Thermal Circuits, Inc.

United States Tax Court

T.C. Memo. 2026-29

THERMAL CIRCUITS, INC.,

Petitioner

v.

COMMISSIONER OF INTERNAL REVENUE,

Respondent

ANTHONY A. KLEIN AND BARBARA N. KLEIN,

Petitioners

v.

COMMISSIONER OF INTERNAL REVENUE,

Respondent

__________

Docket Nos. 33027-21, 33035-21. Filed March 30, 2026.

__________

J. David Moran, for petitioners.

Brian J. Sullivan and James H. Wozny, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

COPELAND, Judge: Thermal Circuits, Inc. (Thermal), designs,

engineers, and manufactures foil heating components. In 2013 British

American Tobacco (BAT), through a wholly owned subsidiary,

Nicoventures Trading Limited (NVT), 1 engaged Thermal to design and

produce foil heating elements in an attempt to break into the “heat-not-

1 The parties have alternatively referred to NVT as BAT, BAT/Nicoventures,

or BAT/NVT; however, all relevant transactions at issue in this case occurred between

Thermal and NVT. Thus, throughout this Opinion we refer to Thermal’s counterparty

only as NVT.

Served 03/30/26

2

[*2] burn” tobacco market. In 2016, as NVT’s demand for heaters began

to outstrip Thermal’s production capacity, BAT, NVT, and Thermal

started exploring ways to increase Thermal’s throughput without

increasing the foil heaters’ unit cost. They eventually settled on an

addition to Thermal’s leased manufacturing facility, to be funded

primarily by NVT. In 2017 NVT provided $4.085 million for the

expansion, and construction began. In 2018 NVT provided an additional

$204,529, and the expansion was completed. Thermal did not report any

of the $4.3 million2 paid by NVT for the leasehold improvements on its

2017 or 2018 Form 1120, U.S. Corporation Income Tax Return. The

Commissioner then issued Thermal a Notice of Deficiency on July 14,

2021, determining deficiencies for Thermal’s 2017 and 2018 tax years of

$1,277,147 and $42,951, respectively, and section 6662(a) 3 accuracy-

related penalties of $255,429 and $8,590, respectively. 4

FINDINGS OF FACT

These findings are derived from the parties’ pleadings and Motion

papers, Stipulations of Facts with attached Exhibits, and the documents

and testimony admitted into evidence at trial. Thermal is a

C corporation that uses the accrual method of accounting. Thermal

timely filed its Petition with this Court on October 12, 2021. At the time

2 The actual cash outlay by NVT was slightly less than $4.3 million; however,

for simplicity throughout this Opinion we refer to the total paid as $4.3 million.

3 Unless otherwise indicated, statutory references are to the Internal Revenue

Code, Title 26 U.S.C. (Code or I.R.C.), in effect at all relevant times, regulation

references are to the Code of Federal Regulations, Title 26 (Treas. Reg.), in effect at all

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

and all dollar amounts are rounded to the nearest dollar.

4 In a Stipulation of Settled Issues, the Commissioner conceded the section

6662(a) penalty with respect to Thermal’s 2018 tax year. The parties further agreed

that (1) Thermal’s 2017 Qualified Production Activities Income (within the meaning of

section 199) is $1,852,258 and (2) any adjustments sustained for Thermal’s 2017 tax

year constitute Domestic Production Gross Receipts for purposes of section 199. In the

case at Docket No. 33035-21 the Commissioner likewise issued to Anthony A. and

Barbara N. Klein a Notice of Deficiency on July 14, 2021. In the Stipulation of Settled

Issues the Commissioner conceded the increases in qualified dividends for the Kleins’

2017 and 2018 tax years and the decrease in itemized deductions for the Kleins’ 2017

tax year. The parties further agreed that the Kleins are not entitled to either (1) an

increased basis in the leased manufacturing facility (for which Anthony Klein was

beneficially the lessor, see infra p. 3) attributable to the portion funded by NVT or (2) a

depreciation deduction for 2018. These concessions resolved all issues related to the

Kleins’ case; consequently, Docket No. 33035-21 will not be addressed further in this

Memorandum Opinion.

3

[*3] of filing the Petition, Thermal’s principal place of business was

Salem, Massachusetts, and the Kleins were residents of Massachusetts.

I. Background

Thermal has produced foil heating components since 1961. They

are used in a wide variety of devices, including electronics, medical

equipment, automobiles, and, as relevant to these cases, electronic

tobacco devices. Thermal manufactures its products in Salem. Since

1996 Thermal has leased land and the manufacturing facility building

thereon from KAK Realty Trust (KAK), a nominee trust whose sole

trustee is Anthony Klein and sole beneficiary is Tech Way Associates,

LLC (Tech Way), a single-member limited liability company whose sole

member is Anthony Klein. 5 Mr. Klein, an engineer by trade, has been

the president, chief executive officer, and sole owner of Thermal since

2010.

In 2013 BAT, looking to enter the “heat-not-burn” tobacco market,

began developing a product called “GLO” through NVT. A key part of

the “GLO” device is the heating element, which NVT engaged Thermal

to design and produce. Thermal began production in 2016, making

approximately 10,000 foil heaters per week for which NVT paid

approximately $10 per unit. For NVT, which sought to gain market

share in a $5 billion industry, this was not sufficient production. Instead

of 10,000 heaters per week, NVT sought nearly 20 times that amount,

at the same per-unit cost. Thermal attempted to meet this demand by

running its production lines for additional hours each day, but labor

overtime costs raised the price per unit by $1.81. At its then-current

size, Thermal could not meet NVT’s demand for foil heaters while

maintaining the $10 per-unit cost. What such a demand required was

for Thermal to expand its manufacturing space, equipment, and

personnel.

II. Negotiation for Additional Capacity

As a relatively small manufacturer, Thermal was wary of putting

all its eggs in the NVT basket. Thermal’s concern was whether NVT

would remain interested in the increased quantities of foil heaters long

term. If not, Thermal would be saddled with more manufacturing space

5 Tech Way, as a domestic single-member limited liability company that did

not elect to be classified as a corporation, is a “disregarded entity,” which is a business

entity “that is disregarded as an entity separate from its owner for Federal income tax

purposes.” See Treas. Reg. § 1.368-2(b)(1)(i)(A).

4

[*4] and machinery than it could effectively put to use and afford. Thus,

while Thermal was interested in scaling up its production capacity, it

needed a way to limit its exposure. At first Thermal sought a minimum

production floor (i.e., NVT would guarantee ordering and purchasing a

set production quantity). NVT refused to guarantee such a floor on its

order volume but eventually agreed to fund the expansion of Thermal’s

manufacturing facility to accommodate the increased production

capacity. In return NVT proposed a damages clause requiring Thermal

to pay NVT if, after NVT funded the building expansion, Thermal did

not produce a sufficient number of foil heaters. 6 In the end Thermal

held its ground, and no damages clause was agreed to.

In January 2017 Thermal obtained plans for an 18,000-square-

foot expansion of its leasehold facility, allowing for additional chemical

etching lines, as well as providing additional dark room facilities and

office space. That addition was projected to cost approximately $2.5

million. On top of NVT’s investment, KAK, as lessor, intended to use

approximately $750,000 of its own funds to make capital improvements

in the form of an expanded wastewater treatment facility that would aid

in meeting NVT’s demand. Later, Thermal proposed alternative

additions: The first was a 27,000-square-foot expansion at an

approximate cost of $3.1 million, capable of producing 10 million foil

heaters a year; the second was a 33,000-square-foot expansion at an

approximate cost of $4 million, capable of producing 15 million foil

heaters a year. NVT agreed to the latter in June 2017 and issued a

purchase order captioned “Pre-payment for heater capacity 2018.” 7 On

top of the over $4 million NVT planned to invest in the leasehold

addition, KAK increased its plans for the improved wastewater

treatment facility such that it now planned on spending nearly

$2 million. It accomplished this goal by borrowing funds from East

Boston Savings Bank secured by a mortgage on the manufacturing

facility property in Salem. In applying for the mortgage Mr. Klein, as

6 NVT proposed damages equal to $1.81 multiplied by the quantity of foil

heaters produced by Thermal short of 1,712,707. The maximum penalty under this

clause would have been $3.1 million.

7 NVT made its purchase orders out to Tech Way, not Thermal. Similarly, all

of the funds NVT provided to Thermal for the leasehold addition flowed to Tech Way,

and it was Tech Way that contracted with Connolly Brothers, Inc. (Connolly Brothers),

the company constructing the addition. However, in the Stipulations, trial testimony,

and briefing, the parties agreed (and implicitly conceded) that Thermal is more

properly treated as the recipient of the funds, with Tech Way acting only as a conduit

to pay Connolly Brothers.

5

[*5] trustee of KAK, represented that the mortgagor owned the property

in fee simple without any other encumbrances.

Connolly Brothers began construction on the leasehold addition

in July 2017. Contemporaneously with Connolly Brothers’ construction

work, Thermal and NVT negotiated the precise terms of their

arrangement, beginning with a “Draft Framework Agreement.” Under

that initial draft’s terms, in a section titled “Capital Investment by

[NVT] in [Thermal],” the default rule was that Thermal would use its

own “equipment, materials and facilities” to manufacture NVT’s foil

heaters. However, NVT could agree to provide funds for Thermal to

purchase “additional machinery, equipment or facilities” (emphasis

added), further defined as “[NVT] Property,” to make additional foil

heaters. The Draft Framework Agreement specified:

Ownership of, and title to, [NVT] Property (including

[NVT] Property which [Thermal] has purchased in its own

name using funding provided by [NVT]) shall remain

vested in [NVT] and [Thermal] shall have no right, title or

interest in or to any part of [NVT] Property other than the

right to use it in accordance with this Agreement.

[Thermal] shall only use [NVT] Property to manufacture

and supply the [foil heaters] to [NVT].

While not specifically defined in the Draft Framework Agreement,

“facilities” seems to have contemplated the leasehold addition; and while

NVT desired vested ownership in such facilities, there is no indication

that any liens protecting such an interest were ever filed in the locale

where said improvements to the real property were located. Further,

the Draft Framework Agreement was never fully executed.

III. Subsequent History

By late 2017 much of the additional manufacturing facility was

complete, and Thermal obtained a certificate of occupancy from the City

of Salem in November 2017. The updated facility included an additional

20,000 square feet of manufacturing space, including an etching room

and a dark room, and an additional 10,000 square feet of office space. 8

As the leasehold addition was being built, manufacturing lines were

installed one by one. Thermal bought the tools and machinery necessary

8 The parties likewise agreed that the additional square footage included a new

maintenance room and a cafeteria but did not specify whether such additions were

part of the 20,000 feet of manufacturing space or the 10,000 feet of office space.

6

[*6] to populate the leasehold addition, for which it charged NVT on a

cost-plus basis. The remainder of the leasehold addition was completed

in late 2018. Since the completion of the leasehold addition, Thermal

has paid the insurance and property taxes for the entire premises,

including the resultant leasehold improvements, and has borne any

attendant risks.

On May 28, 2018, rather than finalizing the Draft Framework

Agreement, Thermal and NVT signed a Supply Heads of Terms

Agreement (HoT Agreement) as the only contract ratified by both

parties. Similar to the Draft Framework Agreement, the HoT

Agreement did not define “facilities.” Instead, under the heading

“Facilities and Equipment,” section 13 of the HoT Agreement defined

only “Equipment” as “premises, tools, fixtures, jigs and equipment . . .

required for the manufacture of the [foil heaters],” with any such

Equipment funded by NVT subject to section 14. Section 14 defined

Equipment funded by NVT as “Dedicated Equipment” and imposed

limitations on Thermal’s use of the Dedicated Equipment such that it

could only be used to manufacture foil heaters for NVT, stipulated that

ownership thereof would remain with NVT, and gave NVT the option to

require Thermal to transfer such Dedicated Equipment to NVT upon

expiration of the agreement. Finally, section 15 reaffirmed that “Title

(ownership) [of the Dedicated Equipment] shall remain vested in NVT,”

though Thermal would bear any risk while it possessed that property.

Pursuant to the terms of the HoT Agreement, Thermal used the

portion of the leasehold addition (and the Dedicated Equipment therein)

funded by NVT only to make foil heaters for NVT. This remained true

until 2021, when NVT terminated the relationship with Thermal and

instructed Thermal to destroy the Dedicated Equipment NVT had

purchased for production of NVT’s heaters. Although Thermal tried to

persuade NVT to sell the Dedicated Equipment at a discount or donate

it, NVT was insistent, and Thermal ultimately acceded. Thermal sought

a written release from NVT to use the leasehold addition but received

no response and has accordingly left the leasehold addition unused since

the termination of the relationship.

IV. Thermal’s 2017 and 2018 Tax Returns

Thermal’s 2017 and 2018 tax returns did not include any of the

$4.3 million received from NVT in its income. Thermal’s 2018 tax return

included Form 8275, Disclosure Statement, that stated:

7

[*7] Taxpayer has received funds in the nature of non-

shareholder contributions to its capital in the amount of

$3,800,000 for the year 2017 and $204,529 for the year

2018. Taxpayer relies upon the application of the U.S.

Supreme Court’s ruling and five-part test explained in

[United States v. Chicago, Burlington, & Quincy Railroad

Co. (CB&Q), 412 U.S. 401 (1973)], and of IRC Sec. 118(a)

as the bases for not reporting this amount as taxable

income on its Forms 1120.

Thermal did not deduct any depreciation on its returns for the portion

of the leasehold addition funded by NVT.

The Commissioner issued Thermal a Notice of Deficiency on July

14, 2021, determining deficiencies and accuracy-related penalties for

2017 and 2018. In its timely Petition, Thermal disagreed with each of

the Commissioner’s determinations. 9

OPINION

I. Burden of Proof

The IRS’s determinations in a Notice of Deficiency are generally

presumed correct, although the taxpayer can rebut this presumption.

See Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). Section

7491 provides that the burden of proof on a factual issue may shift to

the Commissioner if the taxpayer satisfies specified conditions.

Thermal does not contend, and the evidence does not establish, that the

burden of proof has shifted to the Commissioner under section 7491(a)

as to any issue.

II. Whether Thermal Had Taxable Income

It is undisputed that Thermal contracted with NVT to receive

$4.3 million to expand its manufacturing capacity and that NVT paid

that amount for that purpose. It is likewise undisputed that those funds

were ultimately paid to Connolly Brothers to build the leasehold

9 In the alternative, Thermal sought “alternative depreciation options” and

corresponding amendments to its returns. However, Thermal did not address

depreciation on brief. Accordingly, we consider the issue abandoned. See, e.g.,

Thiessen v. Commissioner, 146 T.C. 100, 106 (2016) (“[I]ssues and arguments not

advanced on brief are considered to be abandoned.”); Rockafellor v. Commissioner, T.C.

Memo. 2019-160, at *12; Rose v. Commissioner, T.C. Memo. 2019-73, at *39; see also

Rule 151(e)(4) and (5).

8

[*8] addition and that the leasehold addition was completed. The

parties disagree, however, on who owns the resultant leasehold

addition. Thermal contends that the leasehold addition belongs to NVT.

Conversely, the Commissioner asserts that Thermal is the owner of the

leasehold addition. Thermal argues that NVT wished Thermal to bear

legal title even as NVT held an equitable interest in the leasehold

addition, and that Thermal acceded as an accommodation to NVT. This

crucial point was never specifically memorialized, and there is no other

concrete evidence that proves NVT to be the owner of the leasehold

addition. On the other hand, there is direct evidence showing Thermal’s

ownership: Thermal paid the insurance and the taxes for the entire

building, including the addition; Thermal bore the risks relating to the

leasehold addition while Thermal possessed it; and the certificate of

occupancy is in Thermal’s name. See generally Grodt & McKay Realty,

Inc. v. Commissioner, 77 T.C. 1221, 1237–38 (1981) (setting out indicia

of ownership for tax purposes). In toto, Thermal has not carried its

burden of proving that NVT owned the leasehold addition.

Section 61(a) defines gross income as “all income from whatever

source derived.” Gross income is construed broadly to include all

“accessions to wealth, clearly realized, and over which the taxpayers

have complete dominion.” Commissioner v. Glenshaw Glass Co., 348

U.S. 426, 431 (1955). Accordingly, exclusions therefrom are narrowly

construed. Id. at 429–30. As we have established that the leasehold

addition belongs to Thermal, it follows that Thermal must have

income—as a result of its business arrangement with NVT, Thermal

received possession of a leasehold addition worth $4.3 million. This is

the sort of accession to wealth expressly contemplated by section 61(a).

Moreover, NVT could not realistically prevent Thermal from keeping the

portion of the leasehold improvement attributable to NVT’s funds.

Thus, Thermal had and continues to have “complete dominion” over this

accession to wealth. See Commissioner v. Indianapolis Power & Light

Co., 493 U.S. 203, 210 (1990).

III. Section 118

Thermal argues that the $4.3 million paid by NVT is excludable

from income under section 118(a), which provides that “[i]n the case of

a corporation, gross income does not include any contribution to the

capital of the taxpayer.” The Commissioner argues that the exceptions

to section 118(a) found in section 118(b) preclude a capital contribution

determination. Taxpayers bear the burden of showing that an income

exclusion “falls squarely within the requirements for the exclusion.”

9

[*9] Forste v. Commissioner, T.C. Memo. 2003-103, 85 T.C.M. (CCH)

1146, 1151.

A. Section 118(a), Contribution to Capital

To determine whether a transfer qualifies as a contribution to

capital under section 118(a), we look to the intent of the transferor in

making the transfer. CB&Q, 412 U.S. at 411. However, when this

intent is not explicit (and it often is not), we consider the requirements

for a transfer to be a contribution to capital, as distilled by the CB&Q

court: (1) the contribution becomes part of the transferee’s permanent

working capital structure; (2) the contribution is not compensation for

specific, quantifiable services; (3) the contribution is bargained for;

(4) the contribution must foreseeably result in a benefit to the transferee

in an amount commensurate with its value; and (5) the contribution will

be employed in or contribute to the production of additional income. Id.

at 413. The parties do not contest that the $4.3 million was bargained

for, that it benefited Thermal in an amount commensurate with its

value, or that it contributed to the production of additional income.

Thus, we need only consider the application of (1) and (2) to Thermal.

1. Permanent Working Capital

A contribution to capital must become a permanent part of the

transferee’s working capital structure. Conditions attached to a

transfer, such as a requirement that the funds be spent on capital assets,

tend to show that a contribution has become a part of the permanent

working capital. See Tex. & Pac. Ry. Co. v. United States, 286 U.S. 285,

290 (1932); Commissioner v. BrokerTec Holdings, Inc., 967 F.3d 317, 326

(3d Cir. 2020), rev’g T.C. Memo. 2019-32. Similarly, moneys “committed

for investment and use in the business” become a permanent part of a

corporation’s working capital structure. AT&T, Inc. v. United States,

629 F.3d 505, 520 (5th Cir. 2011). It has been squarely established that

NVT provided the funds for the sole purpose of building the leasehold

addition on land leased by Thermal and that the leasehold addition was

used by Thermal in its manufacturing operations. Thus, we hold that

the $4.3 million contributed by NVT became a permanent part of

Thermal’s working capital structure. This requirement weighs in favor

of finding a contribution to capital.

2. Compensation

A contribution to capital cannot be linked to compensation. See

Treas. Reg. § 1.118-1 (providing that “money or property transferred to

10

[*10] the corporation in consideration for goods or services rendered” is

not excluded from gross income); see also Detroit Edison Co. v.

Commissioner, 319 U.S. 98 (1943). 10 In late 2016, as its demand for foil

heaters outstripped Thermal’s production capacity, NVT was at a

crossroads. With its then-current premises, Thermal could increase

output only by running its production lines for more hours each day.

However, overtime costs would increase the cost per unit by

approximately $1.81. Alternatively, if Thermal had more

manufacturing space, including a larger etching room and bigger

darkroom facilities, it would be able to produce more foil heaters at the

prevailing cost per unit. Adding to Thermal’s leasehold premises would

require significant upfront investment of approximately $4.3 million but

would ultimately result in greater production capacity at a sustained

cost per unit. At this fork, NVT performed a cost-benefit analysis and

concluded that it would recoup its cash outlay for Thermal’s leasehold

addition after purchasing approximately 2.5 million foil heaters.

NVT’s objective was to obtain as many foil heaters as possible for

the most economical price. This goal motivated NVT’s attempt to

negotiate a damages clause in the event that Thermal did not produce

enough foil heaters. Similarly, NVT could have provided funds for a

smaller leasehold addition with lesser production capacity but

consciously opted for the larger production option. These actions are

consistent with NVT’s captioning its purchase order as “Pre-payment for

heater capacity 2018,” which shows that NVT likened its investment in

Thermal’s leasehold addition to an advance payment on future foil

heaters. In this light, the funds were clearly to be compensation for a

service—future production volume at a higher output and a lower price

per unit. Because NVT sought to obtain more foil heaters at a lower

price, we hold that the $4.3 million it paid is compensation to Thermal.

Consequently, NVT did not have the requisite intent to make a

contribution to capital excludable under section 118(a).

10 While Detroit Edison Co. did not directly address the issue at hand, the

Supreme Court first determined there that customer payments (made in years not

before the Supreme Court) to the taxpayer to build infrastructure necessary to provide

electrical services to those customers were the price of services to those customers

rather than a capital contribution by the customers. The Supreme Court then went on

to determine a related issue as whether (in the years before the Supreme Court) the

taxpayer could depreciate that infrastructure.

11

[*11] B. Section 118(b), Exceptions

Even assuming arguendo that NVT had the requisite intent to

make a nonshareholder capital contribution, Thermal must also

navigate the exceptions in section 118(b). 11 The plain text of section

118(b) forecloses the application of the exception from income in section

118(a). In particular, section 118(b)(1) excepts from contributions to

capital contributions “in aid of construction” or those made by “a

customer or potential customer.” The parties do not dispute that NVT’s

funds were used to construct the leasehold addition or that, at the time

NVT provided the $4.3 million, NVT bought foil heaters in significant

quantities from Thermal and intended to continue doing so. Thus, the

$4.3 million NVT provided was both “in aid of construction” and made

by a “customer or potential customer” of Thermal. Accordingly, section

118(b)(1) excepts the funds from being nonshareholder contributions to

capital excludable from gross income under section 118(a) and requires

their inclusion in income. 12

IV. Years of Inclusion

Next, we must decide when Thermal must include the NVT funds

in its income. For taxpayers on the accrual method, “income is

includible in gross income when all the events have occurred which fix

the right to receive such income and the amount thereof can be

determined with reasonable accuracy.” Treas. Reg. § 1.451-1(a).

Generally, all the events that fix the right to receive income occur on the

earliest of the following: (1) the date payment is received; (2) the date

payment is due; or (3) the date of performance. Johnson v.

Commissioner, 108 T.C. 448, 459 (1997) (citing Schlude v.

Commissioner, 372 U.S. 128 (1963)), aff’d in part, rev’d in part on other

grounds, 184 F.3d 786 (8th Cir. 1999). NVT paid $4.085 million in 2017

and $204,529 in 2018. Although the leasehold addition was not

completed until late 2018, while under construction in 2017,

manufacturing lines were brought on line one by one and production

increased incrementally. Consequently, the accrual method requires

Thermal to include the $4.085 million received in 2017 on its 2017 tax

return. With respect to the $204,529 received in 2018, Thermal had not

11 Section 118(b) was amended as part of the Tax Cuts and Jobs Act of 2017,

Pub. L. No. 115-97, § 13312(a)(3), 131 Stat. 2054, 2132. The amendment does not affect

our analysis.

12 Note that section 118(b) is disjunctive—tripping either the “in aid of

construction” prong or the “customer or potential customer” prong would be sufficient

to disqualify funds as contributions to capital.

12

[*12] earned it through performance in a prior year, nor was it

otherwise due in 2017; thus, Thermal must include it on its 2018 tax

return.

V. Accuracy-Related Penalty

In the Notice of Deficiency, the Commissioner determined that

Thermal is liable for a 20% accuracy-related penalty attributable to

negligence or disregard of rules or regulations for 2017. See I.R.C.

§ 6662(a) and (b)(1). Section 6662(c) provides that “the term ‘negligence’

includes any failure to make a reasonable attempt to comply with the

[Code], and the term ‘disregard’ includes any careless, reckless, or

intentional disregard.” Section 6664(c)(1) provides that “[n]o penalty

shall be imposed under section 6662 . . . with respect to any portion of

an underpayment if it is shown that there was reasonable cause for such

portion and that the taxpayer acted in good faith with respect to such

portion.”

Under section 6751(b), “[n]o penalty . . . shall be assessed unless

the initial determination of such assessment is personally approved (in

writing) by the immediate supervisor of the individual making such

determination or such higher level official as the Secretary may

designate.” The parties have stipulated that the Commissioner has

satisfied the requirements of section 6751(b)(1); thus we turn to the

burden of proof. Thermal bears the burden regarding the reasonable

cause defense. See Rule 142(a)(1); Higbee v. Commissioner, 116 T.C.

438, 446–47 (2001).

Reasonable cause requires that the taxpayer have exercised

ordinary business care and prudence as to the disputed item.

Neonatology Assocs., P.A. v. Commissioner, 115 T.C. 43, 98 (2000), aff’d,

299 F.3d 221 (3d Cir. 2002). Whether a taxpayer acted with reasonable

cause and in good faith is decided on a case-by-case basis, taking into

account all pertinent facts and circumstances. Higbee, 116 T.C. at 448;

Treas. Reg. § 1.6664-4(b)(1). Generally, the most important factor is the

extent of the taxpayer’s effort to assess its proper tax liability. Treas.

Reg. § 1.6664-4(b)(1). An honest misunderstanding of fact or law that is

reasonable in light of all of the facts and circumstances may show

reasonable cause and good faith. Higbee, 116 T.C. at 449; Treas. Reg.

§ 1.6664-4(b)(1).

Thermal’s return position was premised on NVT’s ownership of

the leasehold addition. As discussed supra Part II, this position is

13

[*13] incorrect. However, Thermal’s mistake of fact does not prove fatal

to its reasonable cause defense.

Considering the totality of the circumstances, we find Thermal’s

belief to be reasonable. Throughout the course of negotiations, NVT

maintained ownership of the Dedicated Equipment it funded that was

placed in the leasehold addition. The draft Framework Agreement has

a section titled “Capital Investment by [NVT] in [Thermal].” It states

that, in the event that NVT provides funds for Thermal to purchase

“equipment, materials and facilities” (further defined as “[NVT]

Property”) to manufacture more foil heaters, “Ownership of, and title to,

[NVT] Property (including [NVT] Property which [Thermal] has

purchased in its own name using funding provided by [NVT]) shall

remain vested in [NVT].” Because “facilities” were included in that NVT

Property definition, Thermal had reason to believe the “facilities” (i.e.

the leasehold addition) belonged to NVT.

Moving to the signed HoT Agreement, NVT can likewise be seen

as asserting control over the leasehold addition. Although the terms

securing ownership of “facilities” are not replicated in the HoT

Agreement, the agreement does incorporate “premises” in the

definitions of both “Equipment” and “Dedicated Equipment” over which

NVT asserted control. In particular, section 15 states in no uncertain

terms that “Title (ownership) [in the Dedicated Equipment (including

premises)] shall remain vested in NVT.”

Moreover, both Thermal and NVT acted relatively consistently in

implementing these provisions throughout their relationship. Thermal

used the Dedicated Equipment and the leasehold addition only to make

foil heaters for NVT. When NVT instructed Thermal to destroy the

Dedicated Equipment it had bought to produce NVT’s heaters, Thermal

did so despite misgivings. Thermal likewise sought written permission

from NVT to use the leasehold addition; but having received no

response, left the leasehold addition empty and unused. Perhaps most

notably, Thermal did not avail itself of depreciation deductions

attributable to the portion of the leasehold addition funded by NVT.

Taken together, this pattern evinces an honest, though mistaken,

belief that NVT owned the leasehold addition. Accordingly, we conclude

that Thermal had reasonable cause and acted in good faith such that it

is not liable for the accuracy-related penalty.

14

[*14] VI. Conclusion

In sum, Thermal received $4.085 million in 2017 and $204,529 in

2018 from NVT to ensure production of a product and ended up in

possession of a leasehold addition of the same value. Thermal must

therefore include the entire $4.3 million in income for 2017 and 2018,

respectively. However, because Thermal had reasonable cause for its

position, it is not liable for the 20% accuracy-related penalty for its 2017

tax year (or, as conceded, its 2018 tax year).

We have considered all arguments made by the parties and, to the

extent not addressed herein, we find them to be moot, irrelevant, or

without merit.

To reflect the foregoing and other concessions by the parties,

Decisions will be entered under Rule 155.