                         T.C. Memo. 2010-287



                       UNITED STATES TAX COURT



       MICHAEL C. WINTER AND LAUREN WINTER, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 5035-05.                Filed December 30, 2010.



     John B. Beery, Joseph M. Laub, and John J. Scharkey III, for

petitioners.

     Kathleen C. Schlenzig, for respondent.


               MEMORANDUM FINDINGS OF FACT AND OPINION


     HOLMES, Judge:    Michael Winter owned stock in the bank where

he worked.   The bank paid him a large bonus in 2002, but then

fired him and demanded part of the bonus back.   On his 2002

return, Winter reported the full amount of his bonus, and his

share of the bank’s income and deductions--not as those items

were reported by the bank, but from his own estimates.
                                - 2 -

     The parties argued mostly about the consequences of Winter’s

failure to report his income from the bank consistently with its

return, and about the taxability of his bonus in the year he

received it.   I would have held that the Court lacks jurisdiction

over these questions, but my colleagues, in a reviewed opinion,

assured me, the parties, and the rest of the audience for our

opinions that we did have jurisdiction in Winter v. Commissioner,

135 T.C.       (2010) (Winter I).   Retreating back into my role as

the trial judge in the case, and resuming our customary habit of

using the first person plural, we now decide all the remaining

issues in the case.    Winter I laid out the facts in detail and we

assume familiarity with them.

     The key fact was that Winter failed to report his income

from Builders Financial Corporation (BFC) consistently with the

Schedule K-1, Shareholder’s Share of Income, Credits, Deductions,

that BFC prepared for him.   Winter claims he never got the K-1,

and instead used BFC’s published regulatory statements to

calculate his passthrough income.    Using these numbers, Winter

calculated his share of BFC’s income to be a $1.2 million loss

instead of the $820,031 gain BFC reported.    Winter faults BFC’s

tax return for deducting only a portion of his prepaid bonus in

2002.   The Commissioner also asserted that Winter failed to
                               - 3 -

report some dividend, interest, and gambling income.    Winter has

since conceded those adjustments.1

     Yet another dispute arises from an issue not even mentioned

in the notice of deficiency--the taxability of the bonus payment.

Winter doesn’t deny he received a W-2 showing 2002 compensation

of $5,623,559, and he did report this entire amount on his

return.   But now he claims that he didn’t have to.   Finally, the

Commissioner questions the deductibility of Winter’s pro-rata

share of BFC’s charitable contributions and says Winter should

pay an accuracy-related penalty.     There are thus four substantive

issues:

     •     How should Winter have reported his proportionate share
           of BFC’s income or loss (and did BFC report the amount
           correctly);

     •     Was the unearned portion of his bonus income in 2002;

     •     Can he take a charitable-contribution deduction for his
           share of BFC’s donations; and

     •     Is he liable for an accuracy-related penalty?




     1
       Winter expressly conceded $12,111 in dividend and gambling
income, but the notice of deficiency also included an adjustment
for $178 in unreported interest income that isn’t specifically
addressed by either party. Though Winter disputed the “entire
amount of the deficiency” in his petition, he didn’t pursue this
issue on brief and we therefore deem it conceded. See Rule
151(e)(4) and (5); Petzoldt v. Commissioner, 92 T.C. 661, 683
(1989). (This Rule reference, like all Rule references in this
opinion, is to the Tax Court Rules of Practice and Procedure.
All section references are to the Internal Revenue Code unless
otherwise noted.)
                               - 4 -

     Winter was a resident of Illinois when he filed his

petition, and the parties submitted the case for decision under

Rule 122.

                            Discussion

I.   Winter’s Passthrough Income

     Our first puzzle is whether it was wrong for Winter to

report a passthrough loss on his return instead of reporting the

passthrough income shown on his K-1.2    One large difference

between Winter’s and BFC’s reporting–-and the only one the

parties focus on here--is the treatment of the $5.1 million

prepayment of Winter’s five-year, $5.5 million bonus that BFC

made in 2002.   Because BFC is a passthrough corporation, deciding

how it should have treated the bonus will tell us how Winter

should have reported it.

     The major disputes are about the payment’s proper

characterization and the timing of its deduction.    No one

disputes that BFC properly deducted about $1.1 million of the



     2
       S corporations used to be subject to TEFRA, the Tax Equity
and Fiscal Responsibility Act of 1982, Pub. L. 97-248, 96 Stat.
324, one part of which governs the tax treatment and audit
procedures for most partnerships, TEFRA secs. 401-406, 96 Stat.
648. In an effort to promote consistent reporting among
shareholders, TEFRA originally required taxpayers to challenge S
corporations’ taxes in a single, corporation-level proceeding.
In 1996, however, Congress repealed this part of TEFRA, Small
Business Job Protection Act of 1996, Pub. L. 104-188, sec.
1307(c)(1), 110 Stat. 1781, and shareholders like Winter may now
challenge their S corporation’s tax return in individual
proceedings like this one.
                               - 5 -

bonus in 2002--the portion that Winter earned that year.   See

sec. 162(a)(1); sec. 1.162-9, Income Tax Regs.   But Winter claims

BFC, as a cash-basis taxpayer, should also have deducted another

$4 million, the part of the bonus that BFC prepaid.   Winter

claims that BFC had authority to deduct this disputed portion in

2002 under either section 461(f), as a contested liability

because the payment resembled severance, or under section 162 as

an ordinary and necessary business expense.   The Commissioner

disagrees.

     A.   Does Section 461(f) Apply?3

     Unless the Code explicitly allows a taxpayer to make an

election, each of his expenses has a proper year for its

deduction.   Crisp v. Commissioner, T.C. Memo. 1989-668 (“It is

intrinsic to our system of annual accounting that each item of

income and expense has a singular, correct treatment under a

taxpayer’s chosen method of accounting”); see also sec. 1.263(a)-

3(b), Income Tax Regs. (listing Code sections that allow a

taxpayer to elect timing of certain deductions).   Section 461(a)

states the general rule--a deduction is to be taken in the

“proper taxable year under the method of accounting used in

computing taxable income”--and the remaining subsections create



     3
       Section 461(f) applies to both cash-basis and accrual-
method taxpayers. Barnette v. Commissioner, T.C. Memo. 1992-371
(citing Weber v. Commissioner, 70 T.C. 52, 55 n.4 (1978)), affd.
41 F.3d 667 (11th Cir. 1994).
                               - 6 -

various exceptions or qualifications.   So we know at the outset

that if any of the latter subsections applies, its specific rule

will trump section 461(a)’s general one.    See Pilaria v.

Commissioner, T.C. Memo. 2002-230 (citing Bulova Watch Co. v.

United States, 365 U.S. 753, 758 (1961)).

     One of the exceptions is section 461(f), which applies to

“contested liabilities.”   The Commissioner’s main argument on

this issue is that Winter’s prepaid bonus wasn’t contested, and

therefore section 461(f) doesn’t apply.    So we must first decide

if the disputed portion of the bonus was “contested”.   If it was,

we have to follow section 461(f)’s timing rules.   If not, we have

to revert to section 461(a) and analyze the timing of the

deduction under BFC’s accounting method.

     The Code doesn’t say when we should look to see if a contest

exists, but the Commissioner argues the right time to look to see

if a contest exists is the time when the payment was made.

Because BFC paid Winter when both parties were happy with each

other, the Commissioner argues, there was no “contested

liability” under section 461(f).   Without more, this would be a

plausible reading of the statute, but an example in the

regulation points in exactly the opposite direction:

          Example: * * * O [Corporation] receives a large
     shipment of typewriter ribbons from S Company on
     January 30, 1964, which O pays for in full on February
     10, 1964. Subsequent to their receipt, several of the
     ribbons prove defective because of inferior materials
     used by the manufacturer. On August 9, 1964, O orally
                                - 7 -

     notifies S and demands refund of the full purchase
     price of the ribbons. After negotiations prove futile
     and a written demand is rejected by S, O institutes an
     action for the full purchase price. For purposes of
     paragraph (a)(1)(i) of this section, S has asserted a
     liability against O which O contests on August 9, 1964.
     O deducts the contested amount for 1964.

Sec. 1.461-2(b)(3), Income Tax Regs.    This example forces us to

reject the Commissioner’s contention that the contest had to

exist when BFC paid Winter.   We think instead that it makes more

sense to look at whether a contest existed at the end of the tax

year.   We infer this from the regulation, which says a contest

under section 461(f) means “[a]ny contest which would prevent

accrual of a liability under section 461(a).”   Sec. 1.461-

2(b)(2), Income Tax Regs.   If a liability isn’t contested at the

end of the tax year, then the taxpayer can use the ordinary

deduction-timing rules of section 461(a); if it is, he cannot.

     The relevant regulations also say there is a contest when

“there is a bona fide dispute as to the proper evaluation of the

law or the facts necessary to determine the existence or

correctness of the amount of an asserted liability.”   Sec. 1.461-

2(b)(2), Income Tax Regs.   Although beginning a lawsuit is

sufficient to establish a contest, it isn’t necessary–-an

affirmative act denying the validity of the liability is

sufficient.   Id.   It isn’t even necessary that the objection be

in writing.   Id.   Although BFC didn’t sue Winter until 2003, we

find that BFC’s November 2002 “Notice of Termination for Cause”
                                - 8 -

suffices to mark the start of a “contest”.    As in the

regulation’s example, BFC paid without complaint but later

decided to demand partial repayment.    From the example we know a

contest begins on the date the payor notifies the payee of its

discontent.    BFC’s letter was sent in November 2002, before the

close of the tax year.    We also find that BFC’s later demand for

repayment sent in January 2003 proves that the contest continued

to exist at the end of the 2002 tax year.    We therefore must look

to section 461(f).

       B.   Contested Liabilities

       Section 461(f) allows a deduction for a contested liability

in the year paid if the following conditions are met:

            (1) the taxpayer contests an asserted liability,

            (2) the taxpayer transfers money or other property
       to provide for the satisfaction of the asserted
       liability,

            (3) the contest with respect to the asserted
       liability exists after the time of the transfer, and

            (4) but for the fact that the asserted liability
       is contested, a deduction would be allowed for the
       taxable year of the transfer * * * determined after
       application of subsection (h) * * *

       The Commissioner argues that not one of these elements is

met.    He says that because BFC paid Winter voluntarily and did

not contest the amount at the time of the payment, BFC did not

contest an asserted liability or transfer money to provide for

the satisfaction of the asserted liability.    He even reads the
                                - 9 -

third element to say the contest had to exist at the time BFC

made the payment.    The Commissioner finally says the deduction

fails the fourth element because the deduction doesn’t pass the

economic-performance test of subsection (h).    We’ll look at the

elements in order.

          1.     Taypayer Contests an Asserted Liability

     The first element requires us to decide if there was a

contest and if there was an asserted liability.    We’ve already

found that a contest did exist, and turn immediately to figure

out if there was an asserted liability.

     An asserted liability under section 461(f) is “an item with

respect to which, but for the existence of any contest in respect

of such item, a deduction would be allowable under an accrual

method of accounting.”    Sec. 1.461-2(b)(1), Income Tax Regs.

(emphasis added).    For these purposes, we assume the contest

away–-that is, we assume BFC fired Winter without cause and

Winter gets to keep the money–-and we pretend that BFC uses the

accrual method of accounting.    We then ask if, in those

circumstances, BFC should have deducted the entire amount in

2002.

     This brings us to an important characterization question

(and one of the main disagreements):    What did BFC actually pay

for with the disputed portion of the bonus if BFC fired Winter

without cause?   Winter says the characterization of the payment
                                - 10 -

morphed when he got the boot–-it was no longer a prepayment for

future services but compensation for his early dismissal–-a sort

of severance or contract-termination payment.     The Commissioner

doesn’t disagree that severance would be deductible, but instead

argues that the payment’s characterization didn’t change from

earlier in the year--that it was still for services to be

rendered in the future.    The Commissioner then reasons that BFC

can’t deduct the disputed portion in 2002 because Winter did not

“actually render” the services for the disputed portion in that

year.   See sec. 162(a)(1).    Winter argues that this reading

forbids BFC from ever deducting the disputed portion because,

after termination, he would no longer provide services under the

contract.   That would mean, he argues, that he would necessarily

have performed all the services the contract required of him in

2002.   If true, the payment would still be fully deductible.

     We agree with Winter that, were it not for BFC’s attempt to

claw it back, the disputed portion of the bonus would be a

separation payment or severance.     We have said that severance is

paid by an “employer as compensation for termination of the

employer-employee relationship.”     Meehan v. Commissioner, 122

T.C. 396, 401 (2004).     The employment agreement states that it

was meant to memorialize, among other things, “the financial

details relating to any decision that either Executive or

Employer might ever make to terminate this Agreement” and section
                              - 11 -

4(c) of the employment agreement entitles Winter to receive the

entire bonus if he is prematurely terminated without cause.4

     The Commissioner counters that there’s simply no basis for

the recharacterization.   We disagree.   Circumstances surrounding

a payment can change its character.     See Swed Distrib. Co. v.

Commissioner, 323 F.2d 480, 485 (5th Cir. 1963), affg. T.C. Memo.

1962-41.   And according to the employment agreement, while Winter

was employed he earned a right to the bonus on a daily basis as

he provided services–-the $1.1 million Winter earned that way was

deducted without question.   Liability for the disputed portion,

however, arose from another clause of the employment agreement–-

it’s Winter’s remedy for premature termination without cause.      We

therefore agree with Winter that his entitlement to the money

(remember we’re assuming the contest away) arose out of this

provision of the contract and, in the absence of a contest, was

separation pay similar to severance.5


     4
       Winter does note that the unpaid portion of the bonus
would not be deductible in 2002 if he had not been fired. We
agree. BFC was a cash-basis taxpayer, see sec. 1.461-1(a)(1),
Income Tax Regs., and could not have deducted the unearned
portion because of section 1.461-4(g)(7), Income Tax Regs.
(requiring economic performance), and possibly because BFC and
Winter were related taxpayers. See sec. 267(a)(2).
     5
       In the alternative, if BFC paid Winter for services (as
the Commissioner contends), we also agree with Winter that he
provided all the services required under the contract by the end
of 2002, and economic performance therefore still occurred during
that year. See sec. 461(h)(2)(A)(i). Winter is correct that the
Commissioner’s position would leave BFC with no other year in
which to deduct the disputed portion. (The Commissioner denies
                                                   (continued...)
                             - 12 -

     Severance is generally deductible in the year it’s paid.

See sec. 1.162-10(a), Income Tax Regs. (allowing a deduction for

“[a]mounts paid or accrued within the taxable year for dismissal

wages”); Moser v. Commissioner, T.C. Memo. 1989-142 (“It also is

clear to us that the severance benefit * * * constituted

‘dismissal wages’ * * * contemplated under the regulation”),

affd. 914 F.2d 1040 (8th Cir. 1990).   But, returning to the first

element of section 461(f), we must determine the proper year of

deduction if BFC was an accrual-method taxpayer.   Section 461(a)

and an accompanying regulation answer this question–-using the

accrual method, items generally can’t be deducted until all

events that establish the existence of the liability have

happened, the amount of the liability can be determined with

reasonable accuracy, and economic performance has occurred.     Sec.


     5
      (...continued)
this, but doesn’t suggest any rationale to a deduction for the
unearned portion of the bonus in any year other than 2002.)

     It is possible, as the Commissioner suggests in a footnote
to his final reply brief, that the bonus would stumble on the
requirement that compensation be reasonable, if the entire bonus
never lost its character as a payment for services. See sec.
1.162-9, Income Tax Regs. But raising new grounds for
disallowance in a footnote in a reply brief is hardly sufficient
notice to Winter to contest the issue. See, e.g., Tabrezi v.
Commissioner, T.C. Memo. 2006-61 (finding the IRS could not win
on a new matter raised in a posttrial brief without sufficient
supporting evidence). We also note that the reasonableness
determination must take into account the circumstances at the
time the contract is made, rather than when it is questioned.
Sec. 1.162-7(b)(3), Income Tax Regs. And the Commissioner
doesn’t challenge the reasonableness of Winter’s compensation
from the perspective of the time he began work, but only from the
perspective of when BFC fired him.
                                - 13 -

1.461-1(a)(2)(i), Income Tax Regs.       This analysis is sometimes

called the all-events test.     Capital One Fin. Corp. v.

Commissioner, 133 T.C. 136, 196 (2009).

     Assuming the dispute was resolved in Winter’s favor, the

first two prerequisites for deducting a liability in 2002 under

the accrual method would be met–-all events establishing BFC’s

liability would have happened, and BFC would owe Winter the

entire bonus of $5.5 million.    But the Commissioner argues that

the hypothetical runs afoul of the third requirement–-he says

economic performance for the disputed portion didn’t occur in

2002 because Winter performed only one-fifth of the total

services that year.

     The Commissioner may be right if “the liability of the

taxpayer arises out of * * * the providing of services to the

taxpayer by another person,” sec. 461(h)(2)(A)(i), in which case

economic performance occurs as the services are provided.       But in

the counterfactual world the regulation tells us to explore,

BFC’s liability didn’t arise from Winter’s actual work, but from

BFC’s premature termination of his employment.6      The statute


     6
       Of course the employment agreement existed in the first
place to govern Winter’s employment by BFC, and so in a very
broad sense the disputed portion could be construed as arising
from the provision of services. We don’t read section 461(h)
this way, however, particularly because regulations
distinguishing claims--such as workers compensation--would be
swallowed by such an expansive reading. Sec. 1.461-4(g)(2),
Income Tax Regs. We avoid Justice Jackson’s “winding trail of
remote and multiple causations.” Lykes v. United States, 343
                                                    (continued...)
                              - 14 -

doesn’t say when economic performance occurs for a severance

payment, so we turn to the regulations.

     The regulations set out several categories of claims and

establish what constitutes economic performance for each.    See

sec. 1.461-4, Income Tax Regs.   We don’t think the applicable

regulation is section 1.461-4(g)(2), Income Tax Regs., which

covers liabilities arising from a breach of contract.   If BFC

made the payment to Winter in satisfaction of the contract, it

wasn’t in breach.7   So we turn to section 1.461-4(g)’s catchall

provision, which says economic performance occurs when payment is

made to the creditor.   Sec. 1.461-4(g)(7), Income Tax Regs.    We

therefore find that economic performance related to the disputed

portion of the bonus occurred when BFC made the payment to

Winter, and BFC would therefore be able to deduct the paid

portion of the bonus in 2002 under the accrual method of

accounting.   This in turn means that the disputed portion was an

“asserted liability” and the payment therefore meets the first

element of section 461(f).


     6
      (...continued)
U.S. 118, 128 (1952) (Jackson, J., dissenting) (positing that
looking too far back in a causal chain could lead one to suppose
attorney’s fees for effecting a gift actually sprang from the
taxpayer’s decision to have children because if the taxpayer
didn’t have children, there wouldn’t have been a gift).
     7
       Not that it would make a difference–-the time for economic
performance in the breach-of-contract regulation is the same.
Sec. 1.461-4(g)(2), Income Tax Regs. (“economic performance
occurs as payment is made to the person to which the liability is
owed”).
                                - 15 -

            2.    Taxpayer Transfers Money to Satisfy Asserted
                  Liability

     The Commissioner also asserts that Winter can’t show he

meets the second element of the test--a transfer of money to

satisfy an asserted liability.     He does not argue, of course,

that BFC didn’t transfer money to Winter, but he does argue that

it could not have been a transfer to satisfy an asserted

liability because no liability was asserted at the time of

transfer.    But remember the example we discussed above.     The

taxpayer in that example had paid a bill without complaint, and

only later disputed the quality of the merchandise and demanded a

refund.   Sec. 1.461-2(b)(3), Income Tax Regs.    This example shows

that section 461(f) can apply when the taxpayer seeks to recover

money transferred before the dispute began.

     The Commissioner also makes much of the fact that BFC paid

Winter before it had to and says that that means there was no

real liability at the time.     It’s true that cash-basis taxpayers

often can’t deduct voluntarily prepaid business expenses because

it’s not ordinary and necessary in business to pay for things

before one has to.     See sec. 162(a); Bonaire Dev. Co. v.

Commissioner, 679 F.2d 159, 161 (9th Cir. 1982), affg. 76 T.C.

789 (1981).8     But “liability” in this context means “asserted


     8
       The Ninth Circuit noted in Bonaire Dev. Co. v.
Commissioner, 679 F.2d 159, 161 (9th Cir. 1982), affg. 76 T.C.
789 (1981), that there are “two principal exceptions” to the
general rule that a cash-basis taxpayer can’t deduct a prepaid
                                                   (continued...)
                                  - 16 -

liability,” and we have already found that BFC’s bonus expense

was an asserted liability within the regulation’s definition of

that term.    See sec. 1.461-2(b)(1), Income Tax Regs.

            3.      Contest Exists After the Time of the Transfer

     The third element is easily met.      The plain language of the

statute says that the contest must exist after the time of the

transfer.    The regulations clarify that for a contest to exist

after a transfer, “such contest must be pursued subsequent to

such time.       Thus, the contest must have been neither settled nor

abandoned at the time of the transfer.”      Sec. 1.461-2(d), Income

Tax Regs.    The contest had not even begun at the time BFC paid

Winter, so it’s clear that the payment didn’t settle the dispute.

And BFC pursued the contest in late 2002 and into 2003, showing

that its claim wasn’t abandoned at the end of 2002.      We therefore

find Winter satisfies this element.




     8
      (...continued)
expense in the year paid. One of those exceptions is when an
entity has a compelling business reason for prepaying. Id. at
162. The record here establishes that the bonus was prepaid to
help Winter with a tax bill that arose from his exercise of the
stock options that made him more than a quarter-owner of BFC.
BFC’s desire to have its chief executive officer own a
significant chunk of its equity may qualify as a compelling
business reason, though we don’t need to decide the issue.
                              - 17 -

          4.    But for the Contest, a Deduction Would Be Allowed
                After Application of Subsection (h)

     Section 461(f)(4) requires that the contested payment would

otherwise be deductible after application of subsection (h).

Subsection (h) says a liability is not incurred until the time

“when economic performance with respect to such item occurs.”9

We have already found that economic performance occurred when BFC

paid Winter.   See supra pt. I.B.1.    This brings us to the last

requirement, that “[t]he existence of the contest with respect to

an asserted liability must prevent (without regard to section

461(f)) and be the only factor preventing a deduction for the

taxable year of the transfer.”   Sec. 1.461-2(e)(1), Income Tax

Regs.

     So we now have to consider a different hypothetical--if

there wasn’t a contest (and Winter was able to keep the entire

bonus), would BFC be able to deduct the disputed portion in 2002

as a cash-basis taxpayer?   We already determined that the payment

in this hypothetical would be for severance, and that severance

is a deductible expense, but we must look again at timing.

     Once correctly stated, the question is easy to answer.      A

cash-basis taxpayer has to deduct the payment in the year it

makes the payment.   Secs. 1.446-1(c)(1)(i), 1.461-1(a)(1), Income



     9
       The statute allows for exceptions “provided in regulations
prescribed by the Secretary,” sec. 461(h)(2), but Winter doesn’t
bring any relevant exceptions to our attention, nor can we find
any.
                               - 18 -

Tax Regs.    There are of course some limits as to which expenses

can be deducted currently (ordinary expenses) and which have to

be capitalized (capital expenditures).10   See Wells Fargo & Co. &

Subs. v. Commissioner, 224 F.3d 874, 880 (8th Cir. 2000) (citing

Commissioner v. Tellier, 383 U.S. 687, 689-90 (1966)), affg. in

part & revg. in part Norwest Corp. & Subs. v. Commissioner, 112

T.C. 89 (1999).    An expenditure must be capitalized, and not

deducted, if it creates an asset with a useful life extending

“substantially beyond the close of the taxable year.”    Sec.

1.461-1(a)(1), Income Tax Regs.    These rules embody the general

goal of the timing rules–-“to match expenses with the revenues of

the taxable period to which they are properly attributable,

thereby resulting in a more accurate calculation of net income

for tax purposes.”    INDOPCO, Inc. v. Commissioner, 503 U.S. 79,

84 (1992).

     Severance is, as a general rule, immediately deductible.

Rev. Rul. 94-77, 1994-2 C.B. 19, 20 (“The INDOPCO decision does

not affect the treatment of severance payments, made by a

taxpayer to its employees, as business expenses which are

generally deductible under § 162 and § 1.162-10”).    But we must


     10
       Capitalization lets a taxpayer recover the costs of a
separate asset whose life extends beyond a single tax year. In
the case of an intangible asset, such as prepaid compensation, a
taxpayer should create an asset on his books and deduct a portion
of the cost each year over the life of the related asset. This
process smoothes out his income stream and more appropriately
matches expenses to the related income. See INDOPCO, Inc. v.
Commissioner, 503 U.S. 79, 84 (1992).
                              - 19 -

also ask if the payment of the disputed portion of the bonus

created an asset with a useful life extending “substantially

beyond the close of the taxable year.”   Sec. 1.461-1(a)(1),

Income Tax Regs.   If Winter remained employed by BFC, the

prepayment would serve BFC in the production of income for

several years, and the Commissioner is correct that BFC would be

required to create an intangible asset to amortize over the life

of the contract.   See Wildman v. Commissioner, 78 T.C. 943, 962

(1982).   But when BFC fired Winter, it forfeited any future

benefit it might have otherwise received.   Because Winter would

no longer work for BFC, the payment had no remaining value to the

bank and became an immediate loss.11   We therefore find that, but

for the contest, BFC could have deducted the disputed portion in

2002 as a cash-basis taxpayer.   Overall, then, the disputed



     11
       It’s possible that the employment agreement would benefit
BFC beyond 2002 via two restrictive covenants--a confidentiality
and loyalty clause, and a one-year covenant not to compete
following Winter’s termination. See, e.g., Becker v.
Commissioner, T.C. Memo. 2006-264. But it’s not clear from the
contract what portion, if any, of Winter’s compensation was in
consideration for these covenants, or if the covenants offer more
than an incidental benefit. See INDOPCO, 503 U.S. at 87 (“[T]he
mere presence of an incidental future benefit–-‘some future
aspect’–-may not warrant capitalization”). Both parties
implicitly value them at zero. The Commissioner argues that BFC
properly deducted the first $1.1 million in 2002 because Winter
had provided one-fifth of the total services–-this can only be
true if none of the $5.5 million is allocated to the covenants.
Winter also ignores the covenants by arguing that the full
payment should be deducted in 2002 as part compensation and part
severance. This isn’t a jurisdictional argument, so we won’t
make an argument for the parties that they do not make for
themselves.
                               - 20 -

portion satisfies all four elements of section 461(f), and we

hold that the entire $5.1 million was deductible by BFC in

2002.12

II.   Taxability of the Bonus to Winter in 2002

      Winter was not only a shareholder of BFC but also an

employee.    When he filed his 2002 return, he reported his entire

prepaid bonus as taxable employee income, which was consistent

with the W-2 which BFC sent to him.     But Winter now claims only a

portion of the bonus should be taxable in 2002 either because it

was really a loan and not income; or, if it was income, he did

not have unrestricted access to it and so should not be taxed on

it until some later year.

      A.    Was the Bonus Payment a Loan to Winter?

      Winter claims that the unearned portion of his bonus should

not be included in his 2002 gross income because it was a loan.

Both parties agree that loan proceeds are generally not included

in the borrower’s gross income.

            When a taxpayer receives a loan, he incurs an
            obligation to repay that loan at some future


      12
       This deduction, however, seems to resolve about half of
the inconsistent-reporting discrepancy. Winter and the bank were
about $2 million apart on their estimates of his 2002 passthrough
income. Resolving the disputed portion of the bonus payment
appears to account for about $1 million of the difference (the $4
million disputed deduction times Winter’s share of 26 percent,
plus any computational adjustments that may follow). Winter,
however, doesn’t challenge any other items on BFC’s return--and
without a challenge, their treatment on BFC’s tax return is
binding on him. See Rule 151(e)(4) and (5); Petzoldt, 92 T.C. at
683.
                              - 21 -

           date. Because of this obligation, the loan
           proceeds do not qualify as income to the
           taxpayer. When he fulfills the obligation,
           the repayment of the loan likewise has no
           effect on his tax liability.

Commissioner v. Tufts, 461 U.S. 300, 307 (1983).   Winter points

out that, under certain circumstances outlined in his employment

contract, he would be required to repay some of the 2002 bonus.

This potential repayment obligation, he claims, makes the

unearned portion of the bonus a loan.

      The Commissioner argues that Winter must include the entire

bonus paid in his income because it was not a loan but a payment

for personal services subject to a conditional obligation to

repay.   See, e.g., Haag v. Commissioner, 88 T.C. 604, 615-16

(1987), affd. without published opinion 855 F.2d 855 (8th Cir.

1988).   And, even though we found the disputed portion to be

severance, that would likewise be includable in Winter’s 2002

income if it isn’t a loan.   See Putchat v. Commissioner, 52 T.C.

470, 475-77 (1969), affd. 425 F.2d 737 (3d Cir. 1970); sec. 1.61-

2(a)(1), Income Tax Regs.

      Winter argues that his case is like Dennis v. Commissioner,

T.C. Memo. 1997-275, and Gales v. Commissioner, T.C. Memo. 1999-

27.   In Dennis, the taxpayer was an insurance agent who received

advance sales commissions.   Under his employment contract, Dennis

could take a monthly draw against future commission income.     He

was personally liable for the advances, which were payable to the

employer on demand.   Although he had complete control over the
                               - 22 -

money he received, he didn’t include any of it in his income for

tax purposes.   The employer kept records of all advances and

charged Dennis an administrative fee each month.    We found that

Dennis had a bona fide obligation to make repayments and

classified his advance commission as loans not includable in his

gross income.

     Gales also was an insurance sales agent whose employer had

advanced him commissions.    These payments accrued interest, and

their repayment was secured by Gales’s future compensation.      We

found that they were loans and not income, because Gales was

personally obligated to repay them.     Pointing to Dennis and

Gales, Winter argues that the proper test is whether he had a

bona fide personal obligation to repay the bonus advance.    Winter

says that if the bank had won or settled its employment contract

case against him, including its claim that it properly terminated

him for cause, he would then have had an unconditional personal

obligation to repay all or part of his unearned bonus.

     The Commissioner disagrees.    He argues that in both Dennis

and Gales the employers charged the taxpayers interest on the

advances and placed no conditions on the taxpayers’ obligation to

repay.   The Commissioner says that Winter’s case is more like

McCormack v. Commissioner, T.C. Memo. 1987-11, where the taxpayer

received a salary advance.   He and his employer had an understan-

ding that if he didn’t work for the contracted time, he would

have to repay the unearned portion of the advance.     We relied on
                               - 23 -

the absence of a note evidencing indebtedness and the lack of any

interest charged on the debt to characterize the payment as

income.    Most importantly, the primary purpose of the McCormack

arrangement was the provision of personal services and not the

lending of money.

     The Commissioner’s analogy is closer.   Winter’s primary

obligation under his employment contract was, just like

McCormack’s, to work--not to repay a loan secured by future

income.    And just like the employer in McCormack, BFC did not

require Winter to sign a note or pay interest on the bonus

advance.

      Winter also only partially states the correct test.      We

said in Dennis that “whether or not such advances constitute

income depends on whether, at the time of the making of the

payment, the recipient had unfettered use of the funds and

whether there was a bona fide obligation on the part of the agent

to make repayment.”    Dennis, T.C. Memo. 1997-275 (emphasis

added); see also Commissioner v. Indianapolis Power & Light Co.,

493 U.S. 203, 211-12 (1990).   The key question is thus whether

Winter’s obligation to repay the bonus was unconditional at the

time he received it.   And we answer that it was not--he’d have to

repay if and only if he quit or was fired for cause within five

years.    Whether he was able to last that long doesn’t affect the

underlying character of the bonus as compensation when he
                              - 24 -

received it, and its change from compensation for services to

compensation for early dismissal doesn’t matter either.

     B. Should Winter Include the Entire Bonus Payment in His
        2002 Income?

     Now that we have decided the character of the bonus payment

(it’s income, not a loan), we must decide the timing of its

recognition.   The Commissioner argues that the bonus was paid to

Winter in 2002 and so it’s taxable to him in 2002.    We agree.   A

taxpayer’s receipt of money which would otherwise qualify as

taxable income is taxable even though there is a possibility

he’ll have to return the money later.    Hamlett v. Commissioner,

T.C. Memo. 2004-78; see also N. Am. Oil Consol. v. Burnet, 286

U.S. 417, 424 (1932).   A taxpayer cannot postpone paying tax on a

disputed amount until the dispute is finally settled.    See United

States v. Lewis, 340 U.S. 590, 592 (1951).    Section 451(a)

provides the general rule that a taxpayer must report items of

gross income in the year he receives them.    Under section 1.451-

1(a), Income Tax Regs., taxpayers like Winter who use the cash

method of accounting must include such items in gross income when

actually or constructively received.    The Code mitigates the

potential harshness of this rule to a taxpayer who’s later forced

to repay the income by giving him a deduction--but only in the

year he repays it.   Secs. 162, 1341; Pahl v. Commissioner, 67

T.C. 286 (1976).
                                 - 25 -

      Winter got the bonus payment in early 2002 and was free to

use it as he saw fit.   That he might have had to repay some of

the money later on does not relieve him from paying tax on the

bonus in the year he received it.

III. Charitable Contribution

      An S corporation can make charitable contributions, but it

doesn’t deduct them when calculating its income.     See sec.

301.6245-1T(a)(1)(ii), Temp. Proced. & Admin. Regs., 52 Fed. Reg.

3003 (Jan. 30, 1987).   Instead, it notifies its shareholders of

their pro-rata shares so each may deduct his portion on his

individual return subject to each shareholder’s individual limits

on charitable giving.   See, e.g., sec. 170(b).

      On the K-1 that it sent to Winter, BFC listed $5,062 as his

share of its charitable contributions.     Winter did not claim this

deduction on his return, and the Commissioner questioned in his

pretrial brief whether Winter should now be able to.     Because

Winter didn’t address this issue after submission of the case, we

treat him as having conceded it.     See Rule 151(e)(4) and (5);

Petzoldt v. Commissioner, 92 T.C. 661, 683 (1989); Money v.

Commissioner, 89 T.C. 46, 48 (1987).

IV.   Accuracy-Related Penalty

      The last issue is whether Winter is liable for a penalty.

The Commissioner isn’t exactly clear about which misbehavior he

wants to penalize and why.     Section 6662(b) lists triggers for

the accuracy-related penalty, two of which may be at issue here–-
                               - 26 -

a negligence penalty (section 6662(b)(1)) and a substantial-

understatement-of-income-tax penalty (section 6662(b)(2)).13    The

notice of deficiency’s “Explanation of Changes” refers only to

substantial understatement of income tax, defined under section

6662(d), with no mention of negligence.   The Commissioner’s

pretrial brief argued for a negligence or a substantial-

understatement penalty.   The parties stipulated before trial that

the only remaining penalty at issue was for negligence.    But the

Commissioner’s posttrial brief again asserts both grounds.

(Winter was at least consistently vague throughout and stuck to

combating all “section 6662(a)” penalties.)

     We also have to decipher the underpayments to which these

penalties might apply.    The notice of deficiency shows that the

Commissioner determined a penalty against the entire

underpayment–-whether attributable to Winter’s misreported S-

corporation income or to his unreported dividend, interest, and

gambling income.   This seems simple enough.   But although Winter

conceded some adjustments, he didn’t concede the associated

penalty.   And in bearing his burden of production the

Commissioner focuses solely on the big money, without mention of

the smaller items.




     13
       Winter would not be liable for double penalties, but the
Commissioner can argue in the alternative to get at least one to
stick. See sec. 1.6662-2(c), Income Tax Regs.
                              - 27 -

     A. Penalty Tied to Dividend, Interest, and Gambling
        Income

     Winter agreed that he failed to report miscellaneous income

from dividends and gambling, and didn’t fight the Commissioner’s

assertion about some interest income, but he did not concede the

related penalties.   That’s enough to put them at issue, and

trigger the Commissioner’s burden under section 7491(c) of

producing some evidence in support of the penalties.   See Higbee

v. Commissioner, 116 T.C. 438, 446 (2001).

     The Commissioner first asserted, in the notice of

deficiency, only the substantial-understatement penalty.    But he

added to his claim in his pretrial memo by asserting in the

alternative a negligence penalty.   At this point, then, either

penalty was on the table.   See Baker v. Commissioner, T.C. Memo.

2008-247 (citing Estate of Petschek v. Commissioner, 81 T.C. 260,

271-72 (1983), affd. 738 F.2d 67 (2d Cir. 1984), and Koufman v.

Commissioner, 69 T.C. 473, 475-76, (1977)).   But the Commissioner

then stipulated that the only penalty issue “remaining for the

Court to decide [is] * * * [w]hether petitioners are liable for

the negligence penalty imposed under section 6662(a).”    This

knocked the substantial-understatement penalty off the table.

See Money, 89 T.C. at 48 (finding Commissioner conceded

negligence penalty when not pursued on brief or in trial

memorandum); Koufman, 69 T.C. at 475-76 (“It is well settled that

the Court cannot approve a deficiency unless the Commissioner has
                               - 28 -

made a claim therefor”).   The Commissioner’s last-minute attempt

to catch the substantial-understatement penalty and nudge it back

on the table in his posttrial brief is just too late.    Stipula-

tions are binding and cannot be changed unless justice so

requires, Rule 91(e), and the parties’ stipulation of facts

states that all stipulations shall be conclusive.    We also note

that the Commissioner hasn’t even asked to be relieved of this

stipulation, and we will therefore hold him to it.

     The Commissioner is thus left with the burden of producing

some evidence of negligence.   And for this the Commissioner can’t

rest on a concession of the underlying substantive item.      See

Higbee, 116 T.C. at 446.   Section 1.6662-3(b)(1), Income Tax

Regs., tells us that “[n]egligence is strongly indicated where

* * * a taxpayer fails to include on an income tax return an

amount of income shown on an information return.”    So the

Commissioner could start simply by showing that Winter’s

miscellaneous income was included on information returns sent to

Winter and Winter didn’t report it.     See Alonim v. Commissioner,

T.C. Memo. 2010-190.   But the Commissioner failed to do even

this--he didn’t present any evidence or argument related to these

little income items--choosing instead to focus only on the issue

of Winter’s failure to report his passthrough income from BFC.

We therefore find that the Commissioner failed to meet his burden

of production and has conceded the penalty as related to the

unreported dividend, interest, and gambling income.     See Rule
                               - 29 -

151(e)(4) and (5); Petzoldt, 92 T.C. at 683; Money, 89 T.C. at

48.

      B. Penalties Tied to Inconsistent Reporting

      Although we agree with Winter that BFC should have deducted

the disputed portion of his bonus, a significant difference

remains between BFC’s and Winter’s calculation of his passthrough

income.   And the Commissioner did produce evidence of negligence

for Winter’s inconsistent reporting.    He points at copies of

Winter’s K-1 and asserts Winter was negligent because Winter

didn’t report that income or instead file a Form 8082, Notice of

Inconsistent Treatment.   The Commissioner also says that if

Winter didn’t receive the K-1, he should have asked either BFC or

the IRS for a copy.

      Negligence is a failure to “make a reasonable attempt to

comply” with the internal revenue laws or to “exercise ordinary

and reasonable care in the preparation of a tax return.”    Sec.

1.6662-3(b)(1), Income Tax Regs.   And, as we just said,

negligence is “strongly indicated” where the taxpayer “fails to

include on an income tax return an amount of income shown on an

information return.”   Id.   The Code also penalizes a taxpayer who

carelessly, recklessly, or intentionally disregards rules or

regulations.   Sec. 1.6662-3(b)(2), Income Tax Regs.   We find the

Commissioner has met his burden of production here.

      Winter can escape the penalty if he had reasonable cause for

the underpayment and acted in good faith in preparing his return.
                                - 30 -

See sec. 6664(c).   We decide whether a taxpayer had reasonable

cause and good faith based on the facts and circumstances, and

focus on the extent to which the taxpayer tried to figure out his

proper tax liability.     Sec. 1.6664-4(b)(1), Income Tax Regs.

“[A]n honest misunderstanding of fact or law that is reasonable

in light of all the facts and circumstances, including the

experience, knowledge and education of the taxpayer” tends to

show good faith.    Id.   Winter says he made a good-faith effort to

estimate his income when he didn’t receive a K-1 from BFC.     He

admits he should have filed a Form 8082, but he says he shouldn’t

be penalized for this little mistake.

     The parties fight mostly over whether Winter received the

Schedule K-1 from BFC, but we don’t think that matters.     Even if

Winter didn’t receive a K-1, he was well aware that he should

have, and he failed to ask for a copy from either BFC or the IRS.

We agree with the Commissioner that Winter’s long career in the

financial industry and education in finance should have taught

him the potentially significant differences between income

statements for regulatory filings and those for tax reporting.

See Sunoco, Inc. & Subs. v. Commissioner, T.C. Memo. 2004-29

(“the objectives of financial and tax accounting are ‘vastly

different’”).   Winter’s admission that he should have filed a

Form 8082 indicates that he himself was aware of the possibility

that he was reporting inconsistently with BFC, yet he failed to

follow the relevant statute or otherwise alert the Commissioner.
                              - 31 -

     Winter points out that he didn’t have professional help in

preparing his taxes, but if hiring a paid preparer does not

always help taxpayers trying to dodge a negligence penalty, see

sec. 1.6664-4(b)(1), Income Tax Regs., failing to do so certainly

doesn’t.   Winter’s reliance on regulatory financial statements

was not reasonable for someone with his knowledge, education, and

experience.   We therefore sustain the Commissioner’s

determination of an accuracy-related penalty in connection with

Winter’s inconsistently reported income, to the extent any

difference remains after accounting for BFC’s deduction of the

disputed portion of his bonus.   This will take some calculating,

so

                                         Decision will be entered

                                    under Rule 155.
