Court Opinion

ID: 9928664
Source: CourtListenerOpinion
Date Created: 2024-01-31 20:03:17.370767+00
Date Added: 2024-06-11T09:52:52.645780
License: Public Domain

United States Tax Court

                             T.C. Memo. 2024-12

  CYNTHIA L. HUFFMAN AND ESTATE OF CHET S. HUFFMAN,
   DECEASED, CYNTHIA L. HUFFMAN, EXECUTOR, ET AL., 1
                      Petitioners

                                       v.

              COMMISSIONER OF INTERNAL REVENUE,
                          Respondent

                                  —————

Docket Nos. 3255-16, 3256-16,                         Filed January 31, 2024.
            3261-16, 3526-16.

                                  —————

Jonathan N. Kalinski, Robert Samuel Horwitz, Edward M. Robbins, Jr.,
and Evan J. Davis, for petitioners.

Aely K. Ullrich, Alan H. Cooper, D. Anthony Abernathy, and Trent D.
Usitalo, for respondent.

           MEMORANDUM FINDINGS OF FACT AND OPINION

       ASHFORD, Judge: The Internal Revenue Service (IRS or
respondent) determined the following deficiency in federal gift tax and
additions to tax for R. Lloyd (Lloyd) Huffman’s 2 2007 taxable year:

       1 Cases of the following petitioners are consolidated herewith: Infinity
Aerospace Inc., Docket No. 3256-16; Estate of R. Lloyd Huffman, Deceased, Raymond
Lance Huffman, Executor, Docket No. 3261-16; and Patricia Huffman, Docket No.
3526-16.
       2 After trial Lloyd died and was substituted for in this proceeding by his

executor, Raymond Lance Huffman.

                              Served 01/31/24
                                             2

[*2]                                                        Additions to Tax
         Year                Deficiency
                                                  § 6651(a)(1) 3          § 6651(a)(2)

        2007                $3,727,337              $838,651               $931,834

        The IRS determined the following deficiencies in federal gift tax
and additions to tax for Patricia (Patricia) Huffman’s 2007 taxable
year: 4

                                                            Additions to Tax
         Year                Deficiency
                                                   § 6651(a)(1)           § 6651(a)(2)

                            $3,727,337              $838,651               $931,834
        2007
                            10,297,337              2,316,901              2,574,334

       The IRS determined the following deficiencies in income tax,
additions to tax, and penalties for Chet S. (Chet) and Cynthia L. (Cindy)
Huffman’s 5 2008 and 2009 taxable years:

                                                      Additions to Tax/Penalties
         Year                Deficiency
                                                   § 6651(a)(1)            § 6662(a)

        2008                 $284,489                   –                   $56,898

        2009                 6,842,147             $1,591,748              1,368,429

        3 Unless otherwise indicated, statutory references are to the Internal Revenue

Code, Title 26 U.S.C. (Code), in effect at all relevant times, regulation references are
to the Code of Federal Regulations, Title 26 (Treas. Reg.), in effect at all relevant times,
and Rule references are to the Tax Court Rules of Practice and Procedure. Some
monetary amounts are rounded to the nearest dollar.
        4 The IRS issued two deficiency notices to Patricia for her 2007 taxable year.

       5 After trial Chet died and was substituted for in this proceeding by his

executor, Cindy.
                                           3

[*3] The IRS determined the following deficiencies in income tax,
additions to tax, and penalties for Infinity Aerospace, Inc.’s (Dukes’s) 6
2008–10 taxable years:

                                                    Additions to Tax/Penalties
        Year                Deficiency
                                                 § 6651(a)(1)            § 6662(a)

        2008               $1,411,852             $352,963               $282,370

        2009                 481,084               133,635                96,217

        2010               13,031,561             5,693,794             2,606,312

       After certain concessions by the parties in the Cindy and Estate
of Chet S. Huffman case and in the Dukes case, 7 the issues remaining
for decision are whether (1) Patricia and the Estate of Lloyd Huffman
made a taxable gift to Chet in 2007; (2) Patricia made a taxable gift to
Chet in 2007; (3) Patricia and the Estate of Lloyd Huffman are liable for

        6 Infinity Aerospace was formerly known as Dukes, Inc.; for convenience we

will throughout this Opinion refer to this corporation as Dukes.
        7 By way of a Stipulation of Settled Issues in the Cindy Huffman and Estate of

Chet S. Huffman case, the parties agree that Chet (now deceased) and Cindy are
(1) entitled to deduct losses on Schedules E, Supplemental Income and Loss, of
$580,310 and $379,481 for 2008 and 2009, respectively; (2) not entitled to a section 166
bad debt deduction of $571,000 nor a $571,000 capital loss deduction for 2008; (3) not
entitled to a section 170 charitable contribution deduction of $120,000 for 2008; and
(4) not subject to an increase in ordinary dividend income of $120,000 from Dukes for
2008.
        By way of a Stipulation of Settled Issues in the Dukes case, the parties agree
that (1) as part of the computation of “Capital Gain Net Income – Schedule D,” the
amount of “Cost or other basis of property sold” reflected on the Form 886–A,
Explanation of Items, attached to the notice of deficiency is increased to $18,079,778
for 2010; (2) Dukes is not entitled to deductions for legal and professional expenses of
$306,430, $152,875, and $87,727 for 2008–10, respectively; (3) Dukes is not entitled to
deductions for depreciation of $318,973, $644,250, and $104,148 for 2008–10,
respectively; (4) Dukes is not entitled to costs of goods sold of $587,239, $319,244, and
$63,544 for 2008–10, respectively; (5) Dukes is entitled to a net gain reduction of
$2,037,398 for 2010; (6) Dukes is entitled to a net operating loss carryback of
$2,578,291 from 2011 to either 2009 or 2010; and (7) Dukes is entitled to section 170
charitable contribution deductions of $20,000 and $100,000 for 2008 and 2009,
respectively. Additionally, on brief in the Dukes case, respondent concedes that the
section 6651(a)(1) addition to tax for 2010 should be reduced to $2,842,544.
                                    4

[*4] additions to tax pursuant to section 6651(a)(1) and (2) for 2007;
(4) Cindy and the Estate of Chet Huffman had ordinary dividend income
relating to the sale of Dukes to TransDigm, Inc. (TransDigm), in 2009;
(5) Cindy and the Estate of Chet Huffman are liable for accuracy-related
penalties under section 6662 for 2008 and 2009; (6) Cindy and the Estate
of Chet Huffman are liable for an addition to tax under section
6651(a)(1) for 2009; (7) Dukes is liable for tax on an increase to capital
gain net income for 2009; (8) Dukes is liable for additions to tax pursuant
to section 6651(a)(1) for 2008–10; and (9) Dukes is liable for accuracy-
related penalties pursuant to section 6662 for 2008–10.

      When the Petitions were timely filed in these cases, all petitioners
resided in California including Dukes, which maintained its principal
place of business in California. These cases were consolidated for
purposes of trial, briefing, and opinion pursuant to Rule 141(a).

                          FINDINGS OF FACT

      Some of the facts have been stipulated and are so found. The
Stipulation of Facts, the Supplemental Stipulation of Facts, and the
attached Exhibits are incorporated herein by this reference.

I.    Background of Dukes and the Huffman Family

      Dukes was incorporated in 1958 and headquartered in
Northridge, California.    It manufactured and supplied various
engineering components to the aerospace industry. Lloyd and Patricia
both worked for Dukes; he initially as a design engineer and she as a
bookkeeper.

      In 1970 Lloyd was made president of Dukes and acquired 113,365
shares in the company. During Lloyd’s time as president Dukes
employed two of Lloyd and Patricia’s sons: Randy and Lance (Randy and
Lance) Huffman.

      In January 1979 Lloyd and Patricia formed the Huffman Family
Trust (Trust). They appointed themselves trustees of the Trust. Lloyd
had his 113,365 shares in Dukes reissued to the Trust. The Trust
acquired an additional 5,000 shares in 1990.

      Lloyd held the position of Dukes president until 1987. He stepped
down from the role after suffering a near fatal car racing accident.
Within days of the accident, Lloyd and Patricia’s other son, Chet, was
                                      5

[*5] made chief executive officer (CEO) and issued 5,000 shares of
Dukes (representing 0.7% of the total outstanding shares).

       In March 1990 Lloyd and majority shareholder Robert L.
Barneson 8 entered into an agreement (Lloyd-Barneson agreement)
whereby Lloyd was granted the right to purchase Mr. Barneson’s shares.
At that time, Mr. Barneson owned 322,241 shares (representing 43% of
the total outstanding shares). The Lloyd-Barneson agreement entitled
Lloyd to purchase Mr. Barneson’s shares upon Mr. Barneson’s death or
by a right of first refusal for a price not to exceed $2 per share. There
was no specific termination or exercise date for purchasing the shares
in the agreement.

       In June 1993 Lloyd assigned his rights under the Lloyd-Barneson
agreement to Chet (Assignment agreement). In August 1993 Chet
exercised his assignee rights under the Lloyd-Barneson agreement. By
separate agreement (Chet-Barneson agreement), he agreed to pay Mr.
Barneson $150,000 for his 322,241 shares with $50,000 being paid upon
execution and the remaining $100,000 being paid in equal installments
over the following five years. As a result of the purchase, Chet became
the majority shareholder of Dukes with 43.7% of the total outstanding
shares.

      In November 1993 Chet entered into two additional right to
purchase agreements (RTP agreements)—one with Dukes Research and
Manufacturing, Inc. (DRM), and another with the Trust. DRM was an
S corporation owned entirely by Patricia; it owned 304,124 Dukes shares
(representing 40.5% of the total number outstanding). The Trust owned
118,635 Dukes shares (representing 15.8% of the total number
outstanding).

        For a sum of $2 and “other good and valuable consideration,” the
RTP agreements provided Chet with the right to purchase DRM’s and
the Trust’s Dukes shares for a price not to exceed $3.6 million and $1.4
million, respectively, upon the death of Lloyd and Patricia. Chet could
also purchase the shares by virtue of a right of first refusal. The right
of first refusal exempted offers from Randy and Lance, Chet’s brothers.
The parties executed an addendum to the RTP agreements that
provided Chet with the option to purchase the shares at any time, in
addition to the stated events in the agreements themselves.

      8 By January 1971 Mr. Barneson became the majority shareholder of Dukes.
                                    6

[*6] Chet was not permitted to sell, assign, or otherwise transfer his
rights under the RTP agreements without the consent of the owners.
For the RTP agreement between Chet and DRM, Chet had to obtain
DRM’s consent to override the alienability restrictions. For the RTP
agreement between Chet and the Trust, Chet had to obtain Lloyd and
Patricia’s consent to override the alienability restrictions.

      The RTP agreements provided that they were “not compensatory
in nature, rather the purpose [was] to retain the ownership of” Dukes
within the family. A tax opinion letter Chet obtained from the law firm
Proskauer Rose LLP (Proskauer) stated that the purpose behind the
RTP agreements “was not compensatory. It was not in connection with
the performance of services.”

II.   Dukes Under Chet’s Leadership

       Chet graduated from Pepperdine University in 1983 with a
bachelor’s degree in business management. He worked abroad after
college for approximately 14 months before returning stateside to work
in the off-road racing industry. After his father’s accident, he assumed
the role of Dukes’s CEO, at which time the company had annual revenue
of approximately $5 million. From 1993 to 2006 Chet’s salary ranged
from $65,000 to $85,000. In 2007 it increased to $147,000; at this time
the salary of Dukes’s only other paid officer was $243,300.

       Under Chet’s leadership Dukes expanded its product offerings
and implemented a new strategy for acquiring and maintaining
customers. When Chet started at Dukes, the company mainly produced
in-line boost pumps for piston aircrafts. In the early 1990s it began to
supply bleed air valves and landed a key contract with the U.S. Air
Force. This new product line enabled Dukes to build relationships with
manufacturers Hawker Beechcraft and Cessna. In the late 1990s Dukes
expanded into cabin pressure control systems.

       Chet also altered Dukes’s strategy for obtaining new business. In
the aerospace parts manufacturing industry, there is a division of how
parts are incorporated within an aircraft, both in its original design and
in its maintenance and repairs. The original equipment manufacturer
(OEM) is the parts supplier to the aircraft manufacturer. To become an
OEM, an aircraft parts supplier will solicit parts specification requests
from aircraft manufacturers. These are parts that will be incorporated
into the aircraft’s final design. The parts supplier will then design a
part and bid it to the aircraft manufacturer. If the aircraft manufacturer
                                   7

[*7] accepts the bid, it will then subject the part to testing, and upon
passing the tests, the part will be incorporated into the aircraft.

       There is also an aftermarket process by which aircraft parts
suppliers may generate business. It involves selling the products to the
purchasers of the aircrafts. The Federal Aviation Administration (FAA)
has a separate process for this known as Parts & Manufacturing
Approval (PMA).       In this alternative process the aircraft parts
manufacturer would design a product, seek certification of the part by
the FAA, and then sell it directly in the aftermarket. The benefit of
selling via the PMA process was higher profit margins. The aircraft
manufacturer typically purchases parts from the OEM at much lower
prices than it will the spare or replacement parts. Chet used the PMA
process to expand Dukes customer base as well as enhance its
profitability.

        In addition to expanding the company’s product line and altering
its strategy for acquiring new business, Chet networked extensively and
strived to acquire and maintain a strong workforce. By expanding into
the bleed air valve industry, Chet was able to become personally
acquainted with Hawker Beechcraft’s president.           Through that
relationship Chet became a member of the General Aviation
Manufacturers Association (GAMA), a lobbying organization for private
aircraft. Most other GAMA members were industry leaders: presidents
and other corporate executives of major aerospace companies. This
allowed Chet to meet and develop personal relationships with customers
and competitors alike.

      Chet expanded and maintained Dukes’s human capital as well.
When he began with Dukes in the late 1980s, Dukes had approximately
five engineering employees, one of whom was a part-time sales
representative. By 2007 he had expanded the engineering team to
include 18 full-time employees.      Despite a competitive hiring
environment, Dukes was able to keep its employee turnover low. It did
so by instituting a four-day work week and offering deferred
compensation plans for engineering employees, among other incentives.
Under Chet’s leadership Dukes experienced significant growth, and by
the end of fiscal year 2006 it had annual revenue of approximately
$28.14 million.

      Over the years, members of the Huffman family formed and
acquired various business entities to support Dukes’s operations. On
June 25, 2001, Chet and Cindy formed CCC&B, LLC (CCC&B), as equal
                                   8

[*8] 50% owners. They formed CCC&B as a holding company for
various intellectual property assets, including several licensing
agreements with Honeywell Intellectual Properties, Inc. (Honeywell).
CCC&B entered into sublicensing agreements for the Honeywell
licenses with Dukes and another affiliate, PMA Sales, Inc. (PMA Sales).
PMA Sales—owned 60% by Chet Huffman and 40% by Robb Watts—
acted as a distributor for Dukes and specialized in aftermarket sales.

       On January 1, 2005, CCC&B entered into an asset purchase and
sale agreement with GST Industries, Inc., a California corporation that
manufactured and assembled hydraulic and electro-mechanical
components for the U.S. military. CCC&B then organized a new Arizona
corporation, also named GST Industries, Inc. (GST), and transferred all
of the acquired tangible operating assets to that entity.

       Members of the Huffman family formed various business entities
to lease employees and manufacturing equipment to Dukes. As of June
30, 2008, there were three leasing companies: (1) Aviation
Manufacturing & Design Corp. (AMDC); (2) DRM; and (3) TRD of
California, Inc. (TRD). Dukes was the only customer of each of the three
leasing companies. The ownership of the leasing companies is set forth
below:

       Entity        Chet         Lloyd       Patricia       Randy

       AMDC          57%          43%              –            –

       DRM            –            –              100%          –

       TRD           66%           –               –          34%

III.     Hanwha’s Proposed Acquisition of Dukes

      In the early 2000s Chet began receiving correspondence from
parties interested in acquiring Dukes. He rejected the offers because
the company was not for sale. This changed in 2007 when Deloitte
Corporate Finance, LLC (Deloitte), contacted Chet regarding a potential
acquisition by its client, Hanwha Corp. (Hanwha), a Korean company.

      In September 2007 Dukes and Hanwha entered into a nonbinding
memorandum of understanding (MOU), which provided the terms of a
tentative stock acquisition for a purchase price between $85 million and
                                   9

[*9] $105 million, depending on the due diligence findings. The MOU
also contemplated a reorganization before any sale. The following
Dukes-affiliated entities would transfer their assets to Dukes:
(1) CCC&B; (2) DRM; (3) TRD; and (4) AMDC. Chet would then form
the Dukes Group, LLC (Dukes Group), and transfer all of the Dukes
shares to the new entity. Chet would also transfer all GST shares to
Dukes Group. The result would be that Dukes Group would be the sole
shareholder of Dukes and GST with Chet as the sole member of Dukes
Group.

       On October 15, 2007, Chet exercised his rights under the RTP
agreements, purchasing all of the Trust’s and DRM’s Dukes shares for
$1.4 million and $3.6 million, respectively. This equates to $11.83 per
share. He paid for the shares with a promissory note secured by the
shares. At this point he owned 100% of the outstanding stock of Dukes.
On June 23, 2008, Chet formed Dukes Group under Nevada law, electing
to treat it as a disregarded entity. He was the managing member and
100% owner. On June 30, 2008, he transferred all of the stock of Dukes
and GST to Dukes Group.

     As part of the proposed consolidation, Chet caused AMDC, TRD,
DRM, and CCC&B to each enter into asset purchase agreements with
Dukes. These agreements were effective as of June 30, 2008.

      The AMDC Agreement provided that Dukes would pay AMDC
$39,929; the parties would void an employee leasing agreement; and
AMDC would forgive a $148,508 debt owed by Dukes. The TRD
agreement provided that Dukes would pay TRD $41,404; the parties
would void an employee leasing agreement and an equipment leasing
agreement; and TRD would forgive a $42,123 debt owed by Dukes. The
DRM agreement provided that Dukes would pay DRM $85,155; the
parties would void an employee leasing agreement; DRM would forgive
a $465,000 debt owed by Dukes; and Dukes would assume three third-
party contracts. The CCC&B agreement (CCC&B-Dukes agreement)
provided that Dukes would forgive a $904,221 debt owed by CCC&B; the
parties would void a licensing agreement between Dukes and CCC&B;
and Dukes would assume three third-party contracts.

        On February 23, 2009, Hanwha sent a letter to Chet stating that
it no longer wished to acquire Dukes. The letter informed him that after
considering economic conditions and reviewing Dukes’s 2007 and 2008
financial statements, Hanwha had concluded that an acquisition would
not be in Hanwha’s best interest.
                                    10

[*10] After the failed acquisition, Chet caused CCC&B and Dukes to
enter into a modification of the CCC&B-Dukes agreement (Additional
License Modification or ALM). The ALM was effective as of June 30,
2008. It provided that the original asset purchase agreement between
Dukes and CCC&B would be extended to the date of any eventual sale
to a third party. It also provided that the consideration for a future sale
of Dukes would include any additional Honeywell licenses acquired by
CCC&B and that they would be sold for their fair market value at the
time of sale. The ALM also stated that CCC&B would be the direct
payee for any portion of the purchase price attributable to the Honeywell
licenses and any associated goodwill.

      Chet caused CCC&B to enter a second modification (Correcting
Amendment) of the CCC&B-Dukes agreement.                The Correcting
Amendment was dated March 1, 2011, with an effective date of June 30,
2008. In addition to the consideration stated in the CCC&B-Dukes
agreement, the Correcting Amendment provided that Dukes would pay
CCC&B the fair market value of its assets as of the closing date.

IV.   TransDigm’s Acquisition of Dukes

      After Hanwha decided not to acquire Dukes and its affiliates,
Chet continued to pursue a sale of Dukes. On March 25, 2009, he
entered into an agreement on behalf of Dukes with Deloitte to provide
corporate finance advisory services. This agreement provided that
Deloitte would assist Dukes in developing a brochure—the Confidential
Information Memorandum (CIM)—to describe the company, as well as
assist Dukes in marketing the business, selecting a buyer, and
performing due diligence. Deloitte ultimately distributed the CIM to
approximately 40 potential buyers. Dukes chose to pursue negotiation
with TransDigm.

       On September 2, 2009, TransDigm sent a letter of intent to
Dukes, which was approved the same day by Chet as the sole director of
Dukes. On December 1, 2009, Dukes and TransDigm entered into an
asset purchase agreement (Dukes-TransDigm agreement).               The
agreement provided for a $95.75 million purchase price, all of which
would be wired to the sellers at closing, save for $10.5 million which
would be held in escrow for 24 months. In addition to the base purchase
price, the agreement provided Dukes with an earn-out of up to $60
million. The assets acquired by TransDigm were transferred to a newly
formed subsidiary of TransDigm, Dukes Aerospace, Inc. (Dukes
Aerospace).
                                   11

[*11] The assets sold as part of the Dukes-TransDigm agreement
included goodwill, which the agreement defined as “[a]ll goodwill
associated with the Business, including any personal goodwill of Chet
Huffman . . . as it relates to the Purchased Assets and the Business.”
TransDigm was also required to engage the investment bank and
advisory firm Stout Risius Ross, Inc. (SRR), to prepare a valuation of the
purchased assets and allocate the purchase price among those assets.

      Dukes was then required to engage an independent valuation
expert, other than Deloitte, to perform an additional valuation to
determine what portion of the purchase price allocated to goodwill (by
SRR) should be considered Chet’s personal goodwill versus the
company’s enterprise goodwill. The final allocation of the purchase price
was to be binding on the parties.

       In accordance with the Dukes-TransDigm agreement, TransDigm
engaged SRR to perform the asset valuation and purchase price
allocation. SRR allocated $50.042 million to goodwill. Dukes engaged
the consulting firm Duff & Phelps, LLC (Duff & Phelps), to perform the
additional valuation and the allocation of the purchase price among
the goodwill subcategories. TransDigm approved Duff & Phelps as the
designated appraiser.

       On June 10, 2010, Duff & Phelps rendered its valuation opinion,
finding that Chet’s personal goodwill accounted for $21.8 million of the
total $50.042 million (reached by SRR). Duff & Phelps determined that
$17.4 million was attributable to Chet’s relationships with clients and
$4.4 million was attributable to his relationships with Dukes’s key
employees. Shortly before trial, Duff & Phelps revised its valuation of
Chet’s personal goodwill to $19.2 million to account for an 18-month
expected lag time in Chet’s ability to compete.

       As part of the Dukes-TransDigm agreement, Chet entered into a
noncompete agreement with Dukes Aerospace and TransDigm. The
term of the agreement was four years.           The Dukes-TransDigm
agreement also required that PMA Sales execute an agreement
relinquishing its rights to the Honeywell licenses that it entered into in
2001 and 2003. Pursuant to this agreement, PMA Sales agreed not to
seek parts manufacturer approval from the FAA for four years. Finally,
the Dukes-TransDigm agreement provided that the transaction and the
legal relations between the parties would be governed by the laws of the
State of California.
                                         12

[*12] In April 2010 Chet stopped working at the Dukes Aerospace
facility. 9 On August 23, 2011, Chet, Dukes, GST, and Dukes Group filed
a complaint against TransDigm and Dukes Aerospace in the Los
Angeles County Superior Court, asserting claims for contractual fraud
relating to the Dukes-TransDigm agreement. The parties to that suit
eventually settled the matter, agreeing to extend the term of Chet’s
noncompetition agreement to nine years and requiring him to sell his
interest in PMA Sales, among other terms.

V.     Preparation of Tax Returns

        Beginning in the early 1990s, Dukes and the Huffman family
engaged A.R. Beckman and his son Ron Beckman (Mr. Beckman) to
prepare the company’s and the family’s tax returns. After A.R. Beckman
passed away, Mr. Beckman took over the practice, employing another
certified public accountant (CPA), Tammy Ross-Stearn. Chet hired Mr.
Beckman as chief financial officer of Dukes in 2004. Ms. Ross-Stearn
took over Mr. Beckman’s accounting practice and the responsibility of
filing returns on behalf of the Huffman family, Dukes, and all Dukes
affiliates.

       Ms. Ross-Stearn continued to provide accounting and tax
advisory services to the family and Dukes until August 28, 2009, when
she terminated the relationship by letter. The termination letter
indicated that Dukes should immediately retain a new accounting firm
since the 2007 and 2008 returns were coming due. At the same time the
IRS was conducting an audit of Dukes’s 2006 Form 1120, U.S.
Corporation Income Tax Return.

       In November 2009 Mr. Beckman contacted a new CPA, Craig
Whitfield, about being retained as accountant for the Huffman family
and Dukes. Mr. Whitfield was formally engaged on January 4, 2010.
His first task was obtaining his new clients’ books and records for the
year under audit, the delinquent tax returns, and those coming due. He
reached out to Ms. Ross-Stearn for this information; she indicated that
all the records had been sent to Dukes’s Northridge, California, facility
after TransDigm’s acquisition.

      Mr. Whitfield thereafter directed his requests to TransDigm’s
corporate controller, Sean Maroney. After speaking with Mr. Maroney

        9 At a February 3, 2012, meeting of the board of directors of Dukes Aerospace,

Chet’s employment with Dukes Aerospace was terminated, effective immediately.
                                   13

[*13] in January 2010, TransDigm compiled the documents and shipped
some 40 boxes to Mr. Whitfield. The boxes began arriving at the end of
March and early April 2010.         The financial statements were
unorganized and incomplete.

       On May 14, 2010, Mr. Whitfield sent Ms. Ross-Stearn a formal
Circular 230 demand letter, requesting access to Dukes’s client records
for the fiscal year ending June 30, 2007 (the return for this year was
then under audit). This led to a meeting with Ms. Ross-Stearn on June
1, 2010, wherein she provided the trial balance and general ledger of
Dukes for the year ending June 30, 2007. Ms. Ross-Stearn asserted that
all other documents were in TransDigm’s possession.

       After speaking with Ms. Ross-Stearn, Mr. Whitfield reached out
to BDO Seidman, LLP, and obtained the financial statements it had
prepared on behalf of Dukes for fiscal years ending 2007–09. Mr.
Whitfield shared these documents with the IRS revenue agent in charge
of the audit investigation. He also used the documents to begin filing
returns on behalf of Dukes, the Dukes affiliates, and the Huffman
family. Mr. Whitfield engaged another CPA, Mark Hutchinson (a
partner at the accounting firm Rothstein Kass), to assist in the filing of
the returns. Mr. Hutchinson also tried to reach Ms. Ross-Stearn, but
she did not return his calls.

       Mr. Hutchinson filed Chet and Cindy’s 2008 and 2009 Forms
1040, U.S. Individual Income Tax Return, on January 31 and March 8,
2011, respectively. He filed CCC&B’s 2009 Form 1065, U.S. Return of
Partnership Income, in March 2011; on that return he reported
approximately $12.692 million in gain from the sale of CCC&B’s
intellectual property assets. As the members of CCC&B, Chet and
Cindy reported the intellectual property sale proceeds as section 1231
gain on their 2009 Form 1040.

       Mr. Hutchinson filed Dukes’s 2008–10 Forms 1120 on June 22,
September 7, and November 22, 2011, respectively. Mr. Hutchinson
filed separately Patricia and Lloyd’s gift tax returns for 2007 on
December 27, 2010.

      On October 31, 2014, the IRS issued Letters 950-Z (30-day letter)
to Chet and Cindy, as well as to Dukes. The letters stated that they had
30 days to review the proposed adjustments and seek a review from the
                                           14

[*14] IRS Office of Appeals; 10 otherwise a notice of deficiency would be
forthcoming. IRS Team Manager Bryant Stanik signed each 30-day
letter; he was the immediate supervisor of the individual who made the
initial penalty determinations that were reflected in each letter. Chet
and Cindy, as well as Dukes, did not reach a resolution of their cases at
Appeals. On November 12, 2015, the IRS issued notices of deficiency. 11

                                      OPINION

       There are two primary issues in these cases: (1) whether Patricia
and the Estate of Lloyd Huffman made a taxable gift when Chet
exercised his rights in the RTP Agreements in 2007, buying DRM’s and
the Trust’s shares in Dukes for $5 million; and (2) whether Cindy and
the Estate of Chet Huffman, as well as Dukes, properly reported the
gain from the sale proceeds of the TransDigm acquisition in 2009 related
to Chet’s personal goodwill and CCC&B’s intellectual property assets.
The ancillary issue is whether petitioners are liable for certain accuracy-
related penalties and additions to tax.

I.      Burden of Proof Generally

       Generally, the Commissioner’s determinations set forth in a
notice of deficiency are presumed correct, and taxpayers bear the burden
of showing the determinations are erroneous. Rule 142(a); Welch
v. Helvering, 290 U.S. 111, 115 (1933). Section 7491(a) provides an
exception that shifts the burden of proof to the Commissioner as to any
factual issue relevant to the taxpayer’s tax liability if the taxpayer
introduces credible evidence with respect to the issue and meets certain
other conditions. See § 7491(a)(2).

       Petitioners argue that respondent bears the burden of proof on all
issues because respondent asserted valuations at trial that differed from
those in the notices of deficiency. In the notices of deficiency the IRS
valued DRM’s and the Trust’s shares in Dukes as of October 15, 2007,

        10 On July 1, 2019, the IRS Office of Appeals was renamed the IRS Independent

Office of Appeals. See Taxpayer First Act, Pub. L. No. 116-25, § 1001, 133 Stat. 981,
983 (2019). We will use the name in effect at the times relevant to these cases, i.e., the
Office of Appeals or Appeals.
         11 Patricia was issued two notices of deficiency.       One indicated her joint
liability—with Lloyd—for the gift tax and additions to tax associated with the Trust’s
shares. Lloyd received an identical deficiency notice for the liability associated with
the Trust’s shares. The second notice of deficiency that Patricia received indicated her
sole liability for the gift tax and additions to tax associated with DRM’s shares.
                                   15

[*15] at $23.9 million and $9.3 million, respectively. The IRS valued
Chet’s personal goodwill at zero. At trial respondent’s expert testified
that DRM’s and the Trust’s shares were worth $22.5 million and $8.8
million, respectively. Respondent’s expert testified that Chet’s personal
goodwill was worth $3.9 million.

      Petitioners argue that Estate of Simplot v. Commissioner, 249
F.3d 1191, 1193 (9th Cir. 2001), rev’g and remanding 112 T.C. 130
(1999), and Estate of Mitchell v. Commissioner, 250 F.3d 696, 702 (9th
Cir. 2001), aff’g in part, vacating and remanding in part T.C. Memo.
1997-461, prove their point. We agree in part.

        In Estate of Simplot v. Commissioner, 249 F.3d at 1193, the
Commissioner conceded that the assessed deficiency was erroneous,
thus forfeiting the presumption of correctness. In Estate of Mitchell v.
Commissioner, 250 F.3d at 702, the Commissioner concluded in the
notice of deficiency that the stock at issue was worth $105 million; at
trial, the Commissioner’s expert valued the stock at $81 million. This
represented a 19% deviation. The U.S. Court of Appeals for the Ninth
Circuit determined that this change in value rendered the
Commissioner’s initial assessment “arbitrary and excessive,” and
therefore the Commissioner had the burden of proving whether a
deficiency existed and if so the amount. Id.

       Respondent has not conceded that the deficiency notice
determinations were erroneous; therefore, Estate of Simplot is
inapposite. Respondent did, however, alter his valuations. At trial
respondent’s expert valued DRM’s and the Trust’s shares at amounts
that represent a 6% and a 5% change, respectively. We do not think this
makes respondent’s initial valuation arbitrary and excessive. These
figures are still entitled to a presumption of correctness.

       The IRS determined in the notices of deficiency that no amount
should have been attributed to Chet’s personal goodwill. In pretrial
briefing, respondent offered the alternative position that Chet’s personal
goodwill should be valued at $3.9 million.

       On the basis of the Ninth Circuit’s analysis in Estate of Mitchell,
we agree with petitioners that the IRS’s initial determination as to the
personal goodwill was arbitrary. See id. at 703. Respondent bears the
burden of proof on the issue of valuing Chet’s personal goodwill as it
relates to the TransDigm acquisition of Dukes in 2009. All other
determinations retain the presumption of correctness.
                                    16

[*16] II.   Gift Tax Issue

       Respondent asserts that Patricia and the Estate of Lloyd
Huffman are liable for gift tax arising from the sale of Dukes shares to
Chet in 2007 when he exercised the options in the RTP agreements. To
that point respondent argues that the RTP agreements are not
controlling as to the fair market value of the shares, i.e., the shares were
not in fact worth $5 million in 2007.

      Respondent contends that the shares were worth approximately
$31.3 million and so the differential value between the purchase price
and the true fair market value should be deemed a gift. Petitioners
maintain that the RTP Agreements were valid business arrangements
and therefore should be conclusive as to the value of the Dukes shares.
We agree with respondent that the RTP Agreements should be
disregarded. We ascertain the proper value below.

       A.    Section 2703

       Section 2703(a)(1) provides that the value of any property must
be determined without regard to “any option, agreement, or other right
to acquire or use the property at a price less than the fair market value
of the property (without regard to such option, agreement, or right).”
Section 2703(b) provides an exception to section 2703(a) for any option,
agreement, right, or restriction that meets all of the following
requirements: (1) it is a bona fide business arrangement; (2) it is not a
device to transfer such property to members of the decedent’s family for
less than full and adequate consideration in money or money’s worth;
and (3) its terms are comparable to similar arrangements entered into
by persons in an arm’s-length transaction.

       If section 2703(b) requirements are satisfied, then the agreement
may be respected for valuation purposes. See Holman v. Commissioner,
130 T.C. 170, 191 (2008), aff’d, 601 F.3d 763 (8th Cir. 2010). To meet
the first requirement of section 2703(b), an “agreement must further
some business purpose.” Estate of Amlie v. Commissioner, T.C. Memo.
2006-76, slip op. at 33. Maintaining managerial control or family
ownership satisfies section 2703(b)(1). See Holman, 130 T.C. at 194
(“[B]uy-sell agreements serve a legitimate purpose in maintaining
control of a closely held business.”).

       For the second requirement of section 2703(b), we consider the
totality of the facts and circumstances.       Estate of Morrissette
v. Commissioner, T.C. Memo. 2021-60, at *100. Whether an agreement
                                   17

[*17] “constitutes a testamentary device depends in part on the fairness
of the consideration received by the transferor when it executed the
transaction.”    Id. (emphasis added) (citing Estate of True v.
Commissioner, T.C. Memo. 2001-167, aff’d, 390 F.3d 1210 (10th Cir.
2004)).

       The regulations provide guidance on the final requirement of
section 2703(b):

      A right or restriction is treated as comparable to similar
      arrangements entered into by persons in an arm’s length
      transaction if the right or restriction is one that could have
      been obtained in a fair bargain among unrelated parties in
      the same business dealing with each other at arm’s length.

Treas. Reg. § 25.2703-1(b)(4)(i). “A right or restriction is considered a
fair bargain among unrelated parties in the same business if it conforms
with the general practice of unrelated parties under negotiated
agreements in the same business.” Id. This determination will
generally entail consideration of the following factors: (1) the expected
term of the agreement; (2) the current fair market value of the property;
(3) the anticipated changes in value during the term of the arrangement;
and (4) the adequacy of any consideration given in exchange for the
rights granted. Id.

       This Court has described the final prong of the section 2703(b)
exception as “more of a safe harbor than an absolute requirement that
multiple comparables be shown.” Estate of Morrisette, T.C. Memo. 2021-
60, at *103 (quoting Estate of Amlie, T.C. Memo. 2006-76, slip op. at 41).
It is therefore permissible to use an isolated comparable to establish
that section 2703(b)(3) is satisfied. Estate of Amlie, T.C. Memo. 2006-
76, slip op. at 41.

      B.     Analysis of the RTP Agreements

       On the basis of the interrelatedness of the parties to the RTP
agreements, we review them with respect to section 2703 with a
heightened level of scrutiny. See Estate of True, T.C. Memo. 2001-167,
slip op. at 72 (“In evaluating whether buy-sell agreements were
substitutes for testamentary dispositions, greater scrutiny was applied
to intrafamily agreements restricting stock transfers in closely held
businesses than to similar agreements between unrelated parties.”).
                                   18

[*18] The parties agree that the first requirement of section 2703(b) is
satisfied given that the stated purpose of the RTP agreements was to
“retain ownership of the Dukes Shares within the Huffman Family.” See
Holman, 130 T.C. at 194. The parties disagree as to the other
requirements, which we discuss below.

             1.    Whether the RTP Agreements Were a Testamentary
                   Device

       Respondent asserts that Chet paid less than adequate
consideration when he entered into the RTP agreements. According to
respondent’s expert, Joseph Ruble of Caliber Advisers, Inc., the RTP
agreements were together worth approximately $79,800 in 1993 when
they were executed. Chet paid only the stated consideration of $2 for
these rights.

       Petitioners put forth two alternative arguments on the basis of
their expert’s valuation of the agreements. They first argue that the
RTP agreements were worth only $2 each, and so Chet did in fact pay
the full consideration. Petitioners’ expert, Curtis Kimball of Willamette
Management Associates, asserted in his report that $2 is the correct
value “if Dukes simply continued to be operated by the Owners without
any change in strategy or inputs from an incentivized Grantee.”

       Petitioners alternatively assert that the rights under the RTP
agreements were worth $77,850 “if Dukes was operated by the Owners
with changes in strategy and inputs from an incentivized Grantee.”
They argue that notwithstanding this higher valuation, Chet still paid
full consideration, not in dollars up front but in reduced compensation
from the time he became CEO until the time he sold the company. From
1993 to 2006, Chet’s salary ranged from $65,000 to $85,000. In 2007 it
increased to $147,000 but was far less than the only other paid officer’s
salary of $243,300. This, petitioners argue, led to Chet’s forgoing
approximately $3.5 million in compensation over the years.

      Petitioners contend that the RTP agreements contemplated
reduced compensation as a form of payment because each stated that
the agreements were entered into for “Two Dollars ($2.00) and for other
good and valuable consideration.” They argue then that the “other good
and valuable consideration” was the reduced compensation.

       Respondent     disagrees    with petitioners   that   reduced
compensation could have formed part of the consideration that Chet
paid for the rights under the RTP agreements. Respondent points to the
                                  19

[*19] text of the agreements, which each state that “this Agreement is
not compensatory in nature, rather the purpose is to retain the
ownership of” Dukes within the family. Respondent also notes that a
tax opinion letter Chet obtained from Proskauer came to the same
conclusion, noting that the purpose behind the RTP agreements “was
not compensatory. It was not in connection with the performance of
services.”

      We agree with respondent that the rights associated with the RTP
agreements were worth substantially more than $2. This finding is
supported by both parties’ experts’ valuations of the agreements. Still,
we do not think that the RTP agreements were a testamentary device
by which Lloyd and Patricia attempted to pass assets on to their son
Chet. We make this determination on the basis of all of the facts and
circumstances involved. See Estate of Morrisette, T.C. Memo. 2021-60,
at *100.

       If we viewed the exchange of $2 for the rights under the RTP
agreements without considering the circumstances, we would agree that
this was an inequitable exchange. While we take note that the
agreements themselves purported not to be compensatory, Chet did
accept a reduced salary during his years as Dukes’s CEO. Given his
significant contributions to the company, we think that his reduced
salary should be deemed consideration for the RTP agreements.

      We note the significant amount of earnings growth that would
have had to occur for the options to become “in the money.” According
to respondent’s expert, the Dukes shares were worth approximately
$0.51 per share in 1993; petitioners’ expert says they were worth
approximately $0.47 per share. In 2007 Chet was able to purchase the
shares for $11.83 per share. If we average the parties’ per-share 1993
values ($0.49 per share), the Dukes shares that Chet purchased in 2007
had increased in value by 2,414%.

      We view this level of growth as unusual and unexpected. It is
supported by the 1993 transaction by which Chet purchased
Mr. Barneson’s shares for $150,000. Chet and Mr. Barneson—unrelated
parties—reached this figure by estimating annual revenue growth for
Dukes at 4% per year. Using a 4% growth rate, the shares that Chet
was able to purchase via the RTP agreements would have taken between
50 and 70 years to reach an “in the money” value.
                                   20

[*20] We also note that the RTP agreements—though negotiated
among family members—did have the characteristics of an arm’s-length
transaction. Both parties were motivated to reach a fair price. Lloyd
and Patricia were willing to part with their shares only for $5 million—
an amount which they considered sufficient for their retirement. Chet
on the other hand was incentivized to drive this number down so that
he could reach the “in the money” value we mentioned above sooner.
This incentivized Chet both to stay with the company and to increase its
per-share value.

      Taking these facts together, we do not think that the RTP
agreements were a testamentary device by which Lloyd and Patricia
transferred Dukes shares to Chet for less than full consideration.
Section 2703(b)(2) is satisfied.

             2.    Comparability of the RTP Agreements to Similar
                   Arrangements

       Petitioners argue that the final section 2703(b) requirement is
satisfied by the Lloyd-Barneson agreement, which they claim is
comparable to the RTP agreements and was entered into in an arm’s-
length transaction. Petitioners note that the Lloyd-Barneson agreement
contained the following provisions, which are also included in the RTP
agreements: (1) a right to purchase on the death of the grantor and by a
right of first refusal; (2) a maximum purchase price; and (3) no specific
termination or exercise date. Petitioners also point out that the Lloyd-
Barneson agreement was entered into by unrelated parties—Lloyd and
Mr. Barneson—and executed at arm’s length.

      Respondent counters that the Lloyd-Barneson agreement cannot
serve as a good comparable because it was not submitted into evidence.
Respondent notes that there are only two pieces of evidence which
describe the Lloyd-Barneson agreement: a one-paragraph reference in
the Assignment agreement and another in the Chet-Barneson
agreement. Otherwise, the only information provided about the Lloyd-
Barneson agreement comes from witnesses’ testimony, which made
vague references to the agreement.

       Respondent contends that even if we are to find that the
testimony regarding the Lloyd-Barneson agreement is credible, there
are differences among it and the RTP agreements which render the
Lloyd-Barneson agreement not a good comparable.              The noted
differences are that (1) Lloyd Huffman was allowed to freely transfer his
                                     21

[*21] rights whereas Chet had to obtain consent from the owners; (2) the
right of first refusal in the RTP agreements exempted offers from Chet’s
brothers; (3) the RTP agreements had an addendum that granted Chet
the right to purchase the shares at any time at his discretion; and (4) the
stated purpose of the RTP agreements was to retain ownership of Dukes
within the Huffman family.

       We agree with respondent. As we noted in Estate of Amlie, T.C.
Memo. 2006-76, slip op. at 41, reliance on an isolated comparable is
adequate given that the regulations “delineate more of a safe harbor
than an absolute requirement that multiple comparables be shown.”
Use of the Lloyd-Barneson agreement then would be acceptable to show
that the RTP agreements had terms similar to an agreement entered
into at arm’s-length. But as respondent notes, we do not have the Lloyd-
Barneson agreement in evidence. We have only vague and incomplete
references to it and testimony based on those references. We do not have
an isolated comparable to undergo the section 2703(b)(3) analysis.

       Even if we were to accept witnesses’ testimony as sufficient
evidence, we do not think that the Lloyd-Barneson agreement is
sufficiently similar. Even though the three agreements purport to
create rights to purchase Dukes shares for a maximum price, the
differences among them are significant. For example, Chet had the
unfettered right to purchase the Dukes shares at any time and at his
sole discretion; Lloyd did not have this same right. Further, Lloyd was
permitted to assign or otherwise transfer his purchase rights whereas
Chet had to obtain consent to do the same. Chet then had rights
superior to Lloyd’s in purchasing the shares but inferior in transferring
those rights. The terms of the agreements are therefore not comparable
within the meaning of section 2703(b)(3).

       On the basis of the foregoing, we do not think that petitioners
have satisfied the final requirement of section 2703(b). See Estate of
Blount v. Commissioner, T.C. Memo. 2004-116, slip op. at 48 (finding
that solely testimony without production of comparable agreements was
insufficient to satisfy section 2703(b)(3)), aff’d in part, rev’d in part and
remanded, 428 F.3d 1338 (11th Cir. 2005). Section 2703(b) is therefore
not satisfied, and so the RTP agreements must be disregarded for
purposes of valuing the Dukes shares that Chet purchased in 2007. See
§ 2703(a).
                                           22

[*22] C.        Value of Dukes Shares in 2007

       Lloyd and Patricia indirectly owned shares in Dukes by virtue of
their interests in the Trust and DRM. While they had equal interests
in the Trust’s shares, only Patricia had an interest in DRM’s shares. On
October 15, 2007, Chet exercised his rights under the RTP agreements,
purchasing the Trust’s and DRM’s shares for $1.4 million and $3.6
million, respectively. Respondent argues that the shares were worth
more than the amount Chet paid, and therefore Lloyd and Patricia made
taxable gifts when they caused the Trust and DRM to transfer their
shares.

      In the notice of deficiency issued to Lloyd (for his interest in the
Trust), the IRS valued the Trust’s 118,635 shares at $10.7 million. Since
Chet paid $1.4 million for the Trust’s shares, the IRS determined that
Lloyd made a $9.3 million gift to Chet.

      In the first notice of deficiency issued to Patricia (for her interest
in the Trust), the IRS similarly valued the Trust’s 118,635 shares at
$10.7 million. 12 Since Chet paid $1.4 million for the Trust’s shares, the
IRS determined that Patricia made a $9.3 million gift to Chet. In the
second notice of deficiency issued to Patricia (for her interest in DRM),
the IRS valued DRM’s 304,124 shares at $27.5 million. Since Chet paid
$3.6 million for the shares, the IRS determined that Patricia made a
$23.9 million gift to Chet.

       At trial respondent’s expert concluded that the aggregate fair
market value of Dukes shares as of October 15, 2007, should be $31.3
million: $22.5 million attributable to DRM’s shares and $8.8 million
attributable to the Trust’s shares. 13 Under this valuation, Patricia made
a taxable gift of $18.9 million attributable to DRM’s shares and together

       12 Patricia and Lloyd received identical notices of deficiency for their role as

donors of the Trust’s shares in Dukes.
        13 When Chet exercised his rights under the RTP agreement with the Trust, he

purchased its shares for $1.4 million. In the notices of deficiency issued to Patricia and
Lloyd, the IRS determined that they were each liable for gift tax for that transaction
because they had caused the Trust to transfer its shares to Chet for less than their fair
market value.
       When Chet exercised his rights under the RTP agreement with DRM, he
purchased its shares for $3.6 million. In the notice of deficiency issued to Patricia, the
IRS determined that Patricia was liable for gift tax for that transaction because she
had caused DRM to transfer its shares to Chet for less than their fair market value.
                                   23

[*23] Patricia and Lloyd made a taxable gift of $7.4 million attributable
to the Trust’s shares.

       Petitioners argue that the shares were worth in total $5 million—
as provided in the RTP agreements—and therefore Patricia and Lloyd
did not make a taxable gift on October 15, 2007. Alternatively,
petitioners’ expert submitted that the fair market value of the Trust’s
118,645 shares was approximately $4.5 million while that of DRM’s
shares was approximately $11.6 million. Under that valuation, Patricia
made a taxable gift of approximately $8 million attributable to DRM’s
shares and together Patricia and Lloyd made a taxable gift of
approximately $3.1 million attributable to the Trust’s shares. We
consider the parties’ expert reports and arguments below.

             1.    Parties’ Experts’ Reports

                   a.     Respondent’s Valuation

       Mr. Ruble testified on behalf of respondent as an expert for the
purpose of valuing the Dukes shares. Mr. Ruble used three valuation
approaches to ascertain the fair market value of Dukes Group on a
marketable, controlling interest basis: (1) income approach using
a discounted cashflow (DCF) analysis; (2) market approach using a
guideline company analysis; and (3) market approach using a business
transaction analysis. Mr. Ruble determined the value of Dukes Group
under each method, then took the weighted average of the three values
to reach an enterprise value of $74.8 million.

      To determine the fair market value of invested capital in Dukes
Group, Mr. Ruble added to the enterprise value $5.3 million in noncore
net assets and $1.8 million in net working capital. Taking these
adjustments into account, Mr. Ruble reached a fair market value of
invested capital for Dukes Group at $81.9 million as of the valuation
date.

        To determine the fair market value of the invested capital in
Dukes, Mr. Ruble subtracted the fair market value of the Dukes-related
affiliates’ (DRM, AMDC, TRD, and CCC&B) assets from the Dukes
Group invested capital value. He determined that the fair market value
of the Dukes-related affiliates’ assets (DRA) was $1.8 million. After
subtracting the $1.8 million in DRA assets and $3 million in debt owed
by Dukes, Mr. Ruble found that the fair market value of the invested
capital in Dukes was $77 million as of the valuation date.
                                   24

[*24] Lastly, Mr. Ruble took into account discounts for lack of control
and lack of marketability. He determined that the appropriate minority
interest discount was 10%. He determined that the appropriate
marketability discount was 20%. After considering the discounts, Mr.
Ruble determined that the fair market value of Dukes shares on a
privately held, minority-interest basis was $55.3 million, or $74 per
share. He found that the value of the Dukes stock transferred from
Lloyd and Patricia to Chet in 2007 was $31.3 million: $22.5 million
attributable to DRM’s shares and $8.8 million attributable to the Trust’s
shares.

                    b.    Petitioners’ Valuation

       Petitioners’ expert, Duff & Phelps, used the same three valuation
methods as Mr. Ruble. Duff & Phelps’s report similarly weighted each
of the three valuation approaches equally to reach an enterprise value
of $25.9 million. It then added various adjustments: (1) $2.6 million as
the present value of the operating cashflows from CCC&B; (2) $4.4
million and $160,100 as the loan receivable from Chet and the amount
due from PMA Sales, respectively; and (3) $2.5 million as the excess of
working capital. After these adjustments, Duff & Phelps determined
that the enterprise value of Dukes was $35.6 million.

       Duff & Phelps next determined a key person discount by valuing
Chet’s personal relationships with key clients and key employees. It
determined the value of Dukes attributable to Chet’s personal
relationships with key clients to be $3 million. It determined the value
of Dukes attributable to Chet’s relationships with key employees to be
$2.6 million. Duff & Phelps then discounted the $2.6 million to $1.3
million to account for a 50% probability that the key employees would
leave if Chet left. Taking that together, Duff & Phelps reached a key
person discount of $4.3 million or 16.7%.

       After deducting the key person discount, Duff & Phelps reached
a $31.3 million value for Dukes. It then deducted the interest-bearing
debt obligations of Dukes to reach a total fair market value of all equity
in Dukes at $28.7 million. It found this equated to $38.20 per share.
Duff & Phelps then valued the shares held by DRM and the Trust as of
2007 using this per-share value, reaching the final figure of $16.3
million as the aggregate value.
                                   25

[*25]        2.    Parties’ Arguments as to Value

                   a.     Respondent’s Arguments

      Respondent first notes that Duff & Phelps did not use any
information from the Hanwha MOU or the Deloitte CIM in its analysis.
Respondent asserts that these should have been considered in the
valuation determination because they represented actual market
transactions, albeit proposed ones.

       Respondent also notes that Duff & Phelps removed certain
revenues from Dukes relating to the CCC&B licenses after three years.
Duff & Phelps assumed that the sublicense agreement would not be
renewed because the royalty paid was not market rate. Respondent
contends that the royalty was within the market rate range in 2007 and
therefore should not have been phased out in 2010. Mr. Ruble testified
that there would have been an additional $10 million of value if Dukes
had been able to continue using the licenses to sell Honeywell products.

      Respondent asserts that Duff & Phelps calculated the key person
discount improperly. Respondent contends that—instead of subtracting
from the weighted average enterprise value—Duff & Phelps should have
used only the income approach valuation figure as a starting point.
Respondent further contends that Duff & Phelps should have compared
the value of the business assuming that Chet left Dukes to the value of
the business assuming that Chet stayed with Dukes pursuant to the
income approach. According to respondent, Duff & Phelps attributes too
high a value to other key employees. For these reasons, respondent
argues that the total value of the key person discount should be reduced
from $4.3 million to $1.75 million.

       Additionally, respondent argues that Duff & Phelps used
improper pricing multiples for the market approaches. Respondent
asserts that Duff & Phelps selected companies that fell at or below the
lowest quartile of industry performance. For the market transaction
method, Duff & Phelps used multiples of 0.8×, 0.8×, 7.0×, and 7.0×, while
the industry medians were 1.7×, 2.4×, 10.0×, and 8.2×, respectively. For
the market comparable method, Duff & Phelps used multiples of 1.11×,
1.19×, 6.5×, and 8×, while the industry medians were 1.27×, 1.26×,
11.26×, and 9.87×. Myron Marcinkowski of Duff & Phelps testified that
had he used pricing multiples closer to the median, the concluded value
would have increased.
                                         26

[*26] Respondent lastly notes that Mr. Ruble’s valuation of Dukes ($81
million) was comparable to the offer made in the Hanwha MOU
(between $85 and $105 million) and the TransDigm purchase price ($95
million). Since petitioners estimated the enterprise value of Dukes at
$35.6 million, it is not close to the actual transactions that took place
and therefore is unreliable.

                       b.     Petitioners’ Arguments

       Petitioners contend that the difference in enterprise values
reached by the parties’ experts is largely attributable to their EBITDA
figures. 14  Petitioners assert that Mr. Ruble’s inflated EBITDA
calculation resulted from his reduction of the cost of goods sold and
operating expense figures for fiscal year 2007. Petitioners argue that
Mr. Ruble’s adjustments were based on the CIM, which they believe is
unreliable since Deloitte did not independently verify the accuracy of the
information forming the adjustments.

       Petitioners similarly criticize Mr. Ruble’s use of the Hanwha
MOU, asserting that it was nonbinding and contingent and therefore
cannot serve as the basis for a proper valuation. Petitioners also note
that the MOU and Dukes-TransDigm agreement were completely
different transactions. The former contemplated acquiring all Dukes
and GST stock, CCC&B’s intellectual property, and the workforce and
assets of the affiliate companies. In contrast, the Dukes-TransDigm
agreement was structured as an asset purchase.

       Petitioners assert that Mr. Ruble erroneously included the
revenues of GST. They contend this inflated the Dukes valuation by at
least $2 million despite GST’s having gross profit of less than $900,000
in 2007.

       Additionally, petitioners argue that CCC&B would not have
renewed its license with Dukes after 2010. They note that despite there
being market-level royalties for 2007, Chet had control over the licenses.
And if he left Dukes, he would have caused CCC&B to enter into
sublicensing agreements with GST and PMA Sales instead of Dukes.
Petitioners further stress that CCC&B would not have renewed the
licenses because the royalties were projected to be below market for
2008, 2009, and 2010.

      14 EBITDA is an abbreviation for earnings before interest, taxes, depreciation,

and amortization.
                                  27

[*27] Petitioners lastly voiced concerns about Mr. Ruble’s minority
interest discount and marketability discount. They noted that once
Dukes’s EBITDA is adjusted to account for advertising expenses and the
affiliate companies’ shares of earnings, the discounts would bring Mr.
Ruble’s enterprise value below petitioners’ value.

            3.     Conclusions as to Value of Dukes Shares in 2007

       We find that petitioners failed to meet the burden of proof
regarding why their expert’s valuation is correct. We agree with
respondent that Duff & Phelps miscalculated the key person discount.
In its report Duff & Phelps calculated the operating value attributable
to Chet by first calculating the enterprise value without Chet using a
DCF method. Duff & Phelps then subtracted that figure from the
enterprise value calculated using the weighted average of the three
methods. As respondent notes, this creates an apples-to-oranges
comparison whereby the formula will always yield at least $2.5 million
of value attributable to Chet regardless of whether he competes with
Dukes. We think the better approach, as respondent notes, would have
been to use the DCF enterprise value as the starting point.

       We also agree with respondent that Duff & Phelps undervalued
the Dukes shares when using the market approaches. In conducting
this analysis, it selected 19 comparable companies for which to compare
multiples. For both the market transaction and the market comparable
methods, Duff & Phelps selected multiples that were at or below the
lowest quartile of guideline companies. Mr. Ruble selected median
quartile gross profit and EBITDA multiples.

       Mr. Ruble’s valuation is proper except for one adjustment: We
direct the parties to adjust the valuation by removing the revenues
associated with the CCC&B licenses as done by Duff & Phelps.

       We agree with petitioners that the licensing agreement between
Dukes and CCC&B would not likely have been renewed after its
expiration on July 30, 2010, because the licensing fees that Dukes paid
to CCC&B were too low. Although they were consistent with the market
rate in 2007, Duff & Phelps projected that they would be below market
for 2008–10. We do not think that Chet would have allowed CCC&B to
renew the licensing agreement if he could generate higher fees from a
different licensee.

      Even if the fees were projected to be at or above market rate
beyond the expiration date, we do not think Chet would have allowed
                                  28

[*28] CCC&B to renew the licensing agreement because he would no
longer have an interest in the licensee after leaving Dukes. Since he
controlled CCC&B, it is far more likely that he would have caused it to
enter into a new licensing agreement with GST, another manufacturing
company capable of using the licenses, which he owned entirely. We
conclude petitioners properly reduced Dukes’s revenue associated with
the Honeywell licenses owned by CCC&B.

       Where property is transferred for less than adequate and full
consideration in money or money’s worth, the amount by which the
value of the property exceeds the value of the consideration is deemed a
gift. § 2512(b). We direct the parties to make the above change to Mr.
Ruble’s valuation. Chet paid $5 million ($3.6 million for shares from
DRM and $1.4 million for shares from the Trust); this amount should be
deducted from the value and the remaining amount is subject to gift tax.

III.   Income Tax Issues

      The next issue concerns the treatment of sale proceeds from the
Dukes-TransDigm agreement. First, we consider whether Chet and
Cindy, as well as Dukes, properly reported the portion of the sale
proceeds attributable to the CCC&B intellectual property assets.
Second, we consider whether they properly valued and reported the sale
proceeds associated with Chet’s personal goodwill. In each case Chet
and Cindy reported the sale proceeds and income. Respondent contends
that all of the income should have been reported by Dukes as capital
gain net income and then by Chet and Cindy as ordinary dividend
income.

       A.    Sale of CCC&B’s Intellectual Property Assets

             1.    Parties’ Arguments

       Respondent argues that the gain from the sale of the CCC&B
intellectual property assets (i.e., the Honeywell licenses) should have
accrued to Dukes and thereafter as a constructive dividend to Chet and
Cindy. Respondent asserts that petitioners misreported the gains on
CCC&B’s Form 1065 and on Chet and Cindy’s Form 1040 for 2009.

      Respondent asserts that Dukes Group was the proper party to
report the gain because CCC&B sold the assets before the Dukes-
TransDigm agreement was executed. Respondent contends that the
CCC&B-Dukes agreement controlled the methodology of the asset
transfer and that by the terms of that agreement, the only consideration
                                   29

[*29] was Dukes’s forgiveness of a $904,221 debt in addition to other
nonmonetary considerations. Therefore, respondent argues, no portion
of the approximately $12 million in gain should have been reported by
CCC&B.

       Petitioners disagree. Although they recognize the CCC&B-Dukes
agreement, they assert that it was never fulfilled because the Hanwha
deal fell through. On that point petitioners assert that the loan was
never forgiven and CCC&B continued to own the Honeywell licenses
until the TransDigm acquisition in December of 2009.

        Petitioners argue that CCC&B properly reported the gain from
the TransDigm acquisition because they modified the terms of the
CCC&B-Dukes agreement. They allege that they did so twice. Chet
testified that shortly after the Hanwha deal fell through, he executed
the first amendment, the ALM. Petitioners argue that the ALM
extended the effectiveness of the CCC&B-Dukes agreement to the date
of an eventual sale to a third party (which turned out to be TransDigm)
and increased the consideration to the fair market value of the
Honeywell licenses then owned by CCC&B.

      Petitioners additionally argue that the second amendment to the
CCC&B-Dukes agreement, the Correcting Amendment, also increased
the consideration to the fair market value of the licenses. Chet testified
that he executed this second amendment having forgotten about
executing the ALM.

      Respondent argues that neither of the amendments should be
treated as effective. As to the ALM, respondent notes that it is not dated
and therefore cannot be relied upon as having been executed before the
TransDigm acquisition. Since it was not executed before the TransDigm
acquisition, respondent argues, the CCC&B-Dukes agreement
controlled. This would mean that only debt forgiveness was the
consideration for the Honeywell licenses and therefore nothing further
should have been reported by CCC&B or Chet and Cindy.

       As for the Correcting Amendment, respondent argues that—in
contrast to the ALM—it did not (1) extend the effectiveness of the
CCC&B-Dukes agreement, (2) include additional Honeywell licenses
acquired in 2009, or (3) require that CCC&B be the direct payee of the
sales portions attributable to the Honeywell licenses.
                                    30

[*30]        2.     Discussion

       The first principle of income taxation is that tax must be imposed
on income to the party that earned it. Commissioner v. Culbertson, 337
U.S. 733, 739–40 (1949). As we have further concluded, “[t]he choice of
the proper taxpayer revolves around the question of which person or
entity in fact controls the earning of the income rather than the question
of who ultimately receives the income.” Vercio v. Commissioner, 73 T.C.
1246, 1253 (1980) (first citing Am. Sav. Bank v. Commissioner, 56 T.C.
828 (1971); and then citing Wesenberg v. Commissioner, 69 T.C. 1005
(1978)).

       We agree with respondent that CCC&B did not directly sell the
intellectual property assets to TransDigm in the 2009 acquisition.
CCC&B was not a named party to the Dukes-TransDigm agreement, nor
was it to be specifically allocated any of the purchase price. We,
however, conclude petitioners properly reported the gain.

        The facts indicate that the parties did not follow through with the
CCC&B-Dukes agreement in 2008 as contemplated. The Honeywell
licenses were still listed on CCC&B’s 2008 Form 1065 at yearend and so
too was the loan payable owing to Dukes. The terms of the CCC&B-
Dukes agreement then were not carried out as anticipated, and CCC&B
still owned the intellectual property assets going into 2009.

      We believe that the ALM was duly executed in February or March
of 2009 as Chet testified. Although the document is not dated, we
acknowledge Chet’s strategy in keeping the CCC&B intellectual
property held separately. Chet testified that he had modeled this
strategy after Honeywell, which kept its intellectual property assets in
an entity separate from the operating business entity.

       We agree that the timing of the ALM gives its alleged execution
date credibility. Once the Hanwha deal fell through, Chet testified that
he began more aggressively marketing Dukes for sale, hence the CIM
sales brochure generated by Deloitte. This makes it more plausible that
Chet would have sought to extend the effectiveness of the CCC&B-
Dukes agreement until the date of an eventual sale.

     Finally, we think that extending the effectiveness of the CCC&B-
Dukes agreement—especially in early 2009—would have been
advantageous to any eventual purchaser given that Hanwha had
wanted to buy the Dukes organization (and its affiliates) as a whole.
                                   31

[*31] Creating a mechanism then by which all assets would eventually
come under the same corporate umbrella is plausible.

       All of these facts lead us to the conclusion that petitioners have
satisfied their burden of proof as to the CCC&B asset sale. We agree
that the ALM amended the CCC&B-Dukes agreement, increasing the
stated consideration to the fair market value of the then-owned
Honeywell licenses and any other intellectual property held by CCC&B.
On that basis, we agree with petitioners that CCC&B—and not Dukes—
was the proper party to report the gain from the sale. Cindy and the
Estate of Chet Huffman are not liable for dividend income related to the
CCC&B intellectual property assets.

      B.     Sale of Chet’s Personal Goodwill

             1.    Parties’ Arguments

       The next issue is the treatment of the TransDigm acquisition sale
proceeds that petitioners allocated to Chet’s personal goodwill. On their
2009 Form 6252, Installment Sale Income, Chet and Cindy reported
approximately $21.8 million as the sale price attributable to Chet’s
personal goodwill. Of that amount, they reported $19.4 million as
installment sale income.

       Respondent argues that no amount of the sale proceeds can be
attributed to Chet’s personal goodwill, so it was improper for Chet and
Cindy to report the income. Respondent argues that Nevada law applies
because Dukes Group was a Nevada limited liability company.
Respondent notes that under Nevada law, any property owned by a
limited liability company must be held and owned in the name of the
company. See Nev. Rev. Stat. § 86.281 (2010).

      Respondent asserts that Chet was not a party to the Dukes-
TransDigm agreement. Since he was not listed in the agreement,
respondent asserts that the personal goodwill either was not properly
transferred to TransDigm via the Dukes-TransDigm agreement or was
already owned by Dukes Group before the sale. In either case,
respondent argues that the income should have been reported instead
by Dukes.

      Petitioners argue that they properly reported the income
according to the terms of the Dukes-TransDigm agreement. Section 2.01
of the agreement describes the purchased assets, which include
goodwill. Goodwill is defined to include “[a]ll goodwill associated with
                                    32

[*32] the Business, including any personal goodwill of Chet, the sole
member of Dukes Group, as it relates to the Purchased Assets and the
Business.” Section 2.07 requires that the parties engage SRR to allocate
the purchase price among the purchased assets.

       Section 2.07 further provides that the sellers (i.e., Dukes) would
hire an independent valuation expert, other than Deloitte, to prepare an
allocation of the goodwill between enterprise goodwill and the personal
goodwill of Chet. If TransDigm disagreed with the suballocation, then
it could hire a different valuation firm to provide the analysis.
Otherwise, the decision reached by the appraiser was to be binding on
the parties. Section 2.07 finally provides that “[t]he Sellers will allocate
the Adjusted Purchase Price between them and Chet Huffman with
respect to the personal goodwill, if any, as they agree and in a manner
consistent with this Section.”

       Petitioners assert that the parties followed these provisions to the
letter. SRR valued the purchased assets including the goodwill, to which
it ascribed a value of approximately $50 million. Dukes then hired Duff
& Phelps to perform the suballocation among the personal and
enterprise goodwill components. At trial Chet testified that TransDigm
agreed to the engagement of Duff & Phelps. Duff & Phelps valued Chet’s
personal goodwill at $21.8 million. Petitioners argue that because the
Dukes-TransDigm agreement specifically allocated this amount to Chet,
it was his responsibility to report it.

      Despite the valuation from Duff & Phelps, the IRS determined in
the notice of deficiency that Chet’s personal goodwill had no value.
Respondent contends that the expert report from Duff & Phelps cannot
be relied upon because Mr. Marcinkowski made errors.             First,
respondent notes that Mr. Marcinkowski changed his personal goodwill
valuation before trial. He lowered the personal goodwill amount from
$21.8 million to $19.2 million after changing his assumption regarding
when Chet would be effective in competing against Dukes. He decided
that it would instead take Chet 18 months to become competitive.
Respondent argues that this deviation weighs against Mr.
Marcinkowski’s credibility as an expert.

       Respondent also notes that Mr. Marcinkowski used a perpetuity
model to determine the residual value of Chet’s personal goodwill.
Respondent contends that this was improper because Chet was 48 years
old at the time of the TransDigm acquisition in 2009. If Chet retired
within the next 20 years, the value of his personal goodwill would be
                                  33

[*33] reduced to $15.5 million. Finally, respondent argues that there
should have been no portion of Chet’s personal goodwill which was
attributable to other employees at Dukes. Respondent contends that
this is problematic because these employees, like Chet, did not have an
employment agreement in place.

      As an alternative argument, respondent’s expert, Mr. Ruble,
asserted that Chet’s personal goodwill did have some value,
approximately $3.9 million worth. Mr. Ruble confined his report to the
areas in which he assumed that Chet offered the most value to Dukes:
generating new business, either to existing customers or to new
customers. Mr. Ruble asserted that the existing customers were mostly
focused on pricing, quality, and the ability to deliver products timely.
Respondent relies upon Chet’s testimony that the driving factors of
growth for Dukes were a combination of acquisitions and winning new
programs as well as choosing good products with high profit margins.

       In his report, Mr. Ruble concluded that it was unlikely Dukes
would have had fewer opportunities if Chet were no longer with the
company. Mr. Ruble contended that Dukes would likely have hired a
qualified replacement to mitigate the damages created by Chet’s lack of
engagement with the company. Dukes could have hired a replacement
from either an industry competitor, TransDigm, existing Dukes
management, or one of Dukes’s customers.

             2.    Discussion

      As discussed below, we find that Chet had personal goodwill and
that he and Cindy properly reported the sale proceeds attributable to
the goodwill to the extent of its fair market value.

       Petitioners assert that Nevada law is irrelevant despite Dukes
Group’s being formed there. We agree. The Dukes-TransDigm
agreement specifically provides that the transaction and the legal
relations between the parties will be governed by the laws of the State
of California. We apply California law then in determining whether
goodwill can be separated from a business and attributed to an
individual.

      Goodwill has been defined as the expectation of continued
patronage. Newark Morning Ledger Co. v. United States, 507 U.S. 546,
555 (1993). It has also been defined as “the sum total of those
imponderable qualities which attract the custom of a business—what
brings patronage to the business.” Philip Morris Inc. & Consol. Subs.
                                   34

[*34] v. Commissioner, 96 T.C. 606, 634 (1991) (quoting Boe v.
Commissioner, 307 F.2d 339, 343 (9th Cir. 1962), aff’g 35 T.C. 720
(1961)), aff’d, 970 F.2d 897 (2d Cir. 1992). Goodwill can generally take
two forms: (1) personal goodwill owned by key employees or
shareholders and (2) corporate or enterprise goodwill developed and
owned by the company or employer.             Bross Trucking, Inc. v.
Commissioner, T.C. Memo. 2014-107, at *21. A business can only
distribute corporate assets and cannot distribute assets personally
owned by shareholders. See Martin Ice Cream Co. v. Commissioner,
110 T.C. 189, 209 (1998). Key employees may transfer their personal
goodwill via employment contracts or noncompete agreements. Bross
Trucking, Inc., T.C. Memo. 2014-107, at *27 (citing Martin Ice Cream
Co., 110 T.C. at 207).

       We agree with petitioners that Chet created personal goodwill
through his relationships with key employees and customers during his
time as Dukes’s CEO. We also agree on the basis of the Dukes-
TransDigm agreement that the parties to that transaction allocated a
portion of the sale proceeds to Chet as his personal goodwill. Under
California law, personal goodwill is an intangible asset capable of being
owned by an individual. See, e.g., In re Marriage of Nichols, 33 Cal.
Rptr. 2d 13, 20 n.4 (Ct. App. 1994).

       While working for Dukes Chet did not have an employment
contract, nor was he subject to a noncompete agreement. For that
reason we disagree with respondent that he somehow transferred his
goodwill to Dukes before the acquisition. See Bross Trucking, Inc., T.C.
Memo. 2014-107, at *27. He continued to own his personal goodwill up
until the TransDigm acquisition in December 2009; to that end, as part
of the Dukes-TransDigm agreement, Chet entered into a noncompete
agreement. Thus, any gain on the sale of that personal goodwill would
have had to be reported by its owner, Chet. See Commissioner v.
Bollinger, 485 U.S. 340, 344 (“For federal income tax purposes, gain or
loss from the sale or use of property is attributable to the owner of the
property.”). On the basis of these findings, we conclude that respondent
has failed to meet his burden of proof regarding Chet’s personal
goodwill.

       Mr. Marcinkowski derived the personal goodwill value by
performing a scenario analysis using the DCF method. He performed
this same analysis for each component of the personal goodwill value:
that attributable to Chet’s personal relationships with key clients and
that attributable to Chet’s personal relationships with key employees.
                                  35

[*35] The first step he took for the key clients analysis was assessing
the operating value of Dukes if TransDigm received full cooperation and
assistance from Chet in perpetuity (Scenario 1). He discounted future
cashflows from years 2010–14 to derive the Scenario 1 operating value
of $87.084 million.

       He then calculated the operating value of Dukes if TransDigm
received no cooperation or assistance from Chet in perpetuity (Scenario
2). He similarly discounted future cashflows from years 2010 to 2014 to
derive a range of potential values for Scenario 2: between $63.859
million and $75.471 million. The Scenario 2 range of values was
calculated by estimating the percentage of revenue that would be lost if
Chet did not cooperate with TransDigm after the acquisition.

       His report indicated which clients would be vulnerable to Chet’s
influence. Revenue from most clients was expected to remain the same.
Only revenue related to specific aircraft from Bombardier, Cessna,
Cirrus Design, Hawker Beechcraft, and Lockheed Martin was expected
to decline as a result of Chet’s leaving. All other aircraft and clients
were expected to generate the same level of revenue despite Chet’s
absence. Mr. Marcinkowski determined the percentage of revenue lost
as follows for these clients:
                                        36

[*36]             Percentage Revenue Retained After Chet’s Leaving

        Client               Aircraft           Low-End              High-End

     Bombardier            Challenger             75%                  50%
                            604/605

     Bombardier            Challenger             50%                  0%
                           850/850CD

        Cessna               Citation             50%                  0%
                            Sovereign

        Cessna             Citation X             50%                  0%

    Cirrus Design           SR22-G3               50%                  0%

 Hawker Beechcraft             450                55%                  10%

 Hawker Beechcraft         Premier II             70%                  40%

  Lockheed Martin             F-16                50%                  0%

       These percentages were then multiplied by the unadjusted,
projected revenues for each client to reach the adjusted revenues. The
adjusted revenues formed the basis for calculating the future cashflows
that would be discounted back to the present to reach an operating
value. Once Mr. Marcinkowski had derived low- and high-end operating
values for Scenario 2, he averaged the two figures and subtracted the
averages from the Scenario 1 values to reach the values attributable to
Chet’s relationship with key clients. A similar analysis was done to
reach the values attributable to Chet’s relationships with key
employees.

       While we find Mr. Marcinkowski’s methodology sound, we think
that his report overestimated the percentage of revenue that would be
lost as a result of Chet’s failing to cooperate or assist TransDigm after
the acquisition. We agree with Mr. Ruble that Chet would have had a
much lesser impact on revenues from existing clients. His true value
came from his ability to generate new business, be that from existing
clients or new ones. Once the clients were obtained, keeping them was
more a matter of continuing to provide quality products timely. This
                                   37

[*37] was not an area that Chet himself had a direct influence on and
should have been accounted for in Mr. Marcinkowski’s analysis.

       On that basis we conclude that instead of averaging the low- and
high-end Scenario 2 values, it would be more appropriate to use the low-
end value. We direct the parties to use the low-end operating value of
$75.471 million as the Scenario 2 figure (from Exhibit 197, Exhibit C,
p. 1) to reach the value attributable to Chet’s relationship with key
clients. The parties should additionally take into account the 18-month
lag time that, Mr. Marcinkowski conceded at trial, Chet would need to
become competitive with Dukes. We otherwise agree with Mr.
Marcinkowski’s valuation.

       Our adjustments will lower the value attributable to Chet’s
personal goodwill. This means that the difference between the new
value and that originally reported by Chet and Cindy should have been
attributed to enterprise goodwill and reported by Dukes. Since this
amount was distributed to Chet and Cindy, we agree with respondent
that it must reclassified as a constructive dividend. See Truesdell v.
Commissioner, 89 T.C. 1280, 1295 (1987) (“The crucial concept in a
finding that there is a constructive dividend is that the corporation has
conferred a benefit on the shareholder in order to distribute available
earnings and profits without expectation of repayment.”).

       Cindy and the Estate of Chet Huffman had ordinary dividend
income pursuant to section 301, which provides that a dividend is taxed
as ordinary income only to the extent of the distributing corporation’s
earnings and profits. § 301(c); Benson v. Commissioner, T.C. Memo.
2004-272, slip op. at 43–44, supplemented by T.C. Memo. 2006-55, aff’d,
560 F.3d 1133 (9th Cir. 2009). Any excess is a nontaxable return of
capital to the extent of the taxpayer’s basis, and any remaining amount
received is taxable as capital gain from the sale or exchange of a capital
asset. Benson, T.C. Memo. 2004-272, slip op. at 44 (first citing § 301(c);
then citing Truesdell, 89 T.C. at 1295–98; and then citing Barnard v.
Commissioner, T.C. Memo. 2001-242).

       Because a portion of the sale proceeds attributed to Chet’s
personal goodwill was actually enterprise goodwill, Dukes understated
capital gain net income on its 2009 Form 1120. The amount by which
Chet and Cindy overvalued Chet’s personal goodwill should have been
reported by Dukes with the rest of the sale proceeds on its 2009 Form
6252. Dukes is therefore liable for tax on an increase to capital gain net
income for 2009.
                                   38

[*38] IV.   Accuracy-Related Penalties and Additions to Tax

       We now address the ancillary issue of petitioners’ liability for
certain section 6662 accuracy-related penalties and section 6651
additions to tax. The IRS determined accuracy-related penalties against
Cindy and the Estate of Chet Huffman, as well as Dukes, and on the
basis of our redeterminations in this Opinion with respect to those
petitioners, together with the concessions previously noted, see supra
note 7, there are grounds for section 6662 penalties. For all petitioners,
their failure to timely file certain returns and pay the amounts owing
provides grounds for section 6651 additions to tax.

      A.     Burden of Proof

      Under section 7491(c), the Commissioner bears the burden of
production with respect to the liability of an individual for any penalty
or addition to tax. The Commissioner satisfies that burden by
presenting sufficient evidence to show that it is appropriate to impose
the penalty in the absence of available defenses. Graev v. Commissioner,
149 T.C. 485, 493 (2017) (citing Higbee v. Commissioner, 116 T.C. 438,
446 (2001)), supplementing and overruling in part 147 T.C. 460 (2016).

       This burden includes satisfying section 6751(b)(1), which provides
that “[n]o penalty under this title shall be assessed unless the initial
determination of such assessment is personally approved (in writing) by
the immediate supervisor of the individual making such determination
or such higher-level official as the Secretary may designate.” Section
6751(b) does not apply, however, to the addition to tax under section
6651. See § 6751(b)(2)(A); ATL & Sons Holdings, Inc. v. Commissioner,
152 T.C. 138, 150 (2019).

       In Laidlaw’s Harley Davidson Sales, Inc. v. Commissioner, 29
F.4th 1066, 1071 (9th Cir. 2022), rev’g and remanding 154 T.C. 68
(2020), the Ninth Circuit considered the timeline for obtaining
supervisory approval of “assessable penalties,” which are not subject to
deficiency procedures. The Ninth Circuit held that, for an assessable
penalty, supervisory approval is timely if secured before the penalty is
assessed or “before the relevant supervisor loses discretion whether to
approve the penalty assessment.” Id. at 1074. More recently, in Kraske
v. Commissioner, No. 27574-15, 161 T.C. (Oct. 26, 2023), a case (like the
cases here) appealable to the Ninth Circuit (absent stipulation to the
contrary), see § 7482(b), we addressed whether the holding in Laidlaw’s
Harley Davidson should be read so as to encompass penalties subject to
                                   39

[*39] deficiency procedures as well. We held that it should, and
pursuant to Golsen v. Commissioner, 54 T.C. 742, 757 (1970), aff’d, 445
F.2d 985 (10th Cir. 1971), applied the holding to the facts of the case.
Kraske, 161 T.C., slip op. at 7–8. We will afford precedential weight to,
and follow, Kraske in the instant cases as it is squarely on point here.

       For nonindividual taxpayers, the burden of production as to
penalties remains with the taxpayer because section 7491(c) does not
apply to corporations. See NT, Inc. v. Commissioner, 126 T.C. 191, 195
(2006). We held previously that the Commissioner does not have the
burden of production as to supervisory approval under section 6751(b)
for a penalty determined against a corporation in a notice of deficiency.
Dynamo Holdings Ltd. P’ship v. Commissioner, 150 T.C. 224, 231–32
(2018). Accordingly, respondent does not bear the burden of production
for the penalties determined against Dukes.

       Petitioners argue that respondent has not satisfied the burden of
proof because the supervisory approval did not take a specific form.
They note that the IRS supervisor did not sign a Civil Penalty Approval
Form as encouraged by the Internal Revenue Manual. The supervisor
instead signed the 30-day letter, which generally indicates the IRS’s
position on the disputed tax items and provides taxpayers a 30-day
deadline to take their case to Appeals.

       As we noted in Palmolive Building Investors, LLC v.
Commissioner, 152 T.C. 75, 85–86 (2019), “[s]ection 6751(b) does not
require written supervisory approval on any particular form.”
“[P]enalty approval [can] be found in ‘a signed 30-day letter sent by the
supervisor of the examining agent.’” Castro v. Commissioner, T.C.
Memo. 2022-120, at *6 (quoting Tribune Media. Co. v. Commissioner,
T.C. Memo. 2020-2, at *21). Since the IRS supervisor involved in these
cases signed the 30-day letter, approval was properly obtained for the
penalties in question, and respondent has satisfied his initial burden of
proof under section 6751(b) as to the individual petitioners.

      B.     Section 6662 Penalties

             1.    Liability

       Section 6662(a) imposes a 20% accuracy-related penalty on any
portion of an underpayment of tax required to be shown on a return if,
as provided by section 6662(b)(1), the underpayment is attributable to
“[n]egligence or disregard of rules or regulations.” The penalty may also
                                          40

[*40] be imposed for an underpayment attributable to any “substantial
understatement of income tax.” § 6662(b)(2).

       For section 6662(b)(1) purposes, “negligence” includes “any
failure to make a reasonable attempt to comply” with the internal
revenue laws, and “disregard” includes “any careless, reckless, or
intentional disregard.” § 6662(c). Negligence also includes any failure
by the taxpayer to keep adequate books and records or to substantiate
items properly. Treas. Reg. § 1.6662-3(b)(1).

       An understatement is substantial within the meaning of section
6662(b)(2) if it exceeds the greater of (1) 10% of the tax required to be
shown on the return for the taxable year or (2) $5,000. § 6662(d)(1)(A).
For corporations, there is a substantial understatement of income tax
for any taxable year if the amount of the understatement exceeds the
lesser of (1) 10% of the tax required to be shown on the return for the
taxable year (or, if greater, $10,000) or (2) $10,000,000. § 6662(d)(1)(B).
The accuracy-related penalty does not apply with respect to any portion
of the underpayment for which the taxpayer shows that he or she had
reasonable cause and acted in good faith. § 6664(c)(1); see Higbee, 116
T.C. at 448–49.

       Respondent asserts that Cindy and the Estate of Chet Huffman,
as well as Dukes, are liable for substantial understatement penalties
under section 6662(b)(2), or alternatively, for negligence penalties under
section 6662(b)(1). Only one accuracy-related penalty may be applied
with respect to any given portion of an underpayment, even if that
portion is subject to the penalty on more than one ground. Treas. Reg.
§ 1.6662-2(c). As a result of our holdings herein and the parties’
concessions in the cases involving Cindy and the Estate of Chet
Huffman, as well as Dukes, the Rule 155 computations must confirm
substantial understatements of income tax by those petitioners. Should
the Rule 155 computations show substantial understatements of income
tax (which we think they should), we conclude that respondent has met
his burden of production for the accuracy-related penalties under section
6662(b)(2). 15

        15 We note that respondent has in any event demonstrated that Chet and

Cindy, as well as Dukes, acted negligently because the record before us shows that
they failed to maintain books and records sufficient to accurately reflect their incomes.
See Treas. Reg. § 1.6662-3(b)(1).
                                   41

[*41]        2.     Reasonable Cause Defense

      Cindy and the Estate of Chet Huffman, as well as Dukes, assert
that they had reasonable cause that negates any section 6662(a)
penalties because their accountant, Ms. Ross-Stearn, terminated the
business relationship on August 28, 2009. They claim that her hasty
departure impeded their ability to timely submit accurate tax returns.
They further claim that the delay was exacerbated by Ms. Ross-Stearn’s
and TransDigm’s reluctance to provide financial statements that would
form the basis of the tax returns for all of them.

       Cindy and the Estate of Chet Huffman, as well as Dukes, claim
that after Ms. Ross-Stearn disengaged, they employed two accountants
to help them submit all the individuals’ and Dukes-affiliated entities’
income tax returns. They first hired Mr. Whitfield and later Mr.
Hutchinson to expedite the process and determine how Dukes’s sale
proceeds should be reported.

       They claim that they started first by considering the valuation
provided by Duff & Phelps, which determined that $21.8 million of the
sale proceeds were attributable to Chet’s personal goodwill. They assert
that they relied on the Duff & Phelps valuation as well as the Dukes-
TransDigm agreement to allocate the $21.8 million entirely to Chet.

       As for the proceeds attributable to the CCC&B intellectual
property assets, Cindy and the Estate of Chet Huffman, as well as
Dukes, assert that Mr. Whitfield independently determined that the
intellectual property was held by CCC&B—and not Dukes.
Mr. Whitfield also reviewed the licensing agreements and CCC&B’s
prior tax returns in reaching the conclusion that CCC&B was the proper
entity to report the gain from the sale. Since Chet and Cindy were the
sole owners of CCC&B, they contend that it was their responsibility to
report the passthrough income from the sale.

        Cindy and the Estate of Chet Huffman, as well as Dukes, claim
that their reliance on the tax professionals excuses them from section
6662(a) penalties. The Court’s caselaw sets forth the following three
requirements for a taxpayer to use reliance on a tax professional to avoid
liability for a section 6662(a) penalty: “(1) The adviser was a competent
professional who had sufficient expertise to justify reliance, (2) the
taxpayer provided necessary and accurate information to the adviser,
and (3) the taxpayer actually relied in good faith on the adviser’s
                                  42

[*42] judgment.” Neonatology Assocs., P.A. v. Commissioner, 115 T.C.
43, 99 (2000), aff’d, 299 F.3d 221 (3d Cir. 2002).

      Chet and Cindy Huffman, as well as Dukes, relied on
Mr. Whitfield and Mr. Hutchinson in determining how to report the sale
proceeds from TransDigm’s asset purchase. Both Mr. Whitfield and Mr.
Hutchinson were licensed CPAs with significant experience in public
and private tax accounting. Therefore, Chet and Cindy Huffman, as well
as Dukes, were justified in relying on their advice.

       At trial Chet testified that he provided complete access to the
books and records of Dukes, the affiliated entities, and the individual
family members. Chet also testified that he and Mr. Whitfield took
great measures to obtain the tax documents of Dukes and the affiliated
entities once Ms. Ross-Stearn disengaged. They successfully obtained
approximately 40 boxes of financial data from Dukes and later were able
to obtain the Dukes trial balance and general ledger from Ms. Ross-
Stearn. On the basis of this testimony, as well as Mr. Hutchinson’s
testimony, we conclude that Chet and Cindy Huffman, as well as Dukes,
provided the tax professionals with as much accurate information as
they could assemble.

       Finally, we believe that Chet and Cindy Huffman, as well as
Dukes, relied in good faith on Mr. Whitfield’s and Mr. Hutchinson’s
advice. Although Chet was a business school graduate and had
successfully run Dukes for many years by the time of the TransDigm
acquisition in 2009, he was not familiar with complex tax matters such
as these. To ensure that he reported these items accurately, Chet hired
two licensed accountants who rendered reasonable interpretations of the
Code and the regulations. On that basis we find that Chet and Cindy
Huffman, as well as Dukes, had reasonable cause with respect to the
reporting of the Dukes-TransDigm sale proceeds, and thus they are not
liable for the section 6662(a) penalties attributable to that
underpayment. However, because they seemingly do not argue, and the
record does not support in any event, that the reasonable-cause
exception negates their liability for the section 6662(a) penalties
attributable to the conceded adjustments, they are liable for such
penalties to that extent.
                                    43

[*43] C.     Section 6651 Additions to Tax

             1.     Liability

       Section 6651 imposes additions to tax for failure to file timely
returns or failure to pay timely the amount shown as tax on any return.
For failure to file timely returns, there shall be added to the amount
required to be shown as tax 5% of such tax if the failure is for not more
than one month. § 6651(a)(1). The penalty increases by 5% for each
additional month the failure continues. Id.

       For a failure to pay timely, there shall be added to the amount
shown as tax 0.5% if the failure is for not more than one month.
§ 6651(a)(2). The penalty increases by 0.5% for each additional month
the failure continues. Id. For failure either to file or pay timely, the
addition to tax may not exceed 25% in the aggregate. § 6651(a)(1) and
(2). There will be no additions to tax if the failure to file or pay was due
to reasonable cause and not due to willful neglect. Id. The IRS
determined section 6651 additions to tax against all petitioners.

       Lloyd and Patricia—who were issued separate notices of
deficiency for their varying interests in the Trust and DRM—did not
report any taxable gifts for 2007. The due date for the 2007 gift tax
return was April 15, 2008. Under our valuation, they should have
reported a taxable gift to Chet. Because Lloyd and Patricia did not
timely file a gift tax return nor pay tax on the gift, respondent has met
his burden of proof as to the additions to tax. Patricia and the Estate of
Lloyd Huffman must demonstrate that the failure to file/pay was due to
reasonable cause and not due to willful neglect to avoid the additions.

        Chet and Cindy’s 2009 income tax return was due on October 15,
2010. They did not file the return until March 8, 2011. Because they
filed the return late, respondent has met his burden of proving that they
are liable for the additions to tax. Cindy and the Estate of Chet Huffman
must demonstrate that the failure was due to reasonable cause and not
due to willful neglect to avoid the additions.

       Dukes’s 2008 return was due September 15, 2008. Its 2009 return
was due on September 15, 2009. Its 2010 return was due on September
15, 2010. Dukes filed its 2008–10 income tax returns on June 22,
September 7, and November 22, 2011, respectively. Because it filed the
returns late, it is liable for the additions to tax unless it can show that
the failures were due to reasonable cause and not due to willful neglect.
                                     44

[*44]        2.     Reasonable Cause Defense

       All of the aforementioned income tax returns for Chet and Cindy,
as well as Dukes, were filed late. Regardless of whether Ms. Ross-
Stearn was employed during this time, they were responsible for timely
submissions. United States v. Boyle, 469 U.S. 241, 252 (1985) (“The
failure to make a timely filing of a tax return is not excused by the
taxpayer’s reliance on an agent, and such reliance is not ‘reasonable
cause’ for a late filing under § 6651(a)(1).”). Their argument that Ms.
Ross-Stearn’s departure gives them reasonable cause for the untimely
filings is therefore unavailing. The section 6651(a)(1) additions to tax
will be sustained as to Cindy and the Estate of Chet Huffman, as well
as to Dukes.

       Patricia and the Estate of Lloyd Huffman assert a different
argument against imposition of the additions to tax under section
6651(a)(1) and (2). They claim that they were completely unaware of
any gift tax liability. They believed that Chet paid the fair market value
for the Dukes shares by exercising his rights under the RTP agreements
in 2007. Their argument then is not that they failed to file so much as
that they did not think a filing was required.

        They claim that Ms. Ross-Stearn did not advise them of any
potential gift tax liability and so they did not file a return for that year.
We think that is distinguishable from the other petitioners’ section 6651
defenses. See Boyle, 469 U.S. at 251 (“When an accountant or attorney
advises a taxpayer on a matter of tax law, such as whether a liability
exists, it is reasonable for the taxpayer to rely on that advice.” (Second
emphasis added.)).

       We agree with Patricia and the Estate of Lloyd Huffman that they
had reasonable cause for their failure to report any gift tax liability. As
they noted, the analysis in Cavallaro v. Commissioner, T.C. Memo.
2014-189, at *66–71, aff’d in part, rev’d in part and remanded, 842 F.3d
16 (1st Cir. 2016), is instructive. In that case we relied on the same
three-part analysis described in Neonatology Associates, P.A. for
determining whether the taxpayer’s reliance on a tax professional was
sufficient to avoid liability for penalties and additions to tax. Cavallaro,
T.C. Memo. 2014-189, at *71. We will do the same in these cases.

       Lloyd and Patricia relied on Ms. Ross-Stearn to advise on their
tax liability. Ms. Ross-Stearn was a licensed accountant with many
years of experience performing the accounting and payroll function of
                                     45

[*45] Dukes, its affiliates, and the individual family members. She had
enough experience to justify their reliance on her advice.

       Chet testified that Ms. Ross-Stearn was “most certainly aware” of
the RTP agreements and his decision to exercise his rights under the
agreements in 2007. He also testified that Ms. Ross-Stearn would have
had knowledge of the RTP agreements because she “effectively served
as Dukes’[s] accounting department” and was integral to the proposed
acquisition by Hanwha. On that basis, we find that Ms. Ross-Stearn
was provided all the necessary information which would have alerted
her to a potential gift tax liability owing from Lloyd and Patricia.

       Finally, Patricia testified at trial that she “[t]otally relied” on Ms.
Ross-Stearn to advise on tax matters. She further testified that she had
no income or gift tax training whatsoever. She explained that had there
been any indication that a gift tax return should be filed, she would have
made the necessary efforts to do so. On the basis of that testimony, we
agree that Lloyd and Patricia relied in good faith on Ms. Ross-Stearn.
They therefore acted with reasonable cause in their failure to file a gift
tax return and failure to pay the outstanding gift tax. Therefore,
Patricia and the Estate of Lloyd Huffman are not liable for the additions
to tax. Cindy and the Estate of Chet Huffman, as well as Dukes, are
liable for the additions to tax as stated above.

       We have considered all of the arguments made by the parties and,
to the extent they are not addressed herein, we find them to be moot,
irrelevant, or without merit.

       To reflect the foregoing,

       Decisions will be entered under Rule 155.