                        T.C. Memo. 2003-24



                      UNITED STATES TAX COURT



         PAUL F. AND ELEANORE M. NICHOLS, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 6725-01.                Filed January 27, 2003.



     Paul F. and Eleanore M. Nichols, pro sese.

     Jeremy L. McPherson, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     LARO, Judge:   Petitioners petitioned the Court to

redetermine respondent’s determination that they are liable for

Federal income tax deficiencies for 1997 and 1998 of $59,117 and

$62,558, respectively, and for accuracy-related penalties under

section 6662(a) of $11,823.40 and $12,511.60.

     We decide the following issues:
                                -2-

     1.   Whether the trusts petitioners used during 1997 and 1998

should be disregarded for Federal income tax purposes because the

trusts were shams.   We hold they should.

     2.   Whether petitioners are liable for the accuracy-related

penalties under section 6662(a).   We hold they are.

     Unless otherwise noted, section references are to the

applicable versions of the Internal Revenue Code.   Rule

references are to the Tax Court Rules of Practice and Procedure.

                          FINDINGS OF FACT

     Some facts were stipulated and are so found.   The stipulated

facts and the exhibits submitted therewith are incorporated

herein by this reference.   Petitioners resided in Fair Oaks,

California, when they petitioned the Court.   They filed 1997 and

1998 Federal income tax returns on October 15, 1998, and on July

28, 1999, respectively.   They did not report on those tax returns

Social Security benefits, income from self-employment, and income

received by the JREP Trust, PERJ Trust, and CSM Business Trust

(collectively referred to as trusts1).

     Petitioners established the trusts on January 1, 1992.

Petitioners were the initial trustees of CSM Business Trust (CSM

Trust), and Mr. Nichols was an initial trustee of PERJ Trust and



     1
       We use the words “trust” and “trustee” in our findings of
fact for narrative convenience. We do not intend our use of
those terms to indicate any conclusion about the substance of the
transactions at issue.
                                  -3-

of JREP Trust.2   PERJ Trust was the sole beneficiary of CSM

Trust.   During 1997 and 1998, PERJ Trust was the sole beneficiary

of JREP Trust.    The address of each of the trusts was the same as

the address of petitioners’ principal residence.

     On January 1, 1992, petitioners transferred a parking lot

sweeping business to CSM Trust.    Before this transfer, Mr.

Nichols had operated the business as a sole proprietorship under

the name “Clean Sweep Maintenance”.     Petitioners then transferred

their principal residence to PERJ Trust.

     Petitioners transferred the equipment of the sweeping

business to JREP Trust.   JREP Trust leased the equipment of the

sweeping business to CSM Trust.

     On October 13, 1995, petitioners signed and notarized a

“Certification of Revocable Living Trust and Loan Agreement”.    In

the certification, petitioners stated that they are the trustors




     2
       It is not clear from the record who were the trustees of
any of the trusts during the relevant years. James A. Nichols,
petitioners’ son, filed 1997 and 1998 Federal income tax returns
for all three trusts in his capacity as trustee. In the case at
hand, Robert Hogue (Mr. Hogue) cosigned with petitioners the
stipulation of facts as a trustee of JREP and PERJ Trusts. In
addition, Mr. Hogue filed petitions with the Court on behalf of
these trusts. See CSM Trust v. Commissioner, docket No. 9796-
01L; JREP Trust v. Commissioner, docket No. 9795-01L; PERJ Trust
v. Commissioner, docket No. 9794-01L; PERJ Trust v. Commissioner,
docket No. 6727-01; JREP Trust v. Commissioner, docket No. 6726-
01. Because of Mr. Hogue’s failure to establish his capacity as
a trustee, the Court dismissed those cases on the ground that
they were not filed by a proper party.
                                 -4-

of PERJ Trust.    They stated further that PERJ Trust is revocable

at their discretion.

     On July 25, 1995, petitioners signed a “Uniform Residential

Loan Application”.    In the loan application, Mr. Nichols stated

that he had been self-employed for 19 years as the owner-operator

of a sweeping business doing business as Clean Sweep Maintenance.

Petitioners also listed their personal checking and savings

accounts.   Those same accounts were the bank accounts of CSM

Trust, JREP Trust, and PERJ Trust.     During 1997 and 1998,

petitioners were the only persons who had signatory authority

over those bank accounts.

     CSM Trust filed partnership returns for 1997 and 1998.3

PERJ Trust was indicated as a partner holding a 99-percent profit

interest in CSM Trust, and Ms. Nichols was said to be a partner

holding a 1-percent profit interest in CSM Trust.     Those returns

were filed under the same employer identification number as had

been used on the trust income tax returns filed in the name of

CSM Trust for taxable years before 1997.

     On their 1997 and 1998 Federal income tax returns,

petitioners understated their interest income by $25 and $45,

respectively.    Petitioners also did not report Social Security




     3
       The record does not indicate why CSM Trust filed
partnership returns for those years.
                                  -5-

benefits of $7,964 and $8,192 which they received during the

respective years.

     On April 4, 2000, petitioners sent a letter to respondent

with respect to the examination of their tax returns.    The record

does not establish the taxable year(s) to which this letter

pertained.   The letter stated:

          This letter is to inform you that according to IRC
     section 6001, we have NEVER BEEN SERVED NOTICE by the
     SECRETARY. The LAW says, we will be served notice by
     the Secretary as to such books, records, and documents
     that the LAW requires us to keep. Not wanting to skip
     over the most important part of this LAW, but it
     clearly states that this LAW only applies to EVERY
     PERSON LIABLE FOR ANY TAX * * *

     *       *       *        *         *    *       *

          As to the authority to examine us, our research
     has shown that the only IR Code section that comes
     close to authorizing “some type of agent” to examine
     books and records is, IR Code section 7602. Yet this
     IR Code section has NEVER been published in the Federal
     Register under Title 26, only under Title 27. This
     tells us that unless you are a Title 27 Agent (BATF),
     you do not have investigative authority.

     *       *       *        *         *    *       *

          As to you telling us that we have a tax liability,
     it just may not be correct, let us review how a tax
     liability is created. According to the IR code, in
     order to determine liabilities, the Secretary must file
     an assessment and furnish a copy to the taxpayer upon
     request.

     *       *       *        *         *    *       *

          So pursuant to that section, please either furnish
     us with such a record, or notify us that none has been
     made, pursuant to IR Code section 6201 or as a
     consequence of the Secretary not exercising IR Code
     section 6020(b). Until such time that you furnish us a
                                   -6-

     copy of such an assessment, there is NO assessment,
     there is NO tax liability, and you DO NOT have the
     authority by any IR Code section to examine or
     investigate our tax return.

     *       *        *        *          *      *      *

     Any further correspondence from you should be signed
     according to that code section, or you will be in
     violation of IRS Code section 7214(a)(7). If we do not
     have a reply from you within 60 days, we will consider
     this matter dropped.

     On July 14, 2000, petitioners mailed to respondent another

letter, Statement of Protest.      The letter stated:

     Let this letter serve as a written protest that we do
     not agree with any of the adjustments shown in IRS Form
     4549-CG, Income Tax Examination Changes * * *

     *       *        *        *          *      *      *

          As to Form 4549, Income Tax Examination Changes.
     Please be advised that we disagree with the examination
     report in all aspects, and will not accept it as an
     [sic] lawful official documents. If the examiners
     report is a lawful official document, then the examiner
     failed to sign the report under penalty of perjury, as
     per IRC Section 6065.

     *       *        *        *          *      *      *

     Where is the taxing statute that congress mandates you
     identify as to any tax liability that we may have?

                                OPINION

     By notice of deficiency dated March 19, 2001, respondent

determined that the trusts were shams and should be ignored for

tax purposes.    Accordingly, respondent determined, petitioners

underreported their taxable income by the amount of income
                                 -7-

reported by the trusts.    In their petition, petitioners only deny

having unreported income, without specifically addressing any of

respondent’s arguments.

     We agree with respondent.    Respondent’s determinations of

deficiencies in the notice of deficiency are presumed correct,

and petitioners bear the burden of proving those determinations

wrong.    Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115

(1933).    In certain circumstances, if a taxpayer introduces

credible evidence with respect to any factual issue relevant to

ascertaining the taxpayer’s liability for tax, section 7491(a)

places the burden of proof on the Commissioner.4      See sec.


     4
         Specifically, sec. 7491(a)(1) and (2) provides in part:

          SEC. 7491(a). Burden Shifts Where Taxpayer
     Produces Credible Evidence.--

                 (1) General rule.--If, in any court
            proceeding, a taxpayer introduces credible
            evidence with respect to any factual issue
            relevant to ascertaining the liability of the
            taxpayer for any tax imposed by subtitle A or
            B, the Secretary shall have the burden of
            proof with respect to such issue.

                 (2) Limitations.--Paragraph (1) shall
            apply with respect to an issue only if--

                      (A) the taxpayer has complied
                 with the requirements under this
                 title to substantiate any item;

                      (B) the taxpayer has
                 maintained all records required
                 under this title and has cooperated
                                                       (continued...)
                                 -8-

7491(a)(1); Rule 142(a).    Section 7491 is effective with respect

to examinations commenced after July 22, 1998.      See Internal

Revenue Service Restructuring and Reform Act of 1998, Pub. L.

105-206, sec. 3001(c), 112 Stat. 727.      Although the relevant

examination was conducted after July 22, 1998, petitioners failed

to meet the requirements of section 7491(a)(1) and (2) in that

they did not present any credible evidence with respect to any

factual issue relevant to ascertaining their tax liability and

they did not maintain all records and cooperate with reasonable

requests by respondent for information and documents.      The burden

is on the taxpayer to show that the prerequisites of section

7491(a)(2) are satisfied.    Snyder v. Commissioner, T.C. Memo.

2001-255 (citing H. Conf. Rept. 105-599, at 240-241 (1998), 1998-

3 C.B. 747, 994-995).   Because petitioners failed to meet the

requirements of section 7491(a), they bear the burden of proving

that respondent’s determinations of deficiencies in the notice of

deficiency are wrong.

     A trust is disregarded for tax purposes if in substance it

is no more than a paper entity, a sham lacking any valid purpose

other than the avoidance of tax.       Markosian v. Commissioner, 73



     4
      (...continued)
               with reasonable requests by the
               Secretary for witnesses,
               information, documents, meetings,
               and interviews; and * * *
                                 -9-

T.C. 1235, 1244-1245 (1980).    This is so even if the trust was

formed and had a separate existence under local law.    Zmuda v.

Commissioner, 79 T.C. 714, 720 (1982), affd. 731 F.2d 1417 (9th

Cir. 1984).

     Petitioners never introduced a scintilla of evidence which

would disprove respondent’s determinations that the trusts are

shams.   In fact, petitioners failed to establish the very

existence of the trusts.    Petitioners unsuccessfully attempted to

prove the existence of the trusts by Forms 1041, U.S. Income Tax

Return for Estates and Trusts, filed with respondent.    Those

forms do not persuade us that the trusts indicated in the forms

actually existed.   Petitioners have failed to introduce into

evidence any document establishing the terms of the trusts, nor

have they obtained the testimony of James A. Nichols, who is

described on the trust returns as trustee.    Petitioners were made

aware of the need for the trust documents during the examination

of their returns for the years in issue and during discovery.

They have not demonstrated that they lacked access to those

documents, nor have they shown that James A. Nichols is

unavailable to testify.    We infer from petitioners’ failure to

produce such evidence that either it does not exist or, if it

does exist, it would be negative to petitioners.    McKay v.

Commissioner, 886 F.2d 1237, 1238 (9th Cir. 1989), affg. 89 T.C.

1063 (1987); Wichita Terminal Elevator Co. v. Commissioner, 6
                                 -10-

T.C. 1158, 1165 (1946), affd. 162 F.2d 513 (10th Cir. 1947);

Snyder v. Commissioner, supra.

     We conclude on the basis of our analysis and on the record

before us that the trusts were shams.    Accordingly, we will

ignore them for Federal income tax purposes.5   We sustain

respondent’s determination that petitioners are liable for the

deficiencies in Federal income taxes for 1997 and 1998.

     We now turn to the issue of the accuracy-related penalties.

     Respondent determined that petitioners are liable for

accuracy-related penalties under section 6662(a) and (d) as a

result of a substantial understatement of income tax.    Respondent

has the burden of production with respect to these penalties.

Sec. 7491(c).   Section 6662(a) imposes an accuracy-related

penalty in the amount of 20 percent of the portion of the

underpayment attributable to any substantial understatement of

income tax.   Sec. 6662(b)(2).   The understatement is defined as

the excess of the amount of tax required to be shown on the

return over the amount of tax shown on the return reduced by any

rebate.   Sec. 6662(d)(2).   Under section 6662(d)(1), the

understatement is substantial if the amount of the understatement

exceeds the greater of (1) 10 percent of the tax required to be

shown on the return or (2) $5,000.


     5
       We also note that the income which was reported by the
trusts, and which respondent has treated as unreported income of
petitioners, primarily derived from Mr. Nichols’s sweeping
business.
                               -11-

     We conclude that respondent satisfied his burden of

production with respect to these accuracy-related penalties, and

that petitioners are liable for the same.    Petitioners failed to

report the income purportedly received by the trusts.

Petitioners’ tax return for 1997 showed $5,357 as tax due, while

the actual tax due was $64,474.   Petitioners’ tax return for 1998

showed $4,005 as tax due, while the actual tax due was $66,563.

It follows that petitioners’ understatements of income taxes for

1997 and 1998 were substantial.   Petitioners failed to present

any evidence that either of those understatements was due to

reasonable cause.   Nor did petitioners present any evidence that

they had made adequate disclosure, or that any exception applies

in their case to the imposition of accuracy-related penalties for

1997 and 1998.

     We sustain respondent’s determination that petitioners are

liable for accuracy-related penalties under section 6662(a) for

1997 and 1998.

     We have considered all arguments made by the parties and

have found those arguments not discussed herein to be irrelevant

and/or without merit.   To reflect the foregoing,



                                           Decision will be entered

                                      for respondent.
