T.C. Memo. 2017-21
UNITED STATES TAX COURT
EDWARD S. FLUME, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE SERVICE, Respondent
Docket No. 15772-14L. Filed January 30, 2017.
David Rodriguez, for petitioner.
Roberta L. Shumway and Sheila R. Pattison, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
GOEKE, Judge: Petitioner seeks review pursuant to section 6330(d)(1)1 of
the Internal Revenue Service’s (IRS) determination to sustain a proposed levy
1
All section references are to the Internal Revenue Code in effect at all
relevant times, and all Rule references are to the Tax Court Rules of Practice and
Procedure, unless otherwise stated. All monetary amounts are rounded to the
nearest dollar.
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[*2] action with respect to petitioner’s civil penalty liabilities. The IRS assessed
penalties against petitioner under sections 6038 and 6679 totaling $20,000 for
2001, $20,000 for 2002, and $10,000 for each year from tax years 2003 through
2009 for failure to file Forms 5471, Information Return of U.S. Persons With
Respect to Certain Foreign Corporations.
After concessions,2 the issue for decision is whether petitioner is liable for
the penalties assessed against him for his failure to declare his ownership interests
in Franchise Food Services de Mexico S.A. de C.V. (FFM) for tax years 2001 and
2002 and in Wilshire Holdings, Inc. (Wilshire-Belize), for tax years 2001 through
2009 (years in issue). We hold that he is.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found. At the time the
petition was filed, petitioner was a U.S. citizen residing in Mexico.
2
Respondent concedes that the underlying liabilities are at issue and the
appropriate standard of review is de novo, and petitioner concedes that
respondent’s settlement officer did not abuse his discretion in reviewing the
nonliability determinations of the proposed levy. At trial we asked the parties to
address the issue of whether there were prohibited ex parte communications
between the IRS Office of Appeals and the originating function. Petitioner failed
to address this issue and thus is deemed to have conceded it. See Rule 34(b)(4).
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[*3] I. Petitioner’s Business Activities in Mexico
During the years in issue petitioner operated a real estate development and
construction business in Mexico. Petitioner developed land, sold lots, and built
luxury homes.
A. FFM
FFM was incorporated in Mexico in 1995 to operate two fast food
franchises that petitioner owned. Initially, FFM was owned by petitioner and
Norwick Adams, a U.S. citizen who resided in Mexico. Petitioner and Mr. Adams
each held a 50% interest in FFM. Petitioner was president of FFM. The fast food
franchises were sold in 1998, but FFM remained intact.
FFM was a section 957(a) controlled foreign corporation (CFC)3 during
years 2001 and 2002. Petitioner owned 50% of FFM’s stock for the entirety of
2001. On February 8, 2002, petitioner sold a portion of his stock to Victor
Mendez Tornell, reducing his ownership to 9%. During the years in issue Mr.
Tornell was a Mexican citizen. Mr. Tornell has never been an officer or a director
of FFM.
3
A CFC is any foreign corporation in which more than 50% of the total
combined voting power of classes of stock of the corporation entitled to vote, or
the total value of the stock of the corporation, is owned, or is considered as owned
(applying sec. 958(b)), by U.S. shareholders on any day during the taxable year of
the foreign corporation. Sec. 957(a).
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[*4] B. Belizean Wilshire Holdings, Inc.
On April 12, 2001, petitioner and his wife incorporated Wilshire-Belize, a
Belizean international business company. Wilshire-Belize issued two bearer
shares, to petitioner and his wife, resulting in each holding a 50% interest at the
time of incorporation. Petitioner served as president and director, and his wife
served as vice president. Wilshire-Belize’s original articles of association were
later amended to eliminate the two original bearer shares. The amended articles of
association were backdated to April 12, 2001, to reflect the date of incorporation.
Under the amended articles of association, petitioner, his wife, and their daughter
each held a 9% interest and Mr. Tornell held the remaining 73% interest in
Wilshire-Belize. The date on which the original articles of association were
amended to eliminate the two bearer shares and create the new share ownership
structure is unknown.
On October 18, 2005, petitioner and his wife opened an account with United
Bank of Switzerland (UBS) under Wilshire-Belize’s name (UBS account).
Petitioner and his wife were the only individuals with signature authority over the
UBS account.
When the UBS account was opened, petitioner provided UBS with
Wilshire-Belize’s original memorandum and articles of association, a certificate of
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[*5] incumbency, and copies of the two bearer shares. The backdated amended
articles of association were not provided to UBS. UBS’ due diligence documents
identified petitioner and his wife as the beneficial owners of the UBS account and
petitioner as the sole owner of Wilshire-Belize. Petitioner controlled the UBS
account investment activity. Petitioner and his wife directed disbursements from
the UBS account, some of which were deposited directly into their personal bank
and debit card accounts.
II. Examination
Petitioner timely filed his Forms 1040, U.S. Individual Income Tax Return,
for the years in issue but did not attach Forms 5471 to any of his originally filed
returns. Petitioner hired Leonard Purcell, a tax preparation firm in Mexico, to
prepare his tax returns during the years in issue. Adriana Luna, a Leonard Purcell
employee, prepared petitioner’s tax returns. Petitioner did not inform Ms. Luna
until approximately 2008 that he held interests in FFM and Wilshire-Belize.
In 2012 the IRS began an examination of petitioner’s ownership and control
of foreign corporations. As early as August 10, 2012, petitioner was made aware
of his failure to file Forms 5471. Petitioner engaged David Rodriguez to represent
him during the examination. Petitioner submitted delinquent Forms 5471
regarding his interests in FFM on January 23, 2013, when Mr. Rodriguez advised
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[*6] him of his obligation to do so. Petitioner submitted revised Forms 5471 on
April 25, 2013. Both the original and revised Forms 5471 that petitioner
submitted were incomplete.
Respondent assessed penalties for petitioner’s failure to file Forms 5471
declaring his ownership interests in FFM during 2001 and 2002 and in Wilshire-
Belize from 2001 through 2009. Petitioner was assessed a penalty of $20,000 for
2001, two penalties of $10,000 each for 2002, and penalties of $10,000 for each
year from taxable year 2003 through 2009. With the exception of the $10,000
penalty regarding FFM for tax year 2002, which was assessed under section
6679(a) on March 11, 2013, all other penalties were assessed under section
6038(b) on February 18, 2013. On December 16, 2013, respondent issued to
petitioner Letter CP 90, Final Notice--Notice of Intent to Levy and Notice of your
Rights to a Hearing (CDP notice), for the unpaid civil penalties assessed against
him for the years in issue.
Petitioner timely filed Form 12153, Request for Collection Due Process or
Equivalent Hearing (CDP hearing request). Respondent received petitioner’s CDP
hearing request on January 13, 2014. It stated that he did not receive notice of the
penalties, that he did not understand how the penalties were computed, and that
the penalties should not have been assessed. In his CDP hearing request petitioner
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[*7] disputed the underlying liabilities but did not challenge the appropriateness of
the collection action, propose any collection alternative, or raise any spousal
defense.
The CDP hearing was assigned to an IRS settlement officer on February 27,
2014. On April 3, 2014, the settlement officer sent a letter to Mr. Rodriguez to
inform him that the liability issue was open for consideration in the CDP hearing
because petitioner had had no preassessment opportunity to challenge the civil
penalty assessments. The settlement officer afforded petitioner an opportunity to
provide documents supporting petitioner’s argument that he was not liable for
penalties, as well as to prepare a reasonable cause narrative, which petitioner did
not submit.
III. Notice of Determination
On June 3, 2014, the IRS Office of Appeals issued petitioner a Notice of
Determination Concerning Collection Action(s) under section 6320 and/or 6330
(notice of determination) for the years in issue. Petitioner timely petitioned this
Court for review of the notice of determination.
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[*8] OPINION
I. Standard of Review and Burden of Proof
Section 6330(d)(1) grants this Court jurisdiction to review the
Commissioner’s determination that the proposed collection action was proper. In
reviewing the Commissioner’s decision to sustain collection actions, where the
validity of the underlying tax liability is properly at issue the Court reviews the
Commissioner’s determination of the underlying tax liability de novo. Sego v.
Commissioner, 114 T.C. 604, 610 (2000); Goza v. Commissioner, 114 T.C. 176,
181-182 (2000). The Court reviews any other administrative determination
regarding proposed collection actions for abuse of discretion. Sego v.
Commissioner, 114 T.C. at 610; Goza v. Commissioner, 114 T.C. at 182.
Respondent concedes that petitioner sufficiently raised the issue of his underlying
liabilities during the CDP hearing. Therefore, this case will consider the liabilities
on their merits.
II. Failure To File Forms 5471
Section 6038(a)(1) imposes information reporting requirements on any U.S.
person, as defined in section 957(c), who controls a foreign corporation. A person
controls a foreign corporation if he owns or constructively owns stock that is more
than 50% of the total combined voting power of all classes of voting stock or owns
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[*9] more than 50% of the total value of shares of all classes of stock. Sec.
6038(e)(2). A U.S. person must furnish, with respect to any foreign corporation
which that person controls, information that the Secretary may prescribe. Sec.
6038(a)(1). Form 5471 and the accompanying schedules are used to satisfy the
section 6038 reporting requirements. The Form 5471 must be filed with the U.S.
person’s timely filed Federal income tax return. Sec. 1.6038-2(i), Income Tax
Regs.
Additionally, the information reporting requirements prescribed in section
6038(a)(1) also are imposed on any U.S. person treated as a U.S. shareholder of a
corporation that was a CFC for an uninterrupted period of 30 days during its
annual accounting period and who owned stock in the CFC on the last day of the
CFC’s annual accounting period. Secs. 951(a)(1), (b), 6038(a)(4); see also Rev.
Proc. 92-70, sec. 2, 1992-2 C.B. 435, 436. A U.S. shareholder, with respect to any
foreign corporation, is a U.S. person who owns under section 958(a), or is
considered as owning under section 958(b), 10% or more of the total combined
voting power of all classes of stock entitled to vote of the foreign corporation.
Sec. 951(b).
Section 6046 requires information reporting by each U.S. citizen or resident
who is at any time an officer or director of a foreign corporation, where more than
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[*10] 10% (by vote or value) of stock is owned by a U.S. person. Sec.
6046(a)(1)(A). The stock ownership threshold is met if a U.S. person owns 10%
or more of the total value of the foreign corporation’s stock or 10% or more of the
total combined voting power of all classes of stock with voting rights. Sec.
6046(a)(2). A U.S. person who disposes of sufficient stock in the foreign
corporation to reduce his interest to less than the stock ownership requirement is
required to provide certain information with respect to the foreign corporation.
Sec. 1.6046-1(c)(1)(ii)(c), Income Tax Regs.
When a taxpayer, who was required to do so, fails to complete and file a
Form 5471 on time, a fixed penalty of $10,000 per foreign corporation per annual
accounting period is imposed. Secs. 6038(b)(1), 6679. If any failure to provide
the required information continues for more than 90 days after the day on which
the Secretary mails notice of the failure to the U.S. person, the person shall pay a
penalty (in addition to the amount required under section 6038(b)(1)) of $10,000
for each 30-day period, or fraction thereof, during which the failure continues with
respect to any annual accounting period after the expiration of the 90-day period;
however, the increase in any penalty under section 6038(b)(2) shall not exceed
$50,000. Sec. 6038(b)(2). Similar penalties apply for failure to timely file Form
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[*11] 5471 or otherwise provide the information required by section 6046 with
respect to an annual accounting period. See secs. 6046(f), 6679(a).
The instructions for Form 5471 describe the categories of persons required
to file Form 5471 and the information that each category of filer is required to
provide. A category 2 filer is a U.S. person that is an officer or director described
in section 6046(a)(1)(A). A category 3 filer is a U.S. person described in section
6046(a)(1)(B). A category 4 filer is a U.S. person that controls a foreign
corporation as described in section 6038(a)(1) and (e); and a category 5 filer is a
U.S. person that is a U.S. shareholder of a CFC as described in section 6038(a)(4).
We discuss below why petitioner was required to submit Forms 5471 for the years
in issue regarding his interests in FFM and Wilshire-Belize.
A. FFM Form 5471 Filing Requirement
Petitioner was a category 5 filer for tax year 2001 because he was a U.S.
shareholder who owned stock in a CFC for an uninterrupted period of 30 days or
more during tax years 2001. FFM was a CFC throughout tax years 2001 and
2002. Sec. 957(a). Petitioner owned 50% of the stock of FFM for the entire 2001
tax year and maintained his 50% ownership of FFM until February 8, 2002, when
he sold 41% of his interest in FFM. Thus, under section 6038(a)(4), petitioner was
required to file Form 5471 for FFM for tax year 2001.
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[*12] Petitioner was required to file Form 5471 as a category 3 filer for FFM for
tax year 2002. In 2002 petitioner sold 41% of his original 50% shares, thereby
reducing his ownership in FFM to less than 10%. A U.S. shareholder of a CFC
must file Form 5471 if the shareholder “[d]isposes of sufficient stock in such
foreign corporation to reduce his interest to less than 10 percent of the total
combined voting power * * * or the total value of the stock of the foreign
corporation”. Sec. 1.6046-1(c)(1)(ii)(c), Income Tax Regs. Thus, petitioner was
required to file Form 5471 because he reduced his ownership in FFM to less than
10% during tax year 2002.
On January 23, 2013, petitioner filed delinquent Forms 5471 for FFM for
tax years 2001 and 2002. Petitioner argues that his delinquent Forms 5471 for
FFM for tax years 2001 and 2002 should have a retroactive effect and therefore no
penalty should apply. We disagree.
Petitioner’s argument is unavailing. Petitioner was required to file a Form
5471 for FFM with his 2001 income tax return on the date that income tax return
was due. See secs. 1.6038-2(i), 1.6046-1(j)(1), Income Tax Regs. In order to
avoid the penalties, petitioner must show that he had reasonable cause for filing
Forms 5471 after the required deadline. See sec. 6038(c)(4)(B), 6679(a)(1). We
discuss reasonable cause in part C of this opinion.
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[*13] B. Wilshire-Belize Form 5471 Filing Requirement
In addition to his ownership in FFM, respondent determined that petitioner
and his wife each held a 50% interest in Wilshire-Belize during the years at issue.
Petitioner argues that he did not have more than a 9% interest in Wilshire-Belize at
any time; thus, he was not required to file Forms 5471 for Wilshire-Belize for the
years in issue.
Petitioner asserts that the two bearer shares that gave him and his wife each
a 50% ownership in Wilshire-Belize were eliminated and that the share ownership
structure changed, reducing his ownership to 9% for the years in issue. To support
this claim, petitioner provides Wilshire-Belize’s amended articles of association
showing that he held a 9% interest. However, the backdated amended articles of
association and the absence of any evidence as to when or if the change in stock
ownership actually occurred contradict petitioner’s assertion.
Petitioner was the president and a director of Wilshire-Belize. Petitioner
and his wife each held a 50% interest in Wilshire-Belize at the time they
incorporated it in 2001. In determining stock ownership of a foreign corporation
to determine whether it is a CFC, the rules under section 318(a) apply with
modifications. Sec. 958(b). Under these rules, petitioner constructively owned
the 50% interest held by his wife. See sec. 318(a)(1)(A)(i). When this 50%
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[*14] interest is added to the 50% interest that petitioner directly owned, he owned
more than 50% of Wilshire-Belize. Thus, Wilshire-Belize was a CFC for the years
in issue.
The record shows that petitioner retained his 50% ownership up to and
including a portion of tax year 2005. On October 18, 2005, petitioner opened the
UBS account using the original articles of association and copies of the two bearer
shares. Petitioner testified that he used these documents to open the bank account
because they were all he had available.
Nothing in the record indicates a change in petitioner’s 50% ownership for
tax years 2006 through 2009. Petitioner and his wife continuously directed
investments into and out of the UBS account and were the only people with
signature authority over the UBS account. Petitioner controlled the UBS account
investment activity. Furthermore, petitioner has failed to precisely indicate when
the reduction in ownership occurred or to sufficiently dispute the evidence that
suggests that the change did not occur during the years in issue. Petitioner has
merely provided self-serving testimony and a backdated document to support his
claim that he maintained only a 9% ownership interest during the tax years in
issue.
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[*15] Petitioner was a U.S. shareholder and controlled Wilshire-Belize, making
him a category 4 and category 5 filer. As such, petitioner was required under
section 6038 to file Forms 5471 for the years in issue. Therefore, respondent
correctly assessed penalties under section 6038(b) for petitioner’s failure to file
Forms 5471 for Wilshire-Belize for each year from 2001 to 2009.
C. Reasonable Cause
To avoid a section 6038(b) penalty, a taxpayer must make an affirmative
showing that the failure to furnish the appropriate information with his return was
due to reasonable cause. Sec. 6038(c)(4)(B). The time for furnishing required
information can be extended if the Secretary is satisfied that reasonable cause
existed for the delay. Id. Although there are no regulations defining “reasonable
cause” within the specific context of section 6038, the few cases that have
confronted this issue have adopted the Supreme Court’s definition as stated in
United States v. Boyle, 469 U.S. 241, 246 (1985). See, e.g., Congdon v. United
States, No. 4:09-CV-289, 2011 WL 3880524, at *2 (E.D. Tex. Aug. 11, 2011); In
re Wyly, 552 B.R. 338, 442 (Bankr. N.D. Tex. 2016). That is that a taxpayer must
demonstrate that he exercised ordinary business care and prudence but
nevertheless was unable to file within the prescribed time. Boyle, 469 U.S. at 246.
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[*16] Similar rules apply with respect to the civil penalties imposed under section
6679 for failure to file information required under section 6046. Sec. 6679(a)(1);
sec. 301.6679-1(a), Proced. & Admin. Regs. If a taxpayer exercises ordinary
business care and prudence and is nevertheless unable to obtain and provide the
required information, a failure to file will be considered to be due to reasonable
cause. Sec. 301.6679-1(a)(3), Proced. & Admin. Regs.
Petitioner contends that he has established reasonable cause for his failure
to file Forms 5471. Petitioner, however, failed to substantiate this contention.
Petitioner had the opportunity to provide a reasonable cause narrative during the
CDP hearing but failed to do so.
To establish reasonable cause through reliance on a tax adviser’s advice, the
taxpayer must prove: (i) the adviser was a competent professional with sufficient
expertise, (ii) the taxpayer provided necessary and accurate information to the
adviser, and (iii) the taxpayer relied in good faith on the adviser’s judgment.
Neonatology Assocs., P.A. v. Commissioner, 115 T.C. 43, 98-99 (2000), aff’d,
299 F.3d 221 (3d Cir. 2002).
Petitioner claims that Ms. Luna failed to advise him that he was required to
file Forms 5471 for FFM for tax years 2001 and 2002. However, petitioner
testified that he was unaware of Ms. Luna’s qualifications and that he did not
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[*17] inform her of his interests in FFM and Wilshire-Belize. Thus, petitioner
fails the second Neonatology prong because he did not provide his tax return
preparer with all necessary information, barring him from reasonably relying on
his tax return preparer’s advice. Therefore, we find that petitioner failed to show
reasonable cause for his failure to file Forms 5471.
In reaching our holdings herein, we have considered all arguments the
parties made, and, to the extent not mentioned above, we conclude they are moot,
irrelevant, or without merit.
To reflect the foregoing,
Decision will be entered for
respondent.