                        T.C. Memo. 2003-323



                      UNITED STATES TAX COURT



                DAVID A. DEMETREE, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent

     DAVID A. DEMETREE AND DEBORAH DEMETREE, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent


     Docket Nos. 20833-96, 20834-96.     November 24, 2003.


     Kenton V. Sands, for petitioners.

     Stephen R. Takeuchi, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     FOLEY, Judge:   The issues for decision are:   (1) Whether

David A. Demetree (David) failed to report income relating to

1983, 1984, 1985, 1986, 1987, 1988, 1989, and 1991; and (2)

whether David and Deborah Demetree (Deborah) failed to report

income relating to 1992.
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                         FINDINGS OF FACT

     In 1964, David married Michelle Demetree (Michelle).

Between 1966 and 1973, David and Michelle had four children.

During the early 1970s, David, a licensed real estate broker,

opened and operated a property management firm, David Demetree

Associates - Realtors.

     David and Michelle separated in 1979.   In order to devote

most of his time to contentious divorce proceedings, in 1980

David closed his property management firm.   In that year, he also

transferred 797 State Road 434 (797 property) to Arthur and Naomi

Demetree (Arthur and Naomi), his parents, 205 San Sebastian Court

to Walter Pemberton, his friend, and the Brahman Inn to Jeanette

Hinkle, his sister.   In 1983, 1984, 1985, 1986, 1987, 1990, and

1991, Arthur and Naomi reported rental income relating to the 797

property, but in 1988, 1989, and 1992 David received the rental

income.   In addition, David made the mortgage payments and

retained the rental income relating to 205 San Sebastian Court

until the lender foreclosed on the property.   With respect to the

Brahman Inn, Demetree and Associates supervised the collection

and deposit of rents, while an onsite manager handled the day-to-

day operations (e.g., preparation of monthly summaries,

collection of rents, and payment of expenses).

     In 1981, David and Michelle divorced.   The following year

David married Deborah.   Deborah had custody of a daughter from a
                                - 3 -

previous marriage, and in 1983, David was awarded sole custody of

his four children.   Although they struggled financially on

Deborah’s salary as a full-time insurance adjuster, David stayed

at home to care for the five children and perform domestic

duties.

     Prior to and during the years in issue, David had a close

relationship with Arthur, Naomi, and Ms. Hinkle.   David relied

heavily on their generosity to supplement Deborah’s salary.

Arthur and Naomi regularly gave David and his family large gifts.

They gave two homes to David, $900,000 in trust for David’s

children, annual $10,000 gifts to petitioners and each of David’s

children, automobiles to each of petitioners’ children, and

weekly gifts of cash and food to petitioners.   They also made

substantial loans to David documented with numerous promissory

notes.    Upon David’s failure to repay some of these loans, Arthur

and Naomi obtained a $300,000 judgment against him.   Yet they

continued to transfer significant amounts of money to

petitioners.   In addition, Ms. Hinkle lent David funds from the

Brahman Inn business account.   She documented these loans with

promissory notes and upon David’s failure to repay some of these

loans obtained a judgment against him.

     From the early 1970s through his death in 1991, Arthur, a

successful real estate developer and broker, operated Demetree

and Associates, a commercial property management sole
                               - 4 -

proprietorship.   Demetree and Associates’ principal business

activities were the leasing and management of commercial

warehouses owned by partnerships in which Arthur was a partner.

The total management responsibilities relating to Demetree and

Associates were minimal (e.g., the collection of rents and

supervision of repairs).   From 1983 through 1991, David

occasionally assisted Arthur by performing services for Demetree

and Associates.   David also signed, pursuant to a power of

attorney, Arthur’s name on Demetree and Associates’ business

checks and deposit slips, including checks payable to himself or

to third parties on his behalf.   Arthur did not deduct the

amounts he transferred to David, issue David Forms W-2, Wage and

Tax Statements, or issue Forms 1099-MISC, Miscellaneous Income.

Arthur and Naomi reported the income attributable to Demetree and

Associates on the Schedules C, Profit or Loss From Business,

accompanying their 1983, 1984, 1985, and 1986 joint Federal

income tax returns.

     In 1986, Arthur and Naomi lent David funds to purchase a

one-third interest in a partnership formed to build North Lane

Plaza (NLP), a strip mall.   The following year, Arthur and Naomi

also lent David funds to start and operate Scooper’s Ice Cream

(Scooper’s) in one of NLP’s stores.    Scooper’s produced losses

during all its years of operation until David sold it in 1989.

In 1987, 1988, 1989, and 1992, David claimed net operating loss
                               - 5 -

deductions relating to NLP and Scooper’s.    From 1986 through

1990, David managed NLP and reported on his 1990 return $109,000

of compensation relating to his management activities.    In that

year, David transferred his one-third interest to the other

partners.

     In 1987, Demetree and Associates employed Julia Lloyd as a

full-time property manager.   She was responsible for collecting

rents, preparing monthly rental summaries, and assisting David in

securing tenants and negotiating leases for NLP.

     Following Arthur’s death in 1991, David began managing the

properties formerly managed by his father.    Ms. Lloyd worked for

David in the same capacity that she had for Arthur.    David

reported the income relating to his property management

activities on the Schedules C accompanying his 1991 and 1992

returns and claimed a rental loss deduction relating to 1992.

     In 1996, Ms. Lloyd asked David to terminate her so that she

would be eligible to collect unemployment benefits.    When David

refused, she retaliated by filing a complaint with the local

government authorities alleging David’s business use of a

residential condominium.   She also contacted respondent, alleged

that David had taken funds from Demetree and Associates and

failed to report such funds to the Internal Revenue Service, and

prepared ledgers documenting the alleged improprieties.

Respondent then initiated a criminal investigation of David and
                               - 6 -

seized all of David’s records and those relating to Demetree and

Associates.   In 1997, after respondent seized the records, Ms.

Lloyd terminated her employment relationship with David Demetree

and Associates Realtors.   In 2000, respondent ended the criminal

investigation.

     From 1983 through 1991, while petitioners were married,

Deborah filed separate income tax returns.   David did not file

returns relating to 1983 through 1985.   He delinquently filed his

1986 through 1989 returns on January 4, 1993, and his 1991 return

on January 26, 1993.   Petitioners delinquently filed their 1992

return on October 19, 1993.

     By notice of determination (notice), dated June 25, 1996,

respondent determined deficiencies, additions to tax, and

penalties relating to 1983, 1984, 1985, 1986, 1987, 1988, 1989,

and 1991.   The deficiencies totaled $197,823; the section

6651(a)(1),1 6653(a), 6654(a), and 6661 additions to tax totaled

$80,303; and the section 6662 penalties totaled $10,594.     On June

25, 1996, respondent sent petitioners a second notice in which he

determined a $4,040 deficiency and an $808 section 6662 penalty

relating to 1992.

     By amendment to answer filed June 14, 2001, respondent,

after analyzing seized bank statements, checks, and deposit



     1
        Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the years in issue, and
all Rule references are to the Tax Court Rules of Practice and
Procedure.
                               - 7 -

tickets, revised his determinations relating to 1984, 1985, 1986,

1988, 1989, 1991 and 1992.   The increases in the deficiencies

totaled $145,010, the additions to tax totaled $41,028.40, and

the penalties totaled $1,820.60.   With respect to 19832 and 1987,

respondent determined decreases in the deficiencies totaling

$5,935 and additions to tax totaling $4,875.75.

     On September 25, 1996, petitioners, while residing in

Longwood, Florida, filed petitions with this Court.   On April 29,

1997, the Court granted their motion to consolidate the two

cases.

                              OPINION

I.   Burden of Proof

     Petitioners contend that the direct and indirect income

reconstruction methods that respondent used to determine the

deficiencies in his notices were arbitrary and excessive.    We

disagree.   David had a duty, but failed, to maintain adequate

financial records relating to most of the years in issue.    Sec.

6001; sec. 1.6001-1(a), Income Tax Regs.   Accordingly,

respondent’s use of the direct and indirect income reconstruction



     2
        At trial respondent discovered that the revised
deficiency for 1983 in his amendment to answer should have been
increased rather than decreased. In his brief, respondent asks
the Court to rely on the original deficiency in the notice
relating to 1983. We grant respondent’s request on brief because
it does not prejudice petitioners (i.e., petitioners were put on
notice of the deficiency and additions to tax, and the request
does not raise any new issues). See Rule 41(a); Foman v. Davis,
371 U.S. 178, 182 (1962).
                                - 8 -

methods was appropriate, respondent’s determinations were not

arbitrary or excessive, and petitioners bear the burden of going

forward.    See Merritt v. Commissioner, 301 F.2d 484, 486 (5th

Cir. 1962), affg. T.C. Memo. 1959-172; Schroeder v. Commissioner,

40 T.C. 30, 33 (1963).

      Respondent concedes that, pursuant to Rule 142(a), he bears

the burden of proof on matters relating to the increases in the

deficiencies pleaded in his amendment to answer.   With respect to

all of the remaining matters, our conclusion is unaffected by who

bears the burden of proof.3   Accordingly, we need not address the

parties’ burden of proof contentions.

II.   Respondent’s Income Determinations

      Respondent contends that David failed to report income he

received from Demetree and Associates and property he had

transferred to family members and friends.    Petitioners contend

that the amounts they received were gifts and loans and that

David’s transfers of properties were bona fide transactions.

      A.   Demetree and Associates

      Respondent contends that all of the income earned by

Demetree and Associates should have been attributed to David

because he, and not Arthur, controlled the business.    Respondent

asserts that:    David performed the managing and leasing

activities relating to Demetree and Associates; Arthur was never

      3
        Sec. 7491 is inapplicable because the examination of
petitioners’ returns began before the statute’s effective date.
                                - 9 -

present in the office; David routinely signed Arthur’s name; and

Arthur, who was in his seventies during the years in issue, was

unable to manage Demetree and Associates.    In the alternative,

respondent contends that the amounts petitioners received from

Demetree and Associates were compensation for services.    We

disagree.

     David did not control Demetree and Associates.    See Crowley

v. Commissioner, 34 T.C. 333, 345 (1960) (holding that business

income is taxable to the person who owns and controls the

business).    Petitioners, both of whom were credible witnesses,

testified that, while Deborah worked, David performed domestic

duties and was a full-time care provider to their five children.

David merely assisted Arthur, who made the major business

decisions.    Arthur successfully ran Demetree and Associates for

more than 10 years before David began assisting him, he continued

to report the business income on his returns, and he was listed

as the owner or broker on the leases and sales agreements.      The

only contrary evidence was the testimony of Ms. Lloyd, who was

not credible.    Finally, the facts that David signed Arthur’s name

using a power of attorney and Arthur was in his seventies during

the years in issue are of little significance.

     Nor are we persuaded that the amounts that David received

from Demetree and Associates were compensation for services

rendered.    Instead, the testimony and documentary evidence

establish that Arthur and Naomi made gifts and loans from
                               - 10 -

Demetree and Associates to David and his family.   David and Ms.

Hinkle’s testimony established that the disbursements were not

made or intended to be made for any services rendered and that

David was under no obligation to perform services.    See Bogardus

v. Commissioner, 302 U.S. 34, 36-37 (1937) (holding that the

controlling factor to distinguish between a gift and compensation

is the intent of the payor).   Rather, the transfers to David were

consistent with Arthur and Naomi’s established pattern of making

frequent and substantial gifts and loans to David and his family.

Accordingly, we reject respondent’s determinations relating to

1983, 1984, 1985, 1986, 1987, 1988, 1989, and prior to Arthur’s

death in 1991.   David, however, failed to report income relating

to his 1991 and 1992 property management activities.   See sec.

61(a); James v. United States, 366 U.S. 213, 219 (1961).

Therefore, we sustain respondent’s determinations relating to

those years.

     B.   The Brahman Inn

     Respondent contends that the amounts Ms. Hinkle transferred

to David were compensation for his management services related to

the Brahman Inn.   David and Ms. Hinkle’s testimony established

that the amounts he received were loans and that the management

responsibilities relating to the Brahman Inn were handled by an

onsite manager and supervised by Demetree and Associates.

Accordingly, we reject respondent’s determinations.
                              - 11 -

     C.   David’s Property Transfers

     Respondent contends that the rental income, relating to 205

San Sebastian Court and the 797 property transferred by David, is

properly attributable to David.    David is indeed liable for the

taxes relating to the rental income from 205 San Sebastian Court.

In 1980, David transferred 205 San Sebastian Court to Walter

Pemberton.   Prior to the bank’s foreclosing on the property,

however, David continued to make the mortgage payments and

retained all of the rental income.     Even though David transferred

legal title of 205 San Sebastian Court, David remained the

beneficial owner of the property.      Lucas v. Earl, 281 U.S. 111

(1930); Serianni v. Commissioner, 80 T.C. 1090, 1104 (1983),

affd. 765 F.2d 1051 (11th Cir. 1985).     Arthur and Naomi gave

David the rental income from the 797 property relating to 1988,

1989, and 1992, and David did not retain beneficial ownership of

the property.   Accordingly, we sustain respondent’s

determinations relating to 205 San Sebastian Court and reject

respondent’s determinations relating to the 797 property.

     D.   North Lane Plaza and Scooper’s Ice Cream

     Respondent determined that David failed to report

compensation income from NLP and Scooper’s relating to 1986,

1987, 1988, 1989, 1991 and 1992.    Petitioners contend that these

funds were withdrawn to reimburse David for expenditures he made

on behalf of NLP and Scooper’s.    We agree with respondent.   The

funds withdrawn were compensation relating to management services
                                    - 12 -

David rendered on behalf of NLP and Scooper’s.         See sec. 61(a);

James v. United States, supra.         Accordingly, respondent’s

determinations are sustained.

       E.     Interest Income

       Respondent determined that petitioners failed to report

interest income relating to 1986, 1987, 1988, 1989, 1991, and

1992.       We sustain respondent’s determinations relating to David’s

accounts (i.e., interest earned in 1986, 1987, 1988, 1989, 1991,

and 1992), and Deborah’s accounts (i.e., interest earned in

1992).

III.    Petitioners’ Claimed Loss Deductions

       There is no evidence to support petitioners’ claimed 1987,

1988, 1989, and 1992 net operating loss deductions or 1992 rental

loss deduction.       See sec. 6001; sec. 1.6001-1(a), Income Tax

Regs.       Accordingly, respondent’s determinations are sustained.

IV.    Self-Employment Income

       Respondent determined that petitioners were liable, pursuant

to section 1401, for tax on self-employment income relating to

all the years in issue.         We hold that, consistent with our

findings, petitioners are liable for self-employment tax relating

to income from NLP, Scooper’s, and David’s property management

activities relating to 1991 and 1992.         See sec. 1402(a) and (b).

V.     Additions to Tax and Penalties

       Respondent determined additions to tax pursuant to sections

6651(a)(1), 6654(a), and 6661.         Section 6651(a)(1) provides an
                               - 13 -

addition to tax for failure to file a tax return in a timely

manner, unless such failure was due to reasonable cause and not

due to willful neglect.    There was no reasonable cause for the

delay in filing the returns, and, thus, David is liable for the

section 6651(a)(1) additions to tax.    See, e.g., Higbee v.

Commissioner, 116 T.C. 438, 447-448 (2001).    Section 6654(a)

provides an addition to tax for failure to pay estimated income

tax.    David filed no returns and made no estimated tax payments

relating to 1983, 1984, and 1985 and, thus, is liable for those

additions to tax.    See, e.g., Niedringhaus v. Commissioner, 99

T.C. 202, 222-223 (1992).    Section 6661 provides for an addition

to tax for substantial understatements reduced by the portion for

which there is substantial authority or adequate disclosure.

David’s understatements were not based on substantial authority

or adequately disclosed, and, thus, David is liable for those

additions to tax.    See, e.g., Cluck v. Commissioner, 105 T.C.

324, 340 (1995).

       Respondent also determined additions to tax pursuant to

section 6653(a) and accuracy-related penalties pursuant to

section 6662(a).    Petitioners’ failure to keep records and file

timely and accurate returns was due to negligence.    See, e.g.,

Higbee v. Commissioner, supra at 449; Niedringhaus v.

Commissioner, supra at 222.    Accordingly, petitioners are liable

for those additions to tax and accuracy-related penalties.
                             - 14 -

     Contentions we have not addressed are irrelevant, moot, or

meritless.

     To reflect the foregoing,


                                        Decisions will be entered

                                   under Rule 155.
