                        T.C. Memo. 2008-34



                      UNITED STATES TAX COURT



        RONALD B. AND ANNETTE C. TALMAGE, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 13002-05.               Filed February 19, 2008.



     Robert G. Burt, for petitioners.

     Shirley M. Francis and Aimee R. Lobo-Berg, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     HAINES, Judge:   Respondent determined deficiencies in Ronald

B. Talmage’s Federal income tax for 1998, 1999, 2000, and 2001 of

$532,265, $845,454, $1,189,294, and $108,913, respectively, as

well as additions to tax for 1998 and 1999 under section

6651(a)(1) of $53,226 and $84,923, respectively, and fraud

penalties under section 6663(a) for 1998, 1999, 2000, and 2001 of
                              - 2 -

$399,199, $627,542, $885,033, $79,684, respectively.1    Respondent

also determined a deficiency in Ronald B. and Annette C.

Talmage’s Federal income tax for 2002 of $80,609, as well as a

fraud penalty under section 6663(a) of $57,886 with respect to

Ronald B. Talmage and an accuracy-related penalty under section

6662(a) of $15,436 with respect to Annette C. Talmage.




     1
       Unless otherwise indicated, all section references are to
the Internal Revenue Code, as amended, and Rule references are to
the Tax Court Rules of Practice and Procedure. Amounts are
rounded to the nearest dollar.
                              - 3 -

     After concessions,2 the issues for decision are:   (1)

Whether certain wire transfers from Hong Kong to the United

States in 1998, 1999, 2000, 2001, and 2002 constitute nontaxable

loans; (2) whether Ronald B. Talmage (petitioner) failed to

report unexplained bank deposits in 1998, 2001, and 2002 of

$36,263, $13,454, and $42,553 respectively; and (3) whether

petitioner failed to report gains from the sale of rental

property in Vancouver, Washington, and a vacation home in Black

Butte, Oregon, for 1998; (4) whether petitioner is entitled to


     2
       Respondent concedes that the gains from the sale of the
Vancouver, Washington, and Black Butte, Oregon, properties in
1998 were $31,231 and $120,606, respectively.

     Respondent concedes that the bank deposit of $265,269 on
Aug. 24, 1998, to the Talmages’ account No. * * * 3034 with the
US Bank comprised the proceeds from the sale of the Black Butte,
Oregon, property. As a result, only $36,263 of the unexplained
bank deposits for 1998 is in dispute.

     Respondent concedes reductions for the wire transfers from
New Century Properties, Ltd. (NCPL), to A.C. Schommer & Sons,
Inc. (SSI), in 1999 and 2000 of $10,000 and $246,057,
respectively.

     Respondent concedes a reduction for the wire transfers from
NCPL to petitioner for child support in 2002 of $7,320.

     Petitioner concedes FICA tax on unreported wages for 1999,
2000, and 2001 of $3,773, $5,942, and $5,191, respectively.

     Petitioner concedes that losses on Schedules F, Profit or
Loss From Farming, for 2000, 2001, and 2002 of $31,239, $9,706,
and $22,875, respectively, were for activities not engaged in for
profit pursuant to sec. 183.

     Petitioner concedes that the assessment of a deficiency for
1998 is not barred under sec. 6501(a).
                               - 4 -

the full amount of the foreign earned income exclusion for 1999;

(5) whether petitioner is liable for additions to tax under

section 6651(a)(1) for 1998 and 1999; (6) whether petitioner is

liable for civil fraud penalties under section 6663(a), or in the

alternative, accuracy-related penalties under section 6662(a) for

1998, 1999, 2000, 2001, and 2002; (7) whether petitioner Annette

Talmage is liable for the accuracy-related penalty under section

6662(a) for 2002; and (8) whether the assessment of deficiencies

for 1999 and 2000 is barred under section 6501(a).

                         FINDINGS OF FACT

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

The stipulation of facts and the attached exhibits are

incorporated herein by this reference.   Petitioners resided in

Corbett, Oregon, when their petition was filed.

A.   Background

     Petitioner was born and raised in Utah.   After he graduated

from high school in 1971, petitioner enrolled at Brigham Young

University (BYU) in Provo, Utah.   In 1972, petitioner left BYU to

serve a 2-year mission in Japan for the Church of Jesus Christ of

Latter-Day Saints.   While on his mission, petitioner met Kumiko

Wako and returned with her to Salt Lake City, Utah, where they

married on August 12, 1975.   Petitioner re-enrolled at BYU and

graduated with a degree in business administration and Asian

studies.   In February 1978, petitioner and Kumiko Wako Talmage
                                - 5 -

(Kumiko Talmage) moved to Ikuta, Japan, where petitioner

temporarily worked at a language school.    Petitioner and Kumiko

Talmage (Talmages) have three children:    Lisa Talmage Allen, born

in 1976, Korianton Edward Talmage (Kory Talmage), born in 1978,

and Lillian Talmage, born in 1984.

     Beginning in January 1979, petitioner was employed in Japan

to work on various real estate developments and investments and

to provide investment advisory services.

     In May 1990, the Talmages purchased a vacation home in Black

Butte, Oregon (Black Butte property), for $145,000.    In June

1990, the Talmages also purchased, as a rental property, a home

in Vancouver, Washington (Vancouver property), for $101,900.

     On November 17, 1997, the Talmages purchased 47.73 acres of

property for $903,000 at 35701 NE Chamberlain RD, Corbett,

Multnomah County, Oregon (Rivercliff property), to develop into a

permanent residence and farm.   At the closing, the Talmages paid

$383,967 in cash as a downpayment and gave the seller a

promissory note for $519,033 with a trust deed on the Rivercliff

property to secure the unpaid balance.    In February 1998,

petitioner paid the balance owing on the $519,033 promissory note

with funds wire transferred by New Century Properties Limited

(NCPL).3   Petitioner did not report the $519,033 as income on his

     3
       NCPL is a British Virgin Islands registered corporation
organized on Feb. 28, 1991, with authorized capital of $50,000.
                                                   (continued...)
                                - 6 -

Form 1040, U.S. Individual Income Tax Return, for 1998 (1998

return).

     The Rivercliff property is in the protected Columbia River

Gorge National Scenic Area.   Any development plan for the

Rivercliff property is subject to land use review by the Columbia

Gorge Commission, which comprises representatives from cities and

counties on both sides of the Columbia River.   The Talmages could

not place improvements on the Rivercliff property until they

satisfied the land use rules, received the approval of Multnomah

County, and obtained building permits from the city of Gresham,

Oregon.    A “watchdog” group called Friends of the Columbia Gorge

also participated in the review process.

     At the date of purchase, the Rivercliff property was zoned

for a single-family dwelling.   The improvements on the property

included a small modular home, the original farm dwelling (being

used as a storage building), a barn with outbuildings, a kennel

building with multiple dog runs, a gazebo, and a garden shed.

     In 1998, the Talmages engaged the services of Philip McCurdy

(Mr. McCurdy), a Portland architect, and began working on plans

to raze the existing modular home and build their dream home,

renovate the original farm dwelling, build a traditional Japanese

tea house, install a three-horse stable, install farm pasture


     3
      (...continued)
Although NCPL is registered in the British Virgin Islands, its
offices are in Hong Kong.
                                - 7 -

fencing, improve the existing barn, build a tennis court,4

rebuild the existing kennel facility and dog runs, and improve

the other existing structures, including paving access roads with

asphalt.    Petitioner paid Mr. McCurdy $33,649 for architectural

services in 1998.

     The Talmages’ building permits reflected the following

expected costs for doing the work, all of which was to be

completed by June 1999:

     Permit No.              Item                 Cost

          7703             Barn                $120,000
          5804             Dog kennel            15,000
          6106             Building             294,780
         10345             Pole barn, pad,
                             kennel conversion   80,000
           Total                                509,780

The Talmages also planned to raise horses and dogs for personal

purposes and to actively farm the land, including raising

vegetables and fruit and harvesting hay to feed their horses.

Petitioner’s dogs included four Irish setters who were family

pets he trained and showed in competitions as a hobby.

     The Talmages, upon recommendation by their architect,

retained A.C. Schommer & Sons, Inc. (SSI), as their general

contractor for work on the Rivercliff property.    On April 20,

1998, petitioner and SSI entered into a contract to renovate the

original dwelling for $47,801 so that the Talmages could live in


     4
       Kumiko Talmage was an avid tennis player who participated
in tournaments.
                               - 8 -

it until construction of the new home was completed.   Kumiko

Talmage did not sign the contract.

     The Talmages submitted an application for approval of their

plan of development of the Rivercliff property to Multnomah

County on May 5, 1998, but it was rejected as incomplete on July

2, 1998.   Throughout 1998 problems were encountered in obtaining

building permits.   To overcome these problems, the Talmages hired

land use attorneys, engineers, and consultants to assist them.

Ultimately, substantial site improvements were required, costs

began to escalate, and development of the property was delayed.

On August 14, 1998, the Talmages and SSI received a stop work

order from Multnomah County requiring the Talmages to pay fines

for land-disturbing activities.

     Beginning July 2, 1998, petitioner wrote three letters (one

on his attorney’s stationery) to Multnomah County emphasizing the

need to expedite the process to obtain the building permits

because of his goal to permanently move himself and his family to

the Rivercliff property by the spring of 1999.

     On July 10 and August 21, 1998, the Talmages sold the

Vancouver and Black Butte properties for $147,000 and $284,000.

The sales resulted in long-term capital gains of $31,231 and

$120,606, respectively.   The title companies handling the

closings reported the sales on Forms 1099-S, Proceeds From Real

Estate Transactions.   The proceeds from the sale of the Black
                               - 9 -

Butte property were deposited in the Talmages’ account at US

Bank.   The record does not reflect where the proceeds from the

sale of the Vancouver property were deposited.   The proceeds from

the sales of the properties were used for the Talmages’ personal

expenses and to develop the Rivercliff property.

     Petitioner did not report receiving any income from the sale

of the Vancouver or the Black Butte property on his 1998 return.

Petitioner also did not report receiving rental income or claim

deductions for depreciation, mortgage interest, or property tax

with respect to the Vancouver property on his 1998 return.

     On November 3, 1998, petitioner paid $5,785 in property

taxes for the Rivercliff property.

     On December 8, 1998, SSI’s bookkeeper sent a memorandum by

facsimile to petitioner stating:

     The following invoice is the remainder due for
     November.

     Also, there is an “Invoice Summary” recapping all
     invoice’s due with the billing address of your company.
     Is this what you were looking for in the way of billing
     to your company?

     If you could confirm that the company, TPP Limited
     [TPPL], is solely owned by you we would appreciate it.

On December 23, 1998, TPPL wire transferred $249,193 to SSI for

the remainder due on the development of the Rivercliff property

in 1998.   Petitioner did not report the $249,193 as income on his

1998 return.
                             - 10 -

     On December 23, 1998, petitioner signed an employment

contract5 with NCPL by which petitioner was to receive $7,000 a

month in compensation, his and his family’s health, auto, and

life insurance premiums, and bonuses.   The contract also provided

for the possibility of loans from NCPL to petitioner in order for

petitioner to purchase a home.

     Petitioner entered into a purported loan agreement with NCPL

dated January 25, 1999, to borrow funds for the development of

the Rivercliff property, the terms of which were:

     Between:
     New Century Properties Limited of 1520 Prince’s
     Building, 10 Charter Road, Hong Kong (“Lender”),
     and:
     Ronald B. Talmage & Kumiko W. Talmage of 1-31-5 Sakura
     Shin-machi, Setagaya-ku, Tokyo, Japan (collectively the
     “Borrower”)

     Whereas:
     Ronald B. Talmage is under the employ of New Century
     Properties Limited
     and,
     Borrower (husband and wife) together own a certain
     property in the United States, located at 35701 NE
     Chamberlain Road, Corbett, Oregon 97019 (“The
     Property”)
     and,
     Borrower is desirous of borrowing a sum of money for
     the construction of various improvements to The
     Property,
     and
     Lender is willing to lend Borrower a sum of money to
     facilitate the same,

     5
      The Court’s use of the words “employment contract”,
“employee”, “employer”, “loan agreement”, “loan”, and similar
terms is for convenience only and does not indicate the Court’s
agreement that such words reflect the substance of what
transpired.
                        - 11 -

-the undersigned agree to the following terms:-

(1) Lender shall provide a line of credit to Borrower
to facilitate the development, renovation and
construction of various facilities and improvements on
The Property.

(2) The precise amount loaned shall be dictated by the
direct construction costs incurred in the production of
these facilities on The Property.

(3) Billings will be made by A.C. Schommer & Sons
(“Construction/Contractor”) directly to the Lender, and
Lender shall remit such payments directly to the
Construction/Contractor accordingly.
All sums to be loaned must be conducted as payments in
response to a direct billing by
Construction/Contractor.

(4) The total to be loaned shall be calculated from
time to time in accordance with budgets and needs for
the proposed improvements on The Property, and by
mutual counsel and consent of both Lender and Borrower.
A confirmation document showing the amount loaned to
date shall be provided by Lender and agreed to by
Borrower from time to time.
Upon final completion of all of the agreed to
improvements on The Property (projected to be Summer of
2001), a final statement shall be issued by the Lender,
showing the total sum loaned, at which time this shall
be countersigned in agreement by the Borrower.

(5) Repayment of the sum loaned shall begin precisely
Five-years from the date of this agreement, being no
later than January 25, 2004. Repayment shall be in
accordance with an amortization schedule that Lender
shall provide Borrower on or by that date of initial
repayment.

(6) Interest shall be accrued at the rate of 5.25% per
annum, and shall be payable in accordance with the
amortization schedule to be provided by Lender.

(7) Security on the loaned funds shall be in the form
of, firstly, a lien on Ronald’s salary as paid by New
Century Properties Limited, and secondly, at an
appropriate time, a mortgage or lien on The Property.
It is understood at the time of this signing however,
                               - 12 -

     that the Borrower seeks to obtain permanent mortgage
     secured financing from a local US bank or lending
     institution to facilitate a portion or all of the costs
     of the intended improvements to The Property.
     Thus as of the time of this signing, in order to
     cooperate with the Borrower for this potential source
     of borrowing, the requirement of a recorded mortgage in
     favor of the Lender, shall not be immediately
     necessary.
     This does not excuse the Borrower from any repayment
     liability however, and in the event of the obtaining of
     institutional funding, the Borrower agrees to repay of
     portion or all of the funds loaned by the Lender. In
     either case, Lender shall retain a First Priority
     position for repayment of monies obtained.

     (8) The Lender reserves the right to require a First
     Mortgage to be recorded in his favor as he deems
     necessary. Further, in the event of failure to repay
     the funds borrowed, Borrower agrees to deed The
     Property over to the Lender for use and or disposal as
     he deems necessary.

     (9) The Term of this loan shall be Twenty-years from
     the date of this agreement, wherein on or before the
     25th of January 2019, the total sum loaned, plus
     interest accrued to date on any outstanding balance,
     shall be due and payable in full. In the event the
     full amount is not paid by this date, the Lender shall
     exercise his right for foreclosure on The Property.

     (10) This loan agreement shall be governed under the
     Laws of the State of Oregon, USA, wherein The Property
     is located, and Borrower intends to establish residency
     in due course on The Property.

The loan agreement was signed by petitioner and by Mr. Seki on

behalf of NCPL.6   The loan agreement did not have a signature line

for Kumiko Talmage and was not signed by her.   At the time this

document was signed, Kumiko Talmage was unaware of its existence


     6
       Mr. Seki has been represented by petitioner to be the
owner of NCPL. Kumiko Talmage testified that Mr. Seki worked for
petitioner. Mr. Seki could not read or write English.
                              - 13 -

and was unaware of any loans with respect to the Rivercliff

property.

     On April 15, 1999, Multnomah County issued a decision

approving the Talmages’ application to develop the Rivercliff

property.   However, on April 23, 1999, the Friends of the

Columbia Gorge appealed the decision with respect to the

Talmages’ plans to build a new home.   An appeal hearing was held

on the matter on May 21, 1999.

     On June 9, 1999, petitioner, Kumiko Talmage, and Lillian

Talmage moved from Japan to the Rivercliff property and took up

residence in the original farm dwelling.   Petitioner paid the

Cascade Athletic Club $912 with a check dated June 10, 1999, for

Kumiko Talmage’s club membership fees.   Petitioner’s address

listed on the check was the Rivercliff property address.

     On June 28, 1999, Multnomah County approved the construction

of one replacement dwelling for single-family use, subject to a

number of conditions.   Petitioner, not having received the

approval, on June 29, 1999, mailed a letter to Multnomah County

stating that he and his family had not been able to attend the

May 21, 1999, appeal hearing because they had been in the process

of moving from Japan to the Rivercliff property.   The letter also

stated that as of June 29, 1999, petitioner and his family

permanently resided on the Rivercliff property and the Friends’

appeal had become a “considerable and very real burden to [their]
                               - 14 -

daily life”.   Petitioner’s address listed on the letter was the

Rivercliff property address.

     On July 9, 1999, the Multnomah County issued a Clarification

of Land Use Hearings Officer’s Conditions of Approval

(clarification) authorizing only one family dwelling on the

Rivercliff property.   The clarification required that the use of

the original farm dwelling as a residence be discontinued when

the Talmages’ new home was completed.   Sometime in July, after

receiving the clarification, petitioner and Kumiko Talmage signed

a replacement dwelling agreement with Multnomah County in which

they agreed that the Rivercliff property could have only one

dwelling unit, and the original farm dwelling would not be used

for residential purposes once the Talmages’ new home was

occupied.

     On July 27, 1999, the Talmages applied for a new

construction permit for the Rivercliff property with the

condition that original farm dwelling be converted to

nonresidential use within 3 months of their occupying their newly

constructed home.   The application stated that the property

owners were petitioner and Kumiko Talmage.

     On September 21, 1999, petitioner untimely filed his 1998

Federal income tax return with a filing status of married filing
                               - 15 -

separately, which listed Tokyo, Japan, as his home address.7       The

1998 return reported wages of $58,736, taxable interest of

$4,446, and an exclusion of $58,736 on Form 2555, Foreign Earned

Income, and claimed personal exemptions for petitioner and Kumiko

Talmage and dependency exemptions for their three children

resulting in petitioner’s calculation of “0” taxable income.       The

1998 return did not claim a deduction for interest paid.

     The total funds wire transferred by NCPL to SSI for the

development of the Rivercliff property during 1999 were

$2,119,464.    Petitioner did not report the $2,119,464 as income

on his Form 1040 for 1999 (1999 return).

     On March 15, 2000, the Talmages separated, and Kumiko

Talmage moved from the Rivercliff property to an apartment in

Gresham, Oregon.    From March 15 through June 12, 2000, she

withdrew $120,582 from the family bank accounts.

     On May 11, 2000, petitioner untimely filed his 1999 return

with a filing status of married filing separately, which listed

Tokyo, Japan, as his home address.      The 1999 return reported

$76,560 of foreign earned income on Form 2555 and claimed a

maximum foreign earned income exclusion of $74,000, but it did

not report the $2,560 excess as wages on line 7 of page 1 of Form

1040.    The Form 2555 reported that petitioner, Kumiko Talmage,



     7
       In April 1999, petitioner filed an extension to extend the
filing date for his 1998 return to Aug. 16, 1999.
                               - 16 -

Kory Talmage, and Lillian Talmage resided together in Japan

throughout 1999.   Petitioner did report taxable interest of

$3,428 and claimed personal exemptions for himself and Kumiko

Talmage and dependency exemptions for Kory Talmage and Lillian

Talmage resulting in petitioner’s calculation of “0” taxable

income.   The 1999 return did not claim a deduction for interest

paid.

     On June 1, 2000, Kumiko Talmage filed for divorce.

Petitioner’s immediate reaction was to prepare, or have prepared

and signed, three documents, all dated June 16, 2000; i.e., an

addendum to his employment agreement dated December 31, 1998, a

loan reconfirmation agreement, and a letter written by Mr. Seki

to petitioner and Kumiko Talmage which set out the total amount

purportedly lent to date.

     The addendum to the December 23, 1998, employment contract,

dated June 16, 2000, stated:

     [Petitioner] is employed by NCPL in accordance with the
     terms of the Employment Contract executed the 23rd day
     of December 1998,
     and
     RBT is currently undergoing a marital dispute,
     -- The undersigned agree to the following adjustment to
     RBT’s remuneration/compensation package:

     (1) [Petitioner’s] monthly salary [is] temporarily
     increased to US$9,000 per month during the period of
     “Temporary Family Support” as dictated by the pending
     divorce filing by his spouse, Kumiko W. Talmage (filing
     dated June 1, 2000, with Multnomah County, State of
     Oregon, USA).
                             - 17 -

     (2) The actual disbursement of these funds shall be
     US5,000 to [petitioner’s] designated account with US
     Bank, and US4,000 to Kumiko Talmage’s personal account
     as designated by RBT.

     (3) Further NCPL agrees to loan [petitioner] marriage
     settlement monies in the event of a successful
     settlement with Kumiko, the specific details of which
     shall be determined by [a] separate loan agreement.

     NCPL wishes Ron and Kumi the best in their settlement
     of this matter and hope for a peaceful and speedy
     reconciliation.

Petitioner did not report the $4,000 portion of his salary

disbursed to Kumiko Talmage as income on his Form 1040 for 2000

(2000 return).

     The purported loan reconfirmation agreement with NCPL, dated

June 16, 2000, stated:

     Between:
     New Century Properties Limited of 2503 Bank of America
     Tower, 12 Harcourt Road, Hong Kong (“Lender”),

     and:
     Ronald B. Talmage of 35701 NE Chamberlain Road, Corbett,
     Oregon 97019 (“Borrower”)

     Whereas:
     Ronald B. Talmage and his spouse, Kumiko W. Talmage
     collectively executed a Loan Agreement dated the 25th
     of January 1999 (“The Loan”) with Lender,
     and
     Ronald B. Talmage and his spouse, Kumiko W. Talmage are
     jointly the owners of a certain property located at
     35701 NE Chamberlain Road, Corbett, Oregon, USA (“The
     Property”),
     and
     Ronald B. Talmage and his spouse, Kumiko W. Talmage
     collectively have an existing liability with regards to
     funds borrowed from the Lender, via The Loan and have
     pledged certain security via The Loan inclusive of The
     Property itself,
     and
                        - 18 -

Ronald B. Talmage and his spouse, Kumiko W. Talmage are
as of the date of this Agreement, undergoing a marital
separation (beginning with the departure of Kumiko from
The Property as of March 21, 2000), possibly to result
in divorce (subsequent to the Kumiko’s filing with the
County of Multnomah, State of Oregon, USA dated June 1,
2000),
and
Kumiko has also requested and the Family Court of the
County of Multnomah, State of Oregon, USA has
subsequently issued Court Order dated the 1st of June,
2000, that personal finances of the husband and wife
collectively and respectively are to be restrained,
and
Subsequent to Kumiko’s filing and Court Order, there
has arisen a possible new risk as to the security and
repayment of The Loan, and a possible question
concerning further funds to be loaned by the Lender to
the Borrower,
-- The undersigned hereby agree to the following:

(1) As of the date of signing of this Agreement,
Borrower and Lender hereby confirm that the sum total
of principal loaned to Ronald B. and Kumiko W. Talmage
collectively via The Loan currently stands at:
US$3,431,319.65 (Three million four hundred thirty-one
thousand three hundred nineteen US Dollars and sixty-
five cents).

(2) The Borrower reconfirms all commitments, repayment
and security as per the terms of The Loan, respective
of Kumiko’s present or future claims or position on the
matter.

(3) The Lender hereby requests the Borrower to record a
First Mortgage in favor of the Lender, on The Property.
In light of the recent divorce filing by Kumiko, and
subsequent Financial Restraining Order, the Borrower
hereby confirms that he will do his best to secure this
Mortgage for the Lender, and/or provide additional
collateral to further secure The Loan.

(4) The Lender reconfirms his intent to assist the
Borrower via additional funds to be loaned through
completion of the planned improvements on The Property,
as per the original terms and conditions of The Loan.
                              - 19 -

    (5) Lender hereby states and Borrower agrees that in
    the event that The Loan is contested by Kumiko W.
    Talmage and/or her attorney, Lender reserves the right
    to file suit in the County of Multnomah, State of
    Oregon USA, for damages against Kumiko and Borrower
    towards recovery of Lender’s loaned funds, his First
    Security interest in The Property, and/or foreclosure
    on The Property as per the terms of The Loan.

    (6) All other terms as per The Loan remain in effect
    and are hereby reconfirmed by the undersigned.

The loan reconfirmation agreement was signed by petitioner but

not by Kumiko Talmage.

     On July 23, 2000, petitioner sent an e-mail message to

Stephen C. Schommer (Mr. Schommer) (the vice president of SSI)

titled “Letter rewrite” containing instructions and three letters

written by petitioner.   The e-mail message instructed Mr.

Schommer to replace two draft letters Mr. Schommer had written

and given to petitioner for review with two of the three letters

contained in the e-mail.   The third letter contained in the e-

mail was only for Mr. Schommer’s reference.   The e-mail also

instructed Mr. Schommer to have the revised letters typed and

sent as SSI correspondence.   Mr. Schommer complied with

petitioner’s requests.

     On July 31, 2000, Mr. Schommer mailed as SSI correspondence

the first of the e-mailed letters (written by petitioner) to Mr.

Seki, purportedly the chief executive officer (CEO) of NCPL,

which stated:
                             - 20 -

     Dear Mr. Seki,

     Attached herewith please find the record of payments
     (inclusive of bank remittance documentation) received
     to date by A.C. Schommer & Sons, Inc. for RiverCliff
     construction work, from New Century Properties Limited.

     The total received as of the date of this letter stands
     at: $3,666,084.62 (Three million six hundred sixty-six
     thousand eighty-four US dollars and sixty-two cents).

     We appreciate your kind letter of the 16th of June
     reconfirming your commitment to continue with payments
     through completion of the project.

     Should there be any questions, please contact me at any
     time.

     Petitioner’s July 23, 2000, e-mail message to Mr. Schommer

also stated:

     For your information the “June 16 letter” from Mr. Seki
     referred to above, contains the following text. The
     signed original of this letter shall be presented to
     you upon my return from Asia on the 2nd.

     The text petitioner referred to in his July 23, 2000, e-mail

message was a letter allegedly written by Mr. Seki, which stated:

     Dear Mr. Schommer,

     We hereby confirm that we have paid in full all of your
     invoices issued us to date, subject to construction
     work for RiverCliff Farm. As of the date of this
     letter we have paid you the sum total of:

     US$3,431,319.65 (Three million four hundred thirty-one
     thousand three hundred nineteen US Dollars and sixty-
     five cents).

     These funds have been paid you on behalf of our
     borrowers, Ronald B. & Kumiko W. Talmage collectively,
     in accordance with the terms of a loan agreement we
     executed with them dated January 25, 1999.
                             - 21 -

     We further hereby reconfirm our commitment to provide
     continued lending to Ronald B. Talmage via direct
     payment to your future invoices for RiverCliff Farm
     work, through completion of the planned improvements
     and construction.

Mr. Schommer eventually received the June 16, 2000, letter and

kept it with his company’s books and records.    At trial,

petitioner offered this letter into evidence as a letter written

and mailed by Mr. Seki to Mr. Schommer.

     On July 31, 2000, Mr. Schommer also mailed as SSI

correspondence the second of the e-mailed letters (written by

petitioner) to the Talmages, which stated:

     Dear Ron and Kumi:

     Attached herewith please find the record of payments
     (inclusive of bank remittance documentation) received
     to date by A.C. Schommer & Sons, Inc. for RiverCliff
     construction work, directly from yourselves.

     The total received directly from you as of the date of
     this letter stands at: $412,965.76 (Four hundred
     twelve thousand, nine hundred sixty-five dollars and
     seventy-six cents).

     Further to this, for your reference, I am   also
     enclosing a copy of my letter and similar   information
     sent directly to your lender, New Century   Properties
     Limited for their portion of the payments   made to date.

     We sincerely wish you the best in a peaceful and speedy
     resolution to your current challenges. Our prayers are
     with you.

At this time, Kumiko Talmage was not aware of a company named New

Century Properties Limited or that any money had been lent to the

Talmages to develop the Rivercliff property.
                             - 22 -

     Petitioner hired Eric C. Larson (Mr. Larson), to represent

him in the divorce proceedings.    As part of the proceedings,

petitioner was required to disclose all assets and liabilities.

Because petitioner did not have documentation to substantiate his

income with respect to his employment with NCPL and the

liabilities with respect to the development of the Rivercliff

property, on July 27, 2000, Mr. Seki purportedly mailed a letter

to Mr. Larson to confirm Mr. Seki’s and petitioner’s professional

relationship, petitioner’s income, and the liabilities petitioner

had incurred with respect to the Rivercliff property.     The July

27, 2000, letter stated:

     Kumi, Ron and I have been friends for many years. Ron
     and his associates have been extremely helpful to my
     family over the years. He was personally instrumental
     in literally saving us from extreme financial hardship
     at a time when Japan’s economy was failing. I am
     forever indebted to him and his associates for their
     professionalism and expertise.

     After leaving the employment of the Rothschild Banking
     Group, Ron established a loose business affiliation
     with Lloyd G. Tupper and Keiji Y. Takahara, entitled
     “Trans-Pacific Partners.” This partnership was later
     expanded and brought into more formal incorporation and
     capitalized as a subsidiary of New Century Properties
     Limited * * * .

          *      *      *      *        *      *      *

     I hereby confirm to you that I am in fact the 100%
     shareholder and principal (CEO) of the apex company and
     controlling entity of all business matters Ron is
     involved in.

     Ron is an employee of New Century Properties Limited
     and is currently salaried at US$9,000 per month
     (recently increased to adjust for Kumiko’s mandatory
                                - 23 -

     temporary “Family Support”--see copy of employment
     agreement and addendum). Ron does not receive any
     compensation from either Trans-Pacific Partners (BVI)
     Limited, or TPP (HK) Limited. On occasion we may pay
     Ron a bonus, but this is not statutory, has no fixed
     interval or amount and is entirely at my discretion.
     Accordingly, Ron’s salary is determined by myself
     alone.

           *      *      *        *      *    *      *

     It has been our clear understanding that I would
     finance the construction of Ron & Kumi’s facilities at
     RiverCliff (in accordance with the loan agreement
     executed on January 25, 1999). Ron & Kumi would
     thereupon repay this debt over twenty-years from
     various funds Ron would earn during that period.

This letter served as Mr. Larson’s confirmation of petitioner’s

representations regarding his income and the liabilities the

Talmages incurred with respect to the Rivercliff property.    Mr.

Larson never met or spoke with Mr. Seki or anyone else from NCPL.

     On November 14, 2000, Mr. Seki purportedly mailed a letter

to the Talmages, which stated:

     Dear Kumi-san & Ron-san,

     Pardon me for writing you in English, but my attorneys
     have advised me that it is important that this letter
     be a clear statement to the legal proceedings that have
     now tragically become the center of your marriage.

           *      *      *        *      *    *      *

     I have loaned you two a considerable sum of money to
     date for the construction of your mutual dream home at
     RiverCliff Farm. Further I have offered Ron-san
     additional funds to be loaned towards a possible
     financial marital settlement with Kumi-san. Owing to
     the fact that Ron-san has told me that Kumi-san
     rejected Ron-san’s settlement offer (presented via
     Lloyd Tupper), and further, Ron-san’s delivery of the
     message that we now require mortgaged security on our
                               - 24 -

     loan to you was also not responded to by Kumi-san, it
     is hereby necessary for me to formally put you on
     notice, in writing, concerning my position on these
     financial matters.

     In accordance with the terms of the Loan we executed
     with you dated the 25th of January 1999, we hereby
     exercise our right to formally call for collateral in
     the form of a First Mortgage on the RiverCliff Farm
     property. We require that you do so prior to December
     31, 2000. Further, we hereby formally deliver you
     notice that henceforth, we make claim against Ron-san’s
     salary. It is our intention to formally register a
     lien in Hong Kong to this effect should we not receive
     sufficient remedy by January 1, 2001.

     Should we not receive reasonable progress in this
     matter of the mortgage, or better yet
     reconciliation/resolution between the two of you, it is
     our further intention to file formal suit against you,
     in the County of Multnomah, State of Oregon come
     January 2001 to protect our rights as lender.

The Talmages did not grant a security interest in the Rivercliff

property before December 31, 2000, and a lien was never filed

against petitioner’s salary.

     On December 11, 2000, SSI filed a construction lien against

the Rivercliff property for $246,083 because the Talmages

allegedly failed to make timely monthly payments and it was

uncertain when payment would be received.   The balance owing was

computed as follows:

     Contract price           $5,525,195
     Recording fees                   26
     Total                     5,525,221
     Less credits and offsets (5,279,138)
     Balance due claimant        246,083

The construction lien stated that SSI commenced performance of

its contract with the Talmages on April 9, 1998, and “fully
                              - 25 -

completed the contract on or about November 30, 2000 after which

claimant ceased to provide labor, transport or furnish materials

or transport, furnish or rent equipment for the improvement”.

The construction lien was signed by Mr. Schommer and listed

petitioner and Kumiko Talmage as the owners of the Rivercliff

property.

     Although the construction lien stated that the Talmages

failed to make timely monthly payments, the record indicates that

NCPL made timely payments and made a wire transfer payment of

$100,000 on December 8, 2000, 3 days before the construction lien

was filed.   Further, the construction lien stated that the

contract was completed on November 30, 2000.   However, the record

indicates the development of the Rivercliff property was not

completed until January 31, 2005.

     Attached to the construction lien was a document titled

“Notice Of Claim Lien” stating that SSI “intended to file suit to

foreclose the enclosed lien unless payment in full [was] received

within ten (10) days of the date of delivery of this notice”.

NCPL did not make another payment to SSI until March 28, 2001,

and SSI never filed suit to foreclose.

     Moreover, although the contract was allegedly fulfilled and

no payment had been received by SSI, on March 8, 2001, Mr.

Schommer wrote a letter to Mr. Tokos, of the Multnomah County

Planning Division, requesting additional time (until December 31,
                                - 26 -

2001) to convert the original dwelling on the Rivercliff property

into a storage facility so that petitioner could continue using

it as a dwelling until the new home was completed.

     In 2000, NCPL wire transferred to SSI a total of $2,742,794

for the development of the Rivercliff property and a total of

$38,800 to Kumiko Talmage for petitioner’s spousal and child

support obligations.    Petitioner did not report any of the

transferred funds as income on his Form 1040 for 2000 (2000

return).

     On December 19, 2000, Mr. Seki purportedly mailed a letter

to petitioner’s address stating NCPL had lent the Talmages

$4,856,172 for the development of the Rivercliff property

pursuant to the January 25, 1999, loan agreement.8

     On January 15, 2001, Mr. Seki purportedly mailed a letter to

Kumiko Talmage, which stated:

     Dear Kumiko-san,

     I am again writing in follow-up to my notice to you of
     the 14th of November 2000. As of the date of this
     letter, I have not yet received any response from you
     (either directly or via Ronald) regarding my call for
     security on the very sizable loan I have extended to
     you and Ronald for your Oregon property. I thus regard
     your lack of response as a negative and as your having
     the intent to obstruct my lawful right to security on
     the said loan.



     8
       The $4,856,171.94 includes only the amounts NCPL wire
transferred to SSI and does not include the $249,193 TPPL wire
transferred to SSI in 1998 or any amounts petitioner may have
paid SSI directly.
                             - 27 -

     Regretfully therefore I am forced to exercise my right
     of call on the loan. I will also thus be forced to
     impound a suitable portion of Ronald’s salary from New
     Century Properties Limited, to be applied as debt
     service. The good will extended to you in the
     adjustment on Ronald’s salary beginning from May of
     2000, thereupon remitting directly to your personal
     account the sum of US$4,000 monthly-- shall thus
     beginning from this month, be impounded and directly
     applied to debt service on the outstanding loan.
     Accordingly, I shall prohibit Ronald from remitting any
     of his monthly salary to you for your personal
     consumption, until such time that you have fulfilled
     the requirement of providing mortgaged security on the
     outstanding debt. No further funding will be extended
     for construction at RiverCliff, or for your marital
     settlement, until the mortgaged security has been
     confirmed and your marital conflict is resolved.

     It is my understanding you have ample funds available
     to you anyway, in the form of monies you took from a
     joint account held by Ronald and yourself, at the time
     of departure from the family home, last March of 2000.
     I therefore do not feel you are being at all unjustly
     treated in this action.

     I am to understand Ronald has begun proceedings with
     the County of Multnomah Family Services department, in
     attempts to finally be able to communicate with you. I
     sincerely hope this may work to resolve this very
     unpleasant situation you have brought upon Ronald, your
     family, and now reaching to myself and my firm.

Even though Mr. Seki threatened to stop paying petitioner’s

spousal and child support obligations, Kumiko Talmage did not

grant NCPL a security interest in the Rivercliff property and

NCPL did not impound petitioner’s salary or stop funding the

development of the Rivercliff property.

     On March 28, 2001, NCPL wire transferred $274,954 to SSI for

the development of the Rivercliff property.   During 2001, NCPL

also wire transferred a total of $45,714 to Kumiko Talmage for
                                - 28 -

petitioner’s spousal and child support obligations.     Petitioner

did not report any of the transferred funds as income on his Form

1040 for 2001 (2001 return).

     On April 11, 2001, petitioner filed his 2000 return with a

filing status of head of household, claiming an exemption for his

daughter, Lillian Talmage.     The 2000 return reported a salary

from an “Overseas Employer” of $84,000, interest income of

$1,406, a loss of $31,239 on Schedule F, Profit and Loss from

Farming, and a child tax credit of $500, with a tax liability of

$6,460.9    Petitioner did not report the portion of his salary used

to pay his spousal and child support obligations.     The 2000

return also did not claim a deduction for interest paid and did

not indicate petitioner’s employer was NCPL.

         On May 30, 2001, Steven W. Seymour (Mr. Seymour), an

attorney hired by B. Manek & Co., a Hong Kong firm of solicitors

(solicitors) representing NCPL and/or Mr. Seki, mailed a letter

to both Diane E. Rulien (Kumiko Talmage’s attorney) and Mr.

Larson, stating that NCPL had hired him to perfect a security

interest for NCPL in the Rivercliff property.     The letter also

stated that petitioner and Kumiko Talmage were required to:

     execute a mortgage in favor of my client [NCPL or Mr.
     Seki] for recording in the real property records of
     Multnomah County, Oregon. In the event that either, or


     9
       NCPL transferred $3,980 of petitioner’s $9,000 monthly
salary to Kumiko Talmage on Aug. 8, Sept. 11, Oct. 10, Nov. 10,
and Dec. 15, 2000.
                              - 29 -

     both, parties fail or refuse to execute a mortgage in
     favor of my client, I have been instructed to commence
     an appropriate action in Multnomah County Circuit Court
     to obtain and foreclose its interest in the Property so
     as to secure its loan to the borrower.

          Please advise me, within seven days of the date of
     this letter, whether your respective client will agree
     to execute a standard form of real property mortgage in
     favor of my client. If I do not have such commitment
     within this time, I will have no alternative but to
     declare the Loan Agreement in default and commence a
     lawsuit to enforce my client’s rights.

Mr. Seymour never spoke with the solicitors, Mr. Seki, or anyone

else from NCPL.   On June 1, 2001, Mr. Seymour mailed and faxed a

letter to the solicitors stating:

     Dear Sir:

          I have now had a telephone conference with Mr.
     Eric Larson, attorney for Mr. Ronald Talmage in the
     divorce proceeding.

          Mr. Larson first asked me whether I would be
     filing a lawsuit on behalf of New Century Properties
     Limited. I told him that I was prepared to file a
     lawsuit if I had to; however, I would prefer that Mrs.
     Talmage agree to execute the mortgage without the
     necessity of a lawsuit.

          Mr. Larson advised me that the divorce case was
     set for a settlement conference with the judge next
     Wednesday, June 6, 2001. He told me that the threat of
     a lawsuit by New Century Properties Limited would
     probably help settle this divorce case. He also told
     me that he hoped that the terms of the settlement would
     include an award of the Corbett property to his client.
     If that were to happen, his client would cooperate and
     sign a mortgage. This would certainly facilitate the
     resolution of this matter.

          Mr. Larson promised to advise me of the results of
     the settlement conference. I intend to serve Notice of
     Default of the Loan Agreement terms on Tuesday, June 5,
     2001, unless I have agreements from both parties that
                               - 30 -

       they will execute a mortgage. I will then wait to hear
       from Mr. Larson as to the results of the settlement
       conference. I will inform you of the same.

       In response, on June 4, 2001, the solicitors mailed a letter

to Mr. Seymour instructing him to proceed with the title search

and prepare to immediately file for foreclosure in the event the

June 6, 2001, settlement conference was unsuccessful.

       The settlement conference was successful, and Kumiko Talmage

agreed to transfer her 50-percent interest in the Rivercliff

property to petitioner in exchange for a $1,400,000 promissory

note secured by the Rivercliff property.    Neither petitioner nor

Kumiko Talmage determined the fair market value of the Rivercliff

property as part of the divorce proceedings.

       On June 20, 2001, the solicitors mailed another letter to

Mr. Seymour stating Mr. Seki agreed to accept a trust deed

granting NCPL a security interest in the Rivercliff property and

agreed that Kumiko Talmage be granted a “1st security” interest

of $1,400,000 in the Rivercliff property.    The letter also stated

that

       In view of the huge outstanding loan and further
       requirement of US$1,400,000.00 our mutual client
       anticipate that Mr Talmage may not be in a position to
       repay the loan. You may therefore consider to include
       in the Trust Deed default clause (subject to Mrs
       Talmage US$1,400,000.00 security) to require Mr Talmage
       to transfer the ownership of the property to our mutual
       client.

       On July 31, 2001, petitioner executed a promissory note for

the benefit of NCPL for $4,856,172, which provided:
                             - 31 -


          (a) Interest on the unpaid principal balance shall be
     paid annually. The first interest installment of SIXTY-FOUR
     THOUSAND TWO HUNDRED THIRTY-SEVEN AND 26/100 ($64,237.26)
     DOLLARS shall be paid on the 30th day of November, 2001.
     Subsequent annual interest installments of TWO HUNDRED FIFTY
     FOUR THOUSAND NINE HUNDRED FORTY NINE THOUSAND AND 02/100
     ($254,949.02) DOLLARS shall be paid on the 30th day of
     November, 2002, and on the same day of each year thereafter
     until and including the 30th day of November, 2011; and

          (b) On the 30th day of November, 2012, all
     accrued interest to that date plus SIX HUNDRED SEVEN
     THOUSAND TWENTY ONE AND 49/100 ($607,021.49) DOLLARS of
     principal shall be paid, and subsequent payments of
     accrued interest plus SIX HUNDRED SEVEN THOUSAND TWENTY
     ONE AND 49/100 ($607,021.49) DOLLARS of principal shall
     be paid on the same day of each year thereafter through
     the 30th day of November, 2018; and

          (c) The entire principal balance plus all accrued
     interest shall be paid in full eighteen (18) years from
     date hereof, that is, on July 31, 2019.

          (d) All payments hereunder shall be applied first
     to interest and then to principal. Interest shall be
     computed based on a 365-day year.

          This Note is secured by a Trust Deed on real
     property of even date, which real property is situated
     in Multnomah County.

           If any of said installments are not paid within
     ten (10) days of the date due, or in the event of
     default hereunder or under the Trust Deed securing this
     Note, the then unpaid balance of this Note, both
     principal and interest, shall become immediately due
     and collectible at the option of the holder of this
     Note.

The promissory note did not contain a signature line for Kumiko

Talmage, and she did not sign it.

     On August 20, 2001, the Multnomah County Circuit Court

entered a Stipulated Judgment of Dissolution of Marriage; Money
                              - 32 -

Judgment under which petitioner was required to:   (1) Make

monthly child support payments of $1,250 until July 2, 2002; (2)

place $100,000 in trust for the benefit of Lillian Talmage before

December 21, 2001;10 (3) pay Kumiko Talmage a money judgment of

$1,400,000 and execute a first trust deed document encumbering

the Rivercliff property to secure payment of the judgment; (4)

pay interest on any unpaid portion of the $1,400,000 judgment

after December 31, 2001, at a 9-percent per annum simple rate.11

The stipulated judgment also stated that Kumiko Talmage agreed to

a stipulated protective order dated August 8, 2000, requiring her

to refrain from discussing the terms and the provisions of the

marriage settlement.   Kumiko Talmage also agreed to convey her

50-percent interest in the Rivercliff property to petitioner.     On

August 20, 2001, a bargain and sale deed transferring Kumiko

Talmage’s 50-percent interest in the Rivercliff property to

petitioner was recorded in Multnomah County, Oregon.

     On August 21, 2001, petitioner signed a trust deed prepared

by Mr. Seymour granting the Rivercliff property to trustee,

Chicago Title Insurance Co., to be held for the benefit for NCPL

for the purpose of securing payment of $4,856,172 with interest

pursuant to the terms of the promissory note.


     10
       If the $100,000 was not transferred by Dec. 31, 2001, the
full amount would accrue interest at a 9-percent rate until paid.
     11
       On Feb. 4, 2005, NCPL paid $1,400,000 to Kumiko Talmage
to satisfy the judgment against petitioner.
                              - 33 -

     On August 28, 2001, petitioner signed an irrevocable trust

agreement promising to transfer $100,000 by December 31, 2001,

for the benefit of Lillian Talmage, to provide for her health,

education, and support and maintenance during high school,

college, and her church mission.

     On October 6, 2001, Mr. Seki died of liver cancer, and his

wife, Liu Hsiu Chen (Ms. Chen), purportedly became NCPL’s CEO.

     On April 9, 2002, petitioner filed his 2001 return with a

filing status of single.   The 2001 return reported a salary from

an “Overseas Employer” of only $67,850.12    The 2001 return also

reported a taxable distribution of $3,000 and a Schedule F loss

of $9,706, with a tax liability of $7,474.    Petitioner’s Schedule

A, Itemized Deductions, for 2001 reported a real estate tax

deduction of $9,545.   The 2001 return did not claim a deduction

for interest paid or indicate NCPL was petitioner’s employer.

     On June 8, 2002, petitioner married petitioner Annette C.

Talmage.

     During 2002, NCPL wire transferred a total of $182,820 to

Kumiko Talmage for petitioner’s child support obligations and for

interest owing on petitioner’s settlement obligation to Kumiko

Talmage.   Petitioner did not report the $182,820 as income on

petitioners’ jointly filed Form 1040 for 2002 (2002 return).



     12
       The record indicates that NCPL made only one $4,000
payment to Kumiko Talmage in 2001 (Mar. 9, 2001).
                                - 34 -

     On April 10, 2003, petitioners filed their 2002 joint return

and reported a salary from an “Overseas Employer” of $75,000 and

a Schedule F loss of $22,875, with a tax liability of $2,501.

Petitioner’s Schedule A for 2002 reported a real estate tax

deduction of $9,545.   The 2002 return did not claim a deduction

for interest paid.

B.   Respondent’s Examination

     In late 2003, the Japanese taxing authorities, as part of an

information exchange, informed respondent that petitioner, a U.S.

citizen, and TPPL were involved in a business transaction in

which TPPL received over $5 million in 2000.   The Japanese taxing

authorities also disclosed documents which stated that petitioner

was the CEO and chairman of TPPL and that he resided at the

Rivercliff property.   While investigating petitioner, Revenue

Agents Steve Rans and Christopher Beach discovered the Rivercliff

property was titled in the Talmages’ names and that SSI was

involved in a large construction project on the property.

     On January 22, 2004, Agent Rans mailed a letter to

petitioner asking whether he held an ownership interest in TPPL

or NCPL.   The letter referred to documents in which petitioner

identified himself as the chairman, the chairman and CEO, and the

managing partner and chairman of TPPL.   The letter also requested

that petitioner disclose the source of funding for the
                              - 35 -

development of the Rivercliff property and the costs of its

development.

     In response, by letter dated January 25, 2004, petitioner

stated he was employed exclusively by NCPL and at times was

temporarily reassigned to work on projects for TPPL and other

companies at the direction of his employer.13   The letter stated

that, depending on the transaction, his employer instructed him

to use the titles of CEO, chairman, and managing partner.    The

letter also claimed he did not receive any money from TPPL’s

transactions and did not have an ownership or controlling

interest in NCPL or TPPL.   Furthermore, the letter asserted that

petitioner was prohibited by NCPL’s nondisclosure confidentiality

agreement (confidentiality agreement) from providing any

documentation or information to the Internal Revenue Service

(IRS) with respect to NCPL and TPPL and its owners.

     The confidentiality agreement signed by petitioner dated

January 10, 1993, states:

          1. Associate agrees to treat as confidential all
     technical, business, financial and other confidential
     or proprietary information of the Company which is
     disclosed to Associate, whether in written, oral, fax
     (electronic) or other tangible or intangible form,
     including without limitation, corporate information,
     client information, investor information, financial
     transaction documentation, specifications, know-how,
     plans, data, other documentation, reports, ideas,


     13
       At the beginning of respondent’s examination, petitioner
told the agents he was not authorized to use his employer’s
actual name.
                              - 36 -

     concepts, and other information (all of the foregoing
     information hereinafter collectively referred to as the
     “Information”). The term “Information” shall include
     all confidential information of the Company, whether
     disclosed to Associate before, on or after the date
     hereof. Notwithstanding the foregoing, the term
     “Information” shall not include information that
     Associate can demonstrate (a) was known to it prior to
     its receipt of such information from the Company; (b)
     became generally publically known other than by
     Associate’s direct or indirect act; (c) was rightfully
     disclosed to Associate by a third party without
     restriction; or (d) was independently developed by
     Associate without use of or access to the Information.

          *      *      *      *         *      *      *

          5. In the event that Associate or its
     representatives are requested or required (by
     questions, interrogatories, requests or information or
     documents, subpoenas, civil investigation demand court
     orders or other process) to disclose any Information to
     a governmental authority or in connection with any
     litigation, Associate will provide the Company with
     prompt notice (within one day) of any such request or
     requirement so that the Company may seek an appropriate
     protective order. In any event, Associate [shall]
     cooperate with the Company in obtaining an appropriate
     protective order or other reliable assurance that
     confidential treatment will be accorded the
     Information.

     In response to Agent Rans’s question with respect to the

Rivercliff property, the letter stated that petitioner’s employer

purchased the property with the Talmages and had owned it jointly

with the Talmages.   The letter also stated that his employer had

assumed loans it made to petitioner which increased the

employer’s equity in the property.     Additionally the letter

stated:
                               - 37 -

     Schommer and Sons has been the contractor for all
     of the facilities I jointly own with my employer
     here on the Corbett farm [the Rivercliff property]. I
     own the cottage and an interest in the barn. My
     employer owns the new house (still under construction)
     and the tennis court (my wife and I don’t even play
     tennis). These other facilities owned by my employer
     (NCPL) are for the purpose of company use and various
     entertainment for my employer and at his discretion.

     (1)    I do not have a complete figure, as much of the
            work is still in progress. Also the portion
            that is my employer’s ownership I have not
            obtained his consent to release financial figures
            that are not of my personal ownership interest.

     (2)    Various renovations first began in early 1998 and
            are still ongoing as directed by my employer.

     (3)    I funded the cost of the Cottage renovations (our
            residence) and some work on the barn. My
            employer had funded the balance and considers all
            of these as such, his property.

     On February 18, 2004, Agent Rans mailed petitioner a Form

4564, Information Document Request, requesting:    (1) Petitioner’s

Federal income tax returns for 2000, 2001, and 2002; (2) copies

of all monthly bank statements from December 1, 2000, through

January 31, 2002; and (3) records substantiating farm expenses

deducted in 2001 and 2002.    Respondent also separately requested

SSI’s bank statements to determine the source of the funding for

the development of the Rivercliff property.

     Petitioner provided respondent bank statements for two

accounts he held with US Bank and for one account he held with

Wells Fargo Bank.    All three accounts were held in the United

States.    Petitioner also provided the requested Federal income
                               - 38 -

tax returns but failed to provide any documentation

substantiating the farm expenses deducted in 2001 and 2002.

     At a March 17, 2004, meeting between petitioners and Agents

Rans and Beach, petitioner reiterated that his employer owned

most of the Rivercliff property and that he merely owned the barn

and the original dwelling where he resided with his wife, Annette

C. Talmage.    Petitioner also stated that he was earning an equity

interest in the property through the services he provided on the

property and the exact respective percentages of ownership would

be determined at a future date.

     Additionally, during the meeting, petitioner indicated that

his employer’s name was Mr. Chen14 and the champion dogs living on

the property belonged to his employer.   Although the agents

requested, petitioner refused to provide his employer’s contact

information.   Petitioner again asserted that pursuant to

nondisclosure agreements with NCPL he was not allowed to provide

any information about NCPL, TPPL, or his employer.

     Shortly after the March 17, 2004, meeting, respondent

obtained SSI’s bank statements.   After reviewing both SSI’s and

petitioner’s bank statements, respondent discovered that NCPL and

TPPL wire transferred substantial funds to both SSI and

petitioner from bank accounts in Hong Kong.   The Hong Kong banks


     14
       At trial, petitioner testified that Mr. Chen and Mr. Seki
were the same person. However, Mr. Chen/Seki had been deceased
since Oct. 6, 2001.
                              - 39 -

included the Shanghai Banking Corp. at the Harcourt Road branch,

the Hong Kong Bank at the Harcourt Road branch, and the CITIC Ka

Wah Bank.

     On April 2 and 6, 2004, Agent Rans mailed petitioner Forms

4564 requesting:   (1) A narrative explanation from petitioner’s

employer regarding his understanding of his joint ownership in

the Rivercliff property and the terms of the loan agreement; (2)

a narrative explanation from petitioner’s employer stating “why

they are currently paying the interest, and ultimately, the

principal on the $1,400,000 settlement that you owe to your ex-

wife, Kumiko” and why they were paying petitioner’s daughter’s

tuition at BYU; (3) the address, telephone number, and passport

number for petitioner’s employer, Mr. Chen; (4) an explanation of

why NCPL did not have a security interest in the Rivercliff

property until after TPPL and NCPL had advanced approximately $5

million; and (5) an explanation of why monthly wire transfers

from NCPL to petitioner for petitioner’s spousal and child

support obligations did not constitute taxable income.

     Petitioner did not provide the requested information

regarding his employer or his employer’s narrative explanation

with respect to the joint ownership of the Rivercliff property,

the terms of the loan agreement, and the interest payments on the

$1,400,000 settlement judgment.
                              - 40 -

     With respect to the questions regarding the Rivercliff

property, petitioner asserted that NCPL did not have a security

interest in the property until after $5 million had been

transferred for its development because the property was zoned

only for a single-family residence.    The zoning regulations did

not allow the property to be used as a corporate retreat.    Thus,

to avoid permit problems with Multnomah County petitioner wanted

to maintain the appearance that NCPL did not own an interest and

that the property would be used for single-family purposes

throughout the course of the permit process and through

completion of construction.

     With respect to the question regarding NCPL’s advances for

the interest on the $1,400,000 settlement judgment, petitioner

stated:

     I do not consider these payments to my former wife as
     my personal obligation. My employer assumed these
     obligations as his own, in return for her portion of
     the equity in the [Rivercliff] property. The payments
     referred to here are installments towards his acquiring
     all of her position ultimately. * * *

     With respect to the questions regarding NCPL’s payments for

petitioner’s child support and education, he stated:

     Accordingly, these payments here as well, were not my
     personal obligation, but what my employer deemed
     compensation to Kumiko directly. I personally never
     received any benefit whatsoever from her receipt of
     these monies, and therefore do not feel I am obligated
     to have to pay any taxes on these. * * *

     As to Lillian’s portion, I consider these amounts as
     borrowed funds from my employer, to be settled once we
                              - 41 -

     finish the final retitlement of the [Rivercliff]
     Property * * *.

     After discovering that substantial amounts were wire

transferred from NCPL’s and TPPL’s Hong Kong bank accounts to

petitioner’s and SSI’s bank accounts, on May 24, 2004, Agent Rans

mailed petitioner a Form 4564 with two consent directives for

petitioner’s signature.   An attached letter stated:

     Attached are two documents (consent directives) that I
     would like you to sign and mail back to me. The
     purpose of the documents is to send to the Hong Kong
     and Shanghai Bank and the Citic Ka Wa bank in Hong Kong
     to request records. You have stated that you have no
     control over those accounts. In that case, the banks
     would not have the authority to release the requested
     records to me. This would possibly be one way of
     verifying that you do not have control over these
     accounts. Please call me if you have any questions
     regarding this request.

     Respondent was required to obtain consent to acquire the

information because the United States and Hong Kong do not have a

treaty allowing the IRS to subpoena a U.S. citizen’s bank account

information from Hong Kong banks.

     In response, on May 30, 2004, petitioner mailed a letter

stating that he did not have an offshore bank account and his

employer prohibited him from signing the consent directives.

Petitioner returned the consent directive unsigned.

     On September 9, 2004, petitioner and Ms. Chen, on behalf of

NCPL, executed a Memorandum of Confirmation and Agreement, which

states:
                        - 42 -

In accordance with the original terms contracted by the
late, Tsutomu Seki (former Chairman of NCPL) with
regards to employment of Ronald B. Talmage, and
specifically the terms of administration and joint
development of the property known as RiverCliff Farm *
* *, we the undersigned hereby confirm and further
agree to the following clarification, further
definition and formalization of these relationships:

(1) It is hereby reconfirmed that the original intent
of the development of the RiverCliff Farm property was
to be a 50/50 joint-venture between Ronald and NCPL,
Ronald providing the hands-on and resident
administration and some original capital, and NCPL
providing required capital thereafter.

(2) Further, it is hereby reconfirmed that in
accordance with advice from counsel, it was determined
that during the development and construction phase,
particularly as it pertains to the regulatory
permitting process, that initially Ronald and his
spouse would title the property in their name, and as
“nominee” for NCPL’s portion. It is hereby reconfirmed
that in accordance with this process, NCPL capital
participation would initially be in the form of debt,
but with direct payments to invoices regarding actual
construction costs. It is hereby agreed that the
intent to this plan was to convert the debt to equity
at an appropriate time, as deemed most suitable to the
regulatory environment, phase of completion of the
project and any other extenuating circumstances that
might trigger this conversion to equity.

(3) Further, Ronald has since undergone challenges with
divorce and the resulting exposure of confidential matters
and more recently even resulting in audit by the IRS.

(4) Accordingly of recent, counsel has advised the parties
that the current regulatory environment within the Columbia
River Gorge National Scenic Area, and more particularly the
Land Use Planning Department of Multnomah County, has been
greatly eased as compared to the conditions at the time of
initiation of development at the RiverCliff Farm property.

(5) The undersigned have therefore determined that it is now
advisable to proceed to exercise the NCPL right of
conversion to equity and formalization of the title position
                        - 43 -

for NCPL participation in the direct ownership of the
RiverCliff Farm property.

(6) Further, possible tax questions have been raised by the
IRS concerning Ronald’s position in the subject property and
settlement of his divorce and relations to his former
spouse’s (former) equity position in the RiverCliff Farm
property.

(7) We the undersigned therefore intended to proceed with
necessary documentation to resolve the above issues and
convert title as most suitable, including but not limited to
the following points:

     (a) NCPL will purchase Ronald’s former spouse,
     Kumiko’s (former) equity position, by directly
     paying off her remaining obligation. NCPL will
     consider the sum total of any and all interest and
     principal payments on the divorce settlement
     amount as a purchase or swap for equity in the
     RiverCliff Farm property.

     (b) NCPL will also purchase a portion of Ronald’s
     equity in the RiverCliff Farm property, by paying
     the balance due on Lillian Talmage’s trust
     settlement, and likewise consider any and all
     interest and principal payments in this regard as
     a purchase or swap of equity for payment.

     (c) Ronald shall simultaneous to this, transfer
     title ownership in the RiverCliff property, to
     NCPL, to be duly recorded accordingly.

     (d) Ronald shall engage necessary Counsel to effect
     these matters properly, legally and tax efficiently

     (e) NCPL shall carry costs of such advisory,
     proceedings and recordations, and shall make direct
     remittance to appropriate parties as needed.

     (f) Following advice from Counsel, Ronald and NCPL
     shall arrive at a suitable number or portion to
     designate Ronald’s remaining equity in the Rivercliff
     Farm property. Such position can thereupon be
     formalized by appropriate arrangements such as a
     “Limited Partner” position and/or a contractual
     arrangement as advised by Counsel.
                   - 44 -

(g) As a principal, the undersigned hereby agree
that in keeping with the original intent of the
50/50 joint-venture for the ownership and
development of the RiverCliff Farm property--that
Ronald should be left with a minimum a perpetual
use of the RiverCliff Farm property, at least
through the duration of his life. It is the
desire of NCPL to have Ronald act as the resident
manager of the RiverCliff Farm property, and as
such NCPL pledges to provide Ronald and his spouse
Annette, with residence there as long as he
remains in the employ or affiliated with NCPL.

(h) The precise “formula” for this continuing
joint-venture and employer-employee arrangement
with regards to the RiverCliff Farm property,
shall be driven by advice from Counsel as to the
best possible solution for all of the above
issues.

(i) It is the intent of NCPL to make regular use of the
RiverCliff Farm property for company, NCPL shareholder
and corporate client recreation and conference
purposes. Further, NCPL officers and shareholders
intend to place various items of ownership (i.e.,
horses, dogs, vehicles, art pieces etc.) on the
premises, for enjoyment by it’s officers and associates
from time to time.

(j) It is the intent of NCPL and Ronald, that Ronald
will remain in the employ of NCPL and Ronald will
continue to advise NCPL on various business and asset
management matters as per to date, and as new
opportunities present themselves in the future.

(k) It is agreed that this process of title transfer
and formalization of the above arrangements shall be
accomplished in conjunction with the requirements of
payment of the remaining obligation to Ronald’s former
spouse Kumiko, with all necessary documentation and due
process accomplished no later than the 31st of January
2005.

(l) It is agreed that various contracts, notices,
filings and recordations will be part of this
formalization process, and both NCPL and Ronald agree
to cooperate in the completion of any and all required.
                                - 45 -

     (8) Ronald shall herewith proceed to make arrangements with
     Counsel and to notify appropriate parties to begin this
     process, and notify NCPL accordingly. * * *

C.   Events After Issuance of Notices of Deficiency

     The notices of deficiency for 1998, 1999, 2000, 2001, and

2002 were issued on April 11, 2005.

     On June 17, 2005, NCPL incorporated RiverCliff Farm, Inc.

(RFI), as a solely owned subsidiary under the laws of the State

of Oregon for the purpose of operating a vacation home for NCPL.

Ms. Chen was named the president and petitioner was named the

secretary of RFI.    The articles of incorporation for RFI list

Robert G. Burt, P.C., as the registered agent, and Robert G.

Burt, Attorney at Law, as the incorporator.

     Although the appraised fair market value of the Rivercliff

property was only $5,670,000 as of June 30, 2005, petitioner

transferred title, by quitclaim deed, to RFI for $12,608,786 on

June 30, 2005.15    The $12,608,786 comprised $6,869 in cash, a

$3,528,068 promissory note, forgiveness of the $519,033 NCPL

advanced to petitioner to purchase the Rivercliff property, and

other advanced funds totaling $8,554,816.16




     15
       According to an appraisal prepared by Matthew P. Call of
PGP Valuation, Inc., for petitioner’s attorney, Robert G. Burt,
the Rivercliff property had a fair market value of $5,670,000 as
of June 30, 2005.
     16
       NCPL purportedly assigned the $519,033 and $8,554,816 to
RFI as receivables.
                              - 46 -

     The $8,554,816 comprised:   (1) The wire transfer of $249,193

from TPPL to SSI in 1998 for the development of the Rivercliff

property and the wire transfers of $2,109,464, $2,746,708, and

$274,953 from NCPL to SSI in 1999, 2000, and 2001, respectively,

for the development of the Rivercliff property; (2) wire

transfers of $36,263, $13,454, and $42,553 from NCPL to

petitioner in 1998, 2001, and 2002, respectively; and (3) wire

transfers from NCPL to petitioner totaling $3,082,228 for various

other Rivercliff property development costs not at issue in this

case.

     After the Rivercliff property was transferred to RFI,

petitioner purportedly offset the funds NCPL wire transferred to

Kumiko Talmage to pay petitioner’s spousal and child support

obligations and divorce settlement obligations against the

$3,528,068 promissory note from RFI.17

     On June 30, 2005, NCPL transferred its purported interest in

the Rivercliff property to RFI by quitclaim deed.   The quitclaim

deed did not specify the interest NCPL held in the Rivercliff

property or the exact consideration paid by RFI.    The quitclaim

deed stated “Other property or value was paid [as] consideration

for this conveyance”.



     17
       As of June 30, 2005, NCPL had wire transferred $2,095,203
to Kumiko and Lillian Talmage for the amounts petitioner owed
under the divorce settlement and for his spousal and child
support obligations.
                             - 47 -

     On June 30, 2005, petitioners both signed an employment

agreement with RFI to work as the Rivercliff property’s

caretakers, in which their duties included supervising the

completion of the Rivercliff property development, maintaining

the new home for corporate guests, operating the farm, and caring

for their employer’s dogs and horses.   The dogs and horses had

been transferred to RFI by the Talmages by bill of sale.    For

their services, petitioner and Annette C. Talmage were paid

annual salaries of $42,000 and $12,000, respectively, and were

granted full use of the Rivercliff property and permitted to

reside in the property’s newly completed home.

     On July 1, 2005, RFI contracted with SSI to complete the

development of the Rivercliff property development.    SSI was paid

a total of approximately $12,500,000 to develop the Rivercliff

property from 1998 through January 31, 2006.

     Petitioners filed their petition on July 12, 2005.

     On March 3, 2006, petitioners jointly filed their Form 1040

for 2005, in which they reported $2,960,851 in capital gains from

the sale of the Rivercliff property to RFI.    On November 16,

2006, petitioners filed Form 1040X, Amended U.S. Individual

Income Tax Return, in which they reduced the capital gain

recognized on the sale of the Rivercliff property to $2,322,720.
                                - 48 -

                                OPINION

I.   An Overview

     The record in this case presents testimony and documentary

evidence so internally inconsistent and implausible on its face

that we cannot credit it.   Petitioner and Ms. Chen were

petitioners’ primary witnesses.

     Throughout the examination phase of this case, pretrial

preparation, and the subsequent trial, petitioner sought to limit

his testimony and evidence by claiming that confidentiality

agreements with respect to his employment and a protective order

entered by Multnomah County Circuit Court in the divorce case

with Kumiko Talmage required him to do so.

     The stipulated protective order agreed to by petitioner and

Kumiko Talmage prohibited disclosure of any documents and

testimony in the divorce case file in perpetuity.   We have

previously denied petitioner’s motion in limine for exclusion of

documents and testimony in the divorce case.   The protective

order was not issued by the Multnomah County Circuit Court to

resolve a controversy but simply to approve the parties’

stipulated agreement, and petitioner and Kumiko Talmage were

material witnesses in this case.    See Melea Ltd. v. Commissioner,

118 T.C. 218, 223-226 (2002).

     The confidentiality agreement dated January 10, 1993, is the

only such agreement introduced into the record.   The
                              - 49 -

confidentiality agreement, contrary to petitioner’s assertions,

does not prohibit disclosure of information pertaining to

petitioner but requires only that the employer be notified of any

inquiry so that it might seek protection against disclosure of

employer information not related to petitioner.

     At trial petitioner testified that NCPL was owned by Mr.

Seki and that he was employed by Mr. Seki.   The only

corroborating evidence of petitioner’s assertions are letters

written in English signed by Mr. Seki.   Mr. Seki could not read

or write English.   Kumiko Talmage testified that Mr. Seki worked

for petitioner.   The record is devoid of any corporate

documentation including stock certificates, corporate minutes, or

public filings (other than the articles of incorporation for

NCPL, which do not disclose ownership) supporting petitioner’s

assertions.   Moreover, the record as a whole supports the

inference that funds would be transferred when requested by

petitioner with no real limitation as to the amounts.

     Petitioner introduced confirmatory memoranda created long

after transactions had occurred in an attempt to characterize

previous transactions in a manner inconsistent with facts.    The

documentation relative to loans will be discussed shortly.    Other

documentation prepared by, or at the direction of, petitioner, has

been represented by him to originate from others, including the

June 16, 2000, letter signed by Mr. Seki and an officer’s
                                - 50 -

certificate of Liu Hsiu Chen dated November 21, 2006, signed by

Ms. Chen.

     Petitioner, through contradictory testimony and evidence,

has represented his ownership interest in the Rivercliff property

to be:   (1) Outright joint ownership with his wife, Kumiko; (2)

outright ownership of only the original farm dwelling and barn;

(3) 50-50 ownership with his purported employer; or (4) ownership

by his purported employer with petitioner able to work into an

equity position for services rendered.   In spite of all of the

contradictory representations, petitioner held legal title to the

Rivercliff property jointly with Kumiko Talmage until August 20,

2001, when she deeded her ownership interest to petitioner.

Petitioner held sole legal title until June 30, 2005, when he

transferred title to RFI.   Moreover, petitioner continuously

resided in and used the Rivercliff property as his primary

residence from 1999 through the date of trial.

     Petitioner’s testimony relating to the payments by his

purported employer to Kumiko Talmage arising from the divorce is

inconsistent and implausible.   Petitioner categorized the payments

variously as:   (1) Advances due to friendship; (2) obligations

assumed by his employer and therefore no longer his; (3) payments

by NCPL to acquire Kumiko Talmage’s 50-percent ownership interest

in the Rivercliff property (despite the fact that Kumiko Talmage

transferred her interest in the Rivercliff property to petitioner
                                - 51 -

as part of the divorce settlement); and (4) loans.    In view of the

compensation petitioner earned, to suggest that an employer would

advance funds in excess of $2 million to an employee to satisfy an

employee’s divorce obligations is beyond implausible.

     We must determine the credibility of a witness on the basis

of objective facts, the reasonableness of the testimony, and the

demeanor of the witness.    Quock Ting v. United States, 140 U.S.

417, 420-421 (1891); Wood v. Commissioner, 338 F.2d 602, 605 (9th

Cir. 1964), affg. 41 T.C. 593 (1964); Dozier v. Commissioner, T.C.

Memo. 2000-255.    Petitioner’s testimony was inconsistent,

contradictory, implausible, and not credible.

     Ms. Chen is of Chinese ancestry and resides in Taiwan.    She

cannot read or write English and testified through an

interpreter.18    Ms. Chen’s testimony, even giving due regard to the

language barrier, revealed a lack of basic knowledge about her

business relationship with petitioner.    She testified that she had

been the CEO of NCPL since her husband, Mr. Seki, died on October

6, 2001, and that NCPL had only two employees, Susan Lung and

petitioner.   Although she was allegedly the CEO of NCPL, a company

with only two employees, she did not know what petitioner’s salary


     18
       Ms. Chen’s attorney, Philip N. Jones, explained to the
Court that it was “very difficult or impossible for her to tell
what a document is about because of the language barrier”. He
also stated that “the language barrier for my client is quite
severe, and when she is handed a document in English, it’s as if
I was handed a document printed in Chinese characters. She
cannot read it.”
                               - 52 -

was, who determined it, or how it was determined.   Her testimony

with respect to the purported loans by NCPL to petitioner

conflicted, in part, with other evidence.19   Additionally, she was

unable to recall who drafted her Officer’s Certificate dated

November 21, 2006, but when pressed on cross-examination, admitted

receiving the document from petitioner.   Ms. Chen provided no

books or records from NCPL to substantiate any of her testimony,

and the only documents bearing her signature were documents

written in English.

      Ms. Chen attempted to avoid answering questions directly put

to her, she lacked basic knowledge about NCPL and its relationship

to petitioner, and her demeanor at trial led the Court to believe

she would sign any document placed before her by petitioner.

Therefore, the Court finds that her testimony was not credible.

II.   The Purported Loans

      Respondent contends petitioner failed to report the following

wire transfers as income:




      19
       Ms. Chen testified that the amounts advanced for the
divorce and the improvements on the Rivercliff property were
$80,000 and $550,000 respectively. Her testimony with regard to
the $510,000 to $520,000 advanced to purchase the Rivercliff
property was accurate.
                                    - 53 -

                                  Wire            Wire          Wire
                  Wire       transfers to    transfers to     transfers
              transfer to     SSI for the     operate the    for family
 Tax            purchase      development      Rivercliff      support
 year          Rivercliff   of Rivercliff1       farm2      obligations3
 1998         $519,033         $249,193        $36,263          -0-
 1999             --          2,109,464          -0-            -0-
 2000             --          2,746,708          -0-          $12,000
 2001             --            274,953         13,454          8,670
 2002             --             -0-            42,533        181,765
      Total    519,033        5,380,318        92,250         202,435
  1
    The wire transfer to SSI in 1998 of $249,193 for the
development of the Rivercliff property was from TPPL. The wire
transfers for the development of the Rivercliff property in 1999,
2000, and 2001 were from NCPL.
  2
    Using the bank deposits method to reconstruct petitioner’s
income, respondent found that petitioner failed to report income
of $36,263, $13,454, and $42,553 in 1998, 2001, and 2002,
respectively. Petitioner asserted these amounts were loans for
the operation of the farm on the Rivercliff property.
  3
    Petitioner’s family support obligations include the total
amounts NCPL wire transferred to petitioner for his spousal and
child support obligations in 2000, 2001, and 2002 and for the
interest paid on the $1,400,000 divorce settlement in 2002.

       Petitioner does not dispute the amounts of the wire transfers

but contends the transferred funds comprised three nontaxable

loans for:      (1) The purchase of the Rivercliff property; (2) the

development of the Rivercliff property and the operation of the

farm on the property; and (3) petitioner’s spousal and child

support obligations and the interest paid on the $1,400,000

divorce settlement (petitioner’s family support obligations).
                                - 54 -

     Petitioner has the burden to prove the transferred funds

constituted loans.   See Rule 142(a).20

     A loan is “‘an agreement, either expressed or implied,

whereby one person advances money to the other and the other

agrees to repay it upon such terms as to time and rate of

interest, or without interest, as the parties may agree.’”     Welch

v. Commissioner, 204 F.3d 1228, 1230 (9th Cir. 2000) (quoting

Commissioner v. Valley Morris Plan, 305 F.2d 610, 618 (9th Cir.

1962), revg. 33 T.C. 572 (1959) and 33 T.C. 720 (1960)), affg.

T.C. Memo. 1998-121.    Because receipt of money pursuant to a loan

is offset by a corresponding obligation to repay, a loan is not

taxable income.    Commissioner v. Tufts, 461 U.S. 300, 307 (1983).

     For a bona fide loan to arise both parties must have had an

actual intent to establish a debtor-creditor relationship at the

time the funds were advanced.    Estate of Chism v. Commissioner,

322 F.2d 956, 960 (9th Cir. 1963), affg. Chism Ice Cream Co. v.

Commissioner, T.C. Memo. 1962-6; Fisher v. Commissioner, 54 T.C.

905, 909-910 (1970).   Whether the parties intended to establish a

debtor-creditor relationship is determined by the facts and

circumstances.    Fisher v. Commissioner, supra at 910.   The U.S.



     20
       The burden of proof does not shift to respondent    in this
case pursuant to sec. 7491(a) because petitioner failed    to: (1)
Comply with the requirements under the Code to properly
substantiate items; (2) show he maintained all required    records;
and (3) show he cooperated with the reasonable requests    of
respondent for documents and information.
                                - 55 -

Court of Appeals for the Ninth Circuit considers seven factors to

determine whether a debtor-creditor relationship existed, with no

single factor being determinative.21     Welch v. Commissioner, supra

at 1230.   The factors are:   (1) Whether the promise to repay is

evidenced by a note or other instrument; (2) whether interest was

charged; (3) whether a fixed schedule for repayment was

established; (4) whether collateral was given to secure payment;

(5) whether repayments were made; (6) whether the borrower had a

reasonable prospect of repaying the loan and whether the lender

had sufficient funds to advance the loan; and (7) whether the

parties conducted themselves as if the transaction was a loan.

Id.

      The Court will address the purported loans separately

beginning with the loans for the development and operation of the

Rivercliff property, followed by the loans for the purchase of the

Rivercliff property and the loans for petitioner’s family support

obligations.

      A.   The Rivercliff Property Development and Operating Loans

           1.   Whether the Promise To Repay Was Evidenced by a
                Note or Other Instrument

      A note or other instrument is indicative of a debtor-creditor

relationship.   Teymourian v. Commissioner, T.C. Memo. 2005-232.


      21
       Because petitioner resides in the State of Oregon, absent
stipulation otherwise, an appeal of this case would go to the
U.S. Court of Appeals for the Ninth Circuit. See sec.
7482(b)(1)(A).
                               - 56 -

However, an instrument will be given little weight when the form

of the instrument fails to correspond with the substance of the

transaction.   Provost v. Commissioner, T.C. Memo. 2000-177.

     Petitioner did not produce a note or other instrument

indicating he intended to repay TPPL the $249,193 it transferred

to SSI in 1998 for the development of the Rivercliff property or

repay NCPL for the total of $92,250 it transferred to petitioner

for the Rivercliff property’s farm operating expenses in 1998,

2001, and 2002.

     However, petitioner asserts that the January 25, 1999, loan

agreement and the July 31, 2001, promissory note prove he and NCPL

established a debtor-creditor relationship with respect to the

funds NCPL wire transferred to SSI for the development of the

Rivercliff property in 1999, 2000, and 2001.22

     The record reflects that neither petitioner nor NCPL adhered

to the terms of the loan agreement or the promissory note:     (1)

Petitioner did not make a payment by January 25, 2004, as required

under the loan agreement; (2) petitioner did not make the $64,237

payment due on November 30, 2001, or the $254,949 payments due on

November 30 each year thereafter as required under the promissory

note; (3) NCPL did not attempt to collect the full amount owing or


     22
       The documentation created during the period of the
divorce proceedings from June 1, 2000, to Aug. 1, 2001, is given
little weight. It is obvious that petitioner was seeking by
means of preparation of documents and other manipulations to
limit his financial exposure in the divorce case.
                               - 57 -

any portion thereof after each default; and (4) petitioner did not

have the financial ability to repay the funds wire transferred by

NCPL to SSI.   Petitioner reported earning a modest income of only

$58,736, $76,560, $84,000, $67,850, $75,000, $52,059, $49,866 in

1998, 1999, 2000, 2001, 2002, 2003, and 2004, respectively.

     Furthermore, contrary to the loan agreement and the

promissory note, the September 9, 2004, memorandum of confirmation

stated that petitioner and NCPL formed a joint venture to develop

the Rivercliff property, the Talmages’ names on the Rivercliff

property’s title indicated that they served as nominees for NCPL’s

ownership interest, and at a future date petitioner planned to

convert NCPL’s advances into an ownership interest.   Also contrary

to the loan agreement and the promissory note, petitioner

repeatedly testified that until the characterization of the wire

transfer advances was fixed by him and NCPL, he was not required

and did not intend to make any payments on the advanced funds.

Petitioner testified that he and NCPL officially characterized

NCPL’s advances to SSI as a loan on June 30, 2005, when he

transferred the Rivercliff property to RFI as repayment for NCPL’s

advances.

     For the foregoing reasons, the Court finds that neither

petitioner nor NCPL intended to comply with the terms of the loan

agreement or the promissory note.   Thus, the Court gives the loan

agreement and the promissory note little weight.
                               - 58 -

           2.   Whether Collateral Was Given To Secure Payment

     The January 25, 1999, loan agreement stated that “security

for the loaned funds shall be in the form of, firstly, a lien on

Ronald’s salary as paid by NCPL, and secondly, at an appropriate

time, a mortgage or lien on the property.”23

     Although petitioner asserts his salary served as collateral

to secure payment of the funds advanced to SSI for the development

of the Rivercliff property, the salary was not enough to secure a

loan of $4,856,172.   Additionally, NCPL did not garnish

petitioner’s wages when he failed to make the payments required by

the loan agreement and the promissory note.

     Petitioner asserted that the Rivercliff property also served

as collateral to secure payment.    However, the trust deed securing

NCPL’s advances to SSI of $4,856,172 was not executed until August

21, 2001, after the funds secured by the property were advanced.

For a bona fide loan to arise the parties must have so intended at

the time the funds were advanced.    Estate of Chism v.

Commissioner, 322 F.2d at 960; Fisher v. Commissioner, 54 T.C. at

909-910.

     Petitioner testified that because Kumiko Talmage refused to

sign any document encumbering the Rivercliff property, he was

unable to grant a security interest until after she transferred



     23
       The June 16, 2000, loan confirmation agreement also
requested petitioner record a mortgage in favor of NCPL.
                                 - 59 -

him her interest.    Kumiko Talmage credibly testified that, before

the divorce proceedings, she had never heard of NCPL, was not

aware petitioner had borrowed any money to develop the Rivercliff

property, and was not asked to sign an agreement granting a

security interest in the Rivercliff property.

     In addition, petitioner produced no evidence indicating

collateral was given to secure payment of the $249,193 TPPL

transferred to SSI in 1998 for the development of the Rivercliff

property or the total of $92,250 NCPL transferred to petitioner

for the Rivercliff property’s farm operating expenses in 1998,

2001, and 2002.

     This factor indicates the parties did not intend to establish

a debtor-creditor relationship at the time the funds were

advanced.

            3.    Whether a Fixed Schedule for Repayments Was
                  Established

     A fixed schedule for repayment is indicative of a bona fide

loan.    Welch v. Commissioner, 204 F.3d at 1231; Teymourian v.

Commissioner, T.C. Memo. 2005-232.     Evidence that a creditor did

not intend to enforce payment or was indifferent as to the exact

time an advance was repaid indicates a bona fide loan did not

exist.   Gooding Amusement Co. v. Commissioner, 23 T.C. 408, 418-

419 (1954), affd. 236 F.2d 159 (6th Cir. 1956); Provost v.

Commissioner, T.C. Memo. 2000-177.
                                 - 60 -

     The promissory note set forth a fixed schedule for repayment

with a default provision requiring immediate payment of both

principal and interest.    However, the record indicates petitioner

did not make any payments to NCPL and NCPL never attempted to

collect the amount owing after each default.    Petitioner testified

that NCPL did not require him to comply with any fixed terms or

require him to make any payments until the characterization of the

advances was determined.

     Furthermore, petitioner produced no documentation showing

that a fixed schedule was established to repay the $249,193 TPPL

transferred to SSI in 1998 for the development of the Rivercliff

property or the total of $92,250 NCPL transferred to petitioner

for the Rivercliff property’s farm operating expenses in 1998,

2001, and 2002.

     This factor indicates the parties did not intend to establish

a debtor-creditor relationship at the time the funds were

advanced.

            4.    Whether the Borrower Had a Reasonable Prospect of
                  Repaying the Loan and Whether the Lender Had
                  Sufficient Funds To Advance the Loan

     This factor is best determined by looking to whether there

was “a reasonable expectation of repayment in light of the

economic realities of the situation” at the time the funds were

advanced.    Fisher v. Commissioner, supra at 910.   A reasonable

prospect of repayment at the time the funds were advanced
                                  - 61 -

indicates the existence of a bona fide loan.        Welch v.

Commissioner, supra at 1231.     A bona fide loan is not indicated

when a taxpayer is financially unable to repay advanced funds at

the time they are given.     Estate of Taschler v. United States, 440

F.2d 72, 76 (3d Cir. 1971); Commissioner v. Makransky, 321 F.2d

598, 600 (3d Cir. 1963), affg. 36 T.C. 446 (1961).

     During 1998, 1999, 2000, 2001, and 2002, petitioner, directly

or indirectly through SSI, was advanced $6,194,036 for the

purchase, development, and operation of the Rivercliff property

and for family support obligations while allegedly earning only

$58,736, $76,560, $84,000, $67,850, and $75,000 in 1998, 1999,

2000, 2001, and 2002, respectively.        Petitioner did not produce

any documentation indicating he had other assets, other sources of

income, or any prospective means of repaying the large sums of

money he was advanced.     See Commissioner v. Makransky, supra at

600-601.

     Therefore, it was unreasonable to expect at the time the

funds were advanced that he could repay them.       This factor

indicates the parties did not intend to establish a

debtor-creditor relationship at the time the funds were advanced.

           5.     Whether Interest Was Charged

     The payment of interest indicates the existence of a bona

fide loan.      Welch v. Commissioner, supra at 1231; Teymourian v.

Commissioner, supra; Morrison v. Commissioner, T.C. Memo. 2005-53.
                                - 62 -

The record is devoid of any evidence that interest was paid on any

of the advanced funds at any time, including when petitioner

transferred the Rivercliff property to RFI.

     This factor indicates the parties did not intend to establish

a debtor-creditor relationship at the time the funds were

advanced.    See Calumet Indus, Inc. v. Commissioner, 95 T.C. 257,

287 (1990).

            6.   Whether Repayments Were Made

     Repayment is an indication that an advance was intended as a

loan.   Welch v. Commissioner, supra at 1231; Pierce v.

Commissioner, 61 T.C. 424, 431 (1974); Haber v. Commissioner, 52

T.C. 255, 266 (1969), affd. 422 F.2d 198 (5th Cir. 1970).

Repayments must be bona fide.    Crowley v. Commissioner, 962 F.2d

1077, 1083 (1st Cir. 1992), affg. T.C. Memo. 1990-636.

     Petitioner contends that the transfer of the Rivercliff

property to RFI constituted repayment of his outstanding loans.

However, petitioner testified that he did not intend to repay the

funds wire transferred to SSI or him until the character of the

advances could be determined.   He also did not have a present or

prospective means of repaying the advanced funds.   The transfer of

the Rivercliff property to RFI after the notices of deficiency

were issued was directed to an effort to give the funds that had

been advanced a character which they did not have when they were

advanced.    See Estate of Taschler v. United States, supra at 76.
                                - 63 -

Therefore, petitioner’s transfer of the Rivercliff property to RFI

in June 30, 2005, was not a bona fide repayment.   See Commissioner

v. Makransky, supra at 600-601.

     This factor indicates the parties did not intend to establish

a debtor-creditor relationship at the time the funds were

advanced.

            7.   Whether the Parties Conducted Themselves As If the
                 Transaction Were a Loan

     The conduct of the parties may indicate the existence of a

loan.    Baird v. Commissioner, 25 T.C. 387, 395 (1955); Teymourian

v. Commissioner, T.C. Memo. 2005-232; Morrison v. Commissioner,

supra.

     Petitioner produced no evidence showing TPPL and petitioner

conducted themselves in a manner indicating that TPPL’s transfer

of $249,143 to SSI in 1998 was a loan.   Petitioner also failed to

produce evidence showing NCPL and petitioner conducted themselves

in a manner indicating the total of $92,250 NCPL transferred to

petitioner for the Rivercliff property’s farm operating expenses

in 1998, 2001, and 2002 was a loan.

     Although petitioner executed a loan agreement, a promissory

note, and a trust deed indicating the funds transferred to SSI for

the development of the Rivercliff property in 1999, 2000, and 2001

were a loan, neither party abided by the terms of the loan

agreement, the promissory note, or the trust deed.
                                  - 64 -

     Petitioner’s statements regarding the character of the

advances were inconsistent.     During respondent’s examination,

petitioner told respondent’s agents he owned only a small

percentage of the Rivercliff property and NCPL’s transfers of

funds to SSI were for NCPL’s ownership interest in the property,

not his.    Petitioner also testified that as of March 2004, he and

NCPL were still negotiating whether to characterize the advanced

funds as NCPL’s ownership interest in the Rivercliff property or

as a loan to petitioner.      Despite all transfers of title to the

Rivercliff property, petitioner has continued to enjoy full use

and benefit of the Rivercliff property including residing in the

new residence.

     This factor indicates the parties did not intend to establish

a debtor-creditor relationship at the time the funds were

advanced.

            8.   Conclusion

     Petitioner failed to meet his burden of proving that the

$5,380,318 transferred to SSI for the development of the

Rivercliff property and the $92,250 NCPL transferred to petitioner

for the Rivercliff farm operating expenses constituted bona fide

loans.   On this record, the Court finds that petitioner failed to

report as income the funds transferred by TPPL to SSI of $249,193

in 1998, the funds transferred by NCPL to SSI of $2,109,464,

$2,746,708, and $274,953 in 1999, 2000, and 2001, respectively,
                               - 65 -

and the funds transferred by NCPL to petitioner to operate the

Rivercliff property’s farm of $36,263, $13,454, and $42,533 in

1998, 2001, and 2002, respectively.

     B.   The Rivercliff Property Purchase Loan

     With respect to the $519,033 NCPL advanced to petitioner for

the purchase of the Rivercliff property in 1998, the record

discloses that:   (1) No promissory note or other instrument was

executed; (2) no collateral was pledged to secure repayment; (3)

there was no fixed schedule for repayment; (4) as determined

above, it was not reasonable to expect at the time the funds were

advanced petitioner could repay them; (5) no interest was charged

or paid; (6) and petitioner did not intend at the time the funds

were advanced to make any payments.

     At trial petitioner testified that because of his long and

close relationship with Mr. Seki, formalities were not required

and the form of repayment was left open until the Rivercliff

property was completely developed.    However, this does not

demonstrate that petitioner and NCPL conducted themselves in a

manner indicating the $519,033 advance was a loan.

     Petitioner has failed to meet his burden of proving that the

$519,033 advanced to him for the purchase of the Rivercliff

property constituted a bona fide loan.    On this record, the Court

finds that petitioner failed to report the $519,033 as income in

1998.
                                 - 66 -

     C.   Loans for Petitioner’s Family Support Obligations

     Petitioner contends that NCPL lent him $12,000, $8,760, and

$181,765 in 2000, 2001, 2002, respectively, to pay his spousal and

child support obligations and the interest owing on the $1,400,000

divorce settlement.

     With respect to this purported loan, the record discloses:

(1) No promissory note or other instrument was executed; (2) no

collateral was pledged to secure repayment; (4) there was no fixed

schedule for repayment; (4) as determined above, it was not

reasonable to expect at the time the funds were advanced

petitioner could repay them; (5) no interest was charged or paid;

and (6) petitioner did not intend at the time the funds were

advanced to make any payments.

     Petitioner testified that his employer paid his family

support obligations because the divorce was a very difficult time

in petitioner’s life.    According to petitioner, his employer

assured him that he could pay the money back at an “appropriate

time in the future”.    Petitioner had previously written in

response to Agents Rans’s inquiries that the family support

obligations were paid by NCPL to purchase Kumiko Talmage’s equity

in the Rivercliff property.

     Petitioner has failed to meet his burden of proving that the

funds advanced for his family support obligations of $12,000,

$8,760, and $181,765 in 2000, 2001, 2002, respectively,
                               - 67 -

constituted bona fide loans.   On this record, the Court finds that

petitioner failed to report these amounts as income in the

respective years.

III. Whether Petitioner Failed To Report Gains From the Sale of
     the Rental Property in Vancouver, Washington, and the
     Vacation Home in Black Butte, Oregon

     A.    Background

     Section 61(a)(3) defines gross income for purposes of

calculating taxable income as all income from whatever source

derived, including gains derived from dealings in property.

Section 1 imposes a tax on individuals for taxable income

received.24

     From the time the Vancouver and Black Butte properties were

purchased in 1990 through the year of sale, 1998, the Talmages

resided in Japan.   At trial, petitioner testified that the loans

used to purchase the Vancouver and Black Butte properties were in

his and Kumiko Talmage’s names and the properties were titled in

both their names.   Kumiko Talmage testified she and petitioner had

equal ownership interests in both properties.   On brief,

petitioner stated both he and Kumiko Talmage signed the closing

documents when each property was sold.   Third-party payor

information reported that petitioner was paid the proceeds from

the sale of each property.   Additionally, the proceeds from the



      24
       Neither party asserted that the Vancouver or the Black
Butte property was community property.
                                 - 68 -

sale of each property were used for the Talmages’ personal

expenses and to develop the Rivercliff property.

     The Court finds respondent established the requisite

evidentiary foundation connecting petitioner and Kumiko Talmage

with the receipt of the proceeds from the sale of both the

Vancouver and Black Butte properties in 1998.   See Edwards v.

Commissioner, 680 F.2d 1268, 1270 (9th Cir. 1982); Weimerskirch v.

Commissioner, 596 F.2d 358, 361-362 (9th Cir. 1979), revg. 67 T.C.

672 (1977); Petzoldt v. Commissioner, 92 T.C. 661, 689 (1989);

McManus v. Commissioner, T.C. Memo. 2006-68.

     B.     Vancouver Property

     Petitioner contends that Kumiko Talmage was the sole owner of

the Vancouver property because he was opposed to purchasing the

property, he was not involved in leasing the property, and he did

not report income earned or claim losses incurred from leasing the

property.    Thus, petitioner asserts he was not required to report

any of the $31,231 gain from the sale of the Vancouver property on

his 1998 return.25

     Petitioner’s own testimony and the record clearly show

petitioner and Kumiko Talmage owned the Vancouver property

jointly, and they recognized $31,231 of gain on its sale.

Petitioner was not a credible witness, and outside of his self-



     25
       Petitioner filed his 1998 return as married filing
separately.
                                   - 69 -

serving testimony he produced no evidence indicating Kumiko

Talmage was the sole owner.    The fact that petitioner failed to

report the income earned or claim losses incurred from leasing the

property does not prove lack of ownership.

     For the foregoing reasons, the Court finds that petitioner

owned a 50-percent interest in the Vancouver property.

Accordingly, petitioner was required to report $15,616 of long-

term capital gain upon the sale of the property in 1998.     Blair v.

Commissioner, 300 U.S. 5, 12-14 (1937) (Federal income tax

liability follows ownership); Salvatore v. Commissioner, T.C.

Memo. 1970-30, affd. 434 F.2d 600 (2d Cir. 1970).

     C.     Black Butte Property

     Petitioner also contends he was required to report only

$60,303 of the $120,606 gain from the sale of the Black Butte

property in 1998 because he owned only 50 percent of the property.

     As with the Vancouver property, the Court finds that

petitioner owned a 50-percent interest in the Black Butte

property.    Therefore, he recognized $60,303 upon the sale of the

property in 1998.
                                 - 70 -

IV.   Whether Petitioner Is Entitled to the Full Amount of the
      Foreign Earned Income Exclusion for 1999

      A.     The Period in Which Petitioner Was a Qualified
             Individual

      Petitioner contends he is entitled to the full amount of the

foreign earned income exclusion pursuant to section 911(a) for

1999.

      Section 911(a) provides, in part, that a “qualified

individual” may elect to exclude from gross income his or her

“foreign earned income”.     Section 911(b)(1)(A) defines the term

“foreign earned income” as amounts received by an individual from

sources within a foreign country which constitute earned income

attributable to services performed by such individual during the

period described in subparagraph (A) or (B) of subsection (d)(1).

See Harrington v. Commissioner, 93 T.C. 297, 303-304 (1989).

      Section 911(d)(1) establishes requirements a taxpayer must

meet in order to be considered a qualified individual for purposes

of section 911(a).26    First, the taxpayer’s “tax home” must have


        26
       Sec. 911(d)(1) defines the term “qualified individual” as
follows:


             (1) * * * The term “qualified individual” means an
        individual whose tax home is in a foreign country and
        who is--
                  (A) a citizen of the United States and
             establishes to the satisfaction of the Secretary
             that he has been a bona fide resident of a foreign
             country or countries for an uninterrupted period
             which includes an entire taxable year, or
                                                       (continued...)
                                   - 71 -

been in a foreign country during the year at issue.      Sec.

911(d)(1).       Second, the taxpayer must have either been a bona fide

resident of a foreign country for an uninterrupted period which

includes an entire taxable year (the “bona fide residence” test)

or the taxpayer must have been physically present in a foreign

country for 330 days during a consecutive 12-month period (the

“physical presence” test).27      Sec. 911(d)(1)(A) and (B); sec.

1.911-2(c) and (d), Income Tax Regs.

     With respect to the first requirement, section 911(d)(3)

provides that a taxpayer’s “tax home” is his home for purposes of

section 162(a)(2) (relating to traveling expenses while away from

home).       Generally, a taxpayer’s “tax home” for purposes of section

162(a)(2) is the taxpayer’s principal place of business.

Harrington v. Commissioner, supra at 307; Mitchell v.

Commissioner, 74 T.C. 578, 581 (1980); sec. 1.911-2(b), Income Tax

Regs.

     The general rule of section 911(d)(1) is subject to an

exception under section 911(d)(3) which provides that “An



     26
         (...continued)

                    (B) a citizen or resident of the United
               States and who, during any period of 12
               consecutive months, is present in a foreign
               country or countries during at least 330 full days
               in such period.
        27
       Neither party argued the physical presence test applied
to this case.
                               - 72 -

individual shall not be treated as having a tax home in a foreign

country for any period for which his abode is within the United

States.”

     With respect to the term “abode”, section 1.911-2(b), Income

Tax Regs., provides that

     Temporary presence of the individual in the United
     States does not necessarily mean that the individual’s
     abode is in the United States during that time.
     Maintenance of a dwelling in the United States by an
     individual, whether or not that dwelling is used by the
     individual’s spouse and dependents, does not necessarily
     mean that the individual’s abode is in the United
     States.

The Court has held:

     While an exact definition of “abode” depends upon the
     context in which the word is used, it clearly does not
     mean one’s principal place of business. Thus, “abode”
     has a domestic rather than vocational meaning, and
     stands in contrast to “tax home” as defined for purposes
     of section 162(a)(2).

Bujol v. Commissioner, T.C. Memo. 1987-230, affd. without

published opinion 842 F.2d 328 (5th Cir. 1988).

     Respondent concedes that petitioner was entitled to the

foreign earned income exclusion under section 911(a) from January

1 through April 30, 1999.   Respondent, however, contends that

petitioner left Japan and took up residence at the Rivercliff

property on May 1, 1999, and lived there throughout the remainder

of 1999.   Respondent asserts that as of May 1, 1999, petitioner’s

abode was within the United States and as of that date he was no

longer a qualified individual under section 911(d)(1).   Therefore,
                               - 73 -

respondent argues petitioner was not entitled to the foreign

earned income exclusion under section 911(a) from May 1 through

December 31, 1999.

     Petitioner contends that he was only temporarily in the

United States in 1999 and merely provided maintenance for his

family’s dwelling on the Rivercliff property.   As a result, he

argues that pursuant to section 911(d)(3) and section 1.911-2(b),

Income Tax Regs., his tax home remained in Japan throughout 1999.

     On at least three occasions, petitioner informed Multnomah

County by correspondence that he and his family intended to begin

using the Rivercliff property as their permanent residence in the

spring of 1999.   On June 29, 1999, petitioner mailed a letter to

Multnomah County stating that he and his family had not attended a

May 21, 1999, appeal hearing because they had been in the process

of moving from their former Japanese residence to their new

permanent residence at the Rivercliff property.    The June 29,

1999, letter also stated petitioner and his family were presently

residing on the Rivercliff property permanently.

     Kumiko Talmage testified that she, petitioner, and Lillian

Talmage moved to the Rivercliff property on June 9, 1999, with the

intention of living there permanently, while petitioner

occasionally returned to Japan to conduct business.

      Petitioner testified that only Kumiko and Lillian Talmage

intended to move to the Rivercliff property in the spring of 1999.
                                - 74 -

He claimed that after he helped them move to the Rivercliff

property on June 9, 1999, he immediately returned to Japan to

reside at an “extended-stay facility” to complete several pending

business matters.   Outside of occasionally traveling to the United

States to visit his family, he claimed he did not depart from

Japan to reside permanently on the Rivercliff property until

January 2000.

     In support of his testimony, petitioner produced copies of

three checks.   Each check was from his US Bank checking account

and listed his address as the Rivercliff property address.    The

first check, dated November 4, 1999, was made out to Delta

Airlines for $704.53.   Although petitioner asserted it was his

payment for a flight from Japan to Oregon to visit his family, the

face of the check does not indicate a point of departure or a

destination, and petitioner’s reconstructed records state that the

$704.53 paid to Delta Airlines was for a “Farm Travel Expense”.

     The second check, dated December 11, 1999, was made out to

“SHADOW” for $1,000 for “TALMAGE TRANSPORT”.    Petitioner testified

that it was payment for the transportation of his automobile from

Japan to Oregon.    However, his reconstructed records state that

the $1,000 was an “Expense for NCPL Animals”.   The third check,

dated December 27, 1999, was made out to the Oregon Department of

Motor Vehicles for $97.   Petitioner testified that it was payment

to register his automobile.   Petitioner’s reconstructed records
                               - 75 -

state that the $97 was a “Farm Truck Expense”.     The Court finds

that petitioner’s testimony was not credible.

     The evidence indicates petitioner’s tax home was in Japan

for approximately 21 years ending on June 8, 1999.     Although the

period of bona fide residence must include an entire taxable year,

the entire uninterrupted period of residence may include

fractional parts of a taxable year.     See sec. 1.911-3(d)(3),

Income Tax Regs.   For the foregoing reasons, the Court finds that

petitioner was a qualified individual under section 911(d)(1) from

January 1 through June 8, 1999.   Therefore, petitioner was

entitled to the foreign earned income exclusion under section

911(a) from January 1 through June 8, 1999.     See sec. 1.911-

3(d)(2), Income Tax Regs.

     The Court also finds that petitioner established his abode in

the United States as of June 9, 1999.     Accordingly, he was not

entitled to the foreign earned income exclusion under section

911(a) from June 9 through December 31, 1999.28

     B.   Maximum Exclusion Amount

     Generally, the allowable maximum exclusion from foreign

earned income for a tax year under section 911(a)(1) would be the

lesser of the qualified individual’s foreign income for the


     28
       Because the Court found that petitioner failed to meet
the tax home requirement under sec. 911(d)(1), the Court does not
need to determine whether petitioner met the bona fide residence
test or the physical presence test under sec. 911(d)(1)(A) or
(B).
                                    - 76 -

taxable year in excess of amounts that the individual elected to

exclude from gross income under section 911(a)(2) or the annual

exclusion amount provided in section 911(b)(2)(D).29         Sec.

1.911-3(d)(2), Income Tax Regs.        The maximum exclusion from

foreign earned income in 1999 was $74,000.          Sec. 911(b)(2)(D)(i).

     If a taxpayer qualifies for the section 911(a)(1) exclusion

for only a portion of the year, the annual exclusion amount under

section 911(b)(2)(D) is prorated, and the maximum exclusion amount

is the annual exclusion amount for the year, multiplied by a

fraction whose numerator is the number of qualifying days in the

taxable year and whose denominator is the number of days in the

year.        Sec. 1.911-3(d)(2), Income Tax Regs.   A qualifying day is a

day on which the taxpayer was a qualified individual under section

911(d)(1).        Sec. 1.911-3(d)(3), Income Tax Regs.

     Petitioner had 159 qualifying days in 1999.         Thus

petitioner’s maximum exclusion from foreign earned income for 1999

is $32,236 (159 (qualifying days) divided by 365 (days in taxable

year) multiplied by $74,000 (annual exclusion amount for 1999)).




        29
             Petitioner did not make a sec. 911(a)(2) election.
                                     - 77 -

V.   Additions to Tax and Penalties

     A.    Whether Petitioner Is Liable for Fraud Penalties Under
           Section 6663(a)

           1.      Background

     Section 6663(a) imposes a penalty of “an amount equal to 75

percent of the portion of the underpayment which is attributable

to fraud.”      Section 6663(b) specifies that if any portion of the

underpayment is attributable to fraud, the entire underpayment

shall be treated as attributable thereto except to the extent the

taxpayer establishes, by a preponderance of the evidence, that

some part is not due to fraud.        Where taxpayers file a joint

return, section 6663 does not apply to a spouse unless some part

of the underpayment is due to the fraud of the spouse.        Sec.

6663(c).

     When asserting liability under the fraud penalty, the

Commissioner has the burden of proving, by clear and convincing

evidence, that (1) the taxpayer underpaid his income taxes for

each year, and (2) that some portion of the underpayment is due to

fraud.    Sec. 7454(a); Rule 142(b); King’s Court Mobile Home Park,

Inc. v. Commissioner, 98 T.C. 511, 515-516 (1992); Truesdell v.

Commissioner, 89 T.C. 1280, 1301 (1987).

     The existence of fraud is a question of fact to be resolved

from the entire record.         DiLeo v. Commissioner, 96 T.C. 858, 874

(1991), affd. 959 F.2d 16 (2d Cir. 1992); Gajewski v.

Commissioner, 67 T.C. 181, 199 (1976), affd. without published
                                 - 78 -

opinion 578 F.2d 1383 (8th Cir. 1978).       Because fraud can rarely

be established by direct proof of the taxpayer’s intention, fraud

may be established by circumstantial evidence and reasonable

inferences drawn from the record.     DiLeo v. Commissioner, supra at

874-875; Rowlee v. Commissioner, 80 T.C. 1111, 1123 (1983).

     In Bradford v. Commissioner, 796 F.2d 303, 307 (9th Cir.

1986), affg. T.C. Memo. 1984-601, the U.S. Court of Appeals for

the Ninth Circuit set forth a nonexclusive list of circumstantial

factors that may give rise to a finding of fraudulent intent.

Such “badges of fraud” include:     (1) Understatement of income; (2)

inadequate records; (3) failure to file tax returns; (4)

implausible or inconsistent explanations of behavior; (5)

concealment of assets; and (6) failure to cooperate with tax

authorities.     Although no single badge is necessarily sufficient

to establish fraud, the existence of several badges of fraud

constitutes persuasive circumstantial evidence of fraud.       Petzoldt

v. Commissioner, 92 T.C. at 700.

            2.    Understatement of Income

     Respondent’s burden of proving an underpayment of tax

attributable to unreported income may be satisfied in either of

two ways:    (1) By proving a likely source of the unreported

income, or (2) by disproving any alleged nontaxable source.        Dileo

v. Commissioner, supra at 873-874.     Respondent has proved, by

clear and convincing evidence, that petitioner received unreported
                                - 79 -

income from the sale of the Vancouver and Black Butte properties

in 1998 and that the overseas wire transfers in 1998, 1999, 2000,

2001, and 2002 were not loans as asserted by petitioner.

     Petitioner consistently failed to report substantial amounts

of income in each year at issue.   This failure is strong evidence

of fraudulent intent.   See Kurnick v. Commissioner, 232 F.2d 678

(6th Cir. 1956) (consistent, substantial understatement of income

for several years is highly persuasive evidence of intent to

defraud the government), affg. T.C. Memo. 1955-31; Conforte v.

Commissioner, 74 T.C. 1160, 1201 (1980), affd. in part and revd.

on another issue 692 F.2d 587 (9th Cir. 1982); Otsuki v.

Commissioner, 53 T.C. 96, 107-108 (1969); see also Baumgardner v.

Commissioner, 251 F.2d 311, 316 (9th Cir. 1957), affg. T.C. Memo.

1956-112.

            3.   Inadequate Books and Records

     Petitioner made available to respondent his records from

three checking accounts in the United States and his Federal

income tax returns for the years at issue.      In preparation for the

trial, petitioner hired an accountant, Judy Killian (Ms. Killian),

to reconstruct his financial transactions from 1998 through 2005.

At trial, petitioner produced Ms. Killian’s report of his

reconstructed records and asserted that the report was evidence

demonstrating petitioner properly maintained books and records and

cooperated with respondent’s investigation.     To the contrary,
                              - 80 -

petitioner’s records had to be reconstructed because he failed to

maintain proper books and records in the first place.

          4.   Failure To File Income Tax Returns

     Petitioner filed untimely Federal income tax returns for the

years at issue, all of which substantially underreported income.

          5.   Implausible or Inconsistent Explanations of
               Behavior

               a.   Rivercliff Property Ownership and Advanced
                    Funds

     The record shows that the Talmages purchased the Rivercliff

property on November 17, 1997, and it was titled in both their

names until Kumiko Talmage conveyed her 50-percent interest to

petitioner as part of the divorce settlement on August 20, 2001.

Throughout this period, petitioner represented to Kumiko Talmage,

Multnomah County, the Multnomah County Circuit Court, Mr.

Schommer, Mr. Larson (petitioner’s divorce attorney), Diane E.

Rulien (Kumiko Talmage’s divorce attorney), Mr. Seymour (NCPL’s

attorney) and Steven L. Pfeiffer (petitioner’s property law

attorney) that the Talmages owned the Rivercliff property jointly.

The record also shows that after Kumiko Talmage conveyed her 50-

percent interest to him, petitioner was the sole owner of the

property until he transferred it to RFI on June 30, 2005.

Petitioner also occupied the property as his primary residence

from June 9, 1999, through the date of trial.
                               - 81 -

     In the March 17, 2004, meeting with Agents Rans and Beach,

petitioner stated that he owned only the original dwelling on the

Rivercliff property and the barn.   On September 9, 2004,

petitioner signed a memorandum of confirmation and agreement with

NCPL which stated that the original intention was to own the

Rivercliff property as a 50-50 joint venture between petitioner

and NCPL.   After the notices of deficiency were issued,

petitioner’s story further evolved.     He claimed he owned the

Rivercliff property and that the funds transferred to purchase,

develop, and operate the property were nontaxable loans.

     Petitioner and Kumiko Talmage designed the new home on the

Rivercliff property, petitioner developed the property, and

petitioner occupied the property as his primary residence from

June 9, 1999, through the date of trial.     Even after the

Rivercliff property was transferred, RFI purportedly hired

petitioners as caretakers for the property, allowing them to

reside in the Rivercliff property’s new multimillion-dollar home

and enjoy full use of the property.     Despite all his machinations,

from the time petitioner purchased the Rivercliff property, he had

full use, control, and benefit of the property.

     Petitioner’s explanations to respondent and his testimony at

trial with respect to the ownership of the Rivercliff property

were inconsistent and implausible and were created for the sole

purpose of misleading respondent, and the Court finds that
                               - 82 -

petitioner misrepresented his ownership in the Rivercliff property

for the purpose of evading income tax.

               b.   Funds Advanced for Petitioner’s Family
                    Support Obligations

     Petitioner represented in his letter to respondent dated

April 8, 2004, that his obligations to Kumiko Talmage pursuant to

the stipulated judgment in the divorce case were no longer his

personal obligations because they had been assumed by NCPL to buy

Kumiko Talmage’s equity position in the Rivercliff property.

However, Kumiko Talmage transferred her ownership interest to

petitioner, not NCPL, in accordance with the stipulated judgment,

and petitioner held sole legal title to the Rivercliff property

from August 20, 2001, until June 30, 2005, after the notices of

deficiency were filed.   Petitioner subsequently claimed that the

funds advanced by NCPL to pay his family support obligations were

loans which were paid in full when he transferred the Rivercliff

property to RFI.

     Petitioner’s positions regarding his mandatory support and

interest payments were inconsistent and implausible, and we find

that he intended to conceal from respondent the true nature of

these payments for the purpose of evading income tax.

          6.   Concealment

     Fraud is shown by proof that the taxpayer intended to evade

taxes known to be owing by conduct intended to conceal, mislead,
                                 - 83 -

or otherwise prevent the collection of taxes.    Rowlee v.

Commissioner, 80 T.C. at 1123.

     Respondent’s initial contact came from Japanese tax

authorities.    When respondent’s agents made direct inquiries to

petitioner about the source of the funds advanced and the identity

of the owners of NCPL and TPPL, petitioner refused to disclose

information based upon the confidentiality agreement he signed

with NCPL.   The confidentiality agreement provided that petitioner

had to keep all company “Information” confidential.   However, when

the party requesting information and documentation was a

governmental authority, the confidentiality agreement did not

prohibit petitioner from complying with its requests.   It only

required petitioner to give NCPL prompt notice and to cooperate

with it to obtain a protective order or other reliable assurance

that any company information unrelated to petitioner would be kept

confidential.   Even when respondent provided petitioner the

opportunity to verify that he did not have bank accounts or

signatory authority over bank accounts in Hong Kong, he refused to

sign the consent directives, claiming he so refused under

instructions from his employer pursuant to the confidentiality

agreement.   There is no corroborating documentation from NCPL to

that effect.
                               - 84 -

     On this record, petitioner’s conduct evidences an intent to

conceal income and assets to mislead respondent for the purpose of

evading tax.

          7.   Failure To Cooperate With Tax Authorities

     Petitioner was not cooperative or forthright with respondent.

Throughout the examination and pretrial stages of this case

petitioner resisted disclosure of documentation and information

requested by respondent directly related to his employment and his

relation to his purported employer.     When responding to questions,

he gave contradictory and misleading answers.    On this record,

petitioner failed to cooperate with the tax authorities.

          8.   Underpayment Attributable to Fraud

     After consideration of all the relevant factors, the Court

concludes respondent proved by clear and convincing evidence that

petitioner’s underpayments of tax with respect to the funds wire

transferred to him in the years at issue were attributable to

fraud under section 6663(a).   Therefore, the underpayment of tax

attributable to the gains petitioner recognized from the sales of

the Vancouver and Black Butte properties are also attributable to

fraud unless he can establish by a preponderance of the evidence
                               - 85 -

that a portion of the underpayment was not fraudulent.30    See sec.

6663(b).

     With respect to the Vancouver property, petitioner testified

that he was opposed to purchasing the property, he was not

involved in leasing the property, and he did not report income

earned or claim losses incurred from leasing the property.    He

considered Kumiko Talmage to be the sole owner of the Vancouver

property.   Nevertheless, the evidence clearly establishes that he

owned a 50-percent interest in the Vancouver property and did not

report his portion of the gain when it was sold.   Petitioner has

failed to prove, by a preponderance of evidence, that the failure

to report the gain on the Vancouver property was not fraudulent.

     With respect to the Black Butte property, petitioner

testified that he had understood from the tax software program he

was using he was entitled to roll the $60,303 realized from the

sale of the Black Butte property into the Rivercliff property tax

free. Petitioner is a sophisticated taxpayer who has a degree in

business administration and has provided advice on various

financial transactions for over 25 years.   Petitioner’s testimony

is not credible.   Petitioner has failed to prove, by a




     30
       Respondent did not apply the fraud penalty under sec.
6663(a) to the underpayment of tax attributable to respondent’s
finding petitioner was not entitled to the full amount of the
foreign earned income exclusion for 1999 and the Schedule F
losses for 2000, 2001, and 2002, which petitioner conceded.
                               - 86 -

preponderance of evidence, that the failure to report the gain on

the Black Butte property was not fraudulent.

     For the foregoing reasons, the Court finds that petitioner’s

failure to report the $15,616 from the sale of the Vancouver

property and the $60,303 from the sale of the Black Butte property

was due to fraud.

     B.   Section 6662 Accuracy-Related Penalty

     Section 6662(a) imposes a 20-percent accuracy-related penalty

on the portion of any underpayment attributable to negligence or

disregard of rules or regulations.   Sec. 6662(b).   The term

“negligence” includes any failure to make a reasonable attempt to

comply with the provisions of the internal revenue laws or to

exercise ordinary and reasonable care in the preparation of a tax

return.   Sec. 1.6662-3(b)(1), Income Tax Regs.   Respondent bears

the burden of production with respect to any penalty or addition

to tax.   Sec. 7491(c); Higbee v. Commissioner, 116 T.C. 438, 446-

447 (2001).   To meet his burden of production, respondent must

come forward with sufficient evidence indicating that it is

appropriate to impose the penalty.   Higbee v. Commissioner, supra

at 446-447.

     Respondent contends Annette C. Talmage is liable for the

accuracy-related penalty for 2002 under section 6662(a) on the

same underpayment of tax upon which the Court found petitioner

liable for the fraud penalty under section 6663(a).
                                 - 87 -

     Section 6662(a) does not apply to any portion of an

underpayment subject to the fraud penalty under section 6663.

Sec. 6662(b).   When a joint return is filed and one spouse is

found liable for the fraud penalty, imposing the accuracy-related

penalty on the other spouse with respect to the same underpayment

would result in impermissible stacking.    Said v. Commissioner,

T.C. Memo. 2003-148; Zaban v. Commissioner, T.C. Memo. 1997-479.

     Petitioners filed a joint return for 2002.    Respondent

imposed the accuracy-related penalty on Annette C. Talmage for the

same underpayment of tax upon which the Court found petitioner

liable for the fraud penalty.    Therefore, the Court finds that

imposing the accuracy-related penalty on her would result in

impermissible stacking.   Accordingly, Annette C. Talmage is not

liable for the section 6662(a) accuracy-related penalty for 2002.

     C.   Section 6651(a)(1) Addition to Tax

     Section 6651(a)(1) imposes an addition to tax for failure to

timely file a return.   The parties stipulated petitioner failed to

timely file income tax returns for 1998 and 1999.    Therefore, the

Court finds respondent met his burden of production.

     Because respondent has met his burden, petitioner bears the

burden of proving his failure to timely file was due to reasonable

cause and not willful neglect.    To show reasonable cause,

petitioner must show he “exercised ordinary business care and

prudence and was nevertheless unable to file the return within the
                                - 88 -

prescribed time”.   Sec. 301.6651-1(c)(1), Proced. & Admin. Regs.

For illness or incapacity to constitute reasonable cause,

petitioner must show he was incapacitated to a degree that he

could not file his returns.    Williams v. Commissioner, 16 T.C.

893, 905-906 (1951); see, e.g., Joseph v. Commissioner, T.C. Memo.

2003-19 (“Illness or incapacity may constitute reasonable cause if

the taxpayer establishes that he was so ill that he was unable to

file”).

      Petitioner contends that emotional distress caused by his

marital discord was reasonable cause for his failure to timely

file.   However, he produced no evidence indicating the stress

caused him to be incapacitated and unable to prepare his returns

on the dates they were due.

      Therefore, the Court finds petitioner did not have reasonable

cause for failing to timely file.   Accordingly, petitioner is

liable for the section 6651(a)(1) addition to tax for 1998 and

1999.

VI.   Statute of Limitations

      Because the Court has found that petitioner fraudulently

underreported his income and underpaid his income tax in 1999 and

2000, the Court finds that respondent is not barred by section

6501(a) from assessing deficiencies with respect to petitioner’s

1999 and 2000 tax years.   See sec. 6501(c).
                                 - 89 -

     The Court, in reaching its holding, has considered all

arguments made and concludes that any arguments not mentioned

above are moot, irrelevant, or without merit.

     To reflect the foregoing,


                                      Decision will be entered

                                 under Rule 155.
