Johnston v. Commissioner , 80 T.C.M. 477 ( 2000 )

T.C. Memo. 2000-315
UNITED STATES TAX COURT
KEVIN R. JOHNSTON, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 3699-99. Filed October 6, 2000.
Kevin R. Johnston, pro se.
Sherri S. Wilder, Nicholas J. Richards, and Miles D.
Friedman, for respondent.
MEMORANDUM OPINION
BEGHE, Judge: Respondent determined a deficiency of $34,541
in petitioner's Federal income and self-employment tax for 1993.
Respondent also determined additions to tax under section
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6651(a)(1)1 for failure to file a return and under section 6654
for failure to pay estimated tax, of $8,635 and $1,447,
respectively.
We must decide whether petitioner’s gross income includes
certain payments made during 1993 for services performed by
petitioner. Petitioner claims these payments are not his income,
because he did not personally receive them. Instead, petitioner
directed the recipients of his services to pay an entity known as
“Universal Trust” (Universal). Petitioner asserts that Universal
should be recognized as a separate taxable entity and that the
payments made by the service recipients should be treated as
Universal’s income. In the alternative, petitioner asserts he is
entitled to business deductions that offset the services income.
Petitioner has also filed a “Motion for Summary Disposition
and/or Judgment” and a Motion in Limine, which challenge the
validity of the statutory notice, question respondent’s ability
to make certain arguments or introduce certain evidence, and urge
a reallocation of the burden of proof.
In addition to rebutting petitioner’s procedural challenges,
respondent advances three arguments for including in petitioner’s
income the payments made to Universal. First, respondent claims
1
All section references are to the Internal Revenue Code in
effect for 1993, and all Rule references are to the Tax Court
Rules of Practice and Procedure, unless otherwise specified.
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petitioner’s attempt to divert to Universal the income from his
personal services was an invalid assignment of income under the
long line of authority beginning with Lucas v. Earl, 281 U.S. 111
(1930). Second, respondent asserts that Universal should not be
recognized as a separate taxable entity because it is a “sham”
with no economic substance. Third, respondent asserts that even
if Universal is recognized for tax purposes, it is a grantor
trust whose income is taxable to petitioner under sections 671-
679.
Respondent has also moved for a penalty under section 6673,
on the ground that petitioner’s primary position–-that the
payments made to Universal are not petitioner’s income–-is
frivolous. Moreover, respondent has filed a motion (and
expressed reservations in stipulations) asking us to dismiss the
case at hand, treat certain facts as established, or exclude
certain evidence, as a sanction for petitioner’s failure to
respond to discovery requests and to exchange documents as
required by our standing pretrial order.
We reject petitioner’s procedural challenges to respondent’s
actions, deny petitioner’s motions, and hold that petitioner’s
attempted diversion to Universal of the income from his personal
services was an invalid assignment of income. We also hold that
petitioner has failed to show he is entitled to additional
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deductions from that income, except to the very limited extent
described below.
Notwithstanding these conclusions, we deny respondent’s
motion for a penalty under section 6673. We also deny
respondent’s motion (and other requests) for the exclusion of
evidence (or other relief) as a sanction for petitioner’s
conduct.
Procedural Setting
The statutory notice sent to petitioner determined that
petitioner had failed to report $104,786 in business gross
receipts. Respondent also sent notices to Julia Ghavami (Ms.
Ghavami) and to Universal for 1993, reflecting determinations
that Ms. Ghavami and Universal had each received an identical
amount (i.e., $104,786) of business gross receipts. As explained
in more detail below, these notices were “whipsaw” notices,
designed to protect respondent’s position if it should be decided
that Universal had economic substance and should be respected as
a separate taxable entity.
Ms. Ghavami filed a petition with this Court contesting
respondent’s determination for 1993. See Julia Ghavami v.
Commissioner, docket No. 3692-99 (Ghavami). Jimmy C. Chisum (Mr.
Chisum)2, as “Managing Agent for Trustee”, purported to file a
2
We note that Mr. Chisum, and a myriad of purported
“trusts” with which he has claimed to be connected, are well
(continued...)
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petition on behalf of Universal, contesting the notice sent to
Universal for 1993. See Universal Trust 06-15-90, Four WS TT01,
Trustee v. Commissioner, docket No. 3885-98 (Universal).
Due to the common issues involved, we granted respondent’s
motion to consolidate Ghavami and Universal with the case at
hand. Shortly before trial, however, respondent moved to dismiss
Universal for lack of jurisdiction, on the ground that Mr. Chisum
had failed to establish his capacity to file a petition on behalf
of Universal. Respondent also moved to sever Universal from the
consolidated case, and we granted that motion. Shortly
thereafter, Mr. Chisum submitted a motion to dismiss Universal on
various jurisdictional and procedural grounds. Because
respondent and Ms. Ghavami have agreed to a decision that there
is no deficiency in Ms. Ghavami’s tax for 1993, we have also
granted respondent’s motion to sever Ghavami from the case at
hand.
2
(...continued)
known to this Court. See, e.g., Lipari v. Commissioner, T.C.
Memo. 2000-280 (sec. 6673 penalty imposed on taxpayers who
claimed they were unable to obtain records from Mr. Chisum, the
“trustee” of their “trust”); Banana Moon Trust v. Commissioner,
T.C. Memo. 2000-73 (dismissed for lack of jurisdiction because
Mr. Chisum, who claimed to be “trustee”, did not have capacity to
file petition); Jeff Burger Prods., LLC v. Commissioner, T.C.
Memo. 2000-72; Bantam Domestic Trust v. Commissioner, T.C. Memo.
2000-63; Photo Art Mktg. Trust v. Commissioner, T.C. Memo. 2000-
57; George v. Commissioner, T.C. Memo. 1999-381 (“trust” of which
Mr. Chisum was “trustee” was a sham, and payments received by
that “trust” were income of osteopathic physician who performed
services that generated the income).
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A hearing on the cross-motions to dismiss Universal was held
on June 19, 20, and 27, 2000. Mr. Chisum claimed to represent
Universal at this hearing; he also testified briefly on its
behalf. At the end of this hearing, the Court took the motions
under advisement, pending resolution of the case at hand.
Although petitioner was pro se, the Court allowed Mr.
Chisum, who does not claim to be a member of the bar of any
court, to sit beside petitioner at trial. It appears that Mr.
Chisum has been advising petitioner on the conduct of his case.
Petitioner testified neither at the Universal hearing nor in
the case at hand.
Background
The record consists primarily of two sets of stipulations
with exhibits, and a very limited amount of testimony. The
stipulations are incorporated herein by this reference.
Petitioner resided in Lake Forest, California, when the
petition was filed. Petitioner neither filed an income tax
return for 1993 nor paid any estimated tax for that year.
Respondent sent the statutory notice to petitioner on
November 18, 1998. The notice stated that $104,786 of unreported
business (Schedule C, Profit or Loss From Business) gross
receipts were includable in petitioner’s income. It contained no
further explanation of this item. The computation of tax
included in the notice did not allow petitioner any deductions
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other than the standard deduction for single filing status, and a
deduction for one-half the self-employment tax determined by the
notice.
Also on November 18, 1998, respondent sent a statutory
notice for 1993 to Ms. Ghavami, which stated that an identical
amount of unreported business gross receipts (i.e., $104,786) was
includable in her income. At some time or times, Ms. Ghavami and
petitioner lived at the same address.
Approximately 1 year before respondent sent the notices to
petitioner and Ms. Ghavami, the Commissioner sent a statutory
notice to Universal for 1993. The notice to Universal stated
that Universal had $21,711 of unreported gross receipts. Because
Universal had reported $83,075 of gross receipts on its 1993
fiduciary income tax return (Form 1041), the notice reflected a
determination that Universal’s 1993 gross receipts were $104,786,
the same amount of income set forth in the notices sent to
petitioner and Ms. Ghavami.3
The notice to Universal stated that the amount of unreported
gross receipts was determined using the bank deposits method.
3
The notice to Universal also disallowed, for lack of
substantiation, Universal’s claimed deductions for $51,865 of
expenses and $31,210 of distributions. Petitioner asserts that
if payments made to Universal are includable in his income, he is
entitled to deduct many of the expenses paid by Universal on his
behalf. Respondent contends that almost all amounts paid by
Universal were petitioner’s nondeductible personal expenses, not
trade or business expenses.
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During 1993, a checking account at the Bank of California (the
Universal account) was held in Universal’s name. Petitioner and
Ms. Ghavami were signatories on this account and wrote checks on
the account during 1993.
As the parties have stipulated, $104,786 was deposited in
the Universal account during 1993; of this amount, $103,420 was
paid by third parties for work done by petitioner, and $1,341 was
paid for work done by Ms. Ghavami. Thus, all but $25 of the
$104,786 deposited into the Universal account during 1993 was
paid as consideration for services performed by petitioner or Ms.
Ghavami.
After review of some canceled checks drawn on the Universal
account, respondent has conceded that petitioner is entitled to
deduct, as trade or business expenses, $914 paid by Universal for
postage, $220 paid by Universal to sponsor sports teams, and $441
paid by Universal for printing.
Petitioner does not have, and did not maintain during 1993,
a record of his business and personal automobile mileage.
The amount of the distribution deduction claimed by
Universal on its 1993 return, $31,210, was equal to the entire
net income shown on the return. The return states that the
$31,210 was distributed to an entity known as “Oak Hargor [sic]
Finance”, with the following address: “P.O. Box 577, Guelth
[sic], Ontaria [sic] Canada N1H 6K9".
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Facts Concerning Petitioner’s Connection With Universal
On June 15, 1990, Donna L. Chisum as “Settlor”, Four WS TT01
as “First Trustee”, and Mr. Chisum and another individual as
“Witness[es]”, executed a document (the indenture)4 purporting to
create an entity known as “Universal Trust”. The indenture
stated that Universal was a “COMMON LAW BUSINESS TRUST
ORGANIZATION, also known as a CONTRACTUAL COMPANY * * * with
certain assets to be administered by the Trustee for capital Unit
Holders represented by Certificates in accordance with the
inalienable Common Law rights afforded to man.” Notwithstanding
this language purporting to create a trust, the indenture also
stated that “It is expressly declared that an Unincorporated
Business Organization by Contract is hereby created and not a
trust agreement by gift, or a partnership, or a company, or a
corporation, or a joint venture, or any entity of statutory
nature”. (Emphasis added.)
Other documents dated June 15, 1990, show that all 100
“capital units” that could be issued by Universal were issued on
that date to petitioner and Ms. Ghavami. These documents state
that the capital units were issued in exchange for petitioner’s
and Ms. Ghavami’s contribution to Universal of the following:
4
We use the term “indenture” for convenience and not to
suggest that Universal should be recognized as a trust for State
law or Federal income tax purposes.
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Desk, chair, file cabinet, typewriter,
wastebaskets (2) telephones, VCR & TV, bedroom
furnishings, living room furniture dining room set,
coffee tables, end tables, pictures, etc. note owed to
Lynne B. Johnston for $3500.00 knowledge, talent,
ability and labor of [petitioner] * * * office supplies
and office tools[.] [Emphasis added.]
The indenture provided that whenever the “board of trustees”
determined that Universal had income that would be taxable to
Universal if not distributed, the income was to be distributed to
capital unit holders in proportion to their holdings; any
remaining income was to be allocated to principal. The indenture
also provided that on termination of Universal any remaining
assets would be distributed to capital unit holders, also in
proportion to their holdings.
Other documents dated June 15, 1990 named petitioner
“Secretary” and Ms. Ghavami “General Manager” of Universal, and
gave them authority to conduct Universal’s day-to-day business.
As noted above, both petitioner and Ms. Ghavami could and did
sign checks on Universal’s bank account.
A document entitled “Registry of Unit Certificates” purports
to show that in December 1990, the 100 capital units in Universal
were transferred to an entity known as “Isiah 18", and that in
October 1991, they were transferred to an entity known as “Oak
Harbor”. Mr. Chisum testified that Oak Harbor was a trust
established in the Turks and Caicos with a foreign trustee; he
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also testified that neither petitioner nor Ms. Ghavami was a
beneficiary of Isiah 18 or Oak Harbor.
Mr. Chisum claims that he was either Universal’s “trustee”,
or an officer or agent of Universal’s “trustee”, from Universal’s
formation in 1990 until the time of trial, except for the period
from October 1991 until May 1993.
Additional Facts Relating to Petitioner’s Services
Petitioner is a licensed real estate salesperson in the
State of California. At some time not specified in the record,
Walter Blazyk (Mr. Blazyk), the president of World Wide Mortgage
Corporation (WWMC), approached petitioner and asked him to work
for WWMC. Petitioner agreed to do the work provided that WWMC
pay Universal for the work done.
During 1993, petitioner worked for WWMC and a few other
parties. Also during that year, WWMC paid Universal $95,596 for
work done by petitioner; the other parties paid Universal $7,824
for work done by petitioner. As set forth above, this $103,420
paid for petitioner’s services was deposited into Universal’s
bank account.
Petitioner alone did the work for which WWMC paid Universal
the $95,596 during 1993. As far as WWMC was aware, Universal was
not involved in making any of the business decisions necessary to
produce this income. Moreover, Universal was never involved in
the working relationship between petitioner and WWMC. Mr.
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Blazyk’s only contact with Universal occurred when petitioner
asked WWMC to issue the checks for his services to Universal.
Until June 2000, Mr. Blazyk did not know and never had any
contact with Mr. Chisum.
The parties have stipulated that Universal is not legally
entitled to hold a real estate license or conduct a mortgage
business.
According to California Department of Real Estate records,
WWMC was petitioner’s employing broker in 1993 and was still
petitioner’s employing broker in 1997.
Facts Relating to Petitioner’s Motions and Respondent’s Motion
for a Penalty Under Section 6673
On October 7, 1999, the Court filed respondent’s Motion to
Consolidate for Trial, Briefing, and Opinion. A copy of this
motion was mailed to petitioner on October 1, 1999. The motion
stated:
the position of counsel for respondent * * * is that
the Universal Trust is a sham and that individual items
of income are taxed to the individuals Kevin R.
Johnston and Julia Ghavami personally, and individual
expense items, if substantiated, are deductible by them
personally.
On November 8, 1999, the Court filed a copy of respondent’s
Requests for Admission, which had been served on petitioner on
November 5, 1999. These requests sought information relating to
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respondent’s position that Universal was a sham.5 For example,
one request stated that “There has been no change in the use of
assets assigned or transferred to the Universal Trust as a result
of such transfer or assignment.”
On April 26, 2000, the Court filed respondent’s Motion to
Compel Responses to Respondent’s Interrogatories. That motion
stated:
the primary issue is whether Universal Trust, created
by petitioners Ghavami and Johnston; should be
disregarded for tax purposes due to its lack of
economic substance and attempted assignment of income
with the result that the net income reported by the
trust, is properly reported by petitioners Ghavami and
Johnston.
On June 19, 2000, during the hearing on the cross-motions in
Universal, the Court brought to petitioner’s attention and
discussed for his benefit the assignment of income, sham trust,
and grantor trust theories. On June 20, 2000, the Court told
petitioner that trial of the case at hand would begin on June 27,
2000. The Court arranged this 1-week delay in order to give
petitioner yet more time to gather evidence and to encourage the
parties to stipulate as many facts as possible.
5
Among the factors we consider, in deciding whether a
purported trust is a sham for tax purposes, is whether the
grantor’s relationship to the property transferred to the trust
was materially different after the trust’s formation. See
Markosian v. Commissioner, 73 T.C. 1235, 1243 (1980).
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Respondent warned petitioner more than 2 months before trial
that taxpayers in sham trust cases have been penalized under
section 6673 for advancing frivolous arguments. On June 19,
2000, respondent’s counsel informed petitioner that he was
prepared to move for a penalty under section 6673 if petitioner
continued to insist that the $103,420 paid to Universal for work
done by petitioner was not petitioner’s income.
On June 13, 2000, petitioner had stipulated that during
1993, WWMC paid Universal $95,596 for work done by petitioner.
Trial began on June 27, 2000, after the 1-week interval
arranged by the Court; the parties submitted a Second Stipulation
of Facts. In that document, petitioner agreed to a number of
additional stipulations concerning the payment of $103,420 to
Universal for work done by petitioner, and concerning deposits
made to Universal’s bank account during 1993. However,
petitioner refused to testify.
The Parties’ Contentions
Respondent now asserts that petitioner’s gross income
includes $103,420 paid to Universal during 1993 for work done by
petitioner.6 According to respondent, this amount is includable
6
The statutory notice asserted that petitioner’s income
included $104,786 in unreported business gross receipts.
Respondent now claims that petitioner’s gross income should be
increased by only $103,420, the amount the record establishes was
paid to Universal (and deposited in its bank account) for
(continued...)
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in petitioner’s income: (1) Under the assignment of income
doctrine; (2) because Universal was a sham; or (3) if Universal
was not a sham, because Universal’s income is taxable to
petitioner under the grantor trust rules. Respondent has
conceded that petitioner is entitled to a small amount of trade
or business deductions relating to this income.
Petitioner maintains that the $103,420 is Universal’s
income, or in the alternative, contends that he is entitled to
business deductions that offset the income.
Petitioner has filed a “Motion for Summary Disposition
and/or Judgment” contesting the validity and effect of the
statutory notice. Petitioner has also filed a Motion in Limine
contesting respondent’s ability to make certain arguments or
introduce certain evidence. Because our disposition of these
motions could affect our consideration of the substantive issues,
we turn our attention to them now.
I. Petitioner’s Motion for Summary Judgment
According to petitioner’s summary judgment motion,
respondent has failed to establish a sufficient link between
6
(...continued)
services performed by petitioner.
The record also establishes that $1,341 of the $104,786
deposited in Universal’s account was paid for services performed
by Ms. Ghavami. The record contains no information about the
proper treatment of the remaining $25 deposited in the Universal
account ($104,786 minus $103,420 and $1,341 equals $25).
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petitioner and the funds paid to Universal, which respondent
claims are petitioner’s income. Petitioner asserts that as a
result, the statutory notice was an invalid “naked assessment”,
and we must dismiss the case at hand for lack of jurisdiction.
In the alternative, petitioner claims respondent’s failure to
supply the necessary “predicate evidence” deprives the notice of
its usual presumption of correctness, and respondent must bear
the burden of proof on all issues.
A. Validity of Notice
Petitioner’s claim that the notice was invalid effectively
asks us to “look behind” the notice. See Shriver v.
Commissioner, 85 T.C. 1, 3 (1985). As a general rule, we do not
look behind a deficiency notice to examine the evidence used, the
propriety of respondent’s motives, or the administrative policy
or procedure that informs respondent’s determinations. This is
because a trial before the Tax Court is a proceeding de novo; our
determination of a taxpayer’s tax liability must be based on the
merits of the case and not on any previous record developed at
the administrative level. See Greenberg’s Express, Inc. v.
Commissioner, 62 T.C. 324, 327-328 (1974). Moreover, even where
a taxpayer has made a showing casting doubt on the validity of
respondent’s determination, the notice is generally not rendered
void, and it remains sufficient to vest this Court with
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jurisdiction. See Suarez v. Commissioner, 58 T.C. 792, 814
(1972).
The Court of Appeals for the Ninth Circuit, to which an
appeal of the case at hand would lie, has developed an exception
to this rule. In Scar v. Commissioner, 814 F.2d 1363 (9th Cir.
1987), revg. 81 T.C. 855 (1983), the Court of Appeals held a
notice invalid and dismissed the action for lack of jurisdiction
in favor of the taxpayer.
The notice in Scar informed the taxpayers that they had
$138,000 of unreported income from a tax shelter partnership
known as the “Nevada Mining Project”. The notice also stated
that tax was being assessed on this income at the maximum
marginal rate because the taxpayers’ original return was
unavailable. At trial, however, the taxpayers established that
they had no connection with the Nevada Mining Project, and that
they had in fact filed their tax return. As a result, the Court
of Appeals concluded that “the taxpayers proved that a
determination of their deficiency had not been made”. See Scar
v. Commissioner, supra at 1367 n.6.
Petitioner has made no such showing in the case at hand.
The notice sent to petitioner stated that he had $104,786 in
unreported business receipts during 1993. Petitioner has
stipulated that an identical amount was deposited in the
Universal bank account during 1993. Petitioner has also
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stipulated that $103,420 of that $104,786 was paid for personal
services petitioner performed. Moreover, the record reveals that
petitioner was a signatory on the Universal account, that he was
one of the original “capital unit” holders in Universal, and that
as a unit holder he was entitled to receive distributions of
income and of corpus from Universal. Therefore, a comparison of
the facts in the record with the notice sent to petitioner
confirms that respondent actually determined a deficiency in
petitioner’s tax. Moreover, as we conclude in our discussion of
the substantive issues below, the record also proves the accuracy
of the determination made.
Equally importantly, the Court of Appeals for the Ninth
Circuit has limited the application of Scar to the narrow
circumstances where the notice of deficiency reveals on its face
that no determination was made. See Kantor v. Commissioner, 998
F.2d 1514, 1521-1522 (9th Cir. 1993); Clapp v. Commissioner, 875
F.2d 1396, 1402 (9th Cir. 1989); Campbell v. Commissioner, 90
T.C. 110 (1988).
Petitioner argues that respondent’s three statutory notices
to petitioner, Ms. Ghavami, and Universal, which attributed the
same amount of income to each of them, show that respondent
failed to determine a deficiency in petitioner’s tax and that
petitioner’s notice was invalid on its face. We disagree.
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In Clapp v. Commissioner, supra, the individual taxpayers
transferred their businesses to foreign trusts. The Commissioner
issued notices to both the individuals and the trusts; the
notices attributed many of the same items of income to both
parties. The notices also disallowed numerous deductions as
unsubstantiated, including all business expenses claimed by the
individuals and the trusts.
The taxpayers in Clapp challenged the validity of the
notices, stressing the Commissioner’s alternative positions and
the blanket disallowance of deductions. In response, the Court
of Appeals for the Ninth Circuit observed that the Commissioner’s
alternative notices were intended to ensure that the Commissioner
would be able to proceed whether or not the trusts were found to
be shams. The Court of Appeals stated that taking such
alternative positions:
seems to be a reasonable response to a tax evasion
scheme for which there is not as yet a settled legal
interpretation. Any other approach would reward the
tax evader who could come up with a novel scheme and
force the Commissioner to take a single, consistent
legal interpretation. * * * On previous occasions we
have upheld notices of deficiency which took
alternative positions for precisely this reason. Malat
v. Commissioner, 302 F.2d 700, 704 (9th Cir. 1962);
Revell, Inc. v. Riddell, 273 F.2d 649, 660 (9th Cir.
1960). [Clapp v. Commissioner, supra at 1401; fn. ref.
omitted.]
The statutory notices sent to petitioner, Ms. Ghavami, and
Universal, like the notices in Clapp v. Commissioner, supra, were
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“whipsaw” notices designed to protect respondent’s ability to
proceed, if a purported “trust” should be recognized as a
separate taxable entity. In the circumstances of the case at
hand, the notice sent to petitioner was proper.
For this and the other reasons set forth above, we hold that
the notice sent to petitioner was valid and that we have
jurisdiction of the case at hand. Petitioner’s argument to the
contrary has no merit.
B. Presumption of Correctness
In general, a deficiency notice is presumed correct, and the
taxpayer has the burden of proving it wrong. See Rule 142(a);
Welch v. Helvering, 290 U.S. 111 (1933).7 There are certain
exceptions to this rule, however, where the notice alleges that
the taxpayer has received unreported income.
The Court of Appeals for the Ninth Circuit has held in
unreported income cases that the presumption of correctness
applies only where the Commissioner’s determination is supported
by some substantive evidence that the taxpayer received the
unreported income. See Rapp v. Commissioner, 774 F.2d 932, 935
(9th Cir. 1985); Weimerskirch v. Commissioner, 596 F.2d 358, 360-
361 (9th Cir. 1979), revg. 67 T.C. 672 (1977); Petzoldt v.
Commissioner, 92 T.C. 661, 687-690 (1989) (discussing Court of
7
We do not find that the burden-shifting provisions of
current sec. 6201(d) or sec. 7491 apply.
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Appeals for the Ninth Circuit authorities). Once the
Commissioner has introduced the necessary “predicate evidence”
concerning the unreported income, however, the taxpayer has the
usual burden of establishing, by a preponderance of the evidence,
that the Commissioner’s determination is arbitrary or erroneous.
See Rapp v. Commissioner, supra at 935; Petzoldt v. Commissioner,
supra at 689. The Court of Appeals has described the required
evidentiary foundation as “minimal”. Palmer v. IRS, 116 F.3d
1309, 1312-1313 (9th Cir. 1997). Moreover, this exception to the
presumption of correctness applies only to unreported income; the
taxpayer always has the burden of proving entitlement to any
deductions. See United States v. Zolla, 724 F.2d 808, 809-810
(9th Cir. 1984).
Petitioner asserts that the notice in the case at hand
should not be presumed correct, because there is insufficient
evidence linking petitioner to the funds paid to Universal, which
respondent claims are petitioner’s income. Petitioner notes that
Universal, not petitioner, actually received payment of the
funds. Moreover, although petitioner was one of the original
capital unit holders in Universal, petitioner asserts that there
is no evidence that petitioner was a unit holder (or other
beneficiary) of Universal during the year in issue. As a result,
according to petitioner, the presumption of correctness does not
apply because respondent has failed to show that petitioner
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personally received the unreported income described in the
notice.
Although some of the authorities cited by petitioner, such
as Hardy v. Commissioner, 181 F.3d 1002, 1004 (9th Cir. 1999),
and Rapp v. Commissioner, supra at 935, do mention the taxpayer’s
“receipt” of income, it is nevertheless clear that the
Commissioner may satisfy the predicate evidence requirement in
unreported income cases by introducing evidence linking the
taxpayer to tax-generating acts. See Shriver v. Commissioner, 85
T.C. 1, 4 (1985). Alternatively, respondent may satisfy the
predicate evidence requirement by showing the taxpayer was
connected to unexplained bank deposits or cash. See Schad v.
Commissioner, 87 T.C. 609, 618-620 (1986) (discussing Court of
Appeals for the Ninth Circuit authorities); Tokarski v.
Commissioner, 87 T.C. 74 (1986).8
The record contains ample evidence linking petitioner both
to tax-generating acts and to bank deposits of the income
8
The authorities cited by petitioner, when read in full,
support this conclusion. For example, although Rapp v.
Commissioner, 774 F.2d 932, 935 (9th Cir. 1985) does mention
evidence of receipt, it also states that “Once the Government has
carried its initial burden of introducing some evidence linking
the taxpayer with income-producing activity” (emphasis added),
the burden of proof shifts to the taxpayer. Moreover, Hardy v.
Commissioner, 181 F.3d 1002, 1005 (9th Cir. 1999), states that
the exception to the presumption of correctness applies only
where the Commissioner has failed to provide any evidentiary
foundation for the deficiency notice.
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generated by those acts. For example, it is undisputed that
petitioner, a licensed real estate salesperson, worked for WWMC
and a few other parties during 1993. It is also undisputed that
WWMC and the other parties paid a total of $103,420 for
petitioner’s services during that year. Moreover, it is clear
that this $103,420 was deposited into Universal’s bank account,
that petitioner was one of the signatories to that account, and
that petitioner wrote checks on that account. Finally, it is
clear that petitioner was one of the original capital unit
holders of Universal, and as such was once entitled to receive
distributions of income and corpus from Universal. All this more
than amply links petitioner with the unreported income described
in the notice.
Petitioner asserts that, as a matter of law, none of this
evidence may be used to support the statutory notice, because:
(1) Respondent has not shown that respondent had the evidence
when the notice was issued, and (2) the evidence was not
described in the notice itself. We disagree.
In general, any admissible evidence may be used to support a
deficiency notice. See Cook v. United States, 46 Fed. Cl. 110
(2000), which stated that an assessment was not “naked” even if
the administrative file supporting its entry was lost, because:
what is critical, given the de novo nature of the
proceedings * * * is that admissible evidence exists to
support the assessment. If such evidence exists, and
- 24 -
is admitted by the court, it is irrelevant whether it
is the same evidence that the Service relied upon in
originally making its assessment. * * * [Id. at 114;
citations omitted.]
See also Dellacroce v. Commissioner, 83 T.C. 269, 284 (1984)
(stating that in case appealable to Court of Appeals for the
Second Circuit, deficiency notice based on hearsay must be held
arbitrary unless we can find admissible evidence in the record to
support it); Rosano v. Commissioner, 46 T.C. 681, 687 (1966) (“we
know of no rule of law calling for a review of the materials that
were before the Commissioner in order to ascertain whether he
relied upon improper evidence so that the burden of proof might
be shifted to him”); cf. Suarez v. Commissioner, 58 T.C. 792
(1972) (notice not entitled to presumption of correctness where
it was stipulated that notice was based entirely on
constitutionally inadmissible evidence).9
Petitioner’s proposed rule, if accepted, would require
courts to discover and examine the information actually used by
the Commissioner in determining a deficiency, whenever a taxpayer
challenged the validity of a notice. Such routine inquiries
would violate the well-settled rule that we do not, except in
exceptional circumstances, “look behind” a deficiency notice. In
9
We also note that in one of the cases cited by petitioner,
Hardy v. Commissioner, supra at 1005, the Court of Appeals in
part relied on the taxpayer’s stipulations in deciding that the
predicate evidence requirement was satisfied.
- 25 -
effect, the exception set forth in Scar v. Commissioner, 814 F.2d
1363 (9th Cir. 1987), revg. 81 T.C. 855 (1983), would no longer
be limited to cases where the notice of deficiency is invalid on
its face.
In the case at hand, petitioner has not offered any evidence
that could lead us to conclude, or made any assertions that could
even lead us to suspect, that the statutory notice was either
arbitrary or based upon constitutionally tainted evidence.
Moreover, the record contains a great deal of evidence showing
that petitioner in fact received almost all the income charged in
the statutory notice. As a result, petitioner is not being put
in the position of having to “prove a negative” (i.e., the non-
receipt of income), simply because respondent issued a notice
entitled to a presumption of correctness. Cf. Weimerskirch v.
Commissioner, 596 F.2d at 361.
For this and the other reasons described above, we hold that
the notice sent to petitioner is amply supported by the evidence
in the record; the unreported income exception to the presumption
of correctness does not apply to the case at hand. Petitioner’s
arguments to the contrary have no merit.
II. Petitioner’s Motion in Limine
The statutory notice stated that petitioner’s income
included unreported business gross receipts, but it did not give
any further explanation for this determination.
- 26 -
Petitioner’s Motion in Limine asserts that respondent’s
failure to include a fuller explanation in the statutory notice
should have consequences. More particularly, petitioner claims
respondent should not be permitted to raise the assignment of
income, sham, or grantor trust theories in the case at hand. In
the alternative, petitioner asserts that respondent should bear
the burden of proof on factual issues relating to those theories.
A. Issue Preclusion
We note that respondent is not necessarily limited to the
issues or theories discussed in the statutory notice or the
answer. For example, we have considered arguments raised by the
Commissioner for the first time on brief. See Ware v.
Commissioner, 92 T.C 1267, 1268 (1989), where we stated:
The rule that a party may not raise a new issue on
brief is not absolute. Rather, it is founded upon the
exercise of judicial discretion in determining whether
considerations of surprise and prejudice require that a
party be protected from having to face a belated
confrontation which precludes or limits that party’s
opportunity to present pertinent evidence. * * *
More generally, we have stated, in Pagel, Inc. v.
Commissioner, 91 T.C. 200, 211-212 (1988), affd. 905 F.2d 1190
(8th Cir. 1990):
It is well established that a party may rely upon
a theory if the opposing party has been provided with
fair warning of the intention to base an argument upon
that theory. “Fair warning” means that respondent’s
failure to give notice, in the notice of deficiency or
in the pleadings, of his intention to rely on a
particular theory did not prejudice the taxpayer’s
- 27 -
ability to prepare its case. Of key importance in
evaluating the existence of prejudice is the amount of
surprise and the need for additional evidence on behalf
of the party opposed to the new position. [Citations
omitted.]
See also Sundstrand Corp. v. Commissioner, 96 T.C. 226, 346-347
(1991), where we observed that we have refused to consider a new
theory raised by the Commissioner where consideration of the
theory would prejudice the taxpayer. In Sundstrand Corp. we
concluded that the taxpayer was prejudiced because it would have
presented additional evidence at trial if it had known of the new
theory in advance.
In the case at hand, respondent’s Motion to Consolidate
informed petitioner, more than 8 months before trial, of
respondent’s position that Universal was a sham and that
individual items of income were taxed to petitioner personally.
More than 7 months before trial, respondent’s Requests for
Admission sought information that once again put petitioner on
notice of respondent’s position that Universal was a sham. In
addition, almost 2 months prior to trial, respondent’s motion to
compel informed petitioners:
the primary issue is whether Universal Trust, created
by petitioners Ghavami and Johnston; should be
disregarded for tax purposes due to its lack of
economic substance and attempted assignment of income
with the result that the net income reported by the
trust, is properly reported by petitioners Ghavami and
Johnston.
Finally, on June 19, 2000, the Court discussed the assignment of
income, sham, and grantor trust theories with petitioner. The
- 28 -
Court did not start trial until 1 week later, to allow petitioner
yet more time to gather additional evidence and to attempt to
settle as many factual issues as possible. When trial resumed
after this 1-week period, petitioner refused to testify.
Moreover, petitioner has not claimed that he could have found or
offered any additional evidence relevant to any of respondent’s
three theories, if given more time.
For all these reasons, it is clear petitioner had fair
warning of the assignment of income, sham, and grantor trust
theories, and would not be prejudiced by our consideration of
them. Accordingly, we hold that respondent may raise (and we may
consider) any of those theories in this proceeding.10
Petitioner’s argument to the contrary has no merit.
B. Burden of Proof
Rule 142(a) provides that “The burden of proof shall be upon
the petitioner * * * except that, in respect of any new matter,
increases in deficiency, and affirmative defenses, pleaded in the
10
Petitioner also asserts that respondent should be
precluded from introducing any evidence relating to the sham,
grantor trust, and assignment of income theories. Because we
have just decided that petitioner had “fair warning” of these
theories, we can think of no reason why respondent should be
prohibited from introducing evidence relevant to those theories.
See Rule 41(b)(2), which states:
If evidence is objected to at the trial on the ground
that it is not within the issues raised by pleadings,
then the Court may receive the evidence * * * and shall
do so freely when justice so requires and the objecting
party fails to satisfy the Court that the admission of
such evidence would prejudice such party in maintaining
such party’s position on the merits.
- 29 -
answer, it shall be upon the respondent.” Because the statutory
notice did not mention the assignment of income, sham, or grantor
trust theories, petitioner asserts that those theories are “new
matter” on which respondent has the burden of proof.
For many years, a deficiency notice was not required to
contain an explanation. A notice that simply informed the
taxpayer that there was a deficiency and the amount thereof was
sufficient to raise the presumption of correctness and place the
burden of proof on the taxpayer. See Abatti v. Commissioner, 644
F.2d 1385, 1389 (9th Cir. 1981), revg. T.C. Memo. 1978-392; Olsen
v. Helvering, 88 F.2d 650, 651 (2d Cir. 1937). Consistent with
this approach, some courts held that where a deficiency notice
was broadly worded, a theory raised by the Commissioner after the
notice was issued was not “new matter”, unless the new theory was
inconsistent with some position necessarily implicit in the
determination itself. Abatti v. Commissioner, supra at 1390;
Sorin v. Commissioner, 29 T.C. 959, 969-971 (1958), affd. per
curiam 271 F.2d 741 (2d Cir. 1959).
In 1988, section 7522 was enacted by the Technical and
Miscellaneous Revenue Act of 1988, Pub. L. 100-647, 102 Stat.
3735. Section 7522 provides that any deficiency notice mailed
after 1989 “shall describe the basis for * * * the tax due * * *
included in such notice.”
- 30 -
In Shea v. Commissioner, 112 T.C. 183 (1999), we considered
whether a theory raised by the Commissioner for the first time on
brief was “new matter” on which the Commissioner had the burden
of proof. After discussing section 7522, we held that where the
Commissioner relied on a basis that was not stated in the
statutory notice and that required the presentation of different
evidence, the new basis was new matter for purposes of Rule 142.
We need not consider this question further in the case at
hand. As we explain in our discussion of the substantive issues
immediately below, the record establishes that $103,420 of the
$104,786 paid to Universal was petitioner’s income under the
assignment of income rule. We would reach the same result no
matter who had the burden of proof on respondent’s theories.11
III. Does Petitioner’s Income Include the $103,420 Paid to
Universal?
According to documents executed in June 1990, petitioner
transferred his “knowledge, talent, ability and labor” to
Universal, in exchange for certain “capital units” in Universal.
Respondent claims that petitioner’s attempt to transfer his
“knowledge, talent, ability and labor” to Universal was an
archetypical example of an invalid “assignment of income”, under
11
The record also establishes that $1,341 of the $104,786
paid to Universal was paid for work done by Ms. Ghavami.
Respondent has conceded that this $1,341, and the remaining $25
deposited in the Universal account, were not income to
petitioner.
- 31 -
the long line of authority beginning with Lucas v. Earl, 281 U.S.
111 (1930). Accordingly, respondent asserts petitioner’s gross
income includes the $103,420 paid for petitioner’s services
during 1993, even though petitioner did not directly receive the
payments of that income but instead caused the payments to be
diverted to Universal.
Petitioner claims that Universal (and not petitioner) should
be taxed on the $103,420 in question, because Universal was the
“true earner” of that income. According to petitioner, Universal
provided the services for which it was paid; petitioner was
simply Universal’s agent or employee. Petitioner additionally
asserts that in these circumstances, taxing petitioner on the
income in question would conflict with well-settled law
recognizing personal service corporations as the “true earners”
of the income generated by the efforts of their shareholder/
employees.
We agree with respondent. The record establishes that
petitioner’s transfer to Universal was a classic assignment of
income of the kind described in Lucas v. Earl, supra. Because
such assignments are ineffective for Federal income tax purposes,
petitioner remained the party taxable on the income generated by
his services.
One of the primary principles of the Federal income tax is
that income must be taxed to the one who earns it. The Supreme
- 32 -
Court has referred to this assignment of income rule as “the
first principle of income taxation”, Commissioner v. Culbertson,
337 U.S. 733, 739 (1949), and as “a cornerstone of our graduated
income tax system”, United States v. Basye, 410 U.S. 441, 450
(1973). Attempts to subvert this principle by deflecting income
away from its true earner to another entity by means of
contractual arrangements, however cleverly drafted, are not
recognized as dispositive for Federal income tax purposes,
notwithstanding their validity under State law. See Vercio v.
Commissioner, 73 T.C. 1246, 1253 (1980) (citing United States v.
Basye, supra, and Lucas v. Earl, supra).
The assignment of income rule applies with particular force
to personal service income. In the landmark case of Lucas v.
Earl, supra, Mr. Earl and his wife entered into a contract
providing that any property acquired by either of them, including
salary and fees, would be considered joint property. The Supreme
Court assumed that the contract was valid under State law, but
held that Mr. Earl was still taxable on his entire salary and
professional fees, stating:
this case is not to be decided by attenuated
subtleties. It turns on the import and reasonable
construction of the taxing act. There is no doubt that
the statute could tax salaries to those who earned them
and provide that tax could not be escaped by
anticipatory arrangements and contracts however
skillfully devised to prevent the salary when paid from
vesting even for a second in the man who earned it.
* * * [Lucas v. Earl, supra at 114-115.]
- 33 -
Petitioner does not dispute that the $103,420 paid to
Universal for work done by petitioner must be taxed to the earner
of that income. Instead, petitioner asserts that for tax
purposes Universal should be considered to have earned that
income (i.e., was the “true earner” of the income).
We are therefore required to decide whether petitioner or
Universal is the proper party to be taxed on the $103,420
generated by petitioner’s work, but paid to Universal. In cases
similar to the case at hand, we have held that the taxable party
is the person or entity who directed and controlled the earning
of the income, rather than the person or entity who received the
income. See Vercio v. Commissioner, supra at 1253 (citing
Wesenberg v. Commissioner, 69 T.C. 1005 (1978); American Sav.
Bank v. Commissioner, 56 T.C. 828 (1971)); see also Commissioner
v. Sunnen, 333 U.S. 591, 604 (1948) (“The crucial question
remains whether the assignor retains sufficient power and control
over the assigned property or over receipt of the income to make
it reasonable to treat him as the recipient of the income for tax
purposes.”); Corliss v. Bowers, 281 U.S. 376, 378 (1930)
(revocable trust created by husband for benefit of wife and
children treated as invalid assignment of income; Supreme Court
stated that “taxation is not so much concerned with the
refinements of title as it is with actual command over the
property taxed * * *. * * * The income that is subject to a
- 34 -
man’s unfettered command and that he is free to enjoy at his own
option may be taxed to him as his income, whether he sees fit to
enjoy it or not.”).
The record shows that Mr. Blazyk, president of WWMC,
approached petitioner and asked him to work for WWMC. Petitioner
then agreed to do the work provided that WWMC pay Universal for
the work done.
During 1993, WWMC paid Universal $95,596 for work done by
petitioner. Also during that year, a few other parties paid
Universal $7,824 for work done by petitioner. This $103,420 paid
for petitioner’s services was deposited into Universal’s bank
account. Petitioner had signatory authority over that account
and wrote checks on the account during 1993. Moreover, on brief
petitioner has conceded that he used the Universal account to pay
personal expenses during 1993; he also appears to argue that only
approximately $31,000 of the $51,865 of expenses claimed by
Universal on its return for 1993 were in fact business expenses.
The record also shows that petitioner alone did the work for
which WWMC paid Universal during 1993. As far as WWMC was aware,
Universal was not involved in making any of the business
decisions necessary to produce this income. More importantly,
the parties have stipulated that Universal was not legally
entitled to hold a real estate licence or conduct a mortgage
business, and it was never involved in the working relationship
- 35 -
between petitioner and WWMC. Mr. Blazyk’s only contact with
Universal occurred when petitioner asked WWMC to issue the checks
for his services to Universal. Until June 2000, Mr. Blazyk did
not know and never had any contact with Mr. Chisum, although Mr.
Chisum claims that he was either Universal’s trustee, or an
officer or agent of Universal’s trustee, during most of
Universal’s existence. Finally, petitioner did not report (and
has not conceded) that he received any salary (or other income)
as a result of the payments made to Universal for his services.
All this leads us to conclude that there was no negotiation
between petitioner and Universal, and no contract requiring
petitioner to supply his services to Universal and giving
Universal the right to control petitioner’s work. It also causes
us to conclude that Universal did not have a contract with WWMC
obligating Universal to provide services. In this connection, we
note that petitioner did not testify (or offer any other
evidence) about the nature of his employment relationship, if
any, with Universal, about the existence of any contracts he had
with Universal, or about Universal’s relationships or contracts
with the recipients of petitioner’s services. In these
circumstances, we draw the normal inference from petitioner’s
failure to offer evidence on these matters, which is that the
evidence, if produced, would not have been helpful to his cause.
- 36 -
See Wichita Terminal Elevator Co. v. Commissioner, 6 T.C. 1158,
1165 (1946), affd. 162 F.2d 513 (10th Cir. 1947).
For all these reasons, the record establishes that
petitioner, rather than Universal, was the “true earner” of the
$103,420 paid for petitioner’s services during 1993.
Petitioner’s attempted transfer of his “knowledge, talent,
ability and labor” to Universal was a classic assignment of
income. See Vercio v. Commissioner, 73 T.C. 1250-1254
(taxpayers created trusts to which they purportedly conveyed the
“exclusive use of * * * [their] lifetime services and all of the
currently earned remuneration therefrom”; held, taxpayers
retained ultimate direction and control over earning of the
income and the conveyance was an invalid assignment of income, in
part because it was unlikely that a binding contract for services
between the trust and the taxpayers had been entered into, there
was no evidence that the trust had any right to direct the
taxpayers’ income-producing activities, and it was questionable
whether the trusts could in any event obligate the taxpayers to
perform services that were inherently personal in nature); see
also Vnuk v. Commissioner, 621 F.2d 1318, 1319 (8th Cir. 1980),
affg. T.C. Memo. 1979-164 (physician conveyed to a trust “the
exclusive use of * * * [his] lifetime services and all the
currently earned remuneration accruing therefrom”; held,
physician retained ultimate direction and control and conveyance
- 37 -
was an anticipatory assignment of income, in part because the
trust had no right to supervise the taxpayer’s employment or
determine his remuneration, and the taxpayer had no legal duty to
earn money or perform services for the trust).
Petitioner argues that our conclusion conflicts with the
authorities recognizing personal service corporations (PSC’s) as
the “true earners” of the income generated by the efforts of
their shareholder/employees. We disagree.
First, we note that in many circumstances, arrangements
creating PSC’s are invalid assignments of income. See, e.g.,
Leavell v. Commissioner, 104 T.C. 140 (1995); Johnson v.
Commissioner, 78 T.C. 882, 889-890 (1982) (amounts paid by
professional basketball club for player’s services were income to
player rather than to PSC which received the payments), affd.
without published opinion 734 F.2d 20 (9th Cir. 1984). We also
note that Congress has enacted various Code provisions in an
attempt to end various perceived abuses of PSC’s. See, e.g.,
sec. 269A.
Second, the authorities recognizing PSC’s as the true
earners of the income generated by the shareholders’ services
have noted the tension between the assignment of income rule set
forth in Lucas v. Earl, 281 U.S. 111 (1930), and the importance
attributed to the corporate form by Moline Properties, Inc. v.
Commissioner, 319 U.S. 436 (1943). See, e.g., Johnson v.
- 38 -
Commissioner, 78 T.C. 890 n.13; Keller v. Commissioner, 77
T.C. 1014, 1030-1031 (1981), affd. 723 F.2d 58 (10th Cir. 1983).
Of course, in the case at hand petitioner employed a purported
trust in his diversion scheme, and the Moline Properties, Inc.
policy favoring the recognition of shareholders and corporations
as separate taxable entities is simply not applicable.
Third, even when we respect a PSC as the true earner, this
does not end our examination; we then evaluate the arrangement
between the shareholder and the PSC under section 482. In so
doing, we consider whether the shareholder’s total compensation
from the PSC was essentially equivalent to that which he would
have received if he had not employed the PSC structure. See,
e.g., Haag v. Commissioner, 88 T.C. 604, 614-615 (1987), affd.
without published opinion 855 F.2d 855 (8th Cir. 1988); Keller v.
Commissioner, 77 T.C. 1024-1025. This analysis ensures that
the shareholder will be taxed on the reasonable value of his
services, except to the extent his taxable income is reduced by
Code provisions that specifically provide for deferral or
nonrecognition of income (e.g., qualified pension plan
provisions). We repeat that in the case at hand petitioner did
not report (and has not conceded) that he received any salary (or
other income) as a result of the payments made to Universal for
his services. Moreover, Universal’s 1993 tax return claimed a
deduction for a distribution of Universal’s entire net income to
- 39 -
a beneficiary with a foreign address, which Mr. Chisum asserted
was a Turks and Caicos trust with a foreign trustee.
Fourth, we have held that two elements must be present
before a PSC, rather than its service-performing employee, can be
considered the true earner of the income. First, the service-
performing employee must be just that–-an employee of the PSC,
whom the PSC has the right to direct or control in some
meaningful sense. Second, the PSC and the person or entity using
the employee’s services must have a contract or similar
arrangement recognizing the PSC’s controlling position. See
Johnson v. Commissioner, 78 T.C. 891. Neither of these
elements is present in the case at hand.
In short, the authorities concerning the taxation of PSC’s
confirm rather than challenge our conclusion that petitioner’s
attempted diversion to Universal of the compensation for his
services was an invalid assignment of income.
We hold that petitioner’s gross income includes the $103,420
paid to Universal, as determined by respondent. Because we reach
this holding under the assignment of income rule, we need not
consider respondent’s alternative arguments that Universal was a
sham or a grantor trust.12
12
Petitioner also argues that our holding conflicts with
certain Courts of Appeals decisions concerning the tax treatment
of contingent legal fees. See, e.g., Estate of Clarks v. United
(continued...)
- 40 -
IV. Is Petitioner Entitled to Additional Deductions?
The statutory notice did not allow petitioner any deductions
for trade or business expenses. On the basis of copies of a few
checks drawn on the Universal account, respondent has conceded
that petitioner is entitled to deduct, as trade or business
expenses, the following amounts paid by Universal: $914 for
postage, $220 to sponsor sports teams, and $441 for printing.
12
(...continued)
States, 202 F.3d 854 (6th Cir. 2000) (contingent-fee agreement is
not invalid assignment of income, and client’s income does not
include portion of recovery paid to attorney pursuant to the
agreement); Cotnam v. Commissioner, 263 F.2d 119 (5th Cir. 1959),
affg. in part and revg. in part 28 T.C. 947 (1957).
Petitioner’s argument has no merit. Not only do other
Courts of Appeals (including the Court of Appeals for the Ninth
Circuit, to which the present case is appealable) and the Tax
Court disagree with Estate of Clarks and Cotnam, see, e.g., Coady
v. Commissioner, 213 F.3d 1187 (9th Cir. 2000); Baylin v. United
States, 43 F.3d 1451 (Fed. Cir. 1995); Kenseth v. Commissioner,
114 T.C. 399 (2000), but, more importantly, the purported trust
arrangement in the case at hand is completely different from the
contingent fee agreements at issue in Estate of Clarks and
Cotnam.
In Estate of Clarks and Cotnam, the Courts of Appeals
stressed that the client’s claim was, for all practical purposes,
worthless without the services of the attorney who could bring it
to fruition; in Estate of Clarks, the Court of Appeals even
characterized the attorney-client relationship in a contingent-
fee arrangement as similar to a joint venture or partnership. By
contrast, in the case at hand, the record shows that petitioner’s
services had value by themselves; Universal had nothing to do
with, and no control over, the earning of petitioner’s service
income. In short, petitioner’s control of the income generated
by his services was more than sufficient to make him the party
taxable on that income.
- 41 -
Petitioner asserts he is entitled to additional trade or
business deductions on account of other expenses paid by
Universal, in an aggregate amount of approximately $29,500.
Petitioner refused to testify (or supply any other evidence)
about the business purpose of these expenses. The only proof
petitioner offered in support of his claim consists of copies of
various checks drawn on the Universal account.
Respondent objects to the admission of these checks because
petitioner did not exchange them with respondent 15 days prior to
trial, as required by our standing pretrial order. Respondent
also argues that petitioner has not proved his entitlement to any
additional deductions, whether or not the checks are admitted.
Before we can consider these issues, we need to address one
preliminary matter. We have redetermined the amount of
petitioner’s income under the assignment of income rule; we have
not found it necessary to decide whether Universal was a sham.
We also note that respondent has never argued that the income and
deductions in issue should be attributed to different taxpayers.
Respondent has stipulated that petitioner is entitled to
deductions for some amounts paid by Universal; these stipulations
were not conditioned on our deciding that Universal was a sham.
Accordingly, we conclude respondent has conceded that, because we
have decided petitioner’s income includes payments received by
Universal, petitioner may deduct amounts paid by Universal to the
- 42 -
extent petitioner establishes the amounts were paid for valid
trade or business expenses of petitioner.
A. Should the Checks Offered by Petitioner Be Admitted?
We conclude that the copies of checks submitted by
petitioner should be admitted, notwithstanding respondent’s
objection. The parties have stipulated the existence of the
Universal account. Respondent has introduced copies of checks
drawn on that account as evidence that petitioner and Ms. Ghavami
were authorized to (and did) write checks on that account during
1993; petitioner has stipulated the admission of those copies.
In addition, at the Court’s urging, petitioner worked with
respondent’s counsel during the week before trial to agree on
many additional stipulations, including stipulations concerning
deposits to the Universal account that helped prove respondent’s
case. We also note that as part of these additional
stipulations, respondent conceded that petitioner is entitled to
deduct some expenses paid with checks drawn on the Universal
account.
In light of the foregoing, it is clear respondent has not
been surprised by the existence of the Universal account, and
does not question or need to investigate the authenticity of the
copies of checks drawn on that account. Indeed, respondent has
relied on check copies and other information about the Universal
account as proof of respondent’s case in chief; some of that
- 43 -
information was the subject of stipulations entered into after
the 15-day period specified in our pretrial order had expired.
Finally, we note that even if we admit the checks offered by
petitioner as proof that Universal paid the payees named therein,
petitioner is still required to prove that the payments were
ordinary and necessary business expenses. See Interstate Transit
Lines v. Commissioner, 319 U.S. 590, 593 (1943) (taxpayer must
prove entitlement to any deduction claimed). For all these
reasons we conclude that respondent would not be prejudiced by
our admission of the checks submitted by petitioner and that in
fairness we should admit them into evidence.
B. Did Petitioner Prove His Entitlement to Deductions?
Petitioner asserts that the checks prove his entitlement to
deductions for the following categories of expenses: Water;
electricity; gas; home office cleaning and maintenance; medical
insurance; life insurance; equipment; subscriptions and
publications; cellular phone service; supplies; automobile; trash
pickup; and miscellaneous. However, the information contained on
many of the checks does not prove that the checks were actually
used to pay expenses of the category claimed. More importantly,
the checks appear to have been used to pay expenses that could be
either business or personal, depending on the circumstances. In
the absence of any evidence of the business purpose of these
- 44 -
claimed expenses, petitioner is simply not entitled to deduct
them.
However, petitioner has also claimed a deduction for $726 in
pager expenses. After having examined the checks, we are
convinced that such amount was in fact spent on pager services,
and that under the circumstances of this case, this expense was
more likely than not a business expense. We therefore conclude
petitioner is entitled to deduct it.
We hold that other than this amount (and the deductions
conceded by respondent), petitioner is not entitled to any of the
additional deductions claimed.
V. Additions to Tax
Section 6651(a)(1) imposes an addition to tax for the
failure to file an income tax return within the time prescribed
by law, unless it is shown that the failure is due to reasonable
cause and not to willful neglect. The taxpayer bears the burden
of showing that reasonable cause exists. See Rule 142(a); United
States v. Boyle, 469 U.S. 241, 245 (1985).
Petitioner did not file a return for 1993, and there is no
evidence he had reasonable cause for this failure. Accordingly,
petitioner is liable for the maximum 25-percent addition for
failure to file, applied to the amount of the deficiency as
redetermined in accordance with this opinion.
- 45 -
Section 6654(a) provides for an addition to tax in the case
of any underpayment of estimated tax by an individual. This
addition is mandatory absent a showing by the taxpayer that one
of the statutory exceptions applies. See Grosshandler v.
Commissioner, 75 T.C. 1, 20-21 (1980).
Petitioner did not pay any estimated tax for 1993, and he
has not shown that any exceptions apply. Accordingly, the
section 6654 addition applies, determined in accordance with the
rest of this opinion.
VI. Respondent’s Motion for Sanctions Under Rule 104
Approximately 2 weeks before trial, respondent moved for
sanctions under Rule 104(c), in response to petitioner’s failure
to participate in discovery and to comply with the Court’s orders
concerning discovery. At trial, respondent stated that the
stipulations entered into by the parties had rendered this motion
moot. In light of the stipulations and our holdings in this
case, we agree with respondent. Respondent’s motion will be
denied as moot.
VII. Respondent’s Motion for a Penalty Under Section 6673
Section 6673(a)(1) provides that whenever it appears that
the taxpayer has instituted or maintained proceedings in this
Court primarily for delay, or the taxpayer’s position in such
proceedings is frivolous or groundless, or the taxpayer
unreasonably failed to pursue available administrative remedies,
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the Court may require the taxpayer to pay a penalty to the United
States of up to $25,000.
At trial, after petitioner stated that he would not testify,
respondent moved for a penalty under section 6673. According to
respondent’s motion, petitioner’s claim that the $103,420 paid to
Universal is not includable in petitioner’s income is frivolous.
Under the circumstances of the case at hand, we decline to
impose the section 6673 penalty. On June 19, 2000, respondent’s
counsel informed petitioner that he was prepared to move for a
penalty if petitioner continued to insist that the $103,420 paid
to Universal for work done by petitioner was not petitioner’s
income. Respondent’s motion seeks a penalty against petitioner
on this ground.
We note that on June 13, 2000, petitioner had stipulated
that WWMC paid Universal $95,596 for work done by petitioner. We
also note that on June 27, 2000, the parties submitted a Second
Stipulation of Facts. In that document, petitioner made many
additional stipulations concerning the payment of the $103,420 to
Universal for work done by petitioner, and concerning deposits of
that amount to Universal’s bank account. These stipulations
helped prove respondent’s case in chief. Indeed, we note that
respondent did not present any witnesses at trial.
We believe that petitioner’s course of conduct was counseled
by Mr. Chisum, who appears to have advised petitioner throughout
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this proceeding.13 In addition, after respondent’s last warning
on June 19, 2000, the bulk of petitioner’s efforts were devoted
to jurisdictional and procedural challenges to the statutory
notice, rather than to the substantive argument respondent
complains of.14 For these reasons and in these circumstances, we
decline to impose a section 6673 penalty on petitioner.
In conclusion, we note that petitioner’s jurisdictional and
procedural challenges had no legal merit. They were objectively
frivolous and may well have been maintained primarily for delay.
We also note that petitioner is currently before the Court in a
case involving other years.15 Should petitioner ignore the
warnings and holdings of this Court in the case at hand, there
will be ample opportunity to consider whether imposition of a
penalty under section 6673 would be appropriate.
13
We observe that if Mr. Chisum were a lawyer authorized to
practice in this Court, there might well be grounds under Rule
24(g) for disqualifying him from representing petitioner and the
other participants in the trust arrangements that Mr. Chisum has
been promoting and operating, see supra note 2, on the ground
that Mr. Chisum has a conflict of interest. Cf. Para
Technologies Trust v. Commissioner, T.C. Memo. 1992-575. The
predicament that petitioner finds himself in would appear to be
the direct result of the operation of that conflict. See Dixon
v. Commissioner, T.C. Memo. 2000-116, n.18 and accompanying text.
14
In this connection, we note that petitioner’s arguments
against the validity of the statutory notice are almost identical
to Mr. Chisum’s arguments in Universal’s case.
15
Johnston v. Commissioner, docket No. 18619-99.
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We have considered all allegations and arguments of
petitioner that we have not discussed herein; we find them to be
without merit or irrelevant.
To take account of the foregoing,
An order will be issued denying
petitioner’s Motion for Summary
Disposition and/or Judgment and Motion
in Limine and respondent’s Motion for
Sanctions Under Rule 104 and Motion for
Sanctions Under Section 6673; decision
will be entered under Rule 155.