T.C. Memo. 2006-69
UNITED STATES TAX COURT
HOMER L. RICHARDSON, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
GLORIA M. RICHARDSON, Petitioner v.
COMMISSIONER OR INTERNAL REVENUE, Respondent
Docket Nos. 16794-03, 16795-03. Filed April 11, 2006.
Ps established a tiered trust arrangement and
transferred to the entities their assets, including
their personal residence and lifetime services.
Held: The trusts implemented and used by Ps
during 1996 and 1997 should be disregarded for tax
purposes as sham entities lacking in economic
substance, with resultant inclusion by Ps of income
reported by the trusts, recomputation of business
deductions allowable to Ps, and liability for self-
employment taxes.
Held, further, Ps are not entitled to capital loss
amounts claimed for both years and must recognize a
capital gain in 1997.
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Held, further, P H is liable for civil fraud
penalties pursuant to sec. 6663, I.R.C., for 1996 and
1997.
Held, further, P H is liable for an accuracy-
related penalty pursuant to sec. 6662(a), I.R.C., with
respect to that portion of the deficiency for 1996 that
is not attributable to fraud.
Held, further, the statute of limitations does not
bar assessment of liabilities for 1996 and 1997.
Held, further, P W is not entitled to relief
pursuant to sec. 6015, I.R.C., for the years 1996 and
1997.
Robert Alan Jones, for petitioners.
Richard J. Hassebrock and John A. Freeman, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
WHERRY, Judge: Respondent determined the following
deficiencies and penalties with respect to petitioners’ Federal
income taxes for the 1996 and 1997 taxable years:1
Homer L. Richardson - Docket No. 16794-03
Penalties
Year Deficiency Sec. 6662 Sec. 6663
1996 $164,442 $67.80 $123,077.25
1997 123,848 92,886.00
1
Unless otherwise indicated, section references are to the
Internal Revenue Code in effect for the years in issue, and Rule
references are to the Tax Court Rules of Practice and Procedure.
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Gloria M. Richardson - Docket No. 16795-03
Year Deficiency
1996 $164,442
1997 123,848
The principal issues for decision in these consolidated cases
are:
(1) Whether trusts implemented and used by petitioners
during 1996 and 1997 should be disregarded for tax purposes as
sham entities lacking in economic substance, with resultant (a)
inclusion by petitioners of income reported by the trusts; (b)
recomputation of business deductions allowable to petitioners;
and (c) liability for self-employment taxes and entitlement to
corresponding deductions.
(2) Whether petitioners’ reported capital loss for both tax
years should be adjusted.
(3) Whether there exist underpayments due to fraud for 1996
and 1997 such that petitioner Homer L. Richardson
(Mr. Richardson) is liable for civil fraud penalties pursuant to
section 6663.
(4) Whether Mr. Richardson is liable for an accuracy-related
penalty pursuant to section 6662(a) with respect to that portion
of the deficiency for 1996 that is not attributable to fraud.
(5) Whether the statute of limitations bars assessment of
liabilities for 1996 and 1997.
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(6) Whether petitioner Gloria M. Richardson
(Mrs. Richardson) is entitled to relief pursuant to section 6015
for the years 1996 and 1997.
Certain additional adjustments to petitioners’ Social Security
income and personal exemptions are computational in nature and
will be resolved by our holdings on the foregoing issues.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
The stipulations of the parties, with accompanying exhibits, are
incorporated herein by this reference. At all relevant times
throughout the years in issue, at the time the petitions in these
cases were filed, and at the time of trial, petitioners resided
at 758 Quailwoods Drive, Loveland, Ohio 45140.
Personal Background
Petitioners are husband and wife and have four adult
children: Laura Morris, Karen Cahill, Susan Richardson, and
Barton Richardson. Mrs. Richardson is trained as an x-ray
technician. In the past she worked as a medical assistant but
apparently ceased her employment in or about 1997 in conjunction
with undergoing chemotherapy treatments for cancer.
Mr. Richardson graduated from the University of Missouri in
1958, earning a 4-year business degree in marketing. In
connection with obtaining that degree, Mr. Richardson completed
two courses in accounting. Since graduating, Mr. Richardson has
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been engaged in a number of business ventures. He was employed
for 12 years in a supervisory capacity over several Super-X drug
stores located across Ohio, Indiana, and Kentucky. In
approximately 1979, he founded a tool and die business, which he
ran for about 3 years. Mr. Richardson obtained licenses to sell
insurance and mutual funds in around 1983 and maintained those
licenses until allowing them to expire sometime in the 1996 to
1998 timeframe. Each license required Mr. Richardson to attend
approximately 40 hours of classes and to pass an examination.
From 1993 to 1996, Mr. Richardson was self-employed as an
insurance salesman, operating through a sole proprietorship under
the name Benefit Planning Services.
Trust Implementation and Operation
In 1995, petitioners met with representatives from the Aegis
Company (Aegis), an entity that promoted both domestic and
foreign trust packages.2 Michael Vallone was the executive
director of Aegis, Robert Hopper was the managing director, and
Edward Bartoli (Mr. Bartoli)3 was the legal director.
Petitioners purchased a multitrust package from Aegis in 1996 for
2
Use of “trust”, “trustee”, “beneficiary”, and related
appellations is for convenience only and is not intended to
impart any legal significance with respect to characterization
for Federal tax purposes.
3
The parties do not dispute that Mr. Bartoli, although
formerly admitted to practice law in Illinois, was disbarred
subsequent to the years in issue in these cases.
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$5,000. In June of 1996, Mr. Richardson applied for and received
from the Internal Revenue Service (IRS) two employer
identification numbers, one under the name of HG Asset Management
Trust and the other under the name of HG Richardson Charitable
Trust (HGRCT). Each application stated that the respective
business was started or acquired on April 1, 1996. Also in 1996,
Mr. Richardson ceased operations under the name Benefit Planning
Services and thereafter conducted any sole proprietorship
activities under the name Asset Protection Services.
On August 7, 1996, Mrs. Richardson transferred all of her
assets, real and personal, as well as her right to receive future
income and “exclusive use of my lifetime services (exception
being that of an employee situation)”, to Mr. Richardson, in
exchange for $10. On August 8, 1996, petitioners purportedly
transferred their personal residence on 758 Quailwoods Drive to
HG Asset Management Company (HGAMC).4 Petitioners continued to
reside at that location following the transfer.
By a trust instrument dated August 17, 1996, James Quay
(Mr. Quay) as creator, Mr. Richardson as investor, and Mr. Quay
and Mrs. Richardson as acceptors and initial directors
established HGAMC as a “Common Law Business Organization”.
Mr. Quay was an attorney whom Mr. Richardson had met at an Aegis
4
The parties stipulated this fact, but because no documents
dated Aug. 8, 1996, related to the transfer are contained in the
record, any specifics and/or incongruities remain unexplained.
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training presentation earlier in the year and who apparently
prepared the trust documents. The directors were given broad
authority to deal with trust property in their discretion for the
benefit of HGAMC. The trust instrument further provided: “A
Minute of Resolutions of the Board of Directors authorizing what
they determine to do or have done shall be evidence that such an
act is within their power.”
Also on August 17, 1996, a management contract was entered
between HGAMC and Mr. Richardson’s sole proprietorship Asset
Protection Services. The agreement called for HGAMC to provide
management services to the sole proprietorship, through the
services of Mr. Richardson, in return for a “One time set up fee”
of $40,000, a “Monthly management fee” of $12,000, and a charge
for “Strategic and Tactical Planning for 1997” of $10,000. The
agreement was executed by Mr. Richardson on behalf of Asset
Protection Services and by both Mr. and Mrs. Richardson as
directors of HGAMC.5 The majority of the stated fees were never
paid. The contract was renewed on its anniversary in both 1997
and 1998 for compensation to be paid to HGAMC of $5,000 annually.
Initial actions undertaken by HGAMC were memorialized in the
minutes of the entity’s first board meeting on August 17, 1996.
The trust instrument and the minutes reflect and reference the
intended conveyance by Mr. Richardson to HGAMC of real and
5
The Court notes that as of Aug. 17, 1996, Mr. Richardson
had not been appointed as a director of HGAMC.
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personal property as well as the exclusive use of all his
lifetime services. The minutes also show that the directors were
authorized to seek an employer identification number for HGAMC by
substituting the word “Trust” for “Company” in the entity’s name.
On August 19, 1996, petitioners opened two checking accounts at
Fifth Third Bank, one in the name of Asset Protection Services
and one in the name of HGRCT. At some time prior to August of
1996, a checking account at Fifth Third Bank had been opened in
the name of HGAMC. Petitioners held sole signatory authority
over all three of these accounts.
A second meeting of the HGAMC board was held on August 20,
1996. On that date, Mr. Richardson transferred to HGAMC all of
his assets, real and personal, as well as his right to receive
future income and the exclusive use of his lifetime services
(“exception being that of an employee status”). The conveyance
expressly included all that he had received from Mrs. Richardson
under her August 7, 1996, assignment. HGAMC then issued to
Mr. Richardson a certificate representing all of the beneficial
interest; i.e., 100 units, in HGAMC. On the same August 20,
1996, date, Mr. Richardson returned the certificate to HGAMC,
asking the directors to cancel it and to reissue the units as
follows: 40 units to Mr. Richardson; 50 units to Mrs.
Richardson; and 10 units to HGRCT. New certificates were issued
to that effect. According to the terms of the certificates,
benefits conveyed by the units “[consisted] solely of the
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distributions of income from the earnings of the assets as
distributed by the action of The Directors and nothing more.”
Also at the August 20 meeting, Mr. Richardson was appointed
a director of HGAMC and was given the title of Executive
Director. Mrs. Richardson was appointed as Executive Secretary
of HGAMC. HGAMC contracted for the services of petitioners in
those executive roles, in exchange for living accommodations,
expenses incident to company business (e.g., transportation,
office, entertainment, and meeting expenses), life and medical
insurance, and consultant fees.
By a trust instrument likewise dated August 20, 1996, HGAMC
created HGRCT. Petitioners executed the document both as
directors of HGAMC and as trustees of HGRCT. Petitioners did not
obtain section 501(c)(3) status for HGRCT.
On August 23, 1996, Mr. Quay submitted, and petitioners in
their capacities as directors of HGAMC accepted, his resignation
as a director of HGAMC. On August 29, 1996, petitioners
conducted board meetings for both HGAMC and HGRCT. At the HGAMC
meeting, petitioners’ four children were named as successor
directors, in the order listed, and as successors in equal shares
to petitioners’ beneficial interests. At the HGRCT meeting,
HGRCT received 10 units of beneficial interest in HGAMC and in
exchange issued to HGAMC all units of beneficial interest; i.e.,
100, in HGRCT. At a second meeting of the HGRCT on September 1,
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1996, Mr. Richardson was appointed as Executive Trustee, and
Mrs. Richardson was appointed as Executive Secretary.
Petitioners thereafter opened several additional bank
accounts with respect to the various entities discussed above,
all at Lebanon Citizens National Bank. For example, between
September of 1996 and November of 1997, accounts were established
under the following names: (1) HG Asset Management Co., c/o of
Homer Richardson; (2) Homer Richardson d.b.a. Aegis Co., later
renamed HG Asset Management Co. d.b.a. Aegis Co.; (3) Homer
Richardson d.b.a. Asset Protection Co.; and (4) HG Richardson
Charitable Trust. Petitioners had signatory authority over each
of these accounts, and in a few instances one of their children
was given signatory authority as well. Records also show that
certain of the accounts previously established at Fifth Third
Bank were closed in October of 1996.
Minutes from numerous HGAMC board meetings from August of
1996 through May of 2000 reflect activities of the entity
authorized by petitioners in their capacities as directors.
Mrs. Richardson participated in each of these meetings along with
her husband and signed the minutes and resolutions so generated.
Several of the matters garnering the board’s attention involved
petitioners’ transportation and residence. On October 14, 1996,
the directors approved the purchase by HGAMC of a 1996 Mercury
Grand Marquis for $19,950 “to be provided to the Executive
Director”. Mr. Richardson testified that the car was acquired
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with funds from an account held in the name of HGAMC but was
titled in his name.
From their respective inceptions, Mr. Richardson’s sole
proprietorships, HGAMC, and HGRCT were operated out of
petitioners’ residence on Quailwoods Drive. Resolutions
specified that particular business operations of HGAMC would be
conducted at its “headquarters” on Quailwoods Drive and required
the presence of the Executive Director at the site to oversee
maintenance and security. In addition, through a series of
resolutions, HGAMC was authorized to, and did, contract for the
remodeling of the company headquarters.
With respect to business conducted elsewhere, minutes show
that the directors “were authorized to travel to Nashville,
Indiana for purposes of looking at different land investment
opportunities.” Later, a director’s meeting attended by
petitioners’ four children was held at Mike Fink’s Restaurant in
Covington, Kentucky, “for the purpose of discussing duties of
successor directors with those appointed as successor directors”.
At that meeting, “It was dedided [sic] that more time should be
devoted to training & that a two (2) day meeting should be
scheduled for Brown County State Park in the future”. The tab
for the meal was $247.38.
Matters related to tax issues, from administrative functions
related to preparation of the entities’ returns to intentions or
positions on tax topics, were likewise addressed at board
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meetings. As an example of the latter, minutes of the HGAMC
board meeting held on June 27, 1997, read as follows:
The Executive Director, Homer L. Richardson as
instructed by the Board of Directors made available to
the Board of Directors research from the Aegis Company,
Court Cases and legal opinions regarding IRS Notice 97-
24.
Mr. Richardson provided a report from the Aegis Company
that addressed each paragraph of IRS Notice 97-24 in
which it was pointed out that Notice 97-24 was
concerned with I.R.C. Sec 671-679 as it pertains to
grantor trusts and that when a person attempts to apply
business trust procedures of tax reduction to an
“ordinary trust” the trust is labeled by the IRS as an
“abusive trust”. The report concluded that 97-24 is
not addressing legitimate business trusts.
Mr. Richardson also provided a copy of American
Jurisprudence Second Edition volume 13 Business Trusts,
Excerpts from Executive’s Business Law Section
regarding Business Trusts, a report from George M.
Turner, M.S. J.D. regarding the legal foundation of the
Business Trust and taxation of a Business Trust and a
report from the Yale law [sic] Journal titled the trust
as an instrument of Commerce.
The materials supplied, the legal opinions and the
research conducted regarding business trusts do not
support the position that the Aegis business trust is
the kind of trust that is addressed in IRS Notice 97-
24.
In addition to personally implementing an Aegis multitrust
package, Mr. Richardson also became involved in the promotion and
sale of the Aegis system. Beginning in 1996, Mr. Richardson sold
Aegis trust packages through Asset Protection Services, and it
was this business that was managed by HGAMC under the contractual
arrangement detailed above. Generally, HGAMC would retain a
percentage of the sales price of a trust package as a commission
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from Aegis. Mr. Richardson took a 3-day training course from
Mr. Bartoli of Aegis in connection with these activities. The
record contains several examples from the 1998 to 1999 time
period of announcements for trust workshops that reflect the
nature of Mr. Richardson’s promotional efforts in this regard.
For instance, in a 1999 letter addressed to agents working
for State Farm Insurance encouraging them to attend workshops
scheduled for New Orleans, Louisiana; and Mobile, Alabama;
Mr. Richardson introduced himself and his business as set forth
below:
My name is Homer Richardson, and for the past five
years, as a representative of the Aegis Company, I have
been conducting workshops throughout the country
teaching State Farm Agents, doctors, dentists, and
other self employed individuals, how to protect their
assets from lawsuit judgments and dramatically reduce
their income taxes.
This workshop is not open to the general public and is
by invitation only. We teach self employed individuals
how to operate a business using a special kind of
trust. This special trust is a business device that
has several names. It has been referred to as a Blind
Trust, an Unincorporated Business Organization, a
Contractual Business Organization, and a Common Law
Business Organization, just to name a few. We refer to
this special trust as a CBO. However, the IRS refers
to all of these entities as Business Trusts.
This and similar announcements for the introductory workshop
directed toward self-employed professionals consistently tout as
benefits of the business trust system the ability to: Legally
reduce Federal and State income taxes “70% or More”; eliminate
Federal estate taxes no matter the size of the estate; sell a
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business or other assets and pay no capital gain taxes; and
protect personal assets from lawsuit judgments.
Mr. Richardson participated as a featured speaker at various
of these events. For example, with respect to workshops to be
conducted in 1999 in Lexington, Kentucky; Indianapolis, Indiana;
Toledo, Ohio; and Cincinnati, Ohio; the invitation highlighted as
speakers:
Wilson Graham: Former State Farm Insurance employee,
conducted audits and tax reports for Corporate Office.
Mr. Graham also was a controller and vice-president for
a large insurance company in Ohio. for [sic] the past
19 years Graham & Associates has provided tax planning
and accounting services for hundreds of State Farm
Insurance Agents and other self-employed individuals in
several states. For the past four years, Mr. Graham
has conducted Tax Workshops and provided supporting tax
services.
Homer L. Richardson: Mr. Richardson, as Executive
Director of the HG Asset Management Company,
specializes in asset protection, tax engineering, and
wealth accumulation. For the past seven year [sic],
Mr. Richardson has conducted Business Trust workshops
throughout the country teaching people how to protect
their assets from lawsuit judgments and reduce taxes.
Mr. Richardson is extremely knowledgeable regarding
Business Trusts and is a highly sought after speaker.
His workshops are in high demand and filled with
information about the Business Trust and their [sic]
financial advantages.
These announcements generally direct that registrations be sent,
and checks made payable, to HGAMC, or Trust Management Services
(further explained below).
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The record also contains an example of an announcement for
an advanced business trust workshop sponsored by HGAMC in Ohio in
1999.6 Mr. Richardson sent out an invitation stating:
I am writing to let you know about an ADVANCED BUSINESS
TRUST WORKSHOP that HG Asset Management Company is
sponsoring. This workshop will be conducted by Mike
Vallone, the Executive Director of Aegis. It will be
three full days from 9 a.m. until 5 p.m. each day
devoted to the complete CBO System. This workshop goes
beyond what you may have learned at the Basic CBO
Workshop given by Homer Richardson and Wil Graham. You
will study how to properly move money through the
system, and how you should operate the charitable
trust. We will show you how Offshore entities, such as
offshore trusts, and International Business Companies
can be used in connection with this system to get
incredible tax advantages, as well as even greater
privacy and protection from the IRS. In fact, we will
show you how to create a CBO that has NO tax reporting
requirements in the U.S.
To provide ongoing support to clients who purchased trust
packages, petitioners as directors of HGAMC at a December 29,
1998, board meeting affirmed and ratified the creation of a
department within HGAMC to provide management services, to be
known as Trust Management Services. A bank account had been
opened in the name of HG Asset Management Co. d.b.a. Trust
Management Services on June 29, 1998, at Lebanon Citizens
National Bank, over which petitioners had signatory authority.
Subsequently, in February of 2000, the structure of
petitioners’ entities was again altered with the creation of
6
An apparently similar seminar conducted in 1998 was
approved by the Ohio Supreme Court Commission on Continuing Legal
Education for 19.5 hours of CLE credit.
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Atlantis Management Services LLC. HGAMC obtained a 59-percent
membership interest. Other members included Barton Richardson
and Mr. Richardson, who served as the managing member. A second
limited liability company, Apache LLC, was created at some point
not identified in the record. HGAMC received a membership
interest in this entity of approximately 90 percent, and
Mr. Richardson again served as the managing member. Aegis sent a
letter to clients in June of 2000 recommending that an LLC
structure be implemented to “take your future trust returns ‘off
the radar screen’ for audit.”
On January 10, 1997, and January 22, 1998, the board of
directors of HGAMC approved charitable donations to be made to
HGRCT of $259,888 for the 1996 year and $51,299 for the 1997
year. During calendar years 1996 and 1997, HGRCT made no
charitable distributions. On January 27, 1998, the HGRCT board
approved charitable contributions totaling $12,994 to be made to
the American Cancer Society, Berea College, the Wellness
Community, Young Life, the Salvation Army, and New Richmond
Elementary School. Acknowledgments from each of these
organizations confirm that donations were received in 1998,
although the amount in one instance appears to be $500 greater
than that initially approved by the board. A similar pattern of
contributions continued in 1999 through 2002.
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Throughout the years in issue and continuing to the present,
Mr. Richardson made all of the day-to-day investment decisions
with respect to, controlled all of the assets being held by, and
had complete supervisory control over HGAMC and HGRCT.
Tax Reporting
For each of the years in issue, petitioners filed: (1) A
joint Form 1040, U.S. Individual Income Tax Return, for
themselves and including a Schedule C, Profit or Loss From
Business, for Asset Protection Services; (2) a Form 1041, U.S.
Income Tax Return for Estates and Trusts, for HGAMC; and (3) a
Form 990-PF, Return of Private Foundation or Section 4947(a)(1)
Nonexempt Charitable Trust Treated as a Private Foundation, for
HGRCT. Wilson M. Graham (Mr. Graham) of Graham & Associates
signed each of the foregoing returns, except the 1996 Form 1040,
as preparer. Mitchell Graham, also of Graham & Associates and
Mr. Graham’s son, signed the 1996 Form 1040.7 As indicated by
the workshop announcements quoted above, Mr. Graham was involved
in promotion of the Aegis trust system. The 1996 Form 1040 was
filed on April 15, 1997, and the 1997 Form 1040 was filed on
September 23, 1998.
7
Mr. Graham was formerly licensed as a certified public
accountant in the State of Ohio, but his license was revoked in
1994. No evidence reflects that Mitchell Graham was at any time
licensed as a C.P.A., and testimony indicated that he was not.
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On their 1996 Form 1040, petitioners reported adjusted gross
income of $11,069, which amount incorporated a $1,920 loss from
Schedule C, a $3,000 capital loss, and $4,552 of other income.
An attached statement showed that the other income comprised two
“DIRECTORS FEES” of $1,500 each and two “PERSONAL USE OF AUTO”
amounts of $881 and $671. The Schedule C loss for Asset
Protection Services was computed by subtracting $135,088 in
expenses from gross income of $133,168. Taxable income is shown
as zero and total tax as $212 (on account of self-employment
tax).
The 1997 Form 1040 similarly reflected adjusted gross income
of $9,694, including $1,006 in business income from Schedule C, a
$3,000 capital loss, and other income of $8,190. The other
income included two “DIRECTORS FEES” of $3,000 each and two
“PERSONAL USE OF AUTO” amounts of $1,095 each. The Schedule C
income of $1,006 was derived from $8,127 in gross income and
$7,121 of expenses. Petitioners’ taxable income was shown as
zero and total tax as $990.
On the Forms 1041 filed on behalf of HGAMC for 1996 and
1997, respectively, petitioners reported interest income ($74 and
$2,497) and business income from an attached Schedule C ($262,806
and $54,902) and deducted therefrom principally fiduciary fees
($3,000 and $6,000) and charitable deductions to HGRCT ($259,880
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and $51,299), to arrive at taxable income of zero. The Schedule
C business income amounts were computed as follows:
1996 1997
Gross income $516,309 $455,750
Expenses
Advertising 0 356
Car and truck 9,970 11,472
Commissions and fees 224,250 326,940
Depreciation 3,504 4,507
Insurance 1,665 2,273
Mortgage 1,738 4,860
Office 213 11,142
Repairs and maintenance 1,832 8,768
Taxes and licenses 2,519 2,420
Travel 4,086 14,326
Meals and entertainment 256 1,937
Utilities 1,214 3,724
Other 2,256 8,123
Total expenses 253,503 400,848
Net profit 262,806 54,902
The other expenses for 1996 comprised solely meeting expenses,
while the other expenses listed for 1997 included bank service
charges of $486, directors’ meetings of $1,058, education of
$2,164, and medical expenses of $4,415.
The amounts reported as gross receipts represented payments
made by customers for Aegis trust packages sold by Mr. Richardson
and deposited into accounts over which petitioners had signatory
authority. The car and truck expenses related to the 1996
Mercury. The expenses claimed for depreciation, insurance,
mortgage, repairs and maintenance, taxes and licenses, and
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utilities were all attributable in significant part to the
Quailwoods Drive residence. The insurance expense also included
a component for life insurance for Mr. Richardson, and the
medical expenses pertained to healthcare for petitioners.
Mr. Richardson signed each of the Forms 1041 as a fiduciary
of HGAMC. An attachment to the 1996 return contained the
following: “The Fiduciary of this Trust hereby elects to treat
contributions made this year and the next subsequent tax year as
paid during this tax year as provided for by IRC Secion [sic] 642
(c)(1)”. A substantially identical statement was attached to the
1997 return. The attachments further provided that the
contributions for the next year to be treated as paid during 1996
and 1997 were $259,880 and $51,299, respectively.
Concerning HGRCT, the Form 990-PF for 1996 reflected no
revenue (including contributions), expenditures, assets, or
liabilities of any kind. The return listed both petitioners as
trustees and indicated that each devoted 2 hours per week to his
or her position. Mr. Richardson executed the return as a
trustee.
The Form 990-PF for 1997 showed contributions received of
$259,880, interest income of $85, operating and administrative
expenses of $198, and contributions made of $12,994. Resultant
excess of revenue over expenses and disbursements, as well as net
assets, was $246,773. Petitioners were again listed as the
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trustees with an average of 2 hours apiece per week devoted to
their work for HGRCT, and Mr. Richardson again signed the return
as trustee.
Examination
On July 13, 1999, the IRS mailed to each petitioner, with
respect to the 1996 and 1997 taxable years, a letter advising as
follows:
The Internal Revenue Service has information
indicating that you may be involved in a trust
arrangement used for tax avoidance purposes. This
letter is to inform you of the Internal Revenue
Service’s position regarding abusive trust
arrangements. It is the government’s position that
trusts will be disregarded for tax purposes and the
income will be taxed to the person who controls the
trust, if the trust lacks economic substance or has
been structured for tax avoidance purposes.
In addition to disregarding the trust entity, the
government may pursue civil and/or criminal penalties
against taxpayers and promoters who attempt to use
trusts to avoid income tax liability.
If you are a participant in a trust scheme that
has any of the abusive elements described in Notice 97-
24 attached, you have the option of correcting your
income tax filings to reflect the proper income and
expenses on your personal, corporate and partnership
returns, as applicable. Any trust returns previously
filed should also be corrected to eliminate income and
expenses reported.
The letters went on to request that petitioners provide
documentation with respect to the trust (presumably HGAMC) in the
event that they determined that their position was appropriate
under Notice 97-24, 1997-1 C.B. 409.
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Petitioners responded with a letter dated July 21, 1999,
communicating that they had been assured by their legal counsel
and tax accountant that their trust was “NOT an ‘abusive trust’
as described in your material.” They indicated that they would
not be filing an amended return and then proceeded with several
pages questioning the authority of the IRS to request
documentation with respect to the trust. On August 10, 1999, the
IRS sent letters to petitioners notifying that their Forms 1040
and HGAMC’s Forms 1041 for 1996 and 1997 had been selected for
examination. Petitioners were asked to meet with the examining
agent on September 7, 1999, and to provide books, records, and
documents related to the returns. Neither petitioner responded
to the letters or attended the requested meeting.
David Morgason (Mr. Morgason) was the principal IRS employee
responsible for conducting the examination of petitioners’
returns. When petitioners failed to provide any information,
Mr. Morgason sought to obtain records from third parties through
issuance of administrative summonses. One or more such summons
was sent to Lebanon Citizens National Bank, and Mr. Richardson
responded upon learning of the matter with two letters dated
September 22, 1999, one to the IRS and one to the bank. The
letter to the IRS asserted that the agent had violated various
laws and policies and threatened legal action. The letter to the
bank directed the bank not to disclose any of the information
requested by summons until presented with a court order to do so.
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Mr. Morgason later issued additional summonses to Lebanon
Citizens National Bank, and petitioners on February 11, 2000,
responded by filing a petition to quash with the U.S. District
Court for the Southern District of Ohio. The Government filed a
motion to dismiss the petition to quash, and the District Court
granted the motion on July 20, 2000. Meanwhile, after reviewing
the information received to date, Mr. Morgason in the spring of
2000 referred petitioners’ case to the IRS Criminal Investigation
Division. Work on the civil case, other than an unsuccessful
attempt to solicit from petitioners an extension of the statute
of limitations, ceased.
At some point between late 1999 and early 2001,
Mr. Richardson was contacted by Missy Vaselaney, an Ohio attorney
specializing in tax and estate matters.8 Ms. Vaselaney had
become aware of the Aegis trust plan through communications with
State Farm Insurance agents. (Ms. Vaselaney’s husband was
apparently an attorney who did work with State Farm.)
Ms. Vaselaney expressed to Mr. Richardson some concerns about the
legality of the Aegis system and suggested that he cooperate with
her in working with the IRS. Mr. Richardson declined. In the
words of one State Farm agent and former client of
Mr. Richardson, Todd Young (Mr. Young), Ms. Vaselaney assisted a
8
Mr. Richardson first testified that this contact occurred
in late 1999 but later testified that the conversation took place
between the middle part of February and the middle part of March
in 2001.
- 24 -
group of State Farm agents, including Mr. Young, to “get out” of
the Aegis system and to resolve their tax audit matters.
While the criminal investigation was ongoing, the IRS also
commenced an investigation of Mr. Richardson under section 6700,
which imposes a civil penalty for the promotion of abusive tax
shelters. Petitioners were formally notified of the
investigation, likewise conducted by Mr. Morgason, in or about
September of 2002. Mr. Richardson attended an initial conference
in connection with the section 6700 investigation on November 8,
2002, and both spouses attended a closing conference on December
17, 2002. Mr. Richardson raised various frivolous arguments at
those conferences, including challenges to the authority of the
IRS, and while he provided documents, he declined to provide any
of the documentation requested by Mr. Morgason.
Following the December meeting, the IRS referred the section
6700 case to the Department of Justice. On February 5, 2003, the
United States filed a complaint in the U.S. District Court for
the Southern District of Ohio against Mr. Graham, individually
and doing business as Graham & Associates, and against Mr.
Richardson, individually and doing business as HGAMC. United
States v. Graham, No. 1:03cv96 (S.D. Ohio filed Feb. 5, 2003).9
The Government sought injunctive relief against the defendants
with respect to promotion of alleged abusive trust schemes. Id.
9
See infra discussion regarding judicial notice.
- 25 -
On June 23, 2005, the District Court entered an opinion and order
to, inter alia, “preliminarily enjoin Defendants from promoting
the sales of abusive trusts under the name of Aegis, Heritage, or
any other name, or from engaging in any other activities which
are subject to penalty under 26 U.S.C. §§ 6700 and 6701”, based
principally on findings and recommendations made by a magistrate
judge in November of 2003 and February of 2004. Id.
The civil examination of petitioners’ returns resumed in
approximately April of 2003. The Government made a jeopardy
assessment with respect to petitioners’ 1996 and 1997 taxes on
May 14, 2003, after an adviser with whom they had invested
$450,000 attempted to transfer the funds to a Swiss bank account.
The notices of deficiency underlying the cases at bar were then
issued on July 10, 2003, to Mr. Richardson and on July 10 or 11,
2003, to Mrs. Richardson.10
10
Copies of the notice contained in the record bear
different dates.
- 26 -
OPINION
I. Evidentiary Matter
After briefs were filed in these cases, petitioners filed a
motion requesting judicial notice pursuant to rule 201 of the
Federal Rules of Evidence (hereinafter Fed. R. Evid. 201). The
motion recites: “In the Ninth Circuit’s decision in United
States v. Smith, 424 F.3d 992, 1010 (9th Cir. September 13,
2005), the IRS conceded that in some situations, the business
trust could report income on its Form 1041 but could
alternatively, report the income on the individual’s Form 1040 as
long as it was reported.” Petitioners then quote two phrases
from the referenced case and attach a copy of the complete
opinion. The phrases are taken from the following two
paragraphs, set forth in full with the quoted language emphasized
by boldface type:
Smith argues that the particular 1040 personal
returns or 1065 partnership tax returns were not false
for omitting income or revenue that should have been
reported on a separate 1041 trust return. However, IRS
Agent Brown testified that although revenue in a
business trust such as a UBO would typically be
reported on a form 1041, as a default the income could
also be reported on a 1040 personal income tax return.
In any event, the income had to be reported on some IRS
form. Thus, the under-reporting of income on the
clients’ personal returns, that could have been but was
not reported elsewhere, made the personal returns
“false” or “fraudulent.”
* * * * * * *
- 27 -
Smith argues that the evidence was insufficient to
show that he acted willfully “with specific intent to
defraud the government in the enforcement of its tax
laws.” Salerno, 902 F.2d at 1432. While there is
nothing “inherently unlawful with an UBO,” and the
government told the jury during closing argument to
assume UBOs are “legitimate,” the government provided
ample evidence that Smith gave advice to unlawfully use
UBOs to file false or fraudulent tax returns (or not to
file at all). [United States v. Smith, 424 F.3d 992,
1010 (9th Cir. 2005); boldface added.]
Fed. R. Evid. 201 provides in relevant part:
Rule 201. Judicial Notice of Adjudicative Facts
(a) Scope of rule. This rule governs only
judicial notice of adjudicative facts.
(b) Kinds of facts. A judicially noticed fact
must be one not subject to reasonable dispute in that
it is either (1) generally known within the territorial
jurisdiction of the trial court or (2) capable of
accurate and ready determination by resort to sources
whose accuracy cannot reasonably be questioned.
Although the rule does not expressly define “adjudicative facts”,
the Advisory Committee Notes accompanying the rule explains that
they are:
those which relate to the parties, or more fully: When
a court or an agency finds facts concerning the
immediate parties--who did what, where, when, how, and
with what motive or intent--the court or agency is
performing an adjudicative function, and the facts are
conveniently called adjudicative facts. [Advisory
Committee’s Note, 56 F.R.D. 183, 204; internal
quotations omitted.]
See also United States v. Amado-Nunez, 357 F.3d 119, 121 (1st
Cir. 2004) (defining adjudicative facts as “facts about the
parties or events involved in the case”).
- 28 -
With respect to then ascertaining whether particular
adjudicative facts are capable of accurate and ready
determination, this Court has previously noted that “under rule
201, records of a particular court in one proceeding commonly are
the subject of judicial notice by the same and other courts in
other proceedings”, and “Also generally subject to judicial
notice under rule 201 is the fact that a decision or judgment was
entered in a case, that an opinion was filed, as well as the
language of a particular opinion.” Estate of Reis v.
Commissioner, 87 T.C. 1016, 1027 (1986). In a similar vein, we
have observed: “Records of court proceeding are commonly the
subject of judicial notice. * * * Although we may take notice of
matters that cannot reasonably be questioned, the truth of
assertions or findings (as distinguished from the fact that the
assertions or findings were made) is ordinarily not properly the
subject of judicial notice.” Steiner v. Commissioner, T.C. Memo.
1995-122 n.10.
Given these standards, the situation at hand appears to
present a somewhat atypical scenario. While taking judicial
notice of the opinion by the Court of the Appeals for the Ninth
Circuit and the fact that certain statements were made by
Government agents in the course of the underlying proceeding
would generally comply with the dictates of Fed. R. Evid.
201(b)(2), it is debatable whether the foregoing are in reality
- 29 -
adjudicative facts for purposes of the instant litigation.
Petitioners seem to be attempting to employ a motion for judicial
notice in a manner more akin to a supplemental brief. Their
motion essentially calls to the Court’s attention an unrelated
case that they feel is pertinent and supportive of their
position.
However, even leaving aside for the moment procedural
complications and considering the case as we would any other
cited precedent, the Court notes that the quoted statements from
United States v. Smith, supra at 1010, do not assist petitioners
here. Considered in context, the alleged concessions simply
stand for the unremarkable proposition that there can exist
legitimate unincorporated business entities, the income of which
may be properly reported on Forms 1041. The question before us
is whether HGAMC and HGRCT were such legitimate entities or
whether they were part of a sham arrangement designed to avoid
taxes and should be disregarded for tax purposes. This is an
inquiry that we resolve infra based on all the facts and
circumstances of petitioners’ particular situation. The fact
that in an unrelated case decided nearly a decade after the
transactions here at issue Government agents made certain
relatively generic legal statements would not affect our
analysis. Petitioners’ motion will be denied as moot.
- 30 -
II. Income Tax Deficiencies - Unreported Income
The Internal Revenue Code imposes a Federal tax on the
taxable income of every individual. Sec. 1. Section 61(a)
defines gross income for purposes of calculating taxable income
as “all income from whatever source derived”. Respondent has
determined that petitioners were required to include in their
gross income, and failed to report on their Forms 1040, the
receipts they instead attributed to HGAMC.
A. Burden of Proof
As a general rule, the Commissioner’s determinations are
presumed correct, and the taxpayer bears the burden of proving
error therein. Rule 142(a); Welch v. Helvering, 290 U.S. 111,
115 (1933). Although section 7491(a) may shift the burden to the
Commissioner with respect to factual issues where the taxpayer
introduces credible evidence, the provision operates only where
the taxpayer establishes that he or she has complied with all
substantiation requirements, has maintained all required records,
and has cooperated with reasonable requests for witnesses,
information, documents, meetings, and interviews. Here, as
indicated above, petitioners were not forthcoming during the
examination of their returns. Section 7491(a) therefore effects
no shift of burden in the instant cases.
However, an additional limitation on the general rule
potentially bears upon the cases at bar. Various Courts of
- 31 -
Appeals, including that for the Sixth Circuit to which appeal in
the instant cases would normally lie, have indicated that before
the Commissioner may rely on the presumption of correctness in
unreported income scenarios, the determination must be supported
by at least a “minimal” factual predicate or foundation of
substantive evidence linking the taxpayer to income-generating
activity or to the receipt of funds. United States v. Walton,
909 F.2d 915, 918-919 (6th Cir. 1990); see also, e.g., Palmer v.
United States, 116 F.3d 1309, 1313 (9th Cir. 1997); Portillo v.
Commissioner, 932 F.2d 1128, 1133 (5th Cir. 1991), affg. in part,
revg. in part, and remanding T.C. Memo. 1990-68; Anastasato v.
Commissioner, 794 F.2d 884, 886-887 (3d Cir. 1986), vacating and
remanding T.C. Memo. 1985-101; Weimerskirch v. Commissioner, 596
F.2d 358, 361-362 (9th Cir. 1979), revg. 67 T.C. 672 (1977).
To the extent that those decisions might be on point here,
and as will be shown in greater detail below, respondent has
introduced sufficient evidence connecting petitioners to the
income-producing activities attributed to HGAMC and to the
receipt of financial benefits therefrom. For instance,
Mr. Richardson’s services were paramount in generating the
underlying sales, and both petitioners received distributions,
directly or indirectly, out of the funds received.
The Court is satisfied that the totality of the record is
sufficient to meet any pertinent burden of production placed on
- 32 -
respondent with respect to the adjustments related to the income
tax deficiencies and concomitant unreported income at issue here.
The burden of showing error in these determinations by respondent
remains with petitioners.11
B. Economic Substance of the Trusts
Respondent’s principal basis for concluding that petitioners
are liable for deficiencies was that HGAMC and HGRCT were sham
entities with no economic substance and, consequently, should be
disregarded for Federal tax purposes. As a result, all income
earned and allowable expenses incurred under the names of HGAMC
and HGRCT would be reported on petitioners’ personal income tax
returns. Petitioners dispute these sham characterizations. They
argue that HGAMC was a legitimate business trust under the laws
of Ohio created to operate the new business of selling and
servicing Aegis trusts. It is likewise their position that HGRCT
was a proper nonexempt charitable trust treated as a private
foundation under section 4947(a)(1).
The overarching principles that guide analysis of trust
legitimacy are of long provenance. As summarized by this Court
in oft-cited language:
It is well established that a taxpayer has the
legal right to minimize his taxes or avoid them totally
11
The parties’ respective burdens as to issues concerning
penalties, the statute of limitations, and spousal relief, will
be discussed infra in connection with the Court’s analysis of
those matters.
- 33 -
by any means which the law permits. Gregory v.
Helvering, 293 U.S. 465, 469 (1935). However, this
right does not bestow upon the taxpayer the right to
structure a paper entity to avoid tax when that entity
does not stand on the solid foundation of economic
reality. When the form of the transaction has not, in
fact, altered any cognizable economic relationships, we
will look through that form and apply the tax law
according to the substance of the transaction.
Markosian v. Commissioner, 73 T.C. 1235 (1980), citing
Furman v. Commissioner, 45 T.C. 360 (1966), affd. per
curiam 381 F.2d 22 (5th Cir. 1967). This rule applies
regardless of whether the entity has a separate
existence recognized under State law (Furman v.
Commissioner, supra at 365), and whether, in form, it
is a trust, a common law business trust, or some other
form of jural entity. * * * [Zmuda v. Commissioner, 79
T.C. 714, 719-720 (1982), affd. 731 F.2d 1417 (9th Cir.
1984); fn. ref. omitted.]
In ascertaining whether a trust has no economic substance
apart from tax considerations, the Court has identified four
pertinent factors: (1) Whether the taxpayer’s relationship, as
grantor, to the property ostensibly transferred to the 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 other
beneficiaries; and (4) whether the taxpayer felt bound by any
restrictions imposed by the trust itself or the law of trusts.
Markosian v. Commissioner, 73 T.C. 1235, 1243-1244 (1980);
Gouveia v. Commissioner, T.C. Memo. 2004-256; Norton v.
Commissioner, T.C. Memo. 2002-137; Castro v. Commissioner, T.C.
Memo. 2001-115; Muhich v. Commissioner, T.C. Memo. 1999-192
(addressing the Heritage/Aegis multitrust system), affd. 238 F.3d
- 34 -
860 (7th Cir. 2001); Buckmaster v. Commissioner, T.C. Memo. 1997-
236; Hanson v. Commissioner, T.C. Memo. 1981-675, affd. 696 F.2d
1232 (9th Cir. 1983).
As to the first factor, addressing change in relationship to
trust property, the Court as a threshold matter looks to the
economic realities of the arrangement to ascertain the true
grantor, settlor, or creator, notwithstanding mere nominal
designations as such in the trust documents. Zmuda v.
Commissioner, supra at 720-721; Gouveia v. Commissioner, supra;
Buckmaster v. Commissioner, supra. Here, the trust instrument
for HGAMC names Mr. Quay as the creator and a director; however,
he functioned as nothing more than a temporary “straw man” under
the precedent just cited.
Mr. Richardson testified that he had just met Mr. Quay at an
Aegis training convention in May or June of 1996, a few months
before the HGAMC documents were executed, and had no contact with
him after 1997. Mr. Richardson further testified that having an
attorney named as creator and a director of the entity was a
condition imposed by Aegis on the purchase of the trust package.
Any drafting work would also likely have been minimal, given
that, as a mass-marketed trust “package”, the Aegis system
involved distribution to multiple purchasers of similar,
standardized documents. Mr. Quay contributed no assets to HGAMC,
never had signatory authority over any of HGAMC’s accounts,
- 35 -
received no compensation for his duties as director, and resigned
after only 6 days. Hence, it is clear that Mr. Quay’s role, and
a transient one at that, existed on paper only. All stake in
establishing HGAMC patently came from petitioners alone.
Economic realities thus point to petitioners as the true grantors
of HGAMC.
In this connection, we further note that in situations where
one spouse first transfers his or her property to the other
spouse, who in turn transfers the received property along with
his or her own to the entity, courts typically ignore the first
conveyance when considering questions of grantor. E.g., Neely v.
United States, 775 F.2d 1092, 1095 (9th Cir. 1985); Schulz v.
Commissioner, 686 F.2d 490, 496 (7th Cir. 1982), affg. T.C. Memo.
1980-568; Kooyers v. Commissioner, T.C. Memo. 2004-281. Either
of two rationales counsels this approach. The conveyance is
ignored (1) because substance predominates over form in tax
matters and/or (2) because the parties themselves did not treat
the conveyance as either a sale or a gift. Neely v. United
States, supra at 1095; Schulz v. Commissioner, supra at 496;
Kooyers v. Commissioner, supra. Here, the record in any event
shows a scenario akin to a so-called step transaction where
Mrs. Richardson’s transfer was only the first in a series of
preplanned steps, such that intermediary maneuvers should be
ignored in favor of substance.
- 36 -
On a related point, we likewise are satisfied that
petitioners should be considered the true grantors of HGRCT.
Although according to the documentation HGAMC purportedly created
HGRCT, this Court in considering the first of the four factors in
the context of multitiered trust arrangements has made no such
distinction. See Castro v. Commissioner, supra; Muhich v.
Commissioner, supra; see also Kooyers v. Commissioner, supra
(“Because petitioners are grantors of the * * * [first-tier]
Trust, they are also grantors of the * * * [second-tier] Trust
and any other trust for which * * * [those] trusts are
grantors.”); Dahlstrom v. Commissioner, T.C. Memo. 1991-264
(“Petitioners were instrumental in the creation of all the trusts
involved in their multitiered arrangement.”), affd. without
published opinion 999 F.2d 1579 (5th Cir. 1993).
Having determined that petitioners should be viewed as the
grantors of HGAMC and HGRCT, we turn to whether their
relationship to property ostensibly transferred to these entities
differed materially before and after the trusts’ formation.
Here, the record reflects that the relationship of petitioners to
both their physical assets and their income-producing activities
remained essentially unchanged. Notably, petitioners continued
to live in and operate their residence with no restriction on
their personal use of that property or any other of their
tangible assets. The only apparent difference stemming from the
- 37 -
transfer is that petitioners thereafter sought to deduct
substantial personal living expenses incurred in connection with
the property, such as insurance, repairs, maintenance, and
utilities. They even commenced a remodeling project at the
Quailwoods location, and nothing in the record indicates that the
resulting improvements did not enhance petitioners’ personal use
of the property for residential purposes. Attempts to legitimize
deductions of this nature through designation of the property as
HGAMC’s “headquarters” are unavailing. A passing reference by
petitioners on brief to a home office likewise does nothing to
aid their cause. Deductions related to business use of a
residence are strictly circumscribed by the rules of section 280A
and would require petitioners to show, at minimum and as relevant
here, that some portion of the home was “exclusively used on a
regular basis” for business. Sec. 280A(c)(1). The evidence
before the Court does not even so much as suggest that to be the
case.
As regards income-producing activities, again no truly
material change appears to have been worked by implementation of
the trust system. Petitioners’ primary contention in arguing for
a changed relationship centers on this aspect and is summarized
on brief as follows:
The allegation that the taxpayers’ relationship as
grantor to the property did not differ materially
before and after the creation of the trusts is
ludicrous. There was no substantial trust property
(aside from the Richardsons’ home) before the creation
- 38 -
of the trust. The trusts were created to operate a
brand-new business. This new business of selling and
servicing Aegis Trusts is the primary property of the
trusts. Additionally, the creation and use of a
business management trust for such a purpose is a
codified creation of the law of the State of Ohio.
At the outset, we stress again that the legitimacy of an
entity under State law as a business trust or any other
recognized form has no bearing on an economic substance analysis
and will not be discussed further. See Zmuda v. Commissioner, 79
T.C. at 720, and cases following. More importantly, petitioners’
remonstrance concerning a new business is on these facts a
distinction without a difference, not to mention factually
suspect.
The HGAMC trust instrument and the annual contracts between
HGAMC and Asset Protection Services reflect an arrangement where
the sole proprietorship, not HGAMC, conducted the underlying
business of selling Aegis trusts. HGAMC in turn was purportedly
engaged to manage Asset Protection Services through the provision
of Mr. Richardson’s services to his own sole proprietorship.
This structure is corroborated by the descriptions identifying
the nature of HGAMC’s business on certain of its Forms 1041 as
“MANAGEMENT SERVICES”.
Mr. Richardson earned his livelihood as a self-employed
salesman of insurance policies from 1993 through 1996. Thus, at
the time the instruments establishing HGAMC were executed,
Mr. Richardson had been employed for several years in selling
- 39 -
financial management products aimed at protecting assets and/or
addressing contingencies that might arise in the face of death or
other hardship. As he began to focus more of his efforts on
promoting Aegis trusts, he continued to be engaged, through a
sole proprietorship, in selling financial management products
aimed at protecting assets and/or addressing contingencies that
might arise in the face of death or other hardship. Aegis trust
packages were advertised as tools to: Legally reduce Federal and
State income taxes “70% or More”; eliminate Federal estate taxes
no matter the size of the estate; sell a business or other assets
and pay no capital gain taxes; and protect personal assets from
lawsuit judgments. Mr. Richardson testified:
A * * * Asset Protection Services was to
provide asset protection. That’s basically what it
says, and that would be insurance basically and provide
trying to sell trusts as well. Yes.
Q Okay. So your sole proprietorship was to
sell both insurance and Aegis trusts.
A That’s correct.
Q You had been selling insurance for several
years before 1996. Is that correct?
A Right.
Q Back to at least 1992?
A 1992 or ’93.
Q Before 1996 you called your sole
proprietorship Benefit Planning Services.
A That’s correct.
- 40 -
Mr. Richardson also testified that he first received a referral
fee from Aegis in March of 1996 for bringing an individual to
meet with, and introducing him to, Mr. Bartoli in Chicago.
The record is nebulous at best on the genesis of any
activity on the part of HGAMC. The Form SS-4, Application for
Employer Identification Number, stated that business started on
April 1, 1996. The instrument that by its terms “created and
established” HGAMC is dated August 17, 1996. Petitioners’
signatures on many of the documents pertaining to HGAMC and dated
in August were notarized on December 3, 1996. Mr. Richardson’s
testimony on this point was confused, if not contradictory, and
in the midst of an unsuccessful colloquy attempting to reconcile
various dates, he was able only to offer that HGAMC was
“operated” before August 17, 1996.
Given these circumstances, it cannot be said that the record
bears out petitioners’ attempts to portray the establishment of
HGAMC as working some sort of clean break in Mr. Richardson’s
ongoing business activities, in terms of either the nature of
those activities or the timeframe for their occurrence. The
Court thus is unable to perceive that the entity’s existence
engendered any material change in petitioners’ relationship to
the property allegedly transferred thereto. Furthermore, since
the only property contributed to HGRCT was 10 units of beneficial
interest in HGAMC, creation of this second tier likewise produced
no material changes.
- 41 -
The second factor investigates the presence of any bona fide
independent trustee over the entity in question. A nominal
trustee will not withstand scrutiny under this factor absent a
meaningful role in; i.e., an exercise of control over, the
operation of the trust. Gouveia v. Commissioner, T.C. Memo.
2004-256; Norton v. Commissioner, T.C. Memo. 2002-137; Castro v.
Commissioner, T.C. Memo. 2001-115.
With respect to HGAMC, which employed the term “director” as
opposed to “trustee”, Mr. Quay was initially named as such.
Nonetheless, his brief, 6-day stint is devoid of meaning for
reasons akin to those discussed above in connection with his role
as creator. In particular, his lack of even nominal signatory
authority over any of the financial accounts opened in the
entity’s name belies any true oversight or control. As regards
HGRCT, petitioners were from inception designated as the
trustees, and no third party was named to the position. The
facts thus reveal that petitioners were the sole individuals with
operational control over HGAMC and HGRCT, and that their
discretion was unfettered by any independent trustee.
The third factor looks at whether a genuine economic
interest in the trust passed to any beneficiaries other than
petitioners. The 100 units of beneficial interest in HGAMC were
divided between Mr. Richardson, Mrs. Richardson, and HGRCT. The
100 units of beneficial interest in HGRCT were in turn held by
- 42 -
HGAMC. Hence, the pertinent documents did not even purport to
give any third party an economic interest in these entities.
The fourth and final factor considered is whether
petitioners felt bound by any restrictions imposed by the trusts
or the law of trusts. In the case of HGAMC, the authority
granted to petitioners as directors was so broad as to impose no
meaningful restrictions. Any fiduciary duties under relevant law
would also be illusory for all practical purposes in that the
circular arrangement of entities utilized left petitioners as the
only true beneficiaries.
Concerning HGRCT, the trust instrument on its face prohibits
transactions that would “in the opinion of the trustees,
jeopardize the federal income tax exemption of this trust
pursuant to section 501(c)(3) of the Internal Revenue Code”.
However, petitioners never even obtained section 501(c)(3) status
for HGRCT. This failure to implement what would seem to be a
basic, foundational premise for the trust’s operation leads us to
conclude that HGRCT’s existence and purported charitable
character (as well as contribution activities in years subsequent
to those in issue) were hardly more than a facade or window
dressing that did little to bind petitioners’ use of their
assets.12
12
Mr. Young explained the understanding of the Aegis trust
structure that he formed through attendance at a seminar or
seminars conducted by Mr. Graham and Mr. Richardson and review of
(continued...)
- 43 -
Although petitioners make multiple references on brief to
HGRCT as an “IRC §4947(a) non-exempt charitable trust”, these
appellations smack of a dubious and belated attempt to reframe
the scenario and lend legitimacy to HGRCT. More importantly, the
characterizations do nothing to alter the fact that petitioners
were not bound by the paper structure they created but chose to
function under an alternative arrangement. In any event, when
considering a factual scenario and claims virtually
indistinguishable from those at hand, this Court saw no reason to
afford credence to the purported charitable trust. Muhich v.
Commissioner, T.C. Memo. 1999-192. The persuasive power of the
record here is no greater.
To summarize, the factors typically considered by this Court
in assessing the economic reality of a trust structure counsel
that HGAMC and HGRCT do not warrant recognition for tax purposes.
12
(...continued)
Aegis materials as follows:
The way you would save money on your taxes is
you’d set up an asset management company, and then
you’d set up a charitable trust, so you would put your
money into an asset management company, and then you’d
pay your expenses out of that for your house and for
your living expenses.
* * * * * * *
But anyway, the charitable trust was something
that you put your excess money into it was told to me,
and you had to pay out the five percent each year to a
charity, but then it was explained to me that you
essentially would become your own charity, and that was
to be our retirement plan.
- 44 -
The Court therefore concludes that the income and allowable
expenses attributable to HGAMC and HGRCT are taxable to
petitioners.
Specifically, because HGAMC and HGRCT were shams,
petitioners are required to include in their income for 1996 and
1997 business gross income and interest income reported by HGAMC
and interest income reported by HGRCT. In this connection,
petitioners at certain junctures have contended that the amounts
of business income reported on the various returns germane to
this calculation were overstated on account in some instances of
double reporting and in other instances of reporting gross
receipts from the sales of Aegis trusts as opposed to merely the
proper commission income on those sales.
The record, however, contains no documentary evidence
whatsoever that would support or corroborate an alternative
computation. Furthermore, we observe that petitioners, and not
Aegis, had unfettered control and signatory authority over
relevant accounts into which the sales proceeds were deposited.
In these circumstances, we cannot relieve petitioners of the
implied concessions worked by their and their entities’ filed
returns. See Waring v. Commissioner, 412 F.2d 800, 801 (3d Cir.
1969), affg. T.C. Memo. 1968-126; Estate of Hall v. Commissioner,
92 T.C. 312, 337-338 (1989).
As regards expenses, respondent determined that petitioners
were entitled to deduct on their returns a portion of the
- 45 -
business expenses claimed by HGAMC for each year and disallowed
the remainder. Respondent also disallowed a portion of the
expense for commissions and fees claimed by petitioners in 1996
on the Schedule C for Asset Protection Services.
Deductions are a matter of “legislative grace”, and “a
taxpayer seeking a deduction must be able to point to an
applicable statute and show that he comes within its terms.” New
Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934); see also
Rule 142(a). As a general rule, section 162(a) authorizes a
deduction for “all the ordinary and necessary expenses paid or
incurred during the taxable year in carrying on any trade or
business”. An expense is ordinary for purposes of this section
if it is normal or customary within a particular trade, business,
or industry. Deputy v. du Pont, 308 U.S. 488, 495 (1940). An
expense is necessary if it is appropriate and helpful for the
development of the business. Commissioner v. Heininger, 320 U.S.
467, 471 (1943). Section 262, in contrast, precludes deduction
of “personal, living, or family expenses.”
The breadth of section 162(a) is tempered by the requirement
that any amount claimed as a business expense must be
substantiated, and taxpayers are required to maintain records
sufficient therefor. Sec. 6001; Hradesky v. Commissioner, 65
T.C. 87, 89-90 (1975), affd. 540 F.2d 821 (5th Cir. 1976); sec.
1.6001-1(a), Income Tax Regs. When a taxpayer adequately
establishes that he or she paid or incurred a deductible expense
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but does not establish the precise amount, we may in some
circumstances estimate the allowable deduction, bearing heavily
against the taxpayer whose inexactitude is of his or her own
making. Cohan v. Commissioner, 39 F.2d 540, 543-544 (2d Cir.
1930). There must, however, be sufficient evidence in the record
to provide a basis upon which an estimate may be made and to
permit us to conclude that a deductible expense, rather than a
nondeductible personal expense, was incurred in at least the
amount allowed. Williams v. United States, 245 F.2d 559, 560
(5th Cir. 1957); Vanicek v. Commissioner, 85 T.C. 731, 742-743
(1985).
Furthermore, business expenses described in section 274 are
subject to rules of substantiation that supersede the doctrine of
Cohan v. Commissioner, supra. Sanford v. Commissioner, 50 T.C.
823, 827-828 (1968), affd. 412 F.2d 201 (2d Cir. 1969); sec.
1.274-5T(a), Temporary Income Tax Regs., 50 Fed. Reg. 46014 (Nov.
6, 1985). Section 274(d) provides that no deduction shall be
allowed for, among other things, traveling expenses,
entertainment expenses, gifts, and expenses with respect to
listed property (as defined in section 280F(d)(4) and including
passenger automobiles, computer equipment, and cellular
telephones) “unless the taxpayer substantiates by adequate
records or by sufficient evidence corroborating the taxpayer’s
own statement”: (1) The amount of the expenditure or use; (2)
the time and place of the expenditure or use, or date and
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description of the gift; (3) the business purpose of the
expenditure or use; and (4) in the case of entertainment or
gifts, the business relationship to the taxpayer of the
recipients or persons entertained. Sec. 274(d).
On this issue, petitioners neither at trial nor on brief
offered evidence or argument directed towards the deductibility
of any of the specific expenses disallowed by respondent.
Respondent’s determinations therefore are sustained as to those
adjustments.13
In addition, respondent determined that petitioners were
liable for self-employment taxes, and entitled to corresponding
self-employment tax deductions, on business income attributed to
them from HGAMC in 1996 and 1997. Section 1401 imposes an
additional tax on the self-employment income of every individual,
both for old age, survivors, and disability insurance and for
hospital insurance. The term “self-employment income” denotes
“net earnings from self-employment”. Sec. 1402(b). “Net
earnings from self-employment”, in turn, means “the gross income
derived by an individual from any trade or business carried on by
such individual, less the deductions allowed by this subtitle
which are attributable to such trade or business”. Sec. 1402(a).
13
The Court further notes that although petitioners would
generally be entitled to deduct substantiated charitable
contributions on their personal returns in accordance with our
disregard of the trusts, all donations by HGRCT were made in
calendar year 1998 or thereafter. Petitioners are calendar year
taxpayers, and the years before the Court are 1996 and 1997.
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Again, petitioners have offered no evidence or argument
pertaining to the self-employment tax. The Court has concluded
that HGAMC should be disregarded, and the record supports that
Mr. Richardson’s personal services were the prime driver of the
receipts attributed to the entity. Hence, to the extent that we
have sustained respondent’s determinations with respect to
business income, we likewise sustain the imposition of
corresponding self-employment tax thereon.
III. Capital Gain and/or Loss
On their Forms 1040 for each of the years 1996 and 1997,
petitioners claimed a $3,000 capital loss and indicated that
these losses were carried forward from prior years. Respondent
disallowed the amounts claimed, and petitioners have never
explained or substantiated their genesis. Respondent further
determined that in 1997 petitioners sold stock in a company
called Next Level Systems that was held in the name of HGAMC.
Proceeds in the amount of $8,614 were apparently received on the
sale and were not reported on petitioners’ return or that of
HGAMC. As petitioners had not established any basis in the
shares, respondent determined that the full amount constituted
capital gain.
As a general rule, a taxpayer is required on the disposition
of property to report as capital gain the excess of the amount
realized on disposition over his or her adjusted basis in the
property. Sec. 1001. Alternatively, a taxpayer (other than a
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corporation) may claim losses on the sale or exchange of capital
assets to the extent of the lesser of $3,000 ($1,500 if married
filing separately) or the excess of such capital losses over
capital gains. Sec. 1211(b).
Once more, in what is becoming a familiar refrain, the
record is devoid of evidence on this matter. The Court therefore
sustains respondent’s determinations.
IV. Section 6663 Fraud Penalties
Section 6663(a) provides for the imposition of a penalty in
“an amount equal to 75 percent of the portion of the underpayment
which is attributable to fraud.” In addition, section 6663(b)
specifies that, if any portion of the underpayment is
attributable to fraud, the entire underpayment is treated as
attributable thereto, except and to the extent that the taxpayer
establishes some part is not due to fraud.
Respondent bears the burden of proving the applicability of
the civil fraud penalty by clear and convincing evidence. Sec.
7454(a); Rule 142(b). To sustain this burden, respondent must
establish by this level of proof both (1) that there was an
underpayment of tax for each taxable year in issue and (2) that
at least some portion of such underpayment was due to fraud.
DiLeo v. Commissioner, 96 T.C. 858, 873 (1991), affd. 959 F.2d 16
(2d Cir. 1992); Petzoldt v. Commissioner, 92 T.C. 661, 699
(1989).
A. Underpayments of Tax
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The first prong of the above fraud test mandates that
respondent prove the existence of an underpayment of tax for each
year. In doing so, respondent may not simply rely on the
taxpayer’s failure to prove error in the deficiency
determination. DiLeo v. Commissioner, supra at 873; Otsuki v.
Commissioner, 53 T.C. 96, 106 (1969). Here, the evidence leaves
no doubt that substantial taxable income was generated through
Mr. Richardson’s efforts in selling Aegis trusts. The totality
of the record also clearly establishes that the entities that
petitioners attempted to interpose between themselves and those
receipts were not worthy of credence. Petitioners failed to
include that income on their 1996 and 1997 returns and, as a
result, underpaid their taxes. Petitioners’ quibbles over
various details and amounts notwithstanding, respondent has in
any event shown by clear and convincing evidence the essential
elements of the scenario which led to underpayments of tax.
B. Fraudulent Intent
The second prong of the fraud test requires respondent to
show that a portion of the underpayment is attributable to fraud.
Fraud for this purpose is defined as intentional wrongdoing on
the part of the taxpayer, with the specific purpose of avoiding a
tax believed to be owed. Stoltzfus v. United States, 398 F.2d
1002, 1004 (3d Cir. 1968); Webb v. Commissioner, 394 F.2d 366,
377 (5th Cir. 1968), affg. T.C. Memo. 1966-81; Powell v.
Granquist, 252 F.2d 56, 60 (9th Cir. 1958). Stated differently,
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imposition of the civil fraud penalty is appropriate upon a
showing that the taxpayer intended to evade taxes believed to be
owing by conduct designed to conceal, mislead, or otherwise
prevent the collection of taxes. DiLeo v. Commissioner, supra at
874.
The existence of fraud is a question of fact to be resolved
upon consideration of the entire record. Id.; Gajewski v.
Commissioner, 67 T.C. 181, 199 (1976), affd. without published
opinion 578 F.2d 1383 (8th Cir. 1978). Fraud will never be
presumed. Recklitis v. Commissioner, 91 T.C. 874, 909-910
(1988); Beaver v. Commissioner, 55 T.C. 85, 92 (1970). However,
because direct proof of a taxpayer’s intent is seldom available,
fraud may be established by circumstantial evidence. Spies v.
United States, 317 U.S. 492, 499-500 (1943); DiLeo v.
Commissioner, supra at 874. In this connection, courts have
developed a nonexclusive list of circumstantial indicia, or
“badges”, of fraud that may support a finding of fraudulent
intent.
Among the badges of fraud that can be distilled from caselaw
are the following: (1) Understatement of income; (2) maintenance
of inadequate records; (3) failure to file tax returns; (4)
implausible or inconsistent explanations of behavior; (5)
concealment of income or assets; (6) failure to cooperate with
tax authorities; (7) engaging in illegal activities; (8) dealing
in cash; (9) failure to make estimated tax payments; and (10)
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filing false documents. Spies v. United States, supra at 499-
500; Douge v. Commissioner, 899 F.2d 164, 168 (2d Cir. 1990);
Bradford v. Commissioner, 796 F.2d 303, 307-308 (9th Cir. 1986),
affg. T.C. Memo. 1984-601; Recklitis v. Commissioner, supra at
910. In examining these factors, this and other courts have
further noted that the taxpayer’s background, his or her level of
education and prior history of filing proper returns, and the
context of the events in question are relevant to the inquiry.
Plunkett v. Commissioner, 465 F.2d 299, 303 (7th Cir. 1972),
affg. T.C. Memo. 1970-274; Sowards v. Commissioner, T.C. Memo.
2003-180; Temple v. Commissioner, T.C. Memo. 2000-337, affd. 62
Fed. Appx. 605 (6th Cir. 2003).
Applying these considerations here, the Court concludes that
Mr. Richardson fraudulently intended to underpay tax for each of
the years in issue. Because matters of background and context
speak especially loudly in these unique circumstances, several
features are worthy of emphasis at the outset. As regards
personal background, Mr. Richardson was not unsophisticated. He
had passed accounting courses, possessed a business degree in
marketing, and had years of experience in business in general and
the sale of financial products in particular. Respondent’s
concession that petitioners filed correct returns prior to 1996
also speaks to an awareness of tax obligations.
With respect to context for the events in question, perhaps
the most salient feature that must inform any analysis of the
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questions raised by this litigation comes to light.
Mr. Richardson was not a mere participant in or purchaser of a
mass-market trust scheme; he was an active promoter. He traveled
throughout a multistate area lending his prestige and expertise
to and conducting seminars on the Aegis system. He thus was
necessarily intimately acquainted with the details of the program
and the intended benefits. The advertising materials make clear
that tax reduction was emphasized above all other advantages.
This was amply corroborated by the credible testimony of
Mr. Young, who attended a number of seminars involving Mr. Graham
and Mr. Richardson and who purchased first a trust package from
Aegis and later additional management services from
Mr. Richardson. In his words, “the main thrust was to save money
on your taxes as much as 70 percent.” Mr. Richardson’s demeanor
at trial and disingenuous attempts to distance himself from the
Aegis organization, on the other hand, were singularly
unconvincing.
The preeminence of tax considerations in Mr. Richardson’s
implementation of the Aegis system is likewise corroborated by
materials contained in the minutes of HGAMC board meetings. The
quantity of statements addressing tax matters is telling. Even
more revealing is the specific content of the June 27, 1997,
minutes. This document shows that within a few weeks of filing
his 1996 return and long before the 1997 return was filed,
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Mr. Richardson was aware of and expressly opposing the challenges
raised by respondent to similar trust arrangements.
Against this backdrop, a number of the traditional “badges”
of fraud should be considered as well. As regards understatement
of income, consistent failure to report substantial amounts of
income over a number of years is highly persuasive evidence of
fraudulent intent. Kurnick v. Commissioner, 232 F.2d 678, 681
(6th Cir. 1956), affg. T.C. Memo. 1955-31; Temple v.
Commissioner, supra. Petitioners reported gross income of less
than $15,000 and taxable income of less than $1,000 on their
Forms 1040 for each 1996, 1997, and 1998. They did so during a
period when Mr. Richardson generated receipts totaling more than
$1.5 million over the 3 years from selling Aegis trusts and
related services. Petitioners avoided reporting those funds by
intentionally diverting such amounts to returns of other entities
that the Court has held to be devoid of economic substance. This
pattern weighs heavily in favor of a conscious intent to evade
tax.
With respect to record maintenance, petitioners at no time
throughout the administrative or litigation process produced
documentary records to substantiate business income or expenses.
Possible inferences are that they either failed to keep such
records or elected to conceal them to further obfuscate their
activities. Neither is favorable to petitioners.
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Concerning explanations for behavior, petitioners, other
than offering a few broad, general statements, have made little
attempt to justify or illuminate the rationale underlying their
association with the Aegis system. Certain inconsistencies,
however, give us pause. Mr. Richardson at trial testified that
he had consulted with several independent tax professionals
before purchasing the Aegis trust package, but in response to a
previous interrogatory from respondent requesting identification
of persons from whom advice was secured prior to creation of the
trusts had listed only individuals connected with Aegis.
Mr. Richardson’s testimony that he became uncomfortable in late
1999 or 2000 with arguments being asserted by Aegis in
conjunction with challenges to the trust structure and began to
disengage from those positions is likewise suspect.
Mr. Morgason’s description of Mr. Richardson’s behavior during
the 2002 section 6700 investigation is to the contrary and is
corroborated by audio recordings of conferences conducted
pursuant thereto.
Concealment of income and assets is at the crux of this
litigation and requires little further discussion. The
establishment of a trust structure without economic substance, to
which income and assets are transferred for tax avoidance
purposes, has been considered by this Court to be an affirmative
indicium of fraud. Mason v. Commissioner, T.C. Memo. 2004-247;
Dunlap v. Commissioner, T.C. Memo. 1993-187; Brittain v.
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Commissioner, T.C. Memo. 1992-277. As a related point,
petitioners’ use of the trust arrangement to claim business
deductions for personal expenses, especially items related to
their personal residence, likewise bolsters the impression of a
concerted effort to avoid taxation.
Failure to cooperate with tax authorities is another
particularly noteworthy badge on these facts. Petitioners not
only declined to cooperate in the examination of their returns
but also sought actively to impede the audit. Petitioners did
not provide any substantive information in response to
Mr. Morgason’s requests. They then went so far as to prevent
respondent from obtaining data from third parties by, for
instance, discouraging compliance with summonses and even filing
a petition to quash.
The badge pertaining to illegal activities is germane here
as well. Mr. Richardson was in the business of promoting and
selling abusive trust arrangements, which created revenue issues
for respondent and for countless purchasers. Moreover, as
pointed out by the District Court in the section 6700 proceeding
against Mr. Richardson and Mr. Graham, “whether before or after
Muhich I or its affirmance by the Seventh Circuit, the trust
scheme in which they engaged was, and ought to have been known to
be, illegal.” United States v. Graham, No. 1:03cv96 (S.D. Ohio
June 23, 2005). The very business income concealed in
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petitioners’ trust structure was generated through sales of an
illegal product.
Mr. Richardson’s failure to heed warnings with respect to
the improper nature of the Aegis trust structure and analogous
schemes likewise has bearing on his state of mind and intentions
at the time he chose to purchase and use the package.
Specifically, the failure suggests that the legality of the
arrangement was of little concern to Mr. Richardson.
Mr. Richardson was aware of Notice 97-24, 1997-1 C.B. 409, by
June of 1997. He was contacted by Ms. Vaselaney between late
1999 and early 2001. The magistrate judge in the section 6700
proceeding initially recommended a preliminary injunction, based
on Mr. Richardson’s participation in what was characterized as an
“illogical and illegal” scheme, in November of 2003. United
States v. Graham, No. 1:03cv96, 2003 WL 23169851, at *7 (S.D.
Ohio Nov. 19, 2003). In the face of all these warnings, it would
seem that an individual truly interested in a legitimate
arrangement would have at least sought out an independent
evaluation, rather than continuing to align him- or herself with
insiders, many of whom had questionable qualifications.
In summary, the majority of the badges of fraud considered
by this and other courts are present here. Accordingly, the
Court concludes that the circumstantial indicia revealed by the
record in these cases establish by clear and convincing evidence
that Mr. Richardson intended through his use of the Aegis trust
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system to evade taxes known to be owing. Respondent has shown
that at least some part of the underpayment for each 1996 and
1997 is attributable to fraud. Furthermore, because
Mr. Richardson has failed to show that any portion of the
underpayments upon which the section 6663 penalty was computed
was not due to fraud, respondent is sustained as to this issue
with respect to both years.
V. Section 6662 Accuracy-Related Penalty
Subsection (a) of section 6662 imposes an accuracy-related
penalty in the amount of 20 percent of any underpayment that is
attributable to causes specified in subsection (b). Subsection
(b)(1) of section 6662 then provides that among the causes
justifying imposition of the penalty is negligence or disregard
of rules or regulations.
“Negligence” is defined in section 6662(c) as “any failure
to make a reasonable attempt to comply with the provisions of
this title”, and “disregard” as “any careless, reckless, or
intentional disregard.” Caselaw similarly states that
“‘Negligence is a lack of due care or the failure to do what a
reasonable and ordinarily prudent person would do under the
circumstances.’” Freytag v. Commissioner, 89 T.C. 849, 887
(1987) (quoting Marcello v. Commissioner, 380 F.2d 499, 506 (5th
Cir. 1967), affg. on this issue 43 T.C. 168 (1964) and T.C. Memo.
1964-299), affd. 904 F.2d 1011 (5th Cir. 1990), affd. 501 U.S.
868 (1991). Pursuant to regulations, “‘Negligence’ also includes
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any failure by the taxpayer to keep adequate books and records or
to substantiate items properly.” Sec. 1.6662-3(b)(1), Income Tax
Regs.
An exception to the section 6662(a) penalty is set forth in
section 6664(c)(1) and reads: “No penalty shall be imposed under
this part with respect to any portion of an underpayment if it is
shown that there was a reasonable cause for such portion and that
the taxpayer acted in good faith with respect to such portion.”
Regulations interpreting section 6664(c) state:
The determination of whether a taxpayer acted with
reasonable cause and in good faith is made on a case-
by-case basis, taking into account all pertinent facts
and circumstances. * * * Generally, the most important
factor is the extent of the taxpayer’s effort to assess
the taxpayer’s proper tax liability. * * * [Sec.
1.6664-4(b)(1), Income Tax Regs.]
Reliance upon the advice of a tax professional may, but does
not necessarily, demonstrate reasonable cause and good faith in
the context of the section 6662(a) penalty. Id.; see also United
States v. Boyle, 469 U.S. 241, 251 (1985); Freytag v.
Commissioner, supra at 888. Such reliance is not an absolute
defense, but it is a factor to be considered. Freytag v.
Commissioner, supra at 888.
In order for this factor to be given dispositive weight, the
taxpayer claiming reliance on a professional must show, at
minimum: “(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
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(3) 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); see also,
e.g., Charlotte’s Office Boutique, Inc. v. Commissioner, 425
F.3d 1203, 1212 & n.8 (9th Cir. 2005) (quoting verbatim and with
approval the above three-prong test), affg. 121 T.C. 89 (2003);
Westbrook v. Commissioner, 68 F.3d 868, 881 (5th Cir. 1995),
affg. T.C. Memo. 1993-634; Cramer v. Commissioner, 101 T.C. 225,
251 (1993), affd. 64 F.3d 1406 (9th Cir. 1995); Ma-Tran Corp. v.
Commissioner, 70 T.C. 158, 173 (1978); Pessin v. Commissioner, 59
T.C. 473, 489 (1972); Ellwest Stereo Theatres v. Commissioner,
T.C. Memo. 1995-610.
As regards burden of proof, section 7491(c) provides that
“the Secretary shall have the burden of production in any court
proceeding with respect to the liability of any individual for
any penalty, addition to tax, or additional amount imposed by
this title.” The Commissioner satisfies this burden of
production by “[coming] forward with sufficient evidence
indicating that it is appropriate to impose the relevant penalty”
but “need not introduce evidence regarding reasonable cause,
substantial authority, or similar provisions.” Higbee v.
Commissioner, 116 T.C. 438, 446 (2001). Rather, “it is the
taxpayer’s responsibility to raise those issues.” Id.
The notice of deficiency issued to Mr. Richardson asserted
applicability of the section 6662(a) penalty on account of
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negligence or disregard with respect to the portion of the
underpayment attributable to disallowance of the $3,000 capital
loss claimed by petitioners for 1996. We conclude that
respondent has met the section 7491(c) burden of production as to
this matter. The evidence adduced in these cases reveals a
complete absence of adequate records and substantiation for the
reported loss. With this threshold showing, the burden shifts to
Mr. Richardson to establish that he acted with reasonable cause
and in good faith as to this item.
Petitioners did not mention the capital loss or how it was
derived either at trial or on brief, nor have they offered any
specific arguments directed to the section 6662 penalty. The
Court therefore is unable to offer relief from the determined
amount.
VI. Statute of Limitations
As a general rule, section 6501(a) provides that any tax
must be assessed within 3 years of the date on which the
pertinent tax return was filed. However, an exception exists in
the case of “a false or fraudulent return with the intent to
evade tax”, under which exception tax may be assessed “at any
time.” Sec. 6501(c)(1). The Commissioner bears the burden of
proving fraud in this context as well, but again, it is
sufficient for avoidance of the statue of limitations to
establish only that some portion of the deficiency is due to
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fraud. Sec. 7454(a); Rule 142(b); Jackson v. Commissioner, 380
F.2d 661, 664 (6th Cir. 1967), affg. T.C. Memo. 1964-330.
Furthermore, it must be noted that it is the false or
fraudulent return that holds the statute open. Ballard v.
Commissioner, 740 F.2d 659, 663 (8th Cir. 1984), affg. in part
and revg. in part on another ground T.C. Memo. 1982-466; Allen v.
Commissioner, T.C. Memo. 1986-125. As a result, this and other
courts have long held that where a joint return is filed, fraud
by one spouse will serve to lift the statute of limitations as
to, and permit assessment against, both spouses. E.g., Ballard
v. Commissioner, supra at 663; Carsendino v. Commissioner, T.C.
Memo. 1994-79; Dahlstrom v. Commissioner, T.C. Memo. 1991-264;
Allen v. Commissioner, supra.
Because respondent here has by clear and convincing evidence
proven fraud on the part of Mr. Richardson for the reasons
explained above, assessment of petitioners’ 1996 and 1997 tax
liabilities is not barred by the statute of limitations.
Petitioners’ intonations at various junctures that
Mrs. Richardson is entitled to judgment as a matter of law on
statute of limitations grounds are without legal basis or merit.
VII. Relief From Joint and Several Liability
Notwithstanding the Court’s rulings on the foregoing issues,
petitioners assert that Mrs. Richardson is in any event entitled
to relief from joint and several liability under section
6015(b)(1). As a general rule, section 6013(d)(3) provides that
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“if a joint return is made, the tax shall be computed on the
aggregate income and the liability with respect to the tax shall
be joint and several.” An exception to such joint and several
liability exists, however, for spouses able to satisfy the
statutory requirements for relief set forth in section 6015.
Section 6015 authorizes three types of relief. Subsection
(b) provides a form of relief available to all joint filers and
similar to, but less restrictive than, that previously afforded
by former section 6013(e). Subsection (c) permits a taxpayer who
has divorced or separated to elect to have his or her tax
liability calculated as if separate returns had been filed.
Subsection (f) confers discretion upon respondent to grant
equitable relief, based on all facts and circumstances, in cases
where relief is unavailable under subsection (b) or (c).
Mrs. Richardson here explicitly makes her appeal under subsection
(b)(1), the requisite elements of which are as follows:
SEC. 6015(b). Procedures for Relief From
Liability Applicable to All Joint Filers.--
(1) In general.--Under procedures prescribed
by the Secretary, if--
(A) a joint return has been made for a
taxable year;
(B) on such return there is an
understatement of tax attributable to
erroneous items of 1 individual filing the
joint return;
(C) the other individual filing the
joint return establishes that in signing the
return he or she did not know, and had no
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reason to know, that there was such
understatement;
(D) taking into account all the facts
and circumstances, it is inequitable to hold
the other individual liable for the
deficiency in tax for such taxable year
attributable to such understatement; and
(E) the other individual elects (in such
form as the Secretary may prescribe) the
benefits of this subsection not later than
the date which is 2 years after the date the
Secretary has begun collection activities
with respect to the individual making the
election,
then the other individual shall be relieved of
liability for tax (including interest, penalties,
and other amounts) for such taxable year to the
extent such liability is attributable to such
understatement.
The burden rests on Mrs. Richardson to establish that she has met
each of five elements enumerated above. Alt v. Commissioner, 119
T.C. 306, 311 (2002), affd. 101 Fed. Appx. 34 (6th Cir. 2004).
Respondent has conceded that the first and fifth requirements are
satisfied; thus, the second, third, and fourth requirements
remain in dispute.
At the outset, we highlight a few difficulties created by
the state of the record on this issue. Mrs. Richardson did not
testify at trial, so the Court has had no opportunity to assess
her demeanor and credibility, nor has respondent had a chance to
solicit information on cross-examination. In fact, there is a
notable dearth of evidence directed specifically to this issue.
What data can be gleaned about Mrs. Richardson’s involvement in
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the trust scheme must therefore be drawn principally from minutes
of board meetings for HGAMC and HGRCT and from a few comments
made by Mr. Richardson at trial. Neither of these sources is
particularly supportive of petitioners’ position.
Turning to the particular requirements of section 6015(b) in
dispute here, we note that cases interpreting former section
6013(e) remain instructive in our analysis of the parallel
requisites of section 6015(b). Butler v. Commissioner, 114 T.C.
276, 283 (2000). Section 6015(b)(1)(B) mandates that the
understatement of tax be attributable to erroneous items of the
nonrequesting spouse. A similar attribution provision was
contained in former section 6013(e)(1)(B) and has been construed
by this and other courts. As regards the pertinent legal
standard, the Court of Appeals for the Fifth Circuit has stated:
“where omitted income is generated by the performance of
substantial services by one spouse, that income should be
attributed to that spouse for purposes of section 6013(e)(1).”
Allen v. Commissioner, 514 F.2d 908, 913 (5th Cir. 1975), affg.
in part, revg. in part on another ground, and remanding 61 T.C.
125 (1973). This Court has since applied the foregoing principle
in cases under both 6013(e)(1) and 6015(b)(1). E.g., Ishizaki v.
Commissioner, T.C. Memo. 2001-318; Grubich v. Commissioner, T.C.
Memo. 1993-194.
The understatements for 1996 and 1997 in these cases flowed
in large part from petitioners’ failure to include receipts
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generated by sales of Aegis trusts and related services. As
suggested by the preceding findings and discussion, the totality
of the record, while leaving much to be desired, indicates that
it was Mr. Richardson who engaged in the underlying selling
operations. Petitioners would thus seem to have a colorable
argument with respect to at least a portion of the
understatements being attributable to erroneous items of
Mr. Richardson. Nonetheless, it is unnecessary for the Court to
reach a definitive conclusion as to this requirement in light of
the conjunctive nature of the criteria and the following.
Section 6015(b)(1)(C) specifies that the requesting spouse
have had neither knowledge nor reason to know of the
understatement at the time the return was signed. A requesting
spouse is considered to have reason to know in this context if a
reasonably prudent taxpayer in his or her position, at the time
the return was signed, could be expected to know that the return
contained an understatement or that further investigation was
warranted. Butler v. Commissioner, supra at 283. Hence, the
spouse seeking relief may have a “duty of inquiry”. Id. at 284.
In applying the foregoing “reason to know” standard, factors
considered relevant include:
(1) The alleged innocent spouse’s level of education;
(2) the spouse’s involvement in the family’s business
and financial affairs; (3) the presence of expenditures
that appear lavish or unusual when compared to the
family’s past income levels, income standards, and
spending patterns; and (4) the culpable spouse’s
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evasiveness and deceit concerning the couple’s
finances. [Id.; citation omitted]
Here, the degree of involvement suggested by the documentary
record, in the absence of any credible countervailing testimony
by Mrs. Richardson, is fatal to her claim. Mrs. Richardson was a
director of HGAMC and a trustee of HGRCT. She executed each of
the documents involved in establishing and operating the
entities, including the agreements between HGAMC and Asset
Protection Services pertaining to Mr. Richardson’s services. She
signed the minutes for each of the dozens of board meetings,
which recounted in notable detail purported activities of the
entities. Perhaps even more importantly, Mr. Richardson
testified at trial that Mrs. Richardson attended all of the
meetings where those matters were discussed. The Forms 990-PF
claim that Mrs. Richardson devoted 2 hours per week to her work
as trustee for HGRCT. Mrs. Richardson also possessed signatory
authority over entity bank accounts. There is no indication of
any evasiveness toward Mrs. Richardson on Mr. Richardson’s part;
rather, Mrs. Richardson was apparently welcomed as a participant
in the HGAMC and HGRCT arrangement.
Despite the above evidence, petitioners contend on brief
that Mrs. Richardson “was undergoing treatment for cancer and was
unable to work for the entire 1997 tax year. She is 69 years
old, works as a medical assistant and has a high school
education.” They also make reference to her being “unschooled in
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tax matters” and relying on the accountant who prepared the
returns.
Although the Court is not unsympathetic as regards medical
difficulties encountered by Mrs. Richardson, the record contains
no evidence to corroborate any specifics regarding her illness or
level of incapacity during the relevant 1996 to 1997 period. In
fact, the record conflicts with any allegation that her
involvement in HGAMC or HGRCT was materially curtailed.
Furthermore, with respect to tax matters and reliance on a
professional, the Court in other contexts and as previously
explained has required the taxpayer to show, at minimum: “(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, P.A. v. Commissioner, 115
T.C. at 99.
Here, a defense of justifiable reliance rings hollow in
light of Mr. Graham’s connection to the Aegis scheme and the
complete absence of evidence to show that Mrs. Richardson made
any attempt to review the returns in a meaningful way, ask
questions, etc. After all, in light of Mrs. Richardson’s
extensive involvement, including attendance at the June 27, 1997,
meeting addressing Notice 97-24, 1997-1 C.B. 409, and at a later
section 6700 conference with the IRS, it is equally likely on the
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record presented that she was well aware of and condoned the
aggressive tax positions advocated by her husband and Mr. Graham.
On brief, petitioners repeatedly reference the quote: “Mere
knowledge that the spouse has invested in a tax shelter resulting
in substantial tax savings is accordingly, without more,
insufficient to establish constructive knowledge of a substantial
understatement”. Friedman v. Commissioner, 53 F.3d 523, 531 (2d
Cir. 1995), affg. in part and revg. in part T.C. Memo. 1993-549.
The comparison simply is not apt. Not only is the premise
factually distinguishable on the record before us revealing
extensive involvement, the case is also legally distinguishable
in that it addresses the standard in an erroneous deduction
context and expressly highlights that different rules apply for
an omission of income situation. Id. at 530. Furthermore,
petitioners chose not to quote the court’s statement that “an
innocent spouse is one who despite having made reasonable efforts
to investigate the accuracy of the joint return remains ignorant
of its illegitimacy.” Id. at 525. As just mentioned, the
evidence here is silent on any such efforts.
On this record, petitioners have failed to establish that
Mrs. Richardson did not have reason to know of the
understatement. Accordingly, Mrs. Richardson is not entitled to
relief under section 6015(b)(1), as the requisites of that
provision are stated in the conjunctive. Nonetheless, for the
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sake of completeness, a few comments are in order with respect to
the remaining disputed element.
Section 6015(b)(1)(D) demands that, taking into account all
facts and circumstances, it be inequitable to hold the requesting
spouse liable for the deficiency. Here, however, the particulars
of petitioners’ situation recounted above do not persuade the
Court that the necessary inequities would ensue from joint
liability. Petitioners are still married and residing together,
the record documents extensive involvement by Mrs. Richardson in
the HGAMC and HGRCT arrangement, and both petitioners benefited
jointly from the improvements in their financial status
engendered by avoiding taxation on Mr. Richardson’s personal
service income and deducting personal expenses (including
expenditures related to their residence, vehicles, healthcare,
etc.) through HGAMC.
In this connection, petitioners ask us to hold in
Mrs. Richardson’s favor because she did not benefit beyond normal
support, directly or indirectly, from the alleged understatement.
The record, however, is bereft of evidence to support this
contention. The documents chronicle the financial engineering
just described, and petitioners have not offered any evidence
pertaining to their lifestyle before or after implementation of
the Aegis scheme to show that no attendant perks were realized
thereby. Furthermore, all indications are that such attendant
benefits would have been shared equally between the spouses.
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Hence, the scenario at bar simply does not present the type of
disadvantage and unfairness contemplated by the section 6015(b)
criteria. To reiterate, Mrs. Richardson does not qualify for
relief from joint and several liability under section 6015(b)(1).
As a final note, Mrs. Richardson does not seek equitable relief
under section 6015(f).
To reflect the foregoing,
Appropriate orders and
decisions for respondent will
be entered.
Richardson v. Comm'r
Court: United States Tax Court
Date filed: 2006-04-11
Citations: 91 T.C.M. 981, 2006 Tax Ct. Memo LEXIS 71, 2006 T.C. Memo. 69
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