Izen and Evans and trusts, oh my!

[The Observer]

A case that has everything - sham trust, scam artists, tax protestors, scammers fleecing the greedy victims, the return of Joe Izen to the courtroom - and a new pseudo legal term: "coactus feici."

DAVID W. AND CONNIE L. SWANSON,
Petitioners
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent

Release Date: DECEMBER 01, 2008


FSH SERVICES, R. RICHARD EVANS, TRUSTEE,
Petitioner
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent

______________

UNITED STATES TAX COURT

Filed December 1, 2008

Joe Alfred Izen, Jr., for petitioners.

Erin K. Salel and Jolene Itakura, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

COHEN, Judge: In these consolidated cases, respondent determined the following deficiencies, additions to tax, and penalties with respect to petitioners' Federal income taxes:

David W. and Connie L. Swanson (Docket No. 550-00)

Addition to Tax Penalty
Year Deficiency Sec. 6651(a)(1) Sec. 6662(a)
____ __________ _______________ ____________

1993 $ 144,841 -- $ 28,968
1994 278,548 -- 55,710
1995 414,030 $ 41,403 82,963

FSH Services, R. Richard Evans, Trustee (Docket No. 551-00)

Addition to Tax Penalty
Year Deficiency Sec. 6651(a)(1) Sec. 6662(a)
____ __________ _______________ ____________

1993 $ 186,002 $ 46,501 --
1994 311,953 77,988 --
1995 434,977 -- $ 86,995

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 of Procedure.

Respondent concedes that if FSH Services is disregarded for Federal tax purposes, it should not be subject to deficiencies, additions to tax, or penalties. After trial, respondent submitted the following revised computations of the amounts at issue, attributing the income in issue to David W. and Connie L. Swanson (collectively, the Swansons) and taking into account respondent's concessions as to deductions:

Addition to Tax Penalty
Year Deficiency Sec. 6651(a)(1) Sec. 6662(a)
____ __________ _______________ ____________

1993 $ 17,068 -- $ 3,413.60
1994 95,913 -- 19,182.60
1995 191,486 -0- 38,297.20

After concessions, the issues for decision are: (1) Whether the burden of proof has shifted to respondent under section 7491; (2) whether FSH Services is disregarded for Federal tax purposes and its income for the years in issue is attributed to the Swansons; (3) whether the periods of limitations on assessment expired before the deficiency notices were sent; (4) whether the Swansons are liable for self-employment tax on income from FSH Services; (5) whether the Swansons are entitled to deductions in excess of those allowed by respondent; (6) whether the Swansons are liable for the accuracy-related penalty under section 6662(a); and (7) whether the Swansons are liable for a penalty under section 6673.

The terms "trust", "trustee", "settlor", and other related terms are used in this opinion for convenience and are not intended to be conclusive as to the characterization of FSH Services for Federal tax purposes.

FINDINGS OF FACT

Some of the facts have been stipulated, and the stipulated facts are incorporated in our findings by this reference. The Swansons resided in California and FSH Services had a mailing address in California at the time their petitions were filed.

David W. Swanson (Mr. Swanson) and Connie L. Swanson (Mrs. Swanson) are married and have five children. The Swansons are well educated, each having a bachelor of science degree in mechanical engineering from California Polytechnic State University, San Luis Obispo. From 1983 to 1991, Mr. Swanson worked for Hewlett-Packard Co. (Hewlett-Packard), first as an engineer and then as an engineer manager. Wanting to start his own engineering consulting business (the business), Mr. Swanson began investigating which form of business entity would best suit his needs.

In the summer of 1991, Mr. Swanson met with R. Richard Evans (Evans) to discuss the possibility of running the Swansons' forthcoming business through an "unincorporated organization in trust form". The Swansons decided to establish their business in this trust form, and on August 8, 1991, Cache Properties Unlimited (Cache), as named settlor, created FSH Services for this purpose.

One hundred shares called "capital units" represented the beneficial interest in FSH Services and were memorialized on a document called the trust certificate. In exchange for all 100 capital units, Cache purportedly transferred a corpus to the board of trustees, which at that time consisted only of Marcia Doerr (Doerr). According to the trust instrument, referred to as the Declaration of Trust and Indenture (indenture), FSH Service's corpus consisted of:

Personal Property
_________________

Received $ 100
Received $ 200
Paid Out $ 200

The record is not clear as to many details of the transaction, including who received the $ 200 "paid out". It appears that Cache contributed the $ 100 "received", and Doerr transferred all 100 capital units to Cache at this time. The Swansons contributed the $ 200 "received", also in exchange for the 100 capital units, even though the trust certificate designated all 100 capital units to Cache. No other money or property was put into the trust at its creation.

Shortly thereafter, the Swansons further funded the trust with approximately $ 3,400 to "get it going". On October 9, 1991, Doerr transferred 97 capital units to the Swansons and 3 capital units to three of the Swansons' children from the 100 capital units held by Cache. There is no record that Cache received remuneration for transferring its capital units.

Also on October 9, 1991, Doerr appointed the officers of FSH Services, as follows: Mr. Swanson, general manager; Mrs. Swanson, treasurer; Vernon Tritchka (Tritchka), assistant manager and secretary; and Gary McLeod (McLeod), protector. The indenture provided that no officer could be removed "without thirty days written notice given prior to such removal". The indenture also provided that McLeod, as protector, is the "internal guardian of the fiduciary obligation of the Trustees toward the Capital Unit Holder(s)" and that he has the power to access all the records of the trust.

At the same time, Doerr appointed Evans cotrustee of FSH Services, and he served in that capacity for the years in issue. While still serving as treasurer, Mrs. Swanson replaced Tritchka as assistant manager on September 30, 1992. On February 20, 1994, Evans replaced Doerr as executive trustee, and he appointed Susan O'Brien (O'Brien) cotrustee. With respect to appointment of trustees, the indenture provided the following:

Should there remain no Board to appoint a Successor Trustee, the
Protector shall appoint one Trustee, or else the Capital Unit
Holders may apply to a court of competent jurisdiction to appoint
one Trustee; who shall then have power to appoint other Trustees.

The indenture and additional trust provisions contained within the minutes granted all the officers and trustees authority to manage operations of the trust and have signature authority of its bank accounts. The indenture also provided that full health coverage and educational expenses of the officers and certificate holders could be paid for by the trust.

The business initially operated out of a converted bedroom at the Swansons' residence. In 1993, the Swansons built a freestanding workshop on their property that FSH Services used for the business and Mr. Swanson used for his own commercial enterprise. FSH Services paid rent for its use of the residence and workshop and also paid one-quarter of the Swansons' utility bills.

FSH Services treated the Swansons as independent contractors and not as its employees. Personal expenses of the Swansons were nonetheless paid by FHS Services, including family meals, medical and dental expenses, braces for at least one child's teeth, and their children's school tuition. These personal expenses were claimed as deductible expenses of FSH Services.

Mrs. Swanson did the bookkeeping and kept the records for FSH Services. For the years in issue FSH Services had six bank accounts, including an "income" account and an "operations" account, and all the accounts used the Swansons' home address as their mailing address. Mrs. Swanson earned $ 100 a year in her capacity as bookkeeper, treasurer, and assistant manager of FSH Services.

Mr. Swanson quit his job with Hewlett-Packard in early 1992 to concentrate on the business full time. As the general manager of FSH Services, Mr. Swanson found customers, made proposals, and reviewed contracts. He also found and hired other engineers for FSH Services, whom he managed and assigned work. On many contracts he worked as an engineer as well. Mr. Swanson's reputation as an engineer/manager and his expertise, contacts, and goodwill attracted the clients of FSH Services. For the years in issue, Mr. Swanson secured contracts with large companies such as Hewlett-Packard, Gradco USA, Inc., and Proxima Corp. Mr. Swanson earned $ 500 a year in his capacity as general manager of FSH Services.

During the years in issue, Mr. Swanson also worked outside of FSH Services in his personal engineering business. Mr. Swanson decided which engineering jobs he worked through FSH Services and which jobs he personally performed. In the same workshop shared by FSH Services, Mr. Swanson invented products that he patented to himself. He received substantial licensing fees through his patents during this time.

After the business was up and running, Evans purportedly introduced Mr. Swanson to an Englishman named Bernard Putz (Putz). Putz claimed to represent an offshore trust in Gibraltar called the Loire Trust; he allegedly offered to capitalize FSH Services up to $ 200,000 if the Swansons would transfer their capital units to the Loire Trust. On November 16, 1992, the Swansons transferred one of their capital units to another of their children (for a total of 4 capital units in their children's names) and their remaining 96 units to the Loire Trust in exchange for an oral promise from Putz of a loan. The loan never occurred, and the Swansons never attempted to get their 96 units back from Putz or the Loire Trust.

The O'Brien Group, a tax services business owned and operated by O'Brien, prepared FSH Services' tax returns for the years in issue. FSH Services was listed as a simple trust on its Forms 1041, U.S. Income Tax Return for Estates and Trusts, for 1992, 1993, and 1995, and the "Type of entity" box was left unchecked for 1994. As of June 1997, Internal Revenue Service (IRS) records did not show these tax returns as having been filed by FSH Services.

Schedules K-1, Beneficiary's Share of Income, Deductions, Credits, etc., attached to the tax returns showed FSH Services as having made beneficiary income distributions to the Loire Trust as follows: $ 51,789 in 1993; $ 225,813 in 1994; and $ 369,221 in 1995. However, there is no record that FSH Services ever made any distributions to the Loire Trust. FSH Services reported no other beneficial distributions, and the Swansons waived their children's rights to trust income for the years in issue.

On their Forms 1040, U.S. Individual Income Tax Return, the Swansons reported the following:

Year Gross Income Taxable Income Total Tax
____ ____________ ______________ _________
1993 $ 87,471 $ 59,330 $ 20,917
1994 86,393 57,014 20,666
1995 94,258 61,364 21,178

The Swansons wrote the phrase "coactus feici" (sic) in the jurat box of their tax returns for the years in issue. The O'Brien Group prepared the Swansons' 1995 tax return.

The IRS audited petitioners' returns for the years in issue. The IRS recomputed FSH Services' gross receipts using a bank deposit analysis. The IRS determined that FSH Services' net taxable deposits were $ 415,365.83 for 1993, $ 726,956.22 for 1994, and $ 983,721.96 for 1995. After concessions, these amounts were reduced to $ 53,359.44, $ 256,049.54, and $ 481,466.84 for 1993, 1994, and 1995, respectively. For reasons set forth below, and in relation to petitioners' statute of limitations argument, these reduced amounts represent amounts properly includable on but omitted from the Swansons' returns.

Revenue Agent Higgins (Higgins) conducted audit interviews with Mr. Swanson and his agent, O'Brien. When asked questions regarding FSH Services, Mr. Swanson refused to explain the Swansons' close connections with the trust other than his position as general manager. In a followup interview, Mr. Swanson and O'Brien refused to talk with Higgins and demanded that he be replaced on the grounds that Mr. Swanson had filed a lawsuit against him. Revenue Agent Lee (Lee) replaced Higgins and conducted a third interview. Mr. Swanson and O'Brien refused to answer many of Lee's questions, and they made insulting comments to and about Lee.

Higgins also conducted an interview with Evans (accompanied by O'Brien as his agent) regarding FSH Services. Evans refused to answer many questions at the interview, asserting his Fifth Amendment right against self-incrimination.

The IRS sent a notice of deficiency to the Swansons on October 12, 1999. Deficiencies were determined for the years in issue on conclusions that: 1) The Swansons improperly assigned their income to FSH Services; or, alternatively, 2) FSH Services is a sham trust with no economic substance and is disregarded for Federal tax purposes; or, alternatively, 3) FSH Services is determined to be a grantor trust under sections 671-677, and its income is taxable to the Swansons. The adjustments reflected in the notice included unreported gross receipts derived from the bank deposit analyses and disallowance of itemized deductions.

By a separate notice of deficiency sent to FSH Services, the IRS determined deficiencies for the years in issue primarily because of unreported gross receipts. Other adjustments for 1995 included modifications to expenses claimed on Schedule C, Profit or Loss From Business, and disallowance of the income distribution deduction.

After the years in issue, the Swansons discovered checks disappearing and unexplained amounts being withdrawn from the FSH Services' bank accounts. Evans refused to respond to questions regarding these matters. Mr. Swanson brought a copy machine to Evans's home and copied the FSH Services records that were stored there. Upon investigation, the Swansons found that Evans had written several checks that were unaccounted for in the bookkeeping. The Swansons objected to Evans's behavior and, along with O'Brien, requested that Evans resign as trustee. Because Evans did not agree to resign, they demanded that he surrender FSH Services' checkbooks, which he did. The Swansons later transferred the business out of FSH Services and into a new entity, Maxim Automation Products, L.L.C. (Maxim), which acquired all subsequent contracts. FSH Services provided capital for the new venture and became a partner in Maxim.

On October 5, 2006, the U.S. District Court for the Southern District of California found O'Brien guilty of 1 count of conspiracy to defraud the United States, 6 counts of tax evasion, 6 counts of tax evasion -- aiding and abetting, and 28 counts of aiding and assisting the filing of false income tax returns. The court sentenced her to over 10 years in prison.

On October 6, 2006, the District Court found Evans guilty of 1 count of conspiracy to defraud the United States, 6 counts of tax evasion -- aiding and abetting, and 12 counts of aiding and assisting the filing of false income tax returns. The court sentenced him to over 6 years in prison. Joe Alfred Izen, Jr. (Izen), petitioners' counsel in these cases, represented Evans in his trial. Petitioners were aware of and consented to Izen's representation of Evans in spite of potential conflicts of interest between petitioners and Evans.

Because of these criminal convictions, Evans and O'Brien no longer served as trustees. The Swansons chose a friend, Mark Corcoran (Corcoran), as the new trustee of FSH Services.

(continued into next post)

[The Observer]

OPINION

Petitioners argue that FSH Services is a valid entity independent of the Swansons and that all transactions involving FSH Services should be respected for Federal tax purposes. Respondent argues that the Swansons should be taxed on income of FSH Services and adduces three alternative theories as to why: 1) FSH Services is a sham trust that has no economic substance; 2) the assignment of income doctrine applies; or 3) the grantor trust provisions apply. We agree with respondent on the first theory.

Burden of Proof

Petitioners bear the burden of proof in these cases, and it has not shifted under section 7491(a). See Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). Petitioners did not cooperate during IRS examinations but obstructed them by refusing to produce certain documents or to answer questions. See sec. 7491(a)(2)(B). Petitioners were confrontational and insulting to the revenue agents.

Moreover, even though their testimony and exhibits are voluminous, petitioners did not present credible evidence that FSH Services had economic substance. See sec. 7491(a)(1). The 14 evidence that they did produce was undermined by their implausible claims. Their testimony about events and their explanations of improper deductions were not credible. (For example, Mrs. Swanson, during her testimony, attempted to justify the FSH Services deduction of the costs of family meals and a trip by petitioners to Hawaii as "management expenses".) We are not required to accept testimony that is improbable or vague. See Geiger v. Commissioner, 440 F.2d 688, 689-690 (9th Cir. 1971), affg. T.C. Memo. 1969-159; Sanderlin v. Commissioner, T.C. Memo. 2008-209.

The Swansons' testimony was improbable. They claim that the trust they established, with the effect of their reporting minimal tax liability on substantial profits of the business, was not tax motivated. Petitioners contend that they created their business within the trust for "asset protection" purposes. Yet the Swansons, according to their testimony, inexplicably gave away their 96 capital units of FSH Services for nothing more than a stranger's promise of a loan. Petitioners present no evidence of this transaction or of the unknown, off-shore Loire Trust. It is not plausible or credible that the Swansons, gravely concerned about protecting assets, would have given away their legal and beneficial interests in the business that was their livelihood.

The Swansons closely interacted with Evans and O'Brien but deny that they ever discussed tax avoidance. Evans, however, has long been involved with the abusive trusts, and both he and O'Brien promoted tax evasion schemes to their clients. See Buckmaster v. Commissioner, T.C. Memo. 1997-236; see also United States v. Evans, No. 03CR1110-L (S.D. Cal. Oct. 6, 2006) (finding Evans guilty of tax evasion aiding and abetting, among other crimes); United States v. O'Brien, No. 03CR1110-L (S.D. Cal. Oct. 5, 2006) (finding O'Brien guilty of tax evasion aiding and abetting, among other crimes), affd. sub nom. United States v. Cook, 261 Fed. Appx. 52 (9th Cir. 2007). We do not believe that Evans did not promote tax avoidance as a primary objective when proposing his trust schemes to the Swansons.

The Swansons also directly demonstrated tax-protester actions, including writing "coactus feici" in the jurat boxes of their tax returns for the years in issue. Mrs. Swanson understood that coactus feci meant "something like [signing the return] but under protest, or not protest but reserving my rights kind of thing". Mr. Swanson's hostile actions against the examining agents were consistent with protester attitudes. Their associates playing roles in these cases maintained similar positions in other cases. See Corcoran v. Commissioner, T.C. Memo. 2002-18 (Corcoran, a trained accountant, brought standard tax-protester arguments before the Court, which imposed a section 6673(a) penalty for his insistence in pursuing frivolous contentions), affd. 54 Fed. Appx. 254 (9th Cir. 2002); Caralan Trust v. Commissioner, T.C. Memo. 2001-241 (Doerr was the trustee of trusts used by taxpayers to avoid tax and shift income and, as a result, the Court determined a penalty of $ 12,500 was warranted for frivolous claims and positions). Given their antitax position, implausible claims, and dearth of credible evidence, we do not accept petitioners' assertion that they established the trust for nontax business reasons. They have not satisfied the prerequisite to shifting the burden of proof under section 7491(a)(2).

Disregard of FSH Services

Tax motivation alone is not a ground to disregard FSH Services for Federal tax purposes. A taxpayer has the right to elect a business form to minimize or altogether avoid the incidence of taxation by any means that the law permits. See Gregory v. Helvering, 293 U.S. 465, 469 (1935). This right, however, does not grant the taxpayer leeway to structure a paper entity to avoid tax when that entity is without economic substance. Zmuda v. Commissioner, 79 T.C. 714, 719 (1982), affd. 731 F.2d 1417 (9th Cir. 1984). Nor is the Government required to simply accept a taxpayer's election of business form where that form is a sham. Higgins v. Smith, 308 U.S. 473, 477 (1940). Instead, the Government should disregard the sham, as any other result would allow the schemes of the taxpayer to supersede the law. Id.

[Nikki]

Another VICTORY for Izen -- no sanction.

[The Observer]

Due to the length of the article, I tried segmenting this but for some reason the board software is making it difficult to post. I will try later to resubmit.

[wserra]

A case that has everything - sham trust, scam artists, tax protestors, scammers fleecing the greedy victims, the return of Joe Izen to the courtroom - and a new pseudo legal term: "coactus feici."

Not to mentioin at least one Putz:

After the business was up and running, Evans purportedly introduced Mr. Swanson to an Englishman named Bernard Putz (Putz).

[The Observer]

Not to mentioin at least one Putz:

I knew that you would be the one to utter that obvious one-liner.

[wserra]

I knew that you would be the one to utter that obvious one-liner.

Voden?

[The Observer]

I knew that you would be the one to utter that obvious one-liner.

Voden?

Hey, at least you refrained from mentioning his shmekel.

[grixit]

Is "cloaca feces" another way of saying "full colon"?

[notorial dissent]

I think the term is actually “coactus feci” which means under duress or compulsion. Sort of UCC all rights reserved but on steroids. And about as useful in this situation.