EDWARDS v. COMMISSIONER

T.C. Memo. 2002-169

UNITED STATES TAX COURT

DAVID J. EDWARDS, Petitioner v. COMMISSIONER OF
INTERNAL REVENUE, Respondent

Docket No. 7010-00. Filed July 12, 2002.

Noel W. Spaid, for petitioner.

Dale A. Zusi, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

BEGHE, Judge: Respondent determined the following

deficiencies in petitioner’s Federal income taxes and associated

penalties:
 - 2 -

Penalty
TYE Dec. 31 Deficiency Sec. 6662(a)

1996 $540,192 $108,038
1997 511,866 102,373

After concessions by the parties, the issues for decision

are:

1. Whether petitioner failed to report $170,619 of income

for 1996. We hold he did.

2. Whether petitioner is entitled to deduct any portion of

the $278,365 that he claimed for 1996 on Schedule C, Profit or

Loss From Business, and that respondent disallowed. We hold he

is not.

3. Whether petitioner is entitled to deduct any airplane

expenses on Schedules C of his 1996 and 1997 tax returns. We

hold he is not.

4. Whether petitioner is entitled to deduct any expenses of

maintaining his personal residence as a trade or business under

sections 162(a) and 280A. We hold he is not.

5. Whether petitioner is liable for penalties under section

6662(a)1 for 1996 and 1997. We hold he is.

6. Whether sanctions under section 6673(a) should be

imposed on petitioner or his counsel. We hold that petitioner

1
Unless otherwise indicated, section references are to the
Internal Revenue Code as in effect for the years in issue, and
Rule references are to the Tax Court Rules of Practice and
Procedure.
 - 3 -

should be penalized, and that respondent should submit an

affidavit of costs for the Court’s use in deciding whether and to

what extent petitioner’s counsel should be liable for

respondent’s excess costs and the amount of the penalty to be

imposed on petitioner.

FINDINGS OF FACT

Some of the facts have been stipulated and are so found.

The stipulated facts and the attached exhibits are incorporated

herein by this reference. Petitioner resided in Clovis,

California, when he filed the petition.

Petitioner is a medical doctor who has been practicing

preventive medicine since 1961. During the years in issue,

petitioner carried on his medical practice under the name

Sunnyside Medical.

Petitioner also makes movies for use in his medical

practice, provides religious and spiritual guidance to patients,

markets music written by his father, and composes music.

Petitioner also acts as a registered medical examiner for the

Federal Aviation Administration. Petitioner did not track the

receipts and expenditures of his spiritual, music, and movie-

making activities separately from those of his medical practice.

During the years in issue, petitioner resided at 451 Burl

Avenue, Clovis, California (Burl Avenue residence). Petitioner

did not see patients at the Burl Avenue residence. However, he
 - 4 -

made and received patient telephone calls at the Burl Avenue

residence and prepared for meetings with patients. He also

stored audio and video equipment at the Burl Avenue residence.

Petitioner’s main medical office was at 360 South Clovis

Avenue, Fresno, California (Fresno office). Petitioner also

maintained medical offices in Merced, California, and Burbank,

California.

Petitioner stored some of his film-making equipment at the

Burl Avenue residence because he believed it was more secure than

the studio where he had originally stored the equipment.

Petitioner’s film and music equipment was not inventory held for

sale to customers in the ordinary course of business but was

instead used by petitioner to make films and recordings.

In 1995, on the advice of Estate Preservation Services (EPS)

operated by Robert L. Henkell (Henkell), petitioner transferred

ownership of his medical practice, his movie and sound equipment,

his airplane and other vehicles, his personal residence, and

other assets to seven separate trusts. Attached as an appendix

to this opinion are a diagram and a schedule prepared by EPS

showing the ownership of petitioner’s trust entities and the flow

of funds among them. Petitioner’s revocable trust held complete

ownership of the “focus trust”, which in turn held complete

ownership of the remaining trusts. Petitioner retained direct or
 - 5 -

indirect beneficial ownership of all trust assets. Petitioner

also continued to exercise control over the trust assets after

the transfers.

Although petitioner did not recognize or report any gain

when he transferred his assets to these trusts, the trusts took

depreciation deductions on the transferred assets based on their

alleged fair market values at the time of transfer to the trusts

(rather than on the original cost or depreciated basis in

petitioner’s hands).

In 1995, the Commissioner determined that Henkell and EPS

were engaged in promoting illegal tax shelters designed to claim

excessive and/or improper deductions and assessed penalties of

$1,254,000 each against Henkell and EPS pursuant to section 6700.

In 1997, the Commissioner obtained from the U.S. District

Court for the Eastern District of California an injunction

preventing EPS and Henkell from rendering tax shelter advice. In

United States v. Estate Pres. Servs., 202 F.3d 1093 (9th Cir.

2000), the Court of Appeals for the Ninth Circuit affirmed the

injunction issued by the District Court, holding, among other

things, that EPS and Henkell knowingly made false statements to

taxpayers concerning the tax benefits of the trusts they promoted

as tax shelters.

Petitioner filed Form 1040, U.S. Individual Income Tax

Return, reporting $10,613 in taxable income for 1996 and $13,380
 - 6 -

in taxable income for 1997. These returns reported Federal

income tax liabilities of $2,465 for 1996 and $4,497 for 1997.

Each of the trusts filed Forms 1041, U.S. Income Tax Return for

Estates and Trusts, for tax years 1996 and 1997 reporting

negative taxable income.2

Petitioner did not keep a general ledger accounting system.

Instead, petitioner’s counsel admitted at trial that petitioner’s

records consisted of “just gross receipts, a massive amount of

receipts, he does not keep journals and stuff like that”.

On June 13, 1996, respondent sent a form letter to

petitioner’s current spouse, Jeanee Girazian, who at the time was

living with and working for petitioner and was a named trustee of

his trusts. Respondent’s letter stated that he had information

that Ms. Girazian might be involved in trust arrangements used

for tax avoidance purposes. The letter cited substantial

authority holding abusive trusts invalid and recommended that Ms.

Girazian obtain independent advice regarding the validity of the

trusts.

2
Respondent issued notices of deficiency to the trusts
disallowing all trust deductions. The trusts failed to file
petitions to the Tax Court within the 90-day period provided by
sec. 6213(a). Respondent thereupon assessed deficiencies against
the trusts. Respondent has agreed to hold in abeyance efforts to
collect the assessed deficiencies from the trusts while the case
at hand is pending. In view of the agreement of the parties in
the case at hand that the trusts should be disregarded for
Federal income tax purposes since their inception, it is
understood that the assessments against the trusts will be
abated.
 - 7 -

Respondent commenced an audit of petitioner’s 1996 and 1997

tax returns after July 22, 1998. Respondent sent petitioner a

letter requesting that he produce his records for examination.

On January 21, 1999, respondent’s examiner met petitioner and his

adviser, Ilena Hamilton, at respondent’s office.3

Petitioner began the meeting by stating that he would not

provide any information concerning the trusts he had formed

because he was under some unspecified duty not to disclose trust

information. Petitioner told respondent’s agent to obtain the

trust information from the trustees. Petitioner refused to

identify the trustees or to disclose how respondent could obtain

the information.

Respondent then asked whether petitioner had brought any

personal records to support his return. In response, petitioner

read a lengthy prepared statement objecting that it was improper

for respondent to audit more than 1 year’s return at a time. He

stated that he would not provide any records until respondent, in

writing, answered certain questions, and even then he would

produce only those documents that would not “violate my fourth

amendment rights which guarantee the right to privacy of one’s

house, papers, effects and my fifth amendment right which

guaranties that one cannot be compelled to be a witness against

3
The meeting was taped, and a full transcript of the meeting
was admitted into evidence.
 - 8 -

oneself”. Petitioner failed to specify how any of these

privileges would apply to the financial records that formed the

basis for his returns.

Petitioner demanded written answers to his questions before

he would consider cooperating with respondent’s examination.

Petitioner demanded a written response stating: (1) The basis

for respondent’s examiner’s authority to conduct the examination;

(2) the statutory authority for the examination; (3) “you have to

show us where 7006 gets its implementing implant, excuse me,

implementing authority and if that implementing authority on 7602

is all inclusive to the outside of the definition”; and (4)

whether respondent could establish that petitioner had income

from one of the sources identified in section 1.861-8(f), Income

Tax Regs.

At the meeting, respondent’s examiner displayed her badge to

establish her authority to conduct the examination and cited

section 7602 to establish the statutory authority for the

examination. Respondent’s examiner advised petitioner both at

the meeting and in a letter dated February 10, 1999, that: (1)

Statutes are enforceable even if there are no regulations

interpreting them, and (2) section 1.861-8(f), Income Tax Regs.,

is irrelevant to petitioner’s returns and to the examination.

Petitioner did not produce his records in response to
 - 9 -

respondent’s letter of February 10, 1999. Petitioner’s conduct

constituted refusal to cooperate with respondent’s examination.

On April 24, 1999, respondent issued a formal summons for

petitioner’s records. On June 3, 1999, petitioner sent a letter

to respondent making frivolous tax protester arguments by citing

portions of statutes and court decisions entirely out of context

and demanding that respondent answer a new set of frivolous

questions. Petitioner signed his letter “Without prejudice UCC

10207”. The letter evidences petitioner’s continued refusal to

cooperate with respondent’s examination.

On June 12, 1999, petitioner and his counsel attended a

meeting with respondent’s examining agents. Again, petitioner

did not produce records in response to the summons and continued

to make frivolous demands.

Because petitioner did not produce records to support his

return positions, respondent elected to use an indirect method

(the bank deposits method) to determine petitioner’s tax

liability. On March 31, 2000, respondent issued a notice of

deficiency to petitioner. Respondent did not send a preliminary

30-day letter before issuing the notice of deficiency. The

period of limitations for making an assessment of petitioner’s

1996 tax liability would have otherwise expired on April 15,

2000.
 - 10 -

In the notice of deficiency, respondent determined that the

trusts created by petitioner were shams with no economic

substance and should be disregarded, or were grantor trusts all

of whose income is taxable to petitioner. Respondent determined

that petitioner’s reported gross income should be increased by

the gross income reported by the trusts ($560,184 for 1996 and

$495,048 for 1997) and by unexplained deposits made to

petitioner’s bank account ($170,619 for 1996 and $131,190 for

1997) and to one of petitioner’s trust bank accounts ($2,900 for

1996). Respondent disallowed all deductions claimed by

petitioner and the trusts, because petitioner failed to provide

substantiation for the deductions claimed on his returns

($574,430 for 1996 and $619,094 for 1997). Respondent made other

computational adjustments to petitioner’s returns resulting from

the additional income respondent determined (such as determining

that petitioner underreported self-employment taxes by $42,103

for 1996 and $39,443 for 1997). As a result of these

adjustments, respondent determined deficiencies of $540,192 for

1996 and $511,866 for 1997.

Respondent also determined that petitioner is liable for 20-

percent accuracy-related penalties under section 6662(a), because

petitioner was negligent or disregarded rules and regulations in

understating his taxable income, made substantial understatements

of income tax, and had not shown reasonable cause for the
 - 11 -

understatements. Applying the 20-percent rate to the

deficiencies, respondent determined penalties of $108,038 for

1996 and $102,373 for 1997.

Petitioner timely filed an original petition and an amended

petition with this Court. In his amended petition, petitioner

argued that all adjustments respondent made were erroneous.

Petitioner claimed his trusts were valid, and that the grantor

trust rules do not apply because he held neither legal nor

equitable title to the trust assets. Petitioner in his amended

petition also asserted the “Delpit” issue: that the Tax Court

lacks jurisdiction over his petition because respondent made the

determination without sending him a 30-day letter, without

advising him of his administrative rights, and without giving him

an opportunity for adequate administrative review. According to

petitioner’s counsel: “This denial has cost Petitioner undue

burden of Tax Court litigation that could have been resolved

administratively.”

The trial of this case occurred over 2 days, separated by

more than 5 months. This delay was caused in large part by the

failure of petitioner’s counsel to organize in coherent fashion

the exhibits she wished to include in the second of three

stipulations of fact. The first and third stipulations of fact,

prepared primarily by respondent, were filed with the Court at

the beginning of the first day of trial; the second stipulation
 - 12 -

of fact, prepared primarily by petitioner’s counsel, was filed,

subject to numerous objections to many exhibits by respondent on

relevance, hearsay, authentication, or lack of foundation

grounds, almost 4 months after the first day of trial.

Before trial, in petitioner’s trial memorandum, and during

the first day of trial, petitioner made two additional claims:

That the statutory notice of deficiency was invalid because the

wholesale disallowance of deductions amounted to a lack of

determination, the “Scar” issue; and that the Internal Revenue

Service is not an agency of the U.S. Government, the “Agency”

issue.

At the beginning of the second day of trial, petitioner,

through his counsel, made two oral motions: (1) To shift the

burden of proof to respondent under section 7491(a), claiming

that petitioner had cooperated at all levels; and (2) for

imposition of a penalty on respondent under section 6673(a)(1),

on the ground that respondent, by not offering petitioner an

Appeals Office conference prior to issuance of the statutory

notice, had deprived petitioner of administrative remedies.

During both trial days, petitioner continued to claim that

the trusts were valid for Federal income tax purposes. The first

day of trial dealt primarily with the validity of the trusts and

events occurring during the audit. These subjects were also

covered during the second day of trial in the cross-examination
 - 13 -

of the revenue agent who had examined petitioner’s returns and

direct testimony of petitioner. The second day of trial also

covered petitioner’s attempts to prove additional deductions

using amended returns for petitioner and the trusts.

More than 3 months after the second day of trial, and

shortly before posttrial briefs were originally due, respondent

and petitioner entered into a superseding stipulation of settled

issues that resolved many of the issues previously in dispute

between the parties. The parties stipulated that the trusts were

invalid for Federal income tax purposes, and that all the trust

income and deductions should be allocated to petitioner. In

addition, both petitioner and respondent made substantial

concessions regarding the deficiencies. The following table

shows the amount of Schedule C deductions and cost of goods sold

originally claimed, the amount that respondent has agreed to

allow, the disallowed amount that petitioner has conceded, and

the amount that remains in dispute:

1996 1997

Claimed $574,430 $619,094
Allowed (280,195) (426,551)
Disallowed (15,870) (192,543)
Disputed 278,365 ---

The parties also stipulated that petitioner failed to report

income of $62,061 in 1997, and that petitioner is entitled to

deductions on Schedule A, Itemized Deductions, of $21,929 for

1996 and $21,061 for 1997, subject to any statutory limitations
 - 14 -

based on petitioner’s adjusted gross income. The parties

stipulated that petitioner is subject to self-employment tax and

is entitled to a deduction for one-half of the self-employment

tax and that the exemption and taxability of petitioner’s Social

Security receipts are computational and depend on petitioner’s

adjusted gross income.

Finally, the parties agreed that the only issues in dispute

for the Court to decide are the first five issues discussed

below. In addition to those five issues, respondent requested in

his posttrial brief that we impose penalties against petitioner

under section 6673(a)(1). Petitioner objected to the imposition

of section 6673(a)(1) penalties, contending that his arguments

were correct and requesting that we specifically address the

“Delpit”, “Scar”, and “Agency” issues.

OPINION

Petitioner’s Failure To Report $170,619 of Income in 1996

Section 6001 provides that “Every person liable for any tax

imposed by this title, or the collection thereof, shall keep such

records, render such statements, make such returns, and comply

with such rules and regulations as the Secretary may from time to

time prescribe.” Section 1.6001-1(a), Income Tax Regs., requires

any person required to file a return to “keep such permanent

books of account or records, including inventories, as are
 - 15 -

sufficient to establish the amount of gross income, deductions,

credits, or other matters required to be shown by such person in

any return of such tax”.

Petitioner did not maintain any books of account for his

medical practice or his other activities. Petitioner’s counsel

acknowledged that petitioner’s records consisted of “just gross

receipts, a massive amount of receipts, he does not keep journals

and stuff like that”. Petitioner did not offer any books of

account into evidence.

Before filing the petition in this case, petitioner refused

to produce any documents in response to respondent’s informal and

formal requests or to substantiate the income and deductions

reported on his and his trusts’ Federal income tax returns.

Petitioner improperly refused to provide any documents related to

his trusts. Petitioner refused to produce his personal return

documents unless respondent provided acceptable (to him) written

responses to his questions. Petitioner’s questions were

improper, and he had no right to require responses to them before

producing documents. Even though respondent was under no

obligation to do so, respondent provided clear written responses

to petitioner’s improper questions. Even after receiving the

responses, petitioner failed to produce any documents to support

his returns. Petitioner provided no support for his contention

that he was under some privilege not to produce the trust
 - 16 -

documents in his possession or under his control. We are aware

of no such privilege. See Barmes v. Commissioner, 89 AFTR 2d

2249, 2250, 2002-1 USTC par. 50,312 at 83,742 (7th Cir. 2002)

(taxpayer’s argument that trust information was confidential or

privileged held to be frivolous: “The Barmeses should count

themselves fortunate that the Commissioner did not ask for

additional sanctions in this court.”), affg. T.C. Memo. 2001-155;

SEC v. Bilzerian, 131 F. Supp. 2d 10, 16 n.8 (D.C. Cir. 2001)

(expressing serious doubts about validity of trustee’s

confidentiality claims).

Because petitioner did not maintain proper books of account

and wrongfully failed to produce records to substantiate his

return positions, respondent used an indirect method of

determining petitioner’s taxable income. We have repeatedly

upheld the use of an indirect method to determine taxable income

where the taxpayer fails to maintain or produce sufficient

records to establish the taxpayer’s proper tax liability. For

example, in Judy v. Commissioner, T.C. Memo. 1997-232, we stated:

Every taxpayer is required to maintain sufficient
records to enable the Commissioner to establish the
amount of his taxable income. Sec. 6001; sec.
1.6001-1(a) and (b), Income Tax Regs. If such records
are lacking, the Commissioner may reconstruct the
taxpayer's income by any indirect method that is
reasonable under the circumstances. Cebollero v.
Commissioner, 967 F.2d 986, 989 (4th Cir. 1992), affg.
T.C. Memo. 1990-618; Petzoldt v. Commissioner, 92 T.C.
661, 687 (1989); Schellenbarg v. Commissioner, 31 T.C.
1269, 1277 (1959), affd. in part and revd. and remanded
 - 17 -

in part on another issue 283 F.2d 871 (6th Cir. 1960).
* * *

Respondent used the bank deposits method to reconstruct

petitioner’s income. As we recognized in Zuckerman v.

Commissioner, T.C. Memo. 1997-21:

Use of the bank deposits method for reconstructing
income is well established. DiLeo v. Commissioner, 96
T.C. 858, 867 (1991), affd. 959 F.2d 16 (2d Cir. 1992);
Estate of Mason v. Commissioner, 64 T.C. 651, 656
(1975), affd. 566 F.2d 2 (6th Cir. 1977). Under the
bank deposits method there is a rebuttable presumption
that all funds deposited to a taxpayer's bank account
constitute taxable income. Price v. United States, 335
F.2d 671, 677 (5th Cir. 1964); Hague Estate v.
Commissioner, 132 F.2d 775, 777-778 (2d Cir. 1943),
affg. 45 B.T.A. 104 (1941); DiLeo v. Commissioner,
supra at 868. The Commissioner must take into account
any nontaxable sources of deposits of which she is
aware in determining the portion of the deposits that
represent taxable income, but she is not required to
trace deposits to their source. Petzoldt v.
Commissioner, supra 695-696; Estate of Mason v.
Commissioner, supra at 657.

The bank deposits analysis was quite complex by reason of

the massive number of financial transfers petitioner made through

his web of trusts and accounts. Petitioner made many transfers

between accounts in his name, in the names of the eight trusts he

created, and in the name of his current spouse, Jeanee Girazian.

In order to avoid double counting income, it was necessary for

respondent to exclude transfers made between accounts.

Respondent introduced into evidence a detailed bank deposits

analysis itemizing the specific deposits that respondent treated

as constituting income to petitioner.
 - 18 -

Once the Commissioner makes a prima facie case of unreported

income using the bank deposits method and has made a

determination in the notice of deficiency, the taxpayer bears the

burden of proving that the deposits identified by the

Commissioner as unreported income do not, in fact, represent

unreported income. Hardy v. Commissioner, 181 F.3d 1002, 1004-

1005 (9th Cir. 1999) (if the Commissioner introduces some

evidence that the taxpayer received unreported income, the burden

shifts to the taxpayer to show by a preponderance of the evidence

that the deficiency was arbitrary or erroneous), affg. T.C. Memo.

1997-97; Clayton v. Commissioner, 102 T.C. 632 (1994); DiLeo v.

Commissioner, 96 T.C. 858, 869 (1991) (“petitioners, not the

Government, bear the burden of proving that respondent’s

determination of underreported income, computed using the bank

deposits method of reconstructing income, is incorrect”), affd.

959 F.2d 16 (2d Cir. 1992); Beck v. Commissioner, T.C. Memo.

2001-270 (“Bank deposits are prima facie evidence of income.”);4

4
Petitioner moved at trial that respondent should bear the
burden of proof under sec. 7491(a), under which the burden of
proof is placed on respondent as to any factual issue for which
petitioner offers credible evidence that is relevant to his
liability for the income tax deficiencies if certain conditions
have been satisfied. According to the legislative history of
sec. 7491: “The taxpayer has the burden of proving that it meets
each of these conditions, because they are necessary
prerequisites to establishing that the burden of proof is on the
Secretary.” S. Rept. 105-174, at 45 (1998), 1998-3 C.B. 537,
581. Among other conditions, petitioner must show that he “has
maintained all records required under this title and has
(continued...)
 - 19 -

Kling v. Commissioner, T.C. Memo. 2001-78 (“Absent some

explanation, a taxpayer's bank deposits represent taxable income.

* * * The taxpayer has the burden of proving that the bank

deposits came from a nontaxable source.”). Respondent made a

prima facie case by identifying deposits to petitioner’s

accounts. It was therefore incumbent upon petitioner to show a

nontaxable source for the deposits.

Petitioner failed to offer credible evidence to show that

any of the deposits respondent identified in his bank deposits

analysis were from nontaxable sources. Petitioner’s tax adviser,

Catherine Carroll (Carroll),5 offered into evidence the front of

a check in the amount of $10,892.11. Carroll claimed that the

check had been deposited to one of petitioner’s accounts and had

4
(...continued)
cooperated with reasonable requests by the Secretary for
witnesses, information, documents, meetings, and interviews”.
Sec. 7491(a)(2)(B). Petitioner did not maintain proper books and
records as required by the regulations and did not cooperate with
respondent’s reasonable requests for information and documents
during the examination. Because petitioner did not satisfy the
conditions of sec. 7491(a), he bears the burden of proof with
respect to the income tax deficiencies respondent determined.
5
Petitioner hired Carroll to provide forensic accounting
services and expert testimony in connection with this case. She
was not involved in the creation of petitioner’s trusts nor in
the preparation of petitioner’s and the trusts’ original Federal
income tax returns. At trial, Carroll did submit on behalf of
petitioner and the trusts amended Federal income tax returns.
Because respondent claimed from the beginning, and petitioner has
now conceded, that all trust items are taxable to petitioner, the
trust returns and proposed amendments are nullities. Throughout
this opinion we will refer to Carroll as petitioner’s “tax
adviser”.
 - 20 -

been double counted in respondent’s bank deposits analysis. The

check was not timely exchanged with respondent, and the back of

the check was not offered into evidence. Without the back of the

check, it was impossible to determine to which account the check

had been deposited. Petitioner failed to establish that the

check represents a deposit that was treated by respondent as

coming from a taxable source.

Instead of providing evidence of a nontaxable source for the

deposits respondent identified in his bank deposits analysis,

Carroll attempted to offer an alternative bank deposits analysis.

In preparing her bank deposits analysis, Carroll assumed that all

income from a taxable source was deposited into the Medicine

International Account or one of petitioner’s J.G. Edwards

accounts. Carroll testified that her assumption was based on

assurances from petitioner. Carroll admitted that she could not

specifically identify where the deposits came from.

In this case, we do not accept petitioner’s unsworn, self-

serving statements to Carroll, upon which she based her analysis,

as credible. Petitioner intentionally created a confusing web of

bank accounts in his own name, in the names of his eight trusts,

and in the name of his current spouse, and engaged in numerous

interaccount transfers. Petitioner failed to maintain a proper

accounting system to keep track of these transactions and has

been unable to explain with documentary evidence the sources of
 - 21 -

the deposits respondent identified as taxable income. Under

these circumstances, we do not accept Carroll’s bank deposits

analysis.

On brief, respondent states that his revised bank deposits

analysis fixes petitioner’s unreported income for 1996 as

$54,516, rather than $170,619. We sustain respondent’s

concession to this effect.

Petitioner’s Right to Schedule C Deductions and Cost of Goods
Sold in 1996 of $278,365

Because petitioner provided no documentation to substantiate

deductions, respondent disallowed all deductions petitioner

claimed. During discovery in this case, petitioner finally

provided documentation to substantiate some of his business

expense deductions. On the basis of the documentation petitioner

provided during this case, respondent allowed $280,195 of the

$574,430 in business expense deductions and cost of goods sold

petitioner claimed for 1996 and $426,551 of the $619,094 in

business expense deductions petitioner claimed for 1997.

Petitioner conceded the balance he claimed for 1997 but has not

conceded the balance claimed for 1996. We must therefore decide

whether petitioner has substantiated any business expense

deductions and cost of goods sold for 1996 in excess of the

amount allowed by respondent.

Taxpayers who dispute the Commissioner’s disallowance of

deductions claimed on their returns must show they satisfied the
 - 22 -

specific statutory requirements entitling them to the claimed

deductions. New Colonial Ice Co. v. Helvering, 292 U.S. 435

(1934); Davis v. Commissioner, 81 T.C. 806, 815 (1983), affd.

without published opinion 767 F.2d 931 (9th Cir. 1985). While

the Court may estimate the amount of allowable deductions where a

taxpayer establishes his entitlement to, but not the amount of,

the deductions, Cohan v. Commissioner, 39 F.2d 540, 543-544 (2d

Cir. 1930), any such estimate must have a reasonable evidentiary

basis, Vanicek v. Commissioner, 85 T.C. 731, 742-743 (1985).

Without a reasonable evidentiary basis, the Court’s allowance of

deductions would amount to unguided largesse. Williams v. United

States, 245 F.2d 559, 560 (5th Cir. 1957).

Respondent disallowed amounts claimed on petitioner’s

returns for cost of goods sold, car and truck expenses,

commissions, and “other property lease”. In his posttrial brief,

petitioner claimed $315,000 in alleged payments made to “Alpine

Industries” as cost of goods sold and claimed deductions for

$7,899 in “fiduciary fees”, for $7,436 in car and truck expenses

for travel between petitioner’s Fresno and Merced offices, and

for $11,500 in rent paid for petitioner’s Burbank office. On

brief, petitioner did not cite any evidence in the record to

substantiate these deductions.

The alleged “fiduciary fees” were not claimed on any return

and were not listed by petitioner as a disputed item in the
 - 23 -

stipulation of facts, and we were unable to find any reference at

trial to these alleged fees. Petitioner’s brief contains no

citation of the record to support this claim.

Petitioner alleges on brief that $315,000 was paid to Alpine

Industries for cost of goods sold. There is no evidence in the

record to support petitioner’s contention that he made payments

of $315,000 to Alpine Industries. Indeed, petitioner’s tax

adviser, Carroll, testified that the cost of goods sold amount

was based primarily on payments made from one of petitioner’s

bank accounts to another (which was held in the name of the “Claw

trust”). Respondent conceded a deduction of $8,924 for amounts

petitioner paid to Alpine Industries. Petitioner has not

substantiated any portion of the balance of the amount claimed.

Petitioner states on brief that he should be allowed to

deduct $7,436 in car expenses for his travel between his Fresno

and Merced offices. Petitioner must meet the strict

substantiation requirements of section 274(d) with respect to

travel expenses. Except as otherwise provided in the

regulations, section 274(d) requires the taxpayer to substantiate

with adequate records or sufficient evidence corroborating his

own statements: (1) The amount of the expense, (2) the time and

place of the travel, and (3) the business purpose of the expense.

Under the regulations, to meet the “adequate records” requirement

of section 274(d), a taxpayer “shall maintain an account book,
 - 24 -

diary, log, statement of expense, trip sheets, or similar record

* * * and documentary evidence * * * which, in combination, are

sufficient to establish each element of an expenditure”. Sec.

1.274-5T(c)(2)(i), Temporary Income Tax Regs., 50 Fed. Reg. 46017

(Nov. 6, 1985) (emphasis added).

Petitioner did not maintain a mileage log. Carroll

testified that petitioner made one round trip between his Fresno

and Merced offices every other Wednesday. Petitioner testified

that the distance between his Fresno and Merced offices was 60

miles each way. Respondent allowed a deduction for 120 miles of

travel per week at the statutory mileage rate of 31 cents per

mile ($1,934.40 per year).

Petitioner failed to explain coherently the basis for the

additional amounts claimed. Petitioner’s testimony suggests the

additional amounts claimed are an estimate of commuting expenses

between his home and office. Commuting expenses are not

deductible. See sec. 162; Fausner v. Commissioner, 413 U.S. 838

(1973); Heuer v. Commissioner, 32 T.C. 947, 951 (1959), affd. per

curiam 283 F.2d 865 (5th Cir. 1960); Reynolds v. Commissioner,

T.C. Memo. 2000-20. Commuting expenses between a home office and

another place of business are deductible if the home office is

the taxpayer’s principal place of business. Strohmaier v.

Commissioner, 113 T.C. 106, 113-114 (1999); Curphey v.

Commissioner, 73 T.C. 766, 777-78 (1980); Gosling v.
 - 25 -

Commissioner, T.C. Memo. 1999-148. Petitioner’s residence was

not his principal place of business. Therefore, he is not

entitled to deduct his commuting expenses.

Petitioner claims on brief, without any citation of the

record, that the “other property lease” amounts represent rent

paid to the landlord for the Burbank office. Respondent allowed

a deduction for all rent paid for use of the Burbank office. It

is apparent that petitioner has not shown what the $11,500 in

claimed “other property lease” expenses was for. Petitioner did

not substantiate his “other property lease” claim.

Petitioner argues on brief that $1,848 should be allowed for

repairs and maintenance. Respondent already allowed this amount.

Petitioner’s presentation to the Court was so disorganized that

petitioner apparently briefed an issue that is not in dispute.

Respondent has allowed deductions for all amounts petitioner

substantiated. Petitioner has presented no credible evidence to

support the allowance of additional deductions. We therefore

uphold respondent’s determination disallowing Schedule C

deductions and cost of goods sold of $278,365.

Airplane Expenses

Petitioner asks the Court to allow him a deduction for

expenses relating to his airplane. Petitioner did not claim

deductions for airplane expenses on his return, nor did he seek

allowance of deductions for airplane expenses in his petition to
 - 26 -

this Court. Petitioner made no motion to amend his petition and

raised this issue for the first time at trial. Respondent

contends that we should not consider petitioner’s request because

petitioner failed to raise the issue in his petition. “We have

held on numerous occasions that we will not consider issues which

have not been pleaded.” Foil v. Commissioner, 92 T.C. 376, 418

(1989), affd. 920 F.2d 1196 (5th Cir. 1990); Markwardt v.

Commissioner, 64 T.C. 989, 997 (1975); Brumley v. Commissioner,

T.C. Memo. 1998-424.

Copies of petitioner’s “flight log” were received in

evidence, and we heard his testimony on the subject. The issue

was tried by consent, see Rule 41(b), and we will consider the

issue on the merits. For the reasons set forth below, we deny

petitioner’s belated claims for the deductibility of airplane

expenses.

First, petitioner did not show the travel expenses were not

incurred in commuting from his home. Taxpayers cannot deduct

commuting expenses even if the taxpayer’s home is a long distance

from his office. In Commissioner v. Flowers, 326 U.S. 465, 473

(1946), the Supreme Court denied a deduction for travel expenses

between the taxpayer’s home in Jackson, Mississippi, and his

office in Mobile, Alabama, stating: “Whether he maintained one

abode or two, whether he traveled three blocks or three hundred

miles to work, the nature of these expenditures remained the
 - 27 -

same.” See also United States v. Tauferner, 407 F.2d 243 (10th

Cir. 1969); Smith v. Warren, 388 F.2d 671 (9th Cir. 1968);

Bunevith v. Commissioner, 52 T.C. 837 (1969), affd. without

published opinion 25 AFTR 2d 935, 70-1 USTC par. 9414 (1st Cir.

1970).

Petitioner offered conflicting testimony at trial as to

whether his airplane was used for commuting. At one point, he

testified: “I do go from the home office to the airport for

transportation by plane to Burbank where my other office is and

have a car at the airport in Burbank to link up with that airport

and my office there.” He then attempted to change this

testimony: “I usually leave on a Friday afternoon from the

medical office in Fresno and go to the Burbank office. It’s

mainly office to office commuting.”

After trial, petitioner attempted to clarify his testimony

with a self-serving hearsay declaration submitted with his reply

brief. Petitioner states in the declaration that he never

travels directly from his home to Burbank but instead always

leaves from his Fresno office. We decline to consider

petitioner’s declaration submitted after trial. The statements

are hearsay and untimely, and we do not find the statements in

the declaration to be credible in light of petitioner’s

spontaneous trial testimony.
 - 28 -

Second, petitioner’s travel expenses are subject to the

strict substantiation requirements of sections 274(d) and

280F(d)(4)(ii). Petitioner failed to substantiate the amount of

his expenses or the time, place, and business purpose of his

travel. Petitioner’s “flight log” was not legible and did not

contain the specific information required by section 274(d), such

as the business purpose of each flight. Petitioner claimed that

the airplane was used for travel to and from his Burbank office,

for travel to business meetings (none of which were

substantiated), and for maintaining his flying proficiency which

he claims is “helpful”, but not strictly required, for

maintaining his status as a medical examiner for airline pilots.

Petitioner’s compliance with the strict substantiation

requirements of section 274(d) is necessary in order to enable

the Court to determine the percentage of business use and thus

the allowable amount of petitioner’s claimed deductions. See

Noyce v. Commissioner, 97 T.C. 670 (1991) (treating flight

training, personal use, and maintenance flights as nonbusiness

use and allowing deduction only for business-use portion of

expenses).

With respect to deductions other than depreciation,

petitioner must establish that the expenditures were ordinary,

necessary, and reasonable. Id. at 685; Marshall v. Commissioner,

T.C. Memo. 1992-65. To establish that the expenses are ordinary,
 - 29 -

petitioner must show that the expenses were of the type expected

to be incurred in his business and were not personal expenses

incurred for pleasure. See Noyce v. Commissioner, supra at 687;

Marshall v. Commissioner, supra. Petitioner must also establish

that the expenses were reasonable under the circumstances. This

requires petitioner to establish that the expenses did not exceed

the income earned or expected from the activity. See Noyce v.

Commissioner, supra at 687-688. Petitioner failed to show that

he generated a profit from having a Burbank office. In

particular, he did not show that his Friday afternoon trips to

Burbank were made for business and not personal purposes.

Petitioner has failed to establish his entitlement to the

deductions for airplane expenses. Therefore, petitioner’s

request to deduct airplane expenses is denied.

Home Office Deduction

Petitioner seeks to deduct two-thirds of the expenses of

maintaining his home (including his mortgage payments, both

principal and interest, taxes, insurance, and utilities) as

above-the-line business expenses under sections 162(a) and 280A.

Petitioner has already been allowed an itemized deduction for

mortgage interest and real estate taxes. The repayment of

mortgage principal is, of course, not deductible. Commissioner

v. Tufts, 461 U.S. 300, 307 (1983). Petitioner appears to be

seeking a double deduction, which, of course, is not permissible.
 - 30 -

Respondent objects to the Court’s consideration of

petitioner’s request to deduct as business expenses two-thirds of

the expenses incurred in maintaining his home, because petitioner

did not assert the claim in his petition. Although petitioner

did not properly plead this issue, it was tried by consent and we

will decide it.

Petitioner has failed to establish his entitlement to deduct

two-thirds of the costs of maintaining his home (or any portion

of such costs). Under section 280A(c), no deduction is allowed

for expenses relating to a dwelling unit used as a residence,

unless a portion of the residence is “exclusively used on a

regular basis” as either the “principal place of business

* * * of the taxpayer” or “as a place of business which is used

by patients, clients, or customers in meeting or dealing with the

taxpayer in the normal course of his trade or business”.

Petitioner did not use his home as his only place of business.

He maintained business offices in Fresno, Merced, and Burbank.

In addition, petitioner failed to establish that his

residence was his principal place of business. The location of

the taxpayer’s important or significant business activities is an

important indicator of the principal place of business. In

Commissioner v. Soliman, 506 U.S. 168 (1993), the Supreme Court

held that an anesthesiologist’s principal place of business was

the hospital where he performed his medical services, not his
 - 31 -

home office. See also Chong v. Commissioner, T.C. Memo. 1996-232

(rejecting argument by medical doctor that billing and collecting

from patients constitutes a separate trade or business). Like

the anesthesiologists in Soliman and Chong, petitioner does not

see patients at his home office. Petitioner maintains separate

medical offices at which he performs the most important functions

of his medical practice. Petitioner’s home office was not the

principal place of business for his medical practice, or the

place used by patients, clients, or customers in meeting or

dealing with petitioner in the normal course of his trade or

business.

Petitioner argues that his home is the principal place of

business for his separate trade or business of making films and

writing and selling music. However, petitioner did not establish

how much time he spent or money he made on his film and music

activities. Petitioner testified that any receipts from his film

and music activities were commingled with those of his medical

practice and could not be accounted for or determined separately.

Any home-office deduction would be limited to the gross income

derived from the business use of the residence. Sec.

280A(c)(5); Tobin v. Commissioner, T.C. Memo. 1999-328.

Petitioner did not establish that the revenues from the use of

his home would exceed his claimed deductions for mortgage

interest and real estate taxes allocable to such use that were
 - 32 -

allowed irrespective of whether the home was used for business.

Petitioner also failed to establish he conducted a separate

trade or business of making films or of composing and selling

music. Petitioner testified he produced no films in either 1996

or 1997, other than a few slide presentations in 1997 used in his

medical practice. Petitioner also failed to establish that

expenses relating to a separate trade or business of making films

or composing and selling music would have been allowable under

section 183 (which disallows losses from activities not engaged

in for profit).

Finally, petitioner failed to establish that his proposed

allocation of home expenses was appropriate. Petitioner’s

proposed allocation is based on an estimate of the portion of his

home used to store his film and music equipment. A deduction for

use of a home for storage of business property is allowed if the

dwelling is the “sole fixed location of such trade or business”

and is used as a “storage unit for the inventory or product

samples” of the taxpayer’s trade or business. Sec. 280A(c)(2);

Banatwala v. Commissioner, T.C. Memo. 1992-483. Petitioner used

his residence to store audio and video equipment used to make

films and music, not inventory held for sale to customers or

samples. Petitioner also failed to establish that his home is

the sole location of his trade or business. We therefore deny

petitioner’s request to deduct two-thirds or any portion of the
 - 33 -

expenses of maintaining his home as a trade or business expense

under sections 162(a) and 280A because he failed to substantiate

his entitlement to the claimed deductions.

Accuracy-Related Penalties Under Section 6662(a)

Section 6662(a) imposes a 20-percent penalty on the

underpayment of tax attributable to, among other things, the

taxpayer’s “negligence”, sec. 6662(b)(1), or “substantial

understatement of income tax”, sec. 6662(b)(2). Negligence is

defined to include the “failure to make a reasonable attempt to

comply” with the tax laws. Sec. 6662(c). A “substantial

understatement” is an understatement for the taxable year

exceeding the greater of 10 percent of the proper tax or $5,000.

Sec. 6662(d)(1)(A).

Section 7491(c) imposes on respondent the burden of

production of evidence that the section 6662(a) penalty is

appropriate, but respondent need not produce evidence regarding

reasonable cause. See Higbee v. Commissioner, 116 T.C. 438, 446-

447 (2001).

Petitioner reported Federal income tax liabilities of $2,465

for 1996 and $4,497 for 1997. On the basis of concessions made

thereafter and this Court’s rulings, petitioner’s tax liability
 - 34 -

will substantially exceed the amounts shown on his returns.

Petitioner substantially understated his tax liabilities for 1996

and 1997.

Moreover, petitioner was negligent. He failed to maintain

adequate records of his income and deductions, failed to

substantiate many items claimed on his returns, artificially

reduced his income through the use of sham trusts, and (as is

discussed below in connection with the Court’s consideration of

section 6673(a) sanctions) maintained positions on his returns,

in his petition, and through and after trial of this case that

were frivolous.

Petitioner argues that no accuracy-related penalty should be

imposed because he acted in good faith upon the advice of his tax

advisers. We disagree. While section 6664(c)(1) provides for

relief from penalties where the taxpayer shows good faith and

reasonable cause for the understatement, mere reliance on

advisers is not sufficient to establish good faith and reasonable

cause. Sec. 1.6664-4(b)(1), Income Tax Regs. (“Reliance on * * *

the advice of a professional tax advisor * * * does not

necessarily demonstrate reasonable cause and good faith.”).

Petitioner claims he reasonably relied on Henkell, the

shelter promoter, in creating his trust shelters. Petitioner

states that “there was no adverse information surrounding Robert

Henkell and his extensive trust business at the time Dr. Edwards
 - 35 -

relied on him and his advice, 1995. Robert Henkell before his

IRS downfall, was a leader in the Trust business”.

It is well established that taxpayers generally cannot

“reasonably rely” on the professional advice of a tax shelter

promoter. See Goldman v. Commissioner, 39 F.3d 402, 408 (2d Cir.

1994) (“Appellants cannot reasonably rely for professional advice

on someone they know to be burdened with an inherent conflict of

interest.”), affg. T.C. Memo. 1993-480; Neonatology Associates,

P.A. v. Commissioner, 115 T.C. 43, 98 (2000) (“Reliance may be

unreasonable when it is placed upon insiders, promoters, or their

offering materials, or when the person relied upon has an

inherent conflict of interest that the taxpayer knew or should

have known about.”); Marine v. Commissioner, 92 T.C. 958, 992-993

(1989), affd. without published opinion 921 F.2d 280 (9th Cir.

1991). Such reliance is especially unreasonable when the advice

would seem to a reasonable person to be “too good to be true”.

Pasternak v. Commissioner, 990 F.2d 893, 903 (6th Cir. 1993),

affg. Donahue v. Commissioner, T.C. Memo. 1991-181; Elliott v.

Commissioner, 90 T.C. 960, 974 (1988), affd. without published

opinion 899 F.2d 18 (9th Cir. 1990); Gale v. Commissioner, T.C.

Memo. 2002-54.

This is another case of “too good to be true”. Petitioner

could not reasonably have believed that he could transfer fully

depreciated property to the trusts without recognizing gain and
 - 36 -

thereby give the trusts a “stepped-up” basis upon which to take

additional depreciation deductions. Nor could he have reasonably

believed he could successfully use the trusts to come close to

zeroing out his taxable income and his Federal income tax

liabilities. At a minimum, advice to that effect would cause a

reasonable person to seek independent confirmation from a

reliable and disinterested adviser. Moreover, in the case at

hand, petitioner continued to assert the validity of his trusts

long after he learned of the invalidity of Henkell’s trust

schemes.

Petitioner also argues that respondent committed a “misdeed”

by determining deficiencies substantially in excess of the

amounts that ultimately will be redetermined, and that

respondent’s “misdeed” should mitigate petitioner’s liability for

penalties. Petitioner cites no authority for his argument. It

is dead wrong and has no basis in fact or law. Petitioner failed

to maintain and to produce to respondent, in response to

respondent’s proper requests, records to substantiate his income

and expenses. Respondent did not commit a “misdeed” in

reconstructing petitioner’s income and disallowing his deductions

after petitioner failed to produce proper records to support his

return positions. We uphold respondent’s determinations that

petitioner is liable for accuracy-related penalties under section

6662(a).
 - 37 -

Penalties Under Section 6673(a)

Section 6673(a)(1) allows the Tax Court to impose a penalty

of up to $25,000, payable to the United States, when (A) a

taxpayer institutes or maintains a proceeding primarily for

delay, (B) the taxpayer’s position in the proceeding is frivolous

or groundless, or (C) the taxpayer unreasonably failed to pursue

available administrative remedies. Section 6673(a)(2) allows the

Tax Court to require counsel who unreasonably and vexatiously

multiply the proceedings before the Tax Court to pay the other

party’s excess costs, expenses, and attorney’s fees.

Respondent has asked us to impose section 6673(a)(1)

penalties against petitioner because he made frivolous or

groundless arguments regarding: (1) The “Delpit” issue, (2) the

“Scar” issue, (3) the “Agency” issue, and, until 12 days before

posttrial briefs were due, (4) the abusive trust issue. In

reply, petitioner argues these were all strong and proper legal

arguments of first impression. In his reply brief, petitioner

asks us to include in our opinion a detailed ruling on each of

these issues. We consider each of these arguments--and

petitioner’s request--in deciding whether to impose section

6673(a)(1) sanctions against petitioner and section 6673(a)(2)

sanctions against petitioner’s counsel.

The “Delpit” Issue

Petitioner argued throughout the case, despite the Court’s
 - 38 -

admonitions that the argument was without merit as a matter of

law, that the notice of deficiency should be invalidated because

respondent failed to send a preliminary 30-day letter to

petitioner, and failed to offer other administrative hearings,

before issuing the notice of deficiency. Petitioner bases his

argument on Delpit v. Commissioner, 18 F.3d 768 (9th Cir. 1994).

The issue in dispute in Delpit had nothing to do with the

validity of a notice of deficiency. The issue in Delpit was

whether an appeal from a decision of the Tax Court constitutes

the “commencement or continuation * * * of a judicial,

administrative, or other action or proceeding against the debtor”

id. at 770, within the meaning the 11 U.S.C. sec. 362(a)(1), the

automatic stay in bankruptcy. In dicta, the Court of Appeals in

Delpit described the usual procedure in tax cases:

Under the income tax assessment procedure, a taxpayer
is barred from petitioning the Tax Court until he has
first participated in a number of administrative
proceedings that are initiated "against" him. These
proceedings include an audit, a meeting with a revenue
agent and a supervisor, a 30-day letter ("Preliminary
Notice"), formal proceedings before the IRS Appeals
Division, and a 90-day letter ("Notice of Deficiency").
These proceedings may continue with the taxpayer's
request to the Tax Court to remove or reduce the
deficiency assessment and, next, an appeal by one party
or the other to the Court of Appeals. [Id.]

Petitioner asserts that the Court of Appeals’ general

description of ordinary tax procedure, in dicta, in Delpit,

constitutes authority for invalidating the notice of deficiency
 - 39 -

if the ordinary procedure is not followed. Petitioner cites no

case, no statute, no regulation, and no other relevant authority

to support his argument.6

The Internal Revenue Code and the regulations do not require

the Commissioner to send a preliminary 30-day letter or to hold

an administrative Appeals hearing before issuing a notice of

deficiency. A 30-day letter and an opportunity for an Appeals

hearing is a matter of administrative practice and procedure and

not a requirement of law. It is hornbook law that “interpretive

rules, general statements of policy or rules of agency

organization, procedure or practice” are not binding upon an

agency. Chrysler Corp. v. Brown, 441 U.S. 281, 313-314 (1979).

In making his argument, petitioner and his counsel fail to

cite the long unbroken line of cases stretching back nearly 50

years rejecting petitioner’s argument. For example, in a recent

unpublished opinion in Greene v. Commissioner, 12 Fed. Appx. 606,

607 (9th Cir. 2001), affg. T.C. Memo. 2000-26, the Court of

6
Petitioner, in his petition and brief, also cited In re
Universal Life Church, Inc., 191 Bankr. 433 (Bankr., E.D. Cal.
1995); Lyng v. Payne, 476 U.S. 926 (1986); and Fano v. O’Neill,
806 F.2d 1262 (5th Cir. 1987), in support of his argument that
the notice of deficiency is invalid because respondent failed to
follow his administrative guidelines. We do not see, and
petitioner made no effort to explain, the relevance of the
Universal Life Church, Lyng, and Fano cases to his argument that
the notice of deficiency respondent issued is invalid because
respondent failed to provide petitioner with a preliminary 30-day
notice or an opportunity for a hearing before an Appeals officer.
 - 40 -

Appeals for the Ninth Circuit stated:

We further reject Greene’s contention that the Tax
Court lacked jurisdiction over him because the IRS
issued a notice of deficiency without first sending him
a 30-day letter * * * or without conducting formal
proceedings before the IRS Appeals Division. The Tax
Court’s jurisdiction does not depend upon any
preliminary proceedings, but requires only issuance of
a valid deficiency notice. See Kantor v. Commissioner,
998 F.2d 1514, 1521 (9th Cir. 1993). Because a
taxpayer is entitled to a de novo proceeding in the Tax
Court upon the filing of a timely petition for review,
this court will not look behind a deficiency notice to
question the procedures leading to a determination.
Id.

See also Smith v. United States, 478 F.2d 398 (5th Cir. 1973)

(30-day letter directory not mandatory, and therefore not

required); Rosenberg v. Commissioner, 450 F.2d 529 (10th Cir.

1971) (failure to offer Appeals hearing directory, not

mandatory), affg. T.C. Memo. 1970-201; Luhring v. Glotzbach, 304

F.2d 560, 563 (4th Cir. 1962) (“compliance with * * * [procedural

rules] is not essential to the validity of a notice of

deficiency.”); Bromberg v. Ingling, 300 F.2d 859, 861 (9th Cir.

1962) (“The 30-day letter * * * invites the taxpayer to come in

and see the commissioner and ‘argue’ with him if he wants to do

so. But the taxpayer is not required to come. And the 30-day

letter is not required by statute.”); Crowther v. Commissioner,

269 F.2d 292, 293 (9th Cir. 1959) (“30-day letter (not required

by law).”) revg. and remanding 28 T.C. 1293 (1957); Montgomery v.

Commissioner, 65 T.C. 511, 522 (1975) (30-day letter and

administrative hearings are not required); Greenberg’s Express,
 - 41 -

Inc. v. Commissioner, 62 T.C. 324, 327-328 (1974) (“we will not

look into respondent’s alleged failure to issue a 30-day letter

to the petitioners or to afford them a conference before the

Appellate Division”).

Lacking any legal authority to support his argument,

petitioner argues that it would be unfair to require a taxpayer

to exhaust his administrative remedies as a condition to being

eligible to recover legal fees under section 7430 where the

Commissioner fails to give the taxpayer the opportunity to pursue

the administrative remedies. This concern is easily disposed of

by reviewing the language of section 7430. Section 7430(b)(1)

requires the taxpayer only to exhaust “the administrative

remedies available to such party within the Internal Revenue

Service.” (Emphasis added.) If the Commissioner does not

provide an available administrative remedy, then the taxpayer’s

rights are not impaired by the failure to pursue that remedy.

In light of the overwhelming body of specific authority

rejecting petitioner’s argument, the lack of any legal support

for petitioner’s argument, and the lack of any genuine basis for

seeking a change in the law, we hold that petitioner’s “Delpit”

argument is frivolous and groundless within the meaning of

section 6673(a)(1)(B).7

7
By a parity of reasoning, as well as the lack of a specific
provision in sec. 6673(a)(1) for imposition of a penalty against
(continued...)
 - 42 -

The “Scar” Issue

Petitioner argues that the notice of deficiency should be

held invalid under the standard set forth in Scar v.

Commissioner, 814 F.2d 1363 (9th Cir. 1987), revg. 81 T.C. 855

(1983), because respondent’s determination in the notice of

deficiency was not adequately explained, and because respondent

disallowed all of petitioner’s deductions without making a

sufficient attempt to identify the deductions to which petitioner

was entitled. Petitioner’s and his counsel’s misunderstanding of

the Scar opinion is so obvious as to constitute willful

“obtuseness”. See Coleman v. Commissioner, 791 F.2d 68, 72 (7th

Cir. 1986).

In Scar, the Commissioner issued the taxpayers a notice of

deficiency adjusting income in the amount of $138,000 for

“Partnership - Nevada Mining Project.” The taxpayers had nothing

to do with a Nevada mining project partnership. The Commissioner

admitted that the notice of deficiency was issued in error but

sought to proceed to collect other amounts not referenced in the

notice of deficiency that the Commissioner claimed the taxpayers

owed. Citing the general rule that courts do not look behind the

notice of deficiency, the Tax Court held that the notice of

7
(...continued)
the Commissioner, petitioner’s motion for imposition of a penalty
on respondent under sec. 6673(a)(1) will be denied.
 - 43 -

deficiency was effective to confer on it jurisdiction to

determine the correct deficiency owing by the taxpayer. Scar v.

Commissioner, 81 T.C. at 861-862.

The Court of Appeals for the Ninth Circuit reversed, holding

that a notice of deficiency is invalid if it shows on its face

that no determination of tax owing by the taxpayer was made. The

Court of Appeals stated:

We agree with the Tax Court that no particular
form is required for a valid notice of deficiency, and
the Commissioner need not explain how the deficiencies
were determined. * * * “The notice must at a minimum
indicate that the IRS has determined the amount of the
deficiency.” The question confronting us is whether a
form letter that asserts that a deficiency has been
determined, which letter and its attachments make it
patently obvious that no determination has in fact been
made, satisfies the statutory mandate. [Scar v.
Commissioner, 814 F.2d at 1367; fn. ref. and citations
omitted.]

In Kantor v. Commissioner, 998 F.2d 1514, 1521-1522 (9th Cir.

1993), affg. in part and revg. in part T.C. Memo. 1990-380, the

Court of Appeals for the Ninth Circuit explained its Scar opinion

and the limitation thereon announced in Clapp v. Commissioner,

875 F.2d 1396 (9th Cir. 1989), as follows:

As a general rule, however, we will not “look behind a
deficiency notice to question the Commissioner's
motives and procedures leading to a determination.”
Id. at 1368.

We recognized an exception to this rule in Scar,
where the notice of deficiency revealed on its face
that a determination had not been made using the
taxpayer's return. * * *
 - 44 -

We later emphasized in Clapp v. Commissioner,
however, that the kind of review exercised in Scar is
applicable “only where the notice of deficiency reveals
on its face that the Commissioner failed to make a
determination.” In Clapp, we determined that the
notices of deficiency were adequate to establish
jurisdiction where they indicated various adjustments
to income and the fact that these adjustments were
based upon the disallowance of deductions. The
taxpayers in Clapp attempted to show that the
Commissioner had not made an actual determination of
their deficiency by introducing internal IRS documents
which suggested that at the time the notices were
issued, the IRS had not decided which legal theory it
would rely upon to secure a deficiency judgment. We
nevertheless refused to question the Commissioner's
determination because there was no indication on the
face of the notices that a determination had not been
made. The disallowed deductions did not refer to
unrelated entities, nor had the tax rate been
arbitrarily set. [Emphasis added; citations omitted.]

See also Johnston v. Commissioner, T.C. Memo. 2000-315 (“the

Court * * * has limited the application of Scar to the narrow

circumstances where the notice of deficiency reveals on its face

that no determination was made.”). In Meserve Drilling Partners

v. Commissioner, 152 F.3d 1181 (9th Cir. 1998), affg. T.C. Memo.

1996-72, the Court of Appeals for the Ninth Circuit made clear

that all the Commissioner must do is examine the taxpayer’s

returns and consider the taxpayer’s deductions. Recently, in an

unpublished opinion, the Court of Appeals for the Ninth Circuit,

in a case argued by petitioner’s counsel, rejected petitioner’s

argument that Scar applies where, as in the case at hand, the

notice of deficiency shows how the deficiency was computed.

Staggs v. Commissioner, 25 Fed. Appx. 566 (9th Cir. 2001).
 - 45 -

Petitioner’s contention that the notice of deficiency is

invalid because respondent did not adequately explain the basis

for his determination was specifically rejected in the Scar

opinion itself: “the Commissioner need not explain how the

deficiencies were determined.” Scar v. Commissioner, 814 F.2d at

1367. Similarly, petitioner’s contention that the blanket denial

of deductions renders the notice of deficiency invalid was

rejected by the Court of Appeals for the Ninth Circuit in both

Clapp v. Commissioner, supra, and Kantor v. Commissioner, supra.

Petitioner does not allege that the notice of deficiency

shows on its face that the determination relates to another

person or that the tax rates were arbitrarily set. Petitioner’s

allegation that the notice of deficiency was erroneous or even

arbitrary does not raise a proper challenge to its validity under

Scar. Petitioner’s counsel should have known after only a

cursory reading of the cases that the Scar exception does not

apply to the case at hand.

We also reject out of hand petitioner’s unsupported argument

that respondent acted improperly in disallowing all deductions in

the notice of deficiency. Respondent made more than reasonable

efforts to obtain from petitioner records to support the

deductions that petitioner had claimed on his tax returns.

Petitioner refused to produce documentation to support his

deductions. He made unwarranted demands on respondent to reply
 - 46 -

in writing to his frivolous and improper questions.

Petitioner’s contention that Scar v. Commissioner, 814 F.2d

1363 (9th Cir. 1987), supports his argument is dead wrong.

Petitioner’s argument that the notice of deficiency is invalid

because respondent did not make additional efforts to verify

petitioner’s claimed deductions after petitioner refused to

substantiate them is frivolous and groundless within the meaning

of section 6673(a)(1)(B).

The “Agency” Issue

Petitioner has devoted 3 pages of his 12-page reply brief to

arguing that the Internal Revenue Service is not an “agency of

the United States”. Presumably, petitioner intends by this

argument to suggest that respondent has no authority to determine

or collect petitioner’s income tax deficiencies.

In support of his argument, petitioner quotes a footnote

from the Supreme Court’s opinion in Chrysler Corp. v. Brown, 441

U.S. at 297 n.23 (1979), a single page of an answer to a

complaint allegedly filed by the United States in an Idaho

District Court case entitled Diversified Metal Prods., Inc. v. T-

Bow Co. Trust, 78 AFTR 2d 5830, 96-2 USTC par. 50,437 (D. Idaho

1996), citing at note 3 Blackmar v. Guerre, 342 U.S. 512, 514

(1952).

Petitioner’s argument is tax protester gibberish. It’s bad

enough when ignorant and gullible or disingenuous taxpayers utter
 - 47 -

tax protester gibberish. It’s much more disturbing when a member

of the bar offers tax protester gibberish as a substitute for

legal argument.

The Internal Revenue Service is an agency of the United

States Department of the Treasury. Secs. 7801(a), 7803. Section

7801 provides that “the administration and enforcement of this

title shall be performed by or under the supervision of the

Secretary of the Treasury.” Section 7803(a) provides for the

appointment of a Commissioner of Internal Revenue under the

Department of the Treasury. Section 7803(a)(2) provides that the

Commissioner of Internal Revenue shall, among other things,

“administer, manage, conduct, direct, and supervise the execution

and application of the internal revenue laws or related statutes

and tax conventions to which the United States is a party”.

Section 7804(a) authorizes the Commissioner to employ, supervise,

and direct subordinate persons to administer and enforce the

internal revenue laws. These sections of the Internal Revenue

Code dispel any notion that the Internal Revenue Service is not

authorized to administer and enforce the internal revenue laws.

The Supreme Court recognized in Donaldson v. United States,

400 U.S. 517, 534 (1971), that “the Internal Revenue Service is

organized to carry out the broad responsibilities of the

Secretary of the Treasury under section 7801(a) of the 1954 Code

for the administration and enforcement of the internal revenue
 - 48 -

laws.” Courts have repeatedly rejected as frivolous the

argument, advanced by petitioner in the case at hand, that the

Internal Revenue Service is not a governmental agency. In Young

v. IRS, 596 F. Supp. 141, 147 (N.D. Ind. 1984), the court stated:

it is clear that the Secretary of the Treasury has full
authority to administer and enforce the Internal
Revenue Code, 26 U.S.C. §7801, and has the power to
create an agency to administer and enforce the laws.
See 26 U.S.C. §7803(a). Pursuant to this legislative
grant of authority, the Secretary of the Treasury
created the IRS. 26 C.F.R. §601.101. The end result
is that the IRS is a creature of “positive law” because
it was created through congressionally mandated power.
By plaintiff's own “positive law” premise, then, the
IRS is a validly created governmental agency and not a
“private corporation.” * * *

In Salman v. Dept. of Treasury, 899 F. Supp. 471, 472 (D. Nev.

1995), the court stated: “The court finds there is no basis in

fact for Salman's contention that the IRS is not a government

agency of the United States. * * * In short, Salman's action is

wholly frivolous, and this court must dismiss it with prejudice.”

In Kay v. Summers, 86 AFTR 2d 7161, 7165, 2001-1 USTC par.

50,103, at 87,013 (D. Nev. 2000), the court held the plaintiff’s

contention “that the Internal Revenue Service is some sort of

private corporation, not a government agency” to be frivolous.

See also United States v. Fern, 696 F.2d 1269, 1273 (11th Cir.

1983) (“Clearly, the Internal Revenue Service is a ‘department or

agency’ of the United States.”); Thomson v. United States, 88

AFTR 2d 5620, 5621, 2001-2 USTC par. 50,614, at 89,521 (S.D. Fla.
 - 49 -

2001) (“The Internal Revenue Service is a ‘department or agency’

of the United States.”).

In Malone v. Commissioner, T.C. Memo. 1998-372, we imposed

sanctions totaling $15,000 against the taxpayers for advancing

frivolous arguments, including the argument that the Internal

Revenue Service is not an agency of the United States: “Contrary

to petitioners’ argument, there is, in fact and in law, an IRS.”

In Brandt v. Commissioner, T.C. Memo. 1993-411, we imposed

section 6673 sanctions of $5,000 for meritless arguments

disputing the Internal Revenue Service’s authority. Petitioner

cited none of these authorities to the Court.

Furthermore, the authorities petitioner cited do not support

his argument. The issue in Chrysler Corp. v. Brown, 441 U.S. 281

(1979), was whether Chrysler could maintain an action to enjoin

the Secretary of Labor from making public reports that Chrysler,

as a Government contractor, was required to file to show

compliance with Federal affirmative action guidelines. One of

the issues considered by the Court was whether disclosure was

prohibited by the Trade Secrets Act, 18 U.S.C. sec. 1905. The

Court noted that the origins of the modern Trade Secrets Act

could be traced to an 1864 act barring Government revenue

officers from making unauthorized disclosure of a taxpayer’s

business information. The Court noted that the 1864 Act was

repealed in 1948. In a footnote, the Court made a historical
 - 50 -

reference to the difference between the manner in which revenue

officers operated in the 19th century and the way they operate

today:

There was virtually no Washington bureaucracy created
by the Act of July 1, 1862, ch. 119, 12 Stat. 432, the
statute to which the present Internal Revenue Service
can be traced. Researchers report that during the
Civil War 85 percent of the operations of the Bureau of
Internal Revenue were carried out in the field--
“including the assessing and collection of taxes, the
handling of appeals, and punishment for frauds”-- and
this balance of responsibility was not generally upset
until the 20th century. L. Schmeckebier & F. Eble, The
Bureau of Internal Revenue 8, 40-43 (1923). Agents had
the power to enter any home or business establishment
to look for taxable property and examine books of
accounts. Information was collected and processed in
the field. It is, therefore, not surprising to find
that congressional comments during this period focused
on potential abuses by agents in the field and not on
breaches of confidentiality by a Washington-based
bureaucracy. [Id. at 297 n.23.]

Petitioner’s counsel quotes this footnote as support for her

argument that the Internal Revenue Service is not a governmental

agency. We are unable to discern how the footnote or the

Chrysler Corp. opinion in any way supports petitioner’s argument

that the Internal Revenue Service is not an agency of the United

States.

Petitioner next claims that in Diversified Metal Prods.,

Inc. v. T-Bow Co. Trust, 78 AFTR 2d 5830, 96-2 USTC par. 50,437

(D. Idaho 1996), the United States admitted that the Internal

Revenue Service was not an agency, and the court based its

decision on that admission. The issue in Diversified Metal was
 - 51 -

whether the United States’ tax lien had priority over other

claims to funds held in the name of a third party. The United

States claimed the third party was the alter ego of the

taxpayer/debtor, and that its tax lien therefore attached to the

funds. The court agreed with the United States.

Petitioner apparently relies on the following footnote in

the Diversified Metal opinion to support his position:

The Internal Revenue Service, and not the United
States, was originally named as defendant in this
action. However, the United States is correct that the
Internal Revenue Service has no capacity to sue or be
sued. Blackmar v. Guerre, 342 U.S. 512, 514, 96 L. Ed.
534, 72 S. Ct. 410 (1952). Therefore, the United
States is properly substituted for the Internal Revenue
Service in this action. [Id. at 5832 n.3, 96-2 USTC
par. 50,437, at 85,462 n.3.8]

In Blackmar v. Guerre, 342 U.S. 512 (1952), a discharged employee

of the Veterans Administration sued the United States Civil

Service Commission for reinstatement. The Court held that

“Congress has not constituted the Commission a body corporate or

authorized it to be sued eo nomine.” Id. at 514. The Court also

stated “When Congress authorizes one of its agencies to be sued

eo nomine, it does so in explicit language, or impliedly because

the agency is the offspring of such a suable entity.” Id. at

515. By citing Blackmar in support of its decision that the

8
On brief, petitioner grossly mischaracterizes this footnote
as “directing that the cause of action should be against the
Commissioner of Internal Revenue personally since he is not
responsible for the conduct of others claiming to act under his
authority”.
 - 52 -

Internal Revenue Service could not be sued eo nomine, the

District Court in Diversified Metal merely drew a parallel in

that respect between the Internal Revenue Service and the United

States Civil Service Commission. Nothing in the District Court’s

opinion supports petitioner’s argument that the Internal Revenue

Service is not an agency of the United States or that it lacks

authority to administer and enforce the internal revenue laws.

In sum, the statutory authority of the Commissioner and the

Internal Revenue Service is indisputable. The Courts have

repeatedly held that the Internal Revenue Service is an

authorized agency of the United States and rejected as frivolous

arguments to the contrary. Petitioner cited no genuine authority

for his position and failed to cite the substantial body of

contrary authority directly on point. Finally, petitioner failed

to make a nonfrivolous argument for the extension, modification,

or reversal of existing law or the establishment of new law.

Petitioner’s argument that the Internal Revenue Service is not an

agency of the United States and is not authorized to administer

and enforce the internal revenue laws is frivolous and groundless

within the meaning of section 6673(a)(1)(B).

The Abusive Trusts

Petitioner conceded after trial and before the parties’

posttrial briefs were due that the trusts should be disregarded

for Federal income tax purposes. In his Federal income tax
 - 53 -

returns for the years in issue and throughout the trial, however,

petitioner continued to assert that the trusts were separate

entities for Federal income tax purposes. Respondent contends

that petitioner’s position was frivolous, and that we should

impose sanctions on petitioner under section 6673(a) for

maintaining that position.

Petitioner argues that we should not impose sanctions

because he maintained his position in good faith and in reliance

on the promoter of the trusts, Henkell (who, petitioner claims,

was a “leader in the trust business” and “master-trust maker of

his time” before being fined and enjoined from providing trust

advice in United States v. Estate Pres. Servs., 202 F.3d 1093

(9th Cir. 2000)).

The positions taken by petitioner before this Court were

taken and continued long after Henkell had been fined and

enjoined from further promoting his abusive trusts. Respondent

provided petitioner with copious citations of our prior cases

holding trusts like his to be invalid abusive trusts.

Moreover, as discussed above in connection with the

accuracy-related penalties, reliance on the opinion of a shelter

promoter regarding the validity of the shelter is, as a general

matter, not reasonable reliance. Goldman v. Commissioner, 39

F.3d at 480; Neonatology Associates, P.A. v. Commissioner, 115

T.C. at 99; Marine v. Commissioner, 92 T.C. at 992-993. Such
 - 54 -

reliance is especially unreasonable when the advice would seem to

a reasonable person to be “too good to be true”. See e.g.,

Pasternak v. Commissioner, 990 F.2d at 903; Elliott v.

Commissioner, 90 T.C. 960 (1998); Gale v. Commissioner, T.C.

Memo. 2002-54. A reasonable person would find Henkell’s advice

to be too good to be true. At a minimum, such advice would cause

a reasonable person to seek independent counsel.

At trial, petitioner sought to defend the trusts as

established for asset protection purposes rather than tax

avoidance. However, petitioner’s testimony concerning the asset

protection benefits of the trusts was ill-conceived and legally

erroneous.9 Even at the time of trial he had not thought through

the asset protection benefits of using the trusts.

We did not find petitioner’s alleged asset protection

motivations to be credible. Petitioner’s argumentative demeanor

while testifying at trial evidenced an intent to justify the

creation of the trusts by diverting the Court’s attention from

his tax avoidance motives.

Petitioner redeemed himself to some extent, however, by

conceding the issue before the parties’ briefs were due.

Petitioner’s late concession is better than none at all. We will

9
For example, petitioner testified to his alleged
understanding that he would avoid personal liability for causing
an automobile accident if the vehicle he was driving had been
transferred into a trust.
 - 55 -

take petitioner’s belated concession into account in setting any

penalties that should be imposed.

Section 6673(a)(1) Penalties Against Petitioner

We agree with respondent that petitioner should be penalized

under section 6673(a)(1). Many of the positions he took when he

instituted this proceeding, and maintained throughout this

proceeding, were frivolous or groundless. Petitioner’s “Delpit,”

“Scar,” and “Agency” arguments were entirely without merit.

Petitioner’s insistence during most of the case on the validity

of the trusts in the face of overwhelming contrary legal

authority was unjustified.

We also believe that petitioner’s failure, before the

commencement of this case, to comply with respondent’s requests

for records (both his own records and the trusts’ records, which

he controlled), and the unreasonable demands he made on

respondent for answers to clearly frivolous and improper

questions, constitutes a failure to pursue available

administrative remedies. Had he produced his records when

requested by respondent, there would have been fewer disputed

issues at the commencement of this case, and the trial would have

been shorter and far better organized.

As a mitigating factor, petitioner made reasonable attempts

to cooperate with respondent during the trial, resulting in

stipulations to many of the issues originally in dispute.
 - 56 -

Because the Court is raising sua sponte the question whether

petitioner’s counsel should be liable for costs under section

6673(a)(2), we will defer setting the penalties to be imposed on

petitioner under section 6673(a)(1) until the parties have

responded to the Court’s inquiries into respondent’s excess costs

attributable to the conduct of petitioner and his counsel.

Section 6673(a)(2) Liability of Petitioner’s Counsel

Originally, the tax law provided for an award of damages

only against a taxpayer who instituted a case primarily for

delay. See Revenue Act of 1926, ch. 27, sec. 911, 44 Stat. (Part

II) 109. The damages provision was later adopted as section 6673

of the Internal Revenue Code of 1954.

In 1989, Congress added section 6673(a)(2) to provide for an

award of costs, expenses, and attorneys’ fees against an attorney

where an attorney, including an attorney appearing on behalf of

the Commissioner, has unreasonably and vexatiously multiplied the

proceedings in any case. Omnibus Budget Reconciliation Act of

1989, Pub. L. 101-239, sec. 7731(a), 103 Stat. 2400. Section

6673(a)(2) is derived from sec. 1927 of the Judicial Code, 28

U.S.C. sec. 1927 (1988). See H. Rept. 101-247, at 1399-1400

(1989).

In Harper v. Commissioner, 99 T.C. 533, 545 (1992), we noted

the dearth of opinions interpreting and applying section

6673(a)(2), and relied upon caselaw under 28 U.S.C. sec. 1927 for
 - 57 -

the level of misconduct justifying sanctions. The language of 28

U.S.C. sec. 192710 is substantially identical to that of section

6673(a)(2), and the two statutes serve the same purposes in

different fora. See Johnson v. Commissioner, 289 F.3d 452 (7th

Cir. 2002), affg. 116 T.C. 111 (2001); Harper v. Commissioner,

supra at 545. The interpretation given section 6673(a)(2) and 28

U.S.C. sec. 1927 has historically been the same.

In Harper v. Commissioner, supra, we found that while most

Courts of Appeal require a finding of bad faith as a condition

for imposing sanctions under 28 U.S.C. sec. 1927, a few have

adopted the lesser standard of recklessness. Id. at 545-546. The

Court of Appeals for the Ninth Circuit, the venue for an appeal

in the case at hand, has occasionally stated that sanctions under

28 U.S.C. sec. 1927 are appropriate where the attorney conduct

multiplying the proceedings was reckless. B.K.B. v. Maui Police

Dept., 276 F.3d 1091, 1107 (9th Cir. 2002); Fink v. Gomez, 239

F.3d 989, 993 (9th Cir. 2001); United States v. Associated

Convalescent Enters., Inc., 766 F.2d 1342 (9th Cir. 1985).

Because we find petitioner’s counsel’s conduct satisfies the

condition for a finding of bad faith, as formulated by the Court

of Appeals for the Ninth Circuit, we need not decide whether

10
28 U.S.C. sec. 1927 (1988) provides that “Any attorney
* * * who so multiplies the proceedings in any case unreasonably
and vexatiously may be required by the court to satisfy
personally the excess costs, expenses, and attorneys’ fees
reasonably incurred because of such conduct.”
 - 58 -

recklessness, without more, would justify the imposition of

sanctions under section 6673(a)(2). See, e.g., Nis Family Trust

v. Commissioner, 115 T.C. 523, 547 (2000); Dixon v. Commissioner,

T.C. Memo. 2000-116.

In the view of the Court of Appeals for the Ninth Circuit,

“bad faith” is present when an attorney knowingly or recklessly

raises a frivolous argument. In re Keegan Mgmt. Co., Sec.

Litig., 78 F.3d 431, 436 (9th Cir. 1996); Estate of Blas v.

Winkler, 792 F.2d 858, 860 (9th Cir. 1986). This is consistent

with the notion that a member of the bar should be deemed to have

the ability to recognize a frivolous argument when he or she

encounters it. While we have some doubt that Ms. Spaid intended

to harass respondent, we have no doubt she knowingly and

recklessly made frivolous arguments in pretrial memoranda, at

trial, and in posttrial briefs.

All litigants, especially members of the bar who have

received training in law and professional responsibility, are

expected to read the cases cited for the Court, to assure that

those cases remain current, and to advance only those legal

arguments that are warranted by existing law, by nonfrivolous

argument for its extension, modification, or reversal, or by the

establishment of new law. See, e.g., Fed. R. Civ. P. 11(b)(2);

Coleman v. Commissioner, 791 F.2d 68, 72 (7th Cir. 1986) (“The

purpose of sections 6673 and 6702, like the purpose of Rules 11
 - 59 -

and 38 and of sec. 1927 [of 28 U.S.C.], is to induce litigants to

conform their behavior to the governing rules regardless of their

subjective beliefs. Groundless litigation diverts the time and

energies of judges from more serious claims; it imposes needless

costs on other litigants. Once the legal system has resolved a

claim, judges and lawyers must move on to other things. They

cannot endlessly rehear stale arguments.”).

Petitioner’s counsel continued to advance the “Delpit”,

“Scar”, and “Agency” issues long after being warned that the

issues were frivolous and would not be considered by the Court.

Petitioner’s counsel persisted in raising these issues and

requesting that we rule on them even after petitioner stipulated

that they were no longer issues in the case. In making these

arguments, petitioner’s counsel cited no relevant supporting

authority and either failed to perform the basic research to

discover or failed to disclose the substantial body of authority

specifically rejecting her arguments as frivolous.

We are mindful that there can be a thin line between zealous

advocacy and frivolity. The Court must “avoid hindsight review

of the claim, to resolve all doubts in favor of the signer and to

refrain from imposing sanctions where such action would stifle

the enthusiasm or chill the creativity that is the very lifeblood

of the law.” Greenhouse v. United States, 780 F. Supp. 136, 144

(S.D.N.Y. 1991) (discussing sanctions under Fed. R. Civ. P. 11).
 - 60 -

We do not intend by our ruling to stifle the enthusiasm or chill

the creativity of counsel for taxpayers in this Court. We simply

expect petitioner’s counsel to read the authorities she cites for

us, to perform sufficient legal research to assure that her

arguments are not bogus, and to explain the reasoning behind her

arguments.

We recognize that petitioner originally appeared in this

case by filing his petition pro se. Petitioner’s counsel

appeared on his behalf shortly after this case was set for trial.

Some of the frivolous arguments that petitioner’s counsel

advanced during and after trial were originally contained in the

petition, such as the “Delpit” issue and the validity of the

trusts for Federal income tax purposes. Others were added after

her appearance, such as the “Scar” and “Agency” issues. We, of

course, should not and do not hold petitioner’s counsel

responsible for positions taken by petitioner before counsel’s

appearance. However, once counsel appears in the case, counsel

has an obligation to proceed in accordance with the applicable

rules of professional conduct. An attorney cannot advance

frivolous arguments to this Court with impunity, even if those

arguments were initially developed by the client. Petitioner’s

counsel is liable only for the results of her own improper

conduct, and is not liable for actions taken by petitioner before

her appearance in the case.
 - 61 -

We therefore determine that it is appropriate for us to

require petitioner’s counsel, Noel W. Spaid, to pay personally

such excess costs, expenses, and attorney’s fees as have been

reasonably incurred by respondent as a result of the matters

identified above. Respondent will be ordered to submit an

affidavit of such costs, expenses, and attorney’s fees within 60

days for consideration by the Court. The affidavit should be

itemized in sufficient detail to make clear how the time spent by

respondent in each instance was causally related to the frivolous

arguments or other sanctionable behavior of petitioner’s counsel.

Respondent’s affidavit, in a separate section, should identify

any action or nonaction by petitioner and his counsel which, even

though not a ground for increasing the penalty to be imposed on

petitioner’s counsel, imposed additional costs, expenses, and

attorney’s fees on respondent.

Petitioner and his counsel will be permitted to file

objection or objections to respondent’s affidavit within 30

calendar days after the affidavit is filed.

To reflect the foregoing,

An appropriate order will

be issued, and decision will

be entered under Rule 155.
 - 62 -

APPENDIX

David Edwards, M.D.
 - 63 -

FINANCIAL FLOW OF COMMON- LAW TRUST SYSTEMS
IRREVOCABLE, DISCRETIONARY, COMPLEX TRUSTS
TRUST INCOME & EXPENSE FLOW
DAVID EDWARDS, M.D.
CLAW,
SCOTT,
SIERRA,
MALPASO CLAW LAP TAKE FIVE SOL
Trust Upstreaming Upstreaming Personal Investment Other Real Focus
Function Trust- Trust- Residence Trust Estate Trust
Equipment. Service & Trust Trust
(Automobile) Supplies

Income Rent or Payments Rent from Sale Rest or K-1 Dividends
Lease for services other Trusts, Proceeds Lease from other
Contracts w/ or supplies Corporations, Interest Sale Trusts,
business Accounts Tenants, Dividends proceeds
Receivables or Businesses

Expenses Lease or Purchase of Normal Purchase of Advertising Normal
Contract supplies, Mortgage Investments Mortgage Charitable
payments. Account Taxes Dividend to Taxes Contributions
Expenses to Receivables, Maintenance Focus Trust Maintenance K-1 Dividends
maintain Inventory at Insurance Improvements to Beneficiary
equipment standard, Supplies Insurance Educational
Gas resell at Depreciation Supplies expenses,
Supplies Profit Repairs Depreciation Medical
Repairs Dividend to Utilities Repairs Insurance
Rent to Focus Trust Add ons Utilities Medical
other trusts Improvements Add ons payments,
Dividend to Furniture Improvements
Focus Trust Dividend to Furniture Abnormal
Focus Trust Fixtures Life Insurance
Dividend to premiums
Abnormal Focus Trust
T.V.
Newspaper
Phone

Assets held Equipment Contracts Residence Stocks, Property UBIs in other
etc. Trusts

Depreciation Equipment None Residence None Property none
Furniture

Prior to the end of the calendar (tax) year, a Trust can reduce its taxable
income by paying Trustee Fees (1099) or wages to employees (W-2). A Trust can
also make unlimited charitable contributions with a write-off of up to 100%
of the Trust income. If there is still taxable income remaining in your trust
after calendar year end, a Trust has until March 5th (65 days) to make
distributions to the Beneficiaries and further reduce or eliminate Trust
income. Distributions are made on a Fiduciary K-1 form to one or more of the
Beneficiaries. If the taxable income stays in the Trust, then it will be
taxed at the Trust's tax rate which increases very rapidly. However, unlike
people, a Trust is only taxed on income it actually keeps (doesn't
distribute), not on net income earned.