                          T.C. Memo. 2011-257



                        UNITED STATES TAX COURT



        TREVE W. AND STEPHANIE L. KINSEY, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 15862-09.               Filed November 1, 2011.



     Donald W. Wallis and Casey W. Arnold, for petitioners.

     Joel D. McMahan, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     GOEKE, Judge:   Respondent determined a deficiency of $60,333

in petitioners’ 2004 Federal income tax and also asserts an

increased deficiency.    On an amended 2004 joint income tax return

petitioners claimed over $347,000 as a loss on their Schedule E,

Supplemental Income and Loss, asserting that they held 100

percent of the ownership in Twentieth Century Mortgage, Inc.
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(TCM).   The disallowance of this loss is the basis of the

original deficiency.   Respondent disallowed the loss because he

determined petitioners were not owners of TCM in 2004.

Respondent also asserts that petitioners are judicially estopped

from claiming ownership of TCM for 2004 because Mr. Kinsey took a

contrary position in prior litigation.   After this case was

docketed, respondent asserted an increased deficiency on the

basis of a claim that Mr. Kinsey had received income of

$44,152.44 upon TCM’s paying legal fees on his behalf in 2004.

For the reasons stated herein, we find that petitioners were not

shareholders of TCM in 2004, and respondent’s increased

deficiency is not sustained.

                         FINDINGS OF FACT

     Petitioners resided in Florida when the petition was filed.

Before December 2004 petitioners resided in Colorado.    In 1997

Mr. Kinsey founded TCM in Colorado to perform services as a

mortgage broker.   TCM was a subchapter S corporation.

     In February 2002 Mr. Kinsey consulted with Ronald Brasch to

sell TCM.   Mr. Brasch was an experienced business broker working

for First Business Brokers in Colorado Springs, Colorado.    In

early April 2002 Mr. Brasch began representing Mr. Kinsey to

market and sell TCM.   Mr. Brasch created an advertising package

and began extensively marketing TCM on June 12, 2002.    The value

of TCM declined between 2001 and 2003 because the profitability
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of TCM had declined during that period.   In the beginning of 2003

Mr. Brasch updated TCM’s financials to reflect its poor

performance in 2002.   Between January and June 2003 Mr. Brasch

received no formal offers for TCM.

     Gerald Small, a principal of Amerifunding/Amerimax Realty

Group, Inc. (Amerifunding), a mortgage brokerage business,

emailed Mr. Brasch inquiring about the purchase of TCM in January

2003 but did not respond when contacted by Mr. Brasch’s office.

Mr. Small emailed Mr. Brasch again in May 2003 inquiring about

the purchase of TCM.   On May 12, 2003, Mr. Small responded to Mr.

Brasch with appropriate confidentiality paperwork.   On August 19

or 20, 2003, Mr. Brasch received Mr. Small’s letter of intent to

purchase TCM for $2.1 million.    The terms of this initial offer

contemplated a payment of $500,000 at closing with the remainder

to be paid in three quarterly payments.   One day after his

initial offer, Mr. Small increased his offer by approximately

$1.3 million.

     On September 3, 2003, Mr. Kinsey proposed a $100,000

discount to the buyer for an all-cash transaction.   On September

30, 2003, Mr. Brasch received a draft purchase agreement listing

Chad Heinrich, an employee of Amerifunding, as the buyer instead

of Mr. Small.   After learning that Mr. Heinrich would be named as

the purchaser, Mr. Brasch informed Mr. Kinsey that a credit
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report should be completed on Mr. Heinrich.    Mr. Kinsey claims to

have accepted a credit report given to him by Mr. Heinrich.

       First Collateral Services, Inc. (First Collateral), was a

lending institution that provided credit lines to, among others,

TCM.    Before the TCM sale closed, Mr. Kinsey knew that First

Collateral would not do business with Mr. Small.    Mr. Kinsey did

not tell First Collateral of Mr. Small’s relationship to Mr.

Heinrich.

       Mr. Kinsey was represented by an attorney, Robert Horen,

throughout the negotiations and sale of TCM.    Mr. Kinsey, through

his representatives, structured the sale of TCM as $2 million in

cash for the sale of the stock, with the remainder in cash for

Mr. Kinsey’s retained earnings in TCM.    The closing for the sale

of TCM occurred on December 2, 2003, at Mr. Horen’s office.      To

complete Mr. Kinsey’s sale of TCM to Mr. Heinrich, a total of

$3,370,804.76 was wire transferred to First Business Brokers on

December 3, 2003.

       At the closing, Mr. Heinrich received the stock certificate

of TCM.    Mr. Brasch received $190,000 as a fee for brokering the

sale of TCM.    Petitioners received $3,180,804.76 via wire

transfer dated December 3, 2003.    In addition to cash, Mr. Kinsey

obtained an employment agreement to work for TCM as its president

for a $240,000 annual salary, plus bonuses and expenses.      Mr.

Kinsey’s employment agreement with TCM required that he work at
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TCM’s offices in Aurora, Colorado.     During 2004 Mr. Kinsey worked

for TCM pursuant to the employment agreement as a mortgage broker

and president.

     In December 2003 false applications on behalf of

Amerifunding and TCM for a warehouse line of credit with Flagstar

Bank, FSB (Flagstar), a Michigan-based bank, were made in excess

of $15 million.   Flagstar specializes in mortgage lending and, as

part of its mortgage-lending business, originates loans directly

on its own, provides various types of financing for mortgage

brokers, assists brokers on sales and underwriting, and buys and

sells mortgage-backed securities as a correspondent permanent

lender.   A similar line of credit with Impac Warehouse Lending

Group (IMPAC) caused millions of dollars to be advanced to

Amerifunding through TCM in December 2003.

     In April 2003 Flagstar entered into an agreement to advance

Amerifunding an amount not to exceed $20 million.    These funds

were to be used to obtain residential mortgages that TCM would

originate and broker.

     By March 2004 Flagstar had discovered that Amerifunding was

engaged in theft and a scheme to defraud Flagstar.    Amerifunding

had used fraudulent buyers who used false identities and created

fraudulent mortgages in these individuals’ names.    As a result

of the scheme, Flagstar advanced approximately $155 million to

Amerifunding and TCM on the basis of fraudulent loan applications
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and suffered losses of approximately $23.4 million.   IMPAC

advanced approximately $99.7 million to Amerifunding on the basis

of fraudulent loan applications and suffered losses of

approximately $12.9 million.   Mr. Heinrich, Mr. Small, and Mr.

Small’s wife were indicted.

     As a result, in 2004 and 2005 various civil lawsuits were

filed, including a March 2004 suit by Flagstar against

Amerifunding, TCM, Mr. Heinrich, Mr. Small, Mrs. Small, and Mr.

Kinsey.   All of the defendants with exception to Mrs. Small, Mr.

Kinsey, and TCM have defaulted.   In the Flagstar lawsuit, Mr.

Kinsey testified that he was not liable to Flagstar for fraud and

negligence because he was not the owner of TCM and he reported to

Mr. Heinrich acting merely as an employee and under Mr.

Heinrich’s direction.

     On February 18, 2005, Mr. Heinrich pleaded guilty to two

counts of felony fraud against Flagstar in the U.S. District

Court for the District of Colorado, for wire fraud.   As part of

his plea, Mr. Heinrich admitted to his participation in a

conspiracy which used TCM to commit fraud against Flagstar and

IMPAC.    Mr. Heinrich was imprisoned for 28 months and ordered to

pay restitution of $22.4 million to Flagstar and approximately

$12.6 million to IMPAC.

     On May 25, 2005, Flagstar and IMPAC filed a civil action to

levy upon TCM stock held by Mr. Heinrich.   As part of the
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bankruptcy case, TCM filed actions to prevent the transfer of the

stock to Flagstar.    Flagstar also filed an action against Mr.

Kinsey and TCM.    To settle these claims, Mr. Kinsey agreed to pay

Flagstar $1.5 million.    For the payment, Mr. Kinsey and TCM would

receive a release of all claims and Flagstar’s agreement to

facilitate the return of TCM stock to Mr. Kinsey.

       By letter dated June 28, 2004, TCM confirmed with Mr.

Heinrich that Mr. Kinsey was authorized to continue operating

TCM.    In 2004 TCM paid Mr. Kinsey’s personal attorney’s fees in

an amount not less than $44,152.44.

       On June 7, 2005, Mr. Kinsey, as president of TCM, filed for

chapter 11 bankruptcy in the U.S. Bankruptcy Court for the

District of Colorado (the bankruptcy court).    In TCM’s bankruptcy

statement of financial affairs, Mr. Kinsey listed Mr. Heinrich as

the 100-percent owner of TCM.

       On February 14, 2006, the bankruptcy court granted a motion

to approve the settlement agreement.    In his testimony before the

bankruptcy court, in the settlement agreement, and in the motion

to approve settlement, Mr. Kinsey took the position that he had

sold 1,000 shares of stock in TCM to Mr. Heinrich on December 3,

2003, and that he was not an owner of TCM thereafter.

       The bankruptcy court approved the settlement, and Mr. Kinsey

discontinued TCM as a business in 2006.    Petitioners did not

report as income for 2004 TCM’s payments to Mr. Kinsey’s attorney
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in 2004.    Petitioners did not report any distributive share of

income or loss from TCM on their initial 2004 return, but they

claimed the loss from TCM on an amended return, as previously

described.

      On March 27, 2009, respondent issued the notice of

deficiency for 2004 underlying this proceeding and also described

above.    On June 30, 2009, petitioners timely filed their petition

with this Court.

                               OPINION

      We decide this case on the factual record before us, and the

burden of proof does not affect the outcome.

I.   The Original Deficiency Determination

      A sale is generally defined as a transfer of property for

“money or its equivalent”.    Commissioner v. Brown, 380 U.S. 563,

571 (1965).    The key determination is “whether the benefits and

burdens of ownership have passed” from the seller to the buyer.

Grodt & McKay Realty, Inc. v Commissioner, 77 T.C. 1221, 1237

(1981).    This is a factual determination based on the intent of

the parties “as evidenced by the written agreements, read in the

light of the attending facts and circumstances”.    Haggard v.

Commissioner, 24 T.C. 1124, 1129 (1955), affd. 241 F.2d 288 (9th

Cir. 1956).    Relevant factors used by this Court are:   (1)

Whether legal title passed; (2) how the parties treated the

transaction; (3) whether equity was acquired in the property; (4)
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whether the contract created a present obligation on the seller

to deliver and an obligation on the buyer to make payments; (5)

whether the right of possessions vested with the purchaser; (6)

which party pays the taxes associated with the property; (7)

which party bears the risk of loss or damage to the property; and

(8) which party receives the profits from the operation and sale

of the property.    Grodt & McKay Realty, Inc. v. Commissioner,

supra at 1237-1238.

     Although their petition makes reference to Mr. Kinsey’s

“sale” of TCM in December 2003, petitioners’ amended petition

refers to the sale as an “event” and claims that the substance of

the “event” did not shift the benefits and burdens of ownership

in TCM.    Petitioners argue that because Mr. Kinsey disagreed with

the buyer’s operation of TCM, the “event” somehow did not

transfer ownership to the buyer.   Instead, petitioners argue the

substance of the transaction was a lease, rather than a sale.

Petitioners concede that if Mr. Kinsey is not the sole

shareholder of TCM throughout 2004, the notice of deficiency is

correct.   However, for the reasons detailed below, the “event” in

2003 was indeed Mr. Kinsey’s sale of TCM stock, complete with a

purchase and sale agreement and a transaction closing that

occurred at the offices of Mr. Kinsey’s attorney.   Mr. Kinsey’s

sale of TCM stock transferred the benefits and burdens of

ownership from Mr. Kinsey to Mr. Heinrich after the closing
                                - 10 -

occurred on December 2, 2003.    In fact, Mr. Kinsey and Mr.

Heinrich negotiated and signed a detailed “stock purchase and

sale agreement” with the assistance of counsel.    The terms in

this document clearly indicate that the intent of both parties

was to transfer ownership of 1,000 shares of stock in TCM from

Mr. Kinsey to Mr. Heinrich.

     Moreover, in exchange for his stock of TCM, Mr. Kinsey

received $3,370,804.76 in cash via a wire transfer through his

business broker, and Mr. Heinrich received legal title to TCM.

As a result, the “event” petitioners refer to was a transaction

through which Mr. Kinsey received the benefit of his bargain

(i.e., $3.3 million) in exchange for the stock of TCM.    Mr.

Kinsey remained with TCM under an employment agreement, but he

relinquished control of the company to Mr. Heinrich.

Consequently, the benefits and burdens of TCM ownership shifted

in connection with the 2003 TCM stock purchase and sale

agreement.

     The Court of Appeals for the Eleventh Circuit has held that

when a taxpayer attempts to disregard the form of a transaction,

the taxpayer must show that the agreement was a result of fraud,

duress, or undue influence.     Bradley v. United States, 730 F.2d

718, 720 (11th Cir. 1984); Spector v. Commissioner, 641 F.2d 376,

382 (5th Cir. 1981) (relying on Commissioner v. Danielson, 378

F.2d 771, 775 (3d Cir. 1967)), revg. and remanding 71 T.C. 1017
                                 - 11 -

(1979).    However, in this case, Mr. Kinsey was not defrauded but

instead received the full contract price for the sale of his

stock.    Petitioners’ amended petition makes no allegation that

Mr. Kinsey was defrauded.     Instead, Mr. Kinsey admits that he

received approximately $3.3 million via a wire transfer in

exchange for selling his TCM stock.

     Petitioners argue that after the stock sale, Mr. Heinrich

and Mr. Small used TCM to defraud third-party banks that lent

funds to TCM.    They assert that “kind of like with a stolen get-

away car used in a bank robbery, * * * [TCM’s buyer] just trashed

it and abandoned it on the side of the road.”     However, the sale

is not avoided because of the manner in which TCM was later

operated.    Mr. Kinsey was paid the agreed price; the fraud was

not perpetrated on him as part of the sale.

     The Kinseys cite Black v. First Fed. Sav. & Loan Association

of Fargo, N.D., 830 P.2d 1103 (Colo. App. 1992), and claim that

each of the fraud elements described in Black are present in the

instant case.    The court in Black upheld the lower court’s

conclusion that “First Federal was fraudulently induced to loan

money”.     Id. at 1114.   In their argument, petitioners explicitly

concede that “In this case, the contract and the transaction

based on it were not induced by fraud.”

     Next, citing Colo. Plasterers’ Pension Fund v. Plasterers’

Unlimited, Inc., 655 F. Supp. 1184 (1987), petitioners argue that
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the doctrine of fraud in the execution should void Mr. Kinsey’s

sale of TCM ab initio.    However, the court in Colo. Plasterers’

Pension Fund explained that in Colorado, “fraud in the execution

‘is fraud exercised in reference to the acts of signing and

delivering an instrument, sometimes by a deceptive substitution

of documents causing someone to sign an instrument without

knowing the consequences of his act.’”     Id. at 1186-1187 (quoting

Meyers v. Johanningmeier, 11 Brief Times Reporter 122 (Feb. 6,

1987)).

     Quoting the Restatement (Second) of Contracts, sec. 163

Illustration 2 (1981), the court explained by way of example:

     A and B reach an understanding that they will execute
     a written contract containing terms on which they have
     agreed. It is properly prepared and is read by B, but
     A substitutes a writing containing essential terms
     that are different from those agreed upon and thereby
     induces B to sign it in the belief that it is the one
     he has read. B’s apparent manifestation of assent is
     not effective.

Colo. Plasterers’ Pension Fund v. Plasterers’ Unlimited, Inc.,

supra at 1187.

     There has been no allegation and no evidence to suggest that

the TCM sale contract negotiated by Mr. Kinsey’s attorney and

executed in his attorney’s office was surreptitiously replaced by

some other document.     Instead, the record is clear that (1) Mr.

Kinsey was well represented in his transaction by a business

broker and legal counsel, (2) he closed the transaction at the

office of his own counsel, and (3) he received in excess of $3.3
                                 - 13 -

million via wire transfer at the conclusion of the transaction.

We can see no fraud in the execution.1

      Petitioners’ alternative arguments that the transaction must

be voided on the basis of fraud and illegality fail for the

reasons explained regarding the fraud in the execution argument.

II.   The Increased Deficiency

      Section 612 provides that gross income includes all income

from whatever source derived, unless the taxpayer can establish

the application of a specific legislative authorization to

exclude income from taxation.     Commissioner v. Glenshaw Glass

Co., 348 U.S. 426, 429-430 (1955).        In this respect, a third

party’s discharge of a taxpayer’s obligation is income to the

taxpayer.    Old Colony Trust Co. v. Commissioner, 279 U.S. 716

(1929).    During 2004 TCM paid attorney’s fees of $44,152.      The

fees related to the representation of Mr. Kinsey and TCM in TCM’s

bankruptcy proceeding.    As a result, respondent asserts that Mr.

Kinsey should have included in income the amounts paid as

attorney’s fees.    “That the funds were paid directly to

petitioner’s attorney and not to petitioner does not alter this

result.”    Sanford v. Commissioner, T.C. Memo. 2008-158.      There is


      1
      Respondent also asserts judicial estoppel regarding the
sale of TCM stock in 2003 as a result of the representations in
the bankruptcy filing. Because we reject petitioners’ claims
that the sale should be disregarded, it is unnecessary for us to
reach this argument.
      2
      All section references are to the Internal Revenue Code in
effect for 2004.
                             - 14 -

no dispute the amount was paid, and petitioners did not report

this amount on their 2004 tax return or amended return.      At the

time of the legal fee payment, the legitimate operations of TCM

were still directed by Mr. Kinsey.    This issue turns on whether

in directing payment of these legal fees, Mr. Kinsey was paying a

legitimate expense of TCM, rather than his own personal expense.

We find on the facts before us that the payment in 2004 was a

reasonable expenditure of TCM funds in attempting to extricate

TCM and its president, Mr. Kinsey, from the results of the

fraudulent actions after the sale in 2003.   We do not find that

the payment was primarily for Mr. Kinsey’s personal benefit.

Consequently, petitioners’ income should not be increased by

$44,152.44 for the 2004 taxable year.

     To reflect the foregoing,


                                          Decision will be entered

                                     for respondent as to the

                                     original deficiency

                                     determination and for

                                     petitioners as to the

                                     asserted increased deficiency.
