                              T.C. Memo. 2020-68



                        UNITED STATES TAX COURT



DAVID A. NOVOSELSKY AND CHARMAIN J. NOVOSELSKY, Petitioners v.
       COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 22400-13.                        Filed May 28, 2020.



      David A. Novoselsky and Charmain J. Novoselsky, pro sese.

      Alexander R. Roche, Mayer Y. Silber, and Jay D. Adams, for respondent.



                          MEMORANDUM OPINION


      LAUBER, Judge: With respect to petitioners’ Federal income tax for 2009

and 2011, the Internal Revenue Service (IRS or respondent) determined deficien-

cies of $276,398 and $263,049, respectively, and accuracy-related penalties under
                                        -2-

[*2] section 6662(a) of $55,280 and $52,610, respectively.1 During 2009 and

2011 petitioner husband (Mr. Novoselsky or petitioner) practiced law with a focus

on class action litigation. In those years he executed “litigation support

agreements” with various individuals and entities. Under these agreements the

counter-party made an upfront payment to support the cost of litigation. If the

litigation was successful, petitioner was obligated to return to the counter-party,

from his award of attorney’s fees and costs, the counter-party’s initial payment

plus a premium. If the litigation was unsuccessful, petitioner had no obligation to

pay the counter-party anything. Petitioners did not report the payments thus

received as gross receipts on the Schedules C, Profit or Loss From Business, for

Mr. Novoselsky’s law practice.

      The IRS selected petitioners’ returns for examination and determined the

deficiencies and penalties shown above. After concessions,2 the principal ques-



      1
        Unless otherwise indicated, all statutory references are to the Internal
Revenue Code in effect at all relevant times, and all Rule references are to the Tax
Court Rules of Practice and Procedure. We round all dollar amounts to the nearest
dollar.
      2
        The parties filed a stipulation of settled issues in which they agreed that
petitioners for 2009: (1) were not entitled to a Schedule C deduction of $142,414
for legal and professional expenses and (2) had unreported Schedule C gross re-
ceipts of $235,906 (apart from the litigation support payments addressed in this
opinion). All other adjustments are purely computational.
                                         -3-

[*3] tions we must decide are whether the litigation support payments were loans,

as petitioners contend, or constituted gross income currently taxable under section

61(a), and whether petitioners are liable for accuracy-related penalties. We answer

both questions in respondent’s favor.

                                    Background

      The parties submitted this case for decision without trial under Rule 122.

Relevant facts have been stipulated or are otherwise included in the record. See

Rule 122(a).3 Petitioners resided in Wisconsin when they filed their petition. Ab-

sent stipulation to the contrary, appeal of this case would lie to the U.S. Court of

Appeals for the Seventh Circuit. See sec. 7482(b)(1)(A). Where relevant to the

discussion, we note that court’s precedent. See Golsen v. Commissioner, 54 T.C.

742, 757 (1970), aff’d, 445 F.2d 985 (10th Cir. 1971).

I.    Mr. Novoselsky’s Business

      During 2009-2011 petitioner practiced law in the Chicago, Illinois, metro-

politan area. Through his professional and personal relationships he was able to

secure private financing for some of his cases through litigation support agree-

      3
        On July 26, 2018, respondent filed a request for admissions, to which peti-
tioners did not timely respond. See Rule 90(c). However, the parties have
through their stipulations and briefing expressed agreement about all relevant
facts. Accordingly, we need not and do not rely on any deemed admissions for
purposes of this opinion.
                                        -4-

[*4] ments. The counter-parties who supplied this support were plaintiffs in

litigation being handled (or proposed to be handled) by petitioner, persons whose

interests were economically aligned with the interests of such plaintiffs, lawyers

with whom petitioner had fee-sharing arrangements, or individuals seeking a high

return on a speculative investment.4

      During 2009 and 2011 petitioner executed litigation support agreements

with at least nine individuals or entities. These agreements, which differed some-

what in form, may be summarized as follows.

      A.     Friedman-Vainder and Similar Agreements

      On or around August 1, 2009, petitioner executed a “Letter Agreement for

Litigation Support” with Dr. Neil Friedman and Dr. John Vainder. Each doctor

thereby agreed to pay petitioner $30,000 as litigation support. The agreement

stated that each payment

      shall be a litigation support loan to NOVOSELSKY made on a non-
      recourse basis and is used to pay for all time and expenses incurred
      by NOVOSELSKY in pursuant [sic] of this litigation. Said payment
      shall be repaid to FRIEDMAN and VAINDER at the successful
      conclusion of this litigation with annual interest to be paid as simple


      4
       We note that the Illinois Rules of Professional Conduct generally prohibit a
lawyer from splitting attorney’s fees with a non-lawyer. See Ill. S. Ct. R. Prof’l
Conduct 5.4. This rule is designed “to protect the lawyer’s professional indepen-
dence of judgment.” See id. cmt. 1.
                                         -5-

[*5] interest at the rate of eighteen percent (18%) per annum calculated
     pro rata as of the date of concluding this litigation.

      On September 10, 2009, petitioner executed with Dr. Mark Schacht a sub-

stantially similar agreement whereby Dr. Schacht advanced $100,000 to petitioner

for litigation support. On January 19, 2011, petitioner executed with Dr. Friedman

and Dr. Peter Vaselopulos a substantially similar agreement, whereby each ad-

vanced $100,000 to petitioner for litigation support. Petitioner actually received,

during 2009 or 2011 respectively, the payments specified in each agreement.

      The agreement with Dr. Schacht specified that the litigation support pay-

ment would be used to enable petitioner “to file one or more causes of action * * *

contesting the use and accounting/reporting of Court fees by Cook County and its

public officials,” allegedly in violation of Illinois law. The agreements with the

other three doctors specified that their payments would be used to enable petition-

er “to file one or more causes of action * * * challenging current or contemplated

Illinois fee statutes adding fees” for medical professionals and other groups,

allegedly in violation of Illinois and Federal law.

      On December 10, 2011, Drs. Friedman and Schacht executed, on behalf of

Metro Chicago Surgical Oncology, LLC (Metro Chicago), an agreement whereby

Metro Chicago advanced $150,000 to petitioner to support litigation against
                                         -6-

[*6] Northshore University Healthcare Systems (Northshore). This agreement

stated that Metro Chicago “will retain the Services of * * * [Novoselsky] to

represent the interests of METRO CHICAGO * * * as a plaintiff in a lawsuit to be

filed or as intervening party in existing litigation and as representative” of other

medical practices allegedly aggrieved by Northshore’s actions.

      Like the other agreements described above, the Metro Chicago agreement

stated that the funds were being advanced to petitioner “on a nonrecourse basis”

and would be repaid “at the successful conclusion of this litigation.” The only

substantive difference was that interest was to be calculated at the Federal dis-

count rate rather than at 18%. On December 20, 2011, petitioner received from

Metro Chicago a check for $150,000.

      B.     Seidman Agreement

      On January 20, 2009, petitioner executed a “Letter Agreement” with an

attorney, Steven Seidman, amending the terms of their existing arrangement for

splitting fees in a case captioned “Hale v. Cook County.” Attorney Seidman

thereby agreed to advance $250,000 to petitioner for litigation support, with that

sum to “be taken as a credit against any fees to be recovered by Novoselsky Law

Offices.” They agreed to “a 50/50 division of attorney’s fees less expenses to be

shared on the same basis.” They further agreed that they would “amend the law-
                                         -7-

[*7] suit to bring additional causes of action,” with Attorney Seidman having the

option to “participate in the additional causes of action on a basis to be agreed.”

Petitioner received payments totaling $250,000 from Attorney Seidman between

January and April 2009.

       C.     Markoff-Lidawer Agreement

       On July 6, 2011, petitioner executed a “Second Amended Loan Agreement”

with Robert Markoff and Annette Lidawer, both of whom were attorneys. This

document superseded two agreements the parties had executed earlier in 2011.

Attorneys Markoff and Lidawer thereby agreed to advance $500,000 to petitioner

for litigation support, with the advance to “be repaid in the sum of $1,000,000” in

lieu of interest.

       The parties agreed that this advance would be “repaid out of any costs

and/or fees awarded by any Court in the cases listed in Exhibit A attached hereto

and any other cases which the parties shall jointly pursue.” (The record does not

include a copy of “Exhibit A,” so the nature of the litigation supported is unclear.)

The parties agreed that “this is a nonrecourse loan in that Novoselsky shall not be

personally liable for the repayment beyond the proceeds of any attorney fees

and/or costs awarded by the court.” During 2011 Attorneys Markoff and Lidawer

paid petitioner $400,000 of the agreed-upon sum.
                                          -8-

[*8] D.      Atkins Agreement

      On November 10, 2011, Dr. Edward Atkins gave petitioner a check for

$250,000. The next day petitioner executed a “Letter Agreement” with Dr. Atkins

that characterized this advance as a “retainer fee” in connection with “the Shvets

litigation.” (This litigation, like the litigation supported by Dr. Schacht, appears to

have been a class action challenging allegedly improper use of court fees by Illi-

nois public officials.) The reference to the advance as a “retainer fee” suggests

that Dr. Atkins was a client, although he does not appear to have been a plaintiff in

the Shvets litigation. The agreement stated that Dr. Atkins would be repaid his

“retainer fee,” plus a pro-rated premium of $42,500 per year, “before Novoselsky

Law Offices or David Novoselsky personally receive any fees either hourly or

reward based on the Shvets litigation.”

      Respondent contends (and petitioners do not dispute) that, under the terms

of each agreement discussed above, Mr. Novoselsky’s payment obligation was

contingent on the success of the litigation that the counter-party was supporting.

In other words, Mr. Novoselsky was not obligated to repay the funds advanced to

him unless the litigation in question yielded proceeds in the form of attorney’s fees

and/or costs. If the litigation was unsuccessful, Mr. Novoselsky was not obligated
                                         -9-

[*9] to repay his counter-party anything.5 Under these agreements Mr.

Novoselsky received litigation support payments totaling $410,000 in 2009 and

$1 million in 2011.6

II.   IRS Examination

      Petitioners filed timely joint returns on Forms 1040, U.S. Individual Income

Tax Return, for 2009 and 2011. They did not report any of the litigation support

payments discussed above as gross receipts on the Schedules C for Mr. Novosel-

ski’s law practice. For 2009 they reported a Schedule C profit of $255,576 and a




      5
        With respect to each agreement respondent requested a finding of fact that,
“if Novoselsky did not receive a fee at the conclusion of the litigation identified in
the * * * [Litigation Support Agreement], Novoselsky did not have an obligation
to repay.” Petitioners did not object to this requested finding of fact except to say
that respondent should have used the word “monies” rather than “a fee.” Peti-
tioner agreed that he “would be obliged to pay the Litigation Support Agreements
or Letter Agreements at the conclusion of the litigation out of monies paid to him
through a favorable judgment or settlement.” At no point in petitioners’ opening
or answering briefs did they dispute respondent’s contention that repayment of the
counter-parties’ advances was contingent on the success of the litigation they were
supporting.
      6
       The litigation support payments for 2011 discussed in the text exceed the
amount of unreported income for 2011 that respondent determined in the notice of
deficiency. Petitioner appears to have executed another litigation support agree-
ment in 2011, with Arnold Newman, which yielded petitioner an advance of
$175,000. Respondent takes no position concerning the proper characterization of
that agreement and has not asserted an increased deficiency. See infra note 12.
                                       - 10 -

[*10] tax liability of $27,057. For 2011 they reported a Schedule C profit of

$69,440 and a tax liability of zero.

      The IRS selected petitioners’ returns for examination and assigned them to a

revenue agent (RA) in early 2013. The assessment period of limitations for 2009

was set to expire on October 15, 2013. See sec. 6501(a). Petitioners declined to

extend the limitations period, so in June 2013 the RA proceeded to close the case.

      On June 11, 2013, the RA completed a Civil Penalty Approval Form reflect-

ing his recommendation that the IRS assert penalties, for 2009 and 2011, for sub-

stantial understatements of income tax. See sec. 6662(a), (b)(2), (d). That form

was signed by the RA’s immediate supervisor, Group Manager Sabin, on June 12,

2013. The RA sent petitioners a closing letter, likewise dated June 12, 2013, indi-

cating that he was issuing the examination report because petitioners had declined

to extend the limitations period. The RA attached to his letter a Form 4549-A, In-

come Tax Discrepancy Adjustments, dated June 11, 2013, reflecting the deficien-

cies and accuracy-related penalties.

      The RA’s closing letter advised petitioners that they would shortly receive a

notice of deficiency enabling them to petition this Court. On June 24, 2013, the

IRS issued petitioners a notice of deficiency reflecting the adjustments to income
                                        - 11 -

[*11] and accuracy-related penalties stated on the Form 4549-A. Petitioners

timely petitioned this Court for redetermination.

III.   Bankruptcy Court and Tax Court Proceedings

       On July 18, 2014, Mr. Novoselsky filed for bankruptcy in the U.S. Bank-

ruptcy Court for the Eastern District of Wisconsin. On October 29, 2014, respon-

dent filed a Notice of Proceeding in Bankruptcy. By order dated October 31,

2014, we ordered proceedings in this case temporarily stayed pursuant to 11

U.S.C. sec. 362(a)(8) (2012).

       The United States filed a claim in petitioner’s bankruptcy for the 2009 and

2011 deficiencies and penalties determined in the notice of deficiency. Petitioner

did not list the counter-parties to the litigation support agreements as creditors in

his bankruptcy petition. Nor did he list, on the schedules he filed with the Bank-

ruptcy Court, his contingent payment obligations to those counter-parties as claims

against his bankruptcy estate.

       On November 2, 2015, the United States filed a complaint in the bankruptcy

case objecting to petitioner’s discharge. See id. sec. 727(a)(4). It contended that

he had made false oaths by (among other things) failing to list the counter-parties

to the litigation support agreements as creditors. Petitioner moved for partial sum-

mary judgment in that adversary proceeding, contending that the United States
                                        - 12 -

[*12] should be estopped, by the Commissioner’s position in the instant case, from

taking the position that those agreements gave rise to claims against his

bankruptcy estate.

      On December 8, 2016, the bankruptcy court denied petitioner’s motion for

partial summary judgment. It noted that petitioner himself took the position, in his

petition to this Court, that the litigation support agreements gave rise to “loans.”

In any event the Bankruptcy Court ruled that estoppel did not apply: “[T]he

United States’ position that the loans are income for Federal income tax purposes

if a taxpayer’s obligation to repay depends upon a contingency does not logically

entail that the loans are not claims for purposes of Title 11 which a debtor is obli-

gated by 11 U. S. C. § 521(a) to schedule.”

      In 2017 petitioner submitted a written waiver of discharge pursuant to 11

U.S.C. sec. 727(a)(10). On September 5, 2017, the bankruptcy court approved the

waiver, ruling that “[t]he debtor will not receive a discharge in this case.” On

November 9, 2017, we accordingly lifted the bankruptcy stay. See id. sec.

362(c)(2); Smith v. Commissioner, 96 T.C. 10, 17 (1991).

      After the stay was lifted, the parties engaged in discovery. On March 25,

2019, they filed (and we granted) a motion to submit the case without trial under

Rule 122. Multiple rounds of briefing ensued. The issues remaining in dispute
                                        - 13 -

[*13] are whether the payments Mr. Novoselsky received pursuant to the litigation

support agreements were gross income under section 61(a) and whether petitioners

are liable for accuracy-related penalties.

                                     Discussion

      The parties submitted this case for decision without trial under Rule 122(a).

The fact that a case has been submitted under Rule 122(a) “does not alter the bur-

den of proof, or the requirements otherwise applicable with respect to adducing

proof, or the effect of failure of proof.” Rule 122(b).

I.    Unreported Income

      A.     Burden of Proof

      The Commissioner’s determination of tax liability is generally presumed

correct. Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). In order for

this presumption to attach in unreported income cases, the Commissioner must

show a “rational foundation” for the IRS’ determination that the taxpayer received

such income. Pittman v. Commissioner, 100 F.3d 1308, 1313 (7th Cir. 1996),

aff’g T.C. Memo. 1995-243. “Once the Commissioner makes the required thresh-

old showing, the burden shifts to the taxpayer to prove by a preponderance of the

evidence that the Commissioner’s determinations are arbitrary or erroneous.”
                                       - 14 -

[*14] Walquist v. Commissioner, 152 T.C. 61, 67-68 (2019) (citing Helvering v.

Taylor, 293 U.S. 507, 515 (1935)); Tokarski v. Commissioner, 87 T.C. 74 (1986).

      The record shows (and petitioners do not dispute) that Mr. Novoselsky

actually received litigation support payments of at least $410,000 and $1 million

during 2009 and 2011, respectively. Respondent has therefore established a

rational foundation for his determination that petitioners received unreported in-

come. The burden of proof thus shifts to them.7

      B.     Loans vs. Income

      Section 61(a) defines gross income as “all income from whatever source de-

rived,” including income derived from business. Petitioners concede that Mr.


      7
        Petitioners contend that respondent bears the burden of proof with respect
to establishing that the litigation support payments were gross income because it is
a “new matter.” See Rule 142(a)(1) (“[I]n respect of any new matter, * * * [the
burden of proof] shall be upon the respondent.”). A theory presented to sustain a
deficiency “is treated as a new matter when it either alters the original deficiency
or requires the presentation of different evidence.” Wayne Bolt & Nut Co. v.
Commissioner, 93 T.C. 500, 507 (1989). “A new theory which merely clarifies or
develops the original determination is not a new matter” for this purpose. Ibid.
The notice of deficiency determined that petitioners had unreported Schedule C
gross receipts, stating: “Retainers and Fees are reportable in the year in which
payment is received.” Respondent’s position on brief is that the litigation support
payments constituted those unreported gross receipts and should have been in-
cluded in income when received. This position is entirely consistent with the
determination in the notice of deficiency and requires the presentation of precisely
the same evidence. It is not a new matter on which respondent has the burden of
proof.
                                        - 15 -

[*15] Novoselsky received, in connection with his business, litigation support

payments totaling at least $410,000 during 2009 and $1 million during 2011. As

cash method taxpayers, petitioners were required to include those sums in gross

income unless the receipts were nontaxable. See sec. 1.451-1(a), Income Tax

Regs. Petitioners’ primary argument is that the receipts were nontaxable loan

proceeds.

      Because a genuine loan is accompanied by an obligation to repay, loan pro-

ceeds do not constitute income to the taxpayer. Commissioner v. Tufts, 461 U.S.

300, 307 (1983). For this rule to apply, however, the obligation to repay “must be

unconditional and not contingent upon some future event.” Frierdich v. Commis-

sioner, 925 F.2d 180, 185 (7th Cir. 1991) (citing United States v. Henderson, 375

F.2d 36, 39 (5th Cir. 1967)), aff’g T.C. Memo. 1989-393. As the Fifth Circuit

stated in Henderson, 375 F.2d at 39: “Perhaps the most important underlying

principle is that no valid debt exists unless there is an unconditional obligation of

another to pay * * * a definite sum of money.”

      Where an obligation to pay arises only upon the occurrence of a future

event, we have consistently held that a valid debt does not exist for Federal tax

purposes. For example, in Taylor v. Commissioner, 27 T.C. 361 (1956), aff’d, 258

F.2d 89 (2d. Cir. 1958), the taxpayer advanced funds to her nieces and nephew to
                                        - 16 -

[*16] open securities accounts, and they gave her notes agreeing to repay the

advances. We held that the advances were not loans because repayment was

“conditional upon the profitable management of the accounts,” noting that “[a]

valid loan does not exist where there is a conditional obligation to repay.” Id. at

368.

       In Clark v. Commissioner, 18 T.C. 780 (1952), aff’d, 205 F.2d 353 (2d Cir.

1953), the taxpayer advanced funds to his wife to purchase stock in a newspaper

company by which she was employed. She was “obliged to repay the sum only if

the newspaper earned sufficient profits and she received sufficient dividends to

make repayment.” Id. at 782. Assuming arguendo that an obligation existed, we

held that “such obligation would not have constituted a debt since admittedly it

was subject to a contingency that never occurred.” Id. at 783.8




       8
         Accord, e.g., Haag v. Commissioner, 88 T.C. 604, 616 (1987) (“[T]o con-
stitute true loans there must have been, at the time the funds were transferred, an
unconditional obligation on the part of the transferee to repay the money, and an
unconditional intention on the part of the transferor to secure repayment.”), aff’d,
855 F.2d 855 (8th Cir. 1988); Mercil v. Commissioner, 24 T.C. 1150, 1153 (1955)
(“There must be an unconditional obligation to pay, or, stated otherwise, the
amount claimed as the debt must be certainly and in all events payable.”); Winter
v. Commissioner, T.C. Memo. 2010-287, 100 T.C.M. (CCH) 604, 609-610
(holding that the unearned portion of a bonus was not a loan where the employee
was obligated to repay the advance “if and only if he quit or was fired for cause
within five years”).
                                        - 17 -

[*17] The same analysis applies to payment obligations conditioned on the out-

come of litigation. For example, in Bercaw v. Commissioner, 165 F.2d 521, 525

(4th Cir. 1948), the taxpayer advanced funds to a guardian for the purpose of com-

mencing litigation, with the guardian agreeing to repay the advance “from any

funds recovered by the suit [in] an amount equivalent to such advance.” The

Fourth Circuit cited the general principle that “[t]he term ‘indebtedness’ as used in

the Revenue Act implies an unconditional obligation to pay.” Ibid. (quoting

Gilman v. Commissioner, 53 F.2d 47, 50 (8th Cir. 1931), aff’g 18 B.T.A. 1277

(1930)). It held that the taxpayer’s advance was not a “debt” because “[t]he guard-

ian’s duty to repay the money only arose in the event of a successful termination

of the litigation, and that event never took place.” Ibid. We have similarly held

that purported promissory notes did not give rise to loans where repayment “was

to be made only when, if, and to the extent that * * * [the transferee] realized,

through judgment or settlement or otherwise, proceeds from the prosecution of

* * * [a specified] lawsuit.” Estate of Paine v. Commissioner, T.C. Memo. 1963-

275, 22 T.C.M. (CCH) 1383, 1389.

      The facts of the instant case are indistinguishable in substance from the

facts of the cases discussed above. Petitioner during 2009 and 2011 received total

advances in excess of $1.4 million with the understanding that he would use these
                                       - 18 -

[*18] funds to commence or continue specified litigation. The agreements made

clear that the advances were repayable out of the attorney’s fees and costs

petitioner hoped to receive upon “the successful conclusion of this litigation.”

Petitioners do not dispute that Mr. Novoselsky had no obligation to pay the

counter-parties anything if the litigation yielded no proceeds. Because he did not

have an “unconditional obligation * * * to pay * * * [the counter-parties] a definite

sum of money,” the litigation support agreements did not give rise to loans for

Federal income tax purposes. See Henderson, 375 F.2d at 39.9

      We would reach the same conclusion under a multi-factor approach, which

respondent suggests might be an alternative mode of analysis. Whether an ad-

vance of funds constitutes a “loan” for Federal tax purposes is a question that

arises in a variety of contexts. An advance by a shareholder to his corporation

may be a loan or a capital contribution. An advance by a corporation to its share-

holder may be a loan or a dividend. An advance by a mother to her son may be a

      9
        Lawyers who handle contingent fee cases commonly incur litigation ex-
penses that they expect (or at least hope) will be repaid upon successful conclu-
sion of the litigation. In such situations the question may arise whether the law-
yer’s expenditures are currently deductible under section 162(a) or, rather, should
be characterized as loans to the client on whose behalf the litigation is conducted.
Cf. Herrick v. Commissioner, 63 T.C. 562, 566-569 (1975); Canelo v. Commis-
sioner, 53 T.C. 217, 224 (1969), aff’d, 447 F.2d 484 (9th Cir. 1971). Those situa-
tions, where the lawyer is the payor rather than the payee, present a question dif-
ferent from the unreported income question involved here.
                                       - 19 -

[*19] loan or a gift. And as here, an advance to a lawyer by a client or business

associate may be a loan or taxable income.

      Courts have used a variety of tests to guide the determination of whether

particular types of advances should be treated as “loans” for Federal tax purposes.

In Busch v. Commissioner, 728 F.2d 945, 948 (7th Cir. 1984), aff’g T.C. Memo.

1983-98, the Seventh Circuit enunciated an eight-factor test for use in deciding

whether a withdrawal by a shareholder from his corporation should be treated as a

loan or a dividend. In Ill. Tool Works Inc. v. Commissioner, T.C. Memo. 2018-

121, at *29, we considered 14 factors in evaluating whether a transfer of funds

between affiliated corporations should be characterized as a dividend or a loan.10

      Outside the corporation-shareholder context courts have considered dif-

ferent sets of factors. In Welch v. Commissioner, 204 F.3d 1228 (9th Cir. 2000),

aff’g T.C. Memo. 1998-121, the question was whether funds received by the tax-


      10
         Other Circuits have applied somewhat different multi-factor tests to deter-
mine whether an advance should be treated as a loan as opposed to a dividend or a
capital contribution. See, e.g., Tex. Farm Bureau v. United States, 725 F.2d 307,
311 (5th Cir. 1984) (setting forth a 13-factor test to determine whether an advance
by a shareholder to his corporation was a loan or a capital contribution); Alterman
Foods, Inc. v. United States, 505 F.2d 873, 877 n.7 (5th Cir. 1974) (listing nine
factors considered by courts to determine whether a payment by a subsidiary cor-
poration to its parent was a loan or a dividend); Dillin v. United States 433 F.2d
1097, 1100 (5th Cir. 1970) (employing 11-factor test to determine whether an ad-
vance by a corporation to a shareholder was a loan or a dividend).
                                       - 20 -

[*20] payer from a business associate constituted taxable income or a loan. The

Ninth Circuit identified seven factors that may be relevant “in assessing whether a

transaction is a true loan”:

      (1) whether the promise to repay is evidenced by a note or other
      instrument; (2) whether interest was charged; (3) whether a fixed
      schedule for repayments was established; (4) whether collateral was
      given to secure payment; (5) whether repayments were made; (6)
      whether the borrower had a reasonable prospect of repaying the loan
      and whether the lender had sufficient funds to advance the loan; and
      (7) whether the parties conducted themselves as if the transaction
      were a loan. [Id. at 1230 (citing inter alia Frierdich, 925 F.2d at
      182)].

Our Court has applied the same seven factors to determine whether a payment

constituted taxable income or a loan. See Todd v. Commissioner, T.C. Memo.

2011-123, 101 T.C.M. (CCH) 1603, 1605, aff’d, 486 F. App’x 423 (5th Cir.

2012); see also Saunders v. Commissioner, T.C. Memo. 1982-655 (holding that an

advance constituted taxable compensation rather than a loan), aff’d, 720 F.2d 871

(5th Cir. 1983).

      As the Seventh Circuit has recognized, “no single factor is controlling”

when employing these tests. Busch, 728 F.2d at 948. Indeed, “[m]ulti-factor tests

are not ‘talismans of magical power, and the most that can be said is that they

prove a source of helpful guidance.’” MoneyGram Int’l, Inc. & Subs. v. Com-

missioner, 153 T.C. __, __ (slip op. at 51) (Dec. 3, 2019) (quoting Dillin v. United
                                        - 21 -

[*21] States, 433 F.2d 1097, 1100 (5th Cir. 1970)). At bottom we must decide

whether “there [was] a genuine intention to create a debt, with a reasonable

expectation of repayment.” Litton Bus. Sys., Inc. v. Commissioner, 61 T.C. 367,

377 (1973). This determination is “purely a question of fact.” Busch, 728 F.2d at

949.

       The litigation support agreements that petitioner executed with his counter-

parties generally refer to the advances as “loans.” But petitioner did not execute a

formal promissory note; no fixed schedule for repayments was established; peti-

tioner provided no collateral or security; and no payments of principal were ever

made. Some of the agreements provided for interest, others specified a fixed-

dollar success premium. But no interest or other amount was ever paid. The

counter-parties evidently viewed petitioner’s personal ability to repay as irrele-

vant: They made the loans nonrecourse, with the advances being repayable only

out of future litigation proceeds.

       Most importantly, the parties did not conduct themselves as if the transac-

tions were bona fide loans. In each instance they agreed that petitioner had no

obligation to repay the advance unless the litigation was successful. Because re-

payment was contingent on the uncertain outcome of litigation, the funds were not

“advanced with reasonable expectations of repayment regardless of the success of
                                         - 22 -

[*22] the venture.” Ill. Tool Works, at *47 (quoting Gilbert v. Commissioner, 248

F.2d 399, 406 (2d Cir. 1957), remanding T.C. Memo. 1956-137).

      Given these facts, the Seventh Circuit’s opinion in Frierdich seems the most

relevant precedent. The taxpayer there, an attorney, received $100,000 from a

client who had hired the attorney to handle the estate of her late husband. Frier-

dich, 925 F.2d at 181. The parties executed a promissory note providing for 8%

annual interest, but there was no fixed schedule for repayment of principal or in-

terest. Rather, both were “due and payable at the time of payment of attorney’s

fees due * * * [the attorney] subject to [the] closing of the estate” of the client’s

deceased husband. Id. at 182. The note authorized the client to deduct, from the

estate legal fees ultimately payable to the attorney, the $100,000 principal amount

“plus accrued interest.” Ibid. The attorney had made no payments on the sup-

posed loan by the time the notice of deficiency was issued to him, six years after

the note was executed.

      Our Court in Frierdich noted that objective multi-factor tests may be “in-

structive” in determining the parties’ intent and the character of an advance for

Federal tax purposes. Frierdich, 57 T.C.M. (CCH) at 1133 n.4. In ascertaining

whether the parties intended a true loan, we cited such factors as the existence vel

non of a debt instrument; provisions for security, interest, and a fixed repayment
                                         - 23 -

[*23] schedule; the taxpayer’s ability to repay the loan; and whether loan

repayments were in fact made. Id. at 1133 n.4, 1135. “In addition,” we stated,

“the obligation to repay must be unconditional and not contingent upon some

future event.” Id. at 1133 (citing Henderson, 375 F.2d at 39). Placing emphasis

on the terms of the Frierdich promissory note, which explicitly linked repayment

to the attorney’s closing of the estate, we held that the advance “was not a loan,

but rather, an advancement for legal services to be rendered in the future,” and as

such was currently includible in the taxpayer’s income. Id. at 1135.

      The Seventh Circuit affirmed, reviewing our decision under a “clearly erro-

neous” standard. Frierdich, 925 F.2d at 182. It observed that the promissory note

lacked typical loan formalities--e.g., a fixed repayment date, an amortization

schedule, and provisions for security--and that the attorney in fact made no pay-

ments during the ensuing six years. Id. at 184. And the Court of Appeals agreed

with our conclusion that “the repayment of a loan must be unconditional and not

contingent upon some future event.” Id. at 185 (citing Henderson, 375 F.2d at 39).

      In Frierdich repayment of the loan was “expressly conditioned on the clos-

ing of * * * [the] estate” of the client’s deceased husband. Ibid. And the client

had the right to set off, against the estate fees due the attorney, the principal and

accrued interest on the “loan.” Ibid. Given “this purposeful linkage between the
                                          - 24 -

[*24] estate fee, the loan, and * * * [the client’s] stated right to setoff,” the

Seventh Circuit upheld our determination that the $100,000 transfer was not a loan

but was “an advance payment by the estate for legal services, permitting Frierdich

to have tax-free use of $100,000 for what turned out to be many years.” Id. at 185.

      The facts of this case closely resemble those in Frierdich. Petitioner’s coun-

ter-parties were clients, medical professionals with interests aligned to the inter-

ests of his clients, or lawyers with whom he had existing fee-sharing agreements.

As in Frierdich, repayment of the supposed loans was explicitly linked to success-

ful conclusion of the legal matters that petitioner had been retained to handle. In-

deed, the facts here are stronger for respondent than in Frierdich. In this case, re-

payment of the advances was not just linked to successful conclusion of the liti-

gation; repayment was not required at all unless the litigation was successful.

      We accordingly conclude that the advances petitioner received under the

litigation support agreements were not loans for Federal income tax purposes.

Rather, they were advance payments for the legal services that the counter-parties

expected him to perform. As such, the advances were includible in petitioner’s

income when received as gross income under section 61(a).
                                         - 25 -

[*25] C.     Petitioners’ Other Arguments

      Petitioners urge that the IRS should be estopped from contending that the

litigation support agreements gave rise to gross income, citing the position taken

by the United States in the bankruptcy case. This is essentially the same argument

that Mr. Novoselsky advanced in bankruptcy court, viz., that the agreements with

his counter-parties could not give rise to “claims” for bankruptcy purposes unless

they gave rise to “loans” for Federal income tax purposes. Like the bankruptcy

court, we find this argument wholly unpersuasive.

      “Judicial estoppel prevents a party that has taken one position in litigating a

particular set of facts from later reversing its position when it is to its advantage to

do so.” Levinson v. United States, 969 F.2d 260, 264 (7th Cir. 1992). For judicial

estoppel to apply, “the later position must be clearly inconsistent with the earlier

position.” Ibid.

      The Bankruptcy Code defines a “claim” as a “right to payment, whether or

not such right is * * * fixed * * *[or] contingent.” 11 U.S.C. sec. 101(5)(A). Peti-

tioner’s counter-parties had contingent rights to payment from him because he was

obligated to return their advances (with a premium) if the litigation they supported

was successful. The counter-parties thus had “claims” against his estate for bank-

ruptcy purposes, as the bankruptcy court reasoned.
                                        - 26 -

[*26] For tax purposes, by contrast, an advance “must be unconditional and not

contingent upon some future event” in order to constitute a “loan.” Frierdich, 925

F.2d at 185. The Government’s position that the counter-parties had “claims”

against Mr. Novoselsky’s bankruptcy estate is by no means inconsistent with re-

spondent’s position that their advances to him were not “loans.” The doctrine of

judicial estoppel therefore does not apply.

      Finally, petitioners assert that the counter-parties’ advances were excludable

from gross income as “gifts” or as deposits held in “trust.” Neither argument

passes the straight-face test. Nothing in the litigation support agreements suggests

that the counter-parties advanced funds to petitioner out of a “detached and disin-

terested generosity” or “out of affection, respect, admiration, charity or like im-

pulses.” Commissioner v. Duberstein, 363 U.S. 278, 285 (1960). Quite the con-

trary: The counter-parties demanded a return on their investment, viz., interest as

high as 18% or a fixed-dollar payment as high as $500,000. These were plainly

speculative profit-seeking transactions, not gifts.

      “As a general rule, funds that a taxpayer receives in trust for another person

are not includable in the taxpayer’s gross income.” Canatella v. Commissioner,

T.C. Memo. 2017-124, 113 T.C.M. (CCH) 1549, 1553 (citing Ford Dealers

Advert. Fund, Inc. v. Commissioner, 55 T.C. 761, 771 (1971), aff’d, 456 F.2d 255
                                        - 27 -

[*27] (5th Cir. 1972). But the counter-parties plainly did not advance funds with

the expectation that petitioner would hold those funds in trust for them (or anyone

else). Rather, they denominated the payments “litigation support” and expected

that petitioner would spend the money to conduct the litigation they had specified

in the agreement.

      The agreements stated (for example) that the money was to be “used to pay

for all time and expenses incurred by NOVOSELSKY in pursuant [sic] of this

litigation.” If the funds had been meant to be held in trust, Mr. Novoselsky would

not have been permitted to keep the money in his personal or business account.

See Ill. S. Ct. R. Prof’l Conduct 1.15 (requiring that trust funds be kept separate

from the lawyer’s own property). Nothing in the record suggests that Mr. Novo-

selksy held the counter-parties’ funds in a separate trust account.11

      In sum, Mr. Novoselsky during 2009 and 2011 received litigation support

payments totaling $1.41 million that were not reported on petitioners’ tax returns.

Petitioners have failed to carry their burden of proving that these payments were

      11
         Petitioners err in citing Dowling v. Chi. Options Assocs., Inc., 875 N.E. 2d
1012 (Ill. 2007), for the proposition that an attorney is not required to segregate
client trust funds in a separate account. In Dowling, the Illinois Supreme Court
found that advance payments of retainer fees belonged to the firm and thus could
not be kept in a separate trust account for the client’s funds. Id. at 1018. The
court did not suggest that a lawyer was permitted to keep client trust funds in his
own account.
                                        - 28 -

[*28] “loans” or were otherwise excludable from gross income. We will

accordingly sustain the Commissioner’s determinations of unreported income

attributable to these payments.12

II.   Accuracy-Related Penalties

      A.     Burdens of Production and Proof

      The IRS determined, for 2009 and 2011 respectively, accuracy-related pen-

alties of $55,280 and $52,610 for underpayments attributable to substantial under-

statements of income tax. See sec. 6662(a), (b)(2), (d)(1)(A). Section 7491(c)

generally provides that “the Secretary shall have the burden of production in any

court proceeding with respect to the liability of any individual for any penalty.”

This burden requires the Commissioner to come forward with sufficient evidence

indicating that imposition of the penalty is appropriate. See Higbee v. Commis-

sioner, 116 T.C. 438, 446 (2001). Once the Commissioner meets this burden, the

burden of proof is on the taxpayer to “come forward with evidence sufficient to




      12
        As stated supra note 6, the 2011 litigation support payments we have dis-
cussed exceed the amount of unreported income that respondent determined in the
notice of deficiency for 2011. Respondent has not moved to amend his pleadings
to assert increased deficiencies. Our determinations of unreported income are thus
limited to the amounts set forth in the notice of deficiency. See sec. 6214(a);
Estate of Petschek v. Commissioner, 81 T.C. 260, 272 (1983), aff’d, 738 F.2d 67
(2d Cir. 1984).
                                        - 29 -

[*29] persuade a Court that the Commissioner’s [penalty] determination is

incorrect.” Id. at 447.

      The Commissioner’s burden of production under section 7491(c) includes

establishing compliance with section 6751(b). See Chai v. Commissioner, 851

F.3d 190, 217, 221-222 (2d Cir. 2017), aff’g in part, rev’g in part T.C. Memo.

2015-42; Graev v. Commissioner, 149 T.C. 485 (2017), supplementing and over-

ruling in part 147 T.C. 460 (2016). Section 6751(b)(1) provides that “[n]o penalty

under this title shall be assessed unless the initial determination of such assess-

ment is personally approved (in writing) by the immediate supervisor of the indi-

vidual making such determination.”

      In Belair Woods, LLC v. Commissioner, 154 T.C. __, __ (slip op. at 23)

(Jan. 6, 2020), we held that the “initial determination” of a penalty assessment is

typically embodied in a letter “by which the IRS formally notifie[s] * * * [the

taxpayer] that the Examination Division ha[s] completed its work and * * * ha[s]

made a definite decision to assert penalties.” Once the Commissioner introduces

evidence sufficient to show written supervisory approval of a penalty before a

formal communication of the penalty to the taxpayer, the burden shifts to the

taxpayer to show that the approval was untimely, i.e., “that there was a formal

communication of the penalty [to the taxpayer] before the proffered approval” was
                                        - 30 -

[*30] secured. Frost v. Commissioner, 154 T.C. __, __ (slip op. at 21-22) (Jan. 7,

2020).

      B.     Analysis

      Respondent has produced a Civil Penalty Approval Form signed by the

RA’s immediate supervisor on June 12, 2013. The definite decision to assert the

penalties was communicated to petitioners that same day, in the form of a closing

letter dated June 12, 2013, with an attached Form 4549-A showing the penalty

calculation. The Form 4549-A was dated June 11, 2013, but the RA avers in a

sworn declaration that this form was not sent to petitioners until the following day,

as an attachment to the closing letter. Respondent has thus met his initial burden

of showing timely approval. See Chadwick v. Commissioner, 154 T.C. __, __

(slip op. at 17-18) (Jan. 21, 2020); Belair Woods, 154 T.C. at __ (slip op. at 23).

      The Court invited petitioners to submit a copy of a 30-day letter or similar

document, issued to them before June 12, 2013, indicating that the Examination

Division had made, at an earlier time, a definite decision to assert penalties. Peti-

tioners did not do so. Indeed, it appears that the IRS never issued them a 30-day

letter (which would have offered them the opportunity to take their case to the Ap-

peals Office) because they declined to extend the period of limitations, which was

about to expire. See Internal Revenue Manual pt. 8.2.1.3(4) (Oct. 1, 2012) (re-
                                        - 31 -

[*31] quiring that 180 days remain in the assessment limitations period in order

for Appeals to consider a case).13

      We next consider whether imposition of penalties is “appropriate.” Higbee,

116 T.C. at 446. For individual taxpayers, the substantial understatement penalty

applies if the understatement of income tax for a particular year “exceeds the

greater of--(i) 10 percent of the tax required to be shown on the return * * * , or

(ii) $5,000.” Sec. 6662(d)(1)(A). The record shows (and petitioners do not dis-

pute) that the understatements of income tax determined in the notice of deficien-

cy, which we have sustained, exceed $5,000 and 10% of the total tax required to

be shown on petitioners’ returns for 2009 and 2011. Respondent has thus carried

his burden of production by demonstrating a “substantial understatement of in-

come tax.” See sec. 7491(c).

      The section 6662 penalty does not apply to any portion of an underpayment

“if it is shown that there was a reasonable cause for such portion and that the tax-


      13
         Even if the RA had sent petitioners a copy of the Form 4549-A on June 11,
contrary to his averment, it would not change the analysis. The Form 4549-A
shows the calculation of the penalties that the RA was recommending in the Civil
Penalty Approval Form. It was not until the closing letter was issued on June 12
that petitioners were formally notified that “the Examination Division had comple-
ted its work and * * * had made a definite decision to assert penalties.” Belair
Woods, 154 T.C. at __ (slip op. at 23). Because the RA’s supervisor approved the
penalties on June 12, his approval was timely.
                                         - 32 -

[*32] payer acted in good faith with respect to * * * [it].” Sec. 6664(c)(1). The

decision as to whether the 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. Sec. 1.6664-4(b)(1), Income Tax Regs. Circumstances that may

signal reasonable cause and good faith “include an honest misunderstanding of

fact or law that is reasonable in light of all of the facts and circumstances,

including the experience, knowledge, and education of the taxpayer.” Ibid.

      Petitioners have put forth no evidence showing reasonable cause for their

underpayments. Mr. Novoselsky is an attorney who had the knowledge and edu-

cation required to determine his tax obligations correctly. He had considerable

experience with contingent fee litigation and fee-sharing agreements--close to half

of the litigation support payments at issue came from attorneys with whom he had

such arrangements--and the proper tax treatment of such payments was not a novel

issue for him. He has not advanced (and could not plausibly advance) any “reli-

ance on professional advice” defense. See id. para. (c). Finding that petitioners

have not established reasonable cause, we hold that they are liable for accuracy-

related penalties.14

      14
        Part of the deficiency for 2009 was attributable to disallowance of Sched-
ule C deductions of $142,414 and unreported Schedule C income of $235,906
                                                                       (continued...)
                                       - 33 -

[*33] Petitioners’ final contention is that penalties and interest should be reduced

because the IRS unreasonably protracted Mr. Novoselky’s bankruptcy proceedings

by opposing his right to a discharge. Section 6404(f)(1) authorizes the Commis-

sioner to abate “any portion of any penalty * * * attributable to erroneous advice

furnished to the taxpayer in writing by an [IRS] officer or employee.” Petitioners

do not allege that they received erroneous advice from the IRS; in any event, we

lack jurisdiction to consider abatement of penalties (such as those here) that have

not yet been assessed. See sec. 6404(a), (e); Soni v. Commissioner, T.C. Memo.

2013-30, 105 T.C.M. (CCH) 1216, 1220.

      Section 6404(e)(1)(A) authorizes the IRS to abate assessed interest on “any

deficiency attributable in whole or in part to any unreasonable error or delay by an

[IRS] officer or employee * * * in performing a ministerial or managerial act.”

Any delay occasioned by the IRS’ position in the bankruptcy case reflected an

exercise in judgment, not a ministerial act. See sec. 301.6404-2(b), Proced. &

Admin. Regs. In any event we lack jurisdiction to consider a request for abate-




      14
         (...continued)
(wholly apart from the litigation support payments). See supra note 2. Petitioners
conceded these adjustments in full and offered no reasonable cause for their
failure properly to report those items.
                                      - 34 -

[*34] ment of interest where no interest has been assessed and no claim requesting

abatement has been filed. See sec. 6404(a), (h).

      To implement the foregoing,


                                                     Decision will be entered for

                                               respondent.
