T.C. Memo. 2016-44



                         UNITED STATES TAX COURT



               MAKRIC ENTERPRISES, INC., Petitioner v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 1017-13.                            Filed March 9, 2016.



      George W. Connelly, Jr., for petitioner.

      Candace M. Williams, for respondent.



            MEMORANDUM FINDINGS OF FACT AND OPINION


      MORRISON, Judge: The respondent (the “IRS”) issued a notice of

deficiency to the petitioner, Makric Enterprises, Inc. (“Makric”), for its short tax

year April 1 to September 30, 2008. In the notice, the IRS determined an income-

tax deficiency of $2,839,780 and an accuracy-related penalty under section
                                        -2-

[*2] 6662(a)1 of $567,956. The deficiency and the penalty relate to a September

2008 transaction that the IRS alleges was the sale by Makric of the stock of its

wholly owned subsidiary, Alpha Circuits, Inc. (“Alpha”). Makric contends that

the transaction should instead be treated as the sale of Makric stock by Makric’s

shareholders. Makric timely filed a petition under section 6213(a) for a

redetermination of the deficiency and the penalty. We have jurisdiction under

section 6214.

      The two issues before the Court are:

      (1) Did Makric sell the stock of Alpha in 2008? We hold that it did. In

particular: (a) we hold that the agreement that effected the transaction

unambiguously required the sale of Alpha, not Makric, and that therefore Makric

is barred from contending that the transaction was, in substance, the sale of

Makric, (b) we reject Makric’s argument that, in executing the agreement, the

parties to the agreement made a mutual mistake which justifies reformation of the

agreement, and (c) we hold that in substance the transaction was the sale of Alpha.

      (2) Is Makric liable for an accuracy-related penalty under section 6662(a)?

We hold that it is.


      1
      Unless otherwise indicated, all section references are to the Internal
Revenue Code as in effect for the year at issue.
                                        -3-

[*3]                           FINDINGS OF FACT

       Some facts have been stipulated, and they are so found. Makric was a

Texas corporation. When it filed the petition in this case, its principal office was

in Texas.2 Makric was founded on June 28, 1996, by Mark Kisner and Rickey

Williams, the two original shareholders.3 Originally, Kisner and Williams each

owned 50% of the company’s shares.

       Kisner and Williams created Makric to serve as the holding company for

Alpha, a contract manufacturer that they sought to acquire. Kisner and Williams

believed that using a holding company to acquire Alpha (rather than directly

acquiring Alpha) would enhance their flexibility to acquire additional companies

in the future. Makric acquired all of Alpha’s stock on July 8, 1996. Kisner and

Williams intended to have Makric hold Alpha for only several years, during which

time they believed Alpha could be made more profitable. Kisner and Williams

hoped to eventually dispose of Alpha for a gain. At the time Makric acquired

Alpha, Kisner and Williams were unsure of how they would ultimately dispose of

Makric’s interest in Alpha. However, their goal was always to dispose of


       2
       This case is therefore appealable to the U.S. Court of Appeals for the Fifth
Circuit unless the parties stipulate another circuit. See sec. 7482(b)(1)(B), (2).
       3
      The name “Makric” is a combination of letters of the names Mark Kisner
and Rickey Williams.
                                         -4-

[*4] Makric’s interest in Alpha in a way that would cause any income they

realized from the sale to be treated as long-term capital gain.

      Before the 1996 acquisition of Alpha by Makric, Kisner worked in the

electronics business for Texas Instruments. At some point, he left Texas

Instruments and assumed the role of CEO for both Makric and Alpha. In his

capacity as CEO of Alpha, he managed Alpha’s day-to-day operations. This

included overseeing its factory and the development of its products. Kisner also

served on the board of directors for Makric and served as chairman of Alpha’s

board of directors. He continued to serve as Alpha’s CEO and as a member of its

board until Makric sold Alpha in September 2008. The record does not indicate

whether Kisner remained on Makric’s board of directors after it sold Alpha.

      Williams served as a director on the boards of both Makric and Alpha and

held those positions at the time Alpha was sold. He served as president of Makric

and was its president at the time Makric sold Alpha. He also served as Alpha’s

president from the time Makric purchased Alpha, in 1996, until sometime in 2001

(although he remained a member of Alpha’s board of directors after 2001). For

some or all of the time that he was the president of Alpha, he was involved with

Alpha on a day-to-day basis and handled the company’s financial affairs. The
                                      -5-

[*5] record does not indicate whether Williams remained on Makric’s board of

directors after it sold Alpha.

      Sometime before May 2004, Williams approached his friend Jim Wilson

about investing in Makric. Wilson had a business background in mezzanine

lending and private equity. On May 28, 2004, Wilson purchased half of

Williams’s 50% interest in Makric. After this purchase, Wilson was a 25%

shareholder in Makric, Williams was a 25% shareholder in Makric, and Kisner

remained a 50% shareholder in Makric. Wilson became a board member of both

Makric and Alpha and continued serving as a member of Alpha’s board until

Makric sold Alpha in 2008. The record does not indicate whether Wilson

remained a member of Makric’s board after it sold Alpha.

      Kisner, Williams, and Wilson are referred to collectively as “Makric’s

shareholders”. At no time did any of them own a direct interest in Alpha. The

positions that Makric’s shareholders held in Makric and Alpha (and their

ownership percentages in Makric) until Alpha was sold in September 2008 are

summarized in the following table:
                                        -6-

 [*6] Corporation           Kisner             Williams              Wilson
      Makric          CEO                  President
                      Member of            Member of            Member of
                      board                board                board (starting
                                                                2004)
                      50% Shareholder      25% Shareholder      25% Shareholder
                                           after selling half   (starting 2004)
                                           his 50% interest
                                           to Wilson in
                                           2004
       Alpha          CEO                  President (1996-
                                           2001)
                      Chairman of          Member of            Member of
                      board                board                board (starting
                                                                2004)


The record does not reveal that anyone besides Kisner, Williams, and Wilson

served on the board of directors of Alpha or Makric until the sale of Alpha in

September 2008.

      In 2004, at the time Wilson acquired his interest in Makric, Makric’s

shareholders entered into a shareholders agreement. Among other things, the

shareholders agreement provided that

      beginning three years from the date hereof, the Stockholders [i.e.,
      Makric’s shareholders] and the Company [i.e., Makric] will engage
                                         -7-

[*7] the services of one or more investment bankers for the sale of all of
     the assets of or shares in the Company [i.e., Makric] * * *.[4]

Thus, the provision contemplated the potential sale of either (1) Alpha stock (the

“assets of” Makric) by Makric or (2) Makric stock (the “shares in” Makric) by

Makric’s shareholders.

      Because Makric was the holding company for Alpha and had no operating

business of its own, those who did business with Alpha were generally unfamiliar

with Makric. Makric’s shareholders and advisers sometimes used the names

“Alpha” and “Makric” interchangeably or, more commonly, they used “Alpha” to

refer collectively to both Makric and Alpha. However, Makric’s shareholders

understood that they owned direct interests only in Makric, not in Alpha, that the

two corporations were separate and distinct, and that Alpha was Makric’s

subsidiary.

      Sometime in 2007, Makric’s shareholders began making arrangements to

sell Alpha. To this end, on July 11, 2007, acting in their capacities as the directors

of Alpha, they signed a document entitled “Consent of Board of Directors in Lieu

of Annual Meeting”. As of this time, Kisner owned 50% of Makric, and Williams

and Wilson each owned 25% of Makric. The consent authorized, among other


      4
          The shareholders agreement is dated May 28, 2004.
                                        -8-

[*8] things, the listing of Alpha for sale. The consent also authorized the hiring of

the investment bank Gulf Star Group Investment Bankers “to represent the

shareholders [meaning Makric’s shareholders] in the sale.” Gulf Star’s services

with respect to the sale of Alpha included finding buyers for Alpha.

      At the time that Makric’s shareholders began making arrangements for the

disposition of Alpha, they contemplated the following two-step sale structure:

      (1) Makric would be dissolved and its Alpha stock distributed to Makric’s

           three shareholders (Kisner, Williams, and Wilson), and

      (2) Kisner, Williams, and Wilson (now shareholders of Alpha) would sell

           Alpha stock to a buyer.

It was originally thought that the two-step structure, whereby (1) Makric dissolves

and (2) Makric’s shareholders sell Alpha stock, would meet the tax objectives of

Makric’s shareholders, i.e., that the gains from the sale of Alpha would be treated

as long-term capital gain to Kisner, Williams, and Wilson.

      Among the steps that Gulf Star undertook to find a buyer for Alpha was to

prepare a sales memorandum, which Gulf Star distributed to prospective buyers.

This memorandum indicated that the entity for sale was Alpha. It described

Alpha’s history, operations, management, and projected growth. It stated that
                                         -9-

[*9] Alpha was owned by Makric, but that Makric was in the process of being

dissolved.

      Gulf Star found several prospective buyers who expressed interest in buying

Alpha. On October 30, 2007, Southfield Capital Advisors, LLC (“Southfield”), a

private-equity firm, submitted a nonbinding indication of interest expressing

Southfield’s interest in purchasing Alpha. On February 6, 2008, Southfield

submitted a letter of intent regarding its potential purchase of Alpha and

expressing its intent to purchase Alpha from Williams, Wilson, and Kisner. The

letter did not mention Makric.5 In the letter, Southfield stated that it intended for

one of its affiliates, TS3 Technology, Inc. (“TS3”), to acquire Alpha. David

Brunson, the chairman of TS3, signed the letter of intent on behalf of Southfield.

Kisner signed the letter as CEO of Alpha and as a shareholder of Alpha. Williams

and Wilson both signed as shareholders of Alpha. By signing the letter of intent,


      5
        Kisner testified that another company, Main Street Capital, also submitted a
letter of intent regarding the purchase of Alpha. That letter is not in the record,
and the record does not otherwise reveal the precise terms offered in that letter.
We infer from the record, particularly from Kisner’s testimony, that Makric’s
shareholders never signed the letter of intent from Main Street Capital and decided
instead to pursue negotiations with Southfield. Kisner testified that Southfield’s
proposed terms, including its proposed purchase price, were more generous than
Main Street Capital’s. In its letter of intent, Southfield stated that it valued Alpha
at $16.5 million and made a “nonbinding confidential proposal” to pay that
amount for Alpha.
                                        - 10 -

[*10] they agreed to the terms of the letter. These terms included, among other

things, the creation of an “exclusivity period” during which (1) Alpha would not

solicit offers or engage in negotiations with any other parties and (2) Alpha would

give Southfield “full and complete access to its books, records, contracts,

personnel [etc.]”. The letter of intent did not commit Southfield or TS3 to buying

Alpha.

      Makric’s shareholders hired Gary Miller of the law firm Boyar & Miller to

represent them and Alpha in the sale. An engagement letter, dated February 15,

2008, authorized Miller to represent

      Rickey G. Williams, Mark Kisner, James P. Wilson ( * * *
      collectively the “Shareholders”) and Alpha Circuits, Inc. (the
      “Company”), in connection with the proposed sale of 100% of the
      stock of the Company owned by the Shareholders * * *.

      The engagement letter did not mention Makric and thus seemed to assume

that Makric’s shareholders would own Alpha stock directly when it came time to

sell Alpha. Makric’s shareholders signed the letter in their individual capacities,

signifying their agreement to have Miller represent them in connection with the

sale of Alpha. Kisner signed the letter on behalf of Alpha, signifying Alpha’s

agreement to have Miller represent it in the sale.
                                       - 11 -

[*11] Southfield’s representatives generally understood that Makric’s

shareholders intended to structure the sale in a way that would result in the income

realized by Makric’s shareholders upon the sale being characterized as long-term

capital gain for federal-income-tax purposes. Southfield and its representatives

were willing to structure the sale in a way that would meet the tax objectives of

Makric’s shareholders.

      Consistent with the two-step sales structure originally preferred by Makric’s

shareholders, Southfield and Makric initially proceeded in negotiations with the

understanding that TS3 would purchase Alpha stock directly from Kisner,

Williams, and Wilson, who would directly hold Alpha stock following the

anticipated dissolution of Makric.

      Early drafts of the stock purchase agreement also reflected the two-step sale

structure.6 Version 1 of the stock purchase agreement (dated February 22, 2008)

was drafted so as to be executed by the following parties: TS3, defined as the

“Buyer”, and Kisner, Williams, and Wilson, collectively defined as the “Sellers”.

The draft recited that “Sellers own all of the outstanding capital stock of Alpha


      6
        The record contains five drafts of the stock purchase agreement, which are
identified in the stipulation of facts as “Version 1” (dated February 22, 2008),
“Version 2” (undated), “Version 3” (undated), “Version 4” (dated March 3, 2008),
and “Version 5” (dated March 3, 2008).
                                         - 12 -

[*12] Circuits, Inc. * * * (the ‘Company’)” and that “Sellers desire to sell, and

Buyer desires to buy, all of the outstanding capital stock of the Company.”

Section 2.1, “Purchase and Sale”, provided:

        Sellers agree to sell to Buyer, and Buyer agrees to purchase from
        Sellers, all of the issued and outstanding shares of common stock
        * * * of the Company * * * (the “Shares”).

Section 2.5 of the draft, “Deliveries at the Closing”, provided: “Sellers will

deliver, or cause to be delivered to Buyer * * * certificates representing all of the

Shares”. This draft, as well as Versions 2 and 3 of the stock purchase agreement

(both undated), provided that Kisner, Williams, and Wilson would sell Alpha

stock to TS3, thus reflecting the assumption that Makric would dissolve before the

sale.

        At some point, Makric’s shareholders determined that the two-step structure

would not meet their tax objectives, so they abandoned the structure. The

following stipulations by the IRS and Makric address the abandonment of the two-

step structure:

        Initially, it was contemplated that the sale of Alpha would be effected
        through Petitioner [i.e., Makric] being dissolved, the shares of Alpha
        being distributed to the Shareholders [i.e., Kisner, Williams, and
        Wilson], and the Shareholders directly selling the stock of Alpha to
        the Buyer (the “Original Transaction Structure”).

                    *       *      *       *      *       *       *
                                        - 13 -

      [*13] In late 2007, the Shareholders raised concerns that under the
      Original Transaction Structure it was unclear whether the
      Shareholders’ holding period in Petitioner’s stock would “tack” onto
      Alpha’s stock, thus jeopardizing the long-term capital gain treatment
      the Shareholders required.

            The Original Transaction Structure was rejected by the
      Shareholders because they were concerned that under the Original
      Transaction Structure long-term capital gain treatment could not be
      guaranteed for them.

Makric’s shareholders next decided that they preferred an alternative sale structure

whereby Makric’s shareholders would sell their shares of Makric to TS3, so that

TS3 would acquire Alpha as a subsidiary of Makric. They determined that this

sale structure would meet the objective of having the income realized from the sale

treated as long-term capital gain.7 Kisner, who was the lead negotiator for Makric,

informed TS3’s representatives and/or advisers of the decision not to dissolve

Makric and to restructure the sale as the purchase of Makric by TS3. These

conversations took place at a meeting and during a conference call.8 The dates of


      7
       Kisner and Williams acquired their Makric stock in 1996. Wilson acquired
his Makric stock in 2004. Because they had held their Makric stock for more than
one year before they planned to sell Makric or Alpha, a taxable sale of their
Makric stock would have generated long-term capital gain to the shareholders.
See infra note 30.
      8
       Kisner credibly testified that he discussed the structure at a meeting and a
conference call with TS3’s representatives and advisers, including, we presume,
Brunson. Kisner also testified that TS3 agreed to the structure at the meeting and
                                                                        (continued...)
                                        - 14 -

[*14] this meeting and the conference call are unclear. On the morning of

February 28, 2008, Kisner and David Ronn, TS3’s lawyer, had the following email

exchange in which Ronn asked Kisner:

      In the presentation[9] we received, it indicated that Makric was going
      to be dissolved so that the three shareholders of Makric would then
      own Alpha Circuits in the same manner that they owned MakRic
      [sic]. Is that still going to occur or is MakRic [sic] going to be the
      seller of Alpha Circuits.

Kisner responded to Ronn later that morning, stating:

          MakRic [sic] didn’t get dissolved. The purchase will be MakRic
          [sic] which owns 100% of Alpha’s shares.

Kisner’s response intended to explain to Ronn that TS3 would purchase Makric.

Kisner did not receive confirmation that Ronn received this email.

      Soon after the email exchange, Ronn (who had written earlier drafts of the

stock purchase agreement) prepared a new draft (Version 4) of the stock purchase

agreement (dated March 3, 2008). This draft did not reflect the structure discussed

by Kisner in his February 28, 2008 email (i.e., the sale of Makric stock), nor did it



      8
       (...continued)
the conference call. As discussed infra p. 54, we believe that a representative of
TS3 assented to the structure, but we do not go so far as to find that this assent
constituted a final or unchanging expression of TS3’s intent.
      9
       Apart from what is stated in this email, the record does not indicate the
content of this “presentation” or who made the “presentation”.
                                        - 15 -

[*15] reflect the original two-step structure of dissolving Makric and having

Makric’s former shareholders sell Alpha stock. Instead, the draft reflected a third

structure, under which Makric would sell Alpha stock to TS3 instead of

dissolving. The new draft identified the parties to the transaction as:

      [TS3] (“Buyer”), MAKRIC Enterprises, Inc., a Texas Corporation
      (“Seller”) and Mark Kisner (“Kisner”), Rickey Williams
      (“Williams”), and Jim Wilson (“Wilson”) * * * (each individually an
      “Owner”, and collectively, the “Owners”).

The draft recited:

             WHEREAS, Seller [i.e., Makric] owns all of the outstanding
      capital stock of Alpha Circuits Incorporated, a Texas corporation (the
      “Company”).

            WHEREAS, Owners [i.e., Makric’s shareholders] own 2,000
      shares of the common stock of the Seller * * *.

            WHEREAS, Seller [i.e., Makric] desires to sell, and Buyer [i.e.,
      TS3] desires to buy, all of the outstanding capital stock of the
      Company [i.e., Alpha] * * *.

Section 2.1, “Purchase and Sale of Shares at Closing”, provided:

      Seller [i.e., Makric] agrees to sell to Buyer [i.e., TS3], and Buyer
      agrees to purchase from Seller, all of the issued and outstanding
      shares (the “Shares”) of common stock * * * of the Company [i.e.,
      Alpha] (“Company Common Stock”).

Section 2.5, “Deliveries at Closing”, provided:

      At the closing: (i) Seller [i.e., Makric] and Owners [i.e., Makric’s
      shareholders], as the case may be, will deliver, or cause to be
                                        - 16 -

[*16] delivered, to Buyer [i.e., TS3] * * * certificates representing all of the
      Shares [of Alpha] * * *.

Ronn wrote a subsequent draft (Version 5), the relevant terms of which were

substantively identical to those of Version 4 described above. Kisner and Miller

reviewed each of these drafts, but Kisner did not realize that the drafts called for

the sale of Alpha by Makric.

      Makric and the IRS have stipulated that after Version 5 there were eleven

more versions of the stock purchase agreement and that each of these versions

“list” Makric as the “Seller” of Alpha, TS3 as the “Buyer”, and Kisner, Wilson,

and Williams as “Owners” of Makric. We take this stipulation to mean that under

the terms of these eleven drafts, as with Version 4 and Version 5, Makric would

sell its stock in Alpha to TS3. Other than this stipulation, the record does not

reveal the terms of these eleven drafts of the stock purchase agreement. The drafts

themselves are not in the record.

      Possibly around the time that Makric’s shareholders decided not to dissolve

Makric, Ronn and associates at his law firm began conducting a due diligence

inquiry into both Makric and Alpha.10 The information sought by Ronn’s firm


      10
         Due diligence refers to a prospective buyer’s investigation of a company
that the buyer seeks to acquire for the purpose of determining the company’s
assets and liabilities.
                                        - 17 -

[*17] pertained to, among other things, the companies’ finances, personnel,

employment contracts, and litigation.

      On September 30, 2008 (seven months after Kisner emailed Ronn informing

him that the transaction should be structured as the sale of Makric), Makric, TS3,

and Makric’s shareholders executed the stock purchase agreement. Kisner and

Miller reviewed the stock purchase agreement before the closing of the sale, but

Kisner did not realize the agreement called for the sale of Alpha by Makric. The

terms set forth in the stock purchase agreement were, in pertinent respects,

identical to the terms set forth in Version 4 and Version 5 of the draft stock

purchase agreement. The stock purchase agreement provided:

                This Stock Purchase Agreement (this “Agreement”) is made as
          of September 30, 2008, by and among TS3 Technology, Inc., a
          Delaware corporation (“Buyer”), MAKRIC Enterprises, Inc., a Texas
          corporation (“Seller”), and Mark A. Kisner (“Kisner”), Rickey
          Williams (“Williams”), and James P. Wilson (“Wilson”) * * * (each
          individually, an “Owner”, and collectively, the “Owners”).

      In the section entitled “Recitals”, the stock purchase agreement

stated:

            WHEREAS, Seller [i.e., Makric] owns all of the issued and
      outstanding capital stock of Alpha Circuits, Incorporated, a Texas
      corporation (the “Company”);

             WHEREAS, Owners [i.e., Makric’s shareholders] own all of
      the issued and outstanding stock of Seller [i.e., Makric]; and
                                        - 18 -

      [*18] WHEREAS, Seller [i.e., Makric] desires to sell, and Buyer [i.e.,
      TS3] desires to buy, all of the outstanding capital stock of the
      Company [i.e., Alpha] on the terms and subject to the conditions set
      forth in this Agreement.

Section 2.1 of the stock purchase agreement, “Purchase and Sale” provided:

      Seller [i.e., Makric] agrees to sell to Buyer [i.e., TS3], and Buyer
      agrees to purchase from Seller, all of the issued and outstanding
      shares (the “Shares”) of common stock * * * of the Company [i.e.,
      Alpha] (“Company Common Stock”).

Section 2.5 of the stock purchase agreement, “Deliveries at the Closing” provided:

      At the closing: (i) Seller [i.e., Makric] and Owners [i.e., Makric’s
      shareholders], as the case may be, will deliver, or cause to be
      delivered, to Buyer [i.e., TS3] * * * certificates representing all of the
      Shares [i.e., all common stock of Alpha].

The stock purchase agreement was signed by Brunson (chairman of TS3), by

Williams (as president of Makric), and by Makric’s shareholders (as “Owners”) on

September 30, 2008.

      The stock purchase agreement contained several provisions that referred to

Kisner, Williams, and Wilson by name, or that referred to them collectively as

Makric’s “Owners”. Among these provisions was Section 3, “Representations and

Warranties of Seller and Owner”, which made Makric and its “Owner[s]” liable

for various warranties and representations: “Seller [i.e., Makric] and each Owner

[i.e., Kisner, Williams, and Wilson], hereby represent and warrant jointly and
                                        - 19 -

[*19] severally with respect to warranties covering Seller, and severally and not

jointly with respect to representations and warranties covering such Owner”.

Among these representations was a provision, Section 3.1, “Valid and Binding

Agreement”, that stated:

      Each Owner [i.e., Kisner, Williams, and Wilson] is an individual and,
      as such has the legal capacity to execute and deliver this Agreement,
      and to perform his obligations hereunder to consummate the
      transactions contemplated hereunder. This Agreement has been duly
      executed and delivered by Seller [i.e., Makric] and constitutes the
      valid and binding obligation of Seller, enforceable against it in
      accordance with its terms * * *. The execution and delivery of this
      Agreement, the performance by each Owner of his obligations
      hereunder and the consummation by each Owner of the transactions
      contemplated hereby have been duly authorized by all requisite action
      on the part of each Owner.

Another provision, Section 3.5, “Brokerage Arrangements”, stated:

      Except with regard to amounts due to Gulfstar Group upon the
      Closing * * * no Person[11] will be entitled to receive any brokerage
      commission * * * or similar compensation in connection with the
      transactions contemplated by this Agreement based on any
      Contract[12] made by or on behalf of Seller [i.e., Makric] or Owners



      11
         The agreement defined “Person” as: “any individual, corporation
(including any non-profit corporation), general or limited partnership, limited
liability company, joint venture, estate, trust, association, organization, labor
union, Governmental Entity or other entity.”
      12
        The agreement defined “Contract” as: “a contract, agreement,
commitment or binding understanding, whether oral or written, that is in effect as
of the date of this Agreement.”
                                        - 20 -

      [*20] [i.e., Kisner, Williams, and Wilson] for which Buyer [i.e., TS3]
      or the Company [i.e., Alpha] is or could become liable or obligated.

There were three other representations and warranties in Section 3 of the stock

purchase agreement. Furthermore, Section 4 of the stock purchase agreement

provided that “Seller [i.e., Makric] and each Owner [i.e., Makric’s shareholders],

jointly and severally represent and warrant to Buyer [i.e., TS3] that, as of the

Closing Date”: Makric was duly organized, Makric was in compliance with its

organizational documents, Makric was not in violation of any law, Makric’s

financial statements represented fairly its financial position, there were no legal

claims against Makric, and all of Makric’s significant contracts were listed in the

agreement.

      On the same day that the stock purchase agreement was executed, Makric’s

shareholders executed another document relating to the sale. This document,

entitled “Joint Written Consent of the Shareholders and Directors in Lieu of a

Special Meeting”, authorized Makric to sell its stock in Alpha to TS3. The

document began with this recital:

            Whereas, Mark A. Kisner, Rickey Williams and James P.
      Wilson (collectively, the “Shareholders”), own all of the issued and
      outstanding capital stock of the “Corporation” [i.e., Makric];
                                       - 21 -

      [*21] Whereas, the Corporation owns all of the issued and
      outstanding capital stock of the Alpha Circuits Incorporated, a Texas
      Corporation (the “Company”);

             Whereas, the Corporation desires to sell all of the outstanding
      capital stock of the Company (the “Subject Stock”), to TS3
      Technology, Inc. * * *.

Makric’s shareholders each signed this consent form twice: once in their

capacities as directors of Makric and once in their capacities as shareholders of

Makric. The record does not reveal who drafted this consent form. Neither

Kisner, Williams, nor Wilson closely reviewed this document before signing it.

      Also on September 30, 2008, Kisner, as Makric’s CEO, signed a document

entitled “Written Consent of Sole Shareholder of Alpha Circuits Incorporated”.

This document stated:

      RESOLVED, that immediately prior to the consummation [of] the
      transaction contemplated by that certain Stock Purchase Agreement
      between the MAKRIC Enterprises, Inc. (the “Sole Shareholder”), TS3
      Technology, Inc. (the “Purchaser”) and the owners of the Sole
      Shareholder, pursuant to which the Sole Shareholder has agreed to
      sell all of the shares of the common stock of the Company (the “Stock
      Purchase Agreement”), the resignations of the existing directors of
      the Company [i.e., Alpha], Mark Kisner, Rickey Williams and James
      P. Wilson, be and hereby are accepted by the Sole Shareholder.

Kisner did not closely review this document either before he signed it or when he

signed it. The record does not reveal who drafted this consent form. (We refer to
                                        - 22 -

[*22] the two consent forms described above and the stock purchase agreement,

collectively, as the “transactional documents”.)

      Neither Kisner, Miller, nor any of Makric’s other shareholders,

representatives or advisers objected to the terms set forth in the stock purchase

agreement. The stock purchase agreement and the several drafts that preceded it

provided that Makric would sell Alpha stock. Even so, Kisner reviewed the stock

purchase agreement and prior drafts and concluded that the documents provided

that Makric’s shareholders would sell their Makric stock. Ronn, TS3’s lawyer, did

not tell him otherwise.

      The stock purchase agreement required the “Buyer”, i.e., TS3, to make four

types of payments.

      First, TS3 was required to pay Alpha’s creditors the amounts set forth on

Schedule 4.9(e)(2) of the stock purchase agreement. There is no Schedule

4.9(e)(2) attached to the stock purchase agreement. Therefore, the amounts to be

paid to Alpha’s creditors cannot be determined from the text of the stock purchase

agreement.

      Second, Section 9.2 of the stock purchase agreement required TS3 to pay

the transaction costs of the Seller (i.e., Makric) and the Owners (i.e., Makric’s

shareholders) described on Schedule 9.2 of the stock purchase agreement to the
                                      - 23 -

[*23] extent that Makric and Makric’s shareholders set forth the amounts of these

costs on Schedule 9.2. Any such costs described on Schedule 9.2 had to be paid to

the “applicable vendor” listed on Schedule 9.2. There is no Schedule 9.2 attached

to the stock purchase agreement. Therefore, no payment was required of TS3 by

Section 9.2 of the stock purchase agreement.

      Third, Section 2.6 of the stock purchase agreement required TS3, after the

closing, to make a payment to Makric if Alpha’s working capital at closing

exceeded the amount of working capital agreed upon in the stock purchase

agreement. Alternatively, if Alpha’s working capital at closing was less than the

amount of working capital agreed upon in the stock purchase agreement, Makric

would be required to make a reverse payment to TS3. Section 2.6 of the stock

purchase agreement defined what was meant by (1) Alpha’s working capital at

closing and (2) Alpha’s working capital agreed upon in the purchase agreement.

Both of these amounts were defined in part by reference to Schedule 2.6 of the

stock purchase agreement. There is no Schedule 2.6 attached to the stock

purchase agreement. Therefore, the amount of the working-capital-adjustment

payment (or reverse payment) cannot be determined from the stock purchase

agreement.
                                        - 24 -

[*24] Fourth, TS3 was required to pay Makric an amount equal to:

 the “Purchase    –     the amounts set forth on     –    “any expenses described
     Price”               Schedule 4.9(e)(2)                 on Schedule 9.2”

This amount was required to be delivered “by wire transfer of immediately

available funds to the accounts designated by Seller [i.e., Makric] to Buyer [i.e.,

TS3] no later than three Business Days prior to the Closing”, according to the

stock purchase agreement. The “Purchase Price” was defined by Section 2.2 of

the stock purchase agreement. Section 2.2 provided:

      The aggregate purchase price (the “Purchase Price”) for the Shares
      [i.e., the common stock of Alpha] is $16,500,000 million in cash paid
      by Buyer, subject to adjustment pursuant to Section 2.6 of this
      Agreement and any payments provided for in Section 9.2 of this
      Agreement.

Section 9.2 provided that any expenses described on Schedule 9.2 “shall be paid

by Buyer [i.e., TS3] at Closing and the amounts so paid shall be offset against and

serve as a reduction of the amount of the Purchase Price paid by Buyer at

Closing.”

      In summary, there are at least two impediments to determining how much

TS3 was required to pay under the stock purchase agreement. First, the amounts

set forth on Schedule 4.9(e)(2) cannot be determined because of the absence of

Schedule 4.9(e)(2). Second, the working-capital adjustment payment required by
                                       - 25 -

[*25] Section 2.6 of the stock purchase agreement cannot be determined because

of the absence of Schedule 2.6. Despite these impediments to determining how

much TS3 was required to pay Makric under the stock purchase agreement, we

conclude that the amount required to be paid by TS3 under the stock purchase

agreement--and the amount actually paid by TS3--was $16.5 million. This

conclusion is justified by the particular circumstances of the case, which we

describe below.

      In the notice of deficiency, the IRS had determined that Makric’s gain on

the sale of Alpha was $8,060,137. Makric does not contest that this is the correct

amount of gain in the event that it is determined to have sold Alpha. Furthermore,

Makric stipulated that its adjusted basis in Alpha stock was $8,439,863. Under the

Internal Revenue Code, Makric’s gain on the sale of Alpha is equal to the amount

realized from the sale minus its adjusted basis in Alpha stock. Sec. 1001(a).
                                        - 26 -

[*26] Because it is undisputed that Makric’s gain is $8,060,137 and that Makric’s

adjusted basis is $8,439,863, the amount realized is $16.5 million.13 Therefore, we

conclude that Makric received $16.5 million for Alpha’s stock. It is apparent that

some of that amount ended up in the hands of Makric’s shareholders. However,

the record does not reveal the exact amount.

      On January 27, 2009, John O’Brien of Gulf Star sent an email to Michael

Baudler, Makric’s CFO, to suggest that Makric file a short-year federal-income-

tax return for the period April 1 to September 30, 2008. O’Brien began his email

by stating that he had reviewed the stock purchase agreement. He claimed

(erroneously) that under the agreement, Makric’s shareholders had sold the stock

of Makric to TS3. He further claimed that under the agreement the “owners” (by

which he apparently meant Makric’s shareholders) were liable for the “pre-closing

      13
           The equation for computing Makric’s gain is:

               gain = amount realized – adjusted basis

See sec. 1001(a). After the known values are substituted into the equation, the
equation becomes:

               $8,060,137 = amount realized – $8,439,863

Rearranged, this is:

               amount realized    = $8,060,137 + $8,439,863
                                  = $16,500,000
                                       - 27 -

[*27] taxes” (by which he apparently meant Makric’s income-tax liability up to the

closing date of September 30, 2008). For this proposition, O’Brien explicitly

referred to Section 4.12 of the stock purchase agreement, a representation by

Makric and by Makric’s owners that all taxes payable by the “Company” (defined

as Alpha, not Makric as O’Brien assumed) were fully paid as of the closing date of

the stock purchase agreement. O’Brien’s email also claimed that the liability of

the “owners” for “pre-closing taxes” is “typically * * * handled through a return

filed for the year up until closing.” Thus, O’Brien’s email was a suggestion that

Makric file a return for a short year ending on September 30, 2008.

      An accountant, Miles Harper of the firm Gainer, Donnelly & Desroches,

prepared Makric’s Form 1120, “U.S. Corporation Income Tax Return”, for the

short tax year April 1 to September 30, 2008 (the date of the sale). We sometimes

refer to this return as Makric’s “2008 short-year return”. The return was a

consolidated return that reported the consolidated income of Makric and Alpha.14

As of the time Harper prepared this return, he or his firm had been preparing

Makric’s returns for several years. Harper was familiar with Makric’s presale

      14
        A parent company and its wholly-owned subsidiary are permitted to file a
consolidated return reporting their consolidated income for the taxable year. Secs.
1.1502-2, 1.1502-76(b)(1), Income Tax Regs. They may do so even if the parent
sold the subsidiary during the taxable year. Sec. 1.1502-76(b)(5), Example (1)(c),
Income Tax Regs.
                                       - 28 -

[*28] ownership structure and understood (a) that Makric’s shareholders had no

direct interest in Alpha and (b) that Alpha had been Makric’s subsidiary. Harper

was not directly involved in the negotiations leading to the sale of Alpha, though it

was Harper who first alerted Makric’s shareholders to the possibility that the

initial two-step structure might not meet the shareholders’ tax objectives. As

Harper understood the final transaction, TS3 purchased the stock of Makric from

Makric’s shareholders. He did not understand that Makric had actually sold its

interest in Alpha. His misunderstanding of the sale was based on conversations he

had with Makric’s CFO, Baudler. Harper did not read the stock purchase

agreement before, or at the time of, preparing Makric’s 2008 short-year return.

Believing that Makric had not sold Alpha, he did not report the sale of Alpha on

Makric’s return. In July 2009, Harper signed Makric’s 2008 short-year return. The

copy of the Form 1120 in the record is signed only by Harper as the “Preparer”.

The space above the line for “Signature of officer” is blank. We do not know

whether any of Makric’s officers reviewed the form.

      Harper also prepared a Form 1120X, “Amended U.S. Corporation Income

Tax Return”, for Makric for the same tax year. The sole purpose of filing the

amended return was to claim a greater deduction for salary expenses than Makric

had claimed on the original return. The amended return also did not report the sale
                                       - 29 -

[*29] of Alpha. The Form 1120X was signed by Harper as the “Preparer”, but the

space above the line for “Signature of officer” was blank. We do not know if any

of Makric’s officers reviewed the form.

      Harper also prepared the Forms 1040, “U.S. Individual Income Tax Return”,

for Makric’s shareholders for the 2008 tax year. On the Schedule D, “Capital

Gains and Losses”, attached to each return, Harper reported that Kisner, Williams,

and Wilson each had a long-term capital gain from the sale of an asset described

on the return as “Alpha” (even though none of them owned Alpha stock). In

calculating the amount of gain each person realized, Harper subtracted what he

thought was each shareholder’s respective basis in Makric from what he thought

was the shareholder’s share of the proceeds received. Kisner’s return stated that

his basis in “Alpha” was $1,471,015 and his “sales price” for “Alpha” was

$8,250,000. Williams’s return stated that his basis in “Alpha” was $1,456,343 and

that his “sales price” for “Alpha” was $3,576,306. Wilson’s return stated that his

basis in “Alpha” was $1 million and that his “sales price” for “Alpha” was

$3,513,806.15 Harper would later testify that he used “Alpha” to designate Makric

      15
        Thus, the individual returns for Kisner, Williams, and Wilson suggest that
of the $16.5 million Makric received, $15,340,112 (i.e., $8,250,000 + $3,576,306
+ $3,513,806) ended up in the hands of Kisner, Williams, and Wilson. As
previously stated, we find that at least some of the $16.5 million ended up in their
                                                                       (continued...)
                                          - 30 -

[*30] stock because Makric was a holding company that held only Alpha stock.

This testimony was credible because the bases Harper used for “Alpha” were what

Harper thought were Makric’s shareholders’ respective bases in their Makric

stock.

         Kisner and Wilson reviewed their individual returns and each saw that the

returns showed gain from the sale of “Alpha”. (Williams did not review his

individual return before he signed it.)

         The IRS audited Makric’s 2008 short-year return and the 2008 individual

returns for Makric’s shareholders. The IRS questioned why Makric did not report

the sale of Alpha shares. It was at this time that Harper realized that he might

have prepared the returns incorrectly.

         The IRS issued the notice of deficiency to Makric on November 8, 2012.

The IRS determined that Makric had a deficiency of $2,839,780 relating to its

failure to report the sale of Alpha. This deficiency was based on the IRS’s

determination that Makric sold its Alpha stock and should have reported a gain of

$8,060,137. In the notice, the IRS also determined an accuracy-related penalty of

$567,960 under section 6662(a). The IRS determined that the underpayment on


         15
       (...continued)
hands. See supra p. 26. The record does not reveal the exact amount.
                                        - 31 -

[*31] which the penalty was based was a large corporation underpayment under

section 6621(c); such an underpayment is subject to a higher interest rate than the

rate normally charged on underpayments.

      This case was tried in Houston, Texas. At trial, the parties jointly

introduced, and we admitted into evidence, an affidavit of Brunson, TS3’s

chairman. In it, Brunson swore to the following:

      TS3 purchased all of the common stock of Alpha Circuits
      Incorporated * * *. It was represented to TS3 that Alpha was owned
      by Makric * * *.

      In addition, it was my understanding that Messrs. Kisner, Williams
      and Wilson insisted upon a structure for the sale that would produce
      long term capital gain treatment of the proceeds for each of them for
      federal income tax purposes. TS3 was agreeable to such a structure
      and, based on Makric’s and its owners’ comments to the final
      agreement, we thought the executed agreement met their goal.

      It was my understanding at the time that Makric was not an operating
      company, that it was a pure holding company, and that its only asset
      was the stock of Alpha. Assuming due diligence had proven that
      holding company status and if the sellers had provided us with
      appropriate representations, warranties and indemnities regarding
      Makric and its lack of operations, assets and liabilities, TS3 would
      have been willing to purchase the stock of Makric.

On the basis of this affidavit, and on other parts of the record, we find that TS3’s

officers intended for TS3 to acquire the stock of Alpha through the stock purchase

agreement and thought that the stock purchase agreement effected this acquisition.
                                        - 32 -

[*32]                                 OPINION

1.      Deficiency

        With respect to determinations in the notice of deficiency, the taxpayer

generally bears the burden of proof. Tax Ct. R. Pract. & Proc. 142(a); Welch v.

Helvering, 

, 115 (1933). The burden of proof is satisfied by a

preponderance of the evidence. Estate of Gilford v. Commissioner, 

, 51

(1987). The taxpayer may, by introducing credible evidence and cooperating with

the IRS’s reasonable requests for information, shift the burden of proof to the IRS.

See sec. 7491(a)(1); Higbee v. Commissioner, 

, 442 (2001). We

decide this case, as it relates to the amount of the deficiency, on a preponderance

of the evidence. Therefore, we need not determine who bears the burden of proof.

See Knudsen v. Commissioner, 

, 189 (2008).

        The issue before the Court concerns the tax consequences of the transaction

associated with the stock purchase agreement. The IRS contends that Makric, for

federal-income-tax purposes, should be treated as if it sold the stock of Alpha to

TS3. Under this view, Makric would recognize gain on the sale of Alpha stock.

Makric contends that Makric’s shareholders, for federal-income-tax purposes,

should be treated as if they had sold Makric stock to TS3. Under this view,

Makric would have no gain from the sale.
                                        - 33 -

[*33] As described in detail below, the parties make various arguments in favor of

their respective positions. These arguments involve the following legal concepts:

      !      Texas state-law principles of interpreting contracts,

      !      the Texas state-law remedy of reformation of contracts on the

             grounds of mutual mistake, and

      !      the federal tax principles of (1) substance-over-form and (2) the

             Danielson rule.

The relevant aspects of each of these concepts are described below.

      We begin by describing Texas state-law principles of interpreting contracts.

Interpreting a contract is “primarily” a matter of “ascertain[ing] the * * *

intentions of the parties as expressed in the written instrument”. Coker v. Coker,

, 393 (Tex. 1983). A threshold issue in contract interpretation is

whether the contract is unambiguous or ambiguous. A contract is unambiguous if

it is “so worded that it can be given a certain or definite legal meaning or

interpretation”.

ambiguous if “its meaning is uncertain and

doubtful or it is reasonably susceptible to more than one meaning, taking into

consideration circumstances present when the particular writing was executed”.

Lenape Res. Corp. v. Tenn. Gas Pipeline Co., 

, 574 (Tex. 1996).

There are two types of contractual ambiguity: “patent” and “latent”. Nat’l Union
                                         - 34 -

[*34] Fire Ins. Co. v. CBI Indus., Inc., 

, 520 (Tex. 1995). “A

patent ambiguity is evident on the face of the contract”

result of

the use of inherently uncertain or conflicting words”, 11 Williston on Contracts,

sec. 33:43 (4th ed. 2015).16 A latent ambiguity exists if the contract is plain on its

face but is ambiguous in light of “some collateral matter.” Nat’l Union Fire Ins.

. The Texas Supreme Court has given the following

example of a latent ambiguity: “[I]f a contract called for goods to be delivered to

‘the green house on Pecan Street,’ and there were in fact two green houses on the

street, it would be latently ambiguous.”

n.4. The determination of whether a

contract is ambiguous is a matter of law.

determination, courts

cannot consider extrinsic evidence of the parties’ intent. See Meridien Hotels, Inc.

v. LHO Fin. P’ship I, L.P., 

, 816 (Tex. App.--Dallas 2008).

Extrinsic evidence, also known as “parol evidence”, is “evidence not contained in

the body of an agreement or other instrument”. 36 Tex. Jur., Evidence, sec. 316.

Extrinsic evidence of the parties’ intent includes:




      16
         For example, in Furmanite Worldwide, Inc. v. NextCorp., Ltd., 

, 333 (Tex. App.--Dallas 2011), one provision of a contract provided
that the date of the agreement was August 31, 2006, but another provision
provided that the first year of the agreement was 2003, thus making it ambiguous
as to when the agreement took effect.
                                         - 35 -

[*35] !      “expressions of the parties simultaneous with the making of the

             contract”, Remington Rand, Inc. v. Sugarland Indus., 

, 484 (Tex. 1941), and

      !      “evidence of declarations of the parties made out of court as to their

             intentions as to future writings (such as instructions given for drafting

             deeds or wills)”, Henry v. Powers, 

, 743 (Tex. Civ.

             App.--Houston [1st Dist.] 1969).

Although extrinsic evidence of the parties’ intent cannot be considered in

determining whether a contract is ambiguous, see Nat’l Union Fire Ins. 

; Meridien 

, Texas courts have held that

extrinsic evidence of the surrounding circumstances and the subject matter of the

contract may be considered to determine whether a latent ambiguity exists, Loaiza

v. Loaiza, 

, 905 (Tex. App.--Fort Worth 2004) (“Although the

determination of whether a contract is ambiguous should be limited to an

examination of the language of the agreement, appellate courts may examine

extrinsic evidence of ‘surrounding circumstances’ or ‘the subject matter of the

contract’ to determine if a latent ambiguity exists.” (quoting Birmingham Fire Ins.

Co. v. Am. Nat’l Fire Ins. Co., 

, 603 (Tex. App.--Texarkana 1997,

writ denied))).
                                        - 36 -

[*36] If the contract is determined to be unambiguous, it is interpreted in

accordance with its provisions. 

. If a contract is

determined to be ambiguous, the next step is to determine the best interpretation,

i.e., which of the reasonable meanings of the ambiguous term or provision best

represents the parties’ intentions. See Nat’l Union Fire Ins. 

. Determining the best interpretation is a matter of fact. 

(“When a contract contains an ambiguity * * * the interpretation of the

instrument becomes a fact issue.”).17 In determining the best interpretation of an

ambiguous contract, extrinsic evidence of the parties’ intent may be considered.

Lenape Res. 

(“If the written instrument is ambiguous,

the trier of fact may look to parol evidence to determine the parties’ intent.”); see

also Grimes v. Dike, 

, at *2 (Tex. App.--Tyler 2006) (“Parol

evidence is admissible to explain both latent and patent ambiguities.”).

      We have referred to several rules regarding the consideration of extrinsic

evidence of the parties’ intent. We summarize these rules below:




      17
        Determining the best interpretation of an ambiguous contractual provision
is sometimes referred to as “resolving” or “explaining” the ambiguity. See, e.g.,
Exxon Corp. v. W. Tex. Gathering Co., 

, 302 n.3 (Tex. 1993);
Lorino v. Crawford Packing Co., 

, 416 (Tex. 1943).
                                       - 37 -

 [*37]                     Can extrinsic evidence of intent be considered to --

 Type of ambiguity    establish ambiguity?         resolve ambiguity?

 Patent ambiguity     No                           Yes
 Latent ambiguity     No, but extrinsic evidence Yes
                      of surrounding
                      circumstances and subject
                      matter may be considered

      We now describe the Texas state-law remedy of reformation of contracts on

the ground of mutual mistake. The remedy of reformation is an equitable

remedy.18 A suit to reform a contract can be brought in the Texas district courts,

which are general-jurisdiction trial courts with both legal and equitable powers.

Tex. Jur. 3d, Cancellation and Reformation, sec. 132 (1980) (“Reformation may be

sought in the district court.”); Dubai Petroleum Co. v. Kazi, 

, 75

(Tex. 2000) (general jurisdiction); Texas Gov’t Code sec. 24.008 (West 2004)

(legal and equitable powers). Reformation can be the principal object of a suit or


      18
       According to Howard v. Young, 

, 243 (Tex. Civ. App.--
Amarillo 1948, writ ref’d n.r.e.):

             Courts of equity have always exercised jurisdiction over mutual
      mistakes and granted the relief of reforming written instruments by
      ascertaining the intent of the parties who executed them and
      conforming the writing to the real contract which they intended to
      make. * * * The purpose of doing so is to adjust the instrument to the
      conditions of fact and make it effective to carry out the true purpose
      which the parties intended to express. * * *
                                        - 38 -

[*38] it can be ancillary to other claims for relief. Tex. Jur. 3d, Cancellation and

Reformation, sec. 132. A suit for the reformation of a contract requires joinder of

all parties to the contract and all other persons who have an interest in the

controversy. Beneficial Standard Life Ins. Co. v. Trinity Nat’l Bank, 

, 56 (Tex. App.--Dallas 1988). One ground for reformation is a mutual mistake.

Gilbane Bldg. Co. v. Keystone Structural Concrete, Ltd., 

, 300-

301 (Tex. App.--Houston [1st Dist.] 2007, no pet.) (“If a written contract fails to

reflect a party’s original agreement due to a mutual mistake, the court may reform

the contract to properly reflect the party’s true agreement.” (citing Cherokee Water

Co. v. Forderhause, 

, 379 (Tex. 1987))). A mutual mistake

“occurs where the parties to an agreement have a common intention, but the

written contract does not reflect the intention of the parties due to a mutual

mistake.” Okon v. MBank, N.A., 

, 675 (Tex. App.--Dallas 1986,

writ ref’d n.r.e.); see also Sun Oil Co. v. Bennett, 

, 450 (Tex. 1935)

(a mutual mistake is “a mistake common to both parties”); Durham v. Luce, 

, 854-855 (Tex. Civ. App.--Galveston 1911) (“[E]quity will only correct

a mistake in a deed when such mistake is the mutual mistake of all the parties to

the instrument[.]”). The existence of a mutual mistake can be proved by extrinsic

evidence of intent. Estes v. Republic Nat’l Bank, 

, 275 (Tex.
                                           - 39 -

[*39] 1970) (“[P]arol evidence is admissible to show that the writing, because of a

mutual mistake, incorrectly reflects the true agreement”). For mutual mistake to

be proven, the evidence must be “clear, exact, and satisfactory”.

) Finally, “facial ambiguity is not a requirement for

reformation”. 66 Am. Jur. 2d, Reformation of Instruments, sec. 6; see also Brinker

v. Wobaco Trust, Ltd., 

, 164 (Tex. Civ. App.--Texarkana 1980,

writ ref’d n.r.e.) (“The fact that the written language is couched in unambiguous

language * * * will not preclude relief by reformation.”). Thus, a contract that is

clear on its face can still be reformed.

      We now describe the federal tax principles implicated by the parties’

arguments. The substance-over-form doctrine is the principle that “[t]he substance

of the transaction rather than the form of the agreement must determine the tax

consequences to the parties.” Strutzel v. Commissioner, 

, 976 (1973);

see Southgate Master Fund, L.L.C. v. United States, 

, 479 (5th Cir.

2011) (“The substance-over-form doctrine allows a transaction to be re-

characterized so that its taxable form corresponds to its economic substance.”).

The substance-over-form doctrine can be invoked by either the government or the

taxpayer. Estate of Weinert v. Commissioner, 

, 755 (5th Cir. 1961),

rev’g and remanding 

(1959). However, the Court of Appeals for the
                                       - 40 -

[*40] Third Circuit in Commissioner v. Danielson, 

, 775 (3d Cir.

1967), vacating and remanding 

(1965), held that the invocation of the

substance-over-form doctrine by taxpayers is restricted in certain circumstances.

Danielson determined the tax treatment of proceeds received by a company’s

shareholders in exchange for two things: (1) their stock of the company and (2)

their promise that after the sale they would not compete with the company (such a

promise is known as a noncompete covenant).

773. Their agreement with

the buyer stated that 41% of the price was for the noncompete covenant and 59%

was for the stock.

that the entire price was in

“fact” and in “business reality” a payment for the stock.

774. They argued

that the 41%/59% allocation in the agreement should be disregarded for purposes

of determining the tax consequences of their receipt of the proceeds. Id.19 The

Third Circuit rejected the shareholders’ argument.

774-775, 778. The court

held:

        [A] party can challenge the tax consequences of his agreement as
        construed by the Commissioner only by adducing proof which in an

        19
         The portion of the price considered to be for the noncompete covenant
would be taxed as ordinary income to the shareholder. Schmitz v. Commissioner,

, 313 (1968), aff’d sub nom. Throndson v. Commissioner, 

(9th Cir. 1972). The portion of the price considered to be for the stock
would be taxed more favorably as capital gain. Thus, it was in the shareholders’
interest to argue that the price should be considered payment for the stock.
                                        - 41 -

      [*41] action between the parties to the agreement would be
      admissible to alter that construction of the contract or to show its
      unenforceability because of mistake, undue influence, fraud, duress,
      etc. * * *.

775. The court further held that if the shareholders had attempted, in an

action against the buyer, “to avoid or alter the [sales] agreement * * * [they] would

have a heavy burden of showing fraud, duress, undue influence and the like under

what may loosely be called common-law principles”

and that

“examination of all the evidence adduced in this case reveals nothing to

demonstrate that the contract as written was not the taxpayers’ [i.e., the

shareholders’] conscious agreement”

The rule adopted by the Third

Circuit in Danielson, i.e., the “Danielson rule”, CMI Int’l, Inc. v. Commissioner,

, 4 (1999), can be thought of as having both a restrictive and a

permissive component. The restrictive component prevents the taxpayer from

asserting the substance-over-form doctrine. See Commissioner v. 

; Michael Bailiff, “When (and Where) Does the Danielson Rule Limit

Taxpayers Arguing Substance over Form?”, 82 J. Tax’n 362, 362 (1995) (referring

to “Danielson’s nondisavowel principle that binds taxpayers to the form of their

transaction, regardless of its economic substance” (emphasis added)). The

permissive component recognizes that the taxpayer may rely on nontax legal
                                        - 42 -

[*42] principles, such as the state-law principles regarding reformation of

contracts. See CMI Int’l, Inc. v. Commissioner, 

(“Where the terms

of a transaction are set forth in a written contract, the Danielson rule provides that

a party to the contract may disavow the form of such transaction only with

evidence that would allow reformation of the contract (e.g., to prove fraud or

duress).” (citing Commissioner v. 

)). The Danielson

rule applies to a taxpayer’s argument only if the agreement in question is

unambiguous.

is ambiguous, however, the Danielson rule

does not apply.” (citing N. Am. Rayon Corp. v. Commissioner, 

, 589

(6th Cir. 1993), aff’g T.C. Memo. 1992-610)). Although Danielson was an

opinion of the Third Circuit, the Fifth Circuit has applied the Danielson rule in

several cases including Spector v. Commissioner, 

, 386 (5th Cir.

1981), rev’g 

(1979), Smith v. Commissioner, 

, 40 n.13

(5th Cir. 1995), aff’g T.C. Memo. 1994-149, and Insilco Corp. v. United States (In

re Insilco Corp.), 

, 99 (5th Cir. 1995).

      Having described these underlying legal principles, we now explain the

arguments made by the parties in general terms. Makric puts forward “two basic

theories”. First, Makric contends that under the substance-over-form doctrine, the

substance of the transaction in question is a sale by Makric’s shareholders of
                                        - 43 -

[*43] Makric stock to TS3.20 Second, Makric seeks the remedy of “reformation”,

contending that evidence admissible under “state law” shows that “mutual mistake

existed in the drafting of documents by which the owners of Petitioner intended to

sell the stock of Petitioner as distinguished from selling the stock of Alpha”.

      As to Makric’s substance-over-form argument, the IRS contends that the

Danielson rule applies and that therefore we cannot consider Makric’s substance-

over-form argument at all. In addition, the IRS contends that “the substance of

[the] transaction was a sale of Alpha, not Makric.” Makric takes the position that

the Danielson rule does not apply because, in its view, the stock purchase

agreement is ambiguous. As Makric contends:

      Absent a showing of mutual mistake, taxpayers will be bound by the
      terms of their unambiguous documents. Danielson v. Commissioner,
      

(3d Cir. 1967), cert. denied, 

(1967).
      However, the stock purchase agreement is replete with ambiguities, if
      not outright errors.[21]




      20
         It argues: “[T]he doctrine of ‘substance over form’ should be applied to
reflect the transaction as the sale of Petitioner [i.e., Makric] to the buyer [i.e.,
TS3].”
      21
        We note that although Makric contends the stock purchase agreement is
ambiguous for the purpose of avoiding the Danielson rule, Makric does not
contend that under Texas principles of contract interpretation the best
interpretation of the stock purchase agreement is that the agreement is for the sale
of Makric stock.
                                       - 44 -

[*44] The IRS contends that the stock purchase agreement is unambiguous. As

the IRS explained in its closing argument:

      [W]hat is not at all ambiguous are the parties to the stock purchase
      agreement * * *. The buyer: TS3. The seller: Makric, Petitioner.
      Company: Alpha Circuits. Owners of seller: Kisner, Williams, and
      Wilson. “Buyer desires to buy and seller desires to sell company.”
      [paraphrasing stock purchase agreement]

      As to Makric’s reformation argument, the IRS first contends that the Tax

Court is not the appropriate court to hear the argument. In its view, a reformation

action “is a state law action, and they would have to seek reformation of the

contract under state law.” Second, the IRS contends that Makric has not proven

that there was a mutual mistake about the contract. As the IRS argues:

      Petitioner [i.e., Makric] has not alleged fraud or duress in these
      negotiations, but there is likewise not a mutual mistake present in this
      case. In order to establish that a mutual mistake occurred, Petitioner
      must prove that both sides intended the sale to be of Makric. This
      Petitioner has not done.

      These are the parties’ contentions. We resolve these contentions as follows:
                                       - 45 -

 [*45]                     Holding                               Part of opinion
 Makric’s substance-over-form argument is barred by the               1.A
 Danielson rule because the stock purchase agreement, as
 interpreted without recourse to extrinsic evidence of intent,
 is unambiguously an agreement by Makric to sell Alpha
 stock.
 Limited by the Danielson rule to its alternative argument            1.B
 that there was a mutual mistake regarding the stock
 purchase agreement that would justify reformation of the
 agreement under Texas law, Makric failed to make the
 requisite showing of mutual mistake (a determination
 taking into account extrinsic evidence of intent).
 Even if Makric’s substance-over-form argument was not                1.C
 barred by the Danielson rule, the evidence in the record
 shows that the substance of the transaction is the sale by
 Makric of Alpha stock.


      A.     Makric’s substance-over-form argument is barred by the Danielson
             rule because the stock purchase agreement, as interpreted without
             recourse to extrinsic evidence of intent, is unambiguously an
             agreement by Makric to sell Alpha stock.

      We turn first to Makric’s substance-over-form argument. Makric argues

that the substance of the transaction was described in Kisner’s email of February

28, 2008. This email described the transaction as the sale of Makric stock to TS3.

The IRS would have us refrain from considering Makric’s substance-over-form

argument altogether. In the IRS’s view, Makric is barred from advancing a

substance-over-form argument by the Danielson rule. See supra pp. 39-42
                                         - 46 -

[*46] (discussing Danielson rule). Makric argues that Danielson is not applicable

to the instant case because the relevant portions of the stock purchase agreement

are ambiguous. See Commissioner v. 

. Danielson is

not applicable where the underlying agreement is ambiguous. CMI Int’l, Inc. v.

Commissioner, 

. Makric argues that the stock purchase agreement is

ambiguous with respect to who was selling (i.e., whether it was Makric or

Makric’s shareholders) and the stock being sold (i.e., whether it was the stock of

Makric or Alpha). Makric asserts that the agreement is both patently and latently

ambiguous.

      First, Makric contends that there is a patent ambiguity in the agreement in

that Makric’s shareholders were parties to the agreement and that this suggests

(according to Makric) that the agreement called for the sale of Makric shares, not

Alpha shares. Makric’s reasoning ignores unambiguous terms of the stock

purchase agreement. Although Makric’s shareholders were parties to the stock

purchase agreement, the agreement does not require them to sell their shares of

Makric. Instead, the agreement unambiguously requires Makric to sell its shares

of Alpha. It provides that “Seller [i.e., Makric] agrees to sell to Buyer [i.e., TS3],

and Buyer agrees to purchase from Seller, all of the issued and outstanding shares

* * * of common stock * * * of the Company [defined as Alpha]”. The only
                                        - 47 -

[*47] reasonable interpretation of this sentence is that Makric was to sell its Alpha

stock to TS3. The inclusion of Makric’s shareholders as parties to the stock

purchase agreement does nothing to diminish this interpretation of the agreement.

Section 3 of the stock purchase agreement, entitled “Representations and

Warranties of Seller and Owners”, provides: “Seller [i.e., Makric] and each

Owner [i.e., Makric’s shareholders] represent and warrant jointly and severally

with respect to warranties covering Seller [i.e., Makric]”. By this wording (and

similar wording in Section 4 of the stock purchase agreement), Makric’s

shareholders were presumably made liable to TS3 should certain warranties made

in the stock purchase agreement be found false. It is not surprising that Makric’s

shareholders would be required to sign an agreement that would impose such

liability on them. Ordinarily, only a party that executes a contract is liable for

breaching the contract. See Willis v. Donnelly, 

, 271 (Tex. 2006)

(a shareholder who does not sign a contract entered into by a corporation is

ordinarily not liable for breach of such contract). If the reason for including

Makric’s shareholders as parties to the stock purchase agreement was instead to

impose on them an obligation to sell their Makric stock, one would expect the

agreement to have a provision requiring them to sell their stock. But there is no

such provision. Including Makric’s shareholders as parties to the stock purchase
                                        - 48 -

[*48] agreement does not create ambiguity as to who was the seller (Makric) or

what stock was being sold (Alpha stock).

      Second, Makric contends that there is latent ambiguity that is not readily

apparent on the face of the stock purchase agreement but that becomes apparent

upon review of collateral documents, including correspondence and tax returns of

Makric’s shareholders. As discussed supra pp. 33-35, latent ambiguity exists if

the contract is plain on its face but is ambiguous in the light of some collateral

matter. See Nat’l Union Fire Ins. 

-522. Under Texas law,

a court may consider extrinsic evidence to determine whether a latent ambiguity

exists only if that evidence concerns the surrounding circumstances or the subject

matter of the agreement.22 See

type of extrinsic evidence that can

be relied on by Makric to show the stock purchase agreement is latently

      22
         Citing Estate of Craft v. Commissioner, 

(1977), aff’d, 

(5th Cir. 1979), Makric contends that the rule against extrinsic evidence
of the parties’ intent should not be invoked by someone who, like the IRS, was not
a party to the original transaction. Makric’s argument rests on a misunderstanding
of our holding in Estate of Craft. Estate of Craft did not hold that the IRS can
never invoke the rule against extrinsic evidence of the parties’ intent but, rather,
that the decision to exclude such evidence turns on state law.

264.
Specifically, Estate of Craft stated that “in those instances where we are called
upon to make a State law determination as to the existence and extent of legal
rights and interests created by a written instrument, we must look to that state’s
parol-evidence rule in deciding whether or not to exclude extrinsic evidence”.

263. Estate of Craft, applying the relevant state rule, held that the taxpayer
could not introduce extrinsic evidence.

264.
                                        - 49 -

[*49] ambiguous. See 

. However, the extrinsic

evidence relied on by Makric to show the stock purchase agreement is ambiguous

consists only of expressions of the parties and declarations of intentions as to

future writings. See Henry v. 

; Remington Rand, 

. Specifically the extrinsic evidence relied on by Makric is: (1)

the February 28, 2008 email from Kisner to Ronn stating that the transaction

would be structured as the sale of Makric, (2) the January 27, 2009 email from

O’Brien of Gulf Star (Makric’s investment bank) characterizing the sale as that of

Makric, (3) testimony of Makric’s CEO, Kisner, that he reached an agreement with

representatives of TS3, under which TS3 would buy Makric stock, and (4)

Makric’s shareholders’ tax returns reporting a gain from the sale of Makric stock

(though described on the returns as “Alpha” stock). Under Texas law, this

extrinsic evidence may not be considered.23 We therefore hold that the relevant

portions of the stock purchase agreement are not latently ambiguous.24 We reject


      23
         As explained infra pp. 52-56, we do consider extrinsic evidence of intent
to evaluate Makric’s other legal theory that the stock purchase agreement was the
result of mutual mistake and can be reformed on that basis.
      24
       Even if we consider the extrinsic evidence proffered by Makric for the
purpose of determining whether the stock purchase agreement is ambiguous, this
evidence, in our view, does not lead to the conclusion that the stock purchase
agreement is ambiguous. See Commissioner v. 

                                                                       (continued...)
                                        - 50 -

[*50] Makric’s attempt to oppose the application of the Danielson rule on grounds

of contractual ambiguity, patent or latent.

      Makric raises several other arguments as to why the Danielson rule should

not apply. It argues that we should hold that the Danielson rule applies only to

agreements concerning the allocation of monetary consideration. The Court of

Federal Claims followed this approach in Hartman v. United States, 

, 181-182 (2011), aff’d on other grounds, 

(Fed. Cir. 2012).

However, we look to our own precedent and to the law of the U.S. Court of

Appeals for the circuit in which appeal of the case would lie.25 Here that circuit is

the Fifth Circuit. See supra note 2. The Fifth Circuit has not limited the

Danielson rule to the allocation of monetary consideration. See Spector v.

Commissioner, 

(holding taxpayer to the tax consequences of the

form of a partnership-exit agreement which structured the partner’s exit as a



      24
        (...continued)
(holding that the IRS was permitted to invoke the parol-evidence rule to exclude
certain evidence in that case and further holding that even if the IRS was barred
from invoking the parol-evidence rule, and the court could consider the evidence
in question, the additional evidence would not change the outcome of the dispute).
      25
       In Golsen v. Commissioner, 

, 756-757 (1970), aff’d, 

(10th Cir. 1971), we held that we will follow the precedent of the U.S. Court
of Appeals for the circuit that will hear the appeal from the case (if the case is
appealed).
                                        - 51 -

[*51] liquidation of his interest, and rejecting taxpayer’s argument that in

substance he had sold his partnership interest).

      Makric next advances the argument that the Danielson rule should not apply

because no unjust result would attend if TS3 were treated as having bought Makric

rather than Alpha. We disagree with that argument. On the basis of the stock

purchase agreement, TS3 reasonably expected that it would be treated for tax

purposes as if it had purchased the stock of Alpha. See Commissioner v.

.

      Finally, Makric contends that the Danielson rule should not apply because

TS3 did not “specifically negotiate for” the sale of Alpha (as opposed to Makric).26

Even if we were to accept that Makric could avoid application of the Danielson

rule for this reason, we find untenable the position that TS3 did not believe it was

negotiating for the purchase of Alpha. TS3’s lawyers drafted the stock purchase

agreement and its prior versions, all of which contemplated TS3’s purchasing

Alpha. The affidavit from TS3’s Chairman, Brunson, makes clear that he believed

TS3 was agreeing to purchase Alpha specifically, not Makric. If TS3 had

      26
        Makric contends that the Fifth Circuit applied the Danielson rule in
Spector v. Commissioner, 

(5th Cir. 1981), rev’g 

(1979), and Insilco Corp. v. United States (In re Insilco Corp.), 

(5th
Cir. 1995), only because in those cases “the taxpayer was trying to change a
provision that it had specifically negotiated with the other party.”
                                        - 52 -

[*52] purchased Makric, TS3 would have been indirectly burdened with all of

Makric’s liabilities, not just Alpha’s liabilities. Makric’s liabilities would have

included Makric’s potential tax liability if it were to sell Alpha. If TS3 had

negotiated for the sale of Makric, rather than Alpha, it might have negotiated a

reduced price to account for the burden of Makric’s liabilities.

      We hold that the Danielson rule bars Makric from contending that in

substance the stock purchase agreement is for the sale of Makric.

      B.     Limited by the Danielson rule to its alternative argument that there
             was a mutual mistake regarding the stock purchase agreement that
             would justify reformation of the agreement under Texas law, Makric
             failed to make the requisite showing of mutual mistake (a
             determination taking into account extrinsic evidence of intent).

      Even when a taxpayer is restricted by the Danielson rule, a court may

reform an agreement if the relevant portions of the agreement were the result of a

mutual mistake. See Commissioner v. 

. Makric

contends that the relevant portions of the stock purchase agreement (i.e., those

identifying the seller as Makric and the stock to be transferred as the stock of

Alpha) were the result of a mutual mistake. A mutual mistake is one common to

all parties, wherein each labors under the same misconception about a material

fact, the terms of the agreement, or the provisions of a written instrument designed

to embody such an agreement. Hardy v. Bennefield, 

, 650 (Tex.
                                       - 53 -

[*53] App.--Tyler 2012). The question of what the parties intended (and therefore

whether there was a mutual mistake) is a factual issue. See Milner v. Milner, 

, 619 (Tex. 2012). In determining whether there was a mutual mistake,

extrinsic evidence is considered. Estes v. Republic Nat’l Bank of Dallas, 

, 275 (Tex. 1970). A mutual mistake justifies reforming even an

unambiguous contract. 

.

      In support of its theory that the stock purchase agreement, in failing to

effect a sale of Makric stock, resulted from mutual mistake, Makric proffers two

principal pieces of evidence. First, Makric points to Kisner’s email instructing

Ronn, TS3’s lawyer, to structure the transaction so that TS3 would purchase

Makric, not Alpha. See supra p. 14. Second, Makric points to the testimony of its

president, Kisner, who was the lead negotiator for Makric. Kisner testified that he

reached an agreement with a representative of TS3 (presumably Brunson, TS3’s

chairman and lead negotiator) that Makric’s shareholders would sell Makric to

TS3. Both pieces of evidence could, if considered credible, tend to show that the

parties intended to sell Makric and that therefore the stock purchase agreement,

which effected the sale of Alpha, was the result of mutual mistake. We thus

consider this evidence.
                                        - 54 -

[*54] We are unable to conclude that the two pieces of evidence described above

show that the pertinent portions of the stock purchase agreement were the result of

a mutual mistake. We consider first the email sent from Kisner to Ronn on

February 28, 2008. Kisner’s email shows that he intended, at one time, to

structure the transaction as the sale of Makric. And, as we have found, a

representative from TS3, at some time before the February 28, 2008 email, had

assented to that structure. See supra note 8. However, Kisner sent the email to

Ronn seven months before the parties executed the stock purchase agreement.

Over the course of those seven months, Kisner (with Miller, Makric’s lawyer)

reviewed several drafts of the stock purchase agreement, all of which contradict

the premise that the parties intended to exchange Makric stock, rather than Alpha

stock. Critically, the stock purchase agreement itself and several of its drafts

describe a sale structure by which TS3 would acquire Alpha, not Makric.

Additional documents, including those signed prior to the closing and at the

closing itself, are consistent with the premise that TS3 intended to acquire, and

Makric intended to sell, Alpha. For example, in 2007, Makric’s shareholders (in

their capacities as Alpha’s directors) signed a consent authorizing that Alpha be

listed for sale. See supra p. 7. The record contains no comparable document

listing Makric for sale. Makric’s shareholders (in their capacities both as directors
                                        - 55 -

[*55] and shareholders of Makric) also signed a “Joint Written Consent of the

Shareholders and Directors in Lieu of a Special Meeting”, which unambiguously

authorized the sale of Alpha by Makric. See supra pp. 20-21. At the closing,

Kisner, in his capacity as CEO of Makric, signed a “Written Consent of Sole

Shareholder of Alpha Circuits Incorporated”, which also unambiguously

authorized the sale of Alpha by Makric. See supra p. 21. We consider these

documents more probative of the parties’ intent at the time they executed the stock

purchase agreement than Kisner’s single email, which he sent several months

before the transaction occurred. Other than the email, the only evidence that

supports the premise that TS3 intended to purchase Makric is Kisner’s testimony.

He testified that he and representatives of TS3 orally agreed to restructure the sale

such that TS3 would purchase Makric. He further testified that he emailed Ronn

only to put that agreement in writing. While we consider Kisner’s testimony

credible and find it plausible that each side’s negotiators, at some point, approved

the structure described by Kisner’s February 28, 2008 email, the weight of the

evidence, including the transactional documents (i.e., the stock purchase

agreement and the consent forms executed at the closing of the sale), indicates that

Makric and TS3 had agreed to a different structure by the time they executed the

stock purchase agreement. For these reasons, even if we were to conclude that the
                                       - 56 -

[*56] extrinsic evidence proffered by Makric shows that Makric and TS3 may

have, at one point, reached an agreement to sell Makric, this evidence is

insufficient to show that the relevant portions of the stock purchase agreement

were the result of a mutual mistake.

      The record does not reveal why the parties did not ultimately adopt the

structure Kisner described in his email to Ronn (TS3’s lawyer). The persons who,

presumably, could have explained this discrepancy were Ronn (TS3’s lawyer who

prepared the stock purchase agreement and its drafts) and Miller (Makric’s

lawyer). Makric did not call either lawyer as a witness. Regardless, the record

makes clear that the parties to the stock purchase agreement did not ultimately

adopt the structure described in Kisner’s email. Brunson, TS3’s chairman, stated

in his affidavit (see supra pp. 30-31) that TS3 might have been willing to purchase

Makric had TS3 undertaken the requisite steps, including an appropriate due-

diligence inquiry, for such a purchase; however, the affidavit also implies that the

parties did not take such steps.27 Brunson swore: “Assuming due diligence had

proven that holding company status [of Makric] and if the sellers had provided us


      27
       We found that TS3 started a due-diligence inquiry with respect to Makric.
See supra p. 16. However, we know very little about the inquiry. It is plausible
that TS3 would have more thoroughly investigated Makric had TS3 intended to
buy Makric rather than Alpha.
                                        - 57 -

[*57] with appropriate representations, warranties, and indemnities regarding

Makric * * * TS3 would have been willing to purchase the stock of Makric.”

(emphasis added). Such due diligence might have revealed that Makric had

liabilities that TS3 did not wish to assume or which would have required an

adjustment to the amount that TS3 was willing to pay for Makric. Brunson’s

admission that TS3 never conducted the requisite due diligence indicates that TS3

never seriously contemplated purchasing Makric.28 Moreover, even if TS3 had

been amenable to purchasing Makric (as the affidavit suggests), neither the

ultimate transaction, nor the negotiations leading up to it, indicate that TS3

intended to purchase Makric at the time the parties reached a final agreement

about the sale.

      Makric advances numerous additional theories as to why Makric’s

shareholders could not have possibly intended to authorize the sale of Alpha. For

example, Makric argues that, since Makric’s shareholders owned Makric stock, it

is only natural that they would have intended to sell Makric stock. This argument,

however, is contradicted by the fact that Makric originally planned to dissolve and


      28
        It is also possible that TS3 would have paid less for Makric (than it did for
Alpha) because Makric would have had a potential tax liability (attributable to
Makric’s built-in gain from its holding of Alpha stock) if it were to sell Alpha
after having been acquired by TS3. See supra p. 51.
                                        - 58 -

[*58] distribute its Alpha stock to Kisner, Williams, and Wilson. Thus, as they

originally envisioned the transaction, Makric’s shareholders would have held and

sold Alpha stock to TS3. We reject the proposition that Makric’s shareholders

could have only intended a transaction in which they would sell their Makric

stock. Even if this proposition were true, it could show only that Makric was

mistaken about the contents of the stock purchase agreement. It says nothing

about TS3’s intent, which was to purchase Alpha.

      Makric contends that the parties to the stock purchase agreement would

have agreed to the sale of Alpha only by mistake because the sale of Alpha was a

tax-inefficient way to structure the sale and because TS3 knew that Makric wanted

to structure the sale so that the gain from the sale would produce long-term capital

gain. We agree that structuring the transaction as the sale of Alpha may have been

relatively tax-inefficient. The tax consequences to Makric for selling Alpha stock

can be found in the notice of deficiency issued to Makric. The notice of

deficiency calculates that Makric’s tax liability increased $2,839,780 by its sale of

Alpha. Makric does not contest the correctness of this amount should the Court

determine that the transaction is treated as the sale of Alpha.29 By contrast, if the

      29
       Arguably $2,839,780 is not the only tax liability resulting from the sale of
Alpha. Makric’s shareholders appear to face a second layer of tax because they
                                                                      (continued...)
                                        - 59 -

[*59] transaction is treated as the sale of Makric shares, the tax consequences--at

least as reported by Makric’s shareholders (Kisner, Williams, and Wilson)--are

found on their individual tax returns. The shareholders reported that they should

be taxed on the gain from the sale of their Makric stock at the 15% tax rate

imposed on net long-term capital gain. See secs. 1(h), 1001, 1222.30 Using this

rate appears to result in an increased tax to the shareholders of only $1,711,913.

This is less than $2,839,780. The comparison between the two numbers may

illustrate the arguable tax inefficiency of selling Alpha rather than Makric. The

problem with Makric’s tax-efficiency argument is that it conceivably sheds light

only on Makric’s intent in signing the stock purchase agreement. TS3, by

contrast, thought that the form of the agreement it signed met the goals of

Makric’s shareholders. In his affidavit, see supra pp. 30-31, Brunson stated that



      29
        (...continued)
received at least some of the proceeds from this sale. Their receipt of proceeds
could be considered a constructive distribution from Makric. See generally secs.
301, 316 (corporate distributions to shareholders); United States v. Smith, 

, 593 (5th Cir. 1969) (constructive distribution to shareholders treated as
actual distribution). A distribution (constructive or actual) may be taxed as
ordinary income, capital gain, a tax-free return of capital, or a combination of all
three. See sec. 306(c)(1), (2), and (3).
      30
         Net long-term capital gain equals long-term capital gains minus long-term
capital losses. Sec. 1222(7). A long-term capital gain is gain from the sale or
exchange of a capital asset held for more than one year. Sec. 1222(3).
                                       - 60 -

[*60] he believed that the “structure for the sale would produce long term capital

gain treatment of the proceeds for each of them [i.e., each of Makric’s

shareholders] for federal income tax purposes.” If TS3 was wrong about this,31

that meant that TS3 made a mistake about the tax consequences of the agreement.

A mistake concerning the legal or tax consequences of an agreement is not the

type of mistake that reformation can remedy. See Hamlin’s Trust v.

Commissioner, 

, 765 (10th Cir. 1954), aff’g 

(1953);

M. Weingold & Co. v. Commissioner, T.C. Memo. 1977-73, 

, 335 (1977); Marsh v. Marsh, 

, 745 (Tex. App.--Houston

[14th Dist.] 1997).

      The IRS argues that this Court is not the proper court for Makric to seek

reformation of the stock purchase agreement. We need not address this contention

because, for reasons already explained, Makric has not shown that the relevant




      31
        This belief may have been incorrect. The sale of Alpha did produce long-
term capital gain, as Brunson said. Makric must recognize capital gain on the sale
of Alpha. Its resulting tax liability would be economically borne by Makric’s
shareholders. However, Makric’s shareholders received some of the proceeds of
the sale of Alpha by Makric. Therefore, they may be considered to have received
a constructive distribution from Makric. See supra note 29. The individual
shareholders arguably face their own tax liability from the constructive
distribution, in addition to the capital gain that Makric must recognize.
                                       - 61 -

[*61] portions of the stock purchase agreement were the result of mutual

mistake.32 Makric has not advanced any other theory by which reformation is

justified. Thus, we conclude that the 2008 agreement should not be reformed to be

the sale of Makric stock.

      C.     Even if Makric’s substance-over-form argument was not barred by
             the Danielson rule, the evidence in the record shows that the
             substance of the transaction is the sale by Makric of Alpha stock.

      Even if the merits of Makric’s substance-over-form argument should be

reached, despite the Danielson rule, the argument lacks merit. Makric argues that

the transaction was, in substance, the sale of Makric because Makric’s

shareholders intended to sell Makric. This premise would not give us a basis for

concluding that the substance of the transaction was the sale of Makric. Under the

substance-over-form doctrine, the tax consequences of a transaction are not


      32
         The IRS’s contention implicates Deshotels v. United States, 

,
967 (5th Cir. 1971), in which the Fifth Circuit held that an unambiguous contract
cannot be reformed where a party to the contract offers only extrinsic evidence to
reform the contract and the other party to the contract is not a party to the case.
See also State Pipe & Nipple Corp. v. Commissioner, T.C. Memo. 1983-339, 

, 415 (1983). Deshotels appears to be relevant to this case
because (1) Makric offers only extrinsic evidence (an email and testimony) to
prove mutual mistake about the stock purchase agreement, (2) the agreement is
unambiguous, and (3) the other party to the stock purchase agreement (TS3) is not
a party to this case. In our view, Deshotels serves as an alternative ground for our
holding that Makric has made an insufficient showing that a finding of a mutual
mistake is warranted.
                                       - 62 -

[*62] necessarily governed by the intent of a party to that transaction. See PPL

Corp. v. Commissioner, 569 U.S. __, __, 

, 1905 (2013); Frank

Lyon Co. v. United States, 

, 573 (1978). Here, the stock purchase

agreement and the circumstances surrounding its execution make plain that the

transaction was both in form and substance the sale of Alpha by Makric. The

relevant portions of the stock purchase agreement (i.e., the portions identifying the

seller and the stock that would be transferred) were not mere recitals, but were the

very substance of the underlying sale. See generally Mittleman v. Commissioner,

, 175-177 (1971), aff’d, 

(3d Cir. 1972). Specifically,

the parties agreed to the following: “Seller [defined as Makric] agrees to sell to

Buyer [defined as TS3], and Buyer agrees to purchase from Seller, all of the issued

and outstanding shares (the ‘Shares’) of common stock * * * of the Company

[defined as Alpha]”. Makric has not invited our attention to any provision in the

stock purchase agreement that is inconsistent with this statement, nor are we aware

of any such provision. Upon execution of the stock purchase agreement, Makric

transferred Alpha stock to TS3, and Makric’s shareholders continued to own

Makric. Accordingly, we conclude that the transaction was, both in form and in

substance, the sale of Alpha stock by Makric.
                                        - 63 -

[*63] Makric emphasizes that both Makric and TS3 were amenable to structuring

the transaction as a sale of Makric. Makric points to the affidavit from TS3’s

Chairman, Brunson, which stated that: (1) TS3 was aware that Makric’s

shareholders were trying to achieve a particular tax result, (2) TS3 would have

accommodated a sale structure that would have achieved that tax result, and (3) he

believed the sale was structured in a way that achieved that tax result. This

affidavit, however, does no more than show that the sale could have been

structured differently had the parties negotiated for and agreed to a different

structure. It does not alter the terms or substance of the agreement that the parties

in fact reached, the purchase of Alpha by TS3. See Pittsburgh Realty Inv. Trust v.

Commissioner, 

, 275 (1976).33

2.    Penalty

      The IRS determined that Makric is liable for an accuracy-related penalty

under section 6662. Section 6662(a) and (b)(2) imposes a penalty equal to 20% of

an underpayment of tax that is attributable to a substantial understatement of

income tax. An understatement is defined as the excess of the correct amount of

tax over the amount of the tax which is shown on the return. Sec. 6662(d)(2)(A).

      33
       Our holding in part 1.C, that the substance of transaction was the sale of
Alpha stock by Makric, is an alternative to our main holding in part 1.A that
Makric is barred from asserting the substance-over-form doctrine.
                                        - 64 -

[*64] In the case of a corporation, an understatement is substantial if (1) it exceeds

10% of the correct tax and (2) it exceeds $10,000. Sec. 6662(d)(1)(B).

      Under section 7491(c), the IRS bears the burden of production with respect

to the section-6662(a) penalty. This means that the IRS “must come forward with

sufficient evidence indicating that it is appropriate to impose the relevant penalty.”

See Higbee v. Commissioner, 

. The IRS has met that burden. The

understatement is equal to $2,839,780, which is $3,476,671 (the correct amount of

tax) minus $636,891 (the tax shown on the return). The understatement,

$2,839,780, exceeds $10,000. It also exceeds 10% of the correct amount of tax

(i.e., 10% of $3,476,671, or $347,667). Makric’s understatement is thus

substantial. See sec. 6662(d)(1)(B).

      Even if an understatement is substantial, the section-6662 penalty is not

imposed on any portion of the underpayment with respect to which the taxpayer

acted with reasonable cause and in good faith.34 Sec. 6664(c)(1). The taxpayer

has the burden of showing that it acted with reasonable cause and in good faith.

Higbee v. Commissioner, 

. Reasonable cause requires the taxpayer

to have exercised ordinary business care and prudence as to the disputed item--in


      34
        As the notice of deficiency determined, the amount of the underpayment in
this case is $2,839,780, the same as the amount of the understatement.
                                         - 65 -

[*65] this case, gain from the sale of Alpha. See generally United States v. Boyle,

(1985); Gould v. Commissioner, 

, 459 (2012), aff’d,

552 F. App’x 250 (4th Cir. 2014).

      The most important factor in determining good faith is the extent of the

taxpayer’s effort to report the correct amount of tax on the return.35 A taxpayer

may demonstrate good faith if it reasonably relied on the advice of a tax adviser.

Sec. 1.6664-4(b)(1), Income Tax Regs. To reasonably rely on the advice of a tax

adviser, however, the taxpayer must take reasonable steps to ensure that the tax

adviser has all of the relevant facts.36 A taxpayer that prepares its returns without

relying on the advice of a tax adviser can also demonstrate that its tax reporting

was in good faith, provided, however, that the taxpayer reasonably ensured that it

used correct information to prepare its return.37 Thus, whether a taxpayer relies on


      35
        The relevant regulation provides: “Generally, the most important factor is
the extent of the taxpayer’s effort to assess the taxpayer’s proper tax liability.”
Sec. 1.6664-4(b)(1), Income Tax Regs.
      36
        The regulation provides: “For example, the advice must not be based upon
a representation or assumption which the taxpayer knows, or has reason to know,
is unlikely to be true, such as an inaccurate representation or assumption”. Sec.
1.6664-4(c)(1)(ii), Income Tax Regs.; see also Neonatology Assocs., P.A. v.
Commissioner, 

, 99 (2000) (taxpayer must provide necessary and
accurate information to the adviser), aff’d, 

(3d Cir. 2002).
      37
           The relevant regulation provides: “Circumstances that may indicate
                                                                       (continued...)
                                        - 66 -

[*66] a tax adviser or not, the taxpayer must reasonably ensure that its return is

based on correct factual assumptions.

      Makric contends that its failure to report its gain on the sale of Alpha on its

2008 short-year return was in good faith because it relied on Harper to prepare the

return. Harper prepared Makric’s tax return for its short year 2008. The return did

not report gain from the sale of Alpha. This reporting is correct only if one

assumes that Makric did not sell Alpha. Setting aside the question of whether

Harper gave “advice” to Makric,38 one issue with Makric’s alleged reliance on

Harper relates to the source of Harper’s assumption that Makric did not sell Alpha.




      37
         (...continued)
reasonable cause and good faith include an honest misunderstanding of fact or law
that is reasonable in light of all of the facts and circumstances, including the
experience, knowledge, and education of the taxpayer.” Sec. 1.6664-4(b)(1),
Income Tax Regs. The regulation gives the following example of an honest
misunderstanding: “[R]eliance on erroneous information * * * inadvertently
included in data compiled by the various divisions of a multidivisional corporation
or in financial books and records prepared by those divisions generally indicates
reasonable cause and good faith, provided the corporation employed internal
controls and procedures, reasonable under the circumstances, that were designed
to identity such factual errors.”

        Harper did not give formal advice to Makric. He only prepared Makric’s
return. Therefore one might question whether Harper provided “advice” to
Makric. See sec. 1.6664-4(c)(2), Income Tax Regs. (defining advice for this
purpose as a communication setting forth the “analysis” and “conclusion” of the
professional tax adviser).
                                      - 67 -

[*67] Harper was told that this assumption was correct by Baudler, Makric’s CFO.

The question we resolve, therefore, is whether Baudler took reasonable steps to

determine whether this assumption was correct.

      On the record, we are not persuaded that Baudler took reasonable steps to

determine whether Makric had sold Alpha. Baudler was informed by an erroneous

email from O’Brien, one of Makric’s investment bankers, that the final agreement

was for the sale of Makric, not Alpha. We do not know whether Baudler relied on

O’Brien’s email to come to his conclusion that Makric sold Alpha. Even if he did,

we cannot say it was reasonable to do so.39 Perhaps Baudler should have read the

agreement himself or consulted a lawyer such as Miller. Another fact one might

consider is that Kisner, Makric’s CEO, thought that the stock purchase agreement

was for the sale of Makric (just as O’Brien thought). However, nothing shows that

Baudler relied on Kisner’s misunderstanding of the stock purchase agreement in

concluding that Makric had not sold Alpha. Even if Baudler had relied on Kisner,

we would not conclude that it was reasonable to so. Kisner was Makric’s CEO,

not Makric’s lawyer. Makric’s lawyer was Miller. It was Miller whom one would




      39
       The record reveals nothing about O’Brien’s capabilities and experience or
what Baudler knew about them.
                                       - 68 -

[*68] expect to be in a position to understand the stock purchase agreement.40

Kisner testified that Miller did not tell him that the stock purchase agreement

provided for the sale of Alpha; however, the record is silent as to what Miller

affirmatively told Kisner or Baudler in regard to the agreement. Thus, we cannot

conclude that Baudler took reasonable steps to determine whether Makric had sold

Alpha before he told Harper that Makric had not sold Alpha.

      Upon review of the record, we conclude that Makric has not shown that the

underpayment was the result of good faith and reasonable cause.

      In reaching our conclusions, we have considered all arguments made by the

parties, and to the extent that we have not addressed them, we find them to be

moot, irrelevant, or without merit.

      To reflect the foregoing,


                                                Decision will be entered

                                       for respondent.


      40
        Miller was largely absent during the later stages of the negotiations
between Makric and TS3 because he was injured in a car accident a few months
before the closing of the sale. His firm apparently remained involved in the
negotiations while he was absent, although the extent of its involvement is
unclear. Miller did review the stock purchase agreement and the drafts that
immediately preceded it (all of which called for the sale of Alpha to TS3). Neither
Miller nor anyone from his firm was called as a witness.