Johnston v. Commissioner

T.C. Memo. 2000-315

UNITED STATES TAX COURT

KEVIN R. JOHNSTON, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 3699-99. Filed October 6, 2000.

Kevin R. Johnston, pro se.

Sherri S. Wilder, Nicholas J. Richards, and Miles D.

Friedman, for respondent.

MEMORANDUM OPINION

BEGHE, Judge: Respondent determined a deficiency of $34,541

in petitioner's Federal income and self-employment tax for 1993.

Respondent also determined additions to tax under section
 - 2 -

6651(a)(1)1 for failure to file a return and under section 6654

for failure to pay estimated tax, of $8,635 and $1,447,

respectively.

We must decide whether petitioner’s gross income includes

certain payments made during 1993 for services performed by

petitioner. Petitioner claims these payments are not his income,

because he did not personally receive them. Instead, petitioner

directed the recipients of his services to pay an entity known as

“Universal Trust” (Universal). Petitioner asserts that Universal

should be recognized as a separate taxable entity and that the

payments made by the service recipients should be treated as

Universal’s income. In the alternative, petitioner asserts he is

entitled to business deductions that offset the services income.

Petitioner has also filed a “Motion for Summary Disposition

and/or Judgment” and a Motion in Limine, which challenge the

validity of the statutory notice, question respondent’s ability

to make certain arguments or introduce certain evidence, and urge

a reallocation of the burden of proof.

In addition to rebutting petitioner’s procedural challenges,

respondent advances three arguments for including in petitioner’s

income the payments made to Universal. First, respondent claims

1
All section references are to the Internal Revenue Code in
effect for 1993, and all Rule references are to the Tax Court
Rules of Practice and Procedure, unless otherwise specified.
 - 3 -

petitioner’s attempt to divert to Universal the income from his

personal services was an invalid assignment of income under the

long line of authority beginning with Lucas v. Earl, 281 U.S. 111

(1930). Second, respondent asserts that Universal should not be

recognized as a separate taxable entity because it is a “sham”

with no economic substance. Third, respondent asserts that even

if Universal is recognized for tax purposes, it is a grantor

trust whose income is taxable to petitioner under sections 671-

679.

Respondent has also moved for a penalty under section 6673,

on the ground that petitioner’s primary position–-that the

payments made to Universal are not petitioner’s income–-is

frivolous. Moreover, respondent has filed a motion (and

expressed reservations in stipulations) asking us to dismiss the

case at hand, treat certain facts as established, or exclude

certain evidence, as a sanction for petitioner’s failure to

respond to discovery requests and to exchange documents as

required by our standing pretrial order.

We reject petitioner’s procedural challenges to respondent’s

actions, deny petitioner’s motions, and hold that petitioner’s

attempted diversion to Universal of the income from his personal

services was an invalid assignment of income. We also hold that

petitioner has failed to show he is entitled to additional
 - 4 -

deductions from that income, except to the very limited extent

described below.

Notwithstanding these conclusions, we deny respondent’s

motion for a penalty under section 6673. We also deny

respondent’s motion (and other requests) for the exclusion of

evidence (or other relief) as a sanction for petitioner’s

conduct.

Procedural Setting

The statutory notice sent to petitioner determined that

petitioner had failed to report $104,786 in business gross

receipts. Respondent also sent notices to Julia Ghavami (Ms.

Ghavami) and to Universal for 1993, reflecting determinations

that Ms. Ghavami and Universal had each received an identical

amount (i.e., $104,786) of business gross receipts. As explained

in more detail below, these notices were “whipsaw” notices,

designed to protect respondent’s position if it should be decided

that Universal had economic substance and should be respected as

a separate taxable entity.

Ms. Ghavami filed a petition with this Court contesting

respondent’s determination for 1993. See Julia Ghavami v.

Commissioner, docket No. 3692-99 (Ghavami). Jimmy C. Chisum (Mr.

Chisum)2, as “Managing Agent for Trustee”, purported to file a

2
We note that Mr. Chisum, and a myriad of purported
“trusts” with which he has claimed to be connected, are well
(continued...)
 - 5 -

petition on behalf of Universal, contesting the notice sent to

Universal for 1993. See Universal Trust 06-15-90, Four WS TT01,

Trustee v. Commissioner, docket No. 3885-98 (Universal).

Due to the common issues involved, we granted respondent’s

motion to consolidate Ghavami and Universal with the case at

hand. Shortly before trial, however, respondent moved to dismiss

Universal for lack of jurisdiction, on the ground that Mr. Chisum

had failed to establish his capacity to file a petition on behalf

of Universal. Respondent also moved to sever Universal from the

consolidated case, and we granted that motion. Shortly

thereafter, Mr. Chisum submitted a motion to dismiss Universal on

various jurisdictional and procedural grounds. Because

respondent and Ms. Ghavami have agreed to a decision that there

is no deficiency in Ms. Ghavami’s tax for 1993, we have also

granted respondent’s motion to sever Ghavami from the case at

hand.

2
(...continued)
known to this Court. See, e.g., Lipari v. Commissioner, T.C.
Memo. 2000-280 (sec. 6673 penalty imposed on taxpayers who
claimed they were unable to obtain records from Mr. Chisum, the
“trustee” of their “trust”); Banana Moon Trust v. Commissioner,
T.C. Memo. 2000-73 (dismissed for lack of jurisdiction because
Mr. Chisum, who claimed to be “trustee”, did not have capacity to
file petition); Jeff Burger Prods., LLC v. Commissioner, T.C.
Memo. 2000-72; Bantam Domestic Trust v. Commissioner, T.C. Memo.
2000-63; Photo Art Mktg. Trust v. Commissioner, T.C. Memo. 2000-
57; George v. Commissioner, T.C. Memo. 1999-381 (“trust” of which
Mr. Chisum was “trustee” was a sham, and payments received by
that “trust” were income of osteopathic physician who performed
services that generated the income).
 - 6 -

A hearing on the cross-motions to dismiss Universal was held

on June 19, 20, and 27, 2000. Mr. Chisum claimed to represent

Universal at this hearing; he also testified briefly on its

behalf. At the end of this hearing, the Court took the motions

under advisement, pending resolution of the case at hand.

Although petitioner was pro se, the Court allowed Mr.

Chisum, who does not claim to be a member of the bar of any

court, to sit beside petitioner at trial. It appears that Mr.

Chisum has been advising petitioner on the conduct of his case.

Petitioner testified neither at the Universal hearing nor in

the case at hand.

Background

The record consists primarily of two sets of stipulations

with exhibits, and a very limited amount of testimony. The

stipulations are incorporated herein by this reference.

Petitioner resided in Lake Forest, California, when the

petition was filed. Petitioner neither filed an income tax

return for 1993 nor paid any estimated tax for that year.

Respondent sent the statutory notice to petitioner on

November 18, 1998. The notice stated that $104,786 of unreported

business (Schedule C, Profit or Loss From Business) gross

receipts were includable in petitioner’s income. It contained no

further explanation of this item. The computation of tax

included in the notice did not allow petitioner any deductions
 - 7 -

other than the standard deduction for single filing status, and a

deduction for one-half the self-employment tax determined by the

notice.

Also on November 18, 1998, respondent sent a statutory

notice for 1993 to Ms. Ghavami, which stated that an identical

amount of unreported business gross receipts (i.e., $104,786) was

includable in her income. At some time or times, Ms. Ghavami and

petitioner lived at the same address.

Approximately 1 year before respondent sent the notices to

petitioner and Ms. Ghavami, the Commissioner sent a statutory

notice to Universal for 1993. The notice to Universal stated

that Universal had $21,711 of unreported gross receipts. Because

Universal had reported $83,075 of gross receipts on its 1993

fiduciary income tax return (Form 1041), the notice reflected a

determination that Universal’s 1993 gross receipts were $104,786,

the same amount of income set forth in the notices sent to

petitioner and Ms. Ghavami.3

The notice to Universal stated that the amount of unreported

gross receipts was determined using the bank deposits method.

3
The notice to Universal also disallowed, for lack of
substantiation, Universal’s claimed deductions for $51,865 of
expenses and $31,210 of distributions. Petitioner asserts that
if payments made to Universal are includable in his income, he is
entitled to deduct many of the expenses paid by Universal on his
behalf. Respondent contends that almost all amounts paid by
Universal were petitioner’s nondeductible personal expenses, not
trade or business expenses.
 - 8 -

During 1993, a checking account at the Bank of California (the

Universal account) was held in Universal’s name. Petitioner and

Ms. Ghavami were signatories on this account and wrote checks on

the account during 1993.

As the parties have stipulated, $104,786 was deposited in

the Universal account during 1993; of this amount, $103,420 was

paid by third parties for work done by petitioner, and $1,341 was

paid for work done by Ms. Ghavami. Thus, all but $25 of the

$104,786 deposited into the Universal account during 1993 was

paid as consideration for services performed by petitioner or Ms.

Ghavami.

After review of some canceled checks drawn on the Universal

account, respondent has conceded that petitioner is entitled to

deduct, as trade or business expenses, $914 paid by Universal for

postage, $220 paid by Universal to sponsor sports teams, and $441

paid by Universal for printing.

Petitioner does not have, and did not maintain during 1993,

a record of his business and personal automobile mileage.

The amount of the distribution deduction claimed by

Universal on its 1993 return, $31,210, was equal to the entire

net income shown on the return. The return states that the

$31,210 was distributed to an entity known as “Oak Hargor [sic]

Finance”, with the following address: “P.O. Box 577, Guelth

[sic], Ontaria [sic] Canada N1H 6K9".
 - 9 -

Facts Concerning Petitioner’s Connection With Universal

On June 15, 1990, Donna L. Chisum as “Settlor”, Four WS TT01

as “First Trustee”, and Mr. Chisum and another individual as

“Witness[es]”, executed a document (the indenture)4 purporting to

create an entity known as “Universal Trust”. The indenture

stated that Universal was a “COMMON LAW BUSINESS TRUST

ORGANIZATION, also known as a CONTRACTUAL COMPANY * * * with

certain assets to be administered by the Trustee for capital Unit

Holders represented by Certificates in accordance with the

inalienable Common Law rights afforded to man.” Notwithstanding

this language purporting to create a trust, the indenture also

stated that “It is expressly declared that an Unincorporated

Business Organization by Contract is hereby created and not a

trust agreement by gift, or a partnership, or a company, or a

corporation, or a joint venture, or any entity of statutory

nature”. (Emphasis added.)

Other documents dated June 15, 1990, show that all 100

“capital units” that could be issued by Universal were issued on

that date to petitioner and Ms. Ghavami. These documents state

that the capital units were issued in exchange for petitioner’s

and Ms. Ghavami’s contribution to Universal of the following:

4
We use the term “indenture” for convenience and not to
suggest that Universal should be recognized as a trust for State
law or Federal income tax purposes.
 - 10 -

Desk, chair, file cabinet, typewriter,
wastebaskets (2) telephones, VCR & TV, bedroom
furnishings, living room furniture dining room set,
coffee tables, end tables, pictures, etc. note owed to
Lynne B. Johnston for $3500.00 knowledge, talent,
ability and labor of [petitioner] * * * office supplies
and office tools[.] [Emphasis added.]

The indenture provided that whenever the “board of trustees”

determined that Universal had income that would be taxable to

Universal if not distributed, the income was to be distributed to

capital unit holders in proportion to their holdings; any

remaining income was to be allocated to principal. The indenture

also provided that on termination of Universal any remaining

assets would be distributed to capital unit holders, also in

proportion to their holdings.

Other documents dated June 15, 1990 named petitioner

“Secretary” and Ms. Ghavami “General Manager” of Universal, and

gave them authority to conduct Universal’s day-to-day business.

As noted above, both petitioner and Ms. Ghavami could and did

sign checks on Universal’s bank account.

A document entitled “Registry of Unit Certificates” purports

to show that in December 1990, the 100 capital units in Universal

were transferred to an entity known as “Isiah 18", and that in

October 1991, they were transferred to an entity known as “Oak

Harbor”. Mr. Chisum testified that Oak Harbor was a trust

established in the Turks and Caicos with a foreign trustee; he
 - 11 -

also testified that neither petitioner nor Ms. Ghavami was a

beneficiary of Isiah 18 or Oak Harbor.

Mr. Chisum claims that he was either Universal’s “trustee”,

or an officer or agent of Universal’s “trustee”, from Universal’s

formation in 1990 until the time of trial, except for the period

from October 1991 until May 1993.

Additional Facts Relating to Petitioner’s Services

Petitioner is a licensed real estate salesperson in the

State of California. At some time not specified in the record,

Walter Blazyk (Mr. Blazyk), the president of World Wide Mortgage

Corporation (WWMC), approached petitioner and asked him to work

for WWMC. Petitioner agreed to do the work provided that WWMC

pay Universal for the work done.

During 1993, petitioner worked for WWMC and a few other

parties. Also during that year, WWMC paid Universal $95,596 for

work done by petitioner; the other parties paid Universal $7,824

for work done by petitioner. As set forth above, this $103,420

paid for petitioner’s services was deposited into Universal’s

bank account.

Petitioner alone did the work for which WWMC paid Universal

the $95,596 during 1993. As far as WWMC was aware, Universal was

not involved in making any of the business decisions necessary to

produce this income. Moreover, Universal was never involved in

the working relationship between petitioner and WWMC. Mr.
 - 12 -

Blazyk’s only contact with Universal occurred when petitioner

asked WWMC to issue the checks for his services to Universal.

Until June 2000, Mr. Blazyk did not know and never had any

contact with Mr. Chisum.

The parties have stipulated that Universal is not legally

entitled to hold a real estate license or conduct a mortgage

business.

According to California Department of Real Estate records,

WWMC was petitioner’s employing broker in 1993 and was still

petitioner’s employing broker in 1997.

Facts Relating to Petitioner’s Motions and Respondent’s Motion
for a Penalty Under Section 6673

On October 7, 1999, the Court filed respondent’s Motion to

Consolidate for Trial, Briefing, and Opinion. A copy of this

motion was mailed to petitioner on October 1, 1999. The motion

stated:

the position of counsel for respondent * * * is that
the Universal Trust is a sham and that individual items
of income are taxed to the individuals Kevin R.
Johnston and Julia Ghavami personally, and individual
expense items, if substantiated, are deductible by them
personally.

On November 8, 1999, the Court filed a copy of respondent’s

Requests for Admission, which had been served on petitioner on

November 5, 1999. These requests sought information relating to
 - 13 -

respondent’s position that Universal was a sham.5 For example,

one request stated that “There has been no change in the use of

assets assigned or transferred to the Universal Trust as a result

of such transfer or assignment.”

On April 26, 2000, the Court filed respondent’s Motion to

Compel Responses to Respondent’s Interrogatories. That motion

stated:

the primary issue is whether Universal Trust, created
by petitioners Ghavami and Johnston; should be
disregarded for tax purposes due to its lack of
economic substance and attempted assignment of income
with the result that the net income reported by the
trust, is properly reported by petitioners Ghavami and
Johnston.

On June 19, 2000, during the hearing on the cross-motions in

Universal, the Court brought to petitioner’s attention and

discussed for his benefit the assignment of income, sham trust,

and grantor trust theories. On June 20, 2000, the Court told

petitioner that trial of the case at hand would begin on June 27,

2000. The Court arranged this 1-week delay in order to give

petitioner yet more time to gather evidence and to encourage the

parties to stipulate as many facts as possible.

5
Among the factors we consider, in deciding whether a
purported trust is a sham for tax purposes, is whether the
grantor’s relationship to the property transferred to the trust
was materially different after the trust’s formation. See
Markosian v. Commissioner, 73 T.C. 1235, 1243 (1980).
 - 14 -

Respondent warned petitioner more than 2 months before trial

that taxpayers in sham trust cases have been penalized under

section 6673 for advancing frivolous arguments. On June 19,

2000, respondent’s counsel informed petitioner that he was

prepared to move for a penalty under section 6673 if petitioner

continued to insist that the $103,420 paid to Universal for work

done by petitioner was not petitioner’s income.

On June 13, 2000, petitioner had stipulated that during

1993, WWMC paid Universal $95,596 for work done by petitioner.

Trial began on June 27, 2000, after the 1-week interval

arranged by the Court; the parties submitted a Second Stipulation

of Facts. In that document, petitioner agreed to a number of

additional stipulations concerning the payment of $103,420 to

Universal for work done by petitioner, and concerning deposits

made to Universal’s bank account during 1993. However,

petitioner refused to testify.

The Parties’ Contentions

Respondent now asserts that petitioner’s gross income

includes $103,420 paid to Universal during 1993 for work done by

petitioner.6 According to respondent, this amount is includable

6
The statutory notice asserted that petitioner’s income
included $104,786 in unreported business gross receipts.
Respondent now claims that petitioner’s gross income should be
increased by only $103,420, the amount the record establishes was
paid to Universal (and deposited in its bank account) for
(continued...)
 - 15 -

in petitioner’s income: (1) Under the assignment of income

doctrine; (2) because Universal was a sham; or (3) if Universal

was not a sham, because Universal’s income is taxable to

petitioner under the grantor trust rules. Respondent has

conceded that petitioner is entitled to a small amount of trade

or business deductions relating to this income.

Petitioner maintains that the $103,420 is Universal’s

income, or in the alternative, contends that he is entitled to

business deductions that offset the income.

Petitioner has filed a “Motion for Summary Disposition

and/or Judgment” contesting the validity and effect of the

statutory notice. Petitioner has also filed a Motion in Limine

contesting respondent’s ability to make certain arguments or

introduce certain evidence. Because our disposition of these

motions could affect our consideration of the substantive issues,

we turn our attention to them now.

I. Petitioner’s Motion for Summary Judgment

According to petitioner’s summary judgment motion,

respondent has failed to establish a sufficient link between

6
(...continued)
services performed by petitioner.

The record also establishes that $1,341 of the $104,786
deposited in Universal’s account was paid for services performed
by Ms. Ghavami. The record contains no information about the
proper treatment of the remaining $25 deposited in the Universal
account ($104,786 minus $103,420 and $1,341 equals $25).
 - 16 -

petitioner and the funds paid to Universal, which respondent

claims are petitioner’s income. Petitioner asserts that as a

result, the statutory notice was an invalid “naked assessment”,

and we must dismiss the case at hand for lack of jurisdiction.

In the alternative, petitioner claims respondent’s failure to

supply the necessary “predicate evidence” deprives the notice of

its usual presumption of correctness, and respondent must bear

the burden of proof on all issues.

A. Validity of Notice

Petitioner’s claim that the notice was invalid effectively

asks us to “look behind” the notice. See Shriver v.

Commissioner, 85 T.C. 1, 3 (1985). As a general rule, we do not

look behind a deficiency notice to examine the evidence used, the

propriety of respondent’s motives, or the administrative policy

or procedure that informs respondent’s determinations. This is

because a trial before the Tax Court is a proceeding de novo; our

determination of a taxpayer’s tax liability must be based on the

merits of the case and not on any previous record developed at

the administrative level. See Greenberg’s Express, Inc. v.

Commissioner, 62 T.C. 324, 327-328 (1974). Moreover, even where

a taxpayer has made a showing casting doubt on the validity of

respondent’s determination, the notice is generally not rendered

void, and it remains sufficient to vest this Court with
 - 17 -

jurisdiction. See Suarez v. Commissioner, 58 T.C. 792, 814

(1972).

The Court of Appeals for the Ninth Circuit, to which an

appeal of the case at hand would lie, has developed an exception

to this rule. In Scar v. Commissioner, 814 F.2d 1363 (9th Cir.

1987), revg. 81 T.C. 855 (1983), the Court of Appeals held a

notice invalid and dismissed the action for lack of jurisdiction

in favor of the taxpayer.

The notice in Scar informed the taxpayers that they had

$138,000 of unreported income from a tax shelter partnership

known as the “Nevada Mining Project”. The notice also stated

that tax was being assessed on this income at the maximum

marginal rate because the taxpayers’ original return was

unavailable. At trial, however, the taxpayers established that

they had no connection with the Nevada Mining Project, and that

they had in fact filed their tax return. As a result, the Court

of Appeals concluded that “the taxpayers proved that a

determination of their deficiency had not been made”. See Scar

v. Commissioner, supra at 1367 n.6.

Petitioner has made no such showing in the case at hand.

The notice sent to petitioner stated that he had $104,786 in

unreported business receipts during 1993. Petitioner has

stipulated that an identical amount was deposited in the

Universal bank account during 1993. Petitioner has also
 - 18 -

stipulated that $103,420 of that $104,786 was paid for personal

services petitioner performed. Moreover, the record reveals that

petitioner was a signatory on the Universal account, that he was

one of the original “capital unit” holders in Universal, and that

as a unit holder he was entitled to receive distributions of

income and of corpus from Universal. Therefore, a comparison of

the facts in the record with the notice sent to petitioner

confirms that respondent actually determined a deficiency in

petitioner’s tax. Moreover, as we conclude in our discussion of

the substantive issues below, the record also proves the accuracy

of the determination made.

Equally importantly, the Court of Appeals for the Ninth

Circuit has limited the application of Scar to the narrow

circumstances where the notice of deficiency reveals on its face

that no determination was made. See Kantor v. Commissioner, 998

F.2d 1514, 1521-1522 (9th Cir. 1993); Clapp v. Commissioner, 875

F.2d 1396, 1402 (9th Cir. 1989); Campbell v. Commissioner, 90

T.C. 110 (1988).

Petitioner argues that respondent’s three statutory notices

to petitioner, Ms. Ghavami, and Universal, which attributed the

same amount of income to each of them, show that respondent

failed to determine a deficiency in petitioner’s tax and that

petitioner’s notice was invalid on its face. We disagree.
 - 19 -

In Clapp v. Commissioner, supra, the individual taxpayers

transferred their businesses to foreign trusts. The Commissioner

issued notices to both the individuals and the trusts; the

notices attributed many of the same items of income to both

parties. The notices also disallowed numerous deductions as

unsubstantiated, including all business expenses claimed by the

individuals and the trusts.

The taxpayers in Clapp challenged the validity of the

notices, stressing the Commissioner’s alternative positions and

the blanket disallowance of deductions. In response, the Court

of Appeals for the Ninth Circuit observed that the Commissioner’s

alternative notices were intended to ensure that the Commissioner

would be able to proceed whether or not the trusts were found to

be shams. The Court of Appeals stated that taking such

alternative positions:

seems to be a reasonable response to a tax evasion
scheme for which there is not as yet a settled legal
interpretation. Any other approach would reward the
tax evader who could come up with a novel scheme and
force the Commissioner to take a single, consistent
legal interpretation. * * * On previous occasions we
have upheld notices of deficiency which took
alternative positions for precisely this reason. Malat
v. Commissioner, 302 F.2d 700, 704 (9th Cir. 1962);
Revell, Inc. v. Riddell, 273 F.2d 649, 660 (9th Cir.
1960). [Clapp v. Commissioner, supra at 1401; fn. ref.
omitted.]

The statutory notices sent to petitioner, Ms. Ghavami, and

Universal, like the notices in Clapp v. Commissioner, supra, were
 - 20 -

“whipsaw” notices designed to protect respondent’s ability to

proceed, if a purported “trust” should be recognized as a

separate taxable entity. In the circumstances of the case at

hand, the notice sent to petitioner was proper.

For this and the other reasons set forth above, we hold that

the notice sent to petitioner was valid and that we have

jurisdiction of the case at hand. Petitioner’s argument to the

contrary has no merit.

B. Presumption of Correctness

In general, a deficiency notice is presumed correct, and the

taxpayer has the burden of proving it wrong. See Rule 142(a);

Welch v. Helvering, 290 U.S. 111 (1933).7 There are certain

exceptions to this rule, however, where the notice alleges that

the taxpayer has received unreported income.

The Court of Appeals for the Ninth Circuit has held in

unreported income cases that the presumption of correctness

applies only where the Commissioner’s determination is supported

by some substantive evidence that the taxpayer received the

unreported income. See Rapp v. Commissioner, 774 F.2d 932, 935

(9th Cir. 1985); Weimerskirch v. Commissioner, 596 F.2d 358, 360-

361 (9th Cir. 1979), revg. 67 T.C. 672 (1977); Petzoldt v.

Commissioner, 92 T.C. 661, 687-690 (1989) (discussing Court of

7
We do not find that the burden-shifting provisions of
current sec. 6201(d) or sec. 7491 apply.
 - 21 -

Appeals for the Ninth Circuit authorities). Once the

Commissioner has introduced the necessary “predicate evidence”

concerning the unreported income, however, the taxpayer has the

usual burden of establishing, by a preponderance of the evidence,

that the Commissioner’s determination is arbitrary or erroneous.

See Rapp v. Commissioner, supra at 935; Petzoldt v. Commissioner,

supra at 689. The Court of Appeals has described the required

evidentiary foundation as “minimal”. Palmer v. IRS, 116 F.3d

1309, 1312-1313 (9th Cir. 1997). Moreover, this exception to the

presumption of correctness applies only to unreported income; the

taxpayer always has the burden of proving entitlement to any

deductions. See United States v. Zolla, 724 F.2d 808, 809-810

(9th Cir. 1984).

Petitioner asserts that the notice in the case at hand

should not be presumed correct, because there is insufficient

evidence linking petitioner to the funds paid to Universal, which

respondent claims are petitioner’s income. Petitioner notes that

Universal, not petitioner, actually received payment of the

funds. Moreover, although petitioner was one of the original

capital unit holders in Universal, petitioner asserts that there

is no evidence that petitioner was a unit holder (or other

beneficiary) of Universal during the year in issue. As a result,

according to petitioner, the presumption of correctness does not

apply because respondent has failed to show that petitioner
 - 22 -

personally received the unreported income described in the

notice.

Although some of the authorities cited by petitioner, such

as Hardy v. Commissioner, 181 F.3d 1002, 1004 (9th Cir. 1999),

and Rapp v. Commissioner, supra at 935, do mention the taxpayer’s

“receipt” of income, it is nevertheless clear that the

Commissioner may satisfy the predicate evidence requirement in

unreported income cases by introducing evidence linking the

taxpayer to tax-generating acts. See Shriver v. Commissioner, 85

T.C. 1, 4 (1985). Alternatively, respondent may satisfy the

predicate evidence requirement by showing the taxpayer was

connected to unexplained bank deposits or cash. See Schad v.

Commissioner, 87 T.C. 609, 618-620 (1986) (discussing Court of

Appeals for the Ninth Circuit authorities); Tokarski v.

Commissioner, 87 T.C. 74 (1986).8

The record contains ample evidence linking petitioner both

to tax-generating acts and to bank deposits of the income

8
The authorities cited by petitioner, when read in full,
support this conclusion. For example, although Rapp v.
Commissioner, 774 F.2d 932, 935 (9th Cir. 1985) does mention
evidence of receipt, it also states that “Once the Government has
carried its initial burden of introducing some evidence linking
the taxpayer with income-producing activity” (emphasis added),
the burden of proof shifts to the taxpayer. Moreover, Hardy v.
Commissioner, 181 F.3d 1002, 1005 (9th Cir. 1999), states that
the exception to the presumption of correctness applies only
where the Commissioner has failed to provide any evidentiary
foundation for the deficiency notice.
 - 23 -

generated by those acts. For example, it is undisputed that

petitioner, a licensed real estate salesperson, worked for WWMC

and a few other parties during 1993. It is also undisputed that

WWMC and the other parties paid a total of $103,420 for

petitioner’s services during that year. Moreover, it is clear

that this $103,420 was deposited into Universal’s bank account,

that petitioner was one of the signatories to that account, and

that petitioner wrote checks on that account. Finally, it is

clear that petitioner was one of the original capital unit

holders of Universal, and as such was once entitled to receive

distributions of income and corpus from Universal. All this more

than amply links petitioner with the unreported income described

in the notice.

Petitioner asserts that, as a matter of law, none of this

evidence may be used to support the statutory notice, because:

(1) Respondent has not shown that respondent had the evidence

when the notice was issued, and (2) the evidence was not

described in the notice itself. We disagree.

In general, any admissible evidence may be used to support a

deficiency notice. See Cook v. United States, 46 Fed. Cl. 110

(2000), which stated that an assessment was not “naked” even if

the administrative file supporting its entry was lost, because:

what is critical, given the de novo nature of the
proceedings * * * is that admissible evidence exists to
support the assessment. If such evidence exists, and
 - 24 -

is admitted by the court, it is irrelevant whether it
is the same evidence that the Service relied upon in
originally making its assessment. * * * [Id. at 114;
citations omitted.]

See also Dellacroce v. Commissioner, 83 T.C. 269, 284 (1984)

(stating that in case appealable to Court of Appeals for the

Second Circuit, deficiency notice based on hearsay must be held

arbitrary unless we can find admissible evidence in the record to

support it); Rosano v. Commissioner, 46 T.C. 681, 687 (1966) (“we

know of no rule of law calling for a review of the materials that

were before the Commissioner in order to ascertain whether he

relied upon improper evidence so that the burden of proof might

be shifted to him”); cf. Suarez v. Commissioner, 58 T.C. 792

(1972) (notice not entitled to presumption of correctness where

it was stipulated that notice was based entirely on

constitutionally inadmissible evidence).9

Petitioner’s proposed rule, if accepted, would require

courts to discover and examine the information actually used by

the Commissioner in determining a deficiency, whenever a taxpayer

challenged the validity of a notice. Such routine inquiries

would violate the well-settled rule that we do not, except in

exceptional circumstances, “look behind” a deficiency notice. In

9
We also note that in one of the cases cited by petitioner,
Hardy v. Commissioner, supra at 1005, the Court of Appeals in
part relied on the taxpayer’s stipulations in deciding that the
predicate evidence requirement was satisfied.
 - 25 -

effect, the exception set forth in Scar v. Commissioner, 814 F.2d

1363 (9th Cir. 1987), revg. 81 T.C. 855 (1983), would no longer

be limited to cases where the notice of deficiency is invalid on

its face.

In the case at hand, petitioner has not offered any evidence

that could lead us to conclude, or made any assertions that could

even lead us to suspect, that the statutory notice was either

arbitrary or based upon constitutionally tainted evidence.

Moreover, the record contains a great deal of evidence showing

that petitioner in fact received almost all the income charged in

the statutory notice. As a result, petitioner is not being put

in the position of having to “prove a negative” (i.e., the non-

receipt of income), simply because respondent issued a notice

entitled to a presumption of correctness. Cf. Weimerskirch v.

Commissioner, 596 F.2d at 361.

For this and the other reasons described above, we hold that

the notice sent to petitioner is amply supported by the evidence

in the record; the unreported income exception to the presumption

of correctness does not apply to the case at hand. Petitioner’s

arguments to the contrary have no merit.

II. Petitioner’s Motion in Limine

The statutory notice stated that petitioner’s income

included unreported business gross receipts, but it did not give

any further explanation for this determination.
 - 26 -

Petitioner’s Motion in Limine asserts that respondent’s

failure to include a fuller explanation in the statutory notice

should have consequences. More particularly, petitioner claims

respondent should not be permitted to raise the assignment of

income, sham, or grantor trust theories in the case at hand. In

the alternative, petitioner asserts that respondent should bear

the burden of proof on factual issues relating to those theories.

A. Issue Preclusion

We note that respondent is not necessarily limited to the

issues or theories discussed in the statutory notice or the

answer. For example, we have considered arguments raised by the

Commissioner for the first time on brief. See Ware v.

Commissioner, 92 T.C 1267, 1268 (1989), where we stated:

The rule that a party may not raise a new issue on
brief is not absolute. Rather, it is founded upon the
exercise of judicial discretion in determining whether
considerations of surprise and prejudice require that a
party be protected from having to face a belated
confrontation which precludes or limits that party’s
opportunity to present pertinent evidence. * * *

More generally, we have stated, in Pagel, Inc. v.

Commissioner, 91 T.C. 200, 211-212 (1988), affd. 905 F.2d 1190

(8th Cir. 1990):

It is well established that a party may rely upon
a theory if the opposing party has been provided with
fair warning of the intention to base an argument upon
that theory. “Fair warning” means that respondent’s
failure to give notice, in the notice of deficiency or
in the pleadings, of his intention to rely on a
particular theory did not prejudice the taxpayer’s
 - 27 -

ability to prepare its case. Of key importance in
evaluating the existence of prejudice is the amount of
surprise and the need for additional evidence on behalf
of the party opposed to the new position. [Citations
omitted.]

See also Sundstrand Corp. v. Commissioner, 96 T.C. 226, 346-347

(1991), where we observed that we have refused to consider a new

theory raised by the Commissioner where consideration of the

theory would prejudice the taxpayer. In Sundstrand Corp. we

concluded that the taxpayer was prejudiced because it would have

presented additional evidence at trial if it had known of the new

theory in advance.

In the case at hand, respondent’s Motion to Consolidate

informed petitioner, more than 8 months before trial, of

respondent’s position that Universal was a sham and that

individual items of income were taxed to petitioner personally.

More than 7 months before trial, respondent’s Requests for

Admission sought information that once again put petitioner on

notice of respondent’s position that Universal was a sham. In

addition, almost 2 months prior to trial, respondent’s motion to

compel informed petitioners:

the primary issue is whether Universal Trust, created
by petitioners Ghavami and Johnston; should be
disregarded for tax purposes due to its lack of
economic substance and attempted assignment of income
with the result that the net income reported by the
trust, is properly reported by petitioners Ghavami and
Johnston.

Finally, on June 19, 2000, the Court discussed the assignment of

income, sham, and grantor trust theories with petitioner. The
 - 28 -

Court did not start trial until 1 week later, to allow petitioner

yet more time to gather additional evidence and to attempt to

settle as many factual issues as possible. When trial resumed

after this 1-week period, petitioner refused to testify.

Moreover, petitioner has not claimed that he could have found or

offered any additional evidence relevant to any of respondent’s

three theories, if given more time.

For all these reasons, it is clear petitioner had fair

warning of the assignment of income, sham, and grantor trust

theories, and would not be prejudiced by our consideration of

them. Accordingly, we hold that respondent may raise (and we may

consider) any of those theories in this proceeding.10

Petitioner’s argument to the contrary has no merit.

B. Burden of Proof

Rule 142(a) provides that “The burden of proof shall be upon

the petitioner * * * except that, in respect of any new matter,

increases in deficiency, and affirmative defenses, pleaded in the

10
Petitioner also asserts that respondent should be
precluded from introducing any evidence relating to the sham,
grantor trust, and assignment of income theories. Because we
have just decided that petitioner had “fair warning” of these
theories, we can think of no reason why respondent should be
prohibited from introducing evidence relevant to those theories.
See Rule 41(b)(2), which states:

If evidence is objected to at the trial on the ground
that it is not within the issues raised by pleadings,
then the Court may receive the evidence * * * and shall
do so freely when justice so requires and the objecting
party fails to satisfy the Court that the admission of
such evidence would prejudice such party in maintaining
such party’s position on the merits.
 - 29 -

answer, it shall be upon the respondent.” Because the statutory

notice did not mention the assignment of income, sham, or grantor

trust theories, petitioner asserts that those theories are “new

matter” on which respondent has the burden of proof.

For many years, a deficiency notice was not required to

contain an explanation. A notice that simply informed the

taxpayer that there was a deficiency and the amount thereof was

sufficient to raise the presumption of correctness and place the

burden of proof on the taxpayer. See Abatti v. Commissioner, 644

F.2d 1385, 1389 (9th Cir. 1981), revg. T.C. Memo. 1978-392; Olsen

v. Helvering, 88 F.2d 650, 651 (2d Cir. 1937). Consistent with

this approach, some courts held that where a deficiency notice

was broadly worded, a theory raised by the Commissioner after the

notice was issued was not “new matter”, unless the new theory was

inconsistent with some position necessarily implicit in the

determination itself. Abatti v. Commissioner, supra at 1390;

Sorin v. Commissioner, 29 T.C. 959, 969-971 (1958), affd. per

curiam 271 F.2d 741 (2d Cir. 1959).

In 1988, section 7522 was enacted by the Technical and

Miscellaneous Revenue Act of 1988, Pub. L. 100-647, 102 Stat.

3735. Section 7522 provides that any deficiency notice mailed

after 1989 “shall describe the basis for * * * the tax due * * *

included in such notice.”
 - 30 -

In Shea v. Commissioner, 112 T.C. 183 (1999), we considered

whether a theory raised by the Commissioner for the first time on

brief was “new matter” on which the Commissioner had the burden

of proof. After discussing section 7522, we held that where the

Commissioner relied on a basis that was not stated in the

statutory notice and that required the presentation of different

evidence, the new basis was new matter for purposes of Rule 142.

We need not consider this question further in the case at

hand. As we explain in our discussion of the substantive issues

immediately below, the record establishes that $103,420 of the

$104,786 paid to Universal was petitioner’s income under the

assignment of income rule. We would reach the same result no

matter who had the burden of proof on respondent’s theories.11

III. Does Petitioner’s Income Include the $103,420 Paid to
Universal?

According to documents executed in June 1990, petitioner

transferred his “knowledge, talent, ability and labor” to

Universal, in exchange for certain “capital units” in Universal.

Respondent claims that petitioner’s attempt to transfer his

“knowledge, talent, ability and labor” to Universal was an

archetypical example of an invalid “assignment of income”, under

11
The record also establishes that $1,341 of the $104,786
paid to Universal was paid for work done by Ms. Ghavami.
Respondent has conceded that this $1,341, and the remaining $25
deposited in the Universal account, were not income to
petitioner.
 - 31 -

the long line of authority beginning with Lucas v. Earl, 281 U.S.

111 (1930). Accordingly, respondent asserts petitioner’s gross

income includes the $103,420 paid for petitioner’s services

during 1993, even though petitioner did not directly receive the

payments of that income but instead caused the payments to be

diverted to Universal.

Petitioner claims that Universal (and not petitioner) should

be taxed on the $103,420 in question, because Universal was the

“true earner” of that income. According to petitioner, Universal

provided the services for which it was paid; petitioner was

simply Universal’s agent or employee. Petitioner additionally

asserts that in these circumstances, taxing petitioner on the

income in question would conflict with well-settled law

recognizing personal service corporations as the “true earners”

of the income generated by the efforts of their shareholder/

employees.

We agree with respondent. The record establishes that

petitioner’s transfer to Universal was a classic assignment of

income of the kind described in Lucas v. Earl, supra. Because

such assignments are ineffective for Federal income tax purposes,

petitioner remained the party taxable on the income generated by

his services.

One of the primary principles of the Federal income tax is

that income must be taxed to the one who earns it. The Supreme
 - 32 -

Court has referred to this assignment of income rule as “the

first principle of income taxation”, Commissioner v. Culbertson,

337 U.S. 733, 739 (1949), and as “a cornerstone of our graduated

income tax system”, United States v. Basye, 410 U.S. 441, 450

(1973). Attempts to subvert this principle by deflecting income

away from its true earner to another entity by means of

contractual arrangements, however cleverly drafted, are not

recognized as dispositive for Federal income tax purposes,

notwithstanding their validity under State law. See Vercio v.

Commissioner, 73 T.C. 1246, 1253 (1980) (citing United States v.

Basye, supra, and Lucas v. Earl, supra).

The assignment of income rule applies with particular force

to personal service income. In the landmark case of Lucas v.

Earl, supra, Mr. Earl and his wife entered into a contract

providing that any property acquired by either of them, including

salary and fees, would be considered joint property. The Supreme

Court assumed that the contract was valid under State law, but

held that Mr. Earl was still taxable on his entire salary and

professional fees, stating:

this case is not to be decided by attenuated
subtleties. It turns on the import and reasonable
construction of the taxing act. There is no doubt that
the statute could tax salaries to those who earned them
and provide that tax could not be escaped by
anticipatory arrangements and contracts however
skillfully devised to prevent the salary when paid from
vesting even for a second in the man who earned it.
* * * [Lucas v. Earl, supra at 114-115.]
 - 33 -

Petitioner does not dispute that the $103,420 paid to

Universal for work done by petitioner must be taxed to the earner

of that income. Instead, petitioner asserts that for tax

purposes Universal should be considered to have earned that

income (i.e., was the “true earner” of the income).

We are therefore required to decide whether petitioner or

Universal is the proper party to be taxed on the $103,420

generated by petitioner’s work, but paid to Universal. In cases

similar to the case at hand, we have held that the taxable party

is the person or entity who directed and controlled the earning

of the income, rather than the person or entity who received the

income. See Vercio v. Commissioner, supra at 1253 (citing

Wesenberg v. Commissioner, 69 T.C. 1005 (1978); American Sav.

Bank v. Commissioner, 56 T.C. 828 (1971)); see also Commissioner

v. Sunnen, 333 U.S. 591, 604 (1948) (“The crucial question

remains whether the assignor retains sufficient power and control

over the assigned property or over receipt of the income to make

it reasonable to treat him as the recipient of the income for tax

purposes.”); Corliss v. Bowers, 281 U.S. 376, 378 (1930)

(revocable trust created by husband for benefit of wife and

children treated as invalid assignment of income; Supreme Court

stated that “taxation is not so much concerned with the

refinements of title as it is with actual command over the

property taxed * * *. * * * The income that is subject to a
 - 34 -

man’s unfettered command and that he is free to enjoy at his own

option may be taxed to him as his income, whether he sees fit to

enjoy it or not.”).

The record shows that Mr. Blazyk, president of WWMC,

approached petitioner and asked him to work for WWMC. Petitioner

then agreed to do the work provided that WWMC pay Universal for

the work done.

During 1993, WWMC paid Universal $95,596 for work done by

petitioner. Also during that year, a few other parties paid

Universal $7,824 for work done by petitioner. This $103,420 paid

for petitioner’s services was deposited into Universal’s bank

account. Petitioner had signatory authority over that account

and wrote checks on the account during 1993. Moreover, on brief

petitioner has conceded that he used the Universal account to pay

personal expenses during 1993; he also appears to argue that only

approximately $31,000 of the $51,865 of expenses claimed by

Universal on its return for 1993 were in fact business expenses.

The record also shows that petitioner alone did the work for

which WWMC paid Universal during 1993. As far as WWMC was aware,

Universal was not involved in making any of the business

decisions necessary to produce this income. More importantly,

the parties have stipulated that Universal was not legally

entitled to hold a real estate licence or conduct a mortgage

business, and it was never involved in the working relationship
 - 35 -

between petitioner and WWMC. Mr. Blazyk’s only contact with

Universal occurred when petitioner asked WWMC to issue the checks

for his services to Universal. Until June 2000, Mr. Blazyk did

not know and never had any contact with Mr. Chisum, although Mr.

Chisum claims that he was either Universal’s trustee, or an

officer or agent of Universal’s trustee, during most of

Universal’s existence. Finally, petitioner did not report (and

has not conceded) that he received any salary (or other income)

as a result of the payments made to Universal for his services.

All this leads us to conclude that there was no negotiation

between petitioner and Universal, and no contract requiring

petitioner to supply his services to Universal and giving

Universal the right to control petitioner’s work. It also causes

us to conclude that Universal did not have a contract with WWMC

obligating Universal to provide services. In this connection, we

note that petitioner did not testify (or offer any other

evidence) about the nature of his employment relationship, if

any, with Universal, about the existence of any contracts he had

with Universal, or about Universal’s relationships or contracts

with the recipients of petitioner’s services. In these

circumstances, we draw the normal inference from petitioner’s

failure to offer evidence on these matters, which is that the

evidence, if produced, would not have been helpful to his cause.
 - 36 -

See Wichita Terminal Elevator Co. v. Commissioner, 6 T.C. 1158,

1165 (1946), affd. 162 F.2d 513 (10th Cir. 1947).

For all these reasons, the record establishes that

petitioner, rather than Universal, was the “true earner” of the

$103,420 paid for petitioner’s services during 1993.

Petitioner’s attempted transfer of his “knowledge, talent,

ability and labor” to Universal was a classic assignment of

income. See Vercio v. Commissioner, 73 T.C. at 1250-1254

(taxpayers created trusts to which they purportedly conveyed the

“exclusive use of * * * [their] lifetime services and all of the

currently earned remuneration therefrom”; held, taxpayers

retained ultimate direction and control over earning of the

income and the conveyance was an invalid assignment of income, in

part because it was unlikely that a binding contract for services

between the trust and the taxpayers had been entered into, there

was no evidence that the trust had any right to direct the

taxpayers’ income-producing activities, and it was questionable

whether the trusts could in any event obligate the taxpayers to

perform services that were inherently personal in nature); see

also Vnuk v. Commissioner, 621 F.2d 1318, 1319 (8th Cir. 1980),

affg. T.C. Memo. 1979-164 (physician conveyed to a trust “the

exclusive use of * * * [his] lifetime services and all the

currently earned remuneration accruing therefrom”; held,

physician retained ultimate direction and control and conveyance
 - 37 -

was an anticipatory assignment of income, in part because the

trust had no right to supervise the taxpayer’s employment or

determine his remuneration, and the taxpayer had no legal duty to

earn money or perform services for the trust).

Petitioner argues that our conclusion conflicts with the

authorities recognizing personal service corporations (PSC’s) as

the “true earners” of the income generated by the efforts of

their shareholder/employees. We disagree.

First, we note that in many circumstances, arrangements

creating PSC’s are invalid assignments of income. See, e.g.,

Leavell v. Commissioner, 104 T.C. 140 (1995); Johnson v.

Commissioner, 78 T.C. 882, 889-890 (1982) (amounts paid by

professional basketball club for player’s services were income to

player rather than to PSC which received the payments), affd.

without published opinion 734 F.2d 20 (9th Cir. 1984). We also

note that Congress has enacted various Code provisions in an

attempt to end various perceived abuses of PSC’s. See, e.g.,

sec. 269A.

Second, the authorities recognizing PSC’s as the true

earners of the income generated by the shareholders’ services

have noted the tension between the assignment of income rule set

forth in Lucas v. Earl, 281 U.S. 111 (1930), and the importance

attributed to the corporate form by Moline Properties, Inc. v.

Commissioner, 319 U.S. 436 (1943). See, e.g., Johnson v.
 - 38 -

Commissioner, 78 T.C. at 890 n.13; Keller v. Commissioner, 77

T.C. 1014, 1030-1031 (1981), affd. 723 F.2d 58 (10th Cir. 1983).

Of course, in the case at hand petitioner employed a purported

trust in his diversion scheme, and the Moline Properties, Inc.

policy favoring the recognition of shareholders and corporations

as separate taxable entities is simply not applicable.

Third, even when we respect a PSC as the true earner, this

does not end our examination; we then evaluate the arrangement

between the shareholder and the PSC under section 482. In so

doing, we consider whether the shareholder’s total compensation

from the PSC was essentially equivalent to that which he would

have received if he had not employed the PSC structure. See,

e.g., Haag v. Commissioner, 88 T.C. 604, 614-615 (1987), affd.

without published opinion 855 F.2d 855 (8th Cir. 1988); Keller v.

Commissioner, 77 T.C. at 1024-1025. This analysis ensures that

the shareholder will be taxed on the reasonable value of his

services, except to the extent his taxable income is reduced by

Code provisions that specifically provide for deferral or

nonrecognition of income (e.g., qualified pension plan

provisions). We repeat that in the case at hand petitioner did

not report (and has not conceded) that he received any salary (or

other income) as a result of the payments made to Universal for

his services. Moreover, Universal’s 1993 tax return claimed a

deduction for a distribution of Universal’s entire net income to
 - 39 -

a beneficiary with a foreign address, which Mr. Chisum asserted

was a Turks and Caicos trust with a foreign trustee.

Fourth, we have held that two elements must be present

before a PSC, rather than its service-performing employee, can be

considered the true earner of the income. First, the service-

performing employee must be just that–-an employee of the PSC,

whom the PSC has the right to direct or control in some

meaningful sense. Second, the PSC and the person or entity using

the employee’s services must have a contract or similar

arrangement recognizing the PSC’s controlling position. See

Johnson v. Commissioner, 78 T.C. at 891. Neither of these

elements is present in the case at hand.

In short, the authorities concerning the taxation of PSC’s

confirm rather than challenge our conclusion that petitioner’s

attempted diversion to Universal of the compensation for his

services was an invalid assignment of income.

We hold that petitioner’s gross income includes the $103,420

paid to Universal, as determined by respondent. Because we reach

this holding under the assignment of income rule, we need not

consider respondent’s alternative arguments that Universal was a

sham or a grantor trust.12

12
Petitioner also argues that our holding conflicts with
certain Courts of Appeals decisions concerning the tax treatment
of contingent legal fees. See, e.g., Estate of Clarks v. United
(continued...)
 - 40 -

IV. Is Petitioner Entitled to Additional Deductions?

The statutory notice did not allow petitioner any deductions

for trade or business expenses. On the basis of copies of a few

checks drawn on the Universal account, respondent has conceded

that petitioner is entitled to deduct, as trade or business

expenses, the following amounts paid by Universal: $914 for

postage, $220 to sponsor sports teams, and $441 for printing.

12
(...continued)
States, 202 F.3d 854 (6th Cir. 2000) (contingent-fee agreement is
not invalid assignment of income, and client’s income does not
include portion of recovery paid to attorney pursuant to the
agreement); Cotnam v. Commissioner, 263 F.2d 119 (5th Cir. 1959),
affg. in part and revg. in part 28 T.C. 947 (1957).

Petitioner’s argument has no merit. Not only do other
Courts of Appeals (including the Court of Appeals for the Ninth
Circuit, to which the present case is appealable) and the Tax
Court disagree with Estate of Clarks and Cotnam, see, e.g., Coady
v. Commissioner, 213 F.3d 1187 (9th Cir. 2000); Baylin v. United
States, 43 F.3d 1451 (Fed. Cir. 1995); Kenseth v. Commissioner,
114 T.C. 399 (2000), but, more importantly, the purported trust
arrangement in the case at hand is completely different from the
contingent fee agreements at issue in Estate of Clarks and
Cotnam.

In Estate of Clarks and Cotnam, the Courts of Appeals
stressed that the client’s claim was, for all practical purposes,
worthless without the services of the attorney who could bring it
to fruition; in Estate of Clarks, the Court of Appeals even
characterized the attorney-client relationship in a contingent-
fee arrangement as similar to a joint venture or partnership. By
contrast, in the case at hand, the record shows that petitioner’s
services had value by themselves; Universal had nothing to do
with, and no control over, the earning of petitioner’s service
income. In short, petitioner’s control of the income generated
by his services was more than sufficient to make him the party
taxable on that income.
 - 41 -

Petitioner asserts he is entitled to additional trade or

business deductions on account of other expenses paid by

Universal, in an aggregate amount of approximately $29,500.

Petitioner refused to testify (or supply any other evidence)

about the business purpose of these expenses. The only proof

petitioner offered in support of his claim consists of copies of

various checks drawn on the Universal account.

Respondent objects to the admission of these checks because

petitioner did not exchange them with respondent 15 days prior to

trial, as required by our standing pretrial order. Respondent

also argues that petitioner has not proved his entitlement to any

additional deductions, whether or not the checks are admitted.

Before we can consider these issues, we need to address one

preliminary matter. We have redetermined the amount of

petitioner’s income under the assignment of income rule; we have

not found it necessary to decide whether Universal was a sham.

We also note that respondent has never argued that the income and

deductions in issue should be attributed to different taxpayers.

Respondent has stipulated that petitioner is entitled to

deductions for some amounts paid by Universal; these stipulations

were not conditioned on our deciding that Universal was a sham.

Accordingly, we conclude respondent has conceded that, because we

have decided petitioner’s income includes payments received by

Universal, petitioner may deduct amounts paid by Universal to the
 - 42 -

extent petitioner establishes the amounts were paid for valid

trade or business expenses of petitioner.

A. Should the Checks Offered by Petitioner Be Admitted?

We conclude that the copies of checks submitted by

petitioner should be admitted, notwithstanding respondent’s

objection. The parties have stipulated the existence of the

Universal account. Respondent has introduced copies of checks

drawn on that account as evidence that petitioner and Ms. Ghavami

were authorized to (and did) write checks on that account during

1993; petitioner has stipulated the admission of those copies.

In addition, at the Court’s urging, petitioner worked with

respondent’s counsel during the week before trial to agree on

many additional stipulations, including stipulations concerning

deposits to the Universal account that helped prove respondent’s

case. We also note that as part of these additional

stipulations, respondent conceded that petitioner is entitled to

deduct some expenses paid with checks drawn on the Universal

account.

In light of the foregoing, it is clear respondent has not

been surprised by the existence of the Universal account, and

does not question or need to investigate the authenticity of the

copies of checks drawn on that account. Indeed, respondent has

relied on check copies and other information about the Universal

account as proof of respondent’s case in chief; some of that
 - 43 -

information was the subject of stipulations entered into after

the 15-day period specified in our pretrial order had expired.

Finally, we note that even if we admit the checks offered by

petitioner as proof that Universal paid the payees named therein,

petitioner is still required to prove that the payments were

ordinary and necessary business expenses. See Interstate Transit

Lines v. Commissioner, 319 U.S. 590, 593 (1943) (taxpayer must

prove entitlement to any deduction claimed). For all these

reasons we conclude that respondent would not be prejudiced by

our admission of the checks submitted by petitioner and that in

fairness we should admit them into evidence.

B. Did Petitioner Prove His Entitlement to Deductions?

Petitioner asserts that the checks prove his entitlement to

deductions for the following categories of expenses: Water;

electricity; gas; home office cleaning and maintenance; medical

insurance; life insurance; equipment; subscriptions and

publications; cellular phone service; supplies; automobile; trash

pickup; and miscellaneous. However, the information contained on

many of the checks does not prove that the checks were actually

used to pay expenses of the category claimed. More importantly,

the checks appear to have been used to pay expenses that could be

either business or personal, depending on the circumstances. In

the absence of any evidence of the business purpose of these
 - 44 -

claimed expenses, petitioner is simply not entitled to deduct

them.

However, petitioner has also claimed a deduction for $726 in

pager expenses. After having examined the checks, we are

convinced that such amount was in fact spent on pager services,

and that under the circumstances of this case, this expense was

more likely than not a business expense. We therefore conclude

petitioner is entitled to deduct it.

We hold that other than this amount (and the deductions

conceded by respondent), petitioner is not entitled to any of the

additional deductions claimed.

V. Additions to Tax

Section 6651(a)(1) imposes an addition to tax for the

failure to file an income tax return within the time prescribed

by law, unless it is shown that the failure is due to reasonable

cause and not to willful neglect. The taxpayer bears the burden

of showing that reasonable cause exists. See Rule 142(a); United

States v. Boyle, 469 U.S. 241, 245 (1985).

Petitioner did not file a return for 1993, and there is no

evidence he had reasonable cause for this failure. Accordingly,

petitioner is liable for the maximum 25-percent addition for

failure to file, applied to the amount of the deficiency as

redetermined in accordance with this opinion.
 - 45 -

Section 6654(a) provides for an addition to tax in the case

of any underpayment of estimated tax by an individual. This

addition is mandatory absent a showing by the taxpayer that one

of the statutory exceptions applies. See Grosshandler v.

Commissioner, 75 T.C. 1, 20-21 (1980).

Petitioner did not pay any estimated tax for 1993, and he

has not shown that any exceptions apply. Accordingly, the

section 6654 addition applies, determined in accordance with the

rest of this opinion.

VI. Respondent’s Motion for Sanctions Under Rule 104

Approximately 2 weeks before trial, respondent moved for

sanctions under Rule 104(c), in response to petitioner’s failure

to participate in discovery and to comply with the Court’s orders

concerning discovery. At trial, respondent stated that the

stipulations entered into by the parties had rendered this motion

moot. In light of the stipulations and our holdings in this

case, we agree with respondent. Respondent’s motion will be

denied as moot.

VII. Respondent’s Motion for a Penalty Under Section 6673

Section 6673(a)(1) provides that whenever it appears that

the taxpayer has instituted or maintained proceedings in this

Court primarily for delay, or the taxpayer’s position in such

proceedings is frivolous or groundless, or the taxpayer

unreasonably failed to pursue available administrative remedies,
 - 46 -

the Court may require the taxpayer to pay a penalty to the United

States of up to $25,000.

At trial, after petitioner stated that he would not testify,

respondent moved for a penalty under section 6673. According to

respondent’s motion, petitioner’s claim that the $103,420 paid to

Universal is not includable in petitioner’s income is frivolous.

Under the circumstances of the case at hand, we decline to

impose the section 6673 penalty. On June 19, 2000, respondent’s

counsel informed petitioner that he was prepared to move for a

penalty if petitioner continued to insist that the $103,420 paid

to Universal for work done by petitioner was not petitioner’s

income. Respondent’s motion seeks a penalty against petitioner

on this ground.

We note that on June 13, 2000, petitioner had stipulated

that WWMC paid Universal $95,596 for work done by petitioner. We

also note that on June 27, 2000, the parties submitted a Second

Stipulation of Facts. In that document, petitioner made many

additional stipulations concerning the payment of the $103,420 to

Universal for work done by petitioner, and concerning deposits of

that amount to Universal’s bank account. These stipulations

helped prove respondent’s case in chief. Indeed, we note that

respondent did not present any witnesses at trial.

We believe that petitioner’s course of conduct was counseled

by Mr. Chisum, who appears to have advised petitioner throughout
 - 47 -

this proceeding.13 In addition, after respondent’s last warning

on June 19, 2000, the bulk of petitioner’s efforts were devoted

to jurisdictional and procedural challenges to the statutory

notice, rather than to the substantive argument respondent

complains of.14 For these reasons and in these circumstances, we

decline to impose a section 6673 penalty on petitioner.

In conclusion, we note that petitioner’s jurisdictional and

procedural challenges had no legal merit. They were objectively

frivolous and may well have been maintained primarily for delay.

We also note that petitioner is currently before the Court in a

case involving other years.15 Should petitioner ignore the

warnings and holdings of this Court in the case at hand, there

will be ample opportunity to consider whether imposition of a

penalty under section 6673 would be appropriate.

13
We observe that if Mr. Chisum were a lawyer authorized to
practice in this Court, there might well be grounds under Rule
24(g) for disqualifying him from representing petitioner and the
other participants in the trust arrangements that Mr. Chisum has
been promoting and operating, see supra note 2, on the ground
that Mr. Chisum has a conflict of interest. Cf. Para
Technologies Trust v. Commissioner, T.C. Memo. 1992-575. The
predicament that petitioner finds himself in would appear to be
the direct result of the operation of that conflict. See Dixon
v. Commissioner, T.C. Memo. 2000-116, n.18 and accompanying text.
14
In this connection, we note that petitioner’s arguments
against the validity of the statutory notice are almost identical
to Mr. Chisum’s arguments in Universal’s case.
15
Johnston v. Commissioner, docket No. 18619-99.
 - 48 -

We have considered all allegations and arguments of

petitioner that we have not discussed herein; we find them to be

without merit or irrelevant.

To take account of the foregoing,

An order will be issued denying

petitioner’s Motion for Summary

Disposition and/or Judgment and Motion

in Limine and respondent’s Motion for

Sanctions Under Rule 104 and Motion for

Sanctions Under Section 6673; decision

will be entered under Rule 155.