alter ego - nominee issue - fraudulent transfer - offer in compromise case LEEDS LP v. U.S., Cite as 106 AFTR 2d 2010-XXXX, 08/05/2010 ________________________________________ LEEDS LP, Plaintiff, v. UNITED STATES OF AMERICA, Defendant. Case Information: Code Sec(s): Court Name: UNITED STATES DISTRICT COURT SOUTHERN DISTRICT OF CALIFORNIA, Docket No.: Case No. 08cv100 BTM (BLM), Date Decided: 08/05/2010. Disposition: HEADNOTE . Reference(s): OPINION UNITED STATES DISTRICT COURT SOUTHERN DISTRICT OF CALIFORNIA, ORDER RE CROSS-MOTIONS FOR SUMMARY JUDGMENT AND MOTION TO AMEND COMPLAINT Judge: Honorable Barry Ted Moskowitz United States District Judge Plaintiff and Defendant have each filed motions for summary judgment on a variety of claims [Docs. 58, 59]. Also pending is Plaintiff's motion to file a Second Amended Complaint [Doc. 74]. For the following reasons, the Court GRANTS the United States's motion for summary judgment and DENIES Plaintiff's motion for summary judgment. The Court DENIES Plaintiff's motion to file a Second Amended Complaint as moot. I. BACKGROUND This is a quiet-title suit challenging tax liens placed by the United States on real property at 3207 McCall Street, San Diego, CA 92106 (the “McCall Property”). The Internal Revenue Service (“IRS”) placed liens on the property because Don and Susanne Ballantyne, who owe the IRS substantial income taxes, are allegedly its true owners. Plaintiff contends that it is the only owner and that the Ballantynes have no interest in it. This is the core dispute in this case. 1. The IRS Files Tax Liens Against Don and Susanne Ballantyne Don and Susanne Ballantyne owe income taxes to the IRS. Although they owe income taxes for several tax years, the tax years for which they owe the most money are 1985 and 1986. They filed a petition with the United States Tax Court challenging notices of income tax deficiency sent by the IRS for those two years. The court held a trial in May 1995, and on October 10, 1996, the court filed an opinion stating the Ballantynes owed deficiencies of $388,937.00 for 1985, and $931,970.00 for 1986. On appeal, the Ninth Circuit affirmed the judgment of the Tax Court. After trial, on June 30, 1997 the IRS made assessments against the Ballantynes for those two years in the amounts of $388,937.00 (1985) and $931,970 (1986). Notice and demand for payment was made on the same day. 1 The IRS has made other assessments against the Ballantynes: one on January 2, 1995 for $25,164.00, plus interest (1990 tax year) and the other on November 16, 1998 for $11,515.00, plus interest (1997 tax year). On November 14, 1997, the IRS recorded with the San Diego County Recorder's office a Notice of Federal Tax Lien in the amount of $5,539,789.51 against the Ballantynes for tax years 1985 ($1,743,607.49) and 1986 ($3,796,182.02). Several years later, on July 17, 2006, the IRS recorded another Notice of Federal Tax Lien against the McCall Property in the amount of $5,212,494.62, identifying Plaintiff Leeds as the nominee/alter ego of Susanne C. Ballantyne. Plaintiff has now filed this quiet-title action to remove the lien. 2. History of the McCall Property and Its Owners Susanne Ballantyne's parents built the McCall Property around 1929 and they raised her there. The Property was owned by the Susan T. Cramer Trust (“STC Trust”), named after Ms. Ballantyne's mother. After her parents died, Ms. Ballantyne and her brother became the co-beneficiaries of the STC Trust. Her brother took his apportioned distribution of the STC Trust in 1979, leaving Ms. Ballantyne as its only trustee and beneficiary. The STC Trust still owned the McCall Property at that time. In 1987, Susanne Ballantyne formed an intervivos trust, of which she was the sole settlor, trustee and beneficiary, called the Susanne C. Ballantyne Trust, and she placed the entire corpus of her mother's trust, including the McCall Property, into it. Then, on June 21, 1995, the STC Trust transferred legal title to the McCall Property to Leeds LP (the Plaintiff here) in exchange for a 99% limited partnership interest in Leeds. The STC Trust later transferred its 99% interest in Leeds to the Susanne C. Ballantyne Trust in July 1995. Leeds still holds legal title to the McCall Property. Leeds was created in May 1995 by its 1% general partner, B&B Business Services, Inc. Soon thereafter, in June 1995 B&B withdrew as the general partner, and was replaced by Rhodes Investment Corporation. Rhodes is still the 1% general partner of Leeds. Rhodes itself was owned by the Susanne C. Ballantyne Trust; the trust was Rhodes's sole shareholder. And Susanne Ballantyne was Rhodes's president, secretary-treasurer, and director. Clark L. Ballantyne, her son, later took over her roles in Rhodes on November 26, 1997, a month after the Susanne C. Ballantyne Trust sold its interest in Rhodes to the Children's Trusts (defined infra). To summarize the McCall Property's history up until this point, it was originally owned by Susanne Ballantyne's mother's trust, the STC Trust. The STC Trust was later placed in the Susanne C. Ballantyne Trust. The STC Trust then sold the property to Leeds, whose general partner was Rhodes. And Rhodes was owned by the Susanne C. Ballantyne Trust, and operated by Susanne Ballantyne herself. So, in effect, Susanne Ballantyne indirectly owned entities on both sides of the transaction: she indirectly owned the STC Trust, which sold the property, and also indirectly owned Leeds LP, which bought the property. This complicated history continues. In January 1996, a limited partnership called Hemet C bought a 1% limited partnership interest in Leeds. About a year later, the Susanne C. Ballantine Trust transferred the remaining 98% limited partnership interest in Leeds to Hemet C. So, as of February 1997, Hemet C owned about 99% of Leeds as the limited partner, and Rhodes about 1% as general partner. But who owns Hemet C? Hemet C is a limited partnership. Its 99% limited partners are trusts named after Don and Susanne Ballantyne's children, the Clark Lindsay Ballantyne Trust and the Laura Ballantyne Trust (collectively “Children's Trusts”). They each hold a 49.5% interest in Hemet C. A company called Snow Valley Holdings, Inc. holds Hemet C's remaining 1% as the general partner. Snow Valley, Hemet C's general partner, is a corporation whose shares are owned by the Children's Trusts. So, the Children's Trusts are the 99% limited partners in Hemet C, and also own its 1% general partner. At the time Snow Valley became the general partner of Hemet C in December 1995, Don and Susanne Ballantyne were among its officers and directors. Don Ballantyne was a vice president and director, and Susanne Ballantyne was the secretary-treasurer and a director. They resigned their positions in November 1997. In summary, when Leeds purchased the McCall Property from the STC Trust, Leeds's 1% general partner was Rhodes (owned by the Susanne C. Ballantyne Trust) and its 99% limited partner was the Susanne C. Ballantyne Trust. Although Rhodes retained its 1% general partnership interest, Hemet C purchased the 99% limited partnership from the Susanne C. Ballantyne Trust. And Hemet C itself is owned by the Children's Trusts (limited partners) and Snow Valley (general partner), which at the time counted Don and Susanne Ballantyne among its officers and directors. II. LEGAL STANDARD Summary judgment is appropriate under Rule 56 of the Federal Rules of Civil Procedure if the moving party demonstrates the absence of a genuine issue of material fact and entitlement to judgment as a matter of law. Celotex Corp. v. Catrett, 477 U.S. 317, 322 (1986). A fact is material when, under the governing substantive law, it could affect the outcome of the case. Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 248 (1986); Freeman v. Arpaio, 125 F.3d 732, 735 (9th Cir. 1997). A dispute is genuine if a reasonable jury could return a verdict for the nonmoving party.Anderson , 477 U.S. at 248. A party seeking summary judgment always bears the initial burden of establishing the absence of a genuine issue of material fact. Celotex, 477 U.S. at 323. The moving party can satisfy this burden in two ways: (1) by presenting evidence that negates an essential element of the nonmoving party's case; or (2) by demonstrating that the nonmoving party failed to establish an essential element of the nonmoving party's case on which the nonmoving party bears the burden of proving at trial.Id. at 322–23. “Disputes over irrelevant or unnecessary facts will not preclude a grant of summary judgment.” T.W. Elec. Serv., Inc. v. Pacific Elec. Contractors Ass'n, 809 F.2d 626, 630 (9th Cir. 1987). Once the moving party establishes the absence of genuine issues of material fact, the burden shifts to the nonmoving party to set forth facts showing that a genuine issue of disputed fact remains. Celotex, 477 U.S. at 314. The nonmoving party cannot oppose a properly supported summary judgment motion by “rest[ing] on mere allegations or denials of his pleadings.” Anderson, 477 U.S. at 256. When ruling on a summary judgment motion, the court must view all inferences drawn from the underlying facts in the light most favorable to the nonmoving party. Matsushita Elec. Indus. Co. v. Zenith Radio Corp., 475 U.S. 574, 587 (1986). III. DISCUSSION 1. The Basis of the United States's Claimed Interest in the Property In this quiet-title action, the Court must resolve the parties' competing claims against the McCall Property. Plaintiff Leeds believes that the lien imposed by the IRS is improper because the IRS seeks assets of the Ballantynes, and the Ballantynes have no interest in Leeds or the McCall Property. The United States claims that Leeds is merely the nominee of the Ballantynes, and that they are its true owners. “A nominee is one who holds bare legal title to property for the benefit of another.” Scoville v. United States, 250 F.3d 1198, 1202 [87 AFTR 2d 2001-2347] (8th Cir. 2001) (citingBlack's Law Dictionary (7th ed. 1999)). “Property held by a nominee is subject to a tax lien attaching to the property of the true owner.” United States v. Beretta, 2008 WL 4862509 [102 AFTR 2d 2008-6955], at 7 (N.D. Cal. 2008) (citingG.M. Leasing Corp. v. United States , 429 U.S. 338, 351 [39 AFTR 2d 77-475] (1977)); see also 26 U.S.C. § 6321 (If a person fails to pay federal tax after a demand, a lien automatically attaches to “all property and rights to property, whether real or personal, belonging to such person.”). Nominee claims require two levels of analysis, one applying state law and the other applying federal law. A court must “look initially to state law to determine what rights the taxpayer has in the property the Government seeks to reach, then to federal law to determine whether the taxpayer's state-delineated rights qualify as “property” or “rights to property” within the compass of the federal tax lien legislation.” United States v. Craft, 535 U.S. 274, 278 [89 AFTR 2d 2002-2005] (2002) (internal quotation marks and citations omitted). In the first step, a court must determine whether a purported true owner of the property has a state-law interest in the property. United States v. Overman, 424 F.2d 1142, 1144 [25 AFTR 2d 70-1024] (9th Cir. 1970). The purported owner must have an interest in the property on or after the date of the assessment.See 26 U.S.C. § 6322; Rice Inv. Co. v. United States, 625 F.2d 565, 568 [46 AFTR 2d 80-5682] (5th Cir. 1980) (citingGlass City Bank v. United States , 326 U.S. 265 [34 AFTR 1] (1945)). Plaintiff challenges primarily this first step, arguing that the Ballantynes have no state-law property interest in the McCall Property. Plaintiff addresses several forms of state-law ownership, arguing that each is inapplicable or otherwise foreclosed to the United States. The Court addresses each of them below. 2. State-Law Property Rights A. Nominee Ownership Plaintiff first claims that California does not recognize a nominee theory of ownership. Although the parties agree that federal law recognizes a nominee theory of ownership, they dispute whether California law recognizes it. The Court holds that it does. Several California courts have discussed or mentioned nominee ownership. Lewis v. Hankins, 214 Cal. App. 3d 195, 201–02 (1989) (affirming trial court judgment which allowed creditor to levy and sell real property owned by debtor's nominees because debtor was beneficial owner);Parkmerced Co. v. City and County of San Francisco , 140 Cal. App. 3d 1091, 1095 (1983) (noting that one general partner held real property as nominee for partnership);Baldassari v. United States , 79 Cal. App. 3d 267, 272 (1978) (“The validity of the tax liens depends upon whether plaintiffs are the bona fide owners of the properties or are only nominees.”); Baumann v. Harrison, 46 Cal. App. 2d 84, 91 (1941) (stating that “appellant took title as the nominee of [another party] but did not assume or agree to pay the indebtedness secured by the deed of trust”);see also McColcan v. Walter Magee, Inc. , 172 Cal. 182, 186 (1916) (alluding to nominee ownership and stating “one cannot by any disposition of his own property put the same or the income thereof beyond the reach of his creditors, so long as he himself retains the right to receive and use it”). And federal courts have said that California recognizes nominee ownership. United States v. Dubey, 1998 WL 835000 [82 AFTR 2d 98-7050], at 98–7055 (E.D. Cal. Oct. 21, 1998) (“Under the “nominee” doctrine in California, “a person cannot place his property ... beyond the reach of his creditors so long as he himself retains the right to ... use it.””) (quoting In re Camm's Estate, 76 Cal. App. 2d 104 (1946));see Cal Fruit Int'l, Inc. v. Spaich , 2006 WL 2711664 [98 AFTR 2d 2006-6806], at 4 (E.D. Cal. September 21, 2006). Although California law recognizes the theory of nominee ownership, it appears that no California court has ever identified the factors involved in a nominee analysis.Cal Fruit , 2006 WL 2711664 [98 AFTR 2d 2006-6806], at 4 (“There appear to be no reported California decisions which address the issue of what factors are relevant in determining whether an individual is a nominee of a taxpayer.”) In the absence of state-law guidelines, federal courts in California have used the guidelines of federal common law. E.g., United States v. Beretta, 2008 WL 4862509 [102 AFTR 2d 2008-6955], at 7 (N.D. Cal. Nov. 11, 2008);United States v. Lang , 2008 WL 2899819 [102 AFTR 2d 2008-5367], at 5 (S.D. Cal. July 25, 2008); Sequoia Prop. & Equip. Ltd. P'ship v. United States, 2002 WL 31409620 [90 AFTR 2d 2002-6728], at 12 (E.D. Cal. Sept. 19, 2002). Federal courts in other states use the same approach. E.g., Scoville v. United States, 250 F.3d 1198, 1202 [87 AFTR 2d 2001-2347] (8th Cir. 2001) (“A nominee is one who holds bare legal title to property for the benefit of another. Under Missouri law, one who holds such title has no actual interest in the property, which remains with the beneficial owner. No Missouri court has delineated a precise test for determining whether a property holder is a nominee. Missouri courts have, however, provided a test for determining whether a conveyance is fraudulent. In such instances, Missouri courts look to “badges of fraud”.... These elements parallel those we have looked to in determining whether a property holder is in fact merely a nominee.... We think that faced with a similar situation, a Missouri court would likely apply this body of law.”). But at this stage, it does not matter what the specific factors of nominee ownership are. Plaintiff does not argue that the United States has failed to produce evidence showing nominee ownership. Instead, it only argues that nominee ownership does not exist under California law. And because the Court holds that it does, that ends the inquiry. The Court need not analyze whether there is a genuine dispute regarding the nominee factors. Plaintiff argues that because the nominee doctrine is not fleshed out in California, the Court should not borrow from federal common law for its analysis. Instead, the Court should apply an analogous California doctrine, the law of resulting trusts, which has been fleshed out. In support of this argument, Plaintiff cites two cases from other circuits. The first isSpotts v. United States , 429 F.3d 248, 253 [96 AFTR 2d 2005-7101] (6th Cir. 2002), also a federal tax-lien case. The district court, in applying the nominee theory, did not look to Kentucky nominee law because its nominee law is unclear. See id. at 252–53. Instead, it looked to the law of other courts.Id. at 253. The Sixth Circuit reversed, holding that even though Kentucky nominee law was unclear, the district court should have applied an analogous Kentucky state-law doctrine, that of constructive trust. See id. at 253. The second case, Holman v. United States, 505 F.3d 1060 [100 AFTR 2d 2007-6217] (10th Cir. 2007), has a very similar holding. The district court had borrowed another jurisdiction's law regarding nominee ownership, and the Tenth Circuit remanded the case, requiring the IRS to “identify the theory or theories under which it asserts that Mr. Holman has a beneficial interest in the Centerville property under Utah law.” Id. at 1068. These two cases are not binding precedent on this Court. And as the Court has already explained, California law does recognize the nominee theory of ownership. It even gives some general guidance on how to apply it. See Baumann, 46 Cal. App. 2d at 91–92 (taking title to property but not assuming debts, control and possession of the property, and receiving rents from property contributed to nominee status);Lewis , 214 Cal. App. 3d at 201 (analysis focuses on who is the beneficial owner). The Court can supplement these general guidelines with federal common law as many other courts in this circuit have done. E.g., Lang, 2008 WL 2899819 [102 AFTR 2d 2008-5367], at 5 (S.D. Cal. July 25, 2008). Plaintiff's motion for summary judgment on the issue of whether the United States can use a nominee theory of ownership is denied. B. Resulting Trust Plaintiff also claims that the United States cannot use the theory of resulting trust. “A resulting trust arises from a transfer of property under circumstances showing that the transferee was not intended to take the beneficial interest.” 11 Witkin, Summary of Cal. Law, Trusts § 297 (9th ed. 1990). It “is based on the manifestation of the person creating it.” Majewsky v. Empire Constr. Co., Ltd., 2 Cal. 3d 478, 485 (1970). “The trust arises because it is the natural presumption in such a case that it was their intention that the ostensible purchaser should acquire and hold the property for the one with whose means it was acquired.”Id. Plaintiff Leeds assumes (for the purposes of summary judgment only) that when it purchased the McCall Property from the STC Trust in 1995, a resulting trust was created, with Leeds as the trustee and Susanne Ballantyne as the beneficiary. But Plaintiff argues that Susanne Ballantyne sold or repudiated her interest in the resulting trust when Hemet C purchased 99% of Leeds. (Rhodes, a corporation owned by the Susanne C. Ballantyne Trust, retained the remaining 1% of Leeds as general partner.) Resulting trusts can be repudiated. In re Estate of Yool, 151 Cal. App. 4th 867, 875 (2007) (repudiation occurs when demand “has been made upon the trustee and the trustee refuses to account or convey”). Plaintiff claims that Susanne Ballantyne repudiated her interest in the resulting trust when Hemet C purchased most of Leeds. But it is generally the trustee that must repudiate the trust. 2 See, e.g., Yool, 151 Cal. App. 4th at 875. And in this case, the trustee of any resulting trust would be Plaintiff. Yet Plaintiff has failed to produce any evidence showing that it repudiated a resulting trust. A mere change in Plaintiff's ownership, especially when the new owner is a partnership largely owned by the Ballantyne's Children's Trusts and controlled by a corporation which counts the Ballantynes among its officers and directors, does not qualify as repudiation. Plaintiff itself, even with new owners, could still hold the McCall Property in trust for the benefit of the Ballantynes. Moreover, Plaintiff's general partner, Rhodes, was never replaced. Hemet C only bought the limited partnership interest, leaving Rhodes as Plaintiff's general partner. And the Ballantynes owned and controlled Rhodes until 1997. Given the Ballantynes' continued interest and control of Plaintiff through Rhodes and the lack of any act of repudiation, the Court denies summary judgment for Plaintiff on the repudiation issue. Plaintiff also argues that Susanne Ballantyne sold her interest in the resulting trust when Hemet C purchased all of the Susanne C. Ballantyne Trust's interest in Plaintiff. This argument also lacks merit. Plaintiff has not produced any documents referencing the sale of a resulting trust. And although the Susanne C. Ballantyne Trust sold its interest in Plaintiff, Susanne C. Ballantyne herself may still be the beneficiary of a resulting trust. She sold her ownership stake in Plaintiff, not in the resulting trust. Moreover, as discussed above, the Ballantynes still owned Plaintiff's general partner, even after the sale. But even if there was a repudiation, taxpayers cannot simply disclaim interests in property to avoid tax liens. See Drye v. United States, 528 U.S. 49, 60–62 [84 AFTR 2d 99-7160] (1999) (holding that debtor's disclaiming of inheritance according to state law, which generally prohibits creditors from reaching the inheritance under state law, did not defeat federal tax liens);United States v. Mitchell , 403 U.S. 190, 204 [27 AFTR 2d 71-1457] (1971) (holding wife's renouncement of interest in community property under state law could not avoid attachment of federal tax lien to property). Plaintiff's interest in the Fourth Avenue Property would therefore survive any purported repudiation. Lastly, Plaintiff is wrong that the four-year statute of limitations for a resulting trust claim has run. Plaintiff argues that a party must sue within four years of repudiation, and since the purported repudiation happened over four years before the United States filed suit, the resulting trust claim has expired. But “[t]he mere lapse of time, without repudiation, does not affect the beneficiary's rights” under a resulting trust. Yool, 151 Cal. App. 4th at 876. Here, there has been no repudiation, so Plaintiff has not shown anything beyond a “mere lapse of time.” Id. And even if the statute of limitations has run, state-law statutes of limitations are “inapplicable to bar the claims of the United States.” Bresson v. Commissioner of Internal Revenue, 213 F.3d 1173, 1175 [85 AFTR 2d 2000-1901] (9th Cir. 2000). For these reasons, the Ballantynes may have had an interest in the McCall Property on the date of the assessment, and there is a genuine dispute regarding the existence of a resulting trust. But there is no genuine dispute regarding repudiation, and the Court grants the United States motion for summary adjudication on the repudiation issue. C. The United States May Use a Fraudulent Transfer Theory of Ownership Plaintiff believes that the United States cannot use a fraudulent transfer theory to assert an interest in the McCall Property. Plaintiff gives two reasons: (1) the 1997 Notice of Federal Tax Lien did not mention fraudulent transfer, and (2) the United States has not pled a fraudulent transfer claim in its Answer or as a counterclaim. 3 Plaintiff cites no case law in support of its arguments. The United States did not have to specifically plead, or give notice of, a fraudulent transfer claim. The United States has given notice that it proceeds under a nominee theory. The United States can impose a lien on property if the owner of the property is the nominee of the taxpayer. See 26 U.S.C. §§ 6321;see G.M. Leasing Corp. v. United States , 429 U.S. 338, 350–51 [39 AFTR 2d 77-475] (1977) (holding that § 6321 allows the government to impose a lien on property in the hands of a third party straw man). And although the nominee theory requires showing some type of interest in property based on a state-law theory, there is no authority supporting Plaintiff's belief that each state-law theory must be specifically pled. Cf. In re Krause, 386 B.R. 785, 833–34 [101 AFTR 2d 2008-1943] (Bankr. D. Kan. 2008), aff'd, 2009 WL 5064348 [105 AFTR 2d 2010-731] (D. Kan. Dec. 16, 2009) (distinguishing between bringing direct fraudulent conveyance action as a stand alone action, and using fraudulent conveyance law as the basis for finding a state-law interest under a nominee claim). In the absence of support for Plaintiff's argument, the Court holds that the United States has adequately pled its nominee claim and may use a fraudulent transfer theory, either under California common law or statutory law, to show that the Ballantynes have an interest in the Fourth Avenue Property and Plaintiff is merely their nominee. D. The United States May Use an Alter-Ego Theory of Ownership In its reply brief, Plaintiff argues that the United States cannot use an alter-ego theory of ownership for two reasons. 4 First, Plaintiff argues that an alter-ego claim has not been pled. The Court rejects this argument for the same reason it rejected Plaintiff's fraudulent-transfer arguments. The United States only had to plead a nominee claim, not the several theories of state-law property rights that might support such a claim. Second, Plaintiff argues that the United States has said it will not assert an alter-ego claim, and should be precluded from doing so. The United States, in its proposed pretrial order, said that it “is not asserting claims under the theory of alter ego or under the California Fraudulent Conveyance Act.” But the United States has consistently maintained it is asserting a nominee claim, which can use a variety of state-law claims as support. See, e.g., Dalton v. Comm'r of Internal Revenue, 2008 WL 2651424 [TC Memo 2008-165], at 8 (U.S. Tax Ct. 2008) (In actions involving nominee claims, “various theories have been used to support the existence of an interest under State law, depending upon the jurisdiction and particular facts involved. Examples include resulting trust doctrines, constructive trust principles, fraudulent conveyance standards, and concepts drawn from State jurisprudence on piercing the corporate veil.”). Although the United States said it was not asserting alter-ego or California Fraudulent Conveyance Act claims, it may still use alter ego and fraudulent-transfer theories to show a property interest under state law. There is a distinction between asserting an alter-ego or fraudulent-transfer claim directly, and using those theories to support a nominee claim. The United States therefore is not precluded from using the alter-ego theory to support its nominee claim. E. The Constructive Trust Theory of Ownership Plaintiff argues for the first time in its reply brief that the United States may not use a theory of constructive trust in support of its nominee claim. The Court will not grant summary judgment on the constructive-trust theory until the United States has had an opportunity to respond. El Pollo Loco, Inc. v. Hashim, 316 F.3d 1032, 1040–41 (9th Cir. 2003) (court may not grant summary judgment on claims only raised in reply unless opposing party has opportunity to respond). Under California law, a constructive trust is an equitable remedy, not a substantive claim. Batt v. City and County of San Francisco, 155 Cal. App. 4th 65, 82 (2007) (“A constructive trust is not an independent cause of action but merely a type of remedy, and an equitable remedy at that.”) (internal quotations marks and citations omitted); 11 Witkin,Summary of Cal. Law , Trusts § 305 (9th ed. 1990). In order to establish a constructive trust, the purported beneficiary of the trust must have a substantive right to receive the property. United States v. Pegg, 782 F.2d 1498, 1500 (9th Cir. 1986) (“Because a constructive trust is a specific remedy, the plaintiff must have some interest that can be returned to it.”) Whether or not the Ballantynes are beneficiaries, and whether Plaintiff is the trustee, of a constructive trust is not properly before the Court on this motion and may be argued after the trial. 3. The United State May Address Adequacy of Consideration and the Ballantynes' Intent Plaintiff argues that the United States cannot rely on lack of consideration or intent in proving its nominee claim. The Court rejects this argument, as it is entirely without merit. Plaintiff cites no relevant case law supporting its argument. If adequacy of consideration and intent are relevant to establishing the Ballantynes' alleged state-law interest in the McCall Property, or if they are relevant to the nominee factors, the United States may address them. Regarding other factors that are part of the nominee analysis, it appears that the parties recognize that different factors are appropriate depending on the facts of each case, and that there is no fixed number of nominee factors. When this case goes to trial, the parties can make arguments about the relevant nominee factors. 4. There Is a Genuine Dispute of Material Fact About Whether Plaintiff Was a Subsequent Purchaser Under 26 U.S.C. § 6323, tax liens are not effective against third-party purchasers of property until the IRS has filed notice of the lien. Gorospe v. Comm'r of Internal Revenue, 451 F.3d 966, 967 [97 AFTR 2d 2006-2305] (9th Cir. 2006); 26 U.S.C. § 6323(a). Purchasers must have paid “adequate and full consideration” for the property, and must not have “actual notice” of the lien. 26 U.S.C. § 6323(h)(6). Plaintiff argues that the liens are ineffective against it because they were filed after it got legal title to the McCall Property. The United States does not dispute the timing of the notice, but it argues that the statutory lien is effective against Plaintiff as the Ballantyne's nominee. The Court agrees with the United States. If the United States establishes that Plaintiff is the Ballantyne's nominee, then Plaintiff is not entitled to the protections of 26 U.S.C. § 6323(a). See United States v. Clark, 2007 WL 3347515 [100 AFTR 2d 2007-6370], at 1 (M.D. Fla. Sept. 12, 2007) (“April E. Clark holds the subject property as a nominee of Alphonso J. Clark and thus is not entitled to the protection afforded by 26 U.S.C. § 6323.”). Moreover, Plaintiff only gets the protections of § 6323 if it meets the definition of purchaser. And a purchaser must have paid “adequate and full consideration” for the property. 26 U.S.C. § 6323(h)(6). So if the United States shows that Plaintiff did not pay full consideration for the McCall Property, this provision will not protect it. The Court holds that on the present record, there is a genuine dispute regarding whether Plaintiff is a subsequent purchaser under § 6323. A. Rhodes And Hemet C Are Not Subsequent Purchasers Plaintiff also argues that its two partners, Rhodes and Hemet C, are not subject to the tax lien. But § 6323 only applies to purchasers of property who paid full consideration without actual notice. Id. Rhodes and Hemet C did not buy the McCall Property; Plaintiff did. They only purchased an interest in Plaintiff, which is not covered by § 6323.See id. at 6323(h)(6). Moreover, Rhodes and Hemet C had actual notice of the assessments. Susanne Ballantyne herself controlled Rhodes at the time it purchased an interest in Plaintiff. And in January 1996, when Hemet C purchased an interest in Plaintiff, the Ballantynes held director and officer positions in Hemet C's general partner. Because the Ballantynes had actual notice of the assessments before January 1996 (they challenged the assessments in July 1994), that knowledge is imputed to Rhodes and Hemet C. Bank of N.Y. v. Fremont Gen. Corp., 523 F.3d 902, 911 (9th Cir. 2008) (“Generally, the knowledge of a corporate officer within the scope of his employment is the knowledge of the corporation.”) (quotingMeyer v. Glenmoor Homes, Inc. , 246 Cal. App. 2d 242 (1966)). Section 6323 therefore does not apply to Rhodes and Hemet C because they were not purchasers and they had actual knowledge of the assessments. The Court grants the United States's motion for summary adjudication and finds that Rhodes and Hemet C are not subsequent purchasers under § 6323. 5. Notice of the Assessment and Demand for Payment Was Proper Plaintiff challenges the tax assessments against the Ballantynes because of alleged procedural defects. Plaintiff, however, lacks standing to challenge the assessments. The assessment is against the Ballantynes, not Plaintiff. And a “third-party, non-delinquent taxpayer” may not attack a tax assessment based on procedural grounds. See Graham v. United States, 243 F.2d 919, 922 [51 AFTR 213] (9th Cir. 1957) (“We believe that only the taxpayer may question the assessment for taxes, and assert noncompliance by the Commissioner in sending the taxpayer a notice of deficiency by registered mail.”);Macatee, Inc. v. United States , 214 F.2d 717, 720 [45 AFTR 1818] (5th Cir. 1954) (“If there is cause for complaint for failure to give the notice required by 26 U.S.C.A. [6303], that cause belongs to the taxpayer.”). Plaintiff cites no cases contradicting the holding in Graham. But even if Plaintiff did have standing, the evidence establishes that there were no procedural defects in the assessments. The IRS assessed taxes against the Ballantynes several times between 1995 and 1998. 5 In order for those assessments to be valid, the IRS must send notice of the assessment and demand for payment within 60 days to the taxpayer's dwelling, place of business, or last known address. 26 U.S.C. § 6303(a). There is no requirement that the taxpayer actually receive the notice, only that it is sent to the taxpayer's last-known address. United States v. Zolla, 724 F.2d 808, 810 [53 AFTR 2d 84-652] (9th Cir. 1984). Plaintiff argues that the Ballantynes have no recollection of receiving notices of the assessment or demands for payment, and that there is no evidence establishing that they received notice. Because notice and demand for payment are conditions precedent for the creation of a tax lien, see 26 U.S.C. § 6321, if notice was defective, then the liens would be invalid. But here there was no defect. The United States has submitted and properly authenticated four Form 4340's, which show that the IRS properly sent notice and demand for payment. See Hansen v. United States, 7 F.3d 137, 138 [72 AFTR 2d 93-5922] (9th Cir. 1993) (per curiam) (“Form 4340 is probative evidence in and of itself and, in the absence of contrary evidence, shows that notices and assessments were properly made.”). The Form 4340's all state that on a particular date, the IRS sent a “statutory notice of balance due.” (See Black Decl. Exs. A–D.) Although the Ballantynes state that they have no recollection of receiving the notice of tax assessment, that is insufficient to raise a genuine issue as to whether notice was sent.Id. (declaration by taxpayers that they never received notice and demand “does not show the notice was not sent” and “fails to raise a genuine issue of material fact”). Hansen squarely rejected the same argument Plaintiff makes here. Plaintiff relies on several Ninth Circuit cases that precedeHansen to argue that Form 4340, or some other evidence, must show the address to which the IRS sent a demand for payment. In those cases, the Ninth Circuit noted that the Form 4340 contained the taxpayer's correct address. See, e.g., United States v. Zolla, 724 F.2d 808, 810 [53 AFTR 2d 84-652] (9th Cir. 1984). The Form 4340 submitted here does not show the address to which the demands were mailed. But Hansen does not require that a Form 4340 state the address. The presumption that the IRS sent a demand arises when the Form 4340 notes that demand was sent. See United States v. Scott, 290 F. Supp. 2d 1201, 1206 [92 AFTR 2d 2003-6946] (S.D. Cal. 2003) (citing Hansen, 7 F.3d at 138) (“Where a Form 4340 indicates that notice and demand were timely given, it is sufficient in the absence of contrary evidence to establish that such notice and assessment were made.”) And here, the Form 4340's note exactly that. The Court holds that there is not a genuine issue of fact regarding whether the IRS sent the notice and demand. The evidence establishes that notice and demand was proper under 26 U.S.C. § 6303(a). Because Plaintiffs lack standing and the notices and demands were proper, the Court grants the United States's motion for summary adjudication on the issue of proper notice and demand. Plaintiffs cannot challenge this at trial. 6. Plaintiff's Equitable Defenses Actions to levy property subject to a tax lien generally must be brought within ten years of the original assessment. 26 U.S.C. § 6502(a)(1). Although over ten years passed without the United States levying the McCall Property, the United States argues that the statute of limitations was tolled by the Ballantyne's submission of an offer in compromise (“OIC”) to settle their tax liability. While an OIC is pending, the applicable statute of limitations is sometimes tolled.See United States v. McGee , 993 F.2d 184, 186 [71 AFTR 2d 93-1967] (9th Cir. 1993) (citing United States v. Holloway, 798 F.2d 175, 176 [58 AFTR 2d 86-5641] (6th Cir. 1986). In response, Plaintiff asserts that the United States is equitably estopped from arguing tolling of the statute of limitations. Plaintiff points to misconduct and delay in the OIC process as grounds for estoppel. The United States moves for summary adjudication on Plaintiff's estoppel claim. 6 A. Motion for Leave to File Second Amended Complaint The First Amended Complaint does not plead equitable estoppel. Seizing on this, the United States argues that Plaintiff cannot assert equitable estoppel at trial. So Plaintiff has filed a motion for leave to file a Second Amended Complaint, which adds the estoppel claim. The Court denies Plaintiff's motion because, as set forth below, Plaintiff cannot establish estoppel.See Gompper v. VISX, Inc. , 298 F.3d 893, 898 (9th Cir. 2002) (court may deny amendment based on futility). B. Plaintiff Cannot Prove Equitable Estoppel The elements of equitable estoppel are “(1) [t]he party to be estopped must know the facts; (2) he must intend that his conduct shall be acted on or must so act that the party asserting the estoppel has a right to believe it is so intended; (3) the latter must be ignorant of the true facts; and (4) he must rely on the former's conduct to his injury.”Watkin v. United States Army , 875 F.2d 699, 709 (9th Cir. 1989) (citing United States v. Wharton, 514 F.2d 406, 412 (9th Cir. 1975). When a party asserts equitable estoppel against the United States, two more elements must be met: (1) “affirmative conduct going beyond mere negligence;” and (2) the “government's act will cause a serious injustice and the imposition of estoppel will not unduly harm the public interest.” Purcell v. United States, 1 F.3d 932, 932 [72 AFTR 2d 93-5821], 940 (9th Cir. 1993) (quotingS & M Inv. Co. v. Tahoe Regional Planning Agency , 911 F.2d 324, 329 (9th Cir. 1990)). The two additional elements are threshold requirements and the Court should consider them first. Purcell v. United States, 1 F.3d 932, 939 [72 AFTR 2d 93-5821] (9th Cir. 1993). Unreasonable delay and errors in the OIC process do not establish “affirmative conduct going beyond mere negligence,” which is a necessary element of equitable estoppel. Watkin, 875 F.2d at 709. At most, Plaintiff's evidence would show that the IRS was negligent in handling Plaintiff's case, and negligence is insufficient.Id. Plaintiff also cannot show that the “imposition of estoppel will not unduly harm the public interest.” Id. In fact, permitting Plaintiff to assert equitable estoppel might frustrate the legitimate attempts of the IRS to collect on taxes owed by the Ballantynes. Not only can Plaintiff not meet the special requirements for estoppel claims against the government, Plaintiff cannot meet the traditional elements of estoppel, which deal with detrimental reliance on misrepresentations of fact. There must be some “affirmative misrepresentation or affirmative concealment of a material fact by the government.” United States v. Ruby Co., 588 F.2d 697, 703–04 (9th Cir. 1978). Here, there is simply no misrepresentation or concealment that Plaintiff relied on to its detriment. In fact, the Ninth Circuit has already rejected a very similar claim by a taxpayer in United States v. McGee, 993 F.2d 184 [71 AFTR 2d 93-1967](9th Cir. 1993) Although the taxpayer in that case did not raise equitable estoppel specifically, he argued that because the IRS had abandoned his OIC, tolling should have stopped. The Ninth Circuit disagreed, holding that tolling only stops when the OIC is “terminated, withdrawn or formally rejected by the government.” Id. at 186. The Ninth Circuit emphasized that the taxpayer “was also not left unprotected; he could have withdrawn his offer at any time” and restarted the statute of limitations clock. Id. McGee stands for the proposition that if consideration of the OIC takes too long, the taxpayer has a simple remedy: withdraw the OIC. The Ballantynes chose instead to see the OIC process to its conclusion, and even appealed the IRS's rejection of their OIC. If they wanted to restart the clock, they could have. Therefore, the Court enters summary adjudication against Plaintiff on its equitable estoppel claim. 7. The Statutes of Limitations on the Tax Assessments Has Not Expired Plaintiff wants to argue at trial that the statute of limitations on collection of the Ballantynes' tax liabilities has expired. The United States moves for summary judgment on this issue, arguing that the evidence proves the statute of limitations has not run. The statute of limitations on collecting tax liabilities is ten years, starting on the day of the assessment. 26 U.S.C. § 6502. Here, the tax assessments were made in January 1995, June 1997, and November 1998. The parties agree the statute of limitations on all three assessments would have already expired absent tolling. The statute of limitations on tax collection can be tolled. When an OIC is pending, the statute of limitations is tolled until the OIC is “terminated, withdrawn, or formally rejected by the government.” United States v. McGee, 993 F.2d 184, 186 [71 AFTR 2d 93-1967] (9th Cir. 1993) (citing United States v. Holloway, 798 F.2d 175, 176 [58 AFTR 2d 86-5641] (6th Cir. 1986). But due to changes in the law, tolling during the pendency of an OIC did not apply from December 21, 2000 through March 8, 2002. See Staso v. United States, 538 F. Supp. 2d 1335, 1347 [101 AFTR 2d 2008-1100] (D. Kan. 2008) (discussing changes to law regarding tolling during OIC process). Here, the Ballantynes submitted an OIC with respect to the assessments made in 1995, 1997, and 1998. The IRS accepted the OIC for processing on October 24, 2000, which begins the tolling period. See United States v. Bourger, 2008 WL 4424810 [102 AFTR 2d 2008-6343], at 3 (D.N.J. Sept. 24, 2008) (“An offer to compromise becomes pending when it is accepted for processing.”) (quoting I.R.S. Revenue Procedure 2003–71 (2003). On October 23, 2007, the IRS Appeals Office finally rejected the Ballantyne's amended OIC, which terminated the OIC process. Although the OIC was pending during this entire time, there was no tolling from December 21, 2000 through March 8, 2002. Staso, 538 F. Supp. 2d at 1347. So to find the total number of days tolled, the Court starts with the total number of days the OIC was pending and subtracts the days that tolling did not apply: 2555 minus 443 equals 2,112 days. The Court adds 2,112 days, plus the normal 10-year limitations period, to the original expiration dates of the three assessments: January 2, 1995 assessment expires on or about October 15, 2010; June 30, 1997 assessment expires on or about April 12, 2013; November 16, 1998 assessment expires on or about August 28, 2014. None of the statutes of limitation for the three tax assessments have expired. Plaintiff does not dispute these dates, but instead argues that the United States is equitably estopped from asserting tolling. The Court has already rejected that argument. Plaintiff also argues that tolling is only available if the OIC is considered in due course. But Plaintiff relies on a case in which the specific tolling agreement between the IRS and the taxpayer required the IRS to review the OIC in “due course.” United States v. Cooper-Smith, 310 F. Supp. 479, 482 [25 AFTR 2d 70-1063] (E.D.N.Y. 1970). Here, there is no similar language in the Ballantynes' OIC. Plaintiff has failed to show a disputed fact and the Court enters summary adjudication against Plaintiff on the statute of limitations issue. 8. Plaintiff Cannot Limit the Value of the Tax Lien Plaintiff argues that if it loses this quiet title action, the Court should limit the value of the tax lien against the McCall Property to the property's value on the date Plaintiff got title. Plaintiff first raised this argument in its Addendum to the Pretrial Order. It has not been pled. Moreover, Plaintiff gives no support for its argument. It only cites California's Uniform Fraudulent Transfer Act, which states that if a creditor succeeds in a fraudulent transfer action, it may get a judgment against transferees “equal to the value of the asset at the time of the transfer, subject to adjustment as the equities may require.” Cal. Civ. Code § 3439.08(c). First, this provision only addresses claims made under California's fraudulent transfer law, not nominee claims, which is what the United States asserts here. Second, the provision only applies when the creditor seeks a monetary judgment against a transferee of the avoided transfer. See id. It does not apply when the creditor seeks to attach the property or only seeks to avoid the transfer and obtain relief directly from the debtor. See id. The Court enters summary adjudication in favor of the United States on the issue of limiting the value of the tax lien. IV. CONCLUSION The Court GRANTS the United States's motion for summary judgment [Doc. 58]. The Court grants summary adjudication in favor of the United States on the following claims and issues: equitable estoppel, statute of limitations, proper notice and demand, Rhodes' and Hemet C's status as subsequent purchasers, repudiation of a resulting trust, and limiting the value of the tax lien. The Court, however, holds that there is a genuine dispute of material fact regarding Plaintiff's status as a subsequent purchaser. The Court DENIES Plaintiff's motion for summary judgment in its entirety [Doc. 59]. The Court DENIES as moot Plaintiff's motion for leave to file a Second Amended Complaint [Doc. 74]. IT IS SO ORDERED. DATED: August 5, 2010 Honorable Barry Ted Moskowitz United States District Judge ________________________________________ 1 There is a dispute regarding whether notices and demands regarding the assessments were proper. The Court finds they were proper, as discussed in detail infra. ________________________________________ 2 The Court is unable to find any cases where the beneficiary has repudiated a trust. That is presumably because the resulting trust is generally used to protect the beneficiary's interest in the property.See 11 Witkin, Summary of Cal. Law, Trusts § 297 (9th ed. 1990) ________________________________________ 3 Plaintiff originally had a third argument, claiming that the United States's fraudulent transfer claim had been extinguished. Plaintiff has withdrawn this argument based on Bresson v. Commisioner of Internal Revenue, 213 F.3d 1173 [85 AFTR 2d 2000-1901] (9th Cir. 2000), which held that the extinguishment provisions of the California Uniform Fraudulent Transfer Act are inapplicable to actions by the IRS to collect income taxes. ________________________________________ 4 Normally, courts should only address arguments first raised in a reply if the opposing party has had the chance to respond to them. El Pollo Loco, Inc. v. Hashim, 316 F.3d 1032, 1040–41 (9th Cir. 2003). Nevertheless, since the Court rejects Plaintiff's arguments, the Court finds it unnecessary to have the United States respond. ________________________________________ 5 Plaintiff objects to evidence regarding the tax assessments as irrelevant, hearsay, and lacking foundation. The Court overrules the objections. The evidence regarding the assessments are public records attached to a declaration by John Black, an IRS Revenue Officer who is assigned to the Ballantynes case and who reviewed their IRS file. They are obviously relevant to the question of whether the assessments were made, Mr. Black's declaration establishes a proper foundation, and they fall within the public records hearsay exception. Fed. R. Evid. 803(8); see Hughes v. United States, 953 F.2d 531, 539–40 [69 AFTR 2d 92-472] (9th Cir. 1991). ________________________________________ 6 The United States also moved for summary adjudication on Plaintiff's purported laches defense, but Plaintiff states that it is not asserting a laches defense.

Canal Corporation and Subsidiaries v. Commissioner, 135 T.C. No. 9, Code Sec(s) 707; 752; 6662. ________________________________________ CANAL CORPORATION AND SUBSIDIARIES, FORMERLY CHESAPEAKE CORPORATION AND SUBSIDIARIES, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent . Case Information: Code Sec(s): 707; 752; 6662 Docket: Dkt No. 14090-06 Date Issued: 08/5/2010 . Judge: Opinion by KROUPA HEADNOTE XX. Reference(s): Code Sec. 707 ; Code Sec. 752 ; Code Sec. 6662 Syllabus Official Tax Court Syllabus Counsel Clifton B. Cates III, Robert H. Wellen, and David D.Sherwood, for petitioner. Curt M. Rubin, Matthew I. Root, and Steven N. Balahtsis, for respondent. KROUPA, Judge Respondent determined a $183,458,981 1 deficiency in petitioner's (Chesapeake) 2 Federal income tax for 1999, the year at issue. Respondent asserts in his amended answer that Chesapeake owes a $36,691,796 substantial understatement of income tax penalty under section 6662(a) 3 for 1999. We must determine whether Chesapeake's subsidiary's contribution of its assets and most of its liabilities to a newly formed limited liability company and the simultaneous receipt of a $755 million distribution should be characterized as a disguised sale, requiring Chesapeake to recognize a $524 million gain in 1999, the year of contribution and distribution. We hold that the transaction was a disguised sale, requiring Chesapeake to recognize the gain. We must also determine whether Chesapeake is liable for the substantial understatement penalty under section 6662(a). We hold Chesapeake is liable for the penalty. FINDINGS OF FACT Some of the facts have been stipulated and are so found. We incorporate the stipulation of facts and the accompanying exhibits by this reference. Chesapeake's principal place of (Code), and all Rule references are to the Tax Court Rules of Practice and Procedure, unless otherwise indicated. business at the time it filed the petition was Richmond, Virginia. Background of Chesapeake and WISCO Chesapeake is a Virginia corporation organized as a corrugated paper company in 1918. Chesapeake's business has expanded over time into several paper industry segments, including merchandising and specialty packaging, tissue, and forest and land development. Chesapeake eventually became a publicly traded company and served as the common parent of a group of subsidiary corporations filing consolidated Federal income tax returns. Each subsidiary managed its own assets and liabilities. Chesapeake received dividends from the subsidiaries and made loans to the subsidiaries as needed. Chesapeake's largest subsidiary was Wisconsin Tissue Mills, Inc. (WISCO). Chesapeake purchased WISCO's stock from Philip Morris in 1985 in a leveraged buyout transaction. WISCO manufactured commercial tissue paper products, including napkins, table covers, towels, place mats, wipes, and facial and bathroom tissue. WISCO sold its products to commercial and industrial businesses such as restaurants, hotels, schools, offices, hospitals and airlines. WISCO accounted for 46 percent of Chesapeake's sales and 94 percent of Chesapeake's earnings before interest and tax for 1998. Chesapeake and WISCO shared most of the same executive officers. WISCO incurred significant environmental liabilities during the 1950s and 1960s. The Environmental Protection Agency (EPA) determined that a mill WISCO operated contaminated the Fox River in Wisconsin with polychlorinated biphenyls (PCBs). The EPA designated the Fox River area as a Superfund site and held five companies, including WISCO, involved in the contamination jointly and severally liable for the cleanup costs (Fox River liability). Philip Morris indemnified Chesapeake for any Fox River liability costs up to the purchase price of WISCO. Approximately $120 million of the Phillip Morris indemnity remains. Chesapeake also purchased $100 million of environmental remediation insurance to pay costs beyond those covered by the indemnity. Chesapeake's management estimated that WISCO's remaining Fox River liability costs varied between $60 million and $70 million in 1999. In addition to the Fox River liability, WISCO and other Chesapeake subsidiaries also guaranteed a $450 million credit facility enabling Chesapeake to acquire another company in 2000. Tissue Business Tissue is a capital intensive commodities business, and only the largest companies have the ability to make the investment needed to compete in the industry. In the late 1990s, the tissue business experienced much consolidation. Fort Howard Corporation merged with James River Corporation to form Fort James Corporation. Kimberly-Clark Corporation purchased Scott Paper Company. These consolidations put smaller tissue businesses at a strategic disadvantage. Chesapeake, through WISCO and Chesapeake's Mexican subsidiary, Wisconsin Tissue de Mexico, S.A. de C.V. (WISMEX), was a second tier player in the tissue industry. Chesapeake sold its retail tissue business to the Fonda Group, Inc. in 1995. WISCO and WISMEX serviced only commercial accounts and lacked the large timber bases needed to support a retail business. Chesapeake had only two paper mills, one in Wisconsin and one in Arizona, and thus was at a significant logistical disadvantage in servicing the Southeast and Northeast. Restructuring of Chesapeake Chesapeake hired Tom Johnson as its chief executive officer and chairman in 1997. Mr. Johnson sought to restructure Chesapeake. He wanted to move Chesapeake away from its historic commodity products business and focus on specialty packaging and merchandising services. Chesapeake's speciality packaging business involved producing high-value custom packaging for such goods as perfume, liquor and pharmaceuticals. To that end, Chesapeake sold certain assets, including a mill, corrugated box plants, a building products business and substantial land. Chesapeake acquired other businesses and assets to further its specialty packaging business. Commercial tissue did not fit the new specialty packaging strategy. Chesapeake examined several options for the future direction of WISCO's tissue business. Chesapeake considered maintaining the status quo. Management concluded, however, that WISCO would be too small to compete. Management further determined that internal expansion would be too difficult and costly. Management also considered selling Chesapeake and all its subsidiaries. Management surmised that no one would buy all the diverse subsidiary businesses for an acceptable price. Pete Correll, chief executive officer of Georgia Pacific (GP), made overtures to Mr. Johnson regarding GP purchasing WISCO. GP's primary business was the manufacture and distribution of building products, timber, and paper products. GP also had a small profitable tissue business that accounted for 5 to 6 percent of its total sales. GP wanted to expand its tissue business but questioned whether GP's business could grow internally. GP viewed the purchase of WISCO as a strategic piece in advancing its tissue business. Chesapeake considered selling WISCO to generate capital for Chesapeake's new specialty packaging business. Given Chesapeake's low tax basis in WISCO, however, the after-tax proceeds would have been low compared to the pre-tax proceeds. This tax differential caused Chesapeake to decide a direct sale of WISCO would not be advantageous. Chesapeake thereafter engaged Salomon Smith Barney (Salomon) and PricewaterhouseCoopers (PWC) to explore strategic alternatives for the tissue business. Salomon recommended to Chesapeake's management that the best alternative for maximizing shareholder value would be a leveraged partnership structure with GP. 4 The leveraged partnership structure required WISCO to first transfer its tissue business assets to a joint venture. GP would then transfer its tissue business assets to the joint venture. Next, the joint venture would borrow funds from a third party and distribute the proceeds to Chesapeake (special distribution). Chesapeake would guarantee the third-party debt through a subsidiary. WISCO would hold a minority interest in the joint venture after the distribution, and GP would hold a majority interest. Salomon presented the leveraged partnership structure as tax advantageous to Chesapeake because it would allow Chesapeake to get cash out of the business yet still protect Chesapeake from recognizing a gain when the partnership distributed to Chesapeake the proceeds from the third-party loan. Chesapeake's board liked the leveraged partnership idea and thought GP seemed like a good fit as a partner. Chesapeake made clear to PWC and Salomon that the asset transfer and special distribution had to be nontaxable for it to approve the “Project Odyssey” after Homer's “The Odyssey” and identified Chesapeake as “Calypso” and GP as “Zeus.” transaction. Tax deferral enabled Chesapeake to accept a lower price. GP's executives accepted the leveraged partnership structure to expand its tissue business. GP did not have any interest in Chesapeake receiving a tax deferral. GP recognized, however, that it was a necessary part of bridging the purchase price gap. Chesapeake agreed to a lower up-front valuation of WISCO, 5 $775 million, because of the tax deferral benefit. PWC assisted Salomon in negotiating and structuring the joint venture. PWC examined the transaction from both an accounting and a tax perspective. PWC had served as Chesapeake's auditor and tax preparer for many years. Donald Compton (Mr. Compton), a partner in PWC's Richmond office, managed the Chesapeake account and had given Chesapeake advice on different David Miller (Mr. Miller) 6 worked with tax matters in the past. Mr. Compton on the Chesapeake and GP joint venture. PWC advised that Chesapeake did not need to guarantee the debt but needed only to provide an indemnity to the guarantor to defer tax. PWC also determined that the transaction should be treated as a sale for accounting purposes. Mr. Miller helped structure the indemnity agreement and aided in writing the partnership agreement. Indemnity Agreement GP agreed to guarantee the joint venture's debt and did not require Chesapeake to execute an indemnity. Mr. Miller advised Chesapeake, however, that an indemnity was required to defer tax on the transaction. Chesapeake's executives wanted to make the indemnity an obligation of WISCO rather than Chesapeake to limit the economic risk to WISCO's assets, not the assets of Chesapeake. The parties to the transaction agreed that GP would guarantee the joint venture's debt and that WISCO would serve as the indemnitor of GP's guaranty. WISCO attempted to limit the circumstances in which it would be called upon to pay the indemnity. First, the indemnity obligation covered only the principal of the joint venture's debt, due in 30 years, not interest. Next, Chesapeake and GP agreed that GP had to first proceed against the joint venture's assets before demanding indemnification from WISCO. The agreement also provided that WISCO would receive a proportionately increased interest in the joint venture if WISCO had to make a payment under the indemnity obligation. No provision of the indemnity obligation mandated that WISCO maintain a certain net worth. Mr. Miller determined that WISCO had to maintain a net worth of $151 million to avoid taxation on the transaction. GP was aware that WISCO's assets other than its interest in the joint venture were limited. GP nonetheless accepted the deal and never invoked the indemnity obligation. Joint Venture Agreement Chesapeake, WISCO, and GP executed the joint venture The two members (partners) 7 of the joint venture were agreement. WISCO and GP. The agreement provided that GP would reimburse WISCO for any tax cost WISCO might incur if GP were to buy out WISCO's interest in the joint venture. PWC Tax Opinion Chesapeake hired PWC to issue an opinion on the transaction's Federal tax implications. In fact, Chesapeake conditioned the transaction's closing upon PWC's issuing a “should” tax opinion. Instead of Mr. Compton, the PWC partner with the long-term relationship to Chesapeake, PWC assigned Mr. Miller to write the opinion. In effect, Mr. Miller's job was to review the transaction he helped structure. Mr. Miller considered three issues: (1) whether the joint venture qualified as a partnership for tax purposes, (2) whether WISCO was a partner in the joint venture, and (3) whether the distribution toChesapeake should be treated as part of a sale or qualifies under the debt-financed distribution exception. Chesapeake agreed to pay PWC an $800,000 fixed fee for issuing the opinion. The payment did not depend on time spent or expenses incurred by PWC. A letter PWC sent to Chesapeake stated that PWC would bill Chesapeake “at the closing of the joint venture financing.” Chesapeake's board informed Mr. Miller that as a condition to closing the transaction PWC would need to issue the opinion that the special distribution should not be currently taxable. A “should” opinion is the highest level of comfort PWC offers to a client regarding whether the position taken by a taxpayer will succeed on the merits. Mr. Miller and his PWC team reviewed the transaction's structure and approved each item that could affect the tax consequences. Mr. Miller crafted an “all or nothing” test for allocating the joint venture debt. Either all the liability would be allocated to WISCO or none of it would. Mr. Miller reasoned that the transaction would not be characterized as a sale provided the entire liability was allocated to WISCO. Mr. Miller found no legal authority for such a test. He created the test using his own analysis of then existing rulings and procedures. Mr. Miller based his opinion on WISCO's indemnification of GP's guaranty being respected. Mr. Miller assumed that WISCO had the ultimate legal liability for the full amount of the debt if the joint venture became wholly worthless. Mr. Miller concluded that WISCO could defer gain until it sold its remaining assets, paid off the debt, or sold its partnership interest. Mr. Miller advised that WISCO maintain assets of at least 20 percent of its maximum exposure under the indemnity. Mr. Miller did not have direct authority requiring this percentage. He merely made this determination based on Rev. Proc. 89-12, 1989-1 C.B. 798, which was declared obsolete by Rev. Rul. 2003-99, 2003-2 C.B. 388. 8 Moreover, Rev. Proc. 89-12, supra, makes no reference to allocation of partnership liabilities. Chesapeake also sought to transfer the assets of WISMEX to the joint venture. PWC informed Chesapeake that neither the United States nor Mexico could tax (1) the transfer of WISMEX's assets to WISCO or (2) the asset transfer from WISCO to the joint venture. Chesapeake caused WISMEX to transfer its assets to WISCO as advised by PWC. Mr. Miller wrote and signed the “should” opinion before issuing it to Chesapeake. The parties effected the transaction on the same day PWC issued the “should” opinion. The Transaction GP and WISCO formed Georgia-Pacific Tissue LLC (LLC) as the vehicle for the joint venture. GP and WISCO treated the LLC as a partnership for tax purposes. Both partners contributed the assets of their respective tissue businesses to the LLC. GP transferred to the LLC its tissue business assets with an agreed value of $376.4 million in exchange for a 95-percent interest in the LLC. WISCO contributed to the LLC all of the assets of its tissue business with an agreed value of $775 million in exchange for a 5-percent interest in the LLC. The LLC borrowed $755.2 million from Bank of America (BOA) on the same day it received the contributions from GP and WISCO. The LLC immediately transferred the loan proceeds to Chesapeake's bank account 9 as a special cash distribution. 10 GP guaranteed payment of the BOA loan, and WISCO agreed to indemnify GP for any principal payments GP might have to make under its guaranty. The LLC had approximately $400 million in net worth based on the parties' combined initial contribution of assets ($1.15 1 billion) less the BOA loan ($755.2 million), and it had a debt to equity ratio of around 2 to 1. The LLC assumed most of WISCO's liabilities but did not assume WISCO's Fox River liability. Chesapeake and WISCO both indemnified GP and held it harmless for any costs and claims that it might incur with respect to any retained liabilities of WISCO, including the Fox River liability. WISCO used a portion of the funds from the special distribution to repay an intercompany loan to Cary Street, Chesapeake's finance subsidiary. WISCO also used portions of the funds to pay a dividend to Chesapeake, repay amounts owed to Chesapeake and lend $151.05 million to Chesapeake in exchange for a note (intercompany note). The intercompany note was a 5-year note with an 8-percent interest rate. Chesapeake used the loan proceeds to repay debt, repurchase stock and purchase additional specialty packaging assets. WISCO's assets following the transaction included the intercompany note with a face value of $151 million and a corporate jet worth approximately $6 million. WISCO had a net worth, excluding its LLC interest, of approximately $157 million. This represented 21 percent of its maximum exposure on the indemnity. WISCO remained subject to the Fox River liability. Refinancing the Debt The LLC refinanced the BOA loan in two parts soon after the transaction closed. First, the LLC borrowed approximately $491 million from a GP subsidiary, Georgia-Pacific Finance LLC (GP Finance) to partially retire the BOA loan. This transaction occurred about a month after the closing date. Then the LLC borrowed $263 million from GP Finance the following year to repay the balance on the BOA loan. The GP Finance loans had terms similar to those of the BOA loans. GP executed a substantially identical guaranty in favor of the new lender, and WISCO executed a substantially identical indemnity obligation. PWC issued another opinion finding that the refinancing was tax free as well. Characterization of the Transaction for Tax and Non-Tax Purposes Chesapeake timely filed a consolidated Federal tax return for 1999. Chesapeake disclosed the transaction on Schedule M of the return and reported $377,092,299 book gain but no corresponding tax gain. Chesapeake treated the special distribution as non-taxable on the theory that it was a debt- financed transfer of consideration, not the proceeds of a sale. Unlike its treatment for tax purposes, Chesapeake treated the transaction as a sale for financial accounting purposes. Chesapeake did not treat the indemnity obligation as a liability for accounting purposes because Chesapeake determined that there was no more than a remote chance the indemnity would be triggered. Despite Chesapeake's characterization for tax purposes, PWC and Salomon each referred to the transaction as a sale. Standard & Poor's, Moody's and stock analysts also treated the transaction as a sale. Chesapeake executives represented to Standard & Poor's and Moody's that the only risk associated with the transaction came not from WISCO's agreement to indemnify GP but from the tax risk. Moody's downgraded Chesapeake after the announced joint venture because of Chesapeake's readjusted focus, the monetization of WISCO, and the resulting loss of operating income. Standard & Poor's kept its rating of Chesapeake the same because Chesapeake generated significant cash by divesting itself of WISCO for $755 million and of its timberlands for $186 million. End of the Joint Venture The joint venture operated for only a full year. It ended in 2001 when GP sought to acquire the Fort James Corporation. The Department of Justice required GP to sell its LLC interest for antitrust purposes. GP contacted Svenska Cellulosa Aktiebolaget (SCA), a Swedish company, about purchasing its LLC interest. SCA informed GP that it was interested in purchasing only the entire LLC, not just GP's interest in the LLC. Therefore, GP needed to buy WISCO's interest in the joint venture. WISCO agreed to sell its minority interest in the LLC to GP for $41 million, which represented a gain of $21.2 million from its initial valuation of $19.8 million. GP also paid Chesapeake $196 million to compensate Chesapeake for any loss of tax deferral. WISCO declared a $166,080,510 dividend to Chesapeake payable by cancelling Chesapeake's promissory note in 2001. Chesapeake reported a $524 million capital gain on its consolidated Federal tax return for 2001. Chesapeake determined that the termination of the indemnity resulted in WISCO receiving a deemed distribution under section 752. Chesapeake also reported the $196 million tax cost payment it received from GP as ordinary income on its consolidated Federal tax return for 2001. Respondent issued Chesapeake the deficiency notice for 1999. In the deficiency notice, respondent determined the joint venture transaction to be a disguised sale that produced $524 million of capital gain includable in Chesapeake's consolidated income for 1999. Chesapeake timely filed a petition. Respondent asserted in an amended answer a $36,691,796 accuracy-related penalty under section 6662 for substantial understatement of income tax. OPINION We are asked to decide whether the joint venture transaction constituted a taxable sale. Respondent argues that Chesapeake structured the transaction to defer $524 million of capital gain for a period of 30 years or more. Specifically, respondent contends that WISCO did not bear any economic risk of loss when it entered the joint venture agreement because the anti-abuse rule disregards WISCO's obligation to indemnify GP. See sec. 1.752-2(j), Income Tax Regs. Respondent concludes that the transaction should be treated as a taxable disguised sale. Chesapeake asserts that the transaction should not be recast as a sale. Instead, Chesapeake argues that the anti-abuse rule does not disregard WISCO's indemnity and that the LLC's distribution of cash to WISCO comes within the exception for debt-financed transfers. We disagree and begin with the general rules on disguised sales. I. Disguised Sale Transactions The Code provides generally that partners may contribute capital to a partnership tax free and may receive a tax free return of previously taxed profits through distributions. See secs. 721, 731. 11 These nonrecognition rules do not apply, however, where the transaction is found to be a disguised sale of See sec. 707(a)(2)(B). 12 property. A disguised sale may occur when a partner contributes property to a partnership and soon thereafter receives a distribution of money or other consideration from the A transaction may be deemed a sale if, based partnership. Id. on all the facts and circumstances, the partnership's distribution of money or other consideration to the partner would not have been made but for the partner's transfer of the property. Sec. 1.707-3(b)(1), Income Tax Regs. (emphasis added). Such contribution and distribution transactions that occur within two years of one another are presumed to effect a sale unless the facts and circumstances clearly establish otherwise (the 2-year presumption). Sec. 1.707-3(c)(1), Income Tax Regs. Here, WISCO transferred its assets with an agreed value of $775 million to the LLC and simultaneously received a cash distribution of $755.2 million. After the transfer and distribution, WISCO had a 5-percent interest in the LLC. Its assets included only its interest in the LLC, the intercompany note and the jet. We therefore view the transactions together and presume a sale under the disguised sale rules unless the facts and circumstances dictate otherwise. Chesapeake contends that the special distribution was not part of a disguised sale. Instead, it was a debt-financed transfer of consideration, an exception to the disguised sale rules. See sec. 1.707-5(b), Income Tax Regs. Chesapeake argues that the debt-financed transfer of consideration exception to the disguised sale rules limits the applicability of the disguised sale rules and the 2-year presumption in this case. A. Debt-Financed Transfer of Consideration We now turn to the debt-financed transfer of consideration exception to the disguised sale rules. The regulations except certain debt-financed distributions in determining whether a partner received “money or other consideration” for disguised sale purposes. 13 See id. A distribution financed from the proceeds of a partnership liability may be taken into account for disguised sale purposes to the extent the distribution exceeds the distributee partner's allocable share of the partnership liability. See sec. 1.707-5(b)(1), Income Tax Regs. Respondent argues that the entire distribution from the LLC to WISCO should be taken into account for purposes of determining a disguised sale because WISCO did not bear any of the allocable share of the LLC's liability to finance the distribution. We turn now to whether WISCO had any allocable share of the LLC's liability to determine whether the transaction fits within the exception. B. Partner's Allocable Share of Liability 14 In general a partner's share of a recourse partnership liability equals the portion of that liability, if any, for which the partner bears the economic risk of loss. See sec. 1.752- 1(a)(1), Income Tax Regs. A partner bears the economic risk of loss to the extent that the partner would be obligated to make an unreimbursable payment to any person (or contribute to the partnership) if the partnership were constructively liquidated and the liability became due and payable. Sec. 1.752-2(b)(1), Income Tax Regs.; see IPO II v. Commissioner, 122 T.C. 295, 300- 301 (2004). Chesapeake contends that WISCO's indemnity of GP's guaranty imposes on WISCO the economic risk of loss for the LLC debt. Respondent concedes that an indemnity agreement generally is recognized as an obligation under the regulations. Respondent asserts, however, that WISCO's agreement should be disregarded under the anti-abuse rule for allocation of partnership debt. C. Anti-Abuse Rule Chesapeake counters that WISCO was legally obligated to indemnify GP under the indemnity agreement and therefore WISCO should be allocated the entire economic risk of loss of the LLC's liability. We assume that all partners having an obligation to make payments on a recourse debt actually perform those obligations, irrespective of net worth, to ascertain the economic risk of loss unless the facts and circumstances indicate a plan to circumvent or avoid the obligation. Sec. 1.752-2(b)(6), Income Tax Regs. The anti-abuse rule provides that a partner's obligation to make a payment may be disregarded if (1) the facts and circumstances indicate that a principal purpose of the arrangement between the parties is to eliminate the partner's risk of loss or to create a facade of the partner's bearing the economic risk of loss with respect to the obligation, or (2) the facts and circumstances of the transaction evidence a plan to circumvent or avoid the obligation. See , sec. 1.752-2(j)(1), (3), Income Tax Regs. Given these two tests, we must review the facts and circumstances to determine whether WISCO's indemnity agreement may be disregarded as a guise to cloak WISCO with an obligation for which it bore no actual economic risk of loss. See IPO II v. Commissioner, supra at 300-301. 1. Purpose of the Indemnity Agreement We first consider the indemnity agreement. The parties agreed that WISCO would indemnify GP in the event GP made payment on its guaranty of the LLC's $755.2 million debt. GP did not require the indemnity, and no provision of the indemnity mandated that WISCO maintain a certain net worth. WISCO was chosen as the indemnitor, rather than Chesapeake, after PWC advised Chesapeake's executives that WISCO's indemnity would not only allow Chesapeake to defer tax on the transaction, but would also cause the economic risk of loss to be borne only by WISCO's assets, not Chesapeake's. Moreover, the contractual provisions reduced the likelihood of GP invoking the indemnity against WISCO. The indemnity covered only the loan's principal, not interest. In addition, GP would first have to proceed against the LLC's assets before demanding indemnification from WISCO. In the unlikely event WISCO had to pay on the indemnity, WISCO would receive an increased interest in the LLC proportionate to any payment made under the indemnity. We find compelling that a Chesapeake executive represented to Moody's and Standard & Poor's that the only risk associated with the transaction was the tax risk. We are left with no other conclusion than that Chesapeake crafted the indemnity agreement to limit any potential liability to WISCO's assets. 2. WISCO's Assets and Liabilities We now focus on whether WISCO had sufficient assets to cover the indemnity regardless of how remote the possibility it would have to pay. Chesapeake maintains that WISCO had sufficient assets to cover the indemnity agreement. WISCO contributed almost all of its assets to the LLC and received a special distribution and a 5-percent interest in the LLC. Moreover, Chesapeake contends that WISCO did not need to have a net worth covering the full amount of its obligations with respect to the LLC's debt. See sec. 1.752-2(b)(6), Income Tax Regs. WISCO's assets after the transfer to the LLC included the $151.05 million intercompany note and the $6 million jet. WISCO had a net worth, excluding its LLC interest, of approximately $157 million or 21 percent of the maximum exposure on the indemnity. The value of WISCO's LLC interest would have been zero if the indemnity were exercised because the agreement required GP to proceed and exhaust its remedies against the LLC's assets before seeking indemnification from WISCO. We may agree with Chesapeake that no Code or regulation provision requires WISCO to have assets covering the full indemnity amount. We note, however, that a partner's obligation may be disregarded if undertaken in an arrangement to create the appearance of the partner's bearing the economic risk of loss when the substance of the arrangement is in fact otherwise. See sec. 1.752-2(j)(1), Income Tax Regs. WISCO's principal asset after the transfer was the intercompany note. The indemnity agreement did not require WISCO to retain this note or any other asset. Further, Chesapeake and its management had full and absolute control of WISCO. Nothing restricted Chesapeake from canceling the note at its discretion at any time to reduce the asset level of WISCO to zero. In fact WISCO's board, which included many Chesapeake executives, did cancel the note and issued an intercompany dividend to Chesapeake in 2001. We find WISCO's intercompany note served to create merely the appearance, rather than the reality, of economic risk for a portion of the LLC debt. In addition, WISCO remained subject to the Fox River liability, and WISCO and other Chesapeake subsidiaries guaranteed a $450 million credit line obtained by Chesapeake in 2000. This guaranty and the Fox River liability further reduced WISCO's net worth. GP neither asked for nor received any assurances that WISCO would not further encumber its assets. We find that WISCO's agreement to indemnify GP's guaranty lacked economic substance and afforded no real protection to GP. 3. Anti-Abuse Rule Illustration Chesapeake seeks to distinguish the transaction in this case from the transaction illustrated in the anti-abuse rule. See sec. 1.752-2(j)(4), Income Tax Regs. (illustrating when payment obligations may be disregarded). The illustration considers a consolidated group of corporations that use a thinly capitalized subsidiary as a partner in a general partnership with a recourse debt payment guaranteed by the other partner. The circumstances are deemed indicative of a plan enabling the corporate group to enjoy the losses generated by the partnership's property while avoiding the subsidiary's obligation to restore any deficit in its capital account. Chesapeake argues WISCO was not a newly- created entity, as was the subsidiary in the illustration, but had been in business before the transaction. We find WISCO's preexistence insufficient to distinguish this transaction from the illustration. A thinly capitalized subsidiary with no business operations and no real assets cannot be used to shield a parent corporation with significant assets from being taxed on a deemed sale. Chesapeake intentionally used WISCO, rather than itself, to limit its exposure under the indemnity agreement. It further limited its exposure only to the assets of WISCO. We refuse to interpret the illustration to provide additional protection. Moreover, this appears to be a concerted plan to drain WISCO of assets and leave WISCO incapable, as a practical matter, of covering more than a small fraction of its obligation to indemnify GP. We find this analogous to the illustration because in both cases the true economic burden of the partnership debt is borne by the other partner as guarantor. Accordingly, we do not find that the anti- abuse rule illustration extricates Chesapeake, but rather it demonstrates what Chesapeake strove to accomplish. 4. Rev. Proc. 89-12 Does Not Apply to Anti-Abuse Rule Chesapeake also argues that it would be found to bear the economic risk of loss if the Court would apply a 10-percent net worth requirement. In so arguing, Chesapeake relies on Rev. Proc. 89-12, 1989-1 C.B. 798, which stated that a limited partnership would be deemed to lack limited liability for advance ruling purposes if a corporate general partner of the partnership had a net worth equaling 10 percent or more of the total contributions to the partnership. We decline Chesapeake's invitation to extend the 10-percent net worth test. Requirements for advance ruling purposes have no bearing on whether a partner will be treated as bearing the economic risk of loss for a partnership's liability. There are no mechanical tests. The anti-abuse rule mandates that we consider the facts and circumstances. We decline to establish a bright-line percentage test to determine whether WISCO bore the economic risk of loss with respect to the LLC's liability. 5. Speculative Fraudulent Conveyance Claims Chesapeake argues alternatively that WISCO bore the economic risk of loss because GP had a right to make fraudulent conveyance claims against Chesapeake and Chesapeake's financial subsidiary Cary Street. Chesapeake contends that such potential claims exposed WISCO to a risk of loss in excess of WISCO's net worth. This argument is flawed on many points. First, a fraudulent conveyance is simply a cause of action, not an obligation. See La Rue v. Commissioner, 90 T.C. 465, 478-480 (1988); see also Long v. Commissioner, 71 T.C. 1, 7-8 (1978), supplemented by 71 T.C. 724 (1979), affd. in part and remanded on other grounds 660 F.2d 416 [48 AFTR 2d 81-5912] (10th Cir. 1981). The Court may consider obligations only in allocating recourse liabilities of a partnership. See sec. 1.752-2(b)(3), Income Tax Regs. Next, Chesapeake's fraudulent conveyance argument connotes that Chesapeake engaged in a plan to circumvent or avoid the obligation. This argument completely undercuts and overrides Chesapeake's attempt to create an obligation on behalf of Chesapeake and Cary Street. Finally, we would render the anti-abuse rule meaningless by creating an automatic exception for speculative fraudulent conveyance claims. Accordingly, we reject this argument. We have carefully considered the facts and circumstances and find that the indemnity agreement should be disregarded because it created no more than a remote possibility that WISCO would actually be liable for payment. Chesapeake used the indemnity to create the appearance that WISCO bore the economic risk of loss for the LLC debt when in substance the risk was borne by GP. We find that WISCO had no economic risk of loss and should not be allocated any part of the debt incurred by the LLC. Consequently, the distribution of cash to WISCO does not fit within the debt-financed transfer exception to the disguised sale rules. Instead, we find Chesapeake has failed to rebut the 2- year presumption. The facts and circumstances evince a disguised sale. Accordingly, we conclude that WISCO sold its business assets to GP in 1999, the year it contributed the assets to the LLC, not the year it liquidated its LLC interest. II. Whether Chesapeake Is Liable for an Accuracy-Related Penalty Under Section 6662(a) We now turn to respondent's determination that Chesapeake is liable for the accuracy-related penalty under section 6662(a) and (b)(2) for a substantial understatement of income tax. Respondent bears the burden of proof for a penalty asserted in an amended answer. See Rule 142(a). A substantial understatement of income tax exists for a corporation if the amount of the understatement exceeds the greater of 10 percent of the tax required to be shown on the return, or $10,000. Sec. 6662(d)(1); sec. 1.6662-4(b)(1), Income Tax Regs. Chesapeake's correct tax for 1999 is $217,576,519, which includes the $183,458,981 deficiency determined in the deficiency notice. Respondent has established the understatement of income tax is substantial as it exceeds both 10 percent of the correct tax ($21,757,651) and $10,000. The accuracy-related penalty under section 6662(a) does not apply, however, to any portion of an underpayment if a taxpayer shows that there was reasonable cause for, and that the taxpayer acted in good faith with respect to, that portion. Sec. 6664(c)(1); sec. 1.6664-4(a), Income Tax Regs. We consider the pertinent facts and circumstances, including the taxpayer's efforts to assess his or her proper tax liability, the taxpayer's knowledge and experience and the reliance on the advice of a professional in determining whether the taxpayer acted with reasonable cause and in good faith. Sec. 1.6664-4(b)(1), Income Tax Regs. Generally, the most important factor is the extent of the taxpayer's effort to assess the proper tax liability. Id. Reasonable cause has been found when a taxpayer selects a competent tax adviser, supplies the adviser with all relevant information and, in a manner consistent with ordinary business care and prudence, relies on the adviser's professional judgment as to the taxpayer's tax obligations. Sec. 6664(c); United States v. Boyle, 469 U.S. 241, 250-251 [55 AFTR 2d 85-1535] (1985); sec. 1.6664- 4(b)(1), Income Tax Regs. A taxpayer may rely on the advice of any tax adviser, lawyer or accountant. United States v. Boyle, supra at 251. The right to rely on professional tax advice, however, is not unlimited. Neither reliance on the advice of a professional tax adviser nor reliance on facts that, unknown to the taxpayer, are incorrect necessarily demonstrates or indicates reasonable cause or good faith. See Long Term Capital Holdings v. United States, 330 F. Supp. 2d 122, 205-206 [94 AFTR 2d 2004-5666] (D. Conn. 2004), affd. 150 Fed. Appx. 40 [96 AFTR 2d 2005-6344] (2d Cir. 2005). The advice must not be based on unreasonable factual or legal assumptions and must not unreasonably rely on representations, statements, findings, or agreements of the taxpayer or any other person. Sec. 1.6664- 4(c)(1)(ii), Income Tax Regs. Courts have repeatedly held that it is unreasonable for a taxpayer to rely on a tax adviser actively involved in planning the transaction and tainted by an inherent conflict of interest. See e.g., Mortensen v. Commissioner, 440 F.3d 375, 387 [97 AFTR 2d 2006-1229] (6th Cir. 2006), affg. T.C. Memo. 2004-279 [TC Memo 2004-279]; Pasternak v. Commissioner, 990 F.2d 893 [71 AFTR 2d 93-1469] (6th Cir. 1993), affg. Donahue v. Commissioner, T.C. Memo. 1991-181 [1991 TC Memo ¶91,181]; Neonatology Associates, P.A. v. Commissioner, 115 T.C. 43 (2000), affd. 299 F.2d 221 (3d Cir. 2002). A professional tax adviser with a stake in the outcome has such a conflict of interest. See Pasternak v. Commissioner, supra at 903. Chesapeake claims it reasonably relied in good faith on PWC's tax advice and “should” opinion and therefore no penalty should be imposed. Respondent contends that Chesapeake unreasonably relied on an opinion riddled with improper assumptions written by a tax adviser with a conflict of interest. We look to whether PWC's advice was reasonable and inquire whether PWC's advice was based on all pertinent facts and circumstances and not on unreasonable factual or legal assumptions. See Long Term Capital Holdings v. United States, supra at 205-206. A. PWC Based Its Advice on Unreasonable Assumptions We now focus on whether PWC's advice was reasonable. Chesapeake contends that it relied on legal analysis prescribed in PWC's “should” opinion. Chesapeake submitted a draft, not the original, of the “should” opinion into evidence. We therefore look to the draft opinion to determine whether PWC's advice was reasonable. Chesapeake paid PWC an $800,000 flat fee for the opinion, not based on time devoted to preparing the opinion. Mr. Miller testified that he and his team spent hours on the opinion. We find this testimony inconsistent with the opinion that was admitted into evidence. The Court questions how much time could have been devoted to the draft opinion because it is littered with typographical errors, disorganized and incomplete. Moreover, Mr. Miller failed to recognize several parts of the opinion. The Court doubts that any firm would have had such a cavalier approach if the firm was being compensated solely for time devoted to rendering the opinion. In addition, the opinion was riddled with questionable conclusions and unreasonable assumptions. Mr. Miller based his opinion on WISCO maintaining 20 percent of the LLC debt. Mr. Miller had no case law or Code authority to support this percentage, however. He instead relied on an irrelevant revenue procedure as the basis for issuing the “should” opinion. A “should” opinion is the highest level of comfort PWC offers to a client regarding whether the position taken by the client will succeed on the merits. 15 We find it unreasonable that anyone, let alone an attorney, would issue the highest level opinion a firm offers on such dubious legal reasoning. We are also nonplused by Mr. Miller's failure to give an understandable response when asked at trial how PWC could issue a “should” opinion if no authority on point existed. He demurred that it was what Chesapeake requested. The only explanation that makes sense to the Court is that no lesser level of comfort would have commanded the $800,000 fixed fee that Chesapeake paid for the opinion. We are also troubled by the number of times the draft opinion uses “it appears.” For example, it states, "[i]n focusing on the language of the 752 regs, it appears that such regulation adopts an all or nothing approach.” Mr. Miller had no basis for that position other than his interpretation of the regulations. Further, Mr. Miller assumed that the indemnity would be effective and that WISCO would hold assets sufficient to avoid the anti-abuse rule. PWC assumed away the very crux of whether the transaction would qualify as a nontaxable contribution of assets to a partnership. In so doing PWC failed to consider that the indemnity lacked substance. Neither the joint venture agreement nor the indemnity agreement included provisions requiring WISCO to maintain any minimum level of capital or assets. WISCO and Chesapeake could also remove WISCO's main asset, the intercompany note, from WISCO's books at any time and for any reason. This possibility gutted any substance for the indemnity. We find that Chesapeake's tax position did not warrant a “should” opinion because of the numerous assumptions and dubious legal conclusions in the haphazard draft opinion that has been admitted into the record. Further, we find it inherently unreasonable for Chesapeake to have relied on an analysis based on the specious legal assumptions. B. Chesapeake Lacked Good Faith Moreover, Chesapeake did not act with reasonable cause or in good faith as it relied on Mr. Miller's advice. Chesapeake argues that it had every reason to trust PWC's judgment because of its long-term relationship with the firm. PWC crossed over the line from trusted adviser for prior accounting purposes to advocate for a position with no authority that was based on an opinion with a high price tag—$800,000. Any advice Chesapeake received was tainted by an inherent conflict of interest. We would be hard pressed to identify which of his hats Mr. Miller was wearing in rendering that tax opinion. There were too many. Mr. Miller not only researched and drafted the tax opinion, but he also “audited” WISCO's and the LLC's assets to make the assumptions in the tax opinion. He made legal assumptions separate from the tax assumptions in the opinion. He reviewed State law to make sure the assumptions were valid regarding whether a partnership was formed. In addition, he was intricately involved in drafting the joint venture agreement, the operating agreement and the indemnity agreement. In essence, Mr. Miller issued an opinion on a transaction he helped plan without the normal give-and-take in negotiating terms with an outside party. We are aware of no terms or conditions that GP required before it would close the transaction. We are aware only of the condition that Chesapeake's board would not close unless it received the “should” opinion. Chesapeake acted unreasonably in relying on the advice of PWC given the inherent and obvious conflict of interest. See New Phoenix Sunrise Corp. & Subs. v. Commissioner, 132 T.C. 161, 192-194 (2009) (reliance on opinion by law firm actively involved in developing, structuring and promoting transaction was unreasonable in face of conflict of interest); see also CMA Consol., Inc. v. Commissioner, T.C. Memo. 2005-16 [TC Memo 2005-16] (reliance not reasonable as advice not furnished by disinterested, objective advisers); Stobie Creek Invs., LLC v. United States, 82 Fed. Cl. 636, 714-715 [102 AFTR 2d 2008-5442] (2008), affd. ___ Fed. 3d ___ (June 11, 2010). We also find suspect the exorbitant price tag associated with the sole condition of closing. Chesapeake essentially bought an insurance policy as to the taxability of the transaction. PWC received an $800,000 fixed fee for its tax opinion. PWC did not base its fee on an hourly rate plus expenses. The fee was payable and contingent on the closing of the joint venture transaction. PWC would receive payment only if it issued Chesapeake a “should” opinion on the joint venture transaction. PWC therefore had a large stake in making sure the closing occurred. Considering all the facts and circumstances, PWC's opinion looks more like a quid pro quo arrangement than a true tax advisory opinion. If we were to bless the closeness of the relationship, we would be providing carte blanche to promoters to provide a tax opinion as part and parcel of a promotion. Independence of advisers is sacrosanct to good faith reliance. We find that PWC lacked the independence necessary for Chesapeake to establish good faith reliance. We further find that Chesapeake did not act with reasonable cause or in good faith in relying on PWC's opinion. We sustain respondent's determination that Chesapeake is liable for the accuracy-related penalty under section 6662(b)(2) for 1999. 16 We have considered all remaining arguments the parties made and, to the extent not addressed, we find them to be irrelevant, moot, or meritless. To reflect the foregoing, Decision will be entered for respondent. ________________________________________ 1 All monetary amounts are rounded to the nearest dollar. ________________________________________ 2 Chesapeake Corporation changed its name to Canal Corporation in June 2009. We refer to the corporation as Chesapeake in this Opinion. ________________________________________ 3 All section references are to the Internal Revenue Code ________________________________________ 4 Salomon referred to the leveraged partnership deal as ________________________________________ 5 Salomon had valued WISCO between $800 and $900 million in 1998. ________________________________________ 6 Mr. Miller is a licensed attorney. He practiced law with the law firm Jenkens & Gilchrist before joining Coopers & Lybrand's, now PWC's, Washington National Tax practice in 1996. He was not a practicing attorney at the time he gave the legal opinion here. ________________________________________ 7 We use the terms “partners,” “partnership,” and “LLC” for narrative convenience only as these are the terms used by the parties to the transaction. No inference should be drawn from our use of such terms regarding any legal status or relationship. ________________________________________ 8 Rev. Proc. 89-12, sec. 4.07, 1989-1 C.B. 798, 801, states that the Internal Revenue Service will generally rule that an organization lacks limited liability if the net worth of the corporate general partners equals at least 10 percent of the total contributions to the limited partnership and is expected to continue to equal at least 10 percent throughout the life of the partnership. ________________________________________ 9 Chesapeake maintained the bank accounts for its subsidiaries. ________________________________________ 10 The value of WISCO's assets contributed ($775 million) less the distribution ($755.2 million) equals the initial value of WISCO's 5-percent LLC interest ($19.8 million). ________________________________________ 1 ________________________________________ 11 Sec. 731 concerns distributions to a partner acting in his capacity as a partner. Neither party asserts that sec. 731 applies in this case. Moreover, sec. 731 does not apply if a partner contributes property to a partnership and the partnership distributes property to the partner within a short period to effect an exchange of property between two or more partners or between the partnership and a partner. Sec. 1.731-1(c)(3), Income Tax Regs. We will not therefore consider the effect of sec. 731 on the transaction. See sec. 1.707-1(a), Income Tax Regs. ________________________________________ 12 Transfers described in sec. 707(a)(2)(B) are treated as occurring between a partnership and a non-partner or partner acting outside his capacity as a member of the partnership. Sec. 707(a)(1), (2)(B). ________________________________________ 13 A distribution qualifies as a debt-financed transfer if it meets certain requirements. See sec. 1.707-5(b)(1), Income Tax Regs. We consider only the requirements at issue. ________________________________________ 14 A partner's allocable share of a partnership's recourse liability equals the partner's share of liability pursuant to sec. 752 and its regulations, multiplied by a fraction of which the numerator is the portion of the liability that is allocable to the distribution under sec. 1.163-8T, Temporary Income Tax Regs., 52 Fed. Reg. 24999 (July 2, 1987), and the denominator is the total amount of the liability. See secs. 1.707-5(b)(2)(i), 1.752-1(a)(1), 1.752-2, Income Tax Regs. The parties agree that the LLC's liability to BOA was recourse. The parties do not dispute that the special distribution to WISCO and the BOA loan were both $755.2 million. We need only determine WISCO's share of the LLC's liability under sec. 752 and its regulations. ________________________________________ 15 Mr. Miller testified that tax practitioners render different levels of opinion based on their comfort that the legal conclusions contained in the opinion are correct as a matter of law assuming the factual representations and assumptions set forth in the opinion are also correct. A “reasonable basis” opinion has a 33-percent chance of success on the merits. See sec. 1.6662-3(b)(3), Income Tax Regs. A “substantial authority” opinion has a 40-percent chance of success on the merits. See sec. 1.6662-4(d)(2), Income Tax Regs. A “more likely than not” opinion has a 51-percent chance of success on the merits. See id. Mr. Miller did not give an exact percentage regarding a “should” opinion, but he testified that it is materially higher than that of a “more likely than not” opinion. ________________________________________ 16 This holding should not be interpreted as requiring taxpayers to obtain a second tax opinion to qualify for the reasonable reliance exception under sec. 6664(c). Rather, we hold that taxpayers may not reasonably rely on an adviser tainted by an inherent conflict of interest the taxpayer had reason to know of. © 2010 Thomson Disre

Transfer of home to closely held shareholders was constructive dividend; penalties imposed RVJ Cezar Corporation et al, TC Memo 2010 –173 A new Tax Court decision illustrates the need for closely held corporations to be wary of constructive dividends when dealing with their owners. A closely held construction company's transfer of a home to its shareholders resulted in dividend/capital gain income to them, and taxable gain to the corporation. What's more, both the shareholders and the corporation were held liable for accuracy related penalties. Background. A dividend is a distribution of property from a corporation to its shareholders out of the corporation's earnings and profits. ( Code Sec. 316(a) ) The amount of the distribution equals the fair market value of the distributed property on the distribution date. ( Code Sec. 301(b)(1) , Code Sec. 301(b)(3) ) For dividends received before 2011, qualified dividend income is taxed at the same rates as long-term capital gain. ( Code Sec. 1(h)(11) ) After 2010, unless Congress changes the rules, dividend income will be taxed as ordinary income. The amount of a distribution that exceeds earnings and profits, and is therefore not a dividend, is taxable capital gain to the recipient. ( Code Sec. 301(c)(3) ) Under long-established case law, dividends may be formally declared or they may be constructive. A constructive dividend arises when a corporation confers a benefit on a shareholder by distributing available earnings and profits without expectation of repayment. A corporation that distributes appreciated property to a shareholder recognizes gain as if the property were sold to the shareholder at its fair market value. ( Code Sec. 311(b)(1) ) Gain is recognized to the extent that the property's fair market value exceeds the corporation's adjusted basis in the property. Taxpayers are liable for an accuracy-related penalty for any portion of an underpayment of income tax attributable to negligence or disregard of rules and regulations, unless they establish that there was reasonable cause for the underpayment and that they acted in good faith. ( Code Sec. 6662(a) , Code Sec. 6662(b)(1) , Code Sec. 6664(c)(1) ) Under Code Sec. 6662(b) , an accuracy related applies for a substantial understatement of income tax, i.e., the amount of the understatement exceeds the greater of 10% of the tax required to be shown on the return, or $10,000. Facts. Mr and Mrs. Cezar were the sole shareholders of RVJ Cezar Corporation, which built “spec” houses that it sold to the public. They paid $500 for their stock. Mr. Cezar, a general contractor, was the sole employee of the corporation. In 2001, Cezar Corp paid $150,000 for a lot, financing part of the purchase price with a mortgage, and spent $502,000 building an amenity-rich home approximately twice the size of its usual spec homes. Cezar Corp was listed as the sole owner of the spec home on the blueprints, permit, and notice of completion. Some of the construction materials were paid with a credit card issued in both Mr. Cezar's name and Cezar Corp, and the Cezars were unable to document most of the labor costs of building the home. The home was finished in 2004 and was offered for sale, but there were no takers. That year, Cezar Corp transferred the lot and improvements to the Cezars by quitclaim deed; they assumed the outstanding mortgage of $57,227. At the time of the transfer the lot and improvements had a total fair market value of $920,000. The transfer of ownership report filed with the Assessor's Office did not indicate that the property interest transferred to the Cezars was a partial interest. The Cezars did not report the receipt of the lot or the improvements on their return for 2004, nor did the corporation report the distribution of the lot and the improvements on its return for 2004. On audit, IRS determined that the distribution of the lot and the improvements was a constructive dividend from the corporation. It determined that the Cezars received a qualified dividend up to the amount of the corporation's earnings and profits, and treated the balance of the distribution, less their $500 initial capital contribution, as long-term capital gain. IRS also determined that both the Cezars and their corporation were liable for the accuracy related penalty. Tax Court sides with IRS. The Cezars conceded that they received the lot as a constructive dividend from the corporation. However, they argued that the improvements were not a constructive dividend because they owned the improvements by having paid for the construction materials and having done all the work to construct the improvements. The Tax Court agreed with IRS's assessment that improvements are built on land that one owns or else there would be an agreement identifying the rights and responsibilities of the parties. The Cezars failed to show that there was an agreement between them and the corporation that would have allowed them to construct a home on the corporation's property. Their ownership argument also was directly contradicted by Mr. Cezar's statements during the audit that the lot and the improvements were both corporate assets. Moreover, there was no credible evidence to support the Cezars' claim that they owned the improvements by paying the construction costs and personally completing the labor. The only records the Cezars produced to establish that they paid the construction costs were insufficient. Furthermore, the corporation was the sole owner of the lot as well as the improvements from the start of construction until the distribution to the Cezars. The corporation received property tax bills for both the lot and the improvements and did not protest that it had been billed for improvements that it did not own. The Tax Court also find it compelling that the corporation, which was in the business of building and selling homes, offered the lot and the improvements for sale without obtaining any transfer of interest from the Cezars. No prospective buyer would buy only the improvements and not the lot or vice versa. The Tax Court also noted that no other spec home that the corporation sold before or since was owned by the Cezars individually. Rather, all the homes and lots were owned and offered for sale by the corporation. As a result, the Tax Court found that the Cezars didn't establish that they owned the improvements, and sustained IRS's determination that the Cezars must include the distribution of the lot and the improvements in gross income as a constructive dividend from the corporation. The Tax Court also found that treatment of the home as a constructive dividend to the Cezars caused the corporation to recognize taxable income to the extent that the fair market value of the lot and improvement exceeded its adjusted basis. The Tax Court also hit the Cezars with an accuracy related penalty for the underpayment of income tax attributable to negligence or disregard of rules and regulations. It also hit Cezar Corp with an accuracy related penalty for substantial understatement of its income tax.