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T.C. Memo. 2011-105




Docket Nos. 6984-08, 6997-08, Filed May 19, 2011.


Pietro E. Canestrelli and Stanley A. Harter, for


Heather K. McCluskey and Monica D. Gingras, for respondent.

Cases of the following petitioner are consolidated

herewith: Mark E. Warmoth, docket Nos. 6697-08 and 15166-08.


MARVEL, Judge: In separate notices of deficiency respondent determined deficiencies in petitioners’ Federal income taxes and

accuracy-related penalties under section 6662(a)2 as follows:

Penalty Docket Petitioner Year Deficiency Sec. 6661(a) 6984-08 Weekend Warrior Trailers, Inc. 2002 $1,117,383 $446,953 6997-08 Mark E. Warmoth 2002 14,836 2,967 2003 1,252,944 250,589 15166-08 Mark E. Warmoth 2004 471,615 94,323 All monetary amounts have been rounded to the nearest dollar. Respondent subsequently asserted an increased deficiency in each docket. See infra pp. 33-36.

Petitioners contested the determinations by filing timely petitions. The resulting cases have been consolidated.

Unless otherwise indicated, all section references are to the Internal Revenue Code (Code), as amended and in effect for the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.

-3After concessions,3 the issues for decision with respect to Weekend Warrior are: (1) Whether Weekend Warrior is entitled to management fee deductions of $4,175,000, $4,800,000, and $4,595,000 for 2002, 2003, and 2004, respectively, (2) whether Weekend Warrior is entitled to depreciation deductions with respect to the airplane and the Nordic boat (boat), (3) whether Weekend Warrior is entitled to airplane expense deductions, (4) whether Weekend Warrior has interest income under section 7872 from loans to Mark E. Warmoth (Mr. Warmoth) for each year at issue, and (5) whether Weekend Warrior is liable for the accuracy-related penalty under section 6662(a) for 2002.

Weekend Warrior Trailers, Inc. (Weekend Warrior), concedes depreciation deductions with respect to the Malibu boat of $5,885, $3,531, and $3,531 for 2002, 2003, and 2004, respectively. At trial and on brief respondent asserted adjustments to ending inventory for each year different from those in the notices of deficiency. Respondent asserts these adjustments equal $234,423, $222,115, and $539,786 for 2002, 2003, and 2004, respectively. Petitioners failed to address the adjustments to ending inventory in the opening brief, and in the reply brief petitioners state that they concede the adjustments to Weekend Warrior’s ending inventory. At trial and on brief respondent states that the forgone interest adjustment under sec.

7872 to Weekend Warrior’s 2002 return should be $39,896 rather than $41,343 as he had determined in the notice of deficiency, and we treat the $1,447 difference as respondent’s concession.

Lastly, at trial Revenue Agent Timothy Burke testified that the adjustment to depreciation deduction with respect to the 1994 Beechcraft 58 Baron airplane (airplane) for 2003 should be $31 lower than what respondent had determined in the notice of deficiency; we treat the difference as respondent’s concession.

-4The issues for decision with respect to Mr. Warmoth are:

(1) Whether Mr. Warmoth is entitled to items of deduction that flow through from Weekend Warrior in 2003 and 2004 in the light of the issues listed above,4 (2) whether Mr. Warmoth received unreported constructive dividend income from Weekend Warrior in 2002, and (3) whether Mr. Warmoth is liable for the accuracyrelated penalty under section 6662(a) for each year at issue.5

–  –  –

Some of the facts have been stipulated. The stipulation of facts is incorporated herein by this reference. Mr. Warmoth resided in California when he filed his petitions. Weekend Warrior’s principal place of business was also in California when it filed its petition.

I. Background Mr. Warmoth started riding dirt bikes and off-road vehicles when he was 9 years old. After graduating from high school, Mr.

Warmoth worked for a major recreational vehicle (RV) manufacturer for 14 years.

A self-described “desert rat”, Mr. Warmoth vacationed in the desert, where off-road enthusiasts travel to ride off-road vehicles. To transport their off-road vehicles to the desert, Our conclusions with respect to Weekend Warrior for 2003 and 2004 resolve this issue. See sec. 1366(a)(1).

Other adjustments to Mr. Warmoth’s 2002-04 tax returns are computational.

-5off-road enthusiasts build trailers. Having learned how to build RVs during his employment with the RV manufacturer, Mr. Warmoth developed a unique recreational travel trailer to serve this niche market. The concept of the product was a trailer with a drop-down back that could accommodate a motorcycle or an off-road vehicle. In 1988 he started his own business of mass-producing the trailers.

Originally, Mr. Warmoth’s business was “doing business as” Warrior Manufacturing. On August 5, 1995, the business was incorporated as Weekend Warrior.6 Between 1995 and 2002 Weekend Warrior was a C corporation. Effective January 1, 2003, Weekend Warrior elected S corporation status. From its incorporation through December 31, 2009, Mr. Warmoth was the sole shareholder of Weekend Warrior. From January 1, 2000, through December 31, 2005, Mr. Warmoth was Weekend Warrior’s chief executive officer (CEO) and president.

Weekend Warrior designed, manufactured, and sold travel trailers. It manufactured lightweight models at the main plant located at 1320 Oleander Avenue, Perris, California, a leased facility. Another facility, located in the same neighborhood, manufactured heavy-duty wide-body expensive trailers, such as fifth wheelers and full trailers.

–  –  –

Most of the manufacturing process took place outside; the employees started work in the morning and finished by dark because there were no lights outside. Mr. Warmoth spent 5 or 6 days per week at the factory and showed trailers to potential customers approximately 40 weekends annually. Weekend Warrior owned most of the equipment used in the manufacturing process.

Before the changes in structure described below, Weekend Warrior’s main departments were sales, production, and purchasing. Other departments, namely, engineering, service, accounting, and operations, were on a lesser pay scale, as they were perceived to be slightly less valuable. From December 31, 2001, through January 1, 2006, Weekend Warrior had three top managers who reported directly to Mr. Warmoth: Corrie Stoap (Mr.

Stoap), who was in charge of purchasing and later held the position of operations manager and vice president; Gary Denton (Mr. Denton), a sales manager; and Kris Hansen (Mr. Hansen), a production manager, who later became vice president of production.

Weekend Warrior organized the manufacturing process in runs.

Each run produced similar models. On average, 80 percent of the materials used in the production of trailers was the same.

Depending on the model, the run could last 1 or 2 weeks. If a run was 25 trailers long, the purchasing department bought 25

–  –  –

To minimize the need for cash outlay and physical space, Weekend Warrior used just-in-time purchasing. Materials were delivered a few days before they were needed, although Weekend Warrior purchased a 2-week supply of smaller, less expensive items and reordered them when the supply ran low. The purchasing manager at each plant was responsible for inventory on hand, its turnover, and the amount of cash tied up in inventory. Suppliers billed Weekend Warrior for materials and supplies.

Weekend Warrior sold its products through a dealer network.

It had ongoing relationships with various dealerships.

Generally, Weekend Warrior was paid 3 weeks after selling a trailer to a dealer, which created a cashflow problem because Weekend Warrior paid expenses for labor and material as it was building a trailer. Warrior Manufacturing was responsible for warranty work on sold trailers.

Mr. Warmoth was the “sole driving force behind the product.” He performed design work. Around 2002 Mr. Warmoth received his first patent; it was a patent for a part inside a trailer. Mr.

Warmoth subsequently received patents for sofa armrests and a Weekend Warrior held approximately six trademarks.7 bed.

At some point before 1995 Weekend Warrior implemented the Weekend Warrior Bonus Plan (bonus plan) using as a template the

–  –  –

bonus plan of the company for which Mr. Warmoth had worked before starting Weekend Warrior. The bonus plan was not limited to the top managers but rather was for key employees. Under the bonus plan, one-third of Weekend Warrior’s profits became a key employee pool. One-half of the key employee pool was split among the top managers and Mr. Warmoth. One-half of the remaining amount was split among eight assistant managers. The remainder was split among managers at various levels.

Weekend Warrior had no incentive structure for rank-and-file employees. Motivating them was a challenge. The funds remaining after compensating key employees under the bonus plan were insufficient to motivate rank-and-file employees.

By 1997 Weekend Warrior’s annual sales had reached $3 million. Around 1998 off-roading became a popular form of recreation. Weekend Warrior’s gross sales started growing at the annual rate of 50 percent and reached $40 million in 2002. For 2 or 3 years thereafter gross sales continued to grow at the annual rate of 50 percent.

Weekend Warrior had no human resources department, so Mr.

Hansen handled employee matters. He calculated workforce needs on the basis of production schedules, and he hired and fired employees accordingly. To fill an open position, Mr. Hansen placed an advertisement, although many applicants learned about

–  –  –

Warrior advertised positions with special requirements and used headhunters when searching for specific talent. The receptionist answered phone calls and passed potential hires’ contact information to Mr. Hansen. Mr. Hansen then invited the applicants for interviews and made hiring decisions.8 Weekend Warrior did not issue formal offer letters or enter into employment contracts when hiring new employees. Terminating employees was delegated to assistant managers and production managers. Approximately 85 percent of employees worked for Weekend Warrior’s manufacturing department. Although a number of employees had been employed by Weekend Warrior for 15 years, there was a high turnover rate for entry-level employees.

Weekend Warrior employed a controller, but an outside accounting firm handled “all of the detail work”. After 2002 Ray Espera (Mr. Espera) held the controller position. Mr. Espera and Mr. Stoap were responsible for maintaining the books and records.

Weekend Warrior maintained a securities account at Comerica Bank (Comerica) and three accounts with Foothill Independent Bank (Foothill). Mr. Warmoth was the only individual with signature authority over Weekend Warrior’s accounts.

Mr. Hansen’s testimony on this point appears inconsistent with stipulation No. 179, according to which Mr. Warmoth made all hiring decisions for Weekend Warrior. We found Mr. Hansen’s testimony on the point convincing and make our findings of fact regarding the foregoing on the basis of Mr. Hansen’s testimony.

- 10 II. The 2002 Changes

–  –  –

Before 2002 Weekend Warrior engaged the services of attorney John Dana Mitchellweiler (Mr. Mitchellweiler), a partner at Smith, Mitchellweiler in Riverside, California. Mr.

Mitchellweiler described himself as an outside general counsel to Weekend Warrior. Mr. Mitchellweiler practiced law in the business and estates areas. As of the date of trial Mr.

Mitchellweiler had practiced law for 15 years.

In August 2002 Mr. Mitchellweiler introduced Mr. Warmoth to William R. Lindsey (Mr. Lindsey). Mr. Lindsey was a financial adviser with 27 years of financial planning experience and was formerly employed by New York Life. Mr. Lindsey holds a master’s degree in financial services and certificates in business succession and executive compensation and is an accredited estate planner. Mr. Lindsey was a part of an “architectural team of designers” for clients’ estate planning, investment, and life insurance needs.

Mr. Warmoth hired Mr. Lindsey to prepare an overall plan for him. Mr. Lindsey’s firm prepared an outline of Mr. Warmoth’s goals that summarized Mr. Warmoth’s financial philosophy. The goals included developing an investment strategy, achieving financial independence, establishing an estate plan, and other

–  –  –

Mr. Warmoth also sought general advice as to how to handle the company’s rapid growth.

On the basis of Mr. Warmoth’s needs, Mr. Lindsey put together a team of advisers--Mr. Lindsey and his pension administration firm; Mr. Mitchellweiler; Greg Siegler, a certified public accountant from the accounting firm Crabtree & Associates; Steve Tweedlie, an auditor from Crabtree & Associates; Ken Baily (Mr. Baily), a valuation analyst; Curt McCombs from Comerica; and Roland Attenborough, an attorney from Reish & Luftman.9 Mr. Lindsey coordinated the team members and the document preparation. In the last quarter of 2002 the team members met several times to discuss various options.

B. The New Structure and Various Compensation Plans The team of advisers recommended the creation of Leading Edge Designs, Inc. (Leading Edge). On November 11, 2002, the articles of incorporation of Leading Edge were executed. On November 14, 2002, Leading Edge was incorporated under the laws of California. Effective November 14, 2002, Leading Edge elected S corporation treatment. Mr. Mitchellweiler drafted incorporation documents and provided tax advice regarding the consequences of forming an S corporation.

–  –  –

Mr. Warmoth received 10,000 shares of Leading Edge stock.

Mr. Warmoth was to pay $20,000 for the shares, but he failed to execute a promissory note or pay the required amount. Mr.

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