T.C. Memo. 2005-232
UNITED STATES TAX COURT
NARIMAN TEYMOURIAN, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 18106-03. Filed October 5, 2005.
William E. Taggart, Jr., for petitioner.
Davis G. Yee, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
HAINES, Judge: Respondent determined the following
deficiencies and penalties in petitioner’s Federal income tax:
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Year Deficiency Sec. 6662(a)1 Penalty
1999 $323,517.00 $64,703.40
2000 207,511.00 41,502.20
After concessions,2 the issues for decision are: (1) Whether
petitioner received rental income of $16,200 in 1999 and $16,200
in 20003 (years in issue); (2) whether amounts disbursed to or on
behalf of petitioner by Caspian Consulting Group, Inc. (Caspian)
during the years in issue were properly characterized as loans or
should be recharacterized as constructive dividends; and (3)
whether petitioner is liable for accuracy-related penalties under
section 6662(a) for the years in issue.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
The stipulation of facts and the attached exhibits, to the extent
admitted, are incorporated herein by this reference. At the time
1
Unless otherwise indicated, all section references are to
the Internal Revenue Code, as amended, and all Rule references
are to the Tax Court Rules of Practice and Procedure.
2
Petitioner concedes that he received the following: (1)
Capital gain of $137,880 in 1999; (2) additional income of
$4,415.57 in 1999 from personal expenses charged by petitioner to
Caspian’s credit card and paid by Caspian; and (3) additional
inoome of $10,000 in 2000 from petitioner’s personal use of the
company aircraft.
3
In respondent’s notice of deficiency, respondent
determined that petitioner had received rental income of $19,800
for 1999 and $19,800 for 2000. However, respondent subsequently
conceded that this amount was the result of a computational error
and asserted that petitioner received only $16,200 in each year.
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of filing the petition, petitioner resided in Atherton,
California.
Petitioner has a doctoral degree in political science and
master’s degrees in political science and nuclear defense
policies. Petitioner does not have a finance or accounting
background. Petitioner works in software development.
In 1997, petitioner and Bradley K. Morrison (Mr. Morrison)
formed a partnership, Prism Consulting Group (Prism), to develop
software for the health care industry. On August 12, 1998,
petitioner and Mr. Morrison organized Caspian, incorporated under
the laws of the State of California. By the end of 1998,
petitioner and Mr. Morrison transferred their partnership
interests in Prism to Caspian in exchange for all of Caspian’s
stock. During 1998 and 1999, Prism’s business operations were
taken over by Caspian.
During the years in issue, petitioner owned 60 percent of
Caspian’s stock and served as the chief executive officer and
president on the board of directors. Mr. Morrison owned the
remaining 40 percent and served as chief technologist and
secretary and treasurer on the board of directors. Petitioner
and Mr. Morrison were the sole members of the board of directors.
During the years in issue, Caspian hired Cameron & Rolling
to handle its accounting and tax matters. Craig Rolling (Mr.
Rolling) was part owner of Cameron & Rolling. He received his
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B.A. in business administration, a master’s degree in taxation,
and has been a certified public accountant (C.P.A.) for 20 years.
Mr. Rolling personally prepared petitioner’s and Caspian’s tax
returns for the years in issue, and he also provided general
advice to petitioner and Caspian on tax, accounting, and other
financial matters.
During 1999, petitioner applied for a residential loan. In
connection with that loan, petitioner and his wife, Gail S.
Ferrando-Teymourian (Ms. Ferrando-Teymourian), signed a Uniform
Residential Loan Application (loan application). The loan
application was not personally filled out by petitioner, but
instead was prepared by Reza Zargari of Gateway Residential
Funding. On the loan application, under “VI. Assets and
Liabilities, Schedule of Real Estate Owned,” petitioner reported
that he had net rental loss of $948 from property located at 94
Grand Street4 in Redwood City, California (Redwood City house),
and net rental income of $1,350 from property located at 1271
Granville in Los Angeles, California (Los Angeles condominium).
At the time the loan application was filled out, petitioner’s
primary residence was the Redwood City house, and petitioner’s
parents lived in the Los Angeles condominium.
4
On the loan application, due to a typographical error, 94
Grand Street appears “94 Grant Street.”
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During 1999, Caspian made the following disbursements to
petitioner:
9/16/1999 $578,034.59
10/7/1999 65,000.00
____________________________________
Total Disbursements
For 1999: $643,034.59
These disbursements were identified on Caspian’s books as
“Employee Advances”. At the end of 1999, the advances were
converted to “notes” on Caspian’s books. Petitioner used these
funds in connection with the purchase of a new home.
Petitioner and Ms. Ferrando-Teymourian jointly filed a
Federal individual income tax return for 1999, reporting $233,097
of adjusted gross income and $136,519 of taxable income.5 They
did not report the disbursements received from Caspian as income,
nor did they report rental income.
During 2000, Caspian made the following disbursements to or
on behalf of petitioner:
1/05/2000 Bill $108.40
1/12/2000 Check 120,000.00
1/17/2000 Credit Card Charges 7,258.21
2/29/2000 Transfer 80,000.00
3/17/2000 Credit Card Charges 2,200.00
3/28/2000 Transfer 40,000.00
4/16/2000 Credit Card Charges 98.52
4/17/2000 Bills 52,000.00
5
Ms. Ferrando-Teymourian has a separate suit pending in
this Court, docket No. 18139-03, and is not a party to the
present case.
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4/21/2000 Check 62,364.38
5/01/2000 Check #5330 8,000.00
5/08/2000 Bill 5,421.00
5/10/2000 Transfer 20,000.00
5/17/2000 Transfer 100,000.00
5/18/2000 Check 3,000.00
5/18/2000 Bill 1,000.00
5/23/2000 Check 500.00
6/12/2000 Transfer 120,000.00
6/26/2000 Bill 140.35
7/17/2000 Credit card charges 75.78
7/18/2000 Check 2,862.74
8/14/2000 Transfer 100,000.00
8/16/2000 Credit card charges 1,019.45
8/28/2000 Bill 27,767.50
9/15/2000 Check 25,000.00
9/16/2000 Credit card charges 892.20
9/25/2000 Transfer 50,000.00
9/28/2000 Bill 88.70
10/23/2000 Transfer 34,239.55
11/02/2000 Transfer 20,000.00
11/15/2000 Bill 5,350.00
12/04/2000 Check 30,000.00
12/17/2000 Credit cards charges 368.13
12/27/2000 Bill 7,545.08
__________________________________________________
Total Disbursements for 2000: $927,299.99
These disbursements were identified on Caspian’s books as
“1800100 Officer’s Rec - NT”. At the end of 2000, the advances
were converted to “notes” on Caspian’s books.
On December 29, 2000, petitioner used voluntary payroll
deductions to reimburse Caspian $448,344.76. Of this amount,
$48,344.76 represented payment of interest and $400,000
represented repayment of the disbursements. Caspian reported
interest income on its 2000 tax return, reflecting petitioner’s
payment of interest.
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Petitioner and Ms. Ferrando-Teymourian jointly filed a
Federal individual income tax return for 2000, reporting $797,682
of adjusted gross income and $637,805 of taxable income. They
did not report the disbursements made by Caspian as income, nor
did they report rental income.
During the years in issue, Caspian made no formal
declaration or payment of a dividend. Petitioner and Caspian did
not execute formal loan instruments with respect to the amounts
disbursed to or paid on behalf of petitioner.
In the fall of 2001, respondent’s examining agent, Roseann
Kacheris (Ms. Kacheris), began investigating Caspian’s corporate
tax returns for 1999 and 2000. During the course of her
investigation, she also examined petitioner’s individual income
tax returns for the years in issue.
On July 24, 2003, respondent issued petitioner a notice of
deficiency for 1999 and 2000. In the notice, respondent made the
following increases to petitioner’s taxable income:
1999
Type of Adjustment Amount of Increase
Capital gain $137,880
Itemized deductions 24,149
Exemptions 5,155
Rental income 19,800
Dividends 647,290
____________________________________________
Total Adjustments for 1999: $834,274
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2000
Type of Adjustment Amount of Increase
Itemized Deductions $15,263
Rental Income 19,800
Dividends 488,955
____________________________________________
Total Adjustments for 2000: $524,018
Respondent increased petitioner’s tax liability by $323,517 and
$207,511, and imposed section 6662(a) penalties of $64,703.40 and
$41,502.20 for 1999 and 2000, respectively.
On October 22, 2003, petitioner filed his petition with the
Court, alleging that he did not receive rental income, that
respondent improperly recharacterized the loans as constructive
dividends, and that he was not liable for the section 6662(a)
accuracy-related penalties as set forth in respondent’s notice of
deficiency.
OPINION
A. Petitioner Did Not Have Unreported Rental Income
Respondent determined that petitioner received but failed to
report rental income in the amounts of $16,200 in 1999 and
$16,200 in 2000. Petitioner bears the burden of proof to show
that respondent erred in making this determination. Rule 142(a).
On the 1999 residential loan application, petitioner
reported “net rental income” of $1,350 from his Los Angeles
condominium. Ms. Kacheris, respondent’s examining agent,
testified that her sole reason for determining that petitioner
received rental income of $16,200 in 1999 and $16,200 in 2000 was
from statements made by petitioner on the loan application.
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However, petitioner credibly testified that, when Mr. Zargari was
preparing the loan application, petitioner believed the loan
application was asking for the “net rental value”, or the amount
petitioner would have received had he rented out the property.
In addition, petitioner credibly testified that his parents were
living in the Los Angeles condominium, he did not charge his
parents rent, and he did not receive any rent.
Respondent argues that we do not have to accept petitioner’s
self-serving testimony, citing Mendes v. Commissioner, 121 T.C.
308 (2003). In Mendes, the taxpayer was contesting a 10-percent
additional tax on an early distribution from a qualified
retirement plan imposed under section 72(t). Id. at 319-320.
The taxpayer argued that a bank had previously withheld the 10-
percent additional tax but offered no documentation to verify his
testimony. Id. The Court held that it did not have to rely on
the taxpayer’s self-serving testimony when he failed to present
other evidence that the 10-percent additional tax was previously
withheld.
Unlike the taxpayer in Mendes, petitioner is asserting that
he never received income. We recognize the inherent difficulty
in proving a negative, and because we find petitioner’s testimony
to be credible and his explanation of the loan application
persuasive, we accept petitioner’s testimony.
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Given petitioner’s credible and persuasive explanation of
the loan application, we find that peitioner has met his burden
of proof. Based on the above, we hold that petitioner did not
receive rental income during the years in issue and is thus not
liable for any income tax deficiencies relating to rental income.
B. Respondent Improperly Recharacterized Petitioner’s Loans as
Constructive Dividends
Respondent determined that disbursements made by Caspian to
and on behalf of petitioner during the years in issue were
constructive dividends and not loans. The resolution of this
issue does not depend on which party bears the burden of proof.
On the basis of the evidence in the record, we hold that the
amounts disbursed to petitioner were loans.
Whether a corporation’s disbursements to an employee-
shareholder are loans or constructive dividends depends on
whether, at the time of the disbursements, the employee-
shareholder intended to repay the amounts received and the
corporation intended to require payment. J.A. Tobin Constr. Co.
v. Commissioner, 85 T.C. 1005, 1022 (1985); Elec. & Neon, Inc. v.
Commissioner, 56 T.C. 1324, 1338-1339 (1971), affd. without
published opinion 496 F.2d 876 (5th Cir. 1975); Miele v.
Commissioner, 56 T.C. 556, 567 (1971), affd. without published
opinion 474 F.2d 1338 (3d Cir. 1975). If repayment was intended
at the time of disbursement, the amounts are generally considered
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loans. Miele v. Commissioner, supra at 567. On the other hand,
if no repayment was intended, the amounts are to be considered
constructive dividends. Id.
This determination depends on all the facts and
circumstances surrounding the transactions. Estate of Chism v.
Commissioner, 322 F.2d 956, 960 (9th Cir. 1963), affg. T.C. Memo.
1962-6; J.A. Tobin Constr. Co. v. Commissioner, supra at 1022;
Miele v. Commissioner, supra at 567; Roschuni v. Commissioner, 29
T.C. 1193, 1201-1202 (1958), affd. 271 F.2d 267 (5th Cir. 1959).
When an employee-shareholder is in substantial control of the
corporation, such control invites special scrutiny. Roschuni v.
Commissioner, supra at 1202. Mere declarations by an employee-
shareholder that he intended a transaction to constitute a loan
are insufficient if the transaction fails to meet more reliable
indicia of debt. J.A. Tobin Constr. Co. v. Commissioner, supra
at 1022.
In making the necessary factual determination, courts have
looked to a number of objective factors, including:
(1) [W]hether the promise to repay is evidenced by a
note or other instrument; (2) whether interest was
charged; (3) whether a fixed schedule for repayments
was established; (4) whether collateral was given to
secure payment; (5) whether repayments were made; (6)
whether the borrower had a reasonable prospect of
repaying the loan and whether the lender had sufficient
funds to advance the loan; and (7) whether the parties
conducted themselves as if the transaction were a loan.
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Welch v. Commissioner, 204 F.3d 1228, 1230 (9th Cir. 2000), affg.
T.C. Memo. 1998-121; see also J.A. Tobin Construction Co. v.
Commissioner, supra at 1022. No single factor is controlling,
and the transaction must be examined as a whole. Welch v.
Commissioner, supra at 1230. We address each of these factors in
turn.
1. Petitioner’s Promise To Pay Was Not Evidenced by a Note
The absence of a note or other loan documentation is
indicative of a constructive dividend. Miele v. Commissioner,
supra at 568-569; see also Roschuni v. Commissioner, supra at
1201-1202; Jones v. Commissioner, T.C. Memo. 1997-400, affd.
without published opinion 177 F.3d 982 (11th Cir. 1999); Weigel
v. Commissioner, T.C. Memo. 1996-485. However, loans without
documentation are not uncommon between a shareholder and a
closely held corporation, and such documentation is not a
prerequisite to finding that a loan exists. Miele v.
Commissioner, supra at 568-569; Weigel v. Commissioner, supra.
Petitioner stipulated that he did not execute formal loan
documents with respect to the disbursements made by Caspian
during the years in issue. While this factor alone is not
determinative, it weighs in favor of finding a constructive
dividend.
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2. Petitioner Paid $48,344.76 in Interest
The payment of interest indicates the existence of a loan.
Crowley v. Commissioner, 962 F.2d 1077 (1st Cir. 1992), affg.
T.C. Memo. 1990-636; see also Roschuni v. Commissioner, supra at
1201-1202; Jones v. Commissioner, supra.
At trial, Mr. Rolling testified that an interest rate of 6.2
percent was charged. On the other hand, petitioner testified
that he was uncertain as to the percentage, but he believed the
An interest rate was prime plus one. Respondent argues that the
contradictory testimony of Mr. Rolling and petitioner casts doubt
on whether interest was charged. However, petitioner, Mr.
Rolling, and Mr. Morrison all credibly testified that they knew
interest was being charged. In addition, petitioner paid
$48,344.76 in interest on December 29, 2000. While there may
have been some confusion as to the rate of interest, the stated
intent of the parties and the actual payment of interest weighs
in favor of finding a loan.
3. There Was No Fixed Schedule for Repayment
The lack of a fixed schedule for repayment is indicative of
a constructive dividend. See Crowley v. Commissioner, supra;
Roschuni v. Commissioner, supra at 1201; Jones v. Commissioner,
supra. Petitioner testified at trial that there was no fixed
schedule for repayment. This factor weighs in favor of finding a
constructive dividend.
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4. No Collateral Secured Repayment of the Loan
The lack of collateral pledged to secure repayment is
indicative of a constructive dividend. See Crowley v.
Commissioner, supra at 1083; Roschuni v. Commissioner, supra at
1201-1202; Jones v. Commissioner, supra. Petitioner testified
that he was not asked to provide collateral, but he understood
his shares of Caspian would secure repayment. Under California
State law, a creditor can acquire an enforceable security
interest in collateral by having the debtor sign a security
agreement and deliver the certificated security to the secured
party. Cal. Com. Code secs. 8301, 9203(b) (West 2005). The
record is devoid of any evidence that petitioner signed a
security agreement or delivered his Caspian stock to Caspian.
Therefore, we find that there was no collateral, including the
Caspian stock, pledged to secure repayment. This factor weighs
in favor of finding a constructive dividend.
5. Petitioner Made Repayments of $400,000
Repayments of the amounts disbursed indicate the existence
of a loan. Crowley v. Commissioner, supra at 1083; see also
Miele v. Commissioner, supra at 568; Roschuni v. Commissioner,
supra at 1201; Weigel v. Commissioner, supra. However, to be
persuasive, the amounts of repayments in comparison to the
amounts owed must be substantial and not merely nominal. Miele
v. Commissioner, supra at 568.
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During the years in issue, Caspian made disbursements to or
on behalf of petitioner in amounts totaling $1,570,334.58.
Caspian reflected the disbursements on its books as either
advances, officer’s receivables, or notes. On December 29, 2000,
petitioner repaid a total of $448,344.76, of which $400,000 was
applied to reduce the balance of the notes receivable accounts.
Petitioner’s repayment of slightly more than 25 percent of the
total disbursements was substantial and not merely nominal. This
factor weighs in favor of finding a loan.
6. Petitioner Had a Reasonable Prospect of Repayment
A reasonable prospect of repayment indicates the existence
of a loan. See Welch v. Commissioner, 204 F.3d 1228, 1231 (9th
Cir. 2000). A taxpayer’s insolvency or financial difficulty
casts doubt on the ability to repay and thus on the
characterization of a disbursement as a loan. See id.
Petitioner and his wife reported adjusted gross income of
$233,097 and $797,682 for 1999 and 2000 respectively. On
December 29, 2000, petitioner repaid $400,000, leaving
$1,170,334.58 outstanding. Given petitioner’s income and history
of repayment, petitioner had a reasonable prospect of repaying
the remainder of the disbursements. This factor weighs in favor
of finding a loan.
7. The Parties Involved Treated the Disbursements as Loans
The conduct of the parties may indicate the existence of a
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loan. Morrison v. Commissioner, T.C. Memo. 2005-53; see Welch v.
Commissioner, supra at 1230; Baird v. Commissioner, 25 T.C. 387,
395 (1955).
Petitioner credibly testified that, at the time the
disbursements were made, he intended the disbursements to be
loans, he believed that interest would be charged, and he
understood that he would have to repay the amounts disbursed.
During 2000, petitioner paid $48,344.76 in interest and repaid
$400,000 of the disbursements.
Mr. Morrison, the minority shareholder of Caspian, credibly
testified that he understood the amounts disbursed to petitioner
were loans, and he expected petitioner to repay the loans
together with interest.
In addition, Caspian reported petitioner’s $48,344.76
payment as interest income on its 2000 income tax return.
Caspian treated the disbursements to petitioner as notes
receivable, indicating Caspian’s expectation that the amounts
would be repaid.
The behavior of the parties weighs heavily in favor of
finding a loan.
Summary
While three of the seven factors weigh in favor of finding a
constructive dividend, we find those factors to be less
persuasive in the present case. In transactions between
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shareholders and closely held corporations, formalities are often
not followed. A lack of formality does not preclude treatment of
disbursements as loans. See Miele v. Commissioner, supra at 568-
569. The absence of a note does not outweigh the behavior of
petitioner or Caspian in treating the disbursements as loans. In
addition, the fact that petitioner paid back a substantial
portion of the disbursements indicates that the lack of
collateral and the lack of a set repayment schedule did not
diminish his intent to repay.
Petitioner and Mr. Morrison understood the amounts disbursed
to be loans. Petitioner acted in a manner consistent with the
existence of a loan, as demonstrated by his payment of interest
and substantial repayment of a portion of the amounts disbursed.
Due to his salary and his history of repayment, petitioner had a
reasonable prospect of repaying the disbursements in full. Based
on the evidence in the record, we hold that the amounts disbursed
to petitioner during the years in issue were loans.6
C. Petitioner is Not Liable for Section 6662 Accuracy-Related
Penalties
Respondent assessed section 6662(a) penalties of $64,703.40
and $41,502.20 against petitioner for 1999 and 2000,
6
This finding does not include the following amounts
conceded by petitioner: (1) Capital gain of $137,880 received in
1999, and (2) additional income of $4,415.57 and $10,000 received
in 1999 and 2000, respectively.
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respectively. Petitioner contests these penalties, arguing that
there was no underpayment of tax, or in the alternative,
petitioner had reasonable cause for his underpayment of taxes.
Section 6662(a) imposes an accuracy-related penalty of 20
percent of the underpayment of tax attributable to negligence or
disregard of the rules or regulations,7 or attributable to a
substantial understatement of income tax.8 Sec. 6662(a), (b)(1)
and (2). However, no penalty will be imposed if the taxpayer had
reasonable cause for the underpayment of tax and the taxpayer
acted in good faith. Sec. 6664(c); secs. 1.6662-3(a), 1.6664-
4(a), Income Tax Regs.
The Commissioner bears the burden of production with respect
to penalties. Sec. 7491(c); Higbee v. Commissioner, 116 T.C.
438, 446-447 (2001). However, the taxpayer must show that he had
reasonable cause and acted in good faith. Rule 142(a).
Petitioner conceded that he received, but did not report,
long-term capital gain of $137,880, additional income of
$4,415.57 in 1999, and additional income of $10,000 in 2000. We
7
Negligence is defined as the “failure to make a
reasonable attempt to comply with the provisions of this title,
and the term ‘disregard’ includes any careless, reckless, or
intentional disregard.” Sec. 6662(c); sec. 1.6662-3(b)(1),
Income Tax Regs.
8
There is a substantial understatement of income tax for
any year if the amount of understatement exceeds the greater of
10 percent of the tax required to be shown on the return, or
$5000. Sec. 6662(d).
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do not need to reach the issues of whether the resulting
underpayments were substantial or were due to negligence because
we find petitioner had reasonable cause and acted in good faith.
A taxpayer’s reliance on the advice of a professional as to
the tax treatment of certain items does not automatically
constitute reasonable cause. Neonatology Associates v.
Commissioner, 115 T.C. 43, 98-99 (2000), affd. 299 F.2d 221 (3d
Cir. 2002); see sec. 1.6664-4(c)(1), Income Tax Regs. For a
taxpayer to reasonably rely on the advice of a professional, the
taxpayer must show: (1) The adviser was a competent professional
who had sufficient expertise to justify reliance; (2) the
taxpayer provided necessary and accurate information to the
adviser; and (3) the taxpayer actually relied in good faith on
the adviser’s judgment. Neonatology Associates v. Commissioner,
supra at 98-99.
Mr. Rolling has a B.A. in business administration and a
master’s degree in taxation. He is a licensed C.P.A. and has
been practicing for more than 20 years. During the years in
issue, Mr. Rolling prepared tax returns for petitioner and
Caspian, and served as a general consultant to both on tax-
related issues. Throughout the course of Mr. Rolling’s
testimony, we found him to be a competent professional who had
sufficient expertise to justify petitioner’s reliance. Based
upon the testimony of petitioner and Mr. Rolling regarding the
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amounts of income not reported but eventually conceded by
petitioner, the characterization of those amounts was open to
reasonable doubt at the time petitioner filed his returns. Based
upon Mr. Rolling’s testimony and on other evidence submitted, we
find that Mr. Rolling was provided with necessary and accurate
information by both petitioner and Caspian. Finally, based upon
petitioner’s credible testimony, we find that petitioner relied
on Mr. Rolling for the preparation of his tax returns during the
years in issue, and that petitioner’s reliance was in good faith.
For the foregoing reasons, we conclude that petitioner
reasonably and in good faith relied on the advice of a competent
professional, and we hold that petitioner is not liable for the
section 6662(a) penalties.
Conclusion
We hold that petitioner did not receive rental income during
the years in issue and is thus not liable for any income tax
deficiencies relating to rental income. We further hold that
disbursements made by Caspian to and on behalf of petitioner were
loans and not constructive dividends. Finally, we hold that
petitioner is not liable for accuracy-related penalties.
In reaching our holdings, we have considered all arguments
made, and, to the extent not mentioned, we conclude that they are
moot, irrelevant, or without merit.
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To reflect the foregoing,
Decision will be entered
under Rule 155.