T.C. Memo. 2013-98
UNITED STATES TAX COURT
MARK A. BISHOP, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 20810-10. Filed April 10, 2013.
Robert P. Lowell, for petitioner.
Monica D. Gingras for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
LARO, Judge: The instant petition involving petitioner’s 2006 Federal
income tax return seeks a redetermination of respondent’s determination of a
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[*2] deficiency of $88,769, an addition to tax under section 6651(a)(1)1 of
$21,335.50, and a penalty under section 6662(a) of $17,753.80. We decide the
following issues: (1) whether petitioner is entitled to a bad debt deduction under
section 166 for 2006. We hold that he is not; (2) whether petitioner is liable for the
addition to tax under section 6651(a)(1). We hold that he is; and (3) whether
petitioner is liable for the accuracy-related penalty imposed under section 6662(a).
We hold that he is.
FINDINGS OF FACT
The parties filed with the Court a stipulation of facts and related exhibits. The
stipulated facts and the accompanying exhibits are incorporated herein by this
reference. We find the facts accordingly. Petitioner resided in California when he
filed the petition.
From 2001 until June 2006 petitioner was the president of IMPAC
Mortgage Holdings, Inc. (IMPAC), where he worked as a whole-loan trader who
bought and sold pools of loans. During the same period petitioner was also the
president of Novelle Financial (Novelle)--a company IMPAC acquired in
September 2001 and wholly owned at least until June 2006--where petitioner
1
Unless otherwise indicated, section references are to the Internal Revenue
Code (Code) in effect for the year at issue, and Rule references are to the Tax Court
Rules of Practice and Procedure.
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[*3] worked as a mortgage lender.2 Between IMPAC and Novelle, petitioner
worked approximately 60 hours a week. From June 2006 through the rest of the
year petitioner worked for Quick Loan Funding (Quick Loan) as its president whose
duties were mainly focused on the pooling of mortgages originated at Quick Loan
and their sales to investment banks. While at Quick Loan, petitioner worked about
60 hours a week.
Around 2004 and 2005, IMPAC was seeking local appraisers to provide
appraisal services in connection with its purchases of mortgage loans. Landmark
Equities Group (Landmark), which was a real estate appraisal firm that provided
appraisal services to many local lenders from whom IMPAC purchased its mortgage
loans, would occasionally provide such services to IMPAC. Through this
relationship, petitioner became acquainted with James Eaton, who was Landmark’s
principal shareholder and president.
In early 2006 petitioner met with Mr. Eaton several times and learned that
Landmark had begun to develop a new product called the Automated Valuation
Model (AVM product), which Landmark intended to market to investment banks
that purchased and securitized mortgage loans. The AVM product would enable its
users to quickly and efficiently obtain accurate valuations by aggregating title
2
Petitioner terminated his services at Novelle shortly before he left IMPAC.
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[*4] insurance information from numerous providers that could be translated into
real estate values. On the basis of these meetings, petitioner understood that
Landmark would have to raise close to $20 million to fund the development and
marketing of the product; in petitioner’s view, shared with Landmark, this capital
requirement could be met only by either equity syndication or a public offering.
Landmark’s need to raise the necessary capital through a possible public
offering sparked petitioner’s interest in getting involved, as he thought he could
capitalize on his prior success in staging an initial public offering (IPO) by advising
Landmark on a similar offering in exchange for a substantial fee. In 2003 while
working at IMPAC and Novelle, petitioner had successfully advised GVC Holdings
on its IPO on the Alternative Investment Market (AIM) of the London Stock
Exchange (LSE). Through that transaction, petitioner had acquired a few contacts,
including investment bankers and attorneys in London, who petitioner thought might
help Landmark stage a similar offering on the AIM market. It appears the 2003 IPO
was petitioner’s only experience in the area.
With respect to Landmark, petitioner believed he was uniquely positioned to
prepare Landmark for a successful IPO, ostensibly because he understood
Landmark’s business model and the inner workings of the LSE and the AIM
market. He thought the AIM was a good fit for Landmark because it was a “small
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[*5] cap” market that had simpler disclosure requirements and shorter time-to-IPO.
In exchange for the provision of his services, petitioner expected to earn a large fee
that could range from three to five points on the capital raised in the IPO.
To lay the groundwork for a possible IPO, petitioner and Landmark worked
together and purportedly developed a business plan, marketing materials, and a pro
forma for an $80 million public offering.3 Petitioner then contacted Collins-Stewart
in London who would represent Landmark on the investment banking side and
Hunton & Williams, also in London, who would be Landmark’s legal
representation. After some conference calls and exchanges of documents, petitioner
traveled to London with Mr. Eaton, Brian Eaton, and Landmark’s chief financial
officer (CFO), George Shamchula, purportedly to meet with the London-based
investment bankers and attorneys.4
But before Landmark could raise any capital through an IPO, it had
immediate cash needs that had to be met in order to pay its current operational
costs, such as payroll and accounts payable. Landmark tried to borrow $300,000
from Pacific Mercantile Bank (PMB), but PMB declined to extend such a loan
3
Petitioner did not endeavor to submit any of these documents into evidence.
4
The only documentary evidence relating to these meetings is a one-page
meeting schedule petitioner prepared.
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[*6] because it thought Landmark and Mr. Eaton were already overleveraged.
Undeterred and determined to earn his fee one day from putting together a
successful IPO deal, petitioner advanced $300,000 to Landmark to help it meet its
immediate cashflow requirements so that the business could stay afloat and continue
to grow while the company was preparing for an IPO on the LSE. While petitioner
believed that the loan was crucial to Landmark’s growth and a successful IPO,
petitioner testified that he would probably have made the loan even without the
prospect of the IPO because, on the basis of Landmark’s financial health at the time,
the loan itself appeared to be secure. Notably, petitioner did not require as a
condition to the extension of the loan that Landmark pay petitioner a percentage-
point fee based on any capital raised through a subsequent IPO.
To finance the loan to Landmark, petitioner decided to borrow from PMB,
and on April 19, 2006, he entered into a promissory note with PMB (PMB note) in
the amount of $300,000. Under the PMB note, petitioner was required to make a
balloon payment plus all accrued but unpaid interest upon maturity on April 19,
2007. In addition, petitioner was required to make regular interest payments of all
accrued interest due as of each payment date beginning May 19, 2006.
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[*7] Petitioner transferred the $300,000 in proceeds of the PMB loan to
Landmark in exchange for an unsecured promissory note that Landmark executed
(Landmark note) on the same date he signed his promissory note to PMB. The
Landmark note contained an acceleration clause by which in the event of default,
which encompassed nonpayment of principal or interest, petitioner could by
written notice declare all unpaid balance of the note and accrued interest
immediately due and payable.5 The terms of the Landmark note--i.e., the
calculation of interest and the terms of monthly payment--tracked the terms
provided in the PMB note. Further, the Landmark note was set to mature on the
same date as the PMB note upon which the Landmark note would become due and
payable in full. In other words, other than the prospect of earning a large fee for
5
Petitioner testified that the note contained an acceleration clause. But on
brief petitioner, along with respondent, contend that the note did not give petitioner
the right to accelerate repayment of the principal balance of the note upon default.
But this contention is not supported by the terms of the Landmark note. The fifth
paragraph of the note states: “If any of the following events (each, an “Event of
Default”) shall occur, * * * then, the holder of this Note may at any time by written
notice * * * declare the entire unpaid principal of and the interest accrued on this
Note * * * due and payable”. The entire fifth paragraph is one conditional sentence,
in which the conditional clause, or the “if” clause, lists a number of alternative
grounds for default and the main clause that starts with “then” describes the
particular result, i.e., acceleration of the payment of principal, that would happen if
any one of the alternative conditions were met. Because “default in the payment of
any part of the principal or interest on this Note” is one of the alternative conditions,
petitioner had the right to exercise the acceleration clause when Landmark failed to
make its interest payments.
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[*8] staging an IPO for Landmark, petitioner would not make any money on the
loan to Landmark under the loan’s terms.6
In addition to making the short-term loan to Landmark, petitioner also worked
between 20 and 30 hours per week for Landmark for three months from March
through May 2006 to help the company prepare for an IPO. In connection with his
employment at Landmark, petitioner earned wage income from Landmark of
$20,000 that was reported on Form W-2, Wage and Tax Statement.7
6
Petitioner undertook a similar financing arrangement with Daniel Sadek, who
was the principal shareholder of Quick Loan. In 2006 petitioner lent $5 million to
Mr. Sadek, financed by advances petitioner drew on a home equity line of credit
with VirtualBank. In exchange petitioner received a secured promissory note from
Mr. Sadek dated June 19, 2006 (Sadek note). According to its terms, the interest
and monthly payment calculations under the Sadek note reflected the terms of the
VirtualBank Home Equity Line of Credit Agreement (VirtualBank HELOC
agreement) that petitioner entered into with VirtualBank on June 13, 2006. Similar
to the financing arrangement with Landmark, petitioner would not make any profit
on the Sadek note because the Sadek note and the VirtualBank HELOC agreement
had the same terms. Petitioner claimed that the main reason he extended the loan to
Mr. Sadek was to help with Quick Loan’s short-term financial needs so that he
could capture a large fee for staging a potential IPO for Quick Loan in the future.
7
The parties stipulated that petitioner received Form W-2 wage income for
2006 from the following sources:
(continued...)
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[*9] Soon after the execution of the Landmark note, the real estate market showed
signs of trouble and Landmark’s financial condition began to deteriorate. After
Landmark failed to make its first payment under the note, due May 19, 2006,
petitioner made several written demands for payment, including letters dated July
26, September 20, and November 19, 2006, requesting payment, to which
Landmark did not make any specific responses. In addition to the written demands,
petitioner purportedly made other oral demands for repayment as well as personal
visits to Landmark’s office.
From these personal visits that took place every month throughout 2006,
according to petitioner, he was able to gain access to Landmark’s books and
records, providing him an insider’s look at Landmark’s financial health.8 Because
the note would not become due until April 2007, petitioner was interested only in
7
(...continued)
Employer Wages
Landmark $20,000.00
IMPAC 288,454.90
Novelle 141,998.49
Quick Loan 288,000.00
8
Petitioner did not offer into evidence any of the Landmark books and records
that he claimed to have reviewed.
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[*10] getting Landmark to meet its obligation to make interest-only payments.
Indeed, petitioner conceded during trial that the three separate letters that he wrote
to Landmark were demands for interest payments and not principal. And on the
basis of his review of Landmark’s books, petitioner believed Landmark would be
able to meet its interest payment obligation and expected payments to be
forthcoming. Landmark never made a payment under its note.
Despite Landmark’s being in default on the note for nonpayment, petitioner
did not exercise the acceleration clause and demand immediate payment of the
loan’s principal plus accrued and unpaid interest. While petitioner continued to
think Landmark was in a position to make interest payments, on the basis of his
review of the company’s books he understood that Landmark would not be able to
pay the entire principal sum of the Landmark note if he invoked the acceleration
clause. By continuing to work with Landmark, petitioner hoped to keep Landmark
on its feet so that it could make interest payments, especially if Landmark would
undergo significant cuts in staff and expenses.
In any event, while petitioner’s testimony shows Landmark was
experiencing serious financial difficulties, nothing in the record shows one could
conclude in 2006 that Landmark would never be able to repay any portion of the
principal. Moreover, petitioner could not conclude whether Landmark was
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[*11] insolvent by the end of 2006, and it appears to us that Landmark continued to
be a going concern into 2007. Petitioner did not provide any testimony from a
disinterested party or any documentary evidence other than the three written
payment demands to corroborate his worthlessness claim.
John Epperson, a certified public accountant for over 40 years and
petitioner’s accountant for over 20 years, prepared petitioner’s 2006 return.
Petitioner filed a Form 4868, Application for Automatic Extension of Time to File
U.S. Individual Income Tax Return, which extended the time to file the 2006 return
to October 15, 2007. Despite the extension the 2006 return was not filed until May
12, 2008. It was filed late ostensibly because petitioner’s extensive business travel
abroad combined with Mr. Epperson’s living in another State rendered it difficult for
petitioner to meet with Mr. Epperson timely to discuss and prepare the filing of the
2006 return.
When petitioner was eventually able to meet with Mr. Epperson, he
provided Mr. Epperson the Landmark note as well as the PMB note for review.
Petitioner also told Mr. Epperson about his efforts to collect on the Landmark note
but did not otherwise give Mr. Epperson any of the financial documents from
Landmark that formed the basis of petitioner’s determination that the Landmark
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[*12] note was not collectible. Mr. Epperson never personally reviewed the
financial documents in question.
On the basis of the Landmark note and the PMB note and after having
reviewed certain professional publications and legal research materials, including
unspecified IRS publications and court cases, Mr. Epperson determined petitioner
would be entitled to claim a bad debt deduction for 2006. Correspondingly, the
Schedule C, Profit or Loss From Business, attached to petitioner’s 2006 return
claimed an “Outside Services” deduction of $301,000.9 According to Mr.
Epperson, the deduction for “Outside Services” was a clerical mistake, and he
intended to identify the deduction as a bad debt expense.
OPINION
The primary issue of this case is whether petitioner is entitled to a business
bad debt deduction for 2006 under section 166(a). To be able to claim the
deduction for 2006, petitioner must show (1) the Landmark note was a bona fide
debt that became wholly worthless in 2006,10 see Kean v. Commissioner, 91 T.C.
9
Mr. Epperson explained at trial “to the best of * * * [his] recollection” that
the $1,000 in addition to the loan principal was a transaction fee paid to PMB.
Petitioner has not produced any evidence to substantiate this claim.
10
Petitioner has not argued that the note became partially worthless, and the
evidence does not show any portion of the Landmark note was charged off in 2006.
(continued...)
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[*13] 575, 594 (1988), and (2) the debt was not a nonbusiness debt under section
166(d). While we find the Landmark note to be a bona fide debt, we conclude
petitioner has failed to meet his burden to show the note became worthless in 2006.
Because petitioner cannot show the worthlessness of the Landmark note, we need
not decide whether it was a nonbusiness debt as defined in section 166(d)(2).
I. Burden of proof
The Commissioner’s determinations in a notice of deficiency are generally
presumed correct, and a taxpayer bears the burden of proving those determinations
are erroneous. Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933).
Similarly, a taxpayer bears the burden to show he is entitled to claim any deductions
allowed under the Code and to substantiate the amount of any claimed deductions.11
INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992); sec. 1.6001-1(a),
Income Tax Regs. But with respect to liability for additions to tax under section
6651 and any accuracy-related penalty under section 6662, the Commissioner bears
the burden of production under section 7491(c).
10
(...continued)
See sec. 166(a)(2); sec. 1.166-3(a), Income Tax Regs.
11
Petitioner does not contend, nor does the record suggest, that the burden of
proof should be shifted to respondent under sec. 7491(a).
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[*14] II. Section 166 bad debt deductions
A. Bona fide debt
A section 166 bad debt can arise only if the purported debt is a bona fide
debt. Conversely, an advance that is a capital contribution or a gift is not a debt for
purposes of section 166. Kean v. Commissioner, 91 T.C. at 594; sec. 1.166-1(c),
Income Tax Regs. A bona fide debt can arise only from a debtor-creditor
relationship based on a valid and enforceable obligation to pay a fixed or
determinable sum of money. Kean v. Commissioner, 91 T.C. at 594; sec. 1.166-
1(c), Income Tax Regs. We determine whether a purported debt is a bona fide debt
for tax purposes from the facts and circumstances of each case. See Lundgren v.
Commissioner, 376 F.2d 623, 626 (9th Cir. 1967), rev’g on other ground T.C.
Memo. 1965-314; Dixie Dairies Corp. v. Commissioner, 74 T.C. 476, 493 (1980).
The Court of Appeals for the Ninth Circuit, to which this case is appealable
absent any stipulation by the parties, see sec. 7482(b)(1)(A), has identified 11
factors with varying degrees of influence in a debt-equity analysis:
“(1) the names given to the certificates evidencing the indebtedness;
(2) the presence or absence of a maturity date; (3) the source of the
payments; (4) the right to enforce the payment of principal and
interest; (5) participation and management; (6) a status equal to or
inferior to that of regular corporate creditors; (7) the intent of the
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[*15] parties; (8) ‘thin’ or adequate capitalization; (9) identity of
interest between creditor and stock holder; (10) payment of interest
only out of ‘dividend’ money; (11) the ability of the corporation to
obtain loans from outside lending institutions.” * * *
A. R. Lantz Co. v. United States, 424 F.2d 1330, 1333 (9th Cir. 1970) (quoting
O.H. Kruse Grain & Milling v. Commissioner, 279 F.2d 123, 125-126 (9th Cir.
1960)). The Court of Appeals has also cautioned not to place a disproportionate
emphasis on any single factor. Id.
Here, Landmark’s indebtedness was evidenced by its promissory note to
petitioner showing the parties’ intent to structure the advance as a genuine debt.
The note obligated Landmark to pay monthly interest and to make a balloon
payment of the principal and any unpaid but accrued interest upon maturity, which
was set at one year after the execution of the note. The note provided an
acceleration clause by which petitioner could declare the entire balance of the note
due in the event of default. It also appears to place petitioner on equal footing with
other unsecured creditors since there is no evidence of subordination.
Further, petitioner was not an investor in Landmark and did not otherwise
participate in its growth or management. The Landmark note did not make the
interest-only payments contingent on corporate earnings. Quite the opposite,
Landmark’s obligation to repay the debt principal and interest was fixed and
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[*16] determinable under the valid and enforceable promissory note. See sec.
1.166-1(c), Income Tax Regs.
Respondent maintains that the $300,000 advance was not a bona fide debt
because (1) the note was unsecured, (2) Landmark was unable to borrow from PMB
because it thought Landmark was already overleveraged, and (3) petitioner did not
demand payment in full when Landmark defaulted and made only minimal effort to
demand interest payments.
While the existence of collateral would tend to support genuine indebtedness,
its absence alone is not determinative. Similarly, the fact that Landmark could not
obtain a similar loan from a commercial bank because the company was already
overextended is not controlling. See Lundgren v. Commissioner, 376 F.2d at 626;
Taft v. Commissioner, 314 F.2d 620, 622 (9th Cir. 1963), aff’g in part, rev’g in part
T.C. Memo. 1961-230. While extending a $300,000 loan to Landmark without
collateral at a time when a commercial bank would not provide the same loan might
sound like a risky proposition, “it is not our province to inquire into the wisdom of
the loan” so long as petitioner could show genuine indebtedness. Brenhouse v.
Commissioner, 37 T.C. 326, 329 (1961).
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[*17] It is true that petitioner did not exercise the acceleration clause under the note
as it was his right to do. But he did repeatedly make written and oral demands for
interest payments. His reluctance to push Landmark too hard for payments can be
explained by his credible testimony that he wanted to work with his debtor until it
could improve its financial condition and recover from the real estate market crisis
existing at the time so that it might resume making payments.
Ultimately, petitioner had no financial interest in Landmark and was not its
shareholder before or after he provided the $300,000 loan. There was also an
absence of any personal relationship between petitioner and Landmark or Mr. Eaton
that would suggest the advance was a gift. Because Landmark’s repayment
obligation under the note was absolute, there is nothing in evidence that could
explain the advance as something other than genuine indebtedness. See id. at 330.
Accordingly, we find the Landmark note to be a bona fide debt.
B. Worthlessness in 2006
Our determination of whether a debt is wholly or partially worthless is
based on all facts and circumstances, including the financial condition of the debtor.
Sec. 1.166-2(a), Income Tax Regs. Legal action is not required to show
worthlessness if surrounding circumstances indicate that a debt is worthless and
uncollectible and that any legal action in all likelihood would be futile because the
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[*18] debtor would not be able to satisfy a favorable judgment. Sec. 1.166-2(b),
Income Tax Regs. Petitioner bears the burden to show the Landmark note became
worthless in 2006, the year for which petitioner claimed the bad debt deduction
under section 166. See Rule 142(a); Crown v. Commissioner, 77 T.C. 582, 598
(1981).
There is no standard test or formula for determining worthlessness, and the
determination depends on the particular facts and circumstances of the case. Lucas
v. Am. Code Co., 280 U.S. 445, 449 (1930); Crown v. Commissioner, 77 T.C. at
598. The fact that the debt has not matured or that no payment under the debt is due
when a taxpayer claims a bad debt deduction does not of itself prevent its allowance
under section 166. Sec. 1.166-1(c), Income Tax Regs. But a taxpayer usually must
show identifiable events to prove worthlessness in the year claimed. Am. Offshore,
Inc. v. Commissioner, 97 T.C. 579, 593 (1991). Some objective factors include a
decline in the debtor’s business; a decline in the value of the debtor’s assets, if any;
the overall business climate; the debtor’s serious financial reverses; the debtor’s
earning capacity; events of default; insolvency of the debtor; the debtor’s refusal to
pay; actions the creditor took to pursue collection; subsequent dealings between the
creditor and the debtor. Id. at 594.
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[*19] No single factor listed above is conclusive. Id. at 595. Moreover, the mere
fact that a business is on the decline, that it has failed to turn a profit, or that its debt
obligation may be difficult to collect does not necessarily justify treating the debt
obligation as worthless. Intergraph Corp. & Subs. v. Commissioner, 106 T.C. 312,
323 (1996), aff’d without published opinion, 121 F.3d 723 (11th Cir. 1997). This is
especially true where the debtor continues to be a going concern with the potential
to earn a future profit. See Rendall v. Commissioner, 535 F.3d 1221, 1228 (10th
Cir. 2008) (citing Roth Steel Tube Co. v. Commissioner, 620 F.2d 1176, 1182 (6th
Cir. 1980), aff’g 68 T.C. 213 (1977)), aff’g T.C. Memo. 2006-174; ABC Beverage
Corp. v. Commissioner, T.C. Memo. 2006-195, 92 T.C.M. (CCH) 268, 271 (2006).
While petitioner’s testimony suggests that the Landmark note might have
become worthless in 2006, it is insufficient to carry his burden to show
worthlessness without testimony from a disinterested party or some documentary
evidence to corroborate the claim. Petitioner’s testimony as to the overall business
climate in the real estate market at the time intimates that Landmark indeed
experienced decline in its business, but we do not know by how much. Landmark’s
failure to make interest payments may reflect its inability to repay some portion of
its debt to petitioner, but that failure alone is not conclusive.
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[*20] Petitioner claimed he examined Landmark’s financial records every month
before he concluded the Landmark note was worthless, but none of the books
petitioner purportedly examined is in the record for us to make an independent
determination of Landmark’s net worth and ability to pay in 2006. There is no
evidence showing Landmark’s cashflow and earnings. We do not have Landmark’s
balance sheet to help us determine whether its aggregate liabilities exceeded the
value of its assets. Because Landmark remained a going concern into 2007,
producing some evidence demonstrating its ability or inability to turn the business
around and to generate enough income to pay the debt is crucial. In sum, “[t]he
unsupported opinion of the taxpayer alone that the debt is worthless will not usually
be accepted as proof of worthlessness.” Dustin v. Commissioner, 53 T.C. 491, 502
(1969), aff’d, 467 F.2d 47 (9th Cir. 1972).
Even if we credit petitioner’s testimony on its face, which we do not, it does
not support a finding of worthlessness in 2006. While a determination of
worthlessness does not hinge on whether any portion of the debt has become due,
Landmark’s nonpayment of principal could be explained by the fact that the
Landmark note’s principal was not due until April 2007. Indeed, petitioner never
exercised the note’s acceleration clause by sending the required written demand; on
the contrary, petitioner stated during trial that the written demands that he did
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[*21] send to Landmark were only demands for interest payments. Thus, there is
nothing in the record that could even suggest that petitioner actually made an
attempt in 2006 to collect on the note’s principal.12
Even petitioner’s testimony itself allows a strong inference that Landmark
would be able to repay its debt under the note at some point in the future. Petitioner
claimed that he reviewed Landmark’s financial records. On the basis of his
understanding of Landmark’s financial condition, he could not determine whether
Landmark was insolvent but still believed that Landmark could make interest
payments, just not payments on the principal. He also believed Landmark’s
financial health could improve if it was willing to go through significant cuts in staff
and expenses. Petitioner did not want to push Landmark into a corner by
accelerating the note because if Landmark were required to repay the whole debt, as
petitioner’s testimony suggests, it might not be able to pay it at that moment.
But petitioner’s testimony says very little about whether Landmark would
be able to pay the principal in the foreseeable future, especially when petitioner
was willing to provide Landmark some flexibility in meeting its payment
12
The three demand letters referenced “Landmark’s $300,000 note” or “the
$300K note”. But these are only references made to identify the note, and we do
not understand them to be demands for payment of the entire principal balance.
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[*22] obligation. Indeed, it appears from petitioner’s testimony that there was a
glimpse of hope that Landmark could get back on its feet and meet its debt
obligation to him. While petitioner need not be an “incorrigible optimist”, see
United States v. S.S. White Dental Mfg. Co., 274 U.S. 398, 403 (1927), he needs to
persuade us that there was an objective and substantial reason for abandoning any
hope of repayment in the future, see Dallmeyer v. Commissioner, 14 T.C. 1282,
1291-1292 (1950). Because petitioner never exercised the acceleration clause and
demanded payment of the principal, petitioner has failed to persuade us that there
could not be a reasonable expectation of repayment and Landmark could not have
recovered from its financial woes to satisfy the note by the date of maturity. Thus,
petitioner’s testimony at most can only suggest that Landmark’s finances in 2006
would have prevented it from satisfying the debt in full in that year if petitioner had
required it; but he never did. That is insufficient to support a finding of
worthlessness.
Because we find petitioner has failed to meet his evidentiary burden to show
the Landmark note became worthless in 2006, we conclude he is not entitled to the
bad debt deduction under section 166(a) for 2006. Correspondingly, our conclusion
renders it unnecessary to determine whether the debt was a business debt or a
nonbusiness debt under section 166(d).
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[*23] III. Addition to tax and penalty
A. Addition to tax under section 6651(a)(1)
Section 6651(a)(1) imposes an addition to tax for failure to timely file a
Federal income tax return unless the taxpayer can show that the failure was due to
reasonable cause and not willful neglect. It is undisputed that petitioner did not
timely file his tax return. On brief, petitioner did not make any arguments to
establish that he may avail himself of the affirmative defense. Thus, we deem the
defense waived.13 See Zapara v. Commissioner, 124 T.C. 223, 233 (2005), aff’d,
652 F.3d 1042 (9th Cir. 2011); see also Higbee v. Commissioner, 116 T.C. 438,
446-447 (2001).
B. Penalty under section 6662(a)
Respondent determined that petitioner is liable for an accuracy-related
penalty for 2006 because petitioner substantially understated his income tax or,
alternatively, because he was negligent or disregarded rules or regulations. See sec.
6662(a) and (b)(1) and (2). There is a substantial understatement of income tax if
the amount of the understatement for the taxable year exceeds the greater of
13
At trial, Mr. Epperson explained the 2006 return was filed late because
petitioner’s extensive travel abroad made it difficult for them to meet to prepare the
return timely. Even if we were to conclude that petitioner did not abandon the
reasonable cause defense, we would still find Mr. Epperson’s explanation
inadequate to show reasonable cause.
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[*24] 10% of the tax required to be shown on a return for a taxable year or $5,000.
Sec. 6662(d)(1)(A). Alternatively, we will sustain respondent’s determination to
impose an accuracy-related penalty if we determine petitioner failed to make a
reasonable attempt to comply with provisions of the internal revenue laws or
disregarded rules or regulations by acting carelessly, recklessly, or with intentional
disregard. Sec. 6662(c); sec. 1.6662-3(b)(1) and (2), Income Tax Regs. Only one
accuracy-related penalty may be imposed for a given portion of an underpayment
even though that portion implicates more than one form of misconduct described in
section 6662. Sec. 1.6662-2(c), Income Tax Regs. Because respondent has carried
his burden under section 7491(c) to show that the inappropriately claimed bad debt
deduction resulted in a substantial understatement of petitioner’s income tax,14 we
need not decide whether petitioner would also be liable for the penalty by reason of
negligence or reckless disregard of rules and regulations.
Once respondent has proved his prima facie case for imposing the penalty
under section 6662(a), petitioner bears the burden of proving that the penalty is
unwarranted by establishing an affirmative defense such as reasonable cause or
14
The correct tax required to be shown on petitioner’s return was $174,880.
The understatement of tax due from petitioner for 2006 is $88,769. Ten percent of
the correct tax liability for 2006 is $17,488. Thus, petitioner substantially
understated his 2006 income tax liability.
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[*25] substantial authority. See sec. 6664(c)(1); sec. 6662(d)(2)(B). Again,
petitioner did not make any arguments on brief to establish that his claim of the bad
debt deduction was based on reasonable cause or substantial authority. Thus, we
conclude that petitioner has abandoned the argument. See Zapara v. Commissioner,
124 T.C. at 233; see also Higbee v. Commissioner, 116 T.C. at 446-447.
In any event, the record does not show the substantial authority defense
is available to petitioner, who has not otherwise cited any authority, not to
mention substantial authority, to support his worthlessness claim. Reasonable
cause requires that the taxpayer have exercised ordinary business care and
prudence as to the challenged item. See United States v. Boyle, 469 U.S. 241
(1985). A taxpayer’s reliance on the advice of a professional, such as a certified
public accountant, may constitute reasonable cause and good faith if the taxpayer
could prove by a preponderance of the evidence that: (1) the taxpayer reasonably
believed the professional was a competent tax adviser with sufficient expertise to
justify reliance; (2) the taxpayer provided necessary and accurate information to
the advising professional; (3) the taxpayer actually relied in good faith on the
professional’s advice. See Neonatology Assocs., P.A. v. Commissioner, 115 T.C.
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[*26] 43, 98-99 (2000), aff’d, 299 F.3d 221 (3d Cir. 2002); see also sec. 1.6664-
4(c)(1), Income Tax Regs.
It is apparent from the record that petitioner did not provide all the necessary
and accurate information to Mr. Epperson for him to determine whether the
Landmark note was worthless in 2006. Mr. Epperson only reviewed the Landmark
note and the PMB note in addition to IRS publications and some unnamed court
cases. Petitioner did not provide Mr. Epperson the Landmark financial records that
formed the basis of his worthlessness claim. Nor did petitioner take Mr. Epperson
with him to Landmark’s office to review the company’s financial records. Thus,
even if petitioner had relied in good faith on Mr. Epperson’s advice, Mr. Epperson’s
determination that the Landmark note was worthless rings hollow and cannot form
the predicate for the reasonable cause defense.
We have considered all of petitioner’s arguments for a contrary holding, and
to the extent not discussed herein we conclude they are irrelevant, moot, or lacking
in merit.
To reflect the foregoing,
Decision will be entered for
respondent.