Court Opinion

ID: 9408186
Source: CourtListenerOpinion
Date Created: 2023-07-11 19:04:20.149358+00
Date Added: 2024-06-11T17:20:42.565673
License: Public Domain

United States Tax Court

                         T.C. Memo. 2023-86

                        WILLIAM G. ALLEN,
                            Petitioner

                                   v.

            COMMISSIONER OF INTERNAL REVENUE,
                        Respondent

               HUMBOLT INVESTMENTS, LLC,
       ALLEN FAMILY INVESTMENT TRUST U/A/D 12/1/03,
                 TAX MATTERS PARTNER,
                        Petitioner

                                   v.

            COMMISSIONER OF INTERNAL REVENUE,
                        Respondent

                              —————

Docket Nos. 28210-15, 31951-15.                      Filed July 11, 2023.

                              —————

Richard A. Pelak and Jimmie W. Phillips, Jr., for petitioners.

Kimberly B. Tyson and Scott Lyons, for respondent.

       MEMORANDUM FINDINGS OF FACT AND OPINION

       ASHFORD, Judge: By statutory notice of deficiency dated August
11, 2015, the Internal Revenue Service (IRS or respondent) determined
deficiencies in William G. Allen’s federal income tax and accuracy-

                           Served 07/11/23
                                           2

[*2] related penalties pursuant to section 6662 1 for the 2005 and 2006
taxable years as follows:

           Year                       Deficiency                § 6662 Penalty

           2005                      $2,646,969                     $529,394

           2006                       2,054,073                      410,815

By a notice of final partnership administrative adjustment (FPAA)
dated September 28, 2015, the IRS adjusted Humbolt Investments,
LLC’s (Humbolt) ordinary income for the 2009 taxable year, increasing
it by $3,403,027.

       After certain concessions, the issues remaining for decision are
whether (1) Mr. Allen’s businesses—Waterfront Development Services,
Inc. (WDS), its disregarded entity, Waterfront Development Services I,
LLC (WDS I), and Humbolt’s TMP—are entitled to section 166 bad debt
deductions in whole or in part for 2009 and (2) Mr. Allen is liable for
section 6662 accuracy-related penalties for carrying back the section 166
deductions to 2005 and 2006 and thereby understating his income for
those years. We resolve both issues in respondent’s favor.

      When the Petitions were timely filed, Mr. Allen resided in Florida
and Humbolt’s principal place of business was in North Carolina. 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 First Supplemental Stipulation of Facts, the
Second Supplemental Stipulation of Facts, the Third Supplemental
Stipulation of Facts, and the attached Exhibits are incorporated herein
by this reference.

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

Code, Title 26 U.S.C., 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.
                                    3

[*3] I.    Mr. Allen’s Background

        Mr. Allen has significant experience in the residential real estate
industry. His experience includes acquiring, marketing, and selling
large, single-family, residential lot developments in resort residential
communities in the Southeast and in Texas. To effectively manage his
real estate enterprise, Mr. Allen formed many different independent yet
affiliated business entities. He owned or controlled each of the entities
that made up his real estate enterprise.

      Mr. Allen located land that he determined would be marketable
and economically profitable for residential real estate developments. He
used the business entities and trusts to manage, design, and market the
properties as well as to obtain financing for each development project.
Through these business entities, Mr. Allen coordinated lot sales for six
bonded residential real estate developments (collectively, 2009
development projects): (1) Summerhouse at Everett Bay in North
Carolina (Summerhouse Development), which was being developed by
R.A. North Development I, Inc. (RAND I); (2) Cutter Bay in North
Carolina (Cutter Bay Development), which was being developed by RR
Development North III, LLC (RRDN III); (3) Beachside in Texas
(Beachside Development), which was being developed by D.H. Palacios
Development, L.P. (D.H. Palacios); (4) Sanctuary at Costa Grande in
Texas (Sanctuary Development), which was being developed by D.H.
Texas Development, L.P. (D.H. Texas Development); (5) Waterbridge in
South Carolina (Waterbridge Development), which was being developed
by South Carolina Coastal Development I, Inc. (SCCD I); and (6) Water
Ridge in Florida (Water Ridge Development), which was being
developed by R.A. Florida Development, Inc. (RAFD).

       RAND I, RRDN III, D.H. Palacios, D.H. Texas Development,
SCCD I, and RAFD (collectively, development companies) each entered
into a Marketing, Sales, and Administrative Services Agreement (MSAS
Agreement) with WDS to provide services for their respective
development projects. The MSAS Agreements gave WDS the rights to
(1) use marketing companies to market and sell undeveloped lots in each
of the development projects and (2) use Waterfront Communities, Inc.
(Waterfront Communities) (as further discussed infra p. 4), to provide
administrative services for each of the development projects. WDS’s
agency fees ranged from 21.5% to 53.5% of gross proceeds from lot sales.
                                    4

[*4] II.    Mr. Allen’s Real Estate Enterprise

       A.    Allen GST Investment Trust

       The Allen GST Investment Trust (GST Trust) is a qualified
subchapter S trust for federal income tax purposes with a Nevada situs.
At all relevant times, the primary beneficiaries of the GST Trust were
Mr. Allen and his issue. Mr. Allen was the family trustee of the GST
Trust until June 17, 2009, when he resigned. Thereafter, independent
trustees were appointed yet had no involvement in the daily activities of
GST Trust’s business activities.

             1.     The Waterfront Companies: WDS, WDS I, and
                    Waterfront Communities

       The GST Trust wholly owned WDS, a Florida S corporation for
federal income tax purposes. WDS was created on September 13, 2004,
and Mr. Allen was the president and an employee of WDS. WDS wholly
owned WDS I, a Florida limited liability company and disregarded
entity for federal income tax purposes. Mr. Allen was the sole manager
of WDS I.

      The GST Trust wholly owned Waterfront Communities, a North
Carolina S corporation for federal income tax purposes. Mr. Allen was
the president of Waterfront Communities.

       At all relevant times—and on the basis of its MSAS Agreement
with each of the development companies—WDS entered into an
Administrative Services Agreement with Waterfront Communities for
each of the 2009 development projects to provide administrative
services. Mr. Allen agreed to pay Waterfront Communities an agency
fee based on a percentage of the gross sale price of each lot sold.

             2.     Contracts Between WDS, WDS I, and the Marketing
                    Companies

       The GST Trust also wholly owned RR Development Group, LLC
(RRDG), a Nevada limited liability company and disregarded entity for
federal income tax purposes. RRDG was used as an investment vehicle
for the GST Trust. Mr. Allen was the manager of RRDG.

      RRDG owned (1) Southeastern Waterfront Marketing, Inc.
(Southeastern Waterfront); (2) Waterfront Marketing, L.P.;
(3) Waterfront Marketing, LLC (Waterfront Marketing); (4) Intracoastal
                                   5

[*5] Land Sales, Inc. (Intracoastal); and (5) Florida Waterway Sales,
Inc. (Florida Waterway). Water View Sales, Inc. (Water View), was
owned 9% by Mr. Allen and 91% by the Allen Irrevocable Trust (10-31-02
Trust). These six companies are collectively referred to as the marketing
companies.

       In accordance with their agreements with the development
companies, WDS and WDS I contracted with the marketing companies
to provide marketing and sales services specific to each development
project on the basis of their location and buyer demographics. WDS and
WDS I agreed to pay each marketing company a fee based on a
percentage of the gross sale price of each lot sold.

             3.    The Marketing Companies

                   a.     Southeastern Waterfront

      Southeastern Waterfront is a North Carolina S corporation for
federal income tax purposes. As of 2009 Mr. Allen became the president
of Southeastern Waterfront.         In 2006 WDS contracted with
Southeastern Waterfront to market, promote, and sell lots in the
Summerhouse Development in North Carolina based on their MSAS
Agreement with RAND I. WDS was expected to receive 10% of the gross
sales as its fee. During 2009 and 2010 RAND I received a total of
$698,469 in gross revenue from lot sales.

       Similarly, in 2007 WDS contracted with Southeastern Waterfront
to market, promote, and sell lots in the Cutter Bay Development in
North Carolina based on their MSAS Agreement with RRDN III. WDS
was expected to receive 20% of the gross sales as its fee. During 2007
and 2008 RRDN III received a total of $4,568,700 in gross revenue from
lot sales.

                   b.     Waterfront Marketing, L.P.

      Waterfront Marketing, L.P., was a Texas limited partnership and
disregarded entity for federal income tax purposes. Mr. Allen was the
manager of Waterfront Marketing, L.P., before it merged with
Waterfront Marketing.

       From 2005 to 2006 WDS contracted with Waterfront Marketing,
L.P., to market, promote, and sell lots in the Sanctuary Development in
Texas based on their MSAS Agreement with D.H. Texas Development.
WDS was expected to receive 20% of the gross sales as its fee. From
                                   6

[*6] 2006 to 2010 D.H. Texas Development received a total of
$96,798,541 in gross revenue from lot sales.

                   c.     Waterfront Marketing

       Waterfront Marketing is a Texas limited liability company and
disregarded entity for federal income tax purposes. Mr. Allen was a co-
manager of the company. From 2007 to 2010 WDS contracted with
Waterfront Marketing to market, promote, and sell lots in the Beachside
Development in Texas based on the MSAS Agreement with D.H.
Palacios. WDS was expected to receive 20% of the gross sales as its fee.
During 2007 and 2008 D.H. Palacios received a total of $10,095,318 in
gross revenue from lot sales.

                   d.     Intracoastal

       Intracoastal is a South Carolina S corporation for federal income
tax purposes. Mr. Allen was Intracoastal’s president. From 2006 to
2009 WDS contracted with Intracoastal to market, promote, and sell lots
in the Waterbridge Development in South Carolina based on the MSAS
Agreement with SCCD I. WDS was expected to receive 12% of the gross
sales as its fee. From 2006 to 2010 SCCD I received a total of
$66,673,322 in gross revenue from lot sales.

                   e.     Florida Waterway

        Florida Waterway was a Florida S corporation for federal income
tax purposes. Mr. Allen was Florida Waterway’s president. From 2004
to 2009 WDS contracted with Florida Waterway to market, promote, and
sell lots in the Water Ridge Development in Florida based on the MSAS
Agreement with RAFD. WDS was expected to receive 10% of the gross
sales as its fee. From 2005 to 2010 RAFD received a total of $70,580,864
in gross revenue from lot sales.

                   f.     Water View

      Water View is a South Carolina C corporation for federal income
tax purposes and was owned 9% by Mr. Allen and 91% by the 10-31-02
Trust. Mr. Allen was the president of Water View.

      B.     The Allen Family Investment Trust

      Mr. Allen’s real estate enterprise consisted of multiple trusts,
including the Allen Family Investment Trust. The Allen Family
                                             7

[*7] Investment Trust has a Nevada situs, and the primary beneficiaries
of the trust were Mr. Allen, Minok Lee Allen (his spouse), and Monica
Lee Allen and William G. Allen, Jr. (his children).

        C.      Humbolt

       Humbolt is a Nevada limited liability company and is a
partnership for federal income tax purposes. Because the return at
issue was filed in 2009, Humbolt is governed by TEFRA. 2 Humbolt is
owned 99% by the Allen Family Investment Trust and 1% by the GST
Trust. Humbolt was formed in 2003 to lend money to entities and
individuals involved in the residential real estate industry.

       In 2009 Humbolt listed its principal business activity and
principal product or service on its Form 1065, U.S. Return of
Partnership Income, as real estate financing. Since May 2, 2004, Mr.
Allen has been the manager of Humbolt.

        D.      Other Trusts and Entities Involved in Mr. Allen’s Real
                Estate Enterprise

                1.       6-8-05 Trust

      The 6-8-05 Trust is an irrevocable trust (with its situs unknown
from the record), and the primary beneficiary of the trust was Jeanne
Bell, Ms. Allen’s sister. Nell Allen, Mr. Allen’s mother, was the sole
trustee of the trust.

                2.       9-30-02 Trust

      The 9-30-02 Trust is an irrevocable trust with a Nevada situs, and
the primary beneficiaries of the trust were Mr. Allen’s children and
further issue. Mr. Allen was appointed the family trustee of the 9-30-02
Trust on January 1, 2009. Thereafter, independent trustees were
appointed.

         2 The Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), Pub. L. No.

97-248, §§ 401–407, 96 Stat. 324, 648–71, established unified procedures for the IRS
examination of partnerships, rather than a separate examination for each partner.
Although TEFRA was repealed by the Bipartisan Budget Act of 2015, Pub. L. No. 114-
74, § 1101(a), (c)(1), (g), 129 Stat. 584, 625, 638, it still applies for partnership returns
filed before that time.
                                    8

[*8]         3.     6-28-02 Trust

        The 6-28-02 Trust is an irrevocable trust with a North Carolina
situs, and the primary beneficiaries of the trust were Mr. Allen’s sister-
in-law, Kathy Allen, and the issue of Kathy Allen and Mr. Allen’s
brother, Randolph Allen. At all relevant times, Graham Allen, Kathy
and Randolph Allen’s son and Mr. Allen’s nephew, was the sole trustee
of the 6-28-02 Trust. The 6-28-02 Trust wholly owned Graham P.C.
Florida, Inc. (Graham Florida), a Florida S corporation for federal
income tax purposes; Marathon Land Developers, LLC (Marathon), a
North Carolina limited liability company that was treated as a
disregarded entity for federal income tax purposes; and Graham P.C.
Investments, Inc. (Graham Investments), a North Carolina limited
liability company that was treated as an S corporation for federal income
tax purposes. Graham Allen was the president of Graham Florida and
the manager of Graham Investments. Mr. Allen’s spouse was the
manager of Marathon until December 29, 2009, at which time Nancy
Morrison was appointed Marathon’s manager.

             4.     9-2-98 Trust

       The 9-2-98 Trust is an irrevocable trust with a North Carolina
situs, and the primary beneficiaries of the trust were Mr. Allen’s
children. At all relevant times, Mr. Allen was the sole trustee of the
9-2-98 Trust. The 9-2-98 Trust wholly owned ML&G Investments, Inc.
(ML&G Investments), a North Carolina corporation that was treated as
an S corporation for federal income tax purposes. Mr. Allen was the
president of ML&G Investments.

III.   Purported Loan Transactions

      During the early 2000s, WDS, WDS I, and Humbolt issued
purported loans to many of the related entities mentioned above.

      WDS issued the following advances: (1) $460,000 to Waterfront
Communities and (2) $424,631 to Carter Allen, Mr. Allen’s now deceased
brother and then sales representative.

       WDS I issued the following advances: (1) $4,418,586 to
Southeastern Waterfront; (2) $3,245,572 to Waterfront Marketing;
(3) $773,160 to Intracoastal; (4) $518,196 to Florida Waterway;
(5) $1,584,106 to RRDG; (6) $83,051 to Water View; (7) $15,000 to
Waterfront Communities; (8) $629,331 to Marathon; (9) $1,630,000 to
the 9-30-02 Trust; (10) $30,000 to Graham Florida; (11) $661,737 to
                                    9

[*9] ML&G Investments; (12) $2,000 to Carter Allen; and (13) $46,875
to Dustin Calderon, a sales representative.

       Humbolt issued the following advances: (1) $729,804 to D.H.
Palacios; (2) $350,000 to RRDN III; (3) $245,400 to Graham Florida;
(4) $205,000 to Graham Investments; (5) $57,500 to the 6-8-05 Trust;
and (6) $1,815,323 to Marathon.

       The parties who received advances did not (1) complete loan
applications for any of the loans they received; (2) have earnings; or
(3) pay interest on any of the purported debts. Despite receiving no
interest payments, neither WDS nor WDS I made any demands for
repayment or issued notices of default for any amounts.

IV.   Tax Reporting of Mr. Allen, WDS, and Humbolt

      A.     Mr. Allen

       On or about February 18, 2010, Mr. Allen prepared and timely
filed his original 2009 Form 1040, U.S. Individual Income Tax Return.
After filing his original 2009 Form 1040, Mr. Allen filed Form 1045,
Application for Tentative Refund, on February 24, 2010, to claim
$28,427,903 in net operating loss carryback deductions for 2004–06.
The IRS sent Mr. Allen a letter denying this request and informing him
that “[t]here was no election statement to verify [his] 5 year carryback.”
The IRS further stated that “the election must state that you are
electing to apply Section 172(b)(1)(H) under Rev. Proc. 2009-52, and that
you are not a TARP recipient . . . . The statement must specify the length
of the NOL carryback period that you are electing.” The IRS also stated
that “[t]he 2004 figures do not match our records, to process your
carryback application these figures must match, it appears the 1040X
Amended Return for 2004 was not processed.”

      After receiving the IRS’s letter, Mr. Allen filed a second 2009
Form 1045 with the IRS on April 22, 2010. The second 2009 Form 1045
claimed the same $28,427,903 in net operating loss carryback
deductions for 2004–06.

      After filing the original 2009 Form 1040, the original 2009 Form
1045, and the second 2009 Form 1045, Mr. Allen filed with the IRS a
separate, superseding Form 1040 for 2009 on or about October 11, 2010.
The IRS did not process the superseding 2009 Form 1040.
                                   10

[*10] On October 11, 2010, Mr. Allen filed with the IRS a third 2009
Form 1045. As on the first and second 2009 Forms 1045, Mr. Allen
claimed net operating loss carryback deductions for 2004–06. On the
third 2009 Form 1045, Mr. Allen claimed $27,185,388 instead of
$28,427,903.

       Meanwhile, the IRS sent Mr. Allen a letter notifying him that his
original 2009 Form 1040 was being evaluated “to determine whether it
will be examined or accepted without examination. The tentative refund
or claim amount is in excess of $2,000,000.” The IRS included an
information document request describing certain documents that
needed to be provided.

       Ultimately, during the examination the IRS revenue agent
determined that Mr. Allen had understated his income and was subject
to accuracy-related penalties for 2005 and 2006. The IRS revenue agent
obtained written supervisory approval for these penalties on August 30,
2013.

      B.     WDS

      WDS filed its 2009 Form 1120S, U.S. Income Tax Return for an
S Corporation, on or about September 16, 2010. On this return WDS
claimed section 166 bad debt deductions of (1) $460,000 for Waterfront
Communities and (2) $424,631 for Carter Allen.

       On this return WDS also claimed section 166 bad debt deductions
for WDS I of (1) $4,418,586 for Southeastern Waterfront; (2) $3,245,572
for Waterfront Marketing; (3) $773,160 for Intracoastal; (4) $518,196 for
Florida Waterway; (5) $1,584,106 for RRDG; (6) $83,051 for Water View;
(7) $15,000 for Waterfront Communities; (8) $629,331 for Marathon;
(9) $1,630,000 for the 9-30-02 Trust; (10) $30,000 for Graham Florida;
(11) $661,737 for ML&G Investments; (12) $2,000 for Carter Allen; and
(13) $46,875 for Dustin Calderon.

       WDS claimed a total of $14,522,246 in section 166 bad debt
deductions. All of these deductions flowed through the GST Trust to Mr.
Allen’s individual tax return.

      C.     Humbolt

       Humbolt filed its 2009 Form 1065 electronically on June 15, 2010.
On this return Humbolt claimed section 166 bad debt deductions of
(1) $350,000 for RRDN III; (2) $729,804 for D.H. Palacios; (3) $1,815,323
                                     11

[*11] for Marathon; (4) $205,000 for Graham Investments; (5) 245,400
for Graham Florida; and (6) 57,500 for the 6-8-05 Trust.

      Humbolt claimed a total of $3,403,027 in section 166 bad debt
deductions.

V.     Notice of Deficiency and FPAA

      On August 11, 2015, the IRS sent Mr. Allen a notice of deficiency
determining increases in tax of $2,646,969 for 2005 and $2,054,073 for
2006. The notice of deficiency also determined he was liable for
accuracy-related penaltites for substantial understatements of income
tax under section 6662(a) and (b)(2) of $529,394 for 2005 and $410,815
for 2006. The notice of deficiency disallowed $14,522,246 of bad debt
deductions claimed on WDS’s 2009 return.

       On September 28, 2015, through an FPAA, the IRS notified the
Allen Family Investment Trust as tax matters partner for Humbolt that
it was disallowing all of the section 166 bad debt deductions claimed on
its 2009 return.

                                 OPINION

       These consolidated cases present two main issues: whether
(1) the advances to the affiliated companies constituted debt or equity 3
and (2) Mr. Allen is liable for accuracy-related penalties. We address
these questions in turn.

I.     Burden of Proof

       Generally, the Commissioner’s determinations set forth in a
notice of deficiency and an FPAA are presumed correct and, except for
the burden of production in any court proceeding with respect to an
individual’s liability for any “penalty, addition to tax, or additional
amount,” see § 7491(c), the taxpayer bears the burden of proving
otherwise, see Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933).
Furthermore, tax deductions are a matter of legislative grace, and the
taxpayer bears the burden of proving entitlement to any deduction
claimed. INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992); New
Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934); Segel v.
Commissioner, 89 T.C. 816, 842 (1987). As relevant here, this burden

        3 Because we find that the advances constituted equity—and not debt—we

decline to analyze whether the sums were wholly or partially worthless.
                                    12

[*12] requires the taxpayer to demonstrate that the deductions claimed
are allowable pursuant to some statutory provision and to substantiate
by producing adequate records that enable the Commissioner to
determine the taxpayer’s correct liability.        § 6001; Higbee v.
Commissioner, 116 T.C. 438, 440 (2001); Hradesky v. Commissioner, 65
T.C. 87, 89–90 (1975), aff’d per curiam, 540 F.2d 821 (5th Cir. 1976).

      If the taxpayer produces credible evidence with respect to any
factual issue relevant to ascertaining his federal income tax liability and
meets certain other requirements, the burden of proof shifts from the
taxpayer to the Commissioner as to that factual issue. See § 7491(a)(1)
and (2). Petitioners do not contend, and the evidence does not establish,
that the burden of proof shifts to respondent under section 7491(a)(1)
and (2) as to any issue of fact.

II.   Section 166 Bad Debt Deduction

      A.     General Legal Principles

       A taxpayer is allowed as a deduction any bona fide business debt
which becomes worthless in whole or in part within a taxable year. See
§ 166(a); Shaw v. Commissioner, T.C. Memo. 2013-170, at *8, aff’d, 623
F. App’x 467 (9th Cir. 2015); Treas. Reg. § 1.166-1(a)(1). Section
166(a)(1) does not, however, apply to a nonbusiness debt held by a
taxpayer other than a corporation; instead, the taxpayer is allowed a
short-term capital loss deduction for the taxable year in which the debt
becomes worthless. See §§ 166(d)(1), 1211(b); Treas. Reg. § 1.166-5(a)(2).

       Only a bona fide debt qualifies for purposes of section 166. Treas.
Reg. § 1.166-1(c). A debt is bona fide if at the time the funds were
advanced the parties, in good faith, had an actual intent to create “a
debtor-creditor relationship based upon a valid and enforceable
obligation to pay a fixed or determinable sum of money.” Ellinger
v. United States, 470 F.3d 1325, 1333 (11th Cir. 2006) (quoting Treas.
Reg. § 1.166-1(c)).

      A business debt is “a debt created or acquired . . . in connection
with a trade or business of the taxpayer” or “a debt the loss from the
worthlessness of which is incurred in the taxpayer’s trade or business.”
§ 166(d)(2); see also Bercy v. Commissioner, T.C. Memo. 2019-118,
at 11–12; Rutter v. Commissioner, T.C. Memo. 2017-174, at *14. It is
undisputed that petitioners engaged in a trade or business.
                                    13

[*13] A gift or contribution to capital is not considered a “debt” for
purposes of section 166. Kean v. Commissioner, 91 T.C. 575, 594 (1988);
Rutter, T.C. Memo. 2017-174, at *14; see also Treas. Reg § 1.166-1(c).
Capital contributions are considered equity. Am. Underwriters, Inc. v.
Commissioner, T.C. Memo. 1996-548, slip op. at 13.

       A monetary transfer made between affiliated parties is subject to
special scrutiny; however, having an affiliate relationship alone does not
necessarily mean the transfer lacks economic substance. Id., slip op. at
16. Monetary transfers between family members are presumed to be a
gift and “are subject to rigid scrutiny and particularly susceptible to a
finding that a transfer was intended as a gift rather than a debt.” VHC,
Inc. & Subs. v. Commissioner, T.C. Memo. 2017-220, at *52–53 (citing
Estate of Van Anda v. Commissioner, 12 T.C. 1158, 1162 (1949), aff’d per
curiam, 192 F.2d 391 (2d Cir. 1951)), aff’d, 968 F.3d 839 (7th Cir. 2020).
Whether an advance of funds is, in substance, a bona fide worthless
business debt and deductible under section 166(a) is a question of fact
to be decided on the basis of all relevant facts and circumstances of each
case. Id. at *52, *82; Rutter, T.C. Memo. 2017-174, at *14.

       Accordingly, to properly claim a section 166 bad debt deduction,
the taxpayer must establish that he intended to create a debtor-creditor
status and that a genuine debt exists. Clark v. Commissioner, 18 T.C.
780, 783 (1952), aff’d per curiam, 205 F.2d 353 (2d Cir. 1953). The
taxpayer must then show that the debt became wholly or partially
worthless during the taxable year. Dustin v. Commissioner, 53 T.C. 491,
501–02 (1969), aff’d, 467 F.2d 47 (9th Cir. 1972).

       Because Humbolt, WDS, and WDS I advanced funds to affiliated
entities as well as directly and indirectly to family members of Mr. Allen,
we examine the transfers with heightened scrutiny. See VHC, Inc., T.C.
Memo. 2017-220, at *52.

      B.     Tests for Evaluating Debt Versus Equity

      Petitioners assert that all of the advances made to the purported
debtors were bona fide business debts pursuant to section 166(a)(1).
Respondent disagrees.

      “We determine whether a purported debt is in substance and fact
a debt for tax purposes from the facts and circumstances of each case,
with the taxpayer bearing the burden of proof.” VHC, Inc., T.C. Memo.
2017-220, at *52 (first citing Arlington Park Jockey Club, Inc. v. Sauber,
262 F.2d 902, 905 (7th Cir. 1959); and then citing Dixie Dairies Corp. v.
                                    14

[*14] Commissioner, 74 T.C. 476, 493 (1980)). For a bona fide debt to
exist, the parties to a transaction must have had an actual, good-faith
intent to establish a debtor-creditor relationship at the time the funds
were advanced. Beaver v. Commissioner, 55 T.C. 85, 91 (1970).

       An intent to establish a debtor-creditor relationship exists if the
debtor intends to repay the loan and the creditor intends to enforce
repayment. Fisher v. Commissioner, 54 T.C. 905, 909–10 (1970). The
expectation of repayment must not “depend solely on the success of the
borrower’s venture.” Am. Processing & Sales Co. v. United States, 371
F.2d 842, 856 (Ct. Cl. 1967). For that matter “[a]dvances made by an
investor to a closely held or controlled corporation may properly be
characterized, not as a bona fide loan, but as a capital contribution.” See
Shaw, T.C. Memo. 2013-170, at *9 (citing Fin Hay Realty Co. v. United
States, 398 F.2d 694, 697 (3d Cir. 1968)).

       Absent stipulation to the contrary, we follow the relevant
precedent of the court of appeals to which an appeal would generally lie.
See Golsen v. Commissioner, 54 T.C. 742, 757 (1970), aff’d, 445 F.2d 985
(10th Cir. 1971). In these cases the appeal would lie in the U.S. Court
of Appeals for the Fourth and the Eleventh Circuits, which use slightly
different methods to determine the parties’ intent. See Fairchild
Dornier GMBH v. Off. Comm. of Unsecured Creditors (In re Dornier
Aviation (N. Am.), Inc.), 453 F.3d 225, 233–34 (4th Cir. 2006); Lane v.
United States (In re Lane), 742 F.2d 1311, 1314–15 (11th Cir. 1984).

        The Eleventh Circuit has approved use of certain guidelines to
facilitate a determination of whether advances constitute debt or equity.
There are at least 13 factors which merit consideration in determining
this issue: (1) names given to the certificates evidencing the
indebtedness; (2) presence or absence of a fixed maturity date; (3) source
of payments; (4) right to enforce payment of principal and interest;
(5) participation in management flowing as a result; (6) status of the
contribution in relation to regular corporate creditors; (7) intent of the
parties; (8) “thin” or adequate capitalization; (9) identity of interest
between creditor and stockholder; (10) source of interest payments;
(11) ability of the corporation to obtain loans from outside lending
institutions; (12) extent to which the advance was used to acquire capital
assets; and (13) failure of the debtor to repay on the due date or seek a
postponement. Lane, 742 F.2d at 1314–15 (citing Estate of Mixon v.
United States, 464 F.2d 394, 402 (5th Cir. 1972)). The Eleventh Circuit
has stressed that “these guidelines are not rigid rules mandating a
particular conclusion when the court finds certain facts.” Id. at 1315;
                                    15

[*15] see also Tyler v. Tomlinson, 414 F.2d 844, 848 (5th Cir. 1969)
(“[T]ests are, at most, helpful factors to be considered and not fiats to be
bound by.” (quoting Ga. S. & Fla. Ry. Co. v. Alt. Coast Line R.R. Co., 373
F.2d 493, 498 (5th Cir. 1967))).

       While the Fourth Circuit has not adopted the Mixon factors, it has
used a similar test for determining whether a claim should be
recharacterized from debt to equity under the Bankruptcy Code. See
Fairchild Dornier GMBH, 453 F.3d at 233–34 (citing Bayer Corp. v.
MascoTech, Inc. (In re AutoStyle Plastics, Inc.), 269 F.3d 726, 749–50
(6th Cir. 2001)); see also Bd. of Trs., Sheet Metal Workers’ Nat’l Pension
Fund v. Lane & Roderick, Inc., 736 F. App’x 400 (4th Cir. 2018). There
are 11 nonexclusive factors: (1) the names given to the instruments, if
any, evidencing the indebtedness; (2) the presence or absence of a fixed
maturity date and schedule of payments; (3) the presence or absence of
a fixed rate of interest and interest payments; (4) the source of
repayments; (5) the adequacy or inadequacy of capitalization; (6) the
identity of interest between the creditor and the stockholder; (7) the
security, if any, for the advances; (8) the corporation’s ability to obtain
financing from outside lending institutions; (9) the extent to which the
advances were subordinated to the claims of outside creditors; (10) the
extent to which the advances were used to acquire capital assets; and
(11) the presence or absence of a sinking fund to provide repayments.
See Fairchild Dornier GMBH, 453 F.3d at 233.

       Regardless of the factors employed, both the Fourth and the
Eleventh Circuits recognize that “[t]he substance of all of these multi-
factor tests is identical,” and application of the factors is helpful but
what is necessary is evaluating the factors selected by the court to
determine the taxpayer’s intent concerning a transaction. Id. at 234 n.6;
see also Lane, 742 F.2d at 1315 (citing Tyler, 414 F.2d at 848). Because
the Mixon factors used in the Eleventh Circuit are more expansive, we
will use them for the analysis.

III.   Application of the Mixon Factors: Criteria for Bona Fide Debt

       A.    Names Given to the Certificates Evidencing Indebtedness

       Focusing on the first factor, the names on the certificates
evidencing indebtedness, we accord greater weight to the economic
substance of a transaction than to its form. See Rutter, T.C. Memo.
2017-174, at *16–17 (citing Estate of Reynolds v. Commissioner, 55 T.C.
172, 201–02 (1970)). With this factor, we consider the type of instrument
                                   16

[*16] evidencing the advance. Hardman v. United States, 827 F.2d
1409, 1412 (9th Cir. 1987); Rutter, T.C. Memo. 2017-174, at *18.
Issuance of a stock certificate indicates an equitable contribution, and
issuance of a note is indicative of bona fide indebtedness. Estate of
Mixon, 464 F.2d at 403; see also Kean, 91 T.C. at 595–96.

      Humbolt, WDS, and WDS I memorialized their advances by
issuing to each recipient a “Future Advance Promissory Note,” “Second
Note Modification Agreement,” “Assignment of Future Advance
Promissory Note,” or “Promissory Note.” Petitioners assert that these
memorializations indicate bona fide indebtedness.        Respondent
disagrees because the advances were made among related parties: the
GST Trust and the Allen Family Investment Trust—the beneficiaries of
which were Mr. Allen and his family—which together are wholly owned
by Humbolt, WDS, and WDS I. The GST Trust also wholly owned all of
the entities that received advances.

       Although evidence of formal debt instruments is indicative of a
true debt, a genuine debtor-creditor relationship must be accompanied
by “more than the existence of corporate paper encrusted with the
appropriate nomenclature captions.” VHC, Inc., T.C. Memo. 2017-220,
at *54–55 (quoting Tyler, 414 F.2d at 850). This is especially true in the
context of related-party transactions. See Piedmont Mins. Co. v. United
States, 294 F. Supp. 1040, 1045 (M.D.N.C. 1969) (noting that advances
to closely held corporations constitute bona fide debts where they are
made for a valid business purpose besides avoiding taxes), aff’d, 429
F.2d 560 (4th Cir. 1970). Because Humbolt, WDS, and WDS I advanced
funds to affiliated entities as well as to family members both directly
and indirectly, we examine the transfers with special scrutiny.

       Petitioners assert that the advances made to the marketing
companies and Waterfront Communities (purported debtors) were to
finance marketing and administrative services for each of the 2009
development projects. They claim that this fulfilled a valid business
purpose and so the transfers should stand despite there being a
relatedness issue.

      Respondent counters that we should disregard the promissory
notes as objective evidence because the purported debtors did not
properly obtain the funds. To that point, the recipient entities’
organizing documents restricted the amount of debt that could be
incurred and required board approval. Respondent says that no board
resolutions approving the increased debt obligations were entered into
                                   17

[*17] evidence. As well, respondent argues, Humbolt modified the
terms of the new promissory notes without agreement by the purported
debtors.

       We find these arguments compelling as they indicate a general
lack of formalities in executing and fulfilling contractual obligations.
This factor however only questions whether formal lending documents
were in place. They were. As well, since the agreements—which were
made between related parties—also had a valid business purpose, they
withstand the heightened scrutiny we are required to apply here. This
factor weighs in favor of debt.

      B.     Presence or Absence of a Fixed Maturity Date

       The second factor we consider is the presence or absence of a fixed
maturity date. Estate of Mixon, 464 F.2d at 404. Generally, an advance
issued with a fixed maturity date is indicative of an obligation to repay,
a characteristic that supports a bona fide debt. Id. Conversely, the
absence of a fixed maturity date indicates that repayment depends on
the borrower’s success, which signifies that the advance is likely equity.
See id.; see also Hardman, 827 F.2d at 1413 (“The absence of a fixed
maturity date indicates that repayment is tied to the fortunes of the
business.”). Similarly, an advance made with a fixed maturity date that
has been postponed for prolonged periods suggests that “the nominal
lender does not intend to require repayment and that the transfers are
equity.” Laidlaw Transp., Inc. v. Commissioner, T.C. Memo. 1998-232,
slip op. at 59.

       Each note that was issued by Mr. Allen, or one of his business
entities or trusts, identified a fixed maturity date between five to nine
years after the date of issuance. The maturity dates were applied to
original promissory notes and to modified promissory notes. Petitioners
say that the purported debtors issued new notes in late 2008 and early
2009 with substantially similar terms. And the modifications were
agreed to because the belief was that the recession was nearly over and
therefore a reasonable modification would increase the likelihood of
repayment.

      This Court has previously held that modifying the terms of an
original note with similar terms does not remove the original note’s
character as a genuine bona fide debt if the modification is reasonable
under the circumstances.      Green Bay Structural Steel, Inc. v.
Commissioner, 53 T.C. 451, 457 (1969). We have further held that
                                   18

[*18] extending the date of maturity to allow a debtor the opportunity
to improve its financial situation is reasonable. See id.; see also Owens
v. Commissioner, T.C. Memo. 2017-157, at *30. Therefore, the fact that
the promissory notes were modified does not undercut the reality that
they included fixed maturity dates. This factor thus weighs in favor of
characterizing the advances as bona fide debt.

      C.     Source of Payments

      Repayment based solely on the expectation of corporate earnings
or the success of the borrower’s business is more likely to be
characterized as an equitable contribution rather than a bona fide debt,
regardless of its reasonableness. Ellinger, 470 F.3d at 1335; Roth Steel
Tube Co. v. Commissioner, 800 F.2d 625, 631 (6th Cir. 1986), aff’g T.C.
Memo. 1985-58; Lane, 742 F.2d at 1314; Estate of Mixon, 464 F.2d
at 405. Mr. Allen conceded that each of the development companies
agreed to pay WDS a percentage of the gross sale price for each lot sold
from the 2009 real estate development projects on the basis of the MSAS
Agreement. And at trial he confirmed that repayment of the purported
loans was dependent on lot sales, which he identified as “cash flow or
revenue.”

       Petitioners argue that this factor still weighs in their favor
because repayment was not “legally contingent” on the purported
debtor’s success. This argument is not persuasive. Neither the Fourth
nor the Eleventh Circuit requires the source of repayment to be “legally
contingent” on a debtor’s success. See, e.g., Ellinger, 470 F.3d at 1335;
Lane, 742 F.2d at 1314. Because repayment of the loans was dependent
on lot sales, this factor supports characterizing the advances as equity.

      D.     Right to Enforce Payment of Principal and Interest

       An advance with a definite obligation to repay a fixed or
determinable sum of money provides some indicia of a bona fide debt.
Estate of Mixon, 464 F.2d at 405. This factor however is not an exception
to the substance over form doctrine. Despite the plain text of a note,
this Court has held that the “economic reality provides the touchstone”
for determining whether an advance of funds constitutes a bona fide
debt. Shaw, T.C. Memo. 2013-170, at *10. And the fact that the lender
has an enforceable right to payment but “t[akes] none of the customary
steps . . . [to] assure repayment” supports the conclusion that the
advances constitute equity. Lane, 742 F.2d at 1317.
                                    19

[*19] The parties concede that in form Humbolt, WDS, and WDS I had
an enforceable right to payment. Respondent however argues that in
substance this was an equity infusion. We agree. Although Humbolt,
WDS, and WDS I indeed had the legal right to enforce payment, they
clearly did not. They never made written demand on the purported
debtors and never collected interest from any of them. Additionally, and
similarly to the taxpayer’s notes in Lane, the notes here did not create
realistic creditor safeguards: They did not have a sinking fund from
which payments of principal and interest might be made, and the notes
were unsecured, despite having fixed maturity dates. Id. (citing Tyler,
414 F.2d at 849). But cf. Mills v. I.R.S., 840 F.2d 229, 233 (4th Cir. 1988)
(“Related corporations . . . do not provide for sinking funds . . . [n]or do
they ordinarily set up fixed repayment schedules . . . .”), rev’g T.C. Memo.
1986-94.

       Petitioners rely on the past repayment history of affiliated loans
by Humbolt, WDS, and WDS I to support their argument that the
purported debtors in these cases would also have consistent payment
histories. This argument is unsupported. Even if we rely on these past
payment histories, the purported debtors in these cases had little or
negative income. They relied solely on projected cashflow to repay the
loans at issue. Still, knowing this reality and never having received
payments of interest or principal, the maturity dates on the loans were
extended.

       Petitioners additionally argue that demand letters did not need
to be sent to the purported debtors because of their affiliated
relationship to them. They assert that Dynamo Holdings Limited
Partnership v. Commissioner, T.C. Memo. 2018-61, supports their
argument. In Dynamo Holdings, the Commissioner argued that the
transfers were gifts—not equity as in these cases—and so we applied a
different test from the one we apply here. Id. at *50–51. Still, in finding
that the parties had entered into a bona fide debtor-creditor
relationship, we noted that “related-party demand notes are afforded
little weight.” Id. at *59. We stated further that the “these formal
indicia of debt are little more than declarations of intent without
accompanying objective economic indicia of debt.” Id.

      That logic applies here as well. True, Humbolt, WDS, and WDS
I had a contractual right to enforce the payments. And it is clear that
they advanced funds to affiliated entities as well as to family members,
both directly and indirectly. Any formal demand for payment then is
not determinative to our analysis. The economic reality of the situation
                                    20

[*20] is that the advance recipients had no ability to repay the debts.
Therefore although there was an enforceable right in form, there was
not one in substance. This factor weighs in favor of equity.

      E.     Participation in Management

       If as a result of an advance the lender receives an increase in the
business’s management, the advance indicates an equitable
contribution rather than a debt. Stinnett’s Pontiac Serv., Inc. v.
Commissioner, 730 F.2d 634, 639 (11th Cir. 1984), aff’g T.C. Memo.
1982-314; Estate of Mixon, 464 F.2d at 406. The parties have stipulated
the formation of Mr. Allen’s real estate business enterprise. They
acknowledge that Mr. Allen either wholly or partially owned or managed
each of the purported debtors by some direct or indirect interest.

       Respondent contends that this alone is sufficient to weigh the
factor in his favor. This factor however asks whether any increased
voting power or participation was granted “by virtue of the advance.”
Estate of Mixon, 464 F.2d at 406. And since Mr. Allen was already
(either directly or indirectly) at the helm of the purported debtors before
the advances were made, there can be no increase by virtue of the
advances. This factor therefore weighs in favor of debt.

      F.     Status of the Contribution in Relation to Regular Corporate
             Creditors

      An advance made to a purported debtor that expressly or
implicitly becomes subordinate or inferior to the claims of other creditors
may be characterized as equity rather than debt. Id. Nevertheless,
subordination does not necessarily indicate equity when an advance is
given priority over the claims of shareholders. Id.

       The parties seem to agree that neither Humbolt nor WDS or WDI
I subordinated their priority of payment on the general advances made
to the purported debtors. But the two development companies, RRDN
III and D.H. Palacios, took on secured debt to fund capital acquisitions.
This secured debt took greater priority over the unsecured advances.

       The other 13 purported debtors did not have secured debt. And
the record does not provide any persuasive evidence on the order of
priority of the debts of Humbolt, WDS, and WDS I versus those of other
creditors, if there were any. In such a case the Court has looked to
whether the purported creditor received a share of the proceeds from a
sale for which the advance was made. Am. Underwriters, T.C. Memo.
                                     21

[*21] 1996-548, slip op. at 23 (holding that even though priority of a
taxpayer’s debts was uncertain, because “[the taxpayer] . . . receive[d]
. . . [a] share of the proceeds from [the] sale of its real estate . . . [the
taxpayer] held a claim to repayment that was greater than . . .
creditors”). Here, agreements were in place that entitled those
companies to a gross percentage of the purported debtors’ lot sales. So
they would have had priority over other creditors with that entitlement.

       Taken together, we see that two of the purported debtors had
secured debts. These would have taken priority over the claims of
Humbolt, WDS, and WDS I. We also see that the remaining companies
did not have secured debts though we are not certain of their priority
schedule vis-a-vis other creditors. Still, the fact that these other
companies were obligated to pay Humbolt, WDS, and WDS I a portion
of their gross sales indicates that the latter did have some priority. On
the basis of these conflicting points, we find that this factor weighs
neutral towards the analysis.

      G.     Intent of the Parties

       The intent of the parties to create a bona fide debt is examined
objectively. Estate of Mixon, 464 F.2d at 407; NA Gen. P’ship & Subs. v.
Commissioner, T.C. Memo. 2012-172, slip op. at 25. We must look
beyond the parties’ self-serving declarations and, instead, analyze
whether they had a reasonable expectation of repayment, whether their
intentions comported with the economic reality of the debtor-creditor
relationship, and how they treated the relevant documents and
agreements. See Lane, 742 F.2d at 1316; Tyler, 414 F.2d at 850; Tribune
Media Co. v. Commissioner, T.C. Memo. 2021-122, at *74 (citing PepsiCo
P.R., Inc. v. Commissioner, T.C. Memo. 2012-269, at *88). This is an
important factor. Tribune Media Co., T.C. Memo. 2021-122, at *74;
Laidlaw Transp., Inc., T.C. Memo. 1998-232, slip op. at 66.

       Petitioners contend that Mr. Allen intended at all times for the
funds advanced to be bona fide loans. Respondent disagrees and asserts
instead that Mr. Allen’s business purpose was to infuse capital into
recipient companies and then redistribute those funds to himself and his
related business entities as equity.

       The objective facts in the record suggest that the purported loans
complied with the formal indicia of bona fide debt. The parties
stipulated that each advance was documented by a promissory note or
future advance promissory note and required interest to be paid on a
                                   22

[*22] stated maturity date. Additionally, each advance was recorded on
unaudited balance sheets, amortization schedules, general ledgers, and
federal income tax returns as either a “loan,” “loan receivable,” or
“commission receivable.”

       Petitioners further contend that the record supports a finding of
bona fide debt based on the following: (1) each purported debtor reported
cancellation of indebtedness income on their federal income tax returns;
(2) many of the purported debtors repaid the advances, as evidenced by
the fact that WDS and Humbolt received over $26 million and $12
million in repayments, respectively; (3) WDS and Humbolt received over
$465,000 and $2.7 million in interest income, respectively; and (4) the
advances were made before the end of January 2009 when it was still
reasonable to expect repayment.

       While petitioners’ contentions are persuasive, determining intent
is an objective inquiry that is based on all the facts and circumstances
in each case, and formalities should be given minimal consideration in
related-party transactions. VHC, Inc., T.C. Memo. 2017-220, at *55–56
(“[P]romissory notes and bookkeeping entries should be given little
weight unless supported by some other objective evidence . . . especially
on account of the familial relationship.”); Rutter, T.C. Memo. 2017-174,
at *25.

       Other objective facts suggest that the parties did not intend for
the advances to be bona fide debts. For example, respondent asserts
that none of the purported debtors made interest payments. And
although some of the purported debtors duly made principal payments,
there is no consistency across the group. Several of the companies—
Marathon, Waterfront Communities, and Florida Waterways—made
only nominal principal repayments. And others—Intracoastal, the
Allen Irrevocable Trust, ML&G Investments, RRDN III, and Graham
Florida—did not make any principal payments. Respondent says this
failure is consistent with the purported debtors’ financial status—they
had no ability to repay the advances—and their relation to Humbolt,
WDS, and WDS I. Respondent further contends that some of these
companies continued to receive advances even after Mr. Allen and
Humbolt claimed the bad debt deductions at issue.

      On the basis of the foregoing, it is apparent that the advances
were documented to appear to be bona fide debts. The facts however
indicate that there was no real expectation of repayment. This is
evidenced by the complete lack of interest payments and inconsistent
                                    23

[*23] repayment of the principal. As well, although the advances may
have slowed before January 2009, they were still made after Mr. Allen
and Humbolt claimed the bad debt deductions. All of these facts are
amplified by the important fact that all of the companies—lenders and
borrowers—are related entities created by Mr. Allen. Taking all of that
into account leads us to the conclusion that the true intention was to
create equity positions in the recipient companies. This factor therefore
weighs in favor of equity.

      H.     Thin or Adequate Capitalization

       An advance made to a purported debtor who has thin
capitalization is “very strong evidence of a capital contribution.” Estate
of Mixon, 464 F.2d at 408; see also Povolny Grp., Inc. v. Commissioner,
T.C. Memo. 2018-37, at *17 (“[L]ack of capitalization weighs heavily in
favor of finding that the payments at issue were capital contributions
and not bona fide debt.”). For this factor we examine whether the
purported debtor’s initial debt-to-equity ratio was high and whether the
purported debtor realized it might increase. Estate of Mixon, 464 F.2d
at 408. We also consider whether substantial portions of the advances
were used to purchase capital assets or cover expenses needed to
commence operations. Id.

       To determine whether a purported debtor was thinly capitalized,
we may consider the fair market value of its liabilities and assets, which
may include its intangible assets.          Plantation Patterns, Inc. v.
Commissioner, 462 F.2d 712, 723 (5th Cir. 1972), aff’g T.C. Memo. 1970-
182; Nye v. Commissioner, 50 T.C. 203, 215 (1968). Courts frequently
consider the purported debtor’s assets and liabilities to ascertain a debt-
to-equity ratio though “there is no magic debt-equity ratio which is
appropriate for all corporations in all circumstances.” Wood Preserving
Corp. of Balt. v. United States, 347 F.2d 117, 120 (4th Cir. 1965). That
said, the Fourth Circuit has previously suggested that a debt-to-equity
ratio in excess of 5 to 1 is considered to be “high” and may result in
finding inadequate capitalization. Id. at 120 & n.5.

       Respondent argues that 12 of the 15 purported debtors’ debt-to-
equity ratios exceeded the 5 to 1 benchmark and 6 of them had a
“negative equity” position when they received the funds. Respondent
also cites Mr. Allen’s testimony where he indicates that this result was
obtained intentionally. He testified that his goal was to limit liability,
and he did that by creating many different legal entities which held few
assets that judgment creditors could go after.
                                     24

[*24] Petitioners argue that the purported debtors were well
capitalized. They say that respondent’s debt-to-equity ratios are
inaccurate because they do not take into account the companys’
significant intangible assets and their expectation of near-term growth
in the real estate industry.

       Petitioners’ argument relies significantly on intangible assets
such as (1) Mr. Allen’s “sterling business reputation”; (2) “exclusive sales
and administrative contracts for resort residential developments”; (3) a
“well-trained workforce”; (4) a client database worth at least $100
million; (5) development plans; and (6) the ability to quickly “pre-sell . . .
high-value development real estate . . . that [was] expected to generate
sufficient cashflow.” They cite Murphy Logging Co. v. United States, 378
F.2d 222, 224 (9th Cir. 1967), to support their argument that such
intangible assets should be included in a debt-to-equity analysis.

       In Murphy Logging Co., 378 F.2d at 223, the taxpayer corporation
borrowed $240,000 to purchase shareholder assets; the United States
argued to recast the transaction as an equity infusion. The U.S. Court
of Appeals for the Ninth Circuit held that the taxpayer was sufficiently
capitalized despite having only $1,500 in cash because it owned valuable
intangible assets such as future timber contracts and had reputable
shareholders. Id. at 223–24. While informative, this holding is
unpersuasive and should not be used to determine adequate
capitalization since it was rejected by the Fifth Circuit in Plantation
Patterns, Inc. v. Commissioner, 462 F.2d at 723. Because Plantation
Patterns was decided before formation of the “new Fifth,” i.e., the
Eleventh Circuit, it is controlling in these cases. See Bonner v. City of
Prichard, 661 F.2d 1206, 1207 (11th Cir. 1981) (holding that decisions
of the Fifth Circuit before September 30, 1981, are binding precedent in
the Eleventh Circuit).

       In Plantation Patterns, Inc. v. Commissioner, 462 F.2d at 723, the
Fifth Circuit stated that the financial skills of the taxpayer should not
be considered in valuing the debtor’s intangible assets for purposes of
computing its debt-equity ratio. It stated that “intangible assets such
as those claimed for [the taxpayer] have no place in assessing debt-
equity ratio unless it can be shown by convincing evidence that the
intangible asset has a direct and primary relationship to the well-being
of the corporation.” Id. It said further that “it seems clear . . . that the
assets sought to be valued must be something more than management
skills and normal business contacts,” which “are expected of
management in the direction of any corporation.” Id.
                                    25

[*25] We believe that Mr. Allen’s “sterling business reputation” and
ability to quickly presell development projects—similar to the skills
discussed in Plantation Patterns—should not be taken into account as
they would be expected of management in any corporation. And while
the sales contracts, client database, and development plans would have
a “direct and primary relationship to the well-being” of the purported
debtors, we agree with respondent that no evidence of such “off-balance-
sheet assets” has been provided and therefore cannot be included in any
debt-to-equity analysis. For that reason we find that the purported
debtors were thinly capitalized when they received the advances.

       Finally, as discussed more fully below, a larger portion of these
advances went to the purchase of capital assets than they did to
commence operations. See Estate of Mixon, 464 F.2d at 408. Taking all
of this together, we find that this factor favors equity.

      I.     Identity of Interest Between Creditor and Stockholder

       An advance made by a creditor who is also a stockholder is
examined with closer scrutiny. Tribune Media Co., T.C. Memo. 2021-
122, at *78. An inference of equity rather than debt arises when the
amount advanced by the stockholder aligns pro rata with his ownership
interest. Stinnett’s Pontiac Service, Inc. v. Commissioner, 730 F.2d
at 639; Estate of Mixon, 464 F.2d at 409; Tribune Media Co., T.C. Memo.
2021-122, at *78. In contrast, “[a] sharply disproportionate ratio
between a stockholder’s percentage interest in stock and debt is,
however, strongly indicative that the debt is bona fide.” Estate of Mixon,
464 F.2d at 409.

      Petitioners argue that there is no identity of interests because
neither WDS nor Humbolt ever held an ownership interest in any of the
purported debtors. Respondent agrees but says that Mr. Allen or a
member of his family owned 14 of the 15 recipient companies by way of
the Allen Family Investment Trust and the GST Trust. Respondent
thus argues that there was a constructive identity of interests sufficient
to make this factor weigh in favor of equity.

       The issues here are closely aligned to those discussed in Tribune
Media Co., T.C. Memo. 2021-122. There the same family controlled both
the borrowing and issuing entities, and the Commissioner argued that
the transaction should be recast as an equity investment, asserting “that
where identity of interest exists, the creditors will not enforce payment.”
Id. at *79. We agreed with the Commissioner and stated that because
                                   26

[*26] the interests between the borrower and lender were “significantly
intertwined,” the factor favored equity. Id. at *80.

       In accordance with Tribune Media Co. we should “look to the
intertwined interests of the lender and borrower case-by-case.” Id.
Here, the GST Trust and the Allen Family Investment Trust were set
up for the benefit of Mr. Allen, his spouse, and their children. Together
these trusts wholly owned the lenders in these cases: Humbolt, WDS,
and WDS I. The GST Trust also wholly owned most of the entities that
received advances. Therefore, Mr. Allen and his family were on both
sides of the purported lending transactions as beneficiaries, albeit
indirectly.   Consequently, we believe the interests between the
purported borrowers and lenders were “significantly intertwined.” This
factor therefore favors equity.

      J.     Source of Interest Payments

      “[A] true lender is concerned with interest,” and an advance made
with an interest rate suggests an intent to create a bona fide debt.
Estate of Mixon, 464 F.2d at 409 (quoting Curry v. United States, 396
F.2d 630, 634 (5th Cir. 1968)). Generally, unless the purported debtor
provides a reasonable explanation for the lack of interest payments, the
absence of interest payments indicates that the purported creditor is not
expecting substantial interest income and, instead, is more interested in
future earnings, a characteristic of equity. See Am. Underwriters, T.C.
Memo. 1996-548, slip op. at 26 (citing Am. Offshore, Inc. v.
Commissioner, 97 T.C. 579, 604 (1991)).

       The parties agree that no interest payments were made by any of
the purported debtors. Petitioners assert that this factor nonetheless
supports a bona fide debt finding because (1) each advance was issued
with accruing interest due at maturity, (2) Mr. Allen expected the
interest to be paid, and (3) he had a reasonable business explanation for
the lack of enforcement: It allowed for “vital cashflow flexibility.”

       We are not convinced by petitioners’ explanation despite Mr.
Allen’s significant real estate experience. As courts before us have said,
a true lender is concerned with interest income. See Curry, 396 F.2d at
634. Although the advances may have intentionally been structured
with the objective of allowing the purported debtors increased cashflow,
it is not apparent that they were “seriously expecting any substantial
interest income” since none was ever collected. See Estate of Mixon, 464
F.2d at 409. Instead, it appears that the future earnings of the
                                    27

[*27] purported debtors were of utmost importance.            This factor
therefore weighs in favor of equity.

      K.     Ability of the Corporation to Obtain Loans from Outside
             Lending Institutions

      Debt characterization is supported when the advance at issue
could have been obtained with substantially similar terms from an
unrelated outside lending institution. Id. at 410; VHC, Inc., T.C. Memo.
2017-220, at *65 (“[T]he touchstone of economic reality is whether an
outside lender would have made the payments in the same form and on
the same terms.” (quoting Segel, 89 T.C. at 828)).

      Petitioners argue that the purported debtors could have obtained
similar terms from private lenders when the loans were made because
they had significant assets and projected revenue. Petitioners conceded
that an unaffiliated lender might have required a personal guaranty but
argue that, as in Litton Business Systems, such a difference does not
make the purported loans a patent distortion from what was available.
See Litton Bus. Sys., Inc. v. Commissioner, 61 T.C. 367, 379 (1973)
(noting that this is not a “mechanical test of absolute identity between
the advance account and what debt actually or hypothetically would
have been available”).

       Respondent disagrees. He argues that the terms of the purported
loans were not commercially acceptable and that unrelated lenders
would not issue loans with similar terms without personal guaranties,
collateral, or higher interest rates. Respondent also asserts that the
economic reality of the purported debtors’ financial status—i.e., their
being undercapitalized and insolvent—would inhibit an outside lender
from issuing similarly termed advances to the purported debtors.
Respondent argues that this would be especially true for any lender in
the position of Mr. Allen, who had full access to these purported debtors’
financials at the time of the advances.

       Respondent illustrates the weakness of petitioners’ argument by
providing examples which show that a commercial loan from an
unrelated lender was not viable. Waterfront Marketing was formed in
2005 with a $1,000 capital contribution and during that year reported a
$1,013 loss. In the following spring, WDS provided Waterfront
Marketing with a $9,200,000 line of credit at a 4.4% interest rate. This
credit line was unsecured, had no guaranty, and required no payment
for nine years. We find it very difficult to believe an unaffiliated lender
                                    28

[*28] would advance that much money on similar terms. This would
therefore constitute a “patent distortion” from what was available in the
market. See id. at 379.

       Although Waterfront Marketing’s situation is but one example,
petitioners’ expert witness conceded that most of the purported debtors
had credit ratings of below CCC. This means that they were possible
credit risks when the advances were made. Since Humbolt, WDS, and
WDS I had full access to the purported debtors’ financials at that time,
they must have disregarded these risks, indicating that the advances
were not true debts. See VHC, Inc., T.C. Memo. 2017-220, at *63
(holding that advances were not debt when the taxpayer disregarded
“clear signs” that the purported debtor and his related companies were
financially unstable); see also Shaw, T.C. Memo. 2013-170, at *12–13
(holding that “a third-party lender with perfect knowledge of the
company’s finances . . . would not have been so generous” and “no outside
lender, animated by a genuine desire for repayment, would have
behaved as did [the taxpayer]” and so the advances did not constitute “a
bona fide debt that arose from a debtor-creditor relationship”). We
therefore agree with respondent that this factor favors equity.

      L.     Extent to Which the Advance Was Used to Acquire Capital
             Assets

      An advance of funds used to meet the cost of daily operational
needs, rather than to purchase capital assets, is indicative of bona fide
indebtedness. Roth Steel Tube Co. v. Commissioner, 800 F.2d at 632;
Estate of Mixon, 464 F.2d at 410. Conversely, “[u]se of an advance by an
ongoing business to expand its operations, e.g., by acquiring an existing
business,” suggests an equitable contribution. Laidlaw Transp., Inc.,
T.C. Memo. 1998-232, slip op. at 79 (first citing Plantation Patterns, Inc.
v. Commissioner, 462 F.2d at 713–16, 722; and then citing Tyler, 414
F.2d at 846, 848–49).

      The parties have stipulated that WDS contracted with the
marketing companies to provide sales and marketing services for the
2009 development projects and with Waterfront Communities to provide
administrative services for the 2009 development projects in the
Southeast and Texas. Each of the marketing companies agreed to
develop marketing and sales strategies that would be used to promote
and facilitate the lot sales for the 2009 development projects.
                                   29

[*29] Each of these entities received advances from WDS, WDS I, or
Humbolt during the years in issue, some of which were used to meet the
costs of daily operations. At trial, Mr. Allen described the “hot”
residential real estate market as requiring the marketing companies to
“[promote] heavily and [spend] heavily.”

       While we agree with petitioners that some of the advances were
used to meet the costs of daily operations, we acknowledge that others
were used to purchase capital assets, such as real property. For
example, the parties have stipulated that RRDG, Marathon, ML&G
Investments, the 9-30-02 trust, and the 6-08-05 trust were “investment
entities” whose primary purpose was to invest in the real estate market.
In addition in 2006 Southeastern Waterfront was advanced $1,648,000
and reported on its December 31, 2005 and 2006 balance sheets that it
purchased capital assets such as boats and sales trailers. Thus, it
appears that while some of the advances were used to meet the daily
operating needs of the marketing companies and Waterfront
Communities, other advances were used to purchase capital assets;
therefore, this factor is neutral at best.

      M.     Failure of the Debtor to Repay on the Due Date or Seek a
             Postponement

       Both the Fourth and the Eleventh Circuits have held that failure
of the debtor to repay on the due date or seek a postponement is arguably
the most significant factor in the debt-equity analysis. Mills, 840 F.2d
at 233; Lane, 742 F.2d at 1317.

       Here, each of the purported loans at issue included a due date at
least four years after 2009, and the purported debtors were not obligated
to make repayments before the date of maturity included in each of the
purported loans. Since Mr. Allen and Humbolt have already written the
debts off as worthless, the purported debtors technically did not fail to
repay the advances by the due date. For that reason, petitioners argue
that this factor weighs in favor of debt.

       In a similar situation—where no due date existed at all—the
Eleventh Circuit has found that a “strong inference” arises that the
lender never intended to compel repayment if no payments were made
or ever demanded. Stinnett’s Pontiac Serv., Inc. v. Commissioner, 730
F.2d at 640; see also Shedd v. Commissioner, T.C. Memo. 2000-292,
slip op. at 6. In this Court we have held that “it is premature to rely on
this factor as tending to demonstrate either the equity or the debtlike
                                    30

[*30] features of the advance agreements” where the debts have not yet
matured. PepsiCo P.R., Inc., T.C. Memo. 2012-269, at *97.

      As indicated previously in this Opinion, we conclude that the
parties intended these advances to constitute equity although they were
papered as debt. We agree with the Eleventh Circuit that the failure to
demand or make payments leads to a strong inference that there was
never truly an intention to collect the debts. This factor however
questions whether the purported debtors failed to make payments by
the due date. In these cases those dates never arose before the debts
were written off as uncollectible. Accordingly, we find that this factor is
neutral.

IV.   Outcome of the Mixon Factors

       Of the 13 factors listed in Estate of Mixon, 7 favor equity, 3 favor
debt, and 3 are neutral. After weighing them in the context of these
cases, we conclude that the advances do not constitute debt and were
therefore not deductible under section 166. That finding precludes the
need for any analysis on whether the amounts were wholly or partially
worthless.

V.    Section 6662 Accurary-Related Penalities

      The notice of deficiency to Mr. Allen sets forth various grounds for
the imposition of section 6662 accuracy-related penalties. Only one
accuracy-related penalty for a given year 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. See Treas. Reg. § 1.6662-2(c). We
will only address whether Mr. Allen is liable for accuracy-related
penalties on the ground that the underpayments of tax for 2005 and
2006 were substantial under section 6662(b)(2).

       According to our caselaw, “the Commissioner bears the burden of
production with respect to the liability of an individual for any penalty.”
Graev v. Commissioner, 149 T.C. 485, 493 (2017) (citing § 7491(c)),
supplementing and overruling in part 147 T.C. 460 (2016). 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. Id. (citing Higbee, 116 T.C. at 446). This includes
satisfying section 6751(b), 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
                                    31

[*31] supervisor of the individual making such determination or such
higher level official as the Secretary may designate.”

      In Kroner v. Commissioner, 48 F.4th 1272 (11th Cir. 2022), rev’g
in part T.C. Memo. 2020-73, the Eleventh Circuit disagreed with this
Court regarding the timing of the section 6751(b) approval requirement.
The Eleventh Circuit held that “the IRS satisfies [s]ection 6751(b) so
long as a supervisor approves an initial determination of a penalty
assessment before it assesses those penalties.” Id. at 1276.

       We follow the relevant precedent of the Court of Appeals to which
an appeal would generally lie. See Golsen, 54 T.C. at 757. An appeal by
Mr. Allen would lie in the Eleventh Circuit, and therefore Kroner is
controlling. Since the civil penalty forms were approved for Mr. Allen
before the notice of deficiency was issued to him, the IRS complied with
section 6751(b).

        Section 6662(a) and (b)(2) imposes a 20% accuracy-related
penalty for an underpayment of tax due to a substantial understatement
of income tax. For purposes of that section, an understatement of tax
generally means the excess of tax required to be reported on the return
over the amount shown on the return.             § 6662(d)(2)(A).    An
understatement of income tax is substantial in the case of an individual
if it exceeds the greater of 10% of the tax required to be shown on the
return for that taxable year or $5,000. § 6662(d)(1)(A). Mr. Allen’s
income tax was understated by $2,646,969 and $2,054,073 for 2005 and
2006, respectively. Therefore, the understatements were substantial.

       The accuracy-related penalty does not apply with respect to any
portion of the underpayment for which the taxpayer shows that he had
reasonable cause and acted in good faith. § 6664(c)(1); see Higbee, 116
T.C. at 446–47. The determination of whether the taxpayer had
reasonable cause and acted in good faith depends upon the pertinent
facts and circumstances of a particular case. Treas. Reg. § 1.6664-
4(b)(1). We consider, among other factors, the experience, education,
and sophistication of the taxpayer; however, the principal consideration
is the extent of the taxpayer’s efforts to assess the proper tax liability.
Id.; see also Higbee, 116 T.C. at 448. In so assessing, reliance on
professional advice may indicate reasonable cause and good faith “if,
under all the circumstances, such reliance was reasonable and the
taxpayer acted in good faith.” Treas. Reg. § 1.6664-4(b)(1).
                                  32

[*32] Mr. Allen argues that he had a reasonable basis for claiming the
bad debt deductions. We disagree. At trial he testified that he did not
seek professional advice when he determined the purported loans were
worthless. He also said that while he employed legal counsel, he did not
consult with them specifically about the tax consequences of assigning
the purported loans because these decisions were “business decisions
between businesspeople.” There is no evidence that Mr. Allen took any
steps to assess the proper tax liability. We therefore conclude that Mr.
Allen is liable for the substantial underpayment penalties.

VI.   Conclusion

       We conclude the advances made to the purported debtors were
not debt and therefore were not deductible by Mr. Allen and Humbolt as
section 166 bad debt expenses. Because Mr. Allen has not demonstrated
reasonable cause for claiming the deductions, we sustain the section
6662 penalties.

       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.