UNITED STATES TAX COURT '

T.C. Memo. 2012-168

.

UNITED STATES TAX COURT '

STEVEN W. REPETTO AN) GAYLE F. REPETTO, ET AL.,1 Petitioners v.

COMMISSIONER ÖF INTERNAL REVENUE, Respondent

Docket Nos. 17204-09, 17242-09,

17243-09.

Filed June 14, 2012.

David Victor Capes and Sara G. Neill, for petitioners.

Catherine S. Tyson, Steven W. LaBounty, and Peter N. Scharaff, for

respondent.

MEMORANDUM 3INDINGS OF FACT AND OPINION

MARVEL, J_udge: These cases are consolidated for purposes of trial,

briefing, and opinion. One case involves the 2004-06 Federal income taxes and

1Cases of the following petitioners are consolidated herewith: Yolo, Inc.,

docket No. 17242-09; and WFR Investments, Inc., docket No. 17243-09.

SElbr80 JUN 1 4 20E

.

-2the 2004-06 excise taxes under section 49732 of Steven3 W. and Gayle F. Repetto.

The second case involves the 2005-06 Federal income taxes of Yolo, Inc. (Yolo), a

C corporation in.which Mrs. Repetto's Roth individual retirement account (IRA)

owned a 98% interest. The third case invólves the 2005-06 Federal income taxes

of WFR Investments, Inc. (WFR), a C corporation in which Mr. Repetto's Roth

IRA owned a 98% interest.

Respondent determined the following deficiencies, additions to tax, and

penalties:

Mr. and Mrs. Repetto, docket No. 17204-09

Year

Deficiency

2004

2005

2006

$28,779

83,908

62,339

Additions to tax and penalty

Sec. 6651(a)(1)

Sec. 6651(a)(2)'

Sec. 6662A

$1,179.23

2,131.20

3,645.68

to be determined

$9,259.32

to be determined . 21,855.65

to be determined

13,879.43

1Respondent explains in the notice of deficiency that the additions to tax

under sec. 6651(a)(2) will be determined on the basis of the liability shown on the

sec. 6020(b) returns or the redetermined liability, if less.

2Unless otherwise indicated, section references are to the Interñal Revenue

Code (Code), as amended and in effect for the years at issue, and Rule references

are to the Tax Court Rules of Practice and Procedure.

4Some doc'uments in the record show Mr. Repetto's first name as "Stephen".

-3Yola, docket No. 17242-09

.

Year

IbefÊciency

Penalty

Sec. 6662A

2005

2006

$8,811

5,347

$2,640.02

2,691.05

WFR, docket No. 17243-09

.

·.. .

.

Penalty

Year

Deficiency

Sec. 6662A

2005

2006

$5,396

9,903

$3,777.06

2,666.16

After concessions,4 the issues for decision are: (1) whether Mr. and Mrs.

Repetto made excess contributions to their Roth IRAs and are liable for excise

taxes under section 4973; (2) wlËether SGR and WFR may deduct facilities support

expenses;5 (3) whether respond nt properly characterized certain payments from

SGR to Mr. Repetto as compensation; (4) whether Yolo may deduct medical

4Petitioners concede the following adjustments to the Form 1120S, U.S.

Income Tax Return for an S Corporation, of SGR Investments, Inc. (SGR), which

the Repettos wholly owned: rent and occupancy expenses for 2004-05, sellingrelated expenses for 2004-06, ar d automobile and local travel expenses for 2006.

Petitioners also concede the adj stments to Yolo's selling-related expenses for

2005-06. Petitioners are not co ceding the penalties under sec. 6662A on

understatements with respect to these items.

5SGR claimed deductions for facilities support, and WFR claimed

deductions for outside services or facilities staffing and support. For brevity, vve

shall refer to SGR's and WFR's deductions and expenses as facilities support.

reimbursement expenses and officer compensation expenses; (5) whether the

Repettos are liable for the additions to tax under section 6651(a)(1) and (2); and

(6) whether petitioners are liable for enhanced accuracy-related penalties under

section 6662A.

FINDINGS OF FACT

Some of the facts have been stipulated. The stipulation of facts is

incorporated herein by this reference. The Repettos resided in Missouri when they

filed their petition. Yolo and WFR maintained their principal places of business

and principal offices in Missouri when they filed their petitions.6

I.

The Construction Business

A.

The Construction Business Before 2003

Mr. Repetto graduated from college with a degree in business

administration in .1972. From 1972 until 2002 when Mr: Repetto retired, he .

worked as a salesperson for IBM. Mrs. Repetto graduated from collége witlia

degree in engineering management in 1984 and was employed during the years at

issue.

6WFR's bylaws stated that its principal offibe was in Nevada. However, the

record establishes that WFR's principal office and principal place ofbùsiness were

in Missouri

-5In the early 1990s Mr. Repetto met and became friends with Ray Porschen,

Jr. Mr. Porschen was the sole chareholder of Porschen Construction, Inc.

(Porschen Construction), which constructed spec homes7 in the Lake of the Ozarks

area in Missouri.

With his retirement nearing, Mr. Repetto sought an additional source of

income. In 1999 Mr. Repetto entered into a real estate development business with

Porschen Construction. Porschen Construction, Mr. Repetto, and Mrs. Repetto

formed Ozark Future, L.L.C. (Ozark Future), a limited liability company classified

as a partnership for Federal income tax purposes. Porschen Construction had a

50% interest in Ozark Future,

d Mr. and Mrs. Repetto each had a 25% interest.

Ozark Future was in the business of purchasing lots and constructing spec homes.

From Ozark Future's formation until approximately 2002 the Repettos' role

in it was that of investors; their involvement allowed Ozark Future to obtain more

loans. The Repettos signed for Ozark Future's loans and personally guaranteed

them. The Repettos continued working full time, but when Mr. Repetto was able

to, he worked with Mr. Porschen to learn about home building.

7A spec home, as opposed to a custom-built home, is a home that a

developer builds to his own specifications before he has a contract with a

prospective buyer.

-6During that period (until 2002) Porschen Constrùction was primarily

responsible for general contracting and construction management.supervision for

Ozark Future 8 It performed most of the.work involved, including formulating

plans, acquiring land, and obtaining necessary approvals.

Porschen Construction also hired subcontractors for Ozark Future to build

homes on properties Ozark Future had acquired, and it received bids from 50-70

subcontractors.9 Mr. Porschen's wife, Nancy Porschen, worked out design details,

selected and revised plans, and worked with the architect. She alsö sold the

constructed homes through her real estate company. Sometimes Mrs. Repetto

accompanied Mrs. Porschen to design centers and open houses, and occasionally

Mrs. Repetto picked out design elements for homes.

8The parties stipulated that Porschen Construction was primarily responsible

for general contracting and construction management supervision until the end of

2003. However, on the basis of the record as a whole, we find that Porschen

Construction's role in Ozark Future decreased in-2002 with Mr. Porschen's illness.

9The parties stipulated that from the time of Ozark Future's formation until

late 2003 Mr. Repetto was primarily responsible for performing marketing and

design work of Ozark Future, which included marketing, design, and business

development. However, Mr. Repetto credibly testified that in the early years of

Ozark Future (1999-2001) Porschen Construction did the design work. In the

light of Mr. Repetto's testimony, we find that Mr. Repetto became more heavily

involved with design and marketing for Ozark Future starting in 2002, rather than

after Ozark Future's formation.

-7At some point before or in 2001 the Repettos' attorney, John Curran,1°

advised them that their involvement in Ozark Future as individuals was putting

their personal assets at risk; fÒF CXample, in Ca$e a subcontractor became injured.

Mr. Curran also advised them hat if they could not sell a home, the lending bank

could sue them personally. On September 24, 2001, the Repettos caused SGR to

be organized. It elected S corporation status. The Repettos owned 100% of the

stock of SGR." In 2002 the Repettos transferfed their intérests in Ozark Future to

SGR.

In July 2002 Mr. Porschen was diagnosed with cancer. Mrs. Porschen

drove him to St. Louis, Missou i, for frequent medical appointments. Over time

Mr. Porschen's physical condition worsened, and his energy and the amount of

time that he could devote to Ozark Future gradually declined. Because Mr.

Porschen could not be on jobsites as much as he used to be and because

subcontractors required a manágement presence on the jobsite, Mr. Repetto

1°The record also reflects the spelling of his la 541t

name as "Kern".

iiThe 2004-06 Forms 1120S show that Mr. Repetto was SGR's sole

shareholder. However, Mr. and Mrs. Repetto testified that they each own and had

continuously owned a 50% inte est in SGR. The inconsistency in the record does

not affect our resolution of the issues in these cases.

-8

became more involved in Ozark Future's business in 2002, after he retired from

IBM. Mrs. Repetto's involvement in the business also expanded.

As Mr. Porschen's illness progressed, the.Repettos considered Ozark

Future's prospects. They wanted SGR to take advantage of the real estate market

in the Lake of:the Ozarks area and in Florida, yet they did not want to abandon

their relationship with Ozark Future and the Porschens. As of 2003, they

understood that,Mr. Porschen was planning to retire.

B.

The New Structure

In 2003 the Porschens introduced Jhe Repettos to Frank Zerjav, a certified

public accountant (C.P.A.) in St. Louis, Missouri, who had been the Porschens'

accountant for several years Mr. Zerjav told the Repettos about his accounting

firm and stated that he had a lot of experience working with clients in the real

estate business. Mr. Zerjav suggested a meeting in his office. . .

At the first meeting in Mr. Zerjav's office in late summer or early fall of

2003, the Repettos met James Harrell, an attorney and C.P.A. Mr. Harrell received

his C.P.A. certificate in 1973, graduated from law school in 1982, and has

practiced general business and tax law since 1982. At that meeting Mr. Harrell

proposed a structure whèreby two new corporations would be incorporated and

would be owned in part by Roth IRAs. Messfs. Harrell arid Zerjav told the

-9Repettos that such:a structure was preferable from an asset protection standpoint

because the corporate assets cculd not be reached in case of a lawsuit. The

Repettos were unfamiliar with such a structure and questioned Mr. Harrell

regarding its legitimacy. Mr. Harrell confirmed that as long as rules were

followed, it was permissible fo a C corporation to be owned in part by a Roth

IRA.

Mr. Harrell also explaine d the difference between a traditional IRA and a

Roth IRA. Mr. Harrell explained that the corporations would create profits and

pay taxes, that the corporations could pay dividelids to shareholders, including the

Roth IRAs, and that those amounts could be withdrawn from the Roth IRAs upon

retirement tax free. Mr. Harrell and the Repettos understood that the relationship

between SGR and Ozark Future would remain unchanged and that the two new

corporations would provide services to SGR. Although the Repettos did not have

a good understanding of the structure, they retained Mr. Harrell to set it up.

At some point around October 28, 2003, Mr. Harrell sent the Repettos an Engagement and Scope of Services Letter (engagemènt lettei.). According to the

engagement letter, Mr. Harrell

ould form two corporations, one to provide office

and support services for SGR a d the other to provide marketing and business

development services for SGR. The engagement letter also stated that "[i]t is our

-n10 understanding that you will each establish a Roth IRA with a custodian who will

allow" each Roth IRA to become a 98% shareholder of the respective corporation.

Mr. Harrell's services included introducing the Repettos to a Roth IRA

custodian and implementing the structure, including coordinating payment of the

first dividend to the Roth IRA. The engagement letter provided for a $15,000 fee.

Upon receipt of the engagement letter, Mrs. Repetto emailed Mr. Harrell severalquestions, one of which read: "We do not meet the rules for a ROTH IRA as our

Adjusted Gross Income is to {sic] high., I understand that we can pay a fine as you

explained but would our IRA be fraudulent?". Mr. Harrell replied "No".

On November 4, 2003, Mr. Harrell incorporated Yolo,,a Missouri

corporation. Mrs. Repetto became Yolo's sole director and its president, secretary,

and treasurer.

,

On November 7, 2003, Mr. and Mrs. Repetto opened Roth IRAs with a

3

$1,500 contribution to each Roth IRA at First Regional Bank,.Trust

Administration Services.

On November 18,·2003, Mr. Harrell incorporated WFR, a Nevada

corporation. Mr. Repetto became WFR's sole director and its president, secretary,

vice president, and treasurer. Yolo's and WFR's business addresses were the

same as the Repettos' home address.

- 11 The Roth IRA for the benefit of Mrs. Repetto subscribed to 98% of Yolo

stock, and Mrs. Porschen subseribed to the remaining 2%." The Roth IRA for the

benefit of Mr. Repetto subscribed to 98% of WFR stock, and Mr. Porschen

subscribed to the remaining 2%. The stock that the Porschens subscribed to in

Yolo and WFR was nonvoting."

In.November 2003 SGR and Yolo entered into a 10-year agreement (SGR

agreement) according to which Yolo would provide the following services to SGR

at SGR's place of business, i.e. the Repettos' home:9

assistance with entering pccounting information into the computer

accounting application quickbooks; assistance with computer;

assistance with printing eports; accessing internet for material

research; processing email; soliciting and receiving bid [sic] from

potential subcontractors; assistance with marketing communication;

assistance with interior selections; assistance with mail processing;

basic office support such as answering telephone, returning phone

calls, and sending/receiving packages.

The SGR agreement provided that Yolo would be compensated at the rate of

$4,800 per month through 2006 and at the rate of $4,000 per month thereafter. On

"Mrs. Porschen and Mrs Repetto agreed that if Mrs. Porschen opened a

Roth IRA that owned a corpora ion, Mrs. Repetto would be a 2% shareholder of

that corporation. On a date tha does not appear in the record, Mrs. Repetto

became a 2% shareholder of that corporation:

"The copies of the subscription agreements in the record are signed but

undated.

- 12 December 4, 2003, SGR deposited $126,900 into Yolo's account. Starting

January 2004, SGR paid Yolo as per the SGR agreement, although on two

occasions the payments covered multiple mónths. See iñfra pp. 14-15.

Also in November 2003 WFR and Yolo entered into an agreement (WFR

agreement), according to which Yolo would perförm services for WFR and:receive

$2,116 per month for the services. Other than the party names and compensation,

the terms of the two services agreements were identical.. WFR paid.Yolo pursuant

to the WFR agreement, although sometimes payments covered multiple months.

WFR did not make a lump1sum payment to Yolo.

C.

The Construction Business After 2003

Ozark Future continued to purchase lots and construct homes that were

marketed and sold to the public. By 2004 Ozark Future's business enjoyed

increased sales volume; it had multiple homes under construction that were larger

and more expensive. SGR was involved in Ozark Future's projects as an owner of

Ozark. In Mr. Porschen's absence, Mr. Repetto spent more time on the jobsites.

Mrs. Repetto's flexible work schedule allowed her to devote morë time to the

construction business.

SGR purchased and sold real estate independently of Ozark Future. In 2004

SGR made a deposit to purchase a condominium in Florida, and in 2005 it made

- 13 deposits to purchase two additional condominiums in Florida. In 2006 SGR

purchased property in Panama, purchased two condominiums in the Lake of the

Ozarks area, and sold one of the two condominiums. SGR reported gross receipts

(of $176,024) from activities uì1related to Ozark Future for the first time on its

2006 return.

Mr. Repetto reported no salary from SGR for 2004-05 and $24,000 for

2006. Mrs. Repetto did not receive a salary from SGR in 2004-06. Other than Mr.

Repetto in 2006, SGR had no e!nployees.

Mr. Repetto received no ompensation from Yolo or WFR during 2004-06.

Yolo treated Mrs. Repetto as its only employee and paid her $9,600, $9,600, and

$12,000 in 2004, 2005, and 2006, respectively. Yolo issued Mrs. Repetto Forms

W-2, Wage and Tax Statement, withheld taxes from her paycheck, and made

employment tax deposits with t ie Department of Treasury.

D.

Dividends

During the years at issue SGR made payments to WFR of $7,000 per month

for "outside staffing & support'." The payments were irregular and sometimes

"WFR allegedly had a se vices agreement with SGR, but such agreement is

not in the record. On the basis f the record as a whole, we find that no services

agreement existed.

-14 covered multiple months. WFR then declared dividends payable to shareholders

pro rata and paid dividends;to Mr. Repetto's Roth IRA as follows:

Date

Amount

Declared

Amount paid to

Mr. Repetto's Roth IRA

5/04/04

3/10/05

4/10/06

Total

$50,000

20,000

50,000

120,000

$49,000

19,600

49,000

117,600 .

'The parties stipulated incorrect amounts of dividends that WFR paid to the

Roth IRA. The Roth IRA's statement of transactions, WFR's corporate

documents, and the general ledger show that the amounts shown in the stipulation

were the total dividends WFR declared pro rata. We disregard these stipulations

as inconsistent with the record. See Cal-Maine Foods, Inc.·v. Commissioner, 93

T.C. 181, 195 (1989).

SGR and WFR paid Yolo pursuant to the agreements, in addition to SGR's

lump-sum payment of $126,900. See supra pp. 11-12. Yolo then declared

dividends payable to each shareholder pro rata and paid dividends to Mrs.

Repetto's Roth IRA as follows:

-15.Date

Amount

Declared

Amount paid to

Mrs. Repetto's Roth IRA1

5/24/04

3/9/05

Total

$50,000

80,000

130,000

$49,000

78,400

127,400

1The parties stipulated incorrect amounts f dividends that Yolo paid to the

Roth IRA. The Roth IRA's stat ment of transactions, Yolo corporate documents,

and the general ledger show th the amounts shown in the stipulation were total

dividends Yolo declared pro rata. We disregard these stipulations as inconsistent .

with the record. See id.

Mr. Zerjav made the decisions regarding whether WFR and Yolo would issue

dividends to their shareholders.

II.

Yolo's Medical Plan

On January 2, 2004, Mrs. Repetto in her capacity as president of Yolo

established a medical and dental care expense reimbursement plan (Yolo medical

plan) effective January 1, 2004. According to the Yolo medical plan,. Yolo would

reimburse medical expenses of eligible employees, their spouses, and dependents.

Yolo executives had no limitati ns on the amounts of expenses that could be

reimbursed. On the basis of the olo medical plan, Yolo reimbursed the Repettos

for their healthcare expenses tot ling $8,948, $13,622, and $12,865 in 2004, 2005,

and 2006, respectively.

16 III.

Notice 2004-8, 2004-1 C.B. 333

On December 31, 2003, before petitioners filed their 2003 returns, the

Internal Revenue Servic'e (IRS) issued Notice 2004-8, 2004-1 C.B. 333, titled

Abusive Roth IRA Transactions. In Notice 2004-8, supra, the IRS addressed

taxpayers' attempts to avoid limitations on contributions to Roth IRAs. The nåtice

states that the transactions generally involve (1) an individual who o 541vns

a

preexisting business, (2) a Roth IRA maintained for that individual, and (3) a

corporation substantially all the shares of which are owned or acquired by the

Roth IRA (Roth IRA corporation). The notice describes a typical fact pattern to

include acquisitions of property from the preexisting business for less than a fair

market value and any other arrangement between the Roth IRA corporation and

the individual or his business "that has the effect of transferring value to the Roth

IRA Corporation comparable to a contribution to the Roth IRA." Id., 2004-1 C.B.

at 333.

The notice also provides that the IRS would challenge the purported tax

benefits resulting from such transactions. Id. The notice provides that in addition

to any other tax consequences that may be present, the amount treated as a

contribution is subject to the excise tax under section 4973. Id. The notice

identifies these transactions, as well as substantially similar transactions, as listed

- 17 transactions for purposes of se tion 1.6011-4(b)(2) Income Tax Regs. Id., 2004-1

C.B. at 334.

IV.

Procedural:History

A.

.

Federal Tax Returns

.-

-

Mr. Zerjav prepared petitioners' 2004-06 Federal income tax returns. On

SGR's Forms 1120S, SGR reported its'shares of Ozark Future's business incoine

as $117,110, $311,003, and $2 9,91715 for 2004, 2005, and 2006, respectively.

SGR also claimed facilities support deductions of $78,200:$205,000, and

$132,800 for 2004, 2005, and 29006, respectively, for its payments to WFR and

Yolo. SGR reported a busmess loss of $6,376 for 2004, and the Repettos claimed

their distributive share of that loss on their 2004 Schedule E, Supplemental

Income and Loss. On the Schedules E of their Forms 1040 for 2005 and 2006 the

Repettos reported distributive shares of SGR's net income of $52,701 and

$95,174, respectively.

"The parties stipulated an incorrect amount, and we ignore that stipulation

as contrary to the Form 1120S and the Schedule K-1, Partner's Share of Income,

Deductions, and Credits, etc.

- 18 On its Forms 1120S, WFR reported gross income of $139,924, $56,000, and

$140,00016 for its tax years ending October 31, 2004, 2005, and 2006,

respectively. These amounts were the facilities support fees that SG11paid WFR.

WFR deducted facilities support expenses of $35,972 and $25,392 for its tax years

ending October 31, 2005 and.2006, respectively. These deductions were for the

payments WFR made to Yolo. WFR.paid Federal income taxes of $30,301,

$1,967, and $24,615 for the years at issue. Respondent did not adjust for these tax

payments in the notices of deficiency and continues to retain them.

. On its Forms 1120S, Yolo included in its gross income the. payments from

SGR and WFR and reported gross income of $163,596, $122,372,.and $75,792 for

2004, 2005, and 2006, respectively. Yolo paid Federal income taxes of $34,395,

$15,484, and $5,911 for its tax years ending October 31, 2004, 2005, and·2006,

respectively. Respondent did not adjust for these tax payments in the notices of

deficiency and continues to retain them.

The Repettos filed their Forms 1040, U.S. Individual Income Tax Return,

for the years at issue with the filing status of married filing jointly. They did not

16The parties incorrectly stipulated WFR's gross income for the year ending

October 31, 2004, and we ignore the stipulation as inconsistent with WFR's 2005

Form 1120S.

v l9 -

file Forms.5329, Additional Taxes on Qualified Plans (Including IRAs) and Other

Tax-Favored Accounts.

B. i

The Notices of Deficiency

In the notice of deficiency issued to the Repettos, respondent determined

that Mr. Repetto had compensation from SGR of $22,164 for each of,the years

2004 and 2005 and additional compensation of $6,750 for 2006. R.espondent

made corresponding adjustments to SGR's returns allowing deductions in the

same amounts.

Respondent determined hat amounts reported as wages of $9,600 and

$12,000 that Mrs. Repetto received from Yolo in 2005 and 2006, respectively,

were not includable in her taxable income. .These adjustments were consistent

with the adjustments respondent made to Yolo's returns for 2005 and 2006

disallowing the deductions for ages paid to Mrs. Repetto.

042

Respondent also adjusted several items on SGR's returns. The only

adjustmënts that remain at issue are the disallowed deductions for facilities

support of $78,200, $205,000, and $132,800 for:2004, 2005, and 2006,

respectively. Respondent did not explain the reasons for the disallowance in the

notice of deficiency. Responde t adjusted the Repettos' distributive shares of

income from SGR for 2004-06 to reflect the adjustments to SGR's returns.

20 In the notice of deficiency issued to the Repettos, respondent determined

that "the contributions made for the sole benefit of your Roth IRA Individual

Retirement Accounts were excessive contributions and are subject to the

applicable excise tax under the provisions of the Internal Revenue Code" and,

consequently, thé Repettos were liable for the exáise tax under section 4973.c

Respondent alsö determined that the Repettos did:not file the rèquired Forms 5329

and that the Repettos are liable for the sèction 6651(a)(1) addition to tax for failing

to file the Forms 5329 for 2004-06 and the section 6651(a)(2) addition to tax for

failing to pay excise tax due on the excess contributions. Respondent also

deterrì1ined that the Repettos are liable for thé section 6662A accuracy-related

042

penalty for reportable transaction understatements for 2004-06.

In the notice of deficiency issued to WFR, respondent disallowed the

facilities support deductions of $35,972 and $25,392 for taxable years ending

October 1, 2005 and 2006, respectively. Because respondent determined that

WFR had a,refortable transaction understatement for those years, respondent also

determined that WFR ivas;liable for the 30% accuracy-related penalty under 3 . .

section 6662A.

In the notice of deficiency issued to Yolo, respondent disallowed.in full the

medical expense reimbursement deductions Yolo claimed on its 2005 and 2006

- 21 returns as well as the deductions for officer compensation expenses discussed

above.P Respondent also determined for èach year at issue that Yolo was liable«

for the 30% accuracy-related penalty under section 6662A. e

Petitioners timely petitioned this Court.

OPINION

I.

Burden of Proof

Generally, the Commissioner's determinations in the notice of deficiency

are presumed correct, and the táxpayer bears the burden of proving that the

determinations are erroneous. See Rule 142(a); Welch v. Helvering, 290 U.S. 111,

115 (1933). However, pursuant to section 7491(a), in certain circumstances the

burden of proof on factual issues that affect the taxpayer's tax liability "for any tax

imposed by subtitle A or B" m y shift to the Commissioner.

At trial petitioners made an oral motion to shift the burden of proof under

section 7491(a): On brief petiti ners contend that the burden of proof shifts to

respondent because they established that the requirements under section 7491(a)

are met. We disagree. Section 491(a) applies only to subtitles A and B,'which

include income taxes and estate and gift taxes. See also Paschall v.

17Petitioners conceded another adjustment to the Yolo return. See supra

note 4.

- 22 Commissioner, 137 T.C. 8, 17 (2011). Respondent determined the excise tax due

under subtitle D: By its terms sectionr7491(à) does not apply to.taxes detèrmined

under subtitle D, and petitioners bear the burden of proof with respect to the

excise tax adjustments.

Respondent's other determinations, such as the determinations to disallow

SGR's and WFR's facilities support deductions, Mr. Repetto's cómpensation from

SGR, and Yolo's medical expense reimbursement deductions, are under subtitle A.

With respect torthese issues, we base our conclusions on the preponderance of the

evidence and not on any allocation of the burden of proof. See Knudsen v.

Commissioner 131 T.C. 185, 188-189 (2008).

II.

Excess Contributions to the Roth IRAs and Related Determinations

A.

Roth IRAs in General

Congress authorized the Roth IRA, a type of a retirement account, with the

enactment of section 408A of the Taxpayer Relief Act of 1997(Pub. L. No.-105- s

34, sec. 302, 111 Stat. at 825. The distinguishing feature of a Roth IRA is thea

back-end timing of the tax benefit: Contributions to a Roth IRA are not tax

deductible, but alliearnings accumulate tax free, and all qualified distributions are

tax free. Sec. 408A(a), (c)(1), (d)(1); Taproot Admin. Servs., Inc. v.

Commissioner, 133 T.C. 202, 206 (2009), aff'd,

F.3d

2012 WL 933908

- 23 (9th Cir. Mar. 21, 2012). By c mparison, contributions to a traditional IRA are

deductible and earnings accrue tar free (except with respect to section 511

unrelated business income), b t distributions from a traditional IRA are includable

in the recipient's gross income See secs. 219(a), 408(a), (d)(1):(e). Accordingly,

the timing of the tax benefit is he critical difference between a Roth IRA and a

traditional IRA. Both traditional and Roth IRAs are designed to ensure that the

taxpayer includes in income ei her the amounts the taxpayer contributes to the retirement account or the amount that he withdraws from his account. Cf. secs.

408A(c)(1), 408(d)(1).

The total annual contribution a taxpayer may make to a Roth IRA is

effectively limited." Sec. 408A(c)(2) and (3). Although the Code does not

prohibit higher contributions, section 4973(a) imposes for each taxable year an

excise tax of 6% for excess coritributions, computed on the lesser of (1) the

amount of the exceså contribution, and (2) the value of the account as of the end of

the taxable year. The tax appliës eách year until the excess contributions are

eliminated from the taxpayer's Roth IRA. See sec. 4973(b)(2). Section 4973(f)

"The Code establishes a maximum aggregate amount that an individual can

contribute to all of his or her Ráth IRAs for a taxable year, and that amount is

phased out between levels of mbdified adjusted gross income. See sec.

408A(c)(2) and (3).

- 24 defines an exce 541s

contribution.to a Roth IRA as the excess of the ainount

contributed over-the amount allowable as a contribution.. B.

The Parties' Arguments

. Respondent contends that the Repettos followed the general pattern of Notice 2004-8,;supra, and transferred funds into.their Roth IRAs in excess of the

statutory limits using the purported facilities support agreements. Relying on.the

substance-over-form and sham transaction doctrines as well as income shifting

cases such as Green v. United States, 460 F.2d 412, 420-421 (5th Cir. 1972),

Simon v. Commissioner, 248 F.2d 869, 876-877 (8th Cir. 1957), rev'g and

remanding U.S. Packing Co. v. Commissioner, T.C. Memo. 1955-194, and others,

respondent contends that when viewed according to the substance of the

transaction, the Repettos' deemed.contributions to the Roth IRAs were excessive,

and the Repettos are liable for the excise tax under section 4973.

Petitioners contend that their corporate structure had a legitimate business

purpose of asset protection1' and that a Roth IRA may own shares of a C

corporation. .They maintain that respondent,recognized that WFR and Yolo were

legitimate business entities by continuing to retain over $112,000 in Federal

19Because respondent does not argue that WFR and Yolo were sham

corporations and should be disregarded, we shall not address petitioners' argument

regarding the business purpose and economic substance of these corporations.

- 25 corporate income taxes that WFR and Yolo paid during the years at issue and by

having allowed many oftheir eductions. Petitioners also contend that the

payments between the entities were legitimate because Yolo provided

administrative support,,design, and development services to both SGR and WFR,

I

and WFR provided marketing, real estate purchasei design, and development

services to SGR.

C.

,

Analysis

Generallyithe substance and not the form of a transaction deteíanines its tax

consequences. Gregorv v. Helvering, 293 U.S. 465, 469-470 (1935); Lazarus v.

Commissioner, 58 T.C. 854, 864 (1972), aff'd,,513 E.2d 824 (9th Cir. 1975).

Where a series of transactions, taken as a whole, shows either that the transactions

are shams or that the transactions have no "purpose, substance, or utility apart

from their anticipated tax cons quences", the transactions are not recognized for

Federal tax purposes. Goldstein v. Commissioner, 364 F.2d 734, 740 (2d Cir.

1966), aff's 44 T.C. 284 (1965 ; see also Commissioner v.·Court Holding Co., 324

U.S. 331 (1945).

The parties ~agree that ge erally an entity in which substantially all the

interest is owned or acquired by a Roth IRA may be recognized as a legitiniate

business entity for Federal tax urposes. However, in these cases the

- 26 preponderance of credible evidence compels a finding that in substance the

services agreements and the resulting payments were nothing more than a

mechanism for transferring value to the Roth IRAs. The services agreements did

not change who provided the services to SGR, and the Repettos continued to do.

all of the work as:they had done before the agreements were allegedly put in place.

Petitioners introduced no written agreement with respect to the services WFR

purportedly provided to SGR, and we find there was none. The SGR agreement

and the WFR agreement were identical. .WFR and Yolo did notimaintain

contemporaneous timè records for the hervices that they allegedly provided-to

SGR. We also que 541tion

whether the amount 541

of the payments were determined irt

good faith and reflected the value of the services purportedly performed. The

amount of the upfront lump-sum payment from SGR tovYolo, $126,900,

.

underscores the lack of normal business dealings jbetween the corporations.. We

reject petitioners' explanation that Yolo'needed working capital as not credible.

The invoices in the record strongly support our conclusion that the services

agreements and payments were mechanisms to transfer value to the Róth IRAs

The record contains only two'invoices3 for $4,800 and $4,000,,for the servibes that

Yolo allegedly performed for SGR. The invoice for $4,800 bears as sits date a

notation "Monthly 2005", and the÷invoice for $4,000 behrs às its date a notation

- 27 "Monthly 2006". The invoices describe the allegedly provided services as

"Services for Administratiye sùpport", "Office support", ''Internet:' email

processing, material research, marketing information".

The record contains only one invoice for services that Yolo allegedly

performed for WFR. The invoice is for $2,116, and it describes the sérviòes as

"Services for'administrative support" and "Office support"." This invoice al 541o

bears as its date a notation "Mònthly 2005 and 2006". There are no invoices

issued by WFR to SGR in the recórd.

The engagement letter bètween Mr. Harrell and the Repettos supports a

finding that the payment of dividends to the Roth IRAs was the primarý goal of

the facilities support agreements. Under the engagement letter, Mr. Harrell

undertook to coordinate the payment of the first dividend to the Roth IRAs, a step

unlikely to be an area of concern for a new corporation under normal business

circumstances.

Mr. and Mrs. Repetto testified at length regarding the services WF11 and

Yolo performed under the services agreements. Mrs. Repetto testified that Yolo

provided SGR with administrative support by enteririg data into QuickBooks,

keeping track of various charges for the construction jobs, and reordering supplies.

Mrs. Repetto also testified thàt Yolo provided design services for SGR, such'as

- 28 choosing design features for homes.. According to Mrs. Repetto, Yolo also

provided development services for SGR and WFR during the preconstruction.

stage, which involved determining features for the new house on the basis of

research regarding buyers' preferences 20

Mr. Repetto testified about WFR's services to SGR; He testified thatiWFR

found and purchased lots and designed and developed homes. He also testified

that he visited other spec homes held for sale to.understand what people were e

interested in buying. After purchasing a lot, WFR had the home for the lot drawn

and obtained necessary approvals. Then Mr. Repetto had the lot surveyed and

appraised for the purpose of obtaining a construction loan. As the next step, WFR

obtained bids from all subcontractors, and WFR was responsible for working with

them. According to Mr. Repetto, WFR also provided services to SGR in

connegtion with SGR's projects that were independent of Ozark Future, namely,

the Florida and Panama projects.

Mrs..Repetto testified about Yolo's services to WFR. According to her

testimony, because Mr. Repetto was on the jobsites and could not do marketing

and development or design, Jolo performed those services for WFR. The services

20This type of design servicé was performsd before construction, andit

differed from more technical design services, for example, choosing colors or a

specific'supplier of an ifem

29 included putting together docuknentation for the loans and meeting with bank

representatives.

Mrs. Repetto also testifièd about Yolo's support to SGR and WFR in

connection with SGR's projects independent of Ozark Future. She claimed that

such services included administrative support, office functions, communications,

trip planning, and making app intments with real estate agents and condominium

developers. She also took care of books and records for SGR and WFR.

We have no doubt that Gzark Future's and SGR's growing businesses

required the Repettos' ongomg mvolvement. Petitioners have proven,'and we find

that with Mr. Porschen's illness; the Repettos' involvement in Ozark Future's

business increased substantially. Petitioners, however, have failed to convince us

that the Repettos worked in their capacity as Yolo's and WFR's indirect owners or

employees rather than as SGR's owners or that the services provided were worth

the amounts paid under the agreements. The circular arrangement among the

entities further supports this conclusion. WFR provided various services to SGR,

its only client. Yet, WFR subcèntracted some of those services to its only

subcontractor, Yolo, which, in turn, already provided SGR, its only client, a

somewhat overlapping menu of services. There is no credible evidence in the

- 30 record that either WFR or Yolo marketëd its services to potential clients beyond*

SGR.

Petitioners rely on.Swanson v. Commissioner, 106 T.C. 76 (1996),oin which

an IRA-owned.domestic international,sales corporation (DISC) received

commissions from a corporation wholly owned by the taxpayer. However, in

Swanson, the central issue was whether the IRS was substantially justified in its

litigation position for the purpose of determining whether the taxpayer was

entitled to an award of reasoñable litigation costs.21 The issue in these cases is

different. On these facts we fmd that the agreements and the payments made

pursuant theretò were designed to permit and permitted the Repettos to make

excess contributions to the Roth IRAs through the disguised service payments. .

Relying on Hellweg v. Commissioner, T.C. Memo. 2011-58, petitioners also

contend that respondent failed to treat the transaction consistently for section 4973

2iIi3 Swanson v. Commissioner, 106 T.C. 76,,87-88 (1996), the

Commissioner maintained that the IRA's acquisition of the Í)ISC's stock was a

prohibited transaction under sec. 4975(c)(1)(A). We concluded that the DISC was

not a disqualified person under sec. 4975(e)(2)(G) and that therefore the'issuance

of the stock to the IRA was not a prohibited transaction. Swanson v.

Commissioner, 106 T.C. at 88-89. The Commissioner also contended that the

payments of dividends by the DISC to the IRA qualified as prohibited transactions

under sec. 4975(c)(1)(E), but we disagreed. See id. at 89. Accordingly, we held

that the Commissioner's litigation position was not substantially justified. Id. at

91-92.

- 31 and income tax purposes. In Hellweg, the taxpayers owned an S corporation. The

taxpayers established Roth IRAs. The Roth IRAs formed a DISC which entered

into a commission agreement with the S corporation. Each Roth IRA

.

subsequently contributed its ownership interest in the DISC to a C corporation in

exchange for all of that corporation's unissued stock. Because of the DISC's tax

treatment under the Code, the C corporations reported and paid applicable Federal

income taxes resulting from the commission fees. Each C corporation then

distributed some amount as a dividend to the Roth IRA shareholder. The

Commissioner determined that the transaction resulted in excess contributions

subject to the section 4973 excise tax. The Commissioner, however, made no

adjustments for Federal income tax purposes.

.

In Hellweg, we held that the transactions must be treated consistently for

section 4973 and income tax purposes. We stated

Pursuant to Notice 2004-8, supra, reallocation of income or

recharacterization of the irransaction should have resulted in: (1)

Refund of income taxes paid by the C corporations on the dividend

income from * * * [the DISC], (2) reduction or denial of the

deductions claimed by * * * [S corporation] for the * * * commission

payments, (3) additional þassthrough S corporation income to

petitioners from * * * [S corporation], and (4) income to petitioners

under section 1368 to the extent, if any, the distributions they were

deemed to have received from * * * [the S Corporation] exceeded their bases in * * * [the S corporation].

- 32 However, in Hellweg, the Commissioner made no such adjustments We stated

that because the Còmmissioner made no section 482 ädjustment which would

result in distributiöns from the S corporation to th'e taxpayers for income tax

purposes, the commissión-payinents cannot be treated as excess contributions to

petitioners' Roth IRAs. Sèe id.; see also Ohsman v. Comniissioner; T.C. Memon

2011-98.

We have a different set of adjustments in the notices of deficiency in these .

cases. Although respondent did not make a sec'tion 482 reallocation, hè

disallowed all of the business expense deductions SGR claimed for its payments to

WFR and Yolo. These income tax-adjustments are consistent with the excise tax

adjustments at issue, and Hellweg is therefore distinguishable.

Petitioners:also failed'to prove that respondent's disallowance óf SGR's and

WFR's claimed deductions for facilities support expenses under section 162

and/or for lack of substantiation was erroneous. Generally; section 162(a) allows

as a deduction all the ordinary.and necèssary e 576penses

paid or incurred dufing the

taxable year in carrying on any trade.or business. Whether an expenditure is

ordinary and necessary is generally a question of fact. Commissioner v:

Heiningerg 320 U.S. 467, 475.(1943). Ah expense is ordinary if it is customary or

usual within a particular trade, business, or industry or relates to a transaction "of

- -33_

common or frequent occurrence in the type of business involved." Deputy v..du

Pont, 308 U.S. 488, 495 (1940). An expense is necessary if it is appropriate and

helpful for the business. See Commissioner v. Heininger; 320 U.S. at 471. Only

the portion of an expense that is reasonable qualifies for deduction under section

162(a): United States v. Haskel Engg. & Supply Co., 380 F.2d 786, 788-789 (9th

Cir. 1967). In addition, taxpayers must keep sufficient records to substantiate any

deductions otherwise allowed by the Code. Sec. 6001.

We agree with respondent that petitioners have failed to prove thät the

payments under the services agi·eements were necessary or reasonable. In

addition, SGR's and WFR's form invoices fall short of satisfying the

substantiation requirements of the Code. We sustain respondent's disallowance of

the deductions SGR and WFR claimed for facilities support

D.

Con1putational Matters

We now address the amounts of the excess contributions. Generally,

section 4973(f) defines an excess contribution to a Roth IRA as the excess of the

amount contributed over the amount allowable as a contribution. Respondent's

position on the issue has been får from consistent. In the notice of deficiency

issued to the Repettos, respondent calculated the amount contributed to each Roth

IRA as the sum of the increase to the net assét value of WFR and Yolb and

- 34 dividends paid to the.respective Roth IRAs. On brief respondent stands by his

calculation but argues that the transactions should be recharactefized as follows:

(1) The amounts transferred from SGR to WFR and Yolo should be treated as

distributions from SGR to the Repettos, and (2) the distributions should then be

treated as contributed by the Repettos to the Roth IRAs." We disagree with

respondent's methodology.

In Paschall v. Commissioner,-137J.C. at-19-20, another case involving a

tax-motivated transaction with a Roth IRA (conversion of a traditional IRA into a

Roth IRA) that we decided after Hellweg v. Commissioner, T.C. Memo. 2011-58,

we held that the amount contributed and thus, the excise tax deficiencies were to

be calculated on the basis of the fair market value of the Roth IRA at yearend.

Similarly an amount of the Repettos' contributions to the Roth IRAs (and, as the

next step, excess contributions) should be calculated on the basis of the values of

their Roth IRAs at the end of each tax year.

See

Respondent's calculations ignore corporate taxes that WFR and Yolo paid.

Thère were no distributions from the Roth IRAs, and the record does not

allow us to conclude that the value of the Roth IRA increased for a reason other

than the cõntributions.

Ori brief respondent admits that in the Ä$tice 2f cieficiency he failed to

include all.the dividends to jhe Roth IRAs and, specifically, that he omitted (1) a

(continued...)

- 35 20). Because we do not adopt respondent's recharacterization as described in his

brief, the corporate taxes that Yolo and WFR paid are irrelevant for the purpose of

calculating excess contributions for excise tax purposes.24

III.

Other Adjustments

A. -Mr. Repetto's Compensation From SGR

As discussed above, in the notice of deficiency issued to the Repettos,

respondent determined that Mr. Repetto had compensation from SGR of $22,164

for each of the years 2004 and 2005 and additional compensation of $6,750 for

2006. Respondent allowed corresponding deductions on SGR's returns.

Petitioners maintain that the payments to Mr. Repetto were distributions rather

than wages.

(...continued)

$50,000 dividend from Yolo to Mrs. Repetto's Roth IRA dated May 24, 2004, and

(2) two $50,000 dividends from WFR to Mr. Repetto's Roth IRA dated May 4,

2004, and May 13, 2006. Notably, respondent calculates the contributions using

the total rather than pro rata dividends. Because we follow Paschall v.

Commissioner, 137 T.C. 8 (2011), and treat the yearend value of the Roth IRA as

the amount contributed to the respective Roth IRA, respondent's failure to include

all of the dividends in his calculation as well as the use of slightly inflated

numbers as dividends are irrelevant.

24Because the facilities support agreements were shams, the parties shall

exclude income that WFR and Yolo received under those agreements during 2005

and 2006 from income used in the Rule 155 computations. See sec. 6512; cf.

Winter v. Commissioner, 135 T.C. 238, 244 (2010).

-36SGR's géneral ledgers show regular monthly payments of $1,847 to Mr.

Repetto identified as "Payroll expenses", "Salary & Wages (Payroll)", or "Salary".

Mr. Repetto explained that the QuickBooks entries listed the payments as sálary

"just to keep track of the money" that he took out of SGR. At the end of 2004 aí1d

2005, the payments were reclassified as loans. However, the regular timing of the

payments, the consistent amounts, and.the contemporaneous descriptions in the

general ledger support a finding that Mr. Repetto received wages rather than

distributions. We sustain respondent's adjustments.to this item for 2004 and 2005.

With respect to 2006, $6,750 shown as Mr. Repetto's wages in the journal

entries does not exceed the wages from SGR,that Mr. Repetto reported on his

Form 1040. Because the record does not show that Mr. Repetto had additional

compensation income of $6,750 for 2006, we do not sustain respondent's

adjustment to this item for 2006.

B.

e

Mrs. Repetto's Compensation From Yolo and the Medical

Expense Reimbursement Deductions

Yolo deducted as officer compensation expenses payments to Mrs. Repetto

Yolo also deducted reimbursements of the Repettos' medical expenses.

Respondent disallowed these deductions because the employment relationship

between Yolo and Mrs. Repetto was à sham.

-'37 As discussed above, we cannot conclude on this record that Mrs. Repetto

performed work in her capacity as Yolo's employee or officer. Consistent with

our conclusion above, we sustain respondent's disallowance of these deductiòns.

IV.

Additions to Tax and Penalties

A.

s Burden of Proof

Respondent bears the burden of production with regard to the section

6651(a)(1) and (2) additions to tax and the section 6662A penalties. See sec.

7491(c); Higbee v. Commissioner, 116 T.C. 438, 446-447 (2001). To meet his

burden, respondent must produce sufficient evidenòe that it is appropriate to

impose them. Sm Higbee v. Corámissioner, 116 T.C. at 446. Respondent does .

not have to produce evidence of reasonable-cause, substantial authority, or lack of

willful neglect. See id. .

B«

Section 6651(a)(1) and (2) Additions to Tax

In the case of a failure to file timely any retùrn required under section

6011(a), section 6651(a)(1) iniposes an addition of 5% of the tax required to be

shown on the return for each month or fraction thereof for which there is a failure

to file, not to exceed 25% in the aggregate. Generally, "any person made liable for

any tax * * * shall make a return or statement according to the forms and

38 regulations prescribed by the Secretary "25 Sec. 6011(a). The addition to tax does

not apply if the failure to file timely is due to reasonable cause and not due to

willful neglect.

Taxpayers are required to file a Form 5329 for each year they have éxcess

contributions to their IRAs. See Paschall v. Commissionerpl37 T.C. at 21; Frick

v. Commissioner, T.C. Memo. 1989,86, aff'd without published opinion, 916 F.2d

715 (7th Cir. 1990). Form 5329 is a tax return within<the meaning of section

6011, and failure to file it can result in the section 6651(a)(1) addition to táx.

Paschall v. Commissioner, 13LT.C. at 21. We have found that the Repettos had

excess contributions. Also, they did not file the Forms 5329. Responderit

therefore has met his burden of production.

e

Section 6651(a)(2) imposes an addition to tax for failure to pay timely the

amount of tax shown on a return. The section 6651(a)(2) addition to tax applies

only when an amount of.tax is shown on ä return. Cabirác v. Commissiòner, 120

T.C. 163, 170 (2003). Where the taxpayer did not file a valid return, to satisfy the

burdeñ of production for the section 6651(a)(2) addition to tax the Commissionef

must introduce evidence that he prepared a substitute for retürn satisfying the

"The term "Secretary" means the Secretary of the Treasury or his delegate.

Sec. 7701(a)(11).

39 _

requirements under section 6020(b) Wheeler v. Commissioner, 127 T.C. 200

208-209 (2006), aff'd, 521 F.3d 1289 (10th Cir. 2008). A return made by the

Secretary under section 6020(b) is'treated as the return filed by the taxpayer for

purposes of section 6651(a)(2). Sec. 6651(g)(2). Respondent'satisfied his burden

by introducing into evidence Form 13496, IRC Section 6020(b) Certification.

The Repettos contend that the failure to file the Forms 5329 and pay-the

excise tax was due to reasonable cause and not due to willfulnegléct. They claim

that they relied in good faith on Messrs. Zerjav and Harrell.

Generally, the failure to timely file a return is considered to be due to

reasonable cause where a taxpayer is unable to file the return within the prescribed

time despite exercising "'ordinary business care and prudence.'" Jackson v.

Commissioner, 86 T.C. 492, 538 (1986) (quoting section 301.6651-1(c)(1),

Proced. & Admin. Regs.), aff'd, 864 F.2d 1521 (10tli Cif./1989). LWillful neglect

is defined as a "conscious, intentional failure or feckless indifference". United

States v. Boyle, 469 U.S. 241, 245 (1985). While good faith reliance on

professional advice may provide a basis for a reasonable cause defense, it is not

absolute. Freytag v. Commissioner, 89 T.C. 849, 888 (1987), aff'd, 904 F.2d 1011

(5th Cir. 1990), aff'd, 501 U.S. 868 (1991). The advice must be from competent

- 40 and independent parties rather than from promoters of the investment or advisers

with a conflict of interest. Paschall v. Commissioner:137'T.C. at 22.

The Repettos hired Messrs. Zerjav and Harrell to set up the structure

knowing about the limitations on contributions to Roth IRAs and not fully

understanding,the structure.; As,evidenced.by Mrs. Repettö's email to Mi.. Harrell,

the Repettos suspected-the arrangement was improp'er, but relied on Mr.:Harrell's

summary denial to allay their concerns. Messrs. Zerjav and Harrell were the

advisers who suggested the structure, and petitioners' reliance on their advice as to

the proper tax treatment of the transaction was unreasonable. Petitioners failed to

establish-that they meet the reasonable cause exception to the section 6651(a)(1)

and (2);additions to tax. Therefore; we-sustain respondent's imposition of these

additions to tax.

C. .

Sectioñ 6662A Penalties

1.

2

Section 6662A in General

Section 6662A provides that "If a taxpayer has a reportable transaction

understatement for any taxable year, there shall be added to the tax an amount

equal to 20% of the amount of such understatement." The penalty applies to any

deficiency which is attributable to any listed transaction or any reportable

transaction if a significant purpose of the transaction is the avoidance or evasion

- 41 of Federal income tax. Sec. 6662A(b)(2). The penalty is increased from 20% to

30% of the amount of the understatement if the disclosure requirernents of section

6664(d)(2)(A), requiring disclosure in accordance with the regulations under

section 6011, are not met. Sec. 6662A(c).

2.

The Parties' Arguments and Analysis

Respondent argues that the R'epettos, WFR, and Yolo are liable for the

penalty because they participated in a listed transaction. A listed transaction is a

transaction that is the same as or substantially similar to'one of the types of

transactions that the IRS has determined to be a tax avoidance transaction and has

identified by notice, regulation, or other form of published guidance as a listed

transaction. Sec. 6707A(c)(2); see·also BLAK Invs. v: Commissioner, 133 T;C.

431, 445 (2009). Respondent claims that the transaction is substantially similar to

the transaction described in Notice 2004-8, supra.

The regulations defme the term "substantially similar" as "any transaction

that is expected to obtain the same or similar types of tax consequences and that is

either factually similar or based on the same or similar tax strategy." Sec. 1.60114(c)(4), Income Tax Regs. The consequence of the transactions described in

Notice 2004-8, supra, is avoiding the limitations on contributions to Roth IRAs.

This is what the transaction in these cases achieved. Moreover, the transaction

- 42 described in the notice is factually similar to the transaction at issue here. The :

transaction described in the notice has.the same types of parties as the tran~saction

in these cases, namely, an individual who owns a preexisting business; a Roth IRA

that is maintained for that individual, and a Roth IRA corporation. The,examples

of transactions described in the notice include "any other arrangement between the

Roth IRA Corporation and the Taxpayer, a related party * * *, or the Business that

has the effect of transferring value to the Roth IRA Corporation,comparable to a

contribution to the Roth IRA.'.' Notice 2004-8, supra. The facilities support

agreements and payments>between SGR and WFR and Yolo are exactly the-same

type of arrangement in that the agreements and payments have the effect of

transferring value to the Roth IRA corporations.

Respondent claims that petitioners are liable.for the increased 30% penalty.

Petitioners filed their Federal income tax returns but did not attach disclosure

statements as described in section 1.6011-4(c), Income Tax Regs., or any

materially similar documents, indicating their participation in the transaction to the

returns: Therefore,,petitioners are liable for the increased 30% penalty.aSee-sec.

6662A(c).

Section 6664(d) provides that under certain circumstances a taxpayer may ;

avoid section 6662A penalties if there was reasonable cause for the taxpayer's

- 43 treatment of the listed transaction and the taxpayer acted in good faith. However,

this exception applies only if the transaction was disclosed in accordance with the

regulations prescribed under sectiön 6011. Sec. 6664(d)(2)(A). Petitioners did

not disclose their participation in the transaction in accordance with the

regulations under section 6011. Accordingly, petitioners do not qualify for relief

from the section 6662A penalty under the reasonable cause exception.

Petitioners point oüt that the disclosure component in the structure of the

reasonable cause defense as applicable to the section 6662A penalty differs from

the reasonable cause exception for the section 6662(a) penalty, found in section

6664(c)(1). In their view the limitation upon the reasonable cause exceptiön

violates petitioners' constitutional right to due process of law and conflicts with

the reasonableness standard outlined in Boyle, 469 U:S..241. For reasonable

cause to apply under section 6662(a), the taxpayer must have exercised ordinary

business care and prudence as to the disputed item, see id. at 251-252, and in

petitioners' view, the additional disclosure requirement of section 6664(d)(2)(A)

violates this standard. . Petitioners believe that they in fact had reasonable cause

because they relied on their advisers to attach to petitioners' returns all required

forms, which the advisers did not, yet petitioners are unable to rely on the

reasonable cause exception because of the disclosure requirement.

We reject petitioners' argument. To fall within the protection of the Due

Process Clause, petitioners must show that the assessment of the penalties is so

harsh and oppressive as to transgress the constitutional limitation: See, e.g.,

McGehee Family Clinic v. Commissioner, T.C.:Memo. 2010-202. The penalty

structure of section 6662A does not do so

Petitioners also contend that their due process rights have been violated

because the language "substantially similár" set forth in Notice 2004 8, supra, is

void for vagueness. Petitioners believe that there is no clear guidance in section

1.6011-4(c)(4),lncome Tax Regs. as to what makes a transaction "substantially

similar":to a listed transaction.

oo

We reject petitioner's argument. As the Supreine Court stated in Gravned v.

City of Rockford, 408 U.S. 104, 108 (1972), ''[i]t is a basic principle of due

process that an enactment is void for vagueness if,its prohibitions are not clearly

defined."- The vagueness doctrine.is concerñed with the requirenient of explicit

guidelines to avoid arbitrary and discriminatory enforcemènt, and it requires

specificity in laws sufficient to inform those subject to the flaw as to its meaning.

Big Mama Rag, Inc. v. United States; 631 F:2d.1030, 1035.(D.C. Cir. 1980)

Under the vagueness doctrine, courts may invalidate laws if "'men of common

intelligence must necessarily guess at its meaning.'" Ick (quoting Hynes v. Mayor

- - 45 of Oradell, 425 U.S. 610, 620 (1976)); see also United States v. Derezinski, 945

F.2d 1006, 1010 (8th Cir. 1991). It is apparent that Notice 2004-8, supra

addresses transactions structured to circumvent the.statutory limitations on

contributions to Roth IRAs. The notice specifies what type of entities or

individuals the transaction typically involves. We find no unconstitutional

vagueness in Notice 2004-8, supra.

3.

042Calculation of the Amount;of thé Penalty

Although we sustain the imposition of the section 6662A penalties, we

disagree with certain aspects of respondent's calculations. Generally, section

6662A applies, as relevant here, "to any item which.is attributable to" any listed

transaction. Sec. 6662A(b)(2)(A). Respondent, however, calculated the penalty

by including an overly broad range of adjusted items. In particular, he imposed

the penalty on the following adjustments: (1) Mr. Repetto's wages from SGR and

all Schedule E adjustments (including the facilities support adjustment) to the

Repettos' returns, (2) facilities support adjustments to WFR's returns, and (3)

medical expense reimbursement, selling-related expenses, and officer

compensation expense adjustments to Yolo's returns. Not all of these adjustments,

however, are attributable to the listed transaction. The Schedule E adjustments

included disallowance of selling-related expenses, rent and occupancy expenses,

-46and auto/local travel expenses. Unlike the facilities support deduction, these items

are not attributable to the facilities support arrangements between SGR and the

Roth IRA corporations. Similarly, the disallowance ofthe medical expense

reimbursement deductions and the officer compensation expènse deductions

relating to Mrs. Repetto's salary is attributable to Yolo's claiming improper

deductions, not to petitioners' participation in a listed transaction. We expect

respondent to adjust his calculations of the section 6662A penalties accordingly

during the Rule 155 process. 042

We have considered the remaining arguments made by the parties, and to

the extent not discussed above,-we conclude those arguments are irrelevant, moot

or without merit.

.

To reflect the foregoing,

Decisions will be entered

under Rule 155.