Mazzei v. Comm'r

• Decision Date: 05 March 2018
• Docket Number: Docket No. 16702-09,150 T.C. No. 7,Docket No. 16779-09.
• Parties: CELIA MAZZEI, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent ANGELO L. MAZZEI AND MARY E. MAZZEI, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent
• Court: U.S. Tax Court

CELIA MAZZEI, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentANGELO L. MAZZEI AND MARY E. MAZZEI, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent

150 T.C. No. 7

Docket No. 16702-09

Docket No. 16779-09.

UNITED STATES TAX COURT

March 5, 2018

Ps entered into a prepackaged plan to save taxes by routing funds from their family business through a Bermuda-based foreign sales corporation (FSC) and then into Roth IRAs created for this purpose. Pursuant to this plan, in 1998 each P directly contributed $2,000, the applicable contribution limit, to his or her newly created Roth IRA, which then paid a nominal amount for stock in the FSC. From 1998 to 2002 Ps routed payments totaling $533,057 from their family business, through the FSC, and into their Roth IRAs.

Ps contend that we should respect the form of these transactions as payments from Ps' business to the FSC, followed by payments of dividends by the FSC to the Roth IRAs. R contends that the payments from the FSC to Ps' Roth IRAs represented, in substance, contributions from Ps to their Roth IRAs. R contends that because these payments exceeded Ps' contribution limits for their Roth IRAs, Ps are liable for excise taxes under I.R.C. sec. 4973.

Held: On the facts presented, Ps and not their Roth IRAs were the owners, for Federal tax purposes, of the FSC stock; in substance the FSC dividends were income to Ps, who contributed the funds to their Roth IRAs. Summa Holdings, Inc. v. Commissioner, 848 F.3d 779 (6th Cir. 2017), rev'g T.C. Memo. 2015-119, distinguished.

Held, further, pursuant to I.R.C. sec. 4973 Ps are liable for excise taxes on excess contributions to their Roth IRAs.

Held, further, R's imposition of additions to tax under I.R.C. sec. 6651(a)(1) and (2) is not sustained.

Lewis Richard Walton and Lewis Richard Walton, Jr., for petitioners.

Erin Kathleen Salel, Kathleen A. Tagni, and Miles B. Fuller, for respondent.

CONTENTS

FINDINGS OF FACT ............................................... 6

I. WGA's FSC/IRA Program .................................... 8

II. Petitioners' Contribution Limits ............................... 9

III. Petitioners' Entrance Into WGA's FSC/IRA Program ............. 10

A. Operations Procedure Memorandum ...................... 12

B. Commission Agreement ................................ 12 C. Services Agreement ................................... 13

D. Management Agreement ............................... 13

E. Shareholders' Agreement ............................... 13

F. Compliance Guide .................................... 14

IV. Operations of the FSC/IRA Program .......................... 15

V. Procedural Background ..................................... 17

OPINION ........................................................ 18

I. Burden of Proof ............................................ 19

II. Statutory Framework: Roth IRAs and Excess Contributions ........ 19

III. The Parties' Arguments ..................................... 22

IV. General Principles: Substance Over Form ...................... 24

V. The FSC Provisions ........................................ 29

A. Relaxed Transfer Pricing Rules .......................... 30

B. Effective Tax Rate Cut for Qualifying Income .............. 33

C. Application of FSC Rules to Petitioners' Transactions ........ 35

D. The Limited Scope of the FSC Provisions ................. 36

VI. The Payments to the Roth IRAs Were Contributions .............. 38

A. The Roth IRAs Were Exposed to No Risk .................. 43

B. The Roth IRAs Could Expect No Upside Benefits ........... 47 C. Conclusion .......................................... 49

VII. Petitioners' Counterarguments .............................. 51

A. Summa Holdings II ................................... 51

B. Petitioners' Ownership Argument ........................ 55

C. Petitioners' Congressional Purpose Arguments ............. 57

VIII. Response to Dissent ...................................... 59

A. Our Analysis Does Not Sham or Disregard Any Entities ...... 59

B. Our Analysis Properly Considers the Facts as a Whole ........ 59

C. The Substance Inquiry Is Appropriate ..................... 60

D. Our Approach Appropriately Considers Value .............. 63

E. The Dissent's Hypothetical Misconceives Our Analysis ....... 65

F. The Dissent's Approach Lacks Support in the Code .......... 67

IX. Conclusion .............................................. 68

X. Additions to Tax ........................................... 69

THORNTON, Judge:

By notice of deficiency, respondent determined excise tax deficiencies for Angelo and Mary Mazzei for 2002-07, and additions to tax under section 6651(a)(1) and (2):¹

   Additions to tax Year Deficiency Sec. 6651(a)(1) Sec. 6651(a)(2)  2002  $6,637  $1,493  $1,659  2003  9,408  2,116  2,352  2004  10,523  2,367  (1)  2005  11,349  2,553  (1)  2006  13,759  3,095  (1)  2007  15,914  3,580  (1) 

¹Amounts to be determined.

In a separate notice of deficiency, respondent determined excise tax deficiencies for Celia Mazzei for 2002-07, and additions to tax under section 6651(a)(1) and (2):

   Additions to tax Year Deficiency Sec. 6651(a)(1) Sec. 6651(a)(2)  2002  $4,889  $1,100  $1,222  2003  6,148  1,383  1,537  2004  6,372  1,433  (1)  2005  6,817  1,533  (1)  2006  7,850  1,766  (1)  2007  8,616  1,938  (1) 

¹Amounts to be determined.

While residing in California, petitioners timely petitioned this Court with respect to both notices of deficiency. These cases have been consolidated for trial, briefing, and opinion. The issues for decision are (1) whether petitioners are liable for excise taxes under section 4973 for 2002-07 and (2) whether petitioners are liable for section 6651(a)(1) and (2) additions to tax.

FINDINGS OF FACT

Angelo Mazzei graduated from college with a science degree in industrial technology and a minor in business administration. In 1977 he filed his first patent application for an "injector that mixes chemicals with water (for use primarily in agriculture)."² Mr. Mazzei got patent No. 4,123,800--"MixerInjector"--and in 1978, seeing business potential in his idea, he and his wife, Mary Mazzei, formed the Mazzei Injector Corp. (Injector Corp.), an S corporation.³

Initially Mrs. Mazzei was very active in the business and was Injector Corp.'s bookkeeper. She still discusses the business with Mr. Mazzei but is no longer an employee. Mr. and Mrs. Mazzei's daughter, Celia Mazzei, has taken a much more active role in the business. After graduating from college with a degree in mathematics, she became vice president of research and development for Injector Corp. and still works with her father to invent new products. She now owns 10% of both ALM Corp., see infra p. 9, and Injector Corp.

After its inception in 1978 Injector Corp. grew quickly and by its second year started working with distributors to market and sell its products. In or about 1984 Injector Corp. started selling overseas through foreign distributors. Although sales have fluctuated, by 1998 export sales provided a reliable stream of income. Today, Mr. Mazzei has patents in the United States and several foreign countries including Canada and Japan. He has also adapted his injectors for several different industries, including water treatment, wine production, and spa manufacturing.

I. WGA's FSC/IRA Program

The same year Mr. Mazzei got his patent, he joined the Western Growers Association (WGA)--a trade association for farmers. Sometime in the 1990s WGA began creating and selling interests in foreign sales corporations (FSCs) to its members. FSCs were foreign corporations which elected to be taxed under now-repealed sections 921-927.⁴ WGA's FSCs were located in Bermuda and managed by a company called Quail Street Management (Quail Street).⁵ To participate in WGA's FSC/individual retirement account (IRA) program, the individual shareholders or owners of WGA's corporate or passthrough members had to have self-directed section 408 IRAs (traditional IRAs), which the shareholders or owners used to purchase stock in one of WGA's FSCs. Whensection 408A Roth IRAs (Roth IRAs) were added to the Code in August 1997, see Taxpayer Relief Act of 1997, Pub. L. No. 105-34, sec. 302, 111 Stat. at 825, WGA changed its program, substituting Roth IRAs for traditional IRAs. WGA marketed its FSC/IRA program to its members, emphasizing that the FSC/IRA structure would provide tax benefits without any loss of control over the business.

II. Petitioners' Contribution Limits

Contributions to a Roth IRA are limited according to a statutory formula. See sec. 408A(c)(2). The limitation for any year decreases as the taxpayer's modified adjusted gross income (MAGI) increases; if MAGI is high enough, the limitation is reduced to zero. See sec. 408A(c)(3).

Petitioners' pre-1998 contribution limits were customarily zero, but as a result of some restructuring, petitioners claim that they each had a respective contribution limit of $2,000 for 1998. Their restructuring is a bit mysterious even after trial. Mr. and Mrs. Mazzei each started with 45% of Injector Corp. Celia Mazzei owned the remaining 10%. Petitioners organized another S corporation, ALM Corp., owned in the same proportions. ALM Corp. and Injector Corp. then formed an LLC named Mazzei Injector Co. (Injector Co.), which was treated for tax purposes as a partnership.⁶

Respondent describes this restructuring but has not challenged it, so we deem respondent to have waived or conceded any issue with respect to it. Accordingly, we find that each petitioner's contribution limit was $2,000 for 1998. Each petitioner's contribution limit was zero for 1999, 2000, 2001, and 2002.⁷

III. Petitioners' Entrance Into WGA's FSC/IRA Program

In February 1998 Injector Co. applied to WGA's FSC/IRA program. Injector Co.'s application to the program valued its annual export sales at approximately $1.5 million. Once Injector Co. was accepted into the program, each petitioner opened a self-directed Roth IRA and contributed $2,000. Eachpetitioner then...