schedule E, Supplemental Income

and Loss (Schedule E), as part of the 1997 joint return, the 1998

joint return, the 2000 joint return, the 2002 joint return, and

the 2004 joint return. In each of those schedules, petitioners

reported, inter alia, Somerville S Trust’s allocable share of any

income or loss, including any dividend income, from each of the

limited liability companies in which that trust directly or

indirectly invested.14

Notices of Deficiency

On April 26, 2006, respondent issued to petitioners a notice

of deficiency with respect to their taxable years 1997, 1998, and

2000 (notice for 1997, 1998, and 2000). On November 17, 2006,

respondent issued to petitioners a notice of deficiency with

respect to their taxable years 2002 and 2004 (notice for 2002 and

2004). 

Claimed Business Expense Deductions

During the years at issue, various individuals and companies

sought Mr. Ackerman’s advice with respect to certain projects

that those individuals and companies were considering. Mr.
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15Except for a project that pertained to a company that

purchased cellular phone spectrum licenses and that was facing

financial difficulty, the record does not disclose the number or

the nature of any projects, other than the five major projects,

that Mr. Ackerman may have explored and/or pursued during the

years at issue. 

16Mr. Ackerman did not directly own an interest in any of

the companies to which the major projects pertained. Instead, as

discussed in more detail below, Mr. Ackerman invested in each of

those companies through one or more entities in which he directly

or indirectly owned a substantial interest, such as Somerville S

Trust, Somerville, and Santa Monica. Although Mr. Ackerman did

not directly own an interest in any of the companies to which the

major projects pertained, in discussing those projects, we shall

sometimes for convenience not describe Mr. Ackerman’s investments

and ownership interests in those companies as indirect investments and indirect ownership interests.

Ackerman and Crown Capital’s key employees (namely, Mr. Lerner,

Jason Ackerman, and Mr. Deutschman) examined each of those projects in order to determine whether it was a project that Mr.

Ackerman wanted to pursue. Mr. Ackerman and Crown Capital’s key

employees (namely, Mr. Lerner, Jason Ackerman, and Mr.

Deutschman) examined a total of about six to ten potential projects for every project that Mr. Ackerman decided to pursue. It

was Mr. Ackerman who determined which employees of Crown Capital

were to work on the projects that he wanted to pursue. 

During the years at issue, Mr. Ackerman pursued at least

five major projects (major projects).15 As discussed in more

detail below, each of those projects pertained to a company in

which Mr. Ackerman indirectly made a substantial investment.16 As

part of its business, Crown Capital (1) provided certain due
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diligence services in connection with the major projects and 

(2) monitored the progress of Mr. Ackerman’s respective investments in the companies to which those projects pertained. 

Mr. Ackerman maintained no books and records with respect to

the projects that he pursued during the years at issue. Nor did

he have any employees or lease agreements with respect to those

projects. 

One major project that Mr. Ackerman pursued involved the

financing of a resort theater business. On a date not disclosed

by the record, Mr. Lerner introduced Mr. Ackerman to an individual (resort theater developer) who had been in the process of

acquiring a small chain of movie theaters located in certain

resort areas and who had been having difficulty financing those

acquisitions. 

On February 18, 1999, Santa Monica, virtually all of which

Mr. Ackerman owned indirectly, invested $14 million in Resort

Theaters of America, Inc. (Resort Theaters), in exchange for a

100-percent ownership interest in Resort Theaters. On the same

date, Crown Capital entered into a management services agreement

with Resort Theaters (Resort Theaters management service agreement). Pursuant to that agreement, in exchange for certain fees

to be paid by Resort Theaters to Crown Capital, Crown Capital was

to provide to Resort Theaters certain management services, including “consultation, advice and direct management assistance to
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17The record does not disclose whether Mr. Ackerman assisted

Resort Theaters in obtaining financing before or after Santa

Monica invested in that company.

18In Form 1065 for its taxable year 2000, Santa Monica

reported with respect to its investment in Resort Theaters that

(1) it had acquired its interest in Resort Theaters on Feb. 18,

1999; (2) its basis in that interest was $14 million; and (3) it

had sold that interest on Dec. 31, 2000. In that form, Santa

Monica made no entry in the column headed “Sales price” with

respect to the interest in Resort Theaters that it reported it

had sold. 

* * * [Resort Theaters] with respect to operations, strategic

planning, financing and other aspects of the business of [Resort

Theaters]”. 

On certain dates not disclosed by the record, Crown Capital

and Mr. Ackerman assisted the resort theater developer in obtaining certain financing for Resort Theaters.17 

The business operations of Resort Theaters were ultimately

unsuccessful, and it did not pay to Crown Capital any of the fees

required by the Resort Theaters management service agreement. 

Santa Monica reported in Form 1065 for its taxable year 2000

a long-term capital loss of $14 million with respect to its

investment in Resort Theaters.18 

Another major project that Mr. Ackerman pursued involved the

formation of an investment management company. Mr. Ackerman

learned of that project through Jay Regan (Mr. Regan), whom Mr.

Ackerman had known for many years. 

On a date not disclosed by the record in or shortly before

1999, Mr. Regan introduced Mr. Ackerman to Marek Fludzinski (Mr.
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19The record does not establish what ultimately happened to

the investment of $30 million that Mr. Ackerman made with respect

to the project involving the creation of Thales Fund Management. 

Nor does the record establish the specific entity or entities in

which or through which Mr. Ackerman made that investment. 

However, Somerville reported in Form 1065 distributive shares of

taxable income generated by the operations of (1) Thales Fund

Management and Thales Capital, LLC (Thales Capital), for each of

Somerville’s taxable years 1999 through 2004 and (2) Thales Fund,

for each of Somerville’s taxable years 1999, 2000, 2002, and

2004. We presume from Somerville’s Form 1065 for each of its

taxable years 1999 through 2004 that Mr. Ackerman made his

investment of $30 million through Somerville.

Fludzinski). Mr. Fludzinski had been managing a fund for a large

investment partnership and wanted to leave that partnership in

order to start his own investment management business. From 1999

to 2000, Mr. Ackerman assisted Mr. Fludzinski in an undisclosed

manner in forming Thales Fund Management, LLC (Thales Fund Management), which was to be the manager of an investment company

called Thales Fund, LP (Thales Fund). Mr. Ackerman asked Mr.

Lerner to provide assistance with respect to certain of the legal

matters pertaining to the formation of Thales Fund Management. 

On a date not disclosed by the record, Mr. Ackerman and Mr. Regan

made investments of $30 million and $20 million, respectively,

with respect to the project involving the creation of Thales Fund

Management.19 

Another major project that Mr. Ackerman pursued involved

starting a towel manufacturing business in Mexico for Davidson

Cotton Holding Corp. (Davidson Cotton). Mr. Ackerman 
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20Our detailed findings of fact with respect to Mr.

Ackerman’s investment in Davidson Cotton are set forth in the

attached appendix A, which is incorporated herein.

21The record does not disclose what ultimately happened to

Mr. Ackerman’s investment in Davidson Cotton. 

learned of that project through his brother Don Ackerman shortly

after Don Ackerman began working for Crown Capital. 

On December 3, 1999, Mr. Ackerman invested in Davidson

Cotton.20 On the same date, Crown Capital entered into a management services agreement with Davidson Cotton (Davidson Cotton

management services agreement). Pursuant to that agreement, in

exchange for certain fees to be paid by Davidson Cotton to Crown

Capital, Crown Capital was to provide to Davidson Cotton certain

“executive management services, including consultation, advice

and direct management assistance * * * with respect to operations, strategic planning, financing and other aspects of the

business of” Davidson Cotton. 

On certain dates not disclosed by the record, the key employees of Crown Capital (namely, Mr. Lerner, Jason Ackerman, and

Mr. Deutschman) and Mr. Ackerman assisted Davidson Cotton in

starting a towel manufacturing business in Mexico. The business

operations of Davidson Cotton were ultimately unsuccessful, and

the company was liquidated. Davidson Cotton was able to pay to

Crown Capital only a portion of the fees required by the Davidson

Cotton management services agreement.21 
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22Equity Marketing was a marketing/advertising agency located in Los Angeles, Cal. 

Another major project that Mr. Ackerman pursued involved

assisting a company known as Equity Marketing, Inc. (Equity

Marketing),22 in making certain unidentified acquisitions. In

early 2000, Equity Marketing, through one of Mr. Ackerman’s

former colleagues at Drexel, approached Mr. Ackerman and asked

him to make an investment in the company and to provide advice

with respect to the acquisitions that Equity Marketing was seeking to make. Mr. Ackerman asked Jason Ackerman, Mr. Deutschman,

and Mr. Lerner to perform certain due diligence services in order

to determine whether Equity Marketing was a company in which Mr.

Ackerman should invest. 

Sometime before March 22, 2000, Mr. Ackerman decided to

invest in Equity Marketing through Somerville, and on that date

Mr. Ackerman made that investment (discussed in more detail

below). From 2000 to 2008, Mr. Ackerman provided certain advice

to Equity Marketing regarding the acquisitions that it was seeking to make. 

On March 22, 2000, Somerville formed Crown Acquisition

Partners, LLC (Crown Acquisition Partners). On March 29, 2000,

Crown Acquisition Partners entered into a securities purchase

agreement (Equity Marketing securities purchase agreement) with

Equity Marketing. That agreement provided that on March 29,

2000, Equity Marketing was to sell to Crown Acquisition for
- 23 -

$11,900,000 (1) certain shares of series A preferred stock in

Equity Marketing, (2) certain warrants to purchase certain shares

of series B preferred stock in Equity Marketing, and (3) certain

warrants to purchase certain shares of series C preferred stock

in Equity Marketing. The Equity Marketing securities purchase

agreement also provided that “as soon as practicable” Equity

Marketing was to sell to Crown Acquisition Partners for

$13,100,000 (1) certain additional shares of series A preferred

stock in Equity Marketing, (2) certain warrants to purchase

certain additional shares of series B preferred stock in Equity

Marketing, and (3) certain warrants to purchase certain additional shares of series C preferred stock in Equity Marketing. 

As part of its agreement to sell to Crown Acquisition Partners certain shares of stock in Equity Marketing and certain

warrants to purchase certain other shares of stock in Equity

Marketing, Equity Marketing agreed to pay to Crown Acquisition

Partners, or any of its affiliates, including Crown Capital, a

total commitment fee of $1,250,000 in 20 quarterly installments

of $62,500. As required by the Equity Marketing securities

purchase agreement, from June 30, 2000, to March 31, 2005, Equity

Marketing paid to Crown Capital that $1,250,000 commitment fee in

20 quarterly installments of $62,500. 

On April 28, 2000, Crown Acquisition Partners changed its

name to Crown Emak Partners, LLC (Crown Emak Partners). On a
- 24 -

23As of June 13, 2000, the members of Crown Emak Partners

were Crown Emak Investments, Allen Ba (Mr. Ba), Chris Calise (Mr.

Calise), and Ken Squire (Mr. Squire). Mr. Ba, Mr. Calise, and

Mr. Squire were employed by Crown Capital when they became

members of Crown Emak Partners. Crown Emak Investments, which

was the managing member of Crown Emak Partners, owned a 99.31-

percent interest in Crown Emak Partners, which it had received in

exchange for its contribution to Crown Emak Partners of

$24,828,541. 

24Somerville owned a 79.96-percent interest in Crown Emak

Investments, which it had received in exchange for its contribution to Crown Emak Investments of $8,090,000 and its interest in

Crown Emak Partners valued at $11,900,000. Crown Emak Holdings

owned a .04-percent interest in Crown Emak Investments, which it

had received in exchange for its contribution to Crown Emak

Investments of $10,000. J. Rothschild Nominees (Guernsey)

Limited owned the remaining 20-percent interest in Crown Emak

Investments, which it had received in exchange for its contribution to Crown Emak Investments of $5 million.

As of July 17, 2003, the members of Crown Emak Holdings were

Somerville, Jason Ackerman, Mr. Deutschman, Mr. Lerner, Mr.

Squire, Michael Leraris (Mr. Leraris), Suneel Kaji (Mr. Kaji),

and J. Rothschild Nominees (Guernsey) Limited. Jason Ackerman,

Mr. Deutschman, Mr. Lerner, Mr. Squire, Mr. Leraris, and Mr. Kaji

were employees of Crown Capital when they became members of Crown

Emak Holdings.

date not disclosed by the record, Somerville contributed its

interest in Crown Emak Partners to Crown Emak Investments, LLC

(Crown Emak Investments).23 As of June 13, 2000, the members of

Crown Emak Investments were Somerville, Crown Emak Holdings, LLC 

(Crown Emak Holdings), and J. Rothschild Nominees (Guernsey)

Limited.24 

Crown Emak Investments issued to Somerville Schedule K-1,

Partner’s Share of Income, Credits, Deductions, etc. (Schedule K1), for each of Somerville’s taxable years 2000 through 2006. 

Each of those schedules showed dividend income paid by Equity
- 25 -

25The respective Schedules K-1 that Crown Emak Investments

issued to Somerville for Somerville’s taxable years 2001 through

2004 are part of the record. The respective Schedules K-1 that

Crown Emak Investments issued to Somerville for Somerville’s

taxable years 2000, 2005, and 2006 are not part of the record. 

Thus, we do not know whether there was any income reported in any

of those schedules other than the dividend income paid by Equity

Marketing to Crown Emak Partners with respect to the preferred

stock that Crown Emak Partners had acquired pursuant to the

Equity Marketing securities purchase agreement. 

26The respective Schedules K-1 that Crown Emak Holdings

issued to Somerville for Somerville’s taxable years 2000 through

2006 are not part of the record. Thus, we do not know whether

there was any income reported in any of those schedules other

than the dividend income paid by Equity Marketing to Crown Emak

Partners with respect to the preferred stock that Crown Emak

Partners had acquired pursuant to the Equity Marketing securities

purchase agreement. 

Marketing to Crown Emak Partners with respect to the preferred

stock that Crown Emak Partners had acquired pursuant to the

Equity Marketing securities purchase agreement. That dividend

income was the only income reported in the Schedule K-1 that

Crown Emak Investments issued to Somerville for each of

Somerville’s taxable years 2001 through 2004.25

Crown Emak Holdings issued to Somerville Schedule K-1 for

each of Somerville’s taxable years 2000 through 2006. Each of

those schedules showed dividend income paid by Equity Marketing

to Crown Emak Partners with respect to the preferred stock that

Crown Emak Partners had acquired pursuant to the Equity Marketing

securities purchase agreement.26 

Another major project that Mr. Ackerman pursued involved

starting an Internet grocery business. The initial concept of
- 26 -

27In 2006, Rick Braddock (Mr. Braddock) became the chairman

of the board of directors of Fresh Direct. On a date not disclosed by the record before the date on which Mr. Braddock became

the chairman of that board, he had invested in, and entered into

an agreement to provide certain consulting services to, Fresh

Direct.

28Our detailed findings of fact with respect to the ownership of Crown Fresh Direct and certain other related entities are

set forth in the attached appendix B, which is incorporated

herein. 

that business originated with Jason Ackerman. Beginning around

1999, Mr. Ackerman, Crown Capital under the leadership of Jason

Ackerman, and Joe Fedele, a supermarket executive hired by Mr.

Ackerman and Crown Capital, spent approximately two years in

creating a business plan for an Internet grocery business. 

Around 2000, Mr. Ackerman, Crown Capital, and/or Joe Fedele

formed Fresh Direct Holdings, Inc. (Fresh Direct), to operate

that business. 

From the formation of Fresh Direct until early 2006, Mr.

Ackerman served as chairman of the board of directors of Fresh

Direct. In early 2006, Mr. Ackerman resigned as chairman of that

board but continued to serve as a member thereof.27

On a date not disclosed by the record, Mr. Ackerman invested

in Fresh Direct by purchasing 83 percent of the shares of stock

in that corporation for a penny a share. Thereafter, Mr.

Ackerman contributed at least certain of those shares to Crown

Fresh Direct, LLC (Crown Fresh Direct), that had been formed by

Somerville on March 1, 2000.28 
- 27 -

29Mr. Ackerman met Mr. Earls when Mr. Ackerman’s son was in

the same class at Harvard University as Mr. Earls’s daughter.

On a date not disclosed by the record before September 2002,

C. Gregory Earls (Mr. Earls), a well-known businessman in Washington, D.C., whom Mr. Ackerman had known since 1995 or 1996,29

informed Mr. Ackerman that he had certain clients that would be

interested in investing in Fresh Direct. Thereafter, Mr. Earls

and Mr. Ackerman each attempted to raise funds for that corporation. Mr. Ackerman successfully raised a substantial amount of

funds for Fresh Direct. Mr. Earls advised Mr. Ackerman to place

those funds in an escrow account in the name of Mr. Earls, which

Mr. Ackerman did. (We shall refer to the funds that Mr. Ackerman

raised for Fresh Direct and placed into that escrow account as

the Fresh Direct investor funds in escrow.) 

On April 12, 2000, Crown Capital and Fresh Direct entered

into a management services agreement (Fresh Direct management

services agreement), and on April 29, 2003, they entered into an

amended and restated management services agreement (Fresh Direct

amended management services agreement). Pursuant to those agreements, Crown Capital was to provide to Fresh Direct 

advisory and consulting services in relation to the

affairs of * * * [Fresh Direct] in connection with

strategic financial planning, and other services, including, without limitation, advisory and consulting

services relating to the selection, supervision and

retention of independent auditors, the selection, retention and supervision of outside legal counsel, and

the selection, retention and supervision of investment

bankers or other financial advisors or consultants.
- 28 -

30The record does not establish how Crown Capital treated

for book and tax purposes the payments that Mr. Ackerman made to

it during each of the years at issue.

In exchange for the services that Crown Capital provided to Fresh

Direct, Fresh Direct paid to Crown Capital the fees required by

the Fresh Direct management services agreement and the Fresh

Direct amended management services agreement. 

During each of the years at issue, Mr. Ackerman, through

Somerville S Trust, made payments to Crown Capital of the funds

that Crown Capital requested in order to assist it in carrying on

its business activities.30 The total amount of payments that Mr.

Ackerman made to Crown Capital during each of those years was:

Year Total Payment

1997 1$1,954,632

1998 7,300,000

2000 26,687,520

2002 32,254,747

2004 1,000,000

1Of the $1,954,632 that Mr. Ackerman paid to Crown Capital

during 1997, $200,000 pertained to a failed attempt to establish

an insurance company.

2Of the $6,687,520 that Mr. Ackerman paid to Crown Capital

during 2000, $1,827,418 pertained to certain unidentified abandoned projects.

3Of the $2,254,747 that Mr. Ackerman paid to Crown Capital

during 2002, $663,520 pertained to certain unidentified abandoned

projects.

The practice that Crown Capital followed in requesting funds

from Mr. Ackerman was to send an invoice for the funds requested

to Ms. Patriarca, who, as discussed above, handled the bookkeep-
- 29 -

31The invoices that Crown Capital sent to Ms. Patriarca are

not part of the record. 

32The record not establish how Rockport Advisors treated for

book and tax purposes the payments that Mr. Ackerman made to it

during each of petitioners’ taxable years 1997, 1998, and 2002. 

However, we note that the amount of “Gross receipts or sales”

that Rockport Advisors reported in its Form 1120 for its taxable

year 1998 is equal to the total amount of the payments that Mr.

Ackerman made to Rockport Advisors during that year. As for

petitioners’ taxable year 2000, Rockport Advisors booked the

total amount of the payments that Mr. Ackerman made to it during

that year as “ADVISORY FEE INCOME”, and Rockport Advisors reported that amount as “Gross receipts or sales” in its Form 1120

for that year. 

33The record does not disclose any other information regarding Mr. Ackerman’s payments to Rockport Advisors during 1997,

1998, 2000, and 2002. Nor does the record disclose whether Mr.

Ackerman made any payments to Rockport Advisors during petitioners’ taxable year 2004. 

ing for Somerville S Trust.31 After obtaining Mr. Ackerman’s

approval, Ms. Patriarca had the funds requested sent to Crown

Capital. 

During each of petitioners’ taxable years 1997, 1998, 2000,

and 2002, Mr. Ackerman made payments to Rockport Advisors of

certain funds that it requested.32 The total amount of payments

that Mr. Ackerman paid to Rockport Advisors during each of those

years was:33

Year Total Payment

1997 $587,500

1998 950,000

2000 1,235,876

2002 500,000

During each of the years at issue, Mr. Ackerman did not

provide advisory services with respect to the major projects in
- 30 -

exchange for a fee or a commission or with the purpose of selling

his interests in the respective companies involved in those

projects in the ordinary course of any business of his. Nor did

Mr. Ackerman provide advisory services with respect to the major

projects during any of those years in exchange for any other

compensation other than the normal investor’s return. 

As discussed above, in petitioners’ Schedule C for each of

the years at issue, petitioners showed the “Principal business or

profession, including product or service” as “INVESTMENTS AND

BANKING” and the “Business name” as “PETER ACKERMAN”. Mr.

Ackerman maintained no books and records with respect to the

activity reflected in each of those schedules. 

In the 1997 Schedule C, petitioners reported no income in

part I and claimed $2,752,132 as “Other expenses” in part II

consisting of payments of (1) $1,954,632 to Crown Capital, 

(2) $587,500 to Rockport Advisors, and (3) $210,000 to Nevada

Media Partners. In that schedule, petitioners claimed a net loss

of $2,752,132. In determining the taxable income reported in the

1997 joint return, petitioners deducted that net loss. 

In the 1998 Schedule C, petitioners reported no income in

part I and claimed $8,250,000 as “Other expenses” in part II

consisting of payments of (1) $7,300,000 to Crown Capital and 

(2) $950,000 to Rockport Advisors. In that schedule, petitioners

claimed a net loss of $8,250,000. In determining the taxable
- 31 -

34The $50,253 of expenses pertaining to Mr. Ackerman’s book

on nonviolent resistance consisted of expenses for certain

research and publicity and an unidentified “book purchase”.

income reported in the 1998 joint return, petitioners deducted

that net loss.

In the 2000 Schedule C, petitioners reported no income in

part I and claimed $7,973,649 as “Other expenses” in part II

consisting of (1) $50,253 of expenses for a book that Mr.

Ackerman had coauthored on nonviolent resistance34 (Mr. Ackerman’s

book on nonviolent resistance) and (2) payments of 

(a) $6,687,520 to Crown Capital and (b) $1,235,876 to Rockport

Advisors. In that schedule, petitioners claimed a net loss of

$7,973,649. In determining the taxable income reported in the

2000 joint return, petitioners deducted that net loss. 

In the 2002 Schedule C, petitioners reported no income in

part I and claimed $2,754,747 as “Other expenses” in part II

consisting of payments of (1) $2,254,747 to Crown Capital and 

(2) $500,000 to Rockport Advisors. In that schedule, petitioners

reported a net loss of $2,754,747. In determining the taxable

income reported in the 2002 joint return, petitioners deducted

that net loss. 

In the 2004 Schedule C, petitioners reported no income in

part I and claimed $1 million as “Other expenses” in part II

consisting of a payment of that amount to Crown Capital. In that

schedule, petitioners reported a net loss of $1 million. In
- 32 -

35With respect to the payment of $210,000 to Nevada Media

Partners that petitioners deducted in the 1997 Schedule C, the

parties agree that that payment constituted a capital expenditure. They further agree that that $210,000 should not have been

deducted in the 1997 Schedule C but should have been included as

part of Somerville S Trust’s basis in its interest in Santa

Monica. 

determining the taxable income reported in the 2004 joint return,

petitioners deducted that net loss. 

In the notice for 1997, 1998, and 2000 and the notice for

2002 and 2004 (collectively, the notices), respondent determined

that (1) the “Other expenses” that petitioners claimed in Schedule C “are not attributable to an active trade or business under

IRC Section 162”, (2) those expenses are deductible as “expenses

related to the production or collection of income under IRC

Section 212 subject to the 2 percent floor for miscellaneous

deductions”, and (3) therefore petitioners should have reported

those expenses in Schedule A--Itemized Deductions (Schedule A)

instead of Schedule C.35

Claimed Deduction for the

Protection of Business Reputation

In 1918, the maternal grandfather of Don Ackerman and of Mr.

Ackerman started a business that was the predecessor of ECC. In

1964, the father of Don Ackerman and of Mr. Ackerman incorporated

ECC, a supplier of wallpaper sample books and sample cards for

paint, rugs, and wood pieces. Around 1965, when the grandfather,

the father, and the uncle of Don Ackerman and of Mr. Ackerman 
- 33 -

36The record does not disclose when Don Ackerman and Jason

Ackerman acquired their respective stock interests in ECC. 

37Although Mr. Ackerman advanced a total of $7,850,000 to

ECC through Somerville S Trust, in discussing Mr. Ackerman’s

advancing those funds, we shall sometimes for convenience not

(continued...)

developed certain health problems, Don Ackerman took over the

management of ECC. 

Funds Advanced to ECC

During the early 1990s, ECC operated a successful business. 

It generated annual revenue of approximately $25 million and had

approximately 1,500 employees. By 1997, at a time when Don

Ackerman and Jason Ackerman owned ECC,36 that company faced dire

financial circumstances that were due in large part to a reduced

need for wallpaper sample books. 

On a date in 1997 not disclosed by the record before May 7,

Don Ackerman approached his brother Mr. Ackerman and informed him

that ECC was unable to meet its payroll obligations, that ECC

and/or Don Ackerman had accrued a substantial amount of bank

debt, and that ECC and Don Ackerman might have to commence a

bankruptcy proceeding. 

Mr. Ackerman, who was not a stockholder, guarantor, employee, or officer of ECC, decided to advance certain funds to

ECC. On the dates indicated, Mr. Ackerman, through Somerville S

Trust, advanced to ECC the following amounts totaling $7,850,000

($7,850,000 of advanced funds):37
- 34 -

37(...continued)

indicate that Mr. Ackerman advanced those funds through

Somerville S Trust. 

38ISI, ISG, and ISGH were formed on the following dates: 

Entity Date of Formation

ISI 8/27/1997

ISG 8/29/1997

ISGH 11/1/1997

39The parties generally refer to ISI, ISG, and ISGH as the

“International Group”. In describing the activities of the

International Group in their stipulation of facts, the parties do

not make clear whether each of the three companies making up the

International Group engaged in those activities. It appears from

the record that ISG was the only company engaged in manufacturing

(continued...)

Date Amount

5/7/1997 $1,000,000

6/3/1997 1,000,000

7/2/1997 1,000,000

7/30/1997 2,400,000

8/29/1997 500,000

9/26/1997 500,000

10/28/1997 600,000

11/6/1997 100,000

11/21/1997 750,000

ECC never repaid the funds that Mr. Ackerman advanced to it. 

Around the time in 1997 Mr. Ackerman had decided to advance,

and was advancing, $7,850,000 to ECC, a decision had been made to

form International Service Investors, LLC (ISI), International

Service Group, LLC (ISG), and International Service Group Holdings, LLC (ISGH),38 in order to continue the operations of ECC in

modified form.39 Around the same time, Mr. Ackerman also decided
- 35 -

39(...continued)

operations. When referring to one or more of the companies

making up the group that the parties refer to as the “International Group”, we shall sometimes for convenience use the terminology that the parties use. 

40The record does not disclose the specific date in 1997 on

which Somerville invested $18,050,000 in ISI.

41At all relevant times, Don Ackerman owned New Cumberland.

42As of Dec. 31, 1997, ISI was the sole stockholder of ECC. 

The record does not disclose how, or the specific date on which,

ISI acquired its stock interest in ECC. 

43As of Dec. 31, 1997, Jason Ackerman and Mr. Deutschman

each owned a 7-percent interest, New Cumberland owned a 3.75-

percent interest, and Crown Capital owned a 7.25-percent interest

in ISGH. 

to make, and was making, through Somerville an investment of

$18,050,000 in the International Group by investing that amount

in ISI.40 Those funds enabled ISI and the other companies making

up the International Group to conduct their operations. 

As of December 31, 1997, Somerville owned a 98-percent

interest, ECC owned a 1-percent interest, and New Cumberland

Corporation, Inc. (New Cumberland),41 owned a 1-percent interest

in ISI. In exchange for the 1-percent interest in ISI that ECC

owned as of December 31, 1997, ECC contributed all of its assets

(discussed below) totaling $15,190,903, but none of its liabilities, to ISI.42 As of December 31, 1997, ISI owned a 1-percent

interest and ISGH, in which ISI owned a 75-percent interest,43

owned a 99-percent interest in ISG. 
- 36 -

Included in the assets that ECC contributed to ISI were a

substantial, but undisclosed, amount of cash, substantial amounts

of inventory, certain accounts receivable, certain intangible

assets in the form of customer relationships, certain employee

relationships, certain leasehold interests, and substantial

amounts of machinery and equipment that ECC had used in the

production of sample cards and packaging projects. The assets

that ECC contributed to ISI assisted the International Group in

continuing the operations of ECC in modified form. 

After the International Group was formed and received from

Mr. Ackerman, through Somerville, over $18 million and from ECC

over $15 million of assets, the International Group made certain

fundamental changes to ECC’s business model and continued ECC’s

business in modified form. For example, the International Group

engaged in the manufacture of Pokemon cards and the business of

creating packaging for various companies. 

From at least 1998 through 2003, Mr. Deutschman managed the

day-to-day business operations of the International Group from

the International Group’s offices in New Jersey. At all relevant

times, the International Group carried out its operations in New

Jersey, New York City, Texas, and/or Mexico. In 1999, at least

certain of the manufacturing operations of the International

Group were moved from New Jersey to Mexico. 
- 37 -

44In the 1998 Schedule L, ECC incorrectly identified the

amount of the ECC funds as $7,750,000, instead of $7,850,000. 

Book and Tax Treatment of the $7,850,000 of 

Advanced Funds by Somerville and by Santa Monica

At the direction of Mr. Lerner, Somerville S Trust booked

the $7,850,000 of advanced funds as a loan from Somerville S

Trust to ECC. Consistent with Somerville S Trust’s treatment of

the $7,850,000 of advanced funds in its books, ECC booked those

funds as a loan from Somerville S Trust to ECC. In Schedule L,

Balance Sheets per Books (Schedule L), of Form 1120 for each of

its taxable years ended November 30, 1998 (1998 Schedule L), and

November 30, 1999, ECC included the $7,850,000 of advanced funds

as part of its “Other liabilities”.44 In Schedule M-1, Reconciliation of Income (Loss) per Books With Income per Return, of Form

1120 for its taxable year ended November 30, 2000, ECC included

the $7,850,000 of advanced funds as book income from the “CANCELLATION OF DEBT”. 

On December 16, 1997, Somerville S Trust contributed to

Somerville a loan receivable (contributed loan receivable) with

respect to the $7,850,000 of advanced funds. Somerville S

Trust’s basis in its interest in Somerville included the value of

that loan receivable, and the contributed loan receivable was

among the assets held by Somerville when Somerville S Trust

contributed its interest in Somerville to Santa Monica on December 29, 1997. 
- 38 -

45See supra note 7.

46The parties stipulated that Santa Monica’s claimed 2000

ordinary loss included “an ordinary loss in the amount of

$91,171,171 from Somerville LLC.” That stipulation is clearly

contrary to the facts that we have found are established by the

record, and we shall disregard it. See Cal-Maine Foods, Inc. v.

Commissioner, 93 T.C. 181, 195 (1989). The record establishes,

and we have found, that Santa Monica’s claimed 2000 ordinary loss

included Somerville’s claimed 2000 ordinary loss of only

$9,171,171. 

In Schedule L of Form 1065 that it prepared, but did not

file,45 for each of its taxable years 1997, 1998, and 1999,

Somerville included the contributed loan receivable as part of

its “Other current assets”. In Form 1065 that it prepared, but

did not file, for its taxable year 2000, Somerville claimed an

“Ordinary * * * (loss) from trade or business activities” of

$9,171,171 (Somerville’s claimed 2000 ordinary loss). In calculating that loss, Somerville deducted a bad debt of $7,850,000

with respect to the contributed loan receivable. 

On July 2, 2001, Santa Monica, which owned all of

Somerville, filed Form 1065 for its taxable year 2000. In that

form, Santa Monica claimed an “Ordinary * * * (loss) from trade

or business activities” of $10,344,426 (Santa Monica’s claimed

2000 ordinary loss). That ordinary loss that Santa Monica claimed included Somerville’s claimed 2000 ordinary loss.46 Santa

Monica’s claimed 2000 ordinary loss was allocated as follows: 

99.88 percent to Somerville S Trust, .059 percent to Rockport
- 39 -

47Before 2000, Santa Monica, Somerville, and petitioners did

not claim any deductions with respect to the $7,850,000 of

advanced funds. 

48The record does not disclose whether Mr. Lerner reported

in his tax return for his taxable year 2000 his allocable share

of Santa Monica’s claimed 2000 ordinary loss.

Capital, and .059 percent to Perry Lerner.47 In Schedule E of

their 2000 joint return, petitioners reported Somerville S 

Trust’s and Rockport Capital’s respective allocable shares of

Santa Monica’s claimed 2000 ordinary loss.48

On or about August 8, 2005, petitioners and respondent

executed Form 872, Consent to Extend the Time to Assess Tax (Form

872), in which they consented to extend to December 31, 2006, the

time within which to assess petitioners’ tax for their taxable

year 2000. That Form 872 did not provide that it applied to any

tax of petitioners attributable to the partnership items of Santa

Monica. 

Santa Monica did not execute Form 872-P, Consent to Extend

the Time to Assess Tax Attributable to Partnership Items, with

respect to its taxable year 2000. 

In the second amended petition at docket No. 13947-06,

petitioners alleged as an affirmative issue that the $7,850,000

of advanced funds is deductible under section 162(a) for petitioners’ taxable year 1997. 
- 40 -

49For example, from 1998 through 2003, Mr. Deutschman served

as president of ISI. 

Claimed Losses With Respect to ISI

From around early 1998 through 2003, Mr. Deutschman, who

lived in New York City, had a leadership role in each of the

companies (i.e., ISI, ISG, and ISGH) that made up the International Group.49 During each of those years, Mr. Deutschman spent

more than 500 hours managing the day-to-day business operations

of the International Group. Mr. Deutschman performed his management activities with respect to the business operations of the

International Group from the International Group’s offices in New

Jersey. No person spent more time managing the business operations of the International Group than Mr. Deutschman. 

During at least 1998 and 2000, Don Ackerman and Jason

Ackerman also provided certain unidentified management services

to the International Group. 

Mr. Ackerman, who during the years at issue lived in Washington, D.C., was not an employee or officer of any of the companies that made up the International Group, did not receive any

wages from any of those companies, and did not maintain a log

documenting the amount of time that he devoted to any of those

companies.

During 1998 through 2000, Mr. Ackerman communicated on

various occasions with Mr. Deutschman regarding various matters,
- 41 -

including the business operations and finances of the International Group and various other investments of Mr. Ackerman. Mr.

Deutschman sent Mr. Ackerman at least one memorandum dated July

9, 1999, regarding the business operations of the International

Group that served as a basis for discussions between the two of

them. 

During 1998 through 2000, Mr. Ackerman spent at least one or

two days in certain weeks in New York City. During that period,

he also visited New Jersey where his mother and his brother Don

Ackerman lived. While in New York City, Mr. Ackerman spent time

on various matters, including matters relating to certain of the

major projects in which Crown Capital was involved and certain

charitable activities relating to CARE. While in New Jersey, Mr.

Ackerman, inter alia, occasionally visited Mr. Deutschman where

Mr. Deutschman managed the operations of the International Group.

ISI issued to Somerville Schedule K-1 with respect to each

of Somerville’s taxable years 1998 (1998 ISI Schedule K-1 issued

to Somerville) and 2000 (2000 ISI Schedule K-1 issued to

Somerville). In the 1998 ISI Schedule K-1 issued to Somerville,

ISI showed an “Ordinary * * * (loss) from trade or business

activities” of $6,983,996 (1998 ISI loss). In the 2000 ISI

Schedule K-1 issued to Somerville, ISI showed an “Ordinary * * *

(loss) from trade or business activities” of $1,771,427 (2000 ISI

loss). 
- 42 -

In the 1998 joint return and the 2000 joint return, petitioners treated Mr. Ackerman’s allocable portions of the respective 1998 ISI loss and 2000 ISI loss as passive activity losses. 

In the second amended petition at docket No. 13947-06, petitioners alleged as an affirmative issue that the “losses deducted by

Petitioners as passive losses [with respect to ISI] should be

allowed as active because Mr. Ackerman materially participated in

this business activity throughout the years of the deductions.” 

Claimed Theft Loss Deduction

Around 1996 or 1997, Mr. Earls approached Mr. Ackerman with

a proposal to invest in U.S. Technologies, Inc. (U.S. Technologies), a publicly traded Delaware corporation that used prison

labor to manufacture a variety of products. Mr. Ackerman believed that such an investment would be profitable. 

On June 22, 1998, USV Partners, LLC (USV), was formed for

the purpose of acquiring and holding shares of preferred and

common stock of U.S. Technologies. At all relevant times, Mr.

Earls was the sole director, officer, and employee of USV and 

controlled all of its funds.

Pursuant to various subscription agreements, from July 10,

1998, through August 27, 2001, Mr. Ackerman, through Somerville S

Trust, invested funds totaling $4,467,610 in USV. Pursuant to

those agreements, those invested funds were to be used by USV to

purchase shares of common and/or preferred stock in U.S. Technol-
- 43 -

50On a date not disclosed by the record, Mr. Lerner also

invested certain funds in USV. Like the funds that Mr. Ackerman,

through Somerville S Trust, invested in USV, the funds that Mr.

Lerner invested in USV were to be used by USV to purchase shares

of common and/or preferred stock in U.S. Technologies. 

ogies.50 On March 4, 2002, USV distributed to Somerville S Trust

18,759,879 shares of common stock in U.S. Technologies. 

Around September 2002, Mr. Ackerman asked Mr. Earls to

return to him the Fresh Direct investor funds in escrow (discussed above). Mr. Earls was unable to do so because he had

removed from escrow at least certain of those funds. Mr.

Ackerman gave Mr. Earls a deadline by which he had to return to

him the full amount of the Fresh Direct investor funds in escrow. 

Mr. Earls borrowed a certain amount of money and returned to Mr.

Ackerman the full amount of those funds by the deadline that Mr.

Ackerman set. 

When Mr. Ackerman learned that Mr. Earls had removed from

escrow certain of the Fresh Direct investor funds in escrow, Mr.

Ackerman began to question whether Mr. Earls had properly handled

the funds that Mr. Ackerman, through Somerville S Trust, had

invested in USV. On a date not disclosed by the record before

December 9, 2002, Mr. Ackerman learned that Mr. Earls had used

for his own personal benefit certain of the funds that Mr.

Ackerman, through Somerville S Trust, and other members of USV

had invested in USV. Shortly thereafter, Mr. Ackerman informed a
- 44 -

51The record does not disclose which district attorney’s

office in New York Mr. Ackerman informed of Mr. Earls’s conduct

with respect to the funds that Mr. Ackerman, through Somerville S

Trust, and other members of USV had invested in USV.

district attorney in New York51 of Mr. Earls’s conduct with respect to those funds. 

On December 9, 2002, in an effort to recover damages of

approximately $5,953,000, Somerville S Trust and certain other

persons who owned interests in USV filed a complaint (December 9,

2002 complaint) in the United States District Court for the

District of Maryland (U.S. District Court for Maryland) against

David Ferreira (Mr. Ferreira) and Ferreira & Isbell, LLC

(Ferreira & Isbell). (We shall refer to that civil action as the

Ferreira litigation.) In the December 9, 2002 complaint, the

plaintiffs in the Ferreira litigation alleged, inter alia, that

the defendants identified in that complaint had “negligently and

recklessly failed to exercise due care in performing their review

of USV’s general ledgers and trial balances, in making any adjustments thereto, and in performing other accounting services

for USV.” 

On December 18, 2002, criminal complaints were filed against

Mr. Earls in the United States District Court for the Southern

District of New York. Thereafter, on March 24, 2003, Mr. Earls,

who was accused of stealing $13 million of $20 million that had

been invested in USV, was indicted in that court on one count of 
- 45 -

52On a date not disclosed by the record before Mr.

Ackerman’s discovery of Mr. Earls’s conduct with respect to the

funds invested in USV, Somerville S Trust had transferred as

gifts small portions of its USV membership interest to the

Ackerman family trusts. 

securities fraud, 19 counts of wire fraud, and two counts of mail

fraud. 

On June 17, 2003, Mr. Ackerman executed a formal engagement

letter for representation by the law firm of Jenner & Block, LLC

(Jenner & Block), in connection with the Ferreira litigation and

certain other litigation against Mr. Earls in the Superior Court

of the District of Columbia. 

On August 19, 2003, Somerville S Trust entered into three

respective securities and purchase agreements with (1) Mr.

Lerner, (2) WS Investments, LP (WS Investments), and (3) certain

family trusts that were established for the benefit of certain

members of Mr. Ackerman’s family (Ackerman family trusts).52

Pursuant to the securities and purchase agreement entered into by

Somerville S Trust and Mr. Lerner, that trust was to acquire from

Mr. Lerner for a total purchase price of $150,000 (1) any membership interests in USV and shares of stock in U.S. Technologies

that Mr. Lerner owned and (2) any claims that Mr. Lerner had

against Mr. Earls or any of Mr. Earls’s affiliates with respect

to any fraudulent conduct of Mr. Earls concerning those membership interests and shares of stock. Pursuant to the securities

and purchase agreement entered into by Somerville S Trust and WS
- 46 -

Investments, that trust was to acquire from WS Investments for a

total purchase price of $200,000 (1) any membership interests in

USV and shares of stock in U.S. Technologies that WS Investments

owned and (2) any claims that WS Investments had against Mr.

Earls or any of Mr. Earls’s affiliates with respect to any fraudulent conduct of Mr. Earls concerning those membership interests

and shares of stock. Pursuant to the securities and purchase

agreement entered into by Somerville S Trust and the Ackerman

family trusts, Somerville S Trust was to acquire from those

family trusts for a total purchase price of $50,000 (1) any

membership interests in USV and shares of stock in U.S. Technologies that the Ackerman family trusts owned and (2) any claims

that the Ackerman family trusts had against Mr. Earls or any of

Mr. Earls’s affiliates with respect to any fraudulent conduct of

Mr. Earls concerning those membership interests and shares of

stock. 

On August 21, 2003, in an effort to recover damages of at

least $5,952,860, Somerville S Trust, which was represented by

Jenner & Block, filed a complaint (August 21, 2003 complaint) in

the United States District Court for the District of Columbia

(U.S. District Court for the District of Columbia) against, inter

alia, Mr. Earls, USV Partners, and U.S. Technologies. The claims

set forth in the August 21, 2003 complaint included the claims

that were assigned to Somerville S Trust by Mr. Lerner, WS In-
- 47 -

vestments, and the Ackerman family trusts pursuant to the respective securities and purchase agreements described above. 

Somerville S Trust alleged in that complaint, inter alia, that

Mr. Earls had “devised and implemented a fraudulent investment

scheme by which he embezzled and misappropriated funds from

investors for his own personal benefit.” 

On November 26, 2003, the parties involved in the Ferreira

litigation filed a stipulation of dismissal in the U.S. District

Court for Maryland. 

By letter dated March 19, 2004, Jenner & Block sent Mr.

Ackerman a check in the amount of $1,882.73, which had been

recovered from a personal bank account of Mr. Earls. In that

letter, Jenner & Block advised Mr. Ackerman that “We have recently served additional subpoenas and attachment orders on

various banks where Earls had or has accounts”. 

On April 23, 2004, Mr. Earls was convicted on all 22 counts

on which he had been indicted on March 24, 2003, and was sentenced to prison for ten years. 

By letter dated January 11, 2005, Jenner & Block sent Mr.

Ackerman a check in the amount of $772.86, which had been recovered from another personal bank account of Mr. Earls. In that

letter, Jenner & Block advised Mr. Ackerman of the difficulties

and prohibitive costs of recovering any more funds from that

account. 
- 48 -

53The record does not disclose any other information regarding Mr. Joseph. 

54As discussed above, Somerville S Trust alleged in the

August 21, 2003 complaint, inter alia, that Mr. Earls had “devised and implemented a fraudulent investment scheme by which he

embezzled and misappropriated funds from investors for his own

personal benefit.” 

On a date not disclosed by the record, Somerville S Trust

received a memorandum dated February 14, 2005, that had been sent 

to the common shareholders of U.S. Technologies by an individual

named Adam Joseph (Mr. Joseph).53 Mr. Joseph concluded in that

memorandum: “Given the outstanding liabilities of the company

and the illiquid state of the remaining investment portfolio, I

am not optimistic that * * * [U.S. Technologies] shareholders

will realize value.” 

On May 26, 2005, Somerville S Trust filed a motion to dismiss the August 21, 2003 complaint against Mr. Earls, USV Partners, and U.S. Technologies.54 On June 6, 2005, the U.S. District

Court for the District of Columbia granted that motion. 

From around 2002 through 2005, petitioners paid more than

$2.2 million in legal and investigative fees pursuing recovery of

any losses sustained as a result of any fraudulent conduct of Mr.

Earls with respect to the funds invested in USV. 

In the 2002 joint return, petitioners claimed a long-term

capital loss of $4,467,610 with respect to the funds that Mr.

Ackerman, through Somerville S Trust, invested in USV. In the
- 49 -

2004 joint return, petitioners again claimed a long-term capital

loss in the same amount with respect to that investment. 

In the notice for 2002 and 2004, respondent did not make any

determinations regarding the long-term capital loss of $4,467,610

that petitioners claimed in both the 2002 joint return and the

2004 joint return with respect to the funds that Mr. Ackerman,

through Somerville S Trust, invested in USV. In the amended

petition at docket No. 26400-06, petitioners acknowledged that

they are not entitled to deduct that long-term capital loss for

both of their taxable years 2002 and 2004. In that amended

petition, petitioners further alleged as an affirmative issue

that the long-term capital loss that they claimed in both the

2002 joint return and the 2004 joint return with respect to the

funds that Mr. Ackerman, through Somerville S Trust, invested in

USV is “deductible as a theft loss” for their taxable year 2002.

Accuracy-Related Penalty Under Section 6662(a)

Joseph Miller (Mr. Miller) prepared petitioners’ joint

return for each of the years at issue. Ms. Patriarca was responsible for sending to Mr. Miller certain records and schedules

that were pertinent to the preparation of each of those returns. 

Grant Thornton, LLP (Grant Thornton), prepared the respective tax returns of Somerville, Santa Monica, and Crown Capital

for each of the years at issue. 
- 50 -

In February 2001, respondent began an examination of petitioners’ taxable years 1997, 1998, and 2000 (examination of 1997,

1998, and 2000). The only issue involved in that examination was

whether the “Other expenses” that petitioners claimed in Schedule

C for each of their taxable years 1997, 1998, and 2000 should

have been claimed in Schedule A instead of Schedule C. 

Howard Levinton (Mr. Levinton), an accountant who has been

employed by Grant Thornton since 1987, represented petitioners

with respect to the examination of their taxable years 1997,

1998, and 2000. Mr. Levinton presented to respondent’s revenue

agent (revenue agent) who was assigned to that examination certain information that that agent requested. 

During the examination of 1997, 1998, and 2000, Mr. Levinton

also presented to the revenue agent an amended joint return for

petitioners’ taxable year 1999 (1999 amended joint return). In

that amended return, petitioners claimed a refund of $1,857,106. 

Petitioners included Schedule C as part of the 1999 amended joint

return (1999 Schedule C). In that schedule, petitioners showed

the “Principal business or profession, including product or

service” as “INVESTMENTS AND BANKING” and the “Business name” as

“PETER ACKERMAN”. In the 1999 Schedule C, petitioners made no

entries in the section entitled “Income” and claimed “Other

expenses” of $9,694,269 consisting of “INVESTMENT ADVISORY FEES”

of that amount. Petitioners explained in the 1999 amended joint
- 51 -

55In view of respondent’s position on the claimed Schedule C

deductions that are at issue in these cases, we presume that

respondent did not approve the refund that petitioners claimed in

the 1999 amended joint return.

56The Appeals Office conference that Mr. Levinton asked Mr.

Lerner to attend was rescheduled from a date in 2005 not disclosed by the record to a date in December 2005 not disclosed by

the record.

return that “TAXPAYERS INCORRECTLY DEDUCTED INVESTMENT ADVISORY

FEES AS AN ITEMIZED DEDUCTION RATHER THAN DEDUCTING THEM AS A

TRADE OR BUSINESS EXPENSE ON SCHEDULE C.”55 

Around September 2002, respondent issued to petitioners a

30-day letter with respect to their taxable years 1997, 1998, and

2000 (respondent’s 30-day letter). In October 2002, Mr.

Levinton, on petitioners’ behalf, appealed to respondent’s Appeals Office (Appeals Office) the adjustments proposed in that

letter (petitioners’ appeal). Mr. Levinton continued to represent petitioners throughout that appeal process. 

Around early 2005, over a year after petitioners filed the

2002 joint return on November 21, 2003, Mr. Levinton informed Mr.

Lerner of respondent’s position with respect to petitioners’

claimed Schedule C expenses for 1997, 1998, and 2000. Sometime

thereafter in 2005, Mr. Levinton asked Mr. Lerner to accompany

Mr. Levinton to a conference with the Appeals Office (Appeals

Office conference) regarding the adjustments proposed in respondent’s 30-day letter with respect to those years.56 
- 52 -

57It is not clear from the record whether Mr. Levinton was

present at the discussions that Mr. Ackerman had with Mr. Lerner

regarding the propriety of petitioners’ claimed Schedule C

deductions.

Mr. Ackerman had discussions with Mr. Levinton and Mr.

Lerner regarding the propriety of petitioners’ claimed Schedule C

deductions. Mr. Ackerman had those discussions (1) with Mr.

Levinton on a date not disclosed by the record after respondent

began the examination of 1997, 1998, and 2000 but before petitioners filed the 2002 joint return and (2) with Mr. Lerner57 on a

date in 2005 not disclosed by the record after Mr. Levinton

informed him about respondent’s position with respect to petitioners’ claimed Schedule C deductions for 1997, 1998, and 2000

and over a year after petitioners filed the 2002 joint return. 

When Mr. Ackerman discussed the propriety of petitioners’

claimed Schedule C deductions with Mr. Levinton and Mr. Lerner,

he informed them that the expenses for which petitioners claimed

those deductions were “for my business” and “Basically to create

business, to create revenue”. Based upon what Mr. Ackerman told

them, Mr. Levinton and Mr. Lerner advised Mr. Ackerman that they

believed that petitioners’ claimed Schedule C deductions were

proper. 

In December 2005, the Appeals Office held the Appeals Office

conference with Mr. Levinton and Mr. Lerner regarding the adjust-
- 53 -

58In the notice for 1997, 1998, and 2000, respondent did not

determine that petitioners are liable for the accuracy-related

penalty under sec. 6662(a). 

ments proposed in respondent’s 30-day letter with respect to

petitioners’ taxable years 1997, 1998, and 2000. 

At a time not disclosed by the record before November 17,

2006, respondent began an examination of petitioners’ taxable

years 2002 and 2004. Neither Mr. Levinton nor Mr. Lerner was

involved in that examination. 

As discussed above, in the notice for 1997, 1998, and 2000

and the notice for 2002 and 2004, respondent determined (1) that

petitioners’ claimed Schedule C expenses “are not attributable to

an active trade or business under IRC Section 162”, (2) that

those expenses are deductible under section 212 subject to the 2-

percent floor imposed by section 67(a), and (3) that therefore

petitioners should have reported those expenses in Schedule A

instead of Schedule C. In the notice for 2002 and 2004, respondent also determined that petitioners are liable for each of

their taxable years 2002 and 2004 for the accuracy-related penalty under section 6662(a).58 The respective accuracy-related

penalties under section 6662(a) that respondent determined for

petitioners’ taxable years 2002 and 2004 are imposed on respective underpayments for those years that are attributable solely

to respondent’s disallowance of petitioners’ respective Schedule 
- 54 -

C deductions claimed in the 2002 joint return and the 2004 joint

return. 

OPINION

Burden of Proof

Petitioners do not dispute that they bear the burden of

proof with respect to (1) the affirmative issues that they raised

in the pleadings and that remain at issue and (2) the determinations in the notice for 2002 and 2004 to impose the accuracyrelated penalty. Nor do petitioners dispute that they bear the

burden of proof with respect to the determinations in the notices

to disallow their claimed Schedule C deductions. See Rule

142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). Petitioners argue, however, that the burden of proof with respect to the

determinations to disallow those claimed deductions shifts to

respondent under section 7491(a). 

In order for the burden of proof to shift to the Commissioner of Internal Revenue under section 7491(a), the taxpayer

must (1) provide credible evidence with respect to any factual

issue relevant to determining the tax liability of the taxpayer

and (2) comply with the applicable requirements of section

7491(a)(2). Although section 7491(a) does not define the term

“credible evidence”, the legislative history of the statute does. 

The legislative history of section 7491(a) states in pertinent

part:
- 55 -

Credible evidence is the quality of evidence which,

after critical analysis, the court would find sufficient upon which to base a decision on the issue if no

contrary evidence were submitted (without regard to the

judicial presumption of IRS correctness). * * * The

introduction of evidence will not meet this standard if

the court is not convinced that it is worthy of belief.

* * * 

H. Conf. Rept. 105-599, at 240-241 (1998), 1998-3 C.B. 747, 994-

995.

In support of their argument that the burden of proof shifts

to respondent under section 7491(a) with respect to the determinations in the notices to disallow their claimed Schedule C

deductions, petitioners assert: 

The extensive testimony of Mr. Ackerman and others

about his Schedule C activity certainly constitutes

“credible evidence” with respect to all pertinent factual issues. No expense was challenged for lack of

substantiation or failure to maintain records. * * *

Accordingly, the burden of proof on this issue should

shift to respondent. * * *

Respondent counters that 

Petitioners rely heavily on the testimony of petitioner

and related individuals, much of which was overly

broad, vague, misleading, and uncorroborated by any

documentary evidence. This testimony does not constitute credible evidence under section 7491(a)(1). * * *

Furthermore, section 7491(a)(2) specifies certain requirements that must be met before section 7491(a)(1)

can apply. Specifically, the taxpayer must have maintained all records required by the Internal Revenue

Code. I.R.C. § 7491(a)(2)(B). * * * Petitioner did not

maintain any books or records with respect to his

Schedule C activity. * * *

As discussed below, there are material factual issues relevant to determining whether petitioners are entitled under sec-
- 56 -

59Assuming arguendo that petitioners had introduced credible

evidence within the meaning of sec. 7491(a)(1) with respect to

the factual issues relevant to determining whether petitioners

are entitled under sec. 162(a) to their claimed Schedule C

deductions, the burden of proof with respect to that issue

nonetheless would not shift to respondent under sec. 7491(a)(1). 

That is because we have found that Mr. Ackerman maintained no

books and records with respect to the activity reflected in

petitioners’ Schedule C for each of the years at issue. See sec.

7491(a)(2)(B). 

tion 162(a) to their claimed Schedule C deductions as to which

they have not introduced credible evidence within the meaning of

section 7491(a)(1).59 

On the record before us, we find that the burden of proof

does not shift to respondent under section 7491(a) with respect

to any factual issues that pertain to the Schedule C deductions

that petitioners are claiming for each of the years at issue. 

Evaluation of Evidence on Which Petitioners Rely

Petitioners rely on certain testimonial evidence and certain

documentary evidence in order to satisfy their burden of proof

with respect to each of the issues presented.

Testimonial Evidence

The testimonial evidence on which petitioners rely is the

respective testimonies of Mr. Ackerman, Mr. Lerner, Jason

Ackerman, Don Ackerman, Mr. Deutschman, Mr. Levinton, Mr.

Braddock, and Ms. Patriarca. 
- 57 -

Mr. Ackerman’s Testimony

We found the testimony of Mr. Ackerman to be in certain

material respects general, conclusory, vague, ambiguous, confusing, questionable, self-serving, and/or evasive. We shall not

rely on Mr. Ackerman’s testimony to establish petitioners’ respective positions on the various issues to which that testimony

pertained. 

Mr. Lerner’s Testimony

We found the testimony of Mr. Lerner to be in certain material respects vague, ambiguous, questionable, and/or serving the

interests of his longtime associate Mr. Ackerman, who retained

Mr. Lerner to provide certain legal services for him and who

played a significant role in enabling Mr. Lerner to be employed

by Crown Capital. We shall not rely on Mr. Lerner’s testimony to

establish petitioners’ respective positions on the various issues

to which that testimony pertained.

Don Ackerman’s Testimony

We found the testimony of Don Ackerman to be in certain

material respects general, conclusory, vague, ambiguous, questionable, and/or serving the interests of his brother Mr.

Ackerman, who played a significant role in enabling Don Ackerman

to be employed by Crown Capital after the business of ECC that

Don Ackerman was managing began facing dire financial circum-
- 58 -

60See supra note 12.

stances.60 We shall not rely on Don Ackerman’s testimony to

establish petitioners’ respective positions on the various issues

to which that testimony pertained. 

Jason Ackerman’s Testimony

We found the testimony of Jason Ackerman to be in certain

material respects vague, ambiguous, questionable, and/or serving

the interests of his uncle and longtime associate Mr. Ackerman,

who played a significant role in enabling Jason Ackerman to be

employed by Crown Capital. We shall not rely on Jason Ackerman’s

testimony to establish petitioners’ respective positions on the

various issues to which that testimony pertained. 

Mr. Deutschman’s Testimony

We found the testimony of Mr. Deutschman to be in certain

material respects vague, ambiguous, questionable, and/or serving

the interests of his longtime associate Mr. Ackerman, who played

a significant role in enabling Mr. Deutschman to be employed by

Crown Capital. We shall not rely on that testimony to establish

petitioners’ respective positions on the various issues to which

that testimony pertained. 

Ms. Patriarca’s Testimony

We generally found the testimony of Ms. Patriarca to be

credible. However, that testimony, together with other reliable 
- 59 -

61The written agreements on which petitioners rely include,

inter alia, the Equity Marketing securities purchase agreement

and certain management service agreements entered into between

Crown Capital and each of certain corporations in which Mr.

Ackerman invested.

evidence in the record, did not enable us to sustain petitioners’

position on any of the issues to which that testimony pertained.

Mr. Braddock’s Testimony

We generally found the testimony of Mr. Braddock to be

credible. However, that testimony, together with other reliable

evidence in the record, did not enable us to sustain petitioners’

position on the issue to which that testimony pertained. 

Mr. Levinton’s Testimony

We found the testimony of Mr. Levinton to be questionable in

certain material respects. We shall not rely on Mr. Levinton’s

testimony to establish petitioners’ respective positions on the

various issues to which that testimony pertained. 

Documentary Evidence

The documentary evidence on which petitioners rely includes,

inter alia, the notices, the respective tax returns of petitioners and certain entities that petitioners directly or indirectly

owned, certain written agreements,61 certain travel itineraries of

Mr. Ackerman, and certain newspaper articles regarding Mr. Earls. 

Although the documentary evidence on which petitioners rely is

voluminous, that documentary evidence, together with the reliable 
- 60 -

62Virtually all of the expenses that petitioners claimed in

Schedule C for each of their taxable years 1997, 1998, 2000,

2002, and 2004 and that remain at issue, see supra note 35,

consist of payments that Mr. Ackerman made during each of those

years to Rockport Advisors and/or Crown Capital. The only

expenses that remain at issue and that do not consist of payments

to Rockport Advisors and/or Crown Capital are $50,253 of expenses

for Mr. Ackerman’s book on nonviolent resistance that petitioners

claimed in the 2000 Schedule C. See supra note 34. The parties

agree, and we have found, that petitioners paid $50,253 of

expenses for that book. However, petitioners make no argument as

to why they are entitled for their taxable year 2000 to deduct

those expenses under sec. 162(a). We conclude that petitioners

have abandoned that argument.

63For convenience, we shall sometimes refer to Mr.

Ackerman’s claimed business of advising companies about their

finances and management as the alleged business of providing

advisory services.

testimonial evidence in the record, did not enable us to sustain

petitioners’ position on any of the issues presented. 

Claimed Business Expense Deductions

It is petitioners’ position that the claimed Schedule C

expenses that remain at issue are deductible under section

162(a).62 In support of that position, petitioners argue that Mr.

Ackerman incurred those expenses in carrying on the business of

advising companies about their finances and management.63 

It is respondent’s position that the claimed Schedule C

expenses that remain at issue are deductible under section 212(1)

and that therefore those expenses are subject to the 2-percent

floor imposed by section 67(a). In support of that position,

respondent argues that Mr. Ackerman incurred the claimed Schedule 
- 61 -

64See supra note 15. The record does not disclose what

portion of petitioners’ claimed Schedule C deductions for each of

the years at issue that remains at issue pertained to the major

projects. 

65We found petitioners’ arguments on brief in support of

their position that during each of the years at issue Mr.

Ackerman was engaged in the business of providing advisory

services and that therefore the claimed Schedule C expenses are

deductible under sec. 162(a) to be confusing. We state our

understanding of those arguments. 

C expenses that remain at issue as an investor and not in carrying on a trade or business within the meaning of section 162(a). 

Section 162(a) generally allows a deduction for ordinary and

necessary expenses paid or incurred during the taxable year in

carrying on any trade or business. Section 212(1) allows an

individual a deduction for ordinary and necessary expenses paid

or incurred during the taxable year for the production or collection of income.

In support of their claim that during each of the years at

issue Mr. Ackerman was engaged in the business of advising companies about their finances and management, petitioners presented

evidence with respect to the major projects64 and advance what we

understand to be two arguments.65 We address each of those arguments below. 

Petitioners’ Cost Company or Agency Argument

As we understand it, petitioners are arguing that during

each of the years at issue Rockport Advisors and/or Crown Capital

were cost companies and/or agents of Mr. Ackerman. Consequently,
- 62 -

according to petitioners, they are entitled for each of the years

at issue to deduct under section 162(a) the respective payments

that Mr. Ackerman made during each of those years to Rockport

Advisors and/or Crown Capital. It is not clear from petitioners’

briefs whether petitioners are arguing (1) that during each of

the years at issue Rockport Advisors and/or Crown Capital were

cost companies of Mr. Ackerman and that therefore those companies

were his agents or (2) that during each of those years Rockport

Advisors and/or Crown Capital were Mr. Ackerman’s agents regardless of whether they were cost companies of Mr. Ackerman. On the

record before us, we reject both arguments. 

We turn first to whether, as petitioners appear to be arguing, Rockport Advisors and/or Crown Capital were cost companies

of Mr. Ackerman and that therefore those companies were his

agents during each of the years at issue. In support of that

argument, petitioners rely on Revenue Ruling 56-542, 1956-2 C.B.

327 (Revenue Ruling 56-542). In that ruling, the Internal Revenue Service (Service) concluded that the stockholders of a captive mining company (mining company) that had been established as

a cost company were entitled to certain depletion deductions

under section 611 of the Internal Revenue Code of 1954. 

In Revenue Ruling 77-1, 1977-1 C.B. 161 (Revenue Ruling 77-

1), the Service revoked Revenue Ruling 56-542. As a result,

petitioners’ reliance on Revenue Ruling 56-542 is misplaced. In
- 63 -

Revenue Ruling 77-1, the Service concluded that “all corporations

operating as cost companies” within the meaning of Revenue Ruling

56-542 “will be treated as separate taxpayers and will be required to compute their own income, deductions, credits and tax

liabilities.” Rev. Rul. 77-1, 1977-1 C.B. at 161. 

Even if the Service had not revoked Revenue Ruling 56-542 in

Revenue Ruling 77-1, we nonetheless would, and do, conclude that

petitioners’ reliance on Revenue Ruling 56-542 is misplaced. 

That is because the facts that we have found on the record before

us are materially distinguishable from the facts involved in

Revenue Ruling 56-542. Revenue Ruling 56-542 described the facts

involved therein as follows: 

Certain manufacturing corporations, which require for

their normal operations several grades and several

kinds of ore, unite and join with other manufacturers

in an arrangement for the acquisition, by fee or lease,

of mining property and for the exploration, development

and operation of such property. The manufacturers

organize a corporation to own and operate the property,

subscribe to the corporation’s capital stock, and advance all funds needed both for capital and operative

purposes. The mining company, referred to as a ‘cost

company,’ executes a contract with its stockholding

manufacturing corporations. The contract provides

essentially that the participants, each in proportion

to its stock ownership, shall advance all funds, both

capital and operative, necessary for the mining company

to operate and shall share in the same proportion in

the ore produced. Under an agreement signed with its

stockholding manufacturing corporations, the mining

company will not sell any ore and will have no net

income. Its operations, as well as the disposition of

the products mined, will at all times be under the

control of the participants. 
- 64 -

66See supra note 10.

Thus, the basic issue for consideration is whether

the economic interest in the ore thus being produced,

with the resultant right to claim depletion, is in the

captive mining company or its stockholding corporations. 

Rev. Rul. 56-542, 1956-2 C.B. at 327.

In concluding in Revenue Ruling 56-542 that the stockholders

of the mining company involved therein were entitled to certain

depletion deductions under section 611 of the Internal Revenue

Code of 1954, the Service indicated that the mining company must

“file a corporate return showing no income and no deductions on

its face, but containing schedules showing the gross income and

deductions allocable” to its stockholders. 

Although during each of the years at issue Mr. Ackerman made

certain payments to Rockport Advisors and/or Crown Capital, Mr.

Ackerman was not a stockholder of those entities. Moreover,

Rockport Advisors and Crown Capital did not file tax returns as

cost companies described in Revenue Ruling 56-542 in which they

claimed no income and no deductions. Instead, (1) Rockport

Advisors filed Form 1120 for each of its taxable years 1997,

1998, and 200066 in which it reported income and deductions that

were attributable to its business activities, and (2) Crown

Capital filed Form 1120 for its taxable year 1997 and Form 1120S
- 65 -

67See supra note 13.

68Petitioners also rely on Kenco Rests., Inc. v. Commissioner, T.C. Memo. 1998-342, affd. 206 F.3d 588 (6th Cir. 2000),

for the proposition that the “concept of centralizing costs for

several projects in one entity still exists.” Petitioners’

reliance on that case is misplaced. Unlike the instant case,

Kenco Rests., Inc. involved the reallocation under sec. 482 of

deductions claimed by commonly controlled corporations, one of

which had been established as a “cost company” that provided

management and administrative support services to the remaining

commonly controlled corporations there involved. Moreover, the

“cost company” involved in Kenco Rests., Inc. is materially

distinguishable from the cost company described in Rev. Rul. 56-

542, 1956-2 C.B. 327. 

69However, in these cases petitioners did not claim as

Schedule C deductions the respective expenses that Rockport

Advisors and/or Crown Capital incurred during each of the years

at issue. Instead, petitioners claimed as Schedule C deductions

(continued...)

for each of its taxable years 1998 and 200067 in which it reported

income and deductions that were attributable to its business

activities.68 

On the record before us, we find that petitioners have

failed to carry their burden of establishing that during each of

the years at issue Rockport Advisors and/or Crown Capital were

cost companies of Mr. Ackerman.

We turn now to whether, as petitioners appear to be arguing,

Rockport Advisors and/or Crown Capital were Mr. Ackerman’s agents

during each of the years at issue regardless of whether they were

cost companies of Mr. Ackerman. Petitioners state: “A taxpayer

may deduct payments for business expenses made by * * * his agent

on his behalf.”69 In support of that statement, petitioners cite,
- 66 -

69(...continued)

in the joint return for each of the years at issue certain

payments that Mr. Ackerman made during each of those years to

Rockport Advisors and/or Crown Capital, and Rockport Advisors

and/or Crown Capital claimed as deductions in their respective

tax returns the respective expenses that they incurred during

each of those years. 

70In support of their statement that “A taxpayer may deduct

payments for business expenses made by * * * his agent on his

behalf”, petitioners also cite, inter alia, N.Y. Guandong Fin.,

Inc. v. Commissioner, T.C. Memo. 2008-62. In that case, we

discussed and applied the four indicia and two requirements of

corporate agency that the Supreme Court discussed and applied in

Commissioner v. Bollinger, 485 U.S. 340, 346-347 (1988). We

concluded in N.Y. Guandong Fin., Inc., that the facts therein did

not establish the existence of a corporate agency.

71In advancing what appears to be petitioners’ argument that

Rockport Advisors and/or Crown Capital were cost companies of Mr.

Ackerman and that therefore those companies were his agents

during each of the years at issue, petitioners claim that “Crown

[Capital] operated for the account of Mr. Ackerman”. If the

record had established that “Crown [Capital] operated for the

account of Mr. Ackerman”, which we find it does not, as discussed

below, that alleged fact would have been an indicium of agency. 

inter alia, Commissioner v. Bollinger, 485 U.S. 340 (1988), in

which the Supreme Court of the United States (Supreme Court)

discussed and applied the four indicia and two requirements of

corporate agency (discussed below).70 Although petitioners cite

Bollinger, they do not analyze and apply those indicia and requirements to Rockport Advisors and to Crown Capital.71

Before turning to Commissioner v. Bollinger, supra, we shall

consider Natl. Carbide Corp. v. Commissioner, 336 U.S. 422

(1949), the seminal case of the Supreme Court addressing how to

determine the existence of a corporate agency. In addressing
- 67 -

that issue, the Supreme Court set forth the following four indicia and two requirements that are to be considered in making such

a determination:

Whether the corporation operates in the name and for

the account of the principal, binds the principal by

its actions, transmits money received to the principal,

and whether receipt of income is attributable to the

services of employees of the principal and to assets

belonging to the principal are some of the relevant

considerations in determining whether a true agency

exists. If the corporation is a true agent, its relations with its principal must not be dependent upon the

fact that it is owned by the principal, if such is the

case. Its business purpose must be the carrying on of

the normal duties of an agent. * * * [Fn. refs. omitted.]

Id. at 437. (The above-quoted indicia and requirements of corporate agency are commonly referred to, and we shall refer to them,

as the six National Carbide factors.) In Natl. Carbide Corp.,

the Supreme Court applied the six National Carbide factors and

concluded that the facts therein did not establish the existence

of a corporate agency. 

In Commissioner v. Bollinger, supra, the Supreme Court again

addressed how to determine whether a corporate agency exists. In

addressing that issue, the Supreme Court restated the six National Carbide factors, id. at 346-347, and observed that those

factors are designed to ensure “the genuineness of the agency

relationship”, id. at 349. According to the Supreme Court,

the genuineness of the agency relationship is adequately assured * * * when the fact that the corporation is acting as agent for its shareholders with respect to a particular asset is set forth in a written
- 68 -

72See supra note 9. 

73See supra note 33.

agreement at the time the asset is acquired, the corporation functions as agent and not principal with respect to the asset for all purposes, and the corporation is held out as the agent and not principal in all

dealings with third parties relating to the asset. 

* * * 

Id. at 349-350. In Bollinger, the Supreme Court concluded that

the facts therein established “the genuineness of the agency

relationship”. Id.

In order to determine whether Rockport Advisors and/or Crown

Capital were Mr. Ackerman’s agents during each of the years at

issue, we shall apply and analyze the six National Carbide factors. We turn first to Rockport Advisors. As discussed above,

the record is very sparse as to the activities of Rockport Advisors during each of the years at issue,72 including 1997, 1998,

2000, and 2002, the only years in which Mr. Ackerman made certain

payments to that company that petitioners claimed as expenses in

their respective Schedules C for those years.73 We note initially

that the requirement included as one of the six National Carbide

factors that the corporation’s “relations with its principal must

not be dependent upon the fact that it is owned by the principal”, Natl. Carbide Corp. v. Commissioner, supra at 437, is

irrelevant to our resolving whether Rockport Advisors was Mr.

Ackerman’s agent during each of petitioners’ taxable years 1997,
- 69 -

1998, 2000, and 2002. That is because the parties do not dispute

that during each of those years Mr. Ackerman did not have an

ownership interest in Rockport Advisors. See Shenker v. Commissioner, 804 F.2d 109, 113 (8th Cir. 1986), affg. T.C. Memo. 1985-

301. 

With respect to the remaining five National Carbide factors,

on the record before us, we find that petitioners have failed to

carry their burden of establishing that during each of their

taxable years 1997, 1998, 2000, and 2002 (1) Rockport Advisors

acted in the name, and for the account, of Mr. Ackerman; (2)

Rockport Advisors bound Mr. Ackerman by its actions; (3) Rockport

Advisors transmitted money received to Mr. Ackerman; (4) the

receipt of income by Rockport Advisors was attributable to the

services of the employees of Mr. Ackerman and the assets belonging to Mr. Ackerman; or (5) the business purpose of Rockport

Advisors was the carrying on of the normal duties of an agent. 

On the record before us, we find that petitioners have

failed to carry their burden of establishing that during each of

petitioners’ taxable years 1997, 1998, 2000, and 2002 Rockport

Advisors was Mr. Ackerman’s agent. 

We turn now to Crown Capital. We note initially that, as

was true with respect to Rockport Advisors, the requirement

included as one of the six National Carbide factors that the

corporation’s “relations with its principal must not be dependent
- 70 -

74See supra note 71. 

75Although Mr. Ackerman paid Crown Capital the funds that it

requested in order to assist it in carrying on its business

activities, after he did, those funds became the funds of Crown

Capital and no longer belonged to Mr. Ackerman. 

76Moreover, on the record before us, we find that petitioners did not establish the following facts that would have been

helpful in ensuring “the genuineness of the [claimed] agency

(continued...)

upon the fact that it is owned by the principal”, Natl. Carbide

Corp. v. Commissioner, 336 U.S. at 437, is irrelevant to our

resolving whether Crown Capital was Mr. Ackerman’s agent during

each of the years at issue. That is because the parties do not

dispute that during each of those years Mr. Ackerman did not have

an ownership interest in Crown Capital. See Shenker v. Commissioner, supra at 113. 

With respect to the remaining five National Carbide factors,

on the record before us, we find that petitioners have failed to

carry their burden of establishing that during each of the years

at issue (1) Crown Capital acted in the name, and for the account, of Mr. Ackerman;74 (2) Crown Capital bound Mr. Ackerman by

its actions; (3) Crown Capital transmitted money received to Mr.

Ackerman; (4) the receipt of income by Crown Capital was attributable to the services of the employees of Mr. Ackerman and the

assets belonging to Mr. Ackerman;75 or (5) the business purpose of

Crown Capital was the carrying on of the normal duties of an

agent.76 
- 71 -

76(...continued)

relationship”, Commissioner v. Bollinger, 485 U.S. at 349,

between Crown Capital and Mr. Ackerman: (1) There was a written

agreement that set forth that Crown Capital was an agent of Mr.

Ackerman during any of the years at issue; (2) Crown Capital

functioned for any purpose as an agent with respect to the major

projects that he pursued during those years; and (3) Crown

Capital was held out as an agent of Mr. Ackerman in all dealings

with third parties relating to those projects during those years. 

To the contrary, we have found that during the years at issue

Crown Capital, in its own name, entered into various management

service agreements with the respective companies involved in

certain of the projects that Mr. Ackerman pursued. Pursuant to

those agreements, in exchange for certain fees to be paid by

those respective companies to Crown Capital, Crown Capital was to

provide certain services to them. 

On the record before us, we find that petitioners have

failed to carry their burden of establishing that during each of

the years at issue Crown Capital was Mr. Ackerman’s agent. 

Petitioners’ Compensation Argument

As we understand it, petitioners are arguing that during

each of the years at issue Mr. Ackerman received compensation

other than the normal investor’s return for the advisory services

that he provided during each of those years with respect to the

major projects. Consequently, according to petitioners, under

applicable caselaw, during each of the years at issue Mr.

Ackerman was engaged in a trade or business of providing advisory

services within the meaning of section 162(a). The principal

case on which petitioners rely to support that argument is Giblin

v. Commissioner, 227 F.2d 692 (5th Cir. 1955), revg. T.C. Memo. 
- 72 -

77Petitioners also rely on certain other cases to establish

that during each of the years at issue Mr. Ackerman was engaged

in a trade or business of providing advisory services within the

meaning of sec. 162(a). We have carefully considered each of

those other cases. We find all of them to be materially distinguishable from the instant cases and petitioners’ reliance on

them to be misplaced.

1954-186.77 According to petitioners, “Mr. Ackerman’s business

was not dissimilar [to that of the taxpayer in Giblin], as he

helped people create and structure transactions.” What petitioners fail to understand or choose to ignore is that the fact that

Mr. Ackerman may have “helped people create and structure transactions” in providing advisory services during the years at issue

with respect to the major projects is not determinative of

whether for each of those years he was engaged in a trade or

business of providing those services within the meaning of section 162(a). 

In Giblin v. Commissioner, supra, the United States Court of

Appeals for the Fifth Circuit (Court of Appeals for the Fifth

Circuit) addressed whether the taxpayer “was regularly engaged in

the business of seeking out business opportunities, promoting,

organizing and financing them, contributing to them substantially

50% of his time and energy and then disposing of them either at a

profit or loss”. The Court of Appeals for the Fifth Circuit held

that the taxpayer was engaged in that business. In so holding,

that Court relied on, inter alia, Foss v. Commissioner, 75 F.2d 
- 73 -

326 (1st Cir. 1935), and Sage v. Commissioner, 15 T.C. 299

(1950). Giblin v. Commissioner, supra at 696. 

In Whipple v. Commissioner, 373 U.S. 193, 203 n.10 (1963),

which the Supreme Court decided after Giblin, the Supreme Court

expressly disapproved of any statements and holdings in Foss and

Sage that were contrary to its statements and holdings in

Whipple. In Whipple, the Supreme Court addressed whether a

taxpayer who had furnished regular services to several corporations in which he was an investor was engaged in an independent

trade or business. The Supreme Court held that “Absent substantial additional evidence, furnishing management and other services to corporations for a reward not different from that flowing to an investor in those corporations is not a trade or business”. Id. at 203 (fn. ref. omitted). In so holding, the Supreme Court stated:

Devoting one’s time and energies to the affairs of

a corporation is not of itself, and without more, a

trade or business of the person so engaged. Though

such activities may produce income, profit or gain in

the form of dividends or enhancement in the value of an

investment, this return is distinctive to the process

of investing and is generated by the successful operation of the corporation’s business as distinguished

from the trade or business of the taxpayer himself. 

When the only return is that of an investor, the taxpayer has not satisfied his burden of demonstrating

that he is engaged in a trade or business since investing is not a trade or business and the return to the

taxpayer, though substantially the product of his services, legally arises not from his own trade or business but from that of the corporation. Even if the

taxpayer demonstrates an independent trade or business

of his own, care must be taken to distinguish bad debt
- 74 -

losses arising from his own business and those actually

arising from activities peculiar to an investor concerned with, and participating in, the conduct of the

corporate business. 

If full-time service to one corporation does not

alone amount to a trade or business, which it does not,

it is difficult to understand how the same service to

many corporations would suffice. To be sure, the presence of more than one corporation might lend support to

a finding that the taxpayer was engaged in a regular

course of promoting corporations for a fee or commission, * * * or for a profit on their sale, see Giblin

v. Commissioner, 227 F.2d 692 * * *, but in such cases

there is compensation other than the normal investor’s

return, income received directly for his own services

rather than indirectly through the corporate enterprise

* * *

Id. at 202-203. 

Although, as quoted above, the Supreme Court in Whipple

cited Giblin v. Commissioner, 227 F.2d 692 (5th Cir. 1955), it

cited Giblin only for the narrow proposition that “the presence

of more than one corporation might lend support to a finding that

the taxpayer was engaged in a regular course of promoting corporations * * * for a profit on their sale”. Whipple v. Commissioner, supra at 202-203. In citing Giblin for that narrow

proposition, the Supreme Court emphasized that in order to conclude that a taxpayer is engaged in a trade or business “there 

* * * [must be] compensation other than the normal investor’s

return, income received directly for * * * [the taxpayer’s] own

services rather than indirectly through the corporate enterprise”. Id. We must read Giblin in a manner that is consistent 
- 75 -

with Whipple. We did so in Deely v. Commissioner, 73 T.C. 1081

(1980), a case that petitioners do not cite.

In Deely, we addressed whether a taxpayer who had organized

and financed 26 companies was engaged in the trade or business of

promoting, organizing, financing, and/or dealing in corporations. 

We held in Deely that the taxpayer was not engaged in that trade

or business. Id. at 1096. In so holding, we stated: 

In order to establish a business separate from

that of his corporations, * * * [the taxpayer] must

show that the compensation he seeks from his activities

is other than the normal investor’s return and that

income received is directly for his services rather

than indirectly through the successful operation of the

corporate enterprise. Whipple v. Commissioner, supra

at 203. 

* * * [The taxpayer] contends that he was in the

separate business of promoting, organizing, financing,

and/or dealing in corporations. It seems clear from

Whipple that to qualify such activities as a separate

business they must be conducted for a fee or commission

or with the immediate purpose of selling the corporations at a profit in the ordinary course of that business. * * * There is no evidence in this case that 

* * * [the taxpayer] received any fees or commissions

for organizing, financing, or promotional activities;

instead, he usually invested or took an equity interest

in the entities that he organized, promoted, or financed. * * *

Id. at 1093.

In reaching our holding in Deely v. Commissioner, supra at

1093, we considered Giblin v. Commissioner, supra. We concluded

in Deely that in order to come within the holding in Giblin a

taxpayer must show that the taxpayer organized the entities in

which the taxpayer invested “with a view to a quick and profit-
- 76 -

78We observed in Deely v. Commissioner, 73 T.C. 1081, 1093

n.11 (1980), that “it would appear that Giblin v. Commissioner,

227 F.2d 692 (5th Cir. 1955), has been sapped of some of its

vitality by the opinions of the Fifth Circuit in Bodzy v. Commissioner, 321 F.2d 331 (5th Cir. 1963); and United States v. Byck,

325 F.2d 551 (5th Cir. 1963).” 

79Indeed, on the record before us, we find that petitioners

have failed to establish that Mr. Ackerman sold any of his

respective interests in the companies involved in the major

projects in the ordinary course of his alleged business of

providing advisory services.

able sale after each business had become established, rather than

with a view to long-range investment gains.”78 Id.

In contrast to the taxpayer in Giblin v. Commissioner,

supra, petitioners do not claim, and presented no evidence, let

alone credible evidence, see sec. 7491(a), establishing, that

during each of the years at issue Mr. Ackerman provided advisory

services pertaining to the finances and management of the respective companies involved in the major projects with the purpose of

selling his respective interests in those companies at a profit

in the ordinary course of his alleged business of providing those

services.79 We find Giblin to be materially distinguishable from

the instant cases and petitioners’ reliance on that case to be

misplaced.

On the record before us, we find that petitioners have

failed to carry their burden of establishing that during each of

the years at issue Mr. Ackerman provided advisory services with

respect to the major projects with the purpose of selling his
- 77 -

80See supra note 79.

81Petitioners reported no income, let alone income from the

Equity Marketing project, in Schedule C for each of the years at

issue. Moreover, petitioners do not claim, and the record does

not establish, that they reported in any other part of their

joint returns for any of the years at issue the fee that petitioners claim Mr. Ackerman received in exchange for the advisory

services that he provided with respect to the Equity Marketing

project. 

interests in the respective companies involved in those projects

at a profit in the ordinary course of his alleged business of

providing those services.80 See Whipple v. Commissioner, 373 U.S.

at 202-203; Deely v. Commissioner, supra at 1093; cf. Giblin v.

Commissioner, supra. 

We shall address now whether during each of the years at

issue Mr. Ackerman provided advisory services with respect to

each of the major projects in exchange for a fee or a commission

or any other compensation other than the normal investor’s return. See Whipple v. Commissioner, supra at 202-203; Deely v.

Commissioner, supra at 1093. 

With respect to the major project pertaining to Equity

Marketing (Equity Marketing project), petitioners claim that Mr.

Ackerman received a fee in exchange for the advisory services

that he provided with respect to that project.81 To support that

claim, petitioners rely on the testimony of Mr. Ackerman on which

we are unwilling to rely to establish petitioners’ position with

respect to their claimed Schedule C deductions. In this regard,
- 78 -

82The record does not establish, and petitioners do not even

claim, that they reported in any of their joint returns for the

years at issue the commitment fee required in the Equity Marketing securities purchase agreement. See supra note 81.

Mr. Ackerman testified that he received a fee in exchange for the

advisory services that he provided with respect to the Equity

Marketing project. Our understanding is that the fee to which

Mr. Ackerman referred in his testimony is the commitment fee that

Equity Marketing agreed to pay to Crown Acquisition Partners, or

any of its affiliates, as part of Equity Marketing’s agreement to

sell to Crown Acquisition Partners certain shares of its stock

and certain warrants to purchase certain other shares of its

stock. There is no reliable evidence in the record establishing

that Equity Marketing was required to, and did, pay the commitment fee required in the Equity Marketing securities purchase

agreement in exchange for any advisory services that Mr. Ackerman

provided to Equity Marketing. We have found that that commitment

fee was required to be paid to Crown Acquisition Partners or one

of its affiliates as part of Equity Marketing’s agreement to sell

to Crown Acquisition Partners certain shares of its stock and

certain warrants to purchase certain other shares of its stock

and that it was paid to Crown Capital, one of Crown Acquisition

Partners’ affiliates. That commitment fee was not required to

be, and was not, paid to Mr. Ackerman.82 
- 79 -

Petitioners claim not only that Mr. Ackerman received a fee

in exchange for the advisory services that he provided with

respect to the Equity Marketing project, but also that he received dividends in exchange for those services. The parties do

not dispute that petitioners received, and reported in their

joint return for each of their taxable years 2000 through 2006,

certain dividend income from Equity Marketing that had flowed

through, inter alia, Somerville. However, that fact does not

support petitioners’ position that Mr. Ackerman received compensation other than the normal investor’s return in exchange for

the advisory services that he provided with respect to the Equity

Marketing project. The receipt of dividends is “distinctive to

the process of investing and is generated by the successful

operation of the corporation’s business as distinguished from the

trade or business of the taxpayer”. Whipple v. Commissioner,

supra at 202. 

On the record before us, we find that petitioners did not

introduce credible evidence, see sec. 7491(a)(1), and have failed

to carry their burden of, establishing that Mr. Ackerman provided

advisory services with respect to the Equity Marketing project in

exchange for a fee or a commission or any other compensation

other than the normal investor’s return.

With respect to the major project pertaining to Thales Fund

Management (Thales project), petitioners claim that Mr. Ackerman
- 80 -

83Petitioners reported no income, let alone income from the

Thales project, in Schedule C for each of the years at issue. 

Nonetheless, petitioners argue that “Amounts received for services for Thales Fund Management were reported [by petitioners]

through Somerville”. In advancing that argument, petitioners

point to the fact that Somerville reported in its Form 1065 its

respective distributive shares of taxable income that were

generated by the respective operations of (1) Thales Fund Management and Thales Capital for each of Somerville’s taxable years

1999 through 2004 and (2) Thales Fund for each of Somerville’s

taxable years 1999, 2000, 2002, and 2004. Those respective

distributive shares of taxable income that were generated by the

respective operations of Thales Fund Management, Thales Capital,

and Thales Fund did not represent compensation for Mr. Ackerman’s

advisory services.

received as compensation other than the normal investor’s return

certain equity interests in Thales Fund Management and/or one of

its related entities in exchange for the advisory services that

he provided with respect to that project. To support that claim,

petitioners rely on the respective testimonies of Mr. Ackerman

and Mr. Lerner on which we are unwilling to rely to establish

petitioners’ position with respect to their claimed Schedule C

deductions. Although we have found that Mr. Ackerman indirectly

owned certain equity interests in Thales Fund Management, Thales

Capital, and Thales Fund, on the record before us, we find that

petitioners have failed to carry their burden of establishing

that Mr. Ackerman received those respective equity interests as

compensation other than the normal investor’s return for the

advisory services that he provided with respect to the Thales

project.83 
- 81 -

84Petitioners reported no income, let alone income from the

Fresh Direct project, in Schedule C for each of the years at

issue. Moreover, petitioners do not claim, and the record does

not establish, that they reported in any of the joint returns for

the years at issue any income, let alone income in the form of

compensation other than the normal investor’s return, from the

Fresh Direct project. 

On the record before us, we find that petitioners did not

introduce credible evidence, see sec. 7491(a)(1), and have failed

to carry their burden of, establishing that Mr. Ackerman provided

advisory services with respect to the Thales project in exchange

for a fee or a commission or any other compensation other than

the normal investor’s return. 

With respect to the major project pertaining to Fresh Direct

(Fresh Direct project), petitioners claim that Mr. Ackerman

received as compensation other than the normal investor’s return

certain “‘free’ equity” in exchange for the advisory services

that he provided with respect to that project.84 To support that

claim, petitioners rely on the respective testimonies of Mr.

Ackerman and Jason Ackerman on which we are unwilling to rely to

establish petitioners’ position with respect to their claimed

Schedule C deductions. In this regard, Mr. Ackerman testified at

trial that (1) in exchange for the advisory services that he

provided to Fresh Direct, he was able to purchase 83 percent of

the stock of that company for the nominal amount of a penny a

share, (2) the value of each of those shares eventually rose to 
- 82 -

$2, and (3) therefore he received “free equity” in Fresh Direct

that had a value of $135 million. 

Mr. Ackerman’s testimony that, in exchange for the advisory

services that he provided to Fresh Direct, he was able to purchase 83 percent of the stock of Fresh Direct for the nominal

amount of a penny a share is apparently based on the assumption

that the stock of Fresh Direct was worth more than a penny a

share at the time Mr. Ackerman purchased 83 percent of that

stock--an alleged fact that we are unable to find on the record

before us. Mr. Ackerman’s testimony that the value of the shares

of stock of Fresh Direct that he purchased for a penny a share

eventually rose to $2 a share and that therefore he received

“free equity” in Fresh Direct valued at $135 million is apparently based on the assumption that any increase in the value of

the Fresh Direct stock that he purchased establishes that he

received compensation other than the normal investor’s return for

the advisory services that he provided with respect to the Fresh

Direct project–-a conclusion that is contrary to Whipple v.

Commissioner, 373 U.S. 193 (1963). Any enhancement in the value

of the Fresh Direct shares that Mr. Ackerman purchased “is distinctive to the process of investing and is generated by the

successful operation of the corporation’s [Fresh Direct’s] business as distinguished from the trade or business of the taxpayer

[Mr. Ackerman] himself.” Id. at 202. 
- 83 -

85Petitioners reported no income, let alone income from the

Resort Theaters project, in Schedule C for each of the years at

issue. Moreover, petitioners do not claim, and the record does

not establish, that they reported in any of the joint returns for

the years at issue any income, let alone income in the form of

compensation other than the normal investor’s return, from the

Resort Theaters project. 

On the record before us, we find that petitioners did not

introduce credible evidence, see sec. 7491(a)(1), and have failed

to carry their burden of, establishing that Mr. Ackerman provided

advisory services with respect to the Fresh Direct project in

exchange for a fee or a commission or any other compensation

other than the normal investor’s return. 

With respect to the major project pertaining to Resort

Theaters (Resort Theaters project), petitioners claim that Mr.

Ackerman received as compensation other than the normal investor’s return certain “equity compensation” in Resort Theaters in

exchange for the advisory services that he provided with respect

to that project.85 To support that claim, petitioners rely on the

testimony of Mr. Lerner on which we are unwilling to rely to

establish petitioners’ position with respect to their claimed

Schedule C deductions. We have found (1) that on February 18,

1999, Santa Monica, virtually all of which Mr. Ackerman owned

indirectly, invested $14 million in Resort Theaters in return for

which Santa Monica received a 100-percent ownership interest in

Resort Theaters and (2) that Santa Monica reported in Form 1065

for its taxable year 2000 a long-term capital loss of $14 million
- 84 -

86Petitioners reported no income, let alone income from the

Davidson Cotton project, in Schedule C for each of the years at

issue. Moreover, petitioners do not claim, and the record does

not establish, that they reported in any of the joint returns for

the years at issue any income, let alone income in the form of

compensation other than the normal investor’s return, from the

Davidson Cotton project.

with respect to its investment in Resort Theaters. On the record

before us, we find that petitioners have failed to carry their

burden of establishing that Mr. Ackerman received that indirect

equity interest in Resort Theaters as compensation other than the

normal investor’s return for the advisory services that he provided with respect to the Resort Theaters project. 

On the record before us, we find that petitioners did not

introduce credible evidence, see sec. 7491(a)(1), and have failed

to carry their burden of, establishing that Mr. Ackerman provided

advisory services with respect to the Resort Theaters project in

exchange for a fee or a commission or any other compensation

other than the normal investor’s return. 

With respect to the major project pertaining to Davidson

Cotton (Davidson Cotton project), petitioners claim that Mr.

Ackerman received as compensation other than the normal investor’s return what he characterized at trial as an “override” in

exchange for the advisory services that he provided with respect

to that project.86 To support that claim, petitioners rely on the

testimony of Mr. Ackerman on which we are unwilling to rely to

establish petitioners’ position with respect to their claimed
- 85 -

87Mr. Ackerman testified as follows with respect to the socalled override: 

And we negotiated, we went to Jacob Rothschild and

basically negotiated an investment that he would come

in on on which we negotiated an override and with an

other Mexican investor where we negotiated an override.

Now what I mean by we, * * * I meant Jeff

Deutschman, Jason [Ackerman], and Perry [Lerner], and

me as well, as a participant in the overrides we would

get from these other people.

For example, with Jacob Rothschild, we negotiated

a 20 percent override. The relationship, each of the

other three —- Perry, Jason and Jeff –- received three

and a third percent of that override, of that 20 percent; I received ten percent of that override.

88See appendix A.

Schedule C deductions. We understand the ordinary meaning of the

term “override”. However, we do not understand the meaning or

the nature of the “override” to which Mr. Ackerman referred in

his testimony.87 We have found (1) that on December 3, 1999,

Somerville, virtually all of which Mr. Ackerman owned indirectly,

invested $15 million in Crown Davidson Partners and (2) that on

the same date Crown Davidson Partners acquired 15,000 shares of

preferred stock in Davidson Cotton.88 On the record before us, we

find that petitioners have failed to carry their burden of establishing that Mr. Ackerman received compensation other than the

normal investor’s return for the advisory services that he provided with respect to the Davidson Cotton project.
- 86 -

89It was petitioners themselves who described Mr. Ackerman’s

“Principal business or profession, including product or service”

in their Schedule C for each of the years at issue as “INVESTMENTS AND BANKING”. Petitioners do not claim, and the record

does not establish, that Mr. Ackerman was engaged in the business

of banking during any of the years at issue.

On the record before us, we find that petitioners did not

introduce credible evidence, see sec. 7491(a)(1), and have failed

to carry their burden of, establishing that Mr. Ackerman provided

advisory services with respect to the Davidson Cotton project in

exchange for a fee or a commission or any other compensation

other than the normal investor’s return. 

On the record before us, we find that petitioners have

failed to carry their burden of establishing that Mr. Ackerman

provided advisory services with respect to the major projects in

exchange for a fee or a commission or any other compensation

other than the normal investor’s return. See Whipple v. Commissioner, 373 U.S. at 202-203; Deely v. Commissioner, 73 T.C. at

1093. 

It appears from the record before us, including the respective testimonies of Mr. Ackerman and Mr. Deutschman, that during

the years at issue Mr. Ackerman provided advisory services with

respect to the major projects as part of an investment strategy

designed to determine whether to make investments in the respective companies involved in those projects and how to enhance the

value of any such investments made.89 By way of illustration, Mr.
- 87 -

90Crown Capital was the recipient of substantially or virtually all of the payments that petitioners claimed in Schedule C

for each of the years at issue.

Ackerman testified with respect to the Equity Marketing project

that Equity Marketing 

came to me and asked me to make an equity investment

and to also provide direct advice for them in the acquisition process.

What I then did was went to Jason [Ackerman], 

* * * [Mr. Deutschman] and * * * [Mr. Lerner] and said

would you do the due diligence to see whether, number

one, we had an investment that was of interest to us;

and then to see more importantly as [to] whether we

could add value from an advisory point of view in terms

of their negotiating strategy. 

By way of further illustration, Mr. Deutschman, the managing

director of Crown Capital, testified with respect to Mr.

Ackerman’s relationship with Crown Capital90 that “Crown Capital

was a private equity investment business set up to acquire control of middle-market companies or perhaps the seed, the growth

plans, of companies that exhibited attractive grown [sic] opportunities for the benefit of primarily Peter Ackerman.” According

to Mr. Deutschman, “The people in New York [i.e., the employees

of Crown Capital] were responsible for doing diligence, doing a

lot of detail work, reporting back to the managing directors and

Peter [Ackerman] as to the progress in various investments”. 

Based upon our examination of the entire record before us,

we find that petitioners have failed to carry their burden of

establishing that during each of the years at issue Mr. Ackerman
- 88 -

was carrying on a trade or business of advising companies about

their finances and management within the meaning of section

162(a). On that record, we further find that petitioners have

failed to carry their burden of establishing that they are entitled for each of those years to deduct under section 162(a) the

Schedule C expenses that petitioners are claiming.

Claimed Deduction for the

Protection of Business Reputation

It is petitioners’ position that they are entitled for their

taxable year 1997 to deduct under section 162(a) the $7,850,000

that Mr. Ackerman, through Somerville S Trust, advanced to ECC

and that was booked by both Somerville S Trust and ECC as a loan. 

In support of that position, petitioners argue (1) that the

$7,850,000 that Mr. Ackerman advanced to ECC did not constitute a

loan and (2) that Mr. Ackerman’s primary motive in advancing

those funds to ECC was to protect his business reputation. 

It is respondent’s position that petitioners are not entitled for their taxable year 1997 to deduct under section 162(a)

the $7,850,000 that Mr. Ackerman, through Somerville S Trust,

advanced to ECC. In support of that position, respondent argues

that the transfer of those funds constituted a loan from

Somerville S Trust to ECC. Respondent further argues: 

It is clear that the transfers in question were

part of a substantial capital investment by Somerville

S Trust in the International Group. The transfers were

contemporaneous with the formation in 1997 of the individual members of the International Group. Economy
- 89 -

91Respondent argues in the alternative that petitioners are

“barred by * * * the TEFRA partnership provisions” from claiming

a deduction with respect to the $7,850,000 of advanced funds for

their taxable year 1997. See infra note 96.

Color Card was acquired by ISI in 1997, and its assets

and operations were absorbed into the International

Group. Not only did the International Group carry on

the business of Economy Color Card, it also sought to

develop new areas of business. Clearly the transfers

were part of a larger investment in the International

Group. * * *[91]

We need not resolve the parties’ dispute over whether for

tax purposes the $7,850,000 that Mr. Ackerman advanced to ECC

constituted a loan from Somerville S Trust to ECC. That is

because, even if we were to find, as petitioners contend, that

that transfer did not constitute a loan, any such finding would

not affect our ultimate finding with respect to the deductibility

under section 162(a) of the $7,850,000 of advanced funds. 

Petitioners acknowledge that generally a taxpayer may not

deduct the expenses paid on behalf of another. See Welch v.

Helvering, 290 U.S. 111 (1933). Petitioners nonetheless argue

that they are entitled to deduct under section 162(a) the

$7,850,000 of advanced funds because Mr. Ackerman’s primary

motive in advancing those funds was to protect his business

reputation and not to acquire any capital asset or protect an

investment. In support of that argument, petitioners rely on,

inter alia, Allen v. Commissioner, 283 F.2d 785 (7th Cir. 1960), 
- 90 -

affg. in part and revg. in part T.C. Memo. 1959-227, and Lohrke

v. Commissioner, 48 T.C. 679 (1967) (discussed below). 

Although it is not altogether clear, petitioners appear to

be arguing that the business reputation that Mr. Ackerman was

seeking to protect was his reputation in his alleged business of

advising companies about their finances and management. We have

found that petitioners have failed to carry their burden of

establishing that during any of the taxable years at issue,

including 1997 for which petitioners are claiming a deduction

with respect to the $7,850,000 of advanced funds, Mr. Ackerman

was carrying on a trade or business of advising companies about

their finances and management within the meaning of section

162(a). 

Assuming arguendo that petitioners had carried their burden

of establishing that during their taxable year 1997 Mr. Ackerman

was carrying on a trade or business of advising companies about

their finances and management within the meaning of section

162(a), on the instant record, we nonetheless would, and do

below, reject petitioners’ contention that Mr. Ackerman, through

Somerville S Trust, advanced $7,850,000 to ECC in order to protect his reputation in that alleged business. 

In deciding whether petitioners are entitled for their

taxable year 1997 to deduct under section 162(a) the $7,850,000

of advanced funds, we must determine whether Mr. Ackerman’s
- 91 -

primary motive in advancing those funds to ECC was to protect his

reputation in his alleged business of providing advisory services. See Capital Video Corp. v. Commissioner, 311 F.3d 458,

464 (1st Cir. 2002), affg. T.C. Memo. 2002-40; Lohrke v. Commissioner, supra. 

In support of their claim that Mr. Ackerman’s primary motive

in advancing $7,850,000 to ECC was to protect his reputation in

his alleged business of providing advisory services, petitioners

rely on the respective testimonies of Mr. Ackerman, Jason

Ackerman, Don Ackerman, and Mr. Lerner on which we are unwilling

to rely to establish petitioners’ position with respect to their

claimed deduction under section 162(a) of the $7,850,000 of

advanced funds. They also rely on the testimony of Mr. Braddock. 

Mr. Braddock testified that he knew nothing about the business of ECC. Mr. Braddock also testified that he was not even

aware at the time in 1997 Mr. Ackerman made advances totaling

$7,850,000 to ECC that Mr. Ackerman was making those advances. 

Mr. Braddock thus could not have known at that time, and he did

not testify about, why Mr. Ackerman advanced a total of

$7,850,000 to ECC. We are unable to find from Mr. Braddock’s

testimony that Mr. Ackerman’s primary motive in advancing those

funds to ECC was to protect Mr. Ackerman’s reputation in his

alleged business of providing advisory services. 
- 92 -

92Petitioners also rely on certain other cases to establish

that they are entitled to deduct under sec. 162(a) the $7,850,000

of advanced funds. We have carefully considered each of those

other cases. We find all of them to be materially distinguishable from the case at docket No. 13947-06 and petitioners’

reliance on them to be misplaced.

We turn now to Allen v. Commissioner, supra, and Lohrke v.

Commissioner, supra, on which, inter alia, petitioners rely to

support their position that they are entitled to deduct under

section 162(a) the $7,850,000 of advanced funds.92

In Allen v. Commissioner, supra, the United States Court of

Appeals for the Seventh Circuit (Court of Appeals for the Seventh

Circuit) addressed whether the president (Mr. Allen) of a corporation (Tucson corporation), who was a stockholder of that corporation, was entitled to deduct as an ordinary and necessary

business expense $10,000 ($10,000 of Tucson funds) that he had

advanced to that corporation so that it could make certain payments to its creditors. That court held that Mr. Allen was

entitled to do so. Id. at 791. In so holding, the Court of

Appeals for the Seventh Circuit examined Mr. Allen’s purpose in

advancing those funds. Id. at 790. That court found that Mr.

Allen advanced the $10,000 of Tucson funds “to protect the reputation and credit standing” of his sole proprietorship. Id. In

making that finding, the Court of Appeals for the Seventh Circuit

noted that the Tucson corporation was in the process of liquidating when Mr. Allen advanced $10,000 to it and that “The condition
- 93 -

93The Court of Appeals for the Seventh Circuit further held

in Allen v. Commissioner, 283 F.2d 785, 791 (7th Cir. 1960),

affg. in part and revg. in part T.C. Memo. 1959-227, that Mr.

Allen was not entitled to deduct as ordinary and necessary

business expenses certain other payments that he had advanced to

the Tucson corporation before it was in the process of liquidating. The Court of Appeals for the Seventh Circuit held that

those payments, which were advanced as working capital, did not

“bear the requisite relationship to the taxpayer’s business to

qualify them for treatment as other than capital losses or nonbusiness losses”. Id. 

of the [Tucson] corporation and its business belie any intention

of making an investment in the corporation or its business.”93

Id. That Court further reasoned that

the record demonstrates, as taxpayer testified and

contends, he made the payment to protect the reputation

and credit standing of his Milwaukee business operation, a highly successful venture. Default and bankruptcy of the Tucson corporation under his presidency

and management could but reflect adversely on the business reputation of taxpayer’s similar Milwaukee enterprise as a sole proprietor. * * * 

Id.

In Lohrke v. Commissioner, 48 T.C. 679 (1967), the Tax Court

of the United States, a predecessor of this Court, addressed

whether a taxpayer (Mr. Lohrke), who owned a substantial interest

in a corporation (Textiles), was entitled to deduct as an ordinary and necessary business expense a payment (Textiles payment)

that he had made to a customer of that corporation. That Court

held that Mr. Lohrke was entitled to do so. Id. at 689. In so

holding, the Tax Court of the United States examined Mr. Lohrke’s

purpose in making the Textiles payment. Id. at 688-689. That
- 94 -

94The International Group consisted of ISI, ISG, and ISGH. 

See supra note 39.

Court found that Mr. Lohrke’s ultimate purpose in making that

payment was to protect or promote his own business, and not to

keep Textiles in existence. Id. at 689. The Tax Court of the

United States found in Lohrke:

We are inclined to believe that the [taxpayer’s] 

* * * primary motive was the protection of his licensing business. That business was providing him with a

substantial income, and therefore, we can believe him

when he says that he acted to protect that business. 

On the contrary, Textiles was unprofitable, and the

prospects were that it would remain so. Thus, we think

that the most likely explanation is that he acted to

protect his profitable individual business. 

Id. at 689. 

We find the respective facts in Allen v. Commissioner, 283

F.2d 785 (7th Cir. 1960), and Lohrke v. Commissioner, supra, to

be materially distinguishable from the facts before us and petitioners’ reliance on those cases to be misplaced. Unlike the

respective facts in Allen and Lohrke, here, around the time in

1997 Mr. Ackerman had decided to advance, and was advancing,

$7,850,000 to ECC, a decision had been made to form the International Group94 in order to continue ECC’s operations in modified

form. In addition, unlike the respective facts in Allen and

Lohrke, around the time in 1997 Mr. Ackerman had decided to

advance, and was advancing, $7,850,000 to ECC, he also decided to

make, and was making, through Somerville an investment of
- 95 -

95ECC was also an investor in ISI. ECC contributed to ISI

over $15 million of assets, including a substantial amount of

cash, in return for which it received a 1-percent interest in

ISI. Included in the assets that ECC contributed to ISI were

substantial amounts of inventory, certain accounts receivable,

certain intangible assets in the form of customer relationships,

certain employee relationships, certain leasehold interests, and

substantial amounts of machinery and equipment that were used in

the production of sample cards and packaging projects. Those

assets, along with the substantial amount of cash that ECC

contributed to ISI, assisted the International Group in continuing the operations of ECC in modified form. The record does not

disclose how ECC, a company facing dire financial circumstances

in 1997, had a substantial amount of cash to contribute to ISI or

whether the cash that ECC contributed to ISI consisted of a

portion of the $7,850,000 that Mr. Ackerman had advanced to ECC. 

$18,050,000 in the International Group by investing that amount

in ISI.95

On the record before us, we find that petitioners have

failed to carry their burden of establishing that Mr. Ackerman’s

primary motive in advancing $7,850,000 to ECC was to protect his

reputation in his alleged business of providing advisory services. It appears from that record that Mr. Ackerman’s primary

motive in advancing those funds to ECC was to protect the investment that he intended to, and did, make in the International

Group, a group of companies formed in order to continue ECC’s

operations in modified form. 

Based upon our examination of the entire record before us,

we find that petitioners have failed to carry their burden of

establishing that they are entitled for their taxable year 1997 
- 96 -

96Respondent argues in the alternative, see supra note 91,

that petitioners are “barred by * * * the TEFRA partnership

provisions” from claiming a deduction with respect to the

$7,850,000 of advanced funds for their taxable year 1997. In

this regard, Santa Monica, which owned Somerville during each of

the years at issue and which was subject to the provisions of

secs. 6221 through 6234 for each of those years, included in Form

1065 for its taxable year 2000 the bad debt deduction of

$7,850,000 that Somerville claimed with respect to those funds in

Form 1065 that it prepared for its taxable year 2000 but did not

file because it was a disregarded entity. See supra note 7. 

During each of the years at issue, Mr. Ackerman owned virtually

all of Santa Monica through Somerville S Trust. Pursuant to sec.

6222(a), petitioners reported in Schedule E of their 2000 joint

return Somerville S Trust’s allocable share of Santa Monica’s

claimed 2000 ordinary loss, which included Somerville’s claimed

bad debt deduction of $7,850,000. Petitioners now want to

deviate from not only the bad debt tax treatment that Santa

Monica, as the owner of Somerville, claimed for the $7,850,000 of

advanced funds but also the year (i.e., 2000) for which Santa

Monica claimed that treatment. Petitioners here claim a deduction for their taxable year 1997 for the $7,850,000 of advanced

funds as an ordinary and necessary business expense under sec.

162(a). Sec. 6222(a) does not allow them to do so.

97The parties do not dispute that if Mr. Ackerman materially

participated in the business of ISI during each of petitioners’

taxable years 1998 and 2000, petitioners are entitled (1) for

(continued...)

to deduct under section 162(a) the $7,850,000 that Mr. Ackerman,

through Somerville S Trust, advanced to ECC.96

Claimed Losses With Respect to ISI

It is petitioners’ position that Mr. Ackerman’s allocable

portions of the respective 1998 ISI loss and 2000 ISI loss are

not passive activity losses within the meaning of section 469(a). 

That is because, according to petitioners, Mr. Ackerman should be

treated as having materially participated in ISI’s business

during each of petitioners’ taxable years 1998 and 2000.97
- 97 -

97(...continued)

their taxable year 1998 to deduct Mr. Ackerman’s allocable

portion of the 1998 ISI loss and (2) for petitioners’ taxable

year 2000 to deduct his allocable portion of the 2000 ISI loss. 

98A disallowed passive activity loss for a taxable year is

generally treated as a deduction allocable to a passive activity

for the next year. Sec. 469(b).

Pursuant to section 469(a), a passive activity loss of an

individual for the taxable year is generally not allowed as a

deduction for that year.98 For this purpose, the passive activity

loss for the taxable year is generally the amount, if any, by

which the passive activity deductions for the taxable year exceed

the passive activity gross income for such year. Sec. 469(d)(1). 

As pertinent here, section 469(c)(1) defines the term “passive

activity” to include any activity which involves the conduct of

any trade or business and in which the taxpayer does not materially participate. For purposes of section 469(c)(1)(A), the term

“trade or business” is defined in section 469(c)(6) to include

any activity in connection with a trade or business or any activity with respect to which expenses are allowable as a deduction

under section 212.

Section 469(h)(1) provides that generally an individual is

to be treated as materially participating in an activity only if

such individual is involved in the operations of the activity on

a basis that is regular, continuous, and substantial. Congress

expressly authorized the Secretary of the Treasury to prescribe

regulations as may be necessary or appropriate to carry out the
- 98 -

provisions of section 469, including regulations that specify

“what constitutes * * * material participation”. Sec. 469(l)(1).

Both temporary and final regulations relating to the meaning

of the terms “participation” and “material participation” have

been promulgated under section 469. With respect to the term

“participation”, final regulations issued under section 469

provide that generally

any work done by an individual (without regard to the

capacity in which the individual does the work) in

connection with an activity in which the individual

owns an interest at the time the work is done shall be

treated for purposes of this section as participation

of the individual in the activity.

Sec. 1.469-5(f)(1), Income Tax Regs. Temporary regulations

issued under section 469 provide certain exceptions to that

definition of participation. As pertinent here, section 1.469-

5T(f)(2)(ii)(A), Temporary Income Tax Regs., 53 Fed. Reg. 5727

(Feb. 25, 1988), provides that work done by an individual in such

individual’s capacity as an investor in an activity is not to be

treated as participation by the individual in the activity unless

the individual is involved in the day-to-day management or operations of the activity. For this purpose, work done by an individual in such individual’s capacity as an investor in an activity includes:

(1) Studying and reviewing financial statements or

reports on operations of the activity; 
- 99 -

(2) Preparing or compiling summaries or analyses

of the finances or operations of the activity for the

individual’s own use; and 

(3) Monitoring the finances or operations of the

activity in a non-managerial capacity.

Sec. 1.469-5T(f)(2)(ii)(B), Temporary Income Tax Regs., 53 Fed.

Reg. 5727 (Feb. 25, 1988).

As pertinent here, temporary regulations relating to when a

taxpayer is to be treated as “materially participating” in an

activity for purposes of section 469(h)(1) provide that in general

an individual shall be treated, for purposes of section

469 and the regulations thereunder, as materially participating in an activity for the taxable year if and

only if--

(1) The individual participates in the activity

for more than 500 hours during such year * * * 

Sec. 1.469-5T(a), Temporary Income Tax Regs., 53 Fed. Reg. 5725

(Feb. 25, 1988).

As also pertinent here, section 1.469-5T(f)(4), Temporary

Income Tax Regs., 53 Fed. Reg. 5727 (Feb. 25, 1988), provides

that 

The extent of an individual’s participation in an activity may be established by any reasonable means. 

Contemporaneous daily time reports, logs, or similar

documents are not required if the extent of such participation may be established by other reasonable

means. Reasonable means for purposes of this paragraph

may include but are not limited to the identification

of services performed over a period of time and the

approximate number of hours spent performing such services during such period, based on appointment books,

calendars, or narrative summaries.
- 100 -

99Petitioners do not rely on any of the other provisions in

sec. 1.469-5T(a), Temporary Income Tax Regs., 53 Fed. Reg. 5725-

5726 (Feb. 25, 1988), in support of their position that Mr.

Ackerman should be treated as having materially participated in

ISI’s business within the meaning of sec. 469(h)(1). 

According to petitioners, Mr. Ackerman should be treated for

each of their taxable years 1998 and 2000 as having materially

participated in ISI’s business within the meaning of section

469(h)(1) because he participated in ISI’s business for more than

500 hours during each of those years and therefore satisfies

section 1.469-5T(a)(1), Temporary Income Tax Regs., supra.

99

Respondent counters (1) that any “participation” by Mr. Ackerman

in ISI’s activities was performed in his capacity as an investor

and (2) that petitioners have failed to carry their burden of

establishing that during each of their taxable years 1998 and

2000 Mr. Ackerman participated in ISI’s business for more than

500 hours. We need not address respondent’s contention that any

“participation” by Mr. Ackerman in ISI’s activities was performed

in his capacity as an investor. That is because, assuming

arguendo that we were to agree with petitioners that the work

done by Mr. Ackerman with respect to ISI’s activities was not

done in his capacity as an investor, we nonetheless would, and do

below, find that petitioners have failed to carry their burden of

establishing that during each of their taxable years 1998 and

2000 Mr. Ackerman participated in ISI’s business for more than

500 hours. 
- 101 -

100The lack of knowledge that Mr. Ackerman exhibited at trial

regarding the affairs of the International Group, which consisted

of ISI, ISG, and ISGH, belies his claimed participation in ISI’s

business. For example, Mr. Ackerman was unable to answer certain

questions at trial regarding the affairs of the International

Group, including whether the International Group’s production

facility had been moved and whether the International Group

conducted any operations in New York City. 

In support of their position under section 1.469-5T(a)(1),

Temporary Income Tax Regs., supra, petitioners rely principally

on the respective testimonies of Mr. Ackerman,100 Mr. Deutschman,

and Don Ackerman on which we are unwilling to rely to establish

petitioners’ position with respect to whether Mr. Ackerman’s

allocable portions of the respective 1998 ISI loss and 2000 ISI

loss are passive activity losses within the meaning of section

469(a). Although we are unwilling to rely on Mr. Deutschman’s

testimony to establish that position of petitioners, we have

found based on, inter alia, his testimony that during 1998

through 2000 Mr. Ackerman communicated on various occasions with

Mr. Deutschman regarding various matters, including the business

operations and finances of the International Group and various

other investments of Mr. Ackerman. However, we have not found

any reliable evidence in the record establishing the amount of

time that Mr. Ackerman spent during each of the years 1998 and

2000 communicating with Mr. Deutschman on matters relating to the

International Group. 

We have also found based on, inter alia, Mr. Deutschman’s

testimony that during 1998 through 2000 Mr. Ackerman spent at
- 102 -

least one or two days in certain weeks in New York City and that

during that period he also visited New Jersey where his mother

and his brother Don Ackerman lived. We have further found on the

record before us (1) that while in New York City Mr. Ackerman

spent time on various matters, including matters relating to

certain of the major projects in which Crown Capital was involved

and certain charitable activities relating to CARE, and (2) that

while in New Jersey Mr. Ackerman occasionally visited Mr.

Deutschman where Mr. Deutschman managed the operations of the

International Group. However, we have not found any reliable

evidence in the record establishing the amount of time, if any,

that Mr. Ackerman spent during each of the years 1998 and 2000 in

New York and/or New Jersey on matters relating to the International Group. 

In support of their position under section 1.469-5T(a)(1),

Temporary Income Tax Regs., supra, petitioners also rely on the

following documentary evidence: (1) A memorandum dated July 9,

1999, from Mr. Deutschman to Mr. Ackerman and Jason Ackerman

(1999 memorandum) that addresses (a) ISG’s expected cashflow for

the six-month period July through December 1999, (b) a review of

ISG’s then current operations in Mexico, (c) certain adjustments

that were to be made with respect to a deal in which ISG was

involved, and (d) a preliminary forecast of ISG’s operations for

2000; (2) a printed copy of an e-mail dated July 15, 1999, from
- 103 -

101The record does not disclose the related entities of ISG

to which the 1999 e-mail was referring.

Mr. Deutschman to Mr. Ackerman (1999 e-mail), which sets forth

the amount of funding that ISG needed for July and August 1999

and to which was attached a schedule of legal fees that ISG and

certain “related entities”101 incurred at the end of 1998 and in

1999; and (3) certain travel itineraries of Mr. Ackerman (Mr.

Ackerman’s itineraries) covering the periods April 28, 1998,

through June 24, 1999, and September 27 through December 5, 2001. 

With respect to the 1999 memorandum, that document establishes that Mr. Ackerman was involved in certain matters relating

to the business operations of the International Group. However,

the 1999 memorandum does not establish the amount of time that

Mr. Ackerman spent during each of the years 1998 and 2000 on

matters relating to the International Group.

With respect to the 1999 e-mail and the attachment thereto,

those documents establish that Mr. Deutschman informed Mr.

Ackerman that ISG and/or certain of its related entities needed

funding and/or had incurred certain legal fees. However, the

1999 e-mail and the attachment thereto do not establish the

amount of time that Mr. Ackerman spent during each of the years

1998 and 2000 on matters relating to the International Group.

With respect to Mr. Ackerman’s itineraries covering the

periods April 28, 1998, through June 24, 1999, and September 27

through December 5, 2001, those itineraries establish that during
- 104 -

those two periods Mr. Ackerman was scheduled to take certain

trips to New York City and/or New Jersey. However, those itineraries do not establish that on any of those trips Mr. Ackerman

spent time during each of the years 1998 and 2000 on matters

relating to the International Group, let alone the amount of time

that Mr. Ackerman might have spent during each of those years on

any such matters.

Based upon our examination of the entire record before us,

we find that petitioners have failed to carry their burden of

establishing that for each of their taxable years 1998 and 2000

Mr. Ackerman participated in ISI’s business for more than 500

hours and that therefore he should be treated as having materially participated in ISI’s business under section 1.469-5T(a)(1),

Temporary Income Tax Regs., supra. On that record, we further

find that petitioners have failed to carry their burden of establishing that Mr. Ackerman’s allocable portions of the respective

1998 ISI loss and 2000 ISI loss are not passive activity losses

within the meaning of section 469(a). 

Claimed Theft Loss Deduction

It is petitioners’ position that they are entitled for their

taxable year 2002 to deduct under section 165(a) a theft loss

with respect to the $4,467,610 that Mr. Ackerman, through

Somerville S Trust, invested in USV (claimed theft loss). In

support of that position, petitioners argue that the actions of
- 105 -

Mr. Earls with respect to that investment constitute theft under

the law of the District of Columbia (D.C. law) and that as of the

end of their taxable year 2002 there was no reasonable prospect

of recovery with respect to the loss resulting from that theft.

As pertinent here, section 165(a) allows a deduction for any

theft loss sustained during the taxable year that is not compensated for by insurance or otherwise. See sec. 165(c)(3). A

theft loss is sustained during the taxable year in which the

taxpayer discovers it. Sec. 165(e). However,

if in the year of discovery there exists a claim for

reimbursement with respect to which there is a reasonable prospect of recovery, no portion of the loss with

respect to which reimbursement may be received is sustained, for purposes of section 165, until the taxable

year in which it can be ascertained with reasonable

certainty whether or not such reimbursement will be

received. 

Sec. 1.165-1(d)(3), Income Tax Regs. As this Court concluded in

Viehweq v. Commissioner, 90 T.C. 1248, 1255-1256 (1988), “If in

the year of the discovery of the loss there exists a claim for

reimbursement with respect to which there is a reasonable prospect of recovery, then there is no closed and completed transaction fixed by identifiable events and thus no deductible loss.”

A reasonable prospect of recovery exists when the taxpayer

has a bona fide claim for recoupment and there is a substantial

possibility that such claim will be decided favorably for the

taxpayer. Ramsay Scarlett & Co. v. Commissioner, 61 T.C. 795,

811 (1974), affd. 521 F.2d 786 (4th Cir. 1975). Whether a rea-
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sonable prospect of recovery exists is determined as of the end

of the taxable year for which the deduction is claimed. Id.

Petitioners argue, and respondent does not dispute, that

D.C. law determines whether the actions of Mr. Earls with respect

to the $4,467,610 that Mr. Ackerman, through Somerville S Trust,

invested in USV constitute theft. Petitioners and respondent

disagree over whether those actions constitute theft under D.C.

law. We need not resolve that disagreement. That is because,

assuming arguendo that we were to find that the actions of Mr.

Earls with respect to the $4,467,610 that Mr. Ackerman, through

Somerville S Trust, invested in USV constituted theft under D.C.

law, on the instant record, we nonetheless would, and do below,

reject petitioners’ position that they are entitled for their

taxable year 2002 to a deduction under section 165 with respect

to the claimed theft loss.

We have found that Mr. Ackerman became aware of the claimed

theft loss in 2002 and that on December 9, 2002, in an effort to

recover damages of approximately $5,953,000 with respect to that

loss, Somerville S Trust and certain other parties filed a lawsuit in the U.S. District Court for Maryland against Mr. Ferreira

and Ferreira & Isbell. Somerville S Trust pursued that lawsuit

until November 26, 2003, when the parties involved in the

Ferreira litigation filed a stipulation of dismissal. We have

also found that on August 21, 2003, in an effort to recover
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102Somerville S Trust did not file the lawsuit in the U.S.

District Court for the District of Columbia against, inter alia,

Mr. Earls, USV Partners, and U.S. Technologies until Aug. 21,

2003. However, that fact does not negate the inference that as

of the end of their taxable year 2002 Somerville S Trust had a

claim for reimbursement that provided a reasonable prospect of

recovery with respect to the claimed theft loss. See Dawn v.

Commissioner, 675 F.2d 1077, 1078 (9th Cir. 1982), affg. T.C.

Memo. 1979-479; Natl. Home Prods., Inc. v. Commissioner, 71 T.C.

501, 523, 525-526 (1979). Moreover, on the record before us, we

are unable to find that the lawsuits that Somerville S Trust

filed on Dec. 9, 2002, and Aug. 21, 2003, were “‘specious,

speculative, or wholly without merit’”. Gale v. Commissioner, 41

T.C. 269, 274 (1963) (quoting Estate of Scofield v. Commissioner,

266 F.2d 154, 159 (6th Cir. 1959), revg. on this issue 25 T.C.

774 (1956)).

damages of at least $5,952,860 with respect to the claimed theft

loss, Somerville S Trust filed a lawsuit in the U.S. District

Court for the District of Columbia against, inter alia, Mr.

Earls, USV Partners, and U.S. Technologies. The pendency of the

above-described lawsuits to recover the claimed theft loss gives

rise to an inference that as of the end of their taxable year

2002 Somerville S Trust had a claim for reimbursement that provided a reasonable prospect of recovery with respect to that

claimed loss.102 See Dawn v. Commissioner, 675 F.2d 1077, 1078

(9th Cir. 1982), affg. T.C. Memo. 1979-479; Gale v. Commissioner,

41 T.C. 269, 276 (1963). 

Based upon our examination of the entire record before us,

we find that petitioners have failed to carry their burden of

establishing that as of the end of 2002 there was no reasonable

prospect of recovery of the $4,467,610 that Mr. Ackerman, through
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Somerville S Trust, invested in USV. On that record, we further

find that petitioners have failed to carry their burden of establishing that they are entitled for their taxable year 2002 to

deduct under section 165(a) the claimed theft loss.

Accuracy-Related Penalty Under Section 6662(a)

In the notice for 2002 and 2004, respondent determined that

petitioners are liable for each of those years for the accuracyrelated penalty under section 6662(a). According to respondent,

petitioners are liable for those penalties because of substantial

understatements of tax under section 6662(b)(2) that are attributable solely to the respective Schedule C deductions claimed in

the 2002 joint return and the 2004 joint return. 

Section 6662(a) imposes an accuracy-related penalty equal to

20 percent of the underpayment of tax attributable to, inter

alia, a substantial understatement of tax, sec. 6662(b)(2). An

understatement is equal to the excess of the amount of tax required to be shown in the tax return over the amount of tax shown

in the tax return, sec. 6662(d)(2)(A), and is substantial in the

case of an individual if it exceeds the greater of 10 percent of

the tax required to be shown or $5,000, sec. 6662(d)(1)(A).

The amount of the understatement is to be reduced to the

extent that it is attributable to, inter alia, the tax treatment

of an item for which there is or was substantial authority. See

sec. 6662(d)(2)(B)(i). In order to satisfy the substantial
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authority standard of section 6662(d)(2)(B)(i), petitioners must

show that the weight of authorities supporting their tax return

is substantial in relation to those supporting a contrary position. See Antonides v. Commissioner, 91 T.C. 686, 702 (1988),

affd. 893 F.2d 656 (4th Cir. 1990). That standard is not so

stringent that a taxpayer’s treatment must be one that is ultimately upheld in litigation or that has a greater than 50-percent

likelihood of being sustained in litigation. Sec. 1.6662-

4(d)(2), Income Tax Regs. A taxpayer may have substantial authority for a position even where it is supported only by a wellreasoned construction of the pertinent statutory provision as

applied to the relevant facts. See sec. 1.6662-4(d)(3)(ii),

Income Tax Regs. There may be substantial authority for more

than one position with respect to the same item. Sec. 1.6662-

4(d)(3)(i), Income Tax Regs.

The accuracy-related penalty under section 6662(a) does not

apply to any portion of an underpayment if it is shown that there

was reasonable cause for, and that the taxpayer acted in good

faith with respect to, such portion. Sec. 6664(c)(1). The

determination of whether the taxpayer acted with reasonable cause

and in good faith depends on the pertinent facts and circumstances, including the taxpayer’s efforts to assess such taxpayer’s proper tax liability, the knowledge and experience of the

taxpayer, and the reliance on the advice of a professional, such
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as an accountant. Sec. 1.6664-4(b)(1), Income Tax Regs. Reliance on the advice of a professional does not necessarily demonstrate reasonable cause and good faith unless, under all the

circumstances, such reliance was reasonable and the taxpayer

acted in good faith. Id. In this connection, a taxpayer must

demonstrate that the taxpayer’s reliance on the advice of a

professional concerning substantive tax law was objectively

reasonable. Goldman v. Commissioner, 39 F.3d 402, 408 (2d Cir.

1994), affg. T.C. Memo. 1993-480. A taxpayer’s reliance on the

advice of a professional will be objectively reasonable only if

the taxpayer has provided necessary and accurate information to

the professional. Neonatology Associates, P.A. v. Commissioner,

115 T.C. 43, 99 (2000), affd. 299 F.3d 221 (3d Cir. 2002); see

also Ma-Tran Corp. v. Commissioner, 70 T.C. 158, 173 (1978).

Petitioners argue that they are not liable for each of their

taxable years 2002 and 2004 for the accuracy-related penalty

under section 6662(a) because respondent has failed to “introduce

some evidence that it was appropriate to assert” that penalty. 

As we understand it, petitioners are arguing that respondent has

not satisfied respondent’s burden of production under section

7491(c) with respect to those accuracy-related penalties. On the

record before us, we reject that argument. 
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To meet respondent’s burden of production under section

7491(c), respondent must come forward with sufficient evidence

showing that it is appropriate to impose the accuracy-related

penalty under section 6662(a) for each of petitioners’ taxable

years 2002 and 2004. See Higbee v. Commissioner, 116 T.C. 438,

446 (2001). The accuracy-related penalty that respondent determined for each of petitioners’ taxable years 2002 and 2004 is

imposed on an underpayment of tax for each of those years that is

attributable to a substantial understatement of tax resulting

from respondent’s disallowance of petitioners’ claimed Schedule C

deductions, which we have sustained. On the record before us, we

find that respondent has satisfied respondent’s burden of production under section 7491(c) with respect to the accuracy-related

penalty under section 6662(a) that respondent determined for each

of petitioners’ taxable years 2002 and 2004.

Although respondent bears, and has satisfied, the burden of

production with respect to the accuracy-related penalties at

issue, respondent “need not introduce evidence regarding reasonable cause, substantial authority, or similar provisions. * * *

the taxpayer bears the burden of proof with regard to those

issues.” Higbee v. Commissioner, supra at 446. As discussed

above, petitioners do not dispute that they bear the burden of

proof with respect to the accuracy-related penalty under section

6662(a) that respondent determined for each of their taxable
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years 2002 and 2004. Instead, petitioners argue that they are

not liable for each of those years for that penalty because 

(1) there was substantial authority to support their tax return

position with respect to their respective claimed Schedule C

deductions for 2002 and 2004 (petitioners’ substantial authority

argument), and (2) they acted with reasonable cause and in good

faith in taking that position (petitioners’ reasonable cause

argument). 

We turn first to petitioners’ substantial authority argument. It is petitioners’ position that they had substantial

authority for their respective claimed Schedule C deductions in

the 2002 joint return and the 2004 joint return that respondent

disallowed, thereby resulting in a substantial understatement of

tax for each of those years. According to petitioners, they

claimed those Schedule C deductions because during each of petitioners’ taxable years 2002 and 2004 Mr. Ackerman was engaged in

a trade or business of providing advisory services within the

meaning of section 162(a). The principal authorities on which

petitioners rely to establish their claim about Mr. Ackerman’s

alleged business are Revenue Ruling 56-542 and Giblin v. Commissioner, 227 F.2d 692 (5th Cir. 1955). We found those authorities

to be materially distinguishable from the instant cases and 
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103We also found the other cases on which petitioners rely to

establish that during each of the years at issue Mr. Ackerman was

engaged in a trade or business of providing advisory services

within the meaning of sec. 162(a) to be materially distinguishable from the instant cases and petitioners’ reliance on those

other cases to be misplaced. See supra note 77. 

104Mr. Miller prepared the 2002 joint return and the 2004

joint return. 

petitioners’ reliance on those authorities to be misplaced.103 On

the record before us, we reject petitioners’ substantial authority argument.

We turn now to petitioners’ reasonable cause argument. As

we understand it, it is petitioners’ position that they acted

with reasonable cause and in good faith in claiming the respective Schedule C deductions in the 2002 joint return and the 2004

joint return because they relied on Mr. Levinton and Mr. Lerner

in claiming those deductions.104

Mr. Ackerman’s own testimony undermines petitioners’ reasonable cause argument. The trial transcript reflects that the

following exchange took place between petitioners’ counsel and

Mr. Ackerman on direct examination: 

Q Mr., Ackerman, are there ever situations, and

I’m talking the period 1997 through 2004, where tax

reporting issues come to your attention before a tax

return is filed? Do you remember any situations?

A No.

Q Well, how about the deduction of the Schedule

C business expenses for 2002 and 2004?

A I’m sorry. I was told that that was at issue.
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Q Okay. * * * Why did you understand or what

were you told in terms of it being at issue?

A Mr. Levinton and Mr. Lerner said that they

were told that certain of my expenses for the businesses that I was in would not be accepted for a deduction. 

Q Okay. And what did you and they discuss

about them, if anything?

A Well, frankly, I was incredulous because how

could they not be since I was in the business, so I

asked them, I reaffirmed, what is your opinion about

these appropriate deductions for my business, and they

said absolutely.

Q And was this a conversation you had with

respect to both returns, the 2002 and the 2004?

A It was a conceptual discussion about how

these expenses which continued during those periods of

time should be handled.

Q But my question more specifically is do you

recall that discussion with them with respect to both

your 2002 and 2004 returns?

A Only upon learning that these deductions

would not be allowed.

Q Okay.

A But this issue basically existed before then

because of a dispute over Schedule C and Schedule A,

and it’s the same issue, and I went to my accountants

and I went to my lawyers and I said, am I accounting

for these things properly? They said, well, what did

you spend it for? Basically to create business, to

create revenue, to create the things that I’ve

described. They said, well, these are Schedule C deductions plain and simple.

Q And this is Mr. Howard Levinton and Mr. Perry

Lerner?

A Yes. [Reproduced literally.]
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105Indeed, on the record before us, we find that petitioners

could not have relied on any advice of Mr. Lerner in deducting

the claimed Schedule C deductions in petitioners’ 2002 joint

return. That is because Mr. Lerner testified, and we have found,

that he did not even become aware of respondent’s position with

respect to the respective claimed Schedule C deductions for 1997,

1998, and 2000 until around early 2005, which was more than a

year after petitioners filed the 2002 joint return on Nov. 21,

2003. 

Except for the above-quoted testimony of Mr. Ackerman about

what he told Mr. Levinton and Mr. Lerner, there is no evidence in

the record establishing what Mr. Ackerman told Mr. Levinton and

Mr. Lerner when he discussed with them the propriety of petitioners’ claimed Schedule C deductions. On the record before us, we

find that petitioners have failed to carry their burden of establishing that Mr. Ackerman provided necessary and accurate information to Mr. Levinton and Mr. Lerner regarding petitioners’

claimed Schedule C deductions. On that record, we further find

that petitioners have failed to carry their burden of establishing that Mr. Ackerman reasonably relied on the advice of Mr.

Levinton and Mr. Lerner in claiming the respective Schedule C

deductions in the 2002 joint return105 and the 2004 joint return. 

See Neonatology Associates, P.A. v. Commissioner, 115 T.C. at 99;

Ma-Tran Corp. v. Commissioner, 70 T.C. at 173.

On the record before us, we find that petitioners have

failed to carry their burden of establishing that there was

reasonable cause for, and that they acted in good faith with

respect to, the underpayment for each of their taxable years 2002
- 116 -

106See supra note 35 describing the concession by both

respondent and petitioners with respect to the payment of

$210,000 to Nevada Media Partners that petitioners deducted in

the 1997 Schedule C and that respondent disallowed in the notice

for 1997, 1998, and 2000.

and 2004 that is attributable to petitioners’ claimed Schedule C

deductions.

Based upon our examination of the entire record before us,

we find that there is a substantial understatement of tax for

each of petitioners’ taxable years 2002 and 2004. On that record, we further find that petitioners have failed to carry their

burden of establishing that they are not liable for each of their

taxable years 2002 and 2004 for the accuracy-related penalty

under section 6662(a).

We have considered all of the contentions and arguments of

the parties that are not discussed herein, and we find them to be

without merit, irrelevant, and/or moot.

To reflect the foregoing, the concessions of respondent, and

the concession of petitioners,106

Decisions will be entered

under Rule 155.
- 117 -

107The record does not establish the percentage interest that

Somerville owned in Crown Davidson Partners and contributed to

Crown Davidson Investments; nor does it establish the date on

which Somerville acquired that interest. It is not clear from

the record whether Somerville acquired the percentage interest

that it owned in Crown Davidson Partners and contributed to Crown

Davidson Investments in exchange for the $15 million that it

invested in Crown Davidson Partners.

108As of June 13, 2000, Crown Davidson Investments was the

“managing member” of Crown Davidson Partners.

APPENDIX A

On November 17, 1999, Somerville, virtually all of which Mr.

Ackerman owned indirectly, formed Crown Davidson Partners, LLC

(Crown Davidson Partners). On December 3, 1999, (1) Somerville

invested $15 million in Crown Davidson Partners and (2) Crown

Davidson Partners acquired 15,000 shares of preferred stock of

Davidson Cotton. 

On June 14, 2000, Somerville contributed its interest in

Crown Davidson Partners, as well as $4,990,000, to Crown Davidson

Investments, LLC (Crown Davidson Investments),107 in return for

which Somerville received a 62.47-percent interest in Crown

Davidson Investments. As of June 13, 2000, Crown Davidson Investments owned a 99.8-percent interest and Kevin Gay owned a .2-

percent interest in Crown Davidson Partners.108

As of June 13, 2000, Crown Davidson Holdings, LLC (Crown

Davidson Holdings), owned a .03-percent interest, GARD Investments, Inc., owned a 25-percent interest, and J. Rothschild 
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109The record does not disclose the identities of the members

of Crown Davidson Management. The record does establish that, as

of June 13, 2000, Mr. Deutschman served as the manager of that

entity.

110The record does not disclose the respective percentages of

Crown Davidson Holdings that Crown Davidson Management and GARD

Investments owned. 

Nominees (Guernsey) Limited owned a 12.5-percent interest in

Crown Davidson Investments. 

As of June 13, 2000, the members of Crown Davidson Holdings

were Crown Davidson Management, LLC (Crown Davidson Management),109 and GARD Investments.110
- 119 -

111The record does not disclose the percentage of Crown Fresh

Direct that Somerville acquired and contributed to Crown Fresh

Direct Investments.

112As of Apr. 29, 2003, Crown Fresh Direct Investments was

the “managing member” of Crown Fresh Direct. 

113As of Apr. 29, 2003, Crown Fresh Direct Management, LLC

(Crown Fresh Direct Management), was the “managing member” of

Crown Fresh Direct Investments.

APPENDIX B

On dates not disclosed by the record after the formation of

Crown Fresh Direct, Somerville acquired an interest in Crown

Fresh Direct. Thereafter, Somerville contributed that interest

to Crown Fresh Direct Investments, LLC (Crown Fresh Direct Investments).111

As of April 29, 2003, the following owned the percentage

interests listed in Crown Fresh Direct:112

Owner Percentage Interest

 Crown Fresh Direct Investments 98.1836

 Mr. Ba .1534

 Mr. Calise .3835 

 Mr. Squire .8959 

 Judith Leedom Tyrer .0890 

 L-A & A Gift Trust for the

 Benefit of Nathanael Leedom 

 Ackerman

 .1473 

 L-A & A Gift Trust for the 

 Benefit of Elliot Leedom 

 Ackerman

 .1473 

As of April 29, 2003, Crown Fresh Direct II, LLC (Crown

Fresh Direct II), owned a 100-percent interest in Crown Fresh

Direct Investments.113 
- 120 -

114As of Apr. 29, 2003, Somerville was the “managing member”

of Crown Fresh Direct II. As of that date, Jason Ackerman was

also a member of Crown Fresh Direct II.

As of April 29, 2003, Somerville owned a 100-percent interest in Crown Fresh Direct II.114 

As of April 29, 2003, the following owned the percentage

interests listed in Crown Fresh Direct Management:

Owner Percentage Interest

 Mr. Deutschman 66.6

 Mr. Lerner 25.9

 Mr. Squire 2.5

 Mr. Leraris 2.5

 Mr. Kaji 2.5