T.C. Memo. 2013-36
UNITED STATES TAX COURT
GARY L. HOSKINS AND CYNTHIA HOSKINS, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 3850-10. Filed February 4, 2013.
Chad D. Hansen, for petitioners.
Emily J. Giometti, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
COHEN, Judge: Respondent determined deficiencies and penalties with
respect to the joint income tax returns of petitioners as follows:
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[*2] Penalty
Year Deficiency sec. 6662(a)
2006 $43,721 $8,744.20
2007 11,371 2,274.20
The issues for decision are (1) whether petitioners are entitled to deduct
claimed rental real estate losses after section 469 passive loss limitations are
considered ; (2) whether petitioners are entitled to all claimed deductions for real
property expenses; and (3) whether petitioners are liable for accuracy-related
penalties under section 6662(a). Unless otherwise indicated all section references
are to the Internal Revenue Code for the years in issue, and all Rule references are
to the Tax Court Rules of Practice and Procedure.
FINDINGS OF FACT
Some of the facts have been stipulated, and the stipulated facts are
incorporated in our findings by this reference. At the time the petition was filed, and
during the years in issue, petitioners resided in Florida. During the years in issue,
Cynthia Hoskins worked part time as a reservationist for U.S. Airways.
Gary L. Hoskins (petitioner) obtained a real estate sales license in Ohio and
worked as a real estate agent in Ohio for a number of years before petitioners
moved to Florida in 2002 when petitioner obtained his Florida real estate sales
license. During the years in issue petitioner maintained his Florida real estate
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[*3] sales license under a brokerage, Prudential Palms Realty, and worked
approximately 40 hours per week as an independent contractor assisting other
individuals with selling, purchasing, and leasing homes. In addition, as a licensed
real estate salesperson, petitioner provided maintenance services for bank-owned
properties approximately 15 to 20 hours per week. Petitioner was not licensed as a
real estate broker during the years in issue, and he no longer maintained an Ohio
real estate sales license.
During 2006 and 2007 petitioners owned four properties in Ohio (Glenrose,
Hialeah, Martindale, and President) and six properties in Florida (Bentgrass,
Founder, Mellon, Midnight #1, Midnight #2, and Trenton). In 2006 the four Ohio
properties and three of the Florida properties (Bentgrass, Mellon, and Midnight #2)
were rented long term. In 2006 the Midnight #1 property was rented as a short-term
vacation rental for periods that, on average, did not exceed seven days.
The Founder and Trenton properties were under construction in 2006.
Petitioners purchased the Founder property lot in 2005, and construction
commenced that year. At that time, petitioners intended to use the Founder property
as a personal residence. At some point in 2006, petitioners decided that they no
longer wanted to use the Founder property as a personal residence and instead
would sell the property upon completion of construction.
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[*4] In 2007 two of the Ohio properties were rented long term (Glenrose and
President); the Hialeah and Martindale properties were not rented because they
were being prepared for sale. Three of the Florida properties were rented long term
in 2007 (Bentgrass, Mellon, and Trenton), and two of the Florida properties were
rented as short-term vacation rentals for periods that, on average, did not exceed
seven days (Midnight #1 and Midnight #2). The Founder property was not rented in
2007 because it remained under construction through the end of that year.
During the years in issue petitioners hired repair persons, such as plumbers,
electricians, and carpet installers for repairs or remodeling work at the Ohio
properties. Petitioner visited Ohio in 2006 and 2007, generally staying with family.
Petitioner did not maintain records detailing his Ohio visits and did not account for
the time contractors spent working on the properties.
Petitioners hired a professional management company to manage the
Midnight #1 property during 2006 and 2007. Petitioners did not hire a management
company to manage the Midnight #2 property.
Petitioner paid various individuals and companies to perform services such
as plumbing, electrical, pest control, and carpet cleaning at the other Florida
properties. Petitioner spent time at these properties performing property
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[*5] maintenance such as lawn mowing, cleaning, painting, checking for water
leaks, and changing air filters. He also paid bills associated with the properties and
spent time locating tenants for some of the properties. Petitioner did not maintain
contemporaneous daily time reports, appointment books, calendars, or similar
documents that detailed his real estate activities. During 2006 and 2007 Cynthia
Hoskins did not perform any work with respect to any of the properties.
During 2006 and 2007 petitioner received gross receipts of $399,172 and
$188,595, respectively from his activities as a real estate agent. He reported
$290,161 and $126,578 for 2006 and 2007, respectively, as net business income
from real estate.
Petitioners included with their 2006 tax return a form entitled “Election to
Treat All Interests in Rental Real Estate as a Single Rental Real Estate Activity”,
electing to treat all of their interests in rental real estate as a single real estate
activity. Petitioners reported rental real estate losses of $174,646 on Schedule E,
Supplemental Income and Loss, of their 2006 tax return with respect to 10
properties. Petitioners did not hold title to or have an ownership interest in one of
the reported Florida properties (Pinyon) in 2006 or 2007 (petitioners loaned some
money for the downpayment to the purchasers of this property expecting that they
would be paid back and that, upon sale, petitioner would collect a real estate
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[*6] commission through Prudential). No real estate loss was reported with respect
to the Founder property. Petitioners used the losses reported on Schedule E to
offset other income.
Petitioners reported rental real estate losses of $203,962 on Schedule E of
their 2007 tax return with respect to 11 properties (the 10 properties they owned in
2007 and the Pinyon property). Petitioners used these losses to offset other income.
The IRS examined petitioners’ 2006 and 2007 tax returns. During the
examination petitioner stated that he spent approximately 520 hours during 2006
and 520 hours during 2007 working on petitioners’ properties, performing such
activities as painting, lawn mowing, and cleaning the properties to prepare them for
renting. Petitioner did not provide any log or other documentation to support his
statements, nor did he offer any records detailing repairs or maintenance performed
by him or by other individuals.
The IRS determined that the losses petitioners reported for 2006 and 2007
with respect to the Ohio and Florida properties were limited by the section 469
passive activity rules and that, after audit adjustments, petitioners’ adjusted gross
income is above the limit for a partial deduction for 2006 and their deduction is
limited for 2007. See sec. 469(i).
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[*7] The IRS also disallowed deductions claimed for depreciation, insurance,
mortgage interest, and other expenses, such as homeowner association dues with
respect to the Pinyon and Trenton properties for 2006 and the Founder and Pinyon
properties for 2007, and explained in the notice of deficiency that “[p]roperties held
for investment and properties not completed for occupancy are not eligible for
expenses to be deducted.”
Additionally, respondent disallowed cost of goods sold expenses that
petitioners claimed for 2007 on the Schedule C, Profit or Loss From Business, for
petitioner’s real estate sales associate activities. Petitioners did not dispute this
adjustment in the petition or in their pretrial memorandum. Further, petitioners
neither addressed this issue at trial nor provided any evidence to support the claimed
deductions. As a result, this issue is deemed conceded. See Rules 34(b)(4), 149(b).
OPINION
Generally, the taxpayer bears the burden of proving entitlement to any
deductions claimed. See Rule 142(a); INDOPCO, Inc. v. Commissioner, 503 U.S.
79, 84 (1992); Deputy v. du Pont, 308 U.S. 488, 493 (1940). This burden may
shift to the Commissioner if the taxpayer introduces credible evidence with respect
to any relevant factual issue and meets other conditions, including maintaining
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[*8] required records. See sec. 7491(a)(1). Petitioners have not established their
compliance with section 7491(a). Accordingly, petitioners bear the burden of proof.
See Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933).
Taxpayers are allowed deductions for certain business and investment
expenses under sections 162 and 212; however, section 469 generally disallows any
passive activity loss. Sec. 469(a). A passive activity loss is defined as the excess of
the aggregate losses from all passive activities for the taxable year over the
aggregate income from all passive activities for that year. Sec. 469(d)(1). A
passive activity is any trade or business in which the taxpayer does not materially
participate, sec. 469(c)(1), or to the extent provided in regulations, any activity with
respect to which expenses are allowable as a deduction under section 212, sec.
469(c)(6)(B). Rental activity is generally treated as a per se passive activity
regardless of whether the taxpayer materially participates. Sec. 469(c)(2), (4).
Material participation is defined as involvement in the operations of the activity that
is regular, continuous, and substantial. Sec. 469(h)(1).
An exception to the rule that a rental activity is per se passive is found in
section 469(c)(7), which provides that the rental activities of a taxpayer in real
property trades or businesses are not per se passive activities under section
469(c)(2) but are treated as a trade or business subject to the material participation
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[*9] requirements of section 469(c)(1). See sec. 1.469-9(e)(1), Income Tax Regs.
A taxpayer may qualify as a real estate professional if: (1) more than one-half of the
personal services performed in trades or businesses by the taxpayer during the
taxable year are performed in real property trades or businesses in which the
taxpayer materially participates, and (2) the taxpayer performs more than 750 hours
of services during the taxable year in real property trades or businesses in which the
taxpayer materially participates. Sec. 469(c)(7)(B)(i) and (ii). In the case of a joint
return, either spouse must satisfy both requirements. Sec. 469(c)(7)(B). Thus, if
either spouse qualifies as a real estate professional, the rental activities of the real
estate professional are not per se passive under section 469(c)(2).
For purposes of determining whether a taxpayer is a real estate professional, a
taxpayer’s material participation is determined separately with respect to each rental
property, unless the taxpayer makes an election to treat all interests in rental real
estate as a single rental real estate activity. Sec. 469(c)(7)(A); sec. 1.469-9(e)(1),
Income Tax Regs. Petitioners made an election in 2006, which remained in effect
for 2007, to treat their rental properties as a single activity. See sec. 1.469-9(g)(1),
Income Tax Regs.
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[*10] Section 1.469-9(b)(3), Income Tax Regs., defines rental real estate as “any
real property used by customers or held for use by customers in a rental activity
within the meaning of § 1.469-1T(e)(3).” Section 1.469-1T(e)(3), Temporary
Income Tax Regs., 53 Fed. Reg. 5702 (Feb. 25, 1988), states that, except as
otherwise provided, an activity is a rental activity for a taxable year, if “[d]uring
such taxable year, tangible property held in connection with the activity is used by
customers or held for use by customers”. See also sec. 469(j)(8). As provided in
section 1.469-1T(e)(3)(ii)(A), Temporary Income Tax Regs., supra, an “activity
involving the use of tangible property is not a rental activity for a taxable year if for
such taxable year * * * [t]he average period of customer use for such property is
seven days or less”.
The parties agree that in 2006 Midnight #1 was not rental real estate and that
in 2007 both Midnight #1 and Midnight #2 were not rental real estate because the
average period of customer use was seven days or less during those periods. Thus,
these properties are not rental activities for purposes of section 469(c)(2) and are
considered a trade or business or an income-producing activity. See Bailey v.
Commissioner, T.C. Memo. 2001-296. Additionally, the parties agree that in 2007,
when the Martindale property was being prepared for sale, it was not rental real
estate.
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[*11] Respondent contends that the following properties should also not be
considered rental real estate because they were not used or held for use by
customers: (1) in 2006--Founder, Pinyon, and Trenton, and (2) in 2007--Founder,
Hialeah, and Pinyon. The record reflects that none of these properties were used by
customers or held for use by customers during these periods. See sec. 1.469-
9(b)(3), Income Tax Regs. Accordingly, these properties are not considered rental
real estate for the identified years, and may not be grouped with rental activities for
purposes of determining whether petitioner materially participated in the rental real
estate activity. See sec. 1.469-9(e)(3)(i), Income Tax Regs.
When determining a taxpayer’s material participation, section 1.469-9(e)(3),
Income Tax Regs., provides that rental real estate activities cannot be grouped with
any other activity of the taxpayer. Petitioner’s activities as a real estate sales
associate assisting other individuals with listing, selling, and purchasing homes and
maintaining bank-owned properties are separate from his activity as the owner of
residential real estate properties. Petitioner does not own or manage the residential
real estate properties as part of his profession as a real estate sales associate.
Accordingly, petitioner’s rental real estate activity remains subject to the material
participation requirement of section 469(c)(1).
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[*12] A taxpayer can establish material participation by satisfying any one of seven
tests provided in the regulations. Sec. 1.469-5T(a), Temporary Income Tax Regs.,
53 Fed. Reg. 5725-5726 (Feb. 25, 1988); see Miller v. Commissioner, T.C. Memo.
2011-219; Bailey v. Commissioner, T.C. Memo. 2001-296. Petitioners contend that
petitioner satisfies one or more of the following tests:
(1) The individual participates in the activity for more than 500 hours
during such year;
(2) The individual’s participation in the activity for the taxable year
constitutes substantially all of the participation in such activity of all
individuals (including individuals who are not owners of interests in the
activity) for such year;
(3) The individual participates in the activity for more than 100 hours
during the taxable year, and such individual’s participation in the
activity for the taxable year is not less than the participation in the
activity of any other individual (including individuals who are not
owners of interests in the activity) for such year;
* * * * * * *
(5) The individual materially participated in the activity (determined
without regard to this paragraph (a)(5)) for any five taxable years
(whether or not consecutive) during the ten taxable years that
immediately precede the taxable year;
* * * * * * *
(7) Based on all of the facts and circumstances * * *, the individual
participates in the activity on a regular, continuous, and substantial
basis during such year.
[Sec. 1.469-5T(a), Temporary Income Tax Regs., supra.]
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[*13] With respect to the evidence that may be used to establish hours of
participation, section 1.469-5T(f)(4), Temporary Income Tax Regs., 53 Fed. Reg.
5727 (Feb. 25, 1988), provides:
The extent of an individual’s participation in an activity may be
established by any reasonable means. Contemporaneous daily time
reports, logs, or similar documents are not required if the extent of such
participation may be established by other reasonable means.
Reasonable means for purposes of this paragraph may include but are
not limited to the identification of services performed over a period of
time and the approximate number of hours spent performing such
services during such period, based on appointment books, calendars, or
narrative summaries.
In arguing that he is a real estate professional and materially participated in
his rental real estate activity, petitioners rely on petitioner’s testimony that he
worked a total of approximately 65 to 70 hours during 2006 and 2007, with
approximately 40 hours per week devoted to his work as a real estate sales
associate, 15 to 20 hours spent managing the bank-owned properties, and the
remaining 10 to 15 hours devoted to petitioners’ properties. For petitioners’
grouped properties that are considered rental real estate activity, petitioner claimed
that he spent 331 hours in 2006 and 212 in 2007 participating in the rental real
estate activity, but admitted that he kept no records, such as calendars or logs,
detailing his time and activities. Petitioner’s testimony concerning his
participation consisted only of estimates based on recollections of events that had
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[*14] taken place several years before. Petitioner’s subjective time estimates suffer
from a lack of contemporaneous verification by records or other estimates. See id.
This Court has previously noted that while the regulations are somewhat
ambiguous concerning the records to be maintained by taxpayers, we are not
required to accept a postevent “ballpark guesstimate”, or the unverified,
undocumented testimony of taxpayers. See Moss v. Commissioner, 135 T.C. 365,
369 (2010); Estate of Stangeland v. Commissioner, T.C. Memo. 2010-185; Shaw v.
Commissioner, T.C. Memo. 2002-35.
Petitioner presented no evidence demonstrating that his participation was
substantially all of the participation by all individuals in the rental activity or that his
participation was not less than that of any other individual. The record reflects that
with respect to the Ohio properties, a hired individual performed maintenance work
and additional contractors were hired to undertake other maintenance and
remodeling projects at these properties. Petitioner furthermore did not produce any
evidence showing that he materially participated in the rental activity for any 5
taxable years during the 10 taxable years immediately preceding 2006 and 2007.
We cannot conclude that petitioner participated in his rental activity “on a
regular, continuous, and substantial basis”, as contrasted to a sporadic basis,
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[*15] during either year. See sec. 1.469-5T(a)(7), Temporary Income Tax Regs.,
supra. The preponderance of the evidence indicates that his rental activities were
the per se passive activities that are addressed by the limitations of section 469.
Because he did not materially participate in the rental activities, they cannot be
combined with his activities as a real estate salesman or manager as an agent of
others, and his losses on the rental properties may not be used to offset his earnings
from Prudential Palms Realty or his income from managing bank-owned properties.
Because he did not materially participate in the rental activities, we need not decide
whether petitioner's activities as a licensed sales agent qualify as a “real property
trade or business” under section 469(c)(7)(B) and (C).
Real Estate Activities Not Grouped as Rental Real Estate Activities
Section 212 allows as a deduction all of the ordinary and necessary expenses
paid during the year for the production or collection of income or for the
management, conservation, or maintenance of property “held for the production of
income”, including the rental of real property. See sec. 1.212-1(b), Income Tax
Regs. Property held for the production of income also includes property expected to
appreciate over time, even though the property generates no current income. Id.
Sections 162 and 212 are subject to the passive activity loss limitations. See sec.
469(c)(6). Thus with respect to petitioners’ real estate activities that are not
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[*16] grouped with the rental activities, the losses are subject to the passive activity
loss limitations under section 469, unless petitioners can prove that petitioner
materially participated in the nonrental real estate activities.
For essentially the same reasons stated with respect to the rental activities, we
conclude that petitioners have not shown that petitioner materially participated in
any of the real estate activities not considered grouped rental activities, beyond what
respondent has conceded. Petitioners produced no records that substantiated
petitioner’s claims regarding his time spent in these real estate activities, and his
testimony at trial consisted only of recollections and estimates of time recounted
years after the fact.
Petitioners also did not produce any evidence showing that petitioner’s
participation was substantially all of the participation by all individuals in the
activities or that his participation was not less than that of any other individual. The
record suggests otherwise. Petitioners paid an onsite management company to
manage the Midnight #1 property; the Trenton and the Founder properties were
under construction, which would have necessitated the involvement of contractors in
those activities; the Pinyon property was owned by others who would have
participated in the activity to some degree; and individuals and contractors in Ohio
were hired to perform tasks related to the Hialeah and Martindale properties.
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[*17] Furthermore, petitioner did not produce any evidence regarding his material
participation in the activities during the years before 2006 and 2007. Based on the
record, petitioners’ real estate activities that are not grouped with the rental
activities for the relevant periods are subject to the passive activity loss limitations
under section 469.
Petitioners claim that depreciation and certain expenses that they paid are
deductible under section 212 with respect to the Trenton property in 2006, the
Founder property in 2007, and the Pinyon property for both 2006 and 2007.
Section 162(a) allows a deduction for “ordinary and necessary” business
expenses. Under section 263(a)(1) expenditures for “new buildings or for
permanent improvements or betterments made to increase the value of any property
or estate” are capital expenditures and are not immediately deductible. Generally, a
taxpayer must add a capital expenditure to basis. Sec. 1.263(a)-1(b), Income Tax
Regs. And a taxpayer’s cost recovery of capital expenditures, if allowable, will
generally come over time through deductions for amortization or depreciation. See,
e.g., secs. 167, 168, and 169. The Trenton property was under construction during
2006 as was the Founder property during 2006 and 2007. Accordingly, the
expenses incurred during those years are not currently deductible.
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[*18] Section 167(a) allows as a depreciation deduction a reasonable allowance for
the exhaustion, wear, and tear of property used in a trade or business, or property
held for the production of income. Depreciation deductions “are allowed to
investors who have placed capital at risk through the purchase of an asset used in
trade or business or held for production of income”. See Durkin v. Commissioner,
872 F.2d 1271, 1276 (7th Cir. 1989), aff’g T.C. 87 T.C. 1329 (1986). The period
for deprecation of an asset begins when the asset is placed in service. Sec.
1.167(a)-10(b), Income Tax Regs. As a general rule, an asset “is clearly considered
as placed in service when it is acquired and put into use” in a trade or business or
income-producing activity. Piggly Wiggly S., Inc. v. Commissioner, 84 T.C. 739,
746-748 (1985), aff’d on another issue, 803 F.2d 1572 (11th Cir. 1986).
Petitioners presented no evidence that the Trenton and Founder properties
had been placed in service during or before the years in issue. Thus, petitioners are
not entitled to the claimed depreciation deductions for the Trenton property for 2006
and the Founder property for 2006 and 2007.
As to the Pinyon property, petitioners held no ownership or other legal
interest in that property during 2006 or 2007, and petitioners’ expense deductions
claimed in connection with this property could not have been “for the
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[*19] management, conservation, or maintenance of property held for the production
of income.” See sec. 212(2) (emphasis added); see also, e.g., Perret v.
Commissioner, 55 T.C. 712, 717 (1971). In addition, with respect to section
212(1), which allows a deduction for expenses paid or incurred for the production or
collection of income, petitioner presented no evidence that his expenses with regard
to the Pinyon property were ordinary and necessary, as required by section 212.
Also, because of the absence of legal ownership, petitioners’ depreciation
deductions claimed for the Pinyon property must be disallowed. See, e.g., Arevalo
v. Commissioner, 124 T.C. 244, 251-252 (2005), aff’d, 469 F.3d 436 (5th Cir.
2006).
Section 6662(a) Penalty
Section 6662(a) and (b)(2) imposes a 20% accuracy-related penalty on any
underpayment of Federal income tax which is attributable to a substantial
understatement of income tax. An understatement of income tax is substantial if it
exceeds the greater of 10% of the tax required to be shown on the return or $5,000.
Sec. 6662(d)(1)(A).
Under section 7491(c), the Commissioner bears the burden of production
with regard to penalties and must come forward with sufficient evidence
indicating that it is appropriate to impose penalties. Higbee v. Commissioner, 116
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[*20] T.C. 438, 446-447 (2001). Because the understatement of income tax for the
years in issue is substantial, respondent has satisfied the burden of producing
evidence that the penalties are appropriate.
Once the Commissioner has met the burden of production the taxpayer must
come forward with persuasive evidence that the penalty is inappropriate because he
or she acted with reasonable cause and in good faith. Sec. 6664(c)(1); Higbee v.
Commissioner, 116 T.C. at 448-449. 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 of the pertinent facts and circumstances. See sec. 1.6664-4(b)(1),
Income Tax Regs.
Petitioners have not addressed the reasonable cause or good faith defense to
the section 6662(a) penalty. See sec. 6664(b) and (c); Higbee v. Commissioner,
116 T.C. at 448-449. They simply assert that they were entitled to the deductions
they claimed. Petitioners’ income tax returns for 2006 and 2007 were prepared by a
professional tax preparer, but they provided no details regarding what information
they gave to the tax preparer or what the tax preparer’s advice was. See
Neonatology Assocs., P.A. v. Commissioner, 115 T.C. 43, 99 (2000), aff’d, 299
F.3d 221 (3d Cir. 2002). We conclude, therefore, that petitioners have failed
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[*21] to satisfy their burden of proving that they are not liable for the section
6662(a) penalty for tax years 2006 and 2007.
In reaching our conclusions, we have considered all arguments made by the
parties and, to the extent not mentioned above, we conclude they are moot,
irrelevant, or without merit.
To reflect the foregoing and respondent’s concession,
Decision will be entered
under Rule 155.