tcmemo_2015_56 united_states tax_court minchem international inc petitioner v commissioner of internal revenue respondent jerry j sun and sun nam sun petitioners v commissioner of internal revenue respondent docket nos filed date george w connelly jr william p cantrell and rita renee huey for petitioners david q cao lewis a booth ii and carol bingham mcclure for respondent memorandum findings_of_fact and opinion paris judge petitioners in these consolidated cases seek redetermination of respondent’s determinations that minchem international inc minchem a corporation and the owner of minchem jerry j sun and his wife sun nam sun received income from transfers by foreign companies for the or tax_year respondent sent minchem a notice_of_deficiency determining deficiencies of dollar_figure and dollar_figure and fraud penalties under sec_6663 of dollar_figure and dollar_figure for and respectively the notice_of_deficiency also includes alternative penalties under sec_6662 respondent also sent jerry j sun and sun nam sun a notice_of_deficiency determining deficiencies of dollar_figure and dollar_figure and fraud penalties under sec_6663 of dollar_figure and dollar_figure for and respectively the notice_of_deficiency also included alternative penalties under sec_6662 respondent later conceded that the suns are not liable for sec_6663 penalties related to two items a home equity loan interest_deduction and travel and entertainment_expenses that were paid_by minchem but are liable for penalties under sec_6662 after concessions the issues remaining for decision are whether the suns properly deducted an investment_interest expense for interest_paid on a loan secured_by their residence for and whether minchem received unless otherwise indicated all section references are to the internal_revenue_code_of_1986 as amended and in effect for the years in issue and all rule references are to the tax_court rules_of_practice and procedure income from the transfers by foreign companies for or whether the suns received income from the transfers by foreign companies for or whether minchem is liable for penalties under sec_6663 or sec_6662 and whether the suns are liable for penalties under sec_6663 or sec_6662 findings_of_fact some of the facts have been stipulated and are so found the stipulation of facts and the attached exhibits are incorporated herein by this reference petitioners jerry j sun and sun nam sun are husband and wife who have been naturalized citizens since and resided in texas at the time they filed their petition mr sun wholly owns minchem a corporation organized under subchapter_c with a principal_place_of_business in houston texas i the suns and minchem mr sun came to the united_states in for a position with an international mineral trading company and he is still in the same line_of_business respondent disallowed minchem’s business deductions for the suns’ travel and entertainment_expenses of dollar_figure and dollar_figure for the and tax years respectively petitioners concede respondent’s adjustments petitioners also concede respondent’s adjustments to the suns’ gambling income of dollar_figure and dollar_figure for and respectively mrs sun chose not to appear at trial only mr sun testified he earned a college degree in english language and international trade from a chinese university in and first moved to the united_states as a sales representative for a chinese-owned mineral trading company in mr sun organized minchem under the state laws of texas and continues to be the sole shareholder minchem’s primary business_purpose is to import and distribute industrial minerals minchem purchases minerals from suppliers in china and imports the minerals into the united_states minchem had seven employees during and mr sun has served as minchem’s ceo from the time of its organization until the present and received a salary of dollar_figure in both and as minchem’s ceo in and mr sun oversaw daily operations and was responsible for sales and employee hiring mr sun was the sole individual authorized to make purchases in excess of dollar_figure on minchem’s behalf mr sun had assistants and advisers to help with his ceo duties the additional help allowed him to spend only around four to five hours a day on his ceo duties for minchem mr sun also spent a significant amount of time on other investment opportunities in and mr sun owned of sun investment llc sun investment mr sun individually and sun investment invested in various sectors such as commercial properties daycare services banking and rental properties sun investment also invested in the stock market through its two trading accounts one with ameritrade and the other with e trade mr sun was responsible for managing sun investment’s stock investments mr sun also personally held an online trading account with e trade he spent around five hours a day managing stock investments in the suns completed a cash purchase of a real_estate lot and built a residence on that lot they did not borrow any money to finance the lot or construct the residence in the suns borrowed dollar_figure from a bank and used their residence to secure the debt the funds were transferred directly from the lending bank to minchem’s corporate account in mr sun refinanced the loan for dollar_figure and continued to use the residence to secure the debt in and the suns paid interest of dollar_figure and dollar_figure on the loan mr sun was the managing member as well as the tax_matters_partner of sun investment the other of sun investment is owned by a member who is not a party to these cases it is not clear from the record whether mr sun spent the five hours managing solely his personal investments solely sun investment’s investments or some mix of the two respectively the suns allocated the interest_expense between mortgage interest_expense and investment_interest expense on their and schedules a itemized_deductions for the suns deducted dollar_figure of the interest_paid on the loan as home mortgage interest and carried the remaining dollar_figure forward as investment_interest which they deducted for for the suns deducted dollar_figure of the interest_paid on the loan as home mortgage interest and used the remaining dollar_figure as an investment_interest expense deduction ii the investment strategy and mr cheung’s foreign companies mr sun met bill cheung through a mutual business friend in or mr cheung is a resident of hong kong and is a chinese citizen in and mr cheung owned some portion of several shipping companies some of which minchem used to import minerals from china specifically mr cheung claimed ownership of companies called kingdom shipping company limited able glory shipping limited power vast limited and magic way company limited these companies were organized in foreign it is unclear whether mr cheung owned all of the shipping companies or owned only a fraction of the companies during and it is also unclear under what authority or capacity mr cheung operated the companies or authorized international wire transfers neither party addressed these issues jurisdictions but they all operated out of hong kong mr cheung’s shipping activities appeared to continue operating several of these companies at once even though he may have intended each of these companies to act as the subsequent replacement for the former company outside of his shipping companies mr cheung previously had a series of unsuccessful investments he had lost a significant amount of money and was looking for other ways to invest through their business dealings mr sun and mr cheung had become friends in and mr sun and mr cheung would often communicate by telephone and sometimes through email when mr sun traveled to china he would see mr cheung socially and mr cheung would give him rides to and from the airport and they would discuss his american investment opportunities as discussed below the parties agree that all of the bank transfers originated from bank accounts in hong kong appearing to belong to each of the named companies but both respondent and petitioners submitted conflicting documents indicating in which jurisdictions the companies were organized petitioners submitted documents showing the companies are organized in liberia the british virgin islands and panama respondent submitted documents showing companies with the same or substantially_similar names are organized in hong kong neither set of documents reflects mr cheung as the owner of any of the entities the country in which each company is organized is not pertinent to these cases and the court does not decide whether companies sharing the same name are the same company or where the companies are organized mr cheung was impressed by mr sun’s diverse investments and in the two gentlemen verbally agreed on an investment strategy for mr cheung after discussing potential investment opportunities in the united_states the only part of the arrangement that both mr cheung and mr sun consistently agreed on was the general structure of the investment mr cheung would transfer sums of money through his shipping companies’ bank accounts to mr sun who would then invest the money in the united_states mr cheung would decide how much money he wished to send and mr sun had discretion on which investments to pursue with mr cheung’s money the remaining terms of the verbal agreement were not memorialized and are unclear specifically mr sun and mr cheung inconsistently described the investment term the expected_return and enforcement provisions mr sun believed the term was a minimum of years and did not give a maximum period whereas mr cheung believed the term was to years the expected_return is also unclear mr sun believed the return on investment would be a split of the net profit with a minimum gain annually but the return might not be paid annually mr cheung believed the return would be to but was uncertain whether that return was annual or total further mr cheung was unsure whether he would take legal action against mr sun if mr sun failed to achieve the expected_return on investment or repay the transferred amount iii transfers to minchem and minchem’s officer loan account around minchem created an officer loan account solely for the benefit of mr sun the officer loan account would be debited and the balance would be increased when funds were drawn by or paid for the benefit of mr sun conversely the account would be credited and the balance would decrease when funds were paid to minchem minchem did not sign any contracts with mr sun regarding the officer loan account and he was not required to pay interest on any loans from minchem similarly it does not appear that minchem was required to pay interest on any loans from mr sun between march and date a hong kong bank account attributed to a company called kingdom shipping transferred dollar_figure in nine different transactions to minchem the smallest transfer was dollar_figure and the when first asked about the return mr cheung exclaimed that a -15 return was definitely not annual because mr sun would not be able to achieve that but when asked to clarify the return on investment he remarked of course that’s annually the court does not decide whether the companies are the same companies continued largest was dollar_figure the only transfer instruction from mr cheung was a letter accompanying the dollar_figure transfer that indicates that dollar_figure is additional capital but the whole dollar_figure is a gift from mr cheung to mr sun kingdom shipping transferred all the money from an account in hong kong to minchem’s jpmorgan chase bank account in the united_states between september and date hong kong bank accounts attributed to companies called able glory and power vast transferred a total of dollar_figure in four different transactions to minchem the smallest transfer was dollar_figure and the largest was dollar_figure the transferring company transferred the money from its respective account in hong kong to minchem’s jpmorgan chase bank account in the united_states for accounting purposes minchem reported most of the money transferred from mr cheung’s companies as credits in mr sun’s officer loan account specifically in minchem reported dollar_figure of the transferred continued as the hong kong registered companies or the companies organized elsewhere and notes only that all the wire transfers originated from hong kong accounts purporting to be owned by companies with the stated names it is also unclear under what authority or capacity mr cheung originated the wire transfers from hong kong to the u s bank account held by minchem dollar_figure as credits to the officer loan account and also credited the officer loan account for all dollar_figure of the funds transferred in minchem treated the money as mr sun’s funds loaned to the company that would eventually be repaid to him or as return payments for money that minchem had previously loaned to mr sun minchem did not report the money as receipts or other income to minchem because it was not tied to any service minchem could however use the money in the officer loan account for its own business purposes minchem did in fact use some of the transfers to inflate its cashflow when seeking a line of credit minchem reported the funds transferred from mr cheung’s companies as an asset that was offset with an accompanying liability minchem’s in-house accounting personnel believed that the higher assets even if offset with an equal liability looked better to a bank and the stipulation erroneously states the credited amount from kingdom shipping as dollar_figure minchem’s financial ledger shows the actual amount was dollar_figure the court will disregard the stipulation as inconsistent with the financial ledger see rule a see also 93_tc_181 further the record does not show what happened to the dollar_figure that was not reported in the officer loan account able glory recalled dollar_figure of the date transfer minchem returned the amount on date thus the net amount received by minchem and credited to the officer loan account from mr cheung’s companies in was dollar_figure would help establish a line of credit it took advantage of this principle by showing the transferred money was an asset and a liability on the balance sheets provided to a lender when applying for a line of credit mr sun would occasionally direct money from other sources into the officer loan account but the bulk of the credits were from mr cheung’s various foreign companies in minchem’s officer loan account reflected dollar_figure of credit that was not from kingdom shipping or repayment of an amount removed from the officer loan account in minchem’s loan account reflected dollar_figure of credit that was not from one of mr cheung’s foreign companies or repayment of an amount removed from the officer loan account in other words of the independent funds credited to minchem’s officer loan account in and of the independent funds credited in were from credits from mr cheung’s foreign companies by at least date mr sun began frequently using the officer loan account for personal expenses mr sun would either pay his personal expenses as discussed below mr sun made several advances to casinos from the officer loan account and some lesser portions of the advances were returned to the officer loan account and reported as credits or not returned at all similarly on date mr sun loaned a friend dollar_figure dollar_figure of which was repaid and reported as a credit on date these credits are not independent deposits and instead represent portions of amounts that were already credited to the officer loan account directly from the officer loan account or he would remove money and use it at his discretion for example in minchem paid dollar_figure for home automation dollar_figure for a new mercedes benz and dollar_figure for personal real_estate tax in total minchem’s officer loan account was debited dollar_figure in and dollar_figure in for expenses that mr sun identified as personal during his trial testimonydollar_figure some of the personal expenditures included gambling expenses in dollar_figure was transferred to casinos from the officer loan account and dollar_figure was returned in dollar_figure million was transferred to casinos and dollar_figure was returned thus between and mr sun transferred these sums include only the net amounts from mr sun’s transfers to casinos and personal loans mr sun pointed to dollar_figure of debits in and dollar_figure of debits in for which he could not remember whether the related expenses were personal investment or business in minchem’s officer loan account transferred money to the wynn casino in the following amounts dollar_figure on march dollar_figure million on june dollar_figure million on september dollar_figure on september dollar_figure million on november and dollar_figure million on december in the wynn casino transferred money to minchem’s officer loan account in the following amounts dollar_figure on april dollar_figure million on september dollar_figure on december and dollar_figure on december minchem’s officer loan account also transferred dollar_figure to the mgm casino on november and received back dollar_figure from the mgm casino on december in minchem’s officer loan account transferred dollar_figure million to the wynn casino on june minchem’s officer loan account received dollar_figure million and continued dollar_figure from the officer loan account to casinos and received back dollar_figure ie over the two years in issue mr sun lost dollar_figure from gambling from the officer loan accountdollar_figure mr sun told mr cheung about the gambling_losses but still believed that he would be able to earn the promised return on investment in spite of over dollar_figure million in gambling_losses although mr cheung was not sure whether the lost money was money that he sent to mr sun or mr sun’s personal money mr sun did use some of the funds in the officer loan account for investment in mr sun directed transfers of dollar_figure to sun investment and dollar_figure to his personal e trade account in mr sun directed transfers of dollar_figure to sun investment dollar_figure to tiger partners llc continued dollar_figure from the wynn casino on january and june respectively combining the and tax years better reflects mr sun’s gambling transactions because mr sun advanced a casino dollar_figure million on date and dollar_figure million was returned on date thus the debits in the officer loan account appear inflated for and the credits appear inflated for because these two transfers likely stem from the same transaction and result in a zero sum dollar_figure to subhouse capital llc and dollar_figure to maddox interests mr sun did not however distinguish whether the money was his or mr cheung’s money iv additional wire transfers from foreign companies in mr cheung’s foreign companies transferred a total of dollar_figure directly to mr sun’s personal e trade account in two transactions the first on january when magic way company transferred dollar_figure and the second on october when kingdom shipping transferred dollar_figure mr sun did not segregate the transfers in his personal e trade account in mr cheung’s foreign companies also transferred a total of dollar_figure directly to sun investment sun investment received dollar_figure on may and dollar_figure on october from magic way company further on october sun investment received dollar_figure from kingdom shipping in sun investment received dollar_figure from a single transfer from magic way company mr sun was a direct or indirect member for each of these partnership entities v administrative background neither minchem the suns nor the other related businesses reported money received from mr cheung as income for the or tax_year respondent sent minchem a notice_of_deficiency on date for the and tax years determining deficiencies and penalties under sec_6663 for both tax years and in the alternative accuracy-related_penalties under sec_6662 for both tax years respondent later conceded the penalties under sec_6663 for the portions of the underpayments due to some items listed on minchem’s notice_of_deficiency but maintained that minchem remained liable for sec_6662 penalties as to those amounts respondent also sent the suns a notice_of_deficiency on date for the and tax years determining deficiencies and penalties under sec_6663 for both mr and mrs sun for both tax years and in the alternative accuracy-related_penalties under sec_6662 for both tax years respondent later conceded the penalties under sec_6663 for the portions of the underpayments due to some items listed on the suns’ notice_of_deficiency but maintained that the suns remain liable for sec_6662 penalties as to those amounts minchem and the suns timely filed separate petitions with the court to challenge the notices of deficiency the two cases were consolidated for purposes of trial briefing and opinion opinion the issues remaining to be decided are whether the suns properly deducted an investment_interest expense for interest_paid on a loan secured_by their residence for and whether minchem received income as gross_receipts from the transfers from mr cheung’s foreign companies for or whether the suns received income as dividends or ordinary_income from the transfers from mr cheung’s foreign companies for or whether minchem is liable for penalties under sec_6663 or sec_6662 for or and whether the suns are liable for penalties under sec_6663 or sec_6662 for or i home equity loan interest the suns refinanced an outstanding loan for dollar_figure through home_equity_indebtedness for and the suns allocated portions of the interest_paid to mortgage interest and the remainder to investment_interest expenses a form_1098 mortgage interest statement issued to the suns for tax_year showed they paid interest of dollar_figure for the suns deducted dollar_figure paid toward the loan as home mortgage interest and carried dollar_figure of paid interest forward as investment_interest which they claimed for a form_1098 issued to the suns for showed they paid interest of dollar_figure for the suns claimed a deduction of dollar_figure for the interest_paid as home mortgage interest and claimed the remaining interest as an investment_interest expense deduction the notice_of_deficiency denied the suns’ investment_interest deduction in its entirety and adjusted their home mortgage interest_deduction the suns assert that an example in a temporary_regulation is directly applicable and shows the deduction is correct as claimed respondent counters that the temporary_regulation does not apply because the suns have not met its requirements deductions are a matter of legislative grace and taxpayers bear the burden of establishing entitlement to any claimed deduction rule a 503_us_79 292_us_435 this burden requires the taxpayer to substantiate items relating to deductions claimed by keeping and producing adequate_records petitioners made an oral motion to shift the burden as to nonfraud issues under sec_7491 a taxpayer must comply with the requirements to substantiate any item as discussed below petitioners did not substantiate the interest_deduction thus the burden does not shift under sec_7491 with respect to the interest_deduction that enable the commissioner to determine the taxpayer’s correct_tax liability sec_6001 65_tc_87 aff’d per curiam 540_f2d_821 5th cir 43_tc_824 a taxpayer claiming a deduction on a federal_income_tax return must demonstrate that the deduction is allowable pursuant to some statutory provision and must further substantiate that the expense to which the deduction relates has been paid_or_incurred see sec_6001 hradesky v commissioner t c pincite sec_1_6001-1 income_tax regs sec_163 allows taxpayers a deduction for qualified_residence_interest paid on the mortgage on their first or secondary home sec_163 h d sec_1_163-10t temporary income_tax regs fed reg date qualified_residence_interest is either acquisition_indebtedness or home_equity_indebtedness sec_163 acquisition_indebtedness is a loan of up to dollar_figure million that is used to acquire construct or substantially improve a residence when that residence also secures the loan sec_163 new debt to refinance old acquisition_indebtedness is also acquisition_indebtedness for purposes of sec_163 as long as it is not more than the refinanced debt sec_163 home_equity_indebtedness is any other type of loan secured_by a qualified_residence but is capped at the lesser_of dollar_figure or the fair market_value of the residence minus any acquisition_indebtedness on the residence sec_163 there is a limit to qualified_residence_interest where the total average balances for the taxable_year of all secured debts on a residence are more than the adjusted purchase_price of the residence azimzadeh v commissioner tcmemo_2013_169 sec_1_163-10t temporary income_tax regs fed reg date further if the sum of the average balances for the taxable_year of all secured debts exceeds the adjusted purchase_price of the qualified_residence at the end of the taxable_year the taxpayer must use either the simplified_method or the exact_method to determine the amount of interest that is qualified_residence_interest sec_1_163-10t temporary income_tax regs supra the two methods to determine the amount of qualified_residence_interest appear to treat excess paid interest differently the simplified_method treats remaining paid interest as nondeductible personal_interest even if the remaining interest would be allocated under sec_1_163-8t temporary income_tax regs fed reg date to some other category of interest sec_1 10t d temporary income_tax regs fed reg date the exact_method allows remaining interest to be allocated under sec_1 8t temporary income_tax regs supra which makes remaining interest potentially deductible sec_1_163-10t temporary income_tax regs fed reg date the suns point out that the example in sec_1_163-10t temporary income_tax regs supra appears to apply but the suns have failed to substantiate the deduction specifically the suns have not shown that the obtained funds were used for investing in general the nature of interest payments is determined not by the origin of the debt or the collateral that secures the loan but by the eventual use of the funds received as proceeds from the loan sec_1_163-8t temporary income_tax regs supra the suns contend that the interest_paid is deductible as investment_interest because the loan proceeds were deposited in minchem’s bank account the suns posit that minchem is property_held_for_investment because it is a type of property that generally produces dividend income it is not necessary for the court to decide whether minchem is property_held_for_investment because the suns did not purchase or contribute the loan proceeds to minchem instead minchem’s general ledger notes that the company treated the mortgage proceeds as a personal loan from mr sun to minchem in other words mr sun borrowed the money so that he could lend it to minchem and minchem would repay him mr sun has not shown that the funds disbursed for his mortgage to finance his ancillary loan to minchem were for investment further the suns fail to recognize the differences between the simplified_method and the exact method--or explain the application of either the suns have not demonstrated that the deduction is allowable pursuant to any statutory provision because they have not shown the funds were used for investing accordingly respondent’s determinations concerning the suns’ home mortgage and investment_interest expense deduction for the interest_paid on the home equity loan are sustained ii burden_of_proof for unreported income in general taxpayers bear the burden of disproving the commissioner’s determinations rule a petitioners however contend that under 560_f2d_693 5th cir in the court_of_appeals for the fifth circuit to which an appeal of these cases would lie the presumption of correctness does not attach in cases involving unreported income unless the commissioner either identifies the taxable source_of_income or disproves nontaxable sources see sec_7482 and b petitioners assert that respondent has not satisfied either of these requirements further petitioners contend that the burden should shift under sec_7491 and sec_7522 for similar reasons respondent counters that he has sufficiently identified a likely source of income as well as negating the nontaxable source it is unnecessary for the court to address the parties’ disagreements and to determine whether the burden_of_proof has shifted for the unreported income because the outcome of each of the present cases is determined on the preponderance_of_the_evidence see 394_f3d_1030 8th cir aff’g tcmemo_2003_212 124_tc_95 namyst v commissioner tcmemo_2004_263 aff’d 435_f3d_910 8th cir iii transfers to minchem before deciding on the tax consequences of the transfers between mr cheung’s foreign companies and minchem the court needs to address the substance of the arrangement between mr cheung and mr sun respondent determined that the money from mr cheung’s foreign companies is either gross_receipts to minchem which then made a distribution to mr sun or alternatively represents direct income to mr sun petitioners’ position is less clear because while they often assert that mr sun was entrusted to invest mr cheung’s money they also appear to claim that the money was a loan to mr sun a income to minchem sec_61 defines gross_income as all income from whatever source derived a fundamental principle of income_taxation is that income is taxable to the person who earns it 281_us_111 the true_earner of income is the person or entity who controls the earning of such income and not necessarily the person or entity that receives the income barmes v commissioner tcmemo_2001_155 the crucial question is ‘whether the assignor retains sufficient power and control_over the assigned_property or over receipt of the income to make it reasonable to treat him as the recipient of the income for tax purposes ’ id slip op pincite quoting 333_us_591 minchem did not retain sufficient dominion and control_over the funds transferred by mr cheung’s foreign companies to make it the recipient of the income for tax purposes minchem consistently reported money received from mr cheung’s foreign companies as either a loan from mr sun to minchem or as repayment for a loan from minchem to mr sun minchem’s officer loan account records show that the funds repaid money spent on mr sun’s behalf similarly when the funds from mr cheung’s foreign companies exceeded the debts to the officer loan account the funds were treated as cash that mr sun had loaned to minchem and that he could and did use the money for personal reasons further when minchem was applying for a line of credit the money was shown as both an asset and a liability in other words minchem recognized that it held the money but had an obligation to repay it and could not exercise dominion and control_over it see eg 343_us_130 arcia v commissioner tcmemo_1998_178 instead of retaining dominion and control_over the funds minchem acted as a conduit for the money a taxpayer who merely acts as a conduit and disposes of transferred funds to third parties does not receive taxable_income see estate of kalichuk v commissioner tcmemo_1964_336 minchem received the cash from mr cheung’s foreign companies but immediately treated it as belonging to a third party mr sun rather than transferring the money to mr sun it either paid expenses on mr sun’s behalf or held the money in its officer loan account by holding the money in the officer loan account--which was solely for mr sun’s benefit--minchem eliminated the need for mr sun to turn around and loan the money back to the company on his behalf accordingly minchem did not receive taxable_income from mr cheung’s foreign companies because it did not retain sufficient dominion and control_over the transferred funds see barmes v commissioner tcmemo_2001_155 further minchem did not receive taxable_income from mr cheung’s foreign companies because minchem acted as a conduit to mr sun see estate of kalichuk v commissioner tcmemo_1964_336 b income to mr sun respondent contends that the money transferred from mr cheung’s foreign companies is either qualified dividends from minchem or income directly from the foreign companies as discussed above minchem was merely a conduit for the funds and thus they are not qualified dividends to mr sun petitioners’ position is that the funds transferred to minchem are not income to mr sun because he had an obligation to repay them in substance petitioners contend the funds are a loan that mr sun was obligated to repay generally the proceeds of a loan do not constitute income to a borrower because the benefit is offset by an obligation to repay 384_f2d_748 5th cir 48_tc_640 deciding whether a particular transaction constitutes a loan however is a question of fact to be determined upon consideration of all the pertinent facts in the case 54_tc_905 whether a bona_fide debtor-creditor relationship exists is a question of fact and essential elements are the intent of the recipient of the funds to make monetary repayment and the intent of the person advancing the funds to enforce repayment 55_tc_85 fisher v commissioner t c pincite whether the recipient had an intent to repay and the lender an intent to enforce repayment is determined at the time of receipt of the funds 925_f2d_180 7th cir aff’g tcmemo_1989_103 322_f2d_956 9th cir aff’g tcmemo_1962_6 indicative of an intent to repay are that a note evidencing the indebtedness was executed that the parties agreed on the rate of interest that there was a fixed maturity_date that a security_interest was given the creditor and that the debtor had the ability to make repayment frierdich v commissioner f 2d pincite 728_f2d_945 7th cir aff’g tcmemo_1983_98 the funds that the suns received from mr cheung’s foreign companies lacked many of the characteristics usually present when the court finds that money advanced constitutes a bona_fide loan for instance at the time the suns received the funds a note evidencing the indebtedness was not executed and a security_interest was not given further mr sun and mr cheung did not agree on the period of the loan or the rate of interest mr sun believed the term was a minimum of years and did not give a maximum period whereas mr cheung believed the term was to years mr sun and mr cheung also disagreed on the rate of return or interest mr sun believed the return on investment would be a split of the net profit with a minimum gain annually but the return might not be paid annually mr cheung believed the return would be between and but was uncertain whether that return was annual or total in consideration of these factors the transferred funds do not constitute a bona_fide loan between mr sun and mr cheung nor does any of the transfers--including the transfer accompanied by a letter--appear to be a gift because mr cheung lacked donative_intent a gift requires donative_intent actual delivery and relinquishment of dominion and control see 476_f2d_704 5th cir aff’g tcmemo_1971_222 the supreme court has defined a gift as a transfer of property that proceeds from a ‘detached and disinterested generosity ’ ‘out of affection respect admiration charity or like impulses ’ 363_us_278 quoting 351_us_243 and 343_us_711 while the specific terms of the agreement between mr cheung and mr sun were not defined both credibly testified that mr sun was obligated to return some money to mr cheung at some point thus the transfers were not from detached and disinterested generosity because mr cheung expected some return of money from mr sun further mr sun did not report the funds transferred by mr cheung’s foreign companies as gifts or otherwise show that he believed he was receiving gifts generally sec_6039f requires taxpayers to report large foreign gifts the secretary requires taxpayers to file a form_3520 annual return to report transactions with foreign trusts and receipt of certain foreign gifts to report aggregate gifts over dollar_figure from foreign individuals and estates and dollar_figure as adjusted for inflation if the gift purportedly comes from a foreign_corporation notice_97_34 1997_1_cb_422 announcement 1998_1_cb_962 the transfers from mr cheung’s foreign companies exceed either of these thresholds in both tax years and the suns did not file any form_3520 in tax_year or accordingly the transfers are not gifts because mr cheung did not give the money out of detached and disinterested generosity and the suns did not treat the money as gifts in the or tax_year instead it appears that mr cheung’s foreign companies entrusted the money to mr sun for the specific purpose of having him invest the funds state law determines the nature of property rights while federal_law determines the appropriate tax consequences of those rights see united_states v nat’l bank of the sec_6039f exception for certain organizations are not applicable in these cases commerce 472_us_713 blanche v commissioner tcmemo_2001_63 aff’d 33_fedappx_704 5th cir texas law recognizes that a_trust may arise at the implication of an intention to create a_trust mills v gray s w 2d tex citing am jur sec_5 it is not necessary that a formal trust be created in order to find that the property has been entrusted 38_tc_75 money a taxpayer receives in his or her capacity as a fiduciary or agent does not constitute income to that taxpayer 44_tc_96 cedar valley bird co llp v commissioner tcmemo_2013_153 a transferee taxpayer does not receive income when the transferor and the transferee agree that money received is held in trust for the benefit of others see 14_tc_965 rogers v commissioner tcmemo_2011_277 aff’d 728_f3d_673 7th cir further funds received in trust by a trustee are excludable from gross_income when those funds are subject_to a restriction that they be expended for a specific purpose and the taxpayer does not profit gain or benefit in spending the funds for the stated purpose see bailey v commissioner tcmemo_2012_96 citing 55_tc_761 aff’d 456_f2d_255 5th cir aff’d wl 1st cir date mr sun and mr cheung both credibly testified that mr sun was to invest money on behalf of mr cheung and both agree that the funds transferred from mr cheung’s foreign companies to minchem were specifically earmarked for investment purposes mr cheung who was an unsuccessful investor trusted mr sun to invest the money and eventually to earn a profit from those investments mr sun credibly testified that mr cheung did not put any restrictions on how the money was to be invested but the money was designated for investment purposes accordingly the transfers alone do not indicate the funds from mr cheung’s foreign companies are income to mr sun because mr sun held the money for mr cheung’s benefit specifically mr sun held the money on behalf of mr cheung for investment purposes however funds held in trust by a trustee generally become includible in his or her gross_income once he or she misappropriates the money 15_f3d_203 1st cir adams v commissioner tcmemo_1970_104 aff’d 456_f2d_259 9th cir where a taxpayer misappropriates funds for the benefit of a related_party or where he ultimately receives a benefit from the defalcation he has received readily realizable economic value and has been enriched by it hobson v commissioner tcmemo_1992_312 thus a taxpayer must include in his or her gross_income money that was misappropriated from funds that were held for the benefit of others and used to confer a personal benefit see id whether funds have been misappropriated is a question of fact but facts beyond dominion and control must be considered see bailey v commissioner tcmemo_2012_96 more specifically an individual misappropriates funds when money has been entrusted to the individual for the sole purpose of investing and the individual instead uses the money for personal activities degoff v commissioner tcmemo_1966_89 as discussed above mr sun held money transferred by mr cheung’s foreign companies in trust for mr cheung and he misappropriated the funds because he exercised more than mere dominion and control_over the money when he used it for personal purposes in total mr sun identified dollar_figure in the tax_year and dollar_figure in the tax_year of personal expenses paid out of the funds transferred from mr cheung’s foreign companies mr sun undisputedly treated as his own money held for mr cheung’s benefit and specifically earmarked for investment purposes for example mr sun used some of the funds to purchase a personal automobile and a home automation system perhaps the most obvious example of mr sun’s misappropriation of the funds is his gambling activities mr sun transferred around dollar_figure to casinos in and lost around dollar_figure of that money through his gambling activities that year funds that are originally entrusted to an individual for investment purposes and are later used by that individual for gambling activities are considered misappropriated see id accordingly the funds from mr cheung’s foreign companies that mr sun admittedly spent for personal purposes are gross_income for the years in which he misappropriated the funds see webb f 3d pincite adams v commissioner tcmemo_1970_104 mr sun also misappropriated money that remained in the officer loan account that was used to inflate minchem’s cashflow when it was applying for a line of credit because the money benefited mr sun mr sun chose to place the money mr cheung’s foreign companies transferred into minchem’s officer loan account mr sun had a choice of how to invest the money and he decided to leave several million of the foreign company funds in the officer loan account both mr sun and minchem considered the money as owned by mr sun in other words mr sun chose to let minchem use the money as its own in effect lending the money to minchem minchem reported the money and offsetting liability when these amounts do not include two dollar_figure transactions in tax_year on september dollar_figure was debited from minchem’s officer loan account to wynn casino and on december dollar_figure was credited to the officer loan account by wynn casino both transfers note that they are reverse posted funds applying for a loan account to show that the company could pay its large outstanding liabilities if mr cheung’s foreign companies had not sent the money mr sun would have had to loan minchem his own money to achieve the same result further mr sun did not use the money for the mutually agreed-upon purpose when he left the money in the officer loan account rather than pursuing investment opportunities--the action mr cheung trusted mr sun to perform--mr sun left the money idle in the officer loan account this deviation from the agreed-upon investment strategy amounts to a misappropriation of funds thus loaning the money to his company goes beyond merely taking dominion and control and shows that mr sun misappropriated the entrusted funds by placing the money in the officer loan account and not using it for its intended purpose see degoff v commissioner tcmemo_1966_89 mr sun contends that he did invest some of the money mr cheung’s foreign companies transferred to minchem but the evidence shows that only a fraction of it was used for what might be called investment purposes and all of it this is distinctly different from leaving the money in a third-party non- interest-earning account the funds were not merely idle but used to effect a specific purpose chosen by mr sun minchem and mr sun would not have benefited from showing an increased cashflow if the money were deposited and left idle with a disinterested bank was commingled with mr sun’s personal money mr sun contends that in he used dollar_figure out of the dollar_figure transferred into minchem’s officer loan account for investment purposes and in he used dollar_figure out of the dollar_figure transferred specifically in mr sun’s personal e trade account received dollar_figure and sun investment received dollar_figure from minchem’s officer loan account in sun investment received dollar_figure tiger partnerships llc received dollar_figure maddox interests received dollar_figure and subhouse capital llc received dollar_figure from minchem’s officer loan account all of the money transferred was commingled with mr sun’s other personal assets the e trade account was his personally and it held his money for personal investments the money transferred from minchem’s officer loan account was not separated from mr sun’s money within the e trade account and it is not clear whose money mr sun was investing in any particular transaction similarly mr sun was a part owner of all the investments in other words he was using the money from mr cheung’s foreign companies to help support his personal investments while commingling funds alone is not enough to find that money was misappropriated commingling funds combined with failing to regard funds as subject_to restriction on their use may show misappropriation see bailey v commissioner tcmemo_2012_96 the facts in the record clearly show that mr sun treated the money in the officer loan account--including the money he potentially used for investments --as funds without any restrictions the record shows that mr sun viewed the officer loan account as his personal repository of funds that he could use for any reason and the money that was transferred to his investments was not in substance transfers on behalf of mr cheung but instead on behalf of mr sun the outflow of funds to mr sun’s investments is a convenient surrogate to support his contention that the money was used for the benefit of mr cheung but the commingling and the abandonment of restrictions supports a conclusion that any money used as an investment was for mr sun not mr cheung mr sun misappropriated the funds for personal_use abandoned the intended purpose for which the money was entrusted and he did not invest the money in accordance with the agreed-upon strategy accordingly all the money transferred to minchem’s officer loan account from mr cheung’s foreign companies in and is income to mr sun because he treated the funds as his own rather than as restricted funds held in a fiduciary capacitydollar_figure iv other transfers besides transferring money to minchem mr cheung’s foreign companies transferred funds directly to mr sun’s e trade account and to sun investment mr sun’s e trade account received a total of dollar_figure as a result of two transfers from mr cheung’s foreign companies in sun investment received a total of dollar_figure as a result of three transfers from mr cheung’s foreign companies in sun investment also received dollar_figure from mr cheung’s foreign companies in similar to the money transferred into mr sun’s e trade account from minchem’s officer loan account the money transferred directly to mr sun’s e trade account from mr cheung’s foreign companies was commingled and not specifically earmarked as belonging to mr cheung instead mr sun treated all the funds in his e trade account as his personally further mr sun treated all the gains losses and dividends from his e trade account as personal for the additional dollar_figure although not deposited into minchem’s officer loan account was wire transferred to minchem the record does not reflect what happened to the dollar_figure that was not reported in the officer loan account but the court will presume that mr sun also used the funds as his own see supra note example mr sun’s e trade account records show that in the account was paid dollar_figure in taxable dividends mr sun reported dollar_figure in ordinary dividends on his personal tax_return as received by his e trade account the court finds that he was treating all the money transferred to his e trade account as his own he therefore did not treat the money as funds subject_to any restrictions but showed he was investing the money for himself rather than mr cheung see bailey v commissioner tcmemo_2012_96 accordingly the commingling and the abandoning of the original purpose of investing on behalf of mr cheung support a conclusion that the income transferred to mr sun’s e trade account from mr cheung’s foreign companies is income to mr sun the amounts transferred to sun investment are also income to mr sun because he did not honor the intended investment strategy or treat the money as subject_to any use restrictions mr sun treated all the money transferred to sun investment as his personal money sun investment’s specific treatment of the transfers indicate that the money was mr sun’s personal money first sun investment did not give mr cheung a membership interest second sun investment did not increase its liabilities as a result of the transfers third sun investment increased mr sun’s capital_account for incoming transferred money sun investment is organized as a limited_liability_company llc that is taxed as a partnership in general owners of llcs are called members and each member is allocated his or her portion of the llc’s income gain loss deductions or credits in accordance with the partnership_agreement or his or her membership share see sec_704 and b an investor who contributes money to obtain an interest in an llc generally takes a basis in his or her interest in the llc equal to the amount of money contributed sec_722 further llcs treated as partnerships may maintain capital accounts which may be helpful to track partners’ economic interests in the llc sec_1_704-1 income_tax regs mr sun directed mr cheung’s foreign companies to send money to sun investment but sun investment did not recognize any new members in or mr cheung was not allocated any portion of sun investment’s income gain loss deductions or credits further mr cheung did not maintain a capital_account with sun investment and sun investment did not recognize any new_capital accounts for or instead sun investment stayed a two-member llc and the distributive_share of the income gain loss deductions or credits remained the same for the two members during and thus the money sun investment may have shifted distributive_share of the profits from mr sun to the other member in transferred to sun investment did not represent a direct investment by mr cheung because he did not take a membership interest in the llc nor was the foreign person-foreign corporation investment reflected in sun investment’s tax returns similarly the money transferred to sun investment did not represent a loan from mr cheung’s foreign companies to sun investment because the foreign companies and sun investment did not create a debtor creditor relationship and sun investment did not recognize the money as a loan from mr cheung’s foreign companies mr sun represented that the transfers from mr cheung’s foreign companies to sun investment were personal loans from mr cheung although sun investment did not reflect that position on its tax_return the facts show that the transfers were not loans mr sun and mr cheung did not agree on terms specific enough to establish the creation of a debtor creditor relationship for the overall structure nor did they establish a debtor creditor relationship between mr cheung and sun investment see beaver v commissioner t c pincite fisher v commissioner t c pincite grzegorzewski v commissioner tcmemo_1995_49 further despite sun investment’s claim that the dollar_figure transferred from mr cheung’s foreign companies was a loan sun investment reported only a dollar_figure increase in liabilities for for sun investment reported that its total liabilities increased by dollar_figure despite claiming that mr cheung’s foreign companies loaned dollar_figure to the llc accordingly sun investment’s assertion that mr cheung loaned the money to sun investment conflicts with its forms and the money was not a loan to sun investment similar to the substance of the transfers of funds to minchem’s officer loan account discussed above the substance of the transfers to sun investment appears to be that mr cheung’s companies intended to entrust mr sun with funds specifically earmarked for investment purposes instead of creating a debtor creditor relationship mr cheung entrusted mr sun to invest the money mr sun did not invest on behalf of mr cheung but instead chose to use the money for his personal investment in sun investment sun investment shows that the increase in money was from mr sun personally because on mr sun’s schedule_k-1 partner’s share of income deductions credits etc sun investment reported that mr sun contributed an additional dollar_figure of capital sun investment reported a dollar_figure increase in other current liabilities and a dollar_figure increase in mortgages notes bonds payable in year or more on its form_1065 u s return of partnership income sun investment reported increases of dollar_figure in other current liabilities and dollar_figure in liabilities for mortgages notes bonds payable in year or more on the llc’s form_1065 to the llc in similar sun investment reported on mr sun’s schedule_k-1 that mr sun contributed an additional dollar_figure of capital to the llc in thus mr sun was treating the money transferred from mr cheung’s foreign companies as his own mr cheung did not take a membership interest in sun investment sun investment did not recognize that the money was a loan from mr cheung but instead increased mr sun’s capital_account in and accordingly the money transferred directly to sun investment is income to mr sun v penalties respondent determined penalties under sec_6663 for both minchem and the suns for and respondent determined minchem is liable for sec_6663 penalties of dollar_figure and dollar_figure for and respectively respondent originally determined the suns were liable for sec_6663 penalties of dollar_figure and dollar_figure for and respectively these fraud penalties represented of each of the suns’ total underpayments respondent later conceded that the portions of the underpayments resulting from the investment_interest expense deduction and the unreported income from personal meals and entertainment_expenses paid_by minchem in and were not due to fraud thus the suns are not liable for penalties under sec_6663 on the portions of the underpayments stemming from these items respondent instead argues that the suns are liable for penalties under sec_6662 for the portions of the underpayments attributable to these items in the alternative to the remaining sec_6663 penalties respondent determined that the suns and minchem are liable for accuracy-related_penalties for the and years as a result of the transfers from mr cheung’s foreign companies specifically respondent alternatively determined the suns owe accuracy-related_penalties of dollar_figure and dollar_figure for and respectively respondent alternatively contends that minchem owes accuracy- related penalties of dollar_figure and dollar_figure for and respectively a sec_6663 penalties respondent argues that petitioners are liable for the sec_6663 fraud penalties for the years in issue fraud is an intentional wrongdoing on the part of the taxpayer with the specific purpose of evading a tax believed to be owing 829_f2d_828 9th cir aff’g tcmemo_1986_223 a penalty equal to will be imposed on any part of the taxpayer’s underpayment of federal_income_tax that is due to fraud sec_6663 further if any portion of the underpayment is attributable to fraud the entire underpayment will be treated as attributable to fraud unless the taxpayer establishes by a preponderance_of_the_evidence that part of the underpayment is not due to fraud sec_6663 see foxworthy inc v commissioner tcmemo_2009_203 aff’d 494_fedappx_964 11th cir respondent has the burden of proving by clear_and_convincing evidence that an underpayment exists for each of the years in issue and that some portion of the underpayment is due to fraud see sec_6663 sec_7454 rule b 102_tc_632 as discussed above minchem does not have underpayments as a result of the transfers from mr cheung’s foreign companies because in substance the funds were merely deposited in minchem’s officer loan account which was for the benefit of mr sun who then misappropriated the funds by either using the money for personal reasons or leaving the money in minchem’s officer loan account accordingly minchem is not liable for fraud penalties under sec_6663 for and the suns on the other hand do have underpayments as a result of the transfers from mr cheung’s foreign companies to minchem for and the suns have further underpayments as a result of the transfers to mr sun’s e trade account and sun investment accordingly respondent has met the burden with respect to this requirement of the sec_6663 fraud_penalty respondent must also prove by clear_and_convincing evidence that petitioners had the requisite fraudulent intent 94_tc_654 fraud is intentional wrongdoing designed to evade tax believed to be owing 116_tc_79 the existence of fraud is a question of fact to be resolved upon consideration of the entire record 69_tc_391 fraud is not to be presumed or based upon mere suspicion 92_tc_661 however because direct proof of a taxpayer’s intent is rarely available fraudulent intent may be established by circumstantial evidence 182_f3d_275 4th cir aff’g tcmemo_1996_452 the commissioner satisfies this burden_of_proof by showing that the taxpayer intended to evade taxes known to be owing by conduct intended to conceal mislead or otherwise prevent the collection_of_taxes parks v commissioner t c pincite the taxpayer’s entire course of conduct may be examined to establish the requisite intent and an intent to mislead may be inferred from a pattern of conduct 394_f2d_366 5th cir aff’g tcmemo_1966_81 56_tc_213 circumstances that may indicate fraudulent intent commonly referred to as badges_of_fraud include but are not limited to understating income maintaining inadequate records giving implausible or inconsistent explanations concealing income or assets failing to cooperate with tax authorities engaging in illegal activities providing incomplete or misleading information to one’s tax preparer lack of credibility of the taxpayer’s testimony filing false documents including false income_tax returns failing to file tax returns and dealing in cash 317_us_492 morse v commissioner tcmemo_2003_332 aff’d 419_f3d_829 8th cir no single factor is dispositive however the existence of several factors is persuasive circumstantial evidence of fraud vanover v commissioner tcmemo_2012_79 slip op pincite after reviewing the facts and the badges_of_fraud the court concludes that respondent has failed to meet the burden to show that either of the suns had the requisite fraudulent intent to impose penalties under sec_6663 while respondent asserted different badges applied to the suns several of the asserted badges were duplicative excluding the duplicative badges respondent contends the following factors are present in this case the suns underreported income for both and the suns failed to maintain adequate_records the suns offered implausible and inconsistent explanations the suns failed to cooperate with tax authorities the suns provided incomplete or misleading information to their tax preparers mr suns’ testimony was not credible and the suns filed false documents including false income_tax returns understating income a pattern of substantially underreporting income for several years is strong evidence of fraud particularly if the understatement is not satisfactorily explained or due to innocent mistake see 348_us_121 spies u s pincite webb v commissioner f 2d pincite morse v commissioner tcmemo_2003_332 see also green v commissioner tcmemo_2010_109 finding that a satisfactory explanation may weigh against a finding of fraud respondent’s badge of omission of entire source_of_income fits within the understating income badge also asserted by respondent respondent’s badge of making inconsistent representations fits within the implausible and inconsistent explanations badge also asserted by respondent last respondent’s false statement about a material fact fits within the lack of credibility of the taxpayer’s testimony badge also asserted by respondent the suns underreported income for the years in issue as a result of the transfers from mr cheung’s foreign companies mr sun used the money as his own and did not report the funds as income this weighs in favor of finding fraudulent intent as to mr sun maintaining inadequate records fraudulent intent can be inferred from a failure to maintain adequate books_and_records see scott v commissioner tcmemo_2012_65 ark oil gas inc v commissioner tcmemo_1994_497 respondent contends that the lack of loan documents is indicative of fraudulent intent respondent does not assert and did not offer any evidence showing that minchem or mr sun was keeping multiple books or inadequate accounting_records respondent instead contends that it is implausible that mr sun and mr cheung had a verbal loan agreement respondent also contends that the officer loan account arrangement is implausible respondent did not offer evidence or testimony to support contentions that verbal loan agreements were implausible respondent relies on a contention that this is not the usual way that sophisticated people behave in contrast mr sun credibly testified that he often engaged in business transactions without documentation thus while the court ultimately decides that the substance of the transactions was not a loan respondent did not carry the burden to show that the suns failed to maintain adequate_records accordingly this factor is neutral giving implausible or inconsistent explanations a taxpayer’s implausible or inconsistent explanations for his actions may constitute circumstantial evidence of fraudulent intent see 796_f2d_303 9th cir aff’g tcmemo_1984_ 363_f2d_151 9th cir aff’g tcmemo_1963_333 81_fedclaims_772 respondent primarily relies on inconsistencies between mr cheung’s and mr sun’s testimony to show inconsistent explanations this looks more like two people’s not reaching an agreement before conducting a transaction than like mr sun’s giving inconsistent explanations for his actions in fact mr sun’s explanations regarding the transactions were consistent throughout the proceeding he may not have understood the implications of his actions but the record does not indicate that he offered inconsistent explanations with the intent to evade any_tax owed further as discussed above respondent contends that the loan arrangements were implausible but does not offer testimony or other evidence to support his assertion that verbal loan arrangements are necessarily implausible thus respondent has failed to show mr sun offered implausible or inconsistent explanations this factor is neutral failing to cooperate with tax authorities failing to cooperate with tax authorities is indicative of fraud bradford v commissioner f 2d pincite respondent contends that both of the suns failed to cooperate with tax authorities when they failed to respond to three information requests idr and were rude to revenue agents respondent admitted that he previously possessed the information requested in one of the idrs but requested the information through an idr for ease the suns’ certified_public_accountant cpa credibly testified that the suns had sent all the information that they had to satisfy the outstanding idrs any information not provided was information the suns did not have respondent also contends that the suns were rude to one of his agents the agent however appears to have ignored a request by the suns’ cpa to honor a power_of_attorney and not directly contact mr sun instead the agent may have been bypassing the cpa with power_of_attorney to seek information directly from the suns it is understandable that the suns may have become frustrated with a revenue_agent who did not honor a power_of_attorney accordingly this factor is neutral for fraudulent intent providing incomplete or misleading information to one’s tax preparer evidence that a taxpayer provided incomplete or misleading information to his return preparer is circumstantial evidence of fraud see morse v commissioner f 3d pincite a taxpayer acts fraudulently when he conceals income from his return preparer see 781_f2d_1566 11th cir aff’g tcmemo_1985_63 patel v commissioner tcmemo_2008_223 morse v commissioner tcmemo_2003_332 respondent contends that mr sun provided misleading information to his cpa by giving him minchem’s complete general ledger specifically respondent contends that the officer loan account is misleading and it should not have been used to prepare the suns’ tax returns as discussed above mr sun misappropriated the funds transferred by mr cheung’s foreign companies but the officer loan account arrangement was not in itself misleading in fact the officer loan account arrangement is consistent with mr sun’s misappropriation because minchem as well as mr sun treated the funds as his personally thus mr sun did not offer misleading information to his cpa by giving him minchem’s complete general ledger respondent offers no other testimony or other evidence demonstrating that the suns provided incomplete or misleading information accordingly this factor favors the suns lack of credibility of the taxpayer’s testimony a taxpayer’s lack of credibility the inconsistencies in his testimony and his evasiveness on the stand are heavily weighted factors in considering the fraud issue 743_f2d_309 5th cir aff’g tcmemo_1984_25 devries v commissioner tcmemo_2011_185 respondent contends that mr sun offered incredible and inconsistent testimony however mr sun was credible in his testimony he was not evasive he admitted that he used large quantities of the money for personal purposes and he was consistent with regard to his understanding of the arrangement he credibly testified that he thought he was allowed unrestricted use of the money despite the fact that he was mistaken about the implications of treating the funds as his own in other words mr sun was credible and consistent but wrong accordingly this factor is neutral filing false documents including false income_tax returns fraudulent intent may be inferred when a taxpayer files a tax_return intending to conceal mislead or prevent the collection of tax see spies u s pincite respondent contends this badge is very similar to the understating income factor discussed above respondent contends that the suns filed false returns by failing to report income however respondent has not pointed to any evidence suggesting that the suns’ failure to report the income was a result of an attempt to conceal mislead or prevent the collection of tax respondent’s position appears to be that all incorrect tax returns are fraudulent simply because they are incorrect failure to report income is not necessarily fraudulent and may be by misunderstanding respondent has failed to show the suns filed documents with the intent to conceal mislead or prevent the collection of tax accordingly this factor is neutral in sum only one badge of fraud points to finding fraudulent intent the other asserted badges are either neutral or favor the suns’ position after weighing the facts the court finds that respondent has not met his burden to show the suns had the requisite fraudulent intent to impose a penalty under sec_6663 for or respondent did not introduce evidence or pursue any potential reporting requirements in regard to a nonresident_alien or a foreign company transferring large quantities of money into the united_states for a purported investment but for the obvious gift reporting requirement discussed in detail supra p the court will not attempt to analyze any additional potential failure of reporting requirements in regard to the wire transfers and investments b sec_6662 penalties in the alternative to the fraud penalties under sec_6663 relating to the treatment of the transfers by mr cheung’s foreign companies respondent determined that the suns and minchem are liable for accuracy-related_penalties for and respondent also contends that the suns are liable for an accuracy- related penalty relating to the investment_interest expense deduction for and for the deductions for personal expenses paid directly by minchem but not through the officer loan account as discussed above minchem does not have an underpayment as a result of the transfers accordingly minchem is not liable for a penalty under sec_6662 relating to the transfersdollar_figure sec_6662 and b and authorizes the imposition of a penalty on the portion of an underpayment_of_tax that is attributable to among other things negligence or disregard of rules or regulations or any substantial_understatement_of_income_tax only one accuracy-related_penalty may be imposed with respect to any given portion of an underpayment even if that portion is attributable to more than one of the reasons identified in sec_6662 sec_1_6662-2 income_tax regs petitioners’ conceding the adjustments to minchem’s business_expense deductions for the suns’ travel and entertainment will result in a penalty under sec_6662 and a rule computation the commissioner bears the initial burden of production with respect to the taxpayer’s liability for the sec_6662 penalty sec_7491 the commissioner must introduce sufficient evidence indicating that it is appropriate to impose the relevant penalty 116_tc_438 once the commissioner meets his burden of production the taxpayer must come forward with persuasive evidence that the commissioner’s determination is incorrect or that the taxpayer had reasonable_cause or substantial_authority for the position id pincite the term negligence includes any failure to make a reasonable attempt to comply with the provisions of the internal revenue laws and the term disregard includes any careless reckless or intentional disregard sec_6662 sec_1 b and income_tax regs negligence is strongly indicated where a taxpayer fails to make a reasonable attempt to ascertain the correctness of a deduction credit or exclusion on a return that would seem to a reasonable and prudent person to be too good to be true under the circumstances sec_1 b ii income_tax regs disregard of rules or regulations is ‘careless’ if the taxpayer does not exercise reasonable diligence to determine the correctness of a return position and is ‘reckless’ if the taxpayer makes little or no effort to determine whether a rule_or_regulation exists under circumstances which demonstrate a substantial deviation from the standard of conduct that a reasonable person would observe sec_1_6662-3 income_tax regs see also 85_tc_934 respondent has met his burden to show that the suns carelessly recklessly or intentionally disregarded rules and regulations for their home equity loan interest_deduction the suns did not exercise reasonable diligence to determine whether the deduction was correct in fact it appears they specifically looked for a method to deduct all of the home equity loan interest without determining whether a rule_or_regulation prevented the deduction on one form_1098 someone specifically noted that all of the interest was to be deducted somehowdollar_figure accordingly respondent has met his burden of production to show that a sec_6662 penalty for the home equity loan interest_deduction for tax_year is appropriate respondent has also met his burden to show that the suns acted negligently or with careless disregard of rules and regulations with regard to the income received from mr cheung’s foreign companies mr sun’s excluded gambling the note on a form_1098 sent from mr sun for tax_year read dollar_figure to mtg int bal to invest int exp meaning that dollar_figure of the home equity loan interest would be deducted as mortgage interest and the remaining interest would be deducted as an investment_interest expense the suns’ cpa followed this note and deducted the interest accordingly income and the personal travel and entertainment paid for by minchem mr sun used the money transferred by mr cheung’s foreign companies for personal purposes and did not attempt to comply with the provisions of the internal revenue laws he failed to look into the implications of receiving the money and to investigate the obligations associated with using the money a reasonable and prudent person would think receiving the funds from mr cheung’s foreign companies tax free report free and with an un-agreed-upon obligation to repay the money is too good to be true it was also too good to be true that mr sun could use mr cheung’s money for gambling activities or that minchem could pay the suns’ personal travel and entertainment costs without their being taxed on the income accordingly respondent has met his burden and shown that the suns were negligent in failing to report income from transfers by mr cheung’s foreign companies mr sun’s gambling income and personal travel and entertainment paid for by minchem in and taxpayers may avoid liability for the sec_6662 penalty if they demonstrate that they had reasonable_cause for the underpayment and that they acted in good_faith with respect to the underpayment sec_6664 reasonable_cause and good_faith are determined on a case-by-case basis taking into account all pertinent facts and circumstances sec_1_6664-4 income tax regs the most important factor is the extent of the taxpayer’s efforts to assess his or her proper tax_liability id reliance on professional advice may constitute reasonable_cause and good_faith but it must be established that the reliance was reasonable 89_tc_849 aff’d on another issue 904_f2d_1011 5th cir aff’d 501_us_868 the court has previously held that the taxpayer must satisfy a three-prong test to be found to have reasonably relied on professional advice to negate a sec_6662 accuracy-related_penalty the adviser was a competent professional who had sufficient experience to justify the reliance the taxpayer provided necessary and accurate information to the adviser and the taxpayer actually relied in good_faith on the adviser’s judgment 115_tc_43 aff’d 299_f3d_221 3d cir the suns contend that they relied on their cpa to prepare their and tax returns and thus should not be liable for the accuracy-related_penalties reliance necessary to escape the penalty under sec_6662 does not occur when a taxpayer merely provides raw numbers to an accountant for the accountant to prepare the return and the taxpayer does not carefully examine the return see 136_tc_585 in signing the return thus erroneously prepared petitioners were not deliberately following substantive professional advice they were instead unwittingly they contend perpetuating a clerical mistake the defense of reliance on professional advice has no application here jackson v commissioner tcmemo_2014_160 in other words a taxpayer cannot escape the penalty when the taxpayer does not seek or receive an opinion from his or her preparer see todd v commissioner tcmemo_2011_123 aff’d 486_fedappx_423 5th cir the mere fact that a cpa has prepared a tax_return does not mean that he or she has opined on any or all of the items reported therein neonatology v commissioner t c pincite the suns did not show that they relied on their tax preparer’s advice or opinions instead the record reflects the suns’ cpa prepared the tax returns but did not offer any advice or opinions on the positions taken on the returns see id the suns turned over financial information to their cpa and the cpa prepared the returns according to the received information mr sun did not ask about receiving the money from mr cheung’s foreign companies or about spending that money further there is no evidence that mr sun sought advice regarding the home equity loan interest deductions or the travel and entertainment paid for by minchem thus there was no advice on which mr sun could have relied to escape the penalties accordingly the suns cannot use sec_6664 to escape the accuracy-related_penalty under sec_6662 for or the court in reaching its holdings has considered all arguments made and to the extent not mentioned concludes that they are moot irrelevant or without merit to reflect the foregoing decisions will be entered under rule


internal_revenue_service number release date index number ------------------------------ ------------------------------- ----------------------------- in re -------------------- department of the treasury washington dc third party communication none date of communication not applicable_person to contact ----------------- id no ------------------ telephone number ---------------------- refer reply to cc tege eb qp1 plr-108823-17 date date legend decedent trust date date date date daughter company company amount amount amount amount state a law subtrust accounts court ------------------ ---------------------------------------------------------- -------------------------- ------------------- --------------------------- -------------------- ------------------- --------------------------------------------------- --------------------------------------------------------------------- ---------------- ---------------- ------------------ ---------------- -------------- ------------------------------------------------------------------------ --------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------- ------------------------------ --------------------------------------------------------------------------------------------- ------------------ plr-108823-17 dear --------------- this is in response to the date letter submitted on your behalf by your authorized representative as supplemented by further correspondence dated date and date in which you request a letter_ruling under sec_401 of the internal_revenue_code code and its corresponding treasury regulations the following facts and representations have been submitted under penalty of perjury in support of the ruling requested decedent established the trust a living revocable_trust on date on date decedent died at age and was survived by daughter born on date upon decedent’s death the trust became an irrevocable_trust with daughter as the sole beneficiary of the trust further the trust contains a subtrust established to hold all assets from decedent’s retirement accounts the subtrust daughter is also the sole beneficiary of the subtrust at the time of her death decedent held one traditional individual_retirement_account one roth individual_retirement_account and two annuity_contracts under her former employer’s sec_403 plan together the retirement accounts the retirement accounts held insurance and annuity_contracts administered by company and company at the time of decedent’s death the approximate value of the assets held in each of the retirements accounts was amount amount amount and amount respectively subsequent to decedent’s death trustee transferred the assets of the retirement accounts into subtrust accounts article of the trust states that the trust shall be governed by state a law article of the trust states that the determination with respect to what is income and what is principal of the trust estate shall be governed by law article of the trust is titled designed beneficiary trust and creates the subtrust article of the trust states that it is the intent of decedent that this subtrust qualifies as a ’see through’ or ’conduit’ trust within the meaning of section a - a-5 it further states that all provisions of the subtrust be construed in accordance with this primary intent article also states that the subtrust is intended to be the beneficiary of the retirement accounts retirement benefits are defined in article of the trust to include any benefit payable under the trust under an ira as defined in sec_408 a roth_ira as defined in sec_408a an annuity or mutual_fund plan under sec_403 or any other retirement_plan that is subject_to section the minimum distribution_requirements of a article of the trust lists daughter as the beneficiary of the subtrust plr-108823-17 article of the trust states that following the death of decedent beginning in the year of decedent’s death trustee shall withdraw benefits equaling the minimum_required_distribution from any retirement account for which the subtrust is named the beneficiary and distribute those amounts net of expenses free of trust to daughter or daughter’s successors if daughter fails to survive full distribution of her share in the subtrust article of the trust further states that trustee may pay or apply for the benefit of daughter or the successor of daughter’s interest if daughter fails to survive full distribution of her interest in subtrust as much of the income and principal of the subtrust that the trustee deems necessary for daughter’s or daughter’s successors health maintenance support or education article of the trust states that if a beneficiary for whom assets are being held dies before reaching the age of any undistributed balance of his or her share shall be distributed to any person or entity the beneficiary appoints either through a written instrument exercising this power_of_appointment or a valid will or living_trust if the beneficiary does not exercise his or her power_of_appointment the undistributed balance shall be distributed to the beneficiary’s issue article of the trust states that no retirement benefit may be distributed to any non- individual beneficiary article excludes from the definition of issue any person adopted by the beneficiary that is adopted after the death of decedent and older than the oldest beneficiary of the subtrust who was a class member at the time of the death of decedent based on the foregoing you request a ruling that pursuant to the provisions of sec_1_401_a_9_-5 q a-5 b a -5 q a-5 c and a -4 q a-5 that the applicable distribution period for the subject retirement accounts held by decedent is to be calculated based on the life expectancy of daughter the designated_beneficiary of the subtrust under sec_401 a_trust will not be considered qualified unless the plan provides that the entire_interest of each employee will be distributed to such employee not later than the required_beginning_date or will be distributed beginning no later than the required_beginning_date over the life of such employee or over the lives of such employee and a designated_beneficiary or over a period not extending beyond the life expectancy of such employee or the life expectancy of such employee and a designated_beneficiary sec_401 provides that when an employee dies before distributions have begun under subparagraph a ii the entire portion of such interest will be distributed within years after the death of such employee plr-108823-17 sec_401 provides an exception to sec_401 under which if any portion of an employee's benefit is payable to a designated_beneficiary the portion will be distributed over the life of such designated_beneficiary or over a period not extending beyond the life expectancy of such beneficiary provided such distributions begin no later than one year after the employee's death or such later date as the secretary may prescribe by regulations sec_401 provides that required_beginning_date means april of the calendar_year following the later of the calendar_year in which the employee turns age or the calendar_year in which the employee retires sec_401 provides that designated_beneficiary means any individual designated as a beneficiary by the employee sec_1_401_a_9_-4 q a-1 provides in relevant part that a designated_beneficiary is an individual who is designated as a beneficiary under the plan an individual may be designated as a beneficiary under the plan either by the terms of the plan or if the plan so provides by an affirmative election by the employee or the employee’s surviving_spouse specifying the beneficiary a designated_beneficiary need not be specified by name in the plan in order to be a designated_beneficiary so long as the individual who is to be the beneficiary is identifiable under the plan the member of a class of beneficiaries capable of contraction or expansion will be treated as being identifiable if it is possible to identify the class member with the shortest life expectancy sec_1_401_a_9_-4 q a-3 provides that only individuals may be designated beneficiaries for purposes of sec_401 a person who is not an individual such as the employee’s estate or a charitable_organization may not be a designated_beneficiary if a person other than an individual is designated as a beneficiary of an employee's benefit the employee will be treated as having no designated_beneficiary for purposes of sec_401 even if there are also individuals designated as beneficiaries sec_1_401_a_9_-4 q a-4 provides in relevant part that in order to be a designated_beneficiary an individual must be a beneficiary as of the date of the employee’s death generally an employee’s designated_beneficiary will be determined based on the beneficiaries designated as of the date of death who remain beneficiaries as of september of the calendar_year following the calendar_year of the date of death sec_1_401_a_9_-4 q a-5 provides that where a_trust is named as a beneficiary of an employee the trust is not a designated_beneficiary however beneficiaries of the trust with respect to the trust’s interest in the employee’s benefit may be treated as designated beneficiaries if the following requirements are met the trust is valid under state law or would be but for the fact there is no corpus the trust is irrevocable or will by its terms become irrevocable upon the death of the employee the beneficiaries of the trust who are beneficiaries with respect to the trust’s interest in plr-108823-17 the employee’s benefit are identifiable within the meaning of sec_1_401_a_9_-4 q a-1 from the trust instrument and relevant documentation has been timely provided to the plan_administrator sec_1_401_a_9_-4 q a-6 b provides in relevant summary that to meet the requirements set forth in q a-5 at a minimum documentation sufficient to enable a plan_administrator or an ira custodian to identify beneficiaries of the plan or ira must be provided by a trustee to the custodian by october of the calendar_year immediately following the calendar_year in which the ira owner died sec_1_401_a_9_-5 q a- b provides that if an employee dies before the employee's required_beginning_date the applicable distribution period for minimum distributions for distribution calendar years after the distribution calendar_year containing the employee's date of death is determined in accordance with sec_1_401_a_9_-5 q a-5 c sec_1_401_a_9_-5 q a-5 c states that with respect to minimum distributions paid to nonspouse designated_beneficiary the applicable distribution period measured by the beneficiary's remaining life expectancy is determined using the beneficiary's age as of the beneficiary's birthday in the calendar_year immediately following the calendar_year of the employee's death in subsequent calendar years the applicable distribution period is reduced by one for each calendar_year that has elapsed after the calendar_year immediately following the calendar_year of the employee's death sec_403 provides that annuity_contracts and custodial accounts must follow distribution_requirements similar to those contained in sec_401 sec_1_403_b_-6 provides that a sec_403 contract must meet the minimum_required_distribution rules of sec_401 sec_408 provides that under regulations prescribed by the secretary rules similar to the rules of sec_401 shall apply to the distribution of the entire_interest of an individual for whose benefit the trust is maintained sec_1_408-8 q a-1 a provides that an ira is subject_to the required_minimum_distribution rules provided in sec_401 in order to satisfy sec_401 the rules of sec_1_401_a_9_-1 through a -9 must be applied except as otherwise provided sec_1_408-8 q a-1 b provides as relevant that for purposes of applying the required_minimum_distribution rules in sec_1_401_a_9_-1 through a -9 the ira trustee custodian or issuer is treated as the plan_administrator and the ira owner is substituted for the employee plr-108823-17 sec_1_408-8 q a-3 provides that in the case of distributions from an ira the term required_beginning_date means april of the calendar_year following the calendar_year in which the individual attains age sec_1_408a-6 q a-14 provides that for some purposes roth iras are subject_to the required_minimum_distribution rules under sec_401 and the accompanying treasury regulations you have requested a ruling that the applicable distribution period for the retirement accounts is to be calculated based on the life expectancy of daughter as the designated_beneficiary of the subtrust in accordance with sec_1_401_a_9_-4 q a-5 and a -5 q a-5 because the retirement accounts each list the subtrust as the beneficiary we must determine whether the requirements of a see-through trust under sec_1_401_a_9_-4 q a-5 have been met with respect to the subtrust the documentation you provided establish that requirement sec_1 and of sec_1_401_a_9_-4 q a-5 have been met the trust is valid and irrevocable and documentation has been provided the third requirement - that the beneficiary or beneficiaries be identifiable within the trust document - must also be met in order to see through the subtrust as beneficiary and find that daughter is the sole designated_beneficiary of the retirement accounts within the meaning of sec_1_401_a_9_-4 q a-1 the determination of whether the subtrust qualifies as a see-through trust depends on whether the beneficiaries of the subtrust can be identified at the time of decedent’s death article of the trust provides daughter with a testamentary general_power_of_appointment this power_of_appointment generally applies to any accumulation of retirement account distributions that will accumulate in the subtrust however when read together articles and of the subtrust require trustee to pay to daughter any and all funds in the subtrust withdrawn by the trustee including the minimum distributions required under sec_401 during daughter’s lifetime therefore there can be no accumulation of retirement account distributions in the subtrust for the benefit of any other beneficiary because daughter is the only beneficiary named in the subtrust all beneficiaries with respect to the subtrust’s interest in the retirement accounts are identifiable within the meaning of sec_1_401_a_9_-4 q a-1 from the trust instrument accordingly the subtrust satisfies the requirements of a see through trust under sec_1_401_a_9_-4 q a-5 in addition since daughter was the sole designated_beneficiary of the retirement accounts on decedent’s date of death and remained a beneficiary on september of the calendar_year following the calendar_year of the decedent’s death she is the designated_beneficiary of the retirement accounts for purposes of sec_1_401_a_9_-4 q a-1 a court order issued by court on date is consistent with this conclusion plr-108823-17 pursuant to the provisions of sec_1_401_a_9_-5 q a-5 b and a -5 q a- c if an employee dies before his or her required minimum distributions are required to be distributed and payments are made to a nonspouse designated_beneficiary the required minimum distributions are based on the life expectancy of the designated_beneficiary with the shortest life accordingly the required minimum distributions with regard to the retirement accounts are to be calculated based on the life expectancy of daughter the sole designated_beneficiary of the subtrust this ruling expresses no opinion on the property rights of the parties under state law and only provides a ruling on the impact of federal tax law on the specific facts presented this ruling is based on the assumption that the retirement accounts were properly combined into an ira held within the subtrust accounts the ruling contained in this letter is based upon information and representations submitted by the taxpayer and accompanied by a penalty of perjury statement executed by an appropriate party as specified in revproc_2017_1 2017_1_irb_1 b this office has not verified any of the material submitted in support of the request_for_ruling and such material is subject_to verification on examination the associate office will revoke or modify a letter_ruling and apply the revocation retroactively if there has been a misstatement or omission of controlling facts the facts at the time of the transaction are materially different from the controlling facts on which the ruling was based or in the case of a transaction involving a continuing action or series of actions the controlling facts change during the course of the transaction see revproc_2017_1 sec_11 except as expressly provided herein no opinion is expressed or implied concerning the tax consequences of any aspect of any transaction or item discussed or referenced in this letter this ruling is directed only to the taxpayer requesting it sec_6110 of the code provides that it may not be used or cited as precedent in accordance with the power_of_attorney on file with this office a copy of this letter is being sent to your authorized representative plr-108823-17 a copy of this letter must be attached to any income_tax return to which it is relevant alternatively taxpayers filing their returns electronically may satisfy this requirement by attaching a statement to their return that provides the date and control number of the letter_ruling sincerely jason e levine senior technician reviewer qualified_plans branch office of the associate chief_counsel tax exempt and government entities