Misle v. Commissioner , 80 T.C.M. 518 ( 2000 )

T.C. Memo. 2000-322
UNITED STATES TAX COURT
HENRY AND ESTHER MISLE, ET AL.,1 Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 14157-97, 22920-97, Filed October 16, 2000.
16657-98, 16658-98.
Paul J. Peter, Gary J. Nedved, and Gary L. Young, for
petitioners Henry and Esther Misle.
Allen Daubman, M. Shaun McGaughey, and David M. Dvorak, for
petitioners HJA, Inc., & Subsidiaries.
Henry N. Carriger, for respondent.
1
Cases of the following petitioners are consolidated
herewith for purposes of trial, briefing, and opinion because
they present common questions of fact and law: HJA, Inc., &
Subsidiaries, docket No. 22920-97; Henry and Esther Misle, docket
No. 16657-98; and Henry Misle, docket No. 16658-98. The cases
are referred to as this case in this opinion.
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MEMORANDUM FINDINGS OF FACT AND OPINION
MARVEL, Judge: In separate notices of deficiency,
respondent determined the following income tax deficiencies,
penalties, and additions to tax with respect to petitioners’
Federal income tax returns:2
Henry and Esther Misle, Docket No. 14157-97
Penalty
Year Deficiency Sec. 6662(a)
1989 $19,906 $3,981
1990 106,768 21,354
1991 66,964 13,393
1992 25,733 5,147
1993 31,803 6,361
Henry and Esther Misle, Docket No. 16657-98
Penalty
Year Deficiency Sec. 6662(a)
1994 $67,902 $13,428
1996 71,900 14,380
Henry Misle, Docket No. 16658-98
Additions to Tax
Year Deficiency Sec. 6651(a) Sec. 6654
1995 $62,797 $15,591 $3,422
2
All section references are to the Internal Revenue Code in
effect for the years in issue, and all Rule references are to the
Tax Court Rules of Practice and Procedure. Monetary amounts are
rounded to the nearest dollar.
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HJA, Inc., & Subsidiaries, Docket No. 22920-97
Year Deficiency
1991 $6,473
1992 83,578
1993 253,656
Following concessions,3 the issues for decision are:
1. Whether payments made by HJA, Inc., in connection with
an option and stock purchase agreement that were applied to
certain liabilities are taxable to Henry and Esther Misle as
ordinary income and deductible by petitioner HJA, Inc., &
Subsidiaries;
2. whether petitioner Henry Misle may reduce, for income
tax purposes, the gross amount of the option price paid to him or
for his benefit pursuant to the option and stock purchase
agreement by $150,000;
3. whether petitioners Henry and Esther Misle are liable
for accuracy-related penalties for tax years 1989 through 1994
and 1996 under section 6662(a);
4. whether petitioner Henry Misle is liable for an addition
to tax under section 6651(a) for failure to file a return for tax
year 1995; and
3
The parties have settled most of the issues raised in the
notices of deficiency issued to petitioners. The only other
issues to be resolved are computational.
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5. whether petitioner Henry Misle is liable for an addition
to tax under section 6654 for failure to make estimated tax
payments for tax year 1995.
FINDINGS OF FACT4
Most of the facts have been stipulated and are so found.
Stipulations of Fact Nos. 1 and 2 are incorporated into our
opinion by this reference.
A. Background
Petitioners Henry Misle (Henry or HM) and Esther Misle
(Esther) are husband and wife who resided in Lincoln, Nebraska,
at the time the petitions at docket Nos. 14157-97, 16657-98, and
16658-98 were filed. HJA, Inc. (HJA), is a corporation which had
its principal place of business in Lincoln, Nebraska, at the time
the petition at docket No. 22920-97 was filed. For the years at
4
Contrary to Rule 151(e), which governs the form and content
of briefs submitted to the Tax Court, petitioners Henry and
Esther Misle failed to include, among other things, proposed
findings of fact in their opening brief. Instead, petitioners
Henry and Esther Misle set forth their proposed findings of fact
in their reply brief. Presenting proposed findings of fact for
the first time in a reply brief strips opposing parties of the
opportunity to make objections to those proposed findings of
fact. Because petitioners Henry and Esther Misle failed to
include proposed findings of fact in their opening brief, as
required by Rule 151(e), we do not consider them. By failing to
follow the Court’s Rules, “petitioners 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.
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issue, HJA filed consolidated Federal income tax returns with its
subsidiaries. The consolidated group is the petitioner in docket
No. 22920-97.
During all relevant periods, members of the Misle family
operated motor vehicle dealerships (the Misle dealerships) and
related businesses (collectively the Misle group). The Misle
dealerships were located on the north and south sides of O Street
in Lincoln, Nebraska. Until 1990, the three Misle brothers–-
Henry, Abram Misle (Abram or AM), and Julius Misle (Julius or
JM)–-were the primary family members involved in the operation of
the Misle dealerships. Henry controlled and operated the
dealerships on the south side of O Street through a corporation,
Misle Chevrolet & Imports, Inc. (Chevrolet), and Abram controlled
and operated the dealerships on the north side of O Street
through a corporation, Park Place Pontiac-Cadillac-GMC, Inc.
(Park Place). Julius operated other businesses in the Misle
group.
B. The 1986 Reorganization
Before 1986, the Misle group operated through various
partnerships and corporations, ownership of which varied from
entity to entity. Effective August 14, 1986, the Misle group was
reorganized under a unified corporate structure (the
reorganization). A new holding company, HJA, and several
subsidiary corporations, wholly owned either directly or
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indirectly by HJA, were incorporated in connection with the
reorganization. The subsidiary corporations owned the operating
assets used in the Misle group. The prereorganization
partnerships and corporations either were included in the new
corporate structure or were dissolved and liquidated.
1. Dissolution of the Misle Brothers Partnership
The Misle Brothers Partnership was one of the partnerships
dissolved and liquidated as part of the reorganization. Pursuant
to and in furtherance of the reorganization, Henry, Abram, and
Julius executed a dissolution of partnership agreement dated
April 14, 1986. In the dissolution of partnership agreement,
Henry agreed to assume personal liability for $686,467 of
intercompany loans owed by the Misle group to Chevrolet and
another company in the Misle group (the Chevrolet debt).5 Henry
also agreed to hold Abram and Julius harmless and to indemnify
them in the event they were ever required to pay any of the
liabilities Henry agreed to assume.
2. The Reorganization Documents
Various documents and agreements, described below, were
entered into contemporaneously with the reorganization.
5
According to the dissolution of partnership agreement,
Abram and Julius collectively assumed personal liability for
$2,224,942 of intercompany loans owed to Park Place and other
businesses in the Misle group.
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a. Commercial Loan Agreement, FirsTier Notes,
Security Agreement, and Related Guaranties
FirsTier Bank (FirsTier), Chevrolet, BHM Corp. (BHM),6 and
Henry and Esther individually executed a commercial loan
agreement dated June 30, 1986. In accordance with the commercial
loan agreement, Henry and Esther executed a $600,000 term note in
their individual capacities payable to FirsTier dated June 30,
1986 (the FirsTier note), and a security agreement to secure the
FirsTier note. Chevrolet and BHM each executed separate
guaranties of the FirsTier note. During the years at issue, the
FirsTier note was not included as a liability of HJA in HJA’s
books and records.
Chevrolet and BHM executed a separate $756,708 term note
payable to FirsTier dated June 30, 1986 (the companies’ term
note), and a $100,000 revolving credit note payable to FirsTier
dated June 30, 1986. Chevrolet and BHM each executed a separate
security agreement to secure the companies’ term note and the
revolving credit note. Henry and Esther each executed an
6
BHM Corp. was a wholly owned subsidiary of Chevrolet that
owned real estate on which Chevrolet operated.
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individual guaranty of the companies’ term note and the revolving
credit note.7 The companies’ term note was included as a
corporate liability in HJA’s books and records.
b. Escrow Agreement
Contemporaneously with the commercial loan agreement,
Chevrolet, BHM, FirsTier, Henry, and Esther8 executed an escrow
agreement in which FirsTier agreed to hold the sum of $750,000 in
escrow (the escrow fund) and to disburse the fund in accordance
with the escrow agreement.9 The escrow fund consisted of
$600,000 borrowed by Henry and Esther pursuant to the FirsTier
note and another $150,000, the source of which was not described
in the escrow agreement. The escrow agreement provided that the
escrow fund would be disbursed upon the execution and transfer of
7
In the ensuing years, the parties to these documents
executed several amendments to the commercial loan agreement
extending or modifying the companies’ term note, the revolving
credit note, and/or the FirsTier note (the notes). All of the
parties to the notes, including Henry, executed each amendment
except that Henry did not execute a sixth amendment to commercial
loan agreement dated Apr. 5, 1995 (the sixth amendment), and
related documents.
8
Bryan Misle and Laurie Misle, Henry and Esther’s son and
daughter-in-law, also signed the escrow agreement in their
individual capacities; however, they were not referred to in the
escrow agreement other than in one clause, which read, “WHEREAS,
Borrowers [defined earlier in the document only as Henry and
Esther] desires [sic] to execute all loan documents to be entered
into by himself, Misle Chevrolet & Imports, Inc. and/or Bryan
Misle”.
9
Both the commercial loan agreement, dated June 30, 1986,
and the escrow agreement were executed on Aug. 12, 1986.
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all documents in accordance with an agreement for contribution of
assets, dated September 17, 1985, which was not made part of the
record in this case.
The source of the additional $150,000 deposited into the
escrow account was Henry’s son, Bryan Misle (Bryan or BM). Bryan
refinanced some personal real estate to obtain the remaining
$150,000 needed to complete the funding of the escrow. On
several occasions, both Henry and Bryan characterized the
$150,000 transfer as a loan.10
3. Ownership of HJA Following the Reorganization
Upon completion of the reorganization, Henry, Abram, and
Julius each owned 10,000 shares of HJA common stock, representing
a one-third ownership interest in HJA.
C. Henry’s Sale of His HJA Stock
1. HJA’s Option To Acquire Henry’s Stock Under Exclusive
Option Agreement
On March 15, 1990, HJA, Henry, Abram, Julius, and Bryan
entered into an exclusive option agreement (EOA) pursuant to
which Henry, in consideration for the payment of $300,000 (the
10
In this litigation, Henry claimed that Bryan purchased
some of Henry’s HJA stock for $150,000 in 1990 and offered into
evidence a stock certificate in support of his claim. Although
we admitted the stock certificate into evidence, petitioners
failed to prove that it was a valid stock certificate or that it
represented a genuine and completed sale.
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option price), granted HJA the option to purchase Henry’s stock
in HJA for $1,030,000. The option price was to be paid as
follows:
(i) The sum of Forty-Eight Thousand Six
Hundred Fifty-Three and 62/100 Dollars
($48,653.62), already received by HM prior to
execution of this Agreement;
(ii) The sum of One Hundred Seventy-Five
Thousand Three Hundred Forty-Six and 38/100
($175,346.38) at the time of the mutual
execution and delivery of this Agreement;
(iii) Transfer and relinquishment by AM
and JM of all of their right, title and
interest in and to the securities currently
in the possession of HM, valued at
approximately Seventy-Six Thousand Dollars
($76,000.00).
Pursuant to the EOA, HJA transferred funds and assets with
an aggregate value of $286,41111 to Henry for the option to
purchase his stock. The parties agree that $136,411 of this
amount was investment income to Henry in 1990. The tax treatment
of the remaining $150,000 is at issue in this case.
The EOA required that Henry’s HJA stock be placed in escrow
until the option to purchase Henry’s stock was exercised and the
sale closed. The EOA, however, gave Abram and Julius effective
control over Henry’s HJA stock beginning in March 1990.
11
The parties agree that the amount actually paid was
$286,411, despite language in the EOA stating that the aggregate
option price was $300,000. The parties also agree that the
entire payment is taxable in 1990. The only issue regarding the
option payment is to whom the disputed balance of $150,000 is
taxed.
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2. The Restrictive Covenant
On the condition that HJA pay the option price to Henry as
required by the EOA, Henry agreed to be bound by a restrictive
covenant clause, which provided that Henry must not engage in
competition directly or indirectly with HJA, Abram, Julius,
Chevrolet, or Park Place for 5 years commencing on April 1, 1990
(covenant not to compete).12 In consideration for the covenant
not to compete and as an inducement for Henry to enter into the
EOA, HJA agreed to compensate Henry as follows:
HJA shall pay to HM the sum of Two Million Eight
Hundred Fifty-Two Thousand Dollars ($2,852,000.00),
payable in one hundred twenty (120) equal consecutive
monthly installments of Twenty-Three Thousand Seven
Hundred Sixty-Six and 67/100 Dollars ($23,766.67) each,
such payments to compensate HM for his agreement not to
compete, as herein provided.
3. Related Agreements
In order to coordinate the covenant not to compete payments
HJA owed to Henry with the payments Henry owed on the FirsTier
note and the Chevrolet debt, the parties to the EOA entered into
two additional agreements. First, HJA, Henry, Abram, and Julius
entered into a side letter agreement dated March 15, 1990 (the
side letter agreement). The side letter agreement provided for
the establishment of a “sweep account” at National Bank of
Commerce (NBC), into which the covenant not to compete payments
12
The parties have stipulated that the covenant not to
compete is a legal and enforceable covenant under Nebraska law.
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were to be deposited.13 Second, HJA, NBC, Henry, Abram, and
Julius entered into an agreement dated August 27, 1990 (the sweep
account agreement), which established the sweep account agreed
upon in the side letter agreement. The sweep account agreement
required HJA to deposit the covenant not to compete payments
($23,767 per month for 120 months) into the sweep account. It
also required NBC to make specified disbursements of those
deposited funds, including $7,999 per month to FirsTier and
$6,393 per month to Chevrolet “until the obligation of HM is
fully paid”.14 The remainder of the sweep account funds was to
be paid to Henry and to the appropriate Federal, State, and city
income tax agencies to satisfy Henry’s tax obligations resulting
from the purchase of his stock and the covenant not to compete
payments.
4. The Sweep Account Payments
Pursuant to the EOA and the side letter agreement, HJA paid
the option price to Henry and began to deposit the covenant not
to compete payments into the sweep account. HJA continued to
13
Henry and Esther attached the side letter agreement to
their 1992 Federal income tax return.
14
The monthly payment to FirsTier under the sweep account
agreement equaled the monthly payment required by the FirsTier
note signed by Henry and Esther in their individual capacities,
as modified by the Apr. 5, 1990, term note. The monthly payment
to Chevrolet under the sweep account agreement equaled the
monthly payment Henry was required to make on the Chevrolet debt.
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deposit the payments until January 1991 when a dispute arose
among the parties to the sale.
5. HJA’s Exercise of the Option To Purchase Henry’s Stock
Under the EOA, if HJA exercised its option, HJA was entitled
to purchase Henry’s 10,000 shares of HJA stock15 for the sum of
$1,030,000, payable in installments as provided in the EOA. HJA
exercised its option to purchase Henry’s stock on or about
January 11, 1991.
6. The Baird, Kurtz Letter
Baird, Kurtz, & Dobson (Baird, Kurtz), the accounting firm
for HJA and related companies for 25 years, was also Henry and
Esther’s personal accounting firm until 1990 and prepared their
tax returns for the tax years up to and including 1989. By
letter dated April 10, 1990, Baird, Kurtz wrote to Henry to
explain the tax consequences of payments to be made pursuant to
the EOA (the Baird, Kurtz letter).16 The Baird, Kurtz letter
advised, among other things, that, for tax purposes, (1) payments
received from HJA for Henry’s stock under the EOA would be
treated as proceeds from the sale of a capital asset, and the
15
Bryan did not assert any ownership interest in Henry’s HJA
stock in connection with the EOA.
16
The letter was written by Robert K. Muehling, partner-in-
charge of Baird, Kurtz, who knew Henry’s financial situation.
Henry claims that he never received this letter, although a copy
of the letter was attached to Henry and Esther’s 1992 income tax
return.
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resulting capital gain would be recognized using the installment
sale method of accounting, and (2) the covenant not to compete
payments made under the EOA, at $23,767 per month, would be taxed
as ordinary income to Henry in the year received. The Baird,
Kurtz letter also stated with respect to the $150,000 from Bryan
used to fund the escrow account that “It is our understanding
that you [Henry] owe Bryan $150,000, which will be repaid in
1990. Any additional amounts transferred to him [Bryan] would
constitute gifts”. Baird, Kurtz attached a schedule to its
letter entitled “CASH FLOW PROJECTIONS-–HENRY MISLE” which
assumed, among other things, that Henry’s debts to Chevrolet and
FirsTier would remain intact and would be amortized over 10 years
and that Bryan would receive $150,000 from Henry in 1990 as
repayment of Bryan’s loan.
D. State Litigation
In January 1991, disputes arose among HJA, Henry, Abram, and
Julius relating to the EOA. Sometime before January 21, 1991,
HJA stopped making payments into the sweep account under the EOA.
On January 21, 1991, Henry and Bryan filed a lawsuit in the
District Court of Lancaster County, Nebraska, against HJA,
Abram,17 and Julius, alleging breach of the EOA (the State
litigation). The defendants counterclaimed, alleging
misrepresentation and a breach of covenants made by Henry in the
17
During the course of the State litigation, Abram died and
his estate was substituted as a party.
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EOA. The primary issues in the State litigation were: (1)
Whether the defendants breached the EOA by discontinuing payments
into the sweep account, (2) whether the plaintiffs made
misrepresentations when executing the EOA, and (3) whether Henry
breached the covenant not to compete provision of the EOA.
The State litigation was tried from July 29 through August
1, 1996. Following the trial, a modified memorandum opinion and
judgment (modified judgment), dated January 3, 1997, was entered
by the State court in which the court held, among other things,
that (1) the covenant not to compete was valid and enforceable,
(2) Henry did not violate the covenant not to compete, and (3)
HJA was obligated to complete the payment obligations under the
covenant not to compete. The modified judgment was not appealed
by any of the litigants.
Pending resolution of the State litigation, HJA continued to
make payments directly on the FirsTier note and the Chevrolet
debt. On December 29, 1997, the State court entered a journal
entry pursuant to motions, filed by the defendants HJA and Abram,
for an order nunc pro tunc and for partial satisfaction of
judgment. The journal entry provided that HJA was entitled to a
credit against the covenant not to compete payments for certain
payments made by HJA on the FirsTier note and the Chevrolet debt.
The journal entry stated, in part:
IT IS THEREFORE ORDERED and DECREED as follows:
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* * * * * * *
2. That Defendants’ Motion for Partial
Satisfaction of Judgment for payments made to First
Bank [FirsTier] and Park Place Chevrolet [Chevrolet] by
Defendants from and after August 1, 1996 is granted
with Defendant to be given credit on the Modified
Judgment for the sum of $216,165.31 representing
payments from September 1, 1996 through December 17,
1997 of $216,165.31.
* * * * * * *
4. To settle and resolve certain conflicts which
have arisen in regards to the amount payable pursuant
to the * * * Modified Judgment, the Parties, in open
Court, have indicated their agreement to the following:
* * * * * * *
(b) The note of First Bank (f/k/a FirsTier
Bank), referenced in the “side letter
agreement,” dated March 15, 1990, to
which Henry Misle was an accommodating
Party, has been paid by the Defendants,
in full, without Henry Misle’s knowledge
or cooperation and the Defendants are
due a credit on the Modified Judgment
* * *;
(c) Between the dates of January 1 and
January 8, 1998, the Defendants will
cause to be retired the Park Place
Chevrolet note, [Chevrolet debt]
referenced in the “side letter
agreement,” which will satisfy said
indebtedness of Henry Misle completely
and the Defendants will be given a
credit on the Modified Judgment * * *;
E. HJA’s Payments to or for the Benefit of Henry
During the years in issue, HJA made covenant not to compete
payments to Henry or for his benefit in the following amounts:
Year Covenant not to compete payments1
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1990 $213,900
1991 182,088
1992 164,447
1993 176,5032
1994 165,003
1995 166,410
1996 167,817
1
The parties stipulated the amounts that HJA paid under the
covenant not to compete, and those amounts are summarized here.
The amounts listed for 1991, 1995, and 1996 differ from the
amounts shown on the relevant Forms 1099 and in the letters of
explanation. The amounts shown for 1994, 1995, and 1996 were
paid by HJA and deducted, but respondent has not yet disallowed
those deductions.
2
In 1993, HJA made payments directly to FirsTier and
Chevrolet in the amount of $165,003. HJA also made a direct
payment to Henry in the amount of $3,000 and credited it as a
covenant not to compete payment. In 1993, Chevrolet made an
$8,500 payment on personal insurance for Henry and credited the
payment as a covenant not to compete payment.
Part of the covenant not to compete payments was applied to the
Chevrolet debt and the FirsTier note, either through the sweep
account or directly, as follows:
Year Chevrolet debt FirsTier note Total
1990 $38,361 $31,998 $70,359
1991 6,394 7,999 14,393
1992 76,721 87,726 164,447
1993 76,722 88,281 165,003
1994 76,721 88,282 165,003
1995 76,722 89,688 166,410
1996 76,721 91,096 167,817
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Part of the covenant not to compete payments ($17,000 in 199018
and $65,192 in 1991) was disbursed from the sweep account for
other purposes. The parties agree that these amounts were
ordinary income to Henry and Esther and deductible by HJA.
F. Tax Treatment of Covenant Not To Compete Payments
For each taxable year 1990 through 1996, inclusive, HJA
issued a Form 1099 and sent a letter of explanation to Henry that
showed the amount of covenant not to compete payments made to
Henry or for his benefit in that year. In 1990, Henry and Esther
reported $161,036 of the $213,900 of the covenant not to compete
payments as ordinary income.19 Henry and Esther did not include
any other covenant not to compete payments in income for any of
the years at issue.
Henry and Esther claimed interest expense deductions on
their joint individual Federal income tax returns for interest
payments made on the Chevrolet debt as follows:
Year Interest deduction
1989 Unknown
1990 $43,440
18
The parties agree that Henry is entitled to deduct, as an
itemized deduction, the trustee fee of $500 paid in 1990 from the
sweep account.
19
The parties have agreed that the remainder of the 1990
convenant not to compete payments, which was not disbursed to
Henry until 1991, was ordinary income to Henry in 1991.
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Henry and Esther claimed interest expense deductions on their
joint individual Federal income tax returns for payments made on
the FirsTier note as follows:
Year Amount of deduction
1986 Unknown
1987 $64,199
1988 $57,987
1989 Unknown
1990 $72,540
Henry and Esther did not claim interest deductions on the
FirsTier note or the Chevrolet debt after 1990; however, they did
continue to carry over their unused interest deductions from 1990
until at least 1996.
G. Delinquent Returns of Henry and Esther
Henry and Esther filed their 1989, 1990, 1992, 1994, and
1996 Forms 1040, U.S. Individual Income Tax Return, late. As
part of their 1992 tax return, Henry and Esther filed a Form
8275, Disclosure Statement, with attachments. Henry and Esther’s
1996 return also contained a disclosure statement, but the
statement was not made on Form 8275.
Henry failed to file an individual income tax return for
1995.
H. Notices of Deficiency
Respondent examined Henry and Esther’s 1990, 1991, 1992,
1993, and 1994 tax returns and prepared an “Individual Income Tax
Return Substitute for Return” for Henry with filing status
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“Married Filing Separate” for 1995. On April 9, 1997, respondent
mailed Henry and Esther a notice of deficiency for 1989, 1990,
1991, 1992, and 1993. On August 28, 1998, respondent mailed
Henry and Esther a notice of deficiency for 1994 and 1996. On
August 28, 1998, respondent also mailed Henry a notice of
deficiency for 1995. In the notices, respondent determined that
the covenant not to compete payments were income to Henry. In
the notice of deficiency for 1990, respondent also determined
that Henry must report as income the remaining $150,000 of the
option price transferred by Henry to Bryan.
Respondent also examined HJA’s 1990, 1991, 1992, and 1993
tax years. After examining HJA’s 1990 return, respondent
proposed increasing HJA’s taxable income, but the adjustment did
not result in a deficiency because HJA had net operating losses
that absorbed the additional income. For that reason, respondent
did not determine an income tax deficiency for 1990 with respect
to HJA.
On August 28, 1997, respondent issued a notice of deficiency
to HJA for tax years 1991, 1992, and 1993, in which he disallowed
HJA’s deductions for the covenant not to compete payments. In so
doing, respondent has taken inconsistent positions with respect
to Henry and Esther, on the one hand, and HJA, on the other, in
order to avoid the possibility of a whipsaw.
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OPINION
I. Whether Payments Made by HJA in Connection With an Option and
Stock Purchase Agreement, Which Were Applied to the FirsTier Note
and the Chevrolet Debt, Are Taxable to Henry and Esther as
Ordinary Income and Deductible by HJA, Inc., & Subsidiaries
A. The Parties’ Arguments
Henry and Esther contend, in effect, that any payments made
by HJA on the FirsTier note and the Chevrolet debt, either
directly or through the sweep account, did not result in taxable
income to them because the payments did not qualify as covenant
not to compete payments, nor did the payments relieve them of any
primary liability under the FirsTier note and the Chevrolet debt.
Rather, Henry and Esther contend that the payments were made by
HJA to pay down HJA’s own liabilities as to which Henry and/or
Esther were only accommodation parties. HJA disagrees, claiming
that Henry and Esther were primary obligors as to the FirsTier
note and that Henry was the primary obligor as to the Chevrolet
debt; thus, payments made to FirsTier and Chevrolet by HJA from
1990 through 1996 are ordinary income to Henry and Esther and
deductible by HJA.20
20
Respondent did not present an argument as to this issue
and makes no assumptions as to Henry and Esther’s status in
relation to the loans. Respondent concedes that if we hold that
Henry and Esther are the primary obligors on the FirsTier note
and the Chevrolet debt, then HJA is entitled to a full deduction
for the payments that were applied to those liabilities, and
Henry and Esther must include the payments as ordinary income on
their tax returns. Alternatively, respondent concedes that if
Henry and Esther are determined to be accommodation parties on
(continued...)
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With respect to the FirsTier note, Henry and Esther contend
that payments made by HJA are not includable in their taxable
income because: (1) A Nebraska State court already has held that
Henry was merely an accommodation party on the FirsTier note and,
therefore, the doctrine of collateral estoppel requires that this
Court find he was not a primary obligor with respect to that
debt, and (2) even if the doctrine of collateral estoppel does
not apply, Henry was not the primary obligor on the FirsTier
loan, and, therefore, he was not required to recognize income
when the loan was repaid.
With respect to the Chevrolet debt, Henry and Esther argue
that Henry was not the primary obligor because (1) the Chevrolet
debt consisted of intercompany debts owed to Chevrolet by other
companies in the Misle group; (2) when HJA, the successor parent
corporation in the 1986 reorganization, paid off the Chevrolet
debt, it was paying off its own debt, not Henry’s debt; and (3)
since Henry was not the primary obligor on the Chevrolet debt,
HJA’s repayment of that debt did not relieve Henry of any
personal liability. Henry also argues that he did not receive
20
(...continued)
the FirsTier note and the Chevrolet debt, then HJA is entitled to
a deduction only for the total amount of the covenant not to
compete payments less the payments on the FirsTier note and the
Chevrolet debt (with adjustments in related interest income and
interest expense), and Henry and Esther must report a
corresponding amount as ordinary income on their tax returns.
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any of the intercompany loan money personally; rather, the money
was borrowed to finance ongoing corporate operations.
B. Collateral Estoppel Argument
Henry and Esther base their collateral estoppel argument
solely on language in the State court journal entry, which stated
in part:
4. To settle and resolve certain conflicts
which have arisen in regards to the amount payable
pursuant to the * * * Modified Judgment, the
Parties, in open Court, have indicated their
agreement to the following:
* * * * * * *
(b) The note of First Bank (f/k/a
FirsTier Bank), referenced in
the “side letter agreement,”
dated March 15, 1990, to which
Henry Misle was an
accommodating Party, has been
paid by the Defendants, in
full, * * * [Emphasis added].
HJA responds that collateral estoppel cannot be applied against
it because the issue of whether Henry was an accommodation party
was never litigated in the State litigation, and a final and
binding judgment was not entered on the merits with respect to
that issue.
The doctrine of collateral estoppel applies to Federal
income tax cases. See United States v. International Bldg. Co.,
345 U.S. 502, 505 (1953); Commissioner v. Sunnen, 333 U.S. 591,
598 (1948). “Under collateral estoppel, once an issue is
actually and necessarily determined by a court of competent
- 25 -
jurisdiction, that determination is conclusive in subsequent
suits based on a different cause of action involving a party to
the prior litigation.” Montana v. United States, 440 U.S. 147,
153 (1979).
In cases raising an issue concerning the preclusive effect
of prior State court litigation on subsequent Federal litigation,
the application of preclusion doctrines such as res judicata
(sometimes referred to as claim preclusion) and collateral
estoppel (sometimes referred to as issue preclusion) is required
by the Full Faith and Credit Act, 28 U.S.C. sec. 1738 (1994),
which provides, in pertinent part, that “judicial proceedings of
any court of any such State * * *. * * * shall have the same
full faith and credit in every court within the United States and
its Territories and Possessions as they have by law or usage in
the courts of such State”. See Migra v. Warren City School Dist.
Bd. of Educ., 465 U.S. 75, 81 (1984); see also Allen v. McCurry,
449 U.S. 90, 96 (1980) (“Congress has specifically required all
Federal courts to give preclusive effect to state-court judgments
whenever the courts of the State from which the judgments emerged
would do so”).
In this case, the State litigation occurred in Nebraska. We
must apply Nebraska law in determining whether the State
litigation must be given preclusive effect in this case. See
Migra v. Warren City School Dist. Bd. of Educ., supra at 81.
- 26 -
Under Nebraska law, there are four requirements for the
doctrine of collateral estoppel to apply: (1) The identical
issue must have been decided in a prior action, (2) a final
judgment must have been rendered on the merits, (3) the party
against whom the rule is applied must have been a party or in
privity with a party to the prior action, and (4) there must have
been an opportunity to litigate the issue fully and fairly in the
prior action. See Stewart v. Hechtman, 581 N.W.2d 416, 418-419
(Neb. 1998); Cunningham v. Prime Mover, Inc., 567 N.W.2d 178, 181
(Neb. 1997).
With respect to the third requirement, there is no dispute
that HJA was a party to the State litigation. See Cunningham v.
Prime Mover, Inc., supra at 181 (as to status of parties, only
requirement is that party against whom rule is being applied was
party or in privity with party to prior action). There is
considerable disagreement, however, regarding the remaining
requirements.
In order for collateral estoppel to apply under Nebraska
law, the identical issue must have been litigated in the prior
action. An issue is considered “identical” in the absence of a
significant factual change. See Stewart v. Hechtman, supra at
419. Henry’s liability under the FirsTier note was not an issue
in the State litigation. The only issues raised in that
litigation related to the enforceability, breach, and validity of
- 27 -
the EOA and the covenant not to compete clause therein. Indeed,
in its modified judgment the State court did not even address
whether Henry was an accommodation party as to the FirsTier
note-–the only reference to Henry’s status as an accommodation
party was in the postjudgment journal entry. In this case, the
issue we must decide is whether Henry and Esther are the primary
obligors on the FirsTier note. The issues are not identical;
thus, the first requirement is not met.
The remaining two requirements for collateral estoppel to
apply also are not met in this case. In United States v.
International Bldg. Co., supra at 506, the Supreme Court held
that
A judgment entered with the consent of the parties may
involve a determination of questions of fact and law by
the court. But unless a showing is made that that was
the case, the judgment has no greater dignity, so far
as collateral estoppel is concerned, than any judgment
entered only as a compromise of the parties.
In this case, the State court did not enter a judgment regarding
whether Henry and Esther were primary obligors or accommodation
parties with respect to the FirsTier note. Rather, it simply
made a journal entry that referred to Henry as an “accommodating
Party” in connection with a settlement of “certain conflicts
which have arisen in regards to the amount payable pursuant to
* * * the Modified Judgment”. Henry and Esther made no showing
whatsoever as to the nature of the journal entry or that it
embodied determinations of fact and law by the State court.
- 28 -
Moreover, on the record before us, we cannot conclude that HJA
litigated or had a full and fair opportunity to litigate the
issue of whether Henry and Esther were accommodation parties
rather than primary obligors on the FirsTier note.
We hold that the doctrine of collateral estoppel does not
preclude HJA from litigating the issue of whether Henry was an
accommodation party on the FirsTier note.
C. Accommodation Party Status Under Nebraska Law
Before 1992, Nebraska law defined “accommodation party” as
“one who signs the instrument in any capacity for the purpose of
lending his name to another party to it.” Neb. Rev. Stat. U.C.C.
sec. 3-415(1) (Reissue 1980). In 1991, Neb. Rev. Stat. U.C.C.
sec. 3-415 was revised and renumbered as Neb. Rev. Stat. U.C.C.
sec. 3-419 (Reissue 1992). Neb. Rev. Stat. U.C.C. sec. 3-419(a)
defines instruments signed for accommodation as follows:
If an instrument is issued for value given for the
benefit of a party to the instrument (“accommodated
party”) and another party to the instrument
(“accommodation party”) signs the instrument for the
purpose of incurring liability on the instrument
without being a direct beneficiary of the value given
for the instrument, the instrument is signed by the
accommodation party “for accommodation”. [Emphasis
added.]
The term “instrument” means a “negotiable instrument.” See Neb.
Rev. Stat. U.C.C. sec. 3-104(b) (Reissue 1992).
The intent of the parties determines whether a party is an
accommodation party or the principal obligor of an instrument.
- 29 -
See Ashland State Bank v. Elkhorn Racquetball, Inc., 520 N.W.2d
189, 194 (Neb. 1994); Marvin E. Jewell & Co. v. Thomas, 434
N.W.2d 532, 534 (Neb. 1989). A party claiming accommodation
party status under Nebraska law bears the burden of proving its
right to that status. See Rule 142(a); Marvin E. Jewell & Co. v.
Thomas, supra at 536.
1. FirsTier Note
Neb. Rev. Stat. U.C.C. section 3-419(a) and its predecessor
require that both the accommodated party and the accommodation
party be parties to the instrument. We are aware of no cases
that have held otherwise.
The Court of Appeals for the Eighth Circuit, to which an
appeal in this case would lie, has addressed specifically the
elements necessary to qualify as an accommodation party under
former Neb. Rev. Stat. section 3-415(1). See Pioneer Ins. Co. v.
Gelt, 558 F.2d 1303, 1310-1311 (8th Cir. 1977). In Pioneer Ins.
Co., suit was instituted by Pioneer Insurance Co. (Pioneer)
against Harry Gelt to recover on a promissory note. At the
request of a personal friend, Roger Sack, Gelt agreed to act as
the ostensible buyer of an investment corporation so that Sack
could avoid having to obtain the Securities and Exchange
Commission’s approval of the purchase. Sack assured Gelt that
Gelt would be held harmless in connection with the overall
transaction and that he would not be exposed to any financial
- 30 -
risk. Gelt executed certain promissory notes at closing, which
were renewed later. Sack was not a party to the notes. The
holder of the notes subsequently sued Gelt to recover the unpaid
balance. Gelt contended he was an accommodation maker of the
notes and, for that reason, was not liable to Pioneer on the
renewal note.
The Court of Appeals for the Eighth Circuit found that both
the original note and the renewal note were executed by Gelt, as
maker, and the respective payees. There were no other parties to
the instruments. The court held that Gelt was not an
accommodation party under Nebraska law because he “did not ‘lend
his name’ to any other parties to the instrument”. Id. at 1311.
The court noted that “While there is no doubt that Gelt executed
the instruments as an accommodation to Sack, that did not make
him an ‘accommodation party’ within the meaning of [Neb. Rev.
Stat. U.C.C. sec.] 3-415(1) and (5).” Id.
In this case, Henry and Esther were the only obligors under
the FirsTier note and the first five extensions or modifications
of that note. This fact is consistent with other evidence in the
record that overwhelmingly establishes the parties intended for
Henry and Esther to be the primary obligors on the FirsTier note.
See Ashland State Bank v. Elkhorn Racquetball, Inc., supra at
194; Marvin E. Jewell & Co. v. Thomas, supra at 534.
- 31 -
Accordingly, we hold that Henry and Esther were the primary
obligors on the FirsTier note and that the payments made by HJA
on the FirsTier note were taxable as ordinary income to Henry and
Esther in the years determined by respondent and were deductible
by HJA.
2. Chevrolet Debt
Whether Henry was an accommodation party with respect to the
Chevrolet debt depends, in the first instance, on whether the
dissolution of partnership agreement qualifies as a negotiable
instrument under Nebraska law. See Neb. Rev. Stat. U.C.C. sec.
3-104(b), which defines the term “instrument” used in Neb. Rev.
Stat. U.C.C. sec. 3-419(a) to mean “negotiable instrument.”
Neb. Rev. Stat. U.C.C. section 3-104(a) provides that an
instrument is negotiable if the following requirements are met:
(1) The promise or order must be unconditional; (2) the amount of
money must be “a fixed amount of money, with or without interest
or other charges described in the promise or order”; (3) the
promise or order must be “payable to bearer or to order”; (4) the
promise or order must be payable “on demand or at a definite
time”; and (5) the promise or order must not state “any other
undertaking or instruction by the person promising or ordering
payment to do any act in addition to the payment of money”, with
exceptions that do not apply in this case.
- 32 -
The pertinent provision of the dissolution of partnership
agreement stated:
1. Henry hereby agrees to take in full
satisfaction of his partnership interest in Misle
Brothers Partnership the assets listed under his name
on Exhibit A, * * * and to assume the liabilities
listed on such schedule, which total $686,467. It is
understood that the $638,186 of liability listed as
inter-company loans are payable to Misle Chevrolet
Company in the amount of $592,659 and to Novo Imports,
Inc. in the amount of $45,527. Henry further agrees to
hold harmless Abram and Julius and to indemnify them in
the event they shall ever be required to pay any of the
liabilities he has agreed hereunder to assume.
This provision fails to satisfy the requirements for a negotiable
instrument since it did not create a debt payable to bearer or
order, and the amounts Henry assumed were not payable “on demand
or at a definite time”. The dissolution of partnership agreement
is exactly what it purported to be and nothing more. It was an
agreement to dissolve the Misle Brothers Partnership, wherein
Henry agreed to assume outstanding intercompany liabilities. It
was not an unconditional promise or order to pay a fixed sum of
money. See Ford Motor Credit Co. v. All Ways, Inc., 546 N.W.2d
807, 810 (Neb. 1996). Therefore, the dissolution of partnership
agreement does not meet the requirements of a “negotiable
instrument” under Neb. Rev. Stat. U.C.C. section 3-104.
Since the liability that Henry assumed for the Chevrolet
debt did not arise from a negotiable instrument under Nebraska
law, Henry was not an accommodation party with respect to the
Chevrolet debt. We hold that Henry was the primary obligor on
- 33 -
the Chevrolet debt and that the payments made by HJA on the
Chevrolet debt were taxable as ordinary income to Henry in the
years determined by respondent and were deductible by HJA.
D. Alternative Arguments
Relying upon Landreth v. Commissioner, 50 T.C. 803 (1968),
Henry and Esther argue that whether a person is a primary obligor
or an accommodation party depends on whether the person, because
of the loan, “receives a nontaxable increase in assets” at the
time of the distribution of the loan proceeds. Henry and Esther
also cite Payne v. Commissioner, T.C. Memo. 1998-227, revd. on
other grounds 224 F.3d 415 (5th Cir. 2000), and Whitmer v.
Commissioner, T.C. Memo. 1996-83, in support of their argument
that “the repayment of debt that one-–as a guarantor or other
contingent liability debtor-–did not receive the actual benefit
of is not taxable income to the non-benefitting contingent
liability debtor.” Henry and Esther’s argument based on these
cases is misplaced.
Our decisions in Landreth v. Commissioner, supra, Payne v.
Commissioner, supra, and Whitmer v. Commissioner, supra, are
distinguishable. In Landreth, Payne, and Whitmer, the taxpayers
were guarantors, not primary obligors. Because the taxpayer in
each case was a guarantor, we held that the taxpayer did not
receive discharge of indebtedness income when the liabilities he
had guaranteed were discharged.
- 34 -
Since Henry and Esther were not guarantors of the loans at
issue in this case, their reliance on Landreth, Payne, and
Whitmer does not help them.
II. Whether Henry May Reduce the Gross Amount of the Option
Price Paid to Him or for His Benefit Pursuant to the Option and
Stock Purchase Agreement by $150,000, the Amount Allegedly Owed
and Paid to Bryan
The clear language of the EOA indicates that “In
consideration of the grant of the Option by HM to HJA, HJA shall
pay to HM the sum of * * * ($300,000.00)”. Indeed, there is no
dispute that Henry received $286,411 in 1990 for the option. The
only dispute is whether Henry may exclude from his 1990 taxable
income $150,000 of the $286,411 option payment.
Henry and Esther claim in this case that the remaining
$150,000 of the option payment was owed to Bryan for HJA stock
that Bryan acquired in 1990 from Henry. Respondent disagrees,
claiming that the full amount of the option price must be
reported by Henry as investment income on his 1990 Federal income
tax return. We agree with respondent.
The record overwhelmingly supports respondent’s position
that Henry received the $150,000 as part of the consideration
paid by HJA for the option to purchase Henry’s stock under the
EOA and that the subsequent payment by Henry to Bryan of a
portion of that consideration was a loan repayment to Bryan.
When the EOA giving HJA an exclusive option to purchase all of
Henry’s 10,000 shares of HJA’s stock was executed, Bryan, a party
- 35 -
to the EOA, did not assert any ownership interest in HJA. Bryan
testified that at the time the EOA was executed, both he and
Henry took the position that Bryan did not own any HJA stock. By
their signatures on the EOA, Henry and Bryan specifically
warranted that Henry was the sole owner of 10,000 shares of HJA
stock. There was no statement anywhere in the EOA that Bryan
owned any interest in HJA or that Bryan was entitled to receive
any part of the option payment. To the extent that Bryan had any
interest in the Misle group, those interests were addressed
specifically in the EOA. For example, the EOA contained
provisions with respect to Bryan’s ownership interest in BHM, the
allocation of fringe benefits to Bryan in consideration for his
compliance with the terms of the EOA, and the return of funds in
a company bank account belonging to Bryan. Lastly, Sheryl
Matthes, the controller of HJA since 1990, testified there were
no entries in HJA’s books indicating Bryan ever owned stock in
HJA; the only entries relative to HJA’s stock ownership were the
three original entries indicating that Henry, Abram, and Julius
owned 10,000 shares of HJA stock each. Accordingly, we sustain
respondent’s determination.
III. Whether Henry and Esther are Liable for Accuracy-Related
Penalties for Tax Years 1989 Through 1994 and 1996 Under Section
6662(a)
Respondent determined that Henry and Esther are liable for
accuracy-related penalties under section 6662(a) and (b)(2) (for
- 36 -
substantial understatement) for each of the years 1989 through
1994 and 1996. Alternatively, with respect to the years 1989
through 1994, respondent determined that petitioners are liable
for accuracy-related penalties under section 6662(a) and (b)(1)
(for negligence).
Section 6662(a) and (b)(2) imposes a penalty equal to 20
percent of the portion of an underpayment of income tax
attributable to any substantial understatement of tax. A
substantial understatement occurs when the amount of the
understatement exceeds the greater of 10 percent of the amount of
tax required to be shown on the return or $5,000 ($10,000 for
corporations). See sec. 6662(d)(1). The amount of an
understatement on which the penalty is imposed will be reduced by
the portion of the understatement that is attributable to the tax
treatment of an item (1) that was supported by “substantial
authority” or (2) for which the relevant facts were “adequately
disclosed in the return or in a statement attached to the
return”. See sec. 6662(d)(2)(B).21 Additionally, no penalty
will be imposed with respect to any portion of an underpayment if
it is shown that there was reasonable cause for such portion and
the taxpayer acted in good faith with respect to such portion.
See sec. 6664(c)(1).
21
For 1993 and later years, adequate disclosure must be
coupled with “a reasonable basis for the tax treatment”. See
sec. 6662(d)(2)(B)(ii).
- 37 -
Substantial authority exists when the weight of authority
supporting the treatment of an item is substantial as compared to
the weight of authority for the contrary treatment. See sec.
1.6662-4(d)(3)(i), Income Tax Regs. In determining whether there
is substantial authority, all authorities relevant to the tax
treatment of an item, including those authorities pointing to a
contrary result, are taken into account. See id. For this
purpose, authorities include statutory and regulatory provisions,
legislative history, administrative interpretations by the
Commissioner, and court decisions, but not conclusions reached in
treatises or legal periodicals. See Booth v. Commissioner, 108
T.C. 524, 578 (1997); sec. 1.6662-4(d)(3)(iii), Income Tax Regs.
Adequate disclosure for purposes of section 6662 is made in
one of two ways. A disclosure is adequate either if the
disclosure is made on a properly completed form attached to the
taxpayer’s return, see sec. 1.6662-4(f)(1), Income Tax Regs., or
if the disclosure is permitted by annual revenue procedure to be
made on the tax return itself and is made in accordance with the
applicable forms and instructions, see sec. 1.6662-4(f)(2),
Income Tax Regs. If the annual revenue procedure does not permit
the disclosure of an item on the face of the return, disclosure
is adequate only if the disclosure is made on a properly
completed Form 8275, Disclosure Statement, or Form 8275-R,
Regulation Disclosure Statement, attached to the taxpayer’s
- 38 -
return for the year the disclosure applies. See id. Disclosure
of a recurring item must be made for each year in which the item
is taken into account. See id.
In the notices of deficiency for 1989 through 1994 and 1996,
respondent proposed several adjustments with respect to Henry and
Esther’s tax returns. Most of those adjustments were settled
before trial or are computational. As to those items settled in
favor of respondent, Henry and Esther made no showing at trial,
and did not argue on brief, that their tax treatment of those
items was supported by substantial authority or by adequate
disclosure as defined by section 1.6662-4(f)(1) and (2), Income
Tax Regs. Henry and Esther’s only argument in support of their
position that they should not be liable for the penalties was
contained in their reply brief and was limited to the covenant
not to compete payments that were applied to the FirsTier note
and the Chevrolet debt. Consequently, we hold that Henry and
Esther have failed to prove that the section 6662 penalty should
not apply with respect to the settled and computational issues.
See Rule 149(b).
With respect to the covenant not to compete payments,
although Henry and Esther failed to address the section 6662
penalties in their opening brief, they did argue in their reply
brief that the accuracy-related penalty should not be imposed
with respect to the HJA payments applied to the FirsTier note and
- 39 -
the Chevrolet debt because they had substantial authority for
their position and that they were entitled to relief under
section 6664. Respondent anticipated these arguments in his
opening and reply briefs. Although we could treat Henry and
Esther’s failure to address the accuracy-related penalties in
their opening brief as a concession or abandonment of the issue,
we decline to do so under these circumstances. See Rule
151(e)(5); Lencke v. Commissioner, T.C. Memo. 1997-284. Instead,
we shall consider the arguments made by Henry and Esther with
respect to the disputed payments.
Henry and Esther argue that their reporting position
regarding the FirsTier and Chevrolet payments was made on a bona
fide factual belief that they were not the primary obligors of
the FirsTier note or the Chevrolet debt and, therefore, were not
obligated to report as their income the payments made by HJA on
the two liabilities. Henry and Esther also argue that respondent
has not directed the Court’s attention to any rule, regulation,
or case law that required Henry and Esther to declare the
payments as income. They assert that there is significant case
law in support of their reporting position; therefore, they had a
reasonable basis for their view, and they should not be liable
for the accuracy-related penalties.
Henry and Esther did not have substantial authority for
their positions. See sec. 6662(d)(2)(B)(ii). Although they rely
- 40 -
on Landreth v. Commissioner, 50 T.C. 803 (1968), Payne v.
Commissioner, T.C. Memo. 1998-227, and Whitmer v. Commissioner,
T.C. Memo. 1996-83, as substantial authority for their reporting
position, their position is not supported by any well-reasoned
construction of the relevant authorities. The cases cited on
brief are readily distinguishable and, to the extent they are
pertinent, actually undermine Henry and Esther’s argument. See
Estate of Reinke v. Commissioner, 46 F.3d 760, 765 (8th Cir.
1995), affg. T.C. Memo. 1993-197; Antonides v. Commissioner, 91
T.C. 686, 702-703 (1988), affd. 893 F.2d 656 (4th Cir. 1990). We
have rejected the factual basis of Henry and Esther’s claim that
they were accommodation parties, and, thus, the authority they
cite holding that a guarantor does not realize income when the
underlying debt is paid is not substantial authority for purposes
of section 6662.
The only other argument made by Henry and Esther in support
of their position that they should be relieved of any penalty
under section 6662 is that they had reasonable cause for their
reporting position and that they acted in good faith. See sec.
6664(c).22 The determination of whether a taxpayer acted with
22
Although Henry and Esther made disclosures that they had
omitted the payments from their 1992 and 1996 returns, they have
not asserted or argued that the disclosures were adequate
disclosures. See Cramer v. Commissioner, 101 T.C. 225, 255
(1993), affd. 64 F.3d 1406 (9th Cir. 1995); sec. 1.6661-4(b)(3),
Income Tax Regs. Even after respondent, anticipating an adequate
(continued...)
- 41 -
reasonable cause and in good faith is made case by case, taking
into account all pertinent facts and circumstances. See Compaq
Computer Corp. & Subs. v. Commissioner, 113 T.C. 214, 226 (1999);
sec. 1.6664-4(b)(1), Income Tax Regs. In this case, there is
ample evidence that Henry and Esther knew or had reason to know
that the payments made by HJA on the FirsTier note and the
Chevrolet debt generated taxable income to them as determined in
this opinion, including (1) the Baird, Kurtz letter explaining
the consequences of the EOA, (2) Forms 1099 and letters of
explanation issued by HJA showing the amount of covenant not to
compete payments made to Henry each year, (3) the fact that Henry
and Esther reported as income some of the covenant not to compete
payments made in 1990, (4) the establishment and operation of the
sweep account, which coordinated the covenant payments with
payments on the FirsTier note and the Chevrolet debt, and (5)
Henry’s conflicting positions with regard to his liability for
the FirsTier note and the Chevrolet debt taken in the State
22
(...continued)
disclosure claim, argued in his opening brief that Henry and
Esther’s disclosures on their 1992 and 1996 returns were not
adequate, Henry and Esther still did not argue that they made an
adequate disclosure for those years. Since Henry and Esther did
not raise adequate disclosure as a defense to the substantial
understatement prong of the accuracy-related penalty at any point
during the trial or briefing of this case, the issue of whether
the 1992 and 1996 disclosures were adequate is not before us.
- 42 -
litigation and in this case.23 This evidence supports a
conclusion that Henry and Esther’s position regarding the
disputed payments was not asserted in good faith, as required by
section 6664(c).
We hold that Henry and Esther are liable for the accuracy-
related penalty in each of the years 1989 through 1994 and 1996.
In light of our holding, we do not address respondent’s
alternative position regarding section 6662.
IV. Whether Henry Is Liable for an Addition to Tax Under Section
6651(a) for Failure To File a Return for Tax Year 1995
Section 6651(a) imposes an addition to tax for failure to
file a return, unless it is shown that such failure is due to
reasonable cause and not due to willful neglect. See sec.
6651(a)(1); United States v. Boyle, 469 U.S. 241, 245 (1985);
United States v. Nordbrock, 38 F.3d 440, 444 (9th Cir. 1994);
Harris v. Commissioner, T.C. Memo. 1998-332. A failure to file a
timely Federal income tax return is due to reasonable cause if
the taxpayer exercised ordinary business care and prudence and,
nevertheless, was unable to file the return within the prescribed
time. See sec. 301.6651-1(c)(1), Proced. & Admin. Regs. Willful
neglect means a conscious, intentional failure to file or
reckless indifference. See United States v. Boyle, supra at 245.
23
In the State trial, Henry admitted that he had a personal
debt to both FirsTier and Chevrolet and that part of the covenant
not to compete payments deposited into the sweep account was
going to FirsTier and Chevrolet to pay his personal debts.
- 43 -
Henry bears the burden of proving that respondent erred in
determining the addition to tax applies. See Rule 142(a).
Henry concedes that, to date, he has failed to file any 1995
individual income tax return. Henry argues, however, that during
1995 Henry and Esther sold a significant number of shares in
various companies that had been purchased between 1986 and 1995.
At the time of the sale, Henry and Esther did not know their
original basis in the stock and, therefore, did not have
necessary information upon which to file an accurate return to
reflect their capital gains tax liability. Henry contends that,
with the help of their tax preparer, Mr. Goeglein, he made a
diligent attempt to locate the additional necessary information
by contacting various financial institutions and research firms,
but the information regarding the stock was difficult to obtain.
According to Henry, Mr. Goeglein “had ongoing dialogue with
Commissioner’s Revenue Agent Glenn Hofer”, who “insisted that
Henry Misle and Mr. Goeglein obtain an accurate basis for the
stock when filing their return.” Henry essentially contends that
the section 6651(a) addition to tax should not be assessed
because he was acting in good faith to comply with the request of
respondent’s agent and because finding accurate information
necessary to complete a timely return was too difficult.
As a general matter, the unavailability of information is
not reasonable cause for failing to file a timely return. See
- 44 -
Crocker v. Commissioner, 92 T.C. 899, 913 (1989); Electric &
Neon, Inc. v. Commissioner, 56 T.C. 1324, 1342-1344 (1971), affd.
without published opinion 496 F.2d 876 (5th Cir. 1974); Cook v.
Commissioner, T.C. Memo. 1999-50; Barber v. Commissioner, T.C.
Memo. 1997-206. Unless a taxpayer applies for and obtains a
timely extension of time to file, a taxpayer is expected to file
a timely return based on the best information available and then
file an amended return if necessary. See Estate of Vriniotis v.
Commissioner, 79 T.C. 298, 311 (1982); Cook v. Commissioner,
supra; Barber v. Commissioner, supra. Henry has not proved that
his failure to file a 1995 Federal income tax return was due to
reasonable cause and not to willful neglect. See Rule 142(a);
Welch v. Helvering, 290 U.S. 111, 115 (1933). We hold that Henry
is liable for the addition to tax under section 6651(a)(1) for
1995.
V. Whether Henry Is Liable for an Addition to Tax Under Section
6654 for Failure To Make Estimated Tax Payments for Tax Year 1995
Section 6654(a) provides for an addition to tax in the case
of any underpayment of estimated tax by an individual. The
addition to tax under section 6654(a) is mandatory in the absence
of statutory exceptions. See sec. 6654(a), (e); Recklitis v.
Commissioner, 91 T.C. 874, 913 (1988); Grosshandler v.
Commissioner, 75 T.C. 1, 20-21 (1980).
Respondent determined that Henry is liable for the addition
to tax under section 6654 for 1995. Henry and Esther’s only
- 45 -
argument for relief from liability under section 6654 is that
they had reasonable cause for their failure to make estimated tax
payments under section 6654(a). With limited exceptions,24 “This
section has no provision relating to reasonable cause and lack of
willful neglect. It is mandatory and extenuating circumstances
are irrelevant.” Estate of Ruben v. Commissioner, 33 T.C. 1071,
1072 (1960); see also Grosshandler v. Commissioner, supra at 21.
In addition, Henry has offered no evidence that any of the
statutory exceptions under section 6654(e) apply. Accordingly,
respondent’s determination is sustained.
VI. Conclusion
We have carefully considered the remaining arguments of
petitioners for results contrary to those expressed herein and,
to the extent not discussed above, find those arguments to be
irrelevant, moot, or without merit.
To reflect the foregoing and concessions by the parties,
Decisions will be entered
under Rule 155.
24
Sec. 6654(e)(3)(B) provides for an exception for newly
retired or disabled individuals where the taxpayer (1) either is
retired after having attained the age of 62 or became disabled in
the taxable year or the preceding taxable year in which the
estimated payments were required to be made, and (2) can
demonstrate that any underpayment was due to reasonable cause and
not to willful neglect. Sec. 6654(e)(3)(B) does not apply in
this case.