                        T.C. Memo. 2009-245



                      UNITED STATES TAX COURT



        DAVID J. FELT AND SHARON A. FELT, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 3735-06.              Filed October 28, 2009.



     George W. Connolly and Habeeb Gnaim, for petitioners.

     Randy Durfee and Gordon Sanz, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     HOLMES, Judge:   David Felt, a real-estate broker and mortgage

banker, bought a Texas savings-and-loan association in 1983.    It

was failing, and regulators wanted him to sell.   To make matters

worse, David and his wife Sharon failed to file their tax returns
                                 - 2 -

for 1986-87, 1989, and 1994-98.    The Commissioner says their

failure to file concealed massive amounts of income, including:

      !     $4 million in capital gains from the sale of the S&L,

      !     $2 million in cancellation-of-indebtedness income from a
            different business that David also ran, and

      !     a small river of money streaming to the Felts through
            accounts held by David’s aged mother and flowing from
            indistinct sources offshore.

      The Commissioner also asserts various additions to tax, and

resists Sharon Felt’s request for innocent-spouse relief.

                            FINDINGS OF FACT

I.   Beginnings: Reliance Savings Association

      David Felt bought Bowie County Savings & Loan Association in

1983.     He financed the deal with $1.4 million borrowed from the

Texas Investment Bank and from an entity called American Guaranty

Inc. (AGI), which he himself owned.      Felt moved Bowie to Houston

and renamed it Reliance Savings Association.     Reliance was a

state-chartered, federally insured S&L regulated by the Federal

Home Loan Bank Board (FHLBB).

      S&Ls became popular in the early twentieth century as a way

to promote home ownership.    Kendall, The Savings and Loan Business

1 (1962).     They offered slightly higher interest rates on savings

accounts than could some banks, and then used the savings to fund

residential mortgages.     For much of the century, S&Ls enjoyed tax

benefits but also shouldered a heavy regulatory weight–-for

instance, a majority of their assets had to be residential real-
                                 - 3 -

estate loans.   In 1980, Congress passed the Depository

Institutions Deregulation and Monetary Control Act of 1980, Pub.

L. 96-221, sec. 401, 94 Stat. 151, which loosened restrictions on

consumer lending and broadened the types of investments thrifts

could make.   Volatile interest rates, a mismatch of short-term

government-insured liabilities and long-term risky investments--

plus some outright thievery--led to a financial crisis in the

industry when borrowers defaulted at staggering rates.    Hundreds

of S&Ls failed, and Texas was especially hard hit, partly due to

sagging real estate prices; Felt himself estimated that nearly 75%

of the S&Ls in the state failed or disappeared in the 1980s.

     Reliance was one of them.    In 1986, the FHLBB came after Felt

for regulatory violations, and threatened him with removal and a

cease-and-desist order.   Felt took the hint and, in August 1986,

agreed to sell his entire interest in Reliance.   The Bank Board

gave him six months, and warned him to come to the Board for

approval of any deal that he worked out.

     Felt quickly found a consortium of buyers.   They fell into

three groups.   The first were people who had lent money to AGI and

gotten notes back; Felt traded 60 percent of his Reliance stock

for the return of these notes.    The second group paid him $500,000

in cash for 7 percent of the Reliance stock, but borrowed the

money from a bank which required Felt to personally guarantee the

loan.   And a third group bought the remaining 33 percent with
                                 - 4 -

notes from yet another of Felt’s business entities, called

Specialty Finance Company, which held the shares as collateral.

      The deal was trouble from the start.   Felt’s offering

material included unaudited financial statements and failed to

include some information that it should have.     The deal also

depended on anticipated sales to affiliates that were less than

certain to occur.     Felt didn’t fix these problems and the FHLBB

never approved the sale.

      But Felt went ahead with the deal anyway.   The FHLBB’s

response was swift and harsh.     It seized Reliance, and in 1990 it

got a judgment against Felt requiring him to rescind the sale.

This left him to pay a judgment for $4.2 million plus costs and

interest.     The Felts declared bankruptcy in 1992, but even

bankruptcy turned sour in 1997 when the Office of Thrift

Supervision, the FHLBB’s successor agency, won a court order

declaring the $4.2 million judgment nondischargeable because it

arose from Felt’s willful defalcation and breach of fiduciary

duty.

II.   Life After Bankruptcy

        The Felts both testified that life became grim.   David said

they had had an A+ lifestyle before mid-1987, which gradually

became an F lifestyle.     Sharon credibly testified that she and her

husband could no longer afford a housekeeper or a landscaping

company after 1992.     We also believed her testimony that they
                                 - 5 -

could no longer afford new furniture and began instead to accept

used furniture handed down from her elderly mother-in-law, Birdie

Felt.

       It wasn’t just furniture that Birdie was giving the Felts.

By 1994, and until her death in 2000, many of the Felts’ ordinary

household expenses came to be paid from Birdie Felt’s checking

account.     Tens of thousands, and perhaps hundreds of thousands, of

dollars a year for rent, summer camp, college expenses, and

credit-card bills came to the Felts from her account.     She also

deposited money into several of David’s business accounts.

       The source of her plentiful wealth is unclear.   But whatever

its ultimate origins, it flowed from offshore accounts back to the

United States in regular $7,500 wire transfers.    These wire

transfers continued uninterruptedly until March 2000, several

months before Birdie died.    We specifically find that at least

some of her wealth came from her son; for 1995 through 2000, the

bank records of Tower Resources (yet another of David’s many

businesses) show almost $40,000 flowing to Birdie.

III.    AGI and AGI-Nev

        Reliance was only one province of Felt’s empire in the ‘80s.

Another was AGI, a Texas corporation that Felt had formed in 1978,

and which later was to become entangled in the Reliance sale.      As

Felt’s troubles grew, he began to fail to pay AGI’s franchise tax,

and its registration lapsed in November 1989.    Before then,
                                 - 6 -

though, AGI was in the consumer and residential loan business,

which it funded by borrowing money from investors.     AGI’s

importance to this case lies in the notes with a face value of

$2,510,740 that some of its investors exchanged for Reliance stock

in 1986.

     But there was also another AGI.     In 1998, Felt applied for an

Employer Identification Number for “American Guaranty, Inc.” in

Las Vegas, Nevada (we’ll limit our use of the abbreviation AGI to

the Texas corporation, and call this one AGI-Nev).     Felt listed

his aged mother as AGI-Nev’s principal officer.     He described it

as a “holding company” and indicated that “American Guaranty,

Inc.” had never applied for an EIN before.     (AGI-Nev is also

defunct, Nevada having permanently revoked its registration.)

     AGI-Nev is important to the case because David and Birdie

opened at least two bank accounts in its name.     The first was a

checking account, into which they deposited $50,000.     The second

was a money-market account, into which they deposited $250,000.

Felt explained this by saying that he had given some old AGI

(that’s the by-then-defunct Texas AGI, not AGI-Nev) receivables to

a collections company, and that he formed the new company to

handle the money it remitted.    Felt testified that, despite the

corporate facade, he and Birdie used the AGI-Nev money personally

and may have split it equally.    There are several checks bearing

Birdie’s signature from the AGI-Nev accounts.     One check, written
                                    - 7 -

in February 1999, is for $17,048.39 and was endorsed by David

Felt.      The others, from 1998, total $55,000 and were endorsed for

deposit into Birdie’s Wells Fargo account.

IV.    J&N

       A third entity important here is J&N (the initials of the

Felt children).       J&N was not a corporation; Felt described J&N as

“effectively a d/b/a that just held some rental properties and a

couple of notes or something.”       It did, however, have a bank

account in its own name, and at least $153,000 somehow stumbled

into this account in 1997.       The source of the money is also

mysterious--Felt says that J&N took in only $80,000 that year by

collecting an old debt, and after expenses it netted only $73,118.

V.    Notices of Deficiency

       In 2005, the Commissioner issued notices of deficiency to the

Felts.       They showed the following deficiencies in tax:1




       1
       There is no explanation in the record for the different
deficiencies for the two Felts in 1987 and 1996.
                                 - 8 -

                     Year            Deficiency
                     1986            $991,690
                     1987     David: 103,859
                              Sharon: 103,084
                     1989                561,884
                     1994                 36,732
                     1995                 10,632
                     1996     David:      37,102
                              Sharon:     37,779
                     1997                144,567
                     1998                185,864

The Commissioner also asserted additions to tax under sections

6651(a)(1) and (2) and 6654.2    We tried the case in Houston, as the

Felts were Texans when they filed their petition.

                                OPINION

     The parties settled many issues, but these remain:

         !   Whether David and Sharon Felt should have reported
             capital gains for 1986 from the sale of Reliance;

         !   whether they should have reported $2 million in
             cancellation-of-indebtedness income for 1989;

         !   whether they should have reported income from Birdie
             Felt for 1996, 1997, and 1998;

         !   whether they should have reported $153,118 in income
             from J&N for 1997;

         !   whether they should recognize $300,000 in income from
             AGI-Nev for 1998;


     2
       Unless otherwise indicated, all section references are to
the Internal Revenue Code for the years at issue; all Rule
references are to the Tax Court Rules of Practice and Procedure.
                                   - 9 -

          !    whether Sharon Felt is entitled to relief from community
               property liability rules under section 66; and

          !    whether the Commissioner properly asserted additions to
               tax and a penalty against her.

I.   Income from the Sale of Reliance

      A.      Did David Recognize Gains from the Reliance Sale?

      To calculate gain, we subtract a taxpayer’s adjusted basis

from the sale price of the item sold.       Sec. 1001(a).   The parties

agree that Felt’s basis in his Reliance stock was $1,725,852.

Felt says he sold his shares for assets nominally worth $4.5

million.       But simple arithmetic will not do here, because the

parties dispute the actual value of what Felt got for his shares.

We therefore value each piece of what he got:

          !    the AGI notes,

          !    the borrowed cash supported by Felt’s guaranty, and

          !    proceeds from the Specialty Finance loans.

               1.   AGI Notes

      David exchanged about 60 percent of his Reliance shares for

notes payable by AGI.       These notes had a total face value of

$2,510,740, but Felt argues that they were worthless.       The

Commissioner contends that the Felts benefited because they were

the sole owners of AGI, and AGI was now free of a $2.5 million

debt.      Felt does admit that the cancellation of those notes might

have created cancellation-of-indebtedness income for him,3 but


      3
          Gross income includes “all income from whatever source
                                                        (continued...)
                                - 10 -

argues that this would be true only if he were personally liable

for their repayment.   We agree with Felt that we should look first

at whether the sale created cancellation-of-indebtedness income

for him from AGI, and only then at whether the sale created a gain

or loss.

     The Commissioner argues that David was personally liable on

the investors’ notes, got them as part of the Reliance stock sale,

and then canceled them, giving rise to $2.5 million of income.

It’s not immediately apparent why this should be so--AGI was a

corporation, which usually gives shareholders limited liability.

In Texas as elsewhere, a corporation’s creditors cannot

successfully demand that shareholders pay their company’s debts

unless the shareholders have guaranteed them.    See Tex. Bus. Corp.

Act Ann. art. 2.21 (Vernon 2003).

     David provided several pieces of evidence that he had not

personally guaranteed the notes or become otherwise personally

liable.    First is the letter he sent to AGI investors to induce

them to trade for his Reliance stock.    In that letter (of

admittedly dubious credibility) he writes:    “Although I, David

Felt, do not have any personal liability for payment of your AGI

note, and do not assume any liability for payment of your AGI note

* * * I will be preparing an offering circular for my stock in



     3
      (...continued)
derived,” including income from the discharge of indebtedness.
Sec. 61(a)(12).
                                 - 11 -

Reliance Savings Association.”    The parties introduced a more

persuasive AGI note from October 1984, originally made out to a

Tracy V. Huckins, which makes no mention of a personal guaranty by

David and seems to allow recourse only against AGI.

        The Commissioner’s only evidence is a Memorandum and Order

from the Southern District of Texas in FHLBB v. Felt, No. H-88-

1204 (S.D. Tex. 1997) (order to submit final judgment), which

states, “[A]s a result of the exchange, Felt * * * canceled AGI’s

investment debt, allowing Felt to avoid personal liability for

that debt; and allowed Felt to retain AGI’s assets for himself and

to forgive his personal debt to AGI.”     The problem for the

Commissioner here is that he didn’t give us enough context--the

District Court’s order doesn’t explain the basis for its finding.

And the Commissioner never pleaded or argued that Felt had

actually litigated the question in District Court--and we won’t

just assume that actual litigation or the other elements of

collateral estoppel exist.    We therefore find by a bare

preponderance of the evidence that David has produced sufficient

evidence that he was not personally liable on the notes.      He has

met his burden of showing that no cancellation-of-indebtedness

income accrued to him from the exchange of AGI notes.

     That’s not quite enough for the Felts to win this part of the

case.    They must also persuade us that the AGI notes were

worthless at the time of the sale.    The Commissioner helped them

here, presenting evidence from Timothy Wannemuehler, the FHLBB
                                - 12 -

bank examiner who examined AGI’s records in 1986, that AGI was

insolvent in 1986, and could not pay the notes.   This corroborates

Felt’s own claim that he himself knew the notes were worthless

when he accepted them for his Reliance stock–-he sent a letter to

AGI’s investors about that time to warn them of cashflow problems

at AGI and tell them that 90 percent of AGI’s competitors were out

of business or in bankruptcy.   We therefore find that the notes

were worthless.

          2.   Cash

     Five investors paid Felt a total of $500,000 cash for some

Reliance shares.   Some of these investors financed their purchase

through Texas Investment Bank, which required Felt to personally

guarantee the loans.   The record has three guaranty agreements for

a total of $171,000, all signed by Felt, effective December 1986.

All have stated maturity dates of December 31, 1987.    Felt does

not dispute that he received $500,000 cash in 1986.    His only

argument is that he later had to make good on some of his

guaranties and estimates that he had to pay back $100,000.

     He stumbles here on the claim-of-right doctrine, the rule of

tax law that states, “If a taxpayer receives earnings under a

claim of right and without restriction as to its disposition, he

has received income * * * even though it may still be claimed that

he is not entitled to retain the money.”   N.A. Oil Consol. v.

Burnet, 286 U.S. 417, 424 (1932).   If the taxpayer must later

repay, he may take a deduction in the year he repays.    Id.; see
                                 - 13 -

also sec. 1341.    This means the Felts must report the entire

$500,000 as income in 1986, the year they received it.

     That still leaves the question of whether the Felts are

entitled to a deduction in the year Felt made good on the guaranty

(assuming that year is one of the years before us).    Felt bears

the burden of proving both the amount he repaid and the date he

repaid it.   See Rule 142(a).   He offered only his testimony to

prove the amount of the repayment, and no evidence of the date of

the repayment.    We cannot say when he paid the guaranties or

whether he even paid in years covered by the notices of

deficiency, so on this point we find for the Commissioner.    The

Felts must include the entire $500,000 as payment for the Reliance

stock in 1986 and they are not entitled to a deduction for the

alleged $100,000 repayment.

           3.    Specialty Financing Notes

     The final group bought roughly 33 percent of the Reliance

stock.   They financed this with loans from Specialty Finance,

which turns out to be a doing-business-as name for David Felt.

These loans were in the form of promissory notes from the stock

buyers to Specialty Finance.    We have only one note in the record,

and it shows interest payable starting in April 1987, with

principal payments beginning in April 1989 and the entire note

coming due December 31, 1990.    The interest rate is set at either

the highest rate allowed by law or one percent over the prime

rate, whichever was less.    It was secured by the Reliance shares.
                                - 14 -

     Felt argues that because he was insolvent, Specialty Finance

was insolvent, thus making the notes worthless.    His logic is

clearly wrong; just because Citibank, for instance, becomes

insolvent doesn’t mean its credit card holders get off the hook

from paying their bills.    The relevant inquiry is into the

debtor’s solvency; if the debtor is solvent, an insolvent creditor

may sell the notes for immediate (if discounted) cash value.      This

is called “cash equivalence.”

     Individual taxpayers are generally cash basis taxpayers,

which means that they have to recognize income in the year they

“actually or constructively” receive it.    Sec. 451; sec. 1.451-

1(a), Income Tax Regs.   This rule is easy to apply to cash–-cash

is income when the taxpayer gets it in his hands.    It is harder to

apply to debt instruments like promissory notes, which entitle the

taxpayer only to a future income stream.    We evaluate this kind of

consideration for “cash equivalence,” and include it in income in

the year received, rather than counting it as income only when

payments are made.   Felt has the burden of proving that the notes

are not cash equivalents.    See Olster v. Commissioner, 79 T.C.

456, 469 n.14 (1982), affd. 751 F.2d 1168 (11th Cir. 1985).    We

look at whether the note is a “promise to pay of a solvent obligor

* * *, not subject to set-offs, and is of a kind that is

frequently transferred to lenders or investors at a discount not

substantially greater than the generally prevailing premium for
                                - 15 -

the use of money.”   See Cowden v. Commissioner, 289 F.2d 20, 24

(5th Cir. 1961), revg. 32 T.C. 853 (1959).

     Felt could have met his burden by showing, for instance, that

the debtors were insolvent, the notes could not be assigned, or

the notes would have traded at a deep discount.   See id.     But he

gave us nothing about these subissues; and so we find that the

notes were cash equivalents.   Our default rule is to rely on the

face value of the notes, as it is the only measure of this value

that we have.   See A. & A. Tool & Supply Co. v. Commissioner, 182

F.2d 300, 303 (10th Cir. 1950), revg. a Memorandum Opinion of this

Court.    We therefore find that the Felts must recognize as income

in the year of the sale the entire face value--$1,489,260-- of the

Specialty Finance notes.

     The total gain or loss from the sale is the amount Felt

received less his basis.   He received cash and notes worth

$1,989,260, and his basis was $1,725,852.    This leaves a taxable

gain of $263,408.

     B.   Did the Sale Produce Capital Gain or Ordinary Income?

     Felt argues that since he “was a dealer in notes in his

ordinary course of business * * * he is entitled to an ordinary

loss for the total amount of the consideration represented by

these notes.”   We have already found that Felt recognized gain on

the sale, but this argument forces us to determine whether the

gain was a capital gain or ordinary income.   Property held by a

taxpayer is generally a capital asset.   When a capital asset is
                                 - 16 -

sold, the gain or loss is capital too.     Sec. 1222.   Felt spent

considerable time arguing whether the notes he received in the

sale were capital assets, when he should have been arguing about

the Reliance stock that he sold.     Stock is a capital asset unless

it falls within the section 1221(a)(1) exception for dealers who

keep stock as inventory.     Felt was a banker who admittedly dealt

in “notes and mortgages,” not stock.      We therefore find that the

stock was a capital asset; the gains from its sale are capital,

too.    See Kadillak v. Commissioner, 127 T.C. 184, 199 (2006) affd.

534 F.3d 1197 (9th Cir. 2008).

       C.   When Is the Sale Taxable?

       Felt also argues that he did not recognize capital gains in

1986 because the sale was later rescinded by court order.      But, as

with his argument about part of the cash he received in

consideration--cash he later might have to pay back--this argument

founders on the claim-of-right doctrine.     The Felts have to

recognize income in the year they received it, and that year was

1986, because the Commissioner says so and the Felts never rebut

it.    They may have been entitled to a deduction later in the year

of the rescission--if they in fact could prove they paid back the

consideration that they had received--but that year is not before

us.

II.    Cancellation-of-Indebtedness Income

       The next issue is the timing of $2 million in cancellation-

of-indebtedness income.     The Commissioner asserts that Felt
                               - 17 -

borrowed over $2 million from AGI, and there is no dispute that he

never repaid it.   These unrepaid loans became income to Felt

in 1989, when AGI’s business registration lapsed.   Felt’s

counterargument is that he didn’t owe AGI any money and that, if

he did, AGI owed him more, so the amounts should offset.     He also

argues that he didn’t recognize the income in 1989 because AGI

continued operating despite its lapsed registration, and that he

didn’t have to recognize cancellation-of-indebtedness income in

1989 because he was insolvent that year.   See sec. 108(a)(1)(B).

We therefore analyze:

     !     Whether Felt owed AGI money,

     !     whether his debt was offset by a debt AGI owed him,

     !     if he did have cancellation-of-indebtedness income,
           whether he realized it in 1989 or some other year, and

     !     whether he was insolvent at the time he realized the
           income.

     A.   Did Felt Owe a Debt to AGI?

     We face a paucity of evidence about Felt’s debt to AGI.     The

only records we have are the FHLBB examiner’s handwritten notes

and accompanying AGI ledgers, coupled with the Felts’ stipulation

that AGI records showed these loans and the loans were never

repaid.   The records (which are, in places, illegible) show the

following eight loans worth more than $2 million total, falling

due between 1983 and 1987:
                               - 18 -

     Loan No.               Amount              Maturity Date
    31-020259-8         $1,946,672                  1-2-87
    31-020031-1             16,937                 11-1-86
    32-020134-3             14,200                11-15-86
    42-020223-4             16,500                 ?-12-86
                                              [month illegible]
    32-020147-5             40,870                11-16-83
    33-020058-4             16,000                 3-10-84
    38-020086-5             39,794                  7-8-83
    38-020087-3             58,000                11-01-83

     Felt carefully claims that “the record is devoid of any AGI

documentation reflecting” the $2 million loans.    But he doesn’t

actually deny owing AGI money; his briefs dispute only whether the

AGI records showed a debt, and whether they establish its amount.

We agree that the evidence is thin, but the Felts stipulated that

the AGI records “indicated that Mr. Felt was indebted to AGI in

the amount of $2,148,973.   This debt has never been repaid.”

Under Rule 91(e), stipulations are binding unless “justice

requires” the Court to release a party from its stipulation.      The

Felts nowhere claim that we should release them from the

stipulation; and since they were represented by counsel, we would

be unlikely to grant such a request.    We therefore find that Felt

owed AGI $2,148,973 and never paid it.

     B.   Was Felt’s Debt to AGI Offset by the AGI Notes?

     We next examine whether the notes Felt acquired in the

Reliance sale somehow reduce the debt he owed AGI and never
                                - 19 -

repaid.    Felt’s problem here is a failure to present proof that he

took steps to carry out a setoff.    Felt’s setoff argument seems to

be that if he has to realize cancellation-of-indebtedness income,

he need do so only after netting what he owed AGI against what AGI

owed him after he received AGI notes as part of the Reliance stock

sale.    Without a setoff, it is the full amount of Felt’s

indebtedness to AGI that might create cancellation-of-indebtedness

income.

     Setoff is a state-created right.    Citizens Bank of Md. v.

Strumpf, 516 U.S. 16, 18-19 (1995); Dzikowski v. N. Trust Bank of

Fla., N.A. (In re Prudential of Fla. Leasing, Inc.), 478 F.3d

1291, 1297 (11th Cir. 2007).    Texas requires four steps to set off

a debt:

     !      An intent to exercise his right to setoff;

     !      an action to accomplish the setoff;

     !      making a record of the setoff; and

     !      applying the funds taken by setoff to the debt
            owed.

Tex. Commerce Bank-Hurst, N.A. v. United States, 703 F. Supp. 592,

594-95 (N.D. Tex. 1988), affd. sub nom. Tex. Commerce Bank-Ft.

Worth, N.A. v. United States, 896 F.2d 152 (5th Cir. 1990);

Shearson Lehman Bros., Inc. v. Resolution Trust Corporation, No.

05-93-00527-CV (Tex. App., Feb. 23, 1994).    Felt did none of these

things--at least while AGI was still in existence--and his mere
                                - 20 -

declaration of an intent to set off retrospectively is not enough.

See In re Archer, 34 Bankr. 28, 30 (Bankr. N.D. Tex. 1983).

     We therefore find that Felt did not exercise any right to

setoff that he might have had, and that it is the full amount of

his loans from AGI that generates cancellation-of-indebtedness

income.

     C.   When Was There an Identifiable Event Leading to
          Realization of the Income?

     Since we have decided that Felt owed AGI money that was not

diminished by setoff, we next turn to deciding the year in which

his debt to AGI was canceled.   The Commissioner, relying on Cozzi

v. Commissioner, 88 T.C. 435 (1987), argues that there was an

“identifiable event” in 1989 because that was the year AGI

forfeited its corporate charter and, he says, ceased doing

business.   Felt says that AGI continued doing business after 1989

and any cancellation-of-indebtedness income would have arisen at

the time of the bankruptcy proceedings in 1992, which is not a

year at issue.

     We have long recognized the problem of fixing when

indebtedness is canceled; indeed, “it will often be impossible to

find one, and only one, event that clearly establishes the time of

abandonment [of a claim]; there is likely to be a range of times,

any one of which would be reasonable.” Id. at 447.   Our response

to this uncertainty is to make taxpayers show that the

Commissioner’s stated date does not fall within the range of
                                - 21 -

reasonable dates.    Id. at 448; see Rule 142(a).   We look to the

“facts and circumstances relating to the likelihood of payment” to

determine what range of dates would be reasonable.     Id. at 445.

     Cozzi tells us that a “scheduled final payment” passing with

no payment on a loan is an “identifiable event” sufficient to

trigger recognition of cancellation-of-indebtedness income.       Id.

at 447.    Therefore, it would be reasonable to find that the Felts

had $2 million of cancellation-of-indebtedness income as early as

January 1987, because all of the loans were due by then.    See

table supra p. 18.

     Felt wants us to find that he incurred this income in 1992,

the year he declared bankruptcy.   This would be five years after

the last final payment date had passed with no payments (and nine

years after the earliest maturity date had passed).    Felt’s

failure to include these AGI debts on his bankruptcy schedules

also strongly indicates that he was no longer liable for these

amounts.   His suggested date falls outside the reasonable range;

he must have realized this income before 1992.4

     But has Felt proven to us that the Commissioner’s 1989 date

falls outside of the reasonable range, too?   The Commissioner

pinpoints 1989 because he believes that is the year AGI ceased

doing business.   Felt did state during formal discovery that AGI



     4
       We therefore find it unnecessary to decide the parties’
arguments about whether an unlisted debt is discharged in
bankruptcy; this debt was forgiven before Felt’s bankruptcy.
                                 - 22 -

ceased operating sometime before 1992, but argues that AGI didn’t

peter out until sometime after 1989.      And he credibly testified

that AGI continued to operate after its registration lapsed, and

even reported on his 1992 bankruptcy schedules that he had been

involved in running the business within the last two years.

       Felt also directed us to section 7.12 of the Texas Business

Corporation Act, which provides a three-year time limit for

winding up the affairs of a dissolved business, to show that AGI

could still have collected on a past-due debt after 1989.       Tex.

Bus. Corp. Act Ann. art. 7.12(A) (Vernon 2003).     This is useful,

because we apply substantive state corporate law as of November

20, 1989, the date that AGI lost its right to do business in Texas

by failing to pay franchise taxes.    Forfeitures for failure to pay

franchise tax are governed by the Texas Tax Code, section 171.251,

which reads (now and in 1989):    “The comptroller shall forfeit the

corporate privileges of a corporation on which the franchise tax

is imposed if” and lists several triggering events, including

failure to file annual reports and failure to pay franchise taxes.

Tex. Tax Code Ann. sec. 171.251 (Vernon 2008); 1989 Tex. Sess. Law

Serv. 584 (West) (effective Sept. 1, 1989).     The effect of

forfeiture is that the “corporation shall be denied the right to

sue or defend in a court of this state.”     Tex. Tax Code Ann. sec.

171.252(1) (Vernon 2008).    This raises a close question of Texas

law:   Should the three-year winding-down period from the Texas

Business Corporation Act modify the forfeiture provision from the
                                - 23 -

Texas Tax Code?   If so, AGI did not relinquish the right to

collect from Felt when it failed to pay franchise tax, and thus no

identifiable event occurred in 1989.

     There is an answer.   As of August 1989, article 7.12 of the

Texas Business Corporation Act covered only “a corporation

dissolved (1) by the issuance of a certificate of dissolution or

other action by the Secretary of State, (2) by a decree of a court

* * * , or (3) by expiration of its period of duration.”    1989

Tex. Sess. Law Serv. 801 (West) (effective Aug. 28, 1989).     It did

not include in its definition of a dissolved corporation a

corporation which lost its corporate privileges for failure to pay

franchise tax.    See id.; see also In re ABZ Ins. Servs., Inc., 245

Bankr. 255, 260 (Bankr. N.D. Tex. 2000) (explaining that 1993

amendment brought failure to pay franchise tax within purview of

Texas Business Corporation Act article 7.12; before that, three-

year period not applicable to franchise tax forfeitures).    Thus,

we agree with the Commissioner that in 1989, AGI lost its ability

to sue Felt for repayment in 1989, even though AGI could and did

continue to transact business.5

     However, simply because AGI lost its ability to sue Felt in

1989 does not make 1989 the magic year in which he realized

cancellation-of-indebtedness income.     November 1989 (the date of


     5
       AGI could have gotten this right back by paying its
franchise tax. Because we find that the identifiable event is
not later than AGI’s forfeiture, we need not analyze when AGI
finally lost all rights to conduct business or dissolved.
                                 - 24 -

AGI’s forfeiture) fell more than two and a half years after the

last maturity date for these loans and one year after the FHLBB

sued Felt for more than $4 million--at which point any reasonable

creditor probably would have stepped up collection efforts or

considered the debt lost.   We are convinced that, although AGI

lost its ability to pursue legal remedies in 1989, this year is

too late to fall within the reasonable range.

     We find that the Felts realized cancellation-of-indebtedness

income in 1987, the year in which the last final maturity date

came and went without payment.    Cozzi, 88 T.C. at 447.   We

therefore find that the Felts realized $2 million in cancellation-

of-indebtedness income in 1987, another of the years for which we

have jurisdiction.

     D.   Did The Felts Present Sufficient Evidence of Insolvency?

     Our final question is whether, under section 108, the

cancellation of the AGI debts should be excluded from income

because the Felts were insolvent at the time.   If they can find

refuge in section 108, it must be under section 108(a)(1)(B)–-the

Felts’ bankruptcy ended up under Chapter 7, not 11, they are not

farmers, and they make no argument that this is qualified real-

property indebtedness.   That exclusion is limited to the amount of

the insolvency, sec. 108(a)(3), and “insolvency” means that the

taxpayer has an “excess of liabilities over the fair market value

of assets”, sec. 108(d)(3).   The relevant period is immediately
                               - 25 -

before the Felts realized their cancellation-of-indebtedness

income, sometime in late 1986 or early 1987.

     The Felts make only vague arguments as to their solvency.      We

know that in the late 1980s, they owned a home, although they

estimated its value only as of the time of the bankruptcy.6    Sharon

testified that they owned two cars, but neither Felt presented

evidence of their equity in those cars.    Felt testified that he

carried a life-insurance policy worth $250,000, but presented no

evidence of whether he could cash it in.    Felt testified that he

still had the proceeds from his sale of Reliance in 1987, as the

rescission suit did not start until 1988.   Although they did not

file a 1987 tax return, their 1985 and 1988 tax returns show

positive income.   And they stipulated to income in 1987:

            Income Source                        Amount
  Reliance Savings compensation                  $37,500
  Interest                                         4,634
  Self-employment income                          53,042
  Capital gains from stock                         9,246
    Total                                        104,422

The Felts gave us no evidence of savings, investments, or income

from other business ventures in 1987, and fail to convince us they


     6
       Felt’s bankruptcy schedules in 1992 showed an outstanding
balance of $1.2 million on the house, for which the Felts took
mortgage deductions of $80,000-$100,000 in the years in which
they did file tax returns. Yet the Felts provided no evidence of
their equity in the house for any of the years at issue, much
less 1987.
                                     - 26 -

have accounted for all of their income and assets for that year.

For instance, they earned $4,634 in interest in 1987 but never

stated the source of that interest.           (We infer there was an asset

with some positive fair market value generating that interest.)

       Without this evidence, we cannot find that Felt’s liabilities

exceeded the fair market value of his assets.          We therefore find

that the Felts have not met their burden of proving the existence

and extent of their insolvency in 1987 (or any year before their

1992 bankruptcy), and so we find they were not insolvent as to any

of the AGI debt.       We therefore hold that the Felts must recognize

the entire amount as cancellation-of-indebtedness income in 1987.7

III.       Income From Birdie Felt

       Although not the largest dollar amount here, the question of

whether the Felts should recognize income from Birdie Felt is

perhaps the most complicated issue.           The Felts tell us they were

struggling financially after the bankruptcy, and that Birdie

helped by paying their family expenses out of her accumulated

riches.       The Commissioner argues that this is implausible–-Birdie

Felt was a woman in her 80s with no discernible history of gainful


       7
       Felt owed AGI $2,148,973. The Commissioner asserted only
$2 million in cancellation-of-indebtedness income in the notice
of deficiency, and he never moved to amend his pleadings to
assert any increase in deficiency this might cause. There are so
many other adjustments from our findings and the parties’ various
concessions and compromises that we can’t predict whether this
will have the effect of limiting the amount in our final
decision. We direct the parties to be aware of this possible
problem in trying to reach agreement under Rule 155.
                                - 27 -

employment or independent income8 who may have been suffering from

Alzheimer’s.    The Commissioner also points out that she somehow

found hundreds of thousands of dollars to deposit into her bank

account during these years, and unlike most retirees, had bank

deposits that increased fourfold in six years, with wire transfers

remaining relatively stable:

         Year               Wire Transfer         Total Deposits
                               Deposits
         1994                   $45,000              $59,565.74
         1995                        60,000          124,706.09
                                 9
         1996                     90,000             236,854.74
         1997                    90,000              138,100.95
         1998                   102,500              158,173.93
         1999                   107,502              223,130.00

Despite her allegedly close and generous relationship with her son

and daughter-in-law, both professed utter ignorance of the source

of her riches or the nature of her offshore wire transfers.       And

her generosity was total–-she died with no money in her estate but

thousands of dollars of personal credit-card debt.



     8
       Indeed, IRS records presented at trial show that   Birdie
owed no taxes for 1994, 1995, 1996, 1997, or 1998. She    owed $836
for 1988, $1,222 for 1989, and $450 for 1990. Like her    son,
Birdie only occasionally filed tax returns. Unlike her    son, she
may have earned so little that she didn’t have to.
     9
       There was actually $122,207 in wire transfers in 1996.
However, one for $32,207 is from First American Title in Houston,
not the offshore transferors responsible for the other transfers,
and we have excluded it from this calculation.
                                - 28 -

     This all smells not quite right.     The Commissioner determined

that the money flowing from overseas through Birdie’s accounts to

the Felts was the Felts’ own income.     In general, the taxpayer

bears the burden of disproving the Commissioner’s determination.

Rule 142(a).    The Felts argue, however, that the Fifth Circuit, to

which appeal from this case would lie, has held that “a court need

not give effect to the presumption of correctness in a case

involving unreported income if the Commissioner cannot present

some predicate evidence supporting its determination.”     Portillo

v. Commissioner, 932 F.2d 1128, 1133 (5th Cir. 1991), affg. in

part and revg. in part T.C. Memo. 1990-68; see also Siebert v.

Commissioner, T.C. Memo. 1997-6.    So before we can find that the

money Birdie repeatedly dropped on her son was his own income, we

look at whether the Commissioner’s determination on this subject

was arbitrary and erroneous, or whether the Commissioner had “some

factual foundation for * * * [his] assessment.”     Portillo, 932

F.2d at 1133.

     In Portillo, the taxpayer did not receive a Form 1099 in time

to file his tax return, so he just estimated his income.     Id. at

1130-31.   After he filed his return, he finally got a Form 1099

from his employer showing much more income than he had reported.

Id. at 1131.    But the Commissioner, rather than investigate

whether Portillo received the extra income, relied on the

employer’s Form 1099 and issued a notice of deficiency.     He then
                                 - 29 -

relied on the presumption of correctness when Portillo objected.

Id.   The Fifth Circuit held that the Commissioner did not get the

benefit of the presumption until he “engage[d] in one final foray

for truth in order to provide the court with some indicia that the

taxpayer received unreported income;” one way to accomplish this,

the court said, was by analyzing the taxpayer’s bank deposits.

Id. at 1133-34.   In another Fifth Circuit case, that court found

that the Commissioner could not assess wagering excise taxes

without some evidence linking the taxpayer to gambling activities

within the period of assessment.    Carson v. United States, 560

F.2d 693, 696 (5th Cir. 1977).

      But the Felts overlook a key difference in their case:   In

both Portillo and Carson, the taxpayer filed a return.    The rule

is different for taxpayers who don’t file; in Parker v.

Commissioner, 117 F.3d 785, 787 (5th Cir. 1997), the court held

that the Commissioner had no duty to conduct an independent

investigation of third-party payment reports when the taxpayers

failed to file their own sworn statement (such as a Form 1040)

disavowing the income.

      We find that the Commissioner took sufficient steps to

investigate whether the Felts received money from Birdie.   Unlike

what he did in Portillo, the Commissioner here secured extensive

bank records showing checks Birdie wrote to David or for the

Felts’ expenses, as well as records from Sharon Felt’s bank
                               - 30 -

account showing she cashed checks from Birdie; there is no

question that David and Sharon actually received this money.    The

Felts provided no tax return or statement, sworn or otherwise,

saying they did not.   In fact, they confirmed that she gave them

money to pay their bills.

      Although the Commissioner cannot point to any single source

of Felt’s income flowing to Birdie, the Commissioner has supplied

a few pieces of evidence.   The Commissioner showed that the

following entities, all related to David Felt, deposited money

into Birdie’s bank account from 1995-2000:

        Entity                 Year                  Amount
Tower                          1995                 $4,077.61
                               1996                  4,000.00
                               1997                 16,500.00
                               1998                  2,750.00
                               1999                  9,500.00
                               2000                  2,000.00
Gibraltar                      1995                    550.00
                               1996                  6,893.00
J&N                            1995                  1,000.00
                               1998                  1,350.00
AGI-Nev                        1998                 55,000.00
Estate of Vansickle            1995                  4,000.00

  Total                                            107,620.61


      We are therefore convinced that at least some of Birdie’s

deposits are attributable to David Felt’s business activities,

even without knowing their exact source.   We find that the notice
                                 - 31 -

of deficiency was not arbitrary and erroneous, and hold the burden

of disproving the Commissioner’s determination is on the Felts.

     The Felts have several counterarguments.    The first is that

the IRS somehow relied on insufficient IRS records of Birdie’s tax

information.    The second is that the money from Birdie was not

their income, but only gifts from a loving mother.    Finally, the

Felts argue that some of the money flowing into Birdie’s accounts

and then back out to the Felts was (or will be) taxed as income

from J&N, Tower, or other Felt entities.

     While the Felts try to fault the IRS for failing to enter

into evidence certain types of account transcripts, they point to

no specific irregularities or missing information in the IRS

records that we do have.    It’s the Felts’ burden to show that

these records are flawed, but they gave us no evidence and

apparently made no efforts to acquire any through discovery.      We

therefore find that the IRS records of Birdie’s taxes that we have

are reliable.

     On the question of whether Birdie’s transfers were gifts, we

focus on her intent.     Commissioner v. Duberstein, 363 U.S. 278,

285 (1960).    And when the Commissioner asserts that a transfer is

taxable income, the taxpayer has the burden of showing that it was

in fact a gift; this means that the taxpayer has to introduce

credible evidence of the donor’s “detached and disinterested

generosity.”    Id.   Transactions between family members that reduce
                               - 32 -

taxes necessarily cause us to question whether the transaction was

a bona fide gift or just an effort to avoid taxes.     Carriage

Square, Inc. v. Commissioner, 69 T.C. 119, 133 (1977).

     Birdie Felt died years before trial, so we lack her

testimony.   David Felt testified that Birdie gave the Felts money

“because we needed it” and that he never considered it income.       He

also testified that none of the money flowing into Birdie’s

accounts was his money, but later said that he sometimes deposited

money into her accounts from his businesses because he “probably”

was paying back loans she had made.     Sharon testified that Felt

asked Birdie for help paying bills but had no intention of paying

her back.

     We do not find the Felts credible when they deny that the

money from Birdie was really their own.    David and Sharon’s tax

rate would have been much higher than Birdie’s (as she earned no

discernible income in most of the years at issue), and David Felt

had reason to fear creditors’ discovering that he still had

significant sums of money, given the unpaid and undischarged $4.2

million judgment from the Reliance sale.    The bank records in

evidence show that Felt’s businesses shed money in 1996, at the

very time Birdie’s wealth began to rise.    Her payments to the Felt

family peaked during 1996 and 1997--and 1997 was the year the

Office of Thrift Supervision won its judgment against David Felt.

The checks from Felt’s businesses deposited into Birdie’s account
                                 - 33 -

lead us to find Felt not credible when he testified that he did

not deposit money into her accounts.      Together with the Felts’

failure to provide any other evidence of Birdie’s intent, this

also reduces his overall credibility as a witness.      We thus find

that the money from Birdie was not a gift, but the Felts’ own

income circuitously routed.

        That leaves us to decide whether money deposited into

Birdie’s account was actually income on which the Felts already

owe tax or perhaps savings on which they already paid tax.      This

requires a careful parsing of the sources of those deposits.      The

Felts provided no evidence, credible or not, regarding the sources

of Birdie’s wealth.     They chose not to call as witnesses two men

who wrote monthly checks to Birdie, or David Felt’s own family

members who might have had better knowledge of his mother’s

sources of income.     Although the Felts faulted the IRS for not

seeking additional information about the offshore wire transfers,

the Felts also chose not to seek this additional information10 or

provide bank records for any of their other business entities.       We

infer that such information would have proven detrimental to their

case.




        10
       Instead, the Felts claim they “did not have the
authority” to request this information. They did have the
authority, however, to obtain records from Capital Trading
Partners (the organization responsible for wiring Birdie’s money)
and introduce such evidence.
                                  - 34 -

     In the end, the only relief we can provide for the Felts is

to make sure that money flowing from David to Birdie to David is

not taxed twice.   Since the Felts failed to file tax returns for

most years, we must make sure only that we are not double-counting

income already attributed to the Felts in this opinion.        Since,

for reasons we list below, money from J&N is income to the Felts,

that is somewhat easy to trace.     We will also subtract AGI-Nev

money flowing into Birdie’s account from the Felts’ income (as we

explain infra section V).   The parties have stipulated amounts of

income from the Tower account in 1996-98 as well:

      Year             Entity                Amount            Total
      1996             Tower                 $4,000           $4,000
      1997             Tower                 16,500           16,500
      1998             Tower                  2,750            4,100
                        J&N                   1,350

The Commissioner wants us to find the following amounts of income

to the Felts from Birdie:

         1996                      1997                     1998
      $78,262.23                $67,063.38               $112,248.70

     We subtract from the amounts in the notice of deficiency

those moneys coming from Felt-owned entities.         This leaves us with

the following amounts of other income from Birdie Felt:
                               - 35 -

          1996                  1997                   1998
       $74,262.23            $50,563.38             $108,148.70

IV.   J&N Income

      The Commissioner used a bank-deposits analysis to reconstruct

the Felts’ income for several years.    Although David Felt

apparently kept no bank account in his name, the Commissioner

argues that he drew checks for personal expenses from bank

accounts held in the names of his business entities, and therefore

the money flowing into these bank accounts is his income.

Although the parties have resolved some of these disputes, the

Felts and the Commissioner remain far apart on how much of the

money flowing into J&N’s bank account was income in 1997.     The

Commissioner wants to tax all of the $153,118.04 deposited into

this account; the Felts say that J&N’s only cash intake was

$80,000 from a business deal, and they concede that, after

deducting expenses, $73,118 of that was income to them.    They

argue that the Commissioner’s income reconstruction “failed to

take into account any expenses or deductions that * * * [the

Felts] may have been entitled to,” but then provide no evidence

substantiating any business deductions.    This argument fails for

want of proof.

      We think it’s plausible that other business accounts held

money that found its way into the J&N account.    But we won’t

speculate--in the absence of evidence, we’ll rely on the burden of
                               - 36 -

proof, which here lay with the Felts to disprove the

Commissioner’s determination, which therefore stands.

V.   AGI-Nev Income

     Another point of contention between Felt and the Commissioner

is whether the money deposited into the AGI-Nev accounts in 1998

is income.   The Commissioner determined that it was, because forms

from the Southern National Bank of Texas showed two accounts were

opened with $250,000 and $50,000 deposits, respectively.    The

Felts stipulated that these documents were true and correct, so we

find that Felt and his mother deposited $300,000 into those two

bank accounts in 1998.

     The Felts’ only argument is that this was not their income

because it was money owed to AGI when AGI ceased to do business,

and thus should have been income to AGI.   Well, no.   First, AGI

forfeited its right to do business in 1989, and Felt never in the

intervening nine years sought to remove this impediment by paying

the required tax and penalties.   Second, AGI was a Texas

corporation, but Felt chose to deposit the $300,000 in an account

of a corporation with a similar name but incorporated in Nevada.

Corporations don’t succeed to one another’s assets because of

similar names.   And, somewhat oddly, both Felt and his mother were

signatories on the AGI-Nev accounts, though only Felt had been a

shareholder and director of the old AGI.   For all of these
                                - 37 -

reasons, we find the Felts’ arguments on this point wholly

unpersuasive.

     We do find Felt’s testimony that he and his mother used the

$300,000 for personal expenses to be credible.   This, though, just

leads to another question:   How should that money be allocated

between Felt and Birdie?

     Felt claims that they split it equally.

     We don’t believe him--it might even be reasonable to conclude

that it was all his income and he just chose to give some to his

mother.   But in the absence of very much evidence on this issue,

we will look for the amount Birdie actually got from the AGI-Nev

deposits as, by an ever-so-slight preponderance of the evidence,

the correct measure of what she took from AGI’s old creditors.    We

look to the checks submitted as evidence.   There are several from

one of the AGI-Nev accounts.    One check, written in February 1999,

is for $17,048.39 and was endorsed by David Felt.   The others,

from 1998, total $55,000 and were endorsed for deposit into

Birdie’s Wells Fargo account.   Because Felt presented no contrary

evidence, other than his testimony that he and his mom intended to

split it equally, we find that Birdie got only this $55,000 of the

total $300,000 deposited into the AGI-Nev accounts.   We find that

the remaining $245,000 is Felt’s income in 1998.
                               - 38 -

VI.   Section 66 Innocent Spouse Relief

      Texas is a community-property state, and under section 66,

married couples who do not file joint tax returns “generally must

report half of the total community income earned by the spouses

during the taxable year” unless an exception applies.   Sec. 1.66-

1(a), Income Tax Regs.   Sharon Felt asks us to find that she falls

within the section 66(c) exception, and thus that she is liable

only for the income attributable to her.

      Her request falls within section 66(c), which offers two

types of relief--“traditional” and “equitable.”   Sharon requested

“traditional” relief, which helps a spouse who:

      !    Did not file a joint return for the taxable year, and

      !    omitted from gross income an item of community income
           that should have been included but that would have been
           allocated to the other spouse, and

      !    proves that he or she did not know or have reason to
           know of the omitted item, if it would also,

      !    given the facts and circumstances, be inequitable to
           include that item in the requesting spouse’s income.

      The Commissioner does not dispute that Sharon Felt meets the

first two requirements, but he argues that she knew of the omitted

items and that, given the facts and circumstances, it would not be

inequitable to include the items in her income.

      We choose to start with section 66(c)(4), and ask whether,

given all the facts and circumstances, it would be inequitable to

include all the many items at issue in Sharon’s gross income.     We
                                 - 39 -

do this because the last requirement helps narrow the years for

which we must test Sharon’s knowledge of each and every item of

omitted income.     The regulation, section 1.66-4(a)(3), Income Tax

Regs., tell us that one relevant factor--indeed, the only factor

that the parties discuss at any length11--is whether the requesting

spouse benefited from the omitted items of income.     The

regulations are even more helpful, as they go on to clarify that a

“benefit includes normal support, but does not include de minimis

amounts.”     Sec. 1.66-4(a)(3), Income Tax Regs.   The Felts argued

that Sharon’s lifestyle was not lavish during this time, but that

is the test for innocent-spouse relief under section 6015 and

section 66(c) equitable relief, not the test under section

66(c)(4).12




     11
       The regulation, of course, does provide that lack of
significant benefit is only one factor to be considered in what
is supposed to be an all-the-facts-and-circumstances test. The
only other specific factors that it mentions are “desertion,
divorce or separation,” sec. 1.66-4(a)(3), Income Tax Regs., none
of which is present here. The regulation also incorporates by
reference revenue procedure 2000-15 and its own open-ended list
of factors. We don’t make specific findings on these factors
because the Felts didn’t argue them.
     12
       See sec. 1.6015-2(d), Income Tax Regs. (“One relevant
factor * * * is whether the requesting spouse significantly
benefitted * * * A significant benefit is any benefit in excess
of normal support.”). The Commissioner also applies a
significant-benefit test to requests made under section 6015(f)
and the equitable-relief provision of section 66(c). Rev. Proc.
2003-61, 2003-2 C.B. 296, 299, sec. 4.03(2)(a)(v) (applying the
section 6015(b) standard).
                                 - 40 -

     The Felts never argue that Sharon’s standard of living fell

below “normal support,” or that the items of income Felt earned

were diverted to anything but family expenses (i.e., “normal

support”).   Sharon credibly testified that her lifestyle didn’t

change much until 1992, when their mortgage was foreclosed and

they no longer could afford domestic staff; this is a strong

indication that she is not entitled to section 66(c) traditional

relief for any of the omitted items of income before 1992.   After

1992, we still find for the most part that she enjoyed “normal

support,” even taking into account the Felts’ relatively high

standard of living, and we have no evidence Felt diverted his

income from the family.   Sharon testified that whenever she needed

money to pay bills, she would ask David and he would write her a

check.   Although they no longer owned a home, they did rent very

nice houses.   Sharon continued to have a car and a bank account

with substantial balances in most years.

     The Felts stipulated some items of income, and this opinion

upholds the Commissioner’s determination of other items, in the

following amounts for 1994-98:
                                  - 41 -

            Year                  Source                Amount
            1994           NationsBank                 $5,311.00
                           Tower                        5,455.00
             Total                                     10,766.00
            1995           NationsBank                 14,048.00
                           Tower                       19,995.00
             Total                                     34,043.00
            1996           NationsBank                  9,623.00
                           Tower                       13,989.00
                           Self-employment              6,405.00
                           Self-employment             21,842.00
                            income adjustment
                           Birdie Felt                 74,262.23
             Total                                    126,121.23
            1997           NationsBank                  3,516.00
                           Tower                       42,981.00
                           J&N                        143,636.04
                           Birdie Felt                 50,563.38
             Total                                    240,696.42
            1998           NationsBank                  1,131.00
                           Tower                       35,074.00
                           J&N                         27,775.00
                           Birdie Felt                108,148.70
                           AGI-Nev                    245,000.00
             Total                                    417,128.70


     There is evidence that the Felts had a lower income in 1994

and 1995.    There are bank records for those years showing that

Felt diverted income between his businesses and his mother,

suggesting that Sharon may not have gotten the benefit of some

income items.      For those years, we are willing to assume that

Sharon did not receive “normal support” from the income.

     That leaves us to decide whether she meets the last prong of

the traditional relief test, section 66(c)(3), whether she knew or

had reason to know of each item of omitted income in 1994 and
                               - 42 -

1995.   This requires an item-by-item analysis.    If Sharon was

aware of the source of the income, but not aware of the amount,

she is considered to have knowledge of the item.    See sec.

1.66-4(a)(2)(ii), Income Tax Regs.    The regulations also say to

look at “all of the facts and circumstances” to determine whether

a reasonable person would know of the income.    Sec.

1.66-4(a)(2)(i), Income Tax Regs.    The relevant facts and

circumstances can include the nature of the item, amount of the

item relative to other income items, the couple’s financial

situation, Sharon’s educational or business experience, and

whether the item was listed on prior years’ returns.       Id.

     Almost half of the conceded income for each year was in

Sharon’s bank account, over which she had sole signatory power. We

find that she had actual knowledge of that money.       The rest of the

money came from the Tower bank account.    She testified that she

had heard the name Tower but didn’t know what Tower did. However,

Sharon deposited checks from Tower into her own bank account in

1994 and 1995, leading us to find that she knew David had a

business called Tower that generated family income.      Knowledge of

the source of income is sufficient to find knowledge of the items

of income themselves.   We find that Sharon knew of the items

giving rise to the deficiencies, and that she fails the test for

traditional relief under section 66.
                              - 43 -

     We can’t stop yet, however, because Sharon also asks for

equitable relief under the flush language of 66(c).13    The last

sentence of the flush language of section 66(c) reads:

     Under procedures prescribed by the Secretary, if, taking into
     account all the facts and circumstances, it is inequitable to
     hold the individual liable for any unpaid tax or any
     deficiency (or any portion of either) attributable to any
     item for which relief is not available under the preceding
     sentence, the Secretary may relieve such individual of such
     liability.

Unlike the traditional test, which asks whether it would be

inequitable to include a specific item in one spouse’s past


     13
       Although the Commissioner didn’t raise the issue, there
is a real question about the timeliness of Sharon’s section 66(c)
request. That section refers us to the regulations. Section
1.66-4(j)(2)(i), Income Tax Regs., imposes no deadline for
requesting equitable relief. Sec. 1.66-4(j)(2)(ii), Income Tax
Regs. But they do point us to Revenue Procedure 2000-15,
superseded by Revenue Procedure 2003-61. Sec. 1.66-4(a)(3), (b),
Income Tax Regs. (Both paragraphs read: “Factors relevant to
whether it would be inequitable to hold a requesting spouse
liable, more specifically described under * * * Revenue Procedure
2000-15 * * * are to be considered in making a determination
under this paragraph.") The Revenue Procedure states as a
“threshold condition” for equitable relief under section 66(c)--
that the requesting spouse “applies for relief no later than two
years after the date of the Service’s first collection activity,”
and refers us to section 1.6015-5(b)(2)(i), Income Tax Regs., for
the definition of collection activity. Among the actions
qualifying as “collection activity” is “the filing of a claim by
the United States in a court proceeding in which the requesting
spouse is a party or which involves property of the requesting
spouse.” Sec. 1.6015-5(b)(2)(i), Income Tax Regs. The April
1992 order approving Sharon’s bankruptcy disclosure statement
lists the IRS as a priority tax claimant, and lists $28,846.25 of
priority tax claims. Of this, $27,000 represented a federal tax
lien. While this doesn’t prove that the United States actually
filed a claim for any of the years before us, it suggests that
Sharon might have missed one of the threshold requirements of the
revenue procedure for equitable relief. See also Lantz v.
Commissioner, 132 T.C. __ (2009).
                               - 44 -

income, the equitable relief provision looks to the present--would

it be inequitable to make that spouse pay the liability today?14

We have in the past found that we have jurisdiction to hear

section 66(c) equitable claims in deficiency cases, although we

lack jurisdiction over stand-alone claims.    Bernal v.

Commissioner, 120 T.C. 102, 107-08 (2003).    In deficiency cases,

we review these as affirmative defenses.

     First, the procedural issues.    Affirmative defenses must be

raised in the pleadings.   Rule 39.   Although Sharon should have

raised the innocent-spouse defense in her petition, or amended the

petition after it became clear she would raise the issue at trial,

she may still be saved if the Commissioner expressly or impliedly

consented to trying the matter.   See Rule 41(b).   Although counsel

for the Commissioner did inform the Court that he was displeased

at receiving such late notice of the issue, he failed to object at

trial and never raised his concerns on brief, despite extensive

and thorough coverage of the section 66(c) issue.   We find that he

impliedly consented to try the matter.

     The Commissioner on brief argues only that Sharon is not

entitled to section 66(c) equitable relief because she failed to

file a Form 8857, which he claims is “the most fundamental of all



     14
       Despite the past-present distinction, both sections of
the regulations guiding our determination of what is
“inequitable” inexplicably direct us to the same revenue
procedure.
                                - 45 -

the threshold requirements.”    Although he cites Revenue Procedure

2003-61, section 4.01 for this proposition, that requirement is

actually in section 5 and allows a taxpayer to make the request by

Form 8857 or “other similar statement signed under penalties of

perjury.”   See also sec. 1.66-4(j), Income Tax Regs.

     The only document in the record signed by Sharon Felt is the

Tax Court petition, which never mentions innocent-spouse relief or

anything like it.   By failing to provide the Commissioner notice

of the section 66 argument, the Felts effectively prevented the

Commissioner from making a pretrial determination as to whether

Sharon was entitled to equitable relief; therefore, there is no

determination to review.   We find that the Felts failed to provide

proper notice of this claim, and therefore we will not consider

the issue.15

     Although this seems harsh for Sharon Felt, all hope may not

be lost; it is at least possible that she might be able to raise

section 66(c) equitable relief as a defense in any collection

hearing under section 6330.    See sec. 6330(c)(4)(A).




     15
       There is also a potential problem in deciding the
appropriate standard of review. In cases like Beck v.
Commissioner, T.C. Memo. 2001-198, we held that we should review
for abuse of discretion. But we recently held in the closely
related situation of requests for relief under section 6015(f)
that we review de novo. See Porter v. Commissioner, 132 T.C. __
(2009). We will figure out Porter’s effect on section 66(c) in
some later case.
                                - 46 -

VII.    Additions to Tax

       The final issues are all the additions to tax that the

Commissioner asserts under sections 6651(a)(1) and 6654 for all

the tax years at issue, and additions under section 6651(a)(2) for

1996-98.

       Section 6651(a)(1) imposes an addition to tax for failure to

timely file a tax return.    The Commissioner has met his burden of

production because the Felts stipulated that they did not file tax

returns for any of the years at issue.    The Felts argue only that

Sharon should not have to pay these additions, thereby conceding

them as to David.    Sharon seems to make two arguments.   The first

relates only to 1987 and 1989, years for which the Felts got a

letter from the Commissioner stating they did not need to file a

tax return.    David Felt testified that he thought they got the

letters around the time of the bankruptcy and that he didn’t know

why he had received them, because he hadn’t asked for them.      We

admitted the letters as evidence over the objections of the

Commissioner’s counsel, although we share his concerns about their

origin.    The letters are dated 1993, several years after the

Felts’ returns would have been due for 1987 and 1989.      But in 1992

Sharon filed bankruptcy schedules stating:    “The Debtor and her

husband have not filed Federal Individual Income Tax returns for

the calendar years 1986 through 1991 because of losses incurred by

the Debtor’s husband,” the same reason Felt cited for not filing
                               - 47 -

in the first place.   We therefore find that Sharon did not rely on

the 1993 letters in failing to file.

     Her second argument is stronger.    She argues that because she

was unaware of the income from Felt’s businesses, she lacked

sufficient information to file income tax returns.    She relies on

two cases from the early 1980s.   In Crane v. Commissioner, T.C.

Memo. 1982-350, the husband actively hid his income from his wife;

in Fleming v. Commissioner, T.C. Memo. 1984-130, the wife was

afraid of her husband’s violent temper and did not know tax

returns had not been filed.   There is no evidence that Felt

actively hid his income from Sharon.    She did testify credibly

that when Felt would explain his business dealings to her, she

would get bored and lose interest, but that doesn’t amount to

concealment.   And her bankruptcy filings state that Sharon and her

counsel “have examined all transactions for the period commencing

in 1990 until the date of filing of the Petition.”    Those

schedules state that she and her husband expected to earn $70,000

per year during the duration of the bankruptcy plan.    Again, this

indicates that she had at least some access to financial

information.   There is also no sign that Sharon was afraid to ask

Felt about family or business income; she testified that she asked

Felt about the Reliance sale, and she also testified that she

would ask him about expenses in credit-card statements until “he

got irritated and sent the bills to his office.”    Sharon knew
                                - 48 -

about several of Felt’s businesses and even had signatory powers

over the J&N bank account.   She has not convinced us that she

lacked access to the information necessary to file a separate tax

return, and so we will sustain all the failure-to-timely-file

additions to tax.

     The second addition, under section 6651(a)(2), is for failure

to pay tax.    Again, the Felts contest this only as it applies to

Sharon.    The Commissioner must do a little more to meet his burden

here.    He must show either that he filed a substitute for return

(SFR) under section 6020(b) or that the Felts filed a return

showing tax due.    See sec. 6651(a)(2); Wheeler v. Commissioner,

127 T.C. 200, 208-209 (2006), affd. 521 F.3d 1289 (10th Cir.

2008).    The SFRs must meet certain requirements; a bare front page

of a Form 1040 will not suffice.    Id. at 209.   The Commissioner

provided us with SFRs for Sharon Felt for 1996, 1997, and 1998;

these documents include not only the front page of a Form 1040

with Sharon’s name, Social Security number, and filing status, but

also certifications by the preparers, work papers showing amounts

of tax due and penalties, and detailed explanations.    We therefore

hold that the Commissioner has met his burden of production, and

sustain the additions to tax in the face of Sharon’s claim that

she had reasonable cause for her failure for the same reasons we

relied on in sustaining the failure-to-timely-file additions.
                               - 49 -

     The Commissioner also asserted an addition to tax under

section 6654 against both David and Sharon Felt for their failure

to pay estimated tax.   The Felts make no claim of error regarding

these assertions, and we therefore deem them conceded.   Section

6654 additions are mandatory and mathematical, with no reasonable-

cause exception.   Crane v. Commissioner, T.C. Memo. 1982-350.



                                         Decision will be entered

                                    under Rule 155.
