Tuesday, September 29, 2009

Jack A. & Lettie G. Wheeler v. Commissioner., U.S. Tax Court, T.C. Summary Opinion 2009-151, (Sept. 28, 2009

Docket No. 25087-08S. Filed September 28, 2009.

A salesman was denied deductions for various vehicle expenses because he failed to provide adequate substantiation as required under Code Sec. 274(d). The taxpayer did not keep a log of the mileage for business or other use of his vehicle and did not have any contemporaneous records of the times, dates or number of trips taken that would corroborate his reconstruction of his expenses.


COHEN, Judge: This case was heard pursuant to the provisions of section 7463 of the Internal Revenue Code in effect when the petition was filed. Pursuant to section 7463(b), the decision to be entered is not reviewable by any other court, and this opinion shall not be treated as precedent for any other case. Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the year in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.
Respondent determined a deficiency of $5,070 in petitioners' Federal income tax for 2005. The issue for decision is whether Jack A. Wheeler (petitioner) has substantiated deductible vehicle expenses as required under sections 274(d) and 280F(d)(4).
> Background
Petitioners resided in Tennessee at the time that they filed their petition. During 2005 petitioner represented a laboratory that provided testing for clinics performing renal services, including dialysis, to patients. Petitioner's employment required him to make sales and service calls on customers. Petitioner used his personal vehicle in calling on customers. Petitioner did not maintain any logs reflecting his business use of a vehicle or any other contemporaneous records of his vehicle expenses.
On Schedule C, Profit or Loss From Business, attached to petitioners' Form 1040, U.S. Individual Income Tax Return, for 2005, petitioners reported no income but deducted $19,420 as car and truck expenses. Petitioner prepared the return for 2005. Respondent disallowed the claimed deduction and made corresponding adjustments increasing the taxable portion of petitioners' Social Security benefits and reducing deductible medical expenses.
In their petition and at trial, petitioners reduced the amount claimed for car and truck expenses to $4,841, based on a proposed amended Form 1040 and an amended Schedule C prepared by petitioners' counsel. Attached to the proposed amended Form 1040 were a Schedule A, Itemized Deductions, which included a deduction for employee business expenses, and a Form 2106-EZ, Unreimbursed Employee Business Expenses, but neither form separately identified any vehicle expenses. The reduced claim was based on reconstructed mileage for weekly visits to two labs and monthly and less frequent but regular visits to other customers or potential customers of petitioner's employer.
Petitioner and a representative of one of his customers testified at trial. Their testimony was to the effect that petitioner made business calls on certain customers at various intervals, and they estimated the mileage to the customer's places of business from some unspecified locale. Petitioner offered a reconstructed schedule of “examples” of business calls he made on behalf of his employer during 2005, including estimates that he visited certain customers 1-1/2 times per week. Petitioners' counsel acknowledged that the reconstructed mileage was employee business expense, rather than Schedule C expense, and relied on the proposed amended return as stating petitioners' position.
Respondent objected to the testimony, to any discussion of the amended return, and to the reconstruction that did not relate to the amounts claimed on the original Schedule C. Respondent asserts that the proposed amended return was not filed and was “simply a settlement negotiation offer [and] inadmissible.”
From the time the petition was filed, it was apparent that petitioners were not relying on the Schedule C filed with their original return for 2005. If they adequately substantiated deductible vehicle expenses that should have been claimed as employee business expenses, the expenses might be allowable as itemized deductions subject to the limitations on that category of expenses. See secs. 67 and 68. Petitioners elected the small tax case procedure under Rule 171 when they filed their petition, and evidence having probative value is admissible under Rule 174(b). The testimony of petitioner and his witness had probative value in explaining petitioner's business use of his vehicle. Respondent's objections based on the difference between the original Schedule C and the reduced claim are not well founded, and they are overruled.
On the other hand, we cannot accept petitioners' counsel's argument that Rule 174(b) relaxes the standards of evidence of deductible business expenses subject to the section 274(d) requirement of substantiation by adequate records. A passenger vehicle is listed property under section 280F(d)(4). Thus deductions are disallowed unless the taxpayer adequately substantiates the amount of the expense; the time and place of business use of the vehicle; and the business purpose of the travel. These rules were adopted to preclude estimates based solely on a finding that some deductible business expenses were incurred, as allowed in other contexts. See Sanford v. Commissioner, 50 T.C. 823, 827 (1968), affd. per curiam 412 F.2d 201 (2d Cir. 1969). The statutory standard of adequacy of evidence is not modifiable by a rule regarding admissibility of evidence, such as Rule 174(b).
Petitioner admitted during trial that he did not keep a log of the mileage for business or other use of his vehicle, and he did not have any contemporaneous records that would corroborate his reconstruction. He testified only that some motel or gas receipts had been misplaced. We are not persuaded that petitioner ever had adequate records to substantiate either the $19,420 claimed on his filed return or the lesser amount of $4,841 claimed at trial. The disparity in these claims casts doubt on the reliability of petitioner's recollections in reconstructing the events of 2005.
Petitioner has adequately explained and corroborated the business purpose of his calls on customers during 2005. He has not, however, adequately substantiated the time or date and number of trips taken. His reconstruction is based on estimates and averages; obviously he did not make 1-1/2 trips in a week. His reconstruction based on weekly trips in each of 52 weeks or monthly trips in each of 12 months in 2005, without any indication of the day of the week or month on which he made those trips, is unreliable.
We give no weight to the proposed amended return prepared by petitioners' counsel, beyond the concession of reduced business mileage. The proposed amended return contains inconsistencies and obvious errors; it also sets forth other unexplained deductions that are not in issue here. Thus we need not resolve the dispute between the parties about whether the amended return was filed.
The other adjustments made in the statutory notice are automatic, and petitioners have given us no reason to believe that they are erroneous. For the foregoing reasons,

Decision will be entered for respondent.

Monday, September 28, 2009

The Crisci case is interesting in that the IRS can be estopped from seizure and collection if the IRS made relevant misrepresentations. any excess to the trust fund tax liability.
“Estoppel is an equitable doctrine invoked to avoid injustice in particular cases.” Heckler v. Community Health Servs., 467 U.S. 51, 59 (1984). The burden of proof is on the party claiming estoppel. United States v. Asmar, 827 F.2d 907, 912 (3d Cir. 1987) (citing Lyng v. Payne, 476 U.S. 926, 936 (1986)). A party attempting to estop another private party must prove: (1) a misrepresentation by another party; (2) which he reasonably relied upon; (3) to his detriment. Fredericks v. Comm'r, 126 F.3d 433, 438 (3d Cir. 1997); United States v. Asmar, 827 F.2d at 912. In addition, the majority of circuits recognizing estoppel as an equitable defense against government claims, including the Third Circuit, impose an additional burden on claimants to establish some affirmative misconduct on the part of the government officials. United States v. Asmar, 827 F.2d at 911 n.4, 912; see also Kurz v. Philadelphia Elec. Co., 96 F.3d 1544 (3d Cir. 1996).
The court held that there was no IRS representation in this case. But this case is worth saving because the IRS often does make misrepresentations. And the IRS is often wrong on the law.

USTC Cases, Harry E. Crisci, Plaintiff v. United States of America, Defendant and Third Party Plaintiff v. Carole L. McConnell and H. Brian Crisci, Third Party Defendants., U.S. District Court, W.D. Pennsylvania, 2009-2 U.S.T.C. ¶50,647, (Sept. 21, 2009)
U.S. District Court, West. Dist. Pa.; 2:07cv1331, September 21, 2009.
Penalties, civil: Trust fund recovery penalty: Nontrust fund tax liability: Affirmative misconduct: Misrepresentation: Reliance: Reasonableness: Allocation.–
Brian was the President of Ideas in Motion-Pennsylvania, Inc. (“IIM”). Harry was the majority shareholder and owner of IIM, and McConnell was the Controller of the company. Pl. CSF ¶¶ 1, 3 and 4. Harry, Brian and McConnell were assessed a penalty of $177,145.23 by the Internal Revenue Service (IRS), pursuant to 26 U.S.C. § 6672, representing withheld income and FICA taxes of the employees of IIM that had not been timely paid to the IRS. Def. SUF ¶¶ 1 and 2. IIM had been assessed for unpaid trust fund taxes withheld from its employees' pay, and nontrust fund taxes that were owed by the corporation as employer. Id. ¶ 3. Unlike general taxes, employee trust fund liability taxes, if unpaid, may be assessed personally against the subject company's officers and/or owners.
On or about November 30, 2004, Harry, Brian and McConnell met with IRS Officers Robert Allingham (“Allingham”) and William Evans (“Evans”) to discuss the delinquent taxes and tax returns, as well as, solutions to the tax problems. Def. SUF ¶¶ 4 and 5; Pl. CSF ¶¶ 7 and 8. The Taxpayers allege that Allingham and Evans told them that the IRS was mainly concerned with collecting the trust fund taxes, as many corporations file for bankruptcy protection to avoid the non-trust fund taxes. PL. CSF. ¶¶ 9 and 10. The Taxpayers were also told to file all delinquent returns and all future returns when due and to make the required deposits moving forward. Pl. CSF ¶ 16. The Taxpayers were given time to come up with a plan to pay the back taxes. Pl. CSF ¶ 17.
Thereafter, the officers of IIM discussed several options to pay the back taxes, and ultimately decided that the best solution was to sell off the assets of IIM. Pl. CSF ¶¶ 19 and 22. Brian alleges that he had several discussions with Allingham regarding the tax liabilities, all of which were in relation to the trust fund taxes. Pl. CSF. ¶¶ 20 and 21. The Taxpayers contend that the sole purpose of the auction to sell IIM's assets was to pay off the trust fund tax liability and avoid personal liability on IIM's delinquency. PL. CSF ¶ 23. Brian further alleges that he informed Allingham of the decision to sell the corporate assets and their intention to pay off the trust fund taxes. Pl. CSF ¶ 24. Allingham indicated that the auction was an acceptable solution to the payment of the trust fund taxes, and emphasized the proceeds from the auction had to be paid directly to the IRS. Pl. CSF ¶ 25.
At the time of the auction, the outstanding tax liability of IIM was $404,197.90 of which $171,087.90 represented trust fund taxes. Def. SUF ¶ 32. After the auction, but before the certified check was issued by the auctioneer, the officers of IIM consulted with their attorney who advised them to request that only IIM's name be on the check in order to ensure that the proceeds were applied to trust fund taxes in order to eliminate as much of the personal liability of the officers of IIM as possible. Pl. CSF. ¶¶ 27 and 28. Though the officers were aware and agreed that the proceeds would be handed directly over to the IRS, Brian asked the auctioneer to make the check for the auction proceeds payable to IIM. Pl. CSF. ¶¶ 30 and 32. The net proceeds from the auction totaled $192, 210.31. Def. SUF ¶ 37.
Allingham issued a notice of tax levy to the auctioneer on March 23, 2005, in order to secure the proceeds for the IRS. Def. SUF ¶ 40. On March 24, 2005, Brian gave written instructions to Allingham stating that the auction proceeds were to be applied to the trust fund liabilities. Pl. CSF ¶ 33. Despite Brian's written instructions, the proceeds from the auction were allocated as follows: $31,119.69 to trust fund taxes from the last quarter of 2003, and the remaining $161,090.62 to non-trust fund taxes from 2003. Def. SUF ¶ 42. Harry, Brian and McConnell were then assessed the balance of the trust fund tax liability in the amount of $177, 145.33. Def. SUF ¶ 1.
Pursuant to FED. R. CIV. P 56(c), summary judgment shall be granted when there are no genuine issues of material fact in dispute and the movant is entitled to judgment as a matter of law. To support denial of summary judgment, an issue of fact in dispute must be both genuine and material, i.e., one upon which a reasonable fact finder could base a verdict for the non-moving party and one which is essential to establishing the claim. Anderson v. Liberty Lobby, 477 U.S. 242, 248 (1986). When considering a motion for summary judgment, the court is not permitted to weigh the evidence or to make credibility determinations, but is limited to deciding whether there are any disputed issues and, if there are, whether they are both genuine and material. Id. The court's consideration of the facts must be in the light most favorable to the party opposing summary judgment and all reasonable inferences from the facts must be drawn in favor of that party as well. Whiteland Woods, L.P. v. Township of West Whiteland, 193 F.3d 177, 180 (3d Cir. 1999), Tigg Corp. v. Dow Corning Corp., 822 F.2d 358, 361 (3d Cir. 1987).
When the moving party has carried its burden under Rule 56©, its opponent must do more than simply show that there is some metaphysical doubt as to the material facts . See Matsushita Elec. Indus. Co. v. Zenith Radio Corp., 475 U.S. 574, 586 (1986). In the language of the Rule, the nonmoving party must come forward with “specific facts showing that there is a genuine issue for trial.” FED. R. CIV. P 56(e). Further, the nonmoving party cannot rely on unsupported assertions, conclusory allegations, or mere suspicions in attempting to survive a summary judgment motion. Williams v. Borough of W. Chester, 891 F.2d 458, 460 (3d Cir.1989) (citing Celotex Corp. v. Catrett, 477 U.S. 317, 325 (1986)). The non-moving party must respond “by pointing to sufficient cognizable evidence to create material issues of fact concerning every element as to which the non-moving party will bear the burden of proof at trial.” Simpson v. Kay Jewelers, Div. Of Sterling, Inc., 142 F. 3d 639, 643 n. 3 (3d Cir. 1998), quoting Fuentes v. Perskie, 32 F.3d 759, 762 n.1 (3d Cir. 1994).
The parties stipulate that the only issue in this case is whether the IRS was estopped from applying the proceeds from the auction to IIM's various tax liabilities at the discretion of the IRS rather than in accordance with the instructions of the Taxpayers. The Taxpayers contend that Allingham and Evans represented that the Government would permit a liquidation of IIM's assets for the express purpose of paying off the trust fund tax of IIM, thus avoiding personal liability, but leaving the non-trust fund taxes unpaid. The IRS, however, levied on the auction proceeds and applied the involuntary payments, according to IRS procedure, to the non-trust fund tax liability first and then any excess to the trust fund tax liability.
“Estoppel is an equitable doctrine invoked to avoid injustice in particular cases.” Heckler v. Community Health Servs., 467 U.S. 51, 59 (1984). The burden of proof is on the party claiming estoppel. United States v. Asmar, 827 F.2d 907, 912 (3d Cir. 1987) (citing Lyng v. Payne, 476 U.S. 926, 936 (1986)). A party attempting to estop another private party must prove: (1) a misrepresentation by another party; (2) which he reasonably relied upon; (3) to his detriment. Fredericks v. Comm'r, 126 F.3d 433, 438 (3d Cir. 1997); United States v. Asmar, 827 F.2d at 912. In addition, the majority of circuits recognizing estoppel as an equitable defense against government claims, including the Third Circuit, impose an additional burden on claimants to establish some affirmative misconduct on the part of the government officials. United States v. Asmar, 827 F.2d at 911 n.4, 912; see also Kurz v. Philadelphia Elec. Co., 96 F.3d 1544 (3d Cir. 1996).
The Government argues that the Taxpayer's estoppel claim fails because: (1) there is no evidence representatives of the IRS made statements that were sufficiently definite to constitute an affirmative misrepresentation; (2) their reliance on such vague and indefinite statements was unreasonable; and (3) the Taxpayers suffered no legal detriment.
A. Affirmative Misconduct By Government Officials
The Third Circuit has found that not every form of misinformation by the government is sufficient to estop the government, and not all reliance on government statements is reasonable. Fredericks v. Comm'r, 126 F.3d at 438. Affirmative misconduct requires more than a mere omission, negligent failure, or erroneous oral advice from an IRS agent. Id.; United States v. Pepperman, 976 F.2d 123, 131 (3d Cir. 1992). The Third Circuit has recognized that the authority to act, as well as the failure to do so when such authority exists, can give rise to an estoppel claim. Fredericks v. Comm'r, 126 F.3d at 440. In Ritter v. United States, 28 F.2d 265 (3d Cir. 1928), the court stated: “[t]he acts or omissions of the officers of the government, if they be authorized to bind the United States in a particular transaction, will work estoppel against the government ….” Id. at 267.
Considering the facts in the light most favorable to the Taxpayers, and drawing all reasonable inferences therefrom in their favor, there is no reliable evidence in the record that would allow this Court to elevate the vague and ambiguous statements allegedly made by Allingham and/or Evans to affirmative misconduct necessary to work an estoppel against the Government.
The Taxpayers rely on the following as evidence that a material issue of fact exists and to prove affirmative misconduct by the IRS:
(1) At the first meeting with the IRS in November of 2004, Allingham and Evans explained to Harry, Brian and McConnell “what the trust funds were” and that the trust fund taxes were “the responsibility of the officers of the corporation and that many companies actually file bankruptcy to avoid the remaining non-trust fund taxes.” Declaration of H. Brian Crisci (“Brian Decl.”) ¶ 7.
(2) Allingham and Evans were mainly concerned about the trust fund taxes. Brian Decl. ¶ 8; Declaration of McConnell (“McConnell Decl.”) ¶ 7. “[T]he government usually forgives the rest. McConnell Decl. ¶ 7.
(3) Brian had several discussions with the IRS between the initial meeting and the decision to auction IIM's assets during which the following were discussed: (1) IIM was filing and paying taxes in a timely manner; (2) the officer's of IIM were continually looking to pay off taxes and trust fund liabilities; and (3) ultimately IIM was going to auction its assets to pay off the trust fund liability. Brian Deposition p. 36.
(4) After the officers of IIM decided to sell the assets of IIM to pay the trust fund liabilities, Allingham said the auction was “an acceptable way to move forward to pay off theses liabilities, [Allingham] simply emphasized to [Brian] that the auction proceeds had to be paid directly to the IRS.” Brian Decl. ¶ 12.
(5) On March 24, 2005, Brian gave Allingham written instructions indicating that the auction proceeds were to be allocated to IIM's trust fund tax liability. Brian Decl. ¶ 18.
(6) Neither Allingham nor Evans ever told the officers of IIM that they intended to levy the auction proceeds and then allocate such proceeds first to the non-trust fund tax liability of IIM. Brian Decl. ¶ 19.
All the evidence relied upon by the taxpayers consists of the testimony of Brian, Harry or McConnell and what their understanding was regarding the intentions of the IRS. There is neither written nor oral confirmations from anyone at the IRS regarding its intent to forgive the non-trust fund tax liability or to allocate all the auction proceeds to the trust fund taxes. To the extent the IRS indicated the non-trust fund tax liability would be forgiven, that would certainly be a misrepresentation 1, but it does not rise to the level of affirmative misconduct 2.
There is no evidence that Allingham or Evans affirmatively represented to anyone at IIM that the best way to satisfy the trust fund tax liability was to auction IIM's assets. Brian testified that the decision to sell assets was that of the officers of IIM. See Brian Decl. ¶ 12. The IRS impressed upon Brian that the proceeds of the auction had to be paid directly to the IRS. At no time did the IRS indicate that the auction proceeds would be turned over to IIM. Moreover, there is no affirmative representation by the IRS regarding the allocation of the auction proceeds. With regard to IIM's written instructions to Allingham to allocate the proceeds to the trust fund taxes, such instructions were given to Allingham after the IRS had levied on the proceeds and the allocation was then fixed by IRS procedure. See Rev. Proc. 2002-26.
Based on the record currently before the Court, the Taxpayers are unable to show any affirmative misconduct on the part of the IRS, nor can the Court find a material issue of fact with regard to such issue. The Taxpayers' estoppel claim against the Government, therefore, fails as a matter of law.
B Reasonable and Detrimental Reliance
Reliance is undermined when it is based on oral advice, unconfirmed by a writing. Heckler v. Community Health Servs., 467 U.S. at 65; United States v. St. John's Gen. Hosp., 875 F.2d 1064, 1070 (3d Cir. 1989) (noting that the record was devoid of any reliable evidence to estop the government because the alleged misrepresentation was based on inadmissible hearsay, not written correspondence). Moreover, Courts have held that a private party's reliance on governmental actions or omissions is not reasonable if such acts or omissions are contrary to the law or beyond the agents' authority. The Third Circuit expressly ruled:
The acts or omissions of the officers of the government, if they be authorized to bind the United States in a particular transaction, will work estoppel against the government, if the officers have acted within the scope of their authority.
Ritter v. United States, 28 F.2d 265, 267 (3d Cir. 1928). See also Manloading & Mgmt. Assocs. v. United States, 461 F.2d 1299, 198 Ct. Cl. 628 (Ct. Cl. 1972); Walsonavich v. United States, 335 F.2d 96 (3d Cir. 1964). Courts are more likely to apply estoppel when the government's conduct involves a misrepresentation of fact, rather than a misrepresentation of law. Fredericks v. Comm'r, 126 F.3d at 444 (citations omitted). In this instance, where only a misrepresentation outside the authority of an IRS agent may exist, the Court finds any reliance by the Taxpayers upon the vague statements of the intentions of the IRS to be unreasonable.
Finally, to find that the Taxpayers suffered a detriment, the Court must consider whether the conduct attributed to the Government permanently deprived the Taxpayers of a benefit or right to which the Taxpayers were entitled, and in fact, caused the Taxpayers to change their position for the worse. Fredericks v. Comm'r, 126 F.3d at 445-446. One of the detriments Taxpayers contend they suffered was the selling of the assets and ceasing the operation of IIM as a going concern. As of the day of the auction, the total liability on the assessed taxes of IIM was over $400,000,00, and such assessment had become a lien on the assets of IIM, depriving the company of any equity in such assets. Therefore, at the time of the alleged representations regarding allocation of auction proceeds, the Government had a legal right to seize IIM's assets apply the proceeds of the sale of the assets to IIM's non-trust fund tax liability 3. Therefore, the Taxpayers' reliance on the alleged misrepresentations of Allingham and/or Evans did not deprive them of any legal right to which the Taxpayers were entitled absent the alleged misrepresentation.
Based on the foregoing, the Court finds that the Taxpayers' estoppel claim fails as a matter of law, and will grant the motion for summary judgment in favor of the Government. An appropriate order will follow.


IRS agents do not have the authority to forgive tax liabilities. Any forgiveness or compromise of tax liability must be affected in accordance with the provisions of Internal Revenue Code § 7122, 26 U.S.C. § 7122. A forgiveness of tax liability must be in writing and approved by the Secretary of the Treasury or his authorized delegate. United States v. Asmar, 827 F.2d at 913 n. 7. Because it is clear that an officer of the IRS has no authority to forgive or compromise a tax liability, a statement that the non-trust fund taxes would be forgiven was a misrepresentation.
Nor is the Court able to find that the Taxpayers reasonably relied to their detriment on such misrepresentation. In Heckler, the Supreme Court specifically stated that the general rule is "those who deal with the Government are expected to know the law and may not rely on the conduct of Government agents contrary to the law." Heckler v. Community Health Servs., 467 U.S. at 63; see also Federal Crop Insurance Corp. v. Merrill, 332 U.S. 380, 385 (1947).
Further, the Taxpayers admit that had they not auctioned the assets of IIM, the IRS would have levied on such assets and sold them at amounts much less than IIM was able to recoup through its auction. See Brian Decl. ¶ 23.

Friday, September 25, 2009

A "business trust" established by a couple, to which the husband contributed his computer programming sole proprietorship, and which paid the husband a salary, was treated as a vehicle for the improper assignment of the couple’s income, and was also treated as a grantor trust. The couple effectively retained total control over the assets and the income of the trust, and used a credit card attached to an offshore grantor trust which received all income of the business trust not otherwise paid to the husband as wages. . Accordingly, all income received by the business trust was taxable to the couple.
With respect to the deductions the couple claimed to offset their income, the couple did not maintain adequate records and had no other substantiation of such deductions The husband also failed to establish any capital loss carryforward he could use to offset short-term capital gains attributable to his separate day trading activities. Accordingly, almost all of the couple's claimed deductions were disallowed, and the husband's trading gains were computed without regard to any loss carryforward.
The husband, but not the wife, was subject to the Code Sec. 6663 fraud penalty with respect to the underpayment attributable to his actions in assigning his sole proprietorship income to the trust, for which he could not establish either reasonable cause or good faith. No evidence or argument was made with respect to any fraud on the part of the wife.
L. Tarpo and Marla J. Tarpo, et al. v. Commissioner., U.S. Tax Court, CCH Dec. 57,949(M), T.C. Memo. 2009-222, (Sept. 24, 2009)
U.S. Tax Court, Dkt. No. 10338-03; 10303-04; 12819-04, TC Memo. 2009-222, September 24, 2009.

HOLMES, Judge: James and Marla Tarpo wanted to protect as much of their income from taxation as they could. There's nothing wrong with that if done legally, but the Tarpos fell in with a specialist in abusive tax shelters. Following his advice, they put James's business into a trust, manufactured spurious deductions, and misreported large amounts of capital gains as capital losses—when they reported the transactions at all.
We wade through the available records to determine what the Tarpos owe and whether they should be penalized.
The Tarpos were a dual-income family during the years at issue—1999, 2000, and 2001. Most of their income came from James, a computer programmer who contracted his services to corporations in the name of his sole proprietorship, ATE Services. Although he had several clients during 1999-2001, he worked mostly for a corporation named MaxSys. MaxSys and most of James's other clients paid their invoices with checks made out to ATE Services. Marla Tarpo was an independent beauty consultant whose primary financial contribution during those years was the deductions in excess of income she reported on their joint tax return from her own unnamed sole proprietorship.
James Mattatall became a part of the Tarpos' life when a friend recommended his services, perhaps as early as 1997. Mattatall, as the Tarpos admitted they knew, is neither an attorney nor an accountant. He earned his living by setting up tax shelters for his clients. He is now out of that business: In 2004, the U.S. District Court in Los Angeles enjoined him from organizing, selling, or recommending tax shelters; or even from offering tax advice to clients. United States v. Mattatall, No. CV 03-07016 DDP (PJWx) (C.D. Cal., Aug. 17, 2004) (order granting plaintiff's motion for contempt and second amended injunction). Back in 1999, Mattatall recommended that the Tarpos create an elaborate scheme to route James's ordinary income into a trust, move it offshore, and then retrieve it with credit cards.
Here's how it was supposed to work:
• The Tarpos would create a “business trust,” naming Mattatall as the trustee and the Tarpos as managers. The Tarpos would get a separate mailing address for the trust to lend it credibility.
• James would then transfer ATE Services into the trust, thereby removing himself as the sole owner of his business and assigning all of the income earned from his business to the trust.
• The trust would give a portion of the income James earned back to him as wages.
• The stated beneficiary of the trust would be Prosper International, Ltd. (PIL), 2 an offshore company specializing in multilevel marketing schemes and low-cost foreign grantor trusts. Any money the trust didn't give back to James would go to PIL and be deposited in a foreign grantor trust established for the benefit of the Tarpos.
• PIL would then give the Tarpos a credit card that they could use, with the bills paid from the money in the foreign grantor trust.
In July 1999, the Tarpos created Paderborn Trust 3 with PIL as its sole beneficiary, and shortly thereafter leased a post office box at a Mailboxes, Etc. to be Paderborn's address. 4 They also “transferred” ATE Services to Paderborn by getting an employer identification number (EIN) for ATE Services and having Paderborn claim income reported under that EIN on a Schedule C attached to its tax return. 5 They then paid $2,000 to PIL to get a Freedom Card (also known as a Horizon MasterCard), and a PIL Plus Quick Start Trust (PIL Trust), which was an offshore trust specifically designed to eliminate income taxes. For an additional $200, PIL even provided the Tarpos with a foreign grantor for their foreign trust.
James received compensation from Paderborn, and any money that he didn't immediately get from Paderborn went into the PIL Trust. The Horizon MasterCard directly linked to the Trust, and the Trust used money deposited by Paderborn to pay the Tarpos' Horizon credit-card debt each month. The Tarpos were free to use the Horizon card however they wanted and only received an expense summary, never a bill.
The plan had one large hitch at the start. The Tarpos, unable to get a separate bank account set up for Paderborn until 2000, decided instead to deposit checks payable to ATE Services into their personal bank account just as they'd always done. One big exception was the checks from MaxSys, which the Tarpos cashed, depositing most of that cash into their personal account but keeping the rest. 6 Once they set up the Paderborn bank account, they began depositing all checks made out to ATE Services into it, though on at least one occasion Marla withdrew money from that account to pay the Tarpos' personal debts directly. Some money also sloshed between the Tarpos' Paderborn bank accounts over half a dozen times for no reason that we could discern.
Another of the Tarpos' big mistakes was the way that they reported their income and deductions. Each year, James prepared a Schedule C listing the income paid back to him from Paderborn, but he didn't list Paderborn anywhere on the form. Instead, he indicated that the money came through his own sole proprietorship, ATE Services, just as he always had. Both James and Marla also claimed extensive business deductions—without any records to substantiate them—which brought their taxable income down to almost nothing. They used the same tactic on Paderborn's tax return—again, without any substantiation—only there any remaining income was claimed as an income-distribution deduction 7 so that there was no taxable income. 8
James was also a very active day trader during these years, often buying and selling stocks hundreds of times per week. He did not keep any records of his bases in these stocks or his net gains and losses, and in fact he didn't even report these transactions on his 1999 and 2000 tax returns until he submitted amended returns in February 2003. 9 The Commissioner has conceded that the Tarpos are entitled to a $3,000 capital loss deduction for both 2000 and 2001. A major question is how much in capital gains or losses they had at the end of 1999.
Our finding on James's 1999 capital gains or losses has two parts—the loss carryforward and sale proceeds. Neither James nor the Commissioner was able to provide a precise accounting of the Tarpos' capital gains or losses for 1999, so we pieced together the information from what was in the record. James's 1999 amended return included a $34,794 short-term capital loss carryforward, but he offered no substantiation for it at trial. A taxpayer's returns alone do not substantiate deductions or losses because they are nothing more than a statement of his claims. Wilkinson v. Commissioner, 71 T.C. 633, 639 (1979); Roberts v. Commissioner, 62 T.C. 834, 837 (1974). To hold otherwise would undermine our presumption that the Commissioner's determination is correct. See Rule 142; Halle v. Commissioner, 7 T.C. 245, 247 (1946), affd. 175 F.2d 500 (2d Cir. 1949). We therefore find that James had no short-term capital loss carryforward to apply to his 1999 short-term capital gains.
We next turn to figuring out the sale proceeds from James's day trading in 1999. The Commissioner subpoenaed E*Trade Financial Corporation and obtained Forms 1099 listing all of James's trades in 1999. We entered the trades into a spreadsheet and calculated the gain or loss for each company he invested in and found the aggregate gain to be $91,709. The table below shows the gain or loss for each company. 10 James closed out his position in most of the companies by the end of 1999, but he still held shares in the italicized companies at the end of the year. Since we could not match the shares that were sold with their respective purchase date for such companies, we applied the so-called “FIFO Rule,” where the basis in the first lot or share that needs to be identified, on account of a sale, equals the basis of the earliest of those lots purchased. See sec. 1.1012-1(c), Income Tax Regs.
Company Sale Price Basis Gain/(Loss)
At Home $27,204.14 $25,671.15 $1,532.99
Advanced Fibre 11,553.46 12,096.15 (542.69)
Amazon 387,918.52 386,840.35 1,078.17
Applied Mic 15,154.54 13,194.95 1,959.59
Conexant Systems $95,655.69 $89,606.00 $6,049.69
Cyberian Outpost 145,361.71 144,499.60 862.11
E*Trade 368,554.48 355,703.58 12,850.90
Earthlink Network 41,808.70 43,314.90 (1,506.20)
Equity Residential 21,354.33 0.00 21,354.33
IKOS Systems 19,979.38 16,727.40 3251.98
KN Energy Peps 35,133.92 0.00 35,133.92
Netsilicon 20,545.70 17,977.40 2568.30
Purchasepro 33,795.26 38,559.85 (4,764.59)
RealNetworks 281,266.28 281,935.30 (669.02)
Sharper Image 16,729.49 11,207.45 5,522.04
Sportsline.com 16,459.54 17,364.90 (905.36)
Track Data 586.27 707.45 (121.18)
Uroquest Medical 2,266.50 0.00 2,266.50
VISX Delaware 96,743.15 90,956.00 5,787.15
TOTAL 1,638,071.06 1,546,362.43 91,708.63
In 2002, the Commissioner chose the Tarpos' 1999 return for audit. The Tarpos showed up with Mattatall, but didn't bring any of the requested documentation and didn't answer any questions. Instead, they simply handed the examiner affidavits attesting to the truth of the items claimed on their tax returns. They also brought amended tax returns for 1999 and 2000 which included previously unreported stock transactions as well as unreported dividends and interest.
In an effort to get some documentation other than the affidavits, the examiner set up another meeting. This time, Marla showed up alone with a box full of disorganized receipts. She again refused to answer any questions, so the examiner subpoenaed records from the Tarpos' banks, their brokers, and the companies that had used James's services. The Commissioner finally sent a notice of deficiency for 1999 in April 2003. It was signed by an IRS employee with the title Technical Services Territory Manager.
The Tarpos' conduct during the audit of their 1999 return sparked an audit of their 2000 and 2001 returns, which the Commissioner quickly extended to Paderborn's returns for those years. The Tarpos did not respond to any of the examiner's requests for information, and more third-party summonses followed.
In the notices of deficiency, the Commissioner disallowed all of the Tarpos' claimed deductions and set up a whipsaw position, attributing the same income to both Paderborn and the Tarpos. The notices of deficiency for the 2000 and 2001 tax years of both the Tarpos and Paderborn were also signed by the same IRS employee.
The Tarpos timely petitioned us for review of all three notices. The cases were tried together in Los Angeles, where the Tarpos resided when they filed their cases.
I. Jurisdiction
The Tarpos open with a frivolous jurisdictional argument. They claim that the notices of deficiency are invalid because a “Technical Services Territory Manager” is not authorized to issue them. Statutory notices of deficiency are valid only if issued by the Secretary of the Treasury or his delegate. Kellogg v. Commissioner, 88 T.C. 167, 172 (1987); see also secs. 6212(a), 7701(a)(11)(B), (12)(A)(i). The Technical Services Territory Manager position is part of the Small Business/Self-Employed (SB/SE) division of the IRS. SB/SE Territory Managers were specifically delegated the authority to send notices of deficiency in Delegation Order No. 77 (Rev. 28), 61 Fed. Reg. 30937 (June 18, 1996) (effective May 17, 1996). That delegated authority was re-authorized in Delegation Order 4-8, Internal Revenue Manual pt. (Feb. 10, 2004). There is no question that the IRS employee who signed the notices of deficiency had the authority to do so. We therefore hold that we have jurisdiction.
II. Validity of Paderborn Trust
The Commissioner views Paderborn as a fat target, and fires three weapons at it: arguments that Paderborn is a sham trust, that it is a grantor trust, and that Tarpo was just assigning his income to it. We begin by describing how Paderborn worked.
A. Operation of Paderborn
The purpose of the Paderborn/PIL Trust/Horizon MasterCard arrangement was to reduce or eliminate income taxes. By transferring ATE Services to Paderborn and calling James an independent contractor of ATE Services rather than its sole proprietor, James claims he could be paid a fixed amount which he could then offset with unreimbursed Schedule C expenses. Paderborn deducted what it paid to James as “contracted development.” Everything that remained in Paderborn at the end of the year was transferred to the PIL Trust, shipped from the United States, and placed in the hands of foreigners not subject to the Code. By using the Horizon MasterCard, which was paid directly by the PIL Trust, the Tarpos could access the money without repatriating it.
On paper, most of the earned income was reported somewhere. The money which would have been reported on James's Schedule C before the trusts were established was instead reported for 1999-2001 as follows:
Since Paderborn had no separate bank account in 1999, everything that was designated as going to Paderborn was actually cashed by the Tarpos and deposited in their personal checking account. For the other years, anything noted as paid to Paderborn was actually deposited in Paderborn's checking account. Whenever PIL received money, it deposited that money into the PIL Trust.
B. Improper Income Assignment
A basic income tax principle is that a taxpayer is taxed on the income that he earns, and that income cannot be assigned to another. Commissioner v. Banks, 543 U.S. 426, 433-34 (2005); Lucas v. Earl, 281 U.S. 111, 114-15 (1930). When a taxpayer tries to assign the right to future income to another person, the IRS and courts ignore the attempt for tax purposes; the assignor pays all the taxes he would have paid had he not assigned the income. Banks, 543 U.S. at 433-34; see also Burnet v. Leininger, 285 U.S. 136 (1932) (can't escape tax on profits by assigning them); Wesenberg v. Commissioner, 69 T.C. 1005, 1010-11 (1978) (conveyance of earned income ineffective when taxpayer retains “ultimate direction and control over the earning of the compensation”).
Transferring ATE Services to Paderborn didn't actually change anything other than which taxpayer identification number the income was reported under. James still did all the business development, performed all the work, and signed all the timesheets. He was still the one earning the income, and it never left his control. At one point during the trial, James testified that he was assigning his income to Paderborn:
COURT: Okay. So what you were doing then, if I can understand this right, is you would go to a company like MACSIS [sic] or N.H. Services, you would contract with them, and then the idea was for you to assign the income to the Paderborn Trust?
It doesn't get much simpler than that.
We therefore find that the Tarpos improperly assigned James's earned income to Paderborn. We must disregard Paderborn, and will treat James as ATE Services' sole proprietor.
C. Grantor Trust
The Commissioner also argues that Paderborn and PIL were grantor trusts. A grantor trust is created when a person contributes cash or property to a trust, but continues to be treated as owner of it at least in part. See secs. 671-679. The Code tells us to disregard such a trust as a separate taxable entity to the extent of the grantor's retained interest. Sec. 671; sec. 1.671-2(b), Income Tax Regs. And the grantor of a grantor trust is supposed to report his portion of the trust's income and deductions on his own tax return, not the trust's.
We find that the Tarpos retained ownership of all of the assets in Paderborn and the PIL Trust. Sections 674, 676, 677, and 679 11 state that the grantor will be treated as the owner of a trust when he keeps certain powers or takes certain actions. Here's a summary of what the Tarpos did that makes their trusts grantor trusts:
• A grantor may dispose of the trust's income without the approval or consent of an adverse party. Sec. 674(a). The Tarpos had unfettered access to all of Paderborn's assets as comanagers with signatory authority on the Paderborn bank account.
• A grantor can revest title over the property in himself. Sec. 676(a). The Tarpos could revest title of Paderborn assets in themselves at any time; Marla proved this when she purchased a cashier's check payable to James's broker, Computer Clearing Services, to pay off personal debt.
• A grantor trust's income can be distributed or accumulated for future distribution to the grantor or the grantor's spouse. Sec. 677(a). All of the money paid into Paderborn was paid back out to either the Tarpos directly or to PIL, which then distributed the money to the Tarpos via the Horizon card.
• The grantor directly or indirectly transfers property to a foreign trust. Sec. 679(a). The Tarpos transferred property directly to a foreign trust when they set up the PIL Trust, and they transferred property indirectly to the same trust every time Paderborn sent it money.
We therefore find in the alternative that Paderborn and the PIL Trust should be disregarded for income tax purposes as nothing more than grantor trusts. 12
III. Income and Deductions
Having decided that all Paderborn's income properly belongs to the Tarpos, we turn to figuring out what that income was. We then discuss the deductions claimed by both James and Marla on their respective Schedules C that might reduce the portion of that income that is taxable.
A. Income for 1999, 2000, and 2001
The Commissioner did not contest Marla's reported income for any of the years at issue, so we go straight to the question of what income James should have reported on his Schedule C. Since the Tarpos did not produce any records during the audit, the Commissioner relied on bank statements. Through these statements, he discovered the names of the companies that paid James for his services, and was able to find out exactly how much they paid ATE Services each year. From there, the Commissioner was able to compare the bank statements for the Tarpos, ATE Services, and Paderborn to determine where the money was going and how much the Tarpos were actually making. Summarizing the information in tabular form shows how much each client paid James:
Alcon Laboratories, Inc. $8,840
Winsoft Inc. 5,400
USANA, Inc. 988
N.H. Resources, Inc. 15,115
MaxSys Technologies 21,710
Total 52,053
MaxSys Technologies $110,663
Total 110,663
MaxSys Technologies $87,141
Vektrek Electronic Sys 375
Total 87,516
By using these methods, the Commissioner determined that the Tarpos had gross income which should have been reported on James's Schedule C as follows:
1999 2000 2001
$52,053 $110,663 $87,516
We agree with the Commissioner and find that these totals are accurate. 13
B. Deductions for 1999, 2000, and 2001
Expenses are allowable if they are “ordinary and necessary,” but a taxpayer must keep records to show the connection between the expenses and his business. Sec. 162(a); Gorman v. Commissioner, T.C. Memo. 1986-344; sec. 1.6001-1(a), Income Tax Regs. If the taxpayer has no records, but we find he must have incurred some expenses, we can estimate the amounts of those expenses as long as there is something in the record to support the estimate (the Cohan rule). Williams v. United States, 245 F.2d 559, 560 (5th Cir. 1957); Cohan v. Commissioner, 39 F.2d 540, 543-44 (2d Cir. 1930). The Cohan rule does not apply to expenses that the Code lists in section 274(d); taxpayers have to meet special substantiation requirements for these listed expenses. Sec. 1.274-5T(a), Temporary Income Tax Regs., 50 Fed. Reg. 46014 (Nov. 6, 1985); Sanford v. Commissioner, 50 T.C. 823, 827-28 (1968), affd. 412 F.2d 201 (2d Cir. 1969).
The Tarpos claim a great many business expenses, including those claimed by Paderborn on its return. These include expenses we can estimate under the Cohan rule—cost of goods sold, depreciation, interest, supplies, business use of their home, cleaning, equipment, gifts, training, sales promotion—as well as section 274(d) items that we can't estimate under Cohan, like car-and-truck expenses, travel, and meals and entertainment. At no point during audit or pretrial discovery did the Tarpos provide any receipts or explanations for any of these items. During the trial itself, Marla didn't testify at all and James never testified about the disputed deductions.
All the Tarpos ever provided were unsupported affidavits swearing to the truth of each item on each tax return. They did this at Mattatall's suggestion, but as other Mattatall clients have discovered, self-serving affidavits are not substantiation. See Doudney v. Commissioner, T.C. Memo. 2005-267; Kolbeck v. Commissioner, T.C. Memo. 2005-253.
Since we have nothing on which to base any Cohan estimate, we hold that all but one of the Schedule C deductions claimed by the Tarpos are disallowed for lack of substantiation either because they are section 274(d) deductions subject to a higher substantiation standard, or because there was no evidence provided from which this Court could make a reasonable estimate of expenses. The one deduction which we will allow as an ordinary and necessary business expense under Cohan is the $108 licensing fee Marla incurred in 2000. We allow this one because we realize that a beauty consultant requires a license to operate and we are convinced that she actually paid the licensing fee.
IV. Penalties
A. Fraud Penalty
Section 6663 imposes a penalty equal to 75 percent of the underpayment when that underpayment is attributable to fraud. The Commissioner has the burden of proving fraud, and he has to prove by clear and convincing evidence that the taxpayer underpaid and that the underpayment was attributable to fraud. Sec. 7454(a); Rule 142(b); Miller v. Commissioner, T.C. Memo. 1989-461. If the Commissioner succeeds in proving that even part of the underpayment is due to fraud, then “the entire underpayment shall be treated as attributable to fraud, except with respect to any portion of the underpayment which the taxpayer establishes (by a preponderance of the evidence) is not attributable to fraud.” Sec. 6663(b).
The Commissioner easily passes the first part of this test. He proved there was an underpayment when he proved that the Tarpos didn't report the additional income they tried to assign to Paderborn.
But was a portion of that underpayment due to fraud? Fraud is the “willful attempt to evade tax,” and we make that determination by looking at the entire record of a case. Beaver v. Commissioner, 55 T.C. 85, 92 (1970). There are many factors which can indicate fraud, including:
• understatement of income
• inadequate records
• concealing assets
• failure to cooperate with tax authorities
• mischaracterizing the source of income
• implausible or inconsistent explanations of behavior.
See Spies v. United States, 317 U.S. 492 (1943); Bradford v. Commissioner, 796 F.2d 303 (9th Cir. 1986), affg. T.C. Memo. 1984-601; Meier v. Commissioner, 91 T.C. 273 (1988). Although James Tarpo exhibited each and every one of these factors, the most telling was his attempt to conceal assets offshore with PIL. The only plausible reason he had to set up such a foreign grantor trust, where the sole beneficiary was a company which James knew very little about, was to try to hide assets from the IRS to avoid paying taxes. We therefore find that, at least in respect to the income assigned to Paderborn, the Commissioner has proven fraudulent intent by clear and convincing evidence.
Since a portion of the underpayment is attributable to fraud, all of the underpayment will be subject to the fraud penalty unless the Tarpos can show by a preponderance of the evidence that some of the underpayment was not due to fraud. We find that James has met this burden in regard to the capital gains for 1999. We therefore hold that the underpayment attributable to his understating his capital gains is not subject to the fraud penalty. We also find that the Commissioner has met his burden of proof only with regard to James; he has not shown that Marla acted with fraudulent intent—about her intent there was no evidence or argument at all.
James asserts that he had reasonable cause for his return position and that he acted in good faith. Sec. 6664(c). He claims that the entire fiasco is Mattatall's fault, and that his good faith reliance on Mattatall reasonably caused him to act the way he did. While that excuse might work when a licensed and reputable tax professional offers the advice, it doesn't work here.
James never once asked for any credentials from Mattatall, and in fact admitted under oath that he knew Mattatall was neither an attorney nor an accountant. James also knew that the foreign trust setup was specifically created to hide the true ownership of assets and income from the IRS. We therefore find that James has not proved a defense to fraud.
B. Accuracy-related Penalty
Section 6662(a) and (b)(1) and (2) permits the imposition of an accuracy-related penalty equal to 20 percent of the underpayment when that underpayment is due to negligence or a substantial understatement. Because the Tarpos were negligent in their recordkeeping and showed intentional disregard of the tax rules and regulations even in their reporting of their capital gains and supposed expenses, we find that the entire underpayment not attributable to fraud is subject to the accuracy-related penalty.
The same defense of reasonable cause and good faith applies to this penalty, see sec. 6664(c), and the Tarpos must show they acted as reasonable and prudent people would, see Allen v. Commissioner, 925 F.2d 348, 353 (9th Cir. 1991), affg. 92 T.C. 1 (1989). This, we find, they failed to do. James didn't keep any regular records of his day-trading activities despite knowing that he would owe tax on any capital gains he made. He is business savvy and should have known better. And neither Tarpo claims to have kept any other sort of business records. Reasonable people usually keep records to show their entitlement to deductions or at least to track income and expenses. The Tarpos are either not acting reasonably or are not telling the truth. Either way, they do not have a credible defense to the accuracy-related penalty.
For the above reasons,
Decisions will be entered under Rule 155.

Wednesday, September 23, 2009

The IRS has released internal interim guidance on whether an offer in compromise (OIC) will be deemed automatically accepted under Code Sec. 7122(f). Under this provision, all OICs received on or after July 16, 2006, will be deemed accepted if the IRS does not make a determination within two years. The two-year period begins on the date the offer is received by the IRS. Guidance was also provided on how to process OICs that are deemed accepted.

If 24 months have expired since the IRS received date, the offer examiner should conduct a thorough review of the OIC to determine if the deemed acceptance provision apply. If there is any question about whether the 24-month period has expired, the examiner should refer the case to IRS Counsel for review. Once it is confirmed that the IRS did not make the required determination, the taxpayer must be issued an acceptance letter.

The guidance includes an explanation of instances where an OIC will not be deemed accepted pursuant to Code Sec. 7122(f). An OIC will not be deemed accepted if, within 24-month period, the OIC is: rejected by the IRS, returned by the IRS to the taxpayer as not processable or no longer processable, withdrawn by the taxpayer or deemed withdrawn because the taxpayer failed to make the second or later installment of a periodic payment.

2009ARD 183-4


August 4, 2009

Control Number: SBSE-05-0809-019

Expires: August 4, 2010

IRM Impacted: 5.8.10

FROM: Frederick W. Schindler /s/ Laura Hostelley Director, Collection Policy
SUBJECT: Interim Guidance for Offer in Compromise Mandatory Acceptance
The purpose of this memorandum is to issue interim guidance on whether an offer in compromise (OIC) will be deemed an automatic acceptance under Internal Revenue Code (IRC) 7122(f ). It also issues interim guidance on how to process OICs that are deemed accepted. Please ensure this information is distributed to all affected employees. These procedures are effective immediately and apply to all OICs.
On May 17, 2006, the Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA) was enacted. TIPRA created IRC 7122(f), which applies to all OICs received on or after July 16, 2006. Under the new law, an OIC will be deemed accepted if the IRS does not make a determination regarding whether to accept the OIC within two years. The two year period begins on the date the offer is received by the IRS (IRS received date). The postmark date is irrelevant in determining when an OIC is received. If a liability included in the OIC is disputed in a court proceeding, the two year period will not run during the period the liability is in litigation. In addition, the two year period will not run during the period a rejected offer is in Appeals.

Under the deemed acceptance provisions, an OIC is deemed accepted if it is still with the IRS after two years and the IRS has made no determination with regard to the OIC.

An OIC will not be deemed to be accepted pursuant to section 7122(f), if within the 24 month period, the OIC is:
• rejected by the IRS
• returned by the IRS to the taxpayer as not processable or no longer processable
• withdrawn by the taxpayer
• deemed withdrawn under section 7122(c)(1)(B)(ii) because the taxpayer failed to make the second or later installment due on a periodic payment OIC.

Expedited processing should take place if an OIC was received subsequent to July 16, 2006, and over 18 months have expired since the IRS received date.

If 24 months have expired since the IRS received date, the offer examiner or offer specialist should conduct a thorough review of the OIC file to determine if the provisions of IRC 7122(f) apply. This review should include (at a minimum):
• Review the Form 656 to determine the IRS received date. If the IRS received date is prior to July 16, 2006, the OIC is pre-TIPRA and the 24 month mandatory acceptance period does not apply.

• For a TIPRA OIC, determine if 24 months have elapsed since the IRS receipt date. If 24 months from the IRS received date have not elapsed, the OIC is not an automatic acceptance.

• Determine if a decision letter was issued to the taxpayer within 24 months of the IRS received date. If a decision letter was issued within 24 months of the IRS received date, then the OIC is not an automatic acceptance. Decision letters include rejection, return, termination, withdrawal and/or acceptance letters.
• Determine if the tax liability listed in the OIC was disputed in court or was in Appeals during the 24 month period following the IRS received date. The length of time the period was disputed in a judicial proceeding or in Appeals should not be included in the calculation of the 24 month TIPRA determination. If, after the revised calculation, 24 months have not elapsed, then the OIC is not a mandatory acceptance. If a total of 24 months have expired even after subtracting the time in litigation and any time a rejected offer was in Appeals, the OIC will be deemed a mandatory acceptance.

Note: If there is any question about whether the 24 month period has expired, refer the case to IRS Counsel for review.

If the 24 month period has expired, the offer examiner or offer specialist who is currently assigned the OIC, or group manager if the OIC is not assigned, will enter a statement in the AOIC history and ICS history, if applicable, addressing the reason(s) the 24 month period expired. If the OIC is not on AOIC, a history statement will be entered in the system of record, i.e., ICS, AMS, etc. The statement should include any unusual or mitigating circumstances. The group manager or department manager will review the AOIC history, summary statement, and the ICS history as well as any other relevant information to determine if further administrative action is warranted and if disciplinary action is appropriate.

The group or department manager will prepare a memorandum to the territory manager or operations manager detailing the reason(s) the 24 month period expired without the IRS making a decision on the OIC, why further administrative action is or is not warranted, and include any proposed disciplinary actions, if appropriate. The memorandum will also include the following information:

1. IRS received date
2. COIC site of original receipt
3. Date assigned to and received by field area (if applicable)
4. Date received by offer examiner or offer specialist who is currently assigned the OIC investigation
5. Date and type of any proposed recommendations made by an offer examiner or offer specialist.
6. Dates of discussion between manager and employee relative to the 24 month TIPRA issue beginning 18 months after the OIC was received by the IRS
7. Any mitigating circumstances

The territory or operations manager will review the memorandum and forward a copy of the memorandum to the area or service center director along with a cover memorandum outlining any recommended disciplinary action.

After confirming that the IRS did not make a determination with regard to the OIC within 24 months of receipt, the taxpayer must be issued an acceptance letter. The attached letter will be signed by the current level of authority delegated permission to sign an OIC acceptance letter and sent to the taxpayer. Delegation Order Number 5-1 provides the level of authority for approving all OIC dispositions. A copy of the memorandum detailing why the 24 month period expired and a copy of the acceptance letter will be mailed to the National OIC Program Manager. The OIC file will be processed in accordance with IRM 5.8.8 , Acceptance Processing. Since the acceptance is not under Doubt as to Collectibility or Doubt as to Liability, AOIC will be updated to classify the basis of compromise as “A” Alternative Basis for compromise. Use the date the 24 month period expired as the acceptance date on AOIC and the date of the acceptance letter.

These procedures will be incorporated into IRM 5.8.10 , Special Case Processing. If you have any questions, please feel free to contact me, or a member of your staff may contact Diana Estey. Territory and COIC personnel should direct any questions, through their management staff, to the appropriate Area contact.


cc: National Chief, Appeals
Chief Counsel
Director, Examination
National Taxpayer Advocate
Attachment and Exhibit 10-1
Person to Contact:
Telephone Number:
Employee Number:
Taxpayer ID#:
Offer Number:
We have accepted your offer in compromise signed and dated by you on . The date of the acceptance is the date of this letter and our acceptance is subject to the terms and conditions on the enclosed Form 656, Offer in Compromise.
Your offer was accepted under IRC 7122(f) because we did not make a determination within 24 months of receiving your offer.
Please note that the terms and conditions of the offer require you to file and pay all required taxes for five tax years or the period of time payments are being made on the offer, whichever is longer. This will begin on the date shown in the upper right hand corner of this letter.
Additionally, please remember that the conditions of the offer include the provision that an as additional consideration for the offer, we will retain any refunds or credits that you may be entitled to receive for or for earlier tax years. This includes refunds you received in for any overpayments you made toward tax year or toward earlier tax years. If a Notice of Federal Tax Lien has been filed, it will be released when the offer amount is paid in full.
If you are required to make any payments under this agreement, make your check or money order payable to the United States Treasury and send it to:
Internal Revenue Service
P.O. Box 24015
Fresno, California 93779
All other correspondence should be directed to:
Internal Revenue Service
P.O. Box 9006
Holtsville, NY 11742-9006
You must promptly notify the Internal Revenue Service of any change in your address or marital status. This will ensure we have the proper address to advise you of the status of your offer.
If you have submitted a joint offer with your spouse or former spouse and you personally are meeting or have met all the conditions of your offer agreement, but your spouse or former spouse fails to adhere to the conditions of the offer agreement, your offer agreement will not be defaulted.
If you fail to meet any of the terms and conditions of the offer, the Internal Revenue Service will issue a notice to default the agreement. If the offer is defaulted, the original tax including all penalties and interest will be due. Payments made while your offer was pending or in effect will not be refunded. After issuance of the notice the Internal Revenue Service may:
• Immediately file suit to collect the entire unpaid balance of the offer
• Immediately file suit to collect an amount equal to the original amount of the tax liability as liquidating damages, minus any payments already received under the terms of this offer.
• Disregard the amount of the offer and apply all amounts already paid under the offer against the original amount of the tax liability.
• File suit or levy to collect the original amount of the tax liability
If you have any questions, please contact the person whose name and telephone number is shown in the upper right hand corner of this letter.
Enclosure: Form 656, Offer in Compromise

Thursday, September 17, 2009

The IRS’s highly publicized voluntary offshore disclosure initiative is set to end on September 23, 2009. In exchange for full disclosure of offshore accounts by taxpayers not under investigation, the IRS generally will agree not to seek criminal prosecution for tax evasion. Taxpayers must pay back taxes, plus interest and penalties, for six years. September 23 is also the deadline for some taxpayers to file a delinquent Form TD F 90-22, Report of Foreign bank and Financial Accounts (FBAR) without penalty.

"The only way to resolve these tax compliance problems with a high degree of certainty is to enroll in the voluntary disclosure program, and taxpayers have a limited time to get into the program before the doors close," Daniel Gottfried, a member of the Corporate and Business Law Department, Day Pitney, LLP, Hartford, Conn., told CCH.

Application. The IRS has instructed taxpayers to contact the nearest Special Agent in Charge, IRS Criminal Investigation, or submit a letter requesting participation in the initiative. The IRS has posted a streamlined application on its web site ( www.irs.gov/compliance/enforcement/article/0,,id=205909,00.html).


Tuesday, September 15, 2009

ET AL., 1 Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
TC Memo. 2009-203, September 9, 2009.
I. Fraud Penalty
We begin with our consideration of the issue of fraud because, absent fraud, the period of limitations may no longer be open for respondent's assessment of deficiencies in the income tax of the Bells for taxable years 1996, 1997, and 1998. See sec. 6501(c)(1); see, e.g., Langworthy v. Commissioner [ Dec. 52,747(M)], T.C. Memo. 1998-218.
In the case of the filing of a false or fraudulent return with intent to evade tax, the tax may be assessed at any time. Sec. 6501(c)(1). If the return is fraudulent in any respect, it deprives the taxpayer of the bar of the statute of limitations for that year. Lowy v. Commissioner [ 61-1 USTC ¶9350], 288 F.2d 517, 520 (2d Cir. 1961), affg. [ Dec. 24,072(M)], T.C. Memo. 1960-32. “Thus where fraud is alleged and proven, respondent is free to determine a deficiency with respect to all items for the particular taxable year without regard to the period of limitations.” Colestock v. Commissioner [ Dec. 49,703], 102 T.C. 380, 385 (1994). Moreover, if a joint return was filed, proof of the fraudulent intent as to one spouse lifts the bar of the statute of limitations as to both spouses. Vannaman v. Commissioner [ Dec. 30,109], 54 T.C. 1011, 1018 (1970). However, the Commissioner must show fraud clearly and convincingly as to both taxpayers on a joint return for each of them to be liable for the fraud penalty. Balot v. Commissioner [ Dec. 54,287(M)], T.C. Memo. 2001-73.
The fraud penalty is a civil sanction provided primarily as a safeguard for the protection of the revenue and to reimburse the Government for the heavy expense of investigation and the loss resulting from a taxpayer's fraud. See Helvering v. Mitchell [ 38-1 USTC ¶9152], 303 U.S. 391, 401 (1938). Fraud is intentional wrongdoing on the part of the taxpayer with the specific purpose to evade a tax believed to be owing. See McGee v. Commissioner [ Dec. 32,219], 61 T.C. 249, 256 (1973), affd. [ 75-2 USTC ¶9723], 519 F.2d 1121 (5th Cir. 1975).
The Commissioner has the burden of proving fraud by clear and convincing evidence. Sec. 7454(a); Rule 142(b). The Commissioner's burden of proof under section 6501(c)(1) is the same as that imposed by section 6663. See Pennybaker v. Commissioner [ Dec. 49,941(M)], T.C. Memo. 1994-303. To satisfy the burden of proof, the Commissioner must show: (1) An underpayment exists; and (2) the taxpayer intended to evade taxes known to be owing by conduct intended to conceal, mislead, or otherwise prevent the collection of taxes. See Parks v. Commissioner [ Dec. 46,545], 94 T.C. 654, 660-661 (1990). The Commissioner must meet this burden through affirmative evidence because fraud is never presumed. Petzoldt v. Commissioner [ Dec. 45,566], 92 T.C. 661, 699 (1989); see also Beaver v. Commissioner [ Dec. 30,380], 55 T.C. 85, 92 (1970). Once the Commissioner has established by clear and convincing evidence that any portion of an underpayment is attributable to fraud, the entire underpayment shall be treated as attributable to fraud, except with respect to any portion of the underpayment which the taxpayer establishes (by a preponderance of the evidence) is not attributable to fraud. Sec. 6663(b).
A. Underpayment
An “underpayment” is generally defined (insofar as relevant to the instant case) as the amount by which the tax imposed by the Code exceeds the amount shown as the tax by the taxpayer on his return. See sec. 6664(a). Respondent contends that the evidence clearly and convincingly shows that the OEL transactions lacked economic substance and that the money transferred by BCM to NESL, and later ILS, as part of those transactions was income to Mr. Bell, in the form of wages from BCM, which he failed to report on his returns. Respondent contends that the wages were compensation for Mr. Bell's personal services. Respondent also relies on the doctrine of constructive receipt of the funds because Mr. Bell had unfettered control over the funds. Furthermore, respondent argues that Foxworthy should be disregarded as Mr. Bell's alter ego because it did not have a legitimate business purpose and was used as a way for Mr. Bell to claim deductions for his personal expenses and later to operate the tax deed business. Additionally, respondent argues that the Bells fraudulently understated their income by overstating deductions.
1. Economic Substance of the OEL Transactions
Mr. Bell argues that the OEL transactions in which he engaged beginning in 1996 were pursuant to a valid nonqualified “deferred compensation plan” and not done solely to avoid income tax. Respondent argues that the OEL transactions lack economic substance and therefore should be disregarded and that the payments from BCM to NESL, and later to ILS, for Mr. Bell's services constituted wages to Mr. Bell at the time BCM made the payments. We agree with respondent.
Income is taxed to the person who earns it and enjoys the benefit of it when paid. See Helvering v. Horst [ 40-2 USTC ¶9787], 311 U.S. 112, 119 (1940); Corliss v. Bowers [ 2 USTC ¶525], 281 U.S. 376, 378 (1930); cf. Commissioner v. P.G. Lake, Inc. [ 58-1 USTC ¶9428], 356 U.S. 260, 267 (1958); Old Colony Trust Co. v. Commissioner [ 1 USTC ¶408], 279 U.S. 716, 729 (1929). Moreover, the taxpayer who earns income may not avoid taxation through anticipatory arrangements no matter how clever or subtle. Lucas v. Earl [ 2 USTC ¶496], 281 U.S. 111, 115 (1930).
The economic substance of a transaction, rather than its form, controls for Federal income tax purposes. Gregory v. Helvering [ 35-1 USTC ¶9043], 293 U.S. 465 (1935). We conclude that the OEL transactions lacked economic substance and, despite petitioners' contentions, were not made pursuant to a valid nonqualified deferred compensation plan.
Mr. Bell argues that throughout the course of the OEL transactions from 1996 through 2001 he properly deferred over $7 million of income. Moreover, Mr. Bell argues that the benefits were subject to a substantial risk of forfeiture. Mr. Bell argues that the money was sent offshore, ultimately to RHB Corp., where he did not have control over the money; instead he only recommended investments to Elfin. Furthermore, Mr. Bell argues that the OEL transactions have economic substance because the payees of the money, NESL and ISL, were legitimate businesses that leased Mr. Bell's services to BCM. According to Mr. Bell, the OEL transactions offered him greater retirement savings over his previous Salary Reduction Simplified Employee Pension Plan (SARSEP) and to disallow the OEL plan respondent would be condemning retirement planning.
The December 1996 BCM transfer of $800,000 to NESL, was BCM's first transfer to NESL and the only such transfer made in 1996. Mr. Bell reported only $75,000 of income for that year, even though the alleged arrangement among Montrain, NESL, and BCM did not purport to take effect until December 1, 1996. From 1996 through 2000 Mr. Bell continued to report only $75,000 of wages annually. For 2001 Mr. Bell reported $37,500 in wages; the OEL transactions were terminated that year. Mr. Bell alleges that he became an employee of Montrain, an Irish corporation, that Montrain leased his services to NESL, and that NESL, in turn, leased his services to BCM. During the years in issue Mr. Bell continued to perform the same services for BCM as he had in the past. Mr. Bell did not take instructions or orders from anyone at Montrain or NESL. The documents that purport to establish Mr. Bell's employment with Montrain were not completed until November 1997, nearly a year after the purported deferred compensation plan was alleged to have taken effect and BCM's transfer of the $800,000.
Aside from a few days' delay in processing the transactions from entity to entity, Mr. Bell at all times effectively had control of and access to the funds transferred and used the funds at his discretion. The initial $800,000 transfer, less fees, was managed by Mr. Weaver in an account with Rydex Investments. The money in the Rydex Investments account was later transferred to the Rossendale/RHB Corp. Schwab account, which Mr. Bell controlled. We conclude that respondent has shown by clear and convincing evidence that, from the beginning, the money BCM transferred as part of the OEL transactions was set aside for Mr. Bell's use and was not part of any valid deferred compensation plan. Indeed, at one point, Mr. Bell complained to Mr. Reiserer of the interest he was losing as a result of the delay, and Mr. Reiserer reminded him of the immense tax savings. Mr. Reiserer's response did not satisfy Mr. Bell, and he continued to complain.
Mr. Bell argues that the OEL transactions offered him a deferred compensation plan that was payable to him at age 75. Furthermore, Mr. Bell argues that the Montrain, and later Pixley and Fitzwilliam, plans were discretionary and subject to the exclusive discretion of those entities as his employer. Mr. Bell's argument is not persuasive. Mr. Bell, by using the Rydex Investments account and later the Schwab accounts of the Nevis corporations, effectively had access to the funds a few days after BCM transferred the money.
The money transferred in the OEL transactions was ultimately used in various ways. The Bells' Northside residence, selected by the Bells, was purchased in the name of Foxworthy using funds from Helston's and Ballyclare's Schwab accounts. Mr. Bell, in collaboration with Mr. Reiserer, set up three Nevis corporations along with corresponding brokerage accounts at Schwab. The three Schwab accounts were set up at the Cobb County, Georgia, branch, the closest bank branch to BCM's office. Additionally, Mr. Bell used the signature stamp of Mr. Zarrett without his permission in order to obtain power of attorney over the funds. During the course of the OEL transactions, Mr. Bell primarily used RHB Corp. as the repository for the money transferred from BCM.
Mr. Bell, in collaboration with Mr. Reiserer, set up the purchase of Northside using the appearance of loans from Ballyclare and Helston to Foxworthy of $1,080,000 and $1,222,060, respectively. Foxworthy purchased Northside from Sam Foreman in October 1997, using a $2,110,000 wire transfer from a Schwab account in Foxworthy's name. The money in the Schwab account, however, came from Ballyclare and Helston. The money from Ballyclare and Helston came from the Schwab account in Mr. Reiserer's name. The source of the funds in the Reiserer account came from liquidating stock received pursuant to journal entry transfers from four other Schwab accounts in the names of R&P Partnership, Ron H. Bell TTEE; Hoyt Bell Revocable Trust, Ron H. Bell TTEE; Roberta L. Bell Revocable Trust; and Kelli Bell.
Before purchasing Northside, Foxworthy had no assets. Foxworthy's address in Reno was a mail forwarding service that forwarded mail to BCM in Atlanta. Mr. and Mrs. Bell discovered Northside and visited the property before Mr. Bell instructed Foxworthy to purchase it. Although Foxworthy was the entity that, in name, purchased Northside, the homeowners insurance policy listed Mrs. Bell's maiden name, Patricia Small, for the insured. Foxworthy was listed only as an additional insured. After Northside was purchased, Mr. and Mrs. Bell moved in.
From the time Mr. Bell established the RHB Corp. Schwab account, he used the account as the main repository of the money transferred as part of the OEL transactions. Mr. Bell authorized Mr. Weaver to act under a power of attorney in order to cover up a direct link between the RHB Corp. Schwab account and himself. However, Mr. Bell maintained access to the account. Mr. Bell used the RHB Corp. account several times to fund the tax deed business that he began in 1999. After a few days offshore, the money transferred as part of the OEL transactions reverted to Mr. Bell's control.
Additionally, Mr. Bell's control and use of the funds transferred offshore is shown by his $550,000 loan to the church he attended, the Unity Church. The funds came from the RHB Corp. Schwab account.
2. Constructive Receipt of Funds Used in OEL Transactions
Mr. Bell argues that the OEL transactions were part of a deferred compensation plan. Mr. Bell's argument fails because, in addition to the reasons already cited, the alleged plan violates the doctrine of constructive receipt. Section 1.451-2, Income Tax Regs., provides in pertinent part:
(a) General rule.—Income although not actually reduced to a taxpayer's possession is constructively received by him in the taxable year during which it is credited to his account, set apart for him, or otherwise made available so that he may draw upon it at any time, or so that he could have drawn upon it during the taxable year if notice of intention to withdraw had been given. However, income is not constructively received if the taxpayer's control of its receipt is subject to substantial limitations or restrictions. * * *
The constructive receipt doctrine requires a taxpayer who is on the cash method of accounting to recognize income when the taxpayer has an unqualified, vested right to receive immediate payment of income. See Palmer v. Commissioner [ Dec. 53,968(M)], T.C. Memo. 2000-228. Under the constructive receipt doctrine, a taxpayer may not deliberately turn his back on income otherwise available. See Martin v. Commissioner [ Dec. 47,414], 96 T.C. 814, 823 (1991).
A few days after BCM transferred money to NESL, and later to ISL, the money was wired offshore. After a brief delay in processing the transactions, Mr. Bell requested that the money be placed in the various Schwab accounts. All of the Schwab accounts were controlled by Mr. Bell directly, or through Mr. Weaver, who held a power of attorney on the RHB Corp. Schwab account. Additionally, Mr. Bell had access to the money in the accounts as demonstrated by loans to his church and to Foxworthy for the tax deed business. The agreement that Mr. Bell claims to have entered into with Montrain, and later Pixley and Fitzwilliam, to defer his compensation until age 75 is ineffective to prevent constructive receipt of the money because Mr. Bell had access to and control over the money shortly after BCM transferred it. Consequently, we conclude that the record clearly shows that all of the money BCM transferred as part of the OEL transactions was constructively received by Mr. Bell in the years it was transferred, and it is therefore includable in Mr. Bell's income for those years.
3. Disregard of Foxworthy as Mr. Bell's Alter Ego
Respondent argues that the Court should disregard Foxworthy and treat it as Mr. Bell's alter ego. In Moline Props., Inc. v. Commissioner [ 43-1 USTC ¶9464], 319 U.S. 436, 438-439 (1943), the Supreme Court stated:
The doctrine of corporate entity fills a useful purpose in business life. Whether the purpose be to gain an advantage under the law of the state of incorporation or to avoid or to comply with the demands of creditors or to serve the creator's personal or undisclosed convenience, so long as that purpose is the equivalent of business activity or is followed by the carrying on of business * * *, the corporation remains a separate taxable entity. * * * [Fn. refs. omitted.]
Despite the general rule, however, the corporate form will be disregarded when it is determined that the corporation is a sham. Id. at 439.
Mr. Reiserer formed Foxworthy as a Nevada corporation on August 12, 1996, but until it purchased Northside during 1997 it had no assets, no liabilities, and no employees and had not issued any stock. When the Bells decided to purchase Northside, Mr. Reiserer suggested to Mr. Bell that he use Foxworthy to hold title to Northside. The mailing address used for Foxworthy was a mail forwarding service in Reno that Mr. Bell contends he previously had set up because of identity theft issues.
At the time of Foxworthy's formation, Mr. Reiserer was its president, and Ms. Agee, Mr. Reiserer's law firm associate, was its secretary and treasurer. Because Foxworthy's main asset as of the end of 1997, Northside, was in Atlanta, it needed, for convenience, a local individual to sign documents. Mr. Bell suggested Mr. Comsudes, his employee at BCM. Mr. Comsudes never met Mr. Reiserer and was unaware of the identity of Foxworthy's shareholders. Mr. Bell simply instructed Mr. Comsudes to sign the documents. While he was president of Foxworthy, Mr. Comsudes had no day-to-day duties and followed Mr. Bell's instructions.
Although it was not originally formed for Mr. Bell, once Mr. Bell decided to use Foxworthy to purchase Northside, the record clearly shows that Foxworthy's separateness as a corporation became a sham that was executed by Mr. Bell as eyewash for his scheme to fraudulently underpay his taxes. By interjecting Foxworthy between himself and Northside, Mr. Bell implemented a scheme to deduct his personal living expenses.
When the corporate form did not suit Mr. Bell, he simply ignored it, as illustrated by the holding of the homeowners insurance covering Northside in his wife's maiden name because the rate was less than if it had been in Foxworthy's name. Additionally, Mr. Bell purported to negotiate a fictitious lease between BCM and Foxworthy that was allegedly to be used for office space. We conclude that the lease transaction with Northside, however, was just a device for BCM to claim additional deductions, in this instance related to the Bells' personal residence. Indeed, Mr. Graham, whose name appears on the signature line of the lease on behalf of Foxworthy, testified that he did not sign it. Mr. Graham was not authorized to sign for Foxworthy. Northside had always been zoned as residential property; and since the Bells moved in shortly after purchasing it, they have lived in Northside.
Mr. Bell devised another alleged lease between BCM and “The Whitehall Inn”, which Mr. Bell testified was an assumed name for Foxworthy. We conclude that the lease agreement for the Whitehall Inn, like the one purportedly signed by Mr. Graham, was also a sham. Mr. Comsudes was unaware of the lease agreement and the existence of the Whitehall Inn. The Whitehall Inn lease agreement is purportedly signed by Mr. Graham, whose name appears on the signature line of the lease, but he did not sign it. The leases were additional instances of Mr. Bell's use of Foxworthy, and its apparent assumed name, the Whitehall Inn, to suit his needs. Ms. Sagaert prepared invoices for rent payments that purported to reflect guests staying at Northside, but no guests ever stayed at Northside. To the contrary, Mr. Bell told out-of-town guests doing business with BCM to stay at the Waverly Inn and had Ms. Sagaert prepare false invoices to cover up these facts.
During 1998 Mr. Bell became interested in the tax deed business. Mr. Bell felt that the tax deed business was lucrative and decided to use Foxworthy to invest in the business during 1999. Mr. Bell, despite not being a board member, officer, or employee of Foxworthy, made all of the significant decisions regarding the tax deed business. In order to fund the tax deed business, Mr. Bell arranged a series of alleged loans with various parties, including the three Nevis corporations. By the end of 2001, Mr. Bell had invested nearly $9 million from the OEL transactions in the tax deed business.
Mr. Bell is a skilled businessman, and he turned the tax deed business into a profitable venture. Mr. Bell proposed to alter the terms of a loan by having Foxworthy repay the loan from RHB Corp. by October 2000, only to re-borrow the money at a higher interest rate so that Foxworthy could reduce its income. The October 2000 refinancing transaction further demonstrates the control that Mr. Bell exerted over Foxworthy, despite having no formal role with the corporation. On May 27, 1999, Mr. Bell opened a brokerage account at SunTrust Equitable under Foxworthy's name. In addition to Mr. Bell, Mr. Reiserer and Mr. Comsudes had signature authority over the account. Mr. Kallis, the account representative at SunTrust Equitable, took direction only from Mr. Bell, who identified himself to Mr. Kallis as a consultant.
During 2000 Mr. Bell replaced Mr. Comsudes as president of Foxworthy with Mr. Wilson. Before working for BCM, Mr. Wilson's experience was in special events planning. At BCM Mr. Wilson earned a salary of $30,000 overseeing computer systems and special projects. As president of Foxworthy, Mr. Wilson deferred to Mr. Bell and Mr. Reiserer, although he did consult with Mr. Bell. Mr. Wilson never had contact with Foxworthy's alleged owner, Ruritania.
During March 2000 Mr. Bell indicated to Mr. Reiserer that a bank was willing to extend a $10 million line of credit for Foxworthy to purchase tax deeds. Mr. Bell told Mr. Reiserer that although the bank would finance 75 percent of the money, Mr. Bell himself would have to finance the remaining 25 percent. Foxworthy's tax deed business, despite its success, was Mr. Bell's alter ego, as he made all the crucial decisions, appointed and replaced its officers, funded the business primarily through his OEL transactions money, and acted as its representative with banks.
The record clearly and convincingly demonstrates, and we so conclude, that Foxworthy was Mr. Bell's alter ego in all respects, used to avoid taxation and not for any legitimate business reasons, and is further evidence of Mr. Bell's fraudulent understatement of income. We therefore conclude that Foxworthy, as Mr. Bell's alter ego, should be disregarded. As a result of the disregard of Foxworthy, its gross income of $7,400,759.91, $9,627,935, and $2,421,527 for 1999 through 2001, respectively, is gross income to Mr. Bell. Additionally, Foxworthy's claimed deductions 19 in relation to Northside and the tax deed business, if not otherwise disallowed, are allowable as deductions to Mr. and Mrs. Bell. 20
4. Overstatement of Deductions
It is well settled that a fraudulent understatement of income can result from an overstatement of deductions. Drobny v. Commissioner [ Dec. 43,140], 86 T.C. 1326, 1349 (1986).
BCM claimed deductions for a significant number of expenses that Mr. Bell contends are ordinary and necessary business expenses, including rent to Foxworthy. Mr. Bell, as the sole owner of BCM, reported BCM's gross income on his income tax returns as part of Schedule E. The record clearly establishes that the deductions for the payments to Foxworthy for rent are overstated and evidence of fraudulent underpayment of taxes because the payments in fact disguised personal expenses of the Bells. The rent was allegedly for Northside, Mr. and Mrs. Bell's personal residence. Petitioners contend that BCM needed more office space because it had outgrown its then-current office. However, during 1996 BCM moved to new office space. The record clearly shows that BCM did not need to rent office space from Foxworthy and that the rent payments to Foxworthy were merely a device to disguise personal expenses.
The record also clearly shows that other claimed deductions of BCM were overstated. Accordingly, we conclude that, in addition to the rent expenses claimed as deductions, the other claimed deductions for expenses of BCM were improper and were disguised personal expenses for the purpose of overstating deductions and fraudulently underpaying taxes.
During the years in issue, Mr. Bell should have reported but did not report as income any of the money transferred as part of the OEL transactions. Moreover, Mr. Bell overstated his deductions. Consequently, we hold that the record clearly and convincingly establishes that Mr. Bell underpaid his income tax for each of the years in issue.
B. Fraudulent Intent
The Commissioner must prove that a portion of the underpayment for each taxable year at issue was due to fraud. Sec. 7454(a); see also Profl. Servs. v. Commissioner [ Dec. 39,516], 79 T.C. 888, 930 (1982). The existence of fraud is a question of fact to be resolved from the entire record. See Gajewski v. Commissioner [ Dec. 34,088], 67 T.C. 181, 199 (1976), affd. without published opinion 578 F.2d 1383 (8th Cir. 1978). Because direct proof of a taxpayer's intent is rarely available, fraud may be proven by circumstantial evidence, and reasonable inferences may be drawn from the relevant facts. See Spies v. United States [ 43-1 USTC ¶9243], 317 U.S. 492, 499 (1943); Stephenson v. Commissioner [ Dec. 39,562], 79 T.C. 995, 1006 (1982), affd. [ 84-2 USTC ¶9964], 748 F.2d 331 (6th Cir. 1984). A taxpayer's entire course of conduct can be indicative of fraud. See Stone v. Commissioner [ Dec. 30,767], 56 T.C. 213, 223-224 (1971); Otsuki v. Commissioner [ Dec. 29,807], 53 T.C. 96, 105-106 (1969). The following badges of fraud have been used to prove fraud: (1) Understating income, (2) maintaining inadequate records, (3) implausible or inconsistent explanations of behavior, (4) concealment of income or assets, (5) failing to cooperate with tax authorities, (6) engaging in illegal activities, (7) an intent to mislead which may be inferred from a pattern of conduct, (8) lack of credibility of the taxpayer's testimony, (9) filing false documents, (10) failing to file tax returns, and (11) dealing in cash. Bradford v. Commissioner [ 86-2 USTC ¶9602], 796 F.2d 303, 307 (9th Cir. 1986), affg. [ Dec. 41,615(M)], T.C. Memo. 1984-601. No single factor is necessarily sufficient to establish fraud. A combination of factors may constitute persuasive evidence of fraud.
1. Understating Income
As we have found above, Mr. Bell clearly understated his taxable income in each of the taxable years in issue. Mr. Bell should have reported but did not report as wages the money BCM transferred as part of the OEL transactions for 6 consecutive years. Additionally, both Mr. Bell's alter ego Foxworthy and BCM claimed improper deductions for Mr. Bell's disguised living expenses, including maintenance of his personal residence. The disallowed deductions and omitted gross income establish an understatement of Mr. Bell's taxable income for 6 consecutive years, a badge of fraud. See Hicks Co. v. Commissioner [ Dec. 30,920], 56 T.C. 982, 1019 (1971), affd. [ 73-1 USTC ¶9109], 470 F.2d 87 (1st Cir. 1972).
2. Implausible or Inconsistent Explanations of Behavior
Mr. Bell was very successful in business and had developed BCM into a firm managing 1,100 portfolios worth $280 million in aggregate market value by the end of 1995. From 1991 through 1995 Mr. Bell earned an average of $730,455 in annual wages from BCM. Pursuant to the OEL transactions, Mr. Bell claimed that he earned only $75,000 each year, excluding 2001. According to Mr. Bell, the money BCM transferred as part of the transactions, a sum in excess of $7 million, was nonqualified deferred compensation, subject to the control of Mr. Bell's alleged new employer, Montrain, and to a substantial risk of forfeiture until he reached the age of 75. Mr. Bell's argument is flatly contradicted by the record—as we found above, he exerted control over the money at every turn.
3. Concealment of Income or Assets
From the moment Mr. Bell entered into the OEL transactions, we conclude that his goal was to find a way to conceal the money being transferred. The web of organizations and third parties Mr. Bell and Mr. Reiserer conspired to devise clearly was an elaborate scheme designed solely for the purpose of avoiding taxation. In addition to forming corporations allegedly located in Nevis, Mr. Bell used his alter ego Foxworthy to repatriate the money allegedly transferred to those entities. Foxworthy, allegedly owned by Ruritania, a foreign entity, was used to purchase Northside, the property in which Mr. and Mrs. Bell lived in Atlanta, a scheme clearly designed to give Foxworthy an avenue to deduct personal living expenses of the Bells. When Foxworthy purchased Northside, the Bells used Mrs. Bell's maiden name on the homeowners insurance in order to obtain a lower rate and to conceal their true ownership of Northside. Additionally, Mr. Bell insured his Rolls Royce under his name but claimed it was a Foxworthy asset. Once Mr. Bell became involved in the tax deed business and it became successful, he renegotiated alleged loans between organizations he controlled in order to lessen Foxworthy's tax burden.
Mr. Bell was aware that his involvement in many of the transactions in issue would appear “troublesome”, so he frequently used third parties both with and without their permission in his attempt to conceal a link between himself and the funds and assets. Mr. Comsudes, Mr. Bell's employee at BCM, became the president of Foxworthy because Mr. Bell needed an individual in Atlanta to use as a figurehead on paper while Mr. Bell maintained control. Mr. Comsudes signed whatever documents Mr. Bell put in front of him. Later, Mr. Bell replaced Mr. Comsudes with Mr. Wilson. Mr. Wilson admittedly had more involvement with the activities of Foxworthy than did Mr. Comsudes, but Mr. Bell still maintained control. Mr. Bell asked Mr. Graham to stay on at Northside and help maintain the home after Foxworthy purchased it. Mr. Bell used Mr. Graham's name without his knowledge as a signatory on lease documents. Mr. Graham did not sign any lease and was not authorized to do so, yet his name appears as Foxworthy's representative on two alleged leases. Additionally, Mr. Graham's name appears without his permission on Foxworthy's request for an extension to file its 1997 income tax return. Furthermore, Mr. Bell used Mr. Zarrett's signature stamp without his permission. The record clearly establishes that by the use of third party names Mr. Bell attempted to conceal the true nature of the Northside purchase and subsequent lease agreements.
4. An Intent To Mislead
Mr. Bell's behavior, described above, in relation to the concealment of income and assets, also indicates an intent to mislead. Additionally, when the IRS began investigating Mr. Bell, he insisted on having the investigation take place in Daytona Beach, Florida, rather than Atlanta. The Bells used a Florida address on their income tax return. When the IRS agent attempted to reach Mr. Bell in Florida, she discovered that the address used on the return was a mailbox address. Additionally, Mr. Bell owns residential property in Florida. When the IRS agent visited the property, the person who answered the door did not know anyone by the name of Ron H. Bell. Despite his presence in Atlanta, Mr. Bell insisted that the investigation be located in Florida. We conclude that by means of such actions Mr. Bell attempted to mislead the IRS.
5. Filing False Documents
As previously mentioned, on March 13, 1998, Foxworthy filed a Form 7004 for taxable year 1997. The Form 7004 contains Mr. Graham's signature on the signature line; however, Mr. Graham did not sign it.
In sum, we conclude that, on the basis of the extensive record, respondent has proved by clear and convincing evidence that Mr. Bell fraudulently underpaid his Federal income taxes for the years in issue. As to Foxworthy, respondent concedes the determinations made with respect to Foxworthy in the event that we decide that Foxworthy was Mr. Bell's alter ego. As we have decided above that Foxworthy was Mr. Bell's alter ego, we need not consider the determinations made in the notice of deficiency sent to Foxworthy. On the basis of respondent's concession, we hold that Foxworthy is not liable for those determinations.
As to the fraud penalty determined against Mrs. Bell, we conclude that respondent has failed to clearly and convincingly establish any fraudulent intent by Mrs. Bell. See Katz v. Commissioner [ Dec. 44,832], 90 T.C. 1130, 1144 (1988) (a finding of fraud based upon circumstance that creates only suspicion will not be sustained). Consequently, we hold that Mrs. Bell is not liable for the fraud penalty. 21
II. Period of Limitations
The Bells argue that respondent cannot assess the tax deficiencies respondent determined against them for taxable years 1996 through 1998 because the statutory periods of limitations have expired.
In the case of a false or fraudulent return with the intent to evade tax, the tax may be assessed at any time. See sec. 6501(c)(1). A fraudulent return deprives the taxpayer, and the taxpayers' spouse in the case of a joint return, of the protection of the bar of the statutory period of limitations for that year. See Badaracco v. Commissioner [ 84-1 USTC ¶9150], 464 U.S. 386, 396 (1984); Lowy v. Commissioner, 288 F.2d at 520; Vannaman v. Commissioner, 54 T.C. at 1018; see also Colestock v. Commissioner, 102 T.C. at 385.
We have decided above that Mr. Bell filed fraudulent income tax returns for all of the taxable years in issue. Consequently, the period of limitations on assessment for each taxable year in issue remains open as to the Bells.
III. The Deficiencies Determined Against the Bells
Deductions are a matter of legislative grace, and taxpayers generally bear the burden of showing that they are entitled to any deductions claimed on their returns. Rule 142(a); New Colonial Ice Co. v. Helvering [ 4 USTC ¶1292], 292 U.S. 435, 440 (1934).
A taxpayer is required to maintain records that are sufficient to enable the Commissioner to determine the correct tax liability. See sec. 6001; sec. 1.6001-1(a), Income Tax Regs. In addition, the taxpayer bears the burden of substantiating the amount and purpose of the item for the claimed deduction. See Hradesky v. Commissioner [ Dec. 33,461], 65 T.C. 87, 90 (1975), affd. per curiam [ 76-2 USTC ¶9703], 540 F.2d 821 (5th Cir. 1976).
A. Burden of Proof
The Bells argue that respondent bears the burden of proof under section 7491(a)(1) with respect to the deficiencies in issue. In pertinent part, Rule 142(a)(1) provides, as a general rule: “The burden of proof shall be upon the petitioner”. In certain circumstances, however, if the taxpayer introduces credible evidence with respect to any factual issue relevant to ascertaining the proper tax liability, section 7491 places the burden of proof on the Commissioner. See sec. 7491(a)(1); Rule 142(a)(2). Credible evidence is evidence that, after critical analysis, a court would find constituted a sufficient basis for a decision on the issue in favor of the taxpayer if no contrary evidence were submitted. Baker v. Commissioner [ Dec. 55,548], 122 T.C. 143, 168 (2004); Bernardo v. Commissioner [ Dec. 55,736(M)], T.C. Memo. 2004-199, n.6.
The Bells' contention that respondent has the burden of proof lacks merit because, for the reasons discussed throughout the instant opinion, aside from certain of the claimed charitable contribution deductions discussed below, 22 the Bells have not introduced credible evidence with respect to the deficiencies in issue. Consequently, the burden of proof remains on the Bells, a burden that, because of the absence of credible evidence, they cannot sustain. See Bernardo v. Commissioner, supra n.7; see also Rendall v. Commissioner [ 2008-2 USTC ¶50,480], 535 F.3d 1221, 1225 (10th Cir. 2008) (citing Bernardo v. Commissioner, supra), affg. T.C. Memo. 2006-174.
Additionally, section 7491(a) requires that the taxpayer cooperate with reasonable requests by the Commissioner for “witnesses, information, documents, meetings, and interviews”. Sec. 7491(a)(2)(B). Aside from the disallowed charitable contribution deductions, the Bells failed to comply with the substantiation and record-keeping requirements necessary to shift the burden of proof to respondent. Consequently, for the foregoing additional reasons, we hold that the Bells bear the burden of proof as to the deficiencies in issue.
B. OEL Transactions, Foxworthy Deductions, and BCM Deductions
As discussed above with respect to respondent's fraud determinations, respondent determined a series of adjustments to the Bells' income taxes. Most of the Bells' contentions regarding respondent's deficiency determinations are addressed above in our discussion of the fraud penalties and do not bear repeating here, except that we conclude on the record that the Bells have failed, except for the charitable contribution deductions discussed below, to prove that respondent's deficiency determinations are incorrect. Accordingly, we uphold respondent's determinations with respect to the unreported income from the OEL transactions, Foxworthy's overstated deductions with respect to Northside, the Bells' unreported income with respect to Foxworthy's gross income, and the disallowed BCM flowthrough deductions.
We found above that Foxworthy is Mr. Bell's alter ego. Most of Foxworthy's deductions, except the real estate ad valorem taxes paid with respect to Northside, are otherwise personal to the Bells and therefore are not deductible by the Bells. As to those real estate ad valorem taxes, we hold that they are properly allowable deductions by the Bells pursuant to section 164(a)(1). As to the interest deductions Foxworthy claimed for payments on the alleged loans by Helston and Ballyclare, however, those deductions are not proper because we conclude, on the basis of the record, that the loans are a sham. The remaining disputed deductions are addressed below.
C. BCM's Bad Debt Deductions Flowing Through to the Bells
Respondent determined that the Bells are not entitled to their claimed deductions with respect to two alleged Steinberg loans. The Bells claimed a capital loss of $103,286 for taxable year 2000. The loss consists of $91,350 of unsecured notes and $11,936 in legal fees associated with collecting the alleged debts. Respondent contends that the Bells have failed to establish that the debts existed, that the R&P Partnership had bases in the alleged debts, that the alleged debts are of the type that qualifies for a deduction, that the alleged debts were paid, or that the alleged debts, if they were in fact debts, went bad during a year in issue.
Section 166(d)(1)(B) provides that, where any nonbusiness debt becomes worthless within the taxable year, the loss resulting therefrom shall be considered a loss from the sale or exchange, during the taxable year, of a capital asset held for not more than 1 year. Whether a debt is worthless is a factual question on which the taxpayer bears the burden of proof. Estate of Mann v. United States [ 84-1 USTC ¶9454], 731 F.2d 267, 275 (5th Cir. 1984).
The Bells have failed to meet their burden of proof because they have not demonstrated that the alleged Steinberg loans were valid debts and that those alleged debts became worthless. The promissory notes that the Bells submitted as evidence are not dated and are signed only by the alleged debtor Steinberg, with no witness or any notary seal. Furthermore, the Bells allege that in addition to R&P Partnership there were eight creditors of Steinberg. However, there is no evidence to verify this allegation. We conclude that Mr. Bell's testimony lacks credibility and is insufficient to establish the debt and its worthlessness without further corroboration. The Court need not accept at face value a witness's testimony that is self-interested or otherwise questionable. See Archer v. Commissioner [ 55-2 USTC ¶9783], 227 F.2d 270, 273 (5th Cir. 1955), affg. a Memorandum Opinion of this Court dated Feb. 18, 1954; Weiss v. Commissioner [ 55-1 USTC ¶9365], 221 F.2d 152, 156 (8th Cir. 1955), affg. [ Dec. 20,363(M)], T.C. Memo. 1954-51; Schroeder v. Commissioner [ Dec. 43,384(M)], T.C. Memo. 1986-467. We conclude that the Bells have failed to carry their burden to prove the bad debts were bona fide debts and became worthless during a year in issue. We therefore uphold respondent's determinations disallowing the $103,286 in capital losses with respect to the alleged loans.
D. Investment Account Income
The Schwab accounts of Helston, Ballyclare and Rossendale/RHB Corp. earned investment income which the Bells failed to report. The money in those accounts came from the OEL transactions, which we have held to be income to Mr. Bell. Mr. Bell formed the three corporations in Nevis and set up Schwab accounts in Georgia, in the branch closest to BCM's office. All three entities lacked a legitimate business interest. Rossendale/RHB Corp. was the primary recipient of the funds from the OEL transactions. The funds were then used to finance the tax deed business. Helston and Ballyclare were used to lend money for Foxworthy to purchase Northside. Mr. Bell formed the three foreign entities because they were not subject to taxation in the United States, and Mr. Bell used them as a mechanism to repatriate the OEL funds. Section 61 provides that gross income means all income from whatever source derived, including interest and dividends. All of the income in the three accounts, aside from the principal amounts deposited, consists of interest or dividends. Additionally, we note that Mr. Bell stressed to Mr. Reiserer that the speed at which the offshore money was repatriated was unacceptable because he was losing interest. Accordingly, we hold that the Bells have failed to prove that they are not liable for $8,445.10 in interest income from Helston's Schwab account in 1997, $7,469.19 in interest income from Ballyclare's Schwab account in 1997, and $37,031, $168,287.61, $126,963.85, $96,235.40, and $141,916.42 in 1997 through 2001, respectively, from Rossendale/RHB Corp.'s Schwab account. As found above, for 1999, $18,166.50 of the income in the Rossendale/RHB Corp. account was dividend income.
E. Capital Gains on Liquidation of Stock
Respondent argues that the Bells must recognize $329,363.38 as gain on the sale of stock because the shares in the R&P Partnership were owned by Mr. Bell. Mr. Bell authorized the shares in the R&P Partnership to be transferred to the Schwab account in Mr. Reiserer's name. Once in the Reiserer account, the shares were liquidated for $2,225,181.96, with Mr. Bell authorizing the proceeds to be transferred to Rossendale's Schwab account. The Bells argue that the liquidated shares from the Reiserer account were not Mr. Bell's and that he was merely a trustee of his father's and mother's trust accounts. The Bells further argue that respondent has not provided an explanation for the calculation of the gain. Mr. Bell testified that R&P Partnership was another name for himself and his wife. The shares that came from the R&P Partnership and were transferred, first to the Reiserer account and later as liquidation proceeds to the Rossendale account, were owned by the Bells. The shares in the Hoyt Bell account, Roberta Bell account, and Kelli Bell account were eventually transferred to Helston and Ballyclare and used to purchase Northside. The shares in those accounts were not transferred to Rossendale as part of an alleged private annuity transaction. We conclude that the Bells have failed to establish that such a private annuity transaction in fact existed.
As to the Bells' argument regarding respondent's failure to explain the calculation of the gain, it is the Bells who bear the burden of proving that respondent's deficiency determinations are incorrect. On the issue of the capital gains on the liquidation of stock, the Bells have not met their burden of proof. Consequently, we conclude that the Bells are liable for the capital gain on the liquidation of stock of $329,363.38 because the shares were owned by Mr. Bell and sold for a gain.
F. SEC Fine
The Bells concede that the $15,000 fine against BCM was not properly deducted in 1999 as an employee business expense. The Bells argue that the remaining $30,000 was proper because, although the fines were the personal obligation of Mr. Bell, Mr. Comsudes, and Mr. Palmer, respectively, BCM was the beneficiary of the work done by the three individuals. Pursuant to section 162(f), no deduction shall be allowed for any fine or similar penalty paid to a government for the violation of any law. BCM paid the $30,000 to satisfy the SEC fines levied for violation of the Investment Advisers Act of 1940, a Federal law, arguing that it was the beneficiary of the work done by Mr. Bell, Mr. Comsudes, and Mr. Palmer. The SEC order states that Mr. Bell, Mr. Comsudes, and Mr. Palmer aided and abetted BCM in committing violations. Therefore, we hold that BCM was not entitled to deduct $30,000 paid in fines to the SEC on behalf of Mr. Bell, Mr. Comsudes, and Mr. Palmer. 23
G. Charitable Contribution Deductions
The Bells claimed on their returns charitable contribution deductions of $161,604, $192,377, $87,572, $139,653, and $69,386, respectively for taxable years 1996, 1997, 1998, 1999, and 2000. Respondent disallowed the charitable contribution deductions in the following amounts: $155,001 for 1996, $171,103 for 1997, $77,253 for 1998, $139,653 for 1999, and $62,915 for 2000. The contributions in 1996 and 1997 included the contribution to the foundation of shares of Northeast Investments Trust valued at $300,240 for 1996 and $202,320 for 1997. Respondent disallowed the charitable contribution deductions because Mr. Bell controls the foundation and has not demonstrated the transfer of shares took place.
Section 170(a)(1) provides that a taxpayer may deduct “any charitable contribution * * * payment of which is made within the taxable year. A charitable contribution shall be allowable as a deduction only if verified under regulations prescribed by the Secretary.”
Petitioners have provided statements from R&P Partnership's Schwab account that substantiate the transfer of the shares of Northeast Investments Trust to the foundation. The statements show the shares leaving the R&P Partnership account and the foundation's statements show the shares in the account, along with the value of the shares. IRS Revenue Agent Wilcoxon testified that despite receiving substantiation from the Bells regarding the contributions to the foundation, she disallowed the deductions because Mr. Bell controlled the charity. However, respondent has not cited any authority in support of his contention that merely having control over the foundation disqualifies the Bells from claiming the charitable contribution deductions for the contribution of the shares of Northeast Investors Trust to the foundation. Although the foundation is a private foundation controlled by the Bells, control alone is not sufficient to defeat the deduction to the Bells. 24 Control in the context of private foundations generally is an issue in determining whether a private foundation is liable for excise taxes because of self-dealing. See sec. 4941. Respondent, however, does not contend that there was any self-dealing on the part of the foundation or any other violation of the restrictions or requirements of private foundations, and the record shows none. See secs. 4940-4945. Furthermore, respondent does not challenge the tax-exempt status of the foundation.
For the years 1999 and 2000, the Bells claimed total charitable contribution deductions of $650,592. However, at trial the Bells substantiated charitable contributions of only $567,886, leaving $82,706 of unsubstantiated contributions. Consequently, we hold that the Bells are entitled to a total charitable contribution deduction of $567,886.
H. BCM Deductions
Mr. Bell, as the sole owner of BCM, reported its income on his Schedule E for each of the years in issue. BCM claimed deductions on its income tax returns for various expenses. Respondent determined that BCM overstated its deductions by $1,228,088, $1,702,817, $2,678,033, $3,195,463, $1,966,457, and $651,470 for 1996, 1997, 1998, 1999, 2000, and 2001, respectively. BCM claimed deductions of $800,000, $1,220,000, $2,225,000, $2,430,000, $1,880,000, and $425,000 for the services of Mr. Bell in 1996, 1997, 1998, 1999, 2000, and 2001, respectively. The foregoing deductions are proper deductions by BCM as wages paid to Mr. Bell pursuant to section 162(a)(1). As we have previously determined above, however, that salary is taxable to Mr. Bell. Aside from the wages paid to Mr. Bell, the Bells have failed to substantiate that the deductions BCM claimed are legitimate deductions. Excepting Mr. Bell's self-serving testimony, which we do not find credible on the basis of the record, the Bells have not called witnesses or submitted documents that corroborate the claimed deductions. See Archer v. Commissioner, 227 F.2d at 273; Weiss v. Commissioner, 221 F.2d at 156; Schroeder v. Commissioner [ Dec. 43,384(M)], T.C. Memo. 1986-467. Accordingly, we hold that, except for the wages paid to Mr. Bell, BCM is not entitled to the disputed deductions disallowed in the notices of deficiency. Consequently, we sustain respondent's determinations increasing the Bells' income by those amounts.
IV. Negligence Penalty
As to the Bells, respondent concedes the accuracy-related penalty pursuant to section 6662 in the event the Court upholds the fraud penalty against Mr. Bell. As we have held above, Mr. Bell is liable for the section 6663 penalty; consequently, on the basis of respondent's concession, we hold that neither of the Bells is liable for the section 6662 penalty. Mrs. Bell is not liable for the accuracy-related penalty imposed by section 6662(a) because the underpayments are due to fraud by Mr. Bell. See sec. 6662(b); Zaban v. Commissioner [ Dec. 52,316(M)], T.C. Memo. 1997-479; Aflalo v. Commissioner [ Dec. 50,273(M)], T.C. Memo. 1994-596; Minter v. Commissioner [ Dec. 47,614(M)], T.C. Memo. 1991-448.
V. Section 6651(a)(1) Addition to Tax
Respondent determined that the Bells are liable for an addition to tax under section 6651(a)(1) for 1996. Section 6651(a)(1) imposes an addition to tax for failure to file a return by the date prescribed (determined with regard to any extension of time for filing) unless the taxpayer can establish that such failure is due to reasonable cause and not due to willful neglect. Once the Commissioner carries his burden of production, the taxpayer has the burden of proving that the addition to tax is improper. Rule 142(a); United States v. Boyle [ 85-1 USTC ¶13,602], 469 U.S. 241, 245 (1985). Section 7491(c) provides that the Commissioner will bear the burden of production with respect to the liability of any individual for additions to tax and penalties. “The Commissioner's burden of production under section 7491(c) is to produce evidence that it is appropriate to impose the relevant penalty, addition to tax, or additional amount”. Swain v. Commissioner [ Dec. 54,732], 118 T.C. 358, 363 (2002); see also Higbee v. Commissioner [ Dec. 54,356], 116 T.C. 438, 446 (2001). Respondent has met his burden of production.
Respondent received the Bells' joint income tax return for 1996 on August 27, 1997. Petitioners have not shown that they requested an extension. Furthermore, the Bells' return preparer indicated that her records did not reflect that any request by the Bells for an extension had been approved. The Bells have shown no reasonable cause as to the late filing. Consequently, we conclude that the Bells are liable for the section 6651(a)(1) addition to tax for 1996.
VI. Petitioners' Motions To Supplement the Record
Petitioners filed motions in each docket to supplement the record seeking leave to submit as evidence a letter dated July 22, 2008, from the IRS on the status of the investigation of Mr. Reiserer. Reopening the record for the submission of additional evidence lies within the discretion of the Court. Zenith Radio Corp. v. Hazeltine Research, Inc., 401 U.S. 321, 331 (1971). We will not grant a motion to reopen the record unless, among other requirements, the evidence relied on is not merely cumulative or impeaching, the evidence is material to the issues involved, and the evidence probably would change some aspect of the outcome of the case. Butler v. Commissioner [ Dec. 53,869], 114 T.C. 276, 287 (2000). Petitioners argue that it is in the interest of justice to grant their motions. However, petitioners do not articulate why it is in the interest of justice or how the evidence would change any aspect of the outcome of the instant case. We hold that reopening the record is not warranted. Therefore, petitioners' motions will be denied.
In reaching all of our holdings herein, we have considered all of the arguments made by the parties, and, to the extent not mentioned above, we conclude they are without merit, irrelevant or unnecessary to reach.
To reflect the foregoing,
An appropriate order will be issued.
Decisions will be entered for petitioner in docket Nos. 20725-03, 18969-04, and 14612-05.
Decisions will be entered under Rule 155 in docket Nos. 160-04, 601-05, 21699-05, and 24533-06.


Cases of the following petitioners have been consolidated herewith for trial, briefing and opinion: Foxworthy, Inc., docket Nos. 18969-04 and 14612-05, Ron H. Bell and Tricia S. Bell, docket Nos. 160-04, 601-05, 21699-05, and 24533-06. All are hereinafter collectively referred to as the instant case.
Tricia S. Bell is also referred to herein as Patricia D. Small (her maiden name).
Unless otherwise indicated, all section references are to the Internal Revenue Code (Code), and all Rule references are to the Tax Court Rules of Practice and Procedure.
These amounts represented payments as part of the OEL transactions described below.
Kelli Bell is the daughter of petitioners Ron H. Bell and Tricia S. Bell.
Respondent determined that the deduction for the new telephone system should have been capitalized, not deducted.
In addition to the carryover amounts claimed in 1998, 1999, and 2000, the Bells claimed charitable contributions of $10,319 in 1998, $19,719 in 1999, and $6,471 in 2000.
Mr. Bell was not able to produce a copy of a personnel services contract between BCM and ILS.
The “Foreign Deferred Compensation Program” document was written by Mr. Reiserer to Mr. Bell. The document explains the foreign deferred compensation planning program, and contains Mr. Reiserer's legal analysis of the program and how the program of OEL transactions would work for Mr. Bell.
Davis, Weaver & Mendel was an investment management firm based in Atlanta.
Thomas Weaver, a friend of Mr. Bell, was the majority owner and president of Davis, Weaver & Mendel.
RHB Corp. is a Nevis-based corporation Mr. Bell incorporated. RHB Corp.'s original name was Rossendale Investments. Nevis is an island in the Caribbean Sea.
Judy Lovell was one of Mr. Bell's contacts at the Elfin Trust, which was chosen by Mr. Bell to administer Ballyclare Holding, Inc., a Nevis corporation used by Mr. Bell as part of the OEL transactions.
Mr. Zarrett is Mr. Bell's personal friend. The two met in 1968 at Emory University. Mr. Zarrett was the trustee of the Mycroft Trust, set up for Kelli Bell. Mr. Zarrett also had limited power of attorney over Ballyclare and Helston. At the time of trial, Mr. Zarrett was a retired banker.
Sometime before this transfer, NESL changed its name to ISL.
In 1999 Pixley Services (Pixley) took the place of Montrain as Mr. Bell's alleged offshore employer. In 2001 Fitzwilliam took the place of Pixley as Mr. Bell's alleged offshore employer.
Mr. Reiserer died during July 2004.
Mr. Reiserer expected that the Reiserer Schwab account would have income from the liquidation of stock. Mr. Reiserer contacted Mr. Bell about two ways to report the income. Mr. Bell instructed Mr. Reiserer that he preferred Mr. Reiserer to report the income and to pay the tax from the residual amount in the Reiserer Schwab account.
We decide below that, as Mr. Bell's alter ego, Foxworthy is not liable for any amounts determined by respondent in the notices of deficiency in issue.
The Bells are not entitled to deductions for their living expenses including the costs of maintaining Northside, their personal residence, except for real estate taxes, allowable pursuant to sec. 164(a)(1). We discuss such income and deductions below. See infra p. 57.
We note that Mrs. Bell has not raised any defenses pursuant to sec. 6015(b), (c), or (f).

As to the disallowed charitable contribution deductions, we decide below, on the evidence in the record, that the Bells are entitled to some of the claimed deductions. Therefore, as to those deductions that we sustain on the basis of the record, we need not determine where the burden of proof lies.
Mr. Bell does not argue that the payments of the fines imposed on him, on Mr. Comsudes, and on Mr. Palmer were deductible to BCM as wages. Accordingly, we need not reach that issue.
The foundation files Forms 990-PF, Return of Private Foundation, and the Bells do not dispute the foundation's status as a private foundation.