Bailey v. Comm'r of Internal Revenue

• Court: U.S. Tax Court
• Writing for the Court: GUSTAFSON
• Decision Date: 02 April 2012
• Docket Number: Docket No. 3080-08,Docket No. 3081-08
• Citation: Bailey v. Comm'r of Internal Revenue, Docket No. 3080-08, Docket No. 3081-08 (T.C. Apr 02, 2012)
• Parties: F. LEE BAILEY, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent F. LEE BAILEY AND ESTATE OF PATRICIA S. BAILEY, F. LEE BAILEY, PERSONAL REPRESENTATIVE, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent

F. LEE BAILEY, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent F. LEE BAILEY AND ESTATE OF PATRICIA S. BAILEY, F. LEE BAILEY, PERSONAL REPRESENTATIVE, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 3080-08

Docket No. 3081-08

UNITED STATES TAX COURT

Filed April 2, 2012

T.C. Memo. 2012-96

P, a lawyer, represented a criminal defendant who was cooperating with the Federal Government by facilitating the transfer of his foreign assets as restitution. In 1994 P entered into an unusual unwritten agreement with the Government, pursuant to which he would use an existing foreign account of his own to hold $6 million of the client's stock and make expenditures to facilitate the client's plan. P sold some of the stock and borrowed against the remainder, using some of the proceeds for the client's business but also transferring some to other accounts from which he made personal expenditures of his own. He later repaid the funds he had spent for himself.

P conducted a yacht rental activity and an airplane remanufacturing activity through a wholly owned S corporation.Most of the use of the yacht was personal. The airplane remanufacturing activity was devoted to developing a plane as a prototype, including the expensive process of obtaining FAA approval for remanufacturing multiple planes for sale. Neither of the activities ever generated a profit, and P claimed pass-through losses from his S corporation on his individual income tax returns.

P failed to report all of his income on his returns, wrongly reported some income he did not receive, claimed some deductions he could not substantiate, and failed to deduct certain amounts that he did expend.

Held: P realized income not when he received the stock, sold it, or borrowed against it, but only when he transferred sale proceeds to other accounts from which he later made personal expenditures.

Held, further, the yacht rental activity was not engaged in for profit under I.R.C. sec. 183 during any of the tax years at issue; but the airplane remanufacturing activity was engaged in for profit from 1993 until April 1996.

Held, further, for the 1993 through 1995 and 1997 through 2000 tax years, P is liable for the accuracy-related penalty under I.R.C. sec. 6662.

F. Lee Bailey, for himself.

Carina J. Campobasso, Thomas R. Thomas, Frances F. Regan, and Janet F. Appel, for respondent.

CONTENTS

FINDINGS OF FACT..............................................8

Mr. Bailey's career and business ventures .......................... 8

Mr. Bailey's representation of Claude Duboc ....................... 9

Mr. Bailey's unwritten agreement with the Government ............... 9

The terms of the unwritten agreement ............................ 10

Payments under the unwritten agreement .......................... 12

The use of Mr. Bailey's existing Credit Suisse account...............14

Mr. Bailey's work under the agreement ........................... 15

Mr. Bailey's financial transactions ............................... 16

Accounting for and return of stock ............................... 19

Repayment of unapproved expenditures and personal loans ............ 21

Subsequent proceedings ......................................23

Mr. Bailey's subchapter S corporations ........................... 24

Mr. Bailey's records.........................................25

Mr. Bailey's airplane rental activity .............................. 26

Mr. Bailey's yacht rental activity................................27

Mr. Bailey's airplane remanufacturing activity......................30

Project 288 income and expenses ...............................37

Preparation of Mr. Bailey's Forms 1040 and 1120S .................38

Filing of Mr. Bailey's Forms 1040 and 1120S......................39

Mr. Bailey's cooperation with the IRS's examination ................45

Destruction of records ........................................ 47

Notices of deficiency ......................................... 47

OPINION ...................................................... 48

I. Background evidentiary principles .......................... 48

A. Burden of Proof ................................... 48

1. Providing IRS access to records ................. 49

a. Taxpayers are required to keep their own records................................ 50b. Taxpayers are required to retain their records as long as they may become material for tax purposes......................... 51

2. Burden shift under section 7491(a) ...............52

3. Alleged animus .............................. 53

4. New matters ................................ 55

B. Collateral estoppel.................................56

II. Income from wrongful appropriations .......................60

A. Taxable income includes wrongful appropriations......... 60

B. A trustee realizes income from the trust corpus when he actually misappropriates it.................... 62

C. Mr. Bailey realized income when he transferred stock sale proceeds from the advance account............ 64

D. Mr. Bailey did not realize income when he transferred loan proceeds from the advance account................. 66

III. Due process and Mr. Bailey's income from the Broder litigation ....................................... 74

IV. Whether activities are engaged in for profit: general principles ...................................... 78

V. Analysis of Mr. Bailey's yacht rental activity .................80

A. Lack of profit motive for yacht refurbishing activity .......81

1. Manner in which the activity is conducted .......... 82

2. Expertise of the taxpayer and his advisers..........83

3. Time and effort expended ...................... 83

4. Expectation that assets may appreciate in value ...... 84

5. Taxpayer's success in similar or dissimilar activities ........................... 846-7. History of income or loss, amount of

occasional profits ............................84

8. Financial status of the taxpayer..................84

9. Elements of personal pleasure...................85

10. Conclusion .................................86

B. Equitable estoppel ................................. 87

1. Alleged agreement ............................ 87

2. Alleged misleading ...........................88

C. Lack of nexus between yacht refurbishing and

yacht rental ...................................... 90

D. Tax consequences ................................. 91

VI. Analysis of Mr. Bailey's airplane remanufacturing activity .......92

A. Profit motive under section 183.......................92

1. Manner in which the activity is conducted..........92

2. Expertise of the taxpayer and his advisers .......... 94

3. Time and effort expended ......................95

4. Expectation that assets may appreciate in value ...... 96

5. Taxpayer's success in similar or

dissimilar activities ........................... 96

6-7. History of income or loss, amount of

occasional profits ............................ 97

8. Financial status of the taxpayer ..................98

9. Elements of personal pleasure...................98

10. Conclusion ................................. 99

B. Timing of deductions .............................. 100

1. The Commissioner's alternative contention........100

2. Start-up expenditures.........................101

3. Capital expenditures .........................103

4. Analysis .................................. 103VII. Miscellaneous adjustments ..............................106

A. Mr. Bailey's position .............................. 106

B. Analysis ....................................... 108

1. Income items ............................... 109

2. Deductions ................................121

VIII. Failure-to-file additions to tax under section 6651(a)(1).........138

IX. Accuracy-related penalty under section 6662 ................. 139

A. Negligence .....................................140

B. Defenses ....................................... 141

Conclusion .................................................... 143

MEMORANDUM FINDINGS OF FACT AND OPINION

GUSTAFSON, Judge:

The Internal Revenue Service ("IRS") issued to petitioner F. Lee Bailey¹ two statutory notices of deficiency on November 6, 2007, pursuant to section 6212,² showing the IRS's determinations of the followingdeficiencies in income tax and failure-to-file additions to tax and accuracy-related penalties under sections 6651(a)(1) and 6662, respectively, for the 1993 through 2001 tax years:

+-----------------------------------------------------------------+
                ¦Year¦Deficiency¦Addition to tax sec. 6651(a)(1)¦Penalty sec. 6662¦
                +----+----------+-------------------------------+-----------------¦
                ¦1993¦$176,818  ¦---                            ¦$35,364          ¦
                +----+----------+-------------------------------+-----------------¦
                ¦1994¦2,137,907 ¦---                            ¦427,581          ¦
                +----+----------+-------------------------------+-----------------¦
                ¦1995¦174,217   ¦---                            ¦34,843           ¦
                +----+----------+-------------------------------+-----------------¦
                ¦1996¦511,444   ¦---                            ¦---              ¦
                +----+----------+-------------------------------+-----------------¦
                ¦1997¦218,116   ¦---                            ¦43,623           ¦
                +----+----------+-------------------------------+-----------------¦
                ¦1998¦629,209   ¦$94,381                        ¦125,842          ¦
                +----+----------+-------------------------------+-----------------¦
                ¦1999¦130,758   ¦19,530                         ¦                 ¦
                ¦    ¦          ¦                               ¦26,152 13,262    ¦
                ¦2000¦66,309    ¦9,946                          ¦                 ¦
                +----+----------+-------------------------------+-----------------¦
                ¦2001¦82,191    ¦---                            ¦---              ¦
                +-----------------------------------------------------------------+
                

The issues for decision are: (i) whether and when Mr. Bailey realized income from Biochem Pharma stock held in his investment account at Credit Suisse Bank; (ii) whether Mr. Bailey's yacht rental activity and airplane remanufacturing...