T.C. M em o . 2 0 2 0 -8 0

UNITED STATES TAX COURT

E DWARD S. FLUM E AND M ARTHA S. FLUM E, Pet i t i o n ers v . COM M ISSIONER OF INTERNAL REVENUE, Res po n d en t

Do ck etNo . 3 1 1 62 -1 4
. Fi l edJ u n e 9 , 2 0 2 0
.

Dav i dRo dri gu ez, fo r p et i t i o n ers . Ro b ert a L. Sh u m

w ay an dSh ei l a R. Pat t i s o n, fo r res p o n d en t .

M EM ORANDUM FINDINGS OF FACT AND OPINION ASHFORD, J u d g e: By

s t atu to ry n o t i ce o f d efi ci en cy d at edOct o b er 1 , 2 0 1 4 , res p on den td et erm i n edd efi ci en ci es i n p et it i o n ers ’ Fed eral i n co m e t ax an d- 2
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[* 2 ] accu racy -rel at edp en al ti es p u rs uan tt o s ect i o n 6 6 6 2 (a) 1 fo r t h e 2 0 0 6 , 2 0 0 7 , an d 2 0 0 8 t ax ab l e y ears (y ears ati s s u e) as fo l l o ws :

Year Defi ci en cy Pen al ty s ec. 6 6 62 (a) 2 0 0 6 $ 9 , 3 8 4 $1 ,8 7 7 2 0 0 7 2 0 , 1 4 2 4 , 0 28 2 0 0 8 3 1 , 9 3 8 6 , 3 88 Aft er co n ces si o ns , 2 th e i s s u es rem ai n i n g fo r d eci s i o n fo r t h e y ears ati s s u e are wh et h er p et i t i o n ers 3 (1 ) h adad d i t io n al wag e i n co m e, (2 ) h adrep o rt ab le
s ub p artF i nco m e, an d (3 ) are l i ab l e fo r accu racy -rel at edp en al t i es . W e res o l v e t h e fi rs t i s s u e i n res p o n d en t ’ s fav o r fo r 2 0 06 an d2 0 07 an d p art l y i n p et i t i o n ers ’ fav o r fo r 2 0 0 8 , th e s eco n di s s u e i n res po n den t ’ s fav o r fo r

1 Un l es s o th erwi s e i nd i cat ed , al l s ect i o n referen ces are t o th e In t ern al Rev enu e Co de (Co d e) i n effect fo r t h e y ears ati s s u e, an dal l Ru l e referen ces are t o th e Tax Co u rt Ru l es o f Pract ice an dPro cedu re. So m e m o net ary am o u n t s are ro u n dedt o th e n eares td o ll ar.

2 Th e n o ti ce o f d efi ci en cy d et erm i n edi n p ert i n en t p artth atp et i ti o n ers were n o ten ti t l edt o cl ai m

n eto p erat i n g l o s s (NOL) carry fo rward s o f $ 1 ,2 2 9,3 6 4 , $ 1 ,2 2 9 ,3 6 4 , an d $ 1 ,2 2 4 ,6 0 0 fo r 2 0 0 6 , 2 0 0 7 , an d2 0 0 8 , res pect i v el y . Pet i t i o n ers co n ced e t h atth ey are n o t en t it l edt o s ai dNOL carry fo rward s . Ad d it i o n al l y , res p o n d en t co nced es thatb ecau s e o f a co m p u tat i o n al erro r t h e ad di ti o n al wag e i n co m e fo r 2 0 06 d et erm in edi n th e n o t ice o f d efi ci en cy s h o u ld b e redu cedb y $ 8 ,0 0 0
.

3 M rs . Fl u m e d i dn o t ap p ear at tri al , b u tth e Co urt ’ s d eci si o n wi l l b e b i n d i n g up o n b o th s p o u ses .- 3
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[* 3 ] 2 0 0 6 an d 2 0 07 an d i n p et i t i o n ers ’ fav or fo r 2 00 8 , an dth e t h i rdi s s u e i n
res p o n d en t’ s fav o r. FINDINGS OF FACT So m e o f t h e fact s h av e b een s ti p u lat ed an dare s o fo u n d. Th e s t ip u l at i o n o f fact s an dth e at t ach ed ex h i b i ts are i n co rp o rat ed h erei n b y th i s referen ce. Du ri n g th e y ears ati s s u e an dwh en th e p et i t i o n was t im el y fi ledp et i t i o n ers were U.S. ci t i zen s res i di n g i n M ex i co . I. Pet i t i o ners ’ Bu s i n es s Act i v it i es i n M ex i co Si n ce atl eas t1 9 9 0 p et it i o n ers h av e l i v ed an d wo rk edi n M ex i co . Befo re
m o vi n g t o M ex i co M r. Fl u m e was an u rb an p l an n er an dd ev el o p er i n t h e Un i t ed St at es ; M rs . Fl u m e i s a l i cen s edreal es t at e b ro ker i n Tex as an das s i s t edwi th th e
m ark et i n g o f t hei r res i den t i al real p ro p ert i es i n M ex i co . Du ri n g th e y ears ati ss u e p et i t i o n ers o p erat eda real es t at e d ev el op m en tan d
co n st ru ct i o n b us i nes s i n an d aro u n dSan M i g u el d e Al l en de, M ex i co ; th ey d ev el o p ed l an d, s o l d l o t s , an db u i l tl u x u ry h om es . A. Fran ch i se Fo o d Serv i ces d e M ex ico S.A. d e C.V. Fran ch i se Fo o d Serv i ces d e M ex ico S.A. d e C.V. (FFM ) i s a M ex i can
s o ci ed adan o n i m a, wh i ch i s a l im i t edl i ab i l i ty s t ockco rp o rat i on th atad op t edth e fo rm o f a v ari ab l e cap it al co m pan y . FFM was i n co rp o rat edi n Gu ad al ajara,- 4
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[* 4 ] J al i s co , M ex ico , i n 1 99 5 t o o p erat e t wo fas tfo odfran ch is es thatM r. Fl u m e
o wn ed . In i t i al l y

th ere were t wo 5 0 % s hareh o l d ers o f FFM , M r. Fl u m e an d No rwi ckAd am s . M r. Fl u m e was FFM ’ s p res i d en t, an dM r. Ad am s was FFM ’ s
s ecret ary an dtreas u rer. Th e fas tfo o dfran ch i s es were s o l di n 1 9 98 , b u tFFM
rem ai n edi n t act , h av i n g atl eas to n e U.S. b an kacco u n t . OnFeb ru ary 8 , 2 0 0 2 , M r. Fl u m e t ran s ferred 4 1 % o f h i s 5 0 % o wn ers h i p i n t eres ti n FFM t o Vi ct o r M en d ez To rn el l
. 4 Du ri n g the y ears ati s s u e M r. To rn el l
was a M ex i can ci t i zen . M r. To rn el l h as n ev er b een an o ffi cer o r a d i rect o r o f FFM
an d h adn o d es i re t o acti n ei th er cap aci ty . Du ri n g th e y ears ati ss u e FFM was an act i v e co rp o rat io n . OnJ an u ary 1 5 , 2 0 0 7 , p et i t i o n ers en t eredi n t o a co n s u l t i n g an d p ers on al s erv i ces co n tract wi th FFM , an dFFM m ad e p aym en t s t o th em fo r t h ei r s erv i ces . B. W i l s hi re Ho l d i n g s, In c. To m an ag e t hei r real es t at e d ev el op m en t an dco n s tru ct i o n act i v i ti es , o n Feb ru ary 2 3 , 2 0 0 0 , p et it i o n ers i n co rp o rat edW il s hi re Ho l d i n g s , In c. (W i l s h i re), i n th e Bah am as , wi th each h o ld in g o n e b earer s h are o f W i l sh i re cap i t al s to ck
.

4 M r. To rn el l i s th e h u s b an do f Ni co l e Bi s g aardRy an , th e arch i t ect p et i t i o n ers h i redfo r th ei r real es t at e d ev el op m en t an dco n s tru ct i o n b u s i n es s i n M ex i co . OnFeb ru ary

8 , 2 0 0 2 , M r. Ad am s tran s ferred h i s 5 0% o wn ers h i p i n t eres t i n FFM t o h i s n ew wi fe, Al b a Val en zu el a.- 5
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[* 5 ] Du ri n g W i l s h i re’ s Feb ru ary 2 3 , 2 0 0 0 , o rg an izat io nal m eet in g M r. Fl u m e was
n am edas W i l s h i re’ s d i rect or an ds ecret ary . Th e fo l lo wi n g y ear p et i t i o ners ch an gedth e d o m i ci l e o f W il s h ire, rei n co rp o rat i n g i t i n Bel i ze. Ata t i m e n o t
es t ab l i s h edb y th e reco rdp et it i o n ers am en dedW i l s h i re’ s o ri g i n al Bel izean art i cl es
o f as s o ci at i o n . Th es e am en d edart i cl es o f as so ci at i o n were b ack d at edt o Ap ri l 1 2 , 2 0 0 1 , t o refl ect th e d at e o f o ri g i n al i n co rp orat i o n i n Bel ize. As s t at edi n th es e
am en d edart i cl es o f as s o ci at i on p et i t i o ners ’ b earer s h ares i n W i l sh i re were el i m i n at edan dth ey

an dth ei r d au g h t er each h el da 9 % o wn ers h ip i n t eres t , an dM r. To rn el l h el d the rem ai n i n g 7 3 % o wn ers hi p i n teres ti n W i l s h i re. Du ri n g atl eas tth e y ears ati s s u e M r. Fl u m e was the p res i d en tan da d i rect o r o f W i l s h i re, an dM rs . Fl u m e was the v i ce p res i den tan da d i rect o r o f W i ls h i re. Pet i t i o ners o p en edb an ko r b ro k erag e acco u n t s i n W i l s h i re’ s n am e wi th Lared o Nat i o n al Ban k(n o w BBVA Co m p as s Ban k ) i n 2 0 0 0 (BBVA Co m p as s Ban k acco u n t ), Un i t edBan k o f Swi t zerl an d (UBS) i n 2 0 0 5 (UBS acco u n t ), an d Fi d el i ty In v es t m en ts ata t i m e n o tes t ab li s hedb y th e reco rd(Fi d el i ty

acco u n t ). Th ey h ads o l e s ig n atu re au th o ri ty o v er each o f t hes e acco u n t s . Th e BBVA Co m p as s Ban kacco u n twas o p en ed i n th e Un i tedSt at es u s i n g a U.S. i d en t i fi cat i o n
n u m b er p et i t i o n ers o b t ai n edfo r W i l s h i re. Th e UBS acco u n t was o p en ed o u t s i d e th e Un i t edSt at es , an di n d oi ng s o p et i t i o n ers p ro v i d edUBS wi th (am o n g o th er- 6
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[* 6 ] d o cu m en t s ) W i l sh i re’ s o ri g i n al m em o ran du m an dart i cl es o f as s o ci at i o n an da cert ifi cat e o f i ncu m

b en cy fo r W i l s h i re fro m

th e Co rp o rat e Serv i ces Di v i s i o n o f t h e Bel i ze Ban k Li m i t ed i n Bel i ze Ci ty , Bel ize. Th e cert i fi cat e o f i n cu m ben cy i d en t i fi edM r. Fl u m e as W i ls h i re’ s s o l e d i rect o r an d W i l sh i re’ s s hareh o l d ers as two “ [b ] earers ” h o l di n g o ne s h are each o f i t s cap it al s t ock . UBS’ du e d i l i g en ce d o cu m en t s i d en t i fi edp et i t i o n ers as th e b en efi ci al o wn ers o f t he UBS acco u n t , M r. Fl u m e as W i l s h ire’ s “ o n l y s h areh o l d er an do wn er”, an dth e acco u n t ’ s p u rp o s e as

“ [w] eal th [m ] an ag em en t o f ret i rem en tfu n d s ; p ro bab l y [a] l o anfo r [a] fl ati n Pari s.” Iti s u n kn own h ow t h e Fi d el i ty acco u n t was o p en ed
. In ad d i t i o n t o m ai n t ai ni ng atl eas to n e p ers o n al b an kacco u n tan d s ev eral p ers o n al b ro k erag e acco u nt s an dcred i t card s , p et i t i o n ers m ai n tai n eds ev eral b u s i n es s cred i t card s wh ere W i l s h i re an dM r. Fl u m e were l is t edas the p ri m ary card h o ld ers an dM rs . Fl u m e was an au th ori zedu s er. W i l s h i re d i d n o tco m

p en s at e p et i t i on ers b y

ch ecko r d i rect d ep o s i tfo r t h e y ears ati s s u e; i n s t ead , i two u l d t ran s fer fu n d s fro m i t s BBVA Co m p as s Ban k , UBS, an dFi d el i ty

acco u n t s t o p et i t i o ners ’ p ers o n al acco u n t s o r d i rect l y p ay s o m e
o f t h ei r p ers o n al ex p en s es . Paym en t s m ad e b y W i l s h i re o f p et i t i o n ers ’ p ers o n al
ex p en s es du ri n g th e y ears ati s s u e i n cl u d e p aym en t s o f t hei r p ers o n al cred i tcard ch arg es , trav el ex p en s es , h o us eh o l dfu rn i s h i ng s , au t o m at i c t el l er m ach i n e- 7
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[* 7 ] wi th drawal s erv ice ch arg es , tu i t i o n , g i ft s t o rel at i v es , an d ren tfo r an ap art m en ti n San Fran ci s co , Cal i fo rn ia. In ad d i t i o n W i l s h i re wo u ldtran s fer fu n d s fro m i t s BBVA Co m

p as s Ban kacco u n tt o FFM “ in l ieu o f s al ary ” t o p et i t i o n ers . C. SM A Pro p ert y

Dev el o p m en t OnJ an u ary

1 5 , 2 0 0 7 , FFM an d W i l s h i re en tered i n t o a fi v e-y ear jo i n t
v en tu re ag reem en tt o acq ui re, d ev el o p , an ds el l res i den t i al real p ro pert y i n M ex i co . Th i s jo i n tv en tu re o f FFM an dW i l s h ire o perat edu n d er t h e n am e SM A Pro p erty Dev el o p m en t(SM A). Pet i ti o n ers m an ag edth e affai rs an d fu n d s o f SM A,
an d m o re s p eci fi cal l y , M r. Fl um e s erv edas SM A’ s m an ag i ng p art n er. OnJ an u ary 1 5 , 2 0 0 7 , p et i t i o n ers were al s o g i v en p o w ers o f at t o rn ey t o actjo i n t l y an d i n d ep en den t l y

as th e at t o rn ey s -i n -fact o f SM A. As SM A’ s at t o rn ey s -i n -factth ey
were au th o ri zed t o ret ai n an y as s et s o wn edb y

SM A an drei n ves ttho s e as s et s , co o wnas s et s an dco m

m i n g l e t h ei r fu n d s wi th th e fu n ds o f SM A, an dp ers o nal l y g ai n fro m an y tran s act i o n th ey

co m pl et edo n SM A’ s b eh al f. II. Pet i t i o ners ’ J o in tFed eral In co m e Tax Retu rn s Pet i t i o ners ’ jo i n tFed eral i n co m e t ax return s fo r t h e y ears ati s s u e were p rep aredb y

Adri an a Bau t i s t a Lu n a, a t ax retu rnp rep arer at Leo n ardPen d l et o n Pu rcel l , In c., a t ax p rep arat i o n fi rm i n M ex i co thatu s eda p o s to ffi ce b ox i n Ho u s t o n , Tex as , as i t s m ai l i n g ad dres s o n t h es e ret u rn s . Th e reco rdd o es n o t- 8
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[* 8 ] es t ab l i s h M s . Lun a’ s edu cat i o n al b ack g ro un dan d p ro fes si o n al qu al i fi cat i o n s , i n cl u d i n g wh et h er s h e was a U.S. cert i fi edp ub l i c acco un t an t (C.P.A.), an dwe d ecl i ne t o fi n dfact s i n thi s reg ard . Ina p ri o r Tax Co u rt cas e i n v o l v i n g an In t ern al Rev enu e Serv i ce (IRS) p ro p o s edl ev y wi th res p ectt o M r. Fl u m e’ s u np ai d l i ab i l i t i es fo r ci v i l p en al t i es u n der s ect io n s 6 0 3 8 an d 6 6 7 9 fo r th e 2 00 1 -0 9 t ax ab l e y ears fo r fai lu re t o fi l e Fo rm 5 4 7 1 , In fo rm at io n Retu rn o f U.S. Pers o n s W i th Res pect to Cert ai n Fo rei g n Co rp o rat i o ns , M r. Fl u m e ack n o wl ed gedth ath e d i dn o t kn o w wh et h er M s . Lun a h adthe n eces s ary ex p ert i s e t o p ro vi de p et i t i o n ers wi t h U.S. t ax ad v i ce an d t o p rep are t h ei r jo i n tretu rn s fo r t he y ears ati ss u e. 5 Ad d i t i o n al l y , M r. Fl u m e ack n owl ed g edth atM s . Lun a, i n p rep ari n g t h es e ret u rn s , d i dn o t kn o w thatp et i t i o n ers h el do wn ers h ip i nt eres t s i n an y fo rei g n co rp orat i o n
o th er t han FFM an d t h atth ey d i dn o tad v i s e h er t hatth ey h ads o l e s i gn atu re
au th o ri ty o v er fo rei g n b an kacco u nt s , o ther t han th o s e h el di n M ex i co , u n t i l
s o m et i m e i n 2 0 0 8 (o r 2 0 0 9 ). Pet i t i o ners ’ 2 0 0 6 retu rn was fi l edo n Au g u s t3 1, 2 0 0 7 . Itrep o rt edad ju s t ed g ro s s i n co m e o f

! $ 1 ,2 2 7 ,5 6 3 , co n si s t i n g o f “ [w] ag es , s al ari es , t i p s , et c.” o f $ 1 5 6 ,0 0 0 , t ax ab l e i n t eres to f $ 5 5 6 , o rd i n ary d i v i d en d s o f $ 4 ,2 45 , a cap i t al l o s s o f

5 See Fl u m e v . Co m

m i s s i o n er (Fl u m e I), T.C. M em o . 2 0 1 7 -2 1 . Th e t ri al tran s cri p tfro m

Fl u m e I i s a s t i p u lat edex h i b i t i n t h i s cas e.- 9
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[* 9 ] $ 3 ,0 0 0, an d“ [o ] th er i n co m e” o f

! $ 1 ,3 8 5 ,3 64 . Th e rep ort ed“ [w] ag es , s al ari es , t i p s , et c.” co n s i s tedo f wag es o f $ 7 8 ,0 0 0 earn edb y each p et i t i o n er s o l el y fro m FFM . Th e rep o rt ed“ [o ] th er i n co m e” co n s i st edo f a fo rei g n earn edi n co m e
ex cl u s i o n t o t al i n g $ 1 5 6 , 0 0 0 (i
. e., th e rep ort edt o t al wag es fro m FFM ) as refl ect ed
o n Fo rm s 2 5 5 5 , Fo rei g n Earn edIn co m e, at tach edt o th e 2 00 6 retu rn , an dan NOL carry o ver t o t al i n g $ 1 ,2 2 9 ,3 6 4 (a $ 6 1 4 ,6 8 2 NOL carry o v er wi th res p ectt o each p et i t i o n er) as refl ect ed o n a Li ne 2 1, Oth er In co m e St at em en t , al s o at t ach edt o th e 2 0 0 6 retu rn . Pet i t i o ners ’ 2 0 0 7 retu rn was fi l edo n Oct ob er 6 , 2 0 0 8 . It rep o rt edad ju s t ed g ro s s i n co m e o f

! $ 1 ,2 1 6 ,9 0 0 , co n si s t i n g o f “ [w] ag es , s al ari es , t i p s , et c.” o f $ 1 6 2 ,7 4 9 , t ax ab l e i n t eres to f $ 4 2 9 , o rd i n ary d i v i d en d s o f $ 1 4 ,7 7 2 , a cap i t al l o s s o f $ 3 ,0 0 0 , i n co m e fro m

“ [r] en t al real es t at e, ro y al ti es , p art n ers h i p s , S co rp o rat i o n s , tru s t s , et c.” o f $ 1 0 2, an d“ [o ] th er i n co m e” o f

! $ 1 ,3 9 1 ,9 52 . Th e rep ort ed“ [w] ag es , s al ari es , t i p s , et c.” co n s i s tedo f wag es o f $ 8 0 ,3 7 6 an d$ 8 2 ,3 7 3 earn edb y M r. Fl u m e an dM rs . Fl u m e, res p ect i v el y , s o l el y fro m FFM
. Th e rep o rt ed“ [o ] th er i n co m e” co n s i s t edo f a fo rei g n earn edi n co m e ex cl u s i o n t o t al i n g $ 1 6 2 , 7 49 (i .e., th e rep o rt ed t o t al wag es fro m FFM ) as refl ect edo n Fo rm s 2 5 5 5 at t ach edt o th e 2 0 0 7 retu rn , an N O L carry o v er t o t al i n g $ 1,2 2 9 ,3 6 4 (a $ 61 4 ,6 8 2 NOL carry o v er wi th res p ect t o each p et it i on er) as refl ect edo n a Li n e 2 1 , Oth er In co m e St at em en t ,- 1 0 -

[* 1 0 ] al s o at t ach edt o t h e 2 0 0 7 retu rn , an d“ SUBSTITUTE PAYM ENTS” o f $ 1 6 1, al s o as refl ect edo n th e Li n e 2 1, Other In co m e St at em en t . Pet i t i o ners ’ 2 0 0 8 retu rn was fi l edo n J u l y 3 0 , 2 0 0 9 . Itrep o rt edad

j u s t ed g ro s s i n co m e o f

! $ 1 ,2 1 8 ,5 9 2 , co n si s t i n g o f “ [w] ag es , s al ari es , t i p s , et c.” o f $ 1 6 4 ,0 0 0 , t ax ab l e i n t eres to f $ 1 ,3 4 8 , o rd i n ary d i v id en d s o f $ 6 , 8 6 5 , a cap i t al l o s s
o f $ 3 , 0 0 0 , i n co m e fro m

“ [r] en tal real es t at e, ro y al t i es , p artn ers h ip s , S co rp o rat i o n s , tru s t s , et c.” o f $ 7 9 5, an d“ [o ] th er i n co m e” o f

! $ 1 ,3 8 8 ,6 00 . Th e rep ort ed“ [w] ag es , s al ari es , t i p s , et c.” co n s i s tedo f wag es o f $ 8 5 ,0 0 0 an d$ 7 9 ,0 0 0 earn edb y M r. Fl u m e an dM rs . Fl u m e, res p ect i v el y , s o l el y fro m FFM
. Th e rep o rt ed“ [o ] th er i n co m e” co n s i s t edo f a fo rei g n earn edi n co m e ex cl u s i o n t o t al i n g $ 1 6 4 , 0 00 (i .e., th e rep o rt ed t o t al wag es fro m FFM ) as refl ect edo n Fo rm s 2 5 5 5 at t ach edt o th e 2 0 0 8 retu rn , an d an NOL carry o v er t o t al i n g $ 1 ,2 2 4 , 6 0 0 (a $ 6 1 2 ,3 00 NOL carry o ver wi th res p ectt o each p et i t i o n er) as refl ect edo n a Li n e 2 1 , Oth er In co m e St at em en t , al s o at t ach edt o th e 2 0 0 8 retu rn . 6 III. Au d itan dDet erm i n at i o n In 2 0 1 1 th e IRS s el ect edp et i t i o n ers ’ retu rn s fo r t h e y ears at i ss u e an d2 0 1 0 fo r au d i t . Th e au d i t was co n du ct edb y IRS Rev en u e Ag en t Rap h ael l e J o hn s o n

6 Pet i t i on ers ’ 2 0 0 8 retu rn al s o rep o rt ed a reco v ery reb at e cred i to f $ 6 0 0 , res u l ti n g i n a refu ndcl ai m edo f t h ats am e am o un t .- 1 1 -

[* 1 1 ] (RA J o h ns o n ). Pet it i on ers en g ag ed Dav i dRo dri g u ez, t h ei r co u n s el o f
reco rdh ere, t o rep res en tthem du ri n g t he au d i t . RA J o h n s o n i s s u eds ev eral i n fo rm at i o n d o cu m en treq u es t s t o p et it i on ers . Th ro u g h M r. Ro dri g u ez, p et i t i o n ers p ro v id eds o m e o f t h e req u es t edreco rd s i n v ari o u s res p o ns es ; t o wi t , s p an n i n g th e y ears ati s s u e, t h ey p ro v i d ed (1 ) t h ei r p ers o nal b an k acco u n t reco rd s , (2 ) co rp o rat e d o cu m en t s o f W i l s h i re an d FFM , (3 ) W il s h i re’ s g en eral l ed g ers , p ro fi t an dl o s s
s t at em en t s , i n co m e s t at em en t s , an db al an ce s h eet s , an d(4 ) W i l s h i re’ s an d FFM ’ s b an k acco u n treco rd s . Si nce p et i t i o n ers d i d n o tp ro v i d e h er wi th al l o f t h e req u es t edreco rd s , RA J oh n s on i s s u edth i rd -p art y reco rdk eep er s umm o n ses t o
s ev eral U.S. fi n an ci al i n s ti tut i o n s , b ro k erag e co m p an i es , an dcred i tcard
co m p an i es , i n cl u d i n g BBVA Co m p as s Ban kan dFi d el i ty , an d as a res ul t o f t h o s e
s u m m o n ses s h e recei v edad d i ti o n al reco rd s p ert ai ni n g i n p ert i n en t p artt o W i ls h i re’ s acco un t s wi th th o s e i n s t i tu t i o n s an dco m p an i es . Al s o i n RA J o h n s o n ’ s p o s s es s i o n were UBS’ reco rd s p ert ai n i n g t o W i l s h i re’ s UBS acco u n t thatth e IRS recei v edi n res p on s e t o a req u es tfo r t reat y i nfo rm at i o n . Us i n g th es e reco rd s RA J o h n s o n i d en t i fi edd i s b u rs em en t s o r tran s fers t o p et i t i o n ers o r fo r t h ei r b en efi t . Sh e d et erm i nedth atp et i t i o n ers h adad d i t i o n al wag e i n co m e fro m

W i ls h ire, o r i n th e al t ern at i v e, ad di t i o n al d i v i d en di n co m e, o f- 1 2 -

[* 1 2 ] $ 4 4 ,5 2 4, $ 4 7 ,5 35 , an d$ 1 0 7 ,7 6 8 fo r 2 0 0 6 , 2 00 7 , an d2 0 0 8 , res p ect i v el y . 7 Sp eci fi cal l y , fo r 2 0 0 6 RA J o h n s o n d et erm in edth atp et i t i o n ers ’ ad d i t i o n al wag e i n co m e was at tri b ut ab l e t o wi thd rawal s fro m W il s h i re’ s BBVA Co m

p as s Ban k
an d UBS acco u n t s fo r p et i t i o n ers ’ p ers o n al u s e, t o t h ei r p ers o n al acco u n t s , an dfo r th e p aym en to f t h ei r p ers o n al ex p en s es , i n cl u d in g th ei r p ers o n al cred i t card ch arg es . Fo r 2 0 0 7 RA J oh n s o n d et erm i nedth atp et it i o n ers ’ ad d i t i o n al wag e i n co m e was at tri b ut ab l e t o wi thd rawal s fro m W il s h i re’ s BBVA Co m

p as s Ban k , UBS, an dFi d el i ty

acco u n t s fo r p et i t i o n ers ’ p ers o n al u s e, t o p et i t i o n ers ’ p ers o n al
acco u n t s, an d fo r t h e p aym en t o f t h ei r p ers o n al ex p en s es , i n cl u d in g th ei r p ers o n al cred i tcardch arg es . Fo r 2 0 0 8 RA J o h n s on d et erm i n edthatp et i t i on ers ’ ad d i t i o n al wag e i n co m e was at tri b ut ab l e t o wi th drawal s fro m W il sh i re’ s BBVA Co m

p as s Ban k an dUBS acco u n ts fo r p et i t i o n ers ’ p ers o n al u s e, t o t h ei r p ers o n al acco u n t s , an d fo r th e p aym en to f thei r p ers o n al ex p en s es , i n cl u d i ng th ei r p ers o n al cred i tcard ch arg es . RA J o h n s o n al s o d et erm i n edth atW i ls h i re was a co n tro l l ed fo rei g n
co rp o rat i o n (CFC) t h atwas 1 0 0 % o wn edb y p et i t io n ers fo r t h e y ears ati s s u e, t h at th e i n v es t m en ti n co m e fro m W i l s h i re’ s UBS an dFi d el i ty acco u n t s was fo rei g n p ers o n al h o l d i ng co m

p an y i n co m e (FPHCI) u n d er s ub p art F o f t h e Co d e, an dth at

7 RA J o h ns o n al lo cat ed5 0 % o f each am o u n tt o each p et i t i o n er.- 1 3 -

[* 1 3 ] as a res u l tp et i t i o n ers were req u i redt o rep o rtth ei r p ro rat a s h are (1 0 0 %) o f th atFPHCI as s ub p artF i nco m e (an dt ax ab l e as ad d i t i o n al o rd i n ary d i v i den d i n co m e) i n th e fo l l o wi ng am ou n t s : $ 1 5 ,8 1 3 fo r 2 0 0 6 , $ 3 5 , 1 50 fo r 2 0 0 7 , an d $ 1 7 ,7 7 8 fo r 2 0 0 8
. Inth e al t ern at i v e RA J o h n s o n d et erm i n edth at p et i t io n ers were req u i redt o rep o rtas o rd i n ary i n co m e: (1 ) i n t eres ti n co m e at tri b u tab l e t o W i ls h i re’ s UBS an d Fi d el i ty acco u n t s o f $ 1,2 3 8 , $ 1 ,8 8 4 , an d$ 2 ,1 7 2 fo r 2 0 0 6 , 2 0 0 7 , an d2 0 0 8 , res p ect i v el y ; (2 ) o rd i n ary d i v i d en di n co m e at tri b u t ab l e t o W i ls h i re’ s UBS an d Fi d el i ty acco u n t s o f $ 18 ,5 0 2 , $ 4 7 , 5 6 3 , an d $ 2 3 ,8 3 5 fo r 2 0 0 6 , 2 0 0 7 , an d2 0 0 8 , res p ect i v el y ; an d(3 ) cap i t al g ai n s at tri b u t ab l e t o W i ls h i re’ s UBS
an d Fi del i ty

acco u n t s o f zero , $ 1 6 ,3 5 9 , an dzero fo r 2 0 0 6 , 2 0 0 7 , an d2 0 08 , res p ect i vel y . Fi n al l y , RA J o h n s o n d et erm i n edth at accu racy -rel at edp en al t i es fo r
n eg li g en ce, o r i n th e al t ern at i v e, fo r s ub s t an ti al u nd ers t at em en t s o f i n co m e t ax
were warran t ed
. Th e n o t i ce o f d efi ci en cy

s en tt o p et it i on ers o n Oct ob er 1 , 2 0 14 , refl ect s th o s e d et erm i n at i o n s . Pet i t i o n ers were fi rs tn ot i fi ed , h owev er, o f t he p ro p o s ed ch an ges t o th ei r Fed eral i n co m e t ax fo r t h e y ears ati s s u e, i n cl u d i n g the i m po s i t i o n
o f accu racy -rel at ed p en al t i es , v i a a s o -cal led3 0 -d ay l et t er, d at edM ay

1 , 2 0 1 4 , th at th e IRS s en tt o th em (co p i es o f th e l et t er were act u al ly ad dres sedan ds en tt o each- 1 4 -

[* 1 4 ] p et i t i o n er as wel l as t o M r. Ro dri g u ez). 8 Th i s 3 0 -d ay l et t er co n t ai n edi n p ert i nen tp artth e p refat ory h ead i n g “ Wh att o Do i f Yo uDo No tAg ree wi th th e Pro p os edCh an ges ”, b en eat h wh i ch i tex p l ai n edth atp et i t i o n ers co u l dreq u es ta
m eet i n g o r t el ep h on e co n feren ce wi th RA J o h n s o n ’ s s up erv i s o r, an di f aft er th at
m eet i n g o r t el ep h on e co n feren ce t h ey s t i l l d i dn o tag ree wi th th e p ro p o sed ch an ges , th ey

co u l dreq u es ta co n feren ce wi th t h e IRS Offi ce o f Ap p eal s (Ap peal s ) b y s ub m i t t i n g a fo rm al p ro t es t . Th e l et ter fu rt h er ad v i s ed th ati f p et i t i o n ers fai l edt o reach an ag reem en twi th Ap p eal s o r i f t h ey d idn o t res p o n dt o th e l et ter, a n o t i ce o f d efi ci en cy wo u l db e i s s u edt o th em . En cl o s edwi th th e 3 0 -d ay l et ter was (am o n g o th er d o cu m en t s ) an
ex am i n at i o n rep o rt 9 co ns i st i ng o f a Fo rm 4 5 4 9 -A, In co m e Tax Ex am i n at i o n Ch an g es , a Fo rm

8 86 -A, Ex p l an at i o n o f It em s , an dv ari o u s wo rk s h eet s d et ai l i n g th e cal cu l at i o n s o f t h e p ro p o s edd efi ci en ci es an d p en al t i es .

8 As ex p lai n ed i n fra p p . 3 0 -3 3 , we are reo pen i n g th e reco rdt o ad m i tth e 3 0
- d ay l et t er, t o g et h er wi th cert ai n en cl o su res wi th th e l et t er (as d i s cu s s edi n fra p p . 1 4 -1 5 ), an d a d ecl arat i o n o f IRS Su p erv i s ory In t ern al Rev en u e Ag en tRo b ert G. Dav i s i n s o far as i tau th en t i cat es th e 3 0 -d ay l et t er an dth es e en cl o s u res . 9 Th e ex am i n at i o n rep o rti s co m m o n ly cal l eda “ rev en u e ag en t ’ s rep o rt ” o r “ RAR”. Lai d l aw’ s Harl ey Dav i d s o n Sal es , In c. v . Co m m i s si on er, 1 5 4 T.C. _

_ , _

_ (s l i p o p. at7 ) (J an . 1 6, 2 0 2 0 ) (ci t i ng Bran ert o n Co rp . v . Co m m i s si o n er, 6 4 T.C. 1 9 1 , 1 9 4 -1 9 5 (1 9 75 )).- 1 5 -

[* 1 5 ] Th e Fo rm

4 5 4 9-A was s i g n edb y

RA J o h ns o n (o n M ay 1 , 2 0 1 4 , th e s am e d at e as th e 3 0-d ay

l et t er), an dth e 3 0 -d ay

l et t er was s i gn edb y M r. Dav i s , wh o was RA J o h n so n ’ s s up erv i s o r atthe t i m e. Th e reco rdi n cl u d es a co m pl et edCi v il Pen al ty

Ap p ro val Fo rm (d at ed twi ce--Sep t em

b er 2 5 , 2 0 1 3 , an dM ay

2 , 2 0 1 4 ) t h atl i s t s th e y ears at i s s ue an db ears th e s i g n atu re o f Act i n g IRS Su p erv i s o ry In t ern al Rev en u e Ag en t Cas s an dra M o o re, RA J oh n s o n ’ s s up erv i so r o n Au g u s t4 , 2 0 1 4 (t he d at e s h e s i g nedth e fo rm ), ap p ro v i ng s ect i on 6 66 2 (a) an d(b )(1 ) p en al t ies fo r n eg l i g en ce o r d i s reg ard
o f ru l es o r reg u l at i o n s “ du e t o d i s al l o wan ce o f u n s ub s t an t i at edNOL * * * [carry fo rward s ] an du n d ers t at edwag es fro m a rel at edco rp o rat i o n .” 1 0 Th e

“ In tern at i o n al Tech ni cal Serv i ce” o f t h e Sm al l Bu s i n es s/ Sel f-Em p l o y edDi v i s i o n
o f t h e IRS i s s u edth e Oct ob er 1 , 2 0 1 4 , n o t i ce o f d efi ci en cy t o p et i t io n ers ; th e
n o t i ce en cl o s edth e s am e Fo rm 8 8 6 -A an d v ari ou s wo rk s h eet s th atwere en cl o s ed wi th th e 3 0 -d ay

l et t er, as wel l as a Fo rm

4 5 49 -A th at was i n al l res p ect s th e s am e
as th e Fo rm

4 54 9-A al s o en cl o s edwi th th e 3 0 -d ay l et t er ex cep tth atth i s Fo rm

1 0 As i n d i cat edi n fra p p . 3 0 -3 3 , we are al s o reo p en i n g th e reco rdt o ad m i tth e Ci v il Pen al ty

Ap p ro v al Fo rm

(al o n g wi th RA J oh n s o n ’ s “ 5 15 W o rk pap ers ” t h at th e fo rm referen ces ) an da d ecl arat i o n o f M s. M o o re i n so far as i tau th en t i cat es th e Ci v il Pen al ty

Ap p ro v al Fo rm

(an dth e referen ced“ 5 15 W o rk pap ers ”) fo r p u rp o s es o f Fed . R. Ev i d . 9 0 2 (1 1 ).- 1 6 -

[* 1 6 ] 4 5 4 9 -A was d at edSep t em b er 2 5 , 2 0 1 4 , d i d n otrefl ectco m p ut edi n teres t , an d was s i g n edb y

“ L. Reyn o l ds ”. OPINION I. Bu rd en o f Pro o f In g en eral , th e Co m

m i s s i o n er’ s d et erm i n at i o ns s etfo rt h i n a n o ti ce o f d efi ci en cy

are p res u m edco rrect an d , ex cep t fo r t h e b u rd en o f p ro du ct i o n i n an y
co u rtp ro ceed i ng wi th res p ectt o a t ax p ay er’ s l i ab i l i ty fo r an y “p en al ty , ad d i t i o n t o t ax , o r ad d i t io nal am ou n t ”, s ee s ec. 7 4 9 1 (c), th e t ax p ay er b ears th e b u rd en o f p ro v in g o th erwi s e, s ee Ru l e 1 4 2 (a); W el ch v . Hel veri n g , 2 9 0 U.S. 1 1 1 , 1 1 5 (1 9 3 3). Ho wev er, fo r t h i s p res u m p t i o n t o ad h ere i n cas es (s u ch as th i s o n e) i n v o l v i n g u n rep o rt edi n co m e, t h e Co m m i s s i o n er m

u s tp ro v i d e s o m e reas o n ab l e fo u n dat i o n co n n ect i n g the t ax p ay er wi th th e i n co m e-p ro du ci n g act i v i ty . See Bl o hm v . Co m m i s s i o n er, 9 9 4 F.2 d1 5 4 2 , 1 5 4 9 (1 1 th Ci r. 1 9 93 ), aff’ g T.C. M em o . 1 9 9 1 -6 3 6 ; Po rt i l l o v . Co m m i s s i o n er, 9 3 2 F.2 d1 1 2 8, 1 1 33 (5 th Ci r. 1 9 91 ), aff’ g i n p art , rev ’ g i n p art T.C. M em o . 1 9 9 0 -6 8 ; Lem i re v . Co m m i s s i o ner, No s. 8 9 -1 1 8 0 , 8 9 -1 18 1 , 1 9 9 0 U.S. Ap p . LEXIS 6 6 6 4 , at* 8 (D.C. Ci r. 1 9 9 0 ). On ce t h e Co m m i s s i o n er h as d o ne t h i s , th e b u rd en o f p ro o f s h ift s t o the t ax p ay er t o p ro v e b y a p rep o n d eran ce o f t h e ev i d en ce t h atth e Co m m i s s io n er’ s d et erm i nat i o ns o f- 1 7 -

[* 1 7 ] u n rep o rt edi n co m e are arb i traryo r erro neo u s . Hel v eri n g v . Tay l o r, 2 9 3 U.S. 5 0 7 , 5 1 5 (1 9 3 5). Res p o n d en t’ s d et erm i n at i o n s s etfo rt h i n th e Oct o b er 1 , 2 0 1 4 , n o t i ce o f d efi ci en cy

t o p et i ti o n ers were b as edo n s ub s t an t i ve ev i d en ce l i n k i n g p et i t i o n ers wi th th e i nco m e ati s s u e. Th e reco rdi n th is cas e i n cl u d es as s t i p u l at edex h i b i t s (1 ) anan al y si s b y RA J o h n so n o f p et i t io n ers ’ an d W i l s h i re’ s cred i t cardtran s act i o n s fo r t h e y ears at i s su e, (2 ) reco rd s fo r o n e o f p et i t i o n ers ’ p ers on al b an kacco u nt s fo r 2 0 0 6 an d 2 0 0 7 , (3 ) W i l s h i re’ s b an kan d b ro k erag e acco u n t reco rd s fo r t h e y ears ati s s u e, (4 ) FFM ’ s b an k acco u n treco rd s fo r 2 0 0 7 an d2 0 08 , (5 ) cert ai n co rp orat e d o cu m en t s o f W i l s h i re an d FFM , an d(6 ) W i l s h i re’ s g en eral l ed g ers , p ro fi tan d l o s s s t at em en t s , i n co m e s t at em en t s , an db al an ce s h eet s fo r t h e y ears ati s s u e. RA J o h n so n t es t i fi edo n b eh al f o f res p on d en tth ats h e rev i ewedthes e (an do th er)
reco rd s an ds h e i d en t i fi edcert ai n am o u n t s fro m o r at tri b u tab l e t o W i ls hi re t h at
s h o u ldh av e b een treat edas u n rep o rt ed(wag e an ds ubp artF) i nco m e o f p et i t i o n ers . Onthe b as i s o f t h is cred i b le ev id en ce, we are s at i s fi edth atres p o n den t h as p ro v edth atW i l s hi re i s a l i k el y s o u rce o f t h e d et erm i n edu nrep o rt edi n co m e fo r t h e y ears ati s su e. Th u s, as t o th i s i n co m e, t h e b u rd en o f p ro o f s hi ft s t o- 1 8 -

[* 1 8 ] p et i t i o n ers t o s ho w th atres p o n d en t ’ s d et erm i nat i on s i n t h i s reg ardwere arb i trary o r erro n eo u s . 1 1 II. W ag e In co m e A t ax p ay er’ s g ro s s i nco m e i n cl u des “ al l i n co m e fro m wh at ev er s o urce d eri v ed ,” i ncl ud in g “ [c] o m p en s at i o n fo r s erv i ces ”, e.g ., wag es an ds al ari es . Sec. 6 1 (a)(1 ); s ec. 1 .6 1-2 (a)(1 ), In co m e Tax Reg s . A t ax pay er i s req u i red t o m ai n t ai n b o o k s o r reco rd s s u ffi ci en tt o es t ab l i s h th e am o u n t o f h is o r h er g ro s s i n co m e req u i redt o b e s h o wnb y

s u ch p ers on o n an y

retu rn . See s ec. 6 0 0 1 ; s ec. 1 .6 0 0 1 -1 , In co m e Tax Reg s . Iti s wel l s et t l edth ati f th e t ax pay er’ s b o o k s o r reco rd s d o n o t cl earl y refl ecti n co m e, t h en th e Co m m i s si on er i s au th ori zed“ t o reco n s tru cti n co m e i n acco rd an ce wi th a m et h o dwh i ch cl earl y refl ect s th e fu l l am o u n to f i n co m e recei v ed .” Pet zo l d tv . Co m m i s s i o n er, 9 2 T.C. 6 6 1 , 6 8 7 (1 9 8 9 ) (an dcas es ci t ed th ereat ). Th e Co m

m i s si o ner’ s reco n s tru ct i o n n eedo n l y b e reas o n ab l e u n d er al l th e fact s an dci rcu m s t an ces . Id
. Du ri n g th e au d i tfo r t h e y ears ati s s u e RA J oh n s o n d et erm i n ed th at p et i t i o n ers h adad d it i o n al wag e i n co m e fro m W i l s h i re t o t al i n g $ 4 4 ,5 2 4, $ 4 7 ,5 3 5 ,

1 1 Pet i t i o ners d o n ot o th erwi s e co n t en d t h atth e b urd en o f p ro o f s h o ul ds h i ft t o res p o n d en tu n d er s ec. 7 4 91 (a), n or h av e th ey es t ab li s hedth atth e requ irem en t s fo r s h i ft i n g th e b u rd en o f p ro o f h av e b een m et . Acco rd i n g l y , th e b u rd eno f p ro o f rem ai n s o n p et it i o n ers .- 1 9 -

[* 1 9 ] an d $ 1 07 ,7 68 fo r 2 0 0 6 , 2 0 0 7 , an d2 00 8 , res p ect i v el y . Sh e u s edth e s p eci fi c i t em m et h o dt o m ak e t hes e d et erm i n at i o n s . Th e s peci fi c i t em m eth o di s a Co u rt ap p ro v ed“ m et h o d o f i n co m e reco n s tru ct i o n th atco n s i st s o f ev i d en ce o f s peci fi c
am ou n t s o f i n co m e recei v edb y a t ax p ay er an d n o trep o rt edo n th e t ax p ay er’ s retu rn .” Zan g v . Co m

m i s si o ner, T.C. M em o . 2 01 7 -5 5 , at* 1 7 (ci t i n g Es t at e o f Beckv . Co m

m i s s i o n er, 5 6 T.C. 2 9 7 , 3 5 3-3 5 4 , 3 61 (1 9 7 1 )); s ee al so Dy er v . Co m m i s s i o n er, T.C. M em o . 2 0 1 2 -2 2 4 , at* 1 7 (an dcas es ci t edth ereat ) (n o t i n g th at th e Co u rth as ap p ro v edth e s p eci fi c i t em m et h o dfo r reco m

p u t i n g t ax ab l e i n co m e). Pet i t io n ers co n t en dth atres po n d en t ’ s wag e ad ju s t m en ts are erro n eo u s b ecau s e th ey were t ran sfers o r d i s b u rs em en t s fro m W i l s h i re’ s acco u n t s t o p et i t io n ers ’ p ers o n al acco u n t s (1 ) t o “p ay o ff n o t es p ay ab l e t o Pet i t i o n er[s ] fo r am ou n ts * * * [t hey ] p rev i o us l y

reco gn i zedas [wag e] i n co m e” an d(2 ) fo r t h e rei m b u rs em en to f

“ ex p en s es [t h ey ] p ai do n W i ls h i re’ s b eh al f.” Acco rd i ng t o p et it i on ers , th ey rep o rt edal l wag es th ey

recei v edfro m

W i l s h i re (an dFFM ) o n thei r jo i n tFed eral i n co m e t ax retu rn s fo r t h e y ears ati s s u e wh en th e i n co m e was earn edan dth erefo re th e ad d i t i o n al am o u n t s as s ert edb y res p o n d en tas wag e i n co m e “ are b ei n g d o ub l e
co u nt ed
. ” W i th res p ect t o p et i t i o n ers ’ fi rs t reas o n, we ag ree t h atres p o nd en td o ub l e
co u nt ed t o th e ex ten to f $ 5 0 ,4 7 9 fo r 2 0 0 8 . As rel ev an t h ere p et i ti o n ers ’ 2 0 0 7 an d- 2 0 -

[* 2 0 ] 2 0 0 8 retu rn s rep o rt edt o t al wag es o f $ 1 6 2,7 4 9 an d $ 16 4 ,0 0 0, res p ect i v el y ; th es e s am e am o un t s are res p ect i v el y refl ect edi n W i l s h i re’ s g en eral l ed gers fo r 2 0 0 7 an d2 0 0 8 as “ To t al Ex p en s es ”. M o re s p eci fi cal l y , u n d er “ To t al Ex p en s es ” i n W i ls h i re’ s 2 0 0 7 g en eral l ed g er t h ere i s a Decem b er 3 1 , 2 0 0 7 , en try

cat eg ori zedas a “ Gen eral J ou rn al ” en try o f $ 50 ,6 1 6 t o M r. Fl u m e fo r a “ Sal ari es Pay ab l e n o t e”. In o th er wo rd s o n thei r 2 00 7 ret u rn p et i t io n ers actu al l y i ncl u d edth e $ 5 0 ,6 1 6

“ Sal ari es Pay ab l e n o t e” am o un ti n th ei r rep ort edt o t al wag es o f $ 1 6 2,7 4 9
. Sep arat e an d ap artfro m

s ai drep o rt i n g , W i l s h i re’ s 2 0 0 8 g en eral l ed g er i n d i cat es th atdu ri n g 2 0 0 8 W i l sh i re p ai do ff t h e “ Sal ari es Pay ab l e n o te” o f $ 5 0 ,6 1 6 ; th e l ed g er refl ect s 1 2 en tri es cat eg o ri zed as “ Ch eck ” en tri es t o t al i ng $ 5 0 , 4 7 9 t o FFM
an d o n e en try

cat eg ori zedas a “ Gen eral J ou rn al ” en try o f $ 1 79 t o “ recl as s i fy ” t h i s
am ou n tas “ Pay ab l e t o St o ckh o l d ers ”. Ho wev er, as refl ect ed i n the ex am i n at i o n rep o rten cl o sedwi th t h e Oct o ber 1 , 2 0 1 4, n o t i ce o f d efi ci en cy t o p et i t i on ers , RA J o h n so n ’ s co m

p u t at i on o f ad d i t i o n al 2 0 0 8 wag e i n co m e o f $ 1 07 ,7 6 8 s ho ws th atas p arto f h er co m

p u t at i o n s h e i ncl u d edth e s am e 1 2 “ Ch eck ” en tri es (t ot al i n g $ 5 0 ,4 7 9 ) t hatwere refl ect edi n W i l s h ire’ s 2 0 0 8 g en eral l ed g er as p aym en t s t o ward s t h e $ 5 0 , 6 1 6 “ Sal ari es Pay ab l e n o t e” am o u n twh i ch p et i t i o ners h adal read y- 2 1 -

[* 2 1 ] i n cl u d ed i n th ei r g ro s s i n co m e (as p arto f t h e rep o rt ed$ 1 6 2 ,7 4 9 ) o n t h ei r 2 0 0 7 retu rn . Acco rd in g l y , th i s p arto f RA J o h n s o n ’ s co m p u t at i o n was erro n eo u s . 1 2 As fo r p et i ti o n ers ’ s eco n dreas o n , th ey o ffered n o ev id en ce t o s upp o rti t
as i d e fro m

M r. Fl u m e’ s s el f-s erv in g t es t i m o ny , wh i ch we fi n d n o tt o b e cred i b l e.

“ As we h av e s tat edm an y t i m es b efo re, t h i s Co u rti s n o tb o u n dt o accep ta t ax p ay er’ s s el f-s erv i n g , u nv eri fi ed , an du n do cu m en t edt es t i m o n y .” Sh ea v . Co m m i s s i o n er, 1 1 2 T.C. 1 8 3 , 1 8 9 (1 9 9 9) (ci t i n g To k ars k i v . Co m m i s s i o n er, 8 7 T.C. 7 4 , 7 7 (1 98 6 )). Acco rd i ng l y , we s u s t ai n res p o n d en t ’ s d et erm i nat i on o f ad d i t i o n al wag e i n co m e fo r t h e y ears ati s s u e ex cep tt o th e ex t en to f $ 5 7 , 2 89 ($ 1 0 7 ,7 6 8

! $ 5 0 ,4 7 9 ) fo r 2 0 0 8
. 1 3 III. Sub p artF In co m e W i th th e en act m en t o f t h e Rev en u e Acto f 1 9 62 , Pub. L. No
. 8 7 -8 3 4 , s ec. 1 2 , 7 6 St at . at1 0 0 6 , s ub part F was ad d edt o t h e Co d e. Vet co , In c. & Sub s . v . Co m m i s s i o n er, 9 5 T.C. 5 79 , 5 8 5 (1 9 9 0 ). Un d er th i s s t atu t ory s ch em e, a U.S.

1 2 Res p o nd en td o es n ot s eekt o ch an g e t h e t i m in g o f th e wag e i n co m e fro m 2 0 0 7 t o 2 0 0 8
.

1 3 In th e l i g h to f o ur h o l d i n g we n eedn o t ad dres s res p o nd en t’ s al t ern at i v e p o s i t i on as t o th e am o u nt s d i s tri b u tedi n ex ces s o f rep o rt ed wag es , i
. e., thatth e am ou n t s are ad d i t i o n al d i v i den di n co m e t o p et i t i o n ers .- 2 2 -

[* 2 2 ] s h areh o l der o f a CFC m us tg en eral l y

i n cl ud e i n h i s g ro s s i nco m e h i s p ro rat a
s h are o f t h e CFC’ s “ s ub p artF i n co m e” fo r s uch y ear. Id . at5 8 5 -5 8 6 ; s ee s ec. 9 5 1 (a)(1 ). Sect i o n 9 5 1 (b ) d efi n es a U.S. s h areh o l der, wi th res p ectt o an y fo rei g n
co rp o rat i o n, as a U.S. p ers o n “ wh o o wn s (wi th i n th e m ean i n g o f s ect io n 9 5 8 (a)),
o r i s co n s i dered as o wn i n g b y ap p l y i n g th e ru les o f o wn ers h i p o f s ect io n 9 5 8 (b ), 1 0 p ercen to r m o re o f th e t o t al co m b i n ed v o t i n g p o wer o f al l cl as s es o f s t o ck
en t i t l edt o v o t e” o f t h e fo rei g n co rp o rat i o n . Sect io n 9 57 (a) g en eral l y d efi n es a CFC as “ an y

fo rei g n co rp o rat i o n i f m o re t h an 5 0 p ercen to f--(1 ) t he t o t al
co m b i nedv o t i n g p o w er o f al l cl as s es o f s t ocko f s u ch co rp o rat i o n en t i t l edt o v ot e,
o r (2 ) t he t o t al v al u e o f t h e s t o cko f s u ch co rp o rat io n , i s [d i rect ly o r
co n st ru ct i v el y ] o wn ed * * * b y Un i t edSt at es s h areh o l ders o n an y d ay duri n g th e t ax ab l e y ear o f s u ch fo rei g n co rp o rat i o n .” Sect i on 9 5 2 (a)(2 ) d efi n es s ub p artF i n co m e as i n cl u d i ng fo rei g n bas e co m p an y i n co m e as d et erm i n edu n d er s ect i o n 9 5 4 . Un der s ect i on 9 5 4 (a)(1 ) an d (c)(1 ), fo rei g n b as e co m pan y i n co m e i n cl u d es

“ fo rei g n p ers on al h o l d i ng co m p an y i n co m e”, wh i ch i n turn i n cl u des d i v i d en d s , i n t eres t , an dth e ex ces s o f g ai n s o v er l o s s es fro m the s al e o r ex ch an g e o f cert ai n p ro p erty . Res p o n d en td et erm i n edth at p et i t i o n ers h adrep o rt ab l e s ub part F i n co m e-- th e i n v es t m en ti n co m e fro m W i l s h i re’ s UBS an dFi d el i ty acco u n t s--o f $ 1 5 ,8 1 3 ,- 2 3 -

[* 2 3 ] $ 3 5 ,1 5 0, an d$ 17 ,7 78 fo r 2 0 0 6, 2 0 07 , an d2 0 0 8 , res p ect i v el y . Th e d i s p u t e wi th res p ect t o th i s d et erm i nat i o n cen t ers o n wh et h er W il s hi re was a CFC o n an y d ay du ri n g each o f t h e y ears ati s s ue wi th the res ul t thati f W i l s h i re was s u ch a CFC t h en p et i ti o n ers h av e rep o rt ab l e s ub p artF i n co m e fo r t h o s e y ears . 1 4 Iti s
res p o n d en t’ s p o s i t i o n t h atW i l sh i re was a CFC (an d th u s p et i t i o n ers h adrep o rt ab l e
s ub p artF i nco m e i n th e afo rem en t i o n edam o un t s ) b ecau se each p et it i on er h el da 5 0 % o wn ers h i p i n t eres ti n W i ls h i re; p et i t i o n ers , o n t h e o th er h an d, co n ten dth at W i ls h i re was n o ta CFC (an dthu s th ey d i dn ot h av e an y

rep o rt ab l e s ubp artF i n co m e) b ecau s e th ey

each o nl y

h el dn o m o re t han a 9 % o wn ers h ip i n t eres ti n W i ls h i re du ri n g th e y ears ati ss u e. Pet i t i o ners ’ co n t en t i o n , h o wev er, t h atW il s h i re was n o ta CFC i s n o w fo recl o s ed b y

th e d oct ri n e o f co l l at eral es t o p p el , al s o kn o wnas i s s u e p recl u s i o n . Is s u e p recl u si o n “ reco g ni zes th ats u i t s ad dres s ed t o p art i cu l ar cl ai m s m ay p res en t i s su es rel ev an t t o s u i ts o n o th er cl ai m s .” Kas par W i re W o rk s , In c. v . Leco En g ’ g & M ach ., In c., 5 7 5 F.2 d5 3 0, 5 3 5 (5 th Ci r. 1 9 7 8 ). “ Is s u e p recl u s i o n ap p l i es wh en
s u i t s i n vo l v e s ep arat e cl ai m s , b u tp res en ts o m e o f th e s am e i s s u es , an d‘ b ars th e rel i t i gat io n o f i s su es actu al l y ad ju d i cat ed , an des s en ti al t o th e ju d gm en t , i n a p ri o r

1 4 Th ere i s n o d i s pu t e t h atfo r t h e y ears ati s s u e each p et i ti o n er was a “ Un i t ed St at es s h areh o ld er” as th att erm i s d efi nedi n s ec. 9 5 1 (b ).- 2 4 -

[* 2 4 ] l i t i g at i o n b et w een th e s am e p art i es .’ ” M i dwes tM ech . Co n tract o rs , In c. v . Co m m o n weal th Co n st r. Co ., 8 0 1 F.2 d 7 48 , 7 5 1 (5 th Ci r. 1 9 86 ) (qu o t i n g Kas p ar W i re W o rk s , In c., 5 7 5 F.2 dat5 3 5 -5 3 6 ); s ee al s o Cal . Cmty s . Ag ai n s tTo x i cs v . EPA, 9 2 8 F.3 d1 0 4 1 , 1 0 5 1 (D.C. Ci r. 2 01 9 ); Bro tm an v . Co m m i s s i o n er, 1 0 5 T.C. 1 4 1 , 1 4 7 (1 9 9 5). Is s u e p recl u si o n fo cu s es o n wh et h er (1 ) t h e i ss u e i n th e s eco n d
s u i ti s i d en t i cal i n al l res p ect s wi th th e o n e act u al l y l i t ig at ed , d eci d ed , an d
es s en t i al t o th e ju d g m en ti n th e fi rs ts u i t , (2 ) a co u rto f co m p et en tjuri s d i ct i o n
ren d ereda fi n al ju d g m en t i n th e fi rs ts u i t , (3 ) t h e co nt ro l l i n g fact s an d ap p l i cab l e l eg al p ri n ci p l es i n th e s eco n ds u i th av e ch an g eds i g n i fi can tl y s i n ce th e ju d g m en ti n th e fi rs ts u i t , an d (4 ) t h ere are s p eci al ci rcu m st an ces , s u ch as fai rn es s co n cern s , th atwarran tan ex cep t i o n t o p recl u s io n i n th e s eco nds u i t . See Cal . Cmty s . Ag ai n s t T o x ics , 9 2 8 F.3 dat1 0 5 1 -1 0 5 2 (ci t in g Yam ah a Co rp . o f Am . v . Un i t ed St at es , 9 6 1 F.2 d2 4 5 , 2 5 4 (D.C. Ci r. 1 9 9 2 )); M ei er v . Co m m i s s i o n er, 9 1 T.C. 2 7 3 , 2 8 3 (1 98 8 ) (ci t i ng M on t an a v . Un i t edSt at es , 4 4 0 U.S. 1 4 7 , 1 5 5 (1 9 7 9 )). In Fl u m e v . Co m

m i s s i on er (Fl u m e I), T.C. M em o . 2 0 1 7 -2 1, a co l l ect i o n du e p ro ces s cas e, t h e i s su e fo r d eci s i o n was wh et h er M r. Fl u m e was l i ab l e fo r as s es s ed ci v i l p en al t i es u nd er s ect i o ns 6 0 3 8 an d6 6 7 9 fo r h i s fai lu re t o d ecl are (v i a Fo rm s 5 4 7 1 ) h i s o wn ers h i p i n t eres ti n W i l s h i re fo r t h e 2 0 0 1 -0 9 t ax ab l e y ears (an dh i s
o wn ers hi p i n t eres t i n FFM fo r t h e 2 0 0 1 an d2 0 0 2 t ax ab l e y ears ). In d eci d i n g th e- 2 5 -

[* 2 5 ] i s s u e, t h e Co u rth adt o d et erm i n e wh et h er W i l s h ire was a CFC fo r y ears th at i n cl u d edth e y ears ati s s u e i n th e i n s t an tcas e. Th e Co u rt d et erm i n edth at p et i t i o n ers each h el d 5 0 % o wn ers h i p i n t eres t s i n W i l s h ire t h ro u g h o u t a p eri o dthat i n cl u d edth e s ub

jecty ears . Id . at* 1 3 . Th e Co u rtreject ed as u nav ai l i n g M r. Fl u m e’ s as sert i o n th atth e t w o b earer s h ares o f W i l s h i re’ s cap i t al s t o ck th atg av e h i m an dM rs . Fl u m e each 5 0 % o wn ers h i p i n t eres t s i n W i l s h i re were el i m i n at ed
an d th atth e s h are o wn ers hi p s tru ctu re ch an g ed , redu ci n g h i s (an dM rs . Fl um e’ s )
o wn ers hi p t o 9 % (each ) fo r 2 0 0 1 -0 9 . Th e Co u rtco n cl ud edth at“ th e b ack d at ed
am en d edart i cl es o f as s o ci at i on [wh i ch p urp o rt ed ly m em o ri al i zedth e o wn ers h i p
s tru ctu re ch an g e as o f Ap ri l 1 2 , 2 0 0 1 ] an dth e ab s en ce o f an y ev i d en ce as t o wh en
o r i f t h e ch an g e i n s t o ck o wn ers h i p actu al l y o ccu rredco n trad i ct * * * [M r. Fl u m e’ s ] as s ert i o n.” 1 5 Id . Acco rd i n g l y , th e Co u rth el d thatW i l s h i re was a CFC fo r 2 0 0 1 -0 9
. Id
. at* 1 4. Th i s cas e, l i k e Fl um e I, req u i res u s t o d et erm i n e wh et h er W il s h i re was a CFC fo r 2 0 0 6 -0 8
. Th e Co u rti n Fl u m e I en tered i t s d eci s io n o n Feb ru ary 1 5 , 2 0 1 7 ,

1 5 Sp eci fi cal ly , th e Co u rtn o t edth atth e 5 0 % o wn ers h i p s tru ctu re was ret ai n ed up t o a p o rt i o n o f 2 0 0 5 , wh en o n Oct o b er 1 8 , 2 0 0 5 , M r. Fl u m e o pen eda UBS acco u n to n W i ls h i re’ s b eh al f u s i n g the o ri g i n al art i cl es o f as s o ci at i o n an d co p ies o f t he t wo b earer s hares . Fl u m e I, at* 1 4 . Th e Co urtal s o n o t ed that n o th i n g i n th e reco rdi nd i cat eda ch an g e i n o wn ers h i p fo r 2 0 0 6 -0 9 as i d e fro m M r. Fl u m e’ s i n cred i b l e s el f-s erv i n g t es t i m o n y an dthe b ack dat edart icl es o f as s o ci at io n . Id
.- 2 6 -

[* 2 6 ] an d t h atd eci s i on i s n ow a “ fi n al ju d g m en t ”. Th e co nt ro l l i n g fact s an d ap p li cab l e l eg al p ri n ci pl es h ere h av e rem ai n edu n ch an g eds i n ce t h e Co u rt ’ s d eci s i o n i n Fl u m e I; i n d eed , th e t ri al tran scri pt fro m Fl u m e I i s a s t i p u lat edex h i b i t i n thi s cas e. Th ere are al s o n o s p eci al ci rcu m st an ces (s u ch as fai rn es s co n cern s ) th atwo u l dwarran tan ex cep t i o n t o p recl u s i o n i n th i s cas e. Acco rd i n gl y , we h o l d th atth e co nd it i o n s fo r i s s u e p recl u s i o n are s at i s fi ed ; W i l s h i re was a CFC d u ri n g th e y ears ati s s u e. As a co n s equ en ce o f o u r h o l d in g , p et i t i o ners were req u i red , as i n d i cat ed
s up ra p p . 2 1 -2 2, t o rep o rtas g ro s s i n co m e t h ei r p ro rat a s h are o f W i l sh i re’ s
s ub p artF i nco m e fo r t h e y ears ati ss u e. Gi v en th atth ey were 1 0 0 % s h areh o l d ers
o f W i l s h ire fo r t h o se y ears , th en th ei r p ro rat a s h are o f W i l s h i re’ s s ub p artF i n co m e fo r t h o se y ears was 1 0 0%. Ho wev er, t h e p ro rat a am ou n tthata U.S.
s h areh o ld er o f a CFC rep o rt s as s ub p artF i n co m e o f t h e CFC fo r an y t ax ab l e y ear
can n otex ceed th e CFC’ s cu rren tearn i ng s an d p ro fi t s . Sec. 9 5 2 (c)(1 )(A); Co rco ran v . Co m

m i s s i o n er, T.C. M em o . 1 99 1 -3 67 , 1 9 9 1 Tax Ct . M em o LEXIS 4 1 6 , at * 1 6 ; s ee al s o Bo ri s I. Bi t t k er & Lawren ce Lo kk en , Fed eral Tax at i o n o f In co m e, Es t at es & Gi ft s , p ara. 6 9 .1 0 , at* 2 (W es t l aw 2 0 2 0 ) (“ Th e p u rp o s e o f
s ub p artF t o d en y

d eferral o f U.S. t ax at i o n n ev er req ui res th atU.S. s h areh o l d ers o f a CFC b e t ax edo n am o un t s ex ceed i n g the d i v i den d s they wo u ldh av e recei v edi f- 2 7 -

[* 2 7 ] al l i n co m e h adb een d i st ri b u t edcu rren tl y , an d earn i n g s an dp ro fi t s are t h e
m eas u re o f d i v i d en di n co m e.”) A CFC’ s cu rren t earn i n g s an dp ro fi t s are g en eral l y

“ d et erm i ned acco rd i ng t o ru l es s ub s t an t i al l y s i m i lar t o th o s e ap p l i cab le t o d o m es t ic co rp o rat i on s ”. 1 6 Sec. 9 6 4 (a); s ee al s o s ec. 1 .9 6 4 -1 (a), In co m e Tax Reg s . Th e ex am i nat io n rep o rten cl o s edwi th th e Oct o b er 1 , 2 0 1 4 , n o t i ce o f d efi ci en cy t o p et i t i o n ers i n d icat es th atres p o n d en tco m p u t edW il s hi re’ s cu rren tearn i n gs an d p ro fi ts fo r each o f t h e y ears at i s s u e b ecau s e p et i ti o n ers d id n o t p ro v i d e s u ch
co m p u t at i o n s . To th aten d t h e ex am i nat i o n rep o rts t at es th at“ [t ] h ere was
s u ffi ci en tE&P i n each y ear t o co v er t he Su b p artF d i s tri b u t io n s ”, an d i t s et s fo rt h W i ls h i re’ s cu rren tearn i ng s an dp ro fi t s fo r each o f t h e y ears at i s s ue. Th e rep o rt i n d i cat es th atW i l s h i re’ s cu rren ty ear earn i n g s an dp ro fi t s fo r 2 0 0 6 an d 2 0 0 7 were $ 4 6 5 ,3 5 7 an d$ 9 7 ,4 7 3 , res p ect i v el y , b u t

! $ 3 4 4,1 1 6 fo r 2 0 0 8 . Thu s , fo r 2 0 0 6 an d 2 0 0 7 p et i t i o n ers ’ p ro rat a am o un t s o f W i l s h ire’ s s ub p artF i n co m e ($ 1 5 ,8 13 fo r 2 0 0 6 an d$ 3 5 ,1 5 0 fo r 2 0 0 7 ) d i dn o tex ceed W i l s h ire’ s cu rren ty ear earn i ng s an d

1 6 Th e Co d e d o es n o td efi n e t h e t erm “ earn i n g s an dp ro fi ts ” fo r d o m es t i c co rp o rat i o ns . See s ec. 3 1 6 (a); J u h a v . Co m m i s s i o n er, T.C. M em o . 2 0 1 2 -6 8 , s l i p o p . at1 1 n . 1 1 (ci t i n g Hen ry C. BeckCo . v . Co m

m i s s i o ner, 5 2 T.C. 1 , 6 (1 9 6 9 ), aff’ dp er cu ri am , 4 3 3 F.2 d3 0 9 (5 th Ci r. 1 97 0 )). A d o m es ti c co rp o rat io n ’ s earn i n g s an dp ro fi t s “ i s g en eral l y u n d ers t o odt o equ al th e co rp orat i o n ’ s t ax ab l e i n co m e fo r t h e t ax ab l e y ear wi th cert ai n m o d i fi cat i o n s .” Su s anA. J oh n s t o n , Tax at i o n o f Reg u l at ed In v es t m en t Co m p an i es an dTh ei r Sh areh o ld ers , M ech an i cs o f Si n g l e-Ti er Tax at i o n , p ara. 3 .0 4 [2 ] [b ] [i ] & n .1 5 9 ; s ee al s o Eat o n Co rp . & Sub s . v . Co m m i s s i o n er, 1 5 2 T.C. 4 3, 5 0 (2 0 1 9 ).- 2 8 -

[* 2 8 ] p ro fi t s b u t fo r 2 0 0 8 th ei r p ro rat a am o un to f W i l s h ire’ s s ub p artF i n co m e ($ 1 7 , 77 8 ) d i di n factex ceedW i l s h i re’ s cu rren tearn i n g s an d p ro fi t s . Itap p ears th en th atres p o n d en td i dn o t tak e i n t o acco u n t(b u ts h o u l dh av e) t he s ect i o n 9 5 2 (c)(1 )(A) l i m it at i o n fo r 2 00 8 , wi th th e res ul tth atp et i t i o ners s h o ul dh av e n o rep o rt ab l e s ub p artF i n co m e fo r 2 0 0 8
. 1 7 Acco rd i n g l y , we s us t ai n res p o nd en t ’ s d et erm i n at i o n o f rep o rt ab l e s ubp artF i n co m e fo r 2 0 0 6 an d2 0 0 7 b u t n o tfo r 2 0 0 8
. 1 8 IV. Accu racy -Rel at edPen al t i es W e n o wad dres s wh et h er p et i t i o n ers are l iab l e fo r accu racy -rel at ed p en al t i es . Sect io n 6 6 6 2 (a) i m

p o s es a 2 0 % accu racy -rel at ed p en al ty o n an y p o rt i o n o f
an u n d erp aym en t o f t ax req u i redt o b e s h o wno n a retu rn i f, as p ro v i d edb y s ect i on 6 6 6 2 (b )(1 ) an d(2 ), th e u nd erp aym en t i s at tri bu t ab le t o “ [n ] eg l i g en ce o r d i s reg ard
o f ru l es o r reg u l at i o n s” an d/ o r a “ s ub st an t i al u n d ers t at em en to f i n co m e t ax .” Fo r

1 7 W e n o te t h at th e s ubp artF i n co m e fo r 2 0 0 8 th atwas n o ti n cl u dab l e i n p et i t i o n ers ’ g ro s s i n co m e i s s ub jectt o recap tu re i n a fu tu re y ear. See s ec. 1 .9 5 2
- 1 (e)(3 ), In co m e Tax Reg s .; s ee al s o Bo ri s I. Bi t t ker & Lawren ce Lo kk en , Fed eral Tax at i o n o f In co m e, Es t at es & Gi ft s , p ara. 6 9 .1 0 (W es t l aw 2 0 2 0 ).

1 8 In th e l i g h to f o ur h o l d i n g we n eedn o t ad dres s res p o nd en t’ s al t ern at i v e p o s i t i on as t o th e i n t eres ti nco m e, o rd i n ary d i v i d en di n co m e, an dcap it al g ai n s at tri b u t ab l e t o W i l s hi re’ s UBS an dFi d el i ty acco u nt s , i
. e., th atth i s i n co m e i s o rd i n ary i n co m e t o p et i t i o n ers .- 2 9 -

[* 2 9 ] th es e p u rp o s es , “ n eg li g en ce” i n cl u d es “ an y fai l u re t o m ak e a reas o n ab l e at t em p tt o co m p l y ” wi th th e i n t ern al rev enu e l aws , “ d is reg ard ” i n cl u d es “ an y carel es s, reck l es s , o r i nt en t i o n al d i s reg ard ”, an dan u n d ers tat em en to f i n co m e t ax i s s ub s t an t i al i f i t ex ceed s th e g reat er o f 1 0 % o f t h e t ax req u i redt o b e s ho wno n th e ret urn fo r t h at t ax ab l e y ear o r $ 5 ,0 0 0
. Sec. 6 6 6 2 (c) an d(d )(1 )(A). As i n d i cat eds up ra p . 1 6 , th e Co m m i s si on er b ears th e b u rd en o f p ro du ct i o n wi th res p ect t o an i nd i v i dual t ax p ay er’ s l iab i l i ty fo r an y p en al ty . Sec. 7 4 9 1(c). In Fro s tv . Co m

m i s s io n er, 1 5 4 T.C. _

_ , _ _ (s l i p o p. at2 0) (J an . 7 , 2 0 2 0), we recen t l y h el dth atth e Co m

m i ss io n er’ s i n i t i al b u rd en o f p ro du ct i o n u n der s ect i o n 7 4 9 1 (c) i n cl u d es p ro du ci n g ev i d en ce t hath e h as co m p li edwi th th e p ro cedural req u i rem en t s o f s ect i o n 6 7 5 1 (b ) an dth ato n ce h e h as s at i s fi edth is i n i t i al b u rd en th e t ax p ay er m

u stco m e fo rwardwi th co nt raryev i d en ce. Sect i o n 6 7 5 1 (b )(1 ) req u i res th atth e i n i t i al d et erm i n at i o n o f cert ai n p en al ti es b e “ p ers o nal l y ap p ro v ed (i n wri t i n g ) b y

the i m m ed iat e s up erv i so r o f t h e i n d iv i du al m ak i ng s u ch d et erm i n at i o n o r s u ch h i g h er l ev el o ffi ci al as th e Secret ary m ay d es i g n at e.” See Graev v . Co m

m i s si o ner (Graev III), 1 4 9 T.C. 4 8 5 , 4 9 2 -4 9 3 (2 0 1 7 ), s up p lem en t i n g
an d o v erru l i n g i n p artGraev v . Co m m i s s i o n er (Graev II), 1 4 7 T.C. 4 6 0 (2 0 1 6 ); s ee al s o Cl ay v . Co m m i s s i on er, 1 5 2 T.C. 2 2 3, 2 4 8 (2 0 1 9) (q uo t i n g s ect i o n 6 7 5 1 (b )(1 )). In Bel ai r W o o d s, LLC v . Co m m i s s i o n er, 1 5 4 T.C. _

_ , _

_ (s l i p o p .- 3 0 -

[* 3 0 ] at2 4 -2 5 ) (J an . 6 , 2 0 2 0 ), we recen t l y h el dth at“ th e ‘ i n i t i al d et erm i nat i o n ’ o f a p en al ty as s es s m en t * * * is em

b o d i ed i n th e d o cu m en tb y wh ich th e Ex am i n at i o n Di v is i o n fo rm al ly

n o ti fi es th e t ax p ay er, i n wri t i n g , th ati th as co m p l et edi ts wo rk
an d m ad e an u n equ iv o cal d eci si o n t o as s ertp en al t i es .” Tri al o f t h i s cas e was h el d , an dth e reco rdwas cl o s ed , b efo re we i s s u ed Graev III an do v erru l edi n p artGraev II (an di s s u edCl ay , Bel ai r W o o ds , an d Fro s t ). In th e l i gh to f Graev III we o rd eredres p o n d en tt o fi l e a res p o n s e ad dres s i n g th e effect o f s ect i o n 6 7 5 1 (b ) o n th i s cas e an dd irect i n g the Co u rtt o an y
ev i d en ce o f s ect i on 6 7 5 1(b ) s up erv i s o ry ap pro v al i n th e reco rdan d p et i t i o n ers t o
res p o n d
. Res p o n d en t was u nab l e t o d i rect th e Co urtt o an y ev i d en ce i n th e reco rd th ats at i s fi es h i s b u rd en o f p ro du ct i o n wi th res pect t o s ect i o n 6 7 5 1 (b )(1 ) an dfi l ed
a m ot i o n t o reo p en th e reco rdt o o ffer i n t o ev id en ce (1 ) t h e d ecl arat i o n o f M r. Dav is , (2 ) t h e M ay 1 , 2 0 1 4 , 3 0 -d ay l et t er t o p et it io n ers thatwas s i g nedb y M r. Dav is , al o n g wi th RA J o h n s o n ’ s ex am i n at i o n rep o rtthatwas (am o n g o th er d o cu m en t s ) en cl o s edwi th th e 3 0 -d ay l et t er, (3 ) th e d ecl arat i o n o f M s . M o o re, an d (4 ) t h e Ci v il Pen al ty

Ap p ro v al Fo rm

th atM s . M oo re s i g n edo n Au g us t4 , 2 0 1 4 , al o n g wi th RA J o h ns o n ’ s “ 5 1 5 W o rk pap ers ” t hatth e fo rm

referen ces . Pet i t i o n ers
o b ject edt o th e i n tro du ct i o n o f an y ad d i t i o nal ev i d en ce wi th res p ectt o the p en al t i es an d req u es t edth atth e Co urtd en y res p on d en t ’ s m o t i on .- 3 1 -

[* 3 1 ] Reo p en in g t h e reco rdfo r t h e s ub m i ss i o n o f ad d i t i o n al ev i d en ce l i es wi th i n th e Co u rt ’ s d i s cret i on . Zen i th Rad i o Co rp . v . Hazel t i n e Res earch , In c., 4 0 1 U.S. 3 2 1 , 3 3 1 (1 9 7 1); Ch i eft ai n In t ’ l (U.S.), In c. v . Se. Offs ho re, In c., 5 5 3 F.3 d8 1 7 , 8 2 0 (5 th Ci r. 2 0 08 ); Co ol ey v . FERC, 8 43 F.2 d 1 4 6 4 , 1 4 7 3 (D.C. Ci r. 1 9 8 8 ); Bu t ler v . Co m

m i s s i o n er, 1 1 4 T.C. 2 76 , 2 8 6 -2 8 7 (2 0 0 0 ); s ee al s o No r-Cal Ad ju s t ers v . Co m

m i s si o ner, 5 0 3 F.2 d 3 5 9 , 3 6 3 (9 th Ci r. 1 9 7 4) (“ [T] h e Tax Co u rt ’ s
ru l i n g [d en y in g a m o t i o n t o reo p en th e reco rd ] i s n o ts ub jectt o rev i ew ex cep tup o n a d em o n s trat i o n o f ex trao rd i naryci rcu m s t an ces wh ich rev eal a cl ear ab u s e o f d i s cret i o n .”), aff’ g T.C. M em o . 1 9 7 1 -2 0 0 . W e wi l l n o t g ran ta m o ti o n t o reo p en th e reco rdu n l es s, am o n g o th er req u i rem en t s , th e ev i d en ce rel i edo n i s n o t m erel y
cu m u l at i v e o r i m

p each i n g, i s m at eri al t o the i ss u es i n v o lv ed , an dp ro b ab ly wo u l d ch an ge s o m e as p ecto f t h e o u t co m e o f t h e cas e. Bu t l er v . Co m m i s s i o n er, 1 1 4 T.C. at2 8 7 ; s ee al s o Ch i eft ai n In t ’ l (U.S.), In c., 5 53 F.3 d at8 2 0 (ex p lai n i n g th attri al
co u rt s , i n d eci d i n g wh et h er t o al l o w a reo p en i n g o f t h e reco rd , s ho u l d“ w ei g h ‘ t h e i m p o rt an ce an dp ro b at i v e v al u e o f t h e ev i d en ce, t h e reas o n fo r t h e m o v i ng p art y ’ s fai l u re t o i nt ro duce t he ev id en ce earl i er, an dth e p o s s ib i l i ty o f p reju d i ce t o th e
n o n -m o v i n g p art y ’ ” (q u ot i n g Garci a v . W o m an ’ s Ho s p . o f Tex ., 9 7 F.3 d 8 10 , 8 1 4 (5 th Ci r. 1 9 9 6 ))); SEC v . Ro gers , 7 9 0 F.2 d 1 4 5 0 , 1 4 6 0 (9 th Ci r. 1 9 8 6) (ex pl ai n i n g th atth e tri al co u rt “ s h o u l dt ak e i n to acco u n t , i n co n si d eri ng a m o t i o n t o h o l do pen- 3 2 -

[* 3 2 ] th e t ri al reco rd , th e ch aract er o f t h e ad d i t i o n al * * * [ev i d en ce] an dth e effect
o f g ran t i n g th e m o t io n ”), ab ro g at ed o n o th er g ro u nd s b y Pi n t er v . Dah l , 4 8 6 U.S. 6 2 2 (1 98 8 ). In rev iewi n g m ot io n s t o reo pen th e reco rd , co u rt s h av e co n s id eredwh en th e
m o vi n g p art y

knew t h ata fact was d i s p ut ed , wh et h er t h e ev id en t i ary i s su e was fo res eeab l e, an dwh et h er t h e m o v i n g p art y h adreas on fo r t h e fai l u re t o p ro du ce th e ev i d en ce earl i er. See, e.g ., Geo rg e v . Co m m i s s io n er, 8 4 4 F.2 d2 2 5 , 2 2 9 -2 3 0 (5 th Ci r. 1 9 8 8 ) (an d cas es ci t edth ereat ) (h o l d i n g thatrefu sal t o reo p en th e cas e
was n otan ab u s e o f d i s cret io n b ecau s e t h e i s su e was fo res eeab l e t o the t ax p ay ers
an d th e co u rtco u l ds ee n o ex cu s e fo r t h e t ax pay ers ’ fai l u re t o p ro du ce ev i d en ce earl ier), aff’ g Fri nk v . Co m m i ss i o n er, T.C. M em o . 1 9 8 4 -6 6 9 . W e al s o b al an ce t he
m o vi n g p art y ’ s d i l ig en ce ag ai n s tth e p o s s i bl e p reju d ice t o th e n o n m ov i ng p art y . In p art i cu l ar we co n s i d er wh et her reo p en i n g th e reco rd aft er t ri al wo u l dp rev en t th e n o nm o v i n g p art y

fro m ex am i n i n g an d qu es t i on i n g th e ev i d en ce as i t wo u l d h av e du ri n g th e p ro ceed in g . See, e.g ., Es tat e o f Freed m an v . Co m m i s s i o n er, T.C. M em o. 2 0 0 7 -6 1 ; M eg ib o w v . Co m m i s s io n er, T.C. M em o . 2 0 0 4 -4 1
. Th e ev i d en ce t h ati s th e s ub jecto f res p on d en t ’ s m o t i o n wo u l dn o tb e
cu m u l at i v e o f an y

ev i d en ce i n th e reco rdan d wo u l d n o t b e i m p each i n g m at eri al
. Res po n d en tb ears th e b u rd en o f p ro du ct i o n wi th res p ectt o p en al t ies an dwo u l d- 3 3 -

[* 3 3 ] o ffer t h e ev i d en ce as p ro o f t h atth e req u i rem en t s o f s ect i o n 6 7 5 1 (b )(1 ) h av e b een m et . Th e s ubjectev id en ce i s m at eri al t o th e i s s u es i n v o l v edi n th e cas e, an d th e o u tco m e o f the cas e as t o th e i s s u e ath an d wi l l b e ch an g edi f we g ran t
res p o n d en t’ s m o t i o n. Pet i t i o ners s t at e wi th o utfu rt h er ex p l an at i o n th atwh et h er t h ey are l i ab l e fo r th e s ect i o n 6 6 6 2 (a) accu racy -rel at edp en al ti es fo r th e y ears ati s s u e “ was rai s edat th e t ri al * * * wi th al l ev i d en ce p res en t edatth e t i m e o f t ri al .” Ho wev er, wh en th i s
cas e was s ub m i t t edan dth e reco rd cl o s ed , Graev III (as wel l as Cl ay , Bel ai r W o o d s , an dFro s t ) h adn o tb een i s s u ed . W e ag ree wi th res p on d en tth atth e
ev i d en ce h e n o w wi s h es t o h av e ad m i t tedi n t o th e reco rd i s n o tcu m u l at i ve an di s
m at eri al t o th e p en al ty i s s u e i n th i s cas e. W e al s o ag ree wi th res p on d en tth atth e 3 0 -d ay l et t er (al o n g wi th th e en cl o s edex am i nat i o n rep ort ) an dth e Ci v i l Pen al t y Ap p ro v al Fo rm

(al o n g wi th th e referen ced“ 5 1 5 W o rk p ap ers ”) are reco rd s k ep t i n th e o rd i n ary

co u rs e o f b us i nes s act i v i ty an dare au th en t i cat edb y th e res p ect i v e d ecl arat io n s o f M r. Dav is an dM s . M o o re. W e wi l l ad m i tth es e d ocu m en t s i n t o
ev i d en ce an dth e d ecl arat i o ns fo r p u rp o s es o f au th en t icat i o n u n d er ru l e 9 0 2 (1 1 ) o f th e Fed eral Ru l es o f Ev i d en ce. See Cl o u g h v . Co m m i s s i o n er, 1 19 T.C. 1 8 3, 1 9 0 -1 9 1 (2 0 0 2 ).- 3 4 -

[* 3 4 ] W e n o wm

u s t d eci d e wh et h er res p o n d en t’ s ev i d en ce i s s u ffi ci en tt o s at i s fy h i s i n i ti al b u rd en o f p ro du ct io n u n d er s ect i o n 6 75 1 (b )(1 ). See Fro s tv . Co m m i s s i o n er, 1 5 4 T.C. at_

_ (s l i p o p . at2 1). Co n s i st en twi th o u r h o l d in g i n Cl ay , th e M ay 1 , 2 0 1 4 , 3 0 -d ay l et t er wi th RA J oh n s o n ’ s ex am i n at i o n rep o rt
em bo d i edth e i n i t i al det erm i n at i o n --i .e., th e fi rs tfo rm al co m m u n icat i o n o f t h e
co n cl u s i o n --t h atas s ert i o n o f t h e s ect i o n 6 6 6 2 (b )(1 ) an d (2 ) p en al t i es ag ai n s t p et i t i o n ers fo r t h e y ears ati s su e were warran t ed . Th e reco rdi n di cat es thatM r. Dav is rev i ewedRA J o hn s o n ’ s ex am i n at i o n rep o rtan d ap p ro v edi t b y s i g n i n g th e 3 0 -d ay l et t er o n M ay

1 , 2 0 1 4 , an dth en th e l et t er was s en t t o p et i t i o n ers l at er t h at
s am e d ay . W e h o l dth atres p o n d en th as i n tro du cedev i d en ce t hatwri t t en
s up erv i s o ry

ap p ro v al o f t h e s ect i o n 6 6 6 2 (b )(1 ) an d (2 ) p en al t i es was g i v en b efo re a fo rm al co m

m u n icat i o n o f t h o s e p en al t i es t o p et i t i o n ers an dth atth e ev i d en ce i s
s u ffi ci en t , as p arto f h i s i n i t i al b u rd en o f p ro du ct i on u n d er s ect i o n 7 4 9 1 (c), t o
s h o w th ath e co m

p li edwi th th e p ro cedu ral req ui rem en t s o f s ect i o n 6 7 5 1(b ). Th e b u rd enn o w s h ift s t o p et i ti o ners t o o ffer ev i d en ce s u g g es t i n g t h at wri t ten s up erv is o ry

ap p ro v al o f t h e p en al t i es was u n t i m el y --i .e., th atth ere was a fo rm al co m

m u n i cat i o n o f t he p en al t i es b efo re th e p ro fferedap p ro val . See Fro s tv . Co m m i s s i o n er, 1 5 4 T.C. at_

_ (s l i p o p . at2 2). Pet i t i o n ers h av e n o t cl ai m ed , n o r d o es th e reco rds up p o rta co n cl u s i on , th atres p o n d en tfo rm al l y co m m u n i cat edh i s- 3 5 -

[* 3 5 ] i n i t i al p en al ty

d et erm i n at i o n t o p et i ti o n ers b efo re M ay 1 , 2 01 4 --t h e d at e t h at M r. Dav i s s i g n edth e 3 0 -d ay l et t er (t h aten cl o sedth e ex am i n at io n rep o rt ). W e th erefo re h o ldth atth e p en al t i es h ere were ap p ro v edi n wri t i n g b efo re t h e fi rs t fo rm al co m

m u n i cat i o n t o p et i t io n ers o f t ho s e p en al ti es . See i d . at_ _ (s l i p o p . at2 3 ) (ci t i ng Cl ay

v . Co m m i ss i o n er, 1 52 T.C. at2 4 9 ). Res p o n d en th av i n g co m

p l i edwi th th e requ i rem en t s o f s ect i o n 6 7 5 1 (b )(1 ),
we n o w tu rn t o th e rem ai n d er o f h i s i n i t i al b u rd en o f p ro du ct i o n u n der s ect i o n 7 4 9 1 (c). Res p o n d en t’ s p en al ty p o s i ti o n i s th at p et it io n ers are l i ab l e fo r n eg l i g en ce p en al t i es u n d er s ect i o n 6 6 6 2 (b )(1 ), o r, i n th e al t ern at i v e, s ub s t an t i al
u n d ers t at em en tp en al t ies un d er s ect i o n 6 6 6 2(b )(2 ) fo r th e y ears ati s s u e. On l y o n e
accu racy -rel at edp en al ty

m ay b e ap pl i ed wi th res p ect t o an y g i ven p o rt i o n o f an
u n d erp aym en t , ev en i f t h atp ort i o n i s s ub jectt o the p en al ty

o n m ore t han o n e g ro u nd . Sec. 1 .6 6 6 2 -2 (c), In co m e Tax Reg s . W e n eedo n ly ad dres s res po n d en t ’ s cl ai m th atp et i ti o n ers are l i ab l e fo r s ub s t an t i al u n d ers t at em en tp en al t i es b ecau s e h e h as p ro v i d eds u ffi ci en t ev i den ce s h o wi n g th atp et i t i o ners ’ u n d ers t at em en t o f i n co m e t ax fo r each o f th e y ears ati s s u e ex ceed s th e g reat er o f 1 0 % o f t h e t ax- 3 6 -

[* 3 6 ] req u i red t o b e s h o wno n th ei r jo i n t Fed eral i n co m e t ax retu rn s fo r t h os e y ears o r $ 5 ,0 00
. 1 9 Ap p li cat i o n o f t h e s ubs t an t i al u n d ers t at em en tp en al ty m ay b e av o i d edwi t h
res p ectt o an y

p ort i on o f anu n d erp aym en ti f t h e t ax p ay er s ho ws thath e act edi n g o o dfai th wi th res p ectt o s u ch p o rt i o n an dthatth ere i s reas o n ab l e cau s e fo r s u ch p o rt i on . See s ec. 6 6 64 (c)(1 ); Hi g b ee v . Co m m i s s i o ner, 1 1 6 T.C. 4 3 8 , 4 4 6 -4 4 7 (2 0 0 1). Th e d et erm i nat i o n o f wh et h er t h ere i s reas on ab le cau s e an dth e t ax p ay er act edi n g o o dfai th d ep en ds up o n th e p ert i n en t fact s an d ci rcu m s tan ces o f a p art i cu l ar cas e. Sec. 1 .6 6 6 4 -4 (b )(1 ), In co m e Tax Reg s . W e co n s i d er, am o n g o t h er fact ors , th e ex p eri en ce, edu cat i o n , an ds o ph i s t i cat i o n o f t he t ax p ay er, an dth e t ax p ay er’ s rel ian ce o n t h e ad v ice o f a p ro fes s i o n al . Id
. Reas o n ab l e cau se m ay
ex i s t wh ere t h e t ax pay er rel i es o n p ro fes s i o n al ad v ice i f t he t ax p ay er p ro v es b y a

1 9 Pet i t i o ners ’ i n co m e t ax was u n ders t at edb y $ 9 ,3 8 4 , $ 20 ,1 4 3 , an d$ 3 1 ,9 3 8 fo r 2 0 0 6 , 2 0 07 , an d 2 0 0 8 , res p ect iv el y ; as d et erm in edi n th e Oct o ber 1 , 2 0 1 4 , n o t i ce o f d efi ci en cy

t o p et i ti o n ers , th ei r u nd ers t at em en t s o f i n co m e t ax fo r t h e y ears ati s s u e were s ubs t an ti al . W e n o t e th atp et i t i o n ers ’ u n d ers t at em en t s o f i n co m e t ax fo r 2 0 0 6 an d2 0 0 8 rem ai n s ub s t an t ial ev enaft er t ak i n g i nt o co n si d erat io n res p o n den t ’ s co n ces s i on wi th res p ectt o th ei r wag e i n co m e fo r 2 0 0 6 an d th e i s s u es we h av e d eci d edi n p et i t i o n ers ’ fav or fo r 2 0 0 8 . W e fu rt her n o t e t h at res p o n d en t al s o d em o n s trat edth atp et i t i o n ers act edn eg l i g en tl y fo r t he y ears at i s su e b ecau s e t h e reco rdb efo re u s cl earl y s h o ws , s ee s up ra p p. 1 8 -2 1 , th at p et i t i o n ers fai l edt o m ai nt ai n b o o k s o r reco rd s s u ffi ci en tt o accu rat el y refl ectth ei r i n co m e (an ds ub s tan t i at e t h ei r cl ai m edNOLs ), s ee s ec. 1 .6 6 6 2 -3 (b )(1 ), In co m e Tax Reg s . (p ro v i d i ng th at n eg li g en ce i n cl u d es an y fai l ure b y

a t ax p ay er t o k eep ad equat e b o ok s an dreco rd s o r t o s ub s t an t i at e i t em s p ro p erl y ).- 3 7 -

[* 3 7 ] p rep o n d eran ce o f ev i den ce t h at : (1 ) t h e ad v i s er was a co m p et en t p ro fes s i on al wh o h ads u ffi ci en tex p ert i s e t o ju s t i fy th e t ax pay er’ s rel i an ce o n h i m
o r h er; (2 ) t h e t ax p ay er p ro v i d edn eces s ary an d accu rat e i n fo rm at i o n t o th e ad v is er; an d(3 ) t h e t ax p ay er actu al l y rel i edi n g o o dfai th o n the ad v i s er’ s ju d g m en t . Neo n at o l o g y

As s o cs ., P.A. v . Co m

m is si o n er, 1 1 5 T.C. 4 3 , 9 9 (2 0 0 0 ), aff’ d , 2 9 9 F.3 d2 2 1 (3 dCi r. 2 0 0 2 ); s ee al s o Es t at e o f Tem p le v
. Co m

m i s s io n er, 6 7 T.C. 1 4 3 , 1 6 2 (1 9 7 6 ) (“ Wh i l e a t ax p ay er’ s rel i an ce upo n h i s acco u nt an tt o p rep are
accu rat e retu rn s m ay

i n d i cat e an ab s en ce o f frau du l en ti n ten t , * * * th i s i s tru e i n th e fi rs ti n st an ce o n l y if t h e acco u nt an th as b een s up p l i edwi th al l th e i n fo rm at i o n
n eces s ary t o p rep are t h e ret urn s.”). Pet i t i o ners co n t en dth atth ey qual i fy fo r th e reas o n ab l e cau s e d efen s e b ecau s e th ey

h ireda U.S. C.P.A. (i .e., M s . Lu n a) t o p rep are an dfi l e t h ei r jo i n t Fed eral i nco m e t ax return s fo r t h e y ears ati s s u e an dth ey “ reas o n ab l y

rel i edo n [h er] reg ard i n g al l o f * * * [t hei r] b us i nes s en t i t i es ”, h av i n g d i s cl o s ed“ al l i n fo rm at i o n ” t o h er. Th ei r co n t en t i o n l ack s m eri t . Si m p l y em pl oy i n g a t ax retu rn p rep arer fo r t h e y ears at i s s u e d o es n o tp erm i t p et i t i o n ers t o av oi daccu racy -rel at ed p en al t i es . See Neo n at o lo gy As s o cs ., P.A. v
. Co m

m i s s io n er, 1 1 5 T.C. at9 9
. Fu rt h erm o re, t he reco rds h o ws th atM r. Fl u m e ack n o wl ed g edth ath e d i dn o tkn o w wh et h er M s . Lun a h adth e n eces s ary ex p ert i se t o p ro v i d e p et i t i o n ers wi th U.S. t ax- 3 8 -

[* 3 8 ] ad vi ce an d to p rep are t h ei r jo i n tretu rn s fo r t h e y ears at i s s u e. M o reo v er, t h e
reco rds h o ws th atp et i t i o n ers i n factfai l ed t o p ro v i de M s . Lu na wi th co m p let e i n fo rm at i o n as M r. Fl u m e al s o ack n owl ed gedth atM s . Lun a, i n p rep ari n g t h es e retu rn s , d i dn o t kn o w th atth ey h el do wn ers h i p i nt eres t s i n an y fo rei g n co rp o rat i o n
o th er t han FFM an d t h atth ey d i dn o tad v i s e h er t hatth ey h ads o l e s i gn atu re
au th o ri ty o v er fo rei g n b an kacco u nt s , o ther t han th o s e h el di n M ex i co , u n t i l
s o m et i m e i n 2 0 0 8 (o r 2 0 0 9 ). W e t h erefo re fi n dth atp et i ti o n ers d i d n otrel y o n M s. Lu n a’ s “ ju d g m en t ” (l etal o ne reas o n ab l y rel y o n h er “ ju d g m en t ”), n o r d i dth ey act i n g o o d fai th . Pet i t i o n ers h av e fai l edt o p ro v e t h atth ey h adreas o n ab le cau s e wi th i n th e m ean i n g o f s ect i on 6 6 64 (c). Acco rd i ng l y , we s u s tai n res p o n d en t ’ s d et erm i n at i o n reg ard i n g the accu racy -rel at edp en al ti es . W e h av e co n s id eredal l o f t h e arg um en t s m ad e b y th e p art i es an d , t o th e
ex t en tth ey

are n o tad dres s edh erei n , we fi n dth em t o b e m o o t , i rrel ev an t, o r wi th o u tm eri t . To refl ectthe fo reg o i n g , Anap p ro p ri at e o rd er wi ll b e i s s u ed , an dd eci s i on wi l l b e en t ered
u n der Ru l e 1 5 5
.