Ernest S. Ryder & Assocs. v. Comm'r

• Decision Date: 14 July 2021
• Docket Number: Docket No. 9922-12,Docket No. 14619-10,Docket No. 7527-12,Docket No. 31483-15.,Docket No. 14687-10,Docket No. 30196-14,T.C. Memo. 2021-88,Docket No. 9921-12,Docket No. 9977-12
• Parties: ERNEST S. RYDER & ASSOCIATES, INC., APLC, ET AL., Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent
• Court: U.S. Tax Court

ERNEST S. RYDER & ASSOCIATES, INC., APLC, ET AL.,¹ Petitioners
v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

T.C. Memo. 2021-88
Docket No. 14619-10
Docket No. 14687-10
Docket No. 7527-12
Docket No. 9921-12
Docket No. 9922-12
Docket No. 9977-12
Docket No. 30196-14
Docket No. 31483-15.

UNITED STATES TAX COURT

July 14, 2021

Ernest S. Ryder and Richard V. Vermazen, for petitioners.

Kevin W. Coy, Hans Famularo, Blake J. Corry, and Christopher J. Richmond, for respondent.

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CONTENTS

FINDINGS OF FACT .............................................. 5

I. Ryder & Associates, APLC ................................ 8

A. How R&A Made Money ............................. 9
B. What R&A Did With the Money ...................... 28

1. Practice Funding Agreement With BFA ........... 28
2. Establishment of Ryder Law Corp. ................ 29

II. Ryder Goes Ranching ................................... 34

A. Sources of Money for Ranches ....................... 36

1. Counselor Capital as Blocker Entity for Ranches .................................... 36
2. First Counsel Capital as Blocker Entity for Ranches ................................. 37
3. Use of Four Additional Blocker Entities .......... 39
4. RLC and Its Stock Subscription Agreement ........ 41

B. Ryder Ranch Co., LLC Properties ..................... 42
C. Pattern Farms, LLC ................................ 43
D. Canyon View Ranch, LLC .......................... 44
E. Ryder Red Rock Ranch, LLC ........................ 44
F. Rodeo Holdings, LLC .............................. 45

III. Audit, Cashflow, and Trial ............................... 46

A. Audit ........................................... 46
B. Cashflow ........................................ 48

1. Following the Money ......................... 48
2. Gross Income ................................ 49
3. "Other Deductions" for 2005-06 ................. 68
4. Dividend Treatment .......................... 68

i. From R&A Through RLC ................. 69
ii. From Tax Products to Ranch Entities ........ 69
iii. From R&A's Bank Accounts to Third Parties for the Ryders' Benefit ............. 70

5. The Commissioner's Alternative Arguments ....... 72

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6. Disallowed Deductions ........................ 73

i. Substantiation of R&A Expenses ........... 73
ii. Ryder Ranch Co., LLC Losses ............. 76

7. California Pasteleria .......................... 79
8. Other Losses ................................ 80

C. Penalties ......................................... 83
D. Trial ............................................ 83

OPINION ....................................................... 84

I. Burden of Proof ........................................ 84

II. R&A's Unreported Income ............................... 86

A. Assignment of Income by Ryder & Associates .......... 87

1. What R&A Looked Like to Clients .............. 92
2. What Services R&A Provided .................. 93
3. Income Produced Through These Services ........ 95

i. Group Tax Products Income ............... 96
ii. Stand-Alone Products Income ............ 112

B. Additional Attempted Assignments of Income .......... 119

1. Assignment of Fee Income to BFA Through the PFA ................................... 121
2. Assignment of Staffing Income to ESOP Legal Consultants ........................... 125
3. Assignment of GCO Product Income to Individual General Counsel Offices ............. 128

C. "Other Deductions" ............................... 129

1. RLC and the Employee Leasing Agreement ...... 129
2. Remaining Deductions ....................... 132

III. Dividend Adjustment: The Ryders' Liability for Tax on Unreported Constructive Dividend Income ................. 134

A. Dividends From R&A Through RLC ................. 137
B. Dividend Income From Payments Made To Acquire and Operate the Ranch Properties .................... 141

1. Ryder Ranch Co., LLC ....................... 143
2. Pattern Farms, LLC .......................... 154

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3. Canyon View Ranch, LLC .................... 156
4. Ryder Red Rock Ranch, LLC .................. 157
5. Rodeo Holdings, LLC ........................ 158

C. Dividend Income From Payments to American Express and Ben Leland Construction, Inc. ............. 161
D. Summary ....................................... 163

IV. Remaining Issues ...................................... 164

A. Ryder Ranch Losses .............................. 164

1. Jurisdiction ................................ 165
2. Material Participation ........................ 169
3. Substantiation .............................. 173

B. Ordinary Losses From California Pasteleria for 2003 and 2004 ................................... 174
C. Investment Interest Expense for 2005 and Unreimbursed Employee Expenses for 2006 Through 2008 ................................... 175

V. Penalties ............................................. 176

A. Mrs. Ryder ...................................... 183
B. Ryder and R&A .................................. 185

MEMORANDUM FINDINGS OF FACT AND OPINION

HOLMES, Judge: Ryder & Associates, Inc., APLC (R&A), marketed six tax-reduction strategies that produced over $31 million in revenue between 2003 and 2011. The firm's fixed costs were low, and its out-of-pocket expenses not very large. Yet year after year it paid no income tax. Its revenue flowed instead

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into 560 accounts and into Ryder Law Corporation, a related S corporation.² It flowed into more than 1,100 ESOPs,³ other S corporations, LLCs, and other passthroughs. It flowed into ranches in Arizona, and it flowed into other ranches in New Mexico. And then it mostly seemed to pool in places where it would benefit Ernest S. Ryder and his wife Patricia, who received more than $15 million in distributions between 2002 and 2011 but paid only $31,000 in income tax during the years at issue.

Or so the Commissioner says.

FINDINGS OF FACT

Ernest Ryder is the owner of R&A. He and his wife Patricia live in Poway, California, and they are longtime Californians. After graduating from San Diego State College in 1968 with a degree in accounting, Ryder started law school at the University of California, Hastings. While in law school he put his accounting

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degree to use at Touche Ross & Co. There he learned about agricultural cooperatives and "how cooperatives work." Three years later he had a law degree and was admitted to practice in California. He went to work at Price Waterhouse & Co. in San Diego, California. Within a year, he moved back to Touche Ross, but this time in San Diego.⁴

He then moved to New York and enrolled at NYU for his master's degree in taxation, all the while continuing to work for Touche Ross in its Manhattan office. His time on the east coast was short lived, and he returned to California to join Ralph Gano Miller on a temporary job to help prepare and present a paper at the NYU Institute on Federal Taxation. When this was done, he began his career as a practicing tax lawyer at Hewitt & Shaw, a tax and business law firm also in San Diego. His timing was fortunate--he was at the stem-cell stage of his career the year that Congress enacted the Employee Retirement Income Security Act of 1974 (ERISA). When there's an avulsive change in the law like ERISA, young lawyers can develop valuable expertise in an environment uncluttered with more senior competitors.

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Knowledgeable associates in a fast-growing field are a hot commodity, and in 1975 Ryder was hired away by Harrigan, Ruff & Osborne to help that firm's clients get their retirement plans qualified under the new law. "[T]hat's when my career really took a turn," Ryder explained, and he was well on his way to becoming an expert in qualified retirement plans. He stayed at the Harrigan firm; and when he rose to become a shareholder, the name of the firm changed to Harrigan, Ruff, Ryder & Sbardellati.⁵ He ran the firm's pension department for many years, and that is where he started working on many of the aggressive tax-reduction strategies that led to these cases.

The Ryders have been married for more than a quarter century. Unlike her husband, Mrs. Ryder is neither a tax attorney nor a CPA, but she does think she has "a better understanding of tax th[a]n most people walking around on the street." She completed four years of college classes--two at the University of California, Riverside, and two at San Diego State--but never obtained a bachelor's degree. After college and up until the time of trial she had an assortment of jobs that included work at a jewelry store and Brooks Brothers; and she owned her own businesses that included a bridal salon and some cookie stores--stores that are at

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issue in these cases. She claims to work at the many different ranches she owns with her husband, where she says her tasks include "tak[ing] inventory * * * of the animals" and being "involved in their health." She also helped ensure the cattle got the necessary shots, ear tags, and brands; and "kept track of the breeding program" for them.

I. Ryder & Associates, APLC

The aggressiveness of Ryder's tax-reduction strategies seems to have caused some tension with his partners at Ruff Ryder, and he was asked to leave the firm sometime in 1995. Ruff Ryder's entire pension department and its profit-sharing clients left with him.⁶ With ample experience and a fully staffed pension practice, Ryder decided to open up his own firm in early 1996.

And here begins the Ryders' tax problems. R&A is a professional law corporation⁷ and has always been taxed as a C corporation.⁸ Ryder has owned

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100%, and has acted as president, of R&A since its creation. We find that Ryder also provided 100% of his legal services to clients through R&A during the years at issue.

Despite its success and longevity, R&A reported zero taxable income from 2002 through 2011. The Ryders also reported minimal taxable income on their individual returns for those years.

A. How R&A Made Money

Although R&A wasn't clientless when it opened its doors, it "started fresh" with no money in the bank or cashflow from work done by Ryder and his team at Ruff...