T.C. Memo. 2008-269



                      UNITED STATES TAX COURT



                  MARCUS A. KATZ, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 5847-06.              Filed December 3, 2008.



     Charles E. Hodges II and David D. Aughtry, for petitioner.

     John W. Sheffield III, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     FOLEY, Judge:   After stipulations and concessions, the

issues for decision are whether petitioner is entitled to defer

recognition of capital gain relating to the transfer of

appreciated property in exchange for a private annuity and
                                 - 2 -

whether petitioner is liable for a section 6662(a)1 accuracy-

related penalty.

                         FINDINGS OF FACT

     Most of the facts have been stipulated and are so found.    In

1993, petitioner started Educational Loan Administrative Group,

Inc. (ELA), a California-based student loan business.   In 1997,

UICI Acquisition Corp., a subsidiary of UICI (UICI), a publicly

traded company, acquired ELA in a merger transaction in which

petitioner received 470,708 shares of UICI restricted stock in

exchange for his stock in ELA.    In January 1998, petitioner, in

an effort to hedge some of the UICI shares, purchased from

Merrill, Lynch, Pierce, Fenner & Smith (Merrill Lynch) 200,000

UICI common stock put options (put options) and sold Merrill

Lynch 200,000 UICI common stock call options (equity swap

transaction).   The respective strike prices for the put and call

options were $23.09 and $26.93 per share.   The options were

European-style options which, after agreed upon extensions, could

be exercised only on February 3, 2000.

     In December 1999, petitioner, as a part of his retirement

planning, began negotiations with Merrill Lynch and Philip

Langridge, a successful Canadian businessman, to exchange the



     1
       Unless otherwise indicated, all section references are to
the Internal Revenue Code of 1986, as amended and in effect for
the year in issue, and all Rule references are to the Tax Court
Rules of Practice and Procedure.
                                - 3 -

equity swap transaction for a private annuity contract.    On

January 11, 2000, Mr. Langridge’s wholly owned company, SJA

Company, Ltd. (SJA), was incorporated in the Bahamas as an

international business company.

      On February 3, 2000, the date the rights under the equity

swap transaction were due to expire, petitioner entered into a

single lump-sum private variable annuity contract with SJA

(private annuity contract) and an assignment agreement with

Merrill Lynch and SJA.2    Pursuant to the agreements, petitioner

transferred 200,000 UICI shares of common stock and the put

options to SJA in exchange for a private annuity.    The private

annuity contract provided that neither petitioner nor his family

would receive any annuity payments if petitioner died before age

65.   On February 3, 2000, after receiving the UICI shares and put

options, SJA notified Merrill Lynch that it was delivering the

UICI shares to Merrill Lynch and exercising the put options at

the agreed strike price.

      On February 8, 2000, Merrill Lynch settled the sale of the

UICI shares and purchased the shares from SJA for $4,617,841

(UICI stock sale).   Pursuant to the private annuity contract and

assignment agreement, SJA was the owner of the proceeds from the



      2
       To protect its interests, Merrill Lynch required the
equity swap transaction to be transferred by an assignment
agreement in which Merrill Lynch was the “counterparty”,
petitioner was the assignor, and SJA was the assignee.
                                - 4 -

UICI stock sale.   Merrill Lynch, however, deposited the proceeds

from the UICI stock sale in petitioner’s non-interest-bearing

Merrill Lynch account.    Upon discovery of the error, petitioner

immediately notified Merrill Lynch and Mr. Langridge.     Merrill

Lynch informed petitioner and Mr. Langridge that the proceeds had

been temporarily placed in petitioner’s account because SJA had

not yet established a Merrill Lynch account.     Petitioner and Mr.

Langridge agreed that, pursuant to the private annuity contract,

petitioner would keep $800,000 of the UICI stock sale proceeds

erroneously deposited into petitioner’s account.

     In an attempt by petitioner, Merrill Lynch, and SJA to

correct the error, on May 8, 2000, $3,817,841 (i.e., the UICI

stock sale proceeds minus the $800,000 retained by petitioner)

was transferred from petitioner’s Merrill Lynch account to an

account owned by SJA.    Merrill Lynch subsequently issued

petitioner a Form 1099-B, Proceeds From Broker and Barter

Exchange Transactions, which indicated that petitioner received

$4,617,841.   Petitioner timely filed his 2000 Federal income tax

return, on which he disclosed receipt of the Form 1099-B,

indicated that he was a “nominee” for SJA, and reported a basis

in the UICI shares of $4,617,841.    Petitioner had a basis of

$150,650 in the UICI shares, yet reported a basis of $4,617,841

in an attempt to address the Merrill Lynch error and offset the

amount reported on the Form 1099-B.     In a notice of deficiency
                                - 5 -

dated December 22, 2005, respondent determined a $920,813

deficiency in petitioner’s Federal income tax and a $184,163

section 6662(a) accuracy-related penalty relating to 2000.    On

March 23, 2006, petitioner, while residing in California, filed

his petition with the Court.

                               OPINION

     We must determine whether petitioner is entitled to defer

recognition of capital gain relating to the transfer of the UICI

shares in exchange for the private annuity (the transfer).

Pursuant to Rev. Rul. 69-74, 1969-1 C.B. 43, 43-44, when a

taxpayer exchanges appreciated property for a private annuity,

“[t]he gain should be reported ratably over the period of years

measured by the annuitant’s life expectancy and only from that

portion of the annual proceeds which is includible in gross

income by virtue of the application of section 72.”   Thus, a

taxpayer who exchanges appreciated property for a private annuity

is entitled to defer recognition of capital gain relating to the

appreciated property until the taxpayer receives annuity

payments.   Petitioner concedes that he is not entitled to defer

recognition of capital gain relating to the $800,000 that he

retained, but contends that he is entitled to defer recognition

of any other capital gain relating to the transfer.   Respondent

contends that “[t]he facts show the transaction was not an

exchange of appreciated property for a private annuity because
                                - 6 -

petitioner completely orchestrated the simultaneous stock sale

and private annuity purchase in an attempt to unlawfully defer

capital gains under I.R.C. § 72.”    We disagree.

     Regarding the form and substance of the transactions, the

parties stipulated:

          39. Mr. Katz is not related to Mr. Langridge and
     neither Mr. Katz nor any member of his family has any
     direct or indirect ownership interest, control, or
     position of responsibility in SJA or any other company
     owned by Mr. Langridge. Neither Mr. Katz nor Mr.
     Langridge hold any direct or indirect ownership
     interest, control, or positions of responsibility in
     Merrill Lynch.

          *     *     *     *       *     *     *

          49. The terms in the Private Annuity Contract
     meet the requirements of Rev. Rul. 69-74, 1969-1 C.B.
     43 and I.R.C. section 72 subject to Respondent’s
     substance-over-form position.

          *     *     *     *       *     *     *

          50. Subject to Respondent’s substance-over-form
     position, the Private Annuity Contract is a valid
     private annuity in which the manner of taxation of the
     annuity payments to Mr. Katz received after he reaches
     age 65 is as provided by Rev. Rul. 69-74, 1969-1 C.B.
     43 and I.R.C. Section 72.

          *     *     *     *       *     *     *

         54. Mr. Katz irrevocably transferred, conveyed,
     and assigned the 200,000 shares of UICI common stock
     and 200,000 UICI put options to SJA on February 3,
     2000 before the exercise of the put options on
     February 3, 2000.

          *     *     *     *       *     *     *

         58. Mr. Langridge’s company, SJA, was the owner
     of the 200,000 UICI shares and the put options and was
     the owner of the proceeds from the settlement of the
                                     - 7 -

      sale of the 200,000 UICI shares pursuant to the
      exercise of the put options, subject to the Private
      Annuity Contract.

          *     *       *     *       *      *       *

          80. Respondent does not assert the Equity Swap
      Transaction, the Private Annuity Contract, or any
      agreement entered into between Mr. Katz and Philip
      Langridge on behalf of SJA or between Mr. Katz, Philip
      Langridge on behalf of SJA, and Merrill Lynch was a
      “sham” for federal tax purposes or was entered into
      for the purpose of improperly avoiding any federal
      taxes. The parties thus agree the allegations and
      issues asserted in paragraph 8 of the Answer[3] should
      be disregarded.

    Stipulations are treated as conclusive and binding admissions

by the parties unless otherwise permitted by the Court.         Rule

91(e); Petaluma FX Partners, LLC v. Commissioner, 131 T.C. ___,

___ (2008) (slip op. at 9).       Thus, the parties agree and the

evidence establishes that the private annuity contract was a

valid agreement, the form of the private annuity contract met the

requirements of Rev. Rul. 

,          petitioner transferred

the options to SJA before the options were exercised, SJA was the

owner of the proceeds from the UICI stock sale, and the

transactions were not entered into for the purpose of avoiding

Federal income taxes.    Undaunted by stipulations that effectively




     3
       In paragraph 8 of his answer, respondent asserted that
“petitioner’s purported purchase of an annuity from SJA in the
year 2000 is a sham transaction, devoid of economic substance.”
                                - 8 -

eviscerate any plausible challenge to the form and substance of

the transactions, respondent inexplicably contends:

          The fundamental issue in this case is whether
      there was really a trade of 200,000 shares of UICI
      stock put options or the equivalent for a private
      annuity that would cause deferral of the resulting
      capital gains under I.R.C. § 72. * * *

          The facts show the transaction was not an exchange
      of appreciated property for a private annuity because
      petitioner completely orchestrated the simultaneous
      stock sale and private annuity purchase in an attempt
      to unlawfully defer capital gains under I.R.C. § 72.
      This is respondent’s form over substance argument.

    There is no credible evidence supporting respondent’s

position.4    On the one hand, respondent contends petitioner was

“attempting to unlawfully defer capital gains”.    While on the

other hand, respondent stipulated that “respondent does not

assert [that the transaction or any agreement] was a ‘sham’ for

federal tax purposes or was entered into for the purpose of

improperly avoiding any federal taxes.”    In short, respondent

stipulated away the underpinnings of his “form over substance”

contention.    Accordingly, petitioner, with the exception of the

$800,000 that he retained, is entitled to defer recognition of

capital gain relating to the transfer.



     4
       Pursuant to sec. 7491(a), petitioners have the burden of
proof unless they introduce credible evidence relating to the
issue that would shift the burden to respondent. See Rule
142(a). Our conclusion, however, is based on a preponderance of
the evidence, and thus the allocation of the burden of proof is
immaterial. See Martin Ice Cream Co. v. Commissioner, 

, 210 n.16 (1998).
                                - 9 -

    We note that respondent, in an unconvincing attempt to

salvage his “form over substance” contention, cites Usher v.

Commissioner, 

(1965).    Usher is distinguishable.    In

Usher, the taxpayer, who had previously entered into a binding

agreement to sell shares to a specified entity, created a trust

with her children listed as the beneficiaries and on the same

date transferred the shares to the trust in exchange for an

annuity.

  The trust then sold the shares in

accordance with the preexisting agreement.

  The

Commissioner contended and proved that in substance the stock

sale was completed by the taxpayer, and the trust, to which the

taxpayer’s family members were beneficiaries, was a mere conduit.

  In the present case, however, SJA was not a

mere conduit.   In fact, respondent stipulated that petitioner

entered into a private annuity contract with SJA, petitioner had

no direct or indirect interest in SJA or Merrill Lynch, SJA owned

the UICI shares at the time they were sold, Merrill Lynch

erroneously deposited the funds from the UICI stock sale into

petitioner’s account, and the transactions were valid

transactions not entered into for the purpose of improperly

avoiding taxes.    Moreover, in Usher, the taxpayer’s transaction

was not sanctioned by one of the Commissioner’s revenue rulings.

Whereas in the present case, petitioner’s transactions met the

requirements of Rev. Rul. 

.
                                - 10 -

    We must also determine whether petitioner is liable for the

section 6662(a) accuracy-related penalty relating to 2000.

Section 6662(a) provides for an accuracy-related penalty equal to

20 percent of the underpayment of tax if the underpayment is due

to one of the reasons listed in section 6662(b).   Respondent

bears, but has failed to meet, the burden of production relating

to the section 6662(a) penalty.    Sec. 7491(c); Higbee v.

Commissioner, 

, 446 (2001).    Petitioner received

$800,000 in proceeds from the UICI stock sale.   Respondent,

however, conceded that petitioner is entitled to $827,313 of

previously disallowed ordinary business expense deductions.

Thus, there is no underpayment.    Accordingly, petitioner is not

liable for the section 6662(a) accuracy-related penalty.

    Contentions we have not addressed are irrelevant, moot, or

meritless.

    To reflect the foregoing,


                                          Decision will be entered

                                     under Rule 155.