DocketNumber: Nos. 10338-03, 10303-04, 12819-04
Citation Numbers: 98 T.C.M. 283, 2009 Tax Ct. Memo LEXIS 224, 2009 T.C. Memo. 222
Judges: "Holmes, Mark V."
Filed Date: 9/24/2009
Status: Non-Precedential
Modified Date: 11/20/2020
MEMORANDUM FINDINGS OF FACT AND OPINION
HOLMES,
We wade through the available records to determine what the Tarpos owe and whether they should be penalized.
FINDINGS OF FACT
The Tarpos were a dual-income family during the years at issue -- 1999, 2000, and 2001. Most of their income came from James, a computer programmer who contracted his services to corporations in the name of his sole proprietorship, ATE Services. Although he had several clients during 1999-2001, he worked mostly for a corporation named MaxSys. MaxSys and most of James's other clients paid their invoices with checks made out to ATE Services. Marla Tarpo was an independent beauty consultant whose *225 primary financial contribution during those years was the deductions in excess of income she reported on their joint tax return from her own unnamed sole proprietorship.
James Mattatall became a part of the Tarpos' life when a friend recommended his services, perhaps as early as 1997. Mattatall, as the Tarpos admitted they knew, is neither an attorney nor an accountant. He earned his living by setting up tax shelters for his clients. He is now out of that business: In 2004, the U.S. District Court in Los Angeles enjoined him from organizing, selling, or recommending tax shelters; or even from offering tax advice to clients. Here's how it was supposed to work: o The Tarpos would create a "business trust," *226 naming Mattatall as the trustee and the Tarpos as managers. The Tarpos would get a separate mailing address for the trust to lend it credibility. o James would then transfer ATE Services into the trust, thereby removing himself as the sole owner of his business and assigning all of the income earned from his business to the trust. o The trust would give a portion of the income James earned back to him as wages. o The stated beneficiary of the trust would be Prosper International, Ltd. (PIL), *227 created Paderborn Trust*228 They also "transferred" ATE Services to Paderborn by getting an employer identification number (EIN) for ATE Services and having Paderborn claim income reported under that EIN on a Schedule C attached to its tax return. *229 one occasion Marla withdrew money from that account to pay the Tarpos' personal debts directly. Some money also sloshed between the Tarpos' Paderborn bank accounts over half a dozen times for no reason that we could discern. Another of the Tarpos' big mistakes was the way that they reported their income and deductions. Each year, James prepared a Schedule C listing the income paid back to him from Paderborn, but he didn't list Paderborn anywhere on the form. Instead, he indicated that the money came through his own sole proprietorship, ATE Services, just as he always had. Both James and Marla also claimed extensive business deductions -- without any records to substantiate them -- which brought their taxable income down to almost nothing. They used the same tactic on Paderborn's tax return -- again, without any substantiation -- only there any remaining income was claimed as an income-distribution deduction *230 so that there was no taxable income. *231 The Commissioner has conceded that the Tarpos are entitled to a $ 3,000 capital loss deduction for both 2000 and 2001. A major question is how much in capital gains or losses they had at the end of 1999. Our finding on James's 1999 capital gains or losses has two parts -- the loss carryforward and sale proceeds. Neither James nor the Commissioner was able to provide a precise accounting of the Tarpos' capital gains or losses for 1999, so we pieced together the information from what was in the record. James's 1999 amended return included a $ 34,794 short-term capital loss carryforward, but he offered no substantiation for it at trial. A taxpayer's returns alone do not substantiate deductions or losses because they are nothing more than a statement of his claims. We next turn to figuring out the sale proceeds from James's day trading in 1999. The Commissioner subpoenaed E*Trade Financial Corporation and obtained Forms 1099 listing all of James's trades *232 in 1999. We entered the trades into a spreadsheet and calculated the gain or loss for each company he invested in and found the aggregate gain to be $ 91,709. The table below shows the gain or loss for each company. Company Sale Price Basis Gain/(Loss) At Home $ 27,204.14 $ 25,671.15 $ 1,532.99 Advanced Fibre 11,553.46 12,096.15 (542.69) Amazon 387,918.52 386,840.35 1,078.17 Applied Mic 15,154.54 13,194.95 1,959.59 Conexant $ 95,655.69 $ 89,606.00 $ 6,049.69 Systems Cyberian 145,361.71 144,499.60 862.11 Outpost E*Trade 368,554.48 355,703.58 12,850.90 Earthlink 41,808.70 43,314.90 (1,506.20) Network Equity 21,354.33 0.00 21,354.33 Residential IKOS Systems 19,979.38 16,727.40 3251.98 KN Energy Peps 35,133.92 0.00 35,133.92 Netsilicon 20,545.70 17,977.40 2568.30 Purchasepro 33,795.26 38,559.85 (4,764.59) RealNetworks 281,266.28 281,935.30 (669.02) Sharper Image 16,729.49 11,207.45 5,522.04 Sportsline.com 16,459.54 17,364.90 (905.36) Track Data 586.27 707.45 (121.18) Uroquest 2,266.50 0.00 2,266.50 Medical VISX Delaware 96,743.15 90,956.00 5,787.15 TOTAL 1,638,071.06 1,546,362.43 91,708.63
In *233 2002, the Commissioner chose the Tarpos' 1999 return for audit. The Tarpos showed up with Mattatall, but didn't bring any of the requested documentation and didn't answer any questions. Instead, they simply handed the examiner affidavits attesting to the truth of the items claimed on their tax returns. They also brought amended tax returns for 1999 and 2000 which included previously unreported stock transactions as well as unreported dividends and interest.
In an effort to get some documentation other than the affidavits, the examiner set up another meeting. This time, Marla showed up alone with a box full of disorganized receipts. She again refused to answer any questions, so the examiner subpoenaed records from the Tarpos' banks, their brokers, and the companies that had used James's services. The Commissioner finally sent a notice of deficiency for 1999 in April 2003. It was signed by an IRS employee with the title Technical Services Territory Manager.
The Tarpos' conduct during the audit of their 1999 return sparked an audit of their 2000 and 2001 returns, which the Commissioner quickly extended to Paderborn's returns for those years. The Tarpos did not respond to any of the examiner's *234 requests for information, and more third-party summonses followed.
In the notices of deficiency, the Commissioner disallowed all of the Tarpos' claimed deductions and set up a whipsaw position, attributing the same income to both Paderborn and the Tarpos. The notices of deficiency for the 2000 and 2001 tax years of both the Tarpos and Paderborn were also signed by the same IRS employee.
The Tarpos timely petitioned us for review of all three notices. The cases were tried together in Los Angeles, where the Tarpos resided when they filed their cases.
OPINION
The Tarpos open with a frivolous jurisdictional argument. They claim that the notices of deficiency are invalid because a "Technical Services Territory Manager" is not authorized to issue them. Statutory notices of deficiency are valid only if issued by the Secretary of the Treasury or his delegate.
The Commissioner views Paderborn as a fat target, and fires three weapons at it: arguments that Paderborn is a sham trust, that it is a grantor trust, and that Tarpo was just assigning his income to it. We begin by describing how Paderborn worked.
The purpose of the Paderborn/PIL Trust/Horizon MasterCard arrangement was to reduce or eliminate income taxes. By transferring ATE Services to Paderborn and calling James an independent contractor of ATE Services rather than its sole proprietor, James claims he could be paid a fixed amount which he could then offset with unreimbursed Schedule C expenses. Paderborn deducted what it paid to James as "contracted development." Everything that remained in Paderborn at the end of the year was transferred to the PIL Trust, shipped *236 from the United States, and placed in the hands of foreigners not subject to the Code. By using the Horizon MasterCard, which was paid directly by the PIL Trust, the Tarpos could access the money without repatriating it.
On paper, most of the earned income was reported somewhere. The money which would have been reported on James's Schedule C before the trusts were established was instead reported for 1999-2001 as follows:
$(SEE FIGURE IN ORIGINAL$) *237 checking account. Whenever PIL received money, it deposited that money into the PIL Trust.
A basic income tax principle is that a taxpayer is taxed on the income that he earns, and that income cannot be assigned to another.
Transferring ATE Services to Paderborn didn't actually change anything other than which taxpayer identification number the income was reported under. James still did all the business development, performed all the work, and signed all the timesheets. He was still the one earning the income, and it never left his control. *238 At one point during the trial, James testified that he was assigning his income to Paderborn: COURT: Okay. So what you were doing then, if I can understand this right, is you would go to a company like MACSIS [sic] or N.H. Services, you would contract with them, and then the idea was for you to assign the income to the Paderborn Trust? JAMES TARPO: Right.
We therefore find that the Tarpos improperly assigned James's earned income to Paderborn. We must disregard Paderborn, and will treat James as ATE Services' sole proprietor.
The Commissioner also argues that Paderborn and PIL were grantor trusts. A grantor trust is created when a person contributes cash or property to a trust, but continues to be treated as owner of it at least in part. See
We find that the Tarpos retained ownership of all of the assets in Paderborn and the PIL Trust.
o A grantor can revest title over the property in himself.
o A grantor trust's income can be distributed or accumulated for future distribution to the grantor or the grantor's spouse.
o The grantor directly or indirectly transfers property to a foreign trust.
We therefore find in the alternative that Paderborn and the PIL Trust should be disregarded for income tax purposes as nothing more than grantor trusts. Income and Deductions Having decided that all Paderborn's income properly belongs to the Tarpos, we turn to figuring out what that income was. We then discuss the deductions claimed by both James and Marla on their respective Schedules C that might reduce the portion of that income that is taxable. The Commissioner did not contest Marla's reported income for any of the years at issue, so we go straight to the question of what income James should have reported on his Schedule C. Since the Tarpos did not produce any records during the audit, the Commissioner relied on bank statements. Through these statements, he discovered the names of the companies *241 that paid James for his services, and was able to find out exactly how much they paid ATE Services each year. From there, the Commissioner was able to compare the bank statements for the Tarpos, ATE Services, and Paderborn to determine where the money was going and how much the Tarpos were actually making. Summarizing the information in tabular form shows how much each client paid James:CLIENT AMOUNT Alcon Laboratories, Inc. $ 8,840 Winsoft Inc. 5,400 USANA, Inc. 988 N.H. Resources, Inc. 15,115 MaxSys Technologies 21,710 Total 52,053
CLIENT | AMOUNT |
MaxSys Technologies | $ 110,663 |
Total | 110,663 |
$
CLIENT | AMOUNT |
MaxSysTechnologies | $ 87,141 |
Vektrek Electronic Sys | 375 |
Total | 87,516 |
By using these methods, the Commissioner determined that the Tarpos had gross income which should have been reported on James's Schedule C as follows:
1999 | 2000 | 2001 |
$ 52,053 | $ 110,663 | $ 87,516 |
We agree with the Commissioner and find that these totals are accurate. Deductions for 1999, 2000, and 2001 Expenses are allowable if they are "ordinary and necessary," but a taxpayer must keep records to show the connection *242 between the expenses and his business. The Tarpos claim a great many business expenses, including those claimed by Paderborn on its return. These include expenses we can estimate under the All the Tarpos ever provided were unsupported affidavits swearing to the truth of each item on each tax return. They did this at Mattatall's suggestion, but as other Mattatall clients have discovered, self-serving affidavits are not substantiation. See Since we have nothing on which to base any The Commissioner easily passes the first part of this test. He proved there was an underpayment when he proved that the Tarpos didn't report the additional income they tried to assign to Paderborn. But was a portion of that underpayment due to fraud? Fraud is the "willful attempt to evade tax," and we make that determination by looking at the entire record of a case. o understatement of income o inadequate records o concealing assets o failure to cooperate with tax authorities o mischaracterizing the source of income o implausible or inconsistent explanations of behavior. Since a portion of the underpayment is attributable to fraud, all of the underpayment will be subject to the fraud penalty unless the Tarpos can show by a preponderance of the evidence that some of the underpayment was not due to fraud. We find that James *246 has met this burden in regard to the capital gains for 1999. We therefore hold that the underpayment attributable to his understating his capital gains is not subject to the fraud penalty. We also find that the Commissioner has met his burden of proof only with regard to James; he has not shown that Marla acted with fraudulent intent -- about her intent there was no evidence or argument at all. James asserts that he had reasonable cause for his return position and that he acted in good faith. James never once asked for any credentials from Mattatall, and in fact admitted under oath that he knew Mattatall was neither an attorney nor an accountant. James also knew that the foreign trust setup was specifically created to hide the true ownership of assets and income from the IRS. We therefore find that James has not proved a defense to fraud. The same defense of reasonable cause and good faith applies to this penalty, see For the above reasons,
1. Cases of the following petitioners are consolidated herewith: James L. Tarpo and Marla J. Tarpo, docket No. 1030304, and Paderborn Trust, Marla J. Tarpo, Trustee, docket No. 12819-04.↩
2. The principals of PIL, Pierre J. Gauthier and Jean Jay Gauthier, a.k.a. Earl L. Savoy, have agreed to a permanent injunction barring them from offering tax shelters.
3. No trust documents were actually offered into evidence, so it is not clear what the terms of the trust were. We find that Mattatall was named trustee and the Tarpos were named comanagers of the trust, because we do have documents that they signed using those titles. James claimed, however, that he never received a copy of any documents and didn't know what his duties as manager, or what Mattatall's duties as trustee, were.↩
4. The Tarpos used this address only in official government documents; at all other times they used their home as the mailing address for both Paderborn and ATE Services.
5. Toward the end of 1999 James contacted most of the corporations that used his services and asked that they report all his future income, as well as his income for 1999, to the new EIN.↩
6. Neither the Commissioner nor the Tarpos ever established exactly what was done with the cash they kept.↩
7. A trust is generally allowed to deduct taxable income distributed to its beneficiaries. See
8. Paderborn's taxable income was actually negative $ 300 each year because the Tarpos claimed a $ 300 exemption for the trust pursuant to
9. We treat any income reported on the actual and amended returns as admissions by the Tarpos.
10. For shares of stock for which we had no purchase information (other than unsubstantiated estimates), we set the basis at zero. (The taxpayer bears the burden of showing he is not liable for tax on all the proceeds received, and if he fails to do so, we treat the full amount as taxable gain.
1. The trust claimed a $ 300 exemption, which made its reported taxable income -$ 300.↩
2. The 2001 Paderborn tax return wasn't admitted into evidence (we have only an electronic summary), so we don't know why there is a nearly $ 1000 difference between the amount paid to ATE/Paderborn and the amount paid out from Paderborn. We are also unsure why the checks admitted into evidence show more income flowing from MaxSys to ATE than its Form 1099 did for 2001.↩
11. Each of these sections lists exceptions, but none of those exceptions applies in this case.↩
12. As we said at the beginning of this section, the Commissioner had a third theory -- that the trusts were shams -- but we won't pile on.↩
13. To this must be added the capital gains that the Tarpos should have reported on their Schedule D. See
Halle v. Commissioner , 7 T.C. 245 ( 1946 )
Allen v. Commissioner , 92 T.C. 1 ( 1989 )
Halle v. Commissioner of Internal Revenue , 175 F.2d 500 ( 1949 )
William F. Sanford v. Commissioner of Internal Revenue , 412 F.2d 201 ( 1969 )
Cohan v. Commissioner of Internal Revenue , 39 F.2d 540 ( 1930 )
Beaver v. Commissioner , 55 T.C. 85 ( 1970 )
Michael L. Rockwell, and Regina Rockwell v. Commissioner of ... , 512 F.2d 882 ( 1975 )
W. Horace Williams, Sr., and Viola Bloch Williams v. United ... , 245 F.2d 559 ( 1957 )
Kenneth Allen Barbara Allen v. Commissioner of Internal ... , 925 F.2d 348 ( 1991 )
Robert W. Bradford v. Commissioner of Internal Revenue , 796 F.2d 303 ( 1986 )
Spies v. United States , 63 S. Ct. 364 ( 1943 )
Commissioner v. Banks , 125 S. Ct. 826 ( 2005 )
Sanford v. Commissioner , 50 T.C. 823 ( 1968 )
Roberts v. Commissioner , 62 T.C. 834 ( 1974 )
Lucas v. Earl , 50 S. Ct. 241 ( 1930 )
Burnet v. Leininger , 52 S. Ct. 345 ( 1932 )
Kellogg v. Commissioner , 88 T.C. 167 ( 1987 )