In Andrew Mitchell Berry and Sara Berry v. Commissioner, T.C. Memo. 2025-109, the United States Tax Court addressed a determined deficiency of $88,695 and an accuracy-related penalty of $17,739 under section 6662(a) for the petitioners’ 2016 tax year.

Background and Procedural History

The primary issues remaining for decision after substantial concessions by both parties were: (1) whether Andrew Berry was a 50% shareholder of Phoenix Construction & Remodeling, Inc. (PCR), an S corporation, during 2016, and consequently whether petitioners failed to report $77,195 of Schedule E income attributable to that interest; and (2) whether petitioners were liable for the accuracy-related penalty under section 6662(a) and (b)(1) and (2) due to a substantial understatement of income tax or negligence.

PCR, a California construction company, was equally owned (50% each) by Andrew Berry and his father, Ronald Berry, in 2016. Andrew performed work, billed clients, collected receipts, and was an authorized signer on a PCR bank account during that year. PCR timely filed Form 1120S for 2016, issuing Schedules K-1 to both Andrew and Ronald, attributing 50% ownership to each. Petitioners reported a loss from PCR on their joint 2016 Form 1040.

The Commissioner determined that PCR underreported income derived from three sources, none of which were reported on the Form 1120S:

Diverted Receipts: $74,382 paid by clients (the Cancholas) directly to Showhauler Trucks, Inc. for Ronald Berry’s motorhome, in satisfaction of a change order owed to PCR.
Cash Receipts: $21,008 in cash payments from clients (the Strouds) for change orders.
Bank Deposits: $59,000 in bank deposits, comprised of $58,000 from Three B’s Development, LLC, and $1,000 from Paul and Janis Switzer.

Taxpayers’ Request for Relief and Evidentiary Rulings

The petitioners sought relief primarily by arguing that Andrew was not a beneficial shareholder of PCR income for the full year and that the determined unreported amounts were either non-taxable loan repayments or were offset by substantiated expenses. They also raised a whipsaw argument regarding the allocation of income.

Before addressing the substantive issues, the court resolved critical evidentiary matters. The court emphasized that the Standing Pretrial Order required the exchange of all trial documents, other than stipulated facts, at least 14 days before trial. The purpose of this 14-day rule is to allow the opposing party time to review, prepare challenges, or rebut evidence, thereby preventing an "ambush".

The petitioners violated the 14-day rule by producing documents the night before and the morning of trial. The court concluded that this late production prejudiced the Commissioner, particularly since review revealed inconsistencies and alterations in the documents. The court explicitly rejected petitioners’ excuse of late receipt from Ronald Berry, finding Ronald not to be a credible witness. Given the prejudice and lack of good cause, the court excluded several key exhibits (Exhibits 47-P through 50-P, 52-P through 54-P, and 57-P). The court noted that Andrew and Ronald had been involved in prior Tax Court proceedings and were aware of the production requirements.

The court did admit Exhibit 60-R under Federal Rule of Evidence 106, which provides that when a party introduces part of a statement, the adverse party may require the introduction of any other part that in fairness ought to be considered at the same time. Similarly, the court admitted Exhibit 49-P (invoices) because versions of those documents were available in the administrative file, but cautioned that it would discount the weight given to the exhibit due to substantive alterations found on the submitted copies (e.g., “paid” stamps and handwritten notes).

Court’s Analysis of the Law and Application to the Facts

Burden of Proof

The taxpayer generally bears the burden of proving that the determinations in a Notice of Deficiency are in error (Rule 142(a)(1); Welch v. Helvering, 290 U.S. 111, 115 (1933)).

For unreported income cases arising in the Ninth Circuit (the court of appeal absent stipulation to the contrary, per section 7482(b)(1)(A)), the Commissioner must first establish an "evidentiary foundation" connecting the taxpayer with the income-producing activity (Weimerskirch v. Commissioner, 596 F.2d 358, 361–62 (9th Cir. 1979)). The Commissioner satisfied this burden by introducing PCR’s general ledger, bank records, invoices, and emails linking the disputed income items to PCR (Hardy v. Commissioner, 181 F.3d 1002, 1004 (9th Cir. 1999)). Consequently, the burden shifted back to the petitioners to prove the determinations were incorrect.

Andrew Berry’s Shareholder Status

Section 1366(a)(1) mandates that S corporation shareholders must take into account their pro rata share of the S corporation’s income, loss, deductions, and credits, irrespective of whether the income is distributed.

Legal Standard: Stock ownership for federal tax purposes is determined by beneficial ownership, not merely record ownership (Walker v. Commissioner, 544 F.2d 419, 422 (9th Cir. 1976); Hoffman v. Commissioner, 47 T.C. 218, 233 (1966)). Beneficial ownership may be lost only if an agreement with another party or corporate governing articles specifically restrict or limit ownership rights (Dunne v. Commissioner, T.C. Memo. 2008-63, 2008 WL 656496, at 9).

Application: Petitioners claimed Andrew was removed as an officer in March 2016, but removal as an officer does not equate to removal as an owner. Petitioners provided no evidence that Andrew sold his interest or that any agreement restricted his ownership rights. Andrew was attributed 50% of the income via a Schedule K-1 for 2016. Even if petitioners had evidence of a future stock sale, they failed to provide the "strong proof" necessary to establish that beneficial ownership was transferred prior to the effective sale date stated in any potential agreement (Lucas v. Commissioner, 58 T.C. 1022, 1032 (1972)).

Conclusion: The court held that Andrew remained a 50% shareholder of PCR throughout 2016, and petitioners must include his pro rata share of the determined PCR income.

Analysis of PCR’s Unreported Income

Bank Deposits (Loan vs. Income)

Petitioners claimed the $58,000 from Three B’s was a repayment of an alleged bona fide loan.

Legal Standard: Loan proceeds are generally excluded from income because of the obligation to repay (Commissioner v. Tufts, 461 U.S. 300, 307 (1983)). A loan is bona fide only if the parties intended in good faith to establish a debtor-creditor relationship when the funds were advanced, meaning the debtor intended to repay and the creditor intended to enforce repayment (Beaver v. Commissioner, 55 T.C. 85, 91 (1970); Fisher v. Commissioner, 54 T.C. 905, 909–10 (1970)).

Application: Petitioners failed to prove the deposits were loan repayments. The purported loan document was excluded due to late production, and even if admitted, it lacked standard bona fide loan terms, such as charging interest or providing a fixed repayment schedule. Crucially, PCR’s 2016 Form 1120S Schedule L (Balance Sheets) did not report the alleged outstanding loan balance at the beginning of the tax year.

Conclusion: The court sustained the Commissioner’s determination that the entire $59,000 constituted income.

Diverted Gross Receipts (Assignment of Income)

The $74,382 was paid by a client (Cancholas) for PCR services but diverted to pay for Ronald’s motorhome. Ronald argued this represented a loan from PCR to him.

Legal Standard: Income is taxed to the party who earns or otherwise creates the right to receive it (Helvering v. Horst, 311 U.S. 112, 119 (1940)).

Application: Ronald’s testimony regarding the purported loan was not credible and unsubstantiated. The court found that even if a loan existed between PCR and Ronald, the Cancholas’ payment was for services rendered by PCR; therefore, under the assignment of income doctrine, it remained PCR’s income. Petitioners also failed to produce admissible evidence substantiating alleged costs incurred by PCR that might offset this income, a requirement under section 6001.

Conclusion: Petitioners failed to meet their burden of proving that the $74,382 was improperly included in PCR’s income.

Change Order Cash Receipts

Petitioners contended the $21,008 cash payments for change orders were paid to Ronald individually.

Application: The evidence demonstrated that the change orders were for work performed by PCR as the general contractor, and Ronald, in correspondence, directed that the payment should be made to PCR.

Conclusion: Petitioners failed to meet their burden of proof.

Whipsaw Defense

Petitioners attempted to argue that the income should not be attributed to them because it was already attributed to Ronald and his wife.

Legal Standard: The Commissioner is permitted to take inconsistent positions (a "whipsaw") in disputes involving the same transaction among different parties to protect the public fisc and ensure against the possibility of the income escaping taxation entirely (Maggie Mgmt. Co. v. Commissioner, 108 T.C. 430, 446 (1997); Holdner v. Commissioner, T.C. Memo. 2010-175, 2010 WL 3036440, at 7).

Application: Petitioners’ document offered to support this argument (Exhibit 57-P) was missing critical pages and was insufficient to establish that the income had already been taxed to the other parties.

Conclusion: Petitioners failed to meet their burden to establish a whipsaw.

Accuracy-Related Penalty

The court determined whether the accuracy-related penalty under section 6662(a) should apply. The penalty is 20% of the underpayment attributable to a substantial understatement (exceeding the greater of 10% of the tax required or $5,000, per section 6662(d)(1)(A)) or negligence. Negligence includes any failure to make a reasonable attempt to comply with the Internal Revenue Code, including the failure to keep adequate books and records (section 6662(c); Treas. Reg. § 1.6662-3(b)(1)).

Burden of Production: The Commissioner bears the burden of production, which requires showing compliance with the procedural requirement of section 6751(b)(1)—that the initial determination of the penalty assessment was personally approved in writing by the immediate supervisor (Frost v. Commissioner, 154 T.C. 23, 34 (2020)). The court found that the examining agent’s direct supervisor approved the penalty in writing. Respondent thus met the burden of production.

Burden of Proof (Taxpayer): Once the Commissioner meets the production burden, the taxpayer must prove the penalty determination is incorrect or assert an affirmative defense, such as reasonable cause (section 6664(c); Rule 142(a); Higbee v. Commissioner, 116 T.C. 438, 446–47 (2001)).

Application: Petitioners failed to dispute the penalty assessment or raise any affirmative defense. Furthermore, the court noted that petitioners failed to maintain adequate records to substantiate their income and expenses.

Conclusion: The court sustained the accuracy-related penalty, based alternatively on petitioners’ negligence and substantial understatement (assuming the understatement threshold is met pursuant to the Rule 155 calculation).

Final Outcome

Decision will be entered under Rule 155 to reflect the sustained deficiency based on Andrew Berry’s 50% shareholder attribution and the confirmed unreported income, as well as the sustained accuracy-related penalty.

Prepared with assistance from NotebookLM.