                                      SEVEN W. ENTERPRISES, INC. & SUBSIDIARIES, PETITIONERS v.
                                          COMMISSIONER OF INTERNAL REVENUE, RESPONDENT

                                                HIGHLAND SUPPLY CORPORATION & SUBSIDIARIES,
                                                  PETITIONERS v. COMMISSIONER OF INTERNAL
                                                           REVENUE, RESPONDENT
                                               Docket Nos. 13594–08, 13595–08.                           Filed June 7, 2011.

                                                  From February 2001 until March 2002, M worked as a
                                               consultant for P1 and P2 (collectively, Ps). During this period,
                                               M prepared P1’s 2000 tax return and P2’s 2001 tax return. In
                                               March 2002, Ps hired M as their vice president of taxes. As
                                               Ps’ vice president of taxes, M prepared and signed, on behalf
                                               of Ps, P1’s 2001, 2002, and 2003 tax returns and P2’s 2002,
                                               2003, and 2004 tax returns. In 2000 through 2004, Ps incor-
                                               rectly concluded that they were not liable for personal holding
                                               company taxes and, as a result, understated their tax liabil-
                                               ities relating to those years. R issued P1 a notice of deficiency
                                               relating to 2000 through 2003 and P2 a notice of deficiency
                                               relating to 2003 and 2004. In the notices, R determined that
                                               Ps were liable for accuracy-related penalties. Ps contend that
                                               they had reasonable cause for their underpayments and acted
                                               in good faith. Alternatively, Ps contend that they reasonably
                                               relied on the advice of M in 2000 when M served as a consult-

                                                                                                                                    539




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                                      540                136 UNITED STATES TAX COURT REPORTS                                        (539)


                                               ant and in 2001 through 2004 when he served as vice presi-
                                               dent of taxes.
                                                  1. Held: Pursuant to sec. 1.6664–4(b)(1) and (c)(1), Income
                                               Tax Regs., P1 is not liable for an accuracy-related penalty
                                               relating to 2000 because it reasonably relied on M to prepare
                                               its tax return.
                                                  2. Held, further, M does not qualify as ‘‘a person, other than
                                               the taxpayer’’, pursuant to sec. 1.6664–4(c)(2), Income Tax
                                               Regs., with respect to the returns which he signed on behalf
                                               of Ps, and therefore the aforementioned regulation is not
                                               applicable to Ps’ underpayments of taxes relating to 2001
                                               through 2004.
                                                  3. Held, further, Ps are liable for accuracy-related penalties
                                               relating to 2001 through 2004.

                                        Patrick B. Mathis, William J. Niehoff, and Philip D.
                                      Speicher, for petitioners.
                                        James M. Cascino, David B. Flassing, and William G.
                                      Merkle, for respondent.
                                        FOLEY, Judge: The issue for decision is whether petitioners
                                      are liable for section 6662(a) 1 accuracy-related penalties
                                      relating to tax years ending in 2000, 2001, 2002, 2003, and
                                      2004 (years in issue). 2

                                                                          FINDINGS OF FACT

                                         The Weder family controlled two closely held businesses:
                                      Highland Supply Corporation (HSC) and Seven W. Enter-
                                      prises, Inc. (7W). HSC was the parent of a group of corpora-
                                      tions (collectively, HSC Group) which filed a consolidated Fed-
                                      eral income tax return and manufactured floral, packaging,
                                      and industrial wire products. HSC Group included Highland
                                      Southern Wire, Inc., and Weder Investment, Inc. (WI). 3 7W,
                                      a corporation principally engaged in leasing nonresidential
                                      buildings, was the parent of a group of entities (collectively,
                                      7W Group), which filed a consolidated Federal income tax
                                      return. 7W owned an 89-percent interest in Weder Agricul-
                                      tural Limited (WAL), a limited partnership.
                                         In 1990, HSC Group and 7W Group (collectively, peti-
                                      tioners) hired William Mues, a certified public accountant, to
                                        1 Unless otherwise indicated, all section references are to the Internal Revenue Code of 1986,

                                      as amended and in effect for the years in issue.
                                        2 The years in issue are the tax years ending Dec. 31, 2000, 2001, 2002, and 2003, with respect

                                      to 7W Group and the tax years ending Apr. 30, 2003 and 2004, with respect to HSC Group.
                                        3 WI is wholly owned by Highland Southern Wire, Inc., which is wholly owned by HSC.




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                                      (539)              SEVEN W. ENTERS., INC. v. COMMISSIONER                                     541


                                      serve as their tax manager. Mues had experience relating to
                                      personal holding company tax matters and had previously
                                      worked at Deloitte Haskins & Sells, preparing tax returns for
                                      individuals, corporations, partnerships, and trusts, and at
                                      Peabody Coal Co., preparing consolidated returns. In 1991,
                                      petitioners promoted Mues to vice president of taxes. While
                                      employed by petitioners, Mues drafted documents, performed
                                      general legal work, and prepared returns for petitioners and
                                      petitioners’ shareholders. Petitioners provided Mues with full
                                      access to all resources necessary to handle petitioners’ tax
                                      matters (i.e., access to corporate and accounting personnel,
                                      corporate records, research databases, and outside profes-
                                      sionals). In addition, petitioners authorized Mues to sign, on
                                      their behalf, Internal Revenue Service (IRS) documents.
                                        On December 12, 1995, Southpac Trust International, Inc.,
                                      as trustee of the Family Trust (STI), an entity unrelated to
                                      petitioners, executed a $4,062,000 interest-bearing promis-
                                      sory note (the promissory note) for the benefit of HSC. In
                                      1996, HSC assigned the promissory note to WI.
                                        In 1997, the IRS began auditing HSC Group’s 1995 return
                                      and eventually expanded the audit to include HSC Group’s
                                      1996 and 1997 returns. On April 2, 1999, the IRS and HSC
                                      Group reached a settlement with respect to the audit relating
                                      to HSC Group’s 1995, 1996, and 1997 returns. The agreed
                                      adjustments were in excess of $2.2 million and included the
                                      disallowance of more than $450,000 of deductions relating to
                                      HSC’s president’s personal expenses. These adjustments were
                                      set forth on Form CG–4549, Income Tax Examination
                                      Changes, which required HSC Group’s signature. Mues signed
                                      his name on the line labeled ‘‘Signature of Taxpayer’’. The
                                      IRS and petitioners also reached settlements relating to HSC
                                      Group’s and 7W Group’s 1998 and 1999 returns. HSC Group
                                      had recurring adjustments relating to research and develop-
                                      ment expenses.
                                        While an employee of petitioners and prior to 2001, Mues
                                      obtained a master’s degree in business administration and
                                      began law school as a part-time student. In January 2001,
                                      Mues resigned as vice president of taxes and continued his
                                      legal studies as a full-time student. After resigning, Mues,
                                      pursuant to an agreement, provided petitioners with con-
                                      sulting services concerning tax matters and was not subject
                                      to petitioners’ supervision or direction. As a consultant, Mues




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                                      542                136 UNITED STATES TAX COURT REPORTS                                        (539)


                                      prepared 7W Group’s 2000 return and HSC Group’s 2001
                                      return. In March 2002, after Mues completed law school,
                                      petitioners hired him to serve as their vice president of taxes.
                                      In accordance with his responsibilities, Mues prepared and
                                      signed, on behalf of petitioners, 7W Group’s 2001, 2002, and
                                      2003 returns and HSC Group’s 2002, 2003, and 2004 returns.
                                         With respect to the years in issue, Mues incorrectly
                                      characterized petitioners’ income and concluded that peti-
                                      tioners were not liable for personal holding company taxes.
                                      The personal holding company tax is a penalty tax on undis-
                                      tributed income and is designed to discourage individuals
                                      from using closely held corporations to defer taxation on divi-
                                      dends, interest, rents, and other forms of passive income. See
                                      secs. 541, 543; Fulman v. United States, 434 U.S. 528, 530–
                                      531 (1978); H. Rept. 704, 73d Cong., 2d Sess. (1934), 1939–
                                      1 C.B. (Part 2) 554, 562–563; S. Rept. 558, 73d Cong., 2d
                                      Sess. (1934), 1939–1 C.B (Part 2) 586, 596–598. On HSC
                                      Group’s 2003 and 2004 returns, Mues incorrectly concluded
                                      that interest income, relating to the promissory note held by
                                      WI, was income from a source within HSC Group and that WI
                                      was not liable for the personal holding company tax. As a
                                      result, HSC Group, whose consolidated return included WI,
                                      understated its 2003 and 2004 tax liabilities. On 7W Group’s
                                      2000, 2001, 2002, and 2003 returns, Mues made a similar
                                      mistake with respect to interest income received by WAL.
                                      During 2000, 2001, 2002, and 2003, WAL received interest
                                      income relating to an installment note issued by an entity
                                      outside 7W Group, and each year 7W, in determining its
                                      income, took into account a portion of that interest income
                                      equal to 7W’s distributive share. For purposes of calculating
                                      the personal holding company tax, however, Mues did not
                                      take this income into account. In addition, Mues misapplied
                                      the personal holding company tax rules relating to rental
                                      income and, in doing so, incorrectly concluded that 7W’s
                                      rental income was not subject to the personal holding com-
                                      pany tax. As a result, 7W Group understated its 2000
                                      through 2003 tax liabilities.
                                         On March 7, 2008, respondent issued 7W Group a notice
                                      of deficiency relating to 2000, 2001, 2002, and 2003 and HSC
                                      Group a notice of deficiency relating to 2003 and 2004 (collec-
                                      tively, notices). In the notices, respondent determined that
                                      petitioners were liable for section 6662(a) accuracy-related




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                                      (539)              SEVEN W. ENTERS., INC. v. COMMISSIONER                                     543


                                      penalties. On June 4, 2008, petitioners, whose principal place
                                      of business was Highland, Illinois, timely filed petitions with
                                      the Court seeking redetermination of the penalties set forth
                                      in the notices.

                                                                                  OPINION

                                        Section 6662(a) and (b)(2) imposes a 20-percent penalty on
                                      the portion of an underpayment of tax attributable to any
                                      substantial understatement of income tax. The parties agree
                                      that petitioners’ incorrect reporting of personal holding com-
                                      pany tax on their returns relating to the years in issue
                                      resulted in substantial understatements of income tax as
                                      defined in section 6662(d). See sec. 7491(c); Higbee v.
                                      Commissioner, 116 T.C. 438, 446–447 (2001). Section
                                      6664(c)(1), however, provides that no penalty shall be
                                      imposed if a taxpayer demonstrates that there was reason-
                                      able cause for the underpayment and that the taxpayer acted
                                      in good faith. See also sec. 7491(c); Higbee v. Commissioner,
                                      supra. The determination of whether a taxpayer acted with
                                      reasonable cause and in good faith depends upon the facts
                                      and circumstances, including the taxpayer’s efforts to assess
                                      his or her proper tax liability; experience, knowledge, and
                                      education; and reliance on the advice of a professional tax
                                      advisor. Sec. 1.6664–4(b)(1), Income Tax Regs.
                                      I.    7W Group’s 2000 Return
                                        With respect to its 2000 return, 7W Group contends that
                                      it is entitled to relief from the accuracy-related penalty
                                      because it relied in good faith on the advice of Mues, an inde-
                                      pendent, competent tax advisor. Indeed, when he prepared
                                      7W Group’s 2000 return, Mues, having resigned from his
                                      position as petitioners’ vice president of taxes, was working
                                      for petitioners pursuant to a consulting agreement.
                                      Respondent emphasizes that Mues continued to perform the
                                      same activities before and after his resignation; requests, in
                                      essence, that we ignore the consulting agreement; and urges
                                      us to hold that Mues was not sufficiently independent for
                                      petitioners to avail themselves of relief pursuant to section
                                      6664(c).
                                        We reject respondent’s contention. Mues resigned, signed a
                                      valid consulting agreement, and served as petitioners’ inde-




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                                      544                136 UNITED STATES TAX COURT REPORTS                                        (539)


                                      pendent contractor. See Nationwide Mut. Ins. Co. v. Darden,
                                      503 U.S. 318, 322–325 (1992); Weber v. Commissioner, 103
                                      T.C. 378, 387–390 (1994) (delineating factors to be considered
                                      when determining an employment relationship between par-
                                      ties), affd. 60 F.3d 1104 (4th Cir. 1995). In addition, Mues
                                      signed 7W Group’s 2000 return as a paid preparer and the
                                      consulting agreement specifically provided that he was not
                                      subject to petitioners’ supervision. 7W Group provided Mues,
                                      an experienced and knowledgeable tax professional, with all
                                      of the relevant information necessary to prepare the return
                                      and relied, in good faith, on Mues to accurately and correctly
                                      prepare 7W Group’s 2000 return. Therefore, it was reason-
                                      able for 7W Group to rely on Mues to prepare its 2000
                                      return. See sec. 6664(c); Montgomery v. Commissioner, 127
                                      T.C. 43, 67 (2006) (stating that it is reasonable to rely on an
                                      advisor’s professional judgment if the taxpayer ‘‘selects a
                                      competent tax adviser and supplies him or her with all rel-
                                      evant information’’ and that ‘‘a taxpayer who seeks the
                                      advice of an adviser does not have to challenge the adviser’s
                                      conclusions, seek a second opinion, or try to check the advice
                                      by reviewing the tax code himself or herself.’’ (citing United
                                      States v. Boyle, 469 U.S. 241, 250–251 (1985))); sec. 1.6664–
                                      4(b)(1), (c)(1), Income Tax Regs. Accordingly, 7W Group is not
                                      liable for the section 6662(a) accuracy-related penalty
                                      relating to 2000.
                                      II. Petitioners’ 2001 Through 2004 Returns
                                         Petitioners contend that they exercised ordinary business
                                      care and prudence relating to their 2001 through 2004
                                      returns. We disagree. It is unclear whether petitioners’
                                      myriad of mistakes was the result of confusion, inattention
                                      to detail, or pure laziness, but we are convinced that peti-
                                      tioners and Mues failed to exercise the requisite due care.
                                      See United States v. Boyle, supra at 250–251; Neonatology
                                      Associates, P.A. v. Commissioner, 115 T.C. 43, 98 (2000), affd.
                                      299 F.3d 221 (3d Cir. 2002).
                                         Petitioners are sophisticated taxpayers. See Campbell v.
                                      Commissioner, 134 T.C. 20, 33 (2010); sec. 1.6664–4(b)(1),
                                      Income Tax Regs. Indeed, Mues was a well-educated and
                                      experienced tax professional with full access to petitioners’
                                      records and personnel. Petitioners readily acknowledge that




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                                      (539)              SEVEN W. ENTERS., INC. v. COMMISSIONER                                     545


                                      Mues was familiar with the personal holding company tax
                                      rules, yet emphasize that these rules are complex and that
                                      Mues’ mistakes were reasonable. The personal holding com-
                                      pany tax rules certainly are complex, but Mues failed to
                                      apply some of the most basic provisions of those rules. In
                                      fact, Mues conceded that in applying the section 543(a)(2)
                                      test he ‘‘truncated the test’’ and ‘‘misapplied the second
                                      prong’’. He simply did not read the entire test. Moreover, he
                                      did not understand or do the requisite work to ascertain the
                                      basic facts relating to petitioners’ income items. For example,
                                      the applicability of the personal holding company tax rules to
                                      HSC Group (or any member of the affiliated group) depended
                                      in part on the determination of whether income items were
                                      from inside or outside the affiliated group. See sec. 542(b).
                                      Mues failed to recognize that STI (i.e., the debtor on the note
                                      held by WI) was an entity outside the HSC Group. Mues was
                                      petitioners’ vice president of taxes both when the note was
                                      executed and when it was assigned. Furthermore, Mues testi-
                                      fied that he knew at the time he prepared HSC Group’s
                                      returns that the note’s debtor was outside the group, yet he
                                      inexplicably treated the interest income as if it was derived
                                      from within HSC Group and not subject to the personal
                                      holding company tax. When asked by the Court whether this
                                      was reasonable, Mues stated: ‘‘it seemed reasonable at the
                                      time. It seems less reasonable now in hindsight.’’ Petitioners’
                                      repeated audit adjustments relating to multiple IRS audits
                                      coupled with Mues’ experience, expertise, and education fur-
                                      ther bolster our conclusion that petitioners failed to exercise
                                      ordinary business care and prudence as to the disputed
                                      items. See Cobb v. Commissioner, 77 T.C. 1096, 1101–1102
                                      (1981), affd. without published opinion 680 F.2d 1388 (5th
                                      Cir. 1982).
                                         Petitioners further contend that the accuracy-related pen-
                                      alties should not apply because they relied on the advice of
                                      Mues—a competent tax advisor. Again, we disagree. As pre-
                                      viously discussed, good-faith reliance on the advice of an
                                      independent, competent tax advisor may constitute reason-
                                      able cause and good faith. Sec. 1.6664–4(b)(1), (c)(1), Income
                                      Tax Regs.; see also Neonatology Associates, P.A. v. Commis-
                                      sioner, supra at 98. The right to rely on professional tax
                                      advice, however, is subject to certain restrictions. See United
                                      States v. Boyle, supra at 250–251; sec. 1.6664–4(b), (c),




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                                      546                136 UNITED STATES TAX COURT REPORTS                                        (539)


                                      Income Tax Regs. Pursuant to section 1.6664–4(c)(2), Income
                                      Tax Regs., ‘‘advice’’ is ‘‘any communication * * * setting
                                      forth the analysis or conclusion of a person, other than the
                                      taxpayer’’. (Emphasis added.)
                                         Petitioners contend that, pursuant to section 7701(a)(1)
                                      and (14), the definition of a ‘‘taxpayer’’ is limited to peti-
                                      tioners (i.e., the persons subject to the tax) and does not
                                      include Mues—petitioners’ employee. A corporation can act
                                      (e.g., sign the corporation’s return) only through its officers.
                                      See sec. 6062; DiLeo v. Commissioner, 96 T.C. 858, 875
                                      (1991), affd. 959 F.2d 16 (2d Cir. 1992). Petitioners author-
                                      ized Mues to act as both the vice president of taxes and the
                                      taxpayer. Indeed, unlike the 2000 return, which Mues signed
                                      as a paid preparer, the 2001 through 2004 returns were
                                      signed by Mues on petitioners’ behalf. Simply put, Mues does
                                      not qualify as ‘‘a person, other than the taxpayer’’ with
                                      respect to the returns which he signed on behalf of the tax-
                                      payer (i.e., petitioners). Thus, petitioners did not have
                                      reasonable cause for the 2001 through 2004 underpay-
                                      ments. 4 See sec. 1.6664–4(b) and (c), Income Tax Regs. We
                                      need not, and do not, opine as to whether reliance on an in-
                                      house professional tax advisor may establish reasonable
                                      cause in other circumstances.
                                         Contentions we have not addressed are irrelevant, moot, or
                                      meritless.
                                         To reflect the foregoing,
                                                                               Appropriate decisions will be entered.

                                                                               f




                                         4 We note that petitioners, citing several regulations, contend that respondent’s position is con-

                                      trary to regulations providing that reasonable cause includes reliance on the advice of ‘‘house
                                      counsel’’. The cited regulations simply are not applicable. Secs. 53.4941(a)–1(b)(6), 53.4945–
                                      1(a)(2)(vi), 53.4955–1(b)(7), and 53.4958–1(d)(4)(iii)(A), Foundation Excise Tax Regs., relate to
                                      prohibited transactions and the application of excise taxes. Sec. 1.856–7(c)(2)(iii), Income Tax
                                      Regs., relates to the determination of whether an entity qualifies, pursuant to sec. 856(c), as
                                      a real estate investment trust. These regulations are distinguishable because they explicitly pro-
                                      vide that legal counsel includes ‘‘house counsel’’ and that the advice of counsel must be in a
                                      ‘‘reasoned written opinion’’. Furthermore, while sec. 1.6664–4, Income Tax Regs., provides a
                                      standard for determining whether a taxpayer has acted in good faith, the cited regulations re-
                                      late to whether a taxpayer has acted willfully.




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