Mark Feathers & Natalie E. Feathers

United States Tax Court

T.C. Memo. 2024-88

MARK FEATHERS AND NATALIE E. FEATHERS,

Petitioners

v.

COMMISSIONER OF INTERNAL REVENUE,

Respondent

__________

Docket No. 9371-14. Filed September 23, 2024.

__________

Mark Feathers and Natalie E. Feathers, pro sese.

Michael Skeen and Lesley A. Hale, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

HOLMES, Judge: Mark and Natalie Feathers were the majority

shareholders of Small Business Capital Corp. (SBCC). SBCC managed

two LLCs, both of which sent substantial sums of money to SBCC in

2009 and 2010. SBCC itself sent substantial sums of money to Mark

Feathers. SBCC did not include all the money from the LLCs in its gross

receipts. The Featherses did not include all the money from SBCC in

their gross income.

The Featherses claim that the sums sent from the LLCs to SBCC

were merely loans, and that the sums sent from SBCC to Mr. Feathers

were for consulting. The Commissioner says that the Featherses have

no good reason to exclude any part of this cash flow from their taxable

income.

Served 09/23/24

2

[*2] FINDINGS OF FACT

I. The Featherses’ Origins

Mark Feathers was raised up and down the east coast but claims

Pennsylvania as his home state. He earned a bachelor’s degree in

finance from Penn State. After he graduated in 1987, he joined the

Navy, served two years, and landed on the west coast. After coming

ashore he earned an MBA from Golden Gate University. He then began

work at the Small Business Administration’s (SBA) regional and district

offices in San Francisco.

Mr. Feathers’s career in public service was short lived. In 1994,

he moved to a community bank to work as a senior underwriter. He

spent the next several years seeking more opportunity and higher pay

at a succession of community and national banks including Wells Fargo

and Citibank. At each stop he focused on the development and

marketing of SBA-related services.

After years of working for others in both the private and public

sectors, Mr. Feathers opened his own business in 2004. He first named

it 504 1st Mortgage Lending Corp., but by 2006 he had renamed it

SBCC. The name sounds generic, and the record became more confusing

because Mr. Feathers had SBCC do business under the name SB

Capital, LLC (SB Capital), and then in 2009 began a sole proprietorship

under the name Small Business Capital. During the years at issue—

2009 and 2010—Mr. Feathers held around 80% of SBCC’s stock. He was

also a director, the chief executive officer, and the designated broker of

record for the company.

SBCC was in the business of real-estate mortgage brokering, but

was not itself a direct lender. The company profited by setting up

investment funds and creating loan portfolios for them. It also profited

by charging those funds organizational and management fees. We focus

in this case on two funds that Mr. Feathers created for SBCC to

manage—Investors Prime Fund, LLC and SBC Portfolio Fund, LLC.

The brokering and investment-fund businesses went well at first.

SBCC looked like a success, and Mr. Feathers’s wife Natalie left her

position as senior vice president for a community bank to join him at

SBCC.

3

[*3] II. Relationship Between the Featherses and the Entities

Because this case hinges on the characterization of money

transferred between the Featherses and SBCC, as well as between

SBCC and the Funds, we begin with an explanation of the structure of

SBCC and the Funds and then a description of their relationship.

A. Structure of SBCC and the Funds

SBCC was incorporated in California and was at first taxed as a

C corporation. 1 SBCC later elected to be treated as an S corporation on

its return and maintained that status through the tax years at issue. 2

Electing to be treated as an S corporation meant that SBCC was subject

to the laws of subchapter S of the Code. S corporations generally don't

pay federal income tax. They function instead like partnerships—

passthrough entities that route income and deductions to their owners.

See Gitlitz v. Commissioner, 531 U.S. 206, 209 (2001). A shareholder of

an S corporation is required to report his share of the corporation’s

income and deductions on his individual return. Hill v. Commissioner,

100 T.C.M. (CCH) 513, 515 (2010). Since Mr. Feathers was a

shareholder of SBCC, he had such an obligation.

Both of the Funds were also passthrough entities. They were set

up as California LLCs: Investors Prime in 2005 and SBC Portfolio in

2007. Mr. Feathers did not have a direct membership interest in the

Funds, but SBCC was both the Funds’ sole manager and the issuer of

their membership interests.

1 A “C corporation” is a corporation that is taxed under subchapter C of

chapter 1 of the Internal Revenue Code (Code), §§ 301–385. (Unless otherwise

indicated, statutory references are to the Code, Title 26 U.S.C., in effect at all relevant

times, and Rule references are to the Tax Court Rules of Practice and Procedure.)

2 A corporation which would otherwise be treated as a C corporation can elect

to be treated as an S corporation on its return if it is a “small business corporation.”

§ 1362(a). The Code defines a “small business corporation” as a domestic corporation

that does not (1) have more than 100 shareholders, (2) have as a shareholder certain

entities which are not defined as individuals, (3) have a nonresident alien as a

shareholder, or (4) have more than one class of stock. § 1361(b)(1). An election to be

an S corporation stays in effect until it is terminated. § 1362(c).

4

[*4] B. Relationship of SBCC and the Funds

1. Management Responsibilities

SBCC’s role as manager put it in charge of issuing and overseeing

the loans made through the Funds. This is a regulated industry, and

SBCC used its California finance lender license from the California

Department of Corporations, as well as the California real-estate

broker’s license that Mr. Feathers held and could use on SBCC’s behalf.

The Funds had to disclose what they would pay SBCC. In

Investors Prime’s offering circular, and SBC Portfolio’s private-

placement memorandum, the Funds disclosed that each would pay

SBCC both management fees and origination fees if and when SBCC

found loan opportunities that the Funds would be interested in. These

loans would be secured by first and second deeds of trust, which were

themselves secured by both commercial, and income-producing

residential, real estate. Following the old real-estate maxim that “a fast

nickel is worth more than a slow dime” the Funds aimed to make loans

with only a one or two-year maturity. Mr. Feathers’s hope was that

quicker, smaller profits would offset SBCC’s and the Funds’ startup

costs.

These management and origination fees were SBCC’s upside if

the Funds’ lending proved profitable. SBCC, however, did have

protection on the downside because both Funds agreed to reimburse

SBCC for any expenses it incurred in managing them. 3

2. Issuing Membership Interests

In addition to being sole manager of the Funds, SBCC was also in

charge of issuing membership interests in the Funds to investors. This

meant that it had to abide by section 5 of the Securities Act of 1933, 15

U.S.C. § 77(e), which forbids the sale or offering of unregistered

securities in interstate commerce. See W. Fed. Corp. v. Erickson, 739

F.2d 1439, 1442 (9th Cir. 1984). SBCC did not register the Funds, but

3 Both Funds’ operating agreements stated:

The Manager shall be reimbursed by the Company for all

organizational syndication and operating expenses incurred on behalf

of the Company, including without limitation, out of pocket general

and administrative expenses of the Company, accounting and audit

fees, legal fees and expenses, postage, and preparation of reports to

Members.

5

[*5] instead invoked two exceptions to the usual registration

requirement.

Investors Prime relied on section 202(c) of the Securities

Exchange Act of 1934, ch. 404, 48 Stat. 881, 906 (codified as amended at

15 U.S.C. § 77c(a)(11)), and Securities & Exchange Commission (SEC)

Rule 147, 17 C.F.R. § 230.147 (2024). These exceptions allow the

issuance of unregistered securities as long as both offerors and

purchasers reside in the same state. Since SBCC and Investors Prime

were both California entities, this meant that it could sell interests only

to California residents.

SBC Portfolio relied on section 4(2) of the Securities Act of 1933,

ch. 38, 48 Stat. at 77 (codified as amended at 15 U.S.C. § 77d(a)(2)), and

SEC Regulation D, 17 C.F.R. § 230.506 (2024). This exemption allows

for the sale of unregistered securities in a nonpublic offering. 4

III. SBLC Lending License

In 2009, SBCC began working with the SBA to obtain a Small

Business Lending Company (SBLC) license. 5 This license allows

lenders to make “7(a) loans” with federal guaranties. 6 The federal

guaranty reduces the level of risk for a lender as well as the cost of the

loan to a borrower. 7 See 7(a) Loan Program, U.S. Small Bus. Admin.,

4 The Ninth Circuit has a four-factor test to determine if an offering falls within

this exemption: “(1) the number of offerees, (2) the sophistication of the offerees, (3)

the size and the manner of the offering, and (4) the relationship of the offerees to the

issuer.” W. Fed., 739 F.2d at 1442 (citation omitted). SBC Portfolio’s eligibility for this

exemption is not an issue in this case, so we won’t trudge through the factors.

5 An SBLC “is a non-depository lending institution that is SBA licensed and is

-

authorized by SBA to make loans pursuant to section 7(a) of the Small Business Act

and loans to intermediaries in SBA’s Microloan program.” 13 C.F.R. § 120.10 (2024).

6 A 7(a) loan is available to a small business when real estate is part of a

business purchase when a small business needs short or long-term working capital, to

refinance current business debt, to purchase and install machinery and equipment, or

to purchase furniture, fixtures, or supplies. See 7(a) Loans, U.S. Small Bus. Admin.,

https://www.sba.gov/funding-programs/loans/7a-loans#id-what-is-aa-loan (last visited

Sept. 17, 2024).

7 Mr. Feathers testified that the SBA also licensed the Funds to make loans

under the SBA’s 504 loan program. A 504 loan, like a 7(a) loan, is backed by the federal

government. 504 loans are long-term, fixed-rate financing to small businesses to

promote business growth and job creation. See 504 Loans, U.S. Small Bus. Admin.,

https://www.sba.gov/funding-programs/loans/504-loans (last visited Sept. 17, 2024).

These loans can be made by certified development companies that are authorized by

6

[*6] https://www.sba.gov/partners/lenders/7a-loan-program (last visited

Sept. 17, 2024). The active secondary market for loans backed by the

SBA gives an SBLC opportunities to sell the guarantied portion of the

loans on the secondary market. Id. Doing so allows a lender to increase

its liquidity, and issue more loans more quickly. Id.

Obtaining one of these licenses is no small undertaking. In the

1980s the SBA imposed a moratorium on granting new SBLC licenses

after it had issued only 14—and there were no new ones through 2010.

See Press Release No. 23-35, Small Bus. Admin., U.S. Small Business

Administration Now Accepting Applications for Small Business Lending

Company License (June 1, 2023), https://www.sba.gov/article/2023/06/

01/us-small-business-administration-now-accepting-applications-small-

business-lending-company-license. It does not require much study of

economics to predict what happens when the government creates a

shortage of a valuable asset: The creation of a small market in SBLC

licenses from companies that already had one. And this was no free

market—though companies were allowed to negotiate the terms of the

exchange, the SBA reserved to itself the right to reject any transfer.

Small Business Lending Company Application Process, 88 Fed. Reg.

32,623 (May 22, 2023).

The consequence of this government-sponsored shortage was

exactly what one would expect: Even when Mr. Feathers found a license

for sale, it came with an upfront cost of $750,000—though Mr. Feathers

was unclear on whether this was just the cost of the license itself or

included the cost of trips to D.C. to win SBA approval. Mr. Feathers did

not have SBCC pay these costs itself. Investors Prime paid the $750,000

it needed to buy the license in addition to the incidental costs incurred

in its pursuit. It finally got the license in April 2010 and transferred it

to a wholly owned subsidiary named SB Capital.

In addition to the many hats that he wore at SBCC, Mr. Feathers

testified that he also consulted for the company in his personal capacity

through a sole proprietorship that he owned. SBCC’s ledgers do show

that SBCC paid $171,000 to Mr. Feathers in 2009 and $165,000 in 2010.

There was no written consulting agreement between SBCC and Mr.

Feathers, but there were many written notations on the checks or in the

the SBA. See 13 C.F.R. § 120.10. In his testimony, Mr. Feathers did not state when

SBCC obtained authorization or whether part of the license he sought included

obtaining authorization as a certified development company. He only mentions

obtaining a license. Because of this, we will focus on the expenses and challenges of

becoming a 7(a) lender.

7

[*7] descriptions on the wire transfers, which for the most part state

“consulting” or “consulting fee” or something similar.

IV. The “Loan”

The time and effort SBCC devoted to obtaining the license

reduced the time it spent on finding good lending opportunities for the

Funds themselves. And Investors Prime was out even more than

$750,000 8 because Mr. Feathers directed more and more money to flow

from the Funds to SBCC. This put the Funds, and particularly Investors

Prime, into a bit of a hole. Mr. Feathers proposed filling the hole by

restructuring SBCC’s relationship with them. He aimed to accomplish

this by characterizing the transfers as “loans” from the Funds to SBCC.

Mr. Feathers reasoned that relabeling the money that had been

transferred from the Funds to SBCC as a loan and not a reimbursable

expense would signal to potential investors that SBCC would ultimately

be sending money to the Funds instead of the reverse. Mr. Feathers

liked this idea so much that he moved an additional $1,850,000 from

Investors Prime to SBCC in December 2010—he said to pay for future

expenses that SBCC might incur. These loans—if that’s what they

were—were at first accounted for only in Mr. Feathers’s head. But then

in 2011 he had the Funds issue notes to SBCC to create a paper record.

But there was a problem. The Investors Prime offering circular

and the SBC Portfolio’s private-placement memorandum both

prohibited the Funds from lending to SBCC. 9

8 The record is ambiguous as to whether SBC Portfolio was also responsible for

costs associated with obtaining the SBLC license. As we mentioned supra note 7, Mr.

Feathers testified that both the 504 and 7(a) loans authorized by the license were

supplied by the Funds. It is possible that the time Mr. Feathers spent obtaining the

license he also spent obtaining authorization for the 504 loans for which SBC Portfolio

would benefit, but we have no evidence of this.

9 The Featherses dispute the fact that these loans were ever prohibited even

though both SBC Portfolio’s private placement memorandum and Investors Prime’s

offering circular had a provision that stated: “No loans will be made by the Fund to

the Manager or to any of its affiliates, except for any financing extended as part of a

sale of real estate owned or loans purchased as a result of foreclosure.”

The Featherses claim that this language referred to mortgage loans since it fell

within that section of the agreement. The audited financial statements for both

companies, however, state that the notes that SBCC received from both Investors

Prime and SBC Portfolio were prohibited by their operating agreements and that

changes to allow for them were not executed for at least one of each of the companies’

loans until after the notes had been executed.

8

[*8] Mr. Feathers recognized the problem and amended both Funds’

operating agreements to permit them to lend money to SBCC. Investors

Prime was able to make the amendment before the execution of the

notes, but SBC Portfolio was not. 10

V. Tax Reporting

A. SBCC

On its 2009 and 2010 returns, SBCC did not report as gross

receipts all the money that it received from the Funds. It did report

some:

Year Gross Receipts or Sales Losses

2009 $858,839 $470,711

2010 366,452 1,509,924

B. The Featherses

Remember, however, that this is a case about the Featherses’

income, not that of SBCC or the Funds. 11 The Featherses jointly filed

their 2009 tax return in March 2011, and their 2010 tax return in May

2013. They reported the following gross receipts or sales and

passthrough income:

Year Gross Receipts or Sales Passthrough Income

2009 — –$366,445

2010 $63,000 —

C. Investigation and Audits

Money investors send to regulated funds that then send the

money on to their manager which sends it on to the manager’s individual

10 Mr. Feathers’s amendment to Investors Prime’s operating agreement

allowed the conversion of current and future organizational expenses up to 1% of the

maximum fund capitalization into a receivable from the fund manager. This was

ultimately approved by shareholders and the California Corporations Commission in

November 2010. We could find no equivalent language in SBC Portfolio’s operating

agreement before an amendment that became effective as of January 25, 2011.

11 The record can be a bit confusing. In his brief the Commissioner repeatedly

conflates the Featherses and SBCC, referring to SBCC as “petitioner”. We stress that

this case is about the Featherses; SBCC is a passthrough corporation, but is itself a

separate entity.

9

[*9] owners is usually tracked more carefully, and such cash flows are

usually accompanied by a raft of documentation to make it all legal. By

not doing so with the cash that went from the investors to the Funds to

SBCC and then to himself, Mr. Feathers caught the attention of the

SEC. In June 2012, the SEC persuaded a district judge to place SBCC

and the Funds into receivership. And then, in 2014, Mr. Feathers was

indicted for both securities fraud and mail fraud. The indictment

alleged that he had fraudulently represented that the Funds earned

returns of at least 7.5% from their mortgage-loan portfolios, when those

payouts were partially funded with money from new investors.

The indictment also alleged that Mr. Feathers had fraudulently

represented that the Funds could not lend money to SBCC by putting

that text into the Funds’ operating agreements while in fact taking

money from the Funds to send to SBCC. It also charged Mr. Feathers

with breach of fiduciary duty for not disclosing that he was using the

Funds’ money to pay for the operating expenses of SBCC and other

companies.

If that were not enough, the government also alleged that in a

newsletter sent to the Funds, Mr. Feathers and SBCC “regularly made

statements reassuring investors that the funds were making loans

secured by first and second deeds of trust and that all loans were

performing” when in actuality, the “loans” to SBCC were unsecured and

not producing any interest income at all.

To sum it up, Mr. Feathers—in cahoots with SBCC—allegedly

held unsecured loans in excess of $5.5 million owed to the

Funds, handmade ‘Ponzi’ payments intended to lull

investors into a false sense of security by creating the

appearance that the Funds were engaging in successful

debt financing agreements and otherwise acting to

preserve and increase the investors’ monies, and, in the

process, had diverted approximately $2 million dollars to

the personal benefit of FEATHERS and members of his

family as well as other unauthorized expenditures.

Over on the civil side, the Commissioner selected the Featherses’

returns for audit. Since they were shareholders of SBCC, this included

an examination of SBCC’s returns. This task posed an unusual

challenge because at the time of the audit, the receiver had already

10

[*10] taken possession of SBCC’s records, and the Commissioner had to

work with him to get the documents needed to conduct the audit. 12

These many counts were not put to the test at trial. Mr. Feathers

instead pleaded guilty to one count of mail fraud and was sentenced to

33 months in prison. The audit also came to a close after the

Commissioner found what he thought was evidence that SBCC had

underreported its gross receipts and paid Mr. Feathers consulting fees

that the Featherses did not report. He made the following

adjustments to their returns:

13

Unreported

Unreported Gross

Flowthrough Receipts or

Income from Sales from

Tax Year SBCC SBCC Total Adjustment

2009 $756,281 $171,000 $927,281

2010 232,133 102,000 334,133

The Commissioner issued a notice of deficiency to the Featherses

in January 2014. The Featherses filed a timely petition, but trial was

delayed by both criminal and bankruptcy proceedings. 14 We finally tried

the case after Mr. Feathers was released from custody.

In the lead-up to trial, the Commissioner filed with the Court and

served on the Featherses a request for admissions. The Featherses

failed to reply to the request within 30 days of receipt. Under Rule 90(c)

and (f), this means that we deem all those statements admitted.

12 Mr. Feathers believed that there were 95 boxes of documents that the

receiver had in his possession that were not provided to the IRS.

13 In a separate adjustment of SBCC’s 2009 and 2010 returns, the

Commissioner made adjustments of $916,131 and $1,707,613, respectively, for

underreported gross receipts or sales.

14 At the time they filed the petition, the Featherses were residents of

California. Appellate venue for an appeal would presumptively lie in the Ninth

Circuit. See § 7482(b)(1)(A).

11

[*11] OPINION

The major disputes here are about whether, and if so in what

amounts, Mr. Feathers received taxable income from SBCC. 15

I. Money from the Funds to SBCC

The passthrough income that the Commissioner attributes to the

Featherses stems from what he carefully calls unreported income from

the Funds. 16 The Commissioner used a bank-deposits analysis to

determine the income that SBCC received for 2009 and 2010. 17 In a

bank-deposits analysis the Commissioner first equates deposits with

income, then subtracts any identifiable nontaxable items, deductible

expenses, or income that was reported. See Clayton v. Commissioner,

102 T.C. 632, 645–46 (1994). A taxpayer’s bank deposits are prima facie

evidence of income and are sufficient to shift the burden of proof away

from the Commissioner. Welch v. Commissioner, 204 F.3d 1228, 1230

15 The Commissioner made many other adjustments that the Featherses do not

challenge.

16 A determination in a notice of deficiency is presumed correct, but the Ninth

Circuit affords the Commissioner this presumption in cases arising from unreported

income only “once some substantive evidence is introduced demonstrating that the

taxpayer received unreported income.” Delaney v. Commissioner, 743 F.2d 670, 671

(9th Cir. 1984) (quoting Edwards v. Commissioner, 680 F.2d 1268, 1270 (9th Cir. 1982)

(per curiam), aff’g T.C. Memo. 1982-666). This requires only a “minimal evidentiary

foundation.” See Weimerskirch v. Commissioner, 596 F.2d 358, 361 (9th Cir. 1979),

aff’g 67 T.C. 672 (1977); see also Gardner v. Commissioner, 845 F.3d 971, 974 (9th Cir.

2017) (applying the Court’s reasoning in Weimerskirch to unreported income that was

generated legally), aff’g T.C. Memo. 2013-67.

In Weimerskirch, 596 F.2d at 362, the Ninth Circuit stated that “the

requirement that there must be some evidentiary foundation linking the taxpayer to

the alleged income-producing activity is especially acute where, as here, the

government asserts that the taxpayer was engaged in an activity which is otherwise

illegal.” Through avoiding characterization of the transfers as illegal activity, the

Commissioner steers clear of this ever so slightly higher burden of connecting the

income to the income-producing activity which attaches when the alleged income is

derived from illegal activity.

17 In his brief the Commissioner states “Respondent used a combination of the

specific-items method and the bank deposits method to determine the unreported

income petitioners received from SBCC in 2009 and 2010.” The Featherses argue that

this raises a new issue on brief unmentioned before. It does not. There are two distinct

income issues in this case. The Commissioner used the bank-deposits analysis to

compute the income Mr. Feathers received as passthrough income from SBCC; he used

the specific-item method to compute the income Mr. Feathers received from SBCC

directly as “consulting” payments.

12

[*12] (9th Cir. 2000) (citing Calhoun v. United States, 591 F.2d 1243,

1245 (9th Cir. 1978)), aff’g T.C. Memo. 1998-121.

Hannah Kim was the revenue agent who conducted the bank-

deposits analysis in this case. She “relied on bank data including bank

statements, deposited slips, deposited check images, and also, Taxpayer

records including general ledger, and general entries.” 18 If she could

trace the movement of the deposits between accounts, she treated the

transactions as interaccount transfers and not as taxable income. She

also refrained from including any of the money deposited into SBCC’s

brokerage from the analysis. Her analysis revealed the following:

Reported Gross Adjusted Gross Receipts or Sales Total

Year Receipts or Sales per Bank Deposits Analysis Adjustments

2009 $858,839 $1,774,970 $916,131

2010 520,232 2,227,845 1,707,613

These adjustments resulted in changes to SBCC’s income and in

turn the Featherses’ passthrough income:

SBCC SBCC Featherses’ Adjusted

Reported Adjusted Featherses’ Reported Passthrough

Year Income Income Passthrough Income Income 19

2009 –$427,754 $488,377 –$366,445 $389,836

2010 –1,420,795 286,818 — 232,133

Though the bank-deposits analysis was sufficient to establish the

minimal evidentiary foundation of income, there is a gap between the

amount of income the Commissioner deduced that SBCC had received

from the Funds from his bank-deposits analysis for 2009, and the sum

he determined in the notice of deficiency. The 2009 bank-deposits

analysis concluded that SBCC had $1,654,110 in gross receipts, and

$82,310 in rental income not includible on Form 8825, Rental Real

Estate Income and Expenses of a Partnership or an S Corporation.

Adding these two numbers together leaves us with $1,736,420, which is

18 Agent Kim claims that she referred to the forensic accounting general ledger,

but she reached her conclusion from the “bank records and [the] Taxpayer’s documents,

not [the] forensic accounting general ledger.”

19 Mr. Feathers owned 79.8228% of SBCC shares in 2009 and 80.9339% of the

shares in 2010, and this figure is his proportionate share of that passthrough income.

13

[*13] $38,578 less than in the notice of deficiency, requiring a decision

under Rule 155.

Other than that we don’t see any problems with the

Commissioner’s numbers for the 2009 tax year, and there is no doubt

that he has traced that income from the Funds to SBCC and on to Mr.

Feathers.

For 2010 we also have the Commissioner’s bank-deposits

analysis, which shows more than $2 million in extra income—the same

amount that he determined in the notice of deficiency attached then to

the exhibit labeled “2009 bank-deposits analysis.” Though the

Featherses have been deemed to admit these transfers from the Funds

to SBCC, they argue in their posttrial brief that the bank-deposits

analysis is invalid.

First, they argue that Agent Kim’s analysis is unreliable. She

testified that she took over the audit from another agent who organized

things differently and who came to a conclusion with which she did not

agree. The Featherses argue that Agent Kim’s adjustment of the

Commissioner’s findings—which were in their favor—somehow makes

her entire analysis invalid. It does not.

They then argue that the government did not provide Agent Kim

with information necessary for the analysis, and that it was selective in

the information it did provide to her. They specifically cite Agent Kim’s

testimony that the backs of the checks that she relied on for the specific-

item analysis weren’t provided for her review. This is just speculation,

however. We have no actual evidence that the Commissioner withheld

any information from Agent Kim during her review.

Finally, even though Agent Kim testified to not using the audited

financial statements, the Featherses contend that the bank-deposits

analysis contains reference to “forensic accounting and third-party work

product.” They didn’t raise any objections to entering the forensic

accounting into the record at trial, though, and point to no errors in the

bank-deposits analysis itself—only that it may or may not have relied

on a third party.

We therefore find that money was transferred to SBCC from the

Funds:

14

[*14]

Year Unreported Gross Transfers from Unreported Gross Transfers from

SBC Portfolio Investors Prime

2009 $545,137 $609,250

2010 150,513 1,106,043

Transfers are in themselves not necessarily taxable income. And

the Featherses argue that not all these transfers to SBCC were. A minor

problem with their argument is that not all the unreported transfers to

SBCC came from the Funds. The 2009 bank-deposits analysis revealed

a $10,000 deposit from an unidentified source and the 2010 analysis

revealed a total of $180,150 in unreported gross receipts from entities

named Coastal Capital Income Fund, LLC; Valley Produce; and SBC

LLC. The Featherses gave us no explanation for these transfers. The

presumption that these deposits are income is unrebutted.

For the rest of the transfers, however, the Featherses do have an

argument—they say that the transfers were loans from the Funds to

SBCC and thus not taxable. 20

They first point to SBCC’s audited financial statements, which

show the transfers under “Consolidated Statement of Cash Flows” as a

specific item labeled “Loaned to Fund Manager.” (Emphasis added.)

Labels aren’t enough—as the Commissioner correctly points out—and

for these transfers to count as loans, we must find that there was an

agreement “either express or implied, whereby one person advances

money to the other and the other agrees to repay it upon such terms as

to time and rate of interest, or without interest, as the parties may

agree.” Welch, 204 F.3d at 1230 (quoting Commissioner v. Valley Morris

Plan, 305 F.2d 610, 618 (9th Cir. 1962) (citations omitted), rev’g in part

33 T.C. 572 (1959) and Morris Plan Co. of Cal. v. Commissioner, 33 T.C.

720 (1960)).

20 SBCC went into receivership after the years at issue. Mr. Feathers testified

that the receiver filed returns for both 2011 and 2012, and that on those returns the

receiver reported cancellation-of-indebtedness income stemming from these loans. If

true, the Featherses would be correct that imposing a tax on these transfers on the

years before us would be the equivalent of taxing the same income twice. The problem

is that the Featherses provided us with no documentary evidence of SBCC’s 2011 and

2012 returns. The Commissioner notes that the Featherses did not raise the issue of

the 2011 and 2012 returns until the day before trial, and did not produce these returns

or request their production in discovery.

15

[*15] The Ninth Circuit has recognized seven factors that show a bona

fide loan:

• whether the promise to repay is evidenced by a note or other

instrument;

• whether interest was charged;

• whether a fixed schedule for repayments was established;

• whether collateral was given to secure payment;

• whether repayments were made;

• whether the borrower had a reasonable prospect of repaying the

loan and whether the lender had sufficient funds to advance the

loan; and

• whether the parties conducted themselves as if the transaction

were a loan.

Id.

These factors are not exclusive, and no single factor is dispositive.

Id.; see also Dixie Dairies Corp. v. Commissioner, 74 T.C. 476, 493 (1980)

(citing John Kelley Co. v. Commissioner, 326 U.S. 521, 530 (1946)).

Our analysis hinges on “whether there was an intent to create a

debt with a reasonable expectation of repayment and, if so, whether that

intent comports with the economic reality of creating a debtor-creditor

relationship.” Delta Plastics, Inc., 85 T.C.M. (CCH) 940, 943 (2003)

(citing Litton Bus. Sys., Inc. v. Commissioner, 61 T.C. 367, 377 (1973));

accord Estate of Chism v. Commissioner, 322 F.2d 956, 960 (9th Cir.

1963), aff’g Chism Ice Cream Co. v. Commissioner, 21 T.C.M. (CCH) 25

(1962). 21 Whether a transfer of money constitutes a loan is “determined

21 The Featherses argue that the Commissioner cannot speculate as to SBCC’s

and the Funds’ state of mind at the time of the conveyance since “[p]etitioner’s state of

mind during trial” was never at issue. The issue before us is what the evidence shows

us about SBCC’s and the Funds’ intent at the time of the transfers. The Commissioner

asked quite a few questions of Mr. Feathers about that issue, such as the terms of the

loans, the time the notes were executed, and whether a loan existed at the time that

the money was conveyed. There is plenty of objective evidence in the Commissioner’s

favor here. See Keogh v. Commissioner, 713 F.2d 496, 502 (9th Cir. 1983) (“The tax

court is not obliged to believe a taxpayer’s testimony rather than evidence introduced

by the Commissioner”).

16

[*16] upon consideration of all the circumstances present in a particular

case, and depends upon the existence of an intent at the time the

[transfer] is made that it should be paid back.” Estate of Chism, 322

F.2d at 960 (quoting Clark v. Commissioner, 266 F.2d 698, 710–11 (9th

Cir. 1959), remanding T.C. Memo. 1957-129).

Here, the Funds issued three notes to SBCC, one from SBC

Portfolio, and the other two from Investors Prime.

Lender Date of Note Principal Amount Maturity

Investors Prime January 1, 2011 $1,850,000 22 1/1/2016

SBC Portfolio January 1, 2011 707,464 1/1/2016

Investors Prime January 1, 2011 5,000,000 1/1/2016

The notes all included an interest rate of 7.5% and called for

quarterly payments of interest with a balloon payment of the principal

on demand or on the notes’ termination dates. But only one of the notes

spelled out these dates with specificity and was backed by collateral.

These absences weigh against a finding that they were bona fide

loans. But there is an even bigger problem: All the notes were executed

in 2011, the year after the money at issue had been transferred from the

Funds to SBCC. This means that they tell us little about what the

parties’ intent was at the time that the money was transferred.

The Featherses provide us with no evidence that at the time the

money was transferred to SBCC, interest was charged, the loans were

secured by collateral, or there was a fixed repayment schedule. We also

have no evidence that SBCC made payments on the notes, that the

Funds charged late fees, or whether the Funds tried to collect the full

amount or any portion of the notes after each default by SBCC. In his

own testimony, Mr. Feathers admitted that at the time it was

transferred from the Funds to SBCC, at least a portion of the money was

not intended as a loan, but as reimbursements for expenses that SBCC

incurred while managing the Funds. He stated that they did not

metamorphize into loans until the Funds’ investors approved the

amendment to the operating agreements which would allow for the

loans.

22 Though the note on this was dated January 1, 2011, the note explicitly states

that “Lender has advanced to Borrower the sum of $1,850,000 (One Million Eight

Hundred Fifty Thousand Dollars) as of December 31, 2010.”

17

[*17] As for the final factor, we assess whether the ability to repay a

loan is “a reasonable expectation of repayment in light of the economic

realities of the situation.” Fisher v. Commissioner, 54 T.C. 905, 910

(1970). SBCC purportedly owed the following to Investors Prime and

SBC Portfolio at the end of 2009 and 2010:

Year SBC Portfolio Investors Prime

2009 $534,736 $51,461

2010 713,791 1,500,000

These amounts themselves are large relative to SBCC’s income,

which was only roughly $700,000 in 2009 and in 2010—it was operating

in the red both years and reported a total loss of $1,500,000. The size of

the loans compared to SBCC’s shrinking income indicates that SBCC

was not in a financial position to be able to repay. 23 The Featherses

assert that the numerous benefits associated with obtaining the SBLC

license would mean that SBCC would become profitable. There is a

chance that the profitability of SBCC would have increased—but that

reasoning is speculative at best.

That leaves us to find little if any reason to believe that these

transfers were loans. Nearly all the factors that the Ninth Circuit

instructs us to analyze point to the nonexistence of a loan. The only

factor that could arguably be in the Featherses favor—the promise to

repay being evidenced by a note—is weak at best because of the three

notes’ attempted ex post facto execution. Because of this, we agree with

the Commissioner and find it more likely than not that the transfers of

money from the Funds to SBCC were not loans.

II. Money from SBCC to the Featherses

Agent Kim also looked for additional income Mr. Feathers

received from SBCC. She found some amounts that SBCC deducted for

consulting, as well as amounts that according to the company’s ledger

were paid to Mr. Feathers for consulting. We’ll go through the

23 Remember that we look at the time that the money was transferred when

determining whether the reasonable expectation of repayment existed. The transfers

that the Featherses characterize as loans took place in 2009 and 2010, though they

were not documented until 2011. The income on the returns may not give us an

indication of the financial health of SBCC at the specific time that each of the transfers

were made, but they do give us insight into the direction in which the company was

headed.

18

[*18] conclusions that she drew from this “specific-item analysis” and

the Featherses’ challenge to it. And then we’ll briefly discuss an

anomaly in comparing this analysis to the notice of deficiency.

A. Specific-Item Analysis

To lay the Ninth Circuit’s required “minimal evidentiary

foundation” for unreported income, Agent Kim used a specific-item

method of reconstructing the Featherses’ income received from SBCC in

2009 and 2010. This meant she looked at “evidence of particular or

specific amounts of taxable income received by the taxpayer during a

particular tax period, with evidence that the taxpayer did not include

such amounts in his tax return for such period.” See Estate of Beck v.

Commissioner, 56 T.C. 297, 353 (1971).

She noticed that SBCC had deducted commission fees paid to Mr.

Feathers, and the corporation’s general ledger clearly identified the

check numbers and the name of the recipient. These matched SBCC’s

tax returns and the amounts the corporation had deducted. She

calculated that SBCC paid Mr. Feathers $171,000 in such fees in 2009

and $165,000 in 2010.

She then noticed that the Featherses had failed to report all these

fees on their returns for 2009 and 2010. We summarize:

Tax Period Per Return Per Exam Adjustment

2009 — $171,000 $171,000

2010 $63,000 165,000 102,000

The Featherses disputed neither that Mr. Feathers received those

checks nor that they were income. The Featherses also failed to deny

the Commissioner’s requests that they admit these deposits were

taxable. This is yet another grounds for finding for the Commissioner.

See Delaney v. Commissioner, 743 F.2d at 672. Mr. Feathers even

conceded that some of the checks written by SBCC “were to Mark

Feathers and those [he doesn’t] argue were for [his] sole-proprietorship

[so long as] they were reflected as such on the footnote to those checks

as consulting fees.” Since the Featherses present no argument that

19

[*19] money received in their account from SBCC was anything other

than consulting fees, we find that the transfers were taxable income. 24

B. Audit Inconsistencies

One oddity in the evidence is that the sum of the checks for 2010

that the Commissioner put into the record shows that SBCC transferred

more than $200,000 to the Featherses. This includes a number of checks

made out to Mr. Feathers that have “consulting” in the memo line; as

well as checks for $10,000 and $20,000 with no notation; a $5,000 check

to Mr. Feathers with “advanced pay” in the memo line; and a $5,000

consulting fee to SB Capital (the sole proprietorship).

This is more than the amount that the Commissioner used when

he computed the deficiency for that year. The Commissioner never

asked us to find a higher deficiency than that in his notice, though. We

are therefore limited to that initial adjustment, see § 6214(a), and find

these are the total amounts paid out to Mr. Feathers from SBCC as

additional income:

Year Deposit Totals

2009 $171,000

2010 165,000

III. Penalties

A. Section 6662(a)

Section 6662(a) and (b)(2) imposes a 20 percent penalty for

underpayments due to “[a]ny substantial understatement of income

24 Mr. Feathers introduced some confusion about this analysis. He had SBCC

set up a trust account titled SB Capital, the same d.b.a. that SBCC used in its business.

He said that SBCC used this account to hold funds in trust when a borrower was

waiting for an appraisal and environmental review of a property. “SB Capital” was

also, as we mentioned above, the name of Mr. Feathers’s sole proprietorship. This led

him to complain that the Commissioner was including in his analysis checks written

to SB Capital from the trust account as if they belonged to him when they in fact were

SBCC’s funds. He surmised that the Commissioner was mistakenly including this

money as income of his sole proprietorship.

We disagree. The checks that the Commissioner introduced into evidence and

that were made payable to “Mark Feathers” add up to more than the total unreported

consulting income that he used to determine the Featherses’ deficiency.

20

[*20] tax.” Though the Commissioner initially sought penalties for both

2009 and 2010, he later dropped his push for a penalty for 2010.

The Commissioner has both a burden of proof and a burden of

production here. Whether the Commissioner met his burden of

production in this case is a simple math problem. An understatement

of tax is “substantial” if it exceeds the greater of $5,000 or “10 percent of

the tax required to be shown on the return.” § 6662(d)(1)(A). In 2009,

the tax required to be shown on the Featherses’ return is about

$212,278, and the Featherses reported no liability on their return—this

difference is much greater than the 10 percent the Commissioner needs

to satisfy this burden.

His burden of proof is to show that he complied with section 6751.

A group manager approved in writing the determination by Revenue

Agent Thien Tran—the first revenue agent to work on the audit—to

impose an accuracy-related penalty on the ground of substantial

understatement of income tax on December 11, 2013. The notice of

deficiency was issued on January 13, 2014. Given our recent holding

that, for deficiency cases appealable to the Ninth Circuit, the

Commissioner satisfies section 6751 if he can show written supervisory

approval that occurred before assessment or, if earlier, before the

supervisor lost discretion to approve the penalty, we find the

Commissioner has met his burden. See Kraske v. Commissioner, No.

27574-15, 161 T.C. (Oct. 26, 2023) (applying Laidlaw’s Harley Davidson

Sales, Inc. v. Commissioner, 29 F.4th 1066 (9th Cir. 2022), rev’g and

remanding 154 T.C. 68 (2020), and Golsen v. Commissioner, 54 T.C. 742,

756–57 (1970), aff’d, 445 F.2d 985 (10th Cir. 1971)). 25

We also note that the Featherses are deemed to have admitted

liability for the penalty.

25 Though the section 6662(a) penalty does allow for an exception in the case of

a taxpayer who claimed a deduction reasonably and in good faith, see § 6664, the

Featherses did not argue for this at trial or on brief. Mr. Feathers did testify that he

had help preparing his taxes from an accounting firm. An accountant named Dennis

Young prepared the returns for the years at issue, but Mr. Feathers could not

remember with certainty the name of the firm that Mr. Young worked for. Mr.

Feathers did testify that the accountants would come to the firm, spend some time on

the computer, and would download “whatever they asked for.” We cannot find on the

basis of this thin testimony that the accountants were provided with all the

information necessary to prepare the returns or even that the accountants were

qualified.

21

[*21] B. Section 6651(a)(1)

Under section 6651(a) a taxpayer is liable for an addition to tax if

he fails to file a timely tax return. The Featherses did not file their 2009

return until March 2011 and did not file their 2010 return until May

2013. Both returns were therefore late.

The Featherses presented no arguments or evidence to suggest

that their late filing was unavoidable in the face of their exercise of

ordinary business care and prudence. We also have to deem admitted

their liability for these additions to tax. Both are sufficient grounds to

sustain the Commissioner.

IV. Conclusion

The Featherses failed to report Mr. Feathers’s share of SBCC’s

underreported income. They also failed to report the consulting income

that Mr. Feathers received from SBCC. We also find for the

Commissioner for the section 6662(a) penalty for 2009 as well as the

section 6651(a)(1) additions to tax for 2009 and 2010. But although we

find in the Commissioner’s favor on almost all points, it is still necessary

that

Decision will be entered under Rule 155.