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.

- 2 -

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.

- 3 -

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.

- 4

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).

- 5 -

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.

Bookmark to:

December 28th, 2006 | No Comments »

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.

Bookmark to:

December 28th, 2006 | No Comments »

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.

-

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

- -

-

-

-

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.

Bookmark to:

December 28th, 2006 | No Comments »

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