T.C. Memo. 2002-24
UNITED STATES TAX COURT
MICHAEL GRAHAM, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 18341-99. Filed January 24, 2002.
Andrew G. Shebay III and Robert B. Higgs, for petitioner.
Shelly T. Van Doran and Ronald B. Weinstock, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
FOLEY, Judge: By notice dated September 8, 1999, respondent
determined deficiencies in, and a penalty relating to,
petitioner’s Federal excise taxes as follows:
- 2 -
Deficiencies Penalty
Year Sec. 4941(a)(1)1 Sec. 4941(b)(1) Sec. 6684
1993 $ 9,894 -- --
1994 14,156 -- --
1995 17,531 -- --
1996 20,756 -- --
1997 23,981 -- --
1998 27,206 -- --
1999 30,431 $1,217,240 $1,361,195
The issue for determination is whether petitioner was a
substantial contributor who engaged in prohibited acts of self-
dealing with the Irene Cafcalas Hofheinz Foundation (Foundation)
during the years in issue.
FINDINGS OF FACT
Petitioner resided in Houston, Texas, when he filed his
petition.
On December 1, 1989, Bluff Creek Corporation (Bluff Creek)
was incorporated pursuant to Texas law. Petitioner’s wife,
Rosalind Graham, was the sole beneficial owner of Bluff Creek’s
stock until November 1992, when she became the sole shareholder.
On December 8, 1989, Bluff Creek purchased a house (the
residence) for $630,000. Petitioner and his wife lived in the
residence from that date through 1998.
Beginning in mid-1992, petitioner developed a business
relationship with Fred Hofheinz. Mr. Hofheinz was a businessman
and attorney in Houston. Mr. Hofheinz was also the trustee of
1
All section references are to the Internal Revenue Code
in effect for the years in issue.
- 3 -
the Foundation, which was created in 1983, out of the trust
created by his mother’s will. As of the end of 1992, the
Foundation had received contributions and bequests of $2,371,589.
Mr. Hofheinz participated in several of petitioner’s business
deals. Beginning in mid-1992, Mr. Hofheinz also made several
unsecured personal loans to petitioner, totaling more than $1
million (i.e., ranging from $20,000 to $352,137).
On September 28, 1992, petitioner was indicted for Federal
income tax evasion. After the indictment, petitioner needed
$200,000 to pay his attorney. He sought, but Mr. Hofheinz was
unwilling to extend, another unsecured personal loan to
petitioner. Petitioner and Mr. Hofheinz, however, entered an
oral purchase agreement (agreement) for the Foundation to
purchase the residence. At Mr. Hofheinz’s direction, the
Foundation purchased the residence, which had a fair market value
of $535,000. The agreement provided that in exchange for the
residence petitioner: (1) Would receive $250,000 to pay his
criminal attorney and other debts; (2) could later ask for, and
receive, an additional $135,000; and (3) could continue to live
in the residence rent-free for 3 years. Petitioner was
responsible for payment of taxes and insurance on the residence,
but he failed to pay the 1993 property taxes.
Mr. Hofheinz believed that purchasing the residence was a
good deal for the Foundation and that the purchase price was far
- 4 -
enough below its $630,000 tax assessment value that it would
allow the Foundation a substantial profit.
In 1992, petitioner entered into a plea bargain relating to
the Federal income tax evasion indictment. The plea bargain
required him to pay fines and back taxes of $135,000. Pursuant
to the purchase agreement, on June 3, 1993, Mr. Hofheinz
transferred to petitioner an additional $135,000 of Foundation
funds.
Petitioner and Mr. Hofheinz’s relationship deteriorated in
1995. In 1996, after Mr. Hofheinz began proceedings to evict
them from the residence, Mrs. Graham filed a bankruptcy petition.
In the bankruptcy proceeding, Mrs. Graham contended that the sale
was invalid because petitioner had no interest in the residence
owned by Bluff Creek and, therefore, could not sell it.
Although a backdated document (i.e., signed by Mr. Hofheinz
and petitioner sometime after June 3, 1993) stated that the
$135,000 payment was for the Grahams’ furniture, the furniture
remained in their possession. During Mrs. Graham’s bankruptcy
proceeding, the Foundation did not file a claim relating to the
furniture, and Mr. Hofheinz testified that the additional
$135,000 was consideration provided to the Grahams in exchange
for the residence. The bankruptcy court concluded that the 1992
transaction was a sale of the residence to the Foundation but did
not determine what constituted the consideration exchanged for
- 5 -
the residence. Mrs. Graham appealed the ruling. On November 16,
2000, in an unpublished opinion, the Court of Appeals for the
Fifth Circuit affirmed the bankruptcy court’s decision.
Respondent determined that petitioner sold the property at a
“bargain” price, resulting in a contribution to the Foundation
sufficient to make petitioner a substantial contributor.
Consequently, respondent determined deficiencies pursuant to
section 4941 and a section 6684 penalty, as set forth earlier.
OPINION
Section 4941(a)(1) imposes an excise tax on acts of self-
dealing between a private foundation and a disqualified person.
Section 4941(b)(1) imposes a second-tier tax on an act of self-
dealing that is not corrected within the taxable period. Self-
dealing transactions include sale and leases of property and
loans between a disqualified person and a private foundation, as
well as transfers of a foundation’s assets to a disqualified
person. Sec. 4941(d)(1).
Disqualified persons include substantial contributors to a
foundation, as defined in section 507(d)(2). Sec. 4946(a)(1)(A),
(2). A substantial contributor is a person who, in the
aggregate, contributed “more than $5,000 to the private
foundation, if such amount is more than 2 percent of the total
contributions * * * received by the foundation before the close
of the taxable year of the foundation in which the contribution
- 6 -
* * * is received by the foundation from such person.” Sec.
507(d)(2)(A); Dupont v. Commissioner, 74 T.C. 498, 502 (1980).
Contributions are valued at their fair market value when received
by the foundation. Sec. 507(d)(2)(B)(i); sec. 1.507-6(c)(2),
Income Tax Regs.
Respondent contends that the sale was completed on November
10, 1992, for $250,000; the difference between the fair market
value of the residence and the consideration petitioner received
for such residence was a contribution to the Foundation; and, as
a result, petitioner is a substantial contributor to the
Foundation, liable for first- and second-tier excise taxes
pursuant to section 4941. Petitioner contends that he lacked
donative intent and, thus, was not a substantial contributor.
Petitioner further contends that the consideration for the sale
included the initial $250,000, the subsequent payment of
$135,000, and 3 years of rent-free occupation of the residence.
We agree with the bankruptcy court and respondent that the
sale was completed on November 10, 1992, when the residence was
transferred to the Foundation. We, however, agree with
petitioner that the consideration for the sale included the
initial payment made on November 10, 1992, the subsequent payment
made on June 3, 1993, and the 3-year period of rent-free
occupation of the residence.
- 7 -
On November 10, 1992, petitioner sold the residence to the
Foundation. The Foundation gave petitioner $250,000, and
petitioner and his wife continued to live in the residence, rent-
free for 3 years. On June 3, 1993, the Foundation transferred an
additional $135,000 to petitioner. Respondent’s expert testified
that on November 10, 1992, the present value of 3 years of rent
was $111,371,2 and the present value of the additional $135,000
payment was $131,905. Thus, according to the uncontradicted
testimony of respondent’s expert, on November 10, 1992, the fair
market value of the residence was $535,000 and the present value
of the $250,000 payment, the $135,000 payment, and the rent-free
occupation of the residence was $493,276.
Petitioner may be a substantial contributor only if the
transfer to the Foundation exceeds $47,432, which is 2 percent of
the total contributions received by the Foundation at or before
the end of 1992 (i.e., $2,371,589). Sec. 507(d)(2)(A).
Petitioner’s net transfer of $41,724 (i.e., the difference
between the $535,000 fair market value of the residence and the
$493,276 consideration received from the Foundation) was
insufficient to make him a substantial contributor to the
Foundation. At trial, respondent conceded that petitioner would
not be a substantial contributor if the Court found that the
2
The present value was adjusted to take into account the
value of the tenants’ payment of property taxes and insurance.
- 8 -
consideration exchanged for the residence included the $250,000
and $135,000 payments and 3 years of rent-free occupancy of the
residence. Thus, we need not determine whether petitioner’s
transfer of the residence to the Foundation was a contribution,
or whether petitioner had donative intent relating to such
transaction. Accordingly, petitioner is not liable for any
excise tax pursuant to section 4941(a)(1) or (b)(1).
Section 6684 imposes a penalty on a person who becomes
liable for a chapter 42 excise tax (i.e., such as those imposed
by section 4941) where the act or omission was not due to
reasonable cause and the person had been previously liable. The
penalty is also imposed when the act or omission was both willful
and flagrant. Because petitioner is not liable for tax pursuant
to chapter 42, petitioner is not liable for this penalty.
Contentions we have not addressed are moot, irrelevant, or
meritless.
To reflect the foregoing,
Decision will be entered
for petitioner.