The opinion
T.C. Memo. 1996-341
UNITED STATES TAX COURT
WILLIAM AND JOAN SPEARS, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
VINCENT AND CLOTILDE FARRELL, JR., Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 27393-89, 28082-89. Filed July 30, 1996.
Bernard S. Mark and Richard S. Kestenbaum, for petitioners
in docket No. 27393-89.
Hugh Janow, for petitioners in docket No. 28082-89.
Lawrence L. Davidow and Frances Ferrito Regan, for
respondent in docket No. 27393-89.
Barry J. Laterman, for respondent in docket No. 28082-89.
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CONTENTS
Page
MEMORANDUM FINDINGS OF FACT AND OPINION........................2
OPINION OF THE SPECIAL TRIAL JUDGE.............................3
FINDINGS OF FACT...............................................7
A. The Plastics Recycling Transactions......................7
B. The Partnerships.........................................9
C. Stuart Becker, Steven Leicht, and Noel Tucker...........12
D. Petitioners and Their Introduction to the Partnership
Transactions............................................18
OPINION.......................................................25
A. Section 6653(a) - Negligence............................28
1. The So-Called Oil Crisis............................30
2. Petitioners' Purported Reliance on Becker...........35
a. The Circumstances Under Which a Taxpayer May
Avoid Liability Under Section 6653(a)(1) and (2)
Because of Reasonable Reliance on Competent and
Fully Informed Professional Advice..............35
b. Petitioners' Investment Experience,
Sophistication, and Resources...................38
c. Becker's Limited Investigation and Technological
Knowledge and His Emphasis on Disclosure and on
Protection Against Liability....................40
d. Conclusion Concerning Petitioners' Alleged
Reliance on Becker..............................46
3. The Private Offering Memoranda......................48
4. Miscellaneous.......................................53
5. Conclusion As to Negligence.........................57
B. Section 6659 - Valuation Overstatement..................58
1. The Grounds for Petitioners' Underpayments..........60
2. Concession of the Deficiency........................64
3. Section 6659(e).....................................68
MEMORANDUM FINDINGS OF FACT AND OPINION
DAWSON, Judge: These cases were assigned to Special Trial
Judge Norman H. Wolfe pursuant to the provisions of section
7443A(b)(4) and Rules 180, 181, and 183.1 They were tried and
1
All section references are to the Internal Revenue Code in
effect for the years in issue, unless otherwise indicated. All
Rule references are to the Tax Court Rules of Practice and
Procedure.
(continued...)
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briefed separately but consolidated for purposes of opinion. The
Court agrees with and adopts the opinion of the Special Trial
Judge, which is set forth below.
OPINION OF THE SPECIAL TRIAL JUDGE
WOLFE, Special Trial Judge: These cases are part of the
Plastics Recycling group of cases. For a detailed discussion of
the transactions involved in the Plastics Recycling cases, see
Provizer v. Commissioner, T.C. Memo. 1992-177, affd. without
published opinion 996 F.2d 1216 (6th Cir. 1993). The underlying
transactions in these cases are substantially identical to the
transaction considered in the Provizer case.
In a notice of deficiency dated August 21, 1989, respondent
determined a deficiency in the 1982 joint Federal income tax of
William and Joan Spears in the amount of $66,426 and additions to
tax for that year in the amount of $19,928 under section 6659 for
valuation overstatement, in the amount of $3,321 under section
6653(a)(1) for negligence, and under section 6653(a)(2) in an
amount equal to 50 percent of the interest due on the
underpayment attributable to negligence. Respondent also
determined that interest on deficiencies accruing after December
31, 1984, would be calculated at 120 percent of the statutory
rate under section 6621(c).
1
(...continued)
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In a notice of deficiency dated August 25, 1989, respondent
determined deficiencies in Vincent and Clotilde Farrell's Federal
income tax for 1980 and 1982 in the respective amounts of $55,242
and $51,236. Respondent also determined that interest on
deficiencies accruing after December 31, 1984, would be
calculated at 120 percent of the statutory rate under section
6621(c). On February 24, 1994, respondent filed an amendment to
answer and asserted reduced deficiencies for taxable years 1980
and 1982 in the respective amounts of $29,590 and $51,043.
Respondent also asserted additions to tax for taxable year 1982
in the amount of $12,127 under section 6659 for valuation
overstatement, in the amount of $2,552 under section 6653(a)(1)
for negligence, and under section 6653(a)(2) in an amount equal
to 50 percent of the interest due on $50,278. Finally,
respondent asserted that for taxable years 1980 and 1982,
deficiency amounts of $14,795 and $50,278, respectively, were
subject to the increased rate of interest under section 6621(c).2
Petitioners Joan Spears and Clotilde Farrell were named in
the respective notices of deficiency and are petitioners herein
because they filed joint Federal income tax returns with their
husbands during the taxable years in issue. For convenience,
generally hereafter in discussing or mentioning petitioners
2
We note that respondent had determined in the statutory
notice of deficiency as well that the provision for increased
interest under sec. 6621(c) applied.
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Spears we refer to William Spears (Spears), and in discussing or
mentioning petitioners Farrell we refer to Vincent Farrell
(Farrell).
On April 22, 1992, respondent and Farrell filed a
Stipulation of Settled Issues resolving all issues except for
issues relating to his participation in the Plastics Recycling
Program during taxable year 1982.3 On March 31, 1994, respondent
and Farrell filed another Stipulation of Settled Issues
addressing the issues relating to his participation in the
Plastics Recycling Program. A virtually identical Stipulation of
Settled Issues was filed by respondent and Spears on March 9,
1994. These stipulations provide:
1. Petitioners are not entitled to any deductions,
losses, investment credits, business energy investment
credits or any other tax benefits claimed on their tax
returns as a result of their participation in the
Plastics Recycling Program.
2. The underpayments in income tax attributable to
petitioners' participation in the Plastics Recycling
Program are substantial underpayments attributable to
tax motivated transactions, subject to the increased
rate of interest established under I.R.C. §6621(c),
formerly §6621(d).
3
Farrell and respondent stipulated: (1) Mr. and Mrs. Farrell
are liable for a deficiency in the amount of $29,589 for taxable
year 1980; (2) $14,795 of that amount is subject to the increased
rate of interest under sec. 6621(c); (3) the loss of $1,906
claimed on Schedule E of their 1982 Federal income tax return,
and the corresponding adjustment in the notice of deficiency,
relate to their investment in SAB Associates; and (4) they are
entitled to deduct $381 with respect to their interest in SAB
Associates for 1982.
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3. This stipulation resolves all issues that relate to
the items claimed on petitioners' tax returns resulting
from their participation in the Plastics Recycling
Program, with the exception of petitioners' potential
liability for additions to the tax for valuation
overstatements under I.R.C. §6659 and for negligence
under the applicable provisions of §6653(a).
4. With respect to the issue of the addition to the
tax under I.R.C. §6659, petitioners do not intend to
contest the issue of the value of the Sentinel Recycler
or the existence of a valuation overstatement on the
petitioners' return; however, petitioners preserve
their right to contest the issue of whether I.R.C.
§6659 is applicable under the facts and circumstances
of this case.[4]
The only issues remaining in these consolidated cases are:
(1) Whether petitioners are liable for the additions to tax for
negligence or intentional disregard of rules or regulations under
section 6653(a)(1) and (2); and (2) whether petitioners are
liable for the addition to tax under section 6659 for an
underpayment of tax attributable to valuation overstatement.
Farrell's motion for decision, based in general upon
circumstances not discussed herein, has been denied for reasons
set forth in Farrell v. Commissioner, T.C. Memo. 1996-295.
4
The stipulation executed by respondent and Farrell refers
specifically to their 1982 tax returns. Also, the last clause of
the fourth stipulation reads: "however, petitioners preserve
their right to argue that the underpayment in tax is not
attributable to a valuation overstatement within the meaning of
I.R.C. §6659(a)(1), and that the Secretary should have waived the
addition to tax pursuant to the provisions of I.R.C. §6659(e)."
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FINDINGS OF FACT
Some of the facts have been stipulated in each case and are
so found. The stipulated facts and attached exhibits are
incorporated in the respective cases by this reference.
A. The Plastics Recycling Transactions
These cases concern petitioners' investments in two limited
partnerships that leased Sentinel expanded polyethylene (EPE)
recyclers: SAB Resource Recycling Associates (SAB Recycling) and
SAB Resource Reclamation Associates (SAB Reclamation). Spears is
a limited partner in SAB Recycling and Farrell is a limited
partner in SAB Reclamation. For convenience we refer to these
partnerships collectively as the Partnerships.
The transactions involving the Sentinel EPE recyclers leased
by the Partnerships are substantially identical to those in the
Clearwater Group limited partnership (Clearwater), the
partnership considered in Provizer v. Commissioner, T.C. Memo.
1992-177. Petitioners have stipulated substantially the same
facts concerning the underlying transactions as we found in the
Provizer case.
In the Provizer case, Packaging Industries, Inc. (PI),
manufactured and sold six Sentinel EPE recyclers to ECI Corp. for
$981,000 each. ECI Corp., in turn, resold the recyclers to F & G
Corp. for $1,162,666 each. F & G Corp. then leased the recyclers
to Clearwater, which licensed the recyclers to FMEC Corp., which
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sublicensed them back to PI. The sales of the recyclers from PI
to ECI Corp. were financed with nonrecourse notes. Approximately
7 percent of the sales price of the recyclers sold by ECI Corp.
to F & G Corp. was paid in cash with the remainder financed
through notes. These notes provided that 10 percent of the notes
were recourse but that the recourse portion of the notes was only
due after the nonrecourse portion, 90 percent, was paid in full.
All of the monthly payments required among the entities in
the above transactions offset each other. These transactions
were done simultaneously. Although the recyclers were sold and
leased for the above amounts under the structure of simultaneous
transactions, the fair market value of a Sentinel EPE recycler in
1981 and 1982 was not in excess of $50,000.
PI allegedly sublicensed the recyclers to entities that
would use them to recycle plastic scrap. The sublicense
agreements provided that the end-users would transfer to PI 100
percent of the recycled scrap in exchange for a payment from FMEC
Corp. based on the quality and amount of recycled scrap.
Like Clearwater, each of the Partnerships leased Sentinel
EPE recyclers from F & G Corp. and licensed those recyclers to
FMEC Corp. The transactions of the Partnerships differ from the
underlying transaction in the Provizer case in the following
respects: (1) The entity that leased the machines from F & G
Corp. and licensed them to FMEC Corp.; and (2) the number of
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recyclers that the Partnerships leased and licensed.5 For
convenience we refer to the series of transactions among PI, ECI
Corp., F & G Corp., each of the Partnerships, FMEC Corp., and PI
as the Partnership transactions. In addition to the Partnership
transactions, a number of other limited partnerships entered into
transactions similar to the Partnership transactions, also
involving Sentinel EPE recyclers and Sentinel expanded
polystyrene recyclers. We refer to these collectively as the
Plastics Recycling transactions.
B. The Partnerships
SAB Recycling and SAB Reclamation are New York limited
partnerships that were organized and promoted in 1982 by Stuart
Becker (Becker), a certified public accountant (C.P.A.) and the
founder and principal owner of Stuart Becker & Co., P.C. (Becker
Co.), an accounting firm that specialized in tax matters. Becker
organized a total of six recycling partnerships (the SAB
recycling partnerships). Two of the SAB recycling partnerships
closed in late 1981, two closed in early 1982, and two more
closed in late 1982.
5
According to the offering memoranda, SAB Reclamation was to
lease and license eight recyclers and SAB Recycling was to lease
and license seven recyclers. However, the SAB Reclamation
partnership tax return for 1982 indicates that it leased and
licensed only four recyclers.
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The general partner of each of the SAB recycling
partnerships, including SAB Reclamation and SAB Recycling, is SAB
Management Ltd. (SAB Management). SAB Management is wholly owned
by Scanbo Management Ltd. (Scanbo),6 which is wholly owned by
Becker. The officers and directors of SAB Management and Scanbo
are: (1) Becker, president and director; (2) Noel Tucker
(Tucker), vice president, treasurer, and director; and (3) Steven
Leicht (Leicht), vice president, secretary, and director. During
the years in issue, Tucker and Leicht also worked at Becker Co.
Tucker was vice president. Each owned approximately 5 to 7
percent of the stock of Becker Co. SAB Management did not engage
in any business before becoming involved with the SAB recycling
partnerships.
With respect to each of the Partnerships, a private
placement memorandum was distributed to potential limited
partners. Reports by F & G's evaluators, Dr. Stanley M. Ulanoff
(Ulanoff), a marketing consultant, and Dr. Samuel Z. Burstein
(Burstein), a mathematics professor, were appended to the
offering memoranda. In a section highlighting potential
conflicts of interest, each of the memoranda notes that Burstein
was a client and business associate of Elliot I. Miller (Miller),
the corporate counsel to PI.
6
Scanbo is an acronym for three of Becker's children: Scott,
Andy, and Bonnie.
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The offering memoranda of SAB Reclamation and SAB Recycling
provide that SAB Management will receive general partner fees in
the respective amounts of $110,000 and $97,375 from those
partnerships. SAB Management received fees of approximately
$500,000 as the general partner of the SAB recycling
partnerships. In addition, Becker Co. prepared the partnership
returns and Forms K-1 for all of the SAB recycling partnerships
and received fees for those services.
The offering memoranda of SAB Reclamation and SAB Recycling
state that sales commissions and offeree representative fees will
be paid in amounts equal to 7.5 percent of each investment guided
to the partnerships and that SAB Management, as the general
partner of those partnerships, may retain as additional
compensation all amounts not so paid. However, neither Becker
nor SAB Management retained or received any sales commissions or
offeree representative fees. Instead, after the closing of each
SAB recycling partnership, Becker rebated to each investor whose
investment was not subject to a sales commission or offeree
representative fee an amount equal to 7.5 percent of such
investor's original investment.
The offering memoranda list significant business and tax
risk factors associated with investments in the Partnerships.
Specifically, the offering memoranda state: (1) There is a
substantial likelihood of audit by the Internal Revenue Service
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(IRS) and the purchase price paid by F & G to ECI Corp. probably
will be challenged as being in excess of fair market value; (2)
the Partnerships have no prior operating history; (3) the general
partner has no prior experience in marketing recycling or similar
equipment; (4) the limited partners have no control over the
conduct of the Partnerships' business; (5) there is no
established market for the Sentinel EPE recyclers; (6) there are
no assurances that market prices for virgin resin will remain at
their current costs per pound or that the recycled pellets will
be as marketable as virgin pellets; and (7) certain potential
conflicts of interest exist.
C. Stuart Becker, Steven Leicht, and Noel Tucker
Becker does not have an engineering background, and he is
not an expert in plastics materials or plastics recycling. He
received a B.S. degree in accounting from New York University in
1964 and an M.B.A. in taxation from New York University Graduate
School of Business Administration in 1973. Becker passed the
certified public accountancy test in 1967 and was the winner of
the gold medal, awarded for achieving the highest score on the
examination for that year. Since early 1966, Becker has
practiced as an accountant exclusively in the tax area. From
1964 until 1972 he worked for the accounting firm of Touche Ross
& Co., and in 1972 he joined the accounting firm of Richard A.
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Eisner & Co. as the partner in charge of the tax department. In
1977, Becker founded Becker Co.
Becker had considerable experience with tax shelter
transactions before he organized the SAB recycling partnerships.
He prepared opinions regarding tax shelters' economic and tax
projections, advised individuals and companies with respect to
investments in tax shelters, lectured extensively about tax
shelter investments generally, and lectured and published with
respect to leveraged tax shelters.7 Becker Co. specialized in
tax advantaged investments. From 1980 to 1982, approximately 60
percent of the work done by Becker Co. involved tax sheltered and
private investments. Becker has owned minority interests in
general partners of numerous limited partnerships. Prior to
organizing the SAB recycling partnerships, Becker was a 5-percent
owner of the general partner of partnerships involved in
approximately 14 transactions involving river transportation
(such as barges, tow boats, and grain elevators).
7
Becker described a leveraged tax shelter as "a transaction
where [the ratio of] the effective [tax] writeoff, which includes
the value of the tax credit, * * * [to the amount invested]
exceeds one to one."
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Although investment counseling was related to his firm's
line of business, Becker did not consider himself in the business
of providing investment advice. Becker did not normally hire
other professionals for consultation or advice. In circumstances
where he believed there was a need for outside advice, he would
so advise the client. Between 30 and 40 of Becker's clients
invested in the Plastics Recycling partnerships.
Becker learned of the Plastics Recycling transactions when a
prospective client presented him with an offering memorandum
concerning the transactions in August or September 1981. Becker
reviewed the offering memorandum and spoke to Miller, one of the
key figures in the transactions and an acquaintance of Becker's.
Miller was a shareholder of F & G Corp. and, as noted, the
corporate counsel to PI. Thereafter, Becker recommended the
investment to the prospective client. Although the prospective
client did not invest in the Plastics Recycling transactions,
Becker became interested in the proposal and organized the SAB
recycling partnerships in order to make similar investments in
Sentinel EPE recyclers conveniently available to appropriate
clients.
In organizing the SAB recycling partnerships, Becker was not
allowed to change the format of the transactions or the purchase,
lease, or licensing prices of the Sentinel EPE recyclers. He was
allowed only to conduct a limited investigation of the proposed
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investments and choose whether or not to organize similar
partnerships. Becker relied heavily upon the offering materials
and discussions with persons involved in the matter to evaluate
the Plastics Recycling transactions. He and two other members of
Becker Co., Leicht and Tucker, investigated PI and visited its
plant in Hyannis, Massachusetts, where they saw the Sentinel EPE
recyclers.
During his investigation of the Plastics Recycling
transactions Becker did not hire any plastics, engineering, or
technical experts, or recommend that his clients do so. Becker
discussed the transactions with Michael Canno, of the Equitable
Bag Co., a manufacturer of paper and plastic bags. Canno never
saw the recyclers or the pellets and never wrote any reports
assessing the equipment or the pellets.
Becker retained a law firm, Rabin & Silverman8, to assist
him with the legal aspects of organizing the SAB recycling
partnerships, such as reviewing and/or preparing documents in
connection with the SAB recycling partnerships. Michael D.
DiGiovanna9 (DiGiovanna), a partner at Rabin & Silverman and a
8
Rabin & Silverman has undergone several name changes since
that time. At the time of trial, the successor firm was called
Dornbush, Mensch, Mandelstam & Schaeffer.
9
The testimony of DiGiovanna was stipulated into the record
in docket No. 28082-89 (the Farrell case), but not docket No.
27393-89 (the Spears case). His testimony has been disregarded
(continued...)
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specialist in securities and corporate law, advised Becker
regarding his disclosure obligations under the securities laws
and his protection against liability. In so advising Becker,
DiGiovanna was not responsible for, and did not get, independent
verification of any of the representations in the offering
materials. He never visited PI or saw a Sentinel EPE recycler.
DiGiovanna did not have any education or experience in
engineering, plastics materials, or plastics recycling.
Leicht and Tucker also familiarized themselves with the
Plastics Recycling transactions.10 Leicht has a B.A. degree in
finance and accounting from Penn State University, a J.D. from
SUNY Buffalo, and an LL.M. in Taxation from New York University
School of Law. Leicht ran a mathematical check on the numbers
contained in the offering materials for Becker, but he did not
test the underlying assumptions upon which they were based. He
also visited PI in Hyannis and met with Miller and other insiders
to the transactions. Leicht never communicated an opinion as to
the value of the recyclers other than what was presented in the
9
(...continued)
with respect to the Spears case.
10
Leicht testified only in docket No. 28082-89 (the Farrell
case). His testimony has been disregarded with respect to docket
No. 27393-89 (the Spears case).
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offering memoranda. He has no education or expertise in plastics
materials or plastics recycling.
Tucker did not testify at trial. However, Spears submitted
two memoranda written by Tucker and addressed to Becker relating
to the Plastics Recycling transactions. One memorandum, dated
November 12, 1981, is an evaluation of the financial projections
for SAB Leasing Associates (SAB Leasing). Tucker checked all of
the computations in the financial projections prepared by the
management of PI for SAB Leasing, and created several additional
schedules using variable inflation rates and royalty rates. The
second memorandum, dated September 24, 1982, briefly describes a
visit with Becker to PI and contains two additional schedules
using variable numbers.
After the 1981 SAB recycling partnerships closed, Becker had
an accountant sent to PI to confirm, by serial number, that as of
December 31, 1981, the equipment that was leased to the 1981 SAB
recycling partnerships was indeed available for use. Becker
arranged for this verification, independent of PI, because he
understood that the investment tax and business energy credits
would not be available if the qualifying property was not
available for use.
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D. Petitioners and Their Introduction to the Partnership
Transactions
Petitioners William and Joan Spears resided in Greenwich,
Connecticut, at the time their petition was filed. Spears earned
a B.A. in politics and graduated with honors from Princeton
University in 1960. He then attended the Harvard School of
Business where he graduated with distinction in 1962. In July
1962 he joined Loeb, Rhoades & Co. (Loeb, Rhoades) as a
securities analyst. At Loeb, Rhoades, Spears concentrated on the
pharmaceutical and retail industries until 1968, when he acquired
responsibilities in investment management. Spears became a
general partner at Loeb, Rhoades before leaving in 1971. In
January 1972, he formed his own investment management firm, W.G.
Spears, Inc., which eventually became Spears, Benzak, Salomon &
Farrell (Spears, Benzak). From its formation until the time of
trial, Spears, Benzak has managed funds principally for wealthy
individuals, endowment funds, foundations, and pension funds.
Petitioners Vincent and Clotilde Farrell resided in Katonah,
New York, when their petition was filed. Farrell earned a B.A.
in history from Princeton University and an M.B.A. from Iona
College Graduate School of Business. Immediately after college,
in 1969, Farrell was employed as a high school teacher and
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football coach. Four years later he joined the investment firm
of Smith, Barney, Harris & Upham (Smith, Barney). Farrell became
a successful retail salesman for Smith, Barney and eventually
influenced the investment of approximately $50 million. In 1982
Farrell became a partner at the investment management firm of
Spears, Benzak in midtown Manhattan. Over the next 12 years
Spears, Benzak increased the amounts it had under management from
approximately $150 million to nearly $3 billion.
On their joint 1982 Federal Income tax return, William and
Joan Spears reported gross income from wages, interest,
dividends, State and local tax refunds, and capital gains in
excess of $700,000. On their 1982 return, Vincent and Clotilde
Farrell reported gross income from wages, interest, dividends,
and State and local tax refunds in excess of $250,000.
Consequently, in the absence of significant deductions or
credits, petitioners in these consolidated cases were subject to
payment of Federal income taxes in substantial amounts.
Spears and Farrell are both partners in SAB Associates, a
limited partnership initially involved in tax straddle
investments. During 1981, the tax laws changed and as a
consequence SAB Associates was likely to realize substantial
gains. SAB Associates ceased engaging in tax straddle
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investments that year and changed its function to leasing
Sentinel EPE recyclers. Partners were given the option of
withdrawing their capital accounts or continuing with the
partnership. In December 1981, SAB Associates invested $569,600
in SAB Resource Recovery Associates and $975,000 in SAB Leasing
Associates. Investment tax credits and business energy credits
with respect to petitioners' shares of these investments are not
reflected in the records in these cases, presumably because the
investments were made in 1981. Only the operating losses in 1982
are documented in the record in these cases.
In 1982, Spears acquired a 2.538461-percent interest in SAB
Recycling for $25,000.11 On their 1982 return, he and his wife
Joan claimed an operating loss in the amount of $19,870 and
investment tax and business energy credits totaling $41,32012
with respect to his interest in SAB Recycling. They also claimed
an operating loss in the amount of $1,145 with respect to their
interest in SAB Associates. Respondent disallowed all of their
11
The gross amount Spears invested is $25,000, unreduced by
any sales commission rebate or his share of any advance royalty
distributed to him.
12
The regular investment tax credit claimed by Spears and his
wife totaled $54,863, but only $20,660 of that amount was
attributable to SAB Recycling.
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claimed operating losses and credits related to their interests
in SAB Recycling and SAB Associates.
In 1982, Farrell acquired a 4.5-percent limited partnership
interest in SAB Reclamation for $25,000.13 On their 1982 return,
he and his wife Clotilde claimed an operating loss in the amount
of $20,050 and investment tax and business energy credits
totaling $41,856,14 both flowing from his interest in SAB
Reclamation. The Farrells also claimed an operating loss in the
amount of $1,906 with respect to SAB Associates.15 Respondent
disallowed all but $386 of the Farrell's 1982 claimed operating
losses and credits related to SAB Reclamation and SAB
Associates.16
13
Farrell testified that he believed he had invested $20,000.
His Form K-1, Partner's Share of Income, Credits, Deductions,
etc., attached to SAB Reclamation's partnership return, indicates
that he invested $25,000. We note that the $25,000 figure is the
gross amount Farrell invested, unreduced by any rebated sales
commission or his share of any advance royalty distributed to
him.
14
The regular investment tax credit claimed by Farrell and his
wife totaled $21,314, but only $20,928 of that amount was
attributable to SAB Reclamation.
15
As noted, respondent and Farrell stipulated that for taxable
year 1982, he and his wife are entitled to deduct $381 with
respect to their interest in SAB Associates.
16
Respondent explained in the notice of deficiency that
(continued...)
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Spears and Farrell both learned of the Partnership
transactions from Becker. Becker and Spears met in 1974 when
Spears attended board meetings and otherwise represented the
interests of a substantial investor in a company for which Becker
provided accounting services. Spears was impressed with Becker
and hired him to perform accounting and tax work for Spears
individually and for his company. During that time Spears was
also a client and friend of Farrell, and he recommended that
Farrell and Becker meet. Farrell hired Becker Co. to prepare his
returns. Becker also occasionally presented Farrell with tax-
advantaged investments and eventually provided advice in
connection with Farrell's joining Spears, Benzak. Farrell did
not rely on Becker with respect to general investment issues
because he did not think that was Becker's area of expertise. He
16
(...continued)
Farrell and his wife were not entitled to any investment tax
credit or business energy tax credit from SAB Associates and SAB
Reclamation. In both the notice of deficiency and the amendment
to answer, however, respondent allowed $772 of the total
investment and business energy credits claimed by the Farrells.
The Farrells claimed a total of $42,242 in investment tax and
business energy tax credits. Of that amount, $41,856 derived
from their interest in SAB Reclamation (with a basis of $209,280
in the equipment, the investment tax and business energy tax
credits equal $41,856), and $386 was unrelated to SAB Reclamation
($42,242 - $41,856 = $386). Consequently, it appears that in
allowing $772 of total credits, respondent actually allowed $386
of credits related to SAB Reclamation.
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considered Becker knowledgeable with respect to the tax code and
tax advantaged investments. Farrell would not discuss
investments with Becker if they did not have tax benefits.
The tax benefits associated with the Partnership
transactions were a primary investment consideration for Spears.
He understood that he would have taxable income to report when
SAB Associates discontinued its tax straddle business, and that
the investment tax credits from the recyclers would be available
to those partners who rolled over their investments and remained
with SAB Associates. Spears reviewed the offering memorandum for
SAB Recycling, and he and Becker discussed the Sentinel EPE
recyclers and the Partnership transactions in general. Spears
relied upon Becker more than he did the offering materials.
Spears knew he was not able to understand the plastics recycling
technology. He explained that when Spears, Benzak required
analysis of technology investments, the firm "would rely * * * on
others" who had knowledge of the technology in question.
However, even though Spears was the founder and a senior member
of Spears, Benzak, which was a substantial investment counseling
firm, he did not consider it appropriate to "bring resources from
within [his] firm to bear on a personal investment".
- 24 -
Spears did not know the number of SAB recycling partnerships
in which Becker was the general partner. Although Spears knew
that Becker was not an expert in plastics recycling, he never
asked Becker if he had sought advice from an expert independent
of the Partnership and insiders to the Partnership transactions.
Spears claims that he believed the price of the recyclers had
been negotiated at arm's length and that he was unaware of
whether there was an established market for the recycling
equipment. In fact, as Spears stipulated, no negotiations for
the price of the Sentinel EPE recyclers took place between or
among PI, ECI, and F & G, and the offering memoranda clearly
disclosed that there was no established market for leasing or
operating the Sentinel EPE recyclers.
Becker introduced the Plastics Recycling transactions to
Farrell in mid to late 1980. The tax benefits interested
Farrell. He understood that the tax credits would exceed his
investment and thereby eliminate any out-of-pocket investment
expense. He knew Becker was not a plastics recycling expert, but
believed Becker was capable of judging the tax aspects of the
transactions, if not the technical aspects of them. Farrell
never asked Becker if he consulted any experts. Farrell did not
- 25 -
know whether Becker had consulted only PI personnel and other
insiders or whether he had spoken with independent experts.
Petitioners in these consolidated cases never made a profit
in any year from their participation in the Partnership
transactions. Spears and Farrell did not see a Sentinel EPE
recycler prior to investing in the Partnership transactions.
Petitioners in each case do not have any education or work
experience in plastics recycling or plastics materials.
OPINION
We have decided more than two dozen of the Plastics
Recycling group of cases.17 The majority of these cases, like
17
Provizer v. Commissioner, T.C. Memo. 1992-177, affd. without
published opinion 996 F.2d 1216 (6th Cir. 1993), concerned the
substance of the partnership transaction and also the additions
to tax.
The following cases concerned the addition to tax for
negligence, inter alia: Stone v. Commissioner, T.C. Memo. 1996-
230; Reimann v. Commissioner, T.C. Memo. 1996-84; Bennett v.
Commissioner, T.C. Memo. 1996-14; Atkind v. Commissioner, T.C.
Memo. 1995-582; Triemstra v. Commissioner, T.C. Memo. 1995-581;
Pace v. Commissioner, T.C. Memo. 1995-580; Dworkin v.
Commissioner, T.C. Memo. 1995-533; Wilson v Commissioner, T.C.
Memo. 1995-525; Avellini v. Commissioner, T.C. Memo. 1995-489;
Paulson v. Commissioner, T.C. Memo. 1995-387; Zidanich v.
Commissioner, T.C. Memo. 1995-382; Ramesh v. Commissioner, T.C.
Memo. 1995-346; Reister v. Commissioner, T.C. Memo. 1995-305;
Fralich v. Commissioner, T.C. Memo. 1995-257; Shapiro v.
Commissioner, T.C. Memo. 1995-224; Pierce v. Commissioner, T.C.
Memo. 1995-223; Fine v. Commissioner, T.C. Memo. 1995-222;
Pearlman v. Commissioner, T.C. Memo. 1995-182; Kott v.
(continued...)
- 26 -
the consolidated cases herein, raised issues regarding additions
to tax for negligence and valuation overstatement. We have found
the taxpayers liable for such additions to tax in all but one of
the opinions to date on these issues, although procedural rulings
have involved many more favorable results for taxpayers.18
In Provizer v. Commissioner, T.C. Memo. 1992-177, a test
case for the Plastics Recycling group of cases, this Court (1)
found that each Sentinel EPE recycler had a fair market value not
in excess of $50,000, (2) held that the transaction, which is
17
(...continued)
Commissioner, T.C. Memo. 1995-181; Eisenberg v. Commissioner,
T.C. Memo. 1995-180.
Greene v. Commissioner, 88 T.C. 376 (1987), concerned the
applicability of the safe-harbor leasing provisions of sec.
168(f)(8). Trost v. Commissioner, 95 T.C. 560 (1990), concerned
a jurisdictional issue. Baratelli v. Commissioner, T.C. Memo.
1994-484; Estate of Satin v. Commissioner, T.C. Memo. 1994-435;
Fisher v. Commissioner, T.C. Memo. 1994-434; Foam Recycling
Associates v. Commissioner, T.C. Memo. 1992-645; Madison
Recycling Associates v. Commissioner, T.C. Memo. 1992-605,
concerned other issues.
18
In Zidanich v. Commissioner, T.C. Memo. 1995-382, we held
the taxpayers liable for the section 6659 addition to tax, but
not liable for the negligence additions to tax under section
6653(a). As indicated in our opinion, the Zidanich case, and the
Steinberg case consolidated with it for opinion, involved
exceptional circumstances.
In Estate of Satin v. Commissioner, supra, and Fisher v.
Commissioner, supra, after the decision in Provizer v.
Commissioner, supra, the taxpayers were allowed to elect to
accept a beneficial settlement because of exceptional
circumstances.
- 27 -
almost identical to the Partnership transactions in these
consolidated cases, was a sham because it lacked economic
substance and a business purpose, (3) upheld the section 6659
addition to tax for valuation overstatement since the
underpayment of taxes was directly related to the overstatement
of the value of the Sentinel EPE recyclers, and (4) held that
losses and credits claimed with respect to Clearwater were
attributable to tax-motivated transactions within the meaning of
section 6621(c). In reaching the conclusion that the transaction
lacked economic substance and a business purpose, this Court
relied heavily upon the overvaluation of the Sentinel EPE
recyclers.
Although petitioners have not agreed to be bound by the
Provizer opinion, they have stipulated that the investments in
the Sentinel EPE recyclers in these cases are similar to the
investment described in Provizer v. Commissioner, supra. The
underlying transactions in these consolidated cases, and the
Sentinel EPE recyclers considered in these cases, are the same
type of transaction and same type of machine considered in
Provizer v. Commissioner, supra.
Based on the entire records in these cases, including the
extensive stipulations, testimony of respondent's experts, and
- 28 -
petitioner's testimony, we hold that each of the Partnership
transactions herein was a sham and lacked economic substance. In
reaching this conclusion, we rely heavily upon the overvaluation
of the Sentinel EPE recyclers. Respondent is sustained on the
question of the underlying deficiencies. We note that
petitioners have explicitly conceded this issue in the respective
stipulations of settled issues filed shortly before trial. The
record plainly supports respondent's determination regardless of
such concessions. For a detailed discussion of the facts and the
applicable law in a substantially identical case, see Provizer v.
Commissioner, supra.
A. Section 6653(a) - Negligence
In a notice of deficiency, respondent determined that
petitioners William and Joan Spears are liable for the negligence
additions to tax under section 6653(a)(1) and (2). Spears has
the burden of proving that respondent's determination is
erroneous. Rule 142(a); Luman v. Commissioner, 79 T.C. 846, 860-
861 (1982).
In an amendment to answer, respondent asserted that
petitioners Vincent and Clotilde Farrell are liable for additions
to tax for negligence under section 6653(a)(1) and (2). Because
respondent raised these additions to tax for the first time in an
- 29 -
amendment to answer, respondent has the burden of proof on these
issues. Rule 142(a); Vecchio v. Commissioner, 103 T.C. 170, 196
(1994).
Section 6653(a)(1) imposes an addition to tax equal to 5
percent of the underpayment if any part of an underpayment of tax
is due to negligence or intentional disregard of rules or
regulations. Section 6653(a)(2) imposes an addition to tax equal
to 50 percent of the interest payable with respect to the portion
of the underpayment attributable to negligence or intentional
disregard of rules or regulations.
Negligence is defined as the failure to exercise the due
care that a reasonable and ordinarily prudent person would employ
under the circumstances. Neely v. Commissioner, 85 T.C. 934, 947
(1985). The question is whether a particular taxpayer's actions
in connection with the transactions were reasonable in light of
his experience and the nature of the investment or business. See
Henry Schwartz Corp. v. Commissioner, 60 T.C. 728, 740 (1973).
When considering the negligence addition to tax, we evaluate the
particular facts of each case, judging the relative
sophistication of the taxpayers, as well as the manner in which
they approached their investment. McPike v. Commissioner, T.C.
Memo. 1996-46.
- 30 -
Petitioners each contend that they were reasonable in
claiming deductions and investment credits with respect to their
investments in the Partnerships. In support of such contentions,
petitioners each argue, in general terms: (1) That claiming the
deductions and credits with respect to the Partnerships was
reasonable in light of the so-called oil crisis during the years
in issue and (2) that they reasonably relied upon the offering
materials and a qualified adviser.
In the cases before us, expert testimony by report
establishes that the oil pricing changes during the late 1970's
and early 1980's did not justify petitioners' claiming excessive
investment credits and purported losses based on vastly
exaggerated valuations of recycling machinery. Also, we are
unconvinced by the claim of these highly sophisticated, able, and
successful investors that they acted reasonably in failing to
inquire about their investment and simply relying on the offering
circulars and on Becker, despite warnings in the offering
circulars and explanations by Becker about the limitations of his
investigation. In each case these taxpayers knew or should have
known better.
1. The So-Called Oil Crisis
- 31 -
Petitioners each argue that because plastics materials are
oil derivatives, they reasonably believed that the Partnership
transactions had good economic potential in light of the alleged
oil crisis in the United States during 1981. However,
petitioners failed to explain exactly how such supposed oil
crisis provided a reasonable basis for them to invest in the
Partnerships and claim the associated tax deductions and credits.
The offering materials warned that there could be no
assurances that prices for new resin pellets would remain at
their then current level. One of respondent's experts, Steven
Grossman, explained that the price of plastics materials is not
directly proportional to the price of oil. In his report, he
stated that less than 10 percent of crude oil is utilized for
making plastics materials, and that studies have shown that "a
300% increase in crude oil prices results in only a 30 to 40%
increase in the cost of plastics products." Moreover, during
1980 and 1981, in addition to the media coverage of the so-called
oil crisis, there was "extensive continuing press coverage of
questionable tax shelter plans." Zmuda v. Commissioner, 731 F.2d
1417, 1422 (9th Cir. 1984), affg. 79 T.C. 714 (1982).
Spears placed into the record several articles from Modern
Plastics and an energy projections report from the U.S.
- 32 -
Department of Energy (DOE), all published in the years 1980 and
1981. Both the articles from Modern Plastics and the report by
the DOE speculated on the price of oil, among other things. The
preface to the DOE report cautioned about "the tremendous
uncertainties underlying energy projections" and warned "that
[their] projections do not constitute any sort of blueprint for
the future." Reflective of such uncertainties, an April 1980
article in Modern Plastics contemplated resin price hikes, while
a May 1981 article predicted a leveling off of prices, market
disruptions, and an industrywide shakeout. Spears does not
purport to have read, or in any way relied upon, the DOE report
or the Modern Plastics articles, and has not otherwise explained
the connection between these speculative materials and his
investing in the Partnerships.
Petitioners' reliance on Krause v. Commissioner, 99 T.C. 132
(1992), affd. sub nom. Hildebrand v. Commissioner, 28 F.3d 1024
(10th Cir. 1994), and Rousseau v. United States, 71A AFTR 2d 93-
4294, 91-1 USTC par. 50,252 (E.D. La. 1991), is misplaced. The
facts in Krause v. Commissioner, supra, are distinctly different
from the facts of these cases. In the Krause case, the taxpayers
invested in limited partnerships whose investment objectives
concerned enhanced oil recovery (EOR) technology. The Krause
- 33 -
opinion states that during the late 1970's and early 1980's, the
Federal Government adopted specific programs to aid research and
development of EOR technology. Id. at 135-136. In holding that
the taxpayers in the Krause case were not liable for the
negligence additions to tax, this Court noted that one of the
Government's expert witnesses acknowledged that "investors may
have been significantly and reasonably influenced by the energy
price hysteria that existed in the late 1970's and early 1980's
to invest in EOR technology." Id. at 177. In the present cases,
however, as explained by respondent's expert Grossman, supra, the
price of plastics materials was not directly proportional to the
price of oil, and there is no persuasive evidence that the so-
called oil crisis had a substantial bearing on petitioners'
decisions to invest. While EOR was, according to our Krause
opinion, in the forefront of national policy and the media during
the late 1970's and 1980's, there is no showing in these records
that the so-called oil crisis would provide a reasonable basis
for petitioners' investing in recycling of polyethylene,
particularly in the machinery here in question.
Moreover, the taxpayers in the Krause opinion were
experienced in or investigated the oil industry and EOR
technology specifically. One of the taxpayers in the Krause case
- 34 -
undertook significant investigation of the proposed investment
including researching EOR technology. The other taxpayer was a
geological and mining engineer whose work included research of
oil recovery methods and who hired an independent geologic
engineer to review the offering materials. Id. at 166. In the
present cases, petitioners had no education or work experience
with respect to plastics or plastics recycling. There is no
indication in the records that either of petitioners
independently investigated the Sentinel EPE recyclers or hired an
expert in plastics to evaluate the Partnership transactions.
In Rousseau v. United States, supra, the property underlying
the investment, ethanol producing equipment, was widely
considered at that time to be a viable fuel alternative to oil,
and its potential for profit was apparent. In addition, the
taxpayer therein conducted an independent investigation of the
investment and researched the market for the sale of ethanol in
the United States. In contrast, as we noted in distinguishing
the Krause case, there is no showing in these records that the
so-called oil crisis would provide a reasonable basis for
petitioners' investing in the polyethylene recyclers here in
question. There is no indication in the records that petitioners
independently investigated the Sentinel EPE recyclers or hired an
- 35 -
expert in plastics to evaluate the Partnership transactions. The
facts of petitioners' cases are distinctly different from the
Rousseau case. Accordingly, we do not consider petitioners'
arguments with respect to the Krause and Rousseau cases
applicable.
2. Petitioners' Purported Reliance on Becker
Petitioners also maintain that they reasonably relied upon
the advice of a qualified adviser, Becker.19
a. The Circumstances Under Which a Taxpayer May Avoid
Liability Under Section 6653(a)(1) and (2) Because of
Reasonable Reliance on Competent and Fully Informed
Professional Advice
A taxpayer may avoid liability for the additions to tax
under section 6653(a)(1) and (2) if he or she reasonably relied
on competent professional advice. United States v. Boyle, 469
U.S. 241, 250-251 (1985); Freytag v. Commissioner, 89 T.C. 849,
888 (1987), affd. 904 F.2d 1011 (5th Cir. 1990), affd. 501 U.S.
868 (1991). Reliance on professional advice, standing alone, is
19
We note that Farrell extensively argues this point in his
posttrial brief. In general, some of Farrell's factual positions
conflict with the record of his case, and the principal cases
that he cites are inapplicable and distinguishable for the
following general, nonexclusive reasons: (1) They involve far
less sophisticated taxpayers; (2) the reasonableness of the
respective taxpayers' reliance on expert advice was established
in those cases on grounds that do not exist here; and (3) the
advice given was within the adviser's area of expertise.
- 36 -
not an absolute defense to negligence, but rather a factor to be
considered. In order for reliance on professional advice to
excuse a taxpayer from the negligence additions to tax, the
taxpayer must show that such professional had the expertise and
knowledge of the pertinent facts to provide valuable and
dependable advice on the subject matter. Goldman v.
Commissioner, 39 F.3d 402 (2d Cir. 1994), affg. T.C. Memo. 1993-
480; Freytag v. Commissioner, supra; Kozlowski v. Commissioner,
T.C. Memo. 1993-430, affd. without published opinion 70 F.3d 1279
(9th Cir. 1995).
Reliance on representations by insiders, promoters, or
offering materials has been held an inadequate defense to
negligence. Goldman v. Commissioner, supra; Pasternak v.
Commissioner, 990 F.2d 893, 903 (6th Cir. 1993), affg. T.C. Memo.
1991-181; LaVerne v. Commissioner, 94 T.C. 637, 652-653 (1990),
affd. without published opinion 956 F.2d 274 (9th Cir. 1992),
affd. without published opinion sub nom. Cowles v. Commissioner,
949 F.2d 401 (10th Cir. 1991); Marine v. Commissioner, 92 T.C.
958, 992-993 (1989), affd. without published opinion 921 F.2d 280
(9th Cir. 1991); McCrary v. Commissioner, 92 T.C. 827, 850
(1989); Rybak v. Commissioner, 91 T.C. 524, 565 (1988). Pleas of
reliance have been rejected when neither the taxpayer nor the
- 37 -
advisers purportedly relied upon by the taxpayer knew anything
about the nontax business aspects of the contemplated venture.
Goldman v. Commissioner, supra; Freytag v. Commissioner, supra;
Beck v. Commissioner, 85 T.C. 557 (1985); Lax v. Commissioner,
T.C. Memo. 1994-329, affd. without published opinion 72 F.3d 123
(3d Cir. 1995); Steerman v. Commissioner, T.C. Memo. 1993-447;
Rogers v. Commissioner, T.C. Memo. 1990-619.
The concept of negligence and the argument of reliance on an
expert is highly fact intensive. In these cases two remarkably
capable and successful investment advisers, experienced and able
at investigating investment proposals, assert that they relied
upon their accountant to investigate the tax law and the
underlying business circumstances of a proposed investment. The
accountant explains that he made an investigation within the
limits of his resources and abilities and fully disclosed what he
had done. The question here is whether petitioners actually and
reasonably relied on the accountant with respect to valuation
problems requiring expertise in engineering and plastics
technology or whether the accountant gave the tax advice and
facilitated the transaction, but did not make a full and
independent investigation of the relevant business and
technology, and did clearly inform his clients of the limits of
- 38 -
his knowledge and investigation of the transaction. For reasons
set forth below, we believe the latter statement more accurately
describes what happened here.
b. Petitioners' Investment Experience, Sophistication,
and Resources
Petitioners claim that they reasonably relied upon Becker
when they knew that: (1) His forte was the tax analysis aspect
of so-called tax shelter transactions and (2) he had no
experience or expertise in plastics materials or plastics
recycling. Yet petitioners' education and professional
experience, and portions of their own testimony in these cases,
indicate that they clearly knew better than to rely upon a person
for advice on matters beyond his or her expertise.
Petitioners Spears and Farrell are very well educated and
exceptionally sophisticated in investment and financial matters.
The two have had outstanding careers investing and managing funds
for wealthy individuals and institutions; without question they
are highly proficient and knowledgeable investors. During
Farrell's employment at Smith, Barney, approximately $50 million
of client funds were Farrell's responsibility. Spears became a
partner at Loeb, Rhoades & Co. less than 10 years after his
initial employment there. At the time of trial Spears, Benzak
- 39 -
was investing and managing nearly $3 billion of client funds. In
view of their impressive investment experience and skill, there
is little doubt that if petitioners themselves had thoroughly
investigated the Plastics Recycling transactions before
investing, they surely would have learned that the recyclers were
overvalued and therefore the tax benefits flowing from the
Partnerships were illusory.
Spears testified that his firm's policy for investigating
investment opportunities was to rely heavily on people who had
studied the subject industry in depth. Yet Becker was not an
expert in plastics materials or plastics recycling, and he did
not study the plastics recycling industry in depth. Becker's
"investigation" did not even uncover that competing, less
expensive recyclers were already on the market. Even though
Spears knew that Becker had no expertise in plastics materials or
plastics recycling, he never asked Becker if he had consulted any
plastics experts who were independent of the transactions.
Spears testified that he simply assumed Becker had consulted the
appropriate experts.
While Farrell was at Smith, Barney, he did not perform any
due diligence for any proposed investments because such work was
done by the department or committee proposing or sponsoring the
- 40 -
investment, such as the tax shelter department. Even though
Farrell was comfortable with the due diligence efforts at Smith,
Barney, he testified that he "very rarely offered" the tax
shelter investments to his clients because he "did not consider
himself knowledgeable enough" in the subject areas of the
investments. Similarly, Farrell testified that he did not rely
on Becker for general investment issues because he did not think
that was Becker's area of expertise. Farrell knew that Becker's
area of expertise was taxation, and he explained that he would
not discuss investments with Becker if they did not have tax
benefits.
c. Becker's Limited Investigation and Technological
Knowledge and His Emphasis on Disclosure and on
Protection Against Liability
In evaluating the Plastics Recycling transactions and
organizing the SAB recycling partnerships, Becker supposedly
relied upon: (1) The offering materials; (2) a tour of the PI
facility in Hyannis; (3) discussions with insiders to the
transactions; (4) Canno; and (5) his investigation of the
reputation and background of PI and persons involved in the
transactions.
Becker possessed no education, special qualifications, or
professional skills in plastics engineering, plastics recycling,
- 41 -
or plastics materials. Despite his lack of knowledge regarding
the product, the target market, and the technical aspects at the
heart of the Plastics Recycling transactions, Becker did not hire
an expert in plastics materials or plastics recycling, or
recommend that his clients do so. He retained the law firm Rabin
& Silverman to assist him with the legal aspects of organizing
the SAB recycling partnerships. In addition, one of the
partners, DiGiovanna, advised Becker with respect to his
disclosure obligations under the applicable securities laws.
Becker testified that DiGiovanna told him that he had
fulfilled the fiduciary responsibilities associated with his
position and function as a general partner. A specialist in
securities and corporate law, DiGiovanna testified that "Becker
wanted to be covered from the securities law standpoint in terms
of full disclosure." Digiovanna explained that the extent of his
advice encompassed compliance with securities laws. At trial
DiGiovanna could not recall specific discussions he had with
Becker or whether Becker or anyone else at Becker Co. visited PI.
DiGiovanna was not responsible for, and did not get, independent
verification of any of the representations in the offering
materials. He never visited PI or saw a Sentinel EPE recycler.
- 42 -
DiGiovanna did not have any education or experience in
engineering, plastics materials, or plastics recycling.
The only independent person having any connection with the
plastics industry with whom Becker spoke was Canno. A client of
Becker Co., Canno was a part owner and the production manager of
Equitable Bag Co., a manufacturer of paper and plastic bags.
Becker spoke to Canno about the recyclers and PI, but did not
hire or pay him for any advice. Canno did not visit PI's plant
in Hyannis, see or test a Sentinel EPE recycler, or see or test
any of the output from a Sentinel EPE recycler or the recycled
resin pellets after they were further processed by PI. According
to Becker, Canno endorsed the Plastics Recycling transactions
after reviewing the offering materials. Asked at trial if Canno
had done any type of comparables analysis, Becker replied, "I
don't know what Mr. Canno did."
Becker visited the PI plant in Hyannis, toured the facility,
viewed a Sentinel EPE recycler in operation, and saw products
that were produced from recycled plastic. During his visit he
was told that the recycler was unique and that it was the only
machine of its type. In fact, the Sentinel EPE recycler was not
unique; instead, several machines capable of densifying low
density materials were already on the market. Other plastics
- 43 -
recycling machines available during 1981 ranged in price from
$20,000 to $200,000, including the Foremost Densilator,
Nelmor/Weiss Densification System (Regenolux), Buss-Condux
Plastcompactor, and Cumberland Granulator. See Provizer v.
Commissioner, T.C. Memo. 1992-177.
Becker was also told that PI had put an enormous amount of
research and development--10 to 12 years worth--into the creation
and production of the Sentinel EPE recycler. When he asked to
see the cost records for some kind of independent verification,
however, his request was denied. Becker was informed that such
information was proprietary and secret,20 and that he would just
have to take PI's representations as true. Becker decided to
accept PI's representations after speaking with Miller (the
corporate counsel to PI), Canno (who had never been to PI's plant
or seen a Sentinel EPE recycler), and a surrogate judge from
Rhode Island who did business in the Boston-Cape Cod area (and
who had no experience in engineering or plastics materials).
Becker testified that he was allowed to see PI's internal
20
Although PI claimed that all of its information was a trade
secret, and that it never obtained patents on any of its
machines, PI had in fact obtained numerous patents prior to the
recycling transactions and had also applied for a trademark for
the Sentinel recyclers.
- 44 -
accounting controls regarding the allocation of royalty payments
and PI's recordkeeping system in general. In Provizer v.
Commissioner, supra, this Court found that "PI had no cost
accounting system or records."
Becker confirmed at trial that he relied on the offering
materials and discussions with PI personnel to establish the
value and purported uniqueness of the recyclers. Becker
testified that he relied upon the reports of Ulanoff and Burstein
contained in the offering materials, despite the fact: (1)
Ulanoff's report did not contain any hard data to support his
opinion; (2) Ulanoff was not an economics or plastics expert; (3)
Becker did not know whether Burstein was an engineer; and (4)
Burstein was a client of Miller's and was not an independent
expert. In addition, as we found in the Provizer case, "Ulanoff
and Burstein each owned an interest in more than one partnership
which owned Sentinel Recyclers as part of the Plastics Recycling
Program."21 Provizer v. Commissioner, supra.
21
Spears stipulated that Ulanoff owned a 1.27-percent interest
in Plymouth Equipment Associates and a 4.37-percent interest in
Taylor Recycling Associates, both partnerships that leased
Sentinel Recyclers. Spears also stipulated that Burstein owns a
2.605-percent interest in Empire Associates and a 5.82-percent
interest in Jefferson Recycling Associates, also partnerships
that leased Sentinel Recyclers.
- 45 -
Becker explained at trial that when he evaluates prospective
investments for clients, he focuses on the economics of the
transaction and investigates whether there is a need or market
for the product or service. With respect to the Partnership
transactions, the records indicate that Becker overlooked several
red flags regarding the economic viability and market for the
Sentinel EPE recyclers. The offering memoranda for the
Partnership transactions warned that there was no established
market for the Sentinel EPE recyclers. Becker never saw any
marketing plans for selling the pellets or leasing the recyclers.
He accepted representations by PI personnel that they would be
marketing the recyclers to clients and that there was a
sufficient base of end-users for the machines, yet he never saw
PI's client list. At the time of the closing of the
Partnerships, Becker did not know who the end-users were or
whether there were any end-users actually committed to the
transaction.
Becker purportedly checked the price of the pellets by
reading trade journals of the plastics industry. However, he did
not use those same journals to investigate the recyclers'
purported value or to see whether there were any advertisements
for comparable machines. In concluding that the Partnerships
- 46 -
would be economically profitable, Becker made two assumptions
that he concedes were unsupported by any hard data: (1) That
there was a market for the pellets; and (2) that market demand
for them would increase.
d. Conclusion Concerning Petitioners' Alleged
Reliance on Becker
Petitioners in these cases are very well educated and highly
accomplished, sophisticated investors. Without question they
possessed the intellect, skills, experience, and resources to
have the viability of the Plastics Recycling transactions
thoroughly investigated.
Petitioners claim to have relied upon Becker for the bona
fides and viability of the Partnership transactions. Yet
Becker's expertise was in taxation, not plastics materials or
plastics recycling, and Spears and Farrell knew this. Moreover,
Becker indicated that he was careful not to mislead any of his
clients regarding the particulars of his limited investigation.
As he put it: "I don't recall saying to a client I did due
diligence * * * [Rather,] I told [my clients] precisely what I
had done to investigate or analyze the transaction. I didn't
just say I did due diligence, and leave it open for them to
define what I might or might not have done."
- 47 -
The purported value of the Sentinel EPE recycler generated
the deductions and credits in these cases, and that circumstance
was clearly reflected in the offering memoranda. Certainly
Becker recognized the nature of the tax benefits and, given their
education and investment experience, petitioners should have
recognized it as well. Yet neither petitioners nor Becker
verified the purported value of the Sentinel EPE recycler.
Becker confirmed at trial that he relied on PI for the value of
the Sentinel EPE recyclers. Investors as sophisticated as
petitioners either learned or should have learned the source and
shortcomings of Becker's valuation information when he reported
to them and "precisely" disclosed "what [he] had done to
investigate or analyze the transaction." Accordingly, we hold
that petitioners did not in good faith or reasonably rely on
Becker as an expert or a qualified professional working in the
area of his expertise to establish the fair market value of the
Sentinel EPE recycler and the viability or bona fides of the
Partnership transactions. Becker never assumed such
responsibility, and he fully described the particulars of his
investigation, taking care not to mischaracterize it as "due
diligence."
- 48 -
In the end, petitioners and Becker relied upon Miller and
other PI personnel for the value of the Sentinel EPE recycler and
the economic viability of the Partnership transactions. See
Vojticek v. Commissioner, T.C. Memo. 1995-444, to the effect that
advice from such persons "is better classified as sales
promotion." Becker did not possess any education, special
qualifications, or professional skills in plastics materials or
plastics recycling. A taxpayer may rely upon his adviser's
expertise (in these cases accounting and tax advice), but it is
not reasonable or prudent to rely upon a tax adviser regarding
matters outside his field of expertise or with respect to facts
that he does not verify. See Goldman v. Commissioner, 39 F.3d at
408; Skeen v. Commissioner, 864 F.2d 93 (9th Cir. 1989), affg.
sub nom. Patin v. Commissioner, 88 T.C. 1086 (1987); Lax v.
Commissioner, T.C. Memo. 1994-329; Rogers v. Commissioner, T.C.
Memo. 1990-619.
3. The Private Offering Memoranda
In addition to purportedly relying on Becker, petitioners
maintain that they reasonably relied upon the offering memoranda
and the tax opinion letter appended thereto. However,
petitioners' testimony and actions indicate that they did not
thoroughly review or study all of the information set out in the
- 49 -
offering memoranda and that they ultimately did not place a great
deal of reliance, if any, on the representations therein.
On their face, the Partnership transactions should have
raised serious questions in the minds of ordinarily prudent
investors. The offering memoranda included numerous caveats and
warnings with respect to the Partnerships, including: (1) The
substantial likelihood of audit by the IRS and a likely challenge
of the purported value of the recyclers; (2) the general
partner's lack of experience in marketing recycling or similar
equipment; (3) the lack of an established market for the
recyclers; and (4) uncertainties regarding the market prices for
virgin resin and the possibility that recycled pellets would not
be as marketable as virgin pellets. In addition, the offering
memoranda noted a number of conflicts of interest, including
Miller's interest in F & G and his legal representation of
Burstein, PI, and Raymond Grant, who was the sole shareholder of
ECI.
A careful consideration of the materials in the respective
offering memoranda, especially the discussions of high writeoffs
and risk of audit, should have alerted a prudent and reasonable
investor to the questionable nature of the promised deductions
and credits. See Collins v. Commissioner, 857 F.2d 1383, 1386
- 50 -
(9th Cir. 1988), affg. Dister v. Commissioner, T.C. Memo. 1987-
217. According to the offering memoranda, for each $50,000
investor, the projected first-year tax benefits were investment
tax credits in excess of $82,500 plus deductions in excess of
$40,000.22 For Farrell's $25,000 investment in SAB Reclamation
in 1982,23 he and his wife Clotilde claimed an operating loss in
the amount of $20,050 and investment tax and business energy
credits in the amount of $41,856. As a result of Spears' $25,000
investment in SAB Recycling, he and his wife Joan claimed an
operating loss in the amount of $19,870 and investment tax and
business energy credits totaling $41,320.
The direct reductions claimed on Spears' and Farrell's
Federal income tax returns, from the investment tax credits
alone, ranged from 165 to 167 percent of their cash investments,
respectively, without taking into consideration any rebated
commissions and advance royalty payments. Therefore, after
adjustments of withholding, estimated tax, or final payment, like
the taxpayers in Provizer v. Commissioner, T.C. Memo. 1992-177,
"except for a few weeks at the beginning, petitioners [Spears and
Farrell] never had any money in the * * * [Partnership
22
The projected tax benefits for the Partnerships in the first
year of the investment, for each $50,000 investor, were as
follows: Investment tax credits of $82,639 plus deductions of
$40,037 for SAB Recycling in 1982, and investment tax credits of
$83,712 and deductions of $40,234 for SAB Reclamation in 1982.
23
The amounts set forth above as invested by petitioners are
the gross amounts invested, unreduced by any rebated commissions
or advance royalty payments.
- 51 -
transactions]." In view of the disproportionately large tax
benefits claimed on petitioners' 1982 Federal income tax returns,
relative to the dollar amounts invested, further investigation of
the Partnership transactions clearly was required. A reasonably
prudent person would have asked a qualified independent tax
adviser if this windfall were not too good to be true. McCrary
v. Commissioner, 92 T.C. 827, 850 (1989). A reasonably prudent
person would not conclude without substantial investigation that
the Government was providing tax benefits so disproportionate to
the taxpayers' investment of their own capital.
Petitioners' arguments are not supported by the Court of
Appeals for the Ninth Circuit's partial reversal of our decision
in Osterhout v. Commissioner, T.C. Memo. 1993-251, affd. in part
and revd. in part without published opinion sub nom. Balboa
Energy Fund 1981 v. Commissioner, 85 F.3d 634 (9th Cir. 1996).
In Osterhout, on which petitioners rely, we found that certain
oil and gas partnerships were not engaged in a trade or business
and sustained respondent's imposition of the negligence additions
to tax with respect to one of the partners therein.24 The
taxpayer had relied in part upon a tax opinion contained in the
24
Osterhout v. Commissioner, T.C. Memo. 1993-251, affd. in
part and revd. in part without published opinion sub nom. Balboa
Energy Fund 1981 v. Commissioner, 85 F.3d 634 (9th Cir. 1996),
involved a group of consolidated cases. The parties therein
agreed to be bound by the Court's opinion regarding the
application of the additions to tax provided for under sec.
6653(a), inter alia. Accordingly, although the Court's analysis
focused on one taxpayer, the additions to tax were sustained with
respect to all of the parties.
- 52 -
offering materials. The Court of Appeals for the Ninth Circuit
reversed our imposition of the negligence additions to tax.
However, the prefaces to the offering memoranda for the
Partnerships herein warned prospective investors that the tax
opinion letter was not in final form, and was prepared for the
general partner, and that prospective investors should consult
their own professional advisers with respect to the tax benefits
and tax risks associated with the Partnership. The tax opinion
letter was addressed solely to the general partner and contained
the following opening disclaimer:
This opinion is provided to you for your individual
guidance. We expect that prospective investors will
rely upon their own professional advisors with respect
to all tax issues arising in connection with an
investment in the Partnership and the operations
thereof. We recognize that you intend to include this
letter with your offering materials and we have
consented to that with the understanding that the
purpose in distributing it is to assist your offerees'
and their tax advisors in making their own analysis and
not to permit any prospective investor to rely upon our
advice in this matter. [Emphasis added.]
Accordingly, both the offering memoranda and the tax opinion
letter expressly and unambiguously indicated that prospective
investors such as petitioners were not to rely upon the tax
opinion letter. See Collins v. Commissioner, supra. The
limited, technical opinion of tax counsel in these cases was not
designed as advice upon which taxpayers might rely and the
opinion of counsel itself so states.
- 53 -
Moreover, the records indicate that petitioners did not
thoroughly review the offering memoranda, which included the tax
opinion letter, or place much reliance on them. Spears testified
that he relied more on Becker than the offering materials.
Farrell described private placement memoranda as "the legal
documentation necessary to cover one in case things go bad" and
finds that they do not "lead * * * to an understanding of the
merits of [an] investment". He also testified that he does not
place undue influence on them and has never made a decision to
invest based upon one. Petitioners will not be relieved of the
negligence additions to tax based upon the Ninth Circuit Court of
Appeals' partial reversal in the Balboa Energy Fund 1981 case.
4. Miscellaneous
The parties in these consolidated cases stipulated that the
fair market value of a Sentinel EPE recycler in 1981 and 1982 was
not in excess of $50,000. Notwithstanding this concession,
petitioners contend that they were reasonable in claiming credits
on their Federal income tax returns based upon each recycler
having a value of $1,162,666. In support of this position,
Spears submitted into evidence preliminary reports prepared for
respondent by Ernest D. Carmagnola (Carmagnola), the president of
Professional Plastic Associates. Carmagnola had been retained by
the IRS in 1984 to evaluate the Sentinel EPE and EPS recyclers in
light of what he described as "the fantastic values placed on the
[recyclers] by the owners." Based on limited information
- 54 -
available to him at that time, Carmagnola preliminarily estimated
that the value of the Sentinel EPE recycler was $250,000.
However, after additional information became available to him,
Carmagnola concluded in a signed affidavit, dated March 16, 1993,
that the machines actually had a fair market value of not more
than $50,000 each in the fall of 1981 and 1982.
We accord no weight to the Carmagnola reports submitted by
Spears. The projected valuations therein were based on
inadequate information,25 research, and investigation, and were
subsequently rejected and discredited by their author.
Respondent likewise rejected the reports and considered them
unsatisfactory for any purpose; and there is no indication in the
records that respondent used them as a basis for any
determinations in the notices of deficiency. Even so, Spears'
counsel obtained copies of these reports and urges that they
support the reasonableness of the values reported on Spears' 1982
joint return. Not surprisingly, Spears' counsel did not call
Carmagnola to testify in these cases,26 but preferred instead to
25
In one preliminary report, Carmagnola states that he has "a
serious concern of actual profit" from a Sentinel EPE recycler
and that to determine whether the machines actually could be
profitable, he required additional information from PI.
(Emphasis in original.) Carmagnola also indicates that in
preparing the report, he did not have information available
concerning research and development costs of the machines and
that he estimated those costs in his valuations of the machines.
26
Carmagnola has not been called to testify in any of the
Plastics Recycling cases before us.
- 55 -
rely solely upon his preliminary, ill-founded valuation
estimates. The Carmagnola reports were a part of the record
considered by this Court and reviewed by the Sixth Circuit Court
of Appeals in the Provizer case, where we held the taxpayers
negligent. Consistent therewith, we find in these cases, as we
have found previously, that the reports prepared by Carmagnola
are unreliable and of no consequence. Spears will not be
relieved of the negligence additions to tax based on the
preliminary reports prepared by Carmagnola.
Spears also placed into the record of his case several
documents, ostensibly submitted as evidence that he monitored his
investments in the Plastics Recycling transactions. These
included unaudited, unreviewed financial statements of SAB
Leasing Associates for 1982, a 1982 update regarding placement of
the recyclers, financial statements of SAB Associates for 1979
and 1980, and introductory information regarding SAB Leasing
Associates. Spears did not testify or otherwise indicate that he
ever examined these documents. At trial, Spears could not recall
having received and read a confidential memorandum, addressed to
all limited partners, that discussed SAB Associates' change of
business from tax straddle investments to leasing plastics
recyclers. Spears could not recall the conversations he had with
Becker; he did not know how many SAB recycling partnerships
Becker was involved in; and he did not know whether there was an
established market for the Sentinel EPE recyclers. The offering
- 56 -
materials clearly stated that there was no established market for
the recyclers. We decline to infer from these documents or the
balance of the record that Spears actively monitored his
investments in the Plastics Recycling transactions.
Petitioners' reliance on Mollen v. United States, 72 AFTR 2d
93-6443, 93-2 USTC par. 50,585 (D. Ariz. 1993) is misplaced. The
taxpayer in Mollen was a medical doctor who specialized in
diabetes and who, on behalf of the Arizona Medical Association,
led a continuing medical education (CME) accreditation program
for local hospitals. The underlying tax matter involved the
taxpayer's investment in Diabetics CME Group, Ltd., a limited
partnership that invested in the production, marketing and
distribution of medical educational video tapes. District Court
found that the taxpayer's personal expertise and insight in the
underlying investment gave him reason to believe it would be
economically profitable. Although the taxpayer was not
experienced in business or tax matters, he did consult with an
accountant and a tax lawyer regarding those matters. Moreover,
the District Court noted that the propriety of the taxpayer's
disallowed deduction therein was "reasonably debatable." Id.;
see Zfass v. Commissioner, T.C. Memo. 1996-167.
The records in these cases show that neither petitioners nor
Becker had any formal education, expertise, or experience in
plastics materials or plastics recycling. None of them had any
personal insight or industry know-how in plastics recycling that
- 57 -
would reasonably lead them to believe that the Plastics Recycling
transactions would be economically profitable. Becker relied
heavily upon representations by insiders to the Plastics
Recycling transactions, and neither he nor petitioners hired any
independent experts in the field of plastic materials or plastics
recycling. Becker did discuss the transactions with Canno, who
apparently was familiar with the plastics industry, but Canno was
not hired by Becker to investigate PI and the Sentinel EPE
recycler, never saw a Sentinel EPE recycler, and never prepared
any kind of formal, written analysis of the venture. The facts
of these cases are distinctly different from those in the Mollen
case. Therefore, we consider petitioners' arguments with respect
to the Mollen case inapplicable under the circumstances of these
cases.
5. Conclusion As to Negligence
Under the circumstances of these cases, petitioners failed
to exercise due care in claiming large deductions and tax credits
with respect to the Partnerships on their respective Federal
income tax returns. Petitioners did not reasonably rely upon the
offering memoranda or the materials appended thereto. Becker did
not possess any education, special qualifications, or
professional skills in the plastics or recycling industries; he
did not employ any experts in those fields; and he disclosed to
petitioners the limits of his investigation. See Goldman v.
Commissioner, 39 F.3d at 408; Marine v. Commissioner, 92 T.C.
- 58 -
958, 992-993 (1989), affd. without published opinion 921 F.2d 280
(9th Cir. 1991); McCrary v. Commissioner, 92 T.C. 827 (1989);
Rybak v. Commissioner, 91 T.C. 524, 565 (1988). We conclude that
petitioners were negligent in claiming the deductions and credits
with respect to the Partnerships on their Federal income tax
returns for 1982. We hold, upon consideration of the entire
records, that petitioners are liable for the negligence additions
to tax under the provisions of section 6653(a)(1) and (2).
Respondent is sustained on this issue.
B. Section 6659 - Valuation Overstatement
In the notice of deficiency, respondent determined that
William and Joan Spears were liable for the section 6659 addition
to tax on the portion of their underpayment attributable to
valuation overstatement. Spears has the burden of proving that
respondent's determination is erroneous. Rule 142(a); Luman v.
Commissioner, 79 T.C. 846, 860-861 (1982).
In an amendment to answer, respondent asserted that Vincent
and Clotilde Farrell were liable for the section 6659 addition to
tax on the portion of their underpayment attributable to
valuation overstatement. Because this addition to tax was raised
for the first time in respondent's amendment to answer,
respondent bears the burden of proof on this issue. Rule 142(a);
Vecchio v. Commissioner, 103 T.C. 170, 196 (1994).
A graduated addition to tax is imposed when an individual
has an underpayment of tax that equals or exceeds $1,000 and "is
- 59 -
attributable to" a valuation overstatement. Sec. 6659(a), (d).
A valuation overstatement exists if the fair market value (or
adjusted basis) of property claimed on a return equals or exceeds
150 percent of the amount determined to be the correct amount.
Sec. 6659(c). If the claimed valuation exceeds 250 percent of
the correct value, the addition is equal to 30 percent of the
underpayment. Sec. 6659(b).
Petitioners claimed tax benefits, including an investment
tax credit and a business energy credit, based on purported
values of $1,162,666 for each Sentinel EPE recycler. Petitioners
each concede that the fair market value of a Sentinel EPE
recycler in 1981 and 1982 was not in excess of $50,000.
Therefore, if disallowance of petitioners' claimed tax benefits
is attributable to such valuation overstatements, petitioners are
liable for the section 6659 addition to tax at the rate of 30
percent of the underpayment of tax attributable to the tax
benefits claimed with respect to the Partnerships.
Both petitioners argue that respondent erroneously failed to
waive the section 6659 addition to tax. Farrell also expressly
contends that the section 6659 addition to tax is inapplicable
because: (1) Disallowance of the claimed tax benefits was
attributable to other than a valuation overstatement; and (2)
concession of the claimed tax benefits precludes imposition of
the section 6659 additions to tax.
- 60 -
1. The Grounds for Petitioners' Underpayments
Section 6659 does not apply to underpayments of tax that are
not "attributable to" valuation overstatements. See McCrary v.
Commissioner, supra; Todd v. Commissioner, 89 T.C. 912 (1987),
affd. 862 F.2d 540 (5th Cir. 1988). To the extent taxpayers
claim tax benefits that are disallowed on grounds separate and
independent from alleged valuation overstatements, the resulting
underpayments of tax are not regarded as attributable to
valuation overstatements. Krause v. Commissioner, 99 T.C. 132,
178 (1992) (citing Todd v. Commissioner, supra), affd. sub nom.
Hildebrand v. Commissioner, 28 F.3d 1024 (10th Cir. 1994).
However, when valuation is an integral factor in disallowing
deductions and credits, section 6659 is applicable. See Illes v.
Commissioner, 982 F.2d 163, 167 (6th Cir. 1992), affg. T.C. Memo.
1991-449; Gilman v. Commissioner, 933 F.2d 143, 151 (2d Cir.
1991) (section 6659 addition to tax applies if a finding of lack
of economic substance is "due in part" to a valuation
overstatement), affg. T.C. Memo. 1989-684; Masters v.
Commissioner, T.C. Memo. 1994-197, affd. without published
opinion 70 F.3d 1262 (4th Cir. 1995); Harness v. Commissioner,
T.C. Memo. 1991-321.
Farrell argues that the disallowance of the claimed tax
benefits was not "attributable to" a valuation overstatement.
According to Farrell, the tax benefits were disallowed because
- 61 -
the Partnership transactions lacked economic substance, not
because of any valuation overstatements. It follows, he reasons,
that because the "attributable to" language of section 6659
requires a direct causative relationship between a valuation
overstatement and an underpayment in tax, section 6659 cannot
apply to the deficiency. Farrell cites the following cases to
support this argument: Heasley v. Commissioner, 902 F.2d 380
(5th Cir. 1990), revg. T.C. Memo. 1988-408; Gainer v.
Commissioner, 893 F.2d 225 (9th Cir. 1990), affg. T.C. Memo.
1988-416; McCrary v. Commissioner, supra; Todd v. Commissioner,
supra.
This argument rests on the mistaken premise that our holding
that the Partnership transactions lacked economic substance was
separate and independent from the overvaluation of the Sentinel
EPE recyclers. To the contrary, in holding that the Partnership
transactions lacked economic substance, we relied heavily upon
the overvaluation of the recyclers. Overvaluation of the
recyclers was an integral factor in regard to: (1) The
disallowed tax credits and other benefits in these cases; (2) the
underpayments of tax; and (3) our finding that the Partnership
transactions lacked economic substance.
Moreover, a virtually identical argument was rejected in
Gilman v. Commissioner, supra, by the Second Circuit Court of
Appeals, the court to which appeal in these cases lies. See
- 62 -
Golsen v. Commissioner, 54 T.C. 742, 756-758 (1970) affd. 445
F.2d 985 (10th Cir. 1971). In the Gilman case, the taxpayers
engaged in a computer equipment sale and leaseback transaction
that this Court held was a sham transaction lacking economic
substance. The taxpayers therein, citing Heasley v.
Commissioner, supra, and Todd v. Commissioner, supra, argued that
their underpayment of taxes derived from nonrecognition of the
transaction for lack of economic substance, independent of any
overvaluation. The Second Circuit Court of Appeals sustained
imposition of the section 6659 addition to tax because
overvaluation of the computer equipment contributed directly to
this Court's earlier conclusion that the transaction lacked
economic substance and was a sham. Gilman v. Commissioner, supra
at 151. In addition, the Second Circuit Court of Appeals agreed
with this Court and the Eighth Circuit Court of Appeals that
"'when an underpayment stems from disallowed * * * investment
credits due to lack of economic substance, the deficiency is * *
* subject to the penalty under section 6659.'" Gilman v.
Commissioner, supra at 151 (quoting Massengill v. Commissioner,
876 F.2d 616, 619-620 (8th Cir. 1989), affg. T.C. Memo. 1988-
427); see also Rybak v. Commissioner, 91 T.C. 524, 566-567
(1988); Zirker v. Commissioner, 87 T.C. 970, 978-979 (1986);
Donahue v. Commissioner, T.C. Memo. 1991-181, affd. without
- 63 -
published opinion 959 F.2d 234 (6th Cir. 1992), affd. sub nom.
Pasternak v. Commissioner, 990 F.2d 893 (6th Cir. 1993)).
Farrell's reliance on Gainer v. Commissioner, supra, McCrary
v. Commissioner, 92 T.C. 827 (1989), and Todd v. Commissioner,
supra, is misplaced. In contrast to the consolidated cases
herein, it was found that a valuation overstatement did not
contribute to an underpayment of taxes in any of the cited cases.
In the Todd and Gainer cases, the underpayments were due
exclusively to the fact that the property in each case had not
been placed in service. In the McCrary case, the underpayments
were deemed to result from a concession that the agreement at
issue was a license and not a lease. Although property was
overvalued in each of those cases, the overvaluations were not
the ground on which the taxpayers' liability was sustained. In
contrast, "a different situation exists where a valuation
overstatement * * * is an integral part of or is inseparable from
the ground found for disallowance of an item." McCrary v.
Commissioner, supra at 859. Each of petitioners' cases present
just such a "different situation": overvaluation of the
recyclers was integral to and inseparable from the claimed tax
benefits and our finding that the Partnership transactions lacked
economic substance.27
27
To the extent that Heasley v. Commissioner, 902 F.2d 380
(5th Cir. 1990), revg. T.C. Memo. 1988-408, merely represents an
(continued...)
- 64 -
2. Concession of the Deficiency
Farrell argues that his concession of the deficiency
precludes imposition of the section 6659 addition to tax.
Farrell contends that his concession renders any inquiry into the
grounds for such deficiency moot. Absent such inquiry, Farrell
argues that it cannot be known if the underpayments were
attributable to a valuation overstatement or other discrepancy.
According to Farrell, "once the taxpayer concedes the underlying
adjustment, there is no basis upon which the necessary
correlation between understatement in tax and overvaluation can
be established." In support of this line of reasoning, Farrell
relies heavily upon Heasley v. Commissioner, supra, and McCrary
v. Commissioner, supra. Although Spears did not expressly make
this argument, we include the Spears case in our discussion
because he similarly conceded disallowance of the tax benefits
claimed by him and his wife.
27
(...continued)
application of Todd v. Commissioner, 89 T.C. 912 (1987), affd.
862 F.2d 540 (5th Cir. 1988), we consider it distinguishable. To
the extent that the reversal in the Heasley case is based on a
concept that where an underpayment derives from the disallowance
of a transaction for lack of economic substance, the underpayment
cannot be attributable to an overvaluation, this Court and the
Court of Appeals for the Second Circuit have disagreed. See
Gilman v. Commissioner, 933 F.2d 143, 151 (2d Cir. 1991), affg.
T.C. Memo. 1989-684: "The lack of economic substance was due in
part to the overvaluation, and thus the underpayment was
attributable to the valuation overstatement."
- 65 -
Petitioners' open-ended concessions do not obviate our
finding that the Partnership transactions lacked economic
substance due to overvaluation of the recyclers. This is not a
situation where we have "to decide difficult valuation questions
for no reason other than the application of penalties." See
McCrary v. Commissioner, supra at 854. The value of the Sentinel
EPE recycler was established in Provizer v. Commissioner, T.C.
Memo. 1992-177, and stipulated by the parties. As a consequence
of the inflated value assigned to the recyclers by the
Partnerships, petitioners claimed deductions and credits that
resulted in underpayments of tax, and we held that the
Partnership transactions lacked economic substance. Regardless
of petitioners' concessions, in these cases the underpayments of
tax were attributable to the valuation overstatements.
Moreover, concession of the investment tax credit in and of
itself does not relieve taxpayers of liability for the section
6659 addition to tax. See Dybsand v. Commissioner, T.C. Memo.
1994-56; Chiechi v. Commissioner, T.C. Memo. 1993-630. Instead,
the ground upon which the investment tax credit is disallowed or
conceded is significant. Id. Even in situations in which there
are arguably two grounds to support a deficiency and one supports
a section 6659 addition to tax and the other does not, the
taxpayer may still be liable for the addition to tax. Gainer v.
Commissioner, 893 F.2d at 228; Irom v. Commissioner, 866 F.2d
- 66 -
545, 547 (2d Cir. 1989), vacating in part T.C. Memo. 1988-211;
Harness v. Commissioner, supra.
In the present cases, no argument was made and no evidence
was presented to the Court to prove that disallowance and
concession of the investment tax credits related to anything
other than a valuation overstatement. To the contrary,
petitioners each stipulated substantially the same facts
concerning the Partnership transactions as we found in Provizer
v. Commissioner, supra. In the Provizer case, we held that the
taxpayers were liable for the section 6659 addition to tax
because the underpayment of taxes was directly related to the
overvaluation of the Sentinel EPE recyclers. The overvaluation
of the recyclers, exceeding 2325 percent, was an integral part of
our findings in Provizer that the transaction was a sham and
lacked economic substance. Similarly, the records in these cases
plainly show that the overvaluation of the recyclers was integral
to and was the core of our holding that the underlying
transactions here were shams and lacked economic substance.
Petitioners' reliance on McCrary v. Commissioner, supra, is
misplaced. In that case the taxpayers conceded disentitlement to
their claimed tax benefits and the section 6659 additions to tax
were held inapplicable. However, the concessions of the claimed
tax benefits, in and of themselves, did not preclude imposition
of the section 6659 additions to tax. In McCrary v.
- 67 -
Commissioner, supra, the section 6659 addition to tax was
disallowed because the agreement at issue was a license and not a
lease. In contrast, the records in petitioners' cases plainly
show that petitioners' underpayments were attributable to
overvaluation of the Sentinel EPE recyclers. We hold that
petitioners' reliance on McCrary v. Commissioner, supra, is
inappropriate.28
We held in Provizer v. Commissioner, supra, that each
Sentinel EPE recycler had a fair market value not in excess of
$50,000. Our holding in the Provizer case that the Sentinel EPE
recyclers had been overvalued was integral to and inseparable
from our holding of a lack of economic substance. Petitioners
stipulated that the Partnership transactions were similar to the
Clearwater transaction described in the Provizer case, and that
the fair market value of a Sentinel EPE recycler in 1981 and 1982
was not in excess of $50,000. Given those concessions, and the
fact that the records here plainly show that the overvaluation of
the recyclers was the underlying reason for disallowance of the
claimed tax benefits, we conclude that the deficiencies were
attributable to overvaluation of the Sentinel EPE recyclers.
28
Petitioners' reliance on Heasley v. Commissioner, supra, in
support of the concession argument is also inappropriate. That
case was not decided by the Court of Appeals for the Fifth
Circuit on the basis of a concession. Moreover, see supra note
27, to the effect that the Court of Appeals for the Second
Circuit and this Court have not followed the Heasley opinion with
respect to the application of sec. 6659.
- 68 -
3. Section 6659(e)
Both petitioners argue that respondent erroneously failed to
waive the section 6659 additions to tax. Section 6659(e)
authorizes respondent to waive all or part of the addition to tax
for valuation overstatement if taxpayers establish that there was
a reasonable basis for the adjusted bases or valuations claimed
on the returns and that such claims were made in good faith.
Respondent's refusal to waive a section 6659 addition to tax is
reviewable by this Court for abuse of discretion. Krause v.
Commissioner, 99 T.C. 132, 179 (1992).
Petitioners urge that they relied on Becker and the offering
memorandum in deciding on the valuation claimed on their tax
returns. Petitioners contend that such reliance was reasonable,
and, therefore, respondent should have waived the section 6659
additions to tax.29 However, as we explained above in finding
petitioners liable for the negligence additions to tax,
petitioners' purported reliance on Becker and the offering
materials was not reasonable.
Becker possessed no special qualifications or professional
skills in the recycling or plastics industries. He relied
exclusively on PI and its personnel and on the offering materials
29
In his posttrial brief, Farrell referenced the reports
prepared by Carmagnola in support of the reasonableness of the
claimed valuation. For reasons discussed supra, we consider the
reports prepared by Carmagnola to be unreliable and of no
consequence.
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as to the value and purported uniqueness of the machines. The
offering memoranda for the Partnerships warned that the value
placed on the recyclers would probably be challenged by the IRS
as being in excess of fair market value. Nonetheless, Becker
never hired or consulted any plastics engineering or technical
experts with respect to the Plastics Recycling transactions.
Becker did speak to his client Canno, who apparently had some
knowledge of the plastics industry, but the substance of Canno's
purported comments is doubtful and he had only minimal
information about the transaction. Petitioners' reliance on
Becker and the offering materials was not reasonable.
In support of their contention that they acted reasonably,
petitioners cite Mauerman v. Commissioner, 22 F.3d 1001 (10th
Cir. 1994), revg. T.C. Memo. 1993-23. However, the facts in the
Mauerman case are distinctly different from the facts of these
cases. In Mauerman, the Tenth Circuit Court of Appeals held that
the Commissioner had abused her discretion for not waiving a
section 6661 addition to tax. Like section 6659, a section 6661
addition to tax may be waived by the Commissioner if the taxpayer
demonstrates that there was reasonable cause for his underpayment
and that he acted in good faith. Sec. 6661(c). The taxpayer in
Mauerman relied upon independent attorneys and accountants for
advice as to whether payments were properly deductible or
capitalized. The advice relied upon by the taxpayer in Mauerman
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was within the scope of the advisers' expertise, the
interpretation of the tax laws as applied to undisputed facts.
In these cases, particularly with respect to valuation,
petitioners relied upon advice that was outside the scope of
expertise and experience of their advisers. Consequently, we
consider petitioners' reliance on the Mauerman case inapplicable.
We hold that petitioners did not have a reasonable basis for
the adjusted bases or valuations claimed on their tax returns
with respect to their investments in the Partnerships. In these
cases respondent properly could find that petitioners' reliance
on Becker and the offering materials was unreasonable. The
records in these cases do not establish an abuse of discretion on
the part of respondent but support respondent's position. We
hold that respondent's refusal to waive the section 6659 addition
to tax is not an abuse of discretion. Petitioners are liable for
the respective section 6659 additions to tax at the rate of 30
percent of the underpayments of tax attributable to the
disallowed tax benefits. Respondent is sustained on this issue.
Decisions will be entered
under Rule 155.