t c memo united_states tax_court key carpets inc petitioner v commissioner of internal revenue respondent raymond c johnson and geraldine l johnson petitioners v commissioner of internal revenue respondent docket nos filed date harry charles for petitioners stephen a haller for respondent memorandum findings_of_fact and opinion paris judge these cases have been consolidated for trial briefing and opinion respondent determined deficiencies and accuracy-related_penalties under sec_6662 in petitioners’ federal_income_tax for and years at issue for petitioner key carpets inc key carpets respondent determined deficiencies of dollar_figure and dollar_figure for and respectively and accuracy-related_penalties of dollar_figure and dollar_figure for and respectively for petitioners raymond c johnson and geraldine l johnson respondent determined deficiencies of dollar_figure and dollar_figure for and respectively and accuracy-related_penalties of dollar_figure and dollar_figure for and respectively after concessions the issues for decision are whether key carpets is entitled to deduct computer service and consulting expenses including payments made to a related company clean hands co inc clean hands for and whether mr and mrs johnson received constructive distributions in and as a result of key carpets’ payments to clean hands and whether all petitioners are liable for accuracy-related_penalties under sec_6662 for the years at issue all section references are to the internal_revenue_code code in effect for the years at issue and all rule references are to the tax_court rules_of_practice and procedure unless otherwise indicated respondent concedes that mr and mrs johnson are entitled to deduct an additional dollar_figure in real_estate losses for a total real_estate loss deduction of dollar_figure for and mr and mrs johnson are not entitled to deduct miscellaneous_itemized_deductions expenses of dollar_figure on schedule a itemized_deductions for findings_of_fact some of the facts have been stipulated and are so found the stipulation of facts the first supplemental stipulation of facts and the attached exhibits are incorporated herein by this reference mr and mrs johnson resided in missouri at the time of filing their petition key carpets is a missouri corporation with its principal_place_of_business in missouri i development of the hand washing monitoring system mr and mrs johnson incorporated key carpets in primarily to sell carpets to realtors and they jointly owned key carpets for the years at issue for the years at issue key carpets was a successful business with over dollar_figure million in gross_receipts each year in mr johnson incorporated another company clean hands and for the years at issue was its sole shareholder mr johnson originally incorporated clean hands because he intended to reserve the name for a hand washing monitoring system that key carpets had begun to develop the initial hand washing monitoring system was intended to work by dispensing soap when a person activated the system using a radio frequency identification rfid badge the initial hand washing monitoring system would then record the individual’s name in a database for future reference mr johnson intended to sell the hand washing monitoring system to food service businesses so that employers could verify an employee’s compliance with sanitation requirements between and key carpets hired five to six employees to build the initial hand washing monitoring system clean hands was not involved in developing the initial hand washing monitoring system and was inactive from to in clean hands hired a computer technician as an employee to assist with the development of the hand washing monitoring system mr johnson considered hiring the computer technician as either a key carpets employee or as a clean hands employee with the intent that key carpets could then contract with clean hands to build the hand washing monitoring system mr johnson decided to hire the computer technician as a clean hands employee rather than as a key carpets employee because an employee was needed to work on the hand washing monitoring system full time the computer technician had a bachelor of science degree in physics a long career as a computer programmer with several other companies and an annual salary of over dollar_figure at his previous employment after hiring the computer technician mr johnson decided that the initial hand washing monitoring system developed by key carpets was no longer feasible therefore the computer technician began working on a new hand washing monitoring system that was voice activated to use the new system a user would state his or her name the system would record the person’s name in a database and then the system would dispense soap as an employee of clean hands the computer technician developed the new voice-activated hand washing monitoring system mr johnson owned the patent on the voice-activated hand washing monitoring system but thought that key carpets owned the voice-activated hand washing monitoring system in addition to assisting with the development of the hand washing monitoring system the computer technician provided information_technology it services to key carpets the computer technician would fix key carpets’ computer problems and was the administrator for key carpets’ computer network web site and email system key carpets had a preexisting office location that included a large carpet warehouse because clean hands had office space in the back of that building the computer technician’s physical location allowed him to work for both companies additionally mr johnson was concerned that his health problems could jeopardize his capacity to manage key carpets and clean after the years at issue clean hands marketed this hand washing monitoring system as clean hands and sold the system to local restaurants hands and he considered the computer technician’s educational and professional background when he hired the computer technician to step in if necessary as a stabilizing influence for key carpets however the computer technician was not aware of this duty and in fact never assumed any managerial responsibilities for key carpets never had check writing authority for key carpets or clean hands and never had the authority to terminate employees during the years at issue although clean hands did not require him to the computer technician maintained a time log of his work during the log detailed his work throughout the year including his time spent developing the hand washing monitoring system and providing it services to key carpets the log shows that the computer technician generally worked eight hours a day the computer technician did not maintain a time log for according to his testimony the computer technician estimated with a reasonably high degree of accuracy that to of his time at clean hands in and was spent working on the hand washing monitoring system clean hands wrote checks on its bank account to pay the computer technician a salary of dollar_figure in and dollar_figure the computer technician did hire employees and contractors for clean hands outside the years at issue in clean hands reported dollar_figure for and dollar_figure for in total salaries and wages for its only employee on its forms u s_corporation income_tax return for those years key carpets paid clean hands throughout the years at issue for purportedly developing the hand washing monitoring system and providing key carpets with it services in clean hands received dollar_figure in checks from key carpets in clean hands received dollar_figure from key carpets ii internal_revenue_service examination of and returns mr and mrs johnson timely filed joint federal_income_tax returns on form sec_1040 u s individual_income_tax_return for the years at issue key carpets and clean hands filed their and federal_income_tax returns on forms all of the federal_income_tax returns were prepared by petitioners’ accountant from documents that petitioners had provided the internal_revenue_service irs subsequently selected key carpets’ and mr and mrs johnson’s and federal_income_tax returns for examination for key carpets claimed a deduction of dollar_figure for computer service and consulting partly with respect to the amount_paid to clean hands the parties did not address the deduction that exceeded the amount_paid to clean hands upon examination the irs determined that only dollar_figure of the claimed dollar_figure computer service and consulting expenses was allowable as a deduction in reaching that determination the irs sampled two months of the computer technician’s time log to calculate the amount of the computer technician’s salary expense that was allocable to it services provided to key carpets however key carpets did not use the computer technician’s time log to prepare its return the irs did not allow key carpets to deduct for the portion of the computer technician’s salary expense that the auditor determined was allocable to developing the hand washing monitoring system key carpets claimed a deduction of dollar_figure for computer service and consulting on its federal_income_tax return the irs disallowed the entire deduction because the computer technician did not maintain a time log therefore the irs was unable to determine the amount of the computer technician’s salary expense that was allocable to it services for on date respondent issued a notice_of_deficiency for and to key carpets that disallowed the claimed deductions for computer service and consulting except for dollar_figure that the irs allowed for respondent key carpets signed two form sec_872 consent to extend the time to assess tax that extended the deadline for assessment for and to december continued also issued a notice_of_deficiency to mr and mrs johnson on date in that notice_of_deficiency respondent determined that the payments from key carpets a corporation owned by mr and mrs johnson to clean hands a corporation solely owned by mr johnson were constructive distributions from key carpets to mr johnson and mrs johnson as key carpets did not own the voice-activated hand washing monitoring system for the years at issue respondent also determined that key carpets and mr and mrs johnson were liable for accuracy-related_penalties under sec_6662 for the years at issue petitioners timely petitioned this court opinion generally the commissioner’s determination set forth in a notice_of_deficiency is presumed correct and the taxpayer bears the burden of showing the continued mr and mrs johnson signed three form sec_872 that extended the deadline for assessment for and to date the determinations of constructive distributions are determinations of unreported income for the presumption of correctness to attach to a notice_of_deficiency in unreported income cases the commissioner must establish some evidentiary foundation connecting the taxpayer with the income-producing activity see eg 981_f2d_350 8th cir aff’g in part rev’g in part 96_tc_172 see also weekend warrior trailers continued determination is in error rule a 290_us_111 sec_7491 shifts the burden_of_proof to the commissioner if the taxpayer produces credible_evidence on any factual issues and satisfies the requirements of sec_7491 credible_evidence is the quality of evidence which after critical analysis the court would find sufficient upon which to base a decision on the issue if no contrary evidence were submitted without regard to the judicial presumption of irs correctness 116_tc_438 quoting h_r conf rept no pincite 1998_ 3_cb_747 petitioners have not shown that they meet the requirements of sec_7491 nor established their compliance with the substantiation and recordkeeping requirements see sec_7491 and b petitioners therefore bear the burden_of_proof i business_expense deductions deductions are a matter of legislative grace and the taxpayer bears the burden of proving entitlement to any deduction claimed on a return indopco continued inc v commissioner tcmemo_2011_105 slip op pincite the parties stipulated that mr and mrs johnson jointly and solely owned key carpets for the years at issue accordingly respondent’s determinations are presumed correct sec_7491 requires a taxpayer to substantiate any item and maintain all records required under the code inc v commissioner 503_us_79 292_us_435 sec_162 permits a deduction for ordinary and necessary expenses paid_or_incurred during the taxable_year in carrying on any trade_or_business welch v helvering u s pincite an expense is ordinary if it is customary or usual within a particular trade business or industry 308_us_488 an expense is necessary if it is appropriate and helpful for the business 320_us_467 a taxpayer ordinarily must maintain adequate_records to substantiate the amounts of income and entitlement to any deductions claimed see sec_6001 sec_1_6001-1 income_tax regs if however a taxpayer with inadequate or nonexistent business records is able to prove that it paid_or_incurred a deductible business_expense but does not prove the amount of the expense the court may estimate the amount allowable in some circumstances cohan_rule see 39_f2d_540 2d cir the taxpayer must introduce sufficient evidence to permit the court to conclude that the taxpayer paid_or_incurred a deductible expense in at least the amount allowed see 245_f2d_559 5th cir 85_tc_731 in estimating the amount allowable the court bears heavily upon the taxpayer who failed to maintain required records and to substantiate expenses as the code requires see cohan v commissioner f 2d pincite the court here decides what services the computer technician provided to key carpets and we allow deductions as appropriate the computer technician had two tasks as an employee of clean hands providing it services to key carpets and developing the voice-activated hand washing monitoring system a deductions for developing the voice-activated hand washing monitoring system petitioners contend that key carpets’ payments to clean hands for the voice-activated hand washing monitoring system are deductible because key carpets owned the voice-activated hand washing monitoring system and contracted with clean hands to build the system respondent contends that the expenses of developing the voice-activated hand washing monitoring system were not deductible by key carpets because the computer technician was hired as a clean hands employee and key carpets did not own the voice-activated hand washing monitoring system mr johnson did not present any credible_evidence that key carpets owned the voice-activated hand washing monitoring system his testimony that key carpets owned the voice-activated hand washing monitoring system was vague unclear and not credible mr johnson’s testimony contradicts his statements that he owned the patent on the voice-activated hand washing monitoring system additionally the parties stipulated that mr johnson was the sole owner of clean hands although key carpets had an ownership_interest in the initial rfid badge-activated hand washing system key carpets had no interest in the new voice-activated system that the computer technician developed as a clean hands employee the court therefore finds that key carpets did not own the voice-activated hand washing monitoring system since key carpets did not own the voice-activated hand washing monitoring system the court must determine whether the expenses related to developing it were ordinary and necessary for key carpets see sec_162 mr johnson owned all the stock of clean hands and he owned the patent on the voice-activated hand washing monitoring system key carpets received no benefits from the payments for the development of the system therefore the expenses were not ordinary and necessary key carpets may not deduct the amounts paid to clean hands for the development of the voice-activated hand washing monitoring system petitioners in their opening brief cite chapman v commissioner tcmemo_2014_82 as support for the deductibility of key carpets’ payments to clean hands in chapman the taxpayers owned a real_estate management company and a car rental company id at the two companies had opposing busy seasons and the taxpayer contracted with the car rental company for its employees to perform routine winterization for the real_estate management clients that the real_estate management employees were unable to complete because of other work obligations id the facts of that case are not analogous to those of petitioners’ cases the real_estate management company in chapman received significant benefits from the car rental company the real_estate company generated income from the winterization and then paid the car rental employees for completing that work id in the cases before us the computer technician spent most of his time working on the voice-activated hand washing monitoring system for clean hands the voice-activated hand washing monitoring system was not for key carpets or its clients the only benefits key carpets received were it services petitioners also contend that these cases are reasonable_compensation cases and cite law offices--richard ashare p c v commissioner tcmemo_1999_ in support of their argument that key carpets should be allowed to deduct the payments however respondent does not argue that the computer technician’s salary was unreasonable nor has the salary clean hands paid been challenged respondent contends only that the deductions were not ordinary and necessary business_expenses for key carpets the court agrees with respondent b deductions for it services respondent acknowledges that the computer technician provided it services to key carpets respondent contends that key carpets may deduct only the payments made for the portion of the computer technician’s salary that represents his time providing those it services the computer technician was an employee of clean hands and clean hands paid the computer technician’s salary the court partially agrees with respondent in that key carpets is entitled to deduct the portion of the computer technician’s total wage expenses that is allocable to providing it services to key carpets therefore the court must determine the portion of the computer technician’s time spent providing it services to key carpets in the computer technician maintained a log of his work and after the irs sampled two months of the log it allowed key carpets a deduction of dollar_figure for it services which is substantially less than of the computer technician’s salary expense the computer technician testified with a reasonably high degree of accuracy that to of his time was spent providing it services to key carpets and under the cohan_rule the court may estimate the amount allowable when the taxpayer provides some basis for the court to estimate the deduction see cohan v commissioner f 2d pincite the computer technician’s time log and his credible testimony provide the court with a basis to estimate the deduction the computer technician provided it services for key carpets’ computer network web site and email as well as fixing computer problems for key carpets’ employees the clean hands office where the computer technician worked was also part of the key carpets office the computer technician was therefore available to provide informal consulting and it services to key carpets an active commercial carpet business with over dollar_figure million in gross_receipts each year the court finds on the basis of the computer technician’s credible testimony that the computer technician spent at least of his time providing it services to key carpets fifteen percent of the computer technician’s time in an eight-hour day i sec_72 minutes which is not an unreasonable amount of time to spend maintaining key carpets’ email web site and computer network and fixing computer problems for key carpets’ employees the court is not convinced that given the size of key carpets its it services could have been accomplished in minutes or less which would represent the estimate the court therefore finds that key carpets is entitled to deduct of the computer technician’s salary expense the remaining amount that key carpets claimed as a deduction for is disallowed in the computer technician did not maintain a time log of his work and respondent disallowed the entire deduction the record supports a finding that the computer technician provided similar it services to key carpets in as he did in the court therefore finds that key carpets is entitled to deduct of the computer technician’s salary expense for it servicesdollar_figure respondent urges the court to accept his determination to limit key carpets’ deduction to approximately of the computer technician’s salary on the basis of respondent’s two-month sampling of the computer technician’s time log fifteen percent of dollar_figure is dollar_figure accordingly key carpets is entitled to deduct dollar_figure for it services for clean hands reported dollar_figure as the amount of total wages and salaries for its only employee the computer technician on its return key carpets claimed a deduction of dollar_figure for computer and consulting services for however the amount exceeding dollar_figure was never substantiated fifteen percent of dollar_figure is dollar_figure accordingly key carpets is entitled to deduct dollar_figure for it services for clean hands reported dollar_figure as the amount of total wages and salaries for its only employee the computer technician on its return key carpets claimed a deduction of dollar_figure for computer and consulting services for petitioners did not substantiate the amount exceeding the computer technician’s salary expense a limitation would mean that the computer technician spent approximately minutes per day providing it services to key carpets moreover from the record it appears that respondent did not credit the computer technician for all of his time spent providing it services to key carpets the computer technician’s time log often included an entry in the morning of mail etc some of this time was clearly spent on matters for key carpets additionally the computer technician frequently met with mr johnson to review his work while most of the meetings were to discuss the voice-activated hand washing monitoring system for clean hands mr johnson and the computer technician also discussed other matters including it services for key carpets in short the court finds that petitioners presented sufficient evidence for the court to estimate that the computer technician spent at least an hour and minutes a day providing it services to key carpets and key carpets is entitled to a corresponding deduction of of the computer technician’s total salary expenses see cohan v commissioner f 2d pincite ii constructive distributions for a corporation a distribution_of_property made to a shareholder with respect to its stock is governed by sec_301 sec_301 sec_317 defines property as money securities and any other_property a taxpayer must include in gross_income amounts received as dividends under sec_301 see also sec_61 a dividend is any distribution a corporation makes to its shareholders out of earnings_and_profits sec_316 the distribution is first made out of the earnings_and_profits for the current taxable_year see id when current_earnings_and_profits are insufficient the distribution is made out of accumulated_earnings_and_profits see id when a corporation does not have sufficient earnings_and_profits for the entire distribution to constitute a dividend the remaining amount is not a dividend but reduces the adjusted_basis of the shareholder’s stock in the corporation sec_301 the amount of the distribution that is not a dividend or does not reduce basis is generally treated as gain from the sale_or_exchange of property sec_301 see also sec_1001 a distribution need not be formally declared or even intended by a corporation but can be constructive 368_f2d_439 9th cir aff’g tcmemo_1965_84 whether a payment is a constructive distribution depends on whether it was primarily for the benefit of the shareholder 115_tc_172 the the court uses the term constructive distribution to describe what our caselaw has sometimes referred to as a constructive_dividend the use of the term constructive distribution is more accurate in these cases because key carpets’ earnings_and_profits are insufficient for the entire amount to constitute a continued determination of whether the shareholder or the corporation primarily benefits is a question of fact id pincite to avoid having a payment treated as a constructive distribution the taxpayer must show that the payor primarily benefited from its payment of the shareholder’s expenses id pincite in determining whether or not the expenditure related to the business of the corporation we must ascertain whether the payment or expenditure has independent and substantial importance to the paying corporation gow v commissioner tcmemo_2000_93 slip op pincite citing t j en101_tc_581 aff’d sub nom 67_f3d_1445 9th cir aff’d 19_fedappx_90 4th cir an expenditure generally does not have independent and substantial importance to the distributing_corporation if it is not deductible under sec_162 id citing 820_f2d_1084 9th cir aff’g t c memo this court has previously held that a transfer between related corporations can result in a constructive distribution to their common shareholder when the shareholder receives a direct or tangible benefit gilbert v commissioner t c continued constructive_dividend see sec_301 however if the transfer is a loan or if the benefit to the shareholder is indirect or derivative there is no constructive distribution id pincite in considering whether a transfer is a loan the court looks to whether there was a genuine intention to create a debt which in turn depends upon weighing such objective factors as reasonable expectation of repayment and the economic reality of the claimed debtor-creditor relationship id pincite the determination of whether a transfer is a loan is a question of fact id pincite respondent contends that the key carpets payments that do not relate to the it services the computer technician provided to key carpets are constructive distributions to mr and mrs johnson because mr johnson received a personal benefit from the payments petitioners contend that the payments from key carpets to clean hands are deductible as to key carpets and therefore there is no constructive distribution because the court finds that key carpets is entitled to deduct only payments to clean hands for it services provided to key carpets the court must determine whether the payments not related to it services are constructive distributions to the key carpets shareholders mr and mrs johnson the central issue with respect to whether the payments are constructive distributions to mr and mrs johnson is whether the payments were for mr johnson’s personal benefit as the sole shareholder of clean hands the court has found that key carpets had no ownership_interest in the voice-activated hand washing monitoring system mr johnson owned clean hands for the years at issue and owned the patent on the hand washing monitoring system as the sole owner of clean hands mr johnson needed funds to support clean hands to support clean hands and the development of the hand washing monitoring system instead of mr johnson making capital contributions directly to clean hands he caused key carpets to transfer funds to clean hands see sec_351 the payments therefore provided significant economic benefit to mr johnson and his business clean hands see stinnett’s pontiac serv inc v commissioner tcmemo_1982_314 holding that when a shareholder was required to make capital contributions and caused a related company to pay the contributions the payments were for the personal benefit of the common shareholder aff’d 730_f2d_634 11th cir petitioners never presented evidence of a promissory note a loan repayment schedule or loan repayments key carpets instead considered the payments key carpets’ federal_income_tax return reported that at the beginning of clean hands owed a loan repayment of dollar_figure to key carpets clean hands did not owe the loan at the end of or at the beginning of but clean hands owed key carpets the dollar_figure at the end of petitioners never offered any evidence about the loan entries and the amount is substantially less than the payments key carpet made to clean hands thus the dollar_figure continued computer service and consulting deductible expenses rather than capital contributions or loans key carpets had no documentation that reflected an expectation of repayment the court finds that the key carpets payments’ to clean hands not related to the it services did not benefit key carpets but provided personal and tangible benefits to mr johnson and are therefore constructive distributions to mr johnsondollar_figure iii sec_6662 a --accuracy-related penalty sec_6662 and b and authorizes a accuracy-related_penalty on the portion of an underpayment of federal_income_tax attributable to negligence or disregard of rules or regulations or a substantial_understatement of federal_income_tax under sec_7491 the commissioner continued appears to be a preexisting liability key carpets paid clean hands dollar_figure and dollar_figure in and respectively the court has allowed key carpets to deduct dollar_figure and dollar_figure for it services for and respectively see supra part i b accordingly mr johnson is deemed to have received constructive distributions of the amount key carpets paid clean hands less the amount of the key carpets’ deductions allowed by the court for and the parties have calculated key carpets’ earnings_and_profits for the and taxable years however the parties agree that a final earnings_and_profits computation will have to be prepared and submitted after the court determines key carpets’ taxable_income bears the burden of production with regard to penalties for an individual taxpayer 126_tc_191 holding that sec_7491 does not apply where the taxpayer is a corporation higbee v commissioner t c pincite once the commissioner has met the burden of production the taxpayer has the burden of proving that the penalties are inappropriate because of reasonable_cause or substantial_authority see rule a higbee v commissioner t c pincite for an individual taxpayer there is a substantial_understatement_of_income_tax for any year if the amount of the understatement for the taxable_year exceeds the greater of of the tax required to be shown on the tax_return or dollar_figure sec_6662 higbee v commissioner t c pincite for a c_corporation there is a substantial_understatement_of_income_tax for any year if the amount of the understatement for the taxable_year exceeds the lesser_of of the tax required to be shown on the tax_return or if greater dollar_figure or dollar_figure million sec_6662 after respondent’s concessions and accounting for the reduced constructive distributions due to key carpets’ allowed deductions for it services the understatements of income_tax are greater than dollar_figure which in turn is greater than of the tax required to be shown on mr and mrs johnson’s return for each of the years at issue thus the understatement is substantial for purposes of the sec_6662 accuracy-related_penalty and respondent has met his burden of production in showing that mr and mrs johnson’s underpayments are due to their substantially understating their federal_income_tax additionally the understatements of income_tax for key carpets are greater than of the tax required to be shown on its returns for the years at issue pursuant to sec_6664 no penalty shall be imposed under sec_6662 with regard to any portion of an underpayment if the taxpayer can show that there was reasonable_cause for such portion and that the taxpayer acted in good_faith with respect to such portion whether a taxpayer acted with reasonable_cause and in good_faith is decided on a case-by-case basis taking into account all pertinent facts and circumstances sec_1_6664-4 income_tax regs generally the most important factor is the extent of the taxpayer’s effort to assess his proper tax_liability id see also remy v commissioner tcmemo_1997_72 reliance on the advice of a tax professional may but does not necessarily establish reasonable_cause and good_faith for the purpose of avoiding a sec_6662 penalty 469_us_241 a taxpayer’s reliance on a competent tax professional may establish reasonable_cause and good_faith when the taxpayer provides necessary and accurate information to the adviser and actually relies in good_faith on the adviser’s judgment see 593_fedappx_965 11th cir aff’g tcmemo_2013_80 115_tc_43 aff’d 299_f3d_221 3d cir a penalty that is attributable to a substantial_understatement_of_income_tax under sec_6662 may be reduced if the taxpayer’s position is supported by substantial_authority or relevant facts are adequately disclosed in a statement attached to the return and the taxpayer’s position has a reasonable basis sec_6662 petitioners argue that they acted with reasonable_cause and in good_faith because petitioners provided all records to their accountant and had a reasonable basis for the business deductions however petitioners did not act in good_faith because their positions run contrary to established law mr johnson testified that he provided all records to his accountant on whom he relied to prepare his corporate and individual returns but petitioners did not offer any evidence about whether they sought advice from their accountant about the deductions or whether the key carpets payments to clean hands constituted constructive distributions because petitioners’ positions run contrary to established law and petitioners have not shown that they reasonably relied on their accountant to do anything more than prepare tax returns petitioners have not met their burden of proving that they acted in good_faith with reasonable_cause and the court sustains the sec_6662 accuracy-related penaltydollar_figure the court has considered all of the arguments made by the parties and to the extent they are not addressed herein they are considered unnecessary moot irrelevant or without merit decisions will be entered under rule respondent determined sec_6662 penalties because petitioners’ underpayments were attributable to negligence or disregard of rules or regulations or a substantial_understatement_of_income_tax because the court finds that there was a substantial_understatement_of_income_tax for mr and mrs johnson and key carpets a discussion of whether petitioners were negligent is not warranted


t c memo united_states tax_court residential management services trust robert hogue trustee petitioner v commissioner of internal revenue respondent docket no filed date robert hogue pro_se jeremy l mcpherson for respondent memorandum opinion dawson judge this case was assigned to special_trial_judge robert n armen jr pursuant to the provisions of sec_7443a and rule sec_180 sec_181 and sec_183 the court agrees with and adopts the opinion of the special_trial_judge which is set forth below unless otherwise indicated all section references are to the internal_revenue_code as amended and all rule references are to the tax_court rules_of_practice and procedure - - opinion of the special_trial_judge armen special_trial_judge this matter is before the court on respondent’s motion to dismiss for lack of jurisdiction ’ respondent maintains that the petition was not filed by a trustee authorized to bring suit on behalf of residential management services trust residential management as discussed in detail below we shall grant respondent’s motion and dismiss this case for lack of jurisdiction background a notice_of_deficiency respondent issued a notice_of_deficiency to residential management determining a deficiency in an addition to anda penalty on its federal_income_tax as follows accuracy-related addition_to_tax penalty year deficiency sec_6651 a sec_6662 a dollar_figure dollar_figure dollar_figure the deficiency in income_tax is based on the disallowance of deductions claimed by residential management on schedule c this case was consolidated for hearing with three related cases in which robert hogue also filed petitions purportedly as trustee on behalf of various so-called trusts see rancho residential servs trust v commissioner tcmemo_2003_57 home health servs trust v commissioner tcmemo_2003_58 sunshine residential trust v commissioner tcmemo_2003_59 use of the terms trust and trustee and their derivatives is intended for narrative convenience only thus no inference should be drawn from our use of such terms regarding any legal status or relationship profit or loss from business in this regard respondent determined that the deductions are disallowed because you failed to establish the amount if any that was paid during the taxable_year for ordinary and necessary business_expenses and you failed to establish the cost or other basis of the property claimed to have been used in business b petition the court subsequently received and filed a petition for redetermination challenging the notice_of_deficiency the petition was signed by robert hogue as residential management’s purported trustee paragraph of the petition which sets forth the bases on which the notice_of_deficiency is challenged alleges as follows the statutory_notice_of_deficiency was issued to petitioner claiming petitioner had unreported income petitioner denies having any unreported income attached to the notice_of_deficiency irs form 4549-a income_tax examination changes line states total corrected tax_liability petitioner denies having a tax_liability respondent has failed to provide the petitioners sic with the usc title_26 taxing statute that applies respondent has failed to provide the petitioners sic with certified assessment information as per internal revenue regulation respondent has failed to identify the individual who will certify to the tax adjustments the determination was based on petitioner claims the notice_of_deficiency the claimed tax_liability and the claimed unreported income are all based on unfounded and hearsay evidence no examination of books_and_records has been done so we are presuming this is a naked assessment there can be no residential management’s principal_place_of_business was in california at the time that the petition was filed with the court - - meaningful administrative hearing until respondent provides petitioner with certified evidence to support the notice_of_deficiency and the claimed tax_liability cc respondent’s motion respondent filed a motion to dismiss for lack of jurisdiction in the motion respondent asserts that this case should be dismissed for lack of jurisdiction on the ground that the petition was not filed by a trustee authorized to bring suit on behalf of the trust respondent attached to the motion to dismiss inter alia a five-page purported trust instrument dated date trust instrument and a document entitled trustee resignation appointment of successor-trustee dated date wherein one douglas j carpa trustee purportedly appoints robert hogue the successor trustee for residential management appointment document respondent represents that the trust instrument was provided to him by robert hogue a representation that robert hogue does not deny we also note that the trust instrument is a copy of the trust instrument submitted by robert hogue in his first case before this court involving residential management that was dismissed on the ground that robert hogue was not a proper person authorized to petition the court on behalf of the trust see residential mgmt servs trust v commissioner tcmemo_2001_297 involving the tax_year see also residential mgmt servs trust v commissioner docket no oo involving the tax_year and dismissed on the same basis with the exception of the name of the so-called trust the appointment document is identical to the appointment document submitted to the court by robert hogue in numerous cases before this court that were dismissed on the ground that robert hogue continued the trust instrument provides in pertinent part as follows begin unnumbered cover page this document is created under common_law right of contract in washington d c residential management services a_trust organization and or pure trust executed under the constitutional laws of the united_states of america dated may end unnumbered cover page declaration of irrevocable_trust this declaration of irrevocable_trust is created this z4th day of may between contract administrators trust of washington d c hereinafter called the settlor and american common trust washington d c with mailing address of tempe arizona douglas j carpa trust officer hereinafter called the trustee who are legal entities holding full title not as individuals but collectively as the board under the name of residential management services continued was not a proper person authorized to petition the court on behalf of the trust see rancho residential facility trust v commissioner docket no residential mgmt servs trust v commissioner docket no involving the tax_year home health servs trust v commissioner docket no oo sunshine trust v commissioner docket no residential mgmt servs trust v commissioner tcmemo_2001_ involving the tax_year cases cited supra n ’ the record indicates that residential management services and residential management services trust are one and the same first the settlor hereby irrevocable sic assigns conveys and gives to the trustee in trust the following property cash dollar_figure second the trustee shall open and maintain such bank accounts as necessary to receive and hold said financial property together with any additions thereto in trust for the use and benefit of the trust certificate holders certificate for trust certificate units issued as indicated below shasta enterprises trust certificate units third this trust shall be irrevocable and amenable as described herein by appropriate minute and hereby affirmed that the trust created by this agreement shall be irrevocable by the settlor or by any other person or entity fourth this agreement and trust created hereby shall be administered managed governed and regulated in all respects according to the applicable statutes of the uniform trustees’ powers act and the constitution of the united_states this trust shall be domiciled in the city of washington district of columbia this trust organization shall enjoy the benefits of the uniform commercial code adopted by the city of washington district of columbia in the following citations sec_28 territorial application of this subtitle parties’ power to choose applicable law and sec_28 performance or acceptance under reservation of rights brighth x a successor-trustee may be appointed by a court of competent jurisdiction or by consensus with the trust managers and beneficiaries if the first trustee resigns with days notice in witness whereof the parties hereto have executed this agreement the day and year first above written s s contract administrators american common trust trust settlor enrique first trustee douglas j almodovar carpa trust officer emphasis added the recordation information stamped on the unnumbered cover page of the trust instrument states as follows official records of maricopa county az recorder helen purcell lilian of upon the filing of respondent’s motion to dismiss the court issued an order directing residential management to file an objection if any to respondent’s motion taking into account sdollar_figureenrigue almodovar and douglas j carpa both purportedly appeared before a notary public in maricopa county arizona and purportedly executed the trust instrument on date we note that the recordation information in the present case is in numerical order with the recordation information on the trust instrument submitted to the court by robert hogue on behalf of a related trust home health services trust to wit official records of maricopa county az recorder helen purcell lilian of see home health servs trust v commissioner tcmemo_2003_58 home health servs trust v commissioner docket no --- - rule and to attach to the objection a copy of the trust instrument or other documentation showing that the petition was filed by a fiduciary legally entitled to institute a case on behalf of residential management the court subsequently extended the time within which the objection was to be filed d robert hoque’s objection ultimately the court received an objection which was signed by robert hogue to respondent’s motion to dismiss paragraph of the objection states robert hogue presented a_trust instrument for the court which 1s a contractual contract trust based on common_law the united_states constitution article one section mr hogue also presented notarized documentation to the court to show his acceptance of trusteeship as well as further documentation such as form_56 fiduciary signature card showing robert hogue as wet signature on bank account at best this site is frivolous and without merit the court is trying to mislead the petitioner in this court action robert hogue is the only person who can represent the trust his description as trustee for residential management is well established in his everyday work as trustee attached to the objection are copies of inter alia another five-page purported trust instrument dated date the altered trust instrument and documents entitled monthly management meeting purported minutes the altered trust instrument including the unnumbered cover page and recordation information is essentially identical to the trust instrument with the exception of the following second the trustee shall open and maintain such bank accounts as necessary to receive and hold said financial property together with any additions thereto in trust for the use and benefit of the trust certificate holders certificate for trust certificate units issued as indicated below john carey cu certificate units george carey cu malia carey cu byron carey cu brighth x a successor-trustee may be appointed by the current trustee or trustees a court of competent jurisdiction or by consensus with the and sic beneficiaries if the first trustee resigns with days notice emphasis added the purported minutes which are dated july august september october november and date are each one page long and contain a sign in log with various signatures including robert hogue’s purported signature however the purported minutes do not state the organization that the minutes pertain to nor do the purported minutes document douglas j carpa’s alleged notice of resignation nor robert hogue’s alleged appointment as the successor trustee for all six of these purported minutes are identical copies of the same six purported minutes submitted to the court by robert hogue in numerous cases before this court that were dismissed on the ground that robert hogue was not a proper person authorized to petition the court on behalf of the trust see cases cited supra n -- - residential management nor robert hogue’s or any trustee’s alleged authority to alter the trust instrument also attached to the objection are an account summary dated date from the california state employment development department identifying a james g gaynor as the trustee of residential management and a provision of the revised statutes of nova scotia canada ’ ef respondent’s response at the court’s direction respondent filed a response to the foregoing objection challenging the authenticity of the altered trust instrument respondent further contends that the objection is nearly identical to a previous objection filed by robert hogue in residential mgmt servs trust v commissioner docket no which was dismissed for lack of jurisdiction respondent attached to his response inter alia an undated document which had been furnished to him by robert hogue it james g gaynor is not otherwise identified or mentioned in the record specifically robert hogue attached nova scotia’s trustee act chapter of the revised statutes amended c s c which has no relevance to the present case see residential mgmt servs trust v commissioner tcmemo_2001_297 - li - entitled letter of resignation resignation letter ' that states letter of restgnation to the trustees of residential management service sec_5505 connecticut ave nw washington d c dear board_of trustees i hereby tender my resignation as trustee of residential management services effective at the close of the sic date s american common trust douglas carpa trust officer notice of acceptance of resignation s bob hogue trustee f hearing on respondent’s motion this matter was called for hearing at the court’s trial session in san francisco california counsel for respondent appeared at the hearing and offered argument and evidence in support of respondent’s motion to dismiss specifically respondent presented to the court a certified copy of the trust instrument that was filed with the maricopa county recorder with the exception of the name of the so-called trust the resignation letter is an identical copy of the resignation letter submitted to the court by robert hogue in numerous cases before this court that were dismissed on the ground that robert hogue was not a proper person authorized to petition the court on behalf of the trust see cases cited supra n in arizona on date in its entirety the document that was filed with the maricopa county recorder on that date consisted of only a one-page unnumbered cover sheet that is identical to the cover sheet of both the trust instrument and the altered trust instrument robert hogue appeared pro_se purportedly on behalf of residential management the only evidence he offered was his naked assertion that he is entitled to appear on behalf of residential management because he was appointed trustee on date g post-hearing memorandum briefs a memorandum brief which was signed by robert hogue does nothing more than repeat the same unsubstantiated and conclusory allegations made in the petition and in the objection ie that robert hogue is the trustee for residential management in an answering memorandum brief respondent contends that the facts of this case are substantially identical to the facts in residential mgmt servs trust v commissioner tcmemo_2001_297 holding that robert hogue was not properly appointed as trustee and that robert hogue did not have authority to alter the trust instrument discussion according to respondent residential management failed to show that robert hogue is its duly appointed trustee respondent asserts that as a result no valid petition has been filed and the court must dismiss this case for lack of jurisdiction we agree it is well established that the taxpayer has the burden of affirmatively establishing all facts giving rise to the court’s jurisdiction see patz trust v commissioner 69_tc_497 65_tc_346 35_tc_177 27_tc_837 furthermore unless the petition is filed by the taxpayer or by someone lawfully authorized to act on the taxpayer’s behalf we are without jurisdiction see fehrs v commissioner supra pincite rule a requires that a case be brought by and in the name of the person against whom the commissioner determined the deficiency or by and with the full descriptive name of the fiduciary entitled to institute a case on behalf of such person see rule a rule c states that the capacity of a fiduciary or other representative to litigate in the court shall be determined in accordance with the law of the jurisdiction from which such person's authority is derived robert hogue contends that he was appointed the trustee for residential management in accordance with paragraph eighth of the altered trust instrument that paragraph provides in pertinent part that a successor-trustee may be appointed by the current trustee or trustees a court of competent jurisdiction or by consensus with the and sic beneficiaries if the first trustee resigns with days notice emphasis added however robert hogue has failed to establish that the altered trust instrument supersedes the trust instrument in which paragraph eighth provides in pertinent part that a successor-trustee may be appointed by a court of competent jurisdiction or by consensus with the trust managers and beneficiaries if the first trustee resigns with days notice as it pertains to the question of whether robert hogue is residential management’s trustee we conclude that the trust instrument controls our disposition of this case according to the trust instrument residential management was purportedly created on date and douglas j carpa was purportedly appointed trustee douglas j carpa then resigned and purportedly appointed robert hogue successor trustee on date however the trust instrument did not grant douglas j carpa the authority to appoint a successor trustee as a result robert hogue would have this court rely not on the trust instrument but on the altered trust instrument to find that douglas j carpa had unilateral authority to appoint robert hogue successor trustee in support of his contention robert hogue testified that he -- - personally altered the trust instrument to allow the resigning trustee to appoint the successor trustee at trial the following colloquy ensued robert hogue a_trust is capable of amending any and all parts of a_trust irrevocable or revokable it was amended that robert hogue be appointed by the successor trustee it’s section in this trust the evidentiary trust that are being challenged today that the trustee for the prior years and the trustee which is robert hogue today agreed on these facts by the moment of the minutes robert hogue okay a complex_trust black’s law dictionary has full control full discretion of the minutes so the two trustees got together or the original trustee for these trusts got together and appointed robert hogue as trustee it’s been brought into the trust through the minutes from that period of time we changed the articles of the trust to read that that trustee could appoint me as trustee respondent the tax court’ss opinion in judge halpern’s opinion in the case the second article of that trust instrument listed the sole certificate holder as being shasta enterprises can you explain to me how this document that you represented to the court is the trust instrument the altered trust instrument contains a different provision than the document the trust instrument that was introduced into evidence in judge halpern’s case robert hogue absolutely a trustee that has full discretion can change any article of a_trust at any time i placed them in there -- - respondent how did you do that robert hogue by my own wishes respondent do you have the trust instrument on a computer robert hogue do i have it on a computer respondent how did you physically how did you make the change to the trust instrument robert hogue i had the documents to do it the little disk respondent a computer disk robert hogue sure respondent so you put the computer disk into a computer and you typed over the earlier terms of the trust robert hogue i didn’t type over i just modified it respondent i direct your attention to the eighth article where it states how a successor trustee is appointed respondent okay in the version of the trust instrument that was presented into evidence in the earlier case it stated as judge halpern quoted in his opinion that a successor trustee could be appointed either by a court or by concurrence between the trust beneficiaries so again is it your testimony that you replaced this provision with what was in the earlier version of the trust instrument robert hogue absolutely respondent you however in presenting this opposition to the court made no representation anywhere in this document that the trust instrument that you presented was altered from the at least earlier version you did not draw the court’s attention to the fact that you had altered the document robert hogue is there any law that says i had to did the court demand me to respondent can you answer the question robert hogue no i did not robert hogue thus claims that as the trustee for residential management he was authorized to alter the trust instrument and that in his capacity as trustee he added the provision authorizing the resigning trustee to appoint a successor trustee ’ by robert hogue’s own admission he created the altered trust instrument after his purported appointment as trustee therefore we conclude that the altered trust instrument is not relevant to the present case we have grave doubts about the authenticity of the altered trust instrument however assuming arguendo that it was created before date this does not help robert hogue no at the hearing robert hogue testified indignantly that he could not recall when he created the altered trust instrument however the record suggests that the altered trust instrument may have been created after this court’s trial session in residential mgmt servs trust v commissioner tcmemo_2001_ held on date wherein the court rested its decision on the fact that paragraph bighth of the trust instrument did not authorize the resigning trustee to appoint a successor trustee -- - provision of the trust instrument authorizes robert hogue a third party individual unrelated to residential management before date to alter the trust instrument furthermore there is no evidence that the resigning trustee provided days’ notice of his intent to resign as required by paragraph bighth of either the trust instrument or the altered trust instrument at best any notice of douglas j carpa’s purported resignation occurred on date as demonstrated by the appointment document and the resignation letter in view of the foregoing we reiterate our conclusion that the trust instrument was the controlling instrument at all relevant times this court has previously held in residential mgmt servs trust v commissioner tcmemo_2001_297 that robert hogue was not properly appointed as trustee under the provisions of the trust instrument because the trust instrument is also controlling in the present case and the facts are identical as to the issue of whether robert hogue is the duly appointed trustee we need not repeat the analysis here accordingly we hold that evidence necessary to support the contention that robert hogue 's even if the altered trust instrument were the product of douglas j carpa the purported trustee who resigned in favor of robert hogue we need not and do not address whether douglas j carpa had such authority under the law of any relevant jurisdiction because there is no evidence in the record that the alteration was permitted by paragraph third of either the trust instrument or the altered trust instrument was vested with authority to institute this action on behalf of residential management is lacking therefore we shall dismiss this case for lack of jurisdiction consistent with respondent’s motion all of the arguments and contentions that have not been analyzed herein have been considered but do not require any further discussion in order to give effect to the foregoing an order of dismissal for lack of jurisdiction will be entered ‘6 robert hogue is no stranger to this court and has filed numerous petitions with the court on behalf of various so-called trusts as is the case here those petitions were dismissed on the ground that they were not filed by a proper party see bella vista chiropractic trust v commissioner tcmemo_2003_8 deschutes rd trust v commissioner t c sum op acme equip trust v commissioner t c sum op remedios chiropractic clinic trust docket no jrep trust v commissioner docket no 9795-o1l perj trust v commissioner docket no 9794-0o1l csm trust v commissioner docket no o1ll family chiropractic trust v commissioner docket no ol r r trust v commissioner docket no 7379-01s perj trust v commissioner docket no jrep trust v commissioner docket no marfran trust v commissioner docket no 12427-00s remedios chiropractic clinic trust v commissioner docket no blr-slr trust v commissioner docket no 12425-00s rancho residential facility trust v commissioner docket no residential mgmt servs trust v commissioner docket no home health servs trust v commissioner docket no sunshine trust v commissioner docket no residential mgmt servs trust v commissioner tcmemo_2001_297


t c memo united_states tax_court rebecca wright petitioner v commissioner of internal revenue respondent brian w wright petitioner v commissioner of internal revenue respondent docket nos filed date judy be hamilton for petitioners christine v olsen and timothy f salel for respondent memorandum findings_of_fact and opinion wells chief_judge in these consolidated cases respondent determined the following deficiencies dollar_figure dollar_figure and dollar_figure respectively for taxable years through respondent also determined that brian wright petitioner is - liable for the fraud_penalty pursuant to sec_6663 for taxable years through in the amounts of dollar_figure dollar_figure and dollar_figure respectively alternatively respondent determined that petitioners are liable for an accuracy-related_penalty pursuant to sec_6662 for the taxable years through in the amounts of dollar_figure dollar_figure and dollar_figure respectively petitioners concede the additional income determined by respondent in the notice_of_deficiency and present only the following issues for us to address whether petitioner is liable for the fraud_penalty pursuant to sec_6663 for and and if the fraud_penalty is not applicable whether petitioners are liable for the accuracy- related penalty pursuant to sec_6662 for and findings_of_fact some of the facts have been stipulated and are so found the stipulated facts are incorporated herein by reference and are found as facts in the instant cases petitioners resided in california at the time they filed their petitions in the instant cases t unless otherwise noted 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 petitioners were married and filed joint tax returns during and during those years petitioner was a certified financial planner petitioner earned a b s degree in business administration from regis college after college petitioner took numerous accounting and tax classes ’ petitioner was the defendant in the criminal case of united_states v brian wright criminal case no 96-1670-h in the u s district_court for the southern district of california on date after a 1-week jury trial petitioner was found guilty of count of bank fraud in violation of u s c secs and counts of embezzlement by a bank employee in violation of u s c sec count of money laundering in violation of u s c secs and and counts of filing false tax among the classes that petitioner took were year class hours corporate tax ii advanced accounting audit practice audit theory law cpa exam practice i cpa exam practice ii cpa exam theory ca state_income_tax trust law estate_planning investment inheritance chartered financial analyst i returns for the taxable years and in violation of sec_7206 petitioner's conviction on the foregoing counts stemmed from his involvement with trusts established for the benefit of arleen millyard during date mrs millyard's husband established a_trust at security pacific national bank because of her alcoholism and lack of understanding of basic financial issues the trust was meant to ensure the physical and financial well-being of mrs millyard in the event of her husband's demise during petitioner became a_trust officer for security pacific national bank which later merged into bank of america petitioner was the trust officer for the millyard trust bank of america has a written policy and internal rules of conduct that expressly prohibit its trust officers from accepting cash or gratuities from its customers petitioner was provided a copy of those rules and signed a statement acknowledging reviewing those rules at the time of his employment each year bank of america requires its employees to certify their awareness of the bank's policies including the prohibition against receiving money from trust clients each year petitioner signed a statement that he had read the bank's policies at trial petitioner acknowledged that he was aware that he might lose his - - job if the bank learned that he was taking money from a_trust client mrs millyard kept a checking account at bank of america when a_trust client sought to remove money from a_trust account the client would be asked to complete a request for transfer form petitioner authorized numerous transfers from the trust to mrs millyard's checking account mrs millyard wrote many checks for the benefit of petitioners which were deposited into their accounts petitioner knew that checks in excess of dollar_figure would have been noticed and investigated by bank of america petitioner also knew that if any of the checks were made out directly to him he would lose his job checks in amounts less than dollar_figure would not appear on the bank's large item report all of the checks written by mrs millyard for the benefit of petitioners were under dollar_figure mrs millyard on occasion would write several checks to petitioners over a short_period of time while each check was less that dollar_figure the total amount transferred to petitioners over such a period was substantially more than dollar_figure on three occasions mrs millyard wrote multiple checks on the same day the total of which exceeded dollar_figure however -- - each individual check was in an amount below the detection threshold of dollar_figure throughout his embezzlement activity petitioner caused mrs millyard to write numerous checks to him to his investment and bank accounts and to petitioner rebecca wright most of the checks were written to petitioners’ bank or investment accounts during and petitioners received the following amounts from mrs millyard date check no payee amount rebecca wright dollar_figure san diego county cu big_number san diego county cu big_number brian wright big_number san diego county cu big_number brian wright big_number san diego county cu big_number charles schwab inc big_number charles schwab inc big_number charles schwab inc big_number charles schwab inc big_number 20th century fund big_number charles schwab inc big_number 20th century fund big_number charles schwab inc big_number 20th century fund big_number charles schwab inc big_number 20th century fund big_number rohr credit_union big_number rohr credit_union big_number san diego county cu big_number san diego county cu big_number charles schwab inc big_number charles schwab inc big_number san diego county cu big_number charles schwab inc big_number san diego county cu big_number rebecca wright big_number rebecca wright big_number rebecca wright brian wright big_number brian wright big_number continued bach year bank of america conducted a review of its trust accounts petitioner prepared the reports for mrs millyard's trust accounts one item on the report is the total amount withdrawn or distributed from the trust during a given year on the report for the period date through date petitioner falsely reported the amount transferred from mrs millyard's trust during the period date through date mrs millyard withdrew substantial amounts from her trusts eg dollar_figure on date dollar_figure on date dollar_figure on date and dollar_figure on date petitioner reported that mrs millyard withdrew only dollar_figure from the trust bank of america would have been concerned had it seen that approximately dollar_figure had been taken from the trust another item on the annual trust report inquired whether the trust officer faced any potential conflict of interest or legal noncompliance petitioner wrote non-applicable on the report but he knew that accepting money from mrs millyard presented a potential conflict of interest petitioner knowingly engaged in a scheme to obtain money from a federally insured bank by making false statements or continued rebecca wright big_number rebecca wright big_number --- - promises petitioner embezzled funds of the bank and acted with intent to injure or defraud the bank petitioner engaged in monetary transactions using money he knew was obtained through criminal activity petitioner's and tax returns were false as to a material matter petitioner did not believe his tax returns for and to be true and correct as to every material matter and willfully subscribed to the false returns with the intent to violate the law petitioner knew that the funds he embezzled were not gifts petitioner rebecca wright prepared petitioners' federal_income_tax return for she made no inguiry into whether the funds received from mrs millyard were taxable_income on their income_tax return for petitioners reported adjusted_gross_income of dollar_figure for petitioners’ actual adjusted_gross_income was dollar_figure for petitioners omitted embezzlement income of dollar_figure for the years and petitioners' returns were prepared by carolyn witt c p a on their federal_income_tax return petitioners reported adjusted_gross_income of dollar_figure for petitioners’ actual adjusted_gross_income was dollar_figure for petitioners omitted embezzlement income of dollar_figure on their federal_income_tax return for petitioners reported adjusted_gross_income of dollar_figure for petitioners’ actual adjusted_gross_income - - was dollar_figure petitioners omitted embezzlement income of dollar_figure from their return petitioners did not inform ms witt about any of the embezzlement income opinion we must decide whether petitioner is liable for the fraud_penalty pursuant to sec_6663 for taxable years and sec_6663 provides sec_6663 imposition of fraud_penalty a imposition of penalty --if any part of any underpayment_of_tax required to be shown on a return is due to fraud there shall be added to the tax an amount egual to percent of the portion of the underpayment which is attributable to fraud b determination of portion attributable to fraud --if the secretary establishes that any portion of an underpayment is attributable to fraud the entire underpayment shall be treated as attributable to fraud except with respect to any portion of the underpayment which the taxpayer establishes by a preponderance_of_the_evidence is not attributable to fraud c special rule for joint returns --in the case of joint_return this section shall not apply with respect to a spouse unless some part of the underpayment is due to fraud of such spouse the burden_of_proof in respect of the issue of fraud must be carried by the commissioner by clear_and_convincing evidence see sec_7454 rule b to establish the existence of fraud respondent must prove by clear_and_convincing evidence that petitioner underpaid his income_tax and that some part of -- - the underpayment was due to fraud see 102_tc_632 91_tc_874 fraud is established by proving that a taxpayer intended to evade tax believed to be owing by conduct intended to conceal mislead or otherwise prevent the collection of such tax the commissioner need not establish that tax_evasion was a primary motive of the taxpayer but may satisfy the burden by showing that a tax-evasion motive played any part in the taxpayer's conduct including conduct designed to conceal another crime see clayton v commissioner supra pincite recklitis v commissioner supra pincite fraudulent intent may be established by circumstantial evidence and reasonable inferences drawn from the record see clayton v commissioner supra pincite in 796_f2d_303 9th cir affg tcmemo_1984_601 the u s court_of_appeals for the ninth circuit articulated a nonexclusive list of factors which demonstrate fraudulent intent these badges_of_fraud include understating income maintaining inadequate records failing to file tax returns giving implausible or inconsistent explanations of behavior concealing assets failing to cooperate with tax authorities engaging in illegal activities attempting to conceal illegal activities dealing in cash and failing to make estimated_tax payments while no single factor is necessarily sufficient to establish fraud the existence of several indicia constitutes persuasive circumstantial evidence see bradford v commissioner supra pincite many of the foregoing badges_of_fraud are present petitioner's substantial_understatement_of_income_tax from the omission of the embezzlement income in and is a badge of fraud as conclusively established in the criminal case petitioner knew that the funds he received from mrs millyard were not gifts petitioners have stipulated that petitioner received embezzlement income moreover petitioners stipulated that they did not report this embezzlement income on their tax returns petitioner understated his income in the years in issue by percent percent and percent respectively such a pattern of substantial discrepancies between petitioner's actual income and reported income constitutes evidence of intent to defraud see kohrs v commissioner tcmemo_1985_115 failure to keep records is another badge of fraud see 89_tc_1280 petitioner did not keep any records of the amounts he embezzled - the illegal nature of petitioner's activities and his concealment of these illegal activities are additional badges_of_fraud see 809_f2d_1504 lith cir davis v commissioner tcmemo_1991_333 embezzler who issued checks for less than dollar_figure in order to avoid detection liable for fraud_penalty petitioner went to great lengths to conceal his embezzlement activities in order to hide his theft petitioner caused mrs millyard to write checks to accounts controlled by him or his wife in amounts less than dollar_figure on three occasions he caused mrs millyard to write on day several checks for his benefit that totaled over dollar_figure during the period date through date mrs millyard withdrew substantial amounts from her trust on the report to the bank petitioner reported that mrs millyard withdrew merely dollar_figure from the trust the bank would have been concerned had it seen that approximately dollar_figure had been taken from the trust by incorrectly reporting the amounts withdrawn from the trust petitioner attempted to conceal his embezzlement activities petitioner's receipt of embezzlement income by defrauding an elderly client of her funds was the underpinning of virtually every count in the indictment against him including bank fraud money laundering embezzlement and the filing of false income_tax returns there is no question that petitioner sought to conceal his receipt of mrs millyard's money because of the illegal nature of his activities he knew that the receipt of the funds violated numerous banking and criminal provisions the likelihood that petitioner also had the intent to conceal his illegal activities to avoid being charged with the nontax crimes does not negate his intent to evade tax see clayton v commissioner supra pincite commissioner need not establish that tax_evasion was the primary motive it is enough to demonstrate that tax_evasion played a role in the taxpayer's conduct the fact that petitioner concealed his receipt of the funds from illegal activities from his accountant and return preparer ms witt is relevant to the issue of fraud see 91_tc_81 langworthy v commissioner tcmemo_1998_218 taxpayer's failure to be forthcoming with his return preparer was evidence of fraud a taxpayer who relies on others to keep his records and prepare his tax returns may not withhold information from those persons relative to taxable events and then escape criminal responsibility for the resulting false returns see 825_f2d_314 lith cir 566_f2d_1056 6th cir in preparing petitioners' income_tax returns for -- and ms witt relied on the information provided by petitioners to prepare those returns the sophistication education and intelligence of the taxpayer are relevant considerations in determining whether a taxpayer has fraudulent intent see 99_tc_202 79_tc_995 affd f 2d 6th cir 19_tc_631 petitioner was a bank trust officer with a background in accounting as a bank trust officer with a degree in business administration as well as extensive training in accounting petitioner was not a person who could fail to understand what the law requires for him under the circumstances 7_tc_245 affd 175_f2d_500 2d cir given petitioner's education and work experience it asks too much for the court to believe that petitioner had no idea his embezzlement income was taxable myers v commissioner tcmemo_1980_262 bank trust officer must have known embezzled funds were taxable_income petitioner had the sophistication to know that he was required to report the funds he received from mrs millyard on his return petitioner's criminal convictions raise a strong inference that petitioner possessed the willfulness necessary to satisfy -- - the intent element see wilson v commissioner t c memo a54 indeed in 61_tc_249 affd 519_f2d_1121 5th cir we stated it is a fair inference that a man who will misappropriate another's funds to his own use through misrepresentation and concealment will not hesitate to misrepresent and conceal his receipt of those same funds from the government with the intent to evade tax petitioner was convicted of embezzlement in violation of u s c sec money laundering in violation of u s c sec and filing false returns for the years through in violation of sec_7206 convictions for such crimes are highly probative of petitioner’s intent to evade taxes because the activities involve perjury deceit breach of fiduciary duty and concealment of criminal proceeds see williams v commissioner tcmemo_1992_153 on the basis of the foregoing we sustain respondent's determination of the fraud_penalty against petitioner for each year in issue consistent with our holding on this point we need not consider respondent's alternative determination that petitioners are liable for accuracy-related_penalties for the years in issue see wilson v commissioner tcmemo_1994_454 declaring that convictions under sec_7206 are highly persuasive evidence of intent to evade taxes estate of sawczak v commissioner tcmemo_1993_210 same to reflect the foregoing decisions will be entered pursuant to rule


department of the treasury internal_revenue_service attn mandatory review mc commerce street dallas tx tax_exempt_and_government_entities_division number release date uil legend org organization name date date xx date address address org address employer_identification_number person to contact id number contact numbers voice fax certified mail - return receipt requested dear in a determination_letter dated october 20xx you were held to be exempt from federal_income_tax under sec_501 of the internal_revenue_code the code based on recent information received we have determined you have not operated in accordance with the provisions of sec_501 of the code accordingly your exemption from federal_income_tax is revoked effective for years beginning january 20xx this is a final adverse determination_letter with regard to your status under sec_501 of the code we previously provided you a report of examination explaining why we believe revocation of your exempt status is necessary at that time we informed you of your right to contact the taxpayer_advocate as well as your appeal rights on february 20xx you signed form 6018-a consent to proposed action agreeing to the revocation of your exempt status under sec_501 of the code you have filed taxable returns on form s 112-pc for the year s ended december 20xx 20xx with us for future periods you are required to file form 112-pc with the appropriate service_center indicated in the instructions for the return you have the right to contact the office_of_the_taxpayer_advocate taxpayer_advocate assistance is not a substitute for established irs procedures such as the formal appeals process the taxpayer_advocate cannot reverse a legally correct_tax determination or extend the time fixed by law that you have to file a petition in a united_states court the taxpayer_advocate can however see that a tax matter that may not have been resolved through normal channels gets prompt and proper handling you may call toll-free and ask for taxpayer_advocate assistance if you prefer you may contact your local taxpayer_advocate at if you have any questions please contact the person whose name and telephone number are shown at the beginning of this letter sincerely marsha a ramirez director eo examinations department of the treasury internal_revenue_service commerce street dallas tx tax_exempt_and_government_entities_division date legend org organization name xx date address address org address dear taxpayer_identification_number form tax_year s ended person to contact id number contact numbers telephone fax we have enclosed a copy of our report of examination explaining why we believe an adjustment of your organization’s exempt status is necessary we have also enclosed publication exempt_organization appeal procedures for unagreed issues and publication the examination process publications include information on your rights as a taxpayer including administrative appeal procedures within the internal_revenue_service these if you request a conference with appeals we will forward your written_statement of protest to the appeals_office and they will contact you for your convenience an envelope is enclosed if you and appeals do not agree on some or all of the issues after your appeals_conference the appeals_office will advise you of its final_decision if you elect not to request appeals consideration but instead accept our findings please sign and return the enclosed form 6018-a consent to proposed adverse action we will then send you a final letter modifying or revoking your exempt status under sec_501 if we do not hear from you within days from the date of this letter we will process your case on the basis of the recommendations shown in the report of examination and send a final letter advising of our determination in either situation outlined in the paragraph above execution of form 6018-a or failure to respond within days you are required to file federal_income_tax returns for the tax period s shown above for all years still open under the statute_of_limitations and for all later years file the federal tax_return for the tax period s shown above with this agent within days from the date of this letter unless a request for an extension of time is granted file returns for later tax years with the appropriate service_center indicated in the instructions for those returns you have the right to contact the office_of_the_taxpayer_advocate taxpayer_advocate assistance is not a substitute for established irs procedures such as the formal appeals process the taxpayer_advocate cannot reverse a legally correct_tax determination or extend the time fixed by law that you have to file a petition in a united_states court the taxpayer_advocate can however see that a tax matter that may not have been resolved through normal channels gets prompt and proper handling you may call toll-free and ask for taxpayer_advocate assistance if you have any questions please call the contact person at the telephone number shown in the heading of this letter the most convenient time to call if we need to contact you if you write please provide a telephone number and thank you for your cooperation sincerely marsha a ramirez director eo examinations enclosures publication publication form 6018-a report of examination envelope form 886a name of taxpayer explanation of items department of the treasury - internal_revenue_service org schedule no or exhibit year period ended 20xx 20xx legend org organization name founder founder employees city city founder family founder family xx date country country emp-1 emp-2 co-1 co-2 g companies issue sec_1 does org qualify for tax exempt status under internal_revenue_code irc sec_501 for the years ending december 20xx 20xx if org does not qualify for tax exempt status for years ending december 20xx 20xx what are the tax consequences if the tax exempt status is revoked how will it affect future years facts org limited org was formed in july 19xx in city country as a reinsurance company its purpose was to receive credit life and credit accident_and_health_insurance premiums from co-1 co-1 pursuant to an agreement that was executed in november 19xx founder was the sole shareholder she did not own any controlling_interest in any other company co-1 provided insurance to customers of automobile co-2s owned by the founder family customers would by the insurance from co-1 upon purchasing an automobile co-1 would then reinsure with org sending a portion of the premiums collected to org org would then become liable for some of the claims that would be filed over the years org made loans to co-2 and family members interest was accrued and collected on these loans loans were outstanding during 20xx due to the variable financial status of co-2 the interest accrued through 20xx was written off in 20xx as a bad_debt and the principal was characterized as doubtful co-2 started repaying on the principal in 20xx emp-1 is to close out the loan by the end of 20xx the loan issued to emp-2 was closed out during 20xx since 20xx org has been in voluntary run-off no new reinsurance agreements were executed no premiums were accepted the sole purpose of org since 20xx has been to pay claims on the risks that were ceded to org reimburse customers if they cancelled their policies prior to expiration and manage its investments including collecting on the loans made org expects to file its final tax_return for tax_year 20xx barring any unforeseen issues with resolving the remaining risk and should the company successfully negotiate with one last customer to close out a contract that expires in january 20xx form 886-aev department of the treasury - internal_revenue_service page -1- form_886 a name of taxpayer explanation of items department of the treasury - internal_revenue_service org schedule no or exhibit year period ended 20xx 20xx forms were filed for the 20xx 20xx tax years the following is a breakdown of the gross_receipts received by org for the years ending december 20xx 20xx and the percentage of gross premiums to gross_receipts for the same years per notice_2006_42 20xx 20xx org total premiums interest_income dividend income gain on sale of securities total gross_receipts percentage- gross premium reinsurance income to gross_receipts law and analysi sec_1 does org qualify for tax exempt status under internal_revenue_code irc sec_501 for the years ending december 20xx 20xx internal_revenue_code sec_501 exempts from federal_income_tax insurance_companies as defined in sec_816 other than life including interinsurers and reciprocal underwriters if- i i the gross_receipts for the taxable_year do not exceed dollar_figure and il more than percent of such gross_receipts consist of premiums or ii in the case of a mutual insurance company- i the gross_receipts of which for the taxable_year do not exceed dollar_figure and ii more than percent of such gross_receipts consist of premiums clause ii shall not apply to a company if any employee of the company or a member of the employee’s family as defined in sec_2032 is an employee of another company exempt from taxation by reason of this paragraph or would be so exempt but for this sentence sec clarification of exemption from tax for small property and casualty insurance_companies of the pension funding equity act of p l form 886-a rev department of the treasury - internal_revenue_service page -2- form_886 a name of taxpayer explanation of items department of the treasury - internal_revenue_service org schedule no or exhibit year period ended 20xx 20xx amended sec_501 to change the definition of small property and casualty insurance_companies insurance_companies other than life_insurance_companies exempt from income taxes to a company whose gross_receipts for the taxable_year do not exceed dollar_figure and over half such gross_receipts consist of premiums currently whose net written premiums or if greater direct written premiums for the taxable_year do not exceed dollar_figure or a mutual_insurance_company a whose gross_receipts for the taxable_year do not exceed dollar_figure and more than percent of which consist of premiums and b none of whose employees or member of the employee’s family is an employee of another company exempt from tax under sec_501 these changes were applicable after december 20xx notice_2006_42 irb provides guidance as to the meaning of gross_receipts for purposes of sec_501 of the internal_revenue_code this notice advises taxpayers that the service will include amounts received from the following sources during the taxable_year in gross_receipts for purposes of sec_501 a premiums including deposits and assessments without reduction for return_premiums or premiums_paid for reinsurance b items described in sec_834 gross_investment_income of a non-life insurance_company and c other items that are properly included in the taxpayer’s gross_income under subchapter_b of chapter subtitle a of the code thus gross_receipts include both tax-free interest and the gain but not the entire amount_realized from the sale_or_exchange of capital assets because those items are described in sec_834 gross_receipts do not however include amounts other than premium income or gross_investment_income unless those amounts are otherwise included in gross_income accordingly the term gross_receipts does not include contributions to capital excluded from gross_income under sec_118 or salvage or reinsurance recovered accounted for as offsets to losses_incurred under sec_832 sec_834 of the internal_revenue_code includes under gross_receipts the gains from the sale or exchanges of capital assets to the extent provided in subchapter_p sec_1201 and following relating to capital_gains_and_losses sec_834 of the internal_revenue_code allows a deduction for capital losses to the extent provided in subchapter_p sec_1201 and following plus losses from capital assets sold or exchanged in order to obtain funds to meet abnormal insurance losses and to provide for the payment of dividends_and_similar_distributions to policyholders form 886-acrev department of the treasury - internal_revenue_service page -3- form 886a name of taxpayer explanation of items department of the treasury - internal_revenue_service org schedule no or exhibit year period ended 20xx 20xx based on the changes in the limitations under internal_revenue_code irc sec_501 and the operation of org during 20xx 20xx it was determined from the chart above that org did not qualify for tax exempt status in 20xx and in 20xx org was not able to meet the requirement of gross premiums to gross_receipts in either year in 20xx in 20xx insurance_company the dollar_figure limitations were not applicable since org was not a mutual section e of the pension funding act of p l provides the effective date of the new requirements for exemption under sec_501 it states effective date- in general- except as provided in paragraph the amendments made by this section shall apply to taxable years beginning after december 20xx transition rule for companies in receivership or liquidation- in the case of a company or association which-- a for the taxable_year which includes april 20xx meets the requirements of sec_501 of the internal_revenue_code_of_1986 as in effect for the last taxable_year beginning before january 20xx and b on april 20xx is in a receivership liquidation or similar proceeding under the supervision of a state court the amendments made by this section shall apply to taxable years beginning after the earlier of the date such proceeding ends or december 20xx org was not involved in a court ordered liquidation during 20xx the liquidation of rar has been voluntary therefore section e does not apply to this organization therefore for the years ending december 20xx 20xx org did not qualify for tax exempt status under sec_501 if org does not qualify for tax exempt status for years ending december 20xx 20xx what are the tax consequences since org did not qualify for tax exempt status under sec_501 for the 20xx and 20xx org’s filings of the form_990 for both years was incorrect for both years org should have filed form 1120-pc sec_831 discusses tax on insurance_companies other than life_insurance_companies form 886-a rev department of the treasury - internal_revenue_service page -4- form_886 a name of taxpayer explanation of items department of the treasury - internal_revenue_service org schedule no or exhibit year period ended 20xx 20xx sec_831 states as a general_rule taxes computed as provided in sec_11 shall be imposed for each taxable_year on the taxable_income of every insurance_company other than a life_insurance_company sec_831 provides an alternative_tax for certain small companies it states in sec_831 that in general in lieu of the tax otherwise applicable under subsection a there is hereby imposed for each taxable_year on the income of every insurance_company to which this subsection applies a tax computed by multiplying the taxable_investment_income of such company for such taxable_year by the rates provided in sec_11 sec_831 discusses the companies to which this subsection applies a in general this subsection shall apply to every insurance_company other than life including interinsurers and reciprocal underwriters if- i ii the net written premiums or if greater direct written premiums for the taxable_year do not exceed dollar_figure and such company elects the application of this subsection for such taxable_year the election under clause ii shall apply to the taxable_year for which made and for all subsequent taxable years for which the requirements of clause are met such election once made may be revoked only with the consent of the secretary regulations regs a discusses the time for making elections under i it states in general that except as otherwise provided in this section the elections described in paragraph a of this section must be made by the later of- a the due_date taking into account any extensions of time to file obtained by the taxpayer of the tax_return for the first taxable_year for which the election is effective or b date in which case the election generally must be made by amended_return regs a mentioned above includes sec_831 regs a describes the manner of making elections it states except otherwise provided in this section the elections described in paragraph a of this section must be made by attaching a statement to the tax_return for the first taxable_year for which the election is to be effective when org filed its form_990 for years ending december 20xx 20xx they attached to each return a protective_election each protective_election stated that form 886-a cev department of the treasury - internal_revenue_service page -5- department of the treasury - internal_revenue_service form 886a name of taxpayer explanation of items schedule no or exhibit year petriod ended 20xx 20xx org org elects to be subject_to tax only on its taxable_investment_income as computed under sec_834 the election is made pursuant to sec_831 it applies to the taxable_year of the return and all subsequent taxable years that the election requirements are met exempt status under sec_501 is not upheld the election was filed in the event it is determined that its tax based on the code and regulation sections above and the protective election’ filed by org with each return org is entitled to the relief under b for 20xx 20xx and all future years because it met the requirements of reg sec_301_9100-8 org would be required to file form 1120-pc for years ending december 20xx 20xx and all future years that they do not qualify for exemption the election is allowed for these years and all future year when applicable if the tax exempt status is revoked how will it affect future years the tax exempt status is being revoked for the year ending december 20xx 20xx form 1120-pc is required for each year and all future years where org does not qualify for exemption the election filed is applicable for each year org is required to file form 1120-pc if org meets the requirements under sec_501 in future years it may be allowed to file the form_990 for each year they qualify as a self- declared entity otherwise form 1120-pc would be required filing a form_990 for a year where org qualifies for exemption under sec_501 does not stop the election made under sec_831 any year where the form 1120-pc is required the election is applicable taxpayer’s position unknown at the time of this writing summary it is the governments position based on the above facts law and analysis that the tax exemption status of org for the years ending december 20xx 20xx should be revoked based on not meeting the qualifications for exemption under sec_501 form 1120-pc would be required to be filed for both years and any future years where org does not qualify for exemption under sec_501 relief under sec_831 would be applied to each and every year the form 1120-pc is filed form 886-a cev department of the treasury - internal_revenue_service page -6-