UNITED STATES TAX COURT
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T.C. Memo. 1998-127
UNITED STATES TAX COURT
CHEN C.AND VICTORIA R. WANG, ET AL.,1 Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 10511-94, 10512-94,
19176-94, 19177-94,
3857-95, 3858-95.
Filed March 31, 1998.
Martin A. Schainbaum, for petitioners.
David B. Porter (specially recognized), for petitioners.
Patricia A. Golembiewski and Thomas G. Schleier, for
respondent.
1
Cases of the following petitioners are consolidated herewith: EIC Group, Inc. and Subsidiary, docket No. 10512-94; EIC
Group, Inc. and Subsidiaries, docket No. 19176-94; Chen C. and
Victoria R. Wang, docket No. 19177-94; Chen C. and Victoria R.
Wang, docket No. 3857-95; and EIC Group, Inc. and Subsidiaries,
docket No. 3858-95.
- 2 MEMORANDUM FINDINGS OF FACT AND OPINION
FAY, Judge:
These consolidated cases involve the following
determinations by respondent of deficiencies in, and penalties on
petitioners' Federal income taxes:
Docket Nos. 10511-94, 19177-94, 3857-95
Chen C. & Victoria R. Wang
Penalty
Year
Deficiency
Sec.
6662(a)
1989
1990
1991
$76,529
398,475
7,309
$15,306
79,695
1,461
Docket Nos. 10512-94, 19176-94, 3858-95
EIC Group, Inc. and Subsidiaries
Penalty
Year
Deficiency
Sec.
6662(a)
1989
1990
1991
1992
$5,469,221
1,919,053
977,776
1,171,312
$1,093,844
383,811
195,555
234,262
All section references are to the Internal Revenue Code in
effect for the taxable years in issue, and all Rule references
are to the Tax Court Rules of Practice and Procedure, unless
otherwise indicated.
These cases were consolidated for trial, briefing, and
opinion.
Prior to trial, the parties settled a number of
- 3 issues.2
As a result, the deficiencies now asserted by
respondent have been reduced from those set forth in the notices
of deficiency.
After concessions, the issues remaining for
decision are:
1.
Whether petitioners improperly elected to use the
installment method of accounting to report income from sales of
real property; and, if the elections were improper, whether
petitioners should use the accrual method as determined by
respondent or the cost recovery method advocated by petitioners;3
2.
whether petitioner Chen C. Wang's closely held corpora-
tion, EIC Group, Inc. (EIC), is entitled to deduct as reasonable
compensation commissions of $901,428 and a bonus of $500,000 paid
to Chen C. Wang in 1989 and 1990, respectively;
3.
whether expenditures of $550,663 made in 1990 by EIC
for the benefit of the Wangs represent loans to the Wangs or
constructive dividends; and
4.
whether petitioners are liable for the accuracy-related
penalties under section 6662(a).
2
In connection with the settlements, the parties filed with
the Court the first stipulation of settled issues, followed by
the second, third, fourth, fifth, sixth, and seventh stipulations
of settled issues.
3
If we find that petitioners must use the accrual method,
there are several subissues concerning the proper calculation of
income under the accrual method. See infra discussion.
- 4 FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
The stipulation of facts, the first supplemental stipulation of
facts, the second supplemental stipulation of facts, and the
exhibits attached thereto are incorporated herein by this
reference.
Petitioner Chen C. Wang (petitioner) and his wife,
petitioner Victoria R. Wang, resided in Woodside, California, at
the time their petitions were filed.
At the time its petitions
were filed, the principal place of business for EIC was located
in Redwood City, California.
Petitioner moved to the United States from Taiwan nearly 40
years ago.
He has a degree in electrical engineering from San
Jose State University and a Masters in Business Administration
from the University of California at Berkeley.
After completing
his education, petitioner went to work for IBM.
While at IBM,
petitioner investigated ways to increase his income, and he
ultimately decided that the best way to make money was to invest
in real estate.
Thereafter, petitioner began investing in real
estate, eventually leaving IBM to devote more of his time and
energy to increasing his real estate business.
In 1982, peti-
tioner incorporated EIC and used it as the vehicle to effectuate
his real estate investment strategy.
Nevertheless, occasionally
petitioner personally purchased and sold land for his own
account.
- 5 Petitioner's real estate strategy focused on purchasing raw,
undeveloped land and reselling it to investors.
Typically,
petitioner advised his investors that they would have to hold the
land at least 7 to 10 years in order to realize profitable
returns.
Petitioner believed that the most profitable land was
located on the outskirts of a large metropolitan center.
Based
on this belief, during the years at issue, petitioner had decided
that the land with the best investment potential was located in
Lancaster, California, and Palmdale, California, areas well
outside of Los Angeles.
Petitioner felt that this land was well
positioned, given the expected population growth for Los Angeles.
The property petitioner purchased in Lancaster and Palmdale
was generally flat, semi-arid, undeveloped land.
At one time,
the land may have been used as farmland, but, by 1989 it had
reverted to desert.
The land was zoned for agricultural use,
with a density that allowed for one house to be built on every 2
acres of land.
There were no improvements to or on the land
petitioner purchased, such as utilities, streets, curbs, or
gutters.
The land was not subdivided, but simply consisted of
"raw" land in the desert described by metes and bounds.
Typically, either petitioner or EIC would acquire the raw
land by paying 10 or 20 percent down, and giving the seller a
note for the balance.
Then petitioner would sell the land at a
substantial markup in what was described at trial as the "retail
- 6 land market".
The markup could range anywhere from 4 to 6 times
the amount paid for the land.
The buyer would make a sizeable
downpayment to EIC and take the property subject to an allinclusive deed of trust.
An all-inclusive deed of trust includes
the promissory note made by EIC in favor of the original seller.
Under this arrangement, as the buyer made payments on the promissory note to EIC, a part of the payment was used by EIC to make
the payments due on EIC's promissory note given to the original
seller.
EIC also used what is termed an "agreement of sale".
An
agreement of sale is different than a trust deed because, unlike
a trust deed, the agreement of sale is not recorded.
Rather, in
the agreement EIC simply promised to transfer the deed to the
buyer at some future time, presumably after the buyer had made
all the payments due on its promissory note to EIC.
The promissory notes held by EIC were secured by the land.
As outlined supra, typically EIC or petitioner would purchase
large parcels of real estate and then sell undivided interests in
the property to various investors.
These fractional interests
were less attractive as security because an owner would have to
receive the consent of the remaining property owners before
making use of the property.
However, it appears that people who
purchased land from EIC only held it as an investment, and few
buyers, if any, actually built any structures on, or made any
improvements to the property.
- 7 During the years at issue, petitioner and his wife owned
approximately 98 percent of the stock in EIC.
Further, during
this period, petitioner was the chief executive officer, chairman, and, except for a brief period, the president of EIC.
Since
its inception, Mrs. Wang has been the secretary, treasurer, and
chief financial officer of EIC.
hours a day, 6 days a week.
Petitioner typically worked 10
Petitioner is very driven, and he is
involved with nearly every sale transaction that occurs at EIC.
The success enjoyed by EIC and petitioner is a reflection of
petitioner's industry and dedication.
Revenues reported in EIC's
financial statements grew from $4,118,262 in 1985 to $29,411,411
in 1989, while assets grew from $23,343,200 to $46,231,210.
Recent promotional materials for EIC indicate that the company
owns investment property worth in excess of $60,000,000, and that
investors have enjoyed an average annual appreciation of 25.9
percent on their investments, based on a sampling of prices over
a 15-year period.
At the peak of operations, approximately 12
people were employed at EIC's headquarters full time.
In addi-
tion, there were 11 branch offices located throughout California,
and as many as 50 sales agents worked at these branches.
Most of
the agents were independent contractors, although a few were
classified as employees of EIC.
The market for raw land suffered a downturn in 1990.
How-
ever, EIC was able to continue selling land despite this down-
- 8 turn.
Companies that were able to sell land, like EIC, did so by
developing superior marketing techniques or by utilizing connections with overseas buyers.
Accounting Methods
EIC keeps its books and records on the accrual basis for the
purpose of preparing its financial statements.
For tax purposes,
during the years in issue, EIC and petitioner elected to use the
installment method for reporting income in their tax returns.
This is the second instance where petitioner has been
involved in litigation before the Tax Court.
Previously,
respondent issued petitioner and Mrs. Wang notices of deficiency
for their 1979 and 1980 Federal income tax returns.
The most
significant portion of the deficiencies for the 2 years related
to the income and expenses respondent determined in connection
with the Wangs' land sales activities.
Petitioner and Mrs. Wang
presented these issues to this Court in a trial that was held on
November 30, 1989, and December 1, 1989.
However, no opinion was
issued because all of the issues were resolved by the parties
after the trial.
The parties executed a closing agreement on
final determination covering specific matters for the 1979 tax
year (the 1979 closing agreement).4
A decision was entered
4
No closing agreement was executed for the 1980 tax year.
The following constitutes the closing agreement for 1979:
WHEREAS, taxpayers' 1979 income tax return, Docket No.
(continued...)
- 9 pursuant to the terms of the 1979 closing agreement.
Petitioner and Mrs. Wang timely filed their 1989 Federal
income tax return, which was received by the Internal Revenue
Service on October 11, 1990.
On their 1989, 1990, and 1991
Federal income tax returns, the Wangs elected to use the
4
(...continued)
11281-83, is currently before the United States Tax
Court;
WHEREAS, the proceeds from sales of real estate in 1979
were not fully recognized in 1979 or later years;
WHEREAS, the parties hereto wish to determine with
finality the taxpayers' tax liability for the tax year
1979 and the timing of the recognition of the gains
from those 1979 real estate transactions;
NOW IT IS HEREBY DETERMINED AND AGREED for Federal
income tax purposes, that:
(1) there will be no recognition of the gain from the
disputed sales of real estate in 1979;
(2) there is no tax due from, nor refund due to, the
taxpayers for the tax year 1979;
(3) taxpayers are to recognize the gains from the
disputed 1979 sales of real estate, resulting in
increases to their income of $1,369,723 on the
corporate income tax returns of EIC Group, Inc. as
follows:
(a) $500,099.50 income is to be included in the
tax year 1989;
(b) $500,099.50 income is to be included in the
tax year 1990;
(c) $369,524.00 is to be reported in the year it
is paid by the buyer to, or for, the taxpayer;
(4) there are no other items of income nor expense to
be included as income, or taken as a deduction, with
respect to the 1979 real estate transactions except as
stated in (3) above.
- 10 installment method of accounting to report income from land
sales.
EIC also elected to report income based upon the install-
ment method.
However, in October 1994, the Wangs filed an
amended return for 1990, while EIC filed amended returns for the
years 1990 and 1992 in September and June of 1994, respectively.
On these amended returns, the Wangs and EIC reported income from
land sales based on the cost recovery method of accounting.
To
date, neither petitioner nor EIC has submitted to respondent a
Form 3115 requesting a change in their accounting method.
Transactions between the Wangs and EIC
As discussed, supra, the financial success of EIC is due in
large part to the efforts of petitioner and Mrs. Wang.
Over the
years, the Wangs have been compensated for their hard work.
Petitioner and Mrs. Wang each received salaries of $223,250,
$283,200, and $114,417 from EIC in 1989, 1990, and 1991, respectively.
Furthermore, in 1990, EIC paid petitioner a bonus of
$500,000.
Petitioner has maintained a broker's license since the early
1970s, and he regularly acted as the broker in land sales
involving EIC.
A number of independent agents also worked with
EIC in selling land.
EIC dealt almost exclusively in the purchase and sale of raw
land.
Real estate agent commissions on sales of raw land are
significantly higher than those paid in connection with a sale of
- 11 improved real estate.
In fact, EIC typically paid commissions
that were between 10-15 percent of the sales price.
During 1989,
on average, EIC paid commissions of 13 percent.
Often, more than one agent would be involved with a particular sale.
In these cases, petitioner allocated the 13-percent
commission among the sales agents who participated in the sale,
based upon each agent's level of participation.
Petitioner is an
experienced sales agent, however, and many times he would be the
only person involved in a sale by EIC.
In those circumstances,
EIC paid the full 13-percent commission to petitioner alone.
For
1989, petitioner received $901,428 in commissions from EIC, and
EIC claimed a deduction for this amount.
During the years in issue, the financial relationship
between petitioner and EIC was not limited to the compensation
paid to petitioner.
In fact, EIC's financial statements as of
December 31, 1989, disclose both "notes receivable" from petitioner in the amount of $873,194 as well as "notes payable" to
petitioner in the amount of $1,010,895.
These amounts comport to
the figures reported in EIC's December 31, 1989, corporate income
tax return.
EIC maintained separate accounts in its general
ledger to track funds transferred to petitioner and funds
received from petitioner.
As of December 31, 1990, the corporate
income tax return for EIC reported "Loans from Stockholders" of
$1,312,199 and "Loans to Stockholders" of $1,717,892.
The
- 12 minutes of EIC's 1990 and 1991 annual board of director's meetings reflect the board's formal approval and ratification of the
corporation's borrowing money from, and loaning money to, petitioner and Mrs. Wang.
The Notices of Deficiency
Initially, EIC's 1989 corporate income tax return was
selected for audit.
The revenue agent first contacted EIC
personnel in December 1992.
After the revenue agent reviewed
some of the information obtained from the initial document
request and identified EIC's accounting method as a potential
issue, the examination was expanded to include the years 1990 and
1991 for EIC, as well as the Wangs' personal Federal income tax
returns for 1989 through 1991.
Some time later, EIC's 1992
corporate tax return was also opened for examination.
By 1994, the revenue agent had identified a large number of
potential issues in EIC's corporate tax returns and the Wang's
individual returns.
However, the various statutory periods of
limitations were near their expiration dates, and petitioners
refused to grant extensions to respondent.
Consequently, at
different times from February 1994 through February 1995,
respondent issued a statutory notice of deficiency for each year
under audit.
As a result, the notices of deficiency contained
numerous items that could have been resolved in the examination.
For instance, the notice of deficiency relating to EIC's 1990 tax
- 13 return lists 21 items of adjustment, many of them due to lack of
substantiation.
Many of the adjustments determined in the
notices of deficiency have been resolved by the parties through
numerous stipulations of settled issues.
The following determinations made by respondent in the
notices of deficiency remain in dispute.
First, respondent
determined that the accounting method used by EIC and the Wangs
in the returns as originally filed was improper.
Respondent
further determined that they should report income using the
accrual method, which is the method used for their financial
books and records.
Second, respondent determined that the
$901,428 in commissions for 1989, and the $500,000 bonus paid to
petitioner in 1990, represented unreasonable compensation and
therefore were not deductible by EIC.
Third, respondent
determined that, for 1990, expenditures made by EIC on behalf of
the Wangs, reported as loans, were in reality disguised dividends
and, accordingly, were includable in petitioner's income.
Finally, respondent determined that petitioners are liable for
the accuracy-related penalties under section 6662(a).
OPINION
Issue 1.
Method of Accounting
The first issue for decision requires us to decide the
proper method of accounting for calculating gain on the sales of
real property.
EIC and the Wangs originally selected the
- 14 installment method to report income for tax purposes from the
sales of land.
In the notices of deficiency issued to EIC for
the taxable years 1989 through 1992, and to the Wangs for 1990,
respondent determined that the installment method was an impermissible method of accounting for tax purposes, and determined
that the accrual method was one that clearly reflected income.
Petitioner and EIC argue that the installment method is proper,
and therefore respondent improperly changed their accounting
method from one that clearly reflected income.
Section 446(a) requires a taxpayer to compute taxable income
under the method of accounting it regularly uses in keeping its
books.
Section 446(b), however, provides that, if the method of
accounting regularly utilized by the taxpayer does not clearly
reflect taxable income, the computation of taxable income shall
be made under such method as, in the Commissioner's opinion, does
clearly reflect income.
The Commissioner's authority under
section 446(b) reaches not only overall methods of accounting but
also a taxpayer's method of accounting for specific items of
income and expense.
Ford Motor Co. v. Commissioner, 102 T.C. 87,
100 (1994), affd. 71 F.3d 209 (6th Cir. 1995); sec. 1.446-1(a),
Income Tax Regs.
It is well recognized that section 446 grants the Commissioner broad discretion in matters of accounting and gives the
Commissioner wide latitude to adjust a taxpayer's method of
- 15 accounting so as to reflect income clearly.
United States v.
Hughes Properties, Inc., 476 U.S. 593, 603 (1986); Commissioner
v. Joseph E. Seagram & Sons, Inc., 394 F.2d 738, 743 (2d Cir.
1968), revg. 46 T.C. 698 (1966).
To prevail in a dispute over
the Commissioner's determination on an accounting matter, a taxpayer must establish that the determination is "clearly unlawful"
or "plainly arbitrary."
Thor Power Tool Co. v. Commissioner, 439
U.S. 522, 532-533 (1979) (quoting Lucas v. American Code Co., 280
U.S. 445, 449 (1930), and Lucas v. Structural Steel Co., 281 U.S.
264, 271 (1930)).
Nonetheless, where a taxpayer's method of accounting does
clearly reflect income, the Commissioner cannot require the
taxpayer to change to a different method even if the Commissioner's method more clearly reflects income.
Ford Motor Co. v.
Commissioner, 71 F.3d at 213; Ansley-Sheppard-Burgess Co. v.
Commissioner, 104 T.C. 367, 371 (1995); Molsen v. Commissioner,
85 T.C. 485, 498 (1985).
We limit our inquiry to whether the
accounting method at issue clearly reflects income, and we do not
decide whether one method is superior to other possible methods.
RLC Indus. Co. v. Commissioner, 98 T.C. 457, 492 (1992), affd. 58
F.3d 413 (9th Cir. 1995); see also Brown v. Helvering, 291 U.S.
193, 204-205 (1934).
During the years at issue, EIC bought and sold undeveloped
real property in the outlying areas of Los Angeles and elected to
- 16 use the installment method to report gains from sales of this
property.
In 1990, petitioner and Mrs. Wang engaged in the same
type of sales activity as EIC with property held in their own
names.
Like EIC, the Wangs elected to report gains on the
installment method.
The installment sales provisions are contained in section
453.
Section 453(a) permits a taxpayer to report income from an
"installment sale" under the "installment method."
Under the
"installment method", a proportionate amount of income is
recognized in the year when a payment is received.
Sec. 453(c).
An "installment sale" is defined as a "disposition of
property where at least 1 payment is to be received after the
close of the taxable year in which the disposition occurs."
453(b)(1).
Sec.
However, an "installment sale" does not include a
dealer disposition of property.
Sec. 453(b)(2)(A).
A dealer
disposition includes a disposition of real property which is held
by the taxpayer in the ordinary course of his trade or business.
Sec. 453(l)(1)(B)5.
The sale of a residential lot in the
5
Sec. 453(l) defines the term "dealer disposition" for the
purposes of the installment sales rules. That section provides
in part:
(l)
Dealer Dispositions.--For purposes of
subsection (b)(2)(A)-(1)
In general.--The term "dealer
disposition" means any of the following
dispositions:
(continued...)
- 17 -
5
(...continued)
(A) Personal property.--Any disposition
of personal property by a person who
regularly sells or otherwise disposes of
personal property of the same type on the
installment plan.
(B) Real property.--Any disposition of
real property which is held by the taxpayer
for sale to customers in the ordinary course
of the taxpayer's trade or business.
(2)
Exceptions.--The term "dealer
disposition" does not include-(A) Farm property.--The disposition on
the installment plan of any property used or
produced in the trade or business of farming
(within the meaning of section 2032A(e)(4) or
(5)).
(B) Timeshares and residential lots.-(i) In general.--Any dispositions
described in clause (ii) on the
installment plan if the taxpayer elects
to have paragraph (3) apply to any
installment obligations which arise from
such dispositions. An election under
this paragraph shall not apply with
respect to an installment obligation
which is guaranteed by any person other
than an individual.
(ii) Dispositions to which
subparagraph applies.--A disposition is
described in this clause if it is a
disposition in the ordinary course of
the taxpayer's trade or business to an
individual of-(I) a timeshare right to use
or a timeshare ownership interest
in residential real property for
not more than 6 weeks per year, or
a right to use specified
campgrounds for recreational
purposes, or
(continued...)
- 18 ordinary course of a taxpayer's business is not considered a
dealer disposition.
Sec. 453(l)(2)(B)(ii)(II).
Petitioners do not dispute that they were dealers in real
property.6
However, the Wangs and EIC argue that they satisfy
the exception for sales of residential lots.
Respondent asserts
that the land petitioner and EIC sold was not residential property, because EIC's buyers never intended to build homes on the
property they purchased from EIC.
Petitioner argues that the
land was zoned in such a way that the buyers could have built a
house on the property if they had desired to do so.
Based upon
the evidence and the following analysis, we agree with respondent.
With the Tax Reform Act of 1986, Pub. L. 99-514, sec. 811,
100 Stat. 2365, Congress enacted section 453C which generally
denied installment sale treatment to dealer dispositions of
property but provided an exception for sales of residential lots.
See sec. 453C(e)(4)(A)(i)(II), applicable to sales between
March 1, 1986, and December 31, 1987.
The Omnibus Budget
5
(...continued)
(II) any residential lot, but
only if the taxpayer (or any
related person) is not to make any
improvements with respect to such
lot.
6
In fact, in their respective petitions, both petitioner and
EIC state that they are dealers in real estate.
- 19 Reconciliation Act of 1987 (the 1987 Act), Pub. L. 100-203, sec.
10202, 101 Stat. 1330-388, repealed section 453C for sales after
December 31, 1987.
However, the 1987 Act created section 453(l),
which contains language nearly identical to that found in section
453C concerning the denial of installment sales treatment for
dealer dispositions, with an exception for sales of residential
lots.
See 1987 Act sec. 10202(b)(2), 101 Stat. 1330-388.
Thus,
in repealing section 453C and enacting section 453(l), Congress
did not alter the treatment for installment obligations arising
from the sale of residential lots.
H. Conf. Rept. 100-495 at 927
(1987), 1987-3 C.B. 193, 207.
Respondent has not issued regulations in connection with
section 453(l) but previously had issued temporary regulations
for the now-repealed section 453C.
Since the relevant language
in section 453(l) is identical to that used in section 453C, we
turn to the regulations under section 453C for guidance in
interpreting the term "residential lots" contained in section
453(l)(2)(B).
Section 1.453C-8T(4), Temporary Income Tax Regs., 53 Fed.
Reg. 34725 (Sept. 8, 1988), defines a residential lot as "a
parcel of unimproved land upon which the purchaser intends to
construct (or intends to contract to have another person construct) a dwelling unit for use as a residence by the purchaser."
Petitioner argues that the land sold by EIC was zoned such that a
- 20 buyer would be permitted to construct a house on the property if
a buyer so desired.
While this fact is relevant to our decision,
for the following reasons we nonetheless conclude that the land
sold by petitioner and EIC does not satisfy the residential real
estate exception for dealer dispositions.
It is abundantly clear that the land sold by EIC was
marketed to potential buyers as a speculative investment.
The
offering materials exclusively focused on financial factors such
as return on investment, capital preservation (safety), and tax
considerations.
Further, petitioner testified that neither he
nor EIC has ever represented to potential buyers that the land
being sold was suitable for use as residential lots.
There is no
evidence in the record to suggest that buyers purchased land from
petitioner or EIC with the intention of building dwelling units
on that land.
In fact, the overwhelming weight of evidence
strongly suggests that no buyer ever constructed a dwelling unit
on land purchased from EIC or petitioner.
We therefore find that
buyers did not purchase land from petitioner or EIC with the
intent to construct a dwelling unit on the property.
Accord-
ingly, we conclude that petitioner and EIC improperly elected to
use the installment sales method for reporting gain because they
are dealers in real estate and they failed to satisfy the residential real estate exception for dealer dispositions contained
in section 453(l)(2)(B).
- 21 Petitioner also makes a second argument that the cost
recovery method is the proper method for reporting gain from the
sales of land.
In this regard, petitioner notes that the Wangs
and respondent used the cost recovery method to compute the
income contained in the 1979 closing agreement.
Petitioner
contends that both parties are now bound by the 1979 closing
agreement to use the cost recovery method.
Respondent answers that EIC and petitioner failed to file a
Form 3115 when changing from the installment method to the cost
recovery method used in the amended income tax returns.
Tax-
payers are required to use this form in requesting the Commissioner's consent to changes in accounting methods.
Sec.
1.446-1(e)(3)(i), Income Tax Regs.; Rev. Proc. 84-74, 1984-2 C.B.
736.
Respondent asserts that petitioners' failure to follow
established procedures is sufficient to deny their attempt to
change accounting methods.
We agree.
See Witte v. Commissioner,
513 F.2d 391 (D.C. Cir. 1975), revg. in part and remanding T.C.
Memo. 1972-232.
Petitioner argues, however, that the use of the cost
recovery method is mandated by the 1979 Closing Agreement,
thereby obviating the need to file a Form 3115 and requesting the
Commissioner's consent.
contentions.
The facts do not support petitioner's
- 22 The Secretary of the Treasury is authorized to enter into
written closing agreements with respect to the tax liability of
any person for any taxable period.
Sec. 7121(a).
Such closing
agreements are binding on the parties as to the matters agreed
upon and may not be annulled, modified, set
aside, or disre-
garded in any suit or proceeding unless there is a showing of
fraud, malfeasance, or misrepresentation of a material fact.
Sec. 7121(b); Rink v. Commissioner, 100 T.C. 319, 324 (1993),
affd. 47 F.3d 168 (6th Cir. 1995).
A closing agreement is
binding only as to matters agreed upon for the taxable period
stated in the agreement.
T.C. 1, 4 (1991).
Estate of Magarian v. Commissioner, 97
Ordinary principles of contract law govern the
interpretation of closing agreements.
supra at 325.
Rink v. Commissioner,
These principles generally direct courts to look
within the "four corners" of the agreement, unless it is
ambiguous as to essential terms.
Id.
Petitioner's own witnesses at trial were unable to discern
the method used for calculating the income in the 1979 closing
agreement by merely reviewing the agreement.
The words "cost
recovery method" are not present in the 1979 closing agreement.
Further, not one word of the 1979 closing agreement is devoted to
the purportedly agreed upon method for reporting income in future
years.
- 23 Petitioner and EIC used the installment method to report
income in tax returns that were filed after the 1979 closing
agreement was executed.
This seriously undercuts petitioner's
contention that the parties intended that the 1979 closing
agreement would require them to use the cost recovery method in
future years.
See Pacific Portland Cement Co. v. Food Mach. &
Chem. Corp., 178 F.2d 541, 554 (9th Cir. 1949) (when interpreting
a contract, a court may look to the parties' actions in ascertaining their intent).
Therefore, we find that the 1979 closing
agreement does not cover the method for reporting income during
the years at issue.
Based on the foregoing, we conclude that the attempts by
petitioner and EIC to change accounting methods by filing amended
tax returns are ineffectual.
After determining that the Wangs
and EIC used an impermissible accounting method to report income,
respondent may change their method of accounting to any method
that, in respondent's opinion, clearly reflects income.
446(b).
Sec.
Petitioner does not argue that respondent's use of the
accrual method is "clearly unlawful" or "plainly arbitrary."
Thor Power Tool Co. v. Commissioner, 439 U.S. 522, 532-533 (1979)
(quoting Lucas v. American Code Co., 280 U.S. 445, 449 (1930),
and Lucas v. Structural Steel Co., 281 U.S. 264, 271 (1930)).
Accordingly, we sustain respondent's determination that peti-
- 24 tioner and EIC must report income based on the accrual method of
accounting.
Since we have concluded that petitioner and EIC must report
income on the accrual method, there are a number of derivative
computational issues that we must address.
First, in the second
stipulation of settled issues, the parties indicate that they
have not reached an agreement as to the proper amount of income
EIC must report in 1989 under the accrual method.
Respondent
determined in the notice of deficiency dated April 1, 1994, that
the income is $19,584,214, while EIC contends it is $18,850,859.
After a concession of $100,000, respondent now contends that the
income should be $19,484,214.
Petitioner has failed to
adequately address this issue on brief7 or otherwise.
As a
7
In petitioners' reply brief, with respect to the different
calculations of accrual income, petitioner states "We maintain
that the parties must abide by the stipulations they previously
executed." The second stipulation of settled issues presents the
parties' computation of accrual income for EIC as follows:
Income To Be Reported by Petitioner EIC
Year
Cost Recovery
Method
Installment
Method
1989
1990
1991
1992
$4,968,292
3,230,695
3,253,218
2,213,590
$10,093,843
5,506,844
3,072,503
1,978,872
Accrual Method
To Be Determined
$9,990,901
2,801,850
670,700
In the stipulation, the parties indicate that the proper amount
of accrual income for 1989 will be presented to the Court for
(continued...)
- 25 consequence, we conclude EIC did not meet its burden and find
that the proper amount of income for 1989 under the accrual
method is $19,484,214.
Second, respondent contends in the second stipulation of
settled issues that EIC is required to report the following
income from sales that occurred prior to March 1, 1986:
Year
Amount of Adjustment
1989
1990
1991
1992
$337,668
418,548
292,745
291,437
EIC contends that it does not have to report any income from
sales that occurred prior to March 1, 1986.
However, a witness
for EIC, Michael Cummins, a C.P.A. who had served as EIC's
interim controller, testified on cross-examination that EIC would
have to report these amounts if the accrual method were found to
be the proper method of accounting.
EIC did not address this
issue in its opening brief nor its reply brief.
Accordingly, we
treat this as a concession by EIC and find for respondent.
Third, the parties disagreed in the fourth stipulation of
settled issues as to the proper amount of income that the Wangs
7
(...continued)
resolution. Nevertheless, on brief, petitioners do not further
address the differences between their calculation of accrual
income and the amount determined by respondent.
- 26 should report under each of the different methods of accounting.8
Respondent has conceded $226,170 of the difference in the amount
of income for 1990.
Other than documents pertaining to the
$226,170 conceded by respondent, petitioner did not put on any
evidence nor make any arguments on brief concerning the remaining
differences.
We treat this as a concession by petitioner and
Mrs. Wang, and find for respondent.
Issue 2.
Reasonable Compensation
Section 162(a)(1) provides for a deduction for ordinary and
necessary business expenses including "a reasonable allowance for
salaries or other compensation for personal services actually
8
The fourth stipulation of settled issues sets forth the
following amounts as income from real estate sales under the
accrual method:
Income to Be Reported by Petitioners Mr. & Mrs. Wang
(Per Petitioners' Computations)
Year
Accrual Method
1990
1991
1992
Post-92
$663,739
168,545
-0-0-
Income To Be Reported by Petitioners Mr. & Mrs. Wang
(Per Respondent's Computations)
Year
Accrual Method
1990
1991
1992
Post-92
$716,239
183,141
-0-0-
- 27 rendered".
To fall within the ambit of section 162(a)(1), the
compensation must be both reasonable in amount and paid purely
for services.
Sec. 1.162-7(a), Income Tax Regs.
Typically, the
deductibility of compensation turns on whether the compensation
paid is reasonable in amount.
Elliotts, Inc. v. Commissioner,
716 F.2d 1241, 1243-1244, (9th Cir. 1983), revg. and remanding
T.C. Memo. 1980-282.
EIC bears the burden of proving the reason-
ableness of compensation.
Rule 142(a).
The reasonableness of compensation is a question of fact to
be determined on the basis of all the facts and circumstances.
Pacific Grains, Inc. v. Commissioner, 399 F.2d 603, 606 (9th Cir.
1968), affg. T.C. Memo. 1967-7.
Many factors are considered in
determining whether compensation is reasonable, and no single
factor is decisive.
Mayson Manufacturing Co. v. Commissioner,
178 F.2d 115, 119 (6th Cir. 1949), revg. a Memorandum Opinion of
this Court.
In Elliots, Inc. v. Commissioner, supra at 1245-
1248, the Court of Appeals for the Ninth Circuit, the Court to
which these cases are appealable, arranged these factors into
five broad categories.
The first factor focuses on the employee's responsibilities
and duties in the organization.
Relevant considerations include
petitioner's qualifications, hours worked, duties performed, as
well as his importance to EIC's success.
American Foundry v.
Commissioner, 536 F.2d 289, 292 (9th. Cir. 1976), affg. in part
- 28 and revg. in part 59 T.C. 231 (1972).
The second factor compares
the employee’s compensation with that paid by similar companies
in similar industries for similar services.
Elliotts, Inc. v.
Commissioner, supra at 1246; see sec. 1.162-7(b)(3), Income Tax
Regs.
The third factor requires us to focus on EIC's size as
indicated by its sales, or capital value, the complexities of the
business, and the general economic conditions.
Commissioner, supra at 1246.
Elliotts, Inc. v.
The fourth factor considers whether
the relationship between the company and the employee whose
compensation is at issue might permit the company to disguise
nondeductible corporate distributions of income as compensation
deductible under section 162(a)(1).
Id.
A potential for such
abuse exists when the employee whose compensation is at issue is
the company's sole or controlling shareholder.
Charles Schneider
& Co. v. Commissioner, 500 F.2d 148, 152-153 (8th Cir. 1974),
affg. T.C. Memo. 1973-130; sec. 1.162-7(b)(1), Income Tax Regs.
The fifth factor focuses on whether the compensation was paid
pursuant to a structured, formal, and consistently applied
program.
Bonuses not paid pursuant to such plans are suspect.
Elliotts, Inc. v. Commissioner, supra at 1247; Nor-Cal Adjusters
v. Commissioner, 503 F.2d 359, 362 (9th Cir. 1974), affg. T.C.
Memo. 1971-200.
In the notices of deficiency, respondent
determined that commissions of $901,428 paid to petitioner in
1989 and the $500,000 bonus paid to petitioner in 1990 were not
- 29 deductible by EIC because the payments did not constitute
reasonable compensation.
With the foregoing five factors in
mind, we analyze the reasonableness of each payment.
The Commissions of $901,428 Paid in 1989
In EIC's notice of deficiency for 1989, respondent disallowed the $901,428 deduction for real estate commissions paid
to petitioner.
Respondent argues on brief that EIC has not
produced evidence showing how it computed the commissions or
explaining why the commissions were paid to petitioner.
Peti-
tioner responds that the commissions relate to specific sales,
are consistent with the commissions paid to other salespeople,
and are therefore reasonable and fully deductible.
Petitioner maintains a broker's license, and actively
participated in many of the land sales by EIC during 1989.
In
fact, petitioner's experience and ability as a salesman contributed significantly to the success of EIC.
If petitioner
participated in a sale, he was eligible to receive a commission
on the sale.
If petitioner alone was responsible for making the
sale, he received the full 13-percent commission; otherwise, the
commission was allocated among all of the participants.
The 13-
percent rate of commission is standard in the industry for these
types of land sales.
Considering the factors enumerated above, we conclude that
it was reasonable to pay petitioner a commission for each sale in
- 30 which he participated.
Petitioner was compensated for his role
as a salesman, and, as such, his activities and duties were
comparable to those of other salespeople.
The record indicates
that commissions paid by EIC conform with those typically paid in
the industry and were paid to petitioner based upon a formal and
consistently applied program.
Respondent argues that EIC has failed to adduce specific
evidence concerning petitioner's actions relative to the sales on
which he earned commissions.
Respondent posits that, because
petitioner controlled EIC, he had the ability to pay himself the
full commission on a sale, to the detriment of any other salesperson who might have worked on the sale.
in respondent's argument.
We do not find merit
The record indicates that, on several
occasions, petitioner split the commission on a sale with other
salespeople.
Moreover, petitioner's ability to take the full
commission on a sale is limited in those circumstances where
other salespeople participated in the sale.
A salesperson who is
losing commissions to petitioner would likely seek employment
with another real estate dealer where commissions are not being
appropriated by the business owner.
We are unable to find, however, that the commissions paid by
EIC are reasonable in amount.
The commissions paid by EIC for
land sales in 1989 are substantiated by a schedule which lists,
in chronological order, all the land transactions for that year.
- 31 For each sale, the schedule allocates the commissions among the
various salespeople, including petitioner.
While not clear, it
appears that the schedule is produced from information contained
in EIC's general ledger accounting program.
The schedule does
not provide a summary of the total commissions paid to each
individual salesperson, but when added together, all of petitioner's individual commissions for 1989 amounted to $506,986.
Near the bottom of the schedule, there are journal entries
totaling $901,428, the amount actually paid to petitioner.
The
journal entries, made at year end, do not reference any particular sales (as all the other entries do), but instead contain the
notations "all sales override" or "withdraw".
No explanation for
these entries was given at trial.
On brief, EIC has not put forth any arguments concerning
compensation paid to petitioner in 1989 other than to assert that
the commissions were reasonable because they related to specific
sales.
As previously noted, no evidence was presented at trial,
nor was any argument made on brief, concerning the journal
entries totaling $901,428.
Accordingly, based on the entire
record before us, we conclude that $506,986 represents a reasonable amount of compensation to petitioner for his efforts in
selling land for EIC in 1989.
- 32 The $500,000 Bonus Paid in 1990
In EIC's notice of deficiency for 1990, respondent disallowed a deduction for the $500,000 bonus paid to petitioner at
yearend.
Respondent argues on brief that the bonus was excessive
and therefore not deductible as reasonable compensation under
section 162(a).
EIC responds that petitioner, a key employee at
EIC, was instrumental in the corporation's success and entitled
to higher compensation.
EIC therefore concludes that the bonus
was reasonable and fully deductible.
We agree with EIC that petitioner played an important role
in the corporation's financial success.
Petitioner was a central
figure in managing the corporation and worked long hours to
increase its business.
Nevertheless, on the basis of the record
before us, we are unable to conclude that EIC has successfully
demonstrated that the bonus was reasonable in amount.
EIC has not related the bonus to any duties performed by
petitioner.
The record indicates that petitioner's administra-
tive functions with respect to EIC remained constant throughout
the years at issue, while petitioner's 1990 salary of $283,200
exceeded the salary he received in other years.
Thus, the bonus
did not serve to compensate petitioner for any unusual activities
in connection with his administrative functions.
Additionally,
no evidence was presented, nor any argument made, that this bonus
was derived from specific sales generated by petitioner.
- 33 A number of the factors enumerated by the Court of Appeals
for the Ninth Circuit weigh against EIC.
EIC is a closely held
corporation, controlled by petitioner, which did not pay any
dividends for the year.
This presents the textbook case of a
corporation with the opportunity to disguise nondeductible
corporate distributions of income as compensation.
There is no
evidence to indicate that EIC paid any bonuses to any other
employees nor evidence to suggest that the bonus in question was
paid according to a structured, formal, and consistently applied
program.
EIC has not put on any evidence, through expert testi-
mony or otherwise, that compares the compensation paid by EIC
with that paid by companies in similar industries for similar
services.
Accordingly, we conclude that EIC has not met its
burden in demonstrating that compensation paid to petitioner in
excess of his $283,200 salary was reasonable in amount and
therefore find that the $500,000 bonus is not deductible under
section 162(a).
Issue 3.
Loan or Constructive Dividend
During 1990, EIC made expenditures totaling $550,663 for
personal expenses of the Wangs.
The amounts so expended were
recorded as loans to shareholders in EIC's general ledger.
Respondent determined that these payments did not constitute bona
fide loans and instead were constructive dividends to the Wangs.
- 34 We must determine whether payments made by EIC for the
benefit of petitioner and Mrs. Wang constitute loans, as
petitioner contends, or constructive dividends taxable under
sections 301 and 316, as respondent contends.
Sections 301 and
316 provide that a distribution of property made by a corporation
with respect to its stock is a taxable dividend to the extent of
the corporation's earnings and profits.
Petitioner does not
dispute that EIC had earnings and profits sufficient to support
the constructive dividends determined by respondent.
Petitioner has the burden of proving that the amounts
expended for his benefit are bona fide loans and not constructive
dividends.
Rule 142(a), Welch v. Helvering, 290 U.S. 111 (1933).
Further, courts examine transactions between closely held corporations and their shareholders with special scrutiny.
Turner v.
Commissioner, 812 F.2d 650, 654 (11th Cir. 1987), affg. T.C.
Memo. 1985-159; Electric & Neon, Inc. v. Commissioner, 56 T.C.
1324, 1339 (1971), affd. without published opinion sub nom.
Jiminez v. Commissioner, 496 F.2d 876 (5th Cir. 1974).
Whether a distribution from a corporation to a shareholder
constitutes a dividend or a loan depends on whether, at the time
of the distribution, the shareholder intended to repay the
amounts received and the corporation intended to require repayment.
See Chism's Estate v. Commissioner, 322 F.2d 956, 959-960
(9th Cir. 1963), affg. Chism Ice Cream Co. v. Commissioner, T.C.
- 35 Memo. 1962-6; Miele v. Commissioner, 56 T.C. 556, 567 (1971),
affd. without published opinion 474 F.2d 1338 (3d Cir. 1973).
This determination is to be made based on all of the facts and
circumstances of the case.
at 960.
Chism's Estate v. Commissioner, supra
Statements of intent, absent objective indicia of debt,
are less persuasive in situations involving stockholders of a
closely held corporation.
Turner v. Commissioner, supra at 654.
A court may look to a variety of factors to determine
whether there was an intent to make a loan.
The following is a
nonexclusive list of the objective factors often considered in
deciding whether shareholder withdrawals from a corporation are
loans or constructive dividends:
(1)
The taxpayer's degree of control over the corporation;
(2)
the existence of restrictions on the amount of
disbursements;
(3)
the corporate earnings and dividends history;
(4)
the use of customary loan documentation, such as
promissory notes, security agreements or mortgages;
(5)
the ability of the shareholder to repay;
(6)
the treatment of the disbursements on the corporate
records and financial statements;
(7)
the presence of conventional indicia of legal
obligations, such as payment of interest, repayment
schedules, and maturity dates;
- 36 (8)
the corporation's attempts to enforce repayment; and
(9)
the shareholder's intention or attempts to repay the
loan.
See Busch v. Commissioner, 728 F.2d 945, 948 (7th Cir. 1984),
affg. T.C. Memo. 1983-98; Dolese v. United States, 605 F.2d 1146,
1153 (10th Cir. 1979).
No single factor is determinative.
Boecking v. Commissioner, T.C. Memo. 1993-497.
After considering
all of the facts and circumstances, we conclude that the
expenditures made by EIC on behalf of petitioner and Mrs. Wang
constitute constructive dividends to the Wangs.
Several factors support our conclusion.
The Wangs have
unfettered control over EIC, with the authority to make decisions
concerning the timing and extent of payments made on their
behalf.
See Epps v. Commissioner, T.C. Memo. 1995-297.
Despite
the growth in corporate earnings, EIC did not pay a dividend
during any of the years at issue, nor were any dividends disclosed in the financial statements for prior years.
Nothing in
the record indicates that there were any restrictions on the
amount of money lent to the Wangs.
See Crowley v. Commissioner,
962 F.2d 1077, 1081 (1st Cir. 1992), affg. T.C. Memo. 1990-636.
No loan documents, notes, or written instruments of indebtedness
were presented to the Court.
Id. at 1082.
Further, there were
no repayment schedules, maturity dates, or any indication that
the Wangs made interest payments to EIC in connection with the
- 37 purported loans.
enforce repayment.
There is no evidence that EIC ever attempted to
Additionally, there is no evidence that EIC
either requested or received any security or collateral for the
loans.
See Zimmerman v. United States, 318 F.2d 611, 613 (9th
Cir. 1963).
Petitioner argues that, in later years, he and Mrs. Wang
repaid some of the loans.
Petitioner directs our attention to
EIC's Federal income tax returns for subsequent years, wherein
the reported balance in the "Loans to shareholder" account
decreased.
We are not persuaded that this evidence is sufficient
to carry the day for petitioner.
No evidence was introduced
concerning the form of the purported loan repayments made by
petitioner.
Cases have discounted the significance of repayments
that consisted merely of entries in the corporation's books, as
opposed to cash transfers made by the shareholder.
Compare
Boecking v. Commissioner, T.C. Memo. 1993-497 (shareholder's
bonuses that were credited to the shareholder's loan account were
simply bookkeeping entries and did not establish the existence of
bona fide loans), with M. J. Byorick, Inc. v. Commissioner, T.C.
Memo. 1988-252 (repayment is strong evidence that a bona fide
loan exists).
Petitioner also argues that a debtor/creditor relationship
existed throughout the years at issue.
He asserts that
documentary evidence consisting of financial statements, minutes
- 38 of the board of directors, and corporate tax returns supports
this contention.
While consistent treatment on the books of the
corporation is a factor to be considered, "book entries and
records may not be used to conceal a situation which is not in
economic reality what it is made to appear."
Williams v.
Commissioner, T.C. Memo. 1978-306, affd. 627 F.2d 1032 (10th Cir.
1980).
In conclusion, we find that the amounts expended by EIC for
the benefit of the Wangs constitute constructive dividends.
The
purported loans originated because EIC paid personal expenses of
the Wangs and charged the payments to the shareholder loan
account.
It is apparent the petitioners used the loan accounts
to transfer money freely between EIC and the Wangs and, in
effect, permitted the Wangs to use EIC as their personal checking
account.
The nature of the payments are further evidence that
these transfers were not bona fide loans to the shareholder but
rather were dividends fully taxable under sections 301 and 316.
See Dolese v. United States, supra at 1154 (noting that the
"timing and the pattern" of advances to the shareholder "cannot
be ignored").
Accordingly, we sustain respondent's determin-
ation.
Issue 4.
Accuracy Related Penalties
Section 6662(a) imposes a penalty in an amount equal to 20
percent of the portion of the underpayment of tax attributable to
- 39 one or more of the items set forth in section 6662(b).
Respon-
dent determined that the Wangs are liable for accuracy-related
penalties pursuant to section 6662 for 1989, 1990, and 1991; EIC,
for 1989-1992.
Respondent asserts that the section 6662 penal-
ties are due to either a substantial understatement of tax or
negligence or disregard of the rules or regulations.
6662(b)(1) and (2).
Sec.
Petitioners bear the burden of proving that
respondent's determination is erroneous and that they are not
liable for the accuracy-related penalties.
Rule 142(a);
Bixby v. Commissioner, 58 T.C. 757, 791 (1972).
The term "negligence" includes a failure to make a reasonable attempt to comply with the provisions of the internal
revenue laws.
Regs.
Sec. 6662(c); sec. 1.6662-3(b)(1), Income Tax
Negligence has also been defined as a lack of due care or
failure to do what a reasonable person would do under the circumstances.
Norgaard v. Commissioner, 939 F.2d 874, 880 (9th Cir.
1991), affg. in part and revg. in part on other grounds T.C.
Memo. 1989-390; Allen v. Commissioner, 925 F.2d 348, 353 (9th
Cir. 1991), affg. 92 T.C. 1 (1989).
"Disregard" includes any
careless, reckless, or intentional disregard of rules or regulations.
Sec. 6662(c); sec. 1.6662-3(b)(2), Income Tax Regs.
With
respect to individuals, an understatement of tax is substantial
if it exceeds the greater of 10 percent of the tax required to be
- 40 shown in the return or $5,000 ($10,000 for corporations).
Sec. 6662(d)(1)(A) and (B).
The accuracy-related penalty does not apply with respect to
any portion of the underpayment if it is shown that there was
reasonable cause for such portion and that the taxpayer acted in
good faith.
Sec. 6664(c)(1).
The determination of whether a
taxpayer acted with reasonable cause and in good faith depends
upon the pertinent facts and circumstances, including the taxpayer's efforts to assess his or her proper tax liability, the
knowledge and experience of the taxpayer, and reliance on the
advice of a professional, such as an accountant.
Sec.
1.6664-4(b)(1), Income Tax Regs.
Petitioners contend that the accuracy-related penalties are
inappropriate in these cases because they relied on certified
public accountants to prepare their Federal income tax returns
accurately.9
Such reliance, petitioners claim, is evidence that
they acted with reasonable cause and in good faith.
Respondent
disagrees.
Generally, the duty of filing accurate returns cannot be
avoided by placing the responsibility on a tax return preparer.
Metra Chem Corp. v. Commissioner, 88 T.C. 654, 662 (1987).
9
While
Petitioners' 1989 tax returns were prepared by B.D.O.
Seidman. Petitioners' 1990-1992 tax returns were prepared by
Arthur Andersen & Co.
- 41 hiring an attorney or accountant does not insulate the taxpayer
from negligence penalties, good faith reliance on professional
advice concerning tax laws is a defense.
United States v. Boyle,
469 U.S. 241 (1985); Betson v. Commissioner, 802 F.2d 365, 372
(9th Cir. 1986), affg. in part and revg. in part T.C. Memo. 1984264.
Reliance on a qualified adviser may demonstrate reasonable
cause and good faith if the evidence shows that the taxpayer
contacted a competent tax adviser and provided the adviser with
all necessary and relevant information.
Collins v. Commissioner,
857 F.2d 1383, 1386 (9th Cir. 1988), affg. Dister v. Commissioner, T.C. Memo. 1987-217; Jackson v. Commissioner, 86 T.C.
492, 539-540 (1986), affd. 864 F.2d 1521 (10th Cir. 1989).
In
order to prove such reliance, the taxpayer must establish that
the return preparer was supplied with all necessary information,
and the incorrect return was the result of the preparer's mistakes.
Weis v. Commissioner, 94 T.C. 473, 487 (1990).
Respondent contends that all of the deficiencies were due to
negligence, disregard of the rules or regulations, or a substantial understatement of income tax.
Petitioner and EIC provided
evidence of discussions that were held with their accountants
regarding the proper accounting method to be used by them.
With
regard to the remaining items, such as the reasonable compensation, constructive dividends, and numerous concessions by
petitioners, the record is silent as to what information peti-
- 42 tioner may have provided to his accountants, or what advice the
accountants may have given petitioner.
Accordingly, petitioner
and EIC have failed to establish that they relied on any advice
with respect to the remaining items.
Where no reliable evidence
exists in the record suggesting the nature of any advice given by
a preparer, we may conclude that the taxpayers have failed to
carry their burden in proving good faith reliance on that
preparer.
See Howard v. Commissioner, 931 F.2d 578, 582 (9th
Cir. 1991), affg. T.C. Memo. 1988-531; Skeen v. Commissioner, 864
F.2d 93, 96 (9th Cir. 1989), affg. Patin v. Commissioner, 88 T.C.
1086 (1987).
Consequently, we sustain respondent's imposition of
the accuracy-related penalties on the portion of the underpayment
attributable to these items for each of the years at issue.
Petitioner presented evidence of discussions that were held
concerning the election of the installment method.
Petitioner's
accountant from Arthur Andersen & Co. testified about his reasons
for selecting the installment method.
He indicated that peti-
tioner was forthcoming with all necessary information.
On the
basis of this information, petitioner's accountant advised
petitioner to report income from land sales on the installment
method.
Petitioner is not a tax expert, and he relied on his
accountants for this type of advice.
Selecting an accounting
method is a sufficiently technical issue, and reliance on the
advice of an expert is reasonable under these circumstances.
See
- 43 United States v. Boyle, supra at 251 ("Most taxpayers are not
competent to discern error in the substantive advice of an
accountant or attorney").
Accordingly, we do not sustain
respondent's imposition of the accuracy-related penalties on the
portions of the deficiencies relating to the change in accounting
method.
To reflect the foregoing,
Decisions will be entered
under Rule 155.
This is a copy of a public record, reproduced as it was published. It is not legal advice, and it may not be the version a court would rely on. Check the official source before you cite it.