Kooyers v. Comm'r

T.C. Memo. 2004-281

UNITED STATES TAX COURT

ORNEAL AND MARTHA KOOYERS, ET AL.,1 Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket Nos. 20060-02, 20202-02, Filed December 20, 2004.
20203-02.

Orneal and Martha Kooyers, pro sese.

Paul L. Dixon, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

KROUPA, Judge: Respondent determined the following income

tax deficiencies and penalties with respect to petitioners’

1
This case is consolidated with OMK Company Trust, docket No.
20202-02, and OMK Family Trust, docket No. 20203-02.
 - 2 -

Federal income tax returns for 1998:2

Penalties
Accuracy-related Fraud1
Petitioner Deficiency Sec. 6662(a) Sec. 6663

Orneal & Martha $125,772 -- $25,154
OMK Company Trust 50,221 $10,044 --
OMK Family Trust 824 165 --
1
Respondent determined in the alternative that, if Orneal and
Martha Kooyers are not liable for the fraud penalty, they are
liable for the accuracy-related penalty under sec. 6662(a).

Respondent concedes that Orneal and Martha Kooyers are not

liable for the fraud penalty under section 6663. Following that

concession we must first decide whether the OMK Company Trust and

OMK Family Trust (collectively the OMK trusts) should be

disregarded for Federal income tax purposes. We hold that the

OMK trusts are to be disregarded. Because the OMK trusts are

disregarded for Federal income tax purposes, we must decide five

additional issues.

First, we decide whether Orneal and Martha Kooyers

(petitioners) are taxable on income from Tamarisk Operations,

Ltd., and Fountain Global Trust. We hold that they are not.

Second, we decide whether petitioners are taxable on capital

gain of $6,008 as reported by the OMK trusts or $123,391 as

2
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for 1998, and Rule references
are to the Tax Court Rules of Practice and Procedure. Amounts
are rounded to the nearest dollar.
 - 3 -

determined by respondent. We hold that they are taxable on

capital gains of $103,791.

Third, we decide whether petitioners may deduct expenses

claimed as business expenses by the OMK trusts. We hold that

they may not.

Fourth, we decide whether petitioners are liable for self-

employment taxes on compensation paid to the OMK trusts by

Pacific Island Ministries (P.I. Ministries). We hold that they

are.

Finally, we decide whether petitioners are liable for the

accuracy-related penalty under section 6662(a). We hold that

they are.

FINDINGS OF FACT

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

The stipulation of facts and the accompanying exhibits are

incorporated in these findings by this reference. When the

petitions in these cases were filed, petitioners, who are

married, resided in Grass Valley, California, where, at that

time, they conducted the activities of the OMK trusts.

A. Petitioners’ Missionary Service in New Guinea

In the spring of 1959, Mr. Kooyers had an epiphany and

believed himself called to serve as a missionary. At the time,

petitioners were teaching in northern California. After

obtaining releases from their teaching contracts, petitioners
 - 4 -

joined the Wycliffe organization and took linguistic courses for

Bible translators and jungle training conducted by Wycliffe. In

February 1961, petitioners began performing missionary work in

the Sepik River Basin area of Papua, New Guinea. Petitioners

settled with their children in the primitive village of Madiwai,

where they built a house and studied the village culture and the

language of Washkuk. After 2 years, they built a school where

Mrs. Kooyers taught.

Petitioners traveled to the United States in 1966, so that

Mr. Kooyers could recuperate from hepatitis and they could raise

funds for their work in New Guinea. They returned to New Guinea

in the fall of 1967 and settled in the town of Ambunti. Mrs.

Kooyers began teaching classes there, and eventually the classes

evolved into the Ambunti Akademi.

Petitioners completed their translation of the New Testament

in 1975. The Wycliffe organization required its missionaries

upon completion of a translation to relocate to a new area, study

the language, and begin another translation. Petitioners

believed that they had been called to serve in the Sepik area of

New Guinea. Consequently, they separated from the Wycliffe

organization and established P.I. Ministries, through which they

continued to conduct their missionary work in New Guinea.

Petitioners were employed by P.I. Ministries; Mr. Kooyers served
 - 5 -

as chief executive officer, and Mrs. Kooyers served as a teacher

and missionary.

Petitioners’ daughter Leah graduated from college in 1978

and married Doug Heidema, a son of other missionaries. Leah and

Doug settled in Ambunti and assisted petitioners with their

missionary activities. Petitioners also sought and trained New

Guinea nationals to serve as leaders in the mission activities of

P.I. Ministries. Eventually, those nationals conducted a large

portion of the mission’s activities.

Over the years, the activities of P.I. Ministries greatly

contributed to the development of the Sepik area. With funds

provided by the U.S. Agency for International Development, P.I.

Ministries constructed (i) a large joinery to construct canoes,

trusses for buildings, school furniture, and water tanks, (ii)

new wards for the Ambunti clinic, and (iii) rain-collection water

systems for 165 villages. More recently, P.I. Ministries has

supplied villages with medicines and assisted in training

orderlies to provide basic medical treatment.

B. Creation of the OMK Trusts

Petitioners were frugal, made wise investments, and were

provided retirement benefits by P.I. Ministries. Consequently,

by 1995, they had accumulated substantial savings. Petitioners

continued to live a very modest lifestyle, however, even after
 - 6 -

they returned to the United States.3 They primarily wished to

use their savings (i) to ensure that the missionary activities of

P.I. Ministries in New Guinea continued and (ii) to provide for

the education of their grandchildren.

Petitioners made an extended trip to California in 1995.

During that visit, an acquaintance suggested to petitioners that

they consider establishing trusts. Petitioners learned that

National Trust Services (NTS) conducted seminars on investments

and the use of “complex” trusts. They paid $9,000 or $10,000 to

attend an NTS seminar in 1995.

In November 1995, petitioners created the OMK trusts using

forms provided by NTS. Mr. Kooyers was the grantor/creator of

the OMK Family Trust. As part of the OMK Family Trust’s “Complex

Trust System”, the OMK Family Trust created other trusts,

including the OMK Company Trust. Petitioners were trustees of

the OMK trusts and made all decisions concerning the use of trust

assets at all times relevant to these cases.4 The term of the

trusts was 25 years. As trustees, however, petitioners had

3
Since petitioners’ permanent return to the U.S., they have
lived in a mobile home in a mobile home park and have purchased
used cars; e.g., in 1998, they sold a 1987 Buick and purchased a
used 1993 Buick.
4
Mrs. Kooyers and National Trust Services (NTS) were named
trustees of the OMK Family Trust in the declaration of trust,
dated Nov. 16, 1995. Roy Fritts (Fritts) signed on behalf of
NTS. Mr. Kooyers was named as a trustee on Nov. 17, 1995.
Thereafter, neither Fritts nor any other representative of NTS
participated in any meetings or decisions of the trustees.
 - 7 -

discretion to terminate any trust before the end of the 25-year

period and, at the end of the period, could renew the trust

agreement for another period up to 25 years.

Petitioners intended that 20 percent of the beneficial

interest in the OMK Family Trust was to be held by their children

and 80 percent was to be held by P.I. Ministries. Minutes of the

board of trustees of OMK Family Trust, dated November 17, 1995,

indicate that there were 100 beneficial units, of which 80 were

held by the OMK Charitable Trust5 and 20 were held by

petitioners’ children. Minutes of the board of trustees of the

OMK Company Trust, dated November 18, 1995, indicate that the OMK

Family Trust was the sole beneficiary of the OMK Company Trust.

Minutes of the board of trustees of the OMK Family Trust,

dated November 17, 1995, state that the beneficial certificates

convey no interest of any kind in the trust assets; convey no

voice in the management or control of the trust but do convey a

right to receive a pro rata share of “emoluments” that may be

distributed by the trustees.

5
The minutes of the board of trustees of the OMK Family
Trust, dated Nov. 17, 1995, state that the trustees agreed to
create a private charitable foundation (a charitable trust) to
which units of beneficial interest were issued. The declaration
of trust for the OMK Charitable Trust is not in the record.
 - 8 -

Mrs. Kooyers transferred to Mr. Kooyers all of her interest

in all her real and personal property.6 Mr. Kooyers then

transferred all of petitioners’ property, real and personal, to

the OMK Family Trust. The declaration of trust of the OMK Family

Trust states that the trustees were authorized to accept rights,

title, and interest in real and personal property conveyed by Mr.

Kooyers to be the corpus of the trust, including “the exclusive

use of his lifetime services and ALL of his EARNED REMUNERATION

ACCRUING THEREFROM”.

For 1998, the OMK Company Trust entered into separate

agreements with P.I. Ministries, pursuant to which the trust

agreed to provide the services of petitioners as independent

contractors to P.I. Ministries and P.I. Ministries agreed to pay

the trust for services provided by petitioners. Mr. Kooyers was

to serve as assistant to P.I. Ministries’ chief executive

officer, and Mrs. Kooyers was to serve as a missionary. In 1998,

P.I. Ministries paid the OMK Company Trust $106,788 for

petitioners’ services.

In 1998, the OMK Company Trust paid all expenses petitioners

thought were related to their mission work, including the costs

of their housing, medical care, travel, and family gatherings.

6
The property Mrs. Kooyers conveyed to Mr. Kooyers included
exclusive use of her lifetime services “exception being that of
an employee situation”.
 - 9 -

The OMK Company Trust also paid the education expenses of

petitioners’ grandchildren.

C. Investments in Ponzi Schemes

Minutes of the OMK Company Trust trustees meeting, dated May

29, 1996, state that the trust contracted with William Joe Little

(Little) of NTS to act as “Agent Trustee” to handle investments.

Little was also affiliated with Fountainhead Global Trust

(Fountainhead). During the course of his relationship with

petitioners, Little exploited their strong religious motivations

and convinced them that he was a “keen Christian”.

In February 1997, petitioners traveled to Grand Cayman

Island to attend meetings conducted by Little, Fritts, and Lewis

Rowe (Rowe) of Zephyr International Ltd. (Zephyr). The meetings

were to explain the NTS/Zephyr relationship and to promote

investing through an offshore entity. Little, Fritts, and Rowe

convinced petitioners that the proposed investments were sound,

that Little, Fritts, and Rowe were highly qualified and licensed

professionals, and that the “operation is completely legal,

honest, upright and is run by men of highest integrity. Only

these kind of men are so licensed under the authority of the

Caymanian government which operates under British law.”

As advised by Fritts, Little, and Rowe, petitioners

contracted with Zephyr to form Tamarisk Operations Ltd.

(Tamarisk), through which the OMK trusts invested $550,000.
 - 10 -

Tamarisk invested $250,000 in a loan program called “Cash for

Titles” and $300,000 in an investment called Lanstar. Minutes of

OMK Company Trust, dated August 18, 1998, indicate that the Loan

Account (previously Cash for Titles) in which $250,000 had been

invested was “now valued at the August 15 date at $454.6K”. A

Tamarisk statement, dated November 19, 1998, sent to the OMK

trusts by Zephyr, reported that the balance in the loan program

was $333,460 on December 31, 1997, and $472,785 on September 30,

1998. The $139,325 increase was attributable to monthly

transactions recorded as interest.

The OMK trusts also invested with Little in Fountainhead.

Fountainhead quarterly statements for March 31, June 30,

September 30, and December 31, 1998, reported the following

transactions:

Mar. 31 June 30 Sept. 30 Dec. 31

Last quarter’s balance -0- -0- $100,000 $100,000
New investment $100,000 $100,000 -0- -0-
Total interest this quarter -0- 4,160 12,661 12,661
Less return of principal -0- -0- 7,714 7,714
Less return of interest -0- -0- 4,001 4,001
Less management fees -0- 304 946 946
Total investment value 100,000 103,856 100,000 100,000

The “investments” promoted by Little, Fritts, and Rowe were

in reality scams, and petitioners never recovered their money.

The “cash for title” loan program investment was in reality a

large-scale, international Ponzi scheme devised by Michael Gause

(Gause). Gause conducted the scheme in the Cayman Islands
 - 11 -

through a network of corporations and bank accounts that he

controlled.7 Gause and others, including Rowe, represented to

the investors that the proceeds from the sales of securities

would provide high-interest consumer loans. Contrary to those

representations, most of the proceeds were used to pay interest

and principal to earlier investors, as well as commissions and

fees to the promoters. Rather than making a profit on the

investments, petitioners lost most of the money they invested.

D. Petitioners’ and the OMK Trusts’ 1998 Returns

Larry Dickson (Dickson) of Isler & Co. in Medford, Oregon,

prepared the 1998 income tax returns for petitioners and the OMK

trusts. Someone associated with NTS had recommended Dickson as

an accountant knowledgeable in taxation of complex trusts, as

well as a “church member”. Dickson prepared petitioners’ 1998

Form 1040, U.S. Individual Income Tax Return, as well as separate

1998 Forms 1041, U.S. Income Tax Return for Estates and Trusts,

for the OMK Family Trust and the OMK Company Trust.

On their return, petitioners reported total income of

$5,245, including $245 of dividends and $5,000 of trustee fees

7
Gause pleaded guilty to conspiracy, securities fraud, and
international money laundering in connection with the Ponzi
scheme. United States v. Gause, Criminal Action No. 99 Cr. 1100
(S.D.N.Y., Oct. 24, 1999). The Government of the Cayman Islands
charged Rowe and Patrick Tibbetts with money laundering in
connection with Gause’s “Cash 4 Titles” scheme. See In re United
States, No. 04-MC-9 (N.D.W.Va. Apr. 15, 2004)(order granting
motion for writ of habeas corpus ad testificandum).
 - 12 -

($2,500 each, which they each reported as subject to self-

employment taxes of $353). They also reported nontaxable Social

Security benefits of $29,534.

On its return, the OMK Company Trust reported total income

of $129,311, which included $29,481 of interest from

Fountainhead, $2,089 of dividends, $91,732 of other income, and

$6,008 of capital gain. The other income was described as

$106,788 from P.I. Ministries less $15,056 “return of capital

Fountainhead Global”. The capital gain reported on the return

included $1,930 of capital gain from the sale of shares of three

Scudder funds--Scudder Latin American Fund (Latin), Scudder

Greater Europe Growth Fund (Growth), and Scudder Investment Trust

(Investment)--and $4,078 from other investments, reported as

follows:

Sale Gain
Fund Price Basis (Loss)

Scudder funds
Latin $47,755 $45,301 $2,454
Growth 32,719 33,243 (524)
Investment 64,239 64,239 -0-
Other funds
L.A. small cap 27,387 28,194 (807)
L.A. small cap 28,597 30,012 (1,415)
J. Hancock 16,052 16,142 (90)
Pilgrim 15,333 16,137 (804)
L.A. class A 32,186 24,992 7,194
Total $264,268 $258,260 $6,008

The OMK Company Trust claimed total deductions of $129,899,

including $3,729 for fiduciary fees, $56,871 for charitable
 - 13 -

contributions, $900 for attorney, accountant, and return preparer

fees, and $68,399 for other deductions. The other deductions

included $15,970 for continuing education, $6,037 for travel

expenses, $448 for dues and subscriptions, $2,461 for medical,

$2,224 for investment expenses, $6,457 for publishing costs,

$6,724 for rentals, $760 for repairs and maintenance, $12,041 for

supplies, $1,845 for 50 percent of the cost of meals, $4,043 for

other trust expenses, and $9,389 for a net operating loss.

On its return, the OMK Family Trust reported an adjusted

total loss of $944 ($61 of interest income less net operating

loss of $1,005). The OMK Family Trust also reported (but did not

deduct on the basis of the passive activity loss limitations) a

net loss of $5,712 from rental real estate activity, which

included $3,318 unallowed losses from prior years. The $2,394

loss from 1998 rental real estate activity reported on Schedule

E, Supplemental Income and Loss, derived from rental income of

$3,671 and deductions of $120 for repairs, $279 for taxes, $1,991

for utilities, and $3,675 for depreciation.

Respondent examined petitioners’ 1998 return, as well as the

returns filed by the OMK trusts, and issued notices of deficiency

to petitioners and the OMK trusts.

In the notice of deficiency issued to the OMK Family Trust,

respondent disallowed the claimed rental expenses and increased

the trust’s income by the $3,671 rent reported as received on the
 - 14 -

return. Respondent also disallowed the $1,005 net operating loss

and imposed the accuracy-related penalty under section 6662(a).

In the notice of deficiency issued to the OMK Company Trust,

respondent disallowed all items deducted on the trust’s 1998

return, increasing the trust’s taxable income by $129,899.

In the notice of deficiency issued to petitioners,

respondent determined that the OMK trusts should be disregarded

for Federal income tax purposes and consequently made the

following adjustments to petitioners’ income:

Item Adjustment

Taxable Social Security $25,104
Capital gain 123,791
Self-employment tax (7,191)
Itemized deductions (10,127)
Standard deduction 8,800
Exemptions 5,400
Service income Mr. Kooyers 55,974
Fiduciary fees Mr. Kooyers (2,500)
Service income Mrs. Kooyers 50,814
Fiduciary fees Mrs. Kooyers (2,500)
Dividend income 2,089
Interest income 168,868

Respondent determined that the income from P.I. Ministries

was subject to self-employment tax of $15,089. Respondent also

determined that petitioners were liable for the civil fraud

penalty under section 6663 or, alternatively, for an

accuracy-related penalty under section 6662(a) and (b)(1) for

negligence or disregard of rules or regulations.
 - 15 -

OPINION

As a general rule, the Commissioner’s determinations in a

notice of deficiency are presumed correct, and the burden is on

the taxpayer to prove otherwise. Rule 142(a); Welch v.

Helvering, 290 U.S. 111, 115 (1933). The general rule does not

apply, however, under circumstances where section 7491 places the

burden of proof or production on the Commissioner.8

The Commissioner bears the burden of proof with respect to a

factual issue relevant to ascertaining a taxpayer’s liability for

income tax, if the taxpayer introduces credible evidence with

respect to that factual issue. Sec. 7491(a)(1). The preceding

rule applies, however, only if the taxpayer has (i) complied with

requirements under the Code to substantiate any item, (ii)

maintained all records required by the Code, and (iii) cooperated

with reasonable requests by the Secretary for information,

documents, and meetings. Sec. 7491(a)(2). The taxpayer bears

the burden of proving that these requirements have been met.

Snyder v. Commissioner, T.C. Memo. 2001-255 (citing H. Conf.

Rept. 105-599, at 240-241 (1998), 1998-3 C.B. 747, 994-995).

8
Sec. 7491 applies to court proceedings arising in
connection with examinations beginning after July 22, 1998.
Internal Revenue Service Restructuring and Reform Act of 1998,
Pub. L. 105-206, sec. 3001(a), 112 Stat. 726. The year at issue
is 1998, and the examination began after July 22, 1998. Thus,
sec. 7491 applies to this case.
 - 16 -

In this case, there are multiple factual issues relevant to

determining petitioners’ tax liability. Petitioners have not

addressed or provided any evidence concerning $61 of interest

income or substantiated expenses claimed by the OMK trusts.

Consequently, section 7491(a)(2) does not place on respondent the

burden of proving those factual issues. The resolution of the

remaining issues does not depend on which party has the burden of

proof. We resolve those issues on the preponderance of the

evidence in the record.

I. Income of the OMK Trusts Is Taxable to Petitioners

Respondent determined that the OMK trusts should be

disregarded for Federal income tax purposes and the income

reported by the trusts taxed to petitioners.

Courts have consistently invalidated similar trusts for

Federal income tax purposes. Those courts that have been faced

with the issue have been uniform in their determinations that

those entities will not allow a taxpayer to shift the incidence

of taxation away from himself to the trust. We cite only a few

of the many cases so holding. See, e.g., Zmuda v. Commissioner,

731 F.2d 1417 (9th Cir. 1984), affg. 79 T.C. 714 (1982); Holman

v. United States, 728 F.2d 462 (10th Cir. 1984); O’Donnell v.

Commissioner, 726 F.2d 679 (11th Cir. 1984); Hanson v.

Commissioner, 696 F.2d 1232 (9th Cir. 1983), affg. T.C. Memo.

1981-675; Schulz v. Commissioner, 686 F.2d 490 (7th Cir. 1982),
 - 17 -

affg. T.C. Memo. 1980-568; Vnuk v. Commissioner, 621 F.2d 1318

(8th Cir. 1980), affg. T.C. Memo. 1979-164; Wesenberg v.

Commissioner, 69 T.C. 1005 (1978). These cases involved facts

strikingly similar to the facts here.

In the cited cases, family trusts were set up using forms,

materials, and step-by-step instructions bought from promoters of

trust schemes. Generally the wife conveyed her real and personal

property to the husband. The husband then conveyed all family

property, including the family residence and vehicles, to the

trust, along with the right to receive income derived from his

lifetime services. In return, the husband received the entire

beneficial interest in the trust evidenced by beneficial interest

certificates.

Initially, the wife and a third party (usually the promoter)

were designated as trustees.9 Within a day or two, however, the

husbands also were named as trustees. The husband and wife then

became sole trustees, with the trusts to bear all their

trust-related expenses.

Shares of the beneficial interest were then divided between

the husband and wife and/or other family members. Any

disbursement of trust income would be made pro rata in accordance

with the beneficial interests as evidenced by the certificates,

9
See Markosian v. Commissioner, 73 T.C. 1235, 1244 n.7
(1980), where a trustee who served only 1 month without
performing any duties was disregarded as a mere nominee.
 - 18 -

and, if the trust was terminated, the assets were also to be

distributed according to the beneficial interest certificates.

The trustees were empowered to pay compensation to officers,

employees, and agents of the trusts, including themselves. The

term of each trust usually was 25 years unless the trustees

unanimously decided on an earlier termination date. As trustees,

the taxpayers retained almost unlimited discretionary powers to

deal with the trust assets, distribute income, and terminate the

trust. The husbands and wives continued to use and enjoy the

property that had been conveyed and/or leased to their trusts.

Generally, the courts have disregarded these trusts for

Federal income tax purposes. There are four grounds courts have

used to disregard a trust. First, the trust was created as a

guise for deducting personal consumption expenses. Second, the

income of the trust is taxable to the taxpayer under the

assignment of income doctrine. Third, the trust is a grantor

trust under the provisions of sections 671 through 677. Fourth,

the trust lacks substance. See, e.g., Zmuda v. Commissioner,

supra; Holman v. United States, supra; O’Donnell v. Commissioner,

supra; Hanson v. Commissioner, supra; Schulz v. Commissioner,

supra; Vnuk v. Commissioner, supra; Wesenberg v. Commissioner,
 - 19 -

supra. The reasoning of those courts is equally applicable here.

A. Attempted Deduction of Personal Consumption Expenses

After attending the NTS seminars, petitioners thought that

once they had conveyed their personal assets, like cars and

residences, to the OMK trusts, the trusts could deduct personal

consumption expenses such as fire insurance, utilities, and

repair and maintenance--indeed, almost everything except the

costs of food consumed at home. “It is fundamental to our income

tax regime that personal consumption expenditures--food,

clothing, travel, education, entertainment--do not generate

income tax deductions unless they are somehow inextricably linked

to the production of income.” Schulz v. Commissioner, supra at

492-493. Personal expenses do not become deductible expenses of

trust administration merely because title to property is placed

in the trust. Id. There must be a nexus between the expense and

the business conducted by the trust to qualify for a tax

deduction. Conversely, legitimate expenses of a taxpayer’s

business are deductible regardless of whether the taxpayer is an

individual or a trust. United States v. Buttorff, 761 F.2d 1056,

1060 (5th Cir. 1985).

The OMK trusts did not engage in any trade or business.

Thus, the claimed deductions are not deductible under section

162. Transferring property into the trusts did not aid in the

production of income, nor did it alter management activity.
 - 20 -

Petitioners simply restructured the form in which they held their

property. Rearranging title is not related to management or

conservation under section 212. Zmuda v. Commissioner, 731 F.2d

at 1422. Moreover, section 212 was not designed to allow tax

deductions based on mere preservation of net worth. Id. Thus,

respondent could, and did, properly disallow the expenses the

trusts claimed.

B. Assignment of Income

The assignment of income doctrine provides a second and

broader-based attack on family trusts of the type described here.

Schulz v. Commissioner, 686 F.2d at 493. Petitioners provided

services to P.I. Ministries. P.I. Ministries paid the OMK

Company Trust for those services, and the trust reported that

income on its Form 1041. It is established law that income is

taxed to the person who earns it. Commissioner v. Culbertson,

337 U.S. 733, 739-40 (1949). Attempting to avoid taxation by

diverting income from the true earner to another entity does not,

in and of itself, shift the incidence of taxation. United States

v. Basye, 410 U.S. 441 (1973); Lucas v. Earl, 281 U.S. 111

(1930). The determination of the proper taxpayer depends upon

which person or entity in fact controls the earning of the income

rather than who ultimately receives the income. Vnuk v.

Commissioner, 621 F.2d at 1320; Vercio v. Commissioner, 73 T.C.

1246 (1980).
 - 21 -

Where the taxpayer simply assigns his or her lifetime

services and income earned from the performance of those

services, and the taxpayer rather than the trust has the ultimate

direction and control over the earning of the compensation, the

conveyance is ineffective to shift the tax burden from the

taxpayer to the trust. Vnuk v. Commissioner, supra at 1320;

Wesenberg v. Commissioner, 69 T.C. at 1010-1011; see also Holman

v. United States, 728 F.2d at 464; O’Donnell v. Commissioner, 726

F.2d at 681; Hanson v. Commissioner, 696 F.2d at 1234.

Like the taxpayers in the cited cases, petitioners were not

bona fide servants of the OMK Company Trust because the trust had

no right to supervise their employment or determine the resulting

income or benefit. The purported conveyance of petitioners’

lifetime services to the trust did not create a legal obligation

because petitioners were on both sides of the transaction, as

employees and as trustees, leaving no one to enforce the

obligation. See Schulz v. Commissioner, supra at 494.

Similarly, the contracts for services entered into by the

OMK Company Trust and P.I. Ministries concern the services of the

individual having control over P.I. Ministries as its chief

executive officer and over the trust as trustee. Neither the OMK

Company Trust nor P.I. Ministries could be said to have had

control of petitioners’ activities. See Stoecklin v.
 - 22 -

Commissioner, T.C. Memo. 1987-453, affd. 865 F.2d 1221 (11th Cir.

1989).

The “ultimate direction and control” rested in petitioners,

not in the OMK Company Trust. Indeed, it would be unrealistic to

assume that anyone would transfer his or her lifetime services to

a family trust without having such control. Borchert v.

Commissioner, T.C. Memo. 1982-379. Moreover, such a purported

conveyance of lifetime services would be unenforceable and

essentially nugatory under applicable State law in at least the

vast majority of instances. United States v. Buttorff, supra at

1061.

Petitioners were the sole source of the OMK Company Trust’s

earned income and should be taxed on the income they generated

from their services. Cf. Vercio v. Commissioner, supra at 1254.

In such circumstances, the conveyance was merely an anticipatory

assignment of income and was insufficient to shift the incidence

of taxation from petitioners to the OMK trusts. We therefore

hold that the income earned by petitioners through their services

should be taxed to them.

C. Grantor Trusts

Petitioners transferred more than their earning abilities to

the OMK trusts. They also transferred all of their personal and

income producing property to the trusts. Different rules apply

to gifts of income-producing property to trusts. Courts have
 - 23 -

found income from property held in trusts similar to the OMK

trusts taxable to the grantors of those trusts under the “grantor

trust” provisions set out in sections 671 through 677. See,

e.g., Zmuda v. Commissioner, supra at 1421; Holman v. United

States, supra at 464-65; Hanson v. Commissioner, supra at 1234;

Vnuk v. Commissioner, supra at 1321. Under specified

circumstances, the grantor trust provisions treat the grantor of

the trust as the substantial owner of all or part of the trust,

and all of the income and deductions pertaining to that part of

the trust must be taken into account by the grantor. Sec. 671.

The grantor trust is not taxed on the income that is taxable to

the grantor. Id.

For purposes of the grantor trust provisions, a grantor

includes any person to the extent that person either creates a

trust or gratuitously transfers property, directly or indirectly,

to a trust. Sec. 1.671-2(e)(1), Income Tax Regs. If one person

creates or funds a trust on behalf of another person, both

persons are treated as grantors of the trust. Id. Courts have

examined trust arrangements, similar to those at issue here,

where the wife generally conveys all her property to the husband

who then conveys to the trust all his property, including the

property transferred from his wife. Although the wife was not a
 - 24 -

grantor technically, the courts refused to accept this

distinction. Rather, the courts have treated the wife as a

grantor because the adversity between parties is artificial and

will not shield the trust from the operation of the grantor trust

provisions. United States v. Buttorff, 563 F. Supp. 450, 454

(N.D. Tex. 1983), affd. 761 F.2d 1056 (5th Cir. 1985). The

wife’s “conveyance can be ignored, either on the familiar tax

principle that substance predominates over form, or because the

parties themselves treated it as neither a sale nor a gift.”

Schulz v. Commissioner, 686 F.2d at 496 (fn. ref. omitted).

These trusts violate the grantor trust statutes in substance, if

not in form. Id. at 495; accord Zmuda v. Commissioner, 731 F.2d

at 1421; Holman v. United States, supra at 464-65. Thus, Mrs.

Kooyers, as well as Mr. Kooyers, is a grantor of the OMK Family

Trust. Because petitioners are grantors of the OMK Family Trust,

they are also grantors of the OMK Company Trust and any other

trust for which the OMK trusts are grantors. See sec. 1.671-

2(e)(5), Income Tax Regs.

The grantor of the trust will be taxed on the income of the

trust under the grantor trust provisions if any of certain

conditions apply. First, he possesses a disqualifying

reversionary interest. Sec. 673. Second, the trust can be

revoked by the grantor or a nonadverse party. Sec. 676. Third,

trust income can be distributed to the grantor or the grantor’s

spouse or be used to pay for insurance on their lives without the

consent of an adverse party. Sec. 677. Fourth, specified powers
 - 25 -

to control beneficial enjoyment of the corpus or income are

vested in the grantor or certain other persons. Sec. 674.

Fifth, certain administrative powers are exercisable by the

grantor or a nonadverse party. Sec. 675.

Adverse party is defined as “any person having a substantial

beneficial interest in the trust which would be adversely

affected by the exercise or nonexercise of the power which he

possesses respecting the trust.” Sec. 672(a). Even if the

section 672 definition of an adverse party is satisfied, however,

sections 674-677 require a trust’s income to be taxed to the

grantor unless the consent of the adverse party is required

before the grantor may exercise any of the powers enumerated in

those sections. Because petitioners did not hold beneficial

interests in the trusts, they were not adverse parties with

respect to each other. See, e.g., Schulz v. Commissioner, supra

at 495-496.

In 1998, the OMK Company Trust paid petitioners’ costs of

housing, medical care, travel, and family gatherings. The OMK

Company Trust also paid the education expenses of petitioners’

grandchildren, who were not beneficiaries of the OMK trusts.

Several factors indicate that petitioners retained total control

over the OMK trusts and that the trusts are grantor trusts.

First, none of petitioners’ powers as trustees required the

consent of an adverse party. Second, petitioners retained
 - 26 -

enjoyment of the trust corpus and income. Third, petitioners

used the OMK trusts for their own benefit. We hold that the

income of the OMK trusts is taxable to petitioners under the

grantor trust provisions of sections 671-677.

D. Trusts Lack Substance

Finally, courts have frequently found that trusts

substantially identical to the OMK trusts are lacking in any real

substance and thus are without any effect for Federal tax

purposes. See, e.g., Zmuda v. Commissioner, supra at 1421;

Muhich v. Commissioner, T.C. Memo. 1999-192, affd. 238 F.3d 860

(7th Cir. 2001); Dahlstrom v. Commissioner, T.C. Memo. 1991-264,

affd. without published opinion 999 F.2d 1579 (5th Cir. 1993);

Clawson v. Commissioner, T.C. Memo. 1982-321.

Taxpayers have a legal right to structure their transactions

to minimize their tax obligations by whatever means allowable

under the law. Gregory v. Helvering, 293 U.S. 465, 469 (1935).

Transactions that have no significant purpose other than to avoid

tax and do not reflect economic reality, however, will not be

recognized for Federal income tax purposes. Zmuda v.

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

Cir. 1984). If a transaction has not altered any cognizable

economic relationships, we must look beyond the form of the

transaction and apply the tax law according to the transaction’s

substance. Markosian v. Commissioner, 73 T.C. 1235, 1241 (1980).
 - 27 -

This principle applies regardless of whether the transaction

creates an entity with separate existence under State law. Zmuda

v. Commissioner, 79 T.C. at 720.

Petitioners argue that they did not create the OMK trust to

avoid taxes. We find the testimony of Mr. Kooyers was sincere

and credible. He testified that he and Mrs. Kooyers established

the trusts to provide for the continued funding of the missionary

activities of P.I. Ministries and for the education of their

grandchildren. Although we are convinced that petitioners

intended to support the missionary activities of P.I.

Ministries,10 the record does not establish that any beneficial

interest passed to P.I. Ministries. The named beneficiaries of

the OMK trusts are petitioners’ children and the OMK Charitable

Trust. Documents related to the OMK Charitable Trust are not in

the record, however, and the beneficiaries of the OMK Charitable

Trust are not identified in the record.

Courts will disregard a transaction when the transaction has

no economic effects other than the creation of tax benefits.

10
The Department of Justice (DOJ) began a campaign to stop
the spread of phony trust schemes that the Government contends
are being used illegally to evade the payment of taxes. In a
lawsuit the DOJ filed, the Government obtained a permanent
injunction against Roderick Prescott, a former promoter of NTS,
barring him from selling trust schemes that falsely claimed an
individual’s personal expenses could be paid through a trust to
obtain tax benefits not available to the individual. United
States v. Prescott, Civil No. 02-CV-0692-L (S.D. Cal., June 2,
2003).
 - 28 -

Knetsch v. United States, 364 U.S. 361, 365-366 (1960).

Furthermore, even if a transaction has economic effects, it must

be disregarded if it has no business purpose and its motive is

tax avoidance. Gregory v. Helvering, supra at 469; Neely v.

United States, 775 F.2d 1092, 1094 (9th Cir. 1985).

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 1243-1245; Castro v. Commissioner, T.C. Memo. 2001-115; Hanson

v. Commissioner, T.C. Memo. 1981-675, affd. per curiam 696 F.2d

1232 (9th Cir. 1983).

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.

Commissioner, supra at 1243.

The record makes clear that petitioners’ relationship, as

grantors, to their property before they created the OMK trusts
 - 29 -

did not differ materially from their relationship to the property

after they created the trusts and transferred the property to the

trusts. The OMK trusts did not engage in any trade or business,

and petitioners, as trustees, had complete control over the

income-producing property of the trusts.

The second factor we consider is whether the trust had a

bona fide independent trustee. Markosian v. Commissioner, supra

at 1243-1244. Although NTS was named as an initial trustee of

the OMK Family Trust, Fritts of NTS simply signed the formation

documents. In contrast, petitioners exercised complete control

over the OMK trusts’ assets and made all decisions regarding the

trusts. We find that no independent trustee had any meaningful

role in operating the OMK trusts. In addition, the record does

not indicate that a genuine economic interest in the trusts

passed to anyone other than petitioners. As to the fourth factor

whether petitioners honored restrictions imposed by the trusts or

by the law of trusts, we note that petitioners were not bound by

any restrictions imposed by the trust instruments or the law of

trusts as to the use of transferred property. See Norton v.

Commissioner, T.C. Memo. 2002-137. Petitioners’ transferring the

titles of assets to the OMK trusts while retaining the use and

enjoyment of the assets are transactions that have no economic

effect other than to create income tax benefits. Consequently,

the OMK trusts will not be recognized for tax purposes.
 - 30 -

II. Petitioners Did Not Receive Income From Tamarisk and
Fountainhead

Respondent determined that petitioners failed to include

$168,868 of interest in their 1998 income. The notice of

deficiency issued to petitioners does not identify the sources of

the interest. The explanation of items states that interest

income reported on Form 1099-INT was not reported on petitioners’

return. The explanation also states that interest on bank

deposits, coupons payable on bonds, loans, etc., is taxed to a

cash basis taxpayer when credited or due. On brief, respondent

asserts that $29,481 of interest from Fountainhead reported by

the OMK Company Trust and $139,326 shown as interest on the

November 19, 1998, Tamarisk statement but not reported on any

return should be included in petitioners’ income.11 Respondent

contends that those amounts represent “accessions to wealth,

clearly realized, and over which the taxpayers have complete

dominion”. We disagree.

Not only were petitioners misled by the principals and

agents of NTS with respect to the legal effect and benefits of

establishing the OMK trusts; they were defrauded by Little,

Fritts, and Rouse with respect to the investments in Fountainhead

and the Tamarisk loan program, a.k.a, “cash for titles”. The

11
The record is silent with respect to the remaining $61 of
interest reported on the return of the OMK Family Trust that
respondent determined in the notice of deficiency is taxable to
petitioners.
 - 31 -

“investments” promoted by Little, Fritts, and Rowe were in

reality scams, and petitioners never recovered their money. The

“cash for title” loan program investment was in reality a large-

scale, international Ponzi scheme.

Little, Fritts, and Rowe represented to petitioners that the

investment would provide high-interest consumer loans. Contrary

to those representations, most of the proceeds were used to pay

interest and principal to earlier investors, as well as

commissions and fees to the promoters. Petitioners did not make

a profit on the investments. Rather, they lost most of the money

they invested.

The weight of authority holds that certain distributions to

taxpayers in Ponzi or pyramid schemes (where proceeds of later

investors are used to pay distributions to early investors,

lending an appearance of legitimacy to a fraudulent “investment”)

are current income. Parrish v. Commissioner, T.C. Memo.

1997-474, affd. 168 F.3d 1098 (8th Cir. 1999); Premji v.

Commissioner, T.C. Memo. 1996-304, affd. without published

opinion 139 F.3d 912 (10th Cir. 1998); Wright v. Commissioner,

T.C. Memo. 1989-557, affd. without published opinion 931 F.2d 61

(9th Cir. 1991); Murphy v. Commissioner, T.C. Memo. 1980-218,

affd. per curiam 661 F.2d 299 (4th Cir. 1981); Harris v. United

States, 431 F. Supp. 1173 (E.D. Va. 1977). In all but one of the

above cases, however, the taxpayers were early investors who had
 - 32 -

recovered their initial “investments” during the same taxable

year as the Ponzi distributions. In the exceptional case,

Parrish, the taxpayer, an officer and director of the scheme’s

corporate vehicle, did not introduce evidence to show either the

amounts he invested or received, nor did he prove he was a victim

of fraud.

In two other cases, the taxpayers had not recovered their

initial investments during the same tax year as the Ponzi

distributions. Greenberg v. Commissioner, T.C. Memo. 1996-281;

Taylor v. United States, 81 AFTR 2d 98-1683, 98-1 USTC par.

50,354 (E.D. Tenn. 1998). In those cases, the courts held that

the distributions were a return of investment funds, not income.

In Greenberg, the taxpayers transferred funds to a Ponzi

scheme that purported to be a legitimate mortgage company. The

taxpayers were passive investors and were paid monthly payments

from the company’s bank account. They presented sufficient

evidence to establish that the amount they received did not

exceed the amount they paid. This Court found that the payments

the taxpayers received were not interest because the payments

were not compensation for the use or forbearance of money. See

Deputy v. duPont, 308 U.S. 488, 498 (1940) (interest is

compensation for the use or forbearance of money). Instead, we

found that the payments constituted nontaxable return of capital
 - 33 -

made to conceal the fraudulent misappropriation of the taxpayers’

investment.

In Taylor, the taxpayers’ law partner was operating a Ponzi

scheme, providing cash to investors, including the partnership

and its clients, with other clients’ money, rather than providing

true returns on real investments. The taxpayers, the other

partners in the partnership, filed returns for the tax year in

which they had reported their shares of the partnership “phantom

profit” from the scheme. Afterwards they filed amended returns

eliminating that income and claiming refunds of tax. The

taxpayers established that the partnership received less from the

scheme that year than it delivered to the partner in that year

and that the partner made no investments on behalf of the

partnership. The court held that, for those reasons, the

taxpayers were entitled to the refunds.

We conclude that the “interest” label given to the payments

petitioners received in 1998 through their investments with

Little and Rowe was patently erroneous. These payments were not

for the use and forbearance of their money but, rather, were made

to conceal the fraudulent misappropriation by Little and Rowe of

the money petitioners entrusted to them.12 Accordingly, the

12
We note that this Court has held that losses from
investments that turn out to be Ponzi schemes give rise to a
theft loss deduction in the taxable year in which the taxpayer
discovers the loss. Sec. 165(c)(3), (e); Jensen v. Commissioner,
(continued...)
 - 34 -

payments represented a return of petitioners’ investment and are

not includable income as interest simply because the payments

were reported as interest on statements of the investment

accounts. Cf. Burnet v. Logan, 283 U.S. 404 (1931).

Petitioners have not addressed or provided any information

regarding the remaining $61 of interest reported on the return of

the OMK Family Trust that respondent determined in the notice of

deficiency was taxable to petitioners. Respondent’s

determination in the notice of deficiency is presumptively

correct, and petitioners have the burden of proving that no part

of the amounts received constituted interest or was otherwise not

taxable to them. Rule 142(a); Welch v. Helvering, 290 U.S. 111

(1933). Section 7491(a)(1) does not shift the burden of proof to

respondent. Consequently, $61 of interest determined in the

notice of deficiency is to be included in petitioners’ income.

III. Petitioners Had Additional Capital Gain of $103,791 From the
Sale of Mutual Fund Shares

Respondent also determined that petitioners had $123,791 of

unreported capital gain. The explanation in the notice of

deficiency issued to petitioners stated that petitioners’ capital

gain was increased because the OMK trusts are disregarded for

12
(...continued)
T.C. Memo. 1993-393, affd. without published opinion 72 F.3d 135
(9th Cir. 1995); see also Premji v. Commissioner, T.C. Memo.
1996-304, affd. 139 F.3d 912 (10th Cir. 1998).
 - 35 -

income tax purposes. The explanation further stated that the

bases are valued at the original purchase prices and the step-up

in bases given the assets at the time of transfer is not allowed.

On brief, respondent clarifies that the basis in each of the

Scudder funds is $15,000 rather than the amounts reported on the

OMK Company Trust return. Consequently, respondent contends that

the correct amount of the capital gain includable in petitioners’

income is $103,791, computed as follows:

Sale Gain
Fund Price Basis (Loss)

Scudder funds
Latin $47,755 $15,000 $32,755
Growth 32,719 15,000 17,719
Investment 64,239 15,000 49,239
Other funds
L.A. small cap 27,387 28,194 (807)
L.A. small cap 28,597 30,012 (1,415)
J. Hancock 16,052 16,142 (90)
Pilgrim 15,333 16,137 (804)
L.A. class A 32,186 24,992 7,194
Total $264,268 $160,477 $103,791

Petitioners do not challenge respondent’s revised

computation of the capital gain. We hold, therefore, that

petitioners’ income should include $103,791 of capital gain.

IV. Petitioners Failed To Substantiate Expenses Claimed as
Business Expenses of the OMK Trusts

Because the OMK trusts are disregarded, petitioners may be

entitled to deduct expenses claimed by the trusts provided the
 - 36 -

expenses are substantiated and would otherwise be deductible by

petitioners. Respondent allowed petitioners total itemized

deductions of $10,127 computed as follows:

Expense Amount

Medical expense
Total medical expenses $1,916
Less 7.5% AGI (31,451)
Medical expense deduction -0-
Taxes 558
Home interest expense 3,712
Contributions 14,702
Misc. expenses
Total misc. expenses 3,559
Less 2% AGI (8,387)
Excess misc. expense deduction -0-
Total 18,972
Less applicable limitation1 (8,845)
Total itemized deductions 10,127
1
Computed on adjusted gross income of
$419,340.

The OMK Company Trust claimed total deductions of $129,899,

including $3,729 for fiduciary fees, $56,871 for charitable

contributions, $900 for attorney’s, accountant’s, and return

preparer’s fees, $15,970 for continuing education, $6,037 for

travel expenses, $448 for dues and subscriptions, $2,461 for

medical, $2,224 for investment expenses, $6,457 for publishing

costs, $6,724 for rentals, $760 for repairs and maintenance,

$12,041 for supplies, $1,845 for 50 percent of the cost of meals,

$4,043 for other trust expenses, and $9,389 for a net operating

loss. The OMK Family trust claimed deductions of $120 for
 - 37 -

repairs, $279 for taxes, $1,991 for utilities, and $3,675 for

depreciation related to rental real estate.

Although some of those expenses might represent otherwise

deductible expenses, petitioners have not substantiated the

amount or purpose of any of the items claimed by the OMK trusts

on the trusts’ Forms 1041. Consequently, we conclude that

petitioners are entitled to deduct only those items allowed in

the notice of deficiency. The total of itemized deductions

allowed is computational, dependent on the adjustments to income,

and will be determined in the Rule 155 computation.

V. Petitioners Are Liable for Self-Employment Taxes on
Compensation Paid to the OMK Trusts by P.I. Ministries

Respondent determined that amounts paid to the trust for

petitioners’ services are subject to self-employment tax.

Section 1401(a) imposes the tax upon “the self-employment income

of every individual”. The term “self-employment income” is

defined as “net earnings from self employment”. Sec. 1402(b).

Such earnings include “the gross income derived by an individual

from any trade or business carried on by such individual, less

the deductions allowed by this subtitle”. Sec. 1402(a). We find

that Mr. Kooyers was engaged in a trade or business as assistant

to the chief executive officer and Mrs. Kooyers was engaged as a

missionary and that the income they derived pursuant to the

contract for services between the OMK Company Trust and P.I.

Ministries is subject to self-employment tax.
 - 38 -

Our decision is supported by the agreements entered into

between P.I. Ministries and the OMK Company Trust. Those

agreements stated that the OMK Company Trust contracted

petitioners’ services to P.I. Ministries on an independent

contractor basis. Consequently, because no employment

relationship was created, P.I. Ministries did not withhold or pay

any employment taxes on the compensation paid for petitioners’

services. Having been given the opportunity to choose the form

of the contract, petitioners have less freedom than respondent to

ignore the transactional form that they have adopted. See

Coleman v. Commissioner, 87 T.C. 178, 202 (1986), affd. without

published opinion 833 F.2d 303 (3d Cir. 1987); Bolger v.

Commissioner, 59 T.C. 760, 767 n.4 (1973). Petitioners were

independent contractors, and as such they are subject to

self-employment tax. See Simpson v. Commissioner, 64 T.C. 974,

983 (1975). We sustain respondent’s determination on this issue.

VI. Petitioners Are Liable for the Accuracy-Related Penalty
Under Section 6662(a)

Section 6662(a) and (b)(1) imposes a penalty equal to 20

percent of the portion of an underpayment of income tax

attributable to negligence or disregard of rules or regulations.

Negligence is defined as “any failure to make a reasonable

attempt to comply with the provisions of * * * [the Code]”. Sec.

6662(c). Negligence is the lack of due care or the failure to do

what a reasonable and prudent person would do under the
 - 39 -

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

The term “disregard” includes “any careless, reckless, or

intentional disregard.” Sec. 6662(c). Disregard of rules or

regulations is careless if the taxpayer does not exercise

reasonable diligence to determine the correctness of a return

position that is contrary to the rule or regulation.

Respondent has the burden of production under section

7491(c), but petitioners have the burden of proof. See Higbee v.

Commissioner, 116 T.C. 438, 446-447 (2001). Respondent must come

forward with sufficient evidence that it is appropriate to impose

the penalty. See id.

After attending the NTS seminars on investments and the use

of “complex” trusts, petitioners believed NTS’s representations

that once they had conveyed their personal assets, including

lifetime services, to the OMK trusts, they could assign their

income from P.I. Ministries to the OMK trusts and deduct personal

expenses. They also believed Little’s promises of extraordinary

returns on their investments. Unfortunately, petitioners never

sought independent legal or tax advice before or after creating

the OMK trusts pursuant to the trust scheme NTS promoted. A

competent independent tax adviser would have warned petitioners

that the scheme would not survive scrutiny by the Internal

Revenue Service or the courts. This trust scheme was without

economic substance, was an anticipatory assignment of income, and
 - 40 -

was in violation of the grantor trust provisions. See Zmuda v.

Commissioner, 731 F.2d 1417 (9th Cir. 1984); Holman v. United

States, 728 F.2d 462 (10th Cir. 1984); O’Donnell v. Commissioner,

726 F.2d 679 (11th Cir. 1984); Hanson v. Commissioner, 696 F.2d

1232 (9th Cir. 1983); Schulz v. Commissioner, 686 F.2d 490 (7th

Cir. 1982); Vnuk v. Commissioner, 621 F.2d 1318 (8th Cir. 1980);

Wesenberg v. Commissioner, 69 T.C. 1005 (1978).

A taxpayer’s adoption of a flagrant tax avoidance scheme

that has repeatedly been rejected by the courts is patently

negligent. Wesenberg v. Commissioner, supra at 1015; see also

Hanson v. Commissioner, T.C. Memo. 1981-675. Respondent has

produced ample evidence to demonstrate that the OMK trusts lacked

economic substance and served no real purpose other than tax

avoidance. Additionally, petitioners created the OMK trust after

this Court and other courts had considered several cases

involving similar abusive trusts and determined that the trusts

would not be respected for Federal income tax purposes. See,

e.g., 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.

Consequently, we conclude that respondent provided sufficient

evidence that petitioners’ understatement of tax was due to

negligence or disregard of rules and regulations and has met the
 - 41 -

burden of production. Petitioners have the burden of proving

that the accuracy-related penalty does not apply.

The accuracy-related penalty under section 6662(a) does not

apply to any portion of an underpayment, however, if a taxpayer

shows that there was reasonable cause for, and that the taxpayer

acted in good faith with respect to, that portion. Sec.

6664(c)(1); sec. 1.6664-4(b), Income Tax Regs. Generally, the

responsibility to file accurate returns and pay tax when due

rests upon the taxpayer and cannot be delegated; the taxpayer may

have to bear the consequences of any negligent errors committed

by his or her agent. Pritchett v. Commissioner, 63 T.C. 149,

173-175 (1974); Am. Props., Inc. v. Commissioner, 28 T.C. 1100,

1116-1117 (1957), affd. 262 F.2d 150 (9th Cir. 1958).

The determination of whether the taxpayers acted with

reasonable cause and in good faith depends on the pertinent facts

and circumstances, including the taxpayer’s efforts to assess his

or her proper tax liability, the knowledge and experience of the

taxpayers, and the reliance on the advice of the professional.

Sec. 1.6664-4(b)(1), Income Tax Regs. Reasonable cause has been

found when a taxpayer selects a competent tax adviser, supplies

the adviser with all relevant information, and, consistent with

ordinary business care and prudence, relies on the adviser’s

professional judgment as to the taxpayer’s tax obligations. Sec.

6664(c); United States v. Boyle, 469 U.S. 241, 250-251 (1985);
 - 42 -

Estate of Young v. Commissioner, 110 T.C. 297, 317 (1998); Am.

Props., Inc. v. Commissioner, supra; secs. 1.6662-3(a),

1.6664-4(a), Income Tax Regs. In order to so qualify, a taxpayer

must prove by a preponderance of the evidence that (i) the

adviser was a competent professional who had sufficient expertise

to justify the taxpayer’s reliance on him, (ii) the taxpayer

provided necessary and accurate information to the adviser, and

(iii) the taxpayer actually relied in good faith on the adviser’s

judgment. Neonatology Associates, P.A. v. Commissioner, 115 T.C.

43, 99 (2000), affd. 299 F.3d 221 (3d Cir. 2002); Sklar,

Greenstein & Scheer, P.C. v. Commissioner, 113 T.C. 135, 144-145

(1999).

Petitioners hired Dickson because NTS recommended him for

his knowledge of complex trusts. Petitioners introduced no

evidence regarding Dickson’s credentials or his knowledge and

experience in preparing tax returns or analyzing trust

arrangements for Federal income tax purposes. Dickson was not

called as a witness in the trial of these cases. In short,

petitioners failed to prove that Dickson was a competent tax

adviser and that petitioners were justified in relying on him.

See Ewing v. Commissioner, 91 T.C. 396, 423, (1988), affd.

without published opinion sub nom. Toll v. Commissioner, 940 F.2d

1536 (9th Cir. 1991); Bowen v. Commissioner, T.C. Memo. 2001-47;

sec. 1.6664-4(b), Income Tax Regs.
 - 43 -

Because petitioners failed to prove they reasonably relied

on a fully informed and competent tax adviser and because they

did not assert any other basis for relief from the section

6662(a) penalty, we hold that petitioners have failed to prove

that they had reasonable cause within the meaning of section

6664(c). We, therefore, sustain respondent’s determination that

petitioners are liable for the accuracy-related penalty under

section 6662(a).

Because the OMK trusts are disregarded for Federal income

tax purposes, there are no deficiencies in their Federal income

taxes. To reflect the foregoing,

Decision will be entered under

Rule 155 in docket No. 20060-02.

Decisions will be entered for

petitioners in docket Nos. 20202-02

and 20203-02.