Sowards v. Commissioner, Docket No. 10025-99.
| Citation | 85 T.C.M. 1517 |
| Decision Date | 19 June 2003 |
| Docket Number | Docket No. 10025-99.,Docket No. 11144-00. |
| Parties | Ray W. and Marilyn S. Sowards v. Commissioner. |
| Court | United States Tax Court |
David M. Kirsch, for the petitioner Ray W. Sowards.
Basil J. Boutris, for the petitioner Marilyn S. Sowards.
Andrew R. Moore, for the respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
These cases were consolidated by motion of the parties for purposes of trial, briefing, and opinion. Respondent determined deficiencies in petitioners' Federal income taxes, additions to tax pursuant to section 6654,1 accuracy-related penalties pursuant to section 6662(a), and fraud penalties pursuant to section 6663 for the taxable years 1995, 1996, and 1997, in the following amounts:
Additions to Tax Penalties
Year Deficiency Sec. 6654 Sec. 6662(a) Sec. 6663
1995 $98,690 -- $19,738.00 --
1996 61,038 $305.73 1,150.80 $41,463.00
1997 24,818 66.23 774.60 15,708.75
After a concession by respondent the issues to be decided are as follows:
(1) Whether funds deposited into a bank account held in the name of a purported trust are taxable income for the taxable years 1995, 1996, and 1997 in the respective amounts of $58,057, $149,774, and $58,622;
(2) Whether petitioners failed to report $7,725 as additional income in 1997 relating to petitioner Ray Sowards's law practice;
(3) Whether respondent erroneously disallowed deductions for expenses allegedly incurred in 1996 and 1997 relating to petitioner Ray Sowards's law practice;
(4) Whether respondent erroneously disallowed deductions for expenses allegedly incurred in 1996 relating to petitioner Marilyn Sowards's purported organizational consulting business;
(5) Whether petitioner Ray Sowards is liable for fraud penalties pursuant to section 6663 for the taxable years 1996 and 1997;
(6) Whether petitioners are liable for accuracy-related penalties pursuant to section 6662(a) for the taxable years 1995, 1996, and 1997;2
(7) Whether petitioners are liable for additions to tax for failure to pay estimated tax pursuant to section 6654 for the taxable years 1996 and 1997;3 and
(8) Whether petitioner Marilyn Sowards is entitled to relief from joint and several liability pursuant to section 6015 for the taxable years at issue.
Some of the facts have been stipulated and are so found. The stipulation of facts, the second stipulation of facts, the stipulation of settled issues, and the attached exhibits are incorporated herein by this reference. At the time of filing the petition, petitioners resided in San Jose, California. Petitioners have been married to each other since 1969. At the time of filing the petition, petitioners were in the process of dissolving their marriage; they have lived in separate abodes since 1997.
Petitioner Ray Sowards (Mr. Sowards) worked for Pacific Gas and Electric (PG&E) until he became disabled in the mid-1980s. He received disability income from PG&E during the years at issue. Mr. Sowards graduated from Lincoln Law School in 1985. He was a licensed attorney in the State of California at the time the returns at issue were filed. Additionally, during the aforementioned period, Mr. Sowards was admitted to practice before this Court.
After graduating from law school, Mr. Sowards opened a law practice. His practice concentrated on what he described as asset protection. In or about the end of 1993 or 1994, Mr. Sowards became acquainted with Robert Strong (Mr. Strong). Mr. Strong operated a business entity known as System Two Limited (STL). STL was in the tax and financial services business, and it prepared tax returns. As part of this business, STL promoted business trusts. STL's promotion activities included seminars. Mr. Sowards participated in these promotion activities. During the years at issue, Mr. Sowards worked at an office located at STL's place of business. Mr. Sowards went to his STL office on a regular basis.
Mr. Sowards, STL, and Mr. Strong had a close business relationship.4 Mr. Sowards, Mr. Strong, and STL referred clients among themselves. Mr. Sowards performed legal services for STL and advised many of STL's clients.5 Mr. Sowards traveled and assisted Mr. Strong with seminars promoting STL's services conducted in Ohio, Hawaii,6 Alaska, and Texas. STL reimbursed Mr. Sowards for business and travel expenses. STL also provided Mr. Sowards with an American Express credit card.
On or about June 1, 1994, Mr. Sowards, with the assistance of Mr. Strong, purportedly created an inter vivos trust named Wealth Preservation Assistance (WPA). Mr. Sowards was the sole grantor of WPA.7 The trust document states that WPA's business purpose is "diversification of business activities and business assets for planned constructive growth."
Mr. Sowards purportedly assigned certificates of beneficial interest in WPA to his wife, Ms. Sowards, and their six children.8 Mr. Sowards did not inform his wife or children of their purported beneficial interests in WPA.
Mr. Sowards opened and maintained a bank account under the WPA name at the Bank of Milipitas, account No. 1109898 (WPA's bank account). He had sole signatory authority over WPA's bank account. During the relevant years, Mr. Sowards controlled and made all day-to-day decisions regarding WPA. Ms. Vera Morris (Ms. Morris) was named sole trustee of WPA. Ms. Morris was an employee of STL and the mother-in-law of Mr. Strong. WPA did not file Federal income tax returns for 1995, 1996, or 1997.
For the tax years at issue, STL issued checks to WPA approximately every week. On an approximately weekly basis, Mr. Sowards submitted statements to STL for the WPA payments he received. The dated statements read "To: System Two Limited," "From: WPA," "For: Legal Compliance" and list an amount "Due". The statements for 1996 and 1997 list total amounts due to WPA from STL of $131,700 and $46,853.52, respectively. Additionally, Mr. Sowards submitted reimbursement requests to STL for expenditures for gasoline.
During 1995, STL issued 65 checks made payable to WPA in the total amount of $65,833. All the aforementioned checks were deposited into WPA's bank account. During 1996, STL issued 56 checks made payable to WPA in the total amount of $128,000. All the aforementioned checks were deposited into WPA's bank account. During 1997, STL issued 19 checks in the total amount of $50,345 made payable to WPA. All the aforementioned checks were deposited into WPA's bank account.
In 1995, 1996, and 1997, Mr. Sowards wrote checks totaling $51,484.84, $121,685.21, and $62,876.44, respectively, from WPA's bank account. Most of the checks written on WPA's bank account were used to pay for his family's expenses. For example, Mr. Sowards wrote checks to his wife, Ms. Sowards, to the family's church, to a telephone company, to a mortgage lender, etc. Additionally, in 1995, 1996, and 1997, Mr. Sowards wrote checks made payable to cash in the total amounts of $2,800, $18,404.74, and $7,430, respectively.
Mr. Sowards also maintained a bank account at the Bank of the West, account No. 240547269 and a personal joint checking bank account with his wife at First Interstate Bank, account No. 684-0-18497 ().10 Some of the funds deposited into WPA's bank account were subsequently transferred via checks to the joint checking account. Petitioners used the funds in their joint checking account to pay for their living expenses.
In 1995, Mr. Sowards wrote 39 checks totaling $12,995 from WPA's bank account to Ms. Sowards. In 1996, Mr. Sowards wrote 59 checks totaling $17,538 from WPA's bank account to Ms. Sowards. In 1997, Mr. Sowards wrote 28 checks totaling $12,047.20 from WPA's bank account to Ms. Sowards. Ms. Sowards deposited the aforementioned checks into the joint checking account. In 1997, petitioners borrowed $30,000 from a third-party lender. Part of the loan proceeds was deposited into the joint checking account and used to pay, inter alia, credit card bills and home improvement expenses.11
On their 1996 return, petitioners included a Schedule C, Profit or Loss From Business, for "business consulting" that Ms. Sowards allegedly operated. Respondent denied all the expenses associated with this business for lack of substantiation. During respondent's examination, Revenue Agent Terry Daleiden (Agent Daleiden) questioned Mr. Sowards about this business and these expenses. Mr. Sowards represented to Agent Daleiden that his wife performed paralegal services associated with his law practice. Similarly, in responding to respondent's interrogatory concerning the substantiation of the business consulting expenses, Mr. Sowards answered: "All of petitioners' financial and tax data for the years in dispute were destroyed in a fire on April 8, 1998." In his second set of interrogatories, respondent asked Mr. Sowards to "State what duties Marilyn Sowards performed as an organizational consultant during 1996." Mr. Sowards responded: "Marilyn Sowards performed light filing and mailing." However, Ms. Sowards never had a consulting business. Mr. Sowards fabricated the business.12
On their 1996 and 1997 returns, petitioners included Schedules C for Mr. Sowards's law practice. On these Schedules C, petitioners claimed deductions for expenses of $11,197 and $14,805 for 1996 and 1997, respectively. Respondent denied all of petitioners' claimed deductions for lack of substantiation. Additionally, respondent imputed additional income of $7,725 in 1997 to petitioners from the law practice utilizing the bank deposits method of income reconstruction.
Ms. Sowards graduated from Brigham Young University in 1969 and thereafter attended Cal-State Hayward for 2 years. She has never taken an accounting course. During the years at issue, Ms. Sowards was a stay-at-home mother and homemaker....
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