                          T.C. Memo. 2009-196



                        UNITED STATES TAX COURT



            MICHAEL AND MARION BALICE, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 17520-04.                Filed September 2, 2009.



     Michael and Marion Balice, pro sese.

     Kathleen K. Raup, for respondent.



                          MEMORANDUM OPINION


     JACOBS, Judge:     This case is before the Court on

respondent’s motion for summary judgment (respondent’s motion)

pursuant to Rule 121.    For the reasons that follow, we shall

grant respondent’s motion.
                                  - 2 -

      Respondent determined deficiencies in petitioners’ Federal

income tax and additions to tax under section 6662(a) for years

1997 and 1998 as follows:

                                                       Penalty
      Year                Deficiency                 Sec. 6662(a)

      1997                   $28,924                  $5,784.80
      1998                    32,449                   6,489.80

      The issues for decision are:     (i) Whether the periods of

limitations on assessment expired before the deficiency notice

was mailed; (ii) whether Statewide Financial Trust (Statewide)

should be disregarded for Federal income tax purposes and its

income for 1997 and 1998 be attributed to petitioners; and (iii)

whether petitioners are liable for the section 6662(a) accuracy-

related penalty.

      All section references are to the Internal Revenue Code

(Code), and all Rule references are to the Tax Court Rules of

Practice and Procedure.      Petitioners resided in New Jersey when

their petition was filed.

                               Background

I.   Procedural Background

      Respondent mailed petitioners a notice of deficiency for

years 1997 and 1998 on June 21, 2004.       Thereafter, petitioners

challenged respondent’s determinations by filing a petition in

this Court.
                                - 3 -

     On June 16, 2005, respondent served a request for admissions

on petitioners pursuant to Rule 90.     Petitioners failed to

respond, and the admissions so requested are now deemed admitted

pursuant to Rule 90(c).

     Respondent filed a motion for summary judgment on October 4,

2005, and petitioners filed a response thereto on November 2,

2005.   Before any action was taken on respondent’s motion,

petitioners filed a petition for bankruptcy under chapter 13 with

the U.S. Bankruptcy Court for the District of New Jersey.       This

Court thereafter issued an order staying all proceedings in this

case.   Petitioners’ bankruptcy case was dismissed on April 19,

2006.

     On May 16, 2006, Marion Balice (Mrs. Balice) individually

filed a bankruptcy petition under chapter 13 with the U.S.

Bankruptcy Court for the District of New Jersey.     On March 5,

2007, the U.S. Bankruptcy Court for the District of New Jersey

issued an order lifting the automatic stay to allow the case in

this Court to proceed.    By order dated April 22, 2009, this Court

lifted the stay of proceedings, and the matter was assigned to

Judge Julian I. Jacobs for disposition.
                                 - 4 -

II.   Factual Background1

      A.   Michael Balice and His Insurance Business

      During the years at issue, Michael Balice (Mr. Balice) was a

licensed, self-employed insurance agent.     Before 1994 he

conducted his business from petitioners’ home in New Jersey.

      Mr. Balice received commission income from numerous

insurance companies.     He reported the income on Schedule C,

Profit or Loss From Business, of Form 1040, U.S. Individual

Income Tax Return, for years preceding 1994.     By 1994 petitioners

owed significant Federal income tax liabilities dating back to

1984.

      B.   The Trusts2

      In 1994 Mr. Balice attended a trust seminar conducted by

Ronald Ottaviano (Mr. Ottaviano).     At that seminar advice and

instructions were given with respect to the use of irrevocable

trusts in order to obtain tax benefits.     Subsequently,

petitioners caused two trusts to be formed:     The Rosewater Trust

(Rosewater) and Statewide.

      Petitioners executed documents establishing Rosewater on

August 28, 1994.    Petitioners thereafter transferred ownership of



      1
      The factual background is based on the deemed admissions.
See supra pp. 2-3.
      2
       Although we sometimes refer to Statewide and Rosewater
as trusts, this reference is not meant to imply that they are to
be recognized as trusts for Federal income tax purposes.
                                - 5 -

their home to Rosewater on September 9, 1994, and opened a

business checking account for Rosewater on September 22, 1994.

Mr. Ottaviano as well as Mr. Balice is listed as a signatory on

the Rosewater checking account, but at all relevant times

petitioners exercised complete control over this account.      All

deposits into the Rosewater checking account during 1997 and 1998

were from petitioners and Statewide, and all checking account

statements were sent to petitioners’ home address in New Jersey.

     Petitioners are the trustees of Rosewater.    They applied

for, and obtained, an employer identification number for

Rosewater.

     Petitioners executed a declaration of pure trust

establishing Statewide on August 28, 1994.    No assets were

transferred to Statewide at its inception.    Mr. Balice and Mr.

Ottaviano opened a checking account for Statewide on September

22, 1994.    As with Rosewater, Mr. Balice and Mr. Ottaviano are

listed as signatories on the Statewide checking account but

petitioners exercised complete control over the checking account;

and statements for the Statewide checking accounts were sent to

petitioners’ home address in New Jersey.   Statewide’s business

address was the same as the address of the property which

petitioners transferred to Rosewater.    Statewide paid Rosewater

“rent” for the use of the property.
                                - 6 -

     Mr. Balice and Mr. Ottaviano were trustees of Statewide.

Mrs. Balice was listed as the trustor (creator) of Statewide.

The Michael Balice & Marion Balice Family Trust was the sole

beneficiary of Statewide, possessing all 200 units of the

beneficial interest of Statewide.   Mr. Balice exercised complete

control over Statewide in 1997 and 1998.    He applied for, and

obtained, an employer identification number for Statewide.

     C. Interaction Between the Trusts and Mr. Balice’s
        Insurance Business

     In 1996 Mr. Balice restructured the operation of his

insurance business by forming North American Benefits, Inc.

(NAB), and North American Marketing, Inc. (NAM).    NAB

administered employer health insurance plans, classified as

“Single Employer Group Health Insurance Plans”, and NAM marketed

insurance.    In 1997 and 1998 Mr. Balice was the president and the

sales representative of both NAB and NAM.

     NAB had approximately 100 clients during the years at issue,

and it received income from all of them.    In 1997 and 1998 NAB

issued a Form W-2, Wage and Tax Statement, to Mr. Balice

reporting $31,200 for 1997 and $24,150 for 1998.    NAM made weekly

payments to Statewide equal to the commissions generated by Mr.

Balice; the payments by NAM were deposited into Statewide’s

checking account.   These deposits represented income earned by

Mr. Balice.
                                 - 7 -

     During 1997 the weekly deposits into Statewide’s checking

account totaled $80,400.     During 1998 the weekly deposits into

Statewide’s checking account totaled $87,314.     These amounts were

not reported on petitioners’ individual 1997 and 1998 Federal

income tax returns.   NAM did not issue a Form W-2 to Mr. Balice

for either 1997 or 1998.

     In January 1996 Mr. Balice met Alfred Padovano (Mr.

Padovano), an accountant, and retained him to prepare income tax

returns for petitioners, Statewide, Rosewater, NAB, and NAM.       Mr.

Padovano reviewed the trusts and questioned their validity.       Mr.

Balice told Mr. Padovano that the trusts were legal and

instructed him to issue Forms 1099-MISC, Miscellaneous Income, to

Statewide for the amounts it received during 1997 and 1998.

     Petitioners timely filed their 1997 and 1998 income tax

returns.3   On the returns, Mr. Balice reported his Form W-2

income from NAB and a small amount of Schedule C income from his

insurance sales business.4     Mrs. Balice reported her Form W-2

income from her job with Revlon Consumer Corp. in both years.

     Statewide filed Forms 1041, U.S. Income Tax Return for

Estates and Trusts, for 1997 and 1998.     It reported its Form



     3
      Petitioners filed for and were granted extensions to file
for both years. Petitioners filed their 1997 return on Oct. 13,
1998, and their 1998 return on Oct. 8, 1999.
     4
      Mr. Balice reported business income of $1,781 in 1997 and
$712 in 1998.
                                    - 8 -

1099-MISC income from NAM as gross receipts, and it reported

expense deductions, including rent paid to Rosewater for

the use of petitioners’ home.        As a result, Statewide reported

taxable income of $14,563 in 1997 and $6,306 in 1998.

       Rosewater filed Forms 1041 for 1997 and 1998.      Rosewater

reported the rent it received from Statewide and petitioners for

each year on Schedule E, Supplemental Income and Loss.5       However,

Rosewater claimed expense deductions, including mortgage,

repairs, utilities, and taxes, resulting in a loss of $100 in

both 1997 and 1998.

                                 Discussion

I.     Period of Limitations

       Generally, the Commissioner is limited to 3 years from the

date the return was filed to make a valid assessment of income

tax.       See sec. 6501(a).   This 3-year period is extended to 6

years if a taxpayer omits from gross income an amount in excess

of 25 percent of the amount of gross income stated on the return.

Sec. 6501(e)(1).       The Commissioner has the burden of proving that

the taxpayer omitted from gross income an amount properly

includable therein in excess of 25 percent of the gross income

reported on the return.        Davenport v. Commissioner, 48 T.C. 921,

927-928 (1967).



       5
      Rosewater reported rental income in the amount of $27,750
for 1997 and $28,129 for 1998.
                                - 9 -

      On their 1997 return, petitioners reported $78,241 of gross

income.   Respondent determined that petitioners omitted $80,400

in gross income.   On their 1998 return, petitioners reported

$67,146 of gross income.    Respondent determined that they omitted

$87,314 in gross income.    As set forth infra, we uphold

respondent’s determinations with respect to the amount of omitted

income for each year.    The amount of omitted income for each year

exceeds 25 percent of the amount of gross income petitioners

reported on their return.   Consequently, the period of

limitations on assessment was open until October 2004 with

respect to 1997 and until October 2005 with respect to 1998.

Respondent issued the notice of deficiency for both years on June

21, 2004, well within the extended 6-year period of limitations.6

See Meyers v. Commissioner, 435 F.2d 171 (3d Cir. 1970), affg.

T.C. Memo. 1968-289; Swanson v. Commissioner, T.C. Memo. 2008-

265; Carione v. Commissioner, T.C. Memo. 2008-262.

II.   Summary Judgment

      Summary judgment is intended to expedite litigation and

avoid unnecessary and expensive trials.    Fla. Peach Corp. v.

Commissioner, 90 T.C. 678, 681 (1988).    Summary judgment may be



      6
      Petitioners do not argue and there is no basis in the
record for finding that the reporting of gross receipts by
Statewide on its income tax return sufficed for purposes of sec.
6501(e)(1)(A)(ii) to apprise respondent of the nature and amount
of the income omitted from petitioners’ tax returns. See Gouveia
v. Commissioner, T.C. Memo. 2004-256.
                               - 10 -

granted where there is no genuine issue as to any material fact

and a decision may be rendered as a matter of law.      Rule 121(a)

and (b); see also Sundstrand Corp. v. Commissioner, 98 T.C. 518,

520 (1992), affd. 17 F.3d 965 (7th Cir. 1994); Naftel v.

Commissioner, 85 T.C. 527, 529 (1985).       Matters deemed admitted

under Rule 90(c) are conclusively established and may be

considered in deciding whether to grant a motion for summary

judgment.    Morrison v. Commissioner, 81 T.C. 644, 651-652 (1983);

Carey v. Commissioner, T.C. Memo. 2003-281; see Marshall v.

Commissioner, 85 T.C. 267, 272-273 (1985).

III.    Whether Petitioners Omitted Income

       Respondent posits that the commission income ostensibly

received by Statewide is taxable to Mr. Balice for one or more of

the following reasons:    (1) Because Statewide is a sham; (2)

because of the grantor trust provisions of the Code; and (3)

because the transfer of income to Statewide was an assignment of

income earned by Mr. Balice.    Moreover, respondent asserts that

for both 1997 and 1998 Mr. Balice is liable for the self-

employment tax due to earnings from his business dealings.

       It is axiomatic that taxpayers have a legal right, by

whatever means allowable under the law, to structure their

transactions so as to minimize their tax obligations.       Gregory v.

Helvering, 293 U.S. 465, 469 (1935).    However, transactions that

have no significant purpose other than to avoid tax and do not
                                - 11 -

reflect economic reality will not be recognized for Federal

income tax purposes.   See Zmuda v. Commissioner, 79 T.C. 714, 719

(1982), affd. 731 F.2d 1417 (9th Cir. 1984); Gouveia v.

Commissioner, T.C. Memo. 2004-256.       And in this regard, we have

held that if a transaction has not altered any cognizable

economic relationships, we look beyond the form of the

transaction and apply the tax law according to the transaction’s

substance.   See Markosian v. Commissioner, 73 T.C. 1235, 1241

(1980); Gouveia v. Commissioner, supra.       This principle applies

regardless of whether the transaction creates an entity with

separate existence under State law.       Zmuda v. Commissioner, supra

at 720; Gouveia v. Commissioner, supra.

     The right to minimize taxes by any means which the law

permits “does not bestow upon the taxpayer the right to structure

a paper entity to avoid tax when that entity does not stand on

the solid foundation of economic reality.”       Markosian v.

Commissioner, supra at 1241.    Petitioners’ attempts to hide

behind a trust which is a sham will not obstruct our view that

the insurance commissions ostensibly paid to Statewide are

taxable to Mr. Balice.   See id.   We first consider whether

Statewide is a sham.   For if it is, we need not consider

respondent’s other arguments.

     A trust may lack economic substance and be a sham for

Federal tax purposes if:   (A) The taxpayer’s relationship, as
                              - 12 -

grantor, to the property transferred did not differ in any

material aspect before and after the creation of the trust; (B)

there was no independent trustee; (C) no economic interest passed

to other beneficiaries of the trust; (D) the taxpayer was not

bound by any restrictions imposed by the trust or by the law of

trusts.   Id. at 1243-1245.

     A.   Petitioners’ Unchanged Relationship to the Property
          Transferred

     The deemed admissions show that before the formation of

Statewide, Mr. Balice had commission income from his insurance

business paid directly to him and he reported it on Schedule C of

his income tax returns.   During 1997 and 1998 Mr. Balice had his

insurance commissions from NAM paid to Statewide and deposited

into Statewide’s checking account.     Through his control over the

Statewide checking account, Mr. Balice exercised control over

this income.

     The deemed admissions also show that when petitioners formed

Rosewater, they transferred ownership of their home to Rosewater.

After the formation of Rosewater, petitioners continued to live

in the home and exercised complete control over it.

     Before the formation of the two trusts, Mr. Balice operated

his insurance business from his home.    After the formation of the

trusts, Statewide used petitioners’ home as its address.    Mr.

Balice conducted his business activities and petitioners lived in

the home just as before Statewide and Rosewater were created.
                                - 13 -

     In sum, the existence of Statewide did not alter in any

substantive way petitioners’ relationship to the insurance

commissions earned by Mr. Balice.

     B.    Lack of an Independent Trustee

     A trust may be recognized for Federal income tax purposes if

it had a bona fide independent trustee who had a meaningful role

in the operation of the trust, including the power to prevent

taxpayers from acting against the interests of the beneficiaries.

See Markosian v. Commissioner, supra at 1244; Swanson v.

Commissioner, T.C. Memo. 2008-265.

     The deemed admissions show that Statewide had no independent

person or trustee who could prevent Mr. Balice from acting

against the interests of any other beneficiary by using

Statewide’s checking account.    Although Mr. Ottaviano and Mr.

Balice were both identified as trustees, in reality Mr. Ottaviano

exercised no control over Statewide or its affairs.

     Mr. Balice controlled all aspects of Statewide during 1997

and 1998.    He submitted the request for an employee

identification number, he hired Statewide’s accountant, and he

directed the accountant with respect to the preparation of the

trust’s income tax returns and signed Statewide’s 1998 income tax

return.7    Statewide’s monthly statements were sent to



     7
      Statewide’s 1997 Federal income tax return was not signed
by a fiduciary.
                                - 14 -

petitioners’ home, and Mr. Balice signed each check drawn on

Statewide’s bank account.     Although Mr. Ottaviano had signature

authority on the Statewide bank account, he never signed a check

or made a withdrawal from the account.    Moreover, there is no

evidence that Mr. Balice ever consulted Mr. Ottaviano with

respect to withdrawals from the account.    Rather, Mr. Balice used

Statewide’s checking account as he saw fit.

     In sum, there was no independent trustee who had a

meaningful role in operating Statewide.

     C.   No Economic Interest to Other Beneficiaries of
          the Trust

     The declaration of a pure trust which established Statewide

names Mrs. Balice as the trustor of Statewide, and the property

contributed to Statewide consisted almost entirely of Mr.

Balice’s commissions.   The certificate evidencing units of

beneficial interest (part of the declaration of pure trust)

provides that all 200 units of the beneficial interest are owned

by the Michael Balice & Marion Balice Family Trust.    No other

beneficial interest exists.    Petitioners were the beneficiaries

of their own contributions to Statewide.    In sum, no economic

interest passed to other beneficiaries of the trust.

     D.   Petitioners’ Unrestricted Use Of the Trust

     As noted supra p. 5, Mr. Balice had signatory authority on

Statewide’s checking account, had no restrictions on his use of

the account, and was the only signatory of checks drawn on that
                                 - 15 -

account.    Mr. Balice exercised complete control over Statewide,

and the other named trustee, Mr. Ottaviano, was conspicuous by

his absence.    No other trustee required or demanded that Mr.

Balice operate in any specific way.       Mr. Balice was not

restricted in the use of the trust property in any way.

      E.   Conclusion

      Examination of all four factors for testing the economic

reality of Statewide reveals its creation to be nothing more than

an exercise in legerdemain.     Consequently, we hold that Statewide

should be disregarded for Federal income tax purposes.8        In sum,

we shall not respect petitioners’ attempt to shift their income

to a paper entity.      See Markosian v. Commissioner, 73 T.C. at

1243-1245; see also Zmuda v. Commissioner, 79 T.C. at 719-722;

Furman v. Commissioner, 45 T.C. 360, 364-366 (1966), affd. 381

F.2d 22 (5th Cir. 1967); Gouveia v. Commissioner, 2004-256.

IV.   Section 6662(a) Accuracy-Related Penalty

      Respondent determined that petitioners are liable for a

section 6662(a) accuracy-related penalty for 1997 and 1998.

Section 6662(a) imposes a 20-percent penalty on the portion of an

underpayment of tax attributable to, inter alia, a substantial

understatement of income tax, as provided in section 6662(b)(2),

or negligence or disregard of rules or regulations, as provided



      8
      Respondent has not asked for a determination regarding
whether Rosewater should be disregarded for Federal tax purposes.
                                - 16 -

in section 6662(b)(1).    An understatement of income tax is

defined by the Code as the excess of the amount of tax required

to be shown on the return for the taxable year over the amount of

tax shown on the return.    Sec. 6662(d)(2)(A).   The understatement

is substantial in the case of an individual if it exceeds the

greater of 10 percent of the tax required to be shown or $5,000.

Sec. 6662(d)(1)(A).    Negligence is the lack of due care or

failure to do what a reasonable and ordinarily prudent person

would do under the circumstances.     Jean Baptiste v. Commissioner,

T.C. Memo. 1999-96.

     Section 7491(c) provides that the Commissioner has the

burden of production with respect to penalties and must come

forward with sufficient evidence indicating it is appropriate to

impose penalties.     Higbee v. Commissioner, 116 T.C. 438, 446

(2001).   Once the Commissioner has met the burden of production,

the burden of proof remains on the taxpayers, including the

burden of proving that the penalties are inappropriate because of

reasonable cause or substantial authority.     Id. at 446-447.

Respondent’s burden of production is met by proof that

petitioners substantially understated their income tax because

they failed to properly report the income earned by Mr. Balice

and that petitioners were negligent because Mr. Balice

intentionally disregarded Mr. Padovano’s professional opinion

that the trusts’ validity was questionable.
                              - 17 -

     Section 6662(a) penalties are inapplicable to the extent

petitioners had reasonable cause and acted in good faith.     Sec.

6664(c)(1).   Petitioners failed to present evidence of either.

Indeed, when petitioners’ accountant raised concerns about the

validity of the trusts, Mr. Balice ignored his concerns and

directed him to treat the trusts as legitimate.   Given the

evidence presented, we conclude that petitioners neither had

reasonable cause for their underpayments nor acted in good faith.

     To reflect the foregoing,


                                        An order and decision for

                                   respondent will be entered.
