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T.C. Memo. 2021-88

UNITED STATES TAX COURT

ERNEST S. RYDER & ASSOCIATES, INC., APLC, ET AL.,1 Petitioners v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket Nos. 14619-10, 14687-10,

7527-12, 9921-12,

9922-12, 9977-12,

30196-14, 31483-15.

Filed July 14, 2021.

Ernest S. Ryder and Richard V. Vermazen, for petitioners.

Kevin W. Coy, Hans Famularo, Blake J. Corry, and Christopher J.

Richmond, for respondent.

We consolidated many cases for discovery and other pretrial practice. The

parties settled quite a few, but we continued the consolidation through trial and

briefing for Ernest S. Ryder & Associates, Inc., APLC, docket numbers 14619-10

and 9977-12; Ernest S. Ryder and Patricia A. Ryder, docket numbers 14687-10,

9921-12, 30196-14, and 31483-15; Ryder Ranches, LLC, Ernest S. Ryder, Tax

Matters Partner, docket number 7527-12; and First Counsel Capital, Inc., docket

number 9922-12.

Served 07/14/21

-2CONTENTS

[*2]

FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5

Ryder & Associates, APLC . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8

How R&A Made Money . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9

What R&A Did With the Money. . . . . . . . . . . . . . . . . . . . . . 28

Practice Funding Agreement With BFA. . . . . . . . . . . 28

Establishment of Ryder Law Corp.. . . . . . . . . . . . . . . 29

II.

Ryder Goes Ranching . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34

Sources of Money for Ranches . . . . . . . . . . . . . . . . . . . . . . . 36

Counselor Capital as Blocker Entity for

Ranches . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36

First Counsel Capital as Blocker Entity

for Ranches . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37

Use of Four Additional Blocker Entities . . . . . . . . . . 39

RLC and Its Stock Subscription Agreement. . . . . . . . 41

Ryder Ranch Co., LLC Properties. . . . . . . . . . . . . . . . . . . . . 42

Pattern Farms, LLC . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43

Canyon View Ranch, LLC . . . . . . . . . . . . . . . . . . . . . . . . . . 44

Ryder Red Rock Ranch, LLC . . . . . . . . . . . . . . . . . . . . . . . . 44

Rodeo Holdings, LLC . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45

III.

Audit, Cashflow, and Trial . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46

Audit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46

Cashflow . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 48

Following the Money . . . . . . . . . . . . . . . . . . . . . . . . . 48

Gross Income. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49

“Other Deductions” for 2005-06. . . . . . . . . . . . . . . . . 68

Dividend Treatment . . . . . . . . . . . . . . . . . . . . . . . . . . 68

From R&A Through RLC. . . . . . . . . . . . . . . . . 69

ii.

From Tax Products to Ranch Entities. . . . . . . . 69

iii. From R&A’s Bank Accounts to Third

Parties for the Ryders’ Benefit . . . . . . . . . . . . . 70

The Commissioner’s Alternative Arguments . . . . . . . 72

-36.

[*3]

Disallowed Deductions . . . . . . . . . . . . . . . . . . . . . . . . 73

Substantiation of R&A Expenses . . . . . . . . . . . 73

ii.

Ryder Ranch Co., LLC Losses . . . . . . . . . . . . . 76

California Pasteleria . . . . . . . . . . . . . . . . . . . . . . . . . . 79

Other Losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 80

Penalties. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 83

Trial . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 83

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 84

Burden of Proof . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 84

II.

R&A’s Unreported Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 86

Assignment of Income by Ryder & Associates . . . . . . . . . . 87

What R&A Looked Like to Clients . . . . . . . . . . . . . . 92

What Services R&A Provided . . . . . . . . . . . . . . . . . . 93

Income Produced Through These Services . . . . . . . . 95

Group Tax Products Income. . . . . . . . . . . . . . . 96

ii.

Stand-Alone Products Income . . . . . . . . . . . . 112

Additional Attempted Assignments of Income. . . . . . . . . . 119

Assignment of Fee Income to BFA Through

the PFA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 121

Assignment of Staffing Income to ESOP

Legal Consultants . . . . . . . . . . . . . . . . . . . . . . . . . . . 125

Assignment of GCO Product Income to

Individual General Counsel Offices . . . . . . . . . . . . . 128

“Other Deductions” . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 129

RLC and the Employee Leasing Agreement . . . . . . 129

Remaining Deductions . . . . . . . . . . . . . . . . . . . . . . . 132

III.

Dividend Adjustment: The Ryders’ Liability for Tax on

Unreported Constructive Dividend Income . . . . . . . . . . . . . . . . . 134

Dividends From R&A Through RLC . . . . . . . . . . . . . . . . . 137

Dividend Income From Payments Made To Acquire

and Operate the Ranch Properties . . . . . . . . . . . . . . . . . . . . 141

Ryder Ranch Co., LLC . . . . . . . . . . . . . . . . . . . . . . . 143

Pattern Farms, LLC . . . . . . . . . . . . . . . . . . . . . . . . . . 154

-4[*4]

Canyon View Ranch, LLC . . . . . . . . . . . . . . . . . . . . 156

Ryder Red Rock Ranch, LLC . . . . . . . . . . . . . . . . . . 157

Rodeo Holdings, LLC . . . . . . . . . . . . . . . . . . . . . . . . 158

Dividend Income From Payments to American

Express and Ben Leland Construction, Inc. . . . . . . . . . . . . 161

Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 163

IV.

Remaining Issues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 164

Ryder Ranch Losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 164

Jurisdiction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 165

Material Participation . . . . . . . . . . . . . . . . . . . . . . . . 169

Substantiation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 173

Ordinary Losses From California Pasteleria for

2003 and 2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 174

Investment Interest Expense for 2005 and

Unreimbursed Employee Expenses for 2006

Through 2008 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 175

Penalties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 176

Mrs. Ryder . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 183

Ryder and R&A . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 185

MEMORANDUM FINDINGS OF FACT AND OPINION

HOLMES, Judge: Ryder & Associates, Inc., APLC (R&A), marketed six

tax-reduction strategies that produced over $31 million in revenue between 2003

and 2011. The firm’s fixed costs were low, and its out-of-pocket expenses not

very large. Yet year after year it paid no income tax. Its revenue flowed instead

-5[*5] into 560 accounts and into Ryder Law Corporation, a related S corporation.2

It flowed into more than 1,100 ESOPs,3 other S corporations, LLCs, and other

passthroughs. It flowed into ranches in Arizona, and it flowed into other ranches

in New Mexico. And then it mostly seemed to pool in places where it would

benefit Ernest S. Ryder and his wife Patricia, who received more than $15 million

in distributions between 2002 and 2011 but paid only $31,000 in income tax

during the years at issue.

Or so the Commissioner says.

FINDINGS OF FACT

Ernest Ryder is the owner of R&A. He and his wife Patricia live in Poway,

California, and they are longtime Californians. After graduating from San Diego

State College in 1968 with a degree in accounting, Ryder started law school at the

University of California, Hastings. While in law school he put his accounting

If a business meets the requirements of section 1361, it may elect to

become an “S corporation” and pay no corporate tax. Secs. 1362(a), 1363(a); sec.

1.1361-1(b)(1), Income Tax Regs. An S corporation’s income and losses, like a

partnership’s, flow through to its owners, who then pay income tax. See sec.

1363(b); see also Gitlitz v. Commissioner, 531 U.S. 206, 209 (2001). (Unless we

say otherwise, section references are to the Internal Revenue Code in effect for the

years at issue, and all Rule references are to the Tax Court Rules of Practice and

Procedure.)

See infra note 48.

-6[*6] degree to use at Touche Ross & Co. There he learned about agricultural

cooperatives and “how cooperatives work.” Three years later he had a law degree

and was admitted to practice in California. He went to work at Price Waterhouse

& Co. in San Diego, California. Within a year, he moved back to Touche Ross,

but this time in San Diego.4

He then moved to New York and enrolled at NYU for his master’s degree in

taxation, all the while continuing to work for Touche Ross in its Manhattan office.

His time on the east coast was short lived, and he returned to California to join

Ralph Gano Miller on a temporary job to help prepare and present a paper at the

NYU Institute on Federal Taxation. When this was done, he began his career as a

practicing tax lawyer at Hewitt & Shaw, a tax and business law firm also in San

Diego. His timing was fortunate--he was at the stem-cell stage of his career the

year that Congress enacted the Employee Retirement Income Security Act of 1974

(ERISA). When there’s an avulsive change in the law like ERISA, young lawyers

can develop valuable expertise in an environment uncluttered with more senior

competitors.

Ryder was already a CPA at this time, though the record doesn’t tell us

when he became one. His license was canceled in 1996 when he failed to pay his

dues.

-7[*7] Knowledgeable associates in a fast-growing field are a hot commodity, and

in 1975 Ryder was hired away by Harrigan, Ruff & Osborne to help that firm’s

clients get their retirement plans qualified under the new law. “[T]hat’s when my

career really took a turn,” Ryder explained, and he was well on his way to

becoming an expert in qualified retirement plans. He stayed at the Harrigan firm;

and when he rose to become a shareholder, the name of the firm changed to

Harrigan, Ruff, Ryder & Sbardellati.5 He ran the firm’s pension department for

many years, and that is where he started working on many of the aggressive taxreduction strategies that led to these cases.

The Ryders have been married for more than a quarter century. Unlike her

husband, Mrs. Ryder is neither a tax attorney nor a CPA, but she does think she

has “a better understanding of tax th[a]n most people walking around on the

street.” She completed four years of college classes--two at the University of

California, Riverside, and two at San Diego State--but never obtained a bachelor’s

degree. After college and up until the time of trial she had an assortment of jobs

that included work at a jewelry store and Brooks Brothers; and she owned her own

businesses that included a bridal salon and some cookie stores--stores that are at

California is part of the West in some sense, and the firm referred to itself

as “Ruff Ryder.”

-8[*8] issue in these cases. She claims to work at the many different ranches she

owns with her husband, where she says her tasks include “tak[ing] inventory * * *

of the animals” and being “involved in their health.” She also helped ensure the

cattle got the necessary shots, ear tags, and brands; and “kept track of the breeding

program” for them.

Ryder & Associates, APLC

The aggressiveness of Ryder’s tax-reduction strategies seems to have

caused some tension with his partners at Ruff Ryder, and he was asked to leave the

firm sometime in 1995. Ruff Ryder’s entire pension department and its profitsharing clients left with him.6 With ample experience and a fully staffed pension

practice, Ryder decided to open up his own firm in early 1996.

And here begins the Ryders’ tax problems. R&A is a professional law

corporation7 and has always been taxed as a C corporation.8 Ryder has owned

Ryder was careful to note that he remained cordial with his former

partners, and even shared clients with them for different types of work in later

years.

Professional corporations are businesses organized as corporations under

the laws of a specific state, typically consisting of licensed professionals working

in fields like accounting, architecture, engineering, health, law, or science.

This means that R&A itself is taxed separately from its owners under

subchapter C of the Code. So Ryder’s income from the firm would face two layers

(continued...)

-9[*9] 100%, and has acted as president, of R&A since its creation. We find that

Ryder also provided 100% of his legal services to clients through R&A during the

years at issue.

Despite its success and longevity, R&A reported zero taxable income from

2002 through 2011. The Ryders also reported minimal taxable income on their

individual returns for those years.

How R&A Made Money

Although R&A wasn’t clientless when it opened its doors, it “started fresh”

with no money in the bank or cashflow from work done by Ryder and his team at

Ruff Ryder. Ryder began a quiet but substantial marketing campaign for the new

firm. R&A pitched its tax-saving products as “next generation tax management

services” to prosperous professionals and entrepreneurs who wanted to save for

retirement using “unique” plans that would “defer a much greater portion of their

income than they ever dreamed possible, and, as a result, substantially reduce their

tax liability.” After meeting with Ryder in person and receiving a followup letter

laying out the tax benefits of R&A’s services, many took the bait, and R&A began

reeling in the clients. R&A did everything its clients needed to fulfill what it had

(...continued)

of tax: one at the corporate level, and the other when the firm distributes profits in

the form of dividends to him.

- 10 [*10] promised: It set up the necessary entities, handled all filings with the IRS

and any state agencies, created retirement plans, drafted agreements to link its

clients to the companies that held the retirement accounts, helped clients move

money from one account to another as needed, and reviewed tax returns to make

everything look as proper as could be.

R&A earned some of its fees by setting up traditional employee savings

plans and doing certain noncontroversial corporate work. Most of its fees,

however, were earned through the sale of the several “unique” tax plans. This

entire clade of six plans throughout their entire evolution is traceable to Ryder

himself. But to make our discussion of them even minimally understandable we

will first describe some sister clades and their species, then dissect each species in

some detail.

The first division is between group-tax and stand-alone products. The

group-tax products are

a form of insurance called ASIG,

factoring, and

employee leasing.

The stand-alone products are

individual staffing,

- 11 [*11] !

general counsel offices, and

a Son-of-Boss variation.9

The key distinction between the group and stand-alone products is that

buyers of the group product had contracts with a third entity that R&A would set

up. Buyers of stand-alone products each had a contract with R&A itself.

We start with the group products.

ASIG. R&A sold this product through American Specialty Insurance

Group, Ltd. (ASIG), a captive insurance10 company that was itself owned by

another company named Capital Mexicana. ASIG was organized under the laws

of the Turks and Caicos and, like Capital Mexicana, was created during Ryder’s

time at Ruff Ryder. Both ASIG and Capital Mexicana had been in business since

at least 1991.11 When Ryder learned of captive insurance, he wanted to sell the

See infra note 19.

As we explained in Hosp. Corp. of Am. & Subs. v. Commissioner, T.C.

Memo. 1997-482, slip op. at 8:

The insurance laws of some States provide for a category of

limited purpose insurance companies, popularly called captive

insurance companies or captive insurers. Captive insurance company

statutes generally apply to companies that insure on a direct basis

only the risks of companies related by ownership to the insurer.

Ryder organized Capital Mexicana as an Irish nonresident company in

(continued...)

- 12 [*12] product to his clients. To do this, Ruff Ryder had hired the Turks and

Caicos accounting firm Morris Cottingham for the purpose of creating a Turks and

Caicos company--ASIG. ASIG’s main office was located at Morris Cottingham’s

Corporate Services, but Ryder also rented a post office box for ASIG in Las

Vegas. Any mail sent to the P.O. box was forwarded to Ruff Ryder (c/o Ernest

Ryder).

Once ASIG was in place, R&A could provide its clients with what it called

“Disability and Professional Liability Income Insurance” policies. These policies

required that the clients pay premiums to ASIG for the insurance, with the

premiums to be physically mailed to R&A. On top of this, the policyholder was

required to pay an annual 2% policy fee, which was deposited in ASIG’s Charles

Schwab bank account ending in 5337 during the years at issue. In return for all of

(...continued)

Dublin. Irish nonresident companies were companies established in Ireland whose

management was located elsewhere. Under Irish tax law at the time, such a

company would be subject to income tax only in the country of the management’s

residence. And if that management was located in a tax haven like the Turks and

Caicos, it would not owe tax to the Turks and Caicos government either. This

meant that a corporation set up in Ireland whose management was in the Turks and

Caicos would not owe income tax anywhere in the world. Ryder made sure

Capital Mexicana was such a company. Ireland later changed its law to eliminate

nonresident companies (with a few exceptions). See Brian McDonald & John

Homan, “Finance Act Targets Irish Nonresident Companies,” 1999 J. of Int’l

Tax’n 42.

- 13 [*13] this, the policyholder was entitled to 98% of the cash value of the policy

when certain events occurred (i.e., disability, separation from employment, turning

60, or the insured’s termination of the policy).

We’ve already analyzed these policies in Estate of Barnhorst v.

Commissioner, T.C. Memo. 2016-177. Like other ASIG policies, Barnhorst’s

policy was titled “Disability Income Insurance Policy” and ostensibly provided

benefits to him if he became totally or partially disabled, which would make any

payout excludable under section 105 as being from an employer-funded accident

or health plan. See id. at *3.

What makes such policies stand out was that they would also pay out when

the policyholder reached age 60 or died or was no longer employed. See id. at *3*6. A close look at the policy in Estate of Barnhorst showed that payouts weren’t

correlated with actual medical expenses or “computed with reference to the nature

of the injury.” See id. at *14, *18 (quoting section 105(c)(2)). We found it quite

telling that although the policy said it would terminate once Barnhorst turned 60,

ASIG renewed the policy each year. See id. at *6-*7. No new premiums were

ever paid despite these renewals, and only three premium payments were ever

made. These were mailed to R&A and then placed in a segregated account that

Ryder maintained. Id. at *6. Ryder then “invested the premiums in a diversified

- 14 [*14] portfolio of mutual stock and bond funds where they could build value over

the years until benefits had to be paid.” Id. We found that the policy was really a

deferred-compensation plan, despite its stated title. Id. at *16.

These cases do not require us to revisit our analysis in Estate of Barnhorst.

They do require us to find here that from start to finish R&A did everything it

could to make ASIG work. And there were several of these ASIG policies that

produced money for R&A during the years at issue. We summarize the numbers:

Year

Number of

policies paying

fees into account

5337

Total revenue12

2003

$138,322.28

2004

268,477.29

2005

311,585.34

2006

101,619.03

2007

114,917.84

2008

86,654.33

2009

181,513.41

We note that included in some of these amounts is interest on deposits in

the form of “Schwab Money Market Fund-Dividends.” These dividends are

different from the other, nontaxable dividends that the Commissioner excluded

from his bank-deposit analysis. (See infra pp. 86-87 for our discussion of how the

Commissioner conducted this analysis.)

- 15 [*15]

2010

63,172.76

2011

14,297.78

Total

$1,280,560.06

Group Factoring. The second group product was something we’ll call

“group factoring.” We analyzed this transaction in Pacific Management Group v.

Commissioner, T.C. Memo. 2018-131. As we explained there,

“Factoring” is a financial transaction by which one party (the factor)

provides services to another party (the client) and is compensated by

payment of factoring fees. The services that the factor provides

typically include: (1) purchasing the client’s accounts receivable for

cash, (2) collecting on the accounts receivable from the account

debtors, and (3) assuming the downside risk if an account debtor

becomes insolvent. Factoring benefits the client by enabling it to

monetize an illiquid asset immediately. In exchange for its services

the factor receives a fee, typically computed as a discount from the

face amount of the receivables.

Id. at *17. In an arm’s-length relationship, factoring is perfectly legitimate.

Factors provide working capital and liquidity to their clients and do the work

needed to collect the accounts that have been assigned to them. They also perform

the sometimes very important job of moving the credit risk of the account debtor

from their clients to themselves. See id. at *46-*48.

As with ASIG’s “disability” policies, however, “group factoring” used the

words associated with a legitimate practice and made it into something different--a

circular flow of funds from R&A’s clients back to those clients, with some leaking

- 16 [*16] out to R&A itself. See id. at *46. Instead of factors that paid for these

accounts and then collected them, the clients themselves continued to bill and

collect these accounts as if they’d never sold them. The factors were straw men

who received no meaningful economic benefit in return for the money they paid

out to the clients. See id. at *49.

If a client was interested, R&A would create the needed entities. The

evolution of these entities is quite complex and went through four different

generations, with some overlap between them. Here’s the list:

Benefactor Funding Association (BFA) (1996-2002);

United States Factoring Association, LLC (USFA) (2002-04);

Western Funding Group, Inc. (Western Funding) (2004-07); and

WFG, Inc. (WFG) (2008-11)

Each of these four shared many elements in both their setup and execution.

One of these similarities was the way they collected fees paid by clients into a

general account owned by the entity, but which R&A controlled.

Here’s a summary of the gross receipts R&A received in the form of fees

from these products into those accounts:

- 17 [*17]

8497 (BFA)

4564 & 2653

(USFA)13

2935

(Western

Funding)

6874 (WFG)

Total number of

fee payments14

347

---

Gross receipts

$376,465.10

$849,519.83

$549,351.97

$70,440.70

Account(s)

ending in

The Commissioner was unable to identify any specific deposit into the

Western Funding and WFG, Inc. operating accounts as gross receipts to R&A,

because many of the deposits belonged to R&A’s clients. He therefore included as

income only those funds that left the accounts and ended up in R&A’s own bank

account ending in 9815, BFA’s Division 101’s bank account ending in 0449, or

the Ryders’ personal bank account ending in 4461. This means we can’t tell how

many other clients used Western Funding and WFG or how many fee payments

The Commissioner also identified a bank account for U.S. Factoring

Managers, Inc., ending in 8620 that deposited $19,950.03 into the R&A bank

account ending in 9815 in 2003. U.S. Factoring Managers, Inc., was a corporation

owned by Ryder’s brother-in-law, Robert Pancheri. We agree with the

Commissioner that this $19,950.03 is part of the factoring companies’ gross

receipts for that year, and we include it in USFA’s gross receipts.

Note that these numbers are not the numbers of clients paying fees, but

the numbers of deposits that we find were fee payments to R&A. The gross values

of the deposits were quite large. In one employee’s estimation, there were about

“60 requests to have accounts receivable factored” each month, and possibly more

because “some customers factored twice a month.”

- 18 [*18] they made, which makes our findings about R&A’s income from this

product conservative.

The account ending in 8497 was used by R&A’s clients at least from 200410. The account ending in 2653 appears to have been used only in 2003, while the

other account for the USFA product and ending in 4564 was used from 2003-10.

The Western Funding account ending in 2935 was used from 2004-08, and finally,

the WFG, Inc., account ending in 6874 opened in 2008 and was used by R&A’s

clients until 2011.

Employee Leasing. The third group product was employee leasing, and this

one was (to make the record still more complicated) often combined with the

factoring product. As is true of factoring, employee leasing is perfectly legitimate

when done the proper way. In a legitimate employee-lease deal, one business

contracts with another to supply it with workers. The leasing company generally

assumes responsibility for paying the workers’ wages and employment taxes,

while the operating-business owner keeps control over how the workers perform

their jobs and pays the leasing company for payroll, taxes, benefits, and any

administrative fees. See, e.g., Garavaglia v. Commissioner, T.C. Memo. 2011228, 2011 WL 4448913, at *3, aff’d, 521 F. App’x 476 (6th Cir. 2013).

- 19 [*19] This isn’t how R&A’s employee-leasing deals worked. In its deals clients

signed what Ryder labeled “Agreements of Employment” with one of multiple

entities that R&A created. The clients would then lease themselves back to their

real businesses--either directly or through an intermediary--with the difference

between the lease payment and the wages received becoming a form of

compensation that was supposedly immune from current taxation. R&A used five

entities:

Worldwide Career Management, Ltd. (Irish).;

Worldwide Career Management, Inc. (U.S.);

Executive Placement, Inc.;

Westra Capital Management, Inc.; and

ExecuPro Specialty Services, Inc.

Each of these companies had a number of bank accounts that R&A and its

clients would use:

- 20 [*20]

Account type

Number of

accounts

Worldwide Career Management accounts

Westra Capital Management accounts

WCM QSub accounts

Executive Placement accounts

ExecuPro accounts

ExecuPro Specialty Services accounts

WCM QSub & ExecuPro Client accounts

ESOP Client accounts

And here are R&A’s gross receipts from this group-leasing product for each tax

year:

- 21 [*21]

Year

Gross receipts15

2003

$409,176.11

2004

358,868.75

2005

1,188,470.00

2006

404,288.07

2007

684,663.39

2008

60,375.35

2009

51,450.00

2010

1,487,835.00

2011

524,865.19

Total

$5,169,991.86

Staffing Product. For the three remaining types of deals we don’t have to

work as hard to find it more likely than not that R&A was involved. They are all

deals where R&A signed agreements with its clients in its own name. Each client

in these deals received more specifically tailored services. And with these standalone deals it was the clients themselves who acted as officers of the entities

involved.

We note that deposits in these accounts do not equal R&A’s fees, but only

its gross receipts. These accounts and products were up and running before 2003

and may have accumulated money that was not debited until a later year. We find

that the best way to track the flow of funds into R&A is to trace money as it left

these entities’ accounts and moved into other accounts more directly linked to

R&A, such as the law firm’s main accounts.

- 22 [*22] The stand-alone staffing product is the first we’ll look at. It closely

resembles the employee-leasing deals we’ve already described--indeed, there

appears to be some overlap in the clients that used them. R&A’s staffing services

generally looked something like this:

R&A would create a corporation and file an S corporation election on

its behalf;

R&A would establish an ESOP to own the S corporation; and

R&A’s clients would somehow transfer funds from their businesses

to the ESOP-owned corporation.

R&A sold these deals until 2011.

Here’s a breakdown of the gross receipts stemming from the stand-alone

staffing services:

- 23 [*23]

Account ending in

(and years used)

0449 (2003)

3149 (2004-11)

Gross receipts16

$2,378,539.05

$4,315,880.30

Number of fee

payments

190

General Counsel Office (GCO). Ryder’s GCO deals were unusually

creative. He created hundreds of new corporations, none of which had any

existence except on paper, with the plan to draft them into a reserve army awaiting

deployment in his clients’ battle against taxation. He came up with a uniform

pattern--he had each S corporation’s board (of which he himself was the sole

director) appoint him as vice president/general counsel, and R&A employee

DeAun Castro as vice president/ESOP administration. Ryder then filed 2001

federal income tax returns as of December 31, 2001 for the corporations not yet

assigned to a client. Every return reported gross receipts of $100 and expenses of

$97. None reported owing any tax on the resulting $3 in taxable income.

We stress again that gross receipts do not equal R&A’s taxable income

from these accounts, but merely show the money coming in from the product.

R&A’s taxable income depends on when money left these accounts and where it

ended up. Our work was hindered because deposit descriptions were missing for

the account ending in 0449, so we could not be sure which deposits were

specifically related to the staffing product. And this account has deposits from the

factoring product as well. Still, the amount of money flowing into the account for

just one year shows how much money was made from just two of R&A’s products.

See infra pp. 53-64 for analysis of just what R&A’s income was from this product.

- 24 [*24] Any R&A client who wanted in on this type of deal could learn about it

once they bought into a GCO arrangement and signed an “Access Agreement.”

The Access Agreement was basically the same as the letters of representation used

for the staffing-company clients, but with different nomenclature. This agreement

granted the clients access to one of R&A’s corporations and its related ESOP that

R&A had sitting in its inventory. A client agreed in return to pay a percentage of

his operating business’s revenue as a fee. This fee first flowed through the

employee-leasing product into his assigned S corporation and then was pumped

into his assigned ESOP. Each client also had to pay a $25,000 documentation fee

to yet another Wyoming corporation, Prescient Planning, which Ryder had also

formed not long after his incorporation-palooza in early 2001. In the original

Access Agreements, GCO clients promised to pay all the fees that they owed

directly to Prescient Planning.

This product was fairly short lived because the IRS learned about such deals

and made them a listed transaction.17 See Rev. Rul. 2003-6, 2003-1 C.B. 286.

A listed transaction is one that has been identified as a “tax avoidance

transaction.” See sec. 6707A(c)(2). Taxpayers are required to disclose these

transactions on their returns, and promoters of these transactions must register

them with the IRS. Schwab v. Commissioner, 136 T.C. 120, 123 (2011), aff’d,

715 F.3d 1169 (9th Cir. 2013).

- 25 [*25] Ryder and R&A responded with a revised Access Agreement. The changes

weren’t small:

Inclusion of a new section dealing with the creation of the general

counsel office;

A new section requiring the client’s S corporation to enter into an

Agreement of Employment with Ryder for his services as the vice

president/general counsel of the corporation;

A new section requiring the client corporation to pay an annual

budget for the general counsel office in the same percentage as the fee

in the original agreement;

A retitled section that revises “The Payment of Percentage Fees” to

say “Funding of Annual Budget;”

A retitled section that revises the “No Reduction of Percentage Fees”

to say “No Reduction of Annual Budget;” and

A new section dealing with the determination and negotiation of legal

fees owed to Prescient Planning or R&A.

Ryder summarized the changes best in his letter to a client:

Please note that the Access Agreement has been revised to provide

that the amount that otherwise would have been paid as Percentage

Fees to Prescient will instead be budgeted to the Corporation’s new

General Counsel’s Office. In this regard, I am designated as the Vice

President/General Counsel of the corporation, and DeAun Castro is

designated as Vice President/ESOP Administration.

Ryder made one especially notable change--he backdated these new agreements,

which he asked his clients to sign. These new agreements changed the way the

- 26 [*26] GCO product received its gross receipts, with the torrents of cash flowing

into either Prescient Planning or First Counsel Capital’s18 bank accounts, now

relabeled “budget allotments.” The Commissioner determined, and we find, that

these deals generated a total of more than $3.5 million.

Short-Sale Strategy. The final product is one that is no stranger to our

Court--the Son-of-Boss deal.19 See, e.g., BLAK Invs. v. Commissioner, 133 T.C.

431 (2009). Between 1998 and 2002, R&A sold its own Son-of-BOSS variation.

Son-of-BOSS deals are infinitely flexible in the tax savings they promise. For

taxpayers who have large capital gains on which they wish to pay no tax, such

deals can be customized to produce offsetting capital losses in any amount. See

6611, Ltd. v. Commissioner, T.C. Memo. 2013-49, at *11.

The fees R&A charged its clients for this product were held in two

accounts--accounts ending in 9156 and 9214--titled “Ernest S. Rider, APLC,

See infra pp. 37-39.

Son-of-BOSS deals were generally used to artificially inflate someone’s

basis in a partnership interest by contributing assets with large contingent

liabilities (which were ignored in computing basis) and then selling this interest at

fair market value for a huge tax (but no economic) loss. See, e.g., RJT Invs. X v.

Commissioner, 491 F.3d 732 (8th Cir. 2007) (involving typical Son-of-BOSS

transaction); Kligfeld Holdings v. Commissioner, 128 T.C. 192 (2007). There are

other variations. See, e.g., Home Concrete & Supply, LLC v. United States, 634

F.3d 249 (4th Cir. 2011), aff’d, 566 U.S. 478 (2012). We’ve never found a

Son-of-BOSS transaction that worked.

- 27 [*27] Attorney Trust Account,” and “Ernest S. Ryder & Assoc., Inc. Attorney

Client Trust Account.” The total amount of fees from the product into each

account is as follows:

Method of determining gross

income

9156

9214

Total fees deposited from

2003-201120

$698,696.58

$861,478.38

Commissioner’s

determination of taxable

withdrawals during

2003-201121

$1,140,959.76

$498,680.91

Summary of Fees. After going through each of the products sold by R&A,

it’s useful to see the fee structure used for each one. The documentation fee was

charged for the organizational paperwork and setting up clients with the

appropriate bank accounts. The annual percentage fee was for use of the products,

These amounts reflect the deposits going into the accounts, and exclude

nontaxable deposits.

The Commissioner determined income from the client trust fund accounts

to R&A and the Ryders based on the final destination of debits and checks drawn

on the accounts. He determined that the total amount of taxable income that left

the account ending in 9156 was $1,140,959.76. The taxable income that left the

account ending in 9214 was $498,680.91. We suspect that most of the money in

these accounts was deposited before 2003.

- 28 [*28] clients’ access to funds in certain accounts, and the ultimate tax benefit they

gained. The percentage varied from product to product:

Product

Annual fee

Fee classification

ASIG

Characterized as “policy fee” and deposited

into ASIG general account

Group factoring

Characterized as “legal fee” and deposited

into factoring company general or operating

account

Group leasing

6-8%

Characterized as “retention fee” and deposited

into leasing company general account

Staffing

6-8%

Percentage paid from staffing company to

other R&A accounts and entities, such as

ESOP Legal Consultants

GCO

6-8%

Characterized as a “budget” and deposited

into 18 separate general counsel office

accounts

Short-sale

strategy

6-2/3%

Characterized as a contingent fee and

deposited into designated attorney-client trust

account

What R&A Did With the Money

Practice Funding Agreement With BFA

As difficult as it is to trace revenues from clients to R&A, it is even harder

to follow the cash as it flowed to the Ryders themselves. Our difficulty begins

with R&A’s own money management. Although R&A had no resources other

than its “time, energy, and skill” when it opened, Ryder ensured this was not the

- 29 [*29] case for long. He quickly entered into a “practice funding agreement” (PFA)

with BFA, one of R&A’s own factoring companies, to get the startup cash it

needed. This PFA took the form of a factoring agreement, in which R&A “sold”

its accounts receivable and other contracts from the law practice in exchange for

BFA’s agreement to provide funding as needed to R&A. R&A and BFA entered

into these PFAs each year between 1996 and 2003.

Establishment of Ryder Law Corp.

In 2002 R&A’s money management became even more convoluted. Ryder

incorporated Ryder Law Corp. (RLC) as an S corporation in January of that year.

The original articles of incorporation for RLC authorized the issuance of 100,000

shares of common stock and restricted ownership of any outstanding shares to

employees of RLC or an ESOP. On the same day Ryder incorporated RLC, it

executed a stock-subscription agreement with the “Ryder Law Corporation

Employee Stock Ownership Plan and Trust” (RLC ESOP). Under this agreement,

RLC ESOP bought 10,000 shares of RLC common stock for $1 a share, which

made it the 100% owner of RLC. RLC ESOP then transferred these shares to

something called the “Ryder Law Corporation Profit Sharing Plan and Trust” on

October 16, 2003. That same day, Ryder and Bradley Ammon, another attorney at

R&A, themselves bought stock in RLC through their own stock-subscription

- 30 [*30] agreements. Ammon dropped out sometime later and by 2005, Ryder

himself owned nearly all the shares. We tabulate all the twists and turns of RLC’s

ownership from 2002-09:

Shareholder

2002

2003

2004

2005-09

Ernest Ryder

---

10.38%

66.98%

98.59%

RLC ESOP

100%

79.17%

---

Bradley J. Ammon

---

10.38%

30.96%

---

RLC Profit Sharing

Plan and Trust

---

0.07%

2.06%

1.41%

Ryder claimed that his intent in all this was for RLC to become the

employee-staffing corporation for R&A. He testified that all of R&A’s employees

moved from R&A to RLC, and that RLC then leased them back to R&A

throughout all these years. But his testimony is the only evidence we have of this.

Multiple employees credibly testified that they were employees of R&A. Neither

they nor any other R&A employees had written employment agreements to show

they were now RLC’s employees. All these employees still logged their time

using R&A timeslips. The record does show that these employees received their

W-2’s from RLC every year; but as far as the rest of the world could tell, nothing

else changed for these employees.

- 31 [*31] Ryder was trying to solve the same problem many owners of a profitable C

corporation have--one layer of income tax at the corporate level, followed by

another if it pays out its profits in the form of dividends. Ryder set himself to

figuring out some way of moving R&A’s profits to RLC so he could take them as

distributions from an S corporation.22 His solution was an unorthodox one--he

told R&A’s bookkeeper, Amy Herauf, to make multiple adjusting journal entries23

to shift income from R&A to RLC.

These adjusting journal entries would show R&A’s money going to Ryder

in what he labeled “loans”--“loans” from one of the financial accounts of a group

tax product or “loans” from R&A itself (and he would include in these “loans”

money that went from R&A to pay Ryder’s or one of Ryder’s ranch’s credit-card

Ryder explained that distributions from S corporations aren’t considered

income--and are therefore tax free--so long as the shareholder has basis and the

distributions do not exceed that basis. (He’s right about this--section 1368 says

so.)

An adjusting journal entry is “[a]n accounting entry made into a

subsidiary ledger called the General journal to account for a period[’s] changes,

omissions or other financial data required to be reported ‘in the books’ but not

usually posted to the journals used for typical period transactions.” Accounting

Terminology Guide, New York State Society of CPAs,

https://www.nysscpa.org/professional-resources/accounting-terminology-guide#st

hash.OMJATGaN.BomMsjPI.dpbs (last visited June 21, 2021).

- 32 [*32] bills).24 At the end of the year, Ryder would meet with Herauf and R&A’s

return preparer Don Lang to tell them on which accounts he wanted them to make

these adjusting journal entries.

If he wanted money earned from sales of a group product, then Herauf or

Lang would record an asset in the form of a note receivable from Ryder himself on

the books of whichever entity had cash that he wanted. They would also enter on

that entity’s books an offsetting obligation to pay R&A for Ryder’s services as

their attorney. The entity would transfer the note receivable due from Ryder to

R&A to pay R&A’s attorney’s fees.

The note on which Ryder was liable would be entered as an asset on R&A’s

books. Remember though that Ryder had papered RLC to appear to sell

employment services to R&A. R&A would pay for those services that it had

supposedly bought by transferring the note to RLC. Ryder would distribute the

note to himself from RLC. As the note was now in the hands of its putative

maker, it went “poof” as a matter of tax law with no more tax consequence to

Ryder than to someone who writes a check to himself on one account to deposit

into another.

See infra pp. 161-63.

- 33 [*33] At least that’s the position Ryder took--he did not report these notes as

income on his individual returns. He explained that he did so because

distributions from S corporations are not income unless they exceeded their

owner’s basis, see supra note 22, and he treated each transfer from RLC as a

nontaxable return of basis. Where did this basis come from? The basis Ryder

claimed was from the series of stock-subscription notes that he had contributed.

The initial stock-subscription agreement between Ryder and RLC for 150,000

shares at $10.105 per share was financed with promissory notes to RLC from

Ryder in which he promised to pay more than $8,000 a month over 360 months.

He signed a second stock-subscription agreement with RLC in May 2004 for

300,000 shares at the same price per share. He also financed that subscription

with a promissory note. The same month he signed a third subscription agreement

with RLC for another 100,000 shares at the same price and financed with a third

promissory note. And finally in 2005 Ryder claims he bought Ammon’s 150,000

shares in RLC for $10,000 in cash and another note for almost $1.5 million.

Here is a summary:

Date

RLC shares

Amount

Payment method

10/16/03

150,000

$1,515,750

Note

5/10/04

300,000

3,031,500

Note

- 34 [*34] 5/12/04

100,000

1,010,500

Note

1/1/05

150,000

10,000

1,490,063

Cash

Note

Ryder claims that he made payments on these notes, but the Commissioner

says that he did not and that what looked like payments were actually distributions

from RLC that Ryder would lend back to RLC. There were more than 60 of these

payments that volleyed back and forth between Ryder and RLC and totaled almost

$2.6 million.

II.

Ryder Goes Ranching

The revenues and cashflow of R&A and RLC may be baroque in their

complexity. When we approach the Ryders’ ranches, they become rococo. Ryder

himself views the country life as a welcome respite from the daily grind of his

office life. He grew up on a ranch where he learned how to butcher, how to herd

cattle, and how to farm. So we do find that the ranch life always appealed to him.

During a road trip with his wife through southeast Arizona and southwest New

Mexico, Ryder noticed for-sale signs on ranch properties and commented to Mrs.

Ryder that “they were giving * * * the real estate away.”

This led them to start buying ranches. On January 10, 2003, Ryder Ranch

Co., LLC, filed its articles of organization, and the Ryders’ ranch life began. The

- 35 [*35] ranches’ history includes a long list of filings, amendments, and

amendments to amendments of LLC articles all done in an attempt to alter--or at

least give the appearance of altering--their ownership.

By the time we tried these cases, the Ryders had ended up with nine

properties:

Properties

purchased

Date

purchased

Cost

Lazy BK Ranch

1/16/03

$355,000

Varnum property

10/8/08

325,000

Shumaker Farms

4/18/03

420,000

Boggs property

6/10/03

162,000

Moore property

2/16/05

537,500

Canyon View Ranch,

LLC

Rivers property

5/19/03

150,000

Ryder Red Rock Ranch,

LLC

Coon Ranch

4/28/03

650,000

Rodeo Holdings, LLC

Gallery Building

3/15/06

70,000

Escarcega House

8/31/06

180,000

Ranch LLC

Ryder Ranch Company,

LLC

Pattern Farms, LLC

- 36 [*36] A.

Sources of Money for Ranches

Counselor Capital as Blocker Entity for Ranches

One of R&A’s “services provided” was to help its clients retrieve the money

that they had put into one of the products. By “helping them retrieve their

money,” we do not mean filling out withdrawal slips. We mean the more

sophisticated service of shunting money through different accounts held by these

entities, from which money could flow back to the clients as what looked like

loans. Ryder called this type of account a “blocker entity”--Ryder’s term for an

entity between a payor and payee that disguised the true flow of money, or that he

used to “isolate the tax-exempt entity from being engaged [with] an unrelated

trader.” Counselor Capital, for example, was a blocker entity used mainly by

USFA clients. Money from clients would find its way into Counselor Capital’s

bank account, and the clients would then “borrow” their own money from

Counselor Capital. Ryder had access to these accounts, and used them to fund the

ranch entities. Ryder booked this as an investment by Counselor Capital in

another company called First Counsel Capital, which Ryder at least occasionally

papered to look like it was part owner of Ryder Ranch Co., LLC.

- 37 2.

[*37]

First Counsel Capital as Blocker Entity for Ranches

To use First Counsel Capital as a blocker, Ryder had to adjust a number of

different entities. He had, for example, filed articles of organization for Executive

Placement Services - 106, LLC, with the Wyoming secretary of state in November

2002. These articles identified Executive Placement Services, Inc. (a Utah

corporation) as the LLC’s manager. In September 2003 Ryder filed an amendment

to substitute First Counsel Capital, LLC, a California LLC, as manager. Wyoming

then dissolved Executive Placement Services - 106, LLC, for failure to file its

annual report and pay tax, and the company stayed dissolved until April 2006.

Notwithstanding this dissolution, Ryder filed a 2003 income-tax return for

Executive Placement Services - 106, LLC, in October 2004. But that return listed

the partnership as First Counsel Capital, LLC, with a Wyoming address. This

seems to have anticipated another name change, because in April 2006 Ryder filed

paperwork with the Wyoming secretary of state to change the name of Executive

Placement Services - 106, LLC, to First Counsel Capital, LLC. This amendment

also changed the managing member for the LLC to himself in his capacity as an

attorney for R&A.25 Ryder had already opened a bank account for First Counsel

We note that this change to the managing member avoided First Counsel

Capital, LLC, of Wyoming having as its managing member First Counsel Capital,

(continued...)

- 38 [*38] Capital, LLC (Wyoming), on October 20, 2003, almost three years before an

LLC with that name existed. (Ryder Ranch Co., LLC, also filed its 2005 return

showing one of its members as First Counsel Capital, LLC (Wyoming), before any

LLC had that name.) That same month--April 2006--Ryder converted the

Wyoming LLC to a C corporation: First Counsel Capital, Inc.

With First Counsel Capital, Inc., incorporated and at least on paper

sometimes owning an interest in Ryder Ranch, Ryder began to use it as a “blocker

entity” to funnel money out into the ranches. This meant that he again decided to

make adjusting journal entries to record money whose real origin lay in 18 GCO

accounts, ESOP Legal Consultants, Inc., Counselor Capital, and group-leasing

products as money that came from First Counsel Capital, Inc. These transfers

were all opaque, and Ryder made them either through the “adjusting journal entry”

process already described or through a slightly different “loan payable” method.

In this second method, the initial journal entries would list as an asset on the group

product’s balance sheet a receivable due for the amount of a loan from the ranch

entity, and list as a liability on the ranch entity’s balance sheet a loan payable for

the same amount. Ryder would adjust these entries at the end of the year. He

(...continued)

LLC, of California.

- 39 [*39] would adjust the group product’s books to show the loan receivable due

from the ranch entity as an equity investment in First Counsel Capital, Inc. On the

books for the ranch entity, he would reclassify the loan payable as a contribution

by First Counsel Capital, Inc. On First Counsel Capital, Inc.’s books, the

investment from the group product was recorded as a liability and the loan

receivable due from the ranch entity was recorded as an asset. Then the loan

receivable due from the ranch entity was canceled by reclassifying it as an

investment in the ranch entity.

Use of Four Additional Blocker Entities

Ryder expanded his use of “blocker entities” with four additional

investment companies that he used to get money from R&A’s attorney-client trust

account ending in 9156--the account he created to hold fees from clients who had

bought the Son-of-BOSS short-sale product we’ve already described--out to the

ranch entities. These four companies were:

Turnour Investments, Inc.;

Alster Investments, Inc.;

MBSP Investments, Inc.; and

Spanky Investments, Inc.

- 40 [*40] Ryder filed the articles of incorporation for Turnour Investments, Inc., with

Wyoming in November 2002; and for Alster Investments, Inc., MBSP Investments, Inc., and Spanky Investments, Inc., in December 2002. He listed R&A as

the mailing address for each in the annual reports that each company filed.

Once these companies were set up, Ryder made a series of transfers on

December 24, 2002, from R&A’s attorney-client trust account ending in 9156 to

accounts titled to these new companies. The first transfer was to a bank account

titled “Spanky Investments, Inc.” for $75,000. The second was to a bank account

titled “MBSP Investments, Inc.” for $900,000. The third was to a bank account

titled “Alster Investments, Inc.” for $175,000. And the fourth was to a bank

account titled “Turnour Investments, Inc.” for $205,000. Ryder produced stock

certificates dated December 30, 2002, a week before trial that showed BFA as the

registered holder of shares in each of these four companies. Here are the number

of shares held by BFA in each:

Investment company

Shares issued

Spanky Investments, Inc.

75,000

MBSP Investments, Inc.

900,000

Alster Investments, Inc.

175,000

Turnour Investments, Inc.

205,000

- 41 [*41] So for each dollar transferred into the accounts for the investment

companies, BFA received one share.

Ryder claims that the transfer of funds from the trust account to these

investment companies reflected payments under the practice funding agreement

between R&A and BFA that we’ve already described. The trust account held the

fees earned by R&A through the short-sale strategy products. Under the funding

agreement, BFA supposedly had the right to these fees, which made it the

beneficial owner of the funds in the trust account. When Ryder moved the funds

from this account to the companies, it was therefore BFA that received shares in

each of them. Ryder claimed these were payments under the practice funding

agreement.

Once Ryder transferred these funds into the companies’ accounts, these four

companies would send the money to the ranch entities and to Ryder Ranch Co.,

LLC, to fund the ranch activities.

RLC and Its Stock Subscription Agreement

R&A used RLC and RLC’s ESOP as another way to get money out of the

group products. Remember that when Ryder organized RLC he had RLC’s ESOP

sign a stock subscription agreement to buy 10,000 shares of common stock and

RLC ESOP nominally held 100% of the RLC shares. When Ryder and Ammon

- 42 [*42] bought their interests in RLC, the 10,000 shares of RLC stock that RLC’s

ESOP held were nominally transferred to the “RLC Profit Sharing Plan.” Ryder

eventually went on to acquire nearly all of the shares of RLC. Distributions from

RLC to Ryder were made through the adjusting journal entries already described.

And once again, Ryder treated these payments from RLC as a nontaxable return of

basis in an S corporation by claiming basis from the subscription notes he

contributed to RLC.

Ryder Ranch Co., LLC Properties

On January 16, 2003, the Ryders bought the Lazy BK Ranch in Cochise

County, Arizona. The price was $355,000, with a $100,000 downpayment and the

remaining $255,000 financed by a loan. The Ryders put the property in the name

of Ryder Ranch Co., LLC.

Ryder Ranch Co., LLC, bought more Cochise County land from Terryl

Varnum in October 2008. The price was $325,000, and a downpayment and

closing costs of more than $126,000 went from Counselor Capital, Inc.’s bank

account to Pioneer Title Agency. Ryder Ranch Co., LLC, used seller financing for

the rest.

- 43 [*43] C.

Pattern Farms, LLC

Ryder also organized Pattern Farms, LLC.26 He filed its articles of

organization in January 2003 with the Arizona Corporation Commission and then,

as with Ryder Ranch Co., LLC, drove it through a whirlwind of amendments and

refilings.

In April 2003 Pattern Farms, LLC, purchased two parcels of land in Cochise

County from Weldon and Marjorie Shumaker. The price was $420,000, and the

downpayment came from the Ryders’ personal account. Pattern Farms, LLC, got

financing from the Shumakers and gave them a promissory note in which it

promised to pay them $210,000 in two annual installments of $105,000 plus

interest. When time came to send these payments, almost all the money went to

the Shumakers from bank accounts titled “Alster Investments, Inc.” and “MBSP

Investments, Inc.”

In June 2003 Pattern bought two more parcels of land in Cochise County.

The downpayment came from the Ryders’ personal account. The record shows at

least one payment on the note came from an account titled MBSP Investments,

Inc.

The name “Pattern Farms” is a portmanteau of the Ryders’ first names,

Patricia and Ernest.

- 44 [*44] In February 2005 Pattern bought four more properties in Cochise County.

This purchase was also mostly seller-financed, and the money for it again did not

come from the Ryders directly. This time the money came from an account for

First Counsel Capital, LLC (Wyoming).

Canyon View Ranch, LLC

Ryder next formed Canyon View Ranch, LLC. He filed its articles of

organization with the Arizona Corporation Commission on April 24, 2003, and

followed up with the usual amendment shenanigans.

On May 19, 2003, Canyon View Ranch, LLC, completed the purchase of

two parcels of land in Cochise County, Arizona, from Edward Rivers. The

contract price was $150,000, with additional closing costs of $421.50. Canyon

View Ranch, LLC, gave Rivers a promissory note for $120,000 with an annual

interest rate of 6%. A bank account titled “Turnour Investments, Inc.” also

supplied $31,000 for this purchase.

Ryder Red Rock Ranch, LLC

Ryder also wanted to buy ranch land in New Mexico. He first organized a

new entity, Ryder Red Rock Ranch, LLC, in April 2003, and then followed the

same pattern as before.

- 45 [*45] On April 28, 2003, Ryder Red Rock Ranch, LLC, completed its purchase of

four parcels of land (property formerly known as Coon Ranch) in New Mexico’s

Grant and Hidalgo Counties. The contract price was $650,000, with additional

closing costs and state taxes of $1,811.55. Ten thousand dollars came from a bank

account titled “MBSP Investments, Inc.” This same “MBSP Investments, Inc.”

bank account also transferred $645,000 that we find more likely than not went to

the Coons. Since these payments totaled more than the contract-plus-closing

costs, Ryder Red Rock Ranch received a refund from the Hidalgo County Abstract

Escrow Trust.

Rodeo Holdings, LLC

The last of Ryder’s real-estate LLCs is Rodeo Holdings, LLC. He didn’t

organize Rodeo Holdings until February 2006.

It bought two buildings in Hidalgo County, New Mexico. The first was the

“Gallery Building.” The downpayment came from the Ryders’ personal bank

account with the remainder from an account titled to ExecuPro. The second was

the “Escarcega House.” A small part of the price came from the Ryders’ personal

checking account with the rest from accounts titled ExecuPro and Westra Capital

Management.

- 46 [*46] III.

Audit, Cashflow, and Trial

Audit

The IRS began a section 6700 investigation27 into R&A’s use of ESOPs on

August 26, 2003, after someone noticed that the firm had applied to have more

than 800 ESOPs qualified at the same time. Then, like antibodies swarming to an

infection, two more investigations latched onto the promotional activities of

Robert Pancheri and Karen Baker--former R&A employees whom Ryder had used

to “manage” many of the different entities. These converged into a full-blown

audit of the Ryders and his law firm. This überaudit spanned nearly a decade and

expanded backward and forward to the Ryders’ 2002-11 and R&A’s 2005-09 tax

years.

When questioned by IRS agents, Ryder pleaded the Fifth and refused to

answer any questions regarding the tax structures sold by his law firm. Ryder’s

silence left the Commissioner with no choice but to use subpoenas and third-party

interviews. Revenue Agent Huong Phan--the first revenue agent on this case--

Section 6700 imposes a civil penalty for the promotion of abusive tax

shelters. A section 6700 investigation “is conducted independently of, and

without regard to, the determination on [an] income tax case,” see Internal

Revenue Manual pt. 20.1.6.1.2(3) (July 8, 1999), and focuses only on whether the

promoter/preparer is subject to penalties or an injunction for his involvement in

abusive activities.

- 47 [*47] issued over 30 summonses to various financial institutions and third

parties--essentially any party that he was able to recognize.

More investigations broke out. The California Franchise Tax Board

executed a search warrant of R&A’s office in April 2010. The IRS then expanded

its audit team to add Revenue Agent Joseph Haynes. He focused on identifying

what payments and deposits had moved through all these entities and accounts. It

was a staggering job--RA Haynes himself issued over 300 summonses to financial

institutions and other third parties during the course of his investigation. He even

had a summons served on the Franchise Tax Board to get access to the records that

it had seized in its investigation. The Commissioner found a tangle of 560

financial accounts used by hundreds of entities created by Ryder through R&A.

Ryder himself had signature authority over approximately two-thirds of these

accounts; the fraction rises to nearly 95% if one includes accounts where Ryder’s

employees had signature authority. RA Haynes also traced the flow of funds

through R&A’s accounts to identify which were for the Ryders’ benefit. After this

work was completed, RAs Haynes and Phan both analyzed the items going

through the accounts to identify which accounts were used to collect R&A’s fees.

And, finally, Revenue Agent Nistha Boyer--who took over the work of RA Phan

after RA Phan changed roles within the IRS--completed a bank-deposit analysis

- 48 [*48] (BDA) to identify R&A’s gross receipts. RA Boyer also determined that the

Ryders were taking funds out of these accounts to pay personal expenses and

linked these funds to R&A’s gross receipts.

Cashflow

Following the Money

We can begin with a general explanation of this complex analysis by the

Commissioner’s revenue agents. Their work uncovered 41 of R&A’s financial

accounts and 10 of the Ryders’. They identified and sorted the specific items of

income deposited into these accounts, and then sorted the accounts into two

“boxes”.

The first contained the 41 R&A accounts. This is the law-firm box, and the

agents determined that any money coming into that box was income of R&A. But

if money just sloshed around from one account to another inside this box the

agents didn’t count it as R&A income. We find that this is a generally reasonable

way for us to identify R&A’s income.

The second box held the Ryders’ personal accounts. When money came

into this “personal box” from the law-firm box, or left the law-firm box to go to a

third party for the benefit of Ryder or his family, the agents treated it as a

distribution to Ryder, unless the money was already included in their reported

- 49 [*49] income. Just as with the law-firm box, the Commissioner did not add to the

Ryders’ income any deposits and withdrawals between accounts within the

personal box. We also find this to be a generally reasonable way for us to identify

the Ryders’ possibly taxable distributions.

Gross Income

This bank-deposit analysis is the heart of these cases. And given the

astonishing complexity of the cashflows in and out of the accounts, we next

describe in some detail the links between R&A’s tax products and these accounts.

ASIG. The ASIG product was the one that mocked up deferred

compensation to look like disability-insurance policies. R&A would assign each

client who bought these policies a policy number, draft a policy, and open a

dedicated bank account for the client’s use. We find from the records we have that

whenever a client filed for benefits under an ASIG policy, he would complete a

claim package and pay a termination fee. This termination fee would show up as a

deposit into the ASIG bank account ending in 5337. More money would leave

these dedicated accounts twice a year and end up in the same account ending in

5337. Clients agreed that these transfers were Ryder’s legal fees for the services

provided. R&A generated a total of more than $1.28 million in revenue through

these ASIG deals. See supra pp. 14-15.

- 50 [*50] This is not all the income that R&A earned from sales of ASIG policies.

From 1998 through 2002, most of the money from ASIG deals bypassed R&A’s

books and went to Ryder as “loans” whose repayment he owed to R&A. These

“loans” would move from R&A to RLC and back to Ryder himself in 2005

through the adjusting journal entries already described. See supra pp. 31-34.

From 2004 through 2010 R&A’s income from ASIG polices that went into

the 5337 account totaled more than $1 million. A large share, $188,514, left the

account by check to Morris Cottingham Corporate Services, Ltd., of the Turks and

Caicos, and two checks went to Capital Mexicana, Ltd. Nearly all the remaining

funds in the 5337 account were transferred in October 2010 to a bank account

entitled “Execupro Specialty Services, Inc., ESOP Designated Roth Contribution

Account.” This repaid two of R&A’s clients for advances they had made to

Counselor Capital, Inc., from 2007 through 2010 that Ryder had used to fund the

ranch entities. The next year, in September 2011, the 5337 account was drained of

$61,000 that went to Counselor Capital, Inc., again as funds for Ryder’s use in his

ranch entities.

In total, the Commissioner traced $1,027,811.49 of the asserted $1,280,560

of ASIG income received from 2003 to 2011 directly to R&A, or indirectly to pay

off the Counselor Capital, Inc.’s loan for the benefit of Ryder as stated above. We

- 51 [*51] agree and find that this $1,027,811.49 is includable in R&A’s gross income

for the years in which it was deposited.

Group Factoring Products. R&A commingled the money it earned selling

the group factoring product with its clients’ own funds within each of the

product’s bank accounts. We can trace R&A’s earnings, however, because it

labeled its fees for two of the companies it used--BFA and USFA--either

dividends or fees. These “dividends” or fees moved out of the individual clients’

“collection accounts” each quarter into the products’ general bank accounts. From

there, the funds moved--either directly or through BFA’s Division 101 bank

account ending in 0449--into accounts owned by R&A or Ryder, or in some cases

to third parties for their benefit. The Commissioner also mapped the fee flow to

R&A from the other group-factoring entities that R&A created--Western Funding

Group and WFG. This meant he included amounts from those products that ended

up in R&A’s bank account or the BFA Division 101 account.28

The Commissioner determined the following amounts as income to R&A

through the group factoring products:

WFG had an account of its own ending in 6874, but the Commissioner

does not argue that deposits into that account became gross receipts of R&A until

they were deposited into R&A’s own bank account.

- 52 [*52]

R&A gross income

Year

BFA (8497)

USFA (4564

& 2653)

Western

Funding (2935)

WFG (6874)

2003

-0-

$626,740.57

-0-

2004

$108,671.38

202,765.11

$29,176.18

-0-

2005

84,714.22

9,029.18

155,238.73

-0-

2006

61,286.74

7,512.98

136,721.37

-0-

2007

23,003.82

2,646.63

217,454.72

-0-

2008

19,910.03

825.36

10,760.97

$70,440.70

2009

-0-

2010

78,878.91

-0-

2011

-0-

Total

376,465.10

849,519.83

549,351.97

70,440.70

Group Leasing Products. The commingling of R&A’s fees with clients’

money was an even bigger problem within the group leasing products. In the end,

the problem was so severe that instead of figuring out R&A’s income from the

money that entered the bank accounts of the leasing products,29 the Commissioner

These accounts were ExecuPro ESOP’s bank account ending in 8166;

ExecuPro Specialty Services, Inc.’s bank accounts ending in 6170, 4604, 0517,

and 7257; Executive Placement, Inc.’s bank account ending in 6670; Worldwide

Career Management’s bank account ending in 4870; and Westra Capital

Management’s bank account ending in 3209. There was also an account ending in

0392 in the name of ExecuPro Specialty Services, LP, that paid one check for $85

to BFA’s Division 101’s bank account ending in 0449 in 2008. Neither party

(continued...)

- 53 [*53] found income to R&A only when money left the leasing-product bank

accounts and moved into one of R&A’s own bank accounts or a third-party bank

account for the benefit of Ryder or R&A.30 The Commissioner determined that

this product generated more than $5 million in revenue that should be included in

R&A’s gross income. See supra p. 21. We agree with his determination.

Stand-Alone Staffing Products. After the Commissioner began his section

6700 investigation, Ryder drew up an “Agreement of Assignment and

Assumption” dated January 1, 2004, with which he tried to assign all of the

income from R&A’s staffing product to ESOP Legal Consultants, Inc. The

agreement says it was an assignment of R&A’s rights to income only for tax years

2004-06, but Ryder kept using ESOP Legal Consultants’ bank account ending in

3149 all the way up until 2011. In 2004 alone R&A moved more than $600,000

(...continued)

explains the origin or function of ExecuPro Specialty Services, LP, or its relation

to ExecuPro Specialty Services, Inc. With nothing else in the record to guide us,

we will treat ExecuPro Specialty Services, LP, as part of ExecuPro Specialty

Services, Inc.

We include as R&A’s income checks and direct transfers from the groupleasing product accounts into Ryder’s entities, to Ryder’s children, or for Ryder’s

personal benefit. These include checks and transfers into the Ryders’ personal

bank account ending in 4461; R&A’s bank account ending in 9815; BFA’s

Division 101’s bank account ending in 0449; RLC’s bank account ending in 8168;

Ryder Ranch Co., LLC’s bank account ending in 5695; and Pattern Farms, LLC’s

bank account ending in 9446.

- 54 [*54] into it. Deposits came from businesses such as “Pacific Management

Company,” “McMahon Staffing, Inc.,” and “Sentry Funding, Inc.” R&A would

then move this money from ESOP Legal Consultants’ bank account to accounts of

RLC, R&A, the Ryders’ ranch entities, the Ryders themselves, and third parties

likely for the benefit of R&A.31 Ryder did not object to any of the specific

numbers in this part of the Commissioner’s analysis, and we find that they are

more likely than not true. Here is a summary:

For example, payments were made to Seaside Accounting Solutions (f.k.a.

Accounting by the Sea, Inc.), where Herauf, R&A’s bookkeeper, worked at the

time.

- 55 [*55]

Year

Deposits

Debits

Paid to whom

2004

$638,331.88

$623,218.70

RLC

R&A

Ernest Ryder

Ryder Ranch Co., LLC

Pattern Farms, LLC

Canyon View Ranch, LLC

Accounting by the Sea, Inc.

Lippa Associates, Inc.

Capital Analysts of San Diego,

LLC

Wyoming secretary of state

Adams Wilshire Engraving

Inc.

Sungard Corbel, Inc.

2005

1,232,528.55

1,247,428.68

RLC

R&A

First Counsel Capital

Accounting by the Sea,

Inc./Seaside Accounting

Solutions

Osmundo Bernake

Enhanced Accounting

Software, Inc.

ESOP to R&A

ESOP to RLC

State Bar of California

- 56 [*56]

2006

1,178,622.52

1,178,169.85

ESOP to RLC

ESOP to R&A

Clear Visual Ink

Lippa Associates, Inc.

Capital Analysts of San Diego,

LLC

Canyon View Ranch, LLC

Pattern Farms, LLC

Ryder Ranch Co., LLC

Ryder Red Rock Ranch, LLC

Wachovia Bank

State Bar of California

Clear Verse, Inc.

2007

543,983.30

544,440.94

ESOP to RLC

ESOP to R&A

Capital Analysts of San Diego,

LLC

Clear Verse, Inc.

State Bar of California

2008

78,660.56

78,741.90

Clear Verse, Inc.

R&A

2009

376,993.02

377,054.30

Clear Verse, Inc.

R&A

RLC

Westra Capital Management,

Inc.

State Bar of California

2010

306,958.29

364,680.47

R&A

RLC

Lang & Associates, Inc.

Clear Verse, Inc.

California secretary of state

- 57 [*57]

2011

57,781.72

125.00

Total

4,413,859.84

Unknown

General Counsel Office. The Commissioner’s BDA for the general counsel

office deals reviewed the 18 GCO accounts and looked at the flow of money into

and out of them during each of the years at issue. Each GCO client corporation

had two accounts: one for an ESOP S corporation that the client controlled and a

separate GCO account at Charles Schwab that R&A controlled. A client would

move money from his operating business into his ESOP S corporation’s account.

About once a year, he would make a transfer from the S corporation’s account into

the GCO account at Charles Schwab. This made tracing revenue much easier, and

the amounts transferred were tied to the sum of the documentation fee and annual

percentage fee (computed as a percentage of the money the client moved into the

ESOP S corporation) that R&A charged for its services. The amounts in these

GCO accounts were eventually disbursed to one of Ryder’s “blocker” entities-either First Counsel Capital, LLC (Wyoming), or First Counsel Capital, Inc.--as

described earlier. See supra pp. 36-38. The breakdown for each GCO client:

- 58 [*58]

Goldstein Law Corporation

Year

R&A gross receipts

2003

$105,758.80

2004

27,422.77

2005

-0-

2006

32,721.90

2007

64,123.14

2008

-0-

2009

-0-

Total

230,026.61

Grampa’s Programming, Inc.

Year

R&A gross receipts

2003

$40,023.68

2004

30.00

2005

129,857.47

2006

-0-

2007

832.24

2008

4,514.73

2009

2,755.00

Total

178,013.12

- 59 [*59]

Borrego Management Services, Inc.

Year

R&A gross receipts

2003

$100,000.00

2004

-0-

2005

254,696.11

2006

-0-

2007

150,000.00

2008

125,000.00

2009

125,064.35

Total

754,760.46

Vantage 1, Inc.

Year

R&A gross receipts

2003

$182,463.55

2004

-0-

2005

57,644.06

2006

23,617.13

2007

565.18

2008

4,452.25

2009

-0-

Total

268,742.17

- 60 [*60]

Western Head Investments, Inc.

Year

R&A gross receipts

2003

-0-

2004

-0-

2005

$57,644.06

2006

-0-

2007

5,450.00

2008

4,122.56

2009

738.99

Total

67,955.61

Bighorn 2, Inc. General Counsel

Year

R&A gross receipts

2003

-0-

2004

$47,363.68

2005

1,344.72

2006

1,752.47

2007

-0-

2008

100.22

2009

-0-

Total

50,561.09

- 61 [*61]

Orion 1, Inc.

Year

R&A gross receipts

2003

$29,444.87

2004

124,141.00

2005

-0-

2006

312,781.85

2007

-0-

2008

5,304.23

2009

-0-

Total

471,671.95

Consultants 1, Inc.

Year

R&A gross receipts

2003

-0-

2004

$39,324.80

2005

37,116.84

2006

63,998.42

2007

-0-

2008

-0-

2009

-0-

Total

140,440.06

- 62 [*62]

Relativity, Inc.

Year

R&A gross receipts

2003

-0-

2004

$109,527.92

2005

-0-

2006

-0-

2007

-0-

2008

1,158.85

2009

-0-

Total

110,686.77

Pacific Star 5, Inc.

Year

R&A gross receipts

2003

-0-

2004

-0-

2005

$22,047.12

2006

-0-

2007

-0-

2008

-0-

2009

-0-

Total

22,047.12

- 63 [*63]

Buena Ventura 1, Inc.

Year

R&A gross receipts

2003

$74,247.20

2004

3,767.51

2005

-0-

2006

-0-

2007

-0-

2008

-0-

2009

-0-

Total

78,014.71

American Passion, Inc.

Year

R&A gross receipts

2003

-0-

2004

-0-

2005

-0-

2006

-0-

2007

-0-

2008

-0-

2009

-0-

Total

-0-

- 64 [*64]

Tornado Consulting, Inc.

Year

R&A gross receipts

2003

-0-

2004

-0-

2005

-0-

2006

-0-

2007

-0-

2008

$14,000.00

2009

5,500.00

Total

19,500.00

Edgewood Distributors & Management, Inc.

Year

R&A gross receipts

2003

$150,000.00

2004

70,000.00

2005

-0-

2006

1,642.28

2007

-0-

2008

240.00

2009

-0-

Total

221,882.28

- 65 [*65]

Regent 1, Inc.

Year

R&A gross receipts

2003

-0-

2004

-0-

2005

-0-

2006

$118,302.31

2007

50,000.00

2008

91,583.00

2009

25,000.00

Total

284,885.31

L.I.P. Investments, Inc.

Year

R&A gross receipts

2003

$36,094.69

2004

56,805.18

2005

82,665.29

2006

119,881.77

2007

-0-

2008

-0-

2009

-0-

Total

295,446.93

- 66 [*66]

Mani Padme Corporation

Year

R&A gross receipts

2003

$26,185.03

2004

25,021.81

2005

90,160.40

2006

89,669.00

2007

-0-

2008

-0-

2009

-0-

Total

231,036.24

Carlsbad Components, Inc.

Year

R&A gross receipts

2003

$34,738.96

2004

49,031.84

2005

-0-

2006

39,312.23

2007

-0-

2008

-0-

2009

-0-

Total

123,083.03

- 67 [*67] Son-of-BOSS. R&A used QuickBooks to keep track of the income from its

short-sale strategy. Tracing the flow of money from these sales was difficult

because R&A wasn’t entitled to its fee until its client had escaped IRS scrutiny

long enough for the statute of limitations to have run, see infra p. 117-18. Much

of R&A’s work on these deals was done before the years at issue, and the

Commissioner says he can’t trace all the money that R&A earned from their sales.

But he did manage to track a little over $2.8 million, which we find is includable

in R&A’s income for the years at issue.

We make findings on these flows of funds knowing that any navigation of

the labyrinth of entities and accounts that Ryder built will necessarily be

imperfect. Detecting, dissecting, and determining the links between these deposits

and debits and their correct sources is complex. But the complexity, and hence

any imperfection, was not only created by Ryder himself, but also aggravated by

his lack of cooperation in organizing his firm’s records and his producing them

sometimes only a very short time before trial. See Lawson v. Commissioner, T.C.

Memo. 2015-211, at *25 (“In the light of the utter lack of cooperation from

petitioners during the audit, RA Enriquez and respondent showed substantial and

reasonable efforts in compiling the BDA and making sure the findings are

correct”); see also Gleason v. Commissioner, T.C. Memo. 2011-154

- 68 [*68] (Commissioner entitled to any reasonable method to reconstruct income

where taxpayer files no returns and refuses to cooperate).

“Other Deductions” for 2005-06

The Commissioner determined not only to increase R&A’s income but to

disallow a very large number of deductions on R&A’s 2005 and 2006 tax returns.

Ryder called these “client administrative services,” “legal and professional,” and

“meals and entertainment.” The Commissioner claimed that R&A failed to

establish its entitlement to the deductions. He also claimed that to the extent the

deductions were for payments to RLC under the employee-leasing agreement, we

should disallow them because that agreement was a sham.

Dividend Treatment

Any determination about R&A’s gross income is only one part of the story.

The Commissioner also wants us to decide how much income the Ryders

themselves derived from the firm. He asserts that Ryder received almost $16

million in constructive dividends from R&A for 2003-11. These funds, he says,

flowed to Ryder in three different ways:

from R&A through RLC from 2003-09,

from R&A’s several tax products to the ranch entities, and

- 69 !

[*69]

from R&A’s bank accounts to third parties for the Ryders’

benefit.

From R&A Through RLC

The Commissioner determined that the Ryders received nearly $8.3 million

in dividend income from R&A through RLC. He reached this conclusion by

poring through the K-1s that RLC issued to Ryder. He added up the money that

RLC distributed, and excluded any circular flow of these funds.32 He included the

“in-kind” distributions that RLC made to Ryder when Ryder liquidated ESR of

Counsel, LLC, in 2004.33

ii.

From Tax Products to Ranch Entities

The Commissioner also traced the money that went from R&A into the

various ranch entities that Ryder set up to buy land in Arizona and New Mexico.

His first stab at the problem was RA Boyer’s analysis in which he added up the

deposits from the accounts of the various tax products that went into the Ryders’

Excluding the “circular flow of funds” was important because Ryder used

adjusting journal entries to make it seem he was making payments on the notes

that he gave to RLC to “pay” for the stock in RLC that he had signed subscription

agreements for in 2003-05. See supra pp. 29-34.

ESR of Counsel, LLC, was a wholly owned subsidiary of RLC that Ryder

created in 2002. Some of the revenue generated from the Son-of-BOSS product

was diverted to ESR of Counsel and then passed on to R&A and the Ryders.

When ESR of Counsel dissolved, its assets (primarily in the form of notes

receivable) were assumed by RLC, which then distributed them to the Ryders.

- 70 [*70] personal accounts, into accounts for the ranch entities, or to third parties

(e.g., credit-card companies) to pay the Ryders’ personal bills. But then--only a

week before the Phoenix part of the trial--Ryder finally produced the financials for

Ryder Ranch Co., LLC. This information included records of contributions and

loans that went into Ryder Ranch accounts. These were particularly helpful, says

the Commissioner, because they showed the exact amounts that went into the

different ranch entities, and so eliminated what might have been double-counting.

Using these new financials and Ryder’s own testimony, the Commissioner

adjusted his analysis of this form of dividend income. This new information

helped him tweak the timing of transfers to Ryder Ranch to make sure that he

counted it as income when it entered Ryder Ranch’s accounts. It also helped him

avoid double counting income as money flowed from one account to another

within the “personal box.”

iii.

From R&A’s Bank Accounts to Third Parties for the

Ryders’ Benefit

The Commissioner also treated as dividends those payments that R&A made

to third parties for the benefit of the Ryders. For years before 2010, these

payments were first run through RLC and recorded on its books and tax returns as

distributions or advances. But whether from R&A directly or from R&A through

- 71 [*71] RLC, these alleged dividends included payments to American Express for

the Ryders’ credit-card bills and to their personal contractor.

The specific bank accounts from which this money flowed were titled

“Ernest S. Ryder A Professional Law Corporation,” “ESOP Legal Consultants,

Inc.,” “Counselor Capital Inc.,” and “Westra Capital Management Retirement

Savings Plan.” The Commissioner asserts that the nearly $400,000 that came from

these accounts was traceable to R&A’s gross receipts and had not been booked as

loans on Ryder Ranch Company’s financials.

The Commissioner also asserts that Ryder used money from R&A to pay

Ben Leland Construction, Inc., for work done on the Ryders’ home. He traced this

money by matching amounts charged on invoices from the construction company

with check numbers and amounts from various Ryder accounts. The accounts

used to pay these invoices were “Counselor Capital, Inc.,” “Westra Capital

Management, Inc. Retirement Savings Plan,” “Benefactor Funding Assoc., Inc.-General Account,” “ExecuPro Specialty Services, Inc.--General Account,” “Ryder

Law Corp.,” and “Ernest S. Ryder & Associates, Inc., APLC.” And for tax years

2010 and 2011 the Commissioner found more than $400,000 in R&A fee income

that went to pay Ben Leland Construction.

These credit-card and contractor payments totaled $849,547.49.

- 72 5.

[*72]

The Commissioner’s Alternative Arguments

The Commissioner also asserted in the alternative that even if we don’t find

that income flowed to Ryder from R&A, it certainly flowed from RLC to Ryder.

The Commissioner then added up transfers from RLC that he said were income to

Ryder:

unreported distributions from RLC computed from the increase in

Ryder’s distributive share for tax years 2005-09;

unreported distributions from Westra Capital Management computed

from the increase in Ryder’s distributive share for tax years 2005-07;

an unreported short-term capital gain distribution from Westra Capital

Management for 2005;

unreported wages for 2009;

unreported other income for 2004, 2010 and 2011; and

unreported interest income from RLC.34

The Commissioner acknowledges that many of these alternative positions

are already the subject of settlements or prior assessments. The Commissioner

will have to abate any assessments as required to avoid double taxation.

- 73 [*73]

Disallowed Deductions

Substantiation of R&A Expenses

Although much of the fight between Ryder and the Commissioner was

about unreported income, the Commissioner also disallowed many of the

deductions that Ryder and his various entities had claimed. These include:

Year

Disallowed deductions

2004

$579,330

2005

4,154,085

2006

167,243

2007

363,215

2008

661,361

2010

113,307

Total

6,038,541

2005 Investment Interest Expense. Ryder claimed a deduction for

investment interest of nearly $350,000 on his Schedule A for 2005. The

Commissioner disallowed this expense because Ryder reported it as a flowthrough

expense from RLC, but RLC’s K-1 to him included no such amount. Ryder argues

this was a mistake--he says the deduction was legit, but that he should have

reported it on his Schedule E as “business interest” instead.

- 74 [*74] 2006-08 Unreimbursed Employee Expenses. Ryder claimed “unreimbursed

expenses” on his Forms 1040 for 2006 through 2008 of:

Year

Amount

2006

$167,133

2007

357,313

2008

588,836

Total

1,113,282

The Commissioner disallowed these for the same reason as the interest expense-Ryder claimed them as flowthrough expenses from RLC, but they were nowhere to

be found on RLC’s own returns. Ryder now claims that these “unreimbursed

employee expenses” were also really “business interest” that he should have

reported on his Schedule E.

2004, 2005, and 2010 Ordinary Losses From RLC. The Commissioner

disallowed large amounts of ordinary losses that Ryder claimed flowed through

from RLC:

Year

Amount

2004

$579,330

2005

143,253

2010

113,307

Total

835,890

- 75 [*75] The Commissioner’s primary position is that Ryder failed to prove that he

had enough basis in RLC to deduct these as ordinary losses. His backup argument

is that RLC itself didn’t adequately prove that it suffered the losses that it passed

through to Ryder.

2008 Prior-Year Adjustment Basis Carryover. Ryder claimed on his 2008

tax return that he had sufficient basis in RLC to claim a loss of more than $70,000

that he couldn’t claim earlier for failure to have enough basis. See supra note 22;