                 FOR PUBLICATION

  UNITED STATES COURT OF APPEALS
       FOR THE NINTH CIRCUIT


JAMES C. COOPER; LORELEI M.               No. 15-70863
COOPER,
            Petitioners-Appellants,        Tax Ct. No.
                                            17284-12
                 v.

COMMISSIONER OF INTERNAL                      OPINION
REVENUE,
            Respondent-Appellee.


              Appeal from a Decision of the
                United States Tax Court

         Argued and Submitted October 4, 2017
                 Pasadena, California

                Filed December 15, 2017

     Before: Andrew J. Kleinfeld, Susan P. Graber,
         and Morgan Christen, Circuit Judges.

                Opinion by Judge Graber;
Partial Concurrence and Partial Dissent by Judge Kleinfeld
2                          COOPER V. CIR

                            SUMMARY*


                                  Tax

    The panel affirmed the Tax Court’s decision, after a
bench trial, on a petition for redetermination of federal
income tax deficiencies in which taxpayers sought capital
gains treatment of patent-generated royalties pursuant to
26 U.S.C. § 1235(a).

    Taxpayer James Cooper is an engineer and inventor
whose patents generated significant royalties. He and his
wife incorporated and transferred their rights to the patents to
Technology Licensing Corporation (TLC), which was formed
by taxpayers and two other individuals, Walters and Coulter.
If a patent holder, through effective control of the
corporation, retains the right to retrieve ownership of the
patent at will, then there has not been a transfer of all
substantial rights to the patent so as to warrant capital gains
treatment of the royalties under § 1235(a). The panel held that
the Tax Court permissibly concluded that Mr. Cooper did not
transfer “all substantial rights” to the patents to TLC because
Walters and Coulter acted at Mr. Cooper’s direction, did not
exercise independent judgment, and returned patents to Mr.
Cooper when requested for no consideration.

   Taxpayers claimed a deduction for a nonbusiness “bad
debt” pursuant to 26 U.S.C. § 166(d)(1)(B), which allows
short-term capital-loss treatment of a loss “where any
nonbusiness debt becomes worthless within the taxable year.”

    *
      This summary constitutes no part of the opinion of the court. It has
been prepared by court staff for the convenience of the reader.
                       COOPER V. CIR                         3

The panel held that the Tax Court permissibly concluded that
the debt had not become “totally worthless.”

    Finally, the panel upheld the Tax Court’s determination
that taxpayers failed to meet their burden of showing that they
actually relied in good faith on their advisers’ judgment so as
to avoid accuracy-related penalties under 26 U.S.C. §§ 6662
and 6664.

    Judge Kleinfeld dissented as to Section A of the majority
opinion regarding the royalty payments as capital gains,
joined in Section B as to the bad debt deduction, and
observed that the accuracy penalties discussed under Section
C would need to be revisited if his view on the royalties were
to be accepted. Judge Kleinfeld opined that the better
approach to distinguishing “control” from “mere influence”
over a corporation is the approach set forth in Charlson v.
United States, 525 F.2d 1046 (Ct. Cl. 1975) (per curiam), and
Lee v. United States, 302 F. Supp. 945 (E.D. Wis. 1969): that
“control” means the ability to compel what the transferee
corporation does.


                         COUNSEL

Richard G. Stack (argued) and Dennis N. Brager, Brager Tax
Law Group P.C., Los Angeles, California, for Petitioners-
Appellants.

Clint A. Carpenter (argued) and Richard Farber, Attorneys,
Tax Division; Caroline D. Ciraolo, Principal Deputy
Assistant Attorney General; United States Department of
Justice, Washington, D.C.; for Respondent-Appellee.
4                       COOPER V. CIR

                          OPINION

GRABER, Circuit Judge:

    Petitioners James and Lorelei Cooper are married
taxpayers who challenge the Commissioner of Internal
Revenue’s notice of deficiency for tax years 2006, 2007, and
2008. Mr. Cooper’s patents generated significant royalties
during those years. Petitioners sought capital gains treatment
of those royalties pursuant to 26 U.S.C. § 1235(a) on the
theory that Mr. Cooper had transferred to a corporation “all
substantial rights” to the patents. After a bench trial, the Tax
Court disagreed, finding that Mr. Cooper effectively
controlled the recipient corporation such that he had not
transferred all substantial rights to the patents. The Tax Court
also found that Petitioners could not take a bad debt tax
deduction in 2008 because the debt at issue had not become
worthless during that year, and that Petitioners had not
established reasonable cause to avoid accuracy penalties
arising from their underpayment. Because the Tax Court
accurately applied the law and did not clearly err in its factual
findings, we affirm.

       FACTUAL AND PROCEDURAL HISTORY

    Mr. Cooper is an engineer and inventor. He is the named
inventor on more than 75 patents in the United States. His
patents are primarily for products and components used in the
transmission of audio and video signals. Petitioners are co-
trustees of a family trust, referred to as the “Cooper Trust.”
In 1983, Petitioners incorporated Pixel Instruments
Corporation (“Pixel”). Mr. Cooper was president, and Ms.
Cooper held various positions, including vice president.
Petitioners wholly owned Pixel until 2006.
                       COOPER V. CIR                          5

    In 1988, Mr. Cooper and Pixel entered into a
commercialization agreement with Daniel Leckrone. Mr.
Cooper and Pixel assigned their patents to a licensing
company formed by Leckrone, in exchange for royalty
payments arising from the commercialization of the patents.
The arrangement brought significant tax benefits to
Petitioners.     Because Petitioners had transferred “all
substantial rights” to the patents to the licensing company,
26 U.S.C. § 1235(a) permitted Petitioners to treat the
payments from the licensing company as capital gains. But
in 1997, after disputes with Leckrone, Mr. Cooper terminated
the commercialization agreement. All of Mr. Cooper’s patent
rights reverted to his assignee pursuant to a settlement and
arbitration.

    Understandably, Petitioners sought to retain the tax
benefits afforded by § 1235 and, to that end, they sought legal
advice from Gordon Baker. Baker advised them that they
could set up a licensing company to which to transfer the
patents, so long as they complied with two requirements that
are relevant here. First, he advised them that, pursuant to
§ 1235(c),1 they could not own 25 percent or more of the
company. Second, he advised them that, regardless of formal
ownership, they could not effectively control the new
company. The prohibition on effective control had been
discussed at length in Charlson v. United States, 525 F.2d
1046, 1053 (Ct. Cl. 1975) (per curiam).




    1
      Section 1235(c) formerly was labeled § 1235(d). We use the
present-day citation.
6                          COOPER V. CIR

    Petitioners, joined by Lois Walters and Janet Coulter,
incorporated Technology Licensing Corporation (“TLC”).2
Walters is Ms. Cooper’s sister, and Coulter is a long-time
friend of Ms. Cooper and Walters. During all relevant times,
Coulter and Walters lived in Ohio, and both held full-time
jobs unrelated to TLC. Neither Coulter nor Walters had any
experience in patent licensing or patent commercialization
before their involvement with TLC.

    Consistent with Baker’s advice, Petitioners, as co-trustees
of the Cooper Trust, owned only 24% of the TLC stock;
Walters owned 38%; and Coulter owned 38%. Walters was
president and chief financial officer, Ms. Cooper was vice
president, and Coulter was secretary.

    In 1997, Mr. Cooper and Pixel entered into agreements
with TLC. Under the TLC agreements, Mr. Cooper and Pixel
transferred to TLC all rights to certain patents, and TLC
agreed to pay Mr. Cooper and Pixel royalty payments using
a formula that relied on percentages of gross and net proceeds
received from licensing the patents. During 2006, 2007, and
2008—the years at issue here—Mr. Cooper received royalty
payments pursuant to the TLC agreements, and Petitioners
treated those payments as capital gains.

   During 2008, Petitioners also claimed a deduction on their
2008 tax return for a nonbusiness “bad debt” pursuant to

    2
       In 2003, Petitioners moved from California to Nevada. They then
incorporated a second Technology Licensing Corporation in that state,
with the same board membership and the same stock ownership. The two
corporations merged in 2004, with the Nevada corporation emerging as
the surviving corporation. We follow the Tax Court’s convention of
referring to both the original corporation and the surviving corporation as
“TLC.”
                           COOPER V. CIR                               7

26 U.S.C. § 166(d)(1)(B), which allows short-term capital-
loss treatment of a loss “where any nonbusiness debt becomes
worthless within the taxable year.” The debt arose from a
working capital promissory note from the Cooper Trust to
Pixel. At the end of 2008, the outstanding balance on the
promissory note was a little more than $2 million, and Mr.
Cooper concluded that Pixel could not pay the outstanding
balance.

    The Commissioner issued a notice of deficiency to
Petitioners. Relevant here, the Commissioner disagreed that
the royalty payments from TLC qualified as capital gains; he
disagreed that the Pixel promissory note debt qualified as a
bad debt deduction; and he assessed penalties for those errors.
Petitioners sought review by the Tax Court. After a trial, the
Tax Court agreed with the Commissioner on all three points,
and the court ordered Petitioners to pay deficiencies and
penalties totaling approximately $1.5 million. Petitioners
timely appeal.3 See 26 U.S.C. § 7482(a)(1) (permitting
appeals from the Tax Court to the applicable circuit court).

                  STANDARDS OF REVIEW

    “We review decisions of the Tax Court under the same
standards as civil bench trials in the district court. Therefore,
conclusions of law are reviewed de novo, and questions of
fact are reviewed for clear error.” Johanson v. Comm’r,
541 F.3d 973, 976 (9th Cir. 2008) (internal quotation marks
omitted).




   3
     The Tax Court ruled in favor of Petitioners on a separate issue; the
Commissioner did not cross-appeal. That ruling therefore is final.
8                      COOPER V. CIR

                        DISCUSSION

    “Determinations made by the Commissioner in a notice
of deficiency normally are presumed to be correct, and the
taxpayer bears the burden of proving that those
determinations are erroneous.” Merkel v. Comm’r, 192 F.3d
844, 852 (9th Cir. 1999). The burden shifts back to the
Commissioner in certain circumstances, 26 U.S.C. § 7491(a),
but the Tax Court held that Petitioners have neither asserted
nor proved that they have met those requirements. On appeal,
Petitioners do not challenge the Tax Court’s conclusion that
they bear the burden of proof.

    Petitioners challenge the Tax Court’s rulings on (A) the
treatment of royalty payments as capital gains; (B) the
treatment of the Pixel loan as a bad debt; and (C) the
imposition of penalties.

    A. Royalty Payments as Capital Gains

    The Tax Code generally treats income derived from a
capital asset as ordinary income. By contrast, the Tax Code
generally treats the proceeds from the sale of a capital asset
more favorably, as capital gains. Real property provides a
good example: If a homeowner rents a house, the rents are
ordinary income; but if the homeowner sells the house, the
proceeds from the sale are capital gains. Patents do not fit
neatly within that dichotomy, because patent holders often
sell all substantial rights to a patent in exchange for periodic
payments contingent on the patent’s productivity. But
because that payment arrangement appears so similar to rent,
the Commissioner originally treated the proceeds from such
exchanges as ordinary income—even though the patent
holder had divested all meaningful property rights in the
                        COOPER V. CIR                            9

patent. See Fawick v. Comm’r, 436 F.2d 655, 659–61 (6th
Cir. 1971) (describing this history).

    In 1954, Congress responded by enacting 26 U.S.C.
§ 1235. Subsection 1235(a) provides:

            A transfer (other than by gift, inheritance,
        or devise) of property consisting of all
        substantial rights to a patent . . . by any holder
        shall be considered the sale or exchange of a
        capital asset held for more than 1 year,
        regardless of whether or not payments in
        consideration of such transfer are–

            (1) payable periodically over a period
        generally coterminous with the transferee’s
        use of the patent, or

            (2) contingent on the productivity, use, or
        disposition of the property transferred.

Accordingly, if a patent holder transfers “all substantial rights
to a patent,” then the resulting royalty payments are treated as
capital gains, because the patent has been “sold.” By
contrast, if a patent holder retains substantial rights to a patent
and merely licenses the patent, then the resulting payments
are not treated as capital gains, because the patent has not
been “sold.” The key consideration is whether the patent
holder “transfer[red] . . . all substantial rights” to the patent.
Id.

    Petitioners urge us, for the first time on appeal, to
determine whether there has been a transfer of all substantial
rights by looking solely to the formal documents, without
10                          COOPER V. CIR

regard to the practical realities of the transaction.4 We
decline the invitation. A bedrock principle of tax law—now
and in 1954—is that substance controls over form. See, e.g.,
United States v. Eurodif S.A., 555 U.S. 305, 317–18 (2009)
(“[I]t is well settled that in reading regulatory and taxation
statutes, form should be disregarded for substance and the
emphasis should be on economic reality.” (internal quotation
marks omitted)); Helvering v. F. & R. Lazarus & Co.,
308 U.S. 252, 255 (1939) (“In the field of taxation,
administrators of the laws and the courts are concerned with
substance and realities, and formal written documents are not
rigidly binding.”). Nothing in § 1235 suggests that Congress
intended a different rule to apply here. To the contrary,
considerable legal authority supports our conclusion that,
when determining whether there has been a transfer of all
substantial rights, we must look beyond the bare form of the
transaction.

    Acting pursuant to an express statutory delegation,
26 U.S.C. § 7805(a), the Secretary of the Treasury
(“Secretary”) has promulgated regulations concerning the
statutory phrase “all substantial rights to a patent.” 26 C.F.R.
§ 1.1235-2(b). We defer to the Secretary’s regulations. See
Kueneman v. Comm’r, 628 F.2d 1196, 1201 (9th Cir. 1980)
(“The Secretary has broad authority to promulgate reasonable
regulations to implement the revenue laws . . . .”); Comm’r v.
Portland Cement Co. of Utah, 450 U.S. 156, 169 (1981)
(“Treasury Regulations ‘must be sustained unless
unreasonable and plainly inconsistent with the revenue


     4
       The issue is purely one of law, and the parties have briefed it to us.
We exercise our discretion to reach the issue, despite Petitioners’ failure
to raise it before the Tax Court. Bolker v. Comm’r, 760 F.2d 1039, 1042
(9th Cir. 1985).
                        COOPER V. CIR                         11

statutes.’” (quoting Comm’r v. S. Tex. Lumber Co., 333 U.S.
496, 501 (1948))). The pertinent Treasury Regulation states:
“The circumstances of the whole transaction, rather than the
particular terminology used in the instrument of transfer, shall
be considered in determining whether or not all substantial
rights to a patent are transferred in a transaction.” 26 C.F.R.
§ 1.1235-2(b)(1). That interpretation finds support in the
legislative history, specifically a Senate Finance Committee
report that stated:

        It is the intention of your committee to
        continue this realistic test, [developed under
        prior case law,] whereby the entire
        transaction, regardless of formalities, should
        be examined in its factual context to
        determine whether or not substantially all
        rights of the owner in the patent property have
        been released to the transferee . . . .

S. Rep. No. 83-1622, at 440 (1954), as reprinted in 1954
U.S.C.C.A.N. 4621, 5083. Not surprisingly, then, we
previously have described the inquiry in practical terms:
“What did the taxpayer actually give up by the transfer; that
is, was there an actual transfer of the monopoly rights in a
patent . . . .” Kueneman, 628 F.2d at 1199 (emphases added
and original emphasis omitted) (quoting Mros v. Comm’r,
493 F.2d 813, 816 (9th Cir. 1974) (per curiam)).

    In Charlson, 525 F.2d 1046, the United States Court of
Claims described how the principle applies in a case
involving a transfer of patent rights to a corporation. In that
case, the inventor formally transferred all substantial rights to
certain patents to a corporation that was owned by the
inventor’s close friends and associates. Id. at 1048–49.
12                      COOPER V. CIR

Section 1235(c) provides that royalties from a patent transfer
are not taxable as capital gains if the recipient is a “related”
person or entity.         The court held that § 1235(c)’s
requirements concerning formal ownership had been met, but
the court “stressed that § 1235[(c)] was not intended to be an
exclusive or exhaustive statement of the impact of control
over a § 1235(a) transaction.” Id. at 1053. It is “clear,” the
court held, “that retention of control by a holder over an
unrelated corporation can defeat capital gains treatment, if the
retention prevents the transfer of ‘all substantial rights.’” Id.
“This is because the holder’s control over the unrelated
transferee . . . places him in essentially the same position as
if all substantial rights had not been transferred.” Id.; see also
id. (describing Congress’ “obvious intent of having a
transferor’s acts speak louder than his words in establishing
whether a sale of a patent has occurred”).

     We agree: If a patent holder exercises control over the
recipient corporation such that, in effect, there has not been
a transfer of all substantial rights in the subject patent(s), then
the requirements of § 1235(a) are not met, even if the
documents describing the transfer formally assign all
substantial rights. The key inquiry remains whether, as a
practical matter, the transferor shifted all substantial rights to
the recipient. Mere influence by the patent holder is
insufficient to defeat § 1235(a) treatment, as is control by the
patent holder of aspects of the corporation apart from the
patent rights. A patent holder who formally transfers all
substantial patent rights to a qualifying corporation is entitled
to the benefits of § 1235(a) unless, through effective control
of the corporation, he or she did not effectively transfer all
substantial rights to the patent(s).
                       COOPER V. CIR                         13

    Importantly, “[t]he retention of a right to terminate the
transfer at will is the retention of a substantial right for the
purposes of section 1235.” 26 C.F.R. § 1.1235-2(b)(4).
Accordingly, if a patent holder, through effective control of
the corporation, retains the right to retrieve ownership of the
patent at will, then there has not been a transfer of all
substantial rights. Stated differently, if the recipient
corporation stands ready, as a practical matter, to return
ownership of the patent to the patent holder at the holder’s
direction, then there has not been a transfer of all substantial
rights.

    Here, the Tax Court found, and we agree, that Petitioners
complied with the formal requirements of § 1235. Mr.
Cooper formally transferred all substantial rights to the
patents to TLC, and Petitioners owned less than 25 percent of
TLC. The Tax Court further found, however, that Mr.
Cooper effectively controlled TLC within the meaning of
Charlson such that, in effect, there had not been a transfer of
all substantial rights to the patents. For the reasons that
follow, we hold that the Tax Court did not clearly err.

    The Tax Court found that Walters and Coulter—the two
shareholders other than the Cooper Trust—exercised no
independent judgment and acted at Mr. Cooper’s direction.
“During the years at issue, [Walters’ and Coulter’s] duties as
directors and officers consisted largely of signing checks and
transferring funds as directed by TLC’s accountants and
signing agreements as directed by TLC’s attorneys.”
“[S]ubstantially all of TLC’s decisions regarding licensing,
patent infringement, and patent transfers were made either by
Mr. Cooper or at his direction.” Walters and Coulter “acted
in their capacities as directors and officers of TLC at the
direction of Mr. Cooper. They did not make independent
14                      COOPER V. CIR

decisions in accordance with their fiduciary duties to TLC or
act in their best interests as shareholders.”

    Those findings strongly suggest that TLC would take
practically any action requested by Mr. Cooper—including
the return of patent rights—without regard to the interests of
TLC’s shareholders and without regard to the personal
interests of Walters and Coulter. But the Tax Court was not
required to speculate as to whether, upon Mr. Cooper’s
request, TLC would return valuable patent rights to Mr.
Cooper; that event in fact occurred. In 2006, upon request,
TLC returned valuable patent rights to Mr. Cooper for no
consideration. Mr. Cooper quickly commercialized the
patents through a separate entity, which received $120,000 in
revenue.

     In sum, the Tax Court permissibly concluded that Walters
and Coulter acted at Mr. Cooper’s direction; did not exercise
independent judgment; and, when requested, returned patents
to Mr. Cooper for no consideration. Given that Walters and
Coulter acquiesced, without question or explanation, in the
rescission of the transfer of certain patents, there is no reason
to think that they would have objected to the rescission of any
other transfer of patents. Because the right to retrieve
ownership of the patent is a substantial right, the Tax Court
did not clearly err in ruling that Mr. Cooper did not transfer
“all substantial rights” to the patents.

    We respectfully part ways from the dissent’s thoughtful
analysis of this issue and offer the following observations in
response.

   For all the reasons described above, the inquiry into
whether there was a transfer of all substantial rights is a
                       COOPER V. CIR                        15

practical one, not merely a formalistic or legalistic one. We
therefore reject the dissent’s suggestion that we must ask
whether, in theory, TLC could have declined to transfer the
patents back to Mr. Cooper; instead, we must ask whether, as
a practical matter, Mr. Cooper retained the ability to retrieve
the patents at will. Similarly, whether Mr. Cooper
hypothetically could have forced TLC to comply with his
wishes on other matters is beside the point.

    We recognize that there is a difference between mere
influence to control sufficient to defeat § 1235(a) tax
treatment. Reasonable minds may differ on where a
particular situation lies. Having examined the record
developed at trial in this case, and reviewing for clear error,
we hold only that the Tax Court’s conclusion was a
permissible one. Relatedly, we disagree with the dissent that
the facts of Charlson require a different result here. The
officers of the corporation in Charlson exercised independent
judgment, and the corporation never returned patents to the
inventor without consideration.

    Finally, we emphasize that our analysis is limited solely
to the tax consequences of Petitioners’ business
arrangements. Allowing an inventor to have effective control
of the recipient corporation very well may be a smart business
practice in some circumstances. We hold only that, if the
patent holder effectively controls the corporation such that he
or she did not transfer all substantial rights to the patents,
then the tax treatment allowed by § 1235 does not apply.

   B. Bad Debt Deduction

   We review for clear error the Tax Court’s finding of the
worthlessness of a debt. L.A. Shipbuilding & Drydock Corp.
16                     COOPER V. CIR

v. United States, 289 F.2d 222, 228–29 (9th Cir. 1961);
accord Cox v. Comm’r, 68 F.3d 128, 131 (5th Cir. 1995).
The taxpayer bears the burden of proving “that the debt
became worthless within the tax year.” Andrew v. Comm’r,
54 T.C. 239, 244–45 (1970). “The year a debt becomes
worthless is fixed by identifiable events that form the basis of
reasonable grounds for abandoning any hope of recovery.
Petitioner must establish sufficient objective facts from which
worthlessness could be concluded; mere belief of
worthlessness is insufficient.” Aston v. Comm’r, 109 T.C.
400, 415 (1997) (citation omitted). The debt must “become
totally worthless, and no deduction shall be allowed for a
nonbusiness debt which is recoverable in part during the
taxable year.” 26 C.F.R. § 1.166-5(a)(2). A taxpayer need
not have initiated legal action against the debtor, but “he does
have the burden of establishing that such an action, when
considered in the light of objective standards, would in all
probability have been entirely unsuccessful.” Dustin v.
Comm’r, 467 F.2d 47, 48 (9th Cir. 1972) (footnotes omitted).

    The Tax Court found that, contrary to Petitioner’s
assertion, the debt on Pixel’s promissory note did not become
“worthless” in July 2008. 26 U.S.C. § 166(d)(1)(B). The
court reasoned:

           Pixel had total yearend assets each year
       from 2008 through 2012 in excess of
       $172,000, including more than $319,000 in
       assets in 2011 and 2012. It appears to us that
       Pixel remained a going concern well past
       2008. . . . Pixel experienced a decline in its
       business in 2008, but its gross receipts
       increased in 2009. Petitioners as cotrustees of
       the Cooper Trust continued to advance funds
                       COOPER V. CIR                       17

       to Pixel under the terms of the promissory
       note throughout 2008. Indeed, petitioners
       advanced $148,255 to Pixel under the terms of
       the promissory note between July and
       December 2008. We do not find it credible
       that petitioners would have advanced nearly
       $150,000 to Pixel after July 2008 if they
       believed the promissory note had been
       rendered worthless in July 2008 . . . . The
       evidence shows that Pixel had substantial
       assets at the end of the 2008 tax year and that
       its gross receipts increased in 2009.
       Moreover, at the very least, Pixel was entitled
       to an indefinitely continuing annual royalty of
       $22,500 and owned rights in several other
       patents. . . . Pixel’s liabilities to petitioners
       under the terms of the promissory note
       comprised substantially all of Pixel’s
       liabilities in 2008.

(Formatting omitted.)      Those findings are not clearly
erroneous.

    In short, Pixel had a steady, if small, income stream, and
it had hundreds of thousands of dollars worth of assets.
Petitioners almost certainly could not have recovered the full
$2 million and change but, considering that they were
essentially the only creditors, they likely could have made a
partial recovery. The Tax Court permissibly concluded that
the debt had not become “totally worthless.” 26 C.F.R.
§ 1.166-5(a)(2).
18                     COOPER V. CIR

     C. Accuracy Penalties

    Title 26 U.S.C. § 6662(a) imposes a 20 percent penalty to
underpayments of tax if any of the conditions in § 6662(b) is
met. Here, the Tax Court found that two conditions were
met: “Negligence or disregard of rules or regulations,” id.
§ 6662(b)(1), and “[a]ny substantial understatement of
income tax,” id. § 6662(b)(2). On appeal, Petitioners do not
challenge those findings.

    Section 6664(c) provides a “[r]easonable cause exception
for underpayments”: “No penalty shall be imposed under
section 6662 or 6663 with respect to any portion of an
underpayment if it is shown that there was a reasonable cause
for such portion and that the taxpayer acted in good faith with
respect to such portion.” 26 U.S.C. § 6664(c)(1). Petitioners
assert that they relied in good faith on professional advice.

            Reliance on professional advice may
        establish reasonable cause and good faith.
        Treas. Reg. § 1.6664-4(b)(1). The Tax Court
        requires a taxpayer to prove three elements in
        order to show that reliance on advice was
        reasonable: “(1) The adviser was a competent
        professional who had sufficient expertise to
        justify reliance, (2) the taxpayer provided
        necessary and accurate information to the
        adviser, and (3) the taxpayer actually relied in
        good faith on the adviser’s judgment.”
        Neonatology Assocs., P.A. v. Comm’r,
        115 T.C. 43, 99 (2000).             Once the
        Commissioner produces evidence showing
        that an accuracy-related penalty applies, the
                       COOPER V. CIR                        19

       burden of proving the existence of reasonable
       cause and good faith falls on the taxpayer.

DJB Holding Corp. v. Comm’r, 803 F.3d 1014, 1029–30 (9th
Cir. 2015). Here, the Tax Court held that Petitioners failed to
meet their burden of showing that they actually relied in good
faith on an adviser’s judgment. “Whether the taxpayer acted
with reasonable cause and in good faith is a finding of fact
reviewed for clear error.” Id. at 1022.

   1. Royalty Penalty

    With respect to the royalty penalty, Petitioners contended
that they relied on the advice of Baker. The Tax Court found:

           Mr. Baker testified with respect to the
       royalty payments and petitioners’ compliance
       with section 1235 that he advised petitioners
       that Mr. Cooper could not indirectly control
       TLC. Moreover, Mr. Baker did not provide
       advice to petitioners before they filed their
       Forms 1040 for the years at issue, nor did he
       provide advice to petitioners regarding
       whether Mr. Cooper controlled TLC
       following TLC’s incorporation. Petitioners
       did not follow Mr. Baker’s advice to ensure
       that Mr. Cooper did not indirectly control
       TLC. Consequently, petitioners cannot claim
       reliance on the professional advice of Mr.
       Baker to negate the section 6662(a) penalty
       with respect to their erroneous capital gain
       treatment of the royalty payments Mr. Cooper
       received during the years at issue.
20                     COOPER V. CIR

    Those findings are not clearly erroneous, and the Tax
Court’s reasoning is sound. Baker advised Petitioners at the
time they formed TLC that, in order to receive capital gains
treatment, Mr. Cooper could not control TLC indirectly.
Baker also testified specifically that he had no recollection
that he ever advised Petitioners that the way in which they
were operating TLC actually conformed to his advice.
Indeed, there is no evidence that Petitioners ever sought post-
formation advice from anyone about whether their conduct
actually complied with Baker’s advice.

    Nor was the penalty inappropriate because of the
allegedly uncertain state of the law.          “[A]n honest
misunderstanding of fact or law that is reasonable in light of
all of the facts and circumstances” can excuse an
understatement of tax. 26 C.F.R. § 1.6664-4(b)(1). But there
is patently no honest misunderstanding here: Petitioners’
theory at trial was that Baker advised them to conform with
Charlson such that they did not informally control TLC.
Indeed, they conceded before the Tax Court that Charlson
provided the binding legal rule: Capital gains treatment is
unavailable if the taxpayer informally controls the
corporation. It is only on appeal that they have challenged
the legal standard. Accordingly, whatever merit Petitioners’
argument might have had if they truly had been uncertain
about the validity of Charlson (despite the fact that no court
has questioned its validity), Petitioners cannot benefit from
that purported uncertainty because it was not until this appeal
that they alleged any uncertainty.
                       COOPER V. CIR                        21

   2. Bad Debt Penalty

   With respect to the bad debt penalty, Petitioners
contended that they relied on the advice of Mitch Mitchell
and Baker. The Tax Court found:

            With regard to the bad debt deduction,
       petitioners have failed to introduce evidence
       regarding what information they provided to
       Mr. Baker and Mr. Mitchell to enable them to
       determine whether the promissory note was
       worthless within the meaning of section 166
       in 2008. Petitioners did not call Mr. Mitchell
       to testify or otherwise introduce any evidence
       regarding Mr. Mitchell’s advice. Similarly,
       Mr. Baker did not testify regarding any advice
       he may have given to petitioners that would
       indicate that it was his opinion that the
       promissory note became worthless in 2008.
       In short, petitioners have failed to prove that
       they received or relied on the professional
       advice of Mr. Baker and Mr. Mitchell with
       respect to their erroneous section 166 bad debt
       deduction in 2008.

    Again, there is no clear error. Petitioners have not
rebutted the Tax Court’s finding that Petitioners failed to
prove that “the taxpayer provided necessary and accurate
information to the adviser.” DJB Holding Corp., 803 F.3d at
1030. Mitchell did not testify, and neither Petitioners nor the
Commissioner asked Baker any questions about the bad debt
22                         COOPER V. CIR

or about any advice he may have given Petitioners on that
topic.

     AFFIRMED.



KLEINFELD, Senior Circuit Judge, concurring in part and
dissenting in part:

    I respectfully dissent. My dissent is directed only to
Section A, “Royalty Payments as Capital Gains.” I join in
Section B, “Bad Debt Deduction.” As for Section C,
“Accuracy Penalties,” whether and how the penalties would
apply would need to be revisited if my view on royalties were
to be accepted.

    The majority errs because it dilutes the meaning of
“control” from the ability to compel a result to something less
and indeterminate. This puts us at odds with our only sister
circuit to rule on the matter, the Court of Claims in Charlson
v. United States.1 Both Charlson and the Commissioner’s
own regulations show the error of the majority’s approach.

    The majority opinion accurately notes that in Charlson,
the corporation to which inventor Lynn Charlson transferred
his patent was owned by his “close friends and associates.”
Actually, they were more than close friends and associates:
three of the shareholders and directors were his employees,



     1
      525 F.2d 1046 (Ct. Cl. 1975) (per curiam); cf. S. Corp. v. United
States, 690 F.2d 1368, 1370–71 (Fed. Cir. 1982) (en banc) (adopting Court
of Claims opinions as binding precedent).
                            COOPER V. CIR                   23

and the fourth was his personal attorney.2 As such, Charlson
could fire each of them if he disliked how they voted. The
corporation also “frequently sought, received, and followed
the recommendations of Charlson,”3 and Charlson and the
directors were “solicitous of each other’s individual interests
as well as their mutual interests.”4 The Commissioner argued
that the corporation, the directors of which had their
livelihoods subject to Charlson’s preferences, followed his
recommendations, and were solicitous of his personal
interests, was “controlled” by Charlson.5 And Charlson
certainly had more ability to influence than Cooper does.
Cooper cannot fire his sister-in-law and her friend from their
jobs.

    Yet Charlson won his case. The Commissioner lost.6
Despite the evidence that the corporation did what Charlson
wanted, the Court of Claims concluded that he did not
“control” the corporation such that the transfer of patent
rights was not genuine. Today’s majority opinion quotes
Charlson’s statement that the “retention of control by a
holder of an unrelated corporation can defeat capital gains
treatment, if the retention prevents the transfer of all
substantial rights.”7 That language marks the boundary of


   2
       Charlson, 525 F.2d at 1048–49.
   3
       Id. at 1056.
   4
       Id. at 1055.
   5
       Id. at 1052.
   6
       Id. at 1057.
   7
       Id. at 1053 (internal quotation marks omitted).
24                           COOPER V. CIR

capital gains treatment, but Charlson held that the boundary
was not crossed. Charlson had power over the corporate
directors—far more power than Cooper had over TLC’s
directors—but Charlson did not “control” the directors for the
purposes of § 1235.

    The regulations make it clear that even though the
directors in this case are Cooper’s friends and relatives, that
does not amount to control or make TLC a “related” entity.
The regulations are at pains to say that even transferring
patent rights to a corporation controlled by one’s own brother
“is not considered as transferring such rights to a related
person.”8 Since a brother is not a “related person” for
§ 1235(c) purposes, neither is a sister-in-law or a friend of a
sister-in-law.

    The majority correctly concedes that “[m]ere influence by
the patent holder is insufficient to defeat § 1235(a)
treatment.” But influence is all Cooper had. His authority
over Walters (his sister-in-law) and Coulter (a friend of
Walters and of Cooper’s wife) was considerably less than
Charlson’s authority over his employees. Cooper’s situation
is more like the one in Lee v. United States, where the transfer
put the taxpayer’s own longtime personal friend in charge.9
Yet in Lee, as in Charlson, the Commissioner lost. Lee held
that the issue of control is whether the taxpayer can “force”
the transferee to do his bidding.10 There is no evidence
whatsoever that Cooper had that power.


     8
         26 C.F.R. § 1.1235-2(f)(3); see 26 U.S.C. § 1235(c)(2).
     9
         302 F. Supp. 945, 948 (E.D. Wis. 1969).
     10
          Id. at 950.
                       COOPER V. CIR                       25

    Walters and Coulter, like the directors in Charlson, were
solicitous of Cooper’s and each other’s personal interests.
They did transfer a few patents to Cooper for no
consideration so that he could in turn transfer them to a
corporation in which his children had an interest. But
Walters and Coulter still owned 76% of the new corporation.
(Instead of Cooper and his wife owning 24%, Cooper and his
wife owned 1% and their children owned 23%.) And Cooper
was not the only one who benefitted from TLC. Walters and
Coulter each received $40,000 in director’s fees, and TLC
bought them long-term insurance policies worth $115,406
and $63,089, respectively. Cooper did not receive an
insurance policy.

     Although the Commissioner argues that the patent
transfer benefitting Cooper’s children somehow breached a
fiduciary duty to TLC’s shareholders, that argument would
apply equally to the payments made to Walters and Coulter.
And it would be equally irrelevant. All that a breach of
fiduciary duty means is that Walters and Coulter, acting in
their capacity as shareholders, could theoretically sue
themselves in their capacity as directors. That unlikely
possibility does not show control. The core of the
Commissioner’s argument—that the directors knew nothing
about Cooper’s sophisticated inventions and simply followed
his instructions—does not show control. If anything, it shows
that there was no good reason for them to reject Cooper’s
recommendations, because it was his knowledge and skill that
generated millions in revenue, so he did not need control.

    In distinguishing control from influence, our focus should
not be merely on whether TLC’s directors did what Cooper
wanted. There was no reason for them to do anything else.
Instead we must ask whether, as a practical matter, they could
26                            COOPER V. CIR

have done otherwise. Cooper could have, but did not, set up
the corporation to retain control.

    The most obvious way to control a corporation is to own
a majority of its stock. For example, owning 100% of the
stock defeated the tax benefits in the classic sham case
Gregory v. Helvering.11 However, Congress provided that a
patent holder cannot receive capital gains treatment if he
owns 25% or more of the corporation to which he transferred
his patents.12 That is why Cooper and his wife owned only
24% of TLC’s stock.

    Minority shareholders may still control a corporation by
controlling its directors’ votes, and there are well-established
means by which Cooper might have done so. Those means
are often used in close corporations to protect minority
shareholders from oppression. One way to retain control is
to write the articles of incorporation to require a super-
majority so that no decision can be made without the minority
shareholders’ consent.13 Another is to establish a voting trust
so that the majority must vote their shares in line with the
minority’s preferences.14 A third means is to use classified
shares with the minority shares controlling the class that
chooses the directors.15 And a fourth is to contractually
obligate the directors to vote consistently with the minority

     11
          293 U.S. 465, 467–69 (1935).
     12
          26 U.S.C. § 1235(c)(1); see id. § 267(b)(2).
     13
          ROBERT C. CLARK, CORPORATE LAW 775 (1986).
     14
          Id. at 777.
     15
          Id. at 780.
                         COOPER V. CIR                      27

shareholders’ preferences.16 This list is not exhaustive, of
course. But Cooper did not do any of these things. If he had,
then he would have genuinely controlled TLC, not just
influenced it.

     Because Cooper’s inventions generated TLC’s revenue,
Walters and Coulter no doubt thought it was in TLC’s best
interest to accommodate Cooper and keep him productive.
But Cooper could not always count on Walters and Coulter to
do things his way. At some point, he would age out of his
peak productivity, meaning there would be less reason to
listen to him. Moreover, a change in circumstances could
always occur. As Professor Clark wrote in his treatise:

          As time passes, the personal relationships
          among the major participants in a close
          corporation always change in important ways.
          One of several participants will retire or die,
          leaving a gap in a shareholding or managerial
          role that might or might not be filled.
          Participants who were once friendly to each
          other will accumulate grudges.           Some
          participants will want to go on to other
          ventures. Others will want to bring in new
          associates, who may or may not be acceptable
          to the others.17

If, for example, a buyout offer could enrich Walters and
Coulter but would end Cooper’s influence over TLC, that
might create conflict between the shareholders. Yet Cooper


   16
        Id. at 781–83.
   17
        Id. at 763.
28                           COOPER V. CIR

would lack any power to make Walters and Coulter reject the
buyout. They would be multimillionaires and he would lose
his connection to his own inventions.

     Because the majority opinion makes “control” a vague
and ambiguous term, it risks eviscerating § 1235 capital gains
treatment when transfers are made to close corporations.
Congress thought it was a good idea to give patent holders a
tax benefit, but the majority’s decision creates so much risk
of litigation that it may be a bad idea to claim the benefit. A
transfer to a corporation directed by the inventor’s employees
and attorney was good enough in Charlson.18 A transfer to a
corporation directed by one’s longtime friend was good
enough in Lee.19 And a transfer to a corporation controlled by
one’s own brother is good enough under the regulations.20
Yet now a transfer to a corporation controlled by one’s sister-
in-law and her friend is not good enough, even if the taxpayer
lacks any means to compel those directors to do his will.
Accordingly, it is not possible to say with confidence what
close corporation arrangement will qualify for capital gains
treatment.

    In short, the majority opinion does not say how “control”
is distinct from “mere influence,” so mere influence of some
vague and indeterminate kind prevents capital gains
treatment. “Control” means the taxpayer can make the
transferee corporation do what he wants, while “influence”
means that although the corporation may defer to his


     18
          525 F.2d at 1048–49, 1057.
     19
          302 F. Supp. at 948, 950.
     20
          26 C.F.R. § 1.1235-2(f)(3).
                      COOPER V. CIR                       29

judgment or be persuaded by his view, he cannot make the
corporation do what he wants. The better approach is the one
seen in Charlson and Lee: that “control” means the ability to
compel what the transferee corporation does.
