t c memo united_states tax_court jeffrey wycoff and merrie pisanno-wycoff petitioners v commissioner of internal revenue respondent docket no filed date steven r toscher and lacey e strachan for petitioners halvor r melom debra ann bowe and michael e washburn for respondent memorandum findings_of_fact and opinion marvel chief_judge respondent determined deficiencies in petitioners’ federal_income_tax and sec_6662 a accuracy-related_penalties as follows 1unless otherwise indicated all section references are to the internal_revenue_code code as amended and in effect for the years at issue and all rule references are to the tax_court rules_of_practice and procedure all monetary continued year deficiency penalty sec_6662 dollar_figure big_number dollar_figure big_number after concessions the issues for decision are whether two subchapter_s_corporations petitioners owned sirius products inc sirius and restore inc restore are entitled to deduct management fees they paid to albion management inc albion in years at issue and whether petitioners are liable for accuracy-related_penalties pursuant to sec_6662 for the and taxable years continued amounts have been rounded to the nearest dollar 2respondent concedes that petitioners did not receive a deemed_distribution of their vested account balances in an employee_stock_ownership_plan esop trust under sec_409 in petitioners concede that they were not entitled to apply a net_operating_loss nol generated in against their tax_liability and they agree that the nol should be applied against petitioners’ tax_liability all other issues are computational 3we will refer to sirius and restore collectively as the operating companies 4although respondent did not determine a deficiency in petitioners’ federal_income_tax our determination of whether the operating companies are able to deduct management fees paid to albion in will affect the amount of an nol_carryback that petitioners’ claimed on their return findings_of_fact some of the facts have been stipulated the stipulations of facts are incorporated herein by this reference petitioners resided in colorado when they petitioned this court the parties have stipulated that an appeal in this case would lie to the u s court_of_appeals for the tenth circuit i background jeffrey wycoff earned a bachelor of arts degree from ryder college in mr wycoff previously had two california state licenses a b1 contractor’s license and a c54 tile contractor sublicense in he sold life_insurance at some point between and he managed a domino’s pizza franchise from to he sold cars from to he managed the better bath of l a later named tile pros a construction company merrie pisanno-wycoff earned her bachelor of arts degree in public relations from california state university chico in and her doctor of philosophy degree in comparative religion from the university of sedona ii zap in the early 1990s petitioners asked a chemist dr marantz to create a chemical formula for a product that would clean tile dr marantz developed the formula and petitioners named the product zap petitioners filed a trademark application_for the name zap they also attempted to patent the formula but were advised by legal counsel that it was too simple to patent they subsequently decided to sell zap using a direct response marketing model specifically infomercials they had previously used direct response marketing for other products but the marketing for many of those products was not successful in their experience whether the consumer liked the product was the most important factor in determining success they generally expected their products to at best have an 18-month life cycle iii the operating companies a sirius petitioners incorporated sirius on date they initially capitalized sirius with funds from tile pros and personal credit cards they were the only members of sirius’ board_of directors and its only officers sirius formulated manufactured and marketed household chemical products in particular sirius sold zap directly to consumers using infomercials and to various retailers including wal-mart costco bed bath beyond linens ‘n things walgreens target kroger bj’s sam’s club and several grocery stores in salt lake city utah sirius also sold products that it developed which were unrelated to zap sirius used direct response marketing specifically short form television advertisements approximately two minutes long to market its products b restore petitioners incorporated restore on date they initially capitalized restore with funds from sirius restore sold the same products as sirius they incorporated restore because sirius could not market its products using the various direct response companies such as the home shopping network and qvc the operating companies operated out of the same facility and they shared a common labor force restore sold zap under the name restore restore product restore owned the rights to the restore product name restore sold the restore product directly to consumers and through home depot restore marketed its products via long form television advertisements approximately minutes long and on qvc c the operating companies’ operations on date sirius and restore elected to be subchapter_s_corporations and they were subchapter_s_corporations at all times during petitioners were at all relevant times the sole officers and board members of the operating companies after the years at issue restore merged with sirius mr wycoff was primarily responsible for all operations of the operating companies his principal duties included negotiating contracts overseeing advertising purchases and content managing the operating companies’ finances selling the products to retailers and overseeing other employees’ work in short mr wycoff performed all managerial tasks for the operating companies he also referred to himself as the national sales manager and product spokesman because of his duties in selling the products and overseeing advertisements iv the marshall stevens transaction on date robert boespflug of marshall stevens esop5 capital strategies group marshall stevens gave a presentation to barry marlin petitioners’ attorney at the time the presentation outlined how the operating companies and petitioners could purportedly reduce their income_tax liabilities by way of a series of transactions collectively marshall stevens transaction using a subchapter_s_corporation a deferred_compensation plan and an esop petitioners did not attend this presentation during the presentation mr boespflug’s powerpoint slides represented that the objectives of the marshall stevens transaction were to reduce corporate_income_tax liability defer income reduce personal income_tax_liability of owners get equity 5esop is an abbreviation for employee_stock_ownership_plan ownership special benefits in the hands of key people provide broad-based incentives to rank file and create tax advantaged structure in preparation of future asset sale marshall stevens’ powerpoint slides also represented that the proposed steps of the transaction were as follows step one form a new subchapter_s_corporation smc step two create deferred_compensation benefits for key employees of operating entities step three adopt esop 401_k_plan step four sell new smc stock to esop k for dollar_figure promissory note step five pay management fee from each operating entity to smc adopt mgt contracts step six manage the new assets in the smc fund the deferred_compensation benefits and esop k plans after the presentation mr marlin and roland attenborough an attorney with reish luftman hired by marshall stevens to develop the portion of the marshall stevens transaction with respect to the esop met with mr wycoff to discuss the transaction after the meeting mr wycoff instructed mr marlin to review the transaction mr marlin’s review consisted solely of discussions with two accounting firms mr marlin did not provide petitioners with a written legal opinion on the basis of mr marlin’s limited review petitioners decided to implement the transaction and on date petitioners on behalf of sirius executed a contract with marshall stevens to implement the marshall 6trial was held in this case on august and during the course of posttrial proceedings the court became aware of a potential conflict of interest involving petitioners’ then counsel jeffrey d davine an attorney associated with mitchell silberberg knupp llp at the time of trial mr attenborough was and had been since before the filing of the petition an attorney also associated with mitchell silberberg knupp llp after discussing the matter with the parties the court gave petitioners’ counsel time to resolve the potential conflict of interest by obtaining the informed consent of petitioners to counsel’s continuing representation after consultation with independent counsel petitioners advised their counsel and the court that they would not provide the requested waiver consequently petitioners’ former counsel withdrew his representation and new counsel entered an appearance for petitioners in an order dated date we concluded that petitioners’ former counsel had an imputed conflict of interest and we reopened the record for petitioners to inter alia present evidence as to the reasonableness under sec_162 of the management fee and the arm’s-length value of the management services that albion purportedly provided to the operating companies stevens transaction for a fee of dollar_figure the contract contained the following disclaimer the parties acknowledge that the s management_corporation and ksop strategy is an aggressive tax planning program and that the client has been advised of this fact has been advised to and has had the opportunity to seek independent legal and tax counsel with respect thereto and does hereby accept the risk that the irs may challenge and or disqualify any aspect of the program v implemention of the marshall stevens transaction a step albion management on date mr attenborough incorporated albion management inc albion and appointed petitioners as albion’s directors albion then designated mr wycoff as its president dr pisanno-wycoff as its secretary and janie emaus as its chief financial officer petitioners have held their positions with albion ever since albion then issued big_number shares of stock and sold big_number of those shares to mr wycoff for dollar_figure and big_number of those shares to dr pisanno- wycoff for dollar_figure albion also elected to be taxed as a subchapter_s_corporation b step deferred_compensation benefits on date albion hired mr marlin as its in-house counsel and mr wycoff as a full-time manager for albion’s clients mr wycoff’s contract 7an esop that is combined with a sec_401 plan is referred to as a ksop with albion provided that albion would compensate him with an annual salary a deferred_compensation plan a life_insurance_policy and an option to purchase shares of albion’s stock at any time on date albion also established a supplemental retirement_plan and rabbi_trust rabbi_trust the rabbi_trust was an unfunded_deferred_compensation plan for the sole benefit of mr wycoff mr wycoff is and always was the sole beneficiary of the rabbi_trust mr marlin was appointed as the trustee of the rabbi_trust the rabbi_trust agreement specified that it was effective from date either until mr wycoff left the company or until petitioners lost control of the company under the rabbi_trust agreement and mr wycoff’s employment contract all contributions to the rabbi_trust were at albion’s discretion and were to be capped pincite of albion’s management fees the rabbi_trust agreement forbade the assignment alienation pledge or encumbrance of funds in the rabbi_trust 8a rabbi_trust is an unfunded_deferred_compensation plan funds deposited into the trust remain subject_to the claims of the employer’s creditors see in re it group inc 448_f3d_661 3d cir the employee beneficiary of the rabbi_trust is not taxed on the funds deposited into the account until the funds are actually distributed to him see id likewise the employer is not entitled to a deduction for the funds deposited into the rabbi_trust until the rabbi_trust actually distributes the contributions see id pincite because albion was an esop a tax- exempt entity it had no need for a current deduction because its income was tax- exempt see sec_401 sec_501 the rabbi_trust agreement provided that distribution of benefits was to occur upon mr wycoff’s separation_from_service c step ksop and esop trust on date albion established a combined employee stock ownership and sec_401 plan ksop and an employee_stock_ownership_plan trust esop trust albion appointed petitioners as trustees of the ksop and the esop trust the operating companies then agreed to participate in the ksop and the esop trust petitioners did not participate in the ksop or the esop trust d step sell albion to the esop trust on date albion contributed dollar_figure to the esop trust petitioners then sold all big_number shares of albion’s stock to the esop trust for dollar_figure on date marshall stevens determined that the book_value of albion as of date was dollar_figure e step adopt management contracts on date the operating companies entered into management agreements with albion the agreements did not specify the particular services 9albion entered into two other management agreements with soapworks and safety tubs two companies that petitioners incorporated in however because respondent does not challenge the management fees that soapworks and safety tubs paid to albion we do not discuss them that albion employees would provide under these agreements the operating companies agreed to purchase management services from albion for of their respective gross_receipts to determine the management fee mr marlin mr attenborough mr boespflug and mr wycoff held a meeting where mr wycoff described the services that albion would provide to the operating companies petitioners did not hire an adviser familiar with petitioners’ business model to assist with determining the amount of the management fee or to advise with respect to reasonable_compensation mr marlin mr attenborough mr boespflug and mr wycoff had no experience determining reasonable_compensation on the basis of mr wycoff’s information however mr marlin mr attenborough and mr boespflug calculated that an appropriate management fee was of the operating companies’ gross receiptsdollar_figure on date albion hired mr wycoff to provide management services to the client companies of albion so as to fulfill the obligations of 10mr attenborough testified that the management fee was supported by caselaw because courts had upheld similar management fees petitioners did not introduce documentary_evidence to show exactly how the management fee was calculated and the record does not reveal the cases mr attenborough allegedly reviewed or relied on according to mr wycoff the management fees were calculated partially on the basis of the profitability of the operating companies and not on the hours worked or services albion provided albion under its various management agreements the contract between albion and mr wycoff did not specify the particular management services that mr wycoff was to provide however mr wycoff provided the same services to the operating companies that he had provided to them before incorporating albion the operating companies’ functions did not change after they had hired albion except that the employees of the operating companies began providing services via albion employees were not aware of this change until they began receiving their salaries from albion for all practical purposes the operating companies’ employees’ work did not change when they began working for albion on date the operating companies and albion amended their respective management agreements to provide that the operating companies would pay albion of their respective gross_receipts for albion’s services because the operating companies’ revenues had declined on date the operating companies and albion further amended their respective management agreements to provide that the operating companies would pay albion of their respective gross_receipts for albion’s services regardless of the size of the fee albion purportedly provided the same services to the operating companies for the years at issue on their applicable federal_income_tax returns the operating companies reported the following gross_receipts total income or loss management fees and ordinary or taxable_income or loss sirius year gross_receipts total income management fees income or loss dollar_figure big_number big_number big_number big_number big_number dollar_figure big_number big_number big_number big_number big_number --- --- dollar_figure big_number big_number big_number dollar_figure -0- big_number big_number big_number big_number restore year gross_receipts total income management fees income or loss dollar_figure big_number big_number big_number big_number big_number dollar_figure big_number big_number big_number big_number big_number --- --- dollar_figure big_number big_number big_number dollar_figure big_number big_number big_number big_number f step fund deferred_compensation albion’s financial statements for financial year ending fye date fye date nine months ending date and three months ending 3me date show the following rabbi_trust assets accrued deferred_compensation liability and deferred_compensation expense fye rabbi_trust assets accrued deferred_compensation liability deferred_compensation expense date not separately_stated date dollar_figure big_number date date big_number dollar_figure big_number big_number big_number dollar_figure big_number big_number big_number 1this amount was listed on albion’s balance_sheet as follows rabbi_trust ubs-rabbi trust f k a paine web dollar_figure big_number 2albion accrued deferred_compensation liability in its short 3me date year even though its employment agreement with mr wycoff as amended on date stated that such accruals would cease on date the rabbi trust’s ledger does not reflect any contributions by albion to the rabbi_trust instead the rabbi trust’s ledger reflects a series of contributions from the operating companies on date on its forms 1120s u s income_tax return for an s_corporation for and on the attached schedules l balance sheets per books albion reported the following gross_receipts investments in the rabbi_trust total assets and total liabilities and shareholders’ equity gross_receipts assets invested in rabbi_trust total liabilities and shareholders’ equity total assets tye date date date date dollar_figure big_number big_number big_number dollar_figure big_number dollar_figure big_number big_number big_number dollar_figure big_number big_number big_number 1for its taxable years ending sept and date albion did not separately report its investments in the rabbi_trust vi windup of the marshall stevens transaction on date albion revoked its subchapter_s_election and terminated the esop portion of the ksop plan on date marshall stevens determined that the book_value of albion as of date was dollar_figure on date albion and mr wycoff amended mr wycoff’s employment agreement with albion mr wycoff agreed to provide the same services as before in exchange for a dollar_figure annual salary the accrued_benefits in the rabbi_trust and a commitment that albion would amend the rabbi_trust agreement to provide that the rabbi_trust would begin distributing its assets quarterly albion amended the rabbi_trust agreement to provide that the rabbi_trust would begin distributing its assets at mr wycoff’s discretion on date the esop trust sold all of its albion stock to sirius for dollar_figure on date marshall stevens determined that the book_value of albion as of date was zero in its date appraisal marshall stevens opined that albion’s stock was worthless as of date because albion’s total liabilities most of the liabilities consisted of accrued deferred_compensation exceeded the value of its assets on date albion distributed dollar_figure to various employees as a final distribution from the esop vii wages paid to mr wycoff and other employees from to the operating companies issued mr wycoff forms w-2 wage and tax statement showing the following wages sirius dollar_figure big_number big_number year restore dollar_figure 1big_number 1restore issued mr wycoff a form_w-2 stating that his wages were dollar_figure however restore reported on its form_1120s for that mr wycoff’s wages were dollar_figure mr wycoff reported his wage income from restore as dollar_figure on petitioners’ federal_income_tax return for consequently we use the form_w-2 amount from to mr wycoff’s total compensation from albion was as follows year wages dollar_figure big_number big_number big_number deferred_compensation expense1 dollar_figure big_number big_number total dollar_figure big_number big_number big_number 1petitioners’ records vary as to the exact deferred_compensation expenses the court uses the figures reported on albion’s financial statements as deferred_compensation expenses from to albion reported11 the following wage expenses for its employees year wages albion paid excluding wages paid to mr wycoff wages albion paid to mr wycoff payroll_taxes total wage expenses dollar_figure big_number big_number dollar_figure big_number big_number dollar_figure not separately_stated big_number dollar_figure big_number big_number chet millard was the most highly_paid_employee of the operating companies from to other than petitioners mr millard was paid total wages of dollar_figure dollar_figure and dollar_figure by albion and the operating companies for and respectively viii potential sale of operating companies in petitioners hired barrington associates an investment banking firm to solicit offers to buy the stock or assets of the operating companies in drafting a memorandum for potential buyers barrington associates reviewed the operating companies’ financial performance to calculate the profitability of 11some of the amounts reported on forms w-2 issued to employees are different from the wage expenses albion deducted on its tax returns for consistency we rely on the amounts on the forms w-2 12the operating companies also paid wages exclusive of wages paid to mr wycoff of dollar_figure dollar_figure and dollar_figure for the years at issue respectively the operating companies barrington associates excluded the management fees paid to albion because the management fees exceeded market rate salaries barrington associates estimated that a market rate salary for all shareholder compensation was dollar_figure per year ix expert witnesses a respondent’s expert respondent submitted the expert report of kenneth nunes a chartered financial analyst mr nunes earned a master of science degree in mechanical engineering from the university of california davis in and he earned a master’s in business administration from the university of california los angeles in he has over years of experience advising companies on financial valuation and dispute resolution issues since mr nunes has testified as a valuation expert in various federal and state courts mr nunes’s report addressed two issues whether mr wycoff’s compensation from albion was reasonable and whether the management fees that sirius restore safety tubs and soapworks paid to albion were arm’s- length fees within the meaning of sec_482 mr wycoff’s compensation mr nunes examined the condition of the operating companies the market for executive compensation in the industry and in the business community generally and mr wycoff’s relevant qualifications and attributes mr nunes found that compensation is typically determined by industry firm size measured either by company value or revenue and position he determined that mr wycoff was acting as the chief_executive_officer ceo of the operating companies therefore to calculate the reasonable total value of compensation_for mr wycoff mr nunes examined compensation paid to individuals acting as the ceo of comparable companies petitioners had identified the operating companies’ primary business activity as the production and sale of household chemicals therefore mr nunes determined that the operating companies’ peer group was companies that had reported financial information from in the following standard industrial classification sic_codes soap detergents cleaning preparations perfumes cosmetics speciality cleaning polishing and sanitation preparations and perfumes cosmetics and other toilet preparations after reviewing the financial data of the peer group companies he excluded companies with less than dollar_figure million and more than dollar_figure million in annual revenue because the total revenue of the operating companies ranged between dollar_figure million and dollar_figure million mr nunes included companies with annual revenue of dollar_figure million to dollar_figure million because doing so increased the number of companies to which he could compare the operating companies and the additional information helped him determine the upper limits of reasonable_compensation he excluded companies that conducted unrelated activities such as software companies and pharmaceutical drug companies he ultimately identified seven companies that he concluded were comparable to the operating companies peer group mr nunes then compared the data for the peer group with data from a broader group of different companies to ensure that the peer group did not set executive compensation at unreasonably low levels all companies had annual revenue below dollar_figure million and were not pharmaceutical companies in comparing executive compensation between the peer group and the broader group of companies mr nunes used only cash compensation he did not include stock_option compensation because he determined that stock_option compensation was not used in the industry and was a meaningful source of ceo compensation only at larger companies mr nunes found that the peer group did not omit highly compensated individuals but rather included some of the most highly compensated executives of the broader group of companies he therefore concluded that the peer group represented compensation in the industry mr nunes then performed a regression analysis on the peer group data to create an equation for the relationship between annual ceo compensation and a company’s annual revenue the equation allowed him to input a particular annual revenue and determine what a company would pay its ceo he calculated that companies of similar size in terms of annual revenue and in the operating companies’ industry would have paid a ceo baseline compensation of dollar_figure in and dollar_figure in in the operating companies’ revenues were lower than those of the peer group and therefore mr nunes decided that using the equation for was not appropriate instead he calculated that the operating companies would pay a ceo baseline compensation of dollar_figure which was the lowest salary a ceo in the peer group received for dollar_figure after calculating baseline compensation mr nunes considered whether baseline compensation should be increased to account for unique characteristics of 13the company that had the lowest ceo salary for also had the lowest revenue of the peer group the operating companies had revenue of less than dollar_figure million in in the company with the lowest revenue had revenue of approximately dollar_figure million the operating companies and mr wycoff mr nunes decided that a cost of living adjustment was appropriate because of the location of the operating companies he then determined that a decrease in baseline salary for and was appropriate14 because of revenue declines and a increase in was appropriate because the operating companies had performed welldollar_figure he found that mr wycoff’s tenure experience and education were typical of other ceos in the peer group and no adjustment for individual characteristics was necessary mr nunes therefore concluded that the reasonable total compensation_for mr wycoff’s services was dollar_figure dollar_figure and dollar_figure for and respectively arm’s-length management fee mr nunes next determined what an arm’s-length management fee would be for the years at issue he reached his arm’s-length calculation by first determining whether the services albion provided the operating companies were nonintegral or 14petitioners have cited the events of date as a reason for the decline in sales during and mr nunes’ report concludes that the economy was relatively stable for the years at issue with the exception of a brief shock after date 15mr nunes cites academic literature indicating that executive compensation is positively correlated with relative profitability and changes in share value integral services for the purposes of the applicable regulations see sec_1_482-2 b ii income_tax regs mr nunes determined that albion’s services were integral and the applicable regulations required that operating companies pay a management fee that unrelated parties would pay for similar services see sec_1_482-2 income_tax regsdollar_figure to determine an arm’s-length charge for albion’s services mr nunes researched companies comparable to albion he used companies that had annual revenue between dollar_figure million and dollar_figure million and reported themselves as employment agencies help supply services and all other professional services he determined that these companies were similar to albion because albion provided routine management services to the operating companiesdollar_figure mr nunes then excluded companies that did not have a retail focus which led to the exclusion of healthcare and it services companies he therefore determined that eight public companies engaged in management and administrative services with financial information reported during the years at issue were comparable to albion 16mr nunes’ report states that for nonintegral services an arm’s-length price is deemed equal to all costs incurred see sec_1_482-2 income_tax regs 17albion reported itself under all other professional services mr nunes used a cost markup method to determine the arm’s-length management fee his approach required him to determine the operating_profit earned by comparable companies as a percentage of their total costsdollar_figure mr nunes chose this method because albion’s costs were readily observable and services provided are of a routine nature after analyzing the costs of the eight public companies similar to albion he determined that the median cost markup wa sec_4 -0 and -0 respectively for the years at issuedollar_figure mr nunes then calculated albion’s total expenses for each of the years at issue by adding the amount of mr wycoff’s reasonable_compensation that he had determined see supra part ix a and albion’s other reported expenses after applying the median cost markup of comparable companies to albion’s total expenses he determined that albion was entitled to aggregate management fees of 18the regulations refer to this method as the comparable_profits_method cpm see sec_1_482-5 income_tax regs petitioners contend that mr nunes used the cost of services plus method described in sec_1_482-9 income_tax regs however we find that the record supports a finding that mr nunes used the comparable_profits_method because mr nunes compared albion’s operating_profit to that of similar companies see sec_1_482-5 income_tax regs the cost of services plus method compares profit markup of the uncontrolled_transaction with the controlled_transaction see sec_1_482-9 income_tax regs 19the median cost markup was negative for and because the comparable group of companies that mr nunes used had losses during those years dollar_figure5 million dollar_figure7 million and dollar_figure respectively for the years at issue albion provided services during the years at issue to sirius restore safety tubs and soapworks because albion did not maintain time logs for its services to each of the companies mr nunes allocated the management fees on the basis of relative costs incurred by the entities and determined the following allocations company sirius restore safety tubs soapworks total dollar_figure big_number --- --- big_number dollar_figure big_number --- --- big_number dollar_figure big_number big_number big_number big_number mr nunes next considered the combined results of the reasonable_compensation and the arm’s-length management fee analysis after allowing for a deduction for an arm’s-length management fee he calculated that the operating companies had a three-year average operating income margin of because the operating income margin was within the three-year average for the operating companies’ peer group he considered his results reasonable 20albion started providing services to safety tubs and soapworks only in as mr nunes noted in his report emerging companies often require more management time however without logs of the services albion provided mr nunes was unable to allocate the management fee on the basis of services provided to each company b petitioners’ expert sec_1 mr dupler petitioners submitted the expert report of timothy dupler mr dupler has experience working with companies using direct response marketing he does not have any experience training or education in financial analysis or with the valuation of management contracts or executive compensation mr dupler determined that the of gross_receipts that albion charged the operating companies as a management fee was reasonable and customary for a company using direct response marketing he based his opinion on his previous experience with companies using direct response marketing and he did not cite any corroborating sources documents or authorities in his report mr burns petitioner also submitted the expert report of francis x burns who is an accredited senior appraiser in business valuation from the american society of appraisers and who is certified as accredited in business appraisal review by the institute of business appraisers mr burns graduated from stanford university in and earned a master of management degree in finance and economics from northwestern university in he has over years of experience as an economic consultant including experience evaluating executive compensation in the valuation of businesses in commercial damages litigation and in determining the reasonableness of compensation under the code mr burns has testified previously as an expert witness for both the government and taxpayers mr burns first considered the management_contract albion entered into with the operating companies he noted that on the basis of information available in date when the contract was signed scaling management fees to sales was reasonable because all parties assumed some risk of the operating companies’ success however he did not find the fact that petitioners controlled the operating companies and albion relevant when concluding that the contract was reasonable mr burns next looked at the services albion provided with a focus on the services mr wycoff provided he noted that mr wycoff served in a variety of roles for the operating companies including ceo chief financial officer chief operating officer national sales manager and spokesman for the operating companies to determine a reasonable management fee for the services albion provided the operating companies mr burns used four methods first he looked to companies he had determined were comparable to petitioners’ operating companies his consideration of companies that classified themselves as cleaning product companies and direct response industry companies with revenues similar to those of the operating companies resulted in one company because he found only one he expanded the criteria to include companies that classified themselves as chemical and allied products companies which included pharmaceutical companies the new criteria resulted in companies that he considered sufficiently similar to the operating companies of the companies were pharmaceutical companies none of the companies manufactured cleaning products and only two sold cleaning products on the basis of the salaries paid to the ceos of this group and mr wycoff’s other work for the operating companies mr burns determined that a management fee of would be reasonable mr burns’ next method of calculating a reasonable management fee was to compare albion’s ceo compensation with that of consulting firms he considered hourly rates of ceo compensation of six consulting firms and found that the average rate was dollar_figure per hour he then determined on the basis of mr wycoff’s statements that mr wycoff worked hours per day and therefore determined that mr wycoff was entitled to dollar_figure million per year or approximately of expected net sales mr burns’ third method for determining the management fee was to review an executive compensation survey he used survey data from companies in the cleaning polishing and sanitary preparations field with annual revenue of dollar_figure milliondollar_figure after combing the maximum reasonable cash compensation from the survey and the median figures for equity based compensation he determined that an appropriate management fee wa sec_15 of revenue the final method mr burns used to calculate the management fee was an independent_investor_test mr burns’ independent_investor_test required him to calculate the median return on tangible net_worth for companies purportedly operating in the same industry as the operating companies using data from a survey he determined that the median return on tangible net_worth for similar companies was to over the years to the independent_investor_test led him to conclude that the operating companies should pay a management fee of dollar_figure mr burns concluded on the basis of his four methods that it would have been reasonable to pay albion to of the operating companies’ sales for the years at issue he also noted that mr wycoff should be entitled to additional 21the survey data is not from the years at issue the oldest data available for cash compensation was and data for equity compensation was available starting in 22mr burns’ report also notes that on the basis of projections from barrington associates a management fee between and would be acceptable for and compensation_for his roles as national sales manager and product spokesperson x notice_of_deficiency respondent issued a notice_of_deficiency to petitioners on date respondent disallowed the following deductions for management fees that the operating companies reported paying to albion company sirius restore dollar_figure big_number dollar_figure big_number dollar_figure big_number petitioners timely petitioned this court opinion i burden_of_proof generally the commissioner’s determination_of_a_deficiency is presumed correct and the taxpayer bears the burden of proving that the determination is improper rule a 290_us_111 however if a taxpayer produces credible evidence23 with respect to any factual credible_evidence is the quality of evidence which after critical analysis the court would find sufficient upon which to base a decision on the issue if no contrary evidence were submitted without regard to the judicial presumption of irs correctness 116_tc_438 quoting h_r conf rept no pincite 1998_3_cb_747 issue relevant to ascertaining the taxpayer’s liability for any_tax imposed by subtitle a or b of the code and satisfies the requirements of sec_7491 the burden_of_proof on any such issue shifts to the commissioner sec_7491 sec_7491 requires a taxpayer to demonstrate that he or she complied with the requirements under the code to substantiate any item maintained all records required under the code and cooperated with reasonable requests by the secretary24 for witnesses information documents meetings and interviews see 116_tc_438 petitioners contend that the notice_of_deficiency should no longer be presumed correct petitioners contend that the expert reports by mr dupler and mr burns are credible_evidence or that respondent has through his own concessions and expert reports established that his determination in the notice_of_deficiency was erroneous because respondent’s primary position entitles petitioners to deduct some management fees while the notice_of_deficiency disallowed the deduction for all management fees 24the term secretary means the secretary_of_the_treasury or_his_delegate sec_7701 petitioners rely on a series of cases from the u s court_of_appeals for the ninth circuit holding that the commissioner’s adoption of a litigation position that substantially deviates from the position in the notice_of_deficiency results in a forfeiture of any presumption of correctness in the notice and places the burden_of_proof as to factual matters on the commissioner see 250_f3d_696 9th cir aff’g in part vacating in part and remanding tcmemo_1997_461 249_f3d_1191 9th cir rev’g and remanding 112_tc_130 243_f3d_1145 9th cir rev’g and remanding estate of kaufman v commissioner tcmemo_1999_119 the parties have stipulated that appeal in this case would lie to the u s court_of_appeals for the tenth circuit and therefore we are not bound by caselaw from the u s court_of_appeals for the ninth circuit see 54_tc_742 aff’d 445_f2d_985 10th cir even if we were to follow the precedent of the u s court_of_appeals for the ninth circuit the notice_of_deficiency would not lose the presumption of correctness although in the notice_of_deficiency respondent disallowed petitioners’ claimed deductions for management fees on brief he allowed the deductions to the extent petitioners proved that albion had paid wages or payroll taxes when the commissioner concedes certain facts or issues the notice_of_deficiency is still presumed correct see u s holding co v commissioner 44_tc_323 in any event we reach our decision on the basis of the preponderance_of_the_evidence see 131_tc_185 ii management fee deductions a the parties’ positions respondent advances four arguments as to why petitioners’ claimed deductions for management fees that the operating companies paid to albion under the compensation agreement should be reduced respondent’s primary argument is that the operating companies did not substantiate the management fees beyond the amounts that albion reported paying for wages and for payroll_taxes alternatively respondent contends petitioners are entitled to deduct only the portions of the management fees that are considered reasonable_compensation see sec_162 respondent also argues that the management fees should be reallocated under sec_482 or to the extent the management fees constitute unreasonable_compensation the transaction should be recharacterized as distributions to petitioners petitioners contend that the inquiries under section and sec_482 are substantially the same and that under either code provision they are entitled to deduct the management fees on brief respondent concedes that albion is not a sham entity and should not be disregardeddollar_figure respondent asks us to determine mr wycoff’s reasonable_compensation under sec_162 however the management fees that the operating companies paid to albion are before the court and not mr wycoff’s reasonable_compensation because respondent concedes that albion is not a sham entity we will focus our analysis on sec_482 and the proper arm’s-length amounts of the management fees although a sec_482 analysis may require us to determine albion’s costs including mr wycoff’s reasonable_compensation albion is entitled to charge the operating companies an arm’s-length price for its services that may be higher than the salaries albion paiddollar_figure 25in the notice_of_deficiency respondent determined as an alternative position that albion should be disregarded because it lacked a legitimate business_purpose and had no economic_substance 26we also find that the record provides an adequate basis to determine mr wycoff’s reasonable_compensation and therefore we reject respondent’s substantiation argument see 39_f2d_540 2d cir 27additionally the regulations under sec_482 provide that an arm’s-length charge shall not be deemed equal to costs or deductions with respect to integral services see sec_1_482-2 income_tax regs respondent concedes continued b sec_482 sec_482 was enacted to prevent tax_evasion and ensure that taxpayers clearly reflect income relating to transactions between controlled entities 133_tc_297 this section gives the commissioner broad authority to allocate gross_income deductions credits or allowances between two related corporations if the allocations are necessary either to prevent evasion of tax or to clearly reflect the income of the corporations see 102_tc_149 to determine true_taxable_income the standard to be applied in every case is that of a taxpayer dealing at arm’s-length with an uncontrolled taxpayer sec_1_482-1 income_tax regs the arm’s-length result of a controlled_transaction must be determined under the method that under the facts and circumstances provides the most reliable measure of an arm’s-length result id para c in determining which of two or more available methods provides the most reliable measure of an arm’s-length result the two primary factors to take into account are the degree of comparability between the controlled_taxpayer and continued that the services albion provided the operating companies were integral any uncontrolled_comparable and the quality of data and assumptions used in the analysis see sec_1_482-1 income_tax regs the parties dispute the best_method for determining an arm’s-length result petitioners contend that we should accept mr burns’ analysis which applies four different methods that all reach a result of to of the operating companies’ revenues as a management fee respondent contends that the cpm that mr nunes applied is best_method for reaching an arm’s-length result because data of comparable transactions was unavailable and mr nunes’ determination ensured that albion would receive the same profit or loss as companies providing similar services accordingly we must determine the most reliable method for calculating an arm’s-length management feedollar_figure we do so by analyzing the expert reports expert reports both parties introduced expert witness reports and additional testimony to assist the court in determining the management fee expert witnesses are 28for sec_482 to apply the operating companies and albion must be owned or controlled directly or indirectly by the same interests see sec_482 during the years at issue petitioners owned and controlled the operating companies petitioners served as directors of albion and as trustees of the ksop plan and the esop trust petitioners therefore controlled albion accordingly sec_482 applies appropriate to help the court understand an area requiring specialized training knowledge or judgment see fed r evid 93_tc_529 nonetheless the court is not bound by an expert’s opinion and we may either accept or reject expert testimony in the exercise of sound judgment 304_us_282 86_tc_547 furthermore the court may be selective in determining what portions of an expert’s opinion if any to accept parker v commissioner t c pincite a petitioners’ experts petitioners first submitted the expert report of mr dupler mr dupler has previously worked with companies that use direct response marketing and on the basis of that experience he concluded that a management fee of was reasonable for albion to charge mr dupler did not provide any support for his opinion other than his experience and he did not cite any academic literature or trade publications he cited fee arrangements by a company that he had worked for as support for his conclusion but he did not have access to the fee arrangement contracts additionally the contracts were not from the years at issue and we are not convinced that these contracts represent current trends mr dupler also admitted that the contracts had been modified several times accordingly we decline to accept mr dupler’s conclusions in his expert report because they cannot be verified see sec_1_482-1 income_tax regs petitioners also submitted the expert report of mr burns mr burns calculated that the market-based compensation_for management serviced provided by mr wycoff through albion would have been in the range of to mr burns also found that mr wycoff may be entitled to additional compensation_for his role as national sales manager and products spokesman to support his conclusion mr burns used four different methods mr burns’ first method was to look at comparable companies and compare the salaries of the ceos he selected pharmaceutical companies as comparable corporations we disagree that pharmaceutical companies are comparable to the operating companies see id subdiv i stating that as comparability increases inaccuracy is reduced as mr nunes stated in his rebuttal report the development cost of a drug is substantially more than the cost of developing a household cleaner most drugs also have a longer life span and are generally protected through a patent in contrast the product at issue here zap was not eligible for a patent also as petitioners conceded most products that are marketed using direct response have an 18-month product life cycle further the development of drugs requires particular skills and expertise that were not required for petitioners’ business there is no evidence to support the claim that pharmaceutical companies are comparable to the operating companies other than mr burns’ opinion and we do not find that opinion to be credible mr burns did not select any company that manufactures cleaning products and he included only two companies that distributed cleaning products as comparable to the operating companies accordingly we find this method unreliable mr burns’ next method for determining the management fee was to calculate the fee as if albion were a consulting firm he considered the hourly rate of ceo compensation of six consulting firms and after calculating the number of hours mr wycoff worked mr burns determined that albion was entitled to of net sales for a management fee however mr burns’ report is devoid of any analysis of how these six consulting companies compare to albion and the services it provided additionally mr wycoff did not maintain time logs of the work he performed and for which entity other than his testimony which we find exaggerated and not credible there is no evidence in the record to support mr wycoff’s hours mr burns’ third method for determining the management fee was to review an executive compensation survey although the survey includes companies that considered themselves cleaning polishing and sanitary preparations companies with revenue of dollar_figure million mr burns’ report does not identify which companies he includeddollar_figure mr burns’ fourth method for calculating the management fee was an independent_investor_test which included companies from the same company classification as the executive survey he determined that these companies earned a median return on tangible net_worth ranged from to for the operating companies to earn a similar return mr burns’ determined that a management fee of was reasonable we find both mr burns’ executive survey compensation method and independent investor method unreliable under both methods mr burns did not identify the companies he used for these tests we note that respondent’s expert also used data from various company classifications and found that some of the companies in particular classifications were not comparable to the operating companies petitioners have objected to the use of a company in this category that mr nunes included in his report yet petitioners’ expert report does not state what companies were included in the survey or independent investor method in short we decline to accept mr burns’ determination because the underlying data is not 29additionally in calculating an acceptable management fee under the survey method mr burns used the maximum reasonable cash compensation from the survey however mr burns’ report is devoid of any analysis as to why albion would be entitled to the maximum figure available and we are unable to conclude that the companies on which mr burns relied are comparable to the operating companies b respondent’s expert respondent submitted the report of mr nunes mr nunes determined that an appropriate method for calculating an arm’s-length management fee was a markup of albion’s expenses referred to as cpm see sec_1_482-5 income_tax regs mr nunes’ method required that after determining albion’s costs mr nunes multiply the costs by the median profit margin of a comparable group of companies for the particular year at issue mr nunes looked to the cost markup of companies that provided management services to other companies his research found eight public companies that were comparable to albion after analyzing the eight comparable companies mr nunes determined that the cost markups should be -0 and -0 for the years at issue respectively he next determined albion’s costs by using albion’s reported expenses subtracting that portion of the expenses mr nunes considered to be unreasonable_compensation to mr wycoff petitioners contend that mr nunes’ analysis is unreliable because the analysis relies on his determination that mr wycoff was overcompensated because mr nunes determined that mr wycoff’s compensation was unreasonable for the years at issue he adjusted albion’s reported expenses before conducting his cost markup analysis accordingly we will address mr nunes’ reasonable_compensation analysis sec_162 allows a taxpayer to deduct a reasonable allowance for salaries or other compensation_for_personal_services actually rendered as an ordinary and necessary business_expense a taxpayer is entitled to a deduction for compensation payments if the payments are reasonable in amount and in fact paid purely for services sec_1_162-7 income_tax regs the question of whether amounts paid to employees represent reasonable_compensation for services rendered is a question of fact that must be determined in the light of all the evidence 278_us_282 373_f2d_45 10th cir aff’g 44_tc_382 95_tc_525 aff’d 965_f2d_1038 11th cir special scrutiny is given in situations where a corporation is controlled by the employees to whom the compensation is paid because there is a lack of arm’s- length bargaining 528_f2d_176 10th cir aff’g 61_tc_564 k k veterinary supply inc v commissioner tcmemo_2013_84 at sec_1_162-7 income_tax regs provides that the form or method of fixing compensation is not decisive as to deductibility contingent_compensation agreements generally invite scrutiny as a possible distribution of earnings but this court has upheld such agreements under appropriate circumstances see auto inv dev inc v commissioner tcmemo_1993_298 if a contingent_compensation agreement generates payments greater than the amounts that would otherwise be reasonable those payments are generally deductible only if they are paid pursuant to a free bargain between the employer and the individual the agreement is made before the services are rendered and the payments are not influenced by any consideration on the part of the employer other than that of securing the services of the individual on fair and advantageous terms sec_1_162-7 income_tax regs where there is no free bargain between the parties the contingent_compensation agreement is not dispositive as to what is deductible under sec_162 rather the court is free to make its own determination of what is reasonable_compensation pepsi-cola bottling co v commissioner f 2d pincite 425_f2d_31 7th cir aff’g tcmemo_1969_14 the u s court_of_appeals for the tenth circuit to which an appeal in this case would lie applies nine factors to determine the reasonableness of compensation with no factor being determinative the employee’s qualifications the nature extent and scope of the employee’s work the size and complexities of the business a comparison of salaries paid with the gross_income and net_income the prevailing economic conditions a comparison of salaries with distributions to shareholders the prevailing rates of compensation_for comparable positions in comparable concerns the salary policy of the taxpayer as to all employees and in the case of small corporations with a limited number of officers the amount of compensation paid to the particular employee in previous years pepsi-cola bottling co v commissioner f 2d pincite we do not undertake an exhaustive review of each factor to determine that mr wycoff’s compensation was unreasonable mr wycoff had not previously worked in retail or with companies that use direct response marketing in fact mr wycoff testified that he had to learn how direct response marketing worked which is why mr nunes determined that no increase to baseline compensation was warranted to account for mr wycoff’s characteristics the record also does not convince us that mr wycoff’s work was any more complex or extensive than that of a typical executive mr wycoff did work diligently for the operating companies and his other startups however he did not maintain any records reflecting what he did and for which companydollar_figure petitioners also appear to argue that multiple salaries should be aggregated to account for mr wycoff’s multiple roles this court has consistently rejected that argument see pepsi-cola bottling co v commissioner t c pincite richlands med ass’n v commissioner tcmemo_1990_660 aff’d without published opinion 953_f2d_639 4th cir ken miller supply inc v commissioner tcmemo_1978_228 petitioners owned the operating companies shareholder executive compensation in a closely_held_corporation that depletes most of a corporation’s value is generally unreasonable when the deductible salary expenses are a disguise for nondeductible profit distributions see 249_f3d_994 10th cir aff’g tcmemo_1999_211 in this case the management fee depleted most if not all of the operating companies’ profits the management fee in turn was used primarily to pay mr wycoff for example approximately of the management fee went to pay mr wycoff’s compensation in 30petitioners’ expert mr burns noted that mr wycoff claimed to work hours a day seven days a week and weeks a year with no vacation mr wycoff did not maintain logs of his hours and his testimony with respect to his hours was vague we do not find mr wycoff’s testimony credible with respect to his hours our conclusion that mr wycoff’s compensation was unreasonable for each year at issue is bolstered by the fact that the investment bank that petitioners had hired to advise them with respect to the potential sale of the operating companies found that mr wycoff was compensated in excess of market rates and his annual compensation should be approximately dollar_figure mr wycoff’s compensation including deferred_compensation was dollar_figure dollar_figure and dollar_figure in and respectively while mr wycoff’s duties remained constant from prior years to the years at issue mr wycoff received a substantial increase in compensation during the years at issue petitioners contend that a portion of mr wycoff’s compensation was compensation_for work completed before the years at issue see 281_us_115 holding that a taxpayer may deduct compensation paid in the current_year but for services provided in prior years however the record is completely devoid of any evidence proving that mr wycoff was underpaid before the years at issue or what would have constituted reasonable_compensation for those years even if mr wycoff had been underpaid for years before the years at issue the operating companies should have paid mr wycoff directly and not albion albion was not in existence before the years at issue and could not have provided services in summary mr wycoff’s compensation was unreasonable and mr nunes correctly adjusted mr wycoff’s compensation before calculating an arm’s-length management fee in calculating mr wycoff’s reasonable_compensation mr nunes analyzed executive compensation of companies engaged in selling cleaning products and found that mr wycoff’s compensation was substantially more mr nunes provided a list of companies and excluded companies that were dissimilar either by product or revenue we are not convinced that the operating companies’ activities were more complex than the companies that mr nunes relied on because the operating companies also sold cleaning products therefore we find mr nunes’ conclusions regarding mr wycoff’s reasonable_compensation reliable petitioners contend that even if mr nunes computed albion’s expenses including mr wycoff’s compensation correctly mr nunes did not use comparable companies however according to the management_contract albion was providing standard management services similar to those provided by the companies that mr nunes used in his analysis mr nunes’ report lists the comparable companies and describes the work each comparable company performed similarly to albion these companies provided management and consulting services to other companies while the record is vague as to exactly what albion did and for whom we accept mr nunes’ determination that albion provided routine management services petitioners further contend that mr nunes’ determination is not reliable because the cost markup was negative for and however product sales fell during and petitioners claim that this decline was due to the events of date petitioners also testified that a typical direct response marketing is usually profitable for only months assuming without deciding that these statements are true albion should have expected to recognize losses in and albion signed a long-term management_contract petitioners’ expert mr burns stated that the contract was rational from an economic perspective and that if albion oversaw a decline in sales its compensation would be reduced this ensured albion was incentivized to grow sales and that albion would share the risks with the product companies further even after the management fees are adjusted to an arm’s-length result for and the operating companies collectively recognized losses accordingly we find it rational that mr nunes concluded that after substantial declines in sales albion would recognize losses during and petitioners additionally contend that mr nunes’ reasonableness test which averaged the three-year operating margin to determine whether his analysis was consistent with an arm’s-length result was flawed because the test minimized the operating margin from petitioners’ most successful year the applicable regulations under sec_482 however provide that using multiyear data depends on the method being applied and the issue being addressed in various circumstances multiyear data may be considered in determining an arm’s- length result see sec_1_482-1 income_tax regs these circumstances include situations where complete and accurate data is available for the taxable_year under review the taxpayer’s industry is affected by business cycles or the product being examined is affected by a life cycle see id data from one or more years before or after the taxable_year under review must ordinarily be considered for purposes of applying the cpm id mr nunes applied the cpm which generally requires the use of data from one or more years mr nunes had complete and accurate data available from the operating companies’ and albion’s records additionally mr nunes determined and petitioners admitted that the operating companies were affected by macroeconomic recession and the products sold had a defined life cycle therefore the use of multiyear data was appropriate conclusion petitioners and their expert sec_31 have other criticisms of mr nunes’ report we do not find merit in these arguments and do not discuss them we conclude that mr nunes’ determination was reasonable and produced the most reliable measure of an arm’s-length result under the facts and circumstances see sec_1_482-1 income_tax regs determining the best_method depends on the comparability of the transaction or taxpayer and the quality of the data accordingly petitioners’ operating companies are entitled to the following deductions for management fees company sirius restore total dollar_figure big_number big_number dollar_figure big_number big_number dollar_figure big_number big_number iii sec_6662 penalties sec_6662 and b and authorizes the commissioner to impose a penalty on an underpayment_of_tax that is attributable to negligence or disregard of rules or regulations or any substantial_understatement_of_income_tax only one sec_6662 accuracy-related_penalty may be imposed with respect 31this includes the rebuttal report of mr wertlieb however we do not find mr wertlieb’s report persuasive and therefore we do not discuss it to any given portion of an underpayment 132_tc_161 aff’d 408_fedappx_908 6th cir sec_1_6662-2 income_tax regs the term negligence includes any failure to make a reasonable attempt to comply with the provisions of the internal revenue laws and the term disregard includes any careless reckless or intentional disregard sec_6662 sec_1 b and income_tax regs ‘negligence’ also includes any failure by the taxpayer to keep adequate books_and_records or to substantiate items properly sec_1_6662-3 income_tax regs disregard of rules or regulations is ‘careless’ if the taxpayer does not exercise reasonable diligence to determine the correctness of a return position and is ‘reckless’ if the taxpayer makes little or no effort to determine whether a rule_or_regulation exists under circumstances which demonstrate a substantial deviation from the standard of conduct that a reasonable person would observe id subpara see also 85_tc_934 an understatement means the excess of the amount of the tax required to be shown on the return over the amount of the tax imposed which is shown on the return reduced by any rebate sec_6662 an understatement is substantial in the case of an individual if the amount of the understatement for the taxable_year exceeds the greater of of the tax required to be shown on the return or dollar_figure sec_6662 the accuracy-related_penalty does not apply with respect to any portion of the underpayment for which the taxpayer shows that there was reasonable_cause and that he or she acted in good_faith sec_6664 the decision as to whether a taxpayer acted with reasonable_cause and in good_faith is made on a case-by-case basis taking into account all of the pertinent facts and circumstances including the experience knowledge and education of the taxpayer see sec_1 b income_tax regs circumstances that may indicate reasonable_cause and good_faith include an honest misunderstanding of fact or law that is reasonable in light of all of the facts and circumstances including the experience knowledge and education of the taxpayer id reliance on the advice of a tax professional may but does not necessarily establish reasonable_cause and good_faith for the purpose of avoiding a sec_6662 penalty 469_us_241 a taxpayer’s reliance on a competent tax professional may establish reasonable_cause and good_faith when the taxpayer provides necessary and accurate information to the adviser and the taxpayer reasonably relies in good_faith on the adviser’s judgment see 115_tc_43 aff’d 299_f3d_221 3d cir the commissioner bears the burden of production with respect to the taxpayer’s liability for the sec_6662 penalty and must produce sufficient evidence indicating that it is appropriate to impose the penalty see sec_7491 higbee v commissioner t c pincite once the commissioner meets his burden of production the taxpayer must come forward with persuasive evidence that the commissioner’s determination is incorrect or that the taxpayer had reasonable_cause or substantial_authority for the position see higbee v commissioner t c pincite although the parties made concessions before the start of trial and on brief and the court allowed the operating companies to partially deduct the management fees paid to albion the computations under rule will establish that there is a substantial_understatement_of_income_tax respondent has therefore satisfied his burden of production to the extent that the accuracy-related_penalty relates to a substantial_understatement_of_income_tax petitioners contend that they had reasonable_cause and acted in good_faith because they reasonably relied on the advice of tax professionals with respect to setting the management fee petitioners did not contend that they had reasonable_cause or acted in good_faith with respect to the nol therefore with respect to that portion of the underpayment petitioners are liable for accuracy-related_penalties under sec_6662 we next address whether petitioners reasonably relied on the advice of tax professionals with respect to setting the management fees paid to albion petitioners sought the advice of marshall stevens esop capital strategies group barry marlin and roland attenborough to determine the proper management fees that the operating companies should pay albion to determine the management fees petitioners’ tax advisers met with mr wycoff to understand the services albion would provide to the operating companies and researched caselaw with respect to reasonable_compensation petitioners were subsequently advised to set the rate of the management fees pincite of each operating company’s gross_receipts mr wycoff testified in great detail that companies using direct response marketing compensate differently from other companies however petitioners still relied on the advice of marshall stevens mr marlin and mr attenborough to determine the management fee both mr attenborough and marshall stevens were experienced in forming esops but were not experienced in determining an arm’s-length management fee petitioners also knew that mr attenborough was hired by marshall stevens to complete the transaction and that marshall stevens had an economic_interest in petitioners’ going forward with the transaction mr attenborough had an obvious conflict of interest that petitioners and mr marlin knew or should have known about see neonatology assocs p a v commissioner t c pincite additionally aside from the work that mr marlin completed for petitioners none of the advisers had experience with companies using direct response marketing mr marlin’s law practice focused on international tax and petitioners knew or should have known the planning at issue here did not involve any international tax issue petitioners did not consult an economist or any adviser with experience in determining an arm’s-length management fee to calculate the management fees the operating companies paid albion assuming that petitioners’ claims are true regarding direct response marketing a prudent business person in mr wycoff’s situation with similar experience knowledge and education would have sought the advice of an adviser with experience in direct response marketing and or calculating a reasonable management fee see sec_1_6664-4 income_tax regs we are not convinced petitioners reasonably relied on independent advisers who were competent in calculating a reasonable management fee and or executive compensation see neonatology assocs p a v commissioner t c pincite neither did petitioners introduce any documentary_evidence with respect how the management fees were determined petitioners claim a document existed but they claimed they did not have it see 6_tc_1158 stating that a taxpayer’s choosing not to present evidence within his or her possession gives rise to a presumption that it would have been unfavorable if it had petitioners’ advisers testified only vaguely regarding the determination of the management fees the advisers testified that the management fees were originally set pincite of gross_receipts because in caselaw they purportedly reviewed unidentified courts had held that percentage to be reasonabledollar_figure the advisers also met with mr wycoff to understand the services he provides but the record does not indicate whether mr wycoff provided all necessary and accurate information to petitioners’ advisers petitioners presented no credible_evidence that their advisers considered what 32on brief petitioners contend that the court erred in excluding testimony from frederick thomas president of marshall stevens petitioners contend that mr thomas could offer testimony of marshall stevens’ general business practices to prove that an analysis of a reasonable management fee would have been completed as part of the marshall stevens transaction petitioners’ tax advisers testified that an analysis was completed although petitioners’ tax advisers’ description of the analysis is vague we conclude that the testimony of mr thomas would not have been helpful to the court he has no personal knowledge of this particular transaction and other advisers with personal knowledge did testify comparable companies would pay for comparable services when calculating the management fees because the record is so vague as to how petitioners’ advisers calculated the management fees we cannot find that it was reasonable to rely on such an analysis petitioners also knew that the marshall stevens transaction was an aggressive tax planning program petitioners were warned that there were risks and were encouraged to seek independent counsel petitioners did not seek advice from independent counsel and from advisers with the requisite experience in short petitioners’ reliance on their tax advisers who were part of the promoter group was not reasonable accordingly we sustain accuracy-related_penalties under sec_6662 we have considered the parties’ remaining arguments and to the extent not discussed above conclude those arguments are irrelevant moot or without merit to reflect the foregoing decision will be entered under rule


internal_revenue_service number release date index number 2032a ----------------------------------------------------------- ----------------------- --------------------------------- re ------------------------------------- department of the treasury washington dc third party communication none date of communication not applicable_person to contact ---------------------- id no ------------------ telephone number ---------------------- refer reply to cc psi b4 plr-122920-18 date date legend decedent date date date date spouse administrator ad litem attorney accounting firm dear ------------------- -------------------------------------------------- ------------------ --------------------------- --------------------------- ------------------------ ------------------ ---------------------------- ------------------------------------------- ----------------------------------------------- this letter responds to your authorized representative’s letter of date requesting an extension of time pursuant to sec_301_9100-3 of the procedure and administration regulations to elect to specially value qualified_real_property under sec_2032a of the internal_revenue_code the facts and representations submitted are summarized as follows decedent died on date decedent named spouse as personal representative of his estate decedent’s estate included farmland spouse retained attorney to prepare and timely file decedent’s form_706 united_states estate and generation-skipping plr-122920-18 transfer_tax return attorney failed to advise spouse that the decedent’s estate had an option to elect to specially value the farmland under sec_2032a on date spouse timely filed form_706 however she failed to make the sec_2032a election on date court removed spouse as personal representative of decedent’s estate and appointed administrator ad litem to complete the administration of decedent’s estate administrator ad litem retained accounting firm to prepare and file any additional tax returns necessary to completion of the estate administration accounting firm failed to advise administrator ad litem of actions he could take to request an extension of time to make the sec_2032a election on date administrator ad litem filed a supplemental form_706 to correct errors on the original form_706 however he failed to make the sec_2032a election law and analysis sec_2001 imposes a tax on the transfer of the taxable_estate of every decedent who is a citizen or resident_of_the_united_states sec_2032a provides generally that if the decedent was at the time of his death a citizen or resident_of_the_united_states and the executor elections the application of sec_2032a and files the agreement referred to in sec_2032a then for purposes of chapter the value of qualified_real_property shall be its value for the use under which it qualifies under sec_2032a as qualified_real_property sec_2032a d provides that the election under sec_2032a shall be made on the return of tax imposed by sec_2001 such elections shall be made in such manner as the secretary shall by regulations prescribe such an election once made shall be irrevocable sec_301_9100-1 provides that the commissioner may grant a reasonable extension of time under the rules set forth in sec_301_9100-2 and sec_301_9100-3 to make a regulatory election or a statutory election but no more than six months except in the case of a taxpayer who is abroad under all subtitles of the code except subtitles e g h and i sec_301_9100-3 provides the standards the commissioner will use to determine whether to grant an extension of time to make an election whose due_date is prescribed by a regulation and not expressly provided by statute a request for relief under sec_301_9100-3 will be granted when the taxpayer provides evidence to establish to the satisfaction of the commissioner that the taxpayer acted reasonably and in good_faith and that granting relief will not prejudice the interests of the government plr-122920-18 sec_301_9100-3 provides that a taxpayer is deemed to have acted reasonably and in good_faith if the taxpayer reasonably relied on a qualified_tax professional including a tax professional employed by the taxpayer and the tax professional filed to make or advise the taxpayer to make the election based upon the facts submitted and the representations made we conclude that the requirements of sec_301_9100-1 and sec_301_9100-3 have been satisfied accordingly we grant an extension of time of days from the date of this letter to elect to specially value the farmland under sec_2032a the election should be made on a supplemental form_706 filed with the cincinnati service_center at the following address internal_revenue_service cincinnati service_center - stop cincinnati ohio a copy of this letter should be attached to the supplemental form sec_709 a copy is enclosed for this purpose except as expressly provided herein no opinion is expressed or implied concerning the tax consequences of any aspect of any transaction or item discussed or referenced in this letter specifically we express or imply no opinion on whether the estate qualifies for special_use_valuation under sec_2032a the rulings contained in this letter are based upon information and representations submitted by the taxpayer and accompanied by a penalty of perjury statement executed by an appropriate party while this office has not verified any of the material submitted in support of the request for rulings it is subject_to verification on examination this ruling is directed only to the taxpayer requesting it sec_6110 of the code provides that it may not be used or cited as precedent in accordance with the power_of_attorney on file with this office we have sent a copy of this letter to your authorized representative sincerely associate chief_counsel passthroughs special industries by lorraine e gardner lorraine e gardner senior counsel branch office of the associate chief_counsel passthroughs special industries enclosures copy of this letter copy for sec_6110 purposes


t c summary opinion united_states tax_court dean p murray and dionne a murray petitioners v commissioner of internal revenue respondent docket no 26966-10s filed date dean p murray and dionne a murray pro sese christopher a pavilonis for respondent summary opinion goeke judge this case was heard pursuant to the provisions of section of the internal_revenue_code pursuant to sec_7463 the decision to be 1unless otherwise indicated all section references are to the internal_revenue_code code in effect for the years at issue and all rule references are to the tax continued entered is not reviewable by any other court and this opinion shall not be treated as precedent for any other case in a notice_of_deficiency respondent determined the following deficiencies and accuracy-related_penalties with respect to petitioners’ federal_income_tax year deficiency dollar_figure big_number big_number penalty sec_6662 dollar_figure big_number big_number for each taxable_year in question the issues remaining for decision are whether petitioners are entitled to deduct certain unreimbursed employee business_expenses claimed on schedule a itemized_deductions whether petitioners are entitled to deduct certain business_expenses claimed on schedule c profit or loss from business and whether petitioners are liable for the accuracy-related_penalties under sec_6662 we hold that petitioners may not deduct any of the claimed expenditures and are liable for the sec_6662 accuracy-related_penalties for the years in issue continued court rules_of_practice and procedure 2all dollar amounts are rounded background petitioners resided in florida when they filed their petition they filed joint income_tax returns for the and taxable years petitioner dionne murray worked as an independent_contractor for ridgeland group homes inc ridgeland for all taxable years at issue--she reported her income and expenses on a schedule c that related to a patients’ care business she assisted patients living in a residential group home including transporting patients to doctor’s appointments each year she received a form 1099-misc miscellaneous income from ridgeland petitioner dean murray operated a trucking business during the taxable_year and reported the income and expenses on a schedule c he also worked for national freight inc national freight during and he received a form_w-2 wage and tax statement from national freight each year during mr murray used his personal truck for his trucking business and a company truck for his employment with national freight the patient care business respondent disallowed the following expenditures claimed for ms murray’s patient care business_expense advertising depreciation car and truck legal and professional services office repairs and maintenance supplies taxes and licenses travel dollar_figure big_number --- --- --- --- --- dollar_figure dollar_figure big_number big_number --- --- big_number --- big_number --- --- big_number big_number big_number big_number big_number deductible meals and entertainment --- storage --- --- ms murray was not sure whether certain expenses claimed for her patient care business were really attributable to mr murray’s trucking activities for example she did not incur advertising expenses for her patient care business in 2007--petitioners meant to claim the advertising expenses on the schedule c for mr murray’s trucking business moreover the claimed legal and professional services expense related to mr murray’s trucking business the office expense includes the purchase of a laptop and a cell phone although the total amount was estimated the storage expense was for a storage unit that held ms murray’s caregiving supplies and tires for mr murray’s truck the expense for taxes and licenses was not discussed at trial or made clear by the evidence the supplies expense was for uniforms ie scrubs and medical_supplies the meals and entertainment expense was for ms murray’s meals while transporting patients to doctor’s appointments petitioners owned a nissan quest and a hyundai accent in the nissan quest was purchased because the hyundai accent was in constant need of repairs and petitioners wanted a larger automobile for their family the claimed travel 3mr murray testified that the advertising consisted of internet cards and whatever opportunities that they had out there you try to put a little bit in there mr murray did not keep business cards and could not explain any specific advertising he did 4mr murray believed the claimed legal and professional services expense related to filing estimated_tax payments although there is no supporting documentation for them 5ms murray took her children to day care before work each morning expenses car expenses depreciation expense and repairs and maintenance_expenses all relate to costs associated with driving to and from the residential home and taking patients to appointments however ridgeland would reimburse ms murray for her gasoline expenses associated with transporting patients moreover ms murray did not keep a mileage log for either vehicle the trucking business respondent disallowed the following expenditures claimed for mr murray’s trucking business for 6the travel_expenses also included ms murray’s meals 7petitioners also deducted dollar_figure of depreciation expense for the trucking business while petitioners did not attach a depreciation schedule to their income_tax return they did attach form_4562 depreciation and amortization the form_4562 shows total depreciation of dollar_figure including dollar_figure of depreciation expense for the nissan quest purchased in dollar_figure for other depreciation and dollar_figure for assets placed_in_service in tax years beginning before finally petitioners did not explicitly deduct depreciation expense file a depreciation schedule or file form_4562 for the and tax years expense advertising car and truck depreciation insurance other than health legal and professional services office repairs and maintenance supplies taxes and licenses travel dollar_figure big_number big_number big_number big_number big_number big_number as discussed supra there is no supporting documentation for the claimed advertising expenditures nor could mr murray point to any specific advertising he did not maintain a mileage log and he estimated his car and truck expenses as discussed supra the depreciation expense related to mr murray’s truck although no supporting depreciation schedule was included with the return the insurance expense related to health insurance8 for the murray family and auto insurance on the truck some of the claimed legal and professional expenses were for fines mr murray received on account of his truck’s exceeding certain weight 8the health insurance should not have been reported with the auto insurance as line on the schedule c states insurance other than health requirements the supplies expense consisted of estimated expenditures made for tires and truck repairs the taxes and licenses expenses were not discussed at trial or made clear by the evidence finally the travel_expenses were for mr murray’s cell phone--he did not have a separate business phone while respondent disallowed all expenses claimed for the trucking business for he did allow a dollar_figure deduction for the trucking business on the basis of the average expenses for truckers as indicated in bizstats dollar_figure petitioners’ schedule a unreimbursed business_expenses respondent disallowed the following unreimbursed employee_business_expense sec_11 claimed on petitioners’ schedule a 9mr murray believed that his records discussed infra contained receipts for the claimed legal and professional expenses supplies expense and travel_expenses 10bizstats is a free online source for small_business statistics 11while respondent disallowed dollar_figure of unreimbursed business_expenses for petitioners deducted only dollar_figure it appears that respondent mistakenly included a dollar_figure deduction for tax preparation fees with the unreimbursed business_expenses we find no evidence in the record for the claimed dollar_figure deduction for tax preparation fees furthermore we choose not to address this discrepancy because the dollar_figure claimed deduction will not be deductible in any event--miscellaneous itemized_deductions which include tax preparation fees are only deductible to the extent the aggregate of such deductions exceed sec_2 of adjusted_gross_income sec_67 see eg solomon v commissioner tcmemo_2011_91 expense professional subscriptions dollar_figure --- dollar_figure uniforms and protective clothing big_number dollar_figure big_number job search costs work shoes and support work gear and equipment tolls parking and local travel big_number big_number big_number --- big_number big_number --- --- --- big_number the unreimbursed employee business_expenses all related to mr murray’s job as a truck driver the uniforms and protective clothing expenses were for clothing bearing the company’s logo hard boots and a hard hat these expenses were estimates the job search cost expenses were for the purchase and installation of a new engine12 for a nissan maxima although petitioners provided no supporting documentation mr murray could not recall what the or job search cost expenses were for nor could he remember what the work shoe and support expenses were for 12mr murray stated that the engine cost dollar_figure and it was installed by a friend petitioners’ records petitioners’ records consist of multiple envelopes divided into three groups according to the taxable year--2007 and each envelope within a group is labeled with an expense category--mainly automobile expenses office supplies meals and household expenses the expense categories do not reconcile with any deduction claimed on petitioners’ tax returns finally petitioners’ income_tax returns were signed by a third-party preparer notice_of_deficiency in a notice_of_deficiency respondent disallowed the schedule c expenses and schedule a unreimbursed business_expenses discussed supra and determined sec_6662 penalties the notice_of_deficiency informed petitioners that the claimed expenses were disallowed because you did not furnish information needed to support the claimed deduction although respondent did allow dollar_figure of expenses for mr murray’s trucking business for on the basis of the average annual trucker expenses reported in bizstats petitioners timely filed a petition with this court contesting the notice_of_deficiency discussion respondent contends that petitioners’ schedule a unreimbursed business_expenses should be disallowed because they are unsubstantiated or petitioners have not provided a statement from mr murray’s employer indicating whether the expenses were reimbursable moreover respondent asserts that petitioners’ schedule c expenses should be disallowed because they are unsubstantiated i burden_of_proof the commissioner’s determinations in a notice_of_deficiency are presumed correct and taxpayers bear the burden of proving that the commissioner’s determinations are incorrect rule a 290_us_111 deductions are a matter of legislative grace and taxpayers bear the burden of proving that they have met all requirements necessary to be entitled to the claimed deductions rule a 503_us_79 ii sec_162 pursuant to sec_162 a taxpayer is entitled to deduct all the ordinary and necessary expenses paid_or_incurred during the taxable_year in carrying on any trade_or_business such expenses must be directly connected with or pertain to the taxpayer’s trade_or_business sec_1_162-1 income_tax regs an expense is ordinary if it is normal usual or customary within a particular trade business or industry or arises from a transaction of common or frequent occurrence in the type of business involved 308_us_488 an expense is necessary if it is appropriate and helpful for the development of the business 320_us_467 in contrast except where specifically enumerated in the code no deductions are allowed for personal living or family_expenses sec_262 the determination of whether an expenditure satisfies the requirements of sec_162 is a question of fact commissioner v heininger u s pincite iii substantiating expenses taxpayers must keep such permanent books of account or records as are sufficient to establish the amount of gross_income deductions credits or other matters required to be shown by such person in any return of such tax or information sec_1_6001-1 income_tax regs when a taxpayer establishes that he or she has incurred deductible expenses but is unable to substantiate the exact amounts we can estimate the deductible amount but only if the taxpayer presents sufficient evidence to establish a rational basis for making the estimate see 39_f2d_540 2d cir 85_tc_731 in estimating the amount allowable we bear heavily against the taxpayer where the inexactitude of the record is of his or her own making see cohan v commissioner f 2d pincite moreover deductions relating to travel meals and entertainment and certain listed_property defined in sec_280f including passenger automobiles computers and cellular phones are subject_to strict rules of substantiation that supersede the doctrine in cohan v commissioner f 2d pincite see sec_274 sec_1_274-5t temporary income_tax regs fed reg date for deductions to which sec_274 applies a taxpayer must substantiate certain elements of the deductible activity or use through either adequate_records or sufficient evidence corroborating the taxpayer’s own statement sec_274 at a minimum a taxpayer must substantiate the amount of the expense the time and place the expense was incurred the business_purpose of the expense and the business relationship of the taxpayer to other persons benefited by the expense if any id 112_tc_183 if a taxpayer cannot satisfy the substantiation burden imposed by sec_274 with respect to a deduction to which it applies he fails to carry his burden of establishing that he is entitled to deduct that expense regardless of any equities involved sec_274 nicely v commissioner tcmemo_2006_172 sec_1_274-5t temporary income_tax regs fed reg date petitioners’ records are insufficient to substantiate any of the deductions in question the heightened substantiation requirements of sec_274 apply to petitioners’ deductions for travel meals and entertainment and all expenses related to the nissan quest car and truck expenses repairs and maintenance and depreciation petitioners have not met their burden with respect to any of the sec_274 expenditures nor have they met their burden with respect to any other deduction in dispute we are unable to reconcile petitioners’ records with any deduction claimed on their tax returns moreover we are unable to differentiate personal from business receipts in many circumstances and several receipts are clearly personal--ie receipts for women’s fragrances video rentals groceries children’s clothing etc furthermore petitioners testified that many of the expenses were estimates several of which appear to be duplicated or unreasonabledollar_figure finally petitioners are unable to provide any documentation for certain expenses nor are they able to explain many of the deductions accordingly none of the expenditures in dispute are deductible 13for example mr murray testified that he spent dollar_figure from on a hard hat boots and some clothing with a company logo on it iv sec_6662 accuracy-related_penalty respondent determined that petitioners are liable for sec_6662 accuracy-related_penalties for tax years and because the underpayments of income_tax resulted from negligence or disregard of rules or regulations under sec_7491 the commissioner bears the burden of production with regard to penalties and must come forward with sufficient evidence indicating that it is appropriate to impose penalties see 116_tc_438 however once the commissioner has met the burden of production the burden_of_proof remains with the taxpayer including the burden of proving that the penalties are inappropriate because of reasonable_cause or substantial_authority under sec_6664 see rule a higbee v commissioner t c pincite we find respondent has met the burden of production in the light of petitioners’ inability to substantiate the deductions they claimed sec_6662 defines negligence as including any failure to make a reasonable attempt to comply with the provisions of the code sec_6662 also defines disregard as any careless reckless or intentional disregard disregard of rules or regulations is careless if the taxpayer does not exercise reasonable diligence to determine the correctness of a tax return’s position that is contrary to rules or regulations sec_1_6662-3 income_tax regs an underpayment is not attributable to negligence or disregard to the extent that the taxpayer shows that the underpayment is due to the taxpayer’s having reasonable_cause and acting in good_faith sec_6664 115_tc_43 aff’d 299_f3d_221 3d cir reasonable_cause requires that the taxpayer exercise ordinary business care and prudence as to the disputed item see 469_us_241 110_tc_297 good-faith reliance on the advice of an independent competent professional as to the tax treatment of an item may meet this requirement see boyle u s pincite sec_1_6664-4 income_tax regs the decision as to whether a taxpayer acted with reasonable_cause and in good_faith is made on a case-by-case basis taking into account all of the pertinent facts and circumstances sec_1_6664-4 income_tax regs for a taxpayer to rely reasonably upon advice so as to possibly negate a sec_6662 accuracy-related_penalty determined by the commissioner the taxpayer must prove by a preponderance_of_the_evidence that the taxpayer meets each requirement of the following three-prong test the adviser was a competent professional who had sufficient expertise to justify reliance the taxpayer provided necessary and accurate information to the adviser and the taxpayer actually relied in good_faith on the adviser’s judgment neonatology assocs p a v commissioner t c pincite petitioners’ understatements of income_tax resulted from negligence and disregard for rules and regulations moreover petitioners have not shown that their underpayments of income_tax were due to reasonable_cause and good_faith while petitioners’ income_tax returns were signed by a third-party preparer there is no evidence that petitioners provided the preparer with accurate information or that the preparer was a competent tax professional whom they relied upon in preparing their returns conversely petitioners claimed several deductions on their returns on the basis of unreasonable estimations with no supporting documentation furthermore petitioners supported several of their deductions with receipts that were highly personal therefore we find petitioners are liable for the sec_6662 accuracy- related penalties determined by respondent for the years at issue v conclusion for the reasons stated herein we find petitioners are liable for the deficiencies in income_tax and sec_6662 accuracy-related_penalties for the and tax years to reflect the foregoing for respondent decision will be entered