Mortensen v. CIR

RECOMMENDED FOR FULL-TEXT PUBLICATION

Pursuant to Sixth Circuit Rule 206

File Name: 06a0075p.06

UNITED STATES COURT OF APPEALS

FOR THE SIXTH CIRCUIT

_________________

X

Petitioner-Appellant, -

GLENN A. MORTENSEN,

-

-

-

No. 05-1344

v.

,

>

COMMISSIONER OF INTERNAL REVENUE, -

Respondent-Appellee. -

N

On Appeal from the United States Tax Court.

No. 25991-96—Stanley J. Goldberg, Tax Court Judge.

Argued: February 3, 2006

Decided and Filed: February 28, 2006

Before: MERRITT, MARTIN, and GILMAN, Circuit Judges.

_________________

COUNSEL

ARGUED: Terri A. Merriam, PEARSON-MERRIAM, Seattle, Washington, for Appellant.

Annette Wietecha, UNITED STATES DEPARTMENT OF JUSTICE, Washington, D.C., for

Appellee. ON BRIEF: Terri A. Merriam, Wendy S. Pearson, PEARSON-MERRIAM, Seattle,

Washington, for Appellant. Annette Wietecha, Richard Farber, UNITED STATES DEPARTMENT

OF JUSTICE, Washington, D.C., for Appellee.

_________________

OPINION

_________________

BOYCE F. MARTIN, JR., Circuit Judge. This is an appeal from the United States Tax

Court’s decision upholding the Commissioner’s determination that Mr. Mortensen is liable for a

section 6662(a) negligence penalty of $784 for the taxable year 1991. The penalty stems from

Mortensen’s deductions on his tax return based on his investment in cattle breeding partnerships

established by Walter J. Hoyt III. The Hoyt Partnerships have generated litigation across the

country, see e.g., River City Ranches #1, 85 T.C.M. (CCH) 1365, 1371, 2003 WL 21205284, and

culminated in Mr. Hoyt’s fraud conviction and prison sentence of twenty years. Specifically

regarding the taxable year 1991, the Commissioner issued a Notice of Final Partnership

Administrative Adjustment regarding the deductions and made a computational adjustment on

Mortensen’s return. This changed Mortensen’s claimed loss of $16,720 on the partnership to

income of $4,421 and consequently increased Mortensen’s tax liability from $724 to $4,642, an

increase of $3,918. Section 6662(a) permits a negligence penalty of 20% of the underpayment. The

Tax Court found that Mortensen did not carry his burden in proving that the Commissioner’s

1

No. 05-1344 Mortensen v. Commissioner Page 2

assessment was erroneous or that Mortensen did what a reasonably prudent person would have done

under the circumstances. Thus, the Tax Court affirmed the Commissioner’s imposition of the

negligence penalty under section 6662(a). Mortensen appeals. For the following reasons, we

AFFIRM the Tax Court’s decision upholding the negligence penalty.

I.

The history of these partnerships is complex. Courts have described the partnerships in

varying degrees of detail. See Bales v. Commissioner, 58 T.C.M. (CCH) 431, 1989 WL 123005;

Mekulsia v. Commissioner, 389 F.3d 601 (6th Cir. 2004); Adams v. Johnson, 355 F.3d 1179 (9th Cir.

2004). Additionally, the Tax Court below provided an excellent description of the partnerships.

Mortensen v. Commissioner, T.C.M (RIA) 2004-279, 2004 WL 2900972. We therefore only

summarize the salient facts.

Mr. Hoyt’s father was a prominent breeder of Shorthorn cattle and in the late 1960s began

promoting cattle breeding partnerships. When Hoyt’s father died in 1972, Hoyt and other family

members took over the partnerships and from 1971 through 1998, Hoyt organized, promoted, and

operated more than one hundred cattle breeding partnerships. Hoyt acted as the tax matters partner

on each of the partnerships that were subject to the Tax Equity & Fiscal Responsibility Act of 1982.

See 26 U.S.C. § 6231(a)(7); Pub. L. No. 97-248, §§ 402-406, 96 Stat. 324. Hoyt was also the

general partner and was responsible for the preparation of the tax returns for each partnership and

he typically signed and filed each return. In addition, Hoyt operated tax return preparation

companies that prepared most of the investors’s individual tax returns. The relevant return,

Mortensen’s 1991 return, was prepared and signed by Hoyt. Hoyt was also a licensed enrolled

agent, meaning that he was authorized, like a lawyer or CPA, to represent taxpayers and argue in

proceedings before the Internal Revenue Service. See 26 C.F.R. § 601.502; Adams, 355 F.3d at

1182 (“Hoyt was accredited by the IRS as an enrolled agent, thereby permitting Hoyt to prepare

federal income tax returns for the partnership and to represent the partners in dealings with the

IRS.”). At the culmination of the IRS’s investigation, Hoyt and others were indicted for certain

federal crimes — though not tax crimes — and a trial was held in Oregon. The district court

described Hoyt’s crime as “the most egregious white collar crime committed in the history of the

State of Oregon.” Hoyt was found guilty on all counts, sentenced to twenty-years imprisonment,

and ordered to pay restitution of $102 million.1

Mortensen is college educated with a degree in engineering and during the relevant years was

employed as a field engineer. At the time he invested in the partnerships, he had no significant

investment experience and no experience with farming or cattle. Mortensen first learned of the Hoyt

Partnerships from a co-worker in late 1985 or early 1986 and along with four or five co-workers,

requested an informational packet from the Hoyt organization. Mortensen received this packet

which included various promotional materials prepared by the Hoyt organization. These materials

provided rationales for why the partnerships were good investments and why the tax savings were

legitimate. The main document was titled “Hoyt and Sons — The 1,000 lb. Tax Shelter,” and

explained how the partnerships were designed to provide profits to partners over time. This

document emphasized that the primary return on investment would be tax savings. See also Adams,

355 F.3d at 1181-82 (“Each partner was expected to benefit from the partnership in two ways. First,

Hoyt assigned to each partner part of his cattle operation’s expenses, which the partners were able

1

At sentencing, the district court stated the following: “[T]he victims in this case were not people that got into

this as a matter of personal greed. That the victims in this case were truly victimized by a person who is capable of the

greatest deceit — deceitful practices, who deceived everyone around him, including those closest to him . . . [I]t is my

strongest recommendation that those remaining cases that remain open be resolved by denying the tax shelter, but to

eliminate any penalties, or any interest that may have accumulated.” JA 684. Mortensen has pointed to the district

court’s statement as support for his claims.

No. 05-1344 Mortensen v. Commissioner Page 3

to claim as a tax deduction, lowering their tax liability on income from other sources. Second, in

later years the partnerships were expected to produce a profit as each partnership liquidated the

livestock that it had been assigned.”).

The 1,000 lb. Tax Shelter document contained various statements regarding the purported

legality of the tax savings. After explaining the tax benefits, it stated: “Now, can you feel good

about not paying taxes, and feeling like you were not, somehow, abusing the system, or doing

something illegal?” Another section devoted to a discussion of IRS audits stated that the

partnerships would be “branded an ‘abuse’ by the Internal Revenue Service and will be subject to

automatic” and “constant audit.” The document further compared the IRS to children, included a

cartoon depicting the IRS as a Native American preparing to attack the “HS ‘Circle of Wagons,’”

and stated that IRS employees did not have the “proper experience and training” or “working

knowledge of concepts required by the Internal Revenue Code” to properly evaluate the Hoyt

Partnerships.

Another section titled “Tax Aspects” contained a “warning” for investors:

Out here, tax accountants don’t read brands, and our cowboys don’t read tax law.

If you don’t have a tax man who knows you well enough to give you specific

personal advice as to whether or not you belong in the cattle business, stay out. The

cattle business today cannot be separated from tax law any more than cattle can be

separated from grass and water. Don’t have anything to do with any aspect of the

cattle business without thorough tax advice, and don’t waste much time trying to

learn tax law from an Offering Circular.

(emphasis added). Despite its own warning, the circular devoted several pages to explaining the tax

benefits of the Hoyt Partnerships and explained why investors should trust only Hoyt’s organization

to prepare their individual tax returns.

It is the recommendation of the General Partner, as outlined in the private placement

offering circular, that a prospective Partner seek independent tax advice and counsel

concerning this investment . . . The Limited Partners should then authorize the Tax

Office of W.J. Hoyt Sons to prepare their personal returns . . . Then you have an

affiliate of the Partnership preparing all personal and Partnership returns and

controlling all audit activity with the Internal Revenue Service . . . Then, all Partners

are able to benefit from the concept of “Circle the Wagons,” and no individual

Partner can be isolated and have his tax losses disallowed because of the

incompetence or lack of knowledge of a tax preparer who is not familiar with the

law, regulations, format, procedures, and operations concerning the Partnership that

are required to protect the Limited Partners from Internal Revenue audits . . . If a

Partner needs more or less Partnership loss any year, it is arranged quickly within the

office, without the Partner having to pay a higher fee while an outside preparer

spends more time to make the arrangements.

(emphasis added). The document further warned that an audit or disallowance of the deductions by

the Commissioner could take away all or some of the tax benefits and that there would be a

possibility that investors would have to pay back the tax savings plus interest and penalties.

Mortensen testified that prior to investing, he conducted an investigation into the

partnerships. Specifically, Mortensen testified that after receiving the informational packet from the

Hoyt Partnerships, he mailed the packet to his father so that his father could show the information

to a tax attorney. Mortensen testified that his father told him that “[t]he attorney looked over it and

he said there was nothing illegal.” Mortensen testified that he did not know the attorney’s name,

No. 05-1344 Mortensen v. Commissioner Page 4

what research or investigation the attorney conducted, or essentially any other information that his

father told him.

Mortensen also testified that one of his co-workers decided to contact the IRS for

information before investing in the partnerships. The co-worker allegedly told Mortensen that “there

was no indication from the IRS that there was anything wrong with Hoyt or anything like that.”

Another co-worker traveled to California “to go to [Hoyt’s] offices and also . . . to at least one ranch

to be sure that it was a viable business and that there was actually people running a business and

there was actually cows involved.”

In July 1986, Mortensen invested in a Hoyt Partnership named Durham Genetic Engineering

1986-1. In December, Mortensen signed several documents related to the partnership, including

documents that assigned Hoyt power of attorney and gave Hoyt the ability to sign notes on

Mortensen’s behalf. Mortensen also signed a document expressing his intent to make a capital

contribution to and become a limited partner by purchasing units valued at $75,000. Mortensen

testified that at the time he made the investment, he believed that it would produce a profit and

provide retirement income. Mortensen also believed that he would be liable on the promissory

notes, but believed that cattle existed that could be sold to cover the debt.

On Mortensen’s 1986 return, the first year of his investment, he reported wage income of

$43,112, interest income of $3,126, a partnership loss of $27,170 and an investment credit of

$17,412. This led to a zero tax liability. He later filed an amended return, listing the same wage and

interest income, but now a partnership loss of $141,260. Mortensen then filed a Form 1045,

Application2 for Tentative Refund, based on a carryback of a claimed net operating loss of $98,148

from 1986. Net operating losses may be carried back three years, and Mortensen did so, resulting

in a zero tax liability3 for 1983, 1984, and 1985 and the refund of $4,821, $7,517, and $6,210 for

those years.

Starting with this first return and Form 1045 in 1986 and through the 1991 return, Hoyt or

a member of the Hoyt organization prepared Mortensen’s tax forms. Mortensen signed the returns

without knowing how the Hoyt-related items were calculated. He knew only that Hoyt or a member

of the Hoyt organization had entered the items on Schedules K-1 and on his return and he assumed

their correctness. Mortensen never had his returns reviewed by an accountant, lawyer, or anyone

else outside the Hoyt organization prior to signing and filing them.

Throughout the years of Mortensen’s involvement in the Hoyt Partnerships, his investment

was transferred between various partnerships without him taking any action. Mortensen testified

that he believed that Hoyt was using his power of attorney to do the necessary paperwork. He also

testified that he believed one of the reasons for the changes was to maximize tax savings. Hoyt did

not provide Mortensen with any type of verification when changes were made or any

acknowledgment that his name was taken off promissory notes signed on his behalf.

During the years of his investments, Mortensen made substantial cash payments to the Hoyt

organization. These payments totaled approximately $83,000 and included the remittance of his tax

refunds, the payment of quarterly and monthly installments on his promissory notes, special

“assessments” imposed by the partnership, and contributions to purported individual retirement

2

The $98,148 reflects the excess partnership losses greater than the amount necessary to zero out Mortensen’s

tax liability for 1986.

3

Mortensen did, nevertheless, have to pay the alternative minimum tax of $855 in 1984 and $992 in 1985.

No. 05-1344 Mortensen v. Commissioner Page 5

account plans maintained by the Hoyt organization. In4return, Mortensen received only nominal

amounts of his contributions back from the partnership.

For the first time, by letter dated May 23, 1988, the Commissioner notified Mortensen that

partnerships SGE 84-2’s taxable year 1987 was under review. This letter stated in part:

Our information indicates that you were a partner in the above partnership during the

above tax year. Based upon our review of the partnership’s tax shelter activities, we

have apprised the Tax Matters Partner that we believe the purported tax shelter

deductions and/or credits are not allowable and, if claimed, we plan to examine the

return and disallow the deductions and/or credits. The Internal Revenue Code

provides, in appropriate cases, for the application [of various penalties].

A similar letter dated May 9, 1989, notified Mortensen that another of his Hoyt Partnerships was

under review with respect to taxable year 1988.

In late 1988 and mid-1989, Mortensen contacted the IRS regarding the status of his 1987

refund. By letter, the Commissioner notified Mortensen that his 1984 through 1988 returns were

being audited.

Mortensen received additional notices from the Commissioner related to various

partnerships, including DSBS 87-C, the partnership at issue in Mortensen’s 1991 tax return.5 These

notices were dated August 21, 1989, May 21, 1990, August 13, 1990, February 19, 1991 (two

notices), February 3, 1992, and February 18, 1992.

In 1989, Hoyt sent investors a copy of the Tax Court’s opinion in Bales v. Commissioner,

58 T.C.M. (CCH) 431, 1989 WL 123005. Hoyt claimed that the opinion was proof of the legality

of the partnerships. Mortensen testified that he did not read the entire opinion, but understood its

basics, and relied upon information from Hoyt in interpreting the opinion.

Sometime in the early 1990s, Mortensen began attending monthly meetings of Hoyt partners

that were held near his home. At these meetings, the investors would discuss various issues

pertaining to the partnerships with other partners, including partners who had visited the ranches.

Based on his attendance at these meetings, Mortensen considered himself “actively aware of the

proceedings of the business,” and believed that he was materially participating in the partnership.

In January 1992, the Commissioner mailed Hoyt investors a letter regarding the application

of 26 U.S.C. § 469, the passive activity loss limitation provision. In response, Hoyt mailed his

investors a letter setting forth arguments as to why Hoyt investors materially participated in their

investments within the meaning of section 469. This letter asserted that the Commissioner was

incorrect and that the investors should do whatever necessary to materially participate in their

investments at least 100 to 500 hours per year, depending on the circumstances. Hoyt stated that

time spent recruiting new investors and time spent “reading and thinking about these letters” counted

toward the material participation requirement.

4

Mortensen’s brief states that: “Petitioner received $31,586.83 of his claimed refunds. He paid a total of

$83,218.43 to the Hoyt partnerships from 1987 through 1997 for the entire investment period. Thus, Petitioner’s net

investment after taxes exceeded $50,000.00. It is not expected that Petitioner will ever be able to collect the money Hoyt

stole from him.” Brief of Appellant at 19.

5

The underlying partnership adjustment in this case was made with respect to claimed deductions based on

expenses for Durham Shorthorn Breeding Syndicate 1987-C or DSBS 87-C. Although Mortensen’s 1991 return takes

deductions based on investment in this partnership, there are no documents in the record pertaining to any investment

by Mortensen in the partnership.

No. 05-1344 Mortensen v. Commissioner Page 6

By letter dated February 11, 1992, the Commissioner mailed the investors a response stating

that “[i]n Mr. Hoyt’s letter misleading and/or inaccurate premises were made which may directly

affect you and your decision-making process in filing your 1991 individual tax return.” The letter

went on to state that Hoyt had provided his investors with rulings and court cases superseded by

section 469 and were no longer relevant. The letter further informed investors that, contrary to

Hoyt’s claims, time spent “reading and thinking” about the letters did not count as material

participation in their investments. The letter concluded by stating that the Commissioner

“recommend[s] you consider having an independent accountant or attorney review this matter with

you.”

Whenever Mortensen received any correspondence from the Commissioner, he would send

copies to the Hoyt organization. Mortensen took no other action and never sought independent

advice from an accountant or attorney.

Mortensen also received from Hoyt, numerous documents claiming to show the legitimacy

of the partnerships and the legality of the tax claims made by the organization. The Hoyt

organization would portray IRS employees as incompetent and claimed that they were engaging in

unjust harassment of the Hoyt investors. Mortensen testified that he trusted these documents and

believed and relied upon what the Hoyt organization told him. He did not, however, seek

independent advice.

After the February 18, 1992 notice from the Commissioner regarding the examination of

various partnerships that Mortensen was involved in, the Commissioner froze the refunds that

Mortensen had claimed on his 1987 and 1988 returns. Nevertheless, on April 22, 1992, before filing

his 1991 tax return, Mortensen signed another series of documents evidencing his intent to invest

in another partnership known as SGE 84-2.

On his 1991 tax return, Mortensen reported wage income of $48,405, interest income of

$4,512, loss from partnership SGE 84-2 of $39,160, loss from DSBS 87-C of $16,720, capital gain

of $13,003, farm income of $4,824, IRA deduction of $2,000, adjusted gross income of $12,864, and

a total tax liability of $724. The losses from the two partnerships were reported on Schedules K-1.

The capital gain and IRA deduction are derived from SGE 84-2. Mortensen attached a material

participation statement claiming to have spent 121 hours during 1991 working in various Hoyt-

related activities. Hoyt signed the return as preparer on June 18, 1992, and Mortensen signed it on

July 26.

The Commissioner ultimately issued a Notice of Final Partnership Administrative

Adjustment to Mortensen with respect to DSBS 87-C that disallowed various deductions claimed

on his return for 1991. Mortensen did not challenge the disallowance of the deductions. Therefore,

the Commissioner made a computational adjustment against Mortensen changing his claimed DSBS

87-C loss of $16,720 to income of $4,421. This increased Mortensen’s tax liability by $3,918. The

Commissioner then assessed a 20% penalty pursuant to section 6662(a) based on the determination

that Mortensen is liable for negligence or disregard of rules or regulations with respect to the amount

of underpayment resulting from the DSBS 87-C computational adjustment.

Mortensen challenged the Commissioner’s assessment of the 6662(a) penalty for negligence

in the United States Tax Court. Special Trial Judge Goldberg held a trial where Mortensen was the

only witness to testify. After trial, the court issued a detailed forty-three page opinion upholding

the Commissioner’s determination. The court determined that Mortensen “was negligent in signing

the power of attorney forms and in entering into the investment.” Mortensen v. Commissioner,

T.C.M (RIA) 2004-279, 1756. The court further concluded that Mortensen was “negligent in 1991

in claiming the Hoyt partnership loss at issue in this case; namely, the $16,720 loss from DSBS 87-

C.” Id. at 1757. The court rejected Mortensen’s reasonable cause and good faith defenses as

No. 05-1344 Mortensen v. Commissioner Page 7

objectively unreasonable. Id. at 1757-1760. In sum, and “[o]n the basis of the record before the

Court, [it] conclude[d] that petitioner’s actions in relation to the Hoyt investment constituted a lack

of due care and a failure to do what a reasonable or ordinarily prudent person would do under the

circumstances.” Id. at 1762. The court found Mortensen negligent with respect to entering into the

investment and negligent with respect to claiming the DSBS 87-C loss on his return. Id. Mortensen

now appeals to this Court.

II.

The only issue on appeal is whether the Tax Court erred in upholding the Commissioner’s

imposition of the 6662(a) penalty for the tax year 1991.

A. Standard of Review

Mortensen did not challenge the Commissioner’s disallowance of the various deductions.

The only challenge is to the assessment of the negligence penalty pursuant to section 6662(a). “We

review the factual findings of the Tax Court in this regard under the clearly erroneous standard.”

Pasternak v. Commissioner, 990 F.2d 893, 902 (6th Cir. 1993) (citing Leuhsler v. Commissioner,

963 F.2d 907, 910 (6th Cir. 1992)); see also Roberson v. Commissioner, 142 F.3d 435, *5 (6th Cir.

1998) (unpublished) (“We reverse the Tax Court’s factual finding that [the taxpayer] acted

negligently . . . only if the Tax Court clearly erred.”). The Commissioner’s decision to impose the

negligence penalty is presumptively correct and the taxpayer has the burden of proving that he did

not act negligently and that he did what a reasonably prudent person would have done under the

circumstances. Pasternak, 990 F.2d at 902 (citing Skeen v. Commissioner, 864 F.2d 93, 96 (9th Cir.

1989)). The Tax Court’s finding that a taxpayer failed to meet his burden of proving due care is a

finding of fact that this Court reverses only if clearly erroneous. Pasternak, 990 F.2d at 902.

B. Negligence

A taxpayer is not required to be perfect for this would be an unrealistic expectation. Even

tax specialists cannot be perfect. The Code is complex. Reasonable minds can differ over tax

reporting and sometimes the IRS disallows certain transactions. Every time a transaction is

challenged or disallowed, the taxpayer is not liable for penalties. Only those taxpayers who fail to

meet the applicable standard of care — to do what a reasonable taxpayer would do under the

circumstances — can be slapped with negligence penalties and interest. Again, perfection is not

required, but when the predators are circling, no reasonable ostrich sticks its head in the sand. See

American Ostrich Association: Fact or Fiction, available at

http://www.ostriches.org/factor.html#head (stating that ostriches do not stick their heads in the

sand). The ostrich that does pays the penalty.

This Court has defined negligence as “lack of due care or failure to do what a reasonable and

ordinarily prudent person would do under the circumstances.” Id. (quoting Leuhsler, 963 F.2d at

910). Negligence also includes “any failure to make a reasonable attempt to comply with the

provisions of the Internal Revenue Code.” Roberson, 142 F.3d at *4. Negligence is strongly

indicated when a “taxpayer fails to make a reasonable attempt to ascertain the correctness of a

deduction, credit or exclusion on a return which would seem to a reasonable and prudent person to

be ‘too good to be true’ under the circumstances.” Treas. Reg. § 1.6662-3(b)(1)(ii). Thus, we judge

Mortensen’s conduct against that of the reasonable and ordinarily prudent person.

In applying the negligence standard, the Tax Court determined that Mortensen was negligent

both in entering into the investment and in reporting the losses for 1991. The Tax Court cited

Mortensen’s decision to grant Hoyt the authority to sign promissory notes on his behalf up to

$75,000, as well as the authority to control the investments without any sort of confirmation or

consultation. The court faulted Mortensen for placing his trust entirely with the promoters of the

No. 05-1344 Mortensen v. Commissioner Page 8

investment and concluded that he did not adequately “investigate either the legitimacy of the

partnerships or the implications of the promissory notes.” Mortensen, T.C.M (RIA) 2004-279, 1756.

This trust continued throughout, despite the constant switching of investments from partnership to

partnership and without Mortensen ever inquiring about or knowing the status of promissory notes

signed on his behalf. Id.

The Tax Court noted that from 1986 through 1991, Mortensen used the partnerships to report

a total federal income tax liability of $4,349 on income totaling $290,149. Mortensen further filed

the Form 1045 purporting to completely eliminate his tax liabilities for the three years prior to his

investment in the partnerships and resulting in a requested refund of $18,548. Id. These large tax

benefits were based solely on advice received from Hoyt and Mortensen never questioned the

amounts on the returns and never had the returns reviewed by an independent tax professional. Id.

The Tax Court also noted that the initial Hoyt promotional materials included various

warnings and advised Mortensen to consult with an independent tax advisor. The court stated that

Mortensen’s

failure to inquire is especially notable with respect to petitioner’s 1986 return and

amended return. In preparing petitioner’s amended return for that year, the Hoyt

organization prepared a statement in which it was claimed that petitioner’s

partnership interest had been switched from DGE 86-1 to SGE 84-2. At that time,

however, petitioner had signed partnership agreements and other documents

pertaining only to SGE 86; the investment documents in the record show that

petitioner did not invest in SGE 84-2 until April 1992.

Id. Moreover, in the first year of his investment, Mortensen was given a loss allocation of $141,260

and did not question these amounts even though they purported to eliminate his tax liability for 1982

through 1986. Id. Thus, the court found that Mortensen should have been on notice from the

beginning that something was amiss or that the tax savings were “too good to be true” and should

have sought independent advice.

With regard to the 1991 return, the Tax Court noted that Mortensen did not know how the

reported losses were derived and knew only that Hoyt reported them on Mortensen’s Schedules K-1

and his return. Id. at 1756-57. Mortensen “claimed these losses despite the fact that [the

Commissioner] had been warning [Mortensen], at least since May 1988, that there were potential

problems with the tax claims being made on both the partnership returns and on [Mortensen]’s

returns. Prior to signing his 1991 return, [Mortensen] had received at least 12 separate letters from

[the Commissioner] alerting [him] to suspected problems or alerting [him] to reviews that had been

commenced with respect to various Hoyt partnerships in which he was involved.” Id. at 1757.

Despite these warnings, Mortensen did not further investigate the partnership losses and did not seek

outside guidance before claiming them in full on his 1991 tax return. Id. Based on this, the Tax

Court concluded that Mortensen was “negligent in 1991 in claiming the Hoyt partnership loss at

issue in this case; namely, the $16,720 loss from DSBS 87-C.” Id.

C. Mortensen’s Defenses to the Negligence Penalty

Section 6664(c)(1) states that the section 6662(a) penalty is not imposed “with respect to any

portion of an underpayment if it is shown that there was a reasonable cause for such portion and that

the taxpayer acted in good faith with respect to such portion.” According to the Treasury

Regulations, “[t]he determination of whether a taxpayer acted with reasonable cause and in good

faith is made on a case-by-case basis, taking into account all pertinent facts and circumstances.”

Treas. Reg. § 1.6664-4(b)(1). The most important factor in making this determination is the extent

of the taxpayer’s effort to ascertain his proper tax liability.

No. 05-1344 Mortensen v. Commissioner Page 9

Pursuant to section 6664(c)(1), Mortensen claims that he reasonably investigated and relied

on others who similarly investigated. The Supreme Court has held that good faith reliance on

professional advice concerning the tax laws may be a defense to negligence. United States v. Boyle,

469 U.S. 241, 250-51 (1985). In order for reliance on professional tax advice to be reasonable,

however, the advice must generally be from a competent and independent advisor unburdened with

a conflict of interest and not from promoters of the investment. Pasternak, 990 F.2d at 903

(“Although petitioners argue that they relied on advice of ‘financial advisors, industry experts, and

professionals,’ the purported experts were either promoters themselves or agents of the promoters.

Advice of such persons can hardly be described as that of ‘independent professionals.’”); Barlow

v. Commissioner, 301 F.3d 714, 723 (6th Cir. 2002) (noting “that courts have found that a taxpayer

is negligent if he puts his faith in a scheme that, on its face, offers improbably high tax advantages,

without obtaining an objective, independent opinion on its validity”); Illes v. Commissioner, 982

F.2d 163, 166 (6th Cir. 1992) (finding negligence where taxpayer relied on person with financial

interest in the venture); Goldman v. Commissioner, 39 F.3d 402, 408 (2d Cir. 1994); Ryback v.

Commissioner, 91 T.C. 524, 565, 1988 WL 92157 (1988) (sustaining negligence penalty where

taxpayers relied solely on advice of persons not independent of investment promoters). In addition,

the taxpayer must demonstrate that any expert opinion relied upon was rendered by the expert with

knowledge of the pertinent facts necessary to render such advice. Barlow, 301 F.3d at 724

(“[R]eliance must be reasonable and the taxpayer must show that the accountant had all the

necessary information to make an informed decision.”) (citations omitted).

Mortensen first claims reasonable reliance based on information provided by Hoyt and

representatives of the Hoyt organization. As the above citations demonstrate, however, essentially

all courts have found reliance on the promoters of the investment insufficient to support a good faith

defense. Secondly, as the Tax Court found, there is no evidence that Mortensen ever sought advice

regarding his deductions, but rather, when he received his Schedule K-1 and tax returns, assumed

that they were correct. Even assuming that Mortensen received and relied upon advice from the

Hoyt organization, “Mr. Hoyt and his organization created and promoted the partnership, they

completed petitioner’s tax return, and they received the bulk of the tax benefits from doing so. For

petitioner to trust Mr. Hoyt or members of his organization for tax advice and/or to prepare his

return under these circumstances was inherently unreasonable.” Mortensen, T.C.M (RIA) 2004-279,

1758.6

Mortensen further points to Hoyt’s “enrolled agent” status and claims that he reasonably

relied upon a person certified by the IRS to practice before it. Enrolled agents are required to pass

an exam given by the IRS demonstrating their competence prior to being accredited as enrolled

agents. As we stated earlier, Hoyt was an enrolled agent, accredited by the IRS to prepare federal

tax returns for the partnerships and to represent partners in proceedings before the IRS. See also

Adams, 355 F.3d at 1182. Enrolled agent status is certainly relevant in proceedings before the

Service. A taxpayer’s reliance on an enrolled agent’s advice, however, does not insulate the

taxpayer from negligence penalties. An enrolled agent is not a representative of the IRS, but is

merely an individual authorized to appear before the Service. Much like a taxpayer’s reliance on

an attorney or an accountant, reliance on an enrolled agent is a factor we may consider in

determining the reasonableness of a taxpayer’s actions, but in circumstances such as these, where

the enrolled agent is also the promoter of the investment, any purported reliance is of little to no

value.

6

Mortensen also argues that he relied upon tax professionals hired by the Hoyt organization. The Tax Court

found no evidence to indicate that Mortensen relied on any of these professionals and no indication of what details or

advice they allegedly provided. Moreover, these tax professionals are also affiliated with the Hoyt organization as

promoters. We see no error in this finding.

No. 05-1344 Mortensen v. Commissioner Page 10

Aside from his reliance on persons with a conflict of interest, Mortensen also claims to have

made a pre-investment investigation and points to it as sufficient to support his reasonable cause

claim. As part of this investigation, Mortensen points to three actions: (1) reliance on the opinion

of his father’s tax attorney, (2) reliance on his co-worker’s alleged contact with the IRS, and

(3) reliance on his co-worker’s trip to the Hoyt offices. The Tax Court assumed the veracity of

Mortensen’s claims, but nevertheless, rejected Mortensen’s claim that he “reasonably relied upon

any advice from a tax professional concerning the Hoyt investment.” Mortensen, T.C.M (RIA)

2004-279, 1758. We find no error in the Tax Court’s conclusion.

Mortensen first claims that he relied on his father’s tax attorney. The crux of this claim is

that Mortensen mailed his father the informational packet he initially received from Hoyt and his

father gave it to a tax professional to review. According to Mortensen’s testimony, his father told

him that “[t]he attorney looked over it and he said there was nothing illegal.” Id. The Tax Court

found that Mortensen’s testimony on this point was “vague and lacked any degree of detail.” Id.

Mortensen was unable to explain what information the tax professional relied upon, did not know

his name (or even if it was a tax accountant or tax lawyer), and had no written statement from the

professional. In sum, the Tax Court found “that petitioner did not reasonably rely on any advice that

he received from the professional through his father because any such advice was not provided by

someone who had all the necessary information to make an informed decision, and because the

advice was conclusory and did not address any of the specific risks involved in an investment,

including the tax risks.” Id. at 1758-59. The Tax Court’s conclusion is in-line with this Court’s

decisions. In Barlow, this Court held that the taxpayer “failed to show [that he] acted reasonably

or that [the tax professional] had all the information to make an informed decision.” Barlow, 301

F.3d at 724. In Roberson, this Court likewise rejected the taxpayer’s claim where he could not

demonstrate the tax preparer’s knowledge of or expertise in the particular investment field or that

the preparer made any “investigation of the bona fides of the investment.” Roberson, 142 F.3d at

*5. Moreover, this Court rejected Roberson’s reliance on accountants who prepared his tax returns

for two years “because they neither evaluated the merits of the claimed tax credits and deductions,

nor made any inquiries into the bona fides of the investment.” Id. Thus, there is no support for the

conclusion that the Tax Court clearly erred in rejecting Mortensen’s purported reliance on the

alleged tax professional.

Mortensen next points to his co-worker’s alleged contact with the IRS. This co-worker

apparently told Mortensen that “there was no indication from the IRS that there was anything wrong

with Hoyt or anything like that.” Mortensen, T.C.M. (RIA) 2004-279, 1758. The Tax Court found

that “the record is completely devoid of any detail concerning what information he provided to the

IRS or what information he received in return.” Id. at1759. Finally, Mortensen claims that another

co-worker traveled to a Hoyt ranch to confirm that there were actually cows and an operating

business. With regard to this factor, the Tax Court found that “there has been no suggestion that this

coworker had any background in cattle ranching or was otherwise qualified to investigate the Hoyt

organization.” The Tax Court’s decision to reject these two purported good faith reliance claims is

likewise consistent with this Court’s case law. See, e.g., Leuhsler, 963 F.2d at 910 (holding that

even unsophisticated investors cannot escape a negligence penalty by claiming reliance on the

advice of those who are not professional investment counselors). Again, there is no evidence that

the Tax Court clearly erred in its conclusion.

The Tax Court further found that even if Mortensen did rely on these individuals, this

reliance was five years before the 1991 return at issue. In the intervening time, Mortensen took

large deductions nearly wiping out his tax liability from 1983 through 1992. According to the Tax

Court, “in light of the large losses claimed by the partnerships, the discrepancies in the partnerships

in which petitioner was involved, and the continuous warnings being sent by [the Commissioner],”

Mortensen’s reliance “was unreasonable under the circumstances.” Mortensen, T.C.M. (RIA) 2004-

279 at *33-34; see also Pasternak, 990 F.2d at 903 (stating that “a reasonably prudent person would

No. 05-1344 Mortensen v. Commissioner Page 11

have asked a tax advisor if this windfall were not ‘too good to be true’”); Brown v. Commissioner,

43 T.C.M. (CCH) 1322, 1324, 1982 WL 10532 (“To anyone . . . not incorrigibly addicted to the ‘free

lunch’ philosophy of life, the entire scheme had to have been seen as a wholly transparent sham.”).

In these circumstances, a reasonable taxpayer would not, as Lyndon Johnson once said, act like a

prairie rabbit in a hailstorm and just hunker down until it passes. Mortensen did, and the district

court did not clearly err in so finding.

Finally, Mortensen argues that an “average” taxpayer would have been unable to uncover

the fraud perpetrated by Hoyt. The Tax Court did not reject this assertion, but made clear that the

issue is not whether Mortensen could or should have uncovered the fraud, but whether he was

negligent in “not adequately investigating the partnership and/or seeking qualified independent

advice concerning it.” Mortensen, T.C.M. (RIA) 2004-279 at *34. We agree. The law does not

require taxpayers to uncover anything and everything that the Service, with all of its resources, finds

problematic, sometime down the line. At issue here are tax laws designed to encourage taxpayers

to be informed and to be in compliance with the laws; the negligence penalties are not designed to

punish reasonable mistakes. The issue is not whether a taxpayer is wholly successful in determining

the tax legitimacy of a desired investment, but whether he is negligent for not reasonably

investigating in the first place.7

It is also relevant to point out the warnings in the initial Hoyt promotional materials that

Mortensen ignored. One document was titled “Hoyt and Sons — The 1,000 lb. Tax Shelter.”8 The

documents emphasized that the main return on investment was tax savings. The documents posed

the question whether the investors could feel good about not paying taxes and if they could feel like

they were not abusing the system. The documents informed investors up front that the partnerships

would be “branded an ‘abuse’ by the Internal Revenue Service and will be subject to automatic” and

“constant audit.” A warning was given in the “Tax Aspects” section of the documents stating that

“If you don’t have a tax man who knows you well enough to give you specific personal advice as

to whether or not you belong in the cattle business, stay out . . . Don’t have anything to do with any

aspect of the cattle business without thorough tax advice, and don’t waste much time trying to learn

tax law from an Offering Circular.” Despite these statements, Mortensen’s investigation into the

tax aspects was minimal to the extent it existed at all. The Tax Court therefore did not clearly err

in its determinations.

Mortensen’s most credible claim is that he had reasonable cause for the underpayment

because of the Tax Court’s opinion in Bales v. Commissioner. Bales addressed individual investors

in Hoyt partnerships for the taxable years 1974-1979. The Commissioner had asserted various

deficiencies for underpayment of taxes based on deductions for partnership losses. The Tax Court

began the opinion by stating that “[t]he 26 dockets which were tried are test cases for petitioners in

similar partnerships.” Bales, 58 T.C.M. (CCH) at 432. The case specifically involved ten issues for

decision regarding the appropriateness of the transactions and the deductions and held that the

partnerships should be respected for tax purposes and deductions to the extent of the investors’s

investment were permissible. After the decision, Hoyt sent Mortensen and other investors a copy

and his summary, touting it as proof of the partnerships’ legitimacy.

7

Mortensen also claims that an “honest mistake of fact” excuses him from a negligence penalty under section

6664(c)(1) (excusing “an honest misunderstanding of fact or law that is reasonable in light of all the facts and

circumstances, including the experience, knowledge and education of the taxpayer”). The Tax Court found that this

claim does not alter the conclusion that Mortensen was still negligent in investigating or seeking independent advice.

Thus, the claimed honest mistake is insufficient to carry the burden of proving reasonable cause.

8

Interestingly, Hoyt later mailed a letter to his investors stating that “[t]he position of your partnership is that

it is not a tax shelter,” because tax shelters “are never recognized for Federal income tax purposes.” Mortensen, T.C.M.

(RIA) 2004-279, 1753. The IRS then informed the investors that not all tax shelters were illegal.

No. 05-1344 Mortensen v. Commissioner Page 12

The Tax Court below rejected Mortensen’s reliance on Bales. The court reasoned that “Bales

involved different investors, different partnerships, different taxable years, and different issues than

those underlying the present case.” Mortensen, T.C.M. (RIA) 2004-279, 1761. The court then

found that Mortensen failed to establish that he relied on Bales to support his deductions. According

to the Tax Court, there was no evidence that Mortensen personally relied upon the decision, as

opposed to relying on Hoyt’s interpretation of the decision. Because the Tax Court had already

concluded that reliance on Hoyt was unreasonable, any reliance on him for an interpretation of Bales

was likewise unreasonable. The Tax Court further re-asserted that “Bales involved different

investors, different partnerships, different taxable years, and different facts.” Id. Moreover, the

court noted that not all of the deductions claimed by the investors were permitted, but rather only

those to the extent of their investments. Id. Further, the court noted that in Durham Farms #1 v.

Commissioner, 79 T.C.M. 2009, aff’d 59 Fed. Appx. 952 (9th Cir. 2003), it found that by the early

1980s, the Hoyt organization’s management and record keeping practices changed dramatically.

Mortensen, T.C.M. (RIA) 2004-279, 1761.

Although we believe it to be a closer case on this issue, we cannot conclude that the Tax

Court clearly erred by finding Mortensen’s claimed reliance on Bales insufficient to defeat the

penalty. Nevertheless, the Tax Court’s decision in Bales does lend some support to Mortensen’s

claim. At the outset of the Bales opinion, the court stated that the case was a “test case[] for

petitioners in similar partnerships.” Bales, 58 T.C.M. (CCH) at 432. The taxable years were 1974-

1979, well prior to Mortensen’s investment, but assuming he did read the opinion, as he testified that

he did, there are many statements in the opinion that could arguably support a reasonable cause

defense. First, the Tax Court stated that “[t]he Hoyt cattle operation, which encompasses the

partnerships’ cattle, is surely one of the top Shorthorn seedstock operations in the United States.”

Id. at 445. The Tax Court further stated that the Commissioner “has not offered sufficient evidence

to show that this was anything but a first class purebred Shorthorn operation.” Id. at 446. Later in

the opinion, the Tax Court noted that, given the partnerships’ structure, “it would have been quite

possible for Jay Hoyt to manipulate things to his own advantage. Yet there is no indication that he

did so. 9In fact, the evidence in the record shows that he ran the operation for the investors’

benefit.” Id. at 448. The court then concluded that “these transactions clearly had economic

substance. Accordingly, the transactions will not be disregarded as shams.” Id. at 449.

The court did account for the fact that “[a]t first glance, it appears that this is a package of

tax benefits. With a minimum of investment, petitioners were able to claim large deductions from

the activity. They did this by purportedly personally assuming partnership debt. Petitioners had no

expertise in the area. The assets were very high priced. And, the promoter of the investments also

prepared the investors’ personal tax returns.” Id. Nevertheless, the court did not disregard the

transactions as shams, but did note that “[a]fter trial, petitioners conceded that the assumption of

debt and loss allocations was impermissible. The deductions petitioners are still claiming are limited

to the extent of their investments . . . There is no doubt that tax savings play an important role in

these investments. Yet there are profits to be made independent of tax savings. There is a real

chance that petitioners will profit from capital appreciation.” Id. 449-50.

Although we find the Tax Court’s analysis of Bales lacking — in an otherwise well-reasoned

and well-written opinion — we ultimately agree that Mortensen has failed to carry his burden. In

support of Mortensen’s claim, we note that the Bales court stated at the outset that Bales was a test

case of similar partnerships. Further, the Tax Court below relied upon Durham Farms #1 where the

court noted that the Hoyt partnerships’ records deteriorated in the early 1980s. Durham Farms #1,

9

The finding here is likely correct. Subsequent opinions have concluded that the problems and fraud in the

Hoyt operations began in the early 1980s. Thus, the evidence that the Tax Court reviewed for 1974-79 likely

demonstrated a first class operation, which later allowed Hoyt to create and promote so many partnerships based on his

family name.

No. 05-1344 Mortensen v. Commissioner Page 13

however, was issued by the Tax Court in 2000, and Mortensen’s negligence penalty is for 1991.10

The Tax Court also based its decision on the fact that Mortensen said he relied more on Hoyt’s

interpretation of the case and did not entirely understand Bales when he read it. The very beginning

of the opinion, however, mentions that Bales was a test case. The opinion clearly states that the

partnerships were “first class,” that they should be respected for tax purposes, and deductions to the

extent of basis were permitted. Even an uneducated investor could certainly understand these

statements. Further, the Bales court did not express concern with the fact that Hoyt prepared all of

the investors’s tax returns, nor did it express concerns with the form of the partnerships. Mortensen

testified that he read and understood the basics of the opinion — which, to nearly anyone who reads

it, would appear to be a positive endorsement of the partnerships.

Of course, although good faith reliance on professional tax advice — and, in this case, an

opinion of the Tax Court — may be a defense to negligence, Boyle, 469 U.S. at 250-51, “[r]eliance

on professional advice, standing alone, is not an absolute defense to negligence, but rather a factor

to be considered,” Freytag v. Commissioner, 89 T.C. 849, 888 (1987), aff’d. 904 F.2d 1011 (5th Cir.

1990), aff’d. 501 U.S. 868 (1991). Even reliance on a judicial opinion must be reasonable under the

circumstances. The Bales opinion, though having significant similarities, also has, as the Tax Court

wrote, various differences. Business operations are fluid and a court’s opinion or approval of

transactions for a certain period does not stamp them as legitimate for all time. Nor does the Bales

opinion have any preclusive effect on the Commissioner’s ability to challenge deductions for other

years. And finally, Bales did not address any of the partnerships that Mortensen was invested in

(and it is unclear whether Mortensen himself would have known what partnerships he was invested

in anyway). If, based upon the Bales opinion, Mortensen had sought independent professional

advice or, perhaps, a private letter ruling from the IRS, his reliance might be more justified.

In sum, Mortensen relies heavily on Bales as reasonable cause for his underpayment of taxes.

The Commissioner counters that, even if Mortensen relied on Bales, a reasonable taxpayer would

have sought independent professional advice concerning the case’s applicability to his particular

partnership investments. Both Mortensen and the Commissioner make strong arguments based on

Bales. The case does provide Mortensen with some support for his reasonable cause argument.

Balanced against the other issues, however, specifically the absence of any records substantiating

the claimed deductions, the large deductions with a small investment, warnings about seeking

independent counsel, and constant warnings from the Commissioner himself, there is a sufficient

basis for the Tax Court’s decision that a reasonable taxpayer after Bales would still have sought

independent counsel. Additionally, although not addressed by the Tax Court, Bales held that the

taxpayers could take deductions only to the extent of their basis. Mortensen took more than

$300,000 in partnership loss deductions on an investment of approximately $83,000 between 1986-

1991. The amount of deductions, therefore, would not comply with Bales.

III.

Finally, we note again that the Tax Court’s finding that a taxpayer failed to carry his burden

of proving his reasonable care is reversed only if clearly erroneous. Although, at least with regard

to Bales, it may be a closer case than the Tax Court found below, we cannot conclude that the Tax

Court’s decision is clearly erroneous. AFFIRMED.

10

To the extent that the Tax Court below meant that the shoddy records beginning in the early 1980s should

have put Mortensen on notice of a problem, it did not explain, nor does the Commissioner on appeal, how or why

Mortensen should have recognized a problem.