                         T.C. Memo. 1999-392



                     UNITED STATES TAX COURT



     LEON L. ZACHMAN AND ESTATE OF IONE ZACHMAN, DECEASED,
         LEON L. ZACHMAN, REPRESENTATIVE, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



    Docket No. 14059-91.                    Filed December 1, 1999.



    John R. Koch, for petitioners.

    Tracy A. Martinez, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


    THORNTON,   Judge:     Respondent   determined   the   following

deficiencies, additions to tax, and penalties with respect to

petitioners’ Federal income tax liabilities:
                                  - 2 -


                                  Additions to Tax and Penalties
                                 Sec.           Sec.          Sec.
Year          Deficiency     6653(a)(1)(A) 6653(a)(1)(B)* 6662(a)**

1987           $5,766             $288         50% of the        -–
                                               interest due
                                               on $4,446
1988            4,272              214             -–            -–
1989           14,766              -–              -–          $2,477

           *    Sec. 6653(a)(1)(B) was repealed for 1988.
           **   Sec. 6662(a) was enacted in 1989, generally
       effective for returns the due date for which is after
       Dec. 31, 1989.


       The issues for decision are:

       1.    Whether Hillside Farm Co. (Hillside Farm), a putative

business trust established by petitioners, should be disregarded for

Federal income tax purposes because it lacks economic substance.

We hold that it should.

       2.    Whether petitioners are liable for additions to tax for

negligence pursuant to section 6653(a), for taxable years 1987 and

1988, and an accuracy-related penalty pursuant to section 6662(a)

for taxable year 1989.1     We hold that they are.

                            FINDINGS OF FACT

       The parties have stipulated some of the facts, which are so

found.      The stipulated facts and associated exhibits are

incorporated by this reference.


       1
       All section references are to the Internal Revenue Code in
effect for the years in issue. All Rule references are to the
Tax Court Rules of Practice and Procedure.
                               - 3 -

     Leon and Ione Zachman were married until her death in 1989.

Leon Zachman is the representative of the Estate of Ione Zachman.

Unless otherwise indicated, “petitioner” hereinafter refers to

Leon Zachman, and “petitioners” refers to Leon Zachman and Ione

Zachman.   Petitioner resided in Rogers, Minnesota, when the

petition was filed.

     Petitioners have farmed in the Rogers area since 1949.

Prior to 1983, petitioners’ farm was held in Shady Elms Farm, a

trust promoted by Lowell Anderson.2    On January 26, 1983,

petitioners transferred their farm real property to another

trust, Walnut Leaf.   In 1983, petitioner attended a meeting with

other farmers to hear a presentation by James Noske and Norb

Stelton about utilizing business trusts.    On September 8, 1983,

petitioners executed bills of sale, purporting to transfer their

farm equipment and livestock to Hillside Farm.    On the same date,

in their capacities as trustees of Walnut Leaf, petitioners

deeded their interests in the farm real property to Maplewood Co.

(Maplewood).   On October 4, 1983, petitioners executed a bill of

sale whereby for the stated consideration of “One dollar and

other good and valuable consideration” they transferred to


     2
       On Feb. 24, 1983, Lowell Anderson was indicted by a
Federal grand jury in Wyoming for conspiring to defraud the
United States by selling common-law trusts which were used to
evade Federal income taxes. See United States v. Tranakos, 911
F.2d 1422, 1424 (10th Cir. 1990). Lowell Anderson died while the
criminal proceedings were pending. See id.
                               - 4 -

Maplewood two life insurance policies and an extensive assortment

of personal property, including furniture, china, lamps, home

appliances, a popcorn pumper, and a “Blue Madonna picture”.

     Hillside Farm and Maplewood both purport to be business

trusts formed pursuant to Minnesota law.    The named trustees of

each of these trusts are Parnell, Inc. (Parnell) and Armageddon,

Inc. (Armageddon), nonprofit corporations organized under the

laws of South Dakota.   These corporations are also the named

trustees for numerous other business trusts.

     The Declaration of Trust of Hillside Farm (the Declaration

of Trust), dated April 25, 1983, recites that it is made between

Parnell and Armageddon, “herein referred to as Trustees, for the

purpose of enabling the Trustees to hold and manage the trust

estate and to carry on business as hereinafter provided.”   The

Declaration of Trust further provides in pertinent part:

                        ARTICLE III.   SHARES

          SECTION 1. The beneficial interest in this trust shall
     be divided into shares without par value. Upon unanimous
     approval of the Board of Trustees, shares may be sold or
     exchanged for such consideration, and on such terms, as the
     Trustees deem proper. All shares shall be evidenced by
     trust certificates of which [sic] shall be signed by each of
     the Trustees.

          SECTION 2. The certificates shall entitle owners
     thereof to participate proportionately in all dividends and
     other distributions of income or principal as the Trustees
     may, from time to time, in their absolute discretion,
     declare and pay out; provided that, upon the termination of
     the trust, the Trustees shall distribute all of the property
     and accrued income to the certificate holders of record in
                         - 5 -

proportion that the number of shares they own bears to the
total number of shares issued and outstanding.

     SECTION 3. Any Trustee hereunder may acquire, hold and
dispose of shares in this Trust to the same extent and in
the same way as if he were not a Trustee and without
affecting in any way his status or power as such.

     SECTION 4. No shares shall be issued in addition to
those originally specified herein except as replacements for
other certificate holders as authorized by this Declaration.
The total number of shares outstanding shall not exceed 100
(one hundred) in number.

     SECTION 5. Transfers of shares shall be made only on
the books of the business trust and the old certificate
properly endorsed shall be surrendered and canceled before a
new certificate is issued, provided that, no transfer shall
be effective until approved by unanimous vote of the Board
of Trustees.

     *       *       *      *       *       *       *

     SECTION 7.    The rights of trust certificate holders
and other persons becoming entitled to shares of the trust
shall be subject to all terms and conditions of this
Declaration of Trust. The shares shall not be personal
property, and the ownership thereof shall not give any
person any legal or equitable title in or to the trust
property or any part thereof, but shall only entitle the
owners of shares to their proportionate shares of dividends
and distributions as herein provided. No shareholders shall
have any rights to manage or control the property, affairs,
or business of the trust, or any power to control Trustees
in these respects.    No shareholder shall have any right to
a partition of the trust property or to an accounting during
the continuance of the trust. No part of the trust property
or the income therefrom shall be liable for the debts of any
trust certificate holder and no certificate holder shall
have any power to sell, assign, transfer, encumber, or in
any manner to anticipate or dispose of his shares or the
income produced thereby, prior to the actual distribution in
fact, by the Trustee to said certificate holder.

     SECTION 8. The death, insolvency or incapacity of any
trust certificate holder shall not operate to terminate or
dissolve the trust or affect its continuity * * *. If any
                                - 6 -

     certificate holder hereunder dies, becomes insolvent or is
     placed under any legal incapacity before the termination of
     this trust, his shares shall become null and void and shall
     immediately revert to the Board of Trustees, who shall
     thereupon name a replacement beneficiary or beneficiaries
     and issue a new certificate or certificates as provided in
     this Declaration.

                  ARTICLE IV.   BOARD OF TRUSTEES

          SECTION 1. The business and property of the business
     trust shall be managed by Board of Trustees, who shall be
     the persons named in the Declaration of Trust, who shall
     serve until their successors are duly qualified. In the
     event of the death, incapacity, resignation or retirement of
     any Trustee, a successor Trustee shall be appointed by the
     remaining Trustee or Trustees.

           *      *        *       *       *        *      *

          SECTION 3. The Trustees shall hold, in the trust name,
     legal and equitable title to all property, real and
     personal, and shall have absolute and exclusive power and
     control over the management and conduct of the business of
     the trust free from any right of control of any of the
     certificate holders. The Trustees may hold, manage and
     dispose of the property and business of the trust in the
     same manner as if they were absolute proprietors thereof,
     subject only to the specific limitations herein contained.
     The Trustees shall have the power, without limitation, to
     purchase or otherwise acquire property, and to sell,
     exchange, lease, mortgage, pledge or in any manner dispose,
     encumber, improve or deal with the property of the trust,
     real or personal, or any part thereof, or any interest
     therein, on such terms and for such consideration as they
     deem proper. * * *

     The Declaration of Trust, as well as various minutes for the

board meetings of its trustees, bears the signatures of Cheryl A.

Foshaug, president of Armageddon, and Marti Inman, president of

Parnell.   Neither Foshaug nor Inman has ever met petitioners or

heard of Hillside Farm.   Neither ever managed Hillside Farm.
                              - 7 -

They each signed various papers, including blank or incomplete

pages, at the request of James or Joan Noske.   Foshaug often

neither read nor understood the pieces of paper she signed.     As

president of Parnell, Inman took no action other than as directed

by James or Joan Noske.3

     The minutes for the Hillside Farm trustees’ meeting dated

September 8, 1983, signed by Foshaug and Inman, indicate that the

trustees appointed Daniel Strohmeier as manager of Hillside Farm,

with authority to oversee the business operations of the trust

and to issue checks to pay general operating expenses.4   If

Strohmeier ever conducted business related to Hillside Farm, it

was at the direction and under the control of James or Joan

Noske.




     3
       On June 14, 1985, the U.S. District Court for the District
of Minnesota entered a final judgment of permanent injunction as
to Foshaug, Inman, Armageddon, and Parnell, enjoining them under
secs. 7402 and 7408 from organizing or assisting in the
organization of an abusive tax shelter plan or arrangement
involving business trusts.

     4
       Another case involving Noske trusts, Scherping v.
Commissioner, T.C. Memo. 1989-678, includes as a finding of fact
that in June 1983 James and Joan Noske took Strohmeier from an
alcoholic treatment center, made him a figurehead president of an
entity to which the taxpayers had transferred their dairy farm
assets, and placed him on the taxpayers’ family farm to live and
work for the last half of 1983, doing farm chores at the
taxpayers’ direction.
                                - 8 -

     Sometime in 1987 or 1988, John B. Ellering became president

of Armageddon and Parnell, and replaced Strohmeier as

manager of Hillside Farm.5

     Petitioners had no official titles or offices in Hillside

Farm, Armageddon, or Parnell.   Initially, petitioners received

all 100 trust shares in Hillside Farm.     On December 29, 1983,

petitioners surrendered their original 100 shares in Hillside

Farm, each receiving 20 new shares.     The remaining 60 shares

purportedly were transferred to BBCA, Inc. (BBCA), an

organization purporting to be a church.6    The president of BBCA

was Joan Noske.

     Several years before the creation of Hillside Farm,

petitioner had curtailed his work on the farm because of health


     5
       In Sept. 1995, Ellering was convicted by a jury in the
U.S. District Court for the District of Minnesota of conspiracy
to defraud the United States by impeding the Internal Revenue
Service. His conviction was based on his participation with
James and Joan Noske and Imelda Spaeth in a scheme to assist
clients of the Noskes, who sought to reduce or avoid Federal
income taxes, form business trusts that named Armageddon and
Parnell as trustees.

     After Ellering’s criminal conviction, petitioners’ cousin
Gerard became president of Armageddon and Parnell, and
petitioners’ son Dale became managing director of Hillside Farm.

     6
       The minutes of a special meeting of the Hillside Farm
trustees, dated Dec. 29, 1983, and signed by Inman and Foshaug,
recite that these transfers were made upon application of the
petitioners and were unanimously approved by the trustees.
                                 - 9 -

problems.    During the years at issue, his work on the farm

consisted largely of riding a tractor or baling hay no more than

a few times a week.    Ione Zachman did not participate in the farm

work, apart from growing her own garden.   Both before and after

the creation of Hillside Farm, petitioners’ sons, Dale and Paul,

performed most of the farm work.    Dale made most of the farming

decisions.    Dale and Paul each received weekly wages for their

labors.

     All the gross receipts from petitioners’ farming operation

were sent to Joan Noske at a post office box in Cold Springs,

Minnesota.    Joan Noske generally made provision out of “Hillside

Farm” funds for paying farm expenses, as well as certain of

petitioners’ personal expenses, including insurance, medical

bills, income taxes, and property taxes on petitioners’

residence.

     During the years at issue, Joan Noske did all the

bookkeeping for Hillside Farm.    She prepared the Federal income

tax returns for Hillside Farm and at least 20 other trusts that

name Armageddon and Parnell as trustees.   She also prepared

petitioners’ Federal income tax returns for the years in issue.

At least twice a year, petitioners received ledgers from Joan

Noske which accounted for funds purportedly received and

disbursed by Hillside Farm during the years at issue.    The
                               - 10 -

disbursements included $125 per month to Joan Noske for her

bookkeeping services.

     On November 16, 1985, the U.S. District Court for the

District of Minnesota entered a Final Judgment of Permanent

Injunction as to James and Joan Noske, finding that they had

engaged in conduct subject to penalty under section 6700 and

enjoining them from organizing, assisting, selling, or otherwise

promoting business trusts as abusive tax shelters.   As part of

the judgment, the Noskes were ordered to supply respondent’s

District Director with the names and addresses of all purchasers

of the 186 business trusts on file with the Minnesota Secretary

of State which list Armageddon and Parnell as corporate trustees.

Subsequently, the Noskes identified Hillside Farm and Maplewood

as being among the business trusts involved in the injunction

action.

     In September 1995, Joan and James Noske were convicted of,

among other things, conspiracy to defraud the United States by

impeding the Internal Revenue Service, and conspiracy to evade

Federal income taxes.   The convictions were based on the Noskes’

participation in a scheme to assist their clients in reducing or

avoiding Federal income taxes by forming business trusts which

named Armageddon and Parnell as trustees.   It was further

determined that the Noskes participated in a scheme whereby their

clients would transfer all of their income-producing property to
                               - 11 -

the business trusts and then issue 60 percent of their trust

shares to BBCA, thus effectively evading the assessment and

payment of 60 percent of their clients’ Federal income tax

liability.

     Hillside Farm filed Federal income tax returns for 1987

through 1989 reporting Schedule F income from petitioners’

farming operation.   During the years at issue, Hillside Farm

reported that 40 percent of its net income was distributed to

petitioners.7   The trust itself paid no taxes.

     Respondent determined that petitioners are taxable on

Hillside Farm’s gross income because the creation of Hillside

Farm and the subsequent transfer of petitioners’ assets thereto

was a sham transaction lacking in economic substance, because

petitioners have improperly attempted to assign their income to

Hillside Farm, and because petitioners are taxable on the trust

income under the grantor trust rules in sections 671 through 678.

                              OPINION

     If the creation of a trust has no real economic effect and

alters no cognizable economic relationships, it will be

disregarded for Federal income tax purposes; our guidepost is the

economic substance of the transaction.   See Zmuda v.


     7
       Hillside Farm claimed an income distribution deduction for
100 percent of its reported distributable net income, but it
failed to report the recipient of the remaining 60 percent of its
net income.
                                   - 12 -

Commissioner, 79 T.C. 714, 719 (1982), affd. 731 F.2d 1417 (9th

Cir. 1984); Markosian v. Commissioner, 73 T.C. 1235, 1241 (1980).

This rule applies even if the trust is recognized pursuant to

State law as a business trust or other form of jural entity.       See

Zmuda v. Commissioner, supra.8

       Whether a trust lacks economic substance is a question of

fact.       See Paulson v. Commissioner, 992 F.2d 789, 790 (8th Cir.

1993), affg. per curiam T.C. Memo. 1991-508.      Relevant factors

include whether the taxpayer’s relationship as grantor to the

property differed materially before and after the trust’s

formation, whether the trust had an independent trustee, whether

an economic interest passed to other beneficiaries of the trust,

and whether the taxpayer felt bound by any restrictions imposed

by the trust or by the law of trusts.       See Markosian v.

Commissioner, supra at 1243-1245; Muhich v. Commissioner, T.C.

Memo. 1999-192.       The burden of proof is on petitioners.   See Rule

142.



        8
       This is not the first occasion we have had to examine
trust arrangements devised and promoted by the Noskes. On each
occasion, we determined that they were sham entities used by
taxpayers to avoid income tax. See, e.g., Scherping v.
Commissioner, T.C. Memo. 1998-288; Paulson v. Commissioner, T.C.
Memo. 1991-643, affd. without published opinion 994 F.2d 843 (8th
Cir. 1993); Paulson v. Commissioner, T.C. Memo. 1991-508, affd.
992 F.2d 789 (8th Cir. 1993); Scherping v. Commissioner, T.C.
Memo. 1991-384; Chase v. Commissioner, T.C. Memo. 1990-615; Chase
v. Commissioner, T.C. Memo. 1990-164, affd. 926 F.2d 737 (8th
Cir. 1991); Scherping v. Commissioner, T.C. Memo. 1989-678.
                               - 13 -

     The evidence clearly establishes that Hillside Farm lacked

economic substance and was merely a paper entity created for the

primary purpose of reducing petitioners’ Federal income tax.

Petitioners’ relationship to their property did not differ

materially before and after the creation of Hillside Farm.

Although petitioners purported to transfer all their income-

producing personal property to Hillside Farm, in reality they

retained dominion and control over it, with their sons providing

most of the labor in return for weekly wages.

     The record does not establish that Parnell and Armageddon

were independent trustees or that they performed any significant

duties or exercised any significant control or power over the

farm.   Contrary to the terms of Article IV, Section 3, of the

Declaration of Trust, Parnell and Armageddon did not have

“absolute and exclusive power and control over the management and

conduct of the business”.   Petitioners concede that Inman and

Foshaug were strangers to Hillside Farm and were nothing more

than figurehead presidents of the corporate trustees, merely

signing documents, often blank or incomplete, at the instigation

of the Noskes.   The use of strangers as signers of organizational

documents and the absence of any meaningful role by nominal

trustees in the operation of the trust are evidence that the

purported trust lacks economic substance.   See Para Techs. Trust

v. Commissioner, T.C. Memo. 1994-366, affd. without published
                              - 14 -

opinion sub nom. Anderson v. Commissioner, 106 F.3d 406 (9th Cir.

1997), and cases cited therein.

     Petitioners also concede that Strohmeier served no

meaningful function as “manager” of Hillside Farm.   Similarly,

there is no evidence that Strohmeier’s successor, Ellering,

served any meaningful function as manager of Hillside Farm.9    In

fact, there is no evidence that Hillside Farm ever conducted any

business at all.10

     Upon the alleged creation of Hillside Farm, no economic

interest passed to any beneficiary other than petitioners.     Nor

does the record establish that the subsequent purported transfer



     9
       Petitioner testified that Ellering made “some” decisions
about farm activities, but he was unable to offer specific
examples, stating that “we just talked about the weather, and see
what would be the best thing to do.” He testified that his sons,
rather than Ellering, made all decisions about when to plant
crops, cut hay, and such. Dale Zachman testified that there had
been instances when the purchase of new farm machinery had been
“delayed” for Ellering’s approval, but when questioned he could
not recall a specific instance.
     10
       On brief, petitioners seek to attribute to Parnell and
Armageddon the activities of the Noskes, arguing that Parnell and
Armageddon controlled Hillside Farm’s “checkbook” through the
agency of the Noskes. Petitioners have not established, however,
that the Noskes were in fact the agents of Parnell or Armageddon.
There is no mention of the Noskes in the Declaration of Trust.
There is no evidence that the Noskes were authorized to or
actually did assume the fiduciary duties allegedly imposed on the
corporate trustees under the purported trust documents. Rather,
the totality of the evidence strongly suggests that the Noskes
provided petitioners with bookkeeping services, for which they
were compensated, and bad advice as part of a conspiracy to
defraud the United States, for which they were imprisoned.
                                 - 15 -

to BBCA of 60 percent of petitioners’ shares in Hillside Farm was

a valid conveyance of petitioners’ economic interests.   To the

contrary, at trial petitioner vigorously asserted that he never

knowingly authorized or intended any such transfer of shares to

BBCA.   Similarly, on brief petitioners argue that “there were no

valid transfers to BBCA”.

     Petitioners argue that Hillside Farm was created for estate-

planning purposes to keep the farm together in the family.    It is

unclear, however, how the establishment of Hillside Farm would

accomplish any such objective.    Under Article III, Section 8 of

the Declaration of Trust, if any trust certificate holder dies

before termination of the trust, his shares become “null and void

and shall immediately revert to the Board of Trustees, who shall

thereupon name a replacement beneficiary or beneficiaries”.

Accordingly, the creation of Hillside Farm would have provided

petitioners no assurance that the farm would remain in their

family.   To the contrary, under the terms of the Declaration of

Trust, absolute power over the disposition of the farm property,

either during their lives or upon the death of either petitioner,

would have resided with Parnell and Armageddon.   In any event,

the expectancy of an estate-planning advantage does not establish
                               - 16 -

entitlement to an income tax advantage.     See Prindle Intl.

Marketing, UBO v. Commissioner, T.C. Memo. 1998-164.11

     Contending that they received only a share of the Hillside

Farm income, petitioners argue that they should be taxed only on

the share they actually received.12     It is axiomatic, however,

that taxation is concerned with “actual command over the property

taxed-–the actual benefit for which the tax is paid” and that the

transfer of formal legal title will not operate to “shift the

incidence of taxation attributable to ownership of property where

the transferor continues to retain significant control over the

property transferred.”   Frank Lyon Co. v. United States, 435 U.S.

561, 573 (1978); see Sundance Ranches, Inc. v. Commissioner, T.C.

Memo. 1988-535, affd. without published opinion (9th Cir. 1990).

Petitioners clearly retained sufficient power and control over

the farm to be properly treated as the recipients of the income




     11
       On brief, petitioners also argue that creation of the
Hillside Farm allowed petitioner to qualify for Social Security
without reduction for personal service income. The record is
devoid of evidence regarding any such purpose. In any event,
that petitioners may have wished to evade earned income
restrictions for Social Security purposes scarcely bolsters their
case for recognizing the trust for Federal income tax purposes.
     12
       The record does not establish what ultimately happened to
the 60 percent of Hillside Farm income allegedly distributed to
BBCA. Cf. United States v. Klaphake, 64 F.3d 435 (8th Cir. 1995)
(in a case involving the transfer of a family farm business to a
Noske trust of which BBCA was a beneficiary, the taxpayers
received cash back from BBCA on a regular basis).
                                 - 17 -

for tax purposes.    Cf. Commissioner v. Sunnen, 333 U.S. 591, 604

(1948); Hutcherson v. Commissioner, T.C. Memo. 1984-165.

     In light of our holdings on these issues, we need not reach

respondent’s alternative argument that petitioners should be

taxed on the Hillside Farm income under the grantor trust rules.

Additions to Tax and Penalties

     Respondent determined that petitioners are liable for

additions to tax under section 6653(a) for taxable years 1987 and

1988, and an accuracy-related penalty under section 6662 for

taxable year 1989.    Section 6653(a)(1)(A) imposes an addition to

tax equal to 5 percent of the underpayment if any part of the

underpayment is attributable to negligence.    Section

6653(a)(1)(B) imposes an addition to tax equal to 50 percent of

the interest payable on the portion of the underpayment

attributable to negligence.     Section 6662(a) imposes a 20-percent

penalty on any portion of an underpayment that is attributable to

negligence.   Negligence is the lack of due care or failure to do

what a reasonable and ordinarily prudent person would do under

the same circumstances.   See Neely v. Commissioner, 85 T.C. 934

(1985).   Petitioners have the burden of proving that respondent’s

determinations are incorrect.    See Rule 142(a); Bixby v.

Commissioner, 58 T.C. 757, 791-792 (1972).

     Petitioners argue only that because there is no underpayment

of tax, there is no amount upon which to compute additions to tax
                                 - 18 -

or penalties.   We have sustained respondent’s determination that

petitioners understated their Federal income tax liability for

taxable years 1987, 1988, and 1989.       Accordingly, petitioners’

argument must fail.

      Petitioners have not established that they used reasonable

care in ascertaining their income tax liability for these years.

They have not shown that they reasonably relied on a competent

professional adviser independent of those persons who were

involved in marketing these abusive trusts.      We sustain

respondent’s determinations on this issue.

     To reflect the foregoing,


                                      Decision will be entered

                                 for respondent.
