T.C. Memo. 2000-334
UNITED STATES TAX COURT
ROBERT A. AND COLLEEN L. LUND, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
ZERO GEE ENTERPRISES TRUST, SUN FEDERAL, INC., TRUSTEE,
Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 134-99, 219-99. Filed October 30, 2000.
Joe Alfred Izen, Jr., for petitioners.
Ralph W. Jones, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
SWIFT, Judge: These cases were consolidated for trial,
briefing, and opinion. For 1994, 1995, and 1996, respondent
determined deficiencies in petitioners’ Federal income taxes and
accuracy-related penalties as follows:
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Robert A. and Colleen L. Lund
Accuracy-Related Penalty
Year Deficiency Sec. 6662(a)
1994 $ 504,031 $100,806
1995 945,507 189,101
1996 1,292,331 258,466
Zero Gee Enterprises Trust
Accuracy-Related Penalty
Year Deficiency Sec. 6662(a)
1994 $ 495,582 $ 99,116
1995 908,550 181,710
1996 1,259,332 251,866
After settlement of some issues, the primary issue for
decision involves whether a trust1 petitioner established lacks
economic substance and should be disregarded for Federal income
tax purposes.
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the years in issue, and
all Rule references are to the Tax Court Rules of Practice and
Procedure. References to petitioner in the singular are to
Robert A. Lund.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
At the time the petitions were filed, petitioner and Colleen
Lund resided in Albany, Oregon, and the principal place of
1
By use of the terms “trust”, “trustee”, “beneficiary”, and
other related terms, we intend no implication as to the validity
of the trust involved in these cases.
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business of petitioner Zero Gee Enterprises (Zero Gee) was
located in Carson City, Nevada.
In the 1980's, petitioner worked for Hewlett Packard Co.
(HP) and several other computer companies as a computer
programmer. In 1987, petitioner wrote a book called “Taming the
HP 3000”, which described the use and performance of mid-range
and mainframe HP computer systems.
In 1990, petitioner organized as a sole proprietorship a
business to provide consulting services, computer software
development, and UNIX training relating to the HP 3000 Series of
computers. Petitioner was the sole owner of the business, and
the business was operated under the name of Lund Performance
Solutions (LPS).
After several years, petitioner considered selling LPS and
received an offer to purchase LPS for $700,000. Petitioner,
however, rejected the offer because he believed LPS to have a
fair market value of $1 to $2 million.
On May 19, 1993, with assistance from an organization called
Bigelow Charter Corp. (Bigelow Charter), petitioner formed Zero
Gee as a trust, and petitioner purportedly transferred to Zero
Gee his 100-percent ownership interest in LPS in exchange for
100-percent of the beneficial interest in Zero Gee.
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The principals and apparent owners of Bigelow Charter and
the individual promoters of the trust schemes sold by Bigelow
Charter were Loren and Bonnie Troescher.
Upon formation of Zero Gee, Bigelow Charter became the
corporate trustee of Zero Gee, with Loren and Bonnie Troescher
acting on behalf of Bigelow Charter.
In connection with the above transfer to Zero Gee of LPS,
petitioner did not consult with an accountant or an attorney.
Petitioner paid Bigelow Charter approximately $30,000 for
the documents and other assistance Bigelow Charter provided in
organizing the Zero Gee trust.
On May 26, 1993, petitioner purportedly transferred his 100-
percent beneficial or ownership interest in the Zero Gee trust to
a British West Indies corporation named International Palm. The
documentation and evidence in the record does not establish any
consideration or legitimate reason for this transfer to
International Palm.
On October 10, 1994, International Palm purportedly
transferred its alleged 100-percent beneficial or ownership
interest in the Zero Gee trust to Universal Sun, also a British
West Indies corporation.
Evidence in the record in these cases regarding the
ownership and operations of International Palm and of Universal
Sun is conspicuously lacking.
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On July 1, 1994, Sun Federal, a corporation owned by Owen
Charles, another promoter of trust schemes similar to that of
Zero Gee, apparently replaced Bigelow Charter as the corporate
trustee of Zero Gee.
Under terms of the Zero Gee trust document, the trustees of
Zero Gee were to manage, operate, and control Zero Gee for the
benefit of the beneficiaries. During the years in issue,
however, neither the corporate trustee of Zero Gee nor Loren and
Bonnie Troescher were involved in any significant way in the
management, operations, and control of Zero Gee or LPS. Zero Gee
paid Sun Federal a total of only $3,600 a year for Sun Federal’s
alleged services as trustee of Zero Gee.
Under terms of the Zero Gee trust document and other trust
materials:
(1) The trustee was authorized to make noninterest
bearing loans to the Lunds; and
(2) Written approval of the trustees allegedly was
required for trust expenditures in excess of $5,000.
Any approval requirement, however, under (2) above was
rescinded on January 30, 1994.
After the purported transfer of LPS to the Zero Gee trust
and through at least 1996, petitioner continued to manage,
operate, and control the business of LPS and Zero Gee. The
business was conducted in the name of LPS and in essentially the
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same manner as before the transfer to Zero Gee. The customers
were invoiced in the name of LPS, and customers paid their bills
to LPS. Petitioner continued to make all the daily business
decisions for LPS, and petitioner established the levels of
compensation for employees of LPS.
In 1995, petitioner individually borrowed $130,000 and
obtained a $160,000 line of credit from a credit union secured by
real property owned by petitioner and Colleen Lund. The $130,000
loan proceeds and the funds obtained under the line of credit
were used in the business of LPS. The trustees of Zero Gee did
not authorize either of the above credit transactions.
For 1994, 1995, and 1996, the gross and net income of LPS
were as follows:
Year Gross Income Net Income
1994 $1,243,338 $ 170,448
1995 1,751,528 424,960
1996 2,401,225 640,317
Cumulative Total $5,396,091 $1,235,725
Of the above 3-year cumulative total $1,235,725 in net
income, International Palm and Universal Sun (the purported sole
beneficiaries of the trusts) received apparently $41,100, the
nature of which is not established in the record. Of the
$1,194,625 balance in the above 3-year cumulative total net
income of LPS, $750,000 was used to purchase another computer
consulting business, $24,000 was used to purchase gold mining
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equipment for use in Mexico, and $18,000 was invested in sheep in
New Zealand. The ultimate disposition of the approximate
$402,625 remaining in the above cumulative 3-year net income of
LPS is not disclosed in the record. Approximately $100,000 was
also invested in commodity accounts.
For 1994, 1995, and 1996, Zero Gee timely filed its Federal
Income Tax Returns for Estates and Trusts. None of the business
income earned by LPS was reported on petitioners’ joint income
tax returns for 1994, 1995, or 1996.
On Zero Gee’s income tax returns for each of the above
years, distributions equal to the total annual net income of Zero
Gee were claimed as income distribution deductions to the named
beneficiaries of the trust, and no taxable income was reported
for Zero Gee.
For 1994, 1995, and 1996, petitioners timely and jointly
filed their Federal income tax returns and reported thereon wages
and consulting income both from Zero Gee as follows:
Year Wages Consulting Income
1994 $ 0 $103,820
1995 4,000 72,315
1996 29,000 100
Cumulative Total $33,000 $176,235
Petitioners did not report as income on their joint income
tax returns any of the amounts represented by the income
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distribution deductions claimed on Zero Gee’s Federal income tax
returns.
Also, the evidence does not indicate that International Palm
and Universal Sun, the stated beneficiaries of Zero Gee, paid any
taxes (United States, British West Indies, or otherwise) on any
of the funds that Zero Gee treated as income distribution
deductions on its Federal trust income tax returns.
On audit, petitioner did not provide to respondent’s
representatives records relating to LPS and Zero Gee. In the
notice of deficiency issued to petitioners Robert and Colleen
Lund, respondent determined that the Zero Gee trust lacked
economic substance, and respondent charged petitioners for each
year in issue with the entire reported gross income of Zero Gee.
Alternatively, in the notice of deficiency issued to
petitioners Robert and Colleen Lund, respondent determined that
the grantor trust provisions of sections 671 through 677 applied
to Zero Gee and that the income of Zero Gee should be taxed to
petitioners individually.
Further, and protectively in a separate notice of deficiency
issued to Zero Gee for 1994, 1995, and 1996, respondent
determined under sections 671 through 679 for 1994, 1995, and
1996 that Zero Gee should be taxed on the reported income of Zero
Gee. No explanation is given in the notice of deficiency as to
the basis for this deficiency determination and, on brief,
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respondent makes no mention of this protective deficiency
determination against Zero Gee.
During pretrial discovery, petitioner provided information
to respondent’s representatives regarding the income and expenses
incurred in the business of LPS, and the parties agreed to the
above gross and net income figures of the business conducted in
the name of LPS.
OPINION
Taxpayers have a legal right, by whatever means allowable
under the law, to structure their transactions to minimize their
tax obligations. See Gregory v. Helvering, 293 U.S. 465, 469
(1935). Paper transactions, however, that have no significant
purpose other than to avoid tax and that are not based on
economic reality will not be recognized for Federal income tax
purposes. See Zmuda v. Commissioner, 79 T.C. 714, 719 (1982),
affd. 731 F.2d 1417 (9th Cir. 1984).
Where the form of a transaction has not, in fact, altered
any cognizable economic relationships, the courts may look
through the form and apply the tax law according to the substance
of the transaction. See Markosian v. Commissioner, 73 T.C. 1235,
1241 (1980).
Whether a trust is to be regarded as lacking in economic
substance for income tax purposes represents a question to be
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decided on the totality of the facts. See United States v.
Cumberland Pub. Serv. Co., 338 U.S. 451, 454 (1950).
The following factors are generally considered in deciding
whether, for income tax purposes, a purported trust is to be
treated as lacking in economic substance: (1) Whether the
taxpayer’s relationship, as grantor, to the property differed
materially before and after the trust’s formation; (2) whether
the trust had an independent trustee; (3) whether an economic
interest passed to other beneficiaries of the trust; and
(4) whether the taxpayer honored restrictions imposed by the
trust or by the law of trusts. See Markosian v. Commissioner,
supra at 1243-1245.
Petitioner argues that his relationship to LPS materially
changed after the transfer of LPS to Zero Gee. We disagree.
After Zero Gee was established, petitioner essentially continued
to manage and operate LPS in the same manner as before the
purported transfer to Zero Gee. Petitioner’s relationship to LPS
did not materially change. The ordinary business affairs of Zero
Gee were conducted in the name of LPS. Daily business decisions
were made by petitioner. Compensation of employees was
determined by petitioner, and customers were invoiced by and paid
their bills to LPS. The record does not reflect that the named
trustees of Zero Gee limited petitioner’s control over any aspect
of the business of LPS.
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We are incredulous that petitioner would have transferred
his 100-percent ownership interest in LPS, which petitioner
believed to be worth $1 to $2 million, to a foreign corporation
in exchange for no stated consideration and with nothing more
than an unsecured employment relationship. Petitioners have
failed to establish that their relationship to LPS differed
materially before and after the formation of Zero Gee.
With regard to the second factor, in form, Zero Gee
purportedly was managed by an independent trustee. The failure
of Bigelow Charter, Sun Federal, Loren and Bonnie Troescher, or
Owen Charles to have any meaningful role in the management of the
trust is evidence that the Zero Gee trust lacked economic
substance. See Zmuda v. Commissioner, 79 T.C at 720-721. The
evidence in these cases indicates that the trustees of Zero Gee
performed no meaningful work for Zero Gee.
The sparse evidence regarding the third factor indicates
that the beneficiaries of Zero Gee received nothing more than a
token payment for their participation or complicity in the trust
scheme. Clearly, neither International Palm nor Universal Sun
received an economic interest in Zero Gee. In spite of Zero
Gee’s cumulative 3-year net income in excess of $1 million,
International Palm and Universal Sun received nominal funds from
Zero Gee (i.e., the majority of Zero Gee’s income was not
distributed), and yet Zero Gee reported no tax on any of its
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reported income. Additionally, the ownership of International
Palm and Universal Sun was not disclosed. Based on the evidence,
we are convinced that no economic interest in LPS or in Zero Gee
passed to any named beneficiary of Zero Gee.
The evidence also establishes that petitioner, in his
continued management of LPS, was not bound or restricted by the
terms of the Zero Gee trust. Petitioner obtained bank loans and
credit for the business without approval of the trustees of Zero
Gee. Petitioner appears to have had essentially unrestricted use
of the property purportedly transferred to Zero Gee. The
trustees were not meaningfully involved in the business of LPS or
of Zero Gee. Petitioner was not restricted in any meaningful
manner in his use of the funds or in his management of LPS and
Zero Gee.
The only recognizable purpose for the formation of Zero Gee
was tax avoidance. For $30,000, petitioner purchased a sham
trust package supported by no economic substance. We conclude
that Zero Gee lacked economic substance and that the net income
of Zero Gee is taxable to petitioner.
Because we disregard Zero Gee for tax purposes and sustain
respondent’s deficiency determination against petitioners for the
years in issue, respondent’s protective deficiency determination
against Zero Gee is not sustained.
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Section 6662 imposes a penalty of 20 percent on any portion
of an underpayment of tax attributable to negligence or to
disregard of the rules or the regulations. For purposes of
section 6662(a) negligence is a failure to make a reasonable
attempt to comply with the Internal Revenue Code. See sec.
6662(c).
The accuracy-related penalties under section 6662(a) do not
apply to any part of an underpayment if the taxpayer shows
reasonable cause and if the taxpayer acted in good faith based on
the facts and circumstances. See sec. 6664(c). A taxpayer may
establish reasonable cause under section 6662(a) by proving
reasonable reliance in good faith on the advice of a competent,
independent expert or tax professional. See United States v.
Boyle, 469 U.S. 241, 250 (1985).
Where it is common knowledge that a tax planning proposal is
questionable, taxpayers are expected to make reasonable inquiry
as to the legality of the proposal. See Neely v. United States,
775 F.2d 1092, 1095 (9th Cir. 1985).
Petitioner failed to consult with an attorney or accountant
regarding the trust program promoted by Bigelow Charter.
Petitioners negligently disregarded the tax laws and are liable
for the accuracy-related penalties under section 6662(a).
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To reflect the foregoing,
Decisions will be entered
under Rule 155.