Farrow v. Commissioner, T.C. 2006-197 (2006).

T.C. Summary Opinion 2006-197

UNITED STATES TAX COURT

PAUL EDWIN FARROW, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 23763-05S. Filed December 28, 2006.

Paul Edwin Farrow, pro se.

Pamela M. Mable, for respondent.

WELLS, Judge: This case was heard pursuant to the provisions of section 7463 in effect at the time the petition was filed. The decision to be entered is not reviewable by any other court, and this opinion should not be cited as authority. All section references are to the Internal Revenue Code, as amended, and all Rule references are to the Tax Court Rules of Practice and Procedure.

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Respondent determined a deficiency in petitioner’s Federal income tax of $1,116 for taxable year 2002. The issues we must decide are whether certain payments petitioner made to his former spouse are deductible alimony payments or nondeductible child support payments and whether petitioner is entitled to the section 32 earned income credit.

Background

Some of the facts and certain exhibits have been stipulated. The parties’ stipulations of fact are incorporated in this opinion by reference and are found as facts in the instant case. At the time of filing the petition in the instant case, petitioner resided in Ellenwood, Georgia. During 1997, petitioner initiated divorce proceedings against his former spouse in the Superior Court of Solano County, California (Superior Court). Petitioner and his former spouse have two children, both of whom lived with petitioner for two and a half months during 2002.1

By order dated March 9, 1999 (March 1999 order), the Superior Court ordered the garnishment of petitioner’s wages in order to pay petitioner’s former spouse $977 per month for child

1The younger child was under 18 years of age throughout 2002. The older child turned 19 during September 2002 but did not graduate from high school until 2003. Petitioner does not dispute his obligation to support his children during 2002 and, as noted below, claimed the sec. 32 earned income credit based on both children.

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support, $471 per month for spousal support, and an additional $25 per month for child care expenses. The March 1999 order contained instructions (the instructions) to the payor limiting the amount that could be garnished to 50 percent of petitioner’s “disposable earnings”.2 The instructions stated that “If 50 percent of the Obligor’s net disposable earnings will not pay in full all of the assignments for support, prorate it first among all the support assignments in the same proportion that each assignment bears to the total current support owed.” However, the instructions further stated that “When this Order is for child support or family support, it has top priority over a similar order for spousal support.” The March 1999 order was in effect and had not been modified by or during 2002.

On the basis of the March 1999 order, approximately $441 was withheld from petitioner’s military retirement account3 and paid directly to his former spouse. Petitioner made no other payments to his former spouse during 2002. On his 2002 tax return, petitioner deducted as alimony $5,301 paid to his former spouse and claimed the section 32 earned income credit.

2According to the instructions, disposable earnings means earnings remaining after subtracting items required to be withheld by Federal and State law, for example: Federal income tax, Social Security tax, and State income tax.

3Petitioner retired from the U.S. Air Force in 2000. The actual amount garnished varied slightly from month to month based on cost of living increases.

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Discussion

The Commissioner’s determinations in the notice of deficiency generally are presumed correct, and the burden of proving an error is on the taxpayer.4  Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). In general, a payor spouse may deduct alimony payments but may not deduct child support payments. See secs. 71(b) and (c), 215(a) and (b). Section 71(c)(3) provides a special rule where the amount of the child support payment is less than the amount specified in the order: “if any payment is less than the amount specified in the instrument, then so much of such payment as does not exceed the sum payable for support shall be considered a payment for such support.” See also Hazam v. Commissioner, T.C. Memo. 2000-71.

In the instant case, the March 1999 order required petitioner to pay his former spouse each month $977 for child support, $471 for spousal support, and $25 for child care expenses. The instructions limited the amount that could actually be garnished from petitioner’s military retirement account to approximately $441. However, the instructions also stated that payments for child support are given priority over payments for spousal support where the garnishment is

4Sec. 7491(a) does not apply in the instant case to shift the burden of proof to respondent because petitioner did not raise the issue and also did not comply with the substantiation and record keeping requirements of sec. 7491(a)(2).

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insufficient to cover all of the assignments for support. We conclude that the payments from petitioner to his former spouse during 2002 were for child support and not for alimony. Accordingly, we hold that petitioner is not entitled to the claimed $5,301 deduction for taxable year 2002.

As to the section 32 earned income credit claimed by petitioner, that section requires the children to have the same principal place of abode as the taxpayer for more than one half of the taxable year. See secs. 32(c)(3), 152(c). Petitioner testified at trial that his children lived with him for only two and a half months during 2002. Consequently, we hold that petitioner is not entitled to the section 32 earned income credit for taxable year 2002.

To reflect the foregoing,

Decision will be entered for respondent.

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Leggett v. Commissioner, T.C. Memo. 2006-277 (2006).

T.C. Memo. 2006-277

UNITED STATES TAX COURT

WILLIAM M. LEGGETT, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 15167-04L. Filed December 28, 2006.

P filed a petition for judicial review pursuant to sec. 6330, I.R.C., in response to a determination by R that levy action is appropriate.

Held: R’s determination to proceed with collection by levy is sustained;

Held, further, a penalty pursuant to sec. 6673, I.R.C., is due from P and awarded to the United States in the amount of $2,500.

William M. Leggett, pro se.

Monica J. Miller, for respondent.

WHERRY, Judge: This case is before the Court on a petition for judicial review of a Notice of Determination Concerning Collection Action(s) Under Section 6320 and/or 6330. The issues for decision are: (1) Whether respondent may proceed with collection by levy of petitioner’s tax liabilities for the 1994, 1995, and 1996 taxable years; and (2) whether the Court should impose a penalty pursuant to section 6673(a).1

FINDINGS OF FACT At the time the petition was filed, petitioner resided in Sorrento, Florida.

Petitioner failed to file Federal income tax returns for his 1994, 1995, and 1996 taxable years. On July 26, 2000, respondent mailed to petitioner a notice of deficiency for those taxable years. Petitioner timely petitioned this Court, and a trial was held on October 15, 2001 (2001 trial). At trial, petitioner argued that the exchange of his personal physical services for Federal Reserve Notes did not constitute taxable income. The Court issued an Oral Findings of Fact and Opinion which sustained the deficiencies and additions to tax determined by respondent and admonished petitioner for failing to file his returns and raising frivolous tax-protester arguments.

1Unless otherwise indicated, all section references are to the Internal Revenue Code (Code) of 1986, as amended.

Thereafter, on March 1, 2004, respondent issued to petitioner a Final Notice - Notice of Intent to Levy and Notice of Your Right to a Hearing with respect to the years in issue. In response, petitioner timely submitted to respondent a Form 12153, Request for Collection Due Process Hearing, which stated that his disagreement with the levy was as follows: “ASSESSMENT INVALID”. The Appeals Office settlement officer assigned to petitioner’s case, J. Feist (Mr. Feist), wrote to petitioner on June 15, 2004, to notify him of his assignment, conference procedural practices, and the scheduled hearing date of July 2, 2004. Petitioner subsequently sent to Mr. Feist a letter dated June 27, 2004, that requested the hearing date be rescheduled for the middle of July and provided notice of his intention to audio record the hearing.

The hearing was conducted via telephone on July 12, 2004. Shortly after the hearing began, petitioner informed Mr. Feist that he was recording the hearing. Mr. Feist explained to petitioner that only face-to-face hearings may be recorded. He also advised that petitioner did not qualify for a face-to-face hearing as petitioner had only raised frivolous arguments. Mr. Feist ended the hearing when petitioner refused to cease recording and failed to raise any nonfrivolous relevant issues.

Respondent then issued to petitioner the above-mentioned Notice of Determination Concerning Collection Action(s) Under Section 6320 and/or 6330 for the years in issue on July 15, 2004. The attachment to the notice stated that the levy was “appropriate and reasonable under the circumstances thereby balancing the need for efficient collection of the taxes while not being any more intrusive than necessary.” It also indicated that petitioner’s unpaid tax liabilities for 1994, 1995, and 1996, were $77,311.19, $16,470.89, and $23,277.75, respectively, as calculated through July 15, 2004.

Petitioner timely petitioned this Court for review of the collection action. Petitioner argued in the petition that “the IRS violated petitioner’s right to procedural due process by refusing allow [sic] him to make an administrative record by recording the telephone conference on July 12, 2004.” Petitioner also contended that “the IRS failed to comply with the provisions of 26 U.S.C. Section 6321/31″, that “the assessments for the tax period [sic] 1994, 1995, and 1996 are invalid”, and that “the IRS lost its administrative collection powers by failing to comply with the notice requirements of 26 U.S.C. Section 6303.”

In addition, petitioner filed a posttrial brief which stated he did “not and has not engaged in an activity that produces ‘TAXABLE INCOME’, but only an exchange of intellectual and physical property for an agreed upon perceived value in the only medium of exchange of the day i.e. FRN’s [Federal Reserve Notes]”. Petitioner’s brief also stated that petitioner is “a ‘native born American national’, not to be mistaken as a ‘U.S. CITIZEN’”.

OPINION

I. Collection Action

A. General Rules

Pursuant to section 6331(a), if a taxpayer liable to pay taxes fails to do so within 10 days after notice and demand for payment, the Secretary is authorized to collect such tax by levy upon the taxpayer’s property. The Secretary is obliged to provide the taxpayer with 30 days’ advance notice of levy collection and of the administrative appeals available to the taxpayer. Sec. 6331(d). Upon a timely request a taxpayer is entitled to a collection hearing before the IRS Office of Appeals. Sec. 6330(b)(1).

At the collection hearing, the taxpayer may raise “any relevant issue relating to the unpaid tax or the proposed levy, including” appropriate spousal defenses, challenges to the appropriateness of collection actions, and offers of collection alternatives. Sec. 6330(c)(2)(A). The taxpayer may not contest the validity of the underlying tax liability unless the taxpayer did not receive a notice of deficiency for such tax liability or did not otherwise have an opportunity to dispute such tax liability. Sec. 6330(c)(2)(B). In rendering a determination, the Appeals officer must take into consideration verification that “requirements of any applicable law or administrative procedure have been met”, relevant issues relating to the unpaid tax or proposed levy, and “whether any proposed collection action balances the need for the efficient collection of taxes with the legitimate concern of the person that any collection action be no more intrusive than necessary.” Sec. 6330(c)(3).

The taxpayer is entitled to appeal the determination of the Appeals Office made on or before October 16, 2006, to the Tax Court or a U.S. District Court, depending on the type of tax at issue. Sec. 6330(d).2 Where the validity of the underlying tax liability is properly at issue, the Court will review the matter de novo. Sego v. Commissioner, 114 T.C. 604, 610 (2000); Goza v. Commissioner, 114 T.C. 176, 181-182 (2000). The Court reviews any other administrative determination regarding the proposed levy action for an abuse of discretion. Sego v. Commissioner, supra at 610; Goza v. Commissioner, supra at 182.

B. Appeals Hearing

Petitioner alleges that his right to procedural due process was violated because Mr. Feist did not allow him to record his telephonic hearing. Section 7521(a)(1) provides that

Any officer or employee of the Internal Revenue Service in connection with any in-person interview with any taxpayer relating to the determination or collection of

2Determinations made after Oct. 16, 2006, are appealable only to the Tax Court. See Pension Protection Act of 2006, Pub.

L. 109-280, sec. 855, 120 Stat. 1019.

- 7 any tax shall, upon advance request of such taxpayer, allow the taxpayer to make an audio recording of such interview at the taxpayer’s own expense and with the

taxpayer’s own equipment. This Court has held that section 7521 applies to section 6330 face-to-face hearings and a taxpayer providing the IRS with advance notice is allowed to record his face-to-face hearing. Keene v. Commissioner, 121 T.C. 8, 19 (2003). Notably, this Court has held that section 7521 is not applicable to telephonic hearings and a taxpayer is not entitled to record his telephonic hearing. Calafati v. Commissioner, 127 T.C. ___ (2006).

Absent a situation controlled by section 7521, as in the instant case, regulations promulgated under section 6330 provide that “A transcript or recording of any face-to-face meeting or conversation between an Appeals officer or employee and the taxpayer or the taxpayer’s representative is not required.” Sec. 301.6330-1(d)(2), Q&A-D6, Proced. & Admin. Regs. “[T]he applicable statutes and regulations do not confer any right to record a telephone conference conducted as part of a collection due process hearing.” Little v. United States, 97 AFTR 2d 20061466 (M.D.N.C. 2005), affd. 178 Fed. Appx. 230 (4th Cir. 2006).

This Court does not remand cases to the Commissioner’s Appeals Office merely on account of the lack of a recording when to do so is not necessary and would not be productive. Lunsford

v. Commissioner, 117 T.C. 183, 189 (2001); Frey v. Commissioner,

T.C. Memo. 2004-87. “A principal scenario falling short of the necessary or productive standard exists where the taxpayers rely on frivolous or groundless arguments consistently rejected by this and other courts.” Carrillo v. Commissioner, T.C. Memo. 2005-290; see also Lunsford v. Commissioner, supra; Frey v. Commissioner, supra; Durrenberger v. Commissioner, T.C. Memo. 2004-44; Brashear v. Commissioner, T.C. Memo. 2003-196; Kemper v. Commissioner, T.C. Memo. 2003-195. The Court does not find it necessary or productive to remand petitioner’s case for a second hearing as petitioner did not raise any relevant issues relating to his unpaid tax liabilities at his Appeals Office conference or at trial. Petitioner has instead espoused only frivolous and groundless arguments that the Court specifically rejected in petitioner’s 2001 trial and again in a 2005 trial regarding a deficiency and additions to tax for petitioner’s 2001 taxable year. See Leggett v. Commissioner, T.C. Memo. 2005-185.

C. Abuse of Discretion

The existence or amounts of petitioner’s underlying tax liabilities are not properly at issue because petitioner received a notice of deficiency for the years in issue and had the opportunity to dispute such liabilities at his 2001 trial. Accordingly, the Court will review the administrative record of the levy for an abuse of discretion. An abuse of discretion has occurred if the “Commissioner exercised * * * [his] discretion arbitrarily, capriciously, or without sound basis in fact or law.” Woodral v. Commissioner, 112 T.C. 19, 23 (1999).

Petitioner frivolously alleges without any evidentiary support that respondent did not comply with the notice requirements of section 6303. Section 6303(a) provides that “the Secretary shall, as soon as practicable, and within 60 days, after the making of an assessment of a tax pursuant to section 6203, give notice to each person liable for the unpaid tax, stating the amount and demanding payment thereof.” If the notice is mailed, it shall be sent to the taxpayer’s last known address. Sec. 6303(a). A notice of balance due constitutes a notice and demand for payment for purposes of section 6303(a). Craig v. Commissioner, 119 T.C. 252, 262-263 (2002). The record reflects that respondent sent petitioner a notice of balance due for the years in issue on May 12, 2003.

Petitioner alleges broadly that respondent did not comply with sections 6321 and/or 6331. Section 6321 is not relevant to petitioner’s case as it pertains to liens. Section 6331 governs levy actions and thus is applicable. The record reflects that respondent complied with section 6331 as respondent provided petitioner with the requisite notice, a Final Notice - Notice of Intent to Levy and Notice of Your Right to a Hearing, on March 1, 2004, which petitioner apparently received, as he requested a collection hearing.

Petitioner also contends that respondent’s assessments are invalid. Petitioner did not show, or even allege, that there was any irregularity in the assessment procedure that would raise a question about the validity of the assessments. Respondent noted verification in the notice of determination that all requirements of applicable law and administrative procedure had been met and that respondent had properly balanced the need for efficient collection against any legitimate concerns of intrusiveness raised by petitioner. Petitioner has not presented any evidence or persuasive arguments that respondent erred or abused his discretion but instead has raised frivolous and groundless arguments. Hence, the Court concludes that respondent’s determination to proceed with collection of petitioner’s tax liabilities was not in error or an abuse of discretion, and respondent may proceed with the proposed collection.

II. Section 6673 Penalty

Section 6673(a)(1) authorizes the Tax Court to impose a penalty not in excess of $25,000 on a taxpayer for proceedings instituted primarily for delay or in which the taxpayer’s position is frivolous or groundless. “A petition to the Tax Court, or a tax return, is frivolous if it is contrary to established law and unsupported by a reasoned, colorable argument for change in the law.” Coleman v. Commissioner, 791 F.2d 68, 71 (7th Cir. 1986).

Respondent, on brief, asserts that the Court should impose a penalty pursuant to section 6673(a)(1). Petitioner is no stranger to the Court or to the section 6673 penalty. Petitioner raised frivolous arguments in his first trial which involved the taxable years in issue here of 1994, 1995, and 1996. Petitioner made similar arguments in a 2005 trial, regarding a deficiency and additions to tax for his 2001 taxable year, and was ordered to pay $5,000 to respondent for again asserting frivolous arguments. Leggett v. Commissioner, supra. Despite repeated warnings by the Court in petitioner’s two previous trials and the imposition of a section 6673 penalty, petitioner repeated the same frivolous arguments in this current case although he did not dwell on them at trial. The Court is convinced that petitioner’s positions are frivolous and made at least in part for delay. Therefore, the Court concludes that a penalty of $2,500 should be imposed on petitioner.

The Court has considered all of petitioner’s contentions, arguments, requests, and statements. To the extent not discussed herein, we conclude that they are meritless, moot, or irrelevant.

To reflect the foregoing,

An appropriate decision will be entered.

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HJ Builders, Inc. v. Commissioner, T.C. Memo. 2006-278 (2006).

T.C. Memo. 2006-278

UNITED STATES TAX COURT

HJ BUILDERS, INC., Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent

PAUL W. AND CHARLENE R. WRIGHT, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket Nos. 8841-05, 8842-05. Filed December 28, 2006.

Joseph Jay Bullock and Karen Bullock Kreeck, for petitioners.

S. Mark Barnes, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

COHEN, Judge: Respondent determined deficiencies and penalties in these consolidated cases with respect to petitioner HJ Builders, Inc. (HJ Builders or the corporation), for its taxable year ended May 31, 2002, and with respect to petitioners Paul W. and Charlene R. Wright (Mr. and Mrs. Wright, respectively; the Wrights, collectively) for their taxable year ended December 31, 2001, as follows:

Penalty, I.R.C.

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After concessions by both parties, the issues remaining for decision are:

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Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the years in issue, and

all Rule references are to the Tax Court Rules of Practice and Procedure. All amounts have been rounded to the nearest dollar. FINDINGS OF FACT

Some of the facts have been stipulated, and the stipulated facts are incorporated in our findings by this reference. The principal place of business of HJ Builders was in West Jordan, Utah, at the time that the petition was filed at docket No. 8841-05. The Wrights resided in Salt Lake City, Utah, at the time the petition was filed at docket No. 8842-05.

At all times relevant to these cases, Mr. Wright was the sole shareholder and president of HJ Builders, a corporation engaged in residential construction and real estate development. Mr. Wright is known as Paul W. Wright, P. Wayne Wright, and Wayne Wright. HJ Builders uses the cash method of accounting for tax purposes. Distributions to Mr. Wright

In 2001, Mr. Wright received a salary of $60,000 from HJ Builders. Mrs. Wright received no wages from HJ Builders that year. Additional miscellaneous checks totaling $72,000 were paid to Mr. Wright by HJ Builders in 2001. These additional amounts were not reported as income on the Wrights’ 2001 Federal income tax return.

HJ Builders organized its receipts and disbursements using a system of account codes, each identifying a different category of business assets, liabilities, and expenses. There is a unique code attributable to “Loans payable P. Wayne Wright” under HJ Builders’ accounting system. No code was used to classify the checks to Mr. Wright totaling $72,000. HJ Builders did not deduct any of the additional disbursements to Mr. Wright on its corporate income tax return.

HJ Builders recorded a zero balance under the item “Loans from shareholders” on Schedule L, Balance Sheet per Books, of its Form 1120, U.S. Corporation Income Tax Return, for 2002, which Mr. Wright signed as president of HJ Builders under penalties of perjury, affirming that he had examined the return and its accompanying schedules and statements and that they were true, correct, and complete to the best of his knowledge.

There are purported loans from Mr. Wright to HJ Builders recorded in the corporation’s handwritten ledger entitled “Wayne Cash Loans to HJB”, none of which are corroborated by a formal promissory note with principal and interest rate corresponding to the amounts recorded in the ledger. The corporate records contain no repayment schedules, notations of regular payments, or interest calculations with respect to any loans from Mr. Wright to HJ Builders.

A Line of Credit Promissory Note (first note) dated September 1, 1995, bearing stated annual interest at 5 percent and payable on demand, was signed by Mr. Wright. The first note states: “FOR VALUE RECEIVED, P. Wayne Wright, (“Borrower”) promises to pay to the order of HJ Builders (“Lender”), the principal sum of One Million Dollars ($1,000,000)”.

An additional promissory note (second note) dated March 22, 1996, for the principal amount of $337,500, payable on demand to Mr. Wright by HJ Builders, bearing stated annual interest at

9.5 percent, or 12 percent if payment is not made upon demand,was signed on behalf of HJ Builders by Mr. Wright and an unidentified person. The second note is unsecured. The second note is not listed in the “Wayne Cash Loans to HJB” ledger. Attached to the second note is one page from a mortgage agreement dated March 22, 1996, between Mr. Wright and Draper Bank, signed by Mr. Wright in his personal capacity but stating that the loan is for the specified business purpose of purchasing investment property. The bank loan is for the principal amount of $337,500 as well and charges rates of interest identical to those in the second note but has a stated maturity date of April 1, 1999, and is secured by the underlying real estate.

A handwritten document entitled “Wayne’s Ledger” lists disbursements of funds by check number and amount from HJ Builders to Mr. Wright from July 1997 through December 2002. No specific promissory notes or other loan documents are associated with any entries. A notation “loans to Wayne YE 5/31/02” is written next to a bracketed total of $132,000 in disbursements made between June 5, 2001, and April 2, 2002, which includes the $72,000 amount in dispute.

On February 11, 2002, the corporate office of HJ Builders was burglarized. The police report made by Mr. Wright lists the items reported stolen or destroyed in the incident. No promissory notes were reported stolen or destroyed. Charitable Contributions

The Wrights are active and contributing members of their church community, and Mr. Wright is especially involved as a leader in church youth group activities. The Wrights wrote personal checks to their church totaling $28,750 in 2001 but deducted only $18,000 in charitable contributions on their 2001 joint income tax return.

Additional checks were written from an HJ Builders account to the Wrights’ church in the amount of $4,120 to fund a youth trip and to a bus company in the amount of $1,276 to facilitate the trip. HJ Builders did not receive a written acknowledgment from the Wrights’ church indicating that the corporation had made any charitable contributions to the church, and no charitable contribution deductions were claimed by HJ Builders on its tax return for 2002. Instead, the amounts expended by HJ Builders to and for the benefit of the church youth group were deducted as various business expenses on the corporation’s income tax return. The $4,120 disbursement was deducted in the corporate records as

a “Commission Expense” under “Cost of Goods Sold”. The $1,276 disbursement was deducted by the corporation as an “Advertising” expense. Lexus Payment

On July 10, 2001, HJ Builders made a payment of $12,155 to “Lexus”. While there was a 2000 Lexus SUV registered to Mr. Wright individually in 2001, no Lexus was registered in the name of HJ Builders until the corporation acquired a 2003 Lexus SUV. The check stub from the payment to Lexus listed the item under the corporation’s code for “Loans payable P. Wayne Wright”. The bill from Lexus was in Mr. Wright’s personal name, not in the name of HJ Builders. No expense deduction was claimed by HJ Builders for the payment to Lexus. The 2000 Lexus SUV was driven exclusively by Mrs. Wright, who was not a salaried employee of the corporation and was listed as a “housewife” on the Wrights’ 2001 return. No mileage logs were kept by Mrs. Wright or the corporation with respect to the 2000 Lexus. Notices of Deficiency

The Internal Revenue Service (IRS) commenced an audit of the Wrights’ 2001 Form 1040, U.S. Individual Income Tax Return, because of the large percentage of charitable contributions claimed ($18,000) to reported income ($61,176). The examining agent also observed that the Wrights’ standard of living did not appear supportable on their reported income. When the agent asked for substantiation of the charitable contributions, he was initially given an alleged receipt from the Wrights’ church showing $18,000. When he asked for copies of checks associated with the payments, he was presented with a new tithing donation slip for the amount of $28,750, which showed the same dates of contributions as the prior receipt but different amounts. The larger amounts were substantiated with copies of checks.

When the agent asked about the $72,000 in distributions to Mr. Wright, the representative of the corporation and of the Wrights initially had no explanation. Later the agent was told that the distributions were loan payments, but no supporting documentation was presented.

When the agent asked about travel expense substantiation, he was presented with bills for travel for various family members, including the Wrights’ teenaged children, and for greens fees for golf outings. No contemporaneous records substantiating the business purpose of certain trips were provided.

The notices of deficiency determined that checks amounting to $72,000 were taxable to Mr. Wright as constructive dividend income. The notices disallowed the business expense deductions claimed by HJ Builders for the $4,120 disbursement directly to the Wrights’ church and the $1,276 disbursement to the bus company. Those amounts were recharacterized as constructive dividends by the corporation to Mr. Wright. The notices allowed to the Wrights on Schedule A, Itemized Deductions, deductions for the entire $28,750 that was paid directly by the Wrights to their church in 2001. The notices determined that the $12,155 payment to Lexus by HJ Builders was for a personal vehicle and treated the payment of the personal expense as taxable constructive dividend income to Mr. Wright. The notices also determined negligence penalties under section 6662 with respect to the Wrights and HJ Builders.

OPINION

Our Findings of Fact describe in some detail the documentary evidence presented during trial and the progress of the audit that resulted in the statutory notices in issue in these cases, and we discuss that evidence further below in relation to specific issues. Because the only witness presented by petitioners was Mr. Wright, many of the issues depend, at least in part, on the credibility of petitioners’ evidence. Unfortunately, we must conclude that much of the evidence is unreliable. The record establishes that expenses were mislabeled and that the nature of certain of them was thus concealed; explanations were inconsistent and/or belated; and recollection was nonexistent or faulty.

Mr. Wright testified that he purposely understated his charitable contributions on his personal return because he understood that the actual amount was not fully deductible. The more plausible explanation is that he was advised that, in view of his reported income, claiming the actual amount of charitable contributions would increase the likelihood of audit. The cash contributions made would have approached but not exceeded the 50-percent limitation of section 170(b)(1), and the charitable contributions made from corporate funds would have brought the amount to more than 50 percent of the reported income. Respondent now would allow all of the charitable contributions because of the increase in the Wrights’ reportable income, subject to overall reductions in accordance with section 68(a) applicable to 2001. Cash Disbursements to Mr. Wright

Respondent argues that the $72,000 in disbursements at issue from HJ Builders to Mr. Wright was dividend distributions and taxable income to the Wrights. Petitioners argue that the disbursements were in repayment of loans previously made by Mr. Wright to the corporation.

The evidence presented by petitioners is inconsistent regarding the nature of the cash payments. Petitioners argue that the amounts in Wayne’s Ledger reflect repayments of previous loans made by Mr. Wright to HJ Builders. However, a handwritten notation on Wayne’s Ledger instead states that the disbursements between June 5, 2001, and May 2, 2002, totaling $132,000 reflect loans to Mr. Wright. We conclude that Wayne’s Ledger is inconclusive regarding both whether there were any loans from Mr. Wright to the corporation and whether the $72,000 in disbursements to Mr. Wright in 2001 was in repayment of those purported loans.

We also are not persuaded that the promissory notes that were presented by petitioners represent true indebtedness of the corporation. Even though the first note clearly states that the borrower is Mr. Wright and the lender is HJ Builders, petitioners argue that the names of the parties in the document are reversed and that Mr. Wright in fact advanced money on several different occasions to HJ Builders pursuant to the first note. The first note is a general line of credit and bears stated annual interest at 5 percent, but the corporation’s handwritten loan ledger lists several loans at various interest rates. Neither the corporation nor Mr. Wright has presented any record of an accounting for any alleged advancements, repayments, or accruals of interest regarding funds lent pursuant to the first note. There is no record that links the first note explicitly to any actual monetary advance by Mr. Wright to HJ Builders.

Unlike the general line of credit in the first note, the second note is for a specific amount purportedly advanced from Mr. Wright to HJ Builders. However, the second note is neither listed in the corporation’s handwritten ledger of “Wayne Cash Loans to HJB” nor taken into account for book purposes on the balance sheets of HJ Builders. There is no corporate record of any interest payments or repayment schedules in connection with the second note. Thus the first and second notes are unreliable and unpersuasive evidence in support of petitioners’ position that the $72,000 in disbursements to Mr. Wright in calendar year 2001 was in repayment of prior loans by Mr. Wright to HJ Builders.

Other conflicting evidence in the record prevents us from concluding either that the disbursements to Mr. Wright were in repayment of prior loans or that any such loans ever existed. Although HJ Builders had an accounting code for loans payable to Mr. Wright, no code was used to classify the payments totaling $72,000 to Mr. Wright in 2001, and HJ Builders recorded no shareholder loans on its Federal tax return. Petitioners have also claimed that the loan documents were stolen in a burglary of HJ Builders’ offices on February 11, 2002. However, no loan or other corporate documents are included in the list of stolen items provided to the police. Mr. Wright’s uncorroborated testimony that the loan documents were stolen in the burglary is unpersuasive. See Simpson v. Commissioner, T.C. Memo. 1999-274, affd. 23 Fed. Appx. 425 (6th Cir. 2001).

Petitioners have presented no reliable promissory notes, security agreements, payment schedules, amortization schedules, notations of regular payments, interest calculations, or any other similar documents to substantiate their claim that the $72,000 in miscellaneous checks paid to Mr. Wright over the course of 2001 was in repayment of loans from Mr. Wright to the corporation. See Meier v. Commissioner, T.C. Memo. 2003-94. Petitioners have not persuaded us that any loans from Mr. Wright to HJ Builders existed during the years in issue, and thus we must conclude that the cash disbursements to Mr. Wright in 2001 were not made in repayment of such alleged loans.

Even if petitioners had presented consistent and credible evidence that the cash payments to Mr. Wright were in repayment of prior loans to the corporation, we would conclude, based on the facts and circumstances of these cases, that those prior loans were in reality equity contributions and not debt.

Claims of a debt relationship in a transaction between controlling shareholders and their closely held corporations warrant heightened scrutiny because, unlike the situation in an arm’s-length transaction between unrelated parties, there is an opportunity and often a motivation to have investments treated as debt obligations rather than as capital contributions. Fin Hay Realty Co. v. United States, 398 F.2d 694, 696 (3d Cir. 1968); Cuyuna Realty Co. v. United States, 180 Ct. Cl. 879, 883-884, 382 F.2d 298, 300-301 (1967). When presented with the issue of whether a purported loan is debt or equity, the courts have generally weighed the following factors:

- -

-

-

-

The factors applicable to these cases all weigh in favor of

reclassifying any alleged loans from Mr. Wright to the

corporation as equity investments.

First, where funds advanced to a corporation by its

shareholders are proportional to the advancing shareholders’

equity interest in the corporation, there is an identity between

the purported creditor and the purported lender, which gives rise

to a strong inference that the funds advanced are additional

contributions to risk capital rather than loans. Segel v.

Commissioner, 89 T.C. 816, 830 (1987). In these cases,

Mr. Wright, the purported creditor, was the sole shareholder of

the purported debtor, HJ Builders. Mr. Wright was also the

corporation’s sole officer and had complete managerial control

over the corporation. Thus, the interests of debtor and creditor here are identical, and the lack of true bargaining between the parties prevents us from accepting the form of the instrument without an inquiry into the economic reality of the transaction. See Fin Hay Realty Co. v. United States, supra at 697.

Second, when a corporation receives financing that it could not acquire on similar terms from a commercial lender, the character of that financing may be considered equity, not debt. Id.; Segel v. Commissioner, supra at 828-829. Attached to the second note is a mortgage from Draper Bank for the same principal amount as the second note and with terms identical to it, except that the mortgage has a stated maturity date and is secured by the underlying realty. Regarding the relationship between the second note and the mortgage document, Mr. Wright testified at trial:

Later on, when my funds were depleted and I wasn’t able to loan the corporation money, I then approached commercial lending institutions who, because of the number of years that I’ve been in the business and had established a track record, they were willing to loan me personally funds that I then loaned to the corporation.

Comparing the second note and the related mortgage document, the second note had no stated maturity date and was not secured, which put Mr. Wright in a riskier position than Draper Bank. Draper Bank, as a disinterested lender, provided the loan to Mr. Wright for a fixed maturity date and required collateral as security for repayment. See Fin Hay Realty Co. v. United States, supra at 696. Had the corporation actually paid him interest, Mr. Wright would have received the exact same interest, or compensation for the use of his money, as he was required to pay to Draper Bank on its related mortgage. However, Mr. Wright’s purported loan to the corporation was a much riskier investment than the Draper Bank mortgage because it was unsecured and thus logically would have commanded a higher interest rate in the market to compensate Mr. Wright adequately for the increased risk. Mr. Wright could have gained no economic advantage from the nominal interest he would have received from the corporation on the second note, which supports respondent’s argument that the second note was a contribution of risk capital to the corporation and not evidence of true indebtedness.

Finally, no interest payments were ever made to Mr. Wright, and no interest was accrued with regard to any alleged loans. A purported lender who does not insist on interest payments is considered to be interested in the future earnings of the corporation and takes the investment risk of a contributor to capital, rather than that of a true lender. Segel v. Commissioner, supra at 833. A disinterested lender in an arm’s-length transaction would insist on interest accruals and payments. A disinterested lender would also insist on memorializing the loan and its terms in a formal promissory note, none of which exist to corroborate the alleged loans recorded in the corporate ledger “Wayne Cash Loans to HJB”. Therefore, we conclude that any alleged loans from Mr. Wright to HJ Builders were equity contributions to risk capital rather than true debt. See Fin Hay Realty Co. v. United States, 398 F.2d at 696; Segel

v. Commissioner, supra at 832. Thus the disbursements totaling $72,000 in 2001 were dividend distributions taxable to Mr. Wright.

On brief, petitioners assert for the first time that HJ Builders did not have enough earnings and profits in calendar year 2001 to allow for dividend treatment of the distributions paid out to Mr. Wright that year. Petitioners argue that adjustments should be made to HJ Builders’ stated earnings and profits to account for previous distributions to Mr. Wright that should have been treated, for both book and tax purposes, as dividend distributions but were not. Respondent argues that allowing this belated argument would prejudice respondent.

The Court has consistently allowed a party to rely on a theory only if the opposing party is provided with fair warning and is not prejudiced by the need to gather additional evidence to address the opposing party’s theory adequately. Seligman v. Commissioner, 84 T.C. 191, 198-199 (1985), affd. 796 F.2d 116 (5th Cir. 1986). Although petitioners claim that Wayne’s Ledger represents amounts distributed to Mr. Wright that reduced HJ Builders’ earnings and profits balance in previous years,

- 18 there is inadequate evidence in the record to support petitioners’ contentions and calculations. The ledger is unreliable for the reasons previously indicated. Raising the issue of the proper calculation of earnings and profits for the first time on brief has deprived respondent of the opportunity to consider the issue and to examine and/or produce relevant evidence. Therefore, we shall not consider petitioners’ earnings and profits argument. Charitable Contributions

Respondent disallowed the $4,120 payment to the Wrights’ church directly and the $1,276 payment for the benefit of the church’s youth group that were initially claimed as business expenses of the corporation, characterized the amounts as constructive dividends to Mr. Wright, and now proposes to treat the amounts as charitable contributions deductible on the Wrights’ Federal tax return for 2001.

When a corporation pays the personal expenses of a shareholder without expectation of repayment, it may make a constructive dividend distribution taxable to the shareholder. Magnon v. Commissioner, 73 T.C. 980, 993-994 (1980). Whether a constructive dividend exists turns on whether the distribution was primarily for the benefit of the shareholder. Hood v. Commissioner, 115 T.C. 172, 179-180 (2000). Mr. Wright testified at trial that he was personally involved as a counselor in his

church’s youth activities and felt he had a responsibility toward

the youth in his church, which factors led him to cause the

checks to be issued to and for the benefit of his church. Such

charitable motivations, absent some link to the corporation, are

personal. These payments by the corporation bestowed an economic

benefit on Mr. Wright, who was the true charitable donor based on

the economic reality of the transactions, and thus the

distributions out of the corporation to facilitate the youth

retreat from the Wrights’ church were taxable constructive

dividend income to Mr. Wright.

Lexus

Petitioners dispute respondent’s determination that the $12,155 paid to Lexus on July 10, 2001, was a constructive dividend to Mr. Wright. Though HJ Builders did not deduct the $12,155 payment to Lexus as a business expense on its Form 1120, petitioners now argue that the purchase of the Lexus was a capital expenditure by the corporation and not properly characterized as an actual or constructive payment to Mr. Wright.

The Lexus vehicle for which payment was made by the corporation was registered in the name of Mr. Wright individually, not HJ Builders. The vehicle was driven exclusively by Mrs. Wright, who was not a salaried employee of the corporation. The corporation’s check stub characterized the payment to Lexus as a loan payable to P. Wayne Wright.

Petitioners have presented no reliable evidence that the Lexus was a business asset. Although Mr. Wright testified that his wife used the Lexus exclusively for business, she did not appear at trial. Deductions related to passenger vehicles are not allowable unless the taxpayer substantiates by adequate records, or by sufficient evidence corroborating the taxpayer’s own statement, the time, place, and business purpose of the vehicle’s use. Sec. 274(d)(4). Although HJ Builders did not claim a business expense deduction for the payment to Lexus, petitioners argue that the payment is not income to the Wrights because the Lexus vehicle was a business asset. No records of use of the vehicle were provided by petitioners. Therefore, we conclude that the $12,155 payment to Lexus was a personal expense of the Wrights paid by the corporation and thus a constructive dividend distribution out of the corporation to Mr. Wright in 2001. Magnon v. Commissioner, supra at 993-994. Section 6662 Penalties

Section 6662 imposes a 20-percent accuracy-related penalty on any underpayment of Federal income tax attributable to a taxpayer’s substantial understatement of income tax or negligence or disregard of rules or regulations. Sec. 6662(a) and (b)(2). Section 6662(c) defines “negligence” as including any failure to make a reasonable attempt to comply with the provisions of the Internal Revenue Code and defines “disregard” as any careless, reckless, or intentional disregard.

Petitioners have conceded that many of the claimed business expenses disallowed by respondent in the notices of deficiency were personal expenses of the Wrights, not deductible by HJ Builders, and represent additional income to the Wrights. The evidence includes failure to maintain adequate records or to substantiate deductions, mislabeling of expenses, and the errors now conceded by petitioners. Petitioners have not addressed, at trial or on brief, the accuracy-related penalties determined by respondent pursuant to section 6662. Thus we deem petitioners to have conceded their liability for the penalties. See, e.g., Levin v. Commissioner, 87 T.C. 698, 722-723 (1986), affd. 832 F.2d 403 (7th Cir. 1987); Hendricks v. Commissioner, T.C. Memo. 2001-299.

Therefore, petitioners are liable for the accuracy-related penalties determined under section 6662. To reflect the foregoing,

Decisions will be entered under Rule 155.

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Champagne v. Commissioner, T.C. 2006-195 (2006).

T.C. Summary Opinion 2006-195

UNITED STATES TAX COURT

LORI ANN CHAMPAGNE, Petitioner, AND
DARRIN W. CHAMPAGNE, Intervenor v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 14313-05S. Filed December 27, 2006.

Lori Ann Champagne, pro se.

Darrin W. Champagne, pro se.

R. Scott Shieldes, for respondent.

DEAN, Special Trial Judge: This case was heard pursuant to

the provisions of section 7463 of the Internal Revenue Code in effect at the time the petition was filed. Unless otherwise indicated, subsequent section references are to the Internal Revenue Code as in effect for the year at issue, and all Rule

references are to the Tax Court Rules of Practice and Procedure.

The decision to be entered is not reviewable by any other court, and this opinion should not be cited as authority.

Respondent granted, in part, petitioner’s request for

section 6015 relief with respect to unpaid assessments of $27,714 in Federal income tax and a section 6662(a) accuracy-related penalty of $1,162 assessed against petitioner and Darrin W. Champagne (intervenor) for 2000. The issue for decision is whether petitioner is entitled to relief from joint and several liability under section 6015(b), (c), or (f) in excess of the amount determined by respondent.

Background

The stipulated facts and the exhibits received into evidence are incorporated herein by reference. At the time the petition in this case was filed, petitioner resided in Magnolia, Texas. At the time the notice of intervention was filed, intervenor resided in Pineland, Texas.

Petitioner and intervenor were married in 1993. The marriage was dissolved by an agreed final decree of divorce, filed in the district court of Texas, on March 1, 2002.

Petitioner has a bachelor’s degree in elementary education. From January to April of 2000, petitioner was employed by the Magnolia Independent School District as a teacher. Petitioner stayed home for the remainder of 2000 to care for her newborn child and four other minor children. Petitioner resumed her teaching around December of 2001.

Intervenor has taken a few college courses and has received some technical training. During 2000, he was employed by Southwest Computer Services.

On Form 1040, U.S. Individual Income Tax Return, for 2000, petitioner and intervenor reported adjusted gross income of $90,018 and taxable pensions and annuities of $2,919. Using third party information returns, respondent determined that taxable interest of $5 and an additional taxable pension distribution of $19,692, received by intervenor in 2000 (collectively, the omitted income), were not reported on the return.

On November 25, 2002, respondent issued to petitioner and intervenor a statutory notice of deficiency for 2000. Neither petitioner nor intervenor petitioned this Court in response to the notice of deficiency. Accordingly, a deficiency of $7,777

and a section 6662(a) accuracy-related penalty of $1,162 were assessed against petitioner and intervenor.

On March 22, 2003, respondent received a Form 1040X, Amended

U.S. Individual Income Tax Return, for 2000, signed only byintervenor. The amended return included income items that were not accounted for in the notice of deficiency, resulting in an additional assessment of $19,937.

On January 7, 2004, petitioner filed with respondent a Form 8857, Request for Innocent Spouse Relief, along with a questionnaire in which petitioner detailed her claim for relief from joint and several liability under section 6015 with respect to the assessments.

On April 28, 2005, respondent issued to petitioner a notice of determination. Respondent determined that since petitioner did not sign the amended return that resulted in the additional assessment of $19,937, she was entitled to relief from the unpaid tax for that amount under section 6015(f). Respondent, however, denied relief for the balance of the request, i.e., the deficiency assessment, determining that petitioner had knowledge of the omitted income at the time she signed the return.

According to the notice of determination, petitioner’s remaining tax liability is $6,992.1 Petitioner timely filed a petition with the Court seeking a review of respondent’s notice

1On the Form 8857, petitioner requested innocent spouse relief from the entire tax liability for 2000. According to the record, the unpaid tax for 2000 results from two assessments ($7,777 + $19,937), for a total of $27,714. After partial relief of $19,937, petitioner’s remaining tax liability should have been $7,777 plus penalty and interest. There is no explanation why respondent, in the notice of determination, determined that petitioner’s unpaid assessments for 2000 totaled $26,969 instead of $27,714, a difference of $745. The Court assumes that respondent has conceded the difference.

- 5 of determination denying, in part, her request for section 6015 relief. Discussion Jurisdiction

The Tax Court is a court of limited jurisdiction. Naftel v. Commissioner, 85 T.C. 527, 529 (1985). Under section 6015(e)(1)(A), the Court has jurisdiction to review an administrative determination regarding relief from joint and several liability, or a claim for relief where the Commissioner has failed to rule, as a “stand-alone” matter independent of any deficiency proceeding where the Commissioner has asserted a deficiency against the taxpayer. Billings v. Commissioner, 127

T.C. 7 (2006), on appeal (10th Cir., Oct. 23, 2006).

The Court has jurisdiction over this “stand-alone” matter under section 6015(e)(1)(A) because respondent has asserted a deficiency against petitioner for 2000. See sec. 6015(e)(1). Section 6015(c) Relief

Generally, married taxpayers may elect to file a joint Federal income tax return. Sec. 6013(a). After making the election, each spouse is jointly and severally liable for the entire tax due. Sec. 6013(d)(3). As a threshold matter, petitioner argues that she is not liable for the deficiency assessment, because she did not sign the joint return for 2000 that was filed with the Internal Revenue Service (IRS). Petitioner contends that she never saw the return. She further contends that intervenor handled the entire tax preparation process, including signing her name on the return for her. Petitioner, however, testified that she would have signed the return had intervenor presented it to her and that intervenor had her authority to prepare a tax return for her.

The fact that one spouse fails to sign the return is not fatal to the finding of a joint return. Heim v. Commissioner, 27

A spouse (requesting spouse), however, may seek relief from joint and several liability under section 6015(b), or if eligible, may allocate liability according to section 6015(c). If relief is not available under section 6015(b) or (c), the requesting spouse may seek equitable relief under section 6015(f). Sec. 6015(f)(2); Butler v. Commissioner, 114 T.C. 276, 287-292 (2000).

Except as otherwise provided in section 6015, the requesting spouse bears the burden of proof. Rule 142(a); Alt v. Commissioner, 119 T.C. 306, 311 (2002), affd. 101 Fed. Appx. 34 (6th Cir. 2004).

Upon the satisfaction of certain conditions, section 6015(c) relieves the requesting spouse of liability for the items making up the deficiency that would have been allocated solely to the nonrequesting spouse if the spouses had filed separate tax returns for the taxable year. Sec. 6015(d)(1), (3)(A); Cheshire

v. Commissioner, 282 F.3d 326, 332 (5th Cir. 2002), affg. 115

T.C. 183 (2000); Mora v. Commissioner, 117 T.C. 279, 290 (2001). Section 6015(c) applies only to taxpayers who are no longer married, are legally separated, or have been living apart for over a 12-month period. Sec. 6015(c)(3)(A)(i).

Petitioner and intervenor were divorced on March 1, 2002. Petitioner received a statutory notice of deficiency on November 25, 2002, and she subsequently filed a Form 8857.2 Therefore, petitioner was eligible to elect the application of section 6015(c).

2Under sec. 6015(c)(3)(B), an election for relief from joint and several liability under sec. 6015(c) is to be made at any time after a deficiency is asserted but not later than 2 years after the date on which the Commissioner has begun collection activities. Respondent has not raised any issue as to the timeliness of petitioner’s election under sec. 6015(c).

Relief under section 6015(c) is not available if the Commissioner demonstrates that the requesting spouse had actual knowledge, at the time the return was signed, of any item giving rise to a deficiency (or portion thereof) that is not allocable to such individual. Sec. 6015(c)(3)(C); Hopkins v. Commissioner, 121 T.C. 73, 86 (2003); Culver v. Commissioner, 116 T.C. 189, 194 (2001). Petitioner has the burden of proving which items would not have been allocated to her if the spouses had filed separate returns. See Mora v. Commissioner, supra at 290; Levy v. Commissioner, T.C. Memo. 2005-92.

Both this Court and the Court of Appeals for the Fifth Circuit have defined culpable knowledge in an omitted income case, for purposes of section 6015(c)(3)(C), as the “actual and clear awareness” of the item, as distinguished from mere reason to know of the item. Cheshire v. Commissioner, supra at 337 n.26; Cook v. Commissioner, T.C. Memo. 2005-22. While the taxpayer generally has the burden of proof, in order to preclude relief under section 6015(c) the Commissioner must carry the burden of demonstrating by a preponderance of the evidence that the requesting spouse had actual knowledge of “any item giving rise to a deficiency”. Rule 142(a)(1); Culver v. Commissioner, supra at 196; Charlton v. Commissioner, 114 T.C. 333, 341-342 (2000); sec. 1.6015-3(c)(2)(i), Income Tax Regs. “Item” means

- 9 -“an item of income, deduction, or credit”. Cheshire v. Commissioner, supra at 337.

In the case of omitted income, knowledge of the item includes knowledge of the receipt of the income. Sec. 1.6015-3(c)(2)(i)(A), Income Tax Regs. This Court has reviewed the record and finds that there is insufficient evidence to establish that petitioner had actual knowledge that intervenor received the omitted income.

The IRS may rely upon all of the facts and circumstances to demonstrate that a requesting spouse had actual knowledge of an erroneous item at the time the spouse signed the return. Sec. 1.6015-3(c)(2)(iv), Income Tax Regs. Respondent argues that petitioner had actual knowledge of the omitted income, at the time that the return was signed, because: (1) Petitioner had access to a bank account that she held jointly with intervenor during 2000, and (2) petitioner picked up and opened mail at the address where the Forms 1099 for the omitted income were sent.

Petitioner admits that she had access to one of intervenor’s bank accounts. Petitioner contends, however, that intervenor maintained bank accounts held solely in his name, of which she had no knowledge and to which she had no access to during their marriage. According to petitioner, the money from these secret accounts was used to finance intervenor’s “secret life” with other women. Petitioner suggests that it is possible that intervenor deposited the omitted income into one of these secret accounts, without her knowledge, to pay for the expenses of his other women.

One factor that respondent may rely on in demonstrating that petitioner had actual knowledge is whether she made a deliberate effort to avoid learning about the item in order to be shielded from liability. See sec. 1.6015-3(c)(2)(iv), Income Tax Regs. Intervenor did not appear at trial to testify, and there is no suggestion that petitioner made a deliberate effort to avoid learning of the omitted income. Moreover, respondent has not presented any evidence to show that the omitted income was deposited into the bank account that petitioner held jointly with intervenor, or that petitioner otherwise had an actual and clear awareness of the omitted income.

Petitioner contends that she never saw any Forms 1099 for the omitted income. Petitioner testified that there was a sewage leak in her home during 2000, and she and her children moved to temporary housing from May to December of 2000. Petitioner further testified that intervenor “was taking care of everything” and that she had no access to any mail that was sent to her home address during this period. According to petitioner, she was unaware of the omitted income and the attendant tax liability until she called the IRS regarding an unrelated tax issue in January of 2004.

Respondent counters that it is irrelevant whether petitioner was absent from her home from May to December of 2000. The Forms 1099 for the omitted income would have been mailed in early 2001, after petitioner had moved back into the house.

Both petitioner and intervenor had access to the mail at the address where the Forms 1099 were sent during early 2001. Intervenor did not leave petitioner until October of that year. Nevertheless, the Court finds that petitioner’s testimony was credible and persuasive that she was unaware of the omitted income until January of 2004. See Rowe v. Commissioner, T.C. Memo. 2001-325 (finding that the taxpayer had no actual knowledge of an IRA distribution, even though periodic statements from the financial institution managing the IRA were sent to her home address, since other family members also picked up the mail).

Petitioner’s testimony that she had no involvement in any aspect of intervenor’s business was also credible. Petitioner’s training was in elementary education. Petitioner worked as a teacher for the first 4 months in 2000, but was a homemaker for the remainder of the year. Petitioner stayed home with her five children while she relied on intervenor to provide for the family. Respondent has failed to meet his burden to prove that, at the time petitioner signed the 2000 return, she had an actual and clear awareness of the omitted income.

The Forms 1099 for the omitted income were issued solely to intervenor relating to a pension from his previous employment. Petitioner has established by a preponderance of the evidence that the deficiency at issue is entirely allocable to intervenor. See, e.g., Mora v. Commissioner, supra at 290-291.

The Court holds that respondent erred in denying petitioner relief under section 6015(c). Accordingly, petitioner is entitled to relief from joint and several liability under section 6015(c) for 2000. The Court need not address petitioner’s claims for relief under section 6015(b) and (f).

Reviewed and adopted as the report of the Small Tax Case Division.

Decision will be entered for petitioner.

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Wayne v. Commissioner, T.C. Summary Opinion 2006-196 (2006).

T.C. Summary Opinion 2006-196

UNITED STATES TAX COURT

THOMAS WAYNE AND ROSALIE GERALDINE KEENE, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 21153-05S. Filed December 27, 2006.

Thomas Wayne and Rosalie Geraldine Keene, pro se.

Brenda Fitzgerald, for respondent.

WELLS, Judge: This case was heard pursuant to the provisions of section 7463 in effect at the time the petition was filed. The decision to be entered is not reviewable by any other court, and this opinion should not be cited as authority. Unless otherwise indicated, all section references are to the Internal Revenue Code, as amended.

Respondent determined a deficiency in petitioners’ Federal income tax of $1,995 for their 2003 taxable year. The issue we decide is whether certain disability benefits received by petitioner Thomas Wayne Keene (petitioner) as workers’ compensation are includable in gross income pursuant to section 86(a).

Background

Some of the facts and certain exhibits have been stipulated. The parties’ stipulations of fact are incorporated in this opinion by reference and are found as facts in the instant case. At the time of filing the petition in the instant case, petitioners resided in Warner Robins, Georgia.

During 2003, petitioner received disability benefits from the U.S. Department of Labor (DOL), Office of Workers’ Compensation Programs, for a back injury that petitioner suffered on February 23, 1994. During 2003, petitioner also received Social Security disability benefits from the Social Security Administration (SSA). According to the SSA, petitioner’s primary disability is “discogenic/degenerative disorder of the back” and his secondary disability is “diabetes mellitus”.

The SSA reported to the Internal Revenue Service that petitioner had received “Net Benefits for 2003″ totaling $12,019, of which $9,706 was paid by DOL as workers’ compensation benefits. On the basis of a letter from the SSA, petitioner calculated that his taxable Social Security benefits for 2003

were $1,3761 and reported that amount on his 2003 tax return.

Respondent determined that petitioner’s taxable Social Security

benefits totaled $10,216.15, $8,840.15 greater than the amount

reported by petitioner.

Discussion

Petitioners contend, inter alia, that the Workers’

Compensation benefits petitioner received from DOL are not

taxable because they were not paid by the SSA.2 We disagree.

1The SSA letter petitioner used to calculate his taxable Social Security benefits states that petitioner’s monthly Social Security benefits for 2003 would be $192.70, minus a $58.70 deduction for Medicare, resulting in $134 to be deposited in petitioner’s bank account each month.

It is unclear how petitioner determined his taxable Social Security benefits totaled $1,376, because $134 multiplied by 12 months equals $1,608. We note that $192.70 multiplied by 12 months equals $2,312.40, and that the difference between petitioner’s $12,019 net Social Security benefits and the $9,706 paid by DOL is $2,313.

2Petitioners also contend that the issue in the instant case was previously decided in their favor in a Tax Court case at docket No. 22889-04S regarding their 2002 taxable year. Petitioners also rely on a letter from respondent’s Appeals Office dated Mar. 8, 2005, implying that respondent wrongly included petitioner’s workers’ compensation benefits in determining petitioners’ Social Security benefits for 2003.

We note that respondent and petitioner signed an agreed decision in the case at docket No. 22889-04S based on what respondent now contends was an erroneous conclusion by respondent’s Appeals Office. We also note that after respondent’s Appeals Office realized the error contained in the Mar. 8, 2005, letter to petitioners, respondent’s Appeals Office sent another letter dated July 18, 2005, to petitioners informing (continued…)

Gross income includes all income from whatever source derived unless excluded by a provision of the Internal Revenue Code. Sec. 61(a). Section 86(a) provides that gross income includes Social Security benefits in an amount equal to a prescribed formula.3 Social Security benefits mean any amount received by a taxpayer by reason of entitlement to a monthly benefit under title II of the Social Security Act. Sec. 86(d)(1)(A). Title II of the Social Security Act provides for disability benefits. See 42 U.S.C. secs. 401-434 (2000).

Prior to 1984, disability payments received by a taxpayer who retired due to a permanent disability were excluded from gross income pursuant to section 105(d). The Social Security Amendments of 1983, Pub. L. 98-21, sec. 122(b), 97 Stat. 87, repealed section 105(d) and the limited exclusion of disability benefits for tax years beginning after 1983. Since 1984, Social Security disability benefits have been taxed in the same manner

2(…continued) them that the March 8 letter was incorrect and that petitioner’s workers’ compensation benefits are includable in petitioner’s Social Security benefits for 2003.

We agree with petitioners that respondent’s Appeals Office has caused petitioners a great deal of confusion in the instant case. Nonetheless, for reasons stated below, petitioner’s workers’ compensation benefits are includable in gross income as taxable Social Security benefits notwithstanding respondent’s erroneous conclusions in the case at docket No. 22889-04S regarding petitioners’ 2002 taxable year.

3Petitioners have not challenged the formula provided in sec. 86(a).

as other Social Security benefits and subject to tax pursuant to section 86. Sec. 86(d)(1); Thomas v. Commissioner, T.C. Memo. 2001-120 (and cases cited therein). A reduction of Social Security disability benefits due to the receipt of benefits under a workmen’s compensation act does not reduce the total amount of taxable Social Security benefits. Sec. 86(d)(3); Mikalonis v. Commissioner, T.C. Memo. 2000-281. Accordingly, we hold the amounts petitioner received from DOL as workers’ compensation benefits are includable in gross income as taxable Social Security disability benefits.

To reflect the foregoing,

Decision will be entered for respondent.

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Harris v. Commissioner, T.C. Memo. 2006-275 (2006).

T.C. Memo. 2006-275

UNITED STATES TAX COURT

JONATHAN HARRIS, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 7754-06. Filed December 27, 2006.

Jonathan Harris, pro se.

Frederick J. Lockhart, Jr., for respondent.

MEMORANDUM OPINION

LARO, Judge: This case is before the Court on respondent’s motion to dismiss for failure to state a claim upon which relief can be granted and to impose a penalty under section 6673 as supplemented.1 Petitioner did not file a Federal income tax

1 Section references are to the applicable versions of the (continued…)

return for 2000, 2001, or 2002. Respondent prepared a Form 4549A, Income Tax Examination Changes, and issued to petitioner a notice of deficiency dated January 23, 2006, that determined the following deficiencies in petitioner’s Federal income tax and additions to tax:

-

With regard to the section 6651(a)(2) addition to tax for each year, the note marked by the “*” stated that “The amount of the addition to tax cannot be determined at this time, but an addition to tax of .5 percent will be imposed for each month, or fraction thereof, of nonpayment, up to 25 percent, based on the liability shown on this report.”

Petitioner, while residing in Wheat Ridge, Colorado, timely petitioned this Court. In his petition, petitioner denies being a “subject” liable to tax and argues, among other things, that he has, by his actions, relinquished his “subject” status of “U.S. citizenship” and that this Court lacks jurisdiction to decide the case.

1(…continued) Internal Revenue Code. Rule references are to the Tax Court Rules of Practice and Procedure.

Respondent filed a motion to dismiss the case for failure to state a claim upon which relief can be granted and to impose a penalty under section 6673. The motion was calendared for a hearing at a September 11, 2006, session of the Court in Denver, Colorado. Petitioner failed to appear when the case was called.

Rule 34(b)(4) requires that a petition filed in this Court contain clear and concise assignments of each and every error that the petitioning taxpayer alleges to have been committed by the Commissioner in the determination of any deficiency, addition to tax, or penalty in dispute. Rule 34(b)(5) further requires that the petition shall contain clear and concise lettered statements of the facts on which the taxpayer bases the assignments of error. See Funk v. Commissioner, 123 T.C. 213, 215 (2004); Jarvis v. Commissioner, 78 T.C. 646, 658 (1982). Any issue not raised in the pleadings is deemed to be conceded. See Rule 34(b)(4); Funk v. Commissioner, supra at 215. Further, the failure of a party to plead or otherwise proceed as provided in the Court’s Rules may be grounds for the Court to hold such party in default, either on the motion of another party or on the initiative of the Court. See Rule 123(a); Meeker v. Commissioner, T.C. Memo. 2005-146; Ward v. Commissioner, T.C. Memo. 2002-147. The Court also may dismiss a case and enter a decision against a taxpayer for the failure properly to prosecute or to comply with the Rules of this Court. See Rule 123(b); Meeker v. Commissioner, supra; Ward v. Commissioner, supra.

We agree with respondent that petitioner has failed to state a claim upon which relief can be granted. See Funk v. Commissioner, supra at 216-217; Meeker v. Commissioner, supra. Petitioner has failed to present the Court with a petition containing clear and concise assignments of error that petitioner alleges the Commissioner has committed in the determination of the deficiency or the additions related thereto. Petitioner has likewise failed to include in his petition clear and concise statements of the facts on which he bases his assignments of error. Petitioner’s petition contains only the type of frivolous arguments that have been repeatedly made and rejected by this and other courts. See, e.g., Funk v. Commissioner, supra. The petition neither conforms to this Court’s Rules of Practice and Procedure nor states a claim upon which relief can be based. Due to the absence from the petition of specific justiciable allegations of error and of supporting facts, this Court shall grant respondent’s motion. See id.

In respondent’s motion, respondent also asks the Court to impose a penalty on petitioner under section 6673. Section 6673(a)(1) authorizes this Court to require a taxpayer to pay to the United States a penalty not in excess of $25,000 whenever it appears that proceedings have been instituted or maintained by the taxpayer primarily for delay or that the taxpayer’s position in such proceeding is frivolous or groundless. A taxpayer’s position is frivolous or groundless if it is “‘contrary to established law and unsupported by a reasoned, colorable argument for change in the law.’” Williams v. Commissioner, 114 T.C. 136, 144 (2000) (quoting Coleman v. Commissioner, 791 F.2d 68, 71 (7th Cir. 1986)). We find that petitioner has advanced frivolous and groundless statements, contentions, and arguments. We further find that petitioner has instituted this proceeding primarily for delay. Under the circumstances presented, we shall impose on petitioner a penalty in the amount of $5,000.

To reflect the foregoing,

An appropriate order of

dismissal and decision will be

entered for respondent.

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December 27th, 2006 | No Comments »

Great Plains Gasification Associates v. Commissioner, T.C. Memo. 2006-276 (2006).

T.C. Memo. 2006-276

UNITED STATES TAX COURT

GREAT PLAINS GASIFICATION ASSOCIATES, A PARTNERSHIP, TRANSCO COAL GAS COMPANY, A PARTNER OTHER THAN THE TAX MATTERS PARTNER, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 10578-01. Filed December 27, 2006.

H. Karl Zeswitz, Jr., Kent L. Jones, and Mary E. Monahan,

for petitioner.1

Derek B. Matta, David Q. Cao, John F. Eiman, and Elizabeth

Girafalco Chirich, for respondent.

1 The petition was signed by petitioner’s counsel, F. Brook Voght, who died on Sept. 16, 2003.

- 2 MEMORANDUM FINDINGS OF FACT AND OPINION

THORNTON, Judge: This is a partnership-level proceeding subject to the unified audit and litigation procedures of sections 6221 through 6231.2

In the 1970s, reacting to a global energy crisis, the Federal Government reached out to private industry to help develop alternative energy sources, including synthetic fuels. In response, five major energy companies, through their subsidiaries, formed a partnership, Great Plains Gasification Associates (the partnership), to develop, construct, own, and operate a project to produce natural gas from coal (the project). The partnership financed the project with about one-half billion dollars of the partners’ equity contributions and a $1.5 billion loan (the loan) from the Federal Financing Bank (FFB). The loan was secured by a mortgage on the partnership’s assets and guaranteed by the U.S. Department of Energy (DOE). The parent

2 Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the taxable years at issue. All Rule references are to the Tax Court Rules of Practice and Procedure.

The tax matters partner for Great Plains Gasification Associates (the partnership) is ANR Gasification Properties Co. (ANR). The tax matters partner for the partnership did not file a petition for readjustment of partnership items. Transco Coal Gas Co. (Transco), a partner of the partnership other than the tax matters partner, satisfies the requirements of sec. 6226(b) and (d) and timely filed the petition on behalf of the partnership and Transco.

corporation of one of the partnership’s general partners pledged certain stock as security for DOE’s loan guarantee.

The partnership built the coal gasification plant in Mercer County, North Dakota, near available coal reserves. Upon its completion in 1984, the project was the only commercial-scale operation of its type in the United States.

From an engineering perspective, the project was successful, employing innovative catalytic processes to convert low-grade, low-value lignite coal into high-Btu (British thermal units) pipeline-quality synthetic natural gas. The plant achieved average daily production of 125,000 mcf (thousand cubic feet). It remains in production today.

Economically, however, the project was less successful. As construction neared completion, energy prices dropped. Anticipated initial losses from the project rose. Anticipated cashflows fell. In 1985, the partnership defaulted on the DOE-guaranteed loan. Pursuant to the guarantee agreement, DOE paid off the loan; by subrogation, the partnership’s debt shifted from FFB to DOE. In a June 30, 1986, foreclosure sale, DOE bid $1 billion for the partnership’s mortgaged assets, effectively reducing the partnership’s outstanding $1.57 billion liability by $1 billion in exchange for the mortgaged project assets.3

3 In October 1988, the U.S. Department of Energy (DOE) released the partnership’s remaining debt when it took possession (continued…)

The partnership unsuccessfully contested the foreclosure proceedings in litigation which concluded in November 2, 1987, when the U.S. Supreme Court denied the petition for writ of certiorari. For Federal income tax purposes, the partnership reported disposing of the project assets as of that date.

By four separate notices of final partnership administrative adjustments (FPAA), respondent took alternative “whipsaw” positions, determining that the partnership had engaged in a sale or exchange of the plant and related assets as of various dates in 1985, 1986, 1987, and 1988. Respondent determined that, as of these various alternative dates, the partners must recapture previously claimed investment and energy tax credits, forfeit certain deductions and losses relating to the project, and recognize gain from disposition of project assets.

The primary issue for decision is whether for Federal income tax purposes the partnership should be treated as disposing of the project assets before November 2, 1987. We must also decide whether the partnership must take into account the full $1.57 billion debt in the year in which the partnership disposed of the project assets pursuant to the foreclosure sale.

3(…continued) of the stock that one partner’s parent company had pledged as security for the loan guarantee.

- 5

FINDINGS OF FACT

When the petition was filed, the partnership’s principal place of business was in Houston, Texas.4 Evolution of the Great Plains Project

In the 1970s, natural gas shortages were widespread. Energy companies began investigating new supply sources. One idea was to use abundant domestic coal reserves to produce synthetic natural gas in a process known as coal gasification.

American Natural Resources Co. (ANRC), operated two natural gas distribution companies and two natural gas pipelines, in addition to conducting oil and gas exploration. It also owned rights in extensive coal reserves in North Dakota. ANRC had studied the possibility of building a coal gasification plant near these coal reserves. (This project would later become known as Great Plains.) By the mid-1970s, ANRC was working on coal gasification technologies and discussing the potential project with Government officials.

Outside the United States, some coal gasification projects were already operational, but existing technologies allowed coal to be converted only into 500 Btu gas. United States pipelines, by contrast, required 1,000 Btu gas. ANRC, as well as other domestic energy companies, contemplated a project that would be

4 The parties have stipulated that pursuant to sec. 7482(b) venue lies in the U.S. Court of Appeals for the Fifth Circuit.

the first of its kind, employing new, still unproven technologies to convert domestic coal into pipeline-quality natural gas.

DOE actively supported the project, which appeared to hold great promise as an alternative energy source.5 Mr. Jack O’Leary, who was then Deputy Secretary of Energy, encouraged several interstate pipeline companies to form a consortium to raise money for the Great Plains project. Ultimately, five interstate pipeline companies agreed to form a partnership (through their subsidiaries) to design, build, and operate the plant. In addition to ANRC, these companies were Transco Energy Co. (Transco Energy), Tenneco, Inc., Pacific Lighting Co., and MidCon Corp. The Partnership

The partnership, Great Plains Gasification Associates, was formed in 1978 under North Dakota law. The five general partners were wholly owned subsidiaries of the just-named pipeline companies, with ownership percentages in the partnership as follows:

5 Ultimately, DOE viewed the project as a “demonstration program” within the meaning of sec. 207 of Title II of the Department of Energy Act of 1978–Civilian Applications, Pub. L. 95-238, 92 Stat. 61, to produce alternative fuels from coal and other domestic resources and to provide technical and environmental knowledge to assess the long-term viability of synthetic fuel production in the United States.

-

The partners executed an Amended and Restated General Partnership Agreement as of June 1, 1981 (partnership agreement), in which the partnership assumed responsibility for the Great Plains project. Pursuant to the partnership agreement, the partnership’s management committee, composed of one representative of each partner, had exclusive authority and full discretion to manage the partnership’s business. No partner had authority to act for, or assume any obligation or responsibility on behalf of, the partnership without the management committee’s prior approval. The management committee was authorized to act either upon the approval, vote, or “consent” of partners holding at least 65 percent of the total votes, which were allocated according to partners’ ownership percentages. The partnership agreement provided that it was governed by North Dakota law.

Pursuant to the partnership agreement, the partnership was not permitted to acquire assets or incur liabilities until the date when it acquired various preexisting project assets from individual partners. After this date, the plant site and all property acquired by the partnership to construct, operate, and maintain the plant were to be the property of the partnership.

Each partner was obligated to make cash contributions upon notice from the management committee, as necessary to purchase the preexisting project assets from other partners, to pay project costs, and to pay costs incurred by the partnership. The partners were prohibited from making voluntary contributions to the partnership. Funding for the Project

The partnership funded the Great Plains project from two sources: (1) About $550 million of equity contributions from the partners; and (2) a loan of about $1.5 billion provided under a credit agreement with FFB (the credit agreement) and guaranteed by DOE.

Partners’ Equity Contributions

The partners were required to contribute to the partnership $1 of equity for every $3 borrowed under the credit agreement.6 Upon the occurrence of various specified events, the partners could terminate their participation in the project after giving the DOE Secretary at least 14 days’ advance notice and a chance to discuss the matter with the partners’ representatives.7 After

6 Pursuant to an equity funding agreement, each partner’s parent agreed to provide funds to its respective subsidiary as necessary for the partner to make the required equity contributions.

7 In general, partners were entitled to terminate participation in the project at any time prior to the in-service date if projected gross revenues from the project fell below (continued…)

terminating their participation pursuant to these provisions, the partners would have no obligation to continue making equity contributions.

The partners’ equity contributions to the partnership ultimately totaled about $550 million.

The Credit Agreement

Pursuant to the credit agreement dated January 29, 1982, FFB committed to lend the partnership up to $2.02 billion for the design, construction, and startup of the project. The credit agreement provided that if the partnership defaulted on the payment of principal or interest, FFB should demand payment of the partnership and provide notice of the default to DOE. If the partnership or DOE failed to cure the default within 5 days, FFB could terminate the credit agreement and declare the entire outstanding debt due and demand payment by DOE pursuant to DOE’s loan guarantee (discussed below). Pursuant to the credit agreement, FFB agreed that “any recovery on a claim against Borrower [the partnership] or any Partner which may arise under

7(…continued) certain levels; if estimated costs exceeded certain levels; if the estimated in-service date slipped past June 1, 1986; if there were no longer “reasonable assurance” that the project would generate sufficient cash to permit the partnership to service its debts and repay the partners’ equity contributions; or if DOE gave the partnership notice that DOE had determined that there was no longer reasonable assurance that the partnership would be able to timely pay principal and interest on the guaranteed indebtedness.

this Agreement * * * shall be limited to the assets of the

Borrower and such Partner’s interests in such assets”.

Loan Guarantee Agreement

Pursuant to a loan guarantee agreement, also dated January 29, 1982, DOE agreed to guarantee the entire amount of principal and interest on the debt incurred by the partnership under the credit agreement.8 DOE’s guarantee was based on its determination that the guarantee was necessary to encourage the partners’ financial participation in the project.

Pursuant to the loan guarantee agreement, FFB was to make no disbursements to the partnership until DOE reviewed and authorized the proposed disbursements. DOE retained the right, under specified circumstances, to terminate the Government’s participation in guaranteeing additional disbursements for the project. Pursuant to the loan guarantee agreement, if the partnership failed to pay FFB principal or interest on the indebtedness when due, the Secretary was authorized to cause the principal amount of all the guaranteed indebtedness, with accrued interest, to become due and payable from the partnership. If the partnership failed to cure the default, the Secretary, upon payment of the indebtedness to FFB, was authorized to take action

8 DOE was granted authority to guarantee the partnership’s debt pursuant to the Federal Nonnuclear Energy Research and Development Act of 1974, Pub. L. 93-577, 88 Stat. 1878, as amended by the Department of Energy Act of 1978, Pub. L. 95-238, 92 Stat. 47.

to enforce the partnership’s obligations under the guarantee agreement.

Pursuant to the loan guarantee agreement, DOE agreed that its recovery on any claim against the partnership or any partner would generally be limited to the partnership’s assets and to the partners’ interests in those assets. The partnership agreed, “To the full extent permitted by applicable law,” to waive the benefit of any redemption law that might otherwise have been applicable to any right under this agreement. The loan guarantee agreement states that it “shall be governed by and construed and interpreted in accordance with the federal laws of the United States. It is the intent of the United States to preempt any state law conflicting with the provisions of this Agreement”.

Pursuant to the loan guarantee agreement, the partnership was prohibited from engaging in any business other than the project. All proceeds from the guaranteed debt were required to be promptly applied to fund costs that were necessary, reasonable, and directly related to the design, construction, and startup of the project facilities.

Indenture of Mortgage

The credit agreement and the loan guarantee agreement were secured by an Indenture of Mortgage and Security Agreement dated January 15, 1982, between the partnership, as debtor and mortgagor, and Citibank, N.A. (trustee), as trustee and mortgagee, acting in a fiduciary capacity for the benefit of the United States and FFB. Property subject to the mortgage included real estate owned by the partnership; plants, facilities, and buildings owned by the partnership or leased by the partnership; the partnership’s rights to and under certain contracts (including gas purchase agreements, the project administration agreement, and the coal purchase agreement, all of which are discussed infra); and all other real or personal property “now owned or hereafter acquired by Borrower”.

Pursuant to the mortgage, an “event of default” would include termination in the project by any two or more partners and the partnership’s failure to make timely principal or interest payments. In the event of a default, the trustee was entitled to take possession of the mortgaged property without legal process, operate the mortgaged property, receive all income from the operation, pay all expenses, and proceed to sell the mortgaged property in foreclosure proceedings. The United States was authorized to bid on and purchase the mortgaged property. Sale proceeds were to be applied first to paying any interest and principal then due on the note and then to repaying all amounts paid by the United States pursuant to the guarantee. The mortgage provided that the partnership agreed, “To the full extent it may legally do so”, to waive “any and all rights of redemption from sale under order or decree of foreclosure of this Mortgage”. The mortgage stated that it “shall be governed by and

construed and interpreted in accordance with” Federal law. Pledge of ANG Stock ANRC’s wholly owned subsidiary, ANG Coal Gasification Co.

(ANG), was formed in the early stages of the project to design and manage construction of the project and to operate the project after its completion. ANG held certain contractual and other rights and permits relating to the project. As a precondition for the loan guarantee agreement, DOE required ANRC to pledge its ANG stock as additional security for the partnership’s obligations under the loan guarantee agreement. Pursuant to the ANG stock pledge agreement, dated January 29, 1982, if the partnership defaulted on its debt, the DOE secretary was authorized to take possession of the ANG stock certificates and sell the ANG stock to such persons, including himself, as he deemed expedient, applying the sale proceeds against the partnership’s debt. ANG Operates the Plant

Under the project administration agreement, dated January 29, 1982, the partnership appointed ANG as the partnership’s agent to administer the project’s construction, startup, and operation. As project administrator, ANG was responsible for the design, construction, and operation of the gasification plant and coal mine on behalf of the partnership. Pursuant to an agreement

- 14 between ANG and DOE, dated January 29, 1982 (the project administration agreement), if the partnership defaulted on its obligations under the loan documents, ANG would, at the DOE Secretary’s option, continue to act as administrator of the Great Plains project.

In connection with the project administration agreement, ANG and the partnership entered into a coal purchase agreement to provide a source of lignite coal for the project. The agreement was based upon coal rights previously obtained by ANG to buy and receive from a third party sufficient coal to satisfy the project’s requirements. ANG agreed to deliver for the partnership’s account sufficient coal to support the plant’s operation.

ANG served as the project’s sole operator until October 1988. After production commenced at Great Plains in 1984, ANG had 800 to 1,200 full-time workers on site at the project. Partnership Enters Gas Purchase Agreements With Pipeline Affiliates

On January 29, 1982, the partnership entered into 25-year gas purchase agreements with pipeline companies affiliated with four of the partners (the pipeline affiliates). The gas purchase agreements provided that, after the project’s in-service date, the partnership was obligated to tender to the pipeline affiliates all synthetic natural gas produced by the project, and the pipeline affiliates were collectively obligated to purchase all this gas at specified prices or else to pay for gas tendered

but not taken.9

Plant Is Built and Begins Operation

Construction of the project began in 1981. The project was placed in service for tax purposes in 1984. On July 28, 1984, the plant delivered its first synthetic natural gas to the interconnecting gas pipeline. Since then, the plant has continuously produced and delivered synthetic natural gas. Initial Eligibility for Investment and Energy Tax Credits

A substantial part of the project’s assets constituted new section 38 property, qualifying for general business credits (sometimes referred to as investment credits). In addition, a substantial part of the project’s assets constituted alternative energy property within the meaning of section 48(l)(3) and constituted energy property eligible for the energy percentage under section 46(b)(2)(A). The partners and DOE relied on the availability of the investment and energy tax credits as a key

9 These contracts obligated the pipeline affiliates to a payment rate substantially above the market price for the gas produced; the price was to be reduced in periodic increments over a 25-year period. Economic analyses indicated to the partnership that the gas purchase agreements would result in an assured market for the synthetic natural gas produced during the project’s life and that revenues would be adequate to service the debt and also contribute toward the return of invested equity. By separate agreement, in the event a default by the partnership led to the termination of the gas purchase agreements, those agreements could be reinstated between the pipeline affiliates and DOE on the same terms.

consideration in structuring the financial terms of the project and in deciding to pursue the project.

In 1982, the partnership requested an IRS ruling that the partnership’s DOE-guaranteed loan from FFB would not be considered “subsidized energy financing” under section 48(l)(11)(C). In a private letter ruling dated May 8, 1984, the IRS ruled that, because the partnership was required to obtain financing through FFB as a condition to obtaining a loan guarantee from the DOE, the funds that the partnership borrowed from FFB did not constitute subsidized energy financing under section 48(l)(11)(C).10 Financial Difficulties With the Project

In the mid-1980s, as construction of the Great Plains project neared completion, energy prices declined unexpectedly and precipitously. As a result, projected initial short-term losses from the project spiked; there was no longer reasonable assurance that the project would generate sufficient cash for the partnership to repay its debt to FFB on time. Nevertheless, the

10 In response to a subsequent ruling request by the partnership, the IRS ruled in a private letter ruling dated July 25, 1984 (supplemented by letter rulings dated Feb. 12 and Mar. 11, 1985), that the partnership met the requirements for the credit for fuel production from nonconventional sources under sec. 29 (formerly sec. 44D). Because energy tax credits offset the sec. 29 credits in full, however, the partnership and its partners realized no tax benefit from the sec. 29 tax credits.

project remained an important part of the partners’ business plans.

On March 25, 1983, the partnership advised DOE that changing economic conditions required changes in the project’s financial structure. The same day, each partner notified DOE that it believed that conditions existed that would permit it to vote to terminate participation in the project pursuant to the partners consent and agreement, but that it did not presently intend to exercise this right. Debt Restructuring Negotiations

In 1983, the partnership’s representatives began meeting with officials of DOE and the Synthetic Fuels Corp. (SFC) to negotiate additional financial assistance for the project. On September 13, 1983, the partnership applied to SFC for interim price supports for the synthetic natural gas to be produced by the project. The partnership advised SFC that interim price supports would make possible the plant’s completion and operation. Plant construction was then 72 percent complete and on schedule. Approximately $1.2 billion had been invested in the project: $383 million represented the partners’ equity capital; the balance was FFB debt guaranteed by DOE.

Negotiations between the partnership and SFC over price supports dragged on until July 1985. In the meantime, DOE–which was monitoring the SFC negotiations–began contingency plans with respect to the loan guarantee arrangement. DOE was especially concerned about how the project would be funded if the partners terminated participation. DOE lacked appropriated funds to complete the project on its own. In October 1983, DOE Assistant Secretary Jan Mares gave congressional testimony in which he expressed DOE’s support for the price-support negotiations between the partnership and SFC as part of a loan restructuring to ensure the partners’ continued participation in the project. Discussions Concerning Terminating Participation in the Project

On the heels of this congressional testimony, SFC issued a statement deferring any decision on price support assistance for the project, citing concerns that additional legislation might be required for that purpose. The partners then advised DOE that, because the partnership lacked assurance that SFC would negotiate expeditiously for price guarantees, the partnership felt compelled to initiate procedures under the loan guarantee agreement to terminate the partners’ participation in the project.

Consequently, on November 18, 1983, the partnership notified DOE that the management committee was considering a determination by the partners to terminate participation in the project. Each partner provided written notice to DOE, pursuant to the loan documents, that it believed conditions existed permitting the partner to vote to terminate participation in the project because

- 19 the project, as it was then structured, would generate insufficient cash to meet the partnership’s obligations under the credit agreement and to enable the partners to recoup their equity contributions. Upon receiving these notices, DOE publicly expressed optimism that the project would represent a “valuable national asset for the long-term energy security of this country”. DOE also expressed willingness to continue disbursing guaranteed funds so long as the partners continued financing their portion of the project. Partners and SFC Sign Letter of Intent

On April 26, 1984, SFC and the partnership reached a tentative agreement, memorialized by a letter of intent. SFC proposed to provide the partnership up to $790 million of financial assistance under a price guarantee agreement. In return, pursuant to a profit-sharing arrangement, the partnership would eventually pay SFC $1.58 billion out of the project’s operating profits, after first paying the entire amount of the DOE-guaranteed debt. In addition, under the tentative agreement, the partners would reinvest in the project the dollar equivalent of all tax benefits and profits obtained by the partnership for the next 3-1/2 years; this provision would have amounted to an additional equity contribution by the partners of about $690 million.11 The parties agreed to recommend that SFC’s board and the partnership’s management committee approve this tentative price guarantee agreement.

In July 1984, while negotiations continued between the partners and SFC, the gasification plant began producing synthetic natural gas.

In January 1985, the partnership received from SFC a draft price agreement; a draft loan agreement was expected soon thereafter. To enable the partnership to meet its obligations under the loan guarantee obligation, the management committee called, at monthly intervals, for additional equity contributions of $4 million in February 1985, of $6 million in March 1985, of $3 million in April 1985, and of $1 million in May and June 1985. These additional equity contributions were based on the partners’ expectation that support for the project would be forthcoming and their belief that the arrangement would be supported by DOE.

Bolstering that belief, in April 1985 DOE Assistant Secretary Mares appeared before SFC’s board of directors on behalf of newly named DOE Secretary John Herrington. Mr. Mares endorsed the understandings reached by SFC and the partnership.

11 A Comptroller General’s report to Congress on the status of the Great Plains project as of Dec. 31, 1984, noted that over the project’s life, the partners would realize a lower rate of return on their equity investments even with the $790 million price support arrangement because of the partners’ additional equity contributions, accelerated debt repayment, and the profit-sharing arrangement.

He urged the SFC board to move quickly to conclude the price assistance agreement with the partnership. Similarly, in a May 21, 1985, letter to SFC, DOE Secretary Herrington also supported an SFC assistance agreement; he urged that any support agreement should ensure the long-term operation of the plant. By letter dated May 22, 1985, SFC Chairman Edward Noble responded that to ensure the long-term operation of the plant, DOE should restructure the debt repayment schedule. Mr. Noble requested further response from DOE before committing to final negotiations with the partnership.

Also on May 22, 1985, DOE Assistant Secretary Mares gave congressional testimony, describing the need for the price guarantee assistance agreement. He testified that DOE believed that, if SFC provided the intended financial assistance for the project, the sponsors would be able to continue operating the project beyond the year 2000. He testified that, in the event of foreclosure on the project assets, the partnership would be entitled by North Dakota law to a 1-year redemption period and would be entitled to possession of the property and to its rents and profits during that time. He testified that under North Dakota law, although the partnership may have voluntarily waived those rights in the loan documents, contracts in restraint of the right of redemption are void and unenforceable.

The Standstill Agreement

As of June 24, 1985, the partnership’s outstanding balance on its FFB loans was approximately $1.446 billion. An interest payment of over $70 million and a principal payment of $328.5 million were payable to FFB on July 1, 1985. A guarantee fee of $7.684 million was also payable to DOE on July 31, 1985.

To finalize the price support agreement, SFC required approval from the Treasury Department, the Office of Management and Budget, and DOE. Because SFC needed time to obtain these approvals, and the partners were approaching a date when they would have to make substantial payments under the loan documents, the parties negotiated a “standstill agreement”. Under the standstill agreement, dated June 24, 1985, the partnership’s due date for interest, principal, and the guarantee fee payments was extended to August 1, 1985.12

The standstill agreement also required the partners to withdraw their November 18, 1983, notices of consideration of termination of participation and to continue diligently to complete construction of the project, making timely equity investments into the partnership. Addressing the possibility

12 Under the standstill agreement, the parties agreed that the in-service date would occur at the close of business on Aug. 1, 1985. The determination of the in-service date was of key importance to the Government, because the pipelines’ obligation to take or pay for all gas produced from the plant became fixed upon the in-service date.

that the partners could still terminate participation under the partners consent and agreement, the standstill agreement provided that the partners could furnish notice of termination of participation prior to noon on August 1, 1985, in which event termination would be effective as of that date. A notice of termination pursuant to this provision would relieve the partners of the obligation to make further equity contributions to the partnership. Partnership and SFC Reach Price Support Agreement

On July 16, 1985, the partnership reached a final agreement with SFC for a $720 million price guarantee.13 The agreement required the DOE Secretary’s approval. It was not forthcoming. DOE’s Rejection of Price Support Agreement

Notwithstanding DOE’s prior public support for the Great Plains project and a price guarantee agreement, DOE rejected the final agreement between SFC and the partnership in a 2-page letter, dated July 30, 1985, and signed by DOE Secretary

13 Pursuant to this price guarantee assistance agreement, on Aug. 1, 1985, the partnership would “default” on the payments due FFB under the standstill agreement, and DOE would use an existing $673 million reserve to “cure” that default on behalf of the partnership; repayment of the remaining FFB indebtedness would be rescheduled so that no significant burden for mandatory principal payments would be incurred earlier than 1996; price guarantees would be available. Under this agreement, 80 percent of the cashflow would be used to repay the DOE-guaranteed debt, and after that debt was repaid, SFC would be paid. Partners were to make an additional equity investment of $190 million in the project.

Herrington. Acknowledging that this action was not the fault of the project sponsors or SFC, this letter stated summarily that the package “would not be in the best interests of the Nation as a whole” and that DOE would not support the agreement “as currently constituted”. Partners Terminate Participation in the Project

On August 1, 1985, the partners learned of DOE’s rejection of the financial assistance arrangement. The partners were surprised and disappointed; they felt that DOE had doublecrossed them by leading them on in negotiations before summarily rejecting the agreement on the very day that the project was declared in-service. The partners immediately exercised their contractual rights under the partners consent and agreement to decline to make further capital contributions to the partnership that otherwise would have been required under the standstill agreement and the loan guarantee agreement. The written notices to terminate participation, dated August 1, 1985, were based on the determination of the partnership’s management committee that, after Secretary Herrington’s action, there was no longer reasonable assurance that the project would generate sufficient cash to permit the partnership to make timely principal and interest payments on its outstanding debt and to make distributions over a 10-year period following the in-service date that were at least equal to the contributed equity. As previously indicated, these were the contractual premises for termination of participation.

Although the partners terminated participation in the project, the partnership continued its legal existence. No partner withdrew from the partnership. The partnership’s liabilities were unaffected. It was understood, however, that the partners’ termination of participation would lead to an event of default by the partnership under the loan guarantee agreement, allowing DOE to assume control over the project. The Partnership Defaults on the FFB Loan

After the partners declined to contribute further equity to the partnership with respect to the DOE-guaranteed financing, the partnership was unable to make the deferred principal, interest, and guarantee fee payments due on August 1, 1985, under the standstill agreement. The partnership’s failure to make these payments constituted an event of default under the loan guarantee agreement and the mortgage.

In August and September 1985, pursuant to the loan guarantee agreement, DOE made payments to FFB totaling approximately $1.57 billion. This sum represented the entire amount of principal and interest that the partnership owed FFB under the credit agreement and that correspondingly became due from DOE under the loan guarantee agreement. Upon paying these amounts due under the loan guarantee obligations, DOE became subrogated to FFB’s claims. By letter dated October 9, 1985, DOE made written demand upon the partnership for payment of all guaranteed indebtedness, together with accrued interest from September 30, 1985.

DOE Takes Control of the Project

After the partnership’s default, DOE assumed control of the Great Plains project. Legal title to the project and its assets, however, remained with the partnership. In public statements, DOE acknowledged that it was not the legal owner of the Great Plains project and that it would not acquire legal ownership of the facility until there was a foreclosure sale.

By letter dated August 1, 1985, DOE invoked its option to cause ANG, as project administrator, to continue operating the project in substantially the same manner as had been done for the partnership. DOE advised the pipeline affiliates that it was substituting the Secretary of Energy for the partnership as the seller in the gas purchase agreements.

By letter to DOE dated August 2, 1985, the partnership acknowledged receiving a copy of DOE’s prior-day letter to ANG. The partnership advised DOE that, in order to permit the project administrator to carry out its duties as instructed by DOE, the partnership would exercise no responsibility or control over the project as of August 1, 1985. Also on August 2, 1985, the partnership advised vendors and suppliers working for the project that control over the Great Plains project had reverted to DOE and that ANG was now acting solely at the direction and under the control of DOE. The partnership advised the vendors and suppliers that DOE had halted all capital improvements at the project and was unwilling to fund such expenses; accordingly, the partnership instructed the vendors and suppliers to cease providing services, materials, or labor, or otherwise incurring expenses for capital projects until further notice from DOE.

On or about August 13, 1985, DOE stated publicly that it would allow the Great Plains project to continue operating temporarily while DOE and officials for the State of North Dakota discussed ways to meet DOE’s conditions for long-term plant operation. Shortly thereafter, ANG and the United States reached a revised project administration agreement. Under this agreement, ANG was formally reappointed project administrator, with complete authority, subject to the DOE Secretary’s directions, to do all things necessary for the operation and maintenance of the Great Plains gasification plant and related facilities. Under this agreement, ANG was to be paid a performance fee of approximately $3 million per year.

Accordingly, ANG employees (numbering at least 800) continued to operate the project as they had before the partners terminated their participation. Liaison between DOE and the project administrator was conducted through designated employees of the project administrator and DOE’s regional office in Chicago, Illinois. DOE was not, however, directly involved in the plant’s day-to-day operations. The Partnership’s Continued Activity

After DOE assumed control of the project, there were continuing disputes between the partnership and DOE, including disputes over the partnership’s and the partners’ liability for project expenses incurred under the standstill agreement.14 In September and October 1985, ANG and DOE requested the partnership’s permission to sell certain “excess” project assets, including parcels of real property, portable living quarters, and some items of equipment. The partnership declined to approve the sale.15

Although the partnership did not direct or control the Great Plains project after DOE assumed of control of it on August 1,

14 After several months of negotiations, the parties agreed that the partnership owed DOE $13.4 million. In July 1987, the management committee met to approve this agreement and to call for further equity contributions of $12.5 million from the partners to the partnership. The partnership also made an additional cash call to satisfy a settlement with the State of North Dakota for sales and use tax liabilities.

15 In an Oct. 14, 1985, letter to the project administrator, C. W. Rackley, chairman of the partnership’s managementcommittee, advised that authority to approve the sale no longer rested with the Management Committee and suggested that the request be directed to DOE. In a Nov. 1, 1985, letter to DOE, Mr. Rackley indicated that in view of the pending foreclosure action, the partnership had been advised that it would not be appropriate for the management committee to approve the sale.

- 29 1985, representatives of the partners and the partnership continued to meet on matters concerning the partnership and the project. There were numerous meetings of the partnership’s management, tax, and finance committees. ANG continued to maintain insurance on the project, paying the insurance premiums out of project revenues. The partnership continued to be named as the insured party on these insurance policies. The Project’s Improving Financial Situation

During August 1985, DOE advanced approximately $1,597,000 to cover project expenses. The advance was repaid to DOE in December 1985 out of project revenues. After August 1985, DOE provided no other funds for the project.

For the 6 months following August 1, 1985, cumulative revenues from the Great Plains project exceeded cumulative expenses. The project continued to operate with a positive cashflow in 1985, 1986, and 1987, accumulating a surplus of more than $130 million. For the 11 months ended June 30, 1986, the project generated positive cashflow of about $57 million. For the year ended June 30, 1987, the project generated positive cashflow of about $16 million. ANG continued to use project revenues to operate the gasification plant, with excess revenues’ being segregated in separate accounts.

The Partners’ Ongoing Efforts To Reopen Negotiations With DOE

On August 23, 1985, Transco Energy’s CEO, Mr. Jack Bowen, met with DOE Deputy Secretary Boggs to discuss a possible workout of the partnership’s debt. This meeting occurred even as the partners were embarking on a public relations campaign directed at North Dakota citizens, lobbyists, the White House, and members of Congress, to bring DOE back to the negotiating table.

As discussed in greater detail infra, on August 29, 1985, DOE initiated court proceedings to foreclose on the project assets. The next day, Transco Energy submitted to DOE a “discussion draft” outlining key elements for the partnership’s continued participation in the project. This discussion draft contemplated that the partnership would retain title to the plant and proposed making interest on the DOE-guaranteed debt contingent on project cashflow. The discussion draft included no provision for additional capital contributions by the partners.

Between August and November 1985, Mr. Bowen had more meetings and telephone conversations with various high-level DOE officials regarding a possible workout. The other partners were kept informed of these discussions. Mr. Bowen offered to have all the partners meet directly with DOE, but DOE indicated a preference to work through only one contact until a proposal was sufficiently developed to require input from all the partners. DOE agreed to prepare a proposal for the partners’ consideration.

Each partner was represented at a December 6, 1985, meeting between the partnership management committee and DOE representatives. At this meeting, the partners discussed restructuring the $1.57 billion outstanding debt into a contingent-interest debt, similar to what had been envisioned in the price support agreement that the partnership had reached with SFC in July 1985.16

In a December 19, 1985, telephone call with Transco Energy representatives, DOE General Counsel Mike Farrell indicated that the “discussion draft” Transco Energy had submitted on August 30, 1985, was a “non-offer”. In particular, DOE was unwilling to allow the partners to retain title to the plant, retain all tax benefits from the project, and yet have the right to terminate participation. Advised that title to the plant and the resulting tax benefits were the partners’ only source of cash in the event of a revenue shortfall, Mr. Farrell indicated that there was probably some “wiggle room” on the tax benefits issue.

On January 29, 1986, ANRC submitted to DOE an outline of a restructuring proposal.17 The proposal would have allowed the

16 Presumably, interest continued to accrue on the debt. The parties, however, have ignored interest accruals in referring to the $1.57 billion debt. For simplicity, we do the same.

17 Under the proposal, the partnership would retain ownership of the plant and continue to be responsible for its operation, DOE would withdraw its foreclosure action, and the partnership’s debt would be restructured into a contingent-interest obligation.

partnership to retain ownership of the plant and would have required, among other things, that the partnership recommence operating the project, covering cash shortfalls through further cash investments in the project up to an amount equivalent to the tax credits previously earned from the project. On January 30, 1986, representatives of Transco Energy and ANRC met with DOE Deputy Secretary Boggs and DOE General Counsel Farrell regarding the restructuring proposal. The DOE representatives stated that they found “nothing offensive” in the proposal and that DOE would consider it and respond.

The partners continued to meet and discuss these matters. The other partners were divided over whether to join ANRC’s proposal to DOE. At an April 1, 1986, meeting, Transco and Pacific agreed to participate in ANRC’s proposal, although Pacific indicated that it intended to “take a passive position for the present”. Tenneco and Midcon declined to participate in ANRC’s proposal on the ground that the tax benefits they had realized from the project were insufficient to justify the additional capital contributions contemplated under the proposal. Neither Tenneco nor Midcon sought, however, to obstruct the other partners’ efforts to retain the partnership’s future involvement in the project.

In the meantime, other events threatened to overtake the negotiations with DOE. In February 1986, DOE had asked the public for “expressions of interest” in acquiring or participating financially in the project’s operation.18 As discussed in greater detail infra, on April 7, 1986, a Federal District Court directed the mortgage on the partnership’s $1.5 billion debt to be foreclosed; the court scheduled the foreclosure sale for May 18, 1986 (subsequently extended to June 30, 1986). Partners Request Letter Ruling

On May 22, 1986, ANR and Transco filed with the IRS a request for a ruling that the partnership’s default on the indebtedness and related events had not resulted in recapture of investment or energy credits or given rise to gain recognition. The partners viewed such a ruling as fundamental to pending proposals to use prior tax benefits to fund additional capital infusions into the project. The partners did not want to be in the whipsaw position of having both to recapture the tax benefits and to use them to fund the project. ANR and Transco requested the IRS to expedite consideration of the ruling request to enable them to submit their restructuring proposal to DOE and prevent the impending foreclosure sale of the project. (As discussed in greater detail infra, in September 1986 the IRS ruled that the events as of May 22, 1986, had not resulted in recapture of investment or energy credits or given rise to gain recognition.)

18 On Apr. 4, 1986, ANRC filed a statement of interest, which was one of nine received by DOE.

- 34 Final Debt-Restructuring Proposals

On May 28, 1986, ANRC and Transco Energy submitted to DOE a formal restructuring proposal. This proposal contemplated restructuring the DOE debt and providing $210 million of capital infusions to fund continued project operations, contingent upon receipt of a favorable IRS ruling that no recapture of taxable credits or recognition of taxable gain had yet occurred. Although Pacific did not join this formal submission, it was aware of it and contemplated continuing participation in the project if a restructuring agreement could be reached and the IRS provided a favorable ruling.

By letter dated June 9, 1986, DOE rejected the May 28, 1986, proposal. DOE insisted that any proposal must include a “substantial cash payment” to DOE toward partial retirement of the $1.57 billion debt, “such that the payment outweighs the tax benefits subject to recapture if the Project is acquired by an outside party”.

An internal Transco memorandum dated June 20, 1986, from a lawyer in Transco’s legal office, reported communications that day with Mr. S. Kinnie Smith, Jr., ANR’s vice chairman and legal counsel, advising Mr. Smith that Transco did not see a “significant reason” to pursue an appeal of the foreclosure order and did not wish to “dilute” Transco’s appeal on gas contract issues by “interjecting rather weak arguments relating to foreclosure procedures”. The memo indicated that Mr. Smith had already spoken with Tenneco and Pacific “both of whom did not want to participate in an appeal, and therefore did not want to have the partnership itself file an appeal”.

By this time, the foreclosure sale of the project assets, previously scheduled for June 30, 1986, was imminent. In a June 24, 1986, meeting with DOE General Counsel Farrell, ANRC made a final proposal. An introductory page of bullet points regarding the proposal bore the caption “THE PLANT UNDER PRESENT CIRCUMSTANCES IS WORTHLESS”. The proposal included an immediate $100 million payment to DOE, additional cash infusions of $40 million from current partners, and a $90 million letter of credit for project working capital. The proposal also contemplated that a significant part of the project’s cashflows would be applied to pay down the DOE debt. The proposal identified ANRC, Transco Energy, and Pacific as the “participating partners”. In a letter dated June 25, 1986, DOE General Counsel Farrell summarily rejected this final proposal.

A June 26, 1986, Transco interoffice memorandum indicated that, on the basis of conversations with ANR personnel, ANR “does not plan to submit a revised proposal because in their view it would be futile - unless a favorable signal and change in direction comes from the DOE within the next two working days.

P.S. - In short, it sounds like the gig is up”.

As discussed at greater length below, on June 30, 1986, the foreclosure sale was held as scheduled, DOE purchased the project’s mortgaged assets, and ANR filed an appeal of the foreclosure proceeding. The Foreclosure Proceedings

DOE Initiates Foreclosure Proceedings

As previously noted, on August 29, 1985, DOE had initiated proceedings in the United States District Court for the District of North Dakota (the District Court) seeking foreclosure of the mortgage and sale of the mortgaged property. The Government moved for summary judgment. The partnership resisted, contending that the foreclosure should be conducted in accordance with North Dakota law, which it contended gave the partnership redemption rights for up to 1 year after the foreclosure sale.

District Court Decision

On January 14, 1986, the District Court granted the Government’s motion for summary judgment, holding that Federal law applied and gave the partnership no redemption rights. In its memorandum and order, however, the District Court observed that there was no precedent involving this particular loan guarantee program, that a determination under the balancing test of United States v. Kimbell Foods, Inc., 440 U.S. 715 (1979), was a “close question”, and that of the various options presented to the Court by the parties, “All have merit”.

On April 7, 1986, the District Court entered an Order and Decree of Foreclosure and Sale that: (1) Directed the mortgage be foreclosed and the mortgaged assets sold by public auction on May 28, 1986; and (2) held that the partnership and the partners were not entitled to redemption rights.

On April 18, 1986, the partnership filed a motion to amend the District Court’s April 7, 1986, Order and Decree so as to:

(1) Clarify that recovery was limited to the partnership’s assetsand the interests of the partners therein; (2) correct the property descriptions; and (3) defer the foreclosure sale for at least 6 months to enable pending workout negotiations to continue between certain partners and DOE. With regard to this latter point, the motion stated that the partnership had claimed and passed through to its partners investment tax credits of approximately $250 million and deductions of approximately $390 million and that a substantial part of these credits and deductions would be subject to recapture if the plant were disposed of in less than 5 years. The motion indicated that pending proposals by some of the partners to continue operating the plant and to restructure the DOE-guaranteed indebtedness depended upon the continued availability of the economic value of these tax benefits. The partnership requested a period for “equitable redemption” and contended that the foreclosure sale should be deferred pending the partners’ ongoing efforts to restructure the debt. The State of North Dakota intervened, urging delay of the foreclosure sale and citing adverse economic impacts from closing the plant.

By order dated May 8, 1986, the District Court denied the partnership’s motion for a period of equitable redemption, concluding that it lacked authority to grant such relief where the order of foreclosure had already been entered. The District Court also noted that the partnership and the partners “talk of ‘redemption’, but it is apparent that ‘re-negotiation’ would be a more accurate description”. Nevertheless, the District Court postponed the foreclosure sale date from May 28 to June 30, 1986, to permit the notice of sale to be republished with corrected property descriptions.

The June 30, 1986, Foreclosure Sale

On June 30, 1986, the foreclosure sale was held. The lone bidder was DOE, which bid $1 billion for the partnership’s mortgaged assets.19 The U.S. Marshal filed with the District Court a Marshal’s Return and Report of Sale and a Certificate

19 As discussed in more detail infra, certain assets necessary for operating the project were not among the partnership’s mortgaged assets but were instead owned by ANG (the subsidiary of ANRC, which also owned ANR, a general partner in the partnership). As a precondition for the loan guarantee agreement, DOE had required ANRC to pledge as security all its ANG stock. Petitioner asserts, and respondent does not dispute, that DOE purposefully bid less than the full amount of the $1.57 billion debt, intending subsequently to use the balance of the debt to obtain the ANG stock.

of Sale stating that DOE had purchased the mortgaged assets of

the project for $1 billion at the public foreclosure sale.20

Objections to the Foreclosure Sale

On July 7, 1986, ANR filed with the District Court objections to the foreclosure sale. The premise of the objections was that the sale had been improperly conducted without providing the partnership redemption rights under applicable North Dakota foreclosure statutes or equitable rights of redemption under Federal common law. On July 14, 1986, the District Court overruled ANR’s objections and confirmed the foreclosure sale. The court noted that “the legal entity foreclosed upon, the partnership, has not objected to the sale” and questioned whether ANR had standing to object.

On July 16, 1986, the Marshal issued the Marshal’s Deed to DOE, and the deed was recorded in the local property records.

Appeal of the Foreclosure Proceedings

On June 30, 1986, ANR, as a general partner of the partnership, filed a notice of appeal in the foreclosure

20 The $1 billion was applied to pay principal of about $891 million and accrued interest of about $109 million. Although the record is silent on this point, it seems unlikely that any funds actually changed hands in this transaction. Pursuant to the indenture of mortgage, DOE was authorized to bid for and purchase the mortgaged assets, and the trustee was directed to apply the proceeds to repay DOE the amounts DOE had previously paid FFB pursuant to the guarantee agreement. The net result of these transactions would have been simply to reduce the partnership’s obligation to DOE by $1 billion.

litigation to the U.S. Court of Appeals for the Eighth Circuit. The notice of appeal, which was served on all the partners, identified the appellants as the five individual named partners of the partnership and the partnership itself. The four partners other than ANR did not actively participate in the appeal, but they also did not actively oppose it, provided that ANR bore the associated legal expenses. ANR viewed a successful appeal of the foreclosure order as a way to force DOE back to the negotiating table. In addition, if the appeal had been successful, it would have benefited all the partners inasmuch as North Dakota law, if applicable, would have given the partnership rights to redeem the plant for 1 year after the foreclosure sale, while possessing and operating the plant during that 1-year period and retaining the cashflows generated.

On October 17, 1986, the United States filed its brief in the U.S. Court of Appeals for the Eighth Circuit, contending that the District Court properly ruled that North Dakota law should not apply. In its brief, the Government did not challenge ANR’s authority or standing to file the appeal. The Government’s brief asserted, however, that the real motive for ANR’s filing the appeal was to postpone the foreclosure sale so as to “save the Great Plains partners as much as $347 million in tax recapture liability”.

On March 11, 1987, the Eighth Circuit issued its opinion in United States v. Great Plains Gasification Associates, 813 F.2d 193 (8th Cir. 1987). The Court of Appeals affirmed the judgment of the District Court, though on different grounds, holding that the North Dakota redemption statute did not apply to the foreclosure of a loan, such as the FFB loan, that was guaranteed pursuant to the Federal Nonnuclear Research and Development Act of 1974.21 In so doing, however, the Court of Appeals confirmed the nature of the redemption rights that North Dakota law would otherwise afford, stating:

Were we to reverse the district court and look to North Dakota law for our rule of decision Great Plains would have the right to redeem at any time up to one year after judicial sale. N.D. Cent. Code § 32-19-18 (1976). During this period Great Plains would be entitled to the possession, rents, use, and benefit of the plant. N.D. Cent. Code § 28-24-11 (1974). * * * [United States v. Great Plains Gasification Associates, supra at 195.]

The Court of Appeals did not question ANR’s standing to pursue

the litigation as a partner of the partnership.

Petition for Writ of Certiorari

On July 15, 1987, ANR, as a general partner of Great Plains Gasification Associates, filed a timely petition for a writ of certiorari with the U.S. Supreme Court, seeking review of the judgment of the Eighth Circuit. The petition, filed by a legal

21 The Court of Appeals for the Eighth Circuit held further that the District Court did not err in refusing to grant the partnership an equitable right of redemption.

team headed up by former Solicitor General Rex E. Lee, contended that there was a recurring conflict among the circuits as to whether Federal or State law should apply to proceedings under federally guaranteed private loans such as the partnership’s FFB loan. In its brief in opposition to the petition for writ of certiorari, the United States did not suggest that ANR lacked authority or standing to pursue that litigation. On November 2, 1987, the Supreme Court denied the petition for writ of certiorari, and the foreclosure litigation came to an end.

The Partnership’s Ratification of ANR’s Appeal

The partners had monitored the appeal and petition for writ of certiorari. On September 3, 1987, the partnership’s management committee had adopted resolutions that expressly ratified ANR’s actions relating to the foreclosure litigation. By its terms, the ratification was effective retroactive to the date these actions were taken by ANR, as if ANR “had obtained the prior authorization of the Management Committee”. The resolutions also authorized the partnership’s legal committee to determine the manner in which the litigation would be conducted on the partnership’s behalf in the event the Supreme Court granted the petition for writ of certiorari. Discharge of Remaining Debt

As previously noted, ANRC owned the outstanding stock of ANG, which was the project administrator. ANRC had pledged this stock as additional security for the partnership’s obligation to DOE under the loan guarantee agreement. ANG held deeds, easements, and contract rights (the ANG project assets) that were needed to operate the project but that had not been titled in the partnership’s name. Consequently, DOE had not acquired the ANG project assets in the foreclosure sale that was conducted on June 30, 1986. At the foreclosure sale, the Government had applied only $1 billion of the approximately $1.57 billion debt to acquire the partnership’s assets that were subject to the mortgage. The Government had intentionally kept the remaining balance of the indebtedness in reserve for subsequent use in acquiring the ANG stock.

In November 1987, DOE considered foreclosing on the ANG stock. In a settlement agreement entered into on October 13, 1988, ANRC assigned its ANG stock to DOE, which then released the partnership’s outstanding indebtedness. In the settlement agreement, ANRC acknowledged that the fair market value of the ANG stock and all remaining collateral securing the partnership’s obligations under the guarantee agreement was less than the partnership’s outstanding indebtedness to DOE. The settlement agreement recites that ANRC was entering into the settlement agreement partly “to avoid the expense of litigation to foreclose” DOE’s lien on the ANG stock pursuant to the pledge agreement.

- 44 DOE Sells the Project Assets

Once the Supreme Court denied ANR’s petition for writ of certiorari in the foreclosure litigation, DOE began making plans to sell the project assets. In a press release dated December 9, 1987, DOE identified 15 potential buyers of the project. One of these potential buyers was the Coastal Corp. (Coastal), which had acquired ANRC in March 1985. Ultimately, however, DOE selected Basin Electric, a North Dakota cooperative, as the successful bidder. On October 31, 1988, the United States sold the project assets to two subsidiaries of Basin Electric–Dakota Gasification Co. and Dakota Coal Co. The Partnership Continues To Operate

Throughout 1988 and 1989, the partnership’s management, legal, finance, and tax committees continued to meet and report to the partners on open issues, including tax issues related to the project. The partnership’s tax committee concluded that the partnership ceased to own the project for tax purposes on November 2, 1987, the date that the Supreme Court denied the petition for writ of certiorari in the foreclosure proceedings. Respondent’s September 1986 Letter Ruling

As previously noted, on May 22, 1986, while negotiations about a possible debt workout were ongoing with DOE, ANR, and Transco had filed with the IRS a request for a private ruling regarding potential tax consequences from the partnership’s default on the project indebtedness. On September 10, 1986, the

IRS issued Private Letter Ruling 8649051 (the September 1986

letter ruling). In this 28-page ruling, the IRS concluded that,

as of May 22, 1986 (the date of the ruling request), the

partnership had not abandoned the project or made other

disposition of the project. The ruling stated:

There are two facts involved here that negate the argument that * * * [the partnership] has abandoned the Project. First, * * * [ANR] and * * * [Transco] are continuing to seek a solution to the financial difficulties facing the Project by negotiating an agreement with * * * [DOE] that would permit * * * [the partnership’s] continued participation in the Project. Second, by refusing to grant approval for * * * [DOE] to sell excess assets of the Project, * * * [the partnership] has shown that it has not abandoned all rights or involvement in the Project or control over the Project’s assets.

Approximately 10 years after the IRS National Office issued

this letter ruling, the Houston IRS District Office submitted to

the IRS National Office factual and legal objections to the

ruling, contending that the partners’ original ruling request had

omitted or misstated material facts that resulted in an incorrect

ruling. On October 17, 1997, the IRS National Office issued

Technical Advice Memorandum 9811002, which rejected the

objections of the IRS Houston District Office, stating:

although the ruling request omitted certain information

that bore some relevance to the underlying tax issues

and characterized other information differently than

the District, these additional facts and alternate

characterizations, when taken together, were not

material. Therefore, the * * * [ruling] is to be

applied by the district director in the determination

- 46 of the tax liability of * * * [Transco] and * * * [ANR]. Partnership’s Return Position and Respondent’s Determinations

On its 1987 Form 1065, U.S. Partnership Return of Income, the partnership reported that the “partial foreclosure sale” of the coal gasification plant became final on November 2, 1987, the date the Supreme Court denied the petition for a writ of certiorari. On its 1987 return, the partnership reflected income, deductions, losses, and tax credits from the project on the basis that its ownership of the plant ended November 2, 1987, reported gains and losses resulting from the “partial foreclosure sale”, and reported basis of foreclosed assets to enable the partners to determine recapture of tax credits. The partnership reported $1 billion as the proceeds from the “partial foreclosure sale”. In a disclosure statement, the partnership stated that it was treating the $1 billion foreclosure sale price as “the amount of the taxpayer’s nonrecourse indebtedness that was discharged as a result of the disposition of certain assets by the foreclosure sale”. The partnership asserted that DOE was continuing to assert a claim against the partnership for approximately $681 million.22

By four separate notices of final partnership administrative adjustments (FPAA) issued May 24, 2001, respondent took

22 We infer that this amount included interest on the debt.

alternative, whipsaw positions, determining that the partnership had engaged in a sale or exchange of the plant as of various dates in 1985, 1986, 1987, and 1988, requiring recapture of tax credits, recognition of gain resulting from the discharge of the indebtedness, and other tax consequences as of these various alternative dates. In the FPAA for the partnership’s 1985 tax year, respondent asserted that the partnership engaged in a sale or exchange of the project and related assets on or before August 1, 1985. In the FPAA for the partnership’s 1986 tax year, respondent asserted that the partnership engaged in a sale or exchange of the plant and related assets on June 30, 1986, or in the alternative, on July 14, 1986. In the FPAA for the partnership’s 1987 tax year, respondent asserted that the partnership engaged in a sale or exchange of the plant and related assets on January 1, 1987, or in the alternative, on November 2, 1987. In the FPAA for the partnership’s 1988 tax year, respondent asserted that the partnership engaged in a sale or exchange of the project and related assets on January 1, 1988. In each of these FPAAs, respondent asserted identically: “The full amount of the outstanding nonrecourse mortgage, including all accrued interest, is included in the amount realized on disposition of the plant.”

I. Date of the Partnership’s Disposition of Project Assets

We must decide the date as of which the partnership should be treated for Federal tax purposes as having disposed of its interest in the Great Plains project. The parties have stipulated, consistent with respondent’s September 1986 letter ruling, that “no sale, exchange or other disposition of the Great Plains gasification plant or any assets related thereto by Great Plains Gasification Associates occurred on or before May 22, 1986”.

On brief, respondent argues that the partnership disposed of the project assets on June 30, 1986, the date of the foreclosure sale.23 Respondent argues primarily that the foreclosure sale itself constituted the disposition. Alternatively, respondent argues that the partnership abandoned its interests in the project on or by June 30, 1986.

Petitioner contends there was no disposition or abandonment of the project assets until the foreclosure litigation terminated on November 2, 1987.

23 In one sentence, respondent’s opening brief posits alternatively that the disposition occurred on July 14, 1986, “the date the sale was confirmed by the District Court”. Apart from this fleeting reference, however, respondent’s brief makes no separate argument for July 14, 1986, as the disposition date.

A. Did the June 30, 1986, Foreclosure Sale Constitute Disposition by the Partnership? A “transfer upon the foreclosure of a security interest” constitutes a disposition of mortgaged property so as to trigger recapture of a portion of investment tax credits and business energy credits previously claimed with respect to the property.24 Sec. 1.47-2(a)(1), Income Tax Regs. Similarly, a foreclosure

sale constitutes a disposition of property pursuant to section 1001(a).25 See Helvering v. Hammel, 311 U.S. 504 (1941); Aizawa

v. Commissioner, 99 T.C. 197, 198 (1992), affd. 29 F.3d 630 (9th Cir. 1994); Ryan v. Commissioner, T.C. Memo. 1988-12, affd. sub nom. Lamm v. Commissioner, 873 F.2d 194 (8th Cir. 1989).

If local law provides the mortgagor a right to redeem the property, the foreclosure sale generally is not final for tax purposes until the right of redemption expires. Derby Realty Corp. v. Commissioner, 35 B.T.A. 335, 338 (1937); Hawkins v. Commissioner, 34 B.T.A. 918, 922-923 (1936), affd. 91 F.2d 354

24 In general, a taxpayer must recapture a portion of previously allowed investment tax credits or business energy credits if the underlying property is disposed of before the close of the useful life taken into account in computing the credits. See Jacobson v. Commissioner, 96 T.C. 577, 593 (1991), affd. 963 F.2d 218 (8th Cir. 1992).

25 Tax consequences may vary depending upon whether the debt is recourse or nonrecourse, particularly in determining whether any amount realized from the foreclosure sale represents income from discharge of indebtedness. See Aizawa v. Commissioner, 99

T.C. 197, 200-201 (1992), affd. 29 F.3d 630 (9th Cir. 1994).

(5th Cir. 1937). As this Court explained in Ryan v. Commissioner, supra:

This is because the foreclosure action is the amalgam

of two separate events. First, there is an

extinguishment of the underlying indebtedness, giving

rise to income. Cf. secs. 108, 61(a)(12), I.R.C. 1954.

Second, there is a disposition of the property securing

the debt, a sale or exchange. The all events test

requires both of these events to occur before income is

realized.

*******

A foreclosure action that is being appealed is not ‘final’ in the normal sense of that word. Pending foreclosure litigation has “the same effect as would

the fact that there was a period in which the right of redemption under a foreclosure sale could be exercised.” Morton v. Commissioner, 104 F.2d 534, 536 (4th Cir. 1939), revg. 38 B.T.A. 534 (1938). The year in which litigation terminates is the year in which the claimed item is to be taken into account for Federal tax purposes. See Found. Co. v. Commissioner, 14 T.C. 1333, 1354 (1950).

Citing Morton v. Commissioner, supra, and Rev. Rul. 70-63, 1970-1 C.B. 36, respondent acknowledges on brief: “a bona fide contest as to the existence of redemption rights may postpone a disposition, even if such rights are ultimately held not to exist.” Respondent contends, however, that the foreclosure litigation was not bona fide. Respondent contends that “the redemption rights were worthless and would not have been exercised even if the courts had awarded them” because financial considerations made it improbable that the partnership would have redeemed the property.

Respondent focuses too narrowly, we believe, on the question of whether the partnership would have exercised the redemption rights, had they been awarded, to repurchase the project assets from DOE outright. Such an inquiry would improperly lead us “into endless speculation on petitioner’s financial situation and financial hopes”. Derby Realty Corp. v. Commissioner, supra at 341 (rejecting any “supposed principle of probability of redemption”); cf. Abelson v. Commissioner, 44 B.T.A. 98 (1941) (concluding that redemption rights were wholly without value and abandoned by the taxpayer who took no further action after the foreclosure sale to pursue redemption rights). Moreover, respondent fails to appreciate that the public policy served by redemption rights is not merely in providing the mortgagor an opportunity to repurchase property sold in foreclosure but also in “‘allowing time for the mortgagor to refinance and save his property, [and] permitting additional use of the property by the hard-pressed mortgagor’”. Nelson & Whitman, “Reforming Foreclosure: The Uniform Nonjudicial Foreclosure Act”, 53 Duke

L.J. 1399, 1404 (2004) (quoting Hart, “The Statutory Right ofRedemption in California”, 52 Cal. L. Rev. 846, 848 (1964)). North Dakota law reflected this broader purpose of redemption rights, as the Court of Appeals for the Eighth Circuit expressly

acknowledged in ruling upon the partnership’s suit for rights of redemption: Were we to reverse the district court and look to North Dakota law for our rule of decision Great Plains would have the right to redeem at any time up to one year after judicial sale. N.D. Cent. Code § 32-19-18 (1976). During this period Great Plains would be entitled to the possession, rents, use, and benefit of the plant. N.D. Cent. Code § 28-24-11 (1974). * * *

[United States v. Great Plains Gasification Associates, 813 F.2d at 195.] Clearly, the 1-year redemption period, with attendant rights

to possess the plant and receive its profits, would have had substantial value to the partnership. The project had generated significant cashflow both before and after the foreclosure sale.26 According to credible testimony, the partners intended to use the 1-year redemption period to pursue further negotiations with DOE to restructure the debt; the cashflow generated during the 1-year redemption period would have allowed the partnership to sweeten the pot in negotiating with DOE.

Respondent speculates that, in the light of DOE’s unreceptiveness to the debt restructuring proposals put forward immediately before the foreclosure sale, DOE would have also been unreceptive to any further efforts to restructure the debt during any redemption period. There is simply no way of knowing, however, how DOE might have responded if the partnership had been

26 For the 11 months prior to the foreclosure sale, the project had generated positive cashflow of about $57 million. During the year after the foreclosure sale, the project generated positive cashflow of about $16 million.

awarded the redemption rights, especially in the light of DOE’s long track record of mixed signals and reversals over the history of the Great Plains project. But even if we were to assume, for sake of argument, that respondent’s speculations are sound, the fact remains that the partnership would have benefited materially from the cashflows generated by the project during the redemption period.

In support of his position that the litigation over the disputed redemption rights should not postpone the finality of the foreclosure sale, respondent relies on L&C Springs Associates

v. Commissioner, T.C. Memo. 1997-469, affd. 188 F.3d 866 (7th Cir. 1999). Respondent’s reliance on that case is misplaced. L&C Springs Associates held that a realization event with respect to mortgaged real estate occurred in the year before the foreclosure sale, when the taxpayer effectively abandoned the mortgaged property.27 L&C Springs Associates, unlike the instant case, did not involve the effect of ongoing foreclosure litigation on the finality of the foreclosure sale.

Respondent does not appear to dispute that the foreclosure litigation presented genuine legal issues as to whether the partnership retained redemption rights under North Dakota law.28

27 As discussed infra, we conclude that the partnership did not abandon the project prior to the conclusion of the foreclosure litigation.

28 Similarly, respondent does not expressly advance any (continued…)

Respondent contends, however, that “this is largely beside the

point”. Respondent states on brief: “The question is not

whether the legal issues were bona fide, but whether the

litigation was brought by Petitioner to achieve the stated

purpose.” Respondent contends that ANR, and not the partnership

or Transco, undertook the foreclosure litigation “as a desperate

attempt to delay the adverse tax consequences, not to redeem the

property”. Respondent cites Lutz v. Commissioner, 396 F.2d 412

(9th Cir. 1968), revg. 45 T.C. 615 (1966) for the proposition

that litigation postpones tax consequences of a disposition only

when the taxpayer is the party actually litigating the dispute.

Respondent’s bottom line seems to be that even if the foreclosure

28(…continued) argument that the possibility of the foreclosure litigation’s succeeding was too speculative to justify deferring tax consequences of the foreclosure sale. Cf. Boehm v. Commissioner, 146 F.2d 553 (2d Cir. 1945) (loss for worthless stock was not deferred pending outcome of shareholders’ derivative action of unproven value), affd. 326 U.S. 287 (1945); Found. Co. v. Commissioner, 14 T.C. 1333, 1354 (1950) (loss on construction contract with a foreign Government was properly deferred until conclusion of litigation over breach of contract, where the taxpayer held a “reasonable view” that it could prevail on its claim). We note, however, that in the foreclosure proceeding, wherein the partnership contended that the foreclosure should be conducted in accordance with North Dakota law allowing for a 1year redemption period, the District Court characterized the partnership’s position as having “merit” even though it ultimately resolved this “close question” against the partnership. Indeed, in May 1985, DOE Assistant Secretary Mares had testified before Congress that the partnership would be entitled under North Dakota law to a 1-year redemption period, during which it would be entitled to possession of the property and to its rents and profits. Mr. Mares testified that any waiver of those rights by the partnership would be void and unenforceable under North Dakota law.

litigation presented bona fide legal issues, the litigation itself was not bona fide. We are not persuaded by respondent’s arguments.

ANR filed the appeal of foreclosure order in its capacity as a general partner of the partnership. In that capacity, pursuant to applicable provisions of North Dakota partnership law, ANR had actual and apparent authority to bind the partnership with respect to the appeal. See N.D. Cent. Code sec. 45-06-01 (1976). The other partners were aware of the litigation and were willing to let ANR take the lead in the litigation and to pay for it. The other partners gave at least tacit approval to ANR’s pursuing the appeal which, if successful, would have protected the rights of the partnership and the other partners. Indeed, on September 3, 1987, the partnership’s management committee formally ratified ANR’s actions in this regard. Respondent seems to suggest that this formal ratification was invalid or ineffective but has advanced no convincing evidentiary or legal basis for this theory.29

29 Respondent suggests that the ratifying resolutions were invalid, because they did not conform to various procedural steps required by the partnership agreement and because the copy of the ratification resolution in the record is unsigned. Other contemporaneous evidence indicates, however, that the ratification resolutions were in fact adopted by the management committee. For instance, in a letter to the law firm of Fulbright & Jaworski, dated Sept. 14, 1987, C.W. Rackley, chairman of the partnership’s management committee, stated that he had been “duly authorized” to make various representations regarding the foreclosure litigation. Attached to the letter was (continued…)

Respondent notes that ANR and the partnership had a tax incentive to delay final disposition of the project assets and contends that ANR’s pursuit of the appeal and the partnership’s ratification of ANR’s actions were simply “window dressing”. Respondent seems to suggest that the foreclosure litigation lacked economic substance. We disagree. Viewed in its totality, the record convinces us that petitioner and the partnership had legitimate and substantial business reasons, apart from tax considerations, to appeal the foreclosure litigation as part of their sustained effort to restructure the debt and salvage their half-billion dollar investments in the project. Cf. N. Ind. Pub. Serv. Co. v. Commissioner, 115 F.3d 506, 512 (7th Cir. 1997) (business actions “are recognizable for tax purposes, despite any tax-avoidance motive, so long as the corporation engages in bona fide economically-based business transactions”), affg. 105 T.C. 341 (1995).

In sum, we conclude and hold that the transfer of the project assets pursuant to the foreclosure sale was not finalized until November 2, 1987, when the Supreme Court denied the petition for writ of certiorari in the foreclosure litigation.30

29(…continued) a copy of the ratification resolutions, which Mr. Rackley’s letter stated “were duly adopted by the Management Committee of the Partnership on September 3, 1987”.

30 For similar reasons, we reject respondent’s claim, raised in cursory fashion on brief, that as of June 30, 1986, the (continued…)

B. Whether the Partnership Abandoned the Property

On brief, respondent argues alternatively that even if the

June 30, 1986, foreclosure sale did not constitute a final

disposition of the partnership’s project assets, the partnership

had abandoned the project as of June 30, 1986, or alternatively,

as of July 14, 1986 (the date the District Court overruled ANR’s

objections and confirmed the foreclosure sale).31 Respondent has

conceded, consistent with the holding of his September 1986

letter ruling, that no abandonment had occurred as of May 22,

1986. As we understand respondent’s somewhat mercurial position

in this proceeding, events occurring between May 22 and June 30,

1986, or possibly between May 22 and July 14, 1986, or possibly

30(…continued) project assets were owned by the United States and consequently, pursuant to secs. 1.47-2(a)(2) and 1.48-1(k), Income Tax Regs., the project assets ceased to qualify as sec. 38 property as of June 30, 1986. It is not the foreclosure sale itself but the “transfer upon the foreclosure” that represents the final disposition of assets that would trigger tax credit recapture. Sec. 1.47-2(a)(1), Income Tax Regs. As respondent has conceded, a bona fide contest as to the existence of redemption rights postpones a disposition pursuant to a foreclosure sale.

31 On opening brief (but not on reply brief), respondent contends broadly that both the partnership and Transco had abandoned their interests in the project as of June 30, 1986. Inconsistently, respondent’s response to petitioner’s motion in limine, filed Jan. 31, 2005, states: “Respondent no longer contends that the Court should consider the issue of whether the partners abandoned their partnership interests in GPGA.” We deem respondent to have waived any claim that Transco abandoned its partnership interest or its interests in the project (which arose only by virtue of Transco’s partnership interest). Consequently, we need not address whether such a partner-level inquiry is appropriate in this TEFRA proceeding.

on June 30, 1986, or possibly on July 14, 1986, constituted an abandonment by the partnership of the project assets.32 We disagree.

The existence or timing of an abandonment is “inherently a factual matter that requires a practical examination of all the circumstances”. L&C Springs Associates v. Commissioner, supra at 870. The courts have applied different standards for analyzing the timing of abandonment losses and the timing of abandonment gains. Generally, a determination of an abandonment loss requires an intention on the owner’s part to abandon the asset, along with an “affirmative act” of abandonment. A.J. Indus., Inc. v. United States, 503 F.2d 660, 670 (9th Cir. 1974); see L&C Springs Associates v. Commissioner, supra; Middleton v. Commissioner, 77 T.C. 310, 322, affd. per curiam 693 F.2d 124 (11th Cir. 1982). On the other hand, where, as in the instant case, abandonment of an asset would result in income recognition

32 As previously noted, although respondent occasionally posits July 14, 1986, as an alternative date of abandonment, respondent’s arguments do not otherwise direct our attention to any circumstances or analysis supporting that date. Respondent has been inconstant in his position as to whether he believes the partnership abandoned the project before June 30, 1986, or on that date. In a Jan. 5, 2005, hearing on petitioner’s motion for summary judgment, respondent’s counsel advised the Court that respondent’s position “is that there was no abandonment or other disposition of the property until June 30” (emphasis added). Inconsistently, on brief respondent contends that the partnership abandoned the project “by June 30, 1986” (emphasis added). Respondent’s arguments on brief, focusing largely on pre-June 30, 1986, events, suggest that this evolution of respondent’s choice of prepositions is purposeful.

or recapture of tax credits or deductions, an overt act of abandonment is unnecessary if, under the facts and circumstances, “it is clear for all practical purposes that the taxpayer will not retain the property”. L&C Springs Associates v. Commissioner, supra at 870; see Cozzi v. Commissioner, 88 T.C. 435, 445-446 (1987); Brountas v. Commissioner, 74 T.C. 1062, 1074 (1980).

Consistent with his September 1986 letter ruling, respondent has stipulated that the partnership did not dispose of the project before May 22, 1986 (the date of the letter ruling request). Notwithstanding this stipulation, however, respondent suggests that even before May 22, 1986, the partnership was in the process of “gradually” abandoning the project. In support of his position, respondent points to many of the same circumstances that were considered in the September 1986 letter ruling. Respondent notes, among other things, that on August 1, 1985, the partners and partnership gave DOE written notice that they were terminating their participation in the project; that various partners, with varying degrees of interest and of active participation of other partners, attempted unsuccessfully for many months to negotiate with DOE to restructure the debt; and that, in respondent’s view, certain of the partners had effectively abandoned the project. As the September 1986 letter ruling concluded, however, and as respondent now concedes, these pre-May 22, 1986, circumstances did not amount to an abandonment of the project by the partnership.

The gist of respondent’s argument, as we understand it, is that events occurring after May 22, 1986, and no later than July 14, 1986, tipped the balance, transforming what respondent views as the partnership’s gradual abandonment-in-process into actual abandonment, somewhat as ever-colder water will finally make ice. The post-May 22, 1986, events that respondent points to in support of this theory are essentially these: On May 28, 1986, ANRC and Transco Energy submitted to DOE a new proposal, which DOE rejected on June 9, 1986; on June 20, Transco informed ANR that it would not participate in appealing the District Court’s foreclosure order; on June 24, 1986, ANRC and Transco Energy submitted to DOE yet another proposal, which DOE rejected on June 25, 1986; and the foreclosure sale occurred on June 30, 1986, without any bids from the partnership or any partner.

We are unpersuaded that there was such a change in the partnership’s business climate immediately after May 22, 1986, as to say that the partnership should be deemed to have abandoned the project assets on (or by) July 1 or 14, 1986, if, as respondent concedes, the partnership had not abandoned them before then. Rather, it appears to us that the post-May 22, 1986, events were mainly a continuation of the partners’ ongoing, albeit ultimately unsuccessful, efforts to protect their significant investments in the project.

Respondent suggests that the May 1986 proposal and June 1986

proposal lacked genuine substance because they omitted certain

elements previously demanded by DOE and were motivated purely by

tax considerations.33 We disagree. Extensive, uncontradicted

testimony convinces us that these were reasonable business

proposals put forward by the partnership’s principals in good-

faith negotiations with DOE.

Ultimately, the project assets were taken from the

partnership involuntarily through the foreclosure process. Even

then, the partnership did not abandon the assets. To the

contrary, as previously discussed, ANR, with at least the tacit

approval of the partnership’s other partners and ultimately with

33 In support of his claim that there was no substantive nontax purpose for these proposals, respondent cites several internal memoranda written and exchanged by the partners. Among those internal memoranda is a Tenneco interoffice communication dated August 26, 1987 (Exhibit 314-R), which states in part:

The * * * [4 partners other than ANR] previously

refused to actively participate in the appeal because

of the desire to minimize legal exposure on other

matters and the lack of optimism associated with the

litigation. Transco and Pacific * * * have changed

their position and would vote to ratify * * * [ANR’s]

efforts. Midcon is still opposed. A change in our

position would allow the opinion process to go forward.

At trial, petitioner raised evidentiary objections to this document based on authenticity and completeness. The Court overruled the objection as to completeness but reserved ruling on the authenticity objection, inviting the parties to address the issue on brief. Petitioner has not addressed this issue on brief. Consequently, we deem petitioner to have waived authenticity objections to this document, and we shall receive Exhibit 314-R into evidence.

their formal approval, pursued bona fide litigation over the foreclosure order.

This case bears some similarity to Energy Res. Ltd. Pship.

v. Commissioner, T.C. Memo. 1992-386. In that case, a partnership constructed an oil cleansing refinery, using revenue bonds guaranteed by the U.S. Small Business Administration (SBA) and secured by a mortgage on the facility. In 1983, shortly after the facility became operational, financial and technical difficulties forced the partnership to shut the facility down. The partnership went into bankruptcy. Eventually, SBA assumed maintenance and security responsibility for the plant. Nevertheless, the partnership, through its principals, continued efforts to raise additional funds for the project, proposed various types of arrangements to potential purchasers, resisted efforts by SBA to foreclose on the property, and engaged in negotiations with SBA and the bankruptcy court. In 1984, the bankruptcy court granted SBA’s motion to sell the plant to a third party. In holding that the partnership had not abandoned the plant when it was shut down in 1983, this Court observed that the level of activity displayed by the partnership’s principals showed that they considered the project to be of continuing utility and was “sufficiently extensive, repeated, continuous, or substantial” to negate a conclusion that they had abandoned the project.

Similarly, in the instant case, the efforts of the partnership’s principals to restructure the debt and to appeal the foreclosure order convince us that they considered the project to be of continuing utility and had not abandoned it as of June 30 or July 14, 1986.

Consequently, we hold that for Federal tax purposes the there was no sale, exchange, abandonment, or other disposition of the project assets until November 2, 1987, when the foreclosure litigation ended.

II. When Was the Partnership’s Indebtedness Discharged?

In August 1985, the partnership defaulted on its $1.57 billion debt to FFB under the credit agreement. Shortly thereafter, pursuant to the loan guarantee agreement, DOE paid off the debt. The partnership’s obligation to FFB then shifted to DOE, not as a new debt, but by subrogation, with DOE stepping into FFB’s shoes as creditor. See Putnam v. Commissioner, 352

U.S. 82, 85 (1956); Lair v. Commissioner, 95 T.C. 484, 490 (1990).

In July 1986, pursuant to the indenture of mortgage, the partnership’s assets were “sold” to DOE at foreclosure for $1 billion; this amount was applied against the partnership’s debt to DOE. Petitioner asserts, and respondent does not dispute, that DOE purposefully bid less than the full amount of the partnership’s $1.57 billion debt so as to have available the remaining debt to acquire the ANG stock, which ANRC had pledged as additional security for the partnership’s debt to DOE. In October 1988, pursuant to a settlement agreement between ANRC and DOE, ANRC assigned its ANG stock to DOE, which then released the remaining $570 million indebtedness.

The parties disagree as to when this $570 million debt balance should be treated as having been discharged. Petitioner asserts that only $1 billion of the debt was discharged by the foreclosure sale and that the remaining $570 million of the debt was not discharged until October 1988, when ANRC assigned its ANG stock to DOE pursuant to the settlement agreement. Respondent contends that because the debt was nonrecourse, pursuant to Commissioner v. Tufts, 461 U.S. 300 (1983), the partnership must take into account the entire amount of the $1.57 billion indebtedness in the year in which the foreclosure sale became final (1987, pursuant to our analysis supra).

A foreclosure sale constitutes a sale for tax purposes. Helvering v. Hammel, 311 U.S. 504 (1941). The amount realized from a foreclosure sale includes the amount of liabilities “from which the transferor is discharged as a result of the sale”. Sec. 1.1001-2(a)(1), Income Tax Regs.; see Crane v. Commissioner, 331 U.S. 1, 14 (1947); Aizawa v. Commissioner, 99 T.C. at 200201. When debt is discharged in a foreclosure sale, tax consequences may vary depending upon whether the discharged debt is recourse or nonrecourse. In the case of nonrecourse debt, the amount realized on the foreclosure sale includes the entire amount of debt discharged. See, e.g., Commissioner v. Tufts, supra. In the case of recourse debt, on the other hand, the amount realized generally equals the net proceeds received from the foreclosure sale rather than the entire recourse liability.34 Aizawa v. Commissioner, supra; cf. Chilingirian v. Commissioner, 918 F.2d 1251 (6th Cir. 1990) (amount realized from foreclosure sale included amount of recourse debt discharged, where the discharge was closely related to the foreclosure sale), affg.

T.C. Memo. 1986-463 .

Whether the partnership’s debt was nonrecourse is properly determined at the partnership level in this TEFRA proceeding. See Hambrose Leasing 1984-5 Ltd. Pship. v. Commissioner, 99 T.C. 298, 308 (1992); sec. 301.6231(a)(3)-1(a)(1)(v), Proced. & Admin. Regs. Indebtedness is generally characterized as “nonrecourse” if the creditor’s remedies are limited to particular collateral for the debt and as “recourse” if the creditor’s remedies extend to all the debtor’s assets. Raphan v. United States, 759 F.2d 879, 885 (Fed. Cir. 1985). For indebtedness incurred by a partnership, Treasury regulations that were in effect at relevant times defined a nonrecourse liability as one with respect to

34 Thus, the characterization of discharged debt as recourse or nonrecourse may affect the character of any gain or loss on the transaction. In this proceeding, the parties have presented no issue as to the character of any gains realized by the partnership.

which “none of the partners have any personal liability”.35 Sec. 1.752-1(e), Income Tax Regs.; see 1 McKee et al., Federal Taxation of Partnerships and Partners, par. 8.02, at 8-6 (3d ed. 1997).

Pursuant to the terms of the loan guarantee agreement, DOE’s recovery on any claim was limited to the partnership’s assets and to the partners’ interests in those assets. Pursuant to the indenture of mortgage for the loan guarantee agreement, the collateral for the debt included all project assets, including all real or personal property “now owned or hereafter acquired by” the partnership. Insofar as the record reveals, the partnership had no significant assets apart from the project assets that were foreclosed upon. Indeed, pursuant to the partnership agreement and loan guarantee agreement, the partnership was not authorized to acquire nonproject assets or to engage in any business other than the project. After DOE took control of the project and acquired the project assets, there was

35 In support of his argument that the debt was nonrecourse, respondent cites, without elaboration, current Income Tax Reg. sec. 1.752-1(a)(2). This regulation provides that, for purposes of allocating a partnership’s liabilities among its partners, “A partnership liability is a nonrecourse liability to the extent that no partner or related person bears the economic risk of loss for that liability”. These regulations are generally effective for liabilities incurred after Dec. 28, 1991. Sec. 1.752-5(a), Income Tax Regs. The predecessor temporary regulations, which were similar to the final regulations in this regard, were generally effective for liabilities incurred on or after Jan. 30, 1989. T.D. 8274, 1989-2 C.B. 101. Accordingly, the regulations cited by respondent were not in effect at any time relevant to this case.

no realistic possibility that the partnership was going to acquire additional assets.36 In these circumstances, the partnership’s liability on the debt was effectively limited to the project assets that collateralized the indebtedness, and the partners’ liabilities were effectively limited to their interests in those project assets. In these circumstances, the debt was in substance nonrecourse against the partnership and the partners. We do not believe that the partners should be considered to have had any personal liability for the partnership’s debt within the meaning of the then-applicable regulations.37

This conclusion is consistent with the manner in which the partnership treated the debt on its 1987 Form 1065. The partnership reported disposing of the project assets in a “partial foreclosure sale” on November 2, 1987. The partnership treated the $1 billion foreclosure sale price as “the amount of the taxpayer’s nonrecourse indebtedness that was discharged as a result of the disposition of certain assets by the foreclosure

36 Under the partnership agreement, partners were required to make capital contributions to the partnership only as directed by the management committee for the purpose of purchasing project assets and paying project costs and other costs incurred by the partnership. The partners were prohibited from making voluntary contributions to the partnership. The record does not suggest the partnership ever acquired additional assets after the project assets were transferred to DOE.

37 Petitioner has not raised, and accordingly we do not consider, any argument that the partnership’s debt should be considered recourse by virtue of ANRC’s pledge of its ANG stock.

sale” (emphasis added).38 Petitioner has offered no reason why this characterization by the partnership of its indebtedness as nonrecourse should be disregarded here.

Instead, petitioner contends that it is immaterial whether the debt is considered to be recourse or nonrecourse, because even if it were nonrecourse, only $1 billion of the debt was extinguished in the foreclosure sale.39 Petitioner notes that the debt was directly secured by the ANG stock which ANRC had pledged and that DOE did not acquire the pledged stock and release the remaining debt until October 1988. Consequently, petitioner contends, whether the debt is considered to be recourse or nonrecourse, the amount realized on the foreclosure sale should not exceed the $1 billion of the partnership’s debt actually discharged at the time of the foreclosure sale.

38 An opinion letter, dated Dec. 16, 1986, provided to Coastal Corp. (which had purchased ANRC) by the law firm of Fulbright & Jaworksi, stated that the amount realized by the partnership upon the foreclosure sale “would include the outstanding amount of the Partnership’s indebtedness to the DOE. Commissioner v. Tufts, 461 U.S. 300 (1983).”

39 At various places in its 202-page opening brief and 102page reply brief, with little analysis and no citation of authority and without acknowledging that the partnership treated the debt as nonrecourse, petitioner asserts that the liability was recourse. That assertion, however, does not appear in the 2page section of petitioner’s opening brief or the 3-page section of petitioner’s reply brief specifically addressing the timing of the discharge of the partnership’s indebtedness.

We disagree. Whether a debt has been discharged is

dependent on the substance of the transaction and not mere

formalisms. Cozzi v. Commissioner, 88 T.C. at 445.

The moment it becomes clear that a debt will never have to be paid, such debt must be viewed as having been discharged. The test for determining such moment requires a practical assessment of the facts and circumstances relating to the likelihood of payment.

* * * Any “identifiable event” which fixes the loss with certainty may be taken into consideration. * * * [Id.]

See also Friedman v. Commissioner, 216 F.3d 537, 546 (6th Cir.

2000), affg. T.C. Memo. 1998-196; Brountas v. Commissioner, 74

T.C. 1062, 1073 (1980). The conclusion of the foreclosure litigation was the identifiable event whereby it became clear that the partnership’s debt would never be repaid by the partnership. Indeed, according to petitioner’s own representation, DOE bid only $1 billion in the foreclosure sale, rather than the entire amount of the debt, “precisely so that it would retain the ability separately to acquire the remaining collateral”, the ANG stock, from ANRC. Petitioner thereby implicitly acknowledges that DOE had no intention of attempting to recover any part of the remaining debt from the partnership. Subsequent events bear out that conclusion. Insofar as the record reveals, DOE never made any other claims against the partnership for the debt. In October 1988, when DOE reached the settlement agreement with ANRC, it discharged all the remaining debt in exchange for the ANG stock even though, as stated in the settlement agreement, the value of the ANG stock was less than the debt balance.

Petitioner’s reliance upon Aizawa v. Commissioner, 99 T.C. 197 (1992), is misplaced. Aizawa held that where an unpaid deficiency judgment on a recourse debt survived the foreclosure sale, and there was a “clear separation” between the foreclosure sale and the unpaid recourse liability which survived the foreclosure sale, the amount realized under section 1001(a) equaled the foreclosure sale price rather than the full unpaid mortgage principal. By contrast, in the instant case, as previously discussed, the partnership’s and the partners’ liabilities were effectively limited to the partnership’s project assets that collateralized the indebtedness. Consequently, then, these liabilities did not survive the foreclosure sale, since DOE acquired all the partnership’s project assets in the foreclosure sale. Insofar as the record reveals, DOE neither sought nor obtained any deficiency judgment against the partnership or any partner for the debt balance remaining after the foreclosure sale.

In sum, we conclude and hold that the partnership must take into account the full amount of the $1.57 billion debt as the amount the partnership realized upon disposition of the project assets upon the conclusion of the foreclosure litigation on November 2, 1987. See Commissioner v. Tufts, 461 U.S. 300 (1983).

Decision will be entered pursuant to Rule 155.

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Goldsby v. Commissioner, T.C. Memo. 2006-274 (2006).

T.C. Memo. 2006-274

UNITED STATES TAX COURT

THOMAS B. GOLDSBY, JR. AND SANDRA C. GOLDSBY, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 8232-05. Filed December 27, 2006.

Scott F. May, for petitioners.

Edsel Ford Holman, Jr., for respondent.

MEMORANDUM OPINION

KROUPA, Judge: Respondent determined a $124,662 deficiency in petitioners’ Federal income tax for 2002 by denying a $390,629 charitable contribution pass-through deduction petitioners carried over from 2000 regarding conservation easements on real estate owned by the Goldsby-Matthews Trust (the trust). We are asked to decide as a threshold issue whether petitioners may deduct the charitable contribution. We conclude that they may not.

Background

The parties fully stipulated the facts regarding the threshold issue in this case under Rule 122.1 The stipulation of facts and the accompanying exhibits are incorporated by this reference, and the stipulated facts are so found. Petitioners lived in Memphis, Tennessee, at the time they filed the petition. References to petitioner are to Thomas B. Goldsby, Jr. Petitioner and the Trust

Petitioner’s father, Thomas B. Goldsby, Sr., an Arkansas resident, created the trust in 1976 as the settlor. The trust agreement provides that the settlor’s son, petitioner, is the sole income beneficiary and is entitled to all the net income. The net income is to be paid quarterly if convenient but at least annually. Petitioner’s children, the settlor’s grandchildren, are the remainder beneficiaries under the trust agreement. Pursuant to the trust agreement, the grandchildren shall receive the trust corpus once petitioner dies.

1All Rule references are to the Tax Court Rules of Practice and Procedure, and all section references are to the Internal Revenue Code in effect for the year at issue, unless otherwise indicated.

- 3 Petitioner as Trustee

The settlor also named his son, petitioner, trustee of the trust. Petitioner was the initial trustee of the trust and served until 1985. Petitioner served as trustee again from 1986 through at least the date the petition was filed. An unrelated person was trustee in the brief interim.

The trustee has general authority to manage and distribute the trust’s assets and income. The trust agreement obligates the trustee to manage the corpus in a manner that would satisfy the purpose of allowing a distribution of the corpus to the settlor’s grandchildren after petitioner dies. All the powers the trustee has are subject to fiduciary duty limitations and subject to the limitations of the trust agreement.

The trustee is restricted in dealing with the corpus and income by the prudent investor rule, is not allowed to engage in speculation, and is required to seek long-term growth and appreciation of the trust property, considering income production as well as the safety of the corpus. The trust agreement restricts each beneficiary from disposing of his or her interest in the trust. Arkansas law governs the interpretation of the trust agreement. Undistributed Net Income and Deemed Distributions

Petitioner chose not to make or accept the mandated annual distributions of net income despite the requirement in the trust agreement. Some years, petitioner left a portion of the trust income with the trust assets. This undistributed net income, which amounted to approximately $2.2 million by January 1, 2000, was noted in the trust’s books and records. Although petitioner intentionally did not pay himself the trust’s net income, he never intended to relinquish his claim to this undistributed income. Petitioners reported all of the trust’s income (both distributed and undistributed) on their tax returns in the respective years the trust earned the income.

The trust and petitioner treated certain transactions involving the trust’s donations to charity as deemed distributions to petitioner over the years. A financial spreadsheet prepared by the trust’s certified public accountant (CPA) indicates that the trust treated $46,465 as deemed distributions to petitioner during 2000. Land in the Trust

The trust acquired significant real estate over the years. The trust acquired approximately 3,000 acres of land in Tunica County, Mississippi, which we refer to as the Duck Lake property. The trust also acquired several thousand additional acres of contiguous property in Mississippi, north of the Duck Lake property and between the Mississippi River and Tunica Cutoff Lake. This property north of the Duck Lake property is referred to as the Riverbend/M’hoons Bend property.

The trust conveyed conservation easements on the Duck Lake property and the Riverbend/M’hoons Bend property to the Mississippi Land Trust in 2000. Respondent acknowledges that the Mississippi Land Trust is a qualified charitable organization under section 501(c)(3). The trust obtained appraisals of the Duck Lake property and the Riverbend/M’hoons Bend property both before and after the conservation easements that indicated the value of the conservation easements was $5,640,000. Tax Reporting of the Conservation Easement Donations

The trust reported its donation of the conservation easements on its Form 1041, U.S. Income Tax Return for Estates and Trusts, for 2000 and reported that the charitable contribution was allocated to the sole income beneficiary, petitioner. The Schedule K-1, Beneficiary’s Share of Income, Deductions, Credits, etc., attached to the trust’s Form 1041 reported the entire $5,640,000 claimed charitable contribution deduction as passing through to petitioner as the sole income beneficiary. Petitioners deducted a portion of the trust’s charitable contribution on their Federal income tax return for 2000 and carried over the balance subject to the adjusted gross income limitations of section 170(b). Petitioners carried over and deducted portions of the trust’s charitable contribution on their Federal income tax returns for 2001, 2002, 2003, and 2004.

Petitioners’ charitable contribution carryover deduction for 2002 is at issue. Respondent’s Examination

Respondent sent two letters to petitioners requesting information about their carryover deduction for charitable contributions on their return for 2002, but petitioners failed to respond. Instead, an employee of the trust received the letters and filed them without bringing the letters to petitioners’ attention. Having received no response, respondent issued a deficiency notice to petitioners in which he disallowed petitioners’ charitable contribution deduction for 2002. Respondent challenged the value of the conservation easements that the trust donated as well as petitioners’ eligibility for any deduction at all. Petitioners timely filed a petition.

The parties filed, and the Court granted, a joint motion to sever the threshold issue of who is the proper party to claim the charitable contribution from the valuation issue of the conservation easements. Because we conclude that petitioners are not the proper party to claim the charitable contribution deduction, no trial will be necessary to determine the valuation issue.

Discussion We are asked to decide whether petitioners may deduct on their individual joint return a charitable contribution the trust

made with respect to the trust’s property. We conclude that petitioners may not deduct the charitable contribution in 2002. We begin with the burden of proof.

I. Burden of Proof

In general, the Commissioner’s determinations in the deficiency notice are presumed correct, and the taxpayer bears the burden of proving that the Commissioner’s determinations are in error. See Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). The burden of proof may shift to the Commissioner under certain circumstances, however, if taxpayers introduce credible evidence and establish that they substantiated items, maintained required records, and fully cooperated with the Commissioner’s reasonable requests. Sec. 7491(a)(1) and (2)(A) and (B).2

Petitioners admitted that they failed to respond to respondent’s two letters seeking information about their deduction. In addition, petitioners have not argued that the burden of proof should shift to respondent. Accordingly, we find that the burden of proof remains with petitioners.

2Sec. 7491 is effective with respect to court proceedings arising in connection with examinations by the Commissioner commencing after July 22, 1998, the date of enactment of the Internal Revenue Service Restructuring and Reform Act of 1998, Pub. L. 105-206, sec. 3001(a), 112 Stat. 726.

II. Ownership of a Portion of the Trust Under Grantor Trust Rules Petitioners argue that petitioner is the owner of a portion of the trust under the grantor trust rules and should therefore be allowed to deduct the value of the conservation easements the trust contributed to charity. We agree that petitioner is the owner of the income portion of the trust, but we do not find that petitioner is the owner of the corpus portion. Moreover, petitioners have not proven that the charitable contribution was made from the income portion of the trust, and petitioners are

thus not entitled to the deduction. We consider each of these issues in turn.

A. Treating Petitioner as Owner of the Income Portion of the Trust Under Grantor Trust Rules A person is treated as the owner of any portion of a trust with respect to which that person has the power, solely exercisable by himself or herself, to vest the corpus or the income in himself or herself. Sec. 678; Mallinckrodt v. Nunan, 146 F.2d 1 (8th Cir. 1945), affg. 2 T.C. 1128 (1943). When a person is treated as the owner of a portion of a trust under section 678, special rules apply to not tax the trust directly. Secs. 671-678; Estate of O’Connor v. Commissioner, 69 T.C. 165, 174 (1977). Instead, the person treated as the owner takes into

account the trust’s items of income, deduction, and credit attributable to that portion of the trust. Sec. 671.

If the trust makes a donation to charity from that portion of the trust, the person who is treated as the owner of that portion may cumulate those charitable donations with the person’s own charitable donations and deduct them under section 170.3 Sec. 1.671-2(c), Income Tax Regs.

We look to State law to examine the nature of rights and interests in a trust. Estate of Nicholson v. Commissioner, 94

T.C. 666, 672-673 (1990). Arkansas courts consider the four corners of the governing instrument to ascertain the intention of the settlor regarding the nature of interests in a trust. Estate of Whiting v. Commissioner, T.C. Memo. 2004-68 (citing Aycock Pontiac, Inc. v. Aycock, 983 S.W.2d 915, 919-920 (Ark. 1998)); Gregory v. Moose, 590 S.W.2d 665, 667-668 (Ark. Ct. App. 1979).

We look to the provisions of the trust agreement to determine whether petitioner is treated as the owner of any portion of the trust under section 678. We find that petitioner is treated as the owner of the income portion of the trust under section 678. Petitioner has significant powers with respect to the trust income on account of his dual role as trustee and sole

3Scholars have suggested that this provision might be intended to permit a deduction even when the trust’s charitable contribution was not from income. E.g., Blattmachr & Michaelson, Income Taxation of Estates and Trusts, sec. 3:3.3 n.48 (14th ed. 1999). Trusts themselves ordinarily may deduct contributions under sec. 642(c) only if they are made from income. We need not consider this point further because we conclude that petitioner is not treated as the owner of any portion of the trust other than the income portion.

income beneficiary. He was able to, was required to, and did vest the income of the trust in himself. Petitioner as trustee was required to cause the trust periodically to pay him (as income beneficiary) the entire net income of the trust. Petitioner, as trustee, owed fiduciary duties with respect to the income only to himself, the sole income beneficiary.

Accordingly, we conclude that petitioner has the sole power to vest the trust’s income in himself and is treated as the owner of the income portion of the trust.4

B. Petitioner Is Not the Owner of the Trust Corpus Despite the Undistributed Net Income Petitioners argue that they are also the owners of the trust corpus, or at least a portion of it, because petitioner left undistributed net income with the other trust assets and it became commingled with the trust corpus. Accordingly, they reason, they are entitled to the deduction for the charitable contribution no matter the source of the charitable contribution. We disagree. There are several fundamental problems with petitioners’ argument regarding ownership of the trust corpus. An examination

of the trust agreement indicates that the settlor did not intend petitioner to have any rights with respect to the corpus, other

4The unique circumstances require a finding that petitioner should be treated as the owner of the trust’s income portion. We note, and petitioners acknowledge on brief, that this finding does not apply in every situation involving a simple trust.

than to manage it as trustee for the benefit of the remaindermen, petitioner’s children. Petitioner has no right under the trust agreement to vest corpus in himself. The trust agreement strongly shows the settlor’s intent for the trustee to act to preserve the corpus for eventual distribution to the settlor’s grandchildren. Petitioner, as trustee, has fiduciary duties to these remainder beneficiaries and must act for their benefit when dealing with the corpus.

Further, the undistributed income never became part of the trust corpus nor commingled with the trust corpus.5 Petitioner never relinquished his claim to the undistributed net income. Moreover, the trust’s books and records showed the amount of undistributed net income due petitioner. The undistributed net income, unlike the trust corpus, was subject to petitioner’s withdrawal at any time. The undistributed net income was not held subject to the trust agreement, not required to be invested for the benefit of the remaindermen, and therefore, not part of the corpus.

Petitioners have also failed to prove the conservation easements were donated from the undistributed net income

5We note that, if the undistributed net income did become part of the corpus, the trust agreement would impose fiduciary obligations on petitioner with respect to it. Any donation of the undistributed net income, if it became part of corpus, would be a violation of petitioner’s fiduciary duties to maintain the corpus for the benefit of the remaindermen, his children.

regardless of whether the undistributed net income was part of the corpus. Petitioners have not introduced evidence indicating that the trust’s donation of the conservation easements came from the undistributed net income belonging to petitioner. We also note that petitioners have not offered any explanation how $2.2 million in undistributed net income relates to the $5.6 million charitable contribution the trust made, and we decline to speculate.

C. Failure To Prove That the Charitable Contribution Was Made From the Income Portion Although we treat petitioner as the sole owner of the income portion of the trust, petitioners may not deduct the value of the conservation easements the trust contributed to charity because they have not proven that the trust’s contribution was from the income portion. In general, status as owner of one portion of a trust does not permit a person to include income or take deductions not attributable to that portion. See sec. 1.671-3(b), Income Tax Regs. Petitioners have failed to introduce any evidence linking the $5,640,000 conservation easements to the trust’s income. Petitioners have introduced no evidence to prove that the conservation easements transferred were part of the income portion of the trust. Petitioner is entitled to take into

account only those items included in computing the income of a current income beneficiary, and petitioner has failed to show that the $5,640,000 conservation easements meet this standard.6 Absent proof that the trust donated the conservation easements from its income (rather than from the corpus), we cannot allow petitioners to deduct the trust’s charitable contribution. The failure of a party to introduce evidence which, if true, would be favorable to that party gives rise to the presumption that the evidence would be unfavorable if produced. Wichita Terminal Elevator Co. v. Commissioner, 6 T.C. 1158, 1165 (1946), affd. 162 F.2d 513 (10th Cir. 1947).

Petitioners argue that the donation must have come from income because the trust agreement obligates the trustee to hold the corpus for the benefit of the remaindermen, his children. While we agree that petitioner was obligated to hold the corpus for the benefit of the remaindermen, this does not dictate that the conservation easements are part of the income portion of the trust. We note that petitioner did not comply with other directives in the trust agreement, such as the requirement to distribute net income at least annually.

6Charitable contributions deductible by a trust under sec. 642(c) would generally be used in computing distributable net income and would therefore be included in income by a person treated as the owner of the trust’s income. See secs. 643, 642(c); sec. 1.671-3(b)(1) and (c), Income Tax Regs. The charitable contribution at issue, however, would not be deductible by the trust under sec. 642(c) because the trust agreement does not authorize charitable contributions. The charitable contribution thus would not be used in computing the trust’s distributable net income or taxable income.

In sum, although we treat petitioner as the owner of the income portion of the trust, petitioners are not entitled to deduct the value of the conservation easements because petitioners have not proven that the trust’s contribution was from the income portion of the trust.

III. Deemed Distributions of Net Income

Petitioners argue in their reply brief that, alternatively, the trust’s charitable contributions were actually deemed distributions to petitioner followed by charitable contributions by petitioner. We refuse to find the facts as petitioners argue.

The evidence in the record suggests that the trust and petitioners did not account for the charitable contribution as a deemed distribution. Although charitable contributions were made in the past that the trust and petitioners did account for in this manner, this particular contribution does not appear to be one of them. The trust’s financial spreadsheet prepared by the trust’s CPA indicates that only $46,465 was accounted for as a deemed distribution in 2000. Petitioners’ argument therefore contradicts the trust’s own books and records. Moreover, petitioners did not treat themselves on their income tax returns as directly contributing the conservation easements. They claimed pass-through deductions, not direct deductions under section 170. We decline to find the transaction was a deemed distribution to petitioner followed by a direct charitable contribution by petitioner.

IV. Conclusion

We conclude that petitioners are not entitled to a deduction for the trust’s charitable contribution of the conservation easements. While petitioner is treated as the owner of the income portion of the trust, petitioners have failed to prove that the conservation easements were made from the income portion of the trust. The mere fact that petitioner failed to withdraw approximately $2.2 million of income due him does not cause petitioner to be the owner of the corpus because the trust income he was owed was wholly separate from the corpus. Petitioners also have not proven that the trust’s distributions to charity were deemed distributions to petitioner, followed by his contribution of the easements to charity.

No further trial will be necessary concerning the valuation issue because we have found for respondent on the threshold issue.

In reaching our holding, we have considered all arguments made, and, to the extent not mentioned, we conclude that they are moot, irrelevant, or without merit.

To reflect the foregoing,

Decision will be entered for respondent.

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Forristal v. Commissioner, T.C. Summary Opinion 2006-194 (2006).

T.C. Summary Opinion 2006-194

UNITED STATES TAX COURT

THOMAS JOSEPH AND JUDITH JANE FORRISTAL, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 16249-04S. Filed December 26, 2006.

Thomas Joseph and Judith Jane Forristal, pro sese.

Edward L. Walter, for respondent.

GOLDBERG, Special Trial Judge: This case was heard pursuant to the provisions of section 7463 of the Internal Revenue Code in effect at the time the petition was filed. The decision to be entered is not reviewable by any other court, and this opinion should not be cited as authority. Unless otherwise indicated, subsequent section references are to the Internal Revenue Code in effect for the year in issue.

Respondent determined an accuracy-related penalty under section 6662(a) against petitioners for the taxable year 2001. The sole issue for decision is whether petitioners are liable for the penalty.

Background

Some of the facts have been stipulated and are so found. The stipulation of facts and the attached exhibits are incorporated herein by this reference. At the time the petition was filed, petitioners resided in Amelia Island, Florida.

Thomas J. Forristal (petitioner) was a practicing physician in the Cincinnati, Ohio, metropolitan area for 35 years before he retired in 2001. That year petitioner received a $23,800 distribution from a retirement account with UBS PaineWebber. UBS PaineWebber issued petitioner a Form 1099-R, Distributions from Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc., which listed the $23,800 as a taxable amount. Petitioner received the Form 1099-R in or about February 2002. Petitioners were in the process of moving to Florida at that time.

Petitioners used an accounting firm in Cincinnati to prepare their joint 2001 Federal income tax return. Petitioners provided the accounting firm with information concerning their income for that year, but they failed to provide the Form 1099-R. The return prepared by the accounting firm omitted the $23,800 from petitioners’ income. Petitioners signed and filed the return in April 2002.

Respondent sent petitioners a notice of proposed adjustments in July 2003, proposing to include the $23,800 in petitioners’ income. The notice also proposed an accuracy-related penalty. Petitioners agreed to include the $23,800 in income and promptly paid the tax attributable thereto. Petitioners did not agree to the penalty, however, and respondent issued a notice of deficiency in June 2004, determining a $1,315 penalty under section 6662(a).

Discussion

A taxpayer is liable for an accuracy-related penalty of 20 percent of any part of an underpayment attributable to negligence or disregard of rules or regulations. Sec. 6662(a) and (b)(1). The term “negligence” includes any failure to make a reasonable attempt to comply with the provisions of the internal revenue laws or to exercise ordinary and reasonable care in the preparation of a tax return. Sec. 6662(c); Gowni v. Commissioner, T.C. Memo. 2004-154. The term “disregard” includes any careless, reckless, or intentional disregard. Sec. 6662(c); sec. 1.6662-3(b)(2), Income Tax Regs.

The accuracy-related penalty does not apply to any part of an underpayment for which there was reasonable cause and with respect to which the taxpayer acted in good faith. Sec.

6664(c)(1); sec. 1.6664-4(a), Income Tax Regs. The determination of whether a taxpayer acted with reasonable cause and in good faith is made on a case-by-case basis, taking into account all pertinent facts and circumstances. 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 taxpayer’s proper tax liability. Id.

Section 7491(c) places on the Commissioner the burden of producing evidence showing that it is appropriate to impose any penalty or addition to tax. Once the Commissioner meets that burden, the taxpayer must produce evidence sufficient to show that Commissioner’s determination is incorrect. Higbee v. Commissioner, 116 T.C. 438, 447 (2001). The Commissioner need not produce evidence relating to defenses such as reasonable cause. Id. at 446.

Petitioner acknowledges receiving the Form 1099-R but claims that “It got misplaced.” Even if this is true, there is no indication petitioner timely contacted UBS PaineWebber for a replacement Form 1099-R or otherwise informed the accounting firm of the retirement income. Accordingly, we conclude that respondent has met his burden of production by showing that petitioners failed to exercise ordinary and reasonable care in preparing their 2001 tax return. See sec. 6662(c); Gowni v. Commissioner, supra.

Petitioners advance four arguments why they meet the reasonable cause and good faith exception to the penalty. First, they contend they relied on the accounting firm to prepare their return. Reliance on a return preparer may relieve a taxpayer from the accuracy-related penalty where the taxpayer’s reliance is reasonable. ASAT, Inc. v. Commissioner, 108 T.C. 147, 176 (1997). Reliance upon expert advice, however, will not exculpate a taxpayer who supplies the return preparer with incomplete or inaccurate information. Id.; InverWorld, Inc. v. Commissioner,

T.C. Memo. 1996-301. Because petitioners failed to provide the accounting firm with the Form 1099-R, this exception to the accuracy-related penalty does not apply.

Second, petitioners may be arguing that it was reasonable to misplace the Form 1099-R during the upheaval caused by their move to Florida in the spring of 2002. Even if the Form 1099-R was misplaced, unavailability of information does not constitute reasonable cause. Crocker v. Commissioner, 92 T.C. 899, 913 (1989). This is true even if the taxpayer does not receive an information document such as a Form 1099-R. See Goode v. Commissioner, T.C. Memo. 2006-48; Brunsman v. Commissioner, T.C. Memo. 2003-291 (taxpayer did not need to receive a Form 1099 to be alerted that he received income). Petitioners received the Form 1099-R and were aware of the need to report the retirement income on their return. Misplacing the Form 1099-R does not constitute reasonable cause.

Third, petitioners argue they have been accurately filing returns and paying their taxes for 55 years. While petitioners’ history of compliance is admirable, it does not explain why they failed to report the retirement income shown on the Form 1099-R.

Finally, petitioners contend that respondent is estopped from determining an accuracy-related penalty. After respondent issued the notice of proposed adjustments in July 2003, respondent sent petitioners a letter in December 2003 titled “Statement of Account”, which indicated petitioners were owed a $92.77 refund for 2001. Petitioners argue that the December 2003 letter precluded respondent from later issuing the notice of deficiency.

Equitable estoppel is a judicial doctrine that precludes a party from denying his own acts or representations which induced another to act to his detriment. Hofstetter v. Commissioner, 98

T.C. 695, 700 (1992). It is well settled, however, that the Commissioner cannot be estopped from correcting a mistake of law, even where a taxpayer may have relied to his detriment on that mistake. Norfolk S. Corp. v. Commissioner, 104 T.C. 13, 59-60 (1995), affd. 140 F.3d 240 (4th Cir. 1998). An exception exists only in the rare case where a taxpayer can prove he or she would suffer an unconscionable injury because of that reliance. Id.

The following conditions must be satisfied before equitable estoppel will be applied against the Government: (1) A false representation or wrongful, misleading silence by the party against whom the opposing party seeks to invoke the doctrine; (2) an error in a statement of fact and not in an opinion or statement of law; (3) ignorance of the true facts; (4) reasonable reliance on the acts or statements of the one against whom estoppel is claimed; and (5) adverse effects of the acts or statements of the one against whom estoppel is claimed. Id.

Petitioners have not shown that they relied to their detriment on the December 2003 letter or that they suffered unconscionable injury. Accordingly, respondent is not estopped from determining the accuracy-related penalty. Respondent’s determination is sustained.

Reviewed and adopted as the report of the Small Tax Case Division.

To reflect the foregoing,

Decision will be entered for respondent.

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Calafati v. Commissioner, 127 T.C. 16 (2006).

127 T.C. No. 16

UNITED STATES TAX COURT

DOMINIC CALAFATI, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 17529-03L. Filed December 26, 2006.

P filed a motion for summary judgment in this sec. 6330, I.R.C., proceeding. In his petition, P disputed R’s notice of determination concerning collection action with respect to his 1998 tax liability on the ground that he was not permitted by the IRS Appeals Office to make an audio recording of his sec. 6330, I.R.C., telephone hearing, in violation of sec. 7521(a)(1), I.R.C. P informed R before the telephone hearing that he intended to audio record the hearing pursuant to sec. 7521(a)(1), I.R.C., and Keene v. Commissioner, 121 T.C. 8 (2003). R refused to permit P to audio record the telephone hearing but did not inform him of R’s post-Keene policy that a taxpayer could audio record a face-to-face hearing. The parties agreed to consider the scheduled telephone hearing convened and then terminated, with no substantive issues discussed, because P was not allowed to audio record the hearing.

Held: Sec. 7521(a)(1), I.R.C., does not entitle P to make an audio recording of his sec. 6330, I.R.C., telephone hearing with the IRS Appeals Office.

Held, further, because of the uncertainty regarding a taxpayer’s ability to audio record a sec. 6330, I.R.C., hearing existing at the time of P’s sec. 6330, I.R.C., hearing, P’s motion for summary judgment shall be granted in that the case is remanded for further proceedings consistent with this Opinion.

David S. Brady, for petitioner.

Jack T. Anagnostis, for respondent.

OPINION

MARVEL, Judge: This matter is before the Court on petitioner’s motion for summary judgment filed pursuant to Rule 121.1

Background

This is an appeal from respondent’s determination upholding the proposed use of a levy to collect petitioner’s unpaid Federal income tax liability for 1998. The only issues petitioner raises are whether, pursuant to the provisions of section 7521(a)(1), petitioner was entitled to audio record his section 6330 telephone hearing with the Internal Revenue Service Appeals Office (the Appeals Office) and, alternatively, whether

1All Rule references are to the Tax Court Rules of Practice and Procedure, and all section references are to the Internal Revenue Code in effect at all relevant times.

petitioner was entitled to be informed, before the beginning of his section 6330 telephone hearing, of respondent’s post-Keene policy that a face-to-face section 6330 hearing is the only section 6330 hearing section 7521(a)(1) entitles a taxpayer to audio record. Petitioner was a resident of Lansdale, Pennsylvania, when his petition in this case was filed.

Petitioner timely filed his 1998 individual Federal income tax return. On April 3, 2002, respondent issued a notice of deficiency (notice) in which he determined that petitioner was liable for an income tax deficiency of $8,173 and an accuracy-related penalty, pursuant to section 6662(a), of $1,634.60 for 1998. Petitioner sent a letter dated May 14, 2002, to the Internal Revenue Service (the Service) appealing the notice, but he did not petition this Court to review the notice. On August 26, 2002, respondent assessed the deficiency for 1998.

On December 21, 2002, respondent issued a Final Notice of Intent To Levy and Notice of Your Right to a Hearing with regard to petitioner’s unpaid tax liability for 1998. On or around December 30, 2002, petitioner timely submitted a Form 12153, Request for a Collection Due Process Hearing (section 6330 hearing), in which he contended that “The administrative record contains egregious errors, and the correction of those errors will mitigate collection activity. Additionally, several procedural errors were committed violating administrative due process.” On July 8, 2003, after petitioner requested his hearing, we released our Opinion in Keene v. Commissioner, 121 T.C. 8 (2003). In Keene, we held that a taxpayer was entitled to audio record a face-to-face section 6330 hearing under section 7521(a).

By letter dated July 28, 2003, Appeals Officer Paula Stanton (the Appeals officer) informed petitioner that his section 6330 hearing was scheduled to take place on August 12, 2003, at the Service’s Philadelphia, Pennsylvania, Appeals Office. Petitioner’s representative, Albert Wagner (Mr. Wagner), telephoned the Appeals officer to reschedule the hearing for August 18, 2003, and to request that the hearing be conducted by telephone. Mr. Wagner also advised the Appeals officer that he intended to audio record the telephone hearing. The Appeals officer informed Mr. Wagner that audio recording would not be permitted. In response, Mr. Wagner stated that he still wanted to proceed with the telephone hearing.

On or around August 11, 2003, several days after the telephone conversation with Mr. Wagner, the Appeals officer received a facsimile dated August 7, 2003, from Mr. Wagner that confirmed Mr. Wagner’s desire to participate in the August 18 telephone hearing and reiterated his intent to audio record the hearing “pursuant to IRC §7521(a)(1)” and “the recent Tax Court decision, * * * Keene v Commissioner”. The Appeals officer did not advise petitioner or Mr. Wagner of respondent’s post-Keene policy that a taxpayer would be permitted to audio record a face-to-face section 6330 hearing but not a telephone hearing.

The telephone hearing scheduled for August 18, 2003, was rescheduled for August 20, 2003, and was convened on that date. At the beginning of the hearing, Mr. Wagner again informed the Appeals officer that he intended to audio record the hearing, and the Appeals officer again advised Mr. Wagner that the Appeals Office’s policy did not permit audio recording. Mr. Wagner and the Appeals officer agreed that they would consider the hearing started and then terminated, with no substantive issues discussed, because the Appeals officer would not permit audio recording. After Mr. Wagner and the Appeals officer agreed the hearing was terminated, the Appeals officer notified Mr. Wagner that she would issue a notice of determination based on the information in her administrative file. The parties stipulated that petitioner would have continued with the telephone hearing had he been permitted to audio record it.

On September 16, 2003, respondent issued a Notice of Determination Concerning Collection Action(s) Under Section 6320 and/or 6330 (notice of determination) to petitioner. The notice of determination informed petitioner that respondent had determined that a levy was appropriate to collect the 1998 tax liability.

On October 14, 2003, the petition contesting the notice of determination was filed. The only error petitioner alleged was that the section 6330 hearing was not conducted in accordance with section 7521(a)(1). On December 4, 2003, respondent’s answer, in which he denied he erred as alleged, was filed.

Petitioner subsequently filed a motion for summary judgment. In his motion, petitioner asserts there is no dispute as to any material facts and that he is entitled to audio record his section 6330 telephone hearing as a matter of law. We held a hearing on petitioner’s motion. Both petitioner and respondent appeared and were heard. At the hearing, petitioner argued, in the alternative, that he should have received some advance notice of the fact that if he had requested a face-to-face meeting, then he would have been allowed to record it. Respondent’s position is that section 7521(a)(1), which authorizes taxpayers to record “in-person interviews”, is not applicable to section 6330 telephone hearings and that respondent had no obligation to notify petitioner of his policy regarding the recording of section 6330 hearings.

Discussion

A. Summary Judgment

Summary judgment is a procedure designed to expedite litigation and avoid unnecessary, time-consuming, and expensive trials. Fla. Peach Corp. v. Commissioner, 90 T.C. 678, 681 (1988). Summary judgment may be granted with respect to all or any part of the legal issues presented “if the pleadings, answers to interrogatories, depositions, admissions, and any other acceptable materials, together with the affidavits, if any, show that there is no genuine issue as to any material fact and that a decision may be rendered as a matter of law.” Rule 121(a) and (b); see Sundstrand Corp. v. Commissioner, 98 T.C. 518, 520 (1992), affd. 17 F.3d 965 (7th Cir. 1994); Zaentz v. Commissioner, 90 T.C. 753, 754 (1988). The moving party bears the burden of proving that there is no genuine issue of material fact, and factual inferences will be read in a manner most favorable to the party opposing summary judgment. Dahlstrom v. Commissioner, 85 T.C. 812, 821 (1985).

B. Section 6330 Hearing

Section 6331(a) provides that if any taxpayer liable to pay any tax neglects or refuses to pay such tax within 10 days after notice and demand for payment, then the Secretary2 is authorized to collect such tax by levy upon the taxpayer’s property. However, section 6330(a) requires the Secretary to send written

2The term “Secretary” means “the Secretary of the Treasury or his delegate”, sec. 7701(a)(11)(B), and the term “or his delegate” means “any officer, employee, or agency of the Treasury Department duly authorized by the Secretary of the Treasury directly, or indirectly by one or more redelegations of authority, to perform the function mentioned or described in the context”, sec. 7701(a)(12)(A).

notice to the taxpayer of the taxpayer’s right to request a section 6330 hearing before a levy is made.

Section 6330 hearings are informal proceedings, not formal adjudications. Katz v. Commissioner, 115 T.C. 329, 337 (2000); Davis v. Commissioner, 115 T.C. 35, 41 (2000); sec. 301.6330-1(d)(2), Q&A-D6, Proced. & Admin. Regs. Ordinarily, a taxpayer is entitled under section 6330 to a face-to-face hearing with the Appeals Office. Cox v. Commissioner, 126 T.C. 237, 246 (2006); sec. 301.6330-1(d)(2), Q&A-D6 and D7, Proced. & Admin. Regs. If the taxpayer chooses not to participate in a face-to-face hearing, however, “the taxpayer will be given an opportunity for a hearing by correspondence or by telephone.” Sec. 301.6330-1(d)(2), Q&A-D7, Proced. & Admin. Regs. Once the taxpayer has been given a reasonable opportunity for a hearing but has failed to avail himself of that opportunity, the Appeals officer, after reviewing the administrative file, may make a determination regarding whether respondent’s proposed collection action may proceed. See, e.g., Taylor v. Commissioner, T.C. Memo. 2004-25, affd. 130 Fed. Appx. 934 (9th Cir. 2005); Leineweber v. Commissioner, T.C. Memo. 2004-17.

C. Section 7521(a)(1) and the Right To Audio Record an “In-Person Interview” Section 7521(a)(1) provides that, upon advance request of a

taxpayer, an officer or employee of the Service shall permit the taxpayer to make an audio recording of “any in-person interview * * * relating to the determination or collection of any tax”.However, neither section 7521(a)(1) nor the legislative history of section 7521 “directly and clearly defines or otherwise describes the term ‘in-person interview’.” Keene v. Commissioner, 121 T.C. at 14.

In his motion for summary judgment, petitioner contends that a telephone interview conducted pursuant to section 6330 qualifies as an “in-person interview” within the meaning of section 7521(a). Citing Keene, petitioner contends that he is entitled under section 7521(a) to audio record his telephone hearing. We consider petitioner’s contentions below.

1. Keene v. Commissioner and the Definition of “Interview”

In Keene, we considered for the first time whether section 7521(a)(1) entitles a taxpayer to audio record a section 6330 hearing. In that case, the taxpayer requested a section 6330 hearing with the Appeals Office and informed the Appeals Office of his intent to audio record the hearing. Id. at 11. An Appeals officer scheduled a face-to-face hearing with the taxpayer but informed him that the Appeals Office would not allow audio or stenographic recordings of Appeals Office cases. Id. The taxpayer appeared for the face-to-face hearing. Id. at 13. When the Appeals officer again informed the taxpayer that he would not be allowed to record the hearing, the taxpayer decided he did not want the hearing because he could not record it. Id.

The taxpayer subsequently filed a petition in this Court in which he argued that he should have been permitted to record the face-to-face hearing. Id. The Commissioner contended that the taxpayer had no right to record the section 6330 proceeding because a section 6330 hearing was not an “in-person interview” within the meaning of section 7521(a)(1), section 7521 did not apply to hearings conducted by the Appeals Office, and a section 6330 hearing was not covered by section 7521 because it was a voluntary proceeding initiated by a taxpayer and was not an inquisitorial interview conducted by the Examination or Collection Division of the type described in section 7521. Id. at 15-16. We rejected the Commissioner’s contentions.

In our analysis, we acknowledged that section 7521 and its legislative history neither defined nor explained the term “inperson interview”. Id. at 14. Consequently, applying well-established principles of statutory interpretation, our analysis focused on what constitutes an interview:

The term “interview” is defined by Webster’s Third New International Dictionary Unabridged 1183-1184 (1993) as:

a meeting face to face: a private conversation; usu: a

formal meeting for consultation: CONFERENCE

Similar definitions appear in other dictionaries. For

example, the American Heritage Dictionary (4th ed.

1970) defines the term “interview” as “a face to face

meeting arranged for the discussion of some matter”;

Webster’s II New Riverside University Dictionary 639

(1984) defines the term as “a formal face-to-face

meeting”; and Webster’s New Collegiate Dictionary 600

- 11 -(1979) defines the term as “a formal consultation” or “a meeting at which information is obtained”. Id. at 15.

Applying this analysis, we concluded that a section 6330 hearing has the “characteristics of an ‘interview’” because the “meeting between the taxpayer and the Appeals officer is face-to-face, private, arranged for the discussion of specific matters, and formal in the sense that it is prescribed by law.” Id. at 16, 17 (emphasis added). We also concluded that

As the general and ordinary definitions of “interview” suggest, we think the exchange of information that occurs between a taxpayer and an Appeals officer during an administrative hearing conducted under section 6330 constitutes an “in-person interview” within the meaning of that term as used in section 7521(a)(1).

Id. at 16. Because we were also persuaded that (1) a section 6330 hearing “is an integral part of the tax collection process and therefore relates to the ‘collection of any tax’ within the meaning of section 7521(a)(1)”, (2) “denying the taxpayer’s right to audio record would serve to undermine the safeguards in IRS collection actions that Congress created in section 6330”, (3) the Commissioner’s interpretation of section 7521 would have the anomalous result of allowing audio recording of interviews that we typically do not review but not allowing recording of proceedings we are statutorily charged with reviewing, and (4) having a transcript of the section 6330 hearing would facilitate judicial review of the determination made by the Appeals Office with respect to the Commissioner’s proposed levy, we held that the taxpayer had a statutory right under section 7521(a)(1) to audio record his section 6330 hearing. Id. at 17-19. However, we did not specifically address when an interview qualifies as “in-person” in Keene, presumably because that aspect of the taxpayer’s argument was not contested by the Commissioner and could not reasonably be disputed on the facts of the case. That issue is now before us.

2. The Meaning of “In-Person” in Section 7521(a)

As we acknowledged in Keene, section 7521(a) does not define the term “in-person interview”. Although we held in Keene that a face-to-face section 6330 hearing qualified as an “in-person interview” within the meaning of section 7521(a), we did not decide whether other kinds of section 6330 hearings, such as the telephone hearing involved in this case, also qualified as an “in-person interview”.

Where a term is not defined by statute, it is appropriate to accord the term its “ordinary meaning”. Nw. Forest Res. Council

v. Glickman, 82 F.3d 825, 833 (9th Cir. 1996); Keene v. Commissioner, 121 T.C. at 14. “And when there is no indication Congress intended a specific legal meaning for the term, courts may look to sources such as dictionaries for a definition.” Keene v. Commissioner, supra at 14-15; see also Muscarello v.

United States, 524 U.S. 125, 127-132 (1998). The term “inperson” is defined by Merriam Webster’s Collegiate Dictionary 867 (10th ed. 1997) as “in one’s bodily presence”. Similar definitions appear in other dictionaries. For example, the Oxford Dictionary and Usage Guide 440 (1995) and the American Heritage Dictionary 978 (1976) define the term as “physically present”, and the New Shorter Oxford English Dictionary, Vol. 2, 2171 (1993) defines the term as “with one’s own bodily presence” or “personally”.

The ordinary meaning of the term “in person” supports respondent’s argument that section 7521(a) refers to a face-to-face meeting between the interviewer and the person being interviewed. Specifically in the context of section 7521, an “in-person interview” according to respondent contemplates an interview between a taxpayer and/or the taxpayer’s representative and an officer or employee of the Service relating to the determination or collection of any tax. See sec. 7521(a). This interpretation of the language of section 7521(a) is also buttressed by section 7521(b) and its legislative history.

Section 7521(b)(1) provides that in the case of an “inperson interview with the taxpayer” relating to either the determination or collection of any tax, the Service is obligated to provide certain information to the taxpayer either before or at the initial interview. Sec. 7521(b)(1)(A) and (B). The legislative history of section 7521 indicates that the Service may meet this obligation with a “written statement handed to the

taxpayer” at or shortly before the initial in-person interview.

H. Conf. Rept. 100-1104, at 213 (1988), 1988-3 C.B. 473, 703. Together, section 7521(b) and the legislative history suggest that Congress envisioned an “in-person interview” as an interview where both a Service representative and the taxpayer (or his representative), see sec. 7521(c), are physically present and able to “hand” information to each other. See also IRS Field Serv. Advisory 200206055 (February 2002) and IRS General Litigation Bulletin No. 355 (April 1990), which generally distinguish section 7521 “in-person interviews” from “written communication or telephone conversations” between the Service and taxpayers.

We conclude, therefore, that the term “in-person interview” in section 7521(a) refers to an interview in which the IRS representative and the taxpayer and/or his representative are face-to-face, that is, they are within each other’s physical presence.

D. Application to Section 6330 Telephone Hearings

1. Whether Section 7521(a)(1) Entitles Petitioner To Make an Audio Recording of His Section 6330 Telephone Hearing Respondent contends that there is a material difference

between the section 6330 hearing in Keene and the section 6330 hearing at issue here. In Keene v. Commissioner, supra at 13, the section 6330 hearing was a face-to-face meeting between the taxpayer and the Appeals officer. In this case, the section 6330 hearing was telephonic and did not involve any face-to-face meeting between petitioner and the Appeals officer. Respondent argues that the term “in-person interview” in section 7521(a)(1) requires a face-to-face meeting between the taxpayer and the presiding Appeals officer. Petitioner contends, however, that Keene confirms he is entitled to make an audio recording of his section 6330 telephone hearing because the hearing relates to the collection of tax and involves an exchange of information that qualifies as an “in-person interview” as that term is used in section 7521(a)(1) and that “it’s not an issue of whether it’s by telephone or not”. We disagree with petitioner for the following reasons.

First, petitioner’s position that Keene confirms he has a right to audio record his section 6330 hearing pursuant to section 7521(a)(1), regardless of whether it takes place face-to-face, by telephone, or otherwise, is not persuasive. In Keene, we held that section 7521(a)(1) entitled the taxpayer to audio record his section 6330 hearing because the hearing was an “inperson interview” with respect to the collection of tax. We concluded that the hearing had the characteristics of a section 7521(a)(1) “in-person interview”, in part, specifically because the hearing “between the taxpayer and the Appeals officer is face-to-face”. Id. at 16-17 (emphasis added). Consequently, our analysis in Keene does not show that we considered the format of the section 6330 hearing irrelevant to our holding. Instead, our analysis in Keene reveals that for purposes of our holding, we only considered a face-to-face section 6330 hearing. See Wright

v. Commissioner, T.C. Memo. 2005-291 (“In Keene * * *, this Court held that taxpayers are entitled, pursuant to section 7521(a)(1), to audio record a face-to-face section 6330 hearing.” (Emphasis added.)).

Second, petitioner’s interpretation of Keene is undermined by our application of Keene since we issued the Opinion. We have never applied our holding in Keene that a taxpayer is entitled to audio record his section 6330 hearing to anything other than a face-to-face meeting. See, e.g., Meyer v. Commissioner, T.C. Memo. 2005-81, affd. without published opinion 98 AFTR 2d 20066378, 2006-2 USTC par. 50539 (9th Cir., Aug. 31, 2006); Taylor v. Commissioner, T.C. Memo. 2005-74; Frey v. Commissioner, T.C. Memo. 2004-87; see also Yazzie v. Commissioner, T.C. Memo. 2004233 (the Court described the taxpayer’s section 6330 face-to-face hearing as an “in-person conference”), affd. 153 Fed. Appx. 456 (9th Cir. 2005); Johnston v. Commissioner, T.C. Memo. 2004-224 (the Court again described the taxpayer’s section 6330 face-to-face hearing as an “in-person conference”), affd. 153 Fed. Appx. 451 (9th Cir. 2005).

Third, and most significantly, we reject petitioner’s position because, as the general and ordinary definitions of “inperson” suggest, a section 6330 hearing that takes place by telephone is not a hearing where the parties, or their representatives, are within each other’s bodily presence, or “inperson”. To hold that a section 6330 telephone hearing is an “in-person interview” for purposes of section 7521(a)(1), therefore, would be contrary to well-settled rules of statutory construction because it would render the words “in-person” in section 7521 meaningless. Duncan v. Walker, 533 U.S. 167, 174 (2001) (statute ought to be construed so that no clause, sentence, or word is rendered superfluous, void, or insignificant); Weinberger v. Hynson, Westcott & Dunning, Inc., 412 U.S. 609, 633 (1973) (“all parts of a statute, if at all possible, are to be given effect”). For these reasons, we hold that section 7521(a)(1) does not entitle petitioner to make an audio recording of his section 6330 telephone hearing.3

3We recognize that several of the reasons we enumerated in Keene to support our holding that sec. 7521(a)(1) entitles a taxpayer to audio record his sec. 6330 face-to-face hearing would apply equally to a taxpayer who participates in a sec. 6330 telephone hearing. For example, a sec. 6330 telephone hearing is just as integral a part of the tax collection process as a face-to-face hearing, and a transcript of a section 6330 telephone hearing would facilitate judicial review of a determination made by the Appeals Office with respect to a proposed levy by the Commissioner just as a transcript of a face-to-face hearing would. See Keene v. Commissioner, 121 T.C. 8, 17-18 (2003). However, sec. 7521(a)(1) specifically limits a taxpayer’s right (continued…)

2. Whether Respondent Was Obligated To Advise Petitioner of His Post-Keene Policy on Audio Recording Section 6330 Hearings

Alternatively, petitioner argues that respondent had an obligation to provide petitioner with information regarding his post-Keene policy on audio recording section 6330 hearings so that petitioner could have made an informed decision regarding the type of hearing to request. Respondent disagrees, arguing that petitioner was offered a face-to-face hearing and rejected it in favor of a telephone hearing. However, respondent offered the face-to-face hearing, and petitioner rejected it, before we had decided Keene. We issued our opinion in Keene on July 8, 2003, more than a month before the August 20, 2003, telephone hearing was convened. Respondent did not advise petitioner either before the August 20, 2003, telephone hearing or at the beginning of the telephone hearing when petitioner renewed his request to audio record the hearing, that petitioner could only audio record a face-to-face hearing.

Section 6330(a)(1) requires that the Secretary provide notice to a taxpayer of his right to a hearing before a levy is made on the taxpayer’s property or on his right to property.

3(…continued) to audio record collection interviews to those interviews that take place “in-person”, and the “courts may not depart from the statutory text because they believe some other arrangement would better serve the legislative goals.” Herrgott v. U.S. Dist. Court for N. Dist. of Cal. (In re Cavanaugh), 306 F.3d 726, 731732 (9th Cir. 2002).

Section 6330(a)(3) provides that the notice shall include, in simple and nontechnical terms, the amount of the unpaid tax, the right of the person to request the hearing, and the proposed action by the Secretary and the rights of the person with respect to such action. Section 6330(a)(3)(C)(ii) and (iii) specifically requires that the person whose property may be subject to a levy also be advised of “the procedures applicable to the levy and sale of property under this title” and “the administrative appeals available to the taxpayer with respect to such levy and sale and the procedures relating to such appeals”. Section 6330(a) thus confirms that the Commissioner has an affirmative obligation to notify a taxpayer whose property or rights to property could be adversely affected by a proposed levy of his administrative appeal rights and the procedures relating to such appeal.

Respondent issued the notice advising petitioner of his

4

right to a section 6330 hearing before we decided Keene.Petitioner contends in effect that respondent’s obligations to inform a taxpayer of his rights under section 6330 do not end with the mailing of a notice. Petitioner maintains that respondent had an obligation to inform him of his right under

4We recognize that the notice furnished to petitioner under sec. 6330 could not have included any explanation of his rights under sec. 7521 and Keene v. Commissioner, supra, because our Opinion in Keene had not yet been filed when the notice was mailed to petitioner.

section 7521(a) to audio record a section 6330 face-to-face

hearing but not a telephone hearing. Under the circumstances of

this case, we do not have to reach this issue.

Respondent does not dispute for purposes of petitioner’s

motion that, on or before the date of petitioner’s section 6330

hearing, respondent had adopted, at least informally, an

administrative position regarding the effect of our opinion in

Keene on a taxpayer’s right to audio record a section 6330

hearing (post-Keene policy).5 In addition, respondent admits that

5On Sept. 11, 2003, approximately 2 months after we filed our Opinion in Keene, the Office of Chief Counsel issued Notice CC-2003-031 (Sept. 11, 2003) to provide guidance to IRS personnel as to “when the Internal Revenue Service Office of Appeals will offer a taxpayer a face-to-face conference in a lien and levy case arising under I.R.C. §6320 or §6330.” In Notice CC-2003-031, the Office of Chief Counsel limited a taxpayer’s right to obtain a face-to-face conference in a proceeding under sec. 6320 or 6330 in situations where the taxpayer has raised in his hearing request only frivolous or groundless arguments. The notice provides that, if a taxpayer who has raised only frivolous or groundless arguments in his hearing request satisfies the Appeals Office that he is prepared to discuss nonfrivolous issues, the taxpayer may be offered a face-to-face conference, and, if he requests to do so, the taxpayer may audio record the conference in accordance with sec. 7521 and Keene v. Commissioner, supra.

Effective May 27, 2004, the Service revised Internal Revenue Manual (IRM) sec. 8.7.2, Special Collection Appeals Programs, to establish procedures for recording face-to-face hearings before the Appeals Office and to set forth requirements for making an audio recording of an Appeals Office conference. Specifically, IRM sec. 8.7.2.3.6 acknowledges our Opinion in Keene and confirms that the Appeals Office will allow audio recordings of all types of cases that have face-to-face conferences on issues that are not deemed frivolous but will not allow recordings of telephone conferences. Under 4 Administration, IRM (CCH), sec. 8.6.1, at (continued…)

the Appeals officer did not advise petitioner or his representative of respondent’s post-Keene policy prohibiting the audio recording of section 6330 telephone hearings but permitting the audio recording of a face-to-face hearing. Petitioner understandably complains that respondent’s failure to inform him of the policy deprived him of the opportunity to make an informed decision regarding the format of his section 6330 hearing and his right under section 7521 to audio record it.6 Petitioner states, and respondent does not dispute, that if petitioner had known about respondent’s policy, petitioner would have requested a face-to-face hearing so that he could have exercised his right under section 7521 to audio record his section 6330 hearing.

We are not aware of any Service publication or announcement that would have put petitioner on notice of respondent’s post-Keene policy before or at petitioner’s scheduled section 6330 hearing on August 20, 2003. The regulations in effect on August

5(…continued) 27,203, Conference and Settlement Practice, see sec. 8.6.1.2.5., at 27,207, Audio and Stenographic Recording of Conferences, and sec. 8.6.1.2.5.1, at 27,208, Recording Requirements, which were amended, effective May 13, 2004, to provide for audio recording of all cases that have face-to-face conferences on issues that are not deemed frivolous.

6Respondent does not allege that petitioner has asserted only frivolous or groundless arguments in his hearing request, nor does he contend that petitioner had no right to have a sec. 6330 face-to-face hearing. Rather, respondent contends that petitioner was given the opportunity to have a sec. 6330 face-to-face hearing but requested a telephone hearing instead.

20, 2003, did not set forth respondent’s post-Keene policy regarding audio recording of section 6330 hearings, and respondent did not issue any guidance regarding the policy until September 11, 2003.

We recognize that our Opinion in Keene was not filed until July 8, 2003, less than 2 months before petitioner’s section 6330 hearing was convened. We also recognize that the Service must have some reasonable period of time to evaluate the effect of an opinion like Keene and to educate its personnel regarding its application. Nevertheless, it is uncontested that, as of August 20, 2003, respondent had concluded that the right to record a section 6330 hearing that we recognized in Keene is limited to those section 6330 hearings conducted face-to-face.

This Court may remand a case to the Internal Revenue Service for a section 6330 hearing in appropriate circumstances. See Lunsford v. Commissioner, 117 T.C. 183, 189 (2001); Kelby v. Commissioner, T.C. Memo. 2005-25 (If a taxpayer is not afforded a proper opportunity for a section 6330 hearing, we can remand for a hearing if we believe it is necessary or productive). While we acknowledge that petitioner was offered a face-to-face hearing and rejected it in favor of a telephone hearing, we also recognize that petitioner made his decision before Keene was released and before respondent had issued any administrative guidance regarding its post-Keene position. In light of Keene and the unusual circumstances established by the undisputed facts in this case, we conclude, in the exercise of our discretion, that petitioner should be given the opportunity to have a face-to-face hearing, which petitioner may audio record in accordance with section 7521(a).7 Consequently, we shall grant petitioner’s motion for summary judgment, in part, in that we shall remand petitioner’s case to the Appeals Office for further proceedings consistent with this Opinion, and we shall deny petitioner’s motion to the extent that it asserts a right under section 7521 to audio record a section 6330 telephone hearing.

To reflect the foregoing,

An appropriate order will be issued.

7Respondent does not contend that petitioner has asserted frivolous or groundless positions. Consequently, this is not a case where it would be unproductive to remand the case. See, e.g., Lunsford v. Commissioner, 117 T.C. 183, 189 (2001); Williams v. Commissioner, T.C. Memo. 2005-94.

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December 26th, 2006 | 1 Comment »

Hubbard v. Commissioner, T.C. Summary Opinion 2006-193 (2006).

T.C. Summary Opinion 2006-193

UNITED STATES TAX COURT

DANIEL HUBBARD, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 8207-05S. Filed December 21, 2006.

Daniel Hubbard, pro se.

Steven Josephy, for respondent.

GOLDBERG, Special Trial Judge: This case was heard pursuant to the provisions of section 7463 of the Internal Revenue Code in effect at the time the petition was filed. The decision to be entered is not reviewable by any other court, and this opinion should not be cited as authority.

This matter is before the Court on respondent’s Motion for Summary Judgment filed pursuant to Rule 121, Tax Court Rules of Practice and Procedure. Unless otherwise indicated, subsequent section references are to the Internal Revenue Code in effect for the year in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure. In his motion, respondent moves for adjudication of all legal issues in controversy and argues, pursuant to section 6330(c)(2)(B), that petitioner’s receipt of a notice of deficiency should preclude him from challenging the underlying income tax liability for the 2000 taxable year, the only error assigned in the underlying petition. Petitioner has not denied receiving a notice of deficiency but rather maintains that he is not required by law to pay income taxes. The only issue for determination, therefore, is whether petitioner can contest the merits of the tax liability determined in the notice of deficiency and subsequently assessed by respondent.

Background

The parties’ stipulation of facts is incorporated by this reference. At the time that the underlying petition was filed in this case, petitioner resided in Centennial, Colorado.

During the taxable year at issue, petitioner worked as a school bus driver for the Denver Public Schools. Petitioner submitted to respondent a Form 1040, U.S. Individual Income Tax Return, for the taxable year 2000. On the return, petitioner entered zeros on all lines requesting information regarding his income (specifically, line 7), and claimed a refund of all of his

- 3 Federal income tax withheld.

Petitioner attached to the return a 2-page typewritten statement containing frivolous and groundless tax protester arguments such as: (1) No section of the Internal Revenue Code establishes an income tax liability or requires that he pay taxes on the basis of a return; (2) the Privacy Act provides that he is not required to file a return; (3) a Form 1040 with zeros is a valid return; (4) he has no income under the definition of income in Merchants Loan & Trust Co. v. Smietanka, 255 U.S. 509 (1921);

(5) his return is not frivolous; (6) no Internal Revenue Serviceemployee has been delegated authority to determine whether a return is frivolous or to impose a frivolous return penalty; (7) the frivolous return penalty may not be applied to him because no legislative regulation implements it; (8) no statute allows the IRS to prepare a return for him because he has filed a “return”; and (9) income, for purpose of the Federal income tax, “can only be a derivative of corporate activity.”

In a letter dated August 13, 2002, respondent advised petitioner that although he had received petitioner’s 2000 return, it could not be processed. Respondent informed petitioner in this letter that his arguments were frivolous and without merit. Respondent prepared a substitute return for petitioner. On August 13, 2002, respondent sent petitioner a 30day letter, in which respondent adjusted petitioner’s income tax liability for 2000. Petitioner responded to this letter on October 20, 2002, by filing a Form 1040X, Amended U.S. Individual Income Tax Return. Across lines 1-10 of the Form 1040X, petitioner wrote the words, “Not Liable.” He also wrote “Not Liable” on line 19 of the Form 1040X. On line 23, the amount that petitioner wanted as a refund, he wrote “$317.” In Part II of the Form 1040X, petitioner wrote the following as an explanation of the changes he made on the Form 1040X:

“Not Liable! (Explanation!) Not Liable!

Not Liable! I discovered after reading your 1040

instruction book that I’m not liable because line

#7 ask [sic] for my foreign source income; since I

had no foreign source income I’m not liable for

any tax you claim that I owe. Please refund my

overpayment in the amount of $317 that was

withheld.”

Respondent, by means of certified mail dated June 18, 2003, sent a notice of deficiency (the notice) to petitioner, determining an income tax deficiency and proposing additions to tax for the taxable year 2000 as

-

The deficiency in income tax is based on respondent’s determination that in 2000 petitioner received, but failed to report on an income tax return for that year, income from the following sources:

-

The addition to tax under section 6651(a)(1) is based on respondent’s determination that petitioner failed to file a valid income tax return for 2000. The addition to tax under section 6654(a) is based on respondent’s determination that petitioner, having avoided the proper amount of withholding of tax from his wages, failed to pay estimated tax.

Respondent mailed the notice to petitioner’s last known address, 20734 E. Dorado Place in Centennial, Colorado. Petitioner lived at this address at the time that the notice was sent by respondent up to and through the time that this Court held a hearing on respondent’s present motion on November 14, 2005.

Petitioner did not claim the notice from his local United States Post Office. The envelope indicates that the United States Postal Service attempted delivery on June 20, 2003, June 27, 2003, and July 5, 2003. Sometime after July 5, 2003, the notice was returned to respondent with the word “unclaimed” stamped across the face of the envelope.

Petitioner has neither admitted nor denied that he ever received the notice. Petitioner did not file a petition for redetermination with the Tax Court. See sec. 6213(a).

On November 17, 2005, respondent assessed the determined deficiency of $6,419 “per default of 90 day letter,” the addition to tax for failure to file under section 6651(a)(1) in the lesser amount of $1,372.95, and the addition to tax for failure to pay estimated tax under section 6654(a) in the lesser amount of $976.

Respondent issued a Final Notice, Notice of Intent to Levy and Notice of Your Right to a Hearing (which petitioner admitted he did receive) on July 12, 2004. On July 26, 2004, petitioner sent to respondent a Form 12153, Request for a Collection Due Process Hearing (CDP hearing). The CDP hearing was held on March 21, 2005.

At the CDP hearing, petitioner restated all of his previous arguments that his income was not taxable according to his interpretation of the Internal Revenue Code and other materials. No alternative collections options were discussed at the hearing.

Respondent sent to petitioner a Notice of Determination on April 27, 2005. Petitioner filed his petition with this Court on May 5, 2005. Respondent filed his motion for summary judgment, and the motion was heard at the Court’s

- 7 Trial Session in Denver, Colorado. At the hearing, petitioner filed a “PETITION TO WITHDRAWAL FOR LACK OF JURISDICTION” that the Court filed as a Motion to Dismiss for Lack of Jurisdiction.

Discussion

Section 6331(a) authorizes the Commissioner to levy all property and property rights of a taxpayer liable for taxes who fails to pay them within 10 days after notice and demand for payment. Sections 6331(d) and 6330(a) require the Secretary to send written notice to the taxpayer of the intent to levy and to provide the taxpayer with a right to a hearing prior to the collection activity.

Section 6330(c)(2)(A) provides that the taxpayer may raise at the hearing “any relevant issue relating to the unpaid tax or the proposed levy” including spousal defenses, challenges to the appropriateness of collection actions, and alternatives to collection. Section 6330(c)(1) further requires that the Appeals officer obtain verification that the requirements of any applicable law or administrative procedure have been met.

Notably, however, a taxpayer may challenge the assessed amount of the deficiency and any additions to unpaid tax only if he did not receive a notice of deficiency or otherwise have an opportunity to dispute that tax liability.

- 8 Sec. 6330(c)(2)(B); Goza v. Commissioner, 114 T.C. 176, 180181 (2000). For purposes of section 6330(c)(2)(B), receipt of a notice of deficiency means receipt in time to petition this Court for redetermination of the deficiency determined in such notice. Sec. 301.6330-1(e)(3), Q&A-E2, Proced. & Admin. Regs.

The parties agree that respondent has the burden of showing that petitioner either received the notice of deficiency or otherwise had an opportunity to dispute the tax liability.

We now consider respondent’s Motion for Summary Judgment.

Respondent argues that the notice of deficiency was sent to petitioner’s last known address by certified mail and that petitioner refused to accept delivery for it at the United States Postal Service branch where it was held. As evidence of mailing and attempted delivery, respondent has produced a photocopy of the original notice of deficiency, including the envelope in which the notice was sent.

The envelope contains notations made by the United States Postal Service showing that its employees attempted delivery on no less than three separate occasions. Absent clear evidence to the contrary, United States Postal Service employees are presumed to properly discharge their official duties, which justifies the conclusion that the notice of deficiency was sent and that attempts to deliver the notice were made in the manner contended by respondent. Sego v. Commissioner, 114 T.C. 604, 611 (2000).

The record in this case contains a copy of a notice of deficiency dated June 18, 2003, addressed to petitioner; a Form 3877 indicating that the notice was sent on the date it bears; and notations made by the United States Postal Service showing that it attempted delivery on 3 separate occasions over a 4-week span of time. Accordingly, we conclude that although petitioner did not accept delivery of the notice of deficiency, his failure to receive the notice actually stemmed from a deliberate effort to refuse such delivery in furtherance of his ill-conceived line of reasoning that he is exempt from any income tax liability. It is well settled that a notice of deficiency mailed to the taxpayer’s last known address in accordance with the provisions of section 6212(b) is valid irrespective of whether or not the taxpayer actually received it. See Pyo

v. Commissioner, 83 T.C. 626, 632 (1984); Frieling v. Commissioner, 81 T.C. 42, 48 (1983); Zenco Engg. Corp. v. Commissioner, 75 T.C. 318, 321 (1980), affd. without published opinion 673 F.2d 1332 (7th Cir. 1981).

We find that petitioner’s conduct in this case constituted a deliberate refusal of delivery and repudiation of his opportunity to contest the liability determined in the notice of deficiency. The provisions in section 6330(c)(2)(B) limiting in collection due process cases the right to contest the underlying tax liability are clearly designed to prevent the creation of a prepayment remedy in cases like this one. The validity of the underlying tax liability therefore cannot be properly raised by petition in this case.

We will not spend time discussing petitioner’s Cross-Motion to Dismiss on the grounds that the Tax Court lacks jurisdiction “to address the particular notice of deficiency upon which this Docket is based.” In his motion, petitioner continues on for pages making spurious and ridiculous arguments in support of his motion. We will not waste our time addressing them as they are meritless, timeworn protester arguments that have been rejected and discredited by this Court and the other Federal courts. For this reason, petitioner’s motion will be denied.

Respondent’s Motion for Summary Judgment filed on August 11, 2005, will be granted and respondent’s administrative determination to proceed with collection against petitioner will be sustained. Petitioner’s Motion to Dismiss filed on November 14, 2005, will be denied.

- 11 Reviewed and adopted as the report of the Small Tax Case Division.

An appropriate order and decision will be entered.

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December 21st, 2006 | No Comments »