                               T.C. Memo. 2019-93



                         UNITED STATES TAX COURT



             CHRISTOPHER MICHAEL DUFRESNE, Petitioner v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 13282-17.                         Filed July 25, 2019.



      Ronda N. Edgar, for petitioner.

      Lori Katrine Shelton, for respondent.



            MEMORANDUM FINDINGS OF FACT AND OPINION


      KERRIGAN, Judge: Respondent determined the following deficiencies and

penalties with respect to petitioner’s Federal income tax for 2010-14 (years in

issue):
                                         -2-

[*2]                                                   Penalty
                      Year          Deficiency       sec. 6662(a)

                      2010           $89,516            $17,903
                      2011           122,513               24,503
                      2012           175,592               35,118
                      2013           121,710               24,342
                      2014              8,819               -0-

       Unless otherwise indicated, all section references are to the Internal

Revenue Code in effect for the years in issue, and all Rule references are to the

Tax Court Rules of Practice and Procedure. We round all monetary amounts to

the nearest dollar.

       After petitioner’s concessions the remaining issues for our consideration are

whether petitioner: (1) received unreported income in 2010-13 and (2) is liable for

accuracy-related penalties under section 6662(a) for 2010-13.

                               FINDINGS OF FACT

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

facts and the attached exhibits are incorporated herein by this reference. Petitioner

resided in California when he timely filed his petition.
                                        -3-

[*3] Petitioner’s Background

      Petitioner’s mother was Sylvia Browne, a well-known psychic who

appeared on television, wrote books, and gave lectures. During the years in issue

petitioner worked full time as a psychic counselor for his mother’s business,

Sylvia Browne Corp. (Corporation), an S corporation. On behalf of the

Corporation petitioner performed psychic readings as often as seven days a week.

Clients were charged $200 for a 30-minute reading.

      Until Ms. Browne’s death in 2013 she was the majority shareholder of the

Corporation. She became ill several years before her death. For 2012 and 2013

petitioner received Schedules K-1, Shareholder’s Share of Income, Deductions,

Credits, etc., which showed he owned a 0.01% interest in the Corporation.

      Petitioner did not have access to the Corporation’s books and records.

Following Ms. Browne’s death he became the sole heir of her estate and the

Corporation. The Corporation was dissolved in 2015.

      Petitioner reported wage income from the Corporation during the years in

issue as follows:
                                         -4-

[*4]                       Year                Wage income

                           2010                 $528,850
                           2011                  120,200
                           2012                  107,600
                           2013                    -0-
                           2014                   88,850

Before 2010 petitioner’s income was substantially higher. From 2004-10 he

earned approximately $14 million.

Cash Deposits

       Petitioner had unreported taxable cash deposits totaling $1,505,546 for

2010-13. According to petitioner these cash deposits were repayments he received

from Ms. Browne for loans of approximately $1,490,388 for the payment of past

due Federal taxes and for the purchase of real estate properties. Petitioner did not

discuss his mother’s financial affairs with her, and he was not aware of her net

worth. Ms. Browne was in debt at the time of her death.

       From 1985 to 2007, petitioner purchased the following five real estate

properties: (1) a timeshare in Cabo San Lucas, Mexico (timeshare), (2) a property

in Sunnyvale, California (Sunnyvale), (3) a property in Copperopolis, California

(Copperopolis), (4) a property on Concord Ridge Court in San Jose, California

(Concord Ridge), and (5) a property on LaSeyne in San Jose, California (LaSeyne)
                                         -5-

[*5] (collectively, five properties). He produced a letter, with his mother’s

signature, dated January 1, 2008, which stated that she owed him $1,182,670 for

five real estate purchases.

      During the years in issue petitioner held the Concord Ridge and

Copperopolis properties in his name. From 2010-13 he held the LaSeyne and

Sunnyvale properties in his name; he sold both properties in 2013. For the years

in issue petitioner was the sole owner of the timeshare.

      For 2002-08 and 2010-13 petitioner reported rental income and claimed

rental deductions on his Schedules E, Supplemental Income and Loss, for the

Sunnyvale and Concord Ridge properties. For 2008 petitioner reported rental

income and claimed rental deductions on his Schedule E for the Copperopolis

property. For 2010-13 he claimed property tax deductions on his Schedules A,

Itemized Deductions, for the Copperopolis and LaSeyne properties. On his 2010

Form 1040, U.S. Individual Income Tax Return, he reported miscellaneous income

from the timeshare. For 2011-13 he also reported rental income and deducted

expenses on his Schedules E for the timeshare.

      Ms. Browne, before her death, lived at the Concord Ridge property and paid

petitioner rent. On his Schedules E for 2010-13 petitioner reported rental income

of $72,000 with respect to the Concord Ridge property. Petitioner sold the
                                             -6-

[*6] property after his mother’s death and reported the entire capital gain on his

2014 tax return.

      In addition to the five properties petitioner coowned two condominiums

with his mother. These condominiums were acquired in 2003. Ms. Browne had a

mortgage on at least one of these condominiums. She also owned five other

properties, of which petitioner was aware of four.

      According to petitioner he lent his mother money to pay a Federal tax

liability. He produced a letter dated February 1, 2010, with his mother’s signature,

which attests that she owes him $307,718 for the payment of past due Federal

taxes. In 2010 he was not aware that his mother had tax liens against her or the

amount of back taxes she owed.

      Petitioner and Ms. Browne did not draft any formal documents reflecting

the loans before the extension of the funds. Both letters produced by him are

addressed “To Whom It May Concern” and have only Ms. Browne’s signature.

The letters also do not mention how or when repayment is to occur, a rate of

interest, or any collateral or a security.
                                        -7-

[*7] Respondent’s Examination and Notice of Deficiency

      Petitioner timely filed Forms 1040 for the years in issue. In 2014 the

Internal Revenue Service (respondent) commenced an examination of petitioner’s

returns for the years in issue. During the examination respondent determined that

cash deposits into petitioner’s bank accounts were not reflected as taxable income

on his returns.

      Respondent reconstructed petitioner’s income for 2010-13 using the bank

deposit method to determine his taxable income. For 2010-13 respondent

determined petitioner had unreported taxable cash deposits as follows:

                          Year           Unreported deposits

                          2010                $295,402
                          2011                 351,968
                          2012                 539,142
                          2013                 319,034
                          Total               1,505,546

      On March 24, 2017, respondent issued to petitioner a notice of deficiency

determining that the cash deposits were taxable income and determining section

6662(a) penalties for 2010-13. On November 10, 2016, the revenue agent’s

immediate supervisor executed a Civil Penalty Approval Form which approved
                                          -8-

[*8] substantial understatement penalties pursuant to section 6662 as an

alternative position to section 6663 fraud penalties for 2010-13.1

                                       OPINION

I.    Burden of Proof

      Generally, the Commissioner’s determinations in a notice of deficiency are

presumed correct, and the taxpayer bears the burden of proving that those

determinations are erroneous. Rule 142(a)(1); Welch v. Helvering, 290 U.S. 111,

115 (1933). In unreported income cases such as this, the Commissioner must

establish “some evidentiary foundation” connecting the taxpayer with the income-

producing activity or demonstrating that the taxpayer actually received unreported

income. See Weimerskirch v. Commissioner, 596 F.2d 358, 361-362 (9th Cir.

1979), rev’g 67 T.C. 672 (1977); see also Edwards v. Commissioner, 680 F.2d

1268, 1270-1271 (9th Cir. 1982) (holding that the Commissioner’s assertion of a

deficiency is presumptively correct once some substantive evidence is introduced

demonstrating that the taxpayer received unreported income).

      If the Commissioner introduces some evidence that the taxpayer received

unreported income, the burden shifts to the taxpayer, who must establish by a

preponderance of the evidence that the deficiency was arbitrary or erroneous. See

      1
          Respondent did not determine a fraud penalty in the notice of deficiency.
                                        -9-

[*9] Hardy v. Commissioner, 181 F.3d 1002, 1004 (9th Cir. 1999), aff’g T.C.

Memo. 1997-97. Where the taxpayer failed to keep sufficient records under

section 6001, the Commissioner may employ any reasonable method to reconstruct

a taxpayer’s income and thereby lay the requisite evidentiary foundation. See

Petzoldt v. Commissioner, 92 T.C. 661, 693 (1989). The stipulated exhibits

included copies of bank account and deposit statements for petitioner’s bank

accounts for the years in issue. For 2010-13 respondent used these statements to

reconstruct petitioner’s gross income using the bank deposit method. “The use of

the bank deposit method for computing income has long been sanctioned by the

courts.” Estate of Mason v. Commissioner, 64 T.C. 651, 656 (1975), aff’d, 566

F.2d 2 (6th Cir. 1977). “A bank deposit is prima facie evidence of income and

* * * [the Commissioner] need not prove a likely source of that income.” Tokarski

v. Commissioner, 87 T.C. 74, 77 (1986) (citing Estate of Mason v. Commissioner,

64 T.C. at 656-657).

      Respondent has established the requisite minimal evidentiary foundation

linking petitioner with the income from the cash deposits. Therefore, petitioner

bears the burden of proving that respondent’s deficiency determinations are

arbitrary or erroneous. Under section 7491(a)(1) the burden of proof may shift to

the Commissioner if the taxpayer produces credible evidence with respect to any
                                        -10-

[*10] factual issue relevant to ascertaining the taxpayer’s liability. See Higbee v.

Commissioner, 116 T.C. 438, 442-443 (2001). Petitioner contends that he meets

the requirements of section 7491(a) to shift the burden of proof to respondent. We

find that petitioner’s evidence regarding the nature of the cash deposits is not

credible and does not justify shifting the burden of proof under section 7491(a)(1).

The burden of proof remains with petitioner.

II.   Unreported Income

      Respondent contends that the cash deposits constitute unreported income

which petitioner should have included as taxable income on his Federal tax returns

for 2010-13. Respondent further contends that the cash deposits are disguised

compensation. Petitioner does not dispute the amounts of the cash deposits but

contends that the cash deposits are not taxable income because they are

repayments for loans between himself and his mother.

      According to petitioner’s testimony his income from the Corporation

decreased during the years in issue because the Corporation struggled financially,

but his hours remained consistent. He testified that he was willing to accept a

lower salary because of his mother’s ill health and their close relationship, and

because he knew he would be compensated later when the Corporation was able to

pay his customary salary.
                                         -11-

[*11] Section 61(a) defines gross income as “all income from whatever source

derived”. Gross income includes any funds that the taxpayer receives lawfully or

unlawfully, without the consensual recognition, express or implied, of an

obligation to repay. See James v. United States, 366 U.S. 213, 219 (1961). It does

not include loans. Commissioner v. Tufts, 461 U.S. 300, 307 (1983). Intrafamily

transactions, such as the purported loans between petitioner and Ms. Browne, are

evaluated under heightened scrutiny. See Estate of Van Anda v. Commissioner,

12 T.C. 1158, 1162 (1949), aff’d per curiam, 192 F.2d 391 (2d Cir. 1951).

      A.     Purported Loans

      For a bona fide loan to exist the parties to the transaction must have had an

actual, good-faith intent to establish a debtor-creditor relationship at the time the

funds were advanced. Beaver v. Commissioner, 55 T.C. 85, 91 (1970). An intent

to establish a debtor-creditor relationship exists if the debtor intends to repay the

loan and the creditor intends to enforce the repayment. Id.; Fisher v.

Commissioner, 54 T.C. 905, 909-910 (1970).

      Objective factors may be considered to determine the parties’ intent and

whether a bona fide loan occurred, and no single factor is dispositive. See Welch

v. Commissioner, 204 F.3d 1228, 1230 (9th Cir. 2000), aff’g T.C. Memo.

1998-121; Frierdich v. Commissioner, 925 F.2d 180, 182 (7th Cir. 1991), aff’g
                                        -12-

[*12] T.C. Memo. 1989-393. We examine the following factors to determine

whether the cash deposits petitioner received were repayments of loans:

      (1) the ability of the borrower to repay;

      (2) the existence or nonexistence of a debt instrument;

      (3) security, interest, a fixed repayment date, and a repayment schedule;

      (4) how the parties’ records and conduct reflect the transaction;

      (5) whether the borrower has made repayments;

      (6) whether the lender had demanded repayment;

      (7) the likelihood that the loans were disguised compensation for services;

      and

      (8) the testimony of the purported borrower and lender.

Welch v. Commissioner, 204 F.3d at 1230; see also Kaider v. Commissioner, T.C.

Memo. 2011-174.

             1.    The Ability of the Borrower To Repay

      Courts assess the ability to repay by whether there was “a reasonable

expectation of repayment in light of the economic realities of the situation.”

Fisher v. Commissioner, 54 T.C. at 910. Petitioner testified that he expected his

mother to fully repay the purported loans. He claims that he bought five properties

on her behalf. He further testified that he bought property on behalf of his mother
                                        -13-

[*13] because he would qualify for lower loan interest rates than the rates she

would have qualified for on her own.

      Petitioner did not discuss his mother’s finances with her and assumed that

she had poor credit following her bankruptcy filing. He testified that his mother

had poor credit and would have had difficulty obtaining a bank loan. There is no

evidence, when the funds were advanced, that Ms. Browne had the ability to repay

petitioner. See Welch v. Commissioner, 204 F.3d at 1230.

             2.    Existence or Nonexistence of Debt Instrument

      No contemporaneous debt instruments were drafted to memorialize the

purported loans from petitioner to his mother. Petitioner produced two letters

purportedly signed by Ms. Browne attesting to the purported loans in 2008 and

2010, years after the first purported borrowing for a real estate property. While

“[i]ntra-family loans are many times informal arrangements which may not comply

with all of the customary legal formalities that would surround a commercial

loan,” Zohoury v. Commissioner, T.C. Memo. 1983-597, 1983 Tax Ct. Memo

LEXIS 193, at*18, the lack of contemporaneous debt instruments weighs against

petitioner’s argument that the parties intended to create bona fide loans.
                                          -14-

[*14]         3.     Security, Interest, a Fixed Repayment Date, and a Repayment
                     Schedule

        Interest and a fixed schedule for repayment are characteristics of a true

debtor-creditor relationship. See Frierdich v. Commissioner, 925 F.2d at 183-184;

Haag v. Commissioner, 88 T.C. 604, 616 (1987), aff’d without published opinion,

855 F.2d 855 (8th Cir. 1988). The two letters attesting to the purported loans do

not provide for an interest rate, a fixed schedule for repayment, or any security.

Petitioner also provided no other evidence of an interest rate, a repayment

schedule, or any security.

              4.     How the Parties’ Records and Conduct Reflect the Transaction

        Petitioner provided a record, purportedly kept by a Corporation employee,

of Ms. Browne’s payments to him. He testified that Ms. Browne wrote checks out

to cash for a Corporation employee to then cash and deposit into petitioner’s bank

accounts. This document consists of a list of dates, check numbers, check

amounts, and amounts paid to petitioner. On this document the amount of the

check often exceeds the amount purportedly paid to petitioner. He did not provide

any of Ms. Browne’s canceled checks to support his testimony or any other

evidence to support the document, such as testimony of the Corporation employee

who purportedly made and kept the record of the loan repayments.
                                        -15-

[*15]         5.    Whether the Borrower Has Made Repayment

        According to petitioner, when his income from the Corporation decreased or

he needed additional income, he would request payments from his mother. He

testified that to repay the purported loans Ms. Browne would write personal

checks to a Corporation employee, who then would cash the checks and deposit

the cash into petitioner’s bank accounts. According to his testimony, a

Corporation employee kept a record of the purported repayments for 2010-13.

While petitioner testified that Ms. Browne had died before fully repaying the

purported loans, he claimed that she had made unscheduled repayments to him.

There is no evidence to support these unscheduled repayments, except for the

uncorroborated document, see supra p.14, and petitioner’s self-serving testimony.

              6.    Whether the Lender Had Demanded Repayment

        Petitioner testified that when he requested funds toward repayment from his

mother she was responsive to his requests and would comply. However, there is

no evidence to support his claim.

              7.    The Likelihood That the Loans Were Disguised Compensation
                    for Services

        Respondent asserts that the cash deposits petitioner received were payments

to compensate him for his services to the Corporation. During the years in issue
                                        -16-

[*16] petitioner’s salary substantially decreased, and in 2013 he reportedly

received no income. He testified that during the years in issue he was still

performing readings, and his services to the Corporation had not decreased.

      In 2010 the cash deposits in petitioner’s bank accounts, combined with his

Corporation salary, resulted in a salary more consistent with prior years’ salaries.

For 2011-13 his cash deposits were well in excess of the wages reported on his

Federal income tax returns but not as high as prior years’ wages. The cash

deposits were likely compensation for his services to the Corporation rather than

repayment of loans.

                8.   The Testimony of the Purported Borrower and Lender

      This Court is not required to accept a taxpayer’s self-serving testimony. See

Tokarski v. Commissioner, 87 T.C. at 77. Petitioner’s testimony failed to

corroborate his claim of bona fide loans with sufficient reliable evidence. He

claimed that he lent his mother substantial funds without a clear understanding of

her finances.

      Petitioner testified that he lent Ms. Browne funds to pay for liabilities

related to taxes, the nature and extent of which he was unaware. The only

evidence he produced to support this claim was a letter indicating $307,718 was

lent to his mother for paying part of her “past due Federal taxes”.
                                         -17-

[*17] Throughout his testimony petitioner also contended that he purchased

properties on his mother’s behalf. He testified that she would make payments to

him after he purchased the properties. There is no convincing evidence that she

made payments to him for any of the five properties, except the rent payments for

the Concord Ridge property.

      California law requires the purchase of property to be accompanied by some

memorandum in writing that is prescribed by the party charged. Cal. Civ. Code

sec. 1624 (West 2015). The writing must show what the price is and when the

price is to be paid. Breckinridge v. Crocker, 21 P. 179, 181 (Cal. 1889). The

letter regarding the five properties does not address anything about when

repayment will occur. There is no evidence that Ms. Browne ever had any

ownership interest in any of the properties referenced in the letter petitioner

provided. All of the income and tax benefits associated with these properties were

reported on petitioner’s Federal income tax returns.

      We reject petitioner’s contentions that he made loans to his mother to help

her purchase the five properties. There is no evidence to support his claim that he

purchased properties on her behalf and that she was repaying him for such

purchases. He had sole ownership of the five properties, and his mother owned
                                        -18-

[*18] numerous additional properties. Further, his testimony was inconsistent and

illogical, and he did not provide any other credible evidence to support it.

       B.    Conclusion

       After analyzing the factors, we conclude that the purported loans between

petitioner and Ms. Browne do not withstand heightened scrutiny to be considered

bona fide loans. The lack of records and substantiating evidence is particularly

detrimental to petitioner’s claim of bona fide loans.

       Accordingly, we find that the cash deposits constitute unreported income

and were improperly excluded from petitioner’s taxable income on his 2010-13

Federal income tax returns. Respondent contends that the cash payments were

compensation for petitioner’s services to the Corporation. Petitioner provided no

evidence that refutes this argument.

III.   Penalty Pursuant to Section 6662(a)

       For 2010-13 respondent determined that petitioner is liable for accuracy-

related penalties pursuant to section 6662(a). Under section 7491(c) the

Commissioner bears the burden of production with regard to penalties and must

come forward with sufficient evidence indicating that it is appropriate to impose

them. See Higbee v. Commissioner, 116 T.C. at 446. However, once the

Commissioner has met the burden of production, the burden of proof remains with
                                           -19-

[*19] the taxpayer, including the burden of proving that the penalty is

inappropriate. Rule 142(a); Higbee v. Commissioner, 116 T.C. at 446-447.

      In Graev v. Commissioner, 149 T.C. 485 (2017), supplementing and

overruling in part 147 T.C. 460 (2016), we held that the Commissioner’s burden of

production under section 7491(c) includes establishing compliance with the

supervisory approval requirement of section 6751(b). Section 6751(b)(1) provides

that “[n]o penalty under this title shall be assessed unless the initial determination

of such assessment is personally approved (in writing) by the immediate

supervisor of the individual making such determination or such higher level

official as the Secretary may designate.” The Civil Penalty Approval Form was

signed before the first formal communication of penalties, the notice of deficiency,

giving petitioner the right to challenge them. See Clay v. Commissioner, 152 T.C.

__, __ (slip op. at 44) (Apr. 24, 2019).

      Section 6662(a) imposes a 20% penalty on any portion of an underpayment

of tax attributable to, among other things, negligence or disregard of rules or

regulations within the meaning of subsection (b)(1), or any substantial

understatement of income tax within the meaning of subsection (b)(2).

Respondent asserts that petitioner had underpayments due to both substantial

understatements of income tax and negligence for 2010-13. Only one accuracy-
                                        -20-

[*20] related penalty may be applied with respect to any given portion of an

underpayment, even if that portion is subject to the penalty on more than one of

the grounds set out in section 6662(b). Sec. 1.6662-2(c), Income Tax Regs.

      An “understatement” is defined as the excess of the tax required to be

shown on the return over the tax actually shown on the return, less any rebate.

Sec. 6662(d)(2)(A). An understatement of income tax is “substantial” if it exceeds

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

6662(d)(1)(A). Respondent has met the initial burden of production because our

conclusions as to the deficiencies result in the following substantial

understatements of income tax:

                                 10% of tax required
               Year                 to be shown             Understatement

               2010                   $22,956                   $89,516
               2011                     12,251                   122,513
               2012                     17,519                   175,192
               2013                     24,729                   121,710

The burden is on petitioner to prove that the penalties are inappropriate.

      The section 6662(a) penalty does not apply with respect to any portion of

the underpayment for which it is shown that the taxpayer had reasonable cause and

acted in good faith. Sec. 6664(c)(1). Regulations promulgated under section
                                        -21-

[*21] 6664(c) provide that the determination of reasonable cause and good faith

“is made on a case-by-case basis, taking into account all pertinent facts and

circumstances.” Sec. 1.6664-4(b)(1), Income Tax Regs. Petitioner did not

provide persuasive evidence that his underpayments were attributable to

reasonable cause or that he acted in good faith. Consequently, he is liable for the

accuracy-related penalties determined by respondent under section 6662(a).

      Any contentions we have not addressed are irrelevant, moot, or meritless.

      To reflect the foregoing,


                                               Decision will be entered for

                                       respondent.
