                          T.C. Memo. 2014-178



                  UNITED STATES TAX COURT



   CHARLES T. BRUCE AND MARY A. BRUCE, Petitioners v.
    COMMISSIONER OF INTERNAL REVENUE, Respondent



Docket No. 29005-10.                          Filed September 2, 2014.



       P-H desired to sell Ps’ M stock in the ready market. P-H’s
financial planners promoted to P-H a plan to cash out the value of the
stock and pay no Federal tax. P-H, a high-school-educated seafarer
with little tax knowledge, consulted his attorney/tax adviser, who in
turn advised P-H that the plan was legitimate. Pursuant to the plan,
P-H and G entered into two offsetting $5.5 million loans, one of
which was labeled a “Swap” and for which P-H claimed a basis of
$5.5 million. P-H contributed the Swap to a newly formed unitrust in
which he retained a remainder interest and the power to substitute for
the unitrust’s corpus property of equal value. His two daughters each
had a 1% unitrust interest. P-H sold his remainder interest to two
other newly formed trusts (Ts), the beneficiary of each of which was
one of the daughters, in exchange for promissory notes totaling the
portion of the $5.5 million basis that P-H apportioned to the remainder
interest (approximately $5.4 million). P-H substituted the M stock for
the Swap in the belief that each property was of the same value. Ts
acquired the daughters’ unitrust interests, the unitrust was terminated,
and the M stock was distributed to Ts. Ts transferred the M stock to
                                  -2-

[*2] S, a general partnership that Ts formally owned and P-H
controlled. S sold the M stock to a third party for cash, and Ps
received the value of their M stock through Ts’ payments on the
promissory notes from the cash that the third party paid to purchase
the M stock. Ps reported on their Federal income tax return that they
realized no gain or loss on the sale of the remainder interest because
the selling price equaled the basis. Ps did not report that the M stock
was sold or that they realized any gain or loss as to that sale.

       Held: The applicability of the three-year limitations period
under I.R.C. sec. 6501(a) is not properly before the Court in that
(1) Ps attempt inappropriately to raise this issue in their opening brief
and (2) I.R.C. sec. 7491(a)(1) does not require that the Court hold that
the limitations period bars assessment simply because the record
establishes that a deficiency notice was issued after the three-year
period and does not establish that an exception to the three-year
period applies.

       Held, further, Ps’ gross income includes the full proceeds from
the sale of the remainder interest in that P-H’s basis in that interest
was zero. Alternatively, Ps are considered to have sold the stock
directly to the third party for Federal income tax purposes and must
recognize their gain on that sale.

       Held, further, I.R.C. sec. 162(a) does not allow Ps to deduct the
legal and professional expenses related to the plan.

      Held, further, Ps are not liable for the 40% accuracy-related
penalty that R determined under I.R.C. sec. 6662(h) because P-H
reasonably relied on the advice of his attorney.



R. Cody Mayo, Jr., for petitioners.

Marshall R. Jones, for respondent.
                                         -3-

[*3]         MEMORANDUM FINDINGS OF FACT AND OPINION


       WHERRY, Judge: Petitioners petitioned the Court to redetermine

respondent’s determination of an $819,041 deficiency in their Federal income tax

for 2003 and a $327,616.40 accuracy-related penalty under section 6662(h) for a

gross valuation misstatement.1 We decide the following issues:

       1. whether the applicability of the three-year limitations period under

section 6501(a) is properly before the Court. We hold it is not;

       2. whether petitioners underreported their income stemming from a plan

(plan) involving the sale of their stock in Sea & Sea Marine, Inc. (Marine). We

hold they did;

       3. whether petitioners may deduct the legal and professional expenses that

respondent disallowed. We hold they may not;

       4. whether petitioners are liable for the 40% accuracy-related penalty that

respondent determined under section 6662(h). We hold they are not.

       1
        Unless otherwise indicated, section references are to the applicable versions
of the Internal Revenue Code of 1986, as amended for the year in issue (Code),
Rule references are to the Tax Court Rules of Practice and Procedure, and dollar
amounts are rounded to the nearest dollar. While the deficiency notice states on
one page that respondent determined that petitioners are liable for a 20% accuracy-
related penalty under sec. 6662 for negligence, the notice elsewhere clarifies that
respondent determined that the 40% percent accuracy-related penalty for gross
valuation misstatement is applicable and that the 20% accuracy-related penalty for
negligence is not.
                                          -4-

[*4]                             FINDINGS OF FACT 2

I. Preliminaries

       The parties submitted stipulated facts and exhibits, and we find the

stipulated facts accordingly. We incorporate herein the stipulated facts and the

facts drawn from the exhibits.

       Petitioners are husband and wife, and they have two daughters, Rebekah

Ruth Bruce (RRB) and Sarah Jane Bruce (SJB) (collectively, daughters).




       2
        Each party filed an opening brief and a reply brief. Petitioners’ opening
brief, as supplemented (collectively, opening brief), does not comply with Rule
151(e)(3) with respect to proposed findings of fact. Rule 151(e)(3) required that
the opening brief contain

       [p]roposed findings of fact * * * in the form of numbered statements,
       each of which shall be complete and shall consist of a concise
       statement of essential fact * * *. In each such numbered statement,
       there shall be inserted references to the pages of the transcript or the
       exhibits or other sources relied upon to support the statement.

Petitioners’ opening brief fails to set forth petitioners’ proposed findings of fact in
numbered statements; instead, it contains a “STATEMENT OF FACTS” in
narrative form with footnote references throughout which reference portions of the
trial transcript but do not mention the stipulations or any of the exhibits. In
addition, that brief in many instances fails to reference the transcript, exhibit, or
other source upon which petitioners rely to support their recitation of the facts.
While we have thoroughly reviewed the record to find the facts of this case,
petitioners, by their failure to follow our Rules, “have assumed the risk that we
have not considered the record in a light of their own illumination.” Monico v.
Commissioner, T.C. Memo. 1998-10, 75 T.C.M. (CCH) 1556 n.1 (1998).
                                         -5-

[*5] Petitioners filed a joint Federal income tax return for 2003, and they resided at

a Louisiana address when the petition underlying this case was filed.

      Charles Bruce is an experienced, successful tugboat captain and fisherman.

He has a high school education and regularly consults with and relies upon

professionals, friends, and employees to advise and inform him before he makes

his business decisions. He relied upon the advice of Attorneys Francis J. Lobrano

and David J. Lukinovich to effect the plan (discussed infra pp. 10-11), receiving

the latter’s advice directly from him or through Mr. Lobrano. Mr. Bruce also

relied heavily upon the advice of his longtime friend and loyal employee, Wade A.

Rousse.

II. Marine and Maritime Logistics

      A. Marine

      Marine is a Louisiana corporation that was organized in 1991. Each

petitioner owned one-half of Marine’s stock from at least January 1, 2000, when

Marine elected S corporation status for Federal income tax purposes, through early

September 2003. An election was made to characterize Marine as an S corporation

effective January 1, 2000, and petitioners treated Marine as an S corporation from

January 1, 2000, through September 5, 2003. As further discussed infra p. 22,

petitioners caused the Marine stock to be formally owned by a shareholder that
                                        -6-

[*6] made Marine ineligible for status as an S corporation as of September 5, 2003,

and Marine thereafter reported that it was taxable as a C corporation.

      Marine was a small offshore water transportation/tugboat business. Marine

owned a 214-foot offshore oilfield supply vessel named the M/V Sarah Jane Bruce

(Sarah Jane). The Sarah Jane was Marine’s principal asset (and its sole marine

vessel) in 2003. Marine operated the Sarah Jane out of Port Fourchon, Louisiana.

      Marine acquired the Sarah Jane on September 3, 2002, in a “like-kind

exchange” for a boat of then-equal value which Mr. Bruce (through his business)

had acquired for and used in his business since 1993. During 2003 the Sarah Jane

could easily have been sold (and was sold in 2003 as discussed infra p. 24) for $5

million. Marine’s basis in the Sarah Jane was zero as of January 1, 2003.

      B. Maritime Logistics

      Mr. Bruce coowned a second business referred to as “Maritime Logistics”.

Maritime Logistics’ other coowners were Mr. Rousse, Joey Adams, and one or

more other individuals whose identity is not relevant to our analysis. Mr. Adams

was a boat owner, and he owned (through his company) one or more marine

vessels.

      Maritime Logistics was a maritime brokerage business; i.e., essentially a

business in which one or more boat owners worked together to obtain contractual
                                        -7-

[*7] work for their boats. Maritime Logistics obtained contract work for Marine

and for a company owned by Mr. Adams (and possibly for one or more other

companies). Maritime Logistics’ manager and primary worker was Mr. Rousse.

III. Mr. Rousse

      Mr. Rousse grew up in Mr. Bruce’s neighborhood. Mr. Rousse as a teenager

mowed the grass at Mr. Bruce’s home, and they had a special business and

familylike personal relationship. Their personal relationship originally stemmed

from Mr. Bruce’s friendship with Mr. Rousse’s father, which developed from the

father’s and Mr. Bruce’s attending school together and from their working

together. With Mr. Bruce’s encouragement, Mr. Rousse later received a college

degree in business administration and then went to work for Mr. Bruce full time.

Mr. Rousse worked for Mr. Bruce for approximately 20 years, and Mr. Rousse

spearheaded the growth of Mr. Bruce’s businesses during that time.

      Mr. Bruce always encouraged Mr. Rousse to further his education, and Mr.

Rousse earned an M.B.A. from the University of New Orleans while employed by

Mr. Bruce. Mr. Rousse ultimately stopped working for Mr. Bruce to pursue a

master’s degree and a Ph.D in economics from the University of Illinois at

Chicago, Illinois. After earning those degrees during or about 2007, Mr. Rousse
                                       -8-

[*8] went to work for the Federal Reserve Bank of Chicago as an economist

specializing in policy research and economic outreach.

IV. W&T

      W&T Offshore, Inc. (W&T), is a publicly traded oil and gas exploration

company operating primarily in the Gulf of Mexico. In or about March 2003

W&T and Maritime Logistics were negotiating some long-term contracts which

would allow Marine to build one or more supply vessels to service W&T.

V. March 2003 Borrowings

      A. March 19, 2003

      On March 19, 2003, Marine borrowed $2,522,223 from American Horizons

Bank (AHB). This loan was secured by Marine’s deposits with AHB.

      B. March 20, 2003

      On March 20, 2003, Mr. Bruce borrowed $2,303,967 from Marine. Mr.

Bruce secured the repayment of this loan with stock that he owned in FBT

Bancorp, Inc. (FBT), a Delaware corporation.

VI. Mr. Doverspike

      Jack Doverspike is a Larose, Louisiana-based insurance agent and financial

planner with whom Mr. Bruce had done business (e.g., made investments and

purchased life insurance) for several years. In or about 1998 Mr. Doverspike
                                         -9-

[*9] began talking to Mr. Bruce about his and his wife’s estate plans and a possible

“estate freeze” to minimize estate tax, and Mr. Doverspike did some estate work

for Mr. Bruce in or about 2001.

      Soon after W&T and Maritime Logistics began negotiating the long-term

contracts, Mr. Doverspike invited Mr. Bruce to meet with Mr. Doverspike and two

financial planners, John Ohle and Scott Deichmann,3 to discuss Mr. Bruce’s

financial and estate plans further. As of that time Mr. Bruce was planning to retire

and to move permanently to Baton Rouge, Louisiana, where one of his daughters

and her children lived, and he desired to sell Marine (or the Sarah Jane) as part of

those plans. In addition, Mr. Rousse was planning to move to Chicago to pursue

      3
        John B. Ohle III was convicted in 2010 of conspiracy to defraud the Internal
Revenue Service and of attempted tax evasion. See United States v. Ohle, 441
Fed. Appx. 798, 799 (2d Cir. 2011). We take judicial notice from documents filed
in that case that this conviction stemmed from his selling a shelter in 2001 and
2002 devised by Paul Daugerdas as a partner of the now defunct law firm of
Jenkins & Gilchrist that claimed millions of dollars in phony tax losses. See Fed.
R. Evid. 201; Mangiafico v. Blumenthal, 471 F.3d 391, 398 (2d Cir. 2006);
Petzoldt v. Commissioner, 92 T.C. 661, 674 (1989). Mr. Daugerdas was recently
sentenced to 15 years’ confinement as the result of his tax evasion and conspiracy
conviction related to tax shelter transactions commonly referred to as “short sales”,
“short options strategy”, “Swaps” and “HOMER”, to generate fraudulent tax
savings. See United States v. Daugerdas, Dkt. No. 09-cr-00581 (S.D.N.Y. June 27,
2014). We also take judicial notice that Scott D. Deichmann was a conspirator and
a coemployee of John B. Ohle III, and we note that David Lukinovich and John B.
Ohle III were business acquaintances although Mr. Lukinovich was not directly
involved in these tax shelters. See also Ducote Jax Holdings LLC v. Bradley, 335
Fed. Appx. 392, 394, 396, 402 (5th Cir. 2009); Ducote Jax Holdings, L.L.C. v.
Bradley, C.A. No. 04-1943, 2007 WL 2008505 (E.D. La. July 5, 2007).
                                        - 10 -

[*10] his doctoral degree. Mr. Bruce’s most valuable asset was petitioners’ stock

in Marine. Mr. Bruce aspired to maximize the funds petitioners would retain upon

a sale of that stock so that they could live comfortably in his retirement and he

could give some of the sale proceeds to Mr. Rousse in recognition of his

employment with, and his loyalty to, Mr. Bruce.

      Mr. Bruce spoke to Mr. Rousse about Mr. Doverspike’s invitation, and Mr.

Rousse agreed to accompany Mr. Bruce to the meeting in Larose, Louisiana. They

met with Mr. Doverspike and the financial planners shortly thereafter during or

before early 2003. The financial planners were promoting the plan, which Mr.

Ohle (and possibly Mr. Deichmann) devised to provide estate and/or income tax

benefits.

      The framework of the plan apparently required that Mr. Bruce enter into two

offsetting $5.5 million loans, one of which was labeled a “Swap” and for which

Mr. Bruce would claim a basis of $5.5 million.4 Mr. Bruce would then contribute

the Swap to a newly formed unitrust in which each of the daughters had a 1%

interest and he retained a remainder interest and the power to substitute for the

      4
        Documents in the record use the term “Swap” in reference to one of the two
loans, and the parties do likewise. As discussed infra pp. 40-42, the “Swap” is not
a “swap” as that term is used in the financial market, but it is at best a loan
agreement. We follow the parties’ lead and refer to the “Swap” as such to avoid
confusion. We neither intend to suggest nor find that the “Swap” was a “swap”
within the financial market vernacular.
                                         - 11 -

[*11] unitrust’s corpus property of equal value. The next step would be for Mr.

Bruce to sell his remainder interest to two other newly formed trusts, the sole

beneficiary of each of which was one of the daughters, in exchange for promissory

notes totaling the portion of the $5.5 million basis that Mr. Bruce apportioned to

the remainder interest. As to the next step Mr. Bruce would substitute the Marine

stock for the unitrust’s corpus (i.e., the Swap), on the basis that the properties were

of equal value. The two trusts would acquire the daughters’ unitrust interests. The

unitrust would then be terminated and the Marine stock distributed to the two

trusts. The two trusts would transfer the Marine stock to a partnership that the

trusts owned and Mr. Bruce controlled. The partnership would then sell the

Marine stock in the ready market to a third party for cash, and petitioners would

receive the value of their Marine stock through the two trusts’ payments, on the

promissory notes, from the cash that the third party paid to purchase the Marine

stock. Mr. Bruce knew that, without the plan, significant Federal income tax

would be imposed on petitioners’ direct sale of the Marine stock, or on a sale of the

Sarah Jane, and the financial planners generally advised Mr. Bruce that the plan

would allow petitioners to cash out the value of their stock without paying any

Federal tax on the cashout.
                                         - 12 -

[*12] Mr. Lobrano, then a sole practitioner, was Mr. Bruce’s longtime attorney/tax

adviser, having represented him in the purchase and sale of various watercraft.5

Mr. Bruce (or Mr. Rousse on behalf of Mr. Bruce) asked Mr. Lobrano to meet with

the financial planners and then to give Mr. Bruce an independent, more learned

opinion on the plan. Mr. Lobrano later met with Messrs. Bruce, Rousse, Ohle, and

Deichmann, and Mr. Lobrano listened to their promotion spiel. Mr. Lobrano

believed the plan to be valid as he equated it to “a derivative of a sale to a defective

grantor trust strategy, which has been around”. He felt uncomfortable, however,

opining that the plan was valid simply on the basis of his own belief.

      Mr. Doverspike suggested that Mr. Bruce retain Mr. Lukinovich, another

graduate from the New York University School of Law with an LL.M. in tax, to

opine on the validity of the plan. Mr. Lukinovich practiced in southern Louisiana,

and the Louisiana Board of Legal Specialization recognized him as a certified tax

attorney and as a certified estate planning and administration specialist. Mr.

Lobrano advised Mr. Bruce to follow Mr. Doverspike’s suggestion. Mr. Lobrano

      5
        Mr. Lobrano was a local attorney in Belle Chasse, Louisiana, and he had
impeccable tax credentials in the rural suburban Lafourche community in which he
practiced law, part of which included Mr. Bruce’s community of Cut Off,
Louisiana, southwest of New Orleans. Mr. Lobrano graduated from Tulane
University, first with a bachelor of science degree in management and later with a
juris doctor degree, and he earned a master’s degree (LL.M. in taxation) from New
York University School of Law. He was certified by Louisiana as a tax specialist
and enjoyed an AV rating in Martindale Hubbell, of which we take judicial notice.
                                         - 13 -

[*13] knew that Messrs. Lukinovich and Doverspike had some common clients and

thus an ongoing business relationship with each other. Mr. Lobrano also believed

it likely that Messrs. Ohle, Deichmann, and Lukinovich had presented similar plans

to their clients resulting in an ongoing business relationship as to the plans.

      Mr. Lukinovich (at the invitation of Mr. Doverspike or Mr. Lobrano) met

with Messrs. Lobrano, Doverspike, Bruce, and Rousse (and possibly others).

Ultimately, Mr. Lukinovich, working with his future attorney James G. Dalferes,

issued 58-page and 49-page legal opinion letters to Mr. Bruce and to Mr. Rousse

(as trustee of two trusts (Daughters’ Trusts) to be formed for the daughters as part

of the plan), respectively. The opinion letter issued to Mr. Bruce, dated April 13,

2004, stated that Mr. Bruce had “requested our opinions regarding certain federal

income tax consequences” as to the plan and concluded in relevant part that Mr.

Bruce’s sale to the Daughters’ Trusts of his remainder interest in a unitrust named

CTB 2003 Trust No. 1 (CTB), discussed infra pp. 17-18, was “more likely than

not” a taxable event for which he was required to report gain equal to the sale price

less his basis in the interest. While the letter did not specifically state the amount

of Mr. Bruce’s basis in the interest or the amount of any such gain that Mr. Bruce

was required to report, it stated, as a fact, that Mr. Bruce had “purchased a swap
                                        - 14 -

[*14] contract” for $5.5 million and concluded as to Mr. Bruce’s basis in the

remainder interest that

      it is more likely than not, in our opinion, that your basis in your
      retained remainder interest in CTB Trust No. 1 is equal to your basis
       in the Swap Contract contributed to CTB Trust No. 1, less the amount
      of basis allocable to the lead trust unitrust interests in such trust, and
      that the Valuation Rules set forth in Section II of this analysis should
      apply in allocating the basis between your retained remainder interest
      and the lead unitrust interests.

The opinion letter did not state that Mr. Bruce had to report any other income as to

the plan. The opinion letter issued to Mr. Rousse, dated April 14, 2004, stated that

Mr. Rousse had “requested our opinions regarding certain federal income tax

consequences” as to the plan and generally concluded that the Daughters’ Trusts

did not have to report any income on account of the plan. Neither opinion letter

addressed whether petitioners or Sareb Investments, LLC (Sareb),6 a passive entity

that was formally established incident to the plan and the sale of petitioners’

Marine stock, was in substance the seller of that stock.

VII. Consummation of the Plan

      A. Background

      After consulting with his professional advisers and in part on the basis of

their recommendations and advice, Mr. Bruce decided to consummate the plan, and

      6
        The record sometimes refers to Sareb as Sarab. We use the spelling used by
the parties.
                                         - 15 -

[*15] he was generally charged a set billing price to do so. The plan involved

multiple transactions, and Mr. Bruce lacked any understanding of these

transactions, including their purpose or significance, or the risks or benefits

involved. Messrs. Lobrano and Lukinovich, sometimes separately and other times

collaboratively, drafted the necessary documents to carry out the transactions.

      Transactions effected incident to the consummation of the plan were as

follows.

      B. May 23, 2003

      Many transactions were effected on May 23, 2003.

      Mr. Bruce formally issued a promissory note (Gamma note) of $5.5 million

to Gamma Trading Partners Limited Liability Co. (Gamma). The Gamma note

provided that, “FOR VALUE RECEIVED” (supposedly, the $5.5 million that was

referenced in the Gamma note), Mr. Bruce would pay Gamma $5.5 million, plus

interest of 2.9% per annum, on December 31, 2003 (or, if he wanted, an earlier

date after expiration of any transaction evidenced by a confirmation under the

International Swap Dealers Association, Inc.’s Master Agreement of May 23,

2003, between Mr. Bruce and Gamma (Swap)). The Gamma note further provided

that the $5.5 million which Mr. Bruce was referenced to receive under the Gamma
                                       - 16 -

[*16] note had to be used solely to effect the Swap.7 The Gamma note required

Mr. Bruce to pay Gamma an “Initial Loan Fee” and a “Quarterly Loan Fee” in

addition to the stated interest. The former fee equaled 2% of the $5.5 million

($110,000) and was payable on May 23, 2003. The latter fee equaled 0.1% of the

$5.5 million ($5,500) and was payable for each calendar quarter (excluding any

calendar quarter before July 2003) during which the Gamma note was not paid in

full.

        Samyak C. Veera8 (as Gamma’s manager) and Mr. Bruce formally executed

the Swap master agreement (a boilerplate document typically associated with swap

contracts) and a related schedule and confirmation letter. This Swap master

agreement provided that Mr. Bruce would “pay” Gamma $5.5 million on May 23,




        7
        The record does not establish (and we decline to find) that Mr. Bruce
actually received the $5.5 million referenced in the Gamma note. To the contrary,
it appears that he did not. When the Gamma note is viewed in tandem with the
Swap, it seems most likely this was a “paper transaction” whereby the $5.5 million
that Mr. Bruce was entitled to receive from Gamma under the Gamma note was
simply offset against the $5.5 million that Mr. Bruce was required to pay Gamma
under the Swap.
        8
        We take judicial notice of an October 23, 2013, U.S. Department of Justice
press release announcing that an individual named Samyak Veera had recently
been charged with conspiring through a complex, multi-million-dollar tax fraud
scheme to cause more than $200 million in losses to the United States between at
least 2003 and 2011, as well as tax evasion. See Paschall v. Commissioner, 137
T.C. 8, 11 n.7 (2011).
                                        - 17 -

[*17] 2003, and that Gamma would “pay” Mr. Bruce $5,530,152 on July 31, 2003.9

The $30,152 difference between these two payments corresponds to the application

of a 2.9% annual interest rate to the period from May 23 through July 31, 2003,

and completely offsets the interest on the Gamma note that Mr. Bruce was required

to pay to Gamma for the period from May 23 through July 31, 2003.

      Mr. Bruce formally entered into a security agreement with Gamma pledging

and granting a security interest in the Swap and certain other incidental collateral

to secure his obligations under the Gamma note.

      Mr. Bruce, as settlor and with South Dakota Trust Co., LLC (SDTC), as

trustee, formally established CTB under the laws of South Dakota. He retained a

remainder interest in CTB and named his daughters as unitrust beneficiaries who

would receive annual distributions generally equal to 1% of the net fair market

value of CTB’s assets.10 Incident thereto, Mr. Bruce formally assigned his interest

in the Swap to CTB, CTB formally assumed Mr. Bruce’s obligations under the

Swap, and CTB formally agreed not to incur any debt in excess of $20,000 until




      9
        Again, the record does not establish (and we decline to find) that Mr. Bruce
actually paid the $5.5 million referenced in the Swap.
      10
        Mr. Lukinovich’s firm prepared CTB’s trust instrument (and all of the
documents related to the funding of CTB), and Mr. Lukinovich (or possibly Mr.
Ohle) selected SDTC to serve as CTB’s trustee.
                                        - 18 -

[*18] the Gamma note was repaid.11 CTB’s trust agreement allowed Mr. Bruce

during his lifetime to substitute for CTB’s corpus “property of an equivalent

value”, and the plan’s promoters included this provision intending to characterize

CTB as a grantor trust for Federal income tax purposes as long as Mr. Bruce lived

and held this power of substitution. The trust instrument further stated that the

daughters’ rights to receive the annual distributions would terminate two years

later on May 23, 2005.12 Upon termination, Mr. Bruce or his assignee (or Mr.

Bruce’s estate if he died without designating an assignee) would receive all of

CTB’s assets remaining for distribution.

      C. June 1, 2003

      On June 1, 2003, petitioners, as settlors, and Mr. Rousse, as trustee, formally

established the Daughters’ Trusts under the names Sarah Jane Bruce Trust (SJB

Trust) and Rebekah Ruth Bruce Trust (RRB Trust). The original corpus of each of

the Daughters’ Trusts was $50.




      11
         Mr. Bruce’s formal interest and obligations under the Swap, absent default
or early termination, were primarily the obligation to pay $5.5 million on May 23,
2003, and the right to the return of the $5.5 million approximately 2 months later
with an additional amount equal to interest accumulating at 2.9% per annum.
      12
           Mr. Bruce was expected to be alive on May 23, 2005.
                                        - 19 -

[*19] D. July 1, 2003

      On July 1, 2003, petitioners formally transferred 30,000 shares of AHB

stock (worth approximately $300,000) and $60,000 to each of the Daughters’

Trusts.

      E. July 31, 2003

      On July 31, 2003, Mr. Bruce and the Daughters’ Trusts formally entered into

a transaction in which Mr. Bruce sold his remainder interest in CTB, whose only

asset at that time was the Swap, to the Daughters’ Trusts for $5,419,549. The

$5,419,549 was formally paid through each of the Daughters’ Trusts’ issuance of a

promissory note payable to Mr. Bruce in the amount of $2,709,774.48. Each note

required that simple interest at the rate of 2.55% per annum be paid annually on the

anniversary date of the note and that the principal with accrued interest be paid on

or before July 30, 2012.

      By the end of July 31, 2003, Gamma had not paid, as to the Swap, the

$5,530,152 that was then due. The record does not explain why Gamma on July 31,

2003, did not pay the $5,530,152 that was then due, or whether Mr. Bruce took any

action at that time to enforce this payment.
                                         - 20 -

[*20] F. August 13, 2003

      On August 13, 2003, Chaffe & Associates, Inc., Investment Bankers (C&A),

issued a letter appraising Marine’s equity at a fair market value of $5,822,175 as of

January 1, 2003. C&A’s appraisal was solely for the purpose of selling all of the

Marine stock to a grantor retained annuity trust. C&A noted in its appraisal that

Marine owned the Sarah Jane, which Marine represented to C&A (and C&A

presumed) had a market value of $5 million based in part on an appraisal of the

Sarah Jane as of March 12, 2001, by Rivers and Gulf Marine Surveyors, Inc. C&A

also noted that Mr. Lobrano had requested that C&A perform its appraisal on an

“asset approach only” and “disregard any corporate taxes that would be due should

the Company [Marine] sell the vessel prior to the expiration on January 1, 2010 of

the built in corporate tax.”

      G. August 20, 2003

      On August 20, 2003, Mr. Bruce formally exercised his power of substitution

and formally transferred the Marine stock to CTB in exchange for the Swap.13

      13
         The “Substitution Agreement” underlying the August 20, 2003, transfer
refers to a stock certificate dated January 1, 2003, and “a Certificate in the form
attached hereto as Exhibit B” but does not include a copy of either of those
certificates. While petitioners concede that Ms. Bruce owned one-half of the
Marine stock at the beginning of 2003 and the record establishes that she continued
to own that portion of the stock through September 5, 2003, we find no credible
evidence in the record that supports a finding that Mr. Bruce, in his name alone,
                                                                           (continued...)
                                         - 21 -

[*21] Later that day, SDTC informed Mr. Bruce that it intended to resign as CTB’s

trustee within the next few days, stating that “as sole trustee, we did not

contemplate nor do we feel comfortable administering a non-directed trust that

holds closely held assets”. Also on August 20, 2003, the July 31, 2003, payment

date for the Swap was formally extended to August 29, 2003, with a corresponding

increase in the amount payable equal to 2.9% annual interest prorated for the

period of extension.

      H. August 21, 2003

      On August 21, 2003, SJB formally sold her CTB interest to RRB Trust, and

RRB formally sold her CTB interest to SJB Trust. The sale price for each interest

was $55,385.

      I. August 29, 2003

      Sareb was formally established on August 29, 2003, to serve as a holding

company to which all of the Marine stock would be transferred. Each of the

Daughters’ Trusts formally owned one-half of Sareb, and Mr. Rousse was Sareb’s




      13
        (...continued)
could legitimately transfer all of the Marine stock in this transaction. Nor do we
find that the Marine stock, which had just been appraised at a fair market value of
approximately $5.8 million, and the Swap, which we conclude had no value, were
“property of an equivalent value”.
                                        - 22 -

[*22] designated manager. For 2003 Sareb reported its income and expenses for

Federal income tax purposes as if it were a domestic general partnership.

      J. August 31, 2003

      On or about August 31, 2003, Mr. Bruce, Mr. Rousse (as trustee for the

Daughters’ Trusts), and SDTC (as the trustee of CTB) formally executed a

document through which Messrs. Bruce and Rousse consented to CTB’s

termination on August 31, 2003. At its termination, CTB formally owned all of the

Marine stock, and all of that stock was formally distributed equally to the

Daughters’ Trusts in accordance with the terms of the CTB trust agreement.

      K. September 5, 2003

      On September 5, 2003, the Daughters’ Trusts formally transferred all of the

Marine stock to Sareb as a capital contribution. Mr. Lobrano believed that this

transfer caused a termination of Marine’s status as an S corporation because

Sareb’s shareholder was then a limited liability company, and he coordinated the

closing of Marine’s books to reflect that it was no longer an S corporation.

      L. September 9, 2003

      Before September 9, 2003, W&T had abandoned its plan for the long-term

contracts with Maritime Logistics, Mr. Doverspike had contacted Mr. Rousse to

inform him that he knew of a group of buyers from New York who were interested
                                       - 23 -

[*23] in purchasing Marine, and Mr. Rousse had met with the investors to discuss

a possible sale of Marine. On September 9, 2003, Sareb formally sold the Marine

stock to Sea & Sky Mirror Images, L.L.C. (Mirror), a Delaware limited liability

company, for $4,721,627 plus any business receivable (ultimately $321,160) that

Marine collected within 90 days after the closing which Marine reflected in its

books as of the closing. A law firm, Morris, Manning & Martin, LLP (MMM),

was the escrow agent for the sale, and $4,721,627 was delivered to MMM on the

day of the sale. MMM deposited the $4,721,627 into its escrow account for the

Marine stock sale (Marine stock sale escrow account).

      Shortly after the sale, Mirror informed Mr. Rousse that it wanted to sell the

Sarah Jane. Mr. Rousse knew of various local individuals (many of whom during

mealtime conversed daily with each other (and with Messrs. Bruce and Rousse))

who were interested in purchasing the Sarah Jane, and he met with a few of these

individuals.

      M. September 11, 2003

      Wiley Falgout was Mr. Bruce’s friend from high school, and Mr. Falgout

(among others) had asked Mr. Bruce, as early as 2000, if he wanted to sell the

Sarah Jane for $5 million. As of September 11, 2003, Mr. Falgout wanted his two

children to buy the Sarah Jane through their limited liability company, Minnie
                                        - 24 -

[*24] Falgout, L.L.C., a marine supply boat business that Mr. Falgout operated.

Messrs. Bruce and Rousse desired that Mr. Falgout purchase the Sarah Jane in lieu

of any other prospective purchaser.

      On September 11, 2003, Minnie Falgout, L.L.C., and Mirror executed a

purchase agreement under which they agreed that Minnie Falgout, L.L.C., would

buy the Sarah Jane for $5 million with the closing of the sale to occur on or before

October 8, 2003. Mr. Falgout negotiated this agreement directly with Mr. Bruce

while also speaking to Mr. Rousse about the operational aspects of the Sarah Jane.

Mr. Falgout believed at the time that Mr. Bruce (or a company he controlled)

owned the Sarah Jane.

      N. September 16, 2003

      On September 16, 2003, Minnie Falgout, L.L.C., paid $5 million to Marine

(through MMM, as escrow agent) to purchase the Sarah Jane. MMM placed those

funds into an escrow account for that sale (Sarah Jane sale escrow account). Later

that day, MMM wired $2,348,690 from the Sarah Jane sale escrow account to

AHB in final payment of Marine’s $2,522,223 promissory note to AHB, leaving a

balance in the Sarah Jane sale escrow account of $2,651,310. The $2,651,310 and

an additional $390,886 ($3,042,196 in total) were transferred on September 19,

2003, to the account of an entity whose identity appears to be “slto Trading
                                          - 25 -

[*25] Partners”. Later on September 19, 2003, Marine transferred another

$2,307,804 to that entity’s account bringing the balance in the account to

$5,350,000.

      Also on September 16, 2003, MMM wired $2,372,938 to Sareb from the

escrow account for the Marine stock sale, leaving a balance in the escrow account

of $2,348,690 ($4,721,627 ! $2,372,938) .14 The $2,348,690 balance was

transferred later that day to Marine. The amounts owed by the Daughters’ Trusts

under the July 31, 2003, promissory notes were reduced by $2,372,938 on account

of the transfers, and Mr. Bruce’s $2,303,967 promissory note to Marine was

recorded as paid in full.

      O. September 23, 2003

      Sareb purchased an 18-month certificate of deposit in the amount of $1.8

million on September 23, 2003. The certificate of deposit accrued interest at

2.16% per annum and had a maturity date of March 23, 2005.

      P. September 30, 2003

      On September 30, 2003, the Daughters’ Trusts (in equal proportions)

transferred to Mr. Bruce stock in AHB valued at $300,000. Petitioners accounted

for this transfer as payments on the July 31, 2003, promissory notes.


      14
           The $1 discrepancy is a result of rounding.
                                         - 26 -

[*26] Q. October 8 and 9, 2003

      On October 8, 2003, a $400,000 check, drawn on Sareb’s checking account,

was deposited into petitioners’ bank account. The check was paid one day later.

Petitioners accounted for the $400,000 deposit as payments on the July 31, 2003,

promissory notes.

      R. November 13, 2003

      On November 13, 2003, Mr. Rousse wrote Mr. Bruce a $165,000 check

drawn on Sareb’s checking account. The check, which was designated “Loan

Repayment - trusts”, was paid on November 20, 2003. Petitioners accounted for

this transfer as payments on the July 31, 2003, promissory notes.

      S. 2005

      During at least 2005 Sareb had a checking account over which Mr. Bruce

had signature authority although he was neither a manager nor an owner of Sareb.

On March 28, 2005, Sareb deposited $1,858,214 into that account, which deposit

represented the accrued balance of the certificate of deposit purchased September

23, 2003. Between April 12 and October 16, 2005, Mr. Bruce authorized and/or

received $1,850,000 from that account.
                                        - 27 -

[*27] VIII. Cost of Plan

      Mr. Bruce (individually and/or through Marine) paid at least $200,000 to

consummate the plan. Of those payments, at least $181,317 was for professional

fees (including at least $155,000 to Mr. Lukinovich and/or Mr. Ohle, in part for the

opinion letters, and at least $25,000 to Mr. Lobrano). The balance, up to as much

as $25,000, was for incidental costs. The fees which Mr. Bruce paid were

generally set before the consummation of the plan began.

IX. Petitioners’ 2003 Tax Return and Marine’s 2003 Tax Returns

      A. Petitioners’ Return

      Petitioners reported on their 2003 tax return that they purchased “CTB Trust

#1” on May 23, 2003, for $5,419,549, and that they sold that asset on July 31,

2003, for the same amount.15 Petitioners’ 2003 return was prepared by John M.

Estess, an owner of a local certified public accounting firm on the basis of

information given to him by either Mr. Bruce or Mr. Lobrano.




      15
         Petitioners do not specifically explain how they arrived at the $5,419,549
that they reported as their basis in CTB. In that they assert that Mr. Bruce paid
$5.5 million for the Swap, we infer that the $5,419,549 is the portion of the $5.5
million that they believed was attributable to the remainder interest.
                                         - 28 -

[*28] B. Marine’s Returns

              1. Form 1120S

      Marine filed a 2003 Form 1120S, U.S. Income Tax Return for an S

Corporation, which was prepared by Mr. Estess, on June 24, 2004. The 2003 Form

1120S was prepared as a “short-year return”, by virtue of Mr. Lobrano’s believed

termination during the year of Marine’s status as an S corporation, but it did not

indicate either that it was for a “short year” or what portion of 2003 it covered

(although it reported that it was a “Final return”). The 2003 Form 1120S reported

Marine’s operations through the date on which it ceased to be an S corporation and

reported that its only shareholders during the short year were petitioners, each

owning one-half of its stock throughout the short year. Marine also reported on the

2003 Form 1120S, inter alia, that it was entitled to deduct $86,485 of legal and

professional fees.

              2. Form 1120

      On or about September 15, 2004, Marine filed a Form 1120, U.S.

Corporation Income Tax Return, for the remainder of 2003. This return reported

Marine’s operations for 2003 following the believed termination of its S status, but

did not specifically state that it was a “short-year return” or the portion of 2003 that

it covered.
                                         - 29 -

[*29] Marine reported on the 2003 Form 1120, among other things, that it incurred

a $4.75 million ordinary loss from “DKK/USD BINA” that it acquired for $4.75

million on September 15, 2003, and sold for nothing on September 16, 2003; and

that it incurred a $600,000 short-term capital loss from an “INTEREST RATE

SWAP” that it acquired for $600,000 on September 15, 2004 (sic), and sold for

nothing on September 16, 2004 (sic). Marine also reported on the 2003 Form 1120

that on September 16, 2003, it sold a building for $2,651,310, which it had

acquired in May 1991; that it realized a $2,478,536 gain on the sale; that

$1,882,612 and $595,924 of the gain were categorized as ordinary income and

long-term capital gain, respectively; and that it was entitled to completely offset

the $1,882,612 and the $595,924 by the ordinary loss from “DKK/USD BINA”

and by the capital loss from the “INTEREST RATE SWAP”, respectively. Marine

did not report on the 2003 Form 1120 that it sold the Sarah Jane during that year.

X. Deficiency Notice

      A. Overview

      Respondent issued a deficiency notice to petitioners on September 27, 2010.

In the notice, respondent reflected his determinations as to (1) legal and

professional fees, (2) capital gains income, (3) itemized deductions, and (4) the
                                        - 30 -

[*30] application of the 40% accuracy-related penalty under section 6662(h) for a

gross valuation misstatement.

      B. Legal and Professional Fees

      Respondent determined that Marine was not entitled to deduct $52,450 of

legal and professional fees attributable to the plan (the $52,450 was included in the

$86,485 mentioned above). The notice stated that petitioners failed to show that

the “payments were paid or incurred for the purposes designated, or that such

payments otherwise met the requirements for deduction under the Internal Revenue

Code”.

      C. Capital Gains Income

      Respondent determined that petitioners failed to recognize $5,266,724 in

capital gains income. The notice stated:

             1. You have not established that (i) the purported transfers of
      your Sea & Sea Marine, Inc. stock to the CTB Trust, and then to the
      Sarah Jane Bruce Trust and the Rebekah Ruth Bruce Trust and then to
      Sareb Investments, (ii) the purported sale of the Sea & Sea Marine
      stock to Sea & Sky Mirror Images LLC, and (iii) the transactions
      resulting in a loss claimed by Sea & Sea Marine from “DKK/USD
      BINA,” (all of which, including all activities and contractual
      arrangements associated therewith, are hereinafter referred to as the
      Transaction) had any economic substance, were part of an activity
      entered into for profit, were supported by a bona fide business
      purpose, were not entered into for a tax avoidance purpose, were not a
      sham, or should be recognized for federal tax purposes.
                                        - 31 -

      [*31] 2. The substance of the transactions involving purported
      transfers of your Sea & Sea Marine, Inc. stock to the CTB Trust, and
      then to the Sarah Jane Bruce Trust and the Rebekah Ruth Bruce Trust
      and then to Sareb Investments, the purported sale of the Sea & Sea
      Marine stock to Sea & Sky Mirror Images LLC, and the transactions
      resulting in a loss claimed by Sea & Sea Marine, Inc. from
      “DKK/USD BINA,” is not consistent with the form of such
      transactions. It is determined that the substance of the transaction was
      a sale of your stock in Sea & Sea Marine, Inc., for $5,419,549.
      Alternatively, it is determined that the substance of the transaction
      was a sale of assets by Sea & Sea Marine, Inc. while it was an S
      corporation, and a distribution of the sale proceeds along with all of
      its remaining assets to you in a complete liquidation of your interests
      in Sea & Sea Marine, Inc.[16]

      D. Itemized Deductions

      Respondent determined that petitioners could not deduct $28,783 of

itemized deductions. The notice determined that respondent’s adjustments to the

legal and professional fees and to the capital gains income computationally

increased petitioners’ adjusted gross income beyond the threshold amount, thus

resulting in the $28,783 concomitant automatic computational adjustment.




      16
         While the notice of deficiency states that petitioners are considered to have
sold the Marine stock for $5,419,549, it does not explain the manner in which that
then turns into $5,266,724 of unreported capital gains income. Petitioners reported
on their 2003 return that they realized $31,846 in capital losses unrelated to the
plan, and respondent did not disallow any of the deduction for those losses. We
infer that respondent determined that petitioners’ applicable basis in the Marine
stock was $120,979 (($5,419,549 ! $120,979) ! $31,846 = $5,266,724), and we
find accordingly.
                                         - 32 -

[*32] E. Accuracy-Related Penalty

      Respondent determined that petitioners were liable for a 40% accuracy-

related penalty under section 6662(h) for a gross valuation misstatement. The

notice determined that this penalty applied to all of the three adjustments just

discussed.

                                       OPINION

I. Burden of Proof

      The Commissioner’s determinations in a deficiency notice are generally

presumed correct, and taxpayers generally bear the burden of proving those

determinations wrong. See Rule 142(a)(1); Welch v. Helvering, 290 U.S. 111, 115

(1933). Section 7491(a)(1) generally provides an exception to these rules in that

section 7491(a)(1) shifts the burden of proof to the Commissioner as to any factual

issue relevant to a taxpayer’s liability for tax if the taxpayer meets certain

conditions.17 While the parties dispute whether section 7491(a)(1) applies here, we

need not and do not decide that dispute because we render our decision on the basis

of a preponderance of the evidence. See Estate of Bongard v. Commissioner, 124

T.C. 95, 111 (2005); see also Esgar Corp. v. Commissioner, 744 F.3d 648, 654-655

      17
        Sec. 7491(a)(1) generally provides that “[i]f, in any court proceeding, a
taxpayer introduces credible evidence with respect to any factual issue relevant to
ascertaining the liability of the taxpayer for any tax imposed by subtitle A or B, the
Secretary shall have the burden of proof with respect to such issue.”
                                          - 33 -

[*33] (10th Cir. 2014), aff’g T.C. Memo. 2012-35 and Tempel v. Commissioner,

136 T.C. 341 (2011).

II. Limitations Period

      Petitioners’ opening brief states that “petitioners now for the first time raise

the statute of limitations as a bar to the assessment” and acknowledges that “This

argument is problematic since this issue was not raised in the pleadings”.

Petitioners conclude that the three-year limitations period of section 6501(a) bars

assessment because the record establishes that the deficiency notice was issued

more than three years after their 2003 return was filed and fails to establish an

exception to this three-year rule.18

      Petitioners recognize that judicial jurisprudence holds that the applicability

of the limitations period is not properly before the Court where the taxpayer failed

to plead that matter in the petition. Petitioners assert that this jurisprudence is

limited to situations where either the Court had entered a decision in the case

before the issue of the limitations period was raised or the record otherwise showed

that the deficiency notice was timely. Petitioners also contend that, even if the

limitations period is not mentioned in the pleadings, section 7491(a)(1) in its own

right requires the Court to hold that the three-year limitations period bars

      18
        Sec. 6501(a) and (b)(1) generally provides that tax must be assessed as to a
return within three years of the later of its filing or its due date.
                                         - 34 -

[*34] assessment whenever the record establishes that a deficiency notice was

issued after the three-year period and fails to establish that an exception to the

three-year rule applies. As to this latter argument, petitioners claim that Congress,

by enacting section 7491(a)(1), legislatively did away with the Court’s requirement

in Rule 39 that a taxpayer plead that the limitations period has expired in order to

properly place that issue before the Court.

      We disagree with petitioners’ conclusion that the applicability of the

limitations period is properly before the Court. The applicability of the limitations

period is not a jurisdictional requirement that must be met for the Court to decide

this case. The period of limitations is a rule of law that, unlike a jurisdictional

requirement, may be waived if it is not pleaded properly. See Genesis Oil & Gas,

Ltd. v. Commissioner, 93 T.C. 562, 564-565 (1989). Our Rules require that a

taxpayer specifically allege as an affirmative defense in the petition that the

limitations period has run in order to properly raise the applicability of the

limitations period as an issue. See Rule 39; Woods v. Commissioner, 92 T.C. 776,

779 (1989). Petitioners acknowledge that they did not make such an allegation in

the petition. We accordingly conclude that petitioners have waived any dispute
                                           - 35 -

[*35] that they now have as to the applicability of the three-year limitations period

by not timely raising the issue.19

       While we may sometimes exercise our discretion to consider an issue that

was not timely raised, we generally do not exercise that discretion where a party

raises the issue for the first time on brief and our consideration of the issue would

unfairly prejudice the opposing party. See Chapman Glen Ltd. v. Commissioner,

140 T.C. 294, 349 (2013). Respondent asserts that petitioners validly executed

consents extending the limitations period to a date after the date the deficiency

notice was issued, and respondent indicates that he would have offered those




      19
          Petitioners in their reply brief note that Rule 41(b) treats an issue that is not
raised in the pleadings as being raised in the pleadings if the issue was tried by the
express or implied consent of the parties. Petitioners suggest in their reply brief
that Rule 41(b) applies here because the parties’ stipulations establish the date that
petitioners’ 2003 return was filed and that the deficiency notice was issued more
than three years later. As petitioners see it, the parties’ stipulations put respondent
on notice that the expiration of the three-year limitations period was in issue. We
disagree. In addition to the fact that petitioners first raised this argument in their
reply brief, which by itself makes this argument untimely, we read nothing in the
stipulations that specifies either that petitioners were disputing that the deficiency
notice was timely or that the parties were building an evidentiary record for the
Court to decide such a dispute. Had petitioners properly raised the limitations
period as an issue in their pleadings, respondent might have been able to present
evidence that petitioners had in fact extended the limitations periods for both years
by timely executing Form 872, Consent to Extend the Time to Assess Tax, as
respondent claims in his reply brief. Respondent did not present any such evidence
at trial, however, because he was not aware at that time that petitioners wanted to
raise the limitations period as an issue.
                                         - 36 -

[*36] extensions into evidence had petitioners timely raised the applicability of the

limitations period as an issue.

      Respondent essentially concludes that he would be unfairly prejudiced were

we now to allow petitioners to raise the limitations issue and then decide that issue

on the basis of the record at hand. Respondent notes that he helped build the

record without any notification or hint that the consent forms would be relevant to

combat petitioners’ assertions with respect to this issue. We agree. Petitioners had

ample opportunity to timely raise the applicability of the limitations period as an

issue in this case, and their delay in attempting to raise the issue on brief unfairly

prejudiced respondent.

      Further, we do not agree with petitioners’ argument that section 7491(a)(1)

requires that we decide the issue even though it was not raised in the pleadings.

The pleadings serve a vital role in litigation in this Court. While many issues

could theoretically be in dispute in a given case, the pleadings specify the issues

which are actually in dispute, as well as the parties’ respective positions with

respect thereto, and they allow the parties to efficiently and effectively litigate the

case accordingly. See Rule 31(a).

      In recognition and furtherance of this vital role, we have announced time and

time again that we will generally consider only those issues which are properly
                                         - 37 -

[*37] raised in the pleadings. See, e.g., Ill. Power Co. v. Commissioner, 87 T.C.

1417, 1449 (1986); Seligman v. Commissioner, 84 T.C. 191, 198-199 (1985),

aff’d, 796 F.2d 116 (5th Cir. 1986); Rollert Residuary Trust v. Commissioner, 80

T.C. 619, 636 (1983), aff’d, 752 F.2d 1128 (6th Cir. 1985). We do not read section

7491(a)(1) to change or otherwise erode this firmly established rule. The

applicability of the three-year limitations period is not properly before the Court,

and we decline petitioners’ invitation in their opening brief to decide that issue.

III. Capital Gains Income

      Respondent determined that for Federal income tax purposes petitioners are

treated as selling the Marine stock to Mirror. Respondent argues in support of this

determination that Sareb should not be treated as the seller because it was Mr.

Bruce’s conduit or nominee.20 In this regard, respondent asserts, Mr. Bruce had

complete control over Sareb’s finances as evidenced by the facts that he had

signatory authority over Sareb’s bank accounts and appropriated all of the sale

proceeds to himself. In addition, respondent asserts, petitioners effected the plan

primarily to avoid reporting gain on a sale of the Marine stock. Petitioners argue

that the plan should be respected because the transactions underlying the plan had

real economic consequences and the plan meets the letter of the law. In addition,

      20
       Petitioners argue in their reply brief that respondent raised this issue too
late. We disagree. The argument flows directly from the deficiency notice.
                                         - 38 -

[*38] petitioners assert, Mr. Bruce consummated the plan purely for estate

planning purposes as an integral aspect of an “estate-freeze” strategy.

      We agree with respondent, as a secondary holding, that petitioners are

treated as the seller of the Marine stock for Federal income tax purposes. We hold

primarily that petitioners underreported their gain on Mr. Bruce’s sale of his

remainder interest to the Daughters’ Trusts. We recognize that respondent neither

determined nor argued that petitioners underreported their gain on the sale of the

remainder interest. All the same, petitioners have invoked our jurisdiction to

redetermine the deficiency that respondent determined, and the law is well settled

that we may redetermine the deficiency on the basis of reasons other than those

relied upon by the Commissioner or those argued by the parties. See Peoples

Translation Serv. v. Commissioner, 72 T.C. 42, 51 (1979); Wilkes-Barre Carriage

Co. v. Commissioner, 39 T.C. 839, 845 (1963), aff’d, 332 F.2d 421 (2d Cir. 1964);

see also Helvering v. Gowran, 302 U.S. 238, 246 (1937); Cannon v.

Commissioner, 949 F.2d 345, 347-348 (10th Cir. 1991), aff’g T.C. Memo.

1990-148.

      While we generally will not decide a case on grounds other than those that

the parties argued where to do so would surprise or prejudice a party, our decision

that petitioners failed to correctly report the sale of the remainder interest does not
                                         - 39 -

[*39] prejudice, and should not surprise, petitioners. Petitioners reported on their

2003 return that Mr. Bruce’s sale of the remainder interest was a taxable event, and

they reported that Mr. Bruce’s basis in that interest was $5,419,549. Mr.

Lukinovich also generally discussed in his opinion letters Mr. Bruce’s sale of the

remainder interest and concluded that the sale was a taxable event for which Mr.

Bruce was required to recognize gain equal to the difference between his basis in

that interest and its sale price. Furthermore, petitioners’ reply brief essentially

regurgitates Mr. Lukinovich’s discussion on this matter. Neither petitioners nor

Mr. Lukinovich explained in detail why they or he considered Mr. Bruce’s basis in

the Swap to be $5.5 million, a basis that each of them then apparently concluded

entered into the calculation of Mr. Bruce’s basis in the remainder interest. That

omission of a critical step in their analysis does not necessarily mean that

petitioners are prejudiced or should be surprised by our addressing and focusing on

that crucial issue.

       As to our primary holding, taxpayers may most definitely structure their

business transactions in a way that minimizes their tax liability. See, e.g.,

Boulware v. United States, 552 U.S. 421, 430 n.7 (2008); Gregory v. Helvering,

293 U.S. 465, 469 (1935). The mere fact that the form of a transaction literally

complies with the Code, however, does not necessarily mean that the form is
                                         - 40 -

[*40] respected for Federal income tax purposes when in substance it is a different

transaction. See, e.g., Knetsch v. United States, 364 U.S. 361, 365 (1960). Nor are

we bound by a meaningless label (or a mislabel) that the parties to an agreement

give to any or all parts of the agreement, but we decide the true nature of the

agreement by looking to its substance and to the intention of the parties. See, e.g.,

Gregory v. Helvering, 293 U.S. at 469; Sandvall v. Commissioner, 898 F.2d 455,

458 (5th Cir. 1990), aff’g T.C. Memo. 1989-189, and aff’g T.C. Memo. 1989-56.

Substance may therefore trump form, or as Shakespeare more eloquently

explained: “That which we call a rose [b]y any other name would smell as

sweet”.21

      With these thoughts in mind, we analyze the plan and its underlying

transactions to the extent necessary. We need not decide whether the plan was

legitimate, or whether the tax consequences which flow therefrom are as Mr.

Lukinovich opined and as petitioners argue. This is because, even if we assume

that the plan was legitimate, the use in the plan of the Swap is one example of a

contrivance which we decline to recognize for purposes of deciding this case.

Notwithstanding the labeling of the Swap as a “swap” in the relevant documents,

the Swap was not a “swap” within the meaning of the financial market. In Bank


      21
           William Shakespeare, Romeo and Juliet, act 2, sc.2, 43-44.
                                        - 41 -

[*41] One Corp. v. Commissioner, 120 T.C. 174 (2003), aff’d in part, vacated in

part and remanded as to an issue not relevant here sub nom. J.P. Morgan Chase &

Co. v. Commissioner, 458 F.3d 564 (7th Cir. 2006), we dove deep into the world

of financial derivatives and, aided in part by our Court-appointed experts,

addressed matters specifically related to the swap industry. We found that the

swap industry defines a swap as “a bilateral agreement the value of which is

derived * * * from the performance of an underlying asset, reference rate, or

index.” Id. at 185; see also sec. 1.446-3(c)(1), Income Tax Regs. (stating that a

“swap” is a form of a “notional principal contract” and that “[a] notional principal

contract is a financial instrument that provides for the payment of amounts by one

party to another at specified intervals calculated by reference to a specified index

upon a notional principal amount in exchange for specified consideration or a

promise to pay similar amounts”). We see no reason why our Bank One definition

of a “swap” is not applicable here. Because all of the amounts to be advanced and

repaid under the Swap were fixed at the time of the underlying agreement, and the

Swap in turn did not derive its value from the performance of an underlying asset,

reference rate, or index, we decline to recognize the Swap as a “swap” for purposes

of our analysis.
                                        - 42 -

[*42] At best, the Swap here was a loan arrangement under which one party

promises to advance cash to the other party, and the other party promises to repay

that cash with stated interest on a certain date. The terms of the Swap stated that

one party (Mr. Bruce) would pay to the other party (Gamma) $5.5 million on May

23, 2003, and that the other party (Gamma) would pay the first party (Mr. Bruce)

$5,530,152 on July 31, 2003. These terms, on their face, resemble the basic terms

of a loan arrangement. That said, however, the Swap, when viewed in tandem with

the Gamma note, was not even a valid loan arrangement.

      The parties to each of these instruments were the same, and the critical terms

of the instruments were tailored to mirror each other and not to allow for the

payment or receipt of any funds (other than the “fees” that Mr. Bruce had to pay

Gamma under the Gamma note, most likely for its participation in the plan).22 In

addition, we do not find that any of the funds referenced in these instruments were

actually lent or repaid, other than possibly through bookkeeping entries, and the

terms of the Swap were not always followed, e.g., as noted supra p. 19, Gamma did

not on July 31, 2003, pay as to the Swap the $5,530,152 that was then due.




      22
       We do not consider material that the Swap stated that Gamma’s payment
was due on July 31, 2003, while the Gamma note stated that Mr. Bruce’s payment
was due on December 31, 2003.
                                           - 43 -

[*43] The use of offsetting or circular cashflows strongly indicates that a

transaction lacks economic substance. See Merryman v. Commissioner, 873 F.2d

879, 882 (5th Cir. 1989) (tax structuring disregarded where “money flowed back

and forth but the economic positions of the parties were not altered”), aff’g T.C.

Memo. 1988-72; Prof’l Servs. v. Commissioner, 79 T.C. 888, 928 (1982)

(disregarding prearranged circular cashflows through a business trust); see also

Knetsch, 364 U.S. at 366 (offsetting payments on annuity bond and notes resulted

in sham). The use of meaningless labels and the disregard of key terms (or the

failure to act as a reasonable person would as to a violation or enforcement of the

terms) also point to that end.

      Petitioners ask the Court to recognize the Swap and to find that Mr. Bruce’s

basis in the Swap was $5.5 million because, they assert, Mr. Bruce actually paid

$5.5 million for the Swap. We decline to do so. We find no credible evidence in

the record supporting a finding that Mr. Bruce actually paid $5.5 million for the

Swap. Nor do petitioners attempt to rationalize why Mr. Bruce would have paid

$5.5 million for his interest in the Swap, an interest that formally consisted of an

obligation to pay $5.5 million and the right to a return of the $5.5 million shortly

thereafter with interest.23 In fact, it appears that Mr. Lukinovich may have had a

      23
           Petitioners arguably derived their $5.5 million basis in the Swap from the
                                                                           (continued...)
                                         - 44 -

[*44] similar reservation in opining that Mr. Bruce had a $5.5 million basis in the

Swap and therefore conveniently ignored this issue. This lapse is not further

explained by the record in this case, but suffice it to say that the importance of this

issue to the overall plan would be very hard to miss. Nevertheless, we find nothing

in the opinion letters, nor have petitioners pointed to any place, where Mr.

Lukinovich opines that Mr. Bruce’s basis in the Swap was $5.5 million.

      Petitioners assert that the plan should be respected in all regards because it

was undertaken primarily for legitimate estate planning purposes. We disagree.

We note the following facts which erode petitioners’ assertion that the plan was

undertaken primarily for legitimate estate planning purposes: (1) Messrs. Bruce

and Rousse were the linchpin of Marine’s business, and each of them was soon to

be leaving the business which, in turn, meant an end to the business unless it was

sold to someone who was willing to continue it; (2) Mr. Bruce desired to sell

petitioners’ Marine stock or its principal asset, the Sarah Jane, while Marine was


      23
         (...continued)
fact that the Swap provided that Mr. Bruce would “pay” Gamma $5.5 million on
May 23, 2003. This “logic” is faulty. First, Mr. Bruce never actually paid the $5.5
million to Gamma before assigning his interest in the Swap to CTB. Second, even
if he had made any such payment, the $5.5 million was formally stated to be repaid
to him later that year, and petitioners did not realize any of the stated repayment as
income. Petitioners cannot in this second instance reap an inappropriate double
benefit by including the $5.5 million in basis while at the same time not realizing
its repayment as income.
                                          - 45 -

[*45] still in operation and to maximize the proceeds that petitioners retained upon

any such sale; (3) Mr. Bruce participated in the offsetting loans, each with a short

life, and the mislabeling by his advisers of one of the loans as a “swap”; (4) the

Swap which Mr. Bruce reported had a value of $5.5 million was not in his estate

before the plan began; (5) Mr. Bruce on advice of his professional advisers

established CTB to terminate within two years of its making and to distribute its

assets to him upon termination; (6) Mr. Bruce terminated CTB approximately three

months after its making; (7) Mr. Bruce accepted the promissory notes from the

Daughters’ Trusts, which, at that time, were hardly creditworthy of issuing notes of

that monetary amount (e.g., they lacked significant assets relative to the amount of

the notes); (8) Mr. Bruce as an aspect of his advisers’ scheme substituted the

Marine stock, which had just been appraised at a fair market value of

approximately $5.8 million, for the Swap, which had no value; and (9) Mr. Bruce

replaced the value of the Marine stock with an equivalent amount of cash.

      Mr. Lukinovich’s tax opinion letters also speak loudly against finding

petitioners’ estate planning assertion as a fact. The letters state specifically that

they were issued in response to a request as to the Federal income tax

consequences flowing from the plan, and they make no mention that Mr. Bruce (or

Mr. Rousse) was requesting the opinions for estate planning purposes.
                                        - 46 -

[*46] We conclude that Mr. Bruce had no basis in the Swap. Furthermore, we

assume, as petitioners ask us to find, that Mr. Bruce sold his remainder interest to

the Daughters’ Trusts for promissory notes totaling $5,419,549. Mr. Lukinovich

opined that Mr. Bruce was required to recognize any gain that he realized on his

sale of that remainder interest, and we understand petitioners to concede this point.

Mr. Lukinovich also opined that Mr. Bruce’s basis in his remainder interest

equaled a portion of his basis in the Swap, and we understand petitioners to

concede this point as well. Given our conclusion that Mr. Bruce did not have any

basis in the Swap, it naturally follows that he also lacked any basis in his remainder

interest. We accordingly conclude that petitioners’ gross income for 2003 Federal

income tax purposes includes the $5,419,549 notes in full.24 We so hold.

      Petitioners would still not prevail if we decided this case on the grounds that

respondent argues. This is because the facts adequately support respondent’s

position that Mr. Bruce established and used Sareb as his conduit and nominee for

the sale. An intermediary who is interposed between persons involved in a

transaction may be disregarded under substance over form and related principles.


      24
         Petitioners vigorously assert that they elected out of the installment method
as to the sale. See sec. 453. We therefore do not consider the applicability of the
installment method to this sale. We also do not consider whether the fair market
value of the notes was less than their face value. Petitioners have treated the values
as the same, and we do likewise.
                                        - 47 -

[*47] See Gregory v. Helvering, 293 U.S. at 469; Sandvall v. Commissioner, 898

F.2d at 458; Reef Corp. v. Commissioner, 368 F.2d 125, 129-130 (5th Cir. 1966),

aff’g in part, rev’g and remanding in part T.C. Memo. 1965-72; Davant v.

Commissioner, 366 F.2d 874, 880-883 (5th Cir. 1966), aff’g in part, rev’g in part

and remanding S. Tex. Rice Warehouse Co. v. Commissioner, 43 T.C. 540 (1965);

Blueberry Land Co. v. Commissioner, 361 F.2d 93 (5th Cir. 1966), aff’g 42 T.C.

1137 (1964); see also Superior Trading, LLC v. Commissioner, 137 T.C. 70, 88-90

(2011) (discussing the binding commitment test, the end result test, and the

interdependence test, three alternative tests that courts employ to invoke the step

transaction doctrine and disregard a transaction’s intervening steps), aff’d, 728

F.3d 676 (7th Cir. 2013). The record persuades us to (and we do) find that Sareb

was Mr. Bruce’s conduit and nominee for the sale.

      Mr. Bruce aspired to sell petitioners’ Marine stock or the Sarah Jane in

connection with his retirement, and the Marine stock and the Sarah Jane each had a

ready market in which the asset could be sold for approximately $5 million. Mr.

Bruce was mindful that the Marine stock and the Sarah Jane each had a built-in

gain of approximately $5 million and that a significant amount of Federal income

tax would be imposed on that gain when the property was sold. Petitioners

effected the plan to sell their Marine stock in the ready market aiming not to pay
                                         - 48 -

[*48] any Federal tax on the built-in gain, and through the plan, petitioners parted

with the stock, they received the proceeds of the sale, and apparently no one

recognized any of the built-in gain. To be sure, however, Mr. Bruce continued to

act throughout the plan as if petitioners owned the Marine stock up until the time

that Mirror purchased the stock.

      He consciously transferred the Marine stock to CTB in exchange for the

Swap which was of no value, obviously knowing that this transfer was essential to

the plan and that petitioners would eventually receive cash equal to their stock’s

full value. Two, he (through Mr. Rousse, his longtime friend and loyal employee),

established Sareb with the Daughters’ Trusts as its owners and with Mr. Rousse as

its designated manager, and he received from the Daughters’ Trusts promissory

notes in the aggregate amount of the approximate value of the Marine stock.

Three, he and his wife installed Mr. Rousse as the trustee of the Daughters’ Trusts.

Four, he maintained the ability, through Mr. Rousse, to draw from the Daughters’

Trusts the funds which were received in connection with the sale of the stock.

Five, at least during 2005 he maintained the ability to personally draw funds from

one or more of the Daughters’ Trusts’ bank accounts to further receive the sales

proceeds. Six, he allowed the Marine stock to be sold to Mirror. Seven, he

received all of the proceeds of the stock sale. The fact that petitioners (rather than
                                          - 49 -

[*49] Sareb) were the true owners of the Marine stock at the time of its sale is

further seen from the fact that Mr. Bruce (and not Sareb or Mirror) later negotiated

the terms of the sale of the Sarah Jane directly with Mr. Falgout and led Mr.

Falgout to believe that Mr. Bruce (or a company that he controlled) owned the

Sarah Jane at that time.

      We conclude as a holding alternative to our primary holding that petitioners

at all relevant times were the true owners of the Marine stock and that petitioners

must recognize their gain on that sale.

IV. Professional Fees

      Respondent determined that section 162(a) does not let petitioners deduct

$52,450 of the professional fees that Marine claimed for 2003. Petitioners argue

that respondent’s determination is wrong because, they assert, the disputed fees

related to Marine’s business.25 We agree with respondent’s determination.

      Section 162(a) provides that “[t]here shall be allowed as a deduction all the

ordinary and necessary expenses paid or incurred during the taxable year in

carrying on any trade or business”. Marine’s business in 2003 involved operating

the Sarah Jane for profit. Thus, the requirements of section 162(a) must be met as


      25
        Petitioners do not seek to deduct the fees under any other provision. We
therefore do not consider whether the fees are deductible under any other provision
including, for example, sec. 212.
                                        - 50 -

[*50] to that business for Marine to deduct the disputed fees under section 162(a).

See sec. 1.162-1(a), Income Tax Regs.

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

of proving their entitlement to any claimed deduction. See INDOPCO, Inc. v.

Commissioner, 503 U.S. 79, 84 (1992). Professional fees may qualify under

section 162(a) as an ordinary and necessary expense of a business. See

Commissioner v. Tellier, 383 U.S. 687, 689-690 (1966); Bingham’s Trust v.

Commissioner, 325 U.S. 365, 374 (1945); Guill v. Commissioner, 112 T.C. 325,

328-329 (1999). Whether the disputed fees qualify as such is a question of fact,

which hinges on the origin and the character of the fees. See United States v.

Gilmore, 372 U.S. 39, 49 (1963); Commissioner v. Heininger, 320 U.S. 467, 475

(1943). In order to be “necessary”, the fee must be “‘appropriate and helpful’” to

the development of Marine’s business. Commissioner v. Tellier, 383 U.S. at 689

(quoting Welch v. Helvering, 290 U.S. at 113); see also Welch v. Helvering, 290

U.S. at 113-115. In order to be “ordinary”, the fees must be “normal, usual, or

customary” in Marine’s type of business. See Deputy v. du Pont, 308 U.S. 488,

495-496 (1940); see also Welch v. Helvering, 290 U.S. at 113-115.

      Petitioners assert that the disputed fees related to Marine’s business, but they

provide no citation of the record to support that assertion. Nor do we
                                        - 51 -

[*51] independently find any credible evidence in the record to support that

assertion. We find instead that the disputed fees originated from and pertained to

Mr. Bruce’s consummation of the plan and that he consummated the plan to benefit

petitioners personally and without regard to Marine’s business operation. In that

regard, the record establishes that petitioners or Marine sought professional advice

during the subject year primarily with respect to the plan and to its consummation.

Accordingly, because the origin and character of the disputed fees were personal

(and not business), the fees were not ordinary and necessary expenses of Marine’s

business nor directly connected with or proximately resulting from Marine’s

business. See Kornhauser v. United States, 276 U.S. 145 (1928). We sustain

respondent’s determination that the disputed $52,450 in professional fees is not

deductible under section 162(a).26 See also sec. 1.162-1(b) (7), Income Tax Regs.

V. Accuracy-Related Penalty

      Section 6662(a) imposes a 20% accuracy-related penalty if any part of an

underpayment of tax required to be shown on a return is due to, among other

things, a substantial valuation misstatement. See also sec. 6662(b)(3). The

accuracy-related penalty is increased to 40% in the case of a gross valuation

      26
        We note that expenses associated with the planning or the execution of a
sham transaction are not allowable as a deduction. See, e.g., Kirchman v.
Commissioner, 862 F.2d 1486, 1490 (11th Cir. 1989), aff’g Glass v.
Commissioner, 87 T.C. 1087 (1986).
                                         - 52 -

[*52] misstatement. See sec. 6662(h)(1). A gross valuation misstatement exists if,

for the taxable year at issue, the value or adjusted basis of property reported on a

tax return is 400% or more of the amount determined to be the property’s correct

value or adjusted basis. See sec. 6662(e)(1)(A), (h)(1), (2)(A)(i). The value or

adjusted basis claimed on a return for worthless property is considered to be 400%

or more of the correct value or adjusted basis.27 See sec. 1.6662-5(g), Income Tax

Regs.; see also Rovakat, LLC v. Commissioner, T.C. Memo. 2011-225, slip op. at

62, aff’d, 529 Fed. Appx. 124 (3d Cir. 2013). The 40% penalty does not apply

unless the underpayment attributable to the valuation misstatement exceeds $5,000.

See sec. 6662(e)(2).

      Respondent determined that petitioners are liable for the 40% accuracy-

related penalty under section 6662(h).28 Respondent bears the burden of

production on the applicability of the accuracy-related penalty in that he must


      27
        The statute was amended by the Pension Protection Act of 2006, Pub. L.
No. 109-280, sec. 1219(a)(2)(A), 120 Stat. at 1083, effective for tax returns filed
after August 17, 2006, to provide that there is a gross valuation misstatement if the
reported value is 200% or more of the amount determined to be the property’s
correct value.
      28
        Respondent determined that the accuracy-related penalty applied to the
deficiency resulting from his adjustments for legal and professional fees, capital
gains income, and itemized deductions. We have discussed the first two
adjustments and sustained them. Respondent determined that the itemized
deduction adjustment flowed computationally from the first two adjustments, and
petitioners do not dispute that determination. We agree with it as well.
                                         - 53 -

[*53] come forward with sufficient evidence showing that it is proper to impose

the penalty. See sec. 7491(c); see also Higbee v. Commissioner, 116 T.C. 438, 446

(2001). Petitioners claimed a $5,419,549 basis in Mr. Bruce’s remainder interest

which they reportedly sold on July 31, 2003, and we have concluded that Mr.

Bruce’s actual basis in that interest was zero. Petitioners therefore claimed a value

that was 400% or more of the correct adjusted basis. We conclude that respondent

has met his burden of production.29

      Petitioners argue secondarily that they are not liable for the 40% accuracy-

related penalty because, they assert, Mr. Bruce reasonably relied on the advice of

Attorneys Lobrano and Lukinovich. Section 6664(c) excepts from the 40%

accuracy-related penalty any portion of an underpayment for which the taxpayer

establishes that the taxpayer had reasonable cause and acted in good faith.

Whether this exception applies is a factual determination which turns on our

      29
         Petitioners assert that this case is appealable to the Court of Appeals for the
Fifth Circuit and argue primarily that this Court should follow the precedent of that
court, specifically Heasley v. Commissioner, 902 F.2d 380 (5th Cir. 1990), rev’g
T.C. Memo. 1988-408, and Todd v. Commissioner, 862 F.2d 540 (5th Cir. 1988),
aff’g 89 T.C. 912 (1987). Those cases hold that the 40% accuracy-related penalty
does not apply where a transaction is disregarded for lack of economic substance.
After the briefing was closed in this case, the U.S. Supreme Court rejected the
holding of the referenced cases and concluded that the 40% accuracy-related
penalty for gross valuation misstatement applies when a transaction lacking
economic substance results in a valuation misstatement. See United States v.
Woods, 571 U.S. , 134 S. Ct. 557 (2013). We reject petitioners’ primary
argument without further discussion.
                                          - 54 -

[*54] examination of all pertinent facts and circumstances, giving special attention

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

See sec. 1.6664-4(b)(1), Income Tax Regs.

      An individual taxpayer’s honest misunderstanding of fact or law that is

reasonable in the light of, among other things, his or her experience, knowledge,

and education may serve to meet the reasonable cause and good faith requirement.

See id. Where, as here, an individual taxpayer claims reliance on the advice of

professional tax advisers, we also require that the taxpayer establish that he or she

meets “each requirement of the following three-prong test: (1) The adviser was a

competent professional who had sufficient expertise to justify 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); see Charlotte’s Office Boutique, Inc. v. Commissioner, 425 F.3d 1203,

1212 n.8 (9th Cir. 2005) (quoting this three-prong test with approval), aff’g 121

T.C. 89 (2003); see also sec. 1.6664-4(c), Income Tax Regs.

      We conclude that Mr. Bruce aspired to assess petitioners’ proper tax liability

but, through no fault of his own, made an “an honest misunderstanding of fact or

law that is reasonable in light of all of the facts and circumstances”. Sec. 1.6664-
                                         - 55 -

[*55] 4(b)(1), Income Tax Regs. The fact that Mr. Bruce is an experienced and

sophisticated seafarer, fisherman, and sea captain does not necessarily mean that he

should have recognized that he had no basis in the Swap, that his relationship to

Sareb would make petitioners (rather than Sareb) the seller of the stock for Federal

tax purposes, or that the disputed fees were not deductible. Mr. Bruce has a high

school education, and he routinely consults and relies upon professionals and other

businessmen and employees such as Mr. Rousse in making his business decisions.

We viewed and heard him testify credibly that he had a basic understanding as to

tax matters, that he had no understanding of the complex transactions which made

up the plan (including their purpose or significance, or the risks or benefits

involved), that he accepted Mr. Lobrano’s opinion that the plan was valid, and that

he relied upon Mr. Lobrano’s advice in consummating the plan and in reporting its

consequences on petitioners’ 2003 return.

      We also are mindful that when the financial planners advised Mr. Bruce that

the plan provided favorable tax benefits to him, Mr. Bruce did not simply rely

upon that advice. He asked Mr. Lobrano to meet with the financial planners and

then to advise Mr. Bruce whether the plan was valid. In other words, Mr. Bruce

was not content to rely simply upon the promoters’ advice as to the plan, but he

sought independent advice from an experienced trusted tax attorney (Mr. Lobrano)
                                         - 56 -

[*56] who Mr. Bruce retained to discuss with the promoters all relevant and

necessary information as to the plan.

      Mr. Lobrano, in turn, was Mr. Bruce’s longtime tax adviser who regularly

advised him on tax and on other legal matters; Mr. Lobrano had sufficient

ostensible expertise to warrant reliance; Mr. Lobrano knew about the subject

matter underlying the plan; and Mr. Lobrano took steps to make himself even more

knowledgeable on that subject matter so as to assure himself that the plan was

valid. We also add that we find nothing in the record to lead us to conclude that

Mr. Lobrano had an inherent conflict of interest as to the plan. See generally

Countryside Ltd. P’ship. v. Commissioner, 132 T.C. 347, 352-355 (2009)

(distinguishing between a promoter and an independent professional tax adviser for

attorney-client privilege purposes).

      We conclude that it was objectively reasonable for Mr. Bruce to rely on Mr.

Lobrano’s advice, even though we conclude that the advice was wrong.30 See


      30
         The record does not establish that Mr. Bruce or Mr. Lobrano relied solely
on the advice or opinion of Mr. Lukinovich, Mr. Doverspike, Mr. Ohle, and Mr.
Deichmann as to any item. If they did, then that reliance may not have been
reasonable given that Mr. Doverspike, Mr. Ohle, and Mr. Deichmann, and perhaps
also Mr. Lukinovich, appear to have been “promoters” of the plan. See 106 Ltd. v.
Commissioner, 136 T.C. 67, 79 (2011) (stating that a promoter is “‘an adviser who
participated in structuring the transaction or is otherwise related to, has an interest
in, or profits from the transaction’” (quoting Tigers Eye Trading, LLC v.
Commissioner, T.C. Memo. 2009-121)), aff’d, 684 F.3d 84 (D.C. Cir. 2012).
                                         - 57 -

[*57] United States v. Boyle, 469 U.S. 241, 251 (1985) (“To require the taxpayer

to challenge the * * * [expert], to seek a ‘second opinion,’ or to try to monitor * * *

[the qualified adviser] on the provisions of the Code himself would nullify the very

purpose of seeking the advice of a presumed expert in the first place.”); see also

Whitehouse Hotel Ltd. P’ship v. Commissioner, 755 F.3d 236, 247-250 (5th Cir.

2014), aff’g in part, vacating in part and remanding 139 T.C. 304 (2012); Stanford

v. Commissioner, 152 F.3d 450, 461 (5th Cir. 1998), aff’g in part, vacating in part

108 T.C. 344 (1997); Chamberlain v. Commissioner, 66 F.3d 729, 732-733 (5th

Cir. 1995), aff’g in part, rev’g in part T.C. Memo. 1994-228. We hold that the

40% penalty does not apply and reject respondent’s determination that it or a 20%

penalty does. Accord Streber v. Commissioner, 138 F.3d 216, 219-224 (5th Cir.

1998), rev’g T.C. Memo. 1995-601.

      We have considered all arguments that the parties made and have rejected

those arguments not discussed here as without merit.
                                  - 58 -

[*58] To reflect the foregoing,


                                                 Decision will be entered for

                                           respondent with respect to the

                                           deficiency and for petitioners with

                                           respect to the accuracy-related penalty

                                           under section 6662(h).
