861 Follower Hit with Fraud Penalty in Tax Court

[jcolvin2]

T.C. Memo. 2009-34
UNITED STATES TAX COURT
GREGORY A. JUNG, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 7341-06. Filed February 11, 2009.
Gregory A. Fox, for petitioner.
Stephen R. Takeuchi, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION

SWIFT, Judge: Respondent determined deficiencies, additions
to tax, and fraud penalties relating to petitioner’s Federal
income taxes as follows:

Additions to Tax Penalties
Year Deficiency Sec. 6651(a)(1) Sec. 6663(a)
1999 $55,695 $12,263 $41,772
2000 148,390 36,361 111,292
2001 13,832 3,560 10,374

Unless otherwise indicated, 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.

After settlement of some issues, the primary issues for
decision are whether funds petitioner received in 1999 and 2000
from trusts, from family members, and from a real estate
management company constitute income to petitioner and whether
petitioner is liable for the section 6663(a) fraud penalties.
For convenience, we set forth separately for each issue our
findings of fact and our analysis, and we first address the fraud
penalties.

Fraud Penalties

FINDINGS OF FACT

Some of the facts have been stipulated and are so found.

At the time the petition was filed, petitioner resided in
Florida.

After graduating from high school, petitioner attended
Tulane University in New Orleans. During petitioner’s fourth
year of college, petitioner was involved in a car accident and
suffered serious brain trauma. As a result of the accident,
petitioner occasionally suffers from short- and long-term memory
loss, and occasionally petitioner still relies on family members
to manage some of his personal affairs. After a year off because
of the accident, petitioner returned to Tulane University, and in
1984 petitioner received a bachelor’s degree in geology.
After managing restaurants for a number of years, petitioner
entered graduate school, and in 1989 petitioner received a
master’s degree in hotel administration from Florida
International University. Petitioner then worked as an assistant
manager and manager of several hotels in Florida, Texas, and
Costa Rica.

In 1997 petitioner began working in Miami as an operations
manager for a large shipping company. While working for the
shipping company, petitioner became interested in investing in
rental real estate and in trading securities on his own account.
In 1999 petitioner left his job at the shipping company, became a
real estate agent in Tampa, Florida, began investing in real
estate and in the stock market, and began managing rental real
estate.

During 1999, 2000, and 2001 as a result of his rental real
estate and securities trading activities petitioner realized
substantial income.

With regard to his rental real estate and securities trading
activities, petitioner occasionally received advice from his
parents, his brother, and his supervisor at the real estate
management company where he worked, and petitioner received loans
from his parents and brother.

Petitioner’s father apparently was a successful business
consultant and worked for a large oil company. After retiring,
petitioner’s father formed a holding company and established a
family trust to hold and manage family assets. Petitioner and
his brother were named beneficiaries of the trust petitioner’s
father established. Petitioner’s brother was an attorney in
Florida.

In 1999 his supervisor at the real estate management company
where petitioner worked introduced petitioner to Gregory Mayer
(Mayer), an accountant and a promoter of abusive tax avoidance
trusts. Petitioner hired Mayer to assist with bookkeeping
matters relating to petitioner’s rental real estate and
securities trading activity. Petitioner also began receiving
advice from Mayer on the formation of tax avoidance trusts and on
the filing of his Federal income tax returns.

With Mayer’s assistance, on January 4, 2000, petitioner
formed Aladdin Land Trust (ALT), and petitioner transferred to
ALT nominal ownership of three parcels of rental real estate.
Petitioner was the sole beneficiary of ALT, and Mayer was the
trustee.

Mayer explained to petitioner the “section 861 theory” that
was the basis for Mayer’s tax avoidance advice (namely, that most
income derived from sources within the United States by a
resident U.S. citizen was not subject to Federal income taxes).1
On the basis of the section 861 theory, Mayer advised petitioner
that petitioner was not required to report on his Federal income
tax returns any of his income from U.S. sources and that
petitioner owed no taxes for 1999.

Petitioner discussed the section 861 theory with his father,
his brother, and his supervisor, and they all advised petitioner
against relying on the section 861 theory in filing his 1999
individual Federal income tax return. Petitioner did not seek
advice from any independent accountants, attorneys, or other
professionals regarding the section 861 theory.

On March 7, 2001, petitioner late filed his 1999 individual
Federal income tax return, on which he reported zero income and
zero taxes due. Attached to petitioner’s 1999 individual Federal
income tax return was a statement signed by petitioner stating
that he relied on the section 861 theory in the preparation of
his tax return.

On audit, petitioner’s 1999 individual Federal income tax
return was referred to respondent’s Frivolous Claims Unit. On
review, respondent’s audit was expanded to include petitioner’s
2000 and 2001 Federal income taxes as petitioner had not yet
filed tax returns for those years. On Mayer’s advice, during
respondent’s audit petitioner ignored respondent’s requests for
financial information and documentation relating to his 1999,
2000, and 2001 income.

Unable to obtain information from petitioner, respondent
issued summonses to third parties requesting bank deposit
records, brokerage statements, and other information relating to
petitioner’s 1999, 2000, and 2001 income. Using deposit
information relating to petitioner’s bank accounts and sales and
basis information relating to petitioner’s brokerage accounts,
which respondent obtained from third parties, respondent
reconstructed petitioner’s 1999, 2000, and 2001 income using the
bank deposits and cash expenditures methods of proof.

On January 21, 2003, a meeting was held with petitioner,
petitioner’s brother, Mayer, and respondent’s audit examiner. At
the meeting, respondent’s audit examiner explained that the
section 861 theory was not valid. Respondent’s audit examiner
gave to petitioner, to petitioner’s brother, and to Mayer copies
of IRS Notice 2001-40, 2001-1 C.B. 1355, and also copies of
several judicial opinions in which the courts held that the
section 861 theory constituted a frivolous tax-protester
argument. Respondent’s audit examiner also encouraged petitioner
to abandon the section 861 theory, to file a proper amended 1999
Federal income tax return reporting his income and the taxes due
thereon, and to file proper 2000 and 2001 Federal income tax
returns. At the meeting, petitioner was disruptive and
uncooperative and refused to answer the examiner’s questions.
Shortly after the above meeting, petitioner’s brother
reviewed the IRS Notice and the judicial opinions given to him
and advised petitioner to terminate his association with Mayer,
to abandon the section 861 theory, and to file proper Federal
income tax returns for 1999, 2000, and 2001.

On January 27, 2003, petitioner late filed his 2000
individual Federal income tax return on which he reported zero
income and zero taxes due. Attached to petitioner’s 2000 tax
return was a statement signed by petitioner stating that in
reporting no income he relied on the section 861 theory.
On February 8, October 7, and October 12, 2004,
respectively, petitioner filed with respondent amended Federal
income tax returns for 1999 and 2000 and an original Federal
income tax return for 2001. By this time respondent had summoned
third-party records, and respondent had reconstructed
petitioner’s income for 1999, 2000, and 2001. On these tax
returns petitioner did not use the section 861 theory, but
petitioner did not fully report income relating to his rental
real estate and to his securities trading activities.

In 2004 respondent sought an injunction action against Mayer
for, among other things, preparing abusive tax returns and
promoting sham trusts. On March 10, 2005, the U.S. District
Court for the Middle District of Florida enjoined Mayer from
preparing frivolous tax returns and representing taxpayers before
the Commissioner. Mayer discontinued representing petitioner,
but Mayer recommended that petitioner retain Joe Izen (Izen),
Mayer’s attorney. Petitioner consulted with Izen, who advised
petitioner not to give up on the section 861 theory and to ignore
respondent’s requests for information.

On January 10, 2006, respondent mailed to petitioner a
notice of deficiency in which respondent determined that
petitioner had substantially underreported his income and that
petitioner had deficiencies in his 1999, 2000, and 2001 Federal
income taxes of $55,695, $148,390, and $13,832, respectively.
Respondent also determined that the underpayments were due to
petitioner’s fraud and therefore that petitioner was liable for
the section 6663(a) 75-percent civil fraud penalty on the entire
deficiency for each year.

The schedule below reflects the various income and expense
adjustments which respondent made in the notice of deficiency and
which petitioner and respondent now agree to:

Agreed Adjustments Total Increase
Year Income/Expense Amount in P’s Income
1999 Rental income $19,203
Other income 19,042
Capital gain income 40,220
Miscellaneous expenses (19,256)
$59,209
2000 Rental income 12,683
Capital gain income 128,531
Miscellaneous expenses 35,398
176,612
2001 Rental income 15,431
Other income 36,594
Dividend/wage income 2,894
Miscellaneous expenses (18,358)
36,561

The next schedule below reflects the adjustments respondent
made to petitioner’s reported income for 1999 and 2000 which
remain in dispute:2
Increase to
Year Disputed Adjustments P’s Income
1999 Distribution from trust $110,000
Other income 2,500
2000 Distribution from trust 79,541
Other income 190,384

OPINION

Under section 6663(a), where the Commissioner establishes
that an underpayment of tax, or a portion thereof, required to be
shown on a return is attributable to the taxpayer’s fraud, the
Commissioner may add to the tax a penalty equal to 75 percent of
the underpayment. To prove a taxpayer’s fraud, respondent has
the burden of establishing by clear and convincing evidence both
the existence of an underpayment and the taxpayer’s fraudulent
intent. Sec. 7454(a); Rule 142(b); Korecky v. Commissioner, 781
F.2d 1566, 1568 (11th Cir. 1986), affg. T.C. Memo. 1985-63; Parks
v. Commissioner, 94 T.C. 654, 660-661 (1990).

If respondent establishes by clear and convincing evidence
that any portion of an underpayment is attributable to fraud, the
entire underpayment for a year is to be treated as attributable
to fraud, except with respect to so much of the underpayment as
results from adjustments which the taxpayer establishes by a
preponderance of the evidence is not attributable to fraud. Sec.
6663(b). As stated, respondent contends that the 75-percent
civil fraud penalty should apply to all of the positive
adjustments to petitioner’s income.

Fraudulent intent is defined as “‘actual, intentional
wrongdoing, and the intent required is the specific purpose to
evade a tax believed to be owing.’” Estate of Temple v.
Commissioner, 67 T.C. 143, 159 (1976) (quoting Mitchell v.
Commissioner 118 F.2d 308, 310 (5th Cir. 1941), revg. 40 B.T.A.
424 (1939)).

Whether petitioner’s fraudulent intent has been established
is to be analyzed on the basis of all of the facts and
circumstances in evidence, Korecky v. Commissioner, supra at
1568, including petitioner’s experience and education,
Niedringhaus v. Commissioner, 99 T.C. 202, 211 (1992),
Grosshandler v. Commissioner, 75 T.C. 1, 19-20 (1980).
Courts have developed several objective “badges” of fraud,
of which three are particularly relevant in this case:
(1) Substantial understatements of income; (2) failure to
maintain or submit adequate books and records; and (3) failure to
cooperate with tax authorities. Bradford v. Commissioner, 796
F.2d 303, 307-308 (9th Cir. 1986), affg. T.C. Memo. 1984-601;
Clayton v. Commissioner, 102 T.C. 632, 647 (1994).
Petitioner now agrees that he underreported his income and
his tax liabilities for 1999, 2000, and 2001. Thus, to sustain
fraud in this case, we need only decide whether petitioner’s
underpayments were due to fraudulent intent.

Petitioner claims that it was the advice and influence of
Mayer and petitioner’s impaired memory and judgment, rather than
fraudulent intent, that caused petitioner to rely on the section
861 theory, to file zero returns for 1999 and 2000, and to
underreport his income and his tax liabilities. Petitioner also
claims that because he did not file a zero return for 2001, he
did not fraudulently underreport his tax liability for 2001.
With respect to petitioner’s 1999, 2000, and 2001 individual
Federal income tax returns, the evidence establishes petitioner’s
fraudulent intent.

Certainly petitioner’s college accident may have impaired
his cognitive abilities and judgment. However, after the
accident, petitioner earned a bachelor’s degree in geology and a
master’s degree in hotel administration, was a manager at hotels,
restaurants, and a shipping company, and conducted sophisticated
business activities, such as owning and managing rental real
estate and trading securities. Petitioner has not submitted
medical or other documentation showing that during any of the
years pertinent to this case he suffered from a medical condition
which in any substantial way affected his judgment.

At the time he filed his 1999 and 2000 zero tax returns,
petitioner was aware of his obligation to report and to pay taxes
on his income. At the January 21, 2003, meeting, respondent’s
audit examiner informed petitioner that the section 861 theory
was frivolous, warned petitioner of the consequences of filing
frivolous tax returns, and provided petitioner with the
opportunity to avoid those consequences by submitting to
respondent information relating to his actual income for 1999.
Petitioner appears to have ignored the advice of respondent, his
father, his brother (an attorney), and his supervisor, and he
also failed to seek the advice of an independent accountant,
attorney, or other professional.

On audit petitioner was uncooperative, and petitioner
ignored respondent’s telephone and letter requests for records
and financial information relating to 1999, 2000, and 2001.
Further, the statements attached to petitioner’s 1999 and
2000 zero Federal income tax returns do not disclose wage and
income information relating to petitioner’s employment and other
income-producing activity for 1999 and 2000.

Although petitioner in 2004 filed amended returns for 1999
and 2000 and an original return for 2001 reporting some of his
income in each year, petitioner did so only after respondent’s
audit, examination, and repeated notices, warnings, and requests.
We conclude that petitioner’s agreed understatements of
income of $59,209, $176,612, and $36,561 for 1999, 2000, and
2001, respectively, and the underpayments of tax relating
thereto, are attributable to petitioner’s fraudulent intent.

Disputed Adjustments

FINDINGS OF FACT

With regard to respondent’s positive $110,000 adjustment for
1999 relating to a distribution from a trust, on December 16,
1999, petitioner’s mother gave him a $10,000 gift. On
December 17, 1999, petitioner’s parents lent ALT $100,000,
secured by a mortgage note dated December 22, 1999. As evidence
of the $10,000 gift and the $100,000 loan, petitioner submitted a
$10,000 canceled check dated December 17, 1999, from his parents
to him, a canceled $100,000 check dated December 17, 1999, from
his parents to ALT, and a mortgage note dated December 22, 1999,
reflecting ALT’s $100,000 debt obligation in favor of his
parents.

With regard to respondent’s $2,500 adjustment for 1999
relating to other income, in 1999 petitioner’s brother repaid to
petitioner a $2,500 loan petitioner had made to his brother.
This loan repayment was verified by 1999 bank statements
reflecting two check deposits totaling $2,500 from petitioner’s
brother.

With regard to the $79,541 petitioner received in 2000 from
his father’s trust, the evidence indicates that on October 6,
2000, his father lent $79,541 nominally to ALT. The loan was
verified by a $79,541 canceled check dated October 6, 2000, from
petitioner’s father’s trust nominally to ALT and a letter dated
November 8, 2000, from petitioner’s father to petitioner
describing the loan. On September 2, 2005, petitioner repaid his
father the $79,541 loan.

With regard to respondent’s $190,384 adjustment for 2000
relating to other income, on February 29, 2000, and on October 4,
2000, petitioner’s parents lent nominally to ALT $18,500 and
$81,469, respectively. These loans were verified by an $18,500
canceled check dated February 29, 2000, from petitioner’s parents
nominally to ALT, by bank statements for 2000 reflecting a wire
transfer of $81,469 from petitioner’s father nominally to ALT,
and by the above November 8, 2000, letter from petitioner’s
father to petitioner describing the loans. It is unclear from
the record whether petitioner repaid his father the February 29, 2000, $18,500 loan, but on September 2, 2005, petitioner repaid
his father the October 4, 2000, $81,469 loan.
Also, in 2000 petitioner made a $50,000 deposit on the
purchase of a property owned by the real estate management
company at which he worked, and on April 28, 2000, the real
estate management company returned to petitioner the $50,000
deposit. The April 28, 2000, return of petitioner’s $50,000
deposit was verified by a $50,000 canceled check dated April 28,
2000, from the real estate management company to petitioner.

OPINION

Generally, as to the proper calculation of a taxpayer’s
income, the taxpayer bears the burden of proof, and the
Commissioner’s determination of a taxpayer’s income and tax
liabilities are entitled to a presumption of correctness. Rule
142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933); Feldman v.
Commissioner, 20 F.3d 1128, 1132 (11th Cir. 1994), affg. T.C.
Memo. 1993-17.3

Petitioner has met his burden of proof with regard to the
two disputed adjustments for 1999. We conclude that the $110,000
and the $2,500 do not constitute income to petitioner, and we
disallow respondent’s positive 1999 income adjustments relating
thereto.

Petitioner also has met his burden of proof with regard to
the nontaxable nature of the $79,541 received from his father’s
trust and with regard to $149,969 of the total $190,384 other
income in dispute ($18,500 and $81,469 loans from petitioner’s
parents and $50,000 deposit refund equals $149,969). We conclude
that the $79,541 disputed adjustment and $149,969 of the other
income disputed adjustment for 2000 do not constitute income to
petitioner.

However, petitioner has not submitted evidence, and
therefore has not met his burden of proof, with regard to the
remaining $40,415 of the other income disputed adjustment for
2000, and we sustain a $40,415 increase in petitioner’s other
income for 2000.

As stated, because of petitioner’s failure to meet his
burden of proof under section 6663(b) as to the nonfraudulent
nature of the adjustments we sustain, the fraud penalty also
attaches thereto.

To reflect the foregoing,
Decision will be entered
under Rule 155.

1 For a discussion and rejection of Mayer’s sec. 861
theory, see Williams v. Commissioner, 114 T.C. 136 (2000), and
IRS Notice 2001-40, 2001-1 C.B. 1355.

2 No income adjustments remain in dispute for 2001.

3 Because we find that petitioner failed to adequately
cooperate with respondent’s reasonable requests for information
relating to petitioner’s income for 1999, 2000, and 2001,
petitioner does not qualify for a shift in the burden of proof
under sec. 7491(a).

[Edited to Enable BB Code -jc]

[Nikki]

Note a couple of the other actors involved:

Gregory Mayer -- an accountant and a promoter of abusive tax avoidance
trusts -- subsequently enjoined by the government from preparing frivolous tax returns and representing taxpayers before the Commissioner

Joe Alfred Izen Jr. -- Attorney (so far, despite several admonishments, sanctions, and suspensions) -- Mayer recommended that petitioner retain Joe Izen (Izen), Mayer’s attorney. Petitioner consulted with Izen, who advised petitioner not to give up on the section 861 theory and to ignore respondent’s requests for information

With help like that, how could he possibly go wrong.

BTW: Don't bother looking for Izen's web site. It seems that the Texas Bar Association was unhappy with it and made him take it down.

[Lambkin]

BTW: Don't bother looking for Izen's web site. It seems that the Texas Bar Association was unhappy with it and made him take it down.

TIA has it.

http://web.archive.org/web/200705021443 ... index.html

This letter from Lynne Meredith also claims Izen was representing her.

http://www.bigeye.com/meredith.htm

EDIT: actually, Izen's old site is still there. All he did was remove the index page. Stuff like this is still online: http://www.joeizen.com/5thpressrel.htm