                              T.C. Memo. 2015-42



                       UNITED STATES TAX COURT



                        JASON CHAI, Petitioner v.
              COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 18330-09.                        Filed March 11, 2015.



      Frank Agostino, Jeremy M. Klausner, and Lawrence M. Brody, for

petitioner.

      Timothy A. Sloane and Andrew M. Tiktin, for respondent.



              MEMORANDUM FINDINGS OF FACT AND OPINION


      COHEN, Judge: Respondent determined a $63,751 deficiency in

petitioner’s Federal income tax and a $12,750.20 accuracy-related penalty under

section 6662(a) for 2003. In an amendment to answer respondent asserted an

increased deficiency and an increased penalty of $627,619 and $125,524,
                                         -2-

[*2] respectively. Petitioner’s motion to dismiss the increased deficiency and the

increased penalty for lack of jurisdiction was granted on February 13, 2015, by

order of the Court. There are two issues for decision: (1) whether the $2 million

payment petitioner received from Delta Currency Trading, LLC (Delta), in 2003 is

nonemployee compensation subject to self-employment tax; and (2) whether

petitioner is liable for the accuracy-related penalty under section 6662(a) for 2003.

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.

                               FINDINGS OF FACT

      Some of the facts have been stipulated, and the stipulated facts are

incorporated in our findings by this reference. Petitioner resided in Connecticut

when he filed the petition.

A. The Participants

      Petitioner graduated from Harvard University with a master’s degree in

architecture. Petitioner began his career in Los Angeles but moved to New York

in 1999. At all relevant times, petitioner conducted a successful architecture

business. While attending Harvard petitioner met Andrew Beer, who later married

petitioner’s cousin. Beer holds a bachelor of arts degree from Harvard College
                                          -3-

[*3] and a master of business administration degree from Harvard Business

School. He has over 20 years of experience in the investment management

business.

        Beer created and marketed several tax shelters directed to wealthy

individuals. The tax shelters were designed to offset prospective clients’ large tax

liabilities for a particular year. To that end, Beer formed several entities to create

the tax shelter structure. Among others, these entities included Delta, Bricolage

Capital, LLC (Bricolage), and Counterpoint Capital, LLC (Counterpoint).

        Beer formed Bricolage and Delta as Delaware limited liability companies on

July 21, 1999, and May 30, 2000, respectively. Counterpoint was formed as a

Delaware limited liability company on March 2, 2000. At all relevant times, Beer

indirectly owned all or a majority of the interests in Delta, Bricolage, and

Counterpoint (collectively, Bricolage entities). Petitioner never owned an interest

in Delta or Bricolage. The Bricolage entities were affiliated by common

ownership and shared clients, offices, employees, and resources in 2001 and 2002.

They developed and marketed Beer’s tax shelters and advised their clients on the

same.
                                           -4-

[*4] B. The Structure

       Bricolage advised its clients on Partnership Option Portfolio Strategy

(POPS) tax shelters during 2000 and 2001. Counterpoint and Bricolage advised

their clients on Personal Investment Corporation (PICO) tax shelters during 2000

and 2001. Delta also advised its clients on both the POPS and PICO tax shelters

(collectively, tax shelters).

       The tax shelters were designed to eliminate Delta’s clients’ tax liabilities by

generating noneconomic tax losses to offset the clients’ taxable income. The tax

shelters shared three key characteristics: (1) each centered around the formation

of a flowthrough entity; (2) each involved a straddle comprising offsetting

derivatives into which the POPS or PICO entity entered; and (3) each required a

transitory partner or shareholder in the POPS or PICO entity to whom the entity

allocated income from the derivatives so that a tax shelter investor could recognize

offsetting tax losses. To facilitate the transactions, Delta provided a transitory

partner or accommodating party. The POPS and PICO entities allocated income to

the accommodating party and allocated noneconomic losses to Delta’s clients to

offset their large tax liabilities. Petitioner was an accommodating party. For its

part, Delta received sizable fees for advising its clients on the tax shelters and

facilitating the clients’ participation.
                                          -5-

[*5] These transactions were especially profitable for Beer as the majority owner

of the Bricolage entities. For instance, for 2001 Delta reported over $88 million of

income, primarily from client fees. Similarly, for 2002 Delta reported over $93

million of income, primarily from client fees.

      In 2002 the Commissioner released Notice 2002-50, 2002-2 C.B. 98, and

Notice 2002-65, 2002-2 C.B. 690, advising taxpayers and their representatives that

transactions like POPS and PICO were subject to challenge by the Commissioner

and had been designated “listed transactions”.

C. Petitioner’s Role

      After petitioner moved to New York, he lived in Beer’s home during the

summer of 2002. That summer, Beer approached petitioner about participating in

a new tax strategy Beer had developed to reduce tax liabilities of potential clients.

Beer explained to petitioner that he intended to market the tax shelters to

encourage wealthy individuals to become clients of Delta and its affiliated

companies.

      Beer also explained the tax strategy and the structure of the tax shelters to

petitioner. Petitioner understood that the clients had large tax liabilities for a

given year. Additionally, petitioner understood that the structure was a series of

transactions designed to offset clients’ tax liabilities and that his role was to serve
                                          -6-

[*6] as a partner with the potential clients. These partnerships were integral to the

overall structure. Furthermore, petitioner understood he would serve as a conduit

and that the potential clients’ tax liabilities then would be transferred to him. Beer

told petitioner the tax obligations transferred to petitioner would be eliminated by

offsetting activities. Petitioner raised concerns about the transactions and asked

Beer whether POPS and PICO were “pure tax shelters”. Beer assured petitioner

these structures had been vetted by attorneys and accountants.

      Despite his concerns, petitioner agreed to serve as an accommodating party

for the POPS and PICO transactions in exchange for compensation from the

Bricolage entities. Petitioner agreed to a $100,000 annual salary plus a signing

bonus in exchange for his participation in the transactions. Beer and petitioner

also discussed discretionary bonuses petitioner could receive for his involvement

in PICO.

D. The Economics of Petitioner’s Participation

      Petitioner was an accommodating party for at least 131 tax shelters, having

reported over $3.2 billion of noneconomic income, allocated to him by the tax

shelters, on his 2000 and 2001 income tax returns. This income was

approximately equal to the amounts of offsetting noneconomic tax losses allocated

to Delta’s clients. To relieve petitioner’s concerns about increased tax liabilities,
                                           -7-

[*7] Beer assured petitioner that there were strategies they could use to offset

petitioner’s tax liabilities on the basis of his participation in the tax shelters.

Notably, petitioner received and reported offsetting losses from the POPS and

PICO entities for 2000 and 2001 approximately equal to amounts of income

allocated to him from the tax shelters.

E. JJC Trading, LLC

       Petitioner’s participation in the tax shelters involved executing numerous

transactions to facilitate each of the 131 tax shelters. This included signing

binders of legal documents (including articles of incorporation, loan agreements,

wire transfers, and redemption request letters) for the PICO and POPS entities. In

2000 petitioner went to the offices of Delta and its affiliates “a lot” and “regularly”

to sign documents executing the tax shelter transactions. This signing

responsibility was problematic for petitioner because he traveled frequently for his

architecture business. He was often unable to be physically present to sign these

documents.

      Therefore, at Delta’s suggestion, in 2001 petitioner formed JJC Trading,

LLC (JJC), to facilitate and simplify petitioner’s participation in the Bricolage

entities. Petitioner was the sole owner of JJC, and Bricolage was JJC’s

nonmember manager. JJC relieved petitioner of his signature burden because
                                             -8-

[*8] JJC’s operating agreement (signed by petitioner) gave Bricolage authority to

make decisions and sign documents for JJC in petitioner’s stead. Petitioner also

gave Bricolage power of attorney to make decisions and sign documents for JJC.

Petitioner did not maintain books and records regarding his interests in JJC, the

tax shelter entities, or the transactions.

F. Petitioner’s Compensation

      Petitioner received significant compensation from the Bricolage entities in

exchange for his participation in the tax shelters. For instance, in 2000 petitioner

received $1.2 million from Counterpoint as a signing bonus, and in 2001 JJC

received $1 million from Delta. Counterpoint and Delta reported these payments

on Forms 1099-MISC, Miscellaneous Income (Form 1099), as nonemployee

compensation, and petitioner reported them as income on Forms 1040, U.S.

Individual Income Tax Return, and paid the resulting tax. Petitioner also received

several other payments from Bricolage and Counterpoint, totaling $100,000 per

year for 2001 and 2002 and reflecting Beer’s agreement with petitioner that he

would receive an annual salary of $100,000 in exchange for his participation.

Bricolage and Counterpoint reported all of these amounts as petitioner’s wages,

and petitioner paid the resulting tax.
                                        -9-

[*9] G. The 2003 Payment From Delta

      In April 2002 petitioner received an email (April 2002 email) from Delta’s

chief financial officer Helen Del Bove, referencing petitioner’s receipt of $1

million from Delta in 2001. The April 2002 email also notified petitioner he

would receive future fees for consulting work he performed for Delta. On March

3, 2003, petitioner received a $2 million payment from Delta.

      Before petitioner received the $2 million payment, however, he and Del

Bove had exchanged several emails in February 2003 discussing the proper tax

treatment of the $2 million payment. Del Bove notified petitioner that Delta was

going to wire petitioner the $436,000 remaining in JJC, dissolve that entity, and

pay petitioner an additional $2 million. In response, petitioner asked: “To this

end, can you fill me in on how this money should be treated as far as my

accountant is concerned? Will I be issued a 1099 for the whole amount?” Del

Bove responded that the $2 million payment “will be reported on a 1099, so you

should tax-plan accordingly.” Petitioner again asked for clarification on whether

both the $2 million payment and the balance in the JJC account were going to be

reported on his Forms 1099 for 2003. Del Bove responded that “[t]he amount you

receive from JJC Trading is not income and, therefore, will not be reported on a

1099. That money is from what you had originally invested in JJC Trading. The
                                         -10-

[*10] 2mm we pay you will be reported on a 1099, as well as any other subsequent

payments.”

      Beer had authorized, on behalf of Delta, the $2 million payment to

petitioner. Beer viewed the $2 million payment as a discretionary bonus for

services petitioner had provided to Delta. Consistent with past practice, Delta

reported the $2 million on Form 1099 for 2003 as nonemployee compensation.

H. Petitioner’s Tax Reporting

      Petitioner did not report the $2 million payment from Delta as taxable

income, contending that it was a return of capital from his investments. However,

petitioner was not a partner of Delta and did not invest any capital in Delta.

Neither petitioner nor JJC reported receiving a share of Delta’s income or loss.

No Schedule K-1, Partner’s Share of Income, Credits, Deductions, etc., was

prepared by Delta for petitioner.

      All of petitioner’s interests in the other tax shelter entities were either sold

or redeemed before he received the $2 million payment in 2003. In closing

agreements executed between petitioner and the Internal Revenue Service (IRS)

with respect to POPS and PICO, petitioner agreed that he had disposed of all his

interests in the tax shelter entities by the end of 2001. Petitioner reported the
                                        -11-

[*11] amounts he received before 2003 on Forms 1040 for 2000 and 2001. JJC

reported amounts received in completed sales of its interests in 2001.

      Petitioner reported zero total tax on his income tax return for 2003.

Stephen Ellspermann, a certified public accountant, prepared petitioner’s income

tax return for 2003. Petitioner and Ellspermann discussed the nature of the $2

million payment before filing petitioner’s return for 2003. Petitioner told

Ellspermann that he did not know the nature of the $2 million payment. He

indicated to Ellspermann that the $2 million was from activities managed by

Bricolage and that Ellspermann should contact Bricolage to clarify its nature.

      Before filing petitioner’s income tax return for 2003, Ellspermann asked

Del Bove’s replacement, Barney Taglialatela, about money transfers between

petitioner, JJC, Mercato Global Opportunities Fund, LP (Mercato Global), and

Bricolage. He did not ask Taglialatela about money transfers to petitioner from

Delta. Ellspermann understood, on the basis of his conversation with Taglialatela,

that everything pertaining to the partnerships was included on the Mercato Global

Schedule K-1 issued to petitioner. Ellspermann believed that the $2 million

payment was included on the Schedule K-1. He believed this, even though he did

not specifically ask Taglialatela if the $2 million payment was included on the

Schedule K-1. Taglialatela did not tell Ellspermann that the $2 million payment
                                         -12-

[*12] from Delta was not income or that it would not be reported on Form 1099

for 2003. Similarly, Taglialatela never told petitioner or Ellspermann that the $2

million would be reported on Schedule K-1. The $2 million payment was not

reported as a withdrawal or distribution on any Schedule K-1 or any combination

of Schedules K-1 that petitioner received for 2003.

      Before filing his income tax return for 2003, petitioner did not tell

Ellspermann about his email correspondence with Del Bove regarding the $2

million payment and that Delta intended it to be income reported on a Form 1099

for 2003. He also did not tell Ellspermann that Del Bove had notified petitioner

that he would receive future fees for his consulting work with Delta. Ellspermann

first learned of the Delta Form 1099 for 2003 in 2008 during the examination of

petitioner’s income tax return for 2003. Had Ellspermann known of the Form

1099 for 2003, he would have discussed the tax treatment of the $2 million with

Taglialatela.

                                      OPINION

      The parties’ fundamental dispute is over the character of the $2 million

payment Delta made to petitioner in 2003. Petitioner contends that the $2 million

payment from Delta is either a return of capital or, alternatively, a gift from Beer

to petitioner. Neither would be subject to self-employment tax. Respondent
                                        -13-

[*13] contends the $2 million payment is nonemployee compensation subject to

self-employment tax that should have been reported on petitioner’s return.

I. The $2 Million Dollar Payment

      A. Burden of Proof and Production

      Generally, the taxpayer bears the burden of proof. Rule 142(a); Welch v.

Helvering, 290 U.S. 111, 115 (1933). Petitioner contends, however, that pursuant

to sections 6201(d) and 7491(a) respondent should bear the burden of proof.

      If a taxpayer asserts a reasonable dispute with respect to an item of income

reported on an information return filed by a third party and meets certain other

requirements, the Commissioner bears the burden of producing reasonable and

probative evidence, in addition to the information return, concerning the

deficiency attributable to that item. Sec. 6201(d). Respondent has presented

evidence, other than the information return filed by Delta, as to the character of the

income in issue. We therefore are not relying on the characterization reported in

that information return.

      The parties stipulated petitioner’s receipt of the $2 million payment and

Delta’s characterization of that payment for tax purposes. Thus, petitioner must

show the nontaxable character of the payment. See Tokarski v. Commissioner, 87

T.C. 74, 76-77 (1986) (holding that the taxpayer had the burden of proof to show
                                          -14-

[*14] nontaxable nature of payment where the taxpayer indisputably received the

income in issue); Price v. Commissioner, T.C. Memo. 2004-103.

      If a taxpayer produces credible evidence to support her or his position,

complies with substantiation requirements, and cooperates with the Commissioner

with regard to all reasonable requests for information, then the burden of proof

shifts to the Commissioner. Sec. 7491(a); see Higbee v. Commissioner, 116 T.C.

438, 440-441 (2001). A prolonged discussion of burden of proof is unnecessary

because we decide this case on the preponderance of the evidence. See Knudsen

v. Commissioner, 131 T.C. 185, 189 (2008) (“In a case where the standard of

proof is preponderance of the evidence and the preponderance of the evidence

favors one party, we may decide the case on the weight of the evidence and not on

an allocation of the burden of proof.”); see also Estate of Jorgensen v.

Commissioner, T.C. Memo. 2009-66, aff’d, 431 Fed. Appx. 544 (9th Cir. 2011).

      B. Character of the Payment

      Gross income generally includes all income from whatever source derived,

including compensation for services in the form of fees, commissions, or fringe

benefits. Sec. 61(a)(1). The character of a payment for tax purposes is determined

by the intent of the parties, particularly the intent of the payor, as disclosed by the

surrounding facts and circumstances. See Smith v. Commissioner, T.C. Memo.
                                          -15-

[*15] 1995-410; Keck v. Commissioner, T.C. Memo. 1993-538; Watson v.

Commissioner, T.C. Memo. 1960-255. A receipt of capital or a return of capital

does not constitute taxable income. See Doyle v. Mitchell Bros. Co., 247 U.S.

179, 185 (1918); Veenstra & DeHaan Coal Co. v. Commissioner, 11 T.C. 964, 966

(1948); Monico v. Commissioner, T.C. Memo. 1998-10. Similarly, receipt of a

gift is not taxable income. See Estate of Maycann v. Commissioner, 29 T.C. 81,

85 (1957); McDermott v. Commissioner, T.C. Memo. 2003-269.

      The trial testimony supports the conclusion that the $2 million payment was

compensation subject to self-employment tax. Although petitioner attempts to

minimize his role in the tax shelters and describes his activities as investments, the

record reflects that he provided services to Delta to facilitate the tax shelter

transactions. Beer testified that petitioner’s role in the tax shelters was a critical

component of the transactions and the tax shelters could not have functioned as

planned without petitioner’s participation. Delta could not have allocated

noneconomic losses to its clients without petitioner’s acting as the accommodating

party. The allocation of $3.2 billion of noneconomic income to petitioner enabled

Delta’s clients to reap the benefits of an almost equal amount of noneconomic

losses to offset their taxable income. Petitioner’s role was far from nominal.
                                         -16-

[*16] Petitioner argues that because he delegated decisionmaking authority to

Bricolage, he did not perform any meaningful services for Delta (or any of the

other Bricolage entities). Petitioner’s income cannot escape taxation merely

because he delegated certain duties to Bricolage and Beer. The risky nature and

large receipts of the tax shelters provide ample justification for the high

compensation relative to the low amount of personal effort involved.

      Petitioner also provided services in a more apparent manner. Petitioner’s

primary responsibility was to sign binders of formation and organizational

documents for the PICO and POPS entities. He testified that there was often a

flurry of activity requiring him to go to the Bricolage entities’ offices “a lot” and

“regularly” to sign large volumes of legal documents to execute the tax shelter

transactions. This was a burden for petitioner because he traveled frequently for

his architecture business. To alleviate the burden, Delta suggested that he form

JJC and sign a document granting a power of attorney to Bricolage.

      Petitioner argues that the $2 million payment could not have been

compensation for services because after JJC was formed he was completely

removed from that process. Contrary to petitioner’s assertions, signing the

formation and organizational documents was not a menial task but an integral

component of creating the tax shelter entities. Whether petitioner subjectively
                                        -17-

[*17] understood and appreciated the nature of his actions does not eliminate the

significance of the services he provided to Delta and the other tax shelters by

signing the formation and organizational documents. Petitioner’s subsequent

delegation of his signature authority does not absolve him from liability for tax on

the compensation he received.

      The remainder of the record also reflects that the $2 million payment was

compensation. Beer agreed to pay petitioner a $100,000 annual salary plus a

signing bonus in exchange for petitioner’s involvement. Beer and petitioner also

discussed possible discretionary bonuses. Petitioner received several payments

consistent with his agreement with Beer.

      Petitioner received significant payments from the Bricolage entities

characterized and reported as nonemployee income. In 2000 petitioner received a

$1.2 million signing bonus from Counterpoint. Counterpoint reported it as

nonemployee income on its Form 1099 for 2000, and petitioner paid income tax

on the full amount. Similarly, in 2001 petitioner received a $1 million payment

from Delta through JJC. Petitioner testified that he viewed it as another bonus.

Delta reported the $1 million payment as nonemployee income on Form 1099 for

2001, and petitioner paid income tax on the full amount. Additionally, in 2001

and 2002 petitioner received a $100,000 salary paid by Bricolage and
                                        -18-

[*18] Counterpoint and consistent with petitioner’s agreement with Beer.

Bricolage and Counterpoint reported these amounts as wages, and petitioner paid

the resulting tax. There is neither discernable reason nor persuasive justification

for treating the 2003 payment differently.

      Moreover, Del Bove informed petitioner that the $2 million payment in

issue would be reported on the Form 1099 for 2003. In April 2002 Del Bove and

petitioner exchanged several emails regarding the $2 million payment and how

Delta intended to characterize it. After responding to petitioner’s multiple

requests for clarification, Del Bove unequivocally notified him that Delta intended

to report the $2 million payment on the Form 1099 for 2003. After his email

exchange with Del Bove, petitioner still questioned Del Bove’s calculations and

did not believe that all or part of the $2 million payment was taxable income.

Petitioner’s testimony is implausible and unpersuasive. He had received

compensation in prior years pursuant to his agreement with Beer, and he had

notice that the payment was to be treated as compensation by the payor, Delta.

      At trial and in his posttrial supplemental brief petitioner objected to the use

of the Del Bove emails as hearsay. They are admissible, however, for purposes

other than proving that Del Bove was correct in her characterization of the

payment, i.e., for purposes other than the truth of her statements. The emails are
                                        -19-

[*19] admissible to show that petitioner was on notice that the $2 million payment

would be treated as taxable income. See Biegas v. Quickway Carriers, Inc., 573

F.3d 365, 379 (6th Cir. 2009) (holding statement admissible for nonhearsay

purpose to prove plaintiff was on notice of imminent danger, ignored warning, and

acted negligently). The Del Bove emails are also admissible under the state of

mind exception to the hearsay rule to show how Delta intended to report and

characterize the $2 million payment. See Fed. R. Evid. 803(3); Estate of Pruitt v.

Commissioner, T.C. Memo. 2000-287 (holding testimony regarding decedent’s

stated intent to include a power to make gifts in powers of attorney admissible

under rule 803(3) of the Federal Rules of Evidence); Pan Am. Acceptance Corp. v.

Commissioner, T.C. Memo. 1989-440 (holding check with notation “repay debt”

admissible under rule 803(3) of the Federal Rules of Evidence as evidence of

intent to repay loan).

      Petitioner additionally argues that respondent prevented material evidence

from being introduced by not providing Del Bove with limited immunity.

Petitioner also argues that respondent’s failure to do so should create an adverse

inference that Del Bove’s testimony would not have supported respondent’s

position. Contrary to petitioner’s assertions, only the Department of Justice can

grant immunity. See 18 U.S.C. sec. 6003 (2012). Moreover, even if respondent
                                         -20-

[*20] could have granted immunity to Del Bove and chose not to, a negative

inference cannot be drawn from that prosecutorial decision. See United States v.

Myerson, 18 F.3d 153, 158 (2d Cir. 1994) (citing United States v. St. Michael’s

Credit Union, 880 F.2d 579, 598 (1st Cir. 1989), and relying on that court’s

determinations that “the government’s failure to immunize a witness, without

more, does not give rise to a missing witness instruction” and that no “negative

inference may be drawn from that prosecutorial decision”); United States v.

Forbes, 2007 WL 141952, at *7 (D. Conn. Jan. 17, 2007).

      Delta’s treatment of the $2 million payment as nonemployee income was

consistent with Delta and Counterpoint’s treatment of the 2001 and 2002 “bonus”

payments. Delta reported both prior payments as nonemployee compensation, and

petitioner reported them as self-employment income and paid tax on them.

Petitioner has provided no persuasive justification for distinguishing the 2003

$2 million payment from the 2001 or 2002 “bonus” payments. The evidence

establishes that the intent of the parties and specifically the intent of the payor

Delta was to treat the $2 million payment as nonemployee income subject to tax.

Therefore, the character of the $2 million payment is nonemployee income subject

to self-employment tax.
                                         -21-

[*21] Petitioner additionally argues that he is not subject to self-employment tax

on the $2 million payment because he was not engaged in a trade or business as a

tax shelter accommodating party. The term “trade or business” has the same

meaning under section 1402(a) as under section 162. Sec. 1402(c); see Bot v.

Commissioner, 118 T.C. 138, 146 (2002), aff’d, 353 F.3d 595 (8th Cir. 2003). In

Commissioner v. Groetzinger, 480 U.S. 23, 35 (1987), the Supreme Court

determined that to be engaged in a trade or business under section 162 (and, in this

case, section 1402(a)), the taxpayer must be involved in an activity with continuity

and regularity and with the primary purpose of receiving income or profit.

      The record demonstrates that petitioner’s activities were continuous and

regular. Petitioner testified that he went to Bricolage’s offices “a lot” and

“regularly” to execute large volumes of legal documents consisting of formation

and organization documents for the tax shelter entities. This fact remained even

after petitioner formed JJC in 2001. By forming JJC, making Bricolage JJC’s

nonmember manager, and giving Bricolage power of attorney over JJC,

petitioner’s activities remained continuous and regular. Bricolage’s actions with

respect to JJC are imputed to petitioner as his agent. Petitioner established the

legal machinery for others to act on his behalf and cannot now use that delegation

of authority as a shield. The record also demonstrates petitioner’s profit motive.
                                          -22-

[*22] Petitioner was paid for his services through large lump-sum payments that

were reported by the payors as nonemployee compensation on Forms 1099, and

petitioner reported the payments as self-employment income. In short, the record

demonstrates that petitioner accommodated tax shelters with sufficient continuity,

regularity, and a profit motive such that he was engaged in a trade or business as a

tax shelter accommodating party.

      Next, petitioner asserts that the $2 million payment was a return of capital.

Aside from his blanket assertions, the evidence establishes that petitioner was not

a partner in Delta and did not invest capital in Delta. The parties stipulated that

petitioner received the $2 million payment from Delta and Delta’s characterization

of that payment. Simply stated, the payment could not have been a return of

capital because petitioner did not have any capital invested in Delta.

      The evidence establishes that petitioner did not have a capital investment in

any tax shelter entity after 2001. In closing agreements with the IRS, petitioner

agreed that both he and JJC sold or redeemed all of their respective interests in the

tax shelter entities by the end of 2001. He recorded amounts received in sales or

redemptions of his interests in the tax shelter entities on his income tax returns for

2000 and 2001. Similarly, JJC recorded amounts received in sales or redemptions

of its interests in the tax shelter entities on its income tax return for 2001.
                                            -23-

[*23] Nevertheless, petitioner asserts that he had investment capital in the tax

shelter entities when he received the $2 million payment. Petitioner argues that he

understood the initial $1.2 million payment from “Bricolage” would be a signing

bonus in 2000 to be used as his investment capital in the tax shelter entities.

Similarly, petitioner argues that the $1 million deposit into JJC was “ostensibly”

used to invest in the Bricolage entities.

      Petitioner did not know which, or how many, of the Bricolage entities’

partnerships he had invested in. He did not keep track of the partnerships, his

investments in the partnerships, or the transactions they engaged in. He concedes

that it is impossible to trace his investments in the Bricolage entities because the

tax shelters’ structures were too complex and vast to unwind. Finally, he notes

that tracing his investments is impossible because he has repeatedly been denied

access to necessary financial records.

      Petitioner’s argument appears to be that the circumstantial evidence of his

investment in the Bricolage entities demonstrates that the $2 million payment was

a return of capital. We disagree. The preponderance of the evidence establishes

that the $2 million payment was not a return of capital from Delta.

      Petitioner alternatively argues that if the $2 million payment is not a return

of capital, then it was a gift from Beer. Petitioner notes that “[w]hile the Court
                                        -24-

[*24] may think the suggestion that the payment was part gift somewhat

far-fetched, this case must be decided on the evidence presented.” We agree with

petitioner’s characterization of his suggestion and the necessity of deciding the

case on the evidence, but we reject his conclusion. A gift results from a detached

and disinterested generosity motivated by affection, respect, admiration, charity, or

the like. Commissioner v. Duberstein, 363 U.S. 278, 285 (1960). The record is

devoid of any evidence suggesting that the payment resulted from detached and

disinterested generosity. Rather, the evidence establishes that the payor, Delta,

intended the payment as compensation. Notably, Beer testified that he viewed the

$2 million payment as a discretionary bonus for services petitioner provided to

Delta. The evidence compels the conclusion that the $2 million payment in

question was received for services and was neither a gift nor a return of capital

contributions that neither petitioner nor Beer could identify.

II. Accuracy-Related Penalty

      Finally, we consider whether petitioner is liable for the accuracy-related

penalty. See sec. 6662(a). Respondent has the burden of production and must

present sufficient evidence that it is appropriate to impose the penalty. See sec.

7491(c); Higbee v. Commissioner, 116 T.C. at 446-447. Once respondent satisfies

his burden of production, petitioner must present evidence sufficient to persuade
                                         -25-

[*25] the Court that respondent’s determinations are incorrect. See Higbee v.

Commissioner, 116 T.C. at 447.

      A. Section 6751(b)

      Petitioner raises for the first time in his posttrial brief an argument that

respondent failed to carry his burden of production by not introducing evidence of

his compliance with section 6751(b)(1). Petitioner theorizes that for respondent to

meet his burden of production, respondent must introduce evidence that the

individual making the penalty determination had his or her immediate supervisor

approve the accuracy-related penalty in writing. A party may not raise an issue for

the first time on brief if the Court’s consideration of the issue would surprise and

prejudice the opposing party. See Smalley v. Commissioner, 116 T.C. 450, 456

(2001); Seligman v. Commissioner, 84 T.C. 191, 198-199 (1985), aff’d, 796 F.2d

116 (5th Cir. 1986). In deciding whether the opposing party will suffer prejudice,

we consider the degree to which the opposing party is surprised by the new issue

and the opposing party’s need for additional evidence to respond to the new issue.

See Pagel, Inc. v. Commissioner, 91 T.C. 200, 212 (1988), aff’d, 905 F.2d 1190

(8th Cir. 1990). In addition, a party may not rely upon a new theory unless the

opposing party has been provided with fair warning of the intention to base an

argument upon that theory. See id. at 211-212. “Fair warning” means that a
                                         -26-

[*26] party’s ability to prepare its case was not prejudiced by the other party’s

failure to give notice, in the notice of deficiency or in the pleadings, of the

intention to rely on a particular theory. Id.

      Petitioner’s new argument is untimely. We do not rule on the issue of

whether the section 6751(b) requirement is part of respondent’s burden of

production and express no opinion as to the merits of petitioner’s argument.

Petitioner did not allege in the petition, in his pretrial memorandum, or at trial that

respondent failed to comply with section 6751(b). By belatedly raising this

argument in his posttrial opening brief, petitioner would prejudice respondent by

denying him an opportunity to introduce evidence of the IRS’s compliance with

section 6751(b). This case was tried before and submitted to a judge who is no

longer available to decide it. The parties were given an opportunity for a further

trial but did not request one. There is no justification for reopening the record at

this late stage, and we will not address the section 6751(b) argument.

      B. Substantial Understatement of Income Tax

      A taxpayer is liable for an accuracy-related penalty as to any portion of an

underpayment attributable to, among other things, a substantial understatement of

income tax or negligence. Sec. 6662(a) and (b)(1) and (2). There is a substantial

understatement of income tax if the amount of the understatement exceeds the
                                        -27-

[*27] greater of 10% of the tax required to be shown on the return or $5,000. Sec.

6662(d)(1)(A); sec. 1.6662-4(a), Income Tax Regs. Because we determine that

there is a substantial understatement of income tax, we need not address

negligence.

      Petitioner reported zero total tax for 2003, and we are sustaining the

determination in the notice of deficiency that he owes $63,751. Thus, petitioner

understated the tax on his return by $63,751. Accordingly, respondent has met his

burden of producing evidence that petitioner’s underpayment was attributable to a

substantial understatement of income tax and therefore petitioner is liable for the

accuracy-related penalty absent a showing of reasonable cause or some other

defense.

      C. Reasonable Cause and Good Faith

      Once the Commissioner has met the burden of production, the taxpayer

must come forward with persuasive evidence that the penalty is inappropriate

because, for example, he or she acted with reasonable cause and in good faith.

Sec. 6664(c)(1); Higbee v. Commissioner, 116 T.C. at 448-449. The decision as

to whether a taxpayer acted with reasonable cause and in good faith is made on a

case-by-case basis, taking into account all pertinent facts and circumstances. See

sec. 1.6664-4(b)(1), Income Tax Regs. Generally, the most important factor is the
                                          -28-

[*28] extent of the taxpayer’s effort to assess her or his proper tax liability. Id.;

see Halby v. Commissioner, T.C. Memo. 2009-204.

        While reliance on the advice of a professional tax adviser does not

necessarily demonstrate reasonable cause and good faith, it may when “under all

the circumstances, such reliance was reasonable and the taxpayer acted in good

faith.” Sec. 1.6664-4(b)(1), Income Tax Regs. The requirements for reasonable

cause are not satisfied if the taxpayer fails to disclose a fact that he knows, or

reasonably should know, to be relevant to the proper tax treatment of an item.

Sec. 1.6664-4(c)(1)(i), Income Tax Regs.; see Diaz v. Commissioner, T.C. Memo.

2012-280. Additionally, a taxpayer’s education, sophistication, and business

experience are relevant in determining whether the taxpayer’s reliance on the tax

advice was reasonable and made in good faith. Sec. 1.6664-4(c)(1), Income Tax

Regs.

        Petitioner seeks to defend against the accuracy-related penalty by asserting

that he relied on Ellspermann, his tax professional, to prepare the tax return and to

assure him that the $2 million payment was not taxable income. However,

Ellspermann’s advice was only as good as the information that petitioner provided

to him. Petitioner did not provide Ellspermann with necessary and accurate

information.
                                         -29-

[*29] In the April 2002 email Del Bove discussed petitioner’s receipt of the

$1 million payment from Delta in 2001 and notified petitioner that he would

receive future fees for consulting work that he had performed for Delta. In

February 2003 Del Bove emailed petitioner and notified him that he would be

receiving the balance of funds from his JJC account and the $2 million payment

from Delta. Petitioner and Del Bove exchanged several followup emails

discussing the proper tax treatment of the $2 million payment. Del Bove

responded that the $2 million “will be reported on a 1099, so you should tax-plan

accordingly.” Petitioner asked for additional clarification on whether both

amounts would be included on Form 1099 for 2003. Del Bove responded

unequivocally that “[t]he amount you receive from JJC Trading is not income, and

therefore, will not be reported on a 1099. That money is from what you had

originally invested in JJC Trading. The 2mm we pay you will be reported on a

1099, as well as any other subsequent payments.” Petitioner asserts that, after this

email exchange, he questioned Del Bove’s conclusion and exchanged several

emails with Bricolage’s general counsel regarding how much was due to him and

how it would be treated for tax purposes.

      Petitioner’s testimony on these points is not persuasive. Del Bove

unequivocally explained to petitioner, after several clarifications, that the
                                       -30-

[*30] $2 million would be included on his Form 1099 for 2003 and that he should

“tax-plan accordingly.” Del Bove’s emails clearly explained how Delta intended

to characterize the payment. Delta subsequently reported the $2 million payment

as nonemployee compensation on petitioner’s Form 1099 for 2003, consistent with

Del Bove’s emails and explanation. Petitioner never informed Ellspermann of his

February 2003 email exchange with Del Bove regarding the tax treatment of the

$2 million payment or that petitioner was notified it would be treated as income

and included on Form 1099 for 2003.

      Apparently, petitioner’s argument is that he had satisfied himself on the tax

treatment of the $2 million payment. We reject petitioner’s explanation of why he

did not tell Ellspermann about his email exchanges with Del Bove. Instead,

petitioner erroneously told Ellspermann that the $2 million payment was part of

the activities Bricolage managed and that, if Ellspermann had any questions, he

should contact Bricolage regarding the classification and nature of the payment.

Ellspermann testified that he would have followed up with Delta regarding a

potential Form 1099 for 2003 if he had been informed of petitioner’s

correspondence with Del Bove.

      Petitioner must demonstrate by a preponderance of the evidence that he

relied in good faith on his adviser’s judgment to establish good cause. See
                                        -31-

[*31] Neonatology Assocs., P.A. v. Commissioner, 115 T.C. 43, 99 (2000), aff’d,

299 F.3d 221 (3d Cir. 2002); see also 106 Ltd. v. Commissioner, 136 T.C. 67, 77

(2011), aff’d, 684 F.3d 84 (D.C. Cir. 2012). Petitioner cannot establish good-faith

reliance because he withheld from Ellspermann a crucial and probative email

exchange. Petitioner’s decision to withhold that information from Ellspermann

was negligent at best or intentionally obstructive at worst. In either event,

petitioner failed to inform Ellspermann of facts that he knew, or should have

known, were relevant to the proper tax treatment of the $2 million payment. A

reasonably prudent person would have informed his or her tax professional as to

the disputed characterization of a payment. It was objectively unreasonable for

petitioner to fail to do so.

       Additionally, petitioner cannot demonstrate good-faith reliance because he

knew, or should have known, that Ellspermann’s advice was based on incomplete

information and an unreasonable assumption. The advice of a professional must

not be based on unreasonable factual and legal assumptions and must not

unreasonably rely on the representations, statements, findings, or agreements of

the taxpayer or any other person. Sec. 1.6664-4(c)(1)(ii), Income Tax Regs.; see

Canal Corp. v. Commissioner, 135 T.C. 199, 218 (2010); Dunn v. Commissioner,

T.C. Memo. 2010-198. The advice must not be based on a representation or
                                         -32-

[*32] assumption that the taxpayer knows, or has reason to know, is unlikely to be

true. Sec. 1.6664-4(c)(1)(ii), Income Tax Regs.

      Ellspermann determined the $2 million payment could be omitted from

petitioner’s tax return on the basis of an unreasonable and erroneous assumption--

that the payment was recorded on Schedule K-1 as to a partner’s distributive share.

That assumption is erroneous and unreasonable for several reasons. Del Bove’s

replacement, Taglialatela, credibly testified that he never told petitioner or

Ellspermann that the $2 million would be reported on Schedule K-1 or any

combination of Schedules K-1. Similarly, Taglialatela credibly testified that he

never told Ellspermann that the $2 million payment was not income or that it

would not be reported on Form 1099 for 2003. The $2 million payment does not

appear on petitioner’s 2003 Schedules K-1. Petitioner’s failure to inform

Ellspermann about his email exchange with Del Bove bolstered Ellspermann’s

erroneous assumption. Petitioner knew, or had reason to know, that the $2 million

would be reported on Form 1099 for 2003. Therefore, Ellspermann’s advice was

based on a representation or assumption that petitioner knew, or had reason to

know, was unlikely to be true.

      Finally, we note that petitioner is a highly educated businessperson.

Petitioner received his undergraduate and master’s degrees from Harvard, and he
                                        -33-

[*33] owned and operated a successful architecture business. On the basis of

petitioner’s education, sophistication, knowledge, and experience, we find that he

should have known of the importance of informing Ellspermann that he knew, or

had reason to know, the $2 million payment would be treated as nonemployee

compensation.

      In sum, petitioner has not demonstrated reasonable cause for his failure to

report the $2 million payment on his income tax return for 2003. Petitioner did

not provide the necessary and accurate information to Ellspermann and, as a result,

did not rely in good-faith on Ellspermann’s judgment.

      We have considered all remaining arguments the parties made and, to the

extent not addressed, we conclude they are irrelevant, moot, or meritless.

      To reflect the foregoing,


                                               Decision will be entered

                                        for respondent.
