Gouveia v. Comm'r

T.C. Memo. 2004-256

UNITED STATES TAX COURT

GREG WILLIAM GOUVEIA, a.k.a. GREG W. GOUVEIA, a.k.a. GREG GOUVEIA
AND CAROL ANN GOUVEIA, a.k.a. CAROL GOUVEIA, ET AL.,1 Petitioners
v. COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket Nos. 288-03, 562-03, Filed November 9, 2004.
563-03, 564-03.

Joe Alfred Izen, Jr., for petitioners.

Michael E. Melone, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

MARVEL, Judge: In separate notices of deficiency,

respondent determined the following income tax deficiencies and

1
Cases of the following petitioners are consolidated
herewith: Greg Gouveia and Carol Gouveia, docket No. 562-03;
Pago Trust, Phillip Norton, Trustee, docket No. 563-03; and
McKenzie Trust, Charles Boatright, Trustee, docket No. 564-03.
 - 2 -

penalties with respect to petitioners’ Federal income taxes:2

Greg William Gouveia, a.k.a. Greg W. Gouveia, a.k.a. Greg Gouveia
and Carol Ann Gouveia, a.k.a. Carol Gouveia, docket No. 288-03

Accuracy-Related Penalty
Year Deficiency Sec. 6662(a)

1995 $30,521 $6,104
1996 22,947 4,589

Greg Gouveia and Carol Gouveia, docket No. 562-03

Accuracy-Related Penalty
Year Deficiency Sec. 6662(a)

1997 $20,620 $4,124
1998 21,982 4,396

Pago Trust, Phillip Norton, Trustee, docket No. 563-03

Accuracy-Related Penalty
Year Deficiency Sec. 6662(a)

1998 $39,331 $7,866

McKenzie Trust, Charles Boatright, Trustee, docket No. 564-03

Accuracy-Related Penalty
Year Deficiency Sec. 6662(a)

1998 $1,136 $227

Petitioners filed separate petitions to redetermine the

deficiencies and related penalties. We consolidated these cases

(hereinafter this case) for trial, briefing, and opinion pursuant

to Rule 141(a) because they present common issues of fact and

law.

2
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. Monetary amounts are
rounded to the nearest dollar.
 - 3 -

The issues for decision are:3

(1) Whether the petitions filed in the names of the Pago

and/or McKenzie Trusts should be dismissed for lack of

jurisdiction;

(2) whether the Pago and/or McKenzie Trusts should be

disregarded for Federal income tax purposes;

(3) even if the Pago and/or McKenzie Trusts are not

disregarded for Federal income tax purposes, whether the net

income of the rental real estate business, allegedly owned by the

Pago Trust, and the automobile restoration business, allegedly

owned by the McKenzie Trust, must be reported by Greg Gouveia

(petitioner) and Carol Gouveia (collectively referred to as the

Gouveias) on their Federal income tax returns for the years at

issue;

(4) whether the notice of deficiency for the Gouveias’ 1995

and 1996 taxable years was timely;

(5) if the Pago and McKenzie Trusts are respected for

Federal income tax purposes, whether either trust is entitled to

deductions for income distributions, management fees, or

fiduciary fees; and

3
The only other issues raised in the notices of deficiency
and petitions are computational.
 - 4 -

(6) whether petitioners are liable for the accuracy-related

penalty for negligence or disregard of rules or regulations

pursuant to section 6662(a) for each of the years at issue.

FINDINGS OF FACT

I. Background

Some of the facts have been stipulated. We incorporate the

stipulated facts into our findings by this reference. When the

petitions in these cases were filed, the Gouveias4 resided in

Pismo Beach, California. Although the Pago and the McKenzie

Trusts’ petitions alleged that the trusts maintained their

principal places of business in California, the parties did not

stipulate or otherwise introduce any evidence regarding the

addresses of the trustees of the trusts as of the date the

petitions were filed.

A. The Gouveias’ Automobile Restoration Business

In 1976, petitioner started an automobile restoration

business in his father’s garage. Petitioner had previously

studied welding, auto body, and machine tool theory at a junior

college. In 1977, his cousin became a partner in the business,

but in 1978, petitioner purchased his cousin’s interest and

continued the business under the name of “Brassworks”. In the

4
Only Mr. Gouveia appeared and testified at trial. However,
counsel for petitioners represented that Mrs. Gouveia, who is
also a petitioner, was aware of these proceedings, had authorized
Mr. Gouveia and his counsel to represent her interests, and has
agreed to be bound by the results of this litigation.
 - 5 -

course of Brassworks’s business, petitioner fabricated brass

radiator reproductions for Model T Fords and shipped them

worldwide to customers who restored those automobiles, and

petitioner also restored Model T Fords for resale at auctions.

From 1976 through 1993, petitioner worked full time for

Brassworks, and the Gouveias were the sole proprietors of the

business from 1984 until 1993.

In March 1993, the Gouveias sold Brassworks for $661,725 to

Inga, Inc., a corporation established by William and Debra

Ingalls to purchase the business. Inga, Inc. paid the Gouveias

part of the purchase price as a downpayment and executed two

promissory notes and an installment note for the remaining

amount. The principal amounts of the promissory notes were

$35,000 and $16,240, which were payable, with interest, on their

respective maturity dates of March 8, 1995, and March 8, 1999.

The principal amount of the installment note was $363,877.30,

which was payable to the Gouveias, with interest, in monthly

installments of $4,100 beginning on June 8, 1993. As part of the

sale of Brassworks, petitioner agreed that he would no longer

manufacture any brass radiators or water pumps.

B. The Gouveias’ Real Estate Investments

In October 1987, the Gouveias purchased a half acre of

unimproved land located at 285 and 289 Prado Road, San Luis
 - 6 -

Obispo, California (Prado Road property).5 The Prado Road

property was zoned for light industrial construction, and

petitioner subsequently developed that property into five

commercial service units. Each unit consisted of commercial

office space and had metal rollup doors, which contained areas

for light industrial work. Petitioner moved Brassworks to this

location and leased the remaining units to other tenants. After

developing the Prado Road property, petitioner managed and

maintained the property by hiring contractors, locating tenants,

entering into lease agreements with tenants, collecting rent

payments, and paying property taxes. In 1993 and 1994, the

Gouveias earned $41,400 and $57,560 respectively, in gross rental

receipts from the Prado Road property.

II. Pago Trust

A. Formation

In approximately 1992 or 1993, petitioner explored the

possibility of creating trusts and sought advice from a company

called Independent Trust Consultants.6 Petitioner also spoke

with his tax return preparer, John Gragg, about forming trusts,

5
In approximately 1981 or 1982, the Gouveias made their
first real estate investment, but they later sold the property
for a loss. Around 1990, the Gouveias invested in another parcel
of real estate, which they leased with an option to buy and
eventually sold for a small profit.
6
The record is silent as to the advice the company provided
or its role, if any, in assisting petitioner with forming the
trusts at issue.
 - 7 -

but Mr. Gragg was not experienced in that area. In addition,

petitioner conducted his own independent research on the topic of

trusts.

After deciding to form the trusts, petitioner asked Phillip

Norton7 to serve as trustee of the Pago Trust. Mr. Norton had

met petitioner in 1986 when they were neighbors in the same

office park, and Mr. Norton later rented office space from

petitioner in 1989 or 1990. Mr. Norton was involved in the

communications business; he had no experience managing a trust or

developing real property. Petitioner then approached Jeffrey

Jeter and asked for his help in creating a trust. Mr. Jeter had

been a business acquaintance of petitioner since approximately

1989 and had performed some tool and die work for Brassworks.

Mr. Jeter had no prior experience with trusts. Mr. Jeter and Mr.

Norton did not know each other personally but were introduced by

petitioner during discussions about forming the trust.

On May 1, 1993, Mr. Jeter and Mr. Norton executed a contract

entitled “Pago Trust, A Contractual Fiduciary Trust”. The

contract contained a declaration of trust and a trust indenture

which together set forth the terms governing the administration

of the trust.

7
Phillip Norton’s name erroneously appears as “Norton
Phillip” on the notice of deficiency issued to the Pago Trust, on
the petition filed in the name of the Pago Trust, and on all
subsequent filings.
 - 8 -

The declaration of trust identified Mr. Jeter8 as the

trust’s creator and Mr. Norton as the trustee and described the

Pago Trust as a “Common Law contractual business trust

organization” governed by the common law of England.9 The

declaration of trust further provided that the company formed

under the trust shall be domiciled in California and “shall not

operate as a partnership, association, joint venture, joint stock

company, corporation or statutory trust.” The trust indenture

described the purpose of the Pago Trust as “fraternal, social,

economic and remunerative” and stated that “the Trustee(s) shall

have freedom to conduct capitalistic enterprises dealing in

properties, patents, copyrights, trademarks, formulae and

equities, and the acquisition of deeds and deeds of trust in the

aforesaid county.”

The trust indenture granted sole dominion and control over

the administration of the trust to the trustee and expressly

prohibited the creator and any beneficiaries from having any

voice in the trust’s administration. The trustee had the

discretion to determine what amounts constituted capital or

income and was required to distribute all capital gain and

income. The trustee could resign only by tendering a written,

8
Mr. Jeter was not compensated for creating the Pago Trust.
9
By use of the terms “trust”, “trustee”, “beneficiary”, and
other related terms, we intend no implication as to the validity
of the trusts involved in these cases.
 - 9 -

dated, and notarized document to the beneficiaries and board of

trustees.

The declaration of trust directed the trustee to create 100

capital units of beneficial interest, in the form of

certificates, and to issue them to the beneficiaries in exchange

for property contributed to the “corpus of the company”. The

beneficial interest certificates entitled the holder to share in

distributions but conveyed no interest in the trust corpus and

conferred no rights to participate in the management, control, or

administration of the trust. The certificates were freely

transferable and were presumed to be owned by the person who

possessed them. The owner was entitled to his share of any

distributions by presenting the certificate to the board of

trustees and demonstrating his lawful possession of it.

On May 1, 1993, the Gouveias acquired 10 capital units of

the Pago Trust in exchange for $100 and their agreement to assign

the installment and promissory notes from the sale of Brassworks

to the Pago Trust. A certificate for 10 units in the Pago Trust

was issued in the Gouveias’ names and was signed by Mr. Norton.

On May 1, 1993, the Brookes Group acquired 90 capital units

of the Pago Trust in exchange for $100 and its pledge to pay the

Pago Trust, as capital, an amount not to exceed $600,000 but not

less than $300,000. A certificate for 90 units in the Pago Trust

was issued in the Brookes Group’s name and was signed by Mr.
 - 10 -

Norton. The Brookes Group purports to be a private trust of the

Turks and Caicos Islands, British West Indies, and the Century

Trust Company, Ltd. purports to be the Brookes Group’s trustee.10

In 1994 or early 1995, the Gouveias assigned the installment

and promissory notes from the sale of Brassworks to the Pago

Trust.11

B. Operation of the Pago Trust

1. Prado Road Property

On March 16, 1995, the Gouveias transferred the Prado Road

property to the Pago Trust and, in exchange, received an

installment note. The Pago Trust agreed to pay the Gouveias

$1,500 monthly, beginning on January 15, 2017, until the

principal amount of $303,182.59, with interest, was paid in full.

10
The record provides no additional information about the
Brookes Group or the Century Trust Company, Ltd.
11
There is conflicting evidence on record as to the date of
this transaction. The parties stipulated that the Gouveias
assigned the notes to the Pago Trust on Mar. 17, 1995, and
attached to the copies of the installment note and one of the
promissory notes on record are signed statements by the Gouveias
dated Mar. 17, 1995, which purport to assign the notes to the
Pago Trust. However, the record indicates that on July 7, 1994,
the Gouveias filed financing statements pursuant to the
California Uniform Commercial Code that assigned their rights as
secured parties of the installment note and one of the promissory
notes to the Pago Trust. In 1994, the Pago Trust reported income
from the installment note on its Form 1041, U.S. Income Tax
Return for Estates and Trusts, which indicates it began receiving
payments before 1995. Also, the Trustee Chronicle states that
the notes were assigned on July 1, 1994.
 - 11 -

As part of the transfer, the Gouveias’ existing loan on the Prado

Road property was repaid, allegedly by the Pago Trust.12

On March 15, 1995, the Pago Trust entered into a Property

Management Agreement (property agreement) with California

Property Services (CPS) that went into effect on April 1, 1995,

and continued until March 31, 1999. Under the terms of the

property agreement, CPS agreed to act as agent for the Pago Trust

and to perform the following duties with regard to the Prado Road

property: Advertise the availability of the property for rent,

initiate and sign lease agreements, collect rent payments, evict

tenants, make and/or supervise repairs, hire and supervise

contractors to maintain the property, pay expenses and costs

related to the property, deposit all receipts collected into a

trust account for the Pago Trust, and remit funds monthly to the

Pago Trust.13

On April 4, 1995, the Gouveias also agreed to act as the

Pago Trust’s agent and to provide management services for the

Prado Road property. The trust paid the Gouveias management fees

for their services. The relevant terms of the Property

Management and Maintenance Agreement (maintenance agreement)

12
The record does not indicate how the Pago Trust obtained
the funds to satisfy the Gouveias’ debt on the Prado Road
property.
13
The trust’s records show that the Pago Trust never made
any payments to California Property Services for its services
under the contract.
 - 12 -

between the Gouveias and the Pago Trust are, with only minor

exceptions, identical to those contained in the property

agreement between CPS and the Pago Trust, and the formats of the

two agreements closely resemble each other.

After the Gouveias transferred the Prado Road property to

the Pago Trust and through 1998, petitioner supervised repairs

and improvements made by tenants and contractors to the inside

and outside of the buildings, oversaw maintenance and landscaping

work, responded to tenant complaints, signed new lease

agreements, and paid all of the expenses related to the property

from the Pago Trust’s bank account. Petitioner did not perform

his management duties full time but tended to the Pago Trust’s

business “after hours”.

To facilitate petitioner’s payment of expenses attributable

to the Prado Road property and, later, the Cross Street property,

which we discuss below, petitioner and Mr. Norton met

approximately three to four times each year. During these

meetings Mr. Norton signed checks drawn on the Pago Trust’s bank

account.14 Petitioner had usually filled out in advance the

checks that Mr. Norton signed, but Mr. Norton also regularly

signed groups of blank checks for petitioner’s use. In addition,

14
Mr. Norton’s compensation for acting as trustee of the
Pago Trust ranged from $250 to $500 per year.
 - 13 -

Mr. Norton signed checks payable to petitioner for his management

fees, which petitioner had already filled out.

2. Cross Street Property

On February 9, 1998, the Pago Trust purchased unimproved

land located at 102 Cross Street, San Luis Obispo, California

(Cross Street property), for $205,000. Petitioner arranged for

the Pago Trust to borrow $50,000 from Mrs. Gouveia’s father,

Edward Kazmierski, $50,000 from Maddalena Real Estate, and

$105,000 from a “foreign lender” in order to acquire the Cross

Street property.15 Petitioner did not consult with Mr. Norton

before the purchase of the Cross Street property or during its

later development.

On May 12, 1998, the Gouveias entered into a Construction

Project Manager Agreement (manager agreement) in which they

agreed to act as the Pago Trust’s agent and to manage and

coordinate the construction of a commercial building on the Cross

Street property. The trust paid the Gouveias management fees for

their services. Throughout 1998 and 1999, petitioner hired

contractors and located suppliers of raw materials in connection

with the development of the Cross Street property.16 Eventually,

15
The record contains no documentary evidence identifying
the person or entity that provided the $105,000 to the Pago
Trust.
16
According to the trust’s internal management records, the
Pago Trust financed the construction on the Cross Street property
(continued...)
 - 14 -

commercial service units, similar to those petitioner had built

on the Prado Road property, were constructed and leased to

tenants. Petitioner continued to manage the Cross Street

property after its development by overseeing repairs, supervising

maintenance and landscaping, responding to tenant complaints, and

initiating lease agreements.

3. Trust Income and Distributions

The Pago Trust filed Forms 1041, U.S. Income Tax Return for

Estates and Trusts, for the taxable years 1994 through 1998.17

Mr. Norton signed all of the Pago Trust’s tax returns but did not

review them for accuracy or compare the information reported on

the returns to the Pago Trust’s accounting records.

In 1994, the Pago Trust’s only source of income was Inga

Inc.’s payments on the installment note.18 For the taxable years

1995 through 1998, the Pago Trust derived its income solely from

payments on the installment note and from rental fees paid for

the units on the Prado Road property. The Pago Trust’s real

16
(...continued)
by borrowing against the Prado Road property and the Cross Street
real estate.
17
Mary L. Vincent prepared all of the tax returns filed for
the Pago Trust, the McKenzie Trust, and the Gouveias beginning
with the 1994 taxable year. Although petitioner did not know
what her level of training was, he chose Ms. Vincent because she
was familiar with trusts and Forms 1041.
18
All of the payments received on the installment note were
deposited into the Pago Trust’s bank account.
 - 15 -

estate rental business was profitable, and the trust declared

distributions each year. From 1994 to 1998, the trust allegedly

distributed more than $294,000 to the Brookes Group with respect

to its purported ownership of 90 units of beneficial interest in

the Pago Trust. Distributions to the Brookes Group were made via

wire transfer to the Century Trust Company’s overseas bank

account. Because the Pago Trust distributed all of its income

each year and claimed a corresponding income distribution

deduction for those amounts, it never reported any taxable income

or paid any taxes.

The Schedules K-1, Beneficiary’s Share of Income,

Deductions, Credits, etc., attached to the Pago Trust’s Forms

1041, listed petitioner, Mrs. Gouveia, and the Brookes Group as

the beneficiaries of the Pago Trust. According to the Schedules

K-1, the Gouveias received the remaining 10 percent of the Pago

Trust’s distributions.

C. Examination of the Pago Trust’s 1998 Tax Return

On its Form 1041 for 1998, the Pago Trust reported income

and expenses allocable to the Prado Road property on Schedule E,

Supplemental Income and Loss. The trust claimed deductions for

interest, taxes, fiduciary fees, trust manager fees, and income

distributions.

On June 6, 2001, Mr. Norton executed a Form 56, Notice

Concerning Fiduciary Relationship, and a Form 2848, Power of
 - 16 -

Attorney and Declaration of Representative. On Form 2848, Mr.

Norton designated attorney Joe Alfred Izen, Jr. to represent the

Pago Trust before the Internal Revenue Service (IRS) for tax

matters relating to the trust’s 1997, 1998, and 1999 taxable

years. Mr. Norton did not authorize Mr. Izen to perform any

specific additional acts in the power of attorney and left the

spaces on the Form 2848 for any such authorizations blank. The

IRS agent assigned to these cases accepted the Forms 56 and 2848

and never determined that they were invalid.

On August 12, 2002, Mr. Norton agreed to extend the time for

assessment of the Pago Trust’s income tax for 1998 until December

31, 2003, by signing Form 872, Consent to Extend Time to Assess

Tax.

On October 10, 2002, respondent issued a notice of

deficiency to the Pago Trust for its 1998 taxable year in which

respondent disallowed all of the Pago Trust’s deductions for

business expenses, taxes, depreciation, income distributions,

management fees, and fiduciary fees. Accordingly, respondent

increased the Pago Trust’s taxable income by $102,010.

On January 13, 2003, a timely petition for redetermination

challenging the notice of deficiency was filed in this Court on

behalf of the Pago Trust. The caption of the petition contained
 - 17 -

the name of the trust and its fiduciary,19 and the petition was

signed by Joe Alfred Izen, Jr., as attorney for the trust.

On July 9, 2003, Mr. Norton resigned as trustee by means of

a written, notarized notice of resignation addressed to the

beneficiaries and the board of trustees. On July 18, 2003, Mary

L. Vincent, the “appointed fiduciary” for the Pago Trust,

appointed Kathryn Elizabeth Adams as the new trustee.

On October 20, 2003, respondent filed a written motion to

dismiss the petition filed by Pago Trust for lack of

jurisdiction. On the same day, a hearing on the motion was held

in San Francisco, California, and counsel for the parties

presented oral argument. After concluding that the motion

presented a factual issue that required the presentation of

evidence at trial, we reserved ruling on the motion and stated

that we would rule on the motion in this opinion.

III. McKenzie Trust

A. Formation

In 1993, petitioner asked William Hartmann to serve as

creator of the McKenzie Trust and Charles Boatright to act as its

trustee. Mr. Hartmann is Mrs. Gouveia’s stepfather. Mr.

Boatright and petitioner attended the same church and eventually

became friends. Mr. Boatright had no prior experience operating

a trust. Petitioner introduced Mr. Hartmann and Mr. Boatright to

19
See supra note 7.
 - 18 -

each other in the course of signing the documents to establish

the McKenzie Trust.

On May 14, 1993, Mr. Hartmann and Mr. Boatright executed a

contract entitled “McKenzie Trust, A Contractual Fiduciary

Trust”. The contract contained a declaration of trust and trust

indenture, the terms of which were identical to the Pago Trust’s

formation documents. Although Mr. Boatright never issued

certificates representing the 100 units of beneficial interest in

the McKenzie Trust, the parties stipulated that Glenmere

Investments was the 100-percent beneficiary of the trust during

the taxable years 1995 through 1998.20 Glenmere Investments and

its fiduciary are located in Nevis, British West Indies.

B. Operation of the McKenzie Trust

On May 14, 1993, the McKenzie Trust and petitioner executed

a General Agreement in which petitioner agreed to manage the

McKenzie Trust. The terms of the agreement were vague, requiring

only that petitioner perform “duties as the manager of the

McKenzie Trust and make sound business decisions which affect the

function and operation of the said trust as a whole.” The trust

paid petitioner management fees for his services.

20
The McKenzie Trust’s tax returns for 1995 and 1997 have
Schedules K-1 that list Glenmere Investments as a beneficiary,
but there are no Schedules K-1 attached to the 1996 and 1998
returns.
 - 19 -

Although the McKenzie Trust was ostensibly engaged in the

business of restoring Model T Fords, it was petitioner who worked

full time to order automotive parts from suppliers, to purchase

rusted Model T Ford chassis, and to restore them into finished,

operable, and safe Model T Ford speedsters for resale at

auctions. Mr. Boatright signed checks from the trust’s bank

account in advance so that petitioner could fill them out when he

purchased automobile parts. The McKenzie Trust had no employees

other than petitioner, and all of the income earned by the

McKenzie Trust was attributable to petitioner’s labor. No agent

of Glenmere Investments was ever involved with the automobile

restoration business allegedly conducted by the McKenzie Trust.

Petitioner filed Forms 1041 for the taxable years 1995

through 1998 in the name of the McKenzie Trust, which were signed

by Mr. Boatright. The 1995 and 1996 returns claimed income

distribution deductions for amounts allegedly distributed to

Glenmere Investments, and the trust did not pay any income taxes

in 1995 or 1996. On the McKenzie Trust’s 1996 return,

petitioner’s management fees were deducted on Schedule C, Profit

or Loss From Business, as legal and professional services in

computing the trust’s income that was distributed. For the

taxable year 1997, the management fees paid to petitioner

exceeded the McKenzie Trust’s income, and, as a result, the
 - 20 -

McKenzie Trust did not make any distributions, report any taxable

income, or pay any taxes.

C. Examination of the McKenzie Trust’s 1998 Tax Return

The McKenzie Trust reported business income from the

automobile restoration business and claimed deductions for

attorney, accountant, and return preparer fees and other

deductions. The deductions claimed by the McKenzie Trust

exceeded its income, and the trust did not make any distributions

or pay any taxes in 1998.

On June 5, 2001, Mr. Boatright signed Form 2848, in which he

designated Mr. Izen to represent the McKenzie Trust before the

IRS for tax matters relating to the trust’s 1997, 1998, and 1999

taxable years, and Form 56. Mr. Boatright did not authorize Mr.

Izen to perform any specific additional acts in the power of

attorney and left the spaces on the Form 2848 for any such

authorizations blank. The IRS agent accepted the Forms 56 and

2848 and never determined that they were invalid.

On October 10, 2002, respondent issued a notice of

deficiency to the McKenzie Trust for its 1998 taxable year, in

which respondent disallowed all of the McKenzie Trust’s

deductions for business expenses, management fees, and fiduciary

fees. Accordingly, respondent increased the trust’s taxable

income by $5,834.
 - 21 -

On January 13, 2003, a timely petition for redetermination

challenging the notice of deficiency was filed in this Court on

behalf of the McKenzie Trust. The caption of the petition

contained the name of the trust and its fiduciary, and the

petition was signed by Joe Alfred Izen, Jr., as attorney for the

trust.

On October 20, 2003, respondent filed a written motion to

dismiss the petition filed by the McKenzie Trust for lack of

jurisdiction, which we address in the opinion that follows.

IV. The Gouveias’ Income Tax Returns for 1995, 1996, 1997, and
1998

On their income tax returns for the years at issue, the

Gouveias reported the following amounts:

Schedule C Schedule E Total gross
Year Interest net profit/loss net inc./loss income

1995 $3,724 -0- $3,224 $38,458
1996 3,026 $13,224 3,712 21,807
1997 1,568 25,026 3,261 31,725
1998 1,132 30,208 1,854 35,895

The following items of income from the Pago Trust and/or the

McKenzie Trust were included in the above amounts:
 - 22 -

Management fees
reported as
Trust Schedule C
Year Interest distribution gross receipts

1995 $3,711 $2,349 -0-
1996 3,026 3,712 $24,589
1997 1,523 3,261 27,726
1998 Unable Unable Unable
to to to
determine1 determine1 determine1
1
Schedules B, C, D, and E were not attached to the copy of
the Gouveias’ Form 1040, U.S. Individual Income Tax Return, for
1998 that is included in the record. The Gouveias reported
$30,208 of Schedule C net profit on their 1998 Form 1040.

None of the Gouveias’ tax returns for the years at issue

identified the McKenzie Trust as the source of any income

reported on the returns. It appears, however, that the

management fees reported on Schedules C attached to some of the

Gouveias’ tax returns for the years at issue were those paid by

the McKenzie and/or Pago Trusts.

On May 17, 2001, the Gouveias agreed to extend the time for

assessment of their income tax for 1997 until June 30, 2002, by

signing Form 872; on April 10, 2002, the Gouveias agreed to

further extend that date until June 30, 2003, and signed another

Form 872. On August 14, 2002, the Gouveias signed Form 872 for

their 1998 taxable year, which extended the time for assessment

until December 31, 2003.

On October 7, 2002, respondent issued a notice of deficiency

for 1995 and 1996, which was issued more than 3, but less than 6,

years after the 1995 and 1996 returns were filed. On October 10,
 - 23 -

2002, respondent issued a separate notice of deficiency for 1997

and 1998. In the notices of deficiency, respondent increased

petitioner’s Schedule C income and expenses by the amounts

reported on the McKenzie Trust’s tax returns, increased the

Gouveias’ Schedule E rental income and expenses by the amounts

reported on the Pago Trust’s tax returns,21 and increased the

Gouveias’ capital gain and interest income by the Pago Trust’s

capital gain and interest income.

OPINION

I. Motions To Dismiss for Lack of Jurisdiction

Rule 60(a)(1) provides that “A case shall be brought by and

in the name of the person against whom the Commissioner

determined the deficiency * * * and with the full descriptive

name of the fiduciary entitled to institute a case on behalf of

such person.” Rule 60(c) further provides that “The capacity of

a fiduciary or other representative to litigate in the Court

shall be determined in accordance with the law of the

jurisdiction from which such person’s authority is derived.”

Under California law, a trustee is entitled to institute legal

proceedings on behalf of a trust. Cal. Prob. Code sec. 16249

(West Supp. 2004).

21
Respondent did not increase the Gouveias’ Schedule E
expenses for 1997 by the amount of management fees reported on
the Pago Trust’s 1997 tax return.
 - 24 -

In the motions to dismiss the cases filed on behalf of the

Pago and McKenzie Trusts, respondent alleges that both trusts

have failed to show that: (1) Mr. Norton and Mr. Boatright were

acting as trustees on January 13, 2003, when the petitions were

filed; (2) Mr. Norton and Mr. Boatright have ever been

represented by Mr. Izen in connection with the filing of the

petitions; and (3) Mr. Norton and Mr. Boatright authorized Mr.

Izen to file the petitions on behalf of the trusts. As a result,

respondent argues, the petitions were not filed by the proper

party, and we should dismiss the trusts’ petitions for lack of

jurisdiction.

Petitioners argue that by signing Forms 56 and 2848, Mr.

Norton and Mr. Boatright identified themselves as participants in

the trust arrangement and authorized Mr. Izen to represent the

Pago and McKenzie Trusts. Petitioners further argue that because

respondent never challenged the validity of Forms 56 and Forms

2848 during the audit, or at any other proceeding, respondent

should be estopped from asserting that Mr. Izen lacked authority

to file the petitions on behalf of the Pago and McKenzie Trusts.

Unless a petition is filed by the taxpayer or someone

lawfully authorized to act on behalf of the taxpayer, we are

without jurisdiction to consider the petition. See Fehrs v.

Commissioner, 65 T.C. 346, 348 (1975). Petitioners have the

burden of proving that this Court has jurisdiction by
 - 25 -

establishing affirmatively all facts giving rise to our

jurisdiction. See Patz Trust v. Commissioner, 69 T.C. 497, 503

(1977). After reviewing the record, we conclude that petitioners

have failed to carry their burden of proof.

Although the trusts’ petitions conformed to Rule 60(a)(1),

and Mr. Norton and Mr. Boatright may have been the proper parties

to petition this Court on behalf of the trusts,22 neither Mr.

Norton nor Mr. Boatright actually petitioned this Court on behalf

of the trusts. Rather, Mr. Izen signed the petitions as counsel

for the Pago and McKenzie Trusts. Petitioners have not shown

that Mr. Norton or Mr. Boatright authorized or ratified the

filing of the petitions on behalf of either trust.

Neither the Internal Revenue Code nor the Tax Court Rules of

Practice and Procedure define the means by which a taxpayer

authorizes an attorney to file a petition in this Court. See

sec. 7452; Rule 24. Whether a taxpayer has properly granted an

attorney the authority to petition the Tax Court is a factual

issue governed by the common law principles of agency. Adams v.

Commissioner, 85 T.C. 359, 369-372 (1985); Kraasch v.

Commissioner, 70 T.C. 623, 626-629 (1978); Trans World Travel v.

Commissioner, T.C. Memo. 2001-6; John Arnold Executrak Sys., Inc.

v. Commissioner, T.C. Memo. 1990-6. In order to bind the

principal, the agent must have either actual or apparent

22
See infra note 23.
 - 26 -

authority, or the principal must ratify the agent’s acts. Trans

World Travel v. Commissioner, supra. Authority may be granted by

express statements or may be derived by implication from the

principal’s words or actions. Restatement, Agency 2d, sec. 26

(1957). Whether an agent is authorized to act for the principal

is decided by taking into account all the circumstances,

including the relationship of the parties, the common business

practices, the nature of the subject matter, and the facts of

which the agent has notice concerning objects the principal

desires to accomplish. Id. at sec. 34. We must decide the

extent of Mr. Izen’s authority to act for the trusts on the basis

of all the facts and circumstances revealed by the record. Adams

v. Commissioner, supra at 369-373; Kraasch v. Commissioner, supra

at 626-629.

Mr. Norton only became aware of respondent’s examination of

the Pago Trust after a brief conversation with petitioner in

2001, and they never discussed the matter again. Mr. Norton had

never met with or spoken to Mr. Izen before the trial in this

case. Further, Mr. Norton testified that he did not recall

authorizing the hiring of an attorney for the Pago Trust or

authorizing an attorney to file a petition with this Court.

Petitioners have not offered any evidence or elicited any

testimony upon which we can conclude that Mr. Norton later

ratified the filing of the petition, and it is unlikely that any
 - 27 -

such evidence exists given Mr. Norton’s limited knowledge of

respondent’s audit of the Pago Trust.23

In addition, petitioners did not present any testimony from

Mr. Boatright to establish that he authorized Mr. Izen to file

the petition for the McKenzie Trust, and they did not offer any

evidence that he later ratified Mr. Izen’s actions. The failure

to produce such evidence or available testimony leads us to

conclude that Mr. Boatright did not authorize or ratify the

filing of the petition for the McKenzie Trust. Wichita Terminal

Elevator Co. v. Commissioner, 6 T.C. 1158 (1946), affd. 162 F.2d

513 (10th Cir. 1947).

Petitioners rely solely on the Forms 56 and 2848 signed by

Mr. Norton and Mr. Boatright to establish our jurisdiction.

However, filing a Form 56 merely notifies respondent of a

fiduciary relationship and entitles the fiduciary to receive

communications regarding the tax matters specified therein. No

provision of Form 56 operated to create an agency relationship

23
In addition, the record casts doubt on whether Mr. Norton
was still acting as trustee for the Pago Trust on Jan. 13, 2003,
when the petition was filed. Mr. Norton apparently attempted to
resign as trustee in April of 2001, but he did not tender his
official resignation until July 9, 2003. Although Mr. Norton’s
participation in the Pago Trust’s operation was negligible
throughout its existence, petitioners have not demonstrated that
he performed any acts as trustee after June 6, 2001, the date he
signed the Forms 56 and 2848, other than tendering his official
resignation.
 - 28 -

between Mr. Izen and either trust, or between Mr. Izen and the

trustees.

By filing Form 2848, the taxpayer authorizes the

representative to represent the taxpayer before the IRS and to

perform any act that the taxpayer can perform, subject to certain

exceptions not relevant here. While the filing of Form 2848 is a

factor we consider in deciding whether the petition was filed

with the actual or apparent authority of the taxpayer, it is not

determinative; we also consider all of the facts and

circumstances in our analysis of the existence and scope of an

agency relationship. See John Arnold Executrak Sys., Inc. v.

Commissioner, supra; Shopsin v. Commissioner, T.C. Memo. 1984-

151, affd. without published opinion 751 F.2d 371 (2d Cir. 1984).

In Trans World Travel v. Commissioner, supra, John Arnold

Executrak Sys., Inc. v. Commissioner, supra, and Shopsin v.

Commissioner, supra, we held that the taxpayer’s accountant or

attorney had acted as the taxpayer’s authorized agent in filing

and signing the petition filed with this Court on facts showing

that, in addition to executing Form 2848 and appointing the

accountant or attorney as its representative, the taxpayer

routinely delegated the handling of all tax matters to the agent;

spoke regularly with the agent in regard to tax matters; relied

on the agent for advice and deferred to the agent’s judgment on a
 - 29 -

continuing basis; and established a pattern of forwarding all tax

communications from the Commissioner to the agent.

Other than petitioners’ having filed Form 2848, none of the

facts or circumstances mentioned in the cases discussed above are

present herein. In the absence of any credible evidence to

establish that Mr. Izen and the trustees had a relationship from

which we could infer that a sufficient grant of authority

occurred or that they ever communicated with each other regarding

the filing of petitions on behalf of the trusts, we find that

petitioners have failed to prove that the trustees authorized Mr.

Izen to petition this Court on behalf of the Pago and McKenzie

Trusts. Accordingly, we grant respondent’s motion to dismiss the

petitions filed by the Pago and McKenzie Trusts for lack of

jurisdiction, on the ground that no proper persons have

petitioned the Court. As a result of our ruling, we do not

consider or decide any issue raised in the petitions filed in the

names of the Pago and McKenzie Trusts.
 - 30 -

II. Statute of Limitations24

Section 6501(a) provides that the amount of any tax imposed

shall be assessed within 3 years after the return was filed.

However, if the taxpayer omits from gross income an amount

properly includable that is in excess of 25 percent of the gross

income reported on the return, the tax may be assessed within 6

years from the date the return was filed. Sec. 6501(e)(1)(A).

Any amount that is omitted from gross income but is “disclosed in

the return, or in a statement attached to the return, in a manner

adequate to apprise the Secretary of the nature and amount of

such item”, shall not be taken into account for purposes of

computing the amount of gross income omitted from the return.

Sec. 6501(e)(1)(A)(ii). In applying section 6501(e)(1)(A)(ii),

we must consider whether an adjustment to the taxpayer’s gross

income might be apparent from the face of the return to the

“reasonable man”. Univ. Country Club, Inc. v. Commissioner, 64

T.C. 460, 471 (1975). Although section 6501(e)(1)(A)(ii) does

not require that the return disclose the exact amount of the

24
As a preliminary matter, we note that the Gouveias did not
raise the statute of limitations as a defense in their pleadings,
as required by Rule 39. However, we granted respondent leave to
file an amendment to answer that addressed the statute of
limitations issue. Subsequently, both parties discussed the
issue in their pretrial memoranda and on brief. Under these
circumstances, we consider the issue to have been tried by
consent of the parties. Rule 41(b)(1); LeFever v. Commissioner,
103 T.C. 525, 538 (1994), affd. 100 F.3d 778 (10th Cir. 1996);
Anderson v. Commissioner, T.C. Memo. 1993-288, affd. without
published opinion 36 F.3d 1091 (4th Cir. 1994).
 - 31 -

omitted income, the return should provide respondent with a

“‘clue’ to the existence of the error.” Quick Trust v.

Commissioner, 54 T.C. 1336, 1347 (1970), affd. 444 F.2d 90 (8th

Cir. 1971). Respondent bears the burden of proving that the 6-

year period for assessment applies. Bardwell v. Commissioner, 38

T.C. 84, 92 (1962), affd. 318 F.2d 786 (10th Cir. 1963).

The Gouveias assert that the Pago and McKenzie Trusts’ Forms

1041 and attached Schedules K-1 must be considered along with the

Gouveias’ individual income tax returns. When read together, the

Gouveias argue, their returns and the trusts’ returns provided

adequate disclosure of the nature and amount of the omitted items

of income. Therefore, the Gouveias argue, assessment of

deficiencies for 1995 and 1996 is barred by the 3-year statute of

limitations.

Respondent argues that the 6-year period of limitations of

section 6501(e) applies to the Gouveias’ 1995 and 1996 taxable

years because the amount of gross income the Gouveias failed to

report from the Pago and McKenzie Trusts exceeded 25 percent of

the amount of gross income stated on the Gouveias’ returns.

Respondent further argues that the Gouveias’ tax returns did not

adequately disclose the nature and amount of omitted income

attributable to the McKenzie Trust and that the income from the

McKenzie Trust alone exceeds 25 percent of the gross income the

Gouveias reported.
 - 32 -

We agree with respondent for the reasons that follow. The

Gouveias reported gross income of $38,458 and $21,807 on their

1995 and 1996 returns, respectively. Twenty-five percent of

these amounts is $9,615 and $5,452, respectively. The McKenzie

Trust reported gross income of $14,148 and $11,986 in 1995 and

1996, respectively, which exceeds 25 percent of the gross income

reported by the Gouveias for 1995 and 1996. Although the

Gouveias’ returns listed the Pago Trust as a source of income,

the returns contained absolutely no reference to the McKenzie

Trust. Where the individual return makes no reference to the

trust as a source of income, we do not consider any documents in

addition to the individual returns in determining whether the

omitted income was adequately disclosed.25 Connell Bus. Co. v.

Commissioner, T.C. Memo. 2004-131; Reuter v. Commissioner, T.C.

Memo. 1985-607. We conclude, therefore, that respondent was not

apprised of the nature and amount of the omitted income

attributable to the McKenzie Trust. Accordingly, we hold that

the 6-year period of limitations in section 6501(e) applies to

the Gouveias’ 1995 and 1996 taxable years and that respondent’s

determination with respect to those years was timely.

25
Even if we looked beyond the Gouveias’ returns to the
McKenzie Trust’s 1995 and 1996 returns, including the attached
Schedules K-1, they could not have adequately disclosed the
omitted income because they contained absolutely no mention of
the Gouveias.
 - 33 -

III. Burden of Proof

The Gouveias argue that section 7491(a) shifts the burden of

proof to respondent with respect to all other issues. The

Gouveias further contend that according to the Court of Appeals

for the Ninth Circuit, respondent bears the burden of proof in

unreported income cases. Respondent contends that the Gouveias

do not meet the requirements of section 7491(a) and further

contends that respondent’s determinations are entitled to the

presumption of correctness. Although our resolution of the

issues in this case is based on the preponderance of the evidence

rather than the allocation of the burden of proof, we address the

parties’ arguments in the discussion that follows.

In general, respondent’s determinations in the notice of

deficiency are presumed to be correct, and the taxpayer bears the

burden of proving them wrong. Welch v. Helvering, 290 U.S. 111

(1933). Where the taxpayer produces credible evidence with

respect to any factual issue relevant to ascertaining the tax

liability of the taxpayer, the burden of proof shifts to the

Secretary, but only if the taxpayer has complied with

substantiation requirements, has maintained all required records,

and has cooperated with reasonable requests by the Secretary for

witnesses, information, documents, meetings, and interviews.

Sec. 7491(a).
 - 34 -

In cases of unreported income, the Court of Appeals for the

Ninth Circuit, to which an appeal in this case apparently would

lie absent a stipulation to the contrary, requires that the

Commissioner provide a minimal evidentiary foundation connecting

the taxpayer to the unreported income before the presumption of

correctness attaches to respondent’s determination. See Rapp v.

Commissioner, 774 F.2d 932, 935 (9th Cir. 1985); Weimerskirch v.

Commissioner, 596 F.2d 358, 360-361 (9th Cir. 1979), revg. 67

T.C. 672 (1977); Petzoldt v. Commissioner, 92 T.C. 661, 687-691

(1989); Residential Mgmt. Servs. Trust v. Commissioner, T.C.

Memo. 2001-297; Johnston v. Commissioner, T.C. Memo. 2000-315.

Once the Commissioner has met this initial burden of production,

the taxpayer must establish by a preponderance of the evidence

that the Commissioner’s determination is arbitrary or erroneous.

Rapp v. Commissioner, supra; Petzoldt v. Commissioner, supra;

Residential Mgmt. Servs. Trust v. Commissioner, supra. We defer

to the Court of Appeals for the Ninth Circuit’s evidentiary

requirement under the doctrine set forth in Golsen v.

Commissioner, 54 T.C. 742 (1970), affd. 445 F.2d 985 (10th Cir.

1971). However, we note that the Court of Appeals for the Ninth

Circuit’s rule does not automatically shift the burden of proof

regarding the unreported income to respondent, as alleged by the

Gouveias.
 - 35 -

After reviewing the record, we find that respondent has

introduced ample evidence connecting the Gouveias to the income-

producing activities of the Pago and McKenzie Trusts. The record

shows that petitioner managed and developed rental real estate

properties owned by the Pago Trust and that petitioner worked

full time in furtherance of the automobile restoration business

allegedly conducted by the McKenzie Trust. Moreover, the Pago

and McKenzie Trusts compensated petitioner for his management

services, and the Gouveias received distributions from the Pago

Trust. See Johnston v. Commissioner, supra. Accordingly, we

hold that respondent’s determination is entitled to the

presumption of correctness.

We also hold that section 7491(a) does not shift the burden

of proof to respondent. Petitioners failed to produce credible

evidence that the Pago and McKenzie Trusts should be respected

for Federal income tax purposes as required by section

7491(a)(2). Moreover, petitioners did not prove that they had

complied with relevant substantiation requirements, that they had

maintained all records required by the Internal Revenue Code, and

that they had cooperated with reasonable requests for witnesses,

information, documents, meetings, and interviews. Consequently,

section 7491(a) does not shift the burden of proof on the factual

issues raised in this case to respondent, and petitioners must
 - 36 -

bear the burden of proof on all issues in this case, other than

the statute of limitations issue under section 6501.26

IV. Whether the Pago and McKenzie Trusts Lack Economic Substance

Respondent argues that the Pago and McKenzie Trusts were

sham entities with no economic substance and should be

disregarded for Federal income tax purposes. Alternatively,

respondent argues that the income earned by the Pago and McKenzie

Trusts should be taxed to the Gouveias under the assignment of

income doctrine or the grantor trust rules of sections 674(a),

675(1), and 677(a). Petitioners dispute each of respondent’s

arguments and contend that the “McKenzie Trust and Pago Trust

engaged in extensive economic activity” and that the trusts

cannot be characterized as shams because a valid business purpose

for each trust existed.

Taxpayers have a legal right, by whatever means allowable

under the law, to structure their transactions to minimize their

tax obligations. See Gregory v. Helvering, 293 U.S. 465, 469

(1935). Transactions, however, that have no significant purpose

other than to avoid tax and do not reflect economic reality will

not be recognized for Federal income tax purposes. See Zmuda v.

Commissioner, 79 T.C. 714, 719 (1982), affd. 731 F.2d 1417 (9th

Cir. 1984). We have held that, if a transaction has not altered

26
Although respondent has the initial burden of production
with respect to the penalty imposed under sec. 6662, the burden
of proof remains on petitioners. Sec. 7491(c).
 - 37 -

any cognizable economic relationships, we must look beyond the

form of the transaction and apply the tax law according to the

transaction’s substance. See Markosian v. Commissioner, 73 T.C.

1235, 1241 (1980). This principle applies regardless of whether

the transaction creates an entity with separate existence under

State law. Zmuda v. Commissioner, supra at 720.

In deciding whether a purported trust lacks economic

substance, we consider the following factors: (1) Whether the

taxpayer’s relationship, as grantor, to property purportedly

transferred into trust differed materially before and after the

trust’s formation; (2) whether the trust had a bona fide

independent trustee; (3) whether an economic interest in the

trust passed to trust beneficiaries other than the grantor; and

(4) whether the taxpayer honored restrictions imposed by the

trust or by the law of trusts. Markosian v. Commissioner, supra

at 1243-1244; Norton v. Commissioner, T.C. Memo. 2002-137; Castro

v. Commissioner, T.C. Memo. 2001-115; Buckmaster v. Commissioner,

T.C. Memo. 1997-236; Hanson v. Commissioner, T.C. Memo. 1981-675,

affd. per curiam 696 F.2d 1232 (9th Cir. 1983).

A. The Gouveias’ Relationship to the Trusts’ Property

The first factor we consider in deciding whether a trust has

economic substance is whether a taxpayer’s relationship, as

grantor, to the property transferred into trust differed

materially before and after the trust’s formation. Markosian v.
 - 38 -

Commissioner, supra at 1243. In considering this factor, we look

to the economic realities of the arrangement to ascertain the

true grantor of the trust, regardless of who is named as grantor

in the declaration of trust. Zmuda v. Commissioner, supra at

720-721; Stern v. Commissioner, 77 T.C. 614, 647 (1981);

Buckmaster v. Commissioner, supra.

1. Pago Trust

Although Mr. Jeter was the nominal grantor, petitioner

clearly initiated the establishment of the Pago Trust.

Petitioner solicited Mr. Jeter’s assistance in signing the trust

documents, aware of the fact that Mr. Jeter had no prior

experience with trusts, and chose Mr. Norton to serve as trustee.

At petitioner’s direction, Mr. Jeter appointed Mr. Norton to act

as the trustee, having previously met Mr. Norton only once. Mr.

Jeter testified that he understood that once he signed the trust

documents and appointed a trustee, he would play no role in the

management or operation of the trust. According to Mr. Jeter, he

was “helping out a friend”, and since he knew nothing about

trusts, he simply followed petitioner’s orders. Further, Mr.

Jeter knew nothing about the Pago Trust’s business, except that

the trust was “some form of a tax shelter”.

In addition, only petitioner contributed property to the

trust, and the installment note, promissory notes, and the Prado

Road property were the only assets held by the Pago Trust until
 - 39 -

1998. Therefore, we find that Mr. Jeter was merely a “straw man”

used to form the Pago Trust and that petitioner was, in

substance, its true grantor. See Zmuda v. Commissioner, supra at

720-721; Buckmaster v. Commissioner, supra.

Petitioner’s relationship to the Prado Road property

remained essentially unchanged, and petitioner conducted his real

estate investment affairs in the same manner, both before and

after the Pago Trust was formed. Before 1995, petitioner

purchased the unimproved Prado Road property, managed all aspects

of renting and maintaining the industrial facility he had

developed on the property, and collected all of the profits

attributable to the property. After 1995 when petitioner

transferred the Prado Road property to the Pago Trust, petitioner

continued to manage the property under the pretext of the

maintenance agreement. Through his payment of the Pago Trust’s

monthly expenses using the trust’s bank account, petitioner also

maintained access to the income that the Pago Trust received from

the installment note and could use those funds to further the

real estate investments he made through the trust. Petitioner

continued to deal in real estate by selecting the Cross Street

property for the Pago Trust to purchase, arranging for financing,

developing the property into another industrial facility, and

managing it under a contract with the trust. Further, petitioner

continued to receive a significant portion of the profits from
 - 40 -

the Prado Road property in the form of management fees and

distributions from the trust.

Comparing the situations before and after the creation of

the Pago Trust, the only discernible differences in petitioner’s

relationship to the Prado Road property and to his real estate

investment activities were that he used the Pago Trust’s bank

account to deposit income and pay expenses generated by the

rental properties, and petitioner received profits from the

rental property in the form of “management fees” and income

distributions. Petitioner admitted at trial that the only

difference between the managerial duties he performed as the

owner of the Prado Road property and the duties he performed

under the maintenance agreement was that he was responsible for

getting the work done, he could not procrastinate, and he kept

better business records. These differences hardly rise to the

level of being material.

We find that the Gouveias’ relationship to the trust

property before and after its transfer to the Pago Trust was not

materially different. See Norton v. Commissioner, supra; Lund v.

Commissioner, T.C. Memo. 2000-334. This factor favors

respondent.

2. McKenzie Trust

With respect to the McKenzie Trust, we likewise conclude

that Mr. Hartmann was merely a straw man in forming the McKenzie
 - 41 -

Trust and that petitioner was its true grantor. Petitioner

arranged for Mr. Hartmann to act as the trust’s creator, and

petitioner selected Mr. Boatright, a personal friend whom

petitioner knew to be unfamiliar with trusts, to serve as

trustee. Mr. Hartmann appointed Mr. Boatright as trustee without

having met him before signing the trust documents. Further, the

record is devoid of any evidence that anyone other than

petitioner, who contributed his services and technical expertise

in restoring automobiles, transferred any property or services to

the McKenzie Trust. Therefore, we find that petitioner was the

true grantor of the McKenzie Trust. See Zmuda v. Commissioner,

79 T.C. at 720-721; Buckmaster v. Commissioner, T.C. Memo. 1997-

236.

Before forming the trust, petitioner had operated Brassworks

as a sole proprietorship. After selling Brassworks to the

Ingallses, petitioner returned to the automobile restoration

business and operated it under the name of “McKenzie Trust,

Charles Boatright, Trustee”. Although petitioner no longer

fabricated radiators, he continued to restore Model T Fords.

Further, petitioner continued to receive essentially all of the

profits from the automobile restoration business in the form of

management fees. The only apparent difference in petitioner’s

conduct of the business after he formed the trust was that he
 - 42 -

used the McKenzie Trust’s bank account for all of his business

transactions, and the profits he retained from the business were

disguised as management fees.

We find that the Gouveias’ use of the trust property before

and after its transfer to the McKenzie Trust was not materially

different. See Castro v. Commissioner, T.C. Memo. 2001-115;

Buckmaster v. Commissioner, supra. This factor favors

respondent.

B. Independent Trustee

The second factor we consider is whether the trust had a

bona fide independent trustee. Markosian v. Commissioner, 73

T.C. at 1243-1244. Whether the nominal trustee had any

meaningful role in the operation of the trust or exercised any

control over the trust is significant to our consideration of

this factor. See Zmuda v. Commissioner, supra at 720; Norton v.

Commissioner, T.C. Memo. 2002-137; Lund v. Commissioner, supra.

1. Pago Trust

The only act Mr. Norton performed as trustee of the Pago

Trust was to sign various trust documents, such as the trust’s

declaration and indenture, the checks drawn on the trust’s

account, and the trust’s income tax returns. Mr. Norton

understood that the trust served as a business organization

formed to hold the real estate petitioner intended to develop and

that paying the trust’s bills would be the only duty required of
 - 43 -

him. Because Mr. Norton never possessed the Pago Trust’s

checkbook, on the few occasions he and petitioner met each year,

Mr. Norton signed several blank checks at a time, as well as

checks that petitioner had already filled out.

Mr. Norton’s lack of participation in the Pago Trust is

further demonstrated by his failure to review any of the trust’s

formation documents before signing them, his failure to review

any of the Pago Trust’s business records or the income tax

returns he signed, and his failure to inquire into the

reasonableness of the management fees the Pago Trust paid

petitioner. Moreover, Mr. Norton never participated in selecting

the Cross Street property or in any decisions with regard to its

development, and the record lacks any credible evidence that Mr.

Norton controlled any significant trust decisions.

In contrast, petitioner exercised complete control over the

trust’s assets and made all decisions relating to the trust’s

daily business under the authority granted to him in the

maintenance and manager agreements. Moreover, petitioner

maintained the unfettered discretion to determine the amount of

his own management fees.

As a result, we find that no independent trustee had any

meaningful role in operating the Pago Trust. See Markosian v.

Commissioner, supra at 1243; Zmuda v. Commissioner, supra at 720;
 - 44 -

Norton v. Commissioner, supra; Lund v. Commissioner, T.C. Memo.

2000-334. This factor favors respondent.

2. McKenzie Trust

The evidence on record with respect to Mr. Boatright’s

influence and control over the McKenzie Trust is limited to the

appearance of his signature on various trust documents, including

the trust’s declaration and indenture, the checks drawn on the

trust’s account, and the trust’s income tax returns. The record

lacks any credible evidence that Mr. Boatright functioned as an

independent trustee. Mr. Boatright did not testify at trial, and

we conclude, based on his failure to do so, that his testimony

would have been unfavorable to petitioners. Wichita Terminal

Elevator Co. v. Commissioner, 6 T.C. at 1165; Christal v.

Commissioner, T.C. Memo. 1998-255.

It is apparent from the record that petitioner controlled

the operation of the McKenzie Trust. Pursuant to the General

Agreement, the McKenzie Trust granted petitioner broad managerial

powers over the trust, which he exercised by controlling the day-

to-day operation of the automobile restoration business. In

fact, no one other than petitioner performed any work for the

McKenzie Trust, and all of the income earned by the trust was

attributable to his expertise.

Therefore, we find that no independent trustee had any

meaningful role in operating the McKenzie Trust. See Zmuda v.
 - 45 -

Commissioner, 79 T.C. at 720; Markosian v. Commissioner, supra at

1243; Norton v. Commissioner, supra; Lund v. Commissioner, supra.

This factor favors respondent.

C. Economic Interests

The third factor we consider is whether a genuine economic

interest in the trusts passed to anyone other than the Gouveias.

Markosian v. Commissioner, supra at 1243.

1. Pago Trust

Petitioners have not offered any admissible evidence that

identifies the owners or beneficiaries of the Brookes Group or

the ultimate recipient of the funds distributed to its foreign

beneficiary. At trial, counsel for respondent elicited testimony

that shows petitioner possessed the original copy of the Brookes

Group’s certificate for 90 units of beneficial interest in the

Pago Trust. Further, the record is devoid of any credible

evidence that the Brookes Group ever fulfilled its commitment to

advance funds to the Pago Trust to purchase real estate.

It is inconceivable that petitioners would assign to the

trust the steady stream of income from the installment note and

receive only 10 percent of the trust’s distributions in return.27

It is also inconceivable that petitioners, in exchange for

27
We are also unpersuaded by petitioner’s testimony that he
transferred his property to the Pago Trust because he needed only
10 percent of the trust’s income to live on, and he thought that
operating the business in trust form would guarantee him a
lifetime of income distributions.
 - 46 -

payments to begin in the year 2017, would transfer their

profitable rental real estate into a trust that was required to

pay 90 percent of its income to the Brookes Group. See Castro v.

Commissioner, T.C. Memo. 2001-115; Buckmaster v. Commissioner,

T.C. Memo. 1997-236. Petitioners have not introduced any

evidence that the Brookes Group was anything more than an

intermediary designed to move money offshore.

On these facts, we conclude that petitioners have failed to

prove that any economic interest passed to any other

beneficiaries. See Markosian v. Commissioner, 73 T.C. at 1244.

This factor weighs against petitioners.

2. McKenzie Trust

Petitioners failed to produce any admissible evidence that

identifies the owners or beneficiaries of Glenmere Investments,

the purported 100-percent beneficiary of the McKenzie Trust, and

petitioners have not offered any credible evidence that Glenmere

Investments ever received any distributions from the trust. In

fact, the certificate for 100 units of beneficial interest was

never actually issued to Glenmere Investments. Further, in 1996,

the trust paid more than half of its profits from the automobile

restoration business to petitioner in management fees, and in

1997 and presumably in 1998, petitioner’s management fees

exceeded the trust’s business profits, leaving no income to

distribute.
 - 47 -

On these facts, we conclude that petitioners have failed to

prove that any economic interest passed to any other

beneficiaries. See id.; Castro v. Commissioner, supra. This

factor weighs against petitioners.

D. Restrictions Imposed by the Trusts or the Law of Trusts

The fourth factor we consider is whether the Gouveias

honored restrictions imposed by the trusts or by the law of

trusts. Markosian v. Commissioner, supra at 1244.

1. Pago Trust

The terms of the trust granted dominion and control over the

administration of the trust to Mr. Norton. However, the broad

authority granted to petitioner under the maintenance and manager

agreements imposed few, if any, restrictions on petitioner’s

management of the Pago Trust. Petitioner, rather than Mr.

Norton, made all decisions regarding the trust’s assets without

having consulted with or having sought approval from the trustee.

Moreover, petitioner had the absolute discretion to withdraw

management fees from the trust and was not restricted in any

meaningful way by the trustee or the terms of the trust.

Accordingly, we find that petitioners were not bound by any

restrictions imposed by the trust or the law of trusts. See id.;

Norton v. Commissioner, T.C. Memo. 2002-137. This factor weighs

against petitioners.
 - 48 -

2. McKenzie Trust

Under the broad authority granted to petitioner in the

General Agreement, petitioner dealt freely with the trust’s funds

to purchase automotive parts and the Model T Ford chassis he

restored. The record does not indicate that petitioner ever

consulted with Mr. Boatright before purchasing supplies for the

business or selling the restored automobiles, even though the

terms of the trust granted dominion and control over its

administration to Mr. Boatright. Further, while the terms of the

trust mandated that the trust distribute 100 percent of its

profits to Glenmere Investments, petitioner withdrew trust income

in the form of management fees, without restriction, which left

little, if anything, to be distributed to the nominal beneficiary

of the trust. Accordingly, we find that petitioners were not

bound by any restrictions imposed by the trusts or the law of

trusts. Markosian v. Commissioner, supra at 1244; Norton v.

Commissioner, supra. This factor weighs against petitioners.

E. Conclusion

After reviewing the record, we cannot conceive of any

reason, other than tax avoidance, for the Gouveias to have

transferred a substantial portion of their personal income and

property and to have provided their full-time labor to the Pago

and McKenzie Trusts. Our conclusion is supported by the inherent
 - 49 -

implausibility of the trust arrangement and petitioners’ failure

to provide any legitimate reason for creating the trusts.

At trial, petitioner asserted that he chose the trust form

to conduct his businesses so that he would earn the income

without incurring any liability. However, petitioner was unable

to articulate any liability issues that could potentially arise

in the course of his businesses, which undermines petitioner’s

claim that asset protection was a consideration in forming the

trusts. On the other hand, petitioner testified that he did not

expect that the McKenzie Trust’s automobile restoration business

would be profitable. We find petitioner’s testimony to be

completely self-serving, often contradictory, and lacking in

credibility.

Petitioners further contend that petitioner formed the Pago

Trust to obtain foreign financing while maintaining an interest

in the property. However, the record is devoid of any credible

evidence that the Brookes Group ever transferred any funds to the

Pago Trust. To the contrary, the Pago Trust borrowed funds from

a variety of domestic sources in order to purchase and develop

the Cross Street property. Petitioner was not aware of the

Brookes Group’s having ever fulfilled its commitment to provide

funds to the Pago Trust and could not explain why the Pago Trust

continued to wire funds overseas to the Brookes Group.
 - 50 -

Petitioners have not offered any persuasive arguments in support

of their contention that the trusts are not shams.

After considering the four factors set forth in Markosian v.

Commissioner, 73 T.C. at 1243-1244, it is clear that the Pago and

McKenzie Trusts were shams which lacked economic substance and

must be disregarded for Federal income tax purposes.

Accordingly, we sustain respondent’s determination, and we hold

that the net income earned by the Pago and McKenzie Trusts is

properly taxable to the Gouveias.28

V. Section 6662(a) Penalties

Section 6662(a) and (b)(1) authorizes a 20-percent penalty

to be imposed on the portion of an underpayment of income tax

attributable to negligence or disregard of rules or regulations.

Respondent bears the burden of production, but petitioners have

the burden of proof. Sec. 7491(c). Negligence “includes any

failure to make a reasonable attempt to comply with the

provisions of * * * [the Internal Revenue Code]”. Sec. 6662(c);

see also Neely v. Commissioner, 85 T.C. 934, 947 (1985)

(negligence is the lack of due care or failure to do what a

reasonable person would do under the circumstances).

28
In light of our holding, we need not address respondent’s
alternative arguments that the income from the Pago and McKenzie
Trusts is allocable to the Gouveias under the assignment of
income doctrine or the grantor trust rules.
 - 51 -

We have previously held that a taxpayer’s adoption of a

“flagrant tax avoidance scheme” repeatedly rejected by the courts

is patently negligent. Wesenberg v. Commissioner, 69 T.C. 1005,

1015 (1978); see also Hanson v. Commissioner, T.C. Memo. 1981-

675. Respondent has produced ample evidence to demonstrate that

the trusts were created for the purpose of tax avoidance and that

they lacked economic substance. In addition, when the Gouveias

created the trusts, we had already considered several cases

involving abusive business trusts and determined that the trusts

would not be respected for Federal income tax purposes. See

Zmuda v. Commissioner, 79 T.C. 714 (1982); Markosian v.

Commissioner, 73 T.C. 1235 (1980); Schneider v. Commissioner,

T.C. Memo. 1987-560; Hanson v. Commissioner, supra.

The Gouveias argue that the penalty should not be imposed

because they had reasonable cause for the underpayment, and they

acted in good faith by relying on advice from accountants and tax

return preparers. Section 6664(c)(1) provides that the section

6662 accuracy-related penalty shall not be imposed with respect

to any portion of any underpayment if it is shown that a taxpayer

acted in good faith and that there was reasonable cause for the

underpayment. In determining whether a taxpayer acted in good

faith, we consider the taxpayer’s knowledge and experience, the

taxpayer’s reliance, if any, on the advice of well-informed and
 - 52 -

competent tax professionals, and the taxpayer’s efforts to assess

his proper tax liability. Sec. 1.6664-4(b)(1), Income Tax Regs.

Petitioner testified that before forming the trusts, he

spoke with his former tax return preparer, who was not familiar

with trusts, met with a company called the Independent Trust

Consultants, and “read as much material as [he] could from

libraries.” Petitioner also testified that he hired his tax

return preparer because she was “familiar with estates and trusts

[and] Form 1041”, but he did not ascertain her level of

education. The Gouveias introduced no other evidence of their

knowledge or degree of experience in tax matters. Moreover,

petitioner’s testimony does not establish that anyone with whom

the Gouveias consulted provided any advice upon which they relied

or that the Gouveias made any sincere effort to determine whether

the trust arrangement would be respected for Federal income tax

purposes. Because the Gouveias have not demonstrated that they

acted in good faith and that there was reasonable cause for the

underpayment, we sustain respondent’s determination that the

Gouveias are liable for the accuracy-related penalty under

section 6662(a) for 1995, 1996, 1997, and 1998 on any

underpayment of income tax attributable to unreported income from

the Pago and McKenzie Trusts.
 - 53 -

VI. Conclusion

We have carefully considered all remaining arguments made by

the parties for results contrary to those expressed herein, and,

to the extent not discussed above, we find those arguments to be

irrelevant, moot, or without merit.

To reflect the foregoing,

Decisions will be entered

for respondent in docket Nos.

288-03 and 562-03, and

appropriate orders will be

entered in docket Nos. 563-03

and 564-03.