TODD v. COMMISSIONER OF INTERNAL REVENUENo. 11-60845, Summary Calendar.
FREDERICK D. TODD, II; LINDA D. TODD, Petitioners-Appellants,
COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.
COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.
United States Court of Appeals, Fifth Circuit.
Filed: August 16, 2012.
Before: SMITH, STEWART, and PRADO, Circuit Judges.
Petitioners-Appellants Frederick and Linda Todd appeal the decision of the United States Tax Court that a purported $400,000 loan to Frederick was taxable income (and not a loan) and therefore found the Todds liable for both income tax deficiency and a penalty under I.R.C. § 6662(a). Because the Tax Court did not clearly error in finding that the purported $400,000 loan was income nor in finding that the Todds had failed to prove their affirmative defense to the penalty, we AFFIRM.
I. FACTUAL AND PROCEDURAL BACKGROUND
Frederick Todd is the sole shareholder, director, and president of Frederick D. Todd II, M.D., P.A. (the "Corporation"), a Texas professional association for Frederick's neurosurgery practice. In August 1995, the Corporation became a member of a union, which allowed the Corporation to participate in a death-benefits-only plan through the American Workers Benefit Fund Trust ("AWBF"). The death-benefits-only plan provided death benefits of up to eight times an employee's annual salary with a cap at $6 million. To fund these obligations, AWBF took out life insurance policies in the same amount of the death benefit for each of the Corporation's employees from Southland Life Insurance Company ("Southland"). Finally, to continue the eligibility for the death benefits, the Corporation had to make annual payments to AWBF roughly equal to the amount AWBF owed to Southland in combined premiums for the Corporation's employees. Frederick had a $6 million death benefit with his wife Linda named as the beneficiary. In December 2000, the Corporation changed local union affiliation and resultantly transferred its AWBF plan to United Employee Benefit Fund Trust ("UEBF") on the same terms and with the same relationship with Southland.
Under the terms of the UEBF plan, UEBF trustees could, upon a showing of serous financial hardship, make loans to a plan participant up to the accrued equity in his plan. After Frederick inquired to UEBF and after UEBF consulted with Southland, UEBF informed Frederick that his maximum available distribution from the plan was $400,000. In July 2002, Frederick formally applied to UEBF for a $400,000 loan/distribution from his plan due to "unexpected housing costs." UEBF approved Frederick and secured a $400,000 loan from Southland, but after realizing that Southland was going to charge UEBF nearly 5% interest on the loan, UEBF decided that such an arrangement was unacceptable. Instead, UEBF with Frederick's consent decided to reduce the value of the life insurance on Frederick by $400,000 (i.e., a partial surrender), which left UEBF's policy on Frederick's life with a $5.6 million face value. In September 2002, UEBF issued Frederick a check for $400,000 with "participant loan" noted on the memo line. The issuance of the $400,000 check coincided with the last payment to UEBF that the Corporation would make.
Under the terms of the UEBF's trust agreement with the Corporation, UEBF was supposed to secure any loan to a plan participant before making any distribution. Such a note was also required to establish a quarterly payment schedule and bear a reasonable rate of interest. In February 2003, UEBF decided that it needed a promissory note from Frederick. In March 2003, Frederick signed a note for $400,000 to UEBF. That note bore a 1% interest rate and provided for quarterly payments by Frederick of approximately $20,500 until the note was paid off. The note also provided a "dual repayment mechanism," which allowed UEBF to deduct any outstanding balance on the note from any later distribution to Frederick. In practice, that mechanism allowed UEBF to deduct any remaining balance owed on the note from any death benefits owed to Linda upon Frederick's death. As noted above, the Corporation ceased its payments to UEBF in late 2002; similarly, Frederick never made any payments on the note.
The Todds filed their 2002 and 2003 tax returns with the IRS in July 2005. The IRS noted unrelated deficiencies in the Todds' returns for 2002 and 2003, which the Todds challenged in the Tax Court. During the course of its investigation, the IRS discovered the $400,000 distribution from UEBF to Frederick and amended its deficiency charges to include deficiencies caused by the non-reporting of the $400,000 as income. The Tax Court applied a multi-factored approach to the determination of whether the $400,000 constituted a loan and determined that it did not. It therefore concluded that the Todds were deficient in 2002 and found a penalty applicable for the same year.
II. STANDARD OF REVIEW
We review decisions of the Tax Court under the same standard as district court decisions: legal conclusions are reviewed de novo; factual findings are reviewed for clear error. Terrell v. Comm'r,
A. The $400,000 "Loan"
A loan does not "constitute income [under the Internal Revenue Code] because whatever temporary economic benefit the borrower derives from the use of the funds is offset by the corresponding obligation to repay them." Moore, 412 F.2d at 978. The central inquiry for determining if a transaction is a bona fide loan for tax purposes is whether it is "the intention of the parties that the money advanced be repaid." Id. As we noted in Moore, this inquiry is one that "involv[es] several considerations." Id. Moore, however, failed to delineate what those considerations were.
The Tax Court below looked to seven factors laid out by the Ninth Circuit in Welch v. Commissioner,
Id. at 1230 (citing Crowley v. Comm'r,
The Todds contend that the Tax Court clearly erred because they formally satisfied the first three categories, which were three of the central pieces of evidence that the Tax Court used to conclude that the $400,000 was not a loan. While we recognize that Frederick and UEBF executed a note and payment schedule, the fact that the note and schedule were only adopted after the fact, in contravention of UEBF policies, suggests the possibility that doing so was merely "a formalized attempt to achieve the desired tax result while lacking in necessary substance, . . . merely parad[ing] under the false colors" of a bona fide loan. Tomilinson v. 1661 Corp.,
B. Reasonable Cause Defense
Where there is an underpayment that results from negligence or disregard of the rules or that was substantial, the Internal Revenue Code imposes a penalty equal to 20% of the underpayment. 26 U.S.C. § 6662(a)-(b). However, the penalty shall not be imposed "if it is shown that there was a reasonable cause for [any portion of an underpayment] and that the taxpayer acted in good faith with respect to such portion." Id. at § 6664(c)(1). The Todds argue that the penalty should not apply because they had a certified public accountant prepare their 2002 return. Our precedent mandates that the taxpayers show that they "[r]eli[ed] on the advice of a professional tax adviser" and additionally that such reliance was valid due to "the quality and objectivity of the professional advice which they obtained." Bemont Invs., L.L.C. ex. rel. Tax Matters Partner v. United States,
For the foregoing reasons, we AFFIRM the decision of the Tax Court.
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