Vlock v. Comm'r

T.C. Memo. 2010-3

UNITED STATES TAX COURT

FRANCIS J. AND JEANNE M. VLOCK, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 13443-07. Filed January 5, 2010.

Frank W. Pechacek, Jr., and Jamie L. Cox, for petitioners.

James A. Kutten and Stephen A. Haller, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

CHIECHI, Judge: Respondent determined the following defi-

ciencies in, and accuracy-related penalties under section

6662(a)1 on, petitioners’ Federal income tax (tax):

1
All section references are to the Internal Revenue Code
(Code) in effect for the years at issue. All Rule references are
to the Tax Court Rules of Practice and Procedure.
 - 2 -

Accuracy-Related
Year Deficiency Penalty Under Sec. 6662(a)
2003 $33,492 $6,698.40
2004 23,561 4,712.20
2005 31,866 6,373.20

The issues remaining for decision are:

(1) Are petitioners entitled to deduct under section 162(a)

for each of their taxable years 2003 through 2005 certain amounts

that petitioner Francis J. Vlock paid to a certain corporation?

We hold that they are not.

(2) Are petitioners entitled to deduct under section 162(a)

for their taxable year 2003 certain amounts that they claim

petitioner Francis J. Vlock paid to two of their children for

services rendered? We hold that they are not.

(3) Are petitioners liable for each of their taxable years

2003 through 2005 for the accuracy-related penalty under section

6662(a)? We hold that they are.

FINDINGS OF FACT

Some of the facts have been stipulated and are so found

except as stated herein.

At the time petitioners filed the petition in this case,

they resided in Nebraska.
 - 3 -

Mr. Vlock’s Insurance Business

From at least 1978 to the time of the trial in this case,

petitioner Francis J. Vlock (Mr. Vlock)2 served as an insurance

representative of one or more insurance companies. As an insur-

ance representative, Mr. Vlock sold insurance and certain other

financial products, such as variable annuities and other securi-

ties, in several States. From 2000 to the time of the trial in

this case, Mr. Vlock primarily represented New York Life Insur-

ance Co. (New York Life). From 2002 to the time of the trial in

this case, Mr. Vlock was an independent contractor of New York

Life and operated his business (Mr. Vlock’s insurance business)

as a sole proprietorship.

From 1975 until 2002, petitioner Jeanne M. Vlock (Ms. Vlock)

spent most of her time raising and caring for petitioners’ four

children. Before 2002, Ms. Vlock had been involved sporadically

in Mr. Vlock’s insurance business and had occasionally provided

certain unidentified services to Mr. Vlock’s insurance business.

In June 2000, Mr. Vlock underwent hip surgery, which re-

quired him to spend several months recovering. In order to

maintain Mr. Vlock’s insurance business during that period of

recovery, Mr. Vlock worked primarily at petitioners’ personal

2
In referring to Mr. Vlock, the record refers interchange-
ably to Francis J. Vlock, F. Joseph Vlock, Joseph Vlock, and Joe
Vlock.
 - 4 -

residence at South 167th Circle, Omaha, Nebraska (petitioners’

residence).

In 2000, Mr. Vlock and New York Life entered into a contract

whereby Mr. Vlock became a so-called district agent of New York

Life. As such, Mr. Vlock, inter alia, was responsible for

hiring, training, and developing individuals to become agents for

New York Life (agents-in-training). In exchange for his services

as a district agent, Mr. Vlock was entitled to certain commis-

sions on the sales of New York Life insurance products by the

agents-in-training. Mr. Vlock treated the agents-in-training

that he hired in his capacity as a New York Life district agent

as independent contractors.

Starting around 2000, Mr. Vlock acquired as clients approxi-

mately 2,500 to 3,000 individuals (additional clients) who had

been clients of certain other agents of New York Life who had

died or retired. Those additional clients nearly doubled the

total number of clients of Mr. Vlock’s insurance business.

While Mr. Vlock was recovering from his hip surgery and was

acquiring the additional clients, he decided that he needed

additional assistance in order to maintain and improve Mr.

Vlock’s insurance business. Around 2000 or 2001, Mr. Vlock

discussed with Ms. Vlock whether she was willing to become more

involved in Mr. Vlock’s insurance business in order to assist him

in servicing additional clients and obtaining new clients. Ms.
 - 5 -

Vlock was open to that possibility because petitioners’ children

no longer required her full-time care and attention. At a time

between around mid-2000 and the end of 2001, petitioners agreed

that Ms. Vlock was to provide to Mr. Vlock certain assistance in

marketing Mr. Vlock’s insurance business and servicing its

clients.

From 2002 through the summer of 2006, Mr. Vlock operated Mr.

Vlock’s insurance business in office space that he leased at 6901

Dodge Street, Omaha, Nebraska (Dodge Street office). In the

summer of 2006, Mr. Vlock terminated the lease with respect to

that office and moved Mr. Vlock’s insurance business to office

space that New York Life owned at Valmont Plaza, Omaha, Nebraska.

During 2003 through 2005, the years at issue, Mr. Vlock

employed at least one or more of the following individuals in Mr.

Vlock’s insurance business: Paul Jensen, Shirley Schmidt, and

Kiran Khajuria. During those years, those employees performed

their respective duties for Mr. Vlock’s insurance business at the

Dodge Street office.

Paul Jensen, whom Mr. Vlock employed on a full-time basis

during 2003 and part of 2004, served as a receptionist for Mr.

Vlock’s insurance business and also was responsible for perform-

ing certain administrative and secretarial tasks for that busi-

ness. Those tasks included (1) scheduling certain appointments

for Mr. Vlock, (2) creating files for certain new clients and
 - 6 -

certain prospective clients, (3) managing interns that Mr. Vlock

hired, (4) maintaining office equipment used at the Dodge Street

office, and (5) preparing newsletters and other mailings. During

2003 and 2004, Mr. Vlock paid to Paul Jensen total wages of

$29,475.84 and $19,466.56, respectively, and reported those

amounts in Forms W-2, Wage and Tax Statements (Forms W-2), that

he issued to him for those respective years.

Shirley Schmidt, whom Mr. Vlock employed on a part-time

basis during each of the years at issue, was responsible for

performing certain administrative and financial tasks for Mr.

Vlock’s insurance business. Those tasks included (1) payroll

administration, (2) handling certain calls from clients,

(3) preparing disclosure documents and compliance materials,

(4) processing checks, executing wire transfers, and conducting

certain other financial transactions, and (5) preparing certain

tax reporting materials such as Forms W-2 and Forms 1099-MISC,

Miscellaneous Income (Forms 1099-MISC). During 2003, 2004, and

2005, Mr. Vlock paid to Shirley Schmidt total wages of $17,770,

$17,578, and $14,072, respectively, and reported those amounts in

Forms W-2 that he issued to her for those respective years. In

addition to paying those wages to Shirley Schmidt, Mr. Vlock paid

her total nonemployee compensation of $2,320.08, $2,087.27, and

$925.41 during 2003, 2004, and 2005, respectively, and reported
 - 7 -

those amounts in Forms 1099-MISC that he issued to her for those

respective years.

Kiran Khajuria, whom Mr. Vlock employed on a part-time basis

during 2005, was responsible for performing various tasks for Mr.

Vlock’s insurance business. Those tasks included (1) maintaining

prospectuses for the various financial products that Mr. Vlock

sold to clients, (2) maintaining computer equipment at the Dodge

Street office, (3) installing software on the computer system

utilized at the Dodge Street office, and (4) backing up that

computer system and maintaining all backup files. During 2005,

Mr. Vlock paid to Kiran Khajuria total wages of $1,383 and

reported that amount in Form W-2 that he issued to that individ-

ual for that year.

During 2004 and 2005, Mr. Vlock also hired Richard Ness and

Joaquin Wilwayco to provide services to Mr. Vlock’s insurance

business as independent contractors. During those years, Richard

Ness assisted Mr. Vlock’s insurance business with, inter alia,

training staff and identifying and developing new markets for

that business’s insurance and financial products. During 2004

and 2005, Mr. Vlock paid to Richard Ness total nonemployee

compensation of $3,000 and $8,000, respectively, and reported

those amounts in Forms 1099-MISC that he issued to him for those

respective years.
 - 8 -

During 2004, Joaquin Wilwayco provided to Mr. Vlock’s

insurance business certain software training and assisted Mr.

Vlock with certain presentations and educational seminars.

During 2004, Mr. Vlock paid to Joaquin Wilwayco total nonemployee

compensation of $500 and reported that amount in Form 1099-MISC

that he issued to him for that year.

From 2002 through October 2005, Ms. Vlock worked 30 to 50

hours per week performing a number of services for Mr. Vlock’s

insurance business. Those services included (1) preparing and

distributing materials relating to certain seminars and certain

programs that Mr. Vlock’s insurance business offered to its

clients and potential clients; (2) organizing speakers, venues,

itineraries, and other logistics for those seminars and those

programs; (3) receiving and processing certain calls from some

clients of Mr. Vlock’s insurance business regarding their ac-

counts; (4) sorting mail delivered to petitioners’ residence

between personal mail and mail relating to Mr. Vlock’s insurance

business; (5) scheduling for Mr. Vlock certain appointments with

some clients and some potential clients of Mr. Vlock’s insurance

business; (6) arranging and tracking certain medical appointments

for some clients of Mr. Vlock’s insurance business where such

appointments were prerequisites in order to buy certain insurance

products; (7) handling home entertainment and hospitality for

certain clients of Mr. Vlock’s insurance business; (8) processing
 - 9 -

certain claims for benefits; and (9) entering into Mr. Vlock’s

insurance business’s database system certain account information

for some of the additional clients and organizing and maintaining

relevant files with respect to those clients. Beginning in

October 2005, Ms. Vlock reduced the number of hours that she

worked each week for Mr. Vlock’s insurance business to about 30

hours.

Mr. Vlock prepared the following documents with respect to

Mr. Vlock’s insurance business: (1) A document dated December

2002 and entitled “Annual Business Plan for Joe Vlock, CLU, ChFC

& Associates, 1729 South 167 Circle, Omaha, NE 68130” (December

2002 annual business document); (2) a document dated January 2004

and entitled “Annual Business Plan for Joe Vlock, CLU, ChFC &

Associates, 1729 South 167 Circle, Omaha, NE 68130” (January 2004

annual business document); and (3) a document dated January 2005

and entitled “2005 Business Plan, F. Joseph Vlock, CLU, ChFC &

Richard L. ‘Rick’ Ness, LUTCF, New York Life” (January 2005

annual business document). (We shall refer collectively to the

December 2002 annual business document, the January 2004 annual

business document, and the January 2005 annual business document

as the Vlock insurance business annual business documents.)

The second page of the December 2002 annual business docu-

ment (December 2002 annual business document second page) was
 - 10 -

entitled “JOE VLOCK 2002 BUSINESS PLAN, PERFORMED BY

VLOCK/HAMMOND” and stated:

Specific Goals for 2002

1. Chairman’s Council

2. Recreation Time (Family)

3. Education

4. Consistent Growth

5. Prioritize Phone List

6. Keep Notes in File Neat/Clean up Files

7. Workable Plan

8. Creative Time

9. Time Management

The December 2002 annual business document second page was the

only page on which Mr. Vlock referred in the December 2002 annual

business document to “VLOCK/HAMMOND”.3 In the December 2002

annual business document, Mr. Vlock did not set forth any spe-

cific goals that he expected Vlock and Hammond to accomplish, or

any specific tasks that he expected Vlock and Hammond to perform,

with respect to Mr. Vlock’s insurance business.

In the January 2004 annual business document, Mr. Vlock did

not refer to Vlock and Hammond. Instead, Mr. Vlock referred in

that document to “Jeanne” (i.e., Ms. Vlock) the following four

3
We believe that the reference to “VLOCK/HAMMOND” is to
Vlock and Hammond, Inc. (discussed below). (We shall refer to
Vlock and Hammond, Inc., as Vlock and Hammond.)
 - 11 -

times: (1) In a section entitled “Opportunities”, Mr. Vlock

stated that “Jeanne is committed to co-ordinate all marketing and

case preparation and public relations with clients”; (2) in a

section entitled “Threats”, Mr. Vlock asked: “Can Joe & Jeanne

work together”; and (3) in a section entitled “Key Strategies for

Planning Year”, Mr. Vlock stated (a) that he was to “Spend 2-3

hours with Jeanne coordinating monthly seminars, case presenta-

tions and client appreciation workshops”, and (b) “Jeanne to

coordinate center of influence appointments.” Mr. Vlock did not

indicate in the January 2004 annual business document that the

four references in that document to “Jeanne” were to Ms. Vlock

acting on behalf of Vlock and Hammond. Nor did Mr. Vlock refer

in the January 2004 annual business document to “Jeanne” in such

a way as to establish that, if and when Ms. Vlock were to perform

services for Mr. Vlock’s insurance business, she would be acting

on behalf of Vlock and Hammond.

Mr. Vlock did not refer to Vlock and Hammond or to Ms. Vlock

in the January 2005 annual business document. In that document,

Mr. Vlock set forth goals and objectives for Mr. Vlock, Richard

Ness, and a person identified in that document as “Jess”. In the

January 2005 annual business document, Mr. Vlock also set forth

analyses of the strengths and weaknesses of, the opportunities

for, and the threats to Mr. Vlock and Richard Ness. In that

document, Mr. Vlock did not assign any tasks or goals to Vlock
 - 12 -

and Hammond or to Ms. Vlock acting on behalf of Vlock and Hammond

and did not indicate that Vlock and Hammond or Ms. Vlock acting

on behalf of Vlock and Hammond was to assist Mr. Vlock, Richard

Ness, or “Jess” in achieving any of the goals and objectives that

Mr. Vlock set forth in that document for each of them.

During 2003, an unidentified individual prepared two docu-

ments (business potential documents), each of which was entitled

“ASSESS YOUR BUSINESS POTENTIAL REPPORT [sic] - 2003, JOE VLOCK,

CLU, CHFC/VLOCK & HAMMOND”. Each of those titles contained the

only reference to Vlock and Hammond in each of those documents.

Each of the business potential documents contained several

statements that were addressed directly to Mr. Vlock, including

the following:

Joe, here is my summary of your needs for coaching and
activities to go to the next level. All of these
actions and systems could be set up through customized
coaching.

OVERVIEW OF ACTIONS NEEDED AND YOUR COACHING NEEDS

• Clear Goals: for 1 year and 1 quarter
• Clear Marketing Systems: Target market busi-
ness/estate, build strong client centers of
Influence, use your speaking skills.
• Better staff utilization: train Jean[4] to be
your marketing coordinator.
• Polish your office systems: have less ser-
vice interruptions.
• Better time management: plan and coordinate
your day, week, and month; deal with your
time wasters.

4
We believe that the reference to “Jean” is to Ms. Vlock.
 - 13 -

• Get out of your comfort zone: stay “focused”
on your insurance business.
• Increase your sales activity and case size
through target marketing.
• Joe, good things are ahead for you and your
staff. You can go to the next level.

The reference to “Jean” in the above-quoted statement was the

only reference to Ms. Vlock in each of the business potential

documents. The author of each of those documents did not indi-

cate therein that each such reference was to Ms. Vlock acting on

behalf of Vlock and Hammond. Nor did the author refer in either

of the business potential reports to Ms. Vlock in such a way as

to establish that, if and when Ms. Vlock were to perform services

for Mr. Vlock’s insurance business, she would be acting on behalf

of Vlock and Hammond.

Petitioners filed Form 1040, U.S. Individual Income Tax

Return, for each of their taxable years 2003 (2003 return), 2004

(2004 return), and 2005 (2005 return). Frank Pechacek (Mr.

Pechacek), an attorney at the firm of Willson & Pechacek, P.L.C.,

prepared each of those returns for petitioners.5 Petitioners

attached to each of the 2003 return, the 2004 return, and the

2005 return Schedule C, Profit or Loss From Business (Schedule

C). In each of those schedules, Mr. Vlock reported income

derived from, and claimed expenses with respect to, Mr. Vlock’s

insurance business.

5
Mr. Pechacek is the lead attorney who represents petition-
ers in this case.
 - 14 -

In Schedule C that petitioners attached to the 2003 return

(2003 Schedule C), Mr. Vlock claimed the following expenses,

inter alia, with respect to Mr. Vlock’s insurance business:

Description Amount
Rent--Dodge Street office $20,096
Wages 47,246
Contract labor 5,920
Management services 120,000

The amount that Mr. Vlock claimed as a deduction for contract

labor in the 2003 Schedule C included a total of $3,600 that Mr.

Vlock reported as nonemployee compensation in respective Forms

1099-MISC for taxable year 2003 that he issued to petitioners’

daughters Sarina and Jennifer (collectively, Vlock daughters).

In those respective forms, Mr. Vlock claimed that he paid as

“Nonemployee compensation” $1,400 and $2,200 to Sarina and

Jennifer, respectively.

In Schedule C that petitioners attached to the 2004 return

(2004 Schedule C), Mr. Vlock claimed the following expenses,

inter alia, with respect to Mr. Vlock’s insurance business:

Description Amount
Rent--Dodge Street office $18,972
Wages 37,044
Contract labor 4,000
Management services 120,000
 - 15 -

In Schedule C that petitioners attached to the 2005 return

(2005 Schedule C), Mr. Vlock claimed the following expenses,

inter alia, with respect to Mr. Vlock’s insurance business:

Description Amount
Rent--Dodge Street office $20,696
Wages 24,380
Management services 109,000

The respective deductions that petitioners claimed with

respect to management services in the 2003 Schedule C, the 2004

Schedule C, and the 2005 Schedule C represented the respective

amounts that petitioners claimed that Mr. Vlock paid to Vlock and

Hammond during 2003, 2004, and 2005, respectively.

Vlock and Hammond

As discussed above, Ms. Vlock wanted to help Mr. Vlock with

Mr. Vlock’s insurance business, and between around mid-2000 and

the end of 2001 petitioners agreed that Ms. Vlock was to provide

to Mr. Vlock’s insurance business certain assistance in marketing

that business and servicing some of its clients. However,

petitioners wanted Ms. Vlock to do so in a manner that would

achieve certain tax-avoidance objectives (discussed below). In

an attempt to achieve those objectives, on December 27, 2001, Ms.

Vlock incorporated Vlock and Hammond under the laws of the State

of Nebraska. From the incorporation of Vlock and Hammond

throughout the years at issue, Ms. Vlock was its sole stockholder
 - 16 -

and its sole director, and the following individuals served as

its officers:

Jeanne M. Vlock President and Treasurer
Angela Vlock6 Vice President
Francis J. Vlock Secretary

One of the tax-avoidance objectives of petitioners in having

Ms. Vlock incorporate Vlock and Hammond was that they did not

want Ms. Vlock to receive cash wages for the services that she

was to perform for Mr. Vlock’s insurance business because she

would have to report any such wages as income and pay tax on that

income. Another tax-avoidance objective of petitioners in having

Ms. Vlock incorporate Vlock and Hammond was to have Vlock and

Hammond pay virtually all of petitioners’ personal living ex-

penses with funds which Mr. Vlock was to pay to Vlock and Hammond

and for which petitioners were to claim tax deductions.

In an attempt to bolster the chances that they would succeed

in achieving their tax-avoidance objectives, petitioners created

a paper trail relating to Vlock and Hammond.

The Purported Management Agreement

On January 1, 2002, Mr. Vlock and Vlock and Hammond executed

a document entitled “MANAGEMENT CONSULTING AGREEMENT” (purported

management agreement). Ms. Vlock executed that document on

6
Angela Vlock is petitioners’ oldest child.
 - 17 -

behalf of Vlock and Hammond. The purported management agreement

stated in pertinent part:

1. Management Services. [Mr.] Vlock hereby
contracts with [Vlock and Hammond] * * * to perform
management and consulting services in accordance with
the terms and conditions set forth in this Agreement.

[Vlock and Hammond] * * * will consult with [Mr.]
Vlock concerning matters related to the management and
operation of [Mr. Vlock’s insurance business] * * *,
his financial policies, and generally any matter aris-
ing out of the business affairs of [Mr.] Vlock. The
management services shall include, but not be limited
to, advice and services regarding marketing, account-
ing, technical and computer support, and personnel
matters. The management services regarding personnel
matters shall include advice regarding employment
control, supervision, hiring and discharge of employees
and independent contractors hired by [Mr.] Vlock.

[Vlock and Hammond] * * * may provide advice with
respect to employee benefits and enter into negotia-
tions regarding same on behalf of [Mr.] Vlock. [Vlock
and Hammond] * * * will also provide advice with re-
spect to the purchase and/or lease of equipment and
supplies relating to [Mr.] Vlock’s business.

* * * * * * *

3. Payment to Consulting Company. [Mr.] Vlock
shall pay [Vlock and Hammond] * * * the sum of
$10,000.0 [sic] per month on or before the first day of
each month. [Mr.] Vlock shall not be required to pay
any other fee or benefit to [Vlock and Hammond] * * *
for services rendered. [Vlock and Hammond] * * * may
submit reasonable out-of-pocket expenses from time to
time to [Mr.] Vlock which will be reimbursed only upon
[Mr.] Vlock[’s] approval.

4. Duties of Consulting Company. [Vlock and
Hammond] * * * shall furnish consulting and management
services and render advice to [Mr.] Vlock at all times
reasonably requested by [Mr.] Vlock, subject, however,
to the following conditions:

* * * * * * *
 - 18 -

g. [Vlock and Hammond] * * * shall provide ade-
quate office space, office equipment and
furnishings, general liability insurance, all
office supplies, adequate office staff, all
telephone and reception services, all reason-
able subscriptions and all postage, corre-
spondence materials and typing services to
[Mr.] Vlock.

In arriving at the $10,000 amount stated in section 3

(quoted above) of the purported management agreement, neither Mr.

Vlock nor Ms. Vlock consulted an accountant, business manager, or

compensation expert. However, Ms. Vlock consulted Mr. Pechacek,

the attorney whom petitioners retained for the purpose of assist-

ing Ms. Vlock in incorporating Vlock and Hammond and drafting

certain documents for it, including, inter alia, the purported

management agreement.7

On October 25, 2005, Mr. Vlock and Vlock and Hammond exe-

cuted an amendment (2005 amendment) to the purported management

agreement. That amendment reduced the amount stated in section 3

of that purported agreement from $10,000 per month to $7,500 per

month.

7
The record does not establish what Mr. Pechacek, who was
the preparer of petitioners’ 2003 return, 2004 return, and 2005
return and who is the lead attorney representing petitioners in
this case, see supra note 5, told Ms. Vlock when she consulted
him. Before the commencement of the trial in this case, peti-
tioners waived any potential conflicts of interest regarding Mr.
Pechacek, who was not called as a witness at that trial.
 - 19 -

At the times indicated,8 Mr. Vlock paid to Vlock and Hammond

the following amounts (Mr. Vlock’s payments to Vlock and

Hammond):9

Time Amount
January 2003 $5,000.00
Feb. 6, 2003 10,000.00
Mar. 4, 2003 10,000.00
Apr. 9, 2003 10,000.00
May 2003 10,000.00
June 10, 2003 10,000.00
July 21, 2003 5,000.00
Sept. 3, 2003 10,000.00
October 2003 10,000.00
November 2003 10,000.00
Nov. 29, 2003 11,100.00
Dec. 6, 2003 10,000.00
2003 Total $111,100.00

8
The record does not establish the days in all of the months
during the years at issue on which Mr. Vlock made payments to
Vlock and Hammond.
9
Petitioners concede that they are unable to establish that
Mr. Vlock made all of the payments to Vlock and Hammond that they
claimed as the respective deductions in the 2003 Schedule C, the
2004 Schedule C, and the 2005 Schedule C. They also concede that
during each of the years at issue Mr. Vlock paid to Vlock and
Hammond a total amount that was less than (1) the annual total of
the monthly amount stated in sec. 3 of the purported management
agreement and (2) the amount that petitioners claimed as a
deduction for management services in Schedule C included with the
return that they filed for each of those years.
 - 20 -

Jan. 5, 2004 $10,000.00
Feb. 5, 2004 10,000.00
Mar. 29, 2004 10,000.00
Apr. 13, 2004 10,000.00
May 1, 2004 10,000.00
June 11, 2004 10,000.00
July 7, 2004 10,000.00
Aug. 9, 2004 10,000.00
Sept. 10, 2004 10,000.00
Nov. 1, 2004 10,000.00
2004 Total $100,000.00

January 2005 $10,000.00
February 2005 20,000.00
April 2005 10,000.00
May 2005 10,000.00
June 2005 10,000.00
July 2005 5,000.00
August 2005 10,000.00
September 2005 10,000.00
October 2005 10,000.00
November 2005 12,873.33
2005 Total $107,873.33

The Purported Employment Agreement

On January 1, 2002, Ms. Vlock and Vlock and Hammond executed

a document entitled “EMPLOYMENT AGREEMENT” (purported employment

agreement). Ms. Vlock executed that document both in her indi-

vidual capacity and in her capacity as president of Vlock and

Hammond. The purported employment agreement stated in pertinent

part:

An Agreement made between Jeanne M. Vlock of
Omaha, Nebraska, herein referred to as Employee and
Vlock & Hammond, Inc., whose principal place of busi-
ness is located at 1729 South 167th Circle, Omaha,
 - 21 -

Nebraska [petitioners’ residence], herein referred to
as Employer.

* * * * * * *

SECTION 1.

EMPLOYMENT

Employer hereby employs, engages, and hires Em-
ployee as an operational supervisor and monitor of a
portion of Employer’s business, and Employee hereby
accepts and agrees to such hiring, engagement and
employment, subject to the general supervision and
pursuant to the orders, advice and direction of Em-
ployer.

Because of certain necessities required for the
proper performance of the duties which the Employee
must perform for the Employer under this Agreement and
because of the benefits and conveniences accruing to
the Employer by having the Employee residing on busi-
ness premises of the Employer, the Employee shall be
required to live in the housing furnished by the Em-
ployer on the business premises [petitioners’ resi-
dence] of the Employer. * * *

* * * * * * *

SECTION 3.

TERM OF EMPLOYMENT

The term of this Agreement shall be a period of
one year, commencing January 1, 2002, and terminating
Dec. 31, 2003 [sic], subject however, to prior termina-
tion as herein provided. At the expiration date of
Dec. 31, 20023 [alteration in original], this Agreement
shall be considered renewed for regular periods of one
year provided neither party submits a notice of termi-
nation.

* * * * * * *
 - 22 -

SECTION 6.

SPECIFIC DESCRIPTION OF CERTAIN DUTIES

While at all times, the Employee will be subject
to such additional duties and services as may be re-
quired by the Employer, the following are a list of
certain specific duties and responsibilities Employee
[Ms. Vlock] shall have in performing services for the
Employer. The Employee in performing these services
shall be on call twenty-four hours a day except for
reasonable vacations as the Employer may allow. Duties
and responsibilities are to be performed at the loca-
tion as directed by the Employer above.

(1) To constantly be present in the area of
responsibility to deter and guard
against vandalism and theft of equip-
ment, tools, buildings, and other prop-
erty of the Employer.

(2) To maintain watch over the property of
the Employer so as to discover and re-
port any damage to any of the Employer’s
property from wind, fire, freezing, or
other catastrophes and to take any other
action if possible to minimize said
losses.

(3) To be present on the premises so as to
immediately detect and report any inter-
ruption of electrical service to the
facilities of the Employer so as to
minimize the possibility of any losses.

(4) To monitor the performance and activi-
ties of other Employees of the Employer
working on the premises and report to
the Employer concerning their activi-
ties.

(5) To provide assistance to other Employees
of the Employer in case of a breakdown
or emergency while operating on the
property of the Employer.
 - 23 -

(6) To be present to alert other designated
Employees of shipments of materials
being received by Employer.

The purported employment agreement contained a section

entitled “COMPENSATION OF EMPLOYEE” that stated:

SECTION 4.

COMPENSATION OF EMPLOYEE

Employer [Vlock and Hammond] shall pay Employee
[Ms. Vlock] and Employee shall accept from Employer, in
full payment for Employee’s services hereunder, minimum
compensation at the rate of to be determined later[10]
Dollars ($_______) per year, payable ________. Not-
withstanding any language to the contrary, Employer, in
its sole discretion, may pay Employee additional com-
pensation from time to time.

At no time during the years at issue did Ms. Vlock or Vlock and

Hammond determine a rate of compensation to be paid to Ms. Vlock

as stated in section 4 of the purported employment agreement.

Vlock and Hammond’s Board of Directors

On January 1, 2002, Vlock and Hammond held a meeting (Janu-

ary 1, 2002 meeting) of its board of directors (Vlock and Hammond

board), whose only member was Ms. Vlock. The minutes of that

meeting stated, inter alia, that the Vlock and Hammond board

(1) elected officers of Vlock and Hammond, (2) adopted the bylaws

of Vlock and Hammond, (3) designated First Westroads Bank as

Vlock and Hammond’s depository institution, (4) required that

10
The phrase “to be determined later” was handwritten in a
blank underlined space in sec. 4 of the purported employment
agreement.
 - 24 -

Vlock and Hammond’s officers and director use their best efforts

to operate Vlock and Hammond in such a manner that stock of Vlock

and Hammond would qualify as stock under section 1244, (5) ac-

cepted Ms. Vlock’s offer to purchase stock of Vlock and Hammond

and issued to her a certificate representing the number of shares

that she purchased, (6) made an election under section 248 with

respect to Vlock and Hammond’s organizational expenses,

(7) authorized Ms. Vlock to pay any expenses resulting from the

organization of Vlock and Hammond, and (8) adopted a “Nondiscrim-

inatory Medical and Dental Reimbursement Plan”. The minutes of

the January 1, 2002 meeting did not reflect that the Vlock and

Hammond board discussed at that meeting the purported management

agreement and the purported employment agreement that Vlock and

Hammond had executed on the date of that meeting. Nor did those

minutes reflect that the Vlock and Hammond board discussed at

that meeting the nature or the extent of the services (1) that

the purported management agreement stated Vlock and Hammond was

to provide to Mr. Vlock’s insurance business and (2) that the

purported employment agreement stated Ms. Vlock was to provide to

Vlock and Hammond during any of the years at issue.

On November 22, 2003, Vlock and Hammond held a joint meeting

of stockholders of Vlock and Hammond and the Vlock and Hammond

board (November 22, 2003 meeting). The minutes of that meeting

stated, inter alia, that the Vlock and Hammond board elected
 - 25 -

officers of Vlock and Hammond. Those minutes did not reflect

that the Vlock and Hammond board discussed at the November 22,

2003 meeting the purported management agreement or the purported

employment agreement. Nor did the minutes of that meeting

reflect that the Vlock and Hammond board discussed at that

meeting the nature or the extent of the services (1) that the

purported management agreement stated Vlock and Hammond was to

provide to Mr. Vlock’s insurance business and (2) that the

purported employment agreement stated Ms. Vlock was to provide to

Vlock and Hammond during any of the years at issue. The minutes

of the November 22, 2003 meeting did not reflect that the Vlock

and Hammond board discussed at that meeting that during 2003 Mr.

Vlock had failed to pay, or had paid late, certain of the amounts

stated in section 3 of the purported management agreement.

On November 16, 2004, Vlock and Hammond held a joint meeting

of stockholders of Vlock and Hammond and the Vlock and Hammond

board (November 16, 2004 meeting). The minutes of that meeting

stated, inter alia, that the Vlock and Hammond board elected

officers of Vlock and Hammond. Those minutes did not reflect

that the Vlock and Hammond board discussed at the November 16,

2004 meeting the purported management agreement or the purported

employment agreement. Nor did the minutes of that meeting

reflect that the Vlock and Hammond board discussed at that

meeting the nature or the extent of the services (1) that the
 - 26 -

purported management agreement stated Vlock and Hammond was to

provide to Mr. Vlock’s insurance business and (2) that the

purported employment agreement stated Ms. Vlock was to provide to

Vlock and Hammond during any of the years at issue. The minutes

of the November 16, 2004 meeting did not reflect that the Vlock

and Hammond board discussed at that meeting that during 2004 Mr.

Vlock had failed to pay, or had paid late, certain of the amounts

stated in section 3 of the purported management agreement or the

purported employment agreement.

On October 25, 2005, Vlock and Hammond held a joint meeting

of stockholders of Vlock and Hammond and the Vlock and Hammond

board (October 25, 2005 meeting). The minutes of that meeting

stated, inter alia, that the Vlock and Hammond board elected

officers of Vlock and Hammond. Those minutes did not reflect

that the Vlock and Hammond board discussed at the October 25,

2005 meeting the purported management agreement or the purported

employment agreement. Nor did the minutes of that meeting

reflect that the Vlock and Hammond board discussed at that

meeting the 2005 amendment that Vlock and Hammond had executed on

the date of that meeting. The minutes of the October 25, 2005

meeting did not reflect that the Vlock and Hammond board dis-

cussed at that meeting the nature or the extent of the services

(1) that the purported management agreement stated Vlock and

Hammond was to provide to Mr. Vlock’s insurance business and
 - 27 -

(2) that the purported employment agreement stated Ms. Vlock was

to provide to Vlock and Hammond during any of the years at issue.

Nor did those minutes reflect that the Vlock and Hammond board

discussed at that meeting that during 2005 Mr. Vlock had failed

to pay, or had paid late, certain of the amounts stated in

section 3 of the purported management agreement.

Certain Payments Made by Vlock and Hammond

Consistent with petitioners’ tax-avoidance objectives, Vlock

and Hammond (1) did not pay at any time during any of the years

at issue any cash wages to Ms. Vlock11 and (2) paid during each

of those years virtually all of petitioners’ personal living

expenses with funds which Mr. Vlock paid to Vlock and Hammond and

for which petitioners claimed tax deductions.12

Certain Payments Made by Vlock and
Hammond Relating to Petitioners’ Residence

On January 1, 2002, Vlock and Hammond and petitioners

executed a document entitled “REAL ESTATE CONTRACT-INSTALLMENTS”

11
From 2002 until the time of the trial in this case, Vlock
and Hammond (1) did not file Form 941, Employer’s Quarterly
Federal Tax Return, for any quarter or Form 940, Employer’s
Annual Federal Unemployment (FUTA) Tax Return, for any taxable
year and (2) did not issue any Form W-2 or Form 1099-MISC.
12
The parties stipulated the amounts of the personal ex-
penses of petitioners that Vlock and Hammond paid during each of
the calendar years 2003, 2004, and 2005, even though Vlock and
Hammond had a taxable year ending on November 30. As for certain
payments that Vlock and Hammond made to Sarina (discussed below),
the parties stipulated the amounts that Vlock and Hammond paid to
her during each of its taxable years ended Nov. 30, 2003 through
2005.
 - 28 -

(real estate installment document). That document stated in

pertinent part:

IT IS AGREED this 1st day of January, 2002, by and
between F. Joseph Vlock and Jeanne M. Vlock, husband
and wife, of the County of Douglas, State of
IowaNebraska [alteration in original], Sellers; and
Vlock & Hammond, Inc. of the County of Douglas, State
of IowaNebraska [alteration in original], Buyers;

That the Sellers, as in this contract provided,
agree to sell to the Buyers, and the Buyers in consid-
eration of the premises, hereby agree with the Sellers
to purchase the following described real estate situ-
ated in the County of Douglas, State of IowaNebraska
[alteration in original] to-wit:

Lot Twenty-five (25), Pacific Heights Replat I, a
Subdivision in Douglas County, Nebraska [petitioners’
residence]

* * * upon the terms and conditions following:

1. TOTAL PURCHASE PRICE. The Buyers agree to pay
for said property the total of $290,000.00 due and
payable * * * as follows:

* * * * * * *

The sum of $2,941.00, principal and interest, per
month, commencing with the first payment due on Febru-
ary 1, 2002, in the sum of $2,941.00, principal and
interest, on the first day of each and every month
thereafter until all principal and interest is paid in
full. Interest shall accrue at the rate of 9% per
annum.

Buyer shall have the option to prepay in full or in
part at any time without penalty.

The real estate installment document was filed with the Recorder

of Deeds for Omaha, Nebraska. At no time did petitioners execute

a deed in favor of Vlock and Hammond with respect to petitioners’
 - 29 -

residence. Petitioners continued to reside in petitioners’

residence after executing the real estate installment document.13

When petitioners and Vlock and Hammond executed the real

estate installment document, petitioners’ residence was subject

to a mortgage held by CitiMortgage. At no time did petitioners

notify CitiMortgage that they had executed the real estate

installment document.

Vlock and Hammond did not make all of the monthly payments

to petitioners that the real estate installment document stated

it was to make. Instead, Vlock and Hammond paid to petitioners

the following amounts on the dates indicated:

13
On June 23, 2006, petitioners and Vlock and Hammond exe-
cuted a document entitled “WARRANTY DEED-JOINT TENANCY” (warranty
deed). That deed stated in pertinent part:

For the consideration of $224,900.00 Dollar(s) * * *
Vlock & Hammond, Inc., * * * and F. Joseph Vlock and
Jeanne M. Vlock, * * * do hereby Convey to Freddie J.
Thayer and Connie L. Thayer, * * * Lot Twenty-five
(25), Pacific Heights Replat I, a Subdivision, as
surveyed, platted and recorded in Douglas County,
Nebraska [petitioners’ residence]

The warranty deed was recorded with the Recorder of Deeds in
Omaha, Nebraska. Peabody Title & Escrow Co. prepared a “SELLER’S
CLOSING STATEMENT” that identified petitioners as the sellers of
petitioners’ residence and indicated that, after accounting for
all necessary adjustments, petitioners received $179,008.94 in
cash from the sale of petitioners’ residence.
 - 30 -

Date Amount
Apr. 10, 2003 $8,823
July 6, 2003 11,764
Sept. 5, 2003 5,882
Oct. 7, 2003 2,941
Nov. 4, 2003 2,941
Dec. 9, 2003 2,941
2003 Total $35,292

Jan. 4, 2004 $2,941
Feb. 4, 2004 2,941
Apr. 12, 2004 5,882
June 10, 2004 5,882
July 14, 2004 2,941
Aug. 8, 2004 2,941
Sept. 10, 2004 2,941
Oct. 14, 2004 2,941
Nov. 6, 2004 2,941
2004 Total $32,351

Jan. 4, 2005 $2,941
Feb. 10, 2005 5,882
Mar. 16, 2005 2,996
Apr. 16, 2005 2,996
May 17, 2005 2,996
June 16, 2005 2,996
July 15, 2005 2,996
Aug. 6, 2005 2,996
Sept. 13, 2005 2,996
Oct. 5, 2005 2,996
Nov. 10, 2005 2,996
Dec. 14, 2005 2,996
2005 Total $38,783

(We shall refer to the foregoing amounts that Vlock and Hammond

paid to petitioners as the real estate installment document

payments.)
 - 31 -

In addition to the payments described above, during each of

the years at issue Vlock and Hammond paid virtually all of the

expenses relating to petitioners’ residence. Those expenses

included the following amounts that Vlock and Hammond paid during

the years indicated for expenses for real property taxes, repairs

and improvements (e.g., a sprinkler system, pest management, a

refrigerator and other appliances, hardware and other supplies,

plumbers and other home repairmen, carpet cleaning, and contrac-

tors), housecleaning services, landscaping services, bottled

water service, and all utilities (i.e., electric, gas, water, and

sewer service, cable television and Internet access, and tele-

phone service):
 - 32 -

Amount Paid During
Category 2003 2004 2005
Real property taxes $3,484.46 $3,592.96 $4,113.76
Repairs and improvements
Sprinkler system 2,300.00 -- --
Pest management -- 96.30 --
Appliances 75.29 549.68 263.79
Hardware and supplies 658.67 1,523.33 --
Repairmen 2,350.00 424.59 --
Carpet cleaning 317.79 347.75 342.40
Contractors -- 690.00 --
Other items 767.40 487.46 256.22
Housecleaning services -- 150.00 285.00
Landscaping services 246.99 1,228.76 1,650.38
Bottled water service 114.37 8.56 162.20
Utilities
Electric 1,978.68 1,345.12 1,353.33
Gas, water, and sewer 1,540.39 1,667.77 1,611.05
Cable television and
Internet access 358.98 1,160.14 1,490.58
Telephone service 889.86 369.10 --

(We shall refer to the foregoing amounts that Vlock and Hammond

paid for virtually all of the expenses relating to petitioners’

residence as the personal residence expenses.)

During each of the years at issue, Vlock and Hammond also

paid to maintain cellular telephone service for petitioners.

During 2003, 2004, and 2005, Vlock and Hammond paid $1,320.98,

$1,114.09, and $862.63, respectively, for that service. (We shall

refer to the foregoing amounts that Vlock and Hammond paid for

cellular telephone service as the cellular telephone expenses).
 - 33 -

Certain Payments Made by
Vlock and Hammond Relating to Food

During each of the years at issue, Ms. Vlock purchased food

at area grocery stores, including, inter alia, Bakers Grocery

Store, Albertsons Grocery Store, and Hy Vee Grocery Store.

During each of those years, Vlock and Hammond reimbursed Ms.

Vlock for the purchases of food that she made during each such

year. Ms. Vlock used the food for which Vlock and Hammond paid

to prepare meals for her family and friends. During 2003, 2004,

and 2005, Vlock and Hammond reimbursed Ms. Vlock $5,958.20,

$6,254.54, and $7,629.02, respectively, for the food that she

purchased during those years. (We shall refer to the foregoing

amounts that Vlock and Hammond reimbursed Ms. Vlock for food that

she purchased as the reimbursed food expenses.)

Certain Payments Made by Vlock and
Hammond Relating to Medical and Dental Expenses

On January 1, 2002, Vlock and Hammond and Ms. Vlock executed

a document entitled “NONDISCRIMINATORY MEDICAL AND DENTAL REIM-

BURSEMENT PLAN”. That document stated in pertinent part:

the Corporation [Vlock and Hammond] agrees to reimburse
you [Ms. Vlock] for all reasonable medical and dental
expenses up to the sum of $25,000.00 in any fiscal year
* * * which you [Ms. Vlock] and/or members of your
immediate family may incur, except such expenses which
are covered and are reimbursable to you from any medi-
cal, dental, health and/or accident insurance policy
insuring you and/or members of your immediate family.

During each of the years at issue, Vlock and Hammond reim-

bursed Ms. Vlock for the amounts that petitioners paid as
 - 34 -

(1) premiums for a health insurance plan issued by New York Life

to Mr. Vlock (NYL health plan) that he maintained to cover

himself and his family, (2) copayments to health care providers

pursuant to the NYL health plan, and (3) premiums for two long-

term care insurance plans covering Mr. Vlock and two such plans

covering Ms. Vlock.14 (We shall refer collectively to the fore-

going amounts that Vlock and Hammond reimbursed Ms. Vlock as the

reimbursed medical expenses.)

Certain Payments Made by Vlock and
Hammond Relating to Educational Expenses

On January 1, 2003, Vlock and Hammond adopted a document

entitled “Educational Assistance Plan” (educational assistance

document). That document stated in pertinent part:

Article II –- Definitions

* * * * * * *

2.03 “Benefits” means the direct payment or reimburse-
ment of Covered Costs incurred by a Participant for
Educational Courses.

* * * * * * *

2.05 “Covered Costs” means the tuition, fees and
similar payments and the cost of books paid for or
incurred by a Participant in taking an Educational
Course. * * *

14
The record does not establish the total amount that Vlock
and Hammond reimbursed Ms. Vlock during each of the years at
issue. As discussed below, Vlock and Hammond claimed deductions
for reimbursed medical expenses of $4,595, $6,873, and $997 in
the returns that it filed for its taxable years ended Nov. 30,
2003, 2004, and 2005, respectively.
 - 35 -

2.06 “Educational Course” means any course taken by a
Participant at an Accredited Institution, except for a
course that instructs the Participant in any sport,
game or hobby.

* * * * * * *

2.12 “Participant” means any Employee or Former Em-
ployee who has satisfied the eligibility requirements
of Section 3.01.

* * * * * * *

Article III –- Eligibility

3.01 Every Employee who has completed one Year of
Service on the effective date of the Plan and every
Former Employee shall automatically become a Partici-
pant in the Plan on that date. Each other Employee
shall become a Participant in the Plan on the first day
of the Plan Year after he has completed one Year of
Service.

* * * * * * *

Article IV –- Benefits

4.01 Every Participant in the Plan shall be eligible
to receive Benefits under the Plan for Covered Costs
incurred by the Participant, subject to the limitations
of Article V.

* * * * * * *

Article V –- Limitations on Benefits

* * * * * * *

5.05 A Participant may not receive more than $5,250 in
Benefits under the Plan for the year in accordance with
Code Section 127(a).

* * * * * * *

Article VII –- Named Fiduciary and Plan Administrator

7.01 Jeanne M. Vlock is hereby designated as the Plan
Administrator and Named Fiduciary * * *.
 - 36 -

During none of Vlock and Hammond’s taxable years ended

November 30, 2003, 2004, and 2005, was Sarina an employee or a

former employee of Vlock and Hammond as defined in the educa-

tional assistance document. As a result, Sarina was not eligible

during any of those years to receive any benefits under that

document. Nonetheless, Vlock and Hammond paid to Sarina $5,250,

$5,250, and $5,000 during its taxable years ended November 30,

2003, 2004, and 2005, respectively.15 (We shall refer to the

foregoing amounts that Vlock and Hammond paid to Sarina for

tuition and other educational expenses as the educational assis-

tance expenses.)

Certain Payments Made by Vlock and
Hammond Relating to Petitioners’ Automobiles

On January 1, 2002, petitioners executed a document entitled

“INSTALLMENT SALE AGREEMENT” (Lexus sale document). That docu-

ment stated:

The undersigned does hereby sell and transfer to
Vlock & Hammond, Inc. all of their right, title and
interest to the following:

1. 1996 Lexus automobile

2. Price: $20,000.00

3. Interest Rate: 10%

4. Number of Payments: 36

15
From around September 2003 to around May 2007, Sarina was
a student at the University of Kansas. During that time,
Sarina’s tuition, room and board, book, and other expenses at
that university were approximately $18,000 a year.
 - 37 -

5. Monthly Payment Amount: $645.00[16]

DATED: January 1, 2002.

From January 1, 2002, through around the summer of 2005, Mr.

Vlock was the primary user of the 1996 Lexus automobile. During

that time, Mr. Vlock used that automobile for both business and

personal purposes.

On December 1, 2002, petitioners executed another document

entitled “INSTALLMENT SALE AGREEMENT” (Suburban sale document).17

That document stated:

The undersigned does hereby sell and transfer to
Vlock & Hammond, Inc. all of their right, title and
interest to the following:

1. 1999 Suburban automobile

2. Price: $20,000.00

3. Interest Rate: 10%

4. Number of Payments: 36

16
The record does not establish whether Vlock and Hammond
made any of the payments stated in the Lexus sale document.
However, as discussed below, Vlock and Hammond claimed deductions
for depreciation with respect to the 1996 Lexus automobile of
$4,900, $2,950, and $1,152 in the returns that it filed for its
taxable years ended Nov. 30, 2003, 2004, and 2005, respectively.
17
The parties stipulated that petitioners executed the
Suburban sale document on Jan. 1, 2002. That stipulation is
clearly contrary to the facts that we have found are established
by the record, and we shall disregard it. See Cal-Maine Foods,
Inc. v. Commissioner, 93 T.C. 181, 195 (1989). The record
establishes, and we have found, that petitioners executed the
Suburban sale document on Dec. 1, 2002.
 - 38 -

5. Annual Payment Amount: $8,042.30, due on
January 1, 2004, January 1, 2005 and
January 1, 2006[18]

DATED: December 1, 2002.

During the years at issue, Ms. Vlock was the primary user of the

1999 Suburban automobile. During those years, Ms. Vlock used

that automobile for both business and personal purposes.

On July 1, 2005, Vlock and Hammond purchased a 1999 Lexus

automobile for $19,500. From July 1, 2005, through the end of

2005, Mr. Vlock was the primary user of that automobile.19

Vlock and Hammond’s Tax Returns

Vlock and Hammond filed Form 1120, U.S. Corporation Income

Tax Return (Form 1120), for its taxable years ended November 30,

2003 (11/30/03 corporate return), November 30, 2004 (11/30/04

corporate return), and November 30, 2005 (11/30/05 corporate

return). During each of those taxable years, Vlock and Hammond

derived all of its gross receipts from payments that Mr. Vlock

made to Vlock and Hammond during each such year. In its Forms

1120 for its taxable years ended November 30, 2003 through 2005,

18
The record does not establish whether Vlock and Hammond
made any of the payments stated in the Suburban sale document.
However, as discussed below, Vlock and Hammond claimed a deduc-
tion under sec. 179 with respect to the 1999 Suburban automobile
of $20,000 in the return it filed for its taxable year ended Nov.
30, 2003.
19
The record does not disclose whether Mr. Vlock used the
1999 Lexus automobile for business purposes, personal purposes,
or both.
 - 39 -

Vlock and Hammond reported the following amounts as gross re-

ceipts for the year indicated:20

Taxable Year Ended Amount
Nov. 30, 2003 $120,000
1
Nov. 30, 2004 120,100
Nov. 30, 2005 109,000
1
In the 2004 Schedule C, petitioners claimed a deduction for
management services of $120,000. The record does not establish
why there is a $100 discrepancy between that amount and the
amount that Vlock and Hammond reported as gross receipts in the
11/30/04 corporate return.

In its Forms 1120 for its taxable years ended November 30,

2003 through 2005, Vlock and Hammond claimed deductions for each

of those years for, inter alia, the personal residence expenses,

the cellular telephone expenses, the reimbursed food expenses,

the reimbursed medical expenses, and the educational assistance

expenses, as follows:

20
See supra note 9.
 - 40 -

Deductions Claimed
for the Taxable Year Ended
Description 11/30/03 11/30/04 11/30/05
Reimbursed medical expenses $4,595 $6,873 $997
Other expenses
Insurance -- 3,698 929
Real property taxes 3,484 3,592 4,114
Repairs and maintenance 3,972 4,335 2,061
Telephone 1,240 457 --
Utilities 3,746 4,115 4,894
Janitorial 450 -- --
Interest included in real
estate installment
document payments 24,968 23,999 22,940
Educational assistance
expenses 5,250 5,250 5,000
Reimbursed food expenses 5,681 5,463 8,481
Cellular telephone expenses 1,327 941 1,145

Vlock and Hammond attached Form 4562, Depreciation and

Amortization, to the 11/30/03 corporate return, the 11/30/04

corporate return, and the 11/30/05 corporate return. In those

forms, Vlock and Hammond claimed the following depreciation

deductions and section 179 expenses with respect to, inter alia,

petitioners’ residence, certain of the personal residence ex-

penses, the 1996 Lexus automobile, the 1999 Lexus automobile, and

the 1999 Suburban automobile:
 - 41 -

Amount Claimed for
the Taxable Year Ended
Description 11/30/03 11/30/04 11/30/05
1 2
Section 179 expense deduction $22,975 -- $2,960
MACRS deductions for assets
placed in service in prior
3 3 3
tax years 12,451 $11,856 11,481
Listed property4 4,900 2,950 1,152
1
The sec. 179 expense deduction claimed in the 11/30/03
corporate return consisted of claimed expenses of $20,000 for the
1999 Suburban automobile, $1,800 that Vlock and Hammond paid for
a sprinkler system installed at petitioners’ residence, and
$1,175 described as “DOORS”.
2
The sec. 179 expense deduction claimed in the 11/30/05
corporate return was with respect to the 1999 Lexus automobile.
3
The MACRS deductions claimed in the 11/30/03, 11/30/04, and
11/30/05 corporate returns included $10,544 that Vlock and
Hammond claimed as depreciation on petitioners’ residence.
4
The listed property deduction represented depreciation on
the 1996 Lexus automobile that Vlock and Hammond claimed it used
for business purposes 100 percent of the time.

During the summer of 2005, Vlock and Hammond sold the 1996

Lexus automobile to petitioners’ daughter Sarina. Vlock and

Hammond reported that sale in Form 4797, Sales of Business

Property (Form 4797), that it attached to the 11/30/05 corporate

return, as follows:

Description Amount
1
Gross sales price $5,000
Depreciation allowed or
allowable since acquisition 9,002
Cost or other basis, plus
improvements and expense of
sale 20,000
Gain or (loss) (5,998)
1
The record does not establish whether Sarina paid to Vlock
and Hammond the $5,000 that it reported as the gross sales price
of the 1996 Lexus automobile in Form 4797 that it attached to the
11/30/05 corporate return.
 - 42 -

In the 11/30/05 corporate return, Vlock and Hammond did not

report any amount as recapture of depreciation with respect to

the sale of the 1996 Lexus automobile to Sarina.

Vlock and Hammond attached Schedule L, Balance Sheets per

Books, to the 11/30/03 corporate return, the 11/30/04 corporate

return, and the 11/30/05 corporate return. In each of those

schedules, Vlock and Hammond reported the following total amounts

of loans to stockholders outstanding at the beginning and end of

each of those taxable years:

Loan Balance at Loan Balance
Taxable Year Ended Beginning of Year at End of Year
Nov. 30, 2003 $2,315 $17,001
Nov. 30, 2004 17,001 41,476
Nov. 30, 2005 41,476 26,268

Respondent’s Examinations of
Petitioners and Vlock and Hammond

In June 2006, respondent commenced an examination of

(1) petitioners’ taxable years 2003 through 2005 and (2) Vlock

and Hammond’s taxable years ended November 30, 2003 through 2005.

On February 13, 2007, respondent sent to Vlock and Hammond

two letters (no-change letters), one pertaining to its two

taxable years ended November 30, 2003 and 2004, and the other

pertaining to its taxable year ended November 30, 2005. In each

of those letters, respondent notified Vlock and Hammond that

respondent had “completed the examination of your tax return for
 - 43 -

the year(s)” to which each letter pertained and that respondent

“made no changes to your reported tax” for those years.

On March 22, 2007, respondent issued to petitioners a notice

of deficiency with respect to their taxable years 2003 through

2005 (2003-2005 notice). In that notice, respondent determined,

inter alia, (1) that the payments that Mr. Vlock made to Vlock

and Hammond during each of those years and for which petitioners

claimed a deduction for each such year are not deductible under

section 162(a) for each of those years21 and (2) that the amounts

that Mr. Vlock paid to the Vlock daughters during 2003 are not

deductible under section 162(a) for that year. In the 2003-2005

notice, respondent also determined that petitioners are liable

for each of their taxable years at issue for the accuracy-related

penalty under section 6662(a).

OPINION

Petitioners bear the burden of proving that the determina-

tions in the 2003-2005 notice that remain at issue are

erroneous.22 See Rule 142(a); Welch v. Helvering, 290 U.S. 111,

115 (1933).

21
In the 2003-2005 notice, respondent advanced an alterna-
tive determination with respect to constructive dividends. See
infra note 27.
22
Petitioners do not claim that the burden of proof shifts
to respondent under sec. 7491(a). On the record before us, we
find that the burden of proof does not shift to respondent under
that section.
 - 44 -

Before turning to the issues presented, we shall address the

testimonial evidence on which petitioners rely to satisfy their

burden of proof with respect to each of those issues.23 That

testimonial evidence consists of the respective testimonies of

Mr. Vlock and Ms. Vlock.

We found the testimony of Mr. Vlock to be in certain mate-

rial respects questionable, vague, self-serving, and/or

evasive. We shall not rely on Mr. Vlock’s testimony to establish

petitioners’ respective positions with respect to the issues to

which that testimony pertained.

During Ms. Vlock’s testimony, she acknowledged that peti-

tioners had the following tax-avoidance objectives in having her

incorporate Vlock and Hammond: (1) Petitioners did not want Ms.

Vlock to receive cash wages for the services that she was to

perform for Mr. Vlock’s insurance business because she would have

to report any such wages as income and pay tax on that income,

and (2) petitioners wanted Vlock and Hammond to pay virtually all

of petitioners’ personal living expenses with funds which Mr.

Vlock was to pay to Vlock and Hammond and for which petitioners

were to claim tax deductions. We found the remaining testimony

of Ms. Vlock to be in certain material respects questionable,

vague, and/or self-serving. We shall not rely on Ms. Vlock’s

23
Petitioners also rely on certain documentary evidence to
satisfy their burden of proof with respect to the issues pre-
sented. We shall address that documentary evidence below.
 - 45 -

remaining testimony to establish petitioners’ respective posi-

tions with respect to the issues to which that testimony per-

tained.

Claimed Deductions for Mr. Vlock’s
Payments at Issue to Vlock and Hammond

It is the position of petitioners that Mr. Vlock’s payments

to Vlock and Hammond during each of the years at issue are

deductible under section 162(a) for each of those years. In

support of that position, petitioners argue that respondent may

not deny them the deductions that they are claiming for those

payments because when respondent issued the no-change letters to

Vlock and Hammond, respondent acknowledged that those payments

are income to Vlock and Hammond and that therefore they are

deductible by petitioners.

We reject petitioners’ argument about the no-change letters

that respondent issued to Vlock and Hammond. Those no-change

letters did not contain a determination by respondent that Mr.

Vlock’s payments to Vlock and Hammond during each of the years at

issue are includible in Vlock and Hammond’s income.24 In the no-

change letters in question, respondent notified Vlock and Hammond

that respondent had “completed the examination of your tax

return” and “made no changes to your reported tax.”

24
See Miller v. Commissioner, T.C. Memo. 2001-55.
 - 46 -

Respondent could have made changes to Vlock and Hammond’s

taxable years ended November 30, 2003 through 2005, even after

respondent issued to Vlock and Hammond the respective no-change

letters in question pertaining to those taxable years.25 We

conclude that petitioners may not rely on those no-change letters

to establish that Mr. Vlock’s payments to Vlock and Hammond

during each of the years at issue are includible in Vlock and

Hammond’s income, let alone that respondent had determined that

those payments are deductible by petitioners for each of those

years.26

In further support of their position that Mr. Vlock’s

payments to Vlock and Hammond during each of the years at issue

are deductible under section 162(a) for each of those years,

petitioners argue that (1) after acquiring the additional cli-

ents, Mr. Vlock decided that he needed additional assistance in

order to maintain and improve Mr. Vlock’s insurance business;

25
The Commissioner of Internal Revenue generally may issue a
notice of deficiency to a taxpayer for a taxable year of the
taxpayer even after issuing to that taxpayer a no-change letter
pertaining to the same taxable year. See Opine Timber Co. v.
Commissioner, 64 T.C. 700, 712 (1975), affd. without published
opinion 552 F.2d 368 (5th Cir. 1977); Lawton v. Commissioner, 16
T.C. 725, 727 (1951). Petitioners do not assert that that
general rule does not apply in this case.
26
Petitioners could have avoided a potential whipsaw situa-
tion for themselves and Vlock and Hammond by having Vlock and
Hammond file protective claims for refund for each of its taxable
years ended Nov. 30, 2003 through 2005, on the ground that Vlock
and Hammond did not have any income during each of those years.
Petitioners apparently chose not to file any such claims.
 - 47 -

(2) Ms. Vlock incorporated Vlock and Hammond for the purpose of

providing that assistance to Mr. Vlock’s insurance business;

(3) during each of the years at issue, Vlock and Hammond, pursu-

ant to the purported management agreement, provided to Mr.

Vlock’s insurance business certain assistance with respect to

marketing and client servicing; (4) during each of the years at

issue, Mr. Vlock made Mr. Vlock’s payments to Vlock and Hammond

in exchange for Vlock and Hammond’s services; and (5) the amount

that Mr. Vlock paid to Vlock and Hammond during each of the years

at issue for its services was reasonable.

It is the position of respondent that Mr. Vlock’s payments

to Vlock and Hammond during each of the years at issue are not

deductible under section 162(a) for each of those years.27 That

is because, according to respondent, during the years at issue:

Joseph Vlock and Vlock and Hammond, Inc. * * * executed
a management contract whereby Mr. Vlock paid $10,000 a
month (2003, 2004 and most of 2005, and later reduced
to $7,500 a month in October 2005) for alleged manage-
ment and consulting services.

27
Consistent with the 2003-2005 notice, respondent argues in
the alternative that if we were to find that petitioners are
entitled to deduct under sec. 162(a) for each of their taxable
years 2003 through 2005 Mr. Vlock’s payments to Vlock and Hammond
during each of those years, certain payments that Vlock and
Hammond made for petitioners’ personal expenses and certain
disbursements that Vlock and Hammond made on their behalf are
includible as constructive dividends in petitioners’ gross income
for each of those years. In the light of our holding below that
petitioners are not entitled to deduct under sec. 162(a) for each
of their taxable years 2003 through 2005 Mr. Vlock’s payments to
Vlock and Hammond during each of those years, we need not address
respondent’s alternative argument.
 - 48 -

Petitioners deducted the management fees Joseph
Vlock paid to Vlock and Hammond, Inc. in the amounts of
$120,000 (2003 and 2004) and $109,000 (2005) on their
income tax returns. Vlock and Hammond, Inc. utilized
Mr. Vlock’s payments as a source of funds to pay peti-
tioners personal living expenses * * *.

Petitioners planned this transaction to create a
device to deduct their personal living expenses. Mr.
Vlock’s payments to Vlock and Hammond, Inc. are not
deductible business expenses.

In order to carry their burden of proving that Mr. Vlock’s

payments to Vlock and Hammond during each of the years at issue

are deductible under section 162(a) for each of those years,

petitioners must show that those payments are ordinary and

necessary expenses paid or incurred during the taxable year in

carrying on any trade or business. See sec. 162(a). In order to

establish that Mr. Vlock’s payments to Vlock and Hammond during

each of the years at issue are ordinary and necessary expenses

for each of those years, petitioners must show that those pay-

ments (1) constituted “salaries or other compensation for per-

sonal services actually rendered”, sec. 1.162-7(a), Income Tax

Regs., and (2) were reasonable, see id. In order to establish

that Mr. Vlock’s payments to Vlock and Hammond during each of the

years at issue were compensation for services that Vlock and

Hammond in fact rendered to Mr. Vlock’s insurance business,

petitioners must show that Mr. Vlock made those payments during

each of those years for services that Vlock and Hammond, not Ms.

Vlock in her individual capacity, in fact rendered to that
 - 49 -

business. In order to establish that Mr. Vlock’s payments to

Vlock and Hammond during each of the years at issue were reason-

able, petitioners must show that those payments during each of

those years constituted “only such amount as would ordinarily be

paid for like services by like enterprises under like circum-

stances.” Sec. 1.162-7(b)(3), Income Tax Regs.

In an attempt to establish that during each of the years at

issue Vlock and Hammond in fact rendered services to Mr. Vlock’s

insurance business, petitioners rely on the respective testimo-

nies of Mr. Vlock and Ms. Vlock and certain documentary evidence.

As we stated above, we shall not accept those testimonies to

establish petitioners’ contention that during each of the years

at issue Vlock and Hammond in fact performed services for Mr.

Vlock’s insurance business. With respect to the documentary

evidence on which petitioners rely, that evidence includes the

purported management agreement, the purported employment agree-

ment, the Vlock insurance business annual business documents, and

the business potential documents.

We turn first to the purported management agreement. The

purported management agreement is a self-serving attempt by

petitioners to create a paper trail to bolster the chances that

they would succeed in achieving their tax-avoidance objectives.

Petitioners have not shown that that purported agreement has any

economic reality beyond tax planning. On the record before us,
 - 50 -

we find that the purported management agreement does not estab-

lish that during each of the years at issue Mr. Vlock made Mr.

Vlock’s payments to Vlock and Hammond for services that Vlock and

Hammond in fact rendered during each of those years to Mr.

Vlock’s insurance business under that purported agreement.

We turn next to the purported employment agreement. That

agreement is another self-serving attempt by petitioners to

create a paper trail to bolster the chances that they would

succeed in achieving their tax-avoidance objectives. Petitioners

have not shown that that purported agreement has any economic

reality beyond tax planning. On the record before us, we find

that the purported employment agreement does not establish that

during each of the years at issue Ms. Vlock performed any ser-

vices for Vlock and Hammond under that purported agreement.

We turn next to the Vlock insurance business annual business

documents on which petitioners rely. The December 2002 annual

business document second page was entitled “JOE VLOCK 2002

BUSINESS PLAN, PERFORMED BY VLOCK/HAMMOND” and stated:

Specific Goals for 2002

1. Chairman’s Council

2. Recreation Time (Family)

3. Education

4. Consistent Growth

5. Prioritize Phone List
 - 51 -

6. Keep Notes in File Neat/Clean up Files

7. Workable Plan

8. Creative Time

9. Time Management

The December 2002 annual business document second page was the

only page on which Mr. Vlock referred in the December 2002 annual

business document to “VLOCK/HAMMOND”.28 We believe that Mr.

Vlock’s inclusion of “VLOCK/HAMMOND” in the title of the December

2002 annual business document second page was a part of petition-

ers’ effort to create a paper trail to bolster the chances that

they would succeed in achieving their tax-avoidance objectives.

In the December 2002 annual business document, Mr. Vlock did not

set forth any specific goals that he expected Vlock and Hammond

to accomplish, or any specific tasks that he expected Vlock and

Hammond to perform, with respect to Mr. Vlock’s insurance busi-

ness.29 On the record before us, we find that the December 2002

annual business document does not establish that during any of

the years at issue Vlock and Hammond in fact rendered services to

Mr. Vlock’s insurance business.

28
See supra note 3.
29
We note that certain of the goals that Mr. Vlock set forth
in the December 2002 plan, such as “Creative Time” and “Recre-
ation Time (Family)”, do not appear to be related at all to Mr.
Vlock’s insurance business.
 - 52 -

In the January 2004 annual business document, Mr. Vlock did

not refer to Vlock and Hammond. Instead, Mr. Vlock referred in

that document to “Jeanne” (i.e., Ms. Vlock) the following four

times: (1) In a section entitled “Opportunities”, Mr. Vlock

stated that “Jeanne is committed to co-ordinate all marketing and

case preparation and public relations with clients”; (2) in a

section entitled “Threats”, Mr. Vlock asked: “Can Joe & Jeanne

work together”; and (3) in a section entitled “Key Strategies for

Planning Year”, Mr. Vlock stated (a) that he was to “Spend 2-3

hours with Jeanne coordinating monthly seminars, case presenta-

tions and client appreciation workshops”, and (b) “Jeanne to

coordinate center of influence appointments.” Mr. Vlock did not

indicate in the January 2004 annual business document that the

four references in that document to “Jeanne” were to Ms. Vlock

acting on behalf of Vlock and Hammond. Nor did Mr. Vlock refer

in the January 2004 annual business document to “Jeanne” in such

a way as to establish that, if and when Ms. Vlock were to perform

services for Mr. Vlock’s insurance business, she would be acting

on behalf of Vlock and Hammond. On the record before us, we find

that the January 2004 annual business document does not establish

that during any of the years at issue Vlock and Hammond in fact

rendered services to Mr. Vlock’s insurance business. In fact,

that document tends to show that during 2004 Ms. Vlock performed
 - 53 -

services for Mr. Vlock’s insurance business in her individual

capacity, and not on behalf of Vlock and Hammond.30

In the January 2005 annual business document, Mr. Vlock did

not refer to Vlock and Hammond or to Ms. Vlock. In that docu-

ment, Mr. Vlock set forth goals and objectives for Mr. Vlock,

Richard Ness, and a person identified in that document as “Jess”.

In the January 2005 annual business document, Mr. Vlock also set

forth analyses of the strengths and weaknesses of, the opportuni-

ties for, and the threats to Mr. Vlock and Richard Ness. In that

document, Mr. Vlock did not assign any tasks or goals to Vlock

and Hammond or to Ms. Vlock acting on behalf of Vlock and Hammond

and did not indicate that Vlock and Hammond or Ms. Vlock acting

on behalf of Vlock and Hammond was to assist Mr. Vlock, Richard

Ness, or “Jess” in achieving any of the goals and objectives that

Mr. Vlock set forth in that document for each of them. On the

record before us, we find that the January 2005 annual business

30
Like the January 2004 annual business document, the min-
utes of the meetings of the Vlock and Hammond board also tend to
show that during each of the years at issue Vlock and Hammond did
not in fact render services to Mr. Vlock’s insurance business.
None of those minutes indicated that the Vlock and Hammond board
discussed the purported management agreement, the 2005 amendment,
the purported employment agreement, the services that the pur-
ported management agreement stated that Vlock and Hammond was to
provide to Mr. Vlock’s insurance business, or the services that
the purported employment agreement stated Ms. Vlock was to
provide to Vlock and Hammond. On the record before us, we find
that the minutes of the meetings of the Vlock and Hammond board
do not establish that Vlock and Hammond in fact rendered services
during any of the years at issue to Mr. Vlock’s insurance busi-
ness.
 - 54 -

document does not establish that during any of the years at issue

Vlock and Hammond in fact rendered services to Mr. Vlock’s

insurance business.

We turn finally to the business potential documents on which

petitioners rely to establish that during each of the years at

issue Vlock and Hammond in fact rendered services to Mr. Vlock’s

insurance business. Both of those documents were entitled

“ASSESS YOUR BUSINESS POTENTIAL REPPORT [sic] - 2003, JOE VLOCK,

CLU, CHFC/VLOCK & HAMMOND”. Each of those titles contained the

only reference to Vlock and Hammond in each of those documents.

Each of the business potential documents contained several

statements that were addressed directly to Mr. Vlock, including

the following:

Joe, here is my summary of your needs for coaching and
activities to go to the next level. All of these
actions and systems could be set up through customized
coaching.

OVERVIEW OF ACTIONS NEEDED AND YOUR COACHING NEEDS

• Clear Goals: for 1 year and 1 quarter
• Clear Marketing Systems: Target market busi-
ness/estate, build strong client centers of
Influence, use your speaking skills.
• Better staff utilization: train Jean[31] to
be your marketing coordinator.
• Polish your office systems: have less ser-
vice interruptions.
• Better time management: plan and coordinate
your day, week, and month; deal with your
time wasters.

31
See supra note 4.
 - 55 -

• Get out of your comfort zone: stay “focused”
on your insurance business.
• Increase your sales activity and case size
through target marketing.
• Joe, good things are ahead for you and your
staff. You can go to the next level.

The reference to “Jean” in the above-quoted statement was the

only reference to Ms. Vlock in each of the business potential

documents. The author of each of those documents did not indi-

cate therein that each such reference was to Ms. Vlock acting on

behalf of Vlock and Hammond. Nor did the author refer in either

of the business potential reports to Ms. Vlock in such a way as

to establish that, if and when Ms. Vlock were to perform services

for Mr. Vlock’s insurance business, she would be acting on behalf

of Vlock and Hammond.

Except for the title of each of the business potential

documents that referred to Vlock and Hammond, none of those

documents suggests that the author of each of those documents,

who is not identified in the record, understood that Mr. Vlock

was using, or intended to use, the services of Vlock and Hammond

to achieve the goals and objectives identified in those docu-

ments. Moreover, we doubt that that author was the individual

who included the reference to Vlock and Hammond in each of those

titles. We believe that petitioners may have altered the title

of each of the business potential documents to include a refer-

ence to Vlock and Hammond in order to bolster the chances that

they would succeed in achieving their tax-avoidance objectives.
 - 56 -

On the record before us, we find that the business potential

documents do not establish that during any of the years at issue

Vlock and Hammond in fact rendered services to Mr. Vlock’s

insurance business. In fact, those documents tend to show that

during 2003 Ms. Vlock performed services for Mr. Vlock’s insur-

ance business in her individual capacity, and not on behalf of

Vlock and Hammond.

Based upon our examination of the entire record before us,

we find that petitioners have failed to carry their burden of

establishing that during each of the years at issue Vlock and

Hammond in fact rendered services to Mr. Vlock’s insurance

business. On that record, we further find that petitioners have

failed to carry their burden of establishing that Mr. Vlock’s

payments to Vlock and Hammond during each of those years consti-

tuted compensation for services that Vlock and Hammond in fact

rendered to Mr. Vlock’s insurance business. See sec. 1.162-7(a),

Income Tax Regs. On the record before us, we further find that

petitioners have failed to carry their burden of establishing

that Mr. Vlock’s payments to Vlock and Hammond during each of the

years at issue are ordinary and necessary expenses paid or

incurred during each of those years in carrying on Mr. Vlock’s

insurance business.32 See sec. 162(a). On that record, we find

32
Assuming arguendo that we had found that Mr. Vlock’s
payments to Vlock and Hammond during each of the years at issue
(continued...)
 - 57 -

that petitioners have failed to carry their burden of establish-

32
(...continued)
constituted compensation for services that Vlock and Hammond in
fact rendered during each of those years to Mr. Vlock’s insurance
business, on the record before us, we would find that petitioners
have failed to carry their burden of establishing that those
payments during each of those years were what “would ordinarily
be paid for like services by like enterprises under like circum-
stances”, see sec. 1.162-7(b)(3), Income Tax Regs., and thus were
reasonable in amount. In arriving at the $10,000 amount stated
in sec. 3 of the purported management agreement, neither Mr.
Vlock nor Ms. Vlock consulted an accountant, business manager, or
compensation expert. Although Ms. Vlock consulted Mr. Pechacek,
the attorney whom petitioners retained for the purpose of assist-
ing Ms. Vlock in incorporating Vlock and Hammond and drafting
certain documents for it, the record does not establish what he
told her. Mr. Vlock testified that, in arriving at the $10,000
amount stated in sec. 3 of the purported management agreement, he
“calculated about 50- to $60,000 to hire a full-time person with
a tremendous amount of knowledge, and that’s without benefits,
and then included rent, supplies, utilities, things such as that
that I’d have to provide.” Petitioners have failed to carry
their burden of establishing that during each of the years at
issue it would have cost Mr. Vlock $50,000 to $60,000 to hire a
full-time employee to provide to Mr. Vlock’s insurance business
the services that Ms. Vlock provided to it during each of the
years at issue, let alone that he would have paid an additional
$60,000 to $70,000 for “benefits * * * rent, supplies, [and]
utilities”. Moreover, we have found that during 2003 Mr. Vlock
paid to Paul Jensen, the only full-time employee of Mr. Vlock’s
insurance business during that year, total wages of $29,475.84
for serving as a receptionist and for performing certain adminis-
trative and secretarial tasks for that business. Without regard
to the $120,000 that the purported management agreement stated
that Mr. Vlock was to pay to Vlock and Hammond during each of the
years at issue, the $29,475.84 that Mr. Vlock paid to Paul Jensen
during 2003 was the largest amount that Mr. Vlock paid during any
of those years to any individual who performed services for Mr.
Vlock’s insurance business during any of those years. Further-
more, without regard to the $120,000 that the purported manage-
ment agreement stated that Mr. Vlock was to pay to Vlock and
Hammond during each of the years at issue, the total compensation
that Mr. Vlock paid during all the years at issue to all individ-
uals who performed services for Mr. Vlock’s insurance business
during those years was $116,578.16.
 - 58 -

ing that Mr. Vlock’s payments to Vlock and Hammond during each of

the years at issue are deductible under section 162(a) for each

of those years.

Claimed Deduction for Payments to the Vlock Daughters

It is the position of petitioners (1) that the payments that

Mr. Vlock made during 2003 to the Vlock daughters Sarina and

Jennifer were for services that they in fact rendered to Mr.

Vlock’s insurance business during that year and (2) that there-

fore those payments are deductible under section 162(a) for that

year. In support of that position, petitioners argue that during

2003 the Vlock daughters performed certain administrative and

secretarial tasks for Mr. Vlock’s insurance business and that

during that year Mr. Vlock paid them for performing those tasks.

It is the position of respondent that petitioners have not

carried their burden of establishing that during 2003 the Vlock

daughters in fact performed any services for Mr. Vlock’s insur-

ance business.

In order to carry their burden of proving that the payments

that Mr. Vlock made during 2003 to the Vlock daughters are

deductible under section 162(a) for that year, petitioners must

show that those payments are ordinary and necessary expenses paid

or incurred during that taxable year in carrying on any trade or

business. See sec. 162(a). In order to establish that those

payments are ordinary and necessary expenses for their taxable
 - 59 -

year 2003, petitioners must show that those payments constituted

“salaries or other compensation for personal services actually

rendered”.33 Sec. 1.162-7(a), Income Tax Regs. In order to do

so, petitioners must establish that during 2003 Mr. Vlock made

payments to the Vlock daughters for services that the Vlock

daughters in fact rendered to Mr. Vlock’s insurance business.

In an attempt to establish that the Vlock daughters in fact

rendered services during 2003 to Mr. Vlock’s insurance business,

petitioners rely on Mr. Vlock’s testimony, which we have not

accepted, and certain documentary evidence. The documentary

evidence on which petitioners rely consists principally of a

weekly calendar for 2003 (2003 calendar).34

Mr. Vlock testified that on each page of the 2003 calendar

he made certain handwritten notations that showed (1) the name(s)

of his daughter(s) (i.e., Sarina and/or Jennifer) who had worked

for Mr. Vlock’s insurance business during each week, (2) the

day(s) of each week on which Sarina and/or Jennifer had worked,

(3) the number of hours on such day(s) that Sarina and/or

Jennifer had worked, and (4) the amount of money that Sarina

33
In the event that we were to find that Mr. Vlock made
payments to the Vlock daughters during 2003 for services that
they in fact rendered during that year to Mr. Vlock’s insurance
business, respondent does not argue that those payments were not
reasonable in amount. See sec. 1.162-7(a), Income Tax Regs.
34
Each page of the 2003 calendar displayed the seven days of
each week during 2003.
 - 60 -

and/or Jennifer had earned during each week. There is no reli-

able evidence in the record that establishes when Mr. Vlock made

the handwritten notations on the 2003 calendar relating to the

Vlock daughters. Those notations are nothing more than self-

serving notations on which we are unwilling to rely.35

Based upon our examination of the entire record before us,

we find that petitioners have failed to carry their burden of

establishing that during 2003 the Vlock daughters in fact ren-

dered services to Mr. Vlock’s insurance business. On that

record, we further find that petitioners have failed to carry

their burden of establishing that the payments that Mr. Vlock

made during 2003 to the Vlock daughters constituted compensation

for services that they in fact rendered to Mr. Vlock’s insurance

business. See sec. 1.162-7(a), Income Tax Regs. On the record

before us, we further find that petitioners have failed to carry

their burden of establishing that those payments are ordinary and

necessary expenses paid or incurred during 2003 in carrying on

Mr. Vlock’s insurance business. See sec. 162(a). On the record

before us, we find that petitioners have failed to carry their

burden of establishing that the payments that Mr. Vlock made

35
We note that petitioners did not call Sarina and/or
Jennifer to testify in support of petitioners’ position that
Sarina or Jennifer in fact rendered services during 2003 to Mr.
Vlock’s insurance business.
 - 61 -

during 2003 to the Vlock daughters are deductible under section

162(a) for petitioners’ taxable year 2003.

Accuracy-Related Penalty

In the 2003-2005 notice, respondent determined that peti-

tioners are liable for each of their taxable years 2003 through

2005 for the accuracy-related penalty under section 6662(a).

According to respondent, petitioners are liable for that penalty

for each of those years because of (1) negligence or disregard of

rules or regulations under section 6662(b)(1) or (2) a substan-

tial understatement of tax under section 6662(b)(2).

Section 6662(a) imposes an accuracy-related penalty equal to

20 percent of the underpayment of tax attributable to, inter

alia, (1) negligence or disregard of rules or regulations, sec.

6662(b)(1), or (2) a substantial understatement of tax, sec.

6662(b)(2).

The term “negligence” in section 6662(b)(1) includes any

failure to make a reasonable attempt to comply with the Code.

Sec. 6662(c). Negligence has also been defined as a failure to

do what a reasonable person would do under the circumstances.

Leuhsler v. Commissioner, 963 F.2d 907, 910 (6th Cir. 1992),

affg. T.C. Memo. 1991-179; Antonides v. Commissioner, 91 T.C.

686, 699 (1988), affd. 893 F.2d 656 (4th Cir. 1990). The term

“disregard” includes any careless, reckless, or intentional

disregard. Sec. 6662(c).
 - 62 -

For purposes of section 6662(b)(2), an understatement is

equal to the excess of the amount of tax required to be shown in

the tax return over the amount of the tax shown in the tax

return, sec. 6662(d)(2)(A), and is substantial in the case of an

individual if it exceeds the greater of 10 percent of the tax

required to be shown or $5,000, sec. 6662(d)(1)(A).

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

apply to any portion of an underpayment if it is shown that there

was reasonable cause for, and that the taxpayer acted in good

faith with respect to, such portion. Sec. 6664(c)(1). The

determination of whether the taxpayer acted with reasonable cause

and in good faith depends on the pertinent facts and circum-

stances, including the taxpayer’s efforts to assess such tax-

payer’s proper tax liability, the knowledge and experience of the

taxpayer, and the reliance on the advice of a professional, such

as an accountant. Sec. 1.6664-4(b)(1), Income Tax Regs. Reli-

ance on the advice of a professional does not necessarily demon-

strate reasonable cause and good faith unless, under all the

circumstances, such reliance was reasonable and the taxpayer

acted in good faith. Id.

Petitioners argue that they are not liable for each of their

taxable years 2003 through 2005 for the accuracy-related penalty

under section 6662(a) because:

Petitioners did not substantially understate income tax
and did not act negligently or disregard rules or
 - 63 -

regulations. Instead, Petitioners had reasonable cause
and acted in good faith. Petitioners have proven that
their transactions were related to legitimate business
activities, and were not a scheme to deduct Petition-
ers’ personal expenses. Petitioners are not liable for
accuracy-related penalties and Respondent has not
sustained its burden of proof.

It appears that petitioners believe that respondent has the

burden of proof with respect to the accuracy-related penalties at

issue. Petitioners are wrong. Respondent bears only the burden

of production with respect to those penalties. See sec. 7491(c).

To meet respondent’s burden of production, respondent must come

forward with sufficient evidence showing that it is appropriate

to impose the accuracy-related penalty under section 6662(a) for

each of petitioners’ taxable years 2003 through 2005. See Higbee

v. Commissioner, 116 T.C. 438, 446 (2001). Although respondent

bears the burden of production with respect to the accuracy-

related penalties at issue, respondent “need not introduce

evidence regarding reasonable cause, substantial authority, or

similar provisions. * * * the taxpayer bears the burden of proof

with regard to those issues.” Id.

We address only whether there is a substantial understate-

ment in petitioners’ tax for each of the years at issue. That is

because resolution of that question resolves the issue of whether

petitioners are liable for each of those years for the accuracy-

related penalty under section 6662(a). The accuracy-related

penalty that respondent determined for each of petitioners’
 - 64 -

taxable years 2003 through 2005 is imposed on an underpayment of

tax for each of those years that is attributable to a substantial

understatement of tax resulting principally from respondent’s

determinations to disallow petitioners’ claimed deduction for Mr.

Vlock’s payments to Vlock and Hammond for each of those years.

We have sustained those determinations. On the record before us,

we find that respondent has satisfied respondent’s burden of

production under section 7491(c) with respect to the accuracy-

related penalty under section 6662(a) that respondent determined

for each of petitioners’ taxable years 2003 through 2005.

As we understand it, petitioners’ only argument in support

of their position that they are not liable for each of their

taxable years 2003 through 2005 for the accuracy-related penalty

is that they are entitled to the deduction that they claimed for

Mr. Vlock’s payments to Vlock and Hammond for each of those

years. As a result, according to petitioners, they did not

understate their taxes for those respective taxable years. We

have found that petitioners are not entitled to those deductions.

On the record before us, we find that petitioners have failed to

carry their burden of establishing that there was no substantial

understatement of tax for each of the years at issue. See sec.

6662(b)(2), (d)(1)(A), (2)(A).

Petitioners make no argument that they reasonably relied on

the advice of a professional, such as Mr. Pechacek or an accoun-
 - 65 -

tant, to support their claim that they had reasonable cause for,

and acted in good faith with respect to, any portion of the

understatement of tax for each of the years at issue. See sec.

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

On the record before us, we find that petitioners have

failed to carry their burden of establishing that there was

reasonable cause for, and that they acted in good faith with

respect to, any portion of the understatement in tax for each of

the years at issue.

Based upon our examination of the entire record before us,

we find that petitioners have failed to carry their burden of

establishing that they are not liable for each of their taxable

years 2003 through 2005 for the accuracy-related penalty under

section 6662(a).

We have considered all of the contentions and arguments of

the parties that are not discussed herein, and we find them to be

without merit, irrelevant, and/or moot.

To reflect the foregoing,

Decision will be entered

for respondent.