UNITED STATES TAX COURT
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T.C. Memo. 1999-250
UNITED STATES TAX COURT
S. ROBERT DAVIS, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 4449-92, 5744-92,
25088-96.
Filed July 29, 1999.
Michael Quigley, Donald C. Alexander, and Laura D. Byrne,
for
petitioner.
John E. Budde and Joseph P. Grant, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
VASQUEZ, Judge:
Respondent determined the following
deficiencies in and additions to petitioner's Federal income
taxes:
- 2 -
Year
Deficiency
Sec. 6653(b)
1976
1984
1985
1987
$263,353.75
20,255.00
244,848.00
24,986.00
$131,676.88
----
1
Additions to Tax
Sec. 6653(b)(1)
Sec. 6653(b)(2)
-$10,113
---
-1
---
Sec. 6661
-$5,056
---
50 percent of the interest on $20,255.
Respondent also determined that increased interest pursuant to
section 6621(d) applied to the 1976 deficiency.
By three amendments to answer for the year 1985, respondent
(1) increased the deficiency by $367,776 (resulting in a total
deficiency of $612,624), (2) asserted additions to tax pursuant
to (a) section 6653(b)(1) in the amount of 50 percent of the
underpayment, (b) section 6653(b)(2) in the amount of 50 percent
of the interest payable with respect to the deficiency
attributable to fraud, and (c) section 6659 in the amount of
$94,950, and (3) asserted increased interest pursuant to section
6621(d).
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the years in issue, and
all Rule references are to the Tax Court Rules of Practice and
Procedure.
After concessions, the primary issues for decision
are as follows:
(1) Whether petitioner is liable for additions to tax for
fraud for 1976, 1984, and 1985;
- 3 (2) whether petitioner is entitled to a net operating loss
(NOL) carryback from 1988 to 1985 greater than the amount allowed
by respondent; and
(3) whether petitioner is entitled to deduct certain
expenses incurred in 1987.
If we decide that petitioner's tax returns for 1976, 1984,
and 1985 are not fraudulent, we must decide whether the periods
of limitations for these years have expired.
If we conclude that
petitioner's tax returns for 1976, 1984, and 1985 are fraudulent,
we must decide the following issues:
(1) The fair market value of Strata Corp. (Strata) stock for
1985;
(2) the fair market value of an 18-acre parcel of real
estate located at 1450 Brown Road, Columbus, Ohio (Brown Road
property), and a 274+ acre parcel of land in McKean Township,
Licking County, Ohio (the Licking County property), for 1976;
(3) whether petitioner is entitled to certain depreciation
deductions for 1976;
(4) whether the "Riverview" sales are capital transactions
for 1985;
(5) whether petitioner is liable for interest on a
substantial understatement attributable to a tax-motivated
transaction for 1976 and 1985 pursuant to section 6621(d);
- 4 (6) whether petitioner is liable for the addition to tax
pursuant to section 6661 for 1984; and
(7) whether petitioner is liable for the addition to tax
pursuant to section 6659 for 1985.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
The stipulations of facts and the attached exhibits are
incorporated herein by this reference.
At the time he filed his
petition in docket Nos. 4449-92 and 5744-92, petitioner (Mr.
Davis) resided in Amlin, Ohio.
At the time he filed his petition
in docket No. 25088-96, petitioner resided in Tampa, Florida.
Mr. Davis' Professional Activities
Mr. Davis was born on October 31, 1938, in Columbus, Ohio.
In his youth, he often chauffeured his mother, a real estate
agent, around Columbus in connection with her business.
Mr.
Davis observed his mother attentively and learned about real
estate.
As his knowledge increased, he grew anxious to enter the
real estate business.
In February 1955, Mr. Davis applied for,
and received, a real estate license.
Initially, Mr. Davis actively and successfully sold
residential real properties.
Soon thereafter, his emphasis
shifted from selling real estate to constructing, remodeling, and
developing real estate.
sole proprietorship.
Originally, this business operated as a
Gradually, the business expanded, and Mr.
- 5 Davis formed two corporations--one for residential construction
and sales and the other for commercial development and leasing.
During the 1960's, Mr. Davis' corporation that engaged in
the commercial development and leasing business was extremely
successful and grew substantially.
In 1965, he formed a new
corporation, S. Robert Davis & Co., Inc. (Davis Co.), to conduct
business as a developer and builder of real estate projects.
Since the 1960's, apart from his real estate activities, Mr.
Davis has started and promoted various companies.
In the 1960's,
Mr. Davis acquired Kentucky Fried Chicken (KFC) franchises in
Manhattan and Westchester County, New York.
In 1968, Mr. Davis and three other individuals formed
National Diversified Corp. (National Diversified).
elected chief executive officer (CEO).
Mr. Davis was
KFC was National
Diversified's first national account.
In 1969, National Diversified changed its name to National
Fast Food Corp.
National Fast Food Corp. formed a wholly owned
subsidiary named Arthur Treacher's Fish & Chips (Arthur
Treacher's).
Arthur Treacher's grew from an entity owning one
restaurant to an entity owning more than 700 restaurants.
Mr.
Davis was an employee and the chairman of Arthur Treacher's.
In the early 1970's, National Fast Food Corp. changed its
name to NFF Corp.
In 1971, NFF Corp. purchased the stock of Lake
Hamilton Citrus Co. (LHCC).
LHCC owned large citrus groves in
- 6 Florida and produced citrus products.
Around 1972 or 1973, NFF
Corp. changed its name to Orange Co., Inc. (Orange Co.), and
changed LHCC's name to Orange Co. of Florida, Inc.
In 1976,
Orange Co. was listed on the New York Stock Exchange.
In 1978,
Orange Co. sold the Arthur Treacher's chain.
By 1985, Orange Co. had revenues approximating $70 to $80
million a year.
During Mr. Davis' involvement with Orange Co.,
it produced approximately 5 percent of the orange juice consumed
in the United States.
In 1970, Mr. Davis, R. David Thomas (Dave Thomas), and Len
Imke started Wendy's International, Inc. (Wendy's).
Mr. Davis
was a board member, adviser, and investor of Wendy's.
Mr. Davis
held more than 20 percent of the stock of Wendy's at its
inception, and he facilitated financing for the company.
He
built the first freestanding building used by a Wendy's
restaurant and, during the company's first year of operation,
raised $1 million.
Two years later, Mr. Davis raised an
additional $3 million and facilitated additional financing.
In 1976, Buckeye Federal Savings & Loan (Buckeye) was
contemplating a public offering.
substantial investment in Buckeye.
Mr. Davis decided to make a
He went to separate brokerage
firms and informed them that he wished to acquire their allotment
of Buckeye shares.
Through these firms, Mr. Davis acquired 20
- 7 percent of Buckeye's shares.
Sometime thereafter, he was elected
chairman of the board of Buckeye.
In 1981, Mr. Davis (and others) founded Big Bite, Inc. (Big
Bite), to promote fast food franchises serving pita sandwiches.
Mr. Davis was a primary investor in Big Bite.
elected to Big Bite's board of directors.
In 1983, he was
By 1982 or 1983, Big
Bite expanded to a chain of approximately 30 restaurants.
In the
mid-1980's, Big Bite's restaurants fell out of favor with
consumers.
Mr. Davis also was instrumental in the formation and
financing of other corporations traded on the national over-thecounter market.
One of these corporations was Strata.
Strata
was in the oil and gas exploration and drilling business.
Mr.
Davis was the first chairman of the board of Strata and one of
its three majority shareholders.
Over the years, Mr. Davis solicited investments in the
various entities he promoted from a large group of potential
investors.
Mr Davis gave away shares he personally held in the
promoted entities (1) to ensure important potential investors
would be enthusiastic to invest in the next venture/entity he
promoted and (2) in the hope that these investors would help Mr.
Davis in his promotion of certain businesses.
Petitioner held a substantial number of shares in the
entities he promoted with a zero basis in those shares.
Thus, he
- 8 felt it cost him nothing to give away his shares (which he did)
to potential investors or people who could refer potential
investors.
In 1985, Mr. Davis resigned from all positions he held in
public entities and prominent charitable organizations in which
he had been involved to direct his attention to defending himself
in various governmental proceedings that were underway.
Mr.
Davis was under investigation by the Immigration and
Naturalization Service, the Environmental Protection Agency, and
the Securities and Exchange Commission (SEC).
investigation for criminal mail fraud.
He also was under
The Internal Revenue
Service (IRS) was conducting a "TCMP" audit, and State and city
officials also were conducting income tax audits.
These various proceedings garnered Mr. Davis a lot of
unfavorable local publicity on radio and television and in
newspapers and magazines.
During this time, Mr. Davis' ability
to generate income from the public entities he was associated
with was limited.
Mr. Davis' Employees
1.
Jean Davis
In 1964, Jean Davis began working for Mr. Davis as a
secretary.1
1
In the early 1970's, her duties expanded to include
Jean Davis and Mr. Davis are not related.
- 9 bookkeeping.
Since the early 1970's, Jean Davis has maintained
Mr. Davis' books and records including his invoice, payroll,
payroll tax, and real estate files.
2.
Kathleen Blair
Kathleen Blair (Ms. Blair) worked for Strata as executive
secretary for the president.
Davis.
In 1981, she began working for Mr.
Ms. Blair had primary responsibility for maintaining
books and records regarding Mr. Davis' Strata stock transactions.
Mr. Garrison
From 1946 until 1954, Robert Garrison's (Mr. Garrison)
primary business was developing and selling real estate in
Columbus, Ohio.
Since the late 1950's, Mr. Garrison has been
appraising real estate in Ohio, and at least 70 to 80 percent of
his work was in appraising (the rest was in sales).
During the
years in issue, Mr. Garrison and his partner Gerald King owned
the independent appraisal firm of Garrison & King (G & K).
During his career, Mr. Garrison's appraisal work has
included approximately 400 eminent domain cases.
He worked on
only two of these cases for Mr. Davis.
During his career, Mr. Garrison has conducted numerous
appraisals of Ohio properties for many large private and publicly
listed companies.
He also has done appraisals for the IRS.
Mr. Garrison's appraisal work for Mr. Davis, and companies
connected with Mr. Davis, constituted a very small percentage (1
- 10 to 2 percent at a maximum) of Mr. Garrison's appraisal work.
Other than obtaining appraisals from Mr. Garrison, Mr. Davis had
no business dealings with Mr. Garrison except for the purchase of
one lot of real estate more than 30 years ago.
Mr. Garrison always charged Mr. Davis the normal hourly or
flat fee for appraisals.
competitive.
The fees were reasonable and
Mr. Garrison's fee was never contingent on the
outcome of an appraisal.
Neither Mr. Davis nor his employees
ever suggested or implied to Mr. Garrison the conclusion as to
value that Mr. Davis wished the appraisal to reach.
Mr. Davis
never paid Mr. Garrison any compensation other than the appraisal
fee.
Mr. Davis rarely spoke with Mr. Garrison.
Generally, Mr.
Davis' staff--usually Jean Davis--contacted and dealt with Mr.
Garrison or other appraisers.
Since meeting Mr. Garrison in the
1960's, Mr. Davis has met with Mr. Garrison only a few times.
Mr. Davis' Philanthropy
Mr. Davis has made many charitable contributions of stock,
realty, and personalty.
His gifts have included thousands of
shares of Wendy's stock, a 1919 Model T Ford Four Door Touring
Car, and 3 air conditioners and 23 tons of coolant.
- 11 1.
Mr. Davis' Gifts of Real Property to Charities
a.
Brown Road Property
On or about April 21, 1971, Davis Co. purchased the Brown
Road property.
In 1974, Davis Co. liquidated and distributed its
assets, including the Brown Road property, to Mr. Davis.
Paul Eddy (Mr. Eddy), Mr. Davis' brother-in-law, was a
founding member of, and a deacon at, the Maranatha Baptist Church
(MBC).
Mr. Davis was not a member of the MBC.
Eddy solicited a gift from Mr. Davis to the MBC.
During 1976, Mr.
On or about
December 22, 1976, Mr. Davis donated the Brown Road property to
the MBC.
In response to Mr. Eddy's solicitation of Mr. Davis'
donation of the Brown Road property, the MBC's pastor (Pastor
Brock) offered a tuition waiver to Mr. Eddy for his children
attending a school operated by the MBC.
Mr. Eddy declined the
offer because he felt that accepting it was improper for a deacon
of the church.
Mr. Eddy suggested to Pastor Brock that he make the offer to
Judy Mascari (Ms. Mascari) instead.
Ms. Mascari is Mr. Eddy's
sister-in-law and Mr. Davis' sister.
Ms. Mascari and her family
were members of the MBC, and during 1976, some of Ms. Mascari's
children (Mr. Davis' nieces and nephews) attended the school
operated by the MBC.
accepted it.
The offer was made to Ms. Mascari, and she
- 12 Mr. Davis did not condition his gift of the Brown Road
property to the MBC on the MBC's granting to Mr. Eddy or Ms.
Mascari a tuition waiver.
Pastor Brock never discussed this
issue with Mr. Davis.
Mr. Garrison prepared an appraisal of the Brown Road
property as of December 20, 1976.
Mr. Davis and Mr. Garrison had
no conversations regarding the Brown Road property.
Neither Mr.
Davis nor his employees provided G & K with any comparable sales
information concerning the appraisal of the Brown Road property.
The appraisal concluded that the Brown Road property's fair
market value was $400,000.
On Mr. Davis' 1976 Federal income tax return (the 1976
return), Mr. Davis claimed a charitable contribution deduction in
the amount of $400,000 in connection with his donation of the
Brown Road property to the MBC.
The donation of the Brown Road
property was reported and identified on Schedule A of the 1976
return.
Two additional pages concerning the donation also were
attached to the 1976 return:
(1) An acknowledgment letter from
Pastor Brock and (2) a letter from G & K opining that the fair
market value of the Brown Road property as of December 20, 1976,
was $400,000.
The G & K opinion letter made explicit reference
to the contemporaneous appraisal report that detailed the
valuation methodology, but it was not attached.
- 13 b.
Licking County Property
On May 5, 1976, Mr. Davis purchased the Licking County
property.
Mr. Davis partitioned the Licking County property into
four parcels:
(1) A 20-acre parcel that contained buildings and
fences, (2) a 220-acre parcel (the 220 acres), (3) a 12.82-acre
parcel, and (4) a 21.7-acre parcel.
Since 1963, Juan Sotos (Dr. Sotos) has been a faculty member
of the Ohio State University Medical School.
specializes in pediatric endocrinology.
Dr. Sotos
Since this time, Dr.
Sotos has been a doctor on the staff of Children's Hospital.
In 1977, Dr. Sotos and his family became neighbors and
friends of Mr. Davis and his family.
In July or August of 1984, Arthur Krobacher (Mr. Krobacher),
the president-elect of Children's Hospital's board of trustees,
requested that Dr. Sotos discuss with Mr. Davis the possibility
of Mr. Davis' making a donation to Children's Hospital.
Mr.
Krobacher approached Dr. Sotos about soliciting the donation from
Mr. Davis because Mr. Krobacher was aware that Dr. Sotos and Mr.
Davis were neighbors, and Mr. Davis had previously contributed to
the hospital.2
Dr. Sotos felt uncomfortable asking Mr. Davis for a
contribution; however, at a social dinner not long after his
2
Mr. Davis had previously donated 10,000 to 12,000 shares
of Wendy's stock and $100,000 cash.
- 14 meeting with Mr. Krobacher, he solicited a donation from Mr.
Davis.
Mr. Davis immediately committed to making a donation to
be dedicated to Dr. Sotos' research.
On November 14, 1985, Mr.
Davis donated the 220 acres to the Children's Hospital
Foundation.
Mr. Garrison prepared an appraisal (the 1985 appraisal) of
the 220 acres as of May 1, 1985.
Neither Mr. Davis nor his
employees provided G & K with any comparable sales information
concerning the appraisal of the 220 acres.
The 1985 appraisal
concluded that the fair market value of the 220 acres was
$605,000.
On Mr. Davis' 1985 Federal income tax return (the 1985
return), Mr. Davis claimed a $605,000 charitable contribution
deduction for the donation of the 220 acres to Children's
Hospital.
The 1985 appraisal used three comparable sales to determine
the fair market value of the 220 acres.
Two of the three
comparable sales never occurred.
Around 1993, Mr. Garrison first learned that two comparable
sales were nonexistent.
Mr. Garrison obtained this information
from a "runner" at the Licking County Courthouse.
Mr. Garrison
used the runner to obtain comparable sales because the real
property records in Licking County were not readily available.
- 15 Sometime after the commencement of the case at bar, Mr.
Davis learned of the two nonexistent comparable sales used in the
1985 appraisal.
2.
Gifts of Strata Stock
a.
Conrad Ottelin
For many years, Conrad Ottelin (Dr. Ottelin) has practiced
dentistry in Columbus, Ohio.
In late 1983 or early 1984, he
performed a minor adjustment to the dentures of Mr. Davis'
mother.
The adjustment took only 4 to 5 minutes to perform.
Dr.
Ottelin customarily performed this kind of minor service without
charge as a gesture of goodwill.
Dr. Ottelin did not bill Mr.
Davis or his mother for these services.
Sometime afterwards, as a gesture of thanks, Mr. Davis sent
Dr. Ottelin 500 shares of Strata stock.
Dr. Ottelin believed
that the stock was a gift and treated it as such.
In February
1984, Strata stock's traded price was approximately $5 per share.
b.
Ed Walker
Ed Walker (Mr. Walker) was a former professional baseball
player and well-known businessman in Las Vegas, Nevada.3
He had
many influential acquaintances.
Mr. Walker and Mr. Davis were longtime friends.
During
their friendship, Mr. Walker introduced Mr. Davis to many rich
3
Mr. Walker is deceased.
- 16 and famous people including Gene Autry, Art Linkletter, and Danny
Thomas.
Some of the people Mr. Walker introduced to Mr. Davis
invested hundreds of thousands of dollars in companies that Mr.
Davis promoted.
Mr. Walker also invested in several companies promoted by
Mr. Davis including Buckeye, Big Bite, and Orange Co.
In 1984, Mr. Davis gave Mr. Walker 100,000 shares of Strata
stock.
Mr. Davis never received any payment for these shares.
c.
Ohio Dominican College
On January 7, 1985, Mr. Davis donated 40,000 shares of
unregistered class A common stock of Strata to Ohio Dominican
College (ODC).
He gave ODC four stock certificates, dated
November 30, 1983, each of which represented 10,000 shares.
Each
certificate bore a restrictive legend that set forth the
following:
THE SHARES OF CLASS A COMMON STOCK EVIDENCED BY
THIS CERTIFICATE WERE SOLD WITHOUT REGISTRATION UNDER
THE SECURITIES ACT OF 1933 OR ANY STATE SECURITIES LAW
IN RELIANCE ON EXEMPTIONS THEREFROM. THE SHARES MAY
NOT BE SOLD UNLESS REGISTERED OR EXEMPT PURSUANT TO THE
SECURITIES ACT OF 1933 AND ALL APPLICABLE STATE
SECURITIES
ODC acknowledged that the stock was restricted within the meaning
of rule 144 of the Securities Act of 1933 and agreed not to
dispose of the Strata stock in violation of rule 144.
- 17 On January 6 and 7, 1985, the bid and asked prices for
registered, publicly traded Strata stock were $4.50 and $4.75,
respectively.
Mr. Davis claimed a $190,000 charitable contribution
deduction on the 1985 return for the donation of the Strata stock
to ODC.
The 1985 return fully disclosed the contribution of the
Strata stock to ODC on Form 8283, Noncash Charitable
Contributions.
Attached to the 1985 return also were Mr. Davis'
letter to the president of ODC (Sister Mary Andrew), Sister Mary
Andrew's acknowledgment letter, and a certificate, signed by
Sister Mary Andrew, concerning her understanding of the
application of rule 144 of the Securities Act of 1933 to the
donated stock.
Mr. Davis' Legal Expenses
1.
Squirrel Bend Litigation/Mail Fraud
From 1968 through 1985, with the exception of a 10-12 month
period during 1980 and 1981, Mr. Davis resided on Squirrel Bend
Road in the City of Upper Arlington, Ohio.
This area is known as
"Squirrel Bend".
In the spring of 1981, Mr. Davis constructed a waterline
along Squirrel Bend to provide fire protection for the
neighborhood.
In accordance with procedures set forth by the
City of Upper Arlington for construction of the waterline, Mr.
- 18 Davis built the waterline under the supervision of Harold Hyrne
(Mr. Hyrne), the city manager of Upper Arlington, and his staff.
In September 1981, Mr. Davis sold 1,500 shares of Big Bite
to Mr. Hyrne.
On June 12, 1985, in a four-count indictment, the United
States charged Mr. Davis with violating 18 U.S.C. sections 1341
and 1342 (mail fraud).
The indictment alleged that Mr. Hyrne
permitted Mr. Davis to inflate the cost of the waterline in
exchange for Mr. Davis' providing Mr. Hyrne a $3,000 credit for,
and an opportunity to purchase, common stock in Big Bite.
Mr.
Davis pleaded not guilty to the charges, and eventually he was
acquitted of all wrongdoing (altogether, the Squirrel Bend
litigation).
2.
SEC Litigation
In late 1984 or early 1985, the SEC commenced an inquiry
into the unusual amount of trading of Orange Co. securities in
late August 1984.
This period surrounded Orange Co.'s public
announcement concerning the termination of acquisition talks with
potential suitors.
In February 1985, the president of Orange Co. received
notice of this inquiry from the SEC.
The SEC requested a
chronology of events leading up to the public announcement, a
list of all persons aware that the talks had been terminated
before the announcement, and a description of any relationship
- 19 between Jack Binion (Mr. Binion) and Orange Co.
Orange Co.
voluntarily cooperated with the SEC investigation and provided
the SEC with all requested information.
In January 1986, the SEC issued a subpoena to Orange Co.
requesting documents and information regarding the acquisition
talks and matters related to Mr. Binion.
At the time Orange Co.
received the subpoena, it was unaware of the SEC's investigation
of Orange Co. securities trades of Mr. Davis' sons.
Throughout 1986 and through September 1987, Mr. Davis
participated in the SEC investigation of Orange Co.
During the
fall of 1987, Mr. Davis learned that the SEC was no longer
investigating trading in Orange Co. securities by Mr. Binion, but
instead it was focusing on transactions in Orange Co. securities
by his sons.
In September 1987, the SEC filed a civil complaint (SEC
complaint) against petitioner alleging violations of the
Securities Act of 1933 and the Securities Exchange Act of 1934.
The SEC alleged that certain trading in Orange Co. stock by Mr.
Davis' sons was based on material, nonpublic information provided
to them by Mr. Davis.
Mr. Davis denied all allegations of wrongdoing contained in
the SEC complaint.
On February 3, 1989, the SEC complaint was
dismissed with prejudice after obtaining an agreement from Mr.
- 20 Davis not to pursue collection of his costs and attorney's fees
from the SEC.
3.
Orange Co. Litigation
In 1987 and 1988, Mr. Davis was involved in litigation
(Orange Co. litigation) with Stoneridge Resources, Inc.
(Stoneridge)--the successor to Orange Co.
Mr. Davis and the
other directors of Orange Co. were ousted as the result of a
hostile proxy fight.
The new management of Stoneridge alleged
breach of fiduciary duty and breach of contract by the former
officers/directors (including Mr. Davis) in connection with the
proxy fight and the transition of management in the company.
Mr.
Davis was represented in the Orange Co. litigation regarding
these matters by the firm of Squire, Sanders & Dempsey.
Mr. Davis counterclaimed alleging (1) damages from breach of
certain contract rights and (2) unjust enrichment relating to the
conditions and benefits of his employment with Orange Co.
additional claims included claims for:
These
(1) Breach of options he
had to purchase company airplanes, (2) severance pay, (3)
continuation of health benefits, (4) vacation pay, and (5)
accrued salary through his date of termination.
Mr. Davis
retained additional counsel (Laura Byrne) to litigate these
matters.
Mr. Davis also counterclaimed for indemnification for
attorney's fees arising from the Orange Co. litigation.
Orange
- 21 Co.'s certificate of incorporation required indemnification of
officers for expenses arising from acts performed in good faith
and in a manner reasonably believed to be in the best interest of
Orange Co.
All of the SEC litigation expenses Mr. Davis deducted
in 1987 and 1988, see infra, were included in the demand for
indemnification in the Orange Co. litigation.
In 1992, the Orange Co. litigation was resolved.
Stoneridge
agreed to pay Mr. Davis $47,500.
In a letter dated May 18, 1995, Orange Co.'s directors' and
officers' insurance company informed the IRS that it reimbursed
Squire, Sanders & Dempsey for its representation of Mr. Davis and
reimbursed Laura Byrne for her work as counsel for various
officers and directors.
Legal Fees Charts
In 1987, Mr. Davis paid, incurred, and deducted on his
Schedule C for 1987 the following legal fees:4
Matter
Amount
Squirrel Bend litigation
SEC litigation
Orange Co. litigation
Tax matters
General business matters
$179,726
51,285
36,163
3,493
3,115
Total
4
dollar.
273,782
For convenience, all figures are rounded to the nearest
- 22 In 1988, Mr. Davis paid, incurred, and deducted on his
Schedule C for 1988 the following legal fees:
Matter
Incurred
Paid
Deducted
Squirrel Bend litigation
SEC litigation
Orange Co. litigation
Tax matters
General business matters
Hong Kong venture
$252,972
11,646
3,221
7,447
4,225
32,368
$133,082
11,646
3,221
7,447
4,225
32,368
$252,972
11,646
3,221
7,447
4,225
14,823
311,879
191,989
294,334
Total
Consulting Fees
On his Schedules C for 1987 and 1988, Mr. Davis deducted as
professional expenses payments he made to his son, Charles Davis,
in the amounts of $16,600 and $36,000, respectively.
Tax Returns
Mr. Davis timely filed Federal income tax returns, Forms
1040, for 1976, 1984, 1985, and 1987.
On April 17, 1989, Mr.
Davis filed Form 1045, Application for Tentative Refund, on which
he carried back an NOL in the amount of $489,696, generated in
1988, to 1985 (1988 NOL).
Preparation of Mr. Davis' Tax Returns
1.
Mr. Fenn
Donald Fenn (Mr. Fenn) is a public accountant in Ohio.
He
received a bachelor of science from Bowling Green State
University, where he majored in accounting.
has been employed as a public accountant.
Since 1958, Mr. Fenn
He prepares Federal
- 23 and State income tax returns for individuals, corporations, and
nonprofit organizations.
Mr. Fenn prepared the 1976 return including Schedule B,
which disclosed Mr. Davis' charitable contributions.
In
preparing the 1976 return, he had full and unrestricted access to
all of Mr. Davis' books and records.
Jean Davis gave Mr. Fenn
all of Mr. Davis' books and records necessary for the preparation
of the 1976 return.
Mr. Davis' books and records for 1976 were
kept in good and regular order.
Mr. Fenn was provided a copy of the full and complete G &
K appraisal of the Brown Road property.
Mr. Fenn compiled and
marked the attachments to the 1976 return concerning Mr. Davis'
donation of the Brown Road property to the MBC.
Mr. Fenn
determined that it was not necessary to attach the entire G &
K appraisal of the Brown Road property to the 1976 return and
that just the G & K opinion letter was sufficient.
2.
Mr. Stimmel
Richard Stimmel (Mr. Stimmel) is a certified public
accountant.
In 1967 or 1968, he received a business degree from
Franklin University, where he majored in accounting.
Until 1978,
Mr. Stimmel was an accountant with Coopers & Lybrand.
In 1979,
he began working for Mr. Davis.
Mr. Stimmel prepared, or directed the preparation of, Mr.
Davis' 1984, 1985, and 1987 Federal income tax returns.
In
- 24 preparing Mr. Davis' tax returns for 1984, 1985, and 1987, Mr.
Stimmel worked with Jean Davis and Ms. Blair.
Mr. Stimmel had
full and unrestricted access to all of Mr. Davis' books and
records.
Mr. Stimmel determined the attachments to include in the
1985 return concerning Mr. Davis' charitable donations.
He
determined that it was not necessary to attach the entire 1985
appraisal to the 1985 return.
During the years in issue, Mr. Davis relied on professional
accountants, Mr. Fenn and Mr. Stimmel, to prepare his Federal tax
returns.
OPINION
I.
Addition to Tax for Fraud
The addition to tax in the case of fraud is a civil sanction
provided primarily as a safeguard for the protection of the
revenue and to reimburse the Government for the heavy expense of
investigation and the loss resulting from a taxpayer's fraud.
See Helvering v. Mitchell, 303 U.S. 391, 401 (1938).
Fraud is
intentional wrongdoing on the part of the taxpayer with the
specific purpose to evade a tax believed to be owing.
See McGee
v. Commissioner, 61 T.C. 249, 256 (1973), affd. 519 F.2d 1121
(5th Cir. 1975).
The Commissioner has the burden of proving fraud by clear
and convincing evidence.
See sec. 7454(a); Rule 142(b).
To
- 25 satisfy the burden of proof, the Commissioner must show:
(1) An
underpayment exists; and (2) the taxpayer intended to evade taxes
known to be owing by conduct intended to conceal, mislead, or
otherwise prevent the collection of taxes.
See Parks v.
Commissioner, 94 T.C. 654, 660-661 (1990).
The Commissioner must
meet this burden through affirmative evidence because fraud is
never imputed or presumed.
See Beaver v. Commissioner, 55 T.C.
85, 92 (1970).
A.
Fraudulent Intent
The Commissioner must prove that a portion of the
underpayment for each taxable year in issue was due to fraud.
See Professional Servs. v. Commissioner, 79 T.C. 888, 930 (1982).
The existence of fraud is a question of fact to be resolved from
the entire record.
See Gajewski v. Commissioner, 67 T.C. 181,
199 (1976), affd. without published opinion 578 F.2d 1383 (8th
Cir. 1978).
Because direct proof of a taxpayer's intent is
rarely available, fraud may be proven by circumstantial evidence,
and reasonable inferences may be drawn from the relevant facts.
See Spies v. United States, 317 U.S. 492, 499 (1943); Stephenson
v. Commissioner, 79 T.C. 995, 1006 (1982), affd. 748 F.2d 331
(6th Cir. 1984).
A taxpayer's entire course of conduct can be
indicative of fraud.
See Stone v. Commissioner, 56 T.C. 213,
223-224 (1971); Otsuki v. Commissioner, 53 T.C. 96, 105-106
(1969).
The sophistication, education, and intelligence of the
- 26 taxpayer are relevant to determining fraudulent intent.
See
Niedringhaus v. Commissioner, 99 T.C. 202, 211 (1992); Stephenson
v. Commissioner, supra at 1006; Iley v. Commissioner, 19 T.C.
631, 635 (1952).
Over the years, courts have developed a nonexclusive list of
factors that demonstrate fraudulent intent.
fraud include:
These badges of
(1) Understating income, (2) maintaining
inadequate records, (3) implausible or inconsistent explanations
of behavior, (4) concealment of income or assets, (5) failing to
cooperate with tax authorities, (6) engaging in illegal
activities, (7) an intent to mislead which may be inferred from a
pattern of conduct, (8) lack of credibility of the taxpayer's
testimony, (9) filing false documents, (10) failing to file tax
returns, and (11) dealing in cash.
See Spies v. United States,
supra at 499; Douge v. Commissioner, 899 F.2d 164, 168 (2d Cir.
1990); Bradford v. Commissioner, 796 F.2d 303, 307-308 (9th Cir.
1986), affg. T.C. Memo. 1984-601; Recklitis v. Commissioner, 91
T.C. 874, 910 (1988).
Although no single factor is necessarily
sufficient to establish fraud, the combination of a number of
factors constitutes persuasive evidence.
See Solomon v.
Commissioner, 732 F.2d 1459, 1461 (6th Cir. 1984), affg. per
curiam T.C. Memo. 1982-603.
We note that some conduct and
evidence can be classified under more than one factor.
- 27 B.
The Allegedly Fraudulent Items
Respondent claims that the following five items were
fraudulent:
(1) Mr. Davis' charitable contribution deduction for the
donation of the Brown Road property to the MBC in 1976;
(2) Mr. Davis' gift of Strata stock to Mr. Walker in 1984;
(3) Mr. Davis' gift of Strata stock to Dr. Ottelin in 1984;
(4) Mr. Davis' charitable contribution deduction for the
donation of the 220 acres to Children's Hospital in 1985; and
(5) Mr. Davis' charitable contribution deduction for the
donation of Strata stock to ODC in 1985.
C.
General Real Estate Matters
Respondent argues that Mr. Davis' donations of the Brown
Road property and the 220 acres were part of a pattern by Mr.
Davis of donating real estate to charities, inflating the values
of the properties, and reporting the inflated values as
charitable contribution deductions on his tax returns.
Respondent alleges that Mr. Davis was able to inflate the values
of the properties he donated to charities by (1) hiring a pliable
and/or accommodating appraiser who he manipulated and (2) telling
the appraiser, in advance, the conclusions that the appraiser
should reach regarding the value of the property in question.
Respondent further contends that (1) Mr. Garrison was a
discredited appraiser and an old associate of Mr. Davis, (2) Mr.
- 28 Garrison and Mr. Davis had had a collusive relationship since the
1960's, (3) Mr. Davis controlled Mr. Garrison, and (4) Mr.
Garrison lied to respondent's agents and at the trial of this
case.
Respondent also points to testimony in the record that Mr.
Garrison had a reputation for appraisals on the high side.
1.
Mr. Garrison
On the basis of the record and our opportunity to observe
Mr. Garrison at trial, we found him credible.
Mr. Garrison was a
confident World War II veteran, and no one told him what to do or
what to think.
Mr. Garrison was not financially dependent on Mr. Davis.
Mr. Davis did not suggest values for properties he needed
appraised.
Respondent has failed to establish a conspiracy or
any collusive relationship between Mr. Garrison and Mr. Davis.
Assuming arguendo that his appraisals were on the high side,
Mr. Garrison believed his opinions were correct on the basis of
the property's highest and best use.
Mr. Davis believed that Mr.
Garrison was a qualified and experienced appraiser and had no
reason to doubt the values determined by Mr. Garrison.
We fail
to see how Mr. Garrison's alleged reputation establishes fraud on
the part of Mr. Davis.
2.
Valuation
Respondent, on brief, repeatedly states that "this is not a
valuation case".
We agree.
The parties, however, devote much of
- 29 their briefs to the issue of the correct fair market value of the
Brown Road property, the 220 acres, and other real properties not
in issue.
Determining fair market value is an exercise in judgment on
the part of the trier of fact.
See Colonial Fabrics, Inc. v.
Commissioner, 202 F.2d 105, 107 (2d Cir. 1953).
Rarely would a
good faith disagreement by the parties over fair market value
establish fraudulent intent.
Seven experts testified at trial regarding the valuation of
the 220 acres and the Brown Road property.
Ken Wilson and Ray
Jackson, two of the experts, testified that appraisers could
disagree and reach different conclusions.
Even if Mr. Garrison had negligently or fraudulently
overvalued the properties he appraised, the record in this case
does not demonstrate that Mr. Davis was aware of such negligent
or fraudulent behavior on the part of Mr. Garrison.
3.
Conclusion
We conclude that Mr. Davis' use of Mr. Garrison as an
appraiser and his reliance on Mr. Garrison's appraisals do not
establish that Mr. Davis had the requisite fraudulent intent.
D.
Brown Road Property
Respondent also argues that the donation of the Brown Road
property was a barter transaction in which Mr. Davis had an
understanding with the MBC, before he made the donation, that his
- 30 nieces and nephews would be able to attend the MBC's school
tuition free.
Furthermore, respondent contends that any
testimony to the contrary by Mr. Davis, Mr. Eddy, and Pastor
Brock is not credible.
We disagree.
We found as a fact that the tuition waiver was Pastor
Brock's idea.
Mr. Davis did not make the tuition waiver a
condition to the donation of the Brown Road property to the MBC.
Mr. Davis never asked for a tuition waiver or implied that one
should be given to his relatives.
This is corroborated by the
testimony of Pastor Brock, Mr. Eddy, and Mr. Davis, and we find
them to be credible witnesses.
We conclude that the gift of the
Brown Road property to the MBC was not part of a barter
transaction.
E.
220 Acres
To establish fraud, respondent also argues that Mr. Garrison
created two false comparable sales and used them in the 1985
appraisal.
Two of the three comparable sales used in the 1985 appraisal
never occurred.
However, contrary to respondent's assertion, Mr.
Garrison's use of the nonexistent sales was an innocent (or
negligent) mistake, and Mr. Garrison first learned of the mistake
many years after he prepared the 1985 appraisal.
Neither Mr.
Davis nor his employees provided these comparable sales to Mr.
Garrison.
Furthermore, Mr. Davis had no knowledge of the
- 31 nonexistent comparable sales until many years after Mr. Garrison
prepared the 1985 appraisal and Mr. Davis deducted the donation.
We conclude that Mr. Garrison's use of the nonexistent comparable
sales does not establish fraud on the part of Mr. Davis.
Respondent also implies that Mr. Davis improperly "bought"
Dr. Sotos' testimony in the Squirrel Bend litigation via the
donation of the 220 acres to Children's Hospital.
In the Squirrel Bend litigation, Dr. Sotos testified to the
grand jury and at the trial; however, Mr. Davis agreed to make
the donation to Children's Hospital long before he was indicted
in, or Dr. Sotos became aware of, the Squirrel Bend litigation.
Furthermore, Dr. Sotos credibly testified the his integrity was
not for sale.
We conclude that Mr. Davis' donation of the 220 acres to
Children's Hospital was for charitable purposes and was not an
attempt to influence Dr. Sotos' testimony in the Squirrel Bend
litigation.
Respondent also asserts that the 1985 return was fraudulent
because on Form 8283, filed as part of the 1985 return, the basis
of the 220 acres was left blank.
Mr. Stimmel testified that not completing the entry on Form
8283 under donor's cost or adjusted basis was an oversight and
that any blanks were his actions.
See also infra (regarding Mr.
Davis' reliance on return preparers).
He further testified that
- 32 the records that reflected the donor's cost or adjusted basis
were available to him.
We find this testimony to be credible and
conclude his minor oversight does not establish fraud on the part
of Mr. Davis.
F.
Dr. Ottelin
Respondent contends that Mr. Davis' transfer of Strata stock
to Dr. Ottelin was part of a barter transaction (i.e., Dr.
Ottelin adjusted the dentures of Mr. Davis' mother in exchange
for shares of Strata stock) and was not a gift, and any testimony
by Dr. Ottelin or Mr. Davis to the contrary is not credible.
We
disagree.
Dr. Ottelin credibly testified that the adjustment he
performed to the dentures of Mr. Davis' mother was a minor
adjustment, and it was his normal practice not to bill for such
services--they were gestures of goodwill.
Furthermore, the gift
of stock Mr. Davis made to Dr. Ottelin was worth at least
hundreds, if not thousands, of dollars--an amount extremely
disproportionate in comparison to the services Dr. Ottelin
performed for Mr. Davis' mother.
We conclude that the gift of
Strata stock to Dr. Ottelin was not part of a barter transaction.
G.
Mr. Walker
Respondent contends that Mr. Davis sold Mr. Walker 100,000
shares of Strata stock.
Respondent relies on a stock ledger
- 33 which respondent contends shows that the transaction was a sale.
We disagree.
Ms. Blair maintained this ledger.
The ledger contained a
page captioned "S. Robert Davis - Strata".
Ms. Blair testified
that the purpose of this page was to keep track of how much
Strata stock Mr. Davis owned.
She further testified that she
made the entries in the ledger referencing the transfer of
100,000 shares of Strata stock to Mr. Walker and that the
transfer was not a sale of stock.
Ms. Blair was credible, and
her testimony corroborates Mr. Davis' testimony.
Furthermore, Mr. Davis testified that he was always
promoting companies and that he made a practice of giving stock
to people or investors in order to encourage them to send other
investors to him or to keep them as investors.
Mr. Walker was an
important investor and a source of investors, and we believe that
Mr. Davis made the gift to Mr. Walker in order to keep Mr. Walker
as a potential future investor and source of potential future
investors.
Additionally, there is no evidence that petitioner
received any money from Mr. Walker for the Strata stock.
H.
ODC
Respondent claims that petitioner fraudulently overstated
the value of the Strata stock he donated to ODC.
Respondent
argues that the stock was unregistered, and petitioner's claimed
deduction was based on the registered, traded, asked price.
- 34 The 1985 return fully disclosed on Form 8283 the
contribution of the Strata stock to ODC and the method used to
determine the stock's fair market value.
Furthermore, Mr. Davis
relied on Mr. Stimmel to prepare the 1985 return and the Form
8283 regarding the donation of Strata stock to ODC.
I.
See infra.
Reliance on Return Preparers
Respondent argues that petitioner knew about the erroneous
and fraudulent nature of the information provided to his return
preparers, and the return preparers were not in a position to
discover any errors or fraud.
Petitioner argues that his
reliance on his employees and return preparers negates any
fraudulent intent on his part.
We agree with petitioner.
Petitioner's reliance upon third parties to keep his books
and records and to prepare his returns indicates the absence of
fraudulent intent.
See Hill v. Commissioner, T.C. Memo. 1982-
143; see also Marinzulich v. Commissioner, 31 T.C. 487, 490
(1958).
Petitioner, in good faith, relied on members of his
staff to turn over all of his books and records and otherwise
make a full and complete disclosure to his third party return
preparers.
See Merritt v. Commissioner, 301 F.2d 484, 487 (5th
Cir. 1962), affg. T.C. Memo. 1959-172.
Mr. Davis was a busy man who relied on his employees and
professionals.
Jean Davis credibly testified that all
- 35 information was provided to Mr. Fenn and Mr. Stimmel and nothing
was concealed from them.
Respondent's argument that the return preparers were not in
a position to uncover Mr. Davis' influence over the appraisers is
without merit.
Mr. Davis did not control, or conspire with, the
appraisers hired to value the Brown Road property or the 220
acres.
On the basis of the entire record, we conclude that Mr.
Davis (via his employees) provided complete information to his
return preparers, and his reliance on them was reasonable.
This
indicates the absence of fraudulent intent.5
J.
Respondent's Remaining Arguments
Respondent also attempts to establish fraudulent intent by
pointing to the fact that IRS records reflect that Mr. Davis has
not filed any gift tax returns for the years 1970 through 1993
and that Mr. Davis was uncooperative.
While the failure to file gift tax returns for the gifts to
Mr. Walker and Dr. Ottelin might be troubling in a vacuum, we
previously found that Mr. Davis relied on professional
5
Respondent also argues that Mr. Stimmel did not prepare
Mr. Davis' tax returns. This argument is without merit. We
found as a fact that Mr. Stimmel prepared Mr. Davis' tax returns
for 1984, 1985, and 1987. Furthermore, in respondent's proposed
finding of fact No. 307, respondent requested that the Court find
"Richard Stimmel prepared petitioner's income tax returns during
the relevant time period" as a fact.
- 36 accountants, Mr. Fenn and Mr. Stimmel, to prepare his tax
returns.
We also do not believe that Mr. Davis' alleged "failure to
cooperate" is the kind of uncooperativeness envisioned as a badge
of fraud.
One example of uncooperativeness alleged by respondent
relates to pretrial motion practice and discovery requests.
In
this case, we do not believe that asserting privilege, having to
be compelled to comply with discovery requests, and hiring
numerous counsel to represent oneself are badges of fraud.
Furthermore, we do not find Mr. Davis's lack of memory about
certain events to be uncooperative.
The transactions in issue
took place between 15 and 25 years ago, and many witnesses had
difficulty remembering events from so long ago.
In the instant
case, a lack of memory about the distant past is understandable.
K.
Conclusion
After reviewing all of the facts and circumstances, we
conclude that respondent has failed to prove clearly and
convincingly that for 1976, 1984, or 1985 Mr. Davis intended to
evade taxes known to be owing by conduct intended to conceal,
mislead, or otherwise prevent the collection of taxes.
Accordingly, we do not sustain the additions to tax for fraud for
these years.
- 37 II.
Period of Limitations
Respondent concedes that 1976 and 1984 are closed if the
Court determines that petitioner did not file fraudulent tax
returns for those years.
We have so found, and we agree with
respondent.
The parties agree that pursuant to section 6501(h) the
period of limitations on assessment for 1985 remains open for the
deficiency attributable to the carryback of the 1988 NOL.
Respondent, however, argues that 1985 is open not only for the
deficiency attributable to the 1988 NOL carryback, but for any
deficiency for 1985 up to the amount of the NOL carryback.
We
are unable to agree with respondent's interpretation of this
provision.
Section 6501(h) provides an extended period for assessment
in the case of a deficiency attributable to an NOL carryback.
Such a deficiency may be assessed at any time before the
expiration of the period within which a deficiency for the year
generating the NOL carryback may be assessed.
See sec. 6501(h).
The extended period for the assessment of deficiencies under
section 6501(h) applies only to deficiencies attributable to NOL
carrybacks.
See Bouchey v. Commissioner, 19 T.C. 1078, 1081
(1953); Leuthesser v. Commissioner, 18 T.C. 1112, 1125 (1952).
Thus, deficiencies for 1985, the NOL carryback year, that are
attributable to other items (i.e., non-NOL carryback items) are
- 38 barred by the 3-year period of limitations provided by section
6501(a).
III.
1987 Deficiency and 1985 Deficiency Attributable
to the 1988 NOL Carryback
The deficiency for 1985 attributable to the 1988 NOL
carryback consists of, in part, "consulting fees" paid to Charles
Davis and legal expenses for tax matters, the Squirrel Bend
litigation, the SEC litigation, the Orange Co. litigation, and
general business matters.
The deficiency for 1987 consists of "consulting fees" paid
to Charles Davis, a $24,000 travel expense, and legal expenses
for tax matters, the Squirrel Bend litigation, the SEC
litigation, the Orange Co. litigation, the Hong Kong venture, and
general business matters.
Petitioner presented no evidence at trial regarding the
travel expense, and petitioner did not address this issue, or the
consulting fees paid to his son, on brief.
that petitioner abandoned these issues.
Therefore, we find
See Petzoldt v.
Commissioner, 92 T.C. 661, 683 (1989).
A.
Deductibility of Legal Expenses
Deductions are a matter of legislative grace, and petitioner
bears the burden of proving that he is entitled to the deductions
claimed.
See Rule 142(a); INDOPCO, Inc. v. Commissioner, 503
U.S. 79, 84 (1992).
Section 162 allows a deduction for ordinary
- 39 and necessary expenses paid or incurred in carrying on a trade or
business.
Section 212 allows an individual to deduct all of the
ordinary and necessary expenses paid or incurred in:
(1)
Producing income, (2) managing, conserving, or maintaining
property held for the production of income, or (3) determining,
collecting, or refunding a tax.
deductible.
Personal expenses are not
See sec. 262.
Whether an ordinary and necessary litigation expense is
deductible under section 162(a) or section 212 depends on the
origin and character of the claim for which the expense was
incurred and whether the claim bears a sufficient nexus to the
taxpayer's business or income-producing activities.
See Woodward
v. Commissioner, 397 U.S. 572 (1970); United States v. Gilmore,
372 U.S. 39, 44-45 (1963); see also Peckham v. Commissioner, 327
F.2d 855, 856 (4th Cir. 1964), affg. 40 T.C. 315 (1963); Guill v.
Commissioner, 112 T.C. 325 (1999).
Ordinary and necessary
litigation costs are generally deductible under section 162(a)
when the matter giving rise to the costs arises from, or is
proximately related to, a business activity.
See Woodward v.
Commissioner, supra; Kornhauser v. United States, 276 U.S. 145,
153 (1928).
Litigation costs must be "attributable to a trade or
business carried on by the taxpayer" in order to be deductible as
a business expense.
supra.
Sec. 62(a)(1); see Guill v. Commissioner,
- 40 The ascertainment of a claim's origin and character is a
factual determination that must be made on the basis of the facts
and circumstances of the litigation.
Gilmore, supra at 47-49.
See United States v.
The most important factor to consider
is the circumstances out of which the litigation arose.
See
Guill v. Commissioner, supra; Boagni v. Commissioner, 59 T.C. 708
(1973).
In passing on this factor, the fact finder must take
into account, among other things, the allegations set forth in
the complaint, the issues which arise from the pleadings, the
litigation's background, nature, and purpose, and the facts
surrounding the controversy.
See Guill v. Commissioner, supra;
Boagni v. Commissioner, supra at 713.
B.
Squirrel Bend Litigation
Petitioner argues that (1) the origin of the claim in the
Squirrel Bend litigation was Mr. Davis' sale of Big Bite stock to
Mr. Hyrne, and (2) this was directly related to Mr. Davis' trade
or business of promoting Big Bite.
Respondent counters that the
origin of the claim was the construction of the waterline at
Squirrel Bend.
We agree with respondent.
The Squirrel Bend litigation was a mail fraud case.
Mr.
Davis used the U.S. mail to transmit documents associated with
the construction of the waterline at Squirrel Bend.
The
indictment alleged that he improperly inflated the cost of the
waterline.
Mr. Davis was not charged with bribing Mr. Hyrne.
- 41 Although Mr. Hyrne allegedly allowed Mr. Davis to inflate
the cost of the waterline because Mr. Hyrne acquired the
opportunity to purchase Big Bite stock, the sale of the stock
itself was not alleged to be improper; rather, the cost inflation
was allegedly improper.
We conclude, therefore, that the origin
of the claim was the construction of the waterline at Squirrel
Bend.
The parties stipulated that Mr. Davis' activity at Squirrel
Bend was not a trade or business, and petitioner presented no
evidence suggesting that he managed, conserved, or maintained his
personal residence at Squirrel Bend for the production of income.
Therefore, we conclude that petitioner is not entitled to deduct
the legal fees associated with the Squirrel Bend litigation in
any amount greater than that which was allowed by respondent in
the notices of deficiency.
C.
SEC and Orange Co. Litigation Expenses
Petitioner argues that the SEC and Orange Co. litigation
expenses were related to his "business of promoting" or his
business of being an employee of Orange Co. (as an officer and
director).
Respondent contends that the SEC litigation was not
related to a business activity.
In the alternative, respondent
argues that if petitioner's actions were in the course of
petitioner's trade or business of being an employee of Orange
Co., he was entitled to reimbursement of the SEC and Orange Co.
- 42 litigation expenses from Orange Co.
Therefore, respondent
contends that petitioner is not entitled to deduct the SEC and
Orange Co. litigation expenses.
Assuming arguendo that Mr. Davis was in the "business of
promoting"6--which he alleges entailed the starting and promoting
of businesses--the SEC and Orange Co. litigation did not arise
from, were not proximately related to, and did not bear a nexus
to a "business of promoting".
The SEC litigation arose out of
the SEC's investigation of an unusual amount of trading of Orange
Co. stock in August of 1984 by Mr. Binion and Mr. Davis' sons.
The complaint the SEC filed alleged that certain trading by Mr.
Davis' sons was based on material, nonpublic information provided
to them by their father.
The Orange Co. litigation arose out of
a hostile proxy fight, an alleged breach of fiduciary duty and
breach of contract by Orange Co.'s former officers and directors,
and the ouster of the directors of Orange Co.
The Orange Co.
litigation also involved Mr. Davis' additional breach of contract
and unjust enrichment claims.
Assuming arguendo that the aforementioned claims in the SEC
and Orange Co. litigation were related to his position as an
employee of Orange Co., the performance of services as an
6
We make no finding regarding whether Mr. Davis was in the
"business of promoting".
- 43 employee constitutes a trade or business.
See O'Malley v.
Commissioner, 91 T.C. 352, 363-364 (1988).
When an employee, however, has a right to reimbursement for
expenditures related to his status as an employee but fails to
claim such reimbursement, the expenses are not deductible because
they are not "necessary" within the meaning of section 162; i.e.,
it is not necessary for an employee to remain unreimbursed for
expenses to the extent he could have been reimbursed.
See Orvis
v. Commissioner, 788 F.2d 1406, 1408 (9th Cir. 1986), affg. T.C.
Memo. 1984-533; Lucas v. Commissioner, 79 T.C. 1, 7 (1982);
Kennelly v. Commissioner, 56 T.C. 936, 943 (1971), affd. without
published opinion 456 F.2d 1335 (2d Cir. 1972).
The employee has
the burden of establishing that the employer would not reimburse
the expense had the employee requested reimbursement.
v. Commissioner, 24 T.C. 21, 23 (1955).
See Podems
Moreover, the
prohibition of deductions for reimbursable expenses is a "bright
line rule" and applies even when the employee is unaware that the
expenses are reimbursable.
See Orvis v. Commissioner, supra at
1408.
Orange Co.'s certificate of incorporation required
indemnification of officers for expenses arising from acts
performed in good faith and in a manner reasonably believed to be
in the best interest of Orange Co.
All of the SEC and Orange Co.
litigation expenses Mr. Davis deducted in 1987 and 1988 were
- 44 included in the demand for indemnification in the Orange Co.
litigation.
Furthermore, Orange Co.'s directors' and officers'
insurance company paid these attorney's fees, and petitioner has
failed to produce any credible evidence that he was not
reimbursed in full or that during the years in issue the prospect
of being reimbursed was insubstantial.7
Therefore, we conclude
that petitioner was not entitled to deduct the SEC or Orange Co.
litigation expenses for 1987 or 1988.
D.
Hong Kong Legal Fees, General Business Matters,
and Tax Matters
On brief, petitioner merely conclusively asserts that the
Hong Kong legal fees were related to, and a continuation of, his
"business of promoting" and that he incurred the legal fees for
tax matters and general business matters in connection with a
trade or business.
Petitioner neglected to cite any facts and failed to present
any evidence that would support these assertions.
We conclude
that petitioner has failed to meet his burden of proof with
regard to these expenses.
7
See Rule 142(a).
Petitioner contends that he was not reimbursed for the
work Laura Byrne, who represented petitioner in part of the
Orange Co. litigation, did for him. On the basis of the record,
however, petitioner has failed to prove that he was not
reimbursed or that he did not have a right to be reimbursed for
these expenses.
- 45 To reflect the foregoing,
Decision will be entered
for respondent in docket No.
4449-92.
Decision will be entered
under Rule 155 in docket No.
5744-92.
Decision will be entered
for petitioner in docket No.
25088-96.
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