United States Tax Court

United States Tax Court

T.C. Memo. 2024-85

SCENIC TRUST, DENNIS SIMPSON, SPECIAL TRUSTEE,

Petitioner

v.

COMMISSIONER OF INTERNAL REVENUE,

Respondent

DENNIS LEE SIMPSON,

Petitioner

v.

COMMISSIONER OF INTERNAL REVENUE,

Respondent

__________

Docket Nos. 17749-21, 17771-21.

Filed September 5, 2024.

__________

Dennis Lee Simpson (trustee), for petitioner in Docket. No. 17749-21.

Dennis Lee Simpson, pro se in Docket No. 17771-21.

Kelley A. Blaine, Kimberly L. Clark, Janice B. Geier, Karen O. Myrick,

Alex R. Halverson, Caitlin A. Homewood, and Brittany M. Reid, for

respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

BUCH, Judge: Mr. Simpson participated in a direct-mail

subscription business for approximately two decades. The subscription

business consisted of several related entities. Returns were filed for Mr.

Simpson and his related entities for 2012 and 2013 (years in issue). More

than three years after the filing of the 2012 and 2013 returns for Mr.

Simpson and Scenic Trust (petitioners), the Commissioner issued

Served 09/05/24

2

[*2] Notices of Deficiency to petitioners for the years in issue,

determining income tax deficiencies, additions to tax, and civil fraud

penalties. In so doing, the Commissioner relied on the fraud exception

to the statute of limitations. Petitioners argue that the Commissioner’s

determinations are barred by the statute of limitations and, to a lesser

extent, dispute the underlying adjustments.

Mr. Simpson previously argued, and the Court has held, that the

2013 return filed on his behalf was not a valid return. Parducci v.

Commissioner, T.C. Memo. 2023-75. The Commissioner thereafter filed

a First Amended Answer to Second Amended Petition in which he

asserted a revised deficiency and additions to tax under section

6651(a)(1) and (2) 1 for failure to timely file and failure to timely pay,

with the addition for failure to timely file being asserted at the increased

rate of section 6651(f) for a fraudulent failure to file. The Commissioner

also asserted an addition to tax for failure to make estimated tax

payments under section 6654. The Commissioner later conceded the

addition for failure to timely pay. And on brief, the Commissioner did

not address the addition for failure to make estimated tax payments; we

will also regard that addition as conceded.

The Commissioner has failed to establish by clear and convincing

evidence that Mr. Simpson’s 2012 return or Scenic Trust’s 2012 or 2013

return was false or fraudulent with the intent to evade tax. As a result,

the Commissioner’s deficiency determinations for Mr. Simpson for 2012

and Scenic Trust for 2012 and 2013 are barred by the statute of

limitations. The Commissioner has also failed to establish that Mr.

Simpson’s failure to timely file a tax return for 2013 was fraudulent.

Therefore, although Mr. Simpson is liable for the addition to tax for

failure to timely file, it is not at the increased rate for a fraudulent

failure to file. Regarding the underlying deficiency for 2013, the

Commissioner established the deficiency set forth in his First Amended

Answer to Second Amended Petition, and Mr. Simpson did not establish

any error in the Commissioner’s determinations.

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

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

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

and Rule references are to the Tax Court Rules of Practice and Procedure. All monetary

amounts are shown in U.S. dollars and rounded to the nearest dollar.

3

FINDINGS OF FACT

[*3]

I.

Mr. Simpson

Mr. Simpson graduated from college in 1979. He earned his

degree in psychology from California State University, Long Beach.

Mr. Simpson has worked in several industries. After graduating

from college, he joined the Navy and became a helicopter pilot. He

medically retired in 1990. After retiring, Mr. Simpson began working in

the financial industry. He started as a commodity broker, working for

Shearson Lehman and later Merrill Lynch. Around that same time, Mr.

Simpson also became involved in the subscription business.

II.

The Subscription Business

“The subscription business” was a catch-all phrase used by Mr.

Simpson and Jeffrey Hoyal 2 to describe a third-party direct mail

subscription business that they operated from the mid-1990s to 2015.

Mr. Simpson began working in the subscription business in the mid1990s using various entities to provide customer service, data

management, and direct mail marketing to customers. Mr. Hoyal later

became involved in the business. During the years in issue, Mr. Simpson

and Mr. Hoyal operated the subscription business as partners.

A.

General Structure of the Subscription Business

The subscription business had three major components that

worked together cohesively: (1) mailing agents, (2) clearing entities, and

(3) call centers. Mailing agents sent subscription requests, i.e., mailers,

to customers across the United States. The mailers offered the customer

a set price to subscribe or renew a subscription to a publication. When

customers received mailers, they generally had three options: (1) accept

the offer to subscribe to the periodical by sending back to the mailing

agent a completed mailer and a form of payment; (2) call the number on

the mailer to inquire about the subscription; or (3) do nothing and

thereby decline the offer to subscribe. During the years in issue, the

primary mailing agent was Liberty Publishers Service, Inc. (Liberty). 3

2 Mr. Hoyal is a party in related cases. See Docket Nos. 6791-20, 10830-20.

3 Other relevant mailing agents included Orbital Publishing Group, Inc., and

United Publisher’s Exchange, Inc. These mailing agents, including Liberty, were

owned by Henry Cricket Group, LLC (Henry Cricket).

4

[*4] The clearing entities submitted customer orders. If a customer

accepted the offer provided in the mailer, thereby placing an order, the

order was forwarded to a clearing entity for processing. The clearing

entity processed the order by submitting the order and remitting

payment to the publisher or other third-party clearing entity. Once the

order was submitted, a publisher had the authority to accept or reject it.

As with mailing agents, there were several clearing entities.

The last major component of the subscription business involved

call centers. While they had many roles, they primarily handled

customer complaints and inquiries related to the mailers. Call centers

also processed orders placed in response to mailers. This included

processing telephone and internet orders and payments made by

customers.

B.

Entities Involved in the Subscription Business

Mr. Simpson and Mr. Hoyal operated the subscription business

through multiple related entities. They formed the entities to provide

specific services, which mainly included acting as mailing agents,

clearing entities, call centers, or payment distributors. They also formed

entities to hold specific assets. During the years in issue, relevant

entities included Reality Kats, LLC (Reality Kats), 4 Maximillian, Inc.

(Maximillian), and Scenic Trust.

1.

Reality Kats

Dennis Simpson formed Reality Kats as an Oregon limited

liability company (LLC) on July 8, 2005. 5 Mr. Simpson was the manager

and sole member of Reality Kats. During the years in issue, Scenic Trust

reported Reality Kats on Schedules C, Profit or Loss From Business,

filed with its tax returns. However, Mr. Simpson has maintained that

he, not Scenic Trust, owned Reality Kats during the years in issue.

Mr. Simpson controlled Reality Kats. He made and monitored all

important financial decisions for the entity. For example, he determined

which transactions Reality Kats entered into, and he kept track of the

amounts and timing of deposits into Reality Kats’s bank accounts.

4 Documents in the record contain a variety of spellings of Reality Kats. We

make no finding as to which is the “correct” spelling, but we will follow the

predominant spelling in the contemporaneous records.

5 Mr. Simpson later converted Reality Kats to a California LLC.

5

[*5] Additionally, he controlled the amount and timing of payments

made by Reality Kats.

Reality Kats entered into the following relevant transactions

during the years in issue.

a.

3922 Bellinger Lane Property

Reality Kats sold a property at 3922 Bellinger Lane in Medford,

Oregon, to David Lennon and his wife in 2011. Mr. Simpson signed the

contract as manager of Reality Kats. Reality Kats sold the property for

$2,990,000 to the Lennons on credit with a stated interest rate of zero.

b.

14957 Encendido Property

Reality Kats sold property at 14957 Encendido, San Diego,

California, on May 1, 2013, for $626,874. The property had a cost basis

of $302,667. On its return for 2013, Scenic Trust reported a capital gain

of $324,207.

c.

4184 Bellinger Lane Property

Reality Kats sold property at 4184 Bellinger Lane in 2007 for

$2 million. Its cost basis was $250,000. The sale was an installment sale

and was paid in full in 2012.

2.

Maximillian

Maximillian was an Oregon corporation organized on November

21, 2006, by or on behalf of Noel Parducci. Ms. Parducci was its nominal

president and secretary of Maximillian. While on paper Ms. Parducci

seemingly controlled Maximillian, in reality she was subordinate to Mr.

Simpson and Mr. Hoyal, who directed the actions to be taken through

the entity.

Maximillian had a vital role in the subscription business. Its

responsibilities included tracking the financial operations of the

subscription business, coordinating the flow of funds among the various

entities, and disbursing profits to Mr. Simpson and Mr. Hoyal, mainly

through their entities Reality Kats and Hoyal & Associates, Inc. (H&A),

an S corporation jointly owned by Jeffrey and Lori Hoyal. In 2014,

Maximillian and Reality Kats memorialized a consulting agreement

that required Reality Kats to provide consulting services to Maximillian.

The consulting agreement had an “as of” date of January 1, 2012, but

6

[*6] was not actually signed until 2014 for the purpose of showing the

Internal Revenue Service (IRS) the intended flow of money.

3.

Scenic Trust

Scenic Trust was an irrevocable trust formed by Mr. Simpson in

2006. Joesph Petrucelli drafted the Scenic Trust agreement (Trust

Agreement). The Trust Agreement had a stated execution date of

January 1, 2006, but the date accompanying the signature was January

3, 2006. It named Mr. Hoyal as trustee and its beneficiaries as “that

class of individuals constituting my heirs at law.” At the time the trust

was formed, Mr. Simpson was not married, and he did not have any

children. However, he married in 2008. Because of the marriage, Qili-Ye

Simpson became the beneficiary of Scenic Trust during the years in

issue. Mr. Simpson alleges that he was separated during the years in

issue, but the record of these cases does not include any documentary

evidence of a separation, such as a marital separation agreement being

filed with a court of competent jurisdiction.

a.

Mr. Hoyal’s Role in Scenic Trust

Mr. Hoyal was the trustee of Scenic Trust from 2006 to 2015. The

Trust Agreement outlined his role and responsibilities as trustee. He

had sole discretion to distribute income and principal to the beneficiaries

of the trust. However, he could not distribute income to himself.

Furthermore, he had the power to grant a general power of appointment

to a beneficiary, but not to himself. Mr. Hoyal believed his role as trustee

was to keep an eye on Scenic Trust since it ultimately belonged to Mr.

Simpson.

b.

Mr. Simpson’s Role in Scenic Trust

Within the terms of the Trust Agreement, Mr. Simpson did not

have a role with Scenic Trust other than as the settlor. But those who

interacted with Mr. Simpson or the trust viewed him as

indistinguishable from Scenic Trust. Although he was not listed in the

Trust Agreement as a beneficiary, those who interacted with him or the

trust considered him to be the beneficiary. Furthermore, those who

interacted with Mr. Simpson or the trust understood him to be the

primary decision maker for all matters related to Scenic Trust.

7

[*7]

c.

Joseph Petrucelli

Mr. Petrucelli is the managing partner of the San Diego office of

Adkisson Pitet LLP. He has a law degree from California Western

School of Law and an LL.M. in taxation from the University of San Diego

Law School. Mr. Petrucelli has over 25 years of experience as a tax and

estate planning attorney. He has published articles on private annuity

agreements and a book about private annuity trusts.

Mr. Petrucelli was referred to Mr. Simpson to help him with

estate planning and asset protection. Mr. Simpson hired Mr. Petrucelli

to set up Scenic Trust. On December 28, 2005, Mr. Simpson received

engagement materials for Mr. Petrucelli’s representation. The materials

included an engagement letter for Mr. Petrucelli’s legal services, which

included (1) drafting a beneficiary taxed trust; (2) drafting a dynasty

trust; (3) drafting appropriate property transfer documents, including

private annuities; (4) forming an LLC; and (5) engaging an actuary on

behalf of Mr. Simpson to calculate annuity payments associated with

the private annuity. The materials were executed sometime after late

January 2006. Mr. Petrucelli did not receive any interest in any of the

entities owned by Mr. Simpson or his trusts in exchange for his legal

services.

d.

Agreements Entered Into

Formation of Scenic Trust

During

the

As part of the formation of Scenic Trust, a Private Annuity

Agreement was executed between Mr. Simpson and Mr. Hoyal as trustee

of Scenic Trust. The Private Annuity Agreement had an execution date

of January 1, 2006. It designated Mr. Simpson as an annuitant for the

sale of property to Scenic Trust. The property sold (Reality Kats units)

was assigned a fair market value of $16,200,000.

Lastly, in connection with the formation of Scenic Trust and the

execution of the Private Annuity Agreement, a Unit Purchase

Agreement was executed between Mr. Simpson and Mr. Hoyal as trustee

of Scenic Trust. The Unit Purchase Agreement had an execution date of

January 15, 2006, but purported to have been signed on January 1

and 2. The Unit Purchase Agreement was intended to be read in

connection with the Private Annuity Agreement. The Unit Purchase

Agreement identified the property to be transferred as the 100 units of

Reality Kats owned by Mr. Simpson. It further stated that the 100 units

8

[*8] represented “100% of the LLC units of said company.” 6 The

property was transferred for an aggregate price of $16,200,000. This

agreement was provided during discovery.

But a different Unit Purchase Agreement was provided to the

Commissioner during the examination. This revised version had an

execution date of January 15, 2006, with a signature date of January 1,

2006. The terms in the revised version were significantly different from

those of the version provided in discovery. Mr. Simpson does not

consider the revised agreement authentic. But he believed the Trust

Agreement, the Private Annuity Agreement, and the version of the Unit

Purchase Agreement provided during discovery to be authentic

documents.

C.

Mr. Simpson’s Role in the Subscription Business

Mr. Simpson’s role in the subscription business involved

overseeing the mailing operations. Specifically, he oversaw nearly all

aspects of the mailers, including developing the content of the mailers,

identifying the types of potential customers to whom the mailers would

be sent, and dictating where the mailers would be sent. Mr. Simpson

perceived his services to be a key element in the subscription business.

He provided those services to the subscription business through Reality

Kats.

D.

Flow of Services and Payments Between Entities

The subscription business had a general payment structure that

involved entities’ paying one another for services they provided to each

other and deducting offsetting expenses. But in the making of these

payments, money bounced from entity to entity. For example, during the

years in issue, Liberty was the main operating entity of the subscription

business. Mr. Simpson provided services to Liberty through Reality

Kats. To pay for Mr. Simpson’s services, Liberty would make payments

to Henry Crickett, the entity that owned it, and characterize these

payments as payments for consulting services. Henry Crickett would

then make payments to Maximillian for the consulting services. The

money in Maximillian would remain there until Ms. Parducci was

instructed to transfer it to Reality Kats (or H&A if the payment was for

Mr. Hoyal’s services). This instruction could be in an email or an invoice.

Ms. Parducci would transfer the money as instructed. And Mr. Simpson

6 Mr. Simpson argues that the transfer of units did not constitute a complete

sale of Reality Kats to Scenic Trust. The record does not support this argument.

9

[*9] would receive payment for his services through Reality Kats (and

Mr. Hoyal through H&A). During the years in issue, Reality Kats and

H&A received roughly equal transfers of money from Maximillian.

Notwithstanding the convoluted movement of funds, each entity

that received payments for services reported the amounts received in its

gross receipts. All of the wages Mr. Simpson received from Reality Kats

during the years in issue were reported on the returns for those years.

III.

Tax Returns

While Scenic Trust filed tax returns for the years in issue, Mr.

Simpson filed a tax return only for 2012. We previously held that the

2013 income tax return filed for Mr. Simpson was not signed by him or

by someone authorized to sign on his behalf and thus was not a valid

return. See Parducci v. Commissioner, T.C. Memo. 2023-75.

A.

Mr. Ankerberg’s Tax Return Preparation

Curt Ankerberg, now retired, was a licensed certified public

accountant who practiced for 33 years. Mr. Ankerberg worked at several

accounting firms throughout his career. He prepared thousands of tax

returns, gaining experience with individual returns, corporate returns,

partnership returns, and trust returns. Although he prepared trust

returns, he considered himself as having specialized in corporate,

individual, and partnership returns. He prepared trust returns the least

of the various types of returns he prepared. And even then, he mostly

prepared returns for simple trusts, which were not technical and

complex. But he was familiar with complex trusts and had prepared

returns for those types of trusts before meeting the Hoyals.

Mr. Hoyal hired Mr. Ankerberg to prepare tax returns for the

subscription business. At the time, Mr. Ankerberg had recently

established his own accounting practice. Because of a noncompete

agreement with his former accounting firm, he did not have any clients

when he began his own accounting practice. To build up a client base,

he purchased the address information for 7,000 names and sent out

letters to prospective clients. Mr. Hoyal responded to the letter. By the

end of 2005, Mr. Ankerberg’s practice had already found some success

by having Mr. Hoyal and entities related to the subscription business as

clients.

Mr. Ankerberg prepared petitioners’ tax returns from 2006

through 2014. Mr. Simpson was provided with copies of those returns.

10

[*10] B.

The 95% Amortization

During the years in issue, Scenic Trust “amortized” as an

“application of annuity cost” 95% of the gross receipts of Reality Kats,

its Schedule C activity. Reality Kats first claimed this 95% amortization

on its 2006 return. On that return, it reported $4,321,390 in gross

receipts and claimed 95% of that as an amortization deduction.

This 95% amortization is novel. There was much discussion

among Mr. Hoyal, Mr. Petrucelli, and Mr. Ankerberg about how to use

it. In March 2006, Mr. Ankerberg and Mr. Hoyal held a call with Mr.

Petrucelli to discuss private annuity trusts. The purpose of the call was

for Mr. Petrucelli to provide Mr. Ankerberg with the mechanics of how

to prepare a tax return for an annuity trust because of Mr. Ankerberg’s

unfamiliarity with the concept. Mr. Petrucelli failed to explain to him

how the annuity trust worked but advised Mr. Ankerberg to use the 95%

amortization method on the returns. Mr. Ankerberg continued to use

this 95% amortization method in subsequent years.

Mr. Simpson was not a part of the discussion surrounding the use

of the 95% amortization method. At trial, Mr. Petrucelli testified that he

did not recall any conversations with Mr. Hoyal, Mr. Ankerberg, or Mr.

Simpson in which he advised them to use the 95% amortization method.

Mr. Petrucelli was not credible.

C.

Mr. Simpson’s 2013 Return

Mr. Ankerberg prepared a 2013 return for Mr. Simpson. He did

not receive the information to prepare Mr. Simpson’s return until

October 15, 2014, the day on which the return was due. He did not

provide that return directly to Mr. Simpson, and Mr. Simpson never

signed that return or authorized anyone to sign it on his behalf. See

Parducci, T.C. Memo. 2023-75.

IV.

IRS Examination of Petitioners’ and Related Entities’ Returns

The Commissioner examined the returns of Mr. Simpson, Scenic

Trust, and other entities and individuals involved in the subscription

business. During the examination, many of these entities and

individuals, including petitioners, were represented by David Lennon.

Mr. Lennon, a practicing attorney since 1988, worked as an attorney for

the subscription business. Although he is primarily a commercial

litigator, he has some tax litigation experience as well. In addition to his

other work for the subscription business, Mr. Lennon represented all the

11

[*11] entities and individuals that were a part of the subscription

business during litigation with the Federal Trade Commission over

deceptive practices.

During the examination, petitioners and their related entities

provided the Commissioner with extensive records. They provided

organizational documents. They also provided their accounting records

by providing QuickBooks files with general ledgers for various entities.

They provided balance sheets, bank records, and receipts. They also

provided returns of related entities.

Petitioners (or their advisors) also provided altered or backdated

documents. The revenue agent received agreements that had stated

execution dates that predated the dates the agreements were actually

executed. These agreements included the consulting agreement between

Maximillian and Reality Kats, the Trust Agreement, and a private

annuity agreement between Scenic Trust and Mr. Simpson.

Additionally, the revenue agent received more than one version of some

documents, including two versions of a unit purchase agreement

between Scenic Trust and Mr. Simpson. The two versions had very

different terms and both were backdated. At no time during the audits

of petitioners’ or other related entities’ returns was the revenue agent

informed that documents were backdated or altered.

V.

Novato Development, LLC

Novato Development, LLC (Novato), was a real estate

development company owned 50% by Crater Lake Trust, 7 and 50% by

Mr. Simpson and Reality Kats. On December 12, 2019, the

Commissioner issued a Notice of Final Partnership Administrative

Adjustment (FPAA) to Novato. Because no petition for readjustment

was filed with the Tax Court, the adjustments in that FPAA became

final. The Commissioner reflected affected items from Novato as an

“Additional Assessment” on Mr. Simpson’s Notice of Deficiency for 2013.

VI.

Penalty Approval

While assigned to the examination of Scenic Trust’s and Mr.

Simpson’s returns, the revenue agent requested from his supervisor

approval for assertion of the fraud penalty and, in the alternative, the

negligence penalty. The revenue agent’s supervisor approved the fraud

7 Crater Lake Trust is a party at issue in related cases. See Docket Nos. 679120, 10830-20.

12

[*12] penalty and the alternative negligence penalty before the issuance

of the Notices of Deficiency.

VII.

Notices of Deficiency and Concessions

On July 6, 2021, the Commissioner issued Notices of Deficiency

to petitioners for the years in issue. He determined the following

deficiencies and penalties for Mr. Simpson:

Additions to Tax/Penalties

Year

Deficiency

§ 6663

§ 6651(f)

§ 6651(a)(2)

§ 6654

2012

$7,203,670

$5,402,753

—

—

—

2013 8

2,495,267

—

$1,400,964

$483,091

$33,576

He determined the following deficiencies and penalties for Scenic Trust:

Year

Deficiency

§ 6663 Penalty

2012

$6,363,735

$4,772,801

2013

1,337,331

1,002,998

Petitioners timely filed Petitions with the Court. They disputed

the Commissioner’s determinations and argued that the Commissioner’s

adjustments in the notices of deficiency were barred by the applicable

statute of limitations. When the Petitions were filed, Mr. Simpson

resided in California and Scenic Trust’s principal place of

administration was also in California.

VIII. Trial

The Court tried these cases in December 2023. At trial, the Court

heard testimony from several witnesses, including Ms. Parducci, Mr.

Petrucelli, Mr. Ankerberg, Mr. Lennon, the revenue agent, Mr. Simpson,

8 The 2013 amounts are derived from the Commissioner’s First Amended

Answer to Second Amended Petition, filed after the Court held that Mr. Simpson’s

2013 return was not a valid return.

13

[*13] the Hoyals, and others. We found the testimony of several

witnesses helpful in understanding the mechanics of the subscription

business. We also found testimony from certain witnesses conflicting

and not credible, particularly Mr. Simpson’s. For example, Mr. Simpson

testified that he had no control over any of the entities that made up the

subscription business other than Reality Kats. But witnesses other than

Mr. Simpson testified consistently that he was involved with, or

informed of, most of the decisions made regarding Scenic Trust and

Reality Kats. In short, Mr. Simpson’s testimony was not credible.

Before trial, the parties conceded many issues. After concessions,

the following issues remained: (1) whether the period of limitations to

assess tax against petitioners for 2012 and Scenic Trust for 2013 expired

before the Commissioner issued the Notices of Deficiency; (2) whether

the taxable items reported on Scenic Trust’s returns for the years in

issue were accurately reported and should be attributed to Mr. Simpson;

(3) whether Scenic Trust is liable for a section 6663 fraud penalty, or

alternatively a section 6662(a) accuracy-related penalty, for the years in

issue; (4) whether Mr. Simpson is liable for a section 6663 fraud penalty,

or alternatively a section 6662(a) accuracy-related penalty, for 2012;

(5) whether Mr. Simpson is liable for an addition to tax for 2013 for

failure to timely file, failure to timely pay, and failure to make estimated

tax payments, including whether the failure to file addition applies at

the increased rate for a fraudulent failure to file; and (6) whether Mr.

Simpson’s participation in the operations of Novato constituted material

participation under section 469.

OPINION

These consolidated cases involve the flow of income between two

taxpayers and their related entities for tax years 2012 and 2013. The

principal issues we must decide are (1) whether Scenic Trust’s and

Reality Kats’s income should be reattributed to Mr. Simpson for the

years in issue; (2) whether the Commissioner’s deficiency

determinations for petitioners were correct; and (3) whether petitioners

are subject to additions to tax or penalties for the years in issue based

on the Commissioner’s determinations. But before we decide these

issues, we must first address a preliminary issue, which is whether the

periods of limitations to make assessments against Mr. Simpson for

2012 and Scenic Trust for 2012 and 2013 expired before the

Commissioner issued Notices of Deficiency. If the periods expired before

the notices were issued, we need to decide only adjustments related to

Mr. Simpson’s 2013 tax return. However, if the periods of limitations

14

[*14] had not expired, we must determine adjustments for each

petitioner for each year in issue.

I.

Statute of Limitations

Section 6501(a) provides that the Commissioner must generally

assess tax within three years after a return is filed. However, if a

taxpayer files “a false or fraudulent return with the intent to evade tax,

the tax may be assessed . . . at any time.” I.R.C. § 6501(c)(1). “Fraud for

this purpose is defined as intentional wrongdoing by the taxpayer with

the specific purpose of avoiding tax believed to be owed.” Fabian v.

Commissioner, T.C. Memo. 2022-94, at *25.

The Commissioner issued Notices of Deficiency to petitioners on

July 6, 2021, more than three years after the relevant returns were filed.

He relies on section 6501(c)(1) to keep the periods of limitations open.

The Commissioner argues that the periods to assess income tax due from

petitioners for 2012 and 2013 have not expired because he has

established fraud by clear and convincing evidence. Petitioners disagree,

arguing that fraud has not been established and therefore the periods of

limitations have expired.

As a preliminary matter, we note that this statute of limitations

question is not presented for Mr. Simpson’s 2013 liability. In Parducci,

T.C. Memo. 2023-75, Mr. Simpson argued, and we held, that his 2013

return was not signed by him or by anyone authorized by him. As a

result, we held that Mr. Simpson’s 2013 return was not a valid return.

This leaves Mr. Simpson without a valid return for 2013. Under section

6501(a) and (c)(3), when no return is filed, the Commissioner may assess

at any time. Accordingly, the period of limitations on assessment has

not lapsed as to the Commissioner’s determinations regarding Mr.

Simpson’s 2013 tax liability. The remainder of this discussion of the

periods of limitations pertains to Mr. Simpson’s liability for 2012 and

Scenic Trust’s liabilities for 2012 and 2013.

A.

Proof of Fraudulent Return

The Commissioner must establish fraud by clear and convincing

evidence. I.R.C. § 7454(a); Rule 142(b); Botwinik Bros. of Mass., Inc. v.

Commissioner, 39 T.C. 988, 996 (1963). The existence of fraud is a

question of fact to be resolved by considering the entire record. Clark v.

Commissioner, T.C. Memo. 2021-114, at *36–37. The determination of

fraud for purposes of determining whether a taxpayer filed a fraudulent

return under section 6501(c) is the same as the determination of fraud

15

[*15] for purposes of the civil fraud penalty under section 6663.

Browning v. Commissioner, T.C. Memo. 2011-261, 102 T.C.M. (CCH)

460, 467.

To establish fraud, the Commissioner must prove two elements

by clear and convincing evidence: (1) an underpayment of tax and

(2) fraudulent intent with respect to some portion of that underpayment.

DeVries v. Commissioner, T.C. Memo. 2011-185, 102 T.C.M. (CCH) 125,

128. The Commissioner satisfies the clear and convincing evidence

standard when he provides proof that produces “in the mind of the trier

of facts a firm belief or conviction as to the allegations sought to be

established.” Garavaglia v. Commissioner, T.C. Memo. 2011-228, 102

T.C.M. (CCH) 286, 302 (quoting Ohio v. Akron Ctr. for Reprod. Health,

497 U.S. 502, 516 (1990)), aff’d, 521 F. App’x 476 (6th Cir. 2013). This

standard “is intermediate, being more than a mere preponderance, but

not the extent of such certainty as is required beyond a reasonable doubt

in criminal cases. It does not mean clear and unequivocal.” Id. The

Commissioner’s burden applies separately for each of the years in issue.

Castillo v. Commissioner, 84 T.C. 405, 409 (1985). Once fraud is

established, the entire taxable year remains open under section

6501(c)(1) even if only a part of the underpayment for a year is

attributable to fraud. Browning, 102 T.C.M. (CCH) at 467. Likewise, if

the Commissioner establishes that part of an underpayment is due to

fraud, the entire underpayment is treated as attributable to fraud for

penalty purposes, except to the extent the taxpayer establishes

otherwise. I.R.C. § 6663(b).

1.

Fraudulent Intent

To find fraud, we must consider whether the return was prepared

with intent to evade tax believed to be owing by conduct intended to

conceal, mislead, or otherwise prevent the collection of tax. DiLeo v.

Commissioner, 96 T.C. 858, 874 (1991), aff’d, 959 F.2d 16 (2d Cir. 1992).

Because direct evidence of intent to evade tax is rarely available, intent

may be proved by circumstantial evidence and reasonable inferences

from facts. Fabian, T.C. Memo. 2022-94, at *26. Courts have developed

a nonexclusive list of indicia or “badges” of fraud to describe behavior

that may indicate fraudulent intent. Niedringhaus v. Commissioner, 99

T.C. 202, 211 (1992); Clark, T.C. Memo. 2021-114, at *37. The existence

of any one indicium is not dispositive, but multiple indicia together are

strong circumstantial evidence of fraudulent intent. Niedringhaus, 99

T.C. at 211.

16

[*16] Badges of fraud include, but are not limited to: (1) failing to file

tax returns, (2) understating income, (3) maintaining inadequate

records, (4) giving implausible or inconsistent explanations of behavior,

(5) failing to cooperate with tax authorities, (6) concealing income or

assets, (7) engaging in illegal activities, (8) demonstrating a lack of

credibility in testimony, (9) filing false documents (including false tax

returns), (10) dealing in cash, and (11) an intent to mislead which may

be inferred from a pattern of conduct. Id.

Most of these badges are neutral or weigh against a finding of

fraud in these cases. In considering what facts support the presence of

these various badges, we decline to find that a single act supports

multiple badges. Therefore, we conclude that the Commissioner has

failed to establish that petitioners for 2012, and Scenic Trust for 2013,

acted with the requisite fraudulent intent when filing their returns for

the years in issue.

a.

Badges Indicating Fraud

The Commissioner has established the following badges of fraud

were present.

i.

Lack of Credible Testimony

Overall, Mr. Simpson’s testimony at trial was not credible. For

example, he downplayed his role in the subscription business despite the

evidence showing that he and Mr. Hoyal operated the subscription

business as partners. Mr. Simpson also claimed that he lacked

knowledge about various transactions entered into by entities he

controlled. And he pointed to Mr. Hoyal and others as misleading him.

But both the testimony of other witnesses and contemporaneous

documents showed that Mr. Simpson was very involved with and kept

informed about the subscription business. This conduct supports a

finding of fraud.

ii.

Intent to Mislead Inferred from Pattern

of Conduct

The Commissioner argues that petitioners engaged in a pattern

of conduct to mislead by (1) presenting altered or backdated documents;

(2) hiding behind confusing narratives; and (3) attacking the Hoyals.

Petitioners engaged in a pattern of conduct with an intent to

mislead, primarily by providing altered documents to the Commissioner.

17

[*17] During examination, the revenue agent was presented with

altered documents. This conduct shows an intent to mislead and

supports a finding of fraud.

We note, however, that the Commissioner cites the altered

documents as support for the existence of conduct described by several

badges. Although we believe that the altered documents support a

finding of intent to mislead, we decline to use a single act or event to

support multiple badges. Therefore, we will address the altered

documents only under this specific badge.

b.

Badges Not Indicating Fraud

As previously stated, most of the badges are neutral or weigh

against a finding of fraud here. By relying on the same facts to establish

multiple badges of fraud, the Commissioner has failed to establish the

existence of the following badges.

i.

Failing to File Tax Returns

Scenic Trust filed returns for the years in issue. Furthermore, Mr.

Simpson filed a tax return for 2012. This badge weighs against fraud.

ii.

Understating Income

A pattern of substantially underreporting income over several

successive years can be strong evidence of fraudulent intent. See

Zhadanov v. Commissioner, T.C. Memo. 2002-104, 83 T.C.M. (CCH)

1553, 1560. Such a pattern evidences fraudulent intent “even where the

record is ‘devoid of the usual indicia of fraud.’” Isaacson v.

Commissioner, T.C. Memo. 2020-17, at *48–49 (quoting Otsuki v.

Commissioner, 53 T.C. 96, 107–08 (1969)), aff’d, No. 20-71121, 2022 WL

541617 (9th Cir. Feb. 23, 2022).

The Commissioner’s support for this badge is predicated on the

Court’s adoption of his position that the income of Reality Kats and

Scenic Trust should be reattributed to Mr. Simpson. When the relevant

returns are considered as a group, however, there is no pattern of

understating income. This badge is neutral.

iii.

Maintaining Inadequate Records

Taxpayers must maintain records sufficient for the Commissioner

to determine their tax liability. I.R.C. § 6001. Failing “to keep or produce

18

[*18] adequate records to support . . . tax return positions” is an

indicator of fraud. Scott v. Commissioner, T.C. Memo. 2012-65, 103

T.C.M. (CCH) 1310, 1317. For this badge the Commissioner states that

“[t]he evidentiary record in this case is replete with examples of Mr.

Simpson’s idiosyncratic and ends-driven curation of records. It would be

simpler to list the authentic records that Mr. Simpson maintained and

produced, than to list any portion of the confused amalgam produced at

trial.”

But the Commissioner is mistaken. The evidence in the record

does not clearly show that Mr. Simpson failed to maintain adequate

records. In the evidentiary record, we have (1) petitioners’ tax returns;

(2) profit and loss statements for Reality Kats and Scenic Trust for 2013;

(3) balance sheets and bank records for Reality Kats and Scenic Trust;

and (4) receipts, deeds, invoices, and other transactional statements to

substantiate certain transactions and expenses. While the

Commissioner disagrees with how items were reported, petitioners

provided enough documentation to reconcile their reporting on their tax

returns. This badge weighs against fraud.

iv.

Implausible or Inconsistent Explanations of Behavior

A taxpayer’s implausible or inconsistent explanations for his

actions may constitute evidence of fraudulent intent. See Bradford v.

Commissioner, 796 F.2d 303, 307 (9th Cir. 1986), aff’g T.C. Memo. 1984601. “We may consider a taxpayer’s filings and testimony as evidence of

implausible or inconsistent explanations.” Di Giorgio v. Commissioner,

T.C. Memo. 2023-44, at *25. The Commissioner argues that Mr.

Simpson’s implausible or inconsistent explanations of behavior include

(1) Mr. Simpson’s sending an email asking whether he could use Reality

Kats funds to purchase a lot to build a house; (2) Mr. Simpson’s being

included on an email chain that stated he and Mr. Hoyal were in Mr.

Lennon’s office waiting to sign revised Scenic Trust documents; (3) Mr.

Simpson’s being included on an email chain that stated that Mr. Lennon

planned on not pointing out to the revenue agent Scenic Trust’s true

basis in a property sold unless there was further inquiry; and

(4) correspondence between Mr. Lennon and Mr. Petrucelli in which

they state that they need to find a relationship to explain the flow of

money though the subscription business.

These examples are not sufficient to support a finding that Mr.

Simpson provided implausible or inconsistent explanations of behavior.

19

[*19] The most implausible or inconsistent explanation of behavior is

Mr. Simpson’s not recalling revisions to documents while also being

included in an email that stated that he was in Mr. Lennon’s office to

sign Scenic Trust documents. But Mr. Simpson has maintained that

until recently he believed the revisions to the Scenic Trust documents

were to clean up typos, which would easily be unremarkable and

forgettable after more than a decade had passed. This badge is neutral.

v.

Failing to

Authorities

Cooperate

with

Tax

A taxpayer’s failure to cooperate with tax authorities, including a

failure to cooperate with revenue agents during an examination, can

indicate fraudulent intent. Grosshandler v. Commissioner, 75 T.C. 1,

19–20 (1980). The Commissioner argues that petitioners failed to

cooperate during the examination by (1) producing false or misleading

documents and (2) failing to inform the revenue agent that Scenic Trust

inaccurately reported gain on the sale of property.

Petitioners cooperated during the audit. The Commissioner

received adequate information and documentation regarding petitioners

and other entities involved in the subscription business. And while

petitioners failed to inform the revenue agent about an inaccurate

reporting of gain from the sale of property, that incident alone is not

sufficient to establish that petitioners failed to cooperate. This badge is

neutral.

vi.

Concealing Income or Assets

If a taxpayer conceals his ownership of assets or covers up sources

of income, such concealment supports a finding of fraud. Spies v. United

States, 317 U.S. 492, 499 (1943). The Commissioner argues that Mr.

Simpson attempted to conceal the true characteristics of his tax liability

by presenting altered or backdated documents, hiding behind confusing

narratives, and attacking the Hoyals.

But petitioners did not attempt to conceal income or assets.

Petitioners provided records that showed where income came from,

where income went, and where assets were held. Furthermore, the

records supported positions taken on petitioners’ returns. While the flow

of income was convoluted, we do not find an intent to conceal income or

assets. This badge weighs against fraud.

20

vii.

[*20]

Engaging in Illegal Activities

The Commissioner does not argue, and the record does not

support, that petitioners engaged in illegal activities. This badge is

neutral.

viii.

Filing False Documents

The Commissioner does not argue, and the record does not

support, that petitioners filed false documents. This badge is neutral.

ix.

Dealing in Cash

Petitioners did not deal in cash. This badge is neutral.

c.

Badges of Fraud Conclusion

After considering the entire record, we conclude that the

Commissioner has failed to provide clear and convincing evidence that

petitioners filed fraudulent tax returns. While the Commissioner

presented evidence potentially supporting a finding of fraud,

specifically, Mr. Simpson’s lack of credibility and the existence of altered

and backdated documents, those badges alone are not sufficient to

establish fraudulent intent by clear and convincing evidence. The

Commissioner has not carried his burden for establishing fraud.

2.

Underpayment of Tax

Because the Commissioner has not established fraud by clear and

convincing evidence, we need not determine whether there were

underpayments of tax as part of our fraud analysis.

B.

Statute of Limitations Conclusion

The Commissioner has failed to provide clear and convincing

evidence that petitioners filed false or fraudulent returns with the intent

to evade tax. Thus, the extended period of limitations provided in section

6501(c) does not apply. Accordingly, the Commissioner’s determinations

and adjustments relating to petitioners for 2012 and Scenic Trust for

2013 are barred by the statute of limitations.

II.

Mr. Simpson’s 2013 Return

The Commissioner determined a tax deficiency and, by amended

Answer, additions to tax for failure to timely file and failure to timely

21

[*21] pay. Because Mr. Simpson did not file a return for 2013, the period

of limitations has not expired, and we turn to those issues.

A.

Deficiency

1.

Income

a.

Burden of Proof and Production

Generally, the Commissioner’s determinations in a notice of

deficiency are presumed correct, and the taxpayer bears the burden of

proving error. Rule 142(a)(1); Welch v. Helvering, 290 U.S. 111, 115

(1933). With respect to any new matter or increases in deficiency

pleaded in an answer, the burden is on the Commissioner. Rule

142(a)(1). In the U.S. Court of Appeals for the Ninth Circuit, the court

to which these cases would be appealable absent stipulation otherwise,

determinations of unreported income must be supported by a “minimal

evidentiary foundation” before the presumption of correctness applies.

Weimerskirch v. Commissioner, 596 F.2d 358, 361 (9th Cir. 1979), rev’g

67 T.C. 672 (1977); see Golsen v. Commissioner, 54 T.C. 742, 756–58

(1970), aff’d, 445 F.2d 985 (10th Cir. 1971). “[T]he Commissioner must

offer some substantive evidence showing that the taxpayer received

income from the charged activity.” Weimerskirch v. Commissioner, 596

F.2d at 360. “After the Commissioner produces evidence linking the

taxpayer to an income-producing activity, the burden shifts to the

taxpayer to prove the determinations are arbitrary or erroneous.” Estate

of Clemons v. Commissioner, T.C. Memo. 2022-95, at *16. To carry this

burden, Mr. Simpson must show that the income the Commissioner

determined derived from a nontaxable source or was otherwise

excludable from income. See id.

b.

Attribution of Income

The Commissioner argues that Mr. Simpson is liable for the

taxable items assigned to Reality Kats and Scenic Trust by application

of the assignment of income doctrine, grantor trust rules, or sham-trust

doctrine. We agree with the Commissioner.

i.

Assignment of Income Doctrine

The Commissioner argues that Reality Kats’s items of income

should be reattributed to Mr. Simpson pursuant to the assignment of

income doctrine.

22

[*22] The assignment of income doctrine prevents an individual from

avoiding tax on income by assigning that income to another person or

entity. Anyanwu v. Commissioner, T.C. Memo. 2014-123, at *13; see also

Lucas v. Earl, 281 U.S. 111, 114–15 (1930). Under this doctrine, income

is taxed to the person who actually earns it. United States v. Basye, 410

U.S. 441, 450 (1973); see also Anyanwu, T.C. Memo. 2014-123, at *13

(“[I]ncome is taxable to . . . the one who owns the tree on which the fruit

grows.”). Furthermore, a person who “earns income may not avoid

taxation through anticipatory arrangements no matter how clever or

subtle.” Basye, 410 U.S. at 450.

Reality Kats’s income is taxable to Mr. Simpson. Reality Kats was

a single-member LLC, and Mr. Simpson has consistently held himself

out as its owner. He had total control over every financial decision and

transaction that occurred within the entity. The Commissioner linked

Mr. Simpson with the activity of Reality Kats. And the evidence shows

that, although being characterized as merely the settlor of the trust per

the Trust Agreement, Mr. Simpson had full control of the trust.

ii.

Grantor Trust Rules

The Commissioner argues that Scenic Trust’s items of income

should be reattributed to Mr. Simpson pursuant to the grantor trust

rules. The grantor trust rules apply where “a grantor has transferred

property to a trust but has not parted with complete dominion and

control over the property or the income which it produces.” Scheft v.

Commissioner, 59 T.C. 428, 430 (1972). Section 671 provides that if a

grantor or other person is treated as the owner of any portion of a trust,

there shall then be included in computing the taxable

income and credits of the grantor or the other person those

items of income, deductions, and credits against tax of the

trust which are attributable to that portion of the trust to

the extent that such items would be taken into account

under this chapter in computing taxable income or credits

against the tax of an individual.

A grantor or other person will be treated as the owner of all or a portion

of a trust if any one of the circumstances enumerated in sections 673

through 678 is satisfied. Treas. Reg. § 1.671-1(a). We will focus only on

whether the circumstance set out in section 677 applies. Section 677

provides:

23

[*23] The grantor shall be treated as the owner of any portion of

a trust, whether or not he is treated as such owner under

section 674, whose income without the approval or consent

of any adverse party is, or, in the discretion of the grantor

or nonadverse party, or both, may be . . . distributed to the

grantor or the grantor’s spouse . . . [or] held or accumulated

for future distribution to the grantor or the grantor’s

spouse.

I.R.C. § 677(a)(1) and (2). Essentially, a grantor will be treated as an

owner of any portion of a trust if in the discretion of the grantor, the

grantor’s spouse, or a nonadverse party, income is distributed or held

for future distribution to the grantor or the grantor’s spouse without the

approval or consent of any adverse party other than the grantor’s

spouse. I.R.C. § 672(e); Treas. Reg. § 1.677(a)-1(b)(2)(i) and (ii).

a)

Whether Mr. Hoyal Was an

Adverse Party

The parties disagree about whether Mr. Hoyal, as trustee, was a

nonadverse party for purposes of section 677. A nonadverse party is any

person who is not an adverse party. I.R.C. § 672(b). An adverse party is

defined as “any person having a substantial beneficial interest in the

trust which would be adversely affected by the exercise or nonexercise

of the power which he possesses respecting the trust.” I.R.C. § 672(a). “A

person having a general power of appointment over the trust property

is deemed to have a beneficial interest in the trust.” Treas. Reg.

§ 1.672(a)-1(a). And a beneficial interest is substantial “if its value in

relation to the total value of the property subject to the power is not

insignificant.” Id. A trustee does not automatically have a substantial

beneficial interest in a trust. Id.

The Commissioner argues that Mr. Hoyal is not an adverse party

because he did not have a beneficial interest in the trust. Specifically,

the Trust Agreement did not grant him a power of appointment or the

right to share in the income or property of the trust. However, we are

not confined to the Trust Agreement to determine whether Mr. Hoyal

was an adverse party. Mr. Simpson disagrees. He argues that Mr. Hoyal

had a beneficial interest in Scenic Trust because he engaged in fraud to

enrich himself with Scenic Trust assets. The record does not support Mr.

Simpson’s argument.

24

[*24] Mr. Hoyal was not an adverse party. The Trust Agreement

granted him no rights to Scenic Trust’s income or property. Neither was

he granted a power of appointment. And looking beyond the Trust

Agreement, Mr. Hoyal discussed most, if not all, Scenic Trust decisions

with Mr. Simpson. He did not take any action without the explicit or

implicit approval of Mr. Simpson. Furthermore, every decision was

made for the benefit of Mr. Simpson. Therefore, Mr. Hoyal would not be

adversely affected by the exercise or nonexercise of his powers as trustee

of Scenic Trust.

b)

Whether Scenic Trust’s Beneficiary During the Years in Issue

Is Treated as Mr. Simpson’s

Spouse

During the years in issue, Mrs. Simpson was the beneficiary of

Scenic Trust. Pursuant to section 677, income distributed to her or held

for future distribution to her is likewise considered to be distributed or

held for Mr. Simpson unless they were legally separated. See I.R.C.

§ 672(e)(2); Vercio v. Commissioner, 73 T.C. 1246, 1258 (1980).

Individuals are determined to be legally separated, and thus not

determined to be married for purposes of section 677, when there is a

divorce decree or separate maintenance filing. I.R.C. § 672(e)(2).

Mr. Simpson failed to provide sufficient evidence to establish that

he was legally separated during 2013. He points to a marital separation

agreement for support. But we have no record of this agreement’s being

filed with any court. Therefore, we treat Mrs. Simpson as Mr. Simpson’s

spouse for purposes of section 677 for 2013.

c)

Conclusion

Mr. Hoyal was a nonadverse party who had discretion to

distribute, or accumulate for future distribution, trust income or

property to Mr. Simpson’s spouse during the years in issue. Therefore,

Mr. Simpson is treated as the owner of Scenic Trust. See I.R.C. § 677(a).

Consequently, we need not address the sham-trust doctrine.

c.

Specific Items of Income

i.

Imputed Interest Income

The Commissioner determined and established imputed interest

income of $54,442 for Mr. Simpson. This determination was based on

25

[*25] Reality Kats’s sale of 3922 Bellinger for payments over time but

with a stated interest rate of zero. Mr. Simpson did not offer any

argument or evidence to dispute the Commissioner’s determination.

Accordingly, we sustain the Commissioner’s determination.

ii.

Taxable Interest Income

The Commissioner determined and established taxable interest

income of $221,078 for Mr. Simpson. This amount included interest

income from transactions entered into by Scenic Trust and interest

income unreported by Mr. Simpson. Mr. Simpson did not offer any

argument or evidence to dispute the Commissioner’s determination.

Accordingly, we sustain the Commissioner’s determination.

iii.

Reality Kats’s Gross Receipts

The Commissioner determined and established gross receipts of

$3,638,540 as taxable to Mr. Simpson. This amount included Reality

Kats’s gross income reported for 2013 and the gain resulting from

Reality Kats’s sale of 14957 Encendido. Mr. Simpson did not offer any

argument or evidence to dispute the Commissioner’s determination.

Accordingly, we sustain the Commissioner’s determination.

iv.

Schedule C2 Gross Receipts

The Commissioner determined and established additional gross

receipts of $480,968 for Mr. Simpson. This amount reflected unreported

bank deposits and cash payments.

Bank deposits are prima face evidence of the receipt of income,

and the taxpayer bears the burden of proving that the Commissioner’s

determination of unreported income based on the bank deposits is

incorrect. Parks v. Commissioner, 94 T.C. 654, 658 (1990). Mr. Simpson

disputes this amount, stating that he explained to the Commissioner

that the deposits constituted equity transfers between personal

accounts or loan principal repayments. However, Mr. Simpson’s

statement did not direct the Court to any supporting documents at trial

or on brief. Accordingly, we sustain the Commissioner’s determination.

v.

Dividends

The Commissioner determined and established qualified dividend

income of $984 and ordinary dividend income of $31 for Mr. Simpson.

These determinations reflected the amounts shown on Scenic Trust’s

26

[*26] Form 1099‒DIV, Dividends and Distributions, reported by

Morgan Stanley. Mr. Simpson did not offer any argument or evidence to

dispute the Commissioner’s determination. Accordingly, we sustain the

Commissioner’s determination.

vi.

Royalties

The Commissioner determined and established royalty income of

$1,042 for Mr. Simpson. This determination reflected the amount shown

on Mr. Simpson’s Form 1099‒MISC, Miscellaneous Income, reported by

Continental Resources, Inc. Mr. Simpson did not offer any argument or

evidence to dispute the Commissioner’s determination. Accordingly, we

sustain the Commissioner’s determination.

vii.

Rents

The Commissioner determined and established rental income of

$58,437 from 355 Industrial Circle for Mr. Simpson. In 2013, Scenic

Trust rented out the property and received rents. Mr. Simpson did not

offer any argument or evidence to dispute the Commissioner’s

determination. Accordingly, we sustain the Commissioner’s

determination.

viii.

Wages

In 2013, Mr. Simpson received from Reality Kats wages of

$1,556,976. Because Reality Kats’s income should be reattributed to Mr.

Simpson, $1,556,976 should be credited against Reality Kats’s

reattributed gross receipts.

2.

Deductions

Taxpayers bear the burden of proving that they are entitled to

claimed deductions and credits. Rule 142(a); INDOPCO, Inc. v.

Commissioner, 503 U.S. 79, 84 (1992). Carrying that burden requires

the taxpayer to “substantiate the nature, amount, and purpose of a

claimed deduction.” Sezonov v. Commissioner, T.C. Memo. 2022-40,

at *4. In limited situations, the burden may shift to the Commissioner

under section 7491(a). The record does not support shifting the burden

to the Commissioner.

Mr. Simpson did not establish his entitlement to any deductions

for 2013 beyond those allowed in the Commissioner’s First Amended

Answer to Second Amended Petition. Although he claimed itemized

27

[*27] deductions on his since-disavowed 2013 return, the Commissioner

disallowed those deductions in his Notice of Deficiency. And Mr.

Simpson did not offer evidence to substantiate or otherwise support any

deductions beyond those allowed.

3.

Novato

Affected items that require partner level determinations may be

determined in deficiency proceedings. I.R.C. § 6230(a)(2)(A)(i) (TEFRA);

I.R.C. § 6231(a)(5) (TEFRA); Estate of Quick v. Commissioner, 110 T.C.

172, 183 (1998). We have held “that the characterization of losses as

either passive or nonpassive in the hands of a partner is an affected item

under section 469.” Estate of Quick, 110 T.C. at 188. The Commissioner

asks us to determine whether Mr. Simpson’s participation in Novato

constituted passive activity under section 469.

Section 469 prevents a taxpayer from using passive losses to

offset nonpassive income. Lamas v. Commissioner, T.C. Memo. 2015-59,

at *27. Passive activity is defined as activity that involves the conduct

of any trade or business in which the taxpayer does not materially

participate. I.R.C. § 469(c). Taxpayers materially participate if they are

involved in the operations of the trade or business on a regular,

continuous, and substantial basis. I.R.C. § 469(h)(1). The Treasury

regulations set forth seven tests to determine whether a taxpayer

materially participated. Temp. Treas. Reg. § 1.469-5T(a). And a

taxpayer needs to satisfy only one of the tests. Lamas, T.C. Memo. 201559, at *28.

Mr. Simpson did not put forth evidence (at trial or in his brief)

showing that he materially participated in Novato. Thus, Novato was a

passive activity for Mr. Simpson.

B.

Section 6651(f) Addition to Tax

Mr. Simpson did not file a tax return for 2013. Sections 6011 and

6012 require every individual who has gross income above certain

amounts for a taxable year to file an income tax return. Section

6651(a)(1) provides for an addition to tax for failure to file a timely

return, equal to 5% of the amount required to be shown as tax on the

return, for each month or fraction thereof during which such failure

continues, not exceeding 25% in the aggregate. If, however, the failure

to file any return is fraudulent, section 6651(f) imposes an increased

addition to tax equal to 15% of the amount required to be shown as tax

on the return for each month or fraction thereof during which such

28

[*28] failure continues, not exceeding 75% in the aggregate. The

Commissioner has determined that Mr. Simpson’s failure to file for 2013

was fraudulent.

In ascertaining whether a taxpayer’s failure to file was fraudulent

under section 6651(f), the Court considers the same elements that are

considered in imposing the fraud penalty under section 6663. Clayton v.

Commissioner, 102 T.C. 632, 653 (1994). Those two elements of fraud

are (1) the existence of an underpayment and (2) fraudulent intent with

respect to some portion of the underpayment. See Mohamed v.

Commissioner, T.C. Memo. 2013-255, at *17–18. The existence of an

underpayment is not in question here because we have determined that

the income of Reality Kats and Scenic Trust should be reattributed to

Mr. Simpson.

To establish fraudulent intent under section 6651(f), we consider

the badges of fraud and whether they establish that Mr. Simpson

deliberately failed to file his 2013 return, knowing that, by doing so, he

was concealing the fact that he had income subject to tax. See Mohamed,

T.C. Memo. 2013-255, at *21.

This Court has previously decided this issue on facts similar to

those here. In Mohamed, T.C. Memo. 2013-255, at *4–5, *12–13, a

taxpayer’s 2007 return was considered invalid because it was signed by

the taxpayer’s business partner who did not have authority to sign on

the taxpayer’s behalf. The Commissioner determined a section 6651(f)

addition to tax for fraudulent failure to file for the taxpayer. Mohamed,

T.C. Memo. 2013-255, at *16. In finding that the taxpayer’s failure to

file was not fraudulent, we held:

While the evidence may be sufficient to find that [the

taxpayer] intended to file a fraudulent return for 2007 . . .

but failed to do so, the evidence is insufficient for us to

conclude that [the taxpayer] employed [his business

partner] in a deliberate attempt to file a purported return

that, if respondent examined it and charged him with

fraudulent underpayment of tax, [the taxpayer] could then

disavow.

Id. at *30–31. As in Mohamed, a return was filed for Mr. Simpson’s 2013

tax year, but it was not signed by him or someone authorized to sign on

his behalf. And as in Mohamed, nothing in the record establishes that

Mr. Simpson had someone sign his 2013 return without official

29

[*29] authorization so that if the Commissioner examined it, Mr.

Simpson could later disavow it. The Commissioner has failed to

establish that Mr. Simpson’s failure to file his 2013 return was

fraudulent. As a result, the addition to tax for failure to file applies, but

not at the increased rate for a fraudulent failure to file.

III.

Conclusion

The Commissioner has failed to provide clear and convincing

evidence that petitioners filed fraudulent returns. Thus, the extended

period of limitations provided in section 6501(c) does not apply.

Accordingly, the Commissioner’s determinations and adjustments

relating to Mr. Simpson’s 2012 tax year and Scenic Trust’s 2012 and

2013 tax years are barred by the statute of limitations. But because he

did not file a valid return for 2013, the period of limitations to assess tax

for Mr. Simpson remains open for that year.

The Commissioner has failed to establish by clear and convincing

evidence that Mr. Simpson fraudulently failed to file his 2013 return.

Therefore, the section 6651(f) addition to tax does not apply. The

Commissioner has otherwise established the determinations for 2013 as

set forth in his First Amended Answer to Second Amended Petition.

Accordingly, Mr. Simpson is liable for an income tax deficiency for 2013

and an addition to tax for failure to timely file under section 6651(a)(1).

To reflect the foregoing,

Decision will be entered for petitioner in Docket No. 17749-21.

Decision will be entered under Rule 155 in Docket No. 17771-21.