                  T.C. Memo. 2011-89



                UNITED STATES TAX COURT



        JOSEPH B. WILLIAMS, III, Petitioner v.
     COMMISSIONER OF INTERNAL REVENUE, Respondent



Docket No. 2202-08.               Filed April 21, 2011.



     In 1993 P established a British Virgin Islands
(BVI) corporation, A, and placed the shares in a BVI
trust of which he was the sole beneficiary. P opened
accounts in the name of A with a bank in Switzerland.
P provided consulting, negotiation, and other services
to companies and governments, and his clients
transferred money into A’s accounts to pay for those
services. P did not report any of this income on any
U.S. Federal income tax return for 1993 through 2000,
except that in 2003 he amended his 1999 and 2000
individual income tax returns to report investment
income earned on the amounts in the Swiss bank
accounts. P did not include the payments for services
in income on any of those original or amended returns.
Also in 2003 P pleaded guilty to one count of tax
evasion for all 8 years from 1993 through 2000 and to
one count of conspiracy to defraud the IRS for those
same years.
                         - 2 -

     In 1996 P signed an agreement purporting to commit
to purchasing works of art. The seller, S, ostensibly
agreed to hold the art for 1 year before donating it on
P’s behalf to charity and promised that the art would
cost P no more than 24 percent of the final appraised
value of the art. S donated works of art on P’s behalf
in 1997, 1999, and 2000; P paid for the art close in
time to the donations (within a year of each donation);
and he claimed charitable contribution deductions for
the full value determined in appraisals that S
arranged.

     By a notice of deficiency issued in 2007, R
determined deficiencies in P’s original returns for all
8 years, determining that P is liable for tax on the
services and investment income deposited into A’s
accounts and allowing P deductions for the
contributions of art only to the extent of P’s basis in
the art. R determined fraud penalties related to the
unreported income deposited in A’s Swiss bank accounts
and also determined accuracy-related penalties on the
disallowed portions of P’s charitable contribution
deductions.

     Held: P is liable for tax on the net amounts
deposited into A’s accounts in each year, and P is
liable for the fraud penalties on the underpayments
resulting from this unreported income.

     Held, further, P is entitled to charitable
contribution deductions only in the amount of his basis
in the art contributed, and he is liable for the
accuracy-related penalties on the underpayments
resulting from the disallowed deductions.



David H. Dickieson, for petitioner.

John C. McDougal, for respondent.
                                   - 3 -

               MEMORANDUM FINDINGS OF FACT AND OPINION


        GUSTAFSON, Judge:    The Internal Revenue Service (IRS) issued

to petitioner Joseph B. Williams III a notice of deficiency

pursuant to section 6212,1 showing the IRS’s determination of the

following deficiencies and penalties for tax years 1993 through

2000:

                                             Penalties
  Year          Deficiency         Sec. 6663         Sec. 6662

  1993           $417,652          $313,038.00             ---
  1994            304,740           226,206.75             ---
  1995            417,354           313,015.50             ---
  1996          1,572,673         1,179,504.75             ---
  1997            809,620           511,143.00         $25,619.20
  1998             52,733            39,549.75             ---
  1999            113,049            33,395.25          13,704.40
  2000            120,391            74,093.25           4,320.00


Mr. Williams brings this case pursuant to section 6213(a), asking

this Court to redetermine those deficiencies and penalties.2

        The issues for decision are:3


        1
      Unless otherwise indicated, all citations of sections refer
to the Internal Revenue Code (Code, 26 U.S.C.) in effect for the
years in issue, and all citations of Rules refer to the Tax Court
Rules of Practice and Procedure.
        2
      Although Mr. Williams and his wife filed joint Federal
income tax returns for 1993 through 2000, the IRS determined that
section 6015(c) applies to Meredith Williams and that she is not
liable for the deficiencies determined for any of those years.
        3
         In earlier opinions in this case, we held that this Court
                                                      (continued...)
                               - 4 -

     1.   Whether Mr. Williams is individually liable for Federal

income tax on the payments made to ALQI Holdings, Ltd. (ALQI),

during each year in issue; or whether he is individually liable

only for tax on the investment income earned during each year (on

funds held and invested by ALQI), pursuant to sections 951(a) and

954(c).   We hold that his liability is not limited to tax on the

investment income paid to ALQI each year; rather, he is liable

for tax on the entire net amount deposited into the ALQI accounts

during each year in issue.

     2.    Whether section 6663 civil fraud penalties apply to the

underpayments resulting from the unreported income from ALQI.    We

hold that the fact of Mr. Williams’s fraud is established by his

criminal conviction, that he is collaterally estopped from

denying that fraud, see supra note 3, and that he did not

establish that any portion of his underpayment attributable to

the unreported ALQI income is not attributable to fraud.




     3
      (...continued)
lacks jurisdiction to redetermine Mr. Williams’s income tax
liability for 2001, his liability for unassessed interest, and
his liability for penalties for failing to file Forms TD F 90-
22.1, Report of Foreign Bank and Financial Accounts (FBARs),
Williams v. Commissioner, 131 T.C. 54 (2008); and we held that
Mr. Williams’s conviction for tax evasion under section 7201 for
1993 through 2000 collaterally estops him for each of those years
from denying that for each of these years there was an
underpayment of his income tax attributable to civil fraud for
purposes of the statute of limitations and the section 6663(a)
fraud penalty, Williams v. Commissioner, T.C. Memo. 2009-81.
                                - 5 -

       3.   Whether Mr. Williams is entitled to charitable

contribution deductions for his contributions of art in the

amounts claimed--i.e., the appraised values of the art--or

whether his deductions are limited by section 170(e) to his basis

in the art donated.    We hold that his deductions are limited to

his basis in the art.

       4.   Whether Mr. Williams is liable for accuracy-related

penalties on the underpayments resulting from his deducting the

appraised value of the donated art rather than his basis in the

art.    We hold that he is liable for the accuracy-related

penalties.

                          FINDINGS OF FACT

       The parties stipulated some of the facts, and we incorporate

the stipulation of facts by this reference.    The record also

includes the stipulated exhibits, the testimony offered at trial,

and the exhibits admitted at trial.     When he filed his petition,

Mr. Williams resided in Virginia.

Oil-related activities and Swiss bank accounts

       Mr. Williams earned his undergraduate degree from the

University of North Carolina and his law degree from New York

University School of Law.    He began working in the corporate

legal department of Mobil Oil Corp. (Mobil) around 1973.     Mr.

Williams worked for Mobil in Saudi Arabia from 1979 to 1985, and

while there he met Jean-Jaques Bovay, a banker representing
                                - 6 -

Banque Indosuez, a bank in Switzerland.4   He continued working

for Mobil until 1998.   In the 1990s Mobil tasked Mr. Williams

with developing strategic business relationships in Russia and

some of the former Soviet republics, including Azerbaijan,

Turkmenistan, and Kazakhstan.   When he retired from Mobil in

1998, Mr. Williams held the position of general manager for

strategic business development and government crude, in which he

bought and sold crude oil internationally on behalf of Mobil, and

he assisted with the negotiation and closing of major business

deals for Mobil.

     At Mr. Williams’s request, in 1993 Mr. Bovay arranged for

the formation of ALQI in the British Virgin Islands.   The Swiss

bank formed ALQI as a British Virgin Islands International

Business Company, authorized to conduct business anywhere except

the British Virgin Islands.

     The record is unclear as to whether Mr. Williams directly

owned the shares of ALQI or whether the shares were held in a

British Virgin Islands trust of which Mr. Williams was the sole

beneficiary.   The Swiss bank used Overseas Management Trust

(B.V.I.), Ltd., to form ALQI, and Overseas Management appointed

Saturn Corporate Services, Inc. (Panama), as the sole director of


     4
      Credit Agricole Group acquired Banque Indosuez in 1996 and
changed its name to Credit Agricole Indosuez. For convenience,
we will refer to the bank Mr. Williams used in Switzerland as the
Swiss bank.
                                - 7 -

ALQI.   Saturn authorized the Swiss bank to establish accounts in

ALQI’s name.   Saturn operated as Mr. Williams’s nominee, and

Mr. Williams was the only operational director and officer of

ALQI; only he had authority to act on behalf of ALQI, and only he

could instruct the Swiss bank with respect to the ALQI accounts.

The documents submitted to the Swiss bank to open the ALQI

accounts identify Mr. Williams as the only beneficial owner of

all assets deposited into ALQI’s accounts.     Whether Mr. Williams

owned ALQI directly or as the sole beneficiary of a trust, we

find that he directly or indirectly owned and controlled all the

shares of ALQI stock.

     The Swiss bank also provided Mr. Williams and ALQI with a

Swiss mobile telephone, credit cards, and the use of office space

at the bank for business meetings.      The credit cards and mobile

telephone were issued and billed in Mr. Williams’s name.

     Mr. Williams did not maintain formal books of account

recording income and expenses related to his international

consulting and services activity.    However, the Swiss bank

maintained records of deposits, transfers, and payments involving

the ALQI accounts.    Mr. Williams instructed the Swiss bank to

draw on those accounts to pay the mobile telephone bills, the

credit card bills, and various other bills, and to transfer funds

at his direction.    The transfers included several $10,000 and

$20,000 transfers from the Swiss bank to a branch of the same
                                - 8 -

bank in London, to be held for pickup by Mr. Williams.    The

payments included payments totaling $41,409.44 to a former Mobil

secretary who had worked for Mr. Williams.    A $15,000 gift to the

to the wife of Mr. Williams’s deceased father was also paid for

from the ALQI accounts.    Some of the credit card charges ALQI

paid reflect Mr. Williams’s vacationing with his children and a

nearly $30,000 shopping spree in Paris, France.    The instructions

Mr. Williams sent to Mr. Bovay consistently refer to the Swiss

bank account(s) as “my account”; when requesting transfers or

payments from these accounts, Mr. Williams did not refer to them

as ALQI’s accounts or as corporate accounts.    We find that

Mr. Williams paid personal, family, and living expenses and made

gifts to family and friends from the ALQI accounts.

     Beginning in 1993 Mr. Williams found business opportunities

separate from his work for Mobil, and he pursued those

opportunities and earned fees for his consulting and negotiation

services.    One particular project he facilitated, on behalf of

the Khazakhstan Government, was the building of a new pipeline

from the Tengiz oil field in Kazakhstan through Russia to the

Black Sea.    Mr. Williams admits that none of his clients had

written agreements with ALQI.    He did not correspond or deal with

his clients using the ALQI name.    He performed services for these

clients in his individual capacity and not on behalf of ALQI.
                               - 9 -

     Alika Smekhova, a Russian actress, singer, and celebrity,

worked as a consultant with Mr. Williams, translating at meetings

and helping arrange introductions and appointments with Russian

government officials.   Beginning in 1996 Mr. Williams paid

Ms. Smekhova a stipend of $5,000 to $10,000 per month from the

ALQI accounts, and he also paid for her shopping in Paris.

Mr. Williams did not pay himself a salary or commissions from

ALQI, and he retained most of the amounts deposited into the ALQI

accounts in the Swiss bank accounts; but, as noted, he made gifts

and paid some personal expenses from the ALQI accounts.

     ALQI had no written employment or other contracts with

Mr. Williams or Ms. Smekhova, and neither of them was an employee

of ALQI.   ALQI did not have any staff and had no ability to

perform oil- and pipeline-related consulting services without

Mr. Williams’s providing those services directly; and although

Ms. Smekhova rendered services to Mr. Williams, she did not

render services to Mr. Williams’s clients on his or ALQI’s

behalf.

     All amounts deposited into the ALQI accounts during 1993

through 2000 were received for services that Mr. Williams

rendered to third parties, generally in connection with the

negotiation of oil- and pipeline-related contracts.   Ms. Smekhova

facilitated Mr. Williams’s provision of services by translating

and making introductions.   The ALQI accounts received
                               - 10 -

approximately $8 million in deposits between 1993 and 2000.

Between 1993 and 2000, deposits (payments for services) and

earnings (interest, dividends, and capital gains) in the ALQI

accounts included the following:5

         Year       Deposits            Earnings        Total

         1993      $993,837           $35,754      $1,029,591
         1994       693,699            58,781         752,480
         1995       887,964           110,759         998,723
         1996     3,752,879           164,884       3,917,763
         1997     1,344,637           326,254       1,670,891
         1998        41,248            92,124         133,372
         1999         ---             109,168         109,168
         2000         ---             256,235         256,235
          Total   7,714,264         1,153,959       8,868,223

Reporting ALQI’s income on Mr. Williams’s tax returns

     On his Federal income tax returns for 1993 through 2000,

Mr. Williams did not report any of the services income deposited

into the ALQI accounts, nor did he report any of the interest,

dividends, or capital gain income earned on those deposits.     He

did not inform his return preparer of the accounts in the Swiss

bank or of his interest in ALQI, nor did he discuss with his




     5
      The parties stipulated that the deposits and earnings
listed are “net of all expenses”. Mr. Williams does not allege
deductible business expenses beyond any to which the parties
stipulated. We accept the parties’ stipulation (correcting
errors of arithmetic) and refer to the net income or amounts
deposited without analyzing any deductions to which the parties
have agreed.
                               - 11 -

return preparer whether he was required to report income from

ALQI for the years in issue.

     On November 14, 2000, at the request of the United States

Government, the Government of Switzerland froze the ALQI

accounts.   Mr. Williams disclosed his ownership interest in ALQI

and the existence of the Swiss bank accounts on his Federal

income tax return for 2001, which he filed in 2002--after the

Swiss authorities froze the accounts.6

     In 2003 Mr. Williams filed amended Federal income tax

returns for 1999 and 2000.   Mr. Williams also had prepared and

entered into evidence amended returns for 1993 through 1998.

Mr. Williams’s counsel provided unsigned copies of these returns

to the IRS agents during the examination.   These unsigned amended

returns were not filed with the IRS.

     On these unfiled amended returns, Mr. Williams reported

additional income (representing ALQI’s capital gains, dividends,

and interest), and he reported net increases in income as

follows:




     6
      The record does not reflect what ALQI income Mr. Williams
reported on his 2001 return (services income, investment income,
both, or neither). The 2001 tax year is not before us in this
case. See supra note 3.
                               - 12 -

                               Short-    Long-
                                 term     term
                              capital   capital     Total  Increased
 Year    Interest Dividends     gains    gains    earnings   income

  1993    $8,722     $135         -0-   $26,608   $35,465     $35,466
  1994    30,590    9,379      22,718     1,952    64,639      64,639
  1995   101,783    2,093       2,184     3,777   109,837     109,837
  1996   135,492        8      19,961     3,659   159,120     159,120
  1997   207,981      -0-     102,004       -0-   309,985     309,985
  1998    19,933       42       5,920       -0-    25,895      25,895
  1999    53,199      101      39,879    67,495   160,674     160,674
                                                            1
  2000   190,249       80         995   708,626   899,950     751,848
     1
      The record does not explain why the increased income
reported on the amended return for 2000 was less than the
earnings reported on the amended return. On this and subsequent
tables, we do not correct discrepancies that apparently result
from rounding.

     Mr. Williams’s amended returns included Form 5471,

Information Return of U.S. Persons With Respect To Certain

Foreign Corporations, and on Schedule C, Income Statement, of

those forms he reported income, earnings, and deductions as

follows, which he attributed to ALQI:
                              - 13 -

                 Gross     Passive
              receipts or   income
       Year      sales    (earnings) Deductions   Net income

       1993   $1,467,092   $35,754      $12,123   $1,490,723
       1994      725,000    58,781       20,097      763,684
       1995      940,000   110,759        8,753    1,042,007
       1996    3,681,000   164,884      134,442    3,711,442
       1997    1,473,000   326,254       89,718    1,709,536
       1998       25,000    92,124       83,386       33,738
       1999          -0-   255,023       94,349      160,674
       2000          -0-   899,951          -0-      899,951

The net change to his own income that Mr. Williams reported on

these amended returns did not include any of the gross receipts

he listed for ALQI on Forms 5471, and the 2000 Form 5471 does not

shed any light upon the discrepancy noted above with respect to

increased income reported for 2000.    On the amended returns

Mr. Williams included in income only the passive income earned on

the deposits and investments in ALQI’s accounts at the Swiss

bank; none of these amended returns includes in Mr. Williams’s

income any of the services income transferred or deposited into

the ALQI accounts.

     As noted, Mr. Williams prepared but did not file amended

returns for 1993 through 1998, even though each showed additional

income and additional taxes owed.    However, his amended returns

for 1999 and 2000, which he did file, reported additional tax due
                               - 14 -

of $40,462 and $203,148, respectively, and Mr. Williams paid

those additional amounts.7

Criminal prosecution

     On April 14, 2003, the Department of Justice filed a two-

count superseding criminal information charging Mr. Williams with

one count of conspiracy to defraud the United States and the IRS

and one count of tax evasion for the period from 1993 through

2000.    On June 12, 2003, Mr. Williams pleaded guilty to

conspiring to defraud the United States and the IRS and to

evading taxes for each year from 1993 through 2000.

     In connection with entering his guilty plea, Mr. Williams

allocuted as follows:

          In 1993, with the assistance of a banker at Bank
     Indosuez, I opened two bank accounts in the name of a
     corporation ALQI Holdings, Ltd. ALQI was created at
     that time as a British Virgin Islands Corporation. The
     purpose of that account was to hold funds and income I
     received from foreign sources during the years 1993 to
     2000. [Emphasis added.]

          Between 1993 and 2000, more than seven million
     dollars was deposited in the ALQI accounts and more
     than $800,000 in income was earned on those deposits.

          I knew that most of the funds deposited into the
     ALQI accounts and all the interest income were taxable
     income to me. However, [on] the calendar year tax
     returns for ‘93 through 2000, I chose not to report the
     income to my--to the Internal Revenue Service in order
     to evade the substantial taxes owed thereon, until I
     filed my 2001 tax return. [Emphasis added.]


     7
      The IRS disputes that the amended returns for 1999 and 2000
correctly reported the appropriate method of taxing ALQI’s
income.
                             - 15 -

          I also knew that I had the obligation to report to
     the IRS and/or the Department of the Treasury the
     existence of the Swiss accounts, but for the calendar
     year tax returns 1993 through 2000, I chose not to in
     order to assist in hiding my true income from the IRS
     and evade taxes thereon, until I filed my 2001 tax
     return.

          Some of the payments I received in the ALQI
     accounts, including a two million payment I received in
     1996, were paid to me by people, organizations or
     governments with whom I did business on Mobil’s behalf
     while I [was] an employee of Mobil Oil. I did not
     disclose these business relationships to Mobil Oil,
     although I understood I had an obligation to do so.

          I suspect people, organizations, governments
     paying the money to me were not notifying Mobil Oil of
     the payments. None of the people, organizations or
     governments who made payments into my ALQI accounts
     provided any tax reporting documents to me or to the
     IRS.

          Similarly Bank Indosuez provided me with no tax
     reporting documents for the interest and other income
     earned within the ALQI accounts.

          Over the course of several years I came to expect
     that the people with whom I dealt with regularly
     regarding the payments into the ALQI accounts would not
     provide tax reporting information to the United States
     government regarding these transactions, thus allowing
     me to evade taxes on the payments received.

           I knew what I was doing was wrong and unlawful.
     I, therefore, believe that I am guilty of evading the
     payment of taxes for the tax years 1993 through 2000.
     I also believe that I acted in concert with others to
     create a mechanism, the ALQI accounts, which I intended
     to allow me to escape detection by the IRS. Therefore,
     I am--I believe that I’m guilty of conspiring with the
     people would [sic] whom I dealt regarding the ALQI
     accounts to defraud the United States of taxes which I
     owed.

     The judge of the U.S. District Court for the Southern

District of New York accepted Mr. Williams’s allocution and plea
                             - 16 -

and sentenced him to 46 months’ incarceration.    Mr. Williams and

the Government stipulated that the readily provable tax loss the

United States suffered as a result of Mr. Williams’s tax evasion

was at least $3.512 million, and they expected the District Court

to order restitution in that amount.   The District Court ordered

Mr. Williams to pay the entire balance in the ALQI accounts to

the Clerk of the Court, with $3.512 million of that amount paid

to the IRS as restitution and the balance held by the clerk

pending resolution of the amounts Mr. Williams owes the IRS for

1993 through 2000.

     The Swiss bank transferred a total of $7,943,051.33 to the

District Court in November 2003, and the clerk credited $3.512

million to the IRS on January 7, 2004.   The IRS has held that

amount pending the resolution of this case.   The clerk has held

the balance of the funds pending the final determination of

Mr. Williams’s liability for the years in issue, including

interest and penalties.

     The Department of Corrections released Mr. Williams on May

21, 2006.

Charitable contributions

     Sometime in the summer of 1996, Mr. Williams began speaking

with personnel of Abbey Art Consultants, Inc. (Abbey), a

corporation in New York City, about buying art at a discount and

donating it at full fair market value to charitable institutions.
                                - 17 -

     On December 10, 1996, Mr. Williams signed an agreement with

Abbey8 which refers to Mr. Williams as “Client” and provides, in

relevant part:

     1. Client desires to purchase from Abbey the monetary
     quantity of Art specified in Paragraph 2 below. The
     specific items purchased by the Client will be
     described in written appraisals prepared by a qualified
     appraiser selected by Abbey. The appraisal(s) will be
     submitted to the Client when the Client receives
     physical possession of the Art or when the Art is
     donated to a charitable institution.

     2. The total purchase price or consideration for the
     Art shall be $72,000.00 provided, however, that the
     total purchase price shall not exceed twenty-four (24%)
     percent of the cumulative appraised fair market value
     of the Art purchased herein, as determined by the
     qualified appraiser selected by Abbey.

     3. The purchase price shall be paid to Abbey in the
     following manner:

             a) ten (5%) [sic] percent of the total purchase
             price $3,600.00 shall be paid by check at the
             signing of this agreement. * * * Said monies
             shall be held in an escrow account pending
             satisfaction of the provisions contained in this
             Agreement.

             b) the balance of the price shall be paid by good
             check on or before the time when client receives
             physical possession of the Art or when the Art is
             delivered to and accepted [by the] charitable
             institution where the art is being donated. In
             the event that Abbey is unable to facilitate the
             donation of the Art, client may request physical
             possession of the Art or, monies previously paid,
             in which case Abbey shall immediately comply with
             such request.

         *        *       *       *       *        *       *


     8
      Mrs. Williams also signed the agreement.    However, she is
not a party to this case. See supra note 2.
                             - 18 -


     5. Within thirty (30) days after the Client has paid
     to Abbey the deposit payment of the purchase price, the
     Client shall notify Abbey of the Client’s wishes with
     regard to the dispensation [sic] of the Art. Client
     may elect one of the following:

          a) to take physical possession of the Art, in
          which case Abbey will package and ship the Art to
          the Client at Abbey’s expense, provided that full
          payment has been received, or

          b) to retain Abbey as its agent to facilitate the
          donation of the Art to a charitable
          institution(s), in which case Abbey at its sole
          cost and expense will arrange the donation and
          handle all the requisite paperwork needed to
          consummate the desired donation, including the
          packaging and shipping of the Art to the
          charitable institution(s) after the required
          holding period of one (1) year.

     6. In the event Client fails to make any payment
     required herein for the purchase of the Art at any time
     prior to the time Client executes a Bill of Sale
     transferring ownership of the Art to a charitable
     institution, Abbey’s sole remedy shall be to retain as
     liquidated damages all previous payments Client has
     made toward the purchase of the Art and, in addition,
     to reclaim ownership of the Art. * * *[9]

     7. In the event Client elects to donate the Art to a
     charitable institution(s), upon such election Client
     may list three charitable institutions Client wishes to
     be the possible donees. Abbey will endeavor to
     facilitate the donation to one of the specified
     institutions; provided, however, that if Abbey in its
     sole opinion determines that a donation to the


     9
      Paragraph 6 of the agreement included the following
sentence, which was crossed out by hand and initialed:

     All payments owing by Client after Client’s execution
     of the Bill of Sale shall be subject to Abbey’s right
     to require specific performance of Client with respect
     to Clients [sic] obligation to pay Abbey the full
     balance of the purchase price.
                               - 19 -

     requested institution(s) is not practical, Abbey may
     without prior notice to Client, facilitate the donation
     of the Art to qualifying charitable institution(s)
     chosen by Abbey.

     8. If at any time after the donation of the Art to
     qualifying charitable institution(s) any governmental
     body or panel makes a final determination that the
     cumulative fair market value of the Art herein
     purchased is less than the value which is reflected in
     the Appraisal(s), and, as a result of such
     determination, the tax benefit to the Client resulting
     from such donation is reduced, Abbey, within thirty
     (30) days of the submission to Abbey by the Client of
     written documentation evidencing the adjudicated
     reduction of the original fair market value of the Art,
     shall pay to the Client in cash or by check an amount
     of monies equal to the percentage of the dollars paid
     for each dollar the fair market value of the Art has
     been reduced; provided however, that before doing so
     Abbey reserves the right to lawfully challenge any such
     reduction.

     9. This agreement shall be interpreted under the laws
     of the State of New York.

        *       *       *        *      *       *       *

     12. This Agreement contains the entire agreement
     between the respective parties hereto and there are no
     other provisions, obligations, representations, oral or
     otherwise, of any nature whatsoever.

Thus, under this agreement--

•    Mr. Williams expressed interest in paying $72,000 for art,

     but he committed only to pay $3,600--the deposit paid with

     the agreement.

•    Abbey promised to provide a qualified appraiser and to

     provide art with a purchase price of no more than 24 percent

     of the appraised fair market value.
                             - 20 -

•    Mr. Williams was not selecting specific pieces; rather,

     Abbey agreed that when Mr. Williams took possession of art

     or when it was donated to charity, Abbey would identify and

     describe that art in an appraisal.

•    Abbey agreed to bear all the expense--including paperwork,

     appraisal, packing and shipping costs--of donating the art

     to charity, and to refund all of Mr. Williams’s payments if

     it was unable to facilitate the donation.

•    Abbey agreed that its sole remedy for Mr. Williams’s

     non-payment would be to retain any payments already received

     and to retake possession of the art.   (I.e., Abbey could not

     force Mr. Williams to perform, and the only risk

     Mr. Williams bore for non-performance was the loss of his

     deposit.)

•    Although Mr. Williams could propose donees, Abbey retained

     discretion to select the donee.

•    Abbey agreed to share the risk of inflated appraised values

     by promising a pro-rata refund of the discounted purchase

     price.

1997 Contribution

     In November and December of 1997 (i.e., almost a year after

the date of the agreement between Abbey and Mr. Williams), Abbey

arranged for appraisals of three different sets of art, and
                              - 21 -

Mr. Williams introduced at trial the following appraisals,

reciting the following fair market values:

   Appraisal date            Appraiser            Value of art

 November 17, 1997     Shari Cavin                   $34,800
 November 23, 1997     Lawrence Roseman               18,150
 December 1997         Kenneth Jay Linsner           372,675
   Total                                             425,625

     On December 23, 1997, Mr. Williams signed a deed of gift to

Drexel University, and a representative of Drexel University

signed the deed to accept the gift on December 29, 1997.       The

deed provides a very brief description of the art described in

the November and December 1997 appraisals, and it recites a total

appraised value of $425,625--i.e., an amount greater than the

$300,000 contemplated in the agreement.10    The record includes no

evidence as to when Abbey first acquired the art appraised in

late 1997.

     The record includes a letter from Abbey to Mr. Williams,

dated December 29, 1997, reporting that Abbey had delivered his

donation to Drexel.   The letter included an undated invoice that

recites a purchase date of December 10, 1996 (i.e., the date of

the agreement), a description of “art objects as attached”,

appraised value of $425,000, and purchase price of $102,000.         The


     10
      The agreement recited a total purchase price of $72,000
and stated that the purchase price shall not exceed 24 percent of
the cumulative appraised fair market value of the art.
($72,000/24 percent) = $300,000.
                               - 22 -

invoice lists a $3,600 deposit, and indicates a balance due of

$98,400 (an amount obviously greater than the $72,000 required in

the agreement, but consistent with the invoice purchase price of

$102,000 and also consistent with the discount promised in the

agreement; $102,000 is 24 percent of the $425,000 appraised

value).    The December 29, 2007, letter asks Mr. Williams to remit

$98,400 in the enclosed envelope and instructs him to date and

tender his check in 1997, “the year of the donation”.    Finally,

the letter promises that early in 1998 Abbey would send

Mr. Williams the original appraisals and the required IRS forms

signed by the appraisers and Drexel.    Mr. Williams paid Abbey

$98,400 before the end of 1997.   (It would appear that at this

point the agreement had been more than fulfilled, but

Mr. Williams and Abbey behaved otherwise in 1999 and 2000, as we

show below.)

     On his 1997 Federal income tax return, Mr. Williams claimed

deductions for the following charitable contributions:

                        Item                   Amount

        Gifts by cash or check               $2,000
        Gifts other than by cash or check   425,625
          Total                             427,625
     Mr. Williams’s return preparer informed him that so long as

he had a 1-year holding period and appropriate appraisals of the

art, his charitable contribution deduction should not pose a

problem.
                              - 23 -

1999 contribution

     Mr. Williams wrote Abbey on December 17, 1999, stating:

          I have just returned from a trip to London and
     would like your assistance once again to complete
     another gift of art. As I am sure you remember, in
     December 1996, I purchased from Abbey Art approximately
     $800,000 plus[11] of appraised value art and antiquities
     originating from South America, South East Asia, Haiti
     and North Africa. As you also know, I gifted in
     [1997][12] $425,000 in appraised value of art and
     antiquities to Drexel University in Philadelphia, Pa.
     with your assistance. The remaining art has in the
     meantime been stored with you in your wharehouse [sic].
     I would now like to gift approximately $250,000.00 of
     the remaining art to Florida International University
     in Miami for the Tax Year 1999 and ask your assistance
     in completing this gift ASAP. I also ask you to
     continue to wharehouse [sic] the remaining art that I
     previously purchased.

          I hereby enclose a check in the amount of $57,500
     made out to Abbey Art which I understand should cover
     the expenses of the shipping, packing, warehousing,
     updated appraisals and any other expenses related to
     the gift of this art to FIU. I would appreciate an
     itemized list of these expenses once you have completed
     the delivery of the gift.

Mr. Williams signed the letter and included a check for $57,500.

     In December 1999 Abbey arranged for appraisals of two

different sets of art, and Mr. Williams introduced at trial the

following appraisals, reciting the following fair market values:




     11
      The record does not show any basis for this “$800,000
plus” figure. The agreement between Abbey and Mr. Williams
provided for art with a total value of $300,000.
     12
      On the photocopy of the December 17, 1999, letter
introduced into evidence, the last digit of the year Mr. Williams
references is illegible, but we infer that he refers to 1997.
                              - 24 -

        Appraisal date       Appraiser        Value of art

      December 3, 1999    Shari Cavin           $15,100
      December 12, 1999   Jane Werner-Aye       235,425
        Total                                   250,525

The record does not explain why the December 1999 appraisals both

predate Mr. Williams’s December 17, 1999, letter instructing

Abbey to facilitate a donation for 1999.    The record includes no

evidence as to when Abbey first acquired the art appraised in

late 1999.

     On December 21, 1999, Mr. Williams signed a deed of gift

reciting his donation of art appraised at $250,525 to the art

museum at Florida International University, and a representative

of the museum at the university signed the deed to certify

receipt and acceptance of the donation on December 23, 1999.

     Mr. Williams claimed a charitable contribution deduction for

the following contributions for 1999:

                     Item                     Amount

       Gifts by cash or check                 $3,874
       Gifts other than by cash or check     250,825
         Total                               254,699

The non-cash charitable contribution for 2000 includes $300 for

clothing that Mr. Williams reported donating to charity.
                               - 25 -

2000 contribution

     With two separate checks, Mr. Williams paid Abbey $4,600 and

$17,158 toward a 2000 contribution of art.    Other than the

already fulfilled December 1996 agreement, the record does not

include any agreement pursuant to which Mr. Williams might have

made these payments, and he does not allege that there was

another written agreement.

     In November 2000 Abbey arranged the appraisal of another set

of art, and at trial Mr. Williams introduced the following

appraisal, reciting the following fair market value:

           Appraisal date      Appraiser      Value of art

          November 16, 2000 Jane Werner-Aye     $98,900

     Mr. Williams introduced a deed of gift reciting his gift of

$98,900 of art to Drexel University in December 2000.     His

signature is dated December 15, 2000, and a representative of the

university appears to have signed the document on December 24,

2000.   The record includes no evidence as to when Abbey first

acquired the art appraised in late 1999.

     Mr. Williams claimed a deduction for the following

charitable contributions for 2000:

                        Item                    Amount

        Gifts by cash or check                  $1,135
        Gifts other than by cash or check      102,825
          Total                                103,960
                             - 26 -

The non-cash charitable contributions for 2000 include $500 for

clothing and $3,425 for a BMW automobile Mr. Williams reported

donating to charity.

     On December 9, 2000, Abbey sent Mr. Williams a letter that

stated:

          I am writing to remind you that we still have art
     and antiquities held in a segregated manner in our
     warehouse located in New York City from 1997. We thank
     you for your recent $1,000 check for storage etc.
     Sometime in the first half of 2001 we will send you an
     itemized bill and a description of your objects which
     remain. Based upon our last inventory we believe that
     you still have over $200,000 worth of appraised items.

          In the event you wish to gift objects in 2001, we
     would be pleased to work with you in this regard.


     We find that Mr. Williams paid the following amounts and

that his costs represent the following percentages of the

appraised values of the art he donated:

                                                      Percent of
                                                       appraised
Payment date   1997 gift    1999 gift     2000 gift      value

12/10/1996       $3,600
12/26/1997       98,400
  Total         102,000                                     23.96

12/21/1999                   $57,500                        22.95

03/17/2000                                  $4,600
Illegible                                   17,158
  Total                                     21,758          22.00
                             - 27 -

Notice of deficiency

     During Mr. Williams’s incarceration, the IRS examined his

returns for the years in issue.   The IRS issued the notice of

deficiency for 1993 through 2000 on October 29, 2007.   The issues

now before us for decision were addressed as follows in the

notice of deficiency:

Unreported foreign income

     The IRS determined that the amounts deposited into the ALQI

accounts (not only the earnings on deposits and investments held

at the Swiss bank but also the consulting fees paid for services

rendered, net of allowable expenses) were includable taxable

income to Mr. Williams during the year of deposit, that he failed

to report that income on his returns, and that pursuant to

section 6663, the civil fraud penalty applies to all of that

omitted income.13




     13
      The notice of deficiency appears to determine deficiencies
relative to the original returns Mr. Williams filed for 1999 and
2000, not the amended returns he filed in 2003 for 1999 and 2000.
We presume that the IRS is holding the payments made with
Mr. Williams’s amended 1999 and 2000 returns as advance payments
against his liabilities--along with the $3,512,000 restitution
payment.

      Moreover, certain adjustments in the notice of deficiency
result from mechanical application of limitations based on
Mr. Williams’s adjusted gross income for each year. These
include a reduction in allowed exemptions for 1993 and
limitations in itemized deductions. These adjustments are
computational and do not require further analysis.
                                - 28 -

Disallowed charitable contribution deductions

        In the notice of deficiency, the IRS stated:

        The amount shown on your return as a deduction for
        charitable contributions is not allowable in full
        because it has not been established that the total
        amount was paid during the tax year or that the
        unallowable items met the requirements of Section 170
        of the Internal Revenue Code. As a result, your
        contributions deduction is decreased in tax year 1997,
        1999, and 2000.

The IRS disallowed the amounts shown below and determined

accuracy-related penalties under section 6662 on the

underpayments resulting from the disallowed charitable

contribution deductions:14

                                                           Accuracy-
                                                            related
    Year           Claimed      Allowed     Disallowed      penalty

    1997          $427,625     $104,150      $323,475     $25,619.20
    1999           254,699       61,796       192,903      13,704.40
    2000           103,960       26,818        77,142       4,320.00

Trial

        At trial in Washington, D.C., on September 28, 2009,

Mr. Williams testified, and he called as a witness Mr. Donald

Williamson, the C.P.A. whom Mr. Williams’s lawyers retained in

2002 to assist in the preparation of tax returns reporting Mr.

Williams’s ownership interest and income from ALQI.      Mr. Williams


        14
      The amounts the IRS allowed include not only the amounts
Mr. Williams paid for the art he donated through Abbey but also
the amounts he claimed for other non-cash charitable
contributions.
                                - 29 -

did not call any representative from Abbey or anyone affiliated

with ALQI or involved with his consulting activities, nor did he

call the return preparer who prepared his original Federal income

tax returns for 1993 through 2000.

                                OPINION

     The Commissioner’s deficiency determinations are generally

presumed correct, and Mr. Williams, as the petitioner in this

case, has the burden of establishing that the deficiencies

determined in the notice of deficiency are erroneous.    See Rule

142(a).     Similarly, Mr. Williams bears the burden of proving he

is entitled to any disallowed deductions that would reduce his

deficiency.    See INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84

(1992).15

     Conversely, the Commissioner has the burden of proof with

respect to the issue of fraud with intent to evade tax, and that

burden of proof must be carried by clear and convincing evidence.

Sec. 7454(a); Rule 142(b).    Section 6663(b) provides that a

determination that any portion of an underpayment is attributable

to fraud results in the entire underpayment’s being treated as



     15
      Under certain circumstances the burden of proof can shift
to the Commissioner with respect to factual disputes, pursuant to
section 7491(a). However, Mr. Williams does not contend that the
burden has shifted, and the record does not suggest any basis for
such a shift. For example, Mr. Williams has not demonstrated
compliance with the requirements of section 7491(a)(2)--
specifically, substantiating items and maintaining required
records.
                              - 30 -

attributable to fraud, except any portion the taxpayer proves is

not so attributable.

I.   Consulting fee income

     A.   The parties’ contentions

     Mr. Williams contends that his amended returns properly

report his income from the Swiss bank accounts he opened in 1993

and maintained throughout the years in issue.   He maintains that

he is liable for tax only on the investment earnings realized

during those years on the amounts deposited and invested in the

ALQI accounts; and he maintains that because he is liable for tax

only on that omitted passive income, he is therefore liable for

the civil fraud penalty only as to the deficiencies resulting

from the omission of that passive income.   Mr. Williams concedes

that sections 951(a) and 954(c) require that he include in income

each year the earnings on deposits and investments in the Swiss

bank accounts.

     The IRS agrees, of course, that the passive income earned on

the ALQI accounts is taxable to Mr. Williams in each year earned.

However, the IRS also contends that the consulting fee income--

i.e., the corpus of the ALQI accounts--is taxable to

Mr. Williams--because it was his income and not ALQI’s, or, in

the alternative, because of ALQI’s status as a controlled foreign

corporation.   The IRS contends that even if the consulting income

is properly attributable to ALQI, it is taxable to Mr. Williams
                              - 31 -

pursuant to sections 951(a) and 954(c) because Mr. Williams was a

related person to ALQI; that to the extent ALQI performed any

services, ALQI performed those services “for or on behalf of”

Mr. Williams as that concept is defined in 26 C.F.R. section

1.954-4(b)(1)(iv), Income Tax Regs.; and that but for

Mr. Williams’s substantial assistance, ALQI could not have

performed any of those services.

     Mr. Williams counters that he is not liable for tax on the

consulting fees paid into the ALQI accounts until those amounts

were distributed to him (which did not occur during the years in

issue) because (1) ALQI is a legitimate corporation and ALQI

provided the services, (2) the income from those services is not

foreign base company services income under section 954(e), and

(3) section 1.954-4(b)(1)(iv), Income Tax Regs., is invalid.

     The IRS defends section 1.954-4(b)(1)(iv) as a valid

interpretive regulation.   As a result, the IRS contends that all

the services income paid to ALQI during the years in issue is

foreign base company services income and that income, net of

allowable expenses, see supra note 5, is taxable to Mr. Williams

in the year it was deposited into the ALQI accounts.

     The IRS further contends that because Mr. Williams evaded

tax both on the investment income earned on the ALQI deposits and

on the services income deposited into the ALQI accounts during

the years in issue, he is liable for civil fraud penalties on the
                               - 32 -

entire underpayment resulting from the investment income and the

services income he omitted in 1993 through 2000.     As discussed,

supra note 3, Mr. Williams’s conviction estops him from denying

his liability for civil fraud.   This entire underpayment is

deemed attributable to fraud and subject to the 75-percent

penalty unless he proves some part of the underpayment is not

attributable to fraud.   See sec. 6663(a) and (b).

     B.   Discussion

     We have found that the consulting fees deposited into ALQI’s

accounts were in fact the income of Mr. Williams, funneled

through ALQI’s bank accounts only in order to (unsuccessfully)

evade tax.   During his allocution for his guilty plea,

Mr. Williams admitted that the purpose of opening the ALQI

accounts “was to hold funds and income I received” and that “most

of the funds deposited into the ALQI accounts and all the

interest income were taxable to me”,16 and it is little wonder

that he made this admission.   (Emphasis added.)   He had no


     16
      Respondent contends that Mr. Williams’s guilty plea
collaterally estops him from denying that the consulting income
is taxable to him. However, we have held that, even after the
application of collateral estoppel, “the amounts of the
deficiencies of tax and penalties for 1993 through 2000, and the
issue of accuracy-related penalties, remain for trial”, Williams
v. Commissioner, T.C. Memo. 2009-81, slip op. at 21 (emphasis in
original), since that would require addressing subordinate issues
as to which collateral estoppel does not clearly apply. We
therefore treat Mr. Williams’s allocution testimony not as
something that estops his contentions but as evidence. It is,
however, weighty evidence that he was not able to plausibly
contradict at trial.
                              - 33 -

employment contract with ALQI and reported no wages from ALQI;

and the consulting clients did not have agreements with ALQI and

did not even have any awareness of ALQI.   Apart from his own

general testimony, he presented no evidence that any client even

knew that ALQI existed.   The clients were Mr. Williams’s clients,

and their payments were for him.

     It is apparently true that Mr. Williams and his banker

directed his earnings to an ALQI account, but that fact does not

excuse him from liability for tax on his earnings.   His use of

ALQI was, at most, an impermissible assignment of income.    See

Lucas v. Earl, 281 U.S. 111 (1930); Vercio v. Commissioner, 73

T.C. 1246, 1253 (1980) (“income must be taxed to the one that

earns it”).

     Mr. Williams resists this conclusion by arguing that the IRS

has not established that ALQI was a sham, and by pointing out

that the tax law respects the existence of corporations.    See

Moline Props., Inc. v. Commissioner, 319 U.S. 436 (1943).     A

corporation is by definition a fictitious legal person, but

Mr. Williams is right that we honor this legal fiction.    Thus,

when a corporation enters into a contract and becomes entitled to

compensation under the contract, we understand that it is the

corporation (and not its owners or principals) that is the party

to the contract and that is entitled to receive (and is obliged

to pay tax on) the income generated by that contract.
                              - 34 -

     However, Mr. Williams misses the mark when he resists a

“sham” contention that the IRS did not make and did not need to

make.   We assume that ALQI is a real corporation and would be the

taxpayer responsible for any income that it earns.   That

assumption is unhelpful here to Mr. Williams, because ALQI simply

did not earn the income at issue.   The difficulty that

Mr. Williams’s position meets is not that ALQI is treated as a

sham but that ALQI was not a party to the consulting agreements

that produced the income.   We would respect ALQI as a fictitious

legal person, but we do not assume the existence of factually

fictitious agreements between ALQI and Mr. Williams’s clients.

This is not an instance in which we sham a corporation, or invoke

substance over form, in order to deem an individual taxpayer to

be the actual recipient of money nominally earned by a

corporation; rather, in this instance ALQI can be assumed to have

its own valid, legal existence, but we are missing both the

substance and the form of consulting agreements that involve

ALQI.   Mr. Williams earned consulting fees from his clients, and

ALQI’s only role was to be a conduit for Mr. Williams’s earnings

(to evade tax).

     Mr. Williams’s contention that Ms. Smekhova and his Swiss

bankers also provided valuable services is misplaced.     We assume

that they provided assistance to Mr. Williams’s consulting

activity, but there is no evidence that they provided any
                              - 35 -

services to Mr. Williams’s clients, nor any evidence that ALQI

contracted with the bankers or Ms. Smekhova to provide those

services on ALQI’s behalf.   Mr. Williams provided all the

consulting services to his clients, and he directed his clients

to deposit his compensation into Swiss bank accounts that

belonged to ALQI.   The fact that Mr. Williams’s business and

personal expenses were paid out of these same Swiss bank accounts

does not prove that his clients contracted with ALQI or that ALQI

was anything other than the receptacle into which Mr. Williams

diverted his consulting income.   We therefore hold Mr. Williams

liable for the consulting fee income deposited into the ALQI

accounts.

      That being the case, we need not reach the IRS’s alternative

argument--i.e., that even if the income was earned by ALQI,

Mr. Williams owed tax on it pursuant to the controlled foreign

corporation provisions of subchapter F of the Code.   Resolving

that alternative theory would require us to address issues (such

as Mr. Williams’s challenge to the validity of the regulation)

that we need not reach in order to decide the case.

II.   Civil fraud penalty

      Mr. Williams concedes that he is liable for tax on the ALQI

investment income he omitted, and we have found that he is also

liable for tax on the net services income.   His conviction for

tax evasion for 1993 through 2000 satisfies the IRS’s burden of
                             - 36 -

proving fraud and estops him from denying the fact that he

committed tax fraud in those same years.   Mr. Williams is liable

for the civil fraud penalty except to the extent that he proves

part of the underpayment was not attributable to fraud.   See sec.

6663(a) and (b).

     Mr. Williams has not shown that his failure to report any of

the ALQI income was not attributable to fraud.   Therefore, the

civil fraud penalty applies to the entire underpayment related to

his omitted consulting fee and investment income for each year

from 1993 through 2000.

III. Charitable contribution deductions

     A.   The parties’ contentions

     Mr. Williams contends that he signed the art purchase

agreement with Abbey in December 1996, that he obligated himself

in that agreement (and oral agreements that preceded his signing

the agreement) to purchase all the art he donated in 1997, 1999,

and 2000, that Abbey segregated art appraised at approximately

$800,000 in its warehouse in 1996 on the basis of the 1996

agreement, that he owned all of that art as of December 1996, and

that he is entitled to charitable contribution deductions for the

appraised values of the art as claimed on his 1997, 1999, and

2000 returns.

     Mr. Williams further contends that his return preparer

approved his deducting the appraised fair market values, provided
                                  - 37 -

that he held the art for more than 1 year and the art was

properly appraised; and he argues that therefore, even if he is

not entitled to the charitable contribution deductions in full,

he is not liable for any accuracy-related penalties.

       The IRS does not challenge the fact that Mr. Williams and

Abbey signed the agreement, that Mr. Williams made the payments

he alleges, that Abbey made the gifts on Mr. Williams’s behalf,

that the recipients of the gifts were qualified charities, that

the appraisers’ valuations were reasonable, or that Mr. Williams

complied with the procedures for substantiating and reporting the

charitable contribution deductions.        However, the IRS contends

that Mr. Williams did not own the specific art he donated for

more than a year before the dates of his gifts of that art and

that therefore section 170(e) limits Mr. Williams’s donation to

his basis in the art, rather than the fair market values of the

art.

       The IRS further contends that Mr. Williams is liable for

accuracy-related penalties for the underpayments resulting from

the disallowed portions of his charitable contribution

deductions.

       B.   Statutory framework

       Section 170(a)(1) generally allows a deduction for any

charitable contribution made during the tax year, but the

deduction is allowable only if the contribution is verified under
                               - 38 -

regulations provided by the Secretary.    A charitable contribution

includes a contribution or gift to or for the use of a government

organization for public purposes or to a charitable organization.

Sec. 170(c).

     Generally, the amount of the charitable contribution is the

fair market value of the contributed property at the time of

donation.    26 C.F.R. sec. 1.170A-1(a), (c)(1), Income Tax Regs.

     In some situations involving the donation of appreciated

property, the general rule for determining the amount of a

charitable contribution is modified.    Section 170(e)(1)(A)

provides:

          SEC. 170(e). Certain Contributions of Ordinary
     Income and Capital Gain Property.--

                 (1) General rule.--The amount of any
            charitable contribution of property otherwise
            taken into account under this section shall
            be reduced by * * *

                      (A) the amount of gain which
                 would not have been long-term
                 capital gain if the property
                 contributed had been sold by the
                 taxpayer at its fair market value
                 (determined at the time of such
                 contribution) * * * .

Thus, the effect of section 170(e)(1)(A) is to permit the

deduction of long-term capital gain appreciation but, when the

contributed property is not long-term capital gain property, to

limit the deduction to the taxpayer’s basis at the time of
                                - 39 -

contribution.    See Lary v. United States, 787 F.2d 1538, 1540

(11th Cir. 1986).

     Section 1221(a) defines capital assets, and the art at issue

qualified as a capital asset in Mr. Williams’s hands.    Section

1222(3) defines long-term capital gain as “gain from the sale or

exchange of a capital asset held for more than 1 year”.    It

follows that when a taxpayer donates appreciated art that he held

for 1 year or less, the amount of the deduction must be

determined with regard to section 170(e)(1)(A); i.e., the

deduction is limited to the taxpayer’s basis, rather than the

art’s (higher) fair market value.

     C.     Discussion

     As noted, the IRS challenges only Mr. Williams’s claim that

he owned the art for more than a year before the donation.

Mr. Williams alleges that he committed to purchasing art from

Abbey, and he argues that his holding period for the art began in

December 1996 when he and Abbey executed the agreement.

     “Federal tax law is concerned with the economic substance of

the transaction under scrutiny and not the form by which it is

masked.”    United States v. Heller, 866 F.2d 1336, 1341 (11th Cir.

1989).     Accordingly, although the parties titled the agreement

“Art Purchase Agreement”, we will consider the rights, duties,

and obligations the parties actually assumed when they executed

the agreement--whatever its title.
                                - 40 -

     The agreement clearly states that Mr. Williams paid $3,600

to Abbey and that Abbey would hold that amount in escrow to apply

against the $72,000 purchase price.      Paragraph 6 of the agreement

discusses Abbey’s rights in the event Mr. Williams failed to pay

amounts owed to Abbey.     If he failed to pay before he executed a

bill of sale transferring art to a charity, the agreement

provides (also in paragraph 6) that Abbey’s sole remedy was “to

retain as liquidated damages all previous payments Client has

made toward the purchase of the Art and, in addition, to reclaim

ownership of the Art.”17    The draft agreement originally provided

that, in the event that Mr. Williams failed to pay Abbey after he

executed documents transferring art to a charity, Abbey could

require specific performance, i.e., payment.     However,

Mr. Williams crossed out that sentence, and Abbey thus accepted

the agreement without any explicit right to force Mr. Williams’s

payment.18




     17
      From the documents in the record acknowledging the
charities’ receipt of the art, it appears that Abbey delivered
art on loan to charities to hold until Mr. Williams signed and
Abbey delivered the bill of sale or deed of gift. Abbey appears
to have processed the final paperwork only after receiving
Mr. Williams’s payments for the art.
     18
      Considering that Abbey controlled the paperwork, including
the bill of sale or deed of gift, Abbey remained in a position to
reclaim any art delivered on loan to a charity if Mr. Williams
had defaulted on payment after Abbey delivered the art to a
charity. But Mr. Williams was not obligated to proceed.
                                - 41 -

     Because Mr. Williams had the power unilaterally to decide

whether to pay the remainder of the $72,000 purchase price and

execute a bill of sale, in effect his $3,600 payment purchased an

option to buy art--with the full option price applied to the

price of the art.

     An option normally provides a person a right to sell or to

purchase “‘at a fixed price within a limited period of time but

imposes no obligation on the person to do so’”.    See Elrod v.

Commissioner, 87 T.C. 1046, 1067 (1986) (quoting Koch v.

Commissioner, 67 T.C. at 82).    “Options have been characterized

as unilateral contracts because one party to the contract is

obligated to perform, while the other party may decide whether or

not to exercise his rights under the contract.”     Fed. Home Loan

Mortg. Corp. v. Commissioner, 125 T.C. 248, 259 (2005).     Although

the agreement placed no time restriction on Mr. Williams’s right

to purchase the art, it also imposed no binding commitment on him

to follow through with the purchase.

     In contrast to an option agreement, “a contract of sale

contains mutual and reciprocal obligations, the seller being

obligated to sell and the purchaser being obligated to buy.”

Koch v. Commissioner, 67 T.C. at 82.     The agreement at issue

obligated Abbey to sell, but it did not obligate Mr. Williams to

buy; thus, all he purchased in December 1996 was a contractual

right to require Abbey to perform and to apply his $3,600 option
                               - 42 -

payment against the $72,000 total purchase price recited in the

agreement.   Even without a time limit on Mr. Williams’s right to

require performance, in substance the agreement was an option to

purchase art, regardless of the title the parties gave to their

agreement.

     Mr. Williams’s holding period for the art he had the option

either to buy or not to buy did not begin until he exercised the

option, committed himself to paying for the art, and acquired a

present interest in the art.   See Crane v. Commissioner, 45 T.C.

397, 404 (1966), affd. 368 F.2d 800 (1st Cir. 1966).   In each

instance, this occurred within less than a year of his donations.

     Mr. Williams testified that oral discussions he had with

Abbey before signing the agreement did obligate him to purchase

roughly $800,000 of appraised art and that he intended that the

initial commitment described in the agreement--$72,000 total

payment to purchase art with roughly $300,000 of appraised

value--would cover his 1997 donations, while he would pay

additional amounts to donate the remaining art in subsequent

years.   He did not explain how any such oral agreement could have

survived paragraph 12 of the agreement he and Abbey had executed,

which stated that the agreement contains the entire agreement

between him and Abbey.   He also did not explain why Abbey would

segregate $800,000 worth of art on the basis of his signing an

agreement that required him to make a $3,600 deposit and pay the
                              - 43 -

remainder of the $72,000 total purchase price if and only if he

chose to proceed.   Nor did he explain how an agreement for

$300,000 of appraised-value art came to be an agreement for

$800,000 of appraised-value art.

     Mr. Williams testified that he asked Abbey to put together a

collection of the kind of art he appreciated and that he believed

Abbey had a large quantity of such art which Abbey would

segregate and hold for his donation program.    Although he claims

that he believed that Abbey segregated almost $1 million of art

in its warehouse someplace in New York City, he did not have and

did not even profess actual personal knowledge of the timing of

Abbey’s acquisition of the art.    He never requested or received

an inventory of the items segregated on his behalf, and he never

visited the warehouse to inspect the art purportedly purchased

and set aside for his contribution program.19

     Moreover, while it is clear from the age of the art listed

in the appraisals that the pieces certainly existed long before

their dates of donation, there is no evidence, aside from




     19
      Mr. Williams also claimed that he believed the appraisals
Abbey obtained were valid and accurate and that the 416-percent
jump in value legitimately resulted from Abbey’s purchasing the
art oversees in third-world countries and in bulk. Abbey’s
guaranteed appreciation is suspect; and if the art is available
at such deep discounts, the appraisals--purporting to represent
prices a willing buyer and willing seller would negotiate--are
also suspect. However, as the IRS is not challenging valuation,
we need not decide these questions.
                              - 44 -

hearsay20 and Mr. Williams’s testimony, which is not competent on

the point, that even Abbey owned any of this art before the dates

of appraisals.

     The evidence does not show that Mr. Williams owned the art

as of the date of the initial agreement with Abbey in 1996 or at

any other time earlier than a year before the donations.   We find

that Mr. Williams acquired a present interest in the art only

when he agreed to pay Abbey for each batch of appraised art, and

this occurred within less than a year of each donation.    Thus, we

agree with the IRS that because Mr. Williams owned the art for

less than one year, he would not have been entitled to long-term

capital gain treatment on any gain on the art if he had sold it,

and therefore section 170(e)(1) limits his charitable

contribution deduction to his basis in the art.


     20
      Mr. Williams introduced a December 9, 2000, letter from
Abbey asserting that Abbey still had items “held in a segregated
manner in our warehouse located in New York City from 1997”,
promising to send a description of those remaining objects, and
estimating the appraised value of the objects at over $200,000.
If offered to prove the quoted fact, the letter is inadmissible
hearsay, see Fed. R. Evid. 801(c), 802, and Mr. Williams did not
offer into evidence any actual business records substantiating
Abbey’s holdings or any description of any segregated art, nor
did he call any representative of Abbey to testify. Moreover,
Mr. Williams did not reconcile Abbey’s letter’s reference to art
segregated “from 1997” with his assertion that Abbey segregated
all $800,000 of appraised-value art in 1996. We are entitled to
infer from Mr. Williams’s failure to offer evidence proving
purchase in 1996 and segregation thereafter that probative
evidence about the time of purchase and segregation would have
been unfavorable to Mr. Williams’s case. See Wichita Terminal
Elevator Co. v. Commissioner, 6 T.C. 1158, 1165 (1946), affd. 162
F.2d 513 (10th Cir. 1947).
                                 - 45 -

IV.   Accuracy-related penalty

      The IRS determined that Mr. Williams is liable for accuracy-

related penalties for the overstated charitable contribution

deductions.    The Commissioner bears the burden of producing

sufficient evidence showing the imposition of a penalty is

appropriate.    Once the Commissioner meets this burden, the

taxpayer must produce persuasive evidence that the Commissioner’s

determination is incorrect.     Rule 142(a); Higbee v. Commissioner,

116 T.C. 438, 446-447 (2001).

      A.   Negligence

      Section 6662(a) and (b)(1) imposes an accuracy-related

penalty equal to 20 percent of the portion of an underpayment

that is attributable to the taxpayer’s negligence or disregard of

rules or regulations.21   Section 6662(c) provides that “the term




      21
      The accuracy-related penalty is also imposed on the
portion of an underpayment attributable to a “substantial
understatement of income tax.” Sec. 6662(b)(2). By definition,
an understatement of income tax for an individual is substantial
if it exceeds the greater of $5,000 or 10 percent of the tax
required to be shown on the return. Sec. 6662(d)(1)(A).

     The understatements of income tax resulting from the
disallowed charitable contribution deductions and the amounts of
tax required to be shown on the returns follow:


                                                      (continued...)
                                - 46 -

‘negligence’ includes any failure to make a reasonable attempt to

comply with the provisions of this title, and the term

‘disregard’ includes any careless, reckless, or intentional

disregard.”     26 C.F.R. section 1.6662-3(b)(1)(ii), Income Tax

Regs., provides that negligence is strongly indicated where a

“taxpayer fails to make a reasonable attempt to ascertain the

correctness of a deduction, credit or exclusion on a return which

would seem to a reasonable and prudent person to be ‘too good to

be true’ under the circumstances”.       Negligence connotes a lack of

due care or a failure to do what a reasonable and prudent person

would do under the circumstances.     See Allen v. Commissioner, 92

T.C. 1, 12 (1989), affd. 925 F.2d 348 (9th Cir. 1991).      “[C]ourts

have found that a taxpayer is negligent if he puts his faith in a

scheme that, on its face, offers improbably high tax advantages,

without obtaining an objective, independent opinion on its



     21
          (...continued)
                                     1997           1999      2000

Understatement of tax
  attributable to overstated
  charitable contribution           $128,096      $68,522    $21,600
Tax required to be shown           1,537,542      366,424    252,159

Although each understatement exceeds $5,000, only the
understatement for 1999 is greater than 10 percent of the tax
required to be shown on the return, and thus there is a
substantial understatement for 1999 only. We need address the
substantial understatement accuracy-related penalty only to the
extent we determine Mr. Williams is not liable for the negligence
accuracy-related penalty under section 6662(b)(1).
                              - 47 -

validity.”   Barlow v. Commissioner, 301 F.3d 714, 723 (6th Cir.

2002), affg. T.C. Memo. 2000-339.

     Commencing a holding period for hundreds of thousands of

dollars of art donated in 1997, 1999, and 2000 by making a modest

deposit in 1996 on an agreement that allowed Mr. Williams

unfettered flexibility to chose whether or not to actually buy

and donate any art at all was too good to be true.   This

manufactured tax benefit was enough to alert a reasonable and

prudent person that additional scrutiny was required.

Mr. Williams did not seek independent advice to verify the

propriety of his Abbey agreement or the validity of the

anticipated tax benefits.   Accordingly, the negligence penalty

applies.

     B.    Defenses

     A taxpayer who is otherwise liable for the accuracy-related

penalty may avoid the liability if he successfully invokes one of

three other provisions:   Section 6662(d)(2)(B) provides that an

understatement may be reduced, first, where the taxpayer had

substantial authority for his treatment of any item giving rise

to the understatement or, second, where the relevant facts

affecting the item’s treatment are adequately disclosed and the

taxpayer had a reasonable basis for his treatment of that item.

Third, section 6664(c)(1) provides that, if the taxpayer shows

that there was reasonable cause for a portion of an underpayment
                              - 48 -

and that he acted in good faith with respect to such portion, no

accuracy-related penalty shall be imposed with respect to that

portion.   Whether the taxpayer acted with reasonable cause and in

good faith depends on the pertinent facts and circumstances,

including his efforts to assess his proper tax liability, his

knowledge and experience, and the extent to which he relied on

the advice of a tax professional.   26 C.F.R. sec. 1.6664-4(b)(1),

Income Tax Regs.

           1.   Substantial authority

     Mr. Williams did not claim that he relied upon substantial

authority holding that an option to purchase art with guaranteed

appreciation would commence his holding period.

           2.   Disclosure and reasonable basis for treatment

     The IRS does not dispute that Mr. Williams followed the

procedural requirements for claiming the deductions for his

charitable contribution deductions, and the IRS does not

challenge the verification he provided with his returns.

However, considering the contingent nature of Mr. Williams’s

obligation to purchase art from Abbey and the issue that raises

about when he actually began to hold the art, we find that

Mr. Williams’s returns did not include sufficient facts to

provide the IRS with actual or constructive knowledge of the

potential controversy involved with Mr. Williams’s deducting the
                               - 49 -

entire appraised value of the art he donated.      The adequate

disclosure exception does not apply.

            3.   Reasonable cause and good faith

     Where reasonable cause existed and the taxpayer acted in

good faith, section 6664(c)(1) provides a defense to the section

6662 penalty.    Generally, the most important factor is the extent

of the taxpayer’s effort to assess the proper tax liability.

26 C.F.R. sec. 1.6664-4(b)(1), Income Tax Regs.

     For purposes of section 6664(c), a taxpayer may be able to

demonstrate reasonable cause and good faith (and thereby escape

the accuracy-related penalty of section 6662) by showing his

reliance on professional advice.    See sec. 1.6664-4(b)(1), Income

Tax Regs.    However, reliance on professional advice is not an

absolute defense to the section 6662(a) penalty.      Freytag v.

Commissioner, 89 T.C. 849, 888 (1987), affd. 904 F.2d 1011 (5th

Cir. 1990), affd. 501 U.S. 868 (1991).   A taxpayer asserting

reliance on professional advice must prove:    (1) that his adviser

was a competent professional with sufficient expertise to justify

reliance; (2) that the taxpayer provided the adviser necessary

and accurate information; and (3) that the taxpayer actually

relied in good faith on the adviser’s judgment.      See Neonatology

Associates, P.A. v. Commissioner, 115 T.C. 43, 99 (2000), affd.

299 F.3d 221 (3d Cir. 2002).
                             - 50 -

     Mr. Williams testified that his return preparer advised him

that, given appropriate appraisals and a 1-year holding period,

his charitable contribution deductions “shouldn’t be an issue”.

The record includes no evidence on the return preparer’s

qualifications nor on what information Mr. Williams gave his

return preparer in order to obtain his approval of the deduction.

Mr. Williams did not testify whether he provided a copy of the

agreement, explained to the preparer the contingent nature of his

obligation to purchase, or admitted his lack of knowledge of

whether Abbey actually owned the art more than a year before his

contributions.

     Mr. Williams testified that he believed Abbey’s appraisals

were legitimate, that the promised appreciation of the art

resulted from Abbey’s economies of scale from bulk purchases, and

that his return preparer approved the deductions.   We need not

decide--though we doubt--whether Mr. Williams honestly held these

beliefs; it is enough that he failed to demonstrate that he

provided a competent tax professional all the information about

his deal with Abbey and that he actually relied upon an objective

professional’s advice rather than his perception of the deal or

Abbey’s representation of the tax deductions it could manufacture

for him.

     The reasonable cause exception does not apply.
                             - 51 -

     Mr. Williams is therefore liable for the accuracy-related

penalty on the underpayments resulting from the disallowed

charitable contribution deductions for 1997, 1999, and 2000.

V.   Conclusion

     Mr. Williams is liable for tax in each year on the

investment income earned in the ALQI accounts because, as the

parties have agreed, that income is foreign personal holding

company income, pursuant to section 954(a)(1).    He is also liable

for tax in each year on the net consulting income paid into the

ALQI accounts because that income was his own.    Moreover,

Mr. Williams is liable for the civil fraud penalty under section

6663(a) on the entire underpayment resulting from his unreported

ALQI income (both investment income and consulting income) for

each year in issue.

     Mr. Williams is not entitled to charitable contribution

deductions in excess of those the IRS allowed, and he is liable

for the accuracy-related penalties under section 6662(a) and

(b)(1) on the underpayments resulting from the disallowed

charitable contribution deductions.

     To reflect the foregoing,


                                      An appropriate order and

                                 decision will be entered.
