SEVEN W. ENTERS., INC. v. Commissioner

• Decision Date: 07 June 2011
• Docket Number: 13595-08.,Docket Nos. 13594-08
• Citation: 136 T.C. 539
• Court: U.S. Tax Court
• Parties: SEVEN W. ENTERPRISES, INC. & SUBSIDIARIES, Petitioners<BR>v.<BR>COMMISSIONER OF INTERNAL REVENUE, Respondent.<BR>HIGHLAND SUPPLY CORPORATION & SUBSIDIARIES, PETITIONERS<BR>v.<BR>Commissioner of Internal Revenue, Respondent.

136 T.C. 539

SEVEN W. ENTERPRISES, INC. & SUBSIDIARIES, Petitioners
v.
COMMISSIONER OF INTERNAL REVENUE, Respondent.
HIGHLAND SUPPLY CORPORATION & SUBSIDIARIES, PETITIONERS
v.
Commissioner of Internal Revenue, Respondent.

Docket Nos. 13594-08

13595-08.

06-07-2011

[136 T.C. 540]

Patrick B. Mathis, William J. Niehoff, and Philip D. Speicher, for petitioners.

James M. Cascino, David B. Flassing, and William G. Merkle, for respondent.

FOLEY, Judge:

The issue for decision is whether petitioners are liable for section 6662(a)^[1] accuracy-related penalties relating to tax years ending in 2000, 2001, 2002, 2003, and 2004 (years in issue).^[2]

FINDINGS OF FACT

The Weder family controlled two closely held businesses: Highland Supply Corporation (HSC) and Seven W. Enterprises, Inc. (7W). HSC was the parent of a group of corporations (collectively, HSC Group) which filed a consolidated Federal income tax return and manufactured floral, packaging, and industrial wire products. HSC Group included Highland Southern Wire, Inc., and Weder Investment, Inc. (WI).^[3] 7W, a corporation principally engaged in leasing nonresidential buildings, was the parent of a group of entities (collectively, 7W Group), which filed a consolidated Federal income tax return. 7W owned an 89-percent interest in Weder Agricultural Limited (WAL), a limited partnership.

In 1990, HSC Group and 7W Group (collectively, petitioners) hired William Mues, a certified public accountant, to

[136 T.C. 541]

serve as their tax manager. Mues had experience relating to personal holding company tax matters and had previously worked at Deloitte Haskins & Sells, preparing tax returns for individuals, corporations, partnerships, and trusts, and at Peabody Coal Co., preparing consolidated returns. In 1991, petitioners promoted Mues to vice president of taxes. While employed by petitioners, Mues drafted documents, performed general legal work, and prepared returns for petitioners and petitioners' shareholders. Petitioners provided Mues with full access to all resources necessary to handle petitioners' tax matters (i.e., access to corporate and accounting personnel, corporate records, research databases, and outside professionals). In addition, petitioners authorized Mues to sign, on their behalf, Internal Revenue Service (IRS) documents.

On December 12, 1995, Southpac Trust International, Inc., as trustee of the Family Trust (STI), an entity unrelated to petitioners, executed a $4,062,000 interest-bearing promissory note (the promissory note) for the benefit of HSC. In 1996, HSC assigned the promissory note to WI.

In 1997, the IRS began auditing HSC Group's 1995 return and eventually expanded the audit to include HSC Group's 1996 and 1997 returns. On April 2, 1999, the IRS and HSC Group reached a settlement with respect to the audit relating to HSC Group's 1995, 1996, and 1997 returns. The agreed adjustments were in excess of $2.2 million and included the disallowance of more than $450,000 of deductions relating to HSC's president's personal expenses. These adjustments were set forth on Form CG-4549, Income Tax Examination Changes, which required HSC Group's signature. Mues signed his name on the line labeled "Signature of Taxpayer". The IRS and petitioners also reached settlements relating to HSC Group's and 7W Group's 1998 and 1999 returns. HSC Group had recurring adjustments relating to research and development expenses.

While an employee of petitioners and prior to 2001, Mues obtained a master's degree in business administration and began law school as a part-time student. In January 2001, Mues resigned as vice president of taxes and continued his legal studies as a full-time student. After resigning, Mues, pursuant to an agreement, provided petitioners with consulting services concerning tax matters and was not subject to petitioners' supervision or direction. As a consultant, Mues

[136 T.C. 542]

prepared 7W Group's 2000 return and HSC Group's 2001 return. In March 2002, after Mues completed law school, petitioners hired him to serve as their vice president of taxes. In accordance with his responsibilities, Mues prepared and signed, on behalf of petitioners, 7W Group's 2001, 2002, and 2003 returns and HSC Group's 2002, 2003, and 2004 returns.

With respect to the years in issue, Mues incorrectly characterized petitioners' income and concluded that petitioners were not liable for personal holding company taxes. The personal holding company tax is a penalty tax on undistributed income and is designed to discourage individuals from using closely held corporations to defer taxation on dividends, interest, rents, and other forms of passive income. See secs. 541, 543; Fulman v. United States, 434 U.S. 528, 530-531 (1978); H. Rept. 704, 73d Cong., 2d Sess. (1934), 1939-1 C.B. (Part 2) 554, 562-563; S. Rept. 558, 73d Cong., 2d Sess. (1934), 1939-1 C.B (Part 2) 586, 596-598. On HSC Group's 2003 and 2004 returns, Mues incorrectly concluded that interest income, relating to the promissory note held by WI, was income from a source within HSC Group and that WI was not liable for the personal holding company tax. As a result, HSC Group, whose consolidated return included WI, understated its 2003 and 2004 tax liabilities. On 7W Group's 2000, 2001, 2002, and 2003 returns, Mues made a similar mistake with respect to interest income received by WAL. During 2000, 2001, 2002, and 2003, WAL received interest income relating to an installment note issued by an entity outside 7W Group, and each year 7W, in determining its income, took into account a portion of that interest income equal to 7W's distributive share. For purposes of calculating the personal holding company tax, however, Mues did not take this income into account. In addition, Mues misapplied the personal holding company tax rules relating to rental income and, in doing so, incorrectly concluded that 7W's rental income was not subject to the personal holding company tax. As a result, 7W Group understated its 2000 through 2003 tax liabilities.

On March 7, 2008, respondent issued 7W Group a notice of deficiency relating to 2000,...