T.C. Memo. 2012-93
UNITED STATES TAX COURT
ERNEST N. ZWEIFEL, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
CREWS ALL NITE BAIL BONDS, INC., Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 15226-10, 15227-10. Filed March 28, 2012.
John Sherman Winkler, for petitioner.
Miriam C. Dillard, for respondent.
MEMORANDUM OPINION
PARIS, Judge: Respondent determined deficiencies in Ernest Zweifel’s
(Zweifel) Federal income tax, with additions to tax for failure to timely file under
-2-
section 6651(a)(1)1 and accuracy-related penalties under section 6662(a) for taxable
years 2001, 2002, 2003, 2004, 2005, and 2006.2 Respondent determined
deficiencies in Crews All Nite Bail Bonds, Inc.’s (Crews) Federal income tax, with
additions to tax for failure to timely file under section 6651(a)(1) and accuracy-
related penalties under section 6662(a) for taxable years 2004, 2005, and 2006.
After concessions, the issues for decision are: (1) whether Zweifel and Crews
(collectively, petitioners) may deduct as section 162 business expenses in the years
at issue amounts deposited in Build Up Fund (BUF) accounts; (2) whether
petitioners are liable for additions to tax for failure to file; and (3) whether
petitioners are liable for accuracy-related penalties.
Background
These cases have been submitted fully stipulated under Rule 122. The facts
and exhibits have been stipulated and are incorporated herein by reference. At the
time the petitions were filed, Zweifel’s residence and Crews’ principal place of
business were in Florida.
1
All section references are to the Internal Revenue Code in effect for the
years in issue, and all Rule references are to the Tax Court Rules of Practice and
Procedure, unless otherwise indicated.
2
Respondent has conceded that Zweifel is not liable for the sec. 6651(a)(1)
addition to tax for taxable year 2006.
-3-
Zweifel is a licensed professional bail bond agent. Before and during all years
at issue Zweifel conducted business under the name All American Bail Bonds
(AABB). AABB is a sole proprietorship. Zwiefel untimely filed his 2001 through
2005 individual Federal income tax returns on August 6, 2007. He timely filed his
2006 individual Federal income tax return on August 6, 2007. Zweifel reported
receipts and deductions for AABB on Schedule C of his individual income tax
returns for the years at issue.
In February 2004 Zweifel began conducting business through the corporate
entity, Crews, while continuing to conduct business as AABB. Zweifel has been the
president and sole corporate officer of Crews since its incorporation. Crews
untimely filed its 2004 corporate Federal income tax return on July 26, 2006, and
untimely filed its 2005 and 2006 corporate Federal income tax returns on December
14, 2007. Crews consented to an extension of the period of limitations on
assessment to December 31, 2010, for tax years 2004 through 2006. Both Crews
and Zweifel are cash method taxpayers.
Under Fla. Admin. Code Ann. r. 69B-221.085 (2004), bail bondsmen are
required to file with the Office of Insurance Regulation the bail bond rate they intend
-4-
to charge and, once the rate is filed, charge that same rate for every bail bond.3
Petitioners charged a rate for their execution of a bail bond equal to the greater of
10% of the face amount of the bond or $100. For example, if a court sets a
defendant’s bail at $100,000, the cost of the bond would be $10,000. In exchange,
petitioners would assume liability under the bond and guarantee the defendant’s
appearance at court proceedings.
For both AABB and Crews, Zweifel executed bail bonds as an agent of
National Surety Services of Florida, Inc. (National Surety). Pursuant to the contract
between Zweifel and National Surety, Zweifel was required to pay National Surety
15% of the cost of the bond. For example, the fee paid to National Surety on a
$100,000 bond as described above would be $1,500.
If a bonded defendant failed to appear, National Surety would have to pay the
face amount of the bond. Zweifel, as agent and pursuant to the contract with
National Surety, set aside 1% of the face value of a bond in a BUF account in
addition to the 15% fee. BUF accounts are governed by Florida statute and are
intended to indemnify the insuring company from any loss through the posting of bail
bonds by an agent.
3
The stipulation incorrectly concludes that the Florida law requires the rate of
a bail bond be the greater of 10% of the face of the bond or $100. The Florida
Office of Financial Services, which regulates Florida bail bond premiums, suggests
that the required premium for a State bond is the greater of $100 or 10% of bail set,
and that for a Federal bond it is the greater of $100 or 15%.
-5-
Fla. Stat. Ann. sec. 648.29(1) (West 2005) requires that BUF funds “be held
in an individual build-up trust account for the agent or agency in an FDIC-approved
or FSLIC-approved bank or savings and loan association in this state, jointly in the
name of the agent or agency and the insurer or in trust for the agent or agency by the
insurer.” Interest that accrues on the funds accrues to the bail bond agent. Id. sec.
648.29(2). The statute also provides that BUF accounts “are maintained as a trust
fund created on behalf of a bail bond agent or agency, held by the insurer in a
fiduciary capacity to be used to indemnify the insurer for losses and any other
agreed-upon costs related to a bail bond”. Id. sec. 648.29(3). These funds are the
sole property of the agent or agency and, upon termination of the contract with the
insurer and discharge of remaining open bonds, are due and payable to the bail bond
agent or agency. Id.
For the years at issue Zweifel deposited the following amounts in the BUF
account:
Year Deposit
2001 $111,893.38
2002 103,773.51
2003 105,336.32
2004 108,420.49
2005 110,977.60
2006 113,786.24
-6-
On April 2, 2010, respondent issued to Zweifel a notice of deficiency for
taxable years 2001 through 2006. On July 6, 2010, Zweifel filed a timely petition
with the Court. Also on April 2, 2010, respondent issued to Crews a notice of
deficiency for taxable years 2004 through 2006. On July 6, 2010, Crews filed a
timely petition with the Court. On January 25, 2011, these cases were consolidated
for trial and briefing purposes.
Discussion
The parties agree that payments into the BUF accounts are a necessary
condition of petitioners’ doing business. Petitioners argue that they are entitled to
deduct as a business expense the amounts deposited in the BUF accounts in the year
in which the amounts are deposited. Respondent argues that petitioners are entitled
to a business expense deduction only in the year in which the amounts, if ever, are
paid out of the BUF account to National Surety.
Generally, a cash basis taxpayer may deduct business expenses pursuant to
section 162(a) for the taxable year in which the expenses are paid. Sec. 1.461-
1(a)(1), Income Tax Regs. The Court has previously addressed similar buildup fund
accounts and held that payments to such accounts are not deductible in the year
contributed to the account, as the expense for which the account was created
-7-
has not yet arisen.4 See Sebring v. Commissioner, 93 T.C. 220, 227 (1989); Firetag
v. Commissioner, T.C. Memo. 1999-355, aff’d without published opinion, 232 F.3d
887 (4th Cir. 2000); Rankin v. Commissioner, T.C. Memo. 1996-350, aff’d, 138
F.3d 1286 (9th Cir. 1998).
Petitioners continued to have legal title to the funds, and pursuant to Florida
law the amounts in the BUF accounts and any interest earned were for the benefit of
the bail bond agent. Petitioners’ payments into the BUF accounts are not expenses
at the time deposited, as there is no legal obligation for payment at the time the funds
are deposited. The BUF accounts were established pursuant to a contractual
arrangement between petitioners and National Surety to ensure funds were available
to petitioners in the future, and the deposits are not payments of contemporaneous
expenses in that year. A bail bond agent’s BUF account is akin to a reserve account
set up to pay future liabilities that have not yet occurred and his “liability for
expenses associated with a bond forfeiture does not arise prior to * * * [the]
obligation to indemnify the surety.” Sebring v. Commissioner, 93 T.C. at 226.
4
BUF accounts for bail bonds may be distinguished from reserve accounts for
bad debts created by banks. Under sec. 585, certain entities are allowed to deduct
additions to a reserve for bad debts. However, sec. 585 is a closed class, and
petitioners are not acting in a capacity covered by that section.
-8-
Petitioners argue that a BUF account is analogous to the payment of
insurance premiums; that is, petitioners are paying a set amount in order to be
financially protected in the future. The Court finds this unpersuasive. An
insurance premium is defined as “[t]he periodic payment required to keep an
insurance policy in effect.” Black’s Law Dictionary 1300 (9th ed. 2009). Insurance
is generally “[a] contract by which one party * * * undertakes to indemnify another
party * * * against risk of loss, damage, or liability arising from the occurrence of
some specified contingency”. Id. at 870. The BUF accounts are intended to
provide National Surety reassurance that petitioners have the financial capacity to
pay National Surety in case of bond forfeiture. The payments are specific
payments tied to an individual bail bond, not a general contractual agreement to
indemnify against any number of unforeseen losses.
Petitioners were considered the legal owners of the funds for tax purposes
and were required to pay Federal income tax on the interest earned by the funds.
As noted by the Court of Appeals for the Ninth Circuit in affirming the Court’s
holding in Rankin, “[b]y deducting the unspent BUF funds in the year they were
deposited into the BUF accounts and then recognizing them as income decades
later * * * Rankin effectively transformed his BUF accounts into a tax shelter”.
Rankin v. Commissioner, 138 F.3d at 1290. Petitioners are not entitled to deduct
-9-
the funds deposited in the BUF accounts and are required to include them in gross
income for the years at issue.
Section 6651(a)(1) Addition to Tax
Respondent determined a section 6651(a)(1) addition to tax for failure to
timely file. The parties stipulated that Zweifel failed to timely file for taxable years
2001 through 2005 and that Crews failed to timely file for taxable years 2004
through 2006. Respondent has therefore satisfied his burden of production with
respect to the addition, and petitioners are liable unless they can show reasonable
cause for the late filing. See sec. 7491(c); Higbee v. Commissioner, 116 T.C. 438,
446-448 (2001). Petitioners do not present any arguments or facts as to the delay in
filing. Accordingly, the Court sustains respondent’s imposition of an addition to tax
under section 6651(a)(1) as to Zweifel for taxable years 2001 through 2005 and as to
Crews for taxable years 2004 through 2006.
Section 6662(a) Accuracy-Related Penalty
Section 6662 provides that a taxpayer may be liable for a 20% accuracy-
related penalty on the portion of an underpayment of income tax attributable to
negligence or disregard of rules or regulations or a substantial understatement of
income tax. Sec. 6662(a) and (b)(1) and (2). For purposes of section 6662(a),
negligence includes any failure to make a reasonable attempt to comply with the
- 10 -
provisions of the Code or to exercise ordinary and reasonable care in the preparation
of a tax return; disregard includes any careless, reckless, or intentional disregard of
rules or regulations. Sec. 6662(c); sec. 1.6662-3(b)(1) and (2), Income Tax Regs.
Disregard of rules or regulations is careless if the taxpayer does not exercise
reasonable diligence to determine the correctness of a tax return position that is
contrary to the rule or regulation. Sec. 1.6662-3(b)(2), Income Tax Regs.
An understatement of income tax is substantial for an individual if the amount
of the understatement exceeds the greater of 10% of the tax required to be shown on
the return or $5,000 and for a corporation if the amount of the understatement
exceeds the lesser of 10% of the tax required on the return or $10 million. Sec.
6662(d)(1)(A) and (B). An understatement is the excess of the amount of tax
required to be shown on the return over the amount of tax actually reported on the
return reduced by any rebate. Sec. 6662(d)(2).
Under section 7491(c), the Commissioner bears the burden of production with
regard to penalties. Higbee v. Commissioner, 116 T.C. at 446. Once the
Commissioner has met the burden of production, the burden of proof remains with
the taxpayer, including the burden of proving that the penalties are inappropriate
because of reasonable cause or substantial authority. Rule 142(a); Higbee v.
Commissioner, 116 T.C. at 446-447.
- 11 -
Respondent has met the burden of production, as prior caselaw has held that
petitioners’ position is not consistent with prior Court decisions. However, the
accuracy-related penalty under section 6662(a) is not imposed with respect to any
portion of the underpayment to which the taxpayer acted with reasonable cause and
in good faith. Sec. 6664(c)(1); Higbee v. Commissioner, 116 T.C. at 448. The
decision as to whether a taxpayer acted with reasonable cause and in good faith is
made on a case-by-case basis, taking into account all the pertinent facts and
circumstances. Sec. 1.6664-4(b)(1), Income Tax Regs. The Court acknowledges
that petitioners present well-thought-out arguments attempting to distinguish their
circumstances from those in previous cases. However, the failure to timely file
demonstrates that they did not act in good faith or with reasonable cause while
advancing their positions. Consequently, Zweifel is liable for accuracy-related
penalties under section 6662(a) for taxable years 2001 through 2006, and Crews is
liable for accuracy-related penalties under section 6662(a) for taxable years 2004
through 2006.
To reflect concessions and this Court’s conclusions stated above,
Decisions will be entered
under Rule 155.