T.C. Memo. 2003-24
UNITED STATES TAX COURT
PAUL F. AND ELEANORE M. NICHOLS, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 6725-01. Filed January 27, 2003.
Paul F. and Eleanore M. Nichols, pro sese.
Jeremy L. McPherson, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
LARO, Judge: Petitioners petitioned the Court to
redetermine respondent’s determination that they are liable for
Federal income tax deficiencies for 1997 and 1998 of $59,117 and
$62,558, respectively, and for accuracy-related penalties under
section 6662(a) of $11,823.40 and $12,511.60.
We decide the following issues:
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1. Whether the trusts petitioners used during 1997 and 1998
should be disregarded for Federal income tax purposes because the
trusts were shams. We hold they should.
2. Whether petitioners are liable for the accuracy-related
penalties under section 6662(a). We hold they are.
Unless otherwise noted, section references are to the
applicable versions of the Internal Revenue Code. Rule
references are to the Tax Court Rules of Practice and Procedure.
FINDINGS OF FACT
Some facts were stipulated and are so found. The stipulated
facts and the exhibits submitted therewith are incorporated
herein by this reference. Petitioners resided in Fair Oaks,
California, when they petitioned the Court. They filed 1997 and
1998 Federal income tax returns on October 15, 1998, and on July
28, 1999, respectively. They did not report on those tax returns
Social Security benefits, income from self-employment, and income
received by the JREP Trust, PERJ Trust, and CSM Business Trust
(collectively referred to as trusts1).
Petitioners established the trusts on January 1, 1992.
Petitioners were the initial trustees of CSM Business Trust (CSM
Trust), and Mr. Nichols was an initial trustee of PERJ Trust and
1
We use the words “trust” and “trustee” in our findings of
fact for narrative convenience. We do not intend our use of
those terms to indicate any conclusion about the substance of the
transactions at issue.
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of JREP Trust.2 PERJ Trust was the sole beneficiary of CSM
Trust. During 1997 and 1998, PERJ Trust was the sole beneficiary
of JREP Trust. The address of each of the trusts was the same as
the address of petitioners’ principal residence.
On January 1, 1992, petitioners transferred a parking lot
sweeping business to CSM Trust. Before this transfer, Mr.
Nichols had operated the business as a sole proprietorship under
the name “Clean Sweep Maintenance”. Petitioners then transferred
their principal residence to PERJ Trust.
Petitioners transferred the equipment of the sweeping
business to JREP Trust. JREP Trust leased the equipment of the
sweeping business to CSM Trust.
On October 13, 1995, petitioners signed and notarized a
“Certification of Revocable Living Trust and Loan Agreement”. In
the certification, petitioners stated that they are the trustors
2
It is not clear from the record who were the trustees of
any of the trusts during the relevant years. James A. Nichols,
petitioners’ son, filed 1997 and 1998 Federal income tax returns
for all three trusts in his capacity as trustee. In the case at
hand, Robert Hogue (Mr. Hogue) cosigned with petitioners the
stipulation of facts as a trustee of JREP and PERJ Trusts. In
addition, Mr. Hogue filed petitions with the Court on behalf of
these trusts. See CSM Trust v. Commissioner, docket No. 9796-
01L; JREP Trust v. Commissioner, docket No. 9795-01L; PERJ Trust
v. Commissioner, docket No. 9794-01L; PERJ Trust v. Commissioner,
docket No. 6727-01; JREP Trust v. Commissioner, docket No. 6726-
01. Because of Mr. Hogue’s failure to establish his capacity as
a trustee, the Court dismissed those cases on the ground that
they were not filed by a proper party.
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of PERJ Trust. They stated further that PERJ Trust is revocable
at their discretion.
On July 25, 1995, petitioners signed a “Uniform Residential
Loan Application”. In the loan application, Mr. Nichols stated
that he had been self-employed for 19 years as the owner-operator
of a sweeping business doing business as Clean Sweep Maintenance.
Petitioners also listed their personal checking and savings
accounts. Those same accounts were the bank accounts of CSM
Trust, JREP Trust, and PERJ Trust. During 1997 and 1998,
petitioners were the only persons who had signatory authority
over those bank accounts.
CSM Trust filed partnership returns for 1997 and 1998.3
PERJ Trust was indicated as a partner holding a 99-percent profit
interest in CSM Trust, and Ms. Nichols was said to be a partner
holding a 1-percent profit interest in CSM Trust. Those returns
were filed under the same employer identification number as had
been used on the trust income tax returns filed in the name of
CSM Trust for taxable years before 1997.
On their 1997 and 1998 Federal income tax returns,
petitioners understated their interest income by $25 and $45,
respectively. Petitioners also did not report Social Security
3
The record does not indicate why CSM Trust filed
partnership returns for those years.
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benefits of $7,964 and $8,192 which they received during the
respective years.
On April 4, 2000, petitioners sent a letter to respondent
with respect to the examination of their tax returns. The record
does not establish the taxable year(s) to which this letter
pertained. The letter stated:
This letter is to inform you that according to IRC
section 6001, we have NEVER BEEN SERVED NOTICE by the
SECRETARY. The LAW says, we will be served notice by
the Secretary as to such books, records, and documents
that the LAW requires us to keep. Not wanting to skip
over the most important part of this LAW, but it
clearly states that this LAW only applies to EVERY
PERSON LIABLE FOR ANY TAX * * *
* * * * * * *
As to the authority to examine us, our research
has shown that the only IR Code section that comes
close to authorizing “some type of agent” to examine
books and records is, IR Code section 7602. Yet this
IR Code section has NEVER been published in the Federal
Register under Title 26, only under Title 27. This
tells us that unless you are a Title 27 Agent (BATF),
you do not have investigative authority.
* * * * * * *
As to you telling us that we have a tax liability,
it just may not be correct, let us review how a tax
liability is created. According to the IR code, in
order to determine liabilities, the Secretary must file
an assessment and furnish a copy to the taxpayer upon
request.
* * * * * * *
So pursuant to that section, please either furnish
us with such a record, or notify us that none has been
made, pursuant to IR Code section 6201 or as a
consequence of the Secretary not exercising IR Code
section 6020(b). Until such time that you furnish us a
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copy of such an assessment, there is NO assessment,
there is NO tax liability, and you DO NOT have the
authority by any IR Code section to examine or
investigate our tax return.
* * * * * * *
Any further correspondence from you should be signed
according to that code section, or you will be in
violation of IRS Code section 7214(a)(7). If we do not
have a reply from you within 60 days, we will consider
this matter dropped.
On July 14, 2000, petitioners mailed to respondent another
letter, Statement of Protest. The letter stated:
Let this letter serve as a written protest that we do
not agree with any of the adjustments shown in IRS Form
4549-CG, Income Tax Examination Changes * * *
* * * * * * *
As to Form 4549, Income Tax Examination Changes.
Please be advised that we disagree with the examination
report in all aspects, and will not accept it as an
[sic] lawful official documents. If the examiners
report is a lawful official document, then the examiner
failed to sign the report under penalty of perjury, as
per IRC Section 6065.
* * * * * * *
Where is the taxing statute that congress mandates you
identify as to any tax liability that we may have?
OPINION
By notice of deficiency dated March 19, 2001, respondent
determined that the trusts were shams and should be ignored for
tax purposes. Accordingly, respondent determined, petitioners
underreported their taxable income by the amount of income
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reported by the trusts. In their petition, petitioners only deny
having unreported income, without specifically addressing any of
respondent’s arguments.
We agree with respondent. Respondent’s determinations of
deficiencies in the notice of deficiency are presumed correct,
and petitioners bear the burden of proving those determinations
wrong. Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115
(1933). In certain circumstances, if a taxpayer introduces
credible evidence with respect to any factual issue relevant to
ascertaining the taxpayer’s liability for tax, section 7491(a)
places the burden of proof on the Commissioner.4 See sec.
4
Specifically, sec. 7491(a)(1) and (2) provides in part:
SEC. 7491(a). Burden Shifts Where Taxpayer
Produces Credible Evidence.--
(1) General rule.--If, in any court
proceeding, a taxpayer introduces credible
evidence with respect to any factual issue
relevant to ascertaining the liability of the
taxpayer for any tax imposed by subtitle A or
B, the Secretary shall have the burden of
proof with respect to such issue.
(2) Limitations.--Paragraph (1) shall
apply with respect to an issue only if--
(A) the taxpayer has complied
with the requirements under this
title to substantiate any item;
(B) the taxpayer has
maintained all records required
under this title and has cooperated
(continued...)
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7491(a)(1); Rule 142(a). Section 7491 is effective with respect
to examinations commenced after July 22, 1998. See Internal
Revenue Service Restructuring and Reform Act of 1998, Pub. L.
105-206, sec. 3001(c), 112 Stat. 727. Although the relevant
examination was conducted after July 22, 1998, petitioners failed
to meet the requirements of section 7491(a)(1) and (2) in that
they did not present any credible evidence with respect to any
factual issue relevant to ascertaining their tax liability and
they did not maintain all records and cooperate with reasonable
requests by respondent for information and documents. The burden
is on the taxpayer to show that the prerequisites of section
7491(a)(2) are satisfied. Snyder v. Commissioner, T.C. Memo.
2001-255 (citing H. Conf. Rept. 105-599, at 240-241 (1998), 1998-
3 C.B. 747, 994-995). Because petitioners failed to meet the
requirements of section 7491(a), they bear the burden of proving
that respondent’s determinations of deficiencies in the notice of
deficiency are wrong.
A trust is disregarded for tax purposes if in substance it
is no more than a paper entity, a sham lacking any valid purpose
other than the avoidance of tax. Markosian v. Commissioner, 73
4
(...continued)
with reasonable requests by the
Secretary for witnesses,
information, documents, meetings,
and interviews; and * * *
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T.C. 1235, 1244-1245 (1980). This is so even if the trust was
formed and had a separate existence under local law. Zmuda v.
Commissioner, 79 T.C. 714, 720 (1982), affd. 731 F.2d 1417 (9th
Cir. 1984).
Petitioners never introduced a scintilla of evidence which
would disprove respondent’s determinations that the trusts are
shams. In fact, petitioners failed to establish the very
existence of the trusts. Petitioners unsuccessfully attempted to
prove the existence of the trusts by Forms 1041, U.S. Income Tax
Return for Estates and Trusts, filed with respondent. Those
forms do not persuade us that the trusts indicated in the forms
actually existed. Petitioners have failed to introduce into
evidence any document establishing the terms of the trusts, nor
have they obtained the testimony of James A. Nichols, who is
described on the trust returns as trustee. Petitioners were made
aware of the need for the trust documents during the examination
of their returns for the years in issue and during discovery.
They have not demonstrated that they lacked access to those
documents, nor have they shown that James A. Nichols is
unavailable to testify. We infer from petitioners’ failure to
produce such evidence that either it does not exist or, if it
does exist, it would be negative to petitioners. McKay v.
Commissioner, 886 F.2d 1237, 1238 (9th Cir. 1989), affg. 89 T.C.
1063 (1987); Wichita Terminal Elevator Co. v. Commissioner, 6
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T.C. 1158, 1165 (1946), affd. 162 F.2d 513 (10th Cir. 1947);
Snyder v. Commissioner, supra.
We conclude on the basis of our analysis and on the record
before us that the trusts were shams. Accordingly, we will
ignore them for Federal income tax purposes.5 We sustain
respondent’s determination that petitioners are liable for the
deficiencies in Federal income taxes for 1997 and 1998.
We now turn to the issue of the accuracy-related penalties.
Respondent determined that petitioners are liable for
accuracy-related penalties under section 6662(a) and (d) as a
result of a substantial understatement of income tax. Respondent
has the burden of production with respect to these penalties.
Sec. 7491(c). Section 6662(a) imposes an accuracy-related
penalty in the amount of 20 percent of the portion of the
underpayment attributable to any substantial understatement of
income tax. Sec. 6662(b)(2). The understatement is defined as
the excess of the amount of tax required to be shown on the
return over the amount of tax shown on the return reduced by any
rebate. Sec. 6662(d)(2). Under section 6662(d)(1), the
understatement is substantial if the amount of the understatement
exceeds the greater of (1) 10 percent of the tax required to be
shown on the return or (2) $5,000.
5
We also note that the income which was reported by the
trusts, and which respondent has treated as unreported income of
petitioners, primarily derived from Mr. Nichols’s sweeping
business.
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We conclude that respondent satisfied his burden of
production with respect to these accuracy-related penalties, and
that petitioners are liable for the same. Petitioners failed to
report the income purportedly received by the trusts.
Petitioners’ tax return for 1997 showed $5,357 as tax due, while
the actual tax due was $64,474. Petitioners’ tax return for 1998
showed $4,005 as tax due, while the actual tax due was $66,563.
It follows that petitioners’ understatements of income taxes for
1997 and 1998 were substantial. Petitioners failed to present
any evidence that either of those understatements was due to
reasonable cause. Nor did petitioners present any evidence that
they had made adequate disclosure, or that any exception applies
in their case to the imposition of accuracy-related penalties for
1997 and 1998.
We sustain respondent’s determination that petitioners are
liable for accuracy-related penalties under section 6662(a) for
1997 and 1998.
We have considered all arguments made by the parties and
have found those arguments not discussed herein to be irrelevant
and/or without merit. To reflect the foregoing,
Decision will be entered
for respondent.