                         T.C. Memo. 2008-275



                       UNITED STATES TAX COURT



       ALFRED J. OLSEN AND SUSAN K. SMITH, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket Nos. 15665-06, 8038-07.     Filed December 10, 2008.



     Brad S. Ostroff and Martha Combellick Patrick, for

petitioners.

     Anne W. Durning, for respondent.



               MEMORANDUM FINDINGS OF FACT AND OPINION


     KROUPA, Judge:    Respondent determined a $19,168 deficiency

for 1999 and a $17,573 deficiency for 2000 in petitioners’

Federal income tax.   The sole issue for decision is whether
                                  2

petitioners are liable for self-employment tax under section

1402.1    We hold that they are liable.

                          FINDINGS OF FACT

     Some of the facts have been stipulated and are so found.

The stipulation of facts and the accompanying exhibits are

incorporated by this reference.    Petitioners Alfred J. Olsen

(petitioner husband) and Susan K. Smith (petitioner wife) are

both tax and estate planning attorneys.       Petitioners have been

married since 1979 and have no children.       They filed joint

Federal income tax returns for 1999 and 2000 (the years at

issue).    Petitioners reside in Arizona.

Structure of Petitioners’ Business

     Petitioners claim to be employees of Olsen-Smith, Ltd.

(Olsen-Smith), an Arizona general partnership, the partners of

which are three pass-through entities known as professional

limited liability companies (PLCs).       Olsen-Smith was a

professional corporation until 1987 when it became a general

partnership.    The three professional corporations were replaced

by the PLCs in 1992 for various reasons including tax

considerations.    Olsen-Smith’s three equal direct partners during

the years at issue were Smith/Olsen PLC (Smith/Olsen), Smith &

Associates, PLC (Smith & Associates), and Rossie & Associates,


     1
      All section references are to the Internal Revenue Code for
the years at issue, and all Rule references are to the Tax Court
Rules of Practice and Procedure, unless otherwise indicated.
                                   3

PLC (Rossie/Associates).   Petitioners adopted this structure at

some point during the mid-1990s.

     Smith/Olsen was an Arizona PLC that was managed by

petitioner husband and whose members were an irrevocable complex

trust named The 1992 WHO2 Trust (1-percent owner) and an

irrevocable grantor trust named The SKO-96 Trust (99-percent

owner).   Petitioners treated petitioner husband as the grantor of

all property in The SKO-96 Trust for Federal income tax purposes

and listed him as the grantor on the Forms 1041, U.S. Income Tax

Return for Estates and Trusts for 1999 and 2000.3   Petitioner

husband is the beneficiary of both trusts, and petitioner wife is

the trustee for both trusts.

     Smith & Associates was an Arizona PLC that was managed by

petitioner wife and whose members were an irrevocable complex

trust named The 1992 WLK Trust (1-percent owner) and an

irrevocable grantor trust named The MBK-96 Trust (99-percent

owner).   Petitioners treated petitioner wife as the grantor of

all property in The MBK-96 Trust for Federal income tax purposes

and listed him as the grantor on the Forms 1041 for 1999 and




     2
      The trusts are named for the initials of various family
members.
     3
      Similarly, the Court found Alfred J. Olsen the grantor of
The SKO-96 Trust in Olsen-Smith, Ltd. v. Commissioner, T.C. Memo.
2005-174.
                                   4

2000.4   Petitioner wife is the beneficiary of both trusts, and

petitioner husband is the trustee of both trusts.5

     Petitioners designed The MBK-96 Trust and The SKO-96 Trust

to be “Megatrusts,” a trademark held by petitioners and others.

A megatrust is designed to benefit the beneficiaries while

attempting to minimize trust property claims, reduce or eliminate

all wealth transfer taxes, and help the beneficiaries reduce or

eliminate their own income tax and wealth transfer taxes.

Petitioners’ Income

     Petitioners and James J. Rossie, Jr. (Mr. Rossie) worked for

and received salaries and fringe benefit compensation from Olsen-

Smith during the years at issue.       Mr. Rossie was in charge of

personnel, including hiring and firing.       Petitioner husband was

responsible for financials, and petitioner wife oversaw document

management.   Mr. Rossie and petitioner wife earned salaries of

$36,000 a year and petitioner husband earned a salary of $12,000

a year during the years at issue.

     Olsen-Smith had approximately 15 other employees, including

several legal assistants, but petitioners and Mr. Rossie were the


     4
      Similarly, the Court found Susan K. Smith the grantor of
The MBK-96 Trust in Olsen-Smith, Ltd. v. Commissioner, supra.
     5
      The other one-third interest in Olsen-Smith was held by
Rossie/Associates, an Arizona PLC with a single member, a grantor
trust named JJR-97 Trust, whose beneficiary was James J. Rossie,
Jr. (Mr. Rossie). Mr. Rossie practiced law with petitioners and
conceded that his third of partnership income is taxable to him
as earnings from self-employment.
                                   5

only lawyers at the firm.    The legal assistants earned, on

average, more than $35,000 a year, substantially more than

petitioner husband.

Olsen-Smith’s Business Practices

     Olsen-Smith generally contracted with clients and provided

legal services pursuant to engagement letters executed between

the clients and Olsen-Smith.    Clients generally paid Olsen-Smith

for the services rendered by the firm but occasionally made

checks payable to the individual lawyers.

     Olsen-Smith did not have written employment contracts with

any employees including petitioners.    The PLCs practiced law

through their ownership of Olsen-Smith but had no clients or

employees of their own.

Distribution of Income and Payment of Tax

     Olsen-Smith reported net income of $627,7366 in 1999 and

$437,332 in 2000, which was allocated to the PLCs in equal

shares.   Smith/Olsen and Smith & Associates separately filed

Forms 1065, U.S. Partnership Return of Income,7 each reporting

approximately $202,000 of net ordinary income in 1999 and

$141,673 in 2000.     The SKO-96 Trust reported taxable income from



     6
      It appears that the net income of $627,736, as reported on
the Form 1065, was adjusted on audit. Olsen-Smith, Ltd. v.
Commissioner, supra.
     7
      The Form 1065, U.S. Partnership Return of Income, became a
Form 1065, U.S. Return of Partnership Income, in 2000.
                                  6

Smith/Olsen of $189,903 in 1999 and $140,256 in 2000.    The 1992

WHO Trust reported income from Smith/Olsen of $12,502 in 1999 and

$1,417 in 2000.    The MBK-96 Trust reported taxable income from

Smith & Associates of $190,888 in 1999 and $140,256 in 2000.

The 1992 WLK Trust reported taxable income from Smith &

Associates of $11,502 in 1999 and $1,417 in 2000.

     The PLCs distributed the cash that they received from Olsen-

Smith to the trusts as soon as the money was received by the

PLCs.    The trust agreements allowed the independent trustee to

distribute income or principal for the benefit of the

beneficiaries, including for their “benefit, care, comfort,

enjoyment or for any other purposes.”    The trusts made immediate

distributions of all the money to petitioners as soon as they

received it from the PLCs.8

     Respondent issued deficiency notices to petitioners in which

respondent adjusted petitioners’ taxable income to reflect self-

employment tax on the income distributed from the PLCs to the

trusts.9   Petitioners filed petitions for both years.




     8
      The trusts held other assets, including assets inherited
from petitioners’ parents and other partnership interests.
     9
      The Commissioner also audited Olsen-Smith, the PLCs, and
the trusts for 1999 and 2000. Petitioners are not strangers to
this Court. Petitioners, as individuals and representatives of
these entities, have filed petitions in this Court at least 20
other times.
                                  7

                              OPINION

     We are asked to decide whether petitioners are liable for

self-employment tax on funds that were distributed from their law

firm to their PLCs to their trusts and then to them.    Respondent

argues that petitioners are liable for self-employment tax

because petitioners’ transactions with the trusts lack economic

substance.10   Petitioners argue that they are not liable for

self-employment tax because they carefully and meticulously

devised their structure for valid business purposes and the non-

salary income allocated to them as beneficiaries of the trusts is

not taxable under section 1402.

Burden of Proof

     We first address the burden of proof.     Petitioners generally

have the burden of proof.   See Rule 142(a).   Petitioners do not

dispute that they bear the burden of proof with respect to

respondent’s theory that their trusts lack economic substance.11




     10
      Respondent argues, alternatively, that petitioners are
liable for self-employment tax on the law firm earnings under the
assignment of income theory and under secs. 671 through 677. We
need not address these additional arguments because we have
determined that petitioners’ transactions with the trusts lacked
economic substance.
     11
      It is unnecessary to determine the burden of proof with
respect to respondent’s other two theories because we hold that
petitioners’ trusts lacked economic substance.
                                  8

Economic Substance

     We now address the economic substance theory.    Taxpayers

have a legal right, by whatever means allowable under the law, to

structure their transactions to minimize their tax obligations.

See Gregory v. Helvering, 293 U.S. 465, 469 (1935).     We will not

recognize for Federal income tax purposes, however, transactions

that have no significant purpose other than to avoid tax and do

not reflect economic reality.   See Zmuda v. Commissioner, 79 T.C.

714, 719 (1982), affd. 731 F.2d 1417 (9th Cir. 1984).    We look

through the form of a transaction when that form has not altered

any cognizable economic relationships, and we apply tax law

according to the substance of the transaction.   Id. at 720;

Temple v. Commissioner, T.C. Memo. 2000-337, affd. 62 Fed. Appx.

605 (6th Cir. 2003).   This rule applies regardless of whether the

transaction creates an entity with a separate existence under

State law.   Zmuda v. Commissioner, supra at 720; Temple v.

Commissioner, supra.

     We traditionally consider four factors in deciding whether a

trust lacks economic substance.   These four factors include: (1)

Whether the taxpayer’s relationship, as grantor, to property

purportedly transferred into trust differed materially before and

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

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

trust passed to trust beneficiaries other than the grantor; and
                                   9

(4) whether the taxpayer honored restrictions imposed by the

trust or by the law of trusts.     Markosian v. Commissioner, 73

T.C. 1235, 1243-1245 (1980); Castro v. Commissioner, T.C. Memo.

2001-115; Hanson v. Commissioner, T.C. Memo. 1981-675, affd. per

curiam 696 F.2d 1232 (9th Cir. 1983).

     We begin by examining the first factor.      Petitioners’

relationship to the trust property did not change after the

trusts were created.   Petitioners apparently transferred their

PLC interests to the trusts in the mid-1990s.      Petitioners

presented no evidence to suggest that this altered their

relationship with the PLCs or Olsen-Smith.      They continued to

manage the firm, work for the firm, and operate their business

under the same name, in the same location, and in the same

capacity as before the transfer.       The trusts engaged in no trade

or business, and petitioners, as trustees, had complete control

over the income-producing properties of the trusts.

     Petitioners’ relationship to the income did not change

either.   Petitioners and Mr. Rossie received distributions of all

income earned by the law firm.   Each petitioner still took home

one-third of the net profits of the firm.      Though petitioners

testified that assets did not remain in the partnership but were

moved to the trusts to protect them from creditors, the record

does not support their arguments that the trusts were used to

protect the income from creditors.      Petitioners distributed to
                                 10

themselves all the income that their trusts received from Olsen-

Smith.    This suggests that petitioners were not motivated by a

true desire to protect the income from creditors but rather by a

desire for tax avoidance.    We find that this factor weighs

against petitioners.

     As to the second factor, petitioners claimed that they had

independent trustees even though each was the other’s trustee.

Petitioners distributed all the earnings from the PLCs to each

other as a matter of course.    This suggests that they exercised

complete control over the trusts, and petitioners presented no

evidence to convince us otherwise.    We find that this factor also

weighs against petitioners because their reciprocal arrangements

in the two trusts insured that they would act in harmony with one

another.

     As to the third factor, no economic interest in the trusts

ever passed to any beneficiary other than petitioners.    They were

the only beneficiaries, and they had no children or other

descendants to name as beneficiaries.    We find that this factor

also weighs against petitioners.

     As to the final factor, petitioners argue that they honored

all the restrictions imposed by the trusts and by the law of

trusts.    Petitioners presented no evidence to corroborate this.

The evidence does suggest that petitioners used the property as

they desired without restriction and that there were no
                                 11

restrictions on what they did.    Their reciprocal arrangements

with each other’s trusts further suggest that they would not have

faced any such restrictions.    We find that this factor also

weighs against petitioners.

     For these reasons, we find that the trusts lacked economic

substance and we conclude that they are not recognizable for

Federal tax purposes.

Self-Employment Tax

     Section 1401 imposes a tax on the self-employment

income of every individual.    See Baker v. Commissioner, T.C.

Memo. 2001-283.   Self-employment income is defined as the net

earnings from self-employment derived by an individual

during any taxable year.    Sec. 1402(b).   “[N]et earnings

from self-employment” include gross income derived by an

individual from any trade or business carried on by that

individual minus the deductions that are attributable to the

trade or business.    See sec. 1402(a).

     Petitioners have offered no reason other than that their

trusts were the owners of their PLC interests and proper

receptacles for their earnings from the law firm to explain why

the net income from their law firm is not self-employment income

to them.   We have concluded that petitioners’ transactions

resulting in distributions to and from the trusts lacked economic

substance.   It follows that petitioners’ share of the net income
                                 12

of the law firm represents petitioners’ net earnings from self-

employment.   The income represents petitioners’ distributive

share of profits of a business conducted by a partnership of

which they are, indirectly or directly, members.    Petitioners are

liable for self-employment tax on that income for the years at

issue.   Accordingly, we sustain respondent’s determinations in

the deficiency notices.

     To reflect the foregoing,


                                           Decisions will be entered

                                      for respondent.
