                  T.C. Memo. 2001-255



                UNITED STATES TAX COURT



     JAMES D. AND RITA K. SNYDER, Petitioners v.
     COMMISSIONER OF INTERNAL REVENUE, Respondent



Docket No. 11638-99.               Filed September 28, 2001.



     R attributed to Ps’ various items with respect to
two trusts, on the grounds that such trusts were either
shams or grantor trusts, on the ground that the
assignment of income doctrine applied, or on the ground
that Ps failed to report certain trust items. R
determined a sec. 6662(a), I.R.C., accuracy-related
penalty against Ps. At trial, R moved for penalties
on account of delay and for other reasons, under
sec. 6673(a)(1), I.R.C.
     1. Held: Trust income attributed to Ps for
substantially the reasons stated by R.
     2. Held, further, Ps are liable for accuracy-
related penalties under sec. 6662(a), I.R.C.
     3. Held, further, for various reasons, Ps are
liable for a penalty under sec. 6673(a)(1), I.R.C.
                                 - 2 -

     James D. and Rita K. Snyder, pro se.

     Dale A. Suzi, for respondent.



               MEMORANDUM FINDINGS OF FACT AND OPINION


     HALPERN, Judge:    By notice of deficiency dated March 31,

1999 (the notice), respondent determined deficiencies in, and an

addition and penalties with respect to, petitioners’ 1992 through

1995 Federal income taxes, as follows:

                                 Sec. 6651(a)    Sec. 6662(a)
     Year       Deficiency     Addition to Tax     Penalty
     1992        $70,215             --            $14,043
     1993         90,783           $4,547           18,157
     1994         87,301             --             17,460
     1995        120,866             --             24,173

     Unless otherwise indicated, all section references are to

the Internal Revenue Code in effect for the years at issue, and

all Rule references are to the Tax Court Rules of Practice and

Procedure.    For convenience, monetary amounts have been rounded

to the nearest dollar amount.

     At the conclusion of the trial in this case, respondent

moved that the Court impose penalties under section 6673(a)(1),

which provides penalties for procedures instituted primarily for

delay and for other reasons.    We took that motion under

advisement.   Respondent has conceded the addition to tax for

1993, determined under section 6651(a) for failure to file a

return on time.   We accept that concession.
                              - 3 -

     We must decide the following issues for each of the years in

issue:1

     Whether petitioners understated their gross income by

omitting certain items reported by petitioners on returns made by

them for two trusts: Complete Connections Trust and J&R Trust.2

     Whether petitioners are liable for self-employment taxes

(and are entitled to related deductions) on account of each’s

share of the trust items respondent determined petitioners

omitted from gross income.3




     1
        In their reply brief, petitioners state: “The statute of
limitations has expired for the years in question. Respondent
has failed to provide the petitioner any facts or evidence
showing where the statute of limitation has been extended for any
of the tax years in question.” In pertinent part, Rule 39
provides that a party shall set forth in the party’s pleading any
matter constituting an affirmative defense, “including * * * the
statute of limitations”. The petition does not raise any issue
with respect to the statute of limitations, and we cannot
conclude that such issue was tried by consent. See Rule 41(b).
The affirmative defense of statute of limitations is not before
the Court. In any event, it appears that sec. 6501 would not
limit the assessment or collection of any of the tax liabilities
here in issue. See sec. 6501(a), (e)(1).
     2
        In naming, describing, or referring to Complete
Connections Trust and J&R Trust, we use the term “trust” for
convenience, without intending a finding that, in either case, a
trust relationship did, in fact, exist.
     3
        The amount of petitioners’ liability for self-employment
taxes and the amount of the deductions under sec. 164(f) to which
petitioners are entitled are computational matters, the
resolution of which will depend upon our disposition of the gross
income issue. Petitioners have not separately challenged such
liability and deduction, and we do not further discuss those
items.
                                - 4 -

     Whether the exemptions claimed by petitioners must be

reduced on account of any increase in their adjusted gross

income.4

     Whether petitioners are liable for accuracy-related

penalties under section 6662(a).

     Finally, we must decide whether petitioners are liable for a

penalty under section 6673(a)(1).

                           FINDINGS OF FACT

     Some facts are stipulated and are so found.    The first and

second stipulations of facts, filed by the parties, with

accompanying exhibits, are incorporated herein by this reference.

Residence

     At the time the petition was filed, petitioners resided in

Paso Robles, California.

Complete Connections

     In 1985, petitioner Rita Snyder (Rita Snyder) applied to the

City of El Paso de Robles, California (the city), for a business

license.    On the application form for that license (the

application), she stated that she was the owner of the business

in question, its name was “Complete Connection”, and the type of

business to be licensed was “business services”.    In 1988, she

responded to a questionnaire from the city with respect to that


     4
        This also is a computational matter, which petitioners
have not separately challenged, and we will not further discuss
it.
                               - 5 -

business by stating that its name was “Complete Connections”, it

was owned by her and petitioner James Snyder (James Snyder), its

business was “Income Tax/Accounting”, and it was a sole

proprietorship.   On August 31, 1992, she applied for a renewal

business license for the business named “Complete Connections”,

again stating that it was owned by her and James Snyder, and

describing its business as “Computerized Accounting and Tax

Services”.   On January 10, 1996, James Snyder filed a statement,

“Fictitious Business Name Statement”, with the County of San Luis

Obispo, California.   In that statement, Mr. Snyder stated that

the fictitious business name was “Complete Connections Computer

Systems”, the name of the registrant was “James D. Snyder”, and

the business in question was conducted by an individual.

Petitioners’ Federal Income Tax Returns

     For 1991, petitioners made a joint return of income on

Form 1040, U.S. Individual Income Tax Return (the 1991 Form

1040).   Attached to the 1991 Form 1040 is a Schedule C, Profit or

Loss From Business (Sole Proprietorship) (the 1991 Schedule C).

On the 1991 Schedule C, petitioners state that they are the

proprietors of a business named “Complete Connections”, the

business of which is computer sales, bookkeeping, and taxes.   The

1991 Schedule C shows gross receipts of $228,858, cost of goods

sold of $113,974, other income of $186, expenses of $82,267, and
                                 - 6 -

a net profit of $32,803.    The 1991 Form 1040 reports no income

(or any other item) from any trust.

     For 1992 through 1995, petitioners also made joint returns

of income on Forms 1040, U.S. Individual Income Tax Returns (the

1992 through 1995 Forms 1040).    Except for 1995, none of those

returns reports any item identified with a business named

“Complete Connections”.     For 1995, petitioners reported $7,750 of

wages, $3,750 of which is identified on a Form W-2, Wage and Tax

Statement, 1995, as being paid by Complete Connections Trust to

James Snyder.   The 1992 through 1995 Forms 1040 do, however,

report the following amounts of income from J&R Trust:

                     Year             Amount
                     1992            $15,219
                     1993             11,773
                     1994             14,950
                     1995             18,659

Federal Income Tax Returns for Complete Connections Trust

     Beginning with 1992, and continuing for 1993, 1994, and

1995, either Rita or James Snyder made a return of income on

Form 1041, U.S. Fiduciary Return of Income (for 1992 and 1993) or

U.S. Income Tax Return for Estates and Trust (for 1994 and 1995),

claiming to report the income of Complete Connections Trust, a

complex trust, created on January 1, 1992, and carrying on a

business of the same name (such returns being referred to,

collectively, as the Complete Connections Trust returns).    Each

of the Complete Connections Trust returns is signed by one or the
                                 - 7 -

other of James or Rita Snyder as a fiduciary.       For 1992, one

“Kevin R. Richards” is reported as a fiduciary, and, for 1995,

such person is reported as “trustee”.       The business carried on

under the name Complete Connections is described as, for 1992,

bookkeeping, taxes, and computer sales and, for the remaining

years, “business services.”   The Complete Connections Trust

returns report the following amounts of gross receipts and

miscellaneous income from such business and interest income

unrelated to such business:

                 Gross Receipts
     Year        & Misc. Items           Interest      Total
     1992          $183,482                 --       $183,482
     1993           229,466                $159       229,625
     1994           214,517                 221       214,738
     1995           295,903                 --        295,903

The Complete Connections Trust returns report the following costs

of goods sold, expenses, and net profits:

                 Cost of Goods
     Year            Sold                Expenses     Net profit
     1992           $73,027               $80,028      $30,427
     1993           107,168                84,013       38,285
     1994            98,830                93,440       22,247
     1995           147,637               123,466       24,800

The Complete Connections Trust returns report the following

deductions on account of distributions of income to J&R Trust:

                    Year                  Amount
                    1992                 $30,427
                    1993                  38,444
                    1994                  21,608
                    1995                  24,800
                               - 8 -

For each trust year in question, such income distribution

deduction, along with a charitable contribution deduction of $860

for 1994, was sufficient to reduce reported taxable income to

zero.   A tax liability of zero was reported for each trust year,

1992 through 1995.

Rita Snyder’s Business

     During the years in issue, Rita Snyder engaged in business

as a paid tax return preparer, under the name “Complete

Connections”.

Complete Connections Checking Account

     A business checking account, account number 002-502704, in

the name of “Complete Connections” (the Complete Connections

checking account), was opened at Santa Lucia National Bank no

later than August 9, 1990, and was closed on January 28, 1999.

The signature card for that account describes the account as a

trust account and shows as signatories both Rita and James

Snyder, each of whom is described as a manager.   All checks drawn

on the Complete Connections checking account during 1995 were

signed by either James or Rita Snyder.

Federal Income Tax Return for J&R Trust

     Beginning with 1992, and continuing for 1993, 1994, and

1995, either Rita or James Snyder made a return of income on

Form 1041, U.S. Fiduciary Return of Income (for 1992 and 1993) or

U.S. Income Tax Return for Estates and Trust (for 1994 and 1995),
                                   - 9 -

claiming to report the income of J&R Trust, a complex trust,

created on January 1, 1992, and carrying on (1) a business named

“J & R” and (2) other activities (such returns being referred to,

collectively, as the J&R Trust returns).         Each of the J&R Trust

returns is signed by one or the other of James or Rita Snyder as

a fiduciary.   For 1992, one “Kevin R. Richards” is reported as a

fiduciary, and, for 1995, one “David J. Snyder” is reported as

“trustee”.   The business carried on under the name J & R is

described as, for 1992, “management services” and, for the

remaining years, “investments”.        The J&R Trust returns report the

following amounts of gross receipts from such business and

interest income unrelated to such business:

     Year             Gross Receipts       Interest      Total
     1992                   –-                –-           --
     1993                $11,606             $159       $11,765
     1994                 15,000              334        15,334
     1995                  8,800              242         9,042

With respect to such business, the following expenses and net

profits are reported:

               Year           Expenses         Net profit
               1992           $20,512           ($20,512)
               1993            28,096            (16,490)
               1994             4,233             10,767
               1995             4,467              4,446

The J&R Trust returns also report net rental income and

distributions received from Complete Connections Trust in the

following amounts:
                                   - 10 -

          Year               Rental       Distribution
          1992               $11,791        $30,427
                                            1
          1993               10,200           38,285
                                            1
          1994               (5,600)          21,395
          1995                  912           24,800
          1
            The difference between this amount and the deduction
     claimed by Complete Connections Trust for a distribution of
     income for the year is explained by J&R Trust’s separate
     statement of interest income for the year.

The J&R Trust returns report the following deductions on account

of distributions of income to petitioners5:

                       Year       Distribution
                       1992         $18,673
                       1993          27,444
                       1994          35,643
                       1995          28,441

For each trust year in question, such income distribution

deduction, along with charitable contribution deductions of

$3,033, $4,710, $1,253, and $1,959 for such years, respectively,

was sufficient to reduce reported taxable income to zero.         A tax

liability of zero was reported for each trust year, 1992 through

1995.




     5
        Such distributions, when reduced by (1) interest from J&R
Trust reported by petitioners and (2) some or all of the
categories of depreciation allocated to them by J&R Trust, equal,
almost to the dollar, the income reported by petitioners as
having been received by J&R Trust:

  Year        Distribution     Interest    Depreciation   Difference
  1992          $18,673           --          $3,453       $15,222
  1993           27,444          $76          15,535        11,773
  1994           35,643          318          10,374        14,951
  1995           28,441          226           9,555        18,660
                             - 11 -

J&R Checking Account

     A business checking account, account 002-506610, in the name

of “J & R ‘A TRUST’” (the J&R checking account), was opened at

Santa Lucia National Bank no later than February 25, 1994.    The

signature card for that account describes the account as a trust

account and shows as signatories both Rita and James Snyder, each

of whom is described as a manager.    The address shown on the J&R

checking account signature card, checks, and monthly statements

is the same as the address shown on petitioners’ tax returns.

All checks drawn on the J&R checking account during 1995 were

signed by either James or Rita Snyder. Such checks included

checks drawn to the order of Rita Snyder, James Snyder, Robert C.

Miller, D.D.S., Big Creek Lumber Co., Southern California Gas

Co., Pacific Bell, All States, Wal Mart, Home Furniture Gallery,

Dan’s Economy Tires, Albertsons, Paso Robles Waste Disposal, New

Covenant Church of God, K Mart,    Steven J. Harmon, M.D., Central

Coast Pathology, Payless Shoes, Musician’s Emporium, Bakery

Works, and Bauer Speck Student Council.

Petitioners’ Residence

     Petitioners purchased their personal residence (the

residence), located at 386 Quarterhorse Lane, Paso Robles,

California, on November 9, 1992.   The grant deed by which they

acquired the residence (the first grant deed) shows the grantees

as “James D. Snyder and Rita K. Snyder, husband and wife as
                                  - 12 -

tenants in common”.    By grant deed dated November 11, 1992 (the

second grant deed), petitioners (in the same capacity as in the

first grant deed) transferred the residence to Kevin R. Richards

and David J. Snyder, as trustees for J&R Trust.          The second grant

deed was recorded on August 12, 1993.        Between the dates of

execution and recordation of the second grant deed, by deed of

trust dated June 15, 1993, and recorded June 23, 1993,

petitioners, as “husband and wife”, encumbered the residence to

secure their indebtedness to United Savings Bank in the amount of

$141,300.

Respondent’s Adjustments

     Attached to the notice are statements listing and explaining

respondent’s adjustments to petitioners’ income.         Among the

adjustments listed are the following, involving respondent’s

attribution to petitioners of income from Complete Connections

Trust and J&R Trust:

         Trust           1992       1993        1994        1995
     Comp. Conn.       $194,205   $229,625    $214,738    $295,903
     J&R                  --        11,766      15,334       9,042

In the case of both trusts, respondent explains the adjustments

as resulting from, alternatively, (1) respondent’s disregard of

the trust, since it “is a sham with no economic substance”,

(2) the status of the trust as a grantor trust, (3) application

of the assignment of income doctrine (pursuant to which income is

taxed to the true earner of that income), and (4) application of
                                - 13 -

sections 652(a) or 662(a) (including in the gross income of

beneficiaries certain trust amounts).    Also in the case of both

trusts, respondent explains that petitioners have failed to show

that they are entitled to any deductions in excess of the amounts

determined by respondent.

                            OPINION

I.   Burden of Proof

       In pertinent part, Rule 142(a) provides:    “The burden of

proof shall be upon the petitioner”.     In certain circumstances,

if a petitioner introduces credible evidence with respect to any

factual issue relevant to ascertaining such petitioner’s

liability for tax, section 7491 places the burden of proof on

respondent.    See sec. 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 (RRA 1998), Pub. L. 105-206, sec. 3001(c)(2), 112 Stat.

726.    Respondent concedes that the examination of petitioners

commenced after July 22, 1998.

       Section 7491(a)(2) establishes prerequisites (the

prerequisites) to establishing that the burden of proof may lie

with respondent under section 7491(a)(1).    In pertinent part,

section 7491(a)(2) provides:

         (2) Limitations.--Paragraph (1) shall apply with
       respect to an issue only if--
                                  - 14 -

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

              (B) the taxpayer has maintained all records
            required under this title and has cooperated
            with reasonable requests by the Secretary for
            witnesses, information, documents, meetings,
            and interviews; * * *

The burden is on the taxpayer to show that the prerequisites are

satisfied.    See H. Conf. Rept. 105-599, at 240-241 (1998), 1998-3

C.B. 747, 994-995.      At trial, counsel for petitioners (who has

since withdrawn as counsel) conceded that petitioners bear the

burden of proof with respect to the deficiencies determined by

respondent.      We accept that concession and so find.6

      Respondent bears the burden of production with respect to

penalties.    See sec. 7491(c).

II.   Deficiencies in Tax

      A.   Introduction

            1.    Petitioners’ Arguments

      Respondent has adjusted petitioners’ income by attributing

to petitioners items of income reported by Complete Connections

Trust and J&R Trust.      Respondent has done so under the various


      6
        Even if petitioners had not (by their counsel) so
conceded, there is evidence to support such a finding. For
instance, petitioners failed to respond to respondent’s
interrogatories (and were sanctioned by the Court for such
failure) and failed to cooperate with respondent in stipulating
facts for trial. Respondent’s motions to compel production of
documents and responses to interrogatories contain a litany of
petitioners’ failures to provide information to respondent during
the audit of their income tax returns or cooperate in preparation
of this case for trial. Petitioners have provided no rebuttal to
such litany.
                               - 15 -

theories set forth in our findings of fact.   In the petition,

petitioners have assigned error to such adjustments but have

averred no facts in support of such assignments other than facts

concerning perceived procedural errors by respondent.   On brief,

petitioners’ principal argument is that respondent has committed

procedural errors.   We distill from the petition and petitioners’

briefs the following components of petitioners’ argument:

(1) They did not receive a valid notice of deficiency, (2) no tax

has been assessed, and (3) they were denied “due process” during

the examination of their returns.

          2.   Response to Petitioners’ Arguments

     Respondent sees no merit in petitioners’ arguments.    We

agree with that observation.

          a.   Validity of Notice

     Petitioners allege defects in the notice, including that

it and its attachments (1) were not signed under penalties

of perjury, (2) do not cite any “taxing statute” or contain

“certified evidence” to support the adjustments, and

(3) constitute hearsay.

     A short answer to most of petitioners’ complaints can be

found in an opinion of the Court of Appeals for the Ninth

Circuit, the Court of Appeals to which any appeal in this case

likely would lie:

     The Internal Revenue Code does not require the notice
     of deficiency to be signed. See 26 U.S.C. §6212
     (“[i]f the Secretary determines that there is a
     deficiency * * * he is authorized to send such
                                - 16 -

     deficiency to the taxpayer by certified mail or
     registered mail”); see also Commissioner v. Oswego
     Falls Corp., 71 F.2d 673, 677 (2d Cir. 1934) (notice of
     deficiency need not be signed). Moreover, in Scar v.
     Commissioner, we held that “no particular form is
     required for a valid notice of deficiency * * * and the
     Commissioner need not explain how the deficiencies were
     determined.” 814 F.2d 1363, 1367 (9th Cir. 1987)
     (citation omitted). * * *

Urban v. Commissioner, 964 F.2d 888, 889-890 (9th Cir. 1992),

affg. T.C. Memo. 1991-220.    In Scar v. Commissioner, 814 F.2d

1363, 1367 (9th Cir. 1987), the Court of Appeals for the Ninth

Circuit considered a notice of deficiency that, on its face,

revealed that no determination of a deficiency had been made with

respect to the taxpayers in question for the year in question.

See id. at 1370.    The Court of Appeals held that such a notice

was invalid and the petition contesting such notice should have

been dismissed in the taxpayers’ favor for lack of jurisdiction.

See id.   Commenting on Scar, we have held:    “Where the notice of

deficiency does not reveal on its face that the Commissioner

failed to make a determination, a presumption arises that there

was a deficiency determination.”     Campbell v. Commissioner, 90

T.C. 110, 113 (1988).    We have examined the notice and, on its

face, it does not reveal that respondent failed to make a

determination:     It is addressed to petitioners, references their

1992 through 1995 tax years, states both that respondent has

determined that petitioners owe additional tax or other amounts

(or both) for such years and the size of those amounts, and sets
                                 - 17 -

forth the adjustments (and explanations of those adjustments)

giving rise to such determinations.       Petitioners have failed to

rebut the resulting presumption that respondent did determine

deficiencies in petitioners’ income taxes for their 1992 through

1995 taxable years.

       Petitioners’ hearsay objection is misplaced.    The notice

does not constitute hearsay, since it was not admitted into

evidence for the truth of the matters asserted therein, see Fed.

R. Evid. 801(c), but merely to evidence that it was issued and,

thus, formed a predicate for our jurisdiction, see Rule 13(a).

            b.    Assessment of Tax

       Petitioners argue that, since respondent has not made an

assessment of tax under section 6203, there is no deficiency and,

therefore, the notice is invalid and this Court lacks

jurisdiction.

       Petitioners fail to understand that, generally, the

determination of a deficiency in tax precedes assessment of the

tax.    In pertinent part, section 6212(a) provides that, if the

Secretary determines that there is a deficiency in income tax,

“he is authorized to send notice of such deficiency to the

taxpayer by certified mail or registered mail”.       In pertinent

part, section 6213(a) then allows the taxpayer 90 days (150 days

if the notice is addressed to a person outside of the United

States) to file a petition in the Tax Court for review of the

deficiency.      Generally, section 6213(a) prohibits any assessment
                               - 18 -

from being made until either the expiration of the 90 (or 150)

days or after the decision of the Tax Court becomes final.    That

procedure provides an opportunity for a taxpayer to have his or

her tax liability reviewed by the Tax Court before an assessment

is made.   Petitioners’ argument is without merit.

           c.   Audit Level Procedures

     Petitioners argue that they were deprived of due process

because respondent allegedly did not follow administrative

procedures during the audit of their returns.

     Proceedings before the Tax Court are de novo; therefore, our

determination of a taxpayer’s liability is based on the merits of

the case and not on the record developed at the administrative

level.    Greenberg’s Express, Inc. v. Commissioner, 62 T.C. 324,

327-328 (1974); Johnston v. Commissioner, T.C. Memo. 2000-315.

There is no statutory requirement that respondent must follow

certain administrative procedures prior to issuing a notice.

Further, this Court has held that a revenue agent’s failure to

follow administrative procedures prior to issuance of a notice of

deficiency does not invalidate the notice.    See, e.g., Guilford

v. Commissioner, T.C. Memo. 1987-535 (lack of appellate

conference or 30-day letter does not affect the validity of

notice).    In any event, petitioners failed to prove any

irregularities in respondent’s examination.

     B.    Discussion
                               - 19 -

           1.   Introduction

     Notwithstanding the lack of merit to petitioners’ arguments,

petitioners have assigned error to respondent’s adjustments.   The

evidence supports those adjustments, and petitioners have offered

nothing in rebuttal.   Based on the facts we have found, we infer

(and find) the following additional facts:   Both before and after

the years in issue, petitioners carried on a proprietorship

variously called “Complete Connection”, “Complete Connections”,

or “Complete Connections Computer Systems” (without distinction,

Complete Connections).   During such preceding and following

years, under the name Complete Connections, petitioners provided

tax preparation, bookkeeping, and accounting services, and

engaged in certain computer related services.   During the years

in issue, petitioners engaged in some or all of those activities

and reported gross receipts from such activities and

miscellaneous related items of income on returns they made for

Complete Connections Trust.    Petitioners exercised control over

Complete Connections Trust, as evidenced by their signatures, as

fiduciaries, on the Complete Connections Trust returns and their

authority to write checks on the Complete Connections checking

account.   Petitioners distributed the income of Complete

Connections Trust to J&R Trust.   J&R Trust reported such income

and also reported gross receipts from business and interest.

Petitioners transferred their residence to J&R Trust, but
                              - 20 -

continued to treat it as if they owned it, as evidenced by their

use of the residence to secure an indebtedness of theirs after

their purported transfer of it to the trust.   Petitioners

exercised control over J&R Trust, as evidenced by their

signatures, as fiduciary, on the J&R Trust returns and their

authority to write checks on the J&R checking account.

Petitioners distributed the income of J&R Trust to themselves and

used the J&R Trust account to pay their personal expenses, as

evidenced by checks drawn, for instance, to Robert C. Miller,

D.D.S., New Covenant Church of God, K Mart, Steven J. Harmon,

M.D., Central Coast Pathology, Payless Shoes, Musician’s

Emporium, Bakery Works, and Bauer Speck Student Council.

          2.   Fundamental Principles

     A fundamental principle of tax law is that income is taxed

to the person who earns it.   See Commissioner v. Culbertson, 337

U.S. 733, 739-740 (1949); Lucas v. Earl, 281 U.S. 111 (1930).

Recently, in Barmes v. Commissioner, T.C. Memo. 2001-155, we

applied assignment of income principles to tax the income of a

business to a taxpayer who had attempted an anticipatory

assignment of that income to a trust.   We had this to say:

     Attempts to subvert * * * [the fundamental principle
     that income is taxed to the person who earns it] by
     diverting income away from its true earner to another
     entity by means of contractual arrangements, however
     cleverly drafted, are not recognized as dispositive for
     Federal income tax purposes, regardless of whether such
     arrangements are otherwise valid under State law. See
                              - 21 -

     Vercio v. Commissioner, 73 T.C. 1246, 1253 (1980); see
     also Schulz v. Commissioner, 686 F.2d 490, 493 (7th
     Cir. 1982), affg. T.C. Memo. 1980-568. The "true
     earner" of income is the person or entity who
     controlled the earning of such income, rather than the
     person or entity who received the income. See Vercio
     v. Commissioner, supra at 1253 (citing Wesenberg v.
     Commissioner, 69 T.C. 1005, 1010 (1978)); see also
     Commissioner v. Sunnen, 333 U.S. at 604 ("The crucial
     question remains whether the assignor retains
     sufficient power and control over the assigned property
     or over receipt of the income to make it reasonable to
     treat him as the recipient of the income for tax
     purposes."). * * *

Pursuant to a second fundamental principle, we may ignore a

transfer in trust as a sham where the transfer has not, in fact,

altered any cognizable economic relationship between the putative

transferor and the trust property.     See, e.g., Zmuda v.

Commissioner, 79 T.C. 714, 719-722 (1982), affd. 731 F.2d 1417

(9th Cir. 1984).   Recently, in Muhich v. Commissioner, T.C. Memo.

1999-192, affd. 238 F.3d 860 (7th Cir. 2001), we listed the

following factors to be considered in determining whether a trust

lacks economic substance for tax purposes:

     (1) Whether the taxpayer’s relationship as grantor to
     the property differed materially before and after the
     trust’s formation; (2) whether the trust had an
     independent trustee; (3) whether an economic interest
     passed to other beneficiaries of the trust; and
     (4) whether the taxpayer felt bound by any restrictions
     imposed by the trust itself or by the law of trusts.
     * * *


          3.   Grantor Trust Provisions
                               - 22 -

     Under specified circumstances, the statutory grantor trust

provisions (secs. 671 through 679) treat the grantor of the trust

and, sometimes, a third party, as the substantial owner of all or

part of the trust.   Trust income is taxed to the substantial

owner under the rules of section 671.   Because the conditions

imposed by each of the grantor trust provisions are independent

of those imposed by the others, the grantor can avoid taxation

only if (1) he does not possess a disqualifying reversionary

interest (sec. 673), (2) the trust cannot be revoked by the

grantor or a nonadverse party (sec. 676), (3) trust income cannot

be distributed to the grantor or the grantor’s spouse or used to

pay for insurance on their lives without the consent of an

adverse party (sec. 677), (4) specified powers to control

beneficial enjoyment of the corpus or income are not vested in

the grantor or certain other persons (sec. 674), and (5) certain

administrative powers are not exercisable by the grantor or a

nonadverse party (sec. 675).

          4.    Analysis

           a.   Income

     With respect to Complete Connections Trust, we have found

that petitioners carried on the same business activities both

before and after the trust reported income from such activities,

and we have found that petitioners exercised control over the

trust.   Such facts are consistent with (1) respondent’s
                                - 23 -

application of the assignment of income doctrine to tax to

petitioners at least the trust’s income derived from their

personal services and (2) his disregard of the trust as a sham,

which would tax all of the trust’s income to petitioners.

Petitioners have failed to introduce into evidence any indenture

or other document establishing the terms of Complete Connections

Trust, nor have they obtained the testimony of Kevin Richards,

who is described on two of the Complete Connections Trust returns

as either fiduciary or trustee.    Petitioners were made aware of

the need for the trust documents during the examination of their

returns for the years in issue, and such documents were requested

during discovery.   They have not demonstrated (nor would we

easily believe) that they lacked access to such documents, nor

have they shown that Mr. Richards 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 T.C. 1158, 1165 (1946), affd. 162

F.2d 513 (10th Cir. 1947).    If petitioners retained sufficient

power and control over Complete Connections’ receipt of income,

then such income would be taxable to them.    See Barmes v.

Commissioner, supra.   Petitioners have failed to prove that they

retained any less power and control over Complete Connections’
                                - 24 -

receipt of income than necessary to tax to them such income.

They also have failed to prove that Complete Connections Trust

should not be disregarded as a sham, since the transfer in trust

lacked economic substance.     See discussion of relevant factors,

section II.B.2. supra, as set forth in Muhich v. Commissioner,

supra.   Finally, petitioners have failed to prove that one or

both of them should not be treated as the owner of all or a

portion of Complete Connections Trust on account of application

of one or more of the grantor trust rules found in sections 673

through 676.

     With respect to J&R Trust, we have less information with

respect to its business or income producing activities (we know

it obtained title to the residence (petitioners’ home) and paid

their personal expenses).     Nevertheless, we are confident that

petitioners must take into account the trust’s income attributed

to them by respondent since, for similar reasons as with respect

to Complete Connections Trust, petitioners have failed to prove

that the trust should not be disregarded as a sham or is not a

grantor trust.

           b.    Deductions

     In the case of both trusts, respondent has attributed to

petitioners substantial amounts of gross receipts from business

without allowing them various offsetting business deductions (and

costs) claimed by the trusts.     In the notice, respondent explains

that petitioners have failed to show their entitlement to such
                                - 25 -

deductions.    In the petition, petitioners aver no facts

concerning such deductions, and, on brief, they have proposed no

fact, and made no argument, with respect to such deductions.      At

best, we know that Rita Snyder prepared tax returns and may have

provided other business services.    James Snyder testified that he

was in the “general computer business”, buying and selling

computers and doing service work and installations.    While we

assume that James Snyder incurred costs in buying computers for

resale, we have no basis other than the self-serving figures on

the Complete Connections tax returns for estimating such costs.

We need not accept those figures.    A taxpayer must keep

sufficient records to substantiate amounts, such as the cost of

goods sold, required to be shown on a return.    See sec. 1.6001-

1(a), Income Tax Regs; e.g., Newman v. Commissioner, T.C. Memo.

2000-345.     We likewise have no basis for estimating any business

expenses deductible under section 162(a), or any other section.

Indeed, we have found that petitioners paid personal expenses

from the J&R checking account.    Without specific authority, no

deduction is allowed for personal, living, or family expenses.

Sec. 262(a).    While it is within the purview of this Court to

estimate the amount of allowable deductions where there is

evidence that deductible expenses were incurred, Cohan v.

Commissioner, 39 F.2d 540 (2d Cir. 1930), we must have some basis

on which an estimate may be made.     Vanicek v. Commissioner,

85 T.C. 731, 742-743 (1985); see also Norgaard v. Commissioner,
                               - 26 -

939 F.2d 874, 879 (9th Cir. 1991).      Because the record contains

no evidence upon which we could base such an estimate, we

conclude that petitioners have failed to prove that they are

entitled to claim any deductions under section 162(a) or any

other section or any costs of goods sold.

       C.   Conclusion

       The income adjustment on account of Complete Connections

Trust for 1992 is $194,205, while gross receipts reported by

Complete Connections Trust for that year are only $183,482 (no

miscellaneous items of income are reported).     There is no

explanation for that difference, and, therefore, we cannot

sustain an income adjustment for 1992 on account of Complete

Connections Trust in an amount greater than $183,482.     For J&R

Trust for all years, and for Complete Connections Trust for 1993

through 1995, we sustain income adjustments in the amounts

determined by respondent, except as follows.     For all years,

income attributed from the trusts to petitioners must be reduced

to reflect income distributions from J&R Trust to petitioners

reported on the 1992 through 1995 Forms 1040 and salary payments

and any other amounts so reported.      The parties shall take such

adjustments into account in making the Rule 155 computation here

required.

III.    Penalties

       A.   Section 6662(a)
                                - 27 -

     Section 6662(a) provides for an accuracy-related penalty

(the accuracy-related penalty) in the amount of 20 percent of the

portion of any underpayment attributable to, among other things,

negligence or intentional disregard of rules or regulations

(without distinction, negligence), any substantial understatement

of income tax, or any substantial valuation misstatement.

Respondent determined the accuracy-related penalty against

petitioners.    Although the notice states that respondent bases

his imposition of the section 6662(a) accuracy-related penalty

upon “one or more” of the three grounds listed in section

6662(b)(1) through (3), on brief, respondent relies only on his

claims that petitioners were negligent or substantially

understated their income tax.

     Respondent bears the burden of production with respect to

all penalties.    See sec. 7491(c).   The burden imposed by section

7491(c) is only to come forward with evidence regarding the

appropriateness of applying a particular addition to tax or

penalty to the taxpayer.    Respondent need not negate all defenses

to the additions or penalties.    See Higbee v. Commissioner, 116

T.C. 438, 446 (2001).    Respondent has met his burden with respect

to his claim of negligence by establishing that petitioners, in

understating their income, were negligent and disregarded rules

or regulations.    Further, the deficiency we have redetermined for

each year indicates a substantial understatement of income.     See

sec. 6662(d).    In the petition, petitioners aver that they acted
                                   - 28 -

upon professional advice in preparing the 1992 through 1995 Forms

1040.     They have, however, failed to provide evidence that they

received advice on which they were entitled to rely.      We assume

that they rely exclusively on our finding that there was no

deficiency in tax.      Since we have found a deficiency in tax for

each year, we sustain respondent’s determination of a penalty

under section 6662(a) on the grounds of either negligence or

substantial understatement of income, modified only to take

account of the amount of each deficiency that we have determined.

     B.     Section 6673(a)(1)

             1.   Introduction

        Respondent asks that we impose a penalty against petitioners

under section 6673(a)(1).        That section provides:

        SEC. 6673.   SANCTIONS AND COSTS AWARDED BY COURTS.

          (a) Tax Court Proceedings.--

            (1) Procedures instituted primarily for delay,
        etc.--Whenever it appears to the Tax Court that--

               (A) proceedings before it have been instituted
             or maintained by the taxpayer primarily for delay,

               (B) the taxpayer’s position in such proceeding
             is frivolous or groundless, or

               (C) the taxpayer unreasonably failed to pursue
             available administrative remedies,

        the Tax Court, in its decision, may require the
        taxpayer to pay to the United States a penalty not in
        excess of $25,000.

        The purpose of section 6673 is to compel taxpayers to think

and to conform their conduct to settled principles before they
                              - 29 -

file returns and litigate.   Coleman v. Commissioner, 791 F.2d 68,

71 (7th Cir. 1986); see also Grasselli v. Commissioner, T.C.

Memo. 1994-581 (quoting Coleman).   A petition to the Tax Court is

frivolous if it is contrary to established law and unsupported by

a reasoned, colorable argument for change in the law.   Id.    The

petition contains numerous frivolous arguments.   Moreover, the

record is replete with evidence of delay, and it is clear that

petitioners unreasonably failed to pursue available

administrative remedies.   We need not find specific damages to

impose a penalty under section 6673(a)(1); rather, that section

is a penalty provision, intended to deter and penalize frivolous

claims and positions in deficiency proceedings.   Bagby v.

Commissioner, 102 T.C. 596, 613-614 (1994).   Petitioners do not

here argue for any change in the law, and, notwithstanding that,

technically, petitioners do not here prevail because of their

failure to prove their case, there are numerous cases that

establish that taxpayers cannot use trusts, as petitioners appear

to have done, to avoid tax or shift income from one taxpayer to

another.   See, e.g., Zmuda v. Commissioner, 79 T.C. 714 (1982),

affd. 731 F.2d 417 (9th Cir. 1984); Vercio v. Commissioner, 73

T.C. 1246 (1980); Wesenberg v. Commissioner, 69 T.C. 1005 (1978);

Barmes v. Commissioner, T.C. Memo. 2001-155; Matrixinfosys Trust

v. Commissioner; T.C. Memo. 2001-133; Muhich v. Commissioner,

T.C. Memo. 1999-192, affd. 238 F.3d 860 (7th Cir. 2001); Alsop v.

Commissioner, T.C. Memo. 1999-172; Harrold v. Commissioner, T.C.
                               - 30 -

Memo. 1991-274, affd. 960 F.2d 1053 (8th Cir. 1992); Vnuk v.

Commissioner, T.C. Memo. 1979-164, affd. 621 F.2d 1318 (8th Cir.

1980).   Following are our grounds for imposing a penalty on

petitioners under section 6673(a)(1).

           2.   The Petition

     Petitioners’ assignments of error include the following:

Respondent’s failures to show (1) “documented authority to impose

a tax liability”, (2) the “legal authority to impose a tax

liability”, and (4) “the authority source for the imposition of a

legal tax obligation upon revenue sources from within the United

States”.   Petitioners’ averments in support of their assignments

of error include the following:

     The Notice of Deficiency is required by Internal
     Revenue Code to be signed by a duly appointed
     assessment officer. There is nothing indicated on
     form 4549-A, which is an attachment to the Notice of
     Deficiency that clearly defines that a duly authorized
     signature is present as required by the Internal
     Revenue Code sec. 6201, nor are any of the forms in
     compliance to 26 USC § 6065.

     Petitioner, on information and belief, alleges that the
     sole purpose of respondent’s Notice of Deficiency is
     for the obvious purpose of ensnaring the petitioner
     into a fraudulently obtained Federal Tax Court
     jurisdiction.

     On the provision that this petitioner is properly
     documented in the Trust’s “Individual Master File”
     (IMF), this Trust’s source of revenue is from within
     the United States and does not conform to any federally
     regulated “taxable objects”.

     Petitioner, on information and belief, disputes the
     “statutory grouping of gross income and the residual
     grouping of gross income” as it may relate to this
     matter pursuant to 26 CFR § 1.861-8(a)(4).
                              - 31 -

Those assignments and averments contain tax-protester rhetoric

that we are all too familiar with, and which courts have rejected

time and time again.   See, e.g., our discussion supra at section

II.A.2.a. (Validity of Notice); Williams v. Commissioner, 114

T.C. 136 (2000) (rejecting “as reminiscent of tax-protester

rhetoric” source of income argument based on section 1.861-8(a),

Income Tax Regs.); Johnston v. Commissioner, T.C. Memo. 2000-315

(rejecting argument that respondent must follow certain

administrative procedures prior to issuing notice of deficiency);

Browder v. Commissioner, T.C. Memo. 1990-408 (rejecting as

frivolous and groundless claim that the IRS lacked delegated

authority to impose an income tax); Rice v. Commissioner, T.C.

Memo. 1978-334 (rejecting argument that notice of deficiency is

an unlawful taking of property without due process).
                                  - 32 -

            3.     Failure To Cooperate

     By order dated April 26, 2000 (the order), we granted in

part respondent’s motions to compel responses to interrogatories

and to compel production of documents (the motions).       We granted

the motions to the extent that we ordered compliance with such

discovery.       We set for hearing those portions of the motions

seeking the imposition of sanctions if petitioners failed to

comply with the order.       We held such hearing on June 5, 2000 (the

hearing), when this case was called from the calendar at the

trial session of the Court commencing that day in San Francisco,

California.       We imposed sanctions because of petitioners’ failure

to comply with the order.       In the motions, respondent detailed

petitioners’ failures to cooperate in the examination of the 1992

through 1995 Forms 1040 by respondent’s agents prior to the

issuance of the notice and their failure to cooperate in

preparing this case for trial.       Specifically, respondent claimed:

“Petitioners James and Rita Snyder did not provide any documents

or other information to the Internal Revenue Service during the

audit of their 1992 through 1995 Forms 1040 Federal Income Tax

Returns.”    Attached to the motions are copies of letters and

documents evidencing respondent’s repeated, unsuccessful efforts

to obtain petitioners’ cooperation in discovery.       At the hearing,

petitioners had the opportunity to rebut such claims that

petitioners had failed to cooperate, but they did not.       We accept

those claims as true.
                                  - 33 -

            4.   Delay

     Petitioners failed to cooperate in discovery, which we can

(and do) consider as evidence of an intent to delay these

proceedings.     See, e.g., Lipari v. Commissioner, T.C. Memo.

2000-280.    In addition, we consider the following actions as

evidence of delay:       Petitioners refused to stipulate the

authenticity of numerous documents to which petitioners could not

have entertained good faith doubts about such authenticity.

Petitioners refused to stipulate the notice, despite the fact

that they attached a copy of the notice to their petition.         They

refused to stipulate their own tax return for 1991 and the tax

returns for Complete Connections Trust and J&R Trust,

notwithstanding that Rita Snyder personally had prepared the

returns and was familiar with them.        They refused to stipulate to

Complete Connections Trust’s and J&R Trust’s bank records,

despite the fact that petitioners personally handled the two

trusts bank transactions and were familiar with them.       As a

result, respondent was forced unnecessarily to produce

foundational witnesses to attest to the authenticity of these

records.

     Petitioners refused to stipulate certain Government records,

such as deeds to their home, and business licenses for Complete

Connections Trust, which petitioners themselves completed and

submitted to the appropriate local agency.       As a result,
                                 - 34 -

respondent was forced to obtain certified copies of these records

and offer them separately to the Court.

     Petitioners filed a motion on June 5, 2000, requesting that

the notice be declared invalid, which motion the Court denied.

On October 2, 2000, petitioners filed another motion requesting

that the notice be declared invalid despite the fact that the

Court had already considered the issue, which motion the Court

again denied.

     Finally, on brief, petitioners have failed to address the

substance of respondent’s objections.

            5.    Conclusion

     Petitioners are deserving of a penalty under section

6673(a)(1).      As we stated supra, sec. III.B.1.:    The purpose of

section 6673 is to compel taxpayers to think and to conform their

conduct to settled principles before they file returns and

litigate.    Petitioners are intelligent people.      They know that,

when taken together, their returns and the trust returns

virtually eliminate their liability to pay tax by offsetting,

against income that they earned, deductions for personal expenses

that they could not have claimed on their own returns.       Rita

Snyder is a professional preparer of tax returns and, we assume,

has sufficient experience to know that such scheme was

illegitimate.     They failed to cooperate in respondent’s

examination and in preparation of this case for trial.       They have

delayed these proceedings.     Because of their stonewalling and
                              - 35 -

failure to cooperate, they have lost the opportunity to claim

costs and deductions that they might have been able to claim and

substantiate.   That, however, is a cost they have imposed on

themselves.

     Without good reason, petitioners have burdened respondent

and this Court with a case that we believe should not have been

brought.   As a penalty for such action, we impose a penalty under

section 6673(a)(1) of $15,000.


                                         An appropriate order and

                                    decision will be entered under

                                    Rule 155.
