Lawrence F. & Sara L. Peek v. Commissioner

LAWRENCE F. PEEK AND SARA L. PEEK, PETITIONERS

v. COMMISSIONER OF INTERNAL REVENUE,

RESPONDENT

DARRELL G. FLECK AND KIMBERLY J. FLECK,

PETITIONERS v. COMMISSIONER OF

INTERNAL REVENUE,

RESPONDENT

Docket Nos. 5951–11, 6481–11. Filed May 9, 2013.

In 2001 Ps established traditional IRAs. Ps formed FP

Corp. and directed their new IRAs to use rolled-over cash to

purchase 100% of FP Corp.’s newly issued stock. Ps used FP

Corp. to acquire the assets of AFS Corp. Ps personally

guaranteed loans of FP Corp. that arose out of the asset pur-

chase. In 2003 and 2004 Ps undertook to roll over the FP

Corp. stock from their traditional IRAs to Roth IRAs,

including in Ps’ income the value of the stock rolled over in

those years. In 2006 after the FP Corp. stock had significantly

appreciated in value, Ps directed their Roth IRAs to sell all

of the FP stock. Ps’ personal guaranties on the loans of FP

Corp. persisted up to the stock sale in 2006. R contends that

Ps’ personal guaranties of the FP Corp. loan were prohibited

transactions, and, as a result, the gains realized in 2006 and

2007 from the 2006 sales of FP stock should be included in

Ps’ income. Held: Each of Ps’ personal guaranties of the FP

Corp. loan was an indirect extension of credit to the IRAs,

which is a prohibited transaction; and under I.R.C. sec.

408(e), the accounts that held the FP Corp. stock ceased to be

IRAs. Held, further, the gains realized on the sale of the FP

Corp. stock are included in Ps’ income. Held, further, Ps are

liable for the accuracy-related penalty under I.R.C. sec. 6662.

Sheldon Harold Smith, for petitioners.

Shawn P. Nowlan, E. Abigail Raines, and John Q. Walsh,

Jr., for respondent.

216

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(216) PEEK v. COMMISSIONER 217

GUSTAFSON, Judge: Pursuant to section 6212, 1 the

Internal Revenue Service (‘‘IRS’’) issued statutory notices of

deficiency to petitioners Lawrence F. Peek and Sara L. Peek

on December 9, 2010, and to petitioners Darrell G. Fleck and

Kimberly J. Fleck on December 14, 2010, determining the

following deficiencies in income tax and accuracy-related pen-

alties under section 6662(a) for tax years 2006 and 2007:

Penalty

Taxpayers Year Deficiency sec. 6662(a)

Peek 2006 $223,650 $44,730.00

2007 1,399 279.80

Fleck 2006 243,229 48,645.80

2007 4,948 989.60

The issues for decision in these consolidated cases are: (i)

whether Mr. Fleck’s and Mr. Peek’s personal guaranties of a

loan to FP Company were prohibited transactions under sec-

tion 4975(c)(1)(B); 2 and (ii) whether the Flecks and the Peeks

owe accuracy-related penalties under section 6662(a).

FINDINGS OF FACT

These cases were submitted by the parties fully stipulated

under Rule 122 for decision without trial, 3 and the stipu-

lated facts are incorporated herein by this reference.

1 Unless otherwise indicated, all section references are to the Internal

Revenue Code (26 U.S.C.), and all Rule references are to the Tax Court

Rules of Practice and Procedure.

2 Because we hold that the loan guaranties were prohibited transactions,

we need not and do not reach the additional questions of whether prohib-

ited transactions occurred (i) when FP Company made payments of wages

to Mr. Fleck and Mr. Peek (which the IRS contends were prohibited trans-

actions under section 4975(c)(1)(D)), or (ii) when FP Company made pay-

ments of rent to an entity owned by Mrs. Fleck and Mrs. Peek (which the

IRS contends were prohibited transactions under section 4975(c)(1)(E)).

(We also need not consider whether those issues constitute ‘‘new matter’’.

See note 3 below.) Furthermore, because our holding that the loan guaran-

ties were prohibited transactions resolves the income tax issues in favor

of the IRS and against the petitioners, we need not reach the question

whether Mr. Fleck and Mr. Peek would, in the alternative, owe excise tax

for excess contributions to their successor IRAs under section 4973.

3 The burden of proof is generally on the taxpayer, see Rule 142(a)(1),

and the submission of a case as fully stipulated under Rule 122 does not

alter that burden, see Borchers v. Commissioner, 95 T.C. 82, 91 (1990),

Continued

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218 140 UNITED STATES TAX COURT REPORTS (216)

Abbot Fire & Safety, Inc.

In 2001 Mr. Fleck identified Abbott Fire & Safety, Inc.

(‘‘AFS’’), as an attractive business opportunity. AFS special-

ized in providing alarms and fire protection, hood suppres-

sion systems, sprinkler systems, backflow inspections, fire

extinguishers, and emergency lights for businesses. AFS also

engaged in government-mandated compliance testing related

to fire suppression and safety. Mr. Fleck contacted A.J.

Hoyal & Co. (‘‘A.J. Hoyal’’), the brokerage firm through

which AFS was offered for sale. While Mr. Fleck originally

hoped to purchase AFS with a family member as partner,

that relative was unable to join the venture. Instead, Mr.

Peek, an attorney who had provided legal services to Mr.

Fleck in the past, approached Mr. Fleck about joining the

venture. (Mr. and Mrs. Fleck are not related to Mr. and Mrs.

Peek.)

The IACC

A.J. Hoyal introduced Mr. Fleck to Christian Blees, a cer-

tified public accountant (‘‘C.P.A.’’) at a Colorado Springs

accounting firm. Mr. Fleck later introduced Mr. Blees to Mr.

Peek. Neither Mr. Fleck nor Mr. Peek knew Mr. Blees pre-

viously. Mr. Fleck and Mr. Peek engaged Mr. Blees and his

firm to assist in structuring the purchase of AFS’s assets and

to perform due diligence on the transaction.

Mr. Blees presented to Mr. Fleck and Mr. Peek information

on a strategy he identified as the ‘‘IACC’’. On September 6,

2001, Mr. Blees gave to Mr. Fleck and Mr. Peek documents

aff ’d, 943 F.2d 22 (8th Cir. 1991). However, the burden of proof can be

shifted when the Commissioner’s position implicates ‘‘new matter’’ that

was not in the notice of deficiency. Petitioners point out that whereas the

notice of deficiency determined that they had engaged in ‘‘prohibited trans-

actions’’ forbidden in section 4975(c)(1)(C) and (F)—involving ‘‘furnishing of

goods, services’’, etc., and ‘‘receipt of consideration * * * in connection with

a transaction involving the income or assets of a plan’’—the Commissioner

now relies on section 4975(c)(1)(B), which prohibits ‘‘indirect * * * exten-

sion of credit’’. We note that the notices of deficiency make no mention of

the loan guaranties. To the extent that this issue would require different

evidence, it could constitute ‘‘new matter’’. However, we need not resolve

that question, see Dagres v. Commissioner, 136 T.C. 263, 279 (2011), since

the material facts are not actually in dispute, and we can resolve the case

by a mere preponderance of the evidence.

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(216) PEEK v. COMMISSIONER 219

that described the IACC plan. This strategy called for the

participant to establish a self-directed individual retirement

account (‘‘IRA’’), transfer funds into that IRA from an

existing IRA or section 401(k) plan account, set up a new cor-

poration, sell shares in the new corporation to the self-

directed IRA, and use the funds from the sale of shares to

purchase a business interest.

In addition to describing the plan, the IACC documents

included an extensive discussion and an opinion letter from

Mr. Blees about prohibited transactions under section 4975,

which state that such transactions would be detrimental to

the IACC plan’s tax objectives. The documents warned that

‘‘the taxpayer could not engage in transactions with the IRA

that the IRS would determine to be ‘prohibited trans-

actions’ ’’. Also included in the documents was a letter from

the accounting firm, which instructed:

An important distinction to always recognize is that any actions you

take on behalf of the corporation must be taken by you as an agent for

the corporation and not by you personally. Any business done by the cor-

poration must be done in its status as a corporation and realizing that

you are acting as an agent of the corporation only. The corporation

should exercise care to hold itself out at all times to the public as a cor-

poration and not as some other type of entity, or as an extension of you

personally.

* * * * * * *

Failure to properly manage the corporations [sic] affairs, or to conduct

business in any manner other than at arms length could result in

adverse effects to the corporation, your IRA, and to you personally. This

might include, but is not limited to, the assessment of additional income

taxes, penalties and interest from various taxing authorities.

None of the IACC documents indicate that Mr. Fleck or Mr.

Peek informed their accountant that they might guarantee

loans for the new corporation as part of their planned

acquisition of AFS’s assets; and the documents included no

advice to the effect that an extension of credit or personal

guaranty between petitioners and the new corporation would

not be considered prohibited transaction for purposes of sec-

tion 4975.

Mr. Peek completed and submitted an ‘‘IACC Application’’

and, in response, received the ‘‘IACC Plan for FP Company’’,

a document that outlined a plan for the purchase of AFS’s

assets. Mr. Fleck and Mr. Peek subsequently implemented

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220 140 UNITED STATES TAX COURT REPORTS (216)

this plan and compensated Mr. Blees and his firm for struc-

turing the purchase and performing due diligence. Both Mr.

Fleck and Mr. Peek were aware of the compensation.

Implementing IACC with FP Company

Mr. Fleck and Mr. Peek each established at Vista Bank

accounts intended to be self-directed IRAs, over which they

each retained all discretionary authority and control con-

cerning investments. Mr. Fleck rolled over funds on August

17, 2001, into his IRA (the ‘‘Fleck Vista IRA’’), from an

existing account maintained for his benefit at the Allied

Domesq 401(k) Retirement Plan. Mr. Peek rolled over funds

on August 30, 2001, into his IRA (the ‘‘Peek Vista IRA’’),

from an existing account maintained for his benefit at

Charles Schwab. Neither Mr. Fleck nor Mr. Peek contributed

to the other’s IRA.

On August 27, 2001, the articles of incorporation for FP

Company, Inc. (‘‘FP Company’’) were filed with the Colorado

Secretary of State. At formation, Mr. Fleck and Mr. Peek

intended that FP Company would purchase the assets of AFS

and engage in the retail sale of fire suppression systems.

On September 11, 2001, each IRA purchased 5,000 shares

of newly issued stock in FP Company for $309,000 and

thereby acquired a 50% interest in FP Company. The Peek

Vista IRA made its purchase at Mr. Peek’s direction, and the

Fleck Vista IRA made its purchase at Mr. Fleck’s direction.

In so doing, Mr. Peek and Mr. Fleck both intended that FP

Company would purchase the assets of AFS. At the time of

purchase, both Mr. Peek and Mr. Fleck also intended to

serve as corporate officers and directors of FP Company.

In a transaction closed in mid-September 2001 (but with

an agreed effective date of August 28, 2001), FP Company

acquired most of AFS’s assets for a price of $1,100,000, con-

sisting of: (a) $850,000 in cash (derived from (i) a $450,000

bank loan to FP Company from a credit union and (ii)

$400,000 of the proceeds of the sale of FP Company’s stock

to the IRAs); (b) a $50,000 promissory note from FP Com-

pany to A.J. Hoyal (the broker); and (c) a $200,000 promis-

sory note from FP Company to the sellers, secured by per-

sonal guaranties from Mr. Fleck and Mr. Peek.

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(216) PEEK v. COMMISSIONER 221

As part of Mr. Fleck’s and Mr. Peek’s personal guaranties,

a deed of trust on their personal residences was recorded in

El Paso County, Colorado, on September 17, 2001. Mr. Fleck

and Mr. Peek were grantors, and Leslie and Carol Heinrich,

the shareholders of the corporation selling AFS’s assets, were

the grantees of the deed of trust. The guaranties remained

in effect until the sale and merger of FP Company in 2006.

Operation of FP Company d.b.a. Abbott

On September 25, 2001, FP Company filed a Statement of

Change of Registered Officer or Registered Agent with the

Colorado Secretary of State, which named Mr. Peek as the

new registered agent of FP Company. Also on September 25,

FP Company filed two Certificates of Assumed or Trade

Name, indicating that it would hereafter do business as

‘‘Abbott Fire & Safety, Inc.’’ and ‘‘Abbott Fire Extinguisher

Company, Inc.’’

From 2001 until the 2006 sale, Mr. Fleck and Mr. Peek

were the only persons to serve as corporate officers and

directors of FP Company.

Subsequent transactions involving the Fleck and Peek IRAs

In 2002 Mr. Fleck and Mr. Peek’s accountants informed

them that Vista Bank was terminating its services as custo-

dian of the Fleck Vista IRA and the Peek Vista IRA. Con-

sequently, they transferred the Fleck Vista IRA and the Peek

Vista IRA to First Trust Co. of Onaga (to become the ‘‘Fleck

Onaga IRA’’ and the ‘‘Peek Onaga IRA’’). Each man intended

the new account to be self-directed. In each new IRA the sole

asset was the shares of FP Company previously held in the

Vista IRAs.

In 2003 Mr. Fleck converted half of the Fleck Onaga IRA

to a Roth IRA at the same bank (the ‘‘Fleck Roth IRA’’); and

Mr. Peek converted half of the Peek Onaga IRA to a Roth

IRA (the ‘‘Peek Roth IRA’’). In 2004 each transferred the

remaining half of his Onaga IRA into his Roth IRA, so that

thereafter each Roth IRA owned 50% of the stock of FP Com-

pany. Mr. Fleck and Mr. Peek each reported the fair market

values of the converted portions of their accounts as taxable

income for 2003 and 2004.

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222 140 UNITED STATES TAX COURT REPORTS (216)

2006 Sale and merger of FP Company

In 2006 the Roth IRAs sold FP Company to Xpect First Aid

Co. Each Roth IRA received payments on the following dates

and in the following amounts for its 50% interest in FP Com-

pany:

Date Payment

3/14/2006 .............................................................. $1,385,920

4/5/2006 .............................................................. 114,713

9/14/2006 .............................................................. 63,932

11/9/2006 .............................................................. 9,156

4/30/2007 .............................................................. 94,471

Total .................................................................. 1,668,192

Following these payments, neither the Fleck Roth IRA nor

the Peek Roth IRA owned any interest in FP Company, and

neither Mr. Fleck nor Mr. Peek had any involvement with FP

Company or Xpect First Aid Co.

Administrative actions

Both the Flecks and the Peeks timely filed Federal income

tax returns on Forms 1040, ‘‘U.S. Individual Income Tax

Return’’, for the years 2006 and 2007. The IRS examined

those returns, adjusted petitioners’ income to include capital

gain from the sale of FP Company stock, 4 and in the alter-

native imposed excise tax for excess contributions to Mr.

Fleck’s and Mr. Peek’s Roth IRAs during 2006. The IRS

issued statutory notices of deficiency to the Peeks on

December 9, 2010, and to the Flecks on December 14, 2010.

The Peeks timely mailed their petition to this Court on

March 8, 2011; and the Flecks timely mailed their petition

to this Court on March 14, 2011. At the time they filed their

petitions, both the Flecks and the Peeks resided in Colorado.

OPINION

I. IRAs and prohibited transactions

A taxpayer who invests his money in the hope of making

a gain over a period of years—whether to fund his retirement

4 As a result of the increased income, the IRS also made computational

adjustments to exemption amounts, student interest deductions (for the

Flecks only), itemized deductions, and self-employment tax.

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(216) PEEK v. COMMISSIONER 223

or for any other purpose—normally must pay tax on that

gain as he realizes it. Sec. 1001(a), (c). His payment of the

tax from time to time diminishes the size of his investment

and thereby, to some extent, diminishes his future gains.

However, a taxpayer may create an ‘‘individual retirement

account’’, which is exempt from tax under section 408(e)(1)

and in which his investment can therefore increase until his

retirement without being diminished by income tax liability.

As long as the account qualifies as an IRA, the taxpayer-

investor is not liable for income tax on the gains, so that the

undiminished investment account can earn maximum

returns until the time comes for payout, when the taxpayer

will finally owe income tax on those greater gains. Under sec-

tion 408, the benefit of the traditional IRA is thus deferral

of income tax liability on retirement investment gains. 5 Mr.

Fleck and Mr. Peek therefore used IRAs to make their

investments in FP Company, with the intention of deferring

until retirement their income tax liability on the gain they

hoped for (and did experience) from that investment.

However, IRAs are subject to special rules, including the

provision in section 408(e)(2)(A) 6 that an account ceases to

qualify as an IRA if ‘‘the individual for whose benefit any

individual retirement account is established * * * engages in

any transaction prohibited by section 4975’’. The IRS con-

tends that, under that provision, the Fleck Vista IRA, the

Peek Vista IRA, and their successor IRAs ceased to qualify

as IRAs as of the first day of 2001 through 2006 because Mr.

Fleck and Mr. Peek made loan guaranties that were ‘‘prohib-

5 To

the extent Mr. Fleck and Mr. Peek attempted to use Roth IRAs

under section 408A, their desired tax benefit was slightly different. A tax-

payer investing through a Roth IRA does not exclude qualifying contribu-

tions to the Roth IRA from income, but once in the Roth IRA, investments

grow tax free and qualifying distributions from the Roth IRA are not sub-

ject to tax. See sec. 408A. Because the IRAs ceased to qualify before the

attempted Roth conversion, the Roth IRA rules of section 408A have no ap-

plication in these cases.

6 Section 408(e)(2)(A) provides: ‘‘If, during any taxable year of the indi-

vidual for whose benefit any individual retirement account is established,

that individual or his beneficiary engages in any transaction prohibited by

section 4975 with respect to such account, such account ceases to be an

individual retirement account as of the first day of such taxable year.’’

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224 140 UNITED STATES TAX COURT REPORTS (216)

ited transactions’’ under section 4975(c)(1)(B). 7 The IRS

therefore concludes that the IRAs’ assets are, under section

408(e)(2)(B), 8 deemed to have been distributed to Mr. Fleck

and Mr. Peek, who both therefore owe income tax on the gain

on sale in 2006 and 2007. Petitioners dispute the IRS’s

contention that any prohibited transactions occurred, and

instead contend that the IRAs remained qualified as such

and therefore remained exempt from tax under section

408(e)(1).

II. Loan guaranties as prohibited transactions

The IRS argues that Mr. Fleck’s and Mr. Peek’s personal

guaranties of the $200,000 promissory note from FP Com-

pany to the sellers of AFS in 2001 as part of FP Company’s

purchase of AFS’s assets were prohibited transactions. Sec-

tion 4975(c)(1)(B) prohibits ‘‘any direct or indirect * * *

lending of money or other extension of credit between a

[retirement] plan and a disqualified person’’. (Emphasis

added.) Petitioners counter that Mr. Fleck’s and Mr. Peek’s

personal guaranties were not prohibited transactions because

they did not involve ‘‘the plan’’ (i.e., in this case, the IRAs),

whereas the extension of credit prohibited under section

4975(c)(1)(B) is ‘‘between a plan and a disqualified person’’. 9

(Emphasis added.) They acknowledge that a loan guaranty

7 Section4975(c)(1) enumerates categories of prohibited transactions, in-

cluding ‘‘any direct or indirect— * * * (B) lending of money or other exten-

sion of credit between a plan and a disqualified person’’.

8 Section 408(e)(2)(B) provides: ‘‘In any case in which any account ceases

to be an individual retirement account by reason of subparagraph (A) as

of the first day of any taxable year, paragraph (1) of subsection (d) applies

[i.e., ‘‘any amount paid or distributed * * * shall be included in gross in-

come by the payee or distributee’’] as if there were a distribution on such

first day in an amount equal to the fair market value (on such first day)

of all assets in the account (on such first day).’’

9 Section 4975(e)(2)(A) defines ‘‘disqualified person’’ as a ‘‘fiduciary,’’

which is itself defined in section 4975(e)(3) as ‘‘any person who * * * exer-

cises any discretionary authority or discretionary control respecting man-

agement of such plan or exercises any authority or control respecting man-

agement or disposition of its assets’’. See Swanson v. Commissioner, 106

T.C. 76, 88 n.13 (1996). The parties stipulated that Mr. Fleck and Mr.

Peek each retained all authority and control over his Vista IRA and its

successor IRAs, and that each used this discretion to direct their IRAs to

invest in FP Company. Thus, Mr. Fleck and Mr. Peek were ‘‘disqualified

person[s]’’ as to their IRAs for purposes of this section.

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(216) PEEK v. COMMISSIONER 225

can fall within the prohibition, because, though it is not a

direct extension of credit (i.e., a loan), it is an indirect exten-

sion of credit. See Janpol v. Commissioner, 101 T.C. 518, 527

(1993) (‘‘An individual who guarantees repayment of a loan

extended by a third party to a debtor is, although indirectly,

extending credit to the debtor’’). But petitioners argue that

the prohibition applies only to an extension of credit that,

whether direct (like a loan) or indirect (like a loan guaranty),

is ‘‘between a plan and a disqualified person’’. The loan

guaranties at issue were between disqualified persons (Mr.

Fleck and Mr. Peek) and an entity other than the plans—i.e.,

FP Company, an entity owned by the IRAs, rather than the

IRAs themselves.

This reading of the statute, however, would rob it of its

intended breadth. Section 4975(c)(1)(B) prohibits ‘‘any direct

or indirect * * * extension of credit between a plan and a

disqualified person’’. (Emphasis added.) The Supreme Court

has observed that when Congress used the phrase ‘‘any

direct or indirect’’ in section 4975(c)(1), it thereby employed

‘‘broad language’’ and showed an obvious intention to

‘‘prohibit[] something more’’ than would be reached without

it. Commissioner v. Keystone Consol. Indus., Inc., 508 U.S.

152, 159–160 (1993). As the Commissioner points out, if the

statute prohibited only a loan or loan guaranty between a

disqualified person and the IRA itself, then the prohibition

could be easily and abusively avoided simply by having the

IRA create a shell subsidiary to whom the disqualified per-

son could then make a loan. That, however, is an obvious

evasion that Congress intended to prevent by using the word

‘‘indirect’’. The language of section 4975(c)(1)(B), when given

its obvious and intended meaning, prohibited Mr. Fleck and

Mr. Peek from making loans or loan guaranties either

directly to their IRAs or indirectly to their IRAs by way of

the entity owned by the IRAs.

III. Tax consequences of the guaranties on the sale of stock

The IRS’s two notices of deficiency issued to petitioners for

2006 and 2007 are similar, and the one issued to the Flecks

asserted:

The prohibited transaction triggered a liquidation of the IRAs in the [sic]

2001. Following that liquidation, the stock of FP Company Inc. is treated

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226 140 UNITED STATES TAX COURT REPORTS (216)

as owned by the [sic] Fleck and another individual [i.e., Mr. Peek]

personally. Consequently, Fleck and the other individual are taxed

personally on any gain on the sale of such stock.

Petitioners seem to argue that the IRS’s notices of deficiency

issued for 2006 and 2007 are somehow too late (because the

loan guaranties were made in 2001), and that in the absence

of an earlier notice of deficiency the IRAs remained exempt.

Petitioners suggest that if the IRAs did not lose their exemp-

tion until 2006, then petitioners would have realized ordi-

nary income in that year, rather than the capital gain deter-

mined in the notices; and they argue that since the notices

did not make that particular adjustment, the notices are

somehow inadequate to support an assessment of tax based

on capital gains. This argument either misconstrues the tax

consequences to an individual who engages in prohibited

transactions with respect to an IRA or perhaps exaggerates

the importance of the wording of the notices. The notices

determined deficiencies for 2006 and 2007 on the basis of a

prohibited transaction that took place in 2001. We now

redetermine those 2006 and 2007 deficiencies and decide (1)

whether the accounts that held the FP Company stock were

IRAs in 2006 when the stock was sold (we hold they were

not), (2) when they ceased to be IRAs and therefore exempt

from income tax (we hold in 2001), and (3) the tax con-

sequences of their non-exemption (we hold Mr. Fleck and Mr.

Peek are liable for tax on the capital gains realized in 2006

and 2007 from the sale of the FP Company stock).

The loan guaranties were not a once-and-done transaction

with effects only in 2001 but instead remained in place and

constituted a continuing prohibited transaction, thus pre-

venting Mr. Fleck’s and Mr. Peck’s accounts that held the FP

Company stock from being IRAs in subsequent years. 10 On

January 1, 2006, it remained true that Mr. Fleck and Mr.

Peek guaranteed the loan to FP Company; if FP Company

defaulted, they would pay. By its nature, the loan guaranty

that each man made put him and his account in an indirect

10 Sincethe guaranties (i.e., the prohibited transactions) continued

through the time of the sale of FP Company stock in 2006, we do not ad-

dress what, if any, requirements there are to subsequently reform or resus-

citate an IRA that, pursuant to the provisions in section 408(e)(1), has

‘‘ceased to be an individual retirement account’’.

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(216) PEEK v. COMMISSIONER 227

lending relationship that would persist until the loan was

paid off.

Consequently, under section 408(e)(2)(A), each original

account holding the FP Company stock ceased to qualify as

an IRA in 2001. In 2003 and 2004 when Mr. Fleck and Mr.

Peek established Roth IRAs, those accounts ceased to be

Roth IRAs when they funded the accounts with FP Company

stock, because the prohibited transactions continued as to

those accounts. See sec. 408A(a) (‘‘Except as provided in this

section, a Roth IRA shall be treated for purposes of this title

in the same manner as an individual retirement plan’’). For

the same reasons, the accounts holding the FP Company

stock when the stock was sold in 2006 were not Roth IRAs,

and the gains from the sale realized in 2006 and 2007 were

not exempt from tax. The tax liability from the gain is prop-

erly attributable to Mr. Fleck and Mr. Peek as the creators

and beneficiaries of the accounts that sold the FP Company

stock. See secs. 671, 408(a), (e)(2)(A)(i). Petitioners have not

challenged the IRS’s calculation of gain on the sale or

asserted that they were entitled to a higher basis in the

stock than what the IRS allowed. They were therefore liable

for tax on the gains realized in the sale transaction as deter-

mined in the notices of deficiency. 11

IV. Accuracy-related penalties

A. Substantial understatements

The IRS determined that the Flecks and the Peeks are

liable for a 20% accuracy-related penalty because their

underpayments were ‘‘substantial understatement[s] of

income tax’’ under section 6662(b)(2). By definition, an

understatement of income tax is substantial if it exceeds the

greater of $5,000 or 10% of the tax required to be shown on

11 In the alternative, the IRS agues that Mr. Fleck and Mr. Peek owe

excise tax on the excess contributions to their successor IRAs under section

4973(a). While section 4973(a) imposes an excise tax equal to 6% of the ex-

cess contribution made to a traditional/Roth IRA, this tax is imposed only

for each subsequent year in which the excess contribution remains in the

IRA. Under our holding here that when the IRAs engaged in prohibited

transactions, they ceased to be IRAs and the value of the IRAs’ assets con-

stituted deemed distributions to Mr. Peek and Mr. Fleck personally, any

excessive contribution to a new IRA was self-corrected and no excise tax

would be due. We therefore do not address further this alternative theory.

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228 140 UNITED STATES TAX COURT REPORTS (216)

the return. Sec. 6662(d)(1)(A). Pursuant to section 7491(c),

the Commissioner bears the burden of producing sufficient

evidence showing that the imposition of the penalty is appro-

priate in a given case. Higbee v. Commissioner, 116 T.C. 438,

446 (2001). He has met this burden of showing substantial

understatements of income tax for 2006, since the adjust-

ments for 2006 in the notices of deficiency result in defi-

ciencies that exceed the requisite amounts. The same cannot

be said for the 2007 deficiencies; consequently, the Commis-

sioner also maintains that both the 2006 and 2007 underpay-

ments in these cases were attributable to ‘‘negligence or dis-

regard of rules or regulations’’. Sec. 6662(b)(1).

B. Negligence or disregard

For purposes of section 6662, ‘‘the term ‘negligence’

includes any failure to make a reasonable attempt to comply

with the provisions of this title [i.e., 26 U.S.C.]’’. Sec. 6662(c).

Negligence is defined as a lack of due care or failure to do

what a reasonable and ordinarily prudent person would do

under the circumstances. Neely v. Commissioner, 85 T.C. 934

(1985). The term ‘‘disregard’’ includes any careless, reckless,

or intentional disregard of the rules or regulations. Sec.

6662(c).

The underpayments in these cases result from petitioners’

failures to report capital gain income that they realized from

the 2006 sale of FP Company stock; instead petitioners con-

tended that IRAs held the FP Company stock when the stock

was sold and, therefore, the realized gains were not taxable.

However, Mr. Fleck and Mr. Peek were well aware that

prohibited transactions listed in section 4975 could be fatal

to their IRA arrangements, because both the IACC informa-

tion they received and an opinion letter from their account-

ant discussed section 4975 in detail. The IACC information

expressly stated: ‘‘the taxpayer could not engage in trans-

actions with the IRA that the IRS would determine to be

‘prohibited transactions’ ’’.

Section 4975(c)(1)(B) clearly provides that any ‘‘indirect

* * * lending of money or other extension of credit between

a plan and a disqualified person’’ is a prohibited transaction.

As we have held, Mr. Fleck’s and Mr. Peek’s personal

guaranties to FP Company were ‘‘indirect * * * extension[s]

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(216) PEEK v. COMMISSIONER 229

of credit’’ to their IRAs and were prohibited transactions, see

Janpol v. Commissioner, 101 T.C. at 527, and no one advised

them otherwise. Given Mr. Fleck’s and Mr. Peek’s knowledge

about the hazards of prohibited transactions and their per-

sonal involvement with the FP Company transactions (in

particular, their personal guaranties), we conclude that peti-

tioners were negligent when they failed to report income

from the sales of FP Company stock after Mr. Fleck and Mr.

Peek had engaged in a prohibited transaction.

C. Reasonable cause and good faith

Once the Commissioner meets this burden, the taxpayer

must come forward with persuasive evidence that the

Commissioner’s determination is incorrect. Rule 142(a);

Higbee v. Commissioner, 116 T.C. at 447. Petitioners argue

that, even if they owe tax on the gain from the sale of FP

Company, they acted with reasonable cause and in good faith

when they failed to report the capital gains at issue, because

they relied on advice provided by Mr. Blees, the C.P.A. See

sec. 6664(c) (accuracy-related penalty is not due with respect

to any portion of an underpayment if it is shown that there

was reasonable cause and taxpayer acted in good faith with

respect to that portion). However, as Mr. Fleck and Mr. Peek

knew, Mr. Blees was himself not a disinterested professional

but rather an active promoter of the IACC. A ‘‘promoter’’ is

‘‘ ‘an adviser who participated in structuring the transaction

or is otherwise related to, has an interest in, or profits from

the transaction.’ ’’ 106 Ltd. v. Commissioner, 136 T.C. 67, 79

(2011) (quoting Tigers Eye Trading, LLC v. Commissioner,

T.C. Memo. 2009–121), aff ’d, 684 F.3d 84 (D.C. Cir. 2012).

What they received from Mr. Blees was not advice so much

as a sales pitch.

Because of Mr. Blees’s role as promoter, Mr. Fleck and Mr.

Peek could not reasonably and in good faith rely on that

advice. See 106 Ltd. v. Commissioner, 136 T.C. at 79 (‘‘pro-

moters take the good-faith out of good-faith reliance’’). As the

parties have stipulated, Mr. Blees sold to Mr. Fleck and Mr.

Peek the IACC plan, which was later used to structure the

purchase of AFS’s assets. Mr. Blees was thus a promoter,

and Mr. Fleck and Mr. Peek could not reasonably and in

good faith rely on his advice to adopt the IACC.

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230 140 UNITED STATES TAX COURT REPORTS (216)

Moreover, there is no indication that Mr. Fleck and Mr.

Peek informed their accountant of their intention to person-

ally guarantee FP Company loans, or that Mr. Blees gave

them any advice that their personal guaranties would not be

a prohibited transaction under section 4975. Rather, they

were warned not to engage in any transactions that ‘‘the IRS

would determine to be a ‘prohibited transaction’ ’’.

Since Mr. Blees’s advice did not address the issue of per-

sonal guaranties, we conclude that petitioners did not rely on

their accountant’s advice with regard to the prohibited trans-

actions in these cases, and did not have reasonable cause or

act in good faith in failing to report the capital gains in these

cases.

We therefore sustain the imposition of the accuracy-related

penalty under section 6662(a) for both years in issue in both

cases.

To reflect the foregoing,

Decisions will be entered under Rule 155.

f

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