internal_revenue_service number release date index number ---------------------- ------------------------------- ----------------------------------------------------- department of the treasury washington dc third party communication none date of communication not applicable_person to contact ------------------------ id no -------------- telephone number --------------------- refer reply to cc ita plr-128583-08 date date legend taxpayer ex-spouse the couple court year the agreement ------------------------------------------------------------------------------------------------------------------ ----------------- ------------------ ----------------------------------------------------- ----------------------------------------------------------- ------------------- --------------------------------------------------------------------------------- year dollar_figures year year ---------------------------------------------------------------------------------------------------------- ----------------------------------------------- ----------------- --------- ---------------------- --------------------------------------------------------------------------------- dear ------------- this ruling responds to a letter dated year submitted by your authorized representative requesting a ruling that payments made by taxpayer to ex-spouse collectively the couple pursuant to an agreement incorporated into the couple’s final judgment of dissolution of marriage with minor child ren the final judgment constitute alimony as the term is defined by sec_71 of the internal_revenue_code and are deductible under sec_215 of the code facts the couple negotiated the terms of their divorce and memorialized their discussions through a written_agreement entitled the agreement the couple were divorced under florida law by the court the court entered the final judgment on year the court ratified and incorporated the agreement into the final judgment plr-128583-08 in the agreement taxpayer promises to make monthly alimony payments to ex- spouse of at least dollar_figures per month subject_to certain increases based on taxpayer’s gross salary and bonuses the agreement provides in relevant part that taxpayer has agreed to pay ex-spouse alimony in the form of a monthly check given to ex-spouse on the 1st day of each month the first payment shall begin on year and shall continue until year which will signify taxpayer’s final payment the agreement does not contain any language mandating that the alimony payments continue after taxpayer or ex-spouse’s death however the alimony payments terminate if ex-spouse remarries within the period of time during which she is to receive alimony payments from taxpayer taxpayer represents that the couple agreed though not in writing that ex-spouse would include the alimony in her gross_income and taxpayer would be entitled to deduct the payments the couple are not members of the same household law and analysis sec_215 provides that in the case of an individual there shall be allowed as a deduction an amount equal to the alimony or separate_maintenance payments paid during such individual's taxable_year sec_215 provides for purposes of sec_215 the term alimony_or_separate_maintenance_payment means any alimony_or_separate_maintenance_payment as defined in sec_71 which is includible in the gross_income of the recipient under sec_71 sec_71 defines alimony as any payment in cash if a such payment is received by or on behalf of a spouse under_a_divorce_or_separation_instrument b the divorce_or_separation_instrument does not designate such payment as a payment which is not includible in gross_income under this section and not allowable as a deduction under sec_215 c in the case of an individual legally_separated from his spouse under a decree of divorce or of separate_maintenance the payee spouse and the payor spouse are not members of the same household at the time such payment is made and plr-128583-08 d there is no liability to make any such payment for any period after the death of the payee spouse and there is no liability to make any payment in cash or property as a substitute for such payments after the death of the payee spouse a payment must meet all the factors set forth in sec_71 to qualify as alimony as such if after the death of the payee spouse the payor spouse must continue making payments none of the payments made before or after death constitute alimony as defined by sec_71 notice_87_9 1987_1_cb_421 provides that divorce or separate_maintenance instruments executed after date need not expressly state that the payor spouse's liability terminates upon the death of the payee spouse if the termination would occur by operation of state law see also 102_f3d_842 6th cir holding that federal courts look to the state family law if the divorce decree is silent on the issue of whether payments terminate upon payee spouse’s death since the agreement does not expressly state that taxpayer’s liability to ex-spouse terminates upon ex-spouse’s death florida state law dictates whether taxpayer’s alimony payments terminate upon ex-spouse’s death sec_61 of the florida statutes provides in relevant part that i n a proceeding for dissolution of marriage the court may grant alimony to either party which alimony may be rehabilitative or permanent in nature in any award of alimony the court may order periodic_payments or payments in lump sum or both sec_61 indicates that under florida law alimony may be rehabilitative permanent or lump sum in florida the legal effect of alimony payments is determined not by what the payment is called but what it does boyd v boyd so 2d fla dist ct app citing underwood v underwood so 2d fla karch v karch so 2d fla dist ct app zuccarello v zuccarello so 2d fla dist ct app the florida statutes do not indicate the legal effect of each type of alimony payment thus florida case law must provide the legal effect of the three types of alimony payments lump sum alimony is a fixed and certain amount the right to which is vested in the recipient and which is not therefore subject_to increase reduction or termination in the event of any contingency specifically including those of death or remarriage boyd so 2d pincite fla dist ct app citing storer v storer so 2d fla dist ct app cann v cann so 2d fla dist ct app seale v seale so 2d fla dist ct app filipov v filipov so 2d fla dist ct app holding that an award of lump-sum alimony creates a vested right which survives death and is not terminable on the recipient party’s remarriage lump sum alimony can be payable in installments or in a lump sum paid in full morris v plr-128583-08 morris so 2d fla dist ct app citing chester v chester so 2d fla dist ct app permanent and rehabilitative alimony are both types of periodic alimony see kirchman v kirchman so 2d fla dist ct app as a general_rule permanent and rehabilitative periodic alimony terminate upon death of either spouse or remarriage of the receiving spouse canakaris v canakaris so 2d fla holding that permanent periodic alimony is terminated upon death of either spouse or remarriage of receiving spouse citing the first national bank st petersburg v ford so 2d fla in re estate of freeland so 2d fla kirchman so 2d pincite indicating that rehabilitative alimony also terminates upon death of either spouse or remarriage of receiving spouse the payments made by taxpayer to ex-spouse constitute periodic alimony and thus terminate upon ex-spouse’s death taxpayer’s payments to ex-spouse are analogous to the alimony payments in morris v morris so 2d in morris the court found that weekly payments of dollar_figure were periodic alimony payments because the payments were subject_to termination in the event of the payee spouse’s remarriage id pincite the court found that although lump sum alimony may be properly paid in installments the contingencies present in the couple’s divorce decree made the award periodic alimony not lump sum id in this case the agreement like the divorce decree in morris provides that the payments terminate if ex-spouse remarries moreover taxpayer’s alimony payments are subject_to increase based on taxpayer’s salary and bonuses lump sum alimony is a fixed amount not subject_to increase reduction or termination in the event of any contingency boyd so 2d pincite taxpayer’s alimony payments are subject_to termination in the event of ex-spouse’s remarriage and are subject_to increase based on taxpayer’s salary and bonuses therefore the payments fit the definition of periodic alimony since periodic alimony payments terminate upon either spouse’s death the alimony paid_by taxpayer to ex-spouse will terminate upon her death and thus qualifies as alimony under sec_71 and may properly be deducted by taxpayer under sec_215 this ruling is directed only to the taxpayer requesting it sec_6110 of the code provides that it may not be used or cited as precedent in accordance with the power_of_attorney on file with this office a copy of this letter is being sent to your authorized representative a copy of this letter must be attached to any income_tax return to which it is relevant alternatively taxpayers filing their returns electronically may satisfy this requirement by attaching a statement to their return that provides the date and control number of the letter_ruling plr-128583-08 the rulings contained in this letter are based upon information and representations submitted by the taxpayer and accompanied by a penalty of perjury statement executed by an appropriate party while this office has not verified any of the material submitted in support of the request for rulings it is subject_to verification on examination sincerely christopher f kane branch chief branch income_tax accounting cc


t c memo united_states tax_court sugar land ranch development llc sugar land advisors llc tax_matters_partner petitioner v commissioner of internal revenue respondent docket no filed date george w connelly jr and rita renee huey for petitioner candace m williams and carol bingham mcclure for respondent memorandum findings_of_fact and opinion thornton judge pursuant to section respondent issued a notice of final_partnership_administrative_adjustment fpaa for to sugar land 1all section references are to the internal_revenue_code in effect at all relevant times and all rule references are to the tax_court rules_of_practice and procedure unless otherwise indicated monetary amounts are rounded to the nearest dollar acreages are rounded to the nearest tenth of an acre advisors llc sla the tax_matters_partner of sugar land ranch development llc slrd the fpaa recharacterizes net gains from slrd’s sales of two parcels of real_property in from capital_gains to ordinary_income all other adjustments are computational petitioner filed a timely petition contesting these adjustments findings_of_fact slrd was established as a texas limited_liability_company on date it was formed principally to acquire contiguous tracts of land in sugar land texas just southwest of houston and to develop that land into single- family residential building lots and commercial tracts on or about date slrd purchased approximately acres an additional acres was conveyed to slrd on or about date we sometimes refer to all this acreage collectively as the property 2when the petition was filed texas was the principal_place_of_business for slrd 3slrd is owned by sugar land holding corp slhc and sla slhc is owned by lawrence wong and rocky lai sla is owned by omni investments lp and larry johnson omni investments lp is owned by larry johnson’s spouse suzanne johnson and omni investments gp llc omni investments gp llc is owned by larry johnson and suzanne johnson the property had formerly been an oil field and was west of and adjacent to the riverstone master-planned community riverstone community which was being developed by parties related to slrd slrd’s original plan was to clean up the property and subdivide it into residential units for inclusion in the riverstone community to that end between and slrd capped oil wells removed oil gathering lines did some environmental cleanup built a levee and entered into a development agreement with the city of sugar land texas which specified the rules that would apply to the property should it be developed slrd sold or otherwise_disposed_of relatively small portions of the property between and the acres slrd continued to own as of were contiguous but divided by three easements the first easement the hlp easement ran generally from north to south near the eastern end of the property the second easement was for a planned road university boulevard and ran from east to west finally there was an easement for a levee running generally from north to south near the western end of the property 4the record does not disclose what hlp stands for though we note that it resembles the acronym for houston lighting power 5by slrd had sold or conveyed all the land east of the hlp easement apparently to related parties the tax treatment of the parcels east of the hlp easement is not in dispute although respondent argues that the characterization of continued the land west of the hlp easement consisted of four large parcels the westernmost parcel comprised all the land below the levee ie on the river side of the levee it was eventually conveyed to the city of sugar land the remaining three parcels comprising all the acreage between the levee and the hlp easement --a total of approximately acres were sold to a major homebuilder taylor morrison of texas inc taylor morrison in and we will refer to these parcels as tm-1 tm-2 and tm-3 collectively the tm parcels late in the managers of slrd--larry johnson and lawrence wong-- decided that slrd would not attempt to subdivide or otherwise develop the property it held from their long experience in the real_estate development business they believed that slrd would be unable to develop subdivide and sell continued the gains or losses from those sales is relevant to determining the tax treatment of the sales which are at issue 6this parcel appears to have been approximately acres and seemingly could not be developed because it was below ie on the river side of the levee other small portions of the property adjacent to the levee were also conveyed to the city of sugar land 7tm-1 wa sec_110 acres it abutted the hlp easement to the east and ran from university boulevard north to the property line tm-2 was acres and comprised the entire area south of university boulevard between the levee and the hlp easement tm-3 wa sec_73 acres it abutted tm-1 to the east and the levee to the west and ran from university boulevard north to the property line residential and commercial lots from the property because of the effects of the subprime mortgage crisis on the local housing market and the scarcity or unavailability of financing for housing projects in the wake of the financial crisis instead messrs johnson and wong decided that slrd would hold the property as an investment until the market recovered enough to sell it off these decisions were memorialized in a unanimous consent document dated date signed by messrs johnson and wong as well as in an slrd member resolution adopted on date to further clarify slrd’s policy between and the tm parcels just sat there as mr johnson credibly testified that is slrd did not develop those parcels in any way slrd did not list the tm parcels with any brokers or otherwise market the parcels because slrd’s managers believed that there was no market for large tracts of land on account of the subprime mortgage crisis in taylor morrison approached slrd about buying tm-1 and tm-3 ie the acres between the levee and the hlp easement and north of university boulevard taylor morrison ultimately decided to buy all three tm parcels slrd sold tm-1 to taylor morrison in and tm-2 and tm-3 to 8the sale is not at issue in this case respondent asserts that slrd reported the gains from the sale as ordinary_income although the record is continued taylor morrison on december and respectively slrd and taylor morrison executed two sale contracts for this purpose one sale contract tm-3 contract which was executed by slrd and taylor morrison provided for the sale of tm-1 and tm-3 in and respectively the second sale contract tm-2 contract which was executed by slrd taylor morrison and hillsboro estates llc a third party apparently related to slrd provided for the sale of tm-2 in and for the sale of a property directly to the south of tm- which was owned by hillsboro estates llc the tm-2 and tm-3 contracts each called for taylor morrison to pay a lump sum to slrd in for the largely undeveloped tm-2 and tm-3 parcels the tm-2 contract also provided that taylor morrison was obligated to pay slrd of the final sale price of each future home eventually developed and sold out of tm-2 the tm-2 contract specified that each payment would accrue when each home sale closed slrd was also to receive dollar_figure for each plat recorded on tm-2 unlike the tm-2 contract the tm-3 contract did not provide for a per-home payment but did provide for a payment of dollar_figure for each plat recorded on tm-3 the tm-2 and tm-3 contracts also listed other development continued inconclusive on this point obligations for which the parties were responsible these development obligations fell almost entirely on taylor morrison no part of the payments received by slrd from taylor morrison in included either the per-home or per-plat fees provided for in the tm-2 and tm-3 contracts that is the net gain at issue in this case represents only the lump- sum payments slrd received in for the largely undeveloped tm-2 and tm- parcels respondent has not argued nor does the record suggest that the lump sums slrd received in represent payment for anything other than the fair_market_value of the largely undeveloped tm-2 and tm-3 parcels after commencing the sale of the tm parcels slrd decided to close out its property holdings by conveying the remainder of its property to related parties except for land that was eventually conveyed to the city of sugar land for no consideration and except for a one-acre parcel that appears to have been sold to a county in four sales in and these parcels were all to the east of the hlp easement and were and acres respectively these parcels were ultimately included in the riverstone community and appear to have been developed by parties related to slrd the record contains slrd’s forms u s return of partnership income for and on these three returns slrd stated that its principal business activity was development and that its principal product or service was real_estate on it sec_2012 form_1065 slrd reported an dollar_figure capital_gain from its sale of the tm-2 parcel and a dollar_figure capital_loss from its sale of the tm-3 parcel in the fpaa respondent determined that the aggregate net_income from these two transactions should be taxed as ordinary_income opinion in this proceeding we review under sec_6226 respondent’s adjustments to slrd’ sec_2012 partnership return the commissioner’s adjustments in an fpaa are generally presumed correct and the taxpayer bears the burden of proving those adjustments erroneous rule a 107_tc_94 the issue presented is whether slrd’s sales of the tm-2 and tm-3 parcels should be treated as giving rise to capital_gains or ordinary_income a capital 9our jurisdiction is limited to determination of partnership items allocation of partnership items among the partners and the applicability of any penalty addition_to_tax or additional_amount which relates to an adjustment to a partner- ship item sec_6226 the only issue in this case is whether net_proceeds of two of slrd’s sales in should be treated as capital_gains or ordinary_income items of gain of the partnership are partnership items sec_301 a - a i proced admin regs see sec_6231 therefore we have jurisdiction over the issue presented in this case asset is property held by the taxpayer whether or not connected with his trade_or_business but excludes among other things inventory and property held by the taxpayer primarily_for_sale_to_customers in the ordinary_course_of_his_trade_or_business sec_1221 the court_of_appeals for the fifth circuit--the court to which this case is appealable absent a stipulation to the contrary see sec_7482 e --has held that the three principal questions to be considered in deciding whether gain is capital in character are w as taxpayer engaged in a trade_or_business and if so what business w as taxpayer holding the property primarily for sale in that business and w ere the sales contemplated by taxpayer ‘ordinary’ in the course of that business 615_f2d_171 5th cir the court_of_appeals for the fifth circuit has also indicated that various factors may be relevant to these inquiries the frequency and substantiality of sales of property the taxpayer’s purpose in acquiring the property and the duration of ownership the purpose for which the property was subsequently held the extent of developing and improving the property to increase the sales revenue the use of a business office for the sale of property the extent to which the taxpayer used advertising promotion or other activities to increase sales and the time and effort the taxpayer habitually devoted to the sales see id pincite see also 960_f2d_526 5th cir rev’g tcmemo_1990_296 526_f2d_409 5th cir 417_f2d_905 5th cir 54_tc_1278 frequency and substantiality of sales is the most important factor suburban realty f 2d pincite i capital character of net gains from sales the parties agree that slrd was formed to engage in real_estate development--specifically to acquire the property and develop it into single- family residential building lots and commercial tracts the record supports this conclusion slrd’s tax returns the development agreement slrd’s formation documents and the testimony of messrs johnson and wong all clearly show that slrd originally intended to be in the business of selling residential and commercial lots to customers but the evidence also clearly shows that in slrd ceased to hold its property primarily for sale in that business and began to hold it only for investment slrd’s partners decided not to develop the property any further and they decided not to sell lots from those parcels this conclusion is supported by the highly credible testimony of messrs johnson and wong and by the unanimous consent and the member resolution in fact from on slrd did not develop or sell lots from those parcels and the evidence does not suggest that slrd ever sold even a single residential or commercial lot to a customer at any point in its existence respondent concedes that slrd never subdivided the property more particularly when the tm parcels were sold they were not sold in the ordinary course of slrd’s business slrd did not market the parcels by advertising or other promotional activities slrd did not solicit purchasers for the tm parcels nor does any evidence suggest that slrd’s managers or members devoted any time or effort to selling the property taylor morrison approached slrd most importantly sale of the tm parcels was essentially a bulk_sale of a single large and contiguous tract of land which was clearly separated from any other properties by the hlp easement and the levee to a single seller--clearly not a frequent occurrence in slrd’s ordinary business because the taylor morrison parcels were held for investment and were not sold as part of the ordinary course of slrd’s business we hold that net gains from the sales of tm-2 and tm-3 were capital in character ii respondent’s arguments respondent argues that the extent of development of the tm parcels shows that these properties were held primarily for sale in the ordinary course of slrd’s business we are not persuaded it is clear that from to sometime before slrd developed the property to a certain extent but it is also clear that in slrd’s managers decided not to develop those parcels into a subdivision and decided not to market the land as it ordinarily would have as the court_of_appeals for the fifth circuit held in suburban realty f 2d pincite a taxpayer is entitled to show that its primary purpose changed to or back to ‘for investment ’ slrd has made such a showing any development activity that occurred before the marked change in purpose in including whatever respondent thinks was reported on slrd’s and forms is largely irrelevant respondent also argues that the frequency of sales along with the nature and extent of slrd’s business shows that gains from the sale of the tm parcels should be ordinary in character but slrd’s sales were infrequent and the extent of slrd’s business was extremely limited after slrd disposed of its entire property in just nine sales over eight years not counting conveyances to the city of sugar land for which slrd received no consideration cf 705_f2d_1418 5th cir holding that although the taxpayer made sales over a three-year period the taxpayer did not hold the property for sale moreover the tm parcels had not been developed into a subdivision when they were sold and little or no development activity occurred on those parcels for at least three years before sale in any event respondent’s description of the pattern of sales after is inconsistent with the record the tm parcels were on the western side of the hlp easement and were all sold to taylor morrison in a three-part transaction beginning in all of the other parcels sold by slrd ie parcels other than the tm parcels were on the east side of the hlp easement and appear to have been conveyed to related parties with the exception of a one-acre parcel sold to a county the balance of the property was conveyed for no consideration rather than sold to the city of sugar land at various times in sum leaving aside the land that was conveyed for public use after slrd sold all of the undeveloped property west of the hlp easement well over half its property holdings in a single extended transaction to a single buyer taylor morrison and sold the remainder all of which was to the east of the hlp easement to related entities respondent seems to suggest that we should impute to slrd development activity which he says was performed on the eastern parcels by related parties respondent has not pointed us to legal authority or any evidence in support of this position the caselaw appears to be to the contrary see bramblett v commissioner f 2d pincite rejecting argument that activities of corporation in selling and developing land should be attributed to partnership whose partners held ownership interests in the corporation phelan v commissioner tcmemo_2004_206 similar but even if we were to assume for the sake of argument that slrd had substantial development activity on or active and continuous sales from the eastern parcels by imputation or otherwise nevertheless--in the absence of a connection between the eastern parcels and the tm parcels--we are not persuaded that the bulk_sale of the tm parcels would have been in the ordinary course of slrd’s alleged development business considering that all development activity had been halted on the tm parcels at least three years before the sales at issue and that the tm parcels were never developed into a subdivision by slrd as the court_of_appeals for the fifth circuit noted in suburban realty f 2d pincite n if a taxpayer who engaged in a high volume subdivision business sold one clearly segregated tract in bulk he might well prevail in his claim to capital_gain treatment on the segregated tract that is precisely what happened here the tm parcels were clearly segregated from the other parcels by the levee and hlp easement and were sold in bulk to a single buyer respondent argues that there was a connection between the tm parcels and the parcels east of the hlp easement they were all covered by the same development agreement with the city of sugar land taylor morrison agreed to develop the tm parcels in accordance with various restrictions in the land sale deal and slrd was to receive certain payments whenever certain conditions were met we think however that the facts respondent points out are either irrelevant to the adjustment in the fpaa or consistent with investment intent for example there would have been no reason to undo or even modify the development agreement after deciding not to develop the tm parcels there seems to be little doubt that the highest_and_best_use of this land was for development into residential and commercial lots any buyer would likely have been a developer of some kind maintenance of the development agreement was therefore consistent with both development intent and investment intent cf suburban realty f 2d pincite s tanding alone some degree of development activity is not inconsistent with holding property for purposes other than sale as for the restrictions we conclude that they were directed at ensuring that taylor morrison assumed any obligations or liabilities relating to the tm parcels and at ensuring that taylor morrison’s actions would not decrease the value of the riverstone community as a whole such restrictions are not inconsistent with investment intent--a seller of property whether an investor or a dealer might reasonably draft the sale agreement so as to ensure that it would not retain personal liability with respect to the property or to ensure that the buyer would not decrease the value of adjoining properties the seller continues to hold finally the additional payments provided for in the tm-2 and tm-3 contracts are largely irrelevant to the adjustment at issue in this case while it is true that the tm-2 and tm-3 contracts provided for various additional payments when a plat was recorded or when a home sale closed the nature of these additional payments does not illuminate the character of the net gain at issue in this case respondent has not argued nor does the record suggest that either the lump sums paid in for the tm-2 and tm-3 parcels or any of the additional payments were incorrectly priced in the land sale contract additionally it is clear from the record that the payments received by slrd in for the tm-2 and tm-3 parcels did not include any additional per-lot or per-home payments nor does the record support a conclusion that any additional per-lot or per-home payments accrued in consequently even if we were to assume that the additional payments would be treated as ordinary_income if and when they should accrue that circumstance would shed little light on the character of the net gain recognized in because the net gain included no such additional payments we also note that nothing in the land sale agreement or in the record generally suggests that slrd was under any obligation to develop the tm parcels after the sale next respondent points out that on it sec_2012 form_1065 slrd listed its principal business activity as development and its principal product or service as real_estate although this circumstance may count against petitioners to some limited degree we believe that these statements are by no means conclusive of the issue see suburban realty f 2d pincite considering the record as a whole we are inclined to believe that these stock descriptions were inadvertently carried over from earlier returns finally on brief respondent asserts in passing that a stipulated schedule of slrd’s capitalized expenses shows that slrd continued to incur development expenses up until it sold the taylor morrison land but the record as a whole clearly shows that the tm parcels were not developed between and the sale to taylor morrison and respondent concedes that slrd never subdivided the tm parcels or any of its property also most of the post-2008 expenditures on the schedule of capitalized expenditures are either consistent with investment intent or appear to have been incurred with respect to parcels other than the tm parcelsdollar_figure for these reasons we accord the listing of capitalized expenses little weight--certainly not enough to override the factors in slrd’s favor such as the infrequency of sales by slrd which is the most important factor in our analysis see suburban realty f 2d pincite therefore on the basis of all the evidence we conclude that slrd was not engaged in a development business after and held the tm-2 and tm-3 properties as investments accordingly we hold that slrd properly characterized the gains and losses from the sales of these properties as income from capital assets to reflect the foregoing decision will be entered for petitioner 10there are two expenditures in and dollar_figure and dollar_figure respectively which are listed as management development fees neither party has offered an explanation for these fees but considering that similar fees were paid consistently each year from to and then were not paid again until and when taylor morrison offered to purchase the tm parcels it seems most likely that the and fees if they even related to the tm parcels were incurred as part of the sale process rather than as part of a continuing effort to develop the tm parcels


internal_revenue_service department of the treasury number release date index number washington dc person to contact telephone number refer reply to cc psi b01-plr-109834-00 date date legend x d1 this responds to a letter dated date together with subsequent correspondence submitted on behalf of x requesting relief under sec_1362 of the internal_revenue_code facts x was incorporated on d1 x intended to be treated as an s_corporation for federal_income_tax purposes effective on d1 but the s election was not timely filed law and analysis sec_1362 provides that a small_business_corporation may elect to be an s_corporation sec_1362 provides the rule on when an s election will be effective if an s election is made within the first two and one-half months of a corporation’s taxable_year then the corporation will be treated as an s_corporation for the year in which the election is made if the election is made after the first two and one-half months of a corporation’s taxable_year then the corporation will not be treated as an s_corporation until the taxable_year after the year in which the s election is made sec_1362 provides that if no election is made pursuant to sec_1362 or if made the election is made after the date prescribed for making such an election and the secretary determines there was reasonable_cause for the failure to timely make the election then the secretary may treat such an election as timely made for such taxable_year and effective as of the first day of that tax_year x did not file a timely election to be treated as an s_corporation under sec_1362 plr-109834-00 effective on d1 x has however established reasonable_cause for not making a timely election and is entitled to relief under sec_1362 conclusion based solely on the facts submitted and representations made and provided that x otherwise qualifies as a subchapter_s_corporation we conclude that x will be recognized as an s_corporation effective d1 within days from the date of this letter x should submit a properly completed form_2553 with a copy of this letter attached to the relevant service_center except as expressly provided herein no opinion is expressed or implied concerning the tax consequences of any aspect of any transaction or item discussed or referenced in this letter specifically no opinion is expressed concerning whether the original election made by x to be treated as an s_corporation was a valid election under sec_1362 this ruling is directed only to the taxpayer s requesting it sec_6110 of the code provides that it may not be used or cited as precedent s dianna k miosi sincerely chief branch associate chief_counsel passthroughs and special industries enclosures copy of this letter copy for sec_6110 purposes


internal_revenue_service number release date index number ----------------------- --------------------------------------- ----------------------------- ---------------------------- - department of the treasury washington dc third party communication none date of communication not applicable_person to contact ------------------------ id no ------------- telephone number --------------------- refer reply to cc psi b03 plr-139061-04 date date legend x --------------------- ----------------------- state -------------------- ------------------------------------------------------------------------------------------------------ y ------------------------------------------------------------------------------------------------------ a b c d e d1 d2 --------------------------- --------------------------- --------------------------- ------------------------------------------------------------------------------------------------------ ------------------------------------------------------------------------------------------------------ ------------------------------------------------------------------------------------------------------ ------------------------------------------------------------------------------------------------------ --------------------------- ------------------------------------------------------------------------------------------------------ --------------------------- -------------------- ---------------------- --------------- this letter responds to a letter dated date on behalf of x from x’s plr-139061-04 d3 dear -------------- authorized representative requesting inadvertent invalid election relief under sec_1362 of the internal_revenue_code facts according to the information submitted x was incorporated under the laws of state on d1 and timely filed a form_2553 election by a small_business_corporation effective d2 x’s s_corporation_election was accepted by the service_center when x filed its form_2553 x’s shareholders were a b and c all of whom were individuals and y an s_corporation the shareholders of y were d and e both individuals y as an s_corporation was an ineligible shareholder of another s_corporation that was not a qualified_subchapter_s_subsidiary in d3 x was advised by its new legal counsel that y was an ineligible shareholder of an s_corporation and that x’s s_corporation_election was ineffective y distributed its shares of x to e and f and x filed for a private_letter_ruling corporation this includes allocating its items of income loss deduction and credit to all of its shareholders including y y in turn allocated those items to its shareholders d and e x represents that the amount of tax paid during this period was the same as if d and e would have held the stock in x directly or differs by a de_minimis amount the meaning of sec_1362 law and analysis any taxable_year a small_business_corporation for which an election under sec_1362 is in effect for such year domestic_corporation which is not an ineligible_corporation and which does not have as a shareholder a person other than an estate a_trust described in sec_1361 or an organization described in sec_1361 who is not an individual business corporation may elect to be an s_corporation x requests a ruling that its invalid s_corporation_election was inadvertent within sec_1361 provides the term small_business_corporation means a sec_1361 provides that the term s_corporation means with respect to from d2 onward x represents that it filed its tax returns as if it were an s sec_1362 provides that as except as provided in sec_1362 a small sec_1362 provides in part that if an election under sec_1362 by any based solely on the facts submitted and representations made we conclude that plr-139061-04 corporation was not effective for the taxable_year for which made by reason of a failure to meet the requirements of sec_1361 the secretary determines that the circumstances resulting in such ineffectiveness was inadvertent no later than a reasonable period of time after discovery of the circumstances resulting in such ineffectiveness steps were taken so that the corporation is a small_business_corporation and the corporation and each person who was a shareholder in the corporation at any time during the period specified pursuant to sec_1362 agrees to make adjustments consistent with the treatment of the corporation as an s_corporation as may be required by the secretary with respect to such period then notwithstanding the circumstances resulting in such ineffectiveness such corporation shall be treated as any s_corporation during the period specified by the secretary conclusion x's s election was ineffective for the taxable_year beginning on d2 because y was an ineligible shareholder of x we further conclude that the ineffectiveness of x's s election constituted an inadvertent invalid election within the meaning of sec_1362 and thereafter provided that apart from the inadvertent invalid election ruling above x’s s election was otherwise valid and has not otherwise terminated under sec_1362 this ruling is contingent upon x and all its shareholders treating x as having been an s_corporation for the period beginning d2 and thereafter this letter is further contingent upon the shareholders of x adjusting their bases and accumulated adjustment accounts to make up for any discrepancies that occurred when y held x stock federal tax consequences of the facts described above under any other provision of the code specifically no opinion is expressed regarding whether x is otherwise eligible to be an s_corporation code provides that it may not be used or cited as precedent this ruling is directed only to the taxpayer requesting it sec_6110 of the under the provisions of sec_1362 x will be treated as an s_corporation from d2 except as specifically set forth above no opinion is expressed concerning the in accordance with the power_of_attorney on file with this office a copy of this sincerely yours plr-139061-04 letter is being mailed to x’s authorized representatives enclosures cc copy of this letter copy for sec_6110 purposes s jeanne sullivan senior technician reviewer branch office of the associate chief_counsel


t c memo united_states tax_court jerry l crabtree et al petitioners v commissioner of internal revenue respondent docket nos filed date james l chase for petitioners alan friday for respondent memorandum findings_of_fact and opinion whalen judge respondent determined the following deficiencies in and penalties with respect to the federal_income_tax of petitioner jerry l crabtree ‘cases involving the following petitioners are con- solidated herewith eddie l crabtree docket no crabtree investments inc docket nos and year deficiency fraud_penalty sec_6663 dollar_figure dollar_figure big_number big_number big_number big_number unless stated otherwise all section references are to the internal_revenue_code as in effect during the years in issue respondent determined the following deficiencies in and penalties with respect to the federal_income_tax of petitioner eddie l crabtree year deficiency fraud_penalty sec_6663 dollar_figure dollar_figure big_number big_number big_number big_number respondent also determined the following deficiencies in and penalties with respect to the federal_income_tax of petitioner crabtree investments inc crabtree invest-- ments year deficiency fraud_penalty sec_6663 dollar_figure dollar_figure big_number big_number big_number rach petitioner filed a timely petition for redetermination in this court and their cases were consolidated for trial briefing and opinion by order of the court issued pursuant to rule a of the tax_court rules_of_practice and procedure in this opinion all rule references are to the tax_court rules_of_practice and procedure after concessions the issues for decision are whether crabtree investments underreported its gross_income for and if crabtree investments underreported income whether petitioners jerry l and eddie l crabtree each received constructive dividends from the corporation in and of one-half of the gross_income that went unreported whether each petitioner is liable for the fraud_penalty under sec_6663 for the years in issue and if the fraud_penalty is not applicable whether each petitioner is liable for the accuracy-related_penalty under sec_6662 attributable to negligence or disregard of rules or regulations petitioners do not contend that the period of limitations on assessments set forth in sec_6501 applies in these cases findings_of_fact some of the facts have been stipulated and are so found the stipulation of facts and the attached exhibits are incorporated herein by this reference at the time of trial petitioner jerry crabtree and her son petitioner eddie crabtree each owned percent of the stock of crabtree investments they served as the only officers of the corporation at the time they filed their petitions in this court they resided in pensacola florida crabtree investments a florida corporation was incorporated on date and maintained its principal_place_of_business in pensacola florida at the time the instant petitions were filed on its behalf during the years in issue crabtree investments operated a bar and package store in pensacola florida trading under the name justins before the incorporation of crabtree investments the individual petitioners had owned and operated justins since or justins consists of an l-shaped building with the package store in the front and a country and western bar in the rear of the building justins is located near a number of large manufacturing companies during the years in issue ms crabtree managed the package store which generally was open tuesday through saturday from p m until p m mr crabtree managed the bar which was open daily from p m until a m the bar had a maximum seating capacity of persons and usually featured live bands on friday and saturday nights the bar sold prepackaged snacks and had a pay telephone ms crabtree handled all of the bookkeeping for the package store and the bar during the years in issue for federal_income_tax purposes crabtree investments reported income using the calendar_year and a hybrid method_of_accounting the cash_receipts_and_disbursements_method for sales and the accrual_method for purchases petitioners’ accountant mr richard morton prepared a general ledger and other financial records for crabtree investments for each of the years in issue the general ledger for each year itemizes on a monthly basis the checks written on a checking account at first union bank main- tained on behalf of crabtree investments mr morton prepared the general ledgers from the records that the individual petitioners provided to him every month these records included crabtree investments’ check stubs bank statements daily reports and other records on the basis of that information mr morton reconciled the bank account and prepared a sales journal sales_tax returns payroll reports and payroll tax deposits mr morton also prepared the corporation’s income_tax returns from the above information mr morton did the audit of the records of crabtree investments the general ledgers prepared by mr morton include a liability account entitled loans from shareholders the balance of that account at the end of through is as follows dollar_figure dollar_figure dollar_figure dollar_figure the individual petitioners maintained two joint bank accounts during the years in issue one joint account was at amsouth bank of florida the aggregate cash deposits aggregate noncash deposits aggregate withdrawals and the yearend balance of that account for through are as follows cash noncash year deposits deposits withdrawals balances -- -- -- 1dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure big_number dollar_figure dollar_figure dollar_figure big_number dollar_figure dollar_figure dollar_figure balance on date the other joint account was at first union national bank of florida formerly southeast bank of west florida the aggregate cash deposits aggregate noncash deposits aggregate withdrawals and the yearend balance of that account for through are as follows cash noncash year deposits deposits withdrawals balances -- -- -- dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure -- dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure respondent audited crabtree investments’ corporate_income_tax returns for taxable years and during the audit petitioners provided the following records to the revenue_agent canceled checks purchase orders daily reports cash register tapes summaries of the cash register transactions referred to as z tapes deposit slips and general ledgers the revenue_agent analyzed the corporation’s bank account records she found a substantial disparity between the total deposits made to the bank account at first union bank and the sales reported on the corporation’s tax_return for she also found that relatively little cash had been deposited into the account despite the cash nature of the business the revenue_agent determined that the records of crabtree investments were insufficient to determine gross_income therefore she recomputed crabtree investments’ gross_income for and both in the package store and in the bar using the unit markup method as the starting point for the reconstruction the revenue_agent obtained from ms crabtree the original purchase orders for beer and liquor purchases all of crabtree investments’ original records that were provided to the revenue_agent other than the general ledgers were returned to petitioners and afterwards lost in the fire that destroyed justins in they were not available at trial respondent’s determination of crabtree investments’ unreported income for and is based upon eight different categories of income as summarized in the following schedule a bar sales dollar_figure dollar_figure dollar_figure b package store sales big_number big_number big_number on cover charges big_number big_number big_number d vending machine receipts big_number big_number big_number e food sales big_number big_number big_number f flower sales big_number big_number --q- g coke juice coffee big_number big_number big_number h pay telephone receipts big_number big_number big_number total big_number big_number big_number gross_receipts or sales reported on return big_number big_number big_number adjustment big_number big_number on the basis of the above adjustments for and respondent computed tax increases of dollar_figure dollar_figure and dollar_figure returns of crabtree investments bar and package store sales respectively with respect to the the following schedule summarizes the aggregate gross_receipts of the package store and the bar as determined by the revenue_agent description 90-liter 200-liter 375-liter 750-liter 5-liter wine 2-liter 3-liter miscellaneous liter---package liter----at bar beer dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure -o- dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure -o- -o- dollar_figure dollar_figure dollar_figure -o- dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure the revenue_agent reconstructed crabtree investments’ gross_receipts from bar and package store sales using the beer wine and liquor purchases as shown on the purchase orders provided to the agent by petitioners the agent also used the drink and package store prices supplied by petitioners and applied a spillage or waste factor the agent subtracted reported sales from total gross_receipts -- - as thus reconstructed to arrive at the amount of unreported gross_receipts the purchase orders provided to the agent by petitioners showed purchases of alcohol from six vendors two of the vendors sold beer liquor the revenue_agent analyzed petitioners’ and the other four sold purchase records and prepared a summary of the alcohol purchases according to bottle size and alcohol type the revenue agent’s audit_workpapers summarize crabtree investments’ purchase orders for liquor beer and wine as follows quantity purchased items purchased liquor-- 50-liter bottle sec_195 liquor-- 200-liter bottles big_number liquor-- 375-liter bottles big_number liquor-- 750-liter bottles big_number wine--1 5-liter bottle sec_24 -- -- liquor--dollar_figure 2-liter bottles beer--12 0z oz big_number -- -- wine cooler miscellaneous aq1 big_number liquor---liter package big_number liquor---liter at bar big_number big_number big_number beer big_number big_number big_number big_number big_number big_number the original purchase orders from which the agent made the above summary were among the records that were lost in the date fire that destroyed justins and are not included as part of the record in these cases the revenue_agent used the bottle purchases reflected on the purchase orders provided by petitioners to reconstruct the total sales for each year ms crabtree informed the revenue_agent that percent of the liter bottles purchased were used in the bar and percent were sold in the package store the notices of deficiency issued to crabtree investments explain the computation of bar sales and package store sales as follows bar sales were determined based on using percent of your purchases the number of unit purchases bottles times the number of servings per unit purchase times the charges per serving equals the bar sales package sales were determined based on using percent of your purchases the number of unit purchases bottles times the unit sales_price equals the package sales the allocation described in the above explanation applies only to liter bottles on the basis of the statements of petitioners the agent treated all other bottles purchased by crabtree investments as having been sold in the package store throughout the years in issue the bar at justins sold beer for dollar_figure per bottle draft beer in 10-ounce glasses for dollar_figure per draft and liquor for dollar_figure dollar_figure and dollar_figure per drink depending on the type of liquor used mixer liguors increased the drink price by cents justins also sold liquor wine and beer from the package store petitioners kept no record of the number of drinks given away and did not keep records of broken bottles or spilled drinks during the initial audit interview mr crabtree informed the revenue_agent that there was very little spillage of alcohol at the bar in reconstructing bar sales of liquor the agent used a 10-percent spillage or waste factor and in reconstructing bar sales of draft beer the agent used a 5-percent spillage or waste factor during the initial audit interview petitioners told the revenue_agent that the drinks sold in the bar contained approximately ounce of liquor this is consistent with the practice of many other bars in the area the revenue_agent multiplied the number of liter bottles used in the bar by in order to convert liters into ounces after reducing the total volume in ounces by the 10-percent spillage or waste factor and assuming that each drink contained ounce of liquor the revenue_agent determined the number of drinks available per bottle she then multiplied the number of drinks per bottle by the price charged per drink to obtain total liguor sales ms crabtree told the revenue_agent the prices charged for bottles of alcohol sold in the package store the revenue_agent multiplied the number of bottles sold in the package store by the price per bottle to determine total sales in the package store income from cover charges respondent’s agent computed income from cover charges of dollar_figure for each of the years in issue the notices of deficiency issued to crabtree investments provide the following explanation of the computation of this amount cover charges were determined by using a dollar_figure charge for thursday nights per year time sec_250 the lounge capacity and a dollar_figure charge for friday and saturday nights per year times times the lounge capacity or dollar_figure this adjustment is based upon the information provided by ms jerry crabtree and mr eddie crabtree during their initial audit interviews with the agent income from food sales respondent determined food sales from the bar to be dollar_figure per week or dollar_figure per year for each of the taxable years in issue the notices of deficiency issued to crabtree investments state as follows food income was determined using dollar_figure per week based on florida department of revenue estimates for a business your size respondent used this estimate because crabtree investments did not provide any purchase records for the food sold in the bar income from cola juice and coffee sales respondent determined that sales of nonalcoholic beverages such as cola juice and coffee were dollar_figure per year for each of the years at issue the notices of deficiency issued to crabtree investments provide the following explanation coke juice and coffee sales were determined using an assumption that one quarter of the persons paying cover charges for nights when entertainment was provided thursday friday and saturday would pay dollar_figure for these items income from pay telephone receipts respondent determined pay telephone receipts to be dollar_figure per week or dollar_figure per year for each of the years in issue the notices of deficiency issued to crabtree investments provide the following explanation pay telephone income was determined using dollar_figure per week based on florida department of revenue estimates for a business your size the revenue_agent used this estimate because petitioners -- - did not produce any records or other evidence of pay telephone receipts agents from two state taxing authorities audited crabtree investments during the years in issue first the florida department of business regulation division of alcoholic beverages and tobacco dabt conducted a beverage surcharge tax audit for the period date through date the beverage surcharge tax is a tax on consumption of alcohol on the premises as applied in these cases the surcharge tax applies to bar sales but not to package store sales second the florida department of revenue conducted a sales_tax audit for the period date through date the sales_tax audit was initiated after a referral from the dabt opinion unreported income of crabtree investments the first issue for decision is whether crabtree investments underreported its gross_income for and petitioners expressly concede the adjustments involving vending machine receipts and flower sales the remaining adjustments at issue are bar sales package store sales income from cover charges income from food sales income from cola juice and coffee and income from -- - the pay telephone petitioners bear the burden of proving that respondent’s determination is incorrect as to each of those adjustments see rule a petitioners argue that respondent’s use of the unit markup method of reconstructing income is improper because crabtree investments maintained detailed and adequate_records petitioners reason that because its records were consistent with the information reported on its tax returns we must accept the records as clearly reflecting its taxable_income we disagree taxpayers are regquired to keep adequate books_or_records from which their correct_tax liability can be determined see sec_6001 the commissioner may test the adequacy of a taxpayer’s books_and_records by any reasonable method which in the commissioner’s judgment properly reflects taxpayer’s taxable_income see 348_us_121 21_tc_917 affd 220_f2d_871 4th cir if the commissioner determines that a taxpayer’s books_and_records are not adequate then the commissioner is entitled to reconstruct the taxpayer’s income by any reasonable means see sec_446 394_f2d_366 5th cir affg tcmemo_1966_81 we agree that respondent’s use of the unit markup method is justified in the cases involving crabtree investments the revenue_agent found a material difference approximately dollar_figure between the aggregate deposits made into crabtree investments’ account at first union bank and the gross_receipts reported on its corporate tax_return according to the bank statements aggregate deposits of approximately dollar_figure were made into the account in similarly according to the general ledger of crabtree investments with the exception of march deposits which could not be located deposits totaled dollar_figure on the other hand crabtree investments reported sales of dollar_figure on its corporate tax_return the revenue_agent also found that crabtree investments did not maintain complete inventory records and the agent noted a substantial drop in reported sales from approximately dollar_figure in to approximately dollar_figure in furthermore despite the cash nature of the bar business very little cash was deposited into the corporation’s bank account the daily records of the business showed bar sales equal to the total checks received with little or no cash in addition two state taxing authorities noted the inadequacy of crabtree investments’ records first the -- - dabt conducted a beverage surcharge tax audit for the period date through date the dabt auditor noted that crabtree investments did not keep very good records and kept only sketchy inventory records the auditor used the wholesale distributors’ reports dabt summary of purchases to determine the amount of alcohol crabtree investments purchased the dabt summary of purchases is a listing of all items sold by alcohol distributors to a particular licensee florida law requires all wholesalers distributors to report to the dabt all alcohol purchases by a licensee retailer second the florida department of revenue conducted a sales_tax audit for the period date through date the sales_tax auditor used an indirect method of reconstructing sales for taxable_year she obtained the amount of alcohol purchased from the dabt summary of purchases and marked up the purchases to arrive at the selling_price the auditor found that for there was a dollar_figure difference between the sales that they reported to the department of revenue and the sales as they were marked up based on ab t’s numbers petitioners gave the sales_tax auditor deposit slips weekly reports and cash register tapes the auditor found that the original records of crabtree investments were not organized furthermore the records were not complete the auditor was unable to find journal tapes and the cash register tapes for the sample months that she initially chose and was forced to select different months the report of the sales_tax audit states that the accounting_records flow through to the financials without a hitch however the bar business is mostly cash and income is easily hidden from normal view the auditor found that the deposit slips for the business show that deposits consisted mostly of checks she found that to be unusual because bars are typically high cash businesses the auditor noted in the audit report that the taxpayer did not use due care in reporting all sales and deliberately hid income on the basis of the foregoing we find that respondent was justified in using an indirect method of reconstructing income the percentage or unit markup method is an acceptable method of reconstructing a taxpayer’s income see langworthy v commissioner tcmemo_1998_218 stewart v commissioner tcmemo_1990_264 citing 22_tc_1108 22_tc_893 bar sales petitioners attack respondent’s reconstruction of bar sales on four grounds first petitioners assert that the revenue_agent purportedly used the purchase records provided by jerry crabtree however the volume of alcohol used by the revenue_agent in her analysis of reconstructing bar sales is inconsistent with the volume of alcohol actually purchased by the corporate taxpayer petitioners argue that the revenue_agent should have used the dabt summary of purchases as the starting point to reconstruct gross_receipts from alcohol sales petitioners claim that the dabt summary of purchases shows that justins purchased big_number ounces of liquor not including wine or beer during using petitioners’ purchase orders on the other hand the revenue_agent determined that justins purchased dollar_figure ounces of liguor during petitioners assert that respondent’s use of crabtree investments’ purchase orders rather than the dabt summary of purchases results in an overstatement of dollar_figure ounces in liquor purchases petitioners do not reconcile this difference or explain why their purchase records reflect purchases that are so much greater than those reflected in the dabt summary of purchases despite the large difference in ounces of liquor purchased petitioners’ accountant presented this comparison for the first time at trial furthermore petitioners’ argument is based solely on taxable_year at trial petitioners’ accountant testified that he had made a similar analysis for but petitioners did not seek to introduce the accountant’s analysis into evidence in their opening brief petitioners assert although the dabt audit was not extended beyond the comparison of alcohol purchases testified to by the petitioners’ accountant indicates that the revenue agent’s calculation of unreported income is unreliable thus it appears that petitioners are implicitly arguing that the revenue_agent overstated the amount of alcohol purchased in and as well as in furthermore petitioners have shown no reason to believe that the dabt summary of purchases would yield a more accurate amount of alcohol purchased than petitioners’ own purchase records in fact the opposite appears to be the case if we take the total dollar amount of liquor purchases during from crabtree investments’ general ledger and the gallonage of liquor purchased in by justins as reported in the dabt summary of purchases the average monthly price of liquor purchased for is approximately dollar_figure per gallon second petitioners contend that respondent erred in assuming that drinks contained ounce of alcohol the revenue_agent testified that petitioners told her at the initial audit interview that all drinks contained ounce of liquor at trial mr crabtree testified that he did not recall making that statement to the revenue_agent and testified that a 3-ounce drink was common in addition petitioners offered the testimony of three bartenders at justins to rebut the l-ounce assumption the first bartender testified that drinks contained between and ounces of liquor a second bartender testified that drink size varied between and ounces a third bartender who was not employed at justins during the years in issue testified that she poured drinks containing between and ounces of liquor on the basis of the entire record we find that respondent’s assumption that each drink contained ounce of alcohol which was based on petitioner’s statement to the agent is reasonable and that petitioners have shown no reason for the court to find otherwise third petitioners argue that respondent’s recon- struction of bar sales does not take into account drink specials offered by justins during the years in issue - - petitioners claim that between and justins offered two-for-one drink specials during a happy hour which lasted from the opening of the bar until approximately p m when the band began to play petitioners also claim that justins held ladies’ nights during which female customers received free drinks or drinks at a reduced price we find that the record is devoid of any evidence from which we can find the number of promotion drinks during the years in issue in fact there is evidence that justins offered no drink specials the dabt preaudit questionnaire completed by ms crabtree contains the following question do you have any promotions such as buy one get one free or all you can drink specials ms crabtree answered no finally petitioners argue that respondent’s recomputation is incorrect because it fails to take into account losses due to employee theft during the years in issue however the record is devoid of any evidence of employee theft except for the biased and unpersuasive testimony of mr eddie crabtree thus petitioners have failed to satisfy their burden_of_proof on this issue see rule a income from cover charges petitioners attack respondent’s reconstruction_of_income from cover charges as arbitrary upon four grounds first petitioners argue that respondent erred by assuming that a dollar_figure cover charge was collected on thursday nights second petitioners assert that respondent’s assumption that the number of customers paying cover charges was equal to capacity on thursdays and egual to capacity on fridays and saturdays is false third petitioners argue that the revenue_agent failed to take into account the hours on friday and saturday nights during which cover charges were not collected finally petitioners claim that in respondent’s determination of unreported income respondent failed to give them credit for the cover charge revenue reported on crabtree investments’ tax returns as to petitioners’ first contention we note that respondent’s computation is based upon the admission made by the individual petitioners during their initial audit interview with the revenue_agent to the effect that they collected cover charges of dollar_figure per customer on thursday nights as to petitioners’ second and third contentions attacking respondent’s assumptions that customers paid dollar_figure each on thursdays and customers paid dollar_figure each on fridays and saturdays petitioners’ contentions are based - - principally upon the biased testimony of mr eddie crabtree we find no credible_evidence to support petitioners’ argument that respondent’s determination is wrong in this regard we accord no probative weight to the testimony of petitioners’ witnesses as to petitioners’ final contention that respondent failed to give them credit for the cover charges reported on their returns for the years in issue petitioners are wrong respondent’s determination of the unreported income of crabtree investments gives petitioners full credit for the gross_receipts or sales reported on each of the returns in issue thus any cover charges reported by petitioners have been subtracted from the adjustment computed by respondent for each of the subject years accordingly we find that petitioners have failed to prove that respondent’s reconstruction_of_income from cover charge sec_1s incorrect see rule a income from food sales petitioners argue that respondent’s estimate of food sales is unreliable and arbitrary petitioners assert that the revenue_agent could have reviewed crabtree investments’ general ledgers to determine the actual amount of food purchases because food was purchased by check petitioners - - bear the burden of proving respondent’s determination wrong see id we find that petitioners have failed to meet their burden_of_proof for the following reasons first petitioners have failed to produce any records of food sales that refute respondent’s determination second petitioners have failed to produce any records of food purchases from which the amount of food sales could be determined nor have they shown how that amount could be determined from the general ledgers third the record does not support petitioners’ assertion that food was purchased entirely by check to the contrary the florida sales_tax auditor noted in her audit report that the taxpayer pays liquor bills snack bills and petty cash items in cash income from cola juice and coffee sales petitioners argue that the reconstruction of nonalcoholic beverage sales is unreliable and arbitrary petitioners assert that few bar customers ordered nonalcoholic beverages during the years in issue and that nonalcoholic beverages were often served to customers without charge petitioners have failed to produce any evidence of sales of nonalcoholic beverages to refute respondent’s determination other than their own biased testimony accordingly we sustain respondent’s determination see rule a income from pay telephone receipts petitioners argue that respondent’s estimate of pay telephone receipts is unreliable and arbitrary petitioners claim that respondent should have subpoenaed the telephone records to determine the actual amount of money received however petitioners have failed to produce any telephone records that would refute respondent’s estimate accordingly petitioners have not satisfied their burden of proving respondent’s determination wrong see id on the basis of our review of the record we find that petitioners failed to meet their burden_of_proof as to each category of income that respondent’s determination comprises accordingly we sustain respondent’s determination that crabtree investments underreported its gross_income in each of the taxable years in issue deficiencies the second issue for decision is whether one-half of the unreported income of crabtree investments for each of the years in issue is a constructive_dividend to each of - - its shareholders the notice_of_deficiency issued to petitioner jerry crabtree contains the following explanation it is determined that for the years ended date and you received dividends from the corporation crabtree invest-- ments in the amount of dollar_figure dollar_figure and dollar_figure respectively accordingly your taxable_income for the years ended date and is increased in the amounts of dollar_figure dollar_figure and dollar_figure respectively the notice_of_deficiency issued to petitioner eddie crabtree contains a similar explanation petitioners bear the burden of proving respondent’s determination wrong see id sec_61 defines gross_income as all income from whatever source derived including gross_income derived from dividends see sec_61 dividends may be formally declared or they may be constructive see 368_f2d_439 9th cir affg tcmemo_1965_84 321_f2d_598 3d cir affg 36_tc_446 277_f2d_879 8th cir affg 32_tc_815 the determination of whether a constructive_dividend was received 1s a question that - - depends on the facts of each case see 461_f2d_865 5th cir in these cases respondent argues that as the sole and controlling shareholders of crabtree investments petitioners exercised the requisite substantial influence to be taxable on these amounts petitioners’ only argument is that they could not have received constructive dividends from crabtree investments because the corporation did not receive the unreported income determined by respondent as discussed earlier in this opinion we find that crabtree investments received unreported income during and in the amounts determined by respondent thus we reject the sole argument that ms jerry crabtree and mr eddie crabtree did not receive constructive dividends from crabtree investments because the corporation had not received any unreported income accordingly we sustain respondent’s determination that ms jerry crabtree and mr eddie crabtree received dividends in the amounts set forth in the subject notices of deficiency fraud_penalty the third issue for decision is whether petitioners are liable for the fraud_penalty under sec_6663 for each of the years in issue respondent determined that petitioner crabtree investments fraudulently omitted income from its and returns on which there are underpayments of dollar_figure dollar_figure and dollar_figure respectively accordingly respondent determined that crabtree investments is liable for civil_fraud penalties under sec_6663 of dollar_figure dollar_figure and dollar_figure respondent determined that petitioner jerry crabtree fraudulently omitted income from her and returns on which there are underpayments of dollar_figure dollar_figure and dollar_figure respectively accordingly respondent determined that ms jerry crabtree is liable for civil_fraud penalties under sec_6663 of dollar_figure dollar_figure and dollar_figure respondent further determined that petitioner eddie crabtree fraudulently omitted income from his and returns on which there are underpayments of dollar_figure dollar_figure and dollar_figure respectively accordingly respondent determined that mr eddie crabtree is liable for civil_fraud penalties under sec_6663 of dollar_figure dollar_figure and dollar_figure --- - sec_6663 provides that if any part of an underpayment is due to fraud there shall be added to the tax an amount equal to percent of the portion of the underpayment which is attributable to fraud the commissioner bears the burden of proving by clear_and_convincing evidence that an underpayment exists and some portion of the underpayment is attributable to fraud see sec_7454 rule b 96_tc_858 affd 959_f2d_16 2d cir the term underpayment is defined in sec_6664 as the amount by which any_tax imposed by this title exceeds the excess of the sum of a the amount shown as the tax by the taxpayer on his return plus b amounts not so shown previously assessed or collected without assessment over the amount of rebates made the commissioner must establish that the taxpayer is guilty of fraud with respect to his or her return for each taxable_year e g 53_tc_96 ajf transp consultants inc v commissioner tcmemo_1999_16 if the commissioner establishes that any portion of the underpayment is attributable to fraud then the entire underpayment is treated as attributable to fraud unless the taxpayer establishes by a preponderance - - of the evidence that it is not attributable to fraud see sec_6663 in a case like the present cases in which allegations of fraud are intertwined with unreported and indirectly reconstructed income the commissioner may prove the first prong of the fraud test that an underpayment exists in one of two ways by proving a likely source of the unreported income or where the taxpayer alleges a nontaxable source by disproving the nontaxable source so alleged see 94_tc_654 to prove the second prong of the fraud test fraudulent intent the commissioner must show that the taxpayer intended to evade tax believed to be owing by conduct intended to conceal mislead or otherwise prevent the collection of such tax see 91_tc_874 80_tc_1111 the existence of fraud is a question of fact to be resolved upon consideration of the entire record see dilleo v commissioner supra pincite 67_tc_181 affd without published opinion 578_f2d_1383 8th cir fraud will never be imputed or presumed but must be affirmatively - - established by clear_and_convincing evidence see 55_tc_85 because direct proof of a taxpayer’s fraudulent intent is rarely available fraud may be shown by circumstantial evidence see stephenson v commissioner t c affd per curiam 748_f2d_331 6th cir a taxpayer’s entire course of conduct may establish the requisite fraudulent intent see 56_tc_213 otsuki v commissioner supra pincite over the years courts have developed a nonexclusive list of factors that demonstrate fraudulent intent these badges_of_fraud include understating income see holland v united_states u s pincite parks v commissioner t c pincite inadequate books_and_records see 301_f2d_484 5th cir affg tcmemo_1959_172 false entries on or alterations of documents see 317_us_492 failure_to_file tax returns see id implausible or inconsistent explanations of behavior see 75_tc_1 concealment of income or assets see 796_f2d_303 9th cir affg tcmemo_1984_601 dealing in cash and - -- failure to cooperate with tax authorities see id pincite a corporation can act only through its officers see 34_tc_740 affd per curiam 325_f2d_1 2d cir corporate fraud necessarily depends upon the fraudulent intent of the corporate officer id citing 216_f2d_693 1st cir affg 21_tc_191 in these cases the individual petitioners each own percent of the stock of crabtree investments they serve as the only two officers of the corporation on the basis of the entire record we think the individual petitioners exercised sufficient control_over the affairs of crabtree investments to justify imputing their actions to crabtree investments see auerbach shoe co v commissioner supra pincite as to the fraudulent intent prong of the fraud analysis respondent asserts that the following items of circumstantial evidence indicate fraud understatement of income inadequate records implausible explanations of the unreported income petitioners’ decision to rebuild the business after the fire destroyed it and petitioners’ failure to report a robbery at gunpoint due to their fear of an irs audit -- - as discussed above we found that crabtree investments ms jerry crabtree and mr eddie crabtree each understated income in and we agree that a large understatement may in an appropriate case suggest fraudulent intent in cases such as those in issue in which deficiencies were determined using an indirect method of proof and sustained on the basis of petitioners’ failure to disprove such determinations the existence of underpayments standing alone is insufficient to support a finding of fraud see 229_f2d_282 6th cir revg a memorandum opinion of this court dated date 225_f2d_216 6th cir affg in part and revg in part a memorandum opinion of this court dated date 53_tc_96 christensen v commissioner tcmemo_1982_672 cf mazzoni v commissioner tcmemo_1970_37 refusing to pile inference upon inference by basing fraud exclusively on unreported income established by the net_worth_method of reconstructing income affd 451_f2d_197 3d cir this is particularly true in cases such as these where there is no evidence that the taxpayers actually received any of the unreported income computed using an indirect method - - as to the second badge of fraud asserted by respondent that petitioners maintained inadequate records we note that respondent has advanced this argument only with respect to the records of crabtree investments respondent has not introduced any evidence that petitioners jerry and eddie crabtree themselves maintained inadequate records as to the records of crabtree investments we cannot review their adequacy or inadequacy because all of the records except for the general ledgers were destroyed by fire therefore we have no independent means from which to evaluate the revenue agent’s conclusion that the records were inadequate as to the third badge of fraud respondent argues that it is patently unreasonable particularly considering the cash nature of his business for the bar to earn income which just happened to equal the amount of checks received for days upon end petitioners claim that during the years in issue some large manufacturing companies in the area were renovating their plants and employed a number of out-of-town workers petitioners testified that justins provided check-cashing services to these people to entice them to spend their money at justins partly on the basis of the testimony of their accountant petitioners maintain that from time to time -- - they would withdraw cash from their personal savings account at amsouth and would use the money at justins to cash customers’ payroll checks petitioners would deposit the customers’ paychecks into crabtree investments’ business account at first union write a check for cash in that amount and start the process at justins over again eventually they would redeposit the original amount of money into their personal savings account at amsouth as mentioned above virtually all of crabtree investments’ original records were destroyed by fire as a result we cannot fully evaluate petitioners’ assertion that they used cash from their personal accounts in the bar our analysis of the statements from petitioners’ individual checking accounts tends to support petitioners’ explanation furthermore the bank account statements suggest that the individual petitioners were losing money during the years in issue in they deposited the surrender proceeds from shares in the growth fund in the aggregate amount of dollar_figure and mr eddie crabtree deposited a check for dollar_figure apparently the proceeds from the sale of real_property nevertheless during the years in issue the balance in the account went from dollar_figure to dollar_figure respondent does not assert that the withdrawals from the joint bank accounts increased the -- - net_worth of the individual petitioners such as through the purchase of other assets on the basis of the fact that we have insufficient evidence by which to evaluate respondent’s assertion and the fact that there is evidence in the record that tends to support petitioners’ assertion we cannot accept respondent’s position that petitioners’ explanation of the lack of cash deposits is patently unreasonable respondent next asserts that petitioners’ decision to rebuild the business after the fire supports respondent’s determination of fraud respondent argues that petitioners would not have rebuilt an uninsured building if the business had been unprofitable petitioners maintain that the business was losing money mr eddie crabtree testified that petitioners did not recover from the insurance_company because the insurance_company filed for bankruptcy during the same week that justins burned mr eddie crabtree further testified that he consulted a commercial real_estate agent who recommended that it would be easier to sell the property with a structure on it than as bare land we accept petitioners’ explanation for their decision to rebuild after the fire we do not agree with respondent that it 1s an indication of fraud -- -- finally respondent asserts that petitioners’ explanation of their refusal to report a robbery indicates fraud on their part mr eddie crabtree testified that his brother was robbed at gunpoint of approximately dollar_figure mr eddie crabtree further testified that mr morton petitioners’ accountant was afraid to report it because the irs would say--would throw up a yellow flag or red flag respondent argues on brief that the evidence indicates petitioners had every right to fear an audit given the fraudulent nature of the returns in issue we do not agree with respondent that petitioners’ failure to report the alleged robbery based upon the recommendation of their accountant supports a finding of petitioners’ fraud on the basis of the entire record we find that respondent has not met his burden of proving that any part of the underpayment_of_tax in these cases is due to fraud accordingly we do not sustain respondent’s determination that crabtree investments ms jerry crabtree and mr eddie crabtree are liable for the fraud_penalty under sec_6663 -- - penalty for negligence or disregard of rules or regulations because we find that petitioners are not liable for the fraud_penalty under sec_6663 we must consider whether they are liable for the accuracy-related_penalty under sec_6662 for and which respondent determined as an alternative to fraud sec_6662 imposes a penalty equal to percent of any portion of an underpayment_of_tax that is attributable to negligence or disregard of rules or regulations see sec_6662 and b the term negligence is defined as any failure to make a reasonable attempt to comply with the provisions of title_26 of the united_states_code sec_6662 this includes any failure to exercise due care or to do what a reasonable and ordinarily prudent person would do under the circumstances see 91_tc_524 85_tc_934 the term disregard includes any careless reckless or intentional disregard sec_6662 petitioners bear the burden of proving that respondent’s determination of negligence is erroneous see rule a luman v commissioner t c petitioners contend that they maintained adequate and accurate accounting_records petitioners assert that crabtree investments did not intentionally or unintention- ally understate its income from sales during the audit period they also argue that any understatement_of_tax as a result of the adjustments made at trial is insubstantial and not due to any negligence or intentional disregard of rules or regulations on the basis of the entire record of these cases we find that petitioners have not met their burden of proving that the underpayment_of_tax is not attributable to negligence or disregard of rules or regulations accordingly we hereby sustain respondent’s determination that petitioners are liable for the accuracy- related penalty under sec_6662 for the years in issue to reflect the foregoing and concessions by the parties decisions will be entered under rule