Close v. Commissioner of Internal Revenue, 021014 FEDTAX, 20645-07

Docket Nº:20645-07
Opinion Judge:MARVEL, Judge:
Party Name:CHRISTOPHER CARL CLOSE AND LISA MARIE CLOSE, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Attorney:Christopher Carl Close and Lisa Marie Close, pro sese. Catherine L. Campbell and Danae M. Rawson, for respondent.
Case Date:February 10, 2014
Court:United States Tax Court

T.C. Memo. 2014-25

CHRISTOPHER CARL CLOSE AND LISA MARIE CLOSE, Petitioners

v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

No. 20645-07

United States Tax Court

February 10, 2014

Christopher Carl Close and Lisa Marie Close, pro sese.

Catherine L. Campbell and Danae M. Rawson, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

MARVEL, Judge:

Respondent determined deficiencies in Christopher Carl Close and Lisa Marie Close's Federal income tax and additions to tax under sections 6651(a)(1) and (2) and 66541 as follows:

Additions to tax

Year

Deficiency

Sec. 6651(a)(1)

Sec.6651(a)(2)

Sec.6654

Mr. Close

2003

$68, 843

$15, 490

TBD

$1, 802

2004

17, 358

3, 906

TBD

504

Mrs. Close1

2003

$52, 800

$11, 880

TBD

$1, 382

2004

17, 358

3, 906

TBD

504

1Respondent attributed some of the income Mr. Close purportedly earned during these years to Mrs. Close because Idaho, where petitioners then resided, is a community property State.

After concessions, 2 the issues for decision are: (1) whether Mr. Close had unreported income of $323, 246 from logging activities on a 750-acre parcel of real property with an address on Winch Avenue, Rathdrum, Idaho (Winch Road property), in 2003; (2) whether Mr. Close had unreported income of $48, 262 from logging activities on a 120-acre parcel of real property with an address on Nelson Loop Road, Rathdrum, Idaho (Nelson Loop Road property), in 2003; and (3) whether petitioners are liable for additions to tax under sections 6651(a)(1) and (2) and 6654 for 2003.

FINDINGS OF FACT

Some of the facts have been stipulated. The stipulations of facts are incorporated herein by this reference. When they petitioned this Court, Mr. Close was incarcerated in a Federal prison camp in California and Mrs. Close resided in Idaho.

I. Background

Petitioners married in 1990. They have four children. In 1995 Mr. Close started a medical equipment business. On a date that is unclear from the record he sold the medical equipment business.

In 2001 the Federal Government (Government) executed multiple search warrants with respect to Mr. Close's medical equipment business and the entity that purchased it. One of those warrants was executed in November 2001.

On March 12, 2003, the Government filed an indictment, and on August 14, 2003, a superseding indictment, against Mr. Close in the U.S. District Court for the District of Idaho. On July 27, 2004, a jury found Mr. Close guilty of 30 counts of healthcare fraud, 9 counts of money laundering, 1 count of obstructing a Federal audit, and 1 count of obstructing a Federal healthcare fraud investigation. Mr. Close was incarcerated on March 30, 2005. On February 1, 2011, he was released to a halfway house, and on July 30, 2011, he was released from custody. The last Federal income tax return that petitioners filed before Mr. Close's incarceration was their 2001 return.

II. Winch Road Property

A. Option To Purchase the Winch Road Property

In January 2003 Mr. Close and Mike Leach proposed purchasing the Winch Road property from Jerry and Edna Tefft and drafted an option to purchase the Winch Road property dated January 20, 2003 (original Winch Road option). Mr. Close, Mr. Leach, and Mr. and Mrs. Tefft signed the original Winch Road option. Under the original Winch Road option, the Teffts agreed to grant Mr. Close and Mr. Leach an option to purchase the Winch Road property for $1.4 million, and Mr. Close and Mr. Leach agreed to pay the Teffts $1, 000 as consideration for the option. The original Winch Road option further provided that Mr. Close and Mr. Leach would pay 70% of the proceeds of any timber sales to Mr. and Mrs. Tefft until Mr. Close and Mr. Leach paid off the balance owed on the property. The original Winch Road option was recorded on January 30, 2003.

Also on January 30, 2003, Mr. Close, Mr. Leach, and Mr. and Mrs. Tefft recorded an amended Winch Road option. Under the amended Winch Road option, Mr. Close and Mr. Leach gave notice that they would exercise their option to purchase the Winch Road property and agreed to execute a promissory note of $1.4 million for the purchase of the property. Of that amount, $700, 000 was to be due by August 1, 2003, and the remainder was to be due by May 1, 2004. Mr. Close and Mr. Leach agreed that 70% of the proceeds of any timber sales would go toward satisfying the balance due on the promissory note. The amended Winch Road option granted Mr. Close and Mr. Leach the right to immediately commence logging operations on the Winch Road property.

B. Hidden Valley Ranch, LLC

In February 2003 Mr. Close and Mr. Leach formed Hidden Valley Ranch, LLC, for the purpose of managing the logging, farming, and other operations on the Winch Road property. Hidden Valley Ranch, LLC, managed logging and other activities on the Winch Road property throughout 2003 and 2004. It also maintained a checking account, and on November 24, 2004, it filed a Form 1065, U.S. Return of Partnership Income (partnership return), for 2003. Clark, Anderson, McNelis & Co. (Clark Anderson), a public accounting firm, prepared, and Mr. Leach signed, Hidden Valley Ranch, LLC's 2003 partnership return.

On a date that is unclear from the record and for reasons that are unclear from the record Mr. Leach's wife, Donna Leach, who is an accountant but not a certified public accountant (C.P.A.), began to summarize the income and expenses of the logging activities on the Winch Road property. Because she was unable to access the databases on Hidden Valley Ranch, LLC's computer, she had to reconstruct Hidden Valley Ranch, LLC's records for 2003 and 2004. She prepared balance sheets and profit and loss statements for Hidden Valley Ranch, LLC, and gave these to Lynn Anderson, a C.P.A. at Clark Anderson, to prepare an amended 2003 partnership return for Hidden Valley Ranch, LLC.

C. Lost Creek Trust

On February 28, 2003, petitioners, Mr. Leach, and John A. Dixon purported to form Lost Creek Irrevocable Trust (Lost Creek Trust) by signing a trust agreement. Petitioners and Mr. Leach signed the trust agreement as the grantors, and Mr. Dixon signed the trust agreement as the trustee. Under the Lost Creek Trust agreement, the grantors purported to convey their interest in the Winch Road property to the trustee. Thereafter, on a date that is not in the record Mr. and Mrs. Tefft conveyed the Winch Road property to Mr. Dixon as trustee of Lost Creek Trust.3

Petitioners' four children, Mr. Leach's two children, and Mrs. Leach's two children are the beneficiaries of Lost Creek Trust. The Lost Creek Trust agreement requires the trustee to pay for the benefit of each beneficiary such sums from principal and interest as the trustee deems reasonable "for the maintenance, education, support and health of the beneficiaries". The agreement also provided that Carrie Loomis, Mr. Close's sister, and Kelly Scott, Mr. Leach's sister, would serve as successor cotrustees to Mr. Dixon if he would no longer be able or willing to serve. However, on or about December 4, 2004, when Mr. Dixon resigned as trustee, Ms. Scott became the sole successor trustee.

D. Lost Creek Partnership

On January 24, 2005, the District Court in Mr. Close's criminal case issued a postconviction preforfeiture restraining order. The restraining order prohibited, among other things, any harvesting of timber on the Winch Road property.

On March 2, 2005, the District Court issued a preliminary order of forfeiture, preliminarily forfeiting Mr. Close's interest in, among other things, the Winch Road property. On March 29, 2005, Ms. Scott filed a petition to adjudicate the third-party interest of Lost Creek Trust in the Winch Road property.

On February 23, 2006, the Government filed a motion for the District Court to issue an order to show cause with respect to certain alleged violations by Mr. Leach of the January 24, 2005, postconviction preforfeiture restraining order. On February 24, 2006, the District Court issued the requested order to show cause.

On a date that is unclear from the record, Mr. and Mrs. Leach met with Revenue Agent Nicoli Ferrell, Assistant U.S. Attorney Anthony Hall, a Federal marshal, and Mike Anderson, an attorney, at the courthouse in Coeur d'Alene. At the meeting Mr. and Mrs. Leach were told to disregard Lost Creek Trust and Hidden Valley Ranch, LLC, and to instead file partnership returns for what would be known as Lost Creek Partnership. Mr. and Mrs. Leach were also told that the Internal Revenue Service (IRS) would file the partnership returns for them--without including any expenses--if they failed to file the partnership returns themselves.

On April 6, 2006, Revenue Agent Ferrell sent a letter to Mr. Leach informing him that the IRS had determined that Lost Creek Trust is not a valid trust, that Mr. Leach should file amended returns for Hidden Valley Ranch, LLC, reporting zero income, and that Mr. Leach should instead report all income and expenses from timber operations on the Winch Road property on partnership returns for Lost Creek Partnership. Additionally, the letter stated as follows:

As previously discussed, in addition to being required by the circumstances and the law applicable in this case, the partnership filing is likely to be the most economically advantageous position for you and should allow the United States Attorney's office to go forward in its criminal-forfeiture-ancillary-proceeding claims against the defendant, * * * [Mr.] Close, and that portion of the property/partnership subject to the Preliminary Order of Forfeiture, without involving you in lengthy litigation in that proceeding.

On April 10, 2006, the Government filed a notice of status of show-cause proceeding, informing the District Court that it was satisfied that all timber harvested on the Winch Road property had been properly accounted for.4 Also on April 10, 2006,...

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