Sparkman v. C.I.R.
| Decision Date | 10 December 2007 |
| Docket Number | No. 06-71476.,06-71476. |
| Citation | 509 F.3d 1149 |
| Parties | James S. SPARKMAN; Mercury Solar PTO, Amanda McKeough, Trustee, Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee. |
| Court | U.S. Court of Appeals — Ninth Circuit |
Paul J. Sulla, Jr., Laupahoehoe, HI, for the petitioners-appellants.
Eileen J. O'Connor, Assistant Attorney General; Jonathan S. Cohen, Michelle B. Smalling, United States Department of Justice, Tax Division, Washington, D.C., for the respondent-appellee.
Appeal from a Decision of the United States Tax Court. Tax Ct. Nos. 8400-03, 8650-03.
Before: O'SCANNLAIN, TASHIMA, and MILAN D. SMITH, JR., Circuit Judges.
Petitioner-Appellant James Sparkman appeals the decision of the Tax Court upholding the Commissioner's notice of deficiency with respect to tax years 1996 through 2000. See Sparkman v. Comm'r, T.C. Memo 2005-136 (2005). He objects to the Tax Court's ruling that one of his business entities, Mercury Solar PTO, lacked economic substance and should be disregarded for income tax purposes. He contends that the Tax Court improperly excluded his amended 1997 and 2000 tax returns from evidence admitted, erred in holding that he had not substantiated several depreciation and charitable deductions, and erred in calculating his income for 1996, 1997, and 1999. Finally, he argues that the Tax Court erred in imposing accuracy-related penalties under § 6662(a) of the Internal Revenue Code (I.R.C.).1 We reject each argument, and affirm the decision of the Tax Court.
James Sparkman has sold solar water heating systems to homeowners since 1983. Until 1993, Sparkman operated his business as a sole proprietorship, under the registered trade name "Mercury Solar."
In 1993, Sparkman purported to create and transfer his business to Hawaii Environmental Holdings ("HEH"), styled in its formation document an "Unincorporated Business Organization." The formation document, entitled "Contract and Declaration of Unincorporated Business Organization," provides that Sparkman (identified as the "Exchanger or Exchangers") will convey the Mercury Solar business to HEH in exchange "for twenty-five dollars of silver, Certificates comprising a total of one hundred units, and other full and adequate consideration." The formation documents also provide for a "Trustee" who will be responsible for the "exclusive management and control of [HEH's] property and business affairs without any consent of Certificate holders." The original such "Trustee" was "Lee Allan Hansen," who is not otherwise identified in the record. The trustee immediately appointed Sparkman as "Agent" and "President" of HEH, with authority "to open bank accounts, act as the official authorized signature on said bank accounts and to operate the company to the same extent as if he were the owner." Two months later, Hansen appointed Amanda Porter,2 at the time Sparkman's wife, to be trustee. In 1996, Porter was removed as trustee, and Hansen appointed Sparkman himself and Cynthia McNeff as trustees. McNeff was removed as trustee the following year, and in 1999, Hansen was removed, leaving Sparkman as the sole trustee of HEH.
In 1994, HEH purported to transfer its interest in the Mercury Solar business to Mercury Solar PTO, styled in its formation documents a "Pure Trust Organization," in exchange for units in Mercury Solar. Except for designating Mercury Solar a "Pure Trust Organization" and entrusting "exclusive management and control" of the entity with a "Fiduciary Owner" rather than a "Trustee," the formation documents are in almost all respects identical to those of HEH. "J. Clark Atkinson," also not otherwise identified in the record, was initially named as "Fiduciary Owner," but in 1998 Porter was appointed "Trustee," and Atkinson resigned as Fiduciary Owner.
The precise ownership of Mercury Solar PTO is unclear and disputed. The formation documents call for 100 beneficial units, which were initially given to HEH in return for the Mercury Solar business. These appear to have been immediately transferred to Sparkman. The record, stipulated to by both parties, contains a "Certificate Record" that records the assignment of one share each to William Bright, William Montgomery, and Myron Thompson. In testimony before the Tax Court, Porter described the first two entries of assignment as "administrational error[s]" but testified that the assignment to Thompson, an employee of Mercury Solar, was valid. According to Porter, 50 units are owned by HEH, 49 by Sparkman, and one by Thompson. When Thompson himself was asked during testimony whether he was "aware that [he] had a share," he responded, "I am now," but said that he did not know "what happened to the share."
During the years at issue, HEH purported to sell to customers solar energy produced by solar water heating components on the customer's property. It would purchase this equipment from Mercury Solar PTO, and hire Mercury Solar to install it. In addition to the solar service energy contract with HEH, each customer also received a "beneficiary certificate" entitling him to a beneficial ownership interest in HEH. The HEH trustee would thereby have the discretion to pass through solar energy tax credits to the customer, and such credits would be reflected on Schedules K-1 distributed to its "beneficiary"-customers. See generally Hvidding v. Comm'r, T.C. Memo 2003-151 (describing more fully the transaction in the case of a customer claiming a tax credit for the energy purchased); Richter v. Comm'r, T.C. Memo.2002-90 (same). As Thompson testified:
Mercury Solar is really just a contractor, it's a solar contractor. It basically was contacted to put solar panels and hot water heaters in homes and that kind of thing. So that's what our function was. HEH had another function of contracting Mercury Solar to do that for the purposes of selling energy and things like that.
HEH had no employees and shared a common office space with Mercury Solar. Mercury Solar did not have a solar contractor's license in its own name, but rather used Sparkman's.
According to the parties' stipulation, in 1999 the Hawaii Electric Company (HECO) issued a Form 1099 NEC (Non-Employee Compensation) reporting $195,275 in income earned by Mercury Solar. Regarding these payments, Sparkman later testified:
I do know that Mercury Solar in its transaction with Hawaiian Electric Company wanted to be paid faster.
. . . [W]henever someone installs a solar system via the Hawaiian Electric company rebate program either the contractor or the homeowner is entitled to an $800 cash subsidy. However, through its bureaucratic process Hawaiian Electric sometimes doesn't pay anywhere between 120 to 60—six months.
Mercury . . . sought out a factoring company that would take that receivable and pay it in cash. . . . And how it worked was Mercury submitted invoices that it was owed by Hawaiian Electric Company to ABA Funding and ABA Funding took a percentage of the $800 rebate . . . and then HECO sent ABA funding a check made payable to Mercury Solar which ABA Funding cashed. . . .
And apparently mid-1999 ABA Funding or Mercury Solar or HEH decided they wanted the funds directed into the Hawaii Environmental Holdings account instead of the Mercury Solar account.
In 2003, the IRS issued Sparkman a notice of deficiency with respect to the years 1996 to 2000, inclusive. It identified Mercury Solar PTO as "a sham with no economic substance" and accordingly attributed Mercury Solar's income to Sparkman directly. Because the income was attributable as self-employment income to him personally, Sparkman was assessed self-employment tax. The Service adjusted his income to include the $195,275 HECO payment, asserting it to be attributable entirely to Mercury Solar, and hence to Sparkman.3 It disallowed losses flowing through from HEH to Sparkman as unsubstantiated. Finally, it assessed both late filing (I.R.C. § 6651(a)(1)) and negligent underpayment (I.R.C. § 6662) penalties.
The Tax Court conducted a trial, summarizing the issues for decision as follows:
(1) Whether Mercury Solar PTO should be disregarded as an entity separate from Sparkman for Federal tax purposes and its net income attributed to Sparkman for the years at issue; (2) whether in 1999 Mercury Solar PTO (and hence Sparkman) had unreported income resulting from certain rebate payments from Hawaii Electric Company (HECO); (3) whether for the years at issue Sparkman is liable for self-employment tax on his earnings from Mercury Solar PTO; (4) whether for the years at issue Sparkman is entitled to claimed losses from a purported business trust, Hawaii Environmental Holdings (HEH); (5) whether Sparkman is entitled to additional itemized deductions, allegedly not claimed on his Federal income tax returns, for interest or charitable contributions; and (6) whether petitioners are liable for additions to tax and penalties.
It admitted into evidence a stipulation by the parties and attached exhibits (including Sparkman's amended returns for 1996 and 1999), and heard testimony from Porter, Sparkman, Thompson, and Joe Miskowiec, identified as a salesman for HEH. When Sparkman tried to enter into evidence his 1997 and 2000 amended returns, the Tax Court excluded them as irrelevant, but encouraged him to attempt to substantiate their contents through relevant evidence. After trial, the Tax Court decided in favor of the Commissioner on all the issues identified above and entered judgment upholding the Service's amended calculation of the deficiency and denying Sparkman's claim for additional deductions. Sparkman appealed to this court.
"It has long been the law that a transaction with no...
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