DocketNumber： Docket Nos. 3704-12, 3705-12.
Filed Date： 3/24/2015
Status： Non-Precedential
Modified Date： 11/20/2020
Decisions will be entered under
PARIS,
Respondent also sent Jerry J. Sun and Sun Nam Sun a notice of deficiency determining deficiencies of $3,389,720 and $570,218 and fraud penalties under
After concessions the issues remaining for decision are: (1) whether the Suns properly deducted an investment interest expense for interest paid on a loan secured by their residence for 2008 and 2009; (2) whether Minchem received *58 income from the transfers by foreign companies for 2008 or 2009; (3) whether the Suns received income from the transfers by foreign companies for 2008 or 2009; (4) whether Minchem is liable for penalties under Some of the facts have been stipulated and are so found. The stipulation of facts and the attached exhibits are incorporated herein by this reference. Petitioners Jerry J. Sun and Sun Nam Sun are husband and wife who have been naturalized citizens since 1996 and resided in Texas at the time they filed their petition.The Suns and Minchem Mr. Sun came to the United States in 1986 for a position with an international mineral trading company, and he is still in the same line of business. *59 He earned a college degree in English language and international trade from a Chinese university in 1984 and first moved to the United States as a sales representative for a Chinese-owned mineral trading company. In 1993 Mr. Sun organized Minchem under the State laws of Texas and continues to be the sole shareholder. Minchem's primary business purpose is to import and distribute industrial minerals. Minchem purchases minerals from suppliers in China and imports the minerals into the United States. Minchem had2015 Tax Ct. Memo LEXIS 56">*59 seven employees during 2008 and 2009. Mr. Sun has served as Minchem's CEO from the time of its organization until the present and received a salary of $450,000 in both 2008 and 2009. As Minchem's CEO in 2008 and 2009, Mr. Sun oversaw daily operations and was responsible for sales and employee hiring. Mr. Sun was the sole individual authorized to make purchases in excess of $1,000 on Minchem's behalf. Mr. Sun had assistants and advisers to help with his CEO duties. The additional help allowed him to spend only around four to five hours a day on his CEO duties for Minchem. Mr. Sun also spent a significant amount of time on other investment opportunities. In 2008 and 2009 Mr. Sun owned 99% of Sun Investment, LLC*60 (Sun Investment).2015 Tax Ct. Memo LEXIS 56">*60 stock investments.*61 respectively. The Suns allocated the interest expense between mortgage interest expense and investment interest expense on their 2008 and 2009 Schedules A, Itemized Deductions. For 2008 the Suns deducted $7,046 of the interest paid on the loan as home mortgage interest and carried the2015 Tax Ct. Memo LEXIS 56">*61 remaining $166,297.49 forward as investment interest, which they deducted for 2009. For 2009 the Suns deducted $60,000 of the interest paid on the loan as home mortgage interest and used the remaining $97,835.86 as an investment interest expense deduction. Mr. Sun met Bill Cheung through a mutual business friend in 1992 or 1993. Mr. Cheung is a resident of Hong Kong and is a Chinese citizen. In 2008 and 2009 Mr. Cheung owned some portion of several shipping companies, some of which Minchem used to import minerals from China.2015 Tax Ct. Memo LEXIS 56">*62 Specifically, Mr. Cheung claimed ownership of companies called Kingdom Shipping Company Limited, Able Glory Shipping Limited, Power Vast Limited, and Magic Way Company Limited. These companies were organized in foreign *62 jurisdictions, but they all operated out of Hong Kong.2015 Tax Ct. Memo LEXIS 56">*63 their business dealings Mr. Sun and Mr. Cheung had become friends. In 2008 and 2009 Mr. Sun and Mr. Cheung would often communicate by telephone and sometimes through email. When Mr. Sun traveled to China, he would see Mr. Cheung socially and Mr. Cheung would give him rides to and from the airport, and they would discuss his American investment opportunities. *63 Mr. Cheung was impressed by Mr. Sun's diverse investments, and in 2006 the two gentlemen verbally agreed on an investment strategy for Mr. Cheung after discussing potential investment opportunities in the United States. The only part of the arrangement that both Mr. Cheung and Mr. Sun consistently agreed on was the general structure of the investment. Mr. Cheung would transfer sums of money through his shipping companies' bank accounts to Mr. Sun, who would then invest the money in the United States. Mr. Cheung would decide how much money he wished to send, and Mr. Sun had discretion on which investments to pursue with Mr. Cheung's money. The remaining terms of the verbal agreement were not memorialized and are unclear. Specifically, Mr. Sun and Mr. Cheung inconsistently described the investment term, the expected return, and enforcement2015 Tax Ct. Memo LEXIS 56">*64 provisions. Mr. Sun believed the term was a minimum of 5 years and did not give a maximum period, whereas Mr. Cheung believed the term was 7 to 10 years. The expected return is also unclear; Mr. Sun believed the return on investment would be a 50-50 split of the net profit with a minimum 10% gain annually, but the return might not be paid annually. Mr. Cheung believed the return would be 10% to 15%, but was *64 uncertain whether that return was annual or total.Transfers to Minchem and Minchem's Officer Loan Account Around 2006 Minchem created an officer loan account solely for the benefit of Mr. Sun. The officer loan account would be debited and the balance would be increased when funds were drawn by, or paid for the benefit of, Mr. Sun. Conversely, the account2015 Tax Ct. Memo LEXIS 56">*65 would be credited and the balance would decrease when funds were paid to Minchem. Minchem did not sign any contracts with Mr. Sun regarding the officer loan account, and he was not required to pay interest on any loans from Minchem. Similarly, it does not appear that Minchem was required to pay interest on any loans from Mr. Sun. Between March 26 and December 18, 2008, a Hong Kong bank account attributed to a company called Kingdom Shipping transferred $11,255,888 in nine different transactions to Minchem.2015 Tax Ct. Memo LEXIS 56">*66 The smallest transfer was $550,772 and the *65 largest was $1,750,572. The only transfer instruction from Mr. Cheung was a letter accompanying the $550,772 transfer that indicates that $300,000 is "additional capital" but the whole $550,772 is a "gift from Mr. Cheung to Mr. Sun". Kingdom Shipping transferred all the money from an account in Hong Kong to Minchem's JPMorgan Chase Bank account in the United States. Between September 30 and December 15, 2009, Hong Kong bank accounts attributed to companies called Able Glory and Power Vast transferred a total of $3,515,130 in four different transactions to Minchem. The smallest transfer was $628,125 and the largest was $1,028,125. The transferring company transferred the money from its respective account in Hong Kong to Minchem's JPMorgan Chase Bank account in the United States. For accounting purposes Minchem reported most of the money transferred from Mr. Cheung's companies as credits in Mr. Sun's officer loan account. Specifically, in 2008 Minchem reported $10,430,828.51 of the transferred *66 $11,255,8882015 Tax Ct. Memo LEXIS 56">*67 it was not tied to any service. Minchem could, however, use the money in the officer loan account for its own business purposes. Minchem did in fact use some of the transfers to inflate its cashflow when seeking a line of credit. Minchem reported the funds transferred from Mr. Cheung's companies as an asset that was offset with an accompanying liability. Minchem's in-house accounting personnel believed that the higher assets, even if offset with an equal liability, looked better to a bank and *67 would help establish a line of credit. It took advantage of this principle2015 Tax Ct. Memo LEXIS 56">*68 by showing the transferred money was an asset and a liability on the balance sheets provided to a lender when applying for a line of credit. Mr. Sun would occasionally direct money from other sources into the officer loan account, but the bulk of the credits were from Mr. Cheung's various foreign companies. In 2008 Minchem's officer loan account reflected $249,448.48 of credit that was not from Kingdom Shipping or repayment of an amount removed from the officer loan account.2015 Tax Ct. Memo LEXIS 56">*69 In 2009 Minchem's loan account reflected $1,137,949.10 of credit that was not from one of Mr. Cheung's foreign companies or repayment of an amount removed from the officer loan account. In other words, 97.6% of the independent funds credited to Minchem's officer loan account in 2008 and 71% of the independent funds credited in 2009 were from credits from Mr. Cheung's foreign companies. By at least January 2008 Mr. Sun began frequently using the officer loan account for personal expenses. Mr. Sun would either pay his personal expenses *68 directly from the officer loan account or he would remove money and use it at his discretion. For example, in 2008 Minchem paid $135,874.43 for home automation, $158,517.80 for a new Mercedes Benz, and $49,598.81 for personal real estate tax. In total, Minchem's officer loan account was debited $4,116,414.43 in 2008 and $1,811,127.65 in 2009 for expenses that Mr. Sun identified as personal during his trial testimony.2015 Tax Ct. Memo LEXIS 56">*70 transferred to casinos and $1,300,000 was returned.*69 $5,800,100 from the officer loan account to casinos and received back $3,694,550; i.e., over the two years in issue Mr. Sun lost $2,105,550 from gambling from the officer loan account.2015 Tax Ct. Memo LEXIS 56">*71 Mr. Sun told Mr. Cheung about the gambling losses but still believed that he would be able to earn the promised return on investment in spite of over $2 million in gambling losses. Although, Mr. Cheung was not sure whether the lost money was money that he sent to Mr. Sun or Mr. Sun's personal money. Mr. Sun did use some of the funds in the officer loan account for investment. In 2008 Mr. Sun directed transfers of $304,411.22 to Sun Investment and $2,900,000 to his personal E*Trade account. In 2009 Mr. Sun directed transfers of $201,195.57 to Sun Investment, $363,962 to Tiger Partners LLC, *70 $352,085 to Subhouse Capital LLC, and $65,000 to Maddox Interests.Additional Wire Transfers From Foreign Companies In 2008 Mr.2015 Tax Ct. Memo LEXIS 56">*72 Cheung's foreign companies transferred a total of $1,599,977 directly to Mr. Sun's personal E*Trade account in two transactions: the first on January 9, when Magic Way Company transferred $1,199,990, and the second on October 22, when Kingdom Shipping transferred $399,987. Mr. Sun did not segregate the transfers in his personal E*Trade account. In 2008 Mr. Cheung's foreign companies also transferred a total of $3,257,901 directly to Sun Investment. Sun Investment received $558,567 on May 16 and $1,198,567 on October 20 from Magic Way Company. Further, on October 8, Sun Investment received $1,500,767 from Kingdom Shipping. In 2009 Sun Investment received $299,967 from a single transfer from Magic Way Company. Neither Minchem, the Suns, nor the other related businesses reported money received from Mr. Cheung as income for the 2008 or 2009 tax year. Respondent sent Minchem a notice of deficiency on January 4, 2012, for the 2008 and 2009 tax years, determining deficiencies and penalties under Respondent also sent the Suns a notice of deficiency on January 4, 2012, for the 2008 and 2009 tax years, determining deficiencies and penalties under *72 Minchem and the Suns timely filed separate petitions with the Court to challenge the notices of deficiency. The two cases were consolidated for purposes of trial, briefing, and opinion. The issues remaining to be decided are: (1) whether the Suns properly deducted an investment interest expense for interest paid on a loan secured by their residence for 2008 and 2009; (2) whether Minchem received income as gross receipts from the transfers from Mr. Cheung's foreign companies for 2008 or 2009; (3) whether the Suns received income as dividends2015 Tax Ct. Memo LEXIS 56">*74 or ordinary income from the transfers from Mr. Cheung's foreign companies for 2008 or 2009; (4) whether Minchem is liable for penalties under The Suns refinanced an outstanding loan for $2,501,935 through home equity indebtedness. For 2008 and 2009 the Suns allocated portions of the interest paid to mortgage interest and the remainder to investment interest expenses. A Form 1098, Mortgage Interest Statement, issued to the Suns for tax year 2008 showed they paid interest of $173,343.49. For 2008 the Suns deducted $7,046 *73 paid toward the loan as home mortgage interest and carried $166,297.49 of paid interest forward as investment interest, which they claimed for 2009. A Form 1098 issued to the Suns for 2009 showed they paid interest of $157,835.86. For 2009 the Suns claimed a deduction of $60,000 for the interest paid as home mortgage interest and claimed the remaining interest as an investment interest expense deduction. The notice of deficiency denied the Suns' investment interest deduction in its entirety and adjusted their home mortgage interest deduction.2015 Tax Ct. Memo LEXIS 56">*75 The Suns assert that an example in a temporary regulation is directly applicable and shows the deduction is correct as claimed. Respondent counters that the temporary regulation does not apply because the Suns have not met its requirements. Deductions are a matter of legislative grace, and taxpayers bear the burden of establishing entitlement to any claimed deduction. The two methods to determine the amount of qualified residence interest appear to treat excess paid interest differently. The simplified method treats remaining paid interest as nondeductible personal interest even if the remaining interest would be allocated under The Suns point out that the example in The Suns contend that the interest paid is deductible as investment interest because the loan proceeds were deposited in Minchem's bank account. The Suns posit that Minchem is property held for investment because it is a type of property that generally2015 Tax Ct. Memo LEXIS 56">*78 produces dividend income. It is not necessary for the Court to decide whether Minchem is property held for investment because the Suns did not purchase or contribute the loan proceeds to Minchem. Instead, Minchem's general ledger notes that the company treated the mortgage proceeds as a personal loan from Mr. Sun to Minchem. In other words, Mr. Sun borrowed the money so that he could lend it to Minchem and Minchem would repay him. Mr. Sun has not shown that the funds disbursed for his mortgage to finance his ancillary loan to *77 Minchem were for investment. Further, the Suns fail to recognize the differences between the simplified method and the exact method--or explain the application of either. The Suns have not demonstrated that the deduction is allowable pursuant to any statutory provision because they have not shown the funds were used for investing. Accordingly, respondent's determinations concerning the Suns' home mortgage and investment interest expense deduction for the interest paid on the home equity loan are sustained. In general, taxpayers bear the burden of disproving the Commissioner's determinations. Before deciding on the tax consequences of the transfers between Mr. Cheung's foreign companies and Minchem, the Court needs to address the substance of the arrangement between Mr. Cheung and Mr. Sun. Respondent determined that the money from Mr. Cheung's foreign companies is either gross receipts2015 Tax Ct. Memo LEXIS 56">*80 to Minchem, which then made a distribution to Mr. Sun or, alternatively, represents direct income to Mr. Sun. Petitioners' position is less clear because while they often assert that Mr. Sun was entrusted to invest Mr. Cheung's money, they also appear to claim that the money was a loan to Mr. Sun. Minchem did not retain sufficient dominion and control over the funds transferred by Mr. Cheung's foreign companies to make it the recipient of the income for tax purposes. Minchem consistently reported money received from Mr. Cheung's foreign companies as either a loan from Mr. Sun to Minchem or as repayment for2015 Tax Ct. Memo LEXIS 56">*81 a loan from Minchem to Mr. Sun. Minchem's officer loan account records show that the funds "repaid" money spent on Mr. Sun's behalf. Similarly, when the funds from Mr. Cheung's foreign companies exceeded the debts to the officer loan account, the funds were treated as cash that Mr. Sun had loaned to Minchem, and that he could, and did, use the money for personal reasons. Further, when Minchem was applying for a line of credit, the money was shown as both an asset and a liability. In other words, Minchem recognized that it held the money *80 but had an obligation to repay it and could not exercise dominion and control over it. Instead of retaining dominion and control over the funds, Minchem acted as a conduit for the money. A taxpayer who merely acts as a conduit and disposes of transferred funds to third parties does not receive taxable income. Accordingly, Minchem did not receive taxable income from Mr. Cheung's foreign companies because it did not retain sufficient dominion and control over the transferred funds. Respondent contends that the money transferred from Mr. Cheung's foreign companies is either qualified dividends from Minchem or income directly from the foreign companies. As discussed above, Minchem was merely a conduit for the funds, and thus they are not qualified dividends to Mr. Sun. Petitioners' position is that the funds transferred to Minchem are not income to Mr. Sun because he had an obligation to repay them. In substance, petitioners contend the funds are a loan that Mr. Sun was obligated to repay. Generally, the proceeds of a loan do not constitute income to a borrower because the benefit is offset by an obligation to repay. Whether a bona fide debtor-creditor relationship exists is a question of fact, and essential elements are the intent of the recipient of the funds to make monetary repayment and the intent of the person advancing the funds to enforce repayment. The funds that the Suns received from Mr. Cheung's foreign companies lacked many of the characteristics usually present when the Court finds that money advanced constitutes a bona fide loan. For instance, at the time the Suns received the funds, a note evidencing the indebtedness was not executed and a security interest was not given. Further, Mr. Sun and Mr. Cheung did not agree on the period of the2015 Tax Ct. Memo LEXIS 56">*84 loan or the rate of interest. Mr. Sun believed the term was a minimum of 5 years and did not give a maximum period, whereas Mr. Cheung believed the term was 7 to 10 years. Mr. Sun and Mr. Cheung also disagreed on the rate of return, or interest: Mr. Sun believed the return on investment would be a 50-50 split of the net profit with a minimum 10% gain annually, but the return *83 might not be paid annually. Mr. Cheung believed the return would be between 10% and 15% but was uncertain whether that return was annual or total. In consideration of these factors, the transferred funds do not constitute a bona fide loan between Mr. Sun and Mr. Cheung. Nor does any of the transfers--including the transfer accompanied by a letter--appear to be a gift, because Mr. Cheung lacked donative intent. A gift requires donative intent, actual delivery, and relinquishment of dominion and control. *84 Further, Mr. Sun did not report the funds transferred by Mr. Cheung's foreign companies as gifts or otherwise show that he believed he was receiving gifts. Generally, Instead it appears that Mr. Cheung's foreign companies entrusted the money to Mr. Sun for the specific purpose of having him invest the funds. State law determines the nature of property rights while Federal law determines the appropriate tax consequences of those rights. A transferee taxpayer does not receive income when the transferor and the transferee agree that money received is held in trust for the benefit of others. However, funds held in trust by a trustee generally become includible in his or her gross income once he or she misappropriates the money. Whether funds have been misappropriated is a question of fact, but facts beyond "dominion and control" must be considered. As discussed above, Mr. Sun held money transferred by Mr. Cheung's foreign companies in trust for Mr. Cheung, and he misappropriated the funds because he exercised more than mere dominion and control over the money when he used it for personal purposes. In total, Mr. Sun identified $4,116,414.33 in the 2008 tax year and $1,811,127.65 in the 2009 tax year of personal expenses paid out of the funds transferred from Mr. Cheung's foreign companies. Mr. Sun undisputedly treated as his own money held for Mr. Cheung's benefit and specifically earmarked for investment purposes. For example, Mr. Sun used some of the funds to purchase a personal automobile and a home automation system. Perhaps the most obvious example of2015 Tax Ct. Memo LEXIS 56">*89 Mr. Sun's misappropriation of the funds is his gambling activities. Mr. Sun transferred around $4,800,000 to casinos *88 in 2008 and lost around $2,405,450 of that money through his gambling activities that year.See id. Accordingly, the funds from Mr. Cheung's foreign companies that Mr. Sun admittedly spent for personal purposes are gross income for the years in which he misappropriated the funds. Mr. Sun also misappropriated money that remained in the officer loan account that was used to inflate Minchem's cashflow when it was applying for a line of credit because the money benefited Mr. Sun. Mr. Sun chose to place the money Mr. Cheung's foreign companies transferred into Minchem's officer loan account. Mr. Sun had a choice2015 Tax Ct. Memo LEXIS 56">*90 of how to invest the money and he decided to leave several million of the foreign company funds in the officer loan account. Both Mr. Sun and Minchem considered the money as owned by Mr. Sun. In other words, Mr. Sun chose to let Minchem use the money as its own, in effect lending the money to Minchem. Minchem reported the money and offsetting liability when *89 applying for a loan account to show that the company could pay its large outstanding liabilities.2015 Tax Ct. Memo LEXIS 56">*91 loan account. This deviation from the agreed-upon investment strategy amounts to a misappropriation of funds. Thus, loaning the money to his company goes beyond merely taking "dominion and control" and shows that Mr. Sun misappropriated the entrusted funds by placing the money in the officer loan account and not using it for its intended purpose. Mr. Sun contends that he did invest some of the money Mr. Cheung's foreign companies transferred to Minchem; but the evidence shows that only a fraction of it was used for what might be called investment purposes, and all of it *90 was commingled with Mr. Sun's personal money. Mr. Sun contends that in 2008 he used $3,204,411.22 out of the $10,430,828.51 transferred into Minchem's officer loan account for investment purposes, and in 2009 he used $982,242.57 out of the $2,795,103 transferred. Specifically, in 2008 Mr. Sun's personal E*Trade account received $2,900,000, and Sun Investment received $304,411.22 from Minchem's officer loan account. In 2009 Sun Investment received $201,195.57, Tiger Partnerships LLC received $363,962, Maddox Interests received $65,000, and Subhouse Capital LLC received $352,085 from Minchem's officer loan account.2015 Tax Ct. Memo LEXIS 56">*92 All of the money transferred was commingled with Mr. Sun's other personal assets. The E*Trade account was his personally, and it held his money for personal investments. The money transferred from Minchem's officer loan account was not separated from Mr. Sun's money within the E*Trade account, and it is not clear whose money Mr. Sun was investing in any particular transaction. Similarly, Mr. Sun was a part owner of all the "investments". In other words, he was using the money from Mr. Cheung's foreign companies to help support his personal investments. While commingling funds alone is not enough to find that money was misappropriated, commingling funds combined with failing to regard funds as *91 subject to restriction on their use may show misappropriation. Mr. Sun misappropriated the funds for personal use, abandoned the intended purpose for which the money was entrusted, and he did not invest the money in accordance with the agreed-upon strategy. Accordingly, all the money transferred to Minchem's officer loan account from Mr. Cheung's foreign companies in 2008 *92 and 2009 is income to Mr. Sun because he treated the funds as his own, rather than as restricted funds held in a fiduciary capacity.Other Transfers Besides transferring money to Minchem, Mr. Cheung's foreign companies transferred2015 Tax Ct. Memo LEXIS 56">*94 funds directly to Mr. Sun's E*Trade account and to Sun Investment. Mr. Sun's E*Trade account received a total of $1,599,977 as a result of two transfers from Mr. Cheung's foreign companies in 2008. Sun Investment received a total of $3,257,901 as a result of three transfers from Mr. Cheung's foreign companies in 2008. Sun Investment also received $299,967 from Mr. Cheung's foreign companies in 2009. Similar to the money transferred into Mr. Sun's E*Trade account from Minchem's officer loan account, the money transferred directly to Mr. Sun's E*Trade account from Mr. Cheung's foreign companies was commingled and not specifically earmarked as belonging to Mr. Cheung. Instead Mr. Sun treated all the funds in his E*Trade account as his personally. Further, Mr. Sun treated all the gains, losses, and dividends from his E*Trade account as personal. For *93 example, Mr. Sun's E*Trade account records show that in 2008 the account was paid $97,600 in taxable dividends. Mr. Sun reported $97,600 in ordinary dividends on his 2008 personal tax return as received by his E*Trade account. The Court finds that he was treating all the money transferred to his E*Trade account as his own. He therefore did2015 Tax Ct. Memo LEXIS 56">*95 not treat the money as funds subject to any restrictions but showed he was investing the money for himself rather than Mr. Cheung. The amounts transferred to Sun Investment are also income to Mr. Sun because he did not honor the intended investment strategy or treat the money as subject to any use restrictions. Mr. Sun treated all the money transferred to Sun Investment as his personal money. Sun Investment's specific treatment of the transfers indicate that the money was Mr. Sun's personal money. First, Sun Investment did not give Mr. Cheung a membership interest. Second, Sun Investment did not increase its liabilities as a result of the transfers. Third, Sun Investment increased Mr. Sun's capital account for incoming transferred money. *94 Sun Investment is organized as a limited liability company (LLC) that is taxed as a partnership. In general, owners of LLCs are called members and each member is allocated his or her portion of the LLC's2015 Tax Ct. Memo LEXIS 56">*96 income, gain, loss, deductions, or credits in accordance with the partnership agreement or his or her membership share. Mr. Sun directed Mr. Cheung's foreign companies to send money to Sun Investment, but Sun Investment did not recognize any new members in 2008 or 2009. Mr. Cheung was not allocated any portion of Sun Investment's income, gain, loss, deductions, or credits. Further, Mr. Cheung did not maintain a capital account with Sun Investment, and Sun Investment did not recognize any new capital accounts for 2008 or 2009. Instead, Sun Investment stayed a two-member LLC and the distributive share of the income, gain, loss, deductions, or credits remained the same for the two members during 2008 and 2009.*95 transferred to Sun Investment did not represent a direct investment by Mr. Cheung because he did not take a membership interest in the LLC, nor was2015 Tax Ct. Memo LEXIS 56">*97 the foreign person-foreign corporation investment reflected in Sun Investment's tax returns. Similarly, the money transferred to Sun Investment did not represent a loan from Mr. Cheung's foreign companies to Sun Investment because the foreign companies and Sun Investment did not create a debtor/creditor relationship and Sun Investment did not recognize the money as a loan from Mr. Cheung's foreign companies. Mr. Sun represented that the transfers from Mr. Cheung's foreign companies to Sun Investment were personal loans from Mr. Cheung, although Sun Investment did not reflect that position on its tax return The facts show that the transfers were not loans. Mr. Sun and Mr. Cheung did not agree on terms specific enough to establish the creation of a debtor/creditor relationship for the overall structure, nor did they establish a debtor/creditor relationship between Mr. Cheung and Sun Investment. Thus, Mr. Sun was treating the money transferred from Mr. Cheung's foreign companies as his own. Mr. Cheung did not take a membership interest in Sun Investment; Sun Investment did not recognize that the money was a loan from Mr. Cheung but instead increased Mr. Sun's capital account in 2008 and 2009. Accordingly, the money transferred directly to Sun Investment is income to Mr. Sun. Respondent determined penalties under In the alternative to the remaining Respondent argues that petitioners are liable for2015 Tax Ct. Memo LEXIS 56">*101 the Respondent has the burden of proving by clear and convincing evidence that an underpayment exists for each of the years in issue and that some portion of the underpayment is due to fraud. As discussed above, Minchem does not have underpayments as a result of the transfers from Mr. Cheung's foreign companies because in substance the funds were merely deposited in Minchem's officer loan account, which was for the benefit of Mr. Sun, who then misappropriated the funds by either using the money for personal reasons or leaving the money in Minchem's officer loan account. Accordingly, Minchem is not liable2015 Tax Ct. Memo LEXIS 56">*102 for fraud penalties under The Suns, on the other hand, do have underpayments as a result of the transfers from Mr. Cheung's foreign companies to Minchem for 2008 and 2009. The Suns have further underpayments as a result of the transfers to Mr. Sun's *100 E*Trade account and Sun Investment. Accordingly, respondent has met the burden with respect to this requirement of the Respondent must also prove by clear and convincing evidence that petitioners had the requisite fraudulent intent. Circumstances that may indicate fraudulent intent, commonly referred to as "badges of fraud," include but are not limited to: (1) understating income; (2) maintaining inadequate records; (3) giving implausible or inconsistent explanations; (4) concealing income or assets; (5) failing to cooperate with tax authorities; (6) engaging in illegal activities; (7) providing incomplete or misleading information to one's tax preparer; (8) lack of credibility of the taxpayer's testimony; (9) filing false documents, including false income tax returns; (10) failing to file tax returns; and (11) dealing in cash. After reviewing the facts and the badges of fraud, the Court concludes that respondent has failed to meet the burden to show that either of the Suns had the requisite fraudulent intent to impose penalties under A pattern of substantially underreporting income for several years is strong evidence of fraud, particularly if the understatement is not satisfactorily explained or due to innocent mistake. Fraudulent intent can be inferred from a failure to maintain adequate books and records. A taxpayer's implausible or inconsistent explanations for his actions may constitute circumstantial evidence of fraudulent intent. Failing to cooperate with tax authorities is indicative of fraud. Respondent also contends that the Suns were rude to one of his agents. The agent, however, appears to have ignored a request by the Suns' CPA to honor a power of attorney and not directly contact Mr. Sun. Instead the agent may have been bypassing the CPA with power of attorney to seek information directly from the Suns. It is understandable that the Suns may have become frustrated with a revenue agent who2015 Tax Ct. Memo LEXIS 56">*108 did not honor a power of attorney. Accordingly, this factor is neutral for fraudulent intent. Evidence that a taxpayer provided incomplete or misleading information to his return preparer is circumstantial evidence of fraud. A taxpayer's lack of credibility, "the inconsistencies in his testimony and his evasiveness on the stand[,] are heavily weighted factors in considering the fraud issue." Fraudulent intent may be inferred when a taxpayer files a tax return intending to conceal, mislead, or prevent the collection of tax. In the alternative to the fraud penalties under The term "negligence" includes any failure to make a reasonable attempt to comply with the provisions of the internal revenue laws, and the term "disregard" includes any careless, reckless, or intentional disregard. Respondent has met his burden to show that the Suns carelessly, recklessly, or intentionally disregarded rules and regulations for their home equity loan interest deduction. The Suns did not exercise reasonable diligence to determine whether the deduction was correct. In fact it appears they specifically looked for a method to deduct all of the home equity loan interest without determining whether a rule or regulation prevented the deduction. On one Form 1098 someone specifically noted that all of the interest was to be deducted somehow.2015 Tax Ct. Memo LEXIS 56">*114 Accordingly, respondent has met his burden of production to show that a Respondent has also met his burden to show that the Suns acted negligently or with careless disregard of rules and regulations with regard to the income received from Mr. Cheung's foreign companies, Mr. Sun's excluded gambling *112 income, and the personal travel and entertainment paid for by Minchem. Mr. Sun used the money transferred by Mr. Cheung's foreign companies for personal purposes and did not attempt to comply with the provisions of the internal revenue laws. He failed to look into the implications of receiving the money and to investigate the obligations associated with using the money. A reasonable and prudent person would think receiving the funds from Mr. Cheung's foreign companies tax free, report free, and with an un-agreed-upon obligation to repay the money is "too good to be true". It was also too good to be true that Mr. Sun could use Mr. Cheung's2015 Tax Ct. Memo LEXIS 56">*115 money for gambling activities or that Minchem could pay the Suns' personal travel and entertainment costs without their being taxed on the income. Accordingly, respondent has met his burden and shown that the Suns were negligent in failing to report income from transfers by Mr. Cheung's foreign companies, Mr. Sun's gambling income, and personal travel and entertainment paid for by Minchem in 2008 and 2009. Taxpayers may avoid liability for the The Suns contend that they relied on their CPA to prepare their 2008 and 2009 tax returns and thus should not be liable for the accuracy-related penalties. Reliance necessary to escape the penalty under To reflect the foregoing,
1. Unless otherwise indicated, all section references are to the Internal Revenue Code of 1986, as amended and in effect for the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.↩
2. Respondent disallowed Minchem's business deductions for the Suns' travel and entertainment expenses of $156,689.50 and $214,693.37 for the 2008 and 2009 tax years, respectively. Petitioners concede respondent's adjustments. Petitioners also concede respondent's adjustments to the Suns' gambling income of $1,280,300 and $463,700 for 2008 and 2009, respectively.↩
3. Mrs. Sun chose not to appear at trial. Only Mr. Sun testified.↩
4. Mr. Sun was the managing member as well as the tax matters partner of Sun Investment. The other 1% of Sun Investment is owned by a member who is not a party to these cases.↩
5. It is not clear from the record whether Mr. Sun spent the five hours managing solely his personal investments, solely Sun Investment's investments, or some mix of the two.↩
6. It is unclear whether Mr. Cheung owned all of the shipping companies or owned only a fraction of the companies during 2008 and 2009. It is also unclear under what authority or capacity Mr. Cheung operated the companies or authorized international wire transfers. Neither party addressed these issues.
7. As discussed below, the parties agree that all of the bank transfers originated from bank accounts in Hong Kong appearing to belong to each of the named companies, but both respondent and petitioners submitted conflicting documents indicating in which jurisdictions the companies were organized. Petitioners submitted documents showing the companies are organized in Liberia, the British Virgin Islands, and Panama. Respondent submitted documents showing companies, with the same or substantially similar names, are organized in Hong Kong. Neither set of documents reflects Mr. Cheung as the owner of any of the entities. The country in which each company is organized is not pertinent to these cases; and the Court does not decide whether companies sharing the same name are the same company or where the companies are organized.↩
8. When first asked about the return, Mr. Cheung exclaimed that a 10%-15% return was "definitely" not annual because Mr. Sun "would not be able to achieve that", but when asked to clarify the return on investment he remarked: "Of course that's annually".↩
9. The Court does not decide whether the companies are the same companies as the Hong Kong registered companies or the companies organized elsewhere and notes only that all the wire transfers originated from Hong Kong accounts purporting to be owned by companies with the stated names. It is also unclear under what authority or capacity Mr. Cheung originated the wire transfers from Hong Kong to the U. S. bank account held by Minchem.
10. The stipulation erroneously states the credited amount from Kingdom Shipping as $10,730,828.51. Minchem's financial ledger shows the actual amount was $10,430,828.51. The Court will disregard the stipulation as inconsistent with the financial ledger.
11. Able Glory recalled $720,000 of the December 15, 2009, transfer. Minchem returned the amount on December 16, 2009. Thus, the net amount received by Minchem and credited to the officer loan account from Mr. Cheung's companies in 2009 was $2,795,130.↩
12. As discussed below, Mr. Sun made several advances to casinos from the officer loan account and some lesser portions of the advances were returned to the officer loan account and reported as credits or not returned at all. Similarly, on April 4, 2008, Mr. Sun loaned a friend $75,000, $20,000 of which was repaid and reported as a credit on November 14, 2008. These credits are not independent deposits and instead represent portions of amounts that were already credited to the officer loan account.
13. These sums include only the net amounts from Mr. Sun's transfers to casinos and personal loans. Mr. Sun pointed to $3,150,053.50 of debits in 2008 and $114,695 of debits in 2009 for which he could not remember whether the related expenses were personal, investment, or business.↩
14. In 2008 Minchem's officer loan account transferred money to the Wynn casino in the following amounts: $500,000 on March 27, $1 million on June 4, $1 million on September 11, $100 on September 12, $1 million on November 25, and $1 million on December 26. In 2008 the Wynn casino transferred money to Minchem's officer loan account in the following amounts: $480,000 on April 4, $1 million on September 12, $806,000 on December 1, and $100 on December 31. Minchem's officer loan account also transferred $300,000 to the MGM casino on November 24 and received back $108,450 from the MGM casino on December 1.↩
15. In 2009 Minchem's officer loan account transferred $1 million to the Wynn casino on June 12. Minchem's officer loan account received $1 million and $300,000 from the Wynn casino on January 5 and June 23, respectively.↩
16. Combining the 2008 and 2009 tax years better reflects Mr. Sun's gambling transactions because Mr. Sun advanced a casino $1 million on December 26, 2008, and $1 million was returned on January 5, 2009. Thus the debits in the officer loan account appear inflated for 2008 and the credits appear inflated for 2009 because these two transfers likely stem from the same transaction and result in a zero sum.
17. Mr. Sun was a direct or indirect member for each of these partnership entities.↩
18. Petitioners made an oral motion to shift the burden as to nonfraud issues. Under
19. The
20. These amounts do not include two $100 transactions in tax year 2008. On September 12, $100 was debited from Minchem's officer loan account to Wynn casino, and on December 31, $100 was credited to the officer loan account by Wynn casino. Both transfers note that they are "Reverse Posted" funds.↩
21. This is distinctly different from leaving the money in a third-party non-interest-earning account. The funds were not merely idle but used to effect a specific purpose chosen by Mr. Sun. Minchem and Mr. Sun would not have benefited from showing an increased cashflow if the money were deposited and left idle with a disinterested bank.↩
22. The additional $825,059.49, although not deposited into Minchem's officer loan account, was wire transferred to Minchem. The record does not reflect what happened to the $825,059.49 that was not reported in the officer loan account, but the Court will presume that Mr. Sun also used the funds as his own.
23. Sun Investment may have shifted 0.000001% distributive share of the profits from Mr. Sun to the other member in 2009.↩
24. Sun Investment reported a $52,166 increase in "other current liabilities" and a $257,747 increase in "mortgages, notes, bonds payable in 1 year or more" on its 2008 Form 1065, U.S. Return of Partnership Income.↩
25. Sun Investment reported increases of $312 in "other current liabilities" and $284,775 in liabilities for "mortgages, notes, bonds payable in 1 year or more" on the LLC's 2009 Form 1065.↩
26. Respondent's badge of "Omission of entire source of income" fits within the "understating income" badge, also asserted by respondent. Respondent's badge of "Making inconsistent representations" fits within the "Implausible and inconsistent explanations" badge, also asserted by respondent. Last, respondent's "False statement about a material fact" fits within the "Lack of credibility of the taxpayer's testimony" badge, also asserted by respondent.↩
27. Respondent did not introduce evidence or pursue any potential reporting requirements in regard to a nonresident alien or a foreign company transferring large quantities of money into the United States for a purported investment. But for the obvious gift reporting requirement discussed in detail
28. Petitioners' conceding the adjustments to Minchem's business expense deductions for the Suns' travel and entertainment will result in a penalty under
29. The note on a Form 1098 sent from Mr. Sun for tax year 2009 read "$60,000 to mtg int[,] bal. to invest int exp", meaning that $60,000 of the home equity loan interest would be deducted as mortgage interest and the remaining interest would be deducted as an investment interest expense. The Suns' CPA followed this note and deducted the interest accordingly.
Commissioner v. Sunnen ( 1948 )
Neely v. Commissioner ( 2001 )
Weingarten v. Commissioner ( 1962 )
Heminway v. Commissioner ( 1965 )
Estate of Pittard v. Commissioner ( 1977 )
United States v. William J. Rochelle, Jr., Trustee in ... ( 1967 )
neonatology-associates-pa-v-commissioner-of-internal-revenue-tax-court ( 2002 )
Rutkin v. United States ( 1952 )
Freytag v. Commissioner ( 1991 )
Indopco, Inc. v. Commissioner ( 1992 )
Seven-Up Co. v. Commissioner ( 1950 )
Beaver v. Commissioner ( 1970 )
Diane S. Blodgett v. Commissioner of Internal Revenue ( 2005 )
Edward B. Adams v. Commissioner of Internal Revenue ( 1972 )
Kevin J. Morse v. Commissioner of Internal Revenue Service ( 2005 )
Walter R. Carrington and Ada Raye Carrington v. ... ( 1973 )
Michael v. Frierdich and Connie J. Frierdich v. ... ( 1991 )