T .C . Memo . 2010- 3
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T .C . Memo . 2010- 3
UNITED STATES TAX COUR T
FRANCIS J . AND JEANNE M . VLOCK, Petitioners v .
COMMISSIONER OF INTERNAL REVENUE, Responden t
Docket No . 13443-07 .
Filed
January
5,
2010 .
Frank W . Pechacek, Jr . , and Jamie L . Cox , for petitioners .
James A . Kutten and Stephen A . Haller , for respondent .
MEMORANDUM FINDINGS OF FACT AND OPINIO N
CHIECHI,
Judge : Respondent determined the following defi-
ciencies in, and accuracy-related penalties under section
6662(a)' on, petitioners' Federal income tax (tax) :
'All section references are to the Internal Revenue Code
(Code) in effect for the years at issue . All Rule references are
to the Tax Court Rules of Practice and Procedure .
SERVED JAN - 5 2010
Year
2003
Deficiency
2004
23,561
31,866
2005
$33,492
Accuracy-Relate d
Penalty Under Sec . 6662(a )
$ 6,698 .4 0
4,712 .2 0
6,373 .2 0
The issues remaining for decision are :
(1) Are petitioners entitled to deduct under section 162(a)
for each of their taxable years 2003 through 2005 certain amounts
that petitioner Francis J . Vlock paid to a certain corporation?
We hold that they are not .
(2) Are petitioners entitled to deduct under section 162(a)
for their taxable year 2003 certain amounts that they claim
petitioner Francis J . Vlock paid to .two of their children for
services rendered? We hold that they are not .
(3) Are petitioners liable for each of their taxable years
2003 through 2005 for the accuracy-related penalty under section
6662(a)? We hold that they are .
u
FINDINGS OF FAC T
Some of the facts have been stipulated and are so found
except as stated herein .
At the time petitioners filed the petition in this case,
they resided in Nebraska .
- 3 Mr . Vlock's Insurance Busines s
From at least 1978 to the time of the trial in this case,
petitioner Francis J . Vlock (Mr . Vlock)2 served as an insurance
representative of one or more insurance companies . As an insurance representative, Mr . Vlock sold insurance and certain other
financial products, such as variable annuities and other securities, in several States . From 2000 to the time of the trial in
this case, Mr . Vlock primarily represented New York Life Insurance Co . (New York Life) . From 2002 to the time of the trial in
this case, Mr . Vlock was an independent contractor of New York
Life and operated his business (Mr . Vlock's insurance business)
as a sole proprietorship .
From 1975 until 2002, petitioner Jeanne M . Vlock (Ms . Vlock)
spent most of her time raising and caring for petitioners' four
children . Before 2002, Ms . Vlock had been involved sporadically
in'Mr . Vlock's insurance business and had occasionally provided
certain unidentified services to Mr . Vlock's insurance business .
In June 2000, Mr . Vlock underwent hip surgery, which required him to spend several months recovering . In order to
maintain Mr . Vlock's insurance business during that period of
recovery, Mr . Vlock worked primarily at petitioners' . persona l
2In referring to Mr . Vlock, the record refers interchangeably to Francis J . Vlock, F . Joseph Vlock, Joseph Vlock, and Joe
Vlock .
residence at South 167th Circle, Omaha, Nebraska (petitioners'
residence) .
In 2000, Mr . Vlock and New York Life entered into a contract
whereby Mr . Vlock became a so-called district agent of New York
Life . As such, Mr . Vlock, inter alia, was responsible for
hiring, training, and developing individuals to become agents for
New York Life (agents-in-training) .. In exchange for his services
as a district agent, Mr . .Viock was entitled to certain commissions on the sales of New York Life insurance products by th e
agents-in-training .
Vlock treated the agents-in-trainin g
that he hired in his capacity as a New York Life district agent
as independent contractors . .
Starting around 2000, Mr . Vlock acquired as clients approximately 2,500 to 3,000 individuals (additional clients) who had
been clients-of certain other agents of New York Life who had
died or retired . Those additional clients nearly doubled the
total number of clients of Mr . Vlock's insurance business .
While Mr . Vlock was recovering from his hip surgery and was
acquiring the additional clients, he decided that he needed
additional assistance in order to maintain and improve Mr .
Vlock's insurance business . Around 2000 or 2001, Mr . Vlock
discussed with Ms . Vlock whether she was willing to become more
involved in Mr . Vlock's insurance business in order to assist him
in servicing additional clients and obtaining new clients . . Ms .
- 5 Vlock was open to that possibility because petitioners' children
no longer required her full-time care and attention. . At a time
between around mid-2000 and the end of 2001, petitioners agreed
that Ms . Vlock was to provide to Mr . Vlock certain . assistance in
marketing Mr . Vlock's insurance business and servicing it s
clients .
From 2002 through the summer of 2006, Mr . Vlock operated Mr .
Vlock's insurance business in office space that he leased at 6901
Dodge Street, Omaha, Nebraska (Dodge Street office) . In the
summer of 2006, Mr . Vlock terminated the lease with respect to
that office and moved Mr . Vlock'•s insurance business to office
space that New York Life owned at Valmont Plaza, Omaha, Nebraska .
During 2003 through 2005, the years at issue,. Mr . Vlock
employed at least one or more of the following individuals in Mr .
Vlock's insurance business : Paul Jensen, Shirley Schmidt, and
Kiran Khajuria : During those years, those employees performed
their respective duties for Mr . Vlock's insurance business at the
Dodge Street office .
Paul Jensen, whom Mr . Vlock employed on a full-time basis
during 2003 and part of 2004, served as a receptionist for Mr .
Vlock's insurance business and also was responsible for performing certain administrative-and secretarial tasks for that business . Those tasks included (1) scheduling certain appointments
for Mr . .Vlock, (2) creating files for certain new clients and
6 certain prospective clients,
(3)
managing interns that Mr . Vlock
hired, (4) maintaining office equipment used at the Dodge Street
office, and (5) .preparing newsletters and other mailings . During
2003 and 2004, Mr . Vlock paid to Paul Jensen total wages o f
$29,475 .84 and $19,466 .56, respectively, . and reported those
amounts in Forms W-2, Wage and Tax Statements (Forms W-2), that
he issued to him for those respective years .
Shirley Schmidt, whom Mr . Vlock employed on a part-time
basis during each of the years at issue, was responsible for
performing certain administrative and financial tasks for Mr .
Vlock's insurance business . Those tasks included (1) payroll
administration, (2) handling certain calls from clients ,
(3) preparing disclosure documents and compliance materials ,
(4) processing checks, executing wire transfers, and conducting
certain other financial transactions, and (5) preparing certain
tax reporting materials such as Forms W-2 and Forms 1099-MISC,
Miscellaneous Income (Forms 1099-MISC) . During 2003, 2004, and
2005, .Mr . Vlock paid to Shirley Schmidt total wages of $17,770,
$17,578, and $14,072, respectively, and reported those amounts i n
Forms W-2 that he issued to her for those respective years .
addition to paying those wages to Shirley Schmidt, . Mr . Vlock paid
her total nonemployee compensation of $2,320 .08, $2,087 .27, and
$925 .41 during 2003, 2004, and 2005, respectively, and reported
those amounts in Forms 1099-MISC that he issued to her for those
respective years .
Kiran Khajuria, whom Mr . Vlock employed on a part-time basis
during 2005, was responsible for performing various tasks for Mr .
Vlock's insurance business . Those tasks included (1) maintaining
prospectuses for the various financial products that Mr . Vlock
sold to clients, (2) maintaining computer equipment at the Dodge
Street office, (3) installing software on the computer system
utilized at the Dodge Street office, and (4) backing up that
computer system and maintaining all backup files . During 2005,
Mr . Vlock paid to Kiran Khajuria total wages of $1,383 and
reported that amount in Form W-2 that he issued to that individual for that year .
During 2004 and 2005, Mr . Vlock also hired Richard Ness and
Joaquin Wilwayco to provide services°to Mr . Vlock's insurance
business as independent contractors . . During those years, Richard
Ness assisted Mr . Vlock's insurance business with, inter alia,
training staff and identifying and developing new markets for
that business's insurance and financial products . During 2004
and 2005, Mr . Vlock paid to Richard Ness total nonemployee
compensation of $3,000 and $8,000, respectively, and reported
those amounts in Forms 1099-MISC that he issued to him for those
respective years .
8 During 2004, Joaquin Wilwayco provided to Mr . Vlock's
insurance business certain software training and assisted Mr .
Vlock with certain presentations and educational seminars .
During 2004, Mr . Vlock paid to Joaquin Wilwayco total nonemployee
compensation of $500 and reported that amount in Form 1099-MISC
that he issued to him for that year .
From 2002 through October 2005, Ms . Vlock worked 30 to 50
hours per week performing a number of services for Mr . Vlock's
insurance business . Those services included (1) preparing and
distributing materials relating to certain seminars and certain
programs that Mr . Vlock's insurance business offered to it s
clients and potential clients ; (2) organizing speakers, venues,
itineraries, and other logistics for those seminars and those
programs ; (3) receiving and processing certain calls from some
clients of Mr . Vlock's insurance business regarding their accounts ; (4) sorting mail delivered to petitioners' residence
between personal mail and mail relating to Mr . Vlock's insurance
business ; (5) scheduling for Mr . Vlock certain appointments with
some clients and some potential clients of Mr . Vlock's insurance
business ; (6) arranging and tracking certain medical appointments
for some clients of Mr . Vlock's insurance business where such
appointments were prerequisites in order to buy certain insurance
products ; (7) handling home entertainment and hospitality for
certain clients of Mr . Vlock's insurance business ; (8) processing
certain claims for benefits ; and (9) entering into Mr . Vlock's
insurance business's database system certain account information
for some of the additional clients and organizing and maintaining
relevant files with respect to those clients . Beginning in
October 2005, Ms . Vlock reduced the number of hours that she
worked each week for Mr . Vlock's insurance business to about 30
hours .
Mr . Vlock prepared the following documents with respect to
Mr . Vlock's insurance business : (1) A document dated December
2002 and entitled "Annual Business Plan for Joe Vlock, CLU, ChFC
& Associates, 1729 South 167 Circle, Omaha, NE 68130" (December
2002 annual business document) ; (2) a document dated January 2004
and entitled "Annual Business Plan for Joe Vlock, CLU, ChFC &
Associates, 1729 South 167 Circle, Omaha, NE 68130" (January 2004
annual business document) ; and (3) a document dated January .2005
and entitled "2005 Business Plan, F . Joseph Vlock, CLU,IChFC &
Richard L . `Rick' Ness, LUTCF, New York Life" (January-2005
annual business document) . (We shall refer collectively to the
December 2002 annual business document, the January 2004 annual
business document, and the January 2005 annual business document
as the Vlock insurance business annual business documents . )
The second page of the December 2002 annual business document (December 2002 annual business document second page) was
- 10
entitled "JOE VLOCK 2002 BUSINESS PLAN, PERFORMED BY
VLOCK/HAMMOND" and stated :
Specific Goals for 2002
1 . Chairman's Counci l
2 . Recreation Time (Family)
3 . Educatio n
4 . Consistent Growt h
5 . Prioritize Phone Lis t
6 . Keep Notes in File Neat/Clean up Files
7 . Workable Plan
8 . Creative Time
9 . Time Managemen t
The December 2002 annual business document second page was the
only page on which Mr . Vlock referred in the December 2002 annual
business document to "VLOCK/HAMMOND" .3 In the December 2002
annual business document, Mr . Vlock did not set forth any specific goals that he expected Vlock and Hammond to accomplish, or
any specific tasks that he expected Vlock and Hammond to perform,
with respect to Mr . Vlock's insurance business .
In the January 2004 annual business document, Mr . Vlock did
not refer to Vlock and Hammond . Instead, Mr . Vlock referred in
that document to "Jeanne" (i .e ., Ms . Vlock) the following fou r
3We believe that the reference to "VLOCK/HAMMOND" is to
Vlock and Hammond, Inc . (discussed below) . (We shall refer to
Vlock and Hammond, Inc ., as Vlock and Hammond .)
- 11 times : (1) In a section entitled " Opportunities ", Mr . Viock
stated that "Jeanne is committed to co-ordinate all marketing and
case preparation and public relations with clients" ; (2) in a
section entitled " Threats ", Mr . Viock asked : "Can Joe & Jeanne
work together" ; and (3) in a section entitled " Key Strategies for
Planning Year ", Mr . Viock stated (a) that he was
to "Spend 2-3
hours with Jeanne coordinating monthly seminars, case presentations and client appreciation workshops", and (b) " Jeanne to
coordinate center of influence appointments ." Mr . Viock did not
indicate in the January 2004 annual business document that the
four references in that document to "Jeanne" were to Ms . Viock
acting on behalf of Viock and Hammond . Nor did Mr . Viock refer
in the January 2004 annual business document to "Jeanne" in such
a way as to establish that, if and when Ms . Viock were to perform
services for Mr . Vlock's insurance business, she would be acting
on behalf of Viock and Hammond .
Mr . Viock did not refer to Viock and Hammond or to Ms . Viock
in the January 2005 annual business document . In that document,
Mr . Viock set forth goals and objectives for Mr . Viock, Richard
Ness, and a person identified in that document as "Jess" . In the
January 2005 annual business document, Mr . Viock also set forth
analyses of the strengths and weaknesses of, the opportunities
for, and the threats to Mr . Viock and Richard Ness . In that
document, Mr . Viock did not assign any tasks or goals to Viock
- 12 and Hammond or to Ms . Vlock acting on behalf of Vlock and Hammond,
and did not indicate that Vlock and Hammond or Ms . Vlock acting
on behalf of Vlock and Hammond was to assist Mr . Vlock, Richard
Ness, or "Jess" in achieving any of the goals and objectives that
Mr . Vlock set forth in that document for each of them .
During 2003, an unidentified individual prepared two documents (business potential documents), each of which was entitled
"ASSESS YOUR BUSINESS POTENTIAL REPPORT [sic] - 2003, JOE VLOCK,
CLU ., CHFC/VLOCK & HAMMOND" . Each of those titles contained the
only reference to Vlock and Hammond in each of those documents .
Each of the business potential documents contained severa l
statements that were addressed directly to Mr . Vlock, including
the following :
Joe, here is my summary of your needs for coaching and
activities to go to the next level . All of these
actions and systems could be set up through customized
coaching .
OVERVIEW OF ACTIONS NEEDED AND YOUR COACHING NEED S
• Clear Goals : for 1 year and 1 quarte r
• Clear Marketing Systems : Target market business /estate, build strong client centers of
Influence, use your speaking skills .
• Better staff utilization : train Jean~43 to be
your marketing coordinator .
• Polish your office systems : have less service interruptions .
• Better time management : plan and coordinate
your day, week, and month ; deal with your
time wasters .
4We believe that the reference to "Joan" is to Ms . Vlock .
- 13 -
• Get out of your comfort zone :, stay "focused"
.on your insurance business .
• Increase your sales activity and case size
through target marketing .
• Joe, good things are ahead for you and your
staff . You can go to the next level .
The reference to "Jean" in the above-quoted statement was the
only reference to Ms . Vlock in each of the business potential
documents . The author of each of those documents did not indicate therein that each such reference was to Ms . Vlock acting on
behalf of Vlock and Hammond . Nor did the author refer in either
of the business potential reports to Ms . Vlock in such a way,as
to establish that, if and when Ms . Vlock were to perform services
for Mr . Vlock's insurance business, she would be acting on behal f
of Vlock and Hammond .
Petitioners filed Form 1040, U .S .-Individual Income T
Return, for each of their taxable years . 2003 (2003 return), 2004
(2004 return), and 2005 (2005 return) . Frank Pechacek (Mr .
Pechacek), an attorney at the firm of Willson & Pechacek, P .L .C .,
prepared each of those returns for petitioners ..5 Petitioners
attached to each of the 2003 return, the 2004 return, and the
2005 return Schedule C, Profit or Loss From Business (Schedule
C) . In each of those schedules, Mr . Vlock reported income
derived from, and claimed expenses with respect to, Mr . Vlock's
insurance business .
5Mr . Pechacek is the lead attorney who represents petitioners in this case .
- 14 -
In Schedule C that petitioners attached to the 2003 return
(2003 Schedule C), Mr . Vlock claimed the following expenses,
inter alia, with respect to Mr . Vlock' s insurance business :
Description
Amoun t
Rent--Dodge Street office
$20,09 6
Wages
47, :24 6
Contract labor
Management services
5,92 0
120,00 0
The amount that Mr . Vlock claimed as a deduction for contract
labor in the 2003 Schedule C included a total of $3,600 that Mr .
Vlock reported as nonemployee compensation in respective Forms
1099-MISC for taxable year 2003 that he issued to petitioners'
daughters Sarina and Jennifer (collectively, Vlock daughters) .
In those respective forms, Mr . Vlock claimed that he paid as
"Nonemployee compensation" $1,400 and $2,200 to Sarina and
Jennifer, respectively .
In the Schedule C that petitioners attached to the 2004
return (2004 Schedule C), Mr . Vlock claimed the following expenses, inter alia, with respect .to Mr . Vlock's insurance business:
. Description
Amount
Rent--Dodge Street office
Wages
$18,97 2
37,04 4
Contract labor
Management services
4,00 0
120,000
- 15
In Schedule C that petitioners attached to the 2005 return
(2005 Schedule C), Mr . . Vlock claimed the following expenses,
inter alia, with respect to Mr . Vlock' s insurance business :
Description
Amount
Rent--Dodge Street office $20,696
Wages
Management
24,380
services
109,00 0
The respective deductions that petitioners claimed with
respect to management services in the 2003 Schedule C, the 2004
Schedule C, and the 2005 Schedule C ,represented the respective
amounts that petitioners claimed that Mr . Vlock paid to Vlock and
Hammond during 2003, 2004, and 2005, respectively .
Vlock and Hammon d
As discussed above, Ms . Vlock wanted to help Mr . Vlock with
Mr . Vlock's insurance business, and between around mid-2000 and
the end of 2001 petitioners agreed that Ms . Vlock was to provide
to Mr . Vlock's insurance business certain assistance in marketing
that business and servicing some of its clients . However,
petitioners wanted Ms . Vlock to-do so in a manner that woul d
achieve certain tax-avoidance objectives (discussed below) .
an attempt to achieve those objectives, on December 27, 2001, Ms .
Vlock incorporated Vlock and Hammond under the laws of the State
of Nebraska . From the incorporation of Vlock and Hammon d
throughout the years at issue, Ms . Vlock was its sole stockholder
- 16 and its sole director, and the following individuals served as
its officers :
Jeanne M . Vlock President and Treasurer
Angela Vlock6 Vice Presiden t
Francis J . Vlock Secretary
One of the tax-avoidance objectives of petitioners in having
Ms . Vlock incorporate Vlock and Hammond was that they did not
want Ms . Vlock to receive cash wages for the services that she
was to perform for Mr . Vlock's insurance business because she
would have to report any such wages as income and pay tax on that
income . Another tax-avoidance objective of petitioners in having
Ms . Vlock incorporate Viock and Hammond was to have Vlock and
Hammond pay virtually all of petitioners' personal living expenses with funds which Mr . Vlock was to pay to Vlock and Hammond
and for which petitioners were to claim tax deductions .
In an attempt to bolster the chances that they would succeed
in achieving their tax-avoidance objectives, petitioners created
a paper trail relating to Vlock and Hammond .
The Purported Management Agreemen t
On January 1, 2002, Mr . Vlock and Vlock and Hammond executed
a document entitled "MANAGEMENT CONSULTING AGREEMENT" (purported
management agreement) . Ms . Vlock executed that document o n
'Angela Vlock is petitioners' oldest child .
- 17 behalf of Vlock and Hammond . The purported management agreement
stated in pertinent part :
1 . Management Services . [Mr .] Vlock hereby
contracts with [Vlock and Hammond] * * * to perform
management and consulting services in accordance with
the terms and conditions set forth in this Agreement .
[Vlock and Hammond] * * * will consult with [Mr .]
Vlock concerning matters related to the management and
operation of [Mr . Vlock's insurance business] '* * *,
his financial policies, and generally any matter arising out of the business affairs of [Mr .] Vlock . The
management services shall include, but not be limited
to, advice and services regarding marketing, accounting, technical and computer support, and personnel
matters . The management services regarding personnel
matters shall include advice regarding employment
control, supervision, hiring and discharge of employees
and independent contractors hired by [Mr .] Vlock .
[Vlock and Hammond] * * * may provide advice with
respect to employee benefits and enter into negotiations regarding same on behalf of [Mr .] Vlock . [Vlock
and Hammond] * * * will also provide advice with respect to the purchase and/or lease of equipment and
supplies relating to [Mr .] Vlock's business .
*
3 . Payment to Consulting Company . [Mr .] Vlock
shall pay [Vlock and Hammond] * * * the sum of
$10,000 .0 [sic] per' month on or before the first day of
each month . [Mr .] Vlock shall not be required to pay
any other fee or benefit to [Vlock and Hammond] * * *
for services rendered . [Vlock and Hammond] * * * may
submit reasonable out-of-pocket expenses from time to
time to [Mr .] Vlock which will be reimbursed only upon
[Mr .] Vlock [' s ] approval .
4 . Duties of Consulting Company . [Vlock and
Hammond] * * * shall furnish consulting and management
services and render advice to [Mr .] Vlock at all times
reasonably requested by [Mr .] Vlock, subject, however,
to the following conditions :
*
- 18 -
g•
[Vlock and Hammond] * * * shall provide adequate office space, office equipment and
furnishings, general liability insurance, all
office supplies, adequate office staff, all
telephone and reception services, all reasonable subscriptions and . all postage, correspondence materials and typing services to
[Mr .] Vlock .
In arriving at the $10,000 amount stated in section 3
(quoted above) of the purported management agreement, neither Mr .
Vlock nor Ms . Vlock consulted an accountant, business manager, or
compensation expert . However, Ms . Vlock consulted Mr . Pechacek,
the attorney whom petitioners retained for the purpose of assisting Ms . Vlock in incorporating Vlock and Hammond and drafting
certain documents for it, including, inter alia, the purporte d
management agreement . '
On October 25, 2005, Mr . Vlock and Vlock and Hammond executed an amendment (2005 amendment) to the purported management
agreement . That amendment reduced the amount stated in section 3
of that purported agreement from $10,000 per month to $7,500 per
month .
7The record does not establish what Mr . Pechacek, who was
the preparer of petitioners' 2003 return, 2004 return, and 2005
return and who is the lead attorney representing petitioners in
this case, see supra note 5, told Ms . Vlock when she consulted
him . Before the commencement of the trial in this case, petitioners waived any potential conflicts of interest regarding Mr .
Pechacek, who was not called as a witness at that trial .
- 19 At the times, indicated,' Mr . Vlock paid to Vlock and Hammond
the following amounts (Mr . Vlock's payments to Vlock and
Hammond) :'
Time
January 2003
Feb . 6, 2003
Mar . 4, 2003
Amoun t
$5,000 .0 0
10,000 .0 0
Apr . 9, 2003
10,000 .0 0
10,000 .0 0
May 2003
June 10, 2003
10,000 .0 0
10,000 .0 0
July 21, 2003
5,000 .0 0
Sept . 3, 2003
October 2003
10,000 .0 0
10,000 .0 0
November 2003
10,000 .0 0
11,100 .0 0
Nov . 29, 2003
Dec . . 6, 2003
2003 Total
10,000 .0 0
$111,100 .0 0
'The record does not establish the days in all of the months
during the years at issue on which Mr .-Vlock made payments to
Vlock and Hammond .
9Petitioners concede that they are unable to establish that
Mr . Vlock made all of the payments to Vlock and Hammond that they
claimed as the respective deductions in the 2003 Schedule C, the
2004 Schedule C, and the 2005 Schedule C . They also concede that
during each of the years at issue Mr . Vlock paid to Vlock and
Hammond a total amount that was less than (1) the annual total of
the monthly amount stated in sec . 3 of the purported management
agreement and (2) the amount that petitioners claimed as a
deduction for management services in Schedule C included with the
return that they filed for each of those years .
- 20
-
Jan . 5, 2004
Feb . 5, 2004
$10,000 .0 0
10,000 .0 0
10,000 .0 0
Mar . 29, 2004
Apr . 13, 2004
May 1, 2004
10,000 .0 0
10,000 .0 0
June 11, 2004
10,000 .0 0
July 7, 2004
10,000 .0 0
10,000 .0 0
Aug . 9, 2004
Sept . 10, 2004
10,000 .0 0
10,000 .0 0
Nov . 1, 2004
2004 Total
$100,000 .0 0
January 2005
$10,000 .0 0
February 2005
April 2005
20,000 .0 0
10,000 .0 0
May 2005
June 2005
10,000 .0 0
10,000 .0 0
5,000 .0 0
July 2005
,August 2005
10,000 .0 0
10,000 .0 0
September 2005
October 2005
November 2005
2005 Total
10,000 .0 0
12,873 .3 3
$107,873 .3 3
The Purported Employment Agreemen t
On January 1, 2002, Ms . Vlock and Viock-and Hammond executed
a document entitled "EMPLOYMENT AGREEMENT" (purported employment
agreement) . Ms . Vlock executed that document both in her individual capacity and in her capacity as president of Vlock and
Hammond . The purported employment agreement stated in pertinent
part :
An Agreement made between Jeanne M . Vlock of
Omaha, Nebraska, herein referred to as Employee and
Vlock & Hammond, Inc ., whose principal place of business is located at 1729 South 167th Circle, Omaha,
- 21 Nebraska [petitioners' residence], herein referred to
as Employer .
*
*
*
SECTION 1 .
EMPLOYMENT
Employer hereby employs, engages, and hires Employee as an operational supervisor and monitor of a
portion of Employer's business, and Employee hereby
accepts and agrees'to such hiring, engagement and
employment, subject to the general supervision and
pursuant to the orders, advice and direction of Employer .
Because of certain necessities required for the
proper performance of the duties which the Employee
must perform for the Employer under this Agreement and
because of the benefits and conveniences accruing to
the Employer by having the Employee residing on business premises of the Employer, the Employee shall be
required to live in the housing furnished by the Employer on the business premises [petitioners' residence] of the Employer . * * *
*
*
SECTION 3 .
TERM OF EMPLOYMEN T
The term of this Agreement shall be a period of
one year, commencing January 1, 2002, and terminating
Dec . 31, 2003 [sic], subject however, to prior termination as herein provided . At the expiration date of
Dec . 31, 2003 [alteration in original], this Agreement
shall be considered renewed for regular periods of . one
year provided neither party submits a notice of termination .
- 22 SECTION 6 .
SPECIFIC DESCRIPTION OF CERTAIN DUTIE S
While at all times, the Employee will be subject
to such additional duties and services as may be required by the Employer, the following are a list of
certain specific duties and responsibilities Employee
[Ms . Vlock] shall have in performing services for the
Employer . The Employee in performing these services
shall be on call twenty-four hours a day except for
reasonable vacations as the Employer may allow . Duties
and responsibilities are to be performed .at the location as directed by the Employer above .
(1) To constantly be present in the area of
responsibility to deter and guard
against vandalism and theft of equipment, tools, buildings, and other property of the Employer .
(2) To maintain watch over the property of
the Employer so as to discover and report any damage to any of the Employer's
property from wind, fire, freezing, or
other catastrophes and to take any other
action if possible to minimize said
losses .
(3) To be present on the premises so as to
immediately detect and report any interruption of electrical service to the
facilities of the Employer so as to
minimize the possibility of any losses .
(4) To monitor the performance and activities of other Employees of the Employer
working on the premises and report to
the Employer concerning their activities .
(5) To provide assistance to other Employees
of the Employer in case of a breakdown
or emergency while operating on the
property of the Employer .
- 23 (6) To be present to alert other designated
Employees of shipments of materials
being received by Employer .
The purported employment agreement contained a section
entitled "COMPENSATION OF EMPLOYEE" that stated :
SECTION 4 .
COMPENSATION OF EMPLOYE E
Employer [Vlock and Hammond] shall pay Employee
[Ms . Vlock] and Employee shall accept from Employer, in
full payment for Employee's services hereunder, minimum
compensation at the rate of to be determined later tlol
Dollars ($ ) per year, payable Notwithstanding any language to the contrary, Employer, in
its sole discretion, may pay Employee additional compensation from time to time .
At no time during the years at issue did Ms . Vlock or Vlock and
Hammond determine a rate of compensation to be paid to Ms . Vlock
as stated in section 4 of the purported employment agreement .
Vlock and Hammond's Board of Director s
On January 1, 2002, Vlock and Hammond held a meeting (January 1, 2002 meeting) of its board of directors (Vlock and Hammond
board), whose only member was Ms . Vlock . The minutes of that
meeting stated, inter alia, that the Vlock and Hammond boar d
(1) elected officers, of Vlock and Hammond, (2) adopted the bylaws
of Vlock and Hammond, (3) designated First Westroads Bank as
Vlock and Hammond's depository institution, (4) required tha t
"The phrase "to be determined later" was handwritten in a
blank underlined space in sec . 4 of the purported employment
agreement .
- 24
Vlock and Hammond's officers and directoruse their best efforts
to operate Vlock and Hammond in such a manner that stock of Vlock
and Hammond would qualify as stock under section 1244, (5) accepted Ms . Vlock's offer to purchase stock of Vlock and Hammond
and issued to her a certificate representing the number of shares
that she purchased, (6) made an election under section 248 with
respect to Vlock and Hammond's organizational expenses ,
(7) authorized Ms . Vlock to pay any expenses resulting from the
organization of Vlock and Hammond, and (8) adopted a "Nondiscriminatory Medical and Dental Reimbursement Plan" . The minutes of
the January 1, 2002 meeting did not reflect that the Vlock and
Hammond board discussed at that meeting the purported management
agreement and the purported employment agreement that Vlock and
Hammond had executed on the date of that meeting . Nor did those
minutes reflect that the Vlock and Hammond board discussed at
that meeting the nature or the extent of the services (1) that
the purported management agreement stated Vlock and Hammond was
to provide to Mr . Vlock's .insurance business and (2) that the
purported employment agreement stated Ms . Vlock was to provide to
Vlock and Hammond during any of the years at issue .
On November 22, 2003, Vlock and Hammond held a joint meeting
of stockholders of Vlock and Hammond and the Vlock and Hammond
board (November 22, 2003 meeting) . The minutes of that meeting
stated, inter alia, that the Vlock and Hammond board elected
- 25 officers of Vlock and Hammond . Those minutes did not reflect
that the Vlock and Hammond,board discussed at the November 22,,
2003 meeting the purported management agreement or the purported
employment agreement . Nor did the minutes of that meeting
reflect that the Vlock and Hammond board discussed at that,
meeting the nature or the 'extent of the services (1) that the
purported management agreement stated Vlock and Hammond was to
provide to Mr . Vlock's insurance business and (2) that the
purported employment agreement stated Ms . Vlock .was to provide to
Vlock and Hammond during any of the years at issue . The minutes
of the November 22, 2003 meeting did not reflect that the Vlock
and Hammond board discussed at that meeting that during 2003 Mr .
Vlock had failed to pay, or had paid late, certain of the amounts
stated in section 3 of the purported management agreement .
On November 16, 2004, Vlock and Hammond held a joint meeting
of stockholders of Vlock and Hammond and the Vlock and Hammond
board (November 16, 2004 meeting) . The minutes of that meeting
stated, . inter alia, that the Vlock and Hammond board elected
officers of Vlock and Hammond . Those minutes did not reflect
that the Vlock and Hammond board discussed at the November 16,
2004 meeting the purported management agreement or the purported
employment agreement . Nor did the minutes of that meeting
reflect that the Vlock and Hammond board discussed at that
meeting the nature or the extent of the services (1) that the
- 26 purported management agreement stated Viock and Hammond was to
provide to Mr, . Vlock's insurance business and (2) that the
purported employment agreement stated Ms . Vlock was to provide to
Vlock and Hammond during any of the years at issue . The minutes
of the November 16, 2004 meeting did not reflect that the Vlock
.Mr
4
.
and Hammond board discussed at that meeting that during 200
Vlock had failed to pay, or had paid late, certain of the amounts
stated in section 3 of the purported management agreement or the
purported employment agreement .
On October 25, 2005, Vlock and Hammond held a joint meeting
of stockholders of Vlock and Hammond and the Vlock and Hammond
board (October 25, 2005 meeting) . The minutes of that meeting
stated, inter alia, that the Vlock and Hammond board elected
officers of Vlock and Hammond . Those minutes did not reflect
that the Vlock and Hammond board discussed at the October 25,
2005 meeting the purported management agreement or the purported
employment agreement . Nor did the minutes of that meeting
reflect that the Vlock and Hammond board discussed at that
meeting the 2005 amendment that Vlock and Hammond had executed on
the date of that meeting . The minutes of the October 25, 2005
meeting did not reflect that the Vlock and Hammond board discussed at that meeting the nature or the extent of the services
(1) that the purported management agreement stated Vlock and
Hammond was to provide to Mr . Vlock's insurance business and
- 27 (2) that the purported employment agreement stated Ms . Vlock was
to provide to Vlock and Hammond during any of the years at issue .
Nor did those minutes reflect that the Vlock and Hammond boar d
discussed at that meeting that during 2005 Mr . Vlock had failed
to pay, or had paid late, certain of the amounts stated in
section 3 of the purported management agreement .
Certain Payments Made by Vlock and Hammon d
Consistent with petitioners' tax-avoidance objectives, Vlock
and Hammond (1) did not pay at any time during any of the years
at issue any cash wages to Ms . Vlock" and (2) paid during each
of those years virtually all of petitioners' personal living
expenses with funds which Mr . Vlock paid to Vlock and Hammond and
for which petitioners claimed tax deductions .1 2
Certain Payments Made by Vlock and
Hammond Relating to Petitioners' . Residenc e
On January 1, 2002, Vlock and Hammond and petitioner s
executed a document entitled "REAL ESTATE CONTRACT-INSTALLMENTS "
"-From 2002 until the time of the trial in this case, Vlock
and Hammond (1) did not file Form 941, Employer's Quarterly
Federal Tax Return, for any quarter or Form 940, Employer's
Annual Federal Unemployment (FUTA) Tax Return, for any taxable
year and (2) did not issue any Form W-2 or Form 1099-MISC .
12The parties stipulated the amounts of .the personal expenses of petitioners that Vlock and Hammond paid during each of
the calendar years 2003, 2004, and 2005, even though Vlock and
Hammond had a taxable year ending on November 30 . As for certain
payments that Vlock and Hammond made to Sarina (discussed below),
the parties stipulated the amounts that Vlock and Hammond paid to
her during each of its taxable years ended Nov . 30, 2003 through
2005 .
28 -
(real estate installment document) . That document stated in
pertinent part :
IT IS AGREED this 1st day of January, 2002, by and
between F . Joseph Vlock and Jeanne M . Vlock, husband
and wife, of the County of Douglas, State o f
Nebraska [alteration in original], Sellers ; and
Vlock & Hammond, Inc . of the County of Douglas, State
of lowaNebraska [alteration in original], Buyers ;
That the Sellers, as in this contract provided,
agree to sell-to the .Buyers, and the Buyers in consideration of the premises, hereby agree with the Sellers
to purchase the following described real estate situated in the County of Douglas, State of l aNebraska
[alteration in original] to-wit :
Lot Twenty-five (25), Pacific Heights Replat I, a
Subdivision in Douglas County, Nebraska [petitioners'
residence ]
* * * upon the terms and conditions following :
1 . TOTAL PURCHASE PRICE . The Buyers agree to pay
for said property the total of $290,000 .00 due and
payable * * * as follows :
The sum of $2,941 .00, principal and interest, per
month, commencing with the first payment due on February 1, 2002, in the sum of $2,941 .00, principal and
interest, on the first day of each and every month
thereafter until all principal and interest is paid in
full . Interest shall accrue at .the rate of 9-06 per
annum .
Buyer shall have the option to prepay in full or in
part at any time without penalty .
The real estate installment document was filed with the Recorder
of Deeds for Omaha, Nebraska . At no time did petitioners execute
a deed in favor of Vlock and Hammond with respect to petitioners'
I
- 29 residence . Petitioners continued to reside in petitioners'
residence after executing the real estate installment document .13
When petitioners and Vlock and Hammond executed the rea l
estate installment document, petitioners' residence was subject
to a mortgage held by CitiMortgage . At no time did petitioners
notify CitiMortgage that they had executed the real estate
installment document .
Vlock and Hammond did not make all of the monthly payments
to petitioners that the real estate installment document stated
it was to make . Instead, Vlock and Hammond paid to petitioner s
the following amounts on the dates indicated :
13On June 23, 2006, petitioners and Vlock and Hammond executed a document entitled "WARRANTY DEED-JOINT TENANCY" (warranty
deed) . That deed stated in pertinent part :
For the consideration of $224,900 .00 Dollar(s) * * *
Vlock & Hammond, Inc ., * * * and F . Joseph Vlock and
Jeanne M . Viock, * * * do hereby Convey to Freddie J .
Thayer and Connie L . Thayer, * * * Lot Twenty-five
(25), Pacific Heights Replat I, a Subdivision, as
surveyed, platted and recorded in Douglas County,
Nebraska [petitioners' residence ]
The warranty deed was recorded with the Recorder of Deeds in
Omaha, Nebraska . Peabody Title & Escrow Co . prepared a "SELLER'S
CLOSING STATEMENT" that identified petitioners as the sellers of
petitioners' residence and indicated that, after accounting for
all necessary adjustments, petitioners received $179,008 .94 in
cash from the sale of petitioners' residence .
- 30 Date
Apr .
10,
July 6,
Sept .
5,
2003
2003
2003
Amoun t
$8,82 3
11,76 4
5,88 2
Oct .
7,
2003
2,94 1
Nov .
4,
2003
2,94 1
Dec .
9,
2003
2,94 1
2003 Total
$35,29 2
$2,94 1
2,94 1
Jan .
4,
Feb .
4,
2004
2004
Apr .
12,
2004
5,88 2
June
10,
2004
5,88 2
July
14,
2004
2,94 1
Aug . 8, 2004
Sept . 10, 2004
2,94 1
2,94 1
Oct .
Nov .
14, 2004
2,94 1
6, 2004
2004 Total
2,94 1
$32,35 1
Jan .
4, 2005
$2,94 1
Feb .
10, 2005
5,88 2
Mar .
16, 2005
2,99 6
Apr .
16, 2005
2,99 6
May 17, 2005
June 16, 2005
2,99 6
2,99 6
July 15,` 2005
2,99 6
Aug . 6, 2005
Sept . 13, 2005
2,99 6
2,99 6
Oct .
Nov .
5, 2005
10, 2005
2,99 6
2,99 6
Dec .
14, 2005
.2,99 6
2005 Total
$38,78 3
(We shall refer to the foregoing amounts that Vlock and Hammond
paid to petitioners as the real estate installment document
payments .)
- 31 In addition to the payments described above, during each of
the years at issue Vlock and Hammond paid virtually all of the
expenses relating to petitioners' residence . Those expenses
included the following amounts that Vlock and Hammond paid during
the years indicated for expenses for real property taxes, repairs
and improvements (e .g ., a'sprinkler system, pest management, a
refrigerator and other appliances, hardware and other supplies,
plumbers and other home repairmen, carpet cleaning, and contractors), housecleaning services, landscaping services, bottledwater service, and all utilities (i .e ., electric, gas, water, and
sewer service, cable television and Internet access, and telephone service) :
- 32 Amount Paid Durin g
Category
Real property taxe s
2003
$3,484 .4 6
2004
200 5
$3,592 .9 6
$4,113 .7 6
Repairs and improvement s
Sprinkler system
Pest management
Appliances
Hardware and supplies
2,300 .00
-
-96 .30
549 .68
- 263 .7 9
75 .29
658 .67
1,523 .33
--
2,350 .00
424 .59
--
Carpet cleaning
Contractors
317 .79
347 .75
342 .4 0
--
690 .00
--
Other items
767 .40
487 .46
256 .2 2
150 .00
285 .0 0
Landscaping services
-246 .99
Bottled water service
114 .37
1,228 .76
8 .56
1,650 .3 8
162 .2 0
Electric
1,978 .68
1,345 .12
1,353 .3 3
Gas, water, and sewer
1,540 .39
1,667 .77
1,611 .0 5
358 .98
889 .86
1,160 .14
369 .10
1,490 .5 8
Repairmen
Housecleaning services
Utilitie s
Cable television an d
Internet access
Telephone service
--
(We shall refer to the foregoing amounts that Vlock and Hammond
paid for virtually all of the expenses relating to petitioners'
residence as the personal residence expenses . )
During each of the years at issue, Vlock and Hammond also
paid to maintain cellular telephone service for petitioners .
During 2003, 2004, and 2005, Vlock and Hammond paid $1,320 .98,
$1,114 .09, and $862 .63, respectively, for that service . (We shall
refer to the foregoing amounts that Vlock and Hammond paid for
cellular telephone service as the cellular telephone expenses) .
- 33 Certain Payments Made b y
Vlock and Hammond Relating to Foo d
During each of the years at issue, Ms . Vlock purchased food
at area grocery stores, including, inter alia, Bakers Grocery .
Store, Albertsons Grocery Store, and Hy Vee Grocery Store .
During each of those years, Vlock and Hammond reimbursed Ms .
Vlock for the purchases of food that she made during each such
year . Ms . Vlock used the food for which Vlock and Hammond paid
to prepare meals for her family and friends . During 2003, 2004,
and 2005, Vlockand Hammond reimbursed Ms . Vlock $5,958 .20,
$6,254 .54, and $7,629 .02, respectively, for the food that she
purchased during those years . (We shall refer to the foregoing
amounts that Vlock and Hammond reimbursed Ms . Vlock for food that
she purchased as the reimbursed food expenses . )
Certain Payments Made by Vlock an d
Hammond Relating to Medical and Dental Expense s
On January 1, 2002, .Vlock and Hammond and,Ms . Vlock executed
a document entitled "NONDISCRIMINATORY MEDICAL AND DENTAL REIMBURSEMENT
PLAN" . That document stated in pertinent part :
the Corporation [Vlock and Hammond] agrees to reimburse
you [Ms . Vlock] for all reasonable medical and dental
expenses up to the sum of $25,000 .00 in any fiscal year
* * * which you [Ms . Vlock] and/or members of your
immediate family may incur, except such expenses which
are covered and are reimbursable to you from any medi.cal, dental, health and/or accident insurance policy
insuring you and/or members of your immediate family .
During each of the years at issue,,Vlock and .Hammond reimbursed Ms . Vlock for the amounts that petitioners paid as
- 34 (1) premiums for a health insurance plan issued by New York Life
to Mr . Vlock(NYL health plan) that he maintained to cover
himself and his family, ( .2) copayments to health care providers
pursuant to the NYL health plan, and (3) premiums for two longterm care insurance plans covering Mr . Vlock and two such plans
covering Ms . Vlock .14 (We shall refer collectively to the foregoing amounts that Vlock and Hammond reimbursed Ms . Vlock as the
reimbursed medical expenses . )
Certain Payments Made by Vlock and
Hammond Relating to Educational Expense s
On January 1, 2003, Vlock and Hammond adopted a document
entitled "Educational . Assistance Plan" (educational assistance
document) . That document stated in pertinent part :
Article II -- Definition s
*
*
2 .03 "Benefits" means the direct payment or reimbursement of Covered Costs incurred by a Participant for
Educational Courses .
2 .05 "Covered Costs" means the tuition, fees and
similar payments and the cost of books paid for or
incurred by a Participant in taking an Educational
Course . * * *
14The record does not establish the total amount that Vlock
and Hammond reimbursed Ms . Vlock during each of the years at
issue . As discussed below, Vlock and Hammond claimed deductions
for reimbursed medical expenses of $4,595, $6,873, and $997 in
the returns that it filed for its taxable years ended Nov . 30,
2003, 2004, and 2005, respectively .
- 35 2 .06 "Educational Course" means any course taken by a
Participant at an Accredited Institution , except for a
course that instructs the Participant in any sport,
game or hobby .
*
*
2 .12 "Participant " means any Employee or Former Employee who has satisfied the eligibility requirements
of Section 3 .01 .
*
Article III -- Eligibilit y
3 .01 Every Employee who has completed one Year of
Service on the effective date of the Plan and every
Former Employee shall automatically become a Participant in the Plan on that date . Each other Employee
shall become a Participant in the Plan on the first day
of the Plan Year after he has completed one Year of
Service .
*
Article IV - Benefit s
4 .01 Every Participant in the Plan shall be eligible
to receive Benefits under the Plan for Covered Costs
incurred by the Participant, subject to the limitations
of Article V .
Article V -- Limitations on Benefit s
5 .05 A Participant may not receive more than $5,250 in
Benefits under the Plan for the year in accordance with
Code Section 127(a) .
*
Article VII -- Named Fiduciary and Plan Administrator
7 .01 Jeanne M . Vlock is hereby designated as the Plan
Administrator and Named Fiduciary * * * .
- 36 During none of Vlock and Hammond's taxable years ended
November 30, 2003, 2004, and 2005, was Sarina an employee or a
former employee of Vlock and Hammond as defined in the educational assistance document . As a result, Sarina was not eligible
during any of those years to receive any benefits under that
document . Nonetheless, Vlock and Hammond paid to Sarina $5,250,
$5,250, and $5,000 during its taxable years ended November 30,
2003, 2004, and 2005, respectively .l5 (We shall refer to the
foregoing amounts that Vlock and Hammond paid to Sarina for
tuition and other educational expenses as the educational assistance expenses . )
Certain Payments Made by Vlock an d
Hammond Relating to Petitioners' Automobile s
On January 1, 2002, petitioners executed a document entitled
"INSTALLMENT SALE AGREEMENT" (Lexus sale document) . That document stated :
The undersigned does hereby sell and transfer to
Vlock & Hammond, Inc . all of their right, title and
interest to the following :
1 .
1996 Lexus automobil e
2 .
Price : $20,000 .0 0
3 .
Interest Rate :
4 .
Number of Payments :
10 %
36
15 From around September 2003 to around May 2007, Sarina was
a student at the University of Kansas . During that time,
Sarina's tuition, room and board, book, and other expenses at
that university were approximately $18,000 a year .
37 5 . Monthly Payment Amount : $645 .00116)
DATED : January 1, 2002 .
From January 1, 2002, through around the summer of 2005, Mr .
Vlock was the primary user of the 1996 Lexus automobile . During
that time, Mr . Vlock used that automobile for both business and
personal purposes .
On December 1, 2002, petitioners executed another document
entitled "INSTALLMENT SALE AGREEMENT" (Suburban sale document) .17
That document stated :
The undersigned does hereby sell and transfer to
Vlock & Hammond, Inc . all of their right, title and
interest to the following :
1.
1999 Suburban automobil e
2.
Price : $20,000.0 0
3 .
Interest Rate : 10 %
4.
Number of Payments :
36
16The record does not establish whether Vlock and Hammond
made any of the payments stated in the Lexus sale document .
However, as discussed below, Vlock and Hammond claimed deductions
for depreciation with respect to the 1996 Lexus automobile of
$4,900, $2,950, and $1,152 in the returns that it filed for its
taxable years ended Nov . 30, 2003, 2004, and 2005, respectively .
17The parties stipulated that petitioners executed the
Suburban sale document on Jan . 1, 2002 . That stipulation is
clearly contrary to the facts that we have found are established
by the record, and we shall disregard it . See Cal-Maine Foods,
Inc . v . Commissioner , 93 T .C . 181, 195 (1989) . The record
establishes, and we have found, that petitioners executed the
Suburban sale document on Dec . 1, 2002 .
- 38 5 . Annual Payment Amount : $8,042 . 30, due on
January 1 , 2004, January 1, 2005 and
January 1 , 20008 1
DATED : December 1, 2002 .
During the years at issue ,
Ms . Vlock was the primary user of the
1999 Suburban automobile .
During those years, Ms . Vlock used
that automobile for both business and personal purposes .
On July 1, 2005 ,
Vlock and Hammond purchased .a 1999 Lexus
automobile for $19,500 .
From July 1, 2005, through the end of
2005, Mr . Vlock was the primary user of that automobile .1 9
Vlock and Hammond's Tax Return s
Vlock and Hammond filed Form 1120 ,
Tax Return .( Form 1120 ),
2003
for its taxable years ended November 30,
(11/30/ 03 corporate return ),
corporate return ),
return ) .
U .S . Corporation Income
November 30, 2004
and November 30, 2005
( 11/30/04
( 11/30/05 corporate
During each of those taxable years, Vlock and Hammond
derived all of its gross receipts from payments that Mr . Vlock
made to Vlock and Hammond during each such year .
In its Forms
1120 for its taxable years ended November 30, 2003 through 2005 ,
18The record does not establish whether Vlock and Hammond
made any of the payments stated in the Suburban sale document .
However, as discussed below, Vlock and Hammond claimed a deduction under sec . 179 with respect to the 1999 Suburban automobile
of $20,000 in the return it filed for its taxable year ended Nov .
30, 2003 .
19The record does not disclose whether Mr . Vlock used the
1999 Lexus automobile for business purposes, personal purposes,
or both .
- 39 Vlock and Hammond reported the following amounts as gross receipts for the year indicated :2 0
Taxable Year Ended
Amoun t
Nov .
30,
2003
Nov .
30,
2004
$120,00 0
1120,10 0
Nov .
30,
2005
1 .09,00 0
'In the 2004 Schedule C, petitioners claimed a deduction for
management services of $120,000 . The record does not establish
why there is a $100 discrepancy between that amount and the
amount that Vlock and Hammond reported as gross receipts in the
11/30/04 corporate return .
In its Forms 1120 for its taxable years ended November 30,
2003 through 2005, Vlock and Hammond claimed deductions for each
of those years for, inter alia, the personal residence expenses,
the cellular telephone expenses, the reimbursed food expenses,
the reimbursed medical expenses, and the educational assistance
expenses, as follows :
2 0See supra note 9 .
40 Deductions Claime d
for the Taxable Year Ende d
Description
11/30/03
11/30/04
$4,595
$6,873
Insurance
--
3,698
Real property taxes
3,484
3,972
3,592
4,335
1,240
457
3,746
4,115
- 4,89 4
--
--
24,968
23,999
22,94 0
5,250
5,250
5,00 0
5,681
5,463
8,48 1
1,327
941
1,14 5
Reimbursed medical expenses
Other expense s
Repairs and maintenance
Telephone
Utilities
Janitorial
Interest included in rea l
estate installmen t
document payments
Educational assistanc e
expenses
Reimbursed food expenses
Cellular telephone expenses
450
11/30/0 5
$99 7
92 9
4,11 4
2,06 1
Vlock and Hammond attached Form 4562, Depreciation and
Amortization, to the 11/30/03 corporate return, the 11/30/04
corporate return, and the 11/30/05 corporate return . In those
forms, Vlock and Hammond claimed the following depreciation
deductions and section 179 expenses with respect to, inter alia,
petitioners' residence, certain of the personal residence expenses, the 1996 Lexus automobile, the 1999 Lexus automobile, and
the 1999 Suburban automobile :
- 41
Amount Claimed fo r
the Taxable Year Ende d
Description
Section 179 expense deduction
MACRS deductions for asset s
placed in service in prio r
tax years
Listed property4
11/30/03
11/30/04
11/30/0 5
1$22,975
--
2$2,96 0
312 , 12,451
3$11, 856
4,900
2,950
311, 48 1
1,15 2
'The sec . 179 expense deduction claimed in the 11/30/03
corporate return consisted of claimed expenses of $20,000 for the
1999 Suburban automobile, $1,800 that Vlock and Hammond paid for
a sprinkler system installed at petitioners' residence, and
$1,175 described as "DOORS" .
2The sec . 179 expense deduction claimed in the 11/30/05
corporate return was with respect to the 1999 Lexus automobile .
3The MACRS deductions claimed in the 11/30/03, 11/30/04, an d
11/30/05 corporate returns included $10,544 that Vlock and
Hammond claimed as depreciation on petitioners' residence .
4The listed property deduction represented depreciation on
the 1996 Lexus automobile that Vlock and Hammond claimed it used
for business purposes 100 percent of the time .
During the summer of 2005, Vlock and Hammond sold the 199 6
Lexus automobile to petitioners' daughter Sarina . Vlock and
Hammond reported that sale in Form 4797, Sales of Business
Property (Form 4797), that it attached to the 11/30/05 corporat e
return,
as follows :
Description
Gross sales price
Depreciation allowed o r
allowable since acquisition
Cost or other basis, plu s
improvements and expense o f
sale
Gain or (loss)
Amoun t
'$5,00 0
9,00 2
20,00 0
(5,998 )
'The record does not establish whether Sarina paid to Vlock
and Hammond the $5,000 that it reported as the gross sales price
of the 1996 Lexus automobile in Form 4797 that it attached to the
11/30/05 corporate return .
- 42 In the 11/30/05 corporate return, Vlock and Hammond did not
report any amount as recapture of depreciation with respect to
the sale of the 1996 Lexus automobile to Sarina .
Viock and Hammond attached Schedule L, Balance Sheets per
Books, to the 11/30/03 corporate return, the 11/30/04 corporate
return, and the 11/30/05 corporate return . In each of those
schedules, Vlock and Hammond reported the following total amounts
of loans to stockholders outstanding at the beginning and end of
each of those taxable years :
Taxable Year Ended
Loan Balance a t
Beginning of Year
Loan Balanc e
at End of Yea r
Nov .
30,
2003
$2,315
$17,00 1
Nov .
30,
2004
17,001
41,47 6
Nov .
30,
2005
41,476
26,26 8
Respondent's Examinations of
Petitioners and Vlock and Hammon d
In June 2006, respondent commenced an examination o f
(1) petitioners' taxable years 200 .3 through 2005 and (2) Vlock
and Hammond's,taxable years ended November 30, 2003 through 2005 .
On February 13, 2007, respondent sent to Vlock and Hammon d
two letters (no-change letters), one pertaining to its two
taxable years ended November 30, 2003 and 2004, and the other
pertaining to its taxable year ended November 30, 2005 . In each
of those letters, respondent notified Vlock and Hammond tha t
respondent had "completed the examination of your tax return fo r
L
I
- 43 the year(s)" to which each letter pertained and that respondent
"made no changes to your reported tax" for those years .
On March 22, 2007,"respondent issued to petitioners a notice
of deficiency with respect to their taxable years 2003 through
2005 (2003-2005 notice) . In that notice, respondent determined,
inter alia, (1) that the payments that Mr . Vlock made to Vlock
and Hammond during each of those years and for which petitioners
claimed a deduction for each such year are not deductible under
section 162(a) for each of those years21 and (2) that the amounts
that Mr . Vlock paid to the Vlock daughters during 2003 are not
deductible under section 162(a) for that year . In the 2003-2005
notice, respondent also determined, that petitioners are liable
for each of their taxable years at issue for the accuracy-related
penalty under section 6662(a) .
OPINION
Petitioners bear the burden of proving that the determinations in the 2003-2005 notice that remain at issue are
erroneous .22 See Rule 142(a) ;
Welch v . Helvering , 290 U .S . 111,
115 (1933) .
21In the 2003-2005 notice, respondent advanced an alternative determination with respect to constructive dividends ., See
infra note 27 .
22Petitioners do not claim that the burden of proof shifts
to respondent under sec . 7491(a) . On the record before us, we
find that the burden of proof does not shift to respondent under
that section .
- 44 Before turning to the issues presented, we shall address the
testimonial evidence on which petitioners rely to satisfy their
burden of proof with respect to each of those issues .23 That
testimonial evidence consists of the respective testimonies of
Mr . Vlock and Ms . Vlock .
.We found the testimony of Mr .- Vlock to be in certain material respects questionable, vague, self-serving, and/o r
evasive . We shall not rely on Mr . Vlock's testimony to establish
petitioners' respective positions with respect to the issues to
which that testimony pertained .
During Ms . Vlock's testimony, she acknowledged that petitioners had the following tax-avoidance objectives in having her
incorporate Vlock and Hammond : (1) Petitioners did not want Ms .
Vlock to receive cash wages for the services that she was to
perform for Mr . Vlock's insurance business because she would have
to report any such wages as . income and pay tax on that income,
and (2) petitioners wanted Vlock and Hammond to pay virtually all
of petitioners' personal living expenses with funds which Mr .
Vlock was to pay to Vlock and Hammond and for which petitioners
were to claim tax deductions . We found the remaining testimony
of Ms . Vlock to be in certain material respects questionable,
vague, and/or self-serving . We shall not rely on Ms . Vlock' s
23Petitioners also rely on certain documentary evidence to
satisfy their burden of proof with respect to the issues presented . We shall address that documentary evidence below .
- 45 remaining testimony to establish petitioners' respective positions .with respect to the issues to which that testimony pertained .
Claimed Deductions for Mr . Vlock's
Payments at Issue to Vlock and Hammon d
It is the position of petitioners that Mr . Vlock's payments
to Vlock and Hammond during each of the years at issue are
deductible under section 162(a) for each of those years . In
support of that position, petitioners argue that respondent may
not deny them the deductions that they are claiming for those
payments because when respondent issued the no-change letters t o
Mock and Hammond, respondent acknowledged that those payments
are income to Vlock and Hammond and that therefore they are
deductible by petitioners .
We reject petitioners' argument about the no-change letters
that respondent issued to Vlock and Hammond . Those no-change
letters did not contain a determination by respondent that Mr .
Vlock's payments to Vlock and Hammond during each of the years at
issue are includible in Vlock and Hammond's income .24 In the nochange letters in question, respondent notified Vlock and Hammond
that respondent had "completed the examination of your tax
return" and "made no changes to your reported tax . "
24See Miller v . Commissioner , T .C . Memo . 2001-55 .
- 46 Respondent could have made changes to Vlock and Hammond's
taxable years ended November 30, 2003 through 2005, even after
respondent issued to Vlock and Hammond the respective no-change
letters in question pertaining to those taxable years .25 We
conclude that petitioners may not rely on those no-change letters
to establish that Mr . Vlock's payments to Vlock and Hammond
during each of the years at issue are includible in Vlock and
Hammond's income, let alone that respondent had determined that
those payments are deductible by petitioners for each of those
years . 2 6
In further support of their position that Mr . Vlock's
payments to Vlock and Hammond during each of the years at issue
are deductible under section 162(a) for each of those years,
petitioners argue that (1) after acquiring the additional clients, Mr . Vlock decided that he needed additional assistance in
order to maintain and improve Mr . Vlock's insurance business ;
25The Commissioner of Internal Revenue generally may issue a
notice of deficiency to a taxpayer for a taxable year of the
taxpayer even after issuing to that taxpayer a no-change letter
pertaining to the same taxable year . See Opine Timber Co . v .
Commissioner , 64 T .C . 700, 712 (1975), affd . without published
opinion 552 F .2d 368 (5th Cir . 1977) ; Lawton v . Commissioner , 16
T .C . 725, 727 (1951) . Petitioners do not assert that that
general rule does not apply in this case .
26Petitioners could have avoided a potential whipsaw situation for themselves and Vlock and Hammond by having Vlock and
Hammond file protective claims for refund for each of its taxable
years ended Nov . 30, 2003 through 2005, on the ground that Vlock
and Hammond did not have any income during each of those years .
Petitioners apparently chose not to file any such claims .
47 -
(2) Ms . Vlock incorporated Vlock and Hammond for the purpose of
providing that assistance to Mr . Vlock's insurance business ;
(3) during each of the years at issue, Vlock and Hammond, pursuant to the purported management agreement, provided to Mr .
Vlock's insurance business certain assistance with respect to
marketing and client-servicing ; (4) during each of the years at
issue, Mr . Vlock made Mr . Vlock's payments to Vlock and Hammond
in exchange for Vlock and Hammond's services ; and (5) the amount
that Mr . Vlock paid to Vlock and Hammond during each of the years
at issue for its services was reasonable .
It is the position of respondent that Mr . Vlock's payments
to Vlock and Hammond during each of the years at issue are not
deductible under section 162(a) for each of those years .27 That
is because, according to respondent, during the years at issue :
Joseph Vlock and Vlock and Hammond, Inc . .* * * executed
a management contract whereby Mr . Vlock paid $10,000 a
month (2003, 2004 and most of 2005, and later reduced
to $7,500 a month in October 2005) for alleged management and consulting services .
27 Consistent with the 2003-2005 notice, respondent argues in
the alternative that if we were to find that petitioners are
entitled to deduct under sec . 162(a) for each of their taxable
years 2003 through 2005 Mr . Vlock's payments to Vlock and Hammond
during each'of those years, certain payments that Vlock and
Hammond made for petitioners' personal expenses and certain
disbursements that Vlock and Hammond made on their behalf are
includible as constructive dividends in petitioners' gross income
for each of those years . In the light of our holding below that
petitioners are not entitled to deduct under sec . 162(a) for each
of their taxable years 2003 through 2005 Mr . Vlock's payments to
Vlock and Hammond during each of those years, we need not address
respondent's alternative argument .
- 48 Petitioners deducted the management fees Joseph
Vlock paid to Vlock and Hammond, Inc . in the amounts of
$120,000 (2003 and 2004) and $109,000 (2005) on their
income tax returns . Vlock and Hammond, Inc . utilized
Mr . Vlock's payments as a source of funds to pay petitioners personal living expenses * * * .
Petitioners planned this transaction to create a
device to deduct their personal living expenses . Mr .
Vlock's payments to Vlock and Hammond, Inc . are not
deductible business expenses .
In order to carry their burden of proving that Mr . Vlock's
payments to Vlock and Hammond during each of the years at issue
are deductible under section 162(a) for each of those years,
petitioners . must show that those payments are ordinary and
necessary expenses paid or incurred during the taxable year in
carrying on any trade or business . See sec . 162(a) . In order to
establish that Mr . Vlock's payments to Vlock and Hammond during
.each of the years at issue are ordinary and necessary expense s
for each of those years, petitioners must show that those payments (1) constituted "salaries or other compensation for personal services actually rendered", sec . 1 .162-7(a), Income Tax
Regs ., and (2) were reasonable, see id .
In order to establish
that Mr . Vlock's payments to Vlock and Hammond during each of the
years at issue were compensation for services that Vlock and
Hammond in fact rendered to Mr . Vlock's insurance business,
petitioners must show that Mr . Vlock made those payments during
each of those years for services that Vlock and Hammond, not Ms .
Vlock in her individual capacity, in fact rendered to that
- 49 business . In order to establish that Mr . Vlock's payments to
Vlock and Hammond during each of the years at issue were reasonable, petitioners must show that those payments during each of,
those years constituted "only such amount as would ordinarily be
paid for like services by like enterprises under like circumstances ." Sec . 1 .162-7(b)(3), Income Tax Regs .
In an attempt to establish that during each of the years at
issue Vlock and Hammond in fact rendered services to Mr . Vlock' s
insurance business, petitioners rely on the respective testimonies of Mr . Vlock and Ms . Vlock and certain documentary evidence .
As we stated above, we shall not accept those testimonies to,
establish petitioners' contention that during each of the years
at issue Vlock and Hammond in fact performed services for Mr .
Vlock's insurance business . With respect to the documentary
evidence on which petitioners rely, that evidence includes the
purported management agreement, the purported employment agreement, the Vlock insurance business annual business documents, and
the business potential documents .
We turn first to the purported management agreement . The
purported management agreement is a self-serving attempt by
petitioners to create a paper trail to bolster the chances that
they would succeed in achieving their tax-avoidance objectives .
Petitioners have not shown that that purported agreement has any
economic reality beyond tax planning . On the record before us,
- 50 we find that the purported management agreement does not establish that during each of the years at issue Mr . Viock made Mr .
Vlock's payments to Viock and Hammond for services that Viock and
Hammond in fact rendered during each of those years to Mr .
Vlock's insurance business under that purported agreement .
We turn next to the purported employment agreement . That
agreement is another self-serving attempt by petitioners to
create a paper trail to bolster the chances that they would
succeed in achieving their tax-avoidance objectives . Petitioner s
have not shown that that purported agreement has any economic
reality beyond tax planning . On the record before us, we find
that the purported employment agreement does not establish that
during each of the years at issue Ms . Viock performed any services for Viock and Hammond under that purported agreement .
We turn next to the Viock insurance business annual business
documents on which petitioners rely . The December 2002 annual
business document second page was entitled "JOE VLOCK 2002
BUSINESS PLAN, PERFORMED BY VLOCK/HAMMOND" and stated :
Specific Goals for 2002
1 . Chairman's Counci l
2 . Recreation Time (Family)
3 . Educatio n
4 . Consistent Growt h
5 . Prioritize Phone List
51 6 . Keep Notes in File Neat/Clean up Files
7 . Workable Plan
8 . Creative Time
9 . Time Management
The December 2002 annual
business document second page was the
only page on which Mr . Vlock referred in the December 2002 annual
business document to 'VLOCK/HAMMOND" .28 We believe that Mr . .
Vlock's inclusion of "VLOCK/HAMMOND" in the title of the December
2002 annual business document second page was a part of petitioners' effort to create a paper trail to bolster the chances that
they would succeed in achieving their tax-avoidance . objectives .
In the December 2002 annual business document, Mr . Viock did not
set forth any specific . goals that he expected Viock and Hammond
to accomplish, or any specific tasks that he expected Viock and
Hammond to perform, with respect to Mr . Vlock's insurance . business .29
On the record before us, we find that the December 2002
annual business document does not establish that during any of
the years at issue Viock and Hammond in fact rendered services to
Mr . Vlock's insurance business .
28See supra note 3 .
29We note that certain of the goals that Mr . Viock set forth
in the December 2002 plan, such as "Creative Time" and "Recreation Time (Family)", do not appear to be related at all to Mr .
Vlock's insurance business .
52 In the January 2004 annual business document, Mr . Vlock did
not refer to Vlock and Hammond . Instead, Mr . Vlock referred in
that document to "Jeanne" (i .e ., Ms . Vlock) the following four
times : (1) In a section entitled " Opportunities ", Mr . Vlock
stated that "Jeanne is committed to co-ordinate all marketing and
case preparation and public relations with clients" ; (2) in a
section entitled " Threats ", Mr . Vlock asked : "Can Joe & Jeanne
work together" ; and (3) in a section entitled "Key Strategies for
Planning Year ", Mr . Vlock stated (a) that he was to "Spend 2-3
hours with Jeanne coordinating monthly seminars, case presentations and client appreciation workshops", and (b ) "Jeanne to
coordinate center of influence appointments ." Mr . Vlock did not
indicate in the January 2004 annual business document that the
four references in that document to "Jeanne" were to Ms . Vloc k
acting on behalf of Vlock and Hammond . Nor did Mr . Vlock refer
in the January 2004 annual business document to "Jeanne" in such
a way as to establish that, if and when Ms . Vlock were to perform
services for Mr . Vlock's insurance business, she would be acting
on behalf of Vlock and Hammond . On the record before us, we find
that the January 2004 annual business document does not establish
that during any of the years at issue Vlock and Hammond in fact
rendered services to Mr . Vlock's insurance business . In fact,
that document tends to show that during 2004 Ms . Vlock performed
53 services for Mr . Vlock's insurance business in her individual
capacity, and not on behalf of Vlock and Hammond .3 0
In the January 2005 annual business, document, Mr . Vlock did
not refer to Vlock and Hammond or to Ms . Vlock . In that document, Mr . Vlock set forth goals and objectives for Mr . Vlock,
Richard Ness, and a person identified in that document as "Jess" .
In the January 2005 annual business . document, Mr . Vlock also set
forth analyses of the strengths and weaknesses of, the opportunities for,'and the threats to Mr . Vlock and Richard Ness . In that
document, Mr . Vlock did not assign any tasks or goals to Vlock
and Hammond or to Ms . Vlock acting on behalf of Vlock and Hammond
and did not indicate that'Vlock and Hammond or Ms . Vlock acting
on behalf of Vlock and Hammond was to assist Mr . Vlock, Richard
Ness, or "Jess" in achieving any of the goals and objectives that
Mr . Vlock set forth in that document for each of them . On the
record before us, we find that the January 2005 annual busines s
30Like the January 2004 annual business document, the minutes of the meetings of the Vlock and Hammond board also tend to
show that during each of the years at issue Vlock and Hammond did
not in fact render services to Mr . Vlock's insurance business .
None of those minutes indicated that the Vlock and Hammond board
discussed the purported management agreement, the 2005 amendment,
the purported employment agreement, the services that the purported management agreement stated that Vlock and Hammond was to
provide to Mr . Vlock's insurance business, or the services that
the purported employment agreement stated Ms . Vlock was to
provide to Vlock and Hammond . On the record before us, we find
that the minutes of the meetings of the Vlock and Hammond board
do not establish that Vlock and Hammond in fact rendered services
during any of the years at issue to Mr . Vlock's insurance business .
- 54 document does not establish that during any of the years at issue
Vlock and Hammond in fact rendered services to Mr . Vlock's
insurance business .
We turn finally to the business potential documents on which
petitioners rely to establish that during each of the years at
issue Vlock and Hammond in fact rendered services to Mr . Vlock's
insurance business . Both of those documents were entitled
"ASSESS YOUR BUSINESS POTENTIAL REPPORT [sic] - 2003, JOE VLOCK,
CLU, CHFC/VLOCK & HAMMOND" . Each of those titles contained the
only reference to Vlock and Hammond in each of those documents .
Each of the business potential documents contained several
statements that were addressed directly to Mr . Vlock, including
the following :
Joe, here is my summary of your needs for coaching and
activities to go to the next level . All of these
actions and systems could be set up through customized
coaching .
OVERVIEW OF ACTIONS NEEDED AND YOUR COACHING NEED S
•
•
•
•
•
Clear Goals : for 1 year and 1 quarte r
Clear Marketing Systems : Target market busi ness/estate, build strong client centers o f
Influence, use your speaking skills .
Better staff utilization : train Jean [31 1 to
be your marketing coordinator .
Polish your office systems : have less ser v i ce i nterrupt i ons .
Better time management : plan and coordinat e
your day, week, and month ; deal with you r
time wasters .
3 1See supra note 4 .
- 55 -
• Get out of your comfort zone : stay "focused"
on your insurance business .
• Increase your sales activity and case size
through target marketing .
• Joe, good things are ahead for you and your
staff . You can go to the next level .
The reference to "Jean" in the above-quoted statement was the
only reference to Ms . Vlock in each of the business potential
documents . The author of each of those documents did not indicate .therein that each such reference was to Ms . Vlock acting on
behalf of Vlock and Hammond . Nor did the author refer in either
of the business potential reports to Ms . Vlock in such a way as
to establish that, if and when Ms . Vlock were to perform services
for Mr . Vlock's insurance business, she would be acting on behal f
of Vlock and Hammond .
Except for the title of each of the business potential
documents that referred to Vlock and Hammond, none of those
documents suggests that the author of each of those documents,
who is not identified in the record, understood that Mr . Vlock
was using, or intended to use, the services of Vlock and Hammond
to achieve the goals and objectives identified in those documents . Moreover, we doubt that that author was the individual
who included the reference to Vlock and Hammond in each of those
titles . We believe that petitioners may have altered the title
of each of the business potential documents to include a reference to Vlock and Hammond in order to bolster the chances that
they would succeed in achieving their tax-avoidance objectives .
- 56 On the record before us, we find that the business potential
documents do not establish that . during any of the years at issue
Vlock and . Hammond in fact rendered services to Mr . Vlock's
insurance business . In fact,-those documents tend to show that
during 2003 Ms . Vlock performed services for Mr . Vlock's insurance business in her individual capacity, and not on behalf of
Vlock and Hammond .
Based upon our examination of the entire record before us,
we find that petitioners have failed to carry their burden of
establishing that during each of the years at issue Vlock and
Hammond in fact rendered services to Mr . Vlock's insurance
business. On that record, we further find that petitioners have
failed to carry their burden of establishing that Mr . Vlock's
payments to Vlock and Hammond during each of those years constituted compensation for services that Vlock and Hammond in fact
rendered to Mr . Vlock's insurance business . See sec . 1 .162-7(a),
Income Tax Regs . On the record before us, we further find that
petitioners have failed to carry their burden of establishing
that Mr . Vlock's payments to Vlock and Hammond during each of the
years at issue are ordinary and necessary expenses paid or
incurred during each of those years in carrying on Mr . Vlock's
insurance business .32 See sec . 162(a) . On that record, we fin d
32Assuming arguendo that we had found that Mr . Vlock's
payments to Vlock and Hammond during each of the years at issu e
(continued . . .)
- 57 -
that petitioners have failed to carry their burden of establish-
32( . . .continued)
constituted compensation for services that Vlock and Hammond in
fact rendered during each of those years to Mr . Vlock's insurance
business, on the record before us, we would find that petitioners
have failed to carry their burden of establishing that those
payments during each of those years were what "would ordinarily
be paid for like services by like enterprises under like circumstances", see sec . 1 .162-7(b)(3), Income Tax Regs ., and thus were
reasonable in amount . In arriving at the $10,000 amount stated
in sec . 3 of the purported management agreement, neither Mr .
Vlock nor Ms . Vlock consulted an accountant, business manager, or
compensation expert . Although Ms . Vlock consulted Mr . Pechacek,
the attorney whom petitioners retained for the purpose of assisting Ms . Vlock in incorporating Vlock and Hammond and drafting
certain documents for it, the record does not establish what he
told her . Mr . Vlock testified that, .in arriving at the $10,000
amount stated in sec . 3 of the purported management agreement, he
"calculated about 50- to $60,000 to hire a full-time person with
a tremendous amount of knowledge, and that's without benefits,
and then included rent, supplies, utilities, things such as that
that I'd have to provide ." Petitioners have failed to carry
their burden of establishing that during each of the years at
issue it would have cost Mr . Vlock $50,000 to $60,000 to hire a
full-time employee to provide to Mr . Vlock's insurance business
the services that Ms . Vlock provided to it during each of the
years at issue, let alone that he would have paid an additional
$60,000 to $70,000 for "benefits * * * rent, supplies, [and]
utilities" . Moreover, we have found that during 2003 Mr . Vlock
paid to Paul Jensen, the only full-time employee of Mr . Vlock's
insurance business during that year, total wages of $29,475 .84
for serving as a receptionist and for performing certain administrative and secretarial tasks for that business . Without regard
to the $120,000 that the purported management agreement stated
that Mr . Vlock was to pay to Vlock and Hammond during each of the
years at issue, the $29,475 .84 that Mr . Vlock paid to Paul Jensen
during 2003 was the largest amount that Mr . Vlock paid during any
of those years-to any individual who performed services for Mr .
Vlock's insurance business during any of those years . Furthermore, without regard to the $120,000 that the purported management agreement stated that Mr . Vlock was to pay to Vlock and
Hammond during each of the years at issue, the total compensation
that Mr . Vlock paid during all the years at issue to all individuals who performed services for Mr . Vlock's insurance business
during those years was $116,578 .16 .
58 ing that Mr . Vlock's payments to Vlock and Hammond during each of
the years at issue are deductible under section 162(a) for each
of those years .
Claimed Deduction for Payments to the Vlock Daughter s
It is the position of petitioners (1) that the payments that
Mr . Vlock made during 2003 to the Vlock daughters Sarina and
Jennifer were for services that they in fact rendered to Mr .
Vlock's insurance business during that year and (2) that therefore those payments are deductible under section 162(a) for that
year . In support of that position, petitioners argue that during
2003 the Vlock daughters performed certain . administrative and
secretarial tasks for Mr . Vlock's insurance business and that
during that year Mr . Vlock paid them for performing those tasks .
It is the position of respondent that petitioners have not
carried their burden of establishing that during 2003 the Vlock
daughters in fact performed any services for Mr . Vlock's insurance business .
In order to carry their burden of proving that the payments
that Mr . Vlock made during 2003 to the Vlock daughters are
deductible under section 162(a) for that year, petitioners must
show that those payments are ordinary and necessary expenses paid
or incurred during that taxable year in carrying on any trade or
business . See sec . 162(a) . In order to establish that . those
payments are ordinary and necessary expenses for their taxable
i
59 year 2003, petitioners must show that those payments constituted
"salaries or other compensation for personal services actually
rendered" .33 Seca 1 .162-7(a),'Income Tax Regs . In order to do
so, petitioners must establish that during 2003 Mr . Vlock made
payments to the Vlock daughters for services that the Vlock
daughters in fact rendered to Mr . Vlock's insurance business .
In an attempt to establish that the Vlock daughters in fact
rendered services during 2003 to Mr . Vlock's insurance business,
petitioners rely on Mr . Vlock's testimony, which we have not
accepted, and certain documentary evidence . The documentary
evidence on which petitioners rely consists principally of a
weekly calendar for 2003 (2003 calendar) .3 4
Mr . Vlock testified that on each page of . the 2003 calendar
he made certain handwritten notations that showed (1) the name(s)
of his daughter(s) (i .e ., Sarina and/or Jennifer) who had worked
for Mr . Vlock's insurance business during each week, (2) th e
day(s) of each week on which Sarina and/or Jennifer had worked,
(3) the number of hours on such day(s) that Sarina and/or
Jennifer had worked, and (4) the amount of money that Sarin a
33In the event that we were to find that Mr . Vlock made
payments to the Vlock daughters during 2003 for services that
they in fact rendered during that year to Mr . Vlock's insurance
business, respondent does not argue that those payments were not
reasonable in amount . See sec . 1 .162-7(a), Income Tax Regs .
34Each page of thefl2003 calendar displayed the seven days of
each week during 2003 .
60 and/or Jennifer had earned during each week . There is no reliable evidence in the record that establishes when Mr . Vlock made
the handwritten notations on the 2003 calendar relating to the
Vlock daughters . Those notations are nothing more than selfserving notations on which we are unwilling to rely .3 5
Based upon our examination of the entire record before us,
we find that petitioners have failed to carry their burden of
establishing that during 2003 the Vlock daughters in fact rendered services to Mr . Vlock's insurance business . On tha t
record, we further find that petitioners have failed to carry
their burden of establishing that the payments that Mr . Vlock
made during 2003 to the Vlock daughters constituted compensation
for services that they in fact rendered to Mr . Vlock's insurance
business . See sec . 1 .162-7(a), Income Tax Regs . On the record
before us, we further find that petitioners have failed to carry
their burden of establishing that those payments are ordinary and
necessary expenses paid or incurred during 2003 in carrying on
Mr . Vlock's insurance business . See sec . 162(a) . On the record
before us, we find that petitioners have failed to carry their
burden of establishing that the payments that Mr . Vlock made
35We note that petitioners did not call Sarina and/or
Jennifer to testify in support of petitioners' position that
Sarina or Jennifer in fact rendered services during 2003 to Mr .
Vlock's insurance business .
61- during 2003 to the Vlock daughters are deductible under section
162(a) for petitioners' taxable year 2003 .
Accuracy-Related Penalt y
In the 2003-2005 notice, respondent determined that petitioners are liable for each of their taxable years 2003 through
2005 for the accuracy-related penalty under section 6662(a) .
According to respondent, petitioners are liable for that penalty
for each of those years because of (1) negligence or disregard of
rules or regulations under section 6662(b)(1) or (2) a substantial understatement of tax under section 6662(b)(2) .
Section-6662(a) imposes an accuracy-related penalty equal to
20 percent of the underpayment of tax attributable to, inter
alia, (1) negligence or disregard of rules or regulations, sec .
6662(b)(1), or (2) a substantial understatement of tax,_sec .
6662(b)(2) .
The term "negligence" in section 6662(b)(1) includes any
failure to make a reasonable attempt to comply with the Code .
Sec . 6662(c) . Negligence has also been defined as a failure to
do what a reasonable person .would do under the circumstances .
Leuhsler v . Commissioner , 963 F .2d 907, 910 (6th Cir . 1992),
affg . T .C . Memo . 1991-179 ;
Antonides v . Commissioner , 91 T .C .
686, 699 (1988), affd . 893 F .2d 656 (4th Cir . 1990) . The term
"disregard" includes any careless, reckless, or intentional
disregard . Sec . 6662(c) .
62
For purposes of section 6662(b)(2) „an understatement i s
equal to the excess of the amount of tax required to be shown in
the tax return over the amount of the tax shown in the tax .
return, sec . 6662(d)(2)(A), and is substantial in the case of an
individual if it exceeds the greater of 10 percent of the tax
required to be shown or $5,000, sec . 6662(d)(1)(A) .
The accuracy-related penalty under section 6662(a) does not
apply to any portion of an underpayment if it is shown that there
was reasonable cause for, and that the taxpayer acted in good
faith with respect to, such portion . Sec . 6664(c)(1) . The
determination of whether the taxpayer acted with reasonable cause
and in good faith depends on the pertinent facts and circumstances, including the taxpayer's efforts to assess such taxpayer's proper tax liability, the knowledge and experience of the
taxpayer, and the reliance on the advice of a professional, such
as an accountant . Sec . 1 .6664-4(b)(1), Income Tax Regs . Reliance on the advice of a professional does not necessarily demonstrate reasonable cause and good faith unless, under all the
circumstances, such reliance was reasonable and the taxpayer
acted in good faith .
Id .
Petitioners argue that they are not liable for each of their
taxable years 2003 through 2005 for the accuracy-related penalty
under section 6662(a) because :
Petitioners did not substantially understate income tax
and did not act negligently or disregard rules or
- 63 regulations . Instead, Petitioners had reasonable cause
and acted in good faith . Petitioners, have proven that
their transactions were related to legitimate business
activities, and were not a scheme to deduct Petitioners' personal expenses . Petitioners are not liable for
accuracy-related penalties and Respondent has not
sustained its burden of proof .
It appears that petitioners believe that respondent has the
burden of proof with respect to the accuracy-related penalties at
issue . Petitioners are wrong' . Respondent bears only the burden
of production with respect to those penalties . See sec . 7491(c) .
To meet respondent's burden of production, respondent must come
forward with sufficient evidence showing that it is appropriate
to impose the accuracy-related penalty under section 6662(a) for
each of petitioners' taxable years 2003 through 2005 . See Higbee
v . Commissioner , 116 T .C . 438, 446 (2001) . Although respondent
bears the burden of production with respect to the accuracyrelated penalties at issue, respondent "need not introduce
evidence regarding reasonable cause, substantial authority, or
similar provisions . * * * the taxpayer bears the burden of proof
with regard to those issues ."
Id .
We address only whether there is a substantial understatement in petitioners' tax for each of the years at issue . That is
because resolution of that question resolves the issue of whether
petitioners are liable for each of those years for the accuracyrelated penalty under section 6662(a) . The .accuracy-relate d
penalty that respondent determined for each of petitioners'
- 64 taxable years 2003 through 2005 is imposed on an underpayment of
tax for each of those years that is attributable to a substantial
understatement of tax resulting principally from respondent's
determinations to disallow petitioners' claimed deduction for Mr .
Vlock's payments to Vlock and Hammond for each of those years .
We have sustained those determinations . On the record before us,
we find that respondent has satisfied respondent's burden of
production under section 7491(c) with respect to the accuracyrelated penalty under section 6662(a) that respondent determined
for each of petitioners' taxable years 2003 through 2005 .
As we understand it, petitioners' only argument in support
of their position that they are not liable for each of their
taxable years 2003 through 2005 for the accuracy-related penalty
is that they are entitled to the deduction that they claimed for
Mr . Vlock's payments to Vlock and Hammond for each of those
years . As a result, according to petitioners, they did not
understate their taxes for those respective taxable years . We
have found that petitioners are not entitled to those deductions .
On the record before us, we find that petitioners have failed to
carry their burden of establishing that there was no substantial
understatement of tax for each of the years at issue . See sec .
6662(b)(2),
(d) (1) (A) , (2) (A) .
Petitioners make no argument that they reasonably relied on
the advice of a professional, such as Mr . Pechacek or an accoun-
- 65 tant, to support their claim that they had reasonable cause for,
and acted in good faith with respect to, any portion of the
understatement of tax for each of the years at issue . See sec .
1 .6664-4(b)(1), Income Tax Regs .
On the record before us, we find that petitioners have
failed to carry their burden of establishing that there was
reasonable cause for, and that they acted in good faith with
respect to, any portion of the understatement in tax for each o f
the years at issue .
Based upon our examination of the entire record before us,
we find that petitioners have failed to carry their burden of
establishing that they are not liable for each of their taxable
years 2003 through 2005 for the accuracy-related penalty under
section 6662(a) .
We have considered all of the contentions and arguments of
the parties that are not discussed herein, and we find them to be
without merit, irrelevant, and/or moot .
To reflect the foregoing,
Decision will be entere d
for respondent .
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