# UNITED STATES TAX COURT > Briefs, arguments, decisions, and more. URL: https://www.frixlaw.com/law-library/documents/agency%3Atax-court%3A9582f5f89873f884 ## Record - **Collection:** Agency decision - **Document type:** Agency decision ## Text T.C. Memo. 2021-88 UNITED STATES TAX COURT ERNEST S. RYDER & ASSOCIATES, INC., APLC, ET AL.,1 Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent Docket Nos. 14619-10, 14687-10, 7527-12, 9921-12, 9922-12, 9977-12, 30196-14, 31483-15. Filed July 14, 2021. Ernest S. Ryder and Richard V. Vermazen, for petitioners. Kevin W. Coy, Hans Famularo, Blake J. Corry, and Christopher J. Richmond, for respondent. 1 We consolidated many cases for discovery and other pretrial practice. The parties settled quite a few, but we continued the consolidation through trial and briefing for Ernest S. Ryder & Associates, Inc., APLC, docket numbers 14619-10 and 9977-12; Ernest S. Ryder and Patricia A. Ryder, docket numbers 14687-10, 9921-12, 30196-14, and 31483-15; Ryder Ranches, LLC, Ernest S. Ryder, Tax Matters Partner, docket number 7527-12; and First Counsel Capital, Inc., docket number 9922-12. Served 07/14/21 -2CONTENTS [*2] FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 I. Ryder & Associates, APLC . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 A. How R&A Made Money . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 B. What R&A Did With the Money. . . . . . . . . . . . . . . . . . . . . . 28 1. Practice Funding Agreement With BFA. . . . . . . . . . . 28 2. Establishment of Ryder Law Corp.. . . . . . . . . . . . . . . 29 II. Ryder Goes Ranching . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34 A. Sources of Money for Ranches . . . . . . . . . . . . . . . . . . . . . . . 36 1. Counselor Capital as Blocker Entity for Ranches . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36 2. First Counsel Capital as Blocker Entity for Ranches . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37 3. Use of Four Additional Blocker Entities . . . . . . . . . . 39 4. RLC and Its Stock Subscription Agreement. . . . . . . . 41 B. Ryder Ranch Co., LLC Properties. . . . . . . . . . . . . . . . . . . . . 42 C. Pattern Farms, LLC . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43 D. Canyon View Ranch, LLC . . . . . . . . . . . . . . . . . . . . . . . . . . 44 E. Ryder Red Rock Ranch, LLC . . . . . . . . . . . . . . . . . . . . . . . . 44 F. Rodeo Holdings, LLC . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45 III. Audit, Cashflow, and Trial . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46 A. Audit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46 B. Cashflow . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 48 1. Following the Money . . . . . . . . . . . . . . . . . . . . . . . . . 48 2. Gross Income. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49 3. “Other Deductions” for 2005-06. . . . . . . . . . . . . . . . . 68 4. Dividend Treatment . . . . . . . . . . . . . . . . . . . . . . . . . . 68 i. From R&A Through RLC. . . . . . . . . . . . . . . . . 69 ii. From Tax Products to Ranch Entities. . . . . . . . 69 iii. From R&A’s Bank Accounts to Third Parties for the Ryders’ Benefit . . . . . . . . . . . . . 70 5. The Commissioner’s Alternative Arguments . . . . . . . 72 -36. [*3] C. D. Disallowed Deductions . . . . . . . . . . . . . . . . . . . . . . . . 73 i. Substantiation of R&A Expenses . . . . . . . . . . . 73 ii. Ryder Ranch Co., LLC Losses . . . . . . . . . . . . . 76 7. California Pasteleria . . . . . . . . . . . . . . . . . . . . . . . . . . 79 8. Other Losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 80 Penalties. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 83 Trial . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 83 OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 84 I. Burden of Proof . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 84 II. R&A’s Unreported Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 86 A. Assignment of Income by Ryder & Associates . . . . . . . . . . 87 1. What R&A Looked Like to Clients . . . . . . . . . . . . . . 92 2. What Services R&A Provided . . . . . . . . . . . . . . . . . . 93 3. Income Produced Through These Services . . . . . . . . 95 i. Group Tax Products Income. . . . . . . . . . . . . . . 96 ii. Stand-Alone Products Income . . . . . . . . . . . . 112 B. Additional Attempted Assignments of Income. . . . . . . . . . 119 1. Assignment of Fee Income to BFA Through the PFA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 121 2. Assignment of Staffing Income to ESOP Legal Consultants . . . . . . . . . . . . . . . . . . . . . . . . . . . 125 3. Assignment of GCO Product Income to Individual General Counsel Offices . . . . . . . . . . . . . 128 C. “Other Deductions” . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 129 1. RLC and the Employee Leasing Agreement . . . . . . 129 2. Remaining Deductions . . . . . . . . . . . . . . . . . . . . . . . 132 III. Dividend Adjustment: The Ryders’ Liability for Tax on Unreported Constructive Dividend Income . . . . . . . . . . . . . . . . . 134 A. Dividends From R&A Through RLC . . . . . . . . . . . . . . . . . 137 B. Dividend Income From Payments Made To Acquire and Operate the Ranch Properties . . . . . . . . . . . . . . . . . . . . 141 1. Ryder Ranch Co., LLC . . . . . . . . . . . . . . . . . . . . . . . 143 2. Pattern Farms, LLC . . . . . . . . . . . . . . . . . . . . . . . . . . 154 -4[*4] C. D. 3. Canyon View Ranch, LLC . . . . . . . . . . . . . . . . . . . . 156 4. Ryder Red Rock Ranch, LLC . . . . . . . . . . . . . . . . . . 157 5. Rodeo Holdings, LLC . . . . . . . . . . . . . . . . . . . . . . . . 158 Dividend Income From Payments to American Express and Ben Leland Construction, Inc. . . . . . . . . . . . . 161 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 163 IV. Remaining Issues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 164 A. Ryder Ranch Losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 164 1. Jurisdiction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 165 2. Material Participation . . . . . . . . . . . . . . . . . . . . . . . . 169 3. Substantiation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 173 B. Ordinary Losses From California Pasteleria for 2003 and 2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 174 C. Investment Interest Expense for 2005 and Unreimbursed Employee Expenses for 2006 Through 2008 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 175 V. Penalties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 176 A. Mrs. Ryder . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 183 B. Ryder and R&A . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 185 MEMORANDUM FINDINGS OF FACT AND OPINION HOLMES, Judge: Ryder & Associates, Inc., APLC (R&A), marketed six tax-reduction strategies that produced over $31 million in revenue between 2003 and 2011. The firm’s fixed costs were low, and its out-of-pocket expenses not very large. Yet year after year it paid no income tax. Its revenue flowed instead -5[*5] into 560 accounts and into Ryder Law Corporation, a related S corporation.2 It flowed into more than 1,100 ESOPs,3 other S corporations, LLCs, and other passthroughs. It flowed into ranches in Arizona, and it flowed into other ranches in New Mexico. And then it mostly seemed to pool in places where it would benefit Ernest S. Ryder and his wife Patricia, who received more than $15 million in distributions between 2002 and 2011 but paid only $31,000 in income tax during the years at issue. Or so the Commissioner says. FINDINGS OF FACT Ernest Ryder is the owner of R&A. He and his wife Patricia live in Poway, California, and they are longtime Californians. After graduating from San Diego State College in 1968 with a degree in accounting, Ryder started law school at the University of California, Hastings. While in law school he put his accounting 2 If a business meets the requirements of section 1361, it may elect to become an “S corporation” and pay no corporate tax. Secs. 1362(a), 1363(a); sec. 1.1361-1(b)(1), Income Tax Regs. An S corporation’s income and losses, like a partnership’s, flow through to its owners, who then pay income tax. See sec. 1363(b); see also Gitlitz v. Commissioner, 531 U.S. 206, 209 (2001). (Unless we say otherwise, section references are to the Internal Revenue Code in effect for the years at issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.) 3 See infra note 48. -6[*6] degree to use at Touche Ross & Co. There he learned about agricultural cooperatives and “how cooperatives work.” Three years later he had a law degree and was admitted to practice in California. He went to work at Price Waterhouse & Co. in San Diego, California. Within a year, he moved back to Touche Ross, but this time in San Diego.4 He then moved to New York and enrolled at NYU for his master’s degree in taxation, all the while continuing to work for Touche Ross in its Manhattan office. His time on the east coast was short lived, and he returned to California to join Ralph Gano Miller on a temporary job to help prepare and present a paper at the NYU Institute on Federal Taxation. When this was done, he began his career as a practicing tax lawyer at Hewitt & Shaw, a tax and business law firm also in San Diego. His timing was fortunate--he was at the stem-cell stage of his career the year that Congress enacted the Employee Retirement Income Security Act of 1974 (ERISA). When there’s an avulsive change in the law like ERISA, young lawyers can develop valuable expertise in an environment uncluttered with more senior competitors. 4 Ryder was already a CPA at this time, though the record doesn’t tell us when he became one. His license was canceled in 1996 when he failed to pay his dues. -7[*7] Knowledgeable associates in a fast-growing field are a hot commodity, and in 1975 Ryder was hired away by Harrigan, Ruff & Osborne to help that firm’s clients get their retirement plans qualified under the new law. “[T]hat’s when my career really took a turn,” Ryder explained, and he was well on his way to becoming an expert in qualified retirement plans. He stayed at the Harrigan firm; and when he rose to become a shareholder, the name of the firm changed to Harrigan, Ruff, Ryder & Sbardellati.5 He ran the firm’s pension department for many years, and that is where he started working on many of the aggressive taxreduction strategies that led to these cases. The Ryders have been married for more than a quarter century. Unlike her husband, Mrs. Ryder is neither a tax attorney nor a CPA, but she does think she has “a better understanding of tax th[a]n most people walking around on the street.” She completed four years of college classes--two at the University of California, Riverside, and two at San Diego State--but never obtained a bachelor’s degree. After college and up until the time of trial she had an assortment of jobs that included work at a jewelry store and Brooks Brothers; and she owned her own businesses that included a bridal salon and some cookie stores--stores that are at 5 California is part of the West in some sense, and the firm referred to itself as “Ruff Ryder.” -8[*8] issue in these cases. She claims to work at the many different ranches she owns with her husband, where she says her tasks include “tak[ing] inventory * * * of the animals” and being “involved in their health.” She also helped ensure the cattle got the necessary shots, ear tags, and brands; and “kept track of the breeding program” for them. I. Ryder & Associates, APLC The aggressiveness of Ryder’s tax-reduction strategies seems to have caused some tension with his partners at Ruff Ryder, and he was asked to leave the firm sometime in 1995. Ruff Ryder’s entire pension department and its profitsharing clients left with him.6 With ample experience and a fully staffed pension practice, Ryder decided to open up his own firm in early 1996. And here begins the Ryders’ tax problems. R&A is a professional law corporation7 and has always been taxed as a C corporation.8 Ryder has owned 6 Ryder was careful to note that he remained cordial with his former partners, and even shared clients with them for different types of work in later years. 7 Professional corporations are businesses organized as corporations under the laws of a specific state, typically consisting of licensed professionals working in fields like accounting, architecture, engineering, health, law, or science. 8 This means that R&A itself is taxed separately from its owners under subchapter C of the Code. So Ryder’s income from the firm would face two layers (continued...) -9[*9] 100%, and has acted as president, of R&A since its creation. We find that Ryder also provided 100% of his legal services to clients through R&A during the years at issue. Despite its success and longevity, R&A reported zero taxable income from 2002 through 2011. The Ryders also reported minimal taxable income on their individual returns for those years. A. How R&A Made Money Although R&A wasn’t clientless when it opened its doors, it “started fresh” with no money in the bank or cashflow from work done by Ryder and his team at Ruff Ryder. Ryder began a quiet but substantial marketing campaign for the new firm. R&A pitched its tax-saving products as “next generation tax management services” to prosperous professionals and entrepreneurs who wanted to save for retirement using “unique” plans that would “defer a much greater portion of their income than they ever dreamed possible, and, as a result, substantially reduce their tax liability.” After meeting with Ryder in person and receiving a followup letter laying out the tax benefits of R&A’s services, many took the bait, and R&A began reeling in the clients. R&A did everything its clients needed to fulfill what it had 8 (...continued) of tax: one at the corporate level, and the other when the firm distributes profits in the form of dividends to him. - 10 [*10] promised: It set up the necessary entities, handled all filings with the IRS and any state agencies, created retirement plans, drafted agreements to link its clients to the companies that held the retirement accounts, helped clients move money from one account to another as needed, and reviewed tax returns to make everything look as proper as could be. R&A earned some of its fees by setting up traditional employee savings plans and doing certain noncontroversial corporate work. Most of its fees, however, were earned through the sale of the several “unique” tax plans. This entire clade of six plans throughout their entire evolution is traceable to Ryder himself. But to make our discussion of them even minimally understandable we will first describe some sister clades and their species, then dissect each species in some detail. The first division is between group-tax and stand-alone products. The group-tax products are ! a form of insurance called ASIG, ! factoring, and ! employee leasing. The stand-alone products are ! individual staffing, - 11 [*11] ! ! general counsel offices, and a Son-of-Boss variation.9 The key distinction between the group and stand-alone products is that buyers of the group product had contracts with a third entity that R&A would set up. Buyers of stand-alone products each had a contract with R&A itself. We start with the group products. ASIG. R&A sold this product through American Specialty Insurance Group, Ltd. (ASIG), a captive insurance10 company that was itself owned by another company named Capital Mexicana. ASIG was organized under the laws of the Turks and Caicos and, like Capital Mexicana, was created during Ryder’s time at Ruff Ryder. Both ASIG and Capital Mexicana had been in business since at least 1991.11 When Ryder learned of captive insurance, he wanted to sell the 9 See infra note 19. 10 As we explained in Hosp. Corp. of Am. & Subs. v. Commissioner, T.C. Memo. 1997-482, slip op. at 8: The insurance laws of some States provide for a category of limited purpose insurance companies, popularly called captive insurance companies or captive insurers. Captive insurance company statutes generally apply to companies that insure on a direct basis only the risks of companies related by ownership to the insurer. 11 Ryder organized Capital Mexicana as an Irish nonresident company in (continued...) - 12 [*12] product to his clients. To do this, Ruff Ryder had hired the Turks and Caicos accounting firm Morris Cottingham for the purpose of creating a Turks and Caicos company--ASIG. ASIG’s main office was located at Morris Cottingham’s Corporate Services, but Ryder also rented a post office box for ASIG in Las Vegas. Any mail sent to the P.O. box was forwarded to Ruff Ryder (c/o Ernest Ryder). Once ASIG was in place, R&A could provide its clients with what it called “Disability and Professional Liability Income Insurance” policies. These policies required that the clients pay premiums to ASIG for the insurance, with the premiums to be physically mailed to R&A. On top of this, the policyholder was required to pay an annual 2% policy fee, which was deposited in ASIG’s Charles Schwab bank account ending in 5337 during the years at issue. In return for all of 11 (...continued) Dublin. Irish nonresident companies were companies established in Ireland whose management was located elsewhere. Under Irish tax law at the time, such a company would be subject to income tax only in the country of the management’s residence. And if that management was located in a tax haven like the Turks and Caicos, it would not owe tax to the Turks and Caicos government either. This meant that a corporation set up in Ireland whose management was in the Turks and Caicos would not owe income tax anywhere in the world. Ryder made sure Capital Mexicana was such a company. Ireland later changed its law to eliminate nonresident companies (with a few exceptions). See Brian McDonald & John Homan, “Finance Act Targets Irish Nonresident Companies,” 1999 J. of Int’l Tax’n 42. - 13 [*13] this, the policyholder was entitled to 98% of the cash value of the policy when certain events occurred (i.e., disability, separation from employment, turning 60, or the insured’s termination of the policy). We’ve already analyzed these policies in Estate of Barnhorst v. Commissioner, T.C. Memo. 2016-177. Like other ASIG policies, Barnhorst’s policy was titled “Disability Income Insurance Policy” and ostensibly provided benefits to him if he became totally or partially disabled, which would make any payout excludable under section 105 as being from an employer-funded accident or health plan. See id. at *3. What makes such policies stand out was that they would also pay out when the policyholder reached age 60 or died or was no longer employed. See id. at *3*6. A close look at the policy in Estate of Barnhorst showed that payouts weren’t correlated with actual medical expenses or “computed with reference to the nature of the injury.” See id. at *14, *18 (quoting section 105(c)(2)). We found it quite telling that although the policy said it would terminate once Barnhorst turned 60, ASIG renewed the policy each year. See id. at *6-*7. No new premiums were ever paid despite these renewals, and only three premium payments were ever made. These were mailed to R&A and then placed in a segregated account that Ryder maintained. Id. at *6. Ryder then “invested the premiums in a diversified - 14 [*14] portfolio of mutual stock and bond funds where they could build value over the years until benefits had to be paid.” Id. We found that the policy was really a deferred-compensation plan, despite its stated title. Id. at *16. These cases do not require us to revisit our analysis in Estate of Barnhorst. They do require us to find here that from start to finish R&A did everything it could to make ASIG work. And there were several of these ASIG policies that produced money for R&A during the years at issue. We summarize the numbers: 12 Year Number of policies paying fees into account 5337 Total revenue12 2003 20 $138,322.28 2004 14 268,477.29 2005 15 311,585.34 2006 11 101,619.03 2007 10 114,917.84 2008 8 86,654.33 2009 11 181,513.41 We note that included in some of these amounts is interest on deposits in the form of “Schwab Money Market Fund-Dividends.” These dividends are different from the other, nontaxable dividends that the Commissioner excluded from his bank-deposit analysis. (See infra pp. 86-87 for our discussion of how the Commissioner conducted this analysis.) - 15 [*15] 2010 5 63,172.76 2011 1 14,297.78 Total 28 $1,280,560.06 Group Factoring. The second group product was something we’ll call “group factoring.” We analyzed this transaction in Pacific Management Group v. Commissioner, T.C. Memo. 2018-131. As we explained there, “Factoring” is a financial transaction by which one party (the factor) provides services to another party (the client) and is compensated by payment of factoring fees. The services that the factor provides typically include: (1) purchasing the client’s accounts receivable for cash, (2) collecting on the accounts receivable from the account debtors, and (3) assuming the downside risk if an account debtor becomes insolvent. Factoring benefits the client by enabling it to monetize an illiquid asset immediately. In exchange for its services the factor receives a fee, typically computed as a discount from the face amount of the receivables. Id. at *17. In an arm’s-length relationship, factoring is perfectly legitimate. Factors provide working capital and liquidity to their clients and do the work needed to collect the accounts that have been assigned to them. They also perform the sometimes very important job of moving the credit risk of the account debtor from their clients to themselves. See id. at *46-*48. As with ASIG’s “disability” policies, however, “group factoring” used the words associated with a legitimate practice and made it into something different--a circular flow of funds from R&A’s clients back to those clients, with some leaking - 16 [*16] out to R&A itself. See id. at *46. Instead of factors that paid for these accounts and then collected them, the clients themselves continued to bill and collect these accounts as if they’d never sold them. The factors were straw men who received no meaningful economic benefit in return for the money they paid out to the clients. See id. at *49. If a client was interested, R&A would create the needed entities. The evolution of these entities is quite complex and went through four different generations, with some overlap between them. Here’s the list: ! Benefactor Funding Association (BFA) (1996-2002); ! United States Factoring Association, LLC (USFA) (2002-04); ! Western Funding Group, Inc. (Western Funding) (2004-07); and ! WFG, Inc. (WFG) (2008-11) Each of these four shared many elements in both their setup and execution. One of these similarities was the way they collected fees paid by clients into a general account owned by the entity, but which R&A controlled. Here’s a summary of the gross receipts R&A received in the form of fees from these products into those accounts: - 17 [*17] 8497 (BFA) 4564 & 2653 (USFA)13 2935 (Western Funding) 6874 (WFG) Total number of fee payments14 58 347 --- --- Gross receipts $376,465.10 $849,519.83 $549,351.97 $70,440.70 Account(s) ending in The Commissioner was unable to identify any specific deposit into the Western Funding and WFG, Inc. operating accounts as gross receipts to R&A, because many of the deposits belonged to R&A’s clients. He therefore included as income only those funds that left the accounts and ended up in R&A’s own bank account ending in 9815, BFA’s Division 101’s bank account ending in 0449, or the Ryders’ personal bank account ending in 4461. This means we can’t tell how many other clients used Western Funding and WFG or how many fee payments 13 The Commissioner also identified a bank account for U.S. Factoring Managers, Inc., ending in 8620 that deposited $19,950.03 into the R&A bank account ending in 9815 in 2003. U.S. Factoring Managers, Inc., was a corporation owned by Ryder’s brother-in-law, Robert Pancheri. We agree with the Commissioner that this $19,950.03 is part of the factoring companies’ gross receipts for that year, and we include it in USFA’s gross receipts. 14 Note that these numbers are not the numbers of clients paying fees, but the numbers of deposits that we find were fee payments to R&A. The gross values of the deposits were quite large. In one employee’s estimation, there were about “60 requests to have accounts receivable factored” each month, and possibly more because “some customers factored twice a month.” - 18 [*18] they made, which makes our findings about R&A’s income from this product conservative. The account ending in 8497 was used by R&A’s clients at least from 200410. The account ending in 2653 appears to have been used only in 2003, while the other account for the USFA product and ending in 4564 was used from 2003-10. The Western Funding account ending in 2935 was used from 2004-08, and finally, the WFG, Inc., account ending in 6874 opened in 2008 and was used by R&A’s clients until 2011. Employee Leasing. The third group product was employee leasing, and this one was (to make the record still more complicated) often combined with the factoring product. As is true of factoring, employee leasing is perfectly legitimate when done the proper way. In a legitimate employee-lease deal, one business contracts with another to supply it with workers. The leasing company generally assumes responsibility for paying the workers’ wages and employment taxes, while the operating-business owner keeps control over how the workers perform their jobs and pays the leasing company for payroll, taxes, benefits, and any administrative fees. See, e.g., Garavaglia v. Commissioner, T.C. Memo. 2011228, 2011 WL 4448913, at *3, aff’d, 521 F. App’x 476 (6th Cir. 2013). - 19 [*19] This isn’t how R&A’s employee-leasing deals worked. In its deals clients signed what Ryder labeled “Agreements of Employment” with one of multiple entities that R&A created. The clients would then lease themselves back to their real businesses--either directly or through an intermediary--with the difference between the lease payment and the wages received becoming a form of compensation that was supposedly immune from current taxation. R&A used five entities: ! Worldwide Career Management, Ltd. (Irish).; ! Worldwide Career Management, Inc. (U.S.); ! Executive Placement, Inc.; ! Westra Capital Management, Inc.; and ! ExecuPro Specialty Services, Inc. Each of these companies had a number of bank accounts that R&A and its clients would use: - 20 [*20] Account type Number of accounts Worldwide Career Management accounts 2 Westra Capital Management accounts 3 WCM QSub accounts 45 Executive Placement accounts 16 ExecuPro accounts 4 ExecuPro Specialty Services accounts 27 WCM QSub & ExecuPro Client accounts 62 ESOP Client accounts 21 And here are R&A’s gross receipts from this group-leasing product for each tax year: - 21 [*21] Year Gross receipts15 2003 $409,176.11 2004 358,868.75 2005 1,188,470.00 2006 404,288.07 2007 684,663.39 2008 60,375.35 2009 51,450.00 2010 1,487,835.00 2011 524,865.19 Total $5,169,991.86 Staffing Product. For the three remaining types of deals we don’t have to work as hard to find it more likely than not that R&A was involved. They are all deals where R&A signed agreements with its clients in its own name. Each client in these deals received more specifically tailored services. And with these standalone deals it was the clients themselves who acted as officers of the entities involved. 15 We note that deposits in these accounts do not equal R&A’s fees, but only its gross receipts. These accounts and products were up and running before 2003 and may have accumulated money that was not debited until a later year. We find that the best way to track the flow of funds into R&A is to trace money as it left these entities’ accounts and moved into other accounts more directly linked to R&A, such as the law firm’s main accounts. - 22 [*22] The stand-alone staffing product is the first we’ll look at. It closely resembles the employee-leasing deals we’ve already described--indeed, there appears to be some overlap in the clients that used them. R&A’s staffing services generally looked something like this: ! R&A would create a corporation and file an S corporation election on its behalf; ! R&A would establish an ESOP to own the S corporation; and ! R&A’s clients would somehow transfer funds from their businesses to the ESOP-owned corporation. R&A sold these deals until 2011. Here’s a breakdown of the gross receipts stemming from the stand-alone staffing services: - 23 [*23] Account ending in (and years used) 0449 (2003) 3149 (2004-11) Gross receipts16 $2,378,539.05 $4,315,880.30 Number of fee payments 57 190 General Counsel Office (GCO). Ryder’s GCO deals were unusually creative. He created hundreds of new corporations, none of which had any existence except on paper, with the plan to draft them into a reserve army awaiting deployment in his clients’ battle against taxation. He came up with a uniform pattern--he had each S corporation’s board (of which he himself was the sole director) appoint him as vice president/general counsel, and R&A employee DeAun Castro as vice president/ESOP administration. Ryder then filed 2001 federal income tax returns as of December 31, 2001 for the corporations not yet assigned to a client. Every return reported gross receipts of $100 and expenses of $97. None reported owing any tax on the resulting $3 in taxable income. 16 We stress again that gross receipts do not equal R&A’s taxable income from these accounts, but merely show the money coming in from the product. R&A’s taxable income depends on when money left these accounts and where it ended up. Our work was hindered because deposit descriptions were missing for the account ending in 0449, so we could not be sure which deposits were specifically related to the staffing product. And this account has deposits from the factoring product as well. Still, the amount of money flowing into the account for just one year shows how much money was made from just two of R&A’s products. See infra pp. 53-64 for analysis of just what R&A’s income was from this product. - 24 [*24] Any R&A client who wanted in on this type of deal could learn about it once they bought into a GCO arrangement and signed an “Access Agreement.” The Access Agreement was basically the same as the letters of representation used for the staffing-company clients, but with different nomenclature. This agreement granted the clients access to one of R&A’s corporations and its related ESOP that R&A had sitting in its inventory. A client agreed in return to pay a percentage of his operating business’s revenue as a fee. This fee first flowed through the employee-leasing product into his assigned S corporation and then was pumped into his assigned ESOP. Each client also had to pay a $25,000 documentation fee to yet another Wyoming corporation, Prescient Planning, which Ryder had also formed not long after his incorporation-palooza in early 2001. In the original Access Agreements, GCO clients promised to pay all the fees that they owed directly to Prescient Planning. This product was fairly short lived because the IRS learned about such deals and made them a listed transaction.17 See Rev. Rul. 2003-6, 2003-1 C.B. 286. 17 A listed transaction is one that has been identified as a “tax avoidance transaction.” See sec. 6707A(c)(2). Taxpayers are required to disclose these transactions on their returns, and promoters of these transactions must register them with the IRS. Schwab v. Commissioner, 136 T.C. 120, 123 (2011), aff’d, 715 F.3d 1169 (9th Cir. 2013). - 25 [*25] Ryder and R&A responded with a revised Access Agreement. The changes weren’t small: ! Inclusion of a new section dealing with the creation of the general counsel office; ! A new section requiring the client’s S corporation to enter into an Agreement of Employment with Ryder for his services as the vice president/general counsel of the corporation; ! A new section requiring the client corporation to pay an annual budget for the general counsel office in the same percentage as the fee in the original agreement; ! A retitled section that revises “The Payment of Percentage Fees” to say “Funding of Annual Budget;” ! A retitled section that revises the “No Reduction of Percentage Fees” to say “No Reduction of Annual Budget;” and ! A new section dealing with the determination and negotiation of legal fees owed to Prescient Planning or R&A. Ryder summarized the changes best in his letter to a client: Please note that the Access Agreement has been revised to provide that the amount that otherwise would have been paid as Percentage Fees to Prescient will instead be budgeted to the Corporation’s new General Counsel’s Office. In this regard, I am designated as the Vice President/General Counsel of the corporation, and DeAun Castro is designated as Vice President/ESOP Administration. Ryder made one especially notable change--he backdated these new agreements, which he asked his clients to sign. These new agreements changed the way the - 26 [*26] GCO product received its gross receipts, with the torrents of cash flowing into either Prescient Planning or First Counsel Capital’s18 bank accounts, now relabeled “budget allotments.” The Commissioner determined, and we find, that these deals generated a total of more than $3.5 million. Short-Sale Strategy. The final product is one that is no stranger to our Court--the Son-of-Boss deal.19 See, e.g., BLAK Invs. v. Commissioner, 133 T.C. 431 (2009). Between 1998 and 2002, R&A sold its own Son-of-BOSS variation. Son-of-BOSS deals are infinitely flexible in the tax savings they promise. For taxpayers who have large capital gains on which they wish to pay no tax, such deals can be customized to produce offsetting capital losses in any amount. See 6611, Ltd. v. Commissioner, T.C. Memo. 2013-49, at *11. The fees R&A charged its clients for this product were held in two accounts--accounts ending in 9156 and 9214--titled “Ernest S. Rider, APLC, 18 19 See infra pp. 37-39. Son-of-BOSS deals were generally used to artificially inflate someone’s basis in a partnership interest by contributing assets with large contingent liabilities (which were ignored in computing basis) and then selling this interest at fair market value for a huge tax (but no economic) loss. See, e.g., RJT Invs. X v. Commissioner, 491 F.3d 732 (8th Cir. 2007) (involving typical Son-of-BOSS transaction); Kligfeld Holdings v. Commissioner, 128 T.C. 192 (2007). There are other variations. See, e.g., Home Concrete & Supply, LLC v. United States, 634 F.3d 249 (4th Cir. 2011), aff’d, 566 U.S. 478 (2012). We’ve never found a Son-of-BOSS transaction that worked. - 27 [*27] Attorney Trust Account,” and “Ernest S. Ryder & Assoc., Inc. Attorney Client Trust Account.” The total amount of fees from the product into each account is as follows: Method of determining gross income 9156 9214 Total fees deposited from 2003-201120 $698,696.58 $861,478.38 Commissioner’s determination of taxable withdrawals during 2003-201121 $1,140,959.76 $498,680.91 Summary of Fees. After going through each of the products sold by R&A, it’s useful to see the fee structure used for each one. The documentation fee was charged for the organizational paperwork and setting up clients with the appropriate bank accounts. The annual percentage fee was for use of the products, 20 These amounts reflect the deposits going into the accounts, and exclude nontaxable deposits. 21 The Commissioner determined income from the client trust fund accounts to R&A and the Ryders based on the final destination of debits and checks drawn on the accounts. He determined that the total amount of taxable income that left the account ending in 9156 was $1,140,959.76. The taxable income that left the account ending in 9214 was $498,680.91. We suspect that most of the money in these accounts was deposited before 2003. - 28 [*28] clients’ access to funds in certain accounts, and the ultimate tax benefit they gained. The percentage varied from product to product: Product Annual fee Fee classification ASIG 2% Characterized as “policy fee” and deposited into ASIG general account Group factoring 9% Characterized as “legal fee” and deposited into factoring company general or operating account Group leasing 6-8% Characterized as “retention fee” and deposited into leasing company general account Staffing 6-8% Percentage paid from staffing company to other R&A accounts and entities, such as ESOP Legal Consultants GCO 6-8% Characterized as a “budget” and deposited into 18 separate general counsel office accounts Short-sale strategy 6-2/3% Characterized as a contingent fee and deposited into designated attorney-client trust account B. What R&A Did With the Money 1. Practice Funding Agreement With BFA As difficult as it is to trace revenues from clients to R&A, it is even harder to follow the cash as it flowed to the Ryders themselves. Our difficulty begins with R&A’s own money management. Although R&A had no resources other than its “time, energy, and skill” when it opened, Ryder ensured this was not the - 29 [*29] case for long. He quickly entered into a “practice funding agreement” (PFA) with BFA, one of R&A’s own factoring companies, to get the startup cash it needed. This PFA took the form of a factoring agreement, in which R&A “sold” its accounts receivable and other contracts from the law practice in exchange for BFA’s agreement to provide funding as needed to R&A. R&A and BFA entered into these PFAs each year between 1996 and 2003. 2. Establishment of Ryder Law Corp. In 2002 R&A’s money management became even more convoluted. Ryder incorporated Ryder Law Corp. (RLC) as an S corporation in January of that year. The original articles of incorporation for RLC authorized the issuance of 100,000 shares of common stock and restricted ownership of any outstanding shares to employees of RLC or an ESOP. On the same day Ryder incorporated RLC, it executed a stock-subscription agreement with the “Ryder Law Corporation Employee Stock Ownership Plan and Trust” (RLC ESOP). Under this agreement, RLC ESOP bought 10,000 shares of RLC common stock for $1 a share, which made it the 100% owner of RLC. RLC ESOP then transferred these shares to something called the “Ryder Law Corporation Profit Sharing Plan and Trust” on October 16, 2003. That same day, Ryder and Bradley Ammon, another attorney at R&A, themselves bought stock in RLC through their own stock-subscription - 30 [*30] agreements. Ammon dropped out sometime later and by 2005, Ryder himself owned nearly all the shares. We tabulate all the twists and turns of RLC’s ownership from 2002-09: Shareholder 2002 2003 2004 2005-09 Ernest Ryder --- 10.38% 66.98% 98.59% RLC ESOP 100% 79.17% --- --- Bradley J. Ammon --- 10.38% 30.96% --- RLC Profit Sharing Plan and Trust --- 0.07% 2.06% 1.41% Ryder claimed that his intent in all this was for RLC to become the employee-staffing corporation for R&A. He testified that all of R&A’s employees moved from R&A to RLC, and that RLC then leased them back to R&A throughout all these years. But his testimony is the only evidence we have of this. Multiple employees credibly testified that they were employees of R&A. Neither they nor any other R&A employees had written employment agreements to show they were now RLC’s employees. All these employees still logged their time using R&A timeslips. The record does show that these employees received their W-2’s from RLC every year; but as far as the rest of the world could tell, nothing else changed for these employees. - 31 [*31] Ryder was trying to solve the same problem many owners of a profitable C corporation have--one layer of income tax at the corporate level, followed by another if it pays out its profits in the form of dividends. Ryder set himself to figuring out some way of moving R&A’s profits to RLC so he could take them as distributions from an S corporation.22 His solution was an unorthodox one--he told R&A’s bookkeeper, Amy Herauf, to make multiple adjusting journal entries23 to shift income from R&A to RLC. These adjusting journal entries would show R&A’s money going to Ryder in what he labeled “loans”--“loans” from one of the financial accounts of a group tax product or “loans” from R&A itself (and he would include in these “loans” money that went from R&A to pay Ryder’s or one of Ryder’s ranch’s credit-card 22 Ryder explained that distributions from S corporations aren’t considered income--and are therefore tax free--so long as the shareholder has basis and the distributions do not exceed that basis. (He’s right about this--section 1368 says so.) 23 An adjusting journal entry is “[a]n accounting entry made into a subsidiary ledger called the General journal to account for a period[’s] changes, omissions or other financial data required to be reported ‘in the books’ but not usually posted to the journals used for typical period transactions.” Accounting Terminology Guide, New York State Society of CPAs, https://www.nysscpa.org/professional-resources/accounting-terminology-guide#st hash.OMJATGaN.BomMsjPI.dpbs (last visited June 21, 2021). - 32 [*32] bills).24 At the end of the year, Ryder would meet with Herauf and R&A’s return preparer Don Lang to tell them on which accounts he wanted them to make these adjusting journal entries. If he wanted money earned from sales of a group product, then Herauf or Lang would record an asset in the form of a note receivable from Ryder himself on the books of whichever entity had cash that he wanted. They would also enter on that entity’s books an offsetting obligation to pay R&A for Ryder’s services as their attorney. The entity would transfer the note receivable due from Ryder to R&A to pay R&A’s attorney’s fees. The note on which Ryder was liable would be entered as an asset on R&A’s books. Remember though that Ryder had papered RLC to appear to sell employment services to R&A. R&A would pay for those services that it had supposedly bought by transferring the note to RLC. Ryder would distribute the note to himself from RLC. As the note was now in the hands of its putative maker, it went “poof” as a matter of tax law with no more tax consequence to Ryder than to someone who writes a check to himself on one account to deposit into another. 24 See infra pp. 161-63. - 33 [*33] At least that’s the position Ryder took--he did not report these notes as income on his individual returns. He explained that he did so because distributions from S corporations are not income unless they exceeded their owner’s basis, see supra note 22, and he treated each transfer from RLC as a nontaxable return of basis. Where did this basis come from? The basis Ryder claimed was from the series of stock-subscription notes that he had contributed. The initial stock-subscription agreement between Ryder and RLC for 150,000 shares at $10.105 per share was financed with promissory notes to RLC from Ryder in which he promised to pay more than $8,000 a month over 360 months. He signed a second stock-subscription agreement with RLC in May 2004 for 300,000 shares at the same price per share. He also financed that subscription with a promissory note. The same month he signed a third subscription agreement with RLC for another 100,000 shares at the same price and financed with a third promissory note. And finally in 2005 Ryder claims he bought Ammon’s 150,000 shares in RLC for $10,000 in cash and another note for almost $1.5 million. Here is a summary: Date RLC shares Amount Payment method 10/16/03 150,000 $1,515,750 Note 5/10/04 300,000 3,031,500 Note - 34 [*34] 5/12/04 100,000 1,010,500 Note 1/1/05 150,000 10,000 1,490,063 Cash Note Ryder claims that he made payments on these notes, but the Commissioner says that he did not and that what looked like payments were actually distributions from RLC that Ryder would lend back to RLC. There were more than 60 of these payments that volleyed back and forth between Ryder and RLC and totaled almost $2.6 million. II. Ryder Goes Ranching The revenues and cashflow of R&A and RLC may be baroque in their complexity. When we approach the Ryders’ ranches, they become rococo. Ryder himself views the country life as a welcome respite from the daily grind of his office life. He grew up on a ranch where he learned how to butcher, how to herd cattle, and how to farm. So we do find that the ranch life always appealed to him. During a road trip with his wife through southeast Arizona and southwest New Mexico, Ryder noticed for-sale signs on ranch properties and commented to Mrs. Ryder that “they were giving * * * the real estate away.” This led them to start buying ranches. On January 10, 2003, Ryder Ranch Co., LLC, filed its articles of organization, and the Ryders’ ranch life began. The - 35 [*35] ranches’ history includes a long list of filings, amendments, and amendments to amendments of LLC articles all done in an attempt to alter--or at least give the appearance of altering--their ownership. By the time we tried these cases, the Ryders had ended up with nine properties: Properties purchased Date purchased Cost Lazy BK Ranch 1/16/03 $355,000 Varnum property 10/8/08 325,000 Shumaker Farms 4/18/03 420,000 Boggs property 6/10/03 162,000 Moore property 2/16/05 537,500 Canyon View Ranch, LLC Rivers property 5/19/03 150,000 Ryder Red Rock Ranch, LLC Coon Ranch 4/28/03 650,000 Rodeo Holdings, LLC Gallery Building 3/15/06 70,000 Escarcega House 8/31/06 180,000 Ranch LLC Ryder Ranch Company, LLC Pattern Farms, LLC - 36 [*36] A. Sources of Money for Ranches 1. Counselor Capital as Blocker Entity for Ranches One of R&A’s “services provided” was to help its clients retrieve the money that they had put into one of the products. By “helping them retrieve their money,” we do not mean filling out withdrawal slips. We mean the more sophisticated service of shunting money through different accounts held by these entities, from which money could flow back to the clients as what looked like loans. Ryder called this type of account a “blocker entity”--Ryder’s term for an entity between a payor and payee that disguised the true flow of money, or that he used to “isolate the tax-exempt entity from being engaged [with] an unrelated trader.” Counselor Capital, for example, was a blocker entity used mainly by USFA clients. Money from clients would find its way into Counselor Capital’s bank account, and the clients would then “borrow” their own money from Counselor Capital. Ryder had access to these accounts, and used them to fund the ranch entities. Ryder booked this as an investment by Counselor Capital in another company called First Counsel Capital, which Ryder at least occasionally papered to look like it was part owner of Ryder Ranch Co., LLC. - 37 2. [*37] First Counsel Capital as Blocker Entity for Ranches To use First Counsel Capital as a blocker, Ryder had to adjust a number of different entities. He had, for example, filed articles of organization for Executive Placement Services - 106, LLC, with the Wyoming secretary of state in November 2002. These articles identified Executive Placement Services, Inc. (a Utah corporation) as the LLC’s manager. In September 2003 Ryder filed an amendment to substitute First Counsel Capital, LLC, a California LLC, as manager. Wyoming then dissolved Executive Placement Services - 106, LLC, for failure to file its annual report and pay tax, and the company stayed dissolved until April 2006. Notwithstanding this dissolution, Ryder filed a 2003 income-tax return for Executive Placement Services - 106, LLC, in October 2004. But that return listed the partnership as First Counsel Capital, LLC, with a Wyoming address. This seems to have anticipated another name change, because in April 2006 Ryder filed paperwork with the Wyoming secretary of state to change the name of Executive Placement Services - 106, LLC, to First Counsel Capital, LLC. This amendment also changed the managing member for the LLC to himself in his capacity as an attorney for R&A.25 Ryder had already opened a bank account for First Counsel 25 We note that this change to the managing member avoided First Counsel Capital, LLC, of Wyoming having as its managing member First Counsel Capital, (continued...) - 38 [*38] Capital, LLC (Wyoming), on October 20, 2003, almost three years before an LLC with that name existed. (Ryder Ranch Co., LLC, also filed its 2005 return showing one of its members as First Counsel Capital, LLC (Wyoming), before any LLC had that name.) That same month--April 2006--Ryder converted the Wyoming LLC to a C corporation: First Counsel Capital, Inc. With First Counsel Capital, Inc., incorporated and at least on paper sometimes owning an interest in Ryder Ranch, Ryder began to use it as a “blocker entity” to funnel money out into the ranches. This meant that he again decided to make adjusting journal entries to record money whose real origin lay in 18 GCO accounts, ESOP Legal Consultants, Inc., Counselor Capital, and group-leasing products as money that came from First Counsel Capital, Inc. These transfers were all opaque, and Ryder made them either through the “adjusting journal entry” process already described or through a slightly different “loan payable” method. In this second method, the initial journal entries would list as an asset on the group product’s balance sheet a receivable due for the amount of a loan from the ranch entity, and list as a liability on the ranch entity’s balance sheet a loan payable for the same amount. Ryder would adjust these entries at the end of the year. He 25 (...continued) LLC, of California. - 39 [*39] would adjust the group product’s books to show the loan receivable due from the ranch entity as an equity investment in First Counsel Capital, Inc. On the books for the ranch entity, he would reclassify the loan payable as a contribution by First Counsel Capital, Inc. On First Counsel Capital, Inc.’s books, the investment from the group product was recorded as a liability and the loan receivable due from the ranch entity was recorded as an asset. Then the loan receivable due from the ranch entity was canceled by reclassifying it as an investment in the ranch entity. 3. Use of Four Additional Blocker Entities Ryder expanded his use of “blocker entities” with four additional investment companies that he used to get money from R&A’s attorney-client trust account ending in 9156--the account he created to hold fees from clients who had bought the Son-of-BOSS short-sale product we’ve already described--out to the ranch entities. These four companies were: ! Turnour Investments, Inc.; ! Alster Investments, Inc.; ! MBSP Investments, Inc.; and ! Spanky Investments, Inc. - 40 [*40] Ryder filed the articles of incorporation for Turnour Investments, Inc., with Wyoming in November 2002; and for Alster Investments, Inc., MBSP Investments, Inc., and Spanky Investments, Inc., in December 2002. He listed R&A as the mailing address for each in the annual reports that each company filed. Once these companies were set up, Ryder made a series of transfers on December 24, 2002, from R&A’s attorney-client trust account ending in 9156 to accounts titled to these new companies. The first transfer was to a bank account titled “Spanky Investments, Inc.” for $75,000. The second was to a bank account titled “MBSP Investments, Inc.” for $900,000. The third was to a bank account titled “Alster Investments, Inc.” for $175,000. And the fourth was to a bank account titled “Turnour Investments, Inc.” for $205,000. Ryder produced stock certificates dated December 30, 2002, a week before trial that showed BFA as the registered holder of shares in each of these four companies. Here are the number of shares held by BFA in each: Investment company Shares issued Spanky Investments, Inc. 75,000 MBSP Investments, Inc. 900,000 Alster Investments, Inc. 175,000 Turnour Investments, Inc. 205,000 - 41 [*41] So for each dollar transferred into the accounts for the investment companies, BFA received one share. Ryder claims that the transfer of funds from the trust account to these investment companies reflected payments under the practice funding agreement between R&A and BFA that we’ve already described. The trust account held the fees earned by R&A through the short-sale strategy products. Under the funding agreement, BFA supposedly had the right to these fees, which made it the beneficial owner of the funds in the trust account. When Ryder moved the funds from this account to the companies, it was therefore BFA that received shares in each of them. Ryder claimed these were payments under the practice funding agreement. Once Ryder transferred these funds into the companies’ accounts, these four companies would send the money to the ranch entities and to Ryder Ranch Co., LLC, to fund the ranch activities. 4. RLC and Its Stock Subscription Agreement R&A used RLC and RLC’s ESOP as another way to get money out of the group products. Remember that when Ryder organized RLC he had RLC’s ESOP sign a stock subscription agreement to buy 10,000 shares of common stock and RLC ESOP nominally held 100% of the RLC shares. When Ryder and Ammon - 42 [*42] bought their interests in RLC, the 10,000 shares of RLC stock that RLC’s ESOP held were nominally transferred to the “RLC Profit Sharing Plan.” Ryder eventually went on to acquire nearly all of the shares of RLC. Distributions from RLC to Ryder were made through the adjusting journal entries already described. And once again, Ryder treated these payments from RLC as a nontaxable return of basis in an S corporation by claiming basis from the subscription notes he contributed to RLC. B. Ryder Ranch Co., LLC Properties On January 16, 2003, the Ryders bought the Lazy BK Ranch in Cochise County, Arizona. The price was $355,000, with a $100,000 downpayment and the remaining $255,000 financed by a loan. The Ryders put the property in the name of Ryder Ranch Co., LLC. Ryder Ranch Co., LLC, bought more Cochise County land from Terryl Varnum in October 2008. The price was $325,000, and a downpayment and closing costs of more than $126,000 went from Counselor Capital, Inc.’s bank account to Pioneer Title Agency. Ryder Ranch Co., LLC, used seller financing for the rest. - 43 [*43] C. Pattern Farms, LLC Ryder also organized Pattern Farms, LLC.26 He filed its articles of organization in January 2003 with the Arizona Corporation Commission and then, as with Ryder Ranch Co., LLC, drove it through a whirlwind of amendments and refilings. In April 2003 Pattern Farms, LLC, purchased two parcels of land in Cochise County from Weldon and Marjorie Shumaker. The price was $420,000, and the downpayment came from the Ryders’ personal account. Pattern Farms, LLC, got financing from the Shumakers and gave them a promissory note in which it promised to pay them $210,000 in two annual installments of $105,000 plus interest. When time came to send these payments, almost all the money went to the Shumakers from bank accounts titled “Alster Investments, Inc.” and “MBSP Investments, Inc.” In June 2003 Pattern bought two more parcels of land in Cochise County. The downpayment came from the Ryders’ personal account. The record shows at least one payment on the note came from an account titled MBSP Investments, Inc. 26 The name “Pattern Farms” is a portmanteau of the Ryders’ first names, Patricia and Ernest. - 44 [*44] In February 2005 Pattern bought four more properties in Cochise County. This purchase was also mostly seller-financed, and the money for it again did not come from the Ryders directly. This time the money came from an account for First Counsel Capital, LLC (Wyoming). D. Canyon View Ranch, LLC Ryder next formed Canyon View Ranch, LLC. He filed its articles of organization with the Arizona Corporation Commission on April 24, 2003, and followed up with the usual amendment shenanigans. On May 19, 2003, Canyon View Ranch, LLC, completed the purchase of two parcels of land in Cochise County, Arizona, from Edward Rivers. The contract price was $150,000, with additional closing costs of $421.50. Canyon View Ranch, LLC, gave Rivers a promissory note for $120,000 with an annual interest rate of 6%. A bank account titled “Turnour Investments, Inc.” also supplied $31,000 for this purchase. E. Ryder Red Rock Ranch, LLC Ryder also wanted to buy ranch land in New Mexico. He first organized a new entity, Ryder Red Rock Ranch, LLC, in April 2003, and then followed the same pattern as before. - 45 [*45] On April 28, 2003, Ryder Red Rock Ranch, LLC, completed its purchase of four parcels of land (property formerly known as Coon Ranch) in New Mexico’s Grant and Hidalgo Counties. The contract price was $650,000, with additional closing costs and state taxes of $1,811.55. Ten thousand dollars came from a bank account titled “MBSP Investments, Inc.” This same “MBSP Investments, Inc.” bank account also transferred $645,000 that we find more likely than not went to the Coons. Since these payments totaled more than the contract-plus-closing costs, Ryder Red Rock Ranch received a refund from the Hidalgo County Abstract Escrow Trust. F. Rodeo Holdings, LLC The last of Ryder’s real-estate LLCs is Rodeo Holdings, LLC. He didn’t organize Rodeo Holdings until February 2006. It bought two buildings in Hidalgo County, New Mexico. The first was the “Gallery Building.” The downpayment came from the Ryders’ personal bank account with the remainder from an account titled to ExecuPro. The second was the “Escarcega House.” A small part of the price came from the Ryders’ personal checking account with the rest from accounts titled ExecuPro and Westra Capital Management. - 46 [*46] III. A. Audit, Cashflow, and Trial Audit The IRS began a section 6700 investigation27 into R&A’s use of ESOPs on August 26, 2003, after someone noticed that the firm had applied to have more than 800 ESOPs qualified at the same time. Then, like antibodies swarming to an infection, two more investigations latched onto the promotional activities of Robert Pancheri and Karen Baker--former R&A employees whom Ryder had used to “manage” many of the different entities. These converged into a full-blown audit of the Ryders and his law firm. This überaudit spanned nearly a decade and expanded backward and forward to the Ryders’ 2002-11 and R&A’s 2005-09 tax years. When questioned by IRS agents, Ryder pleaded the Fifth and refused to answer any questions regarding the tax structures sold by his law firm. Ryder’s silence left the Commissioner with no choice but to use subpoenas and third-party interviews. Revenue Agent Huong Phan--the first revenue agent on this case-- 27 Section 6700 imposes a civil penalty for the promotion of abusive tax shelters. A section 6700 investigation “is conducted independently of, and without regard to, the determination on [an] income tax case,” see Internal Revenue Manual pt. 20.1.6.1.2(3) (July 8, 1999), and focuses only on whether the promoter/preparer is subject to penalties or an injunction for his involvement in abusive activities. - 47 [*47] issued over 30 summonses to various financial institutions and third parties--essentially any party that he was able to recognize. More investigations broke out. The California Franchise Tax Board executed a search warrant of R&A’s office in April 2010. The IRS then expanded its audit team to add Revenue Agent Joseph Haynes. He focused on identifying what payments and deposits had moved through all these entities and accounts. It was a staggering job--RA Haynes himself issued over 300 summonses to financial institutions and other third parties during the course of his investigation. He even had a summons served on the Franchise Tax Board to get access to the records that it had seized in its investigation. The Commissioner found a tangle of 560 financial accounts used by hundreds of entities created by Ryder through R&A. Ryder himself had signature authority over approximately two-thirds of these accounts; the fraction rises to nearly 95% if one includes accounts where Ryder’s employees had signature authority. RA Haynes also traced the flow of funds through R&A’s accounts to identify which were for the Ryders’ benefit. After this work was completed, RAs Haynes and Phan both analyzed the items going through the accounts to identify which accounts were used to collect R&A’s fees. And, finally, Revenue Agent Nistha Boyer--who took over the work of RA Phan after RA Phan changed roles within the IRS--completed a bank-deposit analysis - 48 [*48] (BDA) to identify R&A’s gross receipts. RA Boyer also determined that the Ryders were taking funds out of these accounts to pay personal expenses and linked these funds to R&A’s gross receipts. B. Cashflow 1. Following the Money We can begin with a general explanation of this complex analysis by the Commissioner’s revenue agents. Their work uncovered 41 of R&A’s financial accounts and 10 of the Ryders’. They identified and sorted the specific items of income deposited into these accounts, and then sorted the accounts into two “boxes”. The first contained the 41 R&A accounts. This is the law-firm box, and the agents determined that any money coming into that box was income of R&A. But if money just sloshed around from one account to another inside this box the agents didn’t count it as R&A income. We find that this is a generally reasonable way for us to identify R&A’s income. The second box held the Ryders’ personal accounts. When money came into this “personal box” from the law-firm box, or left the law-firm box to go to a third party for the benefit of Ryder or his family, the agents treated it as a distribution to Ryder, unless the money was already included in their reported - 49 [*49] income. Just as with the law-firm box, the Commissioner did not add to the Ryders’ income any deposits and withdrawals between accounts within the personal box. We also find this to be a generally reasonable way for us to identify the Ryders’ possibly taxable distributions. 2. Gross Income This bank-deposit analysis is the heart of these cases. And given the astonishing complexity of the cashflows in and out of the accounts, we next describe in some detail the links between R&A’s tax products and these accounts. ASIG. The ASIG product was the one that mocked up deferred compensation to look like disability-insurance policies. R&A would assign each client who bought these policies a policy number, draft a policy, and open a dedicated bank account for the client’s use. We find from the records we have that whenever a client filed for benefits under an ASIG policy, he would complete a claim package and pay a termination fee. This termination fee would show up as a deposit into the ASIG bank account ending in 5337. More money would leave these dedicated accounts twice a year and end up in the same account ending in 5337. Clients agreed that these transfers were Ryder’s legal fees for the services provided. R&A generated a total of more than $1.28 million in revenue through these ASIG deals. See supra pp. 14-15. - 50 [*50] This is not all the income that R&A earned from sales of ASIG policies. From 1998 through 2002, most of the money from ASIG deals bypassed R&A’s books and went to Ryder as “loans” whose repayment he owed to R&A. These “loans” would move from R&A to RLC and back to Ryder himself in 2005 through the adjusting journal entries already described. See supra pp. 31-34. From 2004 through 2010 R&A’s income from ASIG polices that went into the 5337 account totaled more than $1 million. A large share, $188,514, left the account by check to Morris Cottingham Corporate Services, Ltd., of the Turks and Caicos, and two checks went to Capital Mexicana, Ltd. Nearly all the remaining funds in the 5337 account were transferred in October 2010 to a bank account entitled “Execupro Specialty Services, Inc., ESOP Designated Roth Contribution Account.” This repaid two of R&A’s clients for advances they had made to Counselor Capital, Inc., from 2007 through 2010 that Ryder had used to fund the ranch entities. The next year, in September 2011, the 5337 account was drained of $61,000 that went to Counselor Capital, Inc., again as funds for Ryder’s use in his ranch entities. In total, the Commissioner traced $1,027,811.49 of the asserted $1,280,560 of ASIG income received from 2003 to 2011 directly to R&A, or indirectly to pay off the Counselor Capital, Inc.’s loan for the benefit of Ryder as stated above. We - 51 [*51] agree and find that this $1,027,811.49 is includable in R&A’s gross income for the years in which it was deposited. Group Factoring Products. R&A commingled the money it earned selling the group factoring product with its clients’ own funds within each of the product’s bank accounts. We can trace R&A’s earnings, however, because it labeled its fees for two of the companies it used--BFA and USFA--either dividends or fees. These “dividends” or fees moved out of the individual clients’ “collection accounts” each quarter into the products’ general bank accounts. From there, the funds moved--either directly or through BFA’s Division 101 bank account ending in 0449--into accounts owned by R&A or Ryder, or in some cases to third parties for their benefit. The Commissioner also mapped the fee flow to R&A from the other group-factoring entities that R&A created--Western Funding Group and WFG. This meant he included amounts from those products that ended up in R&A’s bank account or the BFA Division 101 account.28 The Commissioner determined the following amounts as income to R&A through the group factoring products: 28 WFG had an account of its own ending in 6874, but the Commissioner does not argue that deposits into that account became gross receipts of R&A until they were deposited into R&A’s own bank account. - 52 [*52] R&A gross income Year BFA (8497) USFA (4564 & 2653) Western Funding (2935) WFG (6874) 2003 -0- $626,740.57 -0- -0- 2004 $108,671.38 202,765.11 $29,176.18 -0- 2005 84,714.22 9,029.18 155,238.73 -0- 2006 61,286.74 7,512.98 136,721.37 -0- 2007 23,003.82 2,646.63 217,454.72 -0- 2008 19,910.03 825.36 10,760.97 $70,440.70 2009 -0- -0- -0- -0- 2010 78,878.91 -0- -0- -0- 2011 -0- -0- -0- -0- Total 376,465.10 849,519.83 549,351.97 70,440.70 Group Leasing Products. The commingling of R&A’s fees with clients’ money was an even bigger problem within the group leasing products. In the end, the problem was so severe that instead of figuring out R&A’s income from the money that entered the bank accounts of the leasing products,29 the Commissioner 29 These accounts were ExecuPro ESOP’s bank account ending in 8166; ExecuPro Specialty Services, Inc.’s bank accounts ending in 6170, 4604, 0517, and 7257; Executive Placement, Inc.’s bank account ending in 6670; Worldwide Career Management’s bank account ending in 4870; and Westra Capital Management’s bank account ending in 3209. There was also an account ending in 0392 in the name of ExecuPro Specialty Services, LP, that paid one check for $85 to BFA’s Division 101’s bank account ending in 0449 in 2008. Neither party (continued...) - 53 [*53] found income to R&A only when money left the leasing-product bank accounts and moved into one of R&A’s own bank accounts or a third-party bank account for the benefit of Ryder or R&A.30 The Commissioner determined that this product generated more than $5 million in revenue that should be included in R&A’s gross income. See supra p. 21. We agree with his determination. Stand-Alone Staffing Products. After the Commissioner began his section 6700 investigation, Ryder drew up an “Agreement of Assignment and Assumption” dated January 1, 2004, with which he tried to assign all of the income from R&A’s staffing product to ESOP Legal Consultants, Inc. The agreement says it was an assignment of R&A’s rights to income only for tax years 2004-06, but Ryder kept using ESOP Legal Consultants’ bank account ending in 3149 all the way up until 2011. In 2004 alone R&A moved more than $600,000 29 (...continued) explains the origin or function of ExecuPro Specialty Services, LP, or its relation to ExecuPro Specialty Services, Inc. With nothing else in the record to guide us, we will treat ExecuPro Specialty Services, LP, as part of ExecuPro Specialty Services, Inc. 30 We include as R&A’s income checks and direct transfers from the groupleasing product accounts into Ryder’s entities, to Ryder’s children, or for Ryder’s personal benefit. These include checks and transfers into the Ryders’ personal bank account ending in 4461; R&A’s bank account ending in 9815; BFA’s Division 101’s bank account ending in 0449; RLC’s bank account ending in 8168; Ryder Ranch Co., LLC’s bank account ending in 5695; and Pattern Farms, LLC’s bank account ending in 9446. - 54 [*54] into it. Deposits came from businesses such as “Pacific Management Company,” “McMahon Staffing, Inc.,” and “Sentry Funding, Inc.” R&A would then move this money from ESOP Legal Consultants’ bank account to accounts of RLC, R&A, the Ryders’ ranch entities, the Ryders themselves, and third parties likely for the benefit of R&A.31 Ryder did not object to any of the specific numbers in this part of the Commissioner’s analysis, and we find that they are more likely than not true. Here is a summary: 31 For example, payments were made to Seaside Accounting Solutions (f.k.a. Accounting by the Sea, Inc.), where Herauf, R&A’s bookkeeper, worked at the time. - 55 [*55] Year Deposits Debits Paid to whom 2004 $638,331.88 $623,218.70 RLC R&A Ernest Ryder Ryder Ranch Co., LLC Pattern Farms, LLC Canyon View Ranch, LLC Accounting by the Sea, Inc. Lippa Associates, Inc. Capital Analysts of San Diego, LLC Wyoming secretary of state Adams Wilshire Engraving Inc. Sungard Corbel, Inc. 2005 1,232,528.55 1,247,428.68 RLC R&A First Counsel Capital Accounting by the Sea, Inc./Seaside Accounting Solutions Osmundo Bernake Enhanced Accounting Software, Inc. ESOP to R&A ESOP to RLC State Bar of California - 56 [*56] 2006 1,178,622.52 1,178,169.85 ESOP to RLC ESOP to R&A Clear Visual Ink Lippa Associates, Inc. Capital Analysts of San Diego, LLC Canyon View Ranch, LLC Pattern Farms, LLC Ryder Ranch Co., LLC Ryder Red Rock Ranch, LLC Wachovia Bank State Bar of California Clear Verse, Inc. 2007 543,983.30 544,440.94 ESOP to RLC ESOP to R&A Capital Analysts of San Diego, LLC Clear Verse, Inc. State Bar of California 2008 78,660.56 78,741.90 Clear Verse, Inc. R&A 2009 376,993.02 377,054.30 Clear Verse, Inc. R&A RLC Westra Capital Management, Inc. State Bar of California 2010 306,958.29 364,680.47 R&A RLC Lang & Associates, Inc. Clear Verse, Inc. California secretary of state - 57 [*57] 2011 57,781.72 125.00 Total 4,413,859.84 4,413,859.84 Unknown General Counsel Office. The Commissioner’s BDA for the general counsel office deals reviewed the 18 GCO accounts and looked at the flow of money into and out of them during each of the years at issue. Each GCO client corporation had two accounts: one for an ESOP S corporation that the client controlled and a separate GCO account at Charles Schwab that R&A controlled. A client would move money from his operating business into his ESOP S corporation’s account. About once a year, he would make a transfer from the S corporation’s account into the GCO account at Charles Schwab. This made tracing revenue much easier, and the amounts transferred were tied to the sum of the documentation fee and annual percentage fee (computed as a percentage of the money the client moved into the ESOP S corporation) that R&A charged for its services. The amounts in these GCO accounts were eventually disbursed to one of Ryder’s “blocker” entities-either First Counsel Capital, LLC (Wyoming), or First Counsel Capital, Inc.--as described earlier. See supra pp. 36-38. The breakdown for each GCO client: - 58 [*58] Goldstein Law Corporation Year R&A gross receipts 2003 $105,758.80 2004 27,422.77 2005 -0- 2006 32,721.90 2007 64,123.14 2008 -0- 2009 -0- Total 230,026.61 Grampa’s Programming, Inc. Year R&A gross receipts 2003 $40,023.68 2004 30.00 2005 129,857.47 2006 -0- 2007 832.24 2008 4,514.73 2009 2,755.00 Total 178,013.12 - 59 [*59] Borrego Management Services, Inc. Year R&A gross receipts 2003 $100,000.00 2004 -0- 2005 254,696.11 2006 -0- 2007 150,000.00 2008 125,000.00 2009 125,064.35 Total 754,760.46 Vantage 1, Inc. Year R&A gross receipts 2003 $182,463.55 2004 -0- 2005 57,644.06 2006 23,617.13 2007 565.18 2008 4,452.25 2009 -0- Total 268,742.17 - 60 [*60] Western Head Investments, Inc. Year R&A gross receipts 2003 -0- 2004 -0- 2005 $57,644.06 2006 -0- 2007 5,450.00 2008 4,122.56 2009 738.99 Total 67,955.61 Bighorn 2, Inc. General Counsel Year R&A gross receipts 2003 -0- 2004 $47,363.68 2005 1,344.72 2006 1,752.47 2007 -0- 2008 100.22 2009 -0- Total 50,561.09 - 61 [*61] Orion 1, Inc. Year R&A gross receipts 2003 $29,444.87 2004 124,141.00 2005 -0- 2006 312,781.85 2007 -0- 2008 5,304.23 2009 -0- Total 471,671.95 Consultants 1, Inc. Year R&A gross receipts 2003 -0- 2004 $39,324.80 2005 37,116.84 2006 63,998.42 2007 -0- 2008 -0- 2009 -0- Total 140,440.06 - 62 [*62] Relativity, Inc. Year R&A gross receipts 2003 -0- 2004 $109,527.92 2005 -0- 2006 -0- 2007 -0- 2008 1,158.85 2009 -0- Total 110,686.77 Pacific Star 5, Inc. Year R&A gross receipts 2003 -0- 2004 -0- 2005 $22,047.12 2006 -0- 2007 -0- 2008 -0- 2009 -0- Total 22,047.12 - 63 [*63] Buena Ventura 1, Inc. Year R&A gross receipts 2003 $74,247.20 2004 3,767.51 2005 -0- 2006 -0- 2007 -0- 2008 -0- 2009 -0- Total 78,014.71 American Passion, Inc. Year R&A gross receipts 2003 -0- 2004 -0- 2005 -0- 2006 -0- 2007 -0- 2008 -0- 2009 -0- Total -0- - 64 [*64] Tornado Consulting, Inc. Year R&A gross receipts 2003 -0- 2004 -0- 2005 -0- 2006 -0- 2007 -0- 2008 $14,000.00 2009 5,500.00 Total 19,500.00 Edgewood Distributors & Management, Inc. Year R&A gross receipts 2003 $150,000.00 2004 70,000.00 2005 -0- 2006 1,642.28 2007 -0- 2008 240.00 2009 -0- Total 221,882.28 - 65 [*65] Regent 1, Inc. Year R&A gross receipts 2003 -0- 2004 -0- 2005 -0- 2006 $118,302.31 2007 50,000.00 2008 91,583.00 2009 25,000.00 Total 284,885.31 L.I.P. Investments, Inc. Year R&A gross receipts 2003 $36,094.69 2004 56,805.18 2005 82,665.29 2006 119,881.77 2007 -0- 2008 -0- 2009 -0- Total 295,446.93 - 66 [*66] Mani Padme Corporation Year R&A gross receipts 2003 $26,185.03 2004 25,021.81 2005 90,160.40 2006 89,669.00 2007 -0- 2008 -0- 2009 -0- Total 231,036.24 Carlsbad Components, Inc. Year R&A gross receipts 2003 $34,738.96 2004 49,031.84 2005 -0- 2006 39,312.23 2007 -0- 2008 -0- 2009 -0- Total 123,083.03 - 67 [*67] Son-of-BOSS. R&A used QuickBooks to keep track of the income from its short-sale strategy. Tracing the flow of money from these sales was difficult because R&A wasn’t entitled to its fee until its client had escaped IRS scrutiny long enough for the statute of limitations to have run, see infra p. 117-18. Much of R&A’s work on these deals was done before the years at issue, and the Commissioner says he can’t trace all the money that R&A earned from their sales. But he did manage to track a little over $2.8 million, which we find is includable in R&A’s income for the years at issue. We make findings on these flows of funds knowing that any navigation of the labyrinth of entities and accounts that Ryder built will necessarily be imperfect. Detecting, dissecting, and determining the links between these deposits and debits and their correct sources is complex. But the complexity, and hence any imperfection, was not only created by Ryder himself, but also aggravated by his lack of cooperation in organizing his firm’s records and his producing them sometimes only a very short time before trial. See Lawson v. Commissioner, T.C. Memo. 2015-211, at *25 (“In the light of the utter lack of cooperation from petitioners during the audit, RA Enriquez and respondent showed substantial and reasonable efforts in compiling the BDA and making sure the findings are correct”); see also Gleason v. Commissioner, T.C. Memo. 2011-154 - 68 [*68] (Commissioner entitled to any reasonable method to reconstruct income where taxpayer files no returns and refuses to cooperate). 3. “Other Deductions” for 2005-06 The Commissioner determined not only to increase R&A’s income but to disallow a very large number of deductions on R&A’s 2005 and 2006 tax returns. Ryder called these “client administrative services,” “legal and professional,” and “meals and entertainment.” The Commissioner claimed that R&A failed to establish its entitlement to the deductions. He also claimed that to the extent the deductions were for payments to RLC under the employee-leasing agreement, we should disallow them because that agreement was a sham. 4. Dividend Treatment Any determination about R&A’s gross income is only one part of the story. The Commissioner also wants us to decide how much income the Ryders themselves derived from the firm. He asserts that Ryder received almost $16 million in constructive dividends from R&A for 2003-11. These funds, he says, flowed to Ryder in three different ways: ! from R&A through RLC from 2003-09, ! from R&A’s several tax products to the ranch entities, and - 69 ! [*69] from R&A’s bank accounts to third parties for the Ryders’ benefit. i. From R&A Through RLC The Commissioner determined that the Ryders received nearly $8.3 million in dividend income from R&A through RLC. He reached this conclusion by poring through the K-1s that RLC issued to Ryder. He added up the money that RLC distributed, and excluded any circular flow of these funds.32 He included the “in-kind” distributions that RLC made to Ryder when Ryder liquidated ESR of Counsel, LLC, in 2004.33 ii. From Tax Products to Ranch Entities The Commissioner also traced the money that went from R&A into the various ranch entities that Ryder set up to buy land in Arizona and New Mexico. His first stab at the problem was RA Boyer’s analysis in which he added up the deposits from the accounts of the various tax products that went into the Ryders’ 32 Excluding the “circular flow of funds” was important because Ryder used adjusting journal entries to make it seem he was making payments on the notes that he gave to RLC to “pay” for the stock in RLC that he had signed subscription agreements for in 2003-05. See supra pp. 29-34. 33 ESR of Counsel, LLC, was a wholly owned subsidiary of RLC that Ryder created in 2002. Some of the revenue generated from the Son-of-BOSS product was diverted to ESR of Counsel and then passed on to R&A and the Ryders. When ESR of Counsel dissolved, its assets (primarily in the form of notes receivable) were assumed by RLC, which then distributed them to the Ryders. - 70 [*70] personal accounts, into accounts for the ranch entities, or to third parties (e.g., credit-card companies) to pay the Ryders’ personal bills. But then--only a week before the Phoenix part of the trial--Ryder finally produced the financials for Ryder Ranch Co., LLC. This information included records of contributions and loans that went into Ryder Ranch accounts. These were particularly helpful, says the Commissioner, because they showed the exact amounts that went into the different ranch entities, and so eliminated what might have been double-counting. Using these new financials and Ryder’s own testimony, the Commissioner adjusted his analysis of this form of dividend income. This new information helped him tweak the timing of transfers to Ryder Ranch to make sure that he counted it as income when it entered Ryder Ranch’s accounts. It also helped him avoid double counting income as money flowed from one account to another within the “personal box.” iii. From R&A’s Bank Accounts to Third Parties for the Ryders’ Benefit The Commissioner also treated as dividends those payments that R&A made to third parties for the benefit of the Ryders. For years before 2010, these payments were first run through RLC and recorded on its books and tax returns as distributions or advances. But whether from R&A directly or from R&A through - 71 [*71] RLC, these alleged dividends included payments to American Express for the Ryders’ credit-card bills and to their personal contractor. The specific bank accounts from which this money flowed were titled “Ernest S. Ryder A Professional Law Corporation,” “ESOP Legal Consultants, Inc.,” “Counselor Capital Inc.,” and “Westra Capital Management Retirement Savings Plan.” The Commissioner asserts that the nearly $400,000 that came from these accounts was traceable to R&A’s gross receipts and had not been booked as loans on Ryder Ranch Company’s financials. The Commissioner also asserts that Ryder used money from R&A to pay Ben Leland Construction, Inc., for work done on the Ryders’ home. He traced this money by matching amounts charged on invoices from the construction company with check numbers and amounts from various Ryder accounts. The accounts used to pay these invoices were “Counselor Capital, Inc.,” “Westra Capital Management, Inc. Retirement Savings Plan,” “Benefactor Funding Assoc., Inc.-General Account,” “ExecuPro Specialty Services, Inc.--General Account,” “Ryder Law Corp.,” and “Ernest S. Ryder & Associates, Inc., APLC.” And for tax years 2010 and 2011 the Commissioner found more than $400,000 in R&A fee income that went to pay Ben Leland Construction. These credit-card and contractor payments totaled $849,547.49. - 72 5. [*72] The Commissioner’s Alternative Arguments The Commissioner also asserted in the alternative that even if we don’t find that income flowed to Ryder from R&A, it certainly flowed from RLC to Ryder. The Commissioner then added up transfers from RLC that he said were income to Ryder: ! unreported distributions from RLC computed from the increase in Ryder’s distributive share for tax years 2005-09; ! unreported distributions from Westra Capital Management computed from the increase in Ryder’s distributive share for tax years 2005-07; ! an unreported short-term capital gain distribution from Westra Capital Management for 2005; ! unreported wages for 2009; ! unreported other income for 2004, 2010 and 2011; and ! unreported interest income from RLC.34 34 The Commissioner acknowledges that many of these alternative positions are already the subject of settlements or prior assessments. The Commissioner will have to abate any assessments as required to avoid double taxation. - 73 [*73] 6. Disallowed Deductions i. Substantiation of R&A Expenses Although much of the fight between Ryder and the Commissioner was about unreported income, the Commissioner also disallowed many of the deductions that Ryder and his various entities had claimed. These include: Year Disallowed deductions 2004 $579,330 2005 4,154,085 2006 167,243 2007 363,215 2008 661,361 2010 113,307 Total 6,038,541 2005 Investment Interest Expense. Ryder claimed a deduction for investment interest of nearly $350,000 on his Schedule A for 2005. The Commissioner disallowed this expense because Ryder reported it as a flowthrough expense from RLC, but RLC’s K-1 to him included no such amount. Ryder argues this was a mistake--he says the deduction was legit, but that he should have reported it on his Schedule E as “business interest” instead. - 74 [*74] 2006-08 Unreimbursed Employee Expenses. Ryder claimed “unreimbursed expenses” on his Forms 1040 for 2006 through 2008 of: Year Amount 2006 $167,133 2007 357,313 2008 588,836 Total 1,113,282 The Commissioner disallowed these for the same reason as the interest expense-Ryder claimed them as flowthrough expenses from RLC, but they were nowhere to be found on RLC’s own returns. Ryder now claims that these “unreimbursed employee expenses” were also really “business interest” that he should have reported on his Schedule E. 2004, 2005, and 2010 Ordinary Losses From RLC. The Commissioner disallowed large amounts of ordinary losses that Ryder claimed flowed through from RLC: Year Amount 2004 $579,330 2005 143,253 2010 113,307 Total 835,890 - 75 [*75] The Commissioner’s primary position is that Ryder failed to prove that he had enough basis in RLC to deduct these as ordinary losses. His backup argument is that RLC itself didn’t adequately prove that it suffered the losses that it passed through to Ryder. 2008 Prior-Year Adjustment Basis Carryover. Ryder claimed on his 2008 tax return that he had sufficient basis in RLC to claim a loss of more than $70,000 that he couldn’t claim earlier for failure to have enough basis. See supra note 22; see also sec. 1366(d). Uncontested Westra Capital Management Items. The Commissioner also asserted that Ryder had misreported several items from another of his passthrough entities, Westra Capital Management: ! a long-term capital loss of nearly $49 million for Westra Capital Management in 2005; ! a consequent long-term capital loss of $13 million for Ryder in 2005; ! long-term capital losses for Ryder of $108 in 2006 and $5,806 in 2007; and ! small ordinary losses for Ryder in 2005 through 2007 that totaled $2,778. - 76 [*76] Because Ryder did not contest any of these in his posttrial brief, we deem them conceded. See Mendes v. Commissioner, 121 T.C. 308, 312-13 (2003); Rybak v. Commissioner, 91 T.C. 524, 566 (1988). ii. Ryder Ranch Co., LLC Losses The Commissioner also disallowed losses claimed by the Ryders for Ryder Ranch Co., LLC. He questions whether the Ryders materially participated in the ranch business and whether that business substantiated certain expenses. Here is a summary of these contested losses: Reason for disallowance Sec. 162 (Lack of substantiation) Sec. 469 (Passive loss) Year Adjustment 2003 $531,583 X 2004 927,497 X 2005 1,054,725 X X 2006 979,454 X X 2007 575,878 X Material Participation. The Commissioner argues that any loss sustained by Ryder Ranch is passive because the Ryders failed to materially participate in its - 77 [*77] activities for the tax years.35 The ranches are in southeast Arizona and southwest New Mexico, and the Commissioner finds it hard to believe that the Ryders could be very active ranchers when they lived in Poway, California, and Ryder would drive out from R&A’s office in San Diego. He bolsters his argument with the observation that the Ryders employed an onsite manager to run them. That was Jacob Ward, who was the onsite manager from September 2004 to October 2009 and who oversaw the ranch operation. Ward credibly testified that he would see Ryder out at the ranches at least once a month while he was working there. Ryder claimed to keep an activity log that he produced a week before the Phoenix part of this trial. There was no testimony about how it was created, who created it, or when it was created. 35 The Commissioner’s presentation of this argument has been inconsistent over the lives of these cases. His notices of deficiency for the Ryders allege that they failed to materially participate in Ryder Ranch Co., LLC, only for tax years 2003, 2004, and 2007. His notice of final partnership administrative adjustment (FPAA) for Ryder Ranch Co., LLC, also makes this argument for 2005 and 2006. He maintains this argument for 2003, 2004, and 2007 in his opening brief, and raises it for the first time as to 2008-11, but makes no mention of 2005 or 2006. He also filed a motion to conform his pleadings so that we might consider the section 469 issue for 2008-11. While we denied that motion, we will consider the 469 issue for 2005 and 2006, as Ryder specifically responded to it in his answering brief, making it tried by consent. See Rule 41(b). - 78 [*78] Substantiation. The Commissioner issued an FPAA36 to Ryder as tax matters partner of Ryder Ranch Co., LLC, on December 20, 2011, for Ryder Ranch’s 2005 and 2006 tax years.37 In it he disallowed all farm losses. The Ryders argue that they can substantiate these deductions as ordinary and necessary. The dispute arises from two Schedules F, Profit or Loss From Farming, Ryder Ranch Co., LLC, attached to its 2005 Form 1065, U.S. Return of Partnership Income. One of these Schedules F reported a net loss of $967,551; the other a loss of $87,174. The first allocated to Ryder Ranch Co., LLC, the depreciation of Pattern Farms, LLC’s Boggs, Moore, and Shumaker properties; Canyon View Ranch, LLC’s Rivers property; and Ryder Ranch Co., LLC’s Lazy BK Ranch property. The second Schedule F allocated the deprecation related to 36 If the IRS decides to adjust any partnership items on a partnership return, it must notify the individual partners of the adjustments by issuing an FPAA. See sec. 6231(a). An FPAA generally includes: (1) a notice of final partnership administrative adjustment; (2) Form 870-PT, Agreement for Partnership Items and Partnership Level Determinations as to Penalties, Additions to Tax, and Additional Amounts, including a Schedule of Adjustments; and (3) a Form 886-A, Explanation of Items, listing the Commissioner’s other adjustments or determinations. 37 He also issued an FPAA for Ryder Ranch’s 2007 tax year in December, 2018, after the completion of the trial for these cases. That FPAA is not at issue here. - 79 [*79] Ryder Red Rock Ranch, LLC’s Coon Ranch property. The Schedules F also include depreciation expenses for multiple trailers and a portable chuckwagon. For the tax years 2005 and 2006, the Commissioner argues that Ryder Ranch Co., LLC, claimed expenses that were actually incurred by Ryder’s other ranch entities. He also argues that Ryder Ranch inflated the bases in many of the assets for which it claimed depreciation. 7. California Pasteleria The Ryders also claimed losses on Mrs. Ryder’s cookie business. During the years at issue she owned and operated California Pasteleria, Inc. She held all the stock of the company and all the officer positions in the business, except that Ryder himself was its counsel. The Commissioner disallowed deductions at the S corporation level for tax years 2003, 2004, and 2006. Only the first two years are still at issue, and all the trouble comes from California Pasteleria’s failure to substantiate many of its claimed deductions for items such as legal fees, automobile expenses, travel expenses, and telephone expenses.38 38 The Commissioner also determined that in the 2006 tax year, Mrs. Ryder received a $36,300 distribution in excess of her basis in the company. The Ryders did report on their 2006 Schedule D a $2,777 gain on repayment of a loan from California Pasteleria, so the Commissioner asserted the difference of $33,523 as (continued...) - 80 8. [*80] Other Losses There are also numerous other miscellaneous loss issues. The Commissioner disallowed them in full: Year Ryder Alpha Dog Investment Management Partners losses losses Net operating losses Coventry Motors losses Total 2002 -0- -0- $272,644 -0- $272,644 2003 -0- -0- 134,400 -0- 134,400 2005 -0- -0- -0- $2,819 2,819 2006 $15,995 -0- -0- 3,402 19,397 2007 39,221 $3,597 -0- 7,138 49,956 2008 3,726 -0- -0- -0- 3,726 2010 -0- -0- 148,368 -0- 148,368 2011 -0- -0- 311,917 -0- 311,917 Alpha Dog Management Losses. Alpha Dog Management, LLC, is a limited liability company that Ryder organized in Wyoming. He reported nonpassive losses from the company for the tax years 2006 through 2008. The Commissioner disallowed all of these because Ryder didn’t explain how he computed his basis. 38 (...continued) unreported income. The Ryders agree that they are liable for tax on the distributions from California Pasteleria to the extent that they exceed their basis, but then they failed to defend that basis. We deem this a concession. See Mendes, 121 T.C. at 312-13; Rybak, 91 T.C. at 566. - 81 [*81] Ryder Investment Partners Losses. Ryder claimed a carryforward loss from Ryder Investment Partners, Ltd., on his 2007 return that the Commissioner disallowed because Ryder hadn’t substantiated his basis. Net Operating Losses for 2002, 2003, 2010, and 2011. These losses depended on proof of losses from other tax years: The Ryders’ claimed loss for 2002 depended on a carryforward loss from 1997 and a carryback loss from 2004. This 2003 loss depended on the carryback loss from 2004 as well. And their 2010 and 2011 losses depended on carryforward losses as well. The Commissioner disallowed them all for lack of substantiation. Coventry Motors Losses. Ryder claimed passthrough losses from Coventry Motors, Ltd., a partnership that he created to own his collection of classic cars. These were relatively small. The Commissioner disallowed them for three reasons: ! lack of profit motive under section 183, ! lack of substantiation of his basis in the partnership, and ! absence of enough passive income to claim them under section 469. This meticulousness just earned the Commissioner a pretrial motion to dismiss for lack of jurisdiction because Ryder argued that TEFRA applied to any examination of Coventry Motors. He argued that the Commissioner needed to - 82 [*82] challenge its reporting in a separate partnership-level proceeding.39 Precedent forced us (and the Commissioner conceded that it was appropriate) to grant Ryder’s motion as to whether Coventry Motors lacked a profit motive, see GAF Corp. & Subs. v. Commissioner, 114 T.C. 519, 527-28 (2000); cf. Ginsburg v. Commissioner, 127 T.C. 75, 83 (2006), but we kept the other two issues for trial in these cases. Ryder put all of these disallowed deductions at issue, but then failed to address them in his posttrial brief. We deem this a concession. See Mendes, 121 T.C. at 312-13; Rybak, 91 T.C. at 566. C. Penalties Also still at issue in these cases is the liability of R&A and the Ryders for numerous penalties and additions to tax. These are: ! 39 section 6651(a)(1) additions to tax for failure to timely file, Before its repeal, see Bipartisan Budget Act of 2015, Pub. L. No. 114-74, sec. 1101(a), 129 Stat. at 625, part of the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), Pub. L. No. 97-248, secs. 401-407, 96 Stat. at 648-671, governed the tax treatment and audit procedures for many partnerships. TEFRA partnerships are subject to special tax and audit rules. See secs. 6221-6234. TEFRA requires the uniform treatment of all “partnership item[s]”--a term defined by section 6231(a)(3)--and its general goal is to have a single point of adjustment for the IRS rather than having it make separate partnership-item adjustments on each partner’s individual return. See H.R. Conf. Rept. No. 97-760, at 599-601 (1982), 1982-2 C.B. 600, 662-63. - 83 [*83] ! section 6651(a)(2) additions to tax for failure to timely pay, ! section 6651(f) penalties for fraudulent failure to file, ! section 6655 penalties for failure to pay estimated corporate income tax, and ! section 6662 accuracy-related penalties. The Commissioner asserted some of these against only R&A, and some against only the Ryders; he asserted some only for some years and not others; and some he asserted only in the alternative. And, as is common, some we have to discuss on their merits and some we do not because of procedural flubs. D. Trial The Ryders filed timely petitions, and we tried the cases in two sessions over two months.40 The record sprawled over 8 million pages. At trial the Commissioner introduced two BDAs by RA Boyer. These BDAs are what the Commissioner relies on for his positions on his adjustments to gross receipts and unreported dividends. As we have mentioned, the Commissioner did tweak these analyses a bit as Ryder produced more information. 40 At all relevant times, petitioners either resided or had their principal places of business in California or Arizona, which makes the decisions in these cases presumptively appealable to the Ninth Circuit. See sec. 7482(b)(1)(A), (B), (E). - 84 [*84] The parties conceded a number of issues, but two very large adjustments remain: unreported gross receipts from R&A for 2005 through 2009 and unreported dividend income to the Ryders for 2003 through 2011. We’ll tackle those first and then run through a number of the unsettled miscellaneous issues. OPINION I. Burden of Proof The parties bicker about the burden of proof, but with more than 8 million pages of evidence and 2,300 pages of transcript we can decide almost all the issues on the preponderance of the evidence. One exception is the issue of fraud--section 7454 and Rule 142(b) require the Commissioner to prove fraud by clear and convincing evidence. We note Ryder’s attacks on the presumption of correctness that we’ve said attaches to the Commissioner’s notices of deficiency and bank-deposit analyses. We don’t need to rule on these objections--the profusion of evidence, which for the BDAs includes credible testimony from the revenue agents who compiled those analyses together with their source material--makes them moot. We do note that these cases pose questions of unreported income, and the Ninth Circuit has held that in such cases the Commissioner must establish some connection between a taxpayer and income-producing activities. See Weimerskirch v. Commissioner, - 85 [*85] 596 F.2d 358, 362 (9th Cir. 1979), rev’g 67 T.C. 672 (1977). A “minimal evidentiary foundation” is all that is required. See id. at 361. The Commissioner’s introduction of volumes of evidence--which he aptly referred to as “buckets”--and the extensive backup to his BDAs show much more than a minimal evidentiary foundation to link Ryder and R&A to this income. We also note our ever more elaborate rules on the burden of production for penalties. Section 7491(c) places this burden on the Commissioner for penalties that he asserts against individuals. We held in Graev v. Commissioner (Graev III), 149 T.C. 485 (2017), supplementing and overruling in part 147 T.C. 460 (2016), that this means the Commissioner has to produce evidence that “the initial determination of such assessment [i.e., of the penalties] [wa]s personally approved (in writing) by the immediate supervisor of the individual making such determination.” See id. at 492-93. Section 6751(b)(2) excepts certain penalties from this written supervisory approval requirement--including those under sections 6651, 6654, and 6655. - 86 [*86] II. R&A’s Unreported Income41 The Commissioner alleges that R&A massively underreported its income for tax years 2005-09 by assigning income to other entities42 and taking very large and unsupportable deductions from what income it did report. His key proof is the BDAs, which start by equating deposits with income, but then subtract any identifiable nontaxable items, deductible expenses, or income that was reported. See Clayton v. Commissioner, 102 T.C. 632, 645-46 (1994). The Commissioner also introduced evidence that some specific R&A deposits into R&A’s accounts were taxable income. That leaves us with a mix of specific-item and bank-deposit analyses--specific-items analyses on 5 accounts 41 Some of the income that the Commissioner alleges is properly reportable by R&A has been attributed to certain entities by way of concessions, settlements, and prior assessments. The Commissioner has agreed to abate assessments on conceding entities to the extent the Court finds the income in question to be R&A’s. See supra note 34. 42 As we explain below, the Commissioner also argues that these entities were actually just tax products that R&A sold to its clients. Whether the entities were “shams” or were in fact legitimate but simply did nothing to earn fees that were properly attributable to R&A is of little consequence, as “the effect would be to render [the entities] a nullity for Federal income tax purposes.” See Keller v. Commissioner, 77 T.C. 1014, 1031 (1981), aff’d 723 F.2d 58 (10th Cir. 1983). Moreover, it isn’t necessary to find that the entities were shams in order to find that they generated income for R&A. See Haag v. Commissioner, 88 T.C. 604, 611 (1987), aff’d without published opinion, 855 F.2d 855 (8th Cir. 1988). - 87 [*87] used by Ryder and R&A, and bank-deposit analyses on 46 accounts used by Ryder and R&A. Here’s a summary of the combined results: Year Per return Per Commissioner Adjustment 2005 $1,571,286 $4,511,331 $2,940,045 2006 1,666,810 3,718,435 2,051,625 2007 -0- 2,635,675 2,635,675 2008 -0- 2,108,466 2,108,466 2009 -0- 1,823,833 1,823,833 Total 3,238,096 14,797,740 11,559,644 R&A failed to file returns for 2007 through 2009. The Commissioner prepared a substitute for return for each of these years under section 6020(b). Ryder later gave RA Phan returns for R&A’s 2007 and 2008 tax years. These were very late, and we note that the gross receipts reported were not subtracted from the BDAs for those years. (They weren’t added to them either.) A. Assignment of Income by Ryder & Associates We ask first whether it is R&A that should be taxed on the money that went into these accounts. The problem is one of the oldest in tax law, and every last - 88 [*88] student in Intro Tax learns that it was solved long ago by Justice Holmes in Lucas v. Earl, 281 U.S. 111, 114-15 (1930):43 There is no doubt that the statute could tax salaries to those who earned them and provide that the tax could not be escaped by anticipatory arrangements and contracts however skilfully devised to prevent the salary when paid from vesting even for a second in the man who earned it. That seems to us the import of the statute before us and we think that no distinction can be taken according to the motives leading to the arrangement by which the fruits are attributed to a different tree from that on which they grew. This “trees and fruits” metaphor has long since ripened into cliche, but it is still generally thought to be an accurate statement of the law. Income should be taxed 43 There is no evidence that the contract analyzed in Earl was motivated by the income tax, since the Earls agreed to it twelve years before the adoption of the Sixteenth Amendment. And, since they were Californians, Mrs. Earl would have had an interest in any after-acquired property and income under that state’s community-property law. When the Earls came before our predecessor, the Board of Tax Appeals, they argued that their only intent was to take all their income and property out of the community-property rules. Earl v. Commissioner, 10 B.T.A. 723, 724 (1928), rev’d, 30 F.2d 898 (9th Cir. 1929), rev’d, 281 U.S. 111 (1930). Then, as now, California makes the community-property rules a default, but one that a married couple can agree between themselves to supplant to make their future income and property separately owned or owned as joint tenants with the right of survivorship. See In re Marriage of Valli, 324 P.3d 274, 276 (Cal. 2014). Mr. Earl testified before us that back in 1901 he had taken ill, and the agreement was a simple and elegant way of planning for his estate. Earl, 10 B.T.A. at 723. Had Mr. Earl died, and courts respected their agreement, Mrs. Earl would have had ownership of all their property without any need for probate. Nowadays that’s a result people achieve (in part) with revocable trusts. The story was unearthed and described in detail in Patricia A. Cain, “The Story of Earl: How Echoes (and Metaphors) from the Past Continue to Shape the Assignment of Income Doctrine,” in Tax Stories 305 (Paul L. Caron ed., 2d ed. 2009). - 89 [*89] to him who earns it, see Commissioner v. Banks, 543 U.S. 426, 433 (2005), and one can’t escape tax by assigning income to another in advance, see id.; see also United States v. Basye, 410 U.S. 441, 449-52 (1973) (partnership members cannot avoid taxation by diverting income to retirement trust fund); Commissioner v. Sunnen, 333 U.S. 591, 604 (1948); Trousdale v. Commissioner, 16 T.C. 1056, 1065 (1951) (“[I]t has long been held that a taxpayer may not avoid his tax liability on income which he has earned by the simple expedient of drawing up legal papers and assigning that income to others”), aff’d, 219 F.2d 563 (9th Cir. 1955). Ryder agrees with this general statement of law, but argues that he carefully planted a great many trees in his orchard and that fruit actually grew on them. Or to dispense with the metaphor, that we should find that the many, many separate entities he created earned that income themselves. Ryder contends we must respect these separate entities under Moline Props., Inc. v. Commissioner, 319 U.S. 436, 438-39 (1943), in which the Supreme Court held: The doctrine of corporate entity fills a useful purpose in business life. Whether the purpose be to gain an advantage under the law of the state of incorporation or to avoid or to comply with the demands of creditors or to serve the creator’s personal or undisclosed convenience, so long as that purpose is the equivalent of business activity or is followed by the carrying on of business by the corporation, the corporation remains a separate taxable entity. - 90 [*90] Ryder argues that it was these entities that earned and received the income found by the Commissioner’s revenue agents, and that R&A was just their lawyer. Although the Commissioner failed to do so himself, we must also acknowledge the statutory avenue generally available in certain situations to reallocate income among taxpayers. Section 482 provides in relevant part that: In any case of two or more organizations, trades, or businesses (whether or not incorporated, whether or not organized in the United States, and whether or not affiliated) owned or controlled directly or indirectly by the same interests, the Secretary may distribute, apportion, or allocate gross income, deductions, credits, or allowances between or among such organizations, trades, or businesses, if he determines that such distribution, apportionment, or allocation is necessary in order to prevent evasion of taxes or clearly to reflect the income of any of such organizations, trades, or businesses. The common-law assignment-of-income doctrine and section 482 overlap considerably, as the latter was devised to provide a “detailed mechanism to deal with the tax-avoidance problems which spur the assignment of income doctrine.” Keller v. Commissioner, 77 T.C. 1014, 1034 (1981), aff’d, 723 F.2d 58 (10th Cir. 1983); cf. Stewart v. Commissioner, 43 T.C.M. (CCH) 1119, 1124 n.10 (1982), aff’d, 714 F.2d 977 (9th Cir. 1983). Analysis under the two theories, therefore, should generally not lead to different results. Keller, 77 T.C. at 1034. Transactions vulnerable to attack under one theory are generally equally - 91 [*91] vulnerable under the other, and both theories are typically invoked together.44 Cf. Boris I. Bittker, “Pervasive Judicial Doctrines in the Construction of the Internal Revenue Code,” 21 How. L.J. 693, 709 (1978). Despite these similarities, some courts have held that section 482 is the better tool to reallocate income among taxpayers, at least in circumstances not “heavily freighted with tax motives.” See Rubin v. Commissioner, 429 F.2d 650, 653 (2d Cir. 1970), rev’g and remanding 51 T.C. 251 (1968); see also Foglesong v. Commissioner, 621 F.2d 865, 872 (7th Cir. 1980), rev’g and remanding T.C. Memo. 1976-294. But choosing between these two tools is not something we must do here, because the Commissioner left section 482 in the shed by failing to mention it in any of his relevant notices of deficiency, pleadings, memoranda, or briefs--and the Ryders did not object. The Ninth Circuit has held that “no reliance may be placed on Section 482 to justify a decision [when] the Commissioner did not rely upon it and g[a]ve no notice of such issues in his Notice of Deficiency to [the taxpayer].” Maxwell Hardware Co. v. Commissioner, 343 F.2d 713, 721 (9th Cir. 1965). 44 There is one situation where section 482 cannot be invoked but the common-law method can, i.e., “where the transaction at issue was not between two or more ‘organizations, trades, or businesses’ within the meaning of the provision.” Stewart, 714 F.2d at 989 (citing Foglesong v. Commissioner, 691 F.2d 848 (7th Cir. 1982)). - 92 [*92] Therefore our analysis has to stick to the common-law assignment-ofincome doctrine. This is a new battle in an old fight, and to referee it we must decide if R&A was the true earner of this income. To do so, we look at how R&A’s clients perceived the services that R&A provided, what these services actually were, and how the income was produced. 1. What R&A Looked Like to Clients From the time it opened its doors, R&A marketed tax-saving products to potential clients. R&A hired employees specifically to promote its products to high-income earners and their CPAs. It was R&A’s name that was on the promotional materials and letters to prospective clients--brochures, videos, and written legal opinions about the tax benefits that they could obtain. Ryder himself would meet with clients to discuss these services, and he himself would follow up with letters to explain these plans and their proposed costs. The clients all appeared on paper to be doing business with one of the different group products. There were, however, always side agreements between the clients and R&A that were almost all oral--at least for these group products. There were written fee agreements, but these were signed by a client and a groupproduct entity that R&A controlled and which R&A used to execute the unique tax - 93 [*93] plan. We specifically find that the clients themselves thought they were hiring R&A to provide retirement plans. For example, Michael Goldstein, a GCO plan client of R&A, credibly testified that he went to see Ryder “for some advice as far as retirement planning” and Ryder ended up providing him “attorney services in that regard.” Kevin Windham, an ASIG client of R&A, testified that the fees he paid to Ryder were part of his retirement plan. Ryder stated that these products were established to create alternative ways for clients to accumulate retirement savings. R&A itself invented these group products and made them run. R&A itself marketed the services to set them up. R&A employees billed clients, and R&A employees controlled the clients’ accounts. As far as the clients knew, they were only ever working directly with R&A. 2. What Services R&A Provided We also looked at these deals from R&A’s perspective. And from this perspective, one sees R&A itself putting into place the “ancillary affiliated businesses” that it used to execute the different “unique tax plans.” It was R&A that created the numerous corporations, partnerships, and limited liability companies that these tax plans required. It was R&A that filed the necessary paperwork with the IRS to elect how these entities would be taxed. Once the structures were in place, it was R&A that went out to find the clients to buy them. - 94 [*94] Ryder argues that each of these ancillary affiliated businesses is an entity unto itself that we must respect. We think this confuses the concept of respect for the corporate form and the concept that income is taxed to the one who earns it. Ryder says that each of these corporations was actively engaged in a trade or business and earned its own income through this trade or business. In his view, R&A merely provided legal and administrative services to these ancillary businesses, but those businesses themselves got paid for services they provided. The Commissioner says that these ancillary businesses just mimicked legitimate business activities to create the illusion that the tax products R&A sold were real businesses. And here we make a key finding and extend the usual metaphor a bit more: R&A was less like the orchardist who plants the seeds of trees and then steps back to watch them grow than it was like a set designer who built a papier-mâché forest and painted it to look like real trees. R&A never stopped tinkering with these entities. It continually filed paperwork with the IRS or state agencies as needed. It drafted additional documents for its clients to connect accounts and entities to justify the movement of funds into each account. It helped clients move money within the various accounts and entities. And it reviewed the clients’ tax returns - 95 [*95] for consistency with appearances and to handle any audit that arose regarding these accounts. We find from this consistent practice that R&A was selling retirementplanning services. R&A directly advertised these special tax structures to set up these retirement plans. R&A employees at the office of R&A did the work necessary to operate and maintain them--which included acting as administrator of the entities and monitoring laws to ensure that the plans adhered to any requirements. Ryder and R&A employees held signature authority over the financial accounts of the retirement products. Ryder maintained authority over employees and agents that held positions with the tax structure entities.45 The fingerprints of R&A can be found all over the services that were provided to the clients. We therefore find that R&A was the one actually providing the services. 3. Income Produced Through These Services Without once again going into great detail, we can say that clients that purchased tax products got access to bank accounts set up by R&A in the name of one of the tax products, while R&A made sure the paperwork was done and the cash flowed from the client’s operating business into the entity’s account with a 45 Ryder, for example, hired and then fired Robert Pancheri--his own brother-in-law--who Ryder claimed was president of many of the factoring entities. - 96 [*96] portion sent on to itself or one of the entities that it controlled. R&A strove to make the entities look real--to look like a group insurance company, a corporate factor, an executive-leasing company, or a staffing company. These entities would report income from their dealings, but then pass it on to tax-exempt entities that R&A also set up. We can take a closer look at how R&A did this. i. Group Tax Products Income R&A set up these products--ASIG insurance policies, factor companies, and employee-leasing firms--to run through master entities that controlled the financial accounts associated with them according to written agreements entered into with their clients. But these written fee agreements between clients and the master entities that R&A created and controlled to run the tax products were not in fact promises to pay for services provided by those entities. We instead find that, for each product, the real agreements were those entered into orally between R&A and its clients to provide what the clients understood to be tax or retirement-planning services. We can hardly find otherwise. The first move for clients who bought these group products was to move money into an account held by the master entity for that particular group product. This wasn’t an account for the entity’s own use in - 97 [*97] its own business. It was just a collection account for each product. It was R&A that kept these accounts and R&A employees who had signature authority over them. ASIG Product. R&A’s fingerprints were all over the ASIG product from the beginning. It was R&A that aggressively marketed these policies. As far as its clients knew, they were only ever working directly with R&A. But once a client agreed to buy an ASIG policy, R&A’s staff faxed a copy of the paperwork to Morris Cottingham to sign, and one would search in vain to see any mention of R&A on the policy itself. Clients nevertheless knew that if any problems arose with the policies, they should call R&A to work it out. It was also R&A’s employees who billed the clients, controlled their ASIG accounts, and made sure fees were paid. These fees were “calculated twice a year [at] 1% of the total bank balance + the loan balances,” and R&A would work with Morris Cottingham to make sure they were collected. Even this was done in a roundabout way: R&A sent form letters of authorization on its letterhead to Morris Cottingham for its signature. Morris Cottingham would send the letters back to R&A, which would fax the letters to Charles Schwab. Charles Schwab would then move money from the account nominally in ASIG’s name (but segregated in an account for the client’s benefit) to a different Schwab account - 98 [*98] ending in 5337.46 This “ASIG” account was in Ryder’s name. The invoices sent to these clients were on ASIG letterhead but were prepared by R&A, which we know because we can trace the computer tagline found in the bottom left corner of the invoices back to R&A. And someone at R&A kept a record of the policy fees from the ASIG clients, sometimes with a notation which read “pymt bypassed [R&A’s] books.” The paperwork between client and ASIG stated that these “policy fees” were to reimburse ASIG for its costs and services, as well as to allow it to “profit thereon.” But we find that ASIG itself did nothing for this. It was all for the work done by R&A and its employees. See Roubik v. Commissioner, 53 T.C. 365, 37981 (1969); Trousdale, 16 T.C. at 1065. We therefore find that this was R&A fee income. Group Factoring Product. We found in Pacific Management Group v. Commissioner, at *17-*18, that the group-factoring entities didn’t work for R&A’s clients. Now we have to see whether they produced income for R&A. These deals on paper were between a separate factoring company and one of R&A’s clients. But let’s look first at who marketed them. It certainly wasn’t a 46 These segregated accounts held in the policies’ names were in reality just tax-deferred and tax-deductible piggy banks for the clients. - 99 [*99] factoring company. R&A itself hired Patrick Scott McKee to market group factoring to potential buyers through CPAs. McKee distributed informational materials on the products, including videos and an R&A tax opinion, and offered to arrange meetings with Ryder if any CPAs or their clients had unanswered questions. For the group factoring product in all its different generations, R&A created the entities to use as general collection accounts. Again, these accounts were titled to BFA, USFA, Western Funding, and WFG. But R&A owned and controlled each of them. A common element in all of these “generations” was a paper trail that made it look like there was a real factoring contract [Text truncated at 120,000 characters. The full text is on the page linked above.] --- Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/agency%3Atax-court%3A9582f5f89873f884. Public record. Not legal advice.