                        T.C. Memo. 2001-172



                      UNITED STATES TAX COURT



       CIM TRUST, CHARLOTTE MORROW, TRUSTEE, Petitioner v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent

          PETER AND CHARLOTTE I. MORROW, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket Nos. 18689-99, 18690-99.            Filed July 12, 2001.




     W. McNab Miller III, for petitioners.

     W. Lance Stodghill, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION

     COHEN, Judge:   Respondent determined deficiencies in

petitioners’ Federal income taxes and accuracy-related penalties

under section 6662(a) as follows:
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CIM Trust, Charlotte Morrow, Trustee
Docket No. 18689-99

                                   Penalty
         Year     Deficiency    Sec. 6662(a)

         1996       $5,713         $1,143
         1997       28,128          5,626

Peter and Charlotte I. Morrow
Docket No. 18690-99

                                   Penalty
         Year     Deficiency    Sec. 6662(a)

         1996       $3,118           $624
         1997        6,379          1,276

     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 by the parties, the issue remaining

for decision is whether petitioner CIM Trust (the trust) should

be disregarded for Federal income tax purposes and the income and

expense from the business operations of I.D.F. Pest Control Co.

attributed to petitioners Peter Morrow and Charlotte I. Morrow

(the Morrows).

                         FINDINGS OF FACT

     Some of the facts have been stipulated, and the stipulated

facts are incorporated in our findings by this reference.

     Peter Morrow and Charlotte I. Morrow (Charlotte Morrow),

husband and wife, resided in Humble, Texas, at the time they
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filed their petition.   The principal address of the trust was

Humble, Texas, at the time of filing its petition.

     Prior to the establishment of the trust, Charlotte Morrow

owned and operated I.D.F. Pest Control Co. as a sole

proprietorship.   I.D.F. Pest Control Co. was engaged in the

business of pest control for residential and commercial

buildings, including determining the type and nature of pest

infestation, the extent of structural damage, and the means to be

used to control or eliminate the pest.    As a sole proprietorship,

all of the equipment was owned or provided by the Morrows

individually.

     The trust was established after the Morrows sought the

advice of their tax preparer, who suggested operating the

business either as a trust or as an S corporation.    The Morrows

then consulted with a tax attorney, to whom they paid $2,495 to

draft the trust document.    The Morrows asked their adult

daughter, Starlesta Kimmey (Kimmey), to become involved in the

trust arrangement, and, on October 1, 1996, Kimmey, as donor, and

Charlotte Morrow, as trustee, executed the trust agreement.    The

trust designated Charlotte Morrow as both the trustee and

beneficiary of the trust.    Peter Morrow was named as the

successor trustee and successor beneficiary of the trust upon the

death of Charlotte Morrow.    Under the terms of the trust, the
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beneficiary, while serving as trustee, had the power to appoint

cotrustees and successor trustees.

     The trust was initially funded with $1 from Kimmey and a

check from Kimmey, dated October 1, 1996, for $1,000 that was

later deposited into the trust bank account.   The trust agreement

provided that any other person could add property acceptable to

the trustee.

     Charlotte Morrow operated the pest control business under

the assumed name “I.D.F. Pest Control Co.” until December 13,

1996, when she filed an Assumed Business Name Certificate,

stating that the trust would be conducting business under the

name “I.D.F. Pest Control Co.”.

     The operations of the pest control business did not change

after the business was transferred to the trust.   As trustee,

Charlotte Morrow performed the same duties for I.D.F. Pest

Control Co. that she performed before the creation of the trust.

I.D.F. Pest Control Co. also used the same service contracts and

same invoices.

     Peter Morrow worked for I.D.F. Pest Control Co. as an

employee both before and after the establishment of the trust.

After the establishment of the trust, Peter Morrow, individually,

and Charlotte Morrow, as trustee, entered into a signed

Employment Contract dated October 1, 1996.   In that contract,

Peter Morrow agreed to provide his services as a pest control
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manager in exchange for a salary of $25,000 annually.    Peter

Morrow received a Form W-2, Wage and Tax Statement, for 1996 from

the trust in the amount of $3,000 and for 1997 from the trust in

the amount of $25,000.

     The ownership of the business bank account was transferred

from Charlotte Morrow, individually, to the trust in December

1996.    Both Peter Morrow and Charlotte Morrow had signature

authority over the trust bank account.    Peter Morrow paid

personal expenses out of the trust bank account.

     The Morrows did not apply for insurance in the name of the

trust.    The commercial general liability insurance policy was

written to Charlotte Morrow d.b.a. I.D.F. Pest Control Co. for

the policy period beginning June 20, 1997.    On the business

automobile insurance policy, the name of the insured was listed

as Charlotte Morrow d.b.a. I.D.F. Pest Control Co. for the policy

period beginning July 31, 1997.

     The Morrows continued to use the same Texas Structural Pest

Control business license that allowed them to operate a pest

control business.    The Texas Sales and Use Tax Returns listed

Charlotte Morrow as the taxpayer, with Charlotte Morrow’s Social

Security number as the taxpayer identification number, and listed

I.D.F. Pest Control Co. as the business both before and after the

Morrows began operating the business through the trust.
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     The Morrows reported the income and expenses of I.D.F. Pest

Control Co. from January 1 to September 30, 1996, on Schedule C,

Profit or Loss From Business, of their jointly filed Form 1040,

U.S. Individual Income Tax Return.       Subsequent to October 1,

1996, the trust reported the income and expenses of I.D.F. Pest

Control Co. on Schedule C of its Form 1041, U.S. Income Tax

Return for Estates and Trusts.    The trust reported no taxable

income in either 1996 or 1997 because its net income from the

pest control business operations was deducted as an income

distribution deduction and reported as such on a Schedule K-1,

Beneficiary’s Share of Income, Deductions, Credits, etc., to

Charlotte Morrow as the beneficiary.       Charlotte Morrow reported

the income distribution from the trust on Schedule E,

Supplemental Income and Loss, Part III, Income or Loss From

Estate and Trusts, of the Morrows’ jointly filed Federal

individual income tax return.

     Peter Morrow owned the equipment used in the pest control

business.   Lease payments in the amount of $8,600 per year were

reported as income by the Morrows on Schedule C of their jointly

filed 1997 Form 1040 and were claimed as an expense on the

trust’s Schedule C of its 1997 Form 1041.       No lease agreement was

executed.   No payments were made by the trust to Peter Morrow for

use of the equipment.   The handling of the equipment lease
                               - 7 -

transaction and of reporting for tax purposes was done by the

Morrows’ tax preparer.

                              OPINION

     Respondent’s position is that the trust lacks economic

substance and should be disregarded for Federal income tax

purposes.   Respondent maintains that the Morrows created a mere

paper entity, the trust, and transferred the business operations

of their sole proprietorship, I.D.F. Pest Control Co., to the

trust for the purpose of avoiding self-employment tax under

section 1402.

     Petitioners argue that the trust should be treated as a

separate entity because:   (1) The trust is a valid trust under

State law; (2) a business may lawfully change from one form of

entity to another, provided that the legal requirements are met;

and (3) the trustee of the trust may operate a sole

proprietorship business within the trust entity.   Petitioners

claim that the income and expenses of I.D.F. Pest Control Co.

were properly reported for Federal income tax purposes, because

the net income from the trust was reported as an income

distribution on a Schedule K-1 to Charlotte Morrow and

accordingly was reflected on the Morrows’ Schedule E of their

jointly filed Federal individual income tax return.

     Taxpayers are entitled to structure their transactions to

minimize their tax obligations.   Gregory v. Helvering, 293 U.S.
                                 - 8 -

465, 469 (1935).   However, transactions that have no significant

purpose other than to avoid tax and that do not reflect economic

reality will not be recognized for Federal income tax purposes.

Zmuda v. Commissioner, 79 T.C. 714, 719 (1982), affd. 731 F.2d

1417 (9th Cir. 1984); Markosian v. Comissioner, 73 T.C. 1235,

1245 (1980); see also Furman v. Commissioner, 45 T.C. 360, 364-

366 (1966), affd. 381 F.2d 22 (5th Cir. 1967).     Where the form of

a transaction has not altered any cognizable economic

relationships, we look through the form of the transaction and

apply the tax law according to the transaction’s substance.

Markosian v. Commissioner, supra at 1241.     This principle applies

regardless of whether the transaction creates an entity with

separate existence under State law.      Zmuda v. Commissioner, supra

at 720; see also Furman v. Commissioner, supra at 364.

     In deciding whether a purported trust lacks economic

substance, we consider the following factors:     (1) Whether the

taxpayer’s relationship, as grantor, to property purportedly

transferred into trust differed materially before and after the

trust’s formation; (2) whether the trust had a bona fide

independent trustee; (3) whether an economic interest in the

trust passed to trust beneficiaries other than the grantor; and

(4) whether the taxpayer honored restrictions imposed by the

trust or by the law of trusts.    See Markosian v. Commissioner,

supra at 1243-1245.
                                 - 9 -

     Respondent argues that the Morrows were effectively the

grantors of the trust because they arranged and paid for the

establishment of the trust and effectively transferred their pest

control business to the trust.    Respondent relies on Zmuda v.

Commissioner, supra at 720, and does not rely on the grantor

trust provisions under sections 671 to 678.     Petitioners assert

that Kimmey was the settlor of the trust because she is named as

the donor in the trust document and she funded the trust with

$1,001.   The Morrows claim that they did not transfer assets, not

even personal assets, to the trust, because the Morrows leased

the business equipment to the trust.     However, Peter Morrow

testified that he had not signed or even seen the purported

lease, and no payments were made by the trust to him for use of

the equipment.

     “In determining the settlors of a trust, we look beyond the

named grantors to the economic realities to determine the true

grantor.”   Id.   Kimmey was a straw man who acted only in form as

the grantor of the trust.   Kimmey’s involvement was a mere

formality; she signed the trust document and funded the trust

with a nominal amount.   Considering the economic realities, the

true grantors of the trust are the Morrows.     The Morrows, upon

the advice of their tax preparer, consulted with an attorney who

drafted the trust documents; the Morrows paid $2,495 for the

trust package and asked their daughter to get involved in the
                               - 10 -

trust arrangement.    The Morrows also transferred intangible

assets to the trust, such as the business name and the ongoing

business operations of I.D.F. Pest Control Co.

     The business was operated in substantially the same manner

both before and after the trust was created.    The business and

its activities continued under the same name, used the same

invoices and service contracts, used the same Texas Structural

Pest Control business license, used the same taxpayer

identification number on the Texas Sales and Use Tax Returns,

used the same insurance policies, and used the same business

equipment.    After the establishment of the trust, Peter Morrow

continued to work for the business and Charlotte Morrow continued

to manage the business.

     The trust did not have an independent trustee.   The Morrows

had control over the trust activities and trust assets.

Charlotte Morrow was named as the sole trustee of the trust, and

she had exclusive control over the trust and the business

operations.    Additionally, Peter Morrow was named as successor

trustee, had signature authority over the trust’s bank account,

and, on occasion, paid the personal expenses of the Morrows from

the trust bank account.    Under the terms of the trust, the

trustee also had the power to appoint successor trustees and

cotrustees.
                               - 11 -

     Petitioners assert that the personal expenses that were paid

from the trust bank account were accounted for as a distribution

and that only the legitimate business expenses were deducted.

Even so, the Morrows had the ability to control fully the trust’s

activities and trust assets for their own benefit because no

independent trustee had any meaningful control over the

management of the trust.

     No one other than the Morrows held any meaningful economic

interest in the trust because, under the terms of the trust

agreement, Charlotte Morrow was the named beneficiary and Peter

Morrow was the successor beneficiary of the income and principal

of the trust.

     Petitioners argue that the Morrows achieved benefits from

operating their sole proprietorship within a trust and not

forming a corporation because:   (1) The trust could protect the

business assets from their personal liabilities and conversely

protect their personal assets from liabilities arising from the

business operations; (2) the trust could avoid the State

franchise tax imposed on the profits of a corporation, which

would have been approximately $1,105; (3) the trust would not

have to pay the State incorporation filing fee of $300; and

(4) the trust did not have to maintain corporate formalities,

such as shareholder minutes.
                              - 12 -

     Peter Morrow testified at trial about the Morrows’ decision

to use a trust entity to operate their sole proprietorship:

          Q    Do you know why you chose a trust over
     choosing an S corporation?

               *     *    *    *     *    *    *

          A    * * * I don’t know how we came to that
     conclusion, other than the fact that my main concern
     was to have protection against lawsuits. You know, and
     if I could get any tax benefits out of it, I left that
     up to my tax people.

     Petitioners’ argument that a trust had advantages over an

S corporation misses the point.    The incorporation alternative is

not an issue here.   Petitioners chose the form of a trust and are

responsible for the consequences of their decision.   Those

consequences are not the same as corporate form.   The U.S.

Supreme Court has observed repeatedly:   “while a taxpayer is free

to organize his affairs as he chooses, nevertheless, once having

done so, he must accept the tax consequences of his choice,

whether contemplated or not, * * * and may not enjoy the benefit

of some other route he might have chosen to follow but did not.”

Commissioner v. Natl. Alfalfa Dehydrating & Milling Co., 417 U.S.

134, 149 (1974) (citations omitted).

     On the totality of the evidence, giving more weight to the

objective facts than to petitioners’ unsupported statements of

subjective intent, we conclude that the primary purpose of the

Morrows in establishing the trust was to avoid employment tax.

The trust lacked independent economic substance.   The Morrows
                              - 13 -

were, in substance, the grantors of the trust.   Thus, the income

and expenses from the operations of the pest control business

during the years in issue are attributable to the Morrows and not

to the trust.   The Morrows are liable for self-employment taxes

on the net income of I.D.F. Pest Control Co. for the years in

issue.

     To reflect the foregoing and concessions of the parties,

                                         Decisions will be entered

                                    under Rule 155.
