Bruce v. Comm'r ( 2014 )

T.C. Memo. 2014-178
UNITED STATES TAX COURT
CHARLES T. BRUCE AND MARY A. BRUCE, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 29005-10. Filed September 2, 2014.
P-H desired to sell Ps’ M stock in the ready market. P-H’s
financial planners promoted to P-H a plan to cash out the value of the
stock and pay no Federal tax. P-H, a high-school-educated seafarer
with little tax knowledge, consulted his attorney/tax adviser, who in
turn advised P-H that the plan was legitimate. Pursuant to the plan,
P-H and G entered into two offsetting $5.5 million loans, one of
which was labeled a “Swap” and for which P-H claimed a basis of
$5.5 million. P-H contributed the Swap to a newly formed unitrust in
which he retained a remainder interest and the power to substitute for
the unitrust’s corpus property of equal value. His two daughters each
had a 1% unitrust interest. P-H sold his remainder interest to two
other newly formed trusts (Ts), the beneficiary of each of which was
one of the daughters, in exchange for promissory notes totaling the
portion of the $5.5 million basis that P-H apportioned to the remainder
interest (approximately $5.4 million). P-H substituted the M stock for
the Swap in the belief that each property was of the same value. Ts
acquired the daughters’ unitrust interests, the unitrust was terminated,
and the M stock was distributed to Ts. Ts transferred the M stock to
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[*2] S, a general partnership that Ts formally owned and P-H
controlled. S sold the M stock to a third party for cash, and Ps
received the value of their M stock through Ts’ payments on the
promissory notes from the cash that the third party paid to purchase
the M stock. Ps reported on their Federal income tax return that they
realized no gain or loss on the sale of the remainder interest because
the selling price equaled the basis. Ps did not report that the M stock
was sold or that they realized any gain or loss as to that sale.
Held: The applicability of the three-year limitations period
under I.R.C. sec. 6501(a) is not properly before the Court in that
(1) Ps attempt inappropriately to raise this issue in their opening brief
and (2) I.R.C. sec. 7491(a)(1) does not require that the Court hold that
the limitations period bars assessment simply because the record
establishes that a deficiency notice was issued after the three-year
period and does not establish that an exception to the three-year
period applies.
Held, further, Ps’ gross income includes the full proceeds from
the sale of the remainder interest in that P-H’s basis in that interest
was zero. Alternatively, Ps are considered to have sold the stock
directly to the third party for Federal income tax purposes and must
recognize their gain on that sale.
Held, further, I.R.C. sec. 162(a) does not allow Ps to deduct the
legal and professional expenses related to the plan.
Held, further, Ps are not liable for the 40% accuracy-related
penalty that R determined under I.R.C. sec. 6662(h) because P-H
reasonably relied on the advice of his attorney.
R. Cody Mayo, Jr., for petitioners.
Marshall R. Jones, for respondent.
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[*3] MEMORANDUM FINDINGS OF FACT AND OPINION
WHERRY, Judge: Petitioners petitioned the Court to redetermine
respondent’s determination of an $819,041 deficiency in their Federal income tax
for 2003 and a $327,616.40 accuracy-related penalty under section 6662(h) for a
gross valuation misstatement.1 We decide the following issues:
1. whether the applicability of the three-year limitations period under
section 6501(a) is properly before the Court. We hold it is not;
2. whether petitioners underreported their income stemming from a plan
(plan) involving the sale of their stock in Sea & Sea Marine, Inc. (Marine). We
hold they did;
3. whether petitioners may deduct the legal and professional expenses that
respondent disallowed. We hold they may not;
4. whether petitioners are liable for the 40% accuracy-related penalty that
respondent determined under section 6662(h). We hold they are not.
1
Unless otherwise indicated, section references are to the applicable versions
of the Internal Revenue Code of 1986, as amended for the year in issue (Code),
Rule references are to the Tax Court Rules of Practice and Procedure, and dollar
amounts are rounded to the nearest dollar. While the deficiency notice states on
one page that respondent determined that petitioners are liable for a 20% accuracy-
related penalty under sec. 6662 for negligence, the notice elsewhere clarifies that
respondent determined that the 40% percent accuracy-related penalty for gross
valuation misstatement is applicable and that the 20% accuracy-related penalty for
negligence is not.
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[*4] FINDINGS OF FACT 2
I. Preliminaries
The parties submitted stipulated facts and exhibits, and we find the
stipulated facts accordingly. We incorporate herein the stipulated facts and the
facts drawn from the exhibits.
Petitioners are husband and wife, and they have two daughters, Rebekah
Ruth Bruce (RRB) and Sarah Jane Bruce (SJB) (collectively, daughters).
2
Each party filed an opening brief and a reply brief. Petitioners’ opening
brief, as supplemented (collectively, opening brief), does not comply with Rule
151(e)(3) with respect to proposed findings of fact. Rule 151(e)(3) required that
the opening brief contain
[p]roposed findings of fact * * * in the form of numbered statements,
each of which shall be complete and shall consist of a concise
statement of essential fact * * *. In each such numbered statement,
there shall be inserted references to the pages of the transcript or the
exhibits or other sources relied upon to support the statement.
Petitioners’ opening brief fails to set forth petitioners’ proposed findings of fact in
numbered statements; instead, it contains a “STATEMENT OF FACTS” in
narrative form with footnote references throughout which reference portions of the
trial transcript but do not mention the stipulations or any of the exhibits. In
addition, that brief in many instances fails to reference the transcript, exhibit, or
other source upon which petitioners rely to support their recitation of the facts.
While we have thoroughly reviewed the record to find the facts of this case,
petitioners, by their failure to follow our Rules, “have assumed the risk that we
have not considered the record in a light of their own illumination.” Monico v.
Commissioner, T.C. Memo. 1998-10, 75 T.C.M. 1556 n.1 (1998).
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[*5] Petitioners filed a joint Federal income tax return for 2003, and they resided at
a Louisiana address when the petition underlying this case was filed.
Charles Bruce is an experienced, successful tugboat captain and fisherman.
He has a high school education and regularly consults with and relies upon
professionals, friends, and employees to advise and inform him before he makes
his business decisions. He relied upon the advice of Attorneys Francis J. Lobrano
and David J. Lukinovich to effect the plan (discussed infra pp. 10-11), receiving
the latter’s advice directly from him or through Mr. Lobrano. Mr. Bruce also
relied heavily upon the advice of his longtime friend and loyal employee, Wade A.
Rousse.
II. Marine and Maritime Logistics
A. Marine
Marine is a Louisiana corporation that was organized in 1991. Each
petitioner owned one-half of Marine’s stock from at least January 1, 2000, when
Marine elected S corporation status for Federal income tax purposes, through early
September 2003. An election was made to characterize Marine as an S corporation
effective January 1, 2000, and petitioners treated Marine as an S corporation from
January 1, 2000, through September 5, 2003. As further discussed infra p. 22,
petitioners caused the Marine stock to be formally owned by a shareholder that
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[*6] made Marine ineligible for status as an S corporation as of September 5, 2003,
and Marine thereafter reported that it was taxable as a C corporation.
Marine was a small offshore water transportation/tugboat business. Marine
owned a 214-foot offshore oilfield supply vessel named the M/V Sarah Jane Bruce
(Sarah Jane). The Sarah Jane was Marine’s principal asset (and its sole marine
vessel) in 2003. Marine operated the Sarah Jane out of Port Fourchon, Louisiana.
Marine acquired the Sarah Jane on September 3, 2002, in a “like-kind
exchange” for a boat of then-equal value which Mr. Bruce (through his business)
had acquired for and used in his business since 1993. During 2003 the Sarah Jane
could easily have been sold (and was sold in 2003 as discussed infra p. 24) for $5
million. Marine’s basis in the Sarah Jane was zero as of January 1, 2003.
B. Maritime Logistics
Mr. Bruce coowned a second business referred to as “Maritime Logistics”.
Maritime Logistics’ other coowners were Mr. Rousse, Joey Adams, and one or
more other individuals whose identity is not relevant to our analysis. Mr. Adams
was a boat owner, and he owned (through his company) one or more marine
vessels.
Maritime Logistics was a maritime brokerage business; i.e., essentially a
business in which one or more boat owners worked together to obtain contractual
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[*7] work for their boats. Maritime Logistics obtained contract work for Marine
and for a company owned by Mr. Adams (and possibly for one or more other
companies). Maritime Logistics’ manager and primary worker was Mr. Rousse.
III. Mr. Rousse
Mr. Rousse grew up in Mr. Bruce’s neighborhood. Mr. Rousse as a teenager
mowed the grass at Mr. Bruce’s home, and they had a special business and
familylike personal relationship. Their personal relationship originally stemmed
from Mr. Bruce’s friendship with Mr. Rousse’s father, which developed from the
father’s and Mr. Bruce’s attending school together and from their working
together. With Mr. Bruce’s encouragement, Mr. Rousse later received a college
degree in business administration and then went to work for Mr. Bruce full time.
Mr. Rousse worked for Mr. Bruce for approximately 20 years, and Mr. Rousse
spearheaded the growth of Mr. Bruce’s businesses during that time.
Mr. Bruce always encouraged Mr. Rousse to further his education, and Mr.
Rousse earned an M.B.A. from the University of New Orleans while employed by
Mr. Bruce. Mr. Rousse ultimately stopped working for Mr. Bruce to pursue a
master’s degree and a Ph.D in economics from the University of Illinois at
Chicago, Illinois. After earning those degrees during or about 2007, Mr. Rousse
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[*8] went to work for the Federal Reserve Bank of Chicago as an economist
specializing in policy research and economic outreach.
IV. W&T
W&T Offshore, Inc. (W&T), is a publicly traded oil and gas exploration
company operating primarily in the Gulf of Mexico. In or about March 2003
W&T and Maritime Logistics were negotiating some long-term contracts which
would allow Marine to build one or more supply vessels to service W&T.
V. March 2003 Borrowings
A. March 19, 2003
On March 19, 2003, Marine borrowed $2,522,223 from American Horizons
Bank (AHB). This loan was secured by Marine’s deposits with AHB.
B. March 20, 2003
On March 20, 2003, Mr. Bruce borrowed $2,303,967 from Marine. Mr.
Bruce secured the repayment of this loan with stock that he owned in FBT
Bancorp, Inc. (FBT), a Delaware corporation.
VI. Mr. Doverspike
Jack Doverspike is a Larose, Louisiana-based insurance agent and financial
planner with whom Mr. Bruce had done business (e.g., made investments and
purchased life insurance) for several years. In or about 1998 Mr. Doverspike
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[*9] began talking to Mr. Bruce about his and his wife’s estate plans and a possible
“estate freeze” to minimize estate tax, and Mr. Doverspike did some estate work
for Mr. Bruce in or about 2001.
Soon after W&T and Maritime Logistics began negotiating the long-term
contracts, Mr. Doverspike invited Mr. Bruce to meet with Mr. Doverspike and two
financial planners, John Ohle and Scott Deichmann,3 to discuss Mr. Bruce’s
financial and estate plans further. As of that time Mr. Bruce was planning to retire
and to move permanently to Baton Rouge, Louisiana, where one of his daughters
and her children lived, and he desired to sell Marine (or the Sarah Jane) as part of
those plans. In addition, Mr. Rousse was planning to move to Chicago to pursue
3
John B. Ohle III was convicted in 2010 of conspiracy to defraud the Internal
Revenue Service and of attempted tax evasion. See United States v. Ohle, 441
Fed. Appx. 798, 799 (2d Cir. 2011). We take judicial notice from documents filed
in that case that this conviction stemmed from his selling a shelter in 2001 and
2002 devised by Paul Daugerdas as a partner of the now defunct law firm of
Jenkins & Gilchrist that claimed millions of dollars in phony tax losses. See Fed.
R. Evid. 201; Mangiafico v. Blumenthal, 471 F.3d 391, 398 (2d Cir. 2006);
Petzoldt v. Commissioner, 92 T.C. 661, 674 (1989). Mr. Daugerdas was recently
sentenced to 15 years’ confinement as the result of his tax evasion and conspiracy
conviction related to tax shelter transactions commonly referred to as “short sales”,
“short options strategy”, “Swaps” and “HOMER”, to generate fraudulent tax
savings. See United States v. Daugerdas, Dkt. No. 09-cr-00581 (S.D.N.Y. June 27,
2014). We also take judicial notice that Scott D. Deichmann was a conspirator and
a coemployee of John B. Ohle III, and we note that David Lukinovich and John B.
Ohle III were business acquaintances although Mr. Lukinovich was not directly
involved in these tax shelters. See also Ducote Jax Holdings LLC v. Bradley, 335
Fed. Appx. 392, 394, 396, 402 (5th Cir. 2009); Ducote Jax Holdings, L.L.C. v.
Bradley, C.A. No. 04-1943, 2007 WL 2008505 (E.D. La. July 5, 2007).
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[*10] his doctoral degree. Mr. Bruce’s most valuable asset was petitioners’ stock
in Marine. Mr. Bruce aspired to maximize the funds petitioners would retain upon
a sale of that stock so that they could live comfortably in his retirement and he
could give some of the sale proceeds to Mr. Rousse in recognition of his
employment with, and his loyalty to, Mr. Bruce.
Mr. Bruce spoke to Mr. Rousse about Mr. Doverspike’s invitation, and Mr.
Rousse agreed to accompany Mr. Bruce to the meeting in Larose, Louisiana. They
met with Mr. Doverspike and the financial planners shortly thereafter during or
before early 2003. The financial planners were promoting the plan, which Mr.
Ohle (and possibly Mr. Deichmann) devised to provide estate and/or income tax
benefits.
The framework of the plan apparently required that Mr. Bruce enter into two
offsetting $5.5 million loans, one of which was labeled a “Swap” and for which
Mr. Bruce would claim a basis of $5.5 million.4 Mr. Bruce would then contribute
the Swap to a newly formed unitrust in which each of the daughters had a 1%
interest and he retained a remainder interest and the power to substitute for the
4
Documents in the record use the term “Swap” in reference to one of the two
loans, and the parties do likewise. As discussed infra pp. 40-42, the “Swap” is not
a “swap” as that term is used in the financial market, but it is at best a loan
agreement. We follow the parties’ lead and refer to the “Swap” as such to avoid
confusion. We neither intend to suggest nor find that the “Swap” was a “swap”
within the financial market vernacular.
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[*11] unitrust’s corpus property of equal value. The next step would be for Mr.
Bruce to sell his remainder interest to two other newly formed trusts, the sole
beneficiary of each of which was one of the daughters, in exchange for promissory
notes totaling the portion of the $5.5 million basis that Mr. Bruce apportioned to
the remainder interest. As to the next step Mr. Bruce would substitute the Marine
stock for the unitrust’s corpus (i.e., the Swap), on the basis that the properties were
of equal value. The two trusts would acquire the daughters’ unitrust interests. The
unitrust would then be terminated and the Marine stock distributed to the two
trusts. The two trusts would transfer the Marine stock to a partnership that the
trusts owned and Mr. Bruce controlled. The partnership would then sell the
Marine stock in the ready market to a third party for cash, and petitioners would
receive the value of their Marine stock through the two trusts’ payments, on the
promissory notes, from the cash that the third party paid to purchase the Marine
stock. Mr. Bruce knew that, without the plan, significant Federal income tax
would be imposed on petitioners’ direct sale of the Marine stock, or on a sale of the
Sarah Jane, and the financial planners generally advised Mr. Bruce that the plan
would allow petitioners to cash out the value of their stock without paying any
Federal tax on the cashout.
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[*12] Mr. Lobrano, then a sole practitioner, was Mr. Bruce’s longtime attorney/tax
adviser, having represented him in the purchase and sale of various watercraft.5
Mr. Bruce (or Mr. Rousse on behalf of Mr. Bruce) asked Mr. Lobrano to meet with
the financial planners and then to give Mr. Bruce an independent, more learned
opinion on the plan. Mr. Lobrano later met with Messrs. Bruce, Rousse, Ohle, and
Deichmann, and Mr. Lobrano listened to their promotion spiel. Mr. Lobrano
believed the plan to be valid as he equated it to “a derivative of a sale to a defective
grantor trust strategy, which has been around”. He felt uncomfortable, however,
opining that the plan was valid simply on the basis of his own belief.
Mr. Doverspike suggested that Mr. Bruce retain Mr. Lukinovich, another
graduate from the New York University School of Law with an LL.M. in tax, to
opine on the validity of the plan. Mr. Lukinovich practiced in southern Louisiana,
and the Louisiana Board of Legal Specialization recognized him as a certified tax
attorney and as a certified estate planning and administration specialist. Mr.
Lobrano advised Mr. Bruce to follow Mr. Doverspike’s suggestion. Mr. Lobrano
5
Mr. Lobrano was a local attorney in Belle Chasse, Louisiana, and he had
impeccable tax credentials in the rural suburban Lafourche community in which he
practiced law, part of which included Mr. Bruce’s community of Cut Off,
Louisiana, southwest of New Orleans. Mr. Lobrano graduated from Tulane
University, first with a bachelor of science degree in management and later with a
juris doctor degree, and he earned a master’s degree (LL.M. in taxation) from New
York University School of Law. He was certified by Louisiana as a tax specialist
and enjoyed an AV rating in Martindale Hubbell, of which we take judicial notice.
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[*13] knew that Messrs. Lukinovich and Doverspike had some common clients and
thus an ongoing business relationship with each other. Mr. Lobrano also believed
it likely that Messrs. Ohle, Deichmann, and Lukinovich had presented similar plans
to their clients resulting in an ongoing business relationship as to the plans.
Mr. Lukinovich (at the invitation of Mr. Doverspike or Mr. Lobrano) met
with Messrs. Lobrano, Doverspike, Bruce, and Rousse (and possibly others).
Ultimately, Mr. Lukinovich, working with his future attorney James G. Dalferes,
issued 58-page and 49-page legal opinion letters to Mr. Bruce and to Mr. Rousse
(as trustee of two trusts (Daughters’ Trusts) to be formed for the daughters as part
of the plan), respectively. The opinion letter issued to Mr. Bruce, dated April 13,
2004, stated that Mr. Bruce had “requested our opinions regarding certain federal
income tax consequences” as to the plan and concluded in relevant part that Mr.
Bruce’s sale to the Daughters’ Trusts of his remainder interest in a unitrust named
CTB 2003 Trust No. 1 (CTB), discussed infra pp. 17-18, was “more likely than
not” a taxable event for which he was required to report gain equal to the sale price
less his basis in the interest. While the letter did not specifically state the amount
of Mr. Bruce’s basis in the interest or the amount of any such gain that Mr. Bruce
was required to report, it stated, as a fact, that Mr. Bruce had “purchased a swap
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[*14] contract” for $5.5 million and concluded as to Mr. Bruce’s basis in the
remainder interest that
it is more likely than not, in our opinion, that your basis in your
retained remainder interest in CTB Trust No. 1 is equal to your basis
in the Swap Contract contributed to CTB Trust No. 1, less the amount
of basis allocable to the lead trust unitrust interests in such trust, and
that the Valuation Rules set forth in Section II of this analysis should
apply in allocating the basis between your retained remainder interest
and the lead unitrust interests.
The opinion letter did not state that Mr. Bruce had to report any other income as to
the plan. The opinion letter issued to Mr. Rousse, dated April 14, 2004, stated that
Mr. Rousse had “requested our opinions regarding certain federal income tax
consequences” as to the plan and generally concluded that the Daughters’ Trusts
did not have to report any income on account of the plan. Neither opinion letter
addressed whether petitioners or Sareb Investments, LLC (Sareb),6 a passive entity
that was formally established incident to the plan and the sale of petitioners’
Marine stock, was in substance the seller of that stock.
VII. Consummation of the Plan
A. Background
After consulting with his professional advisers and in part on the basis of
their recommendations and advice, Mr. Bruce decided to consummate the plan, and
6
The record sometimes refers to Sareb as Sarab. We use the spelling used by
the parties.
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[*15] he was generally charged a set billing price to do so. The plan involved
multiple transactions, and Mr. Bruce lacked any understanding of these
transactions, including their purpose or significance, or the risks or benefits
involved. Messrs. Lobrano and Lukinovich, sometimes separately and other times
collaboratively, drafted the necessary documents to carry out the transactions.
Transactions effected incident to the consummation of the plan were as
follows.
B. May 23, 2003
Many transactions were effected on May 23, 2003.
Mr. Bruce formally issued a promissory note (Gamma note) of $5.5 million
to Gamma Trading Partners Limited Liability Co. (Gamma). The Gamma note
provided that, “FOR VALUE RECEIVED” (supposedly, the $5.5 million that was
referenced in the Gamma note), Mr. Bruce would pay Gamma $5.5 million, plus
interest of 2.9% per annum, on December 31, 2003 (or, if he wanted, an earlier
date after expiration of any transaction evidenced by a confirmation under the
International Swap Dealers Association, Inc.’s Master Agreement of May 23,
2003, between Mr. Bruce and Gamma (Swap)). The Gamma note further provided
that the $5.5 million which Mr. Bruce was referenced to receive under the Gamma
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[*16] note had to be used solely to effect the Swap.7 The Gamma note required
Mr. Bruce to pay Gamma an “Initial Loan Fee” and a “Quarterly Loan Fee” in
addition to the stated interest. The former fee equaled 2% of the $5.5 million
($110,000) and was payable on May 23, 2003. The latter fee equaled 0.1% of the
$5.5 million ($5,500) and was payable for each calendar quarter (excluding any
calendar quarter before July 2003) during which the Gamma note was not paid in
full.
Samyak C. Veera8 (as Gamma’s manager) and Mr. Bruce formally executed
the Swap master agreement (a boilerplate document typically associated with swap
contracts) and a related schedule and confirmation letter. This Swap master
agreement provided that Mr. Bruce would “pay” Gamma $5.5 million on May 23,
7
The record does not establish (and we decline to find) that Mr. Bruce
actually received the $5.5 million referenced in the Gamma note. To the contrary,
it appears that he did not. When the Gamma note is viewed in tandem with the
Swap, it seems most likely this was a “paper transaction” whereby the $5.5 million
that Mr. Bruce was entitled to receive from Gamma under the Gamma note was
simply offset against the $5.5 million that Mr. Bruce was required to pay Gamma
under the Swap.
8
We take judicial notice of an October 23, 2013, U.S. Department of Justice
press release announcing that an individual named Samyak Veera had recently
been charged with conspiring through a complex, multi-million-dollar tax fraud
scheme to cause more than $200 million in losses to the United States between at
least 2003 and 2011, as well as tax evasion. See Paschall v. Commissioner, 137
T.C. 8, 11 n.7 (2011).
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[*17] 2003, and that Gamma would “pay” Mr. Bruce $5,530,152 on July 31, 2003.9
The $30,152 difference between these two payments corresponds to the application
of a 2.9% annual interest rate to the period from May 23 through July 31, 2003,
and completely offsets the interest on the Gamma note that Mr. Bruce was required
to pay to Gamma for the period from May 23 through July 31, 2003.
Mr. Bruce formally entered into a security agreement with Gamma pledging
and granting a security interest in the Swap and certain other incidental collateral
to secure his obligations under the Gamma note.
Mr. Bruce, as settlor and with South Dakota Trust Co., LLC (SDTC), as
trustee, formally established CTB under the laws of South Dakota. He retained a
remainder interest in CTB and named his daughters as unitrust beneficiaries who
would receive annual distributions generally equal to 1% of the net fair market
value of CTB’s assets.10 Incident thereto, Mr. Bruce formally assigned his interest
in the Swap to CTB, CTB formally assumed Mr. Bruce’s obligations under the
Swap, and CTB formally agreed not to incur any debt in excess of $20,000 until
9
Again, the record does not establish (and we decline to find) that Mr. Bruce
actually paid the $5.5 million referenced in the Swap.
10
Mr. Lukinovich’s firm prepared CTB’s trust instrument (and all of the
documents related to the funding of CTB), and Mr. Lukinovich (or possibly Mr.
Ohle) selected SDTC to serve as CTB’s trustee.
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[*18] the Gamma note was repaid.11 CTB’s trust agreement allowed Mr. Bruce
during his lifetime to substitute for CTB’s corpus “property of an equivalent
value”, and the plan’s promoters included this provision intending to characterize
CTB as a grantor trust for Federal income tax purposes as long as Mr. Bruce lived
and held this power of substitution. The trust instrument further stated that the
daughters’ rights to receive the annual distributions would terminate two years
later on May 23, 2005.12 Upon termination, Mr. Bruce or his assignee (or Mr.
Bruce’s estate if he died without designating an assignee) would receive all of
CTB’s assets remaining for distribution.
C. June 1, 2003
On June 1, 2003, petitioners, as settlors, and Mr. Rousse, as trustee, formally
established the Daughters’ Trusts under the names Sarah Jane Bruce Trust (SJB
Trust) and Rebekah Ruth Bruce Trust (RRB Trust). The original corpus of each of
the Daughters’ Trusts was $50.
11
Mr. Bruce’s formal interest and obligations under the Swap, absent default
or early termination, were primarily the obligation to pay $5.5 million on May 23,
2003, and the right to the return of the $5.5 million approximately 2 months later
with an additional amount equal to interest accumulating at 2.9% per annum.
12
Mr. Bruce was expected to be alive on May 23, 2005.
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[*19] D. July 1, 2003
On July 1, 2003, petitioners formally transferred 30,000 shares of AHB
stock (worth approximately $300,000) and $60,000 to each of the Daughters’
Trusts.
E. July 31, 2003
On July 31, 2003, Mr. Bruce and the Daughters’ Trusts formally entered into
a transaction in which Mr. Bruce sold his remainder interest in CTB, whose only
asset at that time was the Swap, to the Daughters’ Trusts for $5,419,549. The
$5,419,549 was formally paid through each of the Daughters’ Trusts’ issuance of a
promissory note payable to Mr. Bruce in the amount of $2,709,774.48. Each note
required that simple interest at the rate of 2.55% per annum be paid annually on the
anniversary date of the note and that the principal with accrued interest be paid on
or before July 30, 2012.
By the end of July 31, 2003, Gamma had not paid, as to the Swap, the
$5,530,152 that was then due. The record does not explain why Gamma on July 31,
2003, did not pay the $5,530,152 that was then due, or whether Mr. Bruce took any
action at that time to enforce this payment.
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[*20] F. August 13, 2003
On August 13, 2003, Chaffe & Associates, Inc., Investment Bankers (C&A),
issued a letter appraising Marine’s equity at a fair market value of $5,822,175 as of
January 1, 2003. C&A’s appraisal was solely for the purpose of selling all of the
Marine stock to a grantor retained annuity trust. C&A noted in its appraisal that
Marine owned the Sarah Jane, which Marine represented to C&A (and C&A
presumed) had a market value of $5 million based in part on an appraisal of the
Sarah Jane as of March 12, 2001, by Rivers and Gulf Marine Surveyors, Inc. C&A
also noted that Mr. Lobrano had requested that C&A perform its appraisal on an
“asset approach only” and “disregard any corporate taxes that would be due should
the Company [Marine] sell the vessel prior to the expiration on January 1, 2010 of
the built in corporate tax.”
G. August 20, 2003
On August 20, 2003, Mr. Bruce formally exercised his power of substitution
and formally transferred the Marine stock to CTB in exchange for the Swap.13
13
The “Substitution Agreement” underlying the August 20, 2003, transfer
refers to a stock certificate dated January 1, 2003, and “a Certificate in the form
attached hereto as Exhibit B” but does not include a copy of either of those
certificates. While petitioners concede that Ms. Bruce owned one-half of the
Marine stock at the beginning of 2003 and the record establishes that she continued
to own that portion of the stock through September 5, 2003, we find no credible
evidence in the record that supports a finding that Mr. Bruce, in his name alone,
(continued...)
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[*21] Later that day, SDTC informed Mr. Bruce that it intended to resign as CTB’s
trustee within the next few days, stating that “as sole trustee, we did not
contemplate nor do we feel comfortable administering a non-directed trust that
holds closely held assets”. Also on August 20, 2003, the July 31, 2003, payment
date for the Swap was formally extended to August 29, 2003, with a corresponding
increase in the amount payable equal to 2.9% annual interest prorated for the
period of extension.
H. August 21, 2003
On August 21, 2003, SJB formally sold her CTB interest to RRB Trust, and
RRB formally sold her CTB interest to SJB Trust. The sale price for each interest
was $55,385.
I. August 29, 2003
Sareb was formally established on August 29, 2003, to serve as a holding
company to which all of the Marine stock would be transferred. Each of the
Daughters’ Trusts formally owned one-half of Sareb, and Mr. Rousse was Sareb’s
13
(...continued)
could legitimately transfer all of the Marine stock in this transaction. Nor do we
find that the Marine stock, which had just been appraised at a fair market value of
approximately $5.8 million, and the Swap, which we conclude had no value, were
“property of an equivalent value”.
- 22 -
[*22] designated manager. For 2003 Sareb reported its income and expenses for
Federal income tax purposes as if it were a domestic general partnership.
J. August 31, 2003
On or about August 31, 2003, Mr. Bruce, Mr. Rousse (as trustee for the
Daughters’ Trusts), and SDTC (as the trustee of CTB) formally executed a
document through which Messrs. Bruce and Rousse consented to CTB’s
termination on August 31, 2003. At its termination, CTB formally owned all of the
Marine stock, and all of that stock was formally distributed equally to the
Daughters’ Trusts in accordance with the terms of the CTB trust agreement.
K. September 5, 2003
On September 5, 2003, the Daughters’ Trusts formally transferred all of the
Marine stock to Sareb as a capital contribution. Mr. Lobrano believed that this
transfer caused a termination of Marine’s status as an S corporation because
Sareb’s shareholder was then a limited liability company, and he coordinated the
closing of Marine’s books to reflect that it was no longer an S corporation.
L. September 9, 2003
Before September 9, 2003, W&T had abandoned its plan for the long-term
contracts with Maritime Logistics, Mr. Doverspike had contacted Mr. Rousse to
inform him that he knew of a group of buyers from New York who were interested
- 23 -
[*23] in purchasing Marine, and Mr. Rousse had met with the investors to discuss
a possible sale of Marine. On September 9, 2003, Sareb formally sold the Marine
stock to Sea & Sky Mirror Images, L.L.C. (Mirror), a Delaware limited liability
company, for $4,721,627 plus any business receivable (ultimately $321,160) that
Marine collected within 90 days after the closing which Marine reflected in its
books as of the closing. A law firm, Morris, Manning & Martin, LLP (MMM),
was the escrow agent for the sale, and $4,721,627 was delivered to MMM on the
day of the sale. MMM deposited the $4,721,627 into its escrow account for the
Marine stock sale (Marine stock sale escrow account).
Shortly after the sale, Mirror informed Mr. Rousse that it wanted to sell the
Sarah Jane. Mr. Rousse knew of various local individuals (many of whom during
mealtime conversed daily with each other (and with Messrs. Bruce and Rousse))
who were interested in purchasing the Sarah Jane, and he met with a few of these
individuals.
M. September 11, 2003
Wiley Falgout was Mr. Bruce’s friend from high school, and Mr. Falgout
(among others) had asked Mr. Bruce, as early as 2000, if he wanted to sell the
Sarah Jane for $5 million. As of September 11, 2003, Mr. Falgout wanted his two
children to buy the Sarah Jane through their limited liability company, Minnie
- 24 -
[*24] Falgout, L.L.C., a marine supply boat business that Mr. Falgout operated.
Messrs. Bruce and Rousse desired that Mr. Falgout purchase the Sarah Jane in lieu
of any other prospective purchaser.
On September 11, 2003, Minnie Falgout, L.L.C., and Mirror executed a
purchase agreement under which they agreed that Minnie Falgout, L.L.C., would
buy the Sarah Jane for $5 million with the closing of the sale to occur on or before
October 8, 2003. Mr. Falgout negotiated this agreement directly with Mr. Bruce
while also speaking to Mr. Rousse about the operational aspects of the Sarah Jane.
Mr. Falgout believed at the time that Mr. Bruce (or a company he controlled)
owned the Sarah Jane.
N. September 16, 2003
On September 16, 2003, Minnie Falgout, L.L.C., paid $5 million to Marine
(through MMM, as escrow agent) to purchase the Sarah Jane. MMM placed those
funds into an escrow account for that sale (Sarah Jane sale escrow account). Later
that day, MMM wired $2,348,690 from the Sarah Jane sale escrow account to
AHB in final payment of Marine’s $2,522,223 promissory note to AHB, leaving a
balance in the Sarah Jane sale escrow account of $2,651,310. The $2,651,310 and
an additional $390,886 ($3,042,196 in total) were transferred on September 19,
2003, to the account of an entity whose identity appears to be “slto Trading
- 25 -
[*25] Partners”. Later on September 19, 2003, Marine transferred another
$2,307,804 to that entity’s account bringing the balance in the account to
$5,350,000.
Also on September 16, 2003, MMM wired $2,372,938 to Sareb from the
escrow account for the Marine stock sale, leaving a balance in the escrow account
of $2,348,690 ($4,721,627 ! $2,372,938) .14 The $2,348,690 balance was
transferred later that day to Marine. The amounts owed by the Daughters’ Trusts
under the July 31, 2003, promissory notes were reduced by $2,372,938 on account
of the transfers, and Mr. Bruce’s $2,303,967 promissory note to Marine was
recorded as paid in full.
O. September 23, 2003
Sareb purchased an 18-month certificate of deposit in the amount of $1.8
million on September 23, 2003. The certificate of deposit accrued interest at
2.16% per annum and had a maturity date of March 23, 2005.
P. September 30, 2003
On September 30, 2003, the Daughters’ Trusts (in equal proportions)
transferred to Mr. Bruce stock in AHB valued at $300,000. Petitioners accounted
for this transfer as payments on the July 31, 2003, promissory notes.
14
The $1 discrepancy is a result of rounding.
- 26 -
[*26] Q. October 8 and 9, 2003
On October 8, 2003, a $400,000 check, drawn on Sareb’s checking account,
was deposited into petitioners’ bank account. The check was paid one day later.
Petitioners accounted for the $400,000 deposit as payments on the July 31, 2003,
promissory notes.
R. November 13, 2003
On November 13, 2003, Mr. Rousse wrote Mr. Bruce a $165,000 check
drawn on Sareb’s checking account. The check, which was designated “Loan
Repayment - trusts”, was paid on November 20, 2003. Petitioners accounted for
this transfer as payments on the July 31, 2003, promissory notes.
S. 2005
During at least 2005 Sareb had a checking account over which Mr. Bruce
had signature authority although he was neither a manager nor an owner of Sareb.
On March 28, 2005, Sareb deposited $1,858,214 into that account, which deposit
represented the accrued balance of the certificate of deposit purchased September
23, 2003. Between April 12 and October 16, 2005, Mr. Bruce authorized and/or
received $1,850,000 from that account.
- 27 -
[*27] VIII. Cost of Plan
Mr. Bruce (individually and/or through Marine) paid at least $200,000 to
consummate the plan. Of those payments, at least $181,317 was for professional
fees (including at least $155,000 to Mr. Lukinovich and/or Mr. Ohle, in part for the
opinion letters, and at least $25,000 to Mr. Lobrano). The balance, up to as much
as $25,000, was for incidental costs. The fees which Mr. Bruce paid were
generally set before the consummation of the plan began.
IX. Petitioners’ 2003 Tax Return and Marine’s 2003 Tax Returns
A. Petitioners’ Return
Petitioners reported on their 2003 tax return that they purchased “CTB Trust
#1” on May 23, 2003, for $5,419,549, and that they sold that asset on July 31,
2003, for the same amount.15 Petitioners’ 2003 return was prepared by John M.
Estess, an owner of a local certified public accounting firm on the basis of
information given to him by either Mr. Bruce or Mr. Lobrano.
15
Petitioners do not specifically explain how they arrived at the $5,419,549
that they reported as their basis in CTB. In that they assert that Mr. Bruce paid
$5.5 million for the Swap, we infer that the $5,419,549 is the portion of the $5.5
million that they believed was attributable to the remainder interest.
- 28 -
[*28] B. Marine’s Returns
1. Form 1120S
Marine filed a 2003 Form 1120S, U.S. Income Tax Return for an S
Corporation, which was prepared by Mr. Estess, on June 24, 2004. The 2003 Form
1120S was prepared as a “short-year return”, by virtue of Mr. Lobrano’s believed
termination during the year of Marine’s status as an S corporation, but it did not
indicate either that it was for a “short year” or what portion of 2003 it covered
(although it reported that it was a “Final return”). The 2003 Form 1120S reported
Marine’s operations through the date on which it ceased to be an S corporation and
reported that its only shareholders during the short year were petitioners, each
owning one-half of its stock throughout the short year. Marine also reported on the
2003 Form 1120S, inter alia, that it was entitled to deduct $86,485 of legal and
professional fees.
2. Form 1120
On or about September 15, 2004, Marine filed a Form 1120, U.S.
Corporation Income Tax Return, for the remainder of 2003. This return reported
Marine’s operations for 2003 following the believed termination of its S status, but
did not specifically state that it was a “short-year return” or the portion of 2003 that
it covered.
- 29 -
[*29] Marine reported on the 2003 Form 1120, among other things, that it incurred
a $4.75 million ordinary loss from “DKK/USD BINA” that it acquired for $4.75
million on September 15, 2003, and sold for nothing on September 16, 2003; and
that it incurred a $600,000 short-term capital loss from an “INTEREST RATE
SWAP” that it acquired for $600,000 on September 15, 2004 (sic), and sold for
nothing on September 16, 2004 (sic). Marine also reported on the 2003 Form 1120
that on September 16, 2003, it sold a building for $2,651,310, which it had
acquired in May 1991; that it realized a $2,478,536 gain on the sale; that
$1,882,612 and $595,924 of the gain were categorized as ordinary income and
long-term capital gain, respectively; and that it was entitled to completely offset
the $1,882,612 and the $595,924 by the ordinary loss from “DKK/USD BINA”
and by the capital loss from the “INTEREST RATE SWAP”, respectively. Marine
did not report on the 2003 Form 1120 that it sold the Sarah Jane during that year.
X. Deficiency Notice
A. Overview
Respondent issued a deficiency notice to petitioners on September 27, 2010.
In the notice, respondent reflected his determinations as to (1) legal and
professional fees, (2) capital gains income, (3) itemized deductions, and (4) the
- 30 -
[*30] application of the 40% accuracy-related penalty under section 6662(h) for a
gross valuation misstatement.
B. Legal and Professional Fees
Respondent determined that Marine was not entitled to deduct $52,450 of
legal and professional fees attributable to the plan (the $52,450 was included in the
$86,485 mentioned above). The notice stated that petitioners failed to show that
the “payments were paid or incurred for the purposes designated, or that such
payments otherwise met the requirements for deduction under the Internal Revenue
Code”.
C. Capital Gains Income
Respondent determined that petitioners failed to recognize $5,266,724 in
capital gains income. The notice stated:
1. You have not established that (i) the purported transfers of
your Sea & Sea Marine, Inc. stock to the CTB Trust, and then to the
Sarah Jane Bruce Trust and the Rebekah Ruth Bruce Trust and then to
Sareb Investments, (ii) the purported sale of the Sea & Sea Marine
stock to Sea & Sky Mirror Images LLC, and (iii) the transactions
resulting in a loss claimed by Sea & Sea Marine from “DKK/USD
BINA,” (all of which, including all activities and contractual
arrangements associated therewith, are hereinafter referred to as the
Transaction) had any economic substance, were part of an activity
entered into for profit, were supported by a bona fide business
purpose, were not entered into for a tax avoidance purpose, were not a
sham, or should be recognized for federal tax purposes.
- 31 -
[*31] 2. The substance of the transactions involving purported
transfers of your Sea & Sea Marine, Inc. stock to the CTB Trust, and
then to the Sarah Jane Bruce Trust and the Rebekah Ruth Bruce Trust
and then to Sareb Investments, the purported sale of the Sea & Sea
Marine stock to Sea & Sky Mirror Images LLC, and the transactions
resulting in a loss claimed by Sea & Sea Marine, Inc. from
“DKK/USD BINA,” is not consistent with the form of such
transactions. It is determined that the substance of the transaction was
a sale of your stock in Sea & Sea Marine, Inc., for $5,419,549.
Alternatively, it is determined that the substance of the transaction
was a sale of assets by Sea & Sea Marine, Inc. while it was an S
corporation, and a distribution of the sale proceeds along with all of
its remaining assets to you in a complete liquidation of your interests
in Sea & Sea Marine, Inc.[16]
D. Itemized Deductions
Respondent determined that petitioners could not deduct $28,783 of
itemized deductions. The notice determined that respondent’s adjustments to the
legal and professional fees and to the capital gains income computationally
increased petitioners’ adjusted gross income beyond the threshold amount, thus
resulting in the $28,783 concomitant automatic computational adjustment.
16
While the notice of deficiency states that petitioners are considered to have
sold the Marine stock for $5,419,549, it does not explain the manner in which that
then turns into $5,266,724 of unreported capital gains income. Petitioners reported
on their 2003 return that they realized $31,846 in capital losses unrelated to the
plan, and respondent did not disallow any of the deduction for those losses. We
infer that respondent determined that petitioners’ applicable basis in the Marine
stock was $120,979 (($5,419,549 ! $120,979) ! $31,846 = $5,266,724), and we
find accordingly.
- 32 -
[*32] E. Accuracy-Related Penalty
Respondent determined that petitioners were liable for a 40% accuracy-
related penalty under section 6662(h) for a gross valuation misstatement. The
notice determined that this penalty applied to all of the three adjustments just
discussed.
OPINION
I. Burden of Proof
The Commissioner’s determinations in a deficiency notice are generally
presumed correct, and taxpayers generally bear the burden of proving those
determinations wrong. See Rule 142(a)(1); Welch v. Helvering, 290 U.S. 111, 115
(1933). Section 7491(a)(1) generally provides an exception to these rules in that
section 7491(a)(1) shifts the burden of proof to the Commissioner as to any factual
issue relevant to a taxpayer’s liability for tax if the taxpayer meets certain
conditions.17 While the parties dispute whether section 7491(a)(1) applies here, we
need not and do not decide that dispute because we render our decision on the basis
of a preponderance of the evidence. See Estate of Bongard v. Commissioner, 124
T.C. 95, 111 (2005); see also Esgar Corp. v. Commissioner, 744 F.3d 648, 654-655
17
Sec. 7491(a)(1) generally provides that “[i]f, in any court proceeding, a
taxpayer introduces credible evidence with respect to any factual issue relevant to
ascertaining the liability of the taxpayer for any tax imposed by subtitle A or B, the
Secretary shall have the burden of proof with respect to such issue.”
- 33 -
[*33] (10th Cir. 2014), aff’g T.C. Memo. 2012-35 and Tempel v. Commissioner,
136 T.C. 341 (2011).
II. Limitations Period
Petitioners’ opening brief states that “petitioners now for the first time raise
the statute of limitations as a bar to the assessment” and acknowledges that “This
argument is problematic since this issue was not raised in the pleadings”.
Petitioners conclude that the three-year limitations period of section 6501(a) bars
assessment because the record establishes that the deficiency notice was issued
more than three years after their 2003 return was filed and fails to establish an
exception to this three-year rule.18
Petitioners recognize that judicial jurisprudence holds that the applicability
of the limitations period is not properly before the Court where the taxpayer failed
to plead that matter in the petition. Petitioners assert that this jurisprudence is
limited to situations where either the Court had entered a decision in the case
before the issue of the limitations period was raised or the record otherwise showed
that the deficiency notice was timely. Petitioners also contend that, even if the
limitations period is not mentioned in the pleadings, section 7491(a)(1) in its own
right requires the Court to hold that the three-year limitations period bars
18
Sec. 6501(a) and (b)(1) generally provides that tax must be assessed as to a
return within three years of the later of its filing or its due date.
- 34 -
[*34] assessment whenever the record establishes that a deficiency notice was
issued after the three-year period and fails to establish that an exception to the
three-year rule applies. As to this latter argument, petitioners claim that Congress,
by enacting section 7491(a)(1), legislatively did away with the Court’s requirement
in Rule 39 that a taxpayer plead that the limitations period has expired in order to
properly place that issue before the Court.
We disagree with petitioners’ conclusion that the applicability of the
limitations period is properly before the Court. The applicability of the limitations
period is not a jurisdictional requirement that must be met for the Court to decide
this case. The period of limitations is a rule of law that, unlike a jurisdictional
requirement, may be waived if it is not pleaded properly. See Genesis Oil & Gas,
Ltd. v. Commissioner, 93 T.C. 562, 564-565 (1989). Our Rules require that a
taxpayer specifically allege as an affirmative defense in the petition that the
limitations period has run in order to properly raise the applicability of the
limitations period as an issue. See Rule 39; Woods v. Commissioner, 92 T.C. 776,
779 (1989). Petitioners acknowledge that they did not make such an allegation in
the petition. We accordingly conclude that petitioners have waived any dispute
- 35 -
[*35] that they now have as to the applicability of the three-year limitations period
by not timely raising the issue.19
While we may sometimes exercise our discretion to consider an issue that
was not timely raised, we generally do not exercise that discretion where a party
raises the issue for the first time on brief and our consideration of the issue would
unfairly prejudice the opposing party. See Chapman Glen Ltd. v. Commissioner,
140 T.C. 294, 349 (2013). Respondent asserts that petitioners validly executed
consents extending the limitations period to a date after the date the deficiency
notice was issued, and respondent indicates that he would have offered those
19
Petitioners in their reply brief note that Rule 41(b) treats an issue that is not
raised in the pleadings as being raised in the pleadings if the issue was tried by the
express or implied consent of the parties. Petitioners suggest in their reply brief
that Rule 41(b) applies here because the parties’ stipulations establish the date that
petitioners’ 2003 return was filed and that the deficiency notice was issued more
than three years later. As petitioners see it, the parties’ stipulations put respondent
on notice that the expiration of the three-year limitations period was in issue. We
disagree. In addition to the fact that petitioners first raised this argument in their
reply brief, which by itself makes this argument untimely, we read nothing in the
stipulations that specifies either that petitioners were disputing that the deficiency
notice was timely or that the parties were building an evidentiary record for the
Court to decide such a dispute. Had petitioners properly raised the limitations
period as an issue in their pleadings, respondent might have been able to present
evidence that petitioners had in fact extended the limitations periods for both years
by timely executing Form 872, Consent to Extend the Time to Assess Tax, as
respondent claims in his reply brief. Respondent did not present any such evidence
at trial, however, because he was not aware at that time that petitioners wanted to
raise the limitations period as an issue.
- 36 -
[*36] extensions into evidence had petitioners timely raised the applicability of the
limitations period as an issue.
Respondent essentially concludes that he would be unfairly prejudiced were
we now to allow petitioners to raise the limitations issue and then decide that issue
on the basis of the record at hand. Respondent notes that he helped build the
record without any notification or hint that the consent forms would be relevant to
combat petitioners’ assertions with respect to this issue. We agree. Petitioners had
ample opportunity to timely raise the applicability of the limitations period as an
issue in this case, and their delay in attempting to raise the issue on brief unfairly
prejudiced respondent.
Further, we do not agree with petitioners’ argument that section 7491(a)(1)
requires that we decide the issue even though it was not raised in the pleadings.
The pleadings serve a vital role in litigation in this Court. While many issues
could theoretically be in dispute in a given case, the pleadings specify the issues
which are actually in dispute, as well as the parties’ respective positions with
respect thereto, and they allow the parties to efficiently and effectively litigate the
case accordingly. See Rule 31(a).
In recognition and furtherance of this vital role, we have announced time and
time again that we will generally consider only those issues which are properly
- 37 -
[*37] raised in the pleadings. See, e.g., Ill. Power Co. v. Commissioner, 87 T.C.
1417, 1449 (1986); Seligman v. Commissioner, 84 T.C. 191, 198-199 (1985),
aff’d, 796 F.2d 116 (5th Cir. 1986); Rollert Residuary Trust v. Commissioner, 80
T.C. 619, 636 (1983), aff’d, 752 F.2d 1128 (6th Cir. 1985). We do not read section
7491(a)(1) to change or otherwise erode this firmly established rule. The
applicability of the three-year limitations period is not properly before the Court,
and we decline petitioners’ invitation in their opening brief to decide that issue.
III. Capital Gains Income
Respondent determined that for Federal income tax purposes petitioners are
treated as selling the Marine stock to Mirror. Respondent argues in support of this
determination that Sareb should not be treated as the seller because it was Mr.
Bruce’s conduit or nominee.20 In this regard, respondent asserts, Mr. Bruce had
complete control over Sareb’s finances as evidenced by the facts that he had
signatory authority over Sareb’s bank accounts and appropriated all of the sale
proceeds to himself. In addition, respondent asserts, petitioners effected the plan
primarily to avoid reporting gain on a sale of the Marine stock. Petitioners argue
that the plan should be respected because the transactions underlying the plan had
real economic consequences and the plan meets the letter of the law. In addition,
20
Petitioners argue in their reply brief that respondent raised this issue too
late. We disagree. The argument flows directly from the deficiency notice.
- 38 -
[*38] petitioners assert, Mr. Bruce consummated the plan purely for estate
planning purposes as an integral aspect of an “estate-freeze” strategy.
We agree with respondent, as a secondary holding, that petitioners are
treated as the seller of the Marine stock for Federal income tax purposes. We hold
primarily that petitioners underreported their gain on Mr. Bruce’s sale of his
remainder interest to the Daughters’ Trusts. We recognize that respondent neither
determined nor argued that petitioners underreported their gain on the sale of the
remainder interest. All the same, petitioners have invoked our jurisdiction to
redetermine the deficiency that respondent determined, and the law is well settled
that we may redetermine the deficiency on the basis of reasons other than those
relied upon by the Commissioner or those argued by the parties. See Peoples
Translation Serv. v. Commissioner, 72 T.C. 42, 51 (1979); Wilkes-Barre Carriage
Co. v. Commissioner, 39 T.C. 839, 845 (1963), aff’d, 332 F.2d 421 (2d Cir. 1964);
see also Helvering v. Gowran, 302 U.S. 238, 246 (1937); Cannon v.
Commissioner, 949 F.2d 345, 347-348 (10th Cir. 1991), aff’g T.C. Memo.
1990-148.
While we generally will not decide a case on grounds other than those that
the parties argued where to do so would surprise or prejudice a party, our decision
that petitioners failed to correctly report the sale of the remainder interest does not
- 39 -
[*39] prejudice, and should not surprise, petitioners. Petitioners reported on their
2003 return that Mr. Bruce’s sale of the remainder interest was a taxable event, and
they reported that Mr. Bruce’s basis in that interest was $5,419,549. Mr.
Lukinovich also generally discussed in his opinion letters Mr. Bruce’s sale of the
remainder interest and concluded that the sale was a taxable event for which Mr.
Bruce was required to recognize gain equal to the difference between his basis in
that interest and its sale price. Furthermore, petitioners’ reply brief essentially
regurgitates Mr. Lukinovich’s discussion on this matter. Neither petitioners nor
Mr. Lukinovich explained in detail why they or he considered Mr. Bruce’s basis in
the Swap to be $5.5 million, a basis that each of them then apparently concluded
entered into the calculation of Mr. Bruce’s basis in the remainder interest. That
omission of a critical step in their analysis does not necessarily mean that
petitioners are prejudiced or should be surprised by our addressing and focusing on
that crucial issue.
As to our primary holding, taxpayers may most definitely structure their
business transactions in a way that minimizes their tax liability. See, e.g.,
Boulware v. United States, 552 U.S. 421, 430 n.7 (2008); Gregory v. Helvering,
293 U.S. 465, 469 (1935). The mere fact that the form of a transaction literally
complies with the Code, however, does not necessarily mean that the form is
- 40 -
[*40] respected for Federal income tax purposes when in substance it is a different
transaction. See, e.g., Knetsch v. United States, 364 U.S. 361, 365 (1960). Nor are
we bound by a meaningless label (or a mislabel) that the parties to an agreement
give to any or all parts of the agreement, but we decide the true nature of the
agreement by looking to its substance and to the intention of the parties. See, e.g.,
Gregory v. Helvering, 293 U.S. at 469; Sandvall v. Commissioner, 898 F.2d 455,
458 (5th Cir. 1990), aff’g T.C. Memo. 1989-189, and aff’g T.C. Memo. 1989-56.
Substance may therefore trump form, or as Shakespeare more eloquently
explained: “That which we call a rose [b]y any other name would smell as
sweet”.21
With these thoughts in mind, we analyze the plan and its underlying
transactions to the extent necessary. We need not decide whether the plan was
legitimate, or whether the tax consequences which flow therefrom are as Mr.
Lukinovich opined and as petitioners argue. This is because, even if we assume
that the plan was legitimate, the use in the plan of the Swap is one example of a
contrivance which we decline to recognize for purposes of deciding this case.
Notwithstanding the labeling of the Swap as a “swap” in the relevant documents,
the Swap was not a “swap” within the meaning of the financial market. In Bank
21
William Shakespeare, Romeo and Juliet, act 2, sc.2, 43-44.
- 41 -
[*41] One Corp. v. Commissioner, 120 T.C. 174 (2003), aff’d in part, vacated in
part and remanded as to an issue not relevant here sub nom. J.P. Morgan Chase &
Co. v. Commissioner, 458 F.3d 564 (7th Cir. 2006), we dove deep into the world
of financial derivatives and, aided in part by our Court-appointed experts,
addressed matters specifically related to the swap industry. We found that the
swap industry defines a swap as “a bilateral agreement the value of which is
derived * * * from the performance of an underlying asset, reference rate, or
index.” Id. at 185; see also sec. 1.446-3(c)(1), Income Tax Regs. (stating that a
“swap” is a form of a “notional principal contract” and that “[a] notional principal
contract is a financial instrument that provides for the payment of amounts by one
party to another at specified intervals calculated by reference to a specified index
upon a notional principal amount in exchange for specified consideration or a
promise to pay similar amounts”). We see no reason why our Bank One definition
of a “swap” is not applicable here. Because all of the amounts to be advanced and
repaid under the Swap were fixed at the time of the underlying agreement, and the
Swap in turn did not derive its value from the performance of an underlying asset,
reference rate, or index, we decline to recognize the Swap as a “swap” for purposes
of our analysis.
- 42 -
[*42] At best, the Swap here was a loan arrangement under which one party
promises to advance cash to the other party, and the other party promises to repay
that cash with stated interest on a certain date. The terms of the Swap stated that
one party (Mr. Bruce) would pay to the other party (Gamma) $5.5 million on May
23, 2003, and that the other party (Gamma) would pay the first party (Mr. Bruce)
$5,530,152 on July 31, 2003. These terms, on their face, resemble the basic terms
of a loan arrangement. That said, however, the Swap, when viewed in tandem with
the Gamma note, was not even a valid loan arrangement.
The parties to each of these instruments were the same, and the critical terms
of the instruments were tailored to mirror each other and not to allow for the
payment or receipt of any funds (other than the “fees” that Mr. Bruce had to pay
Gamma under the Gamma note, most likely for its participation in the plan).22 In
addition, we do not find that any of the funds referenced in these instruments were
actually lent or repaid, other than possibly through bookkeeping entries, and the
terms of the Swap were not always followed, e.g., as noted supra p. 19, Gamma did
not on July 31, 2003, pay as to the Swap the $5,530,152 that was then due.
22
We do not consider material that the Swap stated that Gamma’s payment
was due on July 31, 2003, while the Gamma note stated that Mr. Bruce’s payment
was due on December 31, 2003.
- 43 -
[*43] The use of offsetting or circular cashflows strongly indicates that a
transaction lacks economic substance. See Merryman v. Commissioner, 873 F.2d
879, 882 (5th Cir. 1989) (tax structuring disregarded where “money flowed back
and forth but the economic positions of the parties were not altered”), aff’g T.C.
Memo. 1988-72; Prof’l Servs. v. Commissioner, 79 T.C. 888, 928 (1982)
(disregarding prearranged circular cashflows through a business trust); see also
Knetsch, 364 U.S. at 366 (offsetting payments on annuity bond and notes resulted
in sham). The use of meaningless labels and the disregard of key terms (or the
failure to act as a reasonable person would as to a violation or enforcement of the
terms) also point to that end.
Petitioners ask the Court to recognize the Swap and to find that Mr. Bruce’s
basis in the Swap was $5.5 million because, they assert, Mr. Bruce actually paid
$5.5 million for the Swap. We decline to do so. We find no credible evidence in
the record supporting a finding that Mr. Bruce actually paid $5.5 million for the
Swap. Nor do petitioners attempt to rationalize why Mr. Bruce would have paid
$5.5 million for his interest in the Swap, an interest that formally consisted of an
obligation to pay $5.5 million and the right to a return of the $5.5 million shortly
thereafter with interest.23 In fact, it appears that Mr. Lukinovich may have had a
23
Petitioners arguably derived their $5.5 million basis in the Swap from the
(continued...)
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[*44] similar reservation in opining that Mr. Bruce had a $5.5 million basis in the
Swap and therefore conveniently ignored this issue. This lapse is not further
explained by the record in this case, but suffice it to say that the importance of this
issue to the overall plan would be very hard to miss. Nevertheless, we find nothing
in the opinion letters, nor have petitioners pointed to any place, where Mr.
Lukinovich opines that Mr. Bruce’s basis in the Swap was $5.5 million.
Petitioners assert that the plan should be respected in all regards because it
was undertaken primarily for legitimate estate planning purposes. We disagree.
We note the following facts which erode petitioners’ assertion that the plan was
undertaken primarily for legitimate estate planning purposes: (1) Messrs. Bruce
and Rousse were the linchpin of Marine’s business, and each of them was soon to
be leaving the business which, in turn, meant an end to the business unless it was
sold to someone who was willing to continue it; (2) Mr. Bruce desired to sell
petitioners’ Marine stock or its principal asset, the Sarah Jane, while Marine was
23
(...continued)
fact that the Swap provided that Mr. Bruce would “pay” Gamma $5.5 million on
May 23, 2003. This “logic” is faulty. First, Mr. Bruce never actually paid the $5.5
million to Gamma before assigning his interest in the Swap to CTB. Second, even
if he had made any such payment, the $5.5 million was formally stated to be repaid
to him later that year, and petitioners did not realize any of the stated repayment as
income. Petitioners cannot in this second instance reap an inappropriate double
benefit by including the $5.5 million in basis while at the same time not realizing
its repayment as income.
- 45 -
[*45] still in operation and to maximize the proceeds that petitioners retained upon
any such sale; (3) Mr. Bruce participated in the offsetting loans, each with a short
life, and the mislabeling by his advisers of one of the loans as a “swap”; (4) the
Swap which Mr. Bruce reported had a value of $5.5 million was not in his estate
before the plan began; (5) Mr. Bruce on advice of his professional advisers
established CTB to terminate within two years of its making and to distribute its
assets to him upon termination; (6) Mr. Bruce terminated CTB approximately three
months after its making; (7) Mr. Bruce accepted the promissory notes from the
Daughters’ Trusts, which, at that time, were hardly creditworthy of issuing notes of
that monetary amount (e.g., they lacked significant assets relative to the amount of
the notes); (8) Mr. Bruce as an aspect of his advisers’ scheme substituted the
Marine stock, which had just been appraised at a fair market value of
approximately $5.8 million, for the Swap, which had no value; and (9) Mr. Bruce
replaced the value of the Marine stock with an equivalent amount of cash.
Mr. Lukinovich’s tax opinion letters also speak loudly against finding
petitioners’ estate planning assertion as a fact. The letters state specifically that
they were issued in response to a request as to the Federal income tax
consequences flowing from the plan, and they make no mention that Mr. Bruce (or
Mr. Rousse) was requesting the opinions for estate planning purposes.
- 46 -
[*46] We conclude that Mr. Bruce had no basis in the Swap. Furthermore, we
assume, as petitioners ask us to find, that Mr. Bruce sold his remainder interest to
the Daughters’ Trusts for promissory notes totaling $5,419,549. Mr. Lukinovich
opined that Mr. Bruce was required to recognize any gain that he realized on his
sale of that remainder interest, and we understand petitioners to concede this point.
Mr. Lukinovich also opined that Mr. Bruce’s basis in his remainder interest
equaled a portion of his basis in the Swap, and we understand petitioners to
concede this point as well. Given our conclusion that Mr. Bruce did not have any
basis in the Swap, it naturally follows that he also lacked any basis in his remainder
interest. We accordingly conclude that petitioners’ gross income for 2003 Federal
income tax purposes includes the $5,419,549 notes in full.24 We so hold.
Petitioners would still not prevail if we decided this case on the grounds that
respondent argues. This is because the facts adequately support respondent’s
position that Mr. Bruce established and used Sareb as his conduit and nominee for
the sale. An intermediary who is interposed between persons involved in a
transaction may be disregarded under substance over form and related principles.
24
Petitioners vigorously assert that they elected out of the installment method
as to the sale. See sec. 453. We therefore do not consider the applicability of the
installment method to this sale. We also do not consider whether the fair market
value of the notes was less than their face value. Petitioners have treated the values
as the same, and we do likewise.
- 47 -
[*47] See Gregory v. Helvering, 293 U.S. at 469; Sandvall v. Commissioner, 898
F.2d at 458; Reef Corp. v. Commissioner, 368 F.2d 125, 129-130 (5th Cir. 1966),
aff’g in part, rev’g and remanding in part T.C. Memo. 1965-72; Davant v.
Commissioner, 366 F.2d 874, 880-883 (5th Cir. 1966), aff’g in part, rev’g in part
and remanding S. Tex. Rice Warehouse Co. v. Commissioner, 43 T.C. 540 (1965);
Blueberry Land Co. v. Commissioner, 361 F.2d 93 (5th Cir. 1966), aff’g 42 T.C.
1137 (1964); see also Superior Trading, LLC v. Commissioner, 137 T.C. 70, 88-90
(2011) (discussing the binding commitment test, the end result test, and the
interdependence test, three alternative tests that courts employ to invoke the step
transaction doctrine and disregard a transaction’s intervening steps), aff’d, 728
F.3d 676 (7th Cir. 2013). The record persuades us to (and we do) find that Sareb
was Mr. Bruce’s conduit and nominee for the sale.
Mr. Bruce aspired to sell petitioners’ Marine stock or the Sarah Jane in
connection with his retirement, and the Marine stock and the Sarah Jane each had a
ready market in which the asset could be sold for approximately $5 million. Mr.
Bruce was mindful that the Marine stock and the Sarah Jane each had a built-in
gain of approximately $5 million and that a significant amount of Federal income
tax would be imposed on that gain when the property was sold. Petitioners
effected the plan to sell their Marine stock in the ready market aiming not to pay
- 48 -
[*48] any Federal tax on the built-in gain, and through the plan, petitioners parted
with the stock, they received the proceeds of the sale, and apparently no one
recognized any of the built-in gain. To be sure, however, Mr. Bruce continued to
act throughout the plan as if petitioners owned the Marine stock up until the time
that Mirror purchased the stock.
He consciously transferred the Marine stock to CTB in exchange for the
Swap which was of no value, obviously knowing that this transfer was essential to
the plan and that petitioners would eventually receive cash equal to their stock’s
full value. Two, he (through Mr. Rousse, his longtime friend and loyal employee),
established Sareb with the Daughters’ Trusts as its owners and with Mr. Rousse as
its designated manager, and he received from the Daughters’ Trusts promissory
notes in the aggregate amount of the approximate value of the Marine stock.
Three, he and his wife installed Mr. Rousse as the trustee of the Daughters’ Trusts.
Four, he maintained the ability, through Mr. Rousse, to draw from the Daughters’
Trusts the funds which were received in connection with the sale of the stock.
Five, at least during 2005 he maintained the ability to personally draw funds from
one or more of the Daughters’ Trusts’ bank accounts to further receive the sales
proceeds. Six, he allowed the Marine stock to be sold to Mirror. Seven, he
received all of the proceeds of the stock sale. The fact that petitioners (rather than
- 49 -
[*49] Sareb) were the true owners of the Marine stock at the time of its sale is
further seen from the fact that Mr. Bruce (and not Sareb or Mirror) later negotiated
the terms of the sale of the Sarah Jane directly with Mr. Falgout and led Mr.
Falgout to believe that Mr. Bruce (or a company that he controlled) owned the
Sarah Jane at that time.
We conclude as a holding alternative to our primary holding that petitioners
at all relevant times were the true owners of the Marine stock and that petitioners
must recognize their gain on that sale.
IV. Professional Fees
Respondent determined that section 162(a) does not let petitioners deduct
$52,450 of the professional fees that Marine claimed for 2003. Petitioners argue
that respondent’s determination is wrong because, they assert, the disputed fees
related to Marine’s business.25 We agree with respondent’s determination.
Section 162(a) provides that “[t]here shall be allowed as a deduction all the
ordinary and necessary expenses paid or incurred during the taxable year in
carrying on any trade or business”. Marine’s business in 2003 involved operating
the Sarah Jane for profit. Thus, the requirements of section 162(a) must be met as
25
Petitioners do not seek to deduct the fees under any other provision. We
therefore do not consider whether the fees are deductible under any other provision
including, for example, sec. 212.
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[*50] to that business for Marine to deduct the disputed fees under section 162(a).
See sec. 1.162-1(a), Income Tax Regs.
Deductions are a matter of legislative grace, and taxpayers bear the burden
of proving their entitlement to any claimed deduction. See INDOPCO, Inc. v.
Commissioner, 503 U.S. 79, 84 (1992). Professional fees may qualify under
section 162(a) as an ordinary and necessary expense of a business. See
Commissioner v. Tellier, 383 U.S. 687, 689-690 (1966); Bingham’s Trust v.
Commissioner, 325 U.S. 365, 374 (1945); Guill v. Commissioner, 112 T.C. 325,
328-329 (1999). Whether the disputed fees qualify as such is a question of fact,
which hinges on the origin and the character of the fees. See United States v.
Gilmore, 372 U.S. 39, 49 (1963); Commissioner v. Heininger, 320 U.S. 467, 475
(1943). In order to be “necessary”, the fee must be “‘appropriate and helpful’” to
the development of Marine’s business. Commissioner v. Tellier, 383 U.S. at 689
(quoting Welch v. Helvering, 290 U.S. at 113); see also Welch v. Helvering, 290
U.S. at 113-115. In order to be “ordinary”, the fees must be “normal, usual, or
customary” in Marine’s type of business. See Deputy v. du Pont, 308 U.S. 488,
495-496 (1940); see also Welch v. Helvering, 290 U.S. at 113-115.
Petitioners assert that the disputed fees related to Marine’s business, but they
provide no citation of the record to support that assertion. Nor do we
- 51 -
[*51] independently find any credible evidence in the record to support that
assertion. We find instead that the disputed fees originated from and pertained to
Mr. Bruce’s consummation of the plan and that he consummated the plan to benefit
petitioners personally and without regard to Marine’s business operation. In that
regard, the record establishes that petitioners or Marine sought professional advice
during the subject year primarily with respect to the plan and to its consummation.
Accordingly, because the origin and character of the disputed fees were personal
(and not business), the fees were not ordinary and necessary expenses of Marine’s
business nor directly connected with or proximately resulting from Marine’s
business. See Kornhauser v. United States, 276 U.S. 145 (1928). We sustain
respondent’s determination that the disputed $52,450 in professional fees is not
deductible under section 162(a).26 See also sec. 1.162-1(b) (7), Income Tax Regs.
V. Accuracy-Related Penalty
Section 6662(a) imposes a 20% accuracy-related penalty if any part of an
underpayment of tax required to be shown on a return is due to, among other
things, a substantial valuation misstatement. See also sec. 6662(b)(3). The
accuracy-related penalty is increased to 40% in the case of a gross valuation
26
We note that expenses associated with the planning or the execution of a
sham transaction are not allowable as a deduction. See, e.g., Kirchman v.
Commissioner, 862 F.2d 1486, 1490 (11th Cir. 1989), aff’g Glass v.
Commissioner, 87 T.C. 1087 (1986).
- 52 -
[*52] misstatement. See sec. 6662(h)(1). A gross valuation misstatement exists if,
for the taxable year at issue, the value or adjusted basis of property reported on a
tax return is 400% or more of the amount determined to be the property’s correct
value or adjusted basis. See sec. 6662(e)(1)(A), (h)(1), (2)(A)(i). The value or
adjusted basis claimed on a return for worthless property is considered to be 400%
or more of the correct value or adjusted basis.27 See sec. 1.6662-5(g), Income Tax
Regs.; see also Rovakat, LLC v. Commissioner, T.C. Memo. 2011-225, slip op. at
62, aff’d, 529 Fed. Appx. 124 (3d Cir. 2013). The 40% penalty does not apply
unless the underpayment attributable to the valuation misstatement exceeds $5,000.
See sec. 6662(e)(2).
Respondent determined that petitioners are liable for the 40% accuracy-
related penalty under section 6662(h).28 Respondent bears the burden of
production on the applicability of the accuracy-related penalty in that he must
27
The statute was amended by the Pension Protection Act of 2006, Pub. L.
No. 109-280, sec. 1219(a)(2)(A), 120 Stat. at 1083, effective for tax returns filed
after August 17, 2006, to provide that there is a gross valuation misstatement if the
reported value is 200% or more of the amount determined to be the property’s
correct value.
28
Respondent determined that the accuracy-related penalty applied to the
deficiency resulting from his adjustments for legal and professional fees, capital
gains income, and itemized deductions. We have discussed the first two
adjustments and sustained them. Respondent determined that the itemized
deduction adjustment flowed computationally from the first two adjustments, and
petitioners do not dispute that determination. We agree with it as well.
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[*53] come forward with sufficient evidence showing that it is proper to impose
the penalty. See sec. 7491(c); see also Higbee v. Commissioner, 116 T.C. 438, 446
(2001). Petitioners claimed a $5,419,549 basis in Mr. Bruce’s remainder interest
which they reportedly sold on July 31, 2003, and we have concluded that Mr.
Bruce’s actual basis in that interest was zero. Petitioners therefore claimed a value
that was 400% or more of the correct adjusted basis. We conclude that respondent
has met his burden of production.29
Petitioners argue secondarily that they are not liable for the 40% accuracy-
related penalty because, they assert, Mr. Bruce reasonably relied on the advice of
Attorneys Lobrano and Lukinovich. Section 6664(c) excepts from the 40%
accuracy-related penalty any portion of an underpayment for which the taxpayer
establishes that the taxpayer had reasonable cause and acted in good faith.
Whether this exception applies is a factual determination which turns on our
29
Petitioners assert that this case is appealable to the Court of Appeals for the
Fifth Circuit and argue primarily that this Court should follow the precedent of that
court, specifically Heasley v. Commissioner, 902 F.2d 380 (5th Cir. 1990), rev’g
T.C. Memo. 1988-408, and Todd v. Commissioner, 862 F.2d 540 (5th Cir. 1988),
aff’g 89 T.C. 912 (1987). Those cases hold that the 40% accuracy-related penalty
does not apply where a transaction is disregarded for lack of economic substance.
After the briefing was closed in this case, the U.S. Supreme Court rejected the
holding of the referenced cases and concluded that the 40% accuracy-related
penalty for gross valuation misstatement applies when a transaction lacking
economic substance results in a valuation misstatement. See United States v.
Woods, 571 U.S. , 134 S. Ct. 557 (2013). We reject petitioners’ primary
argument without further discussion.
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[*54] examination of all pertinent facts and circumstances, giving special attention
to the extent of the taxpayer’s effort to assess the taxpayer’s proper tax liability.
See sec. 1.6664-4(b)(1), Income Tax Regs.
An individual taxpayer’s honest misunderstanding of fact or law that is
reasonable in the light of, among other things, his or her experience, knowledge,
and education may serve to meet the reasonable cause and good faith requirement.
See id. Where, as here, an individual taxpayer claims reliance on the advice of
professional tax advisers, we also require that the taxpayer establish that he or she
meets “each requirement of the following three-prong test: (1) The adviser was a
competent professional who had sufficient expertise to justify reliance, (2) the
taxpayer provided necessary and accurate information to the adviser, and (3) the
taxpayer actually relied in good faith on the adviser’s judgment.” Neonatology
Assocs., P.A. v. Commissioner, 115 T.C. 43, 99 (2000), aff’d, 299 F.3d 221 (3d
Cir. 2002); see Charlotte’s Office Boutique, Inc. v. Commissioner, 425 F.3d 1203,
1212 n.8 (9th Cir. 2005) (quoting this three-prong test with approval), aff’g 121
T.C. 89 (2003); see also sec. 1.6664-4(c), Income Tax Regs.
We conclude that Mr. Bruce aspired to assess petitioners’ proper tax liability
but, through no fault of his own, made an “an honest misunderstanding of fact or
law that is reasonable in light of all of the facts and circumstances”. Sec. 1.6664-
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[*55] 4(b)(1), Income Tax Regs. The fact that Mr. Bruce is an experienced and
sophisticated seafarer, fisherman, and sea captain does not necessarily mean that he
should have recognized that he had no basis in the Swap, that his relationship to
Sareb would make petitioners (rather than Sareb) the seller of the stock for Federal
tax purposes, or that the disputed fees were not deductible. Mr. Bruce has a high
school education, and he routinely consults and relies upon professionals and other
businessmen and employees such as Mr. Rousse in making his business decisions.
We viewed and heard him testify credibly that he had a basic understanding as to
tax matters, that he had no understanding of the complex transactions which made
up the plan (including their purpose or significance, or the risks or benefits
involved), that he accepted Mr. Lobrano’s opinion that the plan was valid, and that
he relied upon Mr. Lobrano’s advice in consummating the plan and in reporting its
consequences on petitioners’ 2003 return.
We also are mindful that when the financial planners advised Mr. Bruce that
the plan provided favorable tax benefits to him, Mr. Bruce did not simply rely
upon that advice. He asked Mr. Lobrano to meet with the financial planners and
then to advise Mr. Bruce whether the plan was valid. In other words, Mr. Bruce
was not content to rely simply upon the promoters’ advice as to the plan, but he
sought independent advice from an experienced trusted tax attorney (Mr. Lobrano)
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[*56] who Mr. Bruce retained to discuss with the promoters all relevant and
necessary information as to the plan.
Mr. Lobrano, in turn, was Mr. Bruce’s longtime tax adviser who regularly
advised him on tax and on other legal matters; Mr. Lobrano had sufficient
ostensible expertise to warrant reliance; Mr. Lobrano knew about the subject
matter underlying the plan; and Mr. Lobrano took steps to make himself even more
knowledgeable on that subject matter so as to assure himself that the plan was
valid. We also add that we find nothing in the record to lead us to conclude that
Mr. Lobrano had an inherent conflict of interest as to the plan. See generally
Countryside Ltd. P’ship. v. Commissioner, 132 T.C. 347, 352-355 (2009)
(distinguishing between a promoter and an independent professional tax adviser for
attorney-client privilege purposes).
We conclude that it was objectively reasonable for Mr. Bruce to rely on Mr.
Lobrano’s advice, even though we conclude that the advice was wrong.30 See
30
The record does not establish that Mr. Bruce or Mr. Lobrano relied solely
on the advice or opinion of Mr. Lukinovich, Mr. Doverspike, Mr. Ohle, and Mr.
Deichmann as to any item. If they did, then that reliance may not have been
reasonable given that Mr. Doverspike, Mr. Ohle, and Mr. Deichmann, and perhaps
also Mr. Lukinovich, appear to have been “promoters” of the plan. See 106 Ltd. v.
Commissioner, 136 T.C. 67, 79 (2011) (stating that a promoter is “‘an adviser who
participated in structuring the transaction or is otherwise related to, has an interest
in, or profits from the transaction’” (quoting Tigers Eye Trading, LLC v.
Commissioner, T.C. Memo. 2009-121)), aff’d, 684 F.3d 84 (D.C. Cir. 2012).
- 57 -
[*57] United States v. Boyle, 469 U.S. 241, 251 (1985) (“To require the taxpayer
to challenge the * * * [expert], to seek a ‘second opinion,’ or to try to monitor * * *
[the qualified adviser] on the provisions of the Code himself would nullify the very
purpose of seeking the advice of a presumed expert in the first place.”); see also
Whitehouse Hotel Ltd. P’ship v. Commissioner, 755 F.3d 236, 247-250 (5th Cir.
2014), aff’g in part, vacating in part and remanding 139 T.C. 304 (2012); Stanford
v. Commissioner, 152 F.3d 450, 461 (5th Cir. 1998), aff’g in part, vacating in part
108 T.C. 344 (1997); Chamberlain v. Commissioner, 66 F.3d 729, 732-733 (5th
Cir. 1995), aff’g in part, rev’g in part T.C. Memo. 1994-228. We hold that the
40% penalty does not apply and reject respondent’s determination that it or a 20%
penalty does. Accord Streber v. Commissioner, 138 F.3d 216, 219-224 (5th Cir.
1998), rev’g T.C. Memo. 1995-601.
We have considered all arguments that the parties made and have rejected
those arguments not discussed here as without merit.
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[*58] To reflect the foregoing,
Decision will be entered for
respondent with respect to the
deficiency and for petitioners with
respect to the accuracy-related penalty
under section 6662(h).