Lead Opinion
Pursuant to section 6212,
Taxpayers Year Deficiency Penalty sec. 6662(a)
Peek 2006 $223,650 $44,730.00
2007 1,399 279.80
Fleck 2006 243,229 48,645.80
2007 4,948 989.60
The issues for decision in these consolidated cases are: (i) whether Mr. Fleck’s and Mr. Peek’s personal guaranties of a loan to FP Company were prohibited transactions under section 4975(c)(1)(B);
FINDINGS OF FACT
These cases were submitted by the parties fully stipulated under Rule 122 for decision without trial,
In 2001 Mr. Fleck identified Abbott Fire & Safety, Inc. (“AFS”), as an attractive business opportunity. AFS specialized in providing alarms and fire protection, hood suppression systems, sprinkler systems, backflow inspections, fire extinguishers, and emergency lights for businesses. AFS also engaged in government-mandated compliance testing related to fire suppression and safety. Mr. Fleck contacted A.J. Hoyal & Co. (“A.J. Hoyal”), the brokerage firm through which AFS was offered for sale. While Mr. Fleck originally hoped to purchase AFS with a family member as partner, that relative was unable to join the venture. Instead, Mr. Peek, an attorney who had provided legal services to Mr. Fleck in the past, approached Mr. Fleck about joining the venture. (Mr. and Mrs. Fleck are not related to Mr. and Mrs. Peek.)
The IACC
A.J. Hoyal introduced Mr. Fleck to Christian Blees, a certified public accountant (“C.P.A.”) at a Colorado Springs accounting firm. Mr. Fleck later introduced Mr. Blees to Mr. Peek. Neither Mr. Fleck nor Mr. Peek knew Mr. Blees previously. Mr. Fleck and Mr. Peek engaged Mr. Blees and his firm to assist in structuring the purchase of AFS’s assets and to perform due diligence on the transaction.
Mr. Blees presented to Mr. Fleck and Mr. Peek information on a strategy he identified as the “IACC”. On September 6, 2001, Mr. Blees gave to Mr. Fleck and Mr. Peek documents
In addition to describing the plan, the IACC documents included an extensive discussion and an opinion letter from Mr. Blees about prohibited transactions under section 4975, which state that such transactions would be detrimental to the IACC plan’s tax objectives. The documents warned that “the taxpayer could not engage in transactions with the IRA that the IRS would determine to be ‘prohibited transactions’”. Also included in the documents was a letter from the accounting firm, which instructed:
An important distinction to always recognize is that any actions you take on behalf of the corporation must be taken by you as an agent for the corporation and not by you personally. Any business done by the corporation must be done in its status as a corporation and realizing that you are acting as an agent of the corporation only. The corporation should exercise care to hold itself out at all times to the public as a corporation and not as some other type of entity, or as an extension of you personally.
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Failure to properly manage the corporations [sic] affairs, or to conduct business in any manner other than at arms length could result in adverse effects to the corporation, your IRA, and to you personally. This might include, but is not limited to, the assessment of additional income taxes, penalties and interest from various taxing authorities.
None of the IACC documents indicate that Mr. Fleck or Mr. Peek informed their accountant that they might guarantee loans for the new corporation as part of their planned acquisition of AFS’s assets; and the documents included no advice to the effect that an extension of credit or personal guaranty between petitioners and the new corporation would not be considered prohibited transaction for purposes of section 4975.
Mr. Peek completed and submitted an “IACC Application” and, in response, received the “IACC Plan for FP Company”, a document that outlined a plan for the purchase of AFS’s assets. Mr. Fleck and Mr. Peek subsequently implemented
Implementing IACC with FP Company
Mr. Fleck and Mr. Peek each established at Vista Bank accounts intended to be self-directed IRAs, over which they each retained all discretionary authority and control concerning investments. Mr. Fleck rolled over funds on August 17, 2001, into his IRA (the “Fleck Vista IRA”), from an existing account maintained for his benefit at the Allied Domesq 401(k) Retirement Plan. Mr. Peek rolled over funds on August 30, 2001, into his IRA (the “Peek Vista IRA”), from an existing account maintained for his benefit at Charles Schwab. Neither Mr. Fleck nor Mr. Peek contributed to the other’s IRA.
On August 27, 2001, the articles of incorporation for FP Company, Inc. (“FP Company”) were filed with the Colorado Secretary of State. At formation, Mr. Fleck and Mr. Peek intended that FP Company would purchase the assets of AFS and engage in the retail sale of fire suppression systems.
On September 11, 2001, each IRA purchased 5,000 shares of newly issued stock in FP Company for $309,000 and thereby acquired a 50% interest in FP Company. The Peek Vista IRA made its purchase at Mr. Peek’s direction, and the Fleck Vista IRA made its purchase at Mr. Fleck’s direction. In so doing, Mr. Peek and Mr. Fleck both intended that FP Company would purchase the assets of AFS. At the time of purchase, both Mr. Peek and Mr. Fleck also intended to serve as corporate officers and directors of FP Company.
In a transaction closed in mid-September 2001 (but with an agreed effective date of August 28, 2001), FP Company acquired most of AFS’s assets for a price of $1,100,000, consisting of: (a) $850,000 in cash (derived from (i) a $450,000 bank loan to FP Company from a credit union and (ii) $400,000 of the proceeds of the sale of FP Company’s stock to the IRAs); (b) a $50,000 promissory note from FP Company to A.J. Hoyal (the broker); and (c) a $200,000 promissory note from FP Company to the sellers, secured by personal guaranties from Mr. Fleck and Mr. Peek.
Operation of FP Company d.b.a. Abbott
On September 25, 2001, FP Company filed a Statement of Change of Registered Officer or Registered Agent with the Colorado Secretary of State, which named Mr. Peek as the new registered agent of FP Company. Also on September 25, FP Company filed two Certificates of Assumed or Trade Name, indicating that it would hereafter do business as “Abbott Fire & Safety, Inc.” and “Abbott Fire Extinguisher Company, Inc.”
From 2001 until the 2006 sale, Mr. Fleck and Mr. Peek were the only persons to serve as corporate officers and directors of FP Company.
Subsequent transactions involving the Fleck and Peek IRAs
In 2002 Mr. Fleck and Mr. Peek’s accountants informed them that Vista Bank was terminating its services as custodian of the Fleck Vista IRA and the Peek Vista IRA. Consequently, they transferred the Fleck Vista IRA and the Peek Vista IRA to First Trust Co. of Onaga (to become the “Fleck Onaga IRA” and the “Peek Onaga IRA”). Each man intended the new account to be self-directed. In each new IRA the sole asset was the shares of FP Company previously held in the Vista IRAs.
In 2003 Mr. Fleck converted half of the Fleck Onaga IRA to a Roth IRA at the same bank (the “Fleck Roth IRA”); and Mr. Peek converted half of the Peek Onaga IRA to a Roth IRA (the “Peek Roth IRA”). In 2004 each transferred the remaining half of his Onaga IRA into his Roth IRA, so that thereafter each Roth IRA owned 50% of the stock of FP Company. Mr. Fleck and Mr. Peek each reported the fair market values of the converted portions of their accounts as taxable income for 2003 and 2004.
In 2006 the Roth IRAs sold FP Company to Xpect First Aid Co. Each Roth IRA received payments on the following dates and in the following amounts for its 50% interest in FP Company:
Date Payment
3/14/2006 $1,385,920
4/5/2006 114,713
9/14/2006 63,932
11/9/2006 9,156
4/30/2007 94,471
Total . 1,668,192
Following these payments, neither the Fleck Roth IRA nor the Peek Roth IRA owned any interest in FP Company, and neither Mr. Fleck nor Mr. Peek had any involvement with FP Company or Xpect First Aid Co.
Administrative actions
Both the Flecks and the Peeks timely filed Federal income tax returns on Forms 1040, “U.S. Individual Income Tax Return”, for the years 2006 and 2007. The IRS examined those returns, adjusted petitioners’ income to include capital gain from the sale of FP Company stock,
The Peeks timely mailed their petition to this Court on March 8, 2011; and the Flecks timely mailed their petition to this Court on March 14, 2011. At the time they filed their petitions, both the Flecks and the Peeks resided in Colorado.
OPINION
I. IRAs and prohibited transactions
A taxpayer who invests his money in the hope of making a gain over a period of years — whether to fund his retirement
However, IRAs are subject to special rules, including the provision in section 408(e)(2)(A)
II. Loan guaranties as prohibited transactions
The IRS argues that Mr. Fleck’s and Mr. Peek’s personal guaranties of the $200,000 promissory note from FP Company to the sellers of AFS in 2001 as part of FP Company’s purchase of AFS’s assets were prohibited transactions. Section 4975(c)(1)(B) prohibits “any direct or indirect * * * lending of money or other extension of credit between a [retirement] plan and a disqualified person”. (Emphasis added.) Petitioners counter that Mr. Fleck’s and Mr. Peek’s personal guaranties were not prohibited transactions because they did not involve “the plan” (i.e., in this case, the IRAs), whereas the extension of credit prohibited under section 4975(c)(1)(B) is “between a plan and a disqualified person”.
This reading of the statute, however, would rob it of its intended breadth. Section 4975(c)(1)(B) prohibits “any direct or indirect * * * extension of credit between a plan and a disqualified person”. (Emphasis added.) The Supreme Court has observed that when Congress used the phrase “any direct or indirect” in section 4975(c)(1), it thereby employed “broad language” and showed an obvious intention to “prohibits something more” than would be reached without it. Commissioner v. Keystone Consol. Indus., Inc.,
III. Tax consequences of the guaranties on the sale of stock
The IRS’s two notices of deficiency issued to petitioners for 2006 and 2007 are similar, and the one issued to the Flecks asserted:
The prohibited transaction triggered a liquidation of the IRAs in the [sic] 2001. Following that liquidation, the stock of FP Company Inc. is treatedas owned by the [sic] Fleck and another individual [i.e., Mr. Peek] personally. Consequently, Fleck and the other individual are taxed personally on any gain on the sale of such stock.
Petitioners seem to argue that the IRS’s notices of deficiency issued for 2006 and 2007 are somehow too late (because the loan guaranties were made in 2001), and that in the absence of an earlier notice of deficiency the IRAs remained exempt. Petitioners suggest that if the IRAs did not lose their exemption until 2006, then petitioners would have realized ordinary income in that year, rather than the capital gain determined in the notices; and they argue that since the notices did not make that particular adjustment, the notices are somehow inadequate to support an assessment of tax based on capital gains. This argument either misconstrues the tax consequences to an individual who engages in prohibited transactions with respect to an IRA or perhaps exaggerates the importance of the wording of the notices. The notices determined deficiencies for 2006 and 2007 on the basis of a prohibited transaction that took place in 2001. We now redetermine those 2006 and 2007 deficiencies and decide (1) whether the accounts that held the FP Company stock were IRAs in 2006 when the stock was sold (we hold they were not), (2) when they ceased to be IRAs and therefore exempt from income tax (we hold in 2001), and (3) the tax consequences of their non-exemption (we hold Mr. Fleck and Mr. Peek are liable for tax on the capital gains realized in 2006 and 2007 from the sale of the FP Company stock).
The loan guaranties were not a once-and-done transaction with effects only in 2001 but instead remained in place and constituted a continuing prohibited transaction, thus preventing Mr. Fleck’s and Mr. Peck’s accounts that held the FP Company stock from being IRAs in subsequent years.
Consequently, under section 408(e)(2)(A), each original account holding the FP Company stock ceased to qualify as an IRA in 2001. In 2003 and 2004 when Mr. Fleck and Mr. Peek established Roth IRAs, those accounts ceased to be Roth IRAs when they funded the accounts with FP Company stock, because the prohibited transactions continued as to those accounts. See sec. 408A(a) (“Except as provided in this section, a Roth IRA shall be treated for purposes of this title in the same manner as an individual retirement plan”). For the same reasons, the accounts holding the FP Company stock when the stock was sold in 2006 were not Roth IRAs, and the gains from the sale realized in 2006 and 2007 were not exempt from tax. The tax liability from the gain is properly attributable to Mr. Fleck and Mr. Peek as the creators and beneficiaries of the accounts that sold the FP Company stock. See secs. 671, 408(a), (e)(2)(A)(i). Petitioners have not challenged the IRS’s calculation of gain on the sale or asserted that they were entitled to a higher basis in the stock than what the IRS allowed. They were therefore liable for tax on the gains realized in the sale transaction as determined in the notices of deficiency.
IV. Accuracy-related penalties
A. Substantial understatements
The IRS determined that the Flecks and the Peeks are liable for a 20% accuracy-related penalty because their underpayments were “substantial understatements] of income tax” under section 6662(b)(2). By definition, an understatement of income tax is substantial if it exceeds the greater of $5,000 or 10% of the tax required to be shown on
B. Negligence or disregard
For purposes of section 6662, “the term ‘negligence’ includes any failure to make a reasonable attempt to comply with the provisions of this title [i.e., 26 U.S.C.]”. Sec. 6662(c). Negligence is defined as a lack of due care or failure to do what a reasonable and ordinarily prudent person would do under the circumstances. Neely v. Commissioner,
The underpayments in these cases result from petitioners’ failures to report capital gain income that they realized from the 2006 sale of FP Company stock; instead petitioners contended that IRAs held the FP Company stock when the stock was sold and, therefore, the realized gains were not taxable. However, Mr. Fleck and Mr. Peek were well aware that prohibited transactions listed in section 4975 could be fatal to their IRA arrangements, because both the IACC information they received and an opinion letter from their accountant discussed section 4975 in detail. The IACC information expressly stated: “the taxpayer could not engage in transactions with the IRA that the IRS would determine to be ‘prohibited transactions’ ”.
Section 4975(c)(1)(B) clearly provides that any “indirect * * * lending of money or other extension of credit between a plan and a disqualified person” is a prohibited transaction. As we have held, Mr. Fleck’s and Mr. Peek’s personal guaranties to FP Company were “indirect * * * extensions]
C. Reasonable cause and good faith
Once the Commissioner meets this burden, the taxpayer must come forward with persuasive evidence that the Commissioner’s determination is incorrect. Rule 142(a); Higbee v. Commissioner,
Because of Mr. Blees’s role as promoter, Mr. Fleck and Mr. Peek could not reasonably and in good faith rely on that advice. See 106 Ltd. v. Commissioner,
Since Mr. Blees’s advice did not address the issue of personal guaranties, we conclude that petitioners did not rely on their accountant’s advice with regard to the prohibited transactions in these cases, and did not have reasonable cause or act in good faith in failing to report the capital gains in these cases.
We therefore sustain the imposition of the accuracy-related penalty under section 6662(a) for both years in issue in both cases.
To reflect the foregoing,
Decisions will be entered under Rule 155.
Notes
Unless otherwise indicated, all section references are to the Internal Revenue Code (26 U.S.C.), and all Rule references are to the Tax Court Rules of Practice and Procedure.
Because we hold that the loan guaranties were prohibited transactions, we need not and do not reach the additional questions of whether prohibited transactions occurred (i) when FP Company made payments of wages to Mr. Fleck and Mr. Peek (which the IRS contends were prohibited transactions under section 4975(c)(1)(D)), or (ii) when FP Company made payments of rent to an entity owned by Mrs. Fleck and Mrs. Peek (which the IRS contends were prohibited transactions under section 4975(c)(1)(E)). (We also need not consider whether those issues constitute “new matter”. See note 3 below.) Furthermore, because our holding that the loan guaranties were prohibited transactions resolves the income tax issues in favor of the IRS and against the petitioners, we need not reach the question whether Mr. Fleck and Mr. Peek would, in the alternative, owe excise tax for excess contributions to their successor IRAs under section 4973.
The burden of proof is generally on the taxpayer, see Rule 142(a)(1), and the submission of a case as fully stipulated under Rule 122 does not alter that burden, see Borchers v. Commissioner,
As a result of the increased income, the IRS also made computational adjustments to exemption amounts, student interest deductions (for the Flecks only), itemized deductions, and self-employment tax.
To the extent Mr. Fleck and Mr. Peek attempted to use Roth IRAs under section 408A, their desired tax benefit was slightly different. A taxpayer investing through a Roth IRA does not exclude qualifying contributions to the Roth IRA from income, but once in the Roth IRA, investments grow tax free and qualifying distributions from the Roth IRA are not subject to tax. See sec. 408A. Because the IRAs ceased to qualify before the attempted Roth conversion, the Roth IRA rules of section 408A have no application in these cases.
Section 408(e)(2)(A) provides: “If, during any taxable year of the individual for whose benefit any individual retirement account is established, that individual or his beneficiary engages in any transaction prohibited by section 4975 with respect to such account, such account ceases to be an individual retirement account as of the first day of such taxable year.”
Section 4975(c)(1) enumerates categories of prohibited transactions, including “any direct or indirect— * * * (B) lending of money or other extension of credit between a plan and a disqualified person”.
Section 408(e)(2)(B) provides: “In any case in which any account ceases to be an individual retirement account by reason of subparagraph (A) as of the first day of any taxable year, paragraph (1) of subsection (d) applies [i.e., “any amount paid or distributed * * * shall be included in gross income by the payee or distributee”] as if there were a distribution on such first day in an amount equal to the fair market value (on such first day) of all assets in the account (on such first day).”
Section 4975(e)(2)(A) defines “disqualified person” as a “fiduciary,” which is itself defined in section 4975(e)(3) as “any person who * * * exercises any discretionary authority or discretionary control respecting management of such plan or exercises any authority or control respecting management or disposition of its assets”. See Swanson v. Commissioner,
Since the guaranties (i.e., the prohibited transactions) continued through the time of the sale of FP Company stock in 2006, we do not address what, if any, requirements there are to subsequently reform or resuscitate an IRA that, pursuant to the provisions in section 408(e)(1), has “ceased to be an individual retirement account”.
In the alternative, the IRS agues that Mr. Fleck and Mr. Peek owe excise tax on the excess contributions to their successor IRAs under section 4973(a). While section 4973(a) imposes an excise tax equal to 6% of the excess contribution made to a traditional/Roth IRA, this tax is imposed only for each subsequent year in which the excess contribution remains in the IRA. Under our holding here that when the IRAs engaged in prohibited transactions, they ceased to be IRAs and the value of the IRAs’ assets constituted deemed distributions to Mr. Peek and Mr. Fleck personally, any excessive contribution to a new IRA was self-corrected and no excise tax would be due. We therefore do not address further this alternative theory.