United States Tax Court

United States Tax Court

T.C. Memo. 2024-59

PARKWAY GRAVEL, INC. AND SUBSIDIARIES,

Petitioner

v.

COMMISSIONER OF INTERNAL REVENUE,

Respondent

__________

Docket No. 10819-21.

Filed May 21, 2024.

__________

Charles E. Hodges II and Thomas M. Zaino, for petitioner.

Philip S. Yarberough, Jeannine A. Zabrenski, and Nicole M. Connelly,

for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

KERRIGAN, Chief Judge: Respondent determined a deficiency of

$1,410,280 and a penalty of $282,056 pursuant to section 6662(a) for

2013. The issues for consideration are whether petitioner engaged in a

sham transaction or otherwise assigned income in contravention of the

terms of the transaction and must recognize as income $4.2 million

received by a related entity pursuant to the transaction, and whether

petitioner is liable for a 20% accuracy-related penalty pursuant to

section 6662(a).

We incorporate by reference the Stipulations of Facts and their

Exhibits. Petitioner’s principal place of business has been Delaware

during all times relevant to this case, including when it timely filed its

Petition.

Unless otherwise indicated, statutory references are to the

Internal Revenue Code, Title 26 U.S.C., in effect at all relevant times,

Served 05/21/24

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[*2] and Rule references are to the Tax Court Rules of Practice and

Procedure.

FINDINGS OF FACT

Background of Petitioner and V&N

In 1948 two cousins, Eugene Greggo and Nicholas Ferrara, Sr.,

started a road construction company named Greggo & Ferrara, Inc.

(Greggo & Ferrara). Six years later they incorporated petitioner, a

Delaware sand-and-gravel mining company, which gave the cousins a

means to obtain assorted materials necessary for road construction

projects.

The sons of Eugene Greggo and Nicholas Ferrara, Sr., Vincent

Greggo and Nicholas Ferrara, Jr., respectively, joined their fathers in

the business during the 1960s. Vincent Greggo and Nicholas Ferrara,

Jr. (Messrs. Greggo and Ferrara), believed that the business should

expand into real estate development, and they bought some houses from

the company stock (slated for demolition) and developed them for sale

in 1968.

Inspired by this effort, Messrs. Greggo and Ferrara entered into

a general partnership named V&N in 1972 after Mr. Greggo returned

from military service. Messrs. Greggo and Ferrara were the sole

partners of the partnership at all relevant times.

Over the next 50 years, Messrs. Greggo and Ferrara did assorted

work through V&N, often referred to as the “development arm” of their

larger group of companies. V&N developed a mini-storage facility on

property that it had purchased from petitioner, receiving rent from the

storage units. V&N also owned and rented commercial real estate,

including the Parkway Industrial Park. Additionally, V&N received

payment for Mr. Ferrara’s efforts to help develop a solution to treat

waste-water sludge in New Castle County. V&N conducted some of its

activities in its own name and some through two wholly owned limited

liability companies (LLCs).

Greggo & Ferrara Group

Eventually, Messrs. Greggo and Ferrara assumed the ownership

and operation of Greggo & Ferrara from their fathers. The partners

developed a mutually agreeable division of labor, with Mr. Greggo

taking the lead inside the office (focusing on internal administrative

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[*3] matters) and Mr. Ferrara outside (focusing on negotiations, daily

operations, and business development).

Under their leadership, the group of companies grew to 13

entities (informally, the Greggo & Ferrara Group). During 2013 the

center of the operation was Greggo & Ferrara, which, according to the

notes to its financial statements, was “primarily engaged in the

construction of roads, site development, rental of equipment and real

estate and the operation of a sand plant.” Greggo & Ferrara also served

as the primary employer and administrative hub for the group.

Specifically, it would assign its employees to the other companies as

needed and then bill those companies for the employee time expended

on a project-by-project basis.

Petitioner was engaged in the sale of gravel and soil and in real

estate investments. It also wholly owned two subsidiaries, including PG

Real Estate, Inc., which managed the various real estate holdings of the

Greggo & Ferrara Group and received reimbursements from each entity

for those services.

The other companies in the Greggo & Ferrara Group were

engaged in endeavors including the sale and retail of construction

material and equipment (Contractors Material, LLC, and Bear

Materials, LLC), hauling of construction materials (Contractors

Hauling, LLC), real estate development (4048, LLC, and Galleria, LLC),

and landfill management (Cherry Island, LLC). Like PG Real Estate,

Inc., all of the related companies would bill (and receive payment from)

their sister companies for services rendered. The chief financial officer

for Greggo & Ferrara audited the intragroup billings every few years to

ensure accuracy. Both Messrs. Greggo’s and Ferrara’s families were

involved in the ownership of the companies within the group.

This separation between petitioner and the other companies in

the Greggo & Ferrara Group was not always ironclad. For example,

although petitioner focused on sand-and-gravel mining, it also dabbled

in real estate development with respect to properties that it owned.

Messrs. Greggo and Ferrara kept separate books and records for all the

entities in the Greggo & Ferrara Group, including petitioner and V&N,

and maintained separate tax return preparers for both.

The Freeway Pit

In 1966 petitioner acquired a 58-acre parcel of land on the north

side of Christiana Road and the east side of Churchman’s Road in New

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[*4] Castle, Delaware, commonly referred to as the Freeway Pit. Over

the next few decades petitioner used this parcel as a borrow pit to supply

material for road construction. After it had outlived its usefulness,

materials and waste that had been dumped there were removed and the

site was filled in and brought to a grade where the land could be

developed.

In 2006 petitioner began exploring the sale of the Freeway Pit.

The property was adjacent to the New Castle County Airport and near

Wilmington University and at that time was zoned industrial.

Petitioner offered to sell the Freeway Pit to both the airport and the

university, but neither was interested in the purchase.

Petitioner continued to explore selling the property. In July 2006

petitioner retained a real estate appraiser, who appraised the Freeway

Pit at $6.9 million given the then-current industrial zoning.

Negotiations with Keith Stolz

Messrs. Greggo and Ferrara began to have discussions with a real

estate developer, Keith Stoltz, who was interested in purchasing the

property if it could be rezoned. Mr. Stoltz had a checkered reputation in

the New Castle community because of certain unpopular real estate

developments that he had pursued. As conversations progressed, Mr.

Stoltz and Messrs. Greggo and Ferrara understood that Messrs. Greggo

and Ferrara would lead efforts to rezone the property.

In a document dated August 15, 2006, petitioner granted to V&N

the option to purchase the Freeway Pit for the appraised value of $6.9

million (Option Agreement). This option expired on August 15, 2011,

and shifted any gain from a sale above the appraised value from

petitioner to V&N.

In a document dated May 17, 2007, petitioner, V&N, and

Churchman’s Associates, LLC (Churchman), a company owned by Mr.

Stoltz, entered into an agreement for the purchase of the Freeway Pit

for $17,895,000 (2007 Sale Agreement). The 2007 Sale Agreement

allocated $6.9 million of the purchase price to petitioner and the

remainder to V&N. This agreement provided for a deposit of $500,000,

a due diligence period of 60 days, and a closing date no later than one

year and eleven months after the expiration of the due diligence period,

although that closing date could be extended.

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[*5] In the 2007 Sale Agreement petitioner, V&N, and Churchman

acknowledged that “the preparation and execution of the various

agreements and documents which may be required in connection [with

various applications] will require the mutual cooperation of the parties.”

The 2007 Sale Agreement obligated petitioner, V&N, and Churchman to

“act reasonably and in good faith in undertaking each of their respective

obligations under this Agreement and in cooperating with the other

parties in its efforts to do so.” Petitioner agreed to support Churchman

with respect to applications and other documents necessary for the

development of the Freeway Pit as a shopping center or a mixed-use

project. Specifically, petitioner further agreed to affirmatively support

Churchman’s efforts to obtain approval, including by attending public

hearings and meetings.

The parties entered into six amendments of the original

agreement, which extended the due diligence period and closing dates

with an additional deposit of $500,000. The sixth amendment set a

closing date of December 5, 2011. Petitioner and V&N also extended the

duration of their Option Agreement until August 15, 2016.

Rezoning Efforts

Throughout this negotiation process from 2007 to 2012,

petitioner, V&N, and Churchman worked to obtain the requisite

governmental approvals for rezoning and development of the Freeway

Pit. Although there were multiple entities involved, a civil engineering

firm retained by Mr. Stoltz, Apex Engineering (Apex), took the lead on

the technical requirements, while Mr. Ferrara headed up efforts on the

political front.

Mr. Stoltz’s rezoning efforts focused on enabling construction of

the New Castle Town Center on the Freeway Pit. The New Castle Town

Center would serve as a shopping center consisting of 485,000 square

feet of retail space with Walmart as an anchor tenant. Mr. Stoltz viewed

rezoning the Freeway Pit as essential for the development of the New

Castle Town Center.

Apex

Apex’s work centered around the preparation of the survey and

major development plan for the Freeway Pit, which it filed for review in

January 2008. This filing launched a multistage review by the New

Castle County Planning Board, comprising an exploratory plan review,

a preliminary land development plan review, and a record plan review.

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[*6] At each step Apex would be required to address concerns presented

by Delaware Land Use (DLU) representatives. DLU’s ultimate approval

and recommendations were necessary before consideration by the New

Castle County Council.

During 2007 through 2009 Apex surveyed the property, prepared

the development plan for the proposed New Castle Town Center, and

worked to address issues including stormwater management, sanitary

design, and traffic analysis. Approval from the Delaware Department

of Transportation (DelDOT) is required for every major land

development plan in Delaware. Apex submitted the preliminary plan

for the New Castle Town Center to DelDOT.

In 2010 DLU issued a conditional recommendation in favor of the

rezoning request, subject to the resolution of several issues. Apex spent

the next two years in technical discussions with DLU, DelDOT, the

Delaware River and Bay Authority (DRBA), and the Federal Aviation

Administration (FAA) about two principal issues: (1) the construction of

roads bordering the airport and on the airport grounds and (2) the height

of the proposed development, as some proposed construction would be in

the airport’s flight path. The latter issue was resolved in June 2011, but

the road issue continued to be an obstacle into 2012.

In January 2012 Apex received notice of conditional approval of

the development request, contingent on resolving certain issues,

including the road issue. Apex thereafter obtained extensions from DLU

until August 2012 for recordation of the development plan in order to

resolve the outstanding issues with DelDOT, DRBA, and the FAA.

Mr. Ferrara’s Role

As Apex worked through the technical requirements and

approvals, Mr. Ferrara was responsible for political support and

authorization. From his and Mr. Greggo’s perspectives, rezoning was

necessary for the property to be sold above the appraised price. Mr.

Ferrara’s labors were necessary because of his connections with county

councilmen, Mr. Stoltz’s unfavorable reputation from prior development

in New Castle County, and Apex’s lack of expertise in dealing with the

political side of a deal.

Mr. Ferrara began his political work in 2006 when he first

broached the topic of rezoning with George Smiley, his county

councilman. By March 2007 Mr. Smiley was in favor of changing the

Freeway Pit’s zoning to commercial. In addition to talking to members

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[*7] of the New Castle County Council, Mr. Ferrara focused on building

support with the public at large. He also negotiated with the Delaware

Department of Natural Resources and Environmental Control regarding

the status of a creek on the Freeway Pit. And he took an active role with

respect to the road work that proved a sticking point with DLU,

DelDOT, DRBA, and the FAA.

Impasse and Resolution of Developing the Freeway Pit

In 2012 Mr. Stoltz, petitioner, and V&N reached an impasse, and

in July Mr. Stoltz walked away from the contemplated purchase of the

Freeway Pit. Messrs. Greggo and Ferrara, on behalf of petitioner,

engaged Apex to take over from Mr. Stoltz the process for recording the

land development plan with New Castle County. Messrs. Greggo and

Ferrara agreed to pay Apex $560,000 “to complete the record plan

requirements” as was necessary to preserve the previously established

commercial regional zoning classification for the Freeway Pit.

In August 2012 Apex obtained the necessary approvals from the

State of Delaware Office of the Fire Marshal and the Artesian Water

Co., as well as a letter of no objection from DelDOT regarding the

entrances and associated roadwork. On August 9, 2012, petitioner

(described as the Developer/Owner) entered into a Land Development

Improvement Agreement with New Castle County with respect to the

Freeway Pit. The New Castle County Council unanimously approved

the major development application with commercial zoning on August

21, 2012, and the plan was duly recorded the next day. The recordation

meant that all outstanding issues had been resolved and that

construction could commence once a building permit had been issued.

In late 2012 Mr. Stoltz returned to the bargaining table, and he,

petitioner, and V&N reached an agreement on the purchase of the

Freeway Pit. On December 5, 2012, they entered into an agreement of

sale for a total purchase price “for the [Freeway Pit]” of $11.1 million,

“payable in full . . . to accounts designated by [petitioner] and [V&N]”

(2012 Sale Agreement). Mr. Stoltz purchased the Freeway Pit through

Churchmans 273, LLC (Churchmans 273), a Delaware LLC. The 2012

Sale Agreement states that it is governed by, and construed according

to, Delaware state law.

Mr. Stoltz, petitioner, and V&N structured the 2012 Sale

Agreement such that Churchmans 273 paid V&N $4.2 million in

exchange for the rights to purchase the Freeway Pit, which V&N held

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[*8] pursuant to the Option Agreement. Churchmans 273 then

exercised the option rights to purchase the Freeway Pit from petitioner

and paid petitioner the option price of $6.9 million.

2013 Tax Returns, IRS Examination, and Notice of Deficiency

Petitioner used its portion of the sale proceeds, $6.9 million, to

enter into a like-kind exchange under section 1031. The replacement

property selected as part of this exchange cost approximately $14

million, and petitioner assumed approximately $7 million in debt as part

of that transaction. Petitioner hired Horty & Horty, P.A., to prepare its

tax return for 2013. Petitioner timely filed its Form 1120, U.S.

Corporation Income Tax Return, for its tax year ending September 30,

2013. Petitioner reported the transaction on Form 8824, Like-Kind

Exchanges, attached to its 2013 Form 1120. Through section 1031

petitioner deferred payment of tax on the $6.9 million it received.

V&N hired Kiely & Kiely, P.C., to prepare its tax return for 2012.

V&N reported the $4.2 million in sale proceeds as long-term capital gain

on its 2012 partnership tax return, and $4.13 million was then

distributed to Mr. Greggo and Mr. Ferrara.

The reporting of the Option Agreement in this manner was not

the first time petitioner and V&N had reported an option agreement this

way. V&N had previously engaged in a similar option agreement (again

involving petitioner) regarding the sale of a plot of land. Petitioner used

its portion of the proceeds to enter into a like-kind exchange under

section 1031, and V&N reported as taxable the sale proceeds it received

from the exercise of the option on its 2008 partnership return.

OPINION

I.

Burden of Proof

The Commissioner’s determinations in a notice of deficiency are

generally presumed correct, and taxpayers bear the burden of proving

them erroneous. Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115

(1933). However, if a taxpayer produces credible evidence with respect

to one or more factual issues relevant to the taxpayer’s tax liability, the

burden of proof may shift to the Commissioner as to that issue or issues.

§ 7491(a)(1). Likewise, the Commissioner’s determination does not

receive a presumption of correctness if the determination is shown to be

arbitrary and capricious. Helvering v. Taylor, 293 U.S. 507, 514 (1935);

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[*9] Cohen v. Commissioner, 266 F.2d 5, 11 (9th Cir. 1959), remanding

T.C. Memo. 1957-172.

At trial and in a Motion filed February 22, 2023, petitioner

contends that it met the requirements of section 7491 and that the

burden, therefore, should shift to respondent. We took the oral Motion

under advisement. Because we decide this case on the preponderance

of the evidence, the allocation of the burden of proof is immaterial. See

Knudsen v. Commissioner, 131 T.C. 185, 189 (2008), supplementing T.C.

Memo. 2007-340. Accordingly, we will deny the motion.

II.

Evidentiary Issue

Respondent filed a Motion in Limine, moving, pursuant to Rules

50 and 143(g) and Rules 401, 402, 403, and 702 of the Federal Rules of

Evidence, that the Court exclude the expert witness report of Joyce R.

Teis (a.k.a. Joyce Foster) (Teis report) and her testimony. Respondent

contends that her expert report does not include the data and exhibits

used to summarize or support the opinions set forth in the report in

contravention of Rule 143(g) and Rule 702 of the Federal Rules of

Evidence. Respondent further avers that any data Ms. Teis relied upon

is unreliable and inadmissible. Petitioner disagrees with respondent’s

contention that Ms. Teis’s report fails to comply with Rule 143(g)(1)(B).

At trial the Court entered the Teis report into evidence for the limited

purposes of reflecting Mr. Greggo’s state of mind at the time of the

Option Agreement, while reserving the issue of whether it may be

considered substantive evidence.

Tax Court proceedings are conducted in accordance with the

Federal Rules of Evidence. § 7453; Rule 143(a). Expert testimony is

admissible under Rule 702 of the Federal Rules of Evidence if it assists

the Court in understanding the evidence or determining a fact in issue.

See, e.g., Sunoco, Inc. & Subs. v. Commissioner, 118 T.C. 181, 183 (2002).

The admissibility of expert witness testimony is within the discretion of

the trial judge. Fed. R. Evid. 104; Boltar, L.L.C. v. Commissioner, 136

T.C. 326, 335–36 (2011). In Daubert v. Merrell Dow Pharmaceuticals,

Inc., 509 U.S. 579, 592–93 (1993), the Supreme Court stressed the trial

court’s role as gatekeeper in excluding evidence that is unreliable or

irrelevant.

An expert witness must “prepare a written report for submission

to the Court” before trial. Rule 143(g)(1). If the expert is qualified, the

report is “received in evidence as the direct testimony of the expert

10

[*10] witness.” Rule 143(g)(2). Rule 143(g)(1) accordingly requires that

an expert witness report “shall contain” (among other things) a complete

statement of all opinions the witness expresses and the basis and

reasons for them, the facts or data considered by the witness in forming

her opinions, and any exhibits used to summarize or support her

opinions. Skolnick v. Commissioner, T.C. Memo. 2019-64, at *6.

Rule 143(g)(2) provides that an expert witness’ testimony will be

excluded altogether for failure to comply with these provisions, unless

the failure is shown to be due to good cause and the failure does not

unduly prejudice the opposing party, such as by significantly impairing

the opposing party’s ability to cross-examine the expert or by denying

the opposing party the reasonable opportunity to obtain evidence in

rebuttal to the expert witness’ testimony. While the factual basis of an

expert opinion generally goes to the credibility of the testimony and not

its admissibility, an expert’s opinion must be sufficiently supported to

be admitted. Klingenberg v. Vulcan Ladder USA, LLC, 936 F.3d 824,

829–30 (8th Cir. 2019).

Federal courts acknowledge differences between percipient

witnesses who happen to be experts and those experts who, without

prior knowledge of the facts giving rise to litigation, are recruited to

provide expert opinion testimony. See Downey v. Bob’s Disc. Furniture

Holdings, Inc., 633 F.3d 1, 6 (1st Cir. 2011) (interpreting Federal Rule

of Civil Procedure 26(a)(2)(B)). Percipient witnesses who happen to be

experts fall outside the requirements of Federal Rule of Civil Procedure

26(a)(2)(B). Downey, 633 F.3d at 6; see Fielden v. CSX Transp., Inc., 482

F.3d 866, 869 (6th Cir. 2007). Rule 143(g)(1) is modeled after Federal

Rule of Civil Procedure 26(a)(2)(B) and contains identical wording.

Furthermore, Rule 1 states that we are to give weight to the Federal

Rules of Civil Procedure in instances where there is no applicable Tax

Court Rule.

Ms. Teis was a key actor in the occurrences leading to petitioner’s

signing of the Option Agreement and was not retained for the purpose

of offering expert opinion testimony. See Downey, 633 F.3d at 6. As Ms.

Teis prepared her report in the normal course of her job duties, she is an

“actor with regard to the occurrences from which the tapestry of the

lawsuit was woven.” Id. (quoting Gomez v. Rivera Rodriguez, 344 F.3d

103, 113 (1st Cir. 2003)). Ms. Teis is therefore a percipient witness.

Petitioner, applying Downey, argues that Ms. Teis’s status as a

percipient witness exempts her report from the requirements of

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[*11] Rule 143(g). Rather, we understand Downey to hold that

percipient witnesses who happen to be experts may render opinions

based on their expertise through testimony at trial without submitting

an accompanying report. Downey, 633 F.3d at 7–8. Petitioner, in

contrast, is endeavoring to enter a report prepared by a percipient

witness. The U.S. Court of Appeals for the First Circuit’s holding in

Downey does not appear to extend its exemption from Federal Rule of

Civil Procedure 26(a)(2)(B) (and by extension, Rule 143(g)) to expert

reports submitted by percipient witnesses.

Ms. Teis relied on specialized knowledge in reaching the

valuation conclusions expressed in the report. The Teis report was

prepared as a paired sales examination and was based on “surveys of

market, cost and income data pertinent to this assignment,” collected

from the State of Delaware, New Castle County, and the Delaware

Economic Development Office. This underlying data used in the Teis

report was not included in the report itself or as an addendum. To

reduce the impact of that omission, petitioner provided a study from Ms.

Teis’s office detailing different comparable real estate sales that took

place around the time that Ms. Teis undertook the Teis report (sales

study). At trial, Ms. Teis acknowledged that she did not use any of the

comparable sales included in the sales study in creating the Teis report.

On cross-examination Ms. Teis was unable to point to the specific data

she used or considered in creating the Teis report. When respondent

questioned Ms. Teis about specific data she used, Ms. Teis was often

unable to answer questions in detail or at all. These gaps in information

left respondent unable to examine the foundations of the Teis report as

intended by Rule 143(g).

The Teis report fails to comply with the requirements of Rule

143(g). We will therefore grant respondent’s Motion in Limine and will

not admit the Teis report or the sales study into evidence as an expert

report. Furthermore, as the Teis report uses Ms. Teis’s specialized

knowledge in reaching the valuation conclusions expressed in the

report, it may not be admitted into evidence other than as an expert

report. See Fed. R. Evid. 701. The Teis report remains admitted into

evidence solely for purposes other than establishing the truth of the

matter asserted and for the limited purposes of reflecting Mr. Greggo’s

state of mind at the time of the Option Agreement.

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[*12] III.

Validity of the Structure of the Transaction

Respondent makes various arguments regarding the validity of

the Option Agreement and the subsequent 2012 Sale Agreement. With

respect to the Option Agreement, respondent argues that it lacks

consideration under Delaware law, and is therefore an invalid contract.

With respect to the interaction between the Option Agreement and the

2012 Sale Agreement, respondent argues that petitioner disavows the

correct form of the transaction, incorrectly assigning to V&N a portion

of the proceeds from the sale of the Freeway Pit. With respect to V&N’s

role in the transaction, respondent argues that V&N served as a mere

conduit for the sale of the Freeway Pit, and its proceeds should be

imputed to petitioner. Through each argument, respondent argues that

the $4.2 million reported by V&N is income to petitioner.

Respondent argues that petitioner did not receive any

consideration pursuant to the Option Agreement, and the contract is

therefore invalid. In interpreting the terms of a contract, the Court

looks to the governing state law. Belk v. Commissioner, 140 T.C. 1, 13

n.21 (2013), aff’d, 774 F.3d 221 (4th Cir. 2014). The parties to the 2012

Sale Agreement were each Delaware companies, and the 2012 Sale

Agreement specifically stated that it was governed by, and construed

according to, Delaware state law.

According to Delaware law, “a recital in a written agreement that

a stated consideration has been given facially supports a finding that

the agreement is supported by consideration, absent facts suggesting

that no such consideration was actually given or expected.” Moscowitz

v. Theory Ent. LLC, C.A. No. 2019-0780, 2020 WL 6304899, at *12 (Del.

Ch. Oct. 28, 2020); Restatement (Second) of Contracts § 87 cmt. c (Am.

L. Inst. 1981); see also TA Operating LLC v. Comdata, Inc., C.A. No.

12954, 2017 WL 3981138, at *23 (Del. Ch. Sept. 11, 2017). “Delaware

law does not ‘assume[] that parties to a contract must explicitly detail

the precise consideration they are exchanging’ and ‘makes no such

requirement,’ . . . .” Moscowitz, 2020 WL 6304899, at *12 (quoting

Seiden v. Kaneko, C.A. No. 9861, 2017 WL 1093937, at *6 (Del. Ch. Mar.

22, 2017), aff’d, 177 A.3d 69 (Del. 2017) (unpublished table decision)).

Courts have treated recitals of consideration as not only evidence

that consideration was exchanged but as a binding promise to pay the

nominal amount, for which the promise is itself valid consideration. See

Restatement (Second) of Contracts § 87(1)(a); 2 Corbin on Contracts

§ 5.17 (2024). Further, courts have invoked the doctrines of promissory

13

[*13] and equitable estoppel to “save options from the destructive force

of the exaggerated impact of consideration doctrine.” 2 Corbin on

Contracts § 5.17.

Respondent argues that the Option Agreement lists the

consideration as “Ten Dollars ($10.00) . . . and other good and valuable

consideration,” but that the amount likely went unpaid. The meaning

inferred from a particular provision, however, cannot control the

meaning of the entire agreement if that inference conflicts with the

agreement’s overall scheme. E.I. du Pont de Nemours & Co. v. Shell Oil

Co., 498 A.2d 1108, 1113 (Del. 1985). While the Option Agreement, as

interpreted under Delaware law, provides evidence of cash

consideration, it is not the only consideration provided. Pursuant to

other provisions within the Option Agreement, V&N worked to increase

the value and marketability of the Freeway Pit. Mr. Ferrara, through

V&N, lobbied members of the New Castle County Council to support the

rezoning of the Freeway Pit, and the County Council ultimately

approved the rezoning. Mr. Ferrara also garnered support from the

public at large and conducted negotiations with the Delaware

Department of Natural Resources and Environmental Control as well as

DLU.

Petitioner, V&N, and Mr. Stoltz viewed these efforts as essential

for the sale of the Freeway Pit, serving to increase the value of the

property and to improve petitioner’s chances of selling it.

“[C]onsideration is to be detected if it is present anywhere in the

transaction in question, regardless of whether any label was put on it,

and regardless of whether it was spelled out in the paper-writing.”

Equitable Tr. Co. v. Gallagher, 99 A.2d 490, 492–93 (Del. 1953). The

Option Agreement and its subsequent amendments were therefore

supported by consideration, both explicit and unspoken, and were

enforceable against petitioner.

Respondent argues that the 2012 Sale Agreement allocates the

full $11.1 million to petitioner in exchange for the Freeway Pit and does

not allocate any portion of the sale proceeds to V&N for its option.

Respondent further argues that petitioner, having reported $6.9 million

of the proceeds while V&N reported $4.2 million, is disavowing the form

of its own transaction. Respondent contends that the $4.2 million paid

to V&N was actually earned by and paid to petitioner and should

therefore be characterized as an assignment of income, and petitioner

should recognize the full $11.1 million as payment for real property it

sold. See Commissioner v. Sunnen, 333 U.S. 591, 604 (1948) (stating

14

[*14] that “the mere assignment of the right to receive income is not

enough to insulate the assignor from income tax liability” where “the

assignor actually earns the income or is otherwise the source of the right

to receive and enjoy the income”).

Contracts are construed according to the intent of the parties as

of the time of entering into the agreement. See Long v. Commissioner,

93 T.C. 5, 10 (1989) (first citing United States v. Lane, 303 F.2d 1, 4 (5th

Cir. 1962); and then citing 17A C.J.S. Contracts § 295 (1963)), aff’d, 916

F.2d 721 (11th Cir. 1990) (unpublished table decision). The starting

point for ascertaining the parties’ intent is the contract itself. See

Baldwin v. Univ. of Pittsburgh Med. Ctr., 636 F.3d 69, 76 (3d Cir. 2011)

(“The strongest objective manifestation of intent is the language of the

contract.”). The contract must be read as a whole and interpreted in

context. See Senior Exec. Benefit Plan Participants v. New Valley Corp.

(In re New Valley Corp.), 89 F.3d 143, 149–50 (3d Cir. 1996).

The 2012 Sale Agreement did make an allocation of the $11.1

million payment. The pertinent details of that agreement state that the

purchase price was to be allocated between petitioner and V&N. The

2012 Sale Agreement stated that V&N, as the optionee of the Option

Agreement, would receive $4.2 million from the buyer in exchange for

its right to purchase the Freeway Pit, as provided for in the Option

Agreement. Churchmans 273 then exercised the option, pursuant to the

rights purchased under the 2012 Sale Agreement, and purchased the

Freeway Pit for $6.9 million. The terms of the 2012 Sale Agreement are

consistent with petitioner’s and V&N’s treatment of the income, and no

evidence indicates that petitioner endeavored to disavow the

transaction, nor assign any income.

Respondent cites various cases concerning parties that entered

into agreements they subsequently disavowed but who then claimed

that the covenants had no basis in reality or that subsequent documents

better reflected the parties’ intentions. See Commissioner v. Danielson,

378 F.2d 771 (3d Cir. 1967), vacating and remanding 44 T.C. 549 (1965);

see also G.C. Servs. Corp. v. Commissioner, 73 T.C. 406, 411 (1979).

Respondent contends that petitioner “assigned $4.2 million from the

Freeway Pit sale to V&N and must recognize income on that amount.”

The $4.2 million was paid to V&N pursuant to rights it held under the

Option Agreement and was therefore not petitioner’s to assign.

Petitioner and V&N have consistently complied with the plain reading

of the terms of the 2012 Sale Agreement. Petitioner neither assigned

income to V&N nor disavowed the terms of the 2012 Sale Agreement.

15

[*15] Respondent alternatively argues that V&N served as a conduit

for the sale of the Freeway Pit and the $4.2 million paid to V&N should

be imputed to petitioner through the conduit doctrine (alternatively, the

imputed income rule). See Commissioner v. Court Holding Co., 324 U.S.

331 (1945). In Court Holding, the Supreme Court established the

conduit doctrine by holding that a corporation had to recognize income

on a sale of real property that had been transferred to the shareholders

through a liquidating dividend and then sold to a third-party buyer after

the buyer and the corporation had already reached an oral agreement

for the sale. Id. at 332–33. The Supreme Court subsequently

distinguished Court Holding, recognizing as valid a corporate

distribution of assets to a shareholder that were subsequently sold to a

third party. United States v. Cumberland Pub. Serv. Co., 338 U.S. 451

(1950). The Court noted that, in Cumberland, the corporation initially

rejected the offer from the third-party buyer, and the corporation’s

shareholders decided to pursue the sale by separately negotiating with

the prospective buyer. Id. at 452–53. In making the distinction, the

Supreme Court stated that the corporation in Court Holding had

“negotiated for sale of its assets and had reached an oral agreement of

sale . . . [then] purported to ‘call off’ the sale at the last minute and

distributed the physical properties in kind to the stockholders.” Id.

at 453.

The U.S. Court of Appeals for the Third Circuit, in determining

whether the conduit doctrine applies, has looked at more than moments

of negotiation, holding that “all steps in the process of earning the profits

must be taken into consideration.” Thomas Flexible Coupling Co. v.

Commissioner, 158 F.2d 828, 831 (3d Cir. 1946). The U.S. Court of

Appeals for the Fifth Circuit agreed with this, stating:

We hold that the sine qua non of the imputed income rule

is a finding that the corporation actively participated in the

transaction that produced the income to be imputed. Only

if the corporation in fact participated in the sale

transaction,

by

negotiation,

prior

agreement,

postdistribution activities, or participated in any other

significant manner, could the corporation be charged with

earning the income sought to be taxed. Any other result

would unfairly charge the corporation with tax liability for

a transaction in which it had no involvement or control.

Hines v. United States, 477 F.2d 1063, 1069–70 (5th Cir. 1973); see also

Anderson v. Commissioner, 92 T.C. 138, 165 (1989) (citing Hines, 477

16

[*16] F.2d 1063). To avoid application of the conduit doctrine, the entity

in question must have “participated in the sale transaction, by

negotiation, prior agreement, postdistribution activities, or participated

in any other significant manner.” Hines, 477 F.2d at 1069‒70.

V&N participated in the sale of the Freeway Pit in a significant

manner, as established supra. V&N made extensive efforts to rezone

the property that ultimately proved essential for its sale. Respondent

points to petitioner’s active participation in the sale of the Freeway Pit

as evidence that the conduit theory applies. We agree that its

participation was substantial; and as owners of both V&N and

petitioner, Messrs. Greggo and Ferrara worked on behalf of both entities

in negotiating the sale of the Freeway Pit. The conduit theory is not a

test that weighs participation among involved entities to determine

which is a conduit. Instead, it asks whether the entity alleged to be a

conduit participated in the transaction in a “significant manner.” Id. at

1070. V&N participated in the sale of the Freeway Pit in a significant

manner and is therefore not a conduit.

IV.

Sham Transaction

Alternatively, respondent alleges that the Option Agreement is a

factual and economic sham and should be disregarded for tax purposes.

The sham transaction doctrine allows the IRS to disregard transactions

that have no substance or economic effect. Gregory v. Helvering, 293

U.S. 465 (1935). In applying this doctrine, the Court looks to “objective

economic realities” of a transaction, rather than a particular form

employed by the parties. Frank Lyon Co. v. United States, 435 U.S. 561,

573 (1978). There are two types of sham transactions: a factual sham

and an economic (or legal) sham. CNT Invs., LLC v. Commissioner, 144

T.C. 161, 196 (2015). Factual shams are transactions that either did not

occur, did not occur as reported, or were “performed in violation of some

of the background assumptions of commercial dealing, for example

arms-length dealing at fair market values.” In re CM Holdings, Inc.,

301 F.3d 96, 108 (3d Cir. 2002) (quoting Horn v. Commissioner, 968 F.2d

1229, 1236 n.8 (D.C. Cir. 1992), rev’g Fox v. Commissioner, T.C. Memo.

1988-570, and rev’g Kazi v. Commissioner, T.C. Memo. 1991-37). An

economic sham is a transaction that did take place but had no

independent economic significance aside from its tax implications.

Krumhorn v. Commissioner, 103 T.C. 29, 46 (1994). Respondent asserts

that the Option Agreement was both an economic sham and a factual

sham.

17

[*17] Respondent raises Messrs. Greggo’s and Ferrara’s controlling

interests in petitioner and V&N, rendering the two entities related

parties, as evidence in support of their position. In analyzing whether

a transaction is a sham, courts closely scrutinize related-party

transactions because “the control element suggests the opportunity to

contrive a fictional [transaction].” Geftman v. Commissioner, 154 F.3d

61, 68 (3d Cir. 1998) (quoting United States v. Uneco, Inc. (In re Uneco,

Inc.), 532 F.2d 1204, 1207 (8th Cir. 1976)), rev’g in part, vacating and

remanding in part T.C. Memo. 1996-447; Invs. Diversified Servs., Inc. v.

Commissioner, 39 T.C. 294, 306 (1962), aff’d, 325 F.2d 341 (8th Cir.

1963). A basic criterion in determining whether transactions between

related parties should be recognized is whether the consideration is

comparable to that which would have been exchanged had the parties

been unrelated. Invs. Diversified Servs., 39 T.C. at 306.

The Supreme Court has made clear, however, that an entity

carrying on business activities “remains a separate taxable entity” from

its owner and should not be disregarded for tax purposes. Moline Props.,

Inc. v. Commissioner, 319 U.S. 436, 438–39 (1943). Petitioner and V&N

each have long histories of carrying on separate business activities; their

common control does not provide a basis for disregarding the separate

status of the business entities and the individuals operating those

entities. See, e.g., Gordy v. Commissioner, 36 T.C. 855, 859–60 (1961);

Glasgow Vill. Dev. Corp. v. Commissioner, 36 T.C. 691, 701–02 (1961).

Incorporated by the fathers of Messrs. Greggo and Ferrara in 1954,

petitioner had been conducting its own business operations for over 50

years at the time of the 2012 Sale Agreement. It operates as a sandand-gravel mining company, providing raw materials as required by

other entities in the Greggo & Ferrara Group. V&N was formed as a

partnership in 1972 and had been operating as the real estate

“development arm” of Greggo & Ferrara for approximately 40 years at

the time of the 2012 Sale Agreement. Despite common ownership,

Messrs. Greggo and Ferrara conducted the various business activities

through the appropriate entity that engaged in that type of business,

and the Option Agreement and the 2012 Sale Agreement continue this

pattern of apportioning activities according to the appropriate entity.

Absent evidence that Messrs. Greggo and Ferrara treated petitioner and

V&N as interchangeable or disregarded entities, we do not see a reason

for doing so here.

Factual shams are “transactions” that were never actually

undertaken. Lerman v. Commissioner, 939 F.2d 44, 48 n.6 (3d Cir.

1991), aff’g Fox v. Commissioner, T.C. Memo 1988-570. We have held

18

[*18] transactions to be factual shams when taxpayers were unable to

prove that events leading to losses or deductions ever occurred. See

Julien v. Commissioner, 82 T.C. 492 (1984) (finding that interest

expense on alleged indebtedness incurred to purchase silver bullion was

factual sham when no silver was actually purchased). But see In re CM

Holdings, Inc., 301 F.3d at 108 (stating that circular netting

transactions, where different loans and payments are deemed to occur

simultaneously, thereby offsetting each other, are not by definition

factual shams).

The Option Agreement is not a factual sham. Petitioner and V&N

entered into the agreement in writing on August 15, 2006; it assigned

tasks to both parties to the agreement. Specifically, petitioner pledged

to support Churchman with respect to applications and other documents

necessary for the development of the Freeway Pit. V&N, through the

efforts of Mr. Ferrara, used political connections and experience with

development in New Castle County to generate support for rezoning

efforts and to encourage public support for the development of the

Freeway Pit.

That the written agreement and the subsequent

supporting actions by petitioner and V&N were undertaken shows that

the Option Agreement is not a factual sham.

Economic shams or transactions lacking economic substance are

transactions that have actually taken place but which have no economic

significance beyond expected tax benefits. Sheldon v. Commissioner, 94

T.C. 738, 759 (1990). We have explained economic shams as the

“expedient of drawing up papers to characterize transactions contrary

to objective economic realities and which have no economic significance

beyond expected tax benefits.” Falsetti v. Commissioner, 85 T.C. 332,

347 (1985).

Whether transactions lack economic substance “turns on both the

‘objective economic substance of the transactions’ and the ‘subjective

business motivation’ behind them.” ACM P’ship v. Commissioner, 157

F.3d 231, 247 (3d Cir. 1998) (quoting Casebeer v. Commissioner, 909

F.2d 1360, 1363 (9th Cir. 1990)), aff’g in part, rev’g in part T.C. Memo.

1997-115. The Third Circuit has explained that the objective and

subjective tests of the sham transaction doctrine “do not constitute

discrete prongs of a ‘rigid two-step analysis,’ but rather represent

related factors both of which inform the analysis of whether the

transaction had sufficient substance, apart from its tax consequences, to

be respected for tax purposes.” Id. (quoting Casebeer v. Commissioner,

19

[*19] 909 F.2d at 1363). 1 Although the Third Circuit has signaled that

the objective analysis may be more important than the subjective, the

latter analysis remains important. Id. at 248 n.31 (“[W]here a

transaction objectively affects the taxpayer’s net economic position, legal

relations, or non-tax business interests, it will not be disregarded merely

because it was motivated by tax considerations.”). In applying these

principles we must view the transactions “as a whole, and each step,

from the commencement . . . to the consummation . . . is relevant.”

Weller v. Commissioner, 270 F.2d 294, 297 (3d Cir. 1959), aff’g 31 T.C.

33 (1958), and aff’g Emmons v. Commissioner, 31 T.C. 26 (1958).

In determining whether a transaction has objective economic

substance, courts examine “whether the transaction has any practical

economic effects” other than creating tax benefits. ACM P’ship v.

Commissioner, 157 F.3d at 248 (quoting Jacobson v. Commissioner, 915

F.2d 832, 837 (2d Cir. 1990), rev’g and remanding in part T.C. Memo.

1988-341). Courts ignore transactions that lack “nontax substance”

because they do not “appreciably affect [the taxpayer’s] beneficial

interest except to reduce his tax.” Knetsch v. United States, 364 U.S.

361, 366 (1960) (quoting Gilbert v. Commissioner, 248 F.2d 399, 411 (2d

Cir. 1957) (Hand, J., dissenting), remanding T.C. Memo. 1956-137).

Respondent contends that V&N did not pay any consideration in

support of the Option Agreement and stood to benefit from the Option

Agreement without any risk to itself. Respondent alleges that petitioner

did not stand to gain from the transaction but rather signed away any

potential future gain from appreciation in the Freeway Pit while

continuing to bear the risk of ownership in the property. As already

addressed supra, we disagree with respondent’s position. Petitioner

entered into the Option Agreement seeking assistance with the sale of

the Freeway Pit, having been unable to sell the property through prior

efforts. V&N provided petitioner with nontax benefits by generating

1 We acknowledge that the economic substance doctrine was codified in section

7701(o), effective for transactions entered into after March 30, 2010. See Health Care

and Education Reconciliation Act of 2010, Pub. L. No. 111-152, § 1409(e)(1), 124 Stat.

1029, 1070. Respondent, however, has not invoked section 7701(o) in this case and has

instead pointed us to the approach taken by the U.S. Court of Appeals for the Ninth

Circuit in characterizing transactions for tax purposes. Petitioner has similarly

focused on the law of the Ninth Circuit, making no argument that section 7701(o)

would dictate a different result but instead citing that section in support of the Court

of Appeals’ approach. See also Slone v. Commissioner, 810 F.3d 599, 606 (9th Cir.

2015) (describing section 7701(o) as having “codified a similar approach” to its own),

vacating and remanding T.C. Memo. 2012-67. Consequently, we address section

7701(o) no further.

20

[*20] support among the New Castle County Council for the rezoning of

the Freeway Pit, negotiating with the Delaware Department of Natural

Resources and Environmental Control, and building public support for

the changes. These services, each rendered pursuant to the Option

Agreement, contributed to the rezoning of the Freeway Pit, a condition

viewed as essential for its sale.

We disagree that V&N did not share any risk. V&N worked to

support the rezoning changes without any guarantees that the Freeway

Pit would sell. V&N likewise had no guarantees that offers on the

property would exceed $6.9 million, thereby denying V&N a portion of

the proceeds, despite having already rendered services. Though

petitioner and V&N ultimately succeeded in obtaining rezoning

approval and an offer in excess of $6.9 million, the lack of a guarantee

regarding either was a risk for V&N.

Though the test’s inquiry into objective aspects looks at the

transaction’s economic impact for petitioner, it does so in the context and

expectation of tax benefits to petitioner. See, e.g., ACM P’ship v.

Commissioner, 157 F.3d at 248; see also CNT Invs., 144 T.C. at 199.

Without venturing too far into speculation regarding petitioner’s

behavior, we can say that petitioner does not appear to have created any

tax benefits by entering into the Option Agreement, despite common

control between petitioner and V&N. Petitioner received $6.9 million in

proceeds from the sale of the Freeway Pit and shortly thereafter entered

into a like-kind exchange under section 1031 enabling petitioner to defer

payment of tax on the proceeds. The replacement property petitioner

selected for the exchange cost petitioner approximately $14 million,

towards which petitioner pledged the $6.9 million in proceeds and

assumed approximately $7 million in debt. Respondent does not contest

the nature of the section 1031 exchange.

We could assume that petitioner would have allocated the entire

$11.1 million of proceeds to the $14 million replacement property had

the Option Agreement not been in place. This would result in

petitioner’s assuming approximately $3 million in debt and deferring

recognition of the $11.1 million, but ultimately leaving petitioner with

no larger a tax bill for the year in issue than with the Option Agreement

in place. Petitioner has succeeded in showing that the Option

Agreement meaningfully changed petitioner’s economic position.

The other factor of the economic substance inquiry includes an

analysis of petitioner’s “subjective business motivation.” ACM P’ship v.

21

[*21] Commissioner, 157 F.3d at 247. “The subjective intent inquiry

focuses on whether the taxpayer entered into the transaction intended

to serve a useful business purpose . . . .” Crispin v. Commissioner, 708

F.3d 507, 515 (3d Cir. 2013), aff’g T.C. Memo. 2012-70. The Third

Circuit has focused this inquiry on the taxpayer’s subjective motivations

for entering into the disputed transaction. Id. at 514–15. The subjective

intent inquiry also focuses on the “correlation of losses to tax needs

coupled with a general indifference to, or absence of, economic profits.”

Id. at 515 (quoting Keeler v. Commissioner, 243 F.3d 1212, 1218 (10th

Cir. 2001), aff’g Leema Enters., Inc. v. Commissioner, T.C. Memo.

1998-18).

Shared motives between related parties do not cause a

transaction to lack a business purpose.

See Bowater Inc. v.

Commissioner, T.C. Memo. 1995-164, 1995 WL 160698, at *8 (holding

that a subsidiary’s business purpose justified actions taken by the

parent of the consolidated group).

Petitioner’s stated business purpose for the Option Contract was

to take advantage of the development and rezoning services offered by

Mr. Ferrara as a partner of V&N, in order to succeed in selling the

Freeway Pit, while also respecting the Greggo & Ferrara Group’s

longstanding division of business lines among separate entities. Our

review of petitioner’s reasons for entering into the Option Contract

comports with the evidence presented, and we find that petitioner has

established that it entered into the Option Contract with the requisite

intent and business purpose. Petitioner presented ample evidence of

prior business endeavors conducted through various entities in

accordance with their business lines. Contractors Material, LLC, and

Bear Materials, LLC, engaged in the sale and retail of construction

material and equipment; Contractors Hauling, LLC, engaged in the

hauling of construction materials; Cherry Island, LLC, engaged in

landfill management; petitioner engaged in the sale of gravel and soil,

and in real estate investments; and V&N operated as the “development

arm” of their larger group of companies. Mr. Ferrara, through V&N,

also handled rezoning projects because he had personal relationships

with county political actors, as well as subject-matter knowledge. The

separate business lines, established over decades, support petitioner’s

assertion that the various entities conduct different tasks. By entering

into the Option Agreement and engaging V&N for real estate

development work, an established area of its expertise, petitioner sought

to maintain those divisions. Likewise, using V&N for the rezoning work

took advantage of Mr. Ferrara’s skill and connections in that area.

22

[*22] Petitioner’s and V&N’s ultimate success in their endeavor yielded

millions in proceeds for each entity, a result that had previously proven

elusive.

We conclude that substantial, nontax purposes motivated the

Option Agreement and that attainment of that purpose altered the

parties’ economic positions in a meaningful way and should be

respected.

V.

Conclusion

Petitioner has shown that it and V&N properly entered into the

Option Agreement, receiving $6.9 million and $4.2 million in proceeds,

respectively. As the transaction is valid and there is no deficiency,

petitioner is not liable for the penalty pursuant to section 6662(a) for an

underpayment due to a substantial understatement of income tax.

We have considered all of petitioner’s and respondent’s

contentions, arguments, requests, and statements. To the extent not

discussed herein, we conclude that they are meritless, moot, or

irrelevant.

To reflect the foregoing,

Decision will be entered for petitioner.