                              T.C. Memo. 2015-56



                        UNITED STATES TAX COURT



             MINCHEM INTERNATIONAL, INC., Petitioner v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent

             JERRY J. SUN AND SUN NAM SUN, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket Nos. 3704-12, 3705-12.              Filed March 24, 2015.


      George W. Connelly, Jr., William P. Cantrell, and Rita Renee Huey, for

petitioners.

      David Q. Cao, Lewis A. Booth, II, and Carol Bingham McClure, for

respondent.



               MEMORANDUM FINDINGS OF FACT AND OPINION


      PARIS, Judge: Petitioners in these consolidated cases seek redetermination

of respondent’s determinations that Minchem International, Inc. (Minchem), a
                                        -2-

[*2] corporation, and the owner of Minchem, Jerry J. Sun, and his wife, Sun Nam

Sun, received income from transfers by foreign companies for the 2008 or 2009

tax year. Respondent sent Minchem a notice of deficiency determining

deficiencies of $3,712,541 and $1,030,419 and fraud penalties under section

6663(a) of $2,784,405.75 and $772,814.25 for 2008 and 2009, respectively.1 The

notice of deficiency also includes alternative penalties under section 6662(a).

      Respondent also sent Jerry J. Sun and Sun Nam Sun a notice of deficiency

determining deficiencies of $3,389,720 and $570,218 and fraud penalties under

section 6663(a) of $2,542,290 and $427,663.50 for 2008 and 2009, respectively.

The notice of deficiency also included alternative penalties under section 6662(a).

Respondent later conceded that the Suns are not liable for section 6663(a)

penalties related to two items, a home equity loan interest deduction and travel and

entertainment expenses that were paid by Minchem, but are liable for penalties

under section 6662(a).

      After concessions the issues remaining for decision are: (1) whether the

Suns properly deducted an investment interest expense for interest paid on a loan

secured by their residence for 2008 and 2009; (2) whether Minchem received

      1
       Unless otherwise indicated, all section references are to the Internal
Revenue Code of 1986, as amended and in effect for the years in issue, and all
Rule references are to the Tax Court Rules of Practice and Procedure.
                                             -3-

[*3] income from the transfers by foreign companies for 2008 or 2009; (3)

whether the Suns received income from the transfers by foreign companies for

2008 or 2009; (4) whether Minchem is liable for penalties under section 6663(a)

or 6662; and (5) whether the Suns are liable for penalties under section 6663(a) or

6662.2

                                    FINDINGS OF FACT

         Some of the facts have been stipulated and are so found. The stipulation of

facts and the attached exhibits are incorporated herein by this reference.

Petitioners Jerry J. Sun and Sun Nam Sun are husband and wife who have been

naturalized citizens since 1996 and resided in Texas at the time they filed their

petition.3 Mr. Sun wholly owns Minchem, a corporation organized under

subchapter C with a principal place of business in Houston, Texas.

I. The Suns and Minchem

         Mr. Sun came to the United States in 1986 for a position with an

international mineral trading company, and he is still in the same line of business.


      2
       Respondent disallowed Minchem’s business deductions for the Suns’ travel
and entertainment expenses of $156,689.50 and $214,693.37 for the 2008 and
2009 tax years, respectively. Petitioners concede respondent’s adjustments.
Petitioners also concede respondent’s adjustments to the Suns’ gambling income
of $1,280,300 and $463,700 for 2008 and 2009, respectively.
         3
             Mrs. Sun chose not to appear at trial. Only Mr. Sun testified.
                                       -4-

[*4] He earned a college degree in English language and international trade from a

Chinese university in 1984 and first moved to the United States as a sales

representative for a Chinese-owned mineral trading company.

      In 1993 Mr. Sun organized Minchem under the State laws of Texas and

continues to be the sole shareholder. Minchem’s primary business purpose is to

import and distribute industrial minerals. Minchem purchases minerals from

suppliers in China and imports the minerals into the United States. Minchem had

seven employees during 2008 and 2009.

       Mr. Sun has served as Minchem’s CEO from the time of its organization

until the present and received a salary of $450,000 in both 2008 and 2009. As

Minchem’s CEO in 2008 and 2009, Mr. Sun oversaw daily operations and was

responsible for sales and employee hiring. Mr. Sun was the sole individual

authorized to make purchases in excess of $1,000 on Minchem’s behalf. Mr. Sun

had assistants and advisers to help with his CEO duties. The additional help

allowed him to spend only around four to five hours a day on his CEO duties for

Minchem.

      Mr. Sun also spent a significant amount of time on other investment

opportunities. In 2008 and 2009 Mr. Sun owned 99% of Sun Investment, LLC
                                       -5-

[*5] (Sun Investment).4 Mr. Sun, individually, and Sun Investment invested in

various sectors such as commercial properties, daycare services, banking, and

rental properties. Sun Investment also invested in the stock market through its two

trading accounts, one with Ameritrade and the other with E*Trade. Mr. Sun was

responsible for managing Sun Investment’s stock investments. Mr. Sun also

personally held an online trading account with E*Trade. He spent around five

hours a day managing stock investments.5

      In 2002 the Suns completed a cash purchase of a real estate lot and built a

residence on that lot. They did not borrow any money to finance the lot or

construct the residence.

      In 2003 the Suns borrowed $1,736,079 from a bank and used their residence

to secure the debt. The funds were transferred directly from the lending bank to

Minchem’s corporate account. In 2006 Mr. Sun refinanced the loan for

$2,501,934.84 and continued to use the residence to secure the debt. In 2008 and

2009 the Suns paid interest of $173,343.49 and $157,835.86 on the loan,


      4
       Mr. Sun was the managing member as well as the tax matters partner of
Sun Investment. The other 1% of Sun Investment is owned by a member who is
not a party to these cases.
      5
      It is not clear from the record whether Mr. Sun spent the five hours
managing solely his personal investments, solely Sun Investment’s investments, or
some mix of the two.
                                       -6-

[*6] respectively. The Suns allocated the interest expense between mortgage

interest expense and investment interest expense on their 2008 and 2009

Schedules A, Itemized Deductions. For 2008 the Suns deducted $7,046 of the

interest paid on the loan as home mortgage interest and carried the remaining

$166,297.49 forward as investment interest, which they deducted for 2009. For

2009 the Suns deducted $60,000 of the interest paid on the loan as home mortgage

interest and used the remaining $97,835.86 as an investment interest expense

deduction.

II. The Investment Strategy and Mr. Cheung’s Foreign Companies

      Mr. Sun met Bill Cheung through a mutual business friend in 1992 or 1993.

Mr. Cheung is a resident of Hong Kong and is a Chinese citizen.

      In 2008 and 2009 Mr. Cheung owned some portion of several shipping

companies, some of which Minchem used to import minerals from China.6

Specifically, Mr. Cheung claimed ownership of companies called Kingdom

Shipping Company Limited, Able Glory Shipping Limited, Power Vast Limited,

and Magic Way Company Limited. These companies were organized in foreign


      6
       It is unclear whether Mr. Cheung owned all of the shipping companies or
owned only a fraction of the companies during 2008 and 2009. It is also unclear
under what authority or capacity Mr. Cheung operated the companies or
authorized international wire transfers. Neither party addressed these issues.
                                       -7-

[*7] jurisdictions, but they all operated out of Hong Kong.7 Mr. Cheung’s

shipping activities appeared to continue operating several of these companies at

once, even though he may have intended each of these companies to act as the

subsequent replacement for the former company.

      Outside of his shipping companies, Mr. Cheung previously had a series of

unsuccessful investments. He had lost a significant amount of money and was

looking for other ways to invest.

      Through their business dealings Mr. Sun and Mr. Cheung had become

friends. In 2008 and 2009 Mr. Sun and Mr. Cheung would often communicate by

telephone and sometimes through email. When Mr. Sun traveled to China, he

would see Mr. Cheung socially and Mr. Cheung would give him rides to and from

the airport, and they would discuss his American investment opportunities.




      7
        As discussed below, the parties agree that all of the bank transfers
originated from bank accounts in Hong Kong appearing to belong to each of the
named companies, but both respondent and petitioners submitted conflicting
documents indicating in which jurisdictions the companies were organized.
Petitioners submitted documents showing the companies are organized in Liberia,
the British Virgin Islands, and Panama. Respondent submitted documents
showing companies, with the same or substantially similar names, are organized in
Hong Kong. Neither set of documents reflects Mr. Cheung as the owner of any of
the entities. The country in which each company is organized is not pertinent to
these cases; and the Court does not decide whether companies sharing the same
name are the same company or where the companies are organized.
                                       -8-

[*8] Mr. Cheung was impressed by Mr. Sun’s diverse investments, and in 2006

the two gentlemen verbally agreed on an investment strategy for Mr. Cheung after

discussing potential investment opportunities in the United States.

      The only part of the arrangement that both Mr. Cheung and Mr. Sun

consistently agreed on was the general structure of the investment. Mr. Cheung

would transfer sums of money through his shipping companies’ bank accounts to

Mr. Sun, who would then invest the money in the United States. Mr. Cheung

would decide how much money he wished to send, and Mr. Sun had discretion on

which investments to pursue with Mr. Cheung’s money.

      The remaining terms of the verbal agreement were not memorialized and are

unclear. Specifically, Mr. Sun and Mr. Cheung inconsistently described the

investment term, the expected return, and enforcement provisions. Mr. Sun

believed the term was a minimum of 5 years and did not give a maximum period,

whereas Mr. Cheung believed the term was 7 to 10 years. The expected return is

also unclear; Mr. Sun believed the return on investment would be a 50-50 split of

the net profit with a minimum 10% gain annually, but the return might not be paid

annually. Mr. Cheung believed the return would be 10% to 15%, but was
                                         -9-

[*9] uncertain whether that return was annual or total.8 Further, Mr. Cheung was

unsure whether he would take legal action against Mr. Sun if Mr. Sun failed to

achieve the expected return on investment or repay the transferred amount.

III. Transfers to Minchem and Minchem’s Officer Loan Account

      Around 2006 Minchem created an officer loan account solely for the benefit

of Mr. Sun. The officer loan account would be debited and the balance would be

increased when funds were drawn by, or paid for the benefit of, Mr. Sun.

Conversely, the account would be credited and the balance would decrease when

funds were paid to Minchem. Minchem did not sign any contracts with Mr. Sun

regarding the officer loan account, and he was not required to pay interest on any

loans from Minchem. Similarly, it does not appear that Minchem was required to

pay interest on any loans from Mr. Sun.

      Between March 26 and December 18, 2008, a Hong Kong bank account

attributed to a company called Kingdom Shipping transferred $11,255,888 in nine

different transactions to Minchem.9 The smallest transfer was $550,772 and the


      8
        When first asked about the return, Mr. Cheung exclaimed that a 10%-15%
return was “definitely” not annual because Mr. Sun “would not be able to achieve
that”, but when asked to clarify the return on investment he remarked: “Of course
that’s annually”.
      9
          The Court does not decide whether the companies are the same companies
                                                                     (continued...)
                                       - 10 -

[*10] largest was $1,750,572. The only transfer instruction from Mr. Cheung was

a letter accompanying the $550,772 transfer that indicates that $300,000 is

“additional capital” but the whole $550,772 is a “gift from Mr. Cheung to Mr.

Sun”. Kingdom Shipping transferred all the money from an account in Hong

Kong to Minchem’s JPMorgan Chase Bank account in the United States.

      Between September 30 and December 15, 2009, Hong Kong bank accounts

attributed to companies called Able Glory and Power Vast transferred a total of

$3,515,130 in four different transactions to Minchem. The smallest transfer was

$628,125 and the largest was $1,028,125. The transferring company transferred

the money from its respective account in Hong Kong to Minchem’s JPMorgan

Chase Bank account in the United States.

      For accounting purposes Minchem reported most of the money transferred

from Mr. Cheung’s companies as credits in Mr. Sun’s officer loan account.

Specifically, in 2008 Minchem reported $10,430,828.51 of the transferred




      9
       (...continued)
as the Hong Kong registered companies or the companies organized elsewhere and
notes only that all the wire transfers originated from Hong Kong accounts
purporting to be owned by companies with the stated names. It is also unclear
under what authority or capacity Mr. Cheung originated the wire transfers from
Hong Kong to the U. S. bank account held by Minchem.
                                        - 11 -

[*11] $11,255,88810 as credits to the officer loan account and also credited the

officer loan account for all $3,515,130 of the funds transferred in 2009.11

Minchem treated the money as Mr. Sun’s funds loaned to the company that would

eventually be repaid to him or as return payments for money that Minchem had

previously loaned to Mr. Sun. Minchem did not report the money as receipts or

other income to Minchem because it was not tied to any service.

      Minchem could, however, use the money in the officer loan account for its

own business purposes. Minchem did in fact use some of the transfers to inflate

its cashflow when seeking a line of credit. Minchem reported the funds

transferred from Mr. Cheung’s companies as an asset that was offset with an

accompanying liability. Minchem’s in-house accounting personnel believed that

the higher assets, even if offset with an equal liability, looked better to a bank and



      10
        The stipulation erroneously states the credited amount from Kingdom
Shipping as $10,730,828.51. Minchem’s financial ledger shows the actual amount
was $10,430,828.51. The Court will disregard the stipulation as inconsistent with
the financial ledger. See Rule 91(a); see also Cal-Maine Foods, Inc. v.
Commissioner, 93 T.C. 181, 195-196 (1989). Further, the record does not show
what happened to the $825,059.49 that was not reported in the officer loan
account.
      11
        Able Glory recalled $720,000 of the December 15, 2009, transfer.
Minchem returned the amount on December 16, 2009. Thus, the net amount
received by Minchem and credited to the officer loan account from Mr. Cheung’s
companies in 2009 was $2,795,130.
                                       - 12 -

[*12] would help establish a line of credit. It took advantage of this principle by

showing the transferred money was an asset and a liability on the balance sheets

provided to a lender when applying for a line of credit.

      Mr. Sun would occasionally direct money from other sources into the

officer loan account, but the bulk of the credits were from Mr. Cheung’s various

foreign companies. In 2008 Minchem’s officer loan account reflected

$249,448.48 of credit that was not from Kingdom Shipping or repayment of an

amount removed from the officer loan account.12 In 2009 Minchem’s loan account

reflected $1,137,949.10 of credit that was not from one of Mr. Cheung’s foreign

companies or repayment of an amount removed from the officer loan account. In

other words, 97.6% of the independent funds credited to Minchem’s officer loan

account in 2008 and 71% of the independent funds credited in 2009 were from

credits from Mr. Cheung’s foreign companies.

      By at least January 2008 Mr. Sun began frequently using the officer loan

account for personal expenses. Mr. Sun would either pay his personal expenses

      12
         As discussed below, Mr. Sun made several advances to casinos from the
officer loan account and some lesser portions of the advances were returned to the
officer loan account and reported as credits or not returned at all. Similarly, on
April 4, 2008, Mr. Sun loaned a friend $75,000, $20,000 of which was repaid and
reported as a credit on November 14, 2008. These credits are not independent
deposits and instead represent portions of amounts that were already credited to
the officer loan account.
                                        - 13 -

[*13] directly from the officer loan account or he would remove money and use it

at his discretion. For example, in 2008 Minchem paid $135,874.43 for home

automation, $158,517.80 for a new Mercedes Benz, and $49,598.81 for personal

real estate tax. In total, Minchem’s officer loan account was debited

$4,116,414.43 in 2008 and $1,811,127.65 in 2009 for expenses that Mr. Sun

identified as personal during his trial testimony.13

      Some of the personal expenditures included gambling expenses. In 2008

$4,800,100 was transferred to casinos from the officer loan account and

$2,394,550 was returned.14 In 2009 $1 million was transferred to casinos and

$1,300,000 was returned.15 Thus between 2008 and 2009 Mr. Sun transferred


      13
        These sums include only the net amounts from Mr. Sun’s transfers to
casinos and personal loans. Mr. Sun pointed to $3,150,053.50 of debits in 2008
and $114,695 of debits in 2009 for which he could not remember whether the
related expenses were personal, investment, or business.
      14
        In 2008 Minchem’s officer loan account transferred money to the Wynn
casino in the following amounts: $500,000 on March 27, $1 million on June 4, $1
million on September 11, $100 on September 12, $1 million on November 25, and
$1 million on December 26. In 2008 the Wynn casino transferred money to
Minchem’s officer loan account in the following amounts: $480,000 on April 4,
$1 million on September 12, $806,000 on December 1, and $100 on December 31.
Minchem’s officer loan account also transferred $300,000 to the MGM casino on
November 24 and received back $108,450 from the MGM casino on December 1.
      15
      In 2009 Minchem’s officer loan account transferred $1 million to the
Wynn casino on June 12. Minchem’s officer loan account received $1 million and
                                                                  (continued...)
                                      - 14 -

[*14] $5,800,100 from the officer loan account to casinos and received back

$3,694,550; i.e., over the two years in issue Mr. Sun lost $2,105,550 from

gambling from the officer loan account.16

      Mr. Sun told Mr. Cheung about the gambling losses but still believed that

he would be able to earn the promised return on investment in spite of over $2

million in gambling losses. Although, Mr. Cheung was not sure whether the lost

money was money that he sent to Mr. Sun or Mr. Sun’s personal money.

      Mr. Sun did use some of the funds in the officer loan account for

investment. In 2008 Mr. Sun directed transfers of $304,411.22 to Sun Investment

and $2,900,000 to his personal E*Trade account. In 2009 Mr. Sun directed

transfers of $201,195.57 to Sun Investment, $363,962 to Tiger Partners LLC,




      15
       (...continued)
$300,000 from the Wynn casino on January 5 and June 23, respectively.
      16
         Combining the 2008 and 2009 tax years better reflects Mr. Sun’s gambling
transactions because Mr. Sun advanced a casino $1 million on December 26,
2008, and $1 million was returned on January 5, 2009. Thus the debits in the
officer loan account appear inflated for 2008 and the credits appear inflated for
2009 because these two transfers likely stem from the same transaction and result
in a zero sum.
                                       - 15 -

[*15] $352,085 to Subhouse Capital LLC, and $65,000 to Maddox Interests.17 Mr.

Sun did not, however, distinguish whether the money was his or Mr. Cheung’s

money.

IV. Additional Wire Transfers From Foreign Companies

      In 2008 Mr. Cheung’s foreign companies transferred a total of $1,599,977

directly to Mr. Sun’s personal E*Trade account in two transactions: the first on

January 9, when Magic Way Company transferred $1,199,990, and the second on

October 22, when Kingdom Shipping transferred $399,987. Mr. Sun did not

segregate the transfers in his personal E*Trade account.

      In 2008 Mr. Cheung’s foreign companies also transferred a total of

$3,257,901 directly to Sun Investment. Sun Investment received $558,567 on

May 16 and $1,198,567 on October 20 from Magic Way Company. Further, on

October 8, Sun Investment received $1,500,767 from Kingdom Shipping. In 2009

Sun Investment received $299,967 from a single transfer from Magic Way

Company.




      17
         Mr. Sun was a direct or indirect member for each of these partnership
entities.
                                       - 16 -

[*16] V. Administrative Background

      Neither Minchem, the Suns, nor the other related businesses reported money

received from Mr. Cheung as income for the 2008 or 2009 tax year. Respondent

sent Minchem a notice of deficiency on January 4, 2012, for the 2008 and 2009

tax years, determining deficiencies and penalties under section 6663(a) for both

tax years and, in the alternative, accuracy-related penalties under section 6662 for

both tax years. Respondent later conceded the penalties under section 6663(a) for

the portions of the underpayments due to some items listed on Minchem’s notice

of deficiency but maintained that Minchem remained liable for section 6662(a)

penalties as to those amounts.

      Respondent also sent the Suns a notice of deficiency on January 4, 2012, for

the 2008 and 2009 tax years, determining deficiencies and penalties under section

6663(a) for both Mr. and Mrs. Sun for both tax years and, in the alternative,

accuracy-related penalties under section 6662(a) for both tax years. Respondent

later conceded the penalties under section 6663(a) for the portions of the

underpayments due to some items listed on the Suns’ notice of deficiency but

maintained that the Suns remain liable for section 6662(a) penalties as to those

amounts.
                                       - 17 -

[*17] Minchem and the Suns timely filed separate petitions with the Court to

challenge the notices of deficiency. The two cases were consolidated for purposes

of trial, briefing, and opinion.

                                    OPINION

      The issues remaining to be decided are: (1) whether the Suns properly

deducted an investment interest expense for interest paid on a loan secured by

their residence for 2008 and 2009; (2) whether Minchem received income as gross

receipts from the transfers from Mr. Cheung’s foreign companies for 2008 or

2009; (3) whether the Suns received income as dividends or ordinary income from

the transfers from Mr. Cheung’s foreign companies for 2008 or 2009; (4) whether

Minchem is liable for penalties under section 6663(a) or 6662 for 2008 or 2009;

and (5) whether the Suns are liable for penalties under section 6663(a) or 6662 for

2008 or 2009.

I. Home Equity Loan Interest

      The Suns refinanced an outstanding loan for $2,501,935 through home

equity indebtedness. For 2008 and 2009 the Suns allocated portions of the interest

paid to mortgage interest and the remainder to investment interest expenses. A

Form 1098, Mortgage Interest Statement, issued to the Suns for tax year 2008

showed they paid interest of $173,343.49. For 2008 the Suns deducted $7,046
                                       - 18 -

[*18] paid toward the loan as home mortgage interest and carried $166,297.49 of

paid interest forward as investment interest, which they claimed for 2009. A Form

1098 issued to the Suns for 2009 showed they paid interest of $157,835.86. For

2009 the Suns claimed a deduction of $60,000 for the interest paid as home

mortgage interest and claimed the remaining interest as an investment interest

expense deduction.

      The notice of deficiency denied the Suns’ investment interest deduction in

its entirety and adjusted their home mortgage interest deduction. The Suns assert

that an example in a temporary regulation is directly applicable and shows the

deduction is correct as claimed. Respondent counters that the temporary

regulation does not apply because the Suns have not met its requirements.

       Deductions are a matter of legislative grace, and taxpayers bear the burden

of establishing entitlement to any claimed deduction. Rule 142(a); INDOPCO,

Inc. v. Commissioner, 503 U.S. 79, 84 (1992); New Colonial Ice Co. v. Helvering,

292 U.S. 435, 440 (1934).18 This burden requires the taxpayer to substantiate

items relating to deductions claimed by keeping and producing adequate records

      18
         Petitioners made an oral motion to shift the burden as to nonfraud issues.
Under sec. 7491(a)(2) a taxpayer must comply with the requirements to
substantiate any item. As discussed below, petitioners did not substantiate the
interest deduction. Thus the burden does not shift under sec. 7491 with respect to
the interest deduction.
                                        - 19 -

[*19] that enable the Commissioner to determine the taxpayer’s correct tax

liability. Sec. 6001; Hradesky v. Commissioner, 65 T.C. 87, 89-90 (1975), aff’d

per curiam, 540 F.2d 821 (5th Cir. 1976); Meneguzzo v. Commissioner, 43 T.C.

824, 831-832 (1965). A taxpayer claiming a deduction on a Federal income tax

return must demonstrate that the deduction is allowable pursuant to some statutory

provision and must further substantiate that the expense to which the deduction

relates has been paid or incurred. See sec. 6001; Hradesky v. Commissioner, 65

T.C. at 89-90; sec. 1.6001-1(a), Income Tax Regs.

      Section 163 allows taxpayers a deduction for “qualified residence interest”

paid on the mortgage on their first or secondary home. Sec. 163(a), (h)(2)(D); sec.

1.163-10T(b), Temporary Income Tax Regs., 52 Fed. Reg. 48410 (Dec. 22, 1987).

Qualified residence interest is either “acquisition indebtedness” or “home equity

indebtedness.” Sec. 163(h)(3)(A). Acquisition indebtedness is a loan of up to $1

million that is used to acquire, construct, or substantially improve a residence

when that residence also secures the loan. Sec. 163(h)(3)(B). New debt to

refinance old acquisition indebtedness is also acquisition indebtedness for

purposes of section 163(h)(3)(A)(i) as long as it is not more than the refinanced

debt. Sec. 163(h)(3)(B)(i). Home equity indebtedness is any other type of loan

secured by a qualified residence but is capped at the lesser of $100,000 or the fair
                                        - 20 -

[*20] market value of the residence minus any acquisition indebtedness on the

residence. Sec. 163(h)(3)(C). There is a limit to qualified residence interest where

the total average balances for the taxable year of all secured debts on a residence

are more than the adjusted purchase price of the residence. Azimzadeh v.

Commissioner, T.C. Memo. 2013-169; sec. 1.163-10T(c)(1), Temporary Income

Tax Regs., 52 Fed. Reg. 48411 (Dec. 22, 1987). Further, if the sum of the average

balances for the taxable year of all secured debts exceeds the adjusted purchase

price of the qualified residence at the end of the taxable year, the taxpayer must

use either the simplified method or the exact method to determine the amount of

interest that is qualified residence interest. Sec. 1.163-10T(c)(1), Temporary

Income Tax Regs., supra.

      The two methods to determine the amount of qualified residence interest

appear to treat excess paid interest differently. The simplified method treats

remaining paid interest as nondeductible personal interest even if the remaining

interest would be allocated under section 1.163-8T, Temporary Income Tax Regs.,

52 Fed. Reg. 24999 (July 2, 1987) to some other category of interest. Sec. 1.163-

10T(d)(3), Temporary Income Tax Regs., 52 Fed. Reg. 48411 (Dec. 22, 1987).

The exact method allows remaining interest to be allocated under section 1.163-

8T, Temporary Income Tax Regs., supra, which makes remaining interest
                                        - 21 -

[*21] potentially deductible. Sec. 1.163-10T(e)(4)(ii), Temporary Income Tax

Regs., 52 Fed. Reg. 48412 (Dec. 22, 1987).

      The Suns point out that the example in section 1.163-10T(e)(4)(ii),

Temporary Income Tax Regs., supra, appears to apply, but the Suns have failed to

substantiate the deduction. Specifically, the Suns have not shown that the

obtained funds were used for investing. In general, the nature of interest payments

is determined not by the origin of the debt or the collateral that secures the loan

but by the eventual use of the funds received as proceeds from the loan. Sec.

1.163-8T(a)(3), Temporary Income Tax Regs., supra.

      The Suns contend that the interest paid is deductible as investment interest

because the loan proceeds were deposited in Minchem’s bank account. The Suns

posit that Minchem is property held for investment because it is a type of property

that generally produces dividend income. It is not necessary for the Court to

decide whether Minchem is property held for investment because the Suns did not

purchase or contribute the loan proceeds to Minchem. Instead, Minchem’s general

ledger notes that the company treated the mortgage proceeds as a personal loan

from Mr. Sun to Minchem. In other words, Mr. Sun borrowed the money so that

he could lend it to Minchem and Minchem would repay him. Mr. Sun has not

shown that the funds disbursed for his mortgage to finance his ancillary loan to
                                       - 22 -

[*22] Minchem were for investment. Further, the Suns fail to recognize the

differences between the simplified method and the exact method--or explain the

application of either.

      The Suns have not demonstrated that the deduction is allowable pursuant to

any statutory provision because they have not shown the funds were used for

investing. Accordingly, respondent’s determinations concerning the Suns’ home

mortgage and investment interest expense deduction for the interest paid on the

home equity loan are sustained.

II. Burden of Proof for Unreported Income

      In general, taxpayers bear the burden of disproving the Commissioner’s

determinations. Rule 142(a). Petitioners, however, contend that under Carson v.

United States, 560 F.2d 693, 698 (5th Cir. 1977), in the Court of Appeals for the

Fifth Circuit, to which an appeal of these cases would lie, the presumption of

correctness does not attach in cases involving unreported income unless the

Commissioner either identifies the taxable source of income or disproves

nontaxable sources. See sec. 7482(b)(1)(A) and (B). Petitioners assert that

respondent has not satisfied either of these requirements. Further, petitioners

contend that the burden should shift under sections 7491 and 7522 for similar

reasons. Respondent counters that he has sufficiently identified a likely source of
                                       - 23 -

[*23] income as well as negating the nontaxable source. It is unnecessary for the

Court to address the parties’ disagreements and to determine whether the burden

of proof has shifted for the unreported income because the outcome of each of the

present cases is determined on the preponderance of the evidence. See Blodgett v.

Commissioner, 394 F.3d 1030, 1035 (8th Cir. 2005), aff’g T.C. Memo. 2003-212;

Estate of Bongard v. Commissioner, 124 T.C. 95, 111 (2005); Namyst v.

Commissioner, T.C. Memo. 2004-263, aff’d, 435 F.3d 910 (8th Cir. 2006).

III. Transfers to Minchem

      Before deciding on the tax consequences of the transfers between Mr.

Cheung’s foreign companies and Minchem, the Court needs to address the

substance of the arrangement between Mr. Cheung and Mr. Sun. Respondent

determined that the money from Mr. Cheung’s foreign companies is either gross

receipts to Minchem, which then made a distribution to Mr. Sun or, alternatively,

represents direct income to Mr. Sun. Petitioners’ position is less clear because

while they often assert that Mr. Sun was entrusted to invest Mr. Cheung’s money,

they also appear to claim that the money was a loan to Mr. Sun.

      A. Income to Minchem

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

derived”. A fundamental principle of income taxation is that income is taxable to
                                        - 24 -

[*24] the person who earns it. Lucas v. Earl, 281 U.S. 111, 114-115 (1930). The

“true earner” of income is the person or entity who controls the earning of such

income and not necessarily the person or entity that receives the income. Barmes

v. Commissioner, T.C. Memo. 2001-155. The crucial question is “‘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.’” Id., slip op. at 78 (quoting Commissioner v. Sunnen,

333 U.S. 591, 604 (1948)).

      Minchem did not retain sufficient dominion and control over the funds

transferred by Mr. Cheung’s foreign companies to make it the recipient of the

income for tax purposes. Minchem consistently reported money received from

Mr. Cheung’s foreign companies as either a loan from Mr. Sun to Minchem or as

repayment for a loan from Minchem to Mr. Sun. Minchem’s officer loan account

records show that the funds “repaid” money spent on Mr. Sun’s behalf. Similarly,

when the funds from Mr. Cheung’s foreign companies exceeded the debts to the

officer loan account, the funds were treated as cash that Mr. Sun had loaned to

Minchem, and that he could, and did, use the money for personal reasons. Further,

when Minchem was applying for a line of credit, the money was shown as both an

asset and a liability. In other words, Minchem recognized that it held the money
                                       - 25 -

[*25] but had an obligation to repay it and could not exercise dominion and

control over it. See, e.g., Rutkin v. United States, 343 U.S. 130, 137 (1952); Arcia

v. Commissioner, T.C. Memo. 1998-178.

      Instead of retaining dominion and control over the funds, Minchem acted as

a conduit for the money. A taxpayer who merely acts as a conduit and disposes of

transferred funds to third parties does not receive taxable income. See Estate of

Kalichuk v. Commissioner, T.C. Memo. 1964-336. Minchem received the cash

from Mr. Cheung’s foreign companies but immediately treated it as belonging to a

third party, Mr. Sun. Rather than transferring the money to Mr. Sun, it either paid

expenses on Mr. Sun’s behalf or held the money in its officer loan account. By

holding the money in the officer loan account--which was solely for Mr. Sun’s

benefit--Minchem eliminated the need for Mr. Sun to turn around and loan the

money back to the company on his behalf.

      Accordingly, Minchem did not receive taxable income from Mr. Cheung’s

foreign companies because it did not retain sufficient dominion and control over

the transferred funds. See Barmes v. Commissioner, T.C. Memo. 2001-155.

Further, Minchem did not receive taxable income from Mr. Cheung’s foreign

companies because Minchem acted as a conduit to Mr. Sun. See Estate of

Kalichuk v. Commissioner, T.C. Memo. 1964-336.
                                       - 26 -

[*26] B. Income to Mr. Sun

      Respondent contends that the money transferred from Mr. Cheung’s foreign

companies is either qualified dividends from Minchem or income directly from the

foreign companies. As discussed above, Minchem was merely a conduit for the

funds, and thus they are not qualified dividends to Mr. Sun. Petitioners’ position

is that the funds transferred to Minchem are not income to Mr. Sun because he had

an obligation to repay them. In substance, petitioners contend the funds are a loan

that Mr. Sun was obligated to repay.

      Generally, the proceeds of a loan do not constitute income to a borrower

because the benefit is offset by an obligation to repay. United States v. Rochelle,

384 F.2d 748, 751 (5th Cir. 1967); Arlen v. Commissioner, 48 T.C. 640, 648-649

(1967). Deciding whether a particular transaction constitutes a loan, however, is a

question of fact to be determined upon consideration of all the pertinent facts in

the case. Fisher v. Commissioner, 54 T.C. 905, 909 (1970).

      Whether a bona fide debtor-creditor relationship exists is a question of fact,

and essential elements are the intent of the recipient of the funds to make monetary

repayment and the intent of the person advancing the funds to enforce repayment.

Beaver v. Commissioner, 55 T.C. 85, 91 (1970); Fisher v. Commissioner, 54 T.C.

at 909-910. Whether the recipient had an intent to repay and the lender an intent
                                         - 27 -

[*27] to enforce repayment is determined at the time of receipt of the funds.

Frierdich v. Commissioner, 925 F.2d 180, 184 (7th Cir. 1991), aff’g T.C. Memo.

1989-103; Estate of Chism v. Commissioner, 322 F.2d 956, 960 (9th Cir. 1963),

aff’g T.C. Memo. 1962-6. Indicative of an intent to repay are that a note

evidencing the indebtedness was executed, that the parties agreed on the rate of

interest, that there was a fixed maturity date, that a security interest was given the

creditor, and that the debtor had the ability to make repayment. Frierdich v.

Commissioner, 925 F.2d at 182; Busch v. Commissioner, 728 F.2d 945, 948 (7th

Cir. 1984), aff’g T.C. Memo. 1983-98.

      The funds that the Suns received from Mr. Cheung’s foreign companies

lacked many of the characteristics usually present when the Court finds that

money advanced constitutes a bona fide loan. For instance, at the time the Suns

received the funds, a note evidencing the indebtedness was not executed and a

security interest was not given. Further, Mr. Sun and Mr. Cheung did not agree on

the period of the loan or the rate of interest. Mr. Sun believed the term was a

minimum of 5 years and did not give a maximum period, whereas Mr. Cheung

believed the term was 7 to 10 years. Mr. Sun and Mr. Cheung also disagreed on

the rate of return, or interest: Mr. Sun believed the return on investment would be

a 50-50 split of the net profit with a minimum 10% gain annually, but the return
                                       - 28 -

[*28] might not be paid annually. Mr. Cheung believed the return would be

between 10% and 15% but was uncertain whether that return was annual or total.

In consideration of these factors, the transferred funds do not constitute a bona

fide loan between Mr. Sun and Mr. Cheung.

      Nor does any of the transfers--including the transfer accompanied by a

letter--appear to be a gift, because Mr. Cheung lacked donative intent. A gift

requires donative intent, actual delivery, and relinquishment of dominion and

control. See Carrington v. Commissioner, 476 F.2d 704, 709 (5th Cir. 1973), aff’g

T.C. Memo. 1971-222. The Supreme Court has defined a gift as a transfer of

property that proceeds from a “‘detached and disinterested generosity,”’ “‘out of

affection, respect, admiration, charity or like impulses.”’ Commissioner v.

Duberstein, 363 U.S. 278, 285 (1960) (quoting Commissioner v. LoBue, 351 U.S.

243, 246 (1956), and Robertson v. United States, 343 U.S. 711, 714 (1952)).

While the specific terms of the agreement between Mr. Cheung and Mr. Sun were

not defined, both credibly testified that Mr. Sun was obligated to return some

money to Mr. Cheung at some point. Thus, the transfers were not from detached

and disinterested generosity because Mr. Cheung expected some return of money

from Mr. Sun.
                                        - 29 -

[*29] Further, Mr. Sun did not report the funds transferred by Mr. Cheung’s

foreign companies as gifts or otherwise show that he believed he was receiving

gifts. Generally, section 6039F requires taxpayers to report large foreign gifts.19

The Secretary requires taxpayers to file a Form 3520, Annual Return To Report

Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts, to report

aggregate gifts over $100,000 from foreign individuals and estates and $10,000, as

adjusted for inflation, if the gift purportedly comes from a foreign corporation.

Notice 97-34, 1997-1 C.B. 422; Announcement 98-30, 1998-1 C.B. 962. The

transfers from Mr. Cheung’s foreign companies exceed either of these thresholds

in both tax years 2008 and 2009. The Suns did not file any Form 3520 in tax year

2008 or 2009. Accordingly, the transfers are not gifts because Mr. Cheung did not

give the money out of detached and disinterested generosity and the Suns did not

treat the money as gifts in the 2008 or 2009 tax year.

      Instead it appears that Mr. Cheung’s foreign companies entrusted the money

to Mr. Sun for the specific purpose of having him invest the funds. State law

determines the nature of property rights while Federal law determines the

appropriate tax consequences of those rights. See United States v. Nat’l Bank of


      19
        The sec. 6039F exception for certain organizations are not applicable in
these cases.
                                         - 30 -

[*30] Commerce, 472 U.S. 713, 722 (1985); Blanche v. Commissioner, T.C.

Memo. 2001-63, aff’d, 33 Fed. Appx. 704 (5th Cir. 2002). Texas law recognizes

that a trust may arise at the implication of an intention to create a trust. Mills v.

Gray, 210 S.W.2d 985, 987 (Tex. 1948) (citing 54 Am. Jur. 22, sec. 5). It is not

necessary that a formal trust be created in order to find that the property has been

entrusted. Weingarten v. Commissioner, 38 T.C. 75, 79 (1962). Money a

taxpayer receives in his or her capacity as a fiduciary or agent does not constitute

income to that taxpayer. Heminway v. Commissioner, 44 T.C. 96, 101 (1965);

Cedar Valley Bird Co., LLP v. Commissioner, T.C. Memo. 2013-153.

      A transferee taxpayer does not receive income when the transferor and the

transferee agree that money received is held in trust for the benefit of others. See

Seven-Up Co. v. Commissioner, 14 T.C. 965, 977-978 (1950); Rogers v.

Commissioner, T.C. Memo. 2011-277, aff’d, 728 F.3d 673 (7th Cir. 2013).

Further, funds received in trust by a trustee are excludable from gross income

when those funds are subject to a restriction that they be expended for a specific

purpose and the taxpayer does not profit, gain, or benefit in spending the funds for

the stated purpose. See Bailey v. Commissioner, T.C. Memo. 2012-96 (citing

Ford Dealers Adver. Fund, Inc. v. Commissioner, 55 T.C. 761, 771 (1971), aff’d,

456 F.2d 255 (5th Cir. 1972)), aff’d, 2014 WL 1422580 (1st Cir. Mar. 14, 2014).
                                        - 31 -

[*31] Mr. Sun and Mr. Cheung both credibly testified that Mr. Sun was to invest

money on behalf of Mr. Cheung, and both agree that the funds transferred from

Mr. Cheung’s foreign companies to Minchem were specifically earmarked for

investment purposes. Mr. Cheung, who was an unsuccessful investor, trusted Mr.

Sun to invest the money and eventually to earn a profit from those investments.

Mr. Sun credibly testified that Mr. Cheung did not put any restrictions on how the

money was to be invested, but the money was designated for investment purposes.

Accordingly, the transfers alone do not indicate the funds from Mr. Cheung’s

foreign companies are income to Mr. Sun because Mr. Sun held the money for Mr.

Cheung’s benefit. Specifically, Mr. Sun held the money on behalf of Mr. Cheung

for investment purposes.

      However, funds held in trust by a trustee generally become includible in his

or her gross income once he or she misappropriates the money. Webb v. IRS, 15

F.3d 203, 207 (1st Cir. 1994); Adams v. Commissioner, T.C. Memo. 1970-104,

aff’d, 456 F.2d 259 (9th Cir. 1972). Where a taxpayer misappropriates funds for

the benefit of a related party or where he ultimately receives a benefit from the

defalcation, he has received readily realizable economic value and has been

enriched by it. Hobson v. Commissioner, T.C. Memo. 1992-312. Thus, a taxpayer

must include in his or her gross income money that was misappropriated from
                                       - 32 -

[*32] funds that were held for the benefit of others and used to confer a personal

benefit. See id.

      Whether funds have been misappropriated is a question of fact, but facts

beyond “dominion and control” must be considered. See Bailey v. Commissioner,

T.C. Memo. 2012-96. More specifically, an individual misappropriates funds

when money has been entrusted to the individual for the sole purpose of investing

and the individual instead uses the money for personal activities. DeGoff v.

Commissioner, T.C. Memo. 1966-89.

      As discussed above, Mr. Sun held money transferred by Mr. Cheung’s

foreign companies in trust for Mr. Cheung, and he misappropriated the funds

because he exercised more than mere dominion and control over the money when

he used it for personal purposes. In total, Mr. Sun identified $4,116,414.33 in the

2008 tax year and $1,811,127.65 in the 2009 tax year of personal expenses paid

out of the funds transferred from Mr. Cheung’s foreign companies.

      Mr. Sun undisputedly treated as his own money held for Mr. Cheung’s

benefit and specifically earmarked for investment purposes. For example, Mr. Sun

used some of the funds to purchase a personal automobile and a home automation

system. Perhaps the most obvious example of Mr. Sun’s misappropriation of the

funds is his gambling activities. Mr. Sun transferred around $4,800,000 to casinos
                                        - 33 -

[*33] in 2008 and lost around $2,405,450 of that money through his gambling

activities that year.20 Funds that are originally entrusted to an individual for

investment purposes and are later used by that individual for gambling activities

are considered misappropriated. See id. Accordingly, the funds from Mr.

Cheung’s foreign companies that Mr. Sun admittedly spent for personal purposes

are gross income for the years in which he misappropriated the funds. See Webb,

15 F.3d at 207; Adams v. Commissioner, T.C. Memo. 1970-104.

      Mr. Sun also misappropriated money that remained in the officer loan

account that was used to inflate Minchem’s cashflow when it was applying for a

line of credit because the money benefited Mr. Sun. Mr. Sun chose to place the

money Mr. Cheung’s foreign companies transferred into Minchem’s officer loan

account. Mr. Sun had a choice of how to invest the money and he decided to leave

several million of the foreign company funds in the officer loan account. Both Mr.

Sun and Minchem considered the money as owned by Mr. Sun. In other words,

Mr. Sun chose to let Minchem use the money as its own, in effect lending the

money to Minchem. Minchem reported the money and offsetting liability when


      20
        These amounts do not include two $100 transactions in tax year 2008. On
September 12, $100 was debited from Minchem’s officer loan account to Wynn
casino, and on December 31, $100 was credited to the officer loan account by
Wynn casino. Both transfers note that they are “Reverse Posted” funds.
                                       - 34 -

[*34] applying for a loan account to show that the company could pay its large

outstanding liabilities.21 If Mr. Cheung’s foreign companies had not sent the

money, Mr. Sun would have had to loan Minchem his own money to achieve the

same result.

      Further, Mr. Sun did not use the money for the mutually agreed-upon

purpose when he left the money in the officer loan account. Rather than pursuing

investment opportunities--the action Mr. Cheung trusted Mr. Sun to perform--Mr.

Sun left the money idle in the officer loan account. This deviation from the

agreed-upon investment strategy amounts to a misappropriation of funds. Thus,

loaning the money to his company goes beyond merely taking “dominion and

control” and shows that Mr. Sun misappropriated the entrusted funds by placing

the money in the officer loan account and not using it for its intended purpose.

See DeGoff v. Commissioner, T.C. Memo. 1966-89.

      Mr. Sun contends that he did invest some of the money Mr. Cheung’s

foreign companies transferred to Minchem; but the evidence shows that only a

fraction of it was used for what might be called investment purposes, and all of it

      21
         This is distinctly different from leaving the money in a third-party non-
interest-earning account. The funds were not merely idle but used to effect a
specific purpose chosen by Mr. Sun. Minchem and Mr. Sun would not have
benefited from showing an increased cashflow if the money were deposited and
left idle with a disinterested bank.
                                      - 35 -

[*35] was commingled with Mr. Sun’s personal money. Mr. Sun contends that in

2008 he used $3,204,411.22 out of the $10,430,828.51 transferred into Minchem’s

officer loan account for investment purposes, and in 2009 he used $982,242.57 out

of the $2,795,103 transferred. Specifically, in 2008 Mr. Sun’s personal E*Trade

account received $2,900,000, and Sun Investment received $304,411.22 from

Minchem’s officer loan account. In 2009 Sun Investment received $201,195.57,

Tiger Partnerships LLC received $363,962, Maddox Interests received $65,000,

and Subhouse Capital LLC received $352,085 from Minchem’s officer loan

account.

      All of the money transferred was commingled with Mr. Sun’s other personal

assets. The E*Trade account was his personally, and it held his money for

personal investments. The money transferred from Minchem’s officer loan

account was not separated from Mr. Sun’s money within the E*Trade account, and

it is not clear whose money Mr. Sun was investing in any particular transaction.

Similarly, Mr. Sun was a part owner of all the “investments”. In other words, he

was using the money from Mr. Cheung’s foreign companies to help support his

personal investments.

      While commingling funds alone is not enough to find that money was

misappropriated, commingling funds combined with failing to regard funds as
                                       - 36 -

[*36] subject to restriction on their use may show misappropriation. See Bailey v.

Commissioner, T.C. Memo. 2012-96. The facts in the record clearly show that

Mr. Sun treated the money in the officer loan account--including the money he

potentially used for “investments”--as funds without any restrictions. The record

shows that Mr. Sun viewed the officer loan account as his personal repository of

funds that he could use for any reason, and the money that was transferred to his

“investments” was not in substance transfers on behalf of Mr. Cheung but instead

on behalf of Mr. Sun. The outflow of funds to Mr. Sun’s investments is a

convenient surrogate to support his contention that the money was used for the

benefit of Mr. Cheung; but the commingling and the abandonment of restrictions

supports a conclusion that any money used as an investment was for Mr. Sun, not

Mr. Cheung.

      Mr. Sun misappropriated the funds for personal use, abandoned the intended

purpose for which the money was entrusted, and he did not invest the money in

accordance with the agreed-upon strategy. Accordingly, all the money transferred

to Minchem’s officer loan account from Mr. Cheung’s foreign companies in 2008
                                         - 37 -

[*37] and 2009 is income to Mr. Sun because he treated the funds as his own,

rather than as restricted funds held in a fiduciary capacity.22

IV. Other Transfers

      Besides transferring money to Minchem, Mr. Cheung’s foreign companies

transferred funds directly to Mr. Sun’s E*Trade account and to Sun Investment.

Mr. Sun’s E*Trade account received a total of $1,599,977 as a result of two

transfers from Mr. Cheung’s foreign companies in 2008. Sun Investment received

a total of $3,257,901 as a result of three transfers from Mr. Cheung’s foreign

companies in 2008. Sun Investment also received $299,967 from Mr. Cheung’s

foreign companies in 2009.

      Similar to the money transferred into Mr. Sun’s E*Trade account from

Minchem’s officer loan account, the money transferred directly to Mr. Sun’s

E*Trade account from Mr. Cheung’s foreign companies was commingled and not

specifically earmarked as belonging to Mr. Cheung. Instead Mr. Sun treated all

the funds in his E*Trade account as his personally. Further, Mr. Sun treated all

the gains, losses, and dividends from his E*Trade account as personal. For

      22
         The additional $825,059.49, although not deposited into Minchem’s
officer loan account, was wire transferred to Minchem. The record does not
reflect what happened to the $825,059.49 that was not reported in the officer loan
account, but the Court will presume that Mr. Sun also used the funds as his own.
See supra note 10.
                                         - 38 -

[*38] example, Mr. Sun’s E*Trade account records show that in 2008 the account

was paid $97,600 in taxable dividends. Mr. Sun reported $97,600 in ordinary

dividends on his 2008 personal tax return as received by his E*Trade account.

The Court finds that he was treating all the money transferred to his E*Trade

account as his own. He therefore did not treat the money as funds subject to any

restrictions but showed he was investing the money for himself rather than Mr.

Cheung. See Bailey v. Commissioner, T.C. Memo. 2012-96. Accordingly, the

commingling and the abandoning of the original purpose of investing on behalf of

Mr. Cheung support a conclusion that the income transferred to Mr. Sun’s

E*Trade account from Mr. Cheung’s foreign companies is income to Mr. Sun.

      The amounts transferred to Sun Investment are also income to Mr. Sun

because he did not honor the intended investment strategy or treat the money as

subject to any use restrictions. Mr. Sun treated all the money transferred to Sun

Investment as his personal money. Sun Investment’s specific treatment of the

transfers indicate that the money was Mr. Sun’s personal money. First, Sun

Investment did not give Mr. Cheung a membership interest. Second, Sun

Investment did not increase its liabilities as a result of the transfers. Third, Sun

Investment increased Mr. Sun’s capital account for incoming transferred money.
                                        - 39 -

[*39] Sun Investment is organized as a limited liability company (LLC) that is

taxed as a partnership. In general, owners of LLCs are called members and each

member is allocated his or her portion of the LLC’s income, gain, loss, deductions,

or credits in accordance with the partnership agreement or his or her membership

share. See sec. 704(a) and (b). An investor who contributes money to obtain an

interest in an LLC generally takes a basis in his or her interest in the LLC equal to

the amount of money contributed. Sec. 722. Further, LLCs treated as partnerships

may maintain capital accounts, which may be helpful to track partners’ economic

interests in the LLC. Sec. 1.704-1(b)(2)(iv), Income Tax Regs.

      Mr. Sun directed Mr. Cheung’s foreign companies to send money to Sun

Investment, but Sun Investment did not recognize any new members in 2008 or

2009. Mr. Cheung was not allocated any portion of Sun Investment’s income,

gain, loss, deductions, or credits. Further, Mr. Cheung did not maintain a capital

account with Sun Investment, and Sun Investment did not recognize any new

capital accounts for 2008 or 2009. Instead, Sun Investment stayed a two-member

LLC and the distributive share of the income, gain, loss, deductions, or credits

remained the same for the two members during 2008 and 2009.23 Thus, the money


      23
         Sun Investment may have shifted 0.000001% distributive share of the
profits from Mr. Sun to the other member in 2009.
                                        - 40 -

[*40] transferred to Sun Investment did not represent a direct investment by Mr.

Cheung because he did not take a membership interest in the LLC, nor was the

foreign person-foreign corporation investment reflected in Sun Investment’s tax

returns.

      Similarly, the money transferred to Sun Investment did not represent a loan

from Mr. Cheung’s foreign companies to Sun Investment because the foreign

companies and Sun Investment did not create a debtor/creditor relationship and

Sun Investment did not recognize the money as a loan from Mr. Cheung’s foreign

companies. Mr. Sun represented that the transfers from Mr. Cheung’s foreign

companies to Sun Investment were personal loans from Mr. Cheung, although Sun

Investment did not reflect that position on its tax return

      The facts show that the transfers were not loans. Mr. Sun and Mr. Cheung

did not agree on terms specific enough to establish the creation of a

debtor/creditor relationship for the overall structure, nor did they establish a

debtor/creditor relationship between Mr. Cheung and Sun Investment. See Beaver

v. Commissioner, 55 T.C. at 91; Fisher v. Commissioner, 54 T.C. at 909-911;

Grzegorzewski v. Commissioner, T.C. Memo. 1995-49. Further, despite Sun

Investment’s claim that the $2,059,334 transferred from Mr. Cheung’s foreign

companies was a loan, Sun Investment reported only a $309,913 increase in
                                       - 41 -

[*41] liabilities for 2008.24 For 2009 Sun Investment reported that its total

liabilities increased by $285,087 despite claiming that Mr. Cheung’s foreign

companies loaned $299,967 to the LLC.25 Accordingly, Sun Investment’s

assertion that Mr. Cheung loaned the money to Sun Investment conflicts with its

Forms 1065, and the money was not a loan to Sun Investment.

      Similar to the substance of the transfers of funds to Minchem’s officer loan

account discussed above, the substance of the transfers to Sun Investment appears

to be that Mr. Cheung’s companies intended to entrust Mr. Sun with funds

specifically earmarked for investment purposes. Instead of creating a

debtor/creditor relationship, Mr. Cheung entrusted Mr. Sun to invest the money.

Mr. Sun did not invest on behalf of Mr. Cheung but instead chose to use the

money for his personal investment in Sun Investment. Sun Investment shows that

the increase in money was from Mr. Sun personally because on Mr. Sun’s 2008

Schedule K-1, Partner’s Share of Income, Deductions, Credits, etc., Sun

Investment reported that Mr. Sun contributed an additional $3,436,324 of capital


      24
        Sun Investment reported a $52,166 increase in “other current liabilities”
and a $257,747 increase in “mortgages, notes, bonds payable in 1 year or more” on
its 2008 Form 1065, U.S. Return of Partnership Income.
      25
       Sun Investment reported increases of $312 in “other current liabilities” and
$284,775 in liabilities for “mortgages, notes, bonds payable in 1 year or more” on
the LLC’s 2009 Form 1065.
                                      - 42 -

[*42] to the LLC in 2008. Similar, Sun Investment reported on Mr. Sun’s 2009

Schedule K-1 that Mr. Sun contributed an additional $796,387 of capital to the

LLC in 2009.

       Thus, Mr. Sun was treating the money transferred from Mr. Cheung’s

foreign companies as his own. Mr. Cheung did not take a membership interest in

Sun Investment; Sun Investment did not recognize that the money was a loan from

Mr. Cheung but instead increased Mr. Sun’s capital account in 2008 and 2009.

Accordingly, the money transferred directly to Sun Investment is income to Mr.

Sun.

V. Penalties

       Respondent determined penalties under section 6663(a) for both Minchem

and the Suns for 2008 and 2009. Respondent determined Minchem is liable for

section 6663(a) penalties of $2,784,405.75 and $772,814.25 for 2008 and 2009,

respectively. Respondent originally determined the Suns were liable for section

6663(a) penalties of $2,542,290 and $427,663.50 for 2008 and 2009, respectively.

These fraud penalties represented 75% of each of the Suns’ total underpayments.

Respondent later conceded that the portions of the underpayments resulting from

the 2009 investment interest expense deduction and the unreported income from

personal meals and entertainment expenses paid by Minchem in 2008 and 2009
                                       - 43 -

[*43] were not due to fraud. Thus, the Suns are not liable for 75% penalties under

section 6663(a) on the portions of the underpayments stemming from these items.

Respondent instead argues that the Suns are liable for penalties under section 6662

for the portions of the underpayments attributable to these items.

      In the alternative to the remaining section 6663(a) penalties, respondent

determined that the Suns and Minchem are liable for accuracy-related penalties for

the 2008 and 2009 years as a result of the transfers from Mr. Cheung’s foreign

companies. Specifically, respondent alternatively determined the Suns owe

accuracy-related penalties of $677,944 and $114,043.60 for 2008 and 2009,

respectively. Respondent alternatively contends that Minchem owes accuracy-

related penalties of $742,508.20 and $206,083.90 for 2008 and 2009, respectively.

      A. Section 6663(a) Penalties

      Respondent argues that petitioners are liable for the section 6663 fraud

penalties for the years in issue. Fraud is an intentional wrongdoing on the part of

the taxpayer with the specific purpose of evading a tax believed to be owing.

Edelson v. Commissioner, 829 F.2d 828, 833 (9th Cir. 1987), aff’g T.C. Memo.

1986-223. A penalty equal to 75% will be imposed on any part of the taxpayer’s

underpayment of Federal income tax that is due to fraud. Sec. 6663(a). Further, if

any portion of the underpayment is attributable to fraud, the entire underpayment
                                        - 44 -

[*44] will be treated as attributable to fraud unless the taxpayer establishes by a

preponderance of the evidence that part of the underpayment is not due to fraud.

Sec. 6663(b); see Foxworthy, Inc. v. Commissioner, T.C. Memo. 2009-203, aff’d,

494 Fed. Appx. 964 (11th Cir. 2012).

      Respondent has the burden of proving by clear and convincing evidence

that an underpayment exists for each of the years in issue and that some portion of

the underpayment is due to fraud. See secs. 6663(a), 7454(a); Rule 142(b);

Clayton v. Commissioner, 102 T.C. 632, 646 (1994).

      As discussed above, Minchem does not have underpayments as a result of

the transfers from Mr. Cheung’s foreign companies because in substance the funds

were merely deposited in Minchem’s officer loan account, which was for the

benefit of Mr. Sun, who then misappropriated the funds by either using the money

for personal reasons or leaving the money in Minchem’s officer loan account.

Accordingly, Minchem is not liable for fraud penalties under section 6663(a) for

2008 and 2009.

      The Suns, on the other hand, do have underpayments as a result of the

transfers from Mr. Cheung’s foreign companies to Minchem for 2008 and 2009.

The Suns have further underpayments as a result of the transfers to Mr. Sun’s
                                        - 45 -

[*45] E*Trade account and Sun Investment. Accordingly, respondent has met the

burden with respect to this requirement of the section 6663(a) fraud penalty.

      Respondent must also prove by clear and convincing evidence that

petitioners had the requisite fraudulent intent. Parks v. Commissioner, 94 T.C.

654, 664 (1990). Fraud is intentional wrongdoing designed to evade tax believed

to be owing. Neely v. Commissioner, 116 T.C. 79, 86 (2001). The existence of

fraud is a question of fact to be resolved upon consideration of the entire record.

Estate of Pittard v. Commissioner, 69 T.C. 391, 400 (1977). Fraud is not to be

presumed or based upon mere suspicion. Petzoldt v. Commissioner, 92 T.C. 661,

699-700 (1989). However, because direct proof of a taxpayer’s intent is rarely

available, fraudulent intent may be established by circumstantial evidence.

Grossman v. Commissioner, 182 F.3d 275, 277-278 (4th Cir. 1999), aff’g T.C.

Memo. 1996-452. The Commissioner satisfies this burden of proof by showing

that “the taxpayer intended to evade taxes known to be owing by conduct intended

to conceal, mislead, or otherwise prevent the collection of taxes.” Parks v.

Commissioner, 94 T.C. at 661. The taxpayer’s entire course of conduct may be

examined to establish the requisite intent, and an intent to mislead may be inferred

from a pattern of conduct. Webb v. Commissioner, 394 F.2d 366, 379 (5th Cir.
                                        - 46 -

[*46] 1968), aff’g T.C. Memo. 1966-81; Stone v. Commissioner, 56 T.C. 213, 224

(1971).

      Circumstances that may indicate fraudulent intent, commonly referred to as

“badges of fraud,” include but are not limited to: (1) understating income; (2)

maintaining inadequate records; (3) giving implausible or inconsistent

explanations; (4) concealing income or assets; (5) failing to cooperate with tax

authorities; (6) engaging in illegal activities; (7) providing incomplete or

misleading information to one’s tax preparer; (8) lack of credibility of the

taxpayer’s testimony; (9) filing false documents, including false income tax

returns; (10) failing to file tax returns; and (11) dealing in cash. Spies v. United

States, 317 U.S. 492, 499 (1943); Morse v. Commissioner, T.C. Memo. 2003-332,

aff’d, 419 F.3d 829 (8th Cir. 2005). No single factor is dispositive; however, the

existence of several factors “is persuasive circumstantial evidence of fraud.”

Vanover v. Commissioner, T.C. Memo. 2012-79, slip op. at 11.

      After reviewing the facts and the badges of fraud, the Court concludes that

respondent has failed to meet the burden to show that either of the Suns had the

requisite fraudulent intent to impose penalties under section 6663(a). While

respondent asserted 10 different badges applied to the Suns, several of the asserted
                                        - 47 -

[*47] badges were duplicative.26 Excluding the duplicative badges, respondent

contends the following factors are present in this case: (1) the Suns underreported

income for both 2008 and 2009; (2) the Suns failed to maintain adequate records;

(3) the Suns offered implausible and inconsistent explanations; (4) the Suns failed

to cooperate with tax authorities; (5) the Suns provided incomplete or misleading

information to their tax preparers; (6) Mr. Suns’ testimony was not credible; and

(7) the Suns filed false documents, including false income tax returns.

             1. Understating Income

      A pattern of substantially underreporting income for several years is strong

evidence of fraud, particularly if the understatement is not satisfactorily explained

or due to innocent mistake. See Holland v. United States, 348 U.S. 121, 137-139

(1954); Spies, 317 U.S. at 499; Webb v. Commissioner, 394 F.2d at 379; Morse v.

Commissioner, T.C. Memo. 2003-332; see also Green v. Commissioner, T.C.

Memo. 2010-109 (finding that a satisfactory explanation may weigh against a

finding of fraud).


      26
        Respondent’s badge of “Omission of entire source of income” fits within
the “understating income” badge, also asserted by respondent. Respondent’s
badge of “Making inconsistent representations” fits within the “Implausible and
inconsistent explanations” badge, also asserted by respondent. Last, respondent’s
“False statement about a material fact” fits within the “Lack of credibility of the
taxpayer’s testimony” badge, also asserted by respondent.
                                       - 48 -

[*48] The Suns underreported income for the years in issue as a result of the

transfers from Mr. Cheung’s foreign companies. Mr. Sun used the money as his

own and did not report the funds as income. This weighs in favor of finding

fraudulent intent as to Mr. Sun.

             2. Maintaining Inadequate Records

      Fraudulent intent can be inferred from a failure to maintain adequate books

and records. See Scott v. Commissioner, T.C. Memo. 2012-65; Ark. Oil & Gas,

Inc. v. Commissioner, T.C. Memo. 1994-497. Respondent contends that the lack

of loan documents is indicative of fraudulent intent. Respondent does not assert

and did not offer any evidence showing that Minchem or Mr. Sun was keeping

multiple books or inadequate accounting records. Respondent instead contends

that it is implausible that Mr. Sun and Mr. Cheung had a verbal loan agreement.

Respondent also contends that the officer loan account arrangement is implausible.

Respondent did not offer evidence or testimony to support contentions that verbal

loan agreements were implausible. Respondent relies on a contention that “this is

not the usual way that sophisticated people behave”. In contrast, Mr. Sun credibly

testified that he often engaged in business transactions without documentation.

Thus, while the Court ultimately decides that the substance of the transactions was
                                       - 49 -

[*49] not a loan, respondent did not carry the burden to show that the Suns failed

to maintain adequate records. Accordingly, this factor is neutral.

             3. Giving Implausible or Inconsistent Explanations

      A taxpayer’s implausible or inconsistent explanations for his actions may

constitute circumstantial evidence of fraudulent intent. See Bradford v.

Commissioner, 796 F.2d 303, 307-308 (9th Cir. 1986), aff’g T.C. Memo. 1984-

601; Bahoric v. Commissioner, 363 F.2d 151, 153 (9th Cir. 1966), aff’g T.C.

Memo. 1963-333; Gagliardi v. United States, 81 Fed. Cl. 772, 784 (2008).

Respondent primarily relies on inconsistencies between Mr. Cheung’s and Mr.

Sun’s testimony to show inconsistent explanations. This looks more like two

people’s not reaching an agreement before conducting a transaction than like Mr.

Sun’s giving inconsistent explanations for his actions. In fact, Mr. Sun’s

explanations regarding the transactions were consistent throughout the proceeding.

He may not have understood the implications of his actions, but the record does

not indicate that he offered inconsistent explanations with the intent to evade any

tax owed. Further, as discussed above, respondent contends that the loan

arrangements were implausible but does not offer testimony or other evidence to

support his assertion that verbal loan arrangements are necessarily implausible.
                                       - 50 -

[*50] Thus, respondent has failed to show Mr. Sun offered implausible or

inconsistent explanations. This factor is neutral.

             4. Failing To Cooperate With Tax Authorities

      Failing to cooperate with tax authorities is indicative of fraud. Bradford v.

Commissioner, 796 F.2d at 307-308. Respondent contends that both of the Suns

failed to cooperate with tax authorities when they failed to respond to three

information requests (IDR) and were rude to revenue agents. Respondent

admitted that he previously possessed the information requested in one of the

IDRs but requested the information through an IDR for ease. The Suns’ certified

public accountant (CPA) credibly testified that the Suns had sent all the

information that they had to satisfy the outstanding IDRs. Any information not

provided was information the Suns did not have.

      Respondent also contends that the Suns were rude to one of his agents. The

agent, however, appears to have ignored a request by the Suns’ CPA to honor a

power of attorney and not directly contact Mr. Sun. Instead the agent may have

been bypassing the CPA with power of attorney to seek information directly from

the Suns. It is understandable that the Suns may have become frustrated with a

revenue agent who did not honor a power of attorney. Accordingly, this factor is

neutral for fraudulent intent.
                                       - 51 -

[*51]         5. Providing Incomplete or Misleading Information to One’s Tax
                 Preparer

        Evidence that a taxpayer provided incomplete or misleading information to

his return preparer is circumstantial evidence of fraud. See Morse v.

Commissioner, 419 F.3d at 823-833. A taxpayer acts fraudulently when he

conceals income from his return preparer. See Korecky v. Commissioner, 781

F.2d 1566, 1569 (11th Cir. 1986), aff’g T.C. Memo. 1985-63; Patel v.

Commissioner, T.C. Memo. 2008-223; Morse v. Commissioner, T.C. Memo.

2003-332. Respondent contends that Mr. Sun provided misleading information to

his CPA by giving him Minchem’s complete general ledger. Specifically,

respondent contends that the officer loan account is misleading and it should not

have been used to prepare the Suns’ tax returns. As discussed above, Mr. Sun

misappropriated the funds transferred by Mr. Cheung’s foreign companies, but the

officer loan account arrangement was not in itself misleading. In fact, the officer

loan account arrangement is consistent with Mr. Sun’s misappropriation because

Minchem, as well as Mr. Sun, treated the funds as his personally. Thus, Mr. Sun

did not offer misleading information to his CPA by giving him Minchem’s

complete general ledger. Respondent offers no other testimony or other evidence
                                        - 52 -

[*52] demonstrating that the Suns provided incomplete or misleading information.

Accordingly, this factor favors the Suns.

              6. Lack of Credibility of the Taxpayer’s Testimony

       A taxpayer’s lack of credibility, “the inconsistencies in his testimony and

his evasiveness on the stand[,] are heavily weighted factors in considering the

fraud issue.” Toussaint v. Commissioner, 743 F.2d 309, 312 (5th Cir. 1984), aff’g

T.C. Memo. 1984-25; Devries v. Commissioner, T.C. Memo. 2011-185.

Respondent contends that Mr. Sun offered incredible and inconsistent testimony.

However, Mr. Sun was credible in his testimony. He was not evasive, he admitted

that he used large quantities of the money for personal purposes, and he was

consistent with regard to his understanding of the arrangement. He credibly

testified that he thought he was allowed unrestricted use of the money, despite the

fact that he was mistaken about the implications of treating the funds as his own.

In other words, Mr. Sun was credible and consistent, but wrong. Accordingly, this

factor is neutral.

              7. Filing False Documents, Including False Income Tax Returns

       Fraudulent intent may be inferred when a taxpayer files a tax return

intending to conceal, mislead, or prevent the collection of tax. See Spies, 317 U.S.

at 499. Respondent contends this badge is very similar to the “Understating
                                        - 53 -

[*53] Income” factor discussed above. Respondent contends that the Suns filed

false returns by failing to report income. However, respondent has not pointed to

any evidence suggesting that the Suns’ failure to report the income was a result of

an attempt to conceal, mislead, or prevent the collection of tax.27 Respondent’s

position appears to be that all incorrect tax returns are fraudulent simply because

they are incorrect. Failure to report income is not necessarily fraudulent and may

be by misunderstanding. Respondent has failed to show the Suns filed documents

with the intent to conceal, mislead, or prevent the collection of tax. Accordingly

this factor is neutral.

       In sum, only one badge of fraud points to finding fraudulent intent; the other

asserted badges are either neutral or favor the Suns’ position. After weighing the

facts, the Court finds that respondent has not met his burden to show the Suns had

the requisite fraudulent intent to impose a penalty under section 6663(a) for 2008

or 2009.




       27
         Respondent did not introduce evidence or pursue any potential reporting
requirements in regard to a nonresident alien or a foreign company transferring
large quantities of money into the United States for a purported investment. But
for the obvious gift reporting requirement discussed in detail supra p. 29, the
Court will not attempt to analyze any additional potential failure of reporting
requirements in regard to the wire transfers and investments.
                                        - 54 -

[*54] B. Section 6662 Penalties

      In the alternative to the fraud penalties under section 6663(a) relating to the

treatment of the transfers by Mr. Cheung’s foreign companies, respondent

determined that the Suns and Minchem are liable for accuracy-related penalties for

2008 and 2009. Respondent also contends that the Suns are liable for an accuracy-

related penalty relating to the investment interest expense deduction for 2009 and

for the deductions for personal expenses paid directly by Minchem but not through

the officer loan account. As discussed above, Minchem does not have an

underpayment as a result of the transfers. Accordingly, Minchem is not liable for

a penalty under section 6662 relating to the transfers.28

      Section 6662(a) and (b)(1) and (2) authorizes the imposition of a 20%

penalty on the portion of an underpayment of tax that is attributable to, among

other things, (1) negligence or disregard of rules or regulations or (2) any

substantial understatement of income tax. Only one accuracy-related penalty may

be imposed with respect to any given portion of an underpayment, even if that

portion is attributable to more than one of the reasons identified in section

6662(b). Sec. 1.6662-2(c), Income Tax Regs.

      28
       Petitioners’ conceding the adjustments to Minchem’s business expense
deductions for the Suns’ travel and entertainment will result in a penalty under sec.
6662(a) and a Rule 155 computation.
                                         - 55 -

[*55] The Commissioner bears the initial burden of production with respect to the

taxpayer’s liability for the section 6662 penalty. Sec. 7491(c). The Commissioner

must introduce sufficient evidence “indicating that it is appropriate to impose the

relevant penalty.” Higbee v. Commissioner, 116 T.C. 438, 446 (2001). Once the

Commissioner meets his burden of production, the taxpayer must come forward

with persuasive evidence that the Commissioner’s determination is incorrect or

that the taxpayer had reasonable cause or substantial authority for the position. Id.

at 446-447.

      The term “negligence” includes any failure to make a reasonable attempt to

comply with the provisions of the internal revenue laws, and the term “disregard”

includes any careless, reckless, or intentional disregard. Sec. 6662(c); sec. 1.6662-

3(b)(1) and (2), Income Tax Regs. 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 that would seem to a reasonable and

prudent person to be “too good to be true” under the circumstances. Sec. 1.6662-

3(b)(1)(ii), Income Tax Regs. Disregard of rules or regulations “is ‘careless’ if the

taxpayer does not exercise reasonable diligence to determine the correctness of a

return position” and “is ‘reckless’ if the taxpayer makes little or no effort to

determine whether a rule or regulation exists, under circumstances which
                                       - 56 -

[*56] demonstrate a substantial deviation from the standard of conduct that a

reasonable person would observe.” Sec. 1.6662-3(b)(2), Income Tax Regs.; see

also Neely v. Commissioner, 85 T.C. 934, 947 (1985).

      Respondent has met his burden to show that the Suns carelessly, recklessly,

or intentionally disregarded rules and regulations for their home equity loan

interest deduction. The Suns did not exercise reasonable diligence to determine

whether the deduction was correct. In fact it appears they specifically looked for a

method to deduct all of the home equity loan interest without determining whether

a rule or regulation prevented the deduction. On one Form 1098 someone

specifically noted that all of the interest was to be deducted somehow.29

Accordingly, respondent has met his burden of production to show that a section

6662 penalty for the home equity loan interest deduction for tax year 2009 is

appropriate.

      Respondent has also met his burden to show that the Suns acted negligently

or with careless disregard of rules and regulations with regard to the income

received from Mr. Cheung’s foreign companies, Mr. Sun’s excluded gambling

      29
         The note on a Form 1098 sent from Mr. Sun for tax year 2009 read
“$60,000 to mtg int[,] bal. to invest int exp”, meaning that $60,000 of the home
equity loan interest would be deducted as mortgage interest and the remaining
interest would be deducted as an investment interest expense. The Suns’ CPA
followed this note and deducted the interest accordingly.
                                       - 57 -

[*57] income, and the personal travel and entertainment paid for by Minchem.

Mr. Sun used the money transferred by Mr. Cheung’s foreign companies for

personal purposes and did not attempt to comply with the provisions of the

internal revenue laws. He failed to look into the implications of receiving the

money and to investigate the obligations associated with using the money. A

reasonable and prudent person would think receiving the funds from Mr. Cheung’s

foreign companies tax free, report free, and with an un-agreed-upon obligation to

repay the money is “too good to be true”. It was also too good to be true that Mr.

Sun could use Mr. Cheung’s money for gambling activities or that Minchem could

pay the Suns’ personal travel and entertainment costs without their being taxed on

the income. Accordingly, respondent has met his burden and shown that the Suns

were negligent in failing to report income from transfers by Mr. Cheung’s foreign

companies, Mr. Sun’s gambling income, and personal travel and entertainment

paid for by Minchem in 2008 and 2009.

      Taxpayers may avoid liability for the section 6662(a) penalty if they

demonstrate that they had reasonable cause for the underpayment and that they

acted in good faith with respect to the underpayment. Sec. 6664(c)(1).

Reasonable cause and good faith are determined on a case-by-case basis, taking

into account all pertinent facts and circumstances. Sec. 1.6664-4(b)(1), Income
                                       - 58 -

[*58] Tax Regs. The most important factor is the extent of the taxpayer’s efforts

to assess his or her proper tax liability. Id. Reliance on professional advice may

constitute reasonable cause and good faith, but “it must be established that the

reliance was reasonable.” Freytag v. Commissioner, 89 T.C. 849, 888 (1987),

aff’d on another issue, 904 F.2d 1011 (5th Cir. 1990), aff’d, 501 U.S. 868 (1991).

The Court has previously held that the taxpayer must satisfy a three-prong test to

be found to have reasonably relied on professional advice to negate a section

6662(a) accuracy-related penalty: (1) the adviser was a competent professional

who had sufficient experience to justify the reliance; (2) the taxpayer provided

necessary and accurate information to the adviser; and (3) the taxpayer actually

relied in good faith on the adviser’s judgment. Neonatology Assocs., P.A. v.

Commissioner, 115 T.C. 43, 99 (2000), aff’d, 299 F.3d 221 (3d Cir. 2002).

      The Suns contend that they relied on their CPA to prepare their 2008 and

2009 tax returns and thus should not be liable for the accuracy-related penalties.

Reliance necessary to escape the penalty under section 6662(a) does not occur

when a taxpayer merely provides raw numbers to an accountant for the accountant

to prepare the return and the taxpayer does not carefully examine the return. See

Woodsum v. Commissioner, 136 T.C. 585, 594, (2011) (“In signing the return thus

erroneously prepared, petitioners were not deliberately following substantive
                                       - 59 -

[*59] professional advice; they were instead unwittingly (they contend)

perpetuating a clerical mistake. The defense of reliance on professional advice has

no application here.”); Jackson v. Commissioner, T.C. Memo. 2014-160. In other

words, a taxpayer cannot escape the penalty when the taxpayer does not seek or

receive an opinion from his or her preparer. See Todd v. Commissioner, T.C.

Memo. 2011-123, aff’d, 486 Fed. Appx. 423 (5th Cir. 2012). The mere fact that a

CPA has prepared a tax return does not mean that he or she has opined on any or

all of the items reported therein. Neonatology v. Commissioner, 115 T.C. at 100.

The Suns did not show that they relied on their tax preparer’s advice or opinions.

Instead, the record reflects the Suns’ CPA prepared the tax returns but did not

offer any advice or opinions on the positions taken on the returns. See id. The

Suns turned over financial information to their CPA and the CPA prepared the

returns according to the received information. Mr. Sun did not ask about receiving

the money from Mr. Cheung’s foreign companies or about spending that money.

Further, there is no evidence that Mr. Sun sought advice regarding the home

equity loan interest deductions or the travel and entertainment paid for by

Minchem. Thus there was no advice on which Mr. Sun could have relied to

escape the penalties. Accordingly, the Suns cannot use section 6664 to escape the

accuracy-related penalty under section 6662(a) for 2008 or 2009.
                                       - 60 -

[*60] The Court, in reaching its holdings, has considered all arguments made, and,

to the extent not mentioned, concludes that they are moot, irrelevant, or without

merit.

         To reflect the foregoing,


                                                     Decisions will be entered

                                                under Rule 155.
