Walker v. Comm'r

T.C. Memo. 2003-335

UNITED STATES TAX COURT

CLAUDIA F. WALKER, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 13842-02. Filed December 8, 2003.

J. Scott Moede and Jan R. Pierce, for petitioner.

Shirley M. Francis, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

COHEN, Judge: Respondent determined deficiencies of $9,104

and $32,949 in petitioner’s Federal income taxes for 1997 and

1998, respectively, and penalties of $1,821 and $6,590 under

section 6662(b)(1) or, in the alternative, section 6662(b)(2),

for those years, respectively. The issues for decision are:

(1) Whether petitioner reported the correct amount of gain
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resulting from the sale of her interest in a parcel of property

deeded to petitioner by her former (now deceased) husband, Bert

Walker (Mr. Walker), on her 1997 and 1998 Federal income tax

returns and (2) whether petitioner is liable for accuracy-related

penalties under section 6662(a) for 1997 and 1998.

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. All dollar amounts have been rounded to the nearest

dollar.

FINDINGS OF FACT

Some of the facts have been stipulated, and the stipulated

facts are incorporated in our findings by this reference. At the

time the petition in this case was filed, petitioner resided in

Clackamas, Oregon.

Background

Petitioner and Mr. Walker were married on July 16, 1966.

Prior to their marriage, petitioner had worked in several

factories and had obtained a high school equivalent education.

During their marriage, petitioner did not work outside the home.

Mr. Walker worked as a realtor, property developer, and home

builder. Petitioner and Mr. Walker divorced effective

December 20, 1996.
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At the time of their divorce, petitioner’s and Mr. Walker’s

marital estate was worth several million dollars. Included in

the marital estate was a piece of real property (Happy Valley

property) located next to petitioner’s and Mr. Walker’s home in

Clackamas County, Oregon, in which petitioner and Mr. Walker

jointly owned a 50-percent interest. The other 50-percent

interest in the Happy Valley property had been conveyed to a

trust for the benefit of petitioner and Mr. Walker’s children and

grandchildren (Walker Family Irrevocable Trust).

The marital settlement agreement that was entered into by

petitioner and Mr. Walker severed their joint ownership in the

Happy Valley property and conveyed separate 25-percent interests

to each of them. In accordance with the terms of the marital

settlement agreement and pursuant to a bargain and sale deed

signed and dated by petitioner and notarized on October 10, 1996,

and signed and dated by Mr. Walker and notarized on October 17,

1996, petitioner and Mr. Walker, as grantors, conveyed to

petitioner, as grantee, one-half of their previously jointly

owned 50-percent interest in the Happy Valley property. The

stated consideration for this conveyance was the Stipulated

Judgment of Dissolution of Marriage (divorce decree) entered in

Clackamas County (Oregon) Circuit Court Case No. 96 04 504,

Walker v. Walker. Neither the marital settlement agreement nor
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the divorce decree addressed the sale of the Happy Valley

property.

In addition to providing to petitioner and Mr. Walker

separate 25-percent interests in the Happy Valley property, the

marital settlement agreement divided the rest of their real

property and their personal property, contained a provision for

an equalizing money judgment that required Mr. Walker to pay to

petitioner $500,000, and required Mr. Walker to pay to petitioner

spousal support in the amount of $4,000 per month until he

satisfied the equalizing money judgment. The equalizing money

judgment provided that “No interest shall accrue on the $500,000

judgment if paid within one year. If the judgment is not paid

when due, the judgment shall accrue interest at the rate of

9 percent per annum from the date the judgment is entered.”

Petitioner’s equalizing money judgment against Mr. Walker was

secured by a note and a trust deed on several pieces of real

property that were conveyed to Mr. Walker pursuant to the marital

settlement agreement, including his 25-percent interest in the

Happy Valley property. The equalizing money judgment was entered

against Mr. Walker on November 20, 1996.

Correspondence Regarding the Tax Consequences of Transactions
Involving the Happy Valley Property

On April 21, 1997, petitioner’s divorce attorney, Raymond

Young (Young), wrote a letter to Gary Leavitt (Leavitt), an

accountant in Oregon City, Oregon, requesting advice on a
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possible transaction involving petitioner, Mr. Walker, and the

Happy Valley property. The pertinent parts of Young’s letter to

Leavitt are as follows:

I am writing this letter on behalf of my client,
Claudia Walker, who has a significant post-decree tax
question. * * *

In the divorce decree from Clackamas County in
November 1996, Ms. Walker was awarded a $500,000
judgment against Mr. Walker. The judgment is due one
year from the date of the judgment. As long as it is
paid when due, no interest will accrue on the judgment.
* * *

Five months later, Mr. Walker is running into
financial difficulties and two of the properties, an
apartment complex and some bare land, are in the
process of being sold. * * * In regards to the bare
land, Mr. Walker holds a one-quarter interest in the
property with Mrs. Walker holding another one-quarter
interest in the property. After that sale is made,
Mr. Walker’s one-quarter interest should net him about
$200,000 from the sale.

The big question is, should Mr. Walker Quitclaim
his * * * one-quarter interest in the bare land to
Ms. Walker prior to the sale with a simple notation on
the Quitclaim Deed that the consideration is a credit
against the judgment owed to her for whatever amount
she receives from the sale, who is responsible for the
capital gains on Mr. Walker’s portion? Essentially, it
boils down to if Mr. Walker transfers his interest in
the real property to Mrs. Walker, is it a taxable event
for him, which requires him to declare the capital
gains, or whether the capital gains responsibility and
the basis carries over to Mrs. Walker so she has to pay
capital gains on the proceeds of the sale herself.

Young sent a copy of this letter to petitioner, and she reviewed

it.

On April 29, 1997, Young faxed the letter that he had sent

to Leavitt to Kelly Coburn (Coburn), petitioner’s accountant,
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seeking Coburn’s views on the tax consequences for the facts

stated in the letter to Leavitt. Petitioner and Mr. Walker had

been clients of Coburn’s firm for many years, and Coburn

continued to prepare their individual tax returns after their

divorce. On May 1, 1997, Coburn wrote a response to Young. The

pertinent parts of Coburn’s response are as follows:

I received your fax of a letter you sent to Gary
Leavitt regarding a possible transfer of properties
from Bert to Claudia prior to their sale. If the
transfers occur within one year of the divorce, it is
clear that Internal Revenue Code Section 1041 would
apply. No gain or loss would be reported by Bert
Walker, and Claudia Walker would take his basis in the
property as her own. Therefore, she would be
responsible for any income taxes due on a subsequent
sale. [Emphasis added.]

There are a couple of alternatives that could be
considered. First, since Claudia will probably have
little other income in 1997, she may be in a lower tax
bracket than Bert and thus would pay less income tax on
the gains than Bert would. If Claudia were to accept
an assignment of the properties, Bert could perhaps
agree to reimburse her for the income tax due on the
gains.

Or, since Claudia holds trust deeds on these
properties, it should be possible for the escrow
instructions to provide for a payment of some or all of
the proceeds from the sales, even though Bert would be
the seller. In that case, Bert would remain
responsible for the income taxes on any gain. If this
were done, Bert may wish to retain a portion of the
proceeds, in order to pay the income taxes on the
gains.

Coburn sent copies of his response to Young’s letter to both

petitioner and Mr. Walker, and petitioner reviewed her copy of

his response.
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The Transactions Involving the Happy Valley Property

The Happy Valley property was listed for sale with a realtor

sometime during 1997. Mr. Walker served as the primary contact

person for the realtor on the sale of the Happy Valley property.

On or about August 19, 1997, a prospective purchaser, Cruz

Development, Inc. (Cruz Development), offered to buy the Happy

Valley property. Cruz Development was not related to petitioner

or to Mr. Walker, and neither petitioner nor Mr. Walker had any

legal obligations to Cruz Development. Cruz Development’s offer

to buy the Happy Valley property was based on obtaining approval

for 48 buildable lots on the property at a price of $20,000 per

lot. The sale of the Happy Valley property to Cruz Development,

however, was not completed.

On September 22, 1997, petitioner signed a document entitled

“Settlement Agreement” whereby she agreed to accept Mr. Walker’s

25-percent interest in the Happy Valley property in consideration

for a credit against the $500,000 equalizing money judgment.

The Settlement Agreement used the following language:

I Claudia F. Walker hereby agree to accept from Bert
Walker his 25% interest in real property Tl. 2000 and
Tl.2090 - Happy Valley, Oregon.

This assignment will credit Bert Walker his 1/4
interest being approximately $213,500 less
approximately $60,000 Capital Gains Tax; leaving
$153,500 credit towards the divorce settlement.

This calculation is based on 44 future building lots;
the settlement amount may be adjusted up or down by
$20,833,-per lot after subdivision approval.
 - 8 -

Claudia Walker agrees to pay deferred property taxes on
hers and Bert’s share.

The Settlement Agreement was also signed by Mr. Walker, but it

was not dated by him.

On September 26, 1997, Mr. Walker signed and had notarized

the quitclaim deed that conveyed his 25-percent interest in the

Happy Valley property to petitioner. The Settlement Agreement

was attached to the quitclaim deed and provided the consideration

for the transfer of Mr. Walker’s 25-percent interest in the Happy

Valley property to petitioner.

On September 30, 1997, petitioner signed an earnest money

agreement with a new and unrelated prospective buyer, Parker

Development Northwest, Inc. (Parker Development), for the

potential sale of the Happy Valley property. The earnest money

agreement acknowledged earnest money of $200,000 and provided for

release of that $200,000 to the listed sellers, petitioner and

the Walker Family Irrevocable Trust, by October 15, 1997, and

closing on or before October 31, 1997. On October 1, 1997, the

trustee for the Walker Family Irrevocable Trust, which, as

previously noted, owned a 50-percent interest in the Happy Valley

property, signed the earnest money agreement. Mr. Walker did not

sign the earnest money agreement and is not mentioned in this

document.

The quitclaim deed that conveyed Mr. Walker’s interest in

the Happy Valley property to petitioner was recorded on
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October 2, 1997. The bargain and sale deed that conveyed the

Happy Valley property to Parker Development was signed by

petitioner on October 10, 1997. This bargain and sale deed was

recorded by Parker Development in November 1997. As shown on the

Seller Final Closing Statement (closing statement), the closing

date for Parker Development’s purchase of the Happy Valley

property was November 5, 1997. The closing statement listed only

petitioner and the Walker Family Irrevocable Trust as sellers of

50-percent interests in the Happy Valley property. There was no

reference in the closing statement to Mr. Walker’s participating

in the sale of the Happy Valley property.

Petitioner’s and Mr. Walker’s Tax Returns

Coburn prepared petitioner’s Federal income tax returns for

1997 and 1998 (1997 and 1998 returns) and used the installment

method to report the gain on the sale of a 25-percent interest in

the Happy Valley property on those returns. Petitioner told

Coburn that Mr. Walker agreed to pay the tax on 25 percent of the

gain resulting from the sale of the Happy Valley property to

Parker Development. Petitioner did not provide to Coburn the

Settlement Agreement or quitclaim deed that transferred

Mr. Walker’s interest in the Happy Valley property to her while

Coburn was preparing her 1997 and 1998 returns. Consequently,

Coburn prepared petitioner’s 1997 and 1998 returns without regard
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to the 25-percent interest in the Happy Valley property formerly

owned by Mr. Walker.

Coburn also prepared Mr. Walker’s 1997 Federal income tax

return (1997 return), which Mr. Walker filed on or about May 25,

1998. On his 1997 return, Mr. Walker reported a gain on the sale

of a 25-percent interest in the Happy Valley property. Had

Coburn been provided with the Settlement Agreement and quitclaim

deed that transferred Mr. Walker’s 25-percent interest in the

Happy Valley property to petitioner, he would not have reported

any gain from the sale of the Happy Valley property to Parker

Development on Mr. Walker’s 1997 return.

In January 2000, Mr. Walker gave to Coburn a copy of the

Settlement Agreement that petitioner had signed on September 22,

1997, and which was attached to the quitclaim deed of

September 26, 1997, and requested that Coburn amend his 1997

return. Mr. Walker also supplied to Coburn a copy of the

quitclaim deed. Accordingly, in March 2000, Mr. Walker filed an

amended Federal income tax return for 1997 to remove from his

taxable income the gain on the sale of the Happy Valley property.

When Coburn told petitioner that Mr. Walker had amended his

1997 return, petitioner responded by telling him that the

Settlement Agreement related to a transaction that had not

occurred. Consequently, petitioner did not amend her 1997 and

1998 returns.
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Mr. Walker died on August 31, 2001, while his refund claim

for 1997 was pending. On July 24, 2002, respondent disallowed

the refund claim that was filed by Mr. Walker for 1997 and sent

to petitioner a notice of deficiency for 1997 and 1998. The

notice of deficiency determined that petitioner’s total tax

liabilities were $11,221 for 1997 and $52,017 for 1998.

Consequently, respondent determined deficiencies of $9,104 and

$32,949 in petitioner’s Federal income taxes for 1997 and 1998,

respectively, and accuracy-related penalties of $1,821 and $6,590

under section 6662(a) for 1997 and 1998, respectively. The

deficiencies were based on petitioner’s failure to report the

gain on the sale to Parker Development of the 25-percent interest

in the Happy Valley property that had been transferred to her

from Mr. Walker in September 1997. The accuracy-related

penalties were imposed because the underpayment of tax on

petitioner’s 1997 and 1998 returns was determined to be

attributable to petitioner’s negligence or disregard of the rules

or regulations under section 6662(b)(1) or, alternatively, to a

substantial understatement of income tax under section

6662(b)(2).

The “Whipsaw” Position

This case is related to a refund action that is pending

before the U.S. Court of Federal Claims, Walker Family Trust v.

United States, No. 02-1454 T. The Walker Family Irrevocable
 - 12 -

Trust, which is the plaintiff in the above-referenced refund

action, owns its interest in Mr. Walker’s claim by virtue of an

assignment made by Mr. Walker’s estate. Petitioner’s deficiency

action and the refund action brought by the Walker Family

Irrevocable Trust constitute what is known as a “whipsaw”

position for respondent because of the inconsistent positions

taken by the two parties with respect to the gain resulting from

the sale of the Happy Valley property to Parker Development.

OPINION

Petitioner’s Gain on the Sale of the Happy Valley Property

Petitioner contends that under section 1041 she is liable

for tax on only 25 percent of the gain that resulted from the

sale of the Happy Valley property to Parker Development.

Section 1041 provides a broad rule of nonrecognition-of-gain

treatment for sales, gifts, and other transfers of property

between spouses or between former spouses and incident to

divorce. Sec. 1041(a). The basic policy of section 1041 is to

treat a husband and wife as one economic unit and to defer, but

not eliminate, the recognition of any gain or loss on

interspousal property transfers until the property is conveyed to

a third party outside the economic unit. Blatt v. Commissioner,

102 T.C. 77, 80 (1994). This policy extends to transfers of

property between former spouses so long as the transfers take

place incident to divorce. See sec. 1041(a)(2).
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In advancing her argument, petitioner assumes that she can

disavow the form of the transactions that occurred with respect

to the Happy Valley property. Based on this assumption,

petitioner asserts that the following substance should control

the tax consequences of the transactions involving the Happy

Valley property: The quitclaim deed of September 26, 1997,

constituted a written request from Mr. Walker to petitioner that

she sell his 25-percent interest in the Happy Valley property to

a disinterested third party; therefore, petitioner’s sale of the

Happy Valley property to Parker Development took place on behalf

of Mr. Walker. Petitioner contends that this substance falls

within the scope of the second situation described in section

1.1041-1T(c), Q&A-9, Temporary Income Tax Regs., 49 Fed. Reg.

34453 (Aug. 31, 1984). Accordingly, petitioner concludes that

she should be provided nonrecognition-of-gain treatment under

section 1041(a) as to the 25-percent interest in the Happy Valley

property that she sold on behalf of Mr. Walker. As a backstop to

her substance over form argument, petitioner contends that she

filed her 1997 and 1998 returns in accordance with an agreement

that she had with Mr. Walker that he would report one-half of the

gain resulting from the sale of petitioner’s undivided 50-percent

interest in the Happy Valley property.

Conversely, respondent argues that petitioner failed to

report a gain on the sale of property that she acquired in a
 - 14 -

transaction incident to her divorce from Mr. Walker. Respondent

contends that petitioner agreed to accept a 25-percent interest

in the Happy Valley property from Mr. Walker within 1 year of

their divorce and in partial satisfaction of the equalizing money

judgment. Furthermore, respondent asserts that petitioner’s

substance over form argument has no merit and that Mr. Walker’s

alleged agreement to report part of the gain resulting from the

sale of the Happy Valley property is not determinative.

In order to decide whether petitioner reported the correct

amount of gain on the sale of the Happy Valley property on her

1997 and 1998 returns, we begin by considering whether petitioner

can disavow the form of the transactions involving the Happy

Valley property.

A. Petitioner’s Assumption That She Can Disavow the Form of
the Transactions Involving the Happy Valley Property in
Favor of Their Alleged Substance

As a general rule, a taxpayer is bound by the form of the

transaction that the taxpayer has chosen. Framatome Connectors

USA, Inc. v. Commissioner, 118 T.C. 32, 47 (2002); Steel v.

Commissioner, T.C. Memo. 2002-113; see Estate of Durkin v.

Commissioner, 99 T.C. 561, 571-572 (1992). Taxpayers are

ordinarily free to organize their affairs as they see fit;

however, once having done so, they must accept the tax

consequences of their choice, whether contemplated or not, and

may not enjoy the benefit of some other route that they might
 - 15 -

have chosen but did not. Commissioner v. Natl. Alfalfa

Dehydrating & Milling Co., 417 U.S. 134, 149 (1974); see also In

re Steen, 509 F.2d 1398, 1402-1403 n.4 (9th Cir. 1975)

(maintaining that to allow a taxpayer to challenge his own forms

in favor of asserted “substance” would encourage

posttransactional tax planning and unwarranted litigation and

would raise a monumental administrative burden and substantial

problems of proof for the Government).

Young’s letter of April 21, 1997, and Coburn’s response to

Young’s letter on May 1, 1997, establish that petitioner had been

advised that she had several options that she could pursue with

respect to using Mr. Walker’s 25-percent interest in the Happy

Valley property to satisfy at least a part of her equalizing

money judgment. In particular, Coburn’s response to Young’s

letter asserted that, if petitioner chose to accept Mr. Walker’s

interest in the Happy Valley property within 1 year of the end of

their marriage and then decided to sell her undivided interest in

that property, she would be responsible for the entire amount of

tax resulting from the sale. The record in this case

demonstrates that this option was the one that petitioner chose

to follow.

Petitioner voluntarily entered into the Settlement Agreement

with Mr. Walker on September 22, 1997, and accepted his

25-percent interest in the Happy Valley property in consideration
 - 16 -

for a credit against the $500,000 equalizing money judgment. In

accordance with the Settlement Agreement, Mr. Walker transferred

his 25-percent interest in the Happy Valley property to

petitioner on September 26, 1997, pursuant to a quitclaim deed.

The quitclaim deed was recorded on October 2, 1997. Thus,

Mr. Walker no longer had any rights in the Happy Valley property

as of the date petitioner signed the bargain and sale deed that

conveyed an undivided 50-percent interest in the Happy Valley

property to Parker Development, October 10, 1997.

Petitioner entered into the foregoing transactions after

having been advised of the tax consequences of the form of those

transactions. There is no reason here to disregard that form.

B. Application of Section 1041 to the Transactions
Involving the Happy Valley Property

Because petitioner cannot invoke the doctrine of substance

over form, we must consider whether two separate transactions

qualify for nonrecognition-of-gain treatment under section

1041(a). The first transaction involves Mr. Walker’s transfer of

his 25-percent interest in the Happy Valley property to

petitioner in consideration for a Settlement Agreement that

provided to Mr. Walker a credit against the $500,000 equalizing

money judgment that he owed to petitioner. The second

transaction involves petitioner’s sale of her undivided

50-percent interest in the Happy Valley property to an unrelated

third party, Parker Development.
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Section 1041 provides in pertinent part as follows:

SEC. 1041. TRANSFERS OF PROPERTY BETWEEN SPOUSES
OR INCIDENT TO DIVORCE.

(a) General Rule.–-No gain or loss shall be
recognized on a transfer of property from an individual
to (or in trust for the benefit of)--

(1) a spouse, or

(2) a former spouse, but only if the transfer
is incident to the divorce.

(b) Transfer Treated as Gift; Transferee Has
Transferor’s Basis.–-In the case of any transfer of
property described in subsection (a)--

(1) for purposes of this subtitle, the
property shall be treated as acquired by the
transferee by gift, and

(2) the basis of the transferee in the
property shall be the adjusted basis of the
transferor.

(c) Incident to Divorce.–-For purposes of
subsection (a)(2), a transfer of property is incident
to the divorce if such transfer–-

(1) occurs within 1 year after the date on
which the marriage ceases, or

(2) is related to the cessation of the
marriage.

Mr. Walker’s transfer of his 25-percent interest in the

Happy Valley property to petitioner on September 26, 1997, took

place incident to their divorce because it occurred within 1 year

after the date on which their marriage ceased, December 20, 1996.

Sec. 1041(c)(1). Consequently, Mr. Walker’s transfer of his

interest in the Happy Valley property to petitioner qualified for
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nonrecognition-of-gain treatment under section 1041(a)(2). See

also sec. 1.1041-1T(d), Q&A-10, Temporary Income Tax Regs., 49

Fed. Reg. 34453 (Aug. 31, 1984) (providing that the transferor of

property under section 1041 is to recognize no gain or loss on

the transfer, regardless of whether the transfer is in exchange

for consideration). Petitioner received the 25-percent interest

in the Happy Valley property with a basis equal to Mr. Walker’s

adjusted basis in that 25-percent interest. Sec. 1041(b); see

also sec. 1.1041-1T(d), Q&A-11, Temporary Income Tax Regs., 49

Fed. Reg. 34453 (Aug. 31, 1984) (providing that, in all transfers

subject to section 1041, the basis of the transferred property in

the hands of the transferee is the adjusted basis of such

property in the hands of the transferor immediately before the

transfer, regardless of whether the transfer is a bona fide sale

in which the transferee pays the transferor consideration for the

transferred property).

Petitioner’s sale of her undivided 50-percent interest in

the Happy Valley property in October 1997 is not a transaction

that falls within the statutory language of section 1041(a)

because it was not a transfer to or on behalf of her spouse or

her former spouse and incident to divorce. Therefore, section

1041(a) does not relieve petitioner from recognizing the gain

resulting from the sale of her interest in the Happy Valley

property.
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Petitioner argues that section 1.1041-1T(c), Q&A-9,

Temporary Income Tax Regs., 49 Fed. Reg. 34453 (Aug. 31, 1984),

qualifies her for nonrecognition-of-gain treatment under section

1041(a) for the sale of the 25-percent interest in the Happy

Valley property received from Mr. Walker in September 1997.

Section 1.1041-1T(c), Q&A-9, Temporary Income Tax Regs., 49 Fed.

Reg. 34453 (Aug. 31, 1984), applies only to transfers made by a

taxpayer to a third party on behalf of that taxpayer’s spouse or

former spouse. Generally, a transfer by a taxpayer is considered

to have been made “on behalf of” that taxpayer’s spouse or former

spouse if it satisfied a specific legal obligation or liability

of that taxpayer’s spouse or former spouse. Ingham v. United

States, 167 F.3d 1240, 1243-1245 (9th Cir. 1999); Arnes v. United

States, 981 F.2d 456, 459 (9th Cir. 1992); Blatt v. Commissioner,

102 T.C. 77, 81 (1994). As discussed above, Mr. Walker’s

transfer of his 25-percent interest in the Happy Valley property

on September 26, 1997, satisfied a specific legal obligation that

he owed to petitioner (i.e., a portion of the equalizing money

judgment) and gave her control over an undivided 50-percent

interest in that property. Petitioner’s subsequent sale of her

interest in the Happy Valley property did not satisfy any other

legal obligation or liability that Mr. Walker owed to her or

anyone else. Thus, petitioner did not make the sale “in the

interest of” or “as a representative of” Mr. Walker. Cf. Craven
 - 20 -

v. United States, 215 F.3d 1201, 1207 (11th Cir. 2000); Read v.

Commissioner, 114 T.C. 14, 36-37 (2000). Therefore, petitioner’s

sale of her interest in the Happy Valley property was not made on

behalf of Mr. Walker. Accordingly, section 1.1041-1T(c), Q&A-9,

Temporary Income Tax Regs., 49 Fed. Reg. 34453 (Aug. 31, 1984),

is not applicable to this case.

C. Petitioner’s Argument That She Filed Her 1997 and 1998
Returns in Accordance With an Agreement That She Had With
Mr. Walker

Petitioner relies on Friscone v. Commissioner, T.C. Memo.

1996-193, for her argument that she filed her 1997 and 1998

returns in accordance with an agreement that she had with

Mr. Walker that he would report one-half of the gain resulting

from the sale of petitioner’s undivided 50-percent interest in

the Happy Valley property. The principal issue in Friscone was

whether, following an agreement between a husband and wife that

was incorporated in a divorce decree, the gain on the subsequent

sale of certain stock owned by the husband was to be attributed

to him in its entirety or only in the portion awarded to him by

the divorce decree. In holding that only the gain on the portion

awarded to the husband by the divorce decree was to be attributed

to him, we considered the manner in which the divorce decree

divided the proceeds of the sale of the stock between the husband

and wife. Even though title to the stock remained with the

husband up to the time of its sale under the terms of the divorce
 - 21 -

decree, we concluded that the divorce decree substantively

transferred ownership of 55 percent of the stock to the wife.

Therefore, we decided that the husband was liable for the tax on

only 45 percent of the proceeds of the sale of the stock.

Friscone reflects the proposition that, when a divorce

decree controls the apportionment of property between a husband

and wife, each of them is liable only for the tax on the gain

resulting from the sale of their portion of that property to a

third party. Petitioner’s and Mr. Walker’s divorce decree set

forth that they would receive separate 25-percent interests in

the Happy Valley property. As discussed above, petitioner

accepted Mr. Walker’s 25-percent interest in the Happy Valley

property in consideration for a credit against the $500,000

equalizing money judgment. Mr. Walker then transferred his

25-percent interest in the Happy Valley property to petitioner

pursuant to a quitclaim deed. This transfer extinguished his

ownership interest in the Happy Valley property. Consequently,

the divorce decree no longer controlled the apportionment of the

Happy Valley property between petitioner and Mr. Walker as of the

date of its sale to Parker Development. Therefore, the reasoning

of Friscone is of no help to petitioner in this case.

Because petitioner controlled an undivided 50-percent

interest in the Happy Valley property at the time of its sale,

she had the right to receive the income generated by the sale of
 - 22 -

that interest and to enjoy the benefit of that income when it was

paid to her by Parker Development. One of the general principles

of tax law is that income is taxed “to those who earn or

otherwise create the right to receive it and enjoy the benefit of

it when paid.” Helvering v. Horst, 311 U.S. 112, 119 (1940).

This general principle dictates that the gain that was recognized

on the sale of petitioner’s interest in the Happy Valley property

was taxable to her. Consequently, no effect can be given to an

agreement between petitioner and Mr. Walker as to how the gain on

the sale of her interest in the Happy Valley property was going

to be reported on her 1997 and 1998 returns. See Pesch v.

Commissioner, 78 T.C. 100, 129 (1982); Neeman v. Commissioner, 13

T.C. 397, 399 (1949), affd. per curiam 200 F.2d 560 (2d Cir.

1952); Estate of Ballantyne v. Commissioner, T.C. Memo. 2002-160,

affd. sub nom. Ballantyne v. Commissioner, 341 F.3d 802 (8th Cir.

2003); Bonner v. Commissioner, T.C. Memo. 1979-435.

Section 6662 Accuracy-Related Penalty

Respondent determined accuracy-related penalties under

section 6662(a). Under section 6662(a), a taxpayer may be liable

for a penalty of 20 percent on the portion of an underpayment of

tax due to, inter alia, negligence or disregard of the rules or

regulations. Sec. 6662(b)(1). The term “negligence” includes

any failure to make a reasonable attempt to comply with the

provisions of the internal revenue laws or to exercise ordinary
 - 23 -

and reasonable care in the preparation of a tax return. Sec.

6662(c); sec. 1.6662-3(b)(1), Income Tax Regs. The term

“disregard” includes any careless, reckless, or intentional

disregard. Sec. 6662(c). A taxpayer’s disregard is

“intentional” if the taxpayer knows of the rule or regulation

that is disregarded. Sec. 1.6662-3(b)(2), Income Tax Regs.

Respondent has the burden of production under section 7491(c) and

must come forward with sufficient evidence indicating that it is

appropriate to impose the penalty. See Higbee v. Commissioner,

116 T.C. 438, 446-447 (2001). Once respondent meets his burden

of production, the taxpayer must come forward with persuasive

evidence that respondent’s determination is incorrect. Id.

As discussed above, petitioner was advised as to the tax

consequences of her transactions involving the Happy Valley

property by Coburn in his correspondence of May 1, 1997. Even

though petitioner was aware of the tax consequences of these

transactions, her 1997 and 1998 returns do not reflect the

correct amount of gain that she recognized on the sale of her

undivided 50-percent interest in the Happy Valley property

because she failed to provide to Coburn the Settlement Agreement

and quitclaim deed that transferred Mr. Walker’s 25-percent

interest in the Happy Valley property to her. (When Mr. Walker

filed an amended return for 1997, petitioner made a

misrepresentation to Coburn by stating that the transaction
 - 24 -

embodied by the Settlement Agreement and quitclaim deed did not

take place.) This evidence satisfies respondent’s burden of

production under section 7491(c).

Petitioner contends that respondent’s determination to

impose the accuracy-related penalty due to negligence or

disregard of the rules or regulations is incorrect because the

position that she took on her 1997 and 1998 returns had a

reasonable basis. A return position that has a reasonable basis

is not attributable to negligence or disregard of the rules or

regulations. See sec. 1.6662-(3)(b)(1), (3), Income Tax Regs.

The reasonable basis standard is not satisfied, however, by a

return position that is merely arguable or that is merely a

colorable claim. See sec. 1.6662-3(b)(3), Income Tax Regs.; see

also Indeck Energy Servs., Inc. v. Commissioner, T.C. Memo. 2003-

101 (expressing that the reasonable basis standard was a standard

significantly higher than the “not frivolous” standard prior to

that standard’s being defined by an amendment to section 1.6662-

3(b), Income Tax Regs.).

Petitioner has presented neither persuasive evidence nor

authority justifying her rejection of the tax advice she received

prior to entering into the transactions with Mr. Walker and

Parker Development. Petitioner’s position on her 1997 and 1998

returns was based on an unwarranted assumption that she could

disavow the form of the transactions involving the Happy Valley
 - 25 -

property for their alleged substance. Therefore, we conclude

that petitioner did not have a reasonable basis for the position

taken on her 1997 and 1998 returns.

A taxpayer may also be liable for a penalty under section

6662(a) on the portion of an underpayment due to a substantial

understatement of income tax. Sec. 6662(b)(2). An

understatement of income tax is “substantial” if it exceeds the

greater of 10 percent of the tax required to be shown on the

return or $5,000. Sec. 6662(d)(1)(A). An “understatement” is

defined as the excess of the tax required to be shown on the

return over the tax actually shown on the return, less any

rebate. Sec. 6662(d)(2)(A). In this case, the understatement on

each of petitioner’s returns satisfies the definition of

“substantial”. The amount of the understatement subject to the

penalty is reduced, however, to the extent it is attributable to

the tax treatment of any item by the taxpayer if there is or was

substantial authority for such treatment. Sec. 6662(d)(2)(B)(i).

Alternatively, the amount of the understatement may be reduced to

the extent it is attributable to any item if the relevant facts

affecting the item’s tax treatment are adequately disclosed in

the return or in a statement attached to the return and there is

a reasonable basis for the tax treatment of such item by the

taxpayer. Sec. 6662(d)(2)(B)(ii).
 - 26 -

Petitioner’s treatment of the transactions involving the

Happy Valley property on her 1997 and 1998 returns was not

supported by substantial authority. Furthermore, petitioner

neither disclosed the relevant facts in those returns nor had a

reasonable basis for the position taken on those returns.

Consequently, the understatements of income tax on petitioner’s

1997 and 1998 returns cannot be reduced under section

6662(d)(2)(B).

Whether the section 6662(a) penalty is applied because of an

underpayment attributable to negligence or disregard of the rules

or regulations or to a substantial understatement of income tax,

the penalty will not be imposed with respect to any portion of

the underpayment as to which the taxpayer acted with reasonable

cause and in good faith. Sec. 6664(c)(1); Higbee v.

Commissioner, supra at 448-449. The decision as to whether a

taxpayer acted with reasonable cause and in good faith is made by

taking into account all of the pertinent facts and circumstances.

Sec. 1.6664-4(b)(1), Income Tax Regs.

Generally, the most important factor in deciding whether a

taxpayer acted with reasonable cause and in good faith is the

extent of the taxpayer’s effort to assess the taxpayer’s proper

tax liability. Id. Petitioner primarily argues that she acted

with reasonable cause and in good faith because she filed her

1997 and 1998 returns in accordance with an agreement that she
 - 27 -

had with Mr. Walker that he would report one-half of the gain

resulting from the sale of petitioner’s undivided 50-percent

interest in the Happy Valley property. In essence, petitioner

argues that, even though she incorrectly reported the amount of

the gain that she realized on the sale of her interest in the

Happy Valley property on her 1997 and 1998 returns, we should

conclude that she believed that such an agreement could shift a

portion of her tax liability to Mr. Walker. Respondent counters

by arguing that Mr. Walker never told petitioner, either orally

or in writing, that he would pay any amount of the tax resulting

from the sale of the Happy Valley property.

As discussed above, the alleged agreement that petitioner

argues existed between herself and Mr. Walker would not have

relieved her from her duty to assess her correct tax liability

for 1997 and 1998. See Pesch v. Commissioner, 78 T.C. at 129;

Neeman v. Commissioner, 13 T.C. at 399; Estate of Ballantyne v.

Commissioner, T.C. Memo. 2002-160; Bonner v. Commissioner, T.C.

Memo. 1979-435. Furthermore, the evidence of the alleged

agreement is conflicting and unreliable. Petitioner’s purported

belief is ultimately attributed by her to the agreement that she

would receive $500,000 in the divorce settlement free of tax and

not to any agreement with Mr. Walker at the time of the 1997

transfers of the Happy Valley property. The Settlement

Agreement’s terms, to the contrary, suggest that petitioner would
 - 28 -

be assumed to pay $60,000 in capital gains taxes on the sale of

the Happy Valley property to a third party and that the credit

received by Mr. Walker against his debt to her by reason of the

transfer would be reduced proportionately.

The compelling facts again are that petitioner had been

advised of the tax consequences of the transactions involving the

Happy Valley property before she entered into them. She should

have provided Coburn with the Settlement Agreement and quitclaim

deed so that he could determine the proper tax treatment of

Mr. Walker’s transfer of his 25-percent interest in the Happy

Valley property to her. Because petitioner failed to provide

this information to Coburn and subsequently denied to him that

the transaction occurred, we conclude that petitioner’s efforts

to assess her proper tax liability were neither consistent with

reasonable cause nor in good faith. See Weis v. Commissioner, 94

T.C. 473, 487 (1990); Pessin v. Commissioner, 59 T.C. 473, 489

(1972); Estate of Ballantyne v. Commissioner, supra; sec. 1.6664-

4(c)(1)(i), Income Tax Regs.; see also Nowak v. Commissioner,

T.C. Memo. 1994-428 (upholding imposition of negligence penalty

where taxpayers ignored competent tax advice given to them by

their accountant about proposed transaction).

Conclusion

We hold that respondent did not err in his determination

that petitioner failed to report the correct amount of gain from
 - 29 -

the sale of her interest in the Happy Valley property on her

Federal income tax returns for 1997 and 1998. We also hold that

respondent’s determination to impose accuracy-related penalties

under section 6662(a) was warranted due to petitioner’s

negligence or disregard of the rules or regulations or,

alternatively, to a substantial understatement of income tax. We

have considered the arguments of the parties not specifically

addressed in this opinion. Those arguments are either without

merit or irrelevant to our decision.

To reflect the foregoing,

Decision will be entered

for respondent.