t c memo united_states tax_court salus mundi foundation transferee et al petitioners v commissioner of internal revenue respondent docket nos filed date allen duane webber summer m austin jaclyn j pampel caitlin a urban ryan j kelly and phillip j taylor for petitioners john richard mikalchus for respondent 1cases of the following petitioners are consolidated herewith diebold foundation inc transferee docket no and ceres foundation inc transferee docket no memorandum findings_of_fact and opinion goeke judge in separate statutory notices of liability respondent determined that the salus mundi foundation the diebold foundation inc diebold foundation connecticut and the ceres foundation inc collectively petitioners are liable as transferees of the assets of the diebold foundation inc diebold foundation of dollar_figure each for the corporate_income_tax penalty and accrued interest assessed against double-d ranch inc double-d ranch for the taxable_year ended date the primary issues remaining for decision are whether the diebold foundation is liable as a transferee pursuant to section for the unpaid federal_income_tax and sec_6662 accuracy-related_penalty owed by double-d ranch for the date taxable_year and whether petitioners are liable as transferees of a transferee pursuant to sec_6901 for the unpaid federal_income_tax and sec_6662 accuracy-related_penalty owed by double-d ranch for the date taxable_year for the reasons stated herein we find that 2all amounts are rounded to the nearest dollar 3unless otherwise indicated all section references are to the internal_revenue_code and all rule references are to the tax_court rules_of_practice and procedure the diebold foundation is not liable as a transferee under sec_6901 and therefore petitioners are not liable as subsequent transferees under sec_6901 findings_of_fact some of the facts have been stipulated and the stipulated facts are incorporated by this reference petitioners are three sec_501 private_foundations organized in arizona connecticut and south carolina on october july and date respectively they received all of the assets of the diebold foundation in equal shares pursuant to the diebold foundation’s plan of dissolution and distribution of assets during the diebold foundation’s date taxable_year i the double-d ranch shareholders--the marital trust and the diebold foundation the dorothy r diebold marital trust marital trust was created upon the death of richard diebold on date in which mrs diebold was the sole beneficiary at the time of mr diebold’s death the marital trust owned all issued and outstanding shares of stock big_number shares in the double-d ranch the marital 4the parties also dispute whether the period of limitations expired before the mailing of the notices of liability to petitioners and thus barred respondent from determining transferee_liability as explained infra because we ultimately decide that petitioners are not liable as subsequent transferees it is not necessary that we decide whether the period of limitations expired trust had three cotrustees mrs diebold bessemer trust co n a bessemer trust and andrew w bisset bessemer trust was a national bank that served as trustee asset custodian and investment adviser to the marital trust austin power jr a senior vice president at bessemer trust served as counsel and account manager for both the marital trust and mrs diebold mr power was bessemer trust’s representative in its role as trustee of the marital trust mr bisset is an attorney licensed to practice law in connecticut and new york who served as mrs diebold’s personal attorney after her husband’s death the diebold foundation was a sec_501 charitable_organization organized and incorporated on date under the laws of the state of new york its directors in were mrs diebold mr bisset and mrs diebold’s three children at the request of mrs diebold on date approximately one-third of the outstanding_stock of double-d ranch big_number shares was transferred from the marital trust to the diebold foundation until date the marital trust and the diebold foundation collectively the double-d ranch shareholders owned all of the stock of double-d ranch--they held big_number shares and big_number shares respectively ii double-d ranch from at least date until their resignation effective date double-d ranch’s directors were mrs diebold her three children mr bisset and mr power the assets of double-d ranch consisted primarily of stock in american home products ahp a publicly traded company stock in other publicly traded companies u s treasury securities cash and real_estate the various securities and real_estate had high fair market values but low tax bases iii the decision to sell double-d ranch at some point in may or early date the cotrustees of the marital trust and the directors of the diebold foundation decided to sell the stock of double-d ranch mr power was primarily responsible for implementing the sale of the stock stephen a baxley a senior vice president in bessemer trust’s tax department and morton grosz richard leder and adam braverman assisted in the sale messrs grosz leder and braverman were attorneys at chadbourne parke llp a nationally known law firm messrs power baxley grosz leder and braverman collectively double-d ranch representatives represented double-d ranch throughout the stock sale process 5the real_estate consisted of over acres of property in connecticut the double-d ranch representatives discussed the sale with two groups of purchasers james m rhodes harry zelnick and ari bergmann collectively shap ii6 representatives and fortrend international llc fortrend the double-d ranch representatives initially met with the shap ii representatives on date and with fortrend on date both purchasers presented a similar interest--purchasing the stock of closely held corporations holding assets with high fair market values but low tax bases while it is not entirely clear what details were discussed at these meetings the parties did address the valuation method for the ahp stock the financial statements tax returns and contracts that the seller would need to provide the purchaser and the real_estate held by double-d ranch the double-d ranch representatives ultimately decided to sell the double-d ranch stock to the shap ii representatives and gained the approval of mrs diebold and her children in their various capacities the shap ii representatives created shap acquisition corp ii shap ii to serve as the acquirer of the double-d ranch stock with mr rhodes and mr zelnick serving as shap ii’s directors and officers while it is not clear at what level of detail the parties discussed the structure of the 6shap ii discussed infra was an entity created for the purchase of the double-d ranch stock transaction the double-d ranch representatives assumed that shap ii would use some form of tax strategy to offset the built-in gains in double-d ranch’s assets iv the letter of intent and the valuation of double-d ranch representatives from both the seller and the purchaser negotiated the price and drafted the transaction documents on date shap ii and the double- d ranch shareholders executed a letter of intent confirming the terms of the stock sale the letter of intent was signed by mr rhodes mr power and mr bisset acting on behalf of shap ii the marital trust and the diebold foundation respectively attached to the letter of intent was a term sheet defining the terms of the sale the term sheet reflected that shap ii7 would purchase all issued and outstanding double-d ranch stock for cash in an amount equal to the fair_market_value of the corporation’s assets minus an agreed-upon discount the agreed-upon discount was 7the letter of intent indicated that the purchaser was xyz corporation a special purpose entity until the actual purchaser was identified or organized on date shap ii was incorporated in the state of delaware to purchase the double-d ranch stock set equal to of the fair_market_value of the double-d ranch assets less double-d ranch’s tax basis in those assets as discussed above double-d ranch held mostly marketable_securities and real_estate an appraiser valued the real_estate at dollar_figure on date most of the securities were easily valued on various securities exchanges except for the ahp stock because double-d ranch owned such a large block of ahp stock selling it all at once in the stock market would have an impact on the stock’s value therefore the parties to the double-d ranch stock sale decided to value the ahp stock using the volume weighted average price for the five consecutive trading days before the stock sale closing the average of the weighted prices was considered the value of the ahp stock the double-d ranch assets were valued as follows item amount cash dollar_figure ahp stock big_number other_securities big_number land--farm big_number big_number 8for example if fair_market_value is dollar_figure and the tax basis is dollar_figure the agreed-upon discount would be dollar_figure x dollar_figure - dollar_figure double-d ranch’s marketable_securities were held in two accounts with bessemer trust the remaining marketable_securities were held in an account with the bank of new york v the stock purchase agreement on date shap ii and the double-d ranch shareholders executed a stock purchase agreement mrs diebold mr power as representative for bessemer trust and mr bisset signed on behalf of the marital trust mr bisset signed on behalf of the diebold foundation and mr rhodes signed on behalf of shap ii the stock purchase agreement indicated that the closing for the sale would occur on date the parties established additional bank accounts to handle the various fund transfers made pursuant to the stock purchase agreement finally the parties agreed in article vii section of the stock purchase agreement that-- shap ii will file a consolidated federal_income_tax return and where applicable state and local_tax returns for the period which includes the closing date which returns will include double-d ranch from and including the day following the closing date shap ii will be responsible for will pay or cause to be paid any and all taxes of double-d ranch with respect to any taxable_period ending after the closing date vi the escrow agreement on date the double-d ranch shareholders entered into an escrow agreement with bessemer trust where bessemer trust would serve as the shareholders’ representatives for all matters relating to the stock purchase agreement and an escrow account would be created with bessemer trust whereby bessemer trust would act as the escrow agent the double-d ranch shareholders agreed to deposit a portion of the proceeds from the stock sale into the escrow account for the purpose of satisfying any outstanding business obligations of double-d ranch that may have existed before the stock sale similarly shap ii agreed to hold back dollar_figure million of the stock purchase_price and deposit it in the escrow account this amount would become payable to the double-d ranch shareholders on or before date subject_to any adjustments relating to certain liabilities of double-d ranch vii shap ii’s financing shap ii financed its purchase of the double-d ranch stock with a loan from rabobank nederland rabobank rabobank issued a loan commitment letter to shap ii indicating its agreement to lend up to dollar_figure million for the acquisition of the double-d ranch stock that the loan was to mature no later than days from closing and as collateral for the loan shap ii would grant rabobank a first priority lien on the stock of double-d ranch and any property shap ii now has or hereafter shall have any interest as well as other collateral as mutually acceptable a copy of the commitment letter was provided to the double-d ranch representatives on date the double-d ranch shareholders and their representatives were not listed as a party to the financing agreements between rabobank and shap ii rabobank imposed certain conditions as part of its agreement to lend the dollar_figure million the biggest condition was that shap ii enter into a binding agreement to sell the double-d ranch assets after shap ii purchased double-d ranch’s stock to that end shap ii and morgan stanley executed a document titled execution by morgan stanley of volume-weight average price and market-on-close trades on risk basis shap ii-morgan stanley sale agreement pursuant to this agreement morgan stanley agreed to purchase and shap ii agreed to deliver million shares of ahp stock and various other_securities or their cash_equivalent to morgan stanley on the closing date without regard to whether the transaction between the double-d ranch shareholders and shap ii closed the securities sold pursuant to the shap ii-morgan stanley agreement were valued by the same methods used by 9the shap ii-morgan stanley agreement initially defined the closing date as date but it was later changed to date shap ii to value the double-d ranch assets for the double-d ranch stock sale neither double-d ranch nor the double-d ranch shareholders were a party to this agreement on date shap ii opened an account with morgan stanley to receive custody of the marketable_securities owned by double-d ranchdollar_figure viii the stock sale closing the closing was delayed from july to date and the stock purchase agreement was amended accordingly pursuant to the amended stock purchase agreement shap ii would pay dollar_figure million for the double-d ranch stock--dollar_figure million payable immediately and dollar_figure million held back and placed in escrow shap ii became the owner of all the shares of double-d ranch stock on date after the execution of various closing documents and the requisite money transfer of dollar_figure million to the escrow account at bessemer trustdollar_figure the closing documents included among other documents the following all discussed infra 10double-d ranch’s securities were in the custody of bessemer trust as of date morgan stanley did not receive custody of any marketable_securities in that account before date 11rabobank deposited dollar_figure into shap ii’s rabobank account then dollar_figure million was transferred to the escrow account at bessemer trust and dollar_figure was transferred back to rabobank for its fee for assisting in the transaction the notice of pledge and security_agreement the transfer agreement and the letter agreement at the time of the double-d ranch stock sale double-d ranch owned controlled and possessed assets having a fair_market_value well in excess of its liabilities the transfers of double-d ranch’s assets were arranged as follows custody of the assets held by the bank of new york were to be transferred to shap ii’s morgan stanley account on date after the bank of new york received written confirmation from mr bisset that the stock sale was consummated and custody of the assets held by bessemer trust were to be transferred to shap ii’s morgan stanley account on date pursuant to a letter agreement transfer agreement executed on date between bessemer trust double-d ranch and shap ii the transfer agreement irrevocably instructed bessemer trust to transfer custody of double-d ranch’s assets to shap ii’s morgan stanley account and to not honor any other request or instruction which would cause bessemer to be unable to make such transfer moreover the closing documents included an option contract between double-d ranch and toplands farm llc toplands farm dollar_figure pursuant to thi sec_12toplands farm was formed by one of the diebold children in order to purchase and operate a farm on the real_estate contract toplands farm paid dollar_figure for an option to purchase double-d ranch’s real_estate for its fair_market_value as of date toplands farm paid shap ii a downpayment of dollar_figure on date and a final payment of dollar_figure on august dollar_figure on july and shap ii paid the double-d ranch shareholders the hold back amount and additional purchase_price adjustments ultimately the double-d ranch shareholders received the following consideration for their stock item date amount payment at closing dollar_figure hold back and adjustment big_number price adjustment price adjustment total big_number big_number big_number the following amounts were distributed from the escrow account to the marital trust 13the dollar_figure option the dollar_figure downpayment and the dollar_figure final payment total dollar_figure--the fair_market_value per the appraisal item amount distribution--7 dollar_figure distribution--7 distribution--11 distribution--3 distribution--4 total big_number big_number big_number big_number big_number the following amounts were distributed from the escrow account to the diebold foundation item amount distribution--7 dollar_figure distribution--7 big_number distribution--11 big_number total big_number the transfers from the escrow account at bessemer trust to the marital trust and the diebold foundation were made pursuant to the escrow agreement the distributions to the marital trust corrected a misallocation made at the time of the stock sale ix post-closing transfers on date following the close of the double-d ranch stock sale mr rhodes executed a letter agreement the letter agreement that irrevocably instructed bessemer trust to transfer custody of double-d ranch’s assets to morgan stanley on date in settlement of the shap ii-morgan stanley sale agreement made on date mr rhodes as president of shap ii sent a letter to morgan stanley instructing them to transfer dollar_figure to shap ii’s rabobank account on date and morgan stanley and double-d ranch entered into a pledge and security_agreement which granted morgan stanley a security_interest in the assets held in double-d ranch’s bessemer trust account pursuant to the pledge and security_agreement morgan stanley agreed that it would not take possession of the assets before date mr rhodes sent notice of the pledge and security_agreement to bessemer trust on date neither the double-d ranch shareholders nor their representatives were a party to the pledge and security_agreement on date bessemer trust and the bank of new york transferred double-d ranch’s assets to shap ii’s morgan stanley account shortly thereafter rabobank’s loan was repaid shap ii received the following from its sales of the double-d ranch assets item amount securities dollar_figure land cash total big_number big_number big_number x return filings the double-d ranch shareholders timely filed returns that reflected the sale of their double-d ranch stock to shap ii on date the diebold foundation reported capital_gain with respect to the sale of its big_number shares on form_990-pf return of private_foundation for its taxable_year ended date double-d ranch timely filed form_1120 u s_corporation income_tax return for its short taxable_year ended date and checked the final return box on the return this return did not report any of double-d ranch’s asset sales made after the date stock sale between the double-d ranch shareholders and shap ii shap ii timely filed a consolidated_income_tax_return with double-d ranch for its taxable_year ended on date shap ii’s return reported all of the asset sales made by double-d ranch between date and date but also reported artificial losses resulting in shap ii’s reporting no tax_liability for its date taxable yearend xi procedural history on date respondent issued a notice_of_deficiency to double-d ranch determining a deficiency in income_tax of dollar_figure and a sec_6662 penalty of dollar_figure for the short taxable_year ended on date respondent determined that the sale of double-d ranch’s stock by the double-d ranch shareholders to shap ii should not be respected for federal_income_tax purposes respondent determined that in substance the stock sale was really a sale of double-d ranch’s assets followed by a liquidating_distribution to the double-d ranch shareholders while the notice_of_deficiency was issued after the three-year period of limitations respondent contends that the six-year period of limitations 14the artificial losses arose from some form of son-of-boss transaction see notice_2000_44 2000_2_cb_255 describing so-called son-of-boss transactions see also 128_tc_192 discussing the prototypical son-of-boss transaction under sec_6501 appliesdollar_figure double-d ranch did not file a petition with this court and respondent assessed the following amounts against double-d ranch on date item tax sec_6662 penalty interest amount dollar_figure big_number big_number respondent could not find any assets of double-d ranch from which to collect the assessed liability and determined that any additional efforts would be futile on date respondent issued a notice of liability to mrs diebold as the transferee of the assets of double-d ranch in the amount of dollar_figure for the corporate_income_tax penalty and accrued interest assessed against double-d ranch for the taxable_year ended date mrs diebold timely filed a petition and a trial was held in diebold v commissioner tcmemo_2010_238 we found that the separate legal existence of the marital trust should not be disregarded and 15respondent’s contention that the six-year period of limitations should apply is also predicated on the assumption that the stock sale should be recast as an asset sale followed by a liquidating_distribution that respondent had not met his burden of showing that mrs diebold was liable as a transferee of the marital trust as a result we held that mrs diebold was not liable as a transferee of double-d ranch respondent also determined that the diebold foundation was liable as a transferee of double-d ranch however pursuant to its plan of dissolution and distribution of assets effective on date the diebold foundation distributed all of its assets in equal shares to petitioners resulting in each petitioner’s receiving dollar_figure from the diebold foundationdollar_figure these transfers were not made in exchange for any property or in satisfaction of an antecedent debt on date respondent issued a notice of liability to each petitioner as a transferee of the assets of the diebold foundation in the amount of dollar_figure for the corporate_income_tax penalty and accrued interest assessed against double- d ranch for the taxable_year ended on date petitioners timely filed petitions in this court and the cases have been consolidated and are before this court for a decision without trial under rule dollar_figure 16the plan was approved by the supreme court of the state of new york 17the parties agree that the same evidence that was used in diebold v commissioner tcmemo_2010_238 should be used in the present case including continued opinion sec_6901 is a procedural statute authorizing the assessment of transferee_liability in the same manner and subject_to the same provisions and limitations as in the case of the taxes with respect to which the transferee_liability was incurred sec_6901 does not create or define a substantive liability but merely provides the commissioner a remedy for enforcing and collecting from the transferee of the property the transferor’s existing liability 334_f2d_875 9th cir aff’g 37_tc_1006 57_tc_680 sec_6902 and rule d provide that the commissioner has the burden of proving the taxpayer’s liability as a transferee but not of showing that the transferor was liable for the tax under sec_6901 the commissioner may establish transferee_liability if a basis exists under applicable state law or state equity principles for holding the transferee liable for the transferor’s debts 357_us_39 111_tc_172 aff’d 213_f3d_1173 9th cir frank sawyer trust of date v commissioner t c continued the trial testimony as a result under rule these cases do not require a trial for the submission of evidence memo starnes v commissioner tcmemo_2011_63 diebold v commissioner tcmemo_2010_238 t he existence and extent of liability should be determined by state law commissioner v stern u s pincite thus state law determines the elements of liability and sec_6901 provides the remedy or procedure to be employed by the commissioner as the means of enforcing that liability 305_f2d_664 2d cir aff’g 35_tc_1148 moreover transferee_liability may be asserted against a transferee of a transferee 729_f2d_496 7th cir aff’g magill v commissioner tcmemo_1982_148 the commissioner may collect unpaid taxes of a transferor of assets from a transferee or a successor transferee of those assets sec_6901 c commissioner v stern u s pincite 104_tc_486 aff’d 102_f3d_1088 10th cir the commissioner bears the burden of proving that a party is liable as a transferee under state law or in equity sec_6902 rule d 93_tc_475 aff’d without published opinion 933_f2d_1014 9th cir i parties’ arguments petitioners argue that they cannot be liable as transferees because respondent failed to issue the notices of liability within the applicable three-year period of limitations set forth in sec_6901 and that the six-year period of limitations in sec_6501 does not apply because double-d ranch did not sell its marketable_securities during the date taxable_year moreover petitioners argue that they cannot be liable as transferees because double-d ranch itself was not liable for the deficiency and penalty respondent determined in his notice_of_deficiency for the date taxable_year alternatively if double-d ranch is found liable for the income_tax and penalty respondent determined in his notice_of_deficiency petitioners argue they are not liable under new york fraudulent conveyance law because double-d ranch did not convey any property to the diebold foundation and double-d ranch was solvent at the time of its stock sale respondent argues that the six-year period of limitations under sec_6501 applies to the assessment and collection of double-d ranch’s liability for the short taxable_year ended date because double-d ranch omitted an amount in excess of of gross_income stated in the return respondent argues that under the substance_over_form_doctrine the purported sale of double-d ranch stock to shap ii must be disregarded and recast as a sale of double-d ranch’s assets on date followed by a liquidating_distribution of the proceeds to the diebold foundation and the marital trust therefore under either new york fraudulent conveyance law or the trust fund doctrine the diebold foundation is liable as a transferee of double-d ranch respondent concludes that because the diebold foundation is liable as a transferee and transferred all of its assets to petitioners for no consideration petitioners are liable as subsequent transferees of double-d ranch whether the three-year or the six-year period of limitations applies depends on how we decide to characterize the transaction between the double-d ranch shareholders and shap iidollar_figure therefore we must first determine whether respondent 18in 410_fsupp2d_243 s d n y the court rejected the defendant’s assertion that multiple transfers should be collapsed into one transaction for the purpose of determining when the statute_of_limitations began to run on the plaintiff’s fraudulent conveyance claims the court noted that transactions have never been collapsed to determine whether a fraudulent conveyance is timely under the statute_of_limitations stating because a new claim for fraudulent conveyance accrues at the time of each conveyance it would be illogical and contrary to the spirit of the law to treat a series of transfers as one transaction for the purpose of determining when the statute_of_limitations was triggered however tronox inc v anadarko petroleum corp in re 429_br_73 s d n y rejected this argument in applying the oklahoma fraudulent transfer statute to a spin off reasoning that what constitutes a continued has shown that the transactions surrounding the double-d ranch stock sale should be collapsed under the new york uniform fraudulent conveyance act nyufca in deciding whether the diebold foundation is liable as a transferee if we find the diebold foundation liable as a transferee then we must determine whether petitioners are liable as transferees of a transferee ii new york uniform fraudulent conveyance act the law of the state where the transfer occurred in these cases new york controls the characterization of the transaction see commissioner v stern u s pincite nyufca includes provisions imposing transferee_liability on grounds of both actual and constructive fraud see n y debt cred law sec_273 sec_276 mckinney the elements of fraudulent conveyance claims under nyufca are the same as those under the federal bankruptcy code ames dept stores inc v wertheim schroder co in re 161_br_87 n bankr s d n y respondent asserts that the diebold foundation continued transfer under oklahoma law is very broad and the mills transfers were much more straightforward than the case before it because of our factual differences and our holding as explained subsequently it is not necessary that we address whether a new york court can collapse transactions to determine whether a fraudulent conveyance occurs within the period of limitations is liable as a transferee under the constructive fraud provision of nyufca the constructive fraud provision of nyufca provides that every conveyance made and every obligation incurred by a person who is or will be thereby rendered insolvent is fraudulent as to creditors without regard to his actual intent if the conveyance is made or the obligation is incurred without a fair consideration n y debt cred law sec_273 the party asserting that a transfer should be set_aside under this section bears the burden of showing fraud by a preponderance_of_the_evidence 249_fsupp2d_357 s d n y accordingly establishing constructive fraud and therefore transferee_liability under n y debt cred law sec_273 requires respondent to prove by a preponderance_of_the_evidence a conveyance made without fair consideration by a person who was or will be rendered insolvent by the conveyance see 30_f3d_310 2d cir a conveyance includes every payment of money assignment release transfer lease mortgage or pledge of tangible or intangible_property and also the creation of any lien or incumbrance n y debt cred law sec_270 mckinney fair consideration is given-- a when in exchange for such property or obligation as a fair equivalent therefor and in good_faith property is conveyed or an antecedent debt is satisfied or b when such property or obligation is received in good_faith to secure a present advance or antecedent debt in amount not disproportionately small as compared with the value of the property or obligation obtained id sec_272 fair consideration must be determined upon the facts and circumstances of each particular case 246_br_152 s d n y citing united_states v mccombs f 3d pincite furthermore under n y debt cred law sec_271 mckinney a person is insolvent when the present fair salable value of his assets is less than the amount that will be required to pay his probable liability on his existing debts as they become absolute and matured respondent’s transferee_liability claim under nyufca is predicated on the assertion that the series of transactions among the double-d ranch shareholders shap ii morgan stanley and rabobank should be collapsed and treated as if double-d ranch sold all of its assets and then made a liquidating_distribution to its shareholders if the transactions are collapsed accordingly then double-d ranch will have transferred substantially_all of its assets to the diebold foundation and the marital trust receiving virtually nothing in exchange let alone fair consideration if the preceding is so found it follows that the diebold foundation will be liable as a transferee of double-d ranch’s assets under n y debt cred law sec_273 while intent is generally irrelevant in a constructive fraud action under nyufca when a party is seeking to recharacterize a transaction or series of transactions for purposes of showing no fair consideration was given the party must prove that the multiple transactions were linked and that the transferee had actual or constructive knowledge of the entire scheme that rendered her exchange with the debtor fraudulent see sullivan b r pincite citing 48_f3d_623 2d cir 284_br_355 bankr s d n y constructive knowledge may be found where the initial transferee became aware of circumstances that should have led to further inquiry into the circumstances of the transaction but no inquiry was made hbe leasing corp f 3d pincite while some cases have stated that purchasers who do not make appropriate inquiries are charged with the knowledge that ordinary diligence would have elicited 636_fsupp_1537 s d n y aff’d without published opinion 847_f2d_836 2d cir others appear to have required a more active avoidance of the truth see schmitt v morgan n y s 2d app div test is whether subsequent purchaser who did not make serious inquiry was shielding himself from knowledge that a fraudulent conveyance had occurred the knowledge requirement reflects the policy of the uniform fraudulent conveyance act to protect innocent purchasers for value who received the debtor’s property without awareness of any fraudulent scheme and is closely connected to the requirement of good_faith see 453_br_499 s d n y citing hbe leasing f 3d pincite ufca requirement of ‘good faith’ refers solely to ‘whether the grantee knew or should have known that he was not trading normally but that the purpose of the trade so far as the debtor was concerned was the defrauding of his creditors ’ quoting ggfcp sec pincite the good_faith inquiry is an objective one that generally asks whether the transferee had information that put it on inquiry notice that the transferor was insolvent or that the transfer might be made with a fraudulent purpose and whether a diligent inquiry would have discovered the fraudulent purpose of the transfer wachovia bank b r pincite citing 439_br_284 s d n y discussing u s c sec c hbe leasing involved the application of nyufca in order to collapse multiple transactions on the basis of the knowledge of the transferee the relevant parties included the debtor_corporation the majority shareholder son and the mortgagee mother first the mortgagee mother made loans to the debtor_corporation in exchange for security interests in debtor_corporation property next the majority shareholder son had the debtor_corporation use the borrowed funds for improper purposes the primary question was whether these transactions could be collapsed in order to determine whether the debtor_corporation received fair consideration in exchange for the security_interest granted to the mortgagee mother the court found that there was sufficient evidence to charge the mortgagee mother with constructive knowledge of the improper expenditures of the borrowed funds and therefore collapsed the transactions in determining fair consideration under nyufca where when the mortgagee mother was the director of the debtor_corporation she knew the majority shareholder son had used the debtor_corporation as a conduit for making various payments for family and other noncorporate purposes the mortgagee mother knew the debtor_corporation was a defendant in a rico fraud action and the mortgagee mother knew that the majority shareholder son had made large loans to the debtor_corporation the court found that the mortgagee mother had constructive knowledge under these circumstances because her failure to inquire represented a conscious turning away from the subject hbe leasing f 3d pincite in sunbeam corp b r pincite citing in re greenbrook carpet co 722_f2d_659 11th cir the court stated that a lender may extend a loan to an entity even if it is aware that this entity ultimately intends to use the funds to repay antecedent debt or invest in a speculative venture the court reasoned that the fact that a speculative venture turns out to be unprofitable is not grounds to retroactively impute knowledge to the lender that the debtor’s investment far exceeded its value id pincite on the basis of the authorities discussed in order to collapse the transactions we must determine whether respondent has shown that in the diebold foundation became aware of circumstances that should have led to further inquiry into the circumstances of the transaction but no inquiry was made because the double-d ranch representatives concede that they did not inquire into what shap ii planned on doing we must determine only whether an inquiry was required respondent asserts that the double-d ranch representatives h ad to have been aware that any_tax advantage that shap ii intended to obtain could not have been legitimate knew or should have known that they were engaging the services of a company that marketed transactions that were solely tax motivated and designed to artificially avoid taxes and considering the sophistication and educational level of the representatives their discussions with fortrend sentinel and river run and the large amount of money at stake it is not plausible that the representatives were in the dark about the substance of the transaction it is clear from the record that the double-d ranch representatives knew shap ii would likely need to sell most of the double-d ranch assets in order to repay their 30-day loan from rabobank and shap ii was planning on using tax_attributes to offset the built-in gains of the double-d ranch assets respondent also asserts that while mrs diebold may have desired to diversify her portfolio or transfer some assets as gifts the same objectives could have been accomplished by liquidating double-d ranch however in the absence of knowledge of a nefarious scheme when faced with the choice of liquidating the assets of double-d ranch or selling its stock the double-d ranch shareholders were not required to choose the result that produced the highest tax_liability they chose to maximize the cash proceeds by selling the stock of double-d ranch rather than liquidating it while there is uncertainty as to what the double-d ranch representatives were aware of in concerning the legitimacy of shap ii’s actions we find that their level of awareness about shap ii’s plans to engage in some sort of tax strategy did not require in the double-d ranch representatives to make further inquiry into the circumstances of the transaction notice_2001_16 2001_1_cb_730 regarding intermediary transactions had not been released when the stock sale transaction took placedollar_figure shap ii was an unrelated third party that acquired the benefits_and_burdens_of_ownership of double-d ranch once the stock sale was complete there are legitimate transactions that shap ii could have contemplated to offset or defer double-d ranch’s built-in gains and respondent has failed to show why the double-d ranch representatives should have known that shap ii planned on using a fraudulent tax strategy in order to do so 19notice 2001_1_cb_730 was not released until date and was not published until date the internal_revenue_service and the department of the treasury issued this notice to alert taxpayers and their representatives of certain responsibilities that might arise from participating in an intermediary transaction these transactions were marketed to taxpayers for the avoidance of federal income taxes an intermediary transaction generally involved fraudulently structuring the actions of multiple parties ie an asset purchaser a stock seller and a stock purchaser so that assets and stock changed ownership with no resulting federal income taxes moreover the facts of these cases are much less egregious than the facts found in hbe leasing--our transaction is between unrelated parties as opposed to between mother and son there was no evidence presented that shap ii was a defendant in any relevant legal proceedings and there has been no finding that the double-d ranch representatives had actual knowledge of any past fraudulent activities of shap ii furthermore these cases are similar to sunbeam in that shap ii’s tax strategy can be analogized to a speculative venture while the double-d ranch representatives knew shap ii planned on engaging in some form of tax strategy the fact that the strategy failed should not retroactively impute knowledge to the double-d ranch representatives that shap ii’s plans were specious therefore respondent’s assertions that the double-d ranch representatives should have known that the transaction was not legitimate are insufficient to support a finding that the double-d ranch representatives had constructive knowledge of shap ii’s entire scheme furthermore the facts in these cases closely resemble the facts in frank sawyer trust and starnes--both cases where we decided not to collapse various transactions under uniform fraudulent conveyance statutes in starnes the taxpayers each owned of the stock of tarcon a freight consolidation corporation the taxpayers had sold virtually all of the assets of tarcon to an unrelated third party so that tarcon had only cash and contingent federal and state corporate_income_tax liabilities another unrelated third party midcoast and the tarcon shareholders entered into a contract to sell the tarcon stock where midcoast was obligated to file corporate tax returns and report the capital_gains arising from tarcon’s asset sales after midcoast failed to pay tarcon’s income_tax liabilities the commissioner asserted a transferee_liability action against the tarcon shareholders in frank sawyer trust the taxpayer owned of the stock in taxi corporations and real_estate corporations like starnes the taxpayer had sold all the assets of the corporations to an unrelated third party so that the corporations had only cash and contingent federal and state corporate_income_tax liabilities another unrelated third party fortrend and the taxpayer entered into a contract to sell the corporations’ stock where fortrend was obligated to file corporate tax returns and report the capital_gains arising from the corporations’ asset sales after fortrend failed to pay the corporations’ income_tax liabilities the commissioner asserted a transferee_liability action against the taxpayer in both starnes and frank sawyer trust the corporations’ assets were not used to purchase the stock from the taxpayer but an independent third party rabobank financed the transaction moreover in both cases the corporations were solvent at the time their stock was sold notice_2001_16 supra had been released prior to the transaction in starnes but was released after the transactions in frank sawyer trust we applied state fraudulent conveyance law in both cases to determine whether the taxpayers should be liable for the income_tax liabilities of the corporations specifically we focused on whether all of the parties involved had knowledge of the multiple transactions including the fraudulent scheme to offset the tax_liabilities we held that because the commissioner failed to show the taxpayers’ knowledge of the fraudulent scheme the transactions should not be collapsed we then applied the relevant fraudulent conveyance statute without collapsing the transactions and found that because there was no fraudulent conveyance to the taxpayers they were not liable as transferees we find the facts in these cases to be very similar to those in starnes and frank sawyer trust the transaction between the double-d ranch shareholders and shap ii was conducted between two unrelated parties the double-d ranch assets were not used to purchase the stock from the double-d ranch shareholders rather there was an independent infusion of cash in the form of a loan from rabobank another unrelated third party not only was double-d ranch solvent when sold it had yet to incur any significant tax_liability because it had not sold its assets at the time of the stock sale lastly notice_2001_16 supra had not been released at the time this transaction was consummated as in starnes and frank sawyer trust respondent has not carried the burden of proving we should collapse the transactions accordingly we will respect the form of the transactions in applying nyufca an opinion in another transferee case with similar facts has recently been filed--feldman v commissioner tcmemo_2011_297 holding the taxpayer liable as a transferee however in holding the taxpayer liable as a transferee the court in feldman found that it was absolutely clear that the taxpayer was aware the stock purchaser had no intention of ever paying the tax_liabilities and the loan used to purchase the stock was a sham because it was made by a shareholder of the purchaser and was not evidenced by a writing moreover the feldman transaction took place after the issuance of notice_2001_16 supra in our cases the transaction took place before the issuance of notice_2001_16 supra the funds used to purchase the stock were lent by an independent third party and the level of knowledge possessed by double-d ranch concerning shap ii’s plans did not require further inquiry into the circumstances of the transaction n y debt cred law sec_273 requires respondent to show a conveyance made without fair consideration by a person who was or will be rendered insolvent by the conveyance see united_states v mccombs f 3d pincite at the time the double-d ranch shareholders sold their stock to shap ii double-d ranch was solvent possessing over dollar_figure million in assets and no significant liabilities shap ii paid money to the double-d ranch shareholders in exchange for the stock after the stock sale was consummated double-d ranch sold its assets to morgan stanley and used the proceeds to repay a prior loan from rabobank no assets were conveyed from double-d ranch to the double-d ranch shareholders because there was no conveyance of assets from double-d ranch to the double-d ranch shareholders that rendered double-d ranch insolvent we find that there was no fraudulent conveyance under nyufca from double-d ranch to the double-d ranch shareholders therefore the diebold foundation is not liable as a transferee under sec_6901 iii transferee_liability of petitioners finally we must determine whether petitioners are liable as subsequent transferees of double-d ranch for the unpaid deficiency in corporate_income_tax penalty and interest due from double-d ranch for the short taxable_year ended date as previously mentioned transferee_liability may be asserted against a transferee of a transferee 729_f2d_496 the commissioner may collect unpaid taxes of a transferor of assets from a transferee or a successor transferee of those assets sec_6901 c commissioner v stern u s pincite 104_tc_486 again we apply new york law in determining whether petitioners are liable as subsequent transferees and respondent bears the burden_of_proof under n y debt cred law sec_273 respondent must prove a conveyance made without fair consideration by a person who was or will be rendered insolvent by the conveyance united_states v mccombs f 3d pincite moreover a person is insolvent when the present fair salable value of his assets is less than the amount that will be required to pay his probable liability on his existing debts as they become absolute and matured n y debt cred law sec_271 the diebold foundation transferred all of its assets to petitioners pursuant to its plan of dissolution approved by the supreme court of the state of new york leaving the diebold foundation with no assets in the event that it was held liable as a transferee however because we hold that the diebold foundation is not liable as a transferee of the assets of double-d ranch petitioners cannot be liable as transferees of a transferee therefore we hold that petitioners are not liable under sec_6901 as transferees of a transferee iv conclusion we conclude that respondent has not established that a fraudulent conveyance occurred under new york law in reaching our holding herein we have considered all arguments of the parties and to the extent not mentioned above we conclude they are moot irrelevant or without merit to reflect the foregoing decisions will be entered for petitioners


internal_revenue_service number release date index number --------------------------------------- -------------------------------------- ------------------------------------- ---------------------------- ------------- ------------------------ - re -------------------------------------- ----------------------------- department of the treasury washington dc person to contact ----------------------- id no ------------- telephone number --------------------- refer reply to cc psi b04 - plr-164326-01 date date --------------------- ---------------------- ------------------------ --------------------- ------------------ -------------------- ----------------- ---------------------- ----------------------------------------------------- --------------------------------------------------------------------------------------- legend decedent spouse child a child b grandchild a grandchild b grandchild c grandchild d local court trust ---------------------------------------------------------------------------------------------------------------------- ------------------------------------------------------------------------------------------------- marital trust ---------------------------------------------------------------------------------------------------------------------- ------------------------------------------------------------------------------------------- family_trust -------------------------------------------------------------------------- date date date date trustee a trustee b dollar_figurex state state statute ----------------------------------------------------------- cite ------------------------------------------------------------------------------------------------------------------ --------------------------- --------------------------- --------------------- --------------- -------------- ----------------------------------------------------------------- ------------------ --------------------------------------------------------------------------------------- ---------------------------------------------------------------------------------------- --------------------------------------------------------------------------------- ------------------------ ------------------------ --------------------------------------------------------------------------------- this is in reply to your date letter and other correspondence in decedent created the trust a revocable_trust on date the trust was last article ii paragraph a of the trust provides that at decedent’s death the sum --------------------------------------------------------- ------------------------------------------------- plr-164326-01 cite --------------------------------------------------------------------------------------------------------- cite cite dear ------------------- which you request rulings on the application of the generation-skipping_transfer_tax amended on date after date the trust became irrevocable at decedent’s death on date pursuant to article xi of the trust the trust is to be construed and administered according to the laws of state child a trustee a and trustee b are presently serving as the trustees of dollar_figurex is to be set_aside in the marital trust a separate trust for the benefit of spouse decedent’s surviving_spouse on spouse’s death the remaining principal of the marital trust is to be distributed to or for decedent’s grandchildren spouse survived decedent but has since died marital trust is to be distributed to the family_trust under article v paragraph a the trustees are to pay the net_income of the family_trust in equal shares to decedent’s children child a and child b and after the death of one of them to the survivor of them for life lives shall have the right annually to appoint from the principal of the family_trust outright or in trust to each of his or her living children from time to time an amount equal to the maximum annual exclusion then available to each child children child a or child b each such child shall have the right to appoint a fractional portion of the remaining trust principal the fraction is based on the number of such child’s children who are living or deceased with living descendants in relation to the total number of decedent’s grandchildren who are living or who are deceased with living descendants article v provides that the property remaining in the trust after the creation of the article v paragraph b provides that child a and child b during their respective article v paragraph c provides that on the death of each of decedent’s child a currently has one child grandchild a child b has three children plr-164326-01 such appointment may be outright or in trust in such amounts or proportions to one or more of the deceased child’s descendants or to his or her estate and may be by a lifetime or testamentary appointment exercised in the manner described in article i paragraph c subparagraph in default of appointment in whole or in part the portion not appointed will be distributed per stirpes to the descendants then living of the decedent’s deceased child and each such share or part of a share will be distributed to each such descendant in the manner provided for in article iv paragraph a in the event there are no descendants of a decedent’s child living at the death of the child who fails to exercise the power_of_appointment the then remaining principal and any undistributed_income of the portion of the trust subject_to that child’s power_of_appointment is to be distributed to decedent’s descendants then living in equal shares per stirpes article i paragraph c subparagraph provides that the power_of_appointment may be exercised either by a writing duly acknowledged and filed with the attorneys for the trustees or by will any such instrument in the form of an acknowledged writing may be revoked at any time the acknowledged writing or will which bears the latest date and which has not been revoked shall be effective and controlling grandchild b grandchild c and grandchild d the trustees represent that there is an ambiguity in article v subparagraph c concerning the permissible appointees of an exercise of child a’s and child b’s powers of appointment effective at death specifically the trustees represent that the phrase to one or more of the deceased child’s descendants or to his or her estate can be read to mean either that child a and child b can appoint the trust property to his or her descendants or to the estate of a descendant who has died or that child a and child b can appoint the trust property to his or her descendants or to his child a’s or her child b’s own estate the trustees assert that decedent intended the latter and that child a and child b may exercise their powers in favor of their own estates proper construction of the phrase to one or more of the deceased child’s descendants or to his or her estate the petition stated that the language to his or her estate was drafted into the trust after discussion with decedent and the language was included in the trust agreement with decedent’s full knowledge and approval the language was intended to grant child a and child b general powers of appointment to ensure that the corpus would not be subject_to generation-skipping_transfer_tax on date the court issued an order concluding that the power to appoint to one or more of the deceased child’s descendants or to his or her estate is construed as authorizing child a and child b to exercise his or her respective power_of_appointment in favor of his or her respective estate to resolve the ambiguity the trustees filed a petition in the local court for a you have asked us to rule on the generation-skipping_transfer_tax consequences plr-164326-01 of the exercise by child a or child b of the special power granted in article v paragraph b if that child is a holder of the power granted in article v paragraph c over the remainder of the trust principal allocable to his or her share taxable_estate of every decedent who is a citizen or resident_of_the_united_states sec_2001 of the internal_revenue_code imposes a tax on the transfer of the sec_2041 provides that the value of the gross_estate shall include the sec_2501 provides that a tax is imposed for each calendar_year on the sec_2503 provides that in the case of gifts other than gifts of future sec_2041 provides that the term general_power_of_appointment means value of all property to the extent of any property with respect to which a general_power_of_appointment is exercised by the decedent a power that is exercisable in favor of the decedent the decedent’s estate the decedent’s creditors or the creditors of the decedent’s estate transfer of property by gift during such calendar_year by any individual interests in property made to any person by the donor during the calendar_year the first dollar_figure of such gifts to such person shall not be included in the total_amount_of_gifts made during the year sec_2511 provides that the gift_tax applies whether the transfer is in trust or otherwise direct or indirect and whether the property transferred is real or personal tangible or intangible sec_2514 provides that for gift_tax purposes the exercise or release of a general_power_of_appointment shall be deemed a transfer of property by the individual possessing the power under sec_2514 a general power is defined in the same manner as in sec_2041 sec_25_2514-1 provides that no provision of sec_25_2514-1 through is to be construed as limiting the application of any other section of the internal_revenue_code or the applicable regulations thus the power of the owner of property to dispose_of his interest and nothing more is not a power_of_appointment and the transfer of the interest is includible in taxable_gifts under sec_2511 the regulation provides an example of this principle as follows a_trust created by s provides for payment of the income to a for life with power in a to appoint during a’s life the entire property to a’s children and a further power to dispose_of the entire corpus by will to anyone including a’s estate the regulation provides that if a exercises the inter_vivos power in favor of a’s children a has necessarily made a transfer of a’s income_interest plr-164326-01 which constitutes a taxable gift under sec_2511 without regard to sec_2514 this transfer also results in the relinquishment of a’s general_power_of_appointment by will which constitutes a transfer under sec_2514 see also revrul_79_327 1979_2_cb_342 sec_2601 provides that a tax is imposed on every generation-skipping_transfer made by a transferor to a skip_person with respect to the transferor sec_2611 provides that the term generation-skipping_transfer means a taxable_distribution a taxable_termination and a direct_skip sec_2612 provides that the term taxable_distribution means any distribution from a_trust to a skip_person other than a taxable_termination or a direct_skip sec_2612 provides that the term direct_skip means a transfer subject_to a tax imposed by chapter or of an interest in property to a skip_person sec_2613 provides that the term skip_person means a natural_person assigned to a generation which i sec_2 or more generations below the generation assignment of the transferor sec_2652 provides that the term transferor means in the case of any property subject_to the tax imposed by chapter the decedent and in the case of any property subject_to the tax imposed by chapter the donor sec_26_2652-1 of the generation-skipping_transfer_tax regulations provides that the individual with respect to whom property was most recently subject_to federal estate or gift_tax is the transferor of that property for purposes of chapter an individual is treated as transferring any property with respect to which the individual is the transferor sec_26_2612-1 example considers a situation in which t establishes a testamentary_trust under which the income is to be paid to t’s surviving_spouse s for life and the remainder is to be paid to a grandchild of t and s t’s executor elects to treat the trust as a qualified_terminable_interest_property under sec_2056 the transfer to the trust is not a direct_skip because s a person who is not a skip_person holds a present right to receive income from the trust upon s’s death the trust property is included in s’s gross_estate under sec_2044 and passes directly to a skip_person the gst occurring at that time is a direct_skip because it is a transfer subject_to chapter the fact that the interest created by t is terminated at s’s death is immaterial because s becomes the transferor at the time of the transfer subject_to chapter extent that the power is exercisable wholly in favor of the holder of the power his estate his creditors or the creditors of his estate all other powers of appointment are special powers state statute provides that a power_of_appointment is a general power to the under state law a trustee may petition the appropriate court for an order to in 387_us_456 the court held that plr-164326-01 construe the terms of a_trust see cite cite the prime consideration in a construction proceeding is the intention of the testator or settler as expressed in the instrument all rules of interpretation are subordinated to the requirement that the testator’s or settlor’s actual purpose be sought and effectuated as far as is consonant with principles of law and public policy cite if the court discerns a dominant purpose or plan the individual parts of the will must be read in relation to that purpose and given effect accordingly this is true despite the fact that a literal reading of the portion under construction might yield an inconsistent or contradictory meaning because of the use of awkward language inadvertently or carelessly chosen cite where the issue involved is the determination of property interests for federal tax purposes and the determination is based on state law the highest court of the state is the best authority on its own law the service however is not bound by a lower court decision if there is a decision by a lower court then the federal authority must apply what it finds to be state law after giving proper regard to the state trial court's determination and to relevant rulings of other courts of the state in this respect the federal authority may be said in effect to be sitting as a state court death to appoint to one or more of the deceased child’s descendants or to his or her estate to be general powers of appointment under state law as such these powers are exercisable by child a and child b in favor of his or her own estate we conclude that this construction is consistent with applicable state law see also revrul_73_142 1973_1_cb_405 accordingly the powers constitute general powers of appointment for purposes of sec_2041 and sec_2514 in the instant case child a and child b each currently hold a right to one-half of the income from the family_trust during their respective lives a contingent right to receive the other one-half of the trust income for such time as each survives the other a special power to appoint trust principal to a child annually in an amount equal to the maximum annual exclusion then available to him or her and a general power to appoint trust principal effective at death to his or her estate as is the case in the example contained in sec_25 b the exercise by child a or child b of his or her inter_vivos special_power_of_appointment will result in a transfer by child a or child b for gift_tax purposes under sec_2511 of his or her right to receive the income from the distributed property the exercise of the special power will also result in the release of his or her general power taking effect at death to appoint the distributed property and the release will constitute a transfer by child a or child b that is subject_to gift_tax under sec_2514 in accordance with sec_2652 and sec_26 in this case the court construed child a’s and child b’s power effective at plr-164326-01 a child a or child b as the case may be will be the transferors of these distributions for generation-skipping_transfer_tax purposes since these distributions can only be made to or for the benefit of child a’s and child b’s respective children the distributions will not be made to skip persons with respect to child a or child b as defined in sec_2613 accordingly the transfers will not be subject_to generation-skipping_transfer_tax the ruling contained in this letter is 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_ruling it is subject_to verification on examination the code provides that it may not be used or cited as precedent enclosures copy for sec_6110 purposes george masnik chief branch office of associate chief_counsel passthroughs and special industries this ruling is directed only to the taxpayer requesting it sec_6110 of sincerely yours


tcmemo_1995_497 united_states tax_court andrew zards and margita zards et al petitioners v commissioner of internal revenue respondent docket nos filed date gs is an s_corporation and ps' claimed losses passed through from gs r disallowed ps' losses on various grounds including ps' failure to establish that the losses were incurred_in_a_trade_or_business for the production_of_income and substantiate that the expenses giving rise to the losses actually were incurred or paid held r's disallowance is sustained ps failed to prove that gs was carrying_on_a_trade_or_business during the years in issue and that gs ever incurred or paid its claimed expenses victoria m brown for petitioners diane r mirabito for respondent cases of the following petitioners are consolidated herewith janet weinman docket no vincent donahue docket no and valdis and vaida vipulis docket no memorandum findings_of_fact and opinion halpern judge these cases have been consolidated for trial briefing and opinion respondent has determined deficiencies in income_tax and additions to tax as follows andrew and margita zards - docket no additions to tax_year deficiency a a a b dollar_figure dollar_figure sec sec janet weinman - docket no additions to tax sec sec sec sec year deficiency a a a a b dollar_figure dollar_figure --- dollar_figure big_number big_number --- big_number big_number dollar_figure --- --- vincent donahue - docket no additions to tax sec sec sec sec year deficiency a a a a b dollar_figure dollar_figure --- dollar_figure big_number big_number --- big_number big_number big_number dollar_figure --- --- valdis and vaida vipulis - docket no additions to tax_year a a dollar_figure sec sec sec dollar_figure of sec_6601 interest due on the deficiency amount of the interest due on dollar_figure unless otherwise indicated all section references are to the internal_revenue_code in effect for the years in issue and all rule references are to the tax_court rules_of_practice and procedure the common denominator in these consolidated cases is the claim of tax losses arising from an investment in good shepherd home inc good shepherd an s_corporation within the meaning of sec_1361 we must determine whether such losses are allowable and if not whether petitioners are liable for the additions to tax determined by respondent findings_of_fact introduction some of the facts have been stipulated and are so found the stipulation of facts filed by the parties and the accompanying exhibits are incorporated herein by this reference petitioners andrew and margita zards are individuals who made a joint_return of income for and who resided in lisle illinois at the time their petition was filed petitioner andrew zards became a shareholder of good shepherd on date petitioners janet weinman and vincent donahue are individuals who resided in new york new york at the time their petitions were filed petitioners weinman and donahue both we need determine no deficiency for petitioners vipulis for their losses from good shepherd home inc for that year were subchapter_s items within the meaning of sec the tax treatment of those items is determined at the corporate level see sec the proper treatment of those items was the subject of a proceeding before this court good shepherd home inc valdis vipulis tax_matters_person v commissioner docket no our decision in that case resulted in the disallowance of substantially_all of the losses from good shepherd home inc claimed by petitioners vipulis for we must still however decide the additions to tax became shareholders of good shepherd on date petitioners valdis and vaida vipulis are individuals who made a joint_return of income for and resided in cold springs new york at the time their petition was filed petitioner valdis vipulis became a shareholder of good shepherd on date good shepherd is an indiana corporation incorporated on date all of petitioners and good shepherd are calendar_year taxpayers we will use the term shareholders to refer to those petitioners who were shareholders of good shepherd the property ona pranckeviciute and lithuanian good shepherd home central to our discussion is a parcel of real_property located in cedar lake indiana the property sometime during the summer of ona pranckeviciute ona purchased the property from the salesian society inc salesian in the contract of sale between ona and salesian the property is described as an approximately 86-acre tract containing the following improvements scholastic building cafeteria dormitories gymnasium chapel and water plant ona agreed to pay dollar_figure million for the property she paid dollar_figure immediately and she agreed to pay the remaining dollar_figure in installments without interest her installment_obligation the salesian obligation being secured_by a mortgage against the property the first mortgage ona subsequently conveyed title to the property to lithuanian good shepherd home inc lithuanian an illinois corporation ona was president of lithuanian lithuanian is a corporation unrelated to good shepherd ona intended to convert the property from a school to a nursing home serving the lithuanian community ona was unsuccessful in obtaining a license to operate a nursing home on the property nevertheless sometime prior to three or four elderly individuals took up residence on the property ona charged each a fee of dollar_figure in advance for years of residency the fee was to cover the expense of room and board during the 5-year period in kasa lithuanian federal credit_union kasa loaned dollar_figure to lithuanian to be used to bring the first mortgage current and for improvements on the property lithuanian's obligation to kasa the first kasa obligation was secured_by a second mortgage against the property the first kasa mortgage litas vebeliunas and good shepherd litas investing co inc litas is a new york corporation in date litas purchased the property from lithuanian the property was conveyed to litas by quitclaim_deed the president of litas was vytautas vebeliunas vebeliunas vebeliunas was also president of good shepherd during each of the years in issue moreover vebeliunas was the founder of kasa one of its original directors and its first president on date vebeliunas as president of good shepherd executed a note obligating good shepherd to pay kasa dollar_figure the second kasa obligation on that same date also as president of good shepherd vebeliunas executed a mortgage on the property the second kasa mortgage to secure payment of the second kasa obligation the second kasa mortgage recites that it is subordinate to the first mortgage which is stated to have an approximate principal balance of dollar_figure also on date vebeliunas as president of good shepherd and kasa entered into a mortgage consolidation agreement the consolidation agreement whereby the first and second kasa mortgages were consolidated to secure total debts of dollar_figure the consolidated kasa mortgage the consolidation agreement also recites that it is subordinate to the first mortgage which is stated to have an approximate principal balance of dollar_figure in date vebeliunas as president of litas executed an indenture in favor of salesian under which litas agreed to pay to salesian dollar_figure and accorded to salesian a mortgage in the property to secure that obligation the first litas indenture in date vebeliunas as president of litas executed a second and similar indenture in favor of salesian except that the amount of debt was recited to be dollar_figure the second litas indenture on date vebeliunas as president of litas executed a mortgage assumption_agreement whereby litas assumed the first kasa obligation the litas assumption good shepherd organization and operations the articles of incorporation of good shepherd provide that good shepherd is formed for the following purposes clause a to carry on the business of acquiring constructing owning managing or operating nursing homes and other health care facilities including health care facilities licensed by the indiana health facilities licensing council and performing all other legal activities related thereto clause b to act as agent of or representative for any one or more corporations associations partnerships individuals or other legal entities to the extent that such activities are lawful under the act clause c to transact any or all lawful business for which corporations may be incorporated under the act prior to its involvement with the property good shepherd had never operated a nursing home or a health care or medical facility none of good shepherd's officers had operated a nursing care elder care or health_care_facility good shepherd has never received a license from the state of indiana to operate the property as a nursing home nursing care facility or other medical facility good shepherd has never received a license to operate an elder care facility on the property good shepherd has never obtained medicaid or medicare certification for the property good shepherd did not operate a nursing home or other medical facility in any of the years in issue for and good shepherd reported small amounts of income received either from the sale of livestock raised on the property or timber harvested from the property no income was reported from individuals residing on the property the elderly individuals residing on the property when it was acquired from ona remained in residence until at least the obligation to provide room and board to those individuals was assumed as part of and reduced proportionately the purchase_price of the property for through good shepherd made its returns of income on form_1120s u s income_tax return for an s_corporation for and good shepherd entered the description nursing home on the line requiring a description of its business activity for it left that line blank good shepherd reported income of dollar_figure dollar_figure and dollar_figure for through respectively good shepherd claimed the following deductions for through interest other year depreciation expense deductions tax repairs dollar_figure big_number big_number dollar_figure big_number big_number dollar_figure --- --- big_number --- --- big_number dollar_figure dollar_figure good shepherd itemized its other deductions for and as follows - - management fees travel expense advertising repairs and maint big_number dollar_figure legal professional big_number entertainment big_number outside services dollar_figure big_number outside services dollar_figure telephone utilities dollar_figure misc expense sec_953 engineering expense sec_50 big_number professional legal big_number management fees travel_expenses big_number entertainment_expenses shareholders' investments in good shepherd petitioners' deductions each petitioner was informed by vebeliunas that it was possible to buy shares in good shepherd and information from vebeliunas was the only information each of the shareholders considered in deciding to invest in good shepherd on account of the investments of the shareholders in good shepherd petitioners claimed losses for the years in issue as follows petitioner s zards weinman donahue vipulis --- dollar_figure --- big_number --- big_number dollar_figure --- --- dollar_figure big_number --- --- dollar_figure big_number --- vebeliunas vebeliunas was indicted in on more than counts of violating federal statutes prohibiting conflicts of interest fraud witness tampering racketeering interstate transportation of money and securities obtained by fraud and misapplication of funds vebeliunas was found guilty on virtually all of those counts i introduction opinion under sec_1366 a shareholder in an s_corporation is entitled to take into account his or her pro_rata share of the corporation's losses see sec_1366 respondent has conceded that good shepherd is an s_corporation and we must determine the extent if any of good shepherd's allowable losses for through we must also determine whether petitioners are liable for certain additions to tax in support of her notices of deficiency that underlie these cases respondent explained her adjustments with regard to good shepherd for through as follows it is determined that the losses claimed on your income_tax returns from good shepherd home inc are disallowed in full because you failed to establish that the losses were incurred_in_a_trade_or_business for the production_of_income that the s-corporation was formed entered into operated or conducted for the purpose of making a profit rather than for tax_avoidance that the s-corporation status is valid alternatively if it is established that your s- corporation is valid you have not verified expenses allegedly giving rise to the losses were ever paid_or_incurred in the petitions petitioners assign error to respondent's adjustments and to her determinations of additions to tax petitioners have failed however to provide statements of fact on which they base their assignments of error as to respondent's determinations of additions to tax as required by rule b ii deficiencies in tax a ordinary and necessary business_expenses in pertinent part sec_162 provides there shall be allowed as a deduction all the ordinary and necessary expenses paid_or_incurred during the taxable_year in carrying on any trade_or_business to qualify for deduction under sec_162 an item must be paid_or_incurred during the taxable_year be for carrying on any trade_or_business be an expense be a necessary expense and be an ordinary_expense 503_us_79 by raising an issue of verification respondent challenges whether petitioners have met the first qualification set forth above respondent has also challenged whether petitioners have met the second qualification an item fails to meet the second qualification that it be for carrying_on_a_trade_or_business if it is a preopening expense a preopening expense is an expense incurred between the decision to establish a business and the actual beginning of business operations see e g 345_f2d_901 4th cir vacated and remanded on other issues 382_us_68 original holding on this issue reaffd 354_f2d_410 4th cir overruled on other grounds ncnb corp v united_states 684_f2d_285 4th cir 93_tc_684 86_tc_492 as the court_of_appeals for the fourth circuit said in richmond television corp v united_states f 2d pincite the uniform teaching of certain prior cases is that even though a taxpayer has made a firm decision to enter into business and over a considerable period of time spent money in preparation for entering that business he still has not engaged in carrying on any trade_or_business within the intendment of sec_162 until such time as the business has begun to function as a going concern and performed those activities for which it was organized fn refs omitted except for the interest depreciation and taxes deducted by good shepherd all of good shepherd's deductions for through are deductions governed by sec_162 petitioners bear the burden_of_proof verification respondent has challenged whether expenditures claimed by good shepherd were ever paid_or_incurred petitioners have failed adequately to verify or substantiate those expenditures_for and good shepherd claimed deductions for travel and entertainment petitioners have introduced no evidence that would satisfy the special substantiation requirements imposed by sec_274 with regard to expenditures_for travel and entertainment with regard to good shepherd's other expenditures claimed for deduction under sec_162 for the most part petitioners apparently rely on a stipulated exhibit to satisfy their burden_of_proof that stipulated exhibit exhibit is described as a copy of ledger sheets pertaining to expenses relating to the property in issue in the taxable years and respondent however stipulates only that petitioners' exhibit represents a listing of expenses relating to the property in issue and does not stipulate that petitioners' exhibit had any legal substance or represented bona_fide debts incurred by good shepherd petitioners have made no attempt to tie the entries on exhibit to the deductions claimed on good shepherd's returns petitioners have provided virtually no documents such as canceled checks invoices or bank statements to back up the entries on exhibit only one canceled check is in evidence a check in the amount of dollar_figure drawn to lino engineering co vebeliunas testified that lino engineering was contracted for renovation and change at the property thus it is not clear that the payment is deductible at all because it may well be a capital_expenditure see sec_263 also in evidence are statements showing payments of dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure and dollar_figure to various individuals in since there are no deductions on good shepherd's return for for compensation to officers or salaries or wages we assume that those payments if made were for management services again we do not know whether such payments if made are properly deductible under sec_162 if a claimed deduction is not adequately substantiated we are permitted to estimate expenses when we are convinced from the record that the taxpayer has incurred such expenses 39_f2d_540 2d cir however we require a basis upon which an estimate may be made 85_tc_731 here for the most part we have no such basis moreover since any expense we would estimate would constitute a nondeductible preopening expense no estimate is necessary preopening expenses the parties have stipulated and we have found that good shepherd did not operate a nursing home or other health_care_facility in any of the years in issue on brief petitioners state that beginning in the corporate business of good shepherd was to buy and sell distressed properties fix them and resell or operate them in the case of the property fixing at first meant getting approval for a nursing home license since at or near the time of purchase the nursing home had of improvements needed to operate a nursing home it was the most logical way to turn this distressed property around unfortunately the nursing home approval was never obtained every time it seemed near at hand another problem would crop up even though a licensed health facility manager was in place unexpected environmental and construction problems had to be dealt with efforts to obtain a nursing home license began in and continued through the years in question in this case in support of an averment that the business of good shepherd was to buy fix-up and sell distressed properties petitioners offer the testimony of vebeliunas president of good shepherd during the years in issue vebeliunas testified that the purpose of good shepherd was to own and operate real_estate properties and services related to the real_estate properties vebeliunas' testimony on that point strikes us as enlightened hindsight and we give it no credence first the articles of incorporation of good shepherd specifically provide that it is formed for the purpose of carrying on the business of nursing homes and health care facilities only generally may it carry on other businesses there is no evidence that the directors of good shepherd ever authorized it to engage in the business described on brief by petitioners second vebeliunas was indicted in on more than counts of violating federal statutes prohibiting conflicts of interest fraud witness tampering racketeering interstate transportation of money and securities obtained by fraud and misapplication of funds vebeliunas was found guilty on virtually all of those counts although in many respects we found vebeliunas' testimony forthright and convincing in other respects we found it lacking in credibility he played a role in each of good shepherd litas and kasa and his was the only information relied on by the shareholders in deciding whether to invest in good shepherd petitioners also rely on vebeliunas to avoid the additions to tax for negligence we believe that he has an interest in seeing petitioners prevail we find that at no time during the years in issue was good shepherd in the business of buying fixing-up and selling distressed properties moreover we find that at no time during those years did good shepherd carry on any trade_or_business within the meaning of sec_162 expenditures that otherwise would have qualified for deduction under sec_162 and that related to the establishment of a nursing home or health_care_facility were preopening expenses which for that reason are nondeductible moreover any expenditures that good shepherd may have made with regard to the elderly individuals remaining in residence on the property when it was acquired from ona pranckeviciute were expenditures that constitute part of the cost of the property for that reason such expenditures are nondeductible see sec_263 b taxes sec_164 allows a deduction for certain taxes paid_or_accrued during the taxable_year for good shepherd claimed a deduction for taxes of dollar_figure petitioners have failed to substantiate that such taxes were paid for that reason no deduction is allowed c depreciation sec_167 allows as a depreciation deduction a reasonable allowance for the exhaustion wear_and_tear of property_used_in_the_trade_or_business or of property_held_for_the_production_of_income the depreciable basis_of_property acquired by purchase is cost see sec_167 if depreciable and nondepreciable_property such as improved real_estate is bought for a lump sum the purchase_price must be allocated between the land nondepreciable_property and the depreciable improvements e g buildings see sec_1_167_a_-5 income_tax regs depreciation_deductions may not be claimed until an asset is placed_in_service 91_tc_524 sec_1_167_a_-10 income_tax regs on its return good shepherd claimed a deduction for depreciation of dollar_figure based on a total cost_basis for depreciable_property of dollar_figure we assume that such depreciable_property is a portion of the property deductions for depreciation as set forth in our findings_of_fact were claimed by good shepherd for through in our findings_of_fact we have recited a description of the property as an improved 86-acre tract petitioners have proposed although we have not found that the purchase_price paid_by good shepherd for the property was over dollar_figure million petitioners have failed to show on what basis good shepherd allocated the purchase_price of the property between land and any depreciable buildings or other depreciable improvements thus petitioners have failed to substantiate good shepherd's deductions for depreciation moreover petitioners have failed to show that any buildings or other depreciable improvements were placed_in_service in any trade_or_business or profit-making activity during the years in issue we already have concluded that during those years good shepherd was engaged in preopening activities with regard to the business of operating a nursing home good shepherd was not then engaged in any trade_or_business or other profit-making activity and for that reason alone good shepherd may not claim any deductions for depreciation for those years d interest sec_163 states there shall be allowed as a deduction all interest_paid or accrued within the taxable_year on indebtedness deductible_interest is a payment for the use or forbearance of money 308_us_488 it is well settled that the indebtedness referred to in sec_163 must be genuine and economic realities govern over the form in which a transaction is cast 364_us_361 an indebtedness is an existing unconditional and legally enforceable obligation for the payment of a principal sum e g 86_tc_1284 a taxpayer may deduct as interest on its indebtedness interest_paid by the taxpayer on a mortgage upon real_estate of which the taxpayer is the legal or equitable owner even though the taxpayer is not directly liable upon the bond or note secured_by such mortgage sec_1_163-1 income_tax regs however only interest_paid or accrued on a mortgage on property for the period after the taxpayer becomes the legal or equitable owner of the property is deductible under sec_163 64_tc_300 interest accruing before but paid_by the taxpayer must be capitalized we are unconvinced that good shepherd either made any payments of interest during the years in question or had any genuine indebtedness that would entitle it a tax deduction for interest_paid or accrued no schedule particularizes the interest deducted on the good shepherd returns petitioners have not introduced into evidence any check or other direct evidence that shows that good shepherd paid either principal or interest on any indebtedness indeed journal entries made by good shepherd regarding and indicate that no payments of principal were made on either the first or second kasa obligations during such periods we assume that the indebtedness with regard to which petitioners claim interest deductions are the salesian obligation the first kasa obligation and the second kasa obligation we are convinced that on some date good shepherd acquired title to the property a title insurance_policy effective date states that title to the property is on that date in the name of good shepherd nevertheless we have in evidence no deed or other document conveying title to good shepherd on that date or before we know that title to the property passed to litas by quitclaim_deed in date we also know that in date litas made the first litas indenture in favor of salesian we also know that in date litas made the second litas indenture in favor of salesian there is no evidence that during the years in question good shepherd assumed that salesian obligation petitioners' position is that litas on behalf of good shepherd assumed the salesian obligation vebeliunas testified that litas acted on behalf of good shepherd in that respect again such testimony strikes us as enlightened hindsight and we give it no credence more importantly if litas was acting on behalf of good shepherd it was putting its own credit on the line when it made the two indentures there is however no evidence of any agreement by good shepherd to reimburse litas for any payments it was required to make pursuant to the indentures the logic of that omission is that litas was an obligor on its own behalf and not on behalf of good shepherd we do not understand all that went on here but that is petitioners' fault they have the burden_of_proof suffice it to say that they have not convinced us that good shepherd either paid or was obligated to pay any amount on the salesian obligation during the years in question and we so find we reach a similar conclusion with regard to the first kasa obligation we are aware of course of the consolidation agreement entered into by kasa and good shepherd and purporting to consolidate the mortgages securing the first and second kasa obligations nevertheless we have no evidence that good shepherd ever assumed the first kasa obligation and we have the litas assumption whereby litas did assume the first kasa obligation as with the salesian obligation we are not convinced that good shepherd either paid or was obligated to pay any amount on the first kasa obligation during the years in question and we so find the second kasa obligation was executed by good shepherd there is no evidence of an assumption by litas to be entitled to a deduction for interest_paid or accrued on the second kasa obligation petitioners have the burden of showing that the indebtedness is genuine in the stipulation of facts entered into by the parties respondent stipulated to copies of the second kasa obligation and second kasa mortgage respondent added however that she did not stipulate that those documents had any legal substance or represented a bona_fide debt incurred by good shepherd beyond petitioners' promissory note to kasa petitioners have introduced no evidence such as bank statements or other documents to show that any sum actually was received by good shepherd in consideration of the second kasa obligation more importantly as we have said petitioners have introduced no evidence that good shepherd paid anything either principal or interest with regard to the second kasa obligation we are not convinced that the second kasa obligation represented true indebtedness or that good shepherd paid any interest with respect thereto and we so find for the reasons stated we determine that good shepherd may not claim any interest deductions for either or e conclusion we sustain the deficiencies in tax determined by respondent for the reasons stated therefore we need not address respondent's alternative grounds that good shepherd was organized and operated for purposes of tax_avoidance rather than to make a profit iii additions to tax a negligence sec_6653 imposes one or more additions to tax where an underpayment_of_tax is due to negligence or intentional disregard of rules or regulations hereafter without distinction negligence respondent has determined additions to tax for negligence with respect to all petitioners sec_6653 for returns due in sec_6653 for returns due in and and sec_6653 for returns due in impose an addition_to_tax equal to percent of the entire underpayment if any portion of such underpayment is due to negligence sec_6653 for returns due in and and sec_6653 for returns due in impose an addition_to_tax equal to percent of the interest payable under sec_6601 with respect to the portion of the underpayment due to negligence negligence is lack of due care or failure to do what a reasonable and ordinarily prudent person would do under the circumstances 85_tc_934 quoting marcello v commissioner 380_f2d_499 5th cir affg in part revg in part 43_tc_168 petitioners bear the burden_of_proof rule a as we said in section i supra petitioners have failed to plead facts in support of their assignment of error with regard to respondent's determinations of additions to tax on brief petitioners argue that they did not act negligently because they relied on the advice of their accountant whom we assume was vebeliunas none of petitioners testified vebeliunas testified that he was never an accountant for the zardses the parties have stipulated that information from vebeliunas was the only information each of petitioners considered in deciding whether to invest in good shepherd when asked what information he gave petitioners vebeliunas testified as follows it's a difficult task to remember that many years ago and to reconstruct the conversation if the court would permit me we have as much as people invested with us and many of them talk to me to the best of my recollection this was presented as a distressed property with the possibility of profit and each distressed property acquired is usually employed for whatever was built we had apartment houses we had hotels this was the first one that was a health facility i addressed myself to the value of the property to the placement of the property and so explained it to the investors the actual narrative of it i do not remember it is true that reliance on the advice of an expert can in some circumstances defeat a claim of negligence e g 66_tc_272 the long and the short of it however is that this is not one of those cases not only could vebeliunas not remember well what he advised petitioners petitioners have not pointed out to us any testimony by vebeliunas that relates at all to the tax consequences of their investments petitioners have failed to carry their burden of proving that they were not negligent and we so find we uphold respondent's determinations of negligence in all respects b substantial_understatement respondent has determined additions to tax under sec_6661 for all years in issue and for all petitioners except for petitioners zards for returns due before date sec_6661 provides for an addition_to_tax equal to percent of the amount of any underpayment attributable to a substantial_understatement an understatement is substantial when the understatement for the taxable_year exceeds the greater of percent of the tax required to be shown or dollar_figure the understatement is reduced to the extent that the taxpayer has adequately disclosed his or her position or has substantial_authority for the tax treatment of an item sec_6661 sec_1 a income_tax regs petitioners bear the burden of showing that they are not subject_to the addition_to_tax determined by respondent rule a petitioners have averred no facts in support of their assignment that respondent erred in determining an addition_to_tax under sec_6661 moreover on brief petitioners make no argument disputing respondent's sec_6661 determinations we assume that petitioners have abandoned their claims of error with regard to sec_6661 on that basis respondent's determination of additions to tax under sec_6661 are sustained decisions will be entered for respondent