James T. & Tiffany A. Manning, Petitioner

e T .C . Memo . 2009 15 7 UNITED STATES TAXI COUR T JAMES T . AND TIFFANY A . MANNING, Petitioners v .

COMMISSIONER .OF INTERNAL R E ENUE, Responden t Docket No . 30112-07 .

Filed June 30, 2009 .

Farley P . Katz and Charles J . Muller, III, for petitioners .

Daniel N . Price , for respondent .

MEMORANDUM FINDINGS OF FACT AND OPINION

KROUPA, Judge : Respondent determ Tined a $714,924 deficiency in petitioners' Federal income tax for 2003 and a $142,984 .80 accuracy-related penalty under section 6662 .

'All section references are to the Internal Revenue Code in effect for the year at issue, and all Rule references are to the Tax Court Rules of Practice and Procedure, unless . otherwis e indicated .

SERVED JUN 3 0 ,2009

d After concessions, we are left to decide three issues .2 The first issue is whether payments James Mannin g (petitioner) made to Warrior Fund, LLC (Warrior) are deductible under section 162 . We hold the payments are deductible becaus e _they.nare ordinary and necessary business expenses . In s o hording, we also hold that the payments are not illegal payments syz jer s ; ,., .

" - underection 162(c)(2), nor are . they barred from deductibility - --t-- under---(cid:127)the economic substance doctrine . The second issue i s whether petitioner generated taxable gains as a trading ; agent o f .'-.

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a '` W arr, or su accoun b t W h ld h did o e e not b ecause the ga ns i b petitioner . The third issue is whethe r 1 e1onged to Warrior, no t :..,.

.._~_ pe-titioners are liable for the accuracy-related penalty unde r section 6662 . We hold that petitioners are not liable for an accuracy-related penalty .

FINDINGS OF FAC T

Some of the facts have been stipulated and are so found .

The stipulation of facts, supplemental stipulation of facts, second supplemental stipulation of facts, and their accompanying exhibits are incorporated by this-reference .

Petitioners are husband and wife who resided in Texas at the time they filed the petition . Petitioners timely filed a joint Federal income tax return for 2003 .

2Respondent concedes that petitioners are not taxable on $590,862 in unreported gross receipts or sales and that petitioners are entitled to deduct $60,951 in professional fees . Petitioners concede they mistakenly deducted $100,000 in commission rate adjustments in 2003 that were actually paid in 2004 .

I- Petitioner' s Career as a Day Trade r Petitioner received a bachelor' s egree in busines s .management from Southwest Texas State niversity in'1995 .

Shortly thereaf ter, he entered the high-paced day trading industry .

Day traders use software 'to track stock values and may trade hundreds of thousands of shares per day trying to profit from minute-to-minute changes in their val u Day trading i s extremely risky and often results in s bstantial financial losse s in a short time . In fact, many day traders buy on borrowe d money, increasing their risk beyond th it invested capital . The Securities and Exchange Commission (SE warns that day traders .

should be prepared to lose their entir investment because of the risk of large and immediate financial osses . Petitioner,- however,, beat the odds and consistent¹ made money as a day trader .

Despite his success, petitioner b gan to desire a more stable and less stressful job when his first child was born . H e began to .coach other traders in 2001 w pile continuing to trade his own account. Petitioner mastered how the day trading business operates during this time . P etitioner then decided to open his own business and began negoti ations with Assent, LLC (Assent), the largest national broker- dealer that provided direct-access electronic trading and ther services to day traders .

ft Petitioner became the initial branch manager and Genera l Securities Principal (GSP) of Assent's office in Austin, Texas (branch office) . Petitioner operated the branch office through a .

wholly owned entity, James T . Manning, LLC, a disregarded entity for Federal income tax purposes . Petitioner leased the offices and provided computers, monitors, and extremely fast T-1 lines for Internet connection at the branch office .

Petitioner,.s duties, as branch manager, included handling „compliance matters for the branch office and supervising the itraders . Petitioner was also a Class B member of Assent . Class B members act as group leaders, and recruit business to Assent .

Assent compensated petitioner for his work as a Class B member by permitting him to share in the . commissions generated by .branch office customers . Petitioner was not separately compensated for serving as branch manager .

Assent"s Commission Arrangement With Petitione r Assent charged its customers for various services, ;; including commissions on executed trades . Petitioner negotiated the commission rates with the customers, and the customers paid the commissions directly to Assent . Assent charged commissions as an amount per 1,000 shares of stock purchased or sold ; i .e ., $5 per 1,000 shares . Assent kept a portion of the customers ' ,,commissions and paid the rest to petitioner . Assent's commissio n rate was tied to the volume of shares traded through the branch office . Assent lowered its commission rate when the branch office reached certain tiers in the volume of shares traded . All s shares traded through the branch office were charged the lower rate once the share volume reached the .next volume tier .

Petitioner's business model focus -d on increasing the branch office's trading volume, thereby lowerng Assent's commission rate and allowing petitioner more flexbility to negotiat e commissions with branch office . customer s .

Accordingly, petitioner actively recruited customer who were group leaders with multiple traders trading under them .

For example, petitioner recruited Mike Kestler and Jonathan Kirkland, group leaders affiliated with a different branch office of Assent .

Other group leaders were organized as limited liability companies (LLCs) .

Petitioner recruited Vantage . Capi al, LLC (Vantage) and Warrior, two high - volume LLCs , to trade through the branch office . . These LLCs opened a main account with Assent .

Individual traders who were members of the LLCs acted as designated trading agents andtraded the funds in the main account . Their trading activity was tracked through . individual subaccounts for accounting purposes . Petitioner negotiated with group leaders to determine the commission rates for each of their trading agents , and these rates were assigned to the trader's subaccount .

When a designated trading agent executed a trade, Assent would charge the LLC the negotiated commission rate for that subaccount .

In addition , petitioner brought in many individual accounts .

Commission Rate Adjustment s The LLCs and the group leaders sought the lowest possible .commission :rates because they traded huge volumes of shares . The branch office competed against firms nationwide to attract and keep these customers . Petitioner could request that Assent make a commission rebate to a customer who demanded lower commissions .

Assent routinely made commission rebates where the customer exceeded certain target levels set by a GSP or a branch,4manager .

;Assent required GSPs and branch managers to process requests fo r !icommis'sion rebates on an Assent form . Petitioner requested that i!Assent,make rebates to customers on a number of occasions, bu t they were not happy with the time it took Assent to process the requests . 'Petitioner began to make payments directly to customers from his share of the commissions (commission rate adjustments) to keep them happy . Assent would have made any rebates petitioner requested provided they did not affect Assent's share of the branch office income . Accordingly, the economics were identical for all parties whether Assent processed a commission rebate or petitioner made a commission rate adjustment .

Petitioner made commission rate adjustments for Warrior, ,Vantage, Mr . Kirkland, and Mr . Kestler,that depended onj .thei r !!trading volume . Warrior was the branch office's largest customer and generated most of the branch office's trading volume . Assent charged Warrior an average commission of $3 .75 to $4 .25 :,pe r thousand shares traded . Assent kept $2 as profit and paid a petitioner the remaining amount . Peti ~ ioner agreed to mak e commission rate adjustments so that Wa rrior's net commission rate , would be about $2 .25 per thousand shares traded ., Accordingly, petitioner's net earnings were about 25 cents per thousand shares traded after commission rate adjustments .

Petitioner reported the commission rate adjustments as "commission adjustments " on Forms 1099 - B, Proceeds From Broker and Barter Exchange Transactions , issued to each customer .

Petitioner then deducted $1,335,185 as "commissions" on the Schedule C, Profit-or Loss From Business , for 2003-. -Warrior reported all the commission rate adjustments it received as income for tax purposes .

Petitioner maintained his books and records for 2003 on QuickBooks . Petitioner wife's mother, Vicki McGee, entered all the source data, including checks . Ms . McGee mistakenly recorded two commission rate adjustments as paid on December 31, 2003, even though petitioner actually paid them on January 16, 2004 .

Richard Springer, a certified public accountant, prepared petitioners' tax return for 2003 .' Petitioner believed that the records he provided to Mr . Springer were accurate, and they were accurate with the exception of the two commission rate adjustments that were paid in 2004 .

John Manning and Warrio r John Manning (petitioner's broth r) was a day trader with the Midas touch . He partnered with several day, traders wh o desired to work with him because of hi s success .

He formed Warrior in 2002 to consolidate his multiple trading partnerships under one common entity . Petitioner's brother provided most of Warrior's capital from his own funds and various loans .

,.Petitioner lent his brother $500,000 to help fund the initial trading partnerships, and Warrior took over this debt . Petitione r rbecame a "preferred member" of Warrior, giving him a priorit y right to repayment of the $500,000 loan principal at a 5-percent interest rate . Petitioner had no right of control or management as a result of his interest . Warrior's books reflected tha t petitioner did not share in its profits or losses . Petitioner received $24,375 in interest from Warrior in 2003, and he reported it . Petitioner continued to receive interest until the full principal was repaid .

The trading partners became designated trading agents o f Ii Warrior., each designated by a separate subaccount . The,!trading agents were authorized to act as agents on Warrior's behalf . All gains or losses on the Warrior account belonged to the entity itself subject to negotiated subaccount profit splits . Warrior entered into written agreements with the trading agents setting out the terms of the profit splits . These terms depended on the amount of capital contributed by the individual trader, if any, and the trader' s experience . Warrior issued Schedules K-1, r .Member's Share of Income, Credits, Deductions,- etc ., to!it s members reporting their income from profit-splitting agreements .

Petitioner occasionally traded a Warrior subaccount during his downtime to keep a presence in, and check the pulse of, the market . His trading activity generated gains of $208,329 during 2003 . Warrior was entitled to all profits generated in the subaccount . Petitioner invested no mo ey in the main Warrior account, had no interest in the subacc unt gains, and neve r received any of those gains .

2005 Event s After losing significant customer to better commission rates, including Vantage, Mr . Kirkland, and Mr . Kestler, petitioner decided to reevaluate his b siness model . Petitioner had also lost individual customers who left to trade through LLCs like Vantage or Warrior . .

Petitioner discussed changing his business structure with his brother in 2005 . Petitioner had f and two new scanning software programs, which he believed c uld substantially increase Warrior's trading profits . Petitioner advised his brother to purchase all rights to both programs, nd Warrior did,, for $190,000 each . By purchasing all righ s to that software, Warrior completely controlled it and n competitors(cid:127)'could use it .

Warrior's profitability and volume inc eased as a result of the new software, and its retention of tra ers improved .

Petitioner agreed to supervise an maintain the new software for a split of Warrior's profits . Pet tioner-received n o interest in Warrior 's capital, howeve r Assent's Compliance Since 2003 Assent has been subject to numerous' reviews b y self-regulatory organs a ( ) ke the National z tions SROs y Association of Securities Dealers (NASD) and various exchanges and has an excellent compliance record . No complaints were ever filed by customers . against the branch office or against petitioner . Assent's Director of Compliance periodically conducted compliance reviews of the branch office and conclude d that the office was generally in compliance with Assent's 1 1 :.

requirements . Assent has never sanctioned petitioner, nor has petitioner been sanctioned by or had adverse determinations from the SEC or the Texas Securities Board .

Genesis of Respondent's Investigatio n Despite petitioner's excellent compliance record, respondent challenges the commission rate adjustments petitioner paid to Warrior . Respondent questioned the commission rate adjustments after investigating petitioner's brother concerning his tax reporting position that he was a resident of the United States Virgin Islands (USVI) from 2002 through 2004 . Petitioner' s brother established residency in the USVI because he wa s persuaded that he could obtain significant tax benefits by moving there and participating in a statutory economic development !program . He entered into various agreements with The March Group, LLLP, a Virgin Islands limited liability partnership, to facilitate obtaining these tax benefits .

Petitioner's brother received all-Warrior's income, from . his trading gains, shares of the gains generated by other Warrior traders, and commission rate adjustments from petitioner . He reported on the USVI returns all Warrior's income that flowed through to him through various entitie except for some payments that went to The March Group . In addi ion, petitioner's brother claimed a 90-percent economic .developm nt tax credit . He stopped claiming USVI .residency in 2005 when g idance was released that challenged the tax benefits he was re c iving .

Respondent issued petitioners a d ficiency notice for.2003 as a result-of the investigation into is brother's alleged tax sheltering activities in the USVI . Re pondent's determinations treat the commission rate adjustments aid to Warrior differently from those paid to other customers bec use petitioner's brother ultimately received the payments and r ported them as income in the USVI . Petitioners timely filed a etition .

I .

Introductio n

OPINION

We must now determine . whether pet'tioner took part in his brother's alleged tax sheltering activities in the manner alleged by respondent . Respondent's determinations depend on the premise that petitioner made commission rate a justments to Warrior only to lower petitioner's taxable income and that theses payments were funneled back to petitioner in later years . We ultimately conclude that the record does not supp rt respondent' s determinations .

We first address the burden of pr of . We thenidetermine whether petitioner's commission rate .a justments to Warrior are deductible by petitioner as .ordinary and necessary business expenses under section 162 . In doing o, we decide whether the I commission rate adjustments were illegal . payments under section 162(c)(2) or lacked, economic substance . We then turn to whether .,'petitioners must include Warrior,subaccount gains .in gross income . We finally address whether petitioners are liable for an accuracy-related penalty under section 6662 .

II .

Burden of Proo f The parties disagree as to whether the-burden of proof shifted to respondent under section 7491(a) .3 The Commissioner's determinations in the deficiency notice are generally presumed correct, and the taxpayer has the burden of proving that the „Commissioner's-determinations are in error . Rule 142(a) ; Welch v . Helvering , 290, U .S . 111, 115 (1933) . At trial we granted petitioners' motion to shift the burden of proof to respondent under section .7491(a) because we found that they introduced :credible evidence, substantiated items, maintained required .records, and fully cooperated with respondent's reasonabl e requests .4 See sec . 7491(a)(2)(A) and (B) . We stand by our ruling . Accordingly, respondent bears the burden of proof as to ;fall issues relevant to petitioners' liability for the deficiency .

3The parties agree that respondent bears the burden of proof concerning new issues under Rule 142 and whether the commission rate adjustments were illegal . payments under sec . 162(c)(2) .° Respondent also bears the burden of production concerning the accuracy-related penalty . See sec . 7491(c) .

4.The Court invited the parties to address this issue on brief . We have carefully reviewed the parties' arguments and stand by our ruling that petitioners' challenge of a summons in Federal District Court and motion for protective order in the Tax Court reflected petitioners' legitimate discovery concerns . See Kohler v . Commissioner , T .C . Memo . 2006-152 .

III . Deductibility of Petitioner's Pa ents to Warrio r We now address whether petitioner's commission rate adjustments .to Warrior are deductible under section 162 .

Initially, we note that respondent allowed deductions to petitioner for similar payments to Vantage, Mr . Kirkland, and Mr .

Kestler . Respondent disallowed deductions for the payments to warrior under several theories involving the relationship between petitioner and his brother . Respondent's primary argument is that petitioner's payments to Warrior re not deductible under section 162(a) because the payments were not ordinary and necessary business expenses . Responde t also makes two alternative arguments against deductibility . Respondent firs t argues that petitioner is barred from eductingthe payments because they are illegal payments unde section 162(c)(2) .

Respondent then argues that the paymen s are not deductible because the transactions lack economic substance . We addres s each of respondent's arguments in tur n A .

Ordinary and Necessary Busin ss Expense s Tax deductions are a matter of legislative grace, and taxpayers must satisfy the specific statutory requirements-for the item claimed . Rule 142(a) ; INDOPC Inc . v . Commissioner, 503 U .S . 79, 84 (1992) ; New Colonial I e Co . v . Helvering, 29 2 U .S . 435, 440 (1934) . A taxpayer is ,g enerally permitted to deduct all ordinary and necessary expe uses paid or incurred during the taxable year in carrying on any trade or business .

Sec . 162(a) . The determination of whe her an expenditure satisfies the requirements for deductibility under section 162 is a question of fact . See Commissioner v . Heininger , 320 U .S . 467 , 475 (1943) .

In general, an expense is ordinary if it-i s considered normal, usual, or customary in the context of the particular business out of which it arose .. See Deputy v . du Pont , 308 U .S . 488, 495 (1940) . Generally, an expense is necessary if it is appropriate and helpful to the operation of the taxpayer's trade or business . See Commissioner v . Tellier , 383 U .S . 687, 689 (1966) ; Carbine v . Commissioner , 83 T .C . 356, 363 (1984), affd . 777 F .2d 662 (11th Cir . 1985) .

Respondent argues that petitioner's commission rate adjustments to Warrior were not ordinary because the payments ran contrary . to . Assent's written policies and the regulatory framework in which Assent operated . We disagree .

It is common in the day trading industry to lower .commissions to attract and retain customers . Assent, a large, ;nationwide broker-dealer servicing-day traders, routinely made commission rebates when requested by a GSP or a branch manager .

Petitioner began, making direct commission rate adjustments for several customers when they complained of the untimeliness of Assent's commission rebates . Whether petitioner or Assent paid the commission rebates did not change the economics .' Customers ;demanded that their commissions be lowered, and petitione r -'The parties agree that " three-cornered " transactions between Assent , petitioner , and Assent ' s customers are not rebates for tax purposes and are subject to the rules of deductibility .

negotiated the commission rate adjustments at arm's length to keep them :

Respondent does not challenge the ordinary nature of payments made to Vantage , Mr . Kirkland, or Mr . Kestler, only those made to Warrior .

Warrior was the branch office's biggest customer and generated significant trading volume .

Petitioner was aware'that Warrior - could demand a very low commission rate elsewhere .

In addition , petitioner hoped Warrior ' s trading would cause the branch office to meet certain volume tiers, lowering Assent's commission rate . Petitioner could then have the flexibility to lower commissions and attract more traders . The commission rate adjustments are expenses that would be expected of someone trying to increase and maintain business in the highly competitive world of day trading . This is true regardless of whether the customer is Warrior , Mr . K irkland , Mr .,Kestler, or Vantage . Accordingly , we hold petitioner's payments to Warrior were ordinary expenses for section 162 purposes . See Corrigan v .

Commissioner , T .C . Memo . 2005-119 .

Respondent further argues that the payments were not necessary because customers chose Assent for reasons beyond the commission rates, including Assent's software , and because petitioner could have processed commission rate adjustments through Assent .

Again, we disagree .

Petitioner has satisfied the Court that commission rates were the most critical element to customers . Petitioner eventually lost Mr . Kirkland , Mr . Kestler, and Vantage as customers when they fond better commission rates elsewhere . Further, petitioner did not use the Assent form to process volume rebate credits because his customers were .

dissatisfied by the untimeliness of these payments . An expense may be necessary even where the . taxpayer could have avoided it by pursuing a different course .of conduct .

Mason & Dixon Lines ; Inc . v . United States , 708 F .2d 1043, 1044-1045 (6th Cir . 1983) .

Petitioner's payments were appropriate and helpful to keep customers trading through the . branch office given the highly competitive nature of the day trading industry . Accordingly, we hold that petitioner's payments to Warrior were necessary for section 162 purposes .

B .-- Illegal Payments Under Section 162(c)(2) We-now°turn to whether petitioner's commission rate adjustments to Warrior, while ordinary and necessary, are no t deductible because they are illegal payments under section 162(c)`(`2) . Respondent argues that petitioner's payments to Warrior are illegal payments under section 162(c)(2) because the y were made in violation of Federal law implemented by NASD rul e 2110 .6 .

Deductions are not allowed for payments that constitute a n illegal bribe, an illegal kickback, or other illegal payment under any law of the United States . The term "laws of the United States" includes only Federal statutes, including State laws which are assimilated into Federal law by Federal statute, an d ' 6We do not address whether an NASD rule can properly be considered a "law of the United States" as it is unnecessary to our holding .

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legislative and . interpretive regulatio ns thereunder .

.Sec .,1 .162- 18(a)(4), Income Tax Regs . The term i s further limited t o statutes that prohibit some act or act s for the violation ~of which there is a civil or criminal per alty . Sec . 1 ..162-18(a)(4), Income Tax Regs . Respondent bears the burden of establishing by clear and convincing evidence that the commission rat e adjustments constitute illegal payment s . See secs . 162(c)(2) , 7454 (a) ; Rule 142 (b ) The NASD is a nonprofit Delaware corporation registered with the .SEC as a national securities assoc iation . 7 The NASD serve s as an SRO subject . to extensive oversight, supervision, an d control by the SEC on an ongoing basis See 15 U .S : .C . sec. . 78s (2006) . NASD conduct rule 2110 provi es : "A member, in the conduct of its business, shall observe high standards o f commercial honor and just and equitab e principles of trade ."

Respondent argues that petitioner's p yments to Warrior were commission-sharing payments that viol ted NASD rule 2110 an d subjected him to sanction or suspensi n by the NASD . See Dept .

of Enforcement v . Ryerson , Complaint 1o . C9B040033 (N .A .S .D .R .

Aug . 3, 2006) (holding that an NASD member violated rule 2110 when the member shared commissions wi h an unlicensed person who directed customers to him) .

7An organization's bylaws and rules must conform to the Securities Exchange . Act of 1934, as amended, to become a registered securities association . 1 U .S .C . sec . 78o-3(b) (2006) .

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ii Respondent's argument is misplaced . First, petitioner returned commissions paid by .Warrior, a customer, to ensure that Warrior continued trading through the branch office . Thes e payments were not commission-sharing payments maderin .return fo r referrals of business, as in- Dept . of Enforcement v- .,Ryerson , =supra . Respondent has not otherwise met his burden of showing by clear and convincing evidence that petitioner's commission rate adjustments would be classified by the NASD as commission-sharin g ii payments or that these-payments would .result-in petitioner' s q.

+being subject to a civil or criminal penalty or losing his i license, . In fact, no adverse compliance determinations were mad e ,:against petitioner by Assent, the NASD,-or-the SEC regardin g these payments .

Further, deductions are barred .under section 162(c)(2) fo r payments .that are illegal in and of themselves .

Bilzerian v .

United-States , 41 Fed . Cl . 134, 138 .(1998) . -There must]]] be a 'federal or state law that the payment specifically violates . " ' Id . at,140 . The relevant statute or regulation must "prohibit some act or acts ." Sec . 1 .162-18(a)(4), Income Tax Regs .

Respondent cites no statute-or regulation specifically :j, prohibiting petitioner's payments but relies only on a'genera l rule requiring ethical conduct . We conclude that the payments to Warrior are not illegal per se . Accordingly, we . hold that respondent has not proven by clear and convincing evidence tha t petitioner's .commission rate adjustments were'illegal within the meaning of section 162(c)(2) .

C .

Economic Substanc e We now turn to respondent's argum nt that petitioner's payments to Warrior are not deductible because they lacked economic substance . The effect of dis egarding .a transaction fo r lack of economic substance is that, fo taxation purposes, the transaction is viewed to have never oc curred at all .

Klamath Strategic Inv . Fund, LLC v . United States, _ F .3d (5th Cir ., May 15, 2009) (slip op . at 17) ; see also Winn-Dixie Stores, Inc . v . Commissioner , 113 T .C . 254, 294 (1999), affd . 254 F .3d 1313 (11th Cir . 2001) . Accordingly, deductions are generally prohibited for expenditures in furtherance of a transaction . that is disregarded for lack of economic substance .

Klamath Strategic Inv . Fund, LLC v . United States, supra at (slip op . at 17) ; Winn-Dixie Stores, Inc . v . Commissioner, supr a at 294 .

Respondent argues that petitione and John Manning entered into (cid:127)a symbiotic business relationship intended to produce mutual tax benefits in 2003 . He contends pet, itioner's payments t o Warrior were returned to petitioner . in later years that are not before the Court and argues that we should use the economic substance .doctrine to disregard petitioner's payments to Warrior .

We have fully examined the evidence and find that it does not support respondent's contention .

Petitioner has produced credible evidence and testimon y accounting for all payments he receiv d from Warrior in 2005 and later years . Petitioner received a r turn of all principal plus interest on his $500,000 loan by the end of 2006 . Petitioner also received a share of Warrior's profits in later years when he became responsible for operating and maintaining new trading software he convinced Warrior to purchase . We conclude that the profit-splitting arrangement was attributable to petitioner's new responsibilities at Warrior and not-devised for tax avoidance purposes . Petitioner properly reported his portion of Warrior profits reflected on Schedules K-1 for 2005 and later years and was taxed on these amounts .

Respondent also argues that petitioner's arrangement with Warrior lacked economic substance because it was not .an arm's- length arrangement . He contends that low initial commissions, rather than high initial commissions with the prospect o f rebates, would reflect an arm's-length arrangement . Wehave !found, however, that these arrangements were common practice at Assent . Petitioner has satisfied the Court that the commission .rate adjustments paid to Warrior were necessary and legitimate business expenses, indistinguishable from those paid to unrelated parties . These payments resulted in net commissions to Warrior comparable to those Warrior could have negotiated directly with Assent or other .broker-dealers . There were no strings attached .

Accordingly, we hold that the deductibility of petitioner's payments is not barred by the economic substance doctrine .

IV .

Subaccount Trading Gain s We now decide whether petitioner must include gains from a Warrior subaccount in gross income for 2003 . Gross income includes all income from whatever source derived, unless specifically excluded from gross income . Sec . 61(a) ; Commissioner v . Glenshaw Glass Co . , 34 U .S . .426, 430 (1955) .

Respondent argues that the subaccount gains are includable in petitioner's gross income because other Warrior traders include d gains generated in their respective s u accounts . Respondent ignores the facts .

The other Warrior traders include their portions o f subaccount gains in gross income becau e they received these gains . Petitioner was not entitled t o the gains, nor did he .

receive them . Traders who were entit l d to subaccount gains .had written agreements with Warrior setti n the terms of the profit splits . They also received Schedules -1 reflecting thei r portions of the subaccount gains . Petitioner had no agreement with Warrior giving him rights to a share of the subaccount gains . Respondent has presented no e idence to the contrary, an d we find petitioner's testimony credibl e as to this issue . I n fact, respondent acknowledges that th subaccount belonged to Warrior and that all gains generated 'n the subaccount were passed through a series of entities and ultimately to petitioner's brother .

We conclude that petitioner had' o ownership interest in or rights to the subaccount and never received any funds from the subaccount . Accordingly, we hold that petitioner is not required to include the subaccount trading gains in gross income for 2003 . 8 V .

Accuracy-Related Penalt y We finally consider whether petitioners are liable :; for an accuracy-related penalty under section 6662 . Petitioners . are liable for an accuracy-related penalty for any portion of an underpayment attributable to negligence or disregard of rules an d regulations . Secs . 6662(a) and (b)(1). . Negligence includes "any failure to make a reasonable attempt to comply with the ; provisions of .this title," and the term "disregard" includes "any careless, reckless, or intentional disregard ." Sec . 6662(c) . .

Negligence also includes any failure by the taxpayer to keep adequate books and records or to substantiate items properly .

Sec . 1 .6662-3(b)(1), Income Tax Regs .

We have found for petitioners on all issues . Petitioners .:mistakenly deducted two . commission rate adjustments in 2003 even l~though they were not in fact paid until the following year . All of petitioners' records were accurate and thorough except for this mistake . In fact, respondent conceded more than $500,000 i n .alleged unreported deposits after considering the accuracy of petitioners' records . We find, after considering all the . facts and circumstances, that petitioners are not liable for the :accuracy-related penalty under section 6662(a) for 2003 !

'Respondent first raised the issue of whether the subaccount gains were includable in petitioner's gross income in the answer . Respondent therefore has the burden of proof as to this issue, which we find respondent has not met .

In reaching our holdings, we hav e considered all argument s made., and, to the extent not mentioned we conclude that they ar e moot, irrelevant, or without merit . Tb reflect the foregoing and the concessions of the parties, Decision will be entere d under Rule 155 .