T.C. Memo. 2003-323
UNITED STATES TAX COURT
DAVID A. DEMETREE, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
DAVID A. DEMETREE AND DEBORAH DEMETREE, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 20833-96, 20834-96. November 24, 2003.
Kenton V. Sands, for petitioners.
Stephen R. Takeuchi, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
FOLEY, Judge: The issues for decision are: (1) Whether
David A. Demetree (David) failed to report income relating to
1983, 1984, 1985, 1986, 1987, 1988, 1989, and 1991; and (2)
whether David and Deborah Demetree (Deborah) failed to report
income relating to 1992.
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FINDINGS OF FACT
In 1964, David married Michelle Demetree (Michelle).
Between 1966 and 1973, David and Michelle had four children.
During the early 1970s, David, a licensed real estate broker,
opened and operated a property management firm, David Demetree
Associates - Realtors.
David and Michelle separated in 1979. In order to devote
most of his time to contentious divorce proceedings, in 1980
David closed his property management firm. In that year, he also
transferred 797 State Road 434 (797 property) to Arthur and Naomi
Demetree (Arthur and Naomi), his parents, 205 San Sebastian Court
to Walter Pemberton, his friend, and the Brahman Inn to Jeanette
Hinkle, his sister. In 1983, 1984, 1985, 1986, 1987, 1990, and
1991, Arthur and Naomi reported rental income relating to the 797
property, but in 1988, 1989, and 1992 David received the rental
income. In addition, David made the mortgage payments and
retained the rental income relating to 205 San Sebastian Court
until the lender foreclosed on the property. With respect to the
Brahman Inn, Demetree and Associates supervised the collection
and deposit of rents, while an onsite manager handled the day-to-
day operations (e.g., preparation of monthly summaries,
collection of rents, and payment of expenses).
In 1981, David and Michelle divorced. The following year
David married Deborah. Deborah had custody of a daughter from a
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previous marriage, and in 1983, David was awarded sole custody of
his four children. Although they struggled financially on
Deborah’s salary as a full-time insurance adjuster, David stayed
at home to care for the five children and perform domestic
duties.
Prior to and during the years in issue, David had a close
relationship with Arthur, Naomi, and Ms. Hinkle. David relied
heavily on their generosity to supplement Deborah’s salary.
Arthur and Naomi regularly gave David and his family large gifts.
They gave two homes to David, $900,000 in trust for David’s
children, annual $10,000 gifts to petitioners and each of David’s
children, automobiles to each of petitioners’ children, and
weekly gifts of cash and food to petitioners. They also made
substantial loans to David documented with numerous promissory
notes. Upon David’s failure to repay some of these loans, Arthur
and Naomi obtained a $300,000 judgment against him. Yet they
continued to transfer significant amounts of money to
petitioners. In addition, Ms. Hinkle lent David funds from the
Brahman Inn business account. She documented these loans with
promissory notes and upon David’s failure to repay some of these
loans obtained a judgment against him.
From the early 1970s through his death in 1991, Arthur, a
successful real estate developer and broker, operated Demetree
and Associates, a commercial property management sole
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proprietorship. Demetree and Associates’ principal business
activities were the leasing and management of commercial
warehouses owned by partnerships in which Arthur was a partner.
The total management responsibilities relating to Demetree and
Associates were minimal (e.g., the collection of rents and
supervision of repairs). From 1983 through 1991, David
occasionally assisted Arthur by performing services for Demetree
and Associates. David also signed, pursuant to a power of
attorney, Arthur’s name on Demetree and Associates’ business
checks and deposit slips, including checks payable to himself or
to third parties on his behalf. Arthur did not deduct the
amounts he transferred to David, issue David Forms W-2, Wage and
Tax Statements, or issue Forms 1099-MISC, Miscellaneous Income.
Arthur and Naomi reported the income attributable to Demetree and
Associates on the Schedules C, Profit or Loss From Business,
accompanying their 1983, 1984, 1985, and 1986 joint Federal
income tax returns.
In 1986, Arthur and Naomi lent David funds to purchase a
one-third interest in a partnership formed to build North Lane
Plaza (NLP), a strip mall. The following year, Arthur and Naomi
also lent David funds to start and operate Scooper’s Ice Cream
(Scooper’s) in one of NLP’s stores. Scooper’s produced losses
during all its years of operation until David sold it in 1989.
In 1987, 1988, 1989, and 1992, David claimed net operating loss
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deductions relating to NLP and Scooper’s. From 1986 through
1990, David managed NLP and reported on his 1990 return $109,000
of compensation relating to his management activities. In that
year, David transferred his one-third interest to the other
partners.
In 1987, Demetree and Associates employed Julia Lloyd as a
full-time property manager. She was responsible for collecting
rents, preparing monthly rental summaries, and assisting David in
securing tenants and negotiating leases for NLP.
Following Arthur’s death in 1991, David began managing the
properties formerly managed by his father. Ms. Lloyd worked for
David in the same capacity that she had for Arthur. David
reported the income relating to his property management
activities on the Schedules C accompanying his 1991 and 1992
returns and claimed a rental loss deduction relating to 1992.
In 1996, Ms. Lloyd asked David to terminate her so that she
would be eligible to collect unemployment benefits. When David
refused, she retaliated by filing a complaint with the local
government authorities alleging David’s business use of a
residential condominium. She also contacted respondent, alleged
that David had taken funds from Demetree and Associates and
failed to report such funds to the Internal Revenue Service, and
prepared ledgers documenting the alleged improprieties.
Respondent then initiated a criminal investigation of David and
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seized all of David’s records and those relating to Demetree and
Associates. In 1997, after respondent seized the records, Ms.
Lloyd terminated her employment relationship with David Demetree
and Associates Realtors. In 2000, respondent ended the criminal
investigation.
From 1983 through 1991, while petitioners were married,
Deborah filed separate income tax returns. David did not file
returns relating to 1983 through 1985. He delinquently filed his
1986 through 1989 returns on January 4, 1993, and his 1991 return
on January 26, 1993. Petitioners delinquently filed their 1992
return on October 19, 1993.
By notice of determination (notice), dated June 25, 1996,
respondent determined deficiencies, additions to tax, and
penalties relating to 1983, 1984, 1985, 1986, 1987, 1988, 1989,
and 1991. The deficiencies totaled $197,823; the section
6651(a)(1),1 6653(a), 6654(a), and 6661 additions to tax totaled
$80,303; and the section 6662 penalties totaled $10,594. On June
25, 1996, respondent sent petitioners a second notice in which he
determined a $4,040 deficiency and an $808 section 6662 penalty
relating to 1992.
By amendment to answer filed June 14, 2001, respondent,
after analyzing seized bank statements, checks, and deposit
1
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the years in issue, and
all Rule references are to the Tax Court Rules of Practice and
Procedure.
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tickets, revised his determinations relating to 1984, 1985, 1986,
1988, 1989, 1991 and 1992. The increases in the deficiencies
totaled $145,010, the additions to tax totaled $41,028.40, and
the penalties totaled $1,820.60. With respect to 19832 and 1987,
respondent determined decreases in the deficiencies totaling
$5,935 and additions to tax totaling $4,875.75.
On September 25, 1996, petitioners, while residing in
Longwood, Florida, filed petitions with this Court. On April 29,
1997, the Court granted their motion to consolidate the two
cases.
OPINION
I. Burden of Proof
Petitioners contend that the direct and indirect income
reconstruction methods that respondent used to determine the
deficiencies in his notices were arbitrary and excessive. We
disagree. David had a duty, but failed, to maintain adequate
financial records relating to most of the years in issue. Sec.
6001; sec. 1.6001-1(a), Income Tax Regs. Accordingly,
respondent’s use of the direct and indirect income reconstruction
2
At trial respondent discovered that the revised
deficiency for 1983 in his amendment to answer should have been
increased rather than decreased. In his brief, respondent asks
the Court to rely on the original deficiency in the notice
relating to 1983. We grant respondent’s request on brief because
it does not prejudice petitioners (i.e., petitioners were put on
notice of the deficiency and additions to tax, and the request
does not raise any new issues). See Rule 41(a); Foman v. Davis,
371 U.S. 178, 182 (1962).
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methods was appropriate, respondent’s determinations were not
arbitrary or excessive, and petitioners bear the burden of going
forward. See Merritt v. Commissioner, 301 F.2d 484, 486 (5th
Cir. 1962), affg. T.C. Memo. 1959-172; Schroeder v. Commissioner,
40 T.C. 30, 33 (1963).
Respondent concedes that, pursuant to Rule 142(a), he bears
the burden of proof on matters relating to the increases in the
deficiencies pleaded in his amendment to answer. With respect to
all of the remaining matters, our conclusion is unaffected by who
bears the burden of proof.3 Accordingly, we need not address the
parties’ burden of proof contentions.
II. Respondent’s Income Determinations
Respondent contends that David failed to report income he
received from Demetree and Associates and property he had
transferred to family members and friends. Petitioners contend
that the amounts they received were gifts and loans and that
David’s transfers of properties were bona fide transactions.
A. Demetree and Associates
Respondent contends that all of the income earned by
Demetree and Associates should have been attributed to David
because he, and not Arthur, controlled the business. Respondent
asserts that: David performed the managing and leasing
activities relating to Demetree and Associates; Arthur was never
3
Sec. 7491 is inapplicable because the examination of
petitioners’ returns began before the statute’s effective date.
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present in the office; David routinely signed Arthur’s name; and
Arthur, who was in his seventies during the years in issue, was
unable to manage Demetree and Associates. In the alternative,
respondent contends that the amounts petitioners received from
Demetree and Associates were compensation for services. We
disagree.
David did not control Demetree and Associates. See Crowley
v. Commissioner, 34 T.C. 333, 345 (1960) (holding that business
income is taxable to the person who owns and controls the
business). Petitioners, both of whom were credible witnesses,
testified that, while Deborah worked, David performed domestic
duties and was a full-time care provider to their five children.
David merely assisted Arthur, who made the major business
decisions. Arthur successfully ran Demetree and Associates for
more than 10 years before David began assisting him, he continued
to report the business income on his returns, and he was listed
as the owner or broker on the leases and sales agreements. The
only contrary evidence was the testimony of Ms. Lloyd, who was
not credible. Finally, the facts that David signed Arthur’s name
using a power of attorney and Arthur was in his seventies during
the years in issue are of little significance.
Nor are we persuaded that the amounts that David received
from Demetree and Associates were compensation for services
rendered. Instead, the testimony and documentary evidence
establish that Arthur and Naomi made gifts and loans from
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Demetree and Associates to David and his family. David and Ms.
Hinkle’s testimony established that the disbursements were not
made or intended to be made for any services rendered and that
David was under no obligation to perform services. See Bogardus
v. Commissioner, 302 U.S. 34, 36-37 (1937) (holding that the
controlling factor to distinguish between a gift and compensation
is the intent of the payor). Rather, the transfers to David were
consistent with Arthur and Naomi’s established pattern of making
frequent and substantial gifts and loans to David and his family.
Accordingly, we reject respondent’s determinations relating to
1983, 1984, 1985, 1986, 1987, 1988, 1989, and prior to Arthur’s
death in 1991. David, however, failed to report income relating
to his 1991 and 1992 property management activities. See sec.
61(a); James v. United States, 366 U.S. 213, 219 (1961).
Therefore, we sustain respondent’s determinations relating to
those years.
B. The Brahman Inn
Respondent contends that the amounts Ms. Hinkle transferred
to David were compensation for his management services related to
the Brahman Inn. David and Ms. Hinkle’s testimony established
that the amounts he received were loans and that the management
responsibilities relating to the Brahman Inn were handled by an
onsite manager and supervised by Demetree and Associates.
Accordingly, we reject respondent’s determinations.
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C. David’s Property Transfers
Respondent contends that the rental income, relating to 205
San Sebastian Court and the 797 property transferred by David, is
properly attributable to David. David is indeed liable for the
taxes relating to the rental income from 205 San Sebastian Court.
In 1980, David transferred 205 San Sebastian Court to Walter
Pemberton. Prior to the bank’s foreclosing on the property,
however, David continued to make the mortgage payments and
retained all of the rental income. Even though David transferred
legal title of 205 San Sebastian Court, David remained the
beneficial owner of the property. Lucas v. Earl, 281 U.S. 111
(1930); Serianni v. Commissioner, 80 T.C. 1090, 1104 (1983),
affd. 765 F.2d 1051 (11th Cir. 1985). Arthur and Naomi gave
David the rental income from the 797 property relating to 1988,
1989, and 1992, and David did not retain beneficial ownership of
the property. Accordingly, we sustain respondent’s
determinations relating to 205 San Sebastian Court and reject
respondent’s determinations relating to the 797 property.
D. North Lane Plaza and Scooper’s Ice Cream
Respondent determined that David failed to report
compensation income from NLP and Scooper’s relating to 1986,
1987, 1988, 1989, 1991 and 1992. Petitioners contend that these
funds were withdrawn to reimburse David for expenditures he made
on behalf of NLP and Scooper’s. We agree with respondent. The
funds withdrawn were compensation relating to management services
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David rendered on behalf of NLP and Scooper’s. See sec. 61(a);
James v. United States, supra. Accordingly, respondent’s
determinations are sustained.
E. Interest Income
Respondent determined that petitioners failed to report
interest income relating to 1986, 1987, 1988, 1989, 1991, and
1992. We sustain respondent’s determinations relating to David’s
accounts (i.e., interest earned in 1986, 1987, 1988, 1989, 1991,
and 1992), and Deborah’s accounts (i.e., interest earned in
1992).
III. Petitioners’ Claimed Loss Deductions
There is no evidence to support petitioners’ claimed 1987,
1988, 1989, and 1992 net operating loss deductions or 1992 rental
loss deduction. See sec. 6001; sec. 1.6001-1(a), Income Tax
Regs. Accordingly, respondent’s determinations are sustained.
IV. Self-Employment Income
Respondent determined that petitioners were liable, pursuant
to section 1401, for tax on self-employment income relating to
all the years in issue. We hold that, consistent with our
findings, petitioners are liable for self-employment tax relating
to income from NLP, Scooper’s, and David’s property management
activities relating to 1991 and 1992. See sec. 1402(a) and (b).
V. Additions to Tax and Penalties
Respondent determined additions to tax pursuant to sections
6651(a)(1), 6654(a), and 6661. Section 6651(a)(1) provides an
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addition to tax for failure to file a tax return in a timely
manner, unless such failure was due to reasonable cause and not
due to willful neglect. There was no reasonable cause for the
delay in filing the returns, and, thus, David is liable for the
section 6651(a)(1) additions to tax. See, e.g., Higbee v.
Commissioner, 116 T.C. 438, 447-448 (2001). Section 6654(a)
provides an addition to tax for failure to pay estimated income
tax. David filed no returns and made no estimated tax payments
relating to 1983, 1984, and 1985 and, thus, is liable for those
additions to tax. See, e.g., Niedringhaus v. Commissioner, 99
T.C. 202, 222-223 (1992). Section 6661 provides for an addition
to tax for substantial understatements reduced by the portion for
which there is substantial authority or adequate disclosure.
David’s understatements were not based on substantial authority
or adequately disclosed, and, thus, David is liable for those
additions to tax. See, e.g., Cluck v. Commissioner, 105 T.C.
324, 340 (1995).
Respondent also determined additions to tax pursuant to
section 6653(a) and accuracy-related penalties pursuant to
section 6662(a). Petitioners’ failure to keep records and file
timely and accurate returns was due to negligence. See, e.g.,
Higbee v. Commissioner, supra at 449; Niedringhaus v.
Commissioner, supra at 222. Accordingly, petitioners are liable
for those additions to tax and accuracy-related penalties.
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Contentions we have not addressed are irrelevant, moot, or
meritless.
To reflect the foregoing,
Decisions will be entered
under Rule 155.