UNITED STATES TAX COURT

T.C. Memo. 2003-340

UNITED STATES TAX COURT

PERRY FUNERAL HOME, INC., Petitioner v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 14722-02.

Filed December 16, 2003.

P is a funeral home organized and operating in

Massachusetts. During the years in issue, P entered

into preneed funeral contracts and received payments in

advance of death for goods and services to be provided

later at the contract beneficiary’s death. These

payments were refundable at the contract purchaser’s

request, pursuant to State law, at any time until the

goods and services were furnished. P, an accrual basis

taxpayer, included these payments in income not in the

year of receipt but in the year in which the goods and

services were provided.

Held: Payments received by P under its preneed

funeral contracts are includable in gross income only

upon the provision of the subject goods and services.

Held, further, P is liable for the sec. 6662,

I.R.C., accuracy-related penalty with respect to items

conceded by P, apart from the preneed accounting issue.

- 2 Edward DeFranceschi, David Klemm, and Jason Bell, for

petitioner.

Louise R. Forbes, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

WHERRY, Judge:

Respondent determined the following

deficiencies and penalty with respect to petitioner’s Federal

income taxes for the calendar years 1996 and 1997:

Year

Deficiency

Penalty

I.R.C. Sec. 6662

1996

1997

$1,044,037

1,817

$106,877.80

--

After concessions by the parties, the principal issues for

decision are:

(1) Whether payments received by petitioner under preneed

funeral contracts are includable in gross income during the year

of receipt or during the year in which the goods and services are

provided by petitioner; and

(2) whether petitioner is liable for the section 6662

accuracy-related penalty.1

FINDINGS OF FACT

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

The stipulations of the parties, with accompanying exhibits, are

incorporated herein by this reference.

1

Unless otherwise indicated, section references are to the

Internal Revenue Code in effect for the years in issue, and Rule

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

- 3 Petitioner is a funeral home located at all relevant times

in New Bedford, Massachusetts.

Petitioner began operations in

1963 as a partnership and was incorporated under the laws of the

Commonwealth of Massachusetts on September 19, 1967.

Brothers

Thomas Perry and William Perry each own a 50-percent interest in

petitioner and are funeral directors licensed by the Commonwealth

of Massachusetts.

Petitioner’s Operations

Prior to and during the years in issue, petitioner entered

into preneed funeral contracts.

Under these arrangements, the

contract purchaser selected, on a prospective basis, the goods

and services to be provided by petitioner at the contract

beneficiary’s death.

Petitioner would designate the selected

items and applicable charges on a written form.

If the resultant balance was then paid in advance of death,

either in a lump sum or in installments, petitioner agreed to

honor the contract at death as written, without additional cost

to the purchaser or family.

If the resultant balance was to be

paid through the proceeds of an insurance policy or was left

unfunded, the amount due would be recalculated in accordance with

the prices in effect at the time of death.

The written form used by petitioner for these purposes was

not specific to prearranged funerals and contained no express

provisions regarding the use or refundability of amounts received

- 4 thereunder.

A handwritten notation that the contract was

irrevocable was added to certain of the forms, allegedly for

reasons related to Medicaid eligibility.

Regardless of such

language, however, it was petitioner’s practice to indicate to

purchasers that they had the right to cancel at any time and

would receive their money back.2

The experience of petitioner has been that only a very small

percentage of preneed contracts are in fact canceled.

The record

indicates that during the period from approximately 1997 through

the time of trial in 2003, six contracts were canceled.3

The

amounts paid thereon were refunded, and on certain occasions the

refunds also included an interest component based on “kind of a

guess” about prevailing rates.

During the years in issue, petitioner maintained a business

checking account and the following investments:

A Putnam

Investments mutual fund account, a Merrill Lynch ready asset

account, Fleet Financial shares, Massachusetts Savings

2

The contractual notations were ineffective given their

sham nature and the explicit directives of Massachusetts law

discussed below. See Comdisco, Inc. v. United States, 756 F.2d

569, 576 (7th Cir. 1985) (“in general, a contract entered in

violation of statutory or regulatory law is unenforceable”).

3

The parties stipulated: “Of the pre-need funeral

arrangements in existence on January 1, 1996, six have been

cancelled. Attached hereto and marked as Exhibits 19-J through

24-J are copies of petitioner’s business records related to these

pre-need arrangements.” However, the referenced exhibits bear

contract dates spanning the years 1991 to 1999 and cancellation

dates spanning years 1997 to 2003.

- 5 Investments certificates of deposit, a BayBank money market

account, a BayBrokerage account (for 1996 only), and a BayBank

escrow account.

Moneys received pursuant to preneed contracts

were placed by petitioner in one of the investment vehicles.

Upon petitioner’s provision of goods and services at the death of

a preneed contract beneficiary, an amount equal to the purchase

price of the contract was transferred from the investment

accounts to petitioner’s checking account.

The BayBank escrow account is a compilation of accounts,

opened before 1996, each in the name of an individual contract

beneficiary.

Petitioner’s accountant advised establishment of

the escrow account in the early 1990s.

This account was used for

the deposit of preneed receipts for a period prior to the years

in issue, until the resultant administrative burden caused

petitioner to discontinue the practice.

The balance of the

BayBank escrow account as of January 1, 1996, was $106,579.16,

and those funds are not at issue in this proceeding.

The

investments other than the Baybank escrow account are held solely

in petitioner’s name and list petitioner’s tax identification

number.

- 6 Petitioner’s Accounting and Tax Reporting

Petitioner is an accrual basis taxpayer.

For accounting

purposes, petitioner records payments received pursuant to

preneed contracts as liabilities under the designation

prearranged funerals.

Petitioner does not recognize as income

payments recorded on its books and records as prearranged

funerals until the tax year in which the goods and services are

provided.

Petitioner does recognize interest and dividend income

earned on the investments, exclusive of the BayBank escrow

account, into which the preneed funds are deposited.

Petitioner filed Forms 1120, U.S. Corporation Income Tax

Return, for 1996, 1997, and 1998 consistent with the foregoing

approach.

Attached to each return is a Schedule L, Balance

Sheets per Books.

These Schedules L reflect as “Other

investments” the following balances in petitioner’s investment

vehicles, including the BayBank escrow account:

Year

As of Jan. 1

As of Dec. 31

1996

1997

1998

$2,270,655

2,431,946

2,515,217

$2,431,946

2,515,217

2,503,934

Also on the Schedules L, petitioner included in “Other current

liabilities” the following amounts for prearranged funerals:

Year

As of Jan. 1

As of Dec. 31

1996

1997

1998

$1,587,416

1,612,272

1,614,929

$1,612,272

1,614,929

1,543,284

- 7 Respondent on June 26, 2002, issued to petitioner the

statutory notice of deficiency underlying the present litigation.

Therein, respondent determined, inter alia, that moneys received

under preneed contracts are to be characterized as income to

petitioner in the year of receipt.

OPINION

I.

Preliminary Matters

A.

Burden of Proof

In general, the Commissioner’s determinations are presumed

correct, and the taxpayer bears the burden of proving otherwise.

Rule 142(a).

Section 7491, effective for court proceedings that

arise in connection with examinations commencing after July 22,

1998, may operate, however, in specified circumstances to place

the burden on the Commissioner.

Internal Revenue Restructuring &

Reform Act of 1998, Pub. L. 105-206, sec. 3001(c), 112 Stat. 727.

With respect to factual issues and subject to enumerated

limitations, section 7491(a) may shift the burden of proof to the

Commissioner in instances where the taxpayer has introduced

credible evidence.

Concerning penalties and additions to tax,

section 7491(c) places the burden of production on the

Commissioner.

- 8 The record in this case is not explicit as to when the

underlying examination began.4

As regards the substantive

accounting issues, however, the Court finds it unnecessary to

decide whether the burden should be shifted under section

7491(a).

Few facts concerning how petitioner conducted the

preneed transactions are in dispute.

Given this circumstance,

the record is not evenly weighted and is more than sufficient to

render a decision on the merits based upon a preponderance of the

evidence.

With respect to the penalty, because respondent on

brief assumes that section 7491(c) is applicable, the Court will

do likewise.

B.

Evidentiary Motion

After the trial in this case, petitioner filed a motion for

the Court to take judicial notice of the consent judgment

rendered in Commonwealth v. Deschene-Costa, C.A. No. C03-0647

(Mass. Super. Ct. June 4, 2003).

The motion is made pursuant to

rule 201 of the Federal Rules of Evidence, which provides in

relevant part as follows:

4

Presumably, because the Form 4549-A, Income Tax

Examination Changes, contained in the record covers the 1996,

1997, and 1998 years, the audit would have begun after the

September 15, 1999, date on which petitioner’s 1998 Federal

income tax return appears to have been signed by the return

preparer. The possibility exists, however, that the 1998 or even

the 1997 audit may have been added to an audit for 1996 already

in progress. Nonetheless, as explained in the text, we need not

resolve or rely on such speculation here.

- 9 Rule 201.

Judicial Notice of Adjudicative Facts

(a) Scope of rule.--This rule governs only

judicial notice of adjudicative facts.

(b) Kinds of facts.--A judicially noticed fact

must be one not subject to reasonable dispute in that

it is either (1) generally known within the territorial

jurisdiction of the trial court or (2) capable of

accurate and ready determination by resort to sources

whose accuracy cannot reasonably be questioned.

This Court has previously noted that “under rule 201,

records of a particular court in one proceeding commonly are the

subject of judicial notice by the same and other courts in other

proceedings”, and “Also generally subject to judicial notice

under rule 201 is the fact that a decision or judgment was

entered in a case, that an opinion was filed, as well as the

language of a particular opinion.”

Estate of Reis v.

Commissioner, 87 T.C. 1016, 1027 (1986).

In the judgment that is the subject of petitioner’s motion,

the defendant funeral home operator, when confronted by the

Commonwealth of Massachusetts, consented to a permanent

injunction and to payment of restitution for misuse of funeral

trust funds.

Commonwealth v. Deschene-Costa, supra.

Respondent

agrees that the Court may take judicial notice of the judgment

under the above-quoted standards of rule 201 but questions the

relevance of the material.

Accordingly, the Court will take

judicial notice of the existence and content of the judgment

pursuant to rule 201 but will give it only such consideration as

- 10 is warranted by its pertinence to the Court’s analysis of

petitioner’s case.

II.

General Rules

A.

Federal Taxation Principles

The Internal Revenue Code imposes a Federal tax on the

taxable income of every corporation.

Sec. 11(a).

Section 61(a)

specifies that gross income for purposes of calculating such

taxable income means “all income from whatever source derived”.

Encompassed within this broad pronouncement are all “undeniable

accessions to wealth, clearly realized, and over which the

taxpayers have complete dominion.”

Glass Co., 348 U.S. 426, 431 (1955).

Commissioner v. Glenshaw

Stated otherwise, gross

income includes earnings unaccompanied by an obligation to repay

and without restriction as to their disposition.

James v. United

States, 366 U.S. 213, 219 (1961).

Section 451(a) provides the following general rule regarding

the year in which items of gross income should be included in

taxable income:

The amount of any item of gross income shall be

included in the gross income for the taxable year in

which received by the taxpayer, unless, under the

method of accounting used in computing taxable income,

such amount is to be properly accounted for as of a

different period.

Consistent with the principle of section 451, section 446(a) and

(b) directs that taxpayers are to compute taxable income using

the method of accounting regularly employed for keeping their

- 11 books, with the exception that “if the method used does not

clearly reflect income, the computation of taxable income shall

be made under such method as, in the opinion of the Secretary,

does clearly reflect income.”

In general, the accrual method is

designated a permissible method of accounting for purposes of

section 446.

Sec. 446(c)(2).

Under the accrual method, income is to be included for the

taxable year when all events have occurred that fix the right to

receive the income and the amount of the income can be determined

with reasonable accuracy.

Income Tax Regs.

Secs. 1.446-1(c)(1)(ii), 1.451-1(a),

Typically, all events that fix the right to

receive income have occurred upon the earliest of the following

to take place:

The income is (1) actually or constructively

received; (2) due; or (3) earned by performance.

Schlude v.

Commissioner, 372 U.S. 128, 133 (1963); Johnson v. Commissioner,

108 T.C. 448, 459 (1997), affd. in part, revd. in part and

remanded on another ground 184 F.3d 786 (8th Cir. 1999).

As caselaw applying the above standards has evolved, it has

become well established that amounts constituting advance

payments for goods or services are includable in gross income in

the year received.

Schlude v. Commissioner, supra; AAA v. United

States, 367 U.S. 687 (1961); Auto. Club of Mich. v. Commissioner,

353 U.S. 180 (1957); RCA Corp. v. United States, 664 F.2d 881 (2d

- 12 Cir. 1981); see also Commissioner v. Indianapolis Power & Light

Co., 493 U.S. 203, 207 & n.3 (1990).

In contrast, amounts properly characterized as loans,

deposits, or trust funds are not includable upon receipt.

Commissioner v. Indianapolis Power & Light Co., supra at 207-208;

Johnson v. Commissioner, supra at 467-475; Oak Indus., Inc. v.

Commissioner, 96 T.C. 559, 563-564 (1991); Angelus Funeral Home

v. Commissioner, 47 T.C. 391, 397 (1967), affd. 407 F.2d 210 (9th

Cir. 1969).

The rationale underlying this distinction is that

money received in the capacity solely of a borrower, depository,

agent, or fiduciary, because it is accompanied by an obligation

to repay or restriction as to disposition, is not income at all.

See Commissioner v. Indianapolis Power & Light Co., supra at 208

n.3; Johnson v. Commissioner, supra at 474-475.

Hence, no

question of the timing of income accrual is presented.

See

Commissioner v. Indianapolis Power & Light Co., supra at 208 n.3;

Johnson v. Commissioner, supra at 474-475.

B.

State Funeral Services Regulation

Preneed contracts and arrangements in the Commonwealth of

Massachusetts are governed by the regulations of the Board of

Registration in Embalming and Funeral Directing.

Mass. Regs.

Code tit. 239, secs. 4.01-4.10 (2003); see also Mass. Gen. Laws

Ann. ch. 112, sec. 85 (West 2003) (authorizing the board to

adopt, promulgate, and enforce regulations).

For purposes of

- 13 these regulations, a “pre-need funeral contract” is defined as

“any pre-need funeral services contract or pre-need funeral

arrangements contract, entered into in advance of death”.

Regs. Code tit. 239, sec. 4.01 (2003).

Mass.

A “pre-need funeral

services contract”, in turn, is:

any written agreement whereby a licensed funeral

establishment agrees, prior to the death of a named

person, to provide specifically-identified funeral

goods and/or services to that named person upon his/her

death, and which is signed by both the buyer and a duly

authorized representative of the licensed funeral

establishment. [Id.]

Similarly, “pre-need funeral arrangements contract” means:

any written arrangement between a licensed funeral

establishment and another person which establishes a

source of funds to be used solely for the purpose of

paying for funeral goods and/or services for a named

person, but which does not identify the specific

funeral goods and/or services to be furnished to that

person. [Id.]

The regulations set forth the required contents of “pre-need

funeral contracts”.

Mass. Regs. Code tit. 239, sec. 4.03 (2003).

As pertains to funding, contracts are to contain the following:

A written acknowledgement, signed by the buyer,

which indicates that:

1. The buyer has established a funeral trust fund

pursuant to 239 CMR 4.00 and has received all

disclosures required by 239 CMR 4.06(3); or

2. The buyer has elected to purchase a pre-need

insurance policy or annuity and has received all

disclosures required by 239 CMR 4.07(2); or

3. The buyer has tendered payment in full for all

funeral goods and services specified in the contract

and has received satisfactory written evidence that

- 14 those goods or services will be furnished at time of

death; or

4. The buyer has declined to select a funding method

and has paid no money to the funeral establishment;

[Mass. Regs. Code tit. 239, sec. 4.03(1)(d) (2003).]

A “funeral trust” within the meaning of the foregoing provision

is “a written agreement of trust whereby funds are transferred to

a named trustee with the intention that the trustee will manage

and administer those funds for the benefit of a named beneficiary

and use those funds to pay for funeral goods and/or services to

be furnished to that named beneficiary.”

Mass. Regs. Code tit.

239, sec. 4.01 (2003).

Cancellation rights likewise are specified in the

regulations, as follows:

Any buyer of a pre-need funeral contract may cancel

that contract and receive a full refund of all monies

paid, without penalty, at any time within ten days

after signing said contract. After the expiration of

this ten-day “cooling off period” a pre-need funeral

contract may be canceled in accordance with 239 CMR

4.06(8). [Mass. Regs. Code tit. 239, sec. 4.05(1)

(2003).]

The referenced Mass. Regs. Code tit. 239, sec. 4.06(8) (2003)

reads, in pertinent part:

The buyer who signed a pre-need funeral contract,

or his/her legal representative, may cancel a pre-need

funeral contract with a licensed funeral establishment

at any time by sending written notice of such

cancellation, via certified mail, return receipt

requested, to said funeral establishment. If a funeral

trust has been established to fund said pre-need

funeral contract, and the licensed funeral

establishment is not the trustee, the buyer shall

- 15 forward a copy of said notice of cancellation to the

named trustee of said funeral trust.

III.

Contentions of the Parties

We turn now to the parties’ contentions regarding

application of the foregoing rules to petitioner’s situation.

Petitioner contends that the payments received pursuant to

preneed contracts are not includable in gross income until the

underlying funeral goods and services are provided.

In support

of this assertion, petitioner references three alternative

theories for exclusion.

Petitioner’s primary argument is that

the payments constitute nontaxable deposits under the reasoning

of Commissioner v. Indianapolis Power & Light Co., supra.

Additionally, petitioner maintains that the amounts at issue

should be characterized as trust funds akin to those excluded

from income in cases such as Angelus Funeral Home v.

Commissioner, supra.

Petitioner’s third basis for its treatment

of the payments is that even if the amounts are found to be

advance payments of income, rather than deposits or trust funds,

their deferral is appropriate under the exception established in

Artnell Co. v. Commissioner, 400 F.2d 981 (7th Cir. 1968), revg.

and remanding 48 T.C. 411 (1967), to the general rule requiring

immediate inclusion of advances.

With respect to the section 6662 penalty, petitioner argues

that the lines of cases cited above provide substantial authority

and reasonable cause for taking the position that the funds

- 16 received for preneed contracts were not income or property of

petitioner.

In contrast, respondent contends that petitioner obtained

dominion and control over the preneed funds at the time of

receipt such that the amounts are properly included in income as

advance payments under the all events test.

Respondent further

argues that each of the exceptions relied upon by petitioner is

inapplicable on these facts.

Specifically, it is respondent’s position that advance

payments for services to be rendered by the taxpayer are not the

equivalent of a refundable security deposit or loan and, hence,

are not controlled by the standards set forth in Commissioner v.

Indianapolis Power & Light Co., supra.

Second, respondent

emphasizes that petitioner’s control over the funds and the

absence of any contractual or legal restrictions preclude

treating the moneys as in trust.5

Finally, respondent alleges

that petitioner cannot qualify for the limited Artnell Co. v.

Commissioner, supra, exception to the all events test where there

exists no certainty as to when or whether petitioner will perform

under the contracts.

In connection with the section 6662 penalty, respondent

disputes petitioner’s assertions of substantial authority and

5

Accordingly, respondent considers Rev. Rul. 87-127, 1987-2

C.B. 156, dealing with the treatment of funeral trusts as grantor

trusts of the purchaser, inapplicable here.

- 17 reasonable cause.

Respondent points particularly to the

reporting by petitioner of interest on the preneed payments, the

choice to invest the funds in petitioner’s name rather than in

regulated trust accounts, and the advice petitioner received from

its accountant pertaining to the BayBank escrow account.

IV.

Preneed Accounting

We first consider whether the preneed payments at issue

should be treated as deposits governed by Commissioner v.

Indianapolis Power & Light Co., 493 U.S. 203 (1990).

The Supreme

Court in Commissioner v. Indianapolis Power & Light Co., supra at

210, established what is referred to as the “complete dominion”

test for identifying those payments over which the taxpayer has

such control as to render them income:

In determining whether a taxpayer enjoys “complete

dominion” over a given sum, the crucial point is not

whether his use of the funds is unconstrained during

some interim period. The key is whether the taxpayer

has some guarantee that he will be allowed to keep the

money. * * *

Further, the answer to this inquiry “depends upon the parties’

rights and obligations at the time the payments are made.”

at 211.

With respect to distinguishing between taxable advance

payments and nontaxable deposits, the Supreme Court further

explained:

An advance payment, like the deposits at issue here,

concededly protects the seller against the risk that it

would be unable to collect money owed it after it has

Id.

- 18 furnished goods or services. But an advance payment

does much more: it protects against the risk that the

purchaser will back out of the deal before the seller

performs. From the moment an advance payment is made,

the seller is assured that, so long as it fulfills its

contractual obligation, the money is its to keep.

Here, in contrast, a customer submitting a deposit made

no commitment to purchase a specified quantity of

electricity, or indeed to purchase any electricity at

all. IPL’s right to keep the money depends upon the

customer’s purchase of electricity, and upon his later

decision to have the deposit applied to future bills,

not merely upon the utility’s adherence to its

contractual duties. * * *

*

*

*

*

*

*

*

It is this element of choice that distinguishes an

advance payment * * * The individual who makes an

advance payment retains no right to insist upon the

return of the funds; so long as the recipient fulfills

the terms of the bargain, the money is its to keep.

The customer who submits a deposit to the utility * * *

retains the right to insist upon repayment in cash; he

may choose to apply the money to the purchase of

electricity, but he assumes no obligation to do so, and

the utility therefore acquires no unfettered “dominion”

over the money at the time of receipt. [Id. at 210212; fn. ref. omitted.]

This Court, in applying the reasoning of Commissioner v.

Indianapolis Power & Light Co., supra, has similarly emphasized

the importance of which party controls the conditions under which

repayment or refund of the disputed amounts will be made.

See,

e.g., Herbel v. Commissioner, 106 T.C. 392, 413-414 (1996), affd.

129 F.3d 788 (5th Cir. 1997); Highland Farms, Inc. v.

Commissioner, 106 T.C. 237, 251-252 (1996); Kansas City S.

Indus., Inc. v. Commissioner, 98 T.C. 242, 262 (1992); Michaelis

Nursery, Inc. v. Commissioner, T.C. Memo. 1995-143.

We have

- 19 summarized that “if the payor controls the conditions under which

the money will be repaid or refunded, generally, the payment is

not income to the recipient.”

413.

Herbel v. Commissioner, supra at

“On the other hand, if the recipient of the payment

controls the conditions under which the payment will be repaid or

refunded, we have held that the recipient has some guaranty that

it will be allowed to keep the money, and hence, the recipient

enjoys complete dominion over the payment.”

Id. at 414.

Thus, while refundability per se is insufficient for

identifying nontaxable deposits, Johnson v. Commissioner, 108

T.C. 448, 470-471 (1997), refundability within the buyer’s

control and outside that of the seller is a significant indicator

under the current jurisprudence.

Additionally, to the extent

that any further factual refinement is warranted to distinguish

“the Indianapolis Power & Light line of cases” from earlier

opinions discounting the importance of the refundability

criterion, the law classifying amounts as nontaxable deposits is

clear at least insofar as “the taxpayer’s right to retain them

was contingent upon the customer’s future decisions to purchase

services and have the deposits applied to the bill.”

Johnson v.

Commissioner, supra at 471.

As to other potential indicia, both the Supreme Court in

Commissioner v. Indianapolis Power & Light Co., supra, and this

Court have held that factors such as control over deposits (i.e.,

- 20 absence of a trust fund), unrestricted use, nonpayment of

interest, and later application of the moneys to services are

probative but not dispositive in evaluating the existence of

complete dominion.

Id. at 209-211; Highland Farms, Inc. v.

Commissioner, supra at 251; Kansas City S. Indus., Inc. v.

Commissioner, supra at 261-262; Oak Indus., Inc. v. Commissioner,

96 T.C. 559, 569-574 (1991); Michaelis Nursery, Inc. v.

Commissioner, supra.

With respect to the facts before us, here petitioner’s

customers, and not petitioner, controlled whether and when any

refund of the preneed funds would be made.

The regulatory scheme

governing preneed funeral contracts expressly affords buyers the

right to cancel such contracts at any time.

tit. 239, secs. 4.05, 4.06(8) (2003).

Mass. Regs. Code

Further, while Mass. Regs.

Code tit. 239, sec. 4.06(8) (2003), contains a more detailed

description of the applicable cancellation procedures in the

event that a funeral trust has been established, the express text

covers preneed funeral contracts and does not limit this

cancellation right to those instances involving a funeral trust.

Accordingly, whether or not petitioner placed the preneed funds

in trust is not crucial to our analysis of the refundability

criterion.

In addition, in view of respondent’s comments on brief

suggesting that petitioner’s historical percentage of

- 21 cancellations was so low that the right should be disregarded, we

emphasize that it is the bona fide existence of such a right, not

the exercise or frequency of exercise, which controls.

Because

the cancellation right is State granted,6 we do not face a

situation where the outcome might implicate questions concerning

the nature and legitimacy of the bargain between particular

parties.

Also, we would be hard pressed to say that the right

here was illusory when cancellations did occur, and corresponding

refunds were given, in the course of petitioner’s business.

The consequence of this fixed right is that, to the extent

Commissioner v. Indianapolis Power & Light Co., 493 U.S. at 210,

identifies an advance payment as one which protects against the

risk that the buyer will back out before the seller has a chance

to perform, the preneed contracts and payments fail to serve that

function.

Moreover, the practical reality of the funeral

services business renders this situation analogous to the factual

6

Although the early case of Angelus Funeral Home v.

Commissioner, 47 T.C. 391 (1967), affd. 407 F.2d 210 (9th Cir.

1969), expressly dealt only with whether amounts should be

excluded from income as trust funds and did not consider a

deposit rationale, the facts and result support our analysis

here. In that case, payments made under the mortuary’s revised

preneed contracts were deemed taxable upon receipt (for lack of

trust), id. at 398, and would not appear to have been otherwise

excludable as deposits. The Court noted that such refunds as the

mortuary gave were made “voluntarily”, and it “was not obligated

to refund any moneys collected pursuant to the terms of the

contracts”. Id. at 394. Nor, in any event, does it appear that

the mortuary raised refundability as a defense to accrual of the

income from the revised contracts. Id. at 397-299; see also

Angelus Funeral Home v. Commissioner, 407 F.2d at 213-214.

- 22 scenario noted in Johnson v. Commissioner, supra at 471, as a

hallmark of those refundable receipts clearly within the

reasoning of Commissioner v. Indianapolis Power & Light Co.,

supra.

On account of the open-ended, “at any time”, nature of

the cancellation right, petitioner’s opportunity to perform the

designated services and in fact earn the preneed funds (thereby

eliminating the cancellation right) was contingent upon the later

choice of the decedent’s survivors or representative actually to

call upon petitioner to act under the contract.

The mere execution of a preneed contract did not place

petitioner in a position to fulfill the terms of the bargain.

As

a practical matter, because the ultimate decision to purchase

frequently rested in the hands of third parties, there existed in

these situations what more closely resembles a condition

precedent to petitioner’s right to perform than a condition

subsequent that would eliminate a current right to so act.

See

Charles Schwab Corp. & Subs. v. Commissioner, 107 T.C. 282, 293

(1996) (distinguishing conditions precedent and subsequent in the

context of income accrual), affd. 161 F.3d 1231 (9th Cir. 1998).

The Court is satisfied that the totality of the unique

circumstances of petitioner’s business brings it within the

rationale of Commissioner v. Indianapolis Power & Light Co.,

supra, and its progeny.

We hold that the amounts received by

petitioner under these preneed funeral contracts are includable

- 23 in income only upon the provision of the subject goods and

services.

Furthermore, given this conclusion based upon

Commissioner v. Indianapolis Power & Light Co., supra, we need

not reach petitioner’s alternative contentions regarding

excludable trust funds or deferred recognition of advance

payments.

V.

Section 6662 Penalty

Subsection (a) of section 6662 imposes an accuracy-related

penalty in the amount of 20 percent of any underpayment that is

attributable to causes specified in subsection (b).

Subsection

(b) of section 6662 then provides that among the causes

justifying imposition of the penalty are:

(1) Negligence or

disregard of rules or regulations and (2) any substantial

understatement of income tax.

“Negligence” is defined in section 6662(c) as “any failure

to make a reasonable attempt to comply with the provisions of

this title”, and “disregard” as “any careless, reckless, or

intentional disregard.”

Caselaw similarly states that

“‘Negligence is a lack of due care or the failure to do what a

reasonable and ordinarily prudent person would do under the

circumstances.’”

Freytag v. Commissioner, 89 T.C. 849, 887

(1987) (quoting Marcello v. Commissioner, 380 F.2d 499, 506 (5th

Cir. 1967), affg. on this issue 43 T.C. 168 (1964) and T.C. Memo.

1964-299), affd. 904 F.2d 1011 (5th Cir. 1990), affd. 501 U.S.

- 24 868 (1991).

Pursuant to regulations, “‘Negligence’ also includes

any failure by the taxpayer to keep adequate books and records or

to substantiate items properly.”

Sec. 1.6662-3(b)(1), Income Tax

Regs.

A “substantial understatement” is declared by section

6662(d)(1) to exist where the amount of the understatement

exceeds the greater of 10 percent of the tax required to be shown

on the return for the taxable year or $5,000 ($10,000 in the case

of a corporation).

For purposes of this computation, the amount

of the understatement is reduced to the extent attributable to an

item:

(1) For which there existed substantial authority for the

taxpayer’s treatment thereof, or (2) with respect to which

relevant facts were adequately disclosed on the taxpayer’s return

or an attached statement and there existed a reasonable basis for

the taxpayer’s treatment of the item.

See sec. 6662(d)(2)(B).

An exception to the section 6662(a) penalty is set forth in

section 6664(c)(1) and reads:

“No penalty shall be imposed under

this part with respect to any portion of an underpayment if it is

shown that there was a reasonable cause for such portion and that

the taxpayer acted in good faith with respect to such portion.”

Regulations interpreting section 6664(c) state:

The determination of whether a taxpayer acted with

reasonable cause and in good faith is made on a caseby-case basis, taking into account all pertinent facts

and circumstances. * * * Generally, the most important

factor is the extent of the taxpayer’s effort to assess

- 25 the taxpayer’s proper tax liability. * * * [Sec.

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

Reliance upon the advice of an expert tax preparer may, but

does not necessarily, demonstrate reasonable cause and good faith

in the context of the section 6662(a) penalty.

Id.; see also

United States v. Boyle, 469 U.S. 241, 251 (1985); Freytag v.

Commissioner, supra at 888.

Such reliance is not an absolute

defense, but it is a factor to be considered.

Freytag v.

Commissioner, supra at 888.

In order for this factor to be given dispositive weight, the

taxpayer claiming reliance on a professional must show, at

minimum, that (1) the preparer was supplied with correct

information and (2) the incorrect return was a result of the

preparer’s error.

See, e.g., Westbrook v. Commissioner, 68 F.3d

868, 881 (5th Cir. 1995), affg. T.C. Memo. 1993-634; Cramer v.

Commissioner, 101 T.C. 225, 251 (1993), affd. 64 F.3d 1406 (9th

Cir. 1995); Ma-Tran Corp. v. Commissioner, 70 T.C. 158, 173

(1978); Pessin v. Commissioner, 59 T.C. 473, 489 (1972).

As previously indicated, section 7491(c) places the burden

of production on the Commissioner.

The Commissioner satisfies

this burden by “com[ing] forward with sufficient evidence

indicating that it is appropriate to impose the relevant penalty”

but “need not introduce evidence regarding reasonable cause,

substantial authority, or similar provisions.”

Higbee v.

- 26 Commissioner, 116 T.C. 438, 446 (2001).

Rather, “it is the

taxpayer’s responsibility to raise those issues.”

Id.

The notice of deficiency issued to petitioner determined

applicability of the section 6662(a) penalty for 1996 on account

of both negligence and/or substantial understatement.7

To the

extent that we have ruled in petitioner’s favor on the accounting

issue presented for decision, there can be no underpayment or

corresponding penalty attributable thereto.

However, petitioner also conceded several other adjustments

for 1996.8

The record is entirely devoid of any information

regarding the circumstances surrounding petitioner’s position on

these items, which include amounts claimed for beginning

inventory, cost of goods sold, legal and professional fees, and

depreciation.

To the extent that these concessions result in an

underpayment, we conclude that respondent has satisfied his

burden under section 7491(c) of production of sufficient

evidence.

At minimum, nothing suggests that these errors were

other than negligent.

We also note that the threshold

7

The notice also referenced substantial valuation

misstatement as an additional alternative ground, see sec.

6662(b)(3), but since valuation was not a focus of this case, we

disregard the apparent boilerplate reference.

8

We note that the phrasing of and figures recited in the

parties’ stipulations concerning settled issues raise some

ambiguity regarding the precise nature of the settlement reached.

However, it is clear that petitioner made multiple concessions

and that the parties do not intend for the Court to address the

substantive matters covered by these stipulations.

- 27 determination of any remaining substantial understatement is

primarily a computational matter, which we leave to the parties.

Accordingly, the burden rests on petitioner to show

mitigating circumstances such as substantial authority, a

reasonable basis, or reasonable cause.

Petitioner on brief

claims to have had substantial authority, a reasonable basis,

reasonable cause, and good faith with respect to its reporting of

the preneed contract payments.

In contrast, petitioner directs

no comments to the various conceded adjustments, nor did

petitioner introduce any evidence pertaining to these items.

Furthermore, although petitioner generally points out that its

returns were prepared by a professional tax adviser, again there

has been no showing whatsoever regarding what information

petitioner supplied on the conceded items.

We therefore lack

grounds on which to conclude that the incorrect return resulted

from the preparer’s errors.

Respondent’s determination of the

section 6662 penalty is sustained to the extent warranted by

computations made in accordance with our holding for petitioner

on the preneed accounting issue.

To reflect the foregoing,

An appropriate order will

be issued, and decision will

be entered under Rule 155.