UNITED STATES TAX COURT

136 T.C

No. 28

UNITED STATES TAX COURT

SANG J. PARK & WON KYUNG O, Petitioners y_.

COMMISSlONER OF INTERNAL REVENUE, Respondent

SANG J. PARK, Èetitioner y.

COMMIS$IONER OF INTERNAL REVENUE, Respondent

Diocket Nos.

14159-09,

30063-09.

Filed June 13,

2011.

P, a South Korean national and nonresident alien,

hèd'U.S. gamblincj winnings aihd interest indome that was

not effectively connected with a U.S. trade or

business.

Held: " " The' Treaty of Friendship Commerce and

Navigation, U.S.-S. Kor., art. XI, par. 5(b), Nov. 28,

1 56, 8 U.S.T. 2217, providen exceptions to the most

favored-nation treatment under art. XI, par. 3 and thus

does not'extend to South Korean nationåls the more

favorable treatment regarding exemption from U.S.

income tax df gambling winnings as provided for in some

bilateral income tax treaties that the United States

has entereel into with other boreïgn countries.

3EVED JUN 1 3 20H

- 2 Held, further, P's gambling activities were not

personal services or a U.S. trade or business; thus the

gambling income is not considered income that is

effectively connected with a U.S. trade or business and

is taxable under I.R.C. sec. 871(a) .

Held, further, the interest income reported by a

third party U.S. national bank is excluded from Federal

income tax under I.R.C. sec. 871(i) (1) and (2) as

income from bank deposits . Ps have not shown that the

remaining interest income is from deposits that qualify

f or U. S. tax exemption under I . R.. C . sec . 871 (i) .

Held, further, Ps are liable for the accuracyrelated penalties under I.R.C. sec. 6662(a) and (b) (1)

or (2).

Denis M. McDevitt, for petitioners.

Erin K. Salel, for respondent.

OPINION

COHEN, Judge:

In these consolidated cases, respondent

determined a deficiency of $134,350 in income tax and an

accuracy-related penalty of $20,774 with respect to the jointly

filed 2006 Federal income tax return of Sang J. Park (petitioner)

and Won Kyung O (petitioner -wife) and a deficiency of $23,821 in

incóme tax and an accuracy-related penalty of $4, 438 with respect

to petitioner' s 2007 income tax return.

Unless otherwise

indicated, all section references are to the Internal Revenue

Code in effect for the years in issue, and all Rule references

are to the Tax Court Rules of Practice and Procedure .

The issues for decision are

(1) Whether petitioner' s 2006

and 2007 gambling winnings are súbject ;to tax under section

871(a);

-

(2) whether petitioner'sygambling income is effectively

connected with a U.S. trade or business;

(3) whether the interest

income earned irr 2006 sand-2007 is subject9toe tax; and (4) whether

the section 6662 (a) accuracy-relŠted penalties in posed should be

sustalined:

Background

These cases were submitted" fully stipulatedi under Rule'122.

The stipulated facts are incorporated as our findings by this

reference.

Petitioners ares married and are citi-zens and

residënts of the Republic of. Sout h Korea (South Korea) and had

South: Korean pas sport s - during the - years at is sue .

Pe t it ioners

were nonresident aliens in 2006 -and 2007~,ai.e., they were not

citizens ,of the United States, ~.and neither had a permanent

resident card (g ceen card) . - PetÉtioner has a Social Security

number thats he obtained while m att ending. college - in the United

States; in the mid-1970s

a

Petitioner works as a full-time/high-ranking-business

executive for a Large chemical 'cdmpanye in South Korea.

Petitioner's emp Loyer pays for petitioners'' son to' attend school

in. the United States and for petitioners -to- travel to the United

Statessto visit their son..--Petitioner wife also has'other-family

living in- the United Statest

4 m

- 4 During the years in issue, petitioners traveled to' the

United States for_vacation and to visit family a number of times.

Petitioner enjoys gambling, and during these trips he frequented

the,Pechanga Resort & Casino .(Pechanga) in Temecula, California,

to play the slot machines . . Petitioner gambled at Pechanga on. 20

of- the approximately 68 days- that he was in the United States in

2006 and on 11 of the approximately 46 days that he was in the

United States in 2007.

With respect to the gambling activity,

petitioner did not have a business plan.and did not keep books

and records .

Petitioner did not use for gambling money that was

needed to support his family.

Petitioner wife had no involvement

in any gambling or gaming activities .

In 2006, petitioner won 138 slot machine jackpots of $1, 200

or more, with total gambling winnings of $431,658.

Pechanga

withheld 30 percent of the winnings for payment of Federal income

tax-on three of those jackpots (two jackpots of $50,000 and one

of $1,600), for a total of $30,480. withheld for taxes.

A report

prepared by Pechanga showed that petitioner had losses that

exceeded his 2006 winnings by $4,663.

On February - 18 , 20 07,, - petitioner provided his - Social

Security- number to Pechanga and signed a Form W-9, Request for

Taxpayer Identification Number and /Certification, certifying that

he was not subject to backup withholding and that he was a U.S.

person (including a U.S. resident alien).

In 2007, petitioner

won 43 slot machinet jackpots of $1, 200 or more

gambling winnings of- $103, 874 .

w th total 2 U

Pechanga withheld 30 percenty of

the winnings for payment òf Fede al incómë tax on th ee ijackpots

( jackýots of $$2, 620 ,0 $1,' 4'40 ; and $1¯, 380 ) ,

f or a total of $1, 632 .

A reporti prepared by Pechanga shÓwed that petitiòñer- had*losses

that exceeded his 20 07 winnings Úy' $45, 130 . So

Petitioner received÷ from soùrces within thelUnited States

other income that was noteéffectively coñnected with a U.Setiade

or butsiness in 2006:

(1)

Intereàt income of $6, 585;

gain- incomes of $52, 792; and (3)

ividend

(2) eajpital

ncome ofa $7, 471

(taxable at a rate" of 15 percent under the -Convëntions foï- tihet

Avoidance of Double Taxation and thël Prevention of Fiscal NEve.sion

with Rësp'ect To I'axes on Income and the Encouragement of" International*Trade and Investmelit, U.S.-S. Koi ,marts 12,Mar.

(2) (a), June 4,

treaty) ) .

1.976

30 U.SiT. $253

Petitioner wife 'had n

(U.S;-Korea income tax

U. S

soürce iricame

Petitioners filèd a Form 10 0, U.S. ]!ndividual income ½ax

Return, for 2006 as -married "filii g

ointly, pr'ëpared by a

bookkeeping+service.4 Petitioner

did ñòt trepoÝt any gambling

winnings or añy'associated expenses.

petitioner's òther *U.S. source iricotúe

They did-report

The payersofathé iñÙerest

ancome-was «listed as Bankiof'Amerida

In 20.07; -pe tidionét also received from sources within the

United States income that was not effecti elyTonnectedawithda

- 6 U.S., trade or business:

(1) Interest income of $11,830 and (2)

dividend income of $3,046 (taxable at a rate of 15 percent under

the U.S.-Korea income tax treaty, art. 12, par.

(2) (a)).

Petitioner filed a Forme1040 for 2007 and reported the

interest and dividend income from sources within the United

States, but he did not report the gambling income or any

associated expenses. .The payer of $11,662 of interest-income was

listed 'as "FEDL HOME LOAN BK CONS DISC".

-Petitioner's, 2007.

return.was prepared by a certified public accountant.

Pechanga reported petitioner's jackpot winnings of $1,200 or

more to the Internal Revenue Service (IRS) on completed Forms:W2G, 4Certain Gambling Winnings,

for 2006 and 2007.

The IRS

-

examined the 2006 and 2007 tax returns and determined that

petitioner received unreported gambling income of $431,658 in

2006 and $103,874 in 2007.,

The IRS did not receive reporting

from third parties with respect to the interest income of $6,585

and $11,662, as:reported on the 2006 and 2007 tax returns

respectively.

However, the IRS made -adjustments to the interest

income as reported on the 2007 return to reflect information

reported from third parties:

Wells Eargo Bank, N.A.

(1) $4 less $1 withholding from

(a U.S. national bank chartered and

regulated by the Office of the Comptroller of the Currency) and

(2) $165 from,First Clearing, L.L.C.

The IRS sent a notice of

deficiency to petitioners on March 23, 2009, for determined

1

- 7 -

deficiencies and an accuracy-relÄted penalty with respecê to

20062

On November 9, 2009

the IRSesent a notice of .deficiency

to petitioner -for determined deficiencies land an accuracy-reláted

penalty 'with respect to 2007.

The parties sagree that petit ioners are nonresident aliens

and that for both 2006 and 2007"Förmé 1040 were erroneously filed

instead of Forms 1040NR, U.S. Nonresident

lien Income Tax

Return.

Discu sion

a

Gambling wi anings, includincj slot machine Winriings

gross income.

See sec. 61; United States v. Monteiro,

204, 206

(1st Cic.

107 -108

(1955) .

are

871 F.2d

1989); Johnstón vi. Commissioner; -25 T.C. 106,

In general,

"int erest * s * * -, dividends

rents ,

salariese, wages; premiums, annuit ies, comyensations

remunerations, emoluments, and ot her fixed or determinable annual

or-periodical gaEns, profits, tand?income" that, are received 'by a

nonresident alie:1 from sources w thin the United'States and that

are not -effectively connected with a U.S. trade or business are

subject to a 30-percent tax.

Sec. 871(a) (1) .

Gambling winnings

paid to a nonres Ldent alien fall within this provision, with limitéd exceptions .

T.C. 404, 6406-407

675-678 (1983) .

See sec

87 ( ) ; Abeïd v. Commissioner, 122

(2004); Barba 6 United States,

2 Cl. Ct. -674,

The' parties agreé that petitioner's U.S.

gambling winnings are considered (U.S. source income.

- 8 -

Generally, a recreational or casual gambler's gross income

from a wagering transaction should be calculated by subtracting

the bets placedyto produce the winnings, not as a deduction in

calculating adjusted gross income or taxable income but as.a

preliminary computation in determining gross income.

See Lutz v.

Commissioner, T.C. Memo. 2002-89. - A recreational gambler who

plays the slot machines recognizes a wagering gain or loss at the

time tokens are redeemed and the taxpayer can definitely

calculate the amount above or below basis (the wager) realized.

See Shollenberger v. Commissioner, T.C. Memo. 2009-306.

Section 6001 and the regulations thereunder require

taxpayers to keep permanent records sufficient to substantiate

the amounts of income, deductions, and credits shown on'their tax

returns.

Sec. 1.6001-l(a)

Income Tax Regs.

Petitioner did not

keep books and records with respect to hist gambling activities.

Petitioner's slot machine jackpot,winnings of $1,200 or more for

the years in issue are included in the record, but petitioners

have not supplied evidence ,with respect to the wagering money

used to generate the winnings on a per-session basis or

otherwise.

A nonresident generallyscannot deduct or offset gambling

losses against gambling winnings.

See sec. 873; Barba v. United

States, supra; cf. sec. 165(d),; Shollenberger v. Commissioner

supra (gambling losses other than in the trade or business sof

- 9 -

gambling are allowable, if at all, as iten ized deductions in

calculating taxable income) ; Mac]

1969-26,

affd. 429 F.2d 182

v. Commissioner, T.C. Memo.

(6th Cii~. 1970) ,(gambling losses

incurred other than "in the. trade or business of gainbling- are

allowable for Ú.S. citizens or aliens residing in the United

States, to the ex ent of the gambling winnings) . eThus, a

nonresident alien who is not engaged .in gambling as a business

within the United States ,is subject to tax, under, section

-

871(a) (1) on gross income; from gambling without a deduction, for

gambling losses.

Mhen gambling winnings of $1,200 or nore from a bingo game

or slot machine play are paid, tl e payer is required to- inform

the IRS of the payments .

.See sec a

6041 (a) ; sec .T 7 . 6041-1 (a) ,

Temporary Income Tax Regs.., 42 Fed. Reg. 33286 (June 30,7 19T/) ;

see also Lyszkowski v. Commissiorier, T.C. Memo. 1995-235s

(describing the information repo ting requirements for slot a

machine ¿jaåkpotse , affd.; without published opinion 79 F.3d 1138

(3d Cir. 31996) .

In determining the amount won ifrom such games,,

for a bingo game or slot machine play, the amount wagered is not

deducted.

Regs .

See sec. 7.6041-1(b) ( ) and (2)

Temporary Income Tax

stipra .

For nonresident aliens, sectione1441(a) generally requires

the payer of gambling s winnings tNwithhold from such *items a tax

equal to 30 percent and to submit the amounts withheld to the

- 10 -

IRS.

The withholding entity also must file a Form 1042 S,

Foreign Person's U.S. Source Income Subject to Withholding, with

the IRS to report these gambling winnings and provide a copy of

the form to the recipient for whom the form is prepared.

See

sec . 1.1461-1 (b) and (c) , Income Tax Regs .

The tax and withholding requirements apply to U.S. source

gambling winnings of nonresident alien individuals unless the

proceeds are exempt under provisions not relevant here or a

treaty provision applies.

See sec. 894 (a) .

When interpreting a treaty, we begin with the, text of the

treaty and -the' context in which the written words are -used.

Airlines,

Am.,

Inc. v. Floyd, 499 U.S. -530;,

Inc. v. Avaqliano, 457 U.S.

1'76,

534

E.

(1991); Sumitomo Shoii

179-180

(1982) . . The plain

words of the treaty control unless their effect is contrary to

the intent of .the s ignatories .

Sumitomo Shoi i Am. , Inc . v .

Avagliano, supra at 180; Amaral v. Commissioner, 90 T.C. 802; 812

(1988) .

The words of a treaty are to be interpreted according to

their ordinary meaning as understood in the public law of

nations.

Amaral v. Commissioner, supra at 812.

Where the

Internal Revenue Code provides for the taxation of income,

"Whatever basis there may be * * * for relieving the * * * tax

must be found in the words or implications of the * * *

[treaty] ."

Maximov v. United States,

373 U.S. .49,

51

(1963) ; cf .

- 11 DiPortanova V. United States

231 Ct. Cl. 623,

690 F.2d 169,

177

(1982) .

The U.S. -Korea income t x treaty entered into force ön

Octobers 20, 1979

Article 4

paragraph (1) of this trëaty

provides:

a

? -

A resident of one of the Contracting States may; be

taxed by the other Contracting State on any income from

sources, wit ins that other Contracting State and only' on

Áuch income subject to any limitations set forth in

this Conven ion. - For this purpose,a the rules set forth

in Article 6 (Source of Incobe) shall be applied to

determine t e source of incone.

Article 6

paragraph (9) of the U..S. -Korea income :tax treaty

provides that ïncome not otherwis

addressed

as is -the aase with

gambling income, shalli be determined by ea h of ther Coritracting

States in accorda.nce with i-ts :own law'.

The U S. Korea income tax

treaty does not establish an exemytion from tax for South Korean

residents with respect to U.S. gagbling income, and there istno

provision permitt ing South Koreant residents to deduct 'gambling'

losses or to otherwise hete gainbling losses against gambling

winnings .

Ac cordingly, pe t it ioner ' s gambling winnings are

e

taxable under section 87/1 (a) (1) , and no deductions are permitted

for gambling losses.

.Petitioners do not argue that petitio er'-s gambling income

is not taxable under the U S. -Korea 'income tax t reaty, but they

contend that the Treaty of Friendship, Commerce and Navicgation,

- 12 U.S.-S. Kor.,

art. XI, Nov.

28,

1956,

8 U.-S.T.

221'7

(FCN. treaty),

entitles them to exemption from U.S. tax on the gambling incotne.

The FCN treaty is one of a se-ries of Friendship, Commerce

and Navigation Treaties that the United States signed with

various countries after World War II.

The treaties were

initially negotiated for the purpose of encouraging American

investment abroad but also, secured reciprocal rights that, granted

protection to foreign businesses and individuals operating in the

United States.

1138

See MacNamara v. Korean Air Lines, 863: F.2d 1135,

(3d Cir. 1988)

(citing Walker,

"Treaties for the

Encouragement and Protection of Foreign Investment: Present

United States Practice", 5 'Am. J. Comp. L.- 229 (1956) ) ; «Spiess v.

C.

Itoh & Co.

(America),

Inc., .643 F.2d 353,

359

(5th Cir.

1981) .

South Korea and the United States signed the FCN treaty with the

goals of "strengthening the bonds of peace and friendship

traditionally existing ,between" each other and of ."encouraging

closerr economic- and cultural relations between their peoples . "

FCN treaty, Proclamation.

- ,

Article XI, paragraph 3 of the FCN treaty provides:

Nationals and companies of either Party shall in

no case be subject, within the territories of the other

Party, to the payment of taxes, fees or other charges

imposed upon or applied to income, capital,

transactions, activities or any other object,, or to

requirements with respect to the levy and collection

thereof, 'more burdensome than those borne by nationals;

residents and companies of any third country.

13 -

This provision extends "most-favored-nation" status to nationals

and companies of South Korea and the United. States.

A most-

favored-nation statust assures natïonals of the other signatory

treatment equivalent to the mostdfavorable treatment afforded any

other foreign nationals.

See MacNamara v. Korean Air Lines,

supra at 1142-1143 .

Within the same article, paragraph 5 (b) applies reservations

to this most-favored-nation provision:

Eaáh Party reserves the right to: - (a) extend e

specific tax advantages on the basis of reciprocity;

(b) accord Åpecial -tax advantages by virtue of

âgreements for the avoidance of double taxation or the

mutual prot ction of revenue;' and (c); apply special

provisions in allowing, to non-residents, exemptions of

a -personal nature in connection with income and

inheritance taxes.

Petitioners maintain that because residents of certain third

countries would not be subject t-o tax on gambling winnings from

within the Unite

States under bilateral income tax treaties that

those countries

ave entered with the Unit d States, the most-

favored-nation provision of FCN treaty article XI, paragraph 3,

entitles them to Federal income tax exemption.

Petitioners refer

to IRS Publication 515, Withholding of Tax on Nonresident Aliens

and Foreign Entities, and the section addressing "Other Income",

which states:

Gambling income of resiidents (as defined by

treaty) of he following fo eign countries is not

tjaxable by he United States: Austria, Czech Republic,

Óenmark, Fi land, France, Germany, Hungary, Ireland,

Italy, Japan, Latvia, Lithuania, Luxembourg,

, 14 -

Netherlands Russian Federation, Slovak Republic

Slovenia, South Africa, Spain, Sweden, Tunisia, Turkey,

Ukraine, and the United Kingdom.

- Respondent asserts that the reservations of FCN treaty

article XI, paragraph 5 (b) apply to preclude application of the

mostzfavored-nation provision of FCN treaty article XI, paragraph

3, and that petitioner's U.S. gambling income is subjecteto U.S

inc ome- t ax .

Certain foreign countries, including Japan, have entered

into income tax streaties with the United States that have treaty

benefits excluding U.S., gambling income from the Federal taxable

income of their residents.

See Convention for the Avoidance of

Double Taxation and the Prevention of Fiscal Evasion With Respect

to Taxes on Income, U.S. -Japan, Nov. 6; 2003, Tax Treaties (CCH)

par. 5201 (U.S. -Japan income tax treaty) .

The Senate report from

the Committee on Foreign Relations stated that the principal

purposes of the U.S.-Japan income tax treaty are to reduce or

eliminate double taxation of income earned by residents of either

country from sources within the other country, to prevent

avoidance or evasion of the taxes of the two countries, . to

promote close economic cooperation between the two countries, and

to eliminate possible barriers to trade and investmént caused by

overlapping taxing jurisdictions of the two countries .

See

Senate Comm. on Foreign Relations, S. Exec. Rept. 108-9,.at 1-2

(2004) .

Article 21, paragraph 1 of the U.S.-Japan income tax treaty

provides:

Jttems of income beneficially owned by a-resident of sa

Contracting State, wherever arising, not dealt with in

the foregoing Articles of this Convention * * * shall

be taxable :.n that Contracting State.

The U S. Department of the Treasury Technical Explanation of the

2003 U.S. -Japan Encome Tax Treaty (Feb. 25, 2004) , Tax Treaties

(CCH) par. 5233, states that

Examples of items of income covered by Article 21

include income from gambling, punitive -(but not

compensatory) damages, covenants not to compete, and

income from certain financial instruments to the extent

derived by persons not engaged in the trade or business

, of dealing an such instrume ts * * *.

FCN treaty article-XI, paragraph -5(b),- expressly reserved

the-right to extend specific.tax advantages on the basis of reciprocity and accord special, tax advantages .by virtue of

agreements for the avoidance of double :taxation or the mutual

protec t ion - of revenue .

This reservat ion encompasses -the more

favorable treatment-with,respect to:Federail income tax of U.S.

gambling wa.nnings, as: extendedato Japan and sother relevant .

countzies through the bilateral income tax treaties.

favored-nation provision. under article XI

The most-

paragraph 3 of the FCN

treaty is thus not available when the reservàtions of paragraph

5 (b) apply .

e

a

e conclude that the-plain language of the FCN treaty .doe.s

not extend to petitioners the more favorablé treatment-Federal

- 16 -

income tax exemption--with respect to gambling winnings as

a

provided for in the relevant bilateral income tax treaties

between the United States and other countries.

Trade or Business Within the United States

Petitioners argue that if a treaty provision does not exempt

the gambling winnings from income tax, then the income is from

personal services of petitioner and taxable as income effectively

connected with a U.S. trade or business.

Income of a nonresident alien individual that is effectively

connected with the conduct of a trade or business in the United

States is generally subject to tax in the same .manner and at the

same rates as that of a U.S. person.

See sec. 871(b) .

The

phrase "trade or business within -the United States" generally

includes the performance 'of personal services within the United

States at any time within the taxable year .

Sec . 864 (b) .

Deductions are allowed to the extent that they are related to

effectively connected income.

See sec. 873(a) ."

Section 165(d)

provides that gambling losses, may be deducted against gambling

winnings .

Petitioners rely on Robida v. Commissioner, T.C. Memo. 2197086,

affd. 460 F.2d 1172

(9th Cir.

1972) ,

to support their

position that petitioner' s gambling winnings income is income

from personal services:

Robida addressed "earned income" under

section 911 (regarding foreign earned income and taxation of,U.S.

- 17 -

citizens or residents)·.y Petitionersacontánd that, the te m

"earned income" in section 911(b (1) (A) l'incorporates the same

language as in * * *. section 864 b) :and the regulations as income

attributable- to

servÈcesaperfor ed' and; is certainly consistent

with the definitions of income from personal services used in

* * * section: 864 (b)». "

"The,-issue in Robida was whether the taxpayer',Ta citizéni of

the United. States, ."earned" inconie abroad Nith réspect to hist

slotsmachine winnings far þurposàs of thelforeign earnedsincoine

exclusionsfor U.S. citizens under sectiong910.-

Itewas determined

that the taxpayer' s - "diligent application t of an unusuah skill or

knowledge gained during his previous employment with a

manuf acturer -of slot amachines"? résulted Eine "earned' income" , Sas

compared to assuning - risk and" winning - the income in a game of

chance.

Robida v: Commissioner, 460 F.2d at 11701-175

-I ~

Petitioner exhibited no sucl use of personal skillsfore

strategiesswhen de played thess1 temachines.

Thus, petitione s'

reliance on Robida to claim that the gamb]:ing winnings^weree"

derived, from the performance of

ersonal services is misplaced.

Petitioner' s gambling winnings ir come is riot income from3personal

services.

*

Petitioners did not initial]y argue t hat petitioner' s

gambling activit

a

constituted a trade or liusiness; but tespondent

addressed this issue in his open ng brief

In their reßly Brief

18 -

petitioners argued that petitioner's gambling.activities were a

trade or business because petitioner had a profit motive in playing slot machines and petitioner was willing to commit the

capital necessary to carry.out his gambling activity

To be engaged in a trade or business:within the méaning ofs

section 1402(a), an individual must be involved in an activity

with continuity and regularity, sandathe primary purpose for

engaging in the activity must be for income or profit.

Commissioner v. Groetzinger, -480 U.S.

23,

35

(1987).

If- one's

"gambling activity is pursued full time, in good faith, and with

regularity, to the production of income for a livelihood, and is

not a mere hobby, it is a trade or business".

Id. - Cases using

the Groetzinger standard have analyzed the taxpayer's gambling

activities with regard to regulations promulgated under section

183 to identify activities not engaged in for profiti

See, e.g.,

Chow v. Commissioner, T.C. Memo. 2010-48; Hastings y

Commissioner, T.C. Memo. 2009-69; Merkin v. Commissioner,iT.C.

Memo. 2008-146.

Whether the taxpayer engages in an activity with the primary

purpose of making a profit is a question of fact to be resolved

on the basis of all the facts and circumstances in a particular

case.

Golanty v. Commissioner, 72 T.C.-411, 426 (1979), affd.

without published opinion 647 F.2d 170 (9th Cir. 1981)

1.183-2(a), Income Tax-Regs.

secs -

Section.1.183-2(b), Income Tax

i

- 19 -

Regs., provides a nonexclusive 1 st of relevant factors to be

weighed when considering whether a taxpayer is engaged ih an

activity for profit.

The releva t factors 'are:

(1) The inanner

in which the taxpayer carried or the 'activity;

(2) the expertise

of the taxpayer or his advisers;

(3) the time and effort expended

by the taxpayer in carrying on the activity;

(4) the expectation

that the assets used in the actiŸity may appreciate in value;

(5)

the success of the taxpayer in carrying orf -other- activities for

profit;

(6) the taxpayer's history of income or losses- with

respect to, the activity;

(7). the amount of occasional profits, if

any, - that are earned from the act/ivity;

(8) the financial status

of the etaxpayer; and (9) whether 9elements of personal pleasure or

recreation are involved in the attivity." ¿No one factor' is

determinative of whether an actiÝity is engaged in for profit.

Brannen v. Commissioner, 722 F 2d 695, 704' (11th Cir: 1954) ,

affg.

78mT.C.

471

(1982)-; Golanti v.

Commissioner,

supra at 426;

sec. 1.183 2(b), Income Tax Regs.

Petitioners do not address tihe factors of section. 1:1832 (b) , Income Tax Regs . , and do net persuade us that petitioner' s

primary purpose for engaging in- t he gambling activity was for

income or profit.

Petitioners have not shown that petitioner's

gambling activit i.es are a trade or business within the United

States.

- 20 -

Interest Income

-

" i

The parties have stipulated that petitioners earned U.S.

source interest income in 2006 and 2007 that was not effectively

connected with a U.S. trade or business.

Petitioners contend

that the interest income is excludable from tax as simple

;

interest on deposits under section 871(i) (1) and - (2) (A) .

Respondent requested information from petitioners to demonstrate

that the interest income was from bank deposits to be considered

"earnings from deposits", as petitioners contend.

In their -

brief, petitioners state that they "are still attempting to

provide this evidence, but it is quite apparent from the face of

the tax return that this is bank interest and nothing more . "

Respondent asserts that petitioners have failed to, present

credible evidence regarding the type of interest income received

in 2006 and 2007.

Respondent concedes that article 13,

paragraph (2) of the U.S.-Korea income tax treaty provides for a

reduced tax rate of 12 percent on the interest income for 2006

and 2007, but respondent contends that it is not excludable from

Federal income tax.

Section 871(a) (1) generally provides that a tax of, 30

percent is imposed, as relevant here, on interest that a

.

nonresident alien individual receives from sources within the

United States, provided that the income is not effectively

connected with the conduct of a U.S. trade or business.

Article

- 21 13, paragraph (2) of the U.S. ICo ea rincome' tax treaty provides

that for interest income the tax rate is 12 percent instead of 30

percent.

Section 871(i) (1) and

2) providess an exception for

sinterest on deposits that ise not effectively conne'cted with a

trade or business within the Unit ed States.

provides:

Section 873(i) (3)

s

For purposes of paragraph ( ) , the term "deposit" means amounts which are-(A) deposits with persons öarrying on the

banking business, r

(B) deposits or withdrawable accounts with

savings institutions chartered and supervised as

savings and loan or sitnilar associations under

Federal or State law, Nut only to the extent that

amounts paid or credited on such deposits or

accounts are deductible under séction 591

(deternined without recjard to sections 265 and

291) in computing the (axable income of such

institutions, and

-

(C) amounts held by an insurance company

under an agreement to pay interest thereon.

Petitioners reported intere t income on the 2006 and 2007

tax returns that was not reportect to thë IRS by the payers listed

on the returns.

In the 2007 notice of deficiency, respondent

adjusted the interest income to reflect reporting from third

parties that had not been reportàd on the tax returns, including

interest income L-hat was reported to the IRS by Wells Fargo,

N. A . , : a U. S . nat i.onal banking institution .

Although pe -.itioners did not supply evidence with respect to

the interest income from Wells F rgo, N.A. , it was the bank that

- 22 -

- directly reported the interest income to the IRS.

The interest

income from Wells Fargo, N.A., was erroneously-included by

respondent in the adjusted amount because it is excludable as

deposits with persons carrying on the banking business.

871(i) (1),

(2),

and (3).

.

.

-

See sec.

-

s ,

Interest income for 2007 was reported from another third

party, First Clearing, L.L.C., abuts this entity is not a U.S.

chartered national bank, and petitioners have not shown that this

interest income qualifies for an exception from tax.

See Rule

142(a).

Petitioners have been unable to supply documentation with

respect to the interest income they reported on the tax returns

to demonstrate the reported interest income is from deposits as

defïned in section 871(i) (3) to be excepted from;tax under

section 871(i) (1) and (2).

Tax returns do not -establish the

truth of the facts stated therein.

T.C. 428, 438

Lawinger v. Commissioner, 103

(1994); Wilkinson v. Commissioner,

(1979); Roberts v. Commissioner,

62 T.C.

834,

837

71 T.C.

633,

639

(1974).

The 2006 and 2007 interest income, except the excludable

2007 interest income from Wells Fargo, N.A., is subject to income

tax at the-rate of 12 percent according to the provisions of the

U.S.-Korea income tax treaty.

23 -

Section 6662 (a) Penalties

Petitioners contest the impo ition of accuracy-related

penalties for the years in issue.

Section 6662(a): and (b) (1) and

(2) iniposes a 20 percent accuracy related penaltypon anyre

underpayment of Tederal income ta

attributable to a taxpayer' s

1

negligence or disregard of rules br regurations, or substantial

ùnderstatement of inoome tax y i Se t ione 666!2 (c ) . de f ines negligence

as including any failure to make

reasonable attempt to comply

with the provisions of the-Internal Revenue .Code, and defines

disregard as any carelessy rèckless

or intentional disregard.

Disregard of rulessor'regulations is:c~areless sif the taxpayer

does not" exercise reasonable diligence to determine- the 9 y e

correctness of a return position that isscontrary-to rules-or a

regulations .

sed. 14.6662-3 (b) (2)

Income Tax Rec.js., ,Disregard of

rules or regulations is reckless if ther taxpayer. makes lïttle, or

no effort to determine whether a rule or regulation exists.

Id.

There isi a substantial understatement of income tax -if . the

amount of the understatement exceeds the greater of 10 percent of

the tax required to be shown on the returnt or $5,000

Sec.

6662 (d) (T) (A) .

Under section- 7491(c), the Commissiôner bears the burden:of

þroduction withs

egard to penalt es and must come forward with

suf f idient evidence indicating - that it is appropriate _ to impose

penalties .

See' Hicibee v. Commissioner,

116 T . C.

438 , . 446

(-2001) .

- 24 However, once the Commissioner has met the burden of production,

the burden of proof remains with the taxpayer, including the

burden-of proving that the penalties are inappropriate because of

reasonable cause or substantial authority under section 6664.

See Rule 142(a) ; Higbee v. Commissioner, supra at 446-447.

r

Respondent has met the burden of production by showing that

petitioners' failure to report gambling and interest income for

the years in issue resulted in understatements of their, income

tax-forathe years in issue by.more than $5,000 and by more than

10 percent of the tax required to be shown on the returns.

The accuracy-related-penalty under section 6662(a)

is not

imposed with respect to any portion of the underpayment as to

which the taxpayer acted- with reasonable cause and in good faith.

Sec.

6664(c) (1); Higbee v. Commissioner, 116 T.C. 438,

(2001).

448

The decision as to whether a taxpayer acted with

reasonable cause and in good- faith is made on a case-by-case

basis, taking into account all of the pertinent facts and

circumstances.

Sec. 1.6664-4(b) (1), Income Tax Regs.

"Circumstances that may indicate reasonable cause and good faith

include an honest misunderstanding of fact or law that is

reasonable in light of all of the relevant facts and

circumstances, including the experience, knowledge, and education

of the taxpayer."

Id.

Reliance on professional advice may

constitute reasonable cause and good faith if, under all,the

- 25 -

circumstances, stch reliance was reasonable ands the taxpayer

acted in good fa.itl

See United

tates v. Boyle; 1469 U.Se 241,

250 251 (1985); Freytag v. Commissioner,

af fd.- -904 F . 2d 1C 11

sec

89 T.C.

849,

888

(5th Cir s 1990) , af fd. 501 U: S; - 868

1.6664-4 (b)N1) , Incomer Tax Regs.

(1987),

(1991) ;

In order for reliance on

prof essional -adv-i ce to excusei a tàxpayer f rom negligence, the

taxpayer musta show that the profesional had the requisite

expertise, as well as knowledge o

the pertinent ofacts, to

provide informed advice on-the subject -matter. . See David v.

Commissioner, 43 F.3d -788,

789-79

(2d Cire.

1995)., affg. T.C.

Memo. 1993-621; Freytag v. Commissioner, supra.at 888.

Petitioners contend that the

could reasonably rely on

Pechanga to follow the law and on the tax preparer to properly

report the gambling winnings inco e .

Pechanga did not withhold

the 30-percent tax from all of petitioner's gambling winnings and

reported the winnings on Forms W2-G.

However, petitioner signed

a Form W-9 in 2007 that erroneously represented his status for withholding purposes.

Petitioners have failed to provide any

evidence concerning information provided to or advice received

from ttheir tax return preparers and/or other professionals.

Petitioner

as educated in the United States and is a high-

ranking executive at a large chemical company.

These factors

tend to weigh against petitioners' claim of reasonable cause and

good faith with respect to a 1 o

part of ethe underpayments.

- 26 We conclude that petitioners' underpayments of Federal

income tax were the result of negligence or disregard of rules or

regulations under section 6662 (a) and (b) (1) .

We also conclude

that petitioners have not shown that they had reasonable cause

for and acted in good faith regarding the underpayments.

Thus,

we sustain the IRS determination -that petitioners are liable for

the penalties for 2006 and 200T under section 6662(a) .

We have considered all arguments of othe parties, and to the

extent not mentioned they are moot or without merit.

To reflect

concessions and our conclusions stated above,

Decisions will be entered

under Rule 155.