Court Opinion

ID: 4338909
Source: CourtListenerOpinion
Date Created: 2018-11-14 04:08:44.613577+00
Date Added: 2024-06-11T13:29:41.858338
License: Public Domain

T.C. Memo. 2011-277

                      UNITED STATES TAX COURT

          JOHN E. AND FRANCES L. ROGERS, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent

     Docket No. 22667-07.           Filed November 23, 2011.

     Paul J. Kozacky and Nicholas C. Mowbray, for petitioners.

     Laurie A. Nasky, for respondent.

             MEMORANDUM FINDINGS OF FACT AND OPINION

     HAINES, Judge:   Respondent determined a deficiency in

petitioners’ Federal income tax of $1,302,102 and an accuracy-

related penalty under section 6662(a) of $260,420 for 2003.1

     1
      Unless otherwise indicated, section references are to the
Internal Revenue Code, as amended and in effect for the year in
issue. Rule references are to the Tax Court Rules of Practice
                                                   (continued...)
                             - 2 -

     After stipulations2 the issues remaining for decision are:

(1) Whether Portfolio Properties, Inc. (PPI), an S corporation

incorporated under the laws of Illinois, must include $1,190,500

in income for 2003;3 (2) whether PPI is entitled to deduct in

2003 legal and professional fees attributable to the $1,190,500;

and (3) whether a $218,499 distribution from PPI to its sole

shareholder, petitioner John Rogers (Rogers), is includable in

petitioners’ gross income for 2003.

     Some of the facts have been stipulated and are so found.

The stipulation of facts, the supplemental stipulation of facts,

the stipulation of settled issues, and the exhibits attached

thereto are incorporated herein by this reference.   At the time

they filed their petition, petitioners resided in Illinois.

     1
      (...continued)
and Procedure. Amounts are rounded to the nearest dollar.
     2
      On Feb. 5, 2010, the Court filed the parties’ stipulation
of settled issues, resolving many of the issues set forth in the
notice of deficiency. On Mar. 4, 2010, the Court filed the
parties’ supplemental stipulation of settled issues, resolving
additional issues, including the accuracy-related penalty under
sec. 6662(a).
     3
      Petitioner John Rogers is the sole shareholder of PPI.
Because PPI is an S corporation, we must determine the income and
deduction items of PPI before determining petitioners’ income.
Where a notice of deficiency includes adjustments for S
corporation items with other adjustments, we have jurisdiction to
determine the correctness of all adjustments. See Winter v.
Commissioner, 135 T.C. 238 (2010).
                               - 3 -

                          FINDINGS OF FACT

     Rogers is a tax attorney with over 40 years of experience.

He received a law degree from Harvard University in 1967 and a

master’s degree in business administration from the University of

Chicago.    He worked in the tax department of Arthur Andersen for

over 24 years before serving for 7 years as the tax director and

assistant treasurer at FMC Corp.   In 2003 Rogers was a partner

with the law firm Altheimer & Gray until its bankruptcy on June

30, 2003.   For the remainder of the year Rogers was a partner

with the law firm Seyfarth Shaw, LLP.

     Rogers promoted to clients “tax advantaged” transactions

that dealt with the acquisition of, and sales of indirect

interests in, Brazilian consumer receivables.4   The instant case

is an offshoot of those transactions.   Our concern is not with

the consumer receivables transactions themselves, but with the

income tax, if any, resulting from the receipt of money from

investors by Rogers’ controlled entities and by Rogers himself.

     Rogers set up three business entities to manage numerous

holding and trading companies used in the Brazilian receivable

transactions.    The first, PPI, was incorporated under the laws of

Illinois on April 1, 1989, and elected on January 1, 1992, to be

treated as an S corporation under section 1361(a)(1).   Rogers was

     4
      For the details of these transactions, see Superior
Trading, LLC v. Commissioner, 137 T.C. 70 (2011).
                                - 4 -

its sole shareholder.   The second, Jetstream Business Limited

(Jetstream), a British Virgin Islands limited company, was formed

by Rogers with PPI as its sole shareholder.    Rogers was

Jetstream’s only director.   In 2003 Jetstream was treated as a

disregarded entity for Federal tax purposes.    The third, Warwick

Trading, LLC (Warwick), an Illinois limited liability company

(LLC), was formed in 2001.   In 2003 Jetstream was the managing

member of Warwick.   Consequently, in 2003 Rogers had sole control

over PPI, Jetstream, and Warwick.

     In 2003 Warwick entered into transactions directly and

through affiliated entities for, in effect, purchasing Brazilian

consumer receivables and selling interests in them to numerous

investors through trading and holding companies.5   The investors

paid an aggregate of $2,381,000, all apparently for acquiring

such interests.   Of the $2,381,000, Warwick received and

transferred $1,190,500 to Multicred Investamentos Limitada

(Multicred), a Brazilian collection company.    The other

$1,190,500 was deposited directly in PPI’s bank account on behalf

of Jetstream.   None of Warwick, Jetstream, or PPI had any

obligation to transfer the $1,190,500 deposited directly in PPI’s

bank account to anyone, hold the funds in escrow, or segregate

the funds from any other use.

     5
      See id.
                               - 5 -

     Rogers prepared PPI’s 2003 Form 1120S, U.S. Income Tax

Return for an S Corporation.   PPI reported $1,958,877 of gross

receipts or sales, including income of $27,877 from transactions

unrelated to the receivables, and a deduction of $1,190,500 for

the $1,190,500 transferred to Multicred.      Lucas & Rogers Capital,

Inc. (L&R), a second S corporation with Rogers as its sole

shareholder, reported $450,000 of gross receipts in 2003

attributable to investor money for the receivables.      The parties

agree that the $450,000 L&R reported as gross receipts in 2003

should have been reported by PPI.      Further, the parties agree

that the $1,190,500 transferred to Multicred is not includable in

PPI’s income and does not entitle PPI to a deduction.

     PPI distributed $732,000 to Rogers in 2003.     Petitioners

deposited this amount in their joint bank account.      PPI deducted

$513,501 of this amount as legal and professional fees paid to

Rogers.6   In turn, petitioners included the $513,501 Rogers

received from PPI as income on their Schedule C, Profit or Loss

From Business.   Petitioners did not report the remaining $218,499

distribution as income in 2003.   Petitioners had no obligation to

transfer the $218,499 to anyone, hold the funds in escrow, or

segregate the funds from their personal funds.

     6
      PPI also deducted $22,039 of legal and professional fees
paid to Altheimer & Gray and Seyfarth Shaw.
                                - 6 -

      On August 24, 2007, respondent issued a statutory notice of

deficiency to petitioners determining, among other things, that

the $218,499 was income to petitioners in 2003.     On October 2,

2007, the Court filed petitioners’ timely petition.

                                OPINION

I.    Burden of Proof

      The Commissioner’s determinations in the notice of

deficiency are generally presumed correct, and the taxpayers bear

the burden of proving them incorrect.     See Rule 142(a)(1).

Petitioners do not argue that the burden of proof shifts to

respondent pursuant to section 7491(a), nor have they shown that

the threshold requirements of section 7491(a) have been met.     The

burden therefore remains on petitioners with respect to all

issues to prove that respondent’s determination of the deficiency

in income tax is erroneous.

II.   PPI

      A.     Gross Income

      Generally, unless otherwise provided, gross income under

section 61 includes all accessions to wealth from whatever source

derived.     Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 431

(1955).     Moreover,

      gain * * * constitutes taxable income when its recipient has
      such control over it that, as a practical matter, he derives
      readily realizable economic value from it. That occurs when
      cash * * * is delivered by its owner to the taxpayer in a
      manner which allows the recipient freedom to dispose of it
      at will, even though it may have been obtained by fraud and
                                   - 7 -

     his freedom to use it may be assailable by someone with a
     better title to it. [Rutkin v. United States, 343 U.S. 130,
     137 (1952); citations omitted.]

See also United States v. Rochelle, 384 F.2d 748, 751 (5th Cir.

1967); McSpadden v. Commissioner, 50 T.C. 478, 490 (1968).

The economic benefit accruing to the taxpayer is the controlling

factor in determining whether a gain is income.    Rutkin v. United

States, supra at 137; United States v. Rochelle, supra at 751.

     In 2003 PPI reported $1,958,877 of gross receipts or sales,

including income of $27,877 from transactions unrelated to the

receivables and the $1,190,500 transferred to Multicred.

Additionally, PPI deducted the $1,190,500 transferred to

Multicred.   The parties subsequently have agreed that the

$450,000 L&R reported as gross receipts in 2003 should have been

reported by PPI, and the $1,190,500 transferred to Multicred (1)

is not includable in PPI’s income, and (2) does not entitle PPI

to a deduction.   Therefore, PPI’s gross income for 2003 is its

reported gross receipts or sales of $1,958,877, plus $450,000

from L&R, less the $1,190,500 that was transferred to Multicred,

for a total of $1,218,377.

     Inconsistent with PPI’s 2003 Form 1120S, as prepared by

Rogers, petitioners argue that the $1,190,500 PPI received from

investors was not income to PPI.    Rather, petitioners argue that

the $1,190,500 was:   (1) Held in trust on behalf of Warwick or
                                - 8 -

Jetstream; or (2) income to Warwick.    Neither of these

contentions has merit.

     In Superior Trading, LLC v. Commissioner, 137 T.C. 70

(2011), we held that Warwick was not a partnership for Federal

tax purposes.    Rather, Warwick was a single-member LLC with

Jetstream as its only member.    Because Warwick did not make an

election to be treated as an association under the so-called

check-the-box regulations, it was a disregarded entity in 2003

for Federal tax purposes.    See sec. 301.7701-3(b)(1)(ii), Proced.

& Admin. Regs.

     Jetstream was also a disregarded entity in 2003 for Federal

tax purposes.    Because both Warwick and Jetstream were

disregarded entities for Federal tax purposes, the $1,190,500

received from the investors is attributable only to PPI.    Nothing

in the record supports petitioners’ argument that PPI was

required to hold these funds on behalf of or for the benefit of

any other person or entity.    The $1,190,500 deposited in PPI’s

bank account constituted unrestricted funds.    In fact, PPI

distributed $732,000 of these funds to Rogers.    Consequently, the

$1,190,500 PPI received from the investors is income to PPI in

2003.

     B.   Deductions

     Deductions are a matter of legislative grace, and the

taxpayer must prove he is entitled to the deductions claimed.
                                   - 9 -

Rule 142(a); New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440

(1934).     Section 162(a) provides that “There shall be allowed as

a deduction all the ordinary and necessary expenses paid or

incurred during the taxable year in carrying on any trade or

business”.

     In 2003 PPI deducted legal and professional fees of $513,501

paid to Rogers and $22,039 paid to Altheimer & Gray and Seyfarth

Shaw.     In turn, petitioners included the $513,501 Rogers received

from PPI as income on their Schedule C.    The parties agree that

if PPI must include in income the $1,190,500 received from

investors, it is entitled to a deduction for legal and

professional fees incurred with respect to the $1,190,500.    We

agree with this position.     Consistent with our holding that the

$1,190,500 is PPI’s income, PPI is entitled to deduct legal and

professional fees of $513,501 paid to Rogers and $22,039 paid to

Altheimer & Gray and Seyfarth Shaw.

III. The $218,499 Distribution

     A.      S Corporation Rules

     On its face, the $218,499 transfer from PPI to Rogers is a

distribution from an S corporation to a shareholder.    Generally,

section 1368(b) provides that distributions from an S corporation

with no accumulated earnings and profits (E&P) of a predecessor C

corporation are not included in the gross income of the

shareholder to the extent that they do not exceed the adjusted
                              - 10 -

basis of the shareholder’s stock, and any excess over adjusted

basis is treated as gain from the sale or exchange of property.

If the S corporation has accumulated E&P of a predecessor C

corporation, then the portion of the distributions in excess of

the S corporation’s accumulated adjustment account (AAA) is

treated as a dividend to the extent it does not exceed the

accumulated E&P.   Sec. 1368(c)(1) and (2).    The AAA is intended

to measure the accumulated taxable income of an S corporation

that has not been distributed to the shareholders.     See Williams

v. Commissioner, 110 T.C. 27, 30 (1998).      The portion of a

distribution to a shareholder that does not exceed the AAA is a

nontaxable return of capital to the extent of the shareholder’s

adjusted basis in S corporation stock.   Sec. 1368(b) and (c)(1).

The AAA is increased for the S corporation’s income and decreased

for the S corporation’s losses and deductions and for nontaxable

distributions to shareholders.   See secs. 1367 and 1368.

     Section 1366(a)(1) provides that a shareholder shall

take into account his or her pro rata share of the S

corporation’s items of income, loss, deduction, or credit for the

S corporation’s taxable year ending with or in the shareholder’s

taxable year.   Section 1367 provides that basis in S corporation

stock is increased by income passed through to the shareholder

under section 1366(a)(1), and decreased by, inter alia,
                               - 11 -

distributions not includable in the shareholder’s income pursuant

to section 1368.

     Unless a statutory or legal principle applies to remove the

$218,499 distribution from the S corporation rules described

above, these rules will govern whether the $218,499 distribution

from PPI to Rogers is income to petitioners and, if so, the

character of that income.    Petitioners argue that the rules

should not apply because the $218,499 distribution from PPI to

Rogers was not a distribution from an S corporation to a

shareholder, but rather, a distribution to a fiduciary to be held

in trust.

     B.     Petitioners’ Trust Argument

     Petitioners argue that Rogers held the $218,499 distribution

from PPI in trust pursuant to a duty of loyalty to Warwick under

the Illinois Limited Liability Company Act (Illinois LLC Act).

The Illinois LLC Act requires the manager of an Illinois LLC to

“account to the company and to hold as trustee for it any

property, profit, or benefit derived by the member in the conduct

or winding up of the company’s business”.    805 Ill. Comp. Stat.

Ann. 180/15-3(b)(1) (West 2010).    Petitioners contend that the

$218,499 distribution from PPI to Rogers is not income to

petitioners because Rogers held this amount in a fiduciary

capacity as manager of Warwick through Jetstream.
                              - 12 -

     Petitioners’ reliance on the Illinois LLC Act is illogical

and misguided.   PPI, and not Warwick, distributed the $218,499 in

question to Rogers.   PPI is an S corporation and is not subject

to the Illinois LLC Act.   We have no reason to view the

transaction at issue as anything more than a distribution from an

S corporation to a shareholder.   Therefore, PPI’s $218,499

distribution to Rogers does not give rise to a duty of loyalty

pursuant to the Illinois LLC Act.

     Rogers did not have a fiduciary duty to PPI under the

Illinois LLC Act, but he was a shareholder, officer, and director

of PPI.   Generally, “a taxpayer need not treat as income moneys

which he did not receive under a claim of right, which were not

his to keep, and which he was required to transmit to someone

else as a mere conduit.”   Diamond v. Commissioner, 56 T.C. 530,

541 (1971), affd. 492 F.2d 286 (7th Cir. 1974).   Thus, money a

taxpayer receives in his or her capacity as a fiduciary or agent

does not constitute income to that taxpayer, Herman v.

Commissioner, 84 T.C. 120, 134-136 (1985); Heminway v.

Commissioner, 44 T.C. 96, 101 (1965), and a shareholder who takes

personal control of corporate funds is not taxable on them so

long as it is shown that he held the funds as an agent of the

corporation and/or deployed them for a corporate purpose, AJF

Transp. Consultants, Inc. v. Commissioner, T.C. Memo. 1999-16,

affd. without published opinion 213 F.3d 625 (2d Cir. 2000); St.
                               - 13 -

Augustine Trawlers, Inc. v. Commissioner, T.C. Memo. 1992-148,

affd. sub nom. O’Neal v. Commissioner, 20 F.3d 1174 (11th Cir.

1994); Alisa v. Commissioner, T.C. Memo. 1976-255.

     Whether Rogers was acting as an agent of PPI is a question

of fact.    See Pittman v. Commissioner, 100 F.3d 1308, 1314 (7th

Cir. 1996) (question of fact whether C corporation’s

shareholder’s diversion of corporate funds constitutes

constructive dividend), affg. T.C. Memo. 1995-243.   We look to

Rogers’ testimony and the objective facts to ascertain his

intent.    See, e.g., Busch v. Commissioner, 728 F.2d 945, 948 (7th

Cir. 1984) (objective factors used to determine intent), affg.

T.C. Memo. 1983-98; Spheeris v. Commissioner, 284 F.2d 928, 931

(7th Cir. 1960) (legal relationship between a closely held

corporation and its shareholders as to payments to the latter

“must be established by a consideration of all relevant factors

indicating the true intent of the parties”), affg. T.C. Memo.

1959-225; Kaplan v. Commissioner, 43 T.C. 580, 595 (1965).

      Petitioners rely on Seven-Up Co. v. Commissioner, 14 T.C.
965 (1950), and Mich. Retailers Association v. United States, 676
F. Supp. 151 (W.D. Mich. 1988), to support their fiduciary

theory.    In Seven-Up Co., Seven-Up Co. (7-Up) manufactured and

sold extract for a soft drink to various franchised bottlers.      To

fund a national advertising campaign, participating bottlers were

required to pay 7-Up $17.50 per gallon of extract purchased.    The
                              - 14 -

funds were administered by 7-Up and were to be spent solely for

advertising purposes.   The funds were accounted for separately on

the company’s books but were not placed in a separate bank

account.   This arrangement was the result of a well-documented

arm’s-length negotiation between 7-Up and the bottlers.   Further,

in a letter sent to each bottler 7-Up acknowledged its role as a

trustee handling the bottlers’ money for the purpose of a

national advertising campaign.

     The Commissioner contended that the excess of the amounts

received by 7-Up over the advertising expenses incurred and paid

constituted income to 7-Up.   In holding that the excess was not

taxable, we stated:

     While petitioner had the right to receive the bottlers’
     contributions under its agreements with them, all the facts
     and circumstances surrounding the transaction clearly
     indicate that it was the intention of all of the parties
     concerned that these contributions were to be used to
     acquire national advertising for the 7-Up bottled beverage
     and for that purpose only, and that petitioner was to be a
     conduit for passing on the funds contributed to the
     advertising agency which was to arrange for and supply the
     national advertising. * * * Although the funds were not all
     expended in the year received, for reasons set forth in our
     findings, petitioner did expend them for national
     advertising, did not use them for general corporate
     purposes, treated the amounts on hand in the fund on its
     books as a liability to the bottlers, and considered itself,
     as evidenced by its letter of May 2, 1944, to one of the
     participating bottlers, merely as a trustee, handling the
     bottlers’ money. [Seven-Up Co. v. Commissioner, supra at
     977-978.]

     In Mich. Retailers Association v. United States, supra,

Michigan Retailers Association (MRA), a not-for-profit
                              - 15 -

corporation, was the master policy holder of two group health

insurance policies for its members.    As master policy holder, MRA

received premium credits from insurance companies in 1976 and

1977 because premiums received from its members exceeded claims

paid for their benefit.   The Internal Revenue Service determined

that MRA should have reported these premiums as income.    MRA

argued that the premiums were received and held in trust for the

benefit of its members.

     The premiums were commingled with other funds; however, they

were segregated in MRA’s financial records, earmarked for the

benefit of its members, and credited to a liability account.

Further, MRA’s chief officer and board of directors believed that

they were obligated to use the premium credits for the benefit of

its members.   In 1978 MRA executed a declaration of trust

acknowledging its rights and responsibilities with respect to the

excess premiums.   Citing these facts and circumstances, the Court

held that MRA was merely a conduit through which excess premiums

were returned for the benefit of its members.

     Both Seven-Up Co. v. Commissioner, supra, and Mich.

Retailers Association v. United States, supra, are clearly

distinguishable from the case at hand.   In each of those cases,

the record supported an understanding among all parties that the

moneys received were held in trust for the benefit of others.

Here, Rogers testified that he held the $218,499 in trust to pay
                               - 16 -

administrative costs and to invest further in Brazilian

receivables in 2005.   However, petitioners have failed to support

this claim with any documentation or outside testimony.    We are

not required to accept self-serving testimony, particularly where

it is implausible and there is no persuasive corroborating

evidence.   E.g., Frierdich v. Commissioner, 925 F.2d 180, 185

(7th Cir. 1991) (“The statements of an interested party as to his

own intentions are not necessarily conclusive, even when they are

uncontradicted.”), affg. T.C. Memo. 1989-393; Lerch v.

Commissioner, 877 F.2d 624, 631-632 (7th Cir. 1989), affg. T.C.

Memo. 1987-295; Tokarski v. Commissioner, 87 T.C. 74, 77 (1986).

Additionally, a taxpayer’s testimony as to intent is not

determinative, particularly where it is contradicted by the

objective evidence.    Busch v. Commissioner, supra at 948; Glimco

v. Commissioner, 397 F.2d 537, 540-541 (7th Cir. 1968)

(taxpayer’s uncontradicted testimony need not be accepted), affg.

T.C. Memo. 1967-119.

     The objective evidence in the record contradicts Rogers’

contention that he was acting as an agent of PPI in furtherance

of a corporate purpose.   Rogers did not hold the $218,499 in

escrow or segregate the funds for PPI’s use.   Rather, Rogers held

and used the funds without restriction.   The $218,499 was

transferred to petitioners’ joint bank account.   The record is

devoid of any evidence establishing either an express or
                               - 17 -

constructive trust between Rogers and PPI.     Further, petitioners

have not presented any written agreement providing that Rogers,

through PPI, acted as a trustee to hold the $218,499 for the

benefit of any other entity.   Rogers controlled Warwick,

Jetstream, and PPI.   Nothing in the record indicates that Rogers

used the funds from the sale of the receivables to serve the

interest of any of these entities.      Rather, Rogers’ actions with

respect to these funds clearly show that his only interest was to

use Warwick, Jetstream, and PPI to avoid tax on his income.

Accordingly, we sustain respondent’s determination with respect

to the trust issue.

IV.   Rule 155 Computation

      The $218,499 distribution from PPI to Rogers was nothing

more than a distribution from an S corporation to a shareholder.

PPI was incorporated on April 1, 1989, but did not elect to be

treated as an S corporation until January 1, 1992.     As a result,

it is possible that PPI has accumulated E&P from its predecessor

C corporation.   Pursuant to the S corporation rules discussed

above, if PPI has accumulated E&P then the $218,499 distribution

is a dividend to Rogers to the extent it exceeds PPI’s AAA but

does not exceed its accumulated E&P.     If PPI does not have

accumulated E&P, then the $218,499 distribution must be treated

as a gain from the sale or exchange of property to the extent it

exceeds Rogers’ basis in his PPI stock.     A Rule 155 computation
                             - 18 -

of PPI’s E&P and AAA, as well as Rogers’ basis in his PPI stock,

is required to make a final determination.

     The Court, in reaching its holdings, has considered all

arguments made, and, to the extent not mentioned, concludes that

they are moot, irrelevant, or without merit.

     To reflect the foregoing,

                                      Decision will be entered

                                 under Rule 155.