This case involves the judicial doctring of "substance over form." Generally, the substance and not the form of a transaction
determines its tax consequences. Gregory v. Helvering, 293 U.S. 465, 469-470
[14 AFTR 1191] (1935); Lazarus v. Commissioner, 58 T.C. 854, 864 (1972), aff'd,
513 F.2d 824 [35 AFTR 2d 75-1191] (9th Cir. 1975). Where a series of
transactions, taken as a whole, shows either that the transactions are shams or
that the transactions have no “purpose, substance, or utility apart from their
anticipated tax consequences”, the transactions are not recognized for Federal
tax purposes. Goldstein v. Commissioner, 364 F.2d 734, 740 [18 AFTR 2d 5328]
(2d Cir. 1966), aff'g 44 T.C. 284 (1965); see also Commissioner v. Court
Holding Co. 324 U.S. 331 [33 AFTR 593] , (1945).
Steven W. Repetto, et ux., et al. v. Commissioner, TC Memo
2012-168 , Code Sec(s) 61; 162; 213; 408A; 482; 4973; 6011; 6651; 6662A; 7491.
STEVEN W. REPETTO AND GAYLE F. REPETTO, ET AL., 1
Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent .
Case Information:
Code Sec(s): 61;
162; 213; 408A; 482; 4973; 6011; 6651; 6662A; 7491
Docket: Docket
Nos. 17204-09, 17242-09, 17243-09.
Date Issued: 06/14/2012
HEADNOTE
Catherine S. Tyson, Steven W. LaBounty, and Peter N.
Scharaff, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
MARVEL, Judge: These cases are consolidated for purposes of
trial, briefing, and opinion. One case involves the 2004-06 Federal income
taxes and the 2004-06 excise taxes under section 4973 2 of Steven 3 W. and
Gayle F. Repetto. The second case involves the 2005-06 Federal income taxes of
Yolo, Inc. (Yolo), a C corporation in which Mrs. Repetto's Roth individual
retirement account (IRA) owned a 98% interest. The third case involves the
2005-06 Federal income taxes of WFR Investments, Inc. (WFR), a C corporation in
which Mr. Repetto's Roth IRA owned a 98% interest.
Respondent determined the following deficiencies, additions
to tax, and penalties:
Mr. and Mrs. Repetto, docket No. 17204-09
Additions to tax and penalty Sec. 6651(a)(2) 1
Year Deficiency Sec. 6651(a)(1) Sec. 6662A
2004$28,779$1,179.23to be determined $9,259.32 200583,9082,131.20to be
determined 21,855.65 200662,3393,645.68to be determined 13,879.43
Yolo, docket No. 17242-09
Penalty
Year Deficiency Sec. 6662A 2005 $8,811 $2,640.02 2006 5,347
2,691.05 WFR, docket No. 17243-09
Penalty
Year Deficiency Sec. 6662A 2005 $5,396 $3,777.06 2006 9,903
2,666.16
After concessions, 4 the issues for decision are: (1)
whether Mr. and Mrs. Repetto made excess contributions to their Roth IRAs and
are liable for excise taxes under section 4973; (2) whether SGR and WFR may
deduct facilities support expenses; 5 (3) whether respondent properly
characterized certain payments from SGR to Mr. Repetto as compensation; (4)
whether Yolo may deduct medical reimbursement expenses and officer compensation
expenses; (5) whether the Repettos are liable for the additions to tax under
section 6651(a)(1) and (2); and (6) whether petitioners are liable for enhanced
accuracy-related penalties under section 6662A.
FINDINGS OF FACT
Some of the facts have been stipulated. The stipulation of
facts is incorporated herein by this reference. The Repettos resided in
Missouri when they filed their petition. Yolo and WFR maintained their
principal places of business and principal offices in Missouri when they filed
their petitions. 6
I. The Construction Business
A. The Construction Business Before 2003 Mr. Repetto
graduated from college with a degree in business administration in 1972. From
1972 until 2002 when Mr. Repetto retired, he worked as a salesperson for IBM.
Mrs. Repetto graduated from college with a degree in engineering management in
1984 and was employed during the years at issue.
WFR's bylaws stated that its principal office was in Nevada.
However, the record establishes that WFR's principal office and principal place
of business were in Missouri.
In the early 1990s Mr. Repetto met and became friends with
Ray Porschen, Jr. Mr. Porschen was the sole shareholder of Porschen
Construction, Inc. (Porschen Construction), which constructed spec homes 7 in
the Lake of the Ozarks area in Missouri.
With his retirement nearing, Mr. Repetto sought an
additional source of income. In 1999 Mr. Repetto entered into a real estate development
business with Porschen Construction. Porschen Construction, Mr. Repetto, and
Mrs. Repetto formed Ozark Future, L.L.C. (Ozark Future), a limited liability
company classified as a partnership for Federal income tax purposes. Porschen
Construction had a 50% interest in Ozark Future, and Mr. and Mrs. Repetto each
had a 25% interest. Ozark Future was in the business of purchasing lots and
constructing spec homes.
From Ozark Future's formation until approximately 2002 the
Repettos' role in it was that of investors; their involvement allowed Ozark
Future to obtain more loans. The Repettos signed for Ozark Future's loans and
personally guaranteed them. The Repettos continued working full time, but when
Mr. Repetto was able to, he worked with Mr. Porschen to learn about home
building.
During that period (until 2002) Porschen Construction was
primarily responsible for general contracting and construction management
supervision for Ozark Future. 8 It performed most of the work involved,
including formulating plans, acquiring land, and obtaining necessary approvals.
Porschen Construction also hired subcontractors for Ozark
Future to build homes on properties Ozark Future had acquired, and it received
bids from 50-70 subcontractors. 9 Mr. Porschen's wife, Nancy Porschen, worked
out design details, selected and revised plans, and worked with the architect.
She also sold the constructed homes through her real estate company. Sometimes
Mrs. Repetto accompanied Mrs. Porschen to design centers and open houses, and
occasionally Mrs. Repetto picked out design elements for homes.
At some point before or in 2001 the Repettos' attorney, John
Curran, 10 advised them that their involvement in Ozark Future as individuals
was putting their personal assets at risk, for example, in case a subcontractor
became injured. Mr. Curran also advised them that if they could not sell a
home, the lending bank could sue them personally. On September 24, 2001, the
Repettos caused SGR to be organized. It elected S corporation status. The
Repettos owned 100% of the stock of SGR. 11 In 2002 the Repettos transferred
their interests in Ozark Future to SGR.
In July 2002 Mr. Porschen was diagnosed with cancer. Mrs.
Porschen drove him to St. Louis, Missouri, for frequent medical appointments.
Over time Mr. Porschen's physical condition worsened, and his energy and the
amount of time that he could devote to Ozark Future gradually declined. Because
Mr. Porschen could not be on jobsites as much as he used to be and because
subcontractors required a management presence on the jobsite, Mr. Repetto
became more involved in Ozark Future's business in 2002, after he retired from
IBM. Mrs. Repetto's involvement in the business also expanded.
As Mr. Porschen's illness progressed, the Repettos
considered Ozark Future's prospects. They wanted SGR to take advantage of the
real estate market in the Lake of the Ozarks area and in Florida, yet they did
not want to abandon their relationship with Ozark Future and the Porschens. As
of 2003, they understood that Mr. Porschen was planning to retire. B. The New
Structure In 2003 the Porschens introduced the Repettos to Frank Zerjav, a
certified public accountant (C.P.A.) in St. Louis, Missouri, who had been the
Porschens' accountant for several years. Mr. Zerjav told the Repettos about his
accounting firm and stated that he had a lot of experience working with clients
in the real estate business. Mr. Zerjav suggested a meeting in his office.
At the first meeting in Mr. Zerjav's office in late summer
or early fall of 2003, the Repettos met James Harrell, an attorney and C.P.A.
Mr. Harrell received his C.P.A. certificate in 1973, graduated from law school
in 1982, and has practiced general business and tax law since 1982. At that
meeting Mr. Harrell proposed a structure whereby two new corporations would be
incorporated and would be owned in part by Roth IRAs. Messrs. Harrell and
Zerjav told the Repettos that such a structure was preferable from an asset
protection standpoint because the corporate assets could not be reached in case
of a lawsuit. The Repettos were unfamiliar with such a structure and questioned
Mr. Harrell regarding its legitimacy. Mr. Harrell confirmed that as long as
rules were followed, it was permissible for a C corporation to be owned in part
by a Roth IRA.
Mr. Harrell also explained the difference between a traditional
IRA and a Roth IRA. Mr. Harrell explained that the corporations would create
profits and pay taxes, that the corporations could pay dividends to
shareholders, including the Roth IRAs, and that those amounts could be
withdrawn from the Roth IRAs upon retirement tax free. Mr. Harrell and the
Repettos understood that the relationship between SGR and Ozark Future would
remain unchanged and that the two new corporations would provide services to
SGR. Although the Repettos did not have a good understanding of the structure,
they retained Mr. Harrell to set it up.
At some point around October 28, 2003, Mr. Harrell sent the
Repettos an Engagement and Scope of Services Letter (engagement letter).
According to the engagement letter, Mr. Harrell would form two corporations,
one to provide office and support services for SGR and the other to provide
marketing and business development services for SGR. The engagement letter also
stated that "[i]t is our understanding that you will each establish a Roth
IRA with a custodian who will allow” each Roth IRA to become a 98% shareholder
of the respective corporation.
Mr. Harrell's services included introducing the Repettos to
a Roth IRA custodian and implementing the structure, including coordinating
payment of the first dividend to the Roth IRA. The engagement letter provided
for a $15,000 fee. Upon receipt of the engagement letter, Mrs. Repetto emailed
Mr. Harrell several questions, one of which read: “We do not meet the rules for
a ROTH IRA as our Adjusted Gross Income is to [sic] high. I understand that we
can pay a fine as you explained but would our IRA be fraudulent?” Mr. Harrell
replied “No”.
On November 4, 2003, Mr. Harrell incorporated Yolo, a
Missouri corporation. Mrs. Repetto became Yolo's sole director and its
president, secretary, and treasurer.
On November 7, 2003, Mr. and Mrs. Repetto opened Roth IRAs
with a $1,500 contribution to each Roth IRA at First Regional Bank, Trust
Administration Services.
On November 18, 2003, Mr. Harrell incorporated WFR, a Nevada
corporation. Mr. Repetto became WFR's sole director and its president,
secretary, vice president, and treasurer. Yolo's and WFR's business addresses
were the same as the Repettos' home address.
The Roth IRA for the benefit of Mrs. Repetto subscribed to
98% of Yolo stock, and Mrs. Porschen subscribed to the remaining 2%. 12 The
Roth IRA for the benefit of Mr. Repetto subscribed to 98% of WFR stock, and Mr.
Porschen subscribed to the remaining 2%. The stock that the Porschens
subscribed to in Yolo and WFR was nonvoting. 13
In November 2003 SGR and Yolo entered into a 10-year
agreement (SGR agreement) according to which Yolo would provide the following
services to SGR at SGR's place of business, i.e. the Repettos' home: assistance
with entering accounting information into the computer accounting application
quickbooks; assistance with computer; assistance with printing reports;
accessing internet for material research; processing email; soliciting and
receiving bid [sic] from potential subcontractors; assistance with marketing
communication; assistance with interior selections; assistance with mail
processing; basic office support such as answering telephone, returning phone
calls, and sending/receiving packages. The SGR agreement provided that Yolo
would be compensated at the rate of $4,800 per month through 2006 and at the
rate of $4,000 per month thereafter. On December 4, 2003, SGR deposited
$126,900 into Yolo's account. Starting January 2004, SGR paid Yolo as per the
SGR agreement, although on two occasions the payments covered multiple months.
See infra pp. 14-15.
Also in November 2003 WFR and Yolo entered into an agreement
(WFR agreement), according to which Yolo would perform services for WFR and
receive $2,116 per month for the services. Other than the party names and
compensation, the terms of the two services agreements were identical. WFR paid
Yolo pursuant to the WFR agreement, although sometimes payments covered
multiple months. WFR did not make a lump-sum payment to Yolo.
C. The Construction Business After 2003 Ozark Future
continued to purchase lots and construct homes that were marketed and sold to
the public. By 2004 Ozark Future's business enjoyed increased sales volume; it
had multiple homes under construction that were larger and more expensive. SGR
was involved in Ozark Future's projects as an owner of Ozark. In Mr. Porschen's
absence, Mr. Repetto spent more time on the jobsites. Mrs. Repetto's flexible
work schedule allowed her to devote more time to the construction business.
SGR purchased and sold real estate independently of Ozark
Future. In 2004 SGR made a deposit to purchase a condominium in Florida, and in
2005 it made deposits to purchase two additional condominiums in Florida. In
2006 SGR purchased property in Panama, purchased two condominiums in the Lake
of the Ozarks area, and sold one of the two condominiums. SGR reported gross
receipts (of $176,024) from activities unrelated to Ozark Future for the first
time on its 2006 return.
Mr. Repetto reported no salary from SGR for 2004-05 and
$24,000 for 2006. Mrs. Repetto did not receive a salary from SGR in 2004-06.
Other than Mr. Repetto in 2006, SGR had no employees.
Mr. Repetto received no compensation from Yolo or WFR during
2004-06. Yolo treated Mrs. Repetto as its only employee and paid her $9,600,
$9,600, and $12,000 in 2004, 2005, and 2006, respectively. Yolo issued Mrs.
Repetto Forms W-2, Wage and Tax Statement, withheld taxes from her paycheck,
and made employment tax deposits with the Department of Treasury.
D. Dividends
During the years at issue SGR made payments to WFR of $7,000
per month for “outside staffing & support”. 14 The payments were irregular
and sometimes covered multiple months. WFR then declared dividends payable to
shareholders pro rata and paid dividends to Mr. Repetto's Roth IRA as follows:
Amount Amount paid to
Mr. Repetto's Roth IRA 1
Date Declared
5/04/04 $50,000 $49,000
3/10/05 20,000 19,600
4/10/06 50,000 49,000
Total 120,000 117,600
<1>
The
parties stipulated incorrect amounts of dividends that WFR
paid to the
Roth IRA. The Roth
IRA's statement of transactions, WFR's corporate documents,
and the general
ledger show that the amounts shown in the stipulation were
the total
dividends WFR
declared pro rata. We disregard these stipulations as
inconsistent
with the record. See
Cal-Maine Foods, Inc. v. Commissioner, 93 T.C. 181, 195
(1989).
SGR and WFR paid Yolo pursuant to the agreements, in
addition to SGR's lump-sum payment of $126,900. See supra pp. 11-12. Yolo then
declared dividends payable to each shareholder pro rata and paid dividends to
Mrs. Repetto's Roth IRA as follows:
Amount Amount paid to
Mrs. Repetto's Roth IRA
1
Date Declared
5/24/04 $50,000 $49,000
3/9/05 80,000 78,400
Total 130,000 127,400
<1>
The
parties stipulated incorrect amounts of dividends that Yolo
paid to the
Roth IRA. The Roth
IRA's statement of transactions, Yolo corporate documents,
and the general
ledger show that the amounts shown in the stipulation were
total
dividends Yolo
declared pro rata. We disregard these stipulations as
inconsistent
with the record. See
id.
Mr. Zerjav made the
decisions regarding whether WFR and Yolo would issue
dividends to their
shareholders.
II. Yolo's Medical Plan
On January 2, 2004, Mrs. Repetto in her capacity as
president of Yolo established a medical and dental care expense reimbursement
plan (Yolo medical plan) effective January 1, 2004. According to the Yolo
medical plan, Yolo would reimburse medical expenses of eligible employees,
their spouses, and dependents. Yolo executives had no limitations on the
amounts of expenses that could be reimbursed. On the basis of the Yolo medical
plan, Yolo reimbursed the Repettos for their healthcare expenses totaling
$8,948, $13,622, and $12,865 in 2004, 2005, and 2006, respectively.
III. Notice 2004-8, 2004-1 C.B. 333
On December 31, 2003, before petitioners filed their 2003
returns, the Internal Revenue Service (IRS) issued Notice 2004-8, 2004-1 C.B.
333, titled Abusive Roth IRA Transactions. In Notice 2004-8, supra, the IRS
addressed taxpayers' attempts to avoid limitations on contributions to Roth
IRAs. The notice states that the transactions generally involve (1) an
individual who owns a preexisting business, (2) a Roth IRA maintained for that
individual, and (3) a corporation substantially all the shares of which are
owned or acquired by the Roth IRA (Roth IRA corporation). The notice describes
a typical fact pattern to include acquisitions of property from the preexisting
business for less than a fair market value and any other arrangement between
the Roth IRA corporation and the individual or his business “that has the
effect of transferring value to the Roth IRA Corporation comparable to a
contribution to the Roth IRA.” Id., 2004-1 C.B. at 333.
The notice also provides that the IRS would challenge the
purported tax benefits resulting from such transactions. Id. The notice
provides that in addition to any other tax consequences that may be present,
the amount treated as a contribution is subject to the excise tax under section
4973. Id. The notice identifies these transactions, as well as substantially
similar transactions, as listed transactions for purposes of section
1.6011-4(b)(2), Income Tax Regs. Id., 2004-1 C.B. at 334.
IV. Procedural History
A. Federal Tax Returns
Mr. Zerjav prepared petitioners' 2004-06 Federal income tax
returns. On SGR's Forms 1120S, SGR reported its shares of Ozark Future's
business income as $117,110, $311,003, and $289,917 15 for 2004, 2005, and
2006, respectively. SGR also claimed facilities support deductions of $78,200,
$205,000, and $132,800 for 2004, 2005, and 2006, respectively, for its payments
to WFR and Yolo. SGR reported a business loss of $6,376 for 2004, and the
Repettos claimed their distributive share of that loss on their 2004 Schedule
E, Supplemental Income and Loss. On the Schedules E of their Forms 1040 for
2005 and 2006 the Repettos reported distributive shares of SGR's net income of
$52,701 and $95,174, respectively.
On its Forms 1120S, WFR reported gross income of $139,924,
$56,000, and $140,000 16 for its tax years ending October 31, 2004, 2005, and
2006, respectively. These amounts were the facilities support fees that SGR
paid WFR. WFR deducted facilities support expenses of $35,972 and $25,392 for
its tax years ending October 31, 2005 and 2006, respectively. These deductions
were for the payments WFR made to Yolo. WFR paid Federal income taxes of
$30,301, $1,967, and $24,615 for the years at issue. Respondent did not adjust
for these tax payments in the notices of deficiency and continues to retain
them.
On its Forms 1120S, Yolo included in its gross income the
payments from SGR and WFR and reported gross income of $163,596, $122,372, and
$75,792 for 2004, 2005, and 2006, respectively. Yolo paid Federal income taxes
of $34,395, $15,484, and $5,911 for its tax years ending October 31, 2004,
2005, and 2006, respectively. Respondent did not adjust for these tax payments
in the notices of deficiency and continues to retain them.
The Repettos filed their Forms 1040, U.S. Individual Income
Tax Return, for the years at issue with the filing status of married filing
jointly. They did not file Forms 5329, Additional Taxes on Qualified Plans
(Including IRAs) and Other Tax- Favored Accounts.
B. The Notices of Deficiency
In the notice of deficiency issued to the Repettos,
respondent determined that Mr. Repetto had compensation from SGR of $22,164 for
each of the years 2004 and 2005 and additional compensation of $6,750 for 2006.
Respondent made corresponding adjustments to SGR's returns allowing deductions
in the same amounts.
Respondent determined that amounts reported as wages of
$9,600 and $12,000 that Mrs. Repetto received from Yolo in 2005 and 2006,
respectively, were not includable in her taxable income. These adjustments were
consistent with the adjustments respondent made to Yolo's returns for 2005 and
2006 disallowing the deductions for wages paid to Mrs. Repetto.
Respondent also adjusted several items on SGR's returns. The
only adjustments that remain at issue are the disallowed deductions for
facilities support of $78,200, $205,000, and $132,800 for 2004, 2005, and 2006,
respectively. Respondent did not explain the reasons for the disallowance in
the notice of deficiency. Respondent adjusted the Repettos' distributive shares
of income from SGR for 2004-06 to reflect the adjustments to SGR's returns.
In the notice of deficiency issued to the Repettos,
respondent determined that “the contributions made for the sole benefit of your
Roth IRA Individual Retirement Accounts were excessive contributions and are
subject to the applicable excise tax under the provisions of the Internal
Revenue Code” and, consequently, the Repettos were liable for the excise tax
under section 4973. Respondent also determined that the Repettos did not file
the required Forms 5329 and that the Repettos are liable for the section
6651(a)(1) addition to tax for failing to file the Forms 5329 for 2004-06 and
the section 6651(a)(2) addition to tax for failing to pay excise tax due on the
excess contributions. Respondent also determined that the Repettos are liable
for the section 6662A accuracy-related penalty for reportable transaction
understatements for 2004-06.
In the notice of deficiency issued to WFR, respondent
disallowed the facilities support deductions of $35,972 and $25,392 for taxable
years ending October 31, 2005 and 2006, respectively. Because respondent
determined that WFR had a reportable transaction understatement for those
years, respondent also determined that WFR was liable for the 30% accuracy-related
penalty under section 6662A.
In the notice of deficiency issued to Yolo, respondent
disallowed in full the medical expense reimbursement deductions Yolo claimed on
its 2005 and 2006 returns as well as the deductions for officer compensation expenses
discussed above. 17 Respondent also determined for each year at issue that Yolo
was liable for the 30% accuracy-related penalty under section 6662A.
Petitioners timely petitioned this Court.
OPINION
I. Burden of Proof Generally, the Commissioner's
determinations in the notice of deficiency are presumed correct, and the
taxpayer bears the burden of proving that the determinations are erroneous. See
Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 [12 AFTR 1456] (1933).
However, pursuant to section 7491(a), in certain circumstances the burden of
proof on factual issues that affect the taxpayer's tax liability “for any tax
imposed by subtitle A or B” may shift to the Commissioner.
At trial petitioners made an oral motion to shift the burden
of proof under section 7491(a). On brief petitioners contend that the burden of
proof shifts to respondent because they established that the requirements under
section 7491(a) are met. We disagree. Section 7491(a) applies only to subtitles
A and B, which include income taxes and estate and gift taxes. See also
Paschall v. Commissioner, 137 T.C. 8, 17 (2011). Respondent determined the
excise tax due under subtitle D. By its terms section 7491(a) does not apply to
taxes determined under subtitle D, and petitioners bear the burden of proof
with respect to the excise tax adjustments.
Respondent's other determinations, such as the
determinations to disallow SGR's and WFR's facilities support deductions, Mr.
Repetto's compensation from SGR, and Yolo's medical expense reimbursement
deductions, are under subtitle A. With respect to these issues, we base our
conclusions on the preponderance of the evidence and not on any allocation of
the burden of proof. See Knudsen v. Commissioner, 131 T.C. 185, 188-189 (2008).
II. Excess Contributions to the Roth IRAs and Related
Determinations
A. Roth IRAs in General
Congress authorized the Roth IRA, a type of a retirement
account, with the enactment of section 408A as part of the Taxpayer Relief Act
of 1997, Pub. L. No. 105-34, sec. 302, 111 Stat. at 825. The distinguishing
feature of a Roth IRA is the back-end timing of the tax benefit: Contributions
to a Roth IRA are not tax deductible, but all earnings accumulate tax free, and
all qualified distributions are tax free. Sec. 408A(a), (c)(1), (d)(1); Taproot
Admin. Servs., Inc. v. Commissioner , 133 T.C. 202, 206 (2009), aff'd, ___ F.3d
___, 2012 WL 933908 [109 AFTR 2d 2012-1446] (9th Cir. Mar. 21, 2012). By
comparison, contributions to a traditional IRA are deductible and earnings
accrue tax free (except with respect to section 511 unrelated business income),
but distributions from a traditional IRA are includable in the recipient's
gross income. See secs. 219(a),,, 408(a), (d)(1), (e). Accordingly, the timing
of the tax benefit is the critical difference between a Roth IRA and a
traditional IRA. Both traditional and Roth IRAs are designed to ensure that the
taxpayer includes in income either the amounts the taxpayer contributes to the
retirement account or the amount that he withdraws from his account. Cf. secs.
408A(c)(1), 408(d)(1).
The total annual contribution a taxpayer may make to a Roth
IRA is effectively limited. 18 Sec. 408A(c)(2) and (3). Although the Code does
not prohibit higher contributions, section 4973(a) imposes for each taxable
year an excise tax of 6% for excess contributions, computed on the lesser of
(1) the amount of the excess contribution, and (2) the value of the account as
of the end of the taxable year. The tax applies each year until the excess
contributions are eliminated from the taxpayer's Roth IRA. See sec. 4973(b)(2).
Section 4973(f) defines an excess contribution to a Roth IRA as the excess of
the amount contributed over the amount allowable as a contribution.
B. The Parties' Arguments
Respondent contends that the Repettos followed the general
pattern of Notice 2004-8, supra, and transferred funds into their Roth IRAs in
excess of the statutory limits using the purported facilities support
agreements. Relying on the substance-over-form and sham transaction doctrines
as well as income shifting cases such as Green v. United States, 460 F.2d 412,
420-421 [29 AFTR 2d 72-1138] (5th Cir. 1972), Simon v. Commissioner, 248 F.2d
869, 876-877 [52 AFTR 698] (8th Cir. 1957), rev'g and remanding U.S. Packing
Co. v. Commissioner, T.C. Memo. 1955-194 [¶55,194 PH Memo TC], and others,
respondent contends that when viewed according to the substance of the
transaction, the Repettos' deemed contributions to the Roth IRAs were excessive,
and the Repettos are liable for the excise tax under section 4973.
Petitioners contend that their corporate structure had a
legitimate business purpose of asset protection 19 and that a Roth IRA may own
shares of a C corporation. They maintain that respondent recognized that WFR
and Yolo were legitimate business entities by continuing to retain over
$112,000 in Federal 19
Because respondent does not argue that WFR and Yolo were
sham corporations and should be disregarded, we shall not address petitioners'
argument regarding the business purpose and economic substance of these
corporations. corporate income taxes that WFR and Yolo paid during the years at
issue and by having allowed many of their deductions. Petitioners also contend
that the payments between the entities were legitimate because Yolo provided
administrative support, design, and development services to both SGR and WFR,
and WFR provided marketing, real estate purchase, design, and development
services to SGR.
C. Analysis
The parties agree that generally an entity in which substantially
all the interest is owned or acquired by a Roth IRA may be recognized as a
legitimate business entity for Federal tax purposes. However, in these cases
the preponderance of credible evidence compels a finding that in substance the
services agreements and the resulting payments were nothing more than a
mechanism for transferring value to the Roth IRAs. The services agreements did
not change who provided the services to SGR, and the Repettos continued to do
all of the work as they had done before the agreements were allegedly put in
place. Petitioners introduced no written agreement with respect to the services
WFR purportedly provided to SGR, and we find there was none. The SGR agreement
and the WFR agreement were identical. WFR and Yolo did not maintain
contemporaneous time records for the services that they allegedly provided to
SGR. We also question whether the amounts of the payments were determined in
good faith and reflected the value of the services purportedly performed. The
amount of the upfront lump-sum payment from SGR to Yolo, $126,900, underscores
the lack of normal business dealings between the corporations. We reject
petitioners' explanation that Yolo needed working capital as not credible.
The invoices in the record strongly support our conclusion
that the services agreements and payments were mechanisms to transfer value to
the Roth IRAs. The record contains only two invoices, for $4,800 and $4,000,
for the services that Yolo allegedly performed for SGR. The invoice for $4,800
bears as its date a notation “Monthly 2005”, and the invoice for $4,000 bears
as its date a notation “Monthly 2006”. The invoices describe the allegedly
provided services as “Services for Administrative support”, “Office support”,
“Internet: email processing, material research, marketing information”.
The record contains only one invoice for services that Yolo
allegedly performed for WFR. The invoice is for $2,116, and it describes the
services as “Services for administrative support” and “Office support”. This
invoice also bears as its date a notation “Monthly 2005 and 2006”. There are no
invoices issued by WFR to SGR in the record.
The engagement letter between Mr. Harrell and the Repettos
supports a finding that the payment of dividends to the Roth IRAs was the
primary goal of the facilities support agreements. Under the engagement letter,
Mr. Harrell undertook to coordinate the payment of the first dividend to the
Roth IRAs, a step unlikely to be an area of concern for a new corporation under
normal business circumstances.
Mr. and Mrs. Repetto testified at length regarding the
services WFR and Yolo performed under the services agreements. Mrs. Repetto
testified that Yolo provided SGR with administrative support by entering data
into QuickBooks, keeping track of various charges for the construction jobs,
and reordering supplies. Mrs. Repetto also testified that Yolo provided design
services for SGR, such as choosing design features for homes. According to Mrs.
Repetto, Yolo also provided development services for SGR and WFR during the
preconstruction stage, which involved determining features for the new house on
the basis of research regarding buyers' preferences. 20
Mr. Repetto testified about WFR's services to SGR. He
testified that WFR found and purchased lots and designed and developed homes.
He also testified that he visited other spec homes held for sale to understand
what people were interested in buying. After purchasing a lot, WFR had the home
for the lot drawn and obtained necessary approvals. Then Mr. Repetto had the
lot surveyed and appraised for the purpose of obtaining a construction loan. As
the next step, WFR obtained bids from all subcontractors, and WFR was
responsible for working with them. According to Mr. Repetto, WFR also provided
services to SGR in connection with SGR's projects that were independent of
Ozark Future, namely, the Florida and Panama projects.
Mrs. Repetto testified about Yolo's services to WFR.
According to her testimony, because Mr. Repetto was on the jobsites and could
not do marketing and development or design, Yolo performed those services for
WFR. The services included putting together documentation for the loans and
meeting with bank representatives.
Mrs. Repetto also testified about Yolo's support to SGR and
WFR in connection with SGR's projects independent of Ozark Future. She claimed
that such services included administrative support, office functions,
communications, trip planning, and making appointments with real estate agents
and condominium developers. She also took care of books and records for SGR and
WFR.
We have no doubt that Ozark Future's and SGR's growing
businesses required the Repettos' ongoing involvement. Petitioners have proven,
and we find that with Mr. Porschen's illness, the Repettos' involvement in
Ozark Future's business increased substantially. Petitioners, however, have
failed to convince us that the Repettos worked in their capacity as Yolo's and
WFR's indirect owners or employees rather than as SGR's owners or that the
services provided were worth the amounts paid under the agreements. The
circular arrangement among the entities further supports this conclusion. WFR
provided various services to SGR, its only client. Yet, WFR subcontracted some
of those services to its only subcontractor, Yolo, which, in turn, already
provided SGR, its only client, a somewhat overlapping menu of services. There
is no credible evidence in the record that either WFR or Yolo marketed its
services to potential clients beyond SGR.
Petitioners rely on Swanson v. Commissioner, 106 T.C. 76
(1996), in which an IRA-owned domestic international sales corporation (DISC)
received commissions from a corporation wholly owned by the taxpayer. However,
in Swanson, the central issue was whether the IRS was substantially justified
in its litigation position for the purpose of determining whether the taxpayer
was entitled to an award of reasonable litigation costs. 21 The issue in these
cases is different. On these facts we find that the agreements and the payments
made pursuant thereto were designed to permit and permitted the Repettos to
make excess contributions to the Roth IRAs through the disguised service
payments.
Relying on Hellweg v. Commissioner, T.C. Memo. 2011-58 [TC
Memo 2011-58], petitioners also contend that respondent failed to treat the
transaction consistently for section 4973 and income tax purposes. In Hellweg,
the taxpayers owned an S corporation. The taxpayers established Roth IRAs. The
Roth IRAs formed a DISC which entered into a commission agreement with the S
corporation. Each Roth IRA subsequently contributed its ownership interest in
the DISC to a C corporation in exchange for all of that corporation's unissued
stock. Because of the DISC's tax treatment under the Code, the C corporations
reported and paid applicable Federal income taxes resulting from the commission
fees. Each C corporation then distributed some amount as a dividend to the Roth
IRA shareholder. The Commissioner determined that the transaction resulted in
excess contributions subject to the section 4973 excise tax. The Commissioner,
however, made no adjustments for Federal income tax purposes.
In Hellweg, we held that the transactions must be treated
consistently for section 4973 and income tax purposes. We stated:
Pursuant to Notice 2004-8, supra, reallocation of income or
recharacterization of the Transaction should have resulted in: (1) Refund of
income taxes paid by the C corporations on the dividend income from *** [the
DISC], (2) reduction or denial of the deductions claimed by *** [S corporation]
for the *** commission payments,
(3) additional passthrough S corporation income to
petitioners from * * * [S corporation], and (4) income to petitioners under
section 1368 to the extent, if any, the distributions they were deemed to have
received from *** [the S Corporation] exceeded their bases in *** [the S
corporation]. However, in Hellweg, the Commissioner made no such adjustments.
We stated that because the Commissioner made no section 482 adjustment which
would result in distributions from the S corporation to the taxpayers for
income tax purposes, the commission payments cannot be treated as excess
contributions to petitioners' Roth IRAs. See id.; see also Ohsman v.
Commissioner, T.C. Memo. 2011-98 [TC Memo 2011-98].
We have a different set of adjustments in the notices of
deficiency in these cases. Although respondent did not make a section 482
reallocation, he disallowed all of the business expense deductions SGR claimed
for its payments to WFR and Yolo. These income tax adjustments are consistent
with the excise tax adjustments at issue, and Hellweg is therefore
distinguishable.
Petitioners also failed to prove that respondent's
disallowance of SGR's and WFR's claimed deductions for facilities support
expenses under section 162 and/or for lack of substantiation was erroneous.
Generally, section 162(a) allows as a deduction all the ordinary and necessary
expenses paid or incurred during the taxable year in carrying on any trade or
business. Whether an expenditure is ordinary and necessary is generally a
question of fact. Commissioner v. Heininger , 320 U.S. 467, 475 [31 AFTR 783]
(1943). An expense is ordinary if it is customary or usual within a particular
trade, business, or industry or relates to a transaction “of common or frequent
occurrence in the type of business involved.” Deputy v. du Pont, 308 U.S. 488,
495 [23 AFTR 808] (1940). An expense is necessary if it is appropriate and
helpful for the business. See Commissioner v. Heininger 320 U.S. at 471. Only
the portion of an , expense that is reasonable qualifies for deduction under
section 162(a). United States v. Haskel Engg. & Supply Co., 380 F.2d 786,
788-789 [20 AFTR 2d 5077] (9th Cir. 1967). In addition, taxpayers must keep
sufficient records to substantiate any deductions otherwise allowed by the
Code. Sec. 6001.
We agree with respondent that petitioners have failed to
prove that the payments under the services agreements were necessary or
reasonable. In addition, SGR's and WFR's form invoices fall short of satisfying
the substantiation requirements of the Code. We sustain respondent's
disallowance of the deductions SGR and WFR claimed for facilities support.
D. Computational Matters
We now address the amounts of the excess contributions.
Generally, section 4973(f) defines an excess contribution to a Roth IRA as the
excess of the amount contributed over the amount allowable as a contribution.
Respondent's position on the issue has been far from consistent. In the notice
of deficiency issued to the Repettos, respondent calculated the amount
contributed to each Roth IRA as the sum of the increase to the net asset value
of WFR and Yolo and dividends paid to the respective Roth IRAs. On brief
respondent stands by his calculation but argues that the transactions should be
recharacterized as follows: (1) The amounts transferred from SGR to WFR and
Yolo should be treated as distributions from SGR to the Repettos, and (2) the
distributions should then be treated as contributed by the Repettos to the Roth
IRAs. 22 We disagree with respondent's methodology.
In Paschall v. Commissioner, 137 T.C. at 19-20, another case
involving a tax-motivated transaction with a Roth IRA (conversion of a
traditional IRA into a Roth IRA) that we decided after Hellweg v. Commissioner,
T.C. Memo. 2011-58 [TC Memo 2011-58], we held that the amount contributed and
thus, the excise tax deficiencies were to be calculated on the basis of the
fair market value of the Roth IRA at yearend. Similarly, an amount of the
Repettos' contributions to the Roth IRAs (and, as the next step, excess
contributions) should be calculated on the basis of the values of their Roth
IRAs at the end of each tax year. 23 See id. 20). Because we do not adopt
respondent's recharacterization as described in his brief, the corporate taxes
that Yolo and WFR paid are irrelevant for the purpose of calculating excess
contributions for excise tax purposes. 24
III. Other Adjustments
A. Mr. Repetto's Compensation From SGR As discussed above,
in the notice of deficiency issued to the Repettos, respondent determined that
Mr. Repetto had compensation from SGR of $22,164 for each of the years 2004 and
2005 and additional compensation of $6,750 for 2006. Respondent allowed
corresponding deductions on SGR's returns. Petitioners maintain that the
payments to Mr. Repetto were distributions rather than wages.
SGR's general ledgers show regular monthly payments of
$1,847 to Mr. Repetto identified as “Payroll expenses”, “Salary & Wages
(Payroll)”, or “Salary”. Mr. Repetto explained that the QuickBooks entries
listed the payments as salary “just to keep track of the money” that he took
out of SGR. At the end of 2004 and 2005, the payments were reclassified as
loans. However, the regular timing of the payments, the consistent amounts, and
the contemporaneous descriptions in the general ledger support a finding that
Mr. Repetto received wages rather than distributions. We sustain respondent's
adjustments to this item for 2004 and 2005.
With respect to 2006, $6,750 shown as Mr. Repetto's wages in
the journal entries does not exceed the wages from SGR that Mr. Repetto
reported on his Form 1040. Because the record does not show that Mr. Repetto
had additional compensation income of $6,750 for 2006, we do not sustain
respondent's adjustment to this item for 2006.
B. Mrs. Repetto's Compensation From Yolo and
the Medical
Expense
Reimbursement Deductions
Yolo deducted as officer compensation expenses payments to
Mrs. Repetto. Yolo also deducted reimbursements of the Repettos' medical
expenses. Respondent disallowed these deductions because the employment
relationship between Yolo and Mrs. Repetto was a sham.
As discussed above, we cannot conclude on this record that
Mrs. Repetto performed work in her capacity as Yolo's employee or officer.
Consistent with our conclusion above, we sustain respondent's disallowance of
these deductions.
IV. Additions to Tax and Penalties
A. Burden of Proof
Respondent bears the burden of production with regard to the
section 6651(a)(1) and (2) additions to tax and the section 6662A penalties.
See sec. 7491(c); Higbee v. Commissioner, 116 T.C. 438, 446-447 (2001). To meet
his burden, respondent must produce sufficient evidence that it is appropriate
to impose them. See Higbee v. Commissioner, 116 T.C. at 446. Respondent does
not have to produce evidence of reasonable cause, substantial authority, or
lack of willful neglect. See id.
B. Section 6651(a)(1) and (2) Additions to Tax In the case
of a failure to file timely any return required under section 6011(a), section
6651(a)(1) imposes an addition of 5% of the tax required to be shown on the
return for each month or fraction thereof for which there is a failure to file,
not to exceed 25% in the aggregate. Generally, “any person made liable for any
tax *** shall make a return or statement according to the forms and regulations
prescribed by the Secretary.” 25 Sec. 6011(a). The addition to tax does not
apply if the failure to file timely is due to reasonable cause and not due to
willful neglect.
Taxpayers are required to file a Form 5329 for each year
they have excess contributions to their IRAs. See Paschall v. Commissioner, 137
T.C. at 21; Frick v. Commissioner, T.C. Memo. 1989-86 [¶89,086 PH Memo TC],
aff'd without published opinion 916 F.2d 715 , (7th Cir. 1990). Form 5329 is a
tax return within the meaning of section 6011, and failure to file it can
result in the section 6651(a)(1) addition to tax. Paschall v. Commissioner, 137
T.C. at 21. We have found that the Repettos had excess contributions. Also,
they did not file the Forms 5329. Respondent therefore has met his burden of
production.
Section 6651(a)(2) imposes an addition to tax for failure to
pay timely the amount of tax shown on a return. The section 6651(a)(2) addition
to tax applies only when an amount of tax is shown on a return. Cabirac v.
Commissioner, 120 T.C. 163, 170 (2003). Where the taxpayer did not file a valid
return, to satisfy the burden of production for the section 6651(a)(2) addition
to tax the Commissioner must introduce evidence that he prepared a substitute
for return satisfying the requirements under section 6020(b). Wheeler v.
Commissioner, 127 T.C. 200, 208-209 (2006), aff'd, 521 F.3d 1289 [101 AFTR 2d
2008-1696] (10th Cir. 2008). A return made by the Secretary under section
6020(b) is treated as the return filed by the taxpayer for purposes of section
6651(a)(2). Sec. 6651(g)(2). Respondent satisfied his burden by introducing
into evidence Form 13496, IRC Section 6020(b) Certification.
The Repettos contend that the failure to file the Forms 5329
and pay the excise tax was due to reasonable cause and not due to willful
neglect. They claim that they relied in good faith on Messrs. Zerjav and
Harrell.
Generally, the failure to timely file a return is considered
to be due to reasonable cause where a taxpayer is unable to file the return
within the prescribed time despite exercising “ordinary business care and
prudence.” Jackson v. Commissioner, 86 T.C. 492, 538 (1986) (quoting section
301.6651-1(c)(1), Proced. & Admin. Regs.), aff'd, 864 F.2d 1521 [63 AFTR 2d
89-539] (10th Cir. 1989). Willful neglect is defined as a “conscious,
intentional failure or reckless indifference”. United States v. Boyle, 469 U.S.
241, 245 [55 AFTR 2d 85-1535] (1985). While good faith reliance on professional
advice may provide a basis for a reasonable cause defense, it is not absolute.
Freytag v. Commissioner, 89 T.C. 849, 888 (1987), aff'd, 904 F.2d 1011 [66 AFTR
2d 90-5322] (5th Cir. 1990), aff'd , 501 U.S. 868 [68 AFTR 2d 91-5025] (1991).
The advice must be from competent and independent parties rather than from
promoters of the investment or advisers with a conflict of interest. Paschall
v. Commissioner, 137 T.C. at 22.
The Repettos hired Messrs. Zerjav and Harrell to set up the
structure knowing about the limitations on contributions to Roth IRAs and not
fully understanding the structure. As evidenced by Mrs. Repetto's email to Mr.
Harrell, the Repettos suspected the arrangement was improper, but relied on Mr.
Harrell's summary denial to allay their concerns. Messrs. Zerjav and Harrell
were the advisers who suggested the structure, and petitioners' reliance on
their advice as to the proper tax treatment of the transaction was
unreasonable. Petitioners failed to establish that they meet the reasonable
cause exception to the section 6651(a)(1) and (2) additions to tax. Therefore,
we sustain respondent's imposition of these additions to tax.
C. Section 6662A Penalties
1. Section 6662A in General Section 6662A provides that “If
a taxpayer has a reportable transaction understatement for any taxable year,
there shall be added to the tax an amount equal to 20% of the amount of such
understatement.” The penalty applies to any deficiency which is attributable to
any listed transaction or any reportable transaction if a significant purpose
of the transaction is the avoidance or evasion of Federal income tax. Sec.
6662A(b)(2). The penalty is increased from 20% to 30% of the amount of the
understatement if the disclosure requirements of section 6664(d)(2)(A),
requiring disclosure in accordance with the regulations under section 6011, are
not met. Sec. 6662A(c).
2. The Parties' Arguments and Analysis
Respondent argues that the Repettos, WFR, and Yolo are
liable for the penalty because they participated in a listed transaction. A
listed transaction is a transaction that is the same as or substantially
similar to one of the types of transactions that the IRS has determined to be a
tax avoidance transaction and has identified by notice, regulation, or other
form of published guidance as a listed transaction. Sec. 6707A(c)(2); see also
BLAK Invs. v. Commissioner 133 T.C. , 431, 445 (2009). Respondent claims that
the transaction is substantially similar to the transaction described in Notice
2004-8, supra.
The regulations define the term “substantially similar” as
“any transaction that is expected to obtain the same or similar types of tax
consequences and that is either factually similar or based on the same or
similar tax strategy.” Sec. 1.6011- 4(c)(4), Income Tax Regs. The consequence
of the transactions described in Notice 2004-8, supra, is avoiding the
limitations on contributions to Roth IRAs. This is what the transaction in
these cases achieved. Moreover, the transaction described in the notice is
factually similar to the transaction at issue here. The transaction described
in the notice has the same types of parties as the transaction in these cases,
namely, an individual who owns a preexisting business, a Roth IRA that is
maintained for that individual, and a Roth IRA corporation. The examples of
transactions described in the notice include “any other arrangement between the
Roth IRA Corporation and the Taxpayer, a related party *** , or the Business
that has the effect of transferring value to the Roth IRA Corporation
comparable to a contribution to the Roth IRA.” Notice 2004-8, supra. The
facilities support agreements and payments between SGR and WFR and Yolo are
exactly the same type of arrangement in that the agreements and payments have
the effect of transferring value to the Roth IRA corporations.
Respondent claims that petitioners are liable for the
increased 30% penalty. Petitioners filed their Federal income tax returns but
did not attach disclosure statements as described in section 1.6011-4(c),
Income Tax Regs., or any materially similar documents, indicating their
participation in the transaction to the returns. Therefore, petitioners are
liable for the increased 30% penalty. See sec. 6662A(c).
Section 6664(d) provides that under certain circumstances a
taxpayer may avoid section 6662A penalties if there was reasonable cause for
the taxpayer's treatment of the listed transaction and the taxpayer acted in
good faith. However, this exception applies only if the transaction was
disclosed in accordance with the regulations prescribed under section 6011.
Sec. 6664(d)(2)(A). Petitioners did not disclose their participation in the
transaction in accordance with the regulations under section 6011. Accordingly,
petitioners do not qualify for relief from the section 6662A penalty under the
reasonable cause exception.
Petitioners point out that the disclosure component in the
structure of the reasonable cause defense as applicable to the section 6662A
penalty differs from the reasonable cause exception for the section 6662(a)
penalty, found in section 6664(c)(1). In their view the limitation upon the
reasonable cause exception violates petitioners' constitutional right to due
process of law and conflicts with the reasonableness standard outlined in
Boyle, 469 U.S. 241 [55 AFTR 2d 85-1535]. For reasonable cause to apply under
section 6662(a), the taxpayer must have exercised ordinary business care and
prudence as to the disputed item, see id. at 251-252, and in petitioners' view,
the additional disclosure requirement of section 6664(d)(2)(A) violates this
standard. Petitioners believe that they in fact had reasonable cause because
they relied on their advisers to attach to petitioners' returns all required
forms, which the advisers did not, yet petitioners are unable to rely on the
reasonable cause exception because of the disclosure requirement.
We reject petitioners' argument. To fall within the
protection of the Due Process Clause, petitioners must show that the assessment
of the penalties is so harsh and oppressive as to transgress the constitutional
limitation. See, e.g., McGehee Family Clinic v. Commissioner T.C. Memo.
2010-202 [TC Memo 2010-202]. The penalty , structure of section 6662A does not
do so.
Petitioners also contend that their due process rights have
been violated because the language “substantially similar” set forth in Notice
2004-8,supra, is void for vagueness. Petitioners believe that there is no clear
guidance in section 1.6011-4(c)(4), Income Tax Regs., as to what makes a
transaction “substantially similar” to a listed transaction.
We reject petitioner's argument. As the Supreme Court stated
inGrayned v. City of Rockford, 408 U.S. 104, 108 (1972), "[i]t is a basic
principle of due process that an enactment is void for vagueness if its
prohibitions are not clearly defined.” The vagueness doctrine is concerned with
the requirement of explicit guidelines to avoid arbitrary and discriminatory
enforcement, and it requires specificity in laws sufficient to inform those
subject to the law as to its meaning. Big Mama Rag, Inc. v. United States, 631
F.2d 1030, 1035 [46 AFTR 2d 80-5723] (D.C. Cir. 1980). Under the vagueness
doctrine, courts may invalidate laws if “men of common intelligence must
necessarily guess at its meaning.” Id. (quoting Hynes v. Mayor of Oradell, 425
U.S. 610, 620 (1976)); see also United States v. Derezinski, 945 F.2d 1006,
1010 [68 AFTR 2d 91-5520] (8th Cir. 1991). It is apparent that Notice 2004-8,
supra, addresses transactions structured to circumvent the statutory
limitations on contributions to Roth IRAs. The notice specifies what type of
entities or individuals the transaction typically involves. We find no
unconstitutional vagueness in Notice 2004-8, supra.
3. Calculation of the Amount of the Penalty Although we
sustain the imposition of the section 6662A penalties, we disagree with certain
aspects of respondent's calculations. Generally, section 6662A applies, as
relevant here, “to any item which is attributable to” any listed transaction.
Sec. 6662A(b)(2)(A). Respondent, however, calculated the penalty by including
an overly broad range of adjusted items. In particular, he imposed the penalty
on the following adjustments: (1) Mr. Repetto's wages from SGR and all Schedule
E adjustments (including the facilities support adjustment) to the Repettos'
returns, (2) facilities support adjustments to WFR's returns, and (3) medical
expense reimbursement, selling-related expenses, and officer compensation
expense adjustments to Yolo's returns. Not all of these adjustments, however,
are attributable to the listed transaction. The Schedule E adjustments included
disallowance of selling-related expenses, rent and occupancy expenses, and
auto/local travel expenses. Unlike the facilities support deduction, these
items are not attributable to the facilities support arrangements between SGR
and the Roth IRA corporations. Similarly, the disallowance of the medical
expense reimbursement deductions and the officer compensation expense
deductions relating to Mrs. Repetto's salary is attributable to Yolo's claiming
improper deductions, not to petitioners' participation in a listed transaction.
We expect respondent to adjust his calculations of the section 6662A penalties
accordingly during the Rule 155 process.
We have considered the remaining arguments made by the
parties, and to the extent not discussed above, we conclude those arguments are
irrelevant, moot, or without merit.
To reflect the foregoing,
Decisions will be entered under Rule 155.
2
Unless otherwise
indicated, section references are to the Internal Revenue Code (Code), as
amended and in effect for the years at issue, and Rule references are to the
Tax Court Rules of Practice and Procedure. 3
Some documents in
the record show Mr. Repetto's first name as “Stephen”. 1
Respondent explains
in the notice of deficiency that the additions to tax under sec. 6651(a)(2)
will be determined on the basis of the liability shown on the sec. 6020(b)
returns or the redetermined liability, if less. 4
Petitioners concede
the following adjustments to the Form 1120S, U.S. Income Tax Return for an S
Corporation, of SGR Investments, Inc. (SGR), which the Repettos wholly owned:
rent and occupancy expenses for 2004-05, selling-related expenses for 2004-06,
and automobile and local travel expenses for 2006. Petitioners also concede the
adjustments to Yolo's selling-related expenses for 2005-06. Petitioners are not
conceding the penalties under sec. 6662A on understatements with respect to
these items. 5
SGR claimed
deductions for facilities support, and WFR claimed deductions for outside
services or facilities staffing and support. For brevity, we shall refer to
SGR's and WFR's deductions and expenses as facilities support. 6
WFR's bylaws stated
that its principal office was in Nevada. However, the record establishes that
WFR's principal office and principal place of business were in Missouri. 7
A spec home, as
opposed to a custom-built home, is a home that a developer builds to his own
specifications before he has a contract with a prospective buyer. 8
The parties
stipulated that Porschen Construction was primarily responsible for general
contracting and construction management supervision until the end of 2003.
However, on the basis of the record as a whole, we find that Porschen
Construction's role in Ozark Future decreased in 2002 with Mr. Porschen's
illness. 9
The parties
stipulated that from the time of Ozark Future's formation until late 2003 Mr.
Repetto was primarily responsible for performing marketing and design work of
Ozark Future, which included marketing, design, and business development.
However, Mr. Repetto credibly testified that in the early years of Ozark Future
(1999-2001) Porschen Construction did the design work. In the light of Mr.
Repetto's testimony, we find that Mr. Repetto became more heavily involved with
design and marketing for Ozark Future starting in 2002, rather than after Ozark
Future's formation. 10
The record also
reflects the spelling of his last name as “Kern”. 11
The 2004-06 Forms
1120S show that Mr. Repetto was SGR's sole shareholder. However, Mr. and Mrs.
Repetto testified that they each own and had continuously owned a 50% interest
in SGR. The inconsistency in the record does not affect our resolution of the
issues in these cases. 12
Mrs. Porschen and Mrs.
Repetto agreed that if Mrs. Porschen opened a Roth IRA that owned a
corporation, Mrs. Repetto would be a 2% shareholder of that corporation. On a
date that does not appear in the record, Mrs. Repetto became a 2% shareholder
of that corporation. 13
The copies of the
subscription agreements in the record are signed but undated. 14
WFR allegedly had a
services agreement with SGR, but such agreement is not in the record. On the
basis of the record as a whole, we find that no services agreement existed. 15
The parties
stipulated an incorrect amount, and we ignore that stipulation as contrary to
the Form 1120S and the Schedule K-1, Partner's Share of Income, Deductions, and
Credits, etc. 16
The parties
incorrectly stipulated WFR's gross income for the year ending October 31, 2004,
and we ignore the stipulation as inconsistent with WFR's 2005 Form 1120S. 17
Petitioners conceded
another adjustment to the Yolo return. See supra note 4. 18
The Code establishes
a maximum aggregate amount that an individual can contribute to all of his or
her Roth IRAs for a taxable year, and that amount is phased out between levels
of modified adjusted gross income. See sec. 408A(c)(2) and (3). 19
Because respondent
does not argue that WFR and Yolo were sham corporations and should be
disregarded, we shall not address petitioners' argument regarding the business
purpose and economic substance of these corporations. 20
This type of design
service was performed before construction, and it differed from more technical
design services, for example, choosing colors or a specific supplier of an
item. 21
In Swanson v.
Commissioner, 106 T.C. 76, 87-88 (1996), the Commissioner maintained that the
IRA's acquisition of the DISC's stock was a prohibited transaction under sec.
4975(c)(1)(A). We concluded that the DISC was not a disqualified person under
sec. 4975(e)(2)(G) and that therefore the issuance of the stock to the IRA was
not a prohibited transaction. Swanson v. Commissioner, 106 T.C. at 88-89. The
Commissioner also contended that the payments of dividends by the DISC to the
IRA qualified as prohibited transactions under sec. 4975(c)(1)(E), but we
disagreed. See id. at 89. Accordingly, we held that the Commissioner's
litigation position was not substantially justified. Id. at 91-92. 22
Respondent's
calculations ignore corporate taxes that WFR and Yolo paid. 23
There were no
distributions from the Roth IRAs, and the record does not allow us to conclude
that the value of the Roth IRA increased for a reason other than the
contributions.
On brief respondent admits that in the notice of deficiency
he failed to include all the dividends to the Roth IRAs and, specifically, that
he omitted (1) a $50,000 dividend from Yolo to Mrs. Repetto's Roth IRA dated
May 24, 2004, and (2) two $50,000 dividends from WFR to Mr. Repetto's Roth IRA
dated May 4, 2004, and May 13, 2006. Notably, respondent calculates the
contributions using the total rather than pro rata dividends. Because we follow
Paschall v. Commissioner, 137 T.C. 8 (2011), and treat the yearend value of the
Roth IRA as the amount contributed to the respective Roth IRA, respondent's
failure to include all of the dividends in his calculation as well as the use
of slightly inflated numbers as dividends are irrelevant. 24
Because the
facilities support agreements were shams, the parties shall exclude income that
WFR and Yolo received under those agreements during 2005 and 2006 from income
used in the Rule 155 computations. See sec. 6512; cf. Winter v. Commissioner,
135 T.C. 238, 244 (2010). 25
The term “Secretary”
means the Secretary of the Treasury or his delegate. Sec. 7701(a)(11).
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