JAMES C. COOPER AND LORELEI M. COOPER, PETITIONERS v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
Docket No. 17284-12
United States Tax Court
September 23, 2014
Mr. Scarazzo concluded that petitioners’ approach would reduce the universe of information on the tapes using criteria set by the parties to minimize review time and expense and ultimately result in a focused set of information germane to the matter. He estimated that 200,000 to 400,000 documents would be subject to review under petitioners’ approach at a cost of $80,000 to $85,000, while 3.5 million to 7 million documents would be subject to review under respondent‘s approach at a cost of $500,000 to $550,000.
Our Rules, including our discovery Rules, are to “be construed to secure the just, speedy, and inexpensive determination of every case.”
Accordingly,
An appropriate order will be issued.
Lawrence T. Ullmann, for petitioners.
Nhi T. Luu and Christian A. Speck, for respondent.
whether royalties petitioner James Cooper received during 2006, 2007, and 2008 qualified for capital gain treatment pursuant to section 1235 ;- whether petitioners may deduct professional fees paid during 2006 that were attributable to expenses charged by Holmes Development for work performed with respect to U.S. Patent # 5,157,489 (489 patent);3
- whether petitioners’ advance of $2,046,5704 to Pixel Instruments Corp. (Pixel) is deductible as a nonbusiness bad debt for 2008 pursuant to
section 166 ; and - whether petitioners are liable for
section 6662(a) accuracy-related penalties for the years at issue.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found. The stipulations of facts are incorporated herein by this reference. Petitioners resided in Nevada when they petitioned this Court.
I. Patent Royalties
Mr. Cooper is an engineer and inventor. He has an undergraduate degree in electrical engineering from Oklahoma State University and is the named inventor on more than 75 patents in the United States.5 His patents are primarily for products and components used in the transmission of audio and video signals. Petitioner Lorelei Cooper has an undergraduate degree in communications from Kent State University. She is not the named inventor on any patents.
In 1988 Mr. Cooper consulted Daniel Leckrone, an attorney specializing in patent law and patent licensing, regarding Mr. Cooper‘s portfolio of intellectual property. These con
A number of disputes arose between Mr. Cooper and Mr. Leckrone under the commercialization agreement. In 1997 Mr. Cooper sent Mr. Leckrone notice that he was terminating the commercialization agreement. Mr. Cooper contended that under the terms of the commercialization agreement the patent rights held by VidPro automatically reverted to him as a result of the termination notice. Mr. Leckrone disagreed. Ultimately, this dispute led to litigation between Mr. Cooper and Mr. Leckrone, VidPro, and an attorney on VidPro‘s board of directors (Cooper-Leckrone litigation).8
Subsequently, petitioners, believing that all rights in VidPro‘s audio and video patents reverted to Mr. Cooper, incorporated Technology Licensing Corp., a California corporation (TLC),9 with Lois Walters and Janet Coulter. Ms. Walters is petitioner Lorelei Cooper‘s sister, and Ms. Coulter is a longtime friend of Ms. Cooper and Ms. Walters. Ms. Coulter and Ms. Walters resided in Ohio from 1997 through
Petitioners incorporated TLC to engage in patent licensing and patent commercialization. They wanted TLC to have the “aura” of a fully operating licensing corporation but also wanted people Mr. Cooper could trust—such as their close friend Ms. Coulter and their relative Ms. Walters—to be the shareholders, officers, and directors of TLC.11
Petitioners engaged Attorney R. Gordon Baker, Jr., to provide advice on forming TLC. Among other things, Mr. Baker advised petitioners on the requirements of
Consistent with Mr. Baker‘s advice, the outstanding stock of TLC at formation was as follows: petitioners as cotrustees of the Cooper Trust owned 240 shares (24%); (2) Lois Walters owned 380 shares (38%); and (3) Janet Coulter owned 380 shares (38%). Ms. Walters and Ms. Coulter each made an initial contribution of $3,800 to TLC in exchange for their shares while petitioners as cotrustees of the Cooper Trust contributed $2,400 for the trust‘s shares. Ms. Walters, Ms. Cooper, and Ms. Coulter were the president and chief financial officer, vice president, and secretary of TLC, respectively.12 Mr. Cooper was the general manager of TLC.
By 1999 TLC had begun experiencing financial difficulty. It could not effectively license its patents because the patents were the subject of the Cooper-Leckrone litigation and potential licensees were wary of TLC‘s authority to license the patents. Furthermore, TLC needed legal representation to pursue patent infringement cases.
In an effort to solve TLC‘s financial difficulties, Mr. Cooper contacted Anthony Brown, who was in the business of helping inventors protect and enforce their patents. Mr. Brown owned IP Innovation, LLC (IP Innovation). Subsequently, TLC, Mr. Cooper, and Pixel entered into an agreement (IP Innovation assignment agreement) with IP Innovation assigning an undivided interest in Patent # 5,424,780 (780 patent) to IP Innovation.13 Then, IP Innovation, Mr. Cooper, Pixel, and TLC engaged the patent law firm of Niro, Scavone, Haller & Niro (Niro firm) to represent their interests with respect to the 780 patent. Mr. Cooper agreed to provide technical assistance to the Niro firm as necessary to assist the firm in interpreting the patents, technology, and devices that would be the subject of the licensing and infringement matters the firm was pursuing. Mr. Cooper was not compensated for providing technical assistance to the Niro firm.
On February 28, 2003, TLC and its shareholders adopted a stock restriction agreement providing in relevant part that
In 2004 Anthony Brown formed New Medium, LLC (New Medium), and AV Technologies, LLC (AV Technologies), to pursue patent commercialization. TLC, Pixel, and Mr. Cooper subsequently entered into licensing agreements for certain patents with both New Medium and AV Technologies (collectively, New Medium and AV Technologies agreements). In or about 2004 Acacia Technologies Group (Acacia) purchased IP Innovation and IP Innovation became a subsidiary of Acacia. On March 23, 2005, the parties to the New Medium and AV Technologies agreements and the IP Innovation assignment agreement clarified by agreement (letter agreement) that all material decisions (i.e., licensing, litigation, and prosecution) with respect to the New Medium and AV Technologies agreements and the IP Innovation assignment agreement were to be made according to a majority vote of Mr. Cooper, Acacia,15 and Anthony Brown. Under the letter agreement TLC did not have a vote with respect to the material decisions under either the IP Innovation assignment agree-
Among the patents transferred by Mr. Cooper to TLC under the terms of the TLC agreements were three patents known as the “Lowe patents“. The Lowe patents included the 489 patent. On January 18, 2006, TLC transferred the Lowe patents back to Mr. Cooper. He did not pay any money or transfer any other consideration to TLC for the return of the Lowe patents. The agreement transferring the Lowe patents from TLC to Mr. Cooper simply states that the parties completed the transfer because TLC had not licensed the Lowe patents and TLC and Mr. Cooper desired to return the Lowe patents to Mr. Cooper.
On January 23, 2006, Mr. Cooper transferred the Lowe patents to Watonga Technology, Inc. (Watonga). The shareholders of Watonga were as follows: the Cooper Trust (1%); petitioners’ son (11.5%); petitioners’ daughter (11.5%); Ms. Coulter and Ms. Walters (76% combined). Ms. Coulter was the president of Watonga.17 Under the agreement transferring the Lowe patents to Watonga, Mr. Cooper received 55% of all net revenue (as defined in the agreement), and
The amount of the royalties paid each year to Mr. Cooper was determined under the TLC agreements by accountants hired by TLC. Neither Ms. Walters nor Ms. Coulter, who were the majority shareholders as well as officers and directors, reviewed and verified the amount of royalties paid to Mr. Cooper each year.20 Similarly, neither Ms. Walters nor Ms. Coulter negotiated the terms of TLC‘s agreements to license the subject patents to other companies. Instead, Ms. Walters and Ms. Coulter relied on TLC‘s attorneys and the technical expertise of Mr. Cooper with regard to TLC‘s licensing activities. During the years at issue, Ms. Walters and Ms. Coulter‘s duties as directors and officers consisted largely of signing checks and transferring funds as directed by TLC‘s accountants and signing agreements as directed by TLC‘s attorneys. The only compensation Ms. Walters and Ms. Coulter received from TLC was director‘s fees paid during some years and long-term care insurance policies purchased by TLC in 2003. TLC had no employees and paid no compensation to any party.
We infer from the record and find that substantially all of TLC‘s decisions regarding licensing, patent infringement, and patent transfers were made either by Mr. Cooper or at his
II. Professional Fees
During late 2005 and 2006 Mr. Cooper engaged Mike Holmes of Holmes Development to complete reverse engineering and related services with respect to the 489 patent (reverse engineering services). The reverse engineering services included disassembling televisions and DVD recorders to determine how the products were designed and manufactured and whether any of the products were infringing on Mr. Cooper‘s patents.
The invoices for the reverse engineering services were addressed to Mr. Cooper individually and not to TLC or Watonga.21 Yet TLC and Watonga were the principal owners of the 489 patent during the period when Mr. Holmes completed the reverse engineering services. Mr. Cooper owned the 489 patent for only a few days in 2006. He paid Holmes Development $108,519 in 2006 for the reverse engineering services.
III. Pixel Instruments / Bad Debt
Petitioners incorporated Pixel in 1983 for the purpose of designing and manufacturing audio and video signal processing products. Specifically, Pixel designed products to measure and correct errors in the synchronization of sound and video images. Mr. Cooper was the president of Pixel at all relevant times. Ms. Cooper held various positions with Pixel from 1983 to 2004, including the position of vice president.
In September 1995 Pixel executed a working capital promissory note (promissory note) wherein it promised to pay to the Cooper Trust all sums advanced to Pixel by the Cooper
Until some point in 2006 petitioners wholly owned Pixel. In 2006 petitioners transferred 76% of their shares in Pixel to Mirko Vojnovic and Christopher Smith. Mr. Smith was a longtime consultant to Pixel. He and Mr. Vojnovic owned 22% and 54% of Pixel‘s shares, respectively, during the years at issue.22 They paid nothing or a de minimis amount for their shares. However, in conjunction with the Cooper Trust‘s transfer of shares to Mr. Smith and Mr. Vojnovic, Pixel transferred certain intellectual properties—including its rights to royalties from the patents Pixel previously licensed to TLC—to Mr. Cooper.
When televisions changed from standard definition to high definition in the mid-to-late 2000s, many of Pixel‘s products became obsolete. In an effort to better compete in the marketplace, Pixel began developing a product known as Liptracker to correct lip synchronization errors in high definition televisions. Between 2005 and 2008 petitioners as cotrustees of the Cooper Trust advanced funds to Pixel under the terms of the promissory note. These funds were used in part to fund the Liptracker program.
Pixel contracted with an Indian company to complete the software development necessary for Liptracker. Pixel‘s goal was to have a working and salable Liptracker product for presentation at the National Association of Broadcasters convention in April 2008. Unfortunately, the Indian company could not fulfill its promise to develop the Liptracker software, and Pixel was unable to proceed with the development on its own. Pixel met with representatives from the Indian company in July 2008 who confirmed the company was abandoning its development of the Liptracker software.
In 2008 Pixel faced financial difficulty. It had no new products in development—aside from the stalled Liptracker product—and few older products that were still marketable. Its gross receipts were in excess of $525,000 in both 2005 and 2006 but decreased significantly in 2007 and 2008.
Mr. Cooper continued to advance funds to Pixel under the terms of the promissory note throughout 2008. On December 31, 2008, the outstanding balance on the promissory note was $2,046,901. Mr. Cooper concluded at that time that Pixel could not pay the outstanding balance on the Pixel note, and petitioners treated the balance as a nonbusiness bad debt on petitioners’ 2008 Federal income tax return. Petitioners did not initiate any type of litigation25 to recover the amounts they lent Pixel under the terms of the promissory note and it is unclear from the record what demands, if any, they made for payment of the outstanding balance.
IV. Petitioners’ Tax Reporting and Notice of Deficiency
Petitioners jointly filed Forms 1040, U.S. Individual Income Tax Return, for each of the years at issue. They reported the royalty payments Mr. Cooper received from TLC as capital gain on Schedules D, Capital Gains and Losses, attached to their Forms 1040. The amounts of royalty payments petitioners reported for 2006, 2007, and 2008 were $3,248,886, $1,933,010, and $1,597,450, respectively. Petitioners also reported income and expenses from Mr. Cooper‘s patent licensing business on Schedules C attached to their
On April 4, 2012, respondent issued the notice of deficiency to petitioners. Respondent determined that (1) the royalties Mr. Cooper received from TLC did not qualify for capital gain treatment under
OPINION
I. Burden of Proof
Ordinarily, the Commissioner‘s determinations in a notice of deficiency are presumed correct, and the taxpayer bears the burden of proving that the determinations are erroneous.
Petitioners do not assert nor have they proven that they are entitled to a shift in the burden of proof under
A. Whether a Holder‘s Control Over an Unrelated Corporate Transferee Defeats Capital Gain Treatment Under Section 1235
Respondent does not dispute that (1) the transfer of the patents to TLC under the TLC agreements was other than by gift, inheritance, or devise; (2) Mr. Cooper qualified as a holder of the subject patents; and (3) petitioners owned less than 25% of TLC for purposes of
Neither the Code nor applicable regulations specifically address whether section 1235 applies to transfers to a corporation that is not related to the holder but is indirectly controlled by the holder. Whether a holder‘s control over a corporate transferee that is unrelated (within the meaning of
The Court of Claims in Charlson examined the legislative history of section 1235 and stated that “it is * * * clear that retention of control by a holder over an unrelated corporation can defeat capital gains treatment, if the retention prevents the transfer of ‘all substantial rights.‘” Id. The court supported its conclusion by reasoning that the holder‘s control over the unrelated corporation “places him in essentially the same position as if all substantial rights had not been transferred.” Id. The court found further support for its reasoning in the legislative history of section 1235, noting that a court should closely examine all of the facts and circumstances of transactions under section 1235 and not rely solely on the terms of the transfer agreement to determine whether the owner transferred substantially all rights in the patent to the transferee. See id. (citing S. Rept. No. 83-1622, at 439-440 (1954), 1954 U.S.C.C.A.N. 4621, 5083).
We agree that retention of control places the holder in essentially the same position as if the patent had not been transferred, thereby precluding the application of section 1235. See id. We further agree that Congress intended for a “transferor‘s acts to speak louder than his words in establishing whether a sale of a patent has occurred“. Id. Accordingly, we hold that retention of control by a holder over an unrelated corporation can defeat capital gain treatment under section 1235 because the retention prevents the transfer of “all substantial rights” in the patent.
B. Whether Mr. Cooper Retained Control Over TLC and Therefore Did Not Transfer All Substantial Rights in the Subject Patents to TLC
Petitioners rely on the facts regarding control in Lee v. United States, 302 F. Supp. 945 (E.D. Wis. 1969), and Charlson to support their contention that the directors, offi-
In Lee, the taxpayer transferred patents to Lee Custom Engineering, Inc. (Lee Engineering), a closely held corporation. The three shareholders of Lee Engineering were unrelated but were all friends. The taxpayer owned 24% of the outstanding stock of Lee Engineering. The Government argued that the taxpayer had not transferred all substantial rights in his patents because he controlled Lee Engineering—the exclusive licensee of the patents. Therefore, the Government argued that the taxpayer did not effectively transfer his patents under section 1235.34 The District Court rejected the Government‘s contentions, stating among other things, that there was “no evidence presented which suggested * * * [the taxpayer] was * * * able to force the other stockholders or directors to do his bidding.” Lee, 302 F. Supp. at 950.
In Charlson, the taxpayer transferred an exclusive license to Germane Corp. (Germane) to use, manufacture, and sell items incorporating his patents in exchange for 80% of the royalties that Germane received from licensing the patents to others. Germane was formed for the specific purpose of purchasing and licensing the taxpayer‘s patents, and the shareholders and directors of Germane were all trusted business associates, friends, and employees of the taxpayer.
The taxpayer treated the royalties he received from Germane as capital gain under section 1235. The Government argued that the taxpayer had not transferred all substantial
The court found that although the relationships among the taxpayer, Germane, and the shareholders made more probable the existence of prohibited retained control, the evidence did not establish that the taxpayer was able to exercise such control over Germane. Charlson 525 F.2d at 1055. Instead, the court found that Germane exercised its rights in the patents according to its own discretion even though it frequently sought, received, and followed the taxpayer‘s advice. Id. at 1056.
The court noted, among other things, that the shareholders in Germane all had skills valuable to a small patent licensing company. Id. at 1049. These skills included legal, engineering, design, and business expertise. Id. Further, the court found that although the taxpayer was present in many of Germane‘s licensing negotiations, this was mutually beneficial to both parties since it would potentially lead to higher royalties. Moreover, there was no evidence that the taxpayer—and not Germane—decided the terms of the licensing agreements. Finally, although the taxpayer participated as a joint plaintiff with Germane in patent infringement actions, there was no evidence that the taxpayer controlled or directed the details of the litigation. Id. at 1055. In short, the court rejected the Government‘s position that the taxpayer controlled the operation of Germane. As a result, the court held that the taxpayer had transferred all substantial rights in his patents to Germane—entitling him to capital gain treatment under section 1235. Id. at 1057.
By contrast, TLC did not exercise its rights in the subject patents according to its own discretion. Both Lee and Charlson are distinguishable because the taxpayers in those cases did not control the transferee corporations. Here, Mr. Cooper—troubled by his deteriorated business relationship with Mr. Leckrone—formed TLC with individuals he could trust and ultimately control. Ms. Coulter and Ms. Walters—the shareholders and directors of TLC (along with Ms. Cooper)—did not have the patent, engineering, or other such skills to make them particularly valuable to a small patent
As officers and directors of TLC, Ms. Coulter and Ms. Walters took numerous actions that are inconsistent with acting independently and in the best interest of the corporation. Among other things, Ms. Coulter and Ms. Walters approved TLC‘s transfer of potentially valuable patents to Mr. Cooper for no consideration. At least in one instance, Mr. Cooper almost immediately licensed one of these patents to another related corporation for which that corporation received a royalty of $120,000 in 2007. As shareholders Ms. Coulter and Ms. Walters signed a stock restriction agreement placing restrictions on their ability to transfer shares of stock in TLC to anyone other than petitioners, without receiving any consideration in exchange. The stock restriction agreement did not place similar restrictions on petitioners.
Indeed, it is unclear what material decisions, if any, the officers and directors of TLC made independent of Mr. Cooper.35 Mr. Cooper—and not the officers or directors of TLC—provided technical assistance to the Niro firm in interpreting the subject patents and relevant technology and in formulating patent enforcement strategies. Mr. Cooper conducted all technical matters for TLC—which in substance was all or a large part of TLC‘s activities. Furthermore, in his role as general manager of TLC and under the terms of the letter agreement, Mr. Cooper made all material decisions for TLC with respect to the IP Innovation assignment agreement and the New Medium and AV Technologies agreements.
III. Professional Fees
Generally, a taxpayer is entitled to deduct ordinary and necessary expenses paid or incurred in carrying on a trade or business. See
Generally, a taxpayer who pays another taxpayer‘s business expenses may not treat those payments as ordinary and necessary expenses incurred in the payor‘s trade or business. See Deputy v. du Pont, 308 U.S. at 494–495; Columbian Rope Co. v. Commissioner, 42 T.C. 800, 815 (1964). An exception exists for cases in which the taxpayer paid another taxpayer‘s ordinary and necessary business expenses in order to “protect or promote” the taxpayer‘s own business. See, e.g., Scruggs-Vandervoort-Barney, Inc. v. Commissioner, 7 T.C. 779 (1946).
Under the Lohrke test, we must first “ascertain the purpose or motive which cause[d] the taxpayer to pay the obligations of the other person.” Id. To meet this prong, Mr. Cooper‘s purpose in paying the Holmes Development expenses must have been for the benefit of his business as an inventor. We “must then judge whether it is an ordinary and necessary expense of the * * * [taxpayer‘s] trade or business; that is, is it an appropriate expenditure for the furtherance or promotion of that trade or business? If so, the expense is deductible by the individual paying it.” Id.
Petitioners claimed a deduction of $108,519 in 2006 for professional fees paid to Mr. Holmes for reverse engineering services. Respondent disallowed this deduction in its entirety. Respondent contends that these expenses are properly chargeable to Watonga or TLC and are not Mr. Cooper‘s ordinary and necessary business expenses. Petitioners contend that these expenses are the ordinary and necessary expenses of Mr. Cooper‘s business as an inventor. Alternatively, petitioners contend that even if we find that the expenses are properly chargeable to Watonga or TLC, petitioners are still entitled to deduct the expenses.
Mr. Holmes’ reverse engineering services included the disassembling of televisions and DVD recorders to determine how the products were designed and manufactured and whether any of the products infringed on Mr. Cooper‘s patents. The invoices for the reverse engineering expenses indicated that the services were completed with respect to the 489 patent. However, Mr. Cooper testified that most of these expenses were unrelated to the 489 patent. For example, according to Mr. Cooper, the reverse engineering services included the reverse engineering of plasma televisions that use random dithering and not coherent dithering—the subject of the 489 patent. Regardless, petitioners stipulated that the reverse engineering expenses were
Respondent does not dispute that Mr. Cooper was in the trade or business of patent commercialization and being an inventor during the years at issue. Mr. Cooper testified that he had a long-term working relationship with Mr. Holmes. The Holmes Development invoices, while referencing that the services were completed with respect to the 489 patent, also list Mr. Cooper as the obligor and account holder. Thus, it appears Holmes Development understood its client relationship to be with Mr. Cooper individually and not with Watonga or TLC.38 We find credible Mr. Cooper‘s testimony that Holmes Development‘s business relationship was with him personally, that Holmes Development trusted Mr. Cooper to pay for the services completed, and that nonpayment of the Holmes Development expenses would have adversely affected Mr. Cooper‘s business reputation. See, e.g.,
Mr. Cooper further testified that the services performed by Holmes Development were necessary in his trade or business to keep him apprised of current developments and current engineering practices for audio and video technology. He further testified that the services performed by Holmes Development helped him ascertain whether certain products infringed on any patents that he had developed and commercialized. We conclude that the reverse engineering expenses were proximately related to Mr. Cooper‘s business as an inventor and their payment by him was ordinary and necessary. See id. at 689. Accordingly, we conclude that petitioners have satisfied the second part of the Lohrke test, see id., and they are entitled to deduct the reverse engineering expenses.
IV. Bad Debt
The question of whether a debt became worthless during a taxable year is determined on the basis of all the facts and circumstances. See, e.g., Halliburton Co. v. Commissioner, 93 T.C. 758, 774 (1989), aff‘d, 946 F.2d 395 (5th Cir. 1991). “Specifically, * * * [a taxpayer] must prove that the debt had value at the beginning of the taxable year and that it became worthless during that year.” Milenbach v. Commissioner, 106 T.C. 184, 204 (1996), aff‘d in part, rev‘d in part on other grounds, 318 F.3d 924 (9th Cir. 2003). The taxpayer “must show sufficient objective facts from which worthlessness could be concluded; mere belief of worthlessness is not sufficient.” Fincher v. Commissioner, 105 T.C. 126, 138 (1995). Furthermore, legal action is not required to show worthlessness if surrounding circumstances indicate that a debt is worthless and uncollectible and that any legal action in all likelihood would be futile because the debtor would not be able to satisfy a favorable judgment.
A debt is not worthless for purposes of a
An analysis regarding the deductibility of a bad debt must examine whether the debt was truly worthless, and if so, when it became worthless. The conclusions depend on the particular facts and circumstances of the case, and there is no bright-line test or formula for determining worthlessness within a given taxable year. Lucas v. Am. Code Co., 280 U.S. 445, 449 (1930). To be worthless, a debt must not only be lacking current value and be uncollectible at the time the taxpayer takes the deduction, but it must also be lacking potential value due to the likelihood that it will remain uncollectible in the future. Dustin v. Commissioner, 53 T.C. 491, 501 (1969), aff‘d, 467 F.2d 47 (9th Cir. 1972); see also Fox v. Commissioner, 50 T.C. 813, 822 (1968) (“Mere belief that a debt is bad is insufficient to support a deduction for worthlessness“). The fact that a business is on the decline, that it has failed to turn a profit, or that its debt obligation may be difficult to collect does not necessarily justify treating the debt obligation as worthless. Intergraph Corp. & Subs. v. Commissioner, 106 T.C. 312, 323 (1996), aff‘d without published opinion, 121 F.3d 723 (11th Cir. 1997). This is especially true where the debtor continues to be a going concern with the potential to earn a future profit. See Rendall v. Commissioner, 535 F.3d 1221, 1228 (10th Cir. 2008) (citing Roth Steel Tube Co. v. Commissioner, 620 F.2d 1176, 1182 (6th Cir. 1980), aff‘g 68 T.C. 213 (1977)), aff‘g T.C. Memo. 2006–174; ABC Beverage Corp. v. Commissioner, T.C. Memo. 2006-195.
Petitioners contend that the promissory note became worthless in 2008 following the Indian company‘s abandonment of the Liptracker program. This action, according to petitioners, gave rise to the conclusion that there was no hope of recovering the outstanding amounts under the promissory note. We disagree.
Pixel had total yearend assets each year from 2008 through 2012 in excess of $172,000, including more than $319,000 in assets in 2011 and 2012. It appears to us that Pixel remained a going concern well past 2008. The outcome of Pixel‘s arrangement with the Indian company and the failure of the Liptracker program do not support petitioners’ claim that there was no longer any prospect of recovery of their loans to Pixel. More importantly, the proper inquiry in this case is not whether petitioners acted reasonably in their recovery efforts, but whether sufficient objective facts show that the debt became worthless during the year in question. Here, the facts do not support such a determination.
Pixel experienced a decline in its business in 2008, but its gross receipts increased in 2009. Petitioners as cotrustees of the Cooper Trust continued to advance funds to Pixel under
Mr. Cooper claimed that he consulted with Mr. Mitchell and they determined that filing a lawsuit against Pixel would be futile. Mr. Cooper then concluded that the promissory note was worthless. But petitioners failed to introduce evidence proving what information Mr. Mitchell analyzed to determine that litigation against Pixel would be futile and failed to introduce evidence proving the basis on which Mr. Mitchell made his purported conclusion. Petitioners have failed to satisfy their burden of proving that no prospect of recovery existed in 2008 and failed to prove that the promissory note became worthless in 2008.41 See Rule 142(a). Accordingly, we sustain respondent‘s disallowance of petitioners’ bad debt deduction for 2008.
V. Accuracy-Related Penalties
A. Introduction
The Commissioner bears the initial burden of production with respect to the taxpayer‘s liability for the
B. Petitioners’ Liability for the Section 6662 Penalties
1. Substantial Understatement of Income Tax
A substantial understatement of income tax exists if the amount of the understatement exceeds the greater of 10% of the tax required to be shown on the return or $5,000.
Respondent has introduced sufficient evidence to demonstrate that petitioners have substantially understated their income tax liability for each of the years at issue. Petitioners have not alleged nor have they proven that they had substantial authority for all or any portion of the understatements or that they adequately disclosed their tax positions on their returns. Accordingly, if the Rule 155 computations confirm a substantial understatement, petitioners are liable
2. Negligence or Disregard of Rules or Regulations
The term “negligence” includes any failure to make a reasonable attempt to comply with the provisions of the internal revenue laws, and the term “disregard” includes any careless, reckless, or intentional disregard.
Respondent has met his burden to show that petitioners acted negligently or with careless disregard of rules and regulations with respect to the royalty payments Mr. Cooper received from TLC and with respect to the bad debt deduction for the promissory note. We have found that Mr. Cooper did not transfer all substantial rights to TLC within the meaning of
C. Petitioners’ Reasonable Cause/Good Faith Defense
Taxpayers may avoid liability for the
Petitioners contend that they acted with reasonable cause and good faith based on their reliance on professional advice and therefore no
Mr. Baker testified with respect to the royalty payments and petitioners’ compliance with
With regard to the bad debt deduction, petitioners have failed to introduce evidence regarding what information they provided to Mr. Baker and Mr. Mitchell to enable them to determine whether the promissory note was worthless within the meaning of
Because respondent has met his initial burden of production under
To reflect the parties’ concessions and the foregoing,
Decision will be entered under Rule 155.
DENNIS E. BOHNER, PETITIONER v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
Docket No. 24166–12. Filed September 23, 2014.
Kathryn L. Everlove-Stone, for petitioner.
Joel D. McMahan, for respondent.
KERRIGAN, Judge: Respondent determined a deficiency of $4,590 with respect to petitioner‘s Federal income tax for tax year 2010.
Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the year in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.
The sole issue for consideration is whether a tax-free rollover occurred when petitioner withdrew funds from his traditional individual retirement account (IRA) to cover a deposit of the same amount to the Civil Service Retirement System (CSRS).