MEMORANDUM FINDINGS OF FACT AND OPINION
This case is before the Court on a petition for redetermination of respondent's determination in a notice of deficiency that petitioners owe tax deficiencies and section 6662(a) accuracy-related penalties for their 2001 through 2007 tax years.
FINDINGS OF FACT
Some of the facts have been stipulated, and the stipulations, with the accompanying exhibits, are incorporated herein by this reference. At the time they filed their petition with this Court, petitioners resided in Nevada.
Petitioners filed joint Federal income tax returns for all relevant years. This case stems from petitioner husband Ronald V. Swanson's attempt to "turn an IRA into a Roth IRA" (Roth restructure).
Petitioner wife, Donna-Kay Swanson, was a homemaker for all tax years in issue and relied on her husband to determine whether to engage in the Roth restructure. Mr. Swanson attended college at the University of Michigan where he graduated with a degree in mechanical engineering and mathematics. After graduation, Mr. Swanson began working for Hughes Aircraft (Hughes). Mr. Swanson worked for Hughes or one of its subsidiaries for his entire 36-year career.
While working at Hughes, Mr. Swanson attended graduate school at the University of California Los Angeles (UCLA) where he graduated with a degree in Applied Mechanics. Additionally, Mr. Swanson finished a 2-year extension course at UCLA, where he received a certificate in business management.
During his career, Mr. Swanson worked at Hughes as a part-time master's fellow and then held positions in various areas of structural engineering. Eventually, he was promoted into administrative management.
In approximately 1997 Mr. Swanson helped develop Hughes Global Services, a 20-person company and eventual subsidiary of Hughes. Mr. Swanson was appointed president of Hughes Global As an employee of Hughes, Mr. Swanson was the beneficiary of a thrift and savings plan (Hughes TSP) to help with retirement.
Introduction to the Roth Restructure
Mr. Swanson initially heard about the Roth restructure from Fred Nardi (Mr. Nardi), a friend and coworker. Mr. Nardi told Mr. Swanson that on the basis of his discussions with other tax professionals, including his tax return preparer, Creal & Mather, he understood they felt that the Roth restructure "was solid".
Mr. Nardi showed Mr. Swanson an unsigned opinion letter from Grant Thornton (Nardi letter) detailing the Roth restructure. Mr. Swanson claimed he relied on the Nardi letter in deciding whether to engage in the Roth restructure. Apparently, the Nardi letter discussed listed transactions, and because of this, Mr. Swanson looked at the Internal Revenue Service (IRS) Web site.
In addition to Mr. Nardi, Mr. Swanson also talked with Jim Patton (Mr. Patton) and Bob Mather (Mr. Mather) before contacting Grant Thornton. Mr. Patton is an investment adviser who began advising Mr. Swanson in 2000 and is the only investment adviser Mr. Swanson has ever consulted. Mr. Patton was also of the impression that the Roth restructure "was above board".
Mr. Mather was Mr. Nardi's tax preparer. According to Mr. Swanson, he contacted Mr. Mather, who had other clients doing Roth restructures and apparently did not see any problems with them.
Introduction to Mr. Stover
In approximately March 2000 Mr. Stover met Mr. Swanson while he was on vacation in Las Vegas. Mr. Swanson asked Mr. Stover several questions, claiming his basic concern was that he "did not want to do anything illegal". Mr. Stover explained the Roth restructure in detail and told Mr. Swanson that the transaction was not only legal but had been "court tested".
After deciding to engage in the Roth restructure, Mr. Swanson met with Mr. Stover on other occasions, again inquiring at one or more of these meetings about the legality of the Roth restructure and whether it was a listed transaction. He also visited the IRS Web site and concluded the Roth restructure was not a listed transaction.
On April 11, 2000, Mr. Swanson executed an engagement letter with Grant Thornton. The engagement letter contained a clause providing that Grant Thornton would represent and defend Mr. Swanson or any related entity at no additional cost in case of audit by the IRS. The engagement letter also contained an indemnity clause providing that Grant Thornton would reimburse and indemnify the Swansons and any related entity for any civil negligence or fraud penalty assessed against them by Federal or State tax authorities.
Petitioners paid $120,000 for the Roth restructure, the engagement letter providing that the fee was to be split equally between Grant Thornton and Nevada Corp. Associations (NCA), a law firm. Mr. Swanson assumed NCA was an "outside legal firm providing services to Grant Thornton".
Mr. Swanson did not ask for a formal opinion letter, nor was one ever issued. Mr. Swanson believed that since he and Mr. Nardi were engaging in the same transaction, he did not need his own opinion letter.
Kruse Mennillo and Individuals Other Than Mr. Stover
In addition to Mr. Stover, Mr. Swanson had contact with other individuals at Grant Thornton, including Luther Oliver, a tax lawyer, and Ruth Donovan, a certified public accountant. In September 2001 Mr. Stover, along with other individuals he worked with, left Grant Thornton for Kruse Mennillo, LLP (Kruse Mennillo), another accounting firm. Neither party presented evidence explaining the reason behind Mr. Stover's abrupt move. At the time Mr. Stover left Grant Thornton, Mr. Swanson began using Kruse Mennillo instead of Grant Thornton.
Independent Advice and Knowledge
Despite the remarkable promised tax benefits of converting taxable IRA distributions to nontaxable Roth IRA distributions, Mr. Swanson did not ask anyone who was completely independent of the Mr. Patton and Mr. Stover groups for an opinion on the viability of the Roth restructure. Mr. Swanson knew that there were contribution limits to Roth IRAs, specifically that in 2000 the contribution limit was $2,000.
The Roth Restructure
Before the years in issue and before petitioners engaged Grant Thornton, Mr. Swanson had opened a traditional IRA with Charles Schwab with an account number ending in 6050 (Schwab IRA). Grant Thornton (specifically, Mr. Stover) and NCA, oversaw all of the steps in the Roth restructure. The Roth restructure was implemented as follows:
• March 20, 2000—A corporation, Sierra West Global Holdings, Inc. (Sierra West), was created by NCA. It then joined Northstar Acquisition and Investment Co., Inc. (Northstar), also formed by NCA sometime in the first 6 months of 2000. Sierra West and Northstar shared the same registered agent and registered office during all relevant periods. Mr. Swanson served as president, secretary, and treasurer of both corporations during 2000 and 2001. At some point, a James Hoeppner began serving as president and secretary of Sierra West, but acted as Mr. Swanson's nominee when doing so. Each corporation opened a bank account with an initial deposit of $250 on May 4, 2000.
Reporting the Roth Restructure
With the exception of 1 or 2 years, Mr. Swanson prepared his and Mrs. Swanson's joint tax returns for 1965 through 1998.
As part of the fee Mr. Swanson paid for the Roth restructure, Grant Thornton began preparing the Swansons' tax returns in 1999. This was because Mr. Swanson indicated he "wanted to make sure that the people that had developed the [Roth restructure] * * * continually followed it and knew exactly what they should be doing". Kruse Mennillo prepared the Swansons' tax returns beginning in 2001.
In order to facilitate the preparation of the returns, Mr. Swanson would provide the information and copies of pertinent documents asked for each year by either Grant Thornton or Kruse Mennillo. Individuals including Mr. Stover, Mr. Oliver, and Ms. Donovan presumably worked on the returns. None of these individuals testified.
When Mr. Swanson received the returns, he reviewed them to make sure that all the information he had given was transcribed properly, that the deductions that were taken were proper, and that each of the corporate entities had a tax return. Petitioners' tax returns showed excise tax on excess contributions to a Roth IRA of $2,000 for the 2000, 2001, 2002, 2003, and 2007 tax years; $3,500 for the 2004 tax year; and $5000 for the 2005 and 2006 tax years.
The Result of the Roth Restructure and Audit
As a result of the Roth restructure, Mr. Swanson made an excess contribution of $1,610,000 into his Baum Roth IRA through three different transfers occurring in 2000.
In 2004 Grant Thornton sent Mr. Swanson a letter regarding the Roth restructure (Grant Thornton letter) stating that the Roth restructure was potentially a listed transaction pursuant to IRS Notice 2004-8, 2004-1 C.B. 333. Notice 2004-8, entitled "Abusive Roth IRA Transactions", states, in part, that taxpayers are using transactions "to avoid the limitations on contributions to Roth IRAs" and that "these transactions, as well as substantially similar transaction" are listed transactions. The transactions described in Notice 2004-8,
Mr. Swanson asserts that he discussed the Grant Thornton letter with tax lawyers at Kruse Mennillo, including Mr. Stover, and was told that his transaction was not covered by the notice, he would not be penalized for nondisclosure, and that it was up to him whether he disclosed. Mr. Swanson did not discuss the Grant Thornton letter or attempt to discern whether he had engaged in a listed transaction with anyone else. Mr. Swanson decided to disclose the transaction anyway "just to make sure * * * [he] wasn't violating anything * * * [and because he wanted to take] the safest route". To disclose, Mr. Swanson attached a Form 8886, Reportable Transaction Disclosure Statement, to Northstar's 2003, 2004, and 2006 tax returns.
In 2006 the Swansons' returns were audited by the California Franchise Tax Board. According to Mr. Swanson, this was the first time that he suspected that the Roth restructure was not 100 percent viable. Mr. Stover and his colleague, Marc Sommers, indicated to Mr. Swanson that their opinion was "that the audit would not show any shortcoming of taxes paid". The audit was concluded in 2007 with "no change". Mr. Swanson "felt that the clearance by the California Tax Board was a further indication that the structure was viable and proper".
The Swansons timely filed Forms 1040, U.S. Individual Income Tax Return, and Forms 5329, Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts, for all years in issue. On October 6, 2008, respondent issued three notices of deficiency collectively showing the following deficiencies and section 6662(a) accuracy-related penalties:
The deficiencies for tax years 2001 through 2006 were excise tax deficiencies based upon respondent's determination that Mr. Swanson had made an excess contribution of $1.61 million to his Roth IRA in 2000 and a portion of the excess contribution remained in the account through December 31, 2006. The deficiency for 2007 was an income tax deficiency based upon respondent's determination that Mr. Swanson had unreported income of $1,803,900 and a computational adjustment of $3,168 to itemized deductions. The Swansons timely petitioned this Court. A trial was held on March 5, 2010, in Los Angeles, California.
Burden of Proof
We first address the Swansons' contention that the burden of proof has shifted to respondent. They contend that
Petitioner has confused the burden of proof for penalties, see sec. 7491(c), with the burden of proof for income tax liability, see sec. 7491(a). Pursuant to section 7491(a), the burden of proof on factual issues that affect the taxpayer's income and estate or gift tax liability (imposed by subtitles A and B of title 26 United States Code) may shift to the Commissioner in certain circumstances. There is no underlying income, estate, or gift tax liability at issue. Accordingly, section 7491(a) is not applicable.
Under section 7491(c), respondent bears the burden of production with respect to Mr. Swanson's liability for the section 6662(a) accuracy-related penalty. This means that respondent "must come forward with sufficient evidence indicating that it is appropriate to impose the relevant penalty." See
Section 6662(a) imposes an accuracy-related penalty of 20 percent on any underpayment of tax that is attributable to causes specified in subsection (b). Respondent asserts negligence or disregard of the rules and regulations as the justification for the imposition of the penalty. See sec. 6662(b)(1). More specifically, respondent urges that Mr. Swanson was negligent in failing to report his excess contributions to a Roth IRA for the 2001 through 2006 tax years.
"[N]egligence", for this purpose, is "any failure to make a reasonable attempt to comply with the provisions of * * * [the Internal Revenue Code]".
In determining a taxpayer's liability for a negligence penalty, courts generally look both to whether the underlying investment was legitimate and whether the taxpayer exercised due care in the position taken on the return.
Petitioners' education and experience with business and financial decisionmaking will be considered in determining whether they were negligent in blindly accepting the advice of adviser promoters who charged large fees. Respondent has introduced sufficient evidence that Mr. Swanson negligently failed to report excess contributions to his Roth IRA and therefore has met his burden of production with regards to the section 6662(a) accuracy-related penalty.
Reasonable Cause Exception
There is an exception to the section 6662(a) penalty when a taxpayer can demonstrate: (1) Reasonable cause for the underpayment and (2) that the taxpayer acted in good faith with respect to the underpayment. Sec. 6664(c)(1); sec. 1.6664-4(a), Income Tax Regs. Regulations promulgated under section 6664(c) provide that the determination of reasonable cause and good faith "is made on a case-by-case basis, taking into account all pertinent facts and circumstances." Sec. 1.6664-4(b)(1), Income Tax Regs.
Mr. Swanson bears the burden of proving that he meets the reasonable cause and good faith exception. He asserts that he meets it because he: (1) Investigated the Roth restructure before engaging in it; (2) read and relied on
To begin, we do not determine whether Mr. Swanson's alleged reliance on the "no-change" letter issued by the State of California helps to establish reasonable cause and good faith. Importantly, the issues in this case are the accuracy-related penalties for his 2001 through 2006 tax years, the 2007 year having already been conceded by respondent in full. According to Mr. Swanson's testimony, he received the "no-change" letter in 2007. That means the "no-change" letter could not have had anything to do with the justification for petitioners' failure to act properly with the tax years 2001 through 2005. We recognize that Mr. Swanson's 2006 tax return could have been timely filed in 2007 after the receipt of the "no-change" letter. But, Mr. Swanson never provided any evidence as to exactly when in 2007 he received the "no-change" letter or filed the joint Federal income tax return and attached Form 5329. Further, by failing to introduce the "no-change" letter into evidence, Mr. Swanson has failed to provide this Court with proof as to the exact issues California audited and its reasons for concluding the audit with a "no-change" letter.
We now turn the Swansons' asserted reliance on
We cannot find that the Swansons' claimed reliance on the
Next, we turn to the Swansons' argument that they relied on Mr. Stover and other professionals. To support this argument, petitioners cite
While good faith reliance on professional advice based on all the facts may, in many cases, provide a basis for a reasonable cause defense, it is not absolute.
The general rule in the Court of Appeals for the Ninth Circuit, to which this case would be appealable absent a stipulation to the contrary, is that "a taxpayer cannot negate the negligence penalty through reliance on a transaction's promoters or on other advisors who have a conflict of interest."
At a minimum, Mr. Stover and his colleagues had a conflict of interest and were not independent.
While Mr. Swanson argues that he also relied on Mr. Nardi, Mr. Patton, and Mr. Mather, there is no evidence, other than Mr. Swanson's testimony, that he talked with these three individuals nor what they talked about and the advice he received.
Mr. Swanson appears to believe that his own self-serving testimony is enough to establish reasonable cause and good faith. We disagree. We have "found reliance to be unreasonable where a taxpayer claimed to have relied upon an independent adviser because the adviser either did not testify or testified too vaguely to convince us that the taxpayer was reasonable in relying on the adviser's advice".
Petitioners must surely have realized that the deal was too good to be true. See
Mr. Swanson had doubts, repeatedly asking whether the Roth restructure was legal. Yet, despite these doubts, he never asked for a written opinion letter or sought the advice of an independent adviser, even after receiving a letter from Grant Thornton warning him that he may have engaged in a listed transaction and receiving notice that his returns were being audited by the State of California.
The Court has considered all of petitioner's contentions, arguments, requests, and statements. To the extent not discussed herein, we conclude that they are meritless, moot, or irrelevant.
To reflect the foregoing,