Stokes v. Commissioner

T.C. Memo. 1999-204

UNITED STATES TAX COURT

R. SCOT STOKES, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 8936-97. Filed June 21, 1999.

John R. Riley, for petitioner.

David W. Sorensen, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

SWIFT, Judge: Respondent determined a deficiency of $25,318

in petitioner's Federal income tax for 1994 and an accuracy-

related penalty of $4,916 under section 6662(a).

Unless otherwise indicated, all section references are to

the Internal Revenue Code in effect for the year in issue, and
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all Rule references are to the Tax Court Rules of Practice and

Procedure.

After settlement, the primary issue for decision is

whether a trust1 that petitioner established is to be disregarded

for Federal income tax purposes and whether petitioner is to be

charged with gain from sale of a business.

FINDINGS OF FACT

Some of the facts are stipulated and are so found.

At the time the petition was filed, petitioner resided in

Salt Lake City, Utah.

In 1991, petitioner moved to Butte, Montana, and acquired

ownership of a business that owned and operated a pizza

restaurant.

In July of 1994, petitioner moved from Butte, Montana, to

Salt Lake City, Utah.

On August 1, 1994, with assistance from an organization

called the National Association of Financial and Estate Planners

(Financial Planning Co.), petitioner entered into an annuity

contract and formed a so-called annuity trust, and petitioner

purportedly transferred all of the property and assets of the

1
By mere use of the term “trust” we intend no implication as
to whether the trust should be recognized for Federal income tax
purposes.
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pizza business to the annuity trust in exchange for a joint and

survivor annuity.2

Under provisions of the annuity contract, petitioner and his

wife are not to begin receiving annuity payments until

November 15, 2023. Thereafter, petitioner and his wife are to

receive $4,734 a month for the remainder of their lives. The

annuity trust, however, is entitled to make current distributions

of trust property to the named beneficiaries of the trust who

were all members of petitioner's family.

In documents associated with transfer of the pizza business

to the annuity trust, the pizza business is stated to have a

value of $152,000, and petitioner is stated to have a tax basis

in the business of $75,376.

David J. Orr (Orr) and Barry Crosby (Crosby), employees of

Financial Planning Co., were named as trustees of the annuity

trust, but they were not independent, and they did not function

in any meaningful way as trustees of the trust. Petitioner was

2
There is some evidence in the record that indicates that
petitioner's pizza business was owned by a closely held
corporation, the stock in which was owned by petitioner and his
wife, and that the transfer of the pizza business to the annuity
trust took the form of a stock transfer. Other evidence,
however, indicates that the transfer of the pizza business to the
annuity trust took the form of a transfer of the underlying
property and assets of the business. Petitioner does not dispute
respondent's treatment of the transfer as a transfer of the
underlying property and assets.
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named as manager of the annuity trust. Petitioner controlled the

trust and was a signatory on the trust bank accounts.

On August 17, 1994, the annuity trust sold the property and

assets of the pizza business to Jerry Beagley (Beagley) and

Douglas Lundell (Lundell) for a price of $152,000. The $152,000

total stated sales price was to be paid by Beagley and Lundell as

follows: $50,000 as a cash downpayment, assumption of a $15,556

loan, and monthly payments of $1,516 until the balance of $86,444

is fully paid.

In 1994, Beagley and Lundell paid to the trust the $50,000

cash downpayment plus $6,063 reflecting 4 months of installment

payments. The amount of installment payments made by Beagley and

Lundell after 1994 to the annuity trust is not in evidence.

In 1994, funds were distributed by the annuity trust to

petitioner's children as beneficiaries of the annuity trust. The

specific amount of funds distributed by the annuity trust to

petitioner's children is not in evidence.

In 1995 and later years, petitioner received fees from Orr

for referring to Orr various individuals for establishment of

other annuity trusts.

Petitioner timely filed his 1994 individual Federal income

tax return, and petitioner did not report thereon any income

relating to transfer of the pizza business to the annuity trust

or relating to sale of the pizza business to Beagley and Lundell.
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There was filed on behalf of the annuity trust a 1994

fiduciary Federal income tax return on which there was reported

no income relating to sale of the pizza business to Beagley and

Lundell.

On audit, respondent determined that the annuity trust was a

sham and that the $56,063 in proceeds received in 1994 from

Beagley and Lundell relating to sale to them of the pizza

business is to be treated as received by petitioner.3

OPINION

Gross income includes all income from whatever source

derived. See sec. 61(a). As a fundamental principle of Federal

income tax law, income is taxed to the person who earns the

income. See United States v. Basye, 410 U.S. 441, 450 (1973);

Commissioner v. Culbertson, 337 U.S. 733, 739-740 (1949); Lucas

v. Earl, 281 U.S. 111, 114-115 (1930); Holman v. United States,

728 F.2d 462, 464 (10th Cir. 1984); Leavell v. Commissioner, 104

T.C. 140, 148 (1995).

Tax laws do not recognize as valid for tax purposes sham

transactions or transactions that have no economic substance.

3
The $56,063 received in 1994 ($50,000 downpayment and $6,063
in total monthly installment payments) is treated by respondent
as taxable income to petitioner based on a gross profits
percentage of .5616 or $31,485. Also, under secs. 1245 and 1250,
on sale of the pizza business depreciation recapture income of
$62,426 relating to property of the pizza business is charged by
respondent to petitioner as taxable income.
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See Higgins v. Smith, 308 U.S. 473, 477 (1940); Uri v.

Commissioner, 949 F.2d 371, 374 (10th Cir. 1991), affg. T.C.

Memo. 1989-58. Where establishment of trusts has no real

economic effect, the substance of the transactions involving the

trusts will control over the form. See Zmuda v. Commissioner,

731 F.2d 1417, 1420-1421 (9th Cir. 1984), affg. 79 T.C. 714, 719

(1982); Markosian v. Commissioner, 73 T.C. 1235, 1241 (1980);

Christal v. Commissioner, T.C. Memo. 1998-255. Sham trusts are

treated as lacking in economic substance and as constituting a

nullity for Federal income tax purposes. See Hanson v.

Commissioner, 696 F.2d 1232, 1234 (9th Cir. 1983), affg. per

curiam T.C. Memo. 1981-675; Markosian v. Commissioner, supra;

Wenz v. Commissioner, T.C. Memo. 1995-277.

In general, respondent's determinations in notices of

deficiency are presumed correct, and taxpayers bear the burden of

proof. See Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115

(1933); Schelble v. Commissioner, 130 F.3d 1388, 1391 (10th Cir.

1997), affg. T.C. Memo. 1996-269.

The failure of a party to introduce at trial evidence that

is within the party's control gives rise to a presumption that

the evidence, if provided, would be unfavorable to the party who

has control over the evidence. See O'Dwyer v. Commissioner, 266

F.2d 575, 584 (4th Cir. 1959), affg. 28 T.C. 698 (1957); Stoumen

v. Commissioner, 208 F.2d 903, 907 (3d Cir. 1953), affg. a
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Memorandum Opinion of this Court dated Mar. 13, 1953; Wichita

Terminal Elevator Co. v. Commissioner, 162 F.2d 513, 516 (10th

Cir. 1947), affg. 6 T.C. 1158, 1164 (1946); Cluck v.

Commissioner, 105 T.C. 324, 338 (1995); Bruno v. Commissioner,

T.C. Memo. 1990-109.

Generally, the Court is not required to accept the

self-serving testimony of interested parties. See Day v.

Commissioner, 975 F.2d 534, 538 (8th Cir. 1992); Geiger v.

Commissioner, 440 F.2d 688, 689-690 (9th Cir. 1971), affg. per

curiam T.C. Memo. 1969-159; Sharwell v. Commissioner, 419 F.2d

1057, 1060 (6th Cir. 1969), vacating and remanding on other

issues T.C. Memo. 1968-89; Tokarski v. Commissioner, 87 T.C. 74,

77 (1986); Surloff v. Commissioner, 81 T.C. 210, 239 (1983).

Petitioner argues that the annuity trust constituted a valid

business entity that should be recognized for Federal income tax

purposes and that gain from sale of the pizza business to Beagley

and Lundell should be charged to petitioner only as annuity

payments are received by petitioner and his wife beginning in the

year 2023. Respondent contends that the annuity trust

constituted a sham trust that lacked economic substance, that the

annuity trust was used only for tax avoidance purposes, and that

proceeds received in 1994 relating to sale of the pizza business

to Beagley and Lundell should be charged to petitioner. We agree

with respondent.
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After the annuity trust was established and the pizza

business was purportedly transferred to the trust, there appears

to have been no meaningful change in the operation or control of

the pizza business. Petitioner continued as manager of the

business. The evidence suggests that the named trustees of the

trust (Orr and Crosby) were not independent and performed no

significant duties in connection with the pizza business. The

beneficiaries of the trust were members of petitioner's family.

At trial, other than a summary document entitled "Memorandum

of Trust", there was not admitted into evidence the original or a

copy of any signed trust document. Petitioner was the sole

witness who testified at trial, and his self-serving testimony

was not credible. None of the alleged trustees or other persons

involved in the annuity trust was called as a witness.

Petitioner has not satisfied his burden of proving that the

annuity trust did not constitute a sham trust. See Rule 142(a).

For Federal income tax purposes, the annuity trust is to be

treated as a sham, and petitioner is to be treated as taxable on

the proceeds received in 1994 and on the depreciation recapture

income relating to sale of the pizza business to Beagley and

Lundell.

In light of our holding on the above issue, we need not

address an alternative argument made by respondent that, under
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the grantor trust rules, petitioner should be taxed on gain from

sale of the pizza business.

With regard to the accuracy-related penalty determined by

respondent, petitioner makes no separate argument, and we sustain

respondent's determination of the accuracy-related penalty.

To reflect the foregoing,

Decision will be entered

under Rule 155.