Setty Gundanna and Prabhavathi Katta Viralam v. Commissioner

SETTY GUNDANNA AND PRABHAVATHI KATTA VIRALAM,

PETITIONERS v. COMMISSIONER OF INTERNAL

REVENUE, RESPONDENT

Docket No. 21355–03. Filed February 14, 2011.

In 1998 P–H transferred stocks and cash to X, an organiza-

tion described in I.R.C. sec. 501(c) that was not a private

foundation. X sent P–H acknowledgment letters for the stock

transfers which stated that no goods or services were provided

for the ‘‘donation’’ of the stocks. X sold the stocks in 1998. X

maintained a segregated account for P–H in its records,

reflecting the stocks and cash received, the proceeds from the

sales of the stocks and their reinvestment, the dividends and

interest generated by the assets in the account, and the

disbursements from the account in subsequent years. Pro-

motional materials provided to P–H by X represented that P–

H would be able to direct the distribution of the funds in the

account for purported charitable purposes, including student

loans and as compensation for the performance of charitable

services by P–H or members of his family. P–H anticipated at

the time of the transfers of the stocks to X that account funds

could be used for student loans to his children. Ps claimed a

charitable contribution deduction on their 1998 Federal

income tax return equal to the fair market value of the stocks

and the cash transferred to X. In 2001 and 2002 X transferred

at P–H’s request a total of $70,299 from the account to an

educational institution in payment of the college tuition and

related expenses of P–H’s son. P–H’s son executed loan docu-

ments that obligated him to repay the amounts transferred,

plus interest, in cash or by providing designated amounts of

charitable services. R issued a notice of deficiency for 1998

disallowing the charitable contribution deduction claimed,

requiring the inclusion in Ps’ gross income of capital gains

realized upon the sales of the stocks by X in 1998 after the

transfers as well as the dividends and interest generated by

the account assets in 1998, and determining a penalty under

I.R.C. sec. 6662(a) and (b)(1) and (2). Held: P–H retained

dominion and control over the property transferred to X.

Accordingly, Ps are not entitled to any charitable contribution

deduction on account of the transfers and must include in

151

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152 136 UNITED STATES TAX COURT REPORTS (151)

gross income the capital gains realized upon X’s sales of the

transferred stocks as well as the dividends and interest gen-

erated by the assets in the segregated account. Held, alter-

natively, Ps are not entitled to any charitable contribution

deduction for failure to comply with the substantiation

requirements of I.R.C. sec. 170(f)(8). Held, further, Ps are

liable for a penalty under I.R.C. sec. 6662(a) and (b)(1) or (2).

Michael C. Durney, for petitioners.

Thomas A. Dombrowski and Mark A. Weiner, for

respondent.

GALE, Judge: Respondent determined a deficiency of

$91,948 and an accuracy-related penalty of $18,389 with

respect to petitioners’ 1998 Federal income tax.

The issues for decision are: (1) Whether petitioners are

entitled to a charitable contribution deduction under section

170 1 of $263,933 for purported transfers of appreciated

stocks and cash to the xe´lan Foundation; (2) whether peti-

tioners must include in gross income $93,324 of capital gain

resulting from the sales of the appreciated stocks by the

xe´lan Foundation in 1998 and $981 of interest and dividend

income generated in 1998 by property purportedly trans-

ferred by petitioners to the xe´lan Foundation; and (3)

whether petitioners are liable for an accuracy-related penalty

under section 6662.

FINDINGS OF FACT

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

The stipulation of facts and the attached exhibits are incor-

porated herein by this reference. At the time the petition was

filed, petitioners resided in Florida.

xe´lan

Petitioners are both medical doctors. Petitioner Setty

Gundanna Viralam (petitioner) owned a 50-percent interest

in a medical practice, which he sold in 1998 for $2,262,500,

generating a taxable gain of $2,261,750 in that year. In late

1997, when negotiating the sale of his medical practice, peti-

tioner learned of xe´lan, 2 a financial planning company for

1 Unless otherwise noted, all section references are to the Internal Revenue Code of 1986, as

in effect for the year in issue, and all Rule references are to the Tax Court Rules of Practice

and Procedure. All dollar amounts are rounded to the nearest dollar.

2 According to a xe´ lan publication, the name xe´lan ‘‘[combines] ‘x’, the individual’s savings re-

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(151) VIRALAM v. COMMISSIONER 153

doctors. Petitioner attended a presentation promoting the

financial planning programs of xe´lan and became a member

in November 1997.

xe´lan, also known as the Economic Association of Health

Professionals, Inc., was a membership organization for doc-

tors during the years relevant to this case. It provided

member doctors with financial planning services, including

pension plans, insurance products, tax reduction and asset

protection strategies, and investment management. These

financial services were provided through a network of xe´lan

financial counselors.

Payment of a $975 membership fee entitled a xe´lan

member to the ‘‘xe´lan Tax Reduction Plan’’, including a

questionnaire on which he or she provided personal financial

information from which xe´lan made financial planning rec-

ommendations. Members were also provided various pro-

motional materials, including a Program Summary

describing xe´lan programs and services, and the xe´lan Doc-

tors Financial Education Program (Financial Education Pro-

gram), which provided similar material in video and audio

tape formats. 3 After joining xe´lan, petitioners received copies

of the xe´lan Tax Reduction Plan and the Financial Education

Program in December 1997 and, at some time before

engaging in the transfers at issue, a copy of the Program

Summary. Petitioner was familiar with these materials.

xe´lan Foundation

One of the financial planning strategies summarized in the

xe´lan promotional materials was establishment through

donations to the xe´lan Foundation (Foundation) of an

account that the materials characterized as a ‘‘donor advised

fund’’ or ‘‘family public charity’’ (Foundation account), by

means of which a donor’s donations would be segregated for

quired to finance lifestyle costs through life expectancy, with ‘e´lan’, the French word meaning

a lifestyle of personal freedom.’’

3 Petitioners objected, on the grounds of relevance, duplication, and, in one instance, lack of

foundation, to the admission of most of xe´lan’s promotional materials and to materials from the

files of Rick Jaye, the xe´lan financial counselor assigned to petitioners. We overrule petitioners’

objections. The evidence is relevant because the promotional materials of xe´lan and the xe´lan

Foundation bear upon petitioner’s intent and understanding when he transferred appreciated

stocks to the xe´lan Foundation. The disputed exhibits are not unduly duplicative, as there are

variations in the material that help to establish the chronology of events. As the evidence estab-

lishes that Mr. Jaye was petitioners’ financial counselor at xe´lan, the materials that are stipu-

lated to be from his files do not lack foundational evidence.

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154 136 UNITED STATES TAX COURT REPORTS (151)

investment and future distribution as the donor might rec-

ommend. 4 A xe´lan financial counselor recommended, on the

basis of the personal financial information petitioners pro-

vided, that petitioner establish a Foundation account.

For the periods relevant to this case, the Foundation was

recognized by the Commissioner as an organization described

in section 501(c)(3), having received a determination letter to

that effect on March 20, 1998 (determination letter). The

Foundation was listed as a public charity in Publication 78,

Cumulative List of Organizations described in Section 170(c)

of the Internal Revenue Code of 1986, published in January

1999. 5 The Commissioner issued a determination in 2002

that the Foundation was not a private foundation within the

meaning of section 509.

The promotional materials characterized Foundation

accounts as a ‘‘tax reduction’’ program and stated that the

Foundation ‘‘was created to benefit not only charitable

causes, but also doctors and their families.’’ The Program

Summary describes the Foundation as follows:

The xe´lan Foundation is a public charity that enables doctors to contribute

pre-tax earnings to their own family public charities that are subaccounts

of the ‘‘umbrella’’ xe´lan Foundation charity. * * * Growth on contributions

within the Family Public Charity accounts accrue [sic] tax deferred. Doctor

donors may direct the use of funds accumulated within their family public

charity accounts to finance charitable projects including personal teaching,

research, pro bono works, [and] college and graduate scholarship programs

* * *.

Donors and their family members may work for and be compensated by

their family public charities for good works (teaching, research, or pro-

viding pro bono services) they perform on behalf of their family public

charities. * * *

´ lan materials variously characterized a potential Foundation donor’s segregated ac-

4 The xe

count to be maintained at the Foundation as a ‘‘family public charity’’, a ‘‘sub-foundation of the

umbrella xe´lan Foundation’’, or a ‘‘donor advised fund’’. We shall refer to the account maintained

by the Foundation segregating property petitioner transferred to it, and the income generated

by and disbursements from those segregated assets, as petitioner’s Foundation account.

Any reference to a donor advised fund herein does not denote the term as defined in sec. 4966,

which establishes a definition of, and certain rules applicable to, a ‘‘donor advised fund’’, effec-

tive for periods after those at issue. See Pension Protection Act of 2006 (PPA), Pub. L. 109–

280, sec. 1231(a), 120 Stat. 1094. Likewise, secs. 170(f)(18) and 2522(c)(5), establishing certain

restrictions on deductions of charitable contributions to donor advised funds (as defined in sec.

4966) are effective for periods after those at issue. See PPA sec. 1234, 120 Stat. 1100.

5 The Foundation continued to be listed in Publication 78 at the time of trial. However, the

Commissioner issued an examination report in 2004 proposing revocation of the Foundation’s

exempt status, and that status was revoked on Sept. 13, 2010. Announcement 2010–55, 2010–

37 I.R.B. 346.

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(151) VIRALAM v. COMMISSIONER 155

The Financial Education Program also explained with ref-

erence to Foundation accounts that

Your family then is the advisor to that fund as to the way the money is

invested. And the growth on the invested money accrues tax deferred. Any-

time you want to you could take the money out of your family public

charity and pay yourself compensation to do good works.

The Foundation also offered Foundation account holders a

student loan program whereby Foundation account funds

could be disbursed as loans for college and graduate school

tuition and related expenses. The program’s terms further

provided that the loans could be repaid (with interest) either

through repayments generally commencing 5 years after

graduation or by the recipient’s providing charitable services

for designated periods. A xe´lan financial counselor wrote

petitioner in April 1998 recommending that he ‘‘Establish a

Foundation account for charitable giving, income tax reduc-

tion planning, estate tax reduction, educational funding, and

future retirement planning.’’ (Emphasis added.)

Petitioners had three children, and petitioner advised

Foundation personnel in the questionnaire he completed in

late 1997 that he anticipated paying for 8 years of college

and g for each of his children, at a cost of approximately

$40,000 annually for each. Petitioner was interested in the

Foundation’s student loan program; he understood that his

own children would be able to benefit from the student loan

program if he established a Foundation account and he

intended to use the account for that purpose.

Petitioner’s Establishment of Foundation Account

Following the xe´lan financial counselor’s recommendation,

petitioner took the initial steps to establish a Foundation

account in April 1998. Using funds already on deposit with

xe´lan, petitioner paid a $1,400 setup fee to establish a

Foundation account and made a $100 initial contribution to

the account.

On May 12, 1998, petitioner submitted an ‘‘Application To

Establish a Donor Advised Fund’’ to the Foundation, desig-

nating himself as the ‘‘fund advisor’’. Petitioner signed the

application under a provision labeled ‘‘Fund Advisor State-

ment’’, which stated:

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156 136 UNITED STATES TAX COURT REPORTS (151)

I certify that I understand the nature of donor advised funds and will con-

duct activities which satisfy the requirements of the Internal Revenue

Code. I understand that in order to qualify as a deductible contribution for

income tax purposes, the ownership and custody of my donated funds and

property will be fully relinquished to the xe´lan Foundation.

The application allowed petitioner to choose among 12

investment strategies for managing the assets contributed to

his Foundation account. Petitioner chose a strategy directed

at aggressive growth. 6

Petitioner received and reviewed a brochure describing the

features of the Foundation program entitled ‘‘A New

Approach to Charitable Giving and Savings’’. The brochure

stated, in response to the question ‘‘When can I start

drawing monies out?’’, that a doctor could do so when he

began performing community service work and that, to

comply with the tax code, a formal request was required to

be submitted to and approved by the Foundation’s board of

directors.

The brochure further warranted that ‘‘the xe´lan Founda-

tion will not initiate charitable distributions from your fund,

unless it is left with no advisor.’’

After establishing his Foundation account, petitioner

received a letter from the law firm of Conner & Winters,

legal counsel to the Foundation. The letter expressed an

opinion that it was more likely than not that a contributor

would be entitled to a deduction for a charitable contribution

to the Foundation. The letter represented that the opinion

expressed therein was based on an examination of the

Foundation’s certificate of incorporation, its bylaws, resolu-

tions of its board of directors, and representations made to

the Commissioner of Internal Revenue in connection with the

Foundation’s application for recognition of section 501(c)(3)

tax-exempt status. However, the letter stated that Conner &

Winters had not examined any documents pertaining to, and

would not render an opinion as to the tax effect of, any of

several programs of the Foundation, including ‘‘donor advised

distributions’’, ‘‘educational loans’’, and ‘‘charitable service

[performed by a donor] for the Foundation’’. The letter

expressly disclaimed any opinion on the tax effect of ‘‘any

6 The application also had a section entitled ‘‘Proposed Charitable Purpose’’ wherein the appli-

cant was requested to check off certain charitable purposes or to describe his charitable objec-

tives. Petitioner left this section blank.

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(151) VIRALAM v. COMMISSIONER 157

specific charitable or other activity of the Foundation or any

donor with respect to the Foundation’’. No attorney at

Conner & Winters had any contact with petitioners at any

time before the opinion letter was sent. Conner & Winters

sent similar letters to other doctors who established Founda-

tion accounts.

Petitioner also received a letter from xe´lan’s chairman on

May 26, 1998, thanking him for his participation in the

Foundation program. Enclosed with this letter were sample

student loan program participation forms and a sample dis-

tribution request form.

Upon establishing his Foundation account, petitioner made

several transfers of stocks to the Foundation. The transfers

are summarized as follows.

Date of transfer Stock Value 1

Aug. 25, 1998 Republic Security Financial $85,000

Aug. 25, 1998 Professionals Group, Inc. 51,317

Nov. 20–25, 1998 Various 2 121,536

Dec. 28, 1998 Citrix Systems, Inc. 4,580

Total 262,433

1 Fair

market value as of the date of transfer.

2 The stocks transferred on Nov. 20–25, 1998, consisted of

shares of 25 companies.

The transferred stocks were recorded in the Foundation’s

records in a subaccount denominated the Viralam Family

Charitable Trust (referred to herein as petitioner’s Founda-

tion account).

After each of the transfers summarized above, petitioner

received an acknowledgment letter from the Foundation that

was labeled ‘‘Receipt for Gift of Stock’’. These acknowledg-

ment letters described the stock transferred and its fair

market value on the date of the transfer. Each letter also

contained the following statement: ‘‘No goods or services

were provided for this donation.’’

Petitioner’s aggregate basis in the transferred stocks was

$131,360. The Foundation subsequently sold all of the stocks

during 1998 and invested the proceeds, again segregating

them in the Foundation’s records as petitioner’s Foundation

account. The sales of the stocks yielded the following pro-

ceeds:

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158 136 UNITED STATES TAX COURT REPORTS (151)

Net

Date of sale Stock proceeds

Sept. 28, 1998 Republic Security Financial $73,795

Sept. 28, 1998 Professionals Group, Inc. 40,151

Dec. 3, 1998 Various 106,203

Dec. 30, 1998 Citrix Systems, Inc. 4,535

Total 224,684

The assets in petitioner’s Foundation account generated $981

in dividends and interest in 1998.

The Foundation sent petitioner a monthly accounting of his

Foundation account. Between May 18, 1998, and February 1,

2005, $29,383 was deducted from petitioner’s Foundation

account for management and administration fees, consisting

of a one-time fee equal to 6 percent of the value of the stock

petitioner transferred to the account and an annual invest-

ment fee of 1 percent of the account’s value. 7

Charitable Contribution Deduction for Stock Transfers to

Foundation

Petitioners timely filed a joint Federal income tax return

for 1998. In addition to reporting a $2,261,750 gain from the

sale of petitioner’s medical practice, they claimed a charitable

contribution deduction of $263,933, equal to the fair market

value of the stocks transferred to the xe´lan Foundation in

1998 ($262,433), plus the $1,400 setup fee paid to the

Foundation and the initial $100 in cash deposited into peti-

tioner’s Foundation account in that year. Petitioners’ 1998

return was prepared by petitioners’ accountant, who had

been providing accounting services to petitioners since 1984.

Petitioner discussed the charitable contribution deduction

with the accountant before petitioners signed the return.

Petitioners did not include in income on the 1998 return any

gain from the sales of the stocks that had been transferred

to the Foundation, and the Foundation had sold, in 1998 nor

any dividends or interest generated by the assets in peti-

tioner’s Foundation account during that year.

7 The parties have stipulated that the annual investment fee was 1 percent, whereas the

Foundation brochure in evidence refers to the fee as 1.1 percent. We consider the discrepancy

immaterial for purposes of deciding the case.

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(151) VIRALAM v. COMMISSIONER 159

Distributions From Petitioner’s Foundation Account in Subse-

quent Years

In accordance with petitioner’s requests, the Foundation

made distributions from his Foundation account of $4,000,

$1,000, $5,000, and $4,000 to the Shiva Vishnu Temple in

1999, 2000, 2001, and 2002, respectively, and distributions of

$1,000 and $500 to the Sarada Foundation in 2002 and 2003,

respectively. 8

Also in 2001 petitioner requested that $17,247 be distrib-

uted from his Foundation account to the University of

Pennsylvania in connection with the Foundation’s student

loan program, as a loan to his son Vinay to cover the cost of

Vinay’s tuition and room and board at that institution. The

distribution was made pursuant to a ‘‘distribution request’’

form the Foundation sent to petitioner on April 25, 2001. As

sent to petitioner, the form was dated July 9, 2001, and par-

tially completed. Filled out were entries for the ‘‘amount of

distribution’’: ‘‘$17,247’’; ‘‘name of charity’’: ‘‘University of

Pennsylvania’’; and the ‘‘purpose of distribution’’: ‘‘Student

Loan for Vinay S. Viralam’’. The form had been signed as

approved by a Foundation official and was forwarded to peti-

tioner for his signature, with instructions that it be returned

to the Foundation with certain loan documents to be

executed by Vinay, as described below.

On July 6, 2001, Vinay executed documents with respect to

the $17,247 loan for his tuition and expenses at the Univer-

sity of Pennsylvania. The documents included a ‘‘Commit-

ment Agreement’’ (commitment agreement) and an ‘‘Edu-

cation Expense Repayment Agreement’’ (repayment agree-

ment).

In the commitment agreement Vinay agreed to participate

in the Foundation’s ‘‘Educational Funding Program’’ and, in

return for receiving educational loans from the Foundation,

to provide 2,000 hours of charitable work for the Founda-

tion for each year of educational expenses advanced. The

commitment agreement stated that if Vinay did not under-

take sufficient charitable work to repay the educational

expenses advanced, he would repay the Foundation all edu-

8 Petitioners claimed charitable contribution deductions for the distributions made by peti-

tioner’s Foundation account to Shiva Vishnu Temple in 1999 and 2000 on their Federal income

tax returns for those years but now concede that those deductions were improper.

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160 136 UNITED STATES TAX COURT REPORTS (151)

cational expenses advanced that were not reduced by chari-

table services, together with interest according to the terms

of the repayment agreement. Finally, the commitment agree-

ment stated that ‘‘the student will provide regular reports, at

least annually, of his or her progress in the course of study

and intended work, as well as, his or her plan to meet the

obligations of the Agreement.’’

The repayment agreement acknowledged cash advances on

Vinay’s behalf by the Foundation to the University of

Pennsylvania for tuition, fees, and on-campus room and

board for the period beginning August 2001. The repayment

agreement provided that Vinay would repay to the Founda-

tion the sums advanced plus annual interest equal to speci-

fied Federal long-term rates commencing on the date of the

agreement. Under the agreement, the obligation to repay

principal and interest could be satisfied either by Vinay’s

performance of charitable services at the rate of 2,000 hours

of service for each full year of education expenses advanced,

or by actual payment of principal and accrued interest. No

payments were due until 5 years after Vinay’s ‘‘originally

scheduled graduation date’’. At that time, any balance not

satisfied through the charitable services option was required

to be repaid over a 15-year term.

Sometime shortly after July 6, 2001, petitioner submitted

the completed distribution request form and loan documents,

and on July 25, 2001, the Foundation made a distribution of

$17,247 to the University of Pennsylvania for tuition, fees,

and room and board for Vinay.

Also in July 2001, respondent commenced an examination

of petitioners’ 1998 return. On May 20, 2002, respondent

sent petitioners a 30-day letter, proposing a disallowance of

the charitable contribution deduction claimed for petitioner’s

transfers of appreciated stocks to the Foundation and an

increase in petitioners’ capital gains income (reflecting an

attribution to them of the proceeds of the sales of stocks in

1998 after their transfer to the Foundation).

Petitioner submitted four additional distribution requests

in 2002 that resulted in transfers by the Foundation to the

University of Pennsylvania for Vinay’s tuition, fees, and room

and board (to be treated as loans to Vinay) of $6,769,

$13,073, $14,385, and $18,825, on January 28, May 20, July

24, and December 26, 2002, respectively. The distributions

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(151) VIRALAM v. COMMISSIONER 161

petitioner requested from his Foundation account in 2001

and 2002 for Vinay’s University of Pennsylvania expenses

totaled $70,299.

On June 15, 2003, $19,499, or 10 percent of petitioner’s

Foundation account balance, was withdrawn for ‘‘legal fees’’.

xe´lan paid the fees for petitioners’ legal representation

during the examination of their 1998 return and the fees for

petitioners’ counsel in this proceeding.

On September 16, 2003, respondent issued petitioners a

notice of deficiency for 1998 disallowing their claimed chari-

table contribution deduction for the transfers of stocks (and

cash 9) to the Foundation and determining an accuracy-

related penalty. Eleven days earlier, petitioner arranged for

an entity he and Vinay controlled to pay the Foundation

$70,300, the total of the distributions to the University of

Pennsylvania on Vinay’s behalf from petitioner’s Foundation

account. 10 This payment was credited to petitioner’s Founda-

tion account. The Foundation thereupon waived all interest

that had accrued under the terms of the repayment agree-

ment and returned the commitment agreement and repay-

ment agreement to Vinay marked ‘‘paid in full’’, along with

a letter confirming that the $70,300 payment had fulfilled

Vinay’s obligation to the Foundation.

OPINION

Burden of Proof

Petitioners argue that respondent bears the burden of

proof in this proceeding pursuant to section 7491(a). How-

ever, the burden of proof has no practical consequence in this

case, as there is no evidentiary tie. Our findings with respect

to all factual issues are based upon a preponderance of the

evidence. See Blodgett v. Commissioner, 394 F.3d 1030, 1039

(8th Cir. 2005), affg. T.C. Memo. 2003–212; Knudsen v.

Commissioner, 131 T.C. 185, 188–189 (2008); see also Geiger

9 The disputed charitable contribution deduction reflects 1998 transfers of stocks with a fair

market value of $262,433, plus a $1,400 setup fee, and $100 in cash. The parties have not ad-

vanced any arguments for separate treatment of the setup fee, and we consequently do not dis-

tinguish it in our analysis.

10 We assume the $1 discrepancy between the $70,300 payment petitioner made to the Foun-

dation in 2003 and the $70,299 figure reached by totaling the distributions the Foundation made

to the University of Pennsylvania in 2001 and 2002 reflects rounding.

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162 136 UNITED STATES TAX COURT REPORTS (151)

v. Commissioner, 279 Fed. Appx. 834, 835 (11th Cir. 2008),

affg. T.C. Memo. 2006–271.

Charitable Contribution Deduction

Section 170(a)(1) allows a deduction for any charitable con-

tribution, payment of which is made during the taxable year.

Section 170(c)(2) defines a ‘‘charitable contribution’’ for this

purpose to include a contribution or gift to or for the use of

a foundation organized and operated exclusively for chari-

table or educational purposes. 11

In order for a transfer of property to a charitable organiza-

tion to qualify for a charitable contribution deduction, (1) the

transfer must be a completed gift; that is, the donor must

have relinquished dominion and control over the donated

property, Pollard v. Commissioner, 786 F.2d 1063, 1067 (11th

Cir. 1986), affg. T.C. Memo. 1984–536; (2) the contribution

must have been made with donative intent and without the

expectation of a substantial benefit in return, United States

v. Am. Bar Endowment, 477 U.S. 105, 118 (1986); and (3) a

contribution of $250 or more must be substantiated by a

contemporaneous written acknowledgment of the contribu-

tion by the donee organization that meets the requirements

of section 170(f)(8)(B), sec. 170(f)(8).

Respondent contends that petitioners are not entitled to a

charitable contribution deduction for the stock transfers to

the Foundation because petitioners never surrendered

dominion and control over the property or, alternatively,

because petitioners failed to substantiate the deduction as

required by section 170(f)(8), the Foundation’s acknowledg-

ment of the contribution having failed to describe or value

the goods or services that petitioner expected to receive in

consideration of the contribution. Petitioners contend that

they relinquished to the Foundation all control over the

transferred property, citing petitioner’s certification to that

effect in the Fund Advisor Statement he executed in connec-

tion with establishing his Foundation account. Petitioners

further contend that petitioner’s Foundation account satisfied

the requirements for a donor advised fund as set out in Natl.

Found., Inc. v. United States, 13 Cl. Ct. 486 (1987). They

11 As reflected in our findings, the parties have stipulated that the Foundation was a tax-ex-

empt organization described in sec. 501(c)(3) during the periods relevant to this case.

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(151) VIRALAM v. COMMISSIONER 163

maintain that, consistent with the holding in that case, peti-

tioner could only suggest that the Foundation make des-

ignated charitable contributions from his Foundation account

and suggest an investment strategy for the assets in the

account and that these factors are insufficient to establish

that petitioner retained control over the property transferred

to the Foundation. Finally, petitioners contend that they did

not receive any substantial benefit in return for petitioner’s

contribution to the Foundation and properly substantiated

the charitable contribution deduction claimed.

We agree with respondent that petitioner retained

dominion and control over the property transferred to the

Foundation and held in his Foundation account. We reach

this conclusion principally on the basis of the use of funds in

petitioner’s Foundation account for student loans to his son.

We also find that the promotion of another Foundation

account feature—petitioner’s ability to arrange for distribu-

tions of account funds to compensate himself or family mem-

bers for performance of ‘‘good works’’—also supports the

conclusion that petitioner maintained control of the assets in

his Foundation account.

Petitioner received the xe´lan promotional materials and

was familiar with their contents. The materials petitioner

reviewed identified certain scholarship programs as one of

the undertakings to which a donor could direct funds in his

Foundation account. 12 Petitioner was aware of a Foundation

program under which student loans could be made from

Foundation accounts. The Foundation account arrangements

allowed a donor to designate a ‘‘fund advisor’’ to ‘‘advise’’ the

Foundation regarding distributions from the donor’s account,

and petitioner designated himself as fund advisor to his

account. A Foundation brochure stated that the Foundation

would not initiate charitable distributions from an individual

donor’s account unless there was no fund advisor in place.

Petitioner testified that he understood when deciding to

establish a Foundation account that the Foundation’s student

loan program would be available for his children’s use and

that he was contemplating using the student loan program

12 The Program Summary petitioner reviewed stated that donors to the Foundation with

Foundation accounts ‘‘may direct the use of funds accumulated within their family public charity

accounts to finance charitable projects including * * * college and graduate scholarship pro-

grams.’’

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164 136 UNITED STATES TAX COURT REPORTS (151)

for his children. The significance of the student loan program

in petitioner’s decision to make transfers to his Foundation

account is corroborated by the fact that a sample student

loan participation form was included with the first letter sent

to petitioner (by xe´lan’s chairman) acknowledging petitioner’s

establishment of a Foundation account.

When he established his Foundation account in 1998, peti-

tioner anticipated that each of his three children would incur

8 years of college and graduate school expenses which he

estimated would approximate $40,000 annually per child.

The distributions from petitioner’s Foundation account for

student loans for his oldest son dwarfed the distributions for

other purposes for the first 5 years, until respondent com-

menced an examination of petitioners’ 1998 return and pro-

posed to disallow their deduction for the contributions to the

Foundation. Disregarding payment of the Foundation’s

startup and annual management fees, the distributions made

from petitioner’s Foundation account in 1999 through 2003

for purposes other than Vinay’s student loans totaled

$15,500. 13 The distributions for Vinay’s student loans during

that period totaled $70,299, or approximately 82 percent of

distributions not devoted to management fees. Respondent

first proposed to disallow petitioners’ charitable contribution

deduction for the Foundation transfer in a 30-day letter

issued in May 2002 and formally did so in a notice of defi-

ciency issued on September 16, 2003. No distributions for

student loans were made from petitioner’s Foundation

account in 2003. Indeed, on September 5, 2003, just before

issuance of the notice of deficiency, petitioner arranged for

the repayment of Vinay’s student loans. 14 Given these facts,

we are persuaded that distributions for student loans to peti-

tioners’ children would have continued to constitute the

predominant use of the assets in petitioner’s Foundation

account, but for the scrutiny of the Internal Revenue Service.

The Foundation’s approval of petitioner’s son as a student

loan beneficiary was perfunctory. The Foundation sent peti-

13 For two of these distributions—$4,000 and $1,000 distributed to Shiva Vishnu Temple in

1999 and 2000, respectively—petitioners claimed charitable contribution deductions on their

Federal income tax returns for those years. These deduction claims suggest that petitioners con-

sidered the funds in petitioner’s Foundation account to be under his control in 1999 and 2000.

14 On Sept. 5, 2003, petitioner directed an entity controlled by him and Vinay to pay the Foun-

dation $70,300, the principal balance of the loans to Vinay (excluding accrued interest). Upon

receipt, the Foundation waived all accrued interest and declared the loans paid in full.

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(151) VIRALAM v. COMMISSIONER 165

tioner a distribution request form on which the approval for

a student loan for Vinay had already been signed by a

Foundation official before petitioner executed the form. There

is no evidence that the Foundation reviewed Vinay’s quali-

fications or otherwise exercised any independent judgment in

selecting him for a student loan. In the circumstances, it is

obvious that the selection of Vinay as a beneficiary of the

Foundation’s student loan program arose from his relation-

ship to petitioner and as a result of petitioner’s direction.

Petitioner’s understanding, at the time he transferred the

stocks to his Foundation account in 1998, that the account’s

assets could be used to make student loans to his children,

and the Foundation’s perfunctory acquiescence in making

such loans in subsequent years, provide substantial support

for the conclusion that petitioner neither intended to, nor in

fact did, cede dominion and control over the property trans-

ferred to the Foundation in 1998.

Petitioners, however, point to petitioner’s transfer of legal

title to the stocks he contributed to the Foundation and the

‘‘Fund Advisor Statement’’ petitioner signed when he estab-

lished the Foundation account, which stated that he ‘‘fully

relinquished’’ ownership of the stocks to the Foundation. In

petitioners’ view, these formalities establish that petitioner

had fully relinquished dominion and control over the prop-

erty transferred to the Foundation in 1998.

We disagree. The determination of whether dominion and

control has been surrendered for purposes of a charitable

contribution deduction under section 170 ‘‘must be based

upon all the facts of a particular case.’’ Pollard v. Commis-

sioner, T.C. Memo. 1984–536. In addition to petitioner’s ini-

tial understanding of his ability to direct the use of his

Foundation account funds for his children’s student loans,

and the Foundation’s subsequent course of conduct which

confirmed that understanding, we note that the Foundation

did not treat the purported legal obligations in the student

loan documents as binding. Although the commitment agree-

ment required Vinay to provide an annual report, there is no

evidence that he did so. More significantly, when petitioner

repaid the principal amount of Vinay’s student loans, the

Foundation waived all accrued interest, notwithstanding the

terms of the repayment agreement providing that interest

was to accrue commencing on the date the agreement was

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166 136 UNITED STATES TAX COURT REPORTS (151)

entered. 15 The Foundation having disregarded the obliga-

tions due to it from Vinay under two contracts executed in

connection with Foundation account transactions, there is no

reason to believe that the Foundation would enforce any

rights it held against petitioner by virtue of his execution of

the ‘‘Fund Advisor Statement’’.

A second feature of petitioner’s Foundation dealings also

contributes to the conclusion that he did not relinquish

dominion and control over the property transferred to the

Foundation. The xe´lan promotional materials stated that

‘‘Donors [to a Foundation account] and their family members

may work for and be compensated by their family public

charities [i.e., the donor’s Foundation account] for good works

* * * they perform on behalf of their family public charities.’’

The materials elsewhere represented: ‘‘Anytime you want to

you could take the money out of your family public charity

and pay yourself compensation to do good works.’’

While petitioner apparently did not seek a distribution

from his Foundation account to compensate him or a family

member for ‘‘good works’’, xe´lan’s representation to him that

he would be able to do so is further evidence that the

Foundation intended, and petitioner understood when he

made the transfers, that he could retrieve the transferred

property (or its proceeds) through this technique. A donor

advised fund creator’s option to receive fund assets as com-

pensation for the performance of charitable services by him-

self or family members has been treated as evidence of

retained dominion and control. See New Dynamics Found. v.

United States, 70 Fed. Cl. 782, 800–801 (2006). The materials

in the record describe only in very general terms the stand-

ards to be applied by the Foundation’s board of directors in

determining whether a donor’s Foundation account funds

should be paid out to him or a family member as compensa-

tion for the performance of ‘‘good works’’. We are satisfied on

this record that ‘‘good works’’ distributions were con-

templated by petitioner and the Foundation in 1998 as a

means for petitioner to retrieve his purported contributions

in the future. Consequently, we find that the possibility of

such distributions supports the conclusion that petitioner

15 Petitioners’ own estimate of the interest that had accrued on the Foundation account loans

to Vinay at the time they were repaid was $7,922.

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(151) VIRALAM v. COMMISSIONER 167

retained dominion and control over the property purportedly

contributed to the Foundation.

Petitioners contend that they did not have an impermis-

sible degree of dominion and control over their Foundation

account because it was a donor advised fund similar to the

arrangements found not to have resulted in a retention of

donor control in Natl. Found., Inc. v. United States, 13 Cl. Ct.

486 (1987). Natl. Found., however, is entirely distinguish-

able. The Claims Court there found that while a donor

advised fund creator could suggest a particular charitable

use, the tax-exempt organization administering the donor’s

funds would honor it only if the requested contribution was

‘‘in consonance with § 501(c)(3) charitable purposes.’’ Id. at

492. The court found substantial evidence that the National

Foundation board of directors exercised effective control to

ensure that distributions from its donor advised funds were

for charitable, not personal, purposes. By contrast, petitioner

requested, and the Foundation made, substantial distribu-

tions from petitioner’s Foundation account for a personal use;

namely, educational loans for his child. See Fausner v.

Commissioner, 55 T.C. 620, 624 (1971) (taxpayer’s payment

of children’s secondary school tuition is a personal, not a

charitable, expenditure); Whitaker v. Commissioner, T.C.

Memo. 1994–109 (to same effect for college tuition). More-

over, the arrangements in Natl. Found. did not include an

option whereby the donated funds could be distributed back

to the donor or his family as compensation for the perform-

ance of services deemed charitable by the foundation.

Instead, the Foundation account arrangements more

closely resemble those in New Dynamics Found. v. United

States, supra. In that case, the Court of Federal Claims sus-

tained the Commissioner’s denial of tax-exempt status for an

organization administering purported donor advised funds.

Among the features of those donor advised funds cited by the

court as grounds for denial of tax-exempt status were the

practices of distributing fund assets to donors’ family mem-

bers as compensation for the performance of charitable serv-

ices or to donors’ children as scholarships. Such practices,

which enabled donors to direct purportedly donated funds to

personal uses, contributed to the court’s conclusion that ‘‘the

donors in question did not truly relinquish ownership and

control over the donated funds and property.’’ Id. at 803.

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168 136 UNITED STATES TAX COURT REPORTS (151)

In sum, the Foundation’s representations concerning the

student loan program, petitioner’s understanding at the time

of the 1998 transfers of his ability to direct the use of his

Foundation account for the noncharitable, purely personal

purpose of funding student loans for his children, and peti-

tioner’s subsequent ability to do so in practice all persuade

us that petitioner never intended to, nor in fact did, relin-

quish dominion and control over the property transferred to

the Foundation. This conclusion finds further support in the

‘‘good works’’ option for distribution to petitioner from the

Foundation account. Accordingly, we hold that petitioner

retained dominion and control over the property he trans-

ferred to the Foundation in 1998 and is therefore not entitled

to a deduction under section 170(a). 16

Respondent argues in the alternative that, even if peti-

tioners were found to have ceded dominion and control of the

property they transferred to the Foundation, their claimed

charitable contribution deduction is not allowed because they

did not comply with the substantiation requirements of sec-

tion 170(f)(8). We agree.

Section 170(f)(8)(A) provides that no deduction shall be

allowed under section 170(a) for any contribution of $250 or

more unless the taxpayer substantiates the contribution with

a contemporaneous written acknowledgment of the contribu-

tion by the donee organization that meets certain require-

ments specified in section 170(f)(8)(B). Section 170(f)(8)(B)

requires that the donee organization state in the acknowledg-

ment ‘‘Whether the donee organization provided any goods or

services in consideration, in whole or part, for’’ the contrib-

uted property or cash. Sec. 170(f)(8)(B)(ii). If any goods or

services are so provided, the acknowledgment generally must

include ‘‘A description and good faith estimate of the value

of any goods or services’’ provided. Sec. 170(f)(8)(B)(iii). 17 The

16 Because we conclude that the student loan and ‘‘good works’’ features of petitioner’s Foun-

dation account demonstrate that he retained sufficient dominion and control over the trans-

ferred property to preclude a deduction under sec. 170(a), we find it unnecessary to consider

whether other features of the Foundation account arrangements constituted impermissible re-

tained control, including (i) the fact that petitioner was entitled to elect the investment strategy

for the assets in his Foundation account; (ii) the fact that periodic distributions were made from

petitioner’s Foundation account to compensate the Foundation for investment management serv-

ices provided to petitioner; and (iii) the fact that distributions were made from the account to

pay petitioners’ legal fees for their representation in the examination of their 1998 return and

the prosecution of this case.

17 If the goods or services consist solely of ‘‘intangible religious benefits’’, a statement to that

effect must be given in lieu of the description and good faith estimate of value. Sec.

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(151) VIRALAM v. COMMISSIONER 169

regulations clarify that a donee organization is treated as

having provided goods or services in consideration for the

taxpayer’s payment if the taxpayer expects to receive goods

or services in exchange for the payment at the time it is

made, including where the goods or services are provided in

a year other than the year when the taxpayer makes the

payment.

A donee organization provides goods or services in consideration for a tax-

payer’s payment if, at the time the taxpayer makes the payment to the

donee organization, the taxpayer receives or expects to receive goods or

services in exchange for that payment. Goods or services a donee organiza-

tion provides in consideration for a payment by a taxpayer include goods

or services provided in a year other than the year in which the taxpayer

makes the payment to the donee organization. [Sec. 1.170A–13(f)(6),

Income Tax Regs.]

Respondent argues that petitioner expected when he trans-

ferred the stocks to the Foundation in 1998 that the Founda-

tion would make student loans to his children and that con-

sequently the Foundation provided goods or services in

consideration of petitioner’s transfers within the meaning of

the statute and regulations.

Petitioners contend that respondent bears the burden of

proof on the issue of their receipt of benefits in exchange for

their contributions because it is a ‘‘new matter’’ within the

meaning of Rule 142(a) that was not raised in the notice of

deficiency and which requires the presentation of different

evidence. See Wayne Bolt & Nut Co. v. Commissioner, 93

T.C. 500, 507 (1989). 18 Even assuming, arguendo, that

respondent bears the burden of proving that petitioner

expected a benefit in exchange for his transfers of the stocks

to the Foundation, respondent has met that burden. 19 As our

170(f)(8)(B)(iii).

18 The notice of deficiency issued to petitioners merely states that the deductions claimed for

‘‘charitable contributions to the xe´lan Foundation * * * are not allowable because they were not

charitable contributions within the meaning of section 170 of the Internal Revenue Code.’’ Be-

cause the evidence adduced so clearly establishes that petitioner anticipated receipt of benefits

in exchange for his transfer of the stocks to the Foundation, respondent has satisfied any bur-

den of proof he might bear on this issue. Thus, we find it unnecessary to decide whether re-

spondent’s contention that petitioner received a benefit rendering his substantiation inadequate

under sec. 170(f)(8) ‘‘requires the presentation of different evidence * * * or merely clarifies or

develops the original determination’’. See Wayne Bolt & Nut Co. v. Commissioner, 93 T.C. 500,

507 (1989); see also Shea v. Commissioner, 112 T.C. 183, 191 (1999).

19 Petitioners also appear to suggest that respondent bears the burden of showing that the

fair market values of the goods or services they received equaled or exceeded the values of the

Continued

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170 136 UNITED STATES TAX COURT REPORTS (151)

findings reflect, the preponderance of the evidence shows

that petitioner anticipated at the time he transferred stocks

to the Foundation that the Foundation would extend student

loans to his children. In addition to the abundant cir-

cumstantial evidence on this score, petitioner so testified.

‘‘Goods or services’’ for purposes of section 170(f)(8) means

‘‘cash, property, services, benefits, and privileges.’’ Sec.

1.170A–13(f)(5), Income Tax Regs. We are satisfied that the

provision of student loans to family members falls within this

regulatory definition. The Foundation, upon petitioner’s

request, provided his son a student loan with extended

repayment terms and an option to substitute volunteer

charity work for actual repayment of principal and interest.

The outlays for petitioner’s son’s student loans constituted

more than 80 percent of the distributions from petitioner’s

Foundation account (exclusive of distributions to pay the

Foundation’s management fees) in the first 5 years after its

creation, until respondent began an examination of peti-

tioners’ 1998 return and the loans were repaid (with interest

forgiven) in 2003. The evidence as a whole persuades the

Court that, but for respondent’s scrutiny of the 1998 return,

petitioner would have continued to request and obtain stu-

dent loans for all three children from his Foundation

account. Thus, under the regulations, petitioner’s expectation

in 1998 that the Foundation would provide student loans to

his children in subsequent years means that the Foundation

is deemed to have provided goods or services in consideration

for the donated stocks. See sec. 1.170A–13(f)(6), Income Tax

Regs.

The written acknowledgment necessary under section

170(f)(8) to substantiate petitioners’ charitable contribution

was required to state whether goods or services were pro-

vided by the Foundation in consideration for the stocks

transferred to it and if so to describe them and provide a

good faith estimate of their value. See sec. 170(f)(8)(B). The

Foundation acknowledgment letters offered by petitioners as

substantiation of their claimed donations of stock each state,

stocks transferred, so that a deduction for any excess of the stocks’ values over the fair market

values of the consideration received is foreclosed. See sec. 1.170A–1(h), Income Tax Regs. We

disagree. To establish petitioners’ noncompliance with sec. 170(f)(8), respondent need only show

that petitioner expected to receive a benefit in exchange for his donations to the Foundation.

See Addis v. Commissioner, 374 F.3d 881 (9th Cir. 2004), affg. 118 T.C. 528 (2002).

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(151) VIRALAM v. COMMISSIONER 171

inaccurately, that ‘‘No goods or services were provided for

this donation.’’ Petitioners’ substantiation therefore fails to

comply with section 170(f)(8).

Section 170(f)(8) provides that ‘‘No deduction shall be

allowed’’ unless the taxpayer substantiates a contribution in

accordance with the terms of that section. Where the written

acknowledgment of a charitable contribution by a donee

organization states that the donor received no consideration

and the donor actually received a benefit in exchange for the

donation, the deduction is disallowed in its entirety. Addis v.

Commissioner, 374 F.3d 881 (9th Cir. 2004), affg. 118 T.C.

528 (2002). ‘‘The deterrence value of section 170(f)(8)’s total

denial of a deduction comports with the effective administra-

tion of a self-assessment and self-reporting system.’’ Id. at

887.

Petitioners contend belatedly on brief that the value of the

student loan benefit provided to petitioner’s son was small in

relation to the value of petitioner’s contribution to the

Foundation 20 and that they should be entitled to a partial

deduction equal to the amount by which the donated stocks’

values exceeded the value of the student loan benefit, citing

the ‘‘dual payment’’ rule of United States v. Am. Bar Endow-

ment, 477 U.S. at 117, and section 1.170A–1(h), Income Tax

Regs. However, having failed to satisfy a compliance provi-

sion designed to foster disclosure of ‘‘dual payment’’ or quid

pro quo contributions, petitioners may not now claim dual

payment treatment. See Addis v. Commissioner, supra at 887

(‘‘A partial deduction is foreclosed by the statutory lan-

guage.’’).

Capital Gains and Investment Income

Respondent determined that $93,324 in long-term capital

gain generated by the sales of the stocks in 1998 after peti-

tioner transferred them to the Foundation is includible in

petitioners’ gross income for that year, as well as $981 of

interest and dividends generated by the property in peti-

tioner’s Foundation account in 1998. We agree with

respondent.

20 Petitioners assert that the value of Vinay’s student loan benefit is equal to the interest

waived upon repayment of the loans in 2003, discounted to present value in 1998. This estimate

ignores the value of the loans anticipated for petitioner’s two other children and the value of

the option to repay the loans with charitable services.

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172 136 UNITED STATES TAX COURT REPORTS (151)

The Federal income tax consequences of property owner-

ship generally depend upon beneficial ownership, rather than

possession of mere legal title. Speca v. Commissioner, 630

F.2d 554, 556–557 (7th Cir. 1980), affg. T.C. Memo. 1979–

120; Beirne v. Commissioner, 61 T.C. 268, 277 (1973).

‘‘ ‘[C]ommand over property or enjoyment of its economic

benefits’ * * *, which is the mark of true ownership, is a

question of fact to be determined from all of the attendant

facts and circumstances.’’ Monahan v. Commissioner, 109

T.C. 235, 240 (1997) (quoting Hang v. Commissioner, 95 T.C.

74, 80 (1990)). As outlined in our previous discussion of peti-

tioners’ entitlement to a charitable contribution deduction,

although petitioner transferred legal title to various stocks to

the Foundation in 1998, petitioner retained dominion and

control over the stocks transferred. He understood that the

stocks would be managed according to an investment

strategy he designated, which might include their being sold

and the proceeds invested differently. He understood in 1998

that he would be able to direct that the assets in his Founda-

tion account be distributed to his children as student loans,

and the Foundation complied with his direction that the

account assets be applied in this manner in 2001 and 2002.

The funds so applied and remaining available for that pur-

pose included the proceeds of the sales of the transferred

stocks as well as interest and dividends generated by the

investment of those proceeds. Moreover, ‘‘interest earned on

investment is taxable to the person who controls the prin-

cipal.’’ P.R. Farms, Inc. v. Commissioner, 820 F.2d 1084,

1086 (9th Cir. 1987) (citing Helvering v. Horst, 311 U.S. 112,

116–117 (1940)), affg. T.C. Memo. 1984–549; see also

Monahan v. Commissioner, supra at 239–240. We see no rea-

son a similar rule should not apply to dividends. Because

petitioner retained dominion and control of the assets in his

Foundation account, we sustain respondent’s determination

concerning the capital gains and interest and dividend

income in 1998.

Section 6662 Penalty

Respondent also determined that petitioners are liable for

an accuracy-related penalty for negligence, substantial

understatement of income tax, or substantial valuation

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(151) VIRALAM v. COMMISSIONER 173

misstatement. See sec. 6662(a) and (b)(1)–(3). 21 Section

6662(a) imposes a penalty equal to 20 percent of that portion

of any underpayment of tax attributable to negligence or dis-

regard of rules or regulations, sec. 6662(b)(1), or any substan-

tial understatement of income tax, sec. 6662(b)(2). 22 Gen-

erally, no penalty shall be imposed under section 6662, how-

ever, 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. Sec. 6664(c). Pursuant to section 7491(c), the

Commissioner has the burden of production in any court pro-

ceeding with respect to any penalty imposed by the Internal

Revenue Code. In order to meet that burden, the Commis-

sioner must offer sufficient evidence to indicate that it is

appropriate to impose the penalty. See Higbee v. Commis-

sioner, 116 T.C. 438, 446 (2001). Once the Commissioner

meets his burden of production, the taxpayer bears the bur-

den of proving error in the determination to impose a pen-

alty, including proving reasonable cause, substantial

authority, or other exculpatory factors. See id. at 446–447.

Negligence for this purpose is a lack of due care or the

failure to do what a reasonable and ordinarily prudent per-

son would do under the circumstances, and it includes any

failure to make a reasonable attempt to comply with the

income tax laws. Marcello v. Commissioner, 380 F.2d 499,

506 (5th Cir. 1967), affg. in part and remanding in part 43

T.C. 168 (1964) and T.C. Memo. 1964–299. Disregard

includes any careless, reckless, or intentional disregard. Sec.

6662(c). Negligence is strongly indicated where a taxpayer

fails to make a reasonable attempt to ascertain the correct-

ness of a deduction which would seem to a reasonable or pru-

dent person to be ‘‘too good to be true’’ under the cir-

cumstances. Neonatology Associates, P.A. v. Commissioner,

299 F.3d 221, 234–235 (3d Cir. 2002), affg. 115 T.C. 43

(2000); Pasternak v. Commissioner, 990 F.2d 893, 903 (6th

Cir. 1993), affg. Donahue v. Commissioner, T.C. Memo. 1991–

21 Respondent did not pursue the substantial valuation misstatement penalty at trial or on

brief, and we accordingly deem it abandoned. See Rule 151(e)(4) and (5); Cluck v. Commissioner,

105 T.C. 324, 325 n.1 (1995); Petzoldt v. Commissioner, 92 T.C. 661, 683 (1989).

22 The penalties under sec. 6662(b)(1) and (2) are in the alternative and do not stack, in that

the penalty does not exceed 20 percent of any portion of an underpayment even if it is attrib-

utable to both paragraphs. Sec. 1.6662–2(c), Income Tax Regs. For completeness, we consider

the applicability of both.

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174 136 UNITED STATES TAX COURT REPORTS (151)

181; McCrary v. Commissioner, 92 T.C. 827, 849–850 (1989);

sec. 1.6662–3(b)(1)(ii), Income Tax Regs. Negligence can also

include any failure to substantiate an item properly. Sec.

1.6662–3(b)(1), Income Tax Regs.

We find that petitioners were negligent because petitioner

failed to make a reasonable attempt to ascertain the correct-

ness of a deduction which would seem to a reasonable or pru-

dent person to be ‘‘too good to be true’’ under the cir-

cumstances. A reasonable or prudent person would have per-

ceived as ‘‘too good to be true’’ a deduction for a supposed

charitable contribution where the amounts deducted could be

used to fund student loans for his own children. The same

is true with respect to the avoidance of capital gains taxes

on the sales of stocks where the proceeds remained under

petitioner’s control for use by his children. To the extent peti-

tioner ascertained the validity of the charitable contribution

deduction or capital gains exclusion from xe´lan’s employees

or its printed materials, there was an obvious conflict of

interest on the part of persons promoting xe´lan’s programs.

See Rybak v. Commissioner, 91 T.C. 524, 565 (1988). Any use

of the Conner & Winters opinion letter for this purpose was

also not reasonable in the circumstances. The Conner & Win-

ters letter referred to the Foundation’s student loan program

as follows:

Xe´lan Foundation Programs

We are aware of several programs which the Directors of the Foundation

may undertake in furtherance of the charitable activities of the Founda-

tion. We have no reason to believe that a donor’s participation in any of

the following programs will cause the foundation to lose its status under

Sections 501(c)(3), 509(a)(1) and 170(b)(1)(a)(iv) of the Code. Although we

have not examined documents with respect to any specific program and do

not hereby render an opinion as to the tax effect with respect to any such

program, we make the following general comments regarding the following

possible activities of the Foundation:

* * * * * * *

3. Educational Loans

The Foundation may support an educational loan program whereby stu-

dents may borrow college and graduate school tuition and related expenses

for education in an area related to the Foundation’s charitable purposes.[23]

23 There is no evidence that the Foundation either sought, or that petitioner or Vinay pro-

vided, any information concerning how Vinay’s education was in an area related to the Founda-

tion’s charitable purposes.

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(151) VIRALAM v. COMMISSIONER 175

Each student must agree to a loan agreement under which he or she

agrees to repay the loan, with interest, or alternatively provide one year

of service to a charitable organization or charitable activity for each year

of tuition received. Such agreement will be enforced. There can be no pri-

vate inurement with respect to such program.

[Emphasis added.]

Thus, while the letter specifically identified the student loan

program petitioner contemplated using, it expressly refrained

from offering any opinion concerning the tax effects of

participation in the program and confined itself merely to

describing certain features of the program. If anything, the

Conner & Winters letter should have put a professionally

educated person such as petitioner on notice that further

inquiry was warranted concerning the student loan program.

Petitioner also testified that he consulted with his account-

ant regarding the deduction, but there is nothing in the

record concerning the nature of those discussions or, impor-

tantly, establishing that the accountant was given complete

information, including petitioner’s intention to direct the use

of the proceeds from the contribution for student loans for his

children. Without some evidence that petitioner’s discussions

with his accountant covered his anticipated participation in

the student loan program, there is no basis to conclude that

petitioner made a reasonable attempt to ascertain the

correctness of the deduction. See Patin v. Commissioner, 88

T.C. 1086, 1130 (1987), affd. without published opinion 865

F.2d 1264 (5th Cir. 1989), affd. without published opinion

sub nom. Hatheway v. Commissioner, 856 F.2d 186 (4th Cir.

1988), affd. sub nom. Skeen v. Commissioner, 864 F.2d 93

(9th Cir. 1989), affd. sub nom. Gomberg v. Commissioner, 868

F.2d 865 (6th Cir. 1989).

Finally, as our discussion of section 170(f)(8) reflects, peti-

tioner failed to substantiate the charitable contribution as

required, which is an indication of negligence.

We accordingly find that, absent their showing reasonable

cause (considered infra), petitioners were negligent with

respect to the charitable contribution deduction claimed and

the capital gains and other investment income excluded in

1998 with respect to the property transferred to petitioner’s

Foundation account. Respondent has met his burden of

production with respect to a negligence penalty for the entire

underpayment.

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176 136 UNITED STATES TAX COURT REPORTS (151)

A substantial understatement of income tax exists if the

amount of tax required to be shown on the return exceeds

that shown by 10 percent or by $5,000, whichever amount is

greater. Sec. 6662(d)(1)(A). We have sustained respondent’s

determinations disallowing a charitable contribution deduc-

tion of $263,933 and requiring inclusion of capital gains

income and other investment income of $93,324 and $981,

respectively. The resulting deficiency, which equals the

understatement, is $91,948—which exceeds 10 percent of

$764,560, the amount required to be shown on petitioners’

1998 return. Respondent has therefore satisfied his burden of

production regarding the existence of a substantial under-

statement, and petitioners bear the burden of showing any

exculpatory factors.

Under section 6662(d)(2)(B), any understatement for pur-

poses of the penalty for a substantial understatement of

income tax shall be reduced by that portion of the under-

statement which is attributable to ‘‘the tax treatment of any

item by the taxpayer if there is or was substantial authority

for such treatment’’. Authority for this purpose may include

court cases, private letter rulings, and administrative

pronouncements published by the Internal Revenue Service

in the Internal Revenue Bulletin. Sec. 1.6662–4(d)(3)(iii),

Income Tax Regs. The weight of an authority depends on its

relevance and persuasiveness and the type of document pro-

viding the authority. Sec. 1.6662–4(d)(3)(ii), Income Tax

Regs.

Petitioners contend that they had substantial authority for

the understatement at issue, citing the inclusion of the

Foundation in Publication 78, the determination letter issued

by the Internal Revenue Service to the Foundation deter-

mining that it qualified for tax exemption as an organization

described in section 501(c)(3), and Natl. Found., Inc. v.

United States, 13 Cl. Ct. 486 (1987). 24

We disagree. The inclusion of an organization in Publica-

tion 78 ‘‘signifies that it has received a ruling or determina-

tion letter from the Service stating that contributions by

donors * * * are deductible as provided in section 170 of the

Code.’’ Rev. Proc. 82–39, sec. 2.03, 1982–2 C.B. 759, 760

(emphasis added). The Foundation’s inclusion in Publication

24 Petitioners also refer to ‘‘other authorities’’ on brief but never name them.

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(151) VIRALAM v. COMMISSIONER 177

78 may constitute substantial authority that the organization

to which petitioners made a donation in 1998 satisfied sec-

tion 170(c) (a point that respondent does not dispute), but

petitioners would still be required to show that their chari-

table contribution deduction satisfied other requirements of

section 170. The Foundation’s determination letter, on which

petitioners also rely, makes this point explicitly, stating:

‘‘Donors may deduct contributions to you [the Foundation]

only to the extent that their contributions are gifts, with no

consideration received’’ and citing Rev. Rul. 67–246, 1967–2

C.B. 104. Consequently, neither Publication 78 nor the

Foundation’s determination letter provides any authority

that petitioners were entitled to deduct a contribution where

they anticipated, and in fact received, consideration in

exchange. Natl. Found., Inc. v. United States, supra, likewise

does not constitute authority for petitioners’ position. As ear-

lier discussed, the case is readily distinguishable from peti-

tioners’ circumstances in that the court there found that the

donee organization exercised effective control to ensure that

distributions were for charitable purposes. By contrast, peti-

tioner requested and the Foundation complied with substan-

tial distributions for personal purposes. In sum, petitioners

have failed to show that they had substantial authority for

any portion of the understatement.

Finally, to the extent petitioners may be claiming that they

had reasonable cause in view of their reliance on professional

advice, see sec. 6664(c); sec. 1.6664–4(b)(1), Income Tax

Regs., we find that claim meritless. The Conner & Winters

opinion letter expressly disavowed any opinion concerning a

Foundation donor’s participation in the student loan pro-

gram. As for petitioners’ accountant, as noted there is no evi-

dence that the accountant was given necessary and accurate

information concerning petitioner’s transactions with the

Foundation to form a professional judgment. See Neonatology

Associates, P.A. v. Commissioner, 115 T.C. at 99.

For the foregoing reasons, we sustain respondent’s deter-

mination that petitioners are liable for an accuracy-related

penalty under section 6662 for negligence or for substantial

understatement of income tax.

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178 136 UNITED STATES TAX COURT REPORTS (151)

Conclusion

Petitioners are not entitled to a charitable contribution

deduction under section 170 for their transfers of appreciated

stocks to the Foundation in 1998. Petitioners must include in

gross income the capital gain realized when the Foundation

sold the appreciated stocks in 1998 and must include

the investment income generated in 1998 by the property

in petitioner’s Foundation account. Petitioners are liable for

the accuracy-related penalty under section 6662.

We have considered all other arguments made by the par-

ties, and to the extent not discussed, we conclude those argu-

ments are moot, without merit, or irrelevant.

To reflect the foregoing,

Decision will be entered under Rule 155.

f

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