                        T.C. Memo. 1998-269



                      UNITED STATES TAX COURT


         MICHAEL A. AND KARYN E. SCHMITT, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 22670-95.              Filed July 23, 1998.



     Lawrence M. Lebowsky, for petitioners.

     Michelle Or, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION

     GERBER, Judge:   Respondent determined deficiencies in

petitioners’ Federal income tax in 1990 and 1991 of $24,808 and

$11,800.71, respectively.   The petition in this case seeks a

redetermination only of the deficiency for 1991.

     The issue for our consideration is whether petitioners had

unreported Schedule C income in taxable year 1991.
                               - 2 -


                         FINDINGS OF FACT1

     At the time the petition was filed, petitioners resided in

Woodland Hills, California.   Petitioners are cash basis

taxpayers.   Michael A. Schmitt (petitioner) is a law professor at

Southwestern University School of Law in Los Angeles, California,

and is licensed to practice law in the State of California.      From

1984 through the time of trial, petitioner operated a sole

proprietorship under the name Legal Education Conference Center

(LECC).

     LECC offered a full-service bar review course and

supplemental workshops to law school graduates who were preparing

to take the California bar examination.      The full service bar

review course covered substantive areas of law tested on the

California bar examination, including both the National

multistate law and California State law components of the bar

examination.   LECC also offered three supplemental workshops that

each focused on a specific area of testing on the California bar

examination:   Essay writing, performance skills, and the

multistate law component.   The bar review course and workshops

were offered twice a year coinciding with the testing times for

the California bar examination, which is given in February and

July of each year.   LECC also offered a preliminary bar review

     1
       The stipulation of facts and the attached exhibits are
incorporated herein by this reference.
                               - 3 -


course for third-year law students who were planning to take the

bar examination after graduation.    Petitioner was an instructor

for the bar review courses.

     LECC’s bar review course was offered on either a guaranteed

or nonguaranteed basis.   Under the guaranteed program, students

were entitled to a full refund of their tuition if they failed

the bar examination.   The same course material and instruction

were provided for the guaranteed and nonguaranteed review

courses.   However, students in the nonguaranteed course were not

eligible to receive a refund of any portion of their tuition if

they failed the bar examination.    Also, the tuition for the

guaranteed course (guaranteed tuition) was higher than the

tuition for the nonguaranteed course.    The supplemental workshops

were offered only on a guaranteed basis.    Students enrolled in

the guaranteed bar review course could attend the supplemental

workshops without paying an additional charge.    Alternatively,

students could enroll in a workshop without enrolling in the bar

review course.   Class sizes for the bar review course and

supplemental workshops were limited.

     The cost of the guaranteed bar review course and guaranteed

supplemental workshops included a registration fee and tuition.

The registration fee for the guaranteed course and workshops was

nonrefundable.   The costs of the nonguaranteed and guaranteed

review courses and the guaranteed workshops were as follows:
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                                  Registration
        Course                        Fee        Tuition    Total
Nonguaranteed review course            ---          ---    $1,075
Guaranteed bar review                 $490       $1,000     1,490
Guaranteed performance skills          250          500       750
Guaranteed essay writing               250          500       750
Guaranteed multistate                  175          300       475

The record in this case does not indicate whether the cost of the

nonguaranteed course comprised a registration fee and tuition or

the amounts thereof.

     The registration fee and tuition had to be paid in full

before the first day of review classes.   The course for the

February examination (winter course) began in the preceding

January, and the course for the July examination (summer course)

began in June.   Accordingly, students who were enrolled in the

winter 1992 bar review course paid their tuition in December

1991.   There were 38 students enrolled in LECC’s winter 1992

guaranteed course.   The guaranteed tuition from the winter 1992

course was approximately $30,000 and was subject to a refund in

1992 to any student who failed the February 1992 bar examination.

     LECC promised to pay the tuition refunds to guaranteed

students who failed the bar examination within 2 weeks of the

release of the results.   Petitioner has given certain guaranteed

students the option of reenrolling in LECC’s bar review course

free of charge instead of obtaining a tuition refund.   Petitioner

had discretion over whether to permit a student to reenroll in an

LECC course after failing the bar examination.   If he thought
                                - 5 -


that a failing student had not made an effort to pass the bar

examination during the previous review course, he would not

permit that student to reenroll.    Additionally, LECC’s brochure

stated that a failing student had to have received a score of at

least 1,400 on the prior bar examination to reenroll in the

guaranteed course.    According to the brochure, students who had

less than a 1,400 score on the previous bar examination could

reenroll in the nonguaranteed course.    When a failing student

(who had not obtained a tuition refund) reenrolled in an LECC

course, petitioner provided additional materials and services to

the student without additional compensation from the student.

Also, because the LECC class sizes were limited, a repeating

student reduced petitioner’s ability to generate revenue from the

LECC courses.

     LECC had a checking account at Sanwa Bank (Sanwa account).

During 1991, petitioner deposited the registration fees and the

tuition from both the guaranteed and nonguaranteed bar review

courses and the supplemental workshops into the Sanwa account.

During 1991, petitioner deposited $265,273 into the Sanwa

account.    Petitioner’s deposits into the Sanwa account included

the $30,000 tuition from the winter 1992 guaranteed review

course.2    During 1991, petitioner also paid refunds from the

Sanwa account to guaranteed students who failed the bar

     2
         Amounts are rounded to the nearest dollar.
                                - 6 -


examination.   In that year, petitioner paid refunds of $46,165

from the Sanwa account.    Overall, petitioner withdrew $257,129

from the Sanwa account during 1991.

     Petitioner also had a term savings account at World Savings

and Loan Association (World Savings).    He opened the account on

July 23, 1990, with a $50,000 deposit.    The savings account was

in petitioner’s name and was not designated a trust account.

After making the initial $50,000 deposit in 1990, petitioner did

not deposit any additional money into the World Savings account.

In particular, he did not deposit any of the tuition from the

summer 1991 or winter 1992 guaranteed review courses into the

account.    Petitioner deposited the tuition paid during 1991 into

the Sanwa account and did not transfer any money between the two

accounts.

     Petitioner maintained the account at World Savings until

1994.   Throughout the term of the account, petitioner never made

any withdrawals from it.    He did not pay any refunds to

guaranteed students who failed the bar examination from the World

Savings account.   Nor did petitioner withdraw money from the

account when guaranteed students passed the bar examination.

Petitioner allowed the interest earned on the account to

accumulate and did not pay the interest over to the guaranteed

students.   Petitioners reported the interest income from the

account on their 1991 tax returns.
                               - 7 -


     Respondent computed petitioners’ 1991 Schedule C gross

receipts from LECC using the bank deposits method on the basis of

deposits into the Sanwa account during 1991 and determined that

petitioners underreported their gross receipts by $83,166.

Respondent allowed petitioners a deduction for the $46,165 in

refunds that were paid to failing students during 1991, which

petitioners had not claimed on their 1991 tax return.

Accordingly, respondent determined that petitioners had

unreported Schedule C net income of $37,001 in 1991.

                              OPINION

     Respondent determined that petitioners had unreported

Schedule C net income for 1991 in the amount of $37,001 from bar

review courses that petitioner offered through LECC.    Petitioners

have the burden of showing that they did not have income in the

amount determined by respondent.   Rule 142(a).3   Petitioners have

conceded that they underreported their Schedule C net income by

$1,000.   Petitioners have not offered any explanation for $6,001

in unreported net income determined by respondent.    Accordingly,

we find that petitioners have unreported their taxable income in

these amounts.




     3
       Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the year in issue, and
all Rule references are to the Tax Court Rules of Practice and
Procedure.
                                - 8 -


     With respect to the remaining $30,000 in unreported net

income determined by respondent, petitioners contend that they

were not required to report $30,000 of tuition from LECC’s winter

1992 guaranteed review course that was deposited into the Sanwa

account during 1991.   The guaranteed students paid the tuition in

1991, and the tuition was refundable to students in 1992 if they

failed the bar examination.    Petitioner contends that there were

substantial restrictions on his receipt of the tuition during

1991 because (1) he was required by the LECC contract with the

guaranteed students to place the $30,000 tuition into a set-aside

escrow account until the students passed the bar; and,

(2) pursuant to the contract, he established a trust account at

World Savings for deposit of the refundable tuition.   In this

regard, petitioner argues that the guaranteed tuition should not

be reported as income until the guaranteed students passed the

bar examination.

     Petitioner, however, failed to establish a trust, either in

form or in substance, for the guaranteed tuition.   Petitioner

deposited $50,000 into a savings account at World Savings;

however, he was not required to do so by LECC's guaranty

agreement with the students.   Rather, petitioner personally chose

to put money in the World Savings account and could have decided

to withdraw and spend the money at any time without restriction

or recourse from the guaranteed students.   Petitioner’s failure
                                - 9 -


to properly structure a trust for the receipt of the tuition

payments is especially difficult to excuse because he is an

attorney and law professor and taught trust law for the LECC

review courses.   Petitioner’s arguments, which are addressed

below, that he was contractually obligated to create an

escrow/trust and, in fact, created a trust with the guaranteed

tuition are without merit.

     Taxpayers who use the cash method of accounting, such as

petitioners in this case, must report income when it is actually

or constructively received.    Sec. 451(a); sec. 1.451-1(a), Income

Tax Regs.   Income is constructively received by a taxpayer when

it is "credited to his account, set apart for him, or otherwise

made available so that he may draw upon it at any time".    Sec.

1.451-2(a), Income Tax Regs.   Where the taxpayer’s control of the

receipt of income is subject to substantial limitations or

restrictions, the income is not constructively received by the

taxpayer.   Sec. 1.451-2(a), Income Tax Regs.   The doctrine of

constructive receipt requires taxation of income that is subject

to a taxpayer’s unfettered command and that the taxpayer is free

to enjoy at his own option even though he chooses not to.

Corliss v. Bowers, 281 U.S. 376, 378 (1930).    Petitioners have

the burden of establishing that they did not have actual or

constructive receipt of the $30,000 in tuition from the winter

1992 guaranteed course.   Rule 142(a).
                              - 10 -


     Petitioner has argued that the LECC agreement with the

guaranteed students required that the guaranteed tuition be

placed into a set-aside escrow account.   However, there is no

credible evidence that the agreement between petitioner and the

guaranteed students required petitioner to create an escrow or

trust arrangement.   There was no written escrow agreement between

petitioner and the guaranteed students.   The only reliable

evidence of the terms of the guaranteed review course is the LECC

brochure.   The LECC brochure contains the statement that

petitioner will refund tuition to students enrolled on the

guaranteed basis if they fail the bar examination.   There is

nothing in the brochure that indicates in any way that petitioner

intended to place the tuition into an escrow or trust account or

would not use the tuition before the students passed the bar

examination.   We hold that petitioner was not required by his

agreement with the guaranteed students to establish an escrow or

trust account to hold the tuition payments.   There was no

contractual restriction on petitioner’s use of the $30,000

tuition during 1991, and any restriction on petitioner’s use of

the tuition was imposed by petitioner himself.

     Petitioner contends that he created an oral trust to hold

the guaranteed tuition until the students took the bar

examination.   Under California law, an express trust in personal

property may be made by an oral declaration of trust.    Cal. Prob.
                               - 11 -


Code sec. 15207 (West 1991).    A trust may be created by a

declaration by the owner of property, by the transfer of property

to a third person as trustee, or by an enforceable promise to

create a trust.   Cal. Prob. Code sec. 15200 (West 1991).     The

essential elements of a trust under California law are:     (1) A

manifestation of an intention by the settlor to create a trust;

(2) trust property; (3) a lawful purpose for the trust; and (4)

an identified beneficiary.    Cal. Prob. Code secs. 15200-15205

(West 1991); Osswald v. Anderson, 49 Cal. App. 4th 812, 818, 57

Cal. Rptr. 2d 23, 26 (1996).    The creation of a trust is not

determinative of whether or not petitioner had constructive

receipt of the guaranteed tuition when paid by the students.        A

cash basis taxpayer has constructive receipt of funds paid into

an escrow or trust account upon deposit unless the taxpayer’s

control over the money in the account is subject to substantial

limitations or restrictions.     Stiles v. Commissioner, 69 T.C.

558, 563 (1978); sec. 1.451-2, Income Tax Regs.

     Petitioner did not establish a trust account with the

$30,000 guaranteed tuition.    Petitioner contends that he created

a trust account at World Savings and that he held the tuition in

that account until the students passed the bar examination.      The

World Savings account was in petitioner’s name and was not

designated as a trust account.    No deposits were made to that

account after 1990.   Petitioner never deposited the tuition from
                              - 12 -


the winter 1992 course into the account at World Savings.

Rather, he deposited the $30,000 into the Sanwa account and did

not transfer any money from Sanwa to World Savings.

Consequently, the $30,000 tuition from the winter 1992 guaranteed

course was not held in trust in the World Savings account.

Petitioner also continued to pay refunds to failing students from

the Sanwa account during 1990 and 1991.   He did not withdraw

money from the account when students passed the bar examination

and, under his argument, he would have been entitled to the

tuition.   In fact, petitioner did not make any withdrawals from

the World Savings account until 1994.   Petitioner’s actions in

connection with the World Savings account and his treatment of

the tuition are entirely inconsistent with his claim that he held

the tuition payments in trust at World Savings.   He did not place

the $30,000 of guaranteed tuition in an escrow or trust account.

Rather, he placed all of the tuition into the Sanwa account and

spent the tuition to pay operating expenses of the review

courses.   We hold that petitioner had actual receipt of the money

upon deposit.   Accordingly, petitioner must report the tuition as

income in 1991.

     Petitioner contends that before 1990, he reported the

tuition from the guaranteed course as Schedule C gross receipts

in the year the tuition was paid by the students.   Petitioner

maintains that in 1990, he opened a trust account at World
                             - 13 -


Savings for the purpose of deferring the reporting of the

guaranteed tuition as income until the students passed the bar.

He contends that he deposited $50,000 of refundable tuition from

the guaranteed course offered during 1990 into the World Savings

account to be held in trust for the guaranteed students until

they took the bar examination.    Petitioner has attempted to

explain his failure to deposit the purported trust property,

i.e., the $30,000 in tuition from the winter 1992 guaranteed

course, into the alleged trust account.    He contends that because

he had previously deposited $50,000 into the World Savings

account and did not withdraw the money to pay refunds to failing

students in the previous year, there was sufficient money in the

account to cover tuition refunds for the winter 1992 courses.

Petitioner argues that it was unnecessary for him to deposit the

$30,000 in tuition from the winter 1992 guaranteed course into

the alleged trust account.

     There was some confusion at trial as to which parties,

petitioner or the guaranteed students, were the settlors and

beneficiaries of the alleged trust.    Petitioner argues that both

he and the guaranteed students are the settlors.    Under

California law, a trust is created only if the settlor manifests

an intention to create a trust.    Cal. Prob. Code sec. 15201.

Petitioner contends that he intended to create a trust.

Petitioner's intention, as the trustee or a beneficiary (if the
                               - 14 -


students passed the bar examination) of the trust, to establish a

trust is irrelevant.   Petitioner’s position that he was the

settlor of the purported trust presupposes that he was the owner

of the trust property at the time of the declaration of trust,

because only an owner of property is able to declare an intent to

hold that property in trust.   See Cal. Prob. Code sec. 15200(a).

     It has not been shown that the guaranteed students were the

settlors of the trust and transferred the tuition payments with

the intention that the tuition would be held in trust until the

bar examination results were announced.   Petitioner has not

presented any evidence that the guaranteed students intended to

create a trust or escrow for future payment of the $30,000

tuition to petitioner if they passed the bar examination.    The

guaranteed students paid the tuition for the LECC course during

1991.   There has been no showing of an intention to restrict

petitioner’s use of the tuition money until the students passed

the bar examination.   Rather, the students expected that

petitioner would refund the money if they failed.

     Finally, we note that we are not certain that the $50,000

deposited into the World Savings account was tuition held in

trust for an LECC course offered during 1990.   Petitioner

contends that he withdrew $50,000 of tuition payments from the

Sanwa account and deposited the money into the alleged trust

account at World Savings.   That testimony is not supported by
                               - 15 -


evidence in the record, such as a check issued on Sanwa or a bank

statement from the Sanwa account, that shows that petitioner

withdrew $50,000 from Sanwa.    Petitioner produced bank statements

from the Sanwa account for only the months of May, June, and

December 1990.   The deposit was made on July 23, 1990, and did

not coincide with the payment of tuition by guaranteed students

during that year.   Tuition for the summer 1991 course was

generally paid in May 1990.    Petitioner has not explained his

delay in establishing the alleged trust account.    The logical

conclusion is that petitioner used his own money to open the

World Savings account rather than refundable tuition from the

LECC's 1990 review courses, as he contends.

     There is no documentary support of petitioner’s or the

guaranteed students’ alleged intent to create a trust account or

escrow arrangement.   Petitioner failed to deposit the tuition

into the World Savings account; petitioner’s oral testimony that

he intended to create a trust is not credible.    Petitioner’s

right to retain the tuition from the guaranteed courses was in

some respects contingent on the students' performance on the

California bar examination.    However, the possibility that

petitioner might have had to pay failing students refunds is not

a substantial restriction on his use of the tuition.    The World

Savings account was not a trust account that created a
                             - 16 -


substantial restriction on petitioner’s use and control of the

tuition payments.

     To reflect the foregoing,



                                      Decision will be entered

                                 for respondent.
