t c memo united_states tax_court mark n wright and erica y wright petitioners v commissioner of internal revenue respondent docket no filed date ps established offshore entities and an offshore bank account and credit card that they used to conceal unreported income ps also understated their s corporation’s income and failed to include in their income distributions from the s_corporation that exceeded their basis r determined deficiencies for and and additions to tax pursuant to sec_6651 i r c for and r determined civil_fraud penalties for p-h pursuant to sec_6663 i r c for and in the alternative to liability for sec_6663 i r c r determined accuracy-related_penalties for ps pursuant to sec_6662 i r c for and held r’s deficiency determinations for and are sustained held further ps are liable for the additions to tax pursuant to sec_6651 i r c for and held further p-h is liable for the civil_fraud penalty pursuant to sec_6663 i r c for and mark and erica wright pro sese stephen r takeuchi for respondent memorandum findings_of_fact and opinion wherry judge this case is before the court on a petition for judicial review of a notice_of_deficiency issued date to both petitioners for their and taxable years respondent determined the following federal_income_tax deficiencies additions to tax and penalties for petitioner mark n wright’s mr wright and taxable years year deficiency dollar_figure dollar_figure dollar_figure addition_to_tax sec_6651 dollar_figure dollar_figure -- penalty sec_6663 dollar_figure dollar_figure dollar_figure 1petitioners were represented by william randolph klein at trial on briefing and until his death on date 2unless otherwise indicated all section references are to the internal_revenue_code code in effect for the years in issue and all rule references are to the tax_court rules_of_practice and procedure respondent determined the following federal_income_tax deficiencies additions to tax and penalties for petitioner erica y wright’s mrs wright and taxable years year deficiency dollar_figure dollar_figure dollar_figure addition_to_tax sec_6651 dollar_figure dollar_figure -- penalty sec_6662 dollar_figure dollar_figure dollar_figure after concessions by respondent the issues for decision are whether petitioners failed to report distributions in excess of their basis from an s_corporation m wright associates inc a k a wright associates inc wright associates for their and taxable years in the amounts of dollar_figure dollar_figure and dollar_figure respectively whether petitioners understated their income from wright associates by dollar_figure for taxable_year whether petitioners failed to include in income for their taxable_year dollar_figure that they deposited into an offshore_account 3respondent has conceded that health insurance premiums that wright associates paid on behalf of petitioners for and in the amounts of dollar_figure dollar_figure and dollar_figure respectively and for which petitioners claimed a 60-percent deduction should not be included in petitioners’ taxable_income respondent has also conceded that mrs wright is not liable for the sec_6662 accuracy-related_penalty on any portion of the underpayment to which a sec_6663 civil_fraud penalty applies whether petitioners are liable for the addition_to_tax pursuant to sec_6651 for their and taxable years whether mr wright is liable for the civil_fraud penalty pursuant to sec_6663 for his and taxable years whether in the alternative if mr wright is found not to be liable for the civil_fraud penalty pursuant to sec_6663 on any portion of the underpayment for any of the years in issue petitioners are liable for the accuracy-related_penalty pursuant to sec_6662 on such portion of the underpayment findings_of_fact some of the facts have been stipulated and are so found the stipulations of the parties with accompanying exhibits are incorporated herein by this reference at the time this petition was filed petitioners resided in sarasota florida a general background petitioners had been married for approximately years as of the time of trial mr wright has a bachelor of science degree in business and a master’s degree in business administration mr wright is a certified_public_accountant and certified financial planner who worked in those capacities during and mrs wright has a high school education mr wright is the sole stockholder of wright associates and during and owned and operated the s_corporation a form_1120s u s income_tax return for an s_corporation was filed for wright associates for the years in issue petitioners are and were during the years in issue officers of wright associates mr wright also owns and owned and operated during and consultation mediation services l l c consultation mediation a single member limited_liability_company consultation mediation did not file federal tax returns for the years in issue as it was a disregarded entity4 and its relevant tax matters were reported on schedule c profit or loss from business of petitioners’ joint form_1040 u s individual_income_tax_return mr wright performed accounting services for and provided tax_advice to clients of wright associates and mrs wright performed secretarial duties for wright associates for which they were compensated during the years in issue mr wright also provided investment advice to individuals including inter alia jo ann mohr ms mohr during and mr wright taught a business_entity with only one owner is classified as a corporation or is disregarded if the entity is disregarded its activities are treated in the same manner as a sole_proprietorship branch or division of the owner sec_301_7701-2 proced admin regs 5jo ann mohr ms mohr was not a client of wright associates the record does not indicate whether ms mohr was a continued an estate_planning class at nova southeastern university for which he was compensated mr wright also received compensation from security mutual_life_insurance_company in and although it is unclear what services he performed b filing of federal tax_return sec_1 petitioners’ joint returns petitioners requested an extension of time to date to file their joint form_1040 federal_income_tax return on their request for an extension petitioners estimated their tax_liability to be zero and remitted no payment petitioners mailed their return on date and respondent received it on date petitioners requested an extension of time to date to file their joint form_1040 federal_income_tax return and subsequently requested a further extension to date on their first request for an extension petitioners left the line for the estimate of their tax_liability blank and remitted no payment respondent approved petitioners’ second request respondent received petitioners’ return on date petitioners requested an extension of time to date to file their joint form_1040 federal_income_tax continued client of consultation mediation or a personal client of mr wright return and they subsequently requested a further extension to date on their first request for an extension petitioners estimated their tax_liability to be dollar_figure and remitted no payment petitioners mailed their return on date and respondent received it on date wright associates’ returns mr wright was responsible for filing wright associates’ federal tax returns for the years in issue respondent received wright associates’ form_1120s for its taxable_year on date respondent received wright associates’ form_1120s on date wright associates requested an extension of time to file it sec_2001 form_1120s to date respondent received wright associates’ form_1120s on date on schedule b other information of the and forms 1120s both cash and accrual were checked as the method_of_accounting wright associates did not list any trade notes or accounts receivables on its balance sheets or on schedule l balance sheets per books of its and forms 1120s c distributions during wright associates distributed to petitioners dollar_figure wright associates also issued checks totaling dollar_figure to petitioners’ children also during wright associates issued checks totaling dollar_figure to consultation mediation during wright associates transferred to petitioners amounts totaling dollar_figure either by check or transfer to petitioners’ personal bank account of the total amount transferred to petitioners dollar_figure constituted personal distributions wright associates also issued checks to petitioners’ children totaling dollar_figure and to consultation mediation totaling dollar_figure during wright associates distributed to mr wright dollar_figure in addition for each of the years in issue wright associates paid for petitioners’ health insurance the premiums for this insurance for and were dollar_figure dollar_figure and dollar_figure respectively for which petitioners claimed a 60-percent deduction d offshore banking investments and transactions during the years in issue petitioners maintained an offshore bank account and credit card the offshore bank account was at leadenhall trust company ltd leadenhall in the bahamas leadenhall issued petitioners a mastercard credit card in addition mr wright made offshore investments for 6petitioners’ children paid back dollar_figure to wright associates 7the mastercard credit card issue by leadenhall operated continued petitioners and advised ms mohr to make similar investments petitioners and ms mohr invested in cash-4-titles an investment scheme promoted and operated by individuals and business entities in the united_states the bahamas and the cayman islands cash-4-titles was in fact a massive illegitimate ponzi scheme later shut down by the securities exchange commission sec and investigated as part of the internal revenue service’s irs offshore credit card projectdollar_figure mr wright was apparently continued similar to a debit card the funds petitioners deposited in their leadenhall bank account were used to pay for the charges they incurred on their mastercard credit card 8the operation of cash-4-titles is explained in ex_parte dill dill carr stonbraker hutchings p c so 2d ala as follows ‘ messrs homas and gause raised money from investors that was to be loaned to c4t which in turn would finance the cash titles’ stores to make car loans to the general_public ’ ‘messrs homa and gause agreed to pay investors between and per month on funds loaned to c4t and remit the interest payments to investors on a monthly basis ’ in fact ‘most if not all of the investor funds were not used by c4t for the car title loan business instead c4t transferred the funds to accounts at the bank of bermuda in the cayman islands controlled by messrs homa and gause and used the funds in classic ponzi scheme fashion to pay interest to investors and pay personal expenses for messrs homa and gause to support their lavish lifestyle ’ id pincite 9see sec v homa wl n d ill sec v homa wl n d ill 10on brief and at trial petitioners object pursuant to fed r evid to the court’s consideration of testimony by internal revenue_agent robert sullivan mr sullivan about an alleged deal mr wright attempted to make with mr sullivan during the examination process the court need not consider the objection further because mr sullivan’s testimony would not continued unaware that cash-4-titles was a ponzi scheme but was aware of the offshore credit cards and the tax_evasion opportunity they offered at the time he recommended it to ms mohr and invested himself petitioners and ms mohr made several investments in cash-4- titles the investments in which petitioners and ms mohr both participated resulted in class action lawsuits another investment in which only ms mohr participated resulted in a national association of securities dealers nasd claim by ms mohr against mr wright for violations of the florida securities and investor protection act violations of federal securities laws breach of contract common_law fraud breach of fiduciary duty negligence and gross negligence class action lawsuit in the first type of investment in cash-4-titles petitioners and ms mohr invested in offshore entities known as companies limited by guarantee clgs dollar_figure mr wright paid an continued affect the court’s conclusions thus notwithstanding the trial ruling admitting mr sullivan’s testimony the court has not considered his testimony in that regard in deciding this case 11a company_limited_by_guarantee clg is an entity of united kingdom origin that does not have an exact counterpart in u s tax law bahamian law defines a company_limited_by_guarantee as a company that is formed on the principle of having the liability of its members limited to such amount as the members respectively undertake to contribute to the assets of the company in the event of a winding up companies act act continued application fee of dollar_figure to create an offshore investment package which consisted of a legal opinion letter regarding the u s tax law compliance of clgs and an investment portfolio that included clgs and petitioners’ leadenhall bank account and mastercard credit card mr wright acting through hal jones mr jones a cash-4-titles promoter created the clgs to be conduits to funnel his and his clients’ funds to a new mutual_fund the mutual_fund was set up and run in the bahamas by cardinal international which in turn was supposed to have invested the funds in the u s title loan business a k a cash-4- titles ms mohr invested in a clg called blues brothers limited blues brothers and petitioners invested in clgs called britannia footpaths limited and sarasota investment club the mastercard credit card that leadenhall issued to and that was used by petitioners was in the name of one of their clgs sarasota investment club shortly after petitioners and ms mohr made the investments cash-4-titles was shut down by the sec a class action lawsuit and a lawsuit by the court-appointed receiver were commenced against bank of bermuda by or on behalf of the american continued no sec 12the opinion letter was issued by dean heimos l l c a colorado law firm investors in which petitioners and ms mohr participateddollar_figure the lawsuits were settled and petitioners and ms mohr recovered some of their invested fundsdollar_figure national association of securities dealers claim the second type of cash-4-titles investment which ms mohr made through mr wright was represented by mr wright to be in annuities and mutual funds mr wright received income from selling the mutual funds which income he assigned to wright associates ms mohr per mr wright’s recommendation purchased through her prim securities inc prim securities account promissory notes of rolls royce ltd rolls royce which was another clg used to raise funds for cash-4-titles on date shortly after the sec began its investigation into cash-4-titles ms mohr through her attorney requested by letter that mr wright return her invested funds on date ms mohr instituted an nasd claim against mr wright and prim securitiesdollar_figure ms mohr’s claim was settled via nasd dispute 13see stenger v leadenhall bank trust co wl n d ill wolff v cash titles wl s d fla affd 135_fedappx_329 11th cir see also 351_f3d_1348 11th cir 14the record does not indicate the amount of petitioners’ or ms mohr’s recovery 15ms mohr’s nasd claim against mr wright and prim securities involved her investment in rolls royce ltd promissory notes it was separate from and did not include her investment in the blues brothers limited clg that resulted in her continued resolution in ms mohr was awarded dollar_figure by nasd of which mr wright was responsible for dollar_figuredollar_figure mr wright made what he characterized as a dollar_figure accounting adjustment to reflect and create a reserve for ms mohr’s nasd claim on wright associates’ tax_return on the form_1120s dollar_figure was included in the dollar_figure return and allowance amount listed on line b which was subtracted from gross_receipts or sales on line a as a result wright associates’ and ultimately petitioners’ taxable incomes were decreased by dollar_figure for the accounting adjustment offsetting the debit entry to return and allowance was a credit to a shareholder loan payable account for mr wright offshore credit card account petitioners maintained an offshore credit card at leadenhall in the name of sarasota investment club for all of the years in issue on date petitioners deposited six dollar_figure checks totaling dollar_figure into their bank account at leadenhall one leadenhall deposit check was dated date two were dated date and three were dated date petitioners used their credit card to make personal_expenditure sec_15 continued participation in the class action lawsuits 16prim securities settled with ms mohr for dollar_figure which was deducted from ms mohr’s award of dollar_figure and paid for these expenditures with the dollar_figure deposited in their leadenhall bank account e petitioners’ health mr wright has experienced health problems in recent years in mr wright had a stroke in he developed chest pressure and following a stress test underwent several procedures including two heart catheterizations and placement of stents into obstructed arteries in mr wright sought treatment for memory loss and was scheduled to receive further memory testing at the time of trial mrs wright also has health problems having suffered from crohn’s disease for more than years f procedural history on date petitioners filed a joint bankruptcy petition under chapter of the bankruptcy code on date the bankruptcy court issued an order denying confirmation and dismissing the case in response mr wright on date filed a voluntary conversion of his chapter case to a chapter case mrs wright did not join in the conversion as a result the bankruptcy court directed that the joint bankruptcy case be separated on date in date the bankruptcy court adjudged mr wright’s debts to ms mohr then in the amount of dollar_figure to be nondischargeable mr wright’s chapter case was discharged by the bankruptcy court on date pursuant to u s c section mrs wright’s chapter bankruptcy was closed on date the above-mentioned notice_of_deficiency was issued to petitioners on date petitioners filed a timely petition disputing the deficiencies additions to tax and penalties on february dollar_figure as the petition was timely filed and was not filed during a period the automatic_stay was in effect this court has jurisdictiondollar_figure 17a taxpayer ha sec_90 days or days if the notice is addressed to a person outside the united_states from the date that the notice_of_deficiency is mailed to file a petition with this court for a redetermination of the contested deficiency sec_6213 respondent mailed the notice_of_deficiency to petitioners on date the 90th day thereafter was monday date which was a legal_holiday in the district of columbia see rule b when the last day prescribed under authority of the internal revenue laws for performing any act falls on a legal_holiday the performance of such act shall be considered timely if it is performed on the next succeeding day which is not a legal_holiday sec_7503 pursuant to sec_7503 the last day petitioners could have filed a petition with this court was tuesday date one day later than the date on the notice_of_deficiency 18the bankruptcy code specifically u s c sec_362 expressly bars the commencement or continuation of a proceeding before the united_states tax_court concerning the tax_liability of a debtor who is an individual unless relief from the automatic_stay is granted by order of the bankruptcy court see u s c sec_362 the automatic_stay generally remains in effect until the earliest of the closing of the case the dismissal of the case or the grant of a denial or a discharge u s c sec_362 the normal 90-day period for filing a timely petition with this court is suspended for the period during which the taxpayer is prohibited by reason of the automatic_stay from filing a petition in this court and for days thereafter sec_6213 opinion i burden_of_proof as a general_rule the commissioner’s determination of a taxpayer’s liability for an income_tax deficiency is presumed correct and the taxpayer bears the burden of proving that the determination is improper see rule a 290_us_111 a limitation on this general_rule potentially applies in this case courts of appeals including that for the eleventh circuit to which an appeal in this case would normally lie have indicated that before the commissioner may rely on the presumption of correctness in unreported income cases the determination must be supported by at least a minimal factual predicate or foundation of substantive evidence linking the taxpayer to the income generating activity or to the receipt of funds 994_f2d_1542 11th cir affg tcmemo_1991_636 see also 116_f3d_1309 9th cir 909_f2d_915 6th cir where the commissioner introduces such evidence to support a determination that the taxpayer received unreported income as respondent did here the burden generally is on the taxpayer to show by a preponderance_of_the_evidence that the determination was arbitrary or erroneous 181_f3d_1002 9th cir affg tcmemo_1997_97 deductions are a matter of legislative grace and the taxpayer bears the burden of proving that he is entitled to any claimed deductions 292_us_435 however pursuant to sec_7491 the burden_of_proof on any factual issue that affects the taxpayer’s tax_liability may be shifted to the commissioner where the taxpayer introduces credible_evidence with respect to such issue the burden will shift only if the taxpayer has inter alia complied with substantiation requirements pursuant to the internal_revenue_code and cooperated with reasonable requests by the secretary for witnesses information documents meetings and interviews sec_7491 in the instant case petitioners did not present any credible_evidence at trial notably the court did not find mr wright’s testimony to be credible as he often provided inconsistent and implausible answers in addition petitioners did not comply with the substantiation requirements and failed to provide respondent with requested documentsdollar_figure accordingly sec_7491 is inapplicable and the burden 19respondent sent wright associates form_4564 information_document_request on july and date and date to which petitioners failed to respond fully and properly respondent then formally repeated the three requests by issuing formal document requests with a letter explaining the matter on dec and and date subsequently during discovery petitioners failed to respond to respondent’s interrogatories and request for production of documents and provided incomplete responses after the court granted respondent’s motions to compel see infra note remains on petitioners to prove that respondent’s determination of income_tax deficiencies is incorrect ii s_corporations a general rules an s_corporation is a small_business_corporation that has an s_corporation_election in effect for the taxable_year pursuant to sec_1362 sec_1361 sec_1366 through govern the tax treatment of s_corporation shareholders sec_1366 provides that a shareholder shall take into account his or her pro_rata share of the s corporation’s items of income loss deduction or credit for the s corporation’s taxable_year ending with or in the shareholder’s taxable_year stated otherwise sec_1366 establishes a regime under which items of an s_corporation are generally passed through to shareholders rather than being subject_to tax at the corporate level sec_1366 however limits the aggregate amount of such flowthrough losses and deductions that a shareholder may claim to the sum of his or her adjusted_basis in the stock of the s_corporation and his or her adjusted_basis in any indebtedness of the s_corporation to the shareholder as regards basis sec_1012 sets forth the foundational principle that the basis_of_property for tax purposes shall be the cost of the property cost in turn is defined by regulation as the amount_paid for the property in cash or other_property sec_1_1012-1 income_tax regs sec_1367 specifies adjustments to basis applicable to investments in s_corporations basis in s_corporation stock is increased by income passed through to the shareholder under sec_1366 and decreased by inter alia distributions not includable in the shareholder’s income pursuant to sec_1368 items of loss and deduction passed through to the shareholder under sec_1366 and certain nondeductible noncapital expenses sec_1367 b distributions sec_1368 addresses the treatment of distributions and differentiates s_corporations having accumulated_earnings_and_profits by reason of prior periods of operation as a c_corporation and those without for s_corporations with accumulated_earnings_and_profits dividend treatment applies in enumerated circumstances sec_1368 the typical rule for entities without accumulated_earnings_and_profits such as wright associates is that distributions are not included in a shareholder’s gross_income to the extent that they do not exceed the adjusted_basis of his or her stock but are applied to reduce basis while any distribution amount in excess of basis is treated as gain from the sale_or_exchange of property sec_1368 a taxpayer must establish the basis of his or her stock for purposes of determining the amount of gain he or she must recognize proof of basis is a specific fact which the taxpayer has the burden of proving 271_f2d_44 9th cir affg tcmemo_1957_193 internal revenue_agent robert sullivan and respondent both specifically requested that petitioners provide information about mr wright’s stock basis in wright associatesdollar_figure petitioners despite mr wright’s extensive experience with accounting and tax matters failed to comply petitioners received dollar_figure dollar_figure and dollar_figure as distributions from wright associates in and respectively respondent determined that to the extent the distributions exceeded basis petitioners were required to include them in their income in the amounts of dollar_figure dollar_figure and dollar_figure for and respectively 20respondent served on petitioners interrogatories and a request for production of documents on date requesting inter alia that petitioners provide calculations of their basis in wright associates from its incorporation through petitioners failed to respond and respondent filed with the court on date a motion to compel production of documents and a motion to compel responses to respondent’s interrogatories the court by orders dated date granted both of respondent’s motions to compel petitioners’ responses to the orders to compel failed to provide the requested calculations or documents petitioners’ response to respondent’s request for production stated that petitioners have no records prior to in the computation of mr wright’s stock basis respondent did not allow the carryover of any basis that mr wright may have had in his stock for taxable years preceding it is possible that mr wright had a tax basis in his stock prior to taxable_year however petitioners did not produce any evidence or provide any documentation other than old tax returns without any substantiation of their numeric content to establish the basis of mr wright’s stock the court therefore sustains respondent’s determination that mr wright was not entitled to any carryover_basis in his wright associates stock for taxable years preceding the court also sustains respondent’s determinations that petitioners received income in the amounts of dollar_figure dollar_figure and dollar_figure from wright associates in and respectively c accounting_method an s_corporation may use either the cash receipts and disbursement method cash_method or the accrual_method of accounting with certain limitations see revproc_2002_28 2002_1_cb_815 under the cash_method all items which constitute gross_income are to be included for the taxable_year in which actually or constructively received sec_1 c i income_tax regs expenditures are deducted for the taxable_year in which actually made sec_1_446-1 sec_1_461-1 income_tax regs under the accrual_method income is to be included for the taxable_year when all the events have occurred that fix the right to receive the income and the amount of the income can be determined with reasonable accuracy all_events_test sec_1_446-1 income_tax regs a liability is incurred and taken into account in the taxable_year in which all the events have occurred that establish the fact of the liability the amount of the liability can be determined with reasonable accuracy and economic_performance has occurred with respect to the liability id in determining whether an expense amount has been incurred the all_events_test generally shall not be treated as met any earlier than when economic_performance occurs sec_461 the all_events_test is based on the existence or nonexistence of legal rights or obligations at the close of a particular accounting_period not on the probability--or even absolute certainty--that such right or obligation will arise at some point in the future 90_tc_26 furthermore it is fundamental to the all_events_test that although expenses may be deductible before they have become due and payable liability must first be firmly established this is consistent with our prior holdings that a taxpayer may not deduct a liability that is contingent or contested nor may a taxpayer deduct an estimate of an anticipated expense no matter how statistically certain if it is based on events that have not occurred by the close of the taxable_year citations omitted emphasis added 481_us_239 a deduction shall be taken for the year which is the proper year under the taxpayer’s method of tax_accounting sec_461 it is not entirely clear what method_of_accounting wright associates was using for its and taxable years both cash and accrual_method were checked on schedule b of wright associates’ and forms 1120s mr wright indicated at trial that the returns were in error and that wright associates was on the accrual_method however wright associates had no trade notes or accounts receivables on its balance sheets or schedule l of forms 1120s for or mr wright noted that hypothetically a business could be on the accrual_method and have no trade notes or accounts receivables if they were all paid or collected based on wright associates’ lacking any trade notes or account receivables on its and balance sheets and schedule l of its forms 1120s the court concludes that wright associates despite mr wright’s knowledge of tax and accounting had no consistent method_of_accounting mr wright contends that ms mohr’s claim although not made against wright associates was a liability of that corporation which reduced its income for by dollar_figure and as a result reduced petitioners’ taxable_income by the same amount it is noteworthy that no such liability was reflected on wright associates’ books and tax returndollar_figure nor was any liability attributable to ms mohr’s claim properly deductible for by the corporation or by petitioners under either the cash or accrual_method of accounting under the cash_method no deduction should have been recognized until an amount was paid to ms mohr in no payment by wright associates or mr wright was made to ms mohr under the accrual_method the all_events_test for liabilities was not satisfied in for ms mohr’s claim against mr wright and there was never a claim against wright associates ms mohr did not make a demand for the return of her invested funds from mr wright until january of did not file a formal claim with nasd until date and did not have a fixed legal right to the return of her invested funds until the dispute was resolved in mr wright seeks in the alternative to justify the dollar_figure deduction for as an accrued liability of his own for which he allegedly made a reserve mr wright was not entitled to 21on wright associates’ form_1120s dollar_figure was improperly included in the dollar_figure return and allowance amount listed on line b which was subtracted from gross_receipts or sales on line a the notice_of_deficiency disallowed dollar_figure reducing the return and allowance amount to dollar_figure and eliminating the dollar_figure alleged loan from mr wright shown on wright associates’ books accrue such a deduction under the all events testdollar_figure see hallmark cards inc v commissioner supra pincite united_states v gen dynamic corp supra pincite therefore neither mr wright nor wright associates was entitled to deduct dollar_figure for in respect of ms mohr’s nasd claim accordingly the court sustains respondent’s dollar_figure adjustment to petitioners’ taxable_income for iii offshore accounts and credit card a bank_deposits method a bank deposit is prima facie evidence of income and the commissioner is not required to show a likely source of that income 87_tc_74 the taxpayer bears the burden of showing that respondent’s determination is incorrect rule a 64_tc_651 affd 566_f2d_2 6th cir the bank_deposits method assumes that all money deposited in a taxpayer’s bank account during a given period constitutes taxable_income but the government must take into account any nontaxable source or deductible expense of which it has knowledge 102_tc_632 22no economic_performance within the meaning of sec_461 and the regulations thereunder occurred with respect to the alleged liability during any year in issue also no transfer was made such as would entitle mr wright or wright associates to accrue a contested liability under sec_461 citing 96_tc_858 affd 959_f2d_16 2d cir respondent produced bank deposit records as well as copies of petitioners’ checks showing that petitioners deposited dollar_figure into their leadenhall bank account mr wright had initially told the irs agents assigned to his case that the dollar_figure was a loan from an investor who wanted to remain anonymous petitioners’ reply brief filed with the court further contended that the dollar_figure was a loan and not income at trial mr wright claimed that the six dollar_figure checks totaling dollar_figure represented petitioners’ money but stated i’m not saying they came from previously reported income i’m saying they are not income mr wright additionally stated that the dollar_figure was sent to mr jones and then deposited by mr jones into petitioners’ leadenhall accountdollar_figure mr wright also claimed at trial that he never opened a bank account at leadenhall or obtained a mastercard credit card which the court did not find convincing or credible petitioners did not present any evidence to refute respondent’s determination that the dollar_figure was unreported 23mr wright asserts that petitioners and ms mohr entered into asset management contracts with mr jones that included a best efforts 6-percent return and that mr jones transferred the money from those contracts to clgs the court did not find mr wright’s testimony on this issue to be convincing or credible furthermore petitioners did not provide the alleged contracts or any other evidence regarding such an agreement with mr jones income but instead espoused inconsistent and implausible explanations the court concludes that the dollar_figure deposited by petitioners into their leadenhall bank account was unreported income accordingly the court sustains respondent’s determination on this issue b money and finance regulations regulations prescribe that transactions involving the transfer of more than dollar_figure in monetary instruments at one time from the united_states to a place outside of the united_states or vice versa must be reported to the secretary_of_the_treasury by the individual involved see u s c sec c f_r sec dollar_figure and dollar_figure monetary instruments includes all negotiable instruments such as checks c f_r u violation of the reporting requirements applicable to the exportation or importation of monetary instruments can result in criminal penalties consisting of fines imprisonment or both see u s c sec in response to questioning regarding the avoidance of such reporting requirements mr wright could not explain why he would issue six dollar_figure checks all drawn on the same sun trust bank account over a period of consecutive days all to be deposited on the same day in the bahamas instead of one check for dollar_figure the court concludes that mr wright structured petitioners’ deposit transaction so as to avoid the exportation of monetary instruments reporting requirements and to conceal dollar_figure in income iv penalties and addition_to_tax a burden of production the commissioner bears the burden of production in any court_proceeding with respect to an individual’s liability for penalties or additions to tax sec_7491 to meet this burden the commissioner must present sufficient evidence indicating that it is appropriate to impose the relevant penalty or addition_to_tax 116_tc_438 in instances where an exception to the penalty or addition_to_tax is afforded because of substantial_authority reasonable_cause or similar provisions the taxpayer bears the burden_of_proof with regard to those matters id pincite b sec_6651 addition_to_tax sec_6651 imposes a 5-percent addition_to_tax for each month or portion thereof a required return is filed after the prescribed due_date including extensions not to exceed percent in the aggregate unless such failure_to_file timely is due to reasonable_cause and not due to willful neglect although not defined in the code reasonable_cause is described by the applicable regulations as the exercise of ordinary business care and prudence sec_301_6651-1 proced admin regs see also 469_us_241 w illful neglect is interpreted as a conscious intentional failure or reckless indifference united_states v boyle supra pincite reasonable_cause denotes an absence of fault united_states v boyle supra pincite n a taxpayer must prove that his failure_to_file timely was the result neither of carelessness reckless indifference nor intentional failure id generally factors that constitute ‘reasonable cause’ include unavoidable postal delays death or serious illness of the taxpayer or a member of his immediate_family or reliance on the mistaken legal opinion of a competent tax advisor lawyer or accountant that it was not necessary to file a return 147_f3d_147 2d cir affg tcmemo_1997_24 while the court is sympathetic that mr wright suffered health complications all of these complications occurred after the years in issue mr wright had a stroke in and sought treatment for memory loss in petitioners have not shown reasonable_cause for filing their and tax returns late the court concludes that petitioners are liable for the addition_to_tax pursuant to sec_6651 for and dollar_figure accordingly the court sustains respondent’s determination on this issuedollar_figure c sec_6663 penalty in any case involving the issue of fraud with intent to evade tax respondent bears the burden_of_proof as to that issue sec_7454 the burden_of_proof must be carried by clear_and_convincing evidence rule b sec_6663 imposes a penalty of an amount equal to percent of the portion of the underpayment which is attributable to fraud sec_6663 specifies that if any portion of the underpayment is attributable 24the notice_of_deficiency apparently calculates petitioners’ sec_6651 addition_to_tax based on an date due_date despite petitioners’ failure to reasonably estimate their tax_liability on their request for an extension the notice_of_deficiency calculates petitioners’ sec_6651 addition_to_tax based on an date due_date respondent having granted petitioners’ second request for an extension despite petitioners’ failure to reasonably estimate their tax_liability on their first request for an extension respondent failed to raise these issues in his answer and only subsequently raised them on brief 25the court sustains respondent’s determinations in the notice_of_deficiency see supra note the court notes that because percent is the maximum addition_to_tax allowed under sec_6651 the validity of the extension request is moot for petitioners’ taxable_year petitioners filed their return on date which is more than months late using an date due_date and more than months late using an date due_date the court concludes based on respondent’s granting petitioners’ second request for an extension respondent’s claim in the notice_of_deficiency and respondent’s failure to raise this issue before trial which may have prejudiced petitioners that petitioners are liable for only a 10-percent sec_6651 addition_to_tax for their taxable_year to fraud the entire underpayment shall be treated as attributable thereto except to the extent the taxpayer establishes by a preponderance_of_the_evidence that some part is not due to fraud where taxpayers file a joint_return sec_6663 does not apply to a spouse unless some part of the underpayment is due to the fraud of the spouse sec_6663 respondent must prove on a year-by-year basis by clear_and_convincing evidence that mr wright underpaid his taxes for that year and that some part of that underpayment was due to fraud 94_tc_654 81_tc_640 underpayment_of_tax in satisfying the first prong of the fraud test the commissioner cannot discharge his burden by simply relying on the taxpayer’s failure to prove error in his determination of the deficiency 92_tc_661 53_tc_96 the commissioner’s burden of proving an underpayment_of_tax attributable to unreported and indirectly reconstructed income may be satisfied in either of two ways by proving a likely source of the unreported income or by disproving any alleged nontaxable source dileo v commissioner t c pincite respondent has met his burden for all of the years in issue petitioners and respondent stipulated the amount and source of the distributions that petitioners received from wright associates but failed to include in their income in addition respondent has met his burden of disproving an alleged nontaxable source for the dollar_figure petitioners deposited into their offshore bank account in mr wright initially alleged that the dollar_figure deposited into petitioners’ leadenhall bank account in was nontaxable as it was a loan he claimed at trial that the dollar_figure was in fact petitioners’ money but was nontaxable he also claimed that the dollar_figure was sent to mr jones and that mr jones deposited it into petitioners’ leadenhall bank account mr wright’s numerous explanations are inconsistent accordingly the court concludes that respondent has proved by clear_and_convincing evidence an underpayment of tax--the first prong of the fraud test--for each of the years and fraudulent intent to satisfy the second prong of the fraud test respondent must show that a portion of the underpayment is attributable to fraud for the purposes of sec_6663 fraud which presents a question of fact is defined as intentional wrongdoing by the taxpayer with the specific purpose of avoiding a tax believed to be owed fraud includes conduct intended to conceal mislead or otherwise prevent the collection of such tax 398_f2d_1002 3d cir 91_tc_874 fraud is never presumed and must be established by independent evidence of fraudulent intent petzholdt v commissioner supra pincite recklitis v commissioner supra pincite the taxpayer’s entire course of conduct can be indicative of fraud 56_tc_213 as direct proof of a taxpayer’s intent is seldom available fraud may be established by circumstantial evidence and reasonable inferences drawn from the record stoltzfus v united_states supra pincite dileo v commissioner supra pincite courts have developed a nonexclusive list of factors or badges_of_fraud that support a finding of fraudulent intent see 317_us_492 796_f2d_303 9th cir affg tcmemo_1984_601 although no single factor may be necessarily sufficient to establish fraud the existence of several indicia may be persuasive circumstantial evidence of fraud 732_f2d_1459 6th cir affg tcmemo_1982_603 the badges_of_fraud include understating income maintaining inadequate records failing to file tax returns providing implausible or inconsistent explanations of behavior concealing income or assets failing to cooperate with tax authorities engaging in illegal activities attempting to conceal illegal activities dealing in cash failing to make estimated_tax payments and filing false documents see spies v united_states supra pincite bradford v commissioner supra pincite additional factors to be considered include the taxpayer’s background level of education and prior history of filing proper returns 99_tc_202 the instant case involves many badges_of_fraud accordingly the court concludes that mr wright fraudulently intended to underpay taxes for and notably mr wright is sophisticated in tax matters he is a certified_public_accountant and certified financial planner has a master’s degree in business administration and owns and operates an s_corporation that provides accounting services and tax_advice to its clients additionally mr wright failed to cooperate with the tax authorities mr wright was not a credible witness as he frequently gave inconsistent and implausible answers to questions asked during trial specifically in mr wright concealed income by transferring dollar_figure to petitioners’ offshore bank account mr wright structured petitioners’ dollar_figure deposit transaction specifically to avoid the exportation of monetary instruments reporting requirements additionally mr wright constructed a phony offset of dollar_figure against the gross_receipts of wright associates on form_1120s for further for all of the years in issue petitioners used an offshore credit card to make personal expenditures in order to continue to conceal the dollar_figure in unreported income for taxable years and mr wright understated petitioners’ income by failing to include distributions petitioners received from wright associates which the court concludes is fraudulent in and of itself mr wright also maintained inadequate records for all of the years in issue additionally mr wright failed to make estimated_tax payments for all of the years in issue the court concludes that respondent has proved by clear_and_convincing evidence the second prong of the fraud test for and respondent has shown that at least some part of the underpayment for all of the years in issue is attributable to fraud specifically respondent has shown that petitioners understated their income for all of the years in issue because they fraudulently failed to include in their income distributions from wright associates respondent has also shown that petitioners concealed their unreported income by utilizing an offshore credit card for personal expenditures the court concludes that mr wright’s entire course of conduct relating to petitioners’ offshore bank account and credit card is indicative of fraud mr wright has failed to challenge or explain successfully why respondent’s showing of underpayment_of_tax and fraudulent intent for each of the years in issue is inapplicable or incorrect the court concludes that mr wright is liable for the civil_fraud penalty pursuant to sec_6663 for taxable years and accordingly the court sustains respondent’s determination on this issue v conclusion the court sustains respondent’s determinations regarding petitioners’ deficiencies as adjusted to reflect respondent’s concessions for taxable years and petitioners failed to include in their taxable_income distributions they received from wright associates that exceeded their stock basis as well as dollar_figure they deposited in their offshore_account mr wright was not entitled to a flowthrough deduction of dollar_figure from wright associates for on account of ms mohr’s nasd claim the court sustains respondent’s determination that petitioners are liable for the sec_6651 addition_to_tax for and the court also sustains respondent’s determination that mr wright is liable for the sec_6663 civil_fraud penalty for and to reflect the foregoing and concessions made by respondent decision will be entered under rule


lisa beamon swint petitioner v commissioner of internal revenue respondent docket no filed date prior to marrying p p’s husband had a child with tdw an agreed entry filed by a state court in date provided that p’s husband would be entitled to a dependency_exemption deduction and a child_tax_credit for the child if he was current in his child_support_obligations the agreed entry was not signed by p’s husband or tdw p and her husband filed a joint federal_income_tax return for the taxable_year claiming a dependency_exemption deduction and a child_tax_credit r disallowed p’s claim for a dependency_exemption deduction and a child_tax_credit held sec_1_152-4 income_tax regs provides that for taxable years starting after date a court order or decree or a separation agreement may not serve as a written declaration however sec_1_152-4 income_tax regs provides a carveout to this rule if a written declaration was executed in a taxable_year beginning on or before date we look to the requirements for the form of a written declaration that were in effect at the time the written declaration was executed at the time the agreed entry was filed in there was no prohibition on using a court order or decree or a separation agreement as a written declaration if the other requirements for a written declaration were met held further the agreed entry did not satisfy the requirements for the form of a writ- ten declaration in effect at the time the agreed entry was executed because it was not signed by the custodial_parent and was not unconditional therefore p is not entitled to a dependency_exemption deduction or a child_tax_credit for the child ljubomir nacev for petitioner robert d kaiser and edward lee walter for respondent ruwe judge respondent determined a deficiency in peti- tioner’s federal_income_tax of dollar_figure for the taxable_year year at issue the issues for decision are whether petitioner is entitled to a dependency_exemption deduction under sec_151 and c and whether petitioner is entitled to a child_tax_credit under sec_24 mr nacev entered his appearance after the trial and filed a posttrial memorandum brief on petitioner’s behalf unless otherwise indicated all section references are to the internal_revenue_code in effect for the year at issue and all rule references are continued verdate mar apr jkt po frm fmt sfmt v files boundv wit bv864a swint jamie united_states tax_court reports findings_of_fact some of the facts have been stipulated and are so found the stipulation of facts and the attached exhibits are incor- porated herein by this reference at the time the petition was filed petitioner resided in ohio petitioner married tommy l swint in mr swint passed away in from through petitioner and mr swint filed joint federal_income_tax returns before marrying petitioner mr swint had a child minor child that was born in with tonia dawn wilson an agreed entry between mr swint and ms wilson was filed on date by the common pleas court of mont- gomery county ohio juvenile division the parties sub- mitted into evidence two pages of the agreed entry in regard to the dependency_exemption deduction the agreed entry stated mr swint shall be entitled to claim the minor child as a dependency_exemption as long as he is current in his child_support_obligations for all applicable federal state and local_tax purposes failure to keep cur- rent with his support obligations will result in a forfeiture of any rights under this paragraph until such time as mr swint has elimi- nated all arrearages and is again fully current in his child_support_obligations delinquency in child_support will cause the income_tax deduction to be transferred to ms wilson until the arrearage is paid and all payments are current the parties agree to cooperate with the execution of any and all documents necessary to allow the claiming of these exemptions the pages of the agreed entry submitted into evidence were not signed by either mr swint or ms wilson petitioner and mr swint timely filed a joint federal_income_tax return for the year at issue claiming a depend- ency exemption deduction and a child_tax_credit for the minor child the minor child did not live with petitioner and mr swint during the year at issue on date respondent issued to petitioner a notice_of_deficiency for the notice_of_deficiency dis- allowed the dependency_exemption deduction and the child to the tax_court rules_of_practice and procedure the names of minor children are redacted see rule a verdate mar apr jkt po frm fmt sfmt v files boundv wit bv864a swint jamie swint v commissioner tax_credit for the minor child petitioner timely filed a peti- tion disputing the determinations in the notice_of_deficiency opinion the commissioner’s determinations in a notice of defi- ciency are generally presumed correct and the taxpayer bears the burden of proving that the determinations are in error rule a 290_us_111 dependency_exemption deduction generally a taxpayer may claim dependency_exemption deductions for all individuals who are dependents of the tax- payer for the taxable_year sec_151 c dependent is defined by sec_152 as including a qualifying_child sec_152 in the case of divorced or separated parents sec_152 provides a special rule to determine which parent is entitled to a dependency_exemption deduction for a child generally a child who is in the custody of one or both of the child’s par- ents for more than one-half of the calendar_year and receives more than one-half of his or her support from parents who are divorced or separated or who live apart at all times during the last six months of the calendar_year will be considered the qualifying_child of the custodial_parent sec_152 sec_152 defines the custodial_parent as the parent having custody for the greater portion of the cal- endar year sec_152 defines the noncustodial_parent as the parent who is not the custodial_parent the minor child did not live with mr swint during the year at issue as a result mr swint was the noncustodial_parent of the minor child see sec_152 pursuant to sec_152 a child will be treated as a qualifying_child of the noncustodial_parent rather than of the custodial_parent when certain criteria are met one of the requirements for the child to be the qualifying_child of the noncustodial_parent is that the custodial_parent signs a written declaration in such manner and form as the sec- retary may by regulations prescribe that such custodial_parent will not claim such child as a dependent for any tax- able year beginning in such calendar_year sec_152 verdate mar apr jkt po frm fmt sfmt v files boundv wit bv864a swint jamie united_states tax_court reports the declaration required under sec_152 must be made either on a completed form_8332 or on a statement conforming to the substance of form_8332 114_tc_184 form_8332 release revocation of release of claim to exemption for child by custodial_parent provides an effective and uniform way for a custodial_parent to make the declaration required in sec_152 for the benefit of the noncustodial_parent 139_tc_468 form_8332 requires a taxpayer to furnish the name of the child the name and social_security_number of the noncustodial_parent claiming the dependency_exemption deduction the social_security_number of the custodial_parent the signature of the custodial_parent the date of the custodial parent’s sig- nature and the year s for which the claims were released petitioner argues that the agreed entry filed date suffices as a written declaration conforming to the sub- stance of form_8332 in respondent’s posttrial supplement to his pretrial memorandum respondent argues that d ivorce decrees or comparable documents do not suffice for the pur- poses of a written waiver by form_8332 or a substantially conforming document under sec_152 respondent relies on footnote in armstrong v commissioner t c pincite n for taxable years starting after date a court order signed by the custodial_parent will not satisfy c f_r sec_1_152-4 income_tax regs a written declaration not on the form des- ignated by the irs must conform to the substance of that form and must be a document executed for the sole purpose of serving as a written dec- laration under this section a court order or decree or a separation agreement may not serve as a written declaration this footnote in armstrong was dictum and did not have any effect on the holding of that case armstrong involved a tax_year sec_1_152-4 income_tax regs does provide that for taxable years starting after date a court order or decree or a separation agreement may not serve as a written declaration and the taxable_year in issue here is however sec_1_152-4 income_tax regs also provides a transition rule that creates a carveout to sec_1_152-4 income_tax regs verdate mar apr jkt po frm fmt sfmt v files boundv wit bv864a swint jamie swint v commissioner sec_1_152-4 written declaration - written declaration executed in a taxable_year beginning on or before date -a written declaration executed in a taxable_year beginning on or before date that satisfies the requirements for the form of a written declaration in effect at the time the written dec- laration is executed will be treated as meeting the requirements of para- graph e of this section under sec_1_152-4 income_tax regs if a written declaration was executed in a taxable_year beginning on or before date we look to the requirements for the form of a written declaration that were in effect at the time the written declaration was executed the agreed entry was filed on date there- fore under sec_1_152-4 income_tax regs we must determine whether the agreed entry satisfies the require- ments of a written declaration that were in effect as of feb- ruary at that time there was no prohibition on using a court order decree or separation agreement as a written declaration for purposes of sec_152 as a result petitioner’s reliance on a court order as the written declara- tion does not by itself preclude its potential qualification as a written declaration for purposes of sec_152 see chief_counsel_advice date however a non- custodial_parent may continue to attach pages of a divorce sec_1_152-4 example income_tax regs explains this as fol- lows example i y and z are the divorced parents of child in y and z enter into a separation agreement which is incorporated into a divorce decree under which y the custodial_parent releases y’s right to claim child as a dependent for all future years the separation agree- ment satisfies the requirements for the form of a written declaration in effect at the time it is executed z attaches a copy of the separation agreement to z’s returns for through ii under paragraph e ii of this section a separation agreement may not serve as a written declaration however under paragraph e of this section a written declaration executed in a taxable_year begin- ning on or before date that satisfies the requirements for the form of a written declaration in effect at the time the written declaration is executed will be treated as meeting the requirements of paragraph e of this section therefore the separation agreement may serve as the written declaration required by paragraph b i of this section for and z may claim child as a dependent in and later years verdate mar apr jkt po frm fmt sfmt v files boundv wit bv864a swint jamie united_states tax_court reports decree or separation instrument executed on or before date that unconditionally allows the noncustodial_parent to claim an exemption for a child if the pages constitute a statement substantially_similar to form_8332 under the requirements in effect at the time the decree or agreement was executed our recent opinion in 140_tc_200 involved the taxable_year to which sec_1_152-4 income_tax regs applied however the divorce decree in shenk was entered in id pincite nevertheless in dictum the opinion was decided on other grounds in footnote we stated for the year at issue here a signed judgment copy of a court order cannot satisfy sec_152 see c f_r sec_1_152-4 a court order or decree or a separation agreement may not serve as a writ- ten declaration see 139_tc_468 sec_1_152-4 id pincite n for reasons previously stated we believe that the above dictum in shenk was incomplete and that a court order or decree or a separation agreement entered prior to date can be a written declaration if it satisfies the other requirements in effect at the time of the entry see sec_1_152-4 income_tax regs we must now determine whether the other requirements for a written declaration that were in existence when the agreed entry was filed have been met in order for the agreed entry to qualify as a written declaration under sec_152 signature requirement as of date sec_152 provided that the noncustodial_parent could claim the dependency exemp- tion deduction if the custodial_parent signs a written dec- laration in such manner and form as the secretary may by regulations prescribe that such custodial_parent will not claim such child as a dependent for any taxable_year begin- ning in such calendar_year emphasis added the signa- ture requirement is derived from the plain language of sec_152 that was in effect at the time the agreed entry was filed this court consistently has held that sec_152 clearly and unambiguously requires the custodial_parent to verdate mar apr jkt po frm fmt sfmt v files boundv wit bv864a swint jamie swint v commissioner sign a written declaration releasing the dependency exemp- tion for his or her child to the noncustodial_parent miller v commissioner t c pincite satisfying the signature requirement is critical to the successful release of the dependency_exemption within the meaning of sec_152 id pincite sec_152 and the cor- responding regulations require unequivocally that the sig- nature of the custodial_parent be attached to the return of a noncustodial_parent claiming a dependency_exemption regardless of the form or nature of the documentation attached to the return neal v commissioner tcmemo_1999_97 tax ct memo lexi sec_113 at see also shenk v commissioner t c pincite paulson v commis- sioner tcmemo_1996_560 tax ct memo lexis at petitioner did not attach irs form_8332 to his returns for any of the years in question nor did he attach any other written_statement signed by his former spouse which would in substance comply with the requirements of sec_152 emphasis added a state court order that is not signed by the custodial_parent does not satisfy the express statutory requirements of sec_152 see miller v commissioner t c pincite the agreed entry was not signed by the custodial_parent accordingly we hold that the agreed entry did not satisfy the signature requirement of sec_152 unconditional declaration requirement as of date sec_152 provided that the noncustodial_parent could claim the dependency exemp- tion deduction if the custodial_parent signs a written dec- laration in such manner and form as the secretary may by regulations prescribe that such custodial_parent will not claim such child as a dependent for any taxable_year begin- ning in such calendar_year emphasis added the language will not claim in sec_152 is unconditional as a result in order for a written declaration to comply with sec_152 the declaration by the custodial_parent that he or she will not claim such child as a dependent must also be unconditional this court has previously held that a conditional declaration does not comply with sec_152 see armstrong v commissioner t c pincite her conditional declaration is at odds with the statute see verdate mar apr jkt po frm fmt sfmt v files boundv wit bv864a swint jamie united_states tax_court reports also gessic v commissioner tcmemo_2010_88 tax ct memo lexis at white v commissioner tcmemo_1996_438 tax ct memo lexi sec_455 at prior to the definition of dependent led to substan- tial controversy in cases involving divorced or separated tax- payers because determining which parent provided over one- half of a child’s support presented difficult problems of proof and substantiation h_r rept no part pincite u s c c a n see also miller v commissioner t c pincite in congress amended sec_152 to remove the requirement for the noncustodial_parent to pay child_support in excess of certain thresholds see deficit_reduction_act_of_1984 pub_l_no sec_423 stat pincite instead congress required that the custodial_parent sign a written declaration that he or she will not claim the child as a dependent see id sec_152 this amendment removed the substantial evi- dentiary disputes that this court previously had to resolve in determining which parent could claim the deduction if the dependency_exemption deduction was permitted to be released upon the satisfaction of a conditional declaration this court would have to revert to resolving those difficult problems of proof and substantiation that we were supposed to leave behind with the prior scheme see armstrong v commissioner t c pincite petitioner argues that we should reconsider our previous opinions in miller armstrong and shenk regarding the sig- nature and unconditional waiver requirements because the import of the transitional rule as it affects the signature and unconditional waiver requirements was not before the court in those cases we decline this invitation those cases all involved the sufficiency of purported written declarations made prior to date and correctly considered the statutory and regulatory requirements in existence at the time the writings were created the transition rule does not eliminate any requirements for a valid written declaration that were in existence before date in fact the transi- tion rule confirms the validity of the requirements that were in existence before the effective date see sec_1_152-4 income_tax regs quoted supra p the agreed entry provided that mr swint would be enti- tled to claim the minor child only if he was current in his verdate mar apr jkt po frm fmt sfmt v files boundv wit bv864a swint jamie swint v commissioner child_support_obligations if mr swint was not current on those obligations then ms wilson would have been entitled to claim the minor child the release of the dependency_exemption deduction by ms wilson in the agreed entry was conditional accordingly we hold that the declaration in the agreed entry did not satisfy the unconditional declaration requirement of sec_152 conclusion as of date sec_152 required the custodial_parent to sign a written declaration that he or she will not claim the child as a dependent the agreed entry did not satisfy the signature requirement or the uncondi- tional declaration requirement accordingly we hold that the agreed entry did not satisfy the requirements for the form of a written declaration as of date therefore under sec_152 the minor child was not a qualifying_child of mr swint for the year at issue as a result petitioner is not entitled to a dependency_exemption deduction for the minor child for the year at issue child_tax_credit a taxpayer is entitled to a child_tax_credit for each quali- fying child as defined in sec_152 who has not reached the age of sec_24 c given our determination that under sec_152 the minor child was not a qualifying_child of mr swint for the year at issue it follows that peti- tioner is not entitled to a child_tax_credit for the minor child for that year in reaching our decision we have considered all arguments made by the parties and to the extent not mentioned or addressed they are irrelevant or without merit to reflect the foregoing decision will be entered for respondent f verdate mar apr jkt po frm fmt sfmt v files boundv wit bv864a swint jamie


internal_revenue_service department of index number dollar_figure washington dc person to contact telephone number refer reply to cc dom it a plr-105646-98 date dec taxpayer taxpayer's ein taxpayer's address legend xx a b lender state city state act state statute agreement q cr proposal m n year year year year year year year year year o t o h t o h o h t o a w o b a i w a w o w d w u o v year year year year date dear t o w m o u o h this responds to taxpayer's request for a private_letter_ruling dated date specifically taxpayer has requested a ruling that the termination of taxpayer's power purchase agreement ppa pursuant to the agreement constitutes a compulsory or involuntary_conversion of its ppa and its facility within the meaning of sec_1033 and sec_1231 of the internal_revenue_code code taxpayer has also requested a ruling that the amount of any gain_or_loss required to be recognized by taxpayer in connection with the conversion of its ppa and its facility is a sec_1231 gain or sec_1231 loss taxpayer also requests a ruling that the amounts paid to terminate a financing agreement relating to its facility is deductible under sec_163 in the year paid conclusions the termination of the ppa pursuant to the agreement constitutes a compulsory or involuntary_conversion of the ppa and the facility within the meaning of sec_1033 and sec_1231 the amount of any gain_or_loss required to be recognized by taxpayer in connection with the conversion of its ppa and its facility will be treated as a sec_1231 gain or sec_1231 loss in accordance with the provisions of sec_1231 taxpayer may deduct under sec_163 in the year of payment the amount_paid as a penalty for the prepayment of the financing agreement discussed below facts x is a regulated_public_utility furnishing electricity to various parts of state taxpayer is an independent power producer ipp that was organized in year for purposes of developing financing constructing and operating a q megawatt coal and other solid fuel fired cogeneration_facility facility at city in state taxpayer owns the facility and leases the land on which the facility is located from a the facility was placed_in_service in june year and is certified as a qualifying_facility qf under the public_utility regulatory policies act of u s c 824a as amended ‘purpa’ and the implementing ferc regulations c f_r electricity generated by the facility is sold to x pursuant to the terms of its ppa and high temperature water generated by the facility is sold under contract to a oo sf purpa requires electric utilities to purchase electricity from and enter into legally enforceable obligations with qfs in addition state enacted paralle provisions to purpa that obligated regulated public_utilities such as x to enter into long-term_contracts to purchase electricity from and granted additional rights to entities such as taxpayer that qualified under the state act as co-generation facilities or alternate energy production facilities the prices paid for electricity under these statutorily-mandated contracts were based upon projections of the costs that the regulated_public_utility otherwise would incur to meet its service requirements avoided costs these avoided costs were composed of in all cases variable costs associated with producing electricity and in some cases fixed costs associated with developing and constructing a facility if the regulated_public_utility did not have the generation capacity to meet the demand for electricity in june year x entered into a ppa with b who subsequently assigned the ppa to taxpayer that was priced to reflect both the fixed and variable costs of producing electricity required to be purchased under the agreement the ppa had a term of years and expires in during which term x was required to take and pay for percent of the electricity that taxpayer's facility is capable of producing for the output of taxpayer's facility x was obligated to pay an amount determined by reference to the higher of a r per kilowatt hour or b x's avoided costs as calculated at the time electricity is delivered taxpayer projected that the payments to be made to it under the ppa would cover both the fixed costs associated with the development construction maintenance and operation of the facility as well as certain other costs such as fuel and fuel transportation costs and variable operation and maintenance_costs associated with the production of electricity the ppa can be assigned to a third party by taxpayer with prior written notification to x at the time that the ppa was executed the price x was to pay for electricity was agreed to by taxpayer and x and was believed to be a fair price based on x's projections of the costs it would otherwise have incurred over the term of the ppa however by mid-year x had projected that it had excess electric production capability and thus its new avoided costs rates and accordingly the prices it was required to pay new projects for electricity were substantially less than its year rates thus the price paid_by x pursuant to taxpayer's ppa has for some time exceeded the state public service commission's psc current approved rates initially x was able to recover its costs for electricity produced by and purchased from taxpayer and other ipps under its state psc-approved tariffs which included a fuel adjustment clause however x's electricity rates are much higher than in other areas of the united_states electricity prices and the price paid for electricity under taxpayer's ppa and other ppas the state psc and consumers pressured x to reduce its rates and move toward a competitive market due to the disparity between actual market as eaiy as march year the state psc beasn to investiaate methods to create competitive opportunities for state electricity consumers including x's customers and requested that the utilities do the same pursuant to the state psc's request x commenced negotiations with taxpayer and other ipps to reduce its cost for electricity purchased under those ppas as of april year renegotiated ppa agreements with of ipps that had ppas x had in an attempt to reduce its costs x sought to have rules adopted by the state psc which would permit x to curtail purchases of electricity from the ipps in april year x petitioned the state psc suggesting that such rules were necessary and stating that the currently available settlement opportunities with the ipps had been exhausted although the state psc did not adopt a formal curtailment plan in year it continued its efforts to encourage regulated public_utilities including x competitive electric market for state to develos a in response in october year x submitted a proposal entitied proposal to the state psc for reducing its electric rates to its customers stating that the differences with the ipps had not been resolved the proposal set forth several alternative ways to restructure the ppas including the taking by eminent_domain of the ipps’ electricity generating facilities and the curtailment of x's obligations to purchase electricity generated by the ipps emphasizing that it was essential to the creation of a competitive market that ppas with a significant number of the unregulated ipps be restructured such that those generating units become independent suppliers competing in the wholesale spot market or become suppliers to customers directly in the proposal x stated that if negotiations with the ipps failed to produce the necessary cost savings it proposed to utilize its power of eminent_domain to acquire the generating units owned by the ipps with which it has ppas and subsequently resell them at auction in order to increase competition in the wholesale power market it also stated that it would soon initiate the process necessary to exercise its power of eminent_domain by filing a petition with the state psc ’ taxpayer believed that x would institute an eminent_domain proceeding against the facility unless x was otherwise able to reduce its payments to a significant number of ipps with which it had ppas after the proposal was made public x and certain of the ipps entered into negotiations x took no further action towards exercising its eminent_domain powers because of progress with the negotiations with the ipps during these negotiations x ‘s counsel stated to one of the ipps that if the negotiations were not successful x wouid have no way to restructure its markets and reduce its costs other than by commencing eminent_domain proceedings ' the power of eminent_domain was delegated to x pursuant to state statute which provides that a n electric corporation shall have the power and authority to acquire such real_estate as may be necessary for its corporate purposes _ inthe manner prescribed by the eminent_domain procedure law in may year the state psc issued an order describing its goals and strategies for restructuring state's electric utility industry and stated that all possible efforts to reduce electric rates should be continued including efforts to reduce utility commitments under ipps contracts that include obligations for payments well above current wholesale prices these contracts voluntarily it would pursue policies to mitigate the impact of such contracts on rates subsequently in july year the state psc stated publicly that the ppas with the ipps were a major hurdle to lowering electric rates in state and achieving a competitive electric market two weeks after this public statement x made an offer to ipps to buy out their ppas those ipps retained an investment banking firm to evaluate x's offer it further stated that if the parties were unwilling to restructure active negotiations between x and the ipps continued until december year in december year the administrative law judge when the negotiations stalled considering x's request for curtailment of purchases from the ipps recommended that state utilities be allowed to curtail purchases although taxpayer's ppa prohibits x's curtailment of purchases taxpayer was still concerned that some action by x or government authorities could result in curtailment of electricity purchases to some degree in march year taxpayer and other ipps made a counterproposal to the x's offer which became the basis for further negotiations in may year the state psc approved but did not issue a curtailment order which allowed x to reduce the quantity of electricity that it was required to purchase from certain ipps the ipps believed that the approval of the curtailment order was intended to piace additional pressure on the negotiations with x in july year taxpayer and the other ipps signed the agreement which was in june year the transaction was consummated subsequently amended five times in accordance with the terms of the amended agreement pursuant to the amended agreement consideration in the aggregate of dollar_figure m cash and n shares of x common_stock would be available for ipps to elect from taxpayer received cash and stock in consideration for terminating its ppa taxpayer's ppa was terminated but it has the right to maintain its status as a state qf the right to wheel its output to third parties and the right to have x act as an agent for saies of its electricity to the state electric power pool in year a terminated its high temperature water contract with taxpayer effective as of date after the restructuring taxpayer continued to operate its facility under its contract to provide high temperature water to a until date and continues to sell electricity to x pursuant to short-term ie day power purchase contracts the electricity sold to x under these short-term contracts was priced at the prevailing market rate for electricity at the time of the sale this rate is considerably lower than the rates provided in taxpayer's ppa and consequently the revenue generated from these short-term contracts was not sufficient to enable taxpayer to recover its fixed and variable costs associated with operating its facility because the termination of its ppa severely restricted or eliminated the economic viability of operating the facility under then current market conditions taxpayer has been actively exploring several alternatives to recover the residual_value of the facility if any such as selling or dismantling the facility taxpayer presently is engaged in negotiations to sell the facility and expects to sell the facility by the end of year or during year taxpayer represents that x had threatened during negotiations to pursue eminent_domain actions against the ipps’ facilities including taxpayer’s facility if the restructuring negotiations were not successful in november year x informed the state psc that it had not pursued the exercise of its power of eminent_domain due to the progress in negotiations with the ipps but that it would take necessary measures including exercise of its power of eminent_domain if the restructuring pursuant to the agreement was not effected based on x's actions taxpayer states that it had a reasonable belief that a threat_or_imminence_of_condemnation existed against its facility taxpayer further represents that if x had condemned its facility the ppa would have been unenforceable and wholly worthless and that it could not have sold electricity to x pursuant to the terms of the ppa taxpayer represents that the ppa was site-specific because that the ppa is limited to the purchase and sale of electricity produced and delivered by the facility referenced in the ppa thus if taxpayer's facility were taken by x pursuant to its eminent_domain powers taxpayer could not sell electricity to x pursuant to the terms of the ppa nor couid it assign its ppa to a third party for value because the third party could not sell electricity to x pursuant to the terms of the ppa taxpayer further represents that one of the requirements for qf status is that the facility must be owned by a person not primarily engaged in the generation or sale of electric power other than electric power solely from cogeneration facilities or small power production facilities thus once x an electric utility acquired the facility the facility would lose its qf status which is required by the ppa to be maintained if the qf status is not maintained x has the option of terminating the ppa and it would have terminated the ppa it is also represented that if x had acquired taxpayer's facility it would have auctioned the facility and the new owner of the facility could not have sold power to x pursuant to the ppa but would have to abide by new pricing protocols in the competitive market taxpayer has not treated the ppa as a separate and distinct asset on its books_and_records costs associated with acquiring the ppa such as attorney's_fees and other related costs have been capitalized into a general asset category and amortized accordingly taxpayer entered into a construction and credit agreement dated march year and amended and restated as of february year with lender as trustee for various lenders as successor the financing agreement relating to the construction and iar operation of the facility the financing agreement provided for the prepayment of the loan on date without any prepayment penalty and in the event of default with significant collateral consequences however the financing agreement did not provide for the prepayment of the loan under any other circumstances consequently taxpayer and lender entered into an agreement providing for the prepayment of the loan and the early termination of the financing agreement the agreement provided that taxpayer would pay to lender an amount determined by reference to the difference between the interest rate under the financing agreement and an interest rate tied to the treasury rate for the period commencing on the termination_date of the financing agreement through date the prepayment penalty taxpayer repaid the full principal_amount of and any accrued but unpaid interest on the loan made under the financing agreement and the prepayment penalty taxnayer will not enter into a new financing agreement with lender or another lender with respect to the facility in year law and analysis whether the termination of taxpayer's ppa pursuant to the agreement constitutes a compulsory or involuntary_conversion of its ppa and its facility within the meaning of sec_1033 and sec_1231 sec_1033 provides in part that if property as a result of its destruction in whole or in part theft seizure or requisition or condemnation or threat or imminence thereof is compulsorily or involuntarily converted into money the gain if any shall be recognized except to the extent hereinafter provided in this paragraph sec_1033 provides that if a taxpayer during the period specified in sec_1033 for the purpose of replacing the property so converted purchases other_property similar_or_related_in_service_or_use to the property so converted then at the taxpayer's election the gain shall be recognized only to the extent that the amount_realized upon such conversion regardless of whether such amount is received in one or more taxable years exceeds the cost of such other_property sec_1 a of the income_tax regulations provides in part that an involuntary_conversion may be the result of the destruction of property in whole or in part the theft of property the seizure of property the requisition or condemnation of property or the threat or imminence of requisition or condemnation of property revrul_63_221 1963_2_cb_332 establishes the criteria necessary for the existence of a threat_or_imminence_of_condemnation based on the taxpayer's reasonable belief generally the threat_or_imminence_of_condemnation exists when a property owner is informed either orally or in writing by a representative of a governmental body or public official authorized to acquire property for public use that such body or official has decided to acquire the owner's property and the owner has du reasonable grounds to believe from the information conveyed to him by such representative that the necessary steps to condemn the property will be instituted if a voluntary sale is not arranged revrul_74_8 1974_1_cb_200 modifying revrul_63_221 provides that a threat_or_imminence_of_condemnation may exist where the purchaser a public_utility lacked actual condemnation authority prior to or at the time of the sale but it generally could readily obtain the power to condemn by application to the appropriate state official authority in the event that a voluntary sale was not arranged and there was no reason to believe that such power to condemn the land purchased would be denied revrul_59_361 1959_2_cb_183 recognized the ecanemic unit theory of 30_tc_741 acg 1959_2_cb_5 the taxpayer in masser owned a freight terminal and the parking lots across the street from the terminal that were necessary for its operation the parking lots were condemned and the taxpayer being unable to secure adequate replacement lots in the same vicinity sold the freight terminal the proceeds of the sale of the freight terminal together with the proceeds from the condemnation of the parking lots were reinvested in a similar terminal and parking facilities suitable for the taxpayer's business the court allowed involuntary_conversion treatment for the terminal proceeds and the parking lot proceeds on the theory that the two properties were used as an economic unit accordingly the service stated that where all the facts and circumstances show a substantial economic relationship between the condemned property and the other_property sold by the taxpayer so that together they constituted one economic property unit such as existed in the masser case involuntary_conversion treatment for the proceeds of the voluntary sale will be permitted revrul_82_147 1982_2_cb_190 held that the sale of the taxpayer's fishing resort due to an act of congress declaring the area in which it is located a boundary waters canoe area wilderness constituted an involuntary_conversion the act prohibited the use of motorboats with motors of greater than horsepower on the lake the restriction on horsepower of motorboats effectively denied the taxpayer the former economic use of its resort the act gave an affected resort owner the option to require the government to purchase the resort at its fair_market_value without regard to the restriction the restriction together with the provision authorizing purchase effectively constituted a taking of the property upon payment of fair compensation the actions of the state psc and x with regard to the establishment of a competitive electricity market for state provide notice to taxpayer as well as a reasonable basis for taxpayer to conclude that x would pursue its threat to condemn taxpayer's facility if taxpayer did not renegotiate its ppa the authority under state statute to commence eminent_domain proceedings against taxpayer's facility further it is clear that x had ok taxpayer's representations regarding the relationship between its ppa and its facility establish that the property converted the ppa bears a substantial economic relationship to the threatened property the facility against which x has taken actions that constitute a threat_or_imminence_of_condemnation further if x were to condemn the facility this action would damage completely the value of the ppa to taxpayer thus although x's threat of condemnation was made to taxpayer's facility because the facility and the ppa form an economic unit the termination of taxpayer's ppa pursuant to the agreement constitutes an involuntary_conversion made under a threat_or_imminence_of_condemnation by x of the ppa and the facility whether the amount of any gain_or_loss required to be recognized by taxpayer in connection with the conversion of its ppa and its facility is a sec_1231 gain or sec_1231 loss sec_1231 prescribes in part the treatment of certain gains from involuntary_conversions sec_1231 ii provides that the term sec_1231 gain means any recognized gain from the compulsory or involuntary_conversion as a result of destruction in whole or in part theft or seizure or an exercise of the power of requisition or condemnation or the threat or imminence thereof into other_property or money of property used in a trade_or_business or any capital_asset which is held for more than year and is held in connection with a trade_or_business or a transaction entered into for profit see also sec_1231 losses under sec_1231 if sec_1231 gains for the year exceed sec_1231 losses they are treated as long-term_capital_gains and losses if sec_1231 losses exceed sec_1231 gains they are treated as ordinary gains and losses the provisions in sec_1231 that deal with involuntary_conversions provide a statutory_sale or exchange for such transactions so that they may qualify for potential capital_gain treatment depending on the netting of gains and losses under sec_1231 these provisions were added by congress in part to supplement what is now sec_1033 and are generally interpreted in a similar manner see h_rep_no cong 2d sess 1942_2_cb_372 conf_rep no cong 2d sess 1942_2_cb_701 cf rev_rul 1953_2_cb_36 treatment of severance_damages under sec_1231 accordingly any gain_or_loss recognized by taxpayer in connection with the conversion of its ppa and its facility will be treated as a sec_1231 gain or sec_1231 loss whether taxpayer may deduct under sec_163 in the year of payment the amount_paid as a penalty for prepayment of the financing agreement sec_163 allows a deduction for all interest_paid or accrued within the taxable_year on indebtedness for these purposes the term_interest is defined as amounts paid for the use or forbearance of money 308_us_488 284_us_552 bb generally for a debtor prepayment charges are deductible as interest because they are considered an additional_amount paid for_the_use_of money revrul_86_42 1986_1_cb_82 this rule applies even to a payment that might otherwise be characterized as a repurchase premium sec_1_163-7 but see sec_1271 and 882_f2d_832 cir amounts received by a creditor to retire debt are amounts received in exchange for the debt in determining whether a payment represents interest or another form of compensation the courts will consider the purpose of the charge as well as whether the charge has the characteristics of interest for example whether the charge is related to the amount borrowed 69_tc_421 additionally amounts paid for specific services rather than the use or forbearance of money are not deductible as interest 75_tc_47 in this transaction just as in revrul_86_42 the prepayment penalty is an additional fee for the cost of the use of money the penalty is directly related to the amount borrowed under the financing agreement the payment is not for any specific services other than for the loan for this reason the prepayment penalty is deductible as interest to taxpayer on the date that the financing agreement was terminated taxpayer's liability for the prepayment penalty became fixed and the amount of the penalty could be determined with reasonable accuracy under sec_1 a sec_1_461-4 provides that in the case of interest economic_performance although the prepayment penalty is deductible as interest occurs as the interest cost economically accrues in accordance with the relevant provisions of the code under sec_163 since the imposition of the prepayment penalty is not related to the passage of time this cost does not economically accrue in the manner described in e therefore under sec_1_461-4 economic_performance occurred in the taxable_year in which the prepayment penalty was paid with respect to the financing agreement accordingly taxpayer may deduct the prepayment penalty under sec_163 in the taxabie year in which the penalty was paid oe based on taxpayer's representations and the above analysis we rule as follows the termination of the ppa pursuant to the agreement constitutes a compulsory of involuntary conversion’ of the ppa and the facility within the meaning of sec_1033 and sec_1231 the amount of any gain_or_loss required to be recognized by taxpayer in connection with the conversion of its ppa and its facility will be treated as a sec_1231 gain or sec_1231 loss in accordance with the provisions of sec_1231 taxpayer may deduct under sec_163 in the year of payment the amount_paid as a penalty for prepayment of the financing agreement 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 s requesting it sec_61 k of the code provides that it may not be used or cited as precedent a copy of this letter must be attached to any income_tax return to which it is relevant in accordance with the power_of_attorney on file with this office a copy of this letter is being sent to your authorized representatives sincerely assistant chief_counsel income_tax accounting kelly e afton senior téchnician reviewer branch cc